Report from the Commission to the budgetary authority on guarantees covered by the general budget - Situation at 30 June 2003 [SEC(2004) 33]
Date: 2004-01-15
Institutions: European Commission
Subjects: Community loan, general budget (EU), insured risk

COMMISSION OF THE EUROPEAN COMMUNITIES

Brussels, 15.1.2004
COM(2004) 12 final

REPORT FROM THE COMMISSION

to the budgetary authority on guarantees covered by the general budget
- situation at 30 June 2003

[SEC(2004) 33]

EN

  EN

TABLE OF CONTENTS

Part One: Events Since The Report At 31 December 2002, The Risk Situation And Activation
Of Budget Guarantees ................................................................................................................ 4

1.

1.1.

1.2.

2.

3.

3.1.

3.2.

Introduction: types of operation ................................................................................... 4

Operations with macroeconomic objectives ................................................................ 4

Operations with microeconomic objectives ................................................................. 4

Events since the report at 31 December 2002.............................................................. 4

Risk situation................................................................................................................ 5

Amount outstanding at 30 June 2003 (Table 1) ........................................................... 5

Maximum annual risk borne by the Community budget: operations disbursed at 30
June 2003 ..................................................................................................................... 6

3.3.

Maximum theoretical annual risk borne by the Community budget............................ 6

4.

4.1.

4.2.

5.

6.

7.

Activation of budget guarantees................................................................................... 7

Payments from cash resources ..................................................................................... 7

Activation of the Guarantee Fund ................................................................................ 7

Analysis of the Community's theoretical lending and guarantee capacity in respect of
non-member countries (Table 2).................................................................................. 7

Situation of the Guarantee Fund at 30 June 2003 ........................................................ 9

Relative solidity ........................................................................................................... 9

Part Two: Evaluation Of Potential Risks: Economic And Financial Situation Of The Non-
Member Countries Benefiting From The Most Important Loan Operations ........................... 10

1.

2.

2.1.

2.2.

2.3.

3.

3.1.

3.2.

3.3.

4.

Introduction ................................................................................................................ 10

Candidate countries.................................................................................................... 10

Bulgaria ...................................................................................................................... 10

Romania ..................................................................................................................... 11

Turkey ........................................................................................................................ 12

Western Balkans......................................................................................................... 12

Bosnia and Herzegovina (BiH) .................................................................................. 12

Former Yugoslav Republic of Macedonia (fYRoM) ................................................. 13

Serbia and Montenegro .............................................................................................. 14

Newly Independent States.......................................................................................... 15

4.1.

Armenia...................................................................................................................... 15

2

 
4.2.

4.3.

4.4.

4.5.

4.6.

5.

Belarus........................................................................................................................ 16

Georgia....................................................................................................................... 17

Moldova ..................................................................................................................... 17

Tajikistan.................................................................................................................... 18

Ukraine....................................................................................................................... 19

Other Non-member Countries.................................................................................... 19

5.1.

Algeria........................................................................................................................ 20

5.2

5.3

5.4

Argentina.................................................................................................................... 20

Brazil .......................................................................................................................... 21

Jordan ......................................................................................................................... 22

List of abbreviations................................................................................................................. 23

3

 
Part One:
Events since the Report at 31 December 2002, the risk situation
and activation of Budget Guarantees1

1. 

INTRODUCTION: TYPES OF OPERATION

The risks covered by the Community budget derive from a variety of lending and guarantee
operations  which  can  be  divided  into  two  categories:  loans  with  macroeconomic  objectives
and loans with microeconomic objectives.

1.1. 

Operations with macroeconomic objectives

The  first  of  these  are  the  balance-of-payments  loans  for  Member  States  or  non-member
countries, normally carrying strict economic policy conditions.

1.2. 

Operations with microeconomic objectives

These are loans  to finance  projects  which  are  usually  repaid  over  the  long  term  from  funds
which  these  projects  are  expected  to  generate;  as  a  rule,  they  are  granted  to  companies,
financial institutions or non-member countries and, in addition to the Community guarantee,
are covered by the usual guarantees demanded by banks.

This covers Euratom and NCI2 loans in Member States  and  Euratom  and EIB loans  outside
the Community (Mediterranean countries, Central and Eastern Europe, countries of Asia and
Latin America, Republic of South Africa).

2. 

EVENTS SINCE THE REPORT AT 31 DECEMBER 2002

Regarding  macro-financial  assistance  provided  to  third  countries,  no  new  Council  decision
was  adopted  during  the  period  whilst  loan  disbursements  were  carried  out  on  the  basis  of
existing decisions in favour of Serbia and Montenegro (EUR 10 Million) and FYROM (EUR
10 Million). Another loan in favour of Romania (EUR 50 million) will be disbursed in July
2003.

Regarding  Euratom  no  new  Council  decision  was  adopted  during  the  period  whilst  a
loantranche  disbursement  was  carried  out  on  the  basis  of  an  existing  decision  in  favour  of
Bulgaria (Kozloduy EUR 25 Million).

1

2

A reference to “Annex” in this report is refering to the Commission Staff Working Paper, containing an
annex with a set of detailed tables and explicatory notes to this report.
No disbursements since 1995

4

 
                                                
3. 

RISK SITUATION

There are two methods for evaluating the risks borne by the Community budget:

– 

– 

The method, often used by bankers, of the total amount of capital outstanding for the
operations concerned on a given date (situation described in Annex Table A1);

The  more  budgetary  approach  of  calculating  the  maximum  amount  which  the
Community could have to pay out in each  financial  year in case  of  a  default  of  all
debtors.

The second approach itself has been applied in two different ways:

– 

– 

By  reference  only  to  actual  disbursements  at  the  date  of  the  report,  assuming  that
there are no early repayments (see Annex Table A2 below showing the lower limit of
this maximum risk to the Community budget);

On a more forward-looking basis, by reference to  all the operations decided by the
Council  or  proposed  by  the  Commission  in  order  to  estimate  the  impact  on  future
budgets, assuming that the Commission's proposals are accepted assuming that there
are no early repayments (see Annex Table A3 below showing the upper limit of this
maximum risk borne by the Community budget).

The latter exercise gives some idea of the future level of risks connected with the proposals
made. However, a number of assumptions have to be made about dates of disbursement and
terms of repayment (details are given in the Annex) as well as interest3 and exchange rates4.

The  results  are  shown  in  Annex  Tables  A1  to  A3,  which  make  separate  assessments  of  the
risks relating to countries inside the Community and countries outside the Community.

The  overall  figures  quoted  cover  risks  of  different  types;  loans  to  a  country  in  the  case  of
macro-financial assistance and loans for projects guaranteed by the borrowers in the case of
NCI and EIB operations, for example.

The following analysis distinguishes between total risk, the risk in respect of Member States
and the risk in respect of non-member countries.

3.1. 

Amount outstanding at 30 June 2003

The  total  risk  at  30  June  2003  came  to  €  15.067  million,  as  against  €  15.216  million  at  31
December 2002. Details are shown in Annex Table A1.

The following table shows the operations which have had an effect on the amount outstanding
since the last report.

3

4

An interest rate of 5,49% p.a. has been applied for the new operations in Table A3.
The exchange rates used for loans in currencies other than the euro are those of 30 June 2003.

5

 
                                                
Table 1: Changes of capital outstanding during the last 6 month*

Amount outstanding at 31 December 2002

Loan repayments

Euratom
NIC
Financial assistance
EIB

Loans disbursed

Euratom
NIC
Financial assistance
EIB

Exchange rate differences between Euro and other currencies

Amount outstanding at 30 June 2003

*all guaranteed loans (Member States, non Member States) confounded

€ million

15.216

0
0
-8
-566

25
0
20
321

59

15.067

The capital outstanding in respect of operations in the Member States was € 32 million at 30
June 2003, compared with € 39 million at 31 December 2002.

The  capital  outstanding  from  non-member  countries  at  30  June  2003  was  €  15.035  million,
compared with € 15.177 million at 31 December 2002.

3.2.  Maximum  annual  risk  borne  by  the  Community  budget:  operations  disbursed

at 30 June 2003

For 2003 the total risk amounts to € 984 million.

The risk in respect of the Member States comes to € 8 million.

The risk in respect of non-member countries comes to € 976 million.

– 

– 

– 

Details of the maximum annual risk are set out in Annex Table A2.

3.3.  Maximum theoretical annual risk borne by the Community budget

For 2003 the maximum theoretical risk amounts to € 1.106 million. It will increase from 2004
onwards and reach €3.709 million in 2011.

– 

The trend in the maximum theoretical risk in respect of Member States is the same as
in Table A2.

6

 
– 

For the non-member countries it amounts to €1.092 million  for  2003. The  risk will
increase from 2004 onwards to reach € 3.709 million by 2011.

Details of the maximum theoretical annual risk is set out in Annex Table A3.

4. 

ACTIVATION OF BUDGET GUARANTEES

4.1. 

Payments from cash resources

The  Commission  draws  on  its  cash  resources,  under  Article  12  of  Council  Regulation
(EC, Euratom) No. 1150/2000 of 22 May 2000, implementing Decision 94/728/EC, Euratom,
on the system of the Communities' own resources, in order to avoid delays and resulting costs
in servicing its borrowing operations when a debtor is late in paying.

4.2. 

Activation of the Guarantee Fund

Council  Regulation  (EC,  Euratom)  No  2728/94  of  31  October  1994  (amended  by  Council
Regulation 1149/99 of May 25, 1999) established a Guarantee Fund for external action. In the
event of late payment by a recipient of a loan granted by the Community, the Guarantee Fund
is called on to cover the default within three months of the date on which payment is due. If a
borrower defaults on an EIB loan guaranteed by the Community budget, the Community will
act  within  three  months  of  receiving  a  letter  from  the  Bank  calling  for  the  guarantee  to  be
activated.  The  Commission will then authorise  the  Bank  to  take  the  corresponding  amounts
from the Guarantee Fund.

Default interest for the time between the date on which cash resources are made available and
the date of activation of the Fund is drawn from the Fund and repaid to the cash resources.

5. 

ANALYSIS  OF  THE  COMMUNITY'S  THEORETICAL  LENDING  AND  GUARANTEE
CAPACITY IN RESPECT OF NON-MEMBER COUNTRIES

In  practice,  the  Guarantee  Fund  mechanism  limits  the  Community's  lending  and  guarantee
capacity  to  non-member  countries,  since  the  appropriations  available  for  provisioning  the
Fund  are  limited  by  the  amount  entered  for  the  guarantee  reserve  in  the  Financial
Perspective5. At any given time, the lending capacity is related to the margin remaining in the
guarantee  reserve.  This  margin  is  equal  to  the  difference  between  the  reserve  and  the
estimated amount needed to provision the Guarantee Fund for operations which have already
been adopted and which are in preparation.

Annex Table A4 shows an estimate of the Community's lending capacity in respect of non-EU
countries over the period 2003-2006 in line with the Guarantee Fund mechanism. The method
of calculation and references to legal texts are set out in greater detail in the Annex.

On  the  basis  of  the  decisions  adopted  by  the  Council  or  the  Commission  and  decisions
proposed  and  in  preparation  (see  Annex  Table  A4),  €168,48  million  is  expected  to  be  used
from the guarantee reserve in 2003, leaving € 48,52 million available at the end of the year.

5

The annual figure entered in the 2000-2006 Financial Perspective is €200 million at 1999 prices.

7

 
                                                
If account is taken of the effect on the Guarantee reserve of the provisioning of the Fund in
respect of loans already decided and loans proposed and in preparation for 2003, the  annual
capacity available for loans is as follows:

– 

– 

€ 539,11 million for loans with a 100% guarantee under the Community budget, or

€  829,40  million  for  loans  with  a  65%  guarantee  (in  accordance  with  Council
Decision 2000/24/EC of 22 December 1999).

At  30  June  2003,  outstanding  lending  and  loan  guarantee  operations  for  non-member
countries totalled € 17.542 million.

Table 2: Outstanding lending and loan guarantee operations for non-member countries
as of 30 June 2003

1.  Capital  outstanding,  borrowing  and
lending,  Macro  financial  assistance  and
Euratom

2. Capital outstanding, EIB

3. Capital outstanding, payment defaults

4. Default interest

Unpaid interest due*

TOTAL

€ million

1.478

13.557

0

2.360

147

17.542

* unpaid interest due within the meaning of the Regulation establishing the Guarantee Fund

8

 
6. 

SITUATION OF THE GUARANTEE FUND AT 30 JUNE 2003

At 30 June 2003, the Guarantee Fund amounted to € 1.679,65 million.

The ratio between the Fund’s resources and outstanding capital liabilities, within the meaning
of the Regulation establishing the Fund, was 11,1 %, which is higher than the target figure of
9% set in Regulation No 1149/1999 amending Regulation No 2728/94 establishing the Fund.
The rules state that at the end of a year the surplus shall be paid back to a special heading in
the statement of revenue in the general budget of the European Communities.

The following movements were recorded in the first half of 2003:

– 

– 

– 

– 

on  February  22,  2003  the  fund  was  called  as  a  result  of  a  default  on  a  loan  to  the
Republic  of  Argentina  for  an  amount  of  USD  2.528.800,19  (€  equivalent
2.359.615,74);

the  Commission  was  informed  from  the  EIB  about  arrears  on  another  loan  to  the
Republic  of  Argentina  for  an  amount  of  USD  2.529.527,79,  which  could  lead  to  a
call on the fund in the second half of 2003;

net revenue of € 32,7 million on investments from the Fund’s assets.

The first payment for 2003 from the reserve  (EUR  145,67  Mio)  and  the  surplus  of
the fund as of 31 December 2002 (EUR 263,33 Mio) will be executed in the second
half  of  2003.  The  remaining  cash  balance  of  EUR  117,66  Mio  will  be  reimbursed
from the fund to the budget of the Commission.

7. 

RELATIVE SOLIDITY

The  ratio  between  the  amount  in  the  Fund  at  30  June  2003  (€ 1.679,65  million)  and  the
maximum annual risk for loans to non-member countries (defined as the total amount falling
due) shown for 2003 in Annex Table A3 (€ 1.106 million) is 152%, i.e. the fund could under
the assumption of a worst case scenario cover all obligations for more than a year.

9

 
Part Two:
Evaluation of potential risks: Economic and financial situation of
the non-member countries benefiting from the most important
loan operations

1.

INTRODUCTION

The figures in Part One provide information on quantitative aspects of the risk borne by the
general budget. However, these data should be accompanied by an assessment of the quality
of the risk, which depends on the type of operation and the standing of the borrower. Recent
events, which may influence the portfolio country risk, are analysed below.

As in the previous reports, the country risk evaluation presented in Part Two comprises a table
of risk indicators  (see Annexes) for  each  non-member country that has  received  EC  macro-
financial  assistance  and  still  has  outstanding  debts  to  the  EC  and  EURATOM.  Moreover,
other third countries each representing more than 2% of the total outstanding debt to the EC
(notably  through  guarantees  of  EIB  project  related  lending)  and  either  categorised  as
“severely  indebted”  according  to  criteria  set  by  the  World  Bank  or  facing  notorious
imbalances in their external or debt situation are also included in the risk evaluation.

To complement this, textual analysis is provided for all the countries studied in order to take
into account new information influencing the risk evaluation.

Altogether, the country analysis is covering 48,6% of the total outstanding debt owned by the
EC or guaranteed through its budget, thus providing a meaningful assessment of the risk

2.

CANDIDATE COUNTRIES

Robust  growth  rates  and  decrease  in  inflation  improve  the  perspectives  of  economic
stabilisation for all candidate countries.

2.1.

Bulgaria

In  spite  of  the  difficult  global  economic  situation,  Bulgaria  continued  to  benefit  from  high
growth and stability. Real GDP growth was 4,8% in 2002 and 4,1% in the first half of 2003.
Growth  is  sustained  by  strong  domestic  demand  arising  from  private  consumption  and
investment  as  a  consequence  of  increases  in  employment,  net  incomes  and  bank  credits.
Inflation is on a downward path due to low food prices and low import prices following the
depreciation of the US dollar.  Unemployment  has  decreased  rapidly  to  13,2%  of  the  labour
force  until  July  2003,  and  was  more  than  4  percentage  point  lower  compared  to  one  year
earlier due  to  jobs  created  in  both  the  private  sector  and  government  employment  schemes.
The  privatisation  programme  is  advancing  slower  than  expected,  with  major  difficulties  for
the sales of the telecom and tobacco monopolies.

The currency board arrangement (EUR 1 = BGN 1,95583) is being maintained and continues
to  be  supported  by  high  foreign  reserves.  It  has  not  led  to  a  remarkable  deterioration  of
external competitiveness given that real exchange rate appreciation was broadly matched by
higher productivity growth.

10

 
The current account deficit was lower than in previous years, also because of higher revenues
from tourism, lower interest payments and higher current transfers, but has been higher again
in the first half of 2003 as a consequence of higher deficits in the trade and income balances.
Net inflows of foreign direct investment did not fully cover the current account deficit in 2002
when they were about the same size as in the first half of 2003 alone. The foreign reserves of
the central bank continue to increase and amount to almost 6 months of imports of goods and
non-factor services.

Fiscal  discipline  has  been  maintained  and  contributes  to  internal  and  external  stabilisation.
Similar to previous years, the general government sector had a (cash) deficit of 0,7% of GDP
in  2002.  In  the  first  half  of  2003,  a  budget  (cash)  surplus  of  about  1,8%  of  GDP  was
accumulated. Public debt is falling rapidly, from well above 100% of GDP in 1997 to 56% of
GDP at the end of 2002. Total external debt has decreased to well below 70% of GDP. The
government is conducting an active debt management with the objective of reducing risks by
gradually shifting from a denomination in US dollar towards a denomination in €, from short-
term  to  long-term  maturity,  from  floating  into  fixed  interest  rate  bonds  and  from  foreign  to
domestic financing. This is reflected in slightly improved credit ratings for the country.

2.2

Romania

During  the  first  half  of  2003,  macroeconomic  trends  remained  positive  with  robust  growth
and  declining  inflation.  However,  macroeconomic  risks  increased  as  the  external  account
began to widen again on the back of sharp rises in real wages and booming credit.

Despite a less favourable international environment, economic growth remained robust. After
growing by 4,9% in 2002, GDP rose by 4,3% year-on-year during the first semester of 2003.
However,  contrary  to  2002  when  net  exports  had  positively  contributed  to  the  economic
expansion,  the  recovery  became  increasingly  unbalanced  in  2003.  Sharply  rising  net  wages
and  booming  consumer  credit  boosted  household  consumption  growth  which  accelerated  to
7,4%  year-on-year  in  the  second  quarter.  With  investment  spending  also  continuing  to
increase apace, at 7,9%, import growth remained sustained at 12,1%. At 5,4% year-on-year in
the second quarter, export growth decelerated sharply causing the contribution of net exports
to growth to turn negative again.

As  a  result,  while  in  2002  economic  growth  was  accompanied  by  greater  domestic  and
external stabilisation, in 2003 inflation continued to decline (reaching 14,2% year-on-year in
August) but the current account deficit began widening after falling sharply to 3,4% of GDP
in  2002.  Starting  from  the  second  quarter  of  2003,  in  fact,  rising  outlays  for  the  import  of
goods  and  the  payment  abroad  of  non-labour  income  pushed  the  current  account  deficit
accumulated over the last twelve months to an estimated 4,1% of GDP.

Romania,  however,  continued  to  successfully  tap  the  international  financial  markets  as  its
sovereign paper was repeatedly upgraded. After rising to EUR 14,9 billion (or 34,4% of GDP)
at end-2002, foreign debt declined to EUR 14,4 billion over the first five months of 2003 but
this was only due to the appreciation of the Euro. Also, in July 2003, the debt stock increased
as  a  result  of  a  new  7-year  EUR  700  million  bond  issue.  Largely  thanks  to  the  latter,  after
weakening  somewhat  during  the  first  half  of  2003,  international  reserves  increased  to  EUR
6,6 billion by August 2003, providing coverage for more than four months of imports.

In an attempt to address the weakening of the external accounts, in late August, the authorities
agreed to tighten the policy stance by raising interest rates and increasing energy prices in the
context of the last review of the IMF SBA.

11

 
While it is too early to assess the impact of these measures, prudent fiscal and wage policies
coupled with a continued reduction in the quasi-fiscal deficit will  be  needed  to preserve the
momentum towards greater macroeconomic stability.

2.3

Turkey

During the second quarter of 2003, real GDP growth slowed down to 3,9%, after 8,1% in the
first quarter. On average, real output nevertheless expanded by 5,8%, compared to the same
period  a  year  ago.  However,  economic  growth  still  is  mainly  driven  by  exports  and
restocking,  while  the  contribution  of  private  consumption  remains  limited.  As  a  result  of
import-intensive  restocking,  import  growth  is  rather  strong,  leading  to  a  rapidly  increasing
external  imbalance.  So  far,  the  economic  impact  of  the  crisis  in  neighbouring  Iraq  has
remained very limited. In particular with respect to financial markets, this can be seen as an
indication of strengthened market confidence and a improved shock resilience of the Turkish
economy.  The  strength  of  the  Turkish  lira  contributes  to  the  current  account  deficit,  by
lowering  the  costs  of  imported  commodities  while  impeding  competitiveness  of  Turkish
exports. So far, Turkish exporters managed to maintain market shares and profit margins, by
increasing productivity and containing wage growth.

Inflationary  pressures  have  continued  to  decline  with  reaching  a  12-month  consumer  price
inflation of  25% in August.  In view  of  the  development  during the  recent  months,  reaching
the  end-year  CPI  target  of  20%  appears  to  be  possible.  However,  the  impressive  decline  in
inflationary pressures is supported by weak domestic demand, impeding the pass-through of
price  increases  of  primary  commodities  to  consumers,  and  the  strength  of  the  Turkish
currency, lowering the price of imports, such as oil products.

Public  finances  are  largely  on  track  with  IMF  targets,  envisaging  a  primary  surplus  of  the
general government of 6,5% of GDP in the period 2003-2004. After some fiscal slippage and
higher  costs  of  the  social  security  system  in  the  first  half  of  the  year,  the  government
announced  in  July  additional  measures  (amounting  to  about  0,75%  of  GDP)  in  order  to
safeguard  the  achievement  of  the  primary  surplus  target.  Based  on  substantial  primary
surpluses,  strong  growth  and  the  expectation  of  declining  interest  rates,  the  debt  ratio  is
expected to fall markedly in the near future. In April 2003, the Turkish authorities notified a
2002 general government deficit of 10% of GDP and a debt ratio of 95% of GDP. In 2003, the
Turkish authorities expect a deficit of 7,2% of GDP and a debt ratio of 86,3% of GDP.

3.

WESTERN BALKANS

Public and external debts remain at high level in all countries except FYROM where, in the
medium term, the major risk remains the persistent ethnic divisions.

3.1

Bosnia and Herzegovina (BiH)

Under  the  current  IMF  programme  (fully  on-track),  BiH  maintained  macro-economic
stability, low inflation, and continued efforts with fiscal consolidation. However, the growth
prospects for 2003  have  been  revised  downwards,  at 3,3%  of  real  GDP  growth,  down  from
nearly 4% in 2002, as they are negatively affected by the external environment. In the light of
declining  official  aid,  BiH  still  faces  the  challenge  of  a  sustained  domestically  generated
economic  growth.  Strict  adherence  to  the  currency  board  has  kept  inflation  under  control,
which in the first three months of 2003 was 0,5% on average.

12

 
Moreover,  the  BiH  authorities  have  nominated  in  May  the  members  of  the  new  Governing
Board of the Central Bank, in advance of the new mandate starting in August, hence ensuring
continuity of this successful institution.

Although  the  size  of  public  expenditure  remains  high,  it  is  estimated  to  decline  at  53%  of
GDP  in  2003,  against  56%  in  2002.  After  the  improved  revenue  performance  recorded  in
2002,  with  an  estimated  consolidated  budget  deficit  revised  downwards  at  9,6%  of  GDP
(4,3% after grants), for 2003 the authorities target a level of 6,4% of GDP (2,2% after grants).
By adding external and internal debt (frozen foreign currency deposits and domestic arrears)
total public debt reaches 80% of GDP, and war damage liabilities may add a potential risk.

Contrary  to  previous  estimates,  data  revisions  showed  in  2002  a  sharp  deterioration  in  the
current account deficit (at 20% of GDP excluding official transfers), mostly explained by the
effect on imports of a credit boom and improved border controls. On a positive note, a larger
part of the capital account was financed by FDI, which nearly doubled. In the first quarter of
2003, some improvement is visible, with a current account deficit reduction of 5,5% relative
to  the  first  quarter  of  2002.  The  deteriorated  current  account  deficit  has  started  showing  its
effects  on  gross  official  reserves,  which  in  the  first  quarter  of  2003  have  declined  to  3,5
months of imports cover (against 4,7 months at end-2002).

External debt reached 47% of GDP at the end of 2002 (revised downwards from the projected
52%) and is expected to decline slightly over the medium-term. The ratio of debt service to
exports, which started to pick up in 2002 (8,5%), will continue to increase in 2003 (9,3%) –
mostly due to repayments to the IMF and the World Bank - before going down in the coming
years. BiH is not rated by the credit rating agencies. EBRD transition indicators, which reflect
progress  in  reforms  in  Central  and  Eastern  European  countries,  place  BiH  towards  the  low
end of the scale, even though some progress has been recorded.

Overall, over the first semester of 2003, although BiH remained current on its external debt
service  obligations,  the  balance  of  payments  and  external  debtor  situation  continued  to  be
vulnerable  due  to  large  external  deficits,  declining  foreign  assistance,  and  high  internal  and
external public sector indebtedness.

3.2

Former Yugoslav Republic of Macedonia (FYRoM)

Economic  data  for  the  first  months  of  2003  show  some  positive  signs  after  a  modest  0,7%
annual growth in 2002. According to preliminary unofficial estimates, GDP  growth reached
2,2% in the first quarter of 2003. Both real GDP growth and average inflation are expected to
reach  about  3%  by  year-end.  In  April  2003,  the  IMF  Executive  Board  approved  a  new  14-
month  Stand-By  Arrangement  of  SDR  20  million  (around  €  25  million),  in  favour  of  the
fYRoM. The 2003 budget agreed with the IMF foresees the general government deficit at 2%
of  GDP,  which  represents  a  significant  fiscal  adjustment  of  more  than  3%  with  respect  to
2002. Central government budget execution was satisfactory in the first five months of 2003,
recording a surplus of 0,1% of GDP against a projected deficit of 1,2%.

Foreign trade increased by 27% in the first five months of 2003 compared to the same period
of the previous year. The rise in imports was well above the projections, contributing to the
worsening  of  the  trade  deficit  which  amounted  to  almost  USD  400  million  in  the  first  five
months  of  2003.  The  2003  current  account  deficit  is  forecasted  at  around  7%  of  GDP.
Significant foreign financial assistance, amounting to more than USD 130 million is expected
to finance the balance of payments needs.

13

 
In  the  first  half  of  the  year,  foreign  exchange  reserves  had  been  maintained  to  a  level
equivalent  to  four  months  of  imports,  which  is  the  target  set  by  the  IMF  programme.  The
external  debt  reached  almost  40%  of  GDP  at  the  end  of  2002,  a  rather  moderate  level
compared  to  other  countries  in  the  region,  and  is  expected  to  decline  by  around  three
percentage points in the course of 2003.

In the short-term, there seem to be no major risks, apart from an expected increase in public
expenditure in the second half of the  year, which could increase cash flows in  the economy
and put some pressure on the fixed exchange rate, in case these flows were directed towards
foreign  goods.  In  the  medium-term,  the  main  risks  remain  associated  with  the  persistent
ethnic tensions within the country.

Overall, over the first semester of 2003, the risk profile of the country improved thanks to the
signature of the new IMF agreement, which provided a sound medium-term macroeconomic
framework for the country and allowed the release of frozen foreign assistance. This shows in
the ratings given by the main credit agencies.

3.3

Serbia and Montenegro

In the first half of 2003, macro-economic policies in Serbia and Montenegro continued to be
geared towards sustaining macro-economic stability in line with the current IMF programme,
a  three-year  Extended  Arrangement  approved  in  May  2002.  Structural  reforms  continued,
although at a somewhat slower pace compared to the previous year, in particular with respect
to the restructuring of large enterprises. A 4% real GDP growth is projected for 2003.

Actual  external  developments  so  far  in  2003  present  a  mixed  picture.  The  current  account
seemed to have improved somewhat owing mainly to a lower import demand, but the capital
account came under pressure during the first quarter, as a result of a number of factors, such
as the re-purchase of Serbian Telecom shares from Telecom Italia, some delays in obtaining
external assistance, and a general temporary decline in confidence following the assassination
of  the  Serbian  Prime  Minister  in  March.  This  led  to  a  temporary  loss  in  official  foreign
exchange reserves, which was overcompensated during the second quarter. For the first half
of 2003 as a whole, official reserves increased by some USD 250 million. The exchange rate
of the Dinar depreciated by some 5-6% vis-à-vis the euro and remained broadly unchanged in
real  effective  terms,  in  line  with  the  authorities’  objective  to  use  exchange  rate  policies  to
anchor inflation expectation while taking into account export competitiveness.

Overall,  following  the  assassination  of  Prime  Minister  Djinjic  in  March  2003,  the  external
outlook  of  the  country,  and  in  particular  the  prospects  for  private  capital  inflows,  including
FDI,  appear  to  be  less  certain.  Against  this  background,  the  IMF  has  revised  its  balance  of
payments projections for the current year in the context of the second programme review that
was successfully concluded by the Board in end-July 2003. The revised projections point to
additional  balance  of  payments  needs,  also  as  a  result  of  lower  than  earlier  projected  net
inflows of FDI (USD 623 million instead of USD 731 million).

Following  a  debt  restructuring  agreement  with  the  Paris  Club  reached  in  November  2001,
substantial  debt  relief  is  being  provided  by  official  creditors  while  negotiations  with  the
London  Club  of  private  creditors  have  not  yet  been  concluded.  The  external  debt  stood  at
USD 11,8 billion or 76% of GDP (end-2002) and the country remains one of the most highly
indebted countries in the region, particularly in comparison to its level of exports.

14

 
Debt service obligations are projected to rise considerably from around USD 183 million in
2002 (5,7% of exports of goods and services) to USD 466 million (10,7%) in 2003 and USD
761 million (14,8%) in 2004.

This ratio will deteriorate further over the rest of the decade, as a result of the expiration of
grace periods of restructured debt or of the greater reliance of shorter-term debt.

4.

NEWLY INDEPENDENT STATES

Save  for  the  Ukraine,  debt  sustainability  remains  a  major  issue  in  the  region  and  calls  for
further progress in structural reform.

4.1

Armenia

The Armenian economy continued to experience strong growth also in the first half of 2003
with real GDP growing at 14,8% year-on-year. In 2002 real GDP growth had reached 12,9%.
Economic growth is driven by the diamond polishing, construction, mining and metal sectors.
The present construction boom is financed to a large extent by private transfers from abroad
while  the  mining  and  metals  sectors  have  benefited  from  foreign  direct  investment.  The
Central Bank’s target is to keep inflation below 3%. In mid-2003 the consumer price inflation
picked up  to  4%  year-on-year  due  to  temporary  shortages  in  food  supplies  and  increases  in
utility prices.

The  government  managed  to  narrow  the  fiscal  deficit  significantly  in  2002.  The  central
government deficit for 2002 was lower than expected at 0,6% of GDP (down from a deficit of
3,8% in 2001, on commitments  basis). Expenditures were lower than budgeted  and revenue
collection targets were met comfortably. Reflecting both strong  growth  in  domestic  demand
and  better  tax  administration,  VAT  was  the  main  factor  contributing  to  the  improved  tax
revenue to GDP ratio (up from 14,4% in 2001 to 14,6% in 2002). According to preliminary
information, tax revenues continued to grow in the first half of 2003 at about 12% in nominal
terms.

The current account deficit was narrowed further during 2002 to about 6,5% of GDP (9,5% in
2001).  In  the  first  half  of  2003,  growth  in  import  spending  has  outpaced  that  of  export
revenues  but  owing  to  projected  official  and  private  transfers,  it  is  expected  that  the  deficit
will  deteriorate  only  moderately  from  last  year.  Armenia  formally  joined  the  WTO  in
February 2003.

Armenia’s external public and publicly guaranteed debt stock was USD 1,03 billion at the end
of March 2003 i.e. remains unchanged in nominal terms from the level at the end 2002 when
the  external  debt  amounted  to  43,3%  of  GDP.  Nearly  80%  of  the  debt  is  contracted  on
concessional terms. The NPV of the external debt stock is estimated to have decreased from
129%  of  exports  in  2001  to  about  120%  in  2002.  Debt  service  amounted  to  about  10%  of
exports of goods and services. It is projected that as a result of the agreed debt-to-equity swap
with Russia, the NPV of the external debt will be reduced to 91% of 2003 exports when the
swap takes place. The Central Bank’s gross international reserves increased in 2002 and they
are at a comfortable level equivalent to about 4,5 months of imports.

15

 
4.2

Belarus

The  marked  slowdown  in  economic  growth  recorded  in  recent  years  (from  over  10%  y-o-y
five  years  ago  to  about  3,5%  in  the  year  to  2003)  underlines  the  limits  inherent  in  the
Belarusian economic model. Indeed, whereas Belarus produced the highest growth rates in the
Commonwealth of Independent States during the late 1990s, since 2001 it has lagged behind
several countries that shared similar economic circumstances during the Soviet era.

Belarus's ability  to  sustain  even  weak  economic  growth  depends  on  its  continuing  ties  with
Russia, as the latter absorbs a substantial portion of Belarus's manufactured exports. However,
excessive  reliance  on  the  Russian  market  has  created  a  volatile  environment  for  Belarusian
manufacturers, as seen after the collapse of the Russian rouble in August 1998, when a drop
in  Russian  demand  for  Belarusian  manufactured  goods  sparked  a  sharp  dip  in  Belarusian
growth.

The  Belarusian  state-centred  economic  model  is  designed  to  perpetuate  the  administration's
tight control over the country's political and economic space, and to prevent social unrest. The
government  ensures  high  employment  levels,  widespread  subsidies  and  rising  real  wages.
However, economic collapse has been prevented only through a ready supply of cheap credit
to agriculture, construction and selected manufacturing industries. This has been achieved by
infringing on the independence  of the  National Bank of Belarus and by forcing commercial
banks  to  provide  soft  loans  at  the  cost  of  spiralling  inflation,  widespread  shortages  and  the
collapse  of  the  national  currency.  The  high  inflation  is  a  direct  consequence  of  the
expansionary monetary policies needed to keep outmoded and inefficient economic structures
in  place.  Although  administration  officials  are  aware  of  the  dangers  of  inflation  and  the
consequences of insufficient foreign-currency inflows, they have been  unwilling to abandon
the  economic  model  that  underpins  their  political  control  and  continued  legitimacy.  This
stance has consistently blocked the resumption of any financing by the IMF.

Nevertheless,  since  the  start  of  2000  the  government  has  grudgingly  accepted  the  need  to
unify  the  currency's  various  exchange  rates,  has  replaced  all  quasi-fiscal  operations  by  the
central bank with subsidies through the government budget and has promised to curb pressure
on  the  commercial  banks  to  issue  credit  to  key  sectors.  The  government's  exchange-rate
liberalisation  and  the  proposed  currency  union  with  Russia  could  be  a  major  improvement,
when underpinned by comprehensive structural reforms. The Belarusian authorities, unable to
meet  this  demand  and  in  desperate  need  of  foreign  currency  to  reduce  inflation,  have
increasingly  turned  to  Russia.  The  latter  has  provided  loans  to  help  stabilise  the  Belarusian
rubel, and is likely to continue to do so in advance of the planned currency union between the
two countries. Since late 2001 the government has been negotiating the sales of petrochemical
enterprises to Russian companies - in the hope that this might provide the additional financing
needed  to  preserve  economic  growth  and  low  unemployment  without  needing  to  change
current  policies.  The  country's  fiscal  situation  is  a  bright  spot  against  the  background  of  an
otherwise  dismal  economic  performance,  thus  explaining  some  improvement  in  the  credit
rating of the country.

16

 
4.3

Georgia

Preliminary data for the first half of 2003 give a higher than expected real GDP growth rate of
8,6% year-on-year (real GDP growth reached 5,4% in 2002 as a whole).

The construction of a new oil pipeline from Azerbaijan to Turkey through Georgia is having a
strong effect on the Georgian economy in 2003 and 2004. There are spill over effects to other
sectors of the  economy, notably  transportation  and  other  services.  Industrial  production  and
agriculture  have  also  registered  fairly  strong  growth  recently.  Interruptions  in  the  energy
supply continue to plague production, however. Owing to a good harvest and relatively tight
monetary policy, consumer price inflation has slowed down somewhat during the first half of
2003 compared to 2002 when the average inflation rate was 5,6%.

Some  measures  were  taken  in  2002  to  improve  tax  revenue  collection  but  the  overall
implementation record still remained weak in the first half of 2003.

The  government’s  proposal  for  a  more  comprehensive  reform  of  the  tax  code  has  been
blocked by the parliament. Due to over optimistic expectations concerning non-tax revenues,
notably privatisation proceeds and grants, the government is under strong pressure to restrain
expenditures  in  2003.  In  order  to  resume  financing  from  the  IMF,  the  government  was
requested  in  March  2003  to  implement  fiscal  adjustment  measures  which  would  have
corresponded  to  about  1,5%  of  GDP.  Since  these  measures  were  not  approved  by  the
parliament, Georgia’s PRGF arrangement with the IMF is effectively off-track.

Georgia’s current account deficit for 2002 is estimated at about 7% of GDP. Owing to a rapid
increase  in  imports  during  the  construction  of  the  Baku-Tbilisi-Ceyhan  oil  pipeline  and  a
parallel gas pipeline, the current account deficit is projected to deteriorate to between 12-17%
of GDP in 2003-2004. Foreign direct investment will cover these increases in the deficit. The
National Bank’s gross international reserves increased  during 2002,  but they  still amount to
no more than the equivalent of 1,7 months of imports.

Georgia’s  public  and  publicly  guaranteed  external  debt  stock  was  USD  1,75  billion  (about
52% of GDP) at the end of 2002, and its net present value amounts to over 300% of central
government  revenues.  Because  of  the  projected  increase  in  the  external  debt  service  from
2003 onwards, Georgia is expected to seek an additional rescheduling of its bilateral debts. In
the absence of a working arrangement with the IMF, Georgia will not be able to approach the
Paris Club  to  request an  extension  of  the  consolidation  period  to  take  into  account  the  year
2003  maturity  as  originally  provided  for  in  the  agreement  with  the  Paris  Club  creditors  in
March  2001.  Therefore,  debt  sustainability  still  remains  a  serious  concern  in  the  short  and
medium term.

4.4

Moldova

A generally sound policy mix is expected to ensure moderately strong growth at around 4-5%,
and  to  contain  significant  price  and  currency  instability.  However,  reforms  continue  to
proceed slowly, and the economy remains narrowly based. This brings significant risk, which
is  exacerbated  by  Moldova's  structurally  high  current-account  deficit.  Even  with  oil  prices
easing  relatively  quickly  by  2004,  and  a  4%  cumulative  rise  in  food  and  beverage  export
prices in 2003-04, Moldova is expected to record annual trade deficits equivalent to roughly
25% of GDP, and annual current-account deficits ranging between 7% and 8% of GDP in the
coming years.

17

 
The  risks  created  by  Moldova's  narrow  export  base  are  mitigated  to  some  extent  by  the
likelihood that transfers (primarily technical aid and humanitarian assistance) will continue to
record  a  large  surplus,  and  that  inflows  of  remittances  from  abroad  (which  are  recorded  as
income  rather  than  transfers)  will  remain  large.  These  remain  of  crucial  importance  for
Moldova, which will continue to struggle to  access  external financing or attract investment.
Inflows of foreign direct investment (FDI) will remain low and the Eurobond market out of
reach.

The government is unlikely to reverse the fiscal improvements achieved since 1999, but has
little room for manoeuvre, given the limited financing options. It has failed to secure IMF and
World  Bank  financing  in  2003,  except  small  sums  for  targeted  projects,  and  its  Lei  685
million  (USD  48  million)  privatisation  target  remains  unrealistic.  Faced  with  a  financing
shortfall and sizeable debt-repayment obligations, the government has therefore had to revise
its 2003 budget in order to target a surplus. A new boost in government domestic borrowing is
likely, since the Parliament has already authorised the government to borrow almost Lei 600
million from the National Bank of Moldova.

In  2004  problems  with  budget  planning  and  implementation  are  unlikely  to  diminish,  as  a
result  of  poor  administrative  capacity,  of  the  continued  risk  that  parliament  might  force
through  populist  measures,  as  well  as  of  additional  delays  to  multilateral  and  bilateral
financing  inflows.  In  particular  in  the  first  quarter  of  2004,  debt  servicing  needs  are  huge,
which could become highly problematic.

4.5

Tajikistan

Tajikistan  experienced  high  economic  growth  also  in  the  first  half  of  2003  when  real  GDP
growth reached about 8,5% year-on-year according to preliminary data. For the year 2002 as a
whole the growth rate was 9,1%. The aluminium sector still dominates industrial production
with about 60% of total industrial output but in the first half of 2003 there have been positive
signs of recovery in the light industry as well. Relatively strong growth is also continuing in
the agricultural sector driven by the cotton production. Consumer price inflation is persistent
at an annual average of about 15% owing partly to exogenous factors (severe winter, energy
prices) but also because of occasional lapses in the monetary policy.

The  overall  fiscal  balance  for  the  year  2002  came  out  better  than  expected  since  the
authorities directed higher than expected revenues to debt reduction rather than to increases in
expenditures.  Therefore,  general  government  finances  were  close  to  balance  with  a  small
deficit of 0,1% (excluding  public investment  projects of  about 2,5  % of GDP).  Due to high
economic growth and better tax collection, the tax to GDP ratio increased from 14,1% in 2001
to 14,7% in 2002. In 2003 fiscal revenues have so far exceeded targets, and the government
continues to exercise prudent fiscal policy with a view to creating room for increases in much
needed  social  and  health  expenditures  in  line  with  the  Poverty  Reduction  Strategy  Paper
which was adopted last year.

The current account position improved in 2002 when the deficit was reduced to about 2,8% of
GDP  (7,2%  in  2001).  Excluding  transfers,  the  current  account  deficit  is  estimated  at  about
18% of GDP. In 2003 the deficit will likely widen again partly due to an expected decline in
humanitarian  assistance  and  other  transfers.  A  recovery  in  export  prices  of  cotton  and
aluminium combined with an increase in export volumes mitigates the deterioration, however.

18

 
The  bilateral  debt  rescheduling  agreements  with  Russia  and  Uzbekistan  contributed  to  a
reduction in Tajikistan’s external debt from USD 1.017 million (98% of GDP) at the end of
2001  to  USD  976  million  (82%  of  GDP)  at  the  end  of  last  year.  Debt  service  was  a  high
burden  on  the  country  corresponding  to  over  40%  of  fiscal  revenues  and  about  23%  of
exports. Reaching USD 96 million at the end of 2002, the National Bank’s gross international
reserves  did  not  increase  in  pace  with  the  increase  in  imports.  Therefore,  international
reserves corresponded to only 1,8 months of imports in early 2003.

4.6

Ukraine

Ukraine’s GDP growth accelerated from 4,1% in 2002 to 7,5% in the first half of 2003 (year-
on-year),  amply  exceeding  expectations.  GDP  is  projected  to  expand  at  rates  in  the  5-6  %
range  throughout  the  forecasting  period.  This  high  rate  of  economic  expansion,  combined
with the effect of the poor harvest on food prices, has rekindled inflationary pressures (after
last  year’s  unprecedented  deflation)  but  inflation  is  expected  to  remain  in  single  digits  in
2003. Reflecting the faster than expected economic growth, fiscal performance in the first half
of  the  year  was  much  stronger  than  budgeted  (the  consolidated  government  posted  a  cash
surplus equivalent to 1% of annual GDP). The government has to clear however an important
stock of arrears on VAT refunds, estimated at about USD 2,5 billion at end-June 2003.

For  2004,  the  authorities  have  informally  agreed  with  the  IMF  on  a  consolidated  budget
deficit target of 1,4% of GDP.

The  balance  of  payments  remains  in  a  relatively  comfortable  position.  The  current  account
continues to show a large surplus. The surplus is projected to reach about 8 % of GDP in 2003
but to shrink during 2004-06 as domestic demand gradually replaces net exports as the main
source  of  growth.  The  Hryvnya  has  been  remarkably  stable  in  nominal  terms  and  the  real
exchange  rate  remains  at  a  competitive  level.  Official  foreign  exchange  reserves  have
continued to increase and stood in August 2003 at a level equivalent of 3¼ months of imports.
In  December  2002,  Ukraine  regained  access  to  the  international  capital  markets  with  the
issuance  of  a  USD  350  million  eurobond,  which  was  followed  in  early  June  2003  by  the
successful  placement  of  a  10-year,  USD  800  million  eurobond.  Secondary  market  yield
spreads  on  Ukraine  eurobonds  have  narrowed  very  substantially  since  mid-2001  and
Ukraine’s international ratings are being upgraded.

Progress  with  structural  reforms,  which  slowed  down  significantly  in  2001-02,  remains  the
country’s  key  economic  challenge.  Since  the  beginning  of  the  2003,  encouraging  measures
have  been  taken,  including  tax  reform  and  the  adoption  of  new  pension  legislation,  but
progress in other areas, notably the energy sector, remains very disappointing.

Ukraine  is  currently  negotiating  a  pre-cautionary  stand-by  arrangement  with  the  IMF  and
intends  to  repay  ahead  of  schedule  all  its  debts  to  the  IMF.  It  is  also  discussing  with  the
European Commission the possible policy conditions to be attached to the disbursement of a
new  macro-financial  assistance  of  up  to  EUR  110  million  approved  by  the  Council  in  July
2002.

5.

OTHER NON-MEMBER COUNTRIES

Vulnerability to external shocks remains high in these economies despite some improvement
in their fundamentals.

19

 
5.1

Algeria

Overall,  the  May  21  earthquake  is  not  expected  to  have  had  a  major  immediate  impact  on
growth  and  the  fiscal  and  external  position  in  2003.  Supported  by  continued  expansionary
fiscal policies  and  relatively high oil  prices  growth is expected to  increase  to around 6% of
GDP. The Algerian parliament has approved a supplementary budget allowing for a spending
increase  of  3,5%  of  GDP  to  provide  for  the  construction  of  housing  and  assistance  for  the
affected population.

The fiscal stimulus stemming from the supplementary budgetary law is expected to result in a
pick-up in non-hydrocarbon and non-agricultural production, largely surpassing the negative
growth  consequences  of  the  destruction  in  capital  stock  linked  to  the  earthquake.  As  a
consequence of the additional public spending, the fiscal accounts are expected to turn from a
near-balanced  position  in  2002  to  a  0,4%  deficit  of  GDP  in  2003  (1,2%  deficit  of  GDP  in
2004).

Algeria continued to considerably strengthen its external position in 2003. High hydrocarbon
prices coupled with the maintenance of relatively prudent macroeconomic policies have lifted
gross  official  reserves  to  USD  27  billion  in  June  2003.  Moreover,  Algeria  is  expected  to
achieve  another  substantial  current  account  surplus  in  2003  (8,1%  of  GDP)  reducing  its
foreign debt level to around USD 21,4 billion (around 35% of GDP) at the end of this  year,
while the debt-servicing ratio is heading below the 20% level.

However, the IMF points to Algeria's persisting economic and financial vulnerability vis-à-vis
a  lasting  decline  in  oil  prices,  which  has  increased  due  to  the  financing  needs  of  post-
earthquake  reconstruction.  Oil  revenues  currently  account  for  95%  of  export  revenues  and
60% of budgetary revenues.

Should  oil  prices  drop  to  USD  15  per  barrel  from  2004  on,  the  stock  of  external  reserves
would be reduced to less than 4 months of imports by end-2008. Altogether, the credit ratings
of the country are however improving.

5.2

Argentina

Argentina  continues  to  recover  from  its  worst  economic  and  financial  crisis  ever.  The
authorities and  the  IMF  have  recently  raised their GDP  growth projections  for 2003  to  6 %
and 4,75 %, respectively, which compares with a GDP drop of nearly 11 % last year. At about
18 %, the unemployment rate remains high, however. Inflation has decelerated further, with
the CPI increasing by only 2,5 % in the first seven months of 2003.

Fiscal  performance  in  the  first  half  of  2003  was  better  than  expected,  reflecting  buoyant
collections  from  the  income  tax,  the  VAT  and  trade  taxes  and  continued  tight  control  over
spending.  This  allowed  Argentina  to  outperform  the  IMF  fiscal  targets  both  at  federal  and
provincial  levels.  These  trends  are  consistent  with  the  programme  target  of  a  consolidated
primary surplus above 2,5 % of GDP for 2003 as a whole.

Despite  the  announcement  of  the  lifting  of  the  corralón  (remaining  restrictions  on  deposits
withdrawals)  in  April  2003,  private  bank  deposits  have  continued  to  show  a  slight  upward
trend, while the exchange rate has been moving, most of the time, within a relatively narrow
range  after  recovering  strongly  between  June  2002  and  June  2003.  The  current  account
remains in comfortable surplus but the surplus  is  shrinking  due  to the  recovery  of  domestic

20

 
demand. The IMF is now projecting a current account surplus of 6,3 % of GDP for 2003 as a
whole, down from last year’s 9,5 % of GDP.

Progress with structural reforms since the IMF approved a transitional stand-by  arrangement
(SBA) last January has been disappointing, partly reflecting the interim nature of the previous
government.  While  there  has  been  some  progress  with  the  redemption  of  provincial  and
federal  quasi-moneys  and  the  reform  of  the  tax  administration,  progress  in  other  areas,  in
particular the banking system, the adjustment of utility tariffs and the discussions with private
bondholders  on  the  restructuring  of  the  debt,  has  been  limited.  Moreover,  in  July,  the
government took a structural step backward by introducing certain capital controls.

In September 2003, the IMF Board is to approve a new 3-year SBA for Argentina that would
effectively refinance its repurchases to the  IMF during that period. The approval of the new
arrangement  should  come  after  more  than  a  month  of  difficult  negotiations,  at  one  stage  of
which Argentina failed to make a USD 2,9 billion repurchase to the IMF. Given Argentina’s
still  very  difficult  debt  service  profile  and  the  uncertainties  over  the  amount  of  fiscal
consolidation  Argentina  will  undertake  in  the  coming  years,  Argentina’s  risk  of  default
remains high and is reflected in deteriorated credit ratings.

5.3

Brazil

The improvement of Brazil’s financial indicators that began to be observed at the end of last
year, following the turmoil associated with the October presidential election, continued during
the  first  half  of  2003.  The  orthodox  and  responsible  policies  adopted  by  the  new
administration have undoubtedly contributed to this improvement.

The  exchange  rate  stands  now  at  a  considerably  stronger  level,  yield  spreads  on  Brazil’s
eurobonds  have  narrowed  significantly,  and  the  country’s  access  to  the  international  capital
has improved, with the government having been able to place a number of bond issues and to
successfully conclude a Brady Bond exchange.

Inflation is on a downward trend and is now projected to fall below 10 % by end-2003. This
has  allowed  the  central  bank  to  cut  interest  rates  rather  aggressively  in  recent  months.  The
fiscal targets agreed under the  IMF programme were outperformed in the first half  of 2003,
leaving  within reach the primary  surplus target of 4,25 % of GDP defined for  the  year as a
whole.

The  still  competitive  level  of  the  exchange  rate  continues  to  support  export  growth.  But
despite  strong  export  performance,  GDP  growth  remains  sluggish  due  to  the  persistent
weakness  of  domestic  demand.  GDP  growth  is  now  projected  to  reach  1,5  %  this  year  (the
same rate as last year). The current account has continued to improve, posting a small surplus
in  the  first  half  of  the  year.  This  compares  with  a  deficit  of  4,5  %  of  GDP  in  2001.  At  the
same  time,  however,  FDI  inflows  have  dropped  dramatically,  reflecting  adverse  external
conditions and the virtual completion of Brazil’s privatisation programme.

Despite  this  strengthening  of  Brazil’s  financial  situation,  the  country  remains  vulnerable  to
financial  turmoil.  A  burdensome  debt  service  profile,  weak  economic  growth,  lingering
market doubts about  the  government’s  political  ability  to  push  forward  its  structural  reform
agenda (notably in areas such as pension and tax reform), and the contagion risks stemming
from  a  still  convalescent  Argentinean  economy,  tend  to  keep  Brazil’s  credit  risk  relatively
high.

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5.4

Jordan

Growth performance was strong up to 2003, reaching 5% in 2002. However the impact of the
war in Iraq adversely affected performance in the first quarter of 2003 but growth is likely to
reach 3% for the  year as a whole. Inflation remained subdued in the first half of 2003,  with
the  end  of  period  CPI  likely  to  be  around  2%.  Strong  export  growth  continued  into  2003
despite the conflict in Iraq (a major trade partner) and tourism has appeared to recover fairly
quickly  after  the  conflict.  The  current  account  will  remain  in  surplus,  particularly  due  to
additional donor assistance, which has resulted in reserves building to over USD 4,5 billion
by the end of July 2003 or over 10 months of imports.

Jordan's  external  vulnerability  has  been  lowered  in  recent  years  due  to  improved  policy
performance  and  structural  reforms  including  privatisation.  This  is  reflected  in  stronger
economic  indicators  and  a  higher  level  of  reserves,  which  increases  Jordan’s  resilience  to
external  shocks.  Although  its  debt  level  can  be  still  regarded  as  high,  expected  continued
sound policy performance and reforms will lead to further improvements in external accounts
and the debt situation in 2003 and beyond. Government external debt has been reduced from
95% of GDP in 1998 to around 80% in 2003 and the authorities are aiming to reduce the debt
stock to less than 60% of GDP by 2007 using privatisation proceeds and by increasing fiscal
revenues to reduce deficits. Importantly, the debt service ratio has also decreased substantially
from around 34% ten years ago to 21% in 2003, reducing the risk of external default.

Nevertheless,  Jordan’s  external  debt  level  remains  very  high  with  virtually  all  external
liabilities  denominated  in  foreign  currency,  reflecting  external  creditors  unwillingness  to
expose themselves to the risk of a devaluation. These factors, as well as the difficult regional
environment, constrain Jordan’s credit rating to speculative grade.

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List of abbreviations

CPI

EC

EIB

EU

€

FDI

Consumer Price Index

European Community

European Investment Bank

European Union

Euro

Foreign Direct Investment

PRGF

Poverty Reduction and Growth Facility

GDP

IMF

SBA

USD

Gross Domestic Product

International Monetary Fund

Stand-By Arrangement

Dollar of the United States of America

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