Proposal for a Council Decision on macro-financial assistance to Serbia and Montenegro and amending Decision 2002/882/EC providing further macro-financial assistance to the Federal Republic of Yugoslavia
Date: 2004-09-21
Institutions: European Commission
Subjects: Community loan, EU aid, Serbia and Montenegro, aid policy, economic stabilisation, financial aid

COMMISSION OF THE EUROPEAN COMMUNITIES 

Brussels, 21.09.2004 
COM(2004)605 final 

2004/0204(CNS) 

Proposal for a 

COUNCIL DECISION 

on macro-financial assistance to Serbia and Montenegro 

and amending Decision 2002/882/EC providing further macro-financial assistance to the 
Federal Republic of Yugoslavia 

(presented by the Commission) 

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EXPLANATORY MEMORANDUM 

1. 

BACKGROUND 

Following  the  political  changes  in  Serbia  and  Montenegro  (SCG,  the  former  “Federal 
Republic  of  Yugoslavia”)  in  late  2000,  the  authorities  of  the  country  achieved  remarkable 
results in economic reform and stabilisation. Macro-economic stability has been achieved and 
preserved, and important structural reforms have begun. The privatisation of socially-owned 
enterprises through auctions and tenders has progressed, and the restructuring of the industrial 
and financial sector has been initiated. The agenda of economic reforms has been supported 
through  the  provision  of  subsequent  EC  macro-financial  assistance  packages,  which  have 
been  implemented  subject  to  the  prior  fulfilment  of  agreed  economic  and  structural  policy 
conditions.  

A  first  package  of  EUR  345  million  was  decided  in  July  and  December  2001  and 
implemented  in  2001/2002.  In  November  2002,  the  Council  decided  to  provide  SCG  with 
further  Community  macro-financial  assistance  of  up  to  EUR  130  million  to  underpin 
economic  policies  in  the  context  of  the  three-year  IMF  Extended  Arrangement  (2002-2005) 
approved  in  May  2002  and  to  support  the  balance  of  payments.  A  Memorandum  of 
Understanding (MoU) signed in December 2002 specifies the economic policy conditions and 
structural measures for the release of the second and the third tranches of this assistance.  

So far, the first and the second tranches of the original package of EUR 130 million, totalling 
EUR  105  million,  have  been  released  successfully.  However,  the  implementation  of  the 
remaining  third  tranche  (EUR  25  million)  has  been  substantially  delayed,  also  reflecting  a 
general  slowdown  of  economic  and  structural  reforms  in  the  country  in  the  course  of  2003. 
The latter was also a result of a difficult political situation in Serbia which led to early general 
elections  towards  the  end  of  the  year  and  a  difficult  formation  of  a  new  (minority) 
government in early 2004.  

In November 2003, the Council decided to increase the current EC macro-financial assistance 
to up to EUR 200 million to help addressing additional financing needs identified by the IMF. 
The  modalities  of  this  additional  assistance  of  up  to  EUR  70  million,  including  the  precise 
tranching and attached conditionality, still remain to be negotiated with the authorities, once 
progress has been made with third tranche conditionality.  

2. 

RECENT DEVELOPMENTS AND OUTLOOK 

In  2003,  real  GDP  growth  in  Serbia  reached  2-3%,  somewhat  lower  than  initially  foreseen 
under the current IMF Extended Arrangement, mostly due to weaker industrial output and a 
drought,  which  led  to  a  decline  in  agricultural  production.  For  2004,  the  authorities  project 
GDP to grow by 4 - 6%, reflecting a recovery in industrial output and an expected rebound in 
agricultural  production.  For  the  year  as  a  whole,  the  Serbian  authorities  expect  an  inflation 
rate  of  8.5%.  Montenegro  recorded  a  rather  modest  real  growth  during  the  first  quarter  of 
2004 (0.6%), but the authorities expect an acceleration of growth in the remainder of the year. 
Prices grew by 1.6% in the year to May, and end of period inflation for the year as a whole is 
expected to reach 4.5%. 

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In 2003, the consolidated general government deficit of Serbia and Montenegro reached 4.2% 
of  GDP  (3.8%  in  Serbia  and  0.4%  in  Montenegro,  the  latter  representing  5.2%  of 
Montenegrin GDP). For 2004, the consolidated budget deficit is sought to be reduced by 0.8% 
to  3.4%  of  GDP.  In  Serbia  the  financing  of  the  2004  fiscal  deficit  remains  a  concern,  in 
particular as revenues from privatisation and foreign financing has so far been lacking. 

Despite  continued  considerable  trade  deficits,  the  external  situation  in  2003  was  more 
favourable than initially expected owing to an exceptionally large net inflow of FDI of USD 
1.4  billion  (7%  of  GDP,  twice  the  amount  projected),  mainly  due  to  privatisation  proceeds 
and greenfield investments, and buoyant private remittances (11.2% of GDP). In early 2004, 
international reserves which had increased up to USD 3.6 billion at the end of 2003 began to 
decline  moderately,  also  due  to  seasonal  factors  and  foreign  debt  servicing.  They  reached 
USD 3.3 billion  in  April,  equivalent  to  4  months  of  projected  2004  imports.  The  external 
outlook  may  improve  as  a  result  of  an  agreement  with  London  Club  creditors  on  a  61% 
reduction  of  outstanding  debt  that  was  reached  in  early  July  and  the  granting,  for  the  first 
time,  of  a  credit  rating  by  Standard  and  Poor’s.  However,  gross  financing  requirements 
remain high, and the country requires continued external official financing in the context of 
the current IMF programme. 

Some new momentum on structural reforms has been gained following the creation of a new 
government in Serbia in March 2004. In particular, a substantial legislative agenda has been 
submitted  to  the  Serbian  Parliament  and  the  process  of  privatisation  seemed  to  regain 
momentum. The restructuring of large Socially Owned Enterprises and public utilities, which 
has not yet really started, still represents a major challenge for economic policies in the future.  

For  2004,  the  IMF’s  latest  programme  review  projected  a  remaining  balance-of-payments 
gap,  expected  to  be  covered  by  bilateral  macroeconomic  support,  including  funds  released 
under  the  current  EC  macro-financial  assistance  operation.  On  the  basis  of  preliminary 
indications from creditors, at least half of this amount is projected to be provided in the form 
of bilateral debt relief in the form of a capitalisation of moratorium interest. 

With  regard  to  the  implementation  of  EC  macro-financial  assistance,  in  June/July  2004, 
Commission  services  carried  out  a  mission  to  Serbia  and  Montenegro  to  assess  recent 
economic  developments  and  in  particular  to  review  progress  made  with  respect  to  the 
conditionality  for  the  release  of  the  third  tranche.  Generally,  there  were  some  encouraging 
developments since the establishment of a new government. Legislative work resumed. The 
successful  third  review  under  the  current  IMF  programme  and  the  agreement  on  economic 
policies  with  the  IMF,  reached  in  June  and  to  be  implemented  in  2004,  also  provides  an 
important reform stimulus. As regards third tranche conditionality, further progress was made 
on a number of conditions already fully or broadly met. A number of conditions however still 
required substantial additional efforts in order to be met. It should be noted that the terms and 
conditions  for  the  EUR  70  million  topping  up  amount  have  not  yet  been  agreed  with  the 
authorities.  Negotiations  on  these  will  obviously  only  start  once  third  tranche  conditionality 
has been met to a satisfactory extent.  

3. 

OTHER CONSIDERATIONS LINKED TO PROVIDING MACRO-FINANCIAL ASSISTANCE 

With regard to the recommendations made in the Discharge on the budget execution for 2001 
and  also  in  the  Court  of  Auditors'  Special  report  n°  1/2002  concerning  macro-financial 
assistance to third countries, the Commission services are giving due consideration to the five 

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Genval 
conditionality and financial discipline). 

(exceptional 

criteria 

character,  political  pre-conditions, 

complementarity, 

On other budgetary and financial management conditions, the Commission services are taking 
action  in  order  to  fulfil  requirements  implied  by  the  new  Financial  Regulation.  This  is 
reflected  by  having  made  an  ex-ante  evaluation  (attached)  of  this  proposed  assistance.  In 
particular,  before  proceeding  with  the  actual  implementation  of  the  remainder  of  this 
assistance, the Commission services plan to check (with the help of external consultants) the 
reliability  of  Serbia  and  Montenegro’s  financial  circuits,  administrative  procedures,  internal 
and  external  control  mechanisms  that  are  relevant  to  this  type  of  assistance.  To  this  end  an 
Operational Assessment of the reliability of financial circuits and administrative controls has 
been  commissioned  to  external  consultants  and  its  findings  were  expected  by  August  2004. 
Subject to these findings, prior actions could be required before the release of the outstanding 
funds.  

4. 

PROPOSED  DECISION  MODIFYING  THE  LEGAL  BASE  BY  POSTPONING  THE  EXPIRY 
DATE  

Serbia  and  Montenegro  requires  continued  external  financial  support  from  the  Community 
and other donors in support of its economic stabilisation and reform programme agreed with 
the IMF. Subject to further progress in meeting conditionality, the remaining third tranche of 
EC  macro-financial  assistance  under  Decision  2002/882/EC  could  help  addressing  the 
financing needs in 2004. However, the current legal base for this assistance provides for an 
expiry  date  of  9 November  2004.  This  was  motivated  by  the  expectation  that  the  assistance 
and  the  required  conditions  for  its  release  could  be  implemented  in  a  two-year  period.  As 
mentioned  above,  the  general  slowdown  in  economic  reforms  during  2003  and  the  difficult 
political  situation  in  Serbia  have  contributed  to  delays  in  the  implementation  of  this 
assistance. 

It appears that the new government in Serbia, which took office in March 2003, is committed 
to  accelerate  economic  reform  and  could  accomplish  further  action  to  meet  third  tranche 
conditionality  to  a  satisfactory  extent.  However,  even  if  this  can  be  achieved  by  end-
September  2004  (which  appears  to  be  the  earliest  possible  date),  it  is  very  unlikely  that  the 
actual disbursement of the third tranche could take place before the expiry date. It should be 
noted that the Operational Assessment of the reliability of financial circuits and administrative 
procedures  could  have  a  bearing  on  the  implementation  of  the  third  tranche  of  EC  macro-
financial assistance and call for specific prior measures to be taken before proceeding with the 
release of outstanding amounts.  

Moreover, the topping up of up to EUR 70 million was decided by an amendment of Council 
Decision 2002/882/EC. It will hence not be possible to implement this additional assistance 
after the expiry of the current legal base. In conclusion, the current legal base does no longer 
provide for a full implementation of EC macro-financial assistance. 

Against this background, it appears appropriate for the Community to modify the expiry date 
by amending Council Decision 2002/882/EC. It is suggested to change the expiry date to 30 
June  2006.  This  would  allow  for  a  smooth  and  full  implementation  of  this  assistance, 
including of the topping up of up to EUR 70 million, based on appropriate conditionality to be 
fulfilled  by  the  authorities  of  Serbia  and  Montenegro  before  the  subsequent  release  of 
tranches. 

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2004/0204(CNS) 

Proposal for a 

COUNCIL DECISION 

on macro-financial assistance to Serbia and Montenegro 

and amending Decision 2002/882/EC providing further macro-financial assistance to the 
Federal Republic of Yugoslavia 

THE COUNCIL OF THE EUROPEAN UNION, 

Having regard to the Treaty establishing the European Community, and in particular Article 
308 thereof, 

Having regard to the proposal of the Commission1, 

Having regard to the opinion of the European Parliament2, 

Whereas: 

(1) 

(2) 

(3) 

(4) 

(5) 

(6) 

1 
2 
3 

Council Decision 2002/882/EC of 5 November 2002 providing further macro-financial 
assistance  to  the  Federal  Republic  of  Yugoslavia3  aims  at  ensuring  a  sustainable 
balance of payments situation and strengthening the country’s reserve position. 

Two tranches under this assistance totalling EUR 105 million have been disbursed in 
2002 and 2003. Due to the delays in the implementation of agreed structural measures, 
the  implementation  of  the  third  tranche  (EUR  25  million)  is  still  outstanding.  Terms 
and  policy  conditions  for  the  additional  amount  of  EUR  70  million  decided  in  2003 
remain to be negotiated and agreed.  

The  authorities  of  Serbia  and  Montenegro  are  committed  to  economic  reform  and 
stabilisation under the present IMF programme as evidenced by encouraging signs of a 
revitalisation of structural reforms. 

The country continues to require external financial support in addition to what can be 
provided by International Financial Institutions. 

Decision 2002/882/EC should be amended to permit the commitments of grant funds 
beyond 9 November 2004.  

The Treaty does not provide, for the adoption of this Decision, powers other than those 
of Article 308. 

OJ C 
OJ C 
OJ L 308, 9.11.2002, p.25. Decision amended by Decision 2003/825/EC (OJ L 311, 27.11.2003, p.28). 

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(7) 

After consulting the Economic and Financial Committee, 

HAS DECIDED AS FOLLOWS: 

Article 6 second subparagraph of Decision 2002/882/EC is replaced by the following: 

Sole Article  

“It shall apply until 30 June 2006.” 

Done at Brussels, 

For the Council 
The President 

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FINANCIAL STATEMENT 

1. 

TITLE OF OPERATION 

Macro-financial assistance to Serbia and Montenegro. 

2. 

BUDGET HEADING INVOLVED 

a)  Grant component of the assistance (in EUR) 

Budget line: 01 03 02 02 

Initial Budget 2004 
Carry-over 2003/2004 

Commitment Appropriations 
65 000 000 
45 000 000 

Payment Appropriations 
80 000 000 
20 000 000 

Total for 2004 

110 000 000 

100 000 000 

Serbia and Montenegro, third 
grant tranche 

Albania, macro-financial 
assistance  

0 
(1) 

10 000 000 

16 000 000 

0  

Available 
before action 

appropriations 

94 000 000 

90 000 000 

Bosnia  and  Herzegovina, 
third grant tranche 

and  Montenegro, 
Serbia 
additional  macro-financial 
assistance 

0 
(2) 

15 000 000 

45 000 000 

0 

(1) EUR 75 million committed in December 2002 

(2) EUR 15 million committed in July 2003 

b) 

Loan component of the assistance 

01  04  01  07  –  “EC  guarantee  for  the  borrowing  programmes  contracted  by  the 
Community to provide assistance to the countries of the Western Balkans” 

3. 

LEGAL BASIS 

Article 308 of the Treaty 

4. 

DESCRIPTION AND JUSTIFICATION OF THE ACTION 

a)  Description of the action 

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Modification  of  the  expiry  date  of  the  Council  Decision  2002/882/EC,  as  amended 
by  Council  Decision  2003/825/EC,  providing  additional  macro-financial  assistance 
to Serbia and Montenegro, with a view to supporting the government’s reform efforts 
and ensuring a sustainable balance-of-payments situation. 

b) 

Justification of the action 

The  sustainability  of  the  beneficiary  country’s  economic  stabilisation  and  reform 
achievements heavily depends on external financial assistance from official sources 
at concessional terms. 

5. 

CLASSIFICATION OF THE EXPENDITURE 

a)  Grant component: non-compulsory, differentiated. 

b) 

Loan component: compulsory 

6. 

NATURE OF THE EXPENDITURE 

a) 

b) 

Straight grant (100% subsidy). 

Potential activation  of  budget  guarantee  for  the  Community  borrowing  aimed 
to fund the loan. 

7. 

FINANCIAL IMPACT 

a)  Method of calculation 

The  evaluation  of  the  amount  of  the  assistance  deemed  necessary  is  based  on  the 
present estimates of the beneficiary country’s residual external financing needs. 

For the loan component of the assistance, it is expected that the budget guarantee will 
not be called. The Guarantee Fund for external actions has already been provisioned 
in 2002 and 2003 according to the Fund Regulation, for an amount corresponding to 
9% of the amount of the guaranteed loan (EUR 80 million). As a result, two transfers 
of appropriations (n°54/2002 and n°38/2003) totalling an amount of EUR 7.2 million 
from the Reserve (budget line 01 04 01 13) to the Guarantee Fund (budget line 01 04 
01 14) were authorized by the Budgetary Authority in 2002 and 2003 after adoption 
of the Council Decisions 2002/882/EC and 2003/825/EC.  

b) 

Effect of the action on intervention credits 

For the grant element, the credits under budget line 01 03 02 02 will be used subject 
to compliance with a number of policy conditions to be agreed with the authorities of 
Serbia and Montenegro. 

The  budget  entry  reflecting  the  budget  guarantee  for  the  loan  component  of  the 
assistance will be activated only in the case of an effective call on the guarantee. 

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c) 

Financing of intervention 

(i) Grant 

The following updated schedule of appropriations to be financed within the limits of 
Category 4 of the present Financial Perspective is proposed (in EUR): 

Commitment appropriations 

45 000 000 

2004 

2005 

0 

Payment appropriations 

10 000 000 (1) 

45 000 000 

(1) EUR 75 million committed in December 2002 

(ii) Eventual call on the budget guarantee 

•  Recourse  to  the  Guarantee  Fund  established  by  Council  Regulation  (EC, 
EURATOM)  No.  2728/94  of  31  October  1994,  most  recently  amended  by 
Regulation  No.  1149/1999  of  25  May  1999.  According  to  the  Fund  Regulation, 
the  provisioning  will  take  place  via  a  transfer  of  EUR  0.81  million  from  the 
Reserve to the Fund. 

•  In  case  the  Guarantee  Fund  did  not  contain  sufficient  resources,  additional 

payments would be called up from the budget by transfer: 

–  of  any  margin  remaining  in  the  Reserve  for  guarantees,  according  to  the 
provisions  of  Article  18  of  Council  Regulation  (EC)  No  2040/2000  of  26 
September 2000 on budgetary discipline; 

–  of any overdue payments to the budget for which the budget guarantee had been 

activated, provided that these payments have not been recorded as revenues; 

–  of  any  margin  available  under  the  ceiling  of  category  4  of  the  financial 
perspectives  or  redeployment  therein.  In  this  case,  the  budget  line  01  04  01  07 
“European  Community  Guarantee  for  the  borrowing  programmes  contracted  by 
the  Community  to  provide  financial  assistance  to  the  countries  of  the  Western 
Balkans” would be activated. 

•  In order to fulfil its obligations, the Commission can provisionally ensure the debt 
service  with  funds  from  its  treasury.  In  that  case,  Article  12  (3)  of  the  Council 
Regulation (EC, EURATOM) No 1150/2000 of 22 May 2000 will apply. 

8. 

FRAUD PREVENTION MEASURES 

Before  the  implementation  of  this  assistance,  the  Commission  services,  with  the 
support of duly mandated experts, will check the reliability of financial circuits and 
administrative  procedures  of  the  Central  Bank  and  the  Ministries  of  Finance  of 
Serbia and Montenegro. To this end, and in order to fulfil requirements implied by 
the  Financial  Regulation  applicable  to  the  General  Budget  of  the  European 
Communities,  an  Operational  Assessment  has  been  commissioned  and  its  results 

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were expected by August 2004. This will cover areas like management structure and 
organisation,  reporting  tools,  management  and  control  of  funds,  IT  process  and 
security,  internal  and  external  audit  capacity,  as  well  as  the  independence  of  the 
central bank. Subject to the operational assessment’s findings, prior actions could be 
required before the release of the outstanding funds. 

The latter verifications will also take into consideration available conclusions of IMF 
Safeguard  Assessments  and  of  other  relevant  reports  by  the  IMF  and  the  World 
Bank.  

Finally, the assistance will be liable to verification, control and auditing procedures 
under the responsibility of the Commission, including the European Antifraud Office 
(OLAF), and the European Court of Auditors. 

9. 

ELEMENTS OF COST-EFFECTIVENESS ANALYSIS 

a)  Grounds for the operation and specific objectives 

By  supporting  the  country’s  macro-economic  reform  efforts  and  complementing 
financing by the International Community provided to this country in the context of 
the IMF-supported programme, this assistance would underpin its transition towards 
a market economy.  

b)  Monitoring and evaluation 

This  assistance  is  of  macro-economic  nature  and  its  monitoring  and  evaluation  is 
undertaken  in  the  framework  of  the  IMF-supported  stabilisation  and  reform 
programme  that  the  beneficiary  country  is  implementing.  In  particular,  the 
monitoring  of  the  action  by  the  Commission  services  takes  place  on  the  basis  of  a 
genuine system of macro-economic and structural policy indicators agreed with the 
authorities of the beneficiary country. In this process, the Commission services may 
also  monitor  key  areas  identified  in  the  above-mentioned  operational  assessment. 
Finally, they will remain in close contact with the IMF and World Bank services to 
benefit from their assessment of the recipient country’s stabilisation and reform. 

An annual report to the European Parliament and to the Council has been foreseen in 
the Council decision 2002/882/EC, and includes an evaluation of the implementation 
of this operation. 

Furthermore,  an  independent  ex-post  evaluation  of  the  assistance  is  foreseen  to  be 
carried  out  by  the  Commission  or  duly  authorised  representatives  one  to  two  years 
after  the  assistance  has  been  implemented  and  the  authorities  of  the  country  are 
committed to supply all necessary information.  

10. 

ADMINISTRATIVE EXPENDITURE 

This action is exceptional by nature and will not involve an increase in the number of 
Commission staff. 

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EX ANTE EVALUATION STATEMENT 

MACRO-FINANCIAL ASSISTANCE TO SERBIA AND MONTENEGRO 

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Table of Contents 

Table of Contents ..................................................................................................................... 12 

1. 

1.1. 

1.2. 

2. 

2.1. 

2.2. 

3. 

3.1. 

3.2. 

4. 

5. 

6. 

6.1. 

6.2. 

7. 

Problem analysis and needs assessment..................................................................... 13 

Medium term economic outlook ................................................................................ 13 

Structural reforms....................................................................................................... 14 

Objectives and Related Indicators of the MFA Operation......................................... 14 

Objectives .................................................................................................................. 14 

Indicators  .................................................................................................................. 15 

Alternative delivery mechanisms and risk assessment .............................................. 15 

Delivery mechanisms ................................................................................................. 15 

Risk assessment.......................................................................................................... 15 

Added value of Community involvement .................................................................. 16 

Lessons from the past................................................................................................. 16 

Planning future monitoring and evaluation................................................................ 17 

Monitoring.................................................................................................................. 17 

Evaluation .................................................................................................................. 17 

Achieving cost-effectiveness...................................................................................... 17

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1. PROBLEM ANALYSIS AND NEEDS ASSESSMENTEM ANALYSIS AND NEEDS 
ASSESSMENT 

In 2003, real GDP grew by 2-3%, somewhat slower than initially foreseen under the 
current IMF Extended Arrangement. For 2004, the authorities project GDP to grow 
by  4  -  6%,  reflecting  a  recovery  in  industrial  output  and  an  expected  rebound  in 
agricultural production. 

CPI inflation in Serbia declined to 8.1% in December 2003, but picked up slightly to 
10.5% in May, as a result of higher oil prices and a further adjustment of electricity 
prices.  For  the  year  as  a  whole,  the  Serbian  authorities  expect  an  inflation  rate  of 
8.5%. In real effective terms, the exchange rate remained broadly stable in 2003 and 
slightly depreciated in the first half of 2004 by some 3%. In Montenegro, which has 
unilaterally  introduced  the  euro  as  the  sole  legal  tender,  annual  inflation  reached 
6.6% in 2003, suggesting a substantial real appreciation. End of period inflation for 
the year as a whole is expected to reach 4.5%. 

In  2003,  the  consolidated  general  government  deficit  of  Serbia  and  Montenegro 
reached  4.2%  of  GDP  (3.8%  in  Serbia  and  0.4%  in  Montenegro,  the  latter 
representing 5.2% of Montenegrin GDP). For 2004, the budget deficit is sought to be 
reduced  by  0.8%  to  3.4%  of  GDP.  It  is  planned  to  achieve  this  through  higher 
revenue collection, while expenditures are projected to remain unchanged in relation 
to  GDP,  but  with  a  focus  to  raise  investments  and  lower  current  spending.  The 
financing  of  the  deficit  remains  a  concern  this  year,  in  particular  as  revenues  from 
privatisation have so far been lacking.  

Despite  continued  huge  trade  deficits,  reflecting  strong  import  demand  and  a 
generally weak export base, the external situation in 2003 was more favourable due 
to an exceptionally large net inflow of Foreign Direct Investment (FDI) in the order 
of 7% of GDP and buoyant private remittances (11.2% of GDP). Gross international 
reserves  increased  substantially  to  USD 3.6 billion.  In  early  2004  however, 
international reserves began to decline moderately, also due to seasonal factors and 
foreign  debt  servicing.  They  reached  USD 3.3 billion  in  April,  equivalent  to  4 
months of projected 2004 imports. The external outlook may improve as a result of 
an agreement with London Club creditors on a reduction of outstanding debt that was 
reached  in  July.  However,  gross  financing  needs  remain  high  and  the  country 
continues to require external financial support from the Community and other donors 
in support of its economic stabilisation and reform programme.  

1.1. Medium term economic outlook 

Real GDP growth is expected to average 4-5% in 2004/2005 and annual inflation to 
come down to 5% by end-2005. In 2005 the fiscal deficit is projected to decline to 
2.4% and public debt to below 60%.  

In  the  context  of  the  third  review  under  the  current  IMF  programme  completed  in 
June, the Fund and the authorities have reached agreement on balance-of-payments 
projections  and  gross  financing  requirements  in  2004.  It  is  projected  that  FDI  and 
privatisation  revenues  cannot  be  sustained  at  the  2003  level.  For  2004,  FDI  is 
expected to be halved in USD terms to some USD 700 million (it reached USD 300 

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million in the first five months). Disbursements from private creditors are projected 
to stay at the 2003 level. According to the IMF, a macro-financial gap is expected for 
the  whole  year  2004  (i.e.  the  gap  to  be  covered  by  budget/balance  of  payments 
support  as  opposed  to  project-related  support  and  after  deducting  IMF  and  World 
Bank disbursements) of USD 193 million, to be financed by EC and other bilateral 
donors’ contributions. 

1.2. Structural reforms in the context of the IMF Extended Arrangement 

With respect to structural reforms, some new momentum has been gained following 
the  creation  of  a  new  government  in  Serbia  in  March  2004.  In  particular,  a 
substantial  legislative  agenda  has  been  pushed  through  the  Serbian  Parliament.  32 
new  laws,  mainly  in  the  economic  and  financial  sphere,  have  been  adopted  in  the 
past months or are in the process of being voted, notably on bankruptcy, investment 
promotion,  company  registration,  foreign  trade,  insurance,  indirect  taxation,  and 
energy and railway. A first bank privatisation tender (for Yugobanka) was issued in 
late  May  and  the  Bank  Rehabilitation  Agency  has  received  offers  from  eight 
interested banks. The authorities expect to issue two additional tenders for banks by 
end-September.  The  privatisation  of  companies  through  tenders,  which  has  stalled 
since  mid-2003,  is  expected  to  gain  momentum  and  four  important  companies  are 
being prepared for privatisation in the second half of the year. The restructuring of 
large  state-owned  enterprises  and  public  utilities,  which  has  not  yet  really  started, 
represents a major challenge for economic policies in the future. 

2. OBJECTIVES AND RELATED INDICATORS OF THE MFA OPERATION 

2.1. Objectives 

By  supporting  the  country’s  macro-economic  reform  efforts  and  complementing 
financing by the International Community provided to this country in the context of 
the  IMF  supported  programme,  this  assistance  would  underpin  Serbia  and 
Montenegro’s  transition  towards  a  market  economy.  In  this  context  and  given  the 
challenges and needs identified above the objectives of the proposed MFA operation 
are to: 

•  Contribute to covering the residual external financing needs; 

•  Facilitate  and  encourage  efforts  of  the  authorities  of  Serbia  and  Montenegro  to 
implement  structural  reforms  in  the  area  of  public  finance,  private  sector 
development and banking sector reform through appropriate conditionality. 

Macroeconomic and structural reform objectives that apply to the original amount of 
EUR  130  million  are  defined  in  a  Memorandum  of  Understanding  signed  in 
December 2003. Terms and policy conditions for the additional assistance (topping-
up)  of  EUR  70  million  still  need  to  be  agreed  in  a  Supplemental  Memorandum  of 
Understanding. This could in principle include measures in the following areas: 

•  restructuring/privatisation of the strategic sectors 

•  reform of public administration and in particular public finance  

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•  banking sector reform 

2.2 Indicators 

Quantitative benchmarks included in IMF programmes represent a first category of 
indicators  of  a  macro-economic  nature.  Performance  indicators  are  specified  in  the 
aforementioned Memorandum of Understanding, in agreement with the authorities of 
the beneficiary country. 

3. ALTERNATIVE DELIVERY MECHANISMS AND RISK ASSESSMENT 

3.1. Delivery mechanisms 

Macro-financial Assistance is generally provided either in the form of a loan, a grant 
or  a  combination  of  the  two.  Given  the  country’s  high  level  of  indebtedness,  a 
significant part of this assistance is in the form of a grant (EUR 120 million) and the 
remainder (EUR 80 million) in the form of a loan. 

Macro-financial  assistance  is  an  untied  and  undedicated  macro-economic  support, 
which  helps  the  country  meet  its  external  financing  needs,  including  through  a 
reinforcement of reserves and budget support. Project support would not be able to 
fill this need in the same way, since it could for example not be used for servicing the 
country’s  external  debt  or  strengthening  its  reserves  position.  Moreover,  as 
experienced  with  similar  operations,  including  in  Serbia  and  Montenegro,  the 
economic policy  conditionality attached to this support strengthens the stabilisation 
and reform process. 

3.2. Risk assessment 

There  is  a  risk  that  macro-financial  assistance,  which  is  not  dedicated  to  specific 
expenses (contrary to project financing, for example), would be used in a fraudulent 
way. Generally speaking, this risk is related to factors such as the independence of 
the  central  bank,  quality  of  systems  and  procedures  related  to  the  management, 
control  and  processing  of  such  assistance,  IT  security  and  internal/external  audit 
capacity.  Although  the  provision  of  assistance  in  the  form  of  project  support  may 
seem  to  be  an  alternative,  it  does  not  fulfil  the  country’s  need  for  unaffected 
financing  (i.e.  not  earmarked  for  specific  projects)  and  also  carries  other  risks  of 
fraud.  

Before  the  release  of  this  assistance,  the  Commission  services,  with  the  support  of 
duly  mandated  experts,  will  check  the  reliability  of  Serbia  and  Montenegro’s 
financial circuits, administrative procedures, as well as internal and external control 
mechanisms  that  are  relevant  to  this  type  of  assistance  (see  Financial  Statement, 
section 8). 

Finally, the assistance will be liable to verification, control and auditing procedures 
under the responsibility of the Commission, including the European Antifraud Office 
(OLAF), and the European Court of Auditors. 

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4. ADDED VALUE OF COMMUNITY INVOLVEMENT 

In  May  2002,  the  IMF  approved  a  three-year  Extended  Arrangement  covering  the 
period  until  May  2005.  The  main  priorities  of  the  programme  were  ensuring  fiscal 
and monetary stability, enhancing public expenditure control and tax administration, 
promoting  private  sector  development,  and  cleaning-up  the  banking  system.  The 
authorities of Serbia and Montenegro have achieved remarkable results in economic 
reform and stabilisation. Macro-economic stability has been achieved and preserved, 
and  important  structural  reforms  have  begun.  The  privatisation  of  socially-owned 
enterprises through auctions and tenders has progressed, and the restructuring of the 
industrial  and  financial  sector  has  been  initiated.  The  agenda  of  economic  reforms 
has  been  supported  through  the  provision  of  subsequent  EC  macro-financial 
assistance packages, which have been implemented subject to the prior fulfilment of 
agreed  economic  and  structural  policy  conditions.  Without  continued  EC 
complementary  macro-support,  there  is  a  risk  that  the  stabilisation  and  reform 
programme  supported  by  the  IMF  could  not  be  fully  implemented,  that  popular 
support  for  the  necessary  adjustment  efforts  could  dwindle  and  that  reforms  could 
stall.  Furthermore,  this  assistance  would  encourage  and  support  efforts  that  are 
considered  of  particular  importance  for  the  EC,  notably  those  that  foster  the 
establishment of a single economic space in the country.  

Finally,  macro-financial  assistance  complements  the  Community  Assistance  for 
Reconstruction,  Development  and  Stabilisation  (CARDS)  programme  which  since 
2001  has  been  the  main  EC  financial  instrument  for  co-operation  for  the  Balkan 
countries  and  for  Serbia  and  Montenegro  in  particular.  For  the  period  2000-2004, 
EUR  1,100  million  have  been  earmarked  for  the  country.  The  main  priorities  are 
justice  and  home  affairs,  administrative  capacity  building,  economic  and  social 
development,  environment  and  natural  resources,  and  democratic  stabilisation.  For 
2004, a total amount of EUR 195 million has been foreseen. 

5. LESSONS FROM THE PAST 

In the past, macro-financial assistance to Serbia and Montenegro and other countries 
has  proven  to  be  instrumental  in  supporting  strong  stabilisation  and  reform 
programmes also backed by IMF arrangements and it has become clear that a proper 
articulation  between  EC  and 
to  ensure 
complementary and mutual support but to avoid a too heavy cross conditionality. 

IMF  conditionality 

is  necessary 

Although  macro-financial  assistance  was  initially  provided  mainly  in  the  form  of 
loans, presently assistance often combines loans and grants, taking into account the 
country’s level of income, external debt, and the reimbursement capacity.  

With regard to the recommendations made in the Discharge on the budget execution 
for  2001  and  also  in  the  Court  of  Auditors'  Special  report  n°  1/2002  concerning 
macro-financial  assistance  to  third  countries,  the  Commission  services  have  given 
due  consideration  to  the  five  Genval  criteria  (exceptional  character,  political  pre-
conditions, complementarity, conditionality and financial discipline). 

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6. PLANNING FUTURE MONITORING AND EVALUATION 

This  assistance  is  of  macro-economic  nature  and  its  monitoring  and  evaluation  is 
undertaken  in  the  framework  of  the  IMF-supported  stabilisation  and  reform 
programme that the beneficiary country is implementing. 

6.1. Monitoring 

The  monitoring  system  is  ensured  by  the  provision  of  reports  and  data  by  the 
authorities as set out in the Memorandum of Understanding and the organisation of 
review  missions  in  the  country  concerned.  Although  this  assistance  is  centrally 
managed, where appropriate, Commission delegations on the spot may also be called 
to provide reporting. 

In particular, the monitoring of the action by the Commission services will take place 
on the basis of a genuine system of macro-economic and structural policy indicators 
to  be  agreed  with  the  authorities  of  the  beneficiary  country.  In  this  process,  the 
Commission services may also monitor key areas identified in the above-mentioned 
operational assessment. Finally, they will remain in close contact with the IMF and 
World  Bank  services  to  benefit  from  their  assessment  of  the  recipient  country’s 
stabilisation and reform. 

An  annual  report  to  the  European  Parliament  and  to  the  Council  is  foreseen  in 
the 
Council  Decision  2002/882/EC,  which  will 
implementation of this operation. 

include  an  evaluation  of 

6.2. Evaluation 

In the context of DG ECFIN’s Multi-annual Evaluation Programme, two to three ex-
post evaluations of MFA operations are planned per year. It is in this framework that 
an  independent  evaluation  of  the  assistance  will  be  carried  out  by  duly  authorised 
representatives  of  the  Commission  in  the  course  of  2005/2006.  Financial  resources 
for this evaluation will be drawn from the corresponding MFA budget line 

7. ACHIEVING COST-EFFECTIVENESS 

The  Commission  is  proposing  a  modification  of  the  expiry  date  of  the  underlying 
legal  base  (Council  Decision  2002/882/EC  as  amended  by  Council  Decision 
2003/825/EC)  in  order  to  ensure  a  full  implementation  of  this  assistance  subject  to 
the  fulfilment  of  appropriate  conditionality.  It  is  unlikely  that  any  disbursements 
under this assistance can be made without a modification of the expiry date.  

In  view  of  Serbia  and  Montenegro’s  external  constraints,  the  loan  will  carry  a 
maturity of 15 years with a 10-year grace period, which is comparable to conditions 
of macro-financial assistance loans provided to other Western Balkan countries. The 
adoption  of  this  assistance  would  not  require  any  additional  provisioning  of  the 
Guarantee Fund, given current provisioning rules which require the provisioning to 
take  place  upfront  after  the  assistance  is  decided  by  the  Council.  Accordingly,  as 
indicated  in  the  Financial  Statement  the  Guarantee  Fund  for  external  actions  has 
already been provisioned in 2002 and 2003, for an amount corresponding to 9% of 
the  amount  of  the  guaranteed  loan  (EUR  80  million).  As  a  result,  two  transfers  of 

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appropriations totalling an amount of EUR 7.2 million from the Reserve (budget line 
01 04 01 13) to the Guarantee Fund (budget line 01 04 01 14) were authorized by the 
Budgetary  Authority  in  2002  and  2003  after  adoption  of  Council  Decisions 
2002/882/EC and 2003/825/EC. 

This action is exceptional by nature and will not involve an increase in the number of 
Commission staff. 

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