COMMISSION STAFF WORKING PAPER  Background analysis per beneficiary
Date: 2011-07-07
Institutions: European Commission
Subjects: Community loan, Eastern Bloc countries, Lebanon, aid for restructuring, case study, financial aid, implementation of the budget, transition economy

EUROPEAN COMMISSION 

Brussels, 7.7.2011 
SEC(2011) 873 final 

COMMISSION STAFF WORKING PAPER 

 Background analysis per beneficiary 

Accompanying the document 

Report from the Commission to the Council and the European Parliament on the 
implementation of macro-financial assistance to third countries in 2010 

{COM(2011) 408 final} 
{SEC(2011) 874 final} 

 
 
  
 
 
LIST OF ABBREVIATIONS 

Central European Free Trade Agreement 

Consumer Price Index 

Deep and Comprehensive Free Trade Area 

European Community 

Economic and Financial Committee 

European Investment Bank 

Emergency Post-Conflict Assistance 

European Union 

Euro 

Foreign Direct Investment 

Gross Domestic Product 

Generalised System of Preferences 

International Monetary Fund 

Instrument for Pre-Accession 

Macro-Financial Assistance 

Memorandum of Understanding 

Public Internal Financial Control 

Special Drawing Rights 

Small and Medium-sized Enterprises 

Dollar of the United States of America 

Value Added Tax 

World Trade Organisation 

CEFTA 

CPI 

DCFTA 

EC 

EFC 

EIB 

EPCA 

EU 

EUR 

FDI 

GDP 

GSP 

IMF 

IPA 

MFA 

MoU 

PIFC 

SDR 

SME 

USD 

VAT 

WTO 

 
 
 
 
TABLE OF CONTENTS 

1.  BOSNIA AND HERZEGOVINA............................................................................... 4 

1.1.  Executive summary ........................................................................................... 4 

1.2.  Macroeconomic performance............................................................................ 4 

1.3.  Structural reforms.............................................................................................. 6 

1.4. 

Implementation of macro-financial assistance .................................................. 7 
2.  KOSOVO1 ................................................................................................................. 10 

2.1.  Executive summary ......................................................................................... 10 

2.2.  Macroeconomic performance.......................................................................... 10 

2.3.  Structural reforms............................................................................................ 12 

2.4. 

Implementation of macro-financial assistance ................................................ 13 

1.  PRICE LIBERALISATION...................................................................................... 14 

2.  TRADE LIBERALISATION.................................................................................... 14 

3.  EXCHANGE RATE REGIME ................................................................................. 14 

4.  FOREIGN DIRECT INVESTMENT........................................................................ 14 

5.  MONETARY POLICY ............................................................................................. 14 

6.  PUBLIC FINANCE................................................................................................... 14 

7.  PRIVATISATION AND ENTERPRISE RESTRUCTURING ................................ 14 

8.  FINANCIAL SECTOR REFORM............................................................................ 14 

3.  SERBIA..................................................................................................................... 15 

3.1.  Executive summary ......................................................................................... 15 

3.2.  Macroeconomic performance.......................................................................... 15 

3.3.  Structural reforms............................................................................................ 17 

3.4. 

Implementation of macro-financial assistance ................................................ 18 

1.  PRICE LIBERALISATION...................................................................................... 20 

2.  TRADE LIBERALISATION.................................................................................... 20 

3.  EXCHANGE RATE REGIME ................................................................................. 20 

4.  FOREIGN DIRECT INVESTMENT........................................................................ 20 

5.  MONETARY POLICY ............................................................................................. 20 

6.  PUBLIC FINANCE................................................................................................... 20 

7.  PRIVATISATION AND ENTERPRISE RESTRUCTURING ................................ 20 

8.  FINANCIAL SECTOR REFORM............................................................................ 20 

1   UNSCR 1244 

2 

 
                                                 
4.  ARMENIA ................................................................................................................ 21 

4.1.  Executive summary ......................................................................................... 21 

4.2.  Macroeconomic performance.......................................................................... 21 

4.3.  Structural reforms............................................................................................ 23 

4.4. 

Implementation of macro-financial assistance ................................................ 24 

5.  GEORGIA ................................................................................................................. 27 

5.1.  Executive summary ......................................................................................... 27 

5.2.  Macroeconomic performance.......................................................................... 27 

5.3.  Structural reforms............................................................................................ 29 

5.4. 

Implementation of macro-financial assistance ................................................ 30 

6.  MOLDOVA............................................................................................................... 33 

6.1.  Executive summary ......................................................................................... 33 

6.2.  Macroeconomic performance.......................................................................... 33 

6.3.  Structural reforms............................................................................................ 35 

6.4. 

Implementation of macro-financial assistance ................................................ 36 

7.  UKRAINE ................................................................................................................. 39 

7.1.  Executive summary ......................................................................................... 39 

7.2.  Macroeconomic performance.......................................................................... 39 

7.3.  Structural reforms............................................................................................ 41 

7.4. 

Implementation of macro-financial assistance ................................................ 42 

8.  LEBANON ................................................................................................................ 45 

8.1.  Executive summary ......................................................................................... 45 

8.2.  Macroeconomic performance.......................................................................... 45 

8.3.  Structural reforms............................................................................................ 46 

8.4. 

Implementation of macro-financial assistance ................................................ 48 

1. PRICE LIBERALISATION.......................................................................................... 49 

2. TRADE LIBERALISATION........................................................................................ 49 

3. EXCHANGE REGIME................................................................................................. 49 

4. FOREIGN DIRECT INVESTMENT............................................................................ 49 

5. MONETARY POLICY ................................................................................................. 49 

6. PUBLIC FINANCE....................................................................................................... 49 

7. PRIVATISATION AND ENTERPRISE RESTRUCTURING .................................... 49 

8. FINANCIAL SECTOR REFORM................................................................................ 49 

3 

 
INTRODUCTION 

This working document is published in parallel with the Report from the Commission to 
the  Council  and  to  the  European  Parliament  on  the  implementation  of  macro-financial 
assistance  (MFA)  to  third  countries  in  2010.  It  provides  economic  and  financial 
information regarding the situation of the beneficiary countries as well as more detailed 
information on the implementation of MFA operations in those countries. Statistical data 
on the different macro-financial assistance decisions adopted since 1990, by date and by 
regions, are included in the annex. 

WESTERN BALKANS 

1.  BOSNIA AND HERZEGOVINA 

1.1.  Executive summary 

In  2010,  the  economy  of  Bosnia  and  Herzegovina  was  moderately  recovering  from  the 
recession  experienced  in  2009,  with  a  real  GDP  growth  of  0.9%.  The  recovery  was 
driven  by  exports,  reflecting  the  strong  economic  growth  of  some  of  Bosnia  and 
Herzegovina's  main  trading  partners,  in  particular  Germany.  Preliminary  estimates 
indicate that the consolidated 2010 budget deficit reached 3.8% of GDP, in line with the 
target agreed with the IMF. No agreement was reached on the Global Fiscal Framework 
2011-2013 between the entities and the state level. Because of a political stalemate after 
the 3 October 2010 elections the Parliament and Government of the Federation were only 
constituted  in  mid-March  2011,  while  state  government  formation  was  still  pending  in 
the beginning of June 2011.  

The authorities of all government levels concluded in early May 2009 negotiations with 
the  IMF  on  a  Stand-By  Arrangement  that  comprised  commitments  to  a  number  of 
structural  reforms  and  fiscal  adjustment  measures.  The  Fund's  Board  approved  a  EUR 
1.15  billion  loan  (13%  of  GDP;  600%  of  the  quota)  for  a  three-year  period  on  8  July 
2009.  The  main  policy  condition  under  the  programme  is  a  reduction  of  current 
expenditure, especially wages and social transfers, reducing the structural fiscal deficit. 

No  funds  were  disbursed  in  2010  under  the  current  EU  macro-financial  assistance  to 
Bosnia  and  Herzegovina  (loan  facility  of  up  to  EUR  100  million,  Council  Decision 
2009/891/EC  of  30  November  2009).  In  a  pre-election  environment,  long  internal 
discussions  in  Bosnia  and  Herzegovina  during  2010  delayed  the  adoption  of  the 
Memorandum of Understanding establishing the conditionality of EU MFA, which was 
eventually  signed  on  8  November  2010.  The  corresponding  Loan  Agreement  has  not 
been  ratified  yet,  reflecting  the  difficulties  in  setting  up  governments  and  parliaments 
after the October 2010 elections. Assuming a timely ratification of the Loan Agreement 
and  the  fulfilment  of  the  MoU  conditions,  including  good  progress  under  the  IMF 
programme, the EU MFA is planned to be disbursed in 2011. 

1.2.  Macroeconomic performance 

After  the  recession  experienced  in  2009  with  a  drop  in  real  GDP  of  2.9%,  the  country 
only moderately recovered in 2010, recording a positive real growth rate of 0.9%, driven 
by  external  demand.  Domestic  demand  also picked up, supported by a relatively stable 

4 

 
inflow of remittances. The growth of industrial production in 2010 was slightly positive, 
reaching  1.6%.  When  looking  at  the  trade  balance  in  2010,  the  annual  trend  is  still 
positive as the deficit decreased by 4.7%. Unlike in 2009, this development was driven 
by exports, which nominally soared by 28.3% year-on-year (in 2009 it was the shrink in 
imports that explained the lower deficit). Manufacturing, accounting for almost 90% of 
overall exports, recorded a 30.5% growth, while the export of agricultural products grew 
by 45%, accounting for a mere 2.3% of overall exports. The trend of an improving trade 
balance was reversed in the second half of 2010 when the increase of imports exceeded 
that of exports in volume, as import levels are much higher than export levels. Imports 
rose  by  10.3%  in  2010  (nominally).  Dominated  by  trade  developments,  the  current 
account deficit further decreased, reaching 5.2% of GDP in 2010. However, the current 
account  also  showed  a  reversed  trend  as  of  the  third  quarter  2010.  Capital  inflows,  in 
particular FDI, remained low and below the already low level of 2009. Nevertheless, net 
FDI  turned  positive  again  in  the  third  quarter  2010,  after  two  quarters  of  negative 
volumes.  Foreign  exchange  reserves  remained  stable,  covering  almost  six  months  of 
imports. Due to the continued improvement of the current account and the comfortable 
level of foreign reserves, the external financing needs decreased throughout 2010.2  

Unemployment  was  growing  throughout  the  year,  but  at  a  decelerating  pace.  The  high 
level  of  registered  unemployment  persisted  during  2010,  reaching  43.3%  of  the  total 
labour  force  in  December.  Throughout  2010,  employment  fell  most  in  construction, 
manufacturing and hotels and restaurants, while on the other hand, the highest growth of 
employment  was  registered  in  financial  intermediation  and  transport.  According  to  the 
Labour  Force  Survey  following  ILO  methodology  conducted  annually  in  May, 
unemployment significantly increased to 27.2% in 2010 from 24.1% in 2009. After wage 
increases  of  previous  years,  in  2010  decrease  in  wages  in  real  terms  contributed  to  an 
increase  of  competitiveness  of  the  Bosnian  economy.  Nominal  gross  wages  grew  by 
2.2% in December compared to end-2009.  

Annual inflation reached 2.1% in 2010, compared to an average annual deflation of 0.4% 
in 2009. The highest increase was registered in transport prices that grew by an average 
of 7.1%, after falling by 9.9% a year earlier. Moreover, food prices lowered their decline 
by  0.2  pps  to  0.7%.  Inflation  in  2010  was  also  driven  by  a  hike  in  excise  duties  on 
tobacco  and  alcohol,  as  well  as  telecommunication  costs.  The  monetary  policy  of  the 
Central  Bank  continued  to  be  conducted  under  a  currency  board  arrangement,  with  the 
euro  as  the  anchor  currency,  enjoying  a  high  level  of  confidence  and  credibility. 
Monetary  policy  settings  remained  unchanged  throughout  2010  after  minimum  reserve 
requirements had been lowered in several steps between October 2008 and May 2009 in 
order to boost the liquidity of the banking sector during the financial turmoil.  

The estimated budgetary outcome for 2010 of a consolidated deficit of 3.8% of GDP is 
below the previous year's outcome and the target of 4½% set under the IMF programme.3 
This is due to the faster than expected recovery of revenues and the adjustment measures 
on the expenditure side, in particular wage cuts in the public sector, which reduced the 

2  The estimate by the IMF of external financing needs for 2010 decreased from 5.6% of GDP in the first 

programme review in March to 4.1% of GDP in the second and third reviews in October.  

3 

 It needs to be underlined, though, that in this estimate expenditure side GDP data are used, while the 
IMF uses production-side GDP data (not yet published), which are lower. Therefore, the budget deficit 
to GDP figure following the IMF methodology is likely to be higher. 

5 

 
                                                 
consolidated  wage  bill  by  1.5%  in  nominal  terms.  Consolidated  revenues  increased  by 
2.6% in 2010. 44% of the revenues originated from indirect taxes that increased by 8.3%, 
driven by the resuming economic activity, the development of imports and import prices 
and  the  increase  of  some  road  tolls  and  excise  duties  on  tobacco,  and  despite  the 
reduction of tariffs following the entry into force of the Interim Agreement on trade with 
the  EU  in  mid-2008.  Despite  the  positive  development,  the  level  of  collected  indirect 
taxes in 2010 was still lower than in 2008. Expenses increased by 6.6% year-on-year in 
2010. Current spending dominates the budgets with wages accounting for 27% of overall 
expenditure and subsidies and transfers (mainly social benefits) for 37%, both marginally 
lower in relative terms than in the previous year. Temporary budgets have been in place 
in  the  first  and  second  quarter  2011  at  state  level,  and  in  the  first  quarter  in  the 
Federation.  The  Parliament  of  the  Republika  Srpska  had  adopted  the  2011  budget  in 
December 2010.  

The  sharp  economic  downturn  of  2009  and  the  slow  recovery  of  2010  revealed  the 
vulnerabilities  of 
the  country’s  growth  model  relying  on  externally  financed 
consumption,  thus  creating  large  external  imbalances.  The  current  account  improved 
over  that  period,  but  this  trend  is  already  reversing.  The  productive  capacity  and  the 
competitiveness of the economy remain weak.  

1.3.  Structural reforms 

Commitment  to  fiscal  adjustment  and  structural  reform  measures,  as  well  as  their 
implementation,  was  uneven  across  the  country.  Some  fiscal  and  structural  reform 
measures  were  enacted  under  the  pressure  of  budgetary  imbalances  and  the  IMF 
programme.  Nevertheless,  budgets  are  still  not self-sustaining and the quality  of public 
finances  remains  weak  with  high  shares  of  current  expenditures  to  GDP.  Some 
improvements in public financial management and control structures can be noted, partly 
linked  to  the  MFA  conditionality.  Privatisation,  restructuring  of  public  enterprises  and 
the liberalisation of network industries did not advance. Upgrading of infrastructure has 
proceeded,  though  at  a  slow  pace.  Structural  rigidities  such  as  high  taxation  of  labour   
and low labour mobility continue to hamper job creation and labour market participation. 
The generous and poorly targeted social transfers reduce the propensity to work, further 
highlighting the need for reform of the social benefits system. The business environment 
is affected by administrative inefficiencies and the weak rule of law. 

In the context of the IMF programme, substantial savings were envisaged in the public 
sector  wage  bill  and  in  transfers,  reflecting  the  elimination  of  special  unemployment 
benefits  for  demobilised  soldiers,  the  implementation  of  eligibility  audits  for  civil  and 
war benefit recipients and strict control over pensions provided on favourable terms. The 
State level froze wages in 2010. After initial delays, the Federation advanced the reform 
agenda over the summer: The parliament adopted a new civil service wage law at the end 
of  July  rationalising  the  wage  bill  by,  inter  alia,  consolidating  a  large  number  of 
allowances  into  the  base  wage.  The  government  approved  a  pension  reform  strategy 
which, however, was later withdrawn from parliamentary procedure. Eligibility audits of 
privileged pension and war disability benefit recipients started in July, albeit slowly. In 
Republika  Srpska  wages  in  public  administration  were  frozen  in  2010  after  the  cuts  in 
2009.  As  less  hires  than  planned  were  effected,  the  wage  bill  decreased  by  1.1%.  An 
eligibility  audit  for  social  transfers  was  conducted  in  Republika  Srpska,  reducing  the 
number of beneficiaries. 

6 

 
In Republika Srpska around 69% of the initial stock of state-owned capital intended for 
privatisation  had  been  sold  by  May  2010,  practically  unchanged  from  a  year  earlier. 
After  a  series  of  failed  privatisation  deals  the  privatisation  agency  of  the  Federation 
developed  a  revised  action  plan  for  2009-10,  including  the  privatisation  of  the  entire 
public share in eight companies. Progress in this area is very slow and several auctions 
have failed as they did not attract interested parties. The privatisation of an 88% share in 
the  aluminium  company  Aluminij  d.d.  Mostar,  one  of  the  largest  enterprises  in  the 
country and a key source of export revenue, which had been pending for more than three 
years, was declared to have failed. 

The ‘legislative guillotine’ project to reduce administrative burdens has been completed 
in  Republika  Srpska.  In  the  Federation,  the  parliament  amended  34  laws  in  July  2010 
initiating  the  second  stage  of  this  regulatory  reform,  simplifying  and  streamlining  35 
priority  administrative  procedures.  Businesses  nevertheless  continue  to  suffer  from 
political  instability,  the  high  tax  burden,  and  slow  contract  enforcement  and  business 
registration  procedures.  In  the  World  Bank's  2011  Doing  Business  Report  Bosnia  and 
Herzegovina  ranks  110th  in  the  world  (out  of  183  countries),  still  lagging  behind  its 
neighbours.  Moreover,  complicated  procedures  for  starting  a  business,  dealings  with 
construction  permits,  enforcement  of  contracts  and  difficult  access  to  financing  are 
further deteriorating the business environment.   

1.4.  Implementation of macro-financial assistance 

The  performance  under  the  IMF  Standby  Arrangement,  to  which  the  EU's  macro-
financial  assistance  is  linked,  remained  broadly  satisfactory.  In  March  2010,  the  IMF 
Executive  Board  approved  the  first  review  of  the  programme  which  resulted  in  the 
release of the second and third tranche in the amount of approximately EUR 140 million. 
In  October,  the  IMF  Board  approved  the  second  and  third  reviews,  making  available 
some EUR 130 million. However, the central bank, in view of a comfortable level of its 
foreign exchange reserves, decided not to draw on the funds made available in October. 
Thus,  only  EUR  38  million  of  this  tranche  were  drawn  by  the  authorities,  channelled 
completely as budget support to the entities. A total amount of around EUR 385 million 
has been disbursed under the programme so far, with 100% of these funds transferred to 
the entity budgets.  

In November 2009, the EU Council approved a macro-financial assistance of up to EUR 
100  million  in  the  form  of  loans.  The  assistance  aims  at  alleviating  the  impact  that  the 
economic  crisis  had  on  Bosnia  and  Herzegovina's  stressed  budgetary  and  external 
position and at contributing to fill the remainder of the external and budgetary financing 
gap as identified in the IMF programme.  

In the course of 2010, the Commission agreed the economic policy conditions with the 
Bosnian authorities in a Memorandum of Understanding (MoU) that was finally signed 
in November 2010, after the state and the entities eventually agreed amongst themselves 
on  all  policy  conditions  negotiated  with  the  Commission.  The  disbursement  will  be 
conditional upon a satisfactory track record in the implementation of the current Standby 
Arrangement  with  the  IMF,  as  well  as  upon  a  positive  evaluation  by  the  European 
Commission of progress made with respect to a number of structural reforms. The MoU 
stipulates that the MFA will be disbursed in two tranches and that the proceeds may be 
transferred  to  the  state  and  entity  budgets  according  to  the  following  distribution  key: 
10% to the state level, 60% to the Federation and 30% to Republika Srpska. The specific 

7 

 
policy  conditions  tackle  public  financial  management  issues,  statistics  and  budgetary 
procedures.  The  detailed  financial  terms  of  the  assistance  were  spelled  out  in  the  Loan 
Agreement  which  was  signed  in  November.  However,  due  to  the  non-establishment  of 
governments  and  parliaments  in  Bosnia  and  Herzegovina  after  the  October  2010 
elections, it has not been ratified yet.  

Given  the  delays  in  the  signing  of  the  MoU  and  the  corresponding  Loan  Agreement 
caused  by  internal  political  disagreements  in  a  pre-election  environment  and  by  the 
difficulties in government formation after the elections – the main stumbling blocks for 
the signing of the MoU were the distribution of funds available from the MFA between 
the  different  levels  of  government  and  one  of  the  technical  conditions  related  to  the 
cooperation of the Statistical Institutes at state and entity level – no funds were disbursed 
during 2010. In addition, one of the two policy conditions agreed for the disbursement of 
the first tranche - the approval of the Global Framework of Fiscal Policies by the Fiscal 
Council  of  Bosnia  and  Herzegovina  for  the  years  2011-2013  -  was  not  met.  This 
Framework  is  a  key  instrument  for  medium-term  budgetary  planning  and  an 
indispensable element of the annual budgetary process, of particular relevance in Bosnia 
and  Herzegovina  given  the  federal  structure of the country.  The Fiscal Council  did not 
approve this Framework which by Law was due on 31 May 2010. 

Some progress was, however, made on the fulfilment of policy conditions in the area of 
public financial management. These conditions were mostly derived from the findings of 
the  operational  assessment  of  financial  circuits  and  procedures  in  Bosnia  and 
Herzegovina carried out in November 2009, for example as regards the full functioning 
of the Central Harmonisation Unit and the management of public domestic debt. 

The  disbursement  of  the  EU  MFA  is  planned  for  2011,  assuming  that  the  Loan 
Agreement can be ratified timely enough, that the IMF programme remains on track and 
that  all  policy  conditions  as  laid  down  in the  MoU for  the first  and second  tranche are 
fulfilled.  

8 

 
SUMMARY STATUS OF ECONOMIC REFORM 
BOSNIA AND HERZEGOVINA (BIH) 

1.  Price liberalisation  

Most prices are liberalised even though a number of administered prices remains for some 
utilities and infrastructure as well as in some other areas.  

2.  Trade liberalisation  

BiH started WTO accession negotiations in 1999. In July 2008, the Interim Agreement of 
the Stabilisation and Association Agreement with the EU entered into force. BiH is part of 
the CEFTA agreement. 

3.  Exchange rate regime  

In 1997, the Central Bank of Bosnia and Herzegovina established a currency board with the 
Deutsche Mark as the anchor currency which has functioned smoothly since then. With the 
introduction of the euro the Bosnian Convertible Mark was pegged at 1.95583 to the euro 
and has remained unchanged since then.  

4.  Foreign direct investment  

FDI inflows reached a peak in 2007 (when the telecommunications company of Republika 
Srpska was privatised), fell to a level in line with the years prior to 2007 in 2008 and then 
halved in 2009, falling to around 2½% of GDP. Net FDI became even negative in the first 
half of 2010 and turned positive again in the third quarter. FDI has been mainly related to 
privatisation transactions, as green-field investment is still hampered by weaknesses in the 
business environment.  

5.  Monetary policy  

The  Central  Bank  of  Bosnia  and  Herzegovina  (CBBH)  is  responsible  for  operating  the 
currency  board  arrangement  which  limits  the  scope  of  monetary  policy  basically  to 
minimum reserve requirement ratios.  

6.  Public finances  

The quality of public finances in Bosnia and Herzegovina continues to be low. The ratio of 
general government expenditure to GDP continuously increased in recent years from 37.1% 
in 2005 to 43.4% in 2010. Expenditure was not shifted towards growth-enhancing areas but 
remained  concentrated  in  current  expenditure,  in  particular  on  wages  and  social  benefits. 
The fiscal balance of the general government was positive until 2007, but in the following 
years increasing fiscal deficits materialised due to the economic crisis. 

7.  Privatisation and enterprise restructuring  

While the privatisation and enterprise restructuring process is already advanced in the RS, 
progress has remained limited in the Federation. 

8.  Financial sector reform  

The financial sector is dominated by banks.  The sector remained overall sound and stable 
during  the  economic  and  financial  crisis,  but  it  profitability  and  the  quality  of  the  loan 
portfolio  deteriorated  throughout  2010.  A  Standing  Committee  for  Financial  Stability  was 
established in 2010. The limit on guaranteed bank deposits was further increased to around 
EUR 18,000 (from around EUR 10,000) as of April 2010. 

9 

 
 
 
2.  KOSOVO

4 

2.1.  Executive summary 

According to the latest national accounts data, real GDP grew by 2.9% in 2009, driven 
mainly  by  government  consumption  and  investment.  There  are  growing  risks  to  this 
growth profile, which is likely to have been repeated in 2010, as recent fiscal expansion 
is reaching its limits. The labour market is stagnant with high level of unemployment. By 
end  of  March  2011  consumer  price  inflation  reached  a  double-digit  level,  spurred  by 
raising  food  and  energy  prices.  Providing  a  reliable  electricity  supply  remains  a  major 
challenge for private sector development. 

In  November  2006,  the  Council  decided  to  make  available  to  Kosovo  exceptional 
financial  assistance  in  the  form  of  budget  support  grants  of  up  to  EUR  50  million. 
However, until end-2009 the assistance was not disbursed as key conditions, in particular 
an understanding with the IMF, as well as the confirmation of budgetary financing needs, 
were  not  met.  The  European  Commission  adopted  in  December  2009  a  Decision  to 
extend  the  availability  period  of  the  EU  exceptional  financial  assistance  to  Kosovo  by 
one additional year, until 11 December 2010. 

Following  the  approval  by  the  Executive  Board  of  the  IMF  on  21  July  2010  of  an  18-
month  Stand-By  Arrangement  (SBA),  and  upon  satisfactory  compliance  with 
conditionality requirements agreed upon in 2007, the European Commission disbursed in 
September  2010  the  first  tranche  (EUR  30  million)  of  the  exceptional  Community 
financial assistance to Kosovo. The money entered the budget as a grant. 

In  November  2010,  after  a  non-confidence  motion,  the  Parliament  was  dissolved  and 
early  parliamentary  elections  were  held  on  12  December.  As  a  consequence  of  the 
dissolution of the Assembly, the 2011 budget was not approved. Thus, the IMF could not 
complete  its  review  of  the  SBA  by  the  end  of  November,  as  originally  envisaged,  and 
disburse  the  second  tranche  of  the  IMF  loan.  Under  these  circumstances,  it  was  not 
possible to assess whether the agreement with the IMF remained on track, which was a 
key  condition  for  the  release  of  the  second  tranche  of  the  EU  MFA  to  Kosovo,  thus 
preventing its disbursement before the assistance expired in December 2010. In mid-July 
2011,  the  government  entered  into  a  new  agreement  with  the  IMF  –  a  non-disbursing 
Staff Monitored Programme (SMP) to replace the SBA and run until the end of 2011. 

2.2.  Macroeconomic performance 

In  November  2010,  the  Statistical  Office  of  Kosovo  published  revised  GDP  data  for 
2004-2009  and,  for  the  first  time,  estimates  about  real  GDP  growth  rates.  Real  GDP 
increased  by  2.9%  in  2009,  mainly  driven  by  public  expenditure.  Investments  grew  by 
13.6%,  households  consumption  rose  moderately  by  1.5%,  while  donor  consumption 
shrunk by 14.8%. There are growing risks to the growth profile, as the fiscal expansion 
that has been underpinning it is reaching its limits. 

In 2010 exports of goods (mainly base metals) increased, although from a very low level, 
by  78%.  Imports  increased  as  well,  by  11%.  However,  even  with  the  higher  relative 

4   UNSCR 1244 

10 

 
                                                 
increase of exports, the trade deficit further increased to EUR 1,851 million compared to 
EUR 1,770 million a year earlier. According to balance-of-payments statistics, in the first 
three  quarters  of  2010  the  current  account  deficit  was  EUR  512.2  million,  increasing 
against  a  deficit  of  EUR  450.5  million  in  the  corresponding  period  of  2009.  This 
deterioration  was  mainly  driven  by  increased  payments  for  construction  services  in  the 
second quarter of the year. The surplus on the capital and financial account (EUR 315.1 
million) was not sufficient to cover the current account deficit. The European Union and 
the countries of CEFTA remain the main trading partners of Kosovo. 

The monetary framework is anchored on the use of the euro as legal tender. The Central 
Bank of Kosovo, therefore, cannot implement an independent monetary or exchange rate 
policy.  Its  role  lies  in  supervising  the  financial  sector  and  monitoring  liquidity  in  the 
banking  sector  and  credit  expansion,  with  liquidity  ratios  and  reserve  requirements  as 
main policy tools. The banking system consists of eight banks which mainly engage in 
domestic deposit-taking and lending. The degree of concentration of the banking system 
remains high, with about 80% of the assets managed by three banks. More than 90% of 
the assets in the sector are handled by banks under foreign ownership. By end-February 
2011,  annual  deposit  growth  stood  at  8.1%  and  credit  growth  at  14.4%.  The  loans-to-
deposit  ratio  was  77.2%,  below  the  informal  Central  Bank  benchmark  according  to 
which it should not exceed 80%. The net profit of the banking sector increased by 45% in 
2010 (year-on-year) to EUR 36.6 million, mainly driven by higher interest income. 

After accelerating in the summer of 2010, inflation continued rising steadily to reach a 
double-digit level of 10.8% (year-on-year) by the end of March 2011. The main drivers 
of the inflationary dynamic were food and fuel prices, contributing respectively 8.1 and 
1.4 percentage points. The prices of basic goods, such as bread and cereals and oils and 
fats,  increased  by  more  than  40%,  hitting  disproportionally  the  poor  segments  of  the 
population. By end-March, the goods and services with positive contribution to inflation 
had  increased  their  weight  to  95%  of  the  whole  CPI  basket,  pointing  to  a  broad-based 
inflationary pressure. Average annual inflation in 2010 stood at 3.5%, after a deflation of 
2.4% in 2009. 

The  unemployment  rate  in  Kosovo  is  very  high  at  above  40%.  Most  of  the 
unemployment  is  long-term,  pointing  to  very  low  dynamics  in  the  labour  market,  even 
though the informal sector distorts the actual picture. In the last three quarters of 2010, 
the  number  of  registered  unemployed  remained  stable  at  around  335  thousand,  though 
about 1% lower than a year ago. According to the Ministry of Labour and Social Welfare 
data, registered unemployed decreased slightly across all skill levels. Nevertheless, with 
a  share  of  60%  of  the  total  number  of  unemployed,  unskilled  unemployment  is  still 
dominant. 

Budgetary developments in Kosovo have been quite volatile and hard to predict in recent 
years.  The  budget  deficit  increased  from  0.1%  of  GDP  in  2008  to  0.7%  in  2009.  The 
underlying deficit was, however, much higher, rising to about 5.8% of GDP in 2009, if a 
one-off EUR 200 million dividend payment received from Post and Telecommunications 
of  Kosovo  is  deducted  from  total  revenue.  According  to  preliminary  data  from  the 
Ministry  of  economy  and  finance,  in  2010  the  general  government  had  a  lower  than 
expected  deficit  of  EUR  115  million  (2.8%  of  GDP).  However,  the  underlying  deficit 
(net of grants and dividends) remained broadly unchanged at 5.6% of GDP. By the end 
of  December  2010  usable  and  readily  available  government  bank  balances  were  EUR 
243 million, or slightly above its target according to the IMF programme. 

11 

 
Total revenue and grants stood at EUR 1,156 million by the end of December (including 
EUR  30  million  of  EU  budget  support).  The  underlying  revenue  growth  of  10% 
(excluding  dividends  and  grants)  was  underpinned  by  strong  performance  of  almost  all 
revenue  components.  Total  expenditure  reached  EUR  1,272  million.  Expenditure  at 
central  level  grew  by  3%  and  at  municipal  level  by  14%.  Capital  outlays  increased  by 
11% at central government level and by 23% at municipal level, followed by increased 
spending on wages and salaries – by 23% at central and 12% at local level. 

Due  to  the  early  elections,  the  approval  of  the  2011  budget  was  delayed  and  the 
Assembly  voted  in  on  31  March  2011.  The  budget  includes  a  substantial  increase  of 
government  sector  employees'  wages  (by  30%  to  50%)  –  a  measure  that  deviates  from 
commitments  made  in  the  current  IMF  programme  and  that  is  likely  to  lead  to  a 
deterioration  of  price  competitiveness  and  external  imbalances  as  well  as  to  lower  job 
creation  incentives.  Fiscal  sustainability  remains  at  risk,  as  expenditure  pressures  have 
not subsided. 

2.3.  Structural reforms 

Kosovo’s  enterprise  sector  remained  dominated  by  micro-enterprises,  with  more  than 
90% of the enterprises employing less than four people. The economic structure is highly 
concentrated on the retail sector, with about half of all enterprises operating in this field. 
In  2010,  a  Law  on  Economic  Zones  was  adopted  and  the  procedure  to  establish  six 
zones,  one  at  central  and  five  at  municipal  level,  started.  Information  on  registered 
companies  became  available  online.  Online  registration  of  companies  so  far  is  only 
possible at the ‘one stop shops’ or municipal business centres that have been established 
in 22 municipalities. Fees for starting and closing a business are low, but the relatively 
large  number  of  inactive  firms  in  the  business  register  suggests  that  the  market  exit 
regulations and implementation thereof could be improved further. 

In the area of public finance and administration limited progress was recorded in 2010. In 
order to develop and strengthen its debt management capacity, in June 2010 the Treasury 
reorganised  its  Cash  and  Debt  Management  Division  into  two  separate  units  dealing 
respectively with cash and debt management. In September 2010, the Statistical Office of 
Kosovo  approved  an  action  plan  for  compiling  and  publishing  comprehensive  statistics 
on national accounts and labour market. 

The  Privatisation  Agency  of  Kosovo  continued  the  privatisation  of  socially  owned 
enterprises, albeit mainly small businesses, with limited macroeconomic impact. In 2010, 
the agency started liquidation of socially owned enterprises for which there is no investor 
interest  in  privatisation.  Privatisation  proceeds  from  the  sale  of  socially  owned 
enterprises  have  been  kept,  in  accordance  with  existing  legislation  and  MFA 
conditionality,  in  a  single  trust  account  at  the  Central  Bank.  The  government  hired 
transaction advisors for privatising the Post and Telecommunications of Kosovo and the 
distribution  and  supply  functions  of  the  public  electricity  company  (Kosovo  Energy 
Corporation, KEK). Both privatisation deals and the transaction for the development of a 
new  Kosovo  power  plant  were,  however,  significantly  delayed  and  could  not  be 
concluded in 2010. 

Providing  a  reliable  electricity  supply  remains  a  challenge  for  private  sector 
development.  Despite  some  improvements  in  billing  and  collection  in  2009,  and 
establishment of annual targets for improving billing and bill collection rate in line with 

12 

 
MFA  conditionality,  about  42%  of  the  energy  entering  the  public  electricity  company 
network was not paid for. KEK continued to receive in 2010 substantial subsidies from 
the state budget for electricity imports and loans for financing its investment programme. 

2.4.  Implementation of macro-financial assistance 

In  November  2006,  the  Council  decided  to  make  available  to  Kosovo  exceptional 
financial  assistance  in  the  form  of  budget  support  grants  of  up  to  EUR  50  million 
(Council  Decision  2006/880/EC  of  30  November  2006).  This  assistance  was  made 
available  with  a  view  to  alleviating  the  financial  situation  in  Kosovo,  supporting  the 
development of a sound economic and fiscal framework, facilitating the continuation and 
strengthening  of  essential  administrative  functions,  and  addressing  public  investment 
needs. In December 2007, a Memorandum of Understanding laying down the conditions 
for the release of the assistance was signed between the European Commission and the 
Kosovo  authorities.  However,  the  assistance  was  not  disbursed  by  end-2009  as  key 
conditions,  in  particular  a  financial  arrangement  with  the  IMF,  as  well  as  the 
confirmation of budgetary financing needs, were not met. 

The availability period of the exceptional Community financial assistance to Kosovo was 
to expire two years after the signing of the Memorandum of Understanding laying down 
the  conditions  for  the  release  of  the  assistance,  i.e.  on  11  December  2009,  but  was 
extended in December 2009 for an additional year by the Commission, after consulting 
the  EFC  (Decision  2009/918/EU  of  7  December  2009).  Subsequently,  Addenda  to  the 
Memorandum of Understanding and to the Grant Agreement were signed by the Kosovo 
authorities and the Commission to that effect in early 2010. 

Following  the  approval  by  the  Executive  Board  of  the  IMF  on  21  July  2010  of  an  18-
month  Stand-By  Arrangement,  in  early  September  2010,  and  upon  satisfactory 
compliance  with  other  conditionality  requirements,  the  Commission  disbursed  the  first 
tranche (EUR 30 million) of the exceptional financial assistance to Kosovo. The policy 
conditions  agreed  with  the  EU  included  the  adoption  of  a  revised  Medium-Term 
Expenditure framework in June 2010, enhancing the administrative capacity in the areas 
of  internal  audit  and  Treasury  management,  and  maintaining  the  ring-fencing  of 
privatisation proceeds in line with legislative requirements. The money was disbursed to 
the budget in the form of a grant. 

In November 2010, after a non-confidence motion, the Kosovo Parliament was dissolved 
and  early  parliamentary  elections  were  held  on  12  December.  As  a  consequence  of  the 
dissolution  of  the  Assembly,  the  2011  budget  has  not  been  approved.  Thus,  the  IMF 
could not complete its review of the Stand-By Arrangement by the end of November, as 
originally  envisaged,  and  disburse  the  second  tranche  of  the  IMF  loan.  Under  these 
circumstances,  the  Commission  could  not  assess  whether  the  agreement  with  the  IMF 
remained on track, which was a key condition for the release of the second tranche of the 
EU  macro-financial  assistance  to  Kosovo.  The  availability  of  the  assistance  expired  in 
December 2010 and could not be renewed. 

13 

 
SUMMARY STATUS OF ECONOMIC REFORM 
KOSOVO 

1.  Price liberalisation 

The  price  setting  mechanism  is  basically  free.  Current  governance  arrangements  as  regards 
publicly-owned  enterprises  ensure  the  absence  of  government  interference  in  the  price  setting 
mechanism of their services. 

2.  Trade liberalisation 

Kosovo  does  not  enjoy  preferential  access  to  the  EU  market  following  the  expiration  of  the 
autonomous  trade  measures.  It  is  part  of  CEFTA,  however,  three  parties  to  this  free  trade 
agreement, namely Serbia, Bosnia and Herzegovina and Moldova, do not  recognise its customs 
stamp and, as a result, prevent free flow of goods from Kosovo. 

3.  Exchange rate regime 

Kosovo continued to use the euro as sole legal tender.  The Central Bank of Kosovo is in charge 
of  regulating  foreign  exchange  operations,  providing  payments  services  and  supervising  banks 
and other financial institutions. 

4.  Foreign direct investment 

Net FDI inflows are estimated to have reached EUR 191 million (4.6% of GDP) in the first three 
quarters of 2010, almost unchanged from EUR 195 million (5.0% of GDP) in the same period of 
2009. 

5.  Monetary policy 

The monetary framework remained anchored on the use of the euro as sole legal tender. 

6.  Public finance 

The execution of the budget in 2010 was characterised by a strong revenue performance and a 
substantial  increase  in  both  current  and  capital  spending.    Preliminary  data  point  to  an  annual 
2010 budget deficit of 2.8% of GDP. Fiscal sustainability is at risk, as expenditure pressures have 
not subsided. 

7.  Privatisation and enterprise restructuring 

In  2010,  the  Privatisation  Agency  of  Kosovo  started  liquidating  socially  owned  enterprises  for 
which there is no investor interest in privatisation. The government hired transaction advisors for 
privatising  the  Post  and  Telecommunications  of  Kosovo  and  the  distribution  and  supply 
functions  of  the  public  electricity  company  (Kosovo  Energy  Corporation).  Both  privatisation 
deals  and  the  transaction  for  the  development  of  the  new  Kosovo  power  plant  have,  however, 
been significantly delayed and could not be concluded in 2010. 

8.  Financial sector reform 

The degree of concentration of the banking system remains high, with about 80% of the assets 
managed by three banks. More than 90% of the assets in the sector are handled by banks under 
foreign ownership. By the end-February 2011, the loans-to-deposit ratio was 77.2%, pointing to a 
conservative  banking  model.  In  2010  banks'  profits  increased  by  45%  (year-on-year)  to  EUR 
36.6 million, mainly driven by higher interest income. 

14 

 
 
3.  SERBIA 

3.1.  Executive summary 

Following  a  3.1%  drop  of  output  in  real  terms  in  2009,  Serbia's  economy  recovered  in 
2010  with  GDP  up  by  1.8%  driven  by  vigorous  broad-based  export  growth. 
Macroeconomic  stability  was  anchored  by  the  economic  programme  supported  by  the 
IMF  under  the  Stand-By  Arrangement  (SBA),  which  remained  broadly  on  track 
throughout the implementation period between May 2009 and April 2011. The balance of 
payments position stayed solid thanks to the containment of the current account deficit at 
around 7% of GDP.  However, public finances deteriorated as the supplementary budget 
allowed  the  fiscal  deficit  to  widen  to  4.7%  of  GDP  against  the  provision  of  additional 
social  assistance  and  subsidies.  Considerable  strides  have  been  made  in  transforming 
Serbia  towards  a  market  economy  over  the  past  years,  but  the  pace  of  reforms  slowed 
down in the wake of the recession. 

The  Council  decision  of  30  November  2009  (2009/892/EC),  which  granted  Serbia 
macro-financial assistance in the form of a loan facility of up to EUR 200 million, was 
followed by the signing of a Memorandum of Understanding on 5 July 2010 and of the 
Loan Agreement by the end of the year. The objective of this assistance was to help the 
government  address  residual  external  financing  and  budgetary  needs  that  emerged  as  a 
consequence  of  the  strong  economic  slowdown.  This  assistance  from  the  EU  is 
complementary  to  the  resources  provided  by  international  financial  institutions  and 
bilateral donors. In light of the scaling down of the IMF assistance against lower foreign 
financing  needs,  the  European  Commission  informed  the  Economic  and  Financial 
committee in July 2010 that it was planning to disburse only the first EUR 100 million 
tranche. Following the completion of the ratification procedures in Serbia in March 2011, 
the Commission is currently preparing the disbursement, which is planned to take place 
by July 2011. 

3.2.  Macroeconomic performance 

Following a 3.5% drop of output in real terms in 2009 against the backdrop of the global 
crisis, the economy recovered in 2010. Up by 1.8%, GDP rebounded more than expected 
(1.5%,  according  to  the  IMF  and  national  forecasts).  After  strengthening  steadily  over 
the first half of the year, economic activity accelerated vigorously in the third quarter but 
moderated again in the last three months of the year. 

The economic upturn in 2010 was driven by export expansion as revival was gradually 
underway  in  Serbia's  main  trading  partners,  and  the  dinar  continued  to  depreciate. 
Domestic  consumption  and  investment  began  to  pick  up  only  slowly  against  the 
background of constrained disposable incomes. 

Buoyant  foreign  demand  stimulated  a  rebound  of  industrial  activity,  up  by  almost  3% 
compared  to  2009,  thanks  especially  to  solid  growth  in  manufacturing  of  basic  metals 
and  chemicals.  However,  services  continued  to  provide  the  main  stimulus  to  growth. 
Transport  and  financial  intermediation  expanded  by  almost  7%  following  some 
deceleration  towards  the  end  of  the  year  as  the  economy  hit  a  soft  patch.  By  contrast, 
construction and agriculture shrunk compared to 2009 in face of the ongoing economic 
rebalancing toward more export-based growth and unfavourable market conditions. The 

15 

 
hospitality sector too contracted in spite of a strong acceleration in the fourth quarter on 
the back of a pick-up in private spending. 

Contrary  to  expectations  that  the  gradual  recovery  in  activity  and  trade  would  impair 
Serbia's external position, the current account gap stayed contained well below the pre-
crisis  level  thanks  to  vigorous  broad-based  export  activity.  The  current  account  deficit 
narrowed  further  by  a  notch  to  about  7%  of  GDP  as  the  merchandise  trade  deficit  was 
some 7% lower than the year before. Exports rallied against the solid external demand, 
supported  also  by  the  steady  dinar  depreciation.  By  contrast,  imports  strengthened 
steadily  over  the  year  as  manufacturing  sustained  the  momentum  driven  by  foreign 
demand.  The  current  account  deficit  was  smaller  compared  to  2009  despite  the  higher 
income account deficit (up by a third year-on-year) and the slightly lower surplus on the 
current  transfers  account  (notwithstanding  the  sustained  high  inflow  of  remittances). 
Throughout 2010, financial and capital flows remained modest, with FDI markedly lower 
in comparison with 2009. At the same time, private sector's external liabilities decreased 
as  companies  and  banks  were  repaying  foreign  loans.  Foreign  currency  inflows  have 
been largely insufficient to cover the current account deficit. During 2010, total external 
debt  rose  by  almost  EUR  1.3  billion  to  around  EUR  23.8  billion,  i.e.  close  to  80%  of 
GDP. 

In the context of the sixth SBA review at end-2010, the IMF re-estimated Serbia's 2010 
gross external financing requirements to EUR 6.24 billion (against an earlier estimate of 
EUR 8.54 billion), due to a lower current account deficit and in view of the comfortable 
reserves position. After deducting available financing, the external financing gap stood at 
EUR 470 million in 2010 (against EUR 2.1 billion, expected previously). 

In  2010,  the  foreign  reserves  held  by  the  National  Bank  of  Serbia  (NBS)  remained 
largely  stable  at  about  EUR  10  billion,  i.e.  more  than  a  third  of  GDP,  or  sufficient  to 
cover  some  9  months’  worth  of  imports,  despite  the  NBS  intervening  regularly  on  the 
interbank market. A number of foreign exchange operations were undertaken throughout 
the year to smooth the exchange rate depreciation. Following some strengthening of the 
dinar  towards  the  end  of  the  year,  the  RSD/EUR  exchange  rate  overall  depreciated  by 
around 10% during 2010. Pursuing exchange rate stability partly overshadowed inflation 
targeting,  the  main  monetary  policy  objective.  In  view  of  the  renewed  inflationary 
tensions, the NBS reverted in August from the gradual easing of monetary conditions to a 
monetary tightening. By end-2010, the reference interest rate had been hiked in several 
steps from 8% to 11.5% (currently at 12.5%). Disinflation was interrupted in the middle 
of 2010 due to rising agricultural/food prices and the dinar depreciation. Tensions built 
up  further  based  on  the  expected  strengthening  of  domestic  demand  in  step  with  the 
gradual pick-up of economic activity and higher bank lending. By the end of 2010, CPI 
inflation  soared  to  10.3%  year-on-year  (6.6%  in  2009),  overshooting  the  4-8%  target 
range set by the NBS. 

In  spite  of  the  gradual  economic  recovery,  the  labour  market  situation  remained  strife 
throughout  2010.  The  LFS  unemployment  rate  lingered  at  20%  and  was  one  of  the 
highest in the region. From the second half of the year, job losses were contained and the 
employment rate stabilised at some 47%. In 2010, wage moderation continued to prevail 
owing  largely  to  the  agreement  to  keep  public  sector  wages  frozen  in  nominal  terms. 
Compared to 2009, the average net wage increased by 7.6% in nominal and 0.7% in real 
terms. Wage rises are expected to be more substantial from 2011 onwards as indexation 

16 

 
of public sector salaries is re-introduced, but are likely to remain subdued given the weak 
labour market. 

In  2010,  public  finances  remained  under  pressure  in  the  face  of  a  fragile  economic 
recovery  In  May,  the  revised  agreement  with  the  IMF  allowed  for  the  general 
government deficit to be widened by 0.3pp, to 4.8% of GDP, due to a revenue shortfall in 
face  of  a  sluggish  economic  recovery.  While  revenue  performance  improved  in  the 
second half of the year as economic activity was picking up, a supplementary budget was 
nevertheless  adopted  in  November.  Additional  social  assistance  and  subsidies  were 
provided in response to the weak labour market performance and poor living conditions. 
The outcome was broadly in line with the plans; at 4.7% of GDP the deficit was one of 
the highest in the past decade. 

Compared to 2009, the share of expenditure as a percentage of GDP is estimated to have 
decreased by 0.3 percentage points, to 46.4%. Current expenditure (which accounts for 
more than 90% of total expenditure and almost 40% of GDP) remained constrained as a 
set  of  ad-hoc  emergency  measures  agreed  with  the  IMF  under  the  SBA  programme 
continued  to  be  implemented.  Since  mid-2009,  public  savings  were  fostered  by  the 
nominal freeze of public administration salaries and pensions as well as restricted hiring 
in  the  public  sector.  However,  these  were  partially  offset  by  higher  social  assistance 
spending. Capital expenditure also increased in 2010 by around 13% in nominal terms. 

The revenue ratio is estimated to have reached 41.7% of GDP, a drop of 0.6 percentage 
points  compared  to  2009.  As  the  labour  market was slow to improve and  public  sector 
salaries  remained  frozen,  personal  income  tax  revenue  underperformed.  Furthermore, 
corporate income tax revenue was constrained by the ongoing balance-sheets repair. On 
the other hand, indirect tax revenues began to recover as VAT strengthened in step with 
the gradual economic upturn and excise taxes increased as a consequence of the hike in 
excise  duties  on  diesel  and  gasoline.  In  spite  of  the  steady  rise  in  imports,  however, 
customs revenues continued to decrease due notably to the lowering of tariffs following 
the  start  of  implementation  of  several  free  trade  agreements,  including  the  Interim 
Agreement of the Stabilisation and Association Agreement. 

The  budgetary  gap  spurred  government  borrowing  but  financing  proved  difficult  given 
the  lack  of  investors'  interest  in  treasury  bills  with  long-end  maturities  due  to  the 
significant exchange rate risk. In 2010, public debt rose by around 2 billion, amounting 
to 42.7% of GDP, an increase of around 8.5 percentage points compared to 2009. 

3.3.  Structural reforms 

Considerable  strides  have  been  made  in transforming the  economy over the past years; 
however,  the  pace  of  reforms  slowed  down  in  the  wake  of  the  crisis.  Recently,  the 
momentum took off again. Important challenges remain, especially related to creating a 
viable  market  economy  and  a  business-friendly  environment.  Deficiencies 
in 
competition,  the  regulatory  environment,  administrative  procedures,  rule  of  law  and 
infrastructure bottlenecks remain barriers to doing business. 

With the aim to strengthen fiscal discipline, the government adopted amendments to the 
budget system law in late September 2010, which also constituted a required structural 
reform measure for disbursement of the first MFA instalment. A set of quantitative rules 
has  been  designed  to  underpin  fiscal  consolidation  in  the  medium  run.  Improved 

17 

 
procedures  and  the  setting-up  of  a  fiscal  council  are  deemed  to  anchor  fiscal 
responsibility. Together with the new pension law, which extends the working period and 
age for assuming pension rights and adjusts the indexation mechanism, this may enhance 
the long-term sustainability of public finances. 

Sluggish  privatisation  has  been  one  of  the  weakest  points  of  the  reforms  in  Serbia. 
Privatisation  of  the  socially-owned  companies  continued  in  2009-2010,  but  at  a  slower 
pace.  A  number  of  sale  contracts  were  again  repealed  due  to  non-compliance  with  the 
contracted  obligations,  which  brought  the  number  of  privatisations  annulled  to  almost 
one quarter of the firms initially scheduled for privatisation. The government once more 
extended the deadline for finalising privatisation of the socially-owned companies to 30 
June  2011.  Likewise,  privatisation  of  the  large  state-owned  companies  was  postponed 
given  the  economic  circumstances.  However,  the  government  announced  privatisation 
strategies  for  a  number  of  companies  as  the  situation  in  the  global  markets  improved. 
Notably, a tender for the sale of the telecoms incumbent company was called in October. 
No progress has been made as regards stepping up the processes of denationalisation and 
restitution. 

In  spite  of  further  steps  in  establishing  legal  predictability  and  removing  red  tape,  the 
business environment continues to be constrained by the weak enforcement of the rule of 
law, especially with regard to property rights, which hampers market entry and exit. The 
reform  of  economic  governance  systems  and  regulatory  institutions  is  slow,  which 
further impedes competition. 

There is political consensus on the need to advance structural reforms in the direction of 
developing industrial sectors at the high value-added part of the productive chain, which 
will  bolster  export  expansion.  An  improved  economic  performance  will  further  depend 
on the country’s ability to attract foreign investment and to deal with structural rigidities 
on  the  labour  market,  reflected  in  the  persistently  high  unemployment  and  a  low 
participation rate, particularly of older workers. 

3.4.  Implementation of macro-financial assistance 

Given the tighter external financing conditions in the aftermath of the global crisis, the 
IMF granted Serbia a EUR 3 billion loan in the framework of an SBA programme to run 
between  May  2009  and  April  2011.  By  the  end  of  2010,  Serbia  had  concluded 
successfully  six  of  the  reviews  under  the  IMF  SBA.  The  final  review  of  the  SBA  was 
completed in April 2011. However, since March 2010 the Serbian authorities have been 
drawing  upon  the  available  amounts  only  partially  given  the  country's  ample  foreign 
exchange reserves. The total disbursements under the SBA were about EUR 1.5 billion, 
i.e. roughly half of the programme's funds. 

Over  2010,  complementary  financial  assistance  was  provided  by  international  financial 
institutions  and  bilateral  donors  to  help  the  government  address  residual  budgetary  needs.  The 
World  Bank  approved  lending  of  USD  250  million  through  its  Development  Policy  Loan 
programmes,  part  of  which  was  turned  into  a  guarantee  for  commercial  borrowing  worth  USD 
400 million. Additionally, the EU agreed to provide budget support of EUR 100 million 
under  the  Instrument  for  Pre-Accession  (IPA).  Two  tranches  of  EUR  50  million  each 
were  disbursed  at  the  end  of  2009  and  2010,  in  light  of  the  broadly  satisfactory 
implementation  of  the  economic  policy  programme,  as  assessed  by  the  IMF,  and 
fulfilment of specific conditions required for payment. 

18 

 
To top up the IMF and the World Bank funds, the EU also approved a macro-financial 
assistance  of  up  to  EUR  200  million  in  the  form  of  a  loan  in  November  2009.  The 
objective of this assistance was to help the authorities address residual external financing 
and budgetary needs that emerged as a consequence of the global crisis. 

In  the  spring  of  2010,  a  Memorandum  of  Understanding  and  the  Loan  Agreement 
detailing  a  set  of  economic  policy  conditions  and  the  terms  for  disbursement  of 
assistance  were  negotiated  with  the  Serbian  authorities.  After  consulting  the  EFC,  the 
Memorandum of Understanding was signed on 5 July 2010. It stipulates that a loan for a 
maximum  amount  of  EUR  200  million  would  be  released  in  two  equal  instalments  of 
EUR 100 million each. Disbursements are conditional upon a satisfactory track record in 
the  implementation  of  the  current  IMF  SBA,  as  well  as  priority  reforms  of  the  public 
finance management. The latter priority reforms are due to take place in six major areas: 
fiscal responsibility within the budget process, accounting, internal control, internal and 
external audit, and public debt management. 

The  loan  facility,  while  primarily  geared  towards  covering  balance-of-payments  needs, 
might  also  be  used  to  address  budgetary  needs.  In  light  of  the  gradual  economic 
recovery, lower foreign financing needs and the fact that Serbia had decided to draw on 
only  50%  of  the  funds  made  available  by  the  IMF  under  the  SBA,  the  Commission 
informed  in  July  2010  the  Economic  and  Financial  Committee  of  its  intention  to  scale 
down the planned assistance to half the original amount. Following the completion of all 
the internal ratification procedures in Serbia in March 2011, the Commission is currently 
preparing  the  disbursement  of  the  EUR  100  million  loan  in  one  tranche.  This 
disbursement is planned to take place by July 2011, subject to a satisfactory fulfilment of 
condition requirements. 

19 

 
 
SUMMARY STATUS OF ECONOMIC REFORM - SERBIA 

1.  Price liberalisation 

The  share  of  administrative  prices  accounts  for  about  a  quarter  in  the  CPI  inflation  basket.  The 
the  area  of  fuel,  electricity, 
government  regulates  prices  of  state-owned  utilities 
telecommunication,  communal  and  other  public  services.  In  the  middle  of  2010,  the  market 
formation  of  prices  was  challenged  as  the  state  intervened  following  the  shortage  of  basic  food 
items such as dairy and cooking oil. 

in 

2.  Trade liberalisation 

In December 2009, the EU unblocked the Interim Agreement which Serbia had been implementing 
unilaterally  since  January  2009.  Since  2010,  the  ratification  process  of  the  Stabilisation  and 
Association Agreement signed in April 2008 has been underway. By May 2011, 16 Member States 
had ratified the Agreement. 

3.  Exchange rate regime 

The monetary policy setting fosters a managed float of the dinar. Nevertheless, the National Bank 
of Serbia (NBS) has been intervening in the interbank market. In 2010, the NBS sold more than 
EUR 2.5 billion over a number of FOREX operations. 

4.  Foreign direct investment 

There  are  no  controls  on  inward  direct  investment.  By  end-2010,  net  FDI  inflows  reached  EUR 
860 million (EUR 1.4 billion, i.e. 4.4% of GDP in 2009). 

5.  Monetary policy 

The NBS has been committed to inflationary targeting since 2006. It sets a broad band around the 
targeted  CPI  inflation  rate.  The  main  policy  instrument  is  the  two-week  repo  interest  rate.  In 
August  2010,  gradual  relaxation  of  monetary  conditions  –  pursued  since  early  2009  –  was 
discontinued as inflationary pressures started building up. In a series of rate hikes the interest rate 
was raised from 8% to 12.5%, at present. 

6.  Public finance 

In  2010,  the  slow  and  fragile  economic  recovery  prompted  adoption  of  a  supplementary  budget. 
Revenues  remained  constrained  but  continued  implementation  of  a  number  of  corrective 
expenditure measures helped to rein in current spending. Adoption by government of amendments 
to the budget system law and the pension law was an important step towards improving the quality 
of public finances and is in line with the MFA conditionality requirements. 

7.  Privatisation and enterprise restructuring 

Privatisation of public enterprises remains the weakest point on the reform agenda. Privatisation of 
socially-owned  enterprises  back-paddled  in  2010  while  privatisation  of  state-owned  companies 
continued  to  be  delayed,  partly  due  to  the  lack  of  political  consensus  about  restructuring  and 
privatisation strategies. 

8.  Financial sector reform 

Serbia’s financial sector has been relatively unscathed by the international financial crisis thanks to 
a  set  of  timely  administrative  and  regulatory  repair  measures,  and  also  supported  by  the 
commercial  banks  commitments  under  the  Vienna  Initiative.  The  banking  sector  remained 
generally sound and profitable but the relatively high share of bad loans and considerable exposure 
to exchange rate risk are points to watch. 

20 

 
EASTERN NEIGHBOURHOOD COUNTRIES 

4.  ARMENIA 

4.1.  Executive summary 

In  2010,  the  Armenian  economy  recovered  from  the  sharp  downturn  of  14.2%  in  2009 
but the pace of recovery remained modest. Real GDP grew by 2.6% driven by recovery 
in services and industry. The fiscal deficit was narrowed to 4.9% of GDP from 7.9% of 
GDP  in  2009.  However,  the  recovery  in  investments  and  remittances  remained  fairly 
muted.  Thus,  despite  a  slight  improvement  in  the  current  account  deficit,  from  16%  in 
2009 to 14.6%, a large part of the external financing needs continued to be covered by 
the international community.  

In June 2010, the IMF Board agreed, following Armenia's request, to cancel the Stand-
By  Arrangement  approved  in  March  2009  and  to  replace  it  with  a  new  longer  term 
programme  under  the  Extended  Fund  Facility  (EFF)  and  the  concessional  Extended 
Credit Facility (ECF).  

In December 2010, the Commission and the Armenian authorities reached an agreement 
on the Memorandum of Understanding (MoU) and the related documents stipulating the 
policy conditions for the disbursement of the macro-financial assistance adopted by the 
Council  of  the  European  Union  in  November  2009  (Decision  2009/890/EC).  The 
assistance, consisting of a loan of EUR 65 million and of a grant of EUR 35 million, will 
be released in two instalments over the course of 2011.   

4.2.  Macroeconomic performance 

The Armenian economy experienced a very sharp downturn during the global crisis with 
GDP contracting by 14.2% in 2009. The widening current account deficit and the sharp 
fall  in  external  financing  sources,  in  particular  FDI  and  remittances,  exposed  a  severe 
external financing gap, which could only be filled with foreign assistance. As a result, in 
March  2009,  Armenia  reached  an  agreement  with  the  IMF  for  a  28-month  Stand-By 
Arrangement  of  about  USD  532  million,  with  the  total  amount  of  access  augmented  to 
about USD 820 million in June 2009.  

In 2010, the economic activity started recovering from the deep recession, although the 
pace of recovery was modest. Despite the gradual withdrawal of the fiscal stimulus and 
the unprecedented decline in agricultural output due to adverse weather conditions, GDP 
grew by around 2.6% driven by a recovery in services and industry. Nevertheless, growth 
prospects  are  still  challenging,  due  to  lack  of  diversification,  low-competitiveness  and 
the closed borders with two out of four neighbouring countries. 

Despite  the  increase  in  metal  prices,  the  trade  deficit  did  not  improve  significantly  and 
remained close to 24% of GDP. In addition, the recovery in investments and remittances 
was fairly muted as growth in Russia, Armenia's main trading partner and source of FDI 
and remittances, moderated compared to previous years. As the effects on the Armenian 
economy  of  the  improvements  in  the  country's  external  environment  appeared  to  be 
limited, the current account deficit narrowed only to 14.6% of GDP in 2010, from 16% 
of  GDP  in  2009.  Thus,  a  significant  part  of  the  external  financing  needs  in  2010  was 
covered by the international community; a similar situation is expected for 2011. 

21 

 
In  June  2010,  the  IMF  Executive  Board  decided  upon  Armenia's  request  to  cancel  the 
Stand-By  Arrangement,  initially  agreed  in  March  2009,  and  to  replace  it  with  a  new 
longer  term  programme  under  the  Extended  Fund  Facility  (EFF)  and  the  concessional 
Extended  Credit  Facility  (ECF).  Under  this  programme  which  runs  until  mid-2013, 
Armenia will get access to IMF funds of about USD 410 million; taking into account the 
disbursements  made  under  the  IMF  Stand-By  Arrangement  before  June  2010,  total 
access of Armenia to IMF resources in 2009-2013 is estimated to reach around USD 950 
million.   

Domestic  and  external  supply  shocks,  as  well  as  a  sharp  decline  of  agricultural  output, 
brought the inflation rate to 9.4% year-on-year in December 2010, from 7% in January 
2010. The Central Bank of Armenia left the reference interest rate unchanged at 7.25% 
since  May  2010,  as  the  pace  of  recovery  slowed  down  in  the  second  semester  of  2010 
and the inflationary pressures were not demand driven. The Central Bank expects that in 
the second half of 2011, when shocks to food prices recede, inflation will revert to levels 
below 5.5%. In the meantime, it introduced measures to strengthen the effectiveness of 
monetary policy hampered by the high dollarization of the economy. 

The  fiscal  easing  of  2009  was  reversed  during  2010  on  the  back  of  the  economic 
recovery. Reflecting government's increased focus on ensuring macroeconomic stability, 
fiscal policy was tightened in 2010. As a result, the fiscal deficit was reduced to 4.9% of 
GDP in 2010 compared to 7.9% of GDP in 2009. The reduction in the fiscal deficit was 
mainly  driven  by  a  substantial  increase  in  tax  revenues  supported  by  the  economic 
recovery,  while  on  the  expenditure  side  the  government  limited  the  increase  of  current 
expenditures and made efforts to achieve better targeting of the anti-poverty and social 
programmes.  Nevertheless,  the  tax-to-GDP  ratio  deteriorated  from  22.8%  in  January 
2010  to  16.2%  in  December  2010,  indicating  high  tax  evasion  and  low  tax  collection 
rates.  

The public debt-to-GDP ratio nearly tripled, from 16.1% of GDP in 2008 to 44% of GDP 
in 2010, as a result of the counter-cyclical measures and the financial assistance from the 
international community in the form of loans. The external debt represents around 90% 
of  the  total  public  debt,  thus  increasing  the  exchange  rate  vulnerability  and  the 
dependence on concessional financing in addressing future financing needs. 

The exchange rate market is small and highly volatile, and the Central Bank of Armenia 
often  undertakes  foreign  exchange  interventions  to  limit  the  exchange  rate  volatility. 
Altogether in 2010, the Armenian Dram (AMD) appreciated by 4% against the USD and 
by around 12% against the EUR. Although foreign reserves in December 2010 were at a 
sufficient level (around USD 1.809 billion), a need for reserve built-up remains given the 
persisting high levels of the current account deficit (around 14.6% of GDP in 2010) and 
the weak stream of external inflows to the economy. 

In  2010,  the  authorities  took  steps  to  improve  the  business  climate  by  simplifying  the 
taxpayer reporting system, reducing the discretionary authority of inspectors, introducing 
a  legal  restriction  on  public  officials  from  engaging  in  commercial  activities, 
strengthening the competition commission, and further reducing barriers to entry for new 
businesses,  including  a  recent  cabinet  decree  to  create  a  one-stop  shop  for  business 
registration.  FDI  is  estimated  to  have  decreased  from  8.4%  of  GDP  in  2009  to  around 
6.5% of GDP in 2010. 

22 

 
The  banking  sector  is  well  capitalised  and  has  exhibited  resilience  to  stress-tests.  The 
ratio  of  non-performing  loans  dropped  in  August  2010  to  5%  from  10%  in  2009  as  a 
result of the economic recovery. Nevertheless, the financial intermediation remains low, 
with the private sector credit as a share of GDP at around 25%. Lending rates continue to 
be around 18%, partly due to the currency mismatch between deposits (around 68% of 
total deposits are foreign currency denominated) and assets (around 56% of total assets 
are foreign currency denominated).   

4.3.  Structural reforms 

Armenia  had  a  good  track  record  in  implementing  strong  macroeconomic  policies  and 
structural reforms, which resulted in high growth rates for a series of years prior to the 
economic  crisis.  However,  reform  efforts  should  intensify  as  the  economy  remains 
fragile marked with close borders and high current account deficit, while new challenges 
emerge, like the accumulation of public debt and the moderated future growth prospects.  

Structural reform process has gained momentum in the context of the financial assistance 
by  the  international  community,  often  linked  to  reforms  in  certain  areas  like  tax 
administration, social policy, public finances and debt sustainability and financial sector 
stability. 

In  the  area  of  tax  administration,  measures  have  been  taken  to  reduce  corruption  and 
increase tax compliance by simplifying and streamlining reporting requirements and by 
applying  regulation  consistently  to  all  taxpayers  through  published  normative  acts 
approved by the Ministry of Finance. An appeal body dealing with legal and procedural 
disputes of taxpayers was also established. Processing time for VAT refund claims was 
brought below 90 days while, in preparation of a fully-functional risk based VAT refund 
processing  system,  only  high-risk  VAT  refunds  will  be  subject  to  review.  Efforts  for 
strengthening  tax  administration  are  expected  to  continue,  also  because  they  tax 
administration reform is part of the MFA conditionality. 

In 2010, Armenia continued to tax more heavily the imported tobacco products than the 
domestically  produced  ones  in  a  way  that  constitutes  a  breach  of  the  WTO  rules.  Both 
IMF  and  EU  MFA  programmes  are  encouraging  the  removal  of  this  discrimination.  In 
October  2010,  Armenia  passed  a  law  which  provided  only  for  gradual  removal  of  this 
discrimination  until  2014.  In  relation  to  the  relevant  MFA  condition  which  foresees  a 
more rapid removal of this discrimination, the Government adopted in December 2010 a 
Decree on the implementation of tax collection for imported tobacco products aiming at 
correcting this situation. 

To ensure fiscal consolidation and place the debt on a downward path, the authorities re-
introduced  and  strengthened  the  Medium  Term  Expenditure  Framework  in  2010  and 
adopted a  new debt management strategy. The adoption of a new law on internal audit 
will  also  accelerate  efforts  for  the  implementation  of  a  new  Public  Internal  Financial 
Control strategy across the government. The MFA programme supports both these areas 
by  three  relevant  conditions  foreseeing  the  acquisition  of  a  modern  debt  recording 
system,  the  improvement  of  internal  functions  in  the  debt  management  department  and 
the  methodological  development  and  monitoring  of  financial  management  control  and 
internal audit across the government. 

23 

 
The government improved the targeting of social spending while, in collaboration with 
the  World  Bank,  it  is  working  to  improve  the  coverage  of  social  programmes  and 
develop an integrated system for the provision of social protection services. In the field 
of social policies, the reform of the pension system is addressed by the MFA programme. 

Regarding  the  banking  sector,  the  risk  management  and  supervisory  frameworks  were 
enhanced, including through contingency planning. Prudential regulations to specifically 
address  currency-induced  credit  risk  were  issued,  including  increased  loan-loss 
provisioning  requirements  and  higher  risk  weights  in  capital  requirements  for  foreign 
currency loans. Progress was also made regarding the establishment of the Committee for 
Financial  Stability  and  the  coordination  of  crisis  management  banking  policies  among 
policy makers. Measures to encourage de-dollarisation had some positive results, while 
the new legal framework for insurance and private investment funds was submitted to the 
Parliament. 

Efforts to improve the transmission channels of the monetary policy continued in 2010. 
To this end, preparations for the active management of liquidity and the development of 
transactions in dram-denominated securities advanced.  

4.4.  Implementation of macro-financial assistance 

Despite  the  partial  recovery  of  the  economy  in  2010,  total  private  financing  of  the 
balance  of  payments  left  an  external  financing  gap  of  around  EUR  660  million  for  the 
period 2010-2011. The MFA programme, put in place in close coordination with IMF, is 
part of the external financing provided to cover Armenia's balance of payment needs in 
2011.  It  will  also  support  the  economic  adjustment  and  reform  programme  of  the 
Armenian  authorities  designed  to  achieve  sustainable  medium-term  growth.  The 
assistance will consist of a loan of EUR 65 million and of a grant of EUR 35 million and 
will  be  released  in  two  instalments.  The  first  instalment  is  expected  to  be  released  in 
June/July  2011  following  the  ratification  by  the  Armenian  side  of  the  documents 
pertaining to the assistance, signed in February 2011. The first instalment would amount 
to EUR 40 million (EUR 14 million in grants and EUR 26 million in loans). The second 
instalment, planned for release in autumn 2011, would amount to EUR 60 million (EUR 
21 million in grants and EUR 39 million in loans).  

In addition to the respect of the economic programme agreed between Armenia and the 
IMF, the economic policy conditions for the release of the assistance, also agreed upon in 
2010 (the final agreement was reached in December 2010), comprise specific economic 
policy measures in the areas of public debt management, pension system, public internal 
financial  control,  external  audit,  public  procurement,  tax  policy  and  tax  administration, 
and customs policy.  

Several agreed policy measures build on the results of the Operational Assessment (OA) 
that  was  carried  out  by  the  Commission  (with  the  support  of  external  consultants)  in 
February 2010. The OA detected a real improvement compared to the situation observed 
during the previous OA, carried out in 2004-2005. An important programme of reforms 
in  the  area  of  Public  Finance  Management  (PFM)  has  been  put  in  place,  including  the 
implementation  of  the  programme  budgeting  by  all  central  level  bodies  and  the 
enhancement of the budget preparation process. The external audit function has also been 
developed and the concept of Public Internal Financial Control has been introduced. At 
the same time, the OA formulated a number of recommendations for further actions  such 

24 

 
us the completion of the re-organisation of the Ministry of Finance, the strengthening of 
the  cash  management  and  the  debt  management  function,  the  implementation  of  public 
internal  financial  control  strategy  in  the  context  of  a  new  law  on  internal  audit,  the 
strengthening  of  custom  administration,  the  adoption  of  a  new  public  procurement 
system and the strengthening of the external audit function of the Chamber of Control.. 
These recommendations were indeed taken into account in negotiating the MoU with the 
Armenian authorities. 

In  the  area  of  public  debt  management,  the  authorities  will  implement  steps  in 
developing a debt strategy and put in place a modern debt recording system. In the area 
of public internal financial control (PIFC) and internal audit, the MFA will support the 
broadening of the scope of public internal audits from cash flow controls to organisation, 
management  and  reporting,  as  well  as  the  setting-up  of  a  body  within  the  Ministry  of 
Finance  responsible  for  methodological  development  and  monitoring  of  financial 
management  control  and  internal  audit  across  the  government.  In  the  area  of  external 
audit, it will support the adoption by the Chamber of Control of an Action Plan aiming at 
bringing its working methods closer to international standards. The condition of the MFA 
programme  in  the  area  of  public  procurement  foresees  the  harmonisation  of  Armenia's 
legislation with the EU directives and international standards.  

In  addition  to  Public  Finance  Management  proper,  several  conditions  refer  to  more 
structural questions in the broad area of public finances. They include an Action Plan for 
upgrading  tax  administration  in  several  key  areas  accompanied  by  respective  budget 
allocations  and  steps  to  enhance  tax  collection  for  fiscal  consolidation  and  debt 
sustainability purposes, and the preparation of legislation reforming the pension system 
and introducing a privately funded pillar. 

Finally,  two  trade-relevant  measures  support  Armenia's  efforts  to  create  an  open  and 
transparent  trading  environment.  The  first  condition  refers  to  the  need  for  Armenia  to 
apply a non-discriminatory taxation to the domestically produced and imported tobacco 
products. The second condition reflects the need to reform the customs valuation system 
in a way that it is based on the transaction values and the proper application of the WTO 
rules.  This  condition  entails  the  progressive  development  of  risk-based  post-clearance 
valuation controls. 

25 

 
 
ARMENIA - SUMMARY STATUS OF ECONOMIC REFORM 

1. Price liberalisation 
Prices  are  largely  free  but  there  are  fixed  oligopolistic  conditions  in  many  sectors  of  the 
economy. 
2. Trade regime 
Armenia is a WTO member since 2003. Tariff structure is simple, all tariffs are bound and the 
applied  average  tariff  is  2.7%.  Customs  procedures  have  improved  but  customs  clearance 
remains  slow  and  sometimes  non-transparent  due  to  the  extensive  use  of  'reference'  values  in 
breach of WTO rules. Problems remain regarding technical barriers to trade and in the sanitary 
and  phyto-sanitary  regulations.  A  Decree  was  adopted  aiming  to  lift  the  discriminatory  tax 
treatment  for  tobacco  products.  Taxation  of  beverages  was  still  in  breach  to  WTO  rules. 
Armenia  qualified  for  the  EU  GSP+.  EU  is  ready  to  discuss  the  launching  of  DCFTA 
negotiations with Armenia once the country meets a number of pre-conditions.   
3. Exchange rate regime 
After  the  March  2009  devaluation  of  the  Armenian  dram,  the  central  bank  announced  the 
adoption of a free floating exchange rate regime. However, the exchange rate market is small 
and  highly  volatile,  and  the  central  bank  often  undertakes  foreign  exchange  interventions  to 
limit  exchange  rate  volatility.  In  2010,  the  Central  Bank  of  Armenia  committed  to  intervene 
without contradicting fundamental market trends while communicating clearly its intervention 
policy to avoid creating market misperceptions. 
4. Foreign direct investment 
Overall,  Armenia  has  a  liberal  trade  and  investment  regime.  The  country's  land-locked 
geographical position with two closed borders and the oligarchic structure of the private sector 
hampers growth potential and competitiveness which deteriorated in 2010. Investors' protection, 
payment of taxes, access to finance and corruption appear as points of concern.   
5. Monetary policy 
The  Central  Bank  of  Armenia  follows  an  inflation  targeting  regime.  Efforts  to  improve  the 
transmission channels of the monetary policy continued in 2010.  
6. Public Finances and Taxation 
While public expenditure management is strong there is considerable room for improvement in 
the field of public internal financial control (PIFC). To this end the authorities adopted a new 
PIFC  strategy  and  a  new  law  for  Internal  Audit.  They  also  reverted  to  the  Medium-Term 
Expenditure framework abandoned during the economic crisis. Revenue collection in 2010 did 
not  benefit  substantially  from  the  economic  recovery  resulting  to  a  low  tax-to-GDP  ratio  of 
16.2%.   
7. Privatisation and Enterprise Restructuring 
During  the  1990's  and  early  2000's  most  of  the  small  and  medium-sized  enterprises  had  been 
privatised. Also, the electric power distribution system was privatised and bought by a Russian 
company  in  2005.  Plans  to  privatise  some  remaining  smaller  enterprises  seem  to  have  been 
delayed as a result of the economic crisis. 
8. Financial Sector 
The  banking  sector  in  Armenia  is  relatively  small  (banking  assets  represent  around  45%  of 
GDP) but well capitalised and deposit-funded. It consists mainly of private banks. Nevertheless, 
financial  intermediation  remains  low.  The  Central  Bank  of  Armenia  enhanced  the  risk 
management  and  supervisory  frameworks  in  the  banking  sector,  including  contingency 
planning.  Prudential  regulations  on  higher  capital  and  provisioning  requirements  on  foreign 
currency  loans  were  issued.  Future  efforts  should  focus  not  only  on  enhancing  financial 
stability but also on facing obstacles to credit growth and financial intermediation. 

26 

 
5.  GEORGIA 

5.1.  Executive summary 

Following the double shock of the military conflict with Russia of August 2008 and the 
2008-2009 global crisis, the Georgian economy entered a recovery path in 2010. In line 
with its commitments, the country has maintained a prudent fiscal and monetary policy 
stance, increased the flexibility of its exchange rate and continued to make progress with 
its  structural  reform  agenda.  However,  due  to  a  limited  recovery  in  FDI  inflows  and  a 
still  very  large  current  account  deficit,  Georgia's  external  position  has  remained 
vulnerable. The country has remained dependent on external official financing, including 
EU macro-financial assistance. 

Since  September  2008,  Georgia  has  been  implementing  an  economic  adjustment 
programme  agreed  with  the  IMF  and  supported  by  IMF  funding.  The  programme 
remained  fully  on  track  during  2010.  In  January  2011,  the  IMF  Executive  Board 
completed  successfully  the  seventh  and  the  eighth  programme  reviews.  However,  the 
authorities  indicated  that  they  did  not  intend  to  draw  the  instalment  that  became 
available.  At  the  same  time,  the  authorities  plan  to  conclude  a  follow-up  Stand-By 
Arrangement with the IMF after the current SBA expires in June 2011. 

In 2010, the first macro-financial assistance (MFA) operation to Georgia approved by the 
Council in November 2009 was implemented successfully. The assistance, amounting to 
EUR 46 million in the form of grants, was part of a pledge of two possible EU funded 
MFA  operations  of  the  same  amount  made  by  the  European  Commission  at  the 
International Donors' Conference of October 2008. The approval of the second MFA was 
conditional on the continued existence of external financing needs over and above those 
covered by the IMF arrangement. After thorough assessment of external financing needs 
of Georgia, the Commission considered that the activation of the second part of the MFA 
pledged in 2008 was warranted and adopted a proposal for further MFA in the amount of 
EUR 46 million (half of it in grants and half of it in loans) on 13 January 2011. The joint 
European Parliament and Council Decision is expected for June-July 2011. 

5.2.  Macroeconomic performance 

Following the double shock of the military conflict with Russia of August 2008 and the 
2008-2009  global  crisis,  the  year  2010  saw  a  revival  of  economic  activity.  After  a 
contraction  of  activity  by  3.8%  in  2009,  real  GDP  grew  by  6.3%  in  2010.  The  labour 
market  has  profited  only  marginally  from  the  economic  recovery,  however:  the 
unemployment  rate  remained  high:  it  decreased  by  only  2  percentage  points  from  its 
2009 height of almost 17%.  

On  the  back  of  the  economic  recovery,  the  government  tightened  its  budgetary  and 
monetary policies. In line with the government commitment in the framework of the IMF 
Stand-By Arrangement and of the ENP Action Plan, the fiscal deficit was reduced from 
9.2%  of  GDP  in  2009  to  6.6%  in  2010.  Expenditure  containment  accompanied  by  a 
number  of  spending  cuts  has  been  the  main  means  to  achieve  this  fiscal  consolidation, 
even  if  the  recovering  tax  revenues  were  also  an  important  factor.  The  tax  revenue 
increased  by  almost  10%  in  comparison  to  2009  thus  more  than  compensating  tax 
revenue  fall-out  of  the  previous  year.  The  tightening  of  the  monetary  policy  began  in 
summer  to  keep  inflation  under  control,  with  the  key  policy  interest  rate  having  been 

27 

 
increased by 3 percentage points between May 2010 and February 2011. The authorities 
also increased reserve requirements. However, while CPI inflation in 2010 was 7.1% on 
average,  it  picked  up  at  the  end  of  2010  reaching  11.2%.  One  of  the  reasons  for  the 
strong  increase  in  inflation  is  the  fact  that  almost  half  of  the  CPI  basket  in  Georgia 
consists  of  food  items,  so  that  increases  in  cereals  prices,  especially  those  of  wheat, 
previously  imported  from  Russia,  feed  into  the  higher  CPI.  To  find  a  solution  to  high 
food prices and reduce Georgia's dependency on certain key agricultural exports, such as 
wheat,  the  authorities  reviewed  their  agricultural  policy  announcing  a  greater  political 
commitment to promote growth and jobs in the agricultural sector. 

While  the  economic  recovery  has  taken  hold,  the  external  economic  situation  remains 
vulnerable  as  the  financing  of  the  large  current  account  deficit  remains  uncertain.  By 
weakening  domestic  demand,  the  crisis  contributed  to  a  halving  of  the  current  account 
deficit in 2009. However, the deficit remains very large, at 9.9% of GDP in 2010, and it 
is expected to remain similarly high in 2011. The trade deficit, which reached 22.2% of 
GDP  in  2010,  has  been  the  main  driver  of  the  large  current  account  deficit.  Georgia's 
exports  continue  to  suffer  from  the  trade  embargo  imposed  by  Russia  in  2006  and 
extended  in  2008.  Georgia's  exports  to  the  EU  countries  have  remained  low  and  the 
possibilities  offered  by  the  GSP+  remain  under-exploited.  While  a  certain  trade  re-
orientation  and  changes  in  export  profile  have  recently  taken  place,  Georgia's  exports 
continue  to  lack  diversification.  Overall,  the  Georgian  export  performance  remains  far 
below its potential.  

FDI inflows were negatively affected by the crisis and declined in 2010 in comparison to 
the  previous  year.  Thus,  FDI  inflows  reached  USD  550  million  thus  remaining 
substantially below the 2009 figure of USD 750 million. This disappointing performance 
of  FDI  inflows  puts  at  risk  the  financing  of  the  current  account  and  the  build  up  of 
international  currency  reserves  and  shows  that  foreign  investor  confidence,  which 
experienced  a  dramatic  blow  due  to  the  conflict  with  Russia  in  2008,  has  still  not 
returned.  It  also  reflects  the  loss  of  steam  of  the  privatisation  process,  as  many  of  the 
most  attractive  state  companies  and  assets  have  already  been  sold.  At  the  same  time, 
much of the official donor financing agreed at the 2008 International Donors' Conference 
has  already  been  disbursed  as  it  was  mostly  frontloaded.  A  further  vulnerability  in  the 
balance of payments relates to the fast increasing external public debt that represented in 
2010 34.1% of GDP (up from 16.8% of GDP in 2007), and a significant need for a debt 
roll-over  in  the  coming  years.  Substantial  external  debt  repayment  obligations  are 
expected  to  become  due  in  2013-2015.  A  strong  bunching  of  repayments  foreseen  for 
2013  (USD  750  million)  reflects  the  repayment  of  the  Eurobond  of  USD  500  million 
issued in 2008 and substantial repurchases under the IMF’s Stand-By Arrangement. To 
improve  the  amortisation  profile  and  reduce  the  bunching  of  debt  repayments  in  2013, 
the  authorities  accessed  the  international  capital  markets  in  early  April  2011.  Georgia 
issued a Eurobond of USD 500 million with a ten-year maturity and in parallel redeemed 
USD  417  million  of  the  existing  Eurobond.  Despite  the  improved  creditworthiness  in 
international  capital  markets,  Georgia's  balance  of  payments  situation  remains 
vulnerable. 

In September 2008, the IMF approved an 18-month Stand-By Arrangement for Georgia, 
worth USD 750 million. In August 2009, the Stand-By Arrangement was extended until 
14  June  2011  and  the  financing  package  increased,  bringing  the  total  Stand-By 
Arrangement  programme  to  USD  1.17  billion.  The programme remained fully on track 
during  2010.  In  January  2011,  the  IMF  Executive  Board  completed  successfully  the 

28 

 
seventh and the eighth programme reviews. However, the authorities indicated that they 
did not intend to draw the instalment of around USD 153 million that became available. 
At  the  same  time,  the  authorities  have  indicated  their  interest  to  conclude  a  follow-up 
Stand-By Arrangement with the IMF after the current SBA expires in June 2011. 

Consistent  with  the  commitment  of  the  monetary  authorities  within  the  IMF  Stand-By 
Arrangement  to  increase  the  exchange  rate  flexibility,  the  National  Bank  of  Georgia 
continued its less interventionist exchange rate policy. The depreciation trend against the 
USD during the first half of the year reversed in June, with the appreciation against the 
USD  allowing  for  a  slight  recovery  in  foreign  reserves.  However,  although  gross 
international  reserves  have  recovered  from  a  trough  of  USD  1.5  billion  reached  during 
the  crisis  to  USD  2.7  billion  by  end  March  2011,  they  remained  at  a  suboptimal  level, 
particularly  since  this  recovery  has  partly  been  achieved  by  borrowing  from  the  IMF. 
Despite  a  certain  improvement  at  the  end  of  2010,  net  international  reserves  remained 
low, at USD 882 million in December 2010.  

5.3.  Structural reforms 

Since  the  2003  Rose  Revolution  Georgia  has made significant progress in a number of 
legal  and  regulatory  reforms.  The  tax  system  has  been  simplified  and  public  finance 
management  brought  closer  to  international  practices.  Customs  regime  has  been 
liberalised, while important anti-corruption measures have been taken and the regulatory 
business  environment  has  substantially  improved.  In  2010,  the  reform  efforts  were 
intensified in some areas, although others continued to lag behind the ambitious reform 
plans of the government.  

One policy field that has been at the heart of government's reform efforts has been public 
finance  management.  In  line  with  the  policy  conditionality  of  the  macro-financial 
assistance, internal and external audit reforms continued, as well as reforms in the field 
of  budget  formulation  and  public  procurement.  Thus,  the  law  on  Internal  Audit  and 
Inspection introducing internal audit units in individual ministries was approved by the 
Parliament in March 2010, while the Action Plan on internal audit for 2010 was adopted 
by the government in May 2010. In April 2010, the Chamber of Control adopted a two-
year  capacity  development  plan  that  foresees  the  introduction  of  compliance  audit 
manuals,  quality  control  systems,  staff-recruitment  and  targeted  training.  In  the  area  of 
budget  preparation,  the  Budget  System  Law  was  replaced  by  a  more  comprehensive 
Budget  Code  in  January  2010.  To  advance  the  introduction  of  the  programme-based 
budgeting, a decree outlining a three-year government plan was signed in March 2010. 
Pilot projects for programme-based budgeting were implemented in six line ministries. In 
public  procurement,  the  law  was  amended  to  better  reflect  the  introduction  of  the  e-
procurement  mode  in  December  2010.  Furthermore,  a  dispute  review  mechanism  was 
established  in  December  2010.  Georgia  also  made  some  progress  in  the  area  of  public 
revenue  management.  A  new,  simplified  Tax  Code  was  approved  in  September  2010, 
electronic  filing of tax  returns and VAT invoices was implemented, while tax payment 
control  and  customs  management  systems  have  been  reformed  to  reflect  a  more  risk-
based policy approach of the authorities. 

In the area of trade and of trade-related regulatory reforms, progress was rather limited. 
A  dialogue  with  the  EU  on  the  preparation  for  the  start  of  negotiations  on  a  deep  and 
comprehensive free trade area continued but reforms in key trade-related regulatory and 
institutional reforms, such as sanitary and phyto-sanitary measures, technical regulations 

29 

 
and  competition  policy  have  remained  insufficient  to  allow  the  launching  of  the 
negotiations.  

In  the  area  of  prudential  financial  policy,  the  decision  to  merge    the  Financial 
Supervision Agency with the National Bank of Georgia in December 2009 and appointed 
the National Bank as the single regulator of financial sector was further implemented in 
2010. The supervision is gradually moving towards a risk-based system.  

In  the  field  of  statistics,  a  new  law  ensuring  a  higher  independence  of  the  National 
Statistical  Office  entered  into  force  in  February  2010.  However,  financial  resources  of 
the Statistical Office remained very limited putting at risk the quality of statistical data in 
the country. 

Georgia's  company  law  introduced  an  efficient  registration  system  for  new  enterprises 
that  allows  a  company  to  register  within  half  a  day.  As  far  as  business  climate  is 
concerned,  according  to  the  World  Bank's  'Doing  Business'  indicators,  Georgia  ranked 
12th globally, in particular due to improvement in access to credit and investor protection.  

5.4.  Implementation of macro-financial assistance 

The  EU  Council  Decision  of  30  November  2009  provided  macro-financial  assistance 
(MFA) to Georgia amounting to EUR 46 million, in grants. This assistance was part of a 
pledge  of  two  possible  EU  funded  MFA  operations  of  the  same  amount  made  by  the 
European  Commission  at  the  International  Donors'  Conference  of  October  2008.  This 
pledge  was  part  of  a  comprehensive  Community  package  of  up  to  EUR  500  million  to 
support Georgia's economic recovery in the aftermath of the August 2008 armed conflict 
with Russia. It supported the Stand-By Arrangement agreed by the Georgian government 
with the IMF to help the country through the global crisis. The Union's MFA contributed 
to covering Georgia's external financing needs in 2009-2010. The Commission disbursed 
the first tranche of the assistance of EUR 23 million in two parts amounting to EUR 15.3 
million and EUR 7.7 million in December 2009 and in January 2010, respectively. The 
second tranche of EUR 23 million was disbursed in August 2010.  

The approval of the second MFA operation was conditional on the continued existence of 
external  financing  needs  over  and  above  those  covered  by  the  IMF  arrangement.  In  a 
letter  from  10  May  2010,  the  Georgian  Minister  of  Finance  requested  the  activation  of 
the  second  part  of  the  EC  pledge,  amounting  to  EUR  46  million.  After  thorough 
assessment  of  external  financing  needs  of  Georgia  the  Commission  considered  that  the 
activation of the second part of the MFA pledged in 2008 was warranted and adopted its 
proposal  on  13  January  2011.  The  joint  European  Parliament  and  Council  Decision  is 
expected for June-July 2011. 

The  proposed  assistance  would  be  provided  half  in  grants  and  half  in  loans.  The  new 
MFA  will  support  the  economic  reform  agenda  of  the  government.  It  would  promote 
policy  measures  to  strengthen  public  finance  management  (building  on  those  of  the 
previous  operation  and  of  the  EU's  sectoral  budgetary  support  operation),  as  well  as 
measures  to  foster  economic  and  financial  integration  with  the  EU,  in  particular  by 
exploiting  the  potential  offered  by  the  future  Association  Agreement,  which  aims  at 
concluding a Deep and Comprehensive Free Trade Agreement between the two parties. 

In the context of the preparation of the new MFA operation, the Commission conducted 
at the end of 2010 an operational assessment of the financial procedures and circuits. The 

30 

 
OA is being finalised. Its initial findings suggest that significant efforts have been made 
in  Georgia  since  the  OA  conducted  in  2004-2005  to  build  a  functional  and  transparent 
public finance management system, compliant with international standards. This reform, 
which was supported by the conditionality of the MFA operation implemented in 2009-
2010,  has  translated  in  progress  in  the  areas  of  public  procurement,  programme-based 
budgeting  as  well  as  external  audit.  Also,  the  customs  and  tax  environment  has  been 
simplified.  Yet,  the  OA  report  noted  a  need  for  further  measures  in  areas  including 
budget  planning,  debt  management,  public  internal  financial  control,  external  audit  and 
public procurement. 

31 

 
 
GEORGIA - SUMMARY STATUS OF ECONOMIC REFORM 

1. Price liberalisation  

Prices are largely free. 

2. Trade regime  
Liberal  trade  policy.  Import  tariffs  have  been  abolished  on  around  90%  of  products.  In 
September 2006, the number of tariff bands on imported goods was reduced from 16 to three. 
The  maximum  tariff  of  12%  is  applied  to  those  agricultural  products  and  building  materials 
which  compete  with  domestic  goods.  The  average  weighted  tariff  is  estimated  to  be  1.5%. 
Non-tariff barriers allowed for environmental, security and health reasons only. There are no 
quantitative restrictions on imports and exports.  
Since  December  2005,  under  the  EU  Generalised  System  of  Preferences  (GSP),  Georgia 
benefits  from  the  generous  tariff  preferences  of  the  special  incentive  arrangement  for 
sustainable  development  and  good  governance  covering  7200  items,  the  GSP+.  Georgia's 
GSP+ utilisation rate has been declining. In May 2010, the mandate for the negotiations of the 
Association Agreement between the EU and Georgia was approved. In the area of trade, the 
new  agreement  would  foresee  the  establishment  of  deep  and  comprehensive  free  trade  area, 
once the necessary conditions are met.  

3. Exchange regime 
Floating  exchange  rate  of  the  lari  with  limited  official  intervention  by  the  National  Bank  of 
Georgia.  There  are  no  restrictions  on  current  international  transactions  in  conformity  with 
Article VIII of the IMF’s Articles of Agreement. 

4. Foreign direct investment 
Adequate overall legislation. Unlimited repatriation of capital and profits.  

5. Monetary policy 
Central  Bank's  main  policy  objective  is  the  price  stability.  The  stated  inflation  target  of  the 
monetary  authorities  is  6%.  However,  in  practice,  stability  of  the  external  value  of  the  lari 
against the USD seems to take precedence over the aim of domestic inflation control.  

6. Public finances and taxation 

Public finance management system is largely appropriate. Significant reform efforts have been 
made  allowing  to  build  a  solid  foundation  for  a  functional  and  transparent  public  finance 
management  system.  A  new  tax  and  customs  code  was  introduced  as  well  as  a  number  of 
reforms in external and internal audit, programme-based budgeting and public procurement. 

Georgia has double taxation agreements with 26 countries, including 19 EU Member States.  

8. Privatisation and enterprise restructuring   

The majority of state-owned enterprises have been privatised. Privatisation receipts amounted 
to 3.7% of GDP in 2008, to 2% in 2009 and 1.1% in 2010. 

7. Financial Sector  
There  are  15  banks  in  Georgia  with  foreign  investors  holding  significant  stakes  in  the 
Georgian  banking  industry.  The  two  largest  foreign  banks  are  Société  Générale's  subsidiary 
Bank Republic (holding around 11% of the market in terms of deposits) and HSBC. Russia’s 
Vneshtorgbank,  the  German  Procredit,  the  Kazakh  Turan  Alem  Bank  and  the  Armenian 
Cascade  Bank  are  also  present.  The  share  of  non-performing  loans,  defined  as  overdue  by 
more  than  90  days,  has  remained  low  reaching  5.4%  in  early  2011.  Capital  adequacy  and 
provisioning  rules  in  Georgia  are  more  conservative  than  Basel  standards.  Since  December 
2009, the National Bank of Georgia is the single supervisor of Georgia's financial sector. It is 
currently introducing risk-based bank supervision in line with Basel II. 

32 

 
 
6.  MOLDOVA 

6.1.  Executive summary 

The global crisis hit the Moldovan economy hard. GDP contracted by 6 % in 2009, with 
investment  and  remittances  falling  by  around  30%,  which  exposed  a  severe  external 
financing gap. In 2010, the Moldovan economy started to recover at a rapid pace and real 
GDP grew by 6.9% of GDP. Private consumption and investment rose again, the latter at 
a double-digit growth rate, while the negative external demand subtracted from growth. 
The recovery was broad based, with agriculture, industry and services all growing after 
contractions  in  2009.  Although  exports  rebounded  strongly  they  were  outpaced  by 
imports and together with the narrow export base meant that the persistently high trade 
deficit  expanded  as  a  share  of  GDP.  The  increase  was  however  offset  by  a  rise  in 
remittances  and  labour  income,  and  the  current  account  deficit  slightly  decreased  as  a 
share of GDP. FDI inflows are estimated to have risen to about 3.5% of GDP in 2010. 
loan 
Long-term  external  borrowing  also 
disbursements under the IMF programme. The uncertainty surrounding private external 
financing  implies  that  international  donor  support  remains  important  for  maintaining 
macro-economic stability and supporting the government's reform agenda. 

increased  but  was  supported  by 

the 

The incoming governments' structural reform priorities are broadly those of the previous 
administration but political uncertainty has somewhat hampered progress. The incoming 
government's  main  priorities  are  to  consolidate  and  improve  the  efficiency  and 
sustainability  of  public  finances,  partly  by  overhauling  the  civil  service,  improve  the 
environment  for  businesses,  in  particular  export  oriented  businesses,  by  reducing  the 
number  of business licences, permits  and  authorisations, to support small and medium-
sized enterprises (SMEs), and to improve education and health. 

In  October  2010,  the  EU  co-legislators  adopted  a  decision  to  grant  Moldova  macro-
financial  assistance  of  EUR  90  million.  The  assistance,  in  the  form  of  grants,  is  to  be 
disbursed in three tranches in 2010 and 2011. The first tranche of EUR 40 million was 
disbursed at the end of December 2010. The disbursement of the first tranche was made 
possible by the agreement between the Commission and the authorities on the economic 
policy  conditions  of  the  assistance  reached  in  December  2010.  The  second  and  third 
tranches, of EUR 20 million and EUR 30 million respectively, should be disbursed at the 
end of the second and fourth quarters of 2011. 

6.2.  Macroeconomic performance 

The global crisis hit the Moldovan economy hard. GDP contracted by 6% in 2009, with 
investment and remittances falling by around 30%. The sharp fall in external financing 
sources exposed a severe external financing gap. On 29 January 2010, the IMF agreed to 
provide financial assistance of SDR 369.6 million (EUR 420 million) spread over three 
years. The IMF financing is provided under the Fund's Extended Fund Facility (EFF) and 
the concessional Extended Credit Facility (ECF). On 16 July 2010, the IMF completed 
the  first  of  a  series  of  semi-annual  reviews  of  the  ECF-EFF  arrangement.  The  review 
concluded that the lending programme is on track and that current policies will continue 
to  stabilise  the  economy  and  support  the  recovery.  All  IMF  performance  criteria  and 
indicative  targets  were  met.  The  positive  review  triggered  the  second  disbursement  of 
SDR  60  million.  The  second  IMF  review  was  completed  in  April  2011  and  the  next 
tranche of SDR 50 million was disbursed. 

33 

 
In  2010,  the  Moldovan  economy  began  to  recover.  Real  GDP  grew  by  6.9%  of  GDP. 
Private consumption and investment started to rise again although the external negative 
external  demand  subtracted  from  growth.  On  a  sectoral  basis,  the  recovery  was  broad 
based  with  agriculture,  industry  and  services  all  growing  after  contractions  in  2009. 
Although exports rebounded strongly they were outpaced by imports and together with 
narrow export base meant that the persistently high trade deficit expanded from 36% of 
GDP in 2009 to an estimated 38% of GDP in 2010. The increase   was however offset by 
a rise in remittances and labour income and the current account deficit slightly declined 
from 8.5% of GDP in 2009 to 8.3% of GDP in 2010.  FDI inflows are estimated to have 
risen  to  3.5%  of  GDP  from  1.5%  in  2009.  Long-term  external  borrowing  increased 
although  supported  by  the  loan  disbursements  under  the  IMF  programme.  The 
uncertainty  surrounding  private  external  financing  implies  that  international  donor 
support remains important for maintaining macro-economic stability and supporting the 
government's reform agenda. 

After  decreasing  rapidly  in  2009,  inflation  edged up again through  2010  mainly  due to 
cost  push  pressures  as  credit  and  domestic  demand  remained  subdued.  In  particular, 
inflation was driven up by increases in food prices and energy tariffs, the depreciation of 
the leu, and higher excise rates. The CPI rose to 8.1% at the end of 2010. In response to 
mounting inflationary pressure, the National Bank of Moldova (NBM) reversed the trend 
of monetary easing by raising the base lending rate twice in the first quarter of 2010, to 
7%. The NBM adopted a more explicit policy of inflation-targeting in 2010, with a target 
of 5% ±1.5 percentage point for the end of 2010. The NBM’s policies have started to be 
gauged in quarterly monetary policy reports, the first of which was published in February 
2010.  

The banking system is well capitalised with a capital adequacy ratio of about 30% as of 
March 2011. The large amount of non-performing loans declined from 16.4% in 2009 to 
10.7% in the first quarter of 2011, supported by the resumption in private credit growth. 
The  growth  rate  of  private  credit  turned  positive  to  about  13%  in  2010  and  jumped  to 
around 38% in January 2011 based on higher FX lending to the corporate sector and a 
reduction  of  leu  lending  rates.  Lending  rates  remain  high  at  above  15%  p.a.  while  the 
spread between lending and deposit rates increased significantly in the crisis. In addition, 
a  high  proportion  of  foreign  currency  denominated  loans  (43%)  and  deposits  (46%) 
heighten exchange rate vulnerability.   

Unemployment  has  continued  to  rise  compared  to  2008  and  2009  and  reached  about 
7.4% of the labour force (ILO definition) in 2010. The activity rate declined to less than 
42%  thus  being  very  low  on  account  of  the  large  segment  of  the  population  working 
abroad.   Job losses were reported in agriculture, industry, and catering, while there were 
increases in transport, communications, and construction.  As Moldova is relatively poor, 
the  recession  affected  heavily  the  living  standards  of  the  population.  The  impact  was 
however  alleviated  by  the  multilateral  and  bilateral  official  financing  which  supported 
domestic demand and set the stage for the economic recovery. After having dropped by 
around 6% in euro terms in 2009, GDP per capita bounced back by about 12% in 2010. 
Still, it only reached a low level of about 1,230 euro. 

The  authorities  have  focused  fiscal  and  monetary  policy  on  ensuring  macroeconomic 
stability and fiscal consolidation. Fiscal policy was significantly tightened in 2010. The 
government  reduced  the  deficit  in  2010  to  2.5%  of  GDP  from  6.3%  in  2009.  The 
reduction was driven by cuts in general public services and reduced debt servicing costs, 

34 

 
as well as regulatory rises in taxation that contributed to an increase in revenue of 17% 
compared to 2009. The 2010 budget included increases in VAT on gas, and higher excise 
duty  on  tobacco  products,  luxury  cars,  alcoholic  beverages  and  perfumes.  Government 
debt remained stable at 25.2% of GDP.  

In the context of efforts by international donors to put the economy on a reform path, the 
government  has  adopted  a  wide-ranging  medium-term  structural  reform  programme 
("The  Economic  Stabilisation  and  Recovery  Programme  for  2009-2011")  supported  by 
multilateral and bilateral donors. In the medium term, the government aims at gradually 
narrowing  the  budget  deficit,  mainly  through  an  adjustment  of  current  expenditure  on 
wages,  goods  and  services,  and  subsidies.  The  government  is  also  aiming  at  reforming 
the  civil  service  and  the  judiciary;  combating  corruption;  reducing  and  streamlining 
to  small  and  medium-sized 
business  administration;  providing  greater  support 
enterprises, and improving education and health. 

The major near-term challenge for Moldova is how to expand growth enhancing public 
spending and maintain basic living standards while at the same time consolidate public 
finances.  In  order  to  protect  the  most  vulnerable  groups  from  the  measures  to  increase 
utility  tariffs  and  reduce  subsidies,  the  government  has  put  in  place  targeted 
compensation  schemes  for  heating  costs  for  families  receiving  social  assistance,  low 
wage  public  sector  workers,  and  for  pensioners  on  low  incomes.  In  line  with  the  EU 
Action  Plan  objective  of  ensuring  the  sustainability  of  public  finances,  reforms  were 
agreed to the social insurance systems which have tightened sick leave allowances and 
pulled back early retirement schemes. The authorities also adopted a strategy to improve 
tax  collection,  including  risk-based  auditing,  targeting  economic  agents  outside  the 
formal economy, and combating tax evasion. 

6.3.  Structural reforms 

The incoming governments' structural reform priorities are broadly those of the previous 
administration  but  political  uncertainty  has  somewhat  hampered  progress  and 
expectations were not always met. As indicated already, the incoming government's main 
priorities  are  to  consolidate  and  improve  the  efficiency  and  sustainability  of  public 
finances,  partly  by  overhauling  the  civil  service,  to  improve  the  environment  for 
businesses, in particular export oriented businesses, by reducing the number of business 
licences,  permits  and  authorisations,  to  support  small  and  medium-sized  enterprises 
(SMEs), and to improve education and health. 

With respect to fiscal policy, the government is aiming to reduce the fiscal deficit, at a 
pace  depending  on  the  economy's  speed  of  recovery.  To  achieve  the  consolidation,  the 
government  is  aiming  to  cut  the  public  sector  wage  bill,  reduce  non-essential  current 
spending, and increase tax revenue by improving tax administration, i.e. broadening the 
tax  base  and  reducing  the  level  of  fraud  and  tax  evasion.  In  2010,  the  government 
intensified  efforts  to  reform  public  procurement  and  public  internal  financial  control 
(PIFC),  including  through  the  introduction  of  internal  audit  units  and  approval  of  core 
PIFC  legislation.  These  measures  are  in  line  with  the  structural  reform  criteria  of  the 
MFA.  The  government  also  introduced  new  legislation  to  improve  the  financial 
sustainability  of  the  social  insurance  system,  by  making  sick  leave  benefits  more 
incentive-compatible by assigning the responsibility for the first day of sick leave to the 
employee  and  the  second  day  to  the  employer,  and  by  phasing  out  early  retirement 

35 

 
privileges for civil servants, judges and prosecutors. In future, the government intends to 
introduce a performance-based salary system for all public sector employees.  

The  government  has  continued  to  take  actions  to  create  an  investment-  and  export-
friendly business  environment, advance  liberalization and deregulation, and prepare for 
further privatisations. The government is planning to privatise state owned assets in the 
telecommunications,  rail  and  air  sectors,  and  is  working  with  the  World  Bank  and  the 
IMF  on  a  restructuring  plan  for  the  energy  sector.  The  National  Agency  for  Energy 
Regulation  (ANRE),  in  accordance  with  its  mandate  and  methodology,  has  increased 
tariffs  over  the  past  few  years  to  cost-recovery  levels.  The  government  also  intends  to 
deregulate  wages  in  state  run  utility  companies  by  removing  indexation  to  the  national 
minimum wage. 

With  respect  to  reforming  the  environment  for  businesses,  a  number  of  formal  and 
informal  export  and  import  restrictions  were  removed  in  2010.  The  government  also 
simplified  licensing  requirements,  and  procedures  for  business  registration  and 
liquidation.  The  VAT  regime  was  simplified  by  extending  nationally  the  option  to 
receive  VAT  refunds  for  purchases  of  investment  goods  effective  from  2011.  Business 
overhead costs were lowered by reducing the frequency of inspections of enterprises by 
state agencies and by simplifying access to digital signatures. In order to promote trade, 
one-stop-shop  business  services  linked  to  customs  administration  were  extended.  The 
government  continued  to  improve  IT  facilities  to  enable  automated  data  exchange  and 
electronic document processing. In order to stimulate private investment and strengthen 
the protection of investors’ rights, the government intends to review investment-related 
legislation,  including  the  laws  on  joint  stock  companies,  entrepreneurship  and  capital 
markets.  The  government  also  intends  to  amend  the  Land  Code  and  other  related 
legislation  to  simplify  the  procedure  of  converting  agricultural  land  for  other  business 
use. 

In order to increase efficiency in the education sector, the government passed a decision 
to  merge  several  schools.  It  is  planning  further  consolidation  and  also  intends  to  allow 
schools  to  generate  revenue  from  their  own  assets.  The  proceeds  from  efficiency  gains 
will be reinvested in order to raise the quality of the education sector. 

6.4.  Implementation of macro-financial assistance 

A  Legislative  Decision  (938/2010/EU)  to  provide  EUR  90  million  of  macro-financial 
assistance in grant aid to Moldova was adopted on 20 October 2010. The EU MFA is to 
be disbursed in three tranches in 2010 and 2011. The first tranche of EUR 40 million was 
disbursed  at  the  end  of  December  2010.  The  second  and  third  tranches,  of  EUR  20 
million  and  EUR  30  million  respectively,  should  be disbursed at  the end  of the second 
and fourth quarters of 2011. 

EU  MFA  is  part  of  an  international  financing  package  put  in  place  to  support  the 
Republic  of  Moldova's  efforts  to  meet  substantial  external  financing  needs  and  cover  a 
sharp  deterioration  in  public  finances  in  the  context  of  the  global  economic  crisis.  EU 
MFA will complement financial resources provided by (i) the IMF; (ii) the World Bank 
(WB)  which  is  undertaking  additional  operations  aimed  mainly  at  supporting  growth-
enhancing  structural  reforms;  (iii)  other  multilateral  creditors  and  official  bilateral 
donors;  and  (iv)  the  EU,  in  the  form  of  EIB  loans  and  sectoral  budget  support 
programmes financed under the European Neighbourhood and Partnership Instrument.  

36 

 
The objective of EU MFA is to help bridge the external financing gap and to bring about 
structural reforms which will stabilise the Moldovan economy and raise potential growth. 
In  this  respect,  EU  MFA  is  tied  to  a  number  of  structural  reform  criteria.  The  main 
criteria  included  in  the  Memorandum  of  Understanding,  agreed  with  the  authorities  in 
December  2010,  are  public  finances  and  public  finance  reforms,  financial  stability  and 
financial sector reforms, and legislative and regulatory convergence with the EU. 

EU MFA is mainly tied to a number of actions to reform public finance management and 
improve  the  efficiency  and  effectiveness  of  public  spending.  They  include  the 
preparation  of  a  new  law  on  public  finances,  the  publication  of  a  Medium-Term 
Budgetary Framework (MTBF) for the period 2012-2014 to improve budgetary planning, 
the preparation of a census of all public sector employees to improve control over public 
sector  wage  costs.  Also,  the  Ministry  of  Finance  will  approve  a  new  unified  Chart  of 
Accounts  for  the  whole  public  sector,  put  in  place  a  new  Financial  Management 
Information  System  (FMIS),  and  elaborate,  approve,  and  publish  a  medium-term  debt 
management strategy for the period 2012-2014, also covering the terms of settlement of 
outstanding  government  bonds  held  by  the  National  Bank  of  Moldova.  Finally,  the 
Public  Procurement  Agency  will  receive  new  powers  and  put  forward  regulations  and 
standards to bring public procurement closer to EU standards. 

EU  MFA  is  also  tied  to  several  actions  to  reform  the  financial  sector.  The  government 
will  introduce  legislation  to  define  the  regulatory  and  supervisory  responsibilities  for 
leasing and micro-credit institutions. The Ministry of Finance and the National Bank of 
Moldova  will  jointly  elaborate  a  medium-term  action  plan  to  ensure  the  sufficient 
capitalisation of the National Bank of Moldova. The government, in cooperation with the 
National Bank of Moldova, will modify Central Bank legislation to ensure its compliance 
with the Treaty on the Functioning of the European Union, in particular with respect to 
central bank independence and restriction on monetary financing. 

37 

 
 
MOLDOVA – SUMMARY STATUS OF ECONOMIC REFORM 

1. Price Liberalisation 
Prices are regulated on utilities and some public services. There are price controls on electricity, 
natural gas, water supply and sanitation, housing and medical services, rail and urban passenger 
transport, and postal services.  
2. Trade regime 
Moldova  (a  WTO  member  since  2001)  has  a  liberal  trade  regime.  Since  2006,  Moldova  has 
been a member of the Central European Free Trade Agreement (CEFTA); it has also concluded 
bilateral  free  trade  agreements  with  all  CIS  countries  but  Tajikistan.  Since  March  1,  2008 
Moldova has benefited from Autonomous Trade Preferences (ATP+) with the EU as a result of 
implementation  of  sustainable  development,  good  governance  policies  and  customs 
administration.  Moldova  started  negotiations  with  the  EU  on  an  Association  Agreement  in 
January  2010  including  the  establishment  of  a  DCFTA.  Moldova  does  not  impose  any  taxes, 
quotas  or  other  restrictions  on  exports  while  custom  tariffs  are  applied  to  around  50%  of 
imported products. No tariffs are applied to products originating from the EU and from CEFTA, 
up  to  quota  limits  agreed  within  CEFTA.  The  average  weighted  customs  tariff  is  4.3%.  The 
average tariff on agricultural products is 12.7% and 3.9% on industrial products. 
3. Exchange regime 
The  exchange  rate  regime  has  been  a  managed  float  since  2008.  The  NBM  intervenes  in  the 
domestic  foreign  exchange  interbank  market  in  order  to  smooth  out  sharp  fluctuations  of  the 
Moldovan leu against the US dollar. The NBM publishes information on its interventions. 
4. Foreign Direct Investment 
There are no controls on inward investment. Net FDI inflows amounted to an estimated 3.5% of 
GDP  in  2010.  Before  the  global  economic  crisis  FDI  inflows  were  considerably  higher,  at 
around 11.5% of GDP in 2008. 
5. Monetary policy 
The primary objective of monetary policy is price stability. The central bank adopts an annual 
inflation target and uses the base interest rate as the main policy instrument. In January 2010, 
the National Bank of Moldova (NBM) announced an inflation target of 5 percent with a narrow 
±1.5 percent deviation band. 
6. Public Finances and Taxation 
The Moldovan government is implementing several measures to consolidate public finances, in 
particular to increase tax revenue and to increase the efficiency of public expenditure, notably 
by  improving  public  finance  management  and  rationalising  public  sector  employment. 
Moldova’s  tax  rates  have  been  significantly  reduced  in  recent  years.  The  2008  budget 
simplified income tax by cutting the number of bands from three to two (with top rate of 22%); 
it  also  eliminated  corporate  income  tax  except  for  distributed  profits  and  dividends.  Tax 
revenue amounted to approximately 38% of GDP in 2010. 
7. Privatisation and enterprise restructuring 
Moldova has gradually sought to privatize state owned assets and enterprises. The private sector 
accounts  for  around  60%  of  GDP.  Privatisation  revenues  rose  to  0.5%  of  GDP  in  2010  from 
0.1% of GDP in 2009. One of the government's current priorities is energy sector reform. 
8. Financial sector 
Moldova's  bank-based  financial  system  remains  generally  sound.  The  sector  was  largely 
insulated  from  the  global  financial  crisis  due  to  limited  access  of  local  banks  to  international 
capital markets, but deposits fell and the asset quality deteriorated at the beginning of the crisis. 
Partly  as  a  result  of  supportive  measures  from  the  NBM,  commercial  banks  have  remained 
liquid  and  adequately  capitalized  although  lending  to  the  economy  has  fallen  significantly. 
Recently,  lending  to  the  private  sector  resumed  its  positive  trend  while  the  share  of  non-
performing loans fell from around 17% in April 2010 to about 11% in March 2011. 

38 

 
7.  UKRAINE 

7.1.  Executive summary 

Ukraine’s  economy  entered  a  phase  of  recovery  in  2010.  This,  along  with  a  new  IMF 
Stand-By  Arrangement  concluded  in  July  2010,  helped  the  newly  formed  executive  to 
consolidate the general macroeconomic policy framework. Notably, 2010 saw a return to 
economic growth, lower domestic inflation, a stabilisation of the hryvnia against the US 
dollar and other foreign currencies, a reversal of the losses of foreign exchange reserves 
witnessed  in  2009  and  a  narrowing  of  the  public  deficit.  However,  the  rebound  in 
domestic investment has remained timid, while the current account has swung back into 
deficit, raising some doubts about the medium-term sustainability of the recovery.  

In  terms  of  structural  reforms,  the  government  implemented  a  significant  increase  in 
retail  energy  prices,  strengthened  central  bank  independence  and  started  working  on  a 
pension  reform  in  2010;  all  of  these  measures formed part of the IMF’s  conditionality. 
However, a key weakness in Ukraine remains the operating environment for businesses, 
which is hampered by non-transparent bureaucratic procedures, a lack of administrative 
implementation  and  enforcement  capacity  and  continued  constraints  in  companies’ 
access to credit. 

Against  the  backdrop  of  a  persistent  external financing gap and in order to support the 
economic reform process in the country, the European Commission started to negotiate 
with  the  Ukrainian  authorities  in  July  2010  an  MFA  loan  package  of  up  to  EUR  610 
million, based on the Decisions of 2002 (EUR 110 million) and 2010 (EUR 500 million). 
Unfortunately, progress in these negotiations has been slow, reflecting reluctance on the 
part  of  the  authorities  to  make  clear  commitments  in  some  key  reform  areas,  including 
external audit, VAT refund arrears and energy sector reform. Any disbursements of MFA 
in  2011  are  conditional  on  the  successful  conclusions  of  these  negotiations,  as  well  as 
continued drawings on IMF support by Ukraine under its current Stand-By Arrangement 
on the basis of positive assessments by the IMF of the country’s reform progress.  

7.2.  Macroeconomic performance 

Ukraine was among the EU neighbourhood countries hardest hit by the global economic 
and  financial  crisis.  From  late  2008,  it  suffered  a  parallel  balance-of-payments  and 
banking  crisis,  and  output  contracted  by  15%  in  2009.  However,  in  2010  Ukraine’s 
economic fortunes improved in parallel with the rebound in much of the rest of the world 
and  in  the  wake  of  a  stabilisation  in  the  domestic  political  situation  following  the 
presidential  election  early  in  the  year  and  the  subsequent  formation  of  a  majority 
government.  

The Ukrainian recovery was initially export-led, but spread to domestic demand over the 
course  of  2010.  Official  labour  market  figures  reflect  this  upturn:  unemployment  (ILO 
methodology)  declined  from  9.6%  in  2009  to  8.8%  in  2010,  while  the  number  of  jobs 
rose  slightly  (0.4%).  As  a  consequence  of  an  improved  economic  and  labour  market 
situation, household consumption, rising by 7.0% in real terms, turned into the mainstay 
of economic growth in 2010, which came to 4.2%.  

Investment  also  recovered  in  2010,  albeit  only  in  the  second  half  of  the  year  and 
relatively timidly (4.9% in 2010) considering the favourable base effect stemming from 

39 

 
its  drastic  contraction  during  the  crisis  (-50.5%  in  2009).  This  hesitant  recovery  in 
investment  may  in  part  reflect  severe  problems  in  the  operating  environment  for 
companies, along with persistent difficulties with access to financing. Loans by domestic 
banks to non-financial companies barely increased in real terms in 2010, as the Ukrainian 
banking system continued to grapple with a non-performing loan ratio in excess of 15% 
(compared  with  3%  before  the  crisis)  and  posted  a  consolidated  net  loss  of  UAH  13.0 
billion (albeit down from UAH 38.3 billion in 2009).  

More encouragingly, the National Bank of Ukraine (NBU) managed to control inflation 
relatively  well  by  historical  standards  in  2010.  Following  three  years  of  double-digit 
increases in consumer prices, the year-average headline inflation in 2010 came to 9.4%. 
Core inflation was even slightly lower, at 8.6%, reflecting the fact that part of the price 
pressure stemmed from increases in excise taxes and administered prices, notably for gas 
and communal heating services, in line with the IMF programme.  

In its fiscal policy, Ukraine also broadly followed the consolidation course agreed with 
the  IMF  under  the  July  2010  SBA.  At  just  over  5%  of  GDP,  the  general  government 
deficit was even lower than the programme target of 5.5% in 2010, although this positive 
development was offset by the higher-than-mandated deficit of Naftogaz, which occurred 
despite the gas price hikes implemented under the programme. General government debt 
stood at approximately 36% of GDP, a notable deceleration of the steep increases seen 
during the crisis years of 2008 and 2009. 

On  the  external  front,  the  positive  adjustment  of  the  current  account  that  had  resulted 
from the crisis-related contraction of imports during 2009 continued through the first half 
of 2010, before starting to reverse as domestic demand picked up. The current account 
slipped  back  into  deficit  in  Q3  2010,  i.e.  even  before  the  start  of  the  heating  season, 
which traditionally entails higher gas imports for Ukraine.  

Positively,  the  country  was  able  to  tap  various  sources  of  external  financing.  Notably, 
this included a return to capital markets with a combined USD 2.5 billion of Eurobonds 
issued  in  September  and  December  2010  and  a  further  USD 1.5 billion  issued  in 
February  2011.  The  government  also  secured  a  USD 2 billion  revolving  loan  from  a 
Russian  state-owned  bank  and,  most  importantly,  a  new  Stand-By  Arrangement  (SBA) 
with the IMF in July 2010, worth USD 15 billion and running to end-2012 (following the 
stalling of the preceding SBA in November 2009 over Ukraine’s lack of compliance with 
agreed  programme  parameters).  Meanwhile,  negotiations  between  Ukraine  and  the  EU 
on  a  macro-financial  assistance  loan  of  EUR  610  million  were  launched,  but  not 
concluded, in 2010 (see below). 

The  combination  of  multilateral,  bilateral  and  private  external  borrowing  by  the 
government,  along  with  a  gradual  return  of  external  lending  to  private  borrowers  in 
Ukraine, allowed the National Bank of Ukraine (NBU) to replenish its foreign exchange 
reserves  from  a  low  of  USD 24.1 billion  in February 2010 to USD 34.6 billion at year-
end.  

Thus,  2010  was  overall  a  successful  year  for  Ukraine  in  terms  of  external  economic 
stabilisation. However, the relatively weak rebound in investment, along with persistent 
problems in the operating environment for businesses in Ukraine, calls into question the 
medium-term  sustainability  of  the  recovery.  With  the  current  account  deficit  widening 
again  and  debt  roll-over  requirements  of  around  USD 43 billion,  the  country  may 
continue  to  depend  on  official  external  financial  support  in  2011  if  it  is  to  avoid  a 

40 

 
recurrence  of  a  drain  on  its  foreign  currency  reserves,  as  happened  during  the  crisis  in 
2008-09.  

This  underlines  the  importance  of  continued  cooperation  with  the  IMF.  Ukraine 
successfully concluded the first review of the IMF programme, triggering the release of 
its second tranche (of approximately USD 1.5 billion) in December 2010. However, the 
completion of the second review of the programme, initially scheduled for March 2011, 
has  been  delayed  reflecting  notably  the  postponement  of  parliamentary  adoption  of 
pension reform legislation. 

7.3.  Structural reforms 

The  IMF  programme  was  instrumental  as  an  external  anchor  for  structural  reform 
progress in Ukraine in 2010. In particular, domestic gas prices were increased and are to 
be raised further in a gradual manner with a view to bringing retail energy prices to cost 
recovery levels, thereby reducing the need for state transfers to Naftogaz. As part of the 
IMF  programme,  Ukraine  also  started  working  on  pension  entitlement  reform  and 
committed to a reorientation of monetary policy towards domestic price stability as the 
primary objective, even if the resulting gradual relaxation of the de facto exchange rate 
peg  to  the US dollar did not  become  apparent over the course of 2010. Changes in the 
NBU law also strengthened the central bank’s independence (a reform also contained in 
the EU-Ukraine Association Agenda). 

In a separate development monitored closely both by the IMF and the EU, the Ukrainian 
government  reduced  the  arrears  on  VAT  refunds  that  had  existed  for  many  years  and 
swollen to unprecedented levels during the crisis. In August 2010, the government issued 
VAT bonds with a face value of UAH 16.4 billion or 1.6% of GDP to companies with 
outstanding  VAT  refund  claims.  While  this  measure  cleared  a  large  part  of  the  state’s 
VAT refund debt, it was controversial in the business community, both domestically and 
abroad, as companies felt compelled to sign up (perceiving the bond scheme as the only 
way  of  being  paid  at  all),  even  though  the  bonds  offered  a  coupon  inferior  to  market 
yields  of  comparable  government  bonds.  Indeed,  companies  in  need  of  cash  for  their 
operations had to sell the bonds at a discount of reportedly 20-30% of face value. There 
were  also  complaints  about  preferential  treatment  of  companies  with  close  ties  to  the 
authorities,  while  other  enterprises  reported  that  part  of  their  VAT  refund  claims  were 
not recognised and remained unpaid. Moreover, contrary to government claims that it has 
addressed the VAT refund problems in a durable manner, a renewed build-up of arrears 
was reported by companies in late 2010. 

The controversy about the VAT bond scheme was part of a general picture of growing 
concern  on  the  part  of  businesses  about  the  operating  and  investment  environment  in 
Ukraine  in  the  final  part  of  2010,  in  particular  regarding  red  tape  and  a  lack  of 
transparency  in  dealings  with  the  administration.  In  November-December  2010, 
divergences between the government and the business community came to a head when 
entrepreneurs protested publicly for several weeks against a planned overhaul of the Tax 
Code.  However,  the  government  ultimately  managed  to  defuse  the  protests  by  offering 
some targeted concessions to SMEs and entrepreneurs, thus securing passage of one of 
its flagship reform projects before year-end. 

Aside from the Tax Code, key pieces of legislation in the government’s economic reform 
agenda  of  2010  have  been  new  laws  on  public  procurement  and  the  functioning  of  the 

41 

 
gas market (providing notably for the unbundling of Naftogaz and the end of its domestic 
monopoly), as well as the Budget Code, on the basis of which the authorities drew up a 
2011 budget in line with the consolidation benchmarks agreed with the IMF. However, in 
many  areas,  there  are  problems  or  delays  with  the  implementation  and  enforcement  of 
new  laws,  which  can  therefore  not  unfold  their desired  positive impact on the business 
climate. For example, this has been the case for the public procurement law, as well as 
the  Tax  Code,  while  many  businesses  also  still  complain  about  arbitrary  customs 
valuation procedures, despite the fact that WTO-compliant legislation is in place. 

The  policy  programme  that  is  associated  with  the  EU’s  planned  MFA  operation  and 
currently  under  negotiation  between  the  European  Commission  and  Ukraine  therefore 
seeks to support further legislative developments, as well as the implementation side of 
the economic reform agenda in Ukraine. Meanwhile, recent and ongoing reforms in the 
area  of  public  finance  management  will  be  assessed  in  a  Public  Expenditure  and 
Financial  Accountability  (PEFA)  study  that  is  being  conducted  jointly  by  the  World 
Bank  and  the  European  Commission.  The  results  of  this  PEFA  study  that  will  be 
updating  the  one  conducted  by  the  World  Bank  in  2007will  be  available  in  the  second 
half of 2011. 

7.4. 

 Implementation of macro-financial assistance 

Following the Commission proposal for MFA of EUR 500 million to Ukraine, adopted in 
late 2009 in response to a Ukrainian request of the same year, the co-legislators approved 
the  package  in  July  2010  (as  the  first  MFA  Decision  adopted  under  the  ordinary 
legislative  procedure  as  per  the  Lisbon  Treaty).  In  addition,  EUR  110  million  of  MFA 
stemming from a Council Decision of 2002 are still available to Ukraine. In parallel to 
the  co-legislator’s  deliberations  and  in  order  to  prepare  the  eventual  implementation  of 
the  MFA,  the  Commission  launched  a  new  Operational  Assessment  of  administrative 
procedures and financial circuits of public organisations involved in the management of 
MFA in Ukraine. The consultants submitted their final report in April 2010. Its general 
conclusion is that the framework for sound financial management is effective in Ukraine, 
despite  several  weaknesses  detected  during  this  mission,  such  as  the  absence  of  an 
efficient external audit function, deficiencies in the transparency of public procurement 
and difficulties in the financial management of state-owned enterprises.  

As  of  end-2010,  the  assistance  was  still  at  the  negotiation  stage;  no  disbursement  was 
made  in  the  course  of  the  year.  The  Commission  organised  a  mission  to  Kiev  in  July 
2010,  immediately  after  the  adoption  of  the  aforementioned  MFA  Decision,  to  gather 
detailed  information  on  the  economic  situation  of  the  country  following  the  crisis  of 
2008-09  and  on  the  government’s  planned  reforms.  The  IMF  also  sent  a  mission  to 
Ukraine in July 2010, following which the Executive Board, on 28 July, approved a new 
Stand-By Arrangement worth up to SDR 10 billion and running to end-2012. 

On this basis, the Commission proposed to combine the EU’s MFA loan amounts of the 
2002  and  2010  Decisions  in  a  single  package  (covered  by  one  Memorandum  of 
Understanding and one Loan Agreement) of up to EUR 610 million. This is to be split 
into four tranches (of EUR 100 million, EUR 10 million, EUR 250 million and EUR 250 
million),  of  which  the  second  and  third  (a  combined  EUR  260  million)  could  be 
disbursed on the same date. First drafts of the Memorandum of Understanding and Loan 
Agreement were presented to the authorities at the end of the staff mission in July. The 
policy  measures  proposed  therein  take  into  account  the  shortcomings  in  public  finance 

42 

 
management  detected  by  the  Operational  Assessment  (conducted  in  2009),  while  also 
covering important structural reform priority areas, notably taxation and trade (including 
the  VAT  refund  system  and  customs  valuation  practices),  energy  (unbundling  and 
increased transparency in the gas sector), and finance (legislative approximation with the 
EU).  

Bilateral consultations on the package took place over the following months; these talks 
were  upgraded  to  negotiations  by  the  Ukrainian  side  in  November  2010,  following  the 
President’s  official  authorisation  of  a  negotiating  mandate  for  the  Ministry  of  Finance. 
However, progress in these negotiations has been slow, reflecting reluctance on the part 
of  the  authorities  to  make  clear  commitments  in  some  key  reform  areas,  including 
external audit, VAT refund arrears and energy sector reform.  

Meanwhile,  Ukraine  successfully  concluded  the  first  review  of  the  IMF  programme, 
triggering  the  release  of  its  second  tranche  (of  approximately  USD  1.5  billion)  in 
December  2010.  However,  the  completion  of  the  second  review  of  the  programme, 
the 
initially  scheduled  for  March  2011,  has  been  delayed  reflecting  notably 
postponement  of  parliamentary  adoption  of  pension  reform  legislation.  Continued 
successful conclusions of IMF reviews under the current SBA, as well as an agreement 
between Ukraine and the EU on the pending Memorandum of Understanding and Loan 
Agreement, are pre-conditions for any disbursements of EU MFA in 2011. 

43 

 
 
UKRAINE - SUMMARY STATUS OF ECONOMIC REFORM 

1. Price liberalisation   

Most  prices  are  free,  but  regulated  prices  prevail  for  some  utilities,  notably  gas,  as  well  as  in 
some other areas.  

2. Trade liberalisation   

Ukraine joined the WTO in May 2008. However, export duties and quotas on individual products 
remain in force, and complaints by importers about technical and administrative barriers to trade 
abound.  Positively,  in  late  2010  legal  changes  were  adopted  that  will  facilitate  the  gradual 
replacement  of  obligatory  pre-market  certification  of  non-food  products  (which  presently 
constitutes a trade barrier) with a system of market surveillance. 

3. Exchange rate regime   

While not officially operating a peg or band, the National Bank of Ukraine effectively manages 
the level of the hryvnia against the US dollar.  Since the crisis-related devaluation in late 2008, 
the  central  bank  has  held  the  hryvnia  at  close  to  UAH  8:USD.  A  gradual  reorientation  of 
monetary policy towards domestic price stability has been agreed between Ukraine and the IMF.  

4. Foreign direct investment   

FDI-related flows are largely liberalised, and since May 2010 a registration of foreign investment 
is no longer compulsory. Meanwhile, some sectors remain closed to foreign ownership, notably 
the gas transmission system.  

5. Monetary policy   

The  National  Bank  of  Ukraine  is  responsible  for  controlling  the  domestic  money  supply. 
Amendments to the NBU law of 2010 aimed at strengthening the bank’s political independence 
and its responsibility for price stability. However, in practice, exchange rate stability (against the 
US dollar) still takes precedence over of domestic inflation control.  

6. Public finances   

General  government  expenditure  made  up  an  estimated  48.3%  of  GDP  in  2010.  Nearly  three-
quarters of Ukraine’s government expenditure goes towards wages and social transfers (including 
over one-third on pensions). Gradual domestic gas price increases under the IMF programme are 
aimed  at  balancing  Naftogaz’  finances,  thus  relieving  budgetary  pressures.  Ukraine  has  also 
undertaken some reforms in its public finance management systems (e.g. in public procurement), 
but  many  challenges  remain  (e.g.  in  tax  and  customs  administration  and  the  fight  against 
corruption). 

7. Privatisation and enterprise restructuring   

State-owned companies continue to dominate certain sectors, in particular utilities; the gas sector 
holding Naftogaz remains largely unreformed; and the privatisation of strategic assets, including 
the  gas  transmission  system,  is  prohibited  by  law.  In  December  2010  a  ban  on  privatisation  of 
several  big  companies  in  the  power  generation  and  mining  sectors  was  lifted,  and  the 
privatisation of telecommunications company Ukrtelecom was launched. 

8. Financial sector reform   

At the end of 2010, 176 banks were operating in Ukraine, including 17 foreign-owned institutes. 
Before the crisis, Ukraine had two state-owned banks. In 2009 this number increased to five as 
the  state  became  majority-owner  in  three  troubled  banks.  An  audit  by  the  NBU  in  late  2010 
revealed that these banks require further substantial injections of state resources. Aside from the 
consolidation and recapitalisation of the banking system, it is the authorities’ declared objective 
to  develop  domestic  private  capital  markets  and  to  upgrade  the  independence  and  capacity  of 
financial regulators.  

44 

 
MEDITERRANEAN NEIGHBOURHOOD COUNTRIES 

8.  LEBANON 

8.1.  Executive summary 

Mediterranean Neighbourhood Countries are eligible for MFA under the Genval Criteria. 
Lebanon  is  the  first  country  of  this  group  benefiting  from  MFA  since  the  balance  of 
payments loan granted in 1994 to Algeria (Decision 1994/933/EC). 

Lebanon’s economy continued to grow at a remarkable – although slightly lower – rate 
during 2010, aided by the prudent macroeconomic policies of the past years and a well 
functioning  banking  system.  The  formation  of  a  new  national  unity  government  in  late 
2009 helped to restore confidence and enabled a marked acceleration in capital inflows, 
including  a  steady  stream  of  foreign  deposits  in  the  banking  sector  during  2010.  The 
fiscal  position,  as  well  as  the  balance  of  payments  position,  deteriorated  moderately 
mainly due to rises in government expenditures and oil prices. The sizeable debt-to-GDP 
ratio improved, prolonging the declining trend of the previous years. On the back of the 
unfolding political and social crisis, the Banque du Liban (BdL) has become an effective 
regulator and the central pillar of economic management in the country  

While  macroeconomic  management  and  performance  was  broadly  satisfactory  in  2010, 
the country continued to fail to make progress with structural reforms reflecting the lack 
of  consensus  within  the  coalition  government.  Political  instability  remains  in  2011  a 
main destabilisation factor of the Lebanese economy, with the Prime Minister designate, 
Najib Mikati, struggling to form a cabinet.  

In December 2007, the Council adopted a decision on a MFA to Lebanon amounting to 
EUR  80  million  –  a  combination  of  medium-term  loans  (EUR  50  million)  and  grants 
(EUR 30 million), to be disbursed in two tranches. The first tranches of grants and loans 
were disbursed  in  December 2008 and June 2009 respectively. At the end of 2009, the 
Commission proposed a one-year extension of the period of availability of the assistance  
to  21  December  2010,  to  be  formalised  through  an  addendum  to  the  Memorandum  of 
Understanding.  However,  this  addendum  was  never  signed  by  the  authorities.  This,  as 
well  as  the  lack  of  progress  with  implementing  the  MFA  conditions  and  the  lack  of  a 
successor  IMF  arrangement  thwarted  the  disbursement  of  the  second  tranche  of  the 
MFA, which has now expired. 

8.2.  Macroeconomic performance 

The Lebanese economy showed great resilience to the global financial crisis despite the 
politically  uncertain  environment.  Buoyant  economic  activity  led  to  an  estimated  real 
GDP growth of almost 8% in 2010 from almost 9% in the previous year. This remarkable 
performance  was  partly  attributed  to  low  degree  of  exposure  to  international  financial 
markets  and  the  implementation  of  prudent  banking  regulations  and  supervision. 
Inflation  pressures  stemming  mainly  from  fuel  and  food  price  increases  intensified 
during 2010; average inflation reached 5% during the year after the sharp drop to 1.2% in 
2009  in  the  context  of  the  global  crisis  and  the  associated  decline  in  international 
commodity prices.  

45 

 
The government budget deficit (including grants) is estimated to have widened to 8.7% 
of  GDP  in  2010  from  8.1%  in  2009,  partly  reflecting  capital  expenditures  increases, 
including  substantial  investments  in  electricity  generation,  and  other  government 
expenses,  that  more  than  outweighed  buoyant  fiscal  revenues.  Despite  its  steady 
declining trend during the last years, public debt remains at extremely high levels (139% 
of GDP in 2010) and almost half of it is denominated in foreign currency, underlying the 
country’s  external  vulnerability  and  fiscal  consolidation  challenges.    A  combination  of 
expenditure rationalization and socially balanced tax measures is necessary for lowering 
the debt burden, while maintaining permanently higher investment and social spending. 

On the back of increases in oil prices and the rebound of real import growth, the current 
account balance (including official grants) deteriorated to -11.1% of GDP from -9.5% in 
2009. On a more positive note, the external debt-to-GDP ratio declined to 160% by the 
end  in  2010  (from  171%  in  end  2009),  continuing  the  moderate  downward  trend 
witnessed in previous years.  

In  order  to  reduce  the  vulnerability  to  external  shocks,  the  Banque  du  Liban  has 
endeavoured  to  retain  a  comfortable  level  of  international  reserves.  Abundant  capital 
inflows  enabled  the  accumulation  of  foreign  currency  reserves  during  the  last  years, 
reaching the record level of EUR 32.2 billion in 2010 (corresponding to 10.3 months of 
next year’s imports of goods and services), as compared to EUR 26.8 billion in 2009.  

Despite the overall resilience of the Lebanese economy to global headwinds in 2010, the 
economic situation remains vulnerable. Substantial imbalances in the public finances and 
external accounts could affect the credibility of the exchange rate peg in the longer term. 
The economy is currently directly affected by the political and social unrest in the Arab 
world, given that some of its main trading and financial partners are the countries of the 
Middle  East  and  North  Africa.  In  particular,  Lebanon  depends  significantly  on  worker 
remittances and investments from Gulf Cooperation Council countries. It is also highly 
dependent on imported hydrocarbons for almost all its energy needs, making the country 
particularly vulnerable to international oil price increases. Apart from political risks and 
the slow global upswing, economic vulnerability stems from the high public and external 
debt, the reliance on just a few sectors to provide the bulk of growth, uncertainty about 
the persistence  of foreign inflows  in a  situation where banks continue to have maturity 
mismatches, and possible inflation risks also in view of rising commodity prices.  

8.3.  Structural reforms 

Implementation  of  the  ambitious  programme  of  structural  reforms  adopted  in  the 
aftermath  of  the  Paris  agreements  stalled  as  a  consequence  of  the  political  stalemate, 
which  paralysed  progress  in  legislative  activity  in  the  run-up  to  the  June  2009 
parliamentary elections and during the protracted subsequent negotiations on forming a 
new government.  

During 2010, while macroeconomic policies were relatively prudent, progress in growth-
enhancing  structural  reforms  was  rather  poor.  The  implementation  of  key  structural 
reform  measures  set  by  the  Paris  III  donor  conference  and  the  two  IMF’s  Emergency 
Post-Conflict  Assistance  (EPCA)  programmes,  including  raising  the  value  added  tax 
(VAT)  rate,  eliminating  extra-budgetary  funds,  and  strengthening  public  finance 
management (including overhauling the budget process), was clearly below expectations. 
Changing the heavily subsidised electricity system is another urgent priority in phase of 

46 

 
the frequent power shortages. In addition, modernizing tax administration and reforming 
the  water  and  telecommunications  sectors  remain  key  elements  of  Lebanon’s  reform 
agenda.  

Fiscal reforms, including expanding revenue collection, are necessary to reduce the large 
public debt stock. However, the adoption of fiscal reforms was thwarted by the lack of 
political  consensus  within  the  coalition  government.  The  draft  2010  budget  entailed  an 
increase  in  capital  spending  of  2.4%  of  GDP,  including  substantial  investments  in 
electricity  generation,  but  an  increase  in  VAT  rate  was  not  feasible  due  to  lack  of 
political  support.  Privatization  of  the  two  state-owned  mobile-phone  operators  and 
restructuring  of  the  heavily  subsidised  state-owned  electricity  provider,  Electricité  du 
Liban  (EDL),  have  been  put  on  ice,  reflecting  ongoing  uncertainty  about  market 
conditions,  and  are  not  expected  before  2012.  Nevertheless,  a  20%  cut  in  subsidies  to 
EDL was achieved in 2010, due to the substitution of the provider’s imported fuel oil by 
Egyptian gas. A 25% stake in the national air carrier MEA, held by the central bank, was 
announced to be floated in 2010 thus delaying the time path for full privatisation. 

In the field of public finance management, progress with improving budgetary planning 
and  control  has  been  limited.  This  concerns  measures  aimed  at  improving  budget 
formulation  and  execution,  cash  management  and  implementation  of  a  Single  Treasury 
Account.  The  2010  budget  approved  in  April  2010  includes  some  provisions  on  fiscal 
accountability, but this does not imply a multi-annual fiscal framework. 

In summer 2010, the Commission undertook, with the help of a team of consultants, an 
assessment of the PFM systems in Lebanon according to the methodology developed in 
the context of the Public Expenditure and Financial Accountability (PEFA) partnership. 
The  PEFA  assessment  is  still  being  discussed  with  the  authorities  and  has  not  been 
finalised yet.  

It should be noted that several of the above reforms, namely the introduction of a Single 
Treasury Account, the reform of electricity tariffs and the privatisation of mobile phone 
networks were among the key policy conditions of the MFA operation decided in 2007.   

In view of the large weight of the financial sector in the Lebanese economy, actions to 
improve  prudential  oversight  and  regulations  are  a  key  component  of  the  structural 
reform agenda. Against this background, the Banque du Liban and IMF agreed to have 
an  updated  examination  under  the  Financial  Stability  Assessment  Programme  in  2010 
This would be valuable to identify vulnerabilities in the Lebanese financial system and to 
implemented 
benchmark  against  new  standards  of  oversight 
internationally. The high interest rate spreads charged by commercial banks on domestic 
loans  discourage  both  lending  (notably  to  small  and  medium-term  enterprises)  and  the 
growth of local currency deposits in a highly dollarized economy. 

that  are  being 

More generally, many impediments to a conducive business climate remain unresolved. 
Hence, the ranking of Lebanon according to several business climate measures remained 
poor in comparison with regional peers, many of which made progress in recent years. It 
is  crucial  that  the  authorities  proceed  with  reviving  the  stalled  reform  agenda  to  make 
growth  in  the  country  less  dependant  on  a  few  industries  only,  such  as  finance,  and  to 
develop growth potential in other sectors. Despite relatively favourable macroeconomic 
developments in the last year, the fiscal deficit and public debt remain high and progress 
with fiscal consolidation to reduce the hefty burden of public debt service remains a key 
priority to ensure sustainability. 

47 

 
8.4.  Implementation of macro-financial assistance 

In  2008,  the  Commission  started  the  implementation  of  the  Council  Decision 
2007/860/EC  providing  macro-financial  assistance  of  EUR  80  million  in  the  form  of  a 
combination  of  a  medium-term  loan  and  grant  of  EUR  50  and  30  million  respectively. 
The  assistance  complemented  support  from  the  Bretton  Woods  institutions,  bilateral 
donors  (including  EU  Member  States  and  Arab  countries),  and  other  EU  assistance 
provided under the ENPI and in the form of EIB loans. 

The EU MFA aimed primarily at supporting the authorities' effort of fiscal consolidation, 
strengthening  public  finance  management  and  encouraging  privatisation  efforts.  Thus, 
the  specific  reform  measures  targeted  by  the  programme  focused  on  public  finance 
management  and  on  two  specific  sector  policies  of  particular  importance  for  fiscal 
adjustment and debt reduction, namely the power sector and the social sector. Agreement 
on the conditions to be attached to the disbursement of the assistance was reached in the 
course  of  2008.  Subsequently,  the  EUR  15  million  first  tranche  of  the  grant  was 
disbursed end-December 2008. The first tranche of a 5-year loan of EUR 25 million was 
disbursed on 4 June 2009.  

The disbursement of the second tranche was subject to the fulfilment of the agreed policy 
conditionality.  One  important  element  of  conditionality  is  the  existence  of  an  ongoing 
IMF  programme.  On  9  April  2007  the  IMF  Board  had  approved  an  Emergency  Post-
Conflict  Arrangement  (EPCA  I)  of  SDR  50.75  million  based  on  the  five-year  reform 
program  presented  by  the  Lebanese  authorities  at  the  Paris  III  conference  in  January 
2007  In  November  2008,  the  IMF  Board  approved  a  second  EPCA  package  of  SDR 
25.375  million.  The  EPCA  II  programme  expired  at  the  end  of  June  2009,  with  the 
quantitative targets (focusing on an increase in foreign currency reserves and on targeting 
a  reduction  in  the  primary  fiscal  balance)  comfortably  met.  However,  key  non-
quantitative targets were not met, notably the introduction of a single Treasury account; 
the  reform  of  electricity  tariffs;  and  the  privatisation  of  mobile  phone  networks.  No 
further IMF programmes have been launched. 

Following the expiration of the IMF arrangement, progress with fulfilling the conditions 
was very limited in 2009 due to the difficult political situation in the run-up to elections. 
Against  this  background,  in  December  2009,  the  Commission  proposed  to  extend  the 
availability period of the second tranche of the assistance programme by one year (from 
21  December  2009  to  21  December  2010)  through  an  addendum  to  the  MoU.  This 
addendum was, however, never signed by the Lebanese authorities.  

On 13 December 2010 the Lebanese Minister of Finance requested an extension on the 
disbursement  period  of  the  second  tranche  by  the  Commission  and  a  review  of  the 
conditionality  attached  to  the  MFA  program.  The  request  was  rejected  by  the 
Commission on the grounds of poor implementation by the national authorities of the key 
structural reform conditions during the period of validity of the MFA operation, the lack 
of  a  successor  IMF  financial  arrangement,  the  failure  of  the  authorities  to  accept  the 
proposed  extension  of  the  period  of  validity  of  the  MoU  and  the  improvement  of 
Lebanon’s  balance  of  payments  position.  Hence,  this  MFA  expired  without  the 
disbursement of the second tranche. 

48 

 
 
LEBANON - SUMMARY STATUS OF ECONOMIC REFORM  

1. Price liberalisation 

Most prices are free, but the government subsidises the price of wheat. 

2. Trade liberalisation 

Liberal  international  trade  policy,  but  protectionist  measures  are  occasionally  introduced. 
Lebanon is a founding member of GATT but it withdrew in 1949. It is now negotiating the 
accession to WTO.  

3. Exchange regime 

Fixed exchange rate (peg to the USD). No restrictions on current international transactions 
in  conformity  with  Article  VIII  of  the  IMF’s  Articles  of  Agreement.  Lebanon  has  also 
achieved substantial capital account convertibility. 

4. Foreign direct investment 

Unlimited repatriation of capital and profits and no limitations on holding foreign currency 
bank  accounts.  Legislation  is  overall  adequate  and  an  investment  development  authority 
exists but enforcement of contracts is sometimes problematic in the absence of commercial 
courts and independent judiciary.  

5. Monetary policy 

The  Banque  du  Liban  uses  a  wide  range  of  monetary  policy  instruments  to  maintain 
financial stability and provide liquidity to the banking sector. It also occasionally provides 
financing to the government (on a temporary basis). The exchange rate peg is regarded as a 
key factor in maintaining monetary stability 

6. Public finance 

The  high  public  debt  ratio  and  high  interest  rates  at  which  the  government  is  borrowing 
remain issues of concern. The tax base remains shallow and skewed towards indirect taxes. 
Significant tax exemptions are granted to the banking sector, notably as regards the taxing 
foreign  deposits.  Public  finance  management  reform  focuses  on  budget  formulation  and 
execution and medium-term planning. There has been little progress on this front in recent 
years.  Key  issues,  such  as  the  Treasury  Single  Account  law,  are  still  pending  before 
Parliament. 

7. Privatisation and enterprise restructuring 

The structural reform programme focuses on privatisation, improvement of business climate, 
privatisations,  and  opening  of  markets,  but  progress  has  been  stalled  due  to  the  political 
situation.  Important  privatisations,  for  instance  of  mobile  telephony  licenses  and  the 
electricity company, have been postponed. 

8. Financial sector reform 

Lebanon  has  a  sophisticated  and  developed  financial  sector,  based  on  domestic  private 
banks, which proved resilient to shocks despite vulnerabilities. However, it exhibits a high 
degree of dollarization, with 79.6% of loans and 62.9% of deposits as of March 2010 being 
denominated in foreign currency. 

49 

 
 
Annex  1A 
-  COMMUNITY  MACRO-FINANCIAL  AND  EXCEPTIONAL 
FINANCIAL  ASSISTANCE  TO  THIRD  COUNTRIES  BY  DATES  OF  COUNCIL 
DECISIONS 

Status of effective disbursements as of end-December 2010 (in millions of €) 

Authorisations

Disbursements

Country 

Date of
Decision

Reference of
Decision

Maximum
amount

Dates of
disbursements

Amounts of
disbursements disbursed

Totals

Undisbursed

22.07.91

91/408/EC

187,5

Mar. 1992

187,5

187,5

Hungary I
(Loan)

22.02.90

90/83/EC

870

Czech and 
Slovak Federal Republic

25.02.91

91/106/EC

375

Hungary II
(Loan)

Bulgaria I 
(Loan)

Romania I
(Loan)

Israel1
(Loan)

Algeria I
(Loan)

Albania I
(Grant)

Bulgaria II
(Loan)

24.06.91

91/310/EC

180

24.06.91

91/311/EC

290

22.07.91

91/384/EC

375

23.09.91

91/510/EC

400

28.09.92

92/482/EC

70

19.10.92

92/511/EC

110

Baltics
(Loans); of which:

23.11.92

92/542/EC

220

    Estonia
    Latvia
    Lithuania

Romania II
(Loan)

Moldova I
(Loan)

Romania III
(Loan)

(40)
(80)
(100)

80

45

27.11.92

92/551/EC

13.06.94

94/346/EC

20.06.94

94/369/EC

125

260
(Suspended)

Apr. 1990
Feb. 1991

Mar. 1991
Mar. 1992

Aug. 1991
Jan. 1993

Aug. 1991
Mar. 1992

Jan. 1992
Apr. 1992

350
260

185
190

100
80

150
140

190
185

610

375

180

290

375

400

70

110

135

(20)
(40)
(75)

80

45

125

250
150

35
35

70
40

20
40
50
25

80

25
20

55
40
30

Jan. 1992
Aug. 1994

Dec. 1992
Aug. 1993

Dec. 1994
Aug .1996

March 1993
March 1993
July 1993
Aug. 1995

Feb. 1993

Dec. 1994
Aug. 1995

Nov. 1995
Sep. 1997
Dec. 1997

50 

85
(Suspended)

(20)
(40)
(25)

 
 
 
 
Authorisations

Disbursements

Country 

Date of
Decision

Reference of
Decision

Maximum
amount

Dates of
disbursements

Amounts of
disbursements disbursed

Totals

Undisbursed

28.11.94

94/773/EC

35

June 1995
Oct. 1996

15
20

35

22.12.94

94/938/EC

200

Nov. 1995

100

100

22.12.94

94/939/EC

130

July 1996

Albania II
(Grant)

Algeria II
(Loan)

Slovakia
(Loan)

Ukraine I
(Loan)

Belarus
(Loan)

Ukraine II
(Loan)

22.12.94

94/940/EC

10.04.95

95/132/EC

85

55

23.10.95

95/442/EC

200

Moldova II
(Loan)

25.03.96

96/242/EC

Former Yugoslav 
Republic of Macedonia I
(Loan)

22.07.97

97/471/EC

15

40

Bulgaria III
( Loan)

22.07.97

97/472/EC

250

Armenia, Georgia 
and Tajikistan2
(Loans and grants)
 Agreed amounts with the recipent countires:

17.11.97
modified by
28.3.00

97/787/EC

00/244/EC

   Armenia
   (Loan and grant)

   Georgia
   (Loan and grant)

   Tajikistan
   (Loan and grant)

375

(328)

(58)

(175)

(95)

100
(Suspended)

130
(Cancelled)

25
(Suspended)

85

30

200

15

40

250

294,5

80,5

(58)

(141,5)

(33,5)

(95)

85

30

50
50
100

15

25
15

125
125

28
8
4
5,5
5,5
5,5
1,5

110
10
9
6
6,5

60
7
7
7
7
7

Dec. 1995

Dec. 1995

Aug. 1996
Oct. 1996
Sep. 1997

Dec. 1996

Sep. 1997
Feb. 1998

Feb. 1998
Dec. 1998

Dec. 1998 (loan)
Dec. 1998 (grant)
Dec.  1999 (grant)
Feb. 2002 (grant)
Dec. 2002 (grant)
June 2004 (grant)
Dec. 2005 (grant)

Jul. 1998 (loan)
Aug. 1998 (grant)
Sep. 1999 (grant)
Dec. 2001 (grant)
Dec. 2004 (grant)

Mar. 2001 (loan)
Mar. 2001 (grant)
Dec. 2001 (grant)
Feb. 2003 (grant)
May. 2005 (grant)
Oct. 2007 (grant)

51 

 
 
 
Authorisations

Disbursements

Country 

Date of
Decision

Reference of
Decision

Maximum
amount

Dates of
disbursements

Amounts of
disbursements disbursed

Totals

Undisbursed

Ukraine III
(Loan)

15.10.98
12.07.02

98/592/EC
02/639/EC

150

July 1999

58

58

92
(Cancelled)

20

Albania III
( Loan)

22.04.99

99/282/EC

Bosnia I3
(Loan and grant)

10.05.99
modified by
10.12.01

99/325/EC

01/899/EC

20

60

Bulgaria IV
(Loan)

08.11.99

99/731/EC

100

Former Yugoslav 
Republic of
Macedonia II4
(Loan and grant)

08.11.99

99/733/EC

modified by

10.12.01

01/900/EC

80
18

Romania  IV
(Loan)

Kosovo I5
(Grant )

Montenegro5
(Grant )

08.11.99

99/732/EC

200

19.02.00

00/140/EC

22.05.00

00/355/EC

35

20

15

Moldova III
(Loan)

10.07.00
19.12.02

00/452/EC
02/1006/EC

Kosovo II3
(Grant) 

Serbia and 
Montenegro I6
(ex FRY)
(Loan and grant)

27.06.01

01/511/EC

30

16.07.01

01/549/EC

345

modified by

10.12.01

01/901/EC

12.07.02
Ukraine IV
(Loan) Modification of Decision 
98/592/EC

02/639/EC

110

05.11.02

02/882/EC

130

Serbia and 
Montenegro II7
(ex FRY)
(Loan and grant)

60

100

98

150

50

35

20

30

345

15
(Cancelled)

110

105

25

15
10
10
10
15

40
60

20
10
12
10
10
10
18
8

100
50

20
15

7
13

15
15

225
35
40
45

30
10
35
30

Dec. 1999 (grant)
Dec. 1999 (loan)
Dec. 2000 (grant)
Dec. 2000 (loan)
Dec. 2001 (grant)

Dec. 1999
Sep. 2000

Dec. 2000 (grant)
Dec. 2000 (loan)
Dec. 2001 (loan)
Dec. 2001 (grant)
May 2003 (grant)
June 2003 (loan)
Dec. 2003 (loan)
Dec. 2003 (grant)

June 2000
July 2003

Mar. 2000
Aug. 2000

Aug. 2000
Dec. 2000

Sep. 2001
Dec. 2002

Oct. 2001 (loan)
Oct. 2001 (grant)
Jan. 2002 (grant)
Aug. 2002 (grant)

Dec. 2002 (grant)
Feb. 2003 (loan)
Aug. 2003 (grant)
Aug. 2003 (loan)

52 

 
 
 
Authorisations

Disbursements

Country 

Date of
Decision

Reference of
Decision

Maximum
amount

Dates of
disbursements

Amounts of
disbursements disbursed

Totals

Undisbursed

Bosnia II8
(Loan and grant)

05.11.02

02/883/EC

60

Feb. 2003 (grant)
Dec. 2003 (grant)

15
10

25

 the rest was 
paid under
04/861/EC

Moldova IV
(Grant)

19.12.02

02/1006/EC

15

25.11.03

Serbia and 
Montenegro II7
(ex FRY)
Modification Decision 02/882/EC (grant)

03/825/EC

70

Dec. 2004 (grant)

10

10

15

20
 the rest was 
paid under
04/862/EC

11,5

20
(expired)

40

100

100

25

35

40

22

30

45

40

46

Albania IV9
(Loan and grant)

29.04.04

04/580/EC

25

Nov. 2005 (grant)
March 2006 ( loan)
July 2006 (grant)

Bosnia II8
Modification Decision 
02/883/EC (grant and loan)

7/12/2004

04/861/EC

the balance of
02/883/EC

Dec. 2004 (loan)
June 2005 (grant)
Feb. 2006 (loan)

07.12.2004

Serbia and 
Montenegro II7
(ex FRY)
Modification Decision 02/882/EC (Grant and loan)

04/862/EC

the balance of
03/825/EC

April 2005 (loan)
Dec. 2005 (grant)

Georgia II
(Grant)

        24.01.06

06/41/EC

33,5

August 2006 (grant)
Dec. 2006 (grant)

Kosovo (Grant)

30.11.06

06/880/EC

50

Sept. 2010 (grant)

Moldova
(Grant)

16.04.07

07/259/EC

45

Lebanon10
(Loan and grant)

10.12.07

07/860/EC

Georgia
(Grant)

30.11.09

09/889/EC

80

46

Armenia11
(Loan and grant)

30.11.09

09/890/EC

100

Bosnia and 
Herzegovina (Loan)

30.11.09

09/891/EC

100

3
9
13

10
15
10

15
25

11
11

30

20
10
15

15
25

Oct. 2007 (grant)
June 2008 (grant)
Dec. 2008 ( grant)

Dec. 2008 (grant) 
June 2009 (loan)

Dec. 2009 (grant)
Jan. 2010 (grant)
August 2010 (grant)

15,3
7,7
23

53 

 
 
 
Authorisations

Disbursements

Country 

Date of
Decision

Reference of
Decision

Maximum
amount

Dates of
disbursements

Amounts of
disbursements disbursed

Totals

Undisbursed

Serbia (Loan)

30.11.09

09/892/EC

200

Ukraine (Loan)

29.06.10

338/2010/EU

500

Moldova (Grant)

20.10.10

938/2010/EU

90

Dec. 2010 (grant)

40

40

200

500

50

TOTAL

7440

5391

2049

1 Assistance to Israel includes a loan principal amount of € 160 million and grants of € 27.5 million in the form of interest su bsidies
2 Exceptional financial assistance, which includes a ceiling of € 245 million for the loans and a ceiling of € 130 million for t he grants
  Out of the global amount of € 375 million, maximum amounts of € 58 million, € 175 million and € 95 million 
   were actually agreed with the beneficiary countries
3 Includes a loan principal amount of up to € 20 million and grants of up to € 40 million
4 Includes a loan principal amount of up to € 50 million and grants of up to € 48 million
5 Exceptional financial assistance
6 Includes a loan principal amount of € 225 million and grants of € 120 million
7 Includes a loan principal amount of € 55 million and grants of € 75 million
8 Includes a loan principal amount of € 20 million and grants of € 40 million
9 Includes a loan principal amount of € 9 million and grants of € 16 million
10 Includes a loan principal amount of € 50 million and grants of € 30 million
11 Includes a loan principal amount of € 65 million and grants of € 35 million

54 

 
                                                            
 
Annex  1B 
FINANCIAL ASSISTANCE TO THIRD COUNTRIES BY REGION 

-  COMMUNITY  MACRO-FINANCIAL  AND  EXCEPTIONAL 

Status of effective disbursements as of end-December 2010 (in millions of €) 

Country 

Date of
Decision

Reference of
Decision

Maximum
amount

Dates of
disbursements

Amounts of
disbursements

Totals Undisbursed

Authorisations

Disbursements

A. EU Accession countries

Baltics
(Loans) of which :
    Estonia
    Latvia
    Lithuania

Bulgaria I 
(Loan)

Bulgaria II
(Loan)

Bulgaria III
(Loan)

Bulgaria IV
(Loan)

23.11.92

92/542/EC

220

(40)
(80)
(100)

24.06.91

91/311/EC

290

19.10.92

92/511/EC

110

22.07.97

97/472/EC

250

08.11.99

99/731/EC

100

Czech and 
Slovak Federal Republic
(Loan)

25.02.91

91/106/EC

375

Hungary I
(Structural adjustment loan)

22.02.90

90/83/EC

870

Hungary II
(loan)

Romania I
(Loan)

Romania II
(Loan)

Romania III
(Loan)

Romania  IV
(Loan)

24.06.91

91/310/EC

180

22.07.91

91/384/EC

375

27.11.92

92/551/EC

80

Feb. 1993

20.06.94

94/369/EC

125

08.11.99

99/732/EC

200

Nov. 1995
Sep. 1997
Dec. 1997

June 2000
July 2003

55 

March 1993
March 1993
July 1993
Aug. 1995

Aug. 1991
March 1992

Dec. 1994
Aug. 1996

Feb. 1998
Dec. 1998

Dec. 1999
Sep. 2000

March 1991
March 1992

Apr. 1990
Feb. 1991

Aug. 1991
Jan. 1993

Jan. 1992
Apr. 1992

135

(20)
(40)
(75)

85
(Suspended)
(20)
(40)
(25)

290

110

250

100

375

610

260
( Suspended)

180

375

80

125

150

50

20
40
50
25

150
140

70
40

125
125

40
60

185
190

350
260

100
80

190
185

80

55
40
30

100
50

 
 
 
 
 
Authorisations

Disbursements

Date of
Decision

Reference of
Decision

Maximum
amount

Dates of
disbursements

Amounts of
disbursements

Totals Undisbursed

22.12.94

94/939/EC

130

July 1996

130
Cancelled

3305

2780

525

Country 

Slovakia
(Loan)

TOTAL A

B. Western Balkans

Albania I
(Grant)

Albania II
(Grant)

Albania III
(Loan)

28.09.92

92/482/EC

28.11.94

94/773/EC

22.04.99

99/282/EC

Bosnia I1
(Loan and grant)

10.05.99

99/325/EC

modified by

10.12.01

01/899/EC

Former Yugoslav Republic 
of Macedonia I (Loan)

22.07.97

97/471/EC

Former Yugoslav Republic
of Macedonia II2
(Loan and grant)

08.11.99

99/733/EC

modified by

10.12.2001

01/900/EC

Kosovo I3
(Grant)

Kosovo II3
(Grant)

19.02.00

00/140/EC

27.06.01

01/511/EC

Montenegro3
(Grant budgetary support)

22.05.00

00/355/EC

70

35

20

60

40

80

18

35

30

20

Dec. 1992
Aug. 1993

June 1995
Oct. 1996

Dec. 1999 (grant)
Dec. 1999 (loan)
Dec. 2000 (grant)
Dec. 2000 (loan)
Dec. 2001 (grant)

Sep. 1997
Feb. 1998

Dec. 2000 (grant)
Dec. 2000 (loan)
Dec. 2001 (loan)
Dec. 2001 (grant)
May 2003 (grant)
June 2003 (loan)
Dec. 2003 (loan)
Dec. 2003 (grant)

March 2000
Aug. 2000

Sep. 2001
Dec. 2002

Aug. 2000
Dec. 2000

35
35

15
20

15
10
10
10
15

25
15

20
10
12
10
10
10
18
8

20
15

15
15

7
13

20
( Cancelled)

70

35

60

40

98

35

30

20

345

Serbia and Montenegro I4
(ex FRY)

16.07.01

10.12.2001

01/549/EC
modified by
01/901/EC

345

Oct. 2001 (grant)
Oct. 2001 (loan)
Jan. 2002 (grant)
Aug.2002 (grant)

35
225
40
45

56 

 
 
 
Country 

Date of
Decision

Reference of
Decision

Maximum
amount

Dates of
disbursements

Amounts of
disbursements

Totals Undisbursed

Authorisations

Disbursements

Serbia and Montenegro II5
(ex FRY)
(Loan and grant)

05.11.02

02/882/EC

130

modified by

25.11.03
07.12.04

03/825/EC (7)
04/862/EC

70

Bosnia II6
(Loan and grant)

05.11.02

02/883/EC

60

modified by

07.12.04

04/861/EC

Albania IV8
(Loan and grant)

29.04.04

04/580/EC

25

Dec. 2002 (grant)
Feb. 2003 (loan)
Aug. 2003 (grant)
Aug. 2003 (loan)

Dec. 2004 (grant)
April  2005 (loan)
Dec. 2005 (grant)

Feb. 2003 (grant)
Dec. 2003 (grant)
Dec 2004 (loan)

June 2005 (grant)
Feb. 2006 (loan)

Nov  2005 (grant)
Mar 2006 (loan)
Jul 2006 (grant)

Kosovo  (Grant)

30.11.06

06/880/EC

50

Sept. 2010

Bosnia-Herzegoviona (Loan)

30.11.09

09/891/EC

100

Serbia (Loan)

30.11.09

09/892/EC

200

1388

TOTAL B

C. New Independent States (NIS)

17.11.97
Armenia, Georgia 
and Tajikistan9
modified by
28.3.00
(Loans and grants) 
Agreed amounts with the recipent countires:

   Armenia

   Georgia

   Tajikistan

97/787/EC

00/244/EC

375
downsized to

Dec. 1998 (loan)
Dec. 1998 (grant)
Dec.  1999 (grant)
Feb. 2002 (grant)
Dec. 2002 (grant)
June 2004( grant)
Dec. 2005(grant)

July 1998 (loan)
Aug. 1998 (grant)
Sep. 1999 (grant)
Dec. 2001 (grant)
Dec. 2004 (grant)

March 2001 (loan)
March 2001 (grant)
Dec. 2001 (grant)
Feb. 2003 (grant)
May 2005 (grant)
Oct 2006 (grant)

(328)

(58)

(175)

(95)

57 

105

25

50

20

60

25

30

1003

20
(expired)

100

200

385

294,5

80,5

(58)

(141,5)

(33,5)

(95)

30
10
35
30

10
15
25

15
10
10

15
10

3
9
13

30

28
8
4
5,5
5,5
5,5
1,5

110
10
9
6
6,5

60
7
7
7
7
7

 
 
Country 

Belarus
(Loan)

Moldova I
(Loan)

Moldova II
(Loan)

Moldova III
(Loan)

Moldova IV
(Grant)

Ukraine I
(Loan)

Ukraine II
(Loan)

Ukraine III
(Loan)

Authorisations

Disbursements

Date of
Decision

Reference of
Decision

Maximum
amount

Dates of
disbursements

Amounts of
disbursements

Totals Undisbursed

25
(Suspended)

Dec. 1995

Dec. 1994
Aug. 1995

Dec. 1996

30

25
20

15

30

45

15

10.04.95

95/132/EC

13.06.94

94/346/EC

25.03.96

96/242/EC

10.07.00
19.12.02

00/452/EC
02/1006 EC

19.12.02

02/1006/EC

22.12.94

94/940/EC

55

45

15

15

15

85

Dec. 1995

85

85

23.10.95

95/442/EC

200

Aug. 1996
Oct. 1996
Sep. 1997

200

50
50
100

15.10.98

98/592/EC

150

July 1999

58

58

15
(cancelled)

15

92
(cancelled)

110

Ukraine IV
(Loan)
Modification of decision 98/592/EC

12.07.02

02/639/EC

110

Georgia II

        21.01.06

      06/41/EC

33,5

Moldova

       16.04.07

     07/259/EC

45

Georgia

30.11.09

09/889/EC

46

Armenia10 (Loan and grant)

30.11.09

09/890/EC

100

Ukraine (Loan)

29.06.10

388/10//EU

500

Aug. 2006
Dec 2006

     Oct. 2007
June 2008
Dec. 2008

Dec. 2009 (grant)
Jan. 2009 (grant)
Aug. 2010 (grant)

11
11

20
10
15

15,3
7,7
23

22

11,5

45

46

100

500

Moldova (Grant)

20.10.10

938/2010/EU

90

Dec. 2010 (grant)

40

40

50

TOTAL C

1879,5

880,5

999,0

58 

 
 
 
Country 

Date of
Decision

Reference of
Decision

Maximum
amount

Dates of
disbursements

Amounts of
disbursements

Totals Undisbursed

Authorisations

Disbursements

D. Mediterranean countries

Israel11
(Structural adjustment soft loan)

Algeria I
(Loan)

Algeria II
(Loan)

Lebanon12

TOTAL D

TOTAL A+B+C+D

22.07.91

91/408/EC

187,5

March 1992

187,5

187,5

23.09.91

91/510/EC

400

Jan. 1992
Aug. 1994

250
150

400

22.12.94

94/938/EC

200

Nov. 1995

100

100

100
(Suspended)

10.12.07

     07/860/EC

80

Dec. 2008
June 2009

15
25

40

40

867,5

7440

727,5

140

5391

2049

1 Includes a loan principal amount of € 20 million and grants of € 40 million.
2 Includes a loan principal amount of up to € 50 million and grants of up to € 48 million.
3 Exceptional financial assistance.
4 Includes a loan principal amount of € 225 million and grants of € 120 million.
5 Includes a loan principal amount of € 55 million and grants of € 75 million
5 Includes a loan principal amount of € 20 million and grants of € 40 million
6 Includes a loan principal amount of € 25 million and grants of € 45 million
8 Includes a loan principal amount of € 9 million and grants of € 16 million
9 Exceptional financial assistance, which includes a ceiling of € 245 million for the loans and a ceiling of € 130 million for th e grants
  Out of the global amount of € 375 million, maximum amounts of € 58 million, € 175 million and € 95 million were
  actually agreed with the beneficiary countries
10 Includes a loan principal amount of € 65 million and grants of € 35 million
11 Assistance to Israel includes a loan principal amount of ECU 160 million and grants of ECU 27,5 million in the form of interest subsidies.
12 Includes a loan principal amount of € 50 million and grants of € 30 million

59