IMF Approves US$64 Million Tranche Under Stand-By Credit and US$829 Million Extended Arrangement for the Federal Republic of Yugoslavia (Serbia/Montenegro)

This paper assesses the Federal Republic of Yugoslavia’s (FRY) 2002 Article IV Consultation, Third Review Under the Stand-By Arrangement (SBA), and a Request for an Extended Arrangement. Despite the impressive achievements since late 2000, when FRY succeeded to membership in the IMF, the challenges facing the authorities remain daunting. The FRY authorities’ medium-term program of stabilization sets a good basis for achieving sustainable growth and a viable external position, and deserves the continued support of the IMF through completion of the third review under the current SBA and approval of the proposed extended arrangement.

Abstract

This paper assesses the Federal Republic of Yugoslavia’s (FRY) 2002 Article IV Consultation, Third Review Under the Stand-By Arrangement (SBA), and a Request for an Extended Arrangement. Despite the impressive achievements since late 2000, when FRY succeeded to membership in the IMF, the challenges facing the authorities remain daunting. The FRY authorities’ medium-term program of stabilization sets a good basis for achieving sustainable growth and a viable external position, and deserves the continued support of the IMF through completion of the third review under the current SBA and approval of the proposed extended arrangement.

The Executive Board of the International Monetary Fund (IMF) today completed the third and final review of the Federal Republic of Yugoslavia’s (FRY) economic program supported by a stand-by credit. The completion of the review will enable the FRY to draw another SDR 50 million (about US$64 million) from the IMF immediately. The Stand-By Arrangement was approved June 11, 2001 (see Press Release No. 01/31) for SDR 200 million (about US$255 million), which will have been drawn in total. The Stand-By Arrangement will expire today.

The Executive Board today also approved an Extended Arrangement for SDR 650 million (about US$829 million) to support the FRY’s economic program in 2002-2005. The approval will enable the FRY to draw SDR 50 million (about US$64 million) as soon as the Arrangement goes into effect on May 14, 2002.

Following the Executive Board discussion, Anne Krueger, First Deputy Managing Director and Acting Chair, said:

“The IMF commends the FRY authorities for the impressive achievements in stabilization and reform since late 2000, when the FRY succeeded to membership in the Fund, but noted the major challenges that lie ahead. The authorities’ medium-term economic program, supported by the Extended Fund Arrangement, aims to achieve further progress in stabilization while providing for the restructuring and investment needs of the economy. In light of the exceptionally difficult starting conditions, the program will need to be firmly implemented if FRY is to remain on a path toward durable growth and external sustainability. The authorities’ demonstrated commitment to reform augurs well for progress in achieving these objectives.

“Macroeconomic policies have been prudent, with fiscal and wage restraint underpinning a monetary policy that is geared to lowering inflation. Fiscal performance has been good, reflecting the revenue effects of wide-ranging tax reforms, and the prompt containment of government spending in response to delays in foreign financing and privatization receipts. The authorities moved with impressive speed to implement key structural reforms, notably streamlining the price, exchange, trade, and tax regimes; liberalizing the labor market; and establishing new legal and institutional frameworks to guide the restructuring of the economy.

These measures paved the way for the successful privatization of several large companies and the cleaning up of the banking system through the closure of four large insolvent banks.

“The authorities’ medium-term fiscal policy framework is consistent with achieving lower inflation and fiscal sustainability. There are risks related to macroeconomic uncertainties and the challenges of reform, which could be addressed through prudence and vigilance in policy implementation, to safeguard the inflation and external objectives. It is critical for fiscal sustainability to improve tax administration and streamline expenditure through improved efficiency in the delivery of services and better targeting of benefits. The pension reform adopted recently in Serbia, and plans to adopt similar reforms in Montenegro, represent important steps in this direction.

“Against the background of a continuing real appreciation of the dinar, the National Bank of Yugoslavia appropriately intends to monitor closely developments in the foreign exchange market and to keep exchange rate policy under close review. The IMF welcomes the further liberalization of the exchange system which will pave the way for the acceptance by FRY of the obligations under Article VIII, Sections 2,3, and 4.

“Enterprise and bank reform, as well as an improved business environment, will be critical to enable private sector-led growth. The task of restructuring the decapitalized and overstaffed enterprise sector will be challenging, especially in light of limited fiscal resources to mitigate the costs of restructuring. With the bulk of insolvency removed from the financial sector, development of an efficient banking system will hinge on strengthening bank supervision and privatizing the remaining state-owned banks.

“The IMF welcomes the recent agreement between the federal and republican authorities on a plan for a new constitutional framework, which provides a basis for normalizing relations between Serbia and Montenegro, streamlining joint institutions, and strengthening the custom and tax systems. In light of the initial conditions, the medium-term economic outlook remains challenging, leaving little room for maneuver. The authorities must therefore persevere with reforms, and the international community should remain supportive throughout the intensive medium-term restructuring effort” Ms. Krueger said.

ANNEX Program Summary

The FRY has made satisfactory progress in stabilizing the economy, strengthening confidence in the currency, building the legal and institutional framework to guide transition, and securing debt relief. However, economic conditions remain difficult with output still at a historically very low level, a fragile macroeconomic and external outlook, a largely insolvent, decapitalized and overstaffed enterprise sector, an underperforming banking system, a large and inefficient government sector, and a dilapidated infrastructure.

The authorities’ key economic objectives for 2002-05 are the achievement of low inflation with progress toward sustainable growth and external viability. The government is determined to continue prudent macroeconomic policies and accelerate structural reform.

Inflation in Serbia is targeted to decline rapidly, reflecting tight credit policy and the wearing off of administered price increases; the latter would also support disinflation in Montenegro. The real GDP growth objectives are somewhat higher than those experienced by successful transition economies in the 1990’s but consistent with the potential for a “post-conflict” rebound and sizable amounts of foreign assistance.

The current account deficit (before grants) is expected to widen in 2002, reflecting a resumption in external debt service as well as higher project-related imports. The deficit will be financed by expected inflows of grants, loans from official creditors, and foreign direct investment. Over the medium term, the current account deficit is expected to narrow in relation to GDP on the basis of a recovery in exports to their real 1998 level. Despite rising foreign direct investment inflows, external financing requirements from donors and official creditors will remain significant.

The overall deficit in the FRY is projected to reach 5.7 percent of GDP in 2002, while trending downwards in subsequent years, in line with progress toward fiscal sustainability and lower inflation. The deficit will be financed mostly by foreign grants, concessional loans, and privatization receipts, while the government’s resources to domestic financing will be contained under 1 percent of GDP throughout the arrangement.

Monetary policy will be geared to lowering inflation. Exchange rate policy will seek to strike a proper balance between inflation and external objectives. While the current level of the exchange rate appears appropriate, developments in the foreign exchange market as well as trends in exports, imports, and wages will be monitored closely. Exchange rate policy will be assessed during the program reviews. Wage policy in the government and state enterprises will continue to support monetary policy and protect external competitiveness.

Structural reforms will be broad-ranging, to be implemented with technical assistance from the IMF, the World Bank, and bilateral donors. Reforms in the fiscal sector envisage further institutional improvements and streamlining expenditure where little progress has been made so far. In the financial sector, the cleaning up of the banking sector has set the stage for important reforms: redesign of monetary policy instruments, further liberalization of the foreign exchange market, development of a market-friendly payments system, and strengthening of banking supervision. In the enterprise sector, with the establishment of an appropriate legal and institutional framework, the stage has been set for the difficult task of restructuring and privatizing the bulk of socially-owned enterprises.

With sustained policy implementation, good progress toward a viable external position and sustainable growth could be achieved during the Extended Arrangement. The envisaged policies are consistent with a substantial increase in domestic savings that would offset lower foreign savings and permit an increase in the investment/GDP ratio by about 5 percentage points during 2002-05. External debt as a share of GDP is expected to fall from 109 percent at end-2001 to 59 percent at end-2005 (to 85 percent excluding debt relief).

The FRY, effective December 14, 1992, succeeded as one of five successor republics to the IMF membership of the former Socialist Federal Republic of Yugoslavia. Its quota1 is SDR 467.7 million (about US$597 million). The FRY’s outstanding use of IMF credits totals SDR 266.9 million (about US$341 million)

Table 1.

Federal Republic of Yugoslavia (Serbia/Montenegro): Selected Economic and Financial Indicators, 1998-2002 1/

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Sources: Federal Statistical Office; National Bank of Yugoslavia; Federal and Republican Ministries of and IMF staff estimates.

With the exception of foreign debt, data for 1999-2002 exclude Kosovo. GDP excludes Kosovo

Excludes workers on “forced holiday.”

Fiscal operations of all levels of government, except for Montenegro where it excludes local

Excludes arrears of local governments and most interest payments on foreign debt due but not paid.

From 1999 onwards excludes Montenegro.

For 2002, figures reflect the first phase of the Paris Club debt reduction, and comparable treatment from official bilateral and commercial creditors

1

A member’s quota in the IMF determines, in particulars, the amount of its subscription, its voting weight, its access to IMF financing, and its allocation of SDRs

Federal Republic of Yugoslavia: 2002 Article IV Consultation, Third Review Under the Stand-By Arrangement, and Request for an Extended Arrangement—Staff Report; Staff Supplement; Public Information Notice and Press Release on the Executive Board Discussion; and Statement by the Executive Director for the Federal Republic of Yugoslavia
Author: International Monetary Fund