Bolivia: Request for Stand-By Arrangement

This paper examines Bolivia’s Request for a Stand-By Arrangement (SBA). The Bolivian authorities have focused their efforts on restoring economic and social stability, strengthening the banking and corporate sectors, and establishing the basis for sustained growth. In support of their economic program for 2003, the authorities have requested an SBA equivalent to 50 percent of quota (SDR 86 million). At the same time, the authorities continue to develop a broader set of medium-term structural reforms, for which they plan to seek support through an arrangement under the Poverty Reduction and Growth Facility as soon as possible.

Abstract

This paper examines Bolivia’s Request for a Stand-By Arrangement (SBA). The Bolivian authorities have focused their efforts on restoring economic and social stability, strengthening the banking and corporate sectors, and establishing the basis for sustained growth. In support of their economic program for 2003, the authorities have requested an SBA equivalent to 50 percent of quota (SDR 86 million). At the same time, the authorities continue to develop a broader set of medium-term structural reforms, for which they plan to seek support through an arrangement under the Poverty Reduction and Growth Facility as soon as possible.

I. Background

A. Social and Political Context

1. Bolivia remains one of the poorest and least developed Latin American countries. It is landlocked and has the highest share of indigenous people in its population in Latin America. Almost two thirds of the population lives below the poverty line, with a concentration in rural areas of the highlands (altiplano) and among indigenous people. Income inequality is high in the context of deep social and ethnic divisions and the marked regional disparities.

2. After years of sporadic economic reform, recent declines in real per capita income and employment have heightened social tensions. This has fueled feelings of disenfranchisement and resentment against the government among a growing share of the population. Tensions are particularly high among the indigenous communities and the coca farmers whose situation has been deeply affected by the drug eradication campaign.

3. President Sánchez de Lozada assumed office in August 2002 based on a pact between his party, the Revolutionary National Movement (MNR), and the Revolutionary Left Movement (MIR) (Box 1). The ruling coalition controls a thin majority in both the lower and upper houses of congress and faces strong opposition from its main rival in the presidential elections, Evo Morales, who represents the indigenous communities—and in particular the coca farmers—and is a vocal opponent of economic reforms that were started during the previous term (1993–97) of the current President. The government’s position has been weakened further by the recent social unrest.

B. Economic and Financial Developments

4. Despite a rapid increase in natural gas production, real growth has been weak for the last four years (1½ percent on average). Adverse shocks included the impact of coca eradication on incomes; the impact of low metal export prices on mining output and foreign direct investment; and contagion from the regional financial and economic developments. The economy’s vulnerabilities have been heightened by large fiscal imbalances (Table 1) and weak and highly dollarized financial and corporate sectors.

5. The external current account deficit remained relatively high at 4 percent of GDP in 2002 despite stagnant economic activity—owing partly to exceptional imports to build a new gas pipeline (Figure 1 and Table 2). Foreign direct investment—largely related to hydrocarbon projects—was also very high at more than 7 percent of GDP, although it has been declining since 1999.

6. The fiscal deficit more than doubled over the last two years to 8.7 percent of GDP in 2002 (Table 3). Revenue was restrained by weak domestic demand, delays in tax reforms, and a freeze on domestic fuel prices. At the same time, expenditure surged, reflecting increased real wages (with a cumulative 14 percent real increase in the wage bill) and a stepped-up public investment program (Appendix Box 1). Pension costs—already sizable after the 1997 pension reform—rose further.1

Political Context

The government’s success in implementing the economic program will depend on its ability to make progress in building consensus within congress and to gain the cooperation of a wide range of civil society. The coalition led by President Sanchez de Lozada controls a thin majority in both the lower and upper houses of congress, and faces vocal opposition from Evo Morales, a close runner-up in the presidential elections who represents the indigenous communities, particularly the coca farmers whose situation has been deeply affected by the drug eradication campaign. Mr. Morales has sought to rally widespread popular opposition to market-oriented policies both inside and outside Congress, appealing also to landless farmers and labor unions. The government, already facing strong opposition from political and social groups, was weakened by the recent serious social unrest that followed the government’s initial submission of the budget to congress.

During the first several months of the current administration, the government has yielded on a number of occasions to demands of diverse social groups. In January, the government reached an agreement with Morales—aimed at stopping road blockades and protests—that called for working groups to discuss: a halt to plans for routing a pipeline for the liquefied natural gas (LNG) project through Chile and for furthering regional trade agreements; a freeze in coca eradication; and increased expenditure for social issues in the 2003 budget. The government also agreed, in response to retirees’ demands, to retain most of the indexation of pensions to the U.S. dollar during 2003—with the December 2002 shift in indexation of pensions to inflation having full effect in 2004—following a protest march that led to loss of life. Late last year, the central bank backed down from a decision to widen the spread between the buying and selling exchange rates, at the government’s request, following widespread criticism.

By not fostering a more participatory debate in Congress, the government has faced difficulty in forestalling mounting opposition. The President withdrew the 2003 budget proposal and the tax increase the authorities had designed (Appendix Box 3), following two days of rioting, before it had been considered in the chamber of deputies. The new budget proposal has been developed through a process of consensus-building that should enhance its acceptability. The President has announced a more balanced fiscal program, with cuts in low priority spending, reduced the number of ministries and introduced austerity measures for the central administration. However, the public’s perception of limited progress in fighting corruption, controlling tax evasion, and improving governance may make it difficult to build the alliances with parties outside the coalition that would facilitate the passage of key legislation in Congress.

The program is subject to significant implementation risks to the extent that the consensus remains weak. To minimize these risks will require further progress in the participatory process that the government has embarked upon, so as to enhance the overall political support for the program.

7. Monetary policy in 2002 was accommodative of a large government financing need (Figure 2 and Table 4). In addition, the central bank had to contend with two rounds of deposit instability—in mid-2002 and in February 2003—mat left the dollar deposit base 17 percent below its level at end-2001. In both cases, the central bank increased rediscounts to meet the liquidity needs of financial institutions and raised interest rates (Box 2). With NDA rising sharply, the central bank’s net international reserves fell by US$275 million in 2002 and by a further US$123 million so far in 2003, to a level of US$687 million as of March 12. Correspondingly, the coverage of dollar-denominated deposits of commercial banks by disposable reserves has fallen from 39½ percent at end-2001 to 31½ percent at end-2002, and to 28¼ percent as of March 12, 2003.2

8. The central bank stepped up the pace of nominal depreciation against the U.S. dollar to 10 percent in 2002, in response to the domestic and external shocks.3 However, because of the sharp depreciations of the Argentine peso and Brazilian real, the boliviano still appreciated in real effective terms by more than 4 percent during 2002. The gradual appreciation of the real effective exchange rate and the lackluster performance of nontraditional exports in recent years suggest growing competitiveness concerns.

9. Financial vulnerabilities in the highly dollarized financial system have increased significantly.4 In the aggregate, banks recorded losses in two out of the last three years and the average nonperforming loan ratio more than doubled to almost 19 percent in this period, although all banks in the system report capital adequacy ratios in excess of the minimum requirement.5 Credit to the private sector has contracted by one third since 1999, reflecting more conservative bank lending practices, and more prudent loan provision regulations, combined with a sluggish economy and a persistent decline in broad money (Figure 3, Tables 5 and 6).

The Deposit Run Episodes of Mid-2002 and February 2003

The Bolivian banking system has contracted over the last four years since 1999, with a cumulative 22 percent fall in deposits and 36 percent reduction in the loan portfolio (in U.S. dollar terms). In this context, bank liquidity has generally been ample (see Figure 4). However, during the last year the system faced two episodes of accelerated deposit withdrawals, following political uncertainty: first, during the political transition period starting a few weeks ahead of the June 2002 general elections, until a new government coalition was announced on August 4, 2002; and second, following the intense social unrest the week of February 10. Events followed similar patterns in both cases:

(i) Deposit runs were sizable (18 percent of the financial system deposits in mid-2002, and almost 5 percent in a few days in February 2003). They were reflected in the balance of payments as capital outflows, even though a large proportion of withdrawn deposits were held in cash.

(ii) Withdrawals were spread across all categories of financial institutions, including foreign and local banks, with a proportionately larger impact on savings and loans (that have a large number of small depositors), and in mid-2002 also on mutual funds (SAFIs).

(iii) The central bank (BCB) met the liquidity needs of financial institutions through repo operations and liquidity credits backed by the banks’ liquid asset requirements. Reflecting the high degree of financial dollarization, these operations were mainly in U.S. dollars and prompted large reductions in the international reserves.

(iv) The monetary authorities raised the benchmark interest rates to encourage efficient liquidity management by financial institutions and the placement of short-term deposits with the central bank for those institutions with excess liquidity.

(v) The exchange rate policy was kept broadly unchanged, in part to keep from igniting depositors concerns in view of the high level of dollarization.

(vi) The BCB repatriated the commercial banks’ liquid asset requirements (RAL) in U.S. dollars, which are usually held abroad and are not part of the BCB balance sheet. The central bank also secured a contingent credit line with the Latin American Reserve Fund (FLAR) in July 2002. However, no disbursement was made, since the deposit outflow stopped before the credit was needed.

(vii) Daily monitoring was intensified with respect to the liquidity situation of individual banks.

(viii) In mid-2002, once political tensions abated, the deposit outflow slowly returned to the system and the RAL fluid was gradually transferred back overseas.

A01ufig01

Deposits of the Financial System, Jun. 2002 - Feb. 2003, millions of U.S. dollars

Citation: IMF Staff Country Reports 2003, 179; 10.5089/9781451805697.002.A001

10. Private corporations are afflicted with unproductive assets, operational inefficiencies, and currency mismatches. At the same time, dysfunctional bankruptcy arrangements and weak capital markets complicate the process of corporate restructuring. A recent FSAP mission found that firms’ capacity to generate cash flow to service debt collapsed during 1998–2001 under the weight of weak sales, operational inefficiencies, and the depreciation of the boliviano against the U.S. dollar. The FSAP mission concluded that a coordinated approach dealing with the weaknesses of both the banking and corporate sectors is required to address satisfactorily existing vulnerabilities.

11. Nonfinancial public sector debt rose sharply in 2002 to 62¼ percent of GDP. Both domestic (mainly in U.S. dollars) and nonconcessional external debt have increased rapidly to finance the large fiscal deficits.6 As a result, debt indicators have deteriorated significantly from the path envisaged in June 2001 when Bolivia reached the completion point under the enhanced HIPC Initiative; at end-2002, the ratio of the NPV of external debt to exports increased to 117 percent and the ratio of budgetary debt service to revenue increased to 38 percent.7

II. Policies Under the Stabilization Program for 20038

12. The economic program for 2003, in support of which the authorities are requesting an SBA, focuses on stabilizing the economy after the recent civil disturbances and resulting financial instability and laying the basis for a return to growth. Fiscal policy is aimed at a phased reduction of the public sector deficit while allowing some increase in social spending. Financial policies aim to put in place the first stage of financial and corporate sector restructuring. The authorities also expect to make progress with other institutional and structural reforms to begin addressing factors that may inhibit growth and economic efficiency. In the coming months, a broader set of medium-term structural reforms will be developed, for which the authorities plan to seek support through a successor arrangement under the PRGF.

A. Macroeconomic Framework

13. The program projects a gradual economic recovery led by the hydrocarbon sector, with real GDP growth reaching about 3 percent in 2003, and rising to 4–5 percent in the medium term (Table 7). Inflation would remain low. The external current account deficit would narrow, reflecting the impact of programmed fiscal adjustment on external savings. International reserves would be rebuilt, while public sector debt indicators would be stabilized. This relatively optimistic framework is subject to considerable downside risks and depends upon a swift restoration of economic and social stability.

Table A.

Macroeconomic Framework, 2002–05

(In percent of GDP, unless otherwise indicated)

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14. Growth in 2003 will be fostered by (i) increased output in the hydrocarbon sector; (ii) the boost to manufacturing, in particular textiles, from expanded preferential access to the U.S. market for the Andean countries (since August 2002); and (iii) agricultural growth benefiting from improved irrigation systems and road infrastructure. Regarding domestic demand, private consumption and investment are expected to recover only gradually as confidence is restored and some progress is made with corporate and financial restructuring.

B. Fiscal Policy

15. The fiscal program aims to reduce the combined public sector deficit from 8¾ percent of GDP in 2002 to 6½ percent of GDP in 2003. The authorities intend to sustain the adjustment over 2004–05, so that the deficit can fall to 3–3½ percent of GDP by 2005. This adjustment path would be protective of the debt dynamics, although it would leave debt indicators higher than envisaged at the HIPC completion point. The path remains highly sensitive to risks, with five out of seven stress tests leading initially to rising debt ratios (Annex IV) and will be reassessed at the program reviews.

16. The 2003 program is based on the budget presently before Congress, which the authorities expect to be passed by end-March. The Finance Committee has approved the budget, and a statement of strong support from the President of the Lower House (Chamber of Deputies) is a prior action for Board discussion.

17. The size of the fiscal adjustment now budgeted to take place in 2003 is lower than envisaged in the original budget submitted to Congress in early February (and modified after the civil unrest). The slower adjustment path is more in line with the country’s ability to reduce its fiscal imbalance, given the magnitude of the social tensions in the wake of successive declines in per capita income. The budget includes increased social spending financed by higher external funding from multilateral and bilateral sources (Appendix Box 2 and Table 8). Moreover, the budget no longer relies on increased revenues from the politically sensitive payroll tax, while earlier plans to reduce the VAT rate and the transactions tax have been postponed (see Appendix Box 3). The authorities emphasized that their revised budget submission emerged from consensus-building efforts with key groups of public sector employees and within the legislative branch.

Table B.

Bolivia: Operations of the Combined Public Sector, 2000–03

(In percent of GDP)

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18. The fiscal program for 2003 depends on a combination of revenue and expenditure measures (Box 3).

  • Revenue measures. These rely on changes in the structure of oil sector taxation, elimination of some tax exemptions, and a broadening of the base of some taxes (¶6).9

    Moreover, passage of the tax procedures code by September 2003 would provide the basis for a substantial strengthening of tax administration.

  • Expenditure measures. These rely on holding the line on real wage increases,10 controlling transfers to universities, steps to reduce the size of government, and savings in pension costs (¶ 8).

Fiscal Measures for 20031/

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1/Measures needed to reduce the passive deficit in 2003 (equivalent to 9.4 percent of GDP), to the active deficit of 6.5 percent of GDP (see Text Table B). See Table 14 for quarterly fiscal projections.2/Also, to strengthen budget execution and reporting, the status of implementation of earlier measures needs to be verified, including: the mechanism to align budgeting and execution of expenses at all levels of the government with the classification of poverty-related expenses; progress to improve the internal and external audit system; implementation of the Financial Management Information System (SIGMA) at the municipal level; and the introduction of a functional classification as part of the budgetary classification system.

19. The fiscal program for 2003 is subject to a number of risks.

  • The envisaged yield of several measures may be affected by future legal rulings: (i) the decree that reformed petroleum taxation might be contested in foreign courts; (ii) some measures to reduce the pension costs—notably the planned repeal by mid-2003 of a ministerial resolution that reduced the retirement age—could be subject to legal challenge.

  • There could be delays in the congressional approval of the tax procedures code.

  • There can be political pressures to transform the tax regularization scheme into a tax amnesty (a pardon of tax obligations, including principal, interests and penalties).11

  • Sustained high oil prices would undercut revenues.12

  • Tax administration improvements might raise less revenue than expected.

  • Some revenue measures are “one-off” (tax regularization, higher grants, and capital revenue) and are not expected to yield additional revenue beyond 2003.

20. The authorities are taking steps to reduce risks to the fiscal program. The fiscal program for 2003 includes a contingency plan for raising domestic fuel prices, if international prices persist at high levels and result in fiscal revenue shortfalls.13 This would be politically sensitive. Also, the authorities are planning to delay some investment projects until it is clear that public revenue is at budgeted levels, and have prepared a contingency plan for reducing low-priority public investment, if needed to achieve the fiscal targets.14 The authorities also intend to monitor more closely spending by subnational governments.

21. Net external financing of US$480 million would cover virtually all of the nonfinancial public sector’s financing needs in 2003 (see Table 9 and ¶11).

  • Net external financing to the nonfinancial public sector would come from the World Bank (US$178 million), the IDB (US$58 million), and the CAF (US$112 million) (Table 9). (These amounts include US$90 million of gross balance of payments support from the World Bank and US$70 million from the IDB.) In addition, US$131 million would come mainly from bilateral sources.

  • In addition, the program provides for external grants to the budget of US$146 million (excluding HIPC assistance), including US$30 million additional grants in response to the unrest in February.

  • Central bank credit to the Treasury would be reduced during the year, while the issuance of inflation-indexed long-term bonds to the private pension funds would allow the government to redeem in net terms up to 1.3 percent of GDP in U.S. dollar-denominated bonds and bills held by the financial sector (see Table 3).

C. Monetary and Exchange Rate Policy

22. The monetary program in 2003 will be conducted through control of the central bank’s net domestic assets and targets a small buildup of US$65 million in net international reserves.15 The accumulation of reserves would raise the disposable reserve coverage of dollar-denominated bank deposits to 35 percent by end-2003. Some increase in broad money in U.S. dollar terms can be expected to take place as confidence returns to the economy and bank deposits recover, providing room for a gradual resumption of private credit. However, the program takes a cautious view of the pace at which real money demand would recover.

23. The central bank is committed to meet the system’s liquidity needs in case deposit withdrawals resume. However, there are clear limits to its available resources. In line with recent experiences, the central bank, if faced by a renewed deposit outflow, would try to provide the needed liquidity to the system while raising its repo rate so as to induce banks to find alternative financing sources while making domestic deposits more attractive. The central bank has enhanced its daily monitoring of individual banks and would have access to back-up lines from FLAR. Staff stressed that to limit moral hazard problems, weaker institutions seeking access to central bank credit on the basis of lower quality collateral should be subject to appropriate regulatory oversight.

24. The crawling peg exchange rate system will continue in 2003. The rate of depreciation against the dollar (currently around 8 percent a year) will seek to reverse the real effective exchange rate appreciation during 2002. The staff pointed to the risks of a crawling peg exchange rate regime, especially its limited ability to resist shocks. The authorities agreed on the benefits of moving to a flexible exchange rate regime, but stressed that a rapid real depreciation against the U.S. dollar could result in potentially large adverse effects on corporate and bank balance sheets, given the high degree of financial dollarization (Figure 4). In their view, such a move should take place when the financial system is stronger and actions to encourage a gradual process of de-dollarization are further along.16 Thus, exchange rate policy and its capacity to absorb shocks remains a risk in the program.

25. The central bank will undertake a study in the months ahead, with the assistance of Fund staff, to assess the adequacy of the exchange rate level and to explore ways of increasing exchange rate flexibility. This study should guide the choice of future options for external policies that would maintain Bolivia’s competitiveness.

D. Financial and Corporate Sector Strategy

26. The authorities’ approach to the difficult task of strengthening the corporate and banking sectors is in line with the recommendations of the FSAP mission (¶l9–¶21). (The authorities’ strategy and the main findings of the FSAP mission are presented in Box 4 and Annex V, respectively.) A crisis management team will be appointed in the next few weeks to coordinate the strategy for the corporate and financial sectors and will coordinate closely with the World Bank in implementing the strategy.

Financial and Corporate Sector Strategy

Short-term plans to address the weaknesses of banks have been accelerated:

  • By end-March 2003, banks will have completed their provisioning requirements.

  • A decree will be issued, by end-April, to clarify the roles of institutions with oversight responsibilities for the financial system and their supervisory authority. General norms in accordance with existing laws will be issued by the Executive Branch while the banking superintendency will issue prudential regulations and standards consistent with its supervisory role.

  • Regulations for bank resolution and prompt corrective action mechanisms, together with consistent rules on the provision of central bank liquidity to banks—including those under intensified supervision—will be drafted in consultation with Fund staff by end-April.

  • Other legal changes—needed to clarify the legal powers of different institutions to generate and issue financial sector regulations—will be undertaken during 2003.

Strengthening of financial institutions over the next several months:

  • Contingency plans for potential solvency problems of individual financial institutions are expected to be developed in coordination with the Bank and the Fund in the coming months.

  • By end-June, the soundness of each bank will be evaluated, based on audited accounts, and related action plans will be developed to maintain banks’ soundness.

  • Stress tests will determine the potential impact on banks of corporate restructuring, given the need for debt relief from creditor banks (see next topic).

Medium-term comprehensive strategy for the financial and corporate sectors:

  • A high level management team will be appointed, to develop and coordinate the strategy for the financial and corporate sectors within a set of principles to guide the scheme, to be undertaken in the framework of a voluntary, private, and decentralized decision-making process. The strategy will be formulated by June 2003.

  • This team will analyze the systemic risk in the corporate sector, with a view to analyzing the impact of potential debt relief on banks’ balance sheets; and assessing whether there is room to extend regulatory forbearance to banks that provide debt relief to private firms.

  • Draft laws on bankruptcy procedures and informal workout mechanisms, to be drafted in consultation with World Bank and Fund staffs, will be submitted to Congress by end-April. They are expected to be approved before the third program review.

  • The framework under which any public or publicly guaranteed funds might be provided—only after any previously existing losses have been recognized by private shareholders of distressed firms or financial institutions—will be designed in consultation with Fund staff by the second review.

It will be guided by the following set of general principles:

  • Temporary regulatory forbearance to financial institutions17 or the provision of debt relief on liabilities to the public sector beyond the envisaged tax regularization scheme18 will be granted, if necessary, only in the context of corporate restructuring;

  • Such debt restructuring would be undertaken in the framework of a voluntary, private, and decentralized decision process;

  • Any upgrade in the status of a restructured loan (for purposes of calculating provisioning requirements) would be only allowed once the loan has been regularly serviced; and

  • Any public or publicly guaranteed funds would be provided only after losses have been fully recognized by private shareholders of distressed firms or financial institutions. In this context, care will be taken to minimize the cost of corporate workouts within a transparent process.

27. As part of this strategy, the authorities have committed to putting in place the legal framework, mechanisms, and instruments needed to carry forward the corporate restructuring process. A flexible out-of-court workout mechanism will be introduced, centered on creditor committees, coupled with modern formal bankruptcy proceedings as an important part of the incentive structure to be used when the informal approach fails.

28. The challenges facing the authorities in tackling these complex tasks are daunting. The staff has emphasized the importance of: (i) quickly advancing in the implementation of the corporate restructuring framework, coordinated by a high-level team; (ii) moving in parallel to deal with distressed corporate firms and individual financial institutions, so that the interaction between the two—including the impact of potential relief from banks to viable firms—is fully reflected in restructuring plans; (iii) dealing with potential weaknesses in the banking system that could otherwise distort the proper functioning of the restructuring framework; and (iv) quickly putting in place all regulations and plans for prompt corrective action and bank resolution mechanisms.

E. Medium-Term Policy Framework

29. The authorities are developing a medium-term policy strategy, aimed at raising growth and reducing poverty on a sustained basis. This strategy will build on the current stabilization program in restoring fiscal sustainability and ensuring financial system stability and development. The authorities have prepared a draft PRSP progress report that will be discussed with the donor community, civil society, the political parties, and Congress in the coming months.

30. Efficient exploitation of Bolivia’s vast reserves of gas and oil will be key to Bolivia’s medium-term prospects for growth and a viable balance of payments. The authorities plan to move forward with the project to export liquefied natural gas (LNG) to North America on the most efficient basis. However, if there should be protracted delays in reaching agreement on the LNG project, Bolivia’s opportunity to enter the market for natural gas in California could be jeopardized.19 Also, there is a risk that a choice on purely economic grounds to route the gas pipeline to the Pacific coast through Chile could provoke strong popular opposition due to long-standing political tensions.

31. The authorities are designing structural reforms as part of their medium-term program to address the key constraints to growth. Particular emphasis will be paid to raising the tax contribution of the wealthy and enabling the poorer regions of the country to gain benefits from international trade. Attention also will be placed on improving inadequate infrastructure, and reducing labor market rigidities and high nonwage labor costs.

32. The government aims to reduce the fiscal deficit to 3–3½ percent of GDP in 2005, and further in subsequent years. Achieving this reduction would depend on fiscal reforms, including improvements in tax administration (with ongoing reforms of the two tax agencies, and a new tax code), a second generation of reforms to make fiscal decentralization more effective, and changes in the structure of expenditure following a public expenditure review in the coming months by the World Bank.

33. Medium-term policies for the financial and corporate sectors will center on the implementation of an integrated strategy for restructuring the financial and corporate sectors and reducing the system’s vulnerability to exchange rate risk. Progress in this area will depend on achieving a stable macroeconomic environment. In addition, prudential regulations are needed that adequately reflect risks related to exchange rate movements and that encourage alternative inflation-indexed financial instruments. This would induce a gradual and voluntary shift back to use of the domestic currency without compromising the public’s ability to choose between domestic and foreign currency assets.

F. Debt Sustainability and Capacity to Repay

34. The program would limit the increase in net nonconcessional external debt to US$150 million (about 2 percent of GDP) in 2003, primarily from the CAF and the International Bank for Reconstruction and Development (IBRD) (¶12). The ceiling includes room for disbursements of US$70 million from the IBRD and the CAF to support financial and corporate restructuring, with a downward adjuster in case the operation is delayed. These loans will be used for social sector budget support, road-building, rural infrastructure, and an employment project.

35. Bolivia’s external debt indicators are higher than projected in 2001 at the completion point under the Enhanced HI PC Initiative, although the ratio of the NPV of debt to exports remains below 150 percent. Under the program projections, this ratio peaks at 145 percent in 2004 and falls to 137 percent by 2007 (Annex IV Table 1).

36. Bolivia’s public debt would be sustainable if the government’s ambitious fiscal adjustment path is achieved and economic growth revives. Nonfinancial public sector debt would increase by 8 percentage points of GDP to 70 percent of GDP in 2003 (partly due to the exchange rate) and begin to fall after 2005 (Annex IV Figure 1). Nevertheless, the ratio of dollar-denominated external and domestic public debt20 to exports of goods and services would remain well above the threshold of 200 percent (227 percent at end-2002).

37. Stress tests show that the projected improvement in debt ratios is subject to substantial risks (see Annex IV for details):

  • The projected improvement in the external debt to exports ratio is based upon rapid export growth, which depends on the successful development of natural gas exports to Brazil, the LNG project for the United States, and other projects.

  • If the targeted fiscal consolidation is not achieved, the fiscal position is unsustainable. A stress test indicates that if the fiscal program goes off track by only one standard deviation (1.8 percent of GDP), the public debt to GDP ratio continues to increase.

  • Because 95 percent of public debt is denominated in foreign currencies, a stress test involving a 30 percent real depreciation has a large impact on the debt to GDP ratio.

38. Capacity to repay the Fund. The program is subject to a range of risks (described in Section H) stemming from political and social tensions, which could adversely affect the authorities’ ability to maintain the budget in line with the fiscal program, and to implement the legislative agenda associated with the program. The weaknesses in the financial and corporate sectors also present risks. However, the debt service due to the Fund would constitute a small proportion of Bolivia’s exports of goods and services and gross official reserves (Table 10). Bolivia should be able to meet its obligations to the Fund in a timely manner, given its commitment to prudent financial and macroeconomic policies, strong track record, and low level of outstanding credit from the Fund. Nevertheless, given the political situation, risks clearly remain.

39. A full safeguards assessment is underway, as required under the Fund’s safeguards assessment policy. The required documentation was received from the Central Bank of Bolivia on January 14, 2003. The previous external audit assessment—under the transitional procedures with respect to the PRGF arrangement that has now expired—was completed on October 19, 2000; it concluded that the central bank’s external audit mechanism is adequate, as reported in EBS/01/80.

G. Access and Monitoring

40. Access and phasing. Access is being proposed in an amount equivalent to SDR 85.75 million (50 percent of quota). This level of access reflects Bolivia’s balance of payments need (Table 11) from pressures on the capital account. Despite Bolivia’s high debt level, the proposed access is consistent with Bolivia’s capacity to repay (see paragraph 38). The initial purchase corresponds to the first credit tranche and accounts for the frontloading of purchases; the subsequent four purchases are equivalent to SDR 10.7 million each, following a first review within two months, and three quarterly reviews thereafter (Table 12).

41. Performance criteria have been established for end-March and end-June, and indicative targets for end-September and end-December 2003 as indicated in Table 1 of the MEP. Adjusters are as specified in Table 1 of the TMU. Continuous performance criteria have been established for the nonaccumulation of external arrears. Structural performance criteria and benchmarks are presented in Table 2 of the MEP.

H. Program Risks

42. There are risks to the economic program for 2003. Economic growth prospects and financial stability depend heavily on the authorities’ ability to handle these risks. Failure to put in place convincing measures to ensure that the fiscal position is sustainable, and to allow corporate and financial restructuring, would imply continued economic stagnation.

  • Broad public and congressional support will be needed for the fiscal program. Social pressures pose significant risks that could hinder consistent policy implementation, as reflected in the recent civil conflict (see Box 1).

  • There is limited scope for exchange rate policy to respond to exogenous shocks to the program given high dollarization and weak corporate balance sheets. Full exchange rate flexibility is a medium-term objective.

  • A viable restructuring plan for the financial and corporate sectors must be based on a sound set of general principles. Otherwise, uncertainties related to the fragility of the financial system could impede policy implementation.

43. The authorities recognize that there is no room for slippages in policy implementation. They emphasized their resolve to gain a consensus across social groups about the need for fiscal discipline and to maintain a monetary policy stance consistent with program objectives. The authorities also stressed their commitment to undertake promptly the financial and corporate sector restructuring process in line with FSAP recommendations.

III. Staff Appraisal

44. Following the recent civil disturbances, the Bolivian authorities are implementing an economic program for 2003 that focuses on stabilizing the economy and laying the basis for a return to income growth. Fiscal policy is set to achieve a phased reduction of the public sector deficit while financial policies aim to put in place the first stage of financial and corporate sector restructuring. In the meantime, the authorities are developing a broader set of medium-term structural reforms, for which they plan to seek Fund support under a new Poverty Reduction and Growth Facility in the coming months.

45. The government is seeking the cooperation of a wide range of civil society and Congress to achieve the program objectives. It is well aware that, in the absence of this cooperation, there are significant risks to the country’s social and financial stability. The staff strongly supports the authorities’ efforts to increase the level and efficiency of social spending and their resolve not to accede to the demands of selected interest groups at the expense of the rest of the country. An improvement in Bolivia’s medium-term economic outlook depends on the government’s ability to take decisions based on a long-term perspective rather than short-term demands.

46. The size of the fiscal adjustment now budgeted to take place in 2003 is lower than envisaged in the original budget submitted to Congress in early February. The slower adjustment path reflects a more realistic assessment of the country’s ability to reduce quickly its fiscal imbalance following four years of economic stagnation. It is important that the reduction of the fiscal deficit this year be part of a sustained effort to lower the deficit progressively in the next few years to a level that is consistent with a sustainable debt profile.

47. Implementing the fiscal program will be a considerable challenge. The fiscal program for 2003 depends greatly on increasing revenue, but the envisaged yield of several measures may be affected by future legal rulings, and there could be delays in congressional approval of the tax procedures code. The staff urges the authorities to hold steadfast in their determination to control expenditures tightly and welcomes their commitment to delay some planned investment spending until it is clear that revenue is at budgeted levels. The authorities also plan to react quickly with additional revenue measures if international oil prices persist at high levels and result in fiscal revenue shortfalls. The authorities’ contingency plan for reducing low-priority public investment, if needed to achieve the fiscal targets, is of great importance. In this regard, careful attention will need to be given to protect poverty-reducing expenditure.

48. The central bank has demonstrated its readiness to react appropriately to market uncertainties. In the event of renewed deposit outflows and in line with recent experiences, the staff supports the central bank’s intention to provide the system with needed liquidity and raise the lending rate, so as to encourage banks to find alternative financing sources and make domestic deposits more attractive. However, there are clear limits to the ability of the central bank to provide dollar liquidity and the authorities will need to be careful to ensure that weaker institutions seeking access to central bank liquidity are subject to appropriate regulatory oversight. Over time, the authorities need to build reserve coverage to more comfortable levels.

49. Exchange rate policy under the program will be kept under close review. Developing a more flexible mechanism is, in the staffs view, a priority. However, the authorities believe that increased flexibility of the exchange rate system should take place when the financial system is stronger and mechanisms for dealing with corporate distress are better developed. Actions to establish a sound macro economic framework, encourage a gradual process of de-dollarization, and implement prudential norms that penalize exposure to exchange risks would facilitate the transition to a more flexible regime. Successful implementation of these actions is key to reducing the economy’s vulnerabilities to external shocks and achieving sustained growth.

50. The authorities have made an important commitment to restructure the corporate and financial sectors in line with recommendations of the FSAP mission. It is critical that this strategy—coordinated by a high-level team—follow a sound set of principles—especially that the restructurings be undertaken within the framework of a voluntary, private, and decentralized decision process and that any regulatory forbearance be carefully tailored to ensure that it is in the context of a viable restructuring plan. The staff welcomes the authorities’ commitment to a flexible out-of-court workout mechanism, as a useful complement to modern bankruptcy proceedings.

51. The authorities also need to strengthen the regulatory framework. This will require swift actions to tighten prudential norms and ensure the operational autonomy of the banking superintendency. In parallel, actions need to be taken to improve the financial health of viable firms. Detailed contingency plans for banks should be developed that take into account the impact of potential debt relief that may be provided by banks to viable firms. It will be important that the soundness of each bank is evaluated, based on the audited accounts and related action plans developed to maintain banks’ soundness.

52. Exploitation of Bolivia’s vast reserves of gas and oil will be key to Bolivia’s medium-term prospects for growth and a viable balance of payments. Staff welcomes the authorities’ intention to move forward on the most efficient basis with the project to export liquefied natural gas to North America.

53. The proposed program with Bolivia is subject to a number of risks but deserves support from the Fund. These risks mainly stem from political and social tensions, which will test the authorities’ ability to maintain the budget in line with the fiscal program, and to implement the legislative agenda associated with the program. The weakness in the financial and corporate sectors also presents risks, leaving the economy vulnerable to shocks. The authorities’ commitment to a sustained implementation of the economic and structural policies under this program, including important fiscal and financial measures that reduce existing risks, should help set the stage for a resumption of sustained growth. On the basis of the authorities’ strong commitment to implement their economic program for 2003, the staff recommends approval of Bolivia’s request for a Stand-By Arrangement, and look forward to its replacement as soon as possible by a Poverty Reduction and Growth Facility.

APPENDIX

Performance Under the Third-Year PRGF (June 2001-June 2002) and Under the Informally Monitored Program for 2002

  • The third-year PRGF arrangement that expired in June 2002 went off track in the second half of 2001. The fiscal targets were missed by large margins mainly because of revenue shortfalls due to the much-weaker-than-expected growth, but also a loss in tax efficiency and a freeze of retail fuel prices. The higher deficit was financed through additional domestic bond sales to private pension funds (which must finance annually up to 2 percent of GDP in government long-term bonds, following the 1997 pension reform) and to the financial system; and foreign financing. Meanwhile, approval of the tax code—a critical structural reform under the program—stalled in Congress due to strong opposition from special interest groups.

  • The authorities adopted a financial program for 2002 to reinforce prudent economic management in the run-up to elections in mid-2002. Staff agreed to monitor the authorities’ program on an informal basis.

  • Performance under the authorities’ program was poor. Targets for international reserves and net domestic assets could not be met from the second quarter 2002, initially owing to a deposit run that required the central bank to provide liquidity to financial institutions, and later because of large domestic financing needs of the central government. Fiscal targets were missed from the third quarter, owing to lower royalties from gas exports to Brazil; delays in privatization plans; the continuing freeze of domestic fuel prices; above program wage increases; and large municipal investment outlays in December. Disbursements from the Andean Development Corporation (CAF) boosted nonconcessional financing.

A01app01ufig01

Combined public sector deficit

(Cumulative during year)

Citation: IMF Staff Country Reports 2003, 179; 10.5089/9781451805697.002.A001

A01app01ufig02

Net international reserves

(Change since beginning of year)

Citation: IMF Staff Country Reports 2003, 179; 10.5089/9781451805697.002.A001

The Social Safety Net Under the Program

The main elements of the social safety net are (Table 13 gives further details on costs and financing):

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The Payroll Tax and Fund Staff Advice

The budget submitted to congress in early February 2003 proposed changes to an existing payroll tax, the RC-IVA,1 that would have significantly increased taxes paid by salaried workers. The budget proposal was followed by widespread social protests and by the tragic events of mid-February.

The authorities’ proposal implied that: (i) taxpayers could no longer deduct any of their VAT receipts from their tax liability; (ii) the threshold for the tax would be reduced from four times, to two times, the minimum wage; and (iii) the RC-IVA rate would be cut from 13 percent to 12.5 percent.

A TA mission from the Fund recommended in 1999 to: (i) replace the RC-IVA with a full-fledged, broad-based personal income tax (PIT); (ii) maintain an exemption level for the PIT equivalent to four times the minimum wage, in order to protect low-income households; and (iii) allow taxpayers to present VAT receipts that could cut as much as half of the tax liability, thus maintaining the cross-checking role of the RC-IVA. More recently, Fund staff had advised the authorities to consider a slow transition from the RC-IVA to a conventional PIT while tax administration was being strengthened.

Prior to the budget submission, Fund staff had recommended that a more balanced fiscal adjustment be achieved through expenditure restraint—especially by reducing low-priority capital expenditure—and through alternative revenue measures, including a gradual increase in domestic retail prices for hydrocarbon products. However, the authorities, considering political constraints, chose to submit the modified payroll tax.

1The RC-IVA (in Spanish, complementary tax to the value added tax, VAT) is a withholding tax on wages and interest income of 13 percent, against which taxpayers can credit their VAT receipts to encourage taxpayer compliance with the VAT. By the mid-1990s, it had become clear that the tax was inefficient and inequitable, as it created a black market for VAT invoices.
Figure 1.
Figure 1.

Bolivia: Selected Economic Indicators, 1990–2003

Citation: IMF Staff Country Reports 2003, 179; 10.5089/9781451805697.002.A001

Sources: Central Bank of Bolivia; Ministry of Finance; and Fund staff estimates.1/ December over December.2/ Since 1997, includes reduced reserve requirements on foreign currency deposits and gold valuation of US$250 per troy ounce; for 2003, gold is valued at US$300 per troy ounce; excludes commercial banks’ liquid asset requirement (RAL) held overseas.
Figure 2.
Figure 2.

Bolivia: Monetary and Financial Sector Indicators

Citation: IMF Staff Country Reports 2003, 179; 10.5089/9781451805697.002.A001

Sources: Central Bank of Bolivia, Superintendency of Banks; and International Monetary Fund, International Financial Statistics.1/ In bolivianos, at current exchange rates.2/ Deposits include accraed interest. Credit includes loan portfolio purchased by the central bank and FONDESIF, loans from banks in liquidation, and commercial banks’ investments.3/ In U.S. dollars at current exchange rates.
Figure 3.
Figure 3.

Bolivia: Commercial Bank Performance Indicators, 1996–2003

Citation: IMF Staff Country Reports 2003, 179; 10.5089/9781451805697.002.A001

Source: Superintendency of Banks.1/Data prior to January 2000 have been adjusted to exclude loans that are less than 30-days past due, based on the average ratio of such loans to total past due loans during January-September 2000.2/ In December 2001, three banks were recapitalized through public sector guaranteed subordinated loans under the PROFOP program.
Figure 4.
Figure 4.

Bolivia: Real Exchange Rate and Quality of Bank Portfolio, 1996–2003

Citation: IMF Staff Country Reports 2003, 179; 10.5089/9781451805697.002.A001

Sources: International Monetary Fund, International Financial Statistics; and Fund staff estimates.1/ Increase is an appreciation. Based on exchange rate data available as of end-February 2003, and staff projections for CPI.2/ Weights based on trade with ten countries, excluding trade related to natural gas, in 1996–97.3/ Data prior to January 2000 have been adjusted to exclude loans that are less than 30-days past due, based on the average ratio of such loans to total past due loans during January-September 2000.
Table 1.

Bolivia: Selected Economic and Financial Indicators

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Sources: Central Bank of Bolivia; ministry of finance; and Fund staff estimates and projections.

Proposed program for 2003.

Includes actual and anticipated assistance under the HIPC Initiative, using the HIPC accounting conventions. External financing for 2002 includes a US$100 million (1.3 percent of GDP) transfer of foreign liabilities from the central bank to the central government in 2002.

External debt reflects assistance under the original and enhanced HIPC Initiatives, and beyond HIPC relief; includes obligations to the Fund and debt with public guarantee. Domestic debt is the nonfinancial public sector debt, excluding bonds issued for the recapitalization of the central bank.

Yields on treasury bills are those of the latest auction held; March 18 (March 6 for the lending rate in U.S. dollars) for 2003.

Includes grants for debt-reduction operations in effect prior to July 2000 and rescheduling operations under the original HIPC framework.

Equal to central bank’s gross official reserves plus commercial banks’ liquid asset requirement (RAL) held overseas; excludes reserves from the Latin American Reserve Fund (FLAR). End-2002 figures reflect an increase of US$45 million in the valuation of holdings of gold; import coverage for the following year.

Ratio of central bank gross disposable reserves (excluding gold holdings) plus commercial banks’ liquid asset requirement (RAL) held overseas to dollar deposits in the banking system.

Official (sell) exchange rate; March 18 for 2003.

Weights based on average trade, excluding trade related to natural gas, in 1996–97. Preliminary estimates for December 2002. Data for 2003 refer to February, based on exchange rate data available as of end-February, and Fund staff CPI projections. Positive variation is an appreciation.

Table 2.

Bolivia: Summary Balance of Payments

(In millions of U.S. dollars, unless otherwise noted)

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Sources: Central Bank of Bolivia; and Fund staff estimates and projections.

Capitalized enterprises are formerly state-owned enterprises with foreign capital.

Reflects lower scheduled debt service, owing to HIPC assistance in the form of stock-of-debt reduction (original HIPC starting in 1998, enhanced HIPC starting in 2001).

Excludes reserves from the Latin American Reserve Fund (FLAR).

In months of imports of goods and services in the following year.

Equal to central bank’s gross official reserves plus commercial banks’ liquid asset requirement (RAL) held overseas.

Before any assistance under the HIPC Initiative.

Official transfers and loans to the public sector, excluding HIPC debt relief.

Table 3.

Bolivia: Operations of the Combined Public Sector

(In percent of GPP)

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Sources: Ministry of Finance; Central Bank of Bolivia; and Fund staff estimates and projections.

Includes a US$100 million (1.3 percent of GDP) transfer of foreign liabilities from the central bank to the central government in 2002.

Preliminary estimates for 2002 and projections for 2003.

Table 4.

Bolivia: Monetary Survey 1/

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Sources: Central Bank of Bolivia; and Fund staff estimates and projections.

Flows in foreign currency are valued at the accounting exchange rate for the corresponding period. The banking system comprises the central bank, commercial banks, the National Financial Institution of Bolivia and FONDESIF, which are state-owned second-tier banks.

Includes special certificates of deposits (CDDs) issued by the central bank during the liquidation of failed banks.

Includes deposits and credits in bolivianos that are indexed to the U.S. dollar.

Table 5.

Bolivia: Commercial Bank Performance Indicators

(In percent)

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Source: Superintendency of Banks; and Fund staff estimates.

Provisional data.

Averages in 2001 and 2002 are cumulative from January of each year.

Adjusted to exclude the estimated share of loans overdue by less than one month, which were included in official statistics prior to January 2000; since December 2002, reported nonperforming loans exclude loans overdue by less than a month.

Table 6.

Bolivia: Financial and External Vulnerability Indicators

(In percent; end of period unless otherwise indicated)

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Sources: Central Bank of Bolivia; Superintendency of Banks; and Fund staff estimates and projections.

Debt indicators reflect assistance under the HIPC Initiative, which first became available after September 1998, as well as the relief under the enhanced HIPC Initiative and beyond HIPC. Includes obligations to the Fund and debt with public guarantee. For 2003, new debt with the pension funds is issued in inflation-indexed units (UFVs).

Financial sector effective interest rates.

Data for 2003 correspond to March 6.

Defined as the inverse of the annual average ratio of broad money to annual GDP.

Annual average stock.

Data for 2003 correspond to end of January.

Nonperforming loans are adjusted to exclude the estimated share of loans overdue by less than one month, which were included in official statistics prior to January 2000.

Ratio of central bank gross disposable reserves (excluding gold holdings) plus commercial banks’ liquid asset requirement (RAL) held overseas to dollar deposits in the banking system.

Weights based on average trade, excluding trade related to natural gas, in 1996–97. Positive variation is an appreciation.

Staff estimate.

Gross international reserves equal to central bank’s gross official reserves plus commercial banks’ liquid asset requirement (RAL) held overseas.

Exclude reserves from the Latin American Reserve Fund (FLAR). Import coverage for the following year. From end-2002 on, figures reflect an increase of US$45 million in the valuation of holdings of gold.

Short-term external debt by remaining maturity, added to foreign currency deposits at commercial banks.

Table 7.

Bolivia: Medium-Term Macroeconomic Framework, 1999–2005

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Sources: Central Bank of Bolivia, National Institute of Statistics; and Fund staff estimates and projections.

Based on balance of payments figures from the Central Bank of Bolivia, and Fund staff estimates and projections.

Based on national income accounts.

Table 8.

Bolivia: Poverty-Reducing Expenditure