Bolivia: Fifth Review under the Stand-By Arrangement, Request for Waiver of Nonobservance of Performance Criteria, Rephasing, Augmentation and Extension of the Stand-By Arrangement
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International Monetary Fund
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Publication Date:
29 Apr 2005
eISBN:
9781451805789
Language:
English
Keywords:
ISCR; CR; staff assessment; government; policy development; Executive Board's discussion; SDR; unviable bill; exchange rate; central bank; broad money; government paper; debt service; Government debt management; Global
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This paper discusses Bolivia’s Fifth Review Under the Stand-By Arrangement (SBA), Request for Waiver of Nonobservance of Performance Criteria (PC), and Rephasing, Augmentation, and Extension of the SBA. The 2004 program was on track. All quantitative PCs were met, with the exception of the end-September PC on central bank credit to the nonfinancial public sector. Macroeconomic developments have been positive, largely reflecting the favorable global environment, although the economy is still vulnerable. Real GDP growth is estimated to have reached 3¾ percent in 2004, and is projected to reach 4.5 percent in 2005.

Abstract

This paper discusses Bolivia’s Fifth Review Under the Stand-By Arrangement (SBA), Request for Waiver of Nonobservance of Performance Criteria (PC), and Rephasing, Augmentation, and Extension of the SBA. The 2004 program was on track. All quantitative PCs were met, with the exception of the end-September PC on central bank credit to the nonfinancial public sector. Macroeconomic developments have been positive, largely reflecting the favorable global environment, although the economy is still vulnerable. Real GDP growth is estimated to have reached 3¾ percent in 2004, and is projected to reach 4.5 percent in 2005.

I. political context

1. Political tensions pose serious challenges to the implementation of the authorities’ economic agenda. With difficult relations between the executive and legislative branches, Congress did not approve the new hydrocarbons framework in 2004, while the 2005 budget—which was not in line with the program—became effective on a lapse of time basis without formal congressional approval.

2. Moreover, regional pressures intensified after the authorities raised fuel prices at end-2004. In a long-delayed move, the authorities increased gasoline and diesel prices by 10 percent and 23 percent respectively, while prices of LPG remained unchanged. However, opposition by the rich oil producing eastern regions led to a reduction in the diesel price increase to 15 percent. The price increases also triggered demonstrations and calls for greater regional autonomy.

3. President Mesa has acceded to demands from different political groups. The announced, though not yet implemented, cancellation of a contract with a French firm that provided water services assuaged tensions in El Alto, but has created fears of legal stability for private investors and runs the risk of a costly legal process. Pressures are also growing for the creation of a development bank to reactivate credit flows. Demonstrations in Santa Cruz, Bolivia’s main economic center, in January, led to the authorities to agree to demands for elections of regional governors in June 2005, and a planned referendum on regional autonomy. Against this background, in early February, President Mesa swore in a new cabinet, replacing key ministers, including the Minister of Economic Development.

4. Following continuing political difficulties, President Mesa offered to resign and call early elections. The presidential offer followed steps by Congress toward approving a nonviable hydrocarbons bill and demonstrations and road blockades called by an opposition party.

5. After Congress refused to accept his resignation, President Mesa agreed to stay in office. Domestic conditions have since improved somewhat, as roads and airports have now been cleared. Congress is continuing to consider a controversial hydrocarbons bill, but the authorities has made clear that they will work toward an acceptable bill.

II. recent economic developments and program performance

6. Recent macroeconomic developments continue to be positive and the 2004 targets were largely achieved, but the economy remains vulnerable. Key economic developments are as follows:

  • Economic activity picked up in 2004. Real GDP growth in 2004 is estimated to have been in line with the program projection of 3¾ percent, buoyed by hydrocarbon and mineral exports. Twelve-month inflation reached 4.6 percent by end-year, exceeding the target of 3.5 percent, owing to high imported inflation, and larger than expected transportation costs in anticipation of fuel price increases (Figure 1).

  • The current account surplus is expected to be 3 percent of GDP in 2004, partly offset by capital outflows (Figure 2). Exports rose by about 35 percent, largely reflecting a favorable external environment for hydrocarbon products. A recovery in deposits during the second semester reduced the large capital account deficit in the first semester, and resulted in an overall balance of payments surplus of US$125 million (1½ percent of GDP).

  • Financial system deposits have recovered somewhat, but the system remains highly vulnerable (Figure 3). Deposits partially recovered from losses experienced in the context of the introduction of the financial transactions tax (FTT). Still, end-2004 deposits were 4¼ percent lower than a year earlier, while financial system liquid reserve coverage of deposits stood at 45 percent. As of February 23, 2005, deposits had declined slightly further (by less than 1 percent) relative to end- 2004.

  • Reflecting improving liquidity conditions, placements of government paper in local currency and at longer maturities increased in the latter part of 2004 (Figure 4 and 5). Weekly placements of government paper averaged around US$10 million from mid-July through end-2004 with: (i) the proportion of the stock of government paper in local currency increasing by 5 percentage points through 2004 to 21 percent; and (ii) the maturity on new placements lengthening from under a year at end-June, to over 1½ years by end-year.

  • While interest rates in US dollars have fallen, rates in local currency have remained steady (Figure 6). Despite a sharp increase in mid–2004, the interbank rate and the rate on one-year treasury bills in foreign currency declined by 132 and 193 basis points, respectively, in 2004. This reflected improved liquidity conditions and low international interest rates. However, the rate on treasury bills in local currency only declined by 28 basis points, increasing the spread over one-year foreign currency bonds to over six percentage points.

Figure 1.
Figure 1.

12-Month inflation

Percent change

Citation: IMF Staff Country Reports 2005, 146; 10.5089/9781451805789.002.A001

Figure 2.
Figure 2.

External current and capital account

(In millions of US dollars)

Citation: IMF Staff Country Reports 2005, 146; 10.5089/9781451805789.002.A001

Figure 3.
Figure 3.

Financial system deposits and NIR

Citation: IMF Staff Country Reports 2005, 146; 10.5089/9781451805789.002.A001

Figure 4.
Figure 4.

Stock of government paper in local currency

In millions US$

Citation: IMF Staff Country Reports 2005, 146; 10.5089/9781451805789.002.A001

Figure 5.
Figure 5.

Average maturity of treasury paper placements (TGN)

In days

Citation: IMF Staff Country Reports 2005, 146; 10.5089/9781451805789.002.A001

Figure 6.
Figure 6.

Interest Rates

In percent

Citation: IMF Staff Country Reports 2005, 146; 10.5089/9781451805789.002.A001

7. Most quantitative end-September (PCs) and end-December (indicative) targets were met. The only targets missed were: (i) the end-September PC on central bank credit to the NFPS (by less than US$2 million), owing to delays in grant disbursements; and (ii) the indicative net domestic financing target for end-December, as the authorities opted for domestic financing to compensate for external financing shortfalls.

8. The 2004 fiscal deficit target was met with some margin. Revenues were higher than expected by 0.9 percent of GDP, owing mainly to the tax regularization program and taxes on hydrocarbons exports. This was partially offset by higher capital spending of around 0.6 percent of GDP, mainly on roads. Current spending was in line with the program.

9. NIR were well above targeted levels in 2004, but have declined since. With a recovery in deposits, favorable external conditions, and the receipt of previously delayed external disbursements, NIR at end-2004 were above programmed levels by a large margin (over US$190 million) and registered an increase of US$139 million over the year. Through February 24, 2005, NIR fell by US$79 million from end-December, partly reflecting seasonal factors.

10. Progress has been made on structural reforms, although there have been some delays in important areas (see Table 2 of the MEFP). The high-level expenditure commission completed its recommendations on spending (end-September PC), but the end- September PC on congressional approval of the administrative procedures to the tax code was not met. Although the procedures law has been approved by the Upper House of Congress and received a favorable opinion from the Lower House Finance Committee, Congress as a whole has not taken up the issue given the focus on hydrocarbons issues. Nevertheless, the tax code appears to have been operating correctly. All benchmarks related to the financial sector were implemented, with the exception of that on establishing the Financial Restructuring Fund as a legal entity. Finally, the key end-October benchmark on approving an appropriate hydrocarbons law was not met. The law has been subject to a protracted and contentious debate, while the government has focused on limiting the risks of Congress adopting an inappropriate framework for the sector.

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.

SBA (Country Report No. 04/5).

External debt indicators reflect assistance under the original and enhanced HIPC Initiatives, and beyond HIPC relief. Domestic debt is the nonfinancial public sector debt, excluding bonds issued for the recapitalization of the central bank. End-2003 external debt reflects valuation changes.

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).

Ratio of central bank gross disposable reserves (excluding gold holdings) plus commercial banks’ liquid assets in foreign currency to financial system deposits.

External debt indicators reflect assistance under the original and enhanced HIPC Initiatives, and beyond HIPC relief; includes obligations to the Fund and debt with public guarantee. End-2003 external debt reflects valuation changes.

Official (sell) exchange rate.; August 30, 2004.

Table 2.

Bolivia: Operations of the Combined Public Sector

(In percent of GDP)

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

III. Policy Discussions

11. As Bolivia still needs to develop consensus on medium term policies, program discussions focused on an extension of the SBA. Though the authorities would prefer a three-years PRGF arrangement with the Fund, significant uncertainty still surrounds medium term policies, including the hydrocarbons framework. The planned Constituent Assembly later this year may also have implications for medium-term structural economic issues. Against this background, the staff discussed a twelve-month extension of the SBA predicated on key prior actions (Box 1) and critical fiscal and financial reforms. The extension would help maintain macroeconomic stability during the coming year, as part of continued international efforts to assist Bolivia, while giving the authorities additional time to consolidate consensus on medium-term policies.

Key Policy Measures Adopted since November 2004 1/

Fiscal Policy

  • Increase in domestic prices of gasoline and diesel of 10 and 15 percent, respectively.

  • Issuance of a supreme decree reducing spending limits below the 2005 budget, consistent with a deficit target of the combined public sector of 5.2 percent of GDP after grants.

  • Submission to Congress of a revised budget consistent with the program deficit target and nonconcessional financing of 1.5 percent of GDP.

Financial Sector:

  • Issuance of a supreme decree to eliminate regulatory powers of the Ministry of Finance over the financial system.

  • Issuance of norms tightening loan classification and provision regulations, calling for gradual increases in provisions, with the first effective increase taking place by end-May 2005.

  • Submission to Congress of legislation establishing the Financial Restructuring Fund (FRF) as a legal entity.

1/ Except for the fuel price increase, other measures were prior actions to issue Board documents.

12. Discussions for completion of the fifth review and extension of the program centered on: (i) assessing performance through end-September and end-December, 2004; (ii) monitoring progress toward securing a 2005 budget consistent with a deficit after grants of 5¼ percent of GDP and a net nonconcessional financing ceiling of 1½ percent of GDP; and (iii) assessing alternative debt sustainability scenarios, including under different assumptions for the hydrocarbons sector. The mission also discussed: (i) the recommendations of the expenditure and pension commissions; (ii) recent FAD TA on decentralization and public expenditure management; (iii) recent MFD TA on measures to promote greater exchange rate flexibility and the use of domestic currency; (iv) debt management issues; and (v) progress on preparation of a new PRSP.

A. Fiscal Policy

13. The authorities aim to reduce the fiscal deficit to 5¼ percent of GDP after grants in 2005, and limit nonconcessional financing to 1½ percent of GDP. The authorities have already adopted a balanced package of fiscal measures for 2005, including: (i) fuel price increases; (ii) clear spending priorities to allow for the implementation of key road projects within program ceilings; and (iii) the issuance of decrees to reduce budgeted spending by 3½ percent of GDP and thus set spending ceilings in line with the program. To receive congressional endorsement of the program spending ceilings, the executive recently submitted an amended budget in line with the program. In addition, the program aims to reduce the deficit target further by one-third of any tax revenue over-performance, thus saving revenue windfalls for which there is no sharing agreement with regions.

14. Despite the loss of one time tax amnesty collections (1½ percent of GDP) in 2004, revenues would increase by 0.3 percent of GDP relative to 2004 (Table A). The staff stressed the need to compensate for the loss of temporary revenues, while incorporating appropriate safety nets to protect vulnerable groups. With the signature of agreements with Argentina on higher prices and volumes of gas exports, and programmed volume increases to Brazil, gas royalties would increase by about ½ percent of GDP. In addition, the increase in fuel excise taxes led to a fiscal yield of around 1 percent of GDP. Fuel prices still remain well below the average in Latin America (Table B). To reduce the impact on the poor, the authorities maintained LPG subsidies, despite their high costs to the budget, and strengthened their employment program (PLANE) targeted on rural and poor areas.

Table A.

Fiscal accounts

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Source: Bolivian authorities and staff estimates
Table B.

Domestic Fuel Prices 1/

(US dollars per liter)

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Brazil (December 2004); Chile (December 2004); Peru (January 2005); and Uruguay (November 2004)

15. Overall spending would decline by 0.3 percent of GDP in 2005, with cuts in nonpriority spending allowing the initiation of priority road projects. Spending has been constrained by keeping public sector wage increases below inflation, containing fuel subsidies, and maintaining capital spending at 2004 levels as a share of GDP, through improved quality and reprioritization. The resulting savings more than offset the small increase in pension costs, which reflects the regularization of eligible pensioners under the old system. The authorities also aim to mitigate the rising pension costs by implementing measures to reduce fraud, in line with the findings of the pension commission. The mission urged the authorities to further accelerate pension reform, in cooperation with the IDB.

16. Congressional approval of an amended budget in line with the program and the tax code procedures are PCs for end-June. The staff pressed for these measures before completing the review. However, in light of the difficult political circumstances, the authorities preferred to focus their political capital in early 2005 on adopting an appropriate hydrocarbons framework, before switching attention to the budget and administrative procedures to the tax code. The authorities argued that the current tax code procedures issued by decree were operating well, as evidenced by tax collection in line with the program.

17. Understandings were reached on steps to improve the tax system and implement a sustainable tax reform. Following FAD TA recommendations, the authorities are considering introducing a personal income tax that would exempt 80–85 percent of the population, and eliminating the transactions tax (combined with an increase in the VAT rate) and the various special regimes. In this connection, the authorities would prepare a tax package for submission to Congress in September (benchmark to be converted into a PC after its specific components are identified in the context of the next review), for adoption by end- October 2005 (benchmark). The authorities are also looking to strengthen customs and tax administration.

18. The authorities are taking actions to reduce significant vulnerabilities resulting from the weak budget and decentralization processes (Box 2). The authorities concurred with the diagnosis of recent FAD TA, and have begun to take measures, including by preparing (i) an audit on subnational debt, to be ready by end-September (benchmark); and (ii) a draft organic budget law, with submission and approval as benchmarks for end-June and end-October 2005 respectively.

B. Monetary and Exchange Rate Policy

19. Discussions focused on the need to continue rebuilding reserves, while gradually introducing greater flexibility to the exchange rate. Although reserves were above programmed levels by end-2004, the authorities agreed that, given the fragility of Bolivia’s highly dollarized banking system—and the NIR loss in early 2005—a further build up would be appropriate in the rest of 2005. The staff urged the authorities to follow closely the evolution of NIR and adopt prompt corrective actions should further losses compromise the agreed NIR accumulation target of US$40 million for the year as a whole. The latter would increase reserve coverage to about 46 percent by end-2005, still well below levels in comparable dollarized countries. In line with MFD TA recommendations, the staff pushed for some increased flexibility of the crawling peg regime, including by conducting foreign exchange purchases to take advantage of the positive external environment. The authorities agreed, but indicated that they would move cautiously given the risk of being misinterpreted by market participants. They intend to introduce a two-way auction—taking advantage of a new electronic platform recently introduced for open-market operations—by end-September 2005.

20. With the staff emphasizing the significant debt roll-over risks in 2005, the authorities agreed to take steps to increase further placements of government paper in domestic currency and at longer maturities. While commending the authorities for increasing debt placements in local currency in 2004, the staff noted that (i) nearly 80 percent of Bolivia’s public sector domestic debt stock was still dollar-denominated; and (ii) some US$400 million in domestic debt was falling due in 2005, making Bolivia highly vulnerable to an exchange rate depreciation and roll over risks. To mitigate these risks, the authorities intend to further increase placements of bonds in local currency and at longer maturities, allowing interest rates to increase as necessary. In addition, the authorities have recently stablished a joint Ministry of Finance/Central Bank debt management unit to improve the structure of debt, including by setting targets for reducing short-term and dollar-denominated debt, monitoring progress, and offering recommendations to correct for deviations1.

Budget and Decentralization Processes1

Fiscal policy has been hampered by weak budget and decentralization processes. This has led to soft budget constraints and poor prioritization at all levels of government. Among the main weaknesses are:

  • Based on over-optimistic revenue estimates and unrealistic spending ceilings, the budget and medium term fiscal framework lack credibility;

  • Limitations in the government financial information system (SIGMA), including the lack of a functional budget classification, make it difficult to monitor public sector spending—particularly to adequately track pro-poor and subnational governments’ operations.

  • The lack of clear responsibilities for subnational governments means they have few incentives to manage spending—such as on health and education—efficiently or to raise their own revenues.

  • The complex transfer system with excessive earmarking leads to the simultaneous accumulation of deposits and growing debt at the subnational level.

A strategy to address the structural weaknesses in the budget process is needed. It should focus, in the short-term, on (i) approval of an organic budget law, to have a legal framework for an improved and effective budget process; (ii) improving information systems; and (iii) the use of a proper functional classification.

Weaknesses of the decentralization process should also be addressed, particularly in the context of the forthcoming Constituent Assembly. In particular,

  • Quality of the education and health sectors should be improved, while reducing costs, particularly the wage bill. In the short run, an audit of the number of teachers and health workers should be conducted, and clear salary rules established. In the long run, all responsibilities for teachers should be at one level of government.

  • Subnational governments should be allowed to raise their own revenues, possibly by setting surcharge rates on central taxes and having some control over local tax rates.

  • To increase equity and efficiency, a new equalization system based on revenue capacities and expenditure needs, and clearly defined tied-transfers, to meet central government policy objectives could be set up.

  • An independent audit of subnational floating debt and a debt register should be established.

1 This box relies heavily on a recent FAD TA report on budget and decentralization processes.

C. Financial Sector Policy

21. The authorities are taking a number of steps to protect the financial system and reduce liquidity, solvency, and credit risks (¶16 and 17 of the MEFP). During the last 6 months, the authorities have intervened three savings and loans institutions that failed to comply with capital adequacy requirements in 2004, repealed supreme decrees granting forbearance on loan classification and provisioning, issued a decree eliminating regulatory powers of the Ministry of Finance over the financial system, and introduced a new norm for the gradual phase-in of the additional provisions. Looking ahead, after the staff cautioned against achieving increases in reserve requirements on foreign currency deposits through large increases in marginal rates, the authorities agreed to moderate increases in average rates. This will start in April, with an increase of 2 percentage points (benchmark). The sale process for the state’s participation in banks majority-owned by NAFIBO, is also agreed as an end-December 2005 structural PC.

22. The program incorporates steps toward a properly functioning bank resolution framework. These would be crucial to strengthen supervision, and reduce risks and moral hazard problems in bank resolution. In this connection, the authorities recently submitted to Congress legislation to ensure that the Financial Restructuring Fund is established as a legal entity, and that the bank resolution process continues to function properly in 2005. In addition, a bill creating a deposit insurance scheme, with partial coverage and adequate financing, is expected to be submitted to Congress by end-September 2005 (benchmark).

23. Following staff concerns, the authorities stressed that, despite pressures, they do not intend to create a development bank. The authorities have been searching for ways to support productive activities, but they have reassured the staff that funds devoted to this would come from the reallocation of existing resources; and that activities of second-tier banks (including NAFIBO and FONDESIF) will avoid subsidies, bailouts or special treatment for specific sectors.

24. The pace of corporate restructuring initiatives has been slow. So far, only one firm has qualified for a pilot study, prohibiting any significant lessons from being drawn. Therefore, the end-November 2004 benchmark on submission to Congress of amendments to the corporate restructuring framework was missed. Against this background, and with World Bank advice, the authorities agreed to address known deficiencies of existing laws, including to appropriately protect creditor rights. The authorities intend to submit legislation to Congress improving the corporate restructuring and bankruptcy framework by end- September 2005 (benchmark).

D. Hydrocarbons

25. Given regional pressures and divisions within Bolivian society and Congress, a consensus is yet to emerge on an appropriate hydrocarbons strategy. Oil companies are concerned that the framework under discussion in Congress will increase the role of the state, weaken property rights, and significantly increase taxation on large fields. They argue that if this occurs, it would make new large investments unviable, and have threatened international arbitration. Pulling in opposite directions, some political parties are arguing in Congress for an even greater role for the state, while oil-producing regions are calling for increased autonomy and a higher share of the tax take.

26. The authorities acknowledged the importance of approving an appropriate hydrocarbons law consistent with increased foreign investment and medium-term debt sustainability. The staff welcomed President Mesa’s commitment to veto any inappropriate hydrocarbons law. In the Bolivian legal framework, the veto could be selective and cover only inappropriate provisions. The authorities assured staff that they were committed to working with Congress to secure an appropriate law by end-June 2005 that balances the concerns of the population for a higher tax take, while maintaining an environment conducive to increased investment (benchmark). The staff, in collaboration with the World Bank, will continue to assess progress toward the development of a viable hydrocarbons strategy, taking into the account the findings of the commission of international experts, which were reported to the authorities at end-2004.

E. PRSP and Medium-Term Agenda

27. The National Dialogue was completed by December 2004 and a draft PRSP is under preparation. The National Dialogue discussions concluded that any sustainable poverty reduction strategy needed to increase employment of the poor. Reflecting this, the PRSP is expected to focus on employment generation, as well as improvements in social indicators and infrastructure. The authorities assured the staff that they would not give in to pressures to include populist policies—such as greater state intervention in the economy—in the PRSP. The staff noted that the PRSP should also present sustainable sources of fiscal revenue, well-targeted social safety nets, and clear priorities for national spending, consistent with fiscal sustainability. A follow-up Consultative Group meeting could take place later in the year.

28. Debt sustainability analysis highlights the critical need for further fiscal consolidation coupled with a viable hydrocarbons bill (Box 3). The baseline scenario conservatively assumes increased gas exports only to regional markets, and continued fiscal consolidation. This projection points to a debt to GDP ratio below 48 percent of GDP in net present value terms by 2015. An alternative scenario, based on gas exports remaining at their 2005 levels (Figure 7), shows that debt dynamics deteriorate significantly. Stress tests to the baseline scenario illustrate that debt sustainability is highly vulnerable to a variety of shocks and to policy inertia. In particular, a lack of fiscal consolidation and a large real exchange rate depreciation—given a highly dollarized public debt stock and financial system—would worsen debt dynamics considerably (Figure 8).

Figure 7.
Figure 7.

Alternative Gas scenarios

NPV of public debt (% of GDP)

Citation: IMF Staff Country Reports 2005, 146; 10.5089/9781451805789.002.A001

Figure 8.
Figure 8.

Stress Tests

NPV of public debt (% of GDP)

Citation: IMF Staff Country Reports 2005, 146; 10.5089/9781451805789.002.A001

Medium Term Sustainability of Public Sector Debt

Despite Bolivia’s current high level of public sector debt—around 54 percent of GDP in NPV terms—debt sustainability can be achieved provided a hydrocarbons framework conducive to further investment is adopted and further fiscal consolidation is implemented. Because of the macro-critical nature of the hydrocarbons sector and the significant uncertainty surrounding the new hydrocarbons bill, two alternative scenarios were considered, with high and low hydrocarbons exports. The low hydrocarbons export scenario demonstrates that even to keep debt stable, a high degree of fiscal adjustment is needed. Stress tests further reveal that Bolivia’s debt dynamics are vulnerable to various shocks, particularly an exchange rate depreciation and lack of fiscal adjustment.

Hydrocarbons scenarios (Table 10)

  • Baseline scenario. While Bolivia has large natural gas reserves, this scenario only assumes gas exports to regional markets. The scenario envisages an increase in gas exports to Brazil—as already contracted—and the firming up of talks to extend and augment the contract to export gas exports to Argentina, that is due to expire at end-2005. Even with the projected increase in gas exports, fiscal consolidation is essential to reduce debt. The budget deficit is assumed to decline by 5 percentage points from 2004–2015. The NPV of debt declines from 54 percent of GDP in 2003 to 47 percent of GDP by 2015.

  • High exports scenario. With a more favorable investment climate, Bolivia’s gas reserves are exploited more intensively, with further exports to Brazil or North America as possibilities. The significantly higher exports lead to higher GDP and a lower fiscal deficit, resulting in a bigger decline of NPV of debt to GDP ratio to less than 40 percent by 2015.

  • Low exports scenario. This assumes that Bolivia adopts a hydrocarbons law that is not conducive to continued investment, with gas exports to Brazil and Argentina remaining at 2005 levels and no new projects coming on stream. A higher fiscal deficit and lower GDP lead to the NPV of debt rising to about 63 percent by 2015.

Stress tests (Table 11)

The following stress tests to the baseline were considered:

  • A lower oil prices test assumes that the crude petroleum price falls below the WEO baseline by US$15 in 2005 and US$10 each year thereafter. The reduced revenues from oil exports and lower GDP lead to an increase in NPV of debt to GDP to about 60 percent by 2015.

  • A higher nonconcessional financing test assumes (i) a gradual fall in grants to zero by 2010; (ii) an increase in net non concessional borrowing of 3.1 percent of GDP on average starting in 2005; and (iii) that each 1 percent fall in grants leads to only a 0.7 percent increase in the primary deficit, because the fall in grants will lead to the discontinuation of some externally financed projects. The NPV of debt to GDP reaches 65 percent by 2015.

  • A higher interest rate test assumes that interest rates on nonconcessional external and domestic borrowing increase by 3 percent points each year starting in 2005. The NPV of debt to GDP rises to more about 52 percent by 2015. This likely provides only a lower bound of the impact on debt, as the scenario looks at the passive impact of higher debt service costs on nonconcessional debt and not the negative effect of higher interest rates on economic activity, especially on the financial sector.

  • An exchange rate devaluation test models a 30 percent devaluation in 2005, which remains permanent. The NPV of debt to GDP rises sharply to 80 percent in the aftermath of devaluation, but subsequently gradually falls to 68 percent by 2015. Again, this is likely to be a lower bound as it does not include the potentially debilitating impact of the devaluation on the financial system and hence on economic activity.

  • A higher earmarking test assumes 100 percent earmarking of the revenues from the hydrocarbon tax envisaged under the new hydrocarbons law. The NPV of debt to GDP rises initially until 2009, but thereafter declines to 55 percent by 2015.

  • An unchanged primary balance test assumes that the primary balance stays at the level of 2004 (a -2.7 percent primary deficit) throughout 2005–2015. The NPV of debt to GDP rises to the highest level—83 percent—by 2015 and becomes unsustainable. This result underscores that a lack of fiscal adjustment is the most serious risk.

Table 3.

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.

Revised SBA (Country Report No. 04/5).

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

Commercial banks’ liquid asset requirement (RAL) held overseas added to central bank gross official reserves.

Before any assistance under the HIPC Initiative.

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

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 certficates 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.

Due to some changes in classification, central bank credit to the public, financial and other sectors has been revised in 2002/3.

At the beginning of 2005 Banco Los Andes was reclassified as a bank.

This has led to a step increase in the levels of broad money and credit to the private sector in 2005.
Table 5.

Bolivia: Medium-Term Macroeconomic Framework

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Sources: Central Bank of Bolivia; and Fund staff estimates and projections.
Table 6.

Bolivia: Commercial Banks Performance Indicators

(In percent)

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Source : Superintendency of Banks
Table 7.

Bolivia: Schedule of Purchases Under the Extension of the SBA

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Source: Fund staff estimates.
Table 8.

Bolivia: Millenium Development Goals

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Source: World Development Indicators database, April 2004 Note: In some cases the data are for earlier or later years than those stated. Goal 1 targets: Halve, between 1990 and 2015, the proportion of people whose income is less than one dollar a day. Halve, between 1990 and 2015, the proportion of people who suffer from hunger. Goal 2 target: Ensure that, by 2015, children everywhere, boys and girls alike, will be able to complete a full course of primary schooling. Goal 3 target: Eliminate gender disparity in primary and secondary education preferably by 2005 and to all levels of education no later than 2015. Goal 4 target: Reduce by two-thirds, between 1990 and 2015, the under-five mortality rate. Goal 5 target: Reduce by three-quarters, between 1990 and 2015, the maternal mortality ratio. Goal 6 targets: Have halted by 2015, and begun to reverse, the spread of HIV/AIDS. Have halted by 2015, and begun to reverse, the incidence of malaria and other major diseases. Goal 7 targets: Integrate the principles of sustainable development into country policies and programs and reverse the loss of environmental resources. Halve, by 2015, the proportion of people without sustainable access to safe drinking water. By 2020, to have achieved a significant improvement in the lives of at least 100 million slum dwellers. Goal 8 targets: Develop further an open, rule-based, predictable, non-discriminatory trading and financial system. Address the Special Needs of the Least Developed Countries. Address the Special Needs of landlocked countries and small island developing states. Deal comprehensively with the debt problems of developing countries through national and international measures in order to make debt sustainable in the long term. In cooperation with developing countries, develop and implement strategies for decent and productive work for youth. In cooperation with pharmaceutical companies, provide access to affordable, essential drugs in developing countries. In cooperation with the private sector, make available the benefits of new technologies, especially information and communications.
Table 9.

Bolivia: Indicators of Fund Credit, 2001-2009

(On obligation basis)

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Sources: Central Bank of Bolivia; International Monetary Fund, Treasurer’s Department; and Fund staff projections.

Gross financing needs are defined as the sum of the external current account deficit, scheduled amortization, repayments to the fund, changes in gross international reserves of the central bank, change in arrears, and net private capital flows.

Table 10a.

Bolivia: Scenarios for Public Debt Sustainability Framework

(in percent of GDP)

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Source: Bolivian authorities, and Fund staff estimates.
Table 10b.

Bolivia: Scenarios for Public Debt Sustainability Framework

(in percent of GDP)

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Source: Bolivian authorities, and Fund staff estimates.
Table 10c.

Bolivia: Scenarios for Public Debt Sustainability Framework

(in percent of GDP)

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Source: Bolivian authorities, and Fund staff estimates.
Table 11.

Bolivia: Debt Sustainability Analysis - Stress Tests

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US$ 15 below baseline in 2005 and US$10 below thereafter.

Reduction in grants and higher share of non concessional borrowing result in an increase in net non-concessional financing by 3.1 percent on average each year starting 2006.

Increase in interest rates on nonconcessional external and domestic borrowing by 3 percent each year starting 2005.

Permanent 30% devaluation from 2005.

Higher earmarking just to regions (100%).

29. The authorities considered it essential to be actively involved in free trade negotiations with the U.S. to avoid possible harm to the export sector. The combination of common external tariffs and free trade within the Andean region has benefited key Bolivian exports, including soybean. The staff argued that this advantage could be dismantled sooner than expected, should other Andean countries chose to abolish some of their external tariffs as part of ongoing negotiations with the U.S. over a free trade agreement. The authorities acknowledged the risks of maintaining only observer status in such negotiations, and are (i) planning to participate more actively in the free trade negotiations; and (ii) working on a comprehensive strategy to enhance Bolivian competitiveness.

F. Ex-Post Assessment (EPA) of Longer-Term Program Engagement (LTPE)2

30. The ex-post assessment of the Fund’s engagement with Bolivia concluded that Bolivia’s past performance was hampered by an incomplete implementation of critical reforms. Despite Bolivia undertaking some of the most extensive structural reforms in Latin America during the 1980s and 1990s, trend growth per capita did not take off because the reforms did not succeed in fundamentally altering the character of the state and improving the business environment. The report also analyzed the roots of Bolivia’s continuing financial sector and fiscal fragilities, which are blamed in part on political opposition to critical structural reforms and pressures from various interest groups.

31. The assessment noted that continued Fund support should be conditional on the adoption of a number of key fiscal and financial reforms. Support of the authorities’ program through a new PRGF could be justified provided that it included a comprehensive reform agenda. Fundamental institutional and structural reforms would encompass improving governance, reducing and better managing public expenditure, creating a more equitable and efficient tax system, strengthening the banking system, and beginning a process of financial de-dollarization. If the authorities could start implementing key fiscal and financial reforms, but had not obtained sufficient consensus over medium-term policies, a new one-year SBA, or extension of the current program as being requested, could be considered as a bridge to a new PRGF. Nonetheless, in a situation where Fund support is urgently needed to prevent an imminent financial collapse and provide a framework for continued donor support, a Stand-By that meets adequate standards, along the lines of the 2003 Arrangement, could be justified.

32. The authorities broadly agreed with the assessment’s findings, but felt that the bar for a new PRGF was a high one. They agreed that Bolivia needed a comprehensive reform program, but were concerned that some of the pre-conditions recommended for a PRGF—such as a “litmus test” critical reform to signal the country’s readiness to undertake a new reform effort—may be difficult to meet in the near future given the current political fragmentation.

G. Program Financing

33. The authorities agreed on a multi-year budgetary framework with bilateral donors in late October 2004. Arising from these discussions, donors and multilaterals pledged some US$110 million, in line with estimated concessional financing requirements for 2005 under the program. This assistance was tied inter alia to improvements in the transparency and execution of the budget, better orientation of pro-poor spending, and implementation of a functional classification of expenditures.

H. Program Monitoring and IFIs role

34. Extension, access, and rephasing. It is proposed to extend the SBA to March 31, 2006, rephase the original purchases to backload disbursements, and augment access by 25 percent of quota (SDR 42.86 million). The extension is to allow time for the authorities to build consensus and adopt structural reforms that will help achieve debt sustainability and pave the way for a new three-year arrangement. The proposed augmentation reflects the strength of the program and the balance of payments needs for the period of the extension. A disbursement of SDR 9.66 million (5.63 percent of quota) would become available at completion of the fifth review (Table 7).

35. Capacity to repay. Debt service to the Fund constitutes a small share of Bolivia’s exports of goods and services and gross official reserves (Table 9). Bolivia would therefore be expected to meet its obligations to the Fund fully and on a timely basis. Nevertheless, Fund resources would be at some risk, given sharply rising debt service costs, the fragile social and political situation, and uncertainties about medium-term prospects.

36. Quantitative performance criteria have been proposed for end-June 2005, end-September 2005, and end-December 2005, as shown in Table 1 of the MEFP.

37. Structural conditionality. In line with the recommendations of the EPA, structural conditionality focuses on fiscal reform, strengthening the financial and corporate sectors, and hydrocarbons policy (Table 3 of the MEFP).

38. Next Review. The sixth review will focus on assessing progress toward (i) a draft 2006 budget and tax reform package consistent with a deficit of around 4 percent of GDP, subject to available concessional financing; (ii) the adoption of an appropriate hydrocarbons framework; and (iii) reducing financial vulnerabilities.

39. World Bank and IDB role. As part of a concerted international effort to support Bolivia, these institutions are providing concessional loans, including balance of payment support; with credits focusing on poverty reduction, and strengthening institutions in the fiscal, financial and corporate sectors (Appendices II and III). Both have various projects on roads, health, education and the environment. The World Bank is also advising the government on hydrocarbons issues, including by providing international expertise for Bolivia on the legal framework for the sector. Structural conditionality centers on: (i) corporate sector restructuring (World Bank); (ii) civil service reform (World Bank); (iii) institutional strengthening of customs and tax administration (World Bank and IDB); (iv) land reform (World Bank); (v) social protection and provision of basic services (World Bank and IDB); and (vi) enhancing competitiveness of the private sector (IDB).

I. Program Risks

40. Program risks remain high. In particular:

  • Growing regional and political tensions have increased program implementation risks. Recent events in Santa Cruz and El Alto highlighted the pressures facing the government. The upcoming election of regional governors, the announced referendum on regional autonomy, and the Constituent Assembly could increase divisions in Bolivia.

  • Despite the recent agreement between the administration and traditional political parties, there are still significant difficulties in passing key legislation. The agreement may have strengthened the government’s base in Congress, including for passing an appropriate hydrocarbons law. However, Congress’ insistence on a hydrocarbons bill deemed unacceptable by President Mesa, even after the agreement with political parties, illustrates remaining risks. In addition, a key opposition party’s refusal to sign the agreement and its insistence on a populist hydrocarbons law could further polarize Bolivian society.

  • Fiscal risks are high. While curtailing current spending by decree was successful in 2004, controlling capital spending (as intended in 2005) could prove more challenging in light of regional spending pressures. Roll over risks are also high, given substantial debt falling due in 2005 (almost 5 percent of GDP) and the still large fiscal deficit.

  • The highly dollarized financial system remains vulnerable. Despite recent progress in strengthening the financial system, large cumulative deposit losses during the last few years, low profitability, and lingering political and economic uncertainties make the system vulnerable to renewed deposit withdrawals.

  • Uncertainties surrounding approval of a viable hydrocarbons bill and the investment environment more broadly could threaten medium-term prospects.

  • Bolivia’s dependence on primary commodities makes it vulnerable to external shocks.

41. The proposed program has been designed to help address implementation risks. In particular, key prior actions have been implemented and Fund disbursements have been backloaded.

IV. Staff Appraisal

42. With the pre-conditions for a PRGF still not in place, the proposed extension of the SBA should help catalyze further financial assistance and give the authorities time to develop a medium-term policy agenda. The recent implementation of fuel price increases, several prior actions, and the political agreement between the administration and the majority in Congress, may have improved prospects for the implementation of the authorities’ program, which still needs critical fiscal and financial reforms and the building of consensus on medium-term policies.

43. However, there are substantial risks to the program. The continued social, regional, and political tensions; and insufficient domestic consensus pose high implementation risks. Moreover, the highly dollarized and weak financial system makes the economy particularly vulnerable to further shock.

44. While the authorities have reduced spending limits by decree in line with the 2005 program, they should stand ready to take additional measures should deviations arise. The fuel price increases and spending decrees have given the government a platform on which to carry out the needed fiscal consolidation. Nevertheless, the staff stressed the need to approve a new budget as soon as possible. The authorities should resist spending pressures, and be ready to take contingency measures—including further cuts in current and lower priority capital spending—should the need arise.

45. Given Bolivia’s vulnerability to a number of shocks, saving part of the windfall arising from the current favorable external conditions would be desirable. Bolivia’s reliance on primary commodities and degree of indebtedness suggest that negative external shocks—such as higher global interest rates, or a terms of trade deterioration—would require substantial further fiscal consolidation to maintain debt sustainability. In light of this, the staff welcomed the authorities’ agreement to reduce the deficit further in the event of higher revenues than assumed in the program.

46. Achieving fiscal sustainability will require substantial fiscal consolidation during 2006 and beyond. While the authorities have identified potential revenue and expenditure measures—including a sustainable tax reform and the implementation of the recommendations of the expenditure and pension commissions—it will be crucial to move forward and adopt these measures, and obtain congressional approval where necessary.

47. Implementing effective public expenditure management and reforming the decentralization process are critical reforms. The staff welcomed the authorities’ plan to adopt an organic budget law to set binding budget constraints at all levels of government, and transform the budget into an effective policy tool to set spending priorities. In preparation for potentially increased regional autonomy and the Constituent Assembly, the staff urged the authorities to assess spending and revenue responsibilities across different levels of government to avoid exacerbating existing problems with the decentralization process.

48. The authorities were able to rebuild reserves in 2004, in part owing to the favorable external conditions, but greater efforts are needed to reduce vulnerabilities. In the context of the highly dollarized financial system and the crawling peg regime, the authorities need to further increase reserve coverage. On time, they should introduce a two-way foreign exchange auction to gradually foster greater exchange rate flexibility, better reflect market conditions and improve the ability to withstand shocks.

49. Debt management needs to be strengthened to mitigate roll over and exchange rate risks. Staff commended the authorities for taking steps to increase placements in domestic debt and at longer maturities, but pressed the authorities to strengthen these efforts—at higher interest rates if necessary—given the high level of dollarization and domestic debt falling due in 2005. Staff welcomed the establishment of a debt management unit with explicit targets to improve debt operations.

50. The authorities continue to make progress in strengthening the financial sector but should press ahead in completing pending reforms, and resist pressures to create public sector development banks. While commending the authorities for taking action to resolve various weak savings and loans institutions and tightening the regulation on loan classification and provisions, the staff noted the need to further reduce risks given remaining vulnerabilities. Steps to reduce risks include increasing reserve requirements on dollar deposits; privatizing banks where the public sector holds a majority stake; and approving the law that creates the Financial Restructuring Fund as a legal entity and provides appropriate financing for the bank resolution process.

51. The corporate restructuring agenda needs to be reinvigorated, as it is key to reestablishing credit flows to the private sector and reducing vulnerabilities of the financial system. Progress in this area has been slow and the authorities need to redouble their efforts in amending the relevant legislation in order to protect creditor rights. The staff welcomed the authorities’ commitment to submit to Congress draft legislation strengthening creditor rights later in the year.

52. Passage of a viable hydrocarbons bill and maintaining a general framework conducive to foreign investment are critical to attaining medium-term debt sustainability. Staff welcomed the authorities’ resolve to veto any inappropriate hydrocarbons law, and encouraged them to continue to reach out to Congress to foster greater consensus on a version, that balances the call for greater taxation on hydrocarbons and the need to increase private investment in the sector.

53. Despite the significant risks, staff believes that program objectives can be attained through continued implementation of key reforms. The fragile political situation and regional tensions create substantial implementation risks. However, on the basis of the important prior actions taken, including difficult fuel price increases; the authorities’ commitment to work on broadening domestic support for their policy agenda; and the proposed backloading of Fund disbursements; the program can achieve its objectives. Staff therefore recommends the completion of the fifth review; granting of waivers for nonobservance of performance criteria; and extension and augmentation of the SBA through end-March 2006.

APPENDIX I Bolivia: Fund Relations

(As of January 31, 2005)

I. Membership Status: Joined December 27, 1945; Article VIII.

II. General Resources Account:

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III. SDR Department:

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IV. Outstanding Purchases and Loans:

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V. Latest Financial Arrangements:

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VI. Projected Payments to Fund (Expectations Basis) (SDR Million; based on existing use of resources and present holdings of SDRs):

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Projected Payments to Fund (Obligations Basis) (SDR Million; based on existing use of resources and present holdings of SDRs):

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VII. Implementation of HIPC Initiative:

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Assistance committed under the original framework is expressed in net present value (NPV) terms at the completion point, and assistance committed under the enhanced framework is expressed in NPV terms at the decision point. Hence, these two amounts cannot be added.

Under the enhanced framework, an additional disbursement is made at the completion point corresponding to interest income earned on the amount committed at the decision point but not disbursed during the interim period.

VIII. Safeguards Assessments: Under the Fund’s safeguards assessment policy, the Central Bank of Bolivia (CBB) is subject to an update assessment with respect to augmentation of the April 02, 2003 Stand-by arrangement. The assessment related to the June 10, 2004 augmentation was completed on September 27, 2004 and found no systemic risks in the safeguards of the CBB. The assessment confirmed that all previously identified vulnerabilities, except for those requiring a change in the central bank law, were eliminated. An abbreviated safeguards assessment update is currently underway.

IX. Exchange Rate Arrangement: The Bolivian currency is the boliviano and the exchange rate system is classified as a crawling peg. The central bank holds a daily foreign exchange auction, accepting all bids that are at least equal to the central bank’s minimum price. If acceptable bids exceed the amount offered for auction, the lowest acceptable bids are prorated so as to exhaust the amount offered. The minimum price is adjusted from time to time in light of the evaluation of Bolivia’s real exchange rate with respect to Bolivia’s key trading partners. The administration of the system has resulted in minimal spreads between the maximum and minimum bids (generally 2 cents of boliviano). On September [xx], 2004, the official selling rate was Bs [xx] per U.S. dollar.

X. Article IV Consultation: The previous Article IV consultation and request for the first review under the Stand-By Arrangement July 7, 2003 (Country Report No. 03/257). Bolivia is on 24–month consultation cycle.

XI. Technical Assistance:

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XII. Resident Representative: Mr. Símon Cueva, since September 2003.

APPENDIX II Bolivia: Relations with the World Bank

The World Bank support to Bolivia is being delivered according to the strategy spelled out in the CAS covering fiscal years 2004 and 2005.3 Bolivia is in the CAS base case, hence the annual financing resources to be provided amount to US$100 million, with 50 percent allocated to investment projects. IDA resources amount to around US$45 million a year.

Recent and Forthcoming Actions

Projects under the FY04–05 GAS. These include:

  • the First Programmatic Bank and Corporate Sector Restructuring Project (US$15 million IDA and US$15 million IBRD) aimed at strengthening the banking and corporate sector. This loan was recently extended until June 2006.

  • the Institutional Reform II (US$32 million, IDA) that focuses on the reform of the civil service and key agencies such as customs and other tax administration agencies. This loan will close in June 2005, but an extension could be granted if desired.

  • the Land Reform Project and the Spatial Rural Development/Community-driven Development Project (US$35 million IDA) that responds directly to the problems of inequality and to the problems that the poor have in generating income. This loan is under preparation; and

  • the Second Social Sector Programmatic Adjustment Credit (US$ 20 million IDA) that, like the first credit, will address issues in the basic social protection areas. This loan is also under preparation.

The Emergency Economic Recovery Credit (US$14 Million IDA) approved by the World Bank Board in December 2003 was closed due to government failure to comply with the loan requirement, i.e., to present proof of purchase of imports. Only 70 percent of the total credit was disbursed.

Technical Assistance and Economic Sector Work. The World Bank has provided technical assistance on the hydrocarbons area, including support on the design of Bolivia’s new hydrocarbons law and a study on gas revenue sharing. The Bank is also providing technical assistance to strengthen the capacity of Congress.

A CAS progress report and a Country Economic Memorandum are in progress. The focus of the latter is on growth with special attention to the investment climate and trade issues. Both are expected to become available this fall.

APPENDIX III Bolivia: Relations with the Inter–American Development Bank

Background

As of December 31, 2004, the Inter-American Development Bank (IDB) had approved loans to Bolivia amounting to US$3.7 billion, with disbursements totaling US$3.1 billion. Bolivia’s outstanding debt to the IDB was US$1.8 billion. Since 2000, net cash flows to the country were positive through 2003 owing to debt relief provided by the IDB under the HIPC Initiative and other extraordinary financing disbursed that year. Looking forward, the sign of net flows from the IDB will depend on the pace of disbursements. Project and policy execution have been negatively affected by the ongoing institutional and economic crises.

uA01fig01

Bolivia: IDB Net Principal and Cash Flows

(US$ Million)

Citation: IMF Staff Country Reports 2005, 146; 10.5089/9781451805789.002.A001

Country Strategy and Lending Program

Sustainable poverty reduction is the overarching objective of the Bank’s country strategy with Bolivia. In pursuit of this the Bank is supporting government-led efforts to overcome the country’s economic and social development challenges in three areas: (a) improving the managerial capacity and transparency of the State, (b) supporting competitiveness and sustainable development of the private sector; (c) enhancing efficiency and equity in basic services delivery. The backdrop for the strategy’s implementation is complex, characterized by a widespread rejection of the reform process, fiscal retrenchment, the need to develop a shared vision for the future and a far-reaching political agenda that includes a satisfactory hydrocarbons law following the national consultation on the use of gas reserves, and a Constitutional Assembly. In this context, the strategy has been conceived as a process in which the Bank, in concert with the Government and other partners, identify near-term high priority interventions that could attenuate economic risks and preserve the social gains of the last decade. As political and economic uncertainties diminish, Bank’s actions will increasingly move towards tackling the impediments for a more equitable and sustainable social and economic progress. From the operational standpoint, the Bank’s portfolio in Bolivia represents a valuable resource base from which to implement the strategy. As of December 31, undisbursed balances amounted to US$487.3 million, exceeding the expected allocation of fresh IDB concessional resources to Bolivia in the period 2005–2007, estimated at US$ 300 million.

The IDB’s lending program will continue to provide concessional resources to support fiscal sustainability, while protecting investments that are critical for achieving the Millennium Development Goals. The proposed IDB lending program for Bolivia for 2005 consists of 7 loans amounting to US$115 million.

IDB non-reimbursable technical cooperation and small projects

The IDB’s portfolio in Bolivia also includes active non-reimbursable technical cooperation projects for US$22.7 million, and US$2.3 million in credits for small projects.

ATTACHMENT I

La Paz, Bolivia, March 24, 2005

Mr. Rodrigo de Rato

Managing Director

International Monetary Fund

Washington, D.C. 20431

Dear Mr. de Rato,

1. The macroeconomic policies and structural reforms pursued by our government continue to bear fruit despite difficult political and social conditions. Macroeconomic developments in 2004 were positive with real GDP growth of nearly 4 percent, a significant current account surplus, and increased reserve coverage of deposits.

2. Our program, supported under a Stand-By Arrangement (SBA), was broadly on track in 2004. The quantitative performance criteria (PCs) for end-September were met, except for that on central bank net credit to the nonfinancial public sector (NFPS), which was missed by a marginal amount (less than US$1.5 million). By end-December, central bank credit was back on track and the deficit target was met with a margin. Thus, we are requesting a waiver for the nonobservance of the end-September PC on central bank net credit to the NFPS. We are also requesting a waiver for the nonobservance of the end-September structural PC on congressional approval of the procedural requirements for appeals before the Tax Superintendency. While compliance with this PC was outside the control of the government, we are already working to broaden consensus for the reform agenda with congressional representatives.

3. In support of our policies described in the attached Memorandum of Economic and Financial Policies (MEFP), the Government of Bolivia requests the completion of the fifth review under the SBA, and an extension of the SBA through March 31, 2006, with an increased access level in an amount equivalent to SDR 42.86 million (25 percent of quota). We also request that the remaining amounts available under the Stand-by Arrangement, as well as the amounts corresponding to the requested increased access, be rephased over the next 12–months in four purchases linked to current and subsequent reviews. We finally ask for the establishment of the quantitative PCs for end-June, end September, and end- December 2005 specified in Table 1 of the MEFP; and of the structural PCs specified in Table 3 of the MEFP. Performance under the program will be assessed at the sixth, seventh, and eight reviews to be completed by mid-August 2005, mid-November 2005 and mid-February 2006, respectively.

4. We implemented the prior actions specified in Table 3 of the MEFP before the above-requests were considered by the IMF Board.

5. The Government believes that the policies set forth in the attached MEFP are adequate to achieve the objectives of its program, but will take any further measures that may become appropriate for this purpose. Bolivia will consult with the Fund on the adoption of these measures and in advance of revisions to the policies contained in the MEFP, in accordance with the Fund’s policies on such consultation.

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ATTACHMENT II Supplementary Memorandum of Economic and Financial Policies of the Government of Bolivia Fifth Review under the Stand-By Arrangement, Request for Waiver of Nonobservance of Performance Criteria, Rephasing, Augmentation and Extension of the Stand-By Arrangement

March 24, 2005

1. Despite difficult social and political conditions, we continue to implement a solid macroeconomic program, while gradually reducing social tensions. We have observed all end-September quantitative PCs, except that on central bank net credit to the nonfinancial public sector, which was missed by a marginal amount (less than US$1.5 million). Based on preliminary data, we met all the indicative quantitative targets for end-2004, some with wide margins, except the net domestic financing target, as external disbursements were lower than expected. The recommendations of the expenditure commission were published in September (structural PC). Unfortunately, the more protracted and difficult discussions on the hydrocarbons bill have not allowed us to yet adopt a strategy on gas exports as intended (structural benchmark).

2. The program will continue to be guided by the macroeconomic and structural reform policies described in the Memorandum of March 21, 2003, and modified by the Supplementary Memoranda of June 20, 2003, September 24, 2003, June 2, 2004, September 20, 2004 and December 16, 2004.

3. The next review under the proposed extension of the SBA would focus on assessing progress toward (i) a draft 2006 budget and tax reform package, consistent with a deficit close to 4 percent of GDP, and subject to the availability of concessional financing; (ii) the adoption of a gas exports strategy, including securing Congressional approval of a hydrocarbons bill consistent with increased investment and exports; and (iii) reducing financial vulnerabilities, including those arising from high indebtedness. The test date for quantitative PCs to be assessed at the sixth review would be end-June 2005.

A. Macroeconomic Framework

4. Stronger than expected exports—particularly hydrocarbons—have driven economic activity, with real GDP growth estimated at 3¾ percent in 2004 in line with the program. 12–month inflation was 4.6 percent by end-year, exceeding the program target of 3½ percent, owing mainly to imported inflation. The external current account surplus is estimated to have been around 3 percent of GDP in 2004, with strong growth in gas, minerals, and agricultural exports.

B. Fiscal Policy

5. Preliminary estimates for 2004 point to a deficit of 5.7 percent of GDP, 0.3 percentage points of GDP below the indicative target. Tax revenues were 1.0 percent of GDP higher than programmed, largely due to stronger than expected collection from the tax amnesty and hydrocarbons exports. With higher revenues, we were able to accelerate the implementation of high-priority road and other pro-growth projects, leading to higher than programmed investment by 0.6 percent of GDP. Pro-poor spending is estimated to have increased by 0.2 percent of GDP. Reflecting our austerity efforts, current expenditures have been contained in line with the program.

6. The 2005 budget submitted by the Executive in September 2004 acquired legal status in December, after Congress did not formally approve it within the period established by the Constitution. The budget, combined with a balanced fiscal package already adopted through supreme decrees and ministerial resolutions, is consistent with a deficit target of 5¼ percent of GDP and a maximum net use of nonconcessional financing of 1½ percent of GDP. We would aim at a lower deficit should concessional financing fall short of the assumptions under the program. Despite losing one-time revenues from the tax amnesty in 2004 (1½ percent of GDP), we expect tax revenues to increase by ½ percent of GDP, reflecting already adopted fuel price increases, higher gas export volume and prices to Brazil and Argentina, and the full year impact of the FTT. Overall spending would decline by 0.3 percent of GDP in relation to 2004, notwithstanding the initiation of new important pro-growth projects, including key roads (¾ percent of GDP). These projects have been selected based on the highest quality standards, with World Bank advice on the needs for infrastructure, and principles of transparency and accountability. Current spending would decline by 0.3 percent of GDP in relation to 2004, while cuts in lower priority investment projects would contain capital spending at the 2004 level in percent of GDP.

7. We recently submitted to Congress an amended 2005 budget with a deficit of 5¼ percent of GDP, which we expect Congress to approve before end-June 2005 (structural PC). Moreover, should actual revenues fall short of projected levels, we would reduce expenditure levels to meet the fiscal deficit target. In addition, should tax revenues exceed programmed levels, we would increase spending levels, particularly on high quality, pro-growth and poverty reducing programs drawing on the recommendations from the recent World Bank-IDBs’ public expenditure review and from the independent expenditure commission, by up to 66 percent of the gross tax revenue over-performance (before coparticipation).

8. We have adopted several measures to raise revenues on a sustainable basis, including:

  • In January 2005, we raised excise taxes on fuel derivatives, including gasoline and diesel, with price increases by 10 percent and 15 percent, respectively. This should increase revenues by 1.0 percent of GDP, reduce subsidies by 0.2 percent of GDP, and help contain budget costs related to smuggling and poorly targeted subsidies. Prices of gasoline and diesel remain below regional averages and a recent poverty and social impact analysis (PSIA) suggests that the increases mainly affect upper-middle and high-income segments of the population. Nevertheless, in an effort to minimize the impact on vulnerable groups, we have maintained LPG subsidies; and we are strengthening our special employment program targeted to rural and poor areas.

  • With Fund technical assistance, we are preparing a comprehensive tax reform to enhance revenue collection on a sustainable basis and improve the fairness of the system. Among other measures, we are considering the introduction of a personal income tax, which will exempt 80 percent of the population, and plan to hold consensus-building meetings with different sectors of society. We expect to submit to Congress draft legislation by September 2005 (benchmark, to be converted into a PC in the context of the next review, once we have determined the specific elements of the package). Approval by October 2005 would be a structural benchmark.

  • A clear priority is to strengthen the Tax and Customs administrations. In particular, regarding Customs, we are implementing a comprehensive strategy towards reducing smuggling and corruption. Fund technical assistance has been requested for the first half of the year with respect to this and other initiatives to enhance Tax and Customs performance.

9. We are adopting several recommendations of the expenditure and pensions commissions aimed at containing and improving the composition of public expenditure:

  • We intend to contain the increase in public sector wages below 3 percent. Increased efficiency in both the health and education sectors, with the aim of making progress towards the Millennium Development Goals, will be combined with restraint on new hirings so that the wage bill would decline by 0.3 percent of GDP compared to 2004. This would reduce crowding out of essential goods and services, and contribute to gradually bringing the wage bill as a percent of GDP to levels close to those in neighbor countries. We will complete a comprehensive survey and setup a registry on health and education sector employment by end- September, to reduce fraud and to increase accountability (benchmark). We intend to develop an action plan to reform the civil service, building on the recommendations from the World Bank-IDBs’ Public Expenditure Review (PER).

  • We recently issued a supreme decree with prudential norms to stop pension fraud, such as the 15,000 ineligible pensioners identified by the pension commission’s report. We are committed to implementing the report’s recommendations, which over time could reduce pension costs by up to 0.5 percent of GDP on an annual basis. The program conservatively assumes no savings in 2005.

  • In line with the recommendations of the high-level expenditure commission, university subsidies will be limited to increase at most with inflation for the first time in several years, given the growing spending imbalances between the university and secondary education sectors.

  • Excluding local governments, capital spending and transfers to the state oil company (YPFB) and other state agencies will remain at their 2004 level. To this end, in order to accommodate key new projects, including the Santa Cruz-Puerto Suárez road, we have reduced other projects, mostly financed with nonconcessional resources.

10. Given the challenges and risks associated with decentralization and the planned Constituent Assembly, we intend to take the following steps:

  • With Fund technical assistance, we are preparing an Organic Budget Law, which would set hard budget constraints at all levels of government and make the budget more transparent in defining fiscal priorities. The law will be submitted to Congress by June 2005 (benchmark) and we expect its approval by end- October 2005 (benchmark).

  • By September 2005, we expect to conduct an audit of subnational debts, and take immediate steps to help reduce municipalities’ debt and improve expenditure monitoring, including: (i) implementing sanctions for breaking debt limits; (ii) improving the fiscal accounts at the national and local level by adopting a functional classification for public expenditure; and (iii) improving financial information systems, particularly through the creation of a debt registry, which will also track floating debt.

11. While the new tax code has been useful in increasing tax collection, we believe that the approval of a law regulating the appeals process defined in the code would reinforce the ability of the Tax Superintendency to enforce legislation. We expect the approval of the law to take place by June 2005 (a structural PC).

12. With funds pledged by the international community during the budget support meeting in late October in La Paz, we expect our 2005 fiscal program to be fully financed. As part of our commitments under the Multi-Donor Budget Support Program (PMAP), we will firmly pursue a number of measures to improve fiscal transparency. Should available financing fall short of the levels under the program, we stand ready to reduce spending or adopt revenue measures, including further restraint on current expenditure and cuts in lower priority investment projects.

C. Monetary, Debt and Exchange Rate Policies

13. end-2004 NIR exceeded the program target by around US$193 million, and reserve coverage increased by 8 percentage points to 39 percent of financial sector dollar deposits. Further, monetary policy will target an increase in NIR of the central bank, excluding deposits of financial institutions, of US$40 million in 2005, raising reserve coverage to 41 percent of projected dollar deposits. Should bank deposits further recover, we will aim at maintaining the reserve coverage of deposits.

14. We intend to strengthen and institutionalize our efforts to reduce debt vulnerabilities. During the second half of 2004, we were able to significantly increase gross placements in domestic currency and to lengthen their average maturity, in part by allowing the interest rate premium for one-year domestic over foreign currency bonds to increase by 300 basis points. However, with around 80 percent of domestic debt still dollar-denominated, and US$400 million falling due in 2005, significant vulnerabilities remain. Against this background, (i) we have established a debt management unit, with senior members from the Central Bank and the Ministry of Finance, aimed at institutionalizing efforts to improve the structure of the debt, including setting targets for reducing short-term and indexed, or dollar-denominated debt, monitoring progress towards those goals and recommending changes to correct for any deviations; and (ii) we will, in line with the recommendations of this unit, further improve the currency composition and maturity of domestic debt throughout 2005, including through further increases in interest rates, as necessary. In addition, should market conditions allow us to engage in debt management restructuring operations, we are committed, in consultation with Fund staff, to further reduce the Treasury’s debt with the central bank, and increase central bank net international reserves.

15. The crawling peg exchange regime has served Bolivia well in maintaining low inflation. In addition, Bolivia’s competitiveness has improved markedly, in the context of the appreciation of neighboring countries’ currencies. However, the limited flexibility of the exchange rate, which restricts its ability to deal with shocks, has been a source of concern. In this context, we plan to take advantage of recently introduced technological enhancements to improve the operation of the foreign exchange auction (“Bolsín”) before September 2005. While this system is not expected to alter significantly the operation of the current system, it will allow the central bank to purchase foreign exchange, when appropriate, and the exchange rate to better reflect market conditions.

D. Banking and Corporate Sectors

16. Financial system policies focus on reducing liquidity and solvency risks, and fostering economic growth by improving the efficiency of the financial system:

  1. Bank Supervision has been strengthened through improved early warning systems to monitor liquidity and solvency risks. New regulations for effective supervision of financial conglomerates and improved banks’ liquidity management were recently issued. Further, the 2005 on-site inspections, to start in May, are aimed at taking prompt corrective actions to strengthen vulnerable institutions.

  2. We recently eliminated an essential element of prudential forbearance granted by previous administrations, by repealing supreme decrees that had relaxed provisioning requirements. The SBEF issued norms tightening loan classification and provision regulations, calling for gradual increases in provisions through May 2008, with the first effective increase to take place by end-May 2005. We plan to maintain current regulations regarding repossessed assets.

  3. We have submitted to Congress an amendment to the banking law to establish the Financial Restructuring Fund (FRF) as a legal entity; to ensure appropriate financing for bank resolution processes through end-2005; and to consolidate the SBEF’s regulatory and budgetary autonomy. We have also clarified by decree that the regulatory powers over the financial system lie with the BCB and the SBEF only, and plan to submit by September 2005 a bill creating a deposit insurance scheme, with partial deposit coverage and adequate financing (benchmark). To this end, we plan to request World Bank technical assistance to support joint efforts by the Ministry of Finance, the BCB, and the SBEF.

  4. We will sell the state’s participation in banks majority-owned by Nafibo, by end- December 2005 (structural PC).

  5. We will submit to Congress draft legislation to improve the corporate restructuring and bankruptcy framework by end-September 2005 (benchmark), including through enhanced protection of creditor rights.

17. To further strengthen the prudential framework and induce banks to internalize risks associated with the high level of dollarization, the Central Bank plans to gradually increase reserve requirements on dollar deposits. The first increase will be about two percentage points in April on the average requirements (benchmark) and the effective rate will be stepped up by a cumulative amount of up to 3½ percent by September. The SBEF will require by August 2005 that financial institutions assess their exposure to credit risk derived from debtors’ currency mismatches.

18. Projects to broaden the public sector role in the financial sector, through expanded activities of second-tier banks (including NAFIBO and FONDESIF), will be made within the existing fiscal program limits, avoiding subsidies, bailouts or special treatment of specific sectors. Moreover, the regulatory and supervisory framework (including entry, exit, internal control, prudential rules and governance aspects) of existing or new public financial institutions will be similar to the one applicable to private financial institutions.

E. Medium-Term Issues

19. The efficient exploitation of our large gas reserves is critical to enhance growth, reduce poverty, and achieve debt sustainability over the medium term. In this connection:

  • Despite recent difficulties, we still expect Congress to adopt a hydrocarbons law in the coming months, which will allow us to adopt a strategy on gas exports by end- June 2005 (benchmark). A commission of notables has started working to: (i) facilitate and enrich discussions; and (ii) help us draft the regulations to provide additional and more specific safeguards for the proposed earmarked funds and their use according to strict principles of accountability and transparency. We are also interested in joining the UK’s Extractive Industries Transparency Initiative (EITI).

  • We are committed to the adoption of a framework consistent with increased gas exports and investment, addressing both the wishes of the population—as mandated by the gas referendum results—and the need to maintain an environment conducive to increased private investment.

20. More generally, we are committed to maintaining a general framework friendly to private investment, including respect of signed contracts, as we see the maintenance of the rule of law as critical for Bolivia’s medium-term prospects.

21. Building on the current economic recovery, the government’s objective is to achieve sustained growth of 4½–5 percent (about 2 percent per capita), making a significant dent in poverty levels over the medium term. We intend to pursue further fiscal consolidation to increase the availability of financing to the private sector, while boosting and better targeting pro-poor spending. We also plan to remove structural and institutional barriers to growth, including by improving transparency and governance, and advancing negotiations on free-trade agreements with our main trading partners to ensure access to foreign markets for Bolivian products.

22. We are fully committed to broadening consensus for the reform agenda both in Congress and amongst social and private partners. This consensus will be critical to secure approval by Congress of important reforms, including an appropriate hydrocarbons law, the budgets for 2005 and 2006, a suitable organic budget law, and tax reforms.

23. Through a participatory process with civil society, the National Dialogue was concluded in December 2004 to provide input for a new PRSP, which is still under preparation. We will ensure that the PRSP encompasses fiscal issues, including sustainable sources of fiscal revenue, well-targeted social safety nets, clear priorities for national spending, and ways to increase employment and reduce poverty. We have been holding meetings with the international community to exchange views on such strategy, and intend to hold a follow-up Consultative Group meeting later in the year.

Table 1.

Bolivia: Quantitative Performance Criteria Under the SBA, 2004 1/

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Source: Data provided by the Bolivian authorities.

Definitions of the targets and adjusters as in the TMU of March 21, 2003 and the supplementary TMUs of June 2, 2004, September 23, 2004. September 2004 are PCs and December 2004 indicative targets set in Country Report No. 04/350. For the SBA extension, March 2005 are indicative targets and June, September, and December 2005 are proposed PCs.

The limits on the deficit of the combined public sector will be adjusted downward by the difference between actual and projected program grants (i.e., grants not earmarked for projects). They will be adjusted downward (upward) by the amount of the shortfall (excess) between actual and projected HIPC debt relief and by the amount of the shortfall between actual and projected external financing for social spending, up to the designated ceilings. They will be revised downward by 33 percent of excess tax revenues over programmed levels.

The limits on the net domestic financing of the NFPS will be adjusted upward by the difference between projected and actual net external financing to the NFPS (measured cumulatively over the same period as net domestic financing), excluding HIPC debt relief, up to the designated ceiling; it will be adjusted downward by the amount of any overdue obligations to foreign official creditors.

The limits on the NDA of the BCB will be adjusted downward by the amount of any overdue obligations to foreign official creditors. The ceiling will be adjusted for the flow flow of the Central Bank financial system foreign deposits.

The ceiling on NIR will be adjusted upwards by the amount of any overdue obligations to foreign official creditors and adjusted downward by shortfalls relative to the projected currency issue, up to the designated ceiling. The ceiling will be adjusted for the flow of the Central Bank financial system foreign deposits.

The debt limit will be reduced by the amount, if any, of the shortfall between actual and projected disbursements of loans for financial and corporate restructuring.

Does not include the HIPC debt relief through rescheduling or the amortization component of stock of debt reduction operations under HIPC Initiative and beyond HIPC.

Comprises refinancing and the amortization component of stock of debt reduction operations under the HIPC Initiative and beyond HIPC, both for the financial and nonfinancial public sectors.

Table 2.

Bolivia: Update of Status of Structural Conditionality For the Extension of the Stand-By Arrangement 20044

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Denotes new conditionality added since the conclusion of the third review under the SBA on June 10, 2004.

Table 3.

Bolivia: Structural Conditionality for the Extension of the Stand-By Arrangement 2005

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ANNEX I Bolivia—Supplementary Technical Memorandum of Understanding

1. This technical memorandum supplements the technical memorandum of understanding of March 21, 2003 and the supplementary technical memoranda of understanding of June 2, and September 20, 2004. It outlines the quantitative targets and limits described below for 2005, which will be measured as cumulative flows from December 31, 2004 (Table 1). It refines definitions for existing quantitative targets for (performance criteria for June, September, and December) net domestic financing of the combined public sector. It also includes new adjusters on the deficit of the combined public sector and the net international reserves of the central bank (BCB).

Quantitative performance criteria

2. The definition of net domestic financing of the combined public sector in Table 2 of the technical memorandum of understanding of March 21, 2003 will be replaced by the following:

a) Net domestic financing of the combined public sector (CPS), sum of:

  • (i) Increase in the net claims of the domestic financial system on the NFPS (excluding deposits in the BCB related to foreign loans administered as trust funds;

  • (ii) Cash operating results before distribution to the treasury’s account of the BCB;

  • (iii) Change in the NFPS liabilities to the private sector in the form of fiscal certificates;

  • (iv) Increase in the domestic floating debt of the NFPS (liabilities incurred for goods and services received but not yet paid for, excluding claims on and liabilities to other entities within the NFPS); and

  • (v) All borrowing by the NFPS; including net disbursements to the NFPS related to any new domestic debt instruments issued by the government and held outside the NFPS.

  • Valuation changes (due to changes in inflation) in the stock of domestic debt denominated in inflation-indexed units (UFVs) would be excluded from the computation of net domestic financing of the CPS.

Adjusters to the program

3. New adjuster to the deficit of the combined public sector (CPS): Should tax revenues of the CPS be higher than programmed (see adjuster for tax revenue in the PC Table), the quantitative performance criterion of the deficit of the CPS will be revised downward by 33 percent of the difference between actual and program outturns.

4. New adjuster to the net international reserves of the central bank: The quantitative performance criterion on net international reserves of the BCB will be adjusted upward/downward by the net increase/decrease of the legally required and excess reserves denominated in foreign currency by financial institutions held with the BCB.

Information requirements

5. The treasury will remit to the Central Bank, on a weekly basis, information on all placements of treasury bonds other than open market operations, necessary to monitor the deficit of the combined public sector and net domestic financing of the CPS targets.
1

The US Treasury will be providing TA in this area.

2

The report was prepared by a team led by Jeronimo Zettelmeyer (RES), with representatives from FAD, MFD, PDR, and WHD; and is being issued as a background document.

3

Bolivia-Country Assistance Strategy. Report No 26838-BO. January 8, 2004. Approved by the Board in February 2004.

4

References in the table are to the relevant paragraphs of the Technical Memorandum of Understanding (TMU) of March 21, 2003; June 20, 2003; September 24, 2003; and June 2, 2004.

5

It is proposed to be converted to a performance criterion in the next review once more specificity can be determined.

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Cover IMF Staff Country Reports
Bolivia: Fifth Review under the Stand-By Arrangement, Request for Waiver of Nonobservance of Performance Criteria, Rephasing, Augmentation and Extension of the Stand-By Arrangement
Author:
International Monetary Fund
Volume/Issue:
Volume 2005: Issue 146
Publisher:
International Monetary Fund
ISBN:
9781451805789
ISSN:
1934-7685
Pages:
67
DOI:
https://doi.org/10.5089/9781451805789.002
Figure 1.

12-Month inflation

Percent change
Figure 2.

External current and capital account

(In millions of US dollars)
Figure 3.

Financial system deposits and NIR
Figure 4.

Stock of government paper in local currency

In millions US$
Figure 5.

Average maturity of treasury paper placements (TGN)

In days
Figure 6.

Interest Rates

In percent
Figure 7.

Alternative Gas scenarios

NPV of public debt (% of GDP)
Figure 8.

Stress Tests

NPV of public debt (% of GDP)

Bolivia: IDB Net Principal and Cash Flows

(US$ Million)