Argentina - Banking Sector and First and Second Trade Policy Loans

Docmnent of The World Bank FOR OFFICIAL USE ONLY Report No. 13223 PERFORMANE AUDIT REPORT ARGENTINA TRADE POLICY AND EXPORT DIVERSIFICATION, BANKING SECTOR, AND SECOND TRADE POLICY LOANS (LOANS 2815-AR, 2923-AR AND 2996-AR) JUNE 28, 1994 Operations Evaluation Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS Currency Unit = Peso US$1.00 = Peso 1.00 ABBREVIATIONS AND ACRONYMS ASAL - Agricultural Sector Loan BSL - Banking Sector Loan CEPA - Executive Committee for the Study of Poverty in Argentina OED - Operations Evaluation Department PAR - Performance Audit Report PCR - Program Completion Report TPL 1 - Trade Policy and Export Diversification Loan TPL 2 - Second Trade Policy Loan FISCAL YEAR January 1 - December 31 FOR OFFICIAL USE ONLY THE WORLD BANK Washington, D.C. 20433 U.S.A. Office of Director-General Operations Evaluation June 28, 1994 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT Performance Audit Report on Argentina - Trade Policy and Export Diversification Loan, Banking Sector Loan and Second Trade Policy Loan (Loans 2815-AR. 2923-AR and 2996-AR) Attached is the Performance Audit Report on Argentina - Trade Policy and Export Diversification Loan (TPL 1), Banking Sector Loan (BSL) and Second Trade Policy Loan (TPL 2) (Loans 2815-AR, 2923-AR and 2996-AR) prepared by the Operations Evaluation Department. The primary objective of these loans, which were approved during 1987-88, was to support a gradual opening of Argentina's trade accounts and enhance the banking sector's efficiency and ability to finance private investments. They were the first steps in a program of Bank support for a fundamental transformation of the inward-looking and state-led economy into a more open and market-based system. Wavering Government commitment to comprehensive structural change and in particular to fiscal reform resulted in repeated setbacks. Thus, the absence of serious fiscal reforms during 1987 caused the Government's program to derail and resulted in an unsatisfactory outcome for TPL 1. Likewise, the continuing fiscal impasse made compliance with some of the loan conditions for the BSL impossible: the loan was never signed and the loan offer lapsed 12 months after Board approval; the BSL is therefore not rated by OED. Eventually, shortly after first tranche release of TPL 2, the macroeconomy deteriorated into hyperinflation. The ensuing crisis proved cathartic, however, with old interest groups having lost credibility. A new Government, inaugurated in mid-1989, received genuine political support for reform. At the same time, the Bank had maintained its dialogue throughout the period of crises while its excellent economic work had helped design the reform program. By the time the second tranche of TPL 2 was released, significant reforms were taking hold: the outcome of TPL 2 was clearly satisfactory. Subsequent reforms and economic growth have been impressive, and the sustainability of the overall program is assessed as likely. Because the trade policy loans helped lay the seeds for Argentina's reform program, they made a modest contribution to institutional development. The above assessment is in general agreement with that contained in the Program Completion Report. Probably the most important lesson from this experience is that the Bank's patience and persistence were key factors in the success of the program. The Bank stuck with Argentina, minimized the downside risk of its approach by limiting its exposure, engaged in thorough economic work and was ready with remedial action when the opportunity arose. Robert Picciotto by H. Eberhard K6pp Attachment This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  FOR OFFICIAL USE ONLY PERFORMANCE AUDIT REPORT ARGENTINA TRADE POLICY AND EXPORT DIVERSIFICATION LOAN. BANKING SECTOR LOAN. AND SECOND TRADE POLICY LOAN (LOANS 2815-AR, 2923-AR AND 2996-AR) TABLE OF CONTENTS Page PREFACE ................................................. i BASIC DATA SHEETS ......................................... mi EVALUATION SUMMARY ...................................... ix I. BACKGROUND. .........................................1 II. THE LOANS AND POLICY DIALOGUE ......................... 2 A. Loan Objectives ..................................... 2 B. The Policy Dialogue ................................... 4 III. IMPLEMENTATION AND IMPACT ............................. 6 A . Implementation ...................................... 6 B . Im pact . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9 (i) Economic Impact ................................. 9 (ii) Social Impact .................................... 11 IV. OVERALL EVALUATION, SUSTAINABILITY AND LESSONS LEARNED . . 12 A. Overall Evaluation .................................... 12 B . Sustainability ....................................... 14 C. Lessons Learned ..................................... 14 List of Tables in the Text: 1: Macroeconomic Indicators, 1986-92 ............................. 10 2: Foreign Trade Statistics, 1986-93 ................................... 11 3: Labor Force and Employment as Percent of Total Population; Unemployment as Percent of Labor Force ....................... 12 This report was prepared by Ren6 Vandendries who audited the operations in October 1993; Geri Wise provided word processing assistance. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  -1- PERFORMANCE AUDIT REPORT ARGENTINA TRADE POLICY AND EXPORT DIVERSIFICATION LOAN. BANKING SECTOR LOAN. AND SECOND TRADE POLICY LOAN (LOANS 2815-AR, 2923-AR AND 2996-AR) PREFACE This is a Performance Audit Report (PAR) on the Trade Policy and Export Diversification Loan (TPL 1), the Banking Sector Loan (BSL), and the Second Trade Policy Loan (TPL 2) for Argentina. TPL 1, involving Loan 2815 in the amount of US$500 million equivalent, was approved on May 19, 1987, and closed on December 31, 1990, two and a half years behind schedule. US$4 million was cancelled. The BSL, involving Loan 2923 in the amount of US$400 million equivalent, was approved on March 29, 1988, and re-approved in amended form on October 27, 1988, but was never signed. TPL 2, involving Loan 2996 in the amount of US$300 million equivalent, was approved on October 27, 1988, closed on December 31, 1990, one year behind schedule, and was fully disbursed. The PAR is based on the Program Completion Note (PCN) for the Banking Sector Loan and the Program Completion Report (PCR) for TPLs I and 2, prepared by the Latin America and the Caribbean Regional Office, and issued in 1993 and 1994, respectively,' the President's Reports, sector and economic reports, the loan documents, summaries of the Board discussions, study of the program files, and discussions with Bank staff. An OED mission visited Buenos Aires in October 1993 and discussed the effectiveness of the Bank's assistance with Government officials, the donors, and the business community. Their kind cooperation and invaluable assistance in the preparation of this report is gratefully acknowledged. The report examines the effectiveness of the Bank's strategy in promoting structural change in an extremely difficult environment. It comments upon the economic and social benefits and the sustainability of what has been achieved. The draft PAR was sent to the Government for comments, but none were received. 1' PCN, Armentina - Bankina Sector Loan (Loan 2923-AR), Report No. 12162, July 1, 1993; and PCR, Argentina - Trade Policy and Export Diversification Loan and Second Trade Policy Loan (Loans 2815-AR and 2996-AR), Report No. 12747, February 9, 1994.  - iii - PERFORMANCE AUDIT REPORT ARGENTINA TRADE POLICY AND EXPORT DIVERSIFICATION LOAN (LOAN 2815-AR) BASIC DATA SHEET LOAN POSITION (Amounts in US$ Million) As of May 31, 1994 LOW Oriinal Disbursed Cancelled Repai Outstanding Loan 2815-AR 500.0 496.0 4.0 144.7 379.6* CUMULATIVE ESTIMATED AND ACTUAL DISBURSEMENTS FY88 Appraisal Estimate (US$M) 500.0 Actual (US$M) 496.0 Actual as % of Appraisal (%) 99.2% Date of Final Disbursement: December 30, 1987 PROGRAM DATES Initiating Memorandum - 11/06/86 Policy Statement on Economic Adjustment - 1987 Negotiations - 04/15/87 Board Approval - 05/19/87 Signing - 07/29/87 Effectiveness - 08/19/87 First Tranche Release - 08/30/87 Second Tranche Release - 12/14/87 Loan Closing 06/30/88 12/31/90 STAFFINPUTS (staffweeks) FY86 FY87 FY88 FY89 FY90 FY91 FY92 FY93 TOTAL Preappraisal 43.0 35.8 - - - - - - 78.8 Appraisal - 23.9 - - - - - - 23.9 Negotiations - 5.1 - - - - - - 5.1 Supervision - - 27.9 3.8 3.0 0.2 2.0 0.8 37.7 Total 43.0 64.8 27.9 3.8 3.0 0.2 2.0 0.8 145.5 *Includes an exchange adjustment of $28.3 million as of end-May 1994. - iv - YEAR-END ANNUAL REPORT ON PORTFOLIO PERFORMANCE RATINGS Evaluation Development LUgal Management Year Ovyall Objectives Covenants Performance 1988 2 1 - 3 1989 1 1 2 3 1990 1 1 1 3 OTHER PROGRAM DATA Borrower/Executing Agency: Republic of Argentina Follow-on Operations: Operation: Banking Sector Loan Loan No.: 2923-AR Amount: US$400.0 million Board Date: March 29, 1988 Operation: Second Trade Policy Loan Loan No.: 2996-AR Amount: US$300.0 million Board Date: October 27, 1988 Operation: Public Enterprise Reform Adjustment Loan No.: 3291-AR Amount: US$300.0 million Board Date: February 12, 1991 Operation: Public Sector Reform Loan No.: 3394-AR Amount: US$325.0 million Board Date: July 30, 1991 Operation: Debt and Debt Service Reduction Support Loan No.: 3555-AR Amount: US$450.0 million Board Date: January 5, 1993 Operation: Public Enterprise Reform Adjustment II Loan No.: 3556-AR Amount: US$300.0 million Board Date: January 5, 1993 Operation: Financial Sector Adjustment Loan No.: 3558-AR Amount: US$400.0 million Board Date: February 16, 1993 PERFORMANCE AUDIT REPORT ARGENTINA BANKING SECTOR LOAN (LOAN 2923-AR) BASIC DATA SHEET LOAN POSMON (Amounts in US$ Million) As of May 31. 1994 L&an Original Disbursed Cancelled RaiW Outstanding Loan 2923-AR 400.0 0.0 400.0 0.0 0.0 CUMULATIVE ESTIMATED AND ACTUAL DISBURSEMENTS FY88 E9 ELY90 Appraisal Estimate (US$M) 199.5 395.0 400.0 Actual (US$M) - - - Actual as % of Appraisal (%) - - - Date of Final Disbursement: not applicable PROGRAM DATES Original ACual Initiating Memorandum 05/29/87 05/29/87 Letter of Development Policy 01/31/88 01/31/88 Negotiations - 01/88 Board Approval - 03/29/88 10/27/88 Amended Signing - n.a. Effectiveness - n.a. Loan Closing 11/30/89 n.a. STAFF INPUTS (staffweeks) Elm EMII EMI1 EMI2 EY29 E21 IQTAL Preappraisal 0.4 55.1 - - - - 55.5 Appraisal - 8.3 46.0 - - - 54.3 Negotiations - - 10.8 - - - 10.8 Supervision - - 9.1 28.7 13.3 1.8 52.9 Other 71 .9 _ 21 . - 8 Total 1.9 70.9 72.4 28.7 13.3 1.8 189.0 - VI - YEAR-END ANNUAL REPORT ON PORTFOLIO PERFORMANCE RATINGS Evaluation Development Legal Management Year Overall Objectives Covenants Performance 1989 3 3 1 3 1990 3 3 1 3 OTHER PROGRAM DATA Borrower/Executing Agency: Republic of Argentina Follow-on Operations: Operation: Second Trade Policy Loan Loan No.: 2996-AR Amount: US$300.0 million Board Date: October 27, 1988 Operation: Public Enterprise Reform Adjustment Loan No.: 3291-AR Amount: US$300.0 million Board Date: February 12, 1991 Operation: Public Sector Reform Loan No.: 3394-AR Amount: US$325.0 million Board Date: July 30, 1991 Operation: Debt and Debt Service Reduction Support Loan No.: 3555-AR Amount: US$450.0 million Board Date: January 5, 1993 Operation: Public Enterprise Reform Adjustment II Loan No.: 3556-AR Amount: US$300.0 million Board Date: January 5, 1993 Operation: Financial Sector Adjustment Loan No.: 3558-AR Amount: US$400.0 million Board Date: February 16, 1993 - Vii - PERFORMANCE AUDIT REPORT ARGENTINA SECOND TRADE POLICY LOAN (LOAN 2996-AR) BASIC DATA SHEET LOAN POSITION (Amounts in US$ Million) As of Ma 31, 1994 Loan Ori2inal Disbursed Cancelled Reaid Outstandin2 Loan 2996-AR 300.0 300.0 0.0 14.9 307.8* CUMULATIVE ESTIMATED AND ACTUAL DISBURSEMENTS FY89 FY90 Appraisal Estimate (US$M) 300.0 300.0 Actual (US$M) 150.0 300.0 Actual as % of Appraisal(%) 50% 100% Date of Final Disbursement: September 18, 1990 PROGRAM DATES Original Actual Initiating Memorandum - 03/21/88 Letter of Development Policy - 09/22/88 Letter of Sector Policy - 09/29/88 Negotiations - 08/88 Board Approval - 10/27/88 Signing - 11/14/88 Effectiveness - 11/15/88 First Tranche Release - 11/15/88 Second Tranche Release - 08/09/90 Loan Closing 11/30/89 12/31/90 STAFF INPUTS (staffweeks) FY88 FY89 FY90 FY91 E"9 Y931 FY94 IOAL Preappraisal 68.8 - - - - - - 68.8 Appraisal 27.8 2.8 - - - - - 30.6 Negotiations - 18.2 - - - - - 18.2 Supervision - 8.1 11.2 5.4 2.4 6.9 2.4 36.4 Other 0.5 . - 1.0 - - 3.8 Total 97.1 31.4 11.2 5.4 3.4 6.9 2.4 157.8 *Includes an exchange adjustment of $22.7 million as of end-May 1994. - viii - YEAR-END ANNUAL REPORT ON PORTFOLIO PERFORMANCE RATINGS Evaluation Development Legal Management Year Overall Objectives Covenants Performance 1989 1 1 - 2 1990 1 1 1 1 1991 1 1 1 1 OTHER PROGRAM DATA Borrower/Executing Agency: Republic of Argentina Follow-on Operations: Operation: Public Enterprise Reform Adjustment Loan No.: 3291-AR Amount: US$300.0 million Board Date: February 12, 1991 Operation: Public Sector Reform Loan No.: 3394-AR Amount: US$325.0 million Board Date: July 30, 1991 Operation: Debt and Debt Service Reduction Support Loan No.: 3555-AR Amount: US$450.0 million Board Date: January 5, 1993 Operation: Public Enterprise Reform Adjustment II Loan No.: 3556-AR Amount: US$300.0 million Board Date: January 5, 1993 Operation: Financial Sector Adjustment Loan No.: 3558-AR Amount: US$400.0 million Board Date: February 16, 1993 PERFORMANCE AUDIT REPORT ARGENTINA TRADE POLICY AND EXPORT DIVERSIFICATION LOAN. BANKING SECTOR LOAN. AND SECOND TRADE POLICY LOAN (LOANS 2815-AR, 2923-AR AND 2996-AR) EVALUATION SUMMARY Background The Loans and Policy Dialogue 1. The depression of the 1930s and the LoanQbjective consequent loss of export markets led Argentina to isolate itself from the rest of the world and 3. The primary objective of the 1985 Plan promote import-substituting industrialization Austral was stabilization. At the same time, the and an ever increasing role for the State. In ultimate objective of government policy was to time, the strategy resulted in massive restore growth by turning the inward-looking misallocations of resources, slow economic and state-led economy into a more open and growth, unsustainable budget deficits and market-based system, with the support from the accelerating inflation. Poorly designed Bank. Trade reform and financial deregulation economic reform efforts during the late 1970s were the first steps in the Bank's strategy, to be were eventually abandoned. Following the complemented later on by measures aimed at advent of a new administration in 1983, several broad public sector and public enterprise reform well-intentioned stabilization and reform and at privatization. programs were mounted, particularly the Plan Austral in June 1985 and the Plan Primavera in 4. The focus of TL I was on exports and August 1988. In the end all of these programs export liberalization (para. 2.03). The loan also failed because of a reluctance to tackle the also supported some of the wider objectives of budget deficit. the Bank's assistance strategy at that time by providing fiscal and balance of payments 2. The Bank supported the Plan Austral support as part of external debt rescheduling with sizeable adjustment lending: a $350 efforts. At the same time, progress towards the million Agricultural Sector Loan (ASAL) in achievement of macroeconomic stability was April 1986, a $500 million Trade Policy and monitored by the IMF. Export Diversification Loan (TPL 1) in May 1987 and a $400 million Banking Sector Loan 5. The BSL was first approved by the (BSL) in March 1988. Subsequently, in Board in March 1988. The overall objective October 1988, a $300 million Second Trade was to increase the efficiency of Argentina's Policy Loan (TPL 2) was provided in support financial sector and enhance its ability to of the Plan Primavera. An audit report for the finance new private investment opportunities. ASAL was prepared by OED on May 28, 1993. As it turned out, an excessively high inflation TPL 1, BSL and TPL 2 are evaluated in this rate during 1988 meant that some of the loan report. conditions could not possibly be met. The loan was re-approved by the Board in amended form in October 1988, together with TPL 2, but it was never signed. -x- 6. The explicit objective of TPL 2 was to as well as loans for the Housing ($300 million) broaden the trade reform initiated under TPL 1, and Electric Power ($252 million) sectors. In with primary focus on import liberalization view of the high risks involved, however, the (para. 2.07). In addition, the Bank had by then package was deliberately designed so that assumed the IMF's role of monitoring macro- disbursements would be limited to $150 million policy and especially fiscal discipline, in the (the first tranche of TPL 2), if the program context of the Plan Primavera. The loan was were to go off track (para. 2.16). In the event, also part of the Bank's effort to help Argentina the Plan Primavera also failed, and only $150 avoid a major financial crisis and possibly years million was disbursed. The Bank's thorough of delay in changing the course of the economy. economic work during this period, however, with emphasis on opening up the economy and The Policy Dialogue redefining the role of the state, paid off eventually. It helped lay the basis for 7. An important part of the evaluation of subsequent reform efforts, starting in 1990, that these three loans is a review of the evolution of would prove quite successful. Also, relations the dialogue between the country, the Bank and between the Bank and the Fund improved the Fund. Substantial Fund involvement in following a new agreement on the division of Argentina goes back to 1983, much before the labor between the two. start of the Bank's adjustment operations. The focus of the Fund's programs rightly was on Implementation and Impact stabilization and especially the fiscal problem. As time went on, however, program failures Implementation became a way of life and by end-1987 the Fund began to seriously question the credibility of 9. The dominant feature of the Argentina's reform efforts. In the interim, implementation experience of the two TPLs was TPL 1 had been fully disbursed (paras. 3.03- that, on the whole, most sectoral measures 3.04). By around that time, the Bank had agreed to under the loans were taken but, at the begun to strengthen its own economic work on same time, steady progress towards the overall the fiscal problem. It soon became clear that objectives was interrupted because of the fiscal there were deep-seated structural problems at difficulties. In the case of the BSL, the the root of the fiscal impasse: excessive public macroeconomic impasse eventually kept the employment, massive subsidies to public loan from being signed, even though here also enterprises and to the provinces, and a very there was some progress at the sector level, in weak fiscal administration. Fundamental particular in the form of a liberalization of disagreements arose between the Bank and the interest rates. Fund on substantive issues, including on the role of export taxes, on the desirability of cuts 10. Over the course of 1987, the sector in public investment, and on the rate of speed policy conditions for TPL 1 were largely met of deficit reduction. (para. 3.03). The macroeconomic program was approved by the Fund and TPL 1 was fully 8. Meanwhile, the economic situation in disbursed by year-end. During the first half of Argentina was growing worse. In response to 1988, however, the economic and social an almost complete loss of economic control, situation deteriorated steadily. For all practical the Government announced a last-ditch purposes Argentina's relations with the Fund stabilization effort in August 1988, the Plan had broken off. The Bank, on the other hand, Primavera. Knowing fully well the associated intensified its dialogue on reform and, in the risks, the Bank decided to provide support end, supported the Government's attempt to without being joined by the Fund. A $1.25 avert total chaos (the Plan Primavera) through billion loan package was approved in October TPL 2 (and BSL). Several import liberalization 1988, including TPL 2 and the amended BSL, measures were implemented towards the end of - xI - the year and inflation abated. In the Bank's Impact judgment, the macroeconomic policy framework was consistent with the objectives of the 13. The economic and social impact of the program and all other conditions of TPLs is difficult to disentangle from that of effectiveness were met: the first tranche of other reforms because, in the end, the trade TPL 2 was released and fully disbursed by reforms were delayed until the other reforms January 1989. were already being implemented. Even so, the improved export regime generated by TPL 1 11. By February 1989 the Plan Primavera contributed to strong growth in manufactured collapsed because of an all-around lack of exports during 1987-90; the subsequent domestic support. Second tranche release of economic boom, fueled by large private capital TPL 2 was delayed indefinitely and no action inflows, and an appreciating exchange rate was taken on the BSL, which eventually reversed this trend. Nevertheless, as measured resulted in the loan offer being withdrawn by the ratio of exports and imports to GDP, the (para. 3.11). In April, an explicit across-the- economy has continued to become more open. board export tax of 25% was introduced, and Major new investments in the tradeables' prior approval of advance import declarations sector, however, have yet to materialize. as a condition for import financing was reintroduced: major progress achieved under 14. On the social front, the severe crisis TPL 1 was thus nullified. Inflation accelerated during 1986-90 was accompanied by a further and peaked at more than 200% per month in intensification of poverty, which had been on July, the same month when a newly elected the increase for a number of years. Together President took office. with the reforms and the economic recovery after 1990, poverty levels appear to have been 12. The hyper-inflation and long recession reduced in parallel with employment growth. had traumatized the population, with old interest groups having lost all credibility. As a Overall Evaluation. Sustainability and Lessons result, the Government of President Menem Learned received what had eluded the previous administration: political support for reform. 15. The first trade policy loan must be rated While there were still periodic bouts of inflation as an unsatisfactory operation. While the for a few months, economic policy-making had Government did comply with the sector policy taken on a new sense of purpose (para. 3.12). conditions, at least at that time, the Bank was in A major tax reform became effective in January fact supporting a reform program where deep- 1990, followed by wide-ranging fiscal reforms seated fiscal problems were not being in March. In addition, public enterprise addressed. This approach was bound to, and reforms and a generalized privatization program eventually did, lead to trade policy reversals. took firm root. On the trade policy front also major progress was made, except that, for fiscal 16. An overall evaluation of TPL 2 is more reasons, export taxes remained. The complex. Shortly after first tranche release in Government's over-performance on import November 1988 the lack of domestic support liberalization, however, more than compensated for fiscal reform resurfaced: the Goverment's for this, the anti-export bias of the trade regime program derailed and the Bank stopped having been reduced by more than required in disbursing. The severity of the ensuing crisis the loan agreement. In July 1990, the Bank was such, however, that it sent shock waves released the second tranche of TPL 2. through the country with the result that the Subsequently, reforms accelerated greatly in all newly elected Government in July 1989 finally areas, including trade, fiscal, public enterprise received a mandate for genuine structural and monetary reforms. change. This, together with excellent economic work by the Bank during 1988 and throughout - xii - the crisis meant that the foundations for reform July 1989, which itself was greatly facilitated were now in place. By the time of second by the traumatic experiences of a long recession tranche release of TPL 2 in July 1990, fiscal and of hyper-inflation. In other words, reform was well underway and earlier trade unforeseeable events helped turn a highly risky reform reversals were being undone: TPL 2 undertaking by the Bank eventually into a must therefore be rated as a satisfactory success. Probably the most important lesson operation. Through both loans and through its from this experience is that the Bank, which is economic work the Bank helped lay the seeds meant to have long-term permanent for Argentina's overall reform program; it also relationships with its client countries, made a modest contribution to institutional implemented this relationship to the fullest in development. this case and therefore was ultimately successful. The Bank stuck with Argentina, 17. The BSL never had a chance. The minimized the downside risk of its approach by fiscal impasse made compliance with some loan limiting its exposure, angaged in thorough conditions impossible. The loan was never economic and sector work on the nature of the signed and the loan offer lapsed 12 months after country's problems, and was ready with Board approval. It is therefore not rated by solutions and a large lending program when the OED. opportunity arose. 18. At this stage the reform policies 20. A lesson related to the above is that full certainly appear to be sustainable. Still, country ownership of a program is a sine-qua- ultimate success in achieving sustained and non for success. This ownership came only rapid growth will require continued good after the 1989 debacle when it became clear that economic management. The ban on there was no alternative to reform. government deficit financing by the Central Bank, introduced through the 1991 21. Second, it is evident that without fiscal Convertibility Law, is fundamental to reform, trade liberalization was bound to derail. maintaining confidence and credibility. On the But, at the same time, there appears to be no a other hand the legally fixed nominal exchange priori reason for stabilization to be completed rate regime could create problems. Large before trade liberalization is initiated, because capital inflows during the past three years have the latter itself played an important role in contributed to a real appreciation of the establishing price and wage discipline after exchange rate, which is hampering growth in 1989. the tradeables sector. Partly in response, a number of protectionist measures have been 22. Finally, while the respective roles of the reintroduced in recent months to assist selected Bank and the Fund have been further clarified industries. This could undermine credibility. following the Argentina experience, The emphasis in the near future will have to be disagreements on policy issues will undoubtedly on cost reductions, for which there is good continue to arise. This tension between the two scope through revisions in the social security institutions, however, can be constructive, if it and labor laws and in the tax system. Given leads to better economic analyses and higher the institutional rigidities imposed by the quality advice to the country. Convertibility Law, it becomes essential to bring down the domestic price level relative to the major trading partners. 19. In retrospect, the Bank's Argentina program turned successful primarily because of the unexpectedly strong reform program pursued by the Government that took office in PERFORMANCE AUDIT REPORT ARGENTINA TRADE POLICY AND EXPORT DIVERSIFICATION LOAN. BANKING SECTOR LOAN. AND SECOND TRADE POLICY LOAN (LOANS 2815-AR, 2923-AR AND 2996-AR) I. BACKGROUND 1.01 During the early part of the century, and up until about the second World War, Argentina belonged to the group of most developed nations in the world. Until 1929 the country also enjoyed a fair degree of democracy. The year 1930 marked a turning point. The world economic crisis and increasing corruption in the administration led to the forced deposition of the ruling President and the establishment of Argentina's first military Government. In subsequent years, civilian and military Governments were to alternate fairly frequently, but the armed forces invariably were an active political force. 1.02 On the economic front the depression of the 1930s and the consequent loss of export markets for Argentina led the country to begin to isolate itself from the rest of the world and promote import substituting industrialization and an ever increasing role for the State; this process was greatly intensified between 1946 and 1951 under the guidance of President Peron. The interplay between powerful vested interest groups on the one hand, including regional interests, the armed forces, and trade unions, and a weak bureaucracy on the other hand proved to be fertile ground for massive misallocations of resources in the context of the state-led import substitution strategy. The net result was slow economic growth compared to both developed and many developing countries, hence the significant erosion of Argentina's relative income position in the world over the last several decades. 1.03 By the early 1970s the long-term effects of the import-substitution strategy and of excessive state intervention were becoming very visible: budget deficits had become unsustainable and inflation accelerated. In 1976, the military assumed power once again. Efforts at stabilization and structural reform, however, failed as public spending in excess of revenue collections continued unabated, leading up to the 1982 South Atlantic war. The defeat in that war, human rights abuses and the dismal economic management record dealt a most serious blow to the armed forces' credibility. A new, democratically elected civilian government (President Alfonsin) entered the scene in 1983. 1.04 As reviewed in detail below, the period of the Alfonsin administration (December 1983-July 1989) was replete with good intentions and several stabilization and reform efforts were mounted, particularly the Plan Austral in June 1985 and the Plan Primavera in August 1988. All programs eventually failed, however, because of a reluctance to tackle the fiscal deficit. IMF support for Argentina during the 1980s was generous, starting in 1983, before the Alfonsin administration, and intensifying thereafter. By the end of 1987, however, IMF exposure had reached $3.9 billion (Figure 1) with little to show for it: as a result, the Fund began to seriously question the credibility of Argentina's reform efforts. The Bank had been more cautious, given Argentina's past record, but decided to support the Plan Austral with sizeable adjustment lending: a $350 million Agricultural Sector Loan in April 1986, a $500 million Trade Policy and Export Diversification Loan (TPL 1) in May 1987 and a $400 million Banking Sector Loan (BSL) in March 1988. Subsequently, in October 1988, a $300 million Second Trade Policy Loan (TPL 2) was provided in support of the Plan Primavera. An audit -2- report for the Agricultural Sector Loan was prepared by OED on May 28, 1993. TPL 1, the Banking Sector Loan and TPL 2 are evaluated in this report. Use of IMF Credit and IBRD Debt Outstanding (year-end data in billion dollars) 5 IMF 4 World Bank 1982 1983 191 19S 19 187 1N 1989 1990 1091 1992 Source: Wodd Debt Tables. II. THE LOANS AND POLICY DIALOGUE A. Loan Obiectives 2.01 The primary focus of the 1985 Plan Austral was on stabilization. Still, by early 1986 strategy discussions on genuine structural reforms had been initiated between the Government and the Bank. The ultimate objective of government policy was to restore growth by turning the inward-looking and state-led economy into a more open and market-based system: the objective of the Bank's assistance was to play a major role in helping the Government implement this turnaround. 2.02 Trade reform and financial deregulation were the first steps in the Bank's assistance strategy, supported by the two TPLs and the BSL.1' As explained further below, the Bank's approach varied somewhat over the period of implementation of these loans, at first relying on the IMF in making macroeconomic assessments and pursuing stabilization, then later on playing a more active role in this area. The structural changes in the trade and financial sectors were subsequently to be complemented by measures aimed at broad public sector and public enterprise reforms and at privatization. The Bank 1' And, earlier on, in April 1986, by the Agricultural Sector Loan. -3- felt that proceeding with trade reform, before stabilization was completed, was appropriate as long as progress towards stabilization was being made, the more so because of the role of trade liberalization in generating price and wage discipline. 2.03 TPL I was approved by the Board in May 1987 in support of the first phase of Argentina's trade policy reform program: the focus of this loan was on exports and export liberalization? The essence of the program consisted of (a) granting "free trade" status to industrial exporters through an expansion of the temporary admission regime including automaticity and uniformity in its operation, elimination of remaining export taxes on manufactures and improved reimbursement of indirect taxes on exports;21 (b) simplification of the system of trade administration; and (c) introducing a more rational protection system through the gradual reduction of non-tariff barriers to trade: the latter process would be gradual so as to minimize its impact on employment. 2.04 TPL 1 also supported some of the wider objectives of the Bank's assistance strategy at that time. In close cooperation with other international financial institutions and with bilateral donors, it provided fiscal and balance of payments support as part of external debt rescheduling efforts. At the same time, progress towards the achievement of macroeconomic stability was monitored by the IMF. 2.05 The BSL was first approved by the Board in March 1988. The overall objective was to increase the efficiency of Argentina's financial sector and enhance its ability to finance the new private investment opportunities which would arise in an improved business environment following implementation of the trade policy reforms. More specifically, the objectives were to (a) increase deposit mobilization and confidence in the banking system by liberalizing interest rates; (b) improve credit allocation by reducing reserve requirements and forced investments in non-negotiable Central Bank bonds (essentially a source of budget deficit financing) and rationalizing Central Bank rediscounts; and (c) reduce the cost of credit, primarily by reducing the fiscal deficit. 2.06 As it turned out, inflation remained excessively high (see para. 3.05). The inability to reduce the fiscal deficit placed the burden of the stabilization effort on monetary policy: loan conditions on reserve requirements and Central Bank rediscounts could not possibly be met. The loan was renegotiated and re-approved by the Board in amended form in October 1988, at the time of approval of TPL 2, but, eventually, it was never signed. 2.07 The explicit objective of TPL 2 was to broaden the trade reform initiated under TPL 1, with primary focus on import liberalization. The loan supported, inter alia, further reductions in quantitative restrictions on imports as well as reductions in the average level of tariffs from 43% to 30% and in the maximum tariff rate from 115% to 50%. In addition, as discussed in some detail below, the Bank had by then taken a major role in monitoring macro policy and especially fiscal discipline. TPL 2 (as well as BSL) was also part of the Bank's effort to help Argentina avoid a major financial crisis, including default to preferred creditors and possibly years of delay in changing the course of the economy, although the latter objectives were not explicitly dealt with in the President's Report. 2.08 The bulk of the proceeds of all three of these loans, including the BSL, were to finance general imports, or, in other words, provided balance of payments support. The counterpart funds ' Full details of the loans, conditionalities and compliance status at tranche release are presented in the PCR (Report No. 12747). The discussion here is confined to the essence of the programs and of their implementation. I' The removal of commodity export taxes was supported through the earlier Agricultural Sector Loan. -4- provided fiscal support. In the case of the two TPLs there were small amounts set aside for technical assistance; in the case of the BSL only $0.5 million would actually be spent on sector reform. B. The Policy Dialogue 2.09 A most important part of the evaluation of these three loans is a review of the nature and evolution of the dialogue between the country, the Bank and the Fund. As mentioned earlier, substantial Fund involvement in Argentina dates back to 1983, long before the start of the Bank's program of adjustment operations. The focus of the Fund's programs had rightly been on stabilization and more particularly on Argentina's fiscal problems. As time went on, however, waiver requests and program failures became a way of life, a reflection of the intractable nature of the fiscal problem. By December 1987, the Fund's Board ran out of patience. While granting one more waiver request, it made it clear that it felt that Fund management had been much too lenient with Argentina and that this would not be tolerated any longer. Starting in early 1988, Fund management and staff began to assume a much tougher attitude towards Argentina than before. 2.10 The Bank's first adjustment operation was the Agricultural Sector loan, in April 1986. TPL 1 was approved in May 1987. The Bank was well aware that the trade liberalization process would not succeed unless there was simultaneous progress towards stabilization, specifically a solution to the fiscal problem. The latter, however, was the objective of Fund programs and the Bank, at that time, relied on the findings of the Fund in its monitoring of the macroeconomic framework. 2.11 By late 1987 the Bank had begun to strengthen its own economic and sector work on the Argentinean public finance problem. It soon became clear that instead of a simple demand management problem, there were deep-seated structural problems at the root of Argentina's fiscal impasse. These included excessive public sector employment, massive subsidies to public enterprises and to the provinces, and a very weak fiscal administration. The needed structural reforms would clearly require considerable time. 2.12 The Bank felt that the Fund's focus on the aggregate deficit with insufficient attention to the component parts or the underlying reasons for the deficit was an important factor in the continued failure of stabilization efforts; it was argued that the Fund's approach could be counterproductive. The disagreements between the Bank and the Fund on these issues were fundamental and included, among others: the role of export taxes, with the Bank seeking to eliminate them; further cuts in public investment, with the Bank being concerned about decapitalization; and the rate of speed of deficit reduction, with the Bank being convinced that resolution of many of the underlying causes of the deficit would take time and that therefore patience was required. In March 1988, the President of the Bank, in a letter to the Managing Director of the Fund, took the unusual step of expressing his misgivings to the Fund about unrealistic targets for deficit reduction. The letter was never answered. It may be remembered that by then (para. 2.09) Fund management and staff had begun to toughen their attitude towards Argentina. 2.13 For all practical purposes, the dialogue between the Bank and the Fund had become fruitless. The Bank felt that its analyses of Argentina's fiscal predicament were long overdue and of high quality. Much later on, the Bank proved to have been on the right track as far as the diagnosis was concerned. The Fund, on the other hand, felt that the Bank, by engaging independently in the design of a medium-term program to address Argentina's financial problems, had entered the macro- arena, which was meant to be the primary responsibility of the Fund. The macro versus micro split in responsibilities was an unfortunate (but not unusual) misinterpretation of the division of labor between -5- the two institutions: because, just as macro-decisions influence micro-behavior, so are macroeconomic developments affected by decisions at the micro-economic level. 2.14 Attempts by the Fund to revitalize its program in Argentina, during early 1988,Y were quickly abandoned. Promised fiscal reforms, which had been the basis for the country's eligibility for drawing from the Fund's stand-by and therefore for release of the second tranche of TPL 1 in December 1987, did not materialize. In March 1988, the Government stopped interest payments to external commercial creditors and subsequently came under pressure to default on preferred debt. The Bank continued to process proposed loans and engaged in an intensive dialogue on structural reform, focussed on the fiscal problem. TPL 2 was appraised in April. Between March and July, four loans were approved by the Board, including the BSL which, however, was not signed and was resubmitted to the Board in October (with TPL 2). Meanwhile, the overall economic situation grew gradually worse and the social situation became tense. 2.15 In response to an almost complete loss of economic control, President Alfonsin announced a new stabilization plan in August 1988, the Plan Primavera. While the Bank helped in refining the plan and ensuring internal consistency, the dynamics of economic policy-making in Argentina remained the same; if anything, political obstacles to change were growing. In other words, the country's credibility for implementing policy reform remained as low as ever. This had two implications. First, given the country's dismal past record with the Fund and the difficult relations between the Fund's management and its Board which had developed as a result, the Fund couldn't do anything. Second, while the Bank was beginning to feel reasonably comfortable that at least it understood the technical nature of the fiscal problems and of their solution, it too knew that it would be extremely risky to go ahead. It is unclear whether the Bank would nave proceeded in these circumstances but for the pressure exerted by its major shareholder. 2.16 Shortly before the annual meetings in Berlin the president of the Bank visited Argentina to impress upon the Government the importance of full cooperation in the implementation of a program. Then, at the Berlin meetings, without having informed the Bank Board, he announced a $1.25 billion loan package for Argentina which included TPL 2, the renegotiated BSL, a $300 million loan for the Housing Sector and a $252 million loan for Electric Power. The package was approved by the Board in October with one negative vote, two abstentions on the entire package plus one abstention on the BSL. In view of the high risks involved, the package was deliberately designed so that disbursements would be limited to $150 million (the first tranche of TPL 2, upon effectiveness) if the program were to go quickly off track (as it, indeed, happened). Disbursement of the second tranche of TPL 2 as well as of the first tranche of the BSL would await a review and report by the Bank to its Board some 3 months later (January 1989) that the program was indeed on track.2? 2.17 Through TPL 2 the Bank both pursued structural reform objectives and secured agreement on short-term monitorable macroeconomic targets. The latter was equivalent to assuming the role of the Fund. This has often been seen as the main source of the tension between the two institutions. The real conflict, however, started much earlier when the Bank began to investigate the underlying causes of the fiscal deficit and, in the process, produced some very good macroeconomic work eventually recognized by all parties. I' Including a "secret" meeting between the Managing Director and President Alfonsin in Madrid in February 1988. ' Some Board members expressed misgivings about this unusual approach whereby first tranche disbursement of a loan (the BSL) was made subject to further review by the Bank and discussion by the Board. -6- 2.18 As discussed below, after a few months the Plan Primavera, supported by the Bank, collapsed because the Alfonsin Government simply could not deliver. The economic situation then deteriorated into hyper-inflation. The Fund felt vindicated in its assessment because the Bank's efforts in 1988 also failed. Yet the Bank's thorough economic and sector work had helped lay the basis for subsequent reform efforts, starting in 1990, that would prove quite successful. Eventually relations between the Bank and Fund improved, following a new, though still somewhat ambivalent, agreement (Concordat) on Bank-Fund collaboration, whereby the Fund takes the lead in short-term macroeconomic programming and monitoring while the Bank deals with the institutional underpinnings of macroeconomic policy. III. IMPLEMENTATION AND IMPACT A. Implementation 3.01 The dominant feature of the implementation experience of the two trade policy loans was that, on the whole, most sectoral measures agreed to under the loans were taken but, at the same time, steady progress towards the overall objectives, including stabilization and growth, was interrupted because of the Government's fiscal difficulties. In the case of the BSL, the macroeconomic impasse eventually kept the loan from being signed, yet even here there was some progress at the sector level, in particular in the form of a liberalization of interest rates. 3.02 Shortly after Board approval of TPL 1, a new Stand-by agreement was concluded with the Fund in July 1987. The Bank therefore considered the macro-policy frame to be satisfactory and consistent with the trade reform program objectives. The loan became effective in August, and the first tranche was released and disbursed. The fiscal targets agreed under the Stand-by were not being respected at all, however, particularly in anticipation of elections in September. Thus, in October a new stabilization program was drawn up (Plan Octubre) which, apart from fiscal and other stabilization measures, included some trade reform as well as financial deregulation measures. The new macroeconomic program continued to receive Fund support: the country was declared eligible for the second drawing under the Stand-by in December 1987. (Although by then, as discussed in para. 2.09 above, the Fund's Board had run out of patience and instructed Management to adopt a tougher attitude in the future.) 3.03 Over the course of 1987, the sector conditions for TPL 1 had largely been met. The temporary admissions regime for exporters had been expanded and made more efficient in two steps (March and October), in fact going somewhat beyond second tranche release requirements. Also, export taxes on manufactures had been eliminated and the indirect tax reimbursement scheme had been broadened as planned. In other words, the objective of granting free trade status to industrial exporters had been achieved. In addition, export procedures had been simplified through a "one stop window" process, even though, in this instance, the process had not yet been extended to all customs offices across the country. Finally, quantitative import restrictions had been reduced by more than required under the loan agreement: the transfer of tariff positions from the list requiring prior approval to the list of fully automatic imports exceeded expectations. 3.04 Compliance with the sector policy conditions of the loan, together with Fund approval of the macroeconomic program, led the Bank to approve release of the second tranche of TPL 1 in December 1987; disbursement took place immediately. The weakness in this process was the approval of a macroeconomic program where the necessary fiscal measures were in fact only promises. They -7 - were beyond the Government's immediate control and instead depended on Congressional approval expected in January 1988. In the event, this approval never materialized. 3.05 During the first half of 1988 the economic and social situation deteriorated steadily. In the absence of tax reform Government revenues continued to fall as inflation slowly accelerated. Austerity measures failed to restore private sector confidence. Instead, the country was confronted with major strikes as well as with the threat of a military coup. In March interest payments to external commercial creditors were discontinued. Eventually all stabilization efforts were abandoned. For all practical purposes, Argentina's relations with the Fund had broken off. 3.06 The Bank, during this period, intensified its dialogue on comprehensive structural change and helped design a public sector reform program. Proposed loans for public enterprise reform and for technical assistance in tax administration were being prepared. TPL 2 was appraised and the Board approved the BSL in March. The Bank also continued disbursements from its investment lending program. 3.07 By August, a new stabilization program, the Plan Primavera, had been drawn up in a desperate attempt to avert total chaos. By now the Bank felt comfortable with its diagnosis of Argentina's fiscal nightmare and was confident about the technical viability of remedial strategies. At the same time, it was clear that any structural adjustment lending would be extremely risky. Partly because the Fund could not act, even if it had wanted to (para. 2.15), and partly under political pressure, the Bank did decide to provide major support to the Plan Primavera. In October, a renegotiated BSL and TPL 2 were approved by the Board. 3.08 The Plan Primavera included, among others, a tariff reform program along the lines of agreements reached under TPL 2. Several measures were implemented. Thus, by November, the production coverage of quantitative restrictions was reduced to no more than 18%, the production weighted average tariff on industrial goods was lowered from 43% to 30% of the CIF value of imports, and the maximum tariff was reduced to 50%. In addition, measures included as part of the heterodoxv Plan Primavera had succeeded in reducing the monthly inflation rate starting in September. All conditions of effectiveness for TPL 2 having been met, the first tranche was released and fully disbursed during November 1988 and January 1989. 3.09 One important element of the Plan Primavera was a dual exchange rate system, designed for the Central Bank to make an operating profit on its foreign exchange transactions. This was equivalent to a temporary export tax collected through the Central Bank. It reversed, at least temporarily, trade reform measures supported through TPL 1 (and through the Agricultural Sector Loan). 3.10 By February 1989 the Plan Primavera collapsed because of an all-around lack of support: from the unions, industrialists, Congress, Government, as well as from the opposition party in the pre- election campaign. Unification of the exchange rate in April led to the introduction of an explicit across-the-board export tax of 25%; also, prior approval of advance import declarations as a condition for import financing was reintroduced: major progress achieved under TPL 1 was thus nullified. ' Combining orthodox fiscal and monetary adjustment with nominal anchors to bring inflation to an abrupt halt. (The nominal anchors in this case were price guidelines agreed with industrialists and monthly targets for the exchange rate, public service prices and public sector wages.) -8- Inflation accelerated and peaked at more than 200% per month in July, the same month when a newly elected civilian President took office, ahead of time. 3.11 The Menem Government recognized the need for far-reaching reforms in order to finally come to grips with the country's fiscal dilemma. President Menem also had considerable political support, above all because the ongoing hyper-inflation and long recession had by then traumatized the population, with old interest groups having effectively lost all credibility. A new heterodox stabilization program was soon announced and received support from an IMF Stand-by in November. In the meantime, the ]L, which had never been signed, had been withdrawn in October, 12 months after Board approval, because the macroeconomic environment necessary to be able to comply with the loan conditions and objectives was still lacking. The new stabilization program, again, could not be sustained and collapsed in December 1989, primarily because of an excessive build-up of short-term public sector debt. A new round of hyper-inflation began in December 1989 and lasted through March 1990. 3.12 In the interim, however, economic policy-making had taken on a new sense of purpose. A major tax reform had been submitted to Congress in September 1989, was approved in December and became effective in January 1990. In addition, in early March 1990 a wide-ranging fiscal reform package was announced, including administrative reforms designed to reduce the wage bill, daily indexation of taxes due and, severe limits on allowable financing by the Central Bank. Also, public enterprise reforms and, more in particular, a generalized privatization program, had taken firm root. The Bank can take considerable credit for having contributed to these developments, because the Government was to a large extent implementing a program which the Bank had helped design. First, TPL 2, only half of which had been disbursed at that time, helped maintain the dialogue. Second, the Bank's thorough analytical work, though initiated under the Alfonsin administration, had produced recommendations which were technically solid and fully accepted by the Menem administration. 3.13 In May 1990, agreement was reached with the Fund to resume the November 1989 Stand- by. As it turned out, Argentina's fiscal performance during the second quarter of 1990 was quite satisfactory. Economic policy-making by now rested on a solid foundation of structural reforms in the public sector in a number of areas: taxation, supported by technical assistance from the Bank aimed at modernizing the tax office and thus reduce fraud, administrative reform, particularly major civil service reform and, privatization and restructuring of public enterprises. 3.14 On the trade policy front, good progress had also been made by mid-1990. Full automaticity of imports not subject to quantitative restrictions had been reinstated. The production coverage of quantitative restrictions had been reduced to 7%, compared to a required 15% as condition for second tranche release of TPL 2. Also, tariffs had been reduced beyond second tranche release conditions: the production-weighted average ad valorem tariff stood at 18% (versus 30% in the loan agreement) and the maximum tariff was at 24% (versus 50% in the loan agreement). On the other hand, for fiscal reasons, export taxes had remained, thereby violating second tranche release conditions. The Government's over-performance on import liberalization, however, more than compensated for this: the anti-export bias of the trade regime had been reduced by more than required in the loan agreement. On this basis the condition on the reduction of export taxes was waived and, because the macro- economy finally appeared to be under control, the Bank released the second tranche of TPL 2 on July 31, 1990. Disbursement took place during August and September. 3.15 The road to trade liberalization during 1986-90 had been arduous, primarily because of Argentina's stubborn government deficit. Progress made was consistent with the objectives of the two -9- TPLs but the process was far from completed. An estimate in the PCR suggests that the anti-export bias of the trade regime had been reduced from 65% in 1986 to 44% by July 1990, suggesting a fairly strong residual bias. However, the Government's repeated efforts over the years, with Bank assistance, at finding a solution to the fiscal problem had gradually laid the foundation for sustainable change. In addition, the traumatic experience with hyper-inflation during 1989 gave the new President a very strong mandate for change, and Argentina's structural reform program subsequently accelerated greatly. 3.16 During the course of 1991/92 virtually all export taxes and quantitative restrictions (except for automobiles) were eliminated and average tariffs fell further.2' By 1992 the above referred to measure of the anti-export bias had been reduced to 15%. Also, a major decree further deregulating markets and eliminating administrative barriers was issued in October 1991. In the public finance area, the 1990 fiscal reforms were closely followed by a new fiscal package in February 1991 to close the remaining gap. In April 1991, the so-called Convertibility Law, which established full currency convertibility at a legally fixed exchange rate and forbids Central Bank deficit financing, drastically reduced the risk of inflation and restored confidence in economic policy-making. B. Imact (i) Economic Impact 3.17 Trade liberalization and financial reform were the first steps in the Bank's strategy to help Argentina turn its inward-looking and state-led economic system into a more open, efficient and growing economy. As discussed in the preceding paragraphs, the direct loan objectives of the TPLs were achieved in substance, though with a considerable delay of about 1h years. Because other reforms - privatization, deregulation, fiscal reform -- were gradually being introduced and because all reform accelerated after 1989, a detailed analysis of the impact of trade reform per se on the country's ultimate objectives is difficult. Still, some of the immediate results can be read from Tables 1 and 2. 3.18 Exports, and especially manufactured exports, grew strongly during 1987-90, partly in response to the improved export regime supported through TPL 1, and partly because of a depreciating real exchange rate; the economic crisis during those years and the corresponding decline in domestic demand may also have contributed. The crisis clearly dampened import and investment demand. The economy became slightly more open as measured by the ratio of exports plus imports over GDP. 2' In October 1992 the so-called statistical tax on imports was, temporarily, increased from 3% to 10%. - 10 - Table 1: MACROECONOMIC INDICATORS, 1986-92 1986 1987 1988 1989 1990 1991 1992 Volume Indices GDP 100 103 101 94 94 103 112 Consumption 100 101 97 93 92 104 115 Investment 100 115 113 85 77 96 126 Exports 100 97 114 122 144 133 133 Imports 100 113 100 82 83 136 222 As % of Real GDP Consumption 80.7 79.7 77.5 79.3 78.9 81.6 83.2 Investment 17.4 19.6 19.5 15.7 14.1 16.3 19.6 Exports 8.2 7.7 9.3 10.5 12.5 10.5 9.7 Imports 6.3 7.0 6.3 5.5 5.5 8.4 12.5 As % of Current GDP Public Deficit /a -5.8 -10.1 -10.0 -10.5 -6.1 -2.3 1.5 /b Real Effective Exchange Rate /c 100 109 106 144 108 80 75 Private Capital Inflows /d 113 940 16 -4,337 -769 2,339 7,810 Inflation (%) /e 90 131 343 3,079 2,314 172 25 /a Combined deficit of the Public Sector, i.e. including quasi-fiscal deficit of the Central Bank (accrual basis). /b Estimate. /c Effective Exchange Rate, calculated using international trade weighted indices and domestic combined price index (1986 = 100). /d Amounts in million of current US$. /e Annual percentage change in consumer price index. Sources: Central Bank of Argentina; IMF; World Bank; World Bank Report #10827-AR, Argentina - Public Finance Review, From Insolvency to Growth, February 11, 1993; and BRODA and Associates. 3.19 With the restoration of confidence since 1990, as the public sector deficit was brought under control and the economy stabilized, investment recovered though fragmentary evidence suggests that relatively little new investment is occurring in the tradeables' sector. Major foreign private capital inflows have fueled a strong recovery in GDP growth since 1991, a huge increase in imports and substantial increases in international reservesY The volume of exports, on the other hand, declined, in particular industrial exports, in response partly to an appreciating real exchange rate and partly to !' During the long inflationary period prior to 1991 capital flight had been substantial. Rough estimates of the total stock of Argentinean capital abroad were as high as $50 billion by the end of the decade. - 11 - buoyant domestic demand. Still, as measured by the ratio of exports plus imports over GDP, the economy continued to become more open. Table 2: FOREIGN TRADE STATISTICS, 1986-93 (in million US$) Exports imports Total Manufacturing (% total) Total Consumer (% total) Capital (% total) 1986 6,852 1,808 (26) 4,724 286 (6) 615 (13) 1987 6,360 1,961 (31) 5,819 318 (5) 973 (17) 1988 9,135 3,023 (33) 5,322 226 (4) 847 (16) 1989 9,573 3,796 (40) 4,200 186 (4) 725 (17) 1990 12,353 4,858 (39) 4,077 222 (5) 596 (15) 1991 11,978 4,174 (35) 8,275 1,120 (14) 1,530 (18) 1992 12,237 4,329 (35) 14,872 .. 1993 /a 12,555 .. .. 15,241 .. /a Preliminary. Source: CEPAL. (ii) Social Impact 3.20 The severe economic crisis and extreme instability during 1986-90 was accompanied by only fragmentary structural reforms with few social repercussions arising from the reforms. The steadily increasing rate of unemployment was the result largely of the crisis itself (Table 3). Likewise, poverty (as well as income inequality), which had been on the increase for a number of years because of the overall mismanagement of the economy and resulting long-term decline in incomes, further intensified during this period of recession and hyper-inflation. This was clearly also not a consequence of structural reform; quite the contrary, it was the effect of a lack of it. - 12 - Table 3: LABOR FORCE AND EMPLOYMENT AS PERCENT OF TOTAL POPULATION; UNEMPLOYMENT AS PERCENT OF LABOR FORCE (1986-93: Greater Buenos Aires) Labor Force Employment Unemployment June 1986 39.6 37.7 4.8 April 1987 40.9 38.7 5.4 May 1988 40.4 37.8 6.3 May 1989 41.9 38.6 7.6 May 1990 40.9 37.1 8.6 May 1991 40.9 38.1 6.3 May 1992 41.4 38.6 6.6 May 1993 44.2 39.5 10.6 Source: Ministry of Economy, National Institute of Statistics and Census. 3.21 In parallel with the economic recovery after 1990, there appears to have been a substantial reduction in poverty levels as genuine structural changes began to take hold. Based on household survey data, CEPA (Executive Committee for the Study of Poverty in Argentina) estimated that 22.6% of households in Greater Buenos Aires were below the poverty line in May 1988. Subsequently, during the period of extremely high inflation, the percentage of households below the poverty line increased to an astonishingly high 38.3% in October 1989 and 33.7% in May 1990. By October 1992, however, the percentage had declined to 13.7%.2' On the employment front, in spite of large dismissals by the public sector, employment levels have increased continually by some 400,000 between 1990 and 1993 in Greater Buenos Aires alone. The rate of employment growth has been especially rapid for women. The recent (1992-93) sharp rise in the unemployment rate is the result of an unprecedented increase in additions to the labor force, primarily female labor. Nevertheless, and quite independently of the two trade policy loans, the Government is faced with a major challenge to redress the social consequences of past development policies which led to a severe intensification of income inequality. IV. OVERALL EVALUATION. SUSTAINABILITY AND LESSONS LEARNED A. Overall Evaluation 4.01 The two TPLs, designed to open up the economy, were the cornerstone of the Bank's assistance strategy for Argentina during the turbulent period 1986-90. The BSL played a supporting role, meant to facilitate financing of the new investment opportunities which would arise as a result of the trade reform. 2' Comit6 Ejecutivo para el Estudio de la Pobreza en La Argentina. "Evoluci6n reciente de la pobreza en el Gran Buenos Aires, 1988-1992." Ministerio de Economfa y Obras y Servicios Pdblicos, August 1993. - 13 - 4.02 TPL 1 must be rated as an unsatisfactory operation, even though the Government did comply with the sector policy conditions, at that time. However, the country's deep-seated fiscal problems were not being addressed, or even fully understood. Instead, relying on the Fund's macroeconomic assessment, the Bank was supporting an economic reform program, focussed on agriculture, trade and financial deregulation, where fiscal and public sector reforms were being de- emphasized on the assumption that growth would eventually resolve fiscal imbalances. This sequencing was wrong. It was bound to, and eventually did, lead to trade policy reversals, because the fiscal constraints remained. The Bank began its in-depth economic and sector work and review of the structural nature of Argentina's fiscal impasse only towards the end of 1987 by which time the second tranche of TPL 1 was being disbursed. 4.03 An overall assessment of the role and contribution of TPL 2 is more complex. By the time the loan was approved by the Board, the Bank had a good grasp of the structural dimensions of Argentina's fiscal problem: a poor tax structure, weak tax administration, excessive employment, massive subsidies to the provinces and the burden of inefficient public enterprises. TPL 2 incorporated a number of fiscal measures, including reform of the value added tax, improvements in tax administration and reforms in public enterprise tariff policy. Loan approval was controversial: the Fund could not join the Bank with a parallel program and meanwhile, during early 1988, the economic and social situation in Argentina was growing worse. On the basis of the August 1988 Plan Primavera, the Bank went ahead with TPL 2 knowingly taking a major risk, given the diminishing political power of the Government, but intent on giving the economic reforms a final chance at succeeding. Because of the risk, the Bank's total program of assistance at that time of $1.2 billion (including the $300 million TPL 2 and the $400 million BSL) was designed to stop disbursing after the first $150 million tranche of TPL 2, in case of failure of the Plan Primavera. As it turned out, the Alfonsin Government could not deliver on its promises. The program subsequently derailed and the economy went into hyper-inflation. 4.04 Subsequent developments were conditioned by two key factors which provide a basis for assessing the overall impact of TPL 2. First, the Bank's diagnosis of the fiscal nightmare was now fully understood and accepted by all parties concerned. The Bank's continued presence and involvement in the country's predicament had established confidence in its analyses and proposed remedial actions. The Bank had become a trusted advisor to Argentina. Second, when the Menem Government came to power in July 1989, the ongoing hyper-inflation and continuing recession had traumatized all segments of society, thereby giving the new Government a genuine mandate for reform. For the first time in many years there could be true ownership of policy change. By the time of second tranche release of TPL 2, fiscal reform was well underway, including a broadening of the value added tax base, modernization of the tax administration and privatization of public enterprises, in particular telecommunications and the airlines. Also, earlier trade reform reversals were being undone. In this perspective, TPL 2 must be rated as a satisfactory operation. Furthermore, the continuity provided by the Bank set the stage for a series of follow-up reforms, supported by Bank operations, which have yielded positive results. In retrospect, the Bank's unremitting pursuit of reform helped lay the seeds for the country's subsequently successful economic program; the Bank also made a modest contribution to institutional change in Argentina. 4.05 The BSL never had a chance. Its basic objective of increasing lending to the private sector was contradicted by the continuing inadequate fiscal effort which meant that monetary policy (high reserve requirements, forced investment in Central Bank bonds) had to carry the burden of stabilization efforts. By October 1989, 12 months after the second (amended) Board approval, there was still no satisfactory fiscal solution, and the loan offer lapsed. Its contribution to development can therefore not - 14 - be assessed. Nevertheless, although the loan was never signed, there were important and lasting achievements in the context of the prolonged dialogue, notably market-determined interest rates on lending and time deposits and rationalization of the Central Bank's rediscount policy. B. Sustainability 4.06 At this stage, the policies promoted by the Bank and implemented by the Government certainly appear to be sustainable. In fact, the tax reforms, the removal of subsidies, the downsizing of the public administration and the ongoing privatizations are all enduring reforms, unlikely to be reversed. At the same time, the ultimate success of Argentina's efforts to achieve sustained and rapid economic growth, an objective for which it clearly has the potential and resources, will require continued good economic management. 4.07 Above all, given the country's size, its trade to GDP ratio is still relatively small: in particular, exports will have to be an important source of growth in the coming years. The ban on deficit financing by the Central Bank, through the Convertibility Law, is fundamental to the maintenance of confidence and to the credibility of the reform program. On the other hand, the legally fixed exchange rate regime could create problems. The large capital inflows during the past three years have contributed to a real appreciation of the exchange rate, which is hampering growth in the tradeables sector. In recent months a number of protectionist measures have been introduced to assist selected domestic industries. A continuation of such policies could undermine the transparency of the trade regime. 4.08 If the capital inflows were to dry up, a recession would be inevitable under the current circumstances. In order to avoid such a scenario, the emphasis in the near future will have to be on cost reductions and efficiency increases in order to restore competitiveness. Given the institutional rigidities imposed by the Convertibility Law, it becomes essential to bring down the domestic price level relative to the major trading partners. There is good scope for cost reductions through revisions in the social security and labor laws and in the tax system. Some of these changes are in the making. Such reforms would also provide strong incentives for new investments, especially in the export sector, and bring with them continued foreign capital inflows. C. Lessons Learned 4.09 In retrospect, the Bank's Argentina program turned successful primarily because of the unexpectedly strong reform program pursued by the Menem administration which itself was greatly facilitated by the traumatic experiences of a long recession and of hyper-inflation. In other words, unforeseeable events helped turn a highly risky undertaking by the Bank eventually into a success. Probably the most important lesson from this experience is that the Bank, which is meant to have long- term permanent relationships with its client countries, implemented this relationship to the fullest in this case and therefore was ultimately successful. The Bank stuck with Argentina, without increasing its exposure excessively, engaged in thorough economic and sector work on the nature of the country's problems, and was ready with solutions and a large lending program when the opportunity arose. 4.10 A lesson related to the above is that full country ownership of a program is a sine-qua-non for success. This ownership came only after the 1989 debacle when it became clear that there was no alternative to reform. - 15 - 4.11 Second, it is evident that without fiscal reform, trade liberalization was bound to derail. But, at the same time, there appears to be no a priori reason for stabilization to be completed before trade liberalization is initiated, because the latter itself played an important role in establishing price and wage discipline after 1989. 4.12 Finally, while the respective roles of the Bank and the Fund have been further clarified, disagreements on policy issues will continue to arise. This, however, can have a positive impact on the borrowing country, if it leads to a more thorough technical discussion, over and above institutional positions, and results in higher quality economic advice to the country.