Argentina - Country assistance strategy

Document of The World Bank Report No. 20354 MEMORANDUM OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR THE ARGENTINE REPUBLIC September 8, 2000 Country Management Unit Argentina, Chile and Uruguay PREM Network Latin America and Caribbean Regional Office The International Finance Corporation Latin America and Caribbean Departmnent  The FYO1-04 Country Assistance Strategy (CAS), Report N. 20354, dated May 5, 2000, was discussed by the Executive Directors on June 27, 2000. Based on this discussion, and in agreement with the Government of Argentina, the CAS document has been revised and made available for public information. CURRENCY AND EQUIVALENTS Currency Unit: Argentina Peso (Arg.$) ARG$I = US$1 WEIGHTS AND MEASURES Metric System FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS CAS Country Assistance Strategy 1DB Inter-American Development Bahk IMF International Monetary Fund IFC International Finance Corporation MERCOSUR Southern Cone Common Market MIGA Multilateral Investment Guarantee Agency NBI Indice de Necesidades Basicas (Index of Basic Needs) NGO Non-governmental Organization PSE Plan Social Educativo (Social Education Program) REPO Special Repurchase Facility TRABAJAR Public Works Employment Scheme SME Small and Medium Size Enterprises SSAL Special Structural Adjustment Loan WB Managers and Staff Responsible for this CAS Vice President Mr. David de Ferranti Country Director Ms. Myrna Alexander Sector Director Mr. Guillermo Perry Task Manager Mr. Mark Hagerstrom IFC Managers and Staff Responsible for this CAS Executive Vice President Mr. Peter Woicke Vice President, Investment Operations Mr. Assaad Jabre LAC Director Mr. Karl Voltaire Manager Mr. Bernard Sheahan Task Manager Mr. Toshiya Masuoka  THE ARGENTINE REPUBLIC COUNTRY ASSISTANCE STRATEGY TABLE OF CONTENTS Executive Summary i-vi Message from the Minister of Economy vii- viii A. ECONOMIC AND SOCIAL PERFORMANCE 1 Economic Reform and Growth 1 External Shocks 3 Recent Economic Developments 3 Medium-Term Prospects 5 Social Performance 6 The Poor 8 B. MAIN DEVELOPMENT CHALLENGES 9 Poverty and Human Resource Development 9 Infrastructure 14 Environmental Concems 16 Gender 17 Consolidating Macroeconomic Reforms 18 PrLvate Sector Development 20 Institutional Capacity and Governance 21 Provincial Reform 22 C. GOVERNMENT DEVELOPMENT STRATEGY 24 The First Steps 24 Medium-term Agenda 24 D. BANK GROUP COUNTRY ASSISTANCE STRATEGY 27 Progress and Portfolio Performance 27 Client Survey and Feedback 28 Sector Perspectives on Performance 29 Renewing the Country Strategy 34 Exposure, Net Flows 35 Selectivity in Setting Priorities 35 Comparative Roles of Other Multilateral Institutions 42   An Evolving Relationship 42 Risks 45 ANNEXES Annex A Private Sector Strategy Annex A2 Country At a Glance Annex B2 Selected Indicators of Bank Portfolio Performance and Management Annex B3 Bank Group Program Summary Annex B3 Bank Group Fact Sheet - IFC and MIGA Program Annex B4 Summary of Nonlending Services Annex B5 Poverty and Social Development Indicators Annex B6 Key Economic Indicators Annex B7 Key Exposure Indicators Annex B8 Operations Portfolio Annex B8 Statement of IFC's Held and Disbursed Portfolio Annex B9 CAS Program Matrix MAP IBRD 29348   Executive Summary The last Country Assistance Strategy (CAS)for Argentina was considered in May 1997 for FY98-00, when the country had regained its economicfootingfollowing the regional financial crisis of 1995. A Progress Report was provided in March 1998 in the midst of the emerging crisis in Asia. The proposed program for the Bank Group would span FY01-04, the period of the new administration that took office in late 1999. Regular progress reports would be provided to the Board in the intervening period The Long Road to Reform Since the launch of the Convertibility Plan in 1991, the Argentine economy has been undergoing a massive transformation. The main feature of this program, supported by the World Bank Group, IDB and IMF, was the establishment of a currency board arrangement. This was part of a sweeping set of reforms that altered the monetary system, improvedfiscal and tax policies, liberalized trade, and reformed the public sector, including a rapid privatization program and changes to the social security system. All of this was intended to reverse the historical pattern ofpoor economic management and volatility the country had sufferedfor the previous 25 years. Public institutions had deteriorated and, importantly, poor performance severely eroded confidence in the financial sector, resulting in large savings held abroad Externalfinancing both for the private andpublic sector dominated thel970s, leading to the 1982 debt crisis. Attempts at stabilizing the economy, with Bank and Fund support, were made in the 1980s but none succeeded Each time, inflation returned and surged to higher levels, culminating in hyperinflation in 1989. Nonetheless, efforts to open and deregulate Argentina's economy and a debate on the role of the state were started Another attempt at reform began in 1989 and the results have been dramatic. Argentina has experienced strong average economic growth in the 1990s. The size of the economy expandedfrom $141 billion in 1990 to $282 billion in 1999, despite being hit by external shocks and two severe recessions. Argentina has now one of the world's lowest inflation rates and productivity has rapidly increased, responding to the new economic signals. The banking system has been strengthened through improvements in regulation and supervision, privatization, restructuring and consolidation. The role of the state has been changed, mainly as a result ofprivatization and decentralization to the provinces of health and education. Tax reforms removed many distortions and reduced tax handles and a newfederal public sector financial management system was implemented Poverty quickly fellfrom the peak of 41 percent reached in 1989-90. Remaining Challenges Despite this undeniable progress, major issues remain, including the vulnerability of the economy to external shocks, compounded by lagging competitiveness, persistent poverty (29%), including over 40 percent of children, rising income inequality and high unemployment (14%), especiallyfor the unskilled These statistics point to the fact that the benefits of growth in the 1990s have not been shared Infrastructure is deficient, -1i-  labor regulations rigid, and investments in education, research and development, low. And there is still a long way to go to increase savings and deepen the domestic capital market. Moreover, Argentina does not have an adequate safety net, nor has it yet completed the modernization ofpublic institutions. This is particularly true at the provincial level which experiences wide variation in performance and capacity. Today, Argentina remains heavily indebted, despite the fact that total external debt is now a more manageable 51 percent of GDP, as compared to almost 100 percent in 1989. The public sector continues to rely on international capital markets to refinance its debt stock. Part of this debt stems from the take over ofprivate sector debts in the early 1980s and domestic debts, converted to US dollar obligations, during the 1980s and early 1990s. More recently public debt has risen to cope with the large fiscal deficits associated with the Tequila and Russia/Brazil crises. Social progress and economic progress go hand in hand and Argentina is clearly one of the more developed countries in Latin America. However, certain social indicators have been deteriorating-such as income equity and poverty-- and compare unfavorably with neighboring Chile and Uruguay. Average statistics for Argentina also mask significant variations with the provinces in the North east and North west being the most disadvantaged Moreover, for its income level, Argentina has serious lags in social infrastructure and it is notably weaker as regards policies for social inclusion/equity. Public sector management also needs strengthening when it comes to transparency, accountability and corruption. Social spending in general at 18 percent of GDP compares favorably with Argentina's neighbors. Much of thefiscal space created in the 1990s byprivatization has been used to expand social programs. However, the bulk of this spending is for the contributory pension system and is not targeted Additionally, public programs for housing and higher education--which is free for all-- could clearly be more equitable. Among programs specifically for the poor, there are no major problems in targeting per se and they are strongly pro-poor but their coverage is limited to only about 25 percent ofpoor families. Furthermore, even this spending tends to be pro-cyclical and suffers from budget cuts during fiscal tightening. Health indicators in Greater Buenos Aires are comparable to many developed countries but third world problems remain in the poorer, northern provinces. Looking at education, attainment at the primary level is satisfactory, but secondary and higher education fare poorly relative to comparator countries and progress in improving the system has been slow. In higher education, inefficiency in public universities is compounded by regressive public spending. A particular area for increased attention is the labor market and employment. At the end of the 1980s, Argentina had low productivity and accumulated excess employment in both the public and private sectors. Reforms redressed this situation but in the meantime Argentina's economic transformation had shifted demand to more qualified workers and use of technology. This has left unskilled workers unemployed or with depressed wages and many below the poverty line. Moreover, reforms to make the labor market more flexible have lagged A negative consequence has been the increase in the informal sector, as both firms and employers seek to escape high costs and restrictive regulations. - ii -  The down side is that these workers are excludedfrom many safety net programs, and firms, mainly SMEs, cannot qualify for credit nor do they pay taxes. At the same time, Argentina has experienced widening gaps in wages paid to those with modern skills and a stagnation in wages to those with low skills. Wage disparity, in turn, has led to increased income inequality and disillusionment especially among older workers with obsolete skills and women and youths who lack both experience and skills. These problems compound the sense of vulnerability felt by the poor whose biggest concern, as expressed in the Voices for the Poor, is securing stable work. Argentina is a diverse country with significant regional disparities. The reforms enacted during the 1990s are changing these regional economies, with a substantial shift in favor of natural resources. The growth of these regional economies make new demands on provincial and municipal governments to provide services andfoster investment in addition to their responsibilities in health and education. At present, that capacity rangesfrom very good to very poor and infrastructure investment has lagged Access to water and sewage systems in urban areas remains deficient, and is even worse in rural areas. Poor households suffer from overcrowding, lack running water, and often live in areas of high risk offlooding. Next to securing better employment, improving infrastructure was the greatest concern heard in the Voices of the Poor. Continuing the Transformation Bank support, along with that of the IDB and IMF, has been critical in Argentina 's transformation. But this process is not yet complete and it will take more time and effort to address a complex set of economic, institutional and social issues. Some of these are part of the unfinished agenda from the 1990s, and others are part of the process of adapting to the global economy. From the point of view of the poor, job creation is the highest priority. This will require: - reductions in the cost of capital and improving access of the private sector (particularly middle-market and SMEs) to long term financing through capital market development. These developments will also stimulate sectors such as construction that offer employment opportunities for the unskilled; * the reduction of non-wage labor costs (payroll taxes and other mandatory contributions) in the formal labor market with a commensurate expansion of workers covered by health insurance and pensions; * improvement in skills and education, particularly in secondary education, the inadequacy of which became apparent in the course of economic restructuring under the Convertibility Plan; * reduction of transaction costs, due to the incomplete transformation of institutions such as the tax system, judiciary, and customs, both at the federal and sub-national levels, and high logistic and inventory costs, which are nearly three times higher than OECD countries and over 30 percent of GDP. - 111 -  Beyond sound economic management, investment in education, and pro-employment growth policies, there are a number ofpolicies that would help the poor and address their concerns of vulnerability and access to public services. These include: * expanding the coverage of social safety nets, which are generally well targeted and effective, and making these programs counter cyclical. At the same time, some programs, such qs in nutrition, housing andjob training, should be restructured * focusing public health care expenditures on those without health insurance, by improving cost recovery and the efficiency of the public system. * because of the large number ofpoor children, promoting responsible parenthood and family capacity development, including access to reproductive health services. * in urban areas, providing basic infrastructure services, such as water, sanitation and roads, and providing regular land titles in areas of illegal or informal settlement. * for the rural poor, including indigenous populations, who have been largely forgotten, addressing sustainable development, income generation, access to safe water and other services, and community development. Finally, environmental degradation poses a threat to the health and livelihood of both the poor and non-poor. Stronger policies and programs are required to reduce the threats to water supplies posed by industrial and hazardous wastes in urban areas, to improve water management in rural areas, and to stop excessive soil erosion and overexploitation of marine and other sensitive resources. In many of these areas, the Bank is already engaged, with relatively good progress being made, as reflected in OED 's recent Country Evaluation Update. In other areas, we would be opening up new activities, supporting the next phase ofArgentina 's development agenda. The Government's Program The new administration ofPresident de la Rua is firmly committed to improving social and economic performance within the framework of the Convertibility Plan and MERCOSUR. Enhancing Argentina 's competitiveness and promoting new avenues of growth, including investment in human capital, is a key goal. A prerequisite for this is to reduce Argentina 's vulnerability to external shocks that not only disrupt growth but inflict considerable social costs on those least able to protect themselves. A major element will be to reduce country risk as high risk perceptions by the markets burden, via the increased cost of capital, all sectors of the economy. This implies reducing the accumulation ofpublic debt at the federal and provincial levels and expanding exports. Faced with a prolonged recession, high unemployment and high levels ofpoverty, plus a fiscal deficit of more than 2 percent in 1999, the new administration placed its initial - iv -  priority on the fiscal side, including bringing the fiscal situation under control and negotiating a new program with the IMF. It reached an early agreement with the provinces on stabilizing provincial transfers and has embarked on a debt-reliefprogram with the most heavily indebtedprovinces. All of these measures served to restore confidence in the markets and resulted in a sharp reduction in country risk. The Government was also quick to reaffirm the importance of MERCOSUR and to propose a major piece of legislation on labor reform. These early measures form part of a medium term strategy focused on deepening reform of the state and making Argentina more competitive. At the federal level, there is still a major adjustment to make to comply with the law offiscal responsibility, to increase transparency and to attack private sector tax evasion. Increased investment in infrastructure is seen as a key for enhancing competitiveness and improving coverage of the poor. Education spending would be increasinglyfocused on the poor and health spending wouldfocus on insurance for the uninsured, primary health care and prevention programs. Finally, social assistance would be revamped to increase targeting, coverage of critical groups, and efficiency. The Bank Group's Role Given the continuing development challenges faced by Argentina and the success of the Bank in supporting the Government in meeting them so far, the World Bank Group 's CAS for FYO]-04 would continue to focus on the poor and promoting equitable, sustained growth. The Bank would continue to emphasize three themes: i) enhancing social development, including poverty alleviation and human resource development; ii) improving the performance of the state, particularly at the sub-national level; and iii) consolidating structural reforms. This strategy has been by and large successful, with high rates of achievement ofproject objectives, and low levels ofportfolio problems. IFC 'sfocus would be closely aligned with that of the Bank and include: improving access to investment financing by companies that will create growth and employment, activities which demonstrate tangible benefits of growth and reform, and supporting frontier activities which could be replicated in other World Bank Group countries. MIGA would support the strategy through its guarantee program and investment marketing services. In view ofArgentina 's high level ofper capita income, the future program would aim to improve a series of economic and social indicators designed to guide the evolution of the Bank's role during the comingyears. The proposed base case lending of $3 billion for FYO0-04, as compared to average annual lending of $1.5 billion during FY97-00, takes into account Argentina 's changing needs and absorptive capacity. A gradual reduction in the program would also help to attenuate negative netflows when Argentina is still vulnerable to sharp economic downturns andproblems in accessingfinancial markets. Under the base case, lending wouldfocus on provincial reform, governance, education, continuing reforms in health and improving service for the poor. Infrastructure operations would support increasing competitiveness by reducing logistic costs with -v -  private sectorfinancing, and enhancing access by the poor. Other targetedprograms would include supportfor the urban and long neglected ruralpoor. A high case for lending would be considered under special conditions as in the past when Argentina has been hit by an external shock, assuming satisfactory policies were in place. Such lending would be in the context of coordinated efforts among the Bank, IMF, and IDB and consistent with the Bank's policies on lending to a single large borrower, our lending capacity at the time, and burden-sharing. Additional support for reforms would also be considered as a supplement of $ 500 million to the base case, if there were to be advances in areas such as deepening of health sector reforms, consolidation and simplification of social programs, further reforms in the pension system, or in a new agreement on transfers to provinces. The move to the high case scenario would take into account progress made in addressing the issues of the unfinished reform agenda, including progress towards a revenue-sharing arrangement, as well as the scope and budgetary impact of the reforms that could be supported by the Bank. In turn, a low case scenario would become operative if there were policy slippage and portfolio performance were to worsen. The low case program wouldfocus on poverty targeted operations. The following questions are suggested as possible issues for Board discussion: - Is the proposed pace and timing of the reduction in Bank assistance to Argentina appropriate to the country's current social and economic status?