Transcript of Meeting of the Executive Directors of the IBRD and IDA, held on Tuesday, November 13, 2001

[--- Unable To Translate Box ---] INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION Tuesday, November 13, 2001 Washington, D.C. The meeting of the Executive Directors was convened at 10:36 a.m. in the Board Room, 1818 H Street, N.W., Washington, D.C., Mr. Shengman Zhang, Chairman, presiding. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE C O N T E N T S ITEM PAGE 1 Oral Briefing on Argentina [via videoconference] 3 Opening Remarks by Mr. Levy 3 Opening Remarks by Mr. Perlin 12 Mr. Stek 21,23, 25,69 Mr. Duquesne 26 Mr. Schaffer 27 Mr. Hyden 29 Mr. Zhu 30,51 Mr. Abdul Aziz 32 Mr. Dedeoglu 50 Mr. Passacantando 51 Mr. Jonck 53 Mr. Bugrov 54 Mr. Harada 57 MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE P R O C E E D I N G S MR. ZHANG: Before taking up the agenda, I would like to welcome Mr. Al-Jazzaf. We would like to welcome you again. Welcome onboard. The item before us is an oral briefing on Argentina. I will now ask Mr. Paul Levy of the region to brief us on the current situation in Argentina. We, of course, have Dave as well as Gary here. On the screen you can see Myrna from Buenos Aires. Let's get started. Mr. Levy, please. MR. LEVY: Thank you. Good morning. Our last update to the Board on the evolving situation in Argentina was on October 23, 2001, three weeks ago. On that occasion, we highlighted the continued deterioration of economic and financial indicators, and briefed the Board on the results of the mid-October elections, the government's plans for new measures and the status of our discussions based on David de Ferranti's recent visit to Argentina. Today we will focus on what has happened since our last update: the latest round of economic and social measures announced by the government on November 1st; the approach that the government is taking on debt and for MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE negotiations with the provinces; early market reactions; and the implications for the Bank. We will start with the government's recent measures. As anticipated at the last briefing, the government has announced a new series of measures. The government also took this opportunity to reaffirm its commitment to the present exchange rate regime and to attaining a zero fiscal deficit. The measures announced on November 1st aim to address several mutually reinforcing goals. The first goal is to stimulate aggregate demand. With Argentina now into the fourth year of recession and with mounting unemployment, this is critical. Economic activity is to be stimulated through reducing taxes on consumption by lowering the value-added tax if purchases are made with a debit card and on production by extending the tax benefits in the competitiveness plans put in place on March 24, 2001. These include elimination of the presumed minimum corporate tax and the tax on interest payments, and the possible extension of credit for labor taxes against value-added tax payments. Another measure allows for a reduction of payroll contributions to the private pension system, MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE which will add to disposable income. Other measures expand infrastructure services and help provinces deal with the current problems of flooding. The second goal is to reduce tax fraud and increase tax collections as part of the continuing program of modernization of the state. Consistent with earlier measures, the effort concentrates on putting more economic transactions through the banking system, including those for social security. Additional measures focus on the efficiency of the tax authority by transforming it into an autonomous agency. The third goal is to ease the social burden. The government announced a bold program of new income transfers to the poor with children, transforming the current system of family allowances, and to the aged who do not receive any pension benefits. About 5 million children and 500,000 aged are expected to benefit. In addition, the government plans to restructure key social institutions. These measures are consistent with the Bank's economic work and policy advice on vulnerable groups, and build on the government's public expenditure analysis carried out in 1999. A new program has been added for the direct provision of school MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE supplies for poor families. Putting extra income in the pockets of poor families will have the added benefit of stimulating local demand. The fourth goal is to alleviate financial stress. For the corporate sector, this includes tax preferences to indebted companies to facilitate debt restructuring and a mechanism which would allow tax arrears to be met with government bonds. Additionally, tax incentives will be given for shareholders to recapitalize firms. For the public sector, the ongoing efforts at restructuring debts are obviously a key part, as described in more detail in a minute. The federal government is anticipating that the proposed debt swaps could reduce annual interest costs by about $4 billion. In addition, the federal government will allow the provinces to issue provincial Treasury bills, so-called LECOPs, to suppliers and employees for up to $1.3 billion. These goals are good ones, but we should not expect a quick economic recovery, as the measures, in and of themselves, are not sufficient to alter the market's perceptions, nor overnight to change investor and MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE consumer confidence. They include long-term structural reforms which should eventually have an impact. Now to address the issue of debt. The authorities have announced that they will not be seeking incremental financing from the multilateral institutions for support of a debt exchange operation, and whatever collateral might be needed would be provided by Argentina. Additionally, the government has indicated clearly that debt with the international financial institutions would be fully honored and will in no way be affected by actions that they are considering now, including their proposed new debt swap. The approach they are putting forward for a swap is to offer bondholders new debt instruments for which they can swap their existing high yield holdings. The new instruments would aim to reduce interest payments by at least 30 percent, by capping interest rates at 7 percent per year for fixed rate bonds, or at most 3 percentage points over LIBOR for floating rate bonds. There would be no repayment of capital for three years and commensurately existing maturities would be extended by three years. It is anticipated that this MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE swap would apply to as much as $40 billion in federal debt held by domestic investors. A similar swap of about $10 billion would be attempted with local bondholders and domestic banks which have debts with the provinces. The program was presented formally to domestic creditors on November 6th and offers are expected to be presented by November 16th. The government plans to extend the debt swap to international investors in the near future. President de la Rua visited New York last weekend to attend the United Nations General Assembly, and took the opportunity to meet with the international financial community to explain the government's new economic measures. Concerning the provinces, a key issue is revenue sharing for the remainder of the year and for the coming years. As we had indicated previously, the federal government and the provinces had agreed in November 2000 to a fixed amount as the share of provincial revenue to be transferred. For 2001, that amount was to have been $1.3 billion per month. This amount was to increase in the subsequent years. Since the middle of 2001, however, the federal government, faced with reduced revenues, has MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE not been making such transfers in full and was in arrears to the provinces by about $835 million as of the end of October. Efforts are still underway to resolve the impasse. While governors from the ruling political party signed a fiscal agreement with the federal government last week, governors from the opposition party, which control the largest provinces, have yet to reach such an agreement, although some smaller provinces are planning to do so soon. Lack of political support for a revised fiscal agreement with the provinces could make the implementation of the debt rescheduling operation, both domestic and external, more difficult. On the one hand, if the provinces were to be able to obtain relief on their debts, this would more than compensate for the decline in revenue sharing. On the other hand, the agreement reached in November 2000 is still binding and has the status of law so that for it to be changed the provinces must agree. Market reaction to the above program has been cautious. Since the announcements of November 1st, country risk has risen, peaking at 2,585 basis points on MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE November 2nd. Expectations of a fiscal agreement last week contributed to some improvement in country risk. Lack of support from key governors, however, brought back country risk yesterday to 2,504 basis points. The inter-bank interest rate rose to 195 percent on November 2nd, but has moderated considerably since then, yesterday rates fell to 40 percent. Since the last briefing to the Board, deposits have declined by 4 percent and international reserves fell by 14 percent. Last week, however, the decline in deposits moderated considerably. On November 6th, the rating agency Standard and Poor's lowered Argentina's sovereign credit ratings to selective default. This was justified on their part on the grounds that the proposed swaps would imply a reduction in returns to debt holders. Fitch's rating agency also downgraded Argentina's debt to a single C. Moody's announced that it will not downgrade Argentina's debt as of now. Regarding implications for the Bank, at present there are obviously many uncertainties. The Fund has delayed its Article IV consultations and the fifth review of its standby program until there is more clarity. On MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE our side, when the time comes and the conditions become right, we would return to the Board to lay out any further steps that might be appropriate to consider at that time. The main areas where the government could seek our assistance are included on the agenda of structural issues laid out in the July CAS Progress Report and the recent Structural Reform Loan approved by the Board on August 28, 2001. Most notably, these reforms span: federal- provincial fiscal relations; modernization of the state with particular attention to the tax authority and the social security agencies; and key social policies including health insurance, pensions and social protection programs. All of these areas are being reinforced by the latest government measures. To this agenda, the government may also be interested in seeking our assistance on reforms to enhance Argentina's overall competitiveness and growth potential. Several areas of potential reform are currently being addressed through economic and sector work. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE We are also prepared to work more comprehensively on tax policy as recently requested by the government. In addition, we continue to advance with the provinces, specifically for improvements to education and for more broad-based reforms in selected provinces as laid out in the country strategy for Argentina. Besides the possible changes to the Bank's program, there are other implications for the Bank which we need to take into account. As creditors ourselves, we have an interest in how the debt negotiations unfold over the coming days, weeks or months. Thus, we are studying what implications there may be for us, and are in close contact with the relevant authorities and our colleagues in the International Monetary Fund and the Inter-American Development Bank. Again, as this evolves, we expect to keep the Board abreast of developments. Our colleague, Gary Perlin, may have more to add on this last point. Gary. MR. PERLIN: Thank you. As Paul has just described, in addition to maintaining a perspective on the country situation per se, the situation particularly regarding Argentina's debt clearly has broader market implications and it bears MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE watching from the standpoint of any financial impact on the Bank and indeed on the whole Bank Group and, as a result, my colleagues have asked me to address three points, which I will try to do very quickly so that I don't have to give you too many numbers. I am just asking Secretary's to pass out one sheet of paper that will permit you to listen without having to write down what all the numbers are. And I really would like just to make three points, the first of which is the unique structure of Argentina's public debt. The second will be any lessons that we might derive from some of the more recent experiences with debt restructuring that has taken place over the last couple of years in the form of bond exchanges such as that which has been proposed by the Argentines, and thirdly, just to give you a greater sense of the potential impact on the Bank. First off, and the first two items are the ones that are reflected in the sheet of paper that is coming around to you now. The structure and scope of Argentina's public debt is quite distinctive largely because of its size and because of its composition. And MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE I have just a few highlights on this piece of paper coming around. Perhaps the most important and unique identification of the structure of Argentina's public debt is the very high proportion that is in the form of public bond issues. Close to three-quarters, about $95 billion of their public debt is in the form of public bonds. About a quarter or the remaining amount of Argentine public debt is to multilaterals which means that there is a very small proportion, just a couple of percent at most, to Paris and London Club type creditors. So the structure is very different than what we would see with most of our borrowers and certainly those who have gone through various kinds of restructurings. The second distinctive aspect of Argentine debt is that there are blurred lines between what is internal and what is external for a variety of reasons. As you know, most of Argentina's debt is denominated in US dollars or in foreign currency and a significant portion of bonds are held both by domestic and external investors. Very often, in the same bond issue, there may be different proportions of holdings by domestic bondholders and by international bondholders. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE Third, there are a large number of individual bond issues that have been brought to market over the course of the last decade and, perhaps even more importantly, these bond issues have been brought under the jurisdiction of a wide variety of legal systems, which becomes very important in the case of any sort of reorganization of the debt. A substantial number have been brought under U.S. law where, for example, there is no collective action clause. There are a number of Euro bond issues under U.K. law, where there are some allowances for action, and so forth. The last item, I would just mention about the unique structure and characteristics of Argentine debt is that it has been known for quite a while that there was a potential for a difficulty in terms of Argentina being able to sustain this debt. And combining this with a very high proportion of the debt that is in tradable form means that many of the current holders of Argentine debt may well have purchased this debt with an eye towards being an active participant in any form of reorganization. So this is not a situation where the current holders of the debt are necessarily carrying it on their books at par who are the original holders, who MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE have very different incentives than perhaps holders of debt who may have come into holding it quite recently. The second point I wanted to make was just quickly the range of potential options that might exist in terms of restructuring debt through the process of bond exchanges. And we have highlighted for you on the bottom of the page that was handed out to you some of the recent experiences in debt restructuring through bond exchanges. It kind of gives us a sense of the continuum of the approaches that have been taken but I caution you not to assume that any one of these has been exactly like the other, nor would it necessarily be the same in any future activity related to Argentina or any other borrower. In particular, of course, you will notice that the size and the scope of the countries that have undergone these debt exchanges are substantially different than Argentina, and so the lessons we might draw, although it would bound the range of options, doesn't necessarily tell us what to expect. You will notice, for example, when I say that there are a variety of approaches that have been taken, in the case of Ecuador and Russia, there were very strong MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE incentives on the part of investors to participate because of events that had taken place in terms of servicing the debt, and it resulted in a substantial reduction in the principal of debt outstanding. In the cases of Ukraine and Pakistan, the swap did not involve a reduction in principal and, therefore, it looks a lot more like the swap that Argentina engaged in several months ago -- I think you have certainly been briefed on that by the country team -- where there was a swap that did not involve any principal reduction, simply an extension of maturities where the investors received higher coupons in return for accepting the longer maturities. So that is more akin to what we have seen in places like Ukraine and Pakistan. But again, what distinguished the bond exchanges we have seen over the last couple of years is that the size was certainly in comparison to Argentina much smaller. The body of investors was perhaps more easily identified and were not necessarily investors that had prepared themselves for this event. There was a much more substantial involvement of the London and Paris Clubs in those situations, which in a sense kind of MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE bounded the outcomes. So the bondholders realized there were other creditors that needed to be dealt with. So again, a lot of people are talking about and looking at quite rightly some of the experiences that you have seen in other countries. We wanted you to know that we are looking at those as well, but we understand that what was experienced elsewhere may or may not tell us what the outcome is likely to be in terms of Argentina's situation. Third and finally is to reiterate what Paul has said, which is that we certainly have every reason to expect that regardless of the developments with regard to the restructuring of their public debt, Argentina will continue to service its multilateral debt and any impact on the Bank's finances will be manageable. In this regard, I think it is important to remember a couple of things, the first of which is Argentina in its own history throughout various and sundry circumstances has always adhered to its commitments to meet its multilateral obligation and, as Paul has mentioned, they have announced their intentions again to continue doing so and have specifically excluded from any talk of MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE potential bond exchanges any tampering with their multilateral obligations. I might add from the standpoint of the Bank, given the kind of program that we have in place, there are strong positive incentives for them to do this. It is not just a matter of what they have announced, but there are incentives for them to continue to perform. Secondly, in the four experiences we have seen over the last couple of years, which are mentioned on the page in front of you, in each of those circumstances, the multilateral obligations were met in full. So whenever we have seen debt exchanges occur, the multilateral debt has been serviced. It certainly bears watching in this particular case because there is as a result of some of the items I have already mentioned the potential for protracted negotiations or other unforeseen developments, simply because of the uniqueness of the size and structure of Argentine debt that perhaps events could fall in the way of Argentina being able to fulfill its intention of meeting their debt obligations. And, as a result, we have felt it prudent simply to keep a very watchful eye on the developments that occur with regard to Argentina's MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE negotiation with its public creditors. And we do have a team that is watching this very closely. Obviously the region is closely involved. Our legal colleagues and Finance as well and we are, as Paul said, in close touch with all of the other multilateral creditors as well as many of our counterparts in the market. Finally, as far as the financial implications for the Bank of the current situation, as of now -- and we described this to you a couple of weeks ago when we looked at the current financial situation of the Bank -- we have a number of events occurring in our credit portfolio, some of them positive in the way of workouts and some of our non-accrual situations, the potential which we described for you of some deterioration in the credit in our portfolio, the combined effect of which we don't quite know at the current time, but we expect that it would not have a significant impact on the Bank's income. It could have a bigger impact on the assessment of our risk-bearing capacity because, as we reassess the risks in our accrual portfolio and we run through all those spread sheets that we have walked through with you, MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE we could see the potential for risk is growing but at this point in time, we do not expect any significant impact on the Bank's reported financial performance. Thank you. MR. ZHANG: Thank you very much. Are there any comments or questions? Yes, Mr. Stek. MR. STEK: Well, on the very last point, I thought Gary was very clear until that very last sentence. The potential for risk is growing. That means the risk of risk increasing is high. But that doesn't mean that risk itself has increased already? That is remarkable, because I would say the second derivative is not the way to discuss a thing like that. It is simply the case of first derivative of the portfolio. MR. PERLIN: Let me try and be clear on that final sentence then for Mr. Stek. I appreciate the question. First off, you will recall that we have taken some very difficult decisions in recent months in terms of looking at the risk in our portfolio. And when we do so, I remind you that we are looking at the risk of a non-accrual to the Bank. And so it is reasonable to MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE believe that, while one's assessment of the risks in Argentina, if one were a private creditor, would have changed dramatically, the extent to which that may have changed in terms of the assessment of risk of the Argentine debt and their ability to service their bank debt is likely to change less drastically. So that is the first thing to keep in mind. Secondly, you will recall that in terms of the reported financial event, the provisioning charge that we take against loans that are in accrual is a reflection of the expected loss that we see. And while that may well rise in one country or another, what I am trying to suggest is that the impact of changing assessments is unlikely to be large in terms of the reported loan loss provision as we know it now, because we have no country that since we have reported to you a couple of weeks ago has failed to meet its obligations to us. We see no increase in delays in servicing the Bank's obligations. So in terms of the impact on our reported financial results, we believe that there is not likely to be a large impact based on the facts as we know them now. What I really wanted to convey in the second half of that sentence without being contradictory is you MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE will recall when we went through the spread sheets a couple of weeks ago, that the impact of an unexpected loss may well be significantly larger now than it would have been before it was. So, therefore, I am suggesting that the impact on our risk-bearing capacity, because of the severity of an event were it to occur is not larger, could be significant. However, the impact on our loan loss provisioning charges, the expected loss is unlikely to be very significant. So I was trying to make that distinction. And if I didn't make it as clearly as that, I am appreciative of the chance to do so. MR. ZHANG: Yes, Mr. Stek. MR. STEK: So if this were the point in time where you were to present a proposal for increasing reserves as opposed to provisions, you might well come with a proposal to increase reserves if we looked at this country-by-country, which I think we in fact do without telling everybody what the reserves are per country. And my question which I would like to add on to this: What is the psychological contagion effect of what could happen to the status of Argentinean debt? How will MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE that work through in the Bank reserves if this were the point at which you were recalculating them? MR. ZHANG: Please. MR. PERLIN: Again, we have discussed many times the importance for the valuation of the Bank's balance sheet has to be related to our assumptions about the likelihood of repayment. And we do that based not on levels we observe in the market but rather levels based on our historical experience. And so, certainly, it is the case today that if this were the only change in our portfolio, we would certainly be in a position to say that we would be recommending a higher level of reserves today than we did several weeks ago, but keep in mind that this is only one borrower. There are other borrowers that are undergoing different events. The market is making a much greater distinction these days among different borrowers as we have always done. And so it is hard to presume what the outcome will be simply by looking at one borrower only. Now certainly, both because of the size of the exposure that the Bank has to Argentina and because people are always looking for the experience that helps them to decide what the value of our preferred creditor MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE status is, obviously if there were any untoward event, it could have a significant impact on how we view the value of our other loans. But at this point in time, we have no reason to believe that Argentina will not fulfill its intended and announced intentions to treat its multilateral obligations as preferred obligations that it will service in any event. MR. STEK: I am sorry to come back, but we are talking about unexpected losses at the moment. So I thought this answer does not reflect that question. Couldn't there be a sizable increase in unexpected losses across the spectrum of our more risky debtors? MR. PERLIN: Again, we would look at that country-by-country. If there is contagion which one might not see, right now Paul described the position of Argentine bonds in the market. As you know, they represent a very substantial portion of the emerging bond index. At one point, they represented as much as 25 percent of that index. Now because of their lower market value, they represent closer to about 15 percent. But if you extract Argentine debt from the emerging market bond index, you would find that the MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE impact on other emerging market borrowers has been substantially less significant. So, yes, the unexpected loss that we would calculate for purposes of generating a reserves recommendation specifically with regard to Argentina would now be higher than it was. Whether or not that would follow through into the other credits in the portfolio is not necessarily a conclusion we could re achieve. Again, if anything were to occur that would make us rethink our risk ratings with regard to borrowers and their ability and willingness to perform to the Bank, obviously that would have a very significant impact both on provisions and on our required reserves, both. MR. ZHANG: Thank you very much. Mr. Duquesne. MR. DUQUESNE: Thank you, Mr. Chairman. Three very brief questions. The first one would be to ask the staff what would happen on the 16th of November if there is no agreement on the revenue sharing between the central states and the provinces, if the bondholders are not very sympathetic to the swap proposal, and so on and so forth? So if that is not the MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE situation -- just to remind you that on the eve of Ottawa -- what happens? And my third question would be clearly directly to Gary Perlin. I understand that the bonds already guaranteed by the World Bank have been downgraded by Fitch. So is it true? And if it is true, can you comment on the situation of those bonds, on the markets and the impact it could have, this downgrading could have on the image of the Bank, if not on the rating of the Bank itself? And to conclude, let me just quote, if it is right, the IMF price review of this morning. Our President is supposed to have said that additional aid for Argentina would be futile if the government did not first reach agreement with creditors to restructure its MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE debt. So maybe some comments on that statement of Mr. Wolfensohn. MR. ZHANG: We will come back. Mr. Schaffer. MR. SCHAFFER: In the same direction, what we hear from our embassy does not sound very well. The external as well as the internal preconditions for recovery of the Argentine economy have worsened dramatically during the last weeks. In the elections we have now the opposition parties reaching the majority in both chambers of the parliament. The government is extremely weakened in this deadlock situation. For the government there is hardly any room left for initiating major changes, the kind of changes which would desperately be needing for initiating reforms. In our view, this is also documented in transitions of the governors of the provinces and their power struggle with Minister Cavajho [phonetic] over the monthly payment for the provinces. Although the country over months has not received fresh credit lines and investments have dried out, the governors of the provinces show no commitment whatsoever for radical reforms. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE The financial discussion in Argentina is dominated for several months by the so-called three D's - - default, dollarization and devaluation. It seems that the government was not successful in convincing the Argentine banks and pension funds to convert bonds with the interest rates of 20 to 25 percent into new loans with an interest rates of only 7 percent. So in this situation, I ask myself how does the Bank really assess the measures of the Argentinean Government and the proposed debt swaps? The government will not ask for additional money from the IFIs. The government says it will service the debt with the IFIs fully. But I ask myself is this realistic? Will the IMF and the World Bank be able to maintain the preferred creditor status when all other creditors will lose money? Gary Perlin seems once more to be very optimistic. But I would come back to the question of Pierre: What happens if the Argentinean Government stops servicing, for example, the debt for the Bank? Thank you. MR. ZHANG: Thank you very much. Mr. Hyden. MR. HYDEN: Thank you, Mr. Chairman. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE I also have three questions. Firstly, Gary outlined the commitment of the Argentine Government to maintaining payments to the multilateral institutions. But I wondered if he could comment of what is known of the views of private creditors. He referred to a number of holders of bonds having purchased them in the expectation of carrying through a workout or whatever. So it may be that we have a number of more aggressive holders of those bonds. What indications are there of their views about the Bank's preferred creditor status and that of the other multilaterals? Secondly, what are the legal vulnerabilities to the Bank in this situation? The President told us a little while ago that he was having an examination made of the various instruments. Given the range of courts and countries in which the legal systems, in which these issues may be adjudicated if it comes to that, what vulnerabilities are there? And thirdly, what is our exposure, and in particular that of the IFC? And what is the extent of B loans where the Bank's preferred creditor status may be extended to private sector lenders to whom other private MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE sector creditors may not see the justification for the extension of preferred creditor status? Thank you. MR. ZHANG: Thank you very much. Mr. Zhu. MR. ZHU: Thank you, Mr. Chairman. My question is really: What is the next action we should adopt? And that is also related to the relation between Argentina's situation and the forthcoming meeting in Ottawa. And indeed, Argentina's situation, particularly in the financial market, is very difficult. Now what is the real action to the international market and what is the real action that the international community should be adopting? That is my question here. If this Argentine situation becomes one of the important topics in the forthcoming Ottawa meeting, particularly G- 20 meeting, because G-20 Finance Ministers and the Central Bank Governors will take a very big responsibility for market stability. And if our Ministers adopt such kind of language such as recognizing the current debt service burden is not sustainable and Ministers urge private creditors to MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE work constructively with Argentine authorities and to continue to extend credit in accordance with normal commercial practice to the private sector there with the will to the earliest possible resolution of its problems. And also our Ministers look forward to the International Monetary Finance Committee and Development Committee meeting with a will to ensuring that appropriate public sector support is available for those most affected. And what is the World Bank's role to promote the constructive dialogue between the debtors and creditors? Thank you, Mr. Chairman. MR. ZHANG: Thank you very much. I suggest we take Mr. Abdul Aziz and then Gary can cover what if and, Ko-Yung, you can cover some of the legal implications and David can talk about, among others, what exactly the President said in London. Mr. Abdul Aziz. MR. ABDUL AZIZ: Thank you, Mr. Chairman. I have been hearing only on financing resolutions. Obviously, Argentina has no easy way out except for creditors to share in the responsibility of MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE releasing the debt burden. I want to go beyond the financing issues. What are the assessments now with regard to the policies that Argentina has been following that have brought them into this predicament? If we knock off the high borrowing era of the past government and come back to the structural aspect, is Argentina competitive or not? You can try to resolve these present debt propositions. It shouldn't be a problem, except that it will bring Argentina into a status of rating that is maybe seriating. But looking ahead, it has just got to come out of this debt mess and, if there is no writeoff, no forgiveness or no sharing of the haircut, Argentina will be burdened with unsustainable debt servicing which it can never service with its present growth rate. Are the policies on the macro side and federal/provincial relationship proper to its existing situation of coming out of the mess, the high spending at the provincial level which was also encouraged? I am not sure their policy of decentralization has anything to do with this also. It is always the provinces have too much leeway on financial freedom and autonomy, because in the MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE end the federal government will have to guarantee. Guarantee means coming from not just its future tax revenue but also its assets. I am not sure whether Argentina is in a solvency, bankruptcy situation. I doubt if it is because the GDP is definitely much, much higher than the stock of debt. But existing GDP, the existing export structure, the existing economic policies do not seem to give a way out of this situation that they are in. What I hear has been that creditors insist on Argentina paying up 25 percent interest. This is just an impossibility. During the Asian crisis I called some banks to renegotiate our loans. You cannot have high interest rates. We just cannot do this anymore. But we were in a position to repay all the loans. We have high reserves. Argentina has not that much -- I don't know all of the details -- but it is not in a position to dictate. But it is in a position of weakness. And if the creditors keep on insisting, then it will only cause problems for both sides, Argentina not being able to pay and creditors insisting on the legal rights of their claims. And the banks, the pension funds, the MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE repercussions will need to be assessed also. Will this create financial turmoil within the country? But then, you have to have financial restructuring domestically for which I think the World Bank can come in and assist. We have to look forward. The solution eventually has got to hinge also on competitiveness, and the measures that have been taken is to reduce costs, wages, and everybody is taking pay cuts. But this is not an easy solution. It takes time for people to digest this and accept these pay cuts. The other solution is to look at the external competitiveness. Is the currency board still valid? If there is no more monetary policy in the country, you want to cut down in inflation and you are into deflation, which is fine because it leads to cost reduction. Your unit costs are coming down; you are supposed to be competitive. But again, the productivity is not coming out to bring down unit costs as fast as you can lead it to earnings, the required dollars. The debt is all in dollars. And understandably, the creditors who lend will never want to swap it into pesos. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE But there must be an acceptance by the international financial community to accept the mistakes also. I think the International Monetary Fund, the Bank by staying out will eventually force the international creditors to accept some of this burden of adjusting the debt down. But I want to know more the policies forward. How will Argentina come up ten years down the line, if possible, in the next five years? Thank you. MR. ZHANG: Thank you very much. Gary. MR. PERLIN: Thank you, Mr. Chairman. Let me take a couple of the questions and then hand it over to General Counsel to deal with some of the others. If I might go back to Mr. Duquesne's comments and questions, the first of which has to do with the effect perhaps of the market of any failure to conclude the swap that has been offered largely to domestic investors, as noted by Paul, with the date of the 16th of November. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE In and of itself, right now the market is not expecting that swap offer to be taken up fully. It is only expecting that it will be taken up to a certain degree by largely domestic investors in Argentina. In fact, some market observers believe that the terms are, in fact, a little bit favorable to those who might take those up. So I think right now there is a view that the 16th in and of itself is not going to be a make or break date. In fact, there are others, I think, who would also say as a consensus view in the market that even if this were deemed to be a successful swap on a portion of the debt, it would not in and of itself solve the entire problem. So the failure to achieve a certain level of success in the swap on the 16th is probably not going to tell us much about the ultimate outcome and, therefore, the notion of this being a very high stakes moment in the deliberations, as opposed to all of the others -- not to suggest that this isn't a high stakes game overall -- but that particular moment may not, in fact, be particularly indicative of the ultimate outcome. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE Just as you saw the other day when there was an announcement of an agreement with the provincial governors that 24 hours later seemed to fall apart. Certainly, there was a change in tone, but not necessarily a significant change in the actual likelihood of the outcome. So I would keep that in mind. Secondly, I think it is important to keep in mind as well -- and it is what makes this situation different from others that we have seen -- there has not yet been an event of actual failure to meeting obligations. As Paul described, two of the rating agencies have assigned a rating of selective default, SD, to the bond obligations involved in this initial swap on the expectation that the bondholders will not be made whole as a result of this swap. That is a different event which would, in a sense, again from the rating agencies' standpoint be voluntary or involuntary, but it is not an event of default or an event of an inability or unwillingness to meet a given payment. So it is one of the reasons that this whole situation bears such close watching is that the road map isn't very clear. The dates aren't certain. And a lot MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE of what we are looking at is going to be changing expectations about the ultimate outcome which may not be telegraphed by short-term events. Now in this regard, and Mr. Duquesne's other question for me, which is the potential impact of the downgrading of the Argentine bond issue that has the World Bank's guarantee. When the announcement was made by Standard & Poor's the other day, in which they downgraded the bonds involved in the current swap offer to selective default, they affirmed the Double C and Single C ratings on a variety of other outstanding issues -- the Brady bonds, the Laytes [phonetic] and some of the other Argentine debt obligations. At the time they did that, S&P affirmed the rating of the World Bank guaranteed issues as follows. Now recall the Argentine bond issues that received the guarantee of the Bank, the rolling and reinstatable guarantee of the Bank, were actually done in a series of zero-coupon transactions. So each bond is an individual issue. It was done as a series. There are three series still outstanding. The latest one that was just paid actually matured on October 15th of this year. That was met and paid in full. That MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE means we now are looking at maturities of these three bonds in October of 2002, 2003 and 2004. The 2002 issue is continued to be graded Triple A. S&P affirmed the Triple A on the 2002 series because it has the benefit of having the guarantee that rolled from the previous issues which were paid. So the 2002 series is as good as the Bank's credit. So it has a Triple A. The 2003 and 2004 series have been downgraded to a Triple C, which is consistent with the way the rating agencies have treated these bonds that benefit from a rolling reinstatable guarantee, which is a two to three-notch upgrade versus the sovereign. So if you see a sovereign at a Single C, it makes sense that the issues that bear the rolling reinstatable guarantee of the Bank would be two or three notches above that at Triple C. Now if we felt that that was a view from the market as to the likelihood of the borrower's willingness and capacity to service its debt to the Bank and to make sure that if the guarantee doesn't roll, then at least it would be reinstated, obviously that would be a cause for concern. However, at this point, because these bonds have always been treated in lock step with the sovereign MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE -- which, as you know, in other discussions we have had it looks a bit of a concern to us -- in this case because the market is accustomed to seeing those bonds rated in tandem with sovereign, go down to the sovereign and add two or three notches. This is something that the market fully expected. It is simply treating those obligations in the same way that it has treated them all along, which is very close to the sovereign but taking into account the credit enhancement. At this point in time, we have seen no indication in the way that either these bonds are traded and the other Argentine bonds are traded or the World Bank's bonds are traded to suggest that there has been any implication of this. I think there is important learning to be done, which obviously we are trying to do and we are going to be coming back to you with, but at this point in time it is not a major of great focus for the market. Finally, the question of exposure, the current debt outstanding and disbursed is somewhere in the vicinity of $9-1/2 billion to the IBRD. It was just MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE under $9 billion at the end of the fiscal year. There has been substantial net disbursements since that time. Let's take the simplest answer to what is the worst case scenario. If it were ever to get to a point where Argentina were not servicing its debt to the Bank, after the period of time that is necessary until the borrower is declared in non-accrual status, which, as you know, is a process that actually culminates at 180 days after payments are missed -- there are other actions that take place before that -- if one got to that point, Argentina is an IBRD borrower. Our provision policy would say that we would have to provision 30 percent of the outstanding amount. That is something on the order of $2.8 billion. And just to kind of let you know, since we have run through the spread sheets many times, what does that do? That represents about two years' worth of earnings for the IBRD. But you know that we simulate shocks that are much greater than that. You will recall that we simulate shocks that are closer to $20 billion of loans going into non-accrual at a 40 percent provisioning rate, and we see the Bank surviving certainly, not necessarily in as strong a manner as it goes in. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE So the effect would be very significant and very negative. But the likelihood of getting to that point is something that one really needs to stand back and recognize that there are 180 days of time within which to try and resolve those situations. And then, we have to get into the whole set of dynamics that Mr. Hyden raises about what are the interests of all the participants around the table of debt reorganization with regard to the role of the multilaterals. And again, it will depend on the assumption about what the multilaterals will do in terms of putting new money in, since clearly the multilaterals are likely to be the first to put new money into Argentina when the times comes and when the situation is right. And so it is very hard to suggest that there is not a shared interest not only on the part of the borrower and of this institution but also by the market in general to recognize the role of the multilaterals. Will that be the position of every creditor? We cannot say. If it is possible that one creditor decides that it is not in their interest, can they get in the way of making things happen that the rest of the system wants to occur? That is exactly what our legal colleagues have MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE been looking into, and we believe there are a number of ways to make sure that those strong intentions can be followed through. As far as IFC, I don't know if my colleagues here from IFC want to speak specifically but do recall that the obligations to IFC and through IFC to B loan holders, as far as the preferred position, is preferred access to the availability of foreign exchange, which at this point in time is not the issue. The big risk here obviously is the commercial risk that will result from the economic results of restructuring that Mr. Abdul Aziz and others have spoken about. But we can always come back to IFC. MR. WOICKE: Just to answer Mr. Hyden's question. The IFC net exposure to Argentina right now is about $950 million. The gross exposure is, as you know, at the country limit of 1.2. This $950 million is net of all reserves. The B loan exposure is $914 million. As you might recall, we look at a certain trigger for lender of record, and that in Argentina is still relatively low. My records here show 1.4 percent. It is probably MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE slightly lower than that, because that doesn't take into consideration the reserves. The review trigger is at 3 percent. So we feel reasonably comfortable. And, as Gary said, the issue is not so much the reserves which a preferred creditor status refers to, but the restructuring. I personally would say from the IFC's point of view, we probably can deal reasonably comfortably with a devaluation. We can deal with a default but it is going to be difficult to deal with both if both come together. We have looked very carefully at our larger exposures. Some of the companies clearly will have to be restructured, but that is the IFC's situation. MR. ZHANG: Thank you very much. Ko-Yung. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE MR. ZHANG: David. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE MR. DE FERRANTI: On the question about what Jim was reported to have said, I believe he was signalling that no one, in particular the actors in a possible swap, should be assuming or acting upon expectations that the Bank would do anything beyond its mandate or anything it cannot do. Now I haven't spoken to Jim about this today, but based on the conversations that we have had, that is certainly a point which we all feel and Jim personally feels needs to be in the public domain; that it is not helpful if the actors are floating or assuming ideas about what the Bank would do beyond what is our capacity or mandate to do. On the important questions about the economic policies of the country going forward, as we all know and have discussed, the options are difficult for Argentina now, but it does seem to us that the policies and the measures that the government is undertaking, as Paul outlined them in his opening remarks, are steps that are definitely needed to improve competitiveness and to put them in a better position going forward. These include stimulating aggregate demand, while also maintaining fiscal discipline -- and they have ideas for those -- MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE reducing tax fraud and increasing tax collections and easing the social burden. These are steps that the government needs to be taking. And if they can get through this difficult period, it would help them to get to a better competitiveness position going forward. Finally, on questions about contagion, some figures that may be of interest for you to have, if you asked the question what has happened to spreads, the markets' perceptions of risk since September 10th across I have here countries in Latin America, for Argentina you do see a significant increase of 760 basis points in the emerging markets bond index plus. In the other countries, much, much less; in Brazil, just about 100 points. So Argentina 800 points, Brazil about 100, Ecuador 61, Mexico 50, Peru 15 and so on. So what the markets are perceiving as reflected from September 10th until very recently is a highly increased risk for Argentina but not so for the other countries. MR. ZHANG: Thank you very much. Mr. Dedeoglu. MR. DEDEOGLU: Thank you. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE I am sure the Argentine people would be relieved to know that the Bank would be safe and secure and financially viable even if the debt swap doesn't work fully, because conceivably the debt exchange is a very contentious problem. It is a huge collective problem. And, as my Chinese colleague has mentioned, I think the DC, the IMFC and other international fora similar should help in solving these collective action problems. It is to the benefit of all people. But apart from that, I think as a development institution we should get prepared for the worst case scenario and its implications and its impact on the people of Argentina. So I would like to know if and how the Bank would help, although we do not wish the worst case scenario happens in the coming year or in a short period of time, how would we step up our efforts to help Argentina and the people of Argentina? Thank you. MR. ZHANG: Thank you very much. Mr. Zhu. MR. ZHU: Thank you. Just in connection with the issue raised here, my question is we know that there is a difficult MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE situation that the Bank can provide help, number one is financial support directly, but there are some limitations and some room maybe we can create. But another important point is the comparative advantage of the World Bank is different from the IMF because the World Bank has a direct link with the capital markets. We can directly do something or indirectly do something to convince the market. But the Bank management has that strategy, particularly on this issue. But from the explanation, I didn't hear too much about that strategy. But my question is at this very difficult time, we really hope that the Bank management has a broad vision to help this country in difficulty. Thank you, Mr. Chairman. MR. ZHANG: We shall certainly try. Mr. Passacantando. MR. PASSACANTANDO: First, a question to Gary. You said it is very difficult to distinguish domestic from foreign held debt. So I was wondering how can they have a swap program just for domestic debt if it is so difficult to sever from the national debt? The second question is more general. I see that you are all confident that Argentina will service the MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE debt to us, because in the past it has always done so; there is a commitment. So we are confident. But the issue is not so much the commitment of the authorities, but whether they have the instruments to control the situation beyond certain limits. A country that has a currency board where reserves are endogenous, there is a point in which the ability to continue to serve our debt means abandon the currency board at a level of reserves that would be sufficient to -- so my question is, first of all, if we monitor what is the service capacity of our debt, I understand the reserves are still quite high, between $15 billion and $20 billion, something like that. But part of that is due to the fact that there has been IMF lending. They drew on our loan, on our facility. So I wonder whether we monitor that but, at the same time, I wonder whether we think that there will be a moment in which they themselves have not the ability to service their debt unless they are willing to abandon. Finally, given that in Ottawa, this conversation may arise, are you planning to be in Ottawa? Who is planning to be in Ottawa to discuss about financial problems? MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE MR. ZHANG: The President will be there. We have a whole team who will be there, as needed. Mr. Finn Jonck. MR. JONCK: Thank you, Mr. Chairman. As far as I understand, the Bank is still disbursing on existing loans. In the case that there will be a default on private debt from Argentina's side, Argentina will still be, so to speak, on track on lending terms. And I assume that the continuation of disbursements will then take place. But can you confirm it? But when it comes to new loans, I understand there has been put a hold on new loans to Argentina. But you also said in the introduction that you may come back to the Board some time in the future. It is difficult to predict under which conditions. But could you indicate what kind of scenario you think would be a likely opportunity for staff to come back to the Board? Of course, pacificity is also some kind of action. If we do not take any action, then we just wait then for existing loans to be disbursed and then that is it. But I think we have to defend our action under all circumstances. So if you can outline what kind of scenario could you MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE envisage which would lead you to come back to the Board and bring us into the picture again, so to speak. MR. ZHANG: Thank you very much. Mr. Bugrov. MR. BUGROV: Thank you very much, Shengman. Let me just ask at the beginning if the initial statement of the staff could be circulated, the statement about the developments in Argentina. I don't have any specific questions to make. I will probably say a couple of things by way of observation. But before doing that, I am really thankful to Ko-Yung Tung for his clarifications because I was about to ask a question about the negative pledge clause. I am still not convinced that a lawyer in New York would not raise an issue in court and would question the intention of the Bank. And it is extremely uncertain at the same time, it is very possible that people would challenge our privileged position. I want to raise another issue that was not discussed here. Of course, we are all interested in what is going to happen, how can we assist. But it is understandable because the country is in dire straits. Everyone is preparing for contingency measures; the MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE possibility of another bailout doesn't seem likely. I believe we shall probably follow the events as they develop and at some point in time management would come up with a proposal to the Board, although Finn is quite right that we don't know what kind of scenario may be envisaged here. What I wanted to mention -- and I believe it is an issue for even some further later discussions -- is that when several years ago we approved the Special SAL, the guarantee for Argentina, the Board was presented with a very comprehensive structural reform program to be implemented in the country. And that was very encouraging and, of course, the Board did approve that in good faith and in good expectations that there will be progress in the country. The recent $450 million SAL for Argentina actually revealed exactly the same agenda of structural reform as the one we were talking about several years ago. These were the same issues of fiscal responsibility, revenue sharing and so on. So to me that was as if almost nothing has happened in the country since we provided the Special SAL. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE Reasons for that could be found. It could be internal. There were internal difficulties, lots of external pressure. To me it was quite clear that implementation of those reforms in the country was pretty bad. And one may very scrupulously examined the commitment of the borrower and have the government try to do that but I want to know, and need even to know, whether there are some mistakes on our side, on the part of the management, on the part of the Bank, on the part of the Board, what is our contribution to the problem that we are having in Argentina these days. So I need to know whether our position on developments in Argentina was too relaxed or complacent or politically motivated, if you wish. If we look at this angle, to be honest with you, I believe we failed to help Argentina to advance structural reforms, then at some point in time let's look at it ourselves and try to find out what went wrong, what went wrong in our own processes, in the management of the country program, including our collaboration with the IMF. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE I find it to be extremely serious because ultimately, as we see it now -- and today's discussion proves that -- it all impacts on the Bank Group's status and the market and the risk-bearing capacity and market perception in general. We find it to be an extremely important issue in the context of Argentina and also in the overall context of our management of the World Bank Group. Thank you. MR. ZHANG: Thank you very much. Mr. Harada. MR. HARADA: I also thank for this briefing, even though I had to be a little bit late; I regret that. And many clarifications have been given by those answers to the questions. I have one question about contagion, just a factual question. You gave us information about the changes of spreads since September 10th. I am more interested in the changes since the announcement of this debt restructuring or perhaps since a little before that period, with what you can see from those changes of spreads since that time in Argentina, and other emerging market countries.. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE And also how do you compare those contagions to the ones you saw in the past in the case of the Russian crisis or Asian crisis or the Mexican crisis? Thank you very much. MR. ZHANG: Thank you very much. Anybody else? [No response.] If not, David, do you want to responded? MR. DE FERRANTI: Yes. Thank you. I will be happy to start and then maybe Gary would pick up some parts and, Myrna Alexander, if the connection is working, you could also respond to some of Mr. Bugrov's comments about the program thus far. If it is not working, Paul could cover that. I will first group together some of the questions that had to do with where are we now with the program and where are we going forward. There was a question about are we still disbursing on existing loans and would we continue to do so? And our plan is to follow our existing policies without any deviation from that, which means that if all of the requirements for the disbursements are met, we will disburse. That also includes the situation on the macro, and the compliance MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE with all of the requirements of the loans. And, at this point, we expect that those things will be met so that there will be no disruption expected. Then on the questions of new loans going forward, at this point, as we indicated, the government is not asking for new loans or additional money, and it is a clear moment of being on hold. And the government as well as ourselves feel that is appropriate until the situation clarifies. And when we said we would come back to the Board, it would be as soon as there is some clarity going forward. The question was also give some indication of what directions further steps might take when the situation clarifies. And there I think, although nothing is certain, one can be relatively confident that the direction would be quite consistent with the issues that lay ahead already in the CAS, as we already indicated. The program that we laid out does address and supports the government in addressing exactly the measures that Paul outlined in his opening statement, which, of course, we are happy to distribute as was requested -- tax policy, modernization of the state and easing social burden. Those would be priorities for MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE Argentina going ahead under most every scenario, and those are priorities that we have laid down as important in our strategy going forward and discussed with the government, and they have felt that that is consistent with what they would like our collaboration with them to be. I think at this point I would turn to Myrna, if you can come in, Myrna, to talk about the experience of our program in answer to Mr. Bugrov's question. MS. ALEXANDER: [Via videoconference.] Yes, can you hear me? MR. ZHANG: Very faintly. MR. DE FERRANTI: Can you speak right into the mike as loudly as possible? MS. ALEXANDER: [Via videoconference.] Okay, better? MR. DE FERRANTI: Better. MS. ALEXANDER: Let me just provide some reactions to the questions raised on what has happened to the Bank program over the last several years. I think it is fair to say that Argentina is a country in which the Bank has worked successfully in the past during the 1990s. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE What has happened in the briefest past is a series of external shocks that Argentina obviously got in control of, and then there have been some internal shocks, mainly on the governance side which has not helped Argentina's ability to cope with the external shocks. That said, the convertibility plan, the system does impose a number of constraints on how the government is able to manage these shocks. And so, therefore, I would attribute the situation today as a combination of external shocks beyond Argentina's control, internal shocks which have mainly to do with governance, and then the restrictions posed by the current regime [connection lost] -- into those shocks. Looking at external shocks back to 1995 with the tequila crisis, but only more recently, we had the Asia crisis, we had the devaluation and default in Russia in August of 1998, we had the devaluation of the Brazil Real in January of 1999, combined with low commodity prices and an increasingly -- [connection lost] -- international capital market, partly reflecting what happened in Asia and in Russia. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE That took us through the period of where we had the Special SAL. We have to remind ourselves that in November of 1998 we anticipated that Argentina would be able to respond and manage this difficult period of 1998 and 1999. The internal shocks certainly had to do with the elections and the change in the Executive Branch at the federal level. It went from a position of strength under the Menem administration where the -- [connection lost] - - had majority in the senate and in the house and in a majority of the provinces to a situation under President de la Rua where he was in charge of a coalition government that did not have control of the senate, had a slim majority -- [connection lost] -- and in provinces mainly in the hands of the -- [connection lost]. This puts the Executive Branch in a very weak position, and much of that continues on today, as some of the speakers have announced. Obviously, the Bank is a party to the program in Argentina and we are active supporters of the country. I don't believe that we have been complacent. I believe we have been working with the government to try and overcome these problems. And some of these take more MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE time; some of them need better, more deeper ownership on the side of the country. Certainly, some of the things perhaps didn't work -- [connection lost]. This is the situation with Argentina. I think the willingness on their side and on our side continues to work together to try to overcome the problems they are facing is the important challenge that we have right now. MR. DE FERRANTI: Thank you, Myrna. On Mr. Harada's questions, I will start and then pass it to Gary, and there were also some other questions for Gary. A question was about the spread since the announcement of the government's plans. And basically, spreads have bounced around. There was an initial fall of spreads when expectations were higher regarding the quick resolution of the discussions between the provinces and the federal and then, as that dragged out, it went back up again. But I think your critical point about comparisons still remains valid, that the markets are reading a very significant difference. And we are not seeking evidence of contagion, at least thus far, in what the spreads can tell us about market perceptions. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE Now you also asked beyond Latin America, on that one, I need to turn to Gary. MR. PERLIN: Thank you, Dave. I think it is not so much a matter of going well beyond Latin America, but I think it is also recognizing two other differences between the current situation and the experiences that we had throughout the course of the late 1990s, especially with regard to the question of contagion quite generally. The first is the point I made early on, and I think is an important one to remember in this situation, which is that this is a slow moving process that has been obvious for quite a long time and the contagion has always been worse when events have occurred as a surprise, and markets, as you know, are quick to make judgments and to cut losses and to minimize their risks. And if something occurs out of the blue that changes the basic perception and on which the valuation of market assets has been based, we are likely to see a major effect throughout those markets. And certainly given the way the emerging markets had developed in the course of the 1990s, a lot of optimism, a lot of portfolios looking at emerging markets MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE as an asset class, not making much distinction between one and the other, certainly that which comes as a surprise is going to have a very significant effect. There is very little about Argentina right now that would constitute a surprise. And I think that is important for us to keep in mind. The second point I would make is that we are in a different environment now because of what occurred in the course of what is known as the Asia crisis and many of the situations around that, which is that the holders of emerging market debt -- and you have been told by many of us, Peter perhaps most especially -- about the markets' general attitude towards emerging markets has in fact been radically changed over the course of the last several years. So that, in effect, it is only those who are quite knowledgeable about it and who feel more adept at being able to come in and out that are willing to take a chance in some of these markets. And so the players in the market are more accustomed to this. They have made more of an effort to distinguish among the various credits. And so when these events occur, it is not surprising that we see the kind MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE of lack of contagion that was reflected in the statistics that Dave has shared. Obviously, this is not a source of unmitigated joy. I mean, it also suggests what we have been seeing over the last couple of years, which is a significantly lower level of capital flows to emerging markets. But it is the same situation that led to the decline in capital flows which is also going to affect the behavior of the markets within Latin America, and I think that says an awful lot when you see that distinction within one region. The other general point which I would like to get back to is Mr. Zhu's about the need for action on the part of the international financial system to deal with this. And certainly, I think the Bank and I certainly don't have a monopoly of good ideas on how to get there. But I think in terms of the role of the Bank, it is true that our experience is very high in dealing in the capital markets, but not necessarily in the kinds of situations we are dealing with right now. So I can assure you that we are making every possible use of our knowledge of markets and our close relationships with market participants. I think we are seeing just about MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE every piece of advice that any investor anywhere is receiving on the situation but it doesn't necessarily put us in a better situation for predicting the outcome. It simply means we are in that information flow. But think back to where I began, which was the unprecedented nature of this situation in terms of the proportion of public debt that is held in bond form, and you realize that it would be hard to have a comparative advantage in being able to predict the outcome. And here, we have all been -- and certainly the President has been -- very clear that if there is a lead spokesman in the international financial institution arena on the issues surrounding debt sustainability, particularly in this particular case, it would be the Fund. And our role in this case is simply to make sure that we are feeding as much information to them, sharing information with them as we do and making sure that as a significant creditor, since each of us is a significant creditor, that our interests are taken care of. We are sharing information as well with the IDB again because our interests are so well aligned. And on that, I would really conclude by suggesting that we are taking this extremely seriously. Certainly, I have never MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE been at a table for a country update before, to my recollection, and I don't think that I would be having the level of daily conversation with my colleagues in the region and the legal side and the daily conversations we are having with the President if we weren't taking this as seriously as we are. That does not change our basic opinion, which is that it would be in the interest of borrower, in the interest of the international system and probably in the enlightened interest of most creditors that the role of the multilateral institutions is honored. Not everyone is going to feel that way, but it is in the interest of most to have a source of new funding under the right circumstances. And what we are simply trying to do is make sure that that which is the intention of all the parties can actually take place and does not get thrown off-course because of either the protracted nature of this event or because of the behavior of any one party or another that might be involved. So I simply want to indicate that our judgment is informed but not clouded by the information that we are receiving in the note and the understanding of how MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE significant this situation is for the Bank. We are taking it that seriously, but we will also try and provide you with our best judgment as we go along. MR. ZHANG: Thank you very much. Yes, Mr. Stek. MR. STEK: A very short question. There has been an episode in the past when the Fund did not appear to be fully aware of the interests of IFC. Can we count on it that this time the Fund is fully aware? Okay. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE MR. ZHANG: Thank you very much. Shall we call it a day on this item for today? [No response.] We will keep you posted since the situation, as you know, is evolving. So we will come back, particularly when there are new developments. MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666 STRICTLY CONFIDENTIAL DO NOT REPRODUCE Thank you very much. We will move immediately into the next item. Thank you. Thank you, Myrna. [Whereupon, at 12:19 p.m., the meeting was adjourned.] MILLER REPORTING COMPANY, INC. 735 8th Street, S.E. Washington, D.C. 20003-2802 (202) 546-6666