Argentina - Provincial Reform Loan to Support the Province of Santa Fe Project

Document of THE WORLD BANK FOR OFFICIAL USE ONLY ReportNo. P7462 REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ONA PROPOSED PROVINCIAL REFORM LOAN IN THE AMOUNT OF US$330 MILLION TO THE ARGENTINE REPUBLIC TO SUPPORT THE PROVINCE OF SANTA FE June 21, 2001 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Currency Equivalents Currency Unit: Peso US$1 = ARG$1 Fiscal Year January 1 to December 31 ABBREVIATIONS AND ACRONYMS CAS Country Assistance Strategy EPESF Empresa Provincial de Electricidad (Provincial Electricity Company) IAPOS Instituto Aut6nomo de Obra Social (Provincial Workers Health Insurance Fund) ICR Implementation Completion Report IFD Instituto de Fomento Docente (Teacher Training Institute) IDB Inter-American Development Bank IMF International Monetary Fund LPR Letter of Provincial Reform NBI Necesidades Bdsicas Insatisfechas (Unsatisfied Basic Needs) OECD Organization for Economic Cooperation and Development ONE Operativas Nacionales de Evaluacion de Calidad (National Student Tests) PPASS Programa Provincial de Ayuda Solidaria Santa Fe (Provincial Social Assistance Program) PDP Provincial Development Project PERMER Renewable Energy Project PRESSAL Provincial Health Sector Reform Project PROSAP Provincial Agricultural Development Project PRL Provincial Reform Loan PRODYMES Secondary Education Decentralization Project PROMIN National Program for Maternal and Child Nutrition and Health SARH Sistema de Administracion de Recursos Humanos (Human Resource Management System) SEPC Secretaria de Estado de Promoci6n Comunitaria (Secretary for Community Development) SIGAPE Sistema de Gesti6n y Adminstraci6n Escolar (School Management and Administration System) SINTyS Sistema de Identificacion Nacional Tributario y Social (National Taxpayer and Social Assistance Registry) SMAyDS Secretaria de Medio Ambiente y Desarrollo Sostenible (Provincial Secretary for the Environment) Vice President: Mr. David de Ferranti Country Director: Ms. Myrna Alexander SMU Director: Mr. Ernesto May Task Manager: Mr. Mark Hagerstrom  FOR OFFICLIL USE ONLY ARGENTINE REPUBLIC SANTA FE PROVINCIAL REFORM ADJUSTMENT LOAN TABLE OF CONTENTS Page Number I. THE SETTING Economic and Social Performance 1 Responding to the Challenge 5 The Provincial Context 10 Individual Provincial Reform Programs 18 II. THE REFORMING PROVINCE OF SANTA FE The Challenge 23 The Reform Program of Santa Fe 23 Strengthening Public Finance 25 Modemizing Public Administration 30 Social Protection 32 Health Reform 34 Education Reform 36 Private Sector Development 39 III. THE PROPOSED LOAN Loan Objective and Rationale 41 Lessons Learned from Previous Operations 43 Institutional Capacity and Technical Assistance 44 Coordination with Multilateral Institutions 45 Loan Description 46 Environmental Concerns 47 Gender Analysis 48 Social Consultation 49 Social Impact Analysis 50 Benefits and Risks 51 IV. RECOMMENDATIONS 53 This Report is based on the findings of a team composed of Mark Hagerstrom (team leader), David Rosenblatt, Gillette Hall, Juan Pablo Uribe, Suhas Parandekar, Maria Elena Castro, Sandra Cesilini, Truman Packard, Hermann A. Von Gersdorff, Ariel Fiszbein, Susana Sanchez, Andres Mac Gaul, Susana Cirigliano, Rail Benitez, Philippe Durand, Gerard Liautaud, Mariela Alvarez, Regina Madigan (Consultant) Olympia Icochea (Consultant), Luis Perez (Consultant), Federico Mejer (Consultant), Ercilia Nofal (Consultant Team Leader). This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization.  ANNEXES A. Letter of Provincial Reform (IBC) B. Policy Matrix C. Documents in the Project File D. Statements of Loans and Credits E. Country at a Glance F. Private Sector Development G. Social Impact Assessment and Social Development Strategy H. Institutional Capacity I. Electricity Distibution J. Social Consultation K. The Provinces L. Environmental Aspects Map - IBRD 29348 4  ARGENTINE REPUBLIC SANTA FE PROVINCIAL REFORM ADJUSTMENT LOAN LOAN SUMMARY Borrower: The Argentine Republic Implementing Agencies: The Undersecretary for Provincial Relations of the National Ministry of Economy and the Province of Santa Fe, including the Provincial Coordinating Unit and Provincial ministries and agencies. Beneficiary: Provincial Government of Santa Fe Poverty: Santa Fe's per capita income, at $6,400, is about 85 percent of the national average and reflects high levels of unemployment compounded by gaps in the delivery of health, education, and social protection services. The reform program is designed to support poverty alleviation and equity improvements over the long term and to strengthen the social safety net during the current economic downturn. Specific actions for the short term to strengthen the social safety net include: protecting from budget cuts a new income support program for over 16,000 poor families, most with female heads of households, while promoting efforts to enhance its effectiveness; ensuring that poor pregnant women receive pre-natal care; and improving primary care for children of poor families. Poverty alleviation and equity improvements over the medium to long term would include actions to support human resource development, including providing basic health coverage to non-insured poor and supporting public spending towards schools in poorer neighborhoods, and measures to enhance sustainable economic growth and competitiveness, including a fiscal program consistent with national efforts to strengthen public finances and reduce country risk, public investment to alleviate infrastructure bottlenecks, power tariff reductions for small and medium-sized firms, and lower labor costs by eliminating local payroll taxes. Amount: US$330 million Terms: A single currency loan in US dollars, repaid in 15 years, including five years of grace at the Bank's standard variable interest rate. 5  Commitment Fee: 0.75 percent on undisbursed loan balances, beginning 60 days after signing, less any waiver. Onlending Terms: Identical to those contracted by the Argentine Republic with the Bank Schedule of Disbursements: (in US$ Million) Disbursement Cumulative First Tranche I quarter FY2002 153.3 153.3 Second Tranche 4th quarter FY2002 50.0 203.3 Third Tranche 3ra quarter FY2003 126.7 330.0 Economic Rate of Return: Not applicable Loan Identification No.: P069913 6  REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED PROVINCIAL REFORM ADJUSTMENT LOAN IN THE AMOUNT OF US$330 MILLION TO THE ARGENTINE REPUBLIC TO SUPPORT THE PROVINCE OF SANTA FE 1. I submit for your approval the following memorandum and recommendation on the proposed loan to the Argentine Republic for US$330 million to support fiscal and structural reform of the Province of Santa Fe. The loan would be a variable rate LIBOR- based dollar loan, with a grace period of 5 years, a final maturity of 15 years and level repayment of principal. The Argentine Republic would onlend the local currency equivalent of the loan to the Province on the same terms (an arrangement made possible by the 1:1 peso to US dollar exchange rate fixed by Argentine law). I. THE SETTING Economic and Social Performance Background 2. Since the launch of the Convertibility Plan in 1991, the economy has been transformed through a sweeping set of structural reforms that altered the monetary system (establishing a currency board arrangement with the Argentine peso pegged one-to-one to the US dollar), liberalized trade, and redefined the role of the state. The latter was achieved through privatization, decentralization to the provinces, and reform of the social security system. All of this was intended to reverse the long-term trends of slow growth, low labor productivity, state domination, low domestic savings, weak investment, high economic volatility, and chronic inflation which culminated in 1989 with hyperinflation and the incidence of poverty reaching over 40 percent. 3. The economic results of the Government's program during the 1990s were dramatic. Argentina had average economic growth of 4.8 percent over 1991-1999, despite the Tequila crisis in 1995 and the external shocks and ensuing recession since 1998. In contrast to previous bouts of hyperinflation, during the past decade Argentina has one of the world's lowest rates of inflation, with price deflation in the past two years. The Federal Government's fiscal deficit receded from an average of about 6 to 8 percent of GDP for most of the 1980s to 1.4 percent in 1998 and 2.6 percent in 1999. Total foreign debt--about $147 billion-- is moderate as a share of GDP (equivalent to 52 percent) but large when compared to the country's export base. As a result, external debt represents more than four times the annual base of exports of goods and services, and debt service has represented 60 to 90 percent of total exports in recent years. 4. Argentina's external indebtedness and its dependence on external capital to finance both the public sector's deficits and private investments reflect the currency regime, under which both the dollar and the peso has equal legal status, and the relatively underdeveloped state of the capital markets, creating little capacity for domestic financing. This leaves the economy vulnerable to external shocks and perceptions of the I  international capital markets. This happened during 1994-95 with the Tequila crisis, and again with the Asia crisis of 1997, the Russia crisis of 1998 followed by the Brazil devaluation in 1999. All of these shocks have had negative impacts on the economy's ability to create employment and reduce poverty, particularly as much of the adjustment depends on productivity improvements. Poverty has risen after falling in the early 1990s and unemployment has remained stubbornly high. Moreover, the pace and intensity of economic reforms waned in the latter part of the 1990s, and the end of the decade saw a noticeable deterioration of the fiscal accounts. Recent Economic Performance 5. Economic performance in 1999, with a decline of 3.4 percent of GDP, was the worst since the hyper-inflationary period of 1989. In the first half of 2000, GDP did grow, although only by 0.3 percent (year-on-year) with industrial production by 2 percent (year-on-year). The strongest signals came from exports which grew by almost 14 percent, year-on-year, in the first six months of 2000. These incipient signs of growth were short-lived and economic recovery remained painfully slow through the rest of 2000, as the economy adjusted to the impact of the 1999 Brazil devaluation. At the same time, consumers and investors were wary. A round of tax increases in early 2000 dampened consumer demand, as did salary cuts for senior public employees in May 2000. On the other hand, efforts to stimulate investment via public infrastructure investments did not come to fruition. Investment in 2000 dropped to 16 percent of GDP. 6. The year 2000 ended with a decline of 0.5 percent of GDP even though exports in aggregate, at 13 percent, and manufactures in particular at 18 percent, continued to surge. The current account balance improved significantly from 4.4 percent of GDP in 1999 to 3.3 percent in 2000, with strong export and slack import demand offsetting the rise in foreign interest payments. Unemployment registered 14.7 percent in October 2000 and poverty levels may have worsened. The aggregate provincial deficit was 1.2 percent of GDP (down from 1.6% in 1999) which together with the Federal deficit of 2.4 percent of GDP (roughly the same in 1999), represented a modest improvement over 1999 in spite of the ongoing economic slowdown. 7. The difficulties associated with the lack of growth and inability to reduce the fiscal deficit were exacerbated by a political crisis in October 2000 that resulted in a major Cabinet shake-up and the resignation of the Vice President. This provoked a crisis of confidence that led to a sharp rise in country risk. Over the October-November 2000 period, external debt markets were closed for Argentine public borrowing, and domestic interest rates rose sharply, although not comparable to the worst of the Tequila crisis. The markets were calmed by the swift action by the Government to mobilize international financing, called the blindaje, under the IMF's leadership (see para. 28). With these new reforms and the support package, financial variables improved substantially at the start of 2001. Spreads and interest rates fell by about 3 percentage points from the peaks over of 10 percentage points reached in October. The Government returned to the international bond market with a $4.2 billion debt swap to smooth out the amortization schedule over the 2001-2004 period. New placements have been launched successfully in early 2001. 2  8. But these developments too were short lived and the initial positive reactions by the international capital markets to the blindaje could not be sustained when early results for January and February 2001 showed that fiscal deficit was larger than the indicative targets agreed with the Fund and the level of internal policy debate continued to cast doubt about the direction of economic policy. Specific measures such as the reform of the public pension system have been resisted in congress and remain with out passage, even though they would greatly enhance equity and save some $600 million per year over the medium term. The administration's effort to increase competition in the quasi-public health insurance system have been resisted by the unions and the executive orders to put the new system in place have been challenged in the courts. Thus, many of the previously announced measures, well received initially, were put on hold. 9. In March 2001, the economy was hit by the resignations of two Ministers of Economy in succession. After the first Minister's resignation, the new economic team proposed a program to cut $2 billion from the federal budget to meet the fiscal targets agreed with the Fund. To increase credibility, the program focussed the expenditure side. While the program was well grounded with economic justification for reducing inefficiencies in federal spending, it failed to received adequate political backing (including a massive resignation of other cabinet members) largely due to targeting of cuts in inefficient education spending for salary bonuses paid to teachers at the provincial level and for subsidies to the national public universities. The new minister was replaced only after fifteen days with yet another team headed by Minister Cavallo. 10. These events occurred as the Federal Government had hoped to access the markets to fill its financing plan for the second quarter of 2001, in part to meet planned financing needs not covered by the blindaje and in part to compensate for the higher than anticipated deficit in the first quarter. With the markets effectively closed during March and April 2001-with country risk spreads remaining over 1000 basis points-the Government had little recourse but to tap the domestic market with a $3.5 billion placement. Included in this placement was the issue of a one-year bond for $2 billion that banks can compute towards their liquidity requirements, in addition to effectively lowering these requirements from 20 to 18 percent of deposits. This financing along with the balance of the international package should be sufficient to avoid recourse to the international bond market for the remainder of 2001. Country risk slowly receded to under 1,000 basis points. 11. Throughout most of 2000, confidence in the banking system remained strong, as the monetary authorities had implemented prudent banking policies, strengthening the system since the Tequila crisis. Overall, the banking system continues to be highly dollarized with dollar accounts at 63 percent of total deposits far outweighing peso accounts and the majority of domestic credit is nominated in dollars. The system has maintained its deposit base in both pesos and dollars, exhibiting growth of 7 percent growth in the first half of 2000. However, deposits declined by about 5 percent in the face of the political uncertainty in October and November 2000, but then recovered only to decline once again, by about 6 percent or $5.5 billion, as the economy moved closer to 3  a crisis in March 2001 and its lingering uncertainties in April and May.1 The decline was much sharper for peso deposits as compared to dollar deposits. International reserves have fallen, by about $7 billion between end 2000 and May 2001, but remain strong, totaling $25.4 billion, and fully back the money supply, a requirement to maintain convertibility and the integrity of the currency board system. 12. The recession and the emerging fiscal crisis have had an impact on interest rates and on credit demand. During the early part of 2000, interest rates were relatively stable, albeit high in real terms, and the peso-dollar spread low. However, as the markets began to increase country risks, inter-bank rates spiked in October 2000 and again in March 2001, this time reaching over 80 percent for overnight money. With low investment and consumer confidence, there has been no growth in credit to the private sector and the banks remain highly liquid reflecting a lack of demand for credit at the prevailing high interest rates. Credit to the private sector has been stagnate during 2000, at about $62 billion, or roughly 22 percent of GDP, with prime rates jumping from 8 percent to 24 percent during March 2001. The lack of credit at reasonable rates is a very strong limitation on new investment and a burden on firms attempting to adjust to the change in markets as a result of the devaluation of the Brazilian real. The Government's switch from external to domestic sources of financing further complicates this panorama. In addition, the continuing stagnation of the economy led to an inevitable deterioration in the quality of bank portfolios, albeit this deterioration remains modest, and private banks are generally heavily provisioned for any loses. Social Concerns 13. While many social indicators have improved in the past ten years--for example, infant mortality has dropped from 25 deaths per 1,000 births in 1991 to about 18 deaths in 2000--poverty levels have stubbornly stayed high after having fallen in the immediate recovery period of the early 1990s. The Bank's estimates for 1998 put poverty at about 29 percent of the urban population, down from the peak of 41 percent in 1990, but up 2 from the pre-Tequila crisis level of 22 percent in 1994. Poverty is likely much higher in the rural areas and not likely to have improved in the past two years. This situation is compounded by rising income inequality, underemployment and unemployment, especially for the unskilled, indicating that the benefits of growth have not been widely shared. Income for the unskilled has been stagnate for the past 10 years as productivity increases benefited workers with higher human capital, and much of the burden of reacting to external shocks has come through reductions in unit labor costs. Moreover, as a coping strategy, many firms and employees are opting out of the formal social security system, with about 45 percent of the labor force currently not contributing to pension or health insurance programs adding to social vulnerability. 14. The macro-economic uncertainties experienced during the past year, aggravated by the lack of confidence by the international capital markets since the latter half of 2000, 1 In contrast, during the Tequila crisis, 18 percent of deposits were withdrawn from the system and a significant number of banks were forced to close, restructure and/or merge. 2 See the Bank's most recent Poverty Assessment for Argentina, Report No. 19992-AR; March 23, 2000. 4  have only add to the country's mounting social concerns. The poor have suffered the most during the current economic downturn and the greatest gain in terms of poverty reduction will likely be attained by rapidly restoring sustainable, investment-led growth. As shown in the FYOO Poverty Assessment, Argentina needs sustained growth, combined with no further deterioration in income inequality, to reduce poverty levels materially over the next ten years: for example, per capita income growth of 1.8 percent per year for the next ten years (or annual growth of about 3.3 percent of GDP) could reduce poverty to the 21-24 percent levels. Similarly, reviving employment creation and reducing unemployment helps: full employment could reduce poverty by some 6-8 percentage points. 15. While these analyses show that a significant drop in poverty is attainable with sustained growth and employment creation over the long term, reduction of poverty in Argentina is also very dependent on improving human capital and improving educational levels may be the single most powerful way to reduce poverty levels. This is because incomes for the unskilled have stagnated during the 1990s, while those with superior levels of education continue to do relatively better, even in tougher economic times, as reflected in overall increases in income inequality and increases in the wages paid to those with more education. Thus, human capital formation has to remain at the center of social policies. With social services are shared between the federal and provincial administrations, the provinces are key players in the delivery of primary and secondary education, public hospitals and clinics, housing, and a variety of social protection programs and social expenditures. These services comprise about 53 percent of total provincial spending. Responding to the Challenge The Reform Agenda 16. Since it took over in December 1999, the Administration of President de La Rua has struggled to restore growth and reduce poverty. The challenge rests on overcoming three main drags in the economy: (i) the latest competitiveness shocks caused by the January 1999 devaluation of Brazil, and the appreciation of the US dollar; (ii) fiscal vulnerability given fiscal slippage in 1999 and high roll-over of debt which has been mostly financed externally because of low domestic savings and low levels of intermediation; and (iii) shaken consumer and investor confidence because of the prolonged recession and political uncertainties. 17. At the outset, the new Administration put forward a determined program of economic and social reforms designed to restore growth and promote greater social equity while being fiscally responsible and retaining the Convertibility Plan. As agreed with the IMF, the 2000 budget attempted to reduce modestly the deficit and included a round of tax decreases to stimulate investment compensated by increases of taxes on income and consumption, and a new fiscal agreement with the provinces. This was followed by adoption of new labor laws to decentralize management-union labor negotiations and to eliminate outdated labor contracts. Agreements were reached with the poorest and most highly indebted provinces to restructure their debt in turn for greater fiscal discipline. In keeping with their electoral campaign, the Government began to 5  renegotiate private concession agreements, particularly road, rail, and water concessions, to reduce costs and/or increase service levels. 18. In late 2000, in response to the deteriorating economic and political situation described earlier, the Government initiated a new set of economic reforms with measures to strengthen its fiscal position, including that of provincial governments; promote financial access, particularly for small and medium size firms (responsible for 70 percent of employment), deepen public sector reform to enhance governance, accelerate reform of health care financing, alter the pension system making it more equitable, and strengthen the social safety net. Importantly, the Federal Government secured the agreement of the provinces to advance on reforms at that level, including steps on revising the existing system of federal-provincial revenue sharing, co-participacion. This new Federal-Provincial Agreement included a number of commitments on improved fiscal management by the provinces, in line with federal policies and programs, and a freeze primary expenditures in those provinces with fiscal deficits until 2005. In addition, the Government negotiated an international package, the blindaje, totaling approximately $39.7 billion, aimed at easing the financial stress while the measures to restore growth took hold. This joint effort was designed to provide Argentina with support to address external financing needs for 2001 and to restore market confidence. Renewing the Effort 19. Taking over the economic portfolio in mid-March, 2001, Minister Cavallo, the architect of the Convertibility Plan, launched a series of measures based on two fundamental pillars: (i) reinforcement of the internal consensus within the governing coalition and expansion of the political basis for reform; and (ii) design and implementation of a strategy to address simultaneously the fiscal deficit, the sustainability of public sector financing and the economic growth. The new Minister secured in short order legislative endorsement of the new Law of Competitiveness and the Law on Delegation of Powers. The latter provided the executive branch with powers to modify the Law of Defense of Competition, improve regulation of the capital markets, eliminate exemptions to income and profit taxes, generalize the VAT, and eliminate the minimum presumed income tax on businesses, the tax on interest and employer labor charges for those activities covered by the new competitiveness plans. In practice, these competitiveness plans are intended to rationalize and reduce gradually the tax burden with the goal of eventually converging the tax system to a core of the VAT and income tax, thus eliminating differential tax treatment among sectors and provinces within a two year period. Accompanying these measures was an increase in import tariffs to 35 percent on goods outside the MERCOSUR area, a reduction of duty on capital goods to zero, and a halving of VAT rates for selected sectors. Increased tariff dispersion is expected to be reversed within a two year period. 20. Under the Law of Competitiveness, the new Tax on Financial Transactions provides a rapid injection of revenue and sets the stage for Argentina to meet its fiscal target which allows for a deficit of $6.5 billion in 2001. The new tax is expected to generate revenues of about $2.7 billion for the remainder of 2001. As all transactions over $1,000 now must be processed through the banking system, this tax and the banking system have become important pieces for a medium term program to control tax evasion. 6  Along with increasing revenues via the new tax and elimination of exemptions on VAT, the new team also has enacted expenditure cuts in the order of $860 million. Together, these measures are expected to contribute in meeting the year end fiscal targets. 21. The Government has also indicated its intention to continue with the Convertibility Plan but has also announced that it would alter the currency mix to include the EURO in equal amount to the US dollar. Legislation authorizing this shift to take place when the US dollar and the EURO reach parity is presently being considered by Congress. The rationale for this is to reduce the fluctuations in the real value of the peso and its vulnerability to international monetary shocks and to reflect better the destination of Argentina's exports-currently about 17 percent to the European community and 15 percent for NAFTA countries. The new system would retain the core features of the Convertibility Plan, namely, full backing of the monetary base with reserves and strict limits on monetary policy. 22. In June, the Government successfully concluded a debt exchange with the private sector that delayed debt service on approximately $30 billion worth of public debt. With this innovation, the debt service burden will be reduced over the next five years by $16 billion, with much of the reduced financing needs accruing over the next 18 months. The financial relief allows the Government to regain its focus on economic reforms. In mid- June, new measures were announced, to complete the "Competitiveness Plan." These measures include: tax relief to middle-income families, as a stimulus to consumption; a new export subsidy (import tax) to improve competitiveness; and measures to improve tax collection. 23. The intent of these policies is to enhance competitiveness. The Government has clearly targeted the elimination of distortionary taxes and the excessive tax burden on those who pay taxes, thus, working towards a more efficient and equitable tax system. In addition, past studies also indicate that there remains considerable potential, particularly in the area of transport and logistics to reduce production costs. A recent measure has to be reduce and even out toll charges for road traffic. There is also much to do to lower the transaction costs imposed on business by the state which will be addressed through the modernization of the state program. On the fiscal side, structural changes are being pursued by reducing fraud and better management of the social security system. There are also reforms to be put in place to improve public procurement, reduce costs, and streamline bureaucracy. 24. Turning to social policies, first and foremost on the agenda is restoring economic growth which should go a long way in reducing poverty over the medium term. But this strategy needs to be coupled with policies for effective social protection for the poor. First, there is the issue of income even for the working poor, especially those with dependent children (with some 45 percent of all children in Argentina in poor families) as well as income maintenance for those less able to participate in the work force-such as single mothers--or the aged who do not receive pensions. As highlighted in the Poverty Assessment and recent ESW, these groups are the most vulnerable to economic shocks. Thus, one of the main policy reforms will be to revamp social assistance programs. Second, on social protection, an additional dimension is risk management by those least able to insure against the risk of future income loss and health and/or unanticipated 7  expenditures. The lack of insurance coverage has been exacerbated by the fact that the share of workers in the informal sector has increased substantially since the late 1980s, now accounting for some 45 percent of the labor force. This leaves workers without health insurance, pension coverage, severance benefits or unemployment insurance and adds considerably to the burden faced by public services to provide these services. The present situation creates a serious inter-generational problem. Thus, the second main thrust will be on revamping basic social security systems. 25. The appropriate response to these concerns has to be reconciled with the need to close the fiscal gap, a prerequisite for restoring growth. Thus, the way ahead for Argentina requires judicious management on the fiscal side, including reducing tax evasion, so as not to exacerbate the pro-cyclical nature of social spending. As highlighted in the FY 00 Poverty Assessment and the Government's 1999 review of Public Social Expenditures, there exist a wide array of social programs at both the federal and provincial levels. At the federal level, the Federal Government budgeted some $1.2 billion in targeted social program in 2000 and has been able to maintain service levels albeit at low levels of coverage. Programs include efforts to assist vulnerable groups with programs such as the public works programn, TRABAJAR, school scholarships for poor children, food supplements, community development, and job training for the unemployed. Next steps are to consolidate these programs and to ensure better coverage with a universal system for identifying eligible beneficiaries. Prospects 26. While the economy is currently passing through a critical phase of reengineering economic management, a credible economic program founded on the measures now being introduced by Minister Cavallo could return Argentina to economic growth by the second semester of 2001. Under such a scenario, renewed access to foreign capital would critically assist in this process, lowering domestic interest rates. External private capital flows, which are critical for growth in this country with a low domestic savings rate, are expected to recover slowly, reflecting the still fragile confidence of the international financial market. Inflation would continue to remain low. An accelerating recovery during the course of the year could result in real GDP growth in the range of 1 percent, close to the anticipated rate under the Fund program for 2001. The Government, itself, is more optimistic and aims at growth closer to 2.5 percent, based on a strong reactivation of consumer demand. 27. Looking beyond 2001, we anticipate growth of about 3 percent for 2002 and about 4 percent growth per annum over the medium term. These rates are below Argentina's average for the 1990s-at 4.8 percent per annum-- and reflect the assessment that a quick rebound is not likely in part because concerns about Argentina's solvency will persist until there is demonstrated fiscal credibility. In such a medium term scenario, including a primary expenditure freeze, according to Bank estimates Argentina obtains fiscal and external sustainability. Furthermore, with estimated employment and poverty reduction elasticities, at 4 percent economic growth unemployment could be declining at an annual 8  rate of 0.5 percent3, and poverty by 1.5 percent annually4. Further declines in unemployment could be obtained from a reduction in labor costs (with likely reductions in labor taxation). Without more rapid growth, poverty levels and job creation are not expected to rebound significantly over the short term, and the unemployment rate may remain at relatively high levels. International Support 28. The international community, led by the IMF, helped to mobilize support Argentina as conditions deteriorated in late 2000. The Fund's support was reflected in the agreement with the IMF approved in January 2001 and subsequently modified in May 2001. Expanding the then on-going, three year $7.4 billion Stand-By Arrangement, the Fund program involves $13.7 billion (SDR 10.6 billion), with one-fifth of this amount provided by the IMF's Supplemental Reserve Facility (SRF). From December 2000 to March 2001, the Fund disbursed $5.0 billion. The next disbursement of $1.3 billion in expected in May 2001. Commitments by the private sector comprise about half of the total package, and were designed to rollover debts maturing in 2001 and 2002, with $10 billion committed by private banks (which includes $5 billion of Treasury Bills) and $3 billion by private pension funds. In addition, the package included swap operations for $7 billion, in which short term maturing bonds were exchanged for long maturing bonds. Finally, the package also includes a commitment of $1 billion from the Government of Spain, and World Bank and the Inter-American Development Bank (IDB) pledges of about $2.5 billion each, largely comprising already programmed support. 29. The focus of the Bank's efforts will be structural reform measures under a proposed Programmatic Structural Adjustment Loan (PSAL) which will likely address several outstanding question of social equity, vulnerability, and consolidation of economic reforms. Among the areas on which the Bank is working are further reform in the social security system that reduces the system's deficit and promotes equity among beneficiaries, deregulation to promote competition among health insurance companies as well increase the equity of the system for low income families, consolidation and rationalization of social programs to reduce administrative costs and to target assistance better, federal state restructuring with the goal of reducing public sector size and thus improving its efficiency. The Bank would also likely provide complementary technical assistance under the proposed Social Protection V Project. In parallel, the IDB will be supporting additional reforms in the areas of public pensions, banking and capital markets and competitiveness of the economy which are also key ingredients to Argentina's sustained recovery. 30. Greater efficiency in economic management to enhance fiscal performance and reduce economic volatility-at both the federal and provincial levels-are essential features of the proposed programmatic loan, PSAL. This will include actions regarding administration of the federal taxes that finance much of social expenditures at all levels of 3 Employment elasticity to growth estimates range between 0.3 to 0.5%. Employment elasticity to labor costs is estimated at 4.6% to -1.0%. 4Assuming no deterioration in income inequality, the economy requires 1.4% per capita income growth to obtain a 1% decline in the poverty rate. 9  government and form a key part of the state modernization program, to be supported by the proposed PSAL, with technical assistance provided under a proposed State Modernization Project (which would propose to provide financing through a restructuring of the ongoing Year 2000 Technical Assistance Project). At the provincial level, efforts will continue under the series of Provincial Reform Loans, including the proposed Santa Fe Provincial Reform Loan, to instill fiscal discipline while improving the qualify, equity and efficiency of key social services by sub-national governments. The latest Federal-provincial agreement also established guidelines for transparency of provincial accounts, budgeting and expenditure planning, and the basis for improved federal-provincial coordination in tax administration. This agreement provides the basis for launching a renewed effort, with Bank and IDB support, targeting debt regulations, provincial pension systems, and reforms in public administration under the proposed SAL and Provincial Development III Project. The Provincial Context 31. Provincial governments have long played an important role in overall fiscal performance and macroeconomic stability. Argentina's public sector is highly decentralized, with provinces and municipalities accounting for about half of total public spending. In particular, they have increasingly become the key public sector level for providing public services in health, education and infrastructure, with responsibility for over 90 percent of public spending in health and basic education (Table 1). Thus, provincial reform becomes a central element in the efforts of Argentina to reduce its macroeconomic vulnerability through improved fiscal performance and to increase competitiveness and enhance equity through human resource development. 32. During the 1980s, high inflation rates, lack of budgetary discipline, easy access to borrowing and reliance on the Federal Government for transfers and bailouts all contributed to persistent fiscal deficits. The situation improved in 1992, due to the reforms that the Federal Government had initiated under the Convertibility Plan, and a major national tax effort. However, this deteriorated again soon after due to excessive spending by the provinces, given their inability to manage the rapid increase in the funds transferred from the center. The financial crisis of 1995 aggravated the fiscal situation of the provinces once again when the pool of total public revenues fell dramatically. Provincial revenues dropped 5 percent in real termns, provincial expenditures failed to adjust, and the provincial deficit reached a record high of $3.5 billion or 1.4 percent of GDP, about half of the consolidated public sector deficit at that time (Table 2). In 1995- 96, out of 24 provinces, only four had balanced fiscal accounts. Most of the others faced important liquidity shortages, increased borrowing, and accumulated arrears. Some provinces resorted to printing their own money. 10  Table 1: Argentina: Allocation of Responsibilities by Government Levels Exclusively Central and Provincial Provincial and Municipal Central Governments Municipal Govetnrnents Governments Government (C=Mostly Central, (P=Mostly Provincial, P-Mostly Provincial) M=Mostly Municipal) Spending Defense Social Security, C Primary Education, P Markets, cemeteries Foreign Affaires Social Assistance, C Secondary Education, P Solid Waste Trade regulation Higher Education, C Health Care, P Local streets, drainage Mail and telex Preventive Health, C Social Assistance Inter-provincial Health Care, P Water and Sewerage, P transport Economic development Regional and local roads Infrastructure (e.g. Environmental Protection Land Use, M port concessions, Justice and Security, P Fire Control, M toll roads, Housing railway) Passenger and cargo terminals Regional Infrastructure Electricity and gas energy, P _____ _____ ____ Regulation of public utilities _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ Revenue Value Added Revenue-sharing of value Turnover, Property, Services charges for Income added, fuel, and other taxes Stamnp and Automobile street cleaning, solid Fuel collected by the Central taxes collected mostly waste disposal, and Trade tariffs Government. by provincial cemeteries. Personal Goods governments, with Betterment fees Consumer Goods revenue-sharing Social Security arrangements for contributions municipalities. 33. Recognizing the importance of provincial finances to macro-stability in a federal state, provincial reform has been a priority for the Federal Governnent since the early 1990s. During 1992 and 1993, it negotiated two agreements with the provinces to promote structural economic changes. The provinces agreed to improve own-source mobilization, restructure provincial taxes and eliminate distortionary taxes, privatize public enterprises, including the provincial banks and utilities, deregulate the provincial economy, and transfer the provincial pension funds to the national system. In exchange, the Federal Government guaranteed a shared-revenue floor to each province, sheltering them from any downfalls in revenue. It also provided a Transformation Fund, which helped finance those reforms and provide technical assistance and advisory services. While a number of provinces began implementing a program of reforms during 1993-94, it was not until the financial crisis of 1995 that a large number of provinces began to reform in earnest. 11  Table 2: Fiscal Balance at Federal and Provincial Levels Est. 1995 1996 1997 1998 1999 2000 Millions of pesos Federal Government -2,545 -5,889 -4341 -4170 -7,348 -6,974 Provincial -3,530 -1,840 -1,377 -2,488 -4,633 -3,517* Administrations o/w Buenos Aires -270 -581 -808 -1,355 -2,150 -1,868 Province Total -6,075 -7,729 -5,718 -6,529 -11,981 -10,491 Shares of GDP (%/) Federal Government -1.0 -2.2 -1.5 -1.4 -2.6 -2.4 Provincial -1.4 -0.7 -0.5 -0.8 -1.6 -1.2 Administrations Total -2.4 -2.8 -2.0 -2.2 -4.2 -3.6 Note: Deficits exclude privatization proceeds as revenues Sources: Ministry of Economy, IMF *Bank Staff Estimate 34. With a more favorable macroeconomic environment beginning in late 1996, and the reforms undertaken by many provinces, the overall fiscal situation of the provinces improved remarkably. During the 1997-1998 period the deficit averaged only $0.6 billion (about 30 percent of the consolidated deficit). However, with the current economic downturn, the deficit level has increased again and is estimated to reach $3.5 billion in 1999, similar to the 1995 level relative to GDP during the Tequila. Moreover, a number of provinces that had borrowed excessively now have untenable debt service burdens aggravated by the recent economic downturn: total debt service payments in 1999 were about $4.3 billion on the stock of provincial debt of $19 billion. Since much of these debts are guaranteed with the individual provinces' income from federal revenue sharing and are deducted automatically, the shortfall of revenues after debt service falls directly on the payment of salaries and suppliers the provinces owe. Bank Support for Provincial Reform 35. The Bank has been a major partner of the Government since the early 1990's in supporting provincial reforms and institutional strengthening, through a series of ongoing investment operations in health, education, agriculture, renewable energy, water supply, roads and flood control and successful completed operations, including First Provincial Development Project (Ln. 3280), First Provincial Reform Loan (PRL I) (Ln. 3836), Provincial Bank Privatization Loan (Ln. 3878), and Provincial Pension Reform Loan (Ln. 4116)5, supported with important analytical work.6 As a result: All of these operations were rated either satisfactory or highly satisfactory by OED. 12  * 18 provincial banks and 22 other loss making major public enterprises were privatized during the period 1995-99 and eight provinces transferred their provincial pension systems to the reformed national system; * provinces have initiated programs, and some are well advanced, in improving their tax collection systems (cadasters, etc), fiscal management and budgeting systems; * provinces have entered into fiscal agreements (pactos fiscales) with the Federal Government to change distortionary provincial taxes and there is an active dialogue, facilitated by the Bank and in collaboration with the Fund, on further reform of the federal-provincial tax sharing regime and provincial tax systems (co-participation); * most provinces are engaged in the national program to improve the quality of secondary education; and support is being provided to improve the management of provincial public hospitals; * each year the Bank conducts a review of provincial finances and uses financial criteria to determine eligibility by the provinces to funds for capital investments; the only exceptions are for social sector and for flood protection (in the Northeast, subject to recurring floods that cost the Argentine economy as much as lpercent of GDP in losses); and * during the 1995-99 period, the twelve provinces that participated in the provincial reform program (PRL I and PRL Ij)7 outperformed other provinces in a variety of critical areas. Local tax collections increased 26 percent in the PRL provinces, as compared to 19 percent for all provinces, and expenditure growth was about 25 percent less than the overall average. Main Challenges in Provincial Reform 36. The process of decentralization has increasingly forged a direct link between the institutional capacity of sub-national governments and the human and infrastructure development required to put the country on a sustained growth path. The Argentine public sector over the last decade has shed unproductive activities and become more focussed on core functions. With the federal level concentrating on social security, general regulatory functions and national defense, much of the most complicated and critical service delivery functions rest with the provinces. Social and economic progress in Argentina will depend on the ability of the provinces to deliver health, education and public safety functions effectively and within the context of sustained fiscal balance. 6 Including Argentina Provincial Finances Study, Report No. 15487; Argentina: Reforming Provincial Utilities, Report No. 15063; Cordoba-Public Sector Assessment, Report No. 15132-AR; Argentina: Revitalizing the Tucuman Economy, Joint Bank/IFC Note, dated November 2, 1995. 7 Including the provinces of Entre Rios, Misiones, San Juan, Catamarca, Santiago del Estero, Tucuman, Salta, Rio Negro, Chubut, Santa Cruz, Corrientes, and Chaco. This performance is all the more impressive given that this group includes several provinces that "dropped out" of the reform process, and that the provinces that this group is compared with includes several traditionally strong fiscal performers and provinces undertaking their own adjustment effort outside the PRL umbrella. 13  37. Over the past ten years, the Government's strategy progress from ensuring macro- economic stability, installing a competitive policy framework for the productive sectors, and providing basic security for the population to a strategy increasingly emphasizing second generation reforms, community development and social services. In light of the role of the provinces in these key areas, it is clear that the locus of activity had to shift from the central level of administration to that of sub-national governments. Important challenges remain, which the national and provincial administrations will need to deal with: Revenue-Sharing. A long-standing issue facing the Federal Govermnent and the Provinces has been the system of revenue sharing between the two levels of government and among the provinces (the system of co-participation). At issue are finding a better balance between: (i) the collection of taxes and responsibility for spending; (ii) the incentives for spending and social equity for the poorer provinces; (iii) the predictability of revenues and the need for fiscal adjustment; (iv) the level of revenues collected and the incentives for economic efficiency; and (v) the transparency in the allocation process and the need to provide emergency support. A new agreement that is more equitable and efficient could help provide greater incentives for provinces to collect their own revenues, spend more wisely, and to relieve reoccurring political pressure on the Federal Government for bailouts. However, finding such a balance, while ensuring the 100 percent acceptance by all the parties needed to put the new system into place by law, has been hard (in contrast, the Convertibility Law, which radically changed the economic landscape in Argentina, only required a two-thirds majority vote). The political difficulties of reaching a new agreement cannot be overstated, particularly with current fiscal problems that gives the Federal Government little with which to bargain. Indeed, the Constitutional reform of 1994 had mandated that such an agreement be reached by 1996. On the other hand, as an increasing number of provinces see the wisdom of bringing their own house in fiscal order, with the support of the Federal Government, the Bank and the IDB, the constituents for a system that rewards greater efficiency has grown markedly during the past decade. Heterogeneity among Provinces. There is no uniform solution. The situation in the 24 provinces remains highly disparate. There are well performing provinces, such as La Pampa and San Luis, which are able to provide good quality public services to their small and well off populations. The largest provinces, such as Santa Fe, Mendoza, C6rdoba and the Province of Buenos Aires, have undergone varying degrees of adjustment in the 1990's but still have difficulties in cyclical downturns and need to upgrade the quality and coverage of their public services. Since the largest concentration of the urban poor are in these provinces, it is critical that they are able to meet the challenge of poverty reduction. Other resource rich provinces, such as Chubut, Neuquen and Santa Cruz, have small populations, low levels of poverty, and high revenues from natural resources but could benefit from reforms to enhance quality and efficiency of the public services. At the other end of the spectrum, there are a number of provinces, typically among the poorest, with high social demands, poor institutional capacities, weak fiscal performance and high debt. The general characteristics of the provinces are presented in Annex K. 14  * Fiscal and Debt Problems. Chronic deficits and dangerous levels of indebtedness in a few of provinces generate social and political unrest and contribute to the overall fiscal problem in Argentina. Unfortunately, some of these provinces are among the country's poorest and it is difficult to conceive that growth combined with fiscal restraint will be sufficient to face their debt burdens. A part of the problem is the short term nature of their debts and another part of the problem is the lack of incentives by the banks and capital market to restrain new borrowings as provincial debts enjoy full guarantee from the respective province's share of federal-shared revenues. Achieving a sustainable fiscal position in some cases may require a combination of debt restructuring and fiscal measures; in other cases, fiscal measures alone may be sufficient. The approach should be case-by-case, and well grounded on changing future incentives to prevent a reoccurrence. At the same time, there is still much to be done to lower the overall fiscal deficit, particularly among the largest provinces - such as Buenos Aires, C6rdoba, and Santa Fe-which have the capacity to meet their debt obligations and account for the bulk of the aggregate provincial deficit in the past year. * Regional Dimensions of Poverty. Poverty rates are substantially higher in provinces in the north, particularly in the Northwest (46%) and Northeast (49%). Conversely Buenos Aires (including the City and Province) and five Patagonian provinces in the southern part of the country have lower poverty rates than the national average. Argentina's economic performance has also has a varied impact depending upon the region. In the early 1990's, overall poverty rates fell by 48 percent, but poverty in the two poorest regions in the Northeast and the Northwest fell by about half of that. In other words, the poorest provinces benefited less from overall growth than the richer ones. However, when poverty rose during the 1994-98 period, the increases in poverty were greater in those provinces that traditionally had the lowest poverty rates; that is, the province of Buenos Aires, Cuyo (western provinces straddling the Andes) and the Pampa region (the central plains). More generally, the provinces in the Northeast and Northwest tend to have higher percentages of rural populations and indigenous peoples: a survey of rural poverty in two of these provinces showed that poverty rates among the rural populations are exceedingly high-some 70 percent. * Differences in Social Performance. Social indicators show large variance among regions, particularly in health. In Greater Buenos Areas and the larger provinces such as Santa Fe and C6rdoba, the health profile is broadly similar to that of the developed world. Other areas of the country, particularly the poorer North, face a very different health profile. For example, their infant mortality rates of 29 per 1000 are almost 70 percent higher than in greater Buenos Aires. Regional difference in education are less stark, with most parts of the country performing poorly in retention rates, but the quality of education, based on national testing, is particularly deficient in the North. * Municipal Governments. The process of reform in Argentina has been cascading: it occurred first that the federal level in the early 1990's and then shifted to the provincial level by the mid- 1990's. It has yet to reach the municipalities that have the potential to take on more responsibilities and to become more accountable. Issues in fiscal management and revenue sharing also remain as a major challenge in 15  provincial-municipal relations. Although municipal governments in the aggregate only account for less than 10 percent of public expenditures, the failure of most to engage in meaningful reform undermines these efforts in a number of provinces, and provides a weak basis for confronting growing urban problems and meeting the needs of the poor for basic infrastructure, garbage and waste disposal, and other urban services. A very large deficit of basic water and sanitation services exists. Some municipalities are increasing providing primary health care, day care services, community kitchens and the distribution of food supplements for the poor. Thus, there is room for greater decentralization and consolidation of social services at the local level. Municipalities are also at the interface with the private sector, concerned with business licensing, among other things, which has an impact on private sector development. As of now, there is no comprehensive strategy as to how to bring the process to reform to this level of government. Government Strategy and Bank Assistance 38. The new administration is giving top priority to provincial reform and, as noted above, has included specific benchmarks for this effort under its new agreement with the Fund. Its two-track strategy would seek to continue the dialogue and improving the environment for reforming the current system of co-participation, while further improving the incentives of the current system and supporting the reform efforts of individual provinces. To support improvements in provincial finances, the Federal Government would exercise its authority to limit external debt and borrowing from the domestic banking system by the provinces. This would help to enhance the hard budget constraints and builds on earlier efforts to enhance the transparency of the system and to reduce discretionary transfers. It is also implementing a program of debt relief for about one-third of the smaller provinces willing to put in place fiscal measures to control spending. Specifically, the administration reached agreement with the provinces, the Compromiso Federal, as follows: - Primary distribution through year 2005. For 2001 and 2002, the provinces will receive a fixed monthly amount equal to $1.364 billion, with those funds that might otherwise have gone to them from increased tax collections retained by the Federal Government to meet its obligations. In the short-run this should support fiscal and macro stability. Over the medium term, this stability would be strengthened by agreement to provide the provinces with transfers based on a three-year moving average. This would smooth out such transfers over the 2003-2005 period and avoid the bust-boom in provincial revenues experienced during the 1990s. * New social fund. The Federal Government will would set channel $225 million from its own programs for new employment and social programs to be administered exclusively by the provinces in 2001. The new commitment would give the provinces responsibility for 30-50 percent of employment programs in future years. * A commitment to freeze primary expenditures if a province is running a deficit, and a general agreement to eliminate automatic wage increases. 16  * Commitment to a new general co-participation law during 2001. If by 2003, a new law is not approved, the Federal Government would submit a new law to Congress with certain features listed in the Compromiso Federal. * Public sector modernization. The provinces commit to implementing multi-year budgeting, and to provide detailed, regular publication of fiscal information. The Federal Government would publish information on the geographic location of its expenditures. Other commitments in terms of public sector modernization include implementing SINTyS, the ORISIS tax administration system, and consistent pay scales for public sector workers. 39. The Government's strategy to step up provincial reform is designed to provide a more favorable environment and the political support necessary for reforming the system of revenue sharing. This is a fundamental policy issue which is exceedingly complex and difficult to resolve. As noted above, the Government has a two year window for lasting changes to th svstem and has been able to reach an understanding on some principles, most notabl, the need to smooth these transfers overtime, and to have a more independent body to monitor the system. Through advisory services and ESW, the Bank has been pro-iding the analytical bases for this effort.8 Under the SSAL, the Government prepared a detailed technical proposal, initiated a round of public debate on the subject, and began to work towards a consensus with the provinces. The CAS for FYO1-04 also provides for Bank support to further assist in this effort to improve federal-provincial fiscal relations. 40. The Fede-ral Government has also asked for continued Bank support though direct of selected provinces in meeting the commitments of the Compromiso Federal. As noted, the Federal Government has already engaged 13 of the smaller, heavily-indebted provinces in fiscal reform programs with some success. The first nine participating provinces were able to reduced their combined deficits of $1.2 billion in 1999 to about $0.6 billion in 2000. For its part, the Bank has been requested to continue to focus its support to individual provinces using the approach piloted under the Second Provincial Loan (PRLII) (see para. 42). 41. This approach combines measures to strengthen social assistance during the current economic dowvnturn and longer-term measures to alleviate poverty and enhance equity through human resource development and through sustainable economic growth and competitiveness. Participating provinces would be selected based on ownership of the reform program, demonstrated success in implementing first generation reforms (typically privatization of the provincial bank or other major public enterprises, as well as advances in financial management), have positive performance under other Bank- financed projects, and have attained a modicum of fiscal stability so that they are able to concentrate on structural issues, particularly in the delivery of social services. Priority would be given to those provinces with programs having the greatest potential to have a positive impact on reducing poverty and enhancing equity and which can serve as leading 8 Including the recent report, Argentina: Provincial Tax and Revenue-Sharing Reform, gray cover Report No. 19395-AR, dated June 30, 1999. 17  cases of successful reform for other provinces. The objectives, design and experiences under the PRLII approach are outlined below. Individual Provincial Reform Programs Background 42. In 1996, the Federal Government recognized the need for a second phase of provincial reforms to follow on the First Provincial Reform Loan (PRLI). The PRLI supported first generation structural reforms, including privatization, which provided a better balance in the role of the state and its fiscal means and a more stable, immediate fiscal situation, but it was clear that the provinces needed to address issues of efficiency, quality and equity of core public services, especially in health and education. Four provinces were selected for piloting this approach -- Tucuman, Salta, San Juan and Rio Negro - and to participate in the Bank's Second Provincial Reform Loans (PRL I1), based on their previous reform performance under the PRL I, and the difficulties that they continued to face. Reform Goals and Actions 43. The provincial reform program for individual participating provinces seeks to ensure an efficient and responsive delivery of remaining public social services, particularly those targeted to the poor, within fiscally sound policies. The reform program is designed to face the development challenges of alleviating poverty and enhancing equity with measures designed to promote human resource development and sustainable economic growth and competitiveness over the longer term, as well as actions to strengthen the social safety net during the current economic downturn. While the nature of the problems may vary across provinces and the reform programs are tailor- made to each, the pillars of the reform program are common and include three basic components: public finance, education, and health. 44. Reforms in public finance are focused on achieving a sustainable fiscal situation by rationalizing expenditures, giving priority to core areas benefiting the poor, enhancing local revenue mobilization, and reducing the debt burden. Local resource mobilization is emphasized not only to increase revenues, but to enhance accountability and to reduce, at least somewhat, the pro-cyclical impact of federal transfers derived mainly from consumption taxes. Civil service reform is promoted not only to enhance the productivity of public employees, but to increase resources available for investment by reducing the relative share of the wage bill. Experience under the completed PRL H suggests that increased local revenues, changes in the structure of expenditures, and lowering debt are all required to provide for greater flexibility when the provincial governments need to adjust in the face of economic downturns. The basic elements of the program include: * improvement in tax collection and administration to promote higher reliance on own- source revenues and increased accountability; 18  * civil service reform including reduction of the wage bill and redundant personnel; improved training and compensation; control to lower absenteeism and overpayments; and * rationalization of public expenditures and prioritization of government spending, with emphasis on privatization and outsourcing to improve reliability and quality of public services and lower the fiscal burden. 45. On the social sector side, the emphasis is to increase the efficiency and quality of the education and health sectors, focusing on demand and poverty reduction aspects, while promoting increased involvement by the private sector. The large majority of provinces appear to devote sufficient resources to public health and education, most at levels higher than OECD countries relative to per capita incomes; however, the efficiency, quality and often the equity of this spending are poor. The basic strategy is to protect current levels of spending, while at the same time changing the structure of expenditures to increase investment and providing incentives for improvements. 46. In education, despite attractive returns to higher education, dropout rates from secondary school among the poor are high. In Argentina only 24 percent of students in the lowest quintile complete secondary school, compared to 76 percent for the upper quintile. Proposed reforms seek to ensure the extension of obligatory education (from six to nine years) as mandated the National Education Law, while improving efficiency and quality. Given the low productivity in most provinces, with student/teacher ratios in some cases double those of comparators, and high levels of teacher absenteeism (sometimes four times as high as comparators), much of this can potentially be financed within the current budget, with some short-term increases to cover investment in classrooms, materials and teacher training. In addition, most provinces need to undergo important reforms to provide incentives to improve quality, including changing seniority- based teacher remuneration systems into merit-based systems, and decentralizing greater control to the school level. Priority actions include: * increasing low student/teacher ratios and the participation of staff actively teaching as a share of total staff; * reducing disproportionate use of temporary and substitute education personnel; * improving the incentives for quality improvement; * increasing the participation of the private sector; and * reducing administrative costs. 47. In health, despite the availability of health care generally through public hospitals, care is of poorer quality for poorer people. For example, 25 percent of women in the lowest income levels are delivered by non-doctors, while none at the upper level; over 30 percent of women in the lowest quintile have no post delivery follow-up, compared to only 2 percent of those in the upper quintile; 74 percent from lowest have to wait more than 24 hours for a consultation, as compared to only 45 percent of those in the upper 19  quintile. Proposed health reforms seek to increase overall investment largely within the current budget envelope and to induce improvements in efficiency, quality and equity by promoting the separation of the supply of services from the financing, cost-recovery for care provided by public hospital to insured patients, hospital accreditation and quality assurance systems, and health insurance for the poor. A fundamental element of this strategy, self-administered public hospitals, was pioneered in Argentina under the ongoing Provincial Health Development Project (PRESSAL, Ln. 3931 -AR). On the financing side, the Bank supported reforms in the national health insurance system (Health Insurance Reform Loan Ln. 4002/3AR and Health Insurance Technical Assistance Project Ln 4004-AR) to enhance efficiency and promote competition. The PRL program combines these two reform elements in participating provinces and promotes the incorporation of the uninsured poor into the system to help ensure equity in access to services. The main actions being undertaken cover reforms in the area of personal health care delivery, public health finance and public health administration and include: