Argentina - Agricultural Sector Loan Project

Document of The World Bank FOR OFmFCIAL USE ONLY Report No. P-4161-AR REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED AGRICULTURAL SECTOR LOAN IN AN AMOUNT EQUIVALENT TO USt35O MILLION TO THE ARGENTINE REPUBLIC March 14, 1986 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 QIVALETS US$1 = Austral 0.80 'November 1, 1985) UEICETS AND MEASURES 1 hectare (ha) = 10,000 m2 = 2.47 acres 1 kilogram (kg) = 2.2 pounds 1 metric ton (m ton) = 1,000 kg GLOSSARY OF ABBREVIATIlONS BNA - National Bank of Argentina BCRP. - Central Bank of Argentina CEM - Country Economic Memorandum CFI - Consejo Federal de Inversiones cif - Costs, Insurance and Freight EC - Executive Committee for Implementation of Federal Land Tax EEC - European Economic Community fob - Free on Board IFC - International Finance Corporation IMF - International Monetary Fund INTA - National Institute of Agricultural Technology JNC - National Meat Board JNG - National Grain Board PPF - Project Preparation Facility PRONAGRO - National Agricultur-al Development Program SAG - Secretariat of Agriculture, Livestock and Fisheries UNDP - United Nations Development Programme VAT - Value-Added Tax REPUBLIC OF ARGENTINA FISCAL YEAR January 1 - December 31  FOR OmCIL USE ONLY ARGENTINA AGRICULTURAL SECTOR LOAN Loan and Project Summary Borrower: Argentine Republic Amount: US$350 million equivalent Terms: 15 years, including 3 years of grace, at the standard variable interest rate. Project Description: The proposed loan would support the first phase of a Government program to encourage increases in agricultural production and exports. Under the policy package supported by the proposed loan, the Government would: (a) reduce export taxes on agricultural products; (b) undertake fiscal measures designed to maintain the overall fiscal deficit at satisfactory levels, including the introduction of a federal land tax; and (c) rationalize import tariffs and regulations on agricultural inputs. Complementary studies and institutional support would also be financed. Benefits and Risks: The policy reforms would stimulate increases in agricultural production and exports by: (a) increasing domestic producer prices, bringing them closer to international prices and improving benefit-cost ratios for investment and production inputs; and (b) reducing the subsidy from producers to consumers. Additional net foreign exchange earnings in excess of US$1 billion per annum would be generated by 1989. The Government intends to implement a structural change in Argentina's taxation system by introducing a production-neutral federal land tax substituting for production-negative export taxes. The beneficiaries of the policy reform would be the economy at large and efficient agricultural producers. The risks in achieving the Program's objectives relate to the possibility that the Government may not succeed: (a) in stabilizing the economy, which would inhibit implemen- tation of the policy reforms, and prevent the reduction in export taxes and the anticipated production response; (b) in being able to find suitable means of maintaining the fiscal deficit at satisfactory levels; and (c) in achieving an output response because the export tax reduction may not be sufficient to change producer incentives. The Government's stabilization program, however, is considered appropriate to address current economic difficulties and improve the investment climate in the short-term. It has been successful in stabilizing This document has a restricted distribution and may be used by recipients only in the performance of their official duties Its contents may not otherwise be disclsed without World Bank authorizaion.  - ii - the economy. The Government is also in the process of undertaking a tax reform to seek fair and specific means of maintaining the fiscal deficit at levels consistent with price stability. These risks are also expected to be reduced by IMF monitoring of its stand-by agreement and by Bank monitoring in the context of the loan. Finally, comprehensive quantitative analyses demonstrate that profitability in agriculture would be increased sufficiently by the export tax reduction to promote an output response of the expected magnitude. Estimated Disbursements: Bank FY: 1986 1987 1988 U1$ Million - Policy Component 170.5 170.5 - - Studies/Institutional Support 1.5 4.4 3.1 Total (cumulative) 172.0 346.9 350.0 Appraisal Report: This is a combined President's and Staff Appraisal Report. Map: IBRD 19235.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE ARGENTINE REPUBLIC FOR AN AGRICULTURAL SECTOR LOAN 1. I submit the following report and recommendation on a proposed loan to the Republic of Argentina for the equivalent of US$350 million in support of its policies in the agricultural sector. The loan would have a term of 15 years, including 3 years of grace, at the Bank standard variable interest rate. PART I - THE ECONOMY 2. An economic mission visited Argentina in June/July 1983 and its report (4979-AR) was distributed to the Executive Directors in June 1984. This report reflects the major findings of that mission and subsequent updating missions. The Board has also received a report entitled Argentina: Strategies toward Industrial and Export Development- (5841b-AR), dated September 30, 1985. Country data sheets are presented in Annex I. Background 3. Argentina has rich natural resources, a highly literate popula- tion, an export-oriented and diversified agricultural sector and a large industrial sector. The economic performance of the country has suffered, however, from policy instability and economic distortions introduced by the frequently changing governments. Except for agriculture, public sector participation in the economy is high, industrial production is largely domestic market-oriented, and available resources are not utilized efficiently. A large public sector deficit has contributed significantly to the country's recent very high inflation level. A. Economic Developments of the Last Decade 4. Over the last decade, abrupt shifts in economic policies weakened Argentina's productive capacity and exacerbated structural imbalances. Changes in policies produced large and rapid fluctuations in the real exchange rate, real interest rates, and real salaries. The annual rate of inflation was over 400X in 1976, fell to 100X in 1980 and accelerated again to about 600% in 1984; the external trade balance as a share of GDP has fluctuated between positive 4.8% and a negative 4.3%, while annual GDP growth has ranged from plus 6.7% to minus 6.2%.  5. High and rising inflation, physical and technological deteriora- tion of the country's productive capacity, major dislocations in industrial production and huge external debt service requirements have resulted in general economic stagnation and recession, such that the real 1984 per capita GDP was 14% lower than its 1974 level. Heavy borrowing in the late 1970s multiplied the country's external debt as a share of GDP sevenfold (from 10% to 68%). Today, interest payments on the external debt absorb nearly half of gross domestic savings, compared to less than 5% in the early 1970s. 6. The productive sectors, particularly manufacturing, are beset by thorny structural and financial problems. More than 40% of capacity in the construction industry, artificially inflated during a brief construction boom of the late 1970s, now stands idle. Significant underutilization of capacity also exists in many manufacturing industries and most firms also lack sufficient work'ng capital. Financial intermediation is costly and inefficient, interest rates are high both in nominal and real terms, and oversized banking institutions are suffering severe difficulties. Argentina's self-sufficiency in oil has deteriorated as the ratio of oil reserves to annual output has declined. Proven reserves of gas have increased, but the processing and transport infrastructure to exploit them is deficient. 7. The public sector is simultaneously overstaffed and seriously short of managerial and technical expertise. Ineffective tax administra- tion, together with inadequate budgeting and investment planning processes, contribute significantly to the large public sector deficit. Cuts in investment to curb the public sector deficit have led to a deterioration of social infrastructure and have jeopardized the reliability of power supply. B. Policies for Adjustment 8. Economic mismanagement and the consequences of the 1982 South Atlantic crisis hastened the departure of the military Government. A democratically elected Government took office at the end of 1983, facing spiralling inflation and growing balance of payments difficulties. Also, the after-effects of the industrial recession were threatening the solvency of the financial system. 9. Toward the end of 1984, the Government entered into a 15-month stand-by agreement with the IMF and rescheduled its external debt with official creditors, covering interest and principal up to 1985, and with the commercial banks, covering principal up to 1985. It also obtained the commitment of US$4.2 billion in fresh money to finance the current account deficit and to eliminate arrears accumulated through 1983-85. The principal objectives of the stabilization program were to: (a) lower the rate of inflation from an average of about 20% per month in the last quarter of 1984 to about 8% per month by the end of 1985; and (b) achieve a balance of payments position that would enable Argentina to meet its external obligations while satisfying the needs of domestic recovery. 10. The Government moved to comply with the conditions under the stand-by agreement despite a deepening recession. The fiscal deficit was reduced to 13% of GDP during the last quarter of 1984 and the real exchange  - 3 - rate was improved by 17% between September and December. Public utility prices were raised 9% in real terms. Inflation, however, continued at full speed after a brief pause in October and November. Output and employment and the value of real exports began declining. Monthly wage indexation was reduced to 90Z of the previous month's inflation, from 100% earlier; real wages also fell 17% from July to December. By the end of 1984, shortfalls from the agreed targets of the program were observed; during the first quarter of 1985, the Government's adherence to the program became weaker. Therefore, the DIMF suspended the first conditional draw-down under the stand-by agreement until the completion of the 1985 first quarter review of the program. 11. A new economic team took office in late February 1985 and began preparing a new package to deal with inflation which had already exceeded 20Z per month. By the second quarter of 1985, economic conditions had worsened significantly. The economy was facing spiralling inflation while the recession intensified. The Government then decided to abandon gradual- ism in favor of shock treatment and set about to prepare the country for a major change in economic policy necessary to break inflationary expecta- tions. In June 1985, the Government devalued the peso by 18% to improve relative prices, raised the price of meat by almost 100,Z and introduced a number of fiscal measures with the purpose of drastically reducing the overall fiscal deficit. It increased prices of petroleum and gas products and tariffs on electricity, telephone, transport and postal services; a temporary 10% import surcharge and a 9 percentage points increase in the export tax were approved; a 12% cut in the 1985 budget expenditure took place; and a hiring freeze was declared in the public sector. Following these measures, the Government announced a very strong adjustment program and initiated its implementation. The program was subsequently supported by a revised, and more stringent, stand-by agreement with the IMF. 12. The Government's economic program comprised: (a) a drastic cut in the total public sector deficit (including Central Bank operating losses) from 12.5% of GDP in the first half of 1985 to 2.5% on average in the second half of 1985, with the deficit to be financed by external borrowing, thus eliminating domestic credit expansion to the public sector. Further expenditure cuts were to follow the ones undertaken and lower inflation was to shorten revenue collection lags and allow for lower nominal interest rates, thus reducing interest service payments; (b) a reduction in the balance of payments' current account deficit from 3.5% of GDP in 1984 to 2.4% in 1985; (c) a monetary reform that included the introduction of a new currency unit pegged to the US dollar and a system for de-indexing peso- denominated contracts; and (d) a wage-price freeze. The program was supported by an agreement with commercial bank creditors to: (a) reschedule about US$13.9 billion in principal payments during the period of the stand- by (1985/86); (b) provide US$4.2 billion of new money, of which US$2.2 billion were to be disbursed by September 1985; (c) establish a trade credit maintenance facility to maintain such financing at its level of September 30, 1984; and (d) establish a stand-by money market facility that maintains creditor banks' deposits with Argentine banks at their level of September 30, 1984. 13. The Government has been able to stabilize the economy in the short-term, and meet the targets and draw down the first tranche under the  - 4 - DMF stand-by agreement. The monthly rate of inflation, as measured by the consumer price index, has dropped from 30X in June of 1985 to 2.5X in December. The overall public sector deficit has been reduced to about 4Z of GDP as a result of the revenue and expenditure measures and the sharp drop in inflation. The reserve position of the Central Bank has also shown some improvement, reflecting increased confidence in the Government's policies. The Government has also received the first disbursement of new money under the agreement with the commercial banks. Almost all political and social groups have thus far supported the program despite its austere nature. Since cuts in public spending and high real interest rates will have a dampening effect on domestic demand, the Government has been careful not to raise expectations for a quick economic recovery. In this connection, the industrial and other non-agricultural sectors are experiencing a severe recession which began in late 1984. Real GDP is estimated to have declined by about 4.5% in 1985. Export response to the program has not yet been significantly positive, and recent floods have adversely affected the exportable output of grains. The Government has now moved into a second stage of its program under which it proposes to undertake the policy actions needed to resume strong economic growth on a sustained basis. The Government's program focusses on the expansion of exports, stimulation of new construction, privatization of state enterprises and greater reliance on the private sector for oil exploration and production. 14. The program's risks relate to the possibility of a renewal of inflationary pressures once the wage and price freeze is relaxed. Thus, the Government has indicated that the freeze will continue into 1986 and then be phased out gradually. The Government's economic program has been far more successful than initially expected and augurs well for improved economic performance. A continued effort to reduce the overall fiscal deficit below current levels will be required to break longer-term infla- tionary expectations and ensure the program's success. Thus, the Govern- ment has indicated that it will continue to act in the fiscal area as needed. C. Development ProspectF and Policy Requirements 15. Argentina's growth performance in the next five years will depend heavily on the continued success of the present stabilization policies and the initiation of structural reforms. Restoring domestic and overseas con- fidence in economic management and renewing private sector investment will require maintaining the recent trends in price stability. Moreover, given the burden of external interest payments on Argentina's gross domestic savings, public investment will be limited largely to improving the efficiency of existing capacity and completing unfinished projects. The Government has stated its intention to give priority to those projects which alleviate immediate bottlenecks, have a high rate of return and can generate foreign exchange. 16. Argentina's key development objectives are to: (a) strengthen and expand the growth of exports in order to reduce the country's external debt relative to GDP and exports; and (b) resume medium-term growth as the stabilization program takes hold. The Government's economic program and policies are being designed to achieve these objectives. In particular, special emphasis is being given to the elimination of distortions in order  -5- to produce a rapid output and export response. Faster recovery of per capita consumption can take place only after medium-term growth has resumed. 17. The Government has formulated a medium-term growth strategy for 1985-89. The strategy is based on an improvement of the investment climate and the restoration of adequate export incentives. The proposed policy measures are closely in line with the recommendations of the 1984 Country Economic Memorandum (CEM), i.e., (a) improvement in public sector finances and efficiency; (b) overhaul of the tax system and tax administration; (c) reduction in the number of public enterprises and reform of government- enterprise relationships; (d) improvements in incentives for private indus- try and agriculture; (e) reform of the financial system and active support for manufacturing exports; and (f) increased oil exports through increased private sector participation. Since the strategy aims to promote productive fixed investments, real per capita consumption is projected to rise only slightly during 1985-90. The Government is now in the process of giving this strategy concrete operational content and defining the instruments for its implementation to make it viable over the medium-term. Growth and Balance of Payments Prospects 18. Improving Argentina's growth prospects for the rest of the decade would require successful implementation of the adjustment program during 1986, the rescheduling of the country's external debt by its creditors as it falls due, continued lending at the agreed amounts, and a continued expansion in exports through the rest of the decade. Under those assumptions, the current account deficit of the balance of payments is projected to reach about US$2.3 billion per year during 1986, equivalent to 3.2X of GDP, to be financed largely by disbursements from the IMF stand-by agreement, increasing disbursements of existing and projected loans from public sources, and direct foreign investment. Based on the timely adoption by the Government of medium-term growth policies, real GDP growth, beginning in 1986, could resume at about 3% per year on average. This growth depends on the projected expansion in exports, in particular, by increasing agricultural production through intensified use of fertilizer and expanding industrial production through renewed private sector investment activities, and on the availability of sufficient external financing. Under these assumptions, the current account deficit would decline rapidly from 1988 on, as a result of increasing proceeds from grain and manufacturing exports. Thus, the current account deficit of the balance of payments is projected to fall below US$100 million in 1990. Debt Service and Creditworthiness 19. At the end of 1985, the total public sector external debt of Argentina was US$42.5 billion. From US$8.4 billion at the end of 1978, it had grown more than four-fold. The structure of the debt also had changed radically during the 1978-1983 period. At the end of 1978, the debt to commercial banks constituted 38% of the total, but this ratio rose to 60% by the end of 1980, and to 87% by the end of 1984. By 1979, total debt service requirements already had gone beyond the reach of net exports, and since 1982 the trade surplus, although large, has not been sufficient to pay the accrued interest. Thus, when the South Atlantic crisis disrupted normal roll-overs and lending in 1982, Argentina began accumulating principal and interest arrears. The Government provided exchange rate guarantees for the rescheduled private external debt and eventually assumed  - 6 - a large part of the private sector's external obligations. Total external debt, including arrears and private sector obligations, reached US$46 billion by the end of 1983. Following the agreements with the IMF and its creditors, Argentina initiated a program to eliminate payment arrears, with commercial banks contributing US$4.2 billion to the effort. 20. A continued effort by the Government in implementing domestic policy reform, including a reduction in protectionism, combined with external support from financial sources, should enhance Argentina's export potential and thus improve prospects of reducing its debt servicing ratio and also its total debt as a percentage of GDP during the 1990s. Provided that the arrears are eliminated according to the current program and that the debt amortization payments due in 1986 are restructured with a modest increase in the commercial banks' exposure, Argentina should be able to meet the servicing requirements of its external debt, including new borrowing for high-yielding projects which would support Increased foreign exchange generation, efficient import substitution and increased domestic resource mobilization. At the end of 1985, the Bank's share of Argentina's total debt outstanding and disbursed was 1.4% and its share of external debt service payments was 2.3%. PART II - BANK GROUP OPERATIONS IN ARGENTINA 21. Past Bank lending to Argentina has been sporadic because of periodic macroeconomic and sectoral difficulties. In the period 1979- December 1985, the Bank made loans for ten projects totalling US$1,045 million. Bank lending since 1980 has focused on major infrastructure pro- jects and provision of credit ior development of the industrial and hydro- carbon sectors. The Yacyreta Hydroelectric Project is intended to harness the enormous potential of the Parana River to provide base-load electric energy for Argentina in the 1990s. The Second Industrial Credit Project supports the modernization and expansion of export-oriented industries. A Highway Sector Project is helping to augment and maintain the road network. In parallel with the above projects, the Bank has supported the Government's efforts to exploit Argentina's energy resources; for this purpose, five loans were approved during the above-mentioned period to: (a) help Argentina assess its hydrocarbon reserves; (b) improve the basis for rational exploitation of coal resources; (c) facilitate private sector participation in exploration and production of oil and gas; (d) alter the country's two major refineries in order to meet changing demand patterns; and (e) expend Argentina's capacity to make effective use of its hydro- carbon reso- rces and increase the utilization of natural gas and its by-products. The Water Supply and Sewerage Project approved by the Board last December will help improve sector finances and develop provincial agencies. 22. In recent years, Bank operations in the agriculture sector have been limited to three projects. The Balcarce Livestock Development Project was designed to encourage the adoption of new technology in pasture produc- tion and management and in animal health practices; it was completed with mixed results. The Agricultural Credit Project was approved in May 1978 as a follow-up to the Balcarce Project, to provide medium and long-term credit for on-farm investment. It could not be implemented because of the availability of alternative finance at more attractive terms, and was cancelled in April 1980. The present Grain Storage Project is designed to  - 7 - Increase volumes and improve the efficiency of grain exports. Following changes, the project now provides f or: (a) government construction and rehabilitation of 27 silos; (b) a credit line for private sector investment in grain storage and handling facilities; (c) purchase of some 845 rail-cars for grain transport; and (d) improvements in railway and port infrastructure. All components have now been initiated. 23. The implementation of Bank-assisted projects in Argentina has suffered in recent years from policy reversals, cumbersome bureaucratic procedures, cu:'bs on public investments stemming from the need for fiscal austerity, and the private sector's reluctance to invest in an uncertain economic environment. The Government shares the Bank's concern about this situation, which has resulted in unexpectedly slow disbursements. In response, several existing projects, including the Second Industrial Credit and the Oil and Gas Credit Projects, have been restructured to improve their execution and the First Vocational Training end Technical Education Project is in process of being restructured. The Bank has also instituted procedures for monitoring monthly disbursements and for periodic project implementation reviews with the Government. Disbursements under Bank loans in 1985 were more than double the 1984 rate. 24. Promising prospects for political stability and serious efforts by this Government to tackle Argentina's thorny economic problems provide the Bank with an opportunity to play a key role in the country's economic recovery and future development. The Government has requested the Bank's help in implementing a stabilization program and in preparing the way for renewed long-rerm e'onomic growth. Over the short-term, the Government is seeking help with economic analyses and expanded lending operations designed to enhance domestic resource mobilization and increase the avail- ability of foreign exchange. Our economic and sector work program includes a comprehensive export-oriented industrial study and a major public sector investment review which is being completed. Recently, Bank staff discussed with the Government the framework of a medium-term economic policy reform and development program that could lay the grounds for expanded external lending to foster economic growth and strengthen Argentina's debt servicing capacity. 25. The Bank has appraised a proposed Bahia Blanca Port Project, which would reduce shipping costs for grain exports and a Supplementarv Refinery Conversion Project to support the substitution of abundant natural gas for oil. The Bank is also processing a Technical Assistance Loan for reforning public sector management and strengthening the international competitiveness of the economy. Preparations are underway for further support of the energy sector directed at distribution and transmission requirements. Preparation is also underway for further support in the industrial sector in the areas o' small and medium scale enterprises rnd financial restructuring of private and public sector firms. The Bank is also reviewing possibilities, based on the recommendations of recent public sector investment and industrial sector development missions, to cooperate with the Government through policy-based lending in the implementation of important structural reforms, apart from the reforms initiated under the proposed Agricultural Sector Loan, in the areas of trade and privatization of state enterprises. 26. IFC has made 25 investments in Argentina, totalling US$251 million, of which US$142 million has been repaid, cancelled or sold. A summary of its investments is shown in Annex II. Promotional efforts are  - 8 - geared to export or import substitution-oriented projects with emphasis on oil, petrochemicals and related sectors. IFC will also continue to seek investments in projects where its presence would facilitate the formation of joint ventures with foreign participation, and act as a catalyst to attract higher levels of commercial financing. PART III - THE AGRICULTURAL SECTOR A. Overview 27. Argentina's agricultural sector contributes about 15% of GDP, 17Z of employment, 75% of foreign exchange earnings, and between 14% and 20Z of Central Government tax revenues, principally in the form of export taxes. Argentina's diverse agroclimatic base permits production of a wide range of agricultural commodities that enables self-sufficiency in most agricultural needs. Cereals and oilseeds represent principal crop activities, account- ing for over 90% of the area devoted to crop production. The country has a variety of climatic conditions ranging from subtropical to cold, but lies mainly in the temperate zone. Production conditions in Argentina allow it to have a comparative advantage compared to most of its competitors. While agriculture has been growing at a rate of about 3% annually in recent years, the sector is advancing below its production potential. The sector has progressed in technological improvements (farm mechanization, improved varieties, better crop rotation, and double-cropping), despite government policies non-conducive to rapid introduction of modern technologies and, more recently, the deterioration in the terms of trade resulting from fall- ing world prices. 28. Crop production has grown more than livestock since the early 1970s, primarily through yield improvements rather than area expansion. Yield increases have arisen predominantly from the gradual adoption of modern technologies: (a) higher yielding varieties; (b) plant-protecting chemicals; and Cc) more appropriate farm mechanization permitting improved land preparation and better-timed operations. Each of these technological changes has normally led to high returns on investment with little risk and, except in the case of machinery, has not implied major outlays per hectare. This explains the level of adoption that has occurred even though the policy environment has been less than favorable. Cereal production is dominated by three main crops--wheat, maize, and sorghum--which account for about 95% of total cereal production and for over 95Z of cereal exports. The growth rate of soybeans as a double-crop has been particularly out- standing, supported by a simultaneous increase in area planted and in average yields. Crop-related exports rose from about 70% of total agricul- tural exports in the late 1970s to above 80% in 1983/84. Argentina has generally been supplying about 5% of the annual world wheat exports in recent years and is the fifth largest wheat exporter (after the US, Canada Australia, and the EEC). In maize and sorghum exports, Argentina ranks second only to the US and accounts for about 12% of the world market. Nearly all cereals and oilseed crops are produced under rainfed conditions, and fertilizer is used on only a small proportion of total cultivated area. While rainfed production is expected to continue to dominate, there is substantial e_ope for greater use of fertilizer and other inputs and for investment in infrastructure and equipment to enhance production.  29. The slower growth of livestock production since the mid-1970s partly reflects the normal production cycles of the three major livestock activities (cattle, sheep, and pigs), and also a declining export market for beef as the dominant livestock product; the latter situation has been largely due to subsidized exports from the EEC. With beef prices rela- tively higher than cereals in the late 1960s and early 1970s, the national cattle herd increased substantially up to 1976/77. During the 1973-76 period, crop:beef price ratios began to favor cash cropping, resulting in expansion of cash crop production. Expansion of soybeans as a double-crop with wheat also coincided with this shift away from beef. Livestock exports fell from about 30% of total agricultural export revenues in 1976-80 to less than 10% by 1984. Beef export tonnage was only about 10% of production in 1984. B. Constraints on Agricultural Growth 30. Despite technological advances, a well-developed input distribu- tion system, and a highly competitive environment for agricultural product marketing, the agricultural sector has been growing below potential. This has been largely the result of pricing policies that have depressed domes- tic prices for outputs through export taxes, and artificially raised the costs of some key farm inputs through import tariffs. As a consequence, most farmers have opted for low-risk:lower-input technologies that have translated into a significant opportunity cost to the economy in terms of foregone production and export earnings. Average wheat yields, for example, were 70% of those in the US during the 1980-82 period, in large measure reflecting the use of insufficient technological packages in response to unfavorable pricing policies. 31. The Producer's Economic Environment. Historically, farmers have had to face abrupt shifts in domestic economic policies, in addition to coping with commodity price fluctuations occurring in international markets. The high overall level of export taxes, and the price uncertainty associated with changing export tax rates and with inappropriate exchange rate policies, have had negative effects on agricultural investment. In March 1985 export taxes on agricultural commodities were lowered as part of a strategy to stimulate production. However, in early June 1985, the Government increased expcrt taxes by nine percentage points following the 18% devaluation; this was designed to avoid short-term windfall profits to producers and to provide increased fiscal revenues to alleviate the public sector deficit. 32. The relatively high cost of some modern inputs, combined with the reduced product prices caused by the export tax policy, has meant that benefit:cost ratios for use of many high yield technologies were unfavor- able. Until early-1984, import tariffs on agricultural inputs were sub- stantial, ranging from 25% for urea and veterinary medicines to 38% for agricultural machinery and plant protection chemicals. After reductions in tariffs on some key inputs in 1984, principally on nitrogenous fertilizers and insecticides, import tariffs were raised in early-June 1985 by 1OZ as another fiscal deficit-control measure with a validity period of 180 days. There is also a current prohibition (with exemptions subject to protracted  - 10 - and complicated procedures) on the import of a range of agricultural machinery; this represents a development constraint in the case of some items which are non-traditional or of unusual engineering design (e.g., excavators and efficient subsoilers). Argentina is also subject to two other disadvantages compared to competing exporting countries: (a) on the input side, it does not have an efficient local fertilizer industry, resulting in higher cif-based fertilizer costs; and (b) on the output side, since exporters usually cannot offer advantageous financing conditions to buyers, they generally receive lower prices than their competitors. 33. Price distortions have arisen largely because of the Government's policy of taxing agric'iltural exports and imported inputs in an effort to satisfy the non-agricultural objectives of: (a) maintaining low food prices in urban markets; (b) protecting domestic producers of agricultural inputs; and (c) raising fiscal revenues. Export taxes, by far the more serious of the two taxes, have been traditional. Agricultural exports are currently taxed at rates up to 38% on the fob value, excluding a 1.5% levy (para. 40). By reducing domestic prices, they constitute a price control device that increases real wages in the urban sector at the expense of agricul- tural producers. In most recent years, export taxes contributed about 11% to Central Government fiscal revenues, representing about 1.2% of GDP. Export taxes have come to represent the third most important source of Central Government revenues after value-added and fuel taxes, earning about US$1,000 million in 1983 (1.4% of GDP) and in 1984 and an estimated US$1,300 million in 1985 (1.8% of GDP). Soybeans, maize and wheat account for over 60% of export tax revenues. The provinces of Buenos Aires, Cordoba, and Santa Fe collectively contribute over 75% of these revenues. From the Government's view, the export tax has a number of advantages. It is easy to collect; collection costs are low and controls are simple. Second, changes in tax rates can be enacted by the Government's executive branch without Congressional approval, providing flexibility in varying fiscal revenues in the short-term. Third, export taxes have the political advantage of reducing consumer prices and providing an advantage to pro- cessing industries that use agricultural commodities as raw materials. Export taxes, however, are a serious constraint to production and export expansion by reducing price incentives for input use and on-farm investments. 34. Agricultural producers are also subject to federal income and net worth taxes. Scarcity of data precludes identification of agriculture's contribution to these taxes, but both taxes are relatively small. Total collection of both taxes fell to historical lows in 1984: income tax, from 2.4% of GDP in 1977 to 0.5%, and net worth tax, from 1.0% of GDP in 1982 to 0.6%. Provincial taxation of land is relatively low as a percent of GDP, although it represents an important source of revenues for most provinces, particularly in the Pampa zone. Land taxes represented 22% of provincial taxes in 1983, and Buenos Aires Province, which has the most developed land tax system, collected US$135 million in land taxes in 1984. Agriculture is affected by relatively high special taxes on gasoline and diesel fuels, whizh apply across all sectors. Value-aided taxes (VAT) on agricultural inputs range from zero on veterinary products to 18% on pesticides and machinery, but VAT payments can be discounted against net worth taxes due from agricultural enterprises.  - 11 - C. Recent Changes in Agricultural Policies 35. The Government recognizes the need to stimulate agricultural production and exports to achieve economic recovery and has formulated a four-pronged action plan to achieve this goal. First, the Government has clearly established its intent to reduce significantly export taxes and substitute alternative revenue-generating instruments less damaging to agricultural productivity. The recent increases in export tax rates (para. 31) have been viewed as a temporary, yet necessary, component of its economic stabilization program. Second, the Government has a policy of reducing tariffs on imported agricultural inputs to encourage their use, even though reducing the fiscal deficit necessitated a temporary across- the-board tariff increase on all imports (para. 32). Before the recent increase, Government had eliminated tariffs on most agricultural inputs not produced in the country, fertilizers were freed of tariffs and those insecticides which are also produced locally carried only a 10% tariff. Third, the Government's policy is to phase out most quantitative import restrictions (para. 56). Fourth, the Government has committed itself in its agreements with the IMF to exchange rate adjustments thac would help maintain export competitiveness. 36. Other complementary initiatives have been taken. The Secretariat of Agriculture, Livestock, and Fisheries (SAG) has produced a medium-term development plan (the National Agricultural Development Program--PRONAGRO) that is largely in line with the recommendations made by the Bank's last CEM. The Government also introduced a payment-in-kind credit pragram sponsored by the National Grain Board to stimulate fertilizer use which started in the 1984 winter crop season. In addition, the Government has presented to Congress draft legislation to enable it to introduce, in 1986, a production-neutral federal land tax as a partial substitute for export taxes. Lastly, the Government is planning to promote the expansion of the country's domestic fertilizer industry utilizing abundant natural gas resources as a principal feedstock, consistent with recommendations of a November 1984 Bank mission. 37. PRONAGRO defines the following sectoral objectives: (a) increase production of cereals and oilseeds; (b) expand agricultural exports; (c) develop regional economies, particularly in the relatively neglected non-Pampa zone; (d) generate employment; and (e) encourage natural resource conservation. It proposes achievement of these objectives by adopting distinct, complementary strategies in the Pampa and non-Pampa areas, bolstered by selective nationwide initiatives. In the Pampa, PRONAGRO proposes concentration on cereal and oilseed development through techno- logical improvements, agroindustrial development to capture more value added in exports, increased investment in grain storage, and expansion of cultivated area. The last activity would be associated with a shift of livestock production to less productive, non-Pampa areas with concomitant upgrading of livestock technology. In the non-Pampa zone, PRONAGRO proposes emphasizing expansion of traditional and newer, higher value activities, opening new areas for cultivation of grains and other export- able items, agro-based infrastructure, and integrated rural development. National initiatives geared to complement zonal programs would include gradually replacing export taxes with a federal land tax based on  - 12 - unimproved market value, eliminating import tariffs on agricultural inputs, making fertilizer and herbicide use more economically attractive, granting INTA financial and administrative autonomy in its research and extension pursuits, upgrading meat processing and storage facilities, encouraging dairy development, and broadening lines of credit for private investment in the sector. D. Institutional Framework 38. Argentina's agricultural development program involves the par- ticipation of the institutions described below: 39. Secretariat of Agriculture, Livestock and Fisheries (SAG). SAG is responsible for the establishment and implementation of agricultural policy. The Secretary of Agriculture has cabinet rank, but SAG is under the purview of the Ministry of Economy. In addition to formulating pro- grams to attain policy objectives, SAG coordinates the activities of imple- menting agencies operating within the sector. 40. National Institute of Agricultural Technology (INTA). INTA is Argentina's principal agricultural research agency. While operating under the aegis of SAG, since April 1984 INTA has been financed through a sur- charge of 1.5% on agricultural exports and has received support from the Interamerican Development Bank. In addition to its regular technical publication program, INTA's research activities serve as an important resource for private and public extension technicians who service producers and producer organizations. INTA also conducts training for these technicians. 41. National Bank of Argentina (BNA). Established in 1891 and owned by the Government, BNA is the largest of Argentina's four national banks. It is classified as a commercial bank but its charter gives priority to supporting agricultural production. BNA has historically accounted for about 50% of institutional lending to the agricultural sector (the provin- cial banks of Buenos Aires and Cordoba are the other major agricultural lending institutions). BNA has over 500 branch offices and has been one of the Government's key financial agents for borrowing from international organizations. 42. National Grain Board (JNG). JNG, an autonomous agency of SAG, establishes grading systems and marketing regulations for grain trade, administers and manages public grain elevators and storage facilities, participates in domestic and foreign trade, and acts as SAG's executing agency in its payment-in-kind fertilizer program. JNG was the sole buyer and exporter of the major grains in the mid-1970s until the Government liberalized the grain trade and shifted emphasis to development of market- ing by the private sector. JNG is authorized to operate in the domestic market to ensure adequate domestic supplies and to meet international com- mitments made by the Government. JNG can also fix support prices for grain to be adjusted with market conditions, but has limited this activity and doe" not affect market prices by this means; it does, however, effectively compete in the market.  - 13 - 43. National Meat Board (JNC). JNC is an autonomous agency of SAG with control and service functions in the cattle, pig and sheep slaughter industries. It has responsibility for sanitary control of slaughter facil- ities, livestock yard-sale supervision, meat classification and export quality control, live animal and meat statistical and market information, and industry economic investigation. A slaughterhouse levy of IZ of animal value provides most of the resources required to run the JNC, which receives no budgetary allocation for its operation. PART IV - THE LOAN A. Loan History 44. The proposed Agricultural Sector Loan was prepared by the Govern- ment and examined by an appraisal mission in Hay/June 1985 and by a post- appraisal mission in August 1985, subsequent to a request from the Govern- ment to assist in the implementation of policy changes in agriculture. This request followed a dialogue with the Government on the CEM dated June 22, 1984. Negotiations with the Government were held on January 13-17, 1986. The Government delegation was led by Mr. Ramon da Bouza, Director of External Finance, Ministry of Economy. B. Loan Objectives 45. The proposed loan is the first of several Bank policy loans which are intended to assist Argentina in tackling distortions in the economy. It is aimed at improving the incentives necessary for more intensive use of agricultural resources to increase production and exports. Argentina already has a relatively well-developed and export-oriented agricultural sector. While the sector faces relatively less distortions than other sectors in the economy, and therefore offers promising prospects for rapid response, it also faces important constraints to its deveiopment. The reforms described below are a prerequisite to realizing the potential for increasing production and foreign exchange critically needed for the country's economic recovery. The implementation of these reforms would also be consistent with the immediate fiscal revenue requirements in Argentina's current economic stabilization program. C. Loan Description 46. The policy reforms and complementary activities included under the Government's program include: (a) a substantial reduction in export taxes; (b) undertaking fiscal measures to maintain the overall fiscal deficit at satisfactory levels, including the introduction of a federal land tax; (c) modify regulations and tariffs pertaining to the import of agricultural inputs and (d) complementary studies and institutional support. These reforms have been set forth in a Government statement on macroeconomic and agricultural sector policy (Annex IV) incorporating the principles of the reforms and a number of actions to be undertaken by the Government for this purpose. 47. Export Tax Reduction Program. The Government is aware of the production-negative impact of export taxes, as was evidenced by the reduc- tion in the tax rates in March 1985 (para. 31). However, export taxes have  - 14 - contributed about US$1 billion annually to fiscal revenues in recent years, and cannot be reduced without an alternative source of revenues. This replacement is even more critical in view of the ongoing economic stabili- zation program. 48. Consequently, the Government is assuming at this stage that the sector will have to provide a large part of the substitute revenues for export taxes foregone, at least in the immediate future. A land tax is a feasible alternative means of generating substantial revenues, and the Government will present to Congress, as a condition of loan effectiveness, draft legislation for the introduction of a federal land tax which would yield initially about 0.5% of GDP. Existing data on tax collections does not serve to accurately define agriculture's current contribution to fiscal revenues since it only includes tax collections from a few provinces. Similarly, further analysis is required to assess the proportion of fiscal revenues that should be supplied by the sector. The Government will therefore undertake studies to determine the appropriate level of taxation for the agriculture sector and to analyze the possibilities of alternative fiscal measures to complement the fiscal revenues from the land tax. 49. The IMF supports the reduction in export taxes to strengthen the competitiveness of exports within a viable macroeconomic framework which would maintain the overall fiscal deficit at agreed levels. The Argentine authorities have included in the 1986 Budget the measures needed to control the fiscal deficit at satisfactory levels, consistent with the objectives of the stabilization program. 50. The reduction in export taxes would proceed progressively over a four-year period. The Government has already rescinded the June 1985 export tax increase applicable to wheat, maize, sorghum, sunflower, sunflower oil, sunflower meal, soybeans, soybean oil and soybean meal. It was agreed during negotiations that all of these would be conditions of loan effectiveness; hence, the Government has moved more expeditiously than envisaged at that time. The Government has already provided the Bank with the 1986 budget information indicating the fiscal measures compensating for the loss of revenues arising from this reduction. The resulting reduction in the sector's tax payment would be about US$300 million. As a condition of release of the second tranche of the proposed loan, the Government would further reduce export taxes on all agricultural commodities to a level not to exceed 70% of the May 1985 level, or such other level as may be agreed between the Government and the Bank, based on a forecast of the revenues to be generated by the projected federal land tax (para. 51) and other measures affecting public sector revenues and expenditures in 1987. This second reduction is projected to result in a decrease in export taxes of US$270 million. A larger reduction in export taxes during the initial  - 15 - phase of the program would be difficult to substitute and, therefore, could seriously jeopardize the possibilities for continued success of the Government's adjustment program, which has already required a sharp reduction in the overall fiscal deficit. It is the Government's intention to further reduce export taxes on the major commodities consistent with export competitiveness. It expects to seek Bank support in implementing the later stages of this program. 51. The Federal Land Tax. The draft legislation provides for the introduction of a federal land tax based largely on unimproved land market values. Since there are some constitutional constraints to the establish- ment of a federal land tax, the proposed land tax would be computed as an advance payment of other taxes (i.e., taxes on income and capital) and given an emergency character which would allow it to last for five years. As has been customary with other emergency legislation, it is expected that the land tax will be renewed at the end of each five-year period. Initially, the tax would be at a flat rate of up to 2% on all land with a fiscal value above the exemption level, but progressivity would be introduced as composite ownership registers are improved. All 23 Argentine provinces have cadastres and impose land taxes, but there is a range of methodologies used to calculate fiscal values, which causes inconsistencies in the tax burden on comparable land. Fiscal values of rural land parcels throughout Argentina would, therefore, be adjusted by indices specific to each taxation zone in order to more closely reflect realistic and comparable unimproved land values for each parcel. This adjustment would rely on records of recent land sale prices and assessments by informed public and private sector entities (e.g., bankers, sales agents, agricultural consultants and extension officers). The process would take from four to six months (Annex V), and would provide the basis for the imposition of a land tax able to generate about US$250 million annually after passage of the required law and regulations. This would represent the first of two phases of implementation of the federal land tax program. The Government has furnished the Bank a program for the preparation and implementation of the land tax schedule, which defines (i) federal and provincial institutional arrangements; (ii) studies, activities, equipment and personnel required; (iii) costs, funding sources and arrangements; and (iv) the schedule for the implementation of the land tax in accordance with the draft legislation. 52. Although this country-wide adjustment would put fiscal land values on a comparable basis, some inconsistencies would continue to exist because of erroneous fiscal values of individual parcels that have developed due to peculiarities in local adjustment processes. Therefore, for the more productive agricultural zones and provinces, a more refined fiscal value system which would provide new indices for each land parcel would be established. It would continue to be based on unimproved land market values, but individual land assessments could be reduced to a poten- tial land productivity value, should the latter be less than the market value assessment (Annex V). This would be accomplished before imposition of the second phase of the program, in which it has been estimated that  - 16 - over US$500 million p.a. would be generated initially (including the revenues previously collected by the flat rate tax). Areas not subject to this more refined valuation system would be those that are not as productive, not as valuable, make a minor contribution to current export taxes and, consequently, could not be expected to contribute substantially to the federal land tax. In the medium term, they would be taxed at a relatively low rate in accordance with their lower values based on the revised unimproved market value system. 53. Institutional Arrangements and Taxation Studies. An Executive Committee (EC), chaired by the Secretary of SAG with representatives of the Secretaries of Finance and the Interior, will be formed, as a condition of loan effectiveness, to oversee the preparation and initiation of the federal land tax, and the sectoral tax studies. This also includes participation from the Consejo Federal de Inversiones (representing provincial interests). In each province, advisory committees consisting of the heads of the proviacial cadastral, tax collection and computer centers units will be formed to work with the EC. Considerable cadastral expertise has been built up in Argentina since the 1940s, and the methodology to be used in the program is already well established in some provinces. The Committee will also be supported by a working group on overall sectoral tax policy. A project preparation facility (PPF) advance of US$1 million has been granted to initiate preparation activities. 54. The proposed loan would finance the land tax preparation-impie- mentation program to end-1987, which would amount to US$7 million in loan funds. The priority activities of the EC would be as follows: (a) analysis of the existing cadastral situation in each province, and definition of the requirements for implementing the first and second stages of the land tax program, including funding arrangements for both federal and provincial activities; (b) implementation of the survey to develop adjustment indices for each taxation zone and derivation of fiscal land values based on the revised unimproved land values; (c) historical analysis of the sources of provincial revenues, including fiscal transfers from the Federal Treasury and the role of land taxes in provincial collections, followed by analyt- ical work on provincial-central government tax sharing proposals; and (d) simulation of total fiscal revenue effects of various tax levels and fiscal values based on typical farm systems for each taxation zone. The above activities would be necessary for the implementation of the first phase of the federal land tax program. 55. The EC would also, at the same time, initiate a series of taxa- tion studies required for the full implementation of the land tax proposal and would have completed these by end-1987: (a) additional work on agl.- economic, agroecological, land registration and mapping aspects required for defining zones of similar agricultural potential and improving the cadastral base in the more productive agricultural areas; and (b) institu- tion of a system for monitoring the investment-production environment in the sector to provide information relevant to sectoral taxation policies (this would draw on the continuous analysis of agroeconomic factors necessary to adjust land productivity values). The sectoral taxation work-  - 17 - ing group would analyze the existing tax burden on the agricultural sector, recommend the proportion of the total tax burden which the sector should carry and analyze the fiscal alternatives to the export tax. 56. Import Regulations and Tariffs. The Government has already rescinded the temporary increase in import tariffs imposed in June 1985 with respect to fertilizers. It has agreed, as a condition of the second tranche of the proposed loan, to rescind the temporary import tariff increase affecting herbicides and other agricultural chemical inputs. Moreover, the existing prohibition on the import of tractors and any agricultural machinery would be replaced with an import 'subject to prior review and approval' classification (as a condition of effectiveness) and subsequently (for the second tranche) automatic entry' classification. This would racilitate and practically make automatic the importation of appropriate agricultural equipment. In addition, a proposed Trade Policy Loan (under preparation) would, inter alia and in a broader context, support a program of phasing out quantitative import restrictions and rationalization of tariff levels, in addition to reorienting export policies to provide automatic access to incentives and foreign exchange to export industries, and improving the administrative mechanisms of trade management. 57. Complemnentary Sectoral Studies and Institutional Support. In addition to the resource transfer under the proposed loan in support of the Government's sectoral policy changes and the direct financial support for the land tax and sectoral taxation studies and activities, a number of com- plementary studies and related institutional development components would be financed. They are in consonance with the medium-term development strategy set forth in PRONAGRO (para. 37), and would improve the Govern- ment's ability to manage some of the sectoral changes anticipated under the tax reform program. The studies pertain to (a) marketing and production strategy, and long-term transport and storage requirements for agricultural products, principally grains; (b) technical and economic feasibility of supplementary tubewell irrigation in the maize production region; (c) structural changes in the livestock industry associated with intensi- fication of crop production in the humid Pampa; (d) development and promo- tion of agricultural and agroindustrial exports for the non-Pampa areas; and (e) evaluation of the existing organization of the JNG, definition of necessary improvements and elaboration of legal instruments necessary to effect these changes. Both the JNC and the JNG would receive institutional support under the proposed loan to improve their market information collec- tion, analysis and dissemination systems. 58. The total cost of these studies and programs would be approxi- mately US$2.18 million, of which about US$180,000 would be local counterpart funding (Annex VI). Loan funds for these studies would be administered through the UNDP. The aforementioned US$1 million PPF advance (para. 53), to be repaid with funds from this loan, would also cover eight man-months of consulting time to prepare the terms of reference for the studies (a) to (d) noted in para. 57.  - 18 - D. Loan Features and Oneration 59. An agricultural sector loan of US$350 million is proposed, including the financing of complementary studies and institutional development amounting to US$9 million. The loan would support the Government's efforts to depart from its reliance on easily-collectible but production-negative export taxes for agricultural sector taxation, and to introduce an effective federal land tax. Loan proceeds totalling US$341 million would finance general imports and would be released in two equal tranches following compliance with the conditions for their release, defined below. 60. The first tranche of US$170.5 million, projected to be disbursed before June 30, 1986, would be released upon effectiveness of the loan, which is subject to receipt of evidence of: (a) presentation to Congress of draft legislation for the introduction of a federal land tax; (b) establishment of the Executive Committee (para. 53); (c) redesignation of tractors and agricultural machinery to the -prior approval- classification for imported goods; and (d) Government's execution of subsidiary agreements with the JNC and JNG for the complementary studies and institutional support activities. Disbursement under the loan component for studies and institutional support would be contingent on the presentation of terms of reference acceptable to the Bank for the five complementary sectoral studies and two institutional support components (para. 57), and the agri- cultural sector tax burden study (para. 48) and execution of a project agreement between the Government and UNDP, satisfactory to the Bank, which will define the role and responsibilities of the UNDP and the Argentine ministries and agencies involved in the execution of these components. 61. The second and final tranche of US$170.5 million, projected to be disbursed in January 1987, would be released after receipt of evidence of: (a) the reduction of the export tax on agricultural commodities to a level not to exceed 70% of the rates in force on May 1, 1985 or other such levels as may be jointly agreed; (b) the Government having put into effect fiscal measures sufficient to compensate for any revenue losses resulting from the export tax reduction without increasing the overall tax burden of the agricultural sector as compared to its May 1, 1985 level; (c) the designation of tractors and agricultural machinery to the -automatic entry- classification for imported goods; and (d) the Government having made satisfactory progress in the execution of the agreed land tax implementation schedule (para. 51), including a simulation of the fiscal revenue effects (federal and provincial) of the land tax rates included in the land tax program, and in all studies being financed under the loan. 62. Loan Disbursement. A total of US$341 million of the sector loan would be disbursed within 12 months of loan effectiveness against general imports, excluding specific items. This is appropriate because: (a) there are currently no restrictions on the acquisition of foreign exchange for imports of agricultural inputs; and (b) the limited volume of eligible agricultural imports would not allow quick drawdowns of each tranche. 63. Imports to be financed under the sector loan would be made by public entities and a large number of private sector importers. Contracts for the procurement of goods to cost the equivalent of US$5.0 million or more shall be awarded through international competitive bidding in  - 19 - accordance with Bank guideliness. Contracts under that equivalent would be procured through the normal procurement procedures of the importing entity. Disbursements for these imports would be subject to the Bank's guidelines and restrictions. The taxation and complementary sectoral studies administered through UNDP would be disbursed against a blanket withdrawal application which would allow monthly advances to be justified and replenished against documentation for actual expenditures. All disbursements, except for those administered by UNDP, would be made against a statement of expenditures. Procurement of goods and hiring of consultants under the loan portion administered by UNDP would be made under Bank guidelines. The proceeds of the proposed loan would be disbursed as follows: 100% of foreign expenditures for general imports, total expenditures administered through UNDP, and 100% of amounts due for repayment of the PPF advance. 64. Loan Channeling. The Argentine Republic would be the Borrower of the proposed loan, but the proceeds of the loan will be made available to and administered by the Central Bank (BCRA), except for the technical assistance component which would be transferred to the relevant agencies. BCRA will maintain separate accounts to record and monitor loan disburse- ments and repayments. All records and accounts related to expenditures financed under the proposed loan, including those for statement of expendi- tures and the Special Account would be audited each fiscal year in accord- ance with sound auditing principles by independent auditors acceptable to the Bank. 65. Special Account. In order to facilitate disbursements, a special account in US dollars with an initial deposit of US$50 million would be established in the BCRA. The initial deposit would be made after the con- ditions for the release of the fiist tranche of the US$170.5 million have been met. E. Benefits and Risk 66. Benefits. Taxation reforms proposed are expected to yield higher rates of capital accumulation and greater use of yield-augmenting inputs brought about by improved prospects for profits and enhanced producer con- fidence. To estimate likely increased production and exports, an econo- metric model was employed. The model concentrated on the five major export crops (wheat, maize, sorghum, soybeans and sunflower), which are estimated to have generated about 80% of the 1985 agricultural export tax revenues. The model predicts area planted to each crop in accordance with various price scenarios; the Bank's international commodity price projections were used for calculating future farm product prices and fertilizer costs. Projected beef prices were included because of their interactive effect with some of the crops analyzed, and a variable capturing producer response to risk was also incorporated. Yields per crop were based on estimated farmer adoption of technical packages in accordance with incremental benefit/cost ratios associated with use of these packages. Therefore, planted area, harvested area, export surplus, export revenue, and export taxes under various export tax rate scenarios were derived from the model. 67. The short- and medium-term impact of various export tax scenarios on export revenues and associated income transfer from consumers to produ- cers is described in Annex VII. Under the programmed reduction in export  - 20 - taxes to 50Z of the May 1985 levels by 1988, the model forecasts an incremental 5.4 million tons of the five commodities produced and an incremental 3.9 million tons exported annually by 1990 compared to the level that would prevail in case the export tax would remain unchanged. Such increases in exports would be essential for the projections mentioned in para. 18 to materialize. With the exception of sorghum exports, both production and exports of all major commodities are projected to increase as export tax rates are reduced. These projections take into account the projected decline in world market price through 1990 for the commodities concerned. The incremental net foreign exchange earnings from the five commodities (after deducting additional foreign exchange costs incurred in producing incremental exports) under the programmed export tax levels would be about US$1.2 billion per annum by 1990 compared to the earnings at the higher tax rates. With the export tax rates held at 70% of the May 1985 levels, the incremental net foreign exchange earnings would be about US$800 million. Consequently, the positive effects of the export tax abatements would be substantial. 68. The reduction in export taxes would reduce the implicit subsidy from producers to consumers. However, as only about 27% of the five major crop commodities are consumed locally, the total income transfer from consumers to producers is limited. Cereals and their by-products and edible oils, for which significant price changes would occur under the export tax reduction program, constitute only about 7% of the CPI in the lowest income group; meat prices, which make up about 13% of the CPI in this income group, would incur little change due to their relatively low existing tax rates. The increase in consumer expenditures brought about by the reduction of export taxes would be about 1% for the highest income group and about 2% for lowest income group. 69. Risks. Implementation of the Government's agricultural policy adjustment program and Bank loan are not without risks. The Government may not succeed in stabilizing the economy. This would inhibit implementation of the policy reforms and prevent the anticipated production response. Key elements of the program are: (a) a permanent reduction in the fiscal deficit; (b) elimination of monetary creation by the Central Bank; and (c) the maintenance of an adequate exchange rate. There may be slippages in any of the Government's targets which could potentially jeopardize the sectoral development program. The current stabilization program, however, is considered appropriate to address current economic difficulties and improve the investment climate in the short-term. It has been successful in stabilizing the economy so far. 70. Export taxes have been a politically expedient instrument to generate fiscal revenue. However, once the federal land tax is introduced, the reinstatement of major export taxes after their reduction under the policy reform program is not expected because: (a) the Government states in the introduction of the draft land tax law that the land tax is intended as a substitute for export taxes. Thus, there will have been a structural change in the tax system; and (b) there would be much political opposition to increased export taxes after suitable means of maintaining the fiscal balance at satisfactory levels have been found. In addition, the Government is in the process of undertaking a tax reform to seek fair and specific means of maintaining the fiscal deficit at levels consistent with price stability. These risks are also expected to be reduced because of conditions included in the stand-by agreement with the IHF and by Bank monitoring in the context of the loan.  - 21 - 71. Although Argentina has a history of pervasive tax evasion, the collection of the proposed land tax is not expected to be a significant problem, since the mechanisms for collecting the land tax exist at the provincial level and will be utilized to collect the new tax. In addition, means to address the potential payment delinquency problem would be addressed in regulations supporting the legislation; seminars and training sessions on the administration of tax collection are supported in the preparation activities under the proposed loan; and, furthermore, improvements in tax administration are addressed in the Bank's proposed Technical Assistance Loan. 72. Anticipated increased exports (ranging from 1.5% to 2.5% of the world market for the commodities concerned) are not expected to signifi- cantly influence projected world commodity prices, given the current world market structure. In the event that international commodity prices decline even further than anticipated, Argentina should be able to continue to com- pete and find suitable markets for its products because of its competitive production advantage. Moreover, comprehensive quantitative analyses demon- strate that the profitability in agriculture would be increased suffi- ciently by the export tax reduction to promote an output response of the expected magnitude. F. Monitoring and Reporting 73. The Bank would monitor the progress in execution of agricultural sector policies through: (a) compliance with specific agreements on trade and fiscal reforms included in this loan; and (b) regular supervision and exchange of views with the Government on policies to increase agricultural output and exports. It is envisaged that the Bank's monitoring will incorporate the IMF's view on progress with respect to maintenance of export competitiveness. The federal land tax implementation studies and activities, and the complementary sectoral studies and institutional support component, would be monitored in regular Bank supervision missions and through periodic reports. These reports would be submitted to the Bank by the Government in accordance with a timetable satisfactory to the Bank. Special reports on progress in the land tax preparation study would be sub- mitted to the Bank prior to the release of the second tranche. No later than six months after the closing date of the Loan, the Borrower would sub- mit to the Bank a report on the execution of the Loan. PART V - RECOMMENDATION 74. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed loan. A.W. Clausen President Attachments March 14, 1986 Washington, D.C.  - 22 - T A b L ANNEXI -_-AL J TAY1T Page 1 of 6 WiT (MIT "VWATUU L.T. I3ecLk 197O. "UTArla LAT. AIShCA & CAlt