nmJ STRICTLY CONFIDENTIAL 1 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION Tuesday, March 29, 1988 Washington, D.C. The meeting of the Executive Directors was convened at 10:10 a.m. in the Board Room, 1818 H Street, N.W., Washington, D.C., Messrs. W. David Hopper and Moeen Qureshi, Chairmen, presiding. MIUER REPORTING CO., INC. 507 C Street, N.E. STRICTLY nm2 CONFIDENTIAL 2 C O N T E N T S ITEM PAGE 2 Proposed Loan - Argentina (Banking Sector) 77 Mr. Luschin 79 Mrs. Rubio 93 Mr. Sherwin 96 Mr. Faint 109 Mr. Haxthausen 119 Mr. Potter 127 Mr. Boehmer 140 Mr. Dujmovic 145 Mr. Malan 148 Ms. Burdin 151 Mr. Al-Sultan 152 Mr. Guimaraes 160 Mr. Myers 161 MILLER REPORTING CO., INC. 507 C Street, N.E. Washington , D.C. 20002 STRICTLY CONFIDENTIAL nm77 77 MR. QURESHI: Good morning, ladies and gentlemen. We turn to the second item on the agenda, which is a $400 million banking sector loan to the Republic of Argentina, and Mr. Larrain will present it to you. I am also pleased to welcome from the IMF Mr. Lachman who is attending this meeting. Go ahead, Mr. Larrain. MR. LARRAIN: Thank you. Mr. Chairman, Members of the Board: Efficient financial systems play an important role in mobilizing savings and in allocating these resources to the most productive investments. This role is particularly important in countries with limited access to external financial markets. The mobilization and allocation of resources can be impaired by ceilings on interest rates, lack of confidence in the banking system, government intervention in the allocation of credit, loose lending policies, and insufficient banking supervision. In such an environment, even well-conceived adjustment programs to increase productivity and promote MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm78 78 sustained growth are bound to fail. To give just one example, even if relative prices are adjusted to make exports more competitive, firms may fail tu take advantage of new incentives because the financial system does not provide the required financing. Well developed financial systems also provide, through the capital markets, long-term sources of funds. These funds, whether debt or equity, facilitate the financing of long-term investments. From the savers' point of view, capital markets provide more varied risk/reward options, favoring savings. The loan before you would be the first in a series to help reform Argentina's financial system. It would assist the banking system regain its capacity to mobilize and allocate resources efficiently and return the central bank to its more appropriate functions that include a strong super- visory. Subsequent operations could focus on developing capital markets, on which the Bank will complete a study shortly. Thank you. MR. QURESHI: Thank you, Mr. Larrain. I call upon Mr. Luschin. MR. LUSCHIN: Thank you, Mr. Chairman. MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm79 79 The document describes quite dramatically the present situation of the Argentine banking sector. There can be no doubt that the reforms at which the proposed loan is aiming at are urgently needed by the sector and by the Argentine economy as a whole. The risk associated with this loan is quite a heavy one, in view of the rather erratic performance of the Argentine economy in the past. The recently concluded agreement between Argentina and the IMF on a medium-term policy framework for structural adjustment is certainly a welcomed new development. At the same time, we have to realize that conunercial banks remain skeptical about Argentina's ability to adhere to the agreed progran, in view of Argentina's inability to stick to previously-concluded IMF agreements. This given skepticism will certainly impede discussions on a new medium-term external financing plan also involving commercial banks, which still needs to be worked out. According to the document, for 1988 the new external financing need amounts to some US $3 billion. I am v ery much inte rested to hear how this financial gap can possibly be filled, and what role the World Bank will MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D .C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm80 80 possibly play in this regard. As to the proposed banking sector loan, I certainly would have liked to see a more heavy front-loading of the loan than actually proposed. If we take a look at Annex Roman III of the document, we realize that the loan will become effective and that the first tranche will actually be disbursed on the basis of initiated programs or programs still to be provided by the Argentine authorities. It is only a condition for the release of the seco nd tranche that the Argentine authorities will actually have to comply with the proposed programs. Speaking more generally, I believe that the release of the first tranc he on the basis of programs only constitutes a basic problem of the Bank's policy-based lending operations. It i s exactly fo r this reason, namely that the disbursement of the f i rst tranc h e is bas e d o n p r omises by g o v ernments which might change o r might change their mind, it is exactly for this reason that financial markets are worried abo ut the exte n t o f structura l adjustme nt l o ans and sec tor loans by t h e World Bank, especially for heavily-indebted c ountries. I have ano ther serious problem with the p r oposed sector l o an, and t h at is that there d oe sn ' t seem to be any kind of link between the proposed re form measures in the MILLER REPORTING CO., INC. S07 C Street, N.E. Woshingcon, D .C . 20002 ( 202) S46-6666 STRICTLY CONFIDENTIAL nm81 81 banking sector, on the one side, and the use of the bulk of the loan, on the other side; $399.5 million U.S. dollars out of the proposed $400 million loan will be used to cover the costs of eligible private and public sector imports. Only $1/2 million U.S. dollars of the loan will actually be used to cover costs in connection with the proposed restructuring of the Argentine banking sector. I believe that a substantial portion of a sector loan should actually be used for the support of the policy and institutional reform in the sector concerned. I would have thought that many financial institutions in Argentina are in heavy need for long-term financing in order to allow them a successful restructuring effort. I also would have thought that a deposit insurance scheme can be successfully established only when strongly supported by initial outside financing. In light of the disastrous situation of the Argentine banking system as a whole, I doubt that the Corpo ratio n can b e financed initially by fees from partici- pating banks only. To sum up, Mr. Chairman, I wanted to make two g enera l points. My first point wa s the issue of front- loading. I really believe that there is a serious concern in MILLER REPORTING CO., INC. 507 C Street. N.E. Washington, D .C. 20002 (202) )46-6666 STRICTLY CONFIDENTIAL nm82 82 the markets with regard to the Bank's policy-based lending operation and the reason for this concern, one of the reasons for this concern is, in my view, that there is not enough front-loading of conditions in the policy-based lending operations of the Bank. And the second point I wanted to make is that in my view there should be a link between the sector to be sup- ported, to be reformed, on the one side, and the flow of resources from the World Bank loan, on the other side. In the present case there doesn't almost seem to be any kind of link, as I have pointed out. Thank you very much, Mr. Chairman. MR. QURESHI: Thank you, Mr. Luschin. I think it may be useful that I should ask Mr. Husain and Mr. Bottelier perhaps to address a few general points which you have raised, Mr. Luschin, right at the outset. And those relate, in my view, to how do we view the macroeconomic policy framework within which this loan is going to be implemented? How do we see Argentina's perfor- mance today? Also how do we see its external requirements within which we are trying to provide this kind of support? And thirdly, there is the more specific aspect that Mr. Luschin addressed, which was to what extent should there be a MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm83 83 link between, if you wish, the nature of this reform and the use of the proceeds of this loan? What is this loan intended to accomplish? MR. HUSAIN: Let me just try and put into perspec- tive this loan as far as the overall economic issues in Argentina are concerned. The issues in Argentina perhaps at the moment are the most difficult that any middle-income highly-indebted country faces. Until some time ago, I would have said that Chile probably in Latin America faced the most difficult situation. Chile has benefitted, of course, from a substan- tial improvement in copper prices and an adjustment policy which has bee n implemented now for some time. Exactly the reverse of it has happened in Argentina. Argentina has suffered massively from a worsening of terms of trade , basically because of the h e avy concentration of Argentinean exports in the agricultural sector. Build-up on that has been a very high debt burden and at the moment in terms of the burden of interes t payment. On the Argentinean economy, it is one of the highest burdens. There is a democratic government; there has been a democ ratic government after substantially long mili tary rul e , which has been trying to forge domestic consensus in a very difficult MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D .C. 20002 ( 202) 546-6666 STRICTLY CONFIDENTIAL nm84 84 situation, and perhaps with one of the most heavily-distorted economic structures that any indebted country faces. We all know the history since the Austral Plan that Argentina has had. There has been progress in certain areas, and yet there have been substantial setbacks basically, in controlling the deficit of the public sector and basically in sustaining the improvements that have been made. What essentially it means is that with the long history of inflation and with the tremendous expansion that has taken place of the public sector, with the way difficult relationships that exist between the central government, the provinces and the public enterprises, improvements or projected improvements that remain basically aggregative macroeconomic targets don't get sufficiently anchored in fundamental institutional change and in institutions. Our dialogue with Argentina is improving. We are engaged in substantial work in Argentina on some of the basic structural issues. The basic structural issues include the operation of public enterprises, the trade sector, agriculture and hopefully -- and of course this financial sector that I have mentioned. Our own judgment is that, unless far-reaching substantial meas u res of reform in thes e key are as, name ly the MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D .C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm85 85 operation of public enterprises, namely the financial sector, agriculture and particularly in the social sectors where the weight of social expenditure on government's overall finance is very heavy, the relationship between the federal government and the provinces -- unless far-reaching and deep measures in these areas, not overnight but over a period of three to five years, unless these reforms are put in place, any fiscal targets that are agreed upon, any fiscal targets that are there will not be sustained. And therefore basically Argentina and its financial partners have to think in terms of approaching both the macroeconomic issues in terms of the aggregates as well as external financing, as well as the fundamental support of the macroeconomic question, that is the sectoral issues. You have before you this financial sector reform, which goes a long, long way in deregulating the financial markets, in improving the surveillance of the banking system, in fundamentally basically eliminating in steps the redis- counting and compulsory investments and Mr. Larrain will speak about how much front-loading there may have been in the overall conditions. This is one of the key sectors where the high costs and where the imperfections, built over a period of time, MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002 ( 202) 546-6666 STRICTLY CONFIDENTIAL nm86 86 have taken a heavy toll on the government finances, on the allocation of resources, on savings. We hope that we can complement this over the next year with similar operations in trade, hopefully in public sector enterprise area, and I am very hopeful of the key sector of social reform in health, education, these areas. We are also hoping to work with the government on the whole issue of the fiscal relationship between the provinces and the federal government. So, Mr . Chairman, what I want to say is that, of course, macroeconomic targets will be important in the next year or two or three, but no less important would be how the ma croeconomic targets are complemented by fundamental structural reform in the key sectors of the economy. Let me mention the whole question of external finance. As you know, there is an agreement between the IMF; there is an agreement between the commercial banks in Argentina, and recently the release of an IMF tranche has led to the release of the last tranche of the commercial bank funds. Clearly, Arge ntina will need new money over the next year. The whole question of external finance and this talk of d e bt would need to b e addressed. It wo uld have to b e MILLER REPORTING CO., INC. 507 C Sueet. N.E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL 87 nm87 addressed in the context of the whole structural program, and the medium-term program of Argentina. And we do hope to work with Argentina on that. We hope to initiate a dialogue with the commercial banks on that. The outlines of that will become more clear with time, as the issues of external finance are brought to the table, and as the link between external finance and Argentina's own programs become clearer. One issue just, Mr. Chairman, on the details of the whole question of links between policy loans, the adjustment loans and the use of the loans. The thrust of these adjust- ment loans is institutional and policy reform and, therefore, in the context with the established policy of this Board, the • disbursements have been linked to the implementation of specifically agreed policy here. The whole intent of the loan is to bring about deregulation, to bring about gradual elimination of redis- counting facilities. If this loan had been through a discounting channeled to the banking system, we would have basically reinforced the system that we have been trying to reform. But let me ask Mr. Larrain to speak about the conditionalities and what reform measures Argentina has taken already and how far-reaching these have been upfront. MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002 ( 202) 546-6666 STRICTLY CONFIDENTIAL 88 nm88 MR. LARRAIN: Well, several measures have been already taken. Let me mention the most important ones. First of all, interest rates on savings and time deposits have been liberalized. These rates were controlled by the central bank and usually set at levels below inflation, and that was especially hurting small depositors that could only deposit at these controlled rates. Controlled interest rates represented some 50 percent of time and savings deposits and now are all free. Also with respect to minimum reserve requirements, the central bank has already reduced reserve requirements on incremental deposits, on marginal and new deposits. These are very low. So as long as the system continues to monetize and increase deposit mobilization, then average reserve requirements will come down. In the third place, some important accounting regulations have been put into place. One has to do with a system to classify loans according to risk, and another one prohibiting banks to accrue interest on doubtful loans. The accrual of interest on doubtful loans made all financial statements very unreliable in Argentina. In the fourth place, deposit insurance is now available for all small depositors. In the past only MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm89 89 depositors saving in regulated deposits had access to deposit insurance. Now all small depositors have access to deposit insurance. Then the government has been increasing interest rates on rediscounts, on central bank rediscounts, reducing subsidies in this area, and reducing losses associated to these rediscounts. For example, the increase in rediscounts' interest rates that took place in October of last year meant for the central bank a reduction in its losses that are equivalent to have a point of GDP. Then the government also has been -- the central bank has been very tough in trying to stop the overdrafts from provincial banks. In November the central bank decided that any provincial bank trying to overdraft their accounts with the central bank will be intervened. Since November to date, three provincial banks have been intervened. And just a final point, the liquidation of failed financial institutions has been completely streamlined and speeded up. MR. HUSAIN: But the most important single action which has been taken upfront, Mr. Chairman, is the elimination of control of interest rates, which is a massive reform in a MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL 90 nm90 society which has been used to negative interest rates on regulated funds. MR. QURESHI: Thank you; thank you very much. MR. BOTTELIER: If I may add further amplification of this point to clarify what may be a misunderstanding for those reading the document and not having been involved in the details, in the preparation of the loan, it might appear L-i..~ from the description that the loan is l~kety front-loaded. In fact, the opposite is true. The reforms that have taken place, I think, are the most drastic banking sector reform that I have seen in any country on a very short-time frame. The fact that they don't appear to be conditionality is because in the course of the preparations, those actions had been agreed upon and the actions have been taken. MR. QURESHI: Indeed, that is an important point, Mr. Bottelier. Mr. Luschin. MR. LUSCHIN: Thank you, Mr. Qureshi. I accept the explanations on the front-loading of the loan. Indeed, I think if you read only the document and you are not involved, you might get the wrong impre ssion. But on this issue of the link, I am not quite MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002 ( 202) 546-6666 STRICTLY CONFIDENTIAL 91 nm91 satisfied, I must say. I think it's an extremely important issue, and let me reformulate the issue as I see it. The issue really is: Should these $400 million u.s. dollars actually be used only to satisfy creditors of Argentina, or should at least -- because finally this will be the use of the funds as it is proposed, at least as I see it -- or should at least in part these funds be used for productive purposes in Argentina directly? That's actually the real issue as I see it. MR. QURESHI: Go ahead, Mr. Husain. MR. HUSAIN: Mr . Chairman, we don't make a fast- disbursing loan unless there is a balance of payments problem, which means that of course policy improvement is the purpose of every Bank loan. Now in an adjustment loan, clearly we combine stimulus and support for policy and institutional reform with the support for the immediate balance of payments needs of the country. In this case, filling the balance of payments gap or contributing partly to the filling of the gap is an important element in maintaining a certain pace of economic development and investments in that country. And that is the fundamental rationale for making a quick-disburseme nt loan in MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm92 92 this case. Linking it to rediscounts would merely be a cosmetic issue, but the fundamental purpose is here to stimulate and support reforms, and of course in the process also provide some of the foreign exchange which is in short supply. MR. QURESHI: That, of course, does not mean, Mr. Husain, that there will not be cases when we will want to link -- MR. HUSAIN: Of course. MR. QURESHI: -- in a positive way the use of the proceeds to particular actions that we wish to be taken, but I think that you will see, for example, that in some of the sector l o ans we do from time to time link these loans to -- the use of the proceeds to the purposes of the loans. And it is done. But we have to go basically on the basis of a judgment as to how we can use these proceeds or the country can use these procee ds most effectively in suppo rt o f the overall adjustment p r ocess, rather than in terms of necessa- r ily linking every particular l o an pro c e ed t o a particular o bject ive o f the l oan . I t u r n to Mrs. Rubio . MILLER REPORTING CO., INC. ,01 C Street, N.E. Washington, D .C. 20002 (202) '46-6666 STRICTLY CONFIDENTIAL run9 3 93 MRS. RUBIO: Thank you, Mr. Chairman. Mr. Chairman, the Government of Argentina deserves our respect and support for its political commitment to introduce the reforms suggested by the Bank and mentioned in the Letter of Intent of the authorities of the country to the President of this institution. It is clear that the reforms are needed, but that implementation by a democratic government in a country as sophisticated as Argentina is going to be extremely difficult. The Argentine authorities are going to have such strong domestic pressures in implementing the program that external agents, such as multilateral institutions and commercial banks, should help the process by being flexible and suppor- tive. I would also like to commend the Bank staff involved in the preparation of this project. This document is among the best I have seen since I have been in the Bank. The analysis is utterly thorough, thus leading to what I consider an accurate and detailed diagnosis . Policy recommen- dations are coherent . I would like t o support very strongly Part VI, Bank Gr oup Operations a nd Strate gies. I particular ly agre e with paragraph 92 bec ause I d o b elieve tha t the Bank has an MILLER REPORTING CO., INC. 507 C Street, N .E. Washington , D .C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nrn94 94 opportunity to play a key role in Argentina's economic recovery and future development. The Bank's assistance in the implementation of a structural adjustment program and in the design of the policy framework needed to restore the productive system of the country can be extremely useful to lay the basis for new external lending to foster economic growth and strengthen Argentina's debt-servicing capacity. Development of the productive sectors and the restoration of previous investment levels are seriously handicapped at present by the disequilibria of the financial sector. Industrial development in Argentina is hindered by the high cost of credit owing to larger spreads of financial institutions. Government intervention of banks through reserve requirements and forced investments, difficult credit allocation justifies the high spreads. Consideration of paragraph 58 and Table 8 tells us that government intervention serves the purpose of financing the cost of fiscal deficit. It all results in high lending rates to ultimate investors. Given this framework, it is easy to understand the emphasis placed in a better management of rediscount by the central bank, but the political difficulty of implementing MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm95 95 the measures envisaged should not be underestimated. The reforms aim at increasing deposit mobilization and confidence in the banking system are also consistent. Given interest rates' elasticity of deposits, liberalization of rates seems a must in order to stimulate savings. Enactment of stringent regulations or loan portfolio clas- sification according to risk of default, provisions for potential loan losses and interest accruals on problem loans, and public disclosure of banking institutions' balance sheets and income statements are new elements of discipline. A main feature of the program is the creation of a Deposit Insurance Corporation. I view such a corporation as a systematic and cost-effective mechanism to deal with liquidation or rehabilitation of financial institutions, which eventually could eliminate the costly phase of interven- tion described in paragraph 36. Finally, if confidence is to be restored, all these policies have to be implemented on a background of price stability and realistic exchange rate. I would like to end by referring to paragraph 14, particularly to the difficulties countries face to meet Fund performance criteria for standby agreeme nt's tranche releases. I used to think that these performance criteria are quite MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington. D .C. 20002 STRICTLY CONFIDENTIAL nm96 96 irrelevant to the problem the Fund, the Bank and the conuuer- cial banks pretend to solve, namely the alleviation of debt. In the case of this banking sector loan, I will go one step further. Lack of flexibility of the Fund can seriously jeopardize the implementation of the structural reforms envisaged. The cosmetic short-term arrangements a country has to go through to make accounts look good at one particular date may seriously interfere with deeper medium- term reforms. I am delighted to see that Argentina and the IMF have agreed on the need for a longer-term support arrangement. I also celebrate that the World Bank intends to contribute with investment loans. I think the determination and commitment of the Government of Argentina deserve it. Thank you, Mr. Chairman. MR. QURESHI: Thank you very much, Mrs. Rubio. Mr. Sherwin. MR. SHERWIN: Thank you, Mr. Chairman. Clearly, an efficient structural system of financial intermediation is vital for facilitating and encouraging development. I think the Bank's work in this field is enormously important and t o those of us who attended the MILLER REPORTING CO., INC. S07 C Street, N .E. Washington, D .C. 20002 STRICTLY CONFIDENTIAL nm97 97 Baltimore Colloquium last year I think learned with some surprise the scale of the effort required, the magnitude of the problems in the developing world. So for that reason, we are in broad agreement with the thrust of the proposal for reform of the Argentinean banking sector. The need for reform is obvious. The reforms already implemented or proposed look sound. But, like Mr. Luschin, I have some problems about the way in which this particular proposal is presented to us. For instance, how on earth do we manage to convince ourselves that this program, however worthy, needs $400 million to implement it? If this appears to be the case, this is in fact a balance of payments support, why can't we be explicit about that? I would be perfectly happy to discuss a $10 million or $15 million financial sector reform loan along with the $390 million structural adjustment loan if that is what is needed to fill the financing gap. But I don't see how the Board can adequately fulfill its role in reviewing project documentation if we are no t being upfront about what it is that we are discussing. Thank you. MR. QURESHI: Thank you very much, Mr. Sherwin. I t hink y o u raised anot her important point, to MILLER REPORTING CO., INC. )07 C Street, N .E. Washington, D.C. 20002 STRICTLY CONFIDENTIAL nm98 98 which we have of course referred to indirectly. But I think, Mr. Husain, if you would take up the question of why $400 million in this operation? MR. HUSAIN: Clearly, Mr. Chairman, it is very difficult to justify one figure rather than another when we talk of adjustment loans. When we finance projects, then you have a project, you have a cost estimate of a project, you have the foreign exchange component of the project, you have a financing plan. In the case of policy reform, basically we are led by two or three considerations. One consideration, of course, is the Bank's overall financing and lending in relation to other sources of capital. Second, of course, when we look at an individual policy loan, then the extent of the policy change, the institutional changes, it basically has to be a judgment on the quality of effort with which it should be supported. And third, the overall balance of payme nts situa- tio n. Very clearl y, when we do s upport a certain amount of balance of payments financing, which we are doing in this case, we have to be sufficie ntly conscious and caref ul that it has to be done in the c ontext of sound changes in policy MILLER REPORTING CO., INC. ) 07 C Street, N .E. Washington, D .C. 20002 STRICTLY CONFIDENTIAL nm99 99 and institution. That's what we are doing here. I cannot argue, Mr. Chairman, that $400 million is a better figure than $380 million or $420 million would have been. On the other hand, a very much smaller amount would have substantially compromised our capacity to influence this program. We have been in dialogue with the Argentineans on this very far-reaching reform for quite some time. And as Mr. Larrain has explained, a very large measure of reform already has been undertaken in the process of dialogue between the Bank and Argentina even before we came to the Board. In determining the amount, we also have been led by overall balance of payments of Argentina after taking into account what has been available from the IMF, from the commercial banks and having been an active participant in the negotiations between Argentina and its financial partners last time. MR. QURESHI: Thank you, Mr. Husain. Mr. Sherwin, please go ahead. MR. SHERWIN: Thank you. I mean I presume that the Argentinean Government is convinced of the benefits of reforming the banking system. If they are not, no amount of money that we deliver to them MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D .C. 20002 /202) ,46. 6(,(,6 STRICTLY CONFIDENTIAL mnlOO 100 is going to make this thing successful. So if they are convinced of it, I don't see why we need to put in that much money. Now if the issue is filling a balance of payments gap, and that is what is driving it, then that is what we should be discussing. Thank you. MR. QURESHI: Mr. Husain. MR. HUSAIN: Mr. Chairman, that applies to almost any loan we make, which means that whether it is a project, whether it is a policy, of course none of this would be good enough or worth writing what the paper is written on if the government itself were not convinced of the feasibility of it. In fact, we should not be making a loan if the government itself is not convinced of the feasibility of it. And yet the process of dialogue is essentially analysis, discussion, arriving at a certain agreement on it. And yet the process of implementing the reform, the major changes that have to be undertaken, the groups that have to be brought together have a link with the amount of financing that is available to support it. Clearly, we should not be mak i ng a loan like this in the absence of sectoral policies, as well as broader MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nmlOl 101 macroeconomic programs, however difficult that is. Now in the case of Argentina, we know that there have been difficul- ties in the macroeconomic adjustment partly because of external circumstances, and yet at this moment they remain in good standing with the Fund. MR. QURESHI: If I may add just a few words to what Mr. Husain has said. I think that there is some method behind this otherwise overall judgmental issue, and that method, as Mr. Husain has been delicately trying to suggest, really does not take into account simply the balance of payments gap. There is no question -- I forget what the figure is -- but the balance of payments gap, the requirements of Argentina are in an amo unt of something like $3 billion over a twelve -month period. This is the financial requirements that Argentina has. Cl e arly, we do no t by ourselves suggest that we intend to fill that gap, that unco vered gap, taking into account amount s t hat have al r eady been committed and so on and so f o r t h. But we d o have that in mind, that we wo uld make some contr ibution towards it, t aking into accou nt wha t o the r s a r e d o ing, what the Fund is d oi ng, what t he commercia l banks a re like ly t o d o , what o ther age nc ies a r e p rov i ding to MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm102 102 Argentina . So that is something in the background. We also have in mind the likely size of the lending program, the overall lending program, broadly the view that we are aiming at in line with our own exposure guidelines, in line with our own attempt to look at a medium-term relation- ship with Argentina over the next few years, and therefore the amount of lending that we can support. Now all of that is then boiled down, if I may say so, to a distribution, if you wish, between certain operations which are more of an investment nature and other operations that are of an adjustment nature or policy-related nature. And when you come down then to the policy-related loans that we would be providing, we then try to look at the amount of policy change and policy reform that you are buying and, therefore, when you are providing $400 million to Argentina, you are giving a very strong signal to the government as well that within the overall structural adjustment program that we expect the government to be undertaking, this is a very important component, both in their eyes as well as in our eyes. But there i s at the back of it of course the idea of trying to provide ade quat e support, which is cons istent with our overall lending program, as we have envisione d it , MILLER REPORTING CO., INC. 507 C Succt, N.E. Washington, D .C. 2000 2 ( 202) 546-6666 STRICTLY CONFIDENTIAL nm103 103 as well as with the particular operation that we are taking into account. Now all of that is fuzzy; all of that cannot be made more precise than that. But it does suggest a variety of iterations that have been gone into, fairly extensive dialogue that one undertakes with the government on it because the government has also expectations about the amount of support and involvement that it can get out of the World Bank. And what you see here is the final product of all of those many iterations. If you still yes, Mr. Sherwin. MR. SHERWIN: I admire your eloquence always, but I remain unconvinced that we can't be more explicit about the issue than this. MR. QURESHI: I think what we might perhaps try to do is, Mr. Bottelier, would you.perhaps want to indicate a little bit about what the external financing requirements of Argentina are, how do we see them, what are some of the principal sources that a re now p rovidi ng it? Perhaps that might thro w some light with what the background o f that is. MR. BOTTELIER: Fine , let me try, Mr . Chairman. I think I should like to go back to the beginning of last y ear , whic h was the b e ginning of a new starting point MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D .C. 20002 (202) )46-6666 STRICTLY CONFIDENTIAL nml04 104 in the relation between Argentina and the IMF and also in the relations between Argentina and the commercial banks. As you may recall, Argentina negotiated a new standby in early 1987, and shortly thereafter started negotiations with the commercial banks on a major package for net new money and old debt restructuring. At that time, I believe it was March or April, Argentina succeeded in stretching out the terms on some $30 plus billion existing commercial bank debt, lowered the margin, and negotiated net new money of close to $2 billion that was at that time envisaged to be sufficient to cover the gap in 1987, and perhaps the first part of 1988. This was part of an overall plan supported by an IMF standby, to which the World Bank was also a partner through a program of structural adjustment loans. Some of these loans have already been presented last year, including in particular the $500 million trade loan, which has been very successful in achieving its objective. Unfortunately, towards the end of the year 1987, I think it turned out that the financing needs of Argentina could not be met by the arrangements that had been put in place in the course of the year by the IMF and the commerc ial banks and the program of World Bank loans plus Paris Club, I MILLER REPORTING CO., INC. 507 C Street. N .E. Washington. D .C. 20002 (202) )46-6666 STRICTLY CONFIDENTIAL nm105 105 should have mentioned, renegotiations. What went wrong? The main thing that went wrong and what is underlying, I think, the current liquidity crisis in Argentina to a far greater extent than most people realize is a number of external factors which cause their trade balance to be close to $1.6 billion inferior to what had been expected, and what had been the basis for the financial programming for 1987. Most export prices were lower. Import prices were higher. In other words, terms of trade were significantly worse in 1987 than what had been anticipated. And in addition to that, the country's main sector, the agricultural sector, was plagued by flooding of an area of something like 5 million hectares, which significantly reduced the volumes of agricultural exports. We are now therefore facing a new situation where Argentina has run into arrears, and it is facing a much greater balance of payments gap in 1988 than had been anticipated when this new program was developed in 1987. And this is the difficulty that we are facing at the present time and what Mr. Luschin h as referred t o as the unfinanced gap for 1988. It has arisen partly because there simply hasn' t bee n enough time to get all the maj or actors MILLER REPORTING CO., INC. 507 C Succt, N.E. Washington, D.C. 20002 ( 202) 546-6666 STRICTLY CONFIDENTIAL run106 106 together and to agree on how the problem for 1988 and perhaps 1989 should be assessed and what could be done about it. I think the first significant step to that was an agreement with the IMF just a matter of weeks ago on the release of the third tranche and on the details of a new medium-term -- of a detailed macro plan for 1988. The next important step, I think, has to be an approach to the commercial banks. I think this is currently under preparation, and I think we hope to support that process by stimulating the Argentinean authorities in reformulating, updating their medium-term program of struc- tural reforms to which World Bank sector loans can be linked, such as the one that is being discussed right now. And there is, therefore, now an expectation that with the combined efforts from IMF, World Bank and commercial banks, some time over the next several months, maybe by the middle of the year, a concrete new financing plan and hopefully a medium-term financing plan will be put in place. MR. QURESHI: Thank you. MR. BOTTELIER: I might add just a few remarks specifically on our role in this. As you know, the thrust of our lending program in Argentina at the present time is focused on the major area of sectoral reform programs. MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D .C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nml07 107 The most important areas on which we are working and have been working are trade and industry reform, banking sector reform, the one that is being discussed right now, and in the whole area of state enterprise reform. In all of those areas we have been preparing, and you have already approved some loans and will be asked to approve further loans in the next few years, and most of those loans in light of the overall macro situation, or some of those loans in light of the macro financing needs will have a quick-disbur- sing feature in the sense that they would disburse against general imports to assist in this joint effort with the IMF and the commercial banks to meet overall external financing needs. In addition to that, we have a number of somewhat more narrowly focused sectoral loans in mind that would disburse principally against sectoral investment progr ams. The mo st important of those are in agriculture, in industry, in e ne rgy. We are wo rking very hard on a major loan also for pub l i c ho using program reforms and in the social sec to rs, partic ularly the hea lth and educ a t i o n. All of t he se l o ans , the lat te r category, wi l l be linked t o inve s t ment programs and their disbu r sements will be l i nke d to p artic ul ar i nvestme n t p rograms. MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington , D.C. 20002 ( 202) ~46-6666 STRICTLY CONFIDENTIAL nm108 108 Yet additionally to that, we have a number of loans under consideration and in preparation that have a more traditional character of being focused on particular projects. One of such was approved by the Board last week; that was the Municipal Development Project. We are working on urban transport projects. We have lines of credit for small and medium-scale industry, and we are working on a major new line of credit for investment by private enterprise in agriculture. This gives you an idea of the program that we are working on in Argentina. MR. QURESHI: Thank you. Mr. Al-Sultan on the same point. MR. AL-SULTAN: Thank you, Mr. Chairman. This is the only point I have to make a comment about. I will make it now while we are discussing it. I have had equal concern about pretty much the same thing because you read through documents and you see an excellent analysis of the banking structure, the reforms and what Argentina has done, and then you meet with an abrupt disburseme nt and procurement mechanism, and you see the loan is being used just to finance imports. And what I was wondering is could not in the doc umentation, as I think Mr. She rwin has mentioned it, there MILLER REPORTING CO., INC. ~07 C Street, N .E. Washington, D .C. 20002 ( 202) )46-6666 STRICTLY CONFIDENTIAL nml09 109 should be a much better rationalization as to how the money is used. That is one. The second thing is: Isn't it possible to identify within this project itself that each reform -- for example, there are losses that will happen -- couldn't some of the loan be used for funding, for example, the federal insurance equity needs which will eventually turn up as a result of much of the losses these banks face? Now eventually, the money will be used for imports, but I would have thought when I was reading the documents that this is what the money would be used for, to set up the various schemes and the reforms which eventually would cost the government money. Thank you, Mr. Chairman. MR. QURESHI: Thank you, Mr. Al-Sultan. We will certainly take note of some of the points that you have mentioned . Mr. Faint. MR. FAINT: Thank you, Mr. Chairman. We welc ome this proposed p rogram. The banking sector is v ery importa nt to the overall ef fi ciency of t he eco nomy, and its severe probl e ms have c learly bee n a major obstacle to economic recovery and growth in Argentina. MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nmllO 110 The need for reform is very evident, and this program should, we think, significantly improve resource allocation and increased transparency. We acknowledge the progress that has already been made, and we think that this does demonstrate a real commit- ment on the part of the authorities to reform, and we think that the further measures proposed here will build effectively on what has already been done. We regard the conditionality in this loan as satisfactory and fully adequate. Perhaps I should add in terms of the recent discussion, this Chair certainly supports the whole process of policy dialogue and the concept of fast-disbursing policy related lending. Nonetheless, I think it has sometimes occurred to us too to wonder about the determination of the size of individual loans, and there might be a case for including some discussion of this in Operations as they come to the Board. Our thinking had always been that the size of policy-based loans should obviously, firstly, have some relationship to the size of the country and the economy; secondly, we feel it also ought to have a relationship in the cas e of a sectoral ope ration to the size and importance of that sector in the economy; and thirdly, it should perhaps MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, 0.C. 20002 ( 202) 546-6666 STRICTLY CONFIDENTIAL nmlll 111 have particular regard to the potential effect of the operation on the external sector since these loans have to be repaid. We would be a little unhappy, I think, about a direct relationship between the size of policy-based lending and balance of payments need or a gap. It seems to imply that the Bank is taking on the role of a residual financing source, which I don't think the Bank is in a position to do, certainly not for large countries such as Argentina. But I think it is an interesting subject, and maybe we shall need to revert to it. I have got a brief observation about the macro- economic framework in connection with this operation, and then one or two corrunents on specifics of the program design. Clearly, it is of central importance to the success of this operation that the macroeconomic adjustment efforts should be maintained. And we see the reduction of the fiscal deficit as being particularly critical in this respect. Now the paper has something about fiscal deficit for 1988 at 4 percent of GDP. We believe that this is higher than the latest IMF e stimates which I think are 2.7 percent or the IMF program objective which is 2 percent. I don't know if there is anybody from the Fund staff he re, but if there MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D .C. 20002 {202) 546-6666 STRICTLY CONFIDENTIAL nm112 112 were, I think it might be quite interesting to have a comment on this. The Fund has, I think, projected increasing fiscal deficit after the second quarter, and I think that this underlines the importance of further fiscal measures being taken by the government. Some of the provisions in this operation could have some expansionary effect on the money supply perhaps. We hope that there isn't any conflict with the Fund program targets here. I think we are thinking particularly of the reduced reserve requirements and the reduction of forced investments. Now on one or two of the details of the program. We support the introduction of the deposit insurance scheme. This should help to improve confidence. Insurance premia are likely to add to Bank's costs and partly offset measures to reduce interest spreads, but overall we think that this will be beneficial. And we note that the second tranche release provision envisages that this arrangement will have to be submitted to Congress. We would have thought it might be preferable to provide that it should be enacted into law. There may sometimes be slips between cup and lip, I think. MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D .C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL rnnl 13 113 And we wondered whether the participation in the deposit insurance corporation would be voluntary or mandatory. The second question we wanted to address was the rediscount side of this scheme. We obviously welcome the negative net rediscounts in 1988, cancellations of rediscount lines and reduced subsidization. These are strong features of the program. And I think that this is an area where the program should help to strengthen the fiscal position. So perhaps there is an offsetting effect to the one I mentioned earlier here. But there are two categories of rediscounting which are set somewhat aside. That is the lender of last resort and multilateral related rediscounting. We are not too clear what the amounts of these will be for the control mechanisms since apparently the arrangements for this are not included in the legislation to which I referred earlier. Furthermore, the central bank has allowed some provincial banks in financial difficulties to issue bonds to raise finance, and we wondered to what extent, if at all, the central bank is obliged to provide funds if they can't repay? That could be a sort of countervailing pressure on the desire to reduce rediscounts. Finally, I have a question on procurement arrange- MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002 ( 202) 546-6666 STRICTLY CONFIDENTIAL runl 14 114 ments. In paragraph 86, there is a reference to normal commercial practices and standard government practices. Usually, these words are followed by a statement that these procedures or practices are acceptable to the Bank. And we always like to read this and feel a little bit uneasy when these words, these comforting words are omitted. So perhaps I could have an assurance from the staff that procurement arrangements will not be discriminatory, and that the Bank's procurement guidelines will be complied with. And the final point is the possibility has regis- tered further banking sector loans, and I wonder whether we could have a little information about the timing and amounts of these deposits currently foreseen. Thank you very much. MR. QURESHI: Thank you, Mr. Faint. There are some points that you have raised that I will ask the staff to perhaps provide you with information, but there are a few perhaps more important points that need to responded to right now. Let me take those up. With respect to procurement, I assume that the omission of the language ''acceptable to the Bank" is inadver - tent, or is there some greater advertency there ? MR. BOTTELIER: No, sir. MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D .C . 20002 ( 202) 546-6666 STRICTLY CONFIDENTIAL nrn115 115 MR. QURESHI: Very good. So I think you are assured suitably, Mr. Faint, on that point. What is the position with respect to future Bank operations in this sector? Mr. Bottelier. MR. BOTTELIER: Mr. Chairman, in the context of the overall program that I have tried to outline, we have two activities under active consideration that might be con- stituted as follow-up operations, although they would be substantially different in nature. One is to assist the government in ways that we haven't clearly defined at this point in the restructuring of the Bank that is currently the largest source of fiscal or quasi-fiscal deficits in Argentina, that is the Government Mortgage Bank. The Government Mortgage Bank has been intervened by the central bank some time ago. There is new management in place, and there is an active consultation proce ss ongoing at this time between the central government authorities, the bank and ourselves on how a new financing struct u re for the Bank and possibly involving a Bank loan might b e construct ed. The second important one at that level is a loan to p ro vide long-term industrial financing for firms that would MILLER REPORTING CO., INC. 507 C Succt, N .E. Washington, D .C. 20002 ( 202) 546-6666 STRICTLY CONFIDENTIAL nm116 116 have to respond or wish to respond to the trade liberalization process that is supported by another loan, and that require additional investment financing. In the course of the preparation of that loan, we are working very actively on a significant restructuring of the role of the largest government-owned bank for industrial finance, that is BANADE. I think if we can through our activities materially assist in the restructuring of both the Mortgage Bank and BANADE, that we will have a very significant follow-up at the specific Bank level to this loan. I don't think we contemplate general banking sector loans of the kind as we have presented to you today. MR. QURESHI: Thank you. Mr. Larrain, to what extent is it your view that the deposit insurance scheme should be mandatory, or to what extent it should be discretionary? The question that Mr. Faint was raising was: Would it not be better to have a mandatory deposit insurance scheme? MR. LARRAIN: Well, it is a very good question. There is no correct theoretical answer to make it mandatory or not. And we studied all the different deposit insurance schemes throughout the world, and some of them have a voluntary system and some of the m are mandatory. MILLER REPORTING CO., INC. 507 C Succt, N .E. Washington, D .C. 20002 ( 202) 546-6666 STRICTLY CONFIDENTIAL nmll 7 117 So on that area, we would leave the choice to the government. But clearly -- MR. FAINT: You don't know what the government will choose? MR. LARRAIN: Not yet; not yet, but obviously those countries are -- the U.S. or any other country -- those banks that choose to be part of the deposit insurance scheme can publicize it and will have the benefits of the depositors' confidence. So that is the answer. MR. QURESHI: All right. What about the legisla- tion? To what extent will this be enacted into law, the program that we have here? MR. LARRAIN: Of course, we would have preferred a commitment from the government to say that they will help a lot. Their position was that they cannot commit themselves to something that they don't control. They said that they will make their best efforts to prepare the loan and to send it to Congress, but they cannot make sure that the Congress will approve it because they don't have control on the Congress. Then what we agreed to be sure that t hi s will have an e f fec t were two things: first, that deposits for all small depositors have to be es tablishe d now, and that wa s MILLER REPORTING CO., INC. 507 C Sueet, N.E. Washington, D .C. 20002 ( 202) 546-6666 STRICTLY CONFIDENTIAL nmllB 118 approved by the central bank because they didn't need a law for that. So the first part is done. And secondly, the part that has to do with the restructuring and rehabilitation of the banks that will be in charge of these funds, if it is not approved by the govern- ment, they will implement in the meanwhile a very similar structure within the central bank and that will operate with the same guidelines that otherwise the deposit insurance corporation would operate. And we asked them to put that on their Letter of Financial Policy and also its in the loan agreement. MR. QURESHI: Right. You also asked about the fiscal deficit. I am told, Mr. Faint, that that is a matter that is still under negotiation and discussion. So there is not yet a very definitive position on that issue. MR. FAINT: Sorry. Does the staff think that this project will be neutral or positive or negative in relation to the money supply? That was behind my other question. MR. QURESHI: Right. Mr. Bottelier, would there be an implication, positive or negative? Mr. Larrain, go ahead. MR. LARRJ\.IN: We don't see major monetary implica- tions. There are going to be minor mone tary implications. MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D .C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nmll9 119 And the difference is that if you reduce the stock of reserve requirements, then you have a strong monetary expansion. But since we are working with incremental deposits and with marginal reserve requirements, then the monetary impact will be gradual . MR. QURESHI: Very well. Let me take one other speaker before we adjourn, because we will have to adjourn soon, and the re are a number of speakers still on my list. Mr. Haxthausen. MR. HAXTHAUSEN: Mr. Chairman, information on Argentina's banking sector provided in the President's Report clearly points out major weaknesses and irregularities in the system. The envirorunent in which the domestic capital mobilization is functioning at present is certainly not conducive to orderly and effective credit allocation, which is necessary for enhanced financing of investments and economic growth. Therefore, it does not come as a surprise that earlier Bank loans to important sectors like energy, agricul- ture, industry and transportation continue to be disbursed slowly. This leads me to say that the idea for the World MILLER REPORTING CO., INC. ~07 C Succt, N.E. Washington, D .C. 20002 (202) )46-6666 STRICTLY CONFIDENTIAL nm120 120 Bank at this stage to try to tackle the soundness of the country's financial system is a good one, and I wish to lend my support to this program. Effective domestic resource mobilization is a crucial element in all development financing and its role should not be underestimated. The present regime which severely limits discretio- nary lending by the banking system seems to be a serious impediment to profitable banking with reasonable interest rates. One of the reasons is that governments often like to force private savings to benefit public causes. To some extent, that is understandable, but certainly there are also situations where other routes of government financing would be more appropriate. Such obvious routes are taxation and market borrowing from domestic sourc es. Obviously, the sector reforms which will be undertaken carry s ome c osts f or the government. However, I would like staff t o c la r ify the cost involved in more d etail, in particular ho w the y are linked to individual actio ns t o be take n unde r the prog ram, a s outlined in Annex VI. As Mr. Sherwi n and others, I wo u ld h ave li ke d to h a v e h a d f u rt he r jus t i f i c ati o n f or t h e size o f t his l o an compared to t he ob j e ct i v e s s o that we cou ld more rea s o nabl y MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D .C. 20002 (202) H6-6666 STRICTLY CONFIDENTIAL nml21 121 justify the use of $400 million for this particular purpose. And what I have in mind is, of course, my old hobby horse that I am glad that Mr. Luschin and Mr. Sherwin and others also seem to be riding now, that I feel that there must be a link between the utilization of the loan proceeds and the program we are supporting. If there is no link -- and I see no link in this loan -- then let us admit that we are engaged in pure balance of payments support, financing general imports that have to a certain extent already taken place. But then we must face the fact that we are doing the job that the IMF is supposed to d o . And I think this is a great matter of principle that we should perhaps t ake time one day to dis c uss. Finally, I notice that under proc urement mechanisms no reference is made to international competitive bidding fo r import contracts ove r a certain amount. This has been the case in similar loans, and I wo nde r if this is a new policy or an omission. Thank y o u. MR. QURES HI: Thank you, Mr. Haxthausen. I th i nk we will come back t o the que st ion s t ha t y o u ha v e rai sed when we r e convene, if I may. If that is acc e p- tab le to y o u, let ' s adj o u r n no w and meet a g a in at 2:30. MILLER REPORTING CO., INC. 507 C Street, N.E. Washington , D .C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nml22 122 Thank you. (Whereupon, at 1:01 p.m., the meeting was recessed to reconvene at 2:30 p.m. the same day.) MILLER REPORTING CO., INC. 507 C Sere«. N.E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nml23 123 AFTERNOON SESSION (2:31 p.m.) MR. QURESHI: Let's reconvene, ladies and gentlemen. We had some outstanding questions that were raised once again by Mr. Haxthausen, which was in fact reinforcing the earlier queries that were raised by Mr. Luschin and Mr. Sherwin. Mr. Husain, would you make another try at it? MR. HUSAIN: Thank you, Mr. Chairman. I think what we have been discussing really is not Argentina but the basic rationale of adjustment loans. Why adjustment loans, in what circumstances we make it, and the pure balance of payments financing, how do we determine the size of these loans. Let me go back to the basic rationale of making adjustment loans. There are two aspects, Mr. Chairman, of adjustment loans. One, that they support policy and institu- tional change, far-reaching policy and institutional change as distinct from investments which the normal projects or set investment loans do. The second aspect of the adjustment loan is quick disbursement, and normally not linked t o specific investment goods but either t o a positive list of imports or to imports within a negative list of what cannot be imported. MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002 ( 202) ,46-6666 STRICTLY CONFIDENTIAL nm124 124 Adjustment loans we make where two circumstances are present, and I would put them in the order of importance. One, that the government is undertaking serious sustained or with the prospect of sustained -- adjustments in key sectors of the economy and in the economy as a whole, and where the loan, its disbursements, its tranches can be linked to specific actions. This is the case here. Second, the quick-disbursement part of it we make only if there is an immediate balance of payments problem and where in terms of overall priorities the utilization of the existing capacity and the improvement in the utilization of existing capacity is more important than undertaking of substantial new investment with the assistance of the Bank. Now in the case of Argentina it is the case of both, which means that even though there have been interrup- tions in the implementation of adjustment programs, even though there are certain things which could be better, it is a country which, despite very difficult circumstances, is undertaking serious adjustment programs. And one of the key adjustment programs is in this sector where our loan, the disbursements of our loan, is linked to very specific actions. The quick-disbursement aspect of it clearly is MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D .C. 20002 ( 202) 546-6666 STRICTLY CONFIDENTIAL nml25 125 linked to the need for foreign exchange, which is at the moment a very important limitation and constraint to pursuing development objectives. And I am very purposefully using the development objectives, which means that this is not simply a duplication of the function of the IMF. (a) The reforms that we are financing, supporting are of a long-term and institu- tional nature; second, that we have basically through analysis made a determination that the availability of foreign exchange is a fundamental constraint on development, and that the utilization of existing capacity at this stage is a more important objective for the Argentineans and for us than putting in place large new investments. The question then is, Mr. Chairman: How do we in the context of the Bank's overall operations decide to bring to the Board an adjustment operation, and how do we determine its size? Now in the case of Argentina it has to be linked to two fundamental issues. One is the relationship between the quality of effort and the financial support. Second, the overall financing needs of the country. In the case of Argentina, the overall financing needs this current year are of the order of about $3 billion in terms of net disbursements. We expect that the Bank's contribution would b e about one - fifth of it, MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm126 126 about that order. This appears to us in terms of what might be available from commercial banks, other sources of finance, a reasonable proportion for the Bank to finance. We have also looked in terms of the overall country program the relative importance at this stage of investments, of various adjustment loans, and thereby we have arrived at this figure of about $400 million in terms of the importance, the far-reaching nature of the reforms on which we have had a dialogue for quite some time, the need to support it and the overall financing needs of Argentina. We hope that the remaining part of our lending program for this year would be both investment loans as well as adjustment loans. MR. QURESHI: Thank you, Mr. Husain. Mr. Larrain, would you want to respond to some of the specific questions that were raised by Mr. Haxthausen? MR. LARRAIN: There was a question concerning procurement, and competitive biddings. As stated in the loan agreement, in Schedule 3 of the loan agreement, all contracts for the procurement of goods estimated to cost the equivalent of $5 million or more have to be made through international competitive bidding according to the World Bank guidelines. MR. HUSAIN: This has been omitted in the Presi- dent's Report but it is a part of the loan agreement. It was MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D .C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nml27 127 just an omission. MR. QURESHI: Thank you, sir. If we may proceed with our roster of speakers, I have Mr. Potter next. MR. POTTER: Thank you, sir. I hope you will be a little patient with me because I am going to have to retread some ground that has already been trodden, and I have marked this up so much, I fear I am going to get lost as I make my way through it. But I have tried to abbreviate it. I wanted to start by saying that I thought Mr. Sherwin made some awfully good points, and we have some sympathy with those, and we would like to be marked down as supporting, I think, what he was trying to say and did say. It seems to me that what we have got here is a transaction which in terms of its technical dimensions is well set out, in fact I would say very well set out. It has received some well-earned compliments, but that it fails to make an adequate bridge between the technical elements of the transactions and the policy framework within which it is intended to make a contribution. That might be helped a little, if I may say so, if I may volunteer an opinion, by reordering the sequence of the MILLER REPORTING CO., INC. 507 C Street, N.E. Washington. D.C. 20002 (202) H6-6666 STRICTLY CONFIDENTIAL nm128 128 document. We start with a description of the economy, which strikes me as altogether sensible, and then in paragraph 16 move into the sector, which is the subject of the transaction, and finally in paragraph 91 come to a statement of Bank operations and strategy. It would seem to me that if that were somehow featured at the front of the document and set the framework within which the transaction was intended to operate, that we would be making it more readily understood. While talking about that section on operations and strategy, I notice that in paragraph 92 there is reference to the fact that the government has presented to the Bank its framework for medium-term economic policy reform and develop- ment, but there is a period after that, and, having said that we have it, one wonders what is in it and how it influence our choices and our behavior. I would also say, if you will take this in the generous spirit in which it is offered, that paragraph 94 is not very helpful. We read that our strategy has severa l distinctive c ha r a cteri stic s. We read that it is focused o n policy-based lending, t hat it is diversified to encompass essentially all areas, that it is designed as an integrated whole , and that it is sequenced for synergistic effect . I don't sleep any more soundly at night having read that, Mr . MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington , D.C. 20002 (202) )46-6666 STRICTLY CONFIDENTIAL nm129 129 Chairman, and I would hope that when we talk about our programs that we could put a little more detail into them. Having said all that, I do want to make it awfully clear that the Bank is doing here what we want the Bank to do, and what we have got here before us is a document, which on the whole is very well designed, and whatever we may say about its shortcomings, it should not obscure the fact that it is a good piece of work, in our view. Having done all of that ad libbing now, I will try to be a little more systematic in attempting to respond to the proposal. This is a welcomed step in the Bank's structural support of Argentina's efforts to achieve sustained and satisfactory economic growth. That program is based on strong operations-oriented economic and sector work, designed to direct assistance to critical areas in an integrated way. We support this approach and have no difficulty in principle. We wonder, however, a little about the sequencing. So far there has been an agricultural sector loan in 1986, a trade policy loan in 1987, and a municipal development project approved by the Board last week. We had expected an import liberalization operation before now. We understand that it is in the pipeline , together with an industrial MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D .C. 20002 ( 202) ~46-6666 STRICTLY CONFIDENTIAL nrnlJO 130 restructuring loan. It is at least arguable that either of these operations would fit better into this stage of the sequencing. They would certainly have been more appropriate vehicles for the substantial balance of payments support attached to this loan. It is proposed to issue the loan in two tranches about nine months apart, subject to compliance to certain conditions. With one important exception, those conditions are of a technical nature. The exception provides, quote, "The Bank shall be satisfied that the macroeconomic policy framework of the borrower, including its fiscal monetary and exchange rate policies, is consistent with the objectives of the banking sector reform." This strikes us as a little general. Achieving the principal objectives of the loan will depend on the government's inflation fighting policies, particularly its fiscal behavior, its deficit financing methods, interest rate and credit policies and banking regulations including reserve policies. But more directly, the element which will determine success or failure of this loan is the mac roeco nomic frame- work, a point which is stressed in a number of places in the document and indeed is a condition both of e ffectiveness and MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D .C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm131 131 of second tranche release. Against this background then, what in the context of this loan does a satisfactory macroeconomic framework consistent with the objectives of banking sector reform mean? Is the release of the third tranche of the Fund's standby agreement in mid-March a sufficient or merely a necessary condition for loan effectiveness? If the latter, what additional factors would the Bank require, and how are these to be monitored? Is there an understanding with the Bank and Fund and the authorities as to who will be responsible for monitoring which aspects of the macroeconomic program as part of the coordination process between the Bank and the Fund? What factors determined the 20 percent retroac- tivity? I know we have touched on this, but I have got a more specific question. Does it bear some relationship to the extent of the measures that have already been implemented, or is it related to the Bank's share of the process of providing e xternal financing with other creditors in the context of burden-sharing? The object of this line of inquiry obviously is not to suggest rigidit y but mo re to make the point that what we MILLER REPORTING CO., INC. 507 C Street. N.E. Washington, D .C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nml32 132 are looking for is better standards of transparency. If we are asked to approve the loan and be more than a rubber stamp, it behooves us to understand the policy framework and the choices governing the design of the loan. The restoration of public confidence in the banking system will not be realized unless the Argentine public is convinced that the authorities will bring the economy around, especially in relation to inflation and the fiscal deficit, that a revival of confidence, the remonetizing of the economy will founder, and credit will remain scarce and expensive. All there may be to show for our $400 million may be some technical improvements in the banking system. A postscript or two, if I may, Mr. Chairman: Much is made of the need to improve supervision and to promulgate semi-annually beginning this June centrally the performance of the banks. The document is relatively silent as to how the design of that supervision will work, whether indeed it applies standard reporting formats, the use of outside accountants and so on. It is set out in paragraph 70 and I should have probably raised it before the meeting, but I was away, and I would appreciate it if you could comment on that. The second postscript is: Where and how or will IFC figure into this? I wonder if we could talk about what MILLER REPORTING CO., INC. 507 C Suecc, N.E. Washington, D.C. 20002 (202) H6-6666 STRICTLY CONFIDENTIAL nm133 133 their role is as these discussions take place, and how when the discussions are -- when the nature of the outcome is determined, how indeed it might affect the way in which they go about their business in that jurisdiction? And finally, Mr. Chairman, I would like to say once again that it is not what we are doing here that might be the subject of some criticism; it is how we make the bridge between what appears to us to be good design but in the context which makes it very difficult to understand the choices which have been made, and which therefore make it particularly difficult for us to exercise the responsibility for policy oversight. Thank you. MR. QURESHI: Well, Mr. Potter, since I am com- pletely dedicated to the oversight function of the Board, I will certainly try to be as responsive as I can to the que stions that you have posed. Mr. Husain, y o u and/or your c o ll e agues, why don't you take up first the two major issues that we r e raised by Mr. Po t ter , and t h a t is the r e f e r e nc e s t o an a d e quate macroecon omic po lic y f r amewo rk t h at is menti o ne d t here. But al so b e f ore t hat , I t hink yo u mi ght want to ta lk abou t t he me d i um- term f rame work t hat is refer red t o i n t he section o n MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002 ( 202) 546-6666 STRICTLY CONFIDENTIAL nrn134 134 Bank operations, and which Mr. Potter characterized as beings rather cryptic, and not terribly explanatory in terms of what the Bank has in mind with respect to its own role and with respect to its own operations and strategy. MR. HUSAIN: Thank you, Mr. Chairman. Let me just remind the Board that when we bring these loans, we do bring these loans in the context of some of the previous discussions that have taken place in the Board on the country. And let me remind the Board that when a report was made to the Board on the agreement between commercial banks and Argentina about a year ago, at that time an indication was given about the Bank's own program in support of the adjustment program and as a complement to other sources of finance. The Argentineans and the Bank entered into a substantial discussion on a medium-term strategy about a year ago, where basically we and they arrived at a very broad understanding on a so-ca ll e d business plan. The busines s plan included spec i fic adjustment measures in some of the key sectors, the key sec tors b e ing of course finance , trade, public enterpris e management, agri c ulture . And since then we have been pursuing basically a parallel trac k whereby the government wo uld unde rtake specific reforms in these key MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm135 135 sectors to be supported by Bank adjustment loans. And this is basically the second of those loans . The first one was in that period a trade adjustment loan. We are pursuing a further expansion of this cooperation, a further expansion of cooperation where the focus of the Bank's work is structural, developmental questions, developmental issues largely based on sectors and institutions, key sectors which I mentioned, key institutional issues, such as the relationship between the government and the private sector, relationship between different tiers of government, relationship between the goverrunent and public enterprise, and the government programs in areas such as the social sector which have a substantial bearing on future claims on public resources. Now in that context, the IMF has of course a standby, and the main focus of course of the IMF's work has been the fiscal issues, monetary issues, exchange rate and balance of payments. And there it would have been a serious duplication if the Bank were to mount its own work, although we never had formal cross-conditionality; we clearly draw heavily upon the IMF's work to make up our own judgment about the appropriateness and the suitability of the macroeconomic MILLER REPORTING CO., INC. 507 C Suect , N.E. Washington, D.C. 20002 (202) )46-6666 STRICTLY CONFIDENTIAL nml36 136 framework which is what we have done. So despite some concerns about the fiscal problem, we have been guided very substantially by the IMF's examina- tion, review, its decision to release the third tranche. Now as to Mr. Potter's comment on inadequate details about what the Bank is seeking in Argentina, perhaps we could have expanded para. 94 more, but I would refer Mr. Potter to the previous para. where some of the objectives of the Bank are mentioned as follows: expanding private sector activities; increasing domestic resource mobilization; strengthening external finance; key areas of the cooperation are going to be government's role in public investment, public sector pricing, public enterprise management, divesti- ture of public assets, transfer of services, and central provincial government interaction, private sector incentives. These remain the key areas of the Bank's emphasis as far as the structural and institutional issues are concerned, and we will pursue them through specific sectoral operations, specific work, both economic work and lending work in specific sectors. On the question of retroactivity -- MR. QURESHI: Before that, Mr. Husain, would it be fair to say that the reason for the rather skimpy mention of MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D.C. 20002 (202) H6-6666 STRICTLY CONFIDENTIAL nm137 137 the macroeconomic framework is precisely that it was also the government's preference that the details of the macroeconomic framework be really rediscussed and agreed to and be reflected in the Fund program? MR. HUSAIN: That is correct, and we did not just want to duplicate it, knowing fully well that there has been only a week ago a full discussion in the Fund Board on some of these key issues. But we would be happy to provide to Directors the details of -- MR. QURESHI: The details of that macroeconomic framework that was agreed to. MR. HUSAIN: Just a word, Mr. Chairman, on retroac- tivity. Basically, we limit in these operations retroac- tivity to 20 percent unless there is an overwhelming reason to do otherwise, and this is in accordance with the operatio- nal guidelines, and the reason simply is that this retroac- tivity is limited to the period since appraisal, a period when many of the specific actions agreed upon will have been taken. And, of course, we will reimburse only for expendi- tures which have been incurred in accordance with the agreement and the Bank guidelines. MR. QURESHI: Thank you. MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002 ( 202) )46-6666 STRICTLY CONFIDENTIAL nm138 138 Mr. Larrain, would you comment on the issue of the design of the supervision? How will this be done? And also take up the IFC point of view. What will be IFC's role in this program? These were the other two points that Mr. Potter put forward. MR. LARRAIN: Well, concerning supervision, we have an important technical assistance program. The details of that program are described in Annex VII. That's why we didn't expand more in the text. The basic philosophy is to redirect the emphasis of supervision from just reviewing compliance with regulations and norms towards the assessment of the solvency and liquidity of each institution. The problem is that in Argentina, as in many other developing countries, banking supervision complies a more formal role, but it doesn't study the risk and the solvency of the institutions. So when an institution is failing, they really don't know what to do and it is too late. So we want to focus the technical assistance in enhancing the capacity for risk analysis in the supervision, for enhancing the capacity of the whole on-sight inspection process, and also with enhancing certain supervision, certain regulations to analyze the loan portfolio . MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm139 139 We believe that here in the Bank we have a very good idea on what to do in banking supervision. We have very close relationships with other international agencies, and now we are in the process of giving a seminar for banking supervisors from developing countries in collaboration with the Federal Reserve. Concerning the publishing of financial statements, we believe that to increase transparency, especially in the case of public banks, it is very important. If people don't know what are the size of the losses of these public banks, then public scrutiny is very liberal. With respect to the role of IFC, we can see two types of connections of our work in the financial sector in Argentina with the work of IFC. First of all, with respect to the banking system, any improvement that we make in the banking system will be useful for IFC because IFC is using at this moment certain banks to give credit lines. For example, IFC r ec e ntly gave an agricultural credit line through t he largest p r ivate bank in Argentina. Als o IFC asked equity investments in several private banks in Argentina- The other ro le has to d o with the c apital market_ We are in the p r o cess of f inishing a c api ta l ma r ket s' study MILLER REPORTING CO., INC. ) 07 C Street, N .E. Washington, D .C. 20002 (202) )46-6666 STRICTLY CONFIDENTIAL nml40 140 in Argentina, because equity financing and long-term financing is very low in Argentina. We have had a close collaboration with IFC on this study, and actually they have been respon- sible for part of this study. So if in the future we were to make a further operation, of course we will continue this close dialogue. MR. QURESHI: Thank you, Mr. Larrain. Mr. Boehmer. MR. BOEHMER: Thank you, Mr. Chairman. I support this loan because it is important under two aspects. First, it represents the Bank's contribution to cover Argentina's external financing needs in a very critical phase. And second, it is important as a contribution to rationalize a key sector perhaps at this particular point in time, the key sector of the Argentine economy, and it is the linkage between these two that has apparently become a general concern this morning and this afternoon. But I think this is not a particular feature of this operation; it is a very common featur e of all our adjustme nt lending, and particularly of sector adjustment l ending. In the context of SALs, I think we take it more or l e ss for granted that we are prov iding balance of payments MILLER REPORTING CO., INC. )07 C Succt, N.E. Washington, D .C. 20002 (202) )46-6666 STRICTLY CONFIDENTIAL nm141 141 financing under the premises that the structural adjustment program is going to work to alleviate the balance of payments distortions and overcome the situation during a certain period of time. When we go to sectoral lending, when this connection becomes less apparent, and it is indeed difficult to explain to outsiders why the Bank's sector loan is not a loan for the banking sector. So in the particular case, this question has arisen very clearly, but it is general. So I would suggest that in the context of the forthcoming policy review of adjustment lending, this issue should rank rather prominently and should be addressed in the document that is being made in preparation for it. I think there is some need for further clarification and justification and I think the Bank, if we are going in thls direction, has to say so clearly also to the outside world because there are many questions asked why is the Bank giving balance of payments assistance and trying to disguise this under apparently -- allegedly disguise this under some other headings. But on this specific operation, first of all, I would like to say that the report is a very commendable piece of work insofar as it deals with the analysis of the banking MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D .C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nml42 142 sector in Argentina. The report leaves no doubt that there are serious structural problems in the Argentinean financial sector which need to be addressed urgently, and it is obvious that the main concern in the present situation is that the disorder of the financial sector has serious negative impacts on the productive sectors of the economy. I fully support the three rather simple and clear objectives of this operation, that is to rebuild confidence in the banking system, and thus hopefully increase the mobilization of domestic resources; second, to improve credit allocation; and third, to reduce the cost of credit. I was very glad to read that a number of actions have already been taken by the Argentinean Government to bring about reforms in this sector. And the reform package of October 1987, which removed all controls on interest rates, deposit and credit markets, is most welcome. Moreover, the government's letter of financial policy in Annex V of the document seems to be a solid basis for further measures. While I am generally satisfied with the design of the loan, I nevertheless would like to make some comment which express certain concerns in two different areas. My first issue is the heavy dependence of the MILLER REPORTING CO., INC. ~07 C Street, N .E. Washington, D .C. 20002 (202) )46-6666 STRICTLY CONFIDENTIAL nml43 143 success of the banking sector reform on the political and macroeconomic environment. Developments in both areas, in the political as well as in the macroeconomic situation of the country, may put the sector reform at risk. While the Bank can do little about the political issue, I think the Bank can make an important contribution also in improving the macroeconomic environment and thus help to gather the necessary financing also from different sources of lending. And the second issue is the question whether it would not have been possible and also helpful to describe in the report a scenario which shows what the Argentinean banking sector is expected to look like two or three years from now. The point I would like to make is that, after the authors of the report have analyzed very carefully the banking sector as of today, I wonder if it would not be useful for all parties to have some indicators of a quantita- tive nature about the sector in two or three years from now. This should not necessarily lead to additional conditionality or specific targeting, but it could certainly help to better monitor and evaluate the impact and the results of the implemented reforms. Thank you. MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002 (202) )46-6666 STRICTLY CONFIDENTIAL nm144 144 MR. QURESHI: Thank you very much, Mr. Boehmer. We shall certainly take into account these last two points that you had made, especially if there are to be follow-up operations, as Mr. Bottelier has mentioned. I particularly welcome some of the remarks that you made with respect to SALs and sector loans, because you are absolutely right, that the kinds of considerations that arise in the case of industrial sector loans and agricultural sector loans are not really in essence or in principle any different from those that arise from financial sector loans. But because one provides services and the other provides in some cases imported goods that are associated with it, somehow the other in terms of perceptions, it does not seem as if it is entirely inappropriate to be able to support the first category, in other words, industry and agriculture sector loans with an import list. But here, you have got a different kind of a perception problem. But I do agree with you that this is a sufficiently important issue, and that it should be discussed and clarified in the context of the review that you have mentioned, and we shall certainly try to do so. Mr. Dujmovic. MILLER REPORTING CO., INC. ~07 C Street. N.E. Washington. D .C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm145 145 MR. DUJMOVIC: Thank you, Mr. Chairman. Mr. Chairman, first of all, may I join others in commending the Government of Argentina and the Bank staff for their excellent work on the proposal before us. Mr. Chairman, we appreciate very much that the deep and honest dialogue established between the government and the Bank on all macroeconomic issues, and particularly on issues related to the financial sector which serve as a basis for this sectoral loan. We judge that this would be taken as a good example of how to deal with troubled financial sectors in many heavily-indebted middle-income countries. We strongly support both components of the proposed loan, and we trust that the Government of Argentina will take all necessary measures to minimize the risks associated with this loan. But, Mr. Chairman, you know that the success also presupposes a much better growth supported international environment which has been lacking so far. Under the present international circumstances, I would prefer that the country foreign financing requirements be determined on the basis of one agreed medium-term growth- oriented adjustment program, instead of having the government commitment to maintain a current account deficit compatible MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, O.C. 20002 ( 202) 546-6666 STRICTLY CONFIDENTIAL nml46 146 with available foreign financing. Mr. Chairman, I share two specific questions. Luckily, the first one has been thoroughly discussed. It was related to the issue of the feature of the loan, the amount of the loan and the use of the loan proceeds. I can go along with what has been discussed, and particularly I would like to support Mr. Al-Sultan's suggestions how to use the loan proceeds in this case. But still, I would like to ask: Is the amount of the loan on the upper side, among the others, because the pipeline or project lending in Argentina is not a strong one? Or if you wish to put in the other way around, it seems to me that the balance between policy-based loans and project loans as far as Argentina is concerned is not somehow in the Bank framework as far as the lending policy is concerned. And I would like to add one question more. I find paragraph 7 on page 26 to be very weak and it does not say anything about the exchange rate policy, although the title of the paragraph is inflation and exchange rates. I would like to hear some staff corrunents on this, what is the current exchange rate policy and what it is going to be like . Thank y o u, Mr. Chairman. MR. QURESHI: Thank y ou , sir. MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002 ( 202) 546-6666 STRICTLY CONFIDENTIAL nml47 147 Mr. Husain, perhaps you may want to come back to that point about once again the issue of the need for a certain amount of quick-disbursing funds. You mentioned a figure of disbursements that we expect as a result of our own operations. Perhaps you might want to repeat that point. MR. HUSAIN: Mr. Dujmovic is right, Mr. Chairman, that at this stage in our relationship with Argentina, the accent is on adjustment. And, therefore, for the time being adjustment loans would be the major part of our lending to Argentina, largely because at this stage the overwhelming need in the World Bank relationship with Argentina is support of fundamental change in policies and institutions, and because the fundamental development need is utilization of existing capacity for which foreign exchange is crucial. MR. QURESHI: Thank you. The second question, Mr. Larrain, would you wish to comment o n exchange rate policy? MR. LARRAIN: Basically, they have a free exchange rate, and a crawling peg for t r ade financing. The point that we tried t o make in the report and the relationship with t he banking sector reform is that we feel t hat in the past over- valuation of the d omes t ic c u rrenc y has really aff ected t he demand fo r financial assets i n Argentina. Specifically, in MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D .C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm148 148 1982 or prior to 1982 the domestic currency was over-valued; then there was a very deep devaluation and people got very scared on that. We also mention inflation, because if inflation is very high and very volatile, that of course is not good to increase the possible mobilization. So we mention those two policies as important policies for the success of the reform. MR. QURESHI: Thank you. Mr. Malan. MR. MALAN: Thank you, Mr. Chairman. We support this loan. The operation addresses an important sector where structural rigidities hamper its ability to contribute to Argentina's growth. The program is coherent, well-analyzed and well-designed and has the full and demonstrated commitment of the Argentinean authorities. Several of us around this table have been at an informal seminar for Executive Directors and Alternates in Baltimore last January, dealing precisely with this subject of financial and banking sector r e form. I believe it is fair to say that most of the Executive Directors and Alternates pre sent we re not o nly concerne d but supportive of a greater involvement of the World Bank in this area , given the clear- MILLER REPORTING CO., INC. 507 C Sere«. N.E. Washington, D .C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nml49 149 cut linkages between an efficient financial intermediation system and the so-called real sector whose efficiency and supply responsiveness is at the heart of the development process the Bank has the mandate to support. The proposed loan also forms an important part of the Bank program of assistance to Argentina described less than elegantly -- perhaps I should say with Mr. Potter -- in paragraph 94 as one which, and I quote, "has been designed as an integrated whole; while the loans are associated with individual reforms, they are sequenced for synergistic effects ." I presume that this means that the whole is supposed to be more than the sum of the parts. But we believe that the report wo uld have benefitted from a fuller exposition of the d ebt wo rk-out pro cess envisioned over the medium-term, and Mr. Boehmer has raised some very pertinent and tho ughtful remarks to t hat effect. But with r espec t to the partic u lar p r opo sal before us, Mr. Chairman, we a r e aware of the complex i ties, the diffic ul t ies of the f inanc ial s y ste m r ef o r m progr am b e ing unde rta ke n, the firs t of a c omprehe n s ive nature i n the l ast 5 0 y e a r s. The need for c a r e and sen sit ivity t o imp lementing MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D .C. 20002 ( 202) )46-6666 STRICTLY CONFIDENTIAL nm150 150 it must be stressed. I have one comment on the question of phasing, always an important one in policy reform, and perhaps critically so in banking sector reform. Modern banking, as we all know, depends on confidence for its viability, as equity capital never forms more than a small fraction of deposit and loans. Over the long term, the reform package will clearly strengthen Argentina's financial system, generating an increasing confidence, underpin its ability to achieve its objective of increased efficiency and effectiveness in resource allocation and mobilization. Over the short-term, however, some measures the central bank is taking, such as the more stringent accounting regulations, disclosure requirements, and tighter rediscount access, could precipitate a run on some of the banks that could only be partly mitigated by a new and yet untried safety net of an expanded deposit insurance system. In fact, the safety net would not yet be there when needed. Note that actions to, and I quote, "force problem banks to restructure or exit the market'', unquote, is required before loan e ffectiveness, whereas an autonomous deposit insurance corporation is only expected by the second tranche release, according to the policy matrix on page 52. MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D .C. 20002 (202) )46-6666 STRICTLY CONFIDENTIAL nm151 151 The danger of contamination of even the stronger institution by loss of confidence in the financial system and a reversal of gains already achieved should not be down- played. We are sure that the staff is well aware of these risks. Indeed, this is indicated in paragraph 90, page 32, that the staff will be sensitive to them and exercise a needed flexibility in making the second tranche drawing review. Thank you very much. MR. QURESHI: I thank you, Mr. Malan. Thank you for those thoughtful comments. Ms. Burdin. MS. BURDIN: Thank you, Mr. Chairman. We support this loan which should help the Argen- tinean authorities to come to grips with the structural deficiency of their financial sector. Thus, this reform sector should be able to play its role in the stabilization and development process of the country. For this reform to be efficiently and effectively implemented, it is of the utmost importance that a significant reform of the tax system be decided. Indeed, a meaningful strengthening of the taxation structure and of tax collection would be the single most important factor in alleviating the MILLER REPORTING CO., INC. )07 C Street, N .E. Washington, D .C. 20002 (202) )46-6666 STRICTLY CONFIDENTIAL nm152 152 burden put on monetary management. Under the present circumstances, monetary control cannot be exerted consistently because a lax monetary stance as to supplement a failing fiscal policy through inflation tax. The rationalization of the central bank's operating techniques and specifically the narrowing of the discount window will then remain unworkable a s ~ as j;,f the authori- ties do not come to grips~ with the public sector deficit. More generally, the adjustment process has no room for slippages. Let me conclude by encouraging Argentinean authori- ties to pursue the necessary policy and by welcoming the role being played by the Bank vis-a-vis this country. MR. QURESHI: Thank you so much, Ms. Burdin. Mr. Al-Sultan. MR. AL-SULTAN: Thank you, Mr. Chairman. I have already made one of my points which was supporting Mr. Sherwin's basic approach to indicating the amount of the loans, its relationship to the financial sector. The second point I wanted to raise really more in the form o f the questi o n -- and it is something I would have expected the reform pac kage to have included as a second MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D .C. 20002 (202) '46-6666 STRICTLY CONFIDENTIAL nml53 153 stage -- which would be an estimate of the losses of the banking system. There are hints made in the report that many of the banks have lost all if not most of their capital. And then the rest of the financial sector. Now again I feel -- and some of my colleagues have raised this point -- that if the reforms are meant to regain the confidence, I don't think this can be done within the framework of liquidation and bankruptcies, and especially if we are expecting at this stage that some depositors are also expected to bear some of the losses. This would have been, I think, the second part, which is basically that, while the macroeconomic issues are fundamental, successful restructuring of the financial sector would be the key factor to restoring confidence so that we would have expected the documents to have some indication of the implementation process and the problems and the losses they expected to face, which I also feel would have determined the feasibility of setting up a federal insurance scheme. How can you set up an insurance scheme when you already know that the banking sector is sitting full of losses? So the fi~st decision you want to make is how much of that loss do you want to take or not take? MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002 (202) )46-6666 STRICTLY CONFIDENTIAL nm154 154 Wouldn't it be smart to set out, for example, to first clear the losses and then set up a scheme within the restructured process so that it would take care and give confidence to the public? So I think the second part of the analysis is excellent, but I think that this whole second part seems to be missing, and I am not sure just where we are going. Thank you, Mr. Chairman. MR. QURESHI: Thank you, Mr. Al-Sultan. Mr. Larrain, would you take up this question of implementation and particularly the issue of the extent to which there are likely to be losses in the banking system, what kind of losses, if you have any ideas of the magnitude of those losses, and why then, if there are losses, is it not necessary to take up that issue first before establishing an insurance scheme? MR. LARRAIN: Okay. Well, I think it is a very valid and important question and a very difficult question. Let me go part by part. On estimating the losses, on page 14, Table 2, we give a range. Totally regular loans as a percentage of net worth represent 92 percent. If we deduc t provisions, we come down to 14 MILLER REPORTING CO., INC. 507 C Street. N.E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL runl55 155 percent. And we believe that the exact figure is between those two figures. The problem is that those two figures are very different from 14 percent to 90 percent. Well, to be very honest, if there is not a good banking superintendency with a very good loan classification system, it's impossible to know what the losses are. That's why we are encouraging the country and the already established loan portfolio classific- ation -- it was enacted as a condition of Board presentation, and now we are giving training to the banking seminars. So there are losses; there are important losses. I i.s The equity capital of the Argentinean banking system~ $5 billion. So we believe that the losses can be around 20 percent or something like that. Anyway, there is no need to absorb the losses inunediately, and that is why we are forcing banks to recognize these losses through the new system of loan portfolio classification, but we are doing it gradually. So this will be absorbed in the next two or three years . The fact that not all banks will be restructured and some banks will be liquidated has to do with the un- avoidable fact that the system is over-dimensioned, and that unfortunately not all the banks can exist. MIUER REPORTING CO., INC. 507 C Street, N.E. Washington, D .C. 20002 (202) 546,6666 STRICTLY CONFIDENTIAL nm156 156 One way to reduce the negative impact of these liquidations is going to be the deposit insurance for small depositors. Another way is going to be the new deposit insurance corporations. But in the meanwhile, the central bank is establishing a department within it that will perform similar tasks as the new deposit insurance corporations. And we are already provided guidelines to the central bank of Argentina on how to proceed. Concerning the premiums of the insurance schemes, you are right, I mean one can say it's too late; I mean, losses are too great. So premiums will not be enough. We do not believe that this fund will be financed only with premiums. The central bank will continue to make some -- to lend some money to this fund to support restructurings, and this has been the case of other experiences like the Spanish experience that we have studied, and we believe that the only advantage of this deposit insurance is that the money that the central bank will spend is going to be less than other- wise. MR. QURESHI: I think Mrs. Rubio passed me a note earlier in the morning, which I thought was very revealing, in which she wrote to me saying that what was not being MILLER REPORTING CO., INC. 507 C Succt, N.E. Washington, D .C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm157 157 appreciated is the enormous cultural revolution that is going to take place in Argentina in the financial sector. And I must say I just merely quote her because I thought that that is very correct. And what Mr. Larrain has just said indicates that it really isn't feasible to basically wait until we have set everything right before trying to protect the very small depositors. The issue is whether it can be limited, a limited scheme can indeed be launched while at the same time trying to work on the broader restructuring of the whole system, and I think that is what is being attempted. On your first point, Mr. Al-Sultan, as I mentioned, we will take that up also in the context of the review of adjustment lending. I merely would like to voice a word of caution here. Let us not try in the case of policy-related loans to necessarily try to find approaches that are analogous to project lending merely because those are followed in project lending. In other words, what I am really trying to say is in the case of policy-related loans, we must try to find approaches that ensure that the funds are prudently and appropriately used in order to achieve the objectives that we have in mind, and of course they are deployed under proper MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D.C. 20002 (202) )46-6666 STRICTLY CONFIDENTIAL nml58 158 controls and proper procedures, and we would seek obviously to assure that, but without necessarily trying to duplicate the same procedures that we would have in the case of project loans. Yes, Mr. Luschin. MR. LUSCHIN: Now you touched exactly for me the most important point. How do you ensure that these funds are prudently used? What kind of control do you have over the usage of these funds? None, whatsoever. MR. QURESHI: No, no, I am sorry. We have full control on all of the funds that are in fact utilized under our adjustment-related lending. The procedures are similar to all of those loans . And would you like to explain a little bit -- MR. HUSAIN: Well, Mr. Chairman, the funds that are being provided here are foreign exchange funds. According to procedures agreed, they have to be available for imports of goods with the exception of certain goods that have been mentioned. We have also agreed that in the case of public sector, if the imports are above a certain level, they have to be submitted to international competitive bidding. As you know, we have not tried to control the MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002 (202) H6-6666 STRICTLY CONFIDENTIAL nml59 159 counterpart funds in these cases. Clearly, in project loans you have control related to specific physical works, specific payments to contractors. Here, physical works are not being undertaken; contractors are not being -- MR. QURESHI: That is the only difference in terms of the procedures that are used. But in any event -- MR. HUSAIN: The same audit procedures are -- MR. QURESHI: Precisely. So that what I am trying to get at is that we need to have a different category of loans and a different category of basically objectives that are served in deploying these funds. Mr. Haxthausen, on the same point. MR. HAXTHAUSEN: On this point. I asked Mr. Steckhan three or four months ago if I could have a list of the first trade policy loan to Mexico, which had been disbursed for a long time, and asked him could I have a list of what goods from which countries this loan has financed. And he was not able to give it to me. MR. QURESHI: We shall try to find that information for you. MR. HUSAIN: The audit may not have been completed, Mr. Chairman, but we will try to find it. MR. QURESHI: Mr. Guimaraes. MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D.C. 20002 (202) H6-6666 STRICTLY CONFIDENTIAL nm160 160 MR. GUIMARAES: Thank you, Mr. Chairman. I wish to stress at the very outset first that we share some of the concerns expressed by other speakers, and that we very much welcome the review that we are waiting for of the adjustment lending from the Bank. That's the first. The second one is that we really think that this is a well-designed loan, and we support it. We fully share the objectives of the program and welcome the adoption of the important reforms to increase the efficiency of Argentina's financial sector. This Bank loan is the right complement to the efforts of Argentina's Government in dealing with an extremely difficult economic situation. The macroeconomic indicators speak quite clearly. Between 1983 and 1987 the debt service to export ratio decre ased from 134 percent to 66 percent. The debt service to GDP ratio has likewise decreased from 20 to 8 percent in the same period. The adjustment effort has been massive with great sacrifice of investment expenses and an impressive reduc tion in the budget deficit. I believe tha t a lot of difficulties and a lot of probably not well reached goals will happen in the future, but t h e loan f or its e l f h a s all our s uppo rt . Thank you, Mr. Chairman. MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm161 161 MR. QURESHI: Thank you, Mr. Guimaraes. Mr. Myers. MR. MYERS: Thank you, Mr. Chairman. we have a lot of the questions about certain aspects of adjustment lending similar to those raised by others around the table today, and we of course strongly support the review of policy-based lending that Dr. Fischer is undertaking. Nevertheless, we support the fundamental idea of policy-based lending, which is to utilize fast-disbursing resources, to promote the implementation of needed and effective policy reforms. In that context, and pending Dr. Fischer's findings to the contrary, this operation today is in our view a satisfactory a policy-based loan. In fact, it is a very good one, and we would congratulate the staff. We think it is well designed, it carries strong conditions in a sector that is critical to the development of the Argentine economy, and it is front-loaded. We also commend of course the Government of Argentina for havi11g begun a needed but nevertheless difficult reform of its financial sector. Now, of course, a key risk remains the macroeconomic MILLER REPORTING CO., INC. 507 C Sucet. N.E. Washington, D.C. 20002 ( 202) 546-6666 STRICTLY CONFIDENTIAL nml62 162 performance, and failure there could undermine the efforts of this loan and other sectoral reform loans that the Bank might be pursuing. However, my authorities expect and trust that the Government of Argentina will persevere in its adjustment effort, justifying the support of Argentina's external creditors, including the Bank. Thank you. MR. QURESHI: Thank you, Mr. Myers. Are there other comments, speakers? ( No response. ) MR. QURESHI: If not, let -- Mr. Potter, I am sorry. MR. POTTER: Mr. Chairman, a couple of us asked about sequencing and I am not sure that it ever got answered very well. MR. QURESHI: I'm sorry, sir. MR. POTTER: Sequencing. MR. QURESHI: Sequencing. MR. POTTER: Is that not a loose end on our list? MR. QURESHI: Yes. MR. POTTER: I think it is. MR. QURESHI: All right. MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002 (202) 546-6666 STRICTLY CONFIDENTIAL nm163 163 Mr. Bottelier, would you respond to the question of how we are sequencing basically some of our loans, and what is the logic behind it? What is our strategy in terms of that? MR. BOTTELIER: Let me preface my answer by saying, Mr. Chairman, that whereas there is a certain logic to what we are doing, it isn't a completely random process of picking loans and presenting them to you. It is also true that we do not have complete control over the pace at which important policy reform programs can be prepared by governments to the point that they are ready for your review. You were correct in saying that we have in the past few years, in 1986, submitted to you an agricultural sector loan, in 1987 a trade sector loan, and you proceeded by expressing surprise that we have not yet submitted to you a further import liberalization loan. May I just comment on that particular point first, and then give you a somewhat broader picture. The first trade loan was, in fact, significant in its import liberalization effect. In fact, relatively speaking, much more significant than eve n the Mexica n trade loan which was me ntioned by Mr . Haxthausen just r ecently in terms of the coverage of QR reduction that was achieved under MILLER REPORTING CO., INC. ~07 C Scrccc, N .E. Washington, D.C. 20002 (202) )46-6666 STRICTLY CONFIDENTIAL nm164 164 that loan. The second loan is under active preparation now, and we hope to be able to conclude the process of discussions and negotiations some time soon, and present this to you maybe in June, maybe in July, maybe August. We cannot exactly determine the timing of that because that is partly beyond our control. That loan will complete the trade liberalization process. It will completely deal with the remaining quan- titative restrictions, export restrictions, as well as the tariff reform program which is currently under a very active discussion with the Argentine authorities. That loan is part and parcel of a program of lending in support of industrial reform; hence, the reference in the text, I believe paragraph 94, to the synergistic effect of this lending by a number of loans to support industrial reform at the firm level. We will make available, if all the reforms can be implemented, a number of lines of credit for long-term industrial investment, to support at the supply side the trade liberalization process. These two loans are being prepared simultaneously and should be presented to the Board within a time span of two to three months of each other. MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002 (202) ~46-6666 STRICTLY CONFIDENTIAL nmJ.65 165 So there is a system to what we are doing, and there is a plan, and I think it does make sense. It clearly focuses on what appear to be the critical areas requiring structural reform, trade liberalization, industry policy, the whole question of banking and the financial sector reform and public enterprise reform. These are the three major areas on which we are concentrating our fast-disbursing loans. MR. QURESHI: Thank you, sir. Mr. Luschin. MR. LUSCHIN: Yes, Mr. Chairman. In my intervention this morning I asked one question, and this was: What is the role of the World Bank in filling the financing gap of about $3 billion U.S. dollars? I think I heard Mr. Husain respond to this issue. He said, if I understood him correctly, that the World Bank will pick up one-fifth of the financing gap. I mean, one- fifth means $600 million U.S. dollars. We are discussing today a loan in the order of $400 million. Maybe I could get some clarification on this. MR. QURESHI: Yes. MR. HUSAIN: Mr. Chairman, I am talking in mid- terms. Basically, whe n we talk of the $3 billion, that is the net financing r e quirements of the repayments, and, MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002 (202) )46-6666 STRICTLY CONFIDENTIAL nm166 166 therefore, when I talked about the $600 million that the Bank expressed to disburse into Argentina, that is net of repay- ment MR. QURESHI: The net repayments this year will be in the order of about MR. HUSAIN: $220 million. MR. QURESHI: $220 million. MR. HUSAIN: So our total gross disbursements are expected to be somewhat more than $800 million. MR. QURESHI: Thank you. Well, if there are no further comments, then we shall record your approval of this particular loan. Thank you very much. I think we have had an extremely interesting, and I hope a productive, discussion for the future. MILLER REPORTING CO., INC. ~07 C Smet, N .E. Washington, D.C. 20002 (202) 546-6666
Groupe de la Banque mondiale · Transcript
Transcript of meeting of the Executive Directors of the IBRD and IDA, held on Tuesday, March 29, 1988 : Argentina - Banking Sector Project
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Banque mondiale