Argentina : problems for achieving macro stability

THE WoRLD BANK Internal Discussion Paper LATIN AMERIC k AND THE CARIBBEAN REGION SERIES Report No. IDPI2 Argentina: Probems for Achieving Macro Stabilify F. Desmond McCarthy and Alfredo E. Thome January 1988 Country Operation Country Departmet IV Disans aret the present ise&~ o&yand andof countrya te auted ny mmer to th Ba to Ib a d g oto n( a C the m ~ntie they M ~neen. lecve/a/dlae paper 11st/8-10*0 LAC DISCUSSION PAPER SERIES Report No. Title, Author and Date IDP-3 "An Analysis of the Sources of Earnings Variation Among Brazilian Males" by Marcelo Dabos and George Psacharopoulos, December 1987 IDP-4 "The Efficiency and Effectiveness of Export Credit and Export Credit Insurance Programs" by Bruce Fitzgerald and Terry Monson (Consultant), December 1987 IDP-9 "Export Processing Zones: The Economics of Offshore Manufacturing" by Peter 0. Warr (Consultant), August 1987 IDP-10 "Dumping, Anti-dumping and Efficiency" by Bruce Yandle and Elizabeth M. Young (Consultants), August 11987 IDP-11 "The Regulation of the Quality of Traded Commodities and Services" by Simon Rottenberg and Bruce Yandle (Consultants), June 1937 Summary The paper describes some features of economic policy in Argentina over the last years. It discusses the type of instability that was encountered and how the Austral Plan sought to address these. The economic policy since that time has shown some of the strengths and weaknesses of the plan. In particular, it has not been able to address the externally imposed instability caused by adverse terms of trade and interest rate movements in the external account. On the domestic balance the gains from the Tanzi-Olivera effect were a once-and-for-all effort and failure to make appropriate structural changes strongly limited any prospects for success. Finally, the paper provides an analytical framework to estimate the degree of fiscal reform needed to provide for domestic balance. For external balance an ex-ante swap facility is recommended. ARGENTINA PROBLEMS FOR ACHIEVING MACRO STABILITY Introduction 1. Argentina enjoyed one of the highest standards of living among all counties in the earlier part of this century. In recent years it has suffered more than most countries from erratic changes in political regimes together with inadequate economic policies. 2. Argentina's remarkable, if dismal record, has been the subject of much analysis. Explanations range from political forces, domestic and external, through domestic cultural incompatibilities to more conventional economic explanations. While the causality may be debatable there is general consensus that economic policy has been particularly erratic. One indicator of this is the extremely short tenure of office for ministers of economy - the average tenure over the last 40 years has been less than 1 year (see Dornbusch). i/ Economic Policy Before the Austral Plan 1975-85 3. A quick perusal of economic performance over the last few years shows rapid changes in the external account, high public sector deficits, and a sustained pattern of high inflation rates. The result has been an 1/ Dornbusch, R. and de Pablo, J.C., Debt and Macroeconomic Instability in Argentina, NBER Conference, Developing Country Debt, Washington, 1987. -2- average annual rate of GDP close to zero over the period 1976-85, a gradual decapitalization of the economy together with a pervasive lack of confidence in government in general and in economic policy makers in particular. 4. External Account. Historically the trade account has been in surplus. In the mid-seventies, the external debt was less than US$8 billion. However, the po'-cy of pursuing an overvalued exchange rate, together with an open capital market, resulted in an external debt that climbed rapidly from US$12.5 billion in 1978 to US$35.7 billion in 1981. This resulted in an interest burden of around US$4-5 billion from 1980 onwards. This, in turn, has resulted in the current account typically being in deficit by about US$2 billion for that period. The situation was complicated further by the addition of most of the private external debt to the public sector debt, so that by end-1986 they held 88 percent of that debt compared to 67 percent in 1978. A complicating factor is that the Government controls little of the assets corresponding to that debt. Thus, the Government is faced with the dual problem of: (a) generating enough foreign exchange to meet external obligations; and (b) effecting a transfer from the private sector who generate most of the exports. 5. Public Sector Deficit. If one excludes interest payments on external debt then the current account of the public sector has been close to balance or in surplus most years. However the absorption by the State of the debts of the industrial sector in 1980 drove the current account into deficit. The capital account contributes further to the non-financial -3- public sector deficit (NFPSD). For the period 1980 to 1985 the NFPSD has averaged over 10 percent of GDP (see Table 1). This deficit and its financing is a key element in any stabilization policy. 6. Inflation. Inflation rates in Argentina have been over 100 percent per annum for most of the 10 years since 1975 (see Table 1). Many schemes to moderate these rates have been attempted. Some met with limited success but always for only a limited period before reignition of inflation. Again there are many explanations proferred but in the end a central factor is the inability to finance the fiscal deficit in a sustainable manner to satisfy the needs of all groups. Austral Plan 7. By May 1985 inflation had reached monthly rates of 25 percent and seemed to be heading towards hyperinflation. The Government decided to move from ineffectual gradualism to shock treatment. A plan, since known as the Austral Plan, was introduced. This plan combined some heterodox measures with more traditional measures. The key elements were a wage price freeze, tight fiscal and monetary policy and monetary reform. A new currency, the Austral, was introduced with the exchange rate fixed to the US dollar. Non-indexed contracts were converted into the new currency according to scales designed to eliminate the capital gains and losses due to the drop in inflation. The immediate results were a fall in inflation from near hyperinflation levels to around 2 percent per month for the second half of 1985 and money demand increased with M1/GDP growing from less than 4 percent to over 8 percent. -4- 8. The Government sought restraint in fiscal policy by pledging to finance the public deficit by external borrowing other than by issuing money. The substantial improvement in the fiscal accounts was achieved almost completely on the revenue side. Revenue increased by the equivalent of 6 percent of GDP between the first and second half of 1985 as a result of higher real receipts as inflation fell and of improved tax administration (see Table 2). There was some slippage on the expenditure side because of losses by the Central Bank on its rediscounts and higher-than-expected expenditures by provincial governments. These slippages were partially offset by lower transfers to public enterprises. 9. The economy began to grow during the last quarter of 1985 and GDP grew by 5.7 percent in 1986 after the very sharp fall in the first quarter of 1985. Union groups began to press for wage increases while others expressed skepticism about the ability of the Government to contain the fiscal deficit. Consequently, a second set of measures was introduced in April 1986. This included a move to a crawling peg, some.increases in public sector prices, and increases in wages and pensions to help correct their erosion in real terms. The Government also announced its intention to move from the price freeze to a system of administered prices. Skeptics were only too quick to announce the Plan Austral was going the way of all other plans. Economic Policy Since the Austral Plan 10. The Austral Plan initially enjoyed broad popular support. The external creditors, while retaining a strong degree of skepticism, were sufficiently encouraged to put together a substantial new money package in -5- early 1987. This package had US$1.95 billion new money together with a rescheduling of US$30.5 billion of external debt. The IMF disbursed a CVF of US$664 million (equivalent) and agreed to a Stand-by of US$1.4 billion in mid-1987. This was further complemented by a projected increase in World Bank commitments to reach US$2 billion in 1987/88. In Hay 1987 the Paris Club agreed to a rescheduling of the bilateral debt of US$1 billion. All this financial support seemed to augur well for the Argentine economy. However, by late 1987, the old problems of instability in external accounts and disequilibrium in domestic balance began to reappear. This prompted critics to examine the Austral Plan and ask what should have been done differently and what appropriate policy could be undertaken even at this stage. For convenience, we focus on the external account and domestic balance. 11. External Sector. In 1987 exports of industrial goods are expected to experience a growth of over 10 percent. However, adverse weather domestically, together with further deterioration in export prices, means that even if all expected external financing is forthcoming Argentina will still need about US$1 billion more to close its 1987 current account deficit. This assumes that reserves will be maintained at the acceptable level agreed with the Fund-an increase of US$1,440 million. Since financial agents are also aware of the situation the degree of uncertainty in the economy has increased. The result has been a black market premium for foreign exchange of over 50 percent in September-(early) October and some degree of capital flight. This puts yet more pressure on -6- reserve levels as it induces speculators to bet on the one-sided option of a devaluation. The package with the commercial banks was agreed in early 1987 and included-an early signing bonus. However, it did not produce its expected strong response as the first tranche was not disbursed until early October. By that time a lot of confidence had been eroded so the infusion of external financing, when it finally came, was not able to realize the potential benefits expected earlier in the year. This, in turn, added to inflationary worries and provided further pressure on domestic balances. 12. Domestic Balance. The principal components of the non-financial sector accounts are given in Table 2. The impact of the Austral Plan is quite noticeable. Revenues increased 5 percent of GDP, between 1984 and 1985, while expenditures changed little. Much of the gain in revenues may be attributed to the rise in real receipts as inflation fell (i.e., the Tanz-Olivera effect). This is a one-time gain and is also reversible if inflation begins to increase again. The failure to achieve any gains on the expenditure side may be attributed to a political decision to first consolidate the democratic process by avoiding any significant cuts which could lead to acrimonious struggles. A number of important structural initiatives were, however, taken to open the economy, restructure the public sector, improve tax collection, and reform the financial system. While these reforms were in the correct direction they were unlikely to produce significant results for a number of yerrs. At the same time the success of structural reforms was jeopardized by the failure to stabilize -7. the economy. In a different vein a positive aspect of plan implementation was that policy makers showed such more flexibility when they deemed corrections were needed. This contrasts with the mentors of many previous plans in Argentina when ideological considerations often precluded pragmatic considerations. However, all of these desirable features were not sufficient when the inevitable negative shocks arrived. 13. Negative Shocks. The negative shocks were again a combination of external and domestic factors. In early 1987 the prospects for a strong current account performance were dampened by deterioration in terms of protectionism, and upward pressure on international interest rates. Each 1 percent increase in interest rates increases interest payment obligations by US$500 million per year. The combination of these factors meant that Argentina would need a further US$1 billion to close its current account without depleting its reserves. 14. On the domestic front, unfavorable weather for crops and resurgence of foot-and-mouth disease for cattle, added to the general lack of confidence among private investors. The one-shot nature of the initial improvement in the public accounts became evident. The needed structural reforms to increase revenues and reduce expenditures were not introduced very quickly, partly because of perceived election pressures and so did not produce any compensating reduction in the deficit. Consequently inflation again increased to around 13 percent in September 1987. Once again the cycle seems close to repeating itself. -8- 15. Problems that Need Consideration. With the benefit of hindsight the problems faced by the Austral Plan were not too surprising. At this stage one may also draw on the experience of similar plans in Israel and Brazil. Perhaps the most difficult one is that of externally imposed instability. Argentina has experienced significant swings in its export earnings for many years. Some analysts feel this instability derives from the wage good being also the export good and the difficulty to maintain a stable real exchange rate. In any case heavy dependence on commodity exports automatically subjects export earnings to substantial variability. One can advocate moving exports towards a more stable earning mix and Argentina has made some moves in this direction but it will require some time. Further, the vagaries of international interest rates also create further uncertainty. In view of the inevitability of periodic downswings it seems that policy should seek to take this instability explicitly into account. The recent proposals by Secretary Baker at the World Bank-IMF meetings in September 1987 to replace the CFF facility at the IMF by a broader concept to allow for adverse trade and interest rate effects is one step to help. However, it is an ex-post concept and so would still result in countries suffering losses while measures were being put in place. An alternate approach would be similar to that used by many developing countries to forestall any inappropriate run on reserves by making arrangements in advance for access to swap facility. Inevitably this would also need some safeguards to preclude any inappropriate reliance in the -9- facility. --Much of the succers of the Israeli Plan may be attributed to two factors: (a) the large capital aid flow they received to relieve the pressure on their foreign exchange reserves; and (b) the agreement reached ex-ante with labor groups so that they were aware of the initial deterioration expected in the real wage before improving later. 16. While the externally generated instability played a significant role the domestic situation could also have been Improved by a number of actions. During the honeymoon phase, when the Tanzi-Olivera effect was providing a cushion, a number of actions could have been taken to increase revenues in the short run. These include increasing the yield from sources such as value-added, income and property taxes. This could have been done by improving collection and even reducing some of the rates. Presently, tax administration is being improved but unfortunately some valuable time and perhaps even more importantly the goodwill of the immediate post plan period has been lost. The situation in Brazil also called for strong measures to contain excess demand pressures and their failure to do so is considered a major explanation for the failure of the Cruzado Plan. An analytical framework is provided to estimate the magnitude of tax increases needed to provide a viable public sector balance. Analytical Framework 17. There are many theories which seek to "explain" inflation in Argentina. Their explanatory power varies for the short and the long term and also on the particular circumstances. In a rapidly changing economy - 10 - such as Argentina, fashionable theories tend also to be quite expendable. Empirical evidence tends to fall into two broad categories, structural or monetary, with corresponding emphasis on either the price setting mechanism in different sectors or the fiscal deficit and money growth. Fiscal-Money Growth Approach 18. The fiscal (money growth) approach seems to work well in the medium term. It provides a vehicle for analyzing the intiraction of the current account, fiscal deficit, and its financing. Subject to data quality it can provide broad estimates of the trade-off between critical parameters. In order to obtain some quantitative estimates of the salient variables a simplified framework is developed relating the principal accounts, external and domestic, and the inflation rate. Current Account 19. The simplified current account balance can be described by: CA * E - M - PSP (1) where CA - Current Account E, M - Exports, Imports of Goods and Nonfactor Services FSP - Net Interest Payments to Foreigners - 11 - Equation 1 can also be written as: CA - (Sp - Ip - SPp + INTd) + (Sg - Ig - FSPg - INTd) = DP + DG (2) where DP, DG = Surplus of the Consolidated Private, Public Sector Sp, Sg = Savings of Private, Public Ip, Ie U Investment (Real) Private, Public FSPp, FSPg * Net Interest Payments Abroad by Private, Public INTd = Net Domestic Interest Paid by Public Sector 20. The private sector saves an amount Sp (disposable income less current consumption). It invests Ip, pays FSPp interest to foreigners and receives INTd in domestic interest (from the Government). This results in a surplus for the consolidated private sector account of DP. 21. The public sector saves S (non-interest current account). It invests Ig and pays FSPg in interest to foreigners and INTd in interest domestically. This results in a surplus for the consolidated nonfinancial public sector of DG.2/ What the identity (2) says is that the surplus 2/ It is noted that we consider the nonfinancial public sector deficit only and do not include Central Bank losses. In recent years the latter have been in the range of 1 to 2 percent of GDP. However, recent measures (October 14, 1987) suggest that this loss will now be transferred to the federal public and rapidly reduced. - 12 - (deficit) of the current account is the sum of the surplus (deficit) of the private and public sectors. While this is a technical identity it provides some insight on the options for policy. Typical values are given in Table 3 for recent years. If one takes all components of the private sector accounts as given then any increase in deficit of the public sector will result in direct deterioration of the current account. This, in turn, determines the net (of reserve changes) capital flows needed. Similarly if the level of capital flows are treated as exogenous then there is a direct trade-off between private and public accounts. Within the private accounts one may investigate the possibility of changing Sp and IP. Ideally one would like to increase Ip to enhance growth but in terms of these balances one would like to match this increase with at least a corresponding increase in private savings Sp. In Argentina, the consolidated private sector is typically in balance, or even in surplus (DPZO). Currently about 88 percent of foreign debt is held by the public sector so that much of the current account deficit is closely related to the public sector deficit. The fiscal deficit and financing choices are now considered. Fiscal Deficit i/ 22. The fiscal deficit may now be linked to sources of financing. First, we decompose the consolidated deficit into interest and noninterest components: DG = D + rB + r*B*/q (3) 3/ Much of this analysis follows the recent work of Knight, P. (see Country Economic Memorandum, Brazil, World Bank, 1986) and Anand, R. and van Wijnbergen, S. "Inflation, Real Interest Rates and the Financing of Government Expenditure" mimeo, World Bank, 1986. - 13 - where: D - Real Non-interest Public Sector Deficit rB Domestic Interest Rate (Real), Stock of Domestic Debt r*, B*, q - Foreign Interest Rates (Real), Stock of External Debt in Foreign Currency, Real Exchange Rate Note: rB = INT4 r*B*/q * FSPg 23. The financing components for DG are given by:41 D + rB + r*B*/q aAB +AB*/q + (j + n) M (4) whereAB - New Real Debt - Domestic ,6B*/q = New Real Debt - Foreign P - Inflation Rate n - Growth Rate of Real Income M - Real Money Balances 24. Changes in the real exchange rate will change the value of the external debt in terms of domestic resources. The capital stock change is given by the real rate of depreciation times the real stock of debt (4/q)B*/q. To reflect these changes equation 4 is rewritten as: D + rB + (r* - 4/q) B*/q =AB +A8*/q - (q/q) B*/q + (' + a) M (5) 25. One may normalize by dividing through by y, real GNP, to obtain: d + rb + (r* + )b* - Ab +,6b* + (j+n) m (6) where d - D/y, b - B/y, b* - B*/yq, a - M/y and c - -j/q 4/ This equation assumes, among other things, that stocks are in equilibrium (MS - Md), an income elasticity of money demand equal to one and a bank multiplier of one. - 14 - Equation 6.simply states the following: the non-interest deficit plus interest payments on domestic and foreign debt (all as a share of GNP) equals total fifiancing. The total financing of the deficit for the nonfinancial public sector is given by four sources. Change in stock of domestic and foreign debt, inflation tax, pm, plus seigniorage gain, nm (all as a share of GNP). However, the quantity a, inverse velocity, is itself a function of inflation. 26. Money demand was estimated for equations 7 and 8: log(Md/y) - ao + al log(Md/Y)_1 + a21og i + a3log (EXOVE) + u (7) I * bilNFL + b21REG + e; (8) where: log is natural log and -1 indicates one quarter lag; Md: sum of the stock of currency in circulation and demand deposits at the end of each quarter deflated using the wholesale price index (1970-100); Y: real GDP in 1970 constant Australes; 1: nominal quarterly effective free market interest rate on 7 day deposits; EXOVE: ratio of black market to official (financial) nominal exchange rates; INFL: average quarterly rate of change of consumer price index (1970-100); IREG: nominal quarterly effective regulated interest rate on 7 day deposits. u and e: are error term of equations 7 and 8, respectively. - 15 - 27. In equation (7) we make the demand for money, expressed as the log of the ratio of money to GDP, a function of the dependent variable with one year lag, the free market interest rate and the ratio of the black to the official exchange rate. The dependent variable with one year lag is included to capture the inertia in the adjustment, free market interest rate is a proxy for the opportunity cost of holding money (i.e., the return forgone) and EXOVE captures the expectation of a devaluation. If individuals expect a devaluation they will shift to foreign currency and reduce their demand for money. 28. Equation (8) develops on the determinants of-the free market interest rate. It is made a function of the inflation rate and the regulated interest rate. Each variable affects the free market interest rate independently. 29. This approach differs from more conventional specifications.5/ For Argentina this was deemed more appropriate because of: (a) strong colinearity between free market interest rates and inflation; and (b) spurious correlation between M and Y. The latter is avoided by using their ratio. 5/ A sore conventional specification (see Friedman, 1956, "The Quantity of Theory of Money - A Restatement, in M. Friedman (ed.), Studies in the Quantity Theory of Money, Chicago University Press) would be: log Md - Co + C11og y + C21og I + C3INFL + s; where variables are as before and a is the error term. - 16 - 30. ..The econometric results are given in Table 4 (equations 1 and 2), together with estimates for equations incorporating some modifications (see Table 5). It i's noted that the short-term elasticity of M/Y with respect to the free market interest rate is -0.251 while the corresponding long-term value is -0.416. These values are in line with previous estimates by Mallon and Sourrouille (1975) and Fernandez (1986).6f The short- and long-run elasticities of M/Y with respect to exchange rate overvaluation are -0.217 and -0.36, respectively. These values indicate that high real exchange gap has a substantial negative impact on the level of money demand. The results for the second equation show that free interest rates move closely with both inflation and regulated interest rate (see Table 5). The regression of IREG rate against inflation yield a coefficient significantly less than one (see Table 5) indicating that the regulated rates do not compensate for inflationary erosion. However, equations 2.2 and 2.3 in Table 5 indicate that free market interest rates adjust completely to inflation, its coefficients equal to one. 31. These equations enable one to estimate the inflation tax. Estimates are given in Table 6 for alternate combinations of inflation rate and degree of exchange rate overvaluation. 32. The approximate estimates given in Taole 7 are shown graphically in Graph 1. The graphs may be interpreted as follows. Change in domestic debt is assumed just sufficient to pay the required servicing of the debt. 6/ Mallon, R., and Sourrouille, J. (1975), Economic Policymaking in a Conflict Society, Harvard University Press, Fernandez, R. (1986) Inflacion y economia del Estado, CEMA Buenos Aires. - 17 - The pure A8igniorage gain is between 0.A and 0.2 percent of GDP in each instance. Thus there are three principal variables: annual inflation rate, public sector deficit, and change in foreign lending. They are related in * a rather complex technical manner.7/ One of the key elements is the role of money demand. This relation may change either through expectations or policy initiatives. If we ignore this for the moment the basic relation is shown schematically in Graph 1. For a given availability of external financing (F = constant) there is a direct trade-off between inflation and public sector deficit. i.e., if foreign financing is fixed then any deterioration in the public sector deficit will require a higher level of inflation. At higher levels of inflation 8, the relation will also break down (see, e.g., estimates in Table 6). Similarly, if one sets a definite public sector deficit target the lower inflation levels can only be achieved through higher availability of external financing, higher private savings rates or greater net public sector revenues. 33. In order to obtain some indication of orders of magnitude involved, consider the point P in Graph 1. Here the public sector deficit is 2.5 percent of GDP, annual inflation rate 40 percent (2.8 percent per Vj Recent work by Melnick and Sokoler presents estimates of the converse problem - inflationary consequences of a decline in the rate of growth for eight countries. See Melnick, R., and Sokoler, M., "The Government's Revenue from Money Creation and the Inflationary Effects of a Decline in the Rate of Growth of GNP", Journal of Monetary Economics 13, 1984. 8/ Fernandez, R., a. cit. has made some estimates of the optimum yield from such an inflation tax - for his particular model the rate comes out at over 20 percent per month. Tentative estimates made in this study yield a rate around 10 percent per month. - 18 - month). This requires zero net real increase in foreign financing. Thus with a debt of US$50 billion and an estimate for US GDP annual deflator of 2.5 percent the required external financing is US$1.25 billion (per year) while a deficit of 3.5 percent of GDP (also 40 percent annual inflation rate) would require an additional 1 percent of GDP (in real terms). Note that if additional financing is not available then inflation would rise to TO percent to "accommodate" the 3.5 percent of GDP deficit. Alternatively, public sector deficit cannot increase more than 2.5 percent of GDP if inflation is going to stay at 40 percent per annum. Policy Implications 34. In order to quantify the degree of reform needed for public finances one may combine Table 2 and Table 4. In 1987 the NF`PSD is projected to reach 7 percent of GDP. Table 7 shova a number of possibilities for financing the deficit. In particular, if one aims for a monthly inflation rate of 2 percent per month then the deficit could be financed by an increase in tax revenues of 3.8 percent of GDP without any net new external or domestic financing (both in real terms). One has to analyze the repercussions of such policies carefully as a fiscal contraction of this magnitude could trigger a recession and significant political instability. Hence some degree of net new external financing could be desirable during the transition period. - 19 - Policies That May Affect Relation 35. Demand for Money. Beyond the relation estimated there are a number of possibilities that may affect money demand. These include: (a) financial sector reform; and (b) alternatives to domestic money. If the financial sector reform lowers reserve requirement then it will i2so facto lower the base for the inflation tax. The availability of attractive liquid alternatives could also affect the base. Ready availability of US dollar would send to erode the base. Econometric results in Table 4 indicate that the long-run elasticity of money demand v.r.t. exchange rate overvaluation is as high as that with respect to interest rate. However, some of the US dollar flight could be moderated by the availability of other instruments. These might be indexed (or variable interest rate) bonds or savings instruments such as those used in the UPAC scheme developed in Colombia for the housing sector./ 36. Domestic Financing. In the analysis the role of domestic financing (through a bond issue for instance) is assumed neutral. The Government could in fact increase its domestic debt as a short-term measure to provide additional domestic financing. In the short term, this would help reduce inflation but over time would have the opposite effect so that any major shift in policy here needs careful analysis. 9/ Gomes, C.A.Z., -La Correccion Monetaria y El Credito en UPAC', Talleres de Multigraficos Ltd. Bogota (Colombia), Nov. 1986. - 20 - 37. Measurement of Deficit. The deficit in this discussion does not include explicitly losses of the Central Bank. The progress of the banking reform will no doubt have a substantial impact. In particular, the way the problem of rediscounts is handled needs to be factored into future estimates. 38. Role of Private Sector. In the first section of this paper it was indicated that changes in the public sector deficit would be reflected pari passu in the current account for a given private sector balance. If the focus shifts to the current account then one may also contider the impact of policies on the private sector. Thus, an increase in private sector savings would help reduce the current account for a given public sector deficit. This, in turn, implies that the net foreign flows to the country can be reduced by the improved private sector savings performance. - 21 - Table 1: ARGENTINA: MACROECONOMIC INDICATORS, 1975-1987 fat~hng ate aP Iflatifn bal Effectivn Grvaluation Current Atent 7otal Ot Publit beter Ikficit eros Fåted Investuet oth Ratt (danual avtrage £achag Rata (latio of black Witt balac# utstdfng (as of SP) Privat# Pul1C 1 rate of thange) indes, 1970 a 100) to financial urket (9ill of US 0) and fisbursed on- Central bank (.1 UP) 1 eschange fate) -(n tillie of 88)- Financial Losses I 1975 -0.6 170.6 95.9 .. -1284 .. -15.4 .. 13 6 1976 -0.1 444.1 72.4 .. 665 .. -11.8 .. 13 9 1977 6.4 176.0 87.9 .. 120 11445 4.1 .. 14 11 1978 -3.2 175.5 97.7 99.8 1833 13276 6.8 .. 12 10 1979 6.9 159.5 133.2 99.3 -537 20950 -6.1 .. 14 9 1980 1.6 100.8 15.0 100.0 -4767 27157 -7.5 .. 16 7 1981 -6.8 104.5 120.2 103.5 -4714 35658 -13.3 .. 14 7 1982 -4.6 164.8 94.3 135.9 -2357 43634 -15.1 .. 9 7 1983 2.8 343.8 97.1 136.1 -2461 45087 -11.2 .. 8 6 1984 2.6 626.7 90.6 139.0 -2391 4902 -8.3 -2.5 8 4 l985 -4.5 672.2 90.6 116.0 -953 48310 -4.1 -2.2 7 5 1986 5.7 0.1 .. 112.2 -2782 49209 -2.7 -1.6 7 6 1985 (quarters) 1 -1.3 724.0 %.3 131.5 -780 .. •8.0 11 -4.8 875.9 97.9 108.3 187 .. -7.9 111 -8.9 852.2 85.8 117.3 110 .. -2.1 iv -3.2 672.2 82.5 106.8 -471 .. -2.4 1986 Iarte) 1 0.7 448.3 79.7 113.4 414 .. -2.4 -1.6 11 6.2 228.8 80.1 106.6 -376 .. -0.9 -1.3 III 9.0 126.4 80.0 109.8 .. .. 4.8 -1.2 l9 3.6 0.1 .. 119.1 .. ..7 -2.3 1987 (quarters) 1 2.5 80.0 .. 126.6 .. .. 4.7 -1.8 .. 11 2.6 87.2 .. .. .. .. -6.1 -1.7 .. 1I .. .. ,. . .. .. .. 4.6 W .. iv force: CRA and Statätticsial ppndis. (4) freligigary Estmnate. (04) From 1983 nards thk #knister of Ecemy c~angad their ethodology fer ~stitqa public setor accoma. 7kt explans the differece sa the t"ates. .. m not avallablt. goveaber 20, 1987 •22- 實ableZ:NON刁InA潤CIALP龍LlcS肌TOR Fl刈以你S,1983一6 一（as黑of CoP) ‘•••••••■••••■■• ,，黑鰥荔︰鳥岑弄七 重跑豐麵些旦 黝戶d細細‘•鳥認，．載么驚，．勻，．絲亂觔，．討鳥•，. 11.．悲么神．．觔 鑰•自•d魚•喊••么騙么偽1．婦1.n鳥認么觔馴U么跚么馳忽勰矓么n么斗 勵閑草細•物觀州U。 勵“&d•1以1．鳥細既么總么贊1為1洶l．珍0．訪磚調憑基以0．婦 領自吋勵鬨•細”么訕鳥鵝7•觔馴論，.U亂弱么n,.U亂中，.&,.31,．訂 黝•細•1．但7．認心認江sj躍亂認幫矓‘為勾。編認心7•偽1．幼二鄴 如•開么戲取•認l．神l織1膚么訕忽認賺’么話么訕么跑么萬么幼 馳卹‘馴陣出－么才視巒乎警于各驕各馳才牌各雙豐遷警巒鳥曉警邢各驕 勵自••七血鳥叩2.,1鳥黝鳥點鳥物為祝鳥b乙寫鳥勵1.（么黝Z．寫 餐細g馴戶由－亂騙么論么儲｛‘以么總么卹勾論鳥啊哺誡騰叫。0．越0.l& 跑玆匹匹蝕必旦徑逐d邊徑邊遷匹邑逐選邊名色竺叢匹邊匹．, 觔劉醒 細黝關••細伶魄）匹里必迎叢絕必邊匹匹丑選藝醒巫己匹纏藝匹匹丑叢邑 。黝d•‘臘．卹認“’么。么勿“，切么驚騙j4么論族戲。．“〝”么。 細勵開州b&‘么“斗鑰j磚方紹睡斗雄馴江鳥勾鳥卹汰“么蔔鳥絲j.&l 。勵d越勵•d才黝胞•么絲鳥弘鳥訕鳥魷亂U鳥鄴，認這亂幼訕b亂訂鳥刀亂備 輪．嗡•‘綱吟曉勵“•••亂他斗卹鳥神鳥認鳥鸛馴必紹賺鳥騙訕陽么嗎亂婦鳥“ 仰么•勵••個瞼’闢鰓細••》！Jl湯么購1.10以鴻么1. IJ01禹么鸛么婦鳥神么螂 〕玆座邑座匹匹挫匹蘊乃遷叢絕乃邑藝必叢纏色色叢醒叢邑 勵d鰓鰓U．騙鳥訕鳥騙才d陽么U么涌l亂觀為雙’j牌誡鴻鳥縣l馮 ．■•■•••••••••••• 血勵••自‘戶國團目叮黝”屆• 江黝必團匕叮• 么朧d朧叮d勵•彎自d細d幼閱• 茲勵‘細•處•d牌•細d曉寧潤••此。 23 - Table 3 BALANCE OF SAVINSS, INVESTMENT AND INTEREST PAYMENTS ....... (Z of GDP) .............. ------ w ---------------------------------------------------- ft- ---------------------- 1972 1977 1982 1993 1964 1985 1984 .......................................................... ft ............. .......... wft ........................ Private Sector .............. Saving (So) (Mon-Interest Current A/C) 19.0 19.1 lail 23.5 21.4 12.8 10.6 Investment f1p) /a 13.7 13.2 9.9 8.7 9.1 5.2 5.6 Interest of Foreign Debt (Tip) lb 0.6 0.3 0.9 2.3 3.1 2.1 1.7 Interest of Domestic Debt (Tip) /c -0.6 -1.4 -6.3 -1.0 -0.8 -0.8 -0.1 Net 5.3 7.0 14.1 13.5 10.0 6.3 3.4 Public/fiovt. Sector ------------------ Saving 199) Mon-Interest Current AIQ 4.0 8.0 1.3 -4.4 -3.9 5.6 5.6 Investment (19) 8.5 11.1 6.7 6.4 3.9 5.4 6.1 Interest ef Foreign Debt Mg) lb 0.5 0.6 5.2 5.0 4.2 b.3 3.9 Interest of Domestic Debt (Tfg) /c 0.6 1.4 6.5 1.0 0.8 0.8 0.3 Net -5.6 -5.1 -17.1 -16.8 -12.9 -6.9 -4.7 Wernal/Foreign Sector ---------- - - - - - - - - Saving (Sf) (Trade Deficit) -0.8 -2.0 -3.1 -4.0 -4.5 -7.8 -4.3 Net Factor Service Income (FSY) -1.1 -0.9 -6.1 -7.3 -7.3 -6.4 -5.6 Net 0.3 -1.9 3.0 3.3 2.0 0.6 1.3 Total Balance 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Rego Items.- Gross Investeent/60P 22.3 24.3 16.6 15.1 13.0 10.6 11.9 GDP (US S Billion) 23.2 43.6 62.0 64.6 68.0 64.6 66.3 a/ Including changes in inventories. Investment uses KRA, National Accounts definition This differs from that used by Winisterio de Econosia in its public sector accounts. b/ Interest and net direct investment income. c/ Interest payments on debt by public sector to private sector. d/ 1983 GDP converted at official rate and then adjusted by 6W real grooth rate and U.S. eholesdle price index for the other years. Sources: Tables 2.6, 2.8l 3.3, 5.2 and 5.14 of the Statistical Appendix; and BCRA and 1inister of Economy, 'Argentine Economic Memorandum 1987'. Buenos Aires, 1987. * 24 - Table 4: REGRESSIONS RESULTS SAMPLE PERIOD: 1978.1-1986.1 Eguation L": Instrumental Veriablesa/ Instrumerts used: Constant, (LoaM0-Lo9Y)_x. Lopiv LogEXOVE, INFL, LoglREG. LoqMO-LogY = -0.874 + 0.397(LogM0-LogY)_ - 0.251Lopi (0.244) (0.108) (0.052) - 0.217Lo9EXOVE + u (0.149) Ma=0.844; SEE-0.123; DW=2.58; t ( Ordinary Least Squares Corrected for Serial Correlation (Cochrane-Orcutt) Lugi = 0.21INFL + 1.03SIREG + e (0.149) (0.189) RI=0.92; SEE=7.4; DW=2.08; rho=0.3; (0.18) Short and Long Run Elasticities: i INFL Yb/ EXOVE Short-Run -0.25 -0.27 1.0 -0.22 Long-Run -0.42 -0.42 1.0 -0.36 g/ Figures in parenthesis indicate standard error of the coefficient. Where: Log is the natural log, and -1 denotes a variable lagged one quarter. M4= sum of currency plus demand deposits deflated with the wholesale price index (1970=100); i= nominal quarterly effective free market rate for 7-days deposits; Y= Real GDP in 1970 constant Australes; EXOVE= ratio of black to official(financial) nominal exchange rates; INFL= average quarterly rate of change of consumer price index (1970=100); IREG= nominal quarterly effective regulated rate for 7-days deposits; and, u and e are errors terms of equation 1 and 2 respec- tively. k/ Impo5ed by the structure of the equation. - 25 - V Table 5:- SOME VARIATIONS ON THE MAIN ECONOMETRIC RESULTS /a Sample Period: 1978.1 1986.1 Method: Ordinary Least Squares Equation Const (LooM6-Lo9Y)-x i EXOVE Rm SEE DW 1.1 -1.47 -0.42 0.73 0.155 1.07 (0.16) (0.04) 1..2 -0.71 0.446 -0.266 0.83 0.125 2.51 (0.22) (0.105) (0.052) 1.3 -0.67 0.397 -0.251 -0.217 0.84 0.123 2.58 (0.24) (0.11) (0.05) (0.15) Equation INFL IREG R2 SEE DW 2.1 1.02 0.86 9.6 1.89 (0. 04) 0.307 0.925 0.92 7.4 1.44 (0.15) (0.19) 2.3b/ 0.770 0.85 6.9 1.70 (0.03) a/ Figures in parenthesis are standard error of the coefficient. j/ Dependent variable in this equation is IREG - 26 - Table 6: INFLATION TAX AS A FUNCTION OF ALTERNATIVE - COMBINATIONS OF INFLATION RATE AND DEGREE OF OVERVALUATION OF THE EXCHANGE RATE /a (as a percentage of GDP) Exchange Rate Inflation Rates Overvaluation (Average saonthly percentage rate of change in CPI) (Ratio of Olack liarket to: official excnange rate) 2 5 10 25 (as percentage) ****--------*----------------*- - - - - e-- e------------ ---------*--e e-o--e-*--m e - 60 2.80 3.95 4.46 3.93 80 2.52 3.56 4.02 3.54 100 2.33 3.29 3.71 3.27 120 1 2.18 3.09 3.48 3.06 140 2.06 2.91 3.29 2.90 /a For example, if the ratio of black market to official exchange rate is 100% (i.e., brecha equals to zero) and Inflation rate 5% per month, this would lead to an inflation tax of 3.29% of GDP. If the black market to official rate was 120%, the Implied expectations of devaluation would result in a reduced inflation tax of 3.08% of GDP. Source: These estimates were computed using equations 1 and 2 of Table 4. - 27 - Table 7: FINANCING THE PUBLIC SECTOR DEFICIT (approxiate estimates, all values expressed as % of GDP) FinancL0g Alternatives leflatior tate (sonthly) 21 5 101 I. I Increase in 0.5 0.5 0.5 d noo-interest deficit 1.2 douestic debt INTd interest - domestic 0.5 INF inflation tax 2.3 3.3 3.7 INTf interest - foreign 3.9 SEIG seignorage 0.44 0.3 0.22 F increase in 0 0 0 external debt Public Sector -3.2 Increase (decrease) in additional Wt 0.04 0.9 1.22 Deficit Consol. revenue (expenditure)8 II. 8 0.5 0.5 0.5 d -2.6 INTd 0.5 IF 2.3 3.3 3.7 INTf 3.9 SE16 0.44 0.3 0.22 F 0 0 0 Deficit Consol. -7.0 Increase (decrease) in additional *"J-3.76 -2.9 -2.58 Public Sector revenue (expmnditure)t Assumptions: Real annual interest rate, dsestic 21 Real annual interest rate, foreign 6. Growth rate of economy, 42 Ratio of black to official exchange rate 1002 () A negative (positive) figure indicates that an increase (decrease) in net public sector revenues is needed Source: Division estimates. - 28 - Graph 1: INFLATION IN PUBLIC SECTOR DEFICIT Annual InfLation Rate 80 60 Increased pe Foreign 40 P Financing 40*p F -1 F=0 F =1 20 1 2 3 4 5 PubLic Sector Deficit (% GDP) F is increase in reat foreign financing (% GDP).