Argentina - Banking Sector Adjustment Loan

Document of The World Bank FOR OFFMCIAL tUSE ONLY Rhpt No. 12162 PROGRAM CONPLETION NOTE ARGENTINA BANKING SECTOR LOAN (LOAN 2923-AR) JULY 1, 1993 MICROGRAPHICS Report No: 12162 Type: PCR Trade Finance and Private Sector Development Division Country Department IV Latin America and The Caribbean Region Thi document has a restricted ditibution and may be aud b recipiens only in de pformance of eir official duies. Its coutents may not oterwise be disclosed withou World Bank oriztion.  FOR OFFICIAL USE ONLY THE WORLD BANK Washing0on, D.C. 20433 U.SA Office of Director4,norai Operatons Evaluaton July 1, 1993 MEMORANUM TO THE EXECU=I PRECTO AND THE PEMII)N SUBJECT: Program Completion Note on Argentina - Banking Sector Loan (Loan 2923-AR') Attached is the Program Completion Note on Argentina - Banking Sector Loan (Loan 2923-AR) prepared by the Latin America and the Caribbean Regional Office. The loan was approved by the Board on March 29, 1988, and again (in amended form) on October 27, 1988. It was never signed, and the loan lapsed as of October 31, 1989, at which time the Bank withdrew its offer. It is therefore not rated by OED. The attached Program Completion Note is provided in lieu of a PCR. The Note is candid and explains why the program was abandoned. The objectives of the reforms contained in the program were to increase deposit mobilization and confidence in the banking system, to improve the allocation of credit and, to reduce the cost of credit. The loan would have provided balance of payments support and would have reimbursed 100% of the foreign exchange cost of eligible imports. Following the original approval of the loan, it became clear that the Government would not be able to meet some of the conditions, and the loan was therefore amended. Subsequently, important conditions of effectiveness still could not be met and, above all, the macroeconomic environment remained procarious and not conducive to achieving the objectives of the loan. Because of the accelerating inflation and macroeconomic instability in Argentina at that time, it was not justified to proceed with the loan. However, its indirect contribution to the country's structural adjustrnent efforts during 1986-90, especily through the associated policy dialogue, will be evaluated as part of a cluster audit of adjustment operations in Argentina during those years. Attachment Iis docmet has a restinted distrb and may be used by recionts ol in the eifomnueoft* offeifel dud.. 1ls mno orwis be &diosed wtout Wold Bank athorzation  PROGRAM COMPLETIQN NM ARGEN1fNA BAMNGC SEQCLL LQAN (LOAN 2923-AR) 1. This is a short Program Completion Note for the $400 million Banking Sector Loan (BSL) to Argentina that never was. The Bank's Executive Directors approved the Loan on March 29, 1988. Because expected improvements in the macroeconomic environment failed to occur, and because the Government of Argentina was unable to comply with several policy conditions, the loan had to be renegotiated, and later amended by the Board on October 27, 1988. Since then, regular reviews of effectiveness conditions revealed unlikely compliance in key areas. Therefore, the Ba&k took no initiative for loan signing and the loan lapsed as of October 31, 1989. Consequendy a fuil PCR has not been prepared for this program. 2. Bacgroud. In the 1930s and 1940s Argentina prospered as a market economy open to trade and foreign investment, specializing in the production of agricultural commodities and agro-based manut~ctures. However, increased income generated by trade motivated the authorities to intervene, nationalizing infrastucture enterprises, intensifying industrial policies, and regulating the markets for labor and for financial and other services. The stdte thus came to assume the leading role, increasingly relying on Central Bank financing. The economy became progressively more unstable, and inflationary bursts more common. In the absence of a permanent fiscal reform, the authorities launched various ;heterodox" stabilization programs and began a cycle of tightening/relaxing price controls. 3. In 1987, during one of these sequences, President Alfonsin requested World Bank assistance for a program of structral reforms. At that time the Bank had only a small investment lending program but a growing policy dialogue with Argentina. The Bank, therefore, decided to support the Government's efforts with a package of adjustment and investment loans. The Bank reviewed the Government's request for support in August 1988, and approved, in October 1988, a package of four loans, a total amount of US$1.25 billion. The BSL was one of them. 4. nIeProam. The BSL had the objective of: i) increasing deposit mobilization and confidence in the Argentine banking system, ii) improving the allocation of credit, and iii) reducing the cost of credit. In early 1989, the macroeconomic and financial market conditions took a dramatic turn for the worse. Developments included hyperinflation, runs on bank deposits and foreign exchange markets, collapse of the bond prices, very low economic activity and the specter of deep social tensions. M;acroeconomic crisis subjected the finanial system to great stress. A Bank field mission reviewed the situation on March 1989, and reported that the Government was meeting only two of the seven effectiveness conditions. Key conditions not being met at that time were: (i) presentation to Argentine Congress of a law on deposit insurance; (ii) level of forced investments and their consolidation, as well as the consolidation of rediscounts; (iii) presentation of restructuring plans for the National Development Bank; and (iv) implementon of autotic Nationa Mortgage Bnk foreclosure policies. The compliance with these conditions also depended crucially on the political will which were to be testd after the May 1989 elections. 5. The basic problem was that the monetary authority was mting to carry the burden of the stabilization effort inidated in August 1988 (Plan Primavera), particularly after it became clear that the authorities could not reduce the fisca deficit sufficiendy. The monetary authority employed the only intument of absorption it had, forced levies on the commercial banks. This contradicted the BSL's  -2- basic objective, which was to increase commercial bank lending to the private sector. It, therefore, violated the Loan's forced investment condition, which had been deliberately designed to interrupt the Loan in such circumstances. Also, the excessive real intetest rates and inflationary pressures had strongly discouraged commercial bank operation with the private sector. 6. By the time President Carlos Menem was inaugurated on July 8, 1989, inflation had been 180% in June and reached 220% in July. Output was disrupted by this frenzied price system, demand was falling and unemployment was rising sharply. The austral was devaluing at a faster rate than domestic prices. The public deficit was massive, the banking system was plagued by a run on deposits, and the Government was unable to obtain credit from virtually any source. Bank Management had not cancelled the BSL, since it thought it possible that the Bank might be able to reach an agreement with the new Government on a reform program. The economic team of President-elect Menem, even before May 1989 elections, had approached the Bank with requests for the early resumption of an active dialogue expressing a desire to reactivate the BSL. The Government was preparing a drastic stabilization program and had approached the ll!lF for support. 7. However, by October 1989, the macroeconomic improvements in Argentina necessary to comply with the BSL were still not realized. The Government's inability to meet fiscal targets had led to a deterioration in the incentives framework of the banking system and thus ultimately to the derailment of the loan. Recognizing possible fiscal pitfalls, the Bank Management had provided for adequate safeguards to ensure that disbursement would only take place once the Government could demonstrate that the macro environment was conducive to achieving the objectives of the loan. In the event, these objectives were not met. Also, the World Bank's intenal guidelines required loan signature within twelve months after Board presentation. Iherefore, the Loan was withdrawn as of October 31, 1989. Bank Management decided that any future Bank financial sector operation in Argendna would be condngent on a satisfactory stability program which would also address the issues raised in this Loan. 8. Although the Loan was never signed, the Government made notable progress in a number of key areas in the context of the nearly two years of loan preparation. All of these are still in place. These include: i) market determined interest rates on lending and time deposits, ii) liquidation of some Cen Bank holdings in private banks, and iil) rationalization of Central Bank's rediscount policy. 9. Lessons Leamed. Various lessons of general nature can be derived from this program. It confirms the need to avoid excessive dependency on institutionally fragile and highly politicized institutions, especially at times when the Government's political power is being tested. Thus, the timing of loan presentation in a politically unsetted situation, as well as one of high rates of inflation was risky. A second lesson lies in the conditionality of the loans. Some of the actions indicated in the BSL were carried out and there were some improvements at the technical level, but the benefits of the changes did not become apparent untl macroeconomic conditions were normalized. Due to over optimism at appraisal, intvention by political forces and the deterioration of the economic situation in Argenfina, the physical components of the program, as originally conceived, could not be implemented, in particular, the required action plans for eight public banks. In retrospect the program scope was too ambitious. 10. The main benefits from the program are those which accrued to the recent US$400 million Financial Sector Adjustment (February 16, 1993). Bank Management recognized the cautious and gradua proces that a financia sector reform needed and played an extremely usefl role in helping the Menem Government to work through its program. When the situation stabilized, the information  gathered by the Banks missions and the undeviating dialogue were helpful in formulating plans to restructvw'~ the banking system. Another lesson learned was the importance of attaining sufficient safeguards to ensure that disbursement will only take place once a Government can demonstrate that the macro enironment is conducive to achieving the objectives of an adjustment loan. This program had been deliberately designed to interrupt the Loan in such circumstances and it did. 11. This text and the attached basic data section were prepared by the Trade, Finance and Private Sector Development Division, Department IV of the Latin American and Caribbean Regional Office (LA4TF) and is based, it_aia on the President's Report; supervision reports; correspondence between the Bank and the Borrower; and internal Bank memoranda. The following attadunents include the most relevant information still available on the program.  Witti} ~~I. II XW~~~~~' _}t|et X, I.gZZ Z~0tAE S S 0 ];:|1 2 I I c I  Athment Page 2 of 3 ST INPUIS EXY Eli! EIl E