Transcript of meeting of the Executive Directors of the Bank and IDA, held on Tuesday, March 1, 1994 : Argentina - Capital Market Development Project

nm STRICTLY CONFIDENTIAL 1 NM/AH INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION Tuesday, March 1, 1994 Washington, D.C. The meeting of the Executive Directors was convened at 10:02 a.m. in the Board Room, 700 Eighteenth Street, N.W., Washington, D.C., Mr. Lewis T. Preston, Chairman, presiding. MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002 run STRICTLY CONFIDENTIAL 2 C O N T E N T S ITEM PAGE 2 Proposed Loan - Argentina (Capital Market Development Project) (including Country Assistance Strategy) 109 3 Proposed Loan - Argentina (Capital Market Development - Technical Assistance Project) 109 Mr. Nogues 113. Mr. Fischer 0 115 Mr. Won 118 Mr. Kodera 125 Mr. Jalan 137 Ms. Gaseltine 141 Mrs. Katz 146 Mrs. Herfkens 152? Mr. Al-Mofleh 158 Mrs. Ketu'u 161 Mr. Grilli : ~_;_, l-ttt3" Mr. Haas + 181 MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  nm STRICTLY CONFIDENTIAL 3 C O N T E N T S ITEM PAGE 2 & 3 Proposed Loans - Argentina (cont'd.) Mr. Torres + 195 Mr. Sadik 202 Ms. Boucher 205 Mr. Doumnov 206 Mr. Oyewole 211 Mr. Wang 214 Mr. Akturk 215 MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL run 109 We would like to take up agenda items two and three together. Both are proposed loans to Argentina. Item two is a proposed single currency loan in the amount of U.S.$500 million for a Capital Market Development Project. This memorandum includes a discussion of the Bank Group country assistance strategy for Argentina. Item three is a proposed loan in the amount of $8.5 million equivalent for a Capital Market Development Technical Assistance Project. We are pleased to welcome Mr. Hardy of the IMF who is attending this meeting. Mr. Meo of the Latin America and Caribbean Region will introduce the assistance strategy and the proposals. MILLER REPORTING CO., INC. )07 C Suect, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL nm 110 Then, they may be discussed jointly or separately, as you wish. Mr. Meo. MR. MEO: Thank you very much, Mr. Chairman. Mr. Chairman, Members of the Board: One of the two projects before you contains the CAS on Argentina. As you have observed from the CAS, we remain optimistic about Argentina's medium-term prospects and propose essentially to maintain the same strategy you discussed and approved a year ago. As in other countries, the provinces remain still the Achilles' heel, however, of public finance in Argentina. We shall be addressing this issue via a further provincial adjustment loan and a series of loans with a provincial emphasis in education, health, highways and mining. With the exception of the proposed provincial adjustment loan, however, we shall be shifting our future emphasis towards investment lending, particularly into human resource development. The capital markets loan before you, however, is so novel, so different from our usual financial loans, that we will focus the balance of our opening remarks on this loan. The genesis of the loan was the authorities' and MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL run 111 our desire to lengthen maturities and reduce extremely high spreads in Argentina's still recovering securities and banking markets so as to better finance Argentina's recoverin industries. Normally, we would have considered some form of financial intermediation loan; but, Argentina, like a few other countries that have reestablished confidence in their economic management, is experiencing substantial inflows of capital, last year over U.S.$10 billion. There seemed little need for the Argentine Goverrunent to indebt itself further with only a limited effect on capital market development for a normal Bank credit line. After much analysis, both we and the goverrunent have determined on the proposed approach. It is, in essence, a domestic ECO. The Bank loan will be used to support a backstop facility. This in turn we hope will encourage commercial banks to lend at longer term since they will have the assurance of support to renew their own longer-term borrowings if there is a market disruption when the time for this renewal occurs. Such facilities are not new. They are, however, new for World Bank operations, and it requires some very new MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C 20002  STRICTLY CONFIDENTIAL nm 112 procedures. First, the loan may be successful even if it does not disburse. Secondly, it requires extraordinary grace periods and a unique pricing scheme. Thirdly, it will be the first Bank loan to disburse if it does, to purchase financial instruments, not goods and services. Why then have we chosen such a vehicle? First, the Bank loan will encourage banks to tap private savings first, not resources with a government guarantee. With prior capital flight returning and other funds flowing now into Argentina, this was a primary consideration for the project. Secondly, the project guarantees Bank funds will be available if and when there is a spike in interest rates. If there is not, then the Bank disbursements won't be required. The Bank thus would act in a counter-cyclical manner instead of reinforcing a business cycle. Finally, the project itself will nudge the securities market of Argentina into further development. It standardizes bank instruments, encourages banks to strengthen their own finances, and will develop the securities rating industry. MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL nm 113 Thank you. MR. PRESTON: Thank you, Mr. Meo. Before calling on other speakers, I note that the following Executive Directors have circulated their statement in advance: Mr. Nogues, Mr. de Paiva and Mr. Gerber. That having been said, Mr. Nogues. MR. NOGUES: Thank you, Mr. Chairman. I have circulated, as you said, the statement, which I hope my colleagues have had time to look at. I can, therefore, be very brief and use this opportunity to mention something I did not say in that statement, and that is to appreciate the work done by the staff. Today, you will be discussing an operation that is expected to have a significant impact on the development of Argentina's capital market. For the Bank, this operation represents an innovation with great potential for assisting not only Argentina but other countries as well. I also want to go on record by stating that the intellectual credit of this operation rests entirely with the staff of the Bank. After much hard work had been done in trying to come with a proposal that was best for the development of the capital market, the staff suggested the MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL nm 114 idea before you and then worked very hard in its development. The Government of Argentina commends the Bank staff for the good work that has been done. The note I have circulated explains why the long- run process of Argentina's economic retrogression has come to an end. I would like to conclude this brief remark by reading the last two paragraphs of that note. This refers to the social sectors. "President Menem has recently declared that the time has come for the country to repay the social debt. A soon to be completed poverty assessment study by the Bank will provide knowledge that is crucial for the work of the new Secretariat of Social Action. That is expected to increase the efficiency and effectiveness of targeted poverty reduction programs. "At a broader level, the government is working hard towards the goals of improving educational attainments and primary health care. Following on these goals, the governmen has programmed that between 1993 and 1995 consolidated public investment in the social sectors will increase by 80 percent. Above average increases are expected for investment in education and health." Summing up, Argentina's economic program is a very MILLER REPORTING CO., INC. :;07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL nm 115 successful one, but in no way the government is sitting on its achievements. Economic success that is empty of the moral obligations towards the less fortunate fellow citizens has a low social standing. In this respect, much remains to be done and the Government of Argentina is looking forward to many years of productive work with the World Bank staff. Thank you, Mr. Chairman. MR. PRESTON: Thank you, Mr. Nogues. Mr. Fischer. MR. FISCHER: Thank you, Mr. Chairman. Let me join in expressing my appreciation for the three colleagues who have been kind enough and be in a position to circulate their advanced statements, which we have studied with great interest. Let me start, Mr. Chairman, by alluding to the fact that a group of us visited Argentina some two years ago, and we were all impressed by the great turnaround not only in the economy and the social fabric of this country but, if I may add also, in the thinking and the mentality which is equally important. So, I read the CAS with particular personal interest and we broadly support it, as we can also support MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL run 116 the two projects. Just two or three remarks, Mr. Chairman. First, on the economic reforms and poverty alleviation: Inasmuch as we support the reform process and the Bank's assistance to it, we would have liked in Section A of the CAS an assessment of the progress in reducing poverty and improving social condition, not only because it is a requirement under the new format of the country assistance strategy, but also, Mr, Chairman, as we do not have to go very far to have vivid experiences also due to CNN in recent weeks and months about the potential for social unrest during a reform process. In later sections of the paper, Mr. Chairman, the report does give some hints that this is also a problem in Argentina. Mr. Chairman, the over-arching objective of the Bank is poverty alleviation and we, therefore, must start to analyze and address these issues in a comprehensive way in any country assistance strategy. And I also have noted that the report is vague with regard to the status of the poverty assessment, as I have mentioned already. This is not to belittle the great merits of this paper. There was one particular element of what I would call constructive criticism. MILLER REPORTING CO., INC. 507 C Street, N .E. Washington. D.C. 20002  STRICTLY CONFIDENTIAL nm 117 My second remark, Mr. Chairman, refers to the per capita income of Argentina. With $6,052, the country clearly is in the top lead. And this issue has, therefore, been dealt with and must be dealt with in the CAS document. However, the information that is provided to us in paragraph 52 makes it difficult to get to an informed judgment, except to learn which is important that the adjustment process is still fragile. Because of this difficulty to make an informed judgment, we would have preferred to have different lending scenarios, as stipulated in paragraph 9 of the new CAS guidelines. In any event, Mr. Chairman, I hope and I am confident that Argentina will continue its important and impressive reform process so that at a given time this country will enter the group of graduate students, or should I say graduating students. In any event, the Board would at a given time gladly and with pride hand out such a diploma. Once again, let me say also personally, as I was impressed at our visit two years ago about the astounding reform in Argentina, I continue to be confident -- and this is supported by the CAS in front of us -- that the auspices MILLER REPORTING CO., INC. 507 C Street. N E Washington, D.C. 20002  STRICTLY CONFIDENTIAL run 118 seem to be very good for Argentina to continue that impressiv process. Mr. Chairman, as to the two projects that are somehow interlinked, we can support them. We feel that they are innovative. And if I understand the rationale of the backstop facility correctly, a measure of success will be if not all the resources are finally needed and disbursed. This is an unusual feature of this. It will be interesting to watch the performance of the new instruments, and we would be interested to learn more, if possible, at this stage what is the measure for success. Thank you. MR. PRESTON: Thank you, Mr. Fischer. Mr. Won. MR. WON: Thank you, Mr. Chairman. This Chair would like to offer its strong support for the Argentine reform program. The Argentine authorities have demonstrated an ability to tackle very difficult issues over a rapid time frame. In particular, the ambitious privatization program deserves special mention. We support the Argentine CAS and the two capital market development projects. MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL run 119 Further development of capital markets in Argentina will allow more rapid investment and growth. The capital market development project involves the Bank in an innovative role by providing a backup facility for commercial banks. In this regard, we have a few short questions for the staff. First, the proposed loan backs up U.S. dollar denominated Bank debentures and involves the possibility of selling securities to the facility. Since the facility is only open to commercial banks using dollar-denominated assets and liabilities, will the loan cause increased dollarization of the Argentine economy? Secondly, on Bank prudential supervision, this project is to support a further expansion of the capital market and, hence, the Bank prudential supervision is crucial to the development of financial markets. However, as paragraph 71 notes, the progress of Bank supervision in Argentina is weak. Is there a need to pursue a major strengthening of prudential supervision arrangements? My third question is on the relative roles of the Bank and IFC. The project aims at increasing lending to the private sector. The IFC projects have the capacity to achieve the same end. In fact, paragraph 47 notes that one of IFC's objectives in Argentina is to develop domestic MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL nm 120 capital markets through the establishment of new products and financial institutions. However, this project is suggested by the Bank rather than IFC. What are the reasons behind this? Lastly, like Mr. Fischer, I would note once again the very good progress of Argentina in moving into sustainabl growth and development. In this context, I would welcome the views of Bank staff as to when Argentina is likely to graduate from IBRD lending. Thank you, Mr. Chairman. MR. PRESTON: Thank you, Mr. Won. I think in view of the time and in the interest of coherence, we might now call on the staff to answer those questions and then we will adjourn and reconvene at 2:30. Mr. Meo, Mr. Burki. MR. MEO: Thank you very much, Mr. Chairman. Let's go through them in order very quickly. We regret that the poverty assessment study now underway is not completed. As soon as that is done, we will have much more information, as the GNP, which we will be turning to in only a half a minute implies the statistics are very, very important here, and we and the Argentine authorities have spent a substantial amount of time on statistics on poverty MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL run 121 and income in the Argentine milieu. We hope to have for your very soon a full report on poverty and hopefully some ideas of what to do about it much more practically. Per capita GNP: Argentina is like Cinderella. They knew they were doing well. They thought they were entering high school and then, after a full-blown study of their SNA, their national accounts, we and they were shocked to discover they were far more affluent than they or we had ever considered. I think those of you who have been through the CAS, and as Julio has emphasized, there is a full-blown agenda still remaining. Argentina has undergone an extremely historic transformation, but there is indeed a recovery of the state, recovery of infrastructure, development of human resource institutions which remain. We simply just didn't have the time to work out a five-year graduation strategy at this stage. We are essentially asking the Board for your permisso (Phonetic) to discuss that in a year or so when the foundation of the Argentine economy is a little more solid than it is now. This has been a shock to the Argentines and us, their per capita income. We have gone over the numbers, our MILLER REPORTING CO., INC. '>07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL nm 122 best experts, their own. They are relatively faithful, far more than a few other countries, I might add. But still in this instance, given the development challenge before them, we essentially would prefer to bring up graduation when they have had a sounder track record of reforms. How do we indicate whether we had success in the project? Quite simply, the maturity of bonds, the reduction of spreads in the markets. Today, in the markets, you have spreads of around 12 to 15 percent, in some instances as high as 20 percent for Bank loans. Instruments in the market, in the Argentine market, are most around three years. A few of the best institutions and firms can stretch to maybe five years. If you are a smaller firm, forget it. We clearly believe the project is a success if we can increase the amount of bonds in the market, if we can reduce the spreads and the terms that they have to confront and if the maturitie will indeed be longer. Will a dollar loan increase the propensity for Argentines to go to the dollar? They have a law of convertibility which essentially turns the Central Bank into almost a monetary board. The U.S. currency is a legal exchange in Argentina. MILLER REPORTING CO., INC. S07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL nm 123 Today, U.S. loans are so much cheaper that virtuall any loan beyond 180 days is in U.S. We clearly share your concern that to deepen the market, you have to go to the peso side as well. But, at this stage, what we and the authorities have agreed on is to deepen the market first and then discuss how you do peso loans. We wouldn't rule out in the future something in that area, but at this stage, given the fact that virtually all Bank loans and almost all bonds -- in fact, when I say "almost", I am stretching it a bit; there are perhaps some we haven't found -- virtually all are in U.S. currency. We don't see how we can fight that stream. We would much prefer to bring in the instruments, expand the whole market and provide resources for the productive areas. Prudential supervision, yes, it is a slow process to improve prudential supervision of banks, particularly when through bursts of hyperinflation and a history of financial perversions have been extremely able and intelligent financia speculative area of the whole economy. This is proceeding, but because it is still weak, in this loan the wholesale bank, the Bayse {Phonetic) Bank has established an independent capacity to judge the banks MILLER REPORTING CO., INC. ~07 C Street, N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL nm 124 which would be eligible for the facility. As part of financial sector adjustment loan, which is still ongoing, as part of our work, we are continuing strongly to support Bank supervision improvements. I might also add that the IMF and the IDB are also helping here. This is going to be a labor of five more years at a minimum for the authorities of Argentina. IFC: At my side is the Task Manager of the project, Mr. Carrizosa. As a part of the work that he undertook, we flirted with the idea of securitization. As part of his work, we cleared out with the authorities a substantial amount of administrative under brush which was restricting securitization. And to our pleasure, we find the IFC is now entering this field with a few Argentine banks. We did ask the IFC at the early stages of our work to join with us. However, as we developed the concept beyond securitization into a backstop facility, as it became clear that the key areas were the markets, the government regulator supervision capacity, as we continued the dialogue and as it became clear that this would be a very innovative approach for the Bank as well, the IFC continued with its work, but did not join us. We hope, if we have success in this project, that MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL nm 125 future backstop facilities will be handled with the IFC as well. It is a natural progression. MR. PRESTON: Thank you, Mr. Meo. Mr. Kodera is the next speaker and he has an appointment this afternoon. I beg your indulgence for Mr. Kodera's comments. MR. KODERA: Thank you, Mr. Chairman. Allow me another five minutes. I am also hungry too. (Laughter. ) MR. KODERA: My government already supported the preparation of this project through our trust fund and also our Exim Bank participated in the capital market reform loan through cofinancing with the IDB. Nothing better than these events tell us of our support for these two projects. So, I will rather concentrate myself on the country assistance strategy. I have five points to make. First, the export promotion; second, the level of external debt; third, unemployment; fourth, local government; and lastly, infrastructure development. On the export promotion, it is crucial to promote exports and reduce current account deficit in order to MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D. C. 2000 2  STRICTLY CONFIDENTIAL run 126 maintain the framework of the convertibility law, which is I think the core of the present economic strategy of the goverrunent. I agree with the assessment in paragraph 21 that increased exports should come from increased productivity rather than exchange rate adjustment. In this regard, staff prescribe that reform in the labor market and the social security system are necessary for the strengthening of the competitiveness. This is in paragraphs 25 and 26. i But, I don't believe this prescription is enough. JI I· ·\ I can go along with less interventionist policy stance of the 11 government, but here deeper and closer analysis is necessary. For instance, the CAS should have discussed the kind of I policy measures necessary for the promotion of the foreign direct investment and also technology transfer for strengthening competitiveness, while paragraph 16 points out that the slowdown of the domestic demand could lead to the increased exports. I doubt that this is a realistic assessment because I believe the lack of competition in the domestic market and the lack of export competitiveness are the true reasons behind the lower export growth. Now, let me move on to the external debt. While I MILLER REPORTING CO., INC. ~07 C Streer, N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL nm 127 welcome the reduction of Argentina's external debt through last year's agreement with the commercial banks and while we are witnessing a moderate improvement of the external debt, I cannot be too optimistic at this stage. Annex 5 of the report states that the total outstanding debt to exports and goods service is 4.90 percent and total debt service ratio is 46 percent. This report should have emphasized that the debt issue is not over yet. My concern comes from the assessment that no remarkable improvement for debt indicators is predicted in the next few years, and from the forecast that it is only the short-term private capital inflow which could finance the current account deficit. To address this situation, the CAS should have encouraged the further reduction on the current account deficit through the tightening of the domestic demand and promotion of non-debt nature capital inflow, namely the foreign direct investment, and restraint on the external debt and conversion from short-term debt to long-term debt maturities. Some additional comments on the return of the flight capital, according to some private companies, reports the estimated flight capital amount of over $20 billion U.S. MILLER REPORTING CO,, INC. 507 C Street, N.E. Washington, D.C 20002  STRICTLY CONFIDENTIAL run 128 left Argentina between 1978 and 1987. The report states that these assets have reached a present value of $50 billion U.S. and it proceeds and continues that the capital flight has already returned to $4 billion in 1991 and $8 billion in 1992 I believe that the project would further help to serve the return of flight capital. Now, let me move on to the unemployment. I find it quite disappointing that the CAS didn't take a serious look at increased unemployment situation in Argentina, which poses a major policy challenge for the goverrunent, with the downsizing of the public sector, including local goverrunent, and the restructuring in the various industries through trade liberalization and deregulation, in spite of the high 8 percent growth during the past few years. The unemployment rate is increasing. In order to maintain the public support for present policies, the goverrunent should place emphasis on creation of new jobs through small and medium-sized enterprises and strengthen a retraining program of the unemployed workers in the labor market reform. Fourth, on the local goverrunent, I highly appreciat the CAS emphasis on the macroeconomic reform consolidation, especially the need for the local goverrunents to improve MILLER REPORTING CO., INC. 507 C Street. N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL nm 129 fiscal positions. Because the local governments' deficits ar complicated, Argentina's whole public finance structure and the delay of the reform in this area has caused many problems As mentioned in paragraph 50, the effective Bank assistance may require focusing efforts on selected provinces with due consideration given to the implementation capacity, of course. I have a slightly different view. During the recovery and the stabilization process of the Argentine macroeconomy, the previously wide development gap among regions has been excavated. Also, the federal government had to cut transfer to local government and the Central Bank has suspended the deficit financing to these local governments. As a result, those states with especially weak economic conditions have suffered heavy losses. Indeed, we saw that the delayed payment to the local government employee triggered an uprising last December. In this context, I am also glad to hear, that the Bank is preparing the provincial adjustment loan, but I strongly urge the Bank assistance should prioritize fiscal reform in the poor states. Lastly, on the infrastructure, paragraph 17 indicates that the role of the Bank could be limited on the MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL nm 130 infrastructure because of the Bank's support of the private sector involvement in this sector. However, it is not clear what measure the Bank is contemplating if infrastructure investment by the private sector is not adequate. What is this, quote/unquote, "other element" in paragraph 51? In addition, we are not well informed as to the conclusion drawn from the joint research on the financing newly privatized infrastructure with the Argentine Research Institute. I would appreciate the explanation from staff on this point. But, all in all, I can basically support the present country assistance strategy. Thank you. MR. PRESTON: Thank you, Mr. Kodera. We will save the staff response to this afternoon. We will adjourn now, have a nice golf game, and we will meet at 2:30. (Whereupon, at 1:05 p.m., the meeting was recessed, to reconvene at 2:30 p.m. the same day.) MILLER REPORTING CO., INC. }07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 131 AFTERNOON SESSION [2:30 p.m.] MR. PRESTON: Well, we have a quorum and a chairman so we will go on. I think it would be, for good order's sake a good idea to respond to Mr. Kodera's comments just before lunch, and maybe there were some questions in the written material that you could also cover. Mr. Meo? MR. MEO: Thank you very much, Mr. Chairman. I think it is very useful to begin by thanking the Japanese Ex-Im Bank. Our division is financing a couple of loans with the Japanese Ex-Im Bank, and we tried to cofinance with them this specific one before you. Unfortunately, it is very hard for an export-import bank to finance a Backstop Facility. I must say they tried. We join their concern on export promotion. Clearly, the Argentine economy is small; the actions, the reforms they have undertaken are clearly to open up the Argentine economy to the world in the full sense of the word. There is indeed some grounds for export optimism here in spite of, as Mr. Kodera indicated, an exchange rate which for other reasons is very helpful, but is not a strong stimulus for exports at this stage. MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 132 First, the Argentine terms of trade today are among the worst they have had since the 1930's. Projections before you in the documents indicate a small improvement. My own experience is that we are very conservative in these projec- tions, and indeed they could potentially improve. We hope so The Uruguay Round will indeed assist Argentina. In fact, studies at the Bank have shown of all the developing economies of the world, the Argentines would have gained the most if the Cairnes Group proposals had been accepted. They were not. So the Argentine incremental exports owing to the Uruguay Round will be much more modest, but there will be some. There are also indeed entrepreneurial spirits which are being unleashed. A week ago, the Argentines inaugurated an oil pipeline between the area of Argentina where they produce the oil, and Santiago and Concepcion in Chile. Argentine oil now flows across the Andes. They have begun to work on a gas line as well. These exports are not minor. In fact, oil today is, I think, fourth or fifth as an Argentine export. Nevertheless the challenge will be to do more in this area. I want to combine this answer with a question which the Swiss ED indicated in his paper, which is ultimately MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 133 quite correct. For the diversification and stimulus to export, it will be productivity gains in the work force. And here, the Argentines have been very, very active. First, the privatization process itself has been helpful. The ports of Buenos Aires, for example, have reduced in cost by over 30 percent since they were privatized The manufacturing output has increased almost a third in the past few years. Employment unfortunately has not increased at all, which means that gross or aggregate productivity in that sector has increased by almost a third. The wage costs or taxes are being reduced. The Social Security reform and other reforms have produced a reduction in the employers' wage taxes that they pay, particularly in urban areas. The liberalization of heretofore small monopolies in transport services has also reduced some of the costs. The inflation in the Argentine consumer price index is averaging in the past four months about 6 percent a year. The wholesale index continues to be extremely modest in growth. It is approximately zero for the same four months. Nevertheless, clearly, the Argentines share your concern over export growth. We hope it comes. The external debt, very clearly, is a problem. MILLER REPORTING CO., INC. W7 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 134 They are having to pay an extraordinarily high proportion, over 40 percent of their exports, on debt service. This is still a country which is in a situation which is highly delicate. Direct foreign investment. Argentina probably had the highest flow of direct foreign investment of any develop- ing economy as a percentage of its GNP, as a percentage of it exports, over the past few years. This has been--and again, Mr. Gerber asked the same question--this has been a reflectio of the direct foreign investment flowing into the privatiza- tion process. For example, the petroleum firm itself produced a stock purchase of over $3 billion. The gas privatization was $2.5 billion plus acceptance of debt instruments of almost $1 billion more. The sale of the steel plant, the sale of the water--no; that did not bring any flows--but the privatization itself has reduced the debt outstanding by US$14 billion and produced a net inflow of cash probably around US$6 billion to $7 billion. This is where the direct foreign investment has been going, most of it. Admittedly, with the exception of gas and oil, it has been in nontradeable services--electricity, water, and a few other areas the productive firms sold--plants producing MILLER REPORTING CO., INC. )07 C Street, N .E. Washingron, D.C. 20002  STRICTLY CONFIDENTIAL ah 135 chemicals, steel, the receipts for these have been fairly modest. Nevertheless the Argentines have reformed their direct foreign investment laws. They treat foreigners equally with domestic investors. They are extremely open to foreign investment. They have held road shows to attract even more, with very, very high level staff involved in it. Unemployment no doubt has increased. It is getting to almost 10 percent. It is a problem. I went through the Chilean reforms of the early 1980's, and I remember how high they went in Chile. I am surprised they are not higher in the Argentine milieu. The probability is they will stay high for a year or so. One of the ameliorating factors has been a construe tion boom. The investment and construction in urban areas has been deferred for years, and the first response has been a very important construction boom. This has offered some employment to unskilled workers which has been very helpful in ameliorating some of the process. Nevertheless it is very hard for us to see how you can generate much more employment without expanding the economy, which is what the Argentines are now hoping to do, substantially. Local, regional issues. There was an allusion to the events in Santiago at the Calistero [phonetic]. Unfor- MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D C. 20002  STRICTLY CONFIDENTIAL ah 136 tunately, not all you have heard may have been correct. The transfers to the provinces have increased. They have increased massively. What we have seen in a few of the provinces is equally massive irresponsibility. They took these sums, spent them, and did not even have enough to pay salaries in some cases. And this has not been a very happy occasion for some of the provincial workers. The Constitution of Argentina, and the laws as well, require a coparticipation on many of the taxes. The fisc collects the taxes and must share a large amount with the provinces, and these have been increasing very, very quickly. So it is not owed to a drop in transfers that you have seen these events in a few of the provinces. This is why the Government and we believe that the provincial reforms are absolutely vital if we are to avoid future problems. In some of the provinces, almost half the work force is on the provincial payroll of the Government. These are not easy reforms, but you cannot continue this irrespon- sible action. What are we thinking of in infrastructure? I wish we knew. We do not know. We do know that a Backstop Facility has been used in the UK and in the United States for infrastructure investments. If we have success with this, we MILLER REPORTING CO., INC. 507 C Street, N.E. Washingron, D.C. 20002  STRICTLY CONFIDENTIAL ah 137 may begin discussing with the authorities an option in that area. I would, however, point out the authorities in this case are very reluctant to use the Bank to finance infrastruc ture. They sold this infrastructure to consortia who promised as a part of the deal to make the required invest- ments in the future and finance it themselves. That is why they did not distribute the stock widely. They distributed the stock to consortia who are financially solid. Under those circumstances, the authorities are very reluctant to use IBRD or resources of the IDB with the guarantee of the Government to finance these infrastructures at this stage. MR. PRESTON: Thank you, Mr. Meo. Mr. Jalan? MR. JALAN: Thank you, Mr. Chairman. I must begin by making an apology to you and to the staff, because I have to leave very shortly for another meeting, because I am going to ask a couple of questions and then leave without waiting for an answer. So I hope I would have your permission to leave immediately after making my presentation. MR. PRESTON: Are you playing golf with Mr. Kodera? MR. JALAN: No. I was not as smart as he. MILLER REPORTING CO., INC. 507 C Street, N.E. Washington. D.C. 20002  STRICTLY CONFIDENTIAL ah 138 [Laughter.] MR. JALAN: Mr. Chairman, my first point relates to paragraph 52, about which a reference was made, which is the revision of the national income of Argentina, and thereby it is getting into Category 5, and the initiation of discussions with the Argentine Government for graduation. Now, I do congratulate the Argentineans for waking up one morning and finding that they are nearly twice as rich as they thought. But it does present a slight problem for me--not the revision itself, because that is good; the more comprehensive statistics that you have, the better it is. But if you look at the neighboring countries, I was trying to get hold of whether Argentineans, by any real measure, either of consumption or of purchasing power parity, in real incomes are really twice as well-off as Brazil, Chile, Mexico, and Venezuela. I do not have any firm indicators, but from what limited statistics I have been able to get, it does not seem as if this is really a reality. If you compare Argentina with, say, Venezuela, which is still Category 4, in terms of fertilizer consumption, in terms of share of industry in total GDP, in terms of the calculation of real income, which is purchasing power parity. In the cost of living comparison MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 139 which have been made by the World Bank itself--! think it was the Kravitz [phonetic] study for 1991--Venezuela does not sound as if it is so much better off. You take energy consumption per capita, and it is $17.64 in Argentina as compared with $25.21 in Venezuela, $13.83 in Mexico. You take purchasing power parity, and Argentina's income on purchasing power parity would be $5,000 as against $7,000 for Mexico, $8,000 for Venezuela, and so on and so forth. The point I am raising is that given this particula problem of comparator countries and countries which are at a more or less similar stage of development in a long-term sense, it does present a problem if we start thinking of Argentina as a candidate for graduation because of better statistics for one country and not for others. To me, this seems something which I would urge you to think about, and in any case, from the policy point of view, it does seem to me that we should be proceeding rather slowly in graduating and work out a program which is based more on substance rather than on a statistical indicator, particularly in view of the tremendous performance of Argentina, and also in view of their need both for infrastruc ture investment as well as for social sector investment. I thought I would flag this issue because it did MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 140 strike me as somewhat odd to put Argentina on a special, different footing than other countries which seem to be apparently at a similar stage. And I think that from all the things you have said, Argentina does require continuing assistance for at least five to seven years. Otherwise, I find both the Country Assistance Strategy as well as the sectors on which the emphasis is going to be placed as extremely acceptable and just the right sort of priorities. I do not want to go into other matters, partly because I have to leave and partly because I think all of them have been covered, including in the written memoranda from my colleagues, so I will just leave the CAS right here. So far as the project itself is concerned, as staff said, it is an extremely innovative project, the first of its kind in the Bank's history, and I wish you luck. The only question I had was with regard to the relationship between amount. It is a +ixed amount facility of $500 million, and it is perceived as a Backstop Facility, as a lender of last resort. Now, given the size of the financial market in Argentina, and given the fact that this facility would probably come to be used in a situation which is abnormal-- MILLER REPORTING CO., INC. S07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 141 not a normal situation, because in a normal situation, you expect the market to function, and there will be no need for a Backstop Facility. The question I have is how is one confident that this amount of $500 million, in the event of a market disruption were these facilities to be used, would be sufficient? What is the relationship between this amount and the total size of the market, and particularly since it is thought of as a Backstop Facility. And if you have a market disruption--and given the way markets function, particularly financial markets, about which you know much more--the spread effect is very quick, and you have only $500 million in the kitty, it is known, and it is predetermined, and it is at a rate of interest which is also predetermined. How will it work should there be, God forbid, a market disruption? And do you have a backstop to a backstop? Thank you, Mr. Chairman. That is all. MR. PRESTON: Thank you, Mr. Jalan. MR. Jal,AN: I do apologize for leaving. MR. PRESTON: Ms. Gaseltine? MS. GASELTINE: Thank you, Mr. Chairman. Argentina is now reaping the well-deserved benefits notably in terms of low inflation and growth of an ambitious and impressive economic transformation which is now in the MILLER REPORTING CO., INC. S07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 142 process of consolidation, and with continued adherence to the current stance, the prospects clearly look good. Nevertheless there are still risks, which Mr. Kodera and Mr. Meo have discussed. Argentina remains vulnerable to external shocks, notably a rise in world interest rates given the still heavy reliance on foreign capital and low levels of private domestic saving. Competi- tiveness is still a central concern. Weaknesses in financial policies and administrative capacity of the provinces threaten to undermine overall fiscal discipline, whilst hindering much-needed improvements in Argentina's social sector policies and infrastructure. The reforms carried out at the national level already need to be followed now at the provincial level. Both the authorities and the Bank face new challen- ges in tackling these issues. For the Bank, there is also the ongoing question of the best means of delivering support to the authorities' efforts. Although the balance of payments remains vulnerable, Argentina's access to other sources of finance continues to be large, and the size and financing needs of the public sector are diminishing. As Mr. Meo has said, these circumstances did not dictate the vehicle chosen for this capital market operation. MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 143 So although I fully support the sectoral priorities identified in the Bank's Assistance Strategy, and I agree with the shift from adjustment to investment lending, I would have liked to have seen a fuller discussion of the implica- tions of Argentina's balance of payments position for the balance between lending and nonlending activities, particular ly technical assistance and economic and sector work. I have four specific points and questions on the CAS before turning to the two loans. First, the proposed focus on support for the reform process in the provinces is clearly welcome. The provinces also present particular problems for economic monitoring given the weak statistical base. I would be interested to know what progress has been made in tackling data problems under the ongoing Provincial Development Loan. Meanwhile, I welcome Mr. Meo's assurances that the Poverty Assessment Study, which should provide an essential information base for human resource development largely at the provincial level, will be available soon. Second, as the unemployment rate has increased, so of course has the urgency of the need to improve labor market flexibility, for which the labor reform bill currently in Congress is a key element. I would expect that the Bank economic and sector work underway in this area will have MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D. C. 20002  STRICTLY CONFIDENTIAL ah 144 useful lessons for other countries, and I hope it will receive wide dissemination. Third, portfolio implementation improvements are welcome. During the last CAS discussion, this Chair wondered about the scope for increasing responsibilities at the Buenos Aires field office relative to headquarters as the best way to tackle implementation issues on the ground. This was also a point raised in Mr. Gerber's statement. I wondered what the current position was. Fourth, we were rather surprised by the inclusion o a paragraph about IFC's and MIGA's activities under the heading "Cooperation with Other Multilateral Institutions," in what is intended to be a Bank Group strategy. Moreover, the paragraph did not actually touch on the issue of coopera- tion between these bodies and the IBRD at all, notwithstandin the important common objectives of facilitating private sector development and encouraging private sector domestic savings. Can staff perhaps say something more about the congruence between the IBRD, IFC, and MIGA strategies? Turning to the proposed Capital Market Development Project and accompanying TA loan, we support this innovative way of combining support for the mobilization of term finance for small and medium-sized enterprises whilst extending Bank MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 145 finance on a contingent basis and eliciting important improvements in interest rate determination and the regulatio and supervision of the financial sector. We look forward to further discussion of some of the wider issues involved in this complex and precedent-setting approach at the Private Sector Development Seminar later this week. Other Directors' comments and Mr. Meo's replies have left me with only two points of emphasis and one additional comment on the projects at this stage. First, I was grateful for Mr. Meo's response to the questions raised earlier about IFC's role. I can certainly see virtue in future joint IBRD-IFC operations in the area of capital market development, whether in Argentina or elsewhere which would allow the World Bank Group to benefit from the Bank's policy leverage and headroom capacity, and the IFC's special area of responsibility and expertise. Second, I take Mr. Meo's point about the wish to concentrate at this stage on the development of the local dollar rather than a peso bond market, but I would certainly encourage thought to be given to future support for the peso market as confidence in the currency increases. Finally, technical assistance to support implemen- tation of the new private pension schemes, which should be MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 146 implemented without the foreign currency guarantee of the BNA Pension Fund, is welcome. The private funds should play an important role in the future in increasing private savings and developing local capital markets. I wondered whether IFC was considering investing in some of the new funds as they have done in Peru and Chile. Thank you, Mr. Chairman. MR. PRESTON: Thank you, Ms. Gaseltine. Mrs. Katz? MRS. KATZ: Thank you, Mr. Chairman. I am going to abbreviate my laudatory opening remarks by simply saying that we do support the Government's agenda as described in the Country Strategy and further elaborated on by Mr. Nogues' statement. And we also support the four criteria governing the Bank's lending program, although to these, we would add broadening public participa- tion in the development process. A strong participatory approach will be fundamental to achieving the basic goal of balanced and equitable development and possibly to addressing the concerns raised earlier in the discussion by other Chairs about potential for social upheaval. At the risk of reopening the debate we had this morning on the Country Assistance Strategy for Guinea, again MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 147 we would have liked in the case of Argentina some indication of alternative lending scenarios, for all the reasons that have been fairly well-articulated here. A key risk facing Argentina at this juncture, as Mr. Meo has been quite candid in pointing out, is the weak institutional capacity particularly in the provinces. We share the concerns expressed by Ms. Gaseltine, and we too repeat a point that we made a year ago on whether or not there is a role for the resident mission in helping to address institutional weaknesses in portfolio implementation. Like Mr. Fischer, we also would have welcomed a deeper critique of the progress in reducing poverty and improving social conditions as a basis in particular for evaluating the Bank's strategy for human resource development The progress on the financial sector reform to date is commendable, and we support the two Capital Markets Projects being considered today. I will have a few specific observations on the Capital Markets Development Project, but let me emphasize here that we see it as a consolidating of the progress on the financial sector reform that should permit the Bank in the future to shift investment operations more toward the social sector. On education, we note the Bank's emphasis is on MILLER REPORTING CO., INC. 507 C Street, N.E. Washington. D.C 20002  STRICTLY CONFIDENTIAL ah 148 supporting secondary and also higher education, with IDB taking responsibility essentially for the primary education sector. We were somewhat curious about this, so we checked the Monthly Operational Statement and discovered that the Bank's pipeline includes $500 million for secondary and higher education. We would have liked further justification in the CAS for the level and the focus on higher education. For instance, are the needs for primary education, such as with respect to decentralization, being fully addressed? We are unable to evaluate this from the document. Argentina is clearly a leader in privatizing infrastructure. We agree that developing adequate regulatory and oversight capabilities must go hand-in-hand with privati- zation efforts, and in this regard, we were very pleased that the upcoming mining project will seek to improve national and provincial mining legislation and institutions, and also address issues with respect to environment. We also look forward to a Country Environment Strategy document under preparation. There has been some discussion this morning with respect to graduation. The document does indicate that there might be consideration for phasing down assistance to Argentina. This strikes us as being quite appropriate in MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 149 light of the new national accounts and in the progress achieved in adjustment and in reorienting the economy, although we do agree, like others, that the sustainability of the process needs to be assured. Do I understand from Mr. Meo's response earlier today that we might be expecting a plan for graduation for Argentina, perhaps within the next year, a plan that might be targeted on remaining areas of weakness such as social sectors and institutional capacity? I wonder if I could just get clarification on that? Turning to the two projects, let me say that for some time, we have been urging the Bank Group to take a more forward-looking approach to supporting private sector development, including finding new channels to mobilize financing for newly-privatized industries. The Capital Markets Development Project is clearly an imaginative approach to achieve this without, and I quote, "displacing natural financial sector development," which the SAR candidly acknowledges has been a concern related to conventional financial intermediary lending. Importantly, the operation is buffered by the strong steps taken in recent years to strengthen Argentina's financial system. The strong supervision components built MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 150 into the loan add to our confidence level, as do the condi- tions to ensure macro stability, market-determined interest rates and credit allocation, as well as the institution- building components of the companion Technical Assistance Project. We therefore have just a few specific comments on the Backstop Facility. We appreciate the innovative nature of the opera- tion. Normally, we might have expected a new activity of this sort to be tested on a smaller scale. Like Mr. Jalan, I would be interested in staff's comments on the rationale for the size of the operation--in our case, we were concerned that it might be somewhat large--and the preconditions for which an operation of this type might need to follow. Also, could staff elaborate a bit more on why--and I apologize if I did not catch it this morning--why the securitization option was not pursued in this context? Also, I understand you approached IFC. Could we have a little bit more insight on the reasons why IFC is not participating in this particular operation? I apologize if I did not catch that this morning. As the facility is implemented, let me just say that we are hoping it will be able to identify ways to encourage further development of the domestic bond market. I MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D. C. 20002  STRICTLY CONFIDENTIAL ah 151 listened with interest to Mr. Meo's explanation of the peso- denominated bonds; that was an issue we had raised with the task manager earlier. I understand there are also dollar- denominated local bonds that perhaps could be supported through this facility. Perhaps we could get a comment along those lines. It is also not clear what will happen to the facility after the project is completed. Obviously, much wil depend on the extent to which the facility is accessed and the developments in the capital markets during this period. Any consideration given to extending the facility if it is appropriate, we feel should emphasize privatization of the fund and securing financing directly from private sources without the need for IBRD guarantees. The experience of this operation of tapping private funds first should facilitate this development. With respect to environment, the SAR notes that the project does not fall automatically into any of the Bank's usual environmental categories. I would comment that IFC has developed an FI category, or Financial Intermediary category, environmental classification for projects of this nature. Perhaps the Bank should consider moving in this direction, particularly if these types of operations are pursued. MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 152 Finally, the SAR is quite candid with respect to the risks involved. In addition to the innovative nature of the operation, the project involves a still fragile institu- tional and regulatory environment, ratings agencies and an oversight entity with only limited track records, and a banking system that is emerging from a difficult position. The experience with previous financial intermediary loans in Argentina has been poor, as the report frankly acknowledges, and Argentina has had to request a postponement in meeting Bank supervision reform conditions in a related IDB loan. For these reasons, the high degree of supervision built into the operation seems warranted. We would propose in addition that there be periodic reports to the Board on the Fund's performance, perhaps in conjunction with the formal pauses and onsite reviews of the program. Thank you, Mr. Chairman. MR. PRESTON: Thank you, Mrs. Katz. Mrs. Herfkens? MRS. HERFKENS: Thank you, Mr. Chairman. I would like to start by particularly saying that I am very grateful to Mr. Nogues for his informative note for today's discussion, which actually has led me to reconsider the statement I had prepared, and that is, of course, the MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 153 objective of a circulated statement to be taken into account. But it did raise a bit of a question with me as to what extend the Argentinean Government had been fully consulted in the preparation of this CAS. This note gives a very important message that..-the ~i.a.l.....Q-J:.emefl-t...-..o.t. strong political support for successful implementation of economic reforms is really crucial, the political support and the political will here. I also very much appreciate what Mr. Nogues said on the sequencing of reform measures, which seemed to indicate that we apparently are wasting a lot of time on intellectual handstands on the issue of sequencing. All in all, the economic policy changes over the last years, and which are still ongoing, are highly commen- dable. One of the central issues now is, as others have said and Mr. Nogues also states, and echoed by Mr. Gerber, to make sure that the resulting benefits in terms of growth can be reaped by the population as a whole. And the question to my mind is very much how the Bank can assist the Argentinean Government to embark on such an equitable path of growth as the CAS mentions, because of the huge differences in income in this country. And I very much welcome the point that Mr. Nogues MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 154 made that the Government indeed recognizes that it is time to repay the social debt. I feel it is high time. However, I feel the CAS as such does not provide sufficient answers on this crucial issue, although at least it seems to capture poverty issues a bit better than last year's CAS, and I highly appreciate the extent to which those issues are reflected in the lending portfolio for the future, health, education, agriculture. I fully agree with everything that has been said by Mr. Gerber on the social issues, so I can be short there. I also very much welcome the Bank's effort in decentralization on those issues and institution building and consolidation of economic reforms at the provincial level. Although a poverty assessment is on its way, the lack of basic social data makes it very difficult to judge the overall quality of this Country Assistance Strategy, and I feel that this CAS could at least have done a better job in trying to provide a bit more information on those kinds of issues. For instance, what would be the impact on income distribution of the envisaged deregulation of labor markets, of rising unemployment, et cetera, as Mr. Kodera stated. Another issue I want to touch upon briefly is the heavy reliance of Argentina on foreign savings. The main- MILLER REPORTING CO., INC. S07 C Street, N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 155 tenance of an adequate macroeconomic framework helps to reduce the risk, of course, but the situation might arise in which things are just simply beyond the control of the Government. I would have appreciated a more in-depth analysis of the sustainability of those high capital inflows, but I very much welcome the research in this field; indeed, that is also relevant for some other countries in the region. Mr. Nogues underlines the importance in this aspect, also, of the increase of Argentina's exports, and I as always would say that I whole-heartedly agree with what he said on the issue of agricultural protectionism. The third issue I would like to mention is the whole privatization process. I would have appreciated a more elaborate assessment of that. The signals are mixed as regards the introduction of competition in privatized infrastructure, on price and tariff developments, and on the question would there be sufficient capital. What are the other instruments that the CAS mentions in paragraph 32? I. I~ \,t;f\\(,V\ It seems that the document--aHti-we have discussed in the seminar on the privatization program of Argentina in the Board--does not really fully capture all the underlying problems that there seem to be with the privatization program and I was wondering if maybe a private sector assessment MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 156 would not be able to provide more profound insights than the document we discussed in the seminar--actually, it is the first time that this Chair has asked for a private sector assessment. Then on graduation, given the statement of Mr. Fischer--he suggested that it would be the Board which decides on this--but Mr. Chairman, you might want to confirm what the Bank policy actually is, which is that the GNP per capita threshold only triggers a Bank review and triggers a discussion with the Government concerned and that a country can never be graduated against its will, and that the precedents show that sometimes the time path can be at least a decade between when you start the discussion and actual graduation. The language in the CAS is correct on this matter, I just want to emphasize. What I do feel is that those new figures show that as the average Argentinean is much richer than we thought, that will be all the more reason for the Bank strategy to focus as much as possible on improving the lives of those wh are way below that average. Then on the project, like others, I think it is a really, really nice project, very well-designed. I saw Mr. Rischard this morning--he is not here now--but one of the MII.LER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 157 things I would like to convey is that this type of project would also be fantastic in some of the countries in transitio in Eastern Europe. This is exactly the kind of project that would be extremely helpful there. But what I actually fail to see in the context of the program for Argentina is its developmental impact. I do not really see where the priority of this project is from the point of view if we want to do something about poverty, and I really would have preferred within this Country Assistance Cl. Strategy'l"fflTtt-loan which would have addressed much more the access to credit for small and medium-sized companies, including in the rural sector, in local currency. This project seems to be developed largely to the benefit of the bigger companies. I know that staff say in their document that it is for small and medium companies, but maybe we have here a difference of view as to actually what "small" and "medium" are. I think a program with a maximum loan of $10 million is not really something that you can say is benefitting small and medium enterprises. Then, finally, on the size of the loan, I tend to have the opposite view of Mr. Jalan and agree with Mrs. Katz. I found it rather large, particularly puzzling I found, in MILLER REPORTING CO., INC. )07 C Street, N.E. Washington, D C 20002  STRICTLY CONFIDENTIAL ah 158 view of staff's remark that this loan may be successful even if it does not disburse, or may be even more successful if it does not disburse, and particularly because this is a single- ~ loan. It is very large in relation to the limited size of the overall single-currency loan pilot program. And we have always stated that we felt that as many countries as possible should be able to benefit from this pilot. This loan seems to be a big chunk out of the pilot, and in that sense, I have some problems with it. Thank you. MR. PRESTON: Thank you, Mrs. Herfkens. Mr. Al-Mofleh? MR. AL-MOFLEH: Thank you, Mr. Chairman. Mr. Chairman, it is always a pleasure to discuss a Bank Assistance Strategy for a country that has done as well as Argentina in a relatively short period of time. The authorities are to be commended for their effective and persistent reform efforts, that turned the Argentine economy from one that was on the verge of collapse to one that can boast growth and price stability unknown for many years. The road to reform clearly was not easy, and there remain a number of challenges. These are well-identified in the President's Memorandum, and I will not repeat them here. MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, O.C. 20002  STRICTLY CONFIDENTIAL ah 159 Instead, I will focus on two broad challenges that I consider critical for the consolidation of macroeconomic reform and th sustainability of economic growth. The first challenge concerns the management of capital inflows. The main issue here is to make sure that inflation and monetary developments remain under control so that the real exchange rate does not appreciate further. Further appreciation of the real exchange rate would erode Argentina's competitiveness and decelerate the expansion of its export base. Export diversification is critical for improving the economy's ability to cope with the consequences of increasing international interest rates and the regional tract agreement. There is also a need to make sure that if capital inflows are maintained, more goes to investment than to consumption. However, a deceleration of capital inflows could present a greater challenge given the necessity to maintain fiscal tightness, the required increase in the investment ratio must come from an increase in private savings. The second challenge concerns the smooth transfer of responsibilities from the national to the provincial MILLER REPORTING CO., INC. ~07 C Street, N.E. Washingt0n, D.C. 20002  STRICTLY CONFIDENTIAL ah 160 governments. Besides the reorientation of fiscal respon- sibility, there is an urgent need to improve the delivery of public services that aim at improving the quality of human and fiscal capital. Given the Government has greatly reduced its involvement in the productive sector, it should be in a bette position to focus more on the social ~ectors and the severe deterioration of public infrastructure. Institutional development and reform of public finance in the provinces would facilitate the transfer of such responsibility and improve their effectiveness. With this in mind, Mr. Chairman, I find myself in agreement with the Bank Assistance Strategy for Argentina. I agree that adjustment lending should be phased out quickly and should be replaced by investment operations. In this context, I am pleased to note that the final adjustment operation is aimed at improving fiscal reform efforts at the provincial level. I share the investment priorities that are outlined in the President's Memorandum and particularly the emphasis on supporting social sector and infrastructure projects and on providing much-needed technical assistance. I also welcome the attention that is being increas- ingly given to poverty alleviation. I have noted with MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 161 satisfaction the improvement in the performance of the Bank portfolio in Argentina and its greater access to internationa capital markets. Finally, Mr. Chairman, the project under considera- tion provides an innovative alternative to previous credit line operations in Argentina, and the project and the Technical Assistance Project are consistent with the Country Assistance Strategy. Thank you, Mr. Chairman. MR. PRESTON: Thank you, Mr. Al-Mofleh. Ms. Ketu'u? MS. KETU'U: Thank you, Mr. Chairman. Let me begin by joining others in commending the Argentine authorities for their commitment to a very success- ful economic reform. Having said that, I have the following comments, first on the CAS and then on the project itself. Firstly, we agree with the paper on the pressing need to extend the adjustment process from the national to the provincial level. We note here that future Bank projects will focus on institutional and infrastructure development in the provinces. Having been neglected in the past, public investment in transportation and water will improve social services, which will complement private sector activities. MILLER REPORTING CO., INC. ,01 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 162 Second, we agree with the view that a dynamic private sector will lead the country to an economic recovery. In this case, providing a sound business environment, including macroeconomic stability, needs to be supplemented by a sound financial system to help potential investors who lack the necessary funds. On this issue, we really want to exercise the importance of developing the private sector in this area. Third, on the agriculture sector, we are pleased to note that several projects have been proposed in the CAS. However, we would like to see a more extensive treatment of the role of the agriculture sector int he export industry. In spite of favorable conditions, agriculture in Argentina has not progressed as quickly as it could. In our opinion, there is still ample room to further exploit this potential for poverty reduction and other purposes. Fourth, on portfolio implementation, it is encourag ing to read in Table 2, page 15 of the paper, that since FY92, there is a continued improvement in ratings for both overall status and development objectives. Finally, on the CAS, we welcome the cooperation between the Bank and other institutions, such as the IMF and the IDB. We also endorse the IFC's assistance objectives for MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington. D.C. 20002  STRICTLY CONFIDENTIAL ah 163 Argentina, presented in paragraph 47 of the President's Report. Now turning to the project itself, on the Capital Market Development Project, we agree that undeveloped and unsuitable regulatory and supervisory framework and lack of institutional investors remain serious obstacles to the development of the Argentina capital market. In this respect, we want to emphasize the need to develop the confidence of the private sector. Experience tells us that confidence is a long-term result of political stability and policy consistency. When rules change, potential new investors first try to verify how permanent is the newly created environment. Accordingly, a sustained period of consistent Government actions aimed at building an enabling environment is required to build sufficient confidence among private investors. In this connection, we are broadly in agreement with the staff in putting as a conditio of effectiveness the maintenance of macroeconomic stability and its policy fundamentals presented in paragraph 3.17 of the SAR. Moreover, we must not lose sight of the fact that strong financial and capital market regulations and supervision are no less important determinants for investors' confidence. MILLER REPORTING CO., INC. S07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 164 We are satisfied that the operation will also support small and medium-size businesses as well as small cash borrowers, who have no access to the capital market or to long-term lending by commercial banks. We support the proposed single-currency loan presented before us, which is in line with the present CAS. With regard to the Capital Market Technical Assis- tance Project, as it proposes to facilitate the implemen- tation of the proposed Capital Market Development Project, stated in paragraph 5, we do not have any difficulty in endorsing this. Thank you, Mr. Chairman. MR. PRESTON: Thank you, Mrs. Ketu'u. Mr. Grilli? MR. GRILLI: Thank you, Mr. Chairman. Argentina in the past five years has done a tremendous amount in terms of changing policies and obtaining results from these changes. It has reduced inflation, it ha restored public confidence, and growth has resumed. These are indeed very remarkable results, particularly the stabili- zation cum growth part of it. A major challenge now faced in Argentina is to transform the very heavy policy investment it has made so far MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 165 into self-sustaining growth in the medium term. The challeng of the Bank is how to best support Argentina's strategy. In reading the CAS and the focus on consolidation and deepening of reform, on strengthening of public institu- tions, on rebuilding physical infrastructure, and on support- ing development of the private sector, I can only agree with these goals. These are broadly correct, and I think they are fitting the particular phase in which Argentina finds itself. So I have no difficulty whatsoever with the focus of the Country Assistance Strategy on these objectives. I do see a major risk in this transition phase in which Argentina finds itself, a transition phase which is delicate by nature. The risk is that the engine of growth stop in Argentina due to reduced external competitiveness of those very tradeable goods that reforms aim at stimulating. In this respect, Mr. President, I find that the macro projections in the Country Strategy are based on a series of positive, bordering on perhaps optimistic, assump- tions, particularly on the real exchange rate and on the growth of exports. I know that staff has already commented on it, and I appreciate very much what Mr. Meo and others have said. But I think that there is something which is either a statistical effect or something which is very MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 166 dramatic that seems to have happened in Argentina in the last few years on which we have not paid any attention, and this is that from 1989 to 1993, the ratio of exports to GDP has declined dramatically from 15 percent, which is the standard ratio of export to GDP for a country at the income level of Argentina, to 6 percent, which is really a very, very low ratio. And this has happened in the period during which the real exchange rate has appreciated the most. Are we facing--and this is my question to the staff--a situation where capital inflows are progressively crowding out the production of tradeable goods via the appreciation of the real exchange rates? Are we, in other words, putting at risk, or is the very openness of the economy of Argentina at risk? In this respect, I think that taking the assumption that the exchange rate will remain constant for the last several years is perhaps optimistic in terms of the assumptio and also a little bit also in terms of the results. I know that this is a difficult area. I know that this is a delicate area, and I am fully aware of the sen- sitivity of the issue of the exchange rate regime. But I wonder whether the staff has something more to say on the basis for their expectations which are built into the macro MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 167 projections. Here, I would associate myself with others who have expressed the view that perhaps an alternative set of lending assumptions based on an alternative case for Argentin would have been very useful. As far as the project, I understand this rationale and the importance. We want to strengthen and encourage commercial banks to provide long-term lending and to develop the market for securities connected with that. But we have very limited experience in this area, and therefore I find myself in the group of Directors who are wondering about the size of this loan. If we are experimenting, as I believe we are, and if we do not have much of a track record in this, couldn't we be more modest? Therefore, my question to staff is why the size of the loan was chosen; why $500 million? What is the rationale for it, and why not go more modestly into this? All other questions, Mr. Chairman, that I had about the loan have been answered, and I do not want to repeat. We support this loan. Thank you. MR. PRESTON: Thank you, Mr. Grilli. There have been a number of questions. Let us turn to Mr. Meo. MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 168 MR. MEO: Thank you, Mr. Chairman. There have been a couple of questions about per capita income and graduation and the policy of graduation. I would really prefer to have Mr. Loh, the Country Director, answer these before we begin o the project and the other elements of the CAS. Ping? MR. LOH: Thank you very much, Mr. Chairman. I would have normally asked my able colleague to answer this question, but I want to make it very, very clear. In terms of the graduation policies, the staff felt obligated to raise these under the present policy of the Bank when the per capita income reaches a certain level, that we should discuss this issue. However, the language in the report is very carefully drafted. We see that Argentina has a very short experience of fundamental reforms--no more than three years. So we say that on the assumption that the consolidation and the continuing macro reform is being upheld, plus the fact that Argentina will have improved access to international capital market, then it would be appropriate--after a few years--after a few years, it would be appropriate to discuss with the Government the future in terms of graduation. So we do not have a specific plan next year at this MILLER REPORTING CO., INC. 507 C Screet, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 169 time to submit to the Board any particular graduation plan. We raise it for the Board's discussion because we would like to have the benefit of the thinking of the Board, and actually, this item is related to the other items presented to you for your consideration. For instance, we raise the issue in terms of how do we, the Bank, as an institution, deal with the instruments of financing infrastructure companies which have been privatized. This is not an easy question to ask because it involves the Bank's policy issues, and it involves the Government's attitude toward the guarante of IBRD lending to privatized companies. I think these all need to be considered in their totality. We also have to consider what are the future roles, greater roles, greater participation of IFC in terms of participation in financing private sector in Argentina; we have to see in terms of the greater deepening of reform in the provincial areas. So to all of these, we have no specific answer at this time. We would like to see the problem begin to be thought of with the Government, and after a few years, we will then proceed to think about the gradua- tion policies. MR. PRESTON: Thank you, Mr. Loh. Mr. Burki? MILLER REPORTING CO., INC. 507 C Street. N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 170 MR. BURKI: Mr. Chairman, if I might pick up on this issue for a minute and go back to the statement that was given by Mr. Jalan, in looking at the revaluation of Argentin a's GNP, I am very impressed with the thoroughness of the job that has been done by the country. I know of no other country which has undertaken such a systematic analysis of its GNP and applied new sets of methodologies. The conse- quence of this is that we have now a relatively high figure. But as Mr. Jalan was pointing out, this has to be seen in the context of countries in the region. Comparators are very, very important in coming to any judgment with respect to graduation policy. I believe a paper is being prepared which will be sent to the Board for its information on the two methodologies that have been used for estimating GNP--the ? methodology and the purchasing power methodol ogy. At that point, some of what I have said will obviously be discussed. Therefore, it is premature to talk about any graduation policy with respect to Argentina. We just wanted to point out, as Mr. Ping-Loh has emphasized, the fact that there is a new number, and the number is very different from the number that we had seen before. Thank you. MILLER REPORTING CO., INC. ~07 C Street, N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 171 MR. PRESTON: Thank you, Mr. Burki. Mr. Meo? MR. MEO: Thank you very much, Mr. Chairman. Let us go through some of the questions. There has been a lot on poverty. Yes, indeed, we do plan to have a major push in poverty. Forty percent of our next three-year program is in human resource development and in some of the productive areas, particularly agriculture, and some in infrastructure in provincial areas, will be very much poverty driven. The size is very large. It is 40 percent of our program. It is in secondary education and higher education as well. Argentina is a middle-income economy. It has unfortunately suffered through a deterioration of what was once a very good educational system. It has also devolved to the provinces a secondary education system. We plan to have a pair of loans in this area at least to develop with the States capacity to provide the services we are now responsibl for. The tertiary education system as well has indeed fallen on hard times, and it is a regressive income experimen in the Argentine milieu, in that the vast majority of students are upper-income, and it is a highly subsidized MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 172 education. We hope to not only assist in improving this--and they are very eager for our assistance in this area--as well as begin to charge for some of the services provided in this area. This will be a great challenge. Argentina is the developer of a ? Plan which gave autonomy to its univer- sities for years, and used to be a symbol of university structure in South America. We hope to help them return to that, but the quality today is quite sad. As part of this, I might add, my own division will be closed. This will free resources within our budget constraint to push in the human resource development area. Our view of the IFC is also very similar. We have not had a loan in our division in Chile for five years now. And if you look at Annex A2 on page 31 of your MOP, you will find that for the future, we have no projections for industry-financed loans. I expect IFC will be becoming much more aggressive-- they already have become, and they will continue to be very aggressive in this area and will pick up the very good opportunities a vibrant private sector is providing. We do plan to continue a large amount of work on regulatory issues, bank supervision, utility and even judicial reform, as stated. But these are State roles. We will be leaving or sharing with IFC very much so the future MILLER REPORTING ~07 C Street, N.E. co., INC. I Washington, D.C. 20002 .1  STRICTLY CONFIDENTIAL ah 173 in that area. If I may, there was a question on the size. There is no science here. There is indeed an estimate of stocks outstanding in bond issues. The domestic bond issues outstanding in u.s.--as I told you, anything beyond six months is in United States currency--is about $1 billion. Externally issued, i.e., externally issued, subject to other foreign requirements, is about US$3 billion. The domestic is almost wholly corporate and bank issues. Some of the foreign is also from firms and banks. ·The project before you is structured, however, to be committed over three years. You will be committing only u to a third of it each year, so that you do not end up having to disburse it or support a financial run of the whole amount of it. Given what I have informed you, given the return of financial markets in Mexico, in Chile and in other economies, we do expect a major, major increase in these stocks. I woul not be surprised if three years from now, these would at least have tripled. Given that, given the magnitude of what we wanted to do, we found that $500 million was the maximum we could provide within the program that you had earlier authorized and probably the smallest amount where we could MILLER REPORTING CO., INC. 507 C Street. N.E. Washington, D. C. 20002  STRICTLY CONFIDENTIAL ah 174 have a significant effect on the market. One individual asked about the progress on provin- cial statistics. It is very, very good. Actually, the unit the provincial ? established in the Ministry of Interior has been successful, and we now at last are getting very good statistics on the provincial status and their needs. The reform of labor markets. Argentina has industry-wide norms. The reform proposed by the Executive before the Congress now is to permit firms to negotiate with their unions firm-wide agreements. It seems nonsensical to have a wage agreement in high-cost Buenos Aires equal to that in Ju-Juy, which is way up to the northwest in a very poor state. It would also permit employers to pay less salaries to entrants, apprentices, and new staff, if you would, which would encourage, we hope, a labor growth. Finally, it would provide less severance for those who are recently hired, who today gain very strong security almost immediately upon hiring. The authorities hope this will increase employment if passed in the Congress. A few people have asked about scope for expanding our office. This is not a cheap office. It costs us US$1 million per year to run. we do plan in the very near future to expand it by one locally-hired professional staff who MILLER REPORTING CO., INC. )07 C Street, N.E. Washington, D. C. 2000 2  STRICTLY CONFIDENTIAL ah 175 would help us directly on what you have been discussing, the supervision of the portfolio. We share one comment made, that the pension scheme would be far better if it did not have a guarantee for Banco I de la Nacion. The authorities very much share this view, anctj there is before the Congress a proposed amendment for the law which would end this clause. Environment. We feel, as do some of the speakers, that the "City of Good Airs," as you would put it in English, is not a city of good rivers. The water situation in Argentina is not good. The authorities are moving. The same President who demanded they privatize every PE, every state enterprise, within two years has not demanded that the urban/city rivers, creeks and streams be cleaned up within 1,000 days. He is a man whom you take very seriously. We have just completed a water study which will assist us and the authorities in choosing how we help. We will have a programming visit there with them. They are very much concerned how we help in the water area. Again, this is a provincial responsibility, however, as are most issues affecting the environment, so we will have to work directly with the provinces as well as the national regime. As one speaker said, we have a series of MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 176 loans outstanding as well which would affect the environment, but we very much look forward to next fiscal year when we have a major environment study which will help us and the authorities determine priorities. Agriculture, yes. Lending, yes. The Argentine economy is not full of small farmers, the campasinos found in the sierra. But it is not only the pampas where you have large agro-industries. In the areas of the northwest in particular, you do have some small farmers. We do indeed propose a rural project in that specific area of small and poor farmers in the future. On lending, however, we do believe the banks in the past have been able to provide credit when it was required by a fairly large amount of financially viable farmers, and we do hope that this will lead to a further expansion of credit to farmers. Argentina is not a small country, though, and many of the commercial farmers are very similar in size to that of the United States. One question on the exchange rate. Mr. Grilli did point out it is a sensitive issue. This is a country where the IMF and the World Bank had a very interesting debate around 1987-88, and it was agreed that the IMF would take pride of place in the exchange rate issue. It is also an MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 177 economy which has an Extended Fund Facility for three years. I am fully aware of what Mr. Grilli says, as are the authorities--that the adjustment may require a slower economic expansion. And indeed, our projection of only 4 percent for the next few years implies our own agreement. It may, however, be useful for Mr. Hardy of the IMF, who is here this morning, to comment on the IMF's views of the exchange rate in Argentina. They have just completed a review of the third quarter. MR. PRESTON: Mr. Hardy? MR. HARDY: Thank you, Mr. Chairman. It is fair to say that we share all of the concerns that have been raised around this table in terms of the importance of sustaining competitiveness in Argentina. We have looked at the appreciation of the real exchange rate over the last few years, as measured in terms of relative consumer price indices, and that certainly shows a fairly large appreciation of about 30 percent since the paper was established in March of 1991. However, as Mr. Meo has mentioned, there have been many changes in tax systems, in deregulation, in structural improvements, and right now in social security tax regime, which are tending to lower costs for the goods-producing MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 178 sectors. It is also quite clear that the discipline of the fixed exchange rate regime is forcing major improvements in productivity in the goods-producing sectors. So the logic of the model is to maintain fiscal discipline, monetary discipline, to proceed with structural reforms which will improve competitiveness, and to deepen the structural reform in all areas. I think what we all want to see in terms of improving sustainability over the medium term is this process reflected in a recovery of the dynamism of exports. We are beginning to see at least for the first time in two or three years, some improvement in export performance in 1993. Exports rose by about 6 or 7 percent. And certainly the world environment is not a favorable one for a mainly agricultural goods-producing economy to date, but we hope this will improve over time, also. And as Mr. Meo has mentioned, there are some large projects which are coming to fruition at this stage, par- ticularly the oil pipeline to Chile, which will in turn have an effect on export growth, plus it is hoped that with Brazil settling down and Brazil being Argentina's main market, that again may help in the medium term. But it is obviously a very bold strategy the MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 179 Argentine Government has adopted. It is one that has a great deal of logic to it. It is one in which the Government is following the logic, and it is one which we will have to continue working on all fronts to try to consolidate, particularly in the area of structural reforms. MR. PRESTON: Thank you, Mr. Hardy. I hope you do not feel that we ambushed you. Mrs. Herfkens, a follow-up? MRS. HERFKENS: Yes. On the size of the loan, I raised one aspect which is, of course, not a matter of concern for staff working in Argentina, which is the fact that one borrower gobbles up about a third of the whole room we have to experiment in this pilot project program for SCLs, and which we feel as many borrowers as possible should be able to benefit from. Now, I understand that people who work in Argentina could not care less, and they did a good job getting that high amount for a second single-currency loan. But I would be interested in the monitoring exercise of this, and I would particularly like your commitment, Mr. Chairman, that if this program is such a success, that management would not hesitate coming to the Board to either raise the ceiling or to extend the program. MILL.ER REPORTING CO., INC. 507 C Street, N.E. Washington. D. C. 2000 2  STRICTLY CONFIDENTIAL ah 180 MR. PRESTON: Have no fear about the management, Mrs. Herfkens. MS. DOWSETT-COIROLO: On the single-current loan pilot program, this is the second large SCL that we have had. We had a $610 million loan for Russia's oil rehabilitation, and this is the second big one in the pilot program. At this point, assuming that you approve this loan today, we will have $1.5 billion worth already approved under the pilot program, another $500 million that is reserved for other borrowers, and another $300 million that is identified. So the program seems to be moving along in terms of demand. This reflects 17 different borrowers in 17 different countries. But that is one side of what we are doing during this two-year pilot period. The other side is to have as broad a discussion as we can have with as many other inter- ested borrowers, and we are exhausted doing that, actually, to be frank. We have had discussions with five dozen borrowers from 36 different countries on all aspects of loan terms and had a good discussion on helping those borrowers explore their understanding of the terms, ways to onlend those terms, and to hear back from them what their needs are -- even if they are not eligible for this program, are there other currencies that they might be interested in, and are MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 181 there other products that they might be interested in? We share your view that we would like to have the benefit of a full two years' experience to have this rich exchange with borrowers, and we are monitoring the pipeline. It is premature to come back to you and ask you for more at this point, but we would not hesitate to do it if we thought that the quality of the experience could be improved as a result. MR. PRESTON: Thank you. MRS. HERFKENS: You are doing a great job. Thank you. MR. PRESTON: Mr. Haas must leave in 10 minutes. Can you wait, Mr. Grilli? MR. GRILLI: Yes. MR. PRESTON: Mr. Haas? MR. HAAS: Thank you, Mr. Chairman. Just on that, I am also very happy that we can use very effectively the single-currency loans, yet I believe that what it means is that for the purpose of this project, if I am not mistaken, only a single-currency loan could have been used. So that means that maybe there are projects that are not being done, or that were not possible to do before, because it was impossible to have recourse to single-currency MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 182 loans. So that means, really, that the reflection on our products has to go on and on, and I am very happy that staff is exhausted, by the way. On the Country Assistance Strategy, just one point, if you will allow me. I start from the subject of the per capita income. It is a very difficult subject, everyone has commented, and staff has given extremely interesting answers. I fully agree with those who say we have to exert more judgment than to rely only on our appreciation of statistical data and to derive from this data mechanical consequences. But yet I think we are faced with a fact that has surfaced a little bit brutally, I would say, maybe in an unexpected fashion and only in one shot like that, and we have to respond to it with a clear strategy. I think it would not be enough to respond to it with a sort of strategy which we witness sometimes, which is the fact that the Bank has difficulties ceasing a relationship with a country that it assesses as nonrisky. I think it has to be much more than that, and I think it has to rely on a very precise assessment of what are the priorities for the Bank in Argentina and what is the lending level that is adequate to serve those priorities. As far as the priorities are concerned, I agree MILLER REPORTING CO., INC. )07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 183 totally in fact with the idea that we have to focus on public sector management, human resources infrastructure. I see that we have projects articulated under those headings. I think that this is correct, and I hope that the Bank here will really show its comparative advantage. So I must say I am fully satisfied on that front. On the lending front, it is a little more difficult I think we have two constraints--on the one hand, the constraint of equity. I mean, we have guidelines that have been devised therefor in order to treat all countries in the same manner. So we will have to in one way or another be flexible--! am always happy when the Bank is flexible--but still, we will have to also be fair to all other borrowers. But on the other hand, we have to be extremely thorough on an issue, which is what are the sources of financing growth in the country. And there, the phasing out and the evolution of the burdensharing between public and private sectors, and in that case, low and high scenarios, et cetera, is something that we probably must look into extreme! clearly in order to know exactly if we are in a position to deliver what the country needs should the situation turn badly, so to speak, and should notably private inflows be on the low side. And at the same time, we should also probably MILLER REPORTING CO., INC. 507 C Street. N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 184 not be doing too much should the situation not require it. So I think that here we probably need to know some more. Mr. Loh has said a little bit more than was in the Country Assistance Strategy, and I am sure that if he comes back, he will also say a little bit more in order to really tell me that sort of evaluation has really been done. That is really what I think will be critical. And I am saying that I do not know, in fact, what is the right level that will be needed. I am only saying that I do not think that mechanically, we should say that because the per capita income is higher, economic and sector work is the answer, and nonlending service is the answer, and lending is not the answer anymore. It is not as simple as that. I think we have to have some sort of an equation that we will be able to use over the next years. On the project, Mr. Chairman, I join all those who have said that it was a very good operation, that it relied on a very pertinent analysis, and that the intuition that was the base of it was perfectly relevant. In particular, I know that the team has been working a lot, and I think it really deserves to be commended therefor. The way I view it is the following. I think we MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 185 have two components, one of which is line of credit, basical- ly, and the other one is the technical assistance component-- you will correct me if I am wrong. I would like to comment on those two components one after the other. As far as the line of credit is concerned, I would say two things. First, we have to acknowledge that this is what it is, that we are using in fact a mechanics that if you define it very simply is a subsidy to Argentinean banks to implement and to put into place new credit instruments which are needed for the small and medium-scale enterprises, long- term instruments that were not available in the market. I think this is important--you will correct me if I am wrong--but I think it is important to admit that this is a sort of support to financial intermediaries that we are developing here, and that it could be used, and we have to know that it may bring and lead to distortions of the market. But we accept it. Now, the other point is the following. Could we have achieved the same result with other tools? And on that issue, I have to say I do not have a convincing explanation. First of all, do the Argentinean banks have the financial means to do what they will be asked to do in order to provide the adequate sort of credit to the market? Is that not more MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 186 a question of creating market and some device rather than to mobilize the money? And in fact, the money is there. That is the issue. The issue is that the problem is there, but no of the right nature. On the $500 million, some explanations have been given on this amount. I think that for a pilot experience, it is a very high amount. And really, I still remain, I must say, with some hesitation, and all the more since I am not sure that it wa absolutely necessary for the mechanics of the project itself. And really, the opportunity cost then comes into the picture. When we are talking about lending volume t the country overall, we have a very pressing agenda when it comes to poverty reduction. There is an opportunity cost not to commit money over a period of three years that could have been committed for other purposes. I mean, this is a real question when we are facing pressing needs in other sectors. My last point, Mr. Chairman, will be on the technical assistance component. Basically, I think the objective of the project was simple. It was to transform short-term money into long-term money for the market and for the firms. Now, what have we done? A very complicated, sophisticated options market. Basically, the objective wast give long-term money for a very small-scale enterprise that I MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C 20002  STRICTLY CONFIDENTIAL ah 187 guess wanted to make some new investment. And in fact we have, I think, created a product that is extremely, extremely sophisticated. There again, I have a question, and I am not willing to enter into a discussion on that which might be very judgmental with staff. But I am just saying that I would like, especially because I know that some similar operations might come to the Board for other countries in the hemisphere, I would like when this comes to us to be really absolutely sure that there was no other way to achieve the same result, which is to make more money of a better nature, so to say, a better quality, available to those who are in need of it. And once again, I am saying that because there is an opportunity cost to mobilizing those sort of huge amounts. I very much look forward to knowing more about the alternatives that could have been sought to achieve the same results for another time. Thank you very much, Mr. Chairman. MR. PRESTON: Thank you, Mr. Haas. Mr. Grilli, I am sorry. MR. GRILLI: Thank you, Mr. Chairman. Actually, I have two small follow-up questions. One MILLER REPORTING CO., INC. ~07 C Street, N£ Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 188 is how does one explain between 1989 and 1993 this huge decline in the share of exports to GDP where imports have remained fairly constant? I am really struck. I mean, this is the only case I know of that the country is becoming apparently less open, on the good side, instead of becoming more open. The second is on the size of the loan. Why was it that, for example, the IDB did not take a share into our scheme, and why was it that the Government did not contribute, if I am correct, at all to it, did not participate at all in it? Thank you. MR. PRESTON: Mr. Meo, would you respond to Mr. Grilli's follow-up, please? MR. MEO: Yes. We tried to get the IDB to be involved, as a matter of fact, when we agreed conceptually with the authorities, in fact, Shahid Husain phoned Enrique Iglesias immediately and tried to get him to join us. Unfortunately, the IDB's Articles.of Agreement did not permit them to go forward. I think they were unable to do what the Bank is doing, which is to disburse against financial instruments. I might add that the genesis of this loan is a very MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 189 highly-placed, your servant here is strictly your servant. This is a conceptual idea of Jean-Francois Rischard, pushed t the limit--exhausted, I might say--by Shahid Husain, with an extremely thoughtful opinion by Mr. Shihata. So the IDB was unable to join us in this, as was the Ex-Im Bank of Japan. In each instance, they did examine their Articles, they examined their processes, and they gave it a good shot but finally decided they would be unable to do that. I think I may have confused a few of you with my remarks about a line of credit. Since we may see this in the future, the genius behind what is called a Backstop Facility is Mr. Perlin. In fact, we took him down to Argentina a week after he joined the Bank. He is the Director of the Financial Sector Development Department. Perhaps it would be helpful for Gary to explain why this is not a line of credit and what a Backstop Facility is and is not, particularly not a subsidy. Gary? MR. PERLIN: Thank you, Paul. I think it is useful to start by considering what an alternative might have been. If the alternative might have been a more typical line of credit, in other words, a MILLER REPORTING CO., INC. l07 C Street, N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 190 simple lending of funds through a Government-guaranteed facility to banks, this kind of a credit line would have had a number of significant disadvantages as we saw it, the first of which is what they would have gotten was what we would have put into it. In other words, the line of credit would be limited to what the Bank might have entered into that line. We put in $500 million; that is what is available to the banks. Secondly, there would have been a dependency created, which would have been contrary to the development of a vibrant private financial sector, which is what our objective is. In other words, rather than looking for means of raising their own funds, banks could easily have become accustomed to accessing a line of credit provided by the World Bank. Lastly, there would have been some subsidy involved if there were a Government-guaranteed loan from the World Bank being made available to the individual commercial banks, and it would have been difficult to supervise exactly how competitively those funds would have been made available to banks, and through them, to borrowers. Therefore, the alternative that was considered was one that was much more market-based, one in which banks must MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D.C 20002  STRICTLY CONFIDENTIAL ah 191 continue to compete in the private sector for funds; they need to raise funds in this program on their own, in the market. What this program does, however, is to offer them an assurance, the banks, that is, that if under meeting certain conditions on the usage of the funds, they are unable after a period of time to roll over these bonds, and they have already made loans which require them to continue to access the market, if those banks have maintained their credit- worthiness, but because of market disruption have not been able to roll over those funds, then they would be able to access this facility by selling new bonds at the maturity of the initial bonds to the Backstop Facility. Now, when they sell these bonds to the Backstop Facility, they will not be doing it at a rate that is equal to the initial rate at which they sold bonds, which would represent a very significant subsidy. In fact, when they take out a commitment at the issuance of a bond, they will both pay a fee over the life of the initial bond issue, and the rate at which they can roll over the bond through the Facility will be at a significantly higher yield spread than the initial bond. Therefore, there will be some penalties in terms of higher rates for accessing the Facility. The concern that we are trying to deal with is that MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 192 when a creditworthy bank makes a creditworthy loan, but is looking to create greater maturity in the market, is unable to access the market because of a more general, systemic problem, that there will be a mechanism by which they can remain liquid to cover that period of time until such time as the market comes back. This will not all occur at the same time, because as my colleagues have represented several times, these bonds will be issued not all at a given time, but over a period of time, so that if there is a disruption for a period of time, it will affect a percentage of the commitments that are outstanding under this Facility. The intention is that once the disruption has been overcome, the Facility will be able to sell the bonds that it has bought as part of its Backstop Facility, and it will therefore replenish its capacity to issue additional commitments. MR. PRESTON: Mr. Haas has a follow-on. Thank you for that lucid explanation, Mr. Perlin. MR. HAAS: Yes. Thank you very much. There is certainly merit in that alternative. If that is the only one it is worth considering. I do not agree on some elements of your explanation, particularly the subsidy that would be involved with the line of credit. There is a subsidy in the system as it is now, which is the pricing, and the pricing is MILLER REPORTING CO., INC. 107 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 193 a key issue on which not a lot is said in the document. And in fact, depending on how the Geisencharts [phonetic], there will be a subsidy or not, the whole thing will work or not, our money will be committed or not, there will be high risk or not, and the whole thing will work or not. So there is really a huge element of risk here that you have to put in front of the advantage that you said in balance, and it is, I think, not as simple as that. The second element is that I think one big dif- ference between the line of credit and this system is that the line of credit is something that I understand; it is much more simple--and I guess I am not the only one. And in fact, one thing that immediately comes to my mind is that if you make a line of credit, then in institutional terms, notably in terms of what the Bank can do, what the IFC can do, et cetera, becomes a question, et cetera, and it strikes me that we did not have the benefit of what IFC thinks of that, what its experience has been in Argentina, et cetera. This is also something that would certainly have helped us assess in a broader manner what is really required and how this fits really to the needs of the enterprises that are in need of credit on the spot. I hope this will accelerate something that I hope MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 194 would not have happened spontaneously, which is also somethin that you do not demonstrate, finally, so as Mr. Jalan said, I wish you luck. MR. PRESTON: Thank you, Mr. Haas. Mr. Grilli's second question? MR. MEO: Yes. I remember the debates at the Board that Bank staff always recommended, suggested export-led growth. Clearly, in the Argentine case, you do not have export-led growth. You have a very important stabilization effort cum forcing cleaning out of the private sector fat through a fixed exchange rate regime. So that indeed, the export statistics Mr. Grilli has quoted are accurate; they reflect as well as a non-export-led growth recovery a terms of trade drop, which is extremely significant in this case, and although it does not the exports, the import recovery, if you will--imports were half exports only a few years ago; they have recovered very, very strongly. We hope, as I think other EDs have stressed, the export recovery will occur. It is crucial, vital, important. But yes, indeed, his observation is a correct one. This has not been an export-led transformation. MR. PRESTON: Thank you. Mr. Torres? MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 195 MR. TORRES: Mr. Chairman, although I am as exhausted as all my colleagues around this table, I still welcome this discussion--first, because the document describe the latest chapter of a successful case in the making. Ando course, for what has been achieved, we should congratulate the Argentinean authorities. However, it is a successful story in which it appears that the Bank is playing a decisive role, a sig- nificant contribution, and in that respect we should not be shy in emphasizing this positive role, particularly in an environment that seems to be biased to highlight the contrary, at least if my reading of the weekly newsletter is correct. Second, because the document also includes a very interesting Capital Market Project, innovative in many ways, that addresses a critical constraint that affects the capability of the private sector and of the small and medium- sized enterprises in particular, to fulfill efficiently one of its major responsibilities in the post-adjustment phase-- the financing of private, medium and long-term investment, which is a necessary condition to sustain economic and social progress. In that regard, I would like to commend and congratulate and appreciate Mr. Meo, Mr. Carrizosa and his MILLER REPORTING CO., INC. '.i07 C Street, N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 196 colleagues for the time that they have devoted to our office and to other offices of our colleagues to explain this interesting project, which we support together with the Technical Assistance component. Mr. Chairman, I also appreciate and have enjoyed the statement that has been circulated by Mr. Nogues. Not only does his note add value to the staff document by helping us to better understand the Argentinean case, but it is also a most stimulating input for our discussion. And time permitting, I will comment on some of the issues that he raised. I have no major concern with the Bank strategy. What I would like to do is just make four comments of a more or less general nature. The first refers to the macroeconomic strategic of Argentina. I think that what I want to emphasize in the progress that has been achieved on the policy and economic fronts is that the sustained fiscal adjustment has been a crucial element underlying that success story--an adjustment that has been in just one direction and that has resulted in a dramatic turnaround of the public fiscal position through privatization, rationalization of public expenditure, and better enforcement of tax collection, together with simplifi- MILLER REPORTING CO., INC. 507 C Sueet, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 197 cation and rationalization of the tax system. Preserving fiscal consolidation and improving it to the extent possible, particularly in the provincial finances, which still remain a major source of concern, will continue to be as crucial for the future of stability, growth, and equity in Argentina. This is nothing new, and it is not different from the experience in other successful adjusting countries. What worries me in the case of Argentina--and this is not addressed in the Country Assistance Strategy paper--is that by tying their own hands with a policy of money fully backed by reserves under the convertibility law, the authori- ties have been left with no instrument for stabilization. Obviously, this is a caricature. But it is clear that with a fiscal surplus and a fixed exchange rate, and with a capital account which is open, money supply is basically determined by private capital inflows. So monetary policy is passive. And at the same time, it will be more and more difficult to increase significantly the fiscal surplus as a stabilization tool in case that is needed in the case of revenue shortfalls or in case the inflation does not decline as expected, or there are several scenarios that one could contemplate. In short, Mr. Chairman, what I wonder is whether in MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C 20002  STRICTLY CONFIDENTIAL ah 198 the present circumstances and to maintain stability, the authorities should not be ready just to use monetary policy more actively, to be ready to stabilize capital inflows or undertake open market operations to keep inflation at bay. Obviously, deepening the structural reform program will also be instrumental in that respect, but it may not be enough. And in short, strict compliance with the conver- tibility law may have been necessary, and it has certainly been an efficient strategy to stop hyperinflation first and reduce inflation later. But the requirement to stabilize prices in the long term, which is an explicit objective of the authorities, may call for a change in the strategy, and in particular, a call for a less automatic monetary policy or, as Mr. Grilli was suggesting, exchange rate policy. The second aspect that I want to comment on refers to structural reforms. The implementation of major structura reform has been the other crucial ingredient underlying the recent success in Argentina. It helped build confidence in the program by unambiguously indicating that the economy was moving away from a model of growth based on import substitu- tion, with active participation of the estate, toward a model relying on a market economy and clear rules of the game. These were measures that complemented the stabiliza MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D. C. 20002  STRICTLY CONFIDENTIAL ah 199 tion efforts in the sense that they indicated that the elimination or the reduction in inflation was just one part of a major or broader project, and poor public confidence in the program seems to have grown in parallel with the continue commitment by the authorities to the stabilization and reform efforts. So it is also obvious that the continuation of structural reforms is essential to increase national savings so as to make room for increased domestic investment to improve the competitiveness and productivity of the economy, while reducing the external deficit and still high reliance on foreign capital. In this regard, I think that success in provincial reforms and reforming the social security and health systems, and the labor market in particular, will be crucial to improving the efficiency and the flexibility of the economy. So I welcome the lending and onlending support that the Bank is providing in these areas, as well as in others, which are very well described in the document. The second comment I want to make refers to one of the lessons that Mr. Nogues draws from the Argentina ex- perience, and has been already commented on by Mrs. Herfkens. It refers to his lesson on the timing and sequencing of MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 200 economic policies. I want to comment on that for two reasons, first, because Nogues and I have spent some years working for the Bank in a project precisely on the timing and sequencing of, in that case, trade liberalization policies; and second, because I strongly agree with his conclusion, and the conclusion is that we should not waste much time on issues of sequencing first, Mr. Chairman, because we do not have recipes or blueprints, and second, because even if we had an optimal recipe or blueprint, this is not usually an option for the policymaker. So in the end, perhaps the more common sense recommendation that we are left with in the issue of sequencing, and also on timing or speed of the reform process, is that we should do as much as possible and as quickly as possible. I do not know if we can add much to that. But perhaps to that lesson, I would like to add a corollary, that I think the Argentine experience is also a good case to show the strong complementarity that exists between stabilization and structural reform, first because they both contribute to better allocation of resources, and second and perhaps more important, because doing them together sends a strong signal regarding the direction in MILLER REPORTING CO., INC. '.i07 C Street, N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 201 which the economy is moving. This, for credibility reasons, is important, too. My third comment refers to a comment that has been made also by Mr. de Paiva in this statement that he circulate this morning, on the treatment by the staff of MERCOSUR in the Country Assistance Strategy. I agree with his comments, but I want to take these comments to emphasize again that my impression--it is not the first time that I say this--is that the staff approaches regional integration experiences still with some reluctance. It is clear that in the case of Latin America in particular, the regional dimension is something that cannot be forgotten and that should be present in the analysis of the major countries, and most of them are involved in important and relevant regional experiences. I still lack this approach in a systematic way in the Country Assistance Strategies in particular in the Latin American Region. Mr. Chairman, with those remarks, I would just like to finish by wishing the Argentinean authorities well in their future endeavors and hope that the Bank will continue to support these efforts as efficiently as it has been doing in the recent past. Thank you. MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 202 MR. PRESTON: Thank you, Mr. Torres. Mr. Sadik? MR. SADIK: Thank you, Mr. Chairman. Let me begin by supporting both the strategy and the two proposed project and then let me.remark by saying that Argentina's case is a very interesting one, from different perspectives. Number one, massive efforts have been undertaken to reform the economy, and they have been successful over a very short period of time. Now, from this, I think we have to start asking questions, what are the lessons learned, and how can these be copied or translated into similar programs in countries in more or less similar situations. The third aspect is the fact that perhaps few countries have undergone structural adjustment, and in a very short period of time, there has been a shift from structural adjustment to investment operations. Argentina is in that category. This then raises the question, how many countries do we have in our portfolio that exhibit these characteris- tics. Why do I ask these questions? Because they are very relevant to our future work in structural adjustment and reform, if not to all developing countries, at least to the MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 203 countries in the region. Let me now move to the second remark, and that is, what are the components of the Argentine strategy. As I read through the report, I discovered that there are three pillars--savings, investment, and exports. Mr. Grilli has already made his remark that the fast growth has not been export-led, and the response from the staff was that that was true. I think the reverse is true for the future for this strategy. There is a great deal of emphasis on exports, and if that is so, then the risk will be substantial from the external environment, especially in the case of Argentina. This would lead one to ask the question, how much of past growth was independent of the external environment. In other words, how much of the risk was systematic. How much can Argentina diversify of the total risk? The question of diversification of exports becomes important. At the regional level, the question will arise as to how about the economies of the countries in the region-- are they competitive, or are they complementary? If one or the other, then different policies have to be undertaken accordingly. There is the question of the international economy, MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 204 and we have been warned in the report that this has important repercussions on the Argentine economy. It is very sensitive to questions of interest rates and economic policies in other countries. Now, then, this leads me to what does all this mean in terms of strategy, especially for Argentina; how do we deal with these changes, maybe over this short period of time. But that is not so. We are working for the longer term, and the report rightly stated a kind of a policy in paragraphs 16 and 17, when talking about macroeconomic prospects and risks. I would like to refer to that policy. When it said that if the market does not work in terms of increasing exports, it suggested that exports are important; Argentina had to be competitive and therefore had to increase produc- tivity. But if the market does not work, the paragraph suggested that we should realign prices of tradeables and nontradeables. I frankly found that somehow difficult to describe because if we are under a market economy, then it becomes very, very difficult to make these deliberate policies. I understand, and I hope my understanding is true, that that policy depends on a fixed interest rate regime. MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 205 But presumably in the long run, that is not going to be so. Mr. Chairman, I have already supported the Strategy and the two projects. I think I will stop at this point. Thank you very much. MR. PRESTON: Thank you, Mr. Sadik. Ms. Boucher? MS. BOUCHER: Thank you, Mr. Chairman. At this late stage in the day, as I review my notes on the various comments and questions I had on the Country Assistance Strategy, I note that they have been addressed. We were going to focus on the need to press ahead with the Poverty Assessment Study, but that has been thoroughly discussed, and we have heard that that is well in hand, and we are pleased to hear that. So if I could, I will just go directly to the loan itself. We support this loan. It is consistent with the CAS, and as we have discussed at some length already, we particularly welcome the focus on small and medium-sized enterprises since their access to financing has been limited to date. This Chair noted the need for this type of assis- tance during the February 1993 discussion of the Financial Sector Adjustment Loan, and we fully support the Bank's proposed action in this regard. MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 206 We had just one question that has not come up so far, and that is with respect to how this loan is accounted for in the Bank's exposure numbers. The disbursement patterns are difficult to predict, and I believe the Bank plans to book 50 percent of the loan after three years, regardless of whether or not it has disbursed. But the difficulty here is that the exposure numbers in the Annex end in 1996, so in fact we really have no indication under this document as to what this loan does to the Bank's exposure in Argentina. So we would welcome a comment on that. Thank you. MR. PRESTON: Thank you, Ms. Boucher. Mr. Doumnov? MR. DOUMNOV: Thank you, Mr. Chairman. Let me start by commending the Argentine authoritie for their remarkable achievements in macroeconomic stabiliza- tion and structural adjustment during the last three years. These accomplishments are very encouraging for countries in transition, including Russia, which still are going through tremendous difficulties on the road to economic reform. We could certainly learn a lot from the Argentine experience. I also welcome Mr. Nogues' insightful statement, which contains a brief but comprehensive and coherent review MILLER REPORTING CO., lNC. 507 C Street, N.E. Washington, O.C. 20002  STRICTLY CONFIDENTIAL ah 207 of his country's economic policies and performance. I would like further to compliment the staff for presenting an excellent paper. I agree with the main points of this document and support the Bank's Assistance Strategy. The Bank has contributed to a very successful transformation of the Argentine economy by providing essential support for economic reforms pursued by the Government of President Carlos Menem, and I hope it will do that quite efficiently in the future. I share the positive assessments of Argentina's economic policies and performance. However, I have some observations with regard to the sustainability of the recent spectacular progress. Let us look at Argentina's macroeconomic account, contained in Table 1 on page 64 of the Staff Appraisal Report. Looking at the projections, one can easily identify quite strong economic growth in the next nine years, namely, at an annual rate of 4 percent and above, as well as a steady increase in total investments and their share in GDP. On the other hand, national savings are also expected to grow, but their share in GDP will remain much lower than in the 1970's and 1980's, when it was clearly above 20 percent. MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 208 It is obvious that national savings would not be sufficient to finance the surge of investments as well as strong economic growth. In my view, there are important implications from this macroeconomic constellation, for domestic monetary stability, for external accounts, and for foreign exchange regime. Let me briefly address these issues. First, I think that strong domestic demand will increase the inflationary pressure even if the Government will not deviate from strict budgetary discipline. Inflation projection in the staff paper seems to me very optimistic. I think it will be extremely difficult to keep the inflation rate below 3 percent. It will require a tough monetary policy which could restrict credit supply and jeopardize growth objectives. Furthermore, the established geocurrency system will put certain limits on the central bank's monetary policy. Second, a quite rapid growth of investments, partly financed by external savings and accompanied by deterioration of the current account balance. The current account deficit is expected to stay in the range of US$10 billion for many years ahead and to be covered by massive private capital inflows. I am not quite sure that private capital inflows are a reliable source of finance in the long run. Private MILLER REPORTING CO., INC. 507 C Street, N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 209 capital movements could be affected by many different internal and external factors which, to some extent, are well beyond the Government's control. Even if capital inflows mad staff's expectations, I doubt it would be a sustainable process. My major point of concern is the high level of debt service, which was already mentioned here. The debt service ratio is envisaged to fluctuate around 50 percent in the next nine years. I would like to remind you that this ratio was 77 percent in 1980, just on the eve of the global debt crisis. So I am not quite convinced that the staff has made a prudent assumption projecting the real exchange rate at a stable level, well beyond the turn of the century. A possible acceleration of inflation and an unexpected reversal of capital flows could put under severe test the fixed parity between the peso and the U.S. dollar. To avoid these potential dangers for Argentina's economic development, it is necessary in my view to pay more attention to the following three points. First, enhancing national savings along with development of capital markets as a solid basis for sustained economic growth. I think the proposed Capital Market Development Project is an excellent tool to contribute to MILLER REPORTING CO., INC. )07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 210 this end. Second, promotion of foreign direct investments rather than relying on external borrowings. And third, export promotion as well as diversification of export products and markets. In many countries which have delivered success stories, strong economic growth was to a large extent export- driven. I think we have to learn from this experience. In conclusion, Mr. Chairman, I would like to support the Capital Market Development Project as well as accompanying Technical Assistance Project, which address one of the most urgent needs in mobilizing financial resources for sustained economic growth. I hope that the World Bank could implement similar projects in other countries facing difficulties in transforming short-term funds into long-term investments. In conclusion, Mr. Chairman, I would like to wish the Argentine authorities much success in implementing bold economic reforms. Thank you. MR. PRESTON: Thank you, Mr. Ooumnov. Mr. Oyewole? MR. OYEWOLE: Thank you, Mr. Chairman. MILLER REPORTING CO., INC. l07 C Stteet, N.E. Washington. D.C. 20002  STRICTLY CONFIDENTIAL ah 211 The debt crisis of the early 1980's exacted a heavy toll on Argentina's economy, compounded by inappropriate policy interventions which led to economic stagnation and spiraling inflation. Happily, more favorable economic policies introduce during the early part of this decade have begun to show encouraging results, and already a reversal in Argentina's economic fortunes is clearly evident. We commend the Argentine authorities for their efforts in achieving these developments. In particular, last year's external debt agreement with Argentina's commercial creditors has enhanced the country's access to the international financial markets, thus contributing to the success of the ambitious privatization program. Obstacles still remain, however, to sustained growth. The external environment will need to remain favorable in the coming years if Argentina's low terms of trade are expected to improve. Fortunately, interest rates are projected to remain relatively low for the immediate future, and the company can enjoy some breathing space in this regard while it pursues its development agenda. The priorities which the Argentine authorities have MILLER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 212 set for the economy appear to be appropriate, achieving strong long-term growth while increasing employment and controlling inflation. The private sector is expected to play a very prominent role in this endeavor, and foreign private investment will probably be the dominant source of external capital inflows. The Bank in its Country Assistance Strategy for Argentina will need to stay the course in providing support for the consolidation of the country's macroeconomic reforms, while also addressing its public institutions, infrastructure, and private sector. As the report points out, there is likely to be a reduced need for the Bank's adjustment lending in years to come, with only one adjustment operation in prospect for the near future. However, there will still be a strong need for investment lending, particularly in the social sectors, infrastructure, and capital market develop- ment. This must be combined with a complementary agenda of economic and sector work, with some emphasis on provincial public finance, among other relevant areas. If I may, Mr. Chairman, I would like now to comment briefly on the two projects for Argentina before us today. We too welcome the Capital Market Development Project and the associated Technical Assistance Project. We see the Capital MIUER REPORTING CO., INC. 507 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 213 Market Development Project as a welcome innovation for the IBRD which will enhance Argentina's ability to benefit from the rapidly expanding investment activity in the country. By introducing and consolidating an adequate capital markets infrastructure, the project will help provide an even more conducive environment for private investment while also enabling Argentina's private sector participants to obtain greater access to term lending from the banking system. Mr. Chairman, we too would have thought that this type of project would be one which might be well within the domain of IFC's activities and were somewhat puzzled to learn that IFC plays no role in this project. We are grateful for Mr. Meo's clarification on this matter and would be intereste in knowing whether IFC plans any sort of complementary or follow-up activity to this project. In conclusion, Mr. Chairman, we commend the Argentine authorities for their important accomplishments thus far and wish them well in their continuing efforts at achieving sustained growth and, I might add, readjusting to their newfound affluence. Thank you. MR. PRESTON: Thank you, Mr. Oyewole. MILLER REPORTING CO., INC. )07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 214 Mr. Wang? MR. WANG: Thank you, Mr. Chairman. I fully support the Bank's Assistance Strategy in helping Argentina strengthen its public institutions, with aims to improve delivery of social services, equitable distribution of the income, public management and infrastruc- ture sectors, and environmental management. Such assistance is of great importance to Argentina and will help to address some of its serious problems in such areas as low quality of health services and public education, and the poverty of low-income groups. The responsibility and the role of the public institutions in this area cannot be fully replaced by the private sector and should be further strengthened along with privatization and decentralization efforts. Second, regarding the Bank's Assistance Strategy in enhancing the competitiveness of the Argentine economy, we can concur with the conclusion made in paragraph 25, that labor market reform and the implementation of social security system reform should be pursued, and we support the Bank's efforts in this regard for helping the country to achieve these targets. In addition, we also think the Bank Group could MILLER REPORTING CO., INC. 507 C Strcer, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 215 help the country improve its competitiveness through identify ing its comparative advantages in the global economy and adopting a more outward-looking trade policy. We note that despite a rather high ratio of the industry and services sectors in the total GDP, the pace of the industrialization and economic growth could be even faster if the industry policy in the industry and services sectors could be further improved. In this sense, we believe that there exists an important role the Bank Group can play. Thank you, Mr. Chairman. MR. PRESTON: Thank you, Mr. Wang. Mr. Akturk? MR. AKTURK: Thank you, Mr. Chairman. I would like to start by expressing my appreciation for a very good report and also the supplemental note provided by Mr. Nogues. Argentina has had remarkable success in stabilizing the economy and steering toward a growth path, but there is a lot to be done to increase the competitiveness and the integration of the economy. I see one weakness--and I join Mr. Grilli and Mr. Peretz on this issue--and that is the practice enforced by convertibility law. Although this practice achieved con- MILLER REPORTING CO., INC. ~07 C Street, N.E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 216 siderable gains in terms of repatriation of flight capital, the indexation of the economy, and the deceleration of inflation, the drawbacks of this practice in coming years may be felt seriously, and I think it should be phased out. In coming years, it might discriminate against the domestic market heavily and discriminate against domestic savings. When this is considered with the shrinking Govern- ment expenditures, the task of closing private savings- investment gap might become increasingly difficult, and in this case, the inflow of foreign resources may extensively depend on restrained imports and increased borrowing. Debt-servicing capacity and private sector saving trend should be evaluated from this perspective. The second issue that I would like to touch upon, Mr. Chairman, is that I didn't see any comparison between last year's contrasting study and this year's contrasting study. It would be very helpful to understand where we are, for guidance. Thank you very much. MR. PRESTON: Thank you, Mr. Akturk. Mr. Meo? MR. MEO: Thank you very much, Mr. Chairman. I think four Executive Directors have talked about MILLER REPORTING CO., INC. }07 C Street, N.E. Washington, D.C 20002  STRICTLY CONFIDENTIAL ah 217 the exchange rate. One of them has quite accurately pointed out the implications of the fixed exchange rate continuing over the next few years. I would add the inflation index he looked at was a GDP deflator, and as I pointed out earlier, the wholesale index has not been expanding very much at all. The consumer index, which is what, if you are a wage-earner, you look at, has been growing about 6 to 7 percent a year in the last 18 months, approximately. But yes, I think the best way to describe the Argentine exchange rate regime is very similar to the way Churchill described democracy: It probably doesn't look that good, but all the other options look worse. Argentina adopted this exchange rate regime to really clean out its economy, and it is working very well. It has not produced export expansion, as some of you have ver accurately pointed out. It is essentially a gold standard situation. You do not have the flexibility, obviously. They did try in monetary policy action, when they sold the oil firm. The oil firm sale was linked to the purchase of the bonds which they had earlier extended to retirees, and given the marginal propensity to consume of retirees of very low income, the authorities increased the reserve requirements of banks. This, they did with great reluctance because they MILLER REPORTING CO., INC. ~07 C Street, N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 218 were very concerned about the already high spreads in the banking system. So indeed, their monetary instruments are not very flexible either. The point is, it is working for what they want it to do. It is making the Argentine economy much more produc- tive, much more open, and hopefully, much more resilient. One of you discussed our extremely polite use of jargon. I would unfortunately have to admit the civil servants are polite; international civil servants are very polite. But if indeed the gold standard system does not produce the productivity gains and the export recovery that is needed for the economy, if indeed the recession to adjust the domestic and foreign price levels becomes extensive, a simple way to translate adjusting tradeables versus nontrade- ables is to devalue. At this stage of the game, the authori- ties would not even contemplate it because they feel they are having very good success. Clearly, what we have produced for you in a projection is a trend line projection, and as one of you very ably pointed out, the exponential projection of it means you have a very concerned situation for the next eight to ten years. It is more likely that if you do not get a recovery, you will have a recession. And if the recession becomes MILLER REPORTING CO., INC. 107 C Street, N .E. Washington, D.C. 20002  STRICTLY CONFIDENTIAL ah 219 extensive, the authorities may look at their program. I think given the IMF's exposure there, given the explanation of the IMF, the responsible division chief, I feel that as Bank staff, we are unable to go much beyond this explanation. You had a question about IFC. The Acting Division Chief of IFC's Capital Markets Department is here with us. Mr. Al-Aweh, would you mind answering the question about what IFC proposes to do in the future, particularly in the financial area, in Argentina? MR. AL-AWEH: Thank you, Mr. Chairman and Paul Meo. IFC believes this facility is consistent with its own efforts to provide debt and liquidity to local capital markets and to widen finance options for the small and medium-sized companies. IFC also believes this project complements its own capital market activities, which include a credit line for Argentine issues of debt and equity, support for a private pension fund management company under the new pension system and the establishment of Argentina's first formal leasing company. Paragraph 47 of the report states very well IFC's overall strategy for Argentina. That concludes my comments. MR. PRESTON: Thank you. MILLER REPORTING CO., INC. )07 C Street, N.E. Washingron, D. C. 2000 2  STRICTLY CONFIDENTIAL ah 220 MR. MEO: There is only one outstanding issue, which is the exposure. You are correct in that the projectio we made in the SAR, for illustrative purposes only, has about half the loan disbursing. We don't have a clue whether it will disburse or not. Nevertheless, the loan is 100 percent allocated to the program you have approved for Argentina a year ago and which we ongo, and it will, consistent with the Articles of Agreement of the Bank, a loan or a guarantee, be counted against our exposure. Thank you. MR. PRESTON: Thank you, Mr. Meo. Are there any other questions or comments? [No response.] MR. PRESTON: The loans are approved on the terms proposed, and the Chairman's concluding remarks will be circulated. MILLER REPORTING CO., INC. )07 C Str<:et, N.E. Washington, D.C. 20002