Argentina - Four Second Provincial Reform Adjustment Loan Projects - Rio Negro, Salta, San Juan, and Tucuman

Document of The World Bank FOR. OFFICIAL USE ONLY Report No. P-7136-AR REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON FOUR PROPOSED SECONI) PROVINCIAL REFORM ADJUSTMENT LOANS IN THE AMOUNITS OF US$75 MILLION, US$75 MILLION US$50 MILLION, AND US$100 MILLION TO THE ARGENTINE REPUBLIC TO SUPPORT FOUR REFORMING PROVINCES RIO NEGRO, SALTA, SAN JUAN, AND TUCUMAN July 30, 1997 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Currency Equivalents Currency Unit: Peso US$1 = ARG$1 Fiscal Year January 1 to December 3 1L ABBREVIATIONS AND ACRONYMS BOCEP Bono para la Creaci6n de Empleo Privado (Bonds to Create Private Jobs) CAS Country Assistance Strategy CPE Consejo Provincial de Educaci6n (Ministry of Education in Rio Negro) CPI Consumer Price Index CPSP Consejo Provincial de Salud Publica (Ministry of Health, Rio Negro) CREFI Bonos de Credito Fiscal (Provincial Bonds, San Juan) DGI Direcci6n General Impositiva (National Tax Department) DGR Direcci6n General de Rentas (Provincial Revenues Department) GDP Gross Domestic Product HPA Hospital Puiblico Autonomo (Autonomous Public Hospital) IDB Interamerican Development Bank IDEVI Instituto de Desarrollo de la Vivienda (Housing Institute, Rio Negro) IRR Internal Rate of Return IPPV Instituto Provincial de Politica Vial (Road Institute, Rio Negro) IPSS Instituto Provincial de Seguro de Salud (Provincial Health Insurance Institute) LPR Letter of Provincial Reform MCBA Municipalidad de la Ciudad de Buenos Aires (City of Buenos Aires) MCEN Ministerio de Cultura y Educacion Nacional (Ministry of Education) MSP Ministerio de Salud Publica (Ministry of Health) NBI Necesidades Basicas Insatisfechas (Unsatisfied Basic Needs) OSP Obra Social Provincial (Provincial Health Insurance Fund for Workers) PEP Public Expenditure Program PER Public Expenditure Review PMH Provincial Ministry of Health POF Planta Organica Funcional (school class structure) PRESSAL Provincial Health Sector Reform Project PRL Provincial Reform Loan PRODYMES Secondary Education Decentralization Project SESP Secretaria de Estado de Salud Publica (San Juan, Secretariat of Public Health) SIPROSA Sistema Provincial de Salud (Tucuman, Provincial Health System) SPS Seguro Provincial de Salud (Provincial Health Insurance) TOR Terms of Reference VAT Value Added Tax Vice President: Mr. Shahid Javed Burki Country Director: Ms. Myrna Alexander Sector Director: Mr. Guillermo Perry Task Manager: Ms. Maria E. Freire  ARGENTINA FOR OFFMCIAL USE ONLY SECOND PROVINCIAL REFORM LOAN TABLE OF CONTENTS Page Number L THE SETTING Economic Context ......................................I Provincial Setting .....................................2 I. PROVINCIAL REFORM PROGRAMS Selection of Provinces .........................................4 Reforn Goals ......................................... S5 Public Finance .........................................6 Social Sectors . ....... .............................................................................................. 11 Education ........ 11 Health ......... 14 Private Sector Development ..................................... 17 IIL THE PROPOSEID LOANS Loan Objectives ......................................... 18 Justification for Adjustment Lending ......................................... 18 Loans Description ......................................... 19 Borrower and Loan Amount ......................................... 20 Letters of Provincial Reform ......................................... 20 Conditions of Tranche Release ......................................... 21 Program Implementation ......................................... 23 Disbursement, Procurement and Auditing ......................................... 23 Lessons Learned from Previous Operations .......................................... 24 Experience with Adjustment Operations in Argentina ....................... .................. 24 Relation with Social Sector Operations .......................... .......................................... 25 Technical Assistance Needs ..... ............ ........................................................................ 26 Monitoring Indicators .......................... ............ 26 Rationale for Bark Involvement .......................... 27 Environrnental Aspects .......................... 27 Participatory Approach .......................... 27 Coordination with Multilateral Institutions ............................. 28 Impact, Benefits and Risks ............................. 28 This Report is based on ihe findings of appraisal mission composed of Maria E. Freire (mission leader), Raul Benitez, William Experton, Vicente Paqueo, David Rosenblatt, that visited Argentina in April-May 1997. Other team members are: Richard Bird, Nicholas Burnett, Xavier Coll, Oscar Libonatti, Jose Pablo Gomez-Maeza, Miguel Mercado-Diaz, Donald Winkler and David Vetter. The mission was assisted by tearns from the Argentina's Ministries of Economy, Interior, Health, and Education. Especial collaboration was provicled by Roberto Pagano, Fernando Galimberti and Oscar Bertea. During loan preparation, the responsible Division Chief, Projects Adviser, and Departmnent Director in this operation were, respectively, Paul Meo, Orville Grnmes and Gobind T. Nankani. The current CMU Director and, Sector Director are, respectively, Myrna Alexander and Guillermo Perry. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  TABLE OF CONTENTS (Cont.) Page Number IV. RECOMMENDATION ......................................... . 29 ANNEXES A Fact Sheet for Rio Negro, Salta, San Juan and Tucuman .30 B Rio Negro, Letter of Provincial Reform. 31 C Rio Negro, Policy Matrix .41 D Salta, Letter of Provincial Reform .44 E Salta, Policy Matrix .55 F San Juan, Letter of Provincial Reform .57 G San Juan, Policy Matrix .69 H Tucuman, Letter of Provincial Reform .72 I Tucuman, Policy Matrix .83 J Status of Bank Group Operations .85 K Status of IFC Investments .86 L Argentina at a Glance .89 Map - IBRD No 26842  ARGENTINA PROVINCIAL REFORM ADJUSTMENT LOANS RIO NEGRO, SALTA, SAN JUAN AND TUCUMAN Loans Summary Borrower: The Argentine Republic Implementing Agencies: Subsecretaria de Programaci6n Regional, Ministerio de Economia, y 'Servicios y Obras Puiblicas and the Implementation Units in the Ministry of Finance of the four beneficiary provinces Beneficiaries: Four Provincial Governments - Rio Negro, Salta, San Juan and Tucuman Poverty: The programs' health components have a specific goal to reach the poor and provide basic health coverage to non-insured indigent population Amounts: US$75 million (Rio Negro); US$75 million (Salta); US$50 million (San Juan); and US$100 million (Tucuman) Terms: Each single currency loan in U.S. dollars, repaid in 15 years, including five years of grace at the Bank's standard variable interest rate Commitment Fee: 0.75 percent on undisbursed loan balances, beginning 60 days after signing, less any waiver Onlending Terms: Identical to those contracted by the Argentine Republic with the Bank Schedule of Disbursements: (in US$ Million) Rio Negro Salta San Juan Tucuman Disb. Cum. Disb. Cum. Disb. Cum. Disb. Cum. Bank FY98 2nd Quarter 25 25 45 45 10 10 55 55 4th Quarter 25 50 - 45 25 35 - 55 Bank FY99 3rd Quarter 25 75 30 75 15 50 45 100 Economic Rate of Return: Not applicable Loan Identification Nos.: AIR-PE-51695 (Rio Negro); AR-PE-51693 ( Salta); AR-PE- 51694 (San Juan); AR-PE - 6006 (Tucuman); Map: IBRD No.26842   REPORT AND RLECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON FOUR PROPOSED SECOND PROVINCLAL ADJUSTMENT LOANS IN THIE AMOUNTS OF US$75 MILLION, US$75 MILLION US$50 MILLION AND US$100 MILLION TO THIE ARGENTINE REPUBLIC TO SUPPORT THE ADIJUSTMENT PROGRAMS OF FOUR REFORMING PROVINCES: RICI NEGRO, SALTA, SAN JUAN AND TUCUMAN 1. I submit for your approval the following memorandum and recommendation on four proposed loans to the Argentine Republic for US$75 million, US$75 million, US$50 million, and US$100 million to support fiscal adjustment and structural reform in four reforming provinces: Rio Negro, Salta, San Juan, and Tucuman. The loans would be variable rate LIBOR-based Dollar loans, with a grace period of 5 years, a final maturity of 15 years and level repayment of principal. The Argentine Republic would onlend the local currency equivalent of each loan to the provinces on the same terms (an arrangement made possible by the 1:1 peso:dollar exchange rate fixed by Argentine law). I. THE SETTING Economic Context 2. In 1991 the Argentine government adopted an ambitious stabilization program aimed at bringing down hyperinflation, disciplining public spending and creating the conditions for economic stability and development. The Convertibility Plan has been remarkably successful. Between 1991 and 1994, output growth averaged 7.7% per year, and the price level dropped from the heights of hyperinflation to an annual inflation rate of 3.9% in 1994. In addition, the consumption-led boom of the early years of stabilization matured into a pattern of investment and export-led growth. Privatization of state assets was far-reaching, and more successful than expected. 3. The situation deteriorated sharply in 1995, due to the combination of the "Tequila Effect" and the severity of the necessary adjustment effort. Reduced investors' confidence in Argentina, together with higher international interest rates, contributed to net capital outflows and consequent demonetization of the economy. This had negative economic and financial implications; GDP fell 4.4% and unemployment soared to 18%. 4. The government took prompt measures to control the crisis. On the one hand, it tried to reduce the fiscal deficit by cutting expenditures and raising main tax rates. On the banking system, measures were taken 1:o enhance liquidity and prevent further bank failures. Moreover, with the support of the IMF, Bank and IDB, a package of US$1.1 billion was  2 Argentina: PRL2 made available in support of the Convertibility Plan'. This backing helped to restore confidence in the economy and the financial sector. 5. By the end of 1995, the Argentine economy had recovered and is now well out of recession. Economic growth reached 4.4% in 1996, and inflation (CPI) was practically nil. Imports recovered in line with economic activity, but healthy export growth secured a trade surplus for a second consecutive year. Access to international financial markets was restored. In January 1997, the government issued a US$2 billion global bond with a record 20-year maturity at a yield of about 11.5%. In February, for the first time Argentina issued internationally a 10-year bond in pesos at a yield of 11.85%. 6. The impetus of the structural reform occurred primarily at the federal level. Privatization, deregulation, opening of the economy and stabilization took place under the strong hold of the presidency and the national Cabinet. Provincial reforms followed at a much slower and unequal pace. Decades of dependency on the center and hyperinflation destroyed incentives for major reforms. The privatization of provincial assets began only two years after the major national privatizations took place; provincial fiscal adjustment only materialized in 1996. 7. On the fiscal side, progress has lagged. While the public sector deficit may have improved from 3.5% of GDP in 1995 to 2.5% of GDP in 1996, the financial targets negotiated with the IMF in 1996 were not attained at the federal level. The improvement at the provincial level was mostly cyclical, reflecting the increase in transfers from the center rather than a sustained effort to reduce expenditures and improve resource allocation. Ensuring a sustained fiscal balance at the provincial level continues to be a major challenge for the govermnent and for the success of the stability program. 8. Prospects: In the absence of an external shock, the Argentine economy is expected to grow at 5% in 1997 and 5.5% during the next five years, based on export growth and investments. Dependency on foreign savings will decline as domestic savings grow with the strengthening of the financial system and sustained confidence. Foreign debt as a share of GDP may have peaked. Continued attention is given in the government reform program to ensure prudence in public finance, labor market flexibility and strengthening the financial sector. The ongoing provincial reform is part of this agenda. The program negotiated with the IMF for 1997 seems to be on track, as the government met the targets for the first quarter of the year. The Provincial Setting 9. Argentina's public sector is highly decentralized. The 24 jprovincial governments2 are responsible for 45% of public sector expenditures, a share higher than in most Latin American countries. In 1995, the Argentine provinces undertook 97% of basic education, 92% of health A Bank Capitalization Trust Fund was created to handle the recapitalization/restructuring of distressed private banks; another fund assisted the privatization of many provincial banks. 2Including the city of Buenos Aires, which is larger in population than most provinces.  Argentina: PRL2 3 and 84% of welfare outlays. On the revenue side, provinces collect 18% of the public sector revenues. Their "own-source revenues" average 37% of provincial expenditures. The gap between expenditures and revenues is filled by transfers and shared revenues, mostly block grants. The central government is constitutionally responsible for monetary and foreign policy but has little leverage on the way the provinces manage their finances, borrow, or deliver public services. Matching grants are seldom used. Earmarked funds are transferred from the nation to finance provincial welfhre and housing programs. Only recently has the federal government requested counterpart funds from the provinces for these programs. 10. Fiscal Perfonnance. Provincial fiscal performance has traditionally been poor. During the 1980s, high inflation rates, lack of budgetary discipline, easy access to borrowing and reliance on the central government for transfers and bailouts all contributed to persistent fiscal deficits. The situation improved briefly in 1992 (due to the Convertibility Plan, associated Tanzi effect, and a major national tax effort) but deteriorated sharply thereafter. The national crisis of 1995 aggravated the critical situation of the provinces. Provincial revenues dropped 5% in real terms, provincial expenditures failed to adjust, and the provincial deficit reached a record high of US$3.6 billion or 1.3% of GDP, about half of the consolidated public sector deficit. Out of 24 provinces, ordy four had balanced fiscal accounts. Most of the others faced important liquidity shortages, increased borrowing, and accumulated arrears. Some provinces resorted to printing their own money. Table 1: Provincial Fiscal Performance 11. In 1996, the provincial fiscal situation improved. Revenues recovered D (Bi*ion Peins, Cnn.t Pr) "with economic activity, expenditures were _ 1993 1994 1995 1996 curbed in response to increased fiscal Current Expenditures 25.2 26.5 25.8 2515 discipline. On the one hand, the central Current Savings -0.8 -0.9 -1.7 -0.1 government increased its selectivity in Transfers 1.7 1.9 2.2 2.2 bailing out bankrupt provinces, leading to Capital Spending 3.5 4.1 4.2 4.0 severe social problems whenever public Total Deficit -2.2 -2.7 -3.6 -1.5 workers were not paid. On the other hand, Amortization 1.0 1.1 1.7 3.7 Gross Financing 3.3 .3.9 -5.3 -52 the generation of Governors who won the Gross Fin.