Statement by Julio J. Nogues at the Board meeting of May 15, 1997

CONFIDENTIAL 87146 International Bank for Reconstruction and Development International Development Association International Finance Corporation Multilateral Investment Guarantee Agency FOR OFFICIAL USE ONLY EDS97-152 May 14,1997 Board Meeting of May 15, 1997 Statement by Julio J. Nogues Argentina: Country Assistance Strategy I. Introduction In spite ofthe severe economic crisis of 1995, underlying Argentina's resumption of increasing economic growth rates since 1996 (Figure 1), is an ambitious economic reform program implemented under the full working of democratic institutions. Following my tradition when the Board has discussed the CAS of my country, I will share with colleagues some insights on the recent road that has been traveled by its economy, and where the leadership is taking it in the upcoming years. Before entering into the presentation, let me say from the outset that the CAS document is fully owned by my authorities and that it conveys in an insightful way, the salient features of the economic and social issues of Argentina. Furthermore, the assistance strategy proposed in this document has been discussed in depth with my authorities, and there is full agreement that it offers a mix of investment and reform projects with the prospects of yielding a very high social and economic payoff. Finally, I want to express the appreciation of my authorities to the engaging and very productive work carried by the Bank staff in Argentina. II. The Road Traveled This and the next section are subdivided in economic and social policy issues. 1. The economy The CAS document discusses accurately, the performance of the economy with particular attention paid to what has happened since the crisis year of 1995. I would like to share with colleagues a somewhat longer perspective, as well as to emphasize the central role played by political commitment at crucial moments in recent history. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. It should not be distributed without the consent of the Executive Director concerned.  2 Between 1980 and 1990, per capita GDP declined by an accumulated amount of22.8%. Misguided economic policies and a repressive military dictatorship which ended in late 1983 when President Alfonsin took office, inflicted serious wounds to the social fabric of my country. The economic performance of the 80s contrasts sharply with a cumulative increase in per capita GDP of29.3% recorded between 1990 and 1996, with additional important increases expected for 1997 and subsequent years. Several reforms started to be discussed and some implemented in late 1989 and 1990, a process which was accelerated and deepened with the Convertibility Law (CL) proposed by the Executive in early 1991 and approved shortly after by the Congress. This drastic stabilization scheme according to which the monetary base has to be fully backed by gold or foreign exchange reserves, came after decades of numerous failed stabilization programs and stop-go cycles which resulted in worldwide records of inflation and economic instability. Against the odds and forecasts of prominent observers that the peso would soon after be devalued and that Argentina would return to its past poor social and economic performance, more than six years after it was passed, the CL stands proud as an example of a policy decision that changed the economic, political and social landscape of Argentina. What happened? I believe that underlying the pessimistic forecasts was an oversight by most observers regarding the political commitment to Convertibility. In contrast to these odds, the ex-post record shows that the commitment of the Congress and the Executive in favor of Convertibility was so strong that they were prepared to do everything that was necessary in order to sustain this law. In trying to understand the origins of this commitment, we should recall that in its decision to approve the CL, the Congress put itself in a straightjacket and since early 1991, it has had to pass most ofthe fundamental legislation considered necessary to support it including the approval of legislation granting independence to the Central Bank, the privatization of practically all loss-making public enterprises, and a vast array of deregulation measures. Without these and other legislation such as the ones leading to the rationalization of public expenditures and the overhaul of the tax system, Convertibility could have simply not been sustained. Some of the responses to the ambitious economic reform program are portrayed in the figures I have annexed to these comments. Although they speak for themselves, let me highlight two aspects: inflation and trade. The average annual inflation rate as measured by the CPI has come down steadily from 1,344% in 1990 to 0.1% in 1996 (Figure 2). As public expenditures continue to be rationalized and tax collection efforts strengthened, small and declining fiscal deficits will continue consolidating one of the lowest inflation rates in the world. We should stress that during the last couple of years, quite often monthly inflation has been negative which is an indication of how flexible the price system has become. Underlying the impressive trade performance, is an ambitious reduction of trade barriers implemented on a non-discriminatory basis and strengthened by the MERCOSUR. As a consequence of these far-reaching liberalization measures, between 1990 and 1996 aggregate trade in goods measured in nominal dollars increased by nearly two times (Figure 3). The liberalization gains to Argentina in terms of productivity improvements and creation of productive employment opportunities have been very important. I would also like to stress that at an average of $40,000 of exports per job created, the increase in Argentina's imports has helped The electronic version of the document is provided for convenience. (The official record is the version printed by the Corporate Secretariat). 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 the consent of the Executive Director concerned.  3 to create close to five hundreds thousands jobs in the exporting countries of which an important fraction have been in industrial countries. Argentina is moving fast to revert the losses accumulated through many decades of misguided economic policies but we are aware that in spite of the gains already achieved, much remains to be done in both the economic and social fronts. For example, in 1996, the trade in goods to GDP, the investment to GDP and the bank deposits to GDP ratios were 16%, 17.7% and 17.8% respectively. By the standards of the most successful countries, these ratios are low a fact which illustrates the vast array of opportunities lying ahead for economic and financial growth. Furthermore, although the aggregate productivity of the economy has grown at a very fast rate- 5.3% per annum between 1990 and 1994-, more progress will be achieved as the microeconomic adjustment to organizational arrangements required to meet the challenges of a more globalized economy continue to be implemented. 2. Social effects The CAS document is very clear in signaling that" ... Argentina's poor suffered disproportionately from the country's past disappointing economic performance, with those living in poverty doubling from 1980 to 1989 ... " (paragraph 16 of the CAS document). The impressive economic response and decline in inflation recorded between 1990 and 1994, resulted in a more than 50% reduction in the percentage of people living below the poverty line. Unfortunately, the crisis of 1995 made things worse as in May of that year, the open unemployment rate jumped to 18.4% a level which has declined slightly in subsequent official measurements (Figure 4). In view of these developments, it is not surprising that the poverty indicators have worsened but I should also stress that in spite of this setback, at present, the incidence of poverty remains well below the levels recorded at the eve of the reform program. While a decline in the unemployment rate is expected to reduce the incidence of poverty, significant progress on this front will continue to materialize as growth proceeds and the unproductive regulations in the labor market continue to be eliminated and/or reformed. Nevertheless, in the medium to long run, a permanent reduction in the incidence of poverty will materialize when the efficiency of public investment in health and education continue to 1mprove. III. Prospects 1. Economic As is well known and documented in the CAS, in 1995 Argentina suffered the consequences of a serious economic crisis that at its worst moment resulted in an almost 20% drop in bank deposits during the initial months and for the year as a whole, a 4.6% decline in GDP. The CAS document is very clear in emphasizing that: (i) the leaders used the opportunity of the crisis to make progress on a number of reform measures that had not advanced as fast as the Executive would had liked including the privatization of many public banks and additional deregulation policies The electronic version of the document is provided for convenience. (The official record is the version printed by the Corporate Secretariat). 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 the consent of the Executive Director concerned.  4 mainly in the labor market and that as a consequence, (ii) " ... the Convertibility Plan was strengthened by the 1995 crisis ... " (paragraph 11 of the CAS document). This is in sharp contrast to the historical response at times of economic crisis when import restrictions were tightened and monetary expansion eased in order to reinvigorate the economy. The CAS update and my comments to the Board in 1996 highlight the very positive short term response of several financial indicators following the peak ofthe crisis in march of 1995. I will not go into this again, but I would like to share with my colleagues the news that all financial indicators including foreign exchange reserves, the stock exchange index (Figure 5), interest spreads and bank deposits (Figure 6) among others, are today better, some of them much better, positioned than what they were prior to the crisis in December of 1994 when the devaluation of the Mexico peso that ignited the problems took place. The fruits of the deepening of the economic reform program during the crisis and the positive financial response have already begun to be collected. 1996 was the second year in modem times when a GDP growth of 4.4% surpassed the rate of inflation of 0.1 %; 1994 had been the previous year when this occurred. This growth was led essentially by a resumption of investment and a continued excellent performance of the foreign trade sector. In this healthy take-off, the participation of foreign capital in the form of direct investment and portfolio flows is playing a crucial role. In this way, after decades ofbeing shunned off from the private international fmancial and trade markets, Argentina's reform program has allowed it to create the conditions for attracting foreign savings. Economic performance is expected to continue improving with trade and investment making increasingly significant contributions to growth. For 1997 export, investment and GDP are expected to grow by 14.3%, 15.5% and 6% respectively, while the inflation rate is expected to be 1%. In the view of my authorities, the policy framework that has now been established is appropriate for the consolidation of a competitive private sector economy. While certain aspects of this framework such as those resulting in lower fiscal deficits and deregulation of labor markets will improve the economic conditions, we expect that trade and investment will continue to be the dynamic elements leading to sustained GDP growth. 2. Social My authorities are in full agreement with the CAS assessment presented in paragraph 18 and Box 2 on the very important role that a number of reform policies regarding labor market regulations will have on the unemployment rate. Nevertheless, it would be naive to assume that this deregulation will imply a fast reduction in the rate of unemployment. The issues underlying this problem are quite complex and while a flexible labor market is crucial for an efficient working of a competitive economy, there are many other issues at stake including a better understanding of the dynamics of the labor force participation particularly of women and the educational skill mix required by fast changing technologies and a competitive economy that is increasingly integrated in the international flows oftrade and capital. The electronic version of the document is provided for convenience. (The official record is the version printed by the Corporate Secretariat). 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 the consent of the Executive Director concerned.  5 In the short run, the alleviation of poverty is closely linked to the labor requirements of a growing economy as well as to the efficiency with which resources for social programs will be allocated. On the first issue, preliminary indicators suggest that the worst part of the employment cycle is over and that while economic growth recorded during 1996 did not generate sufficient jobs, the ongoing acceleration of economic activity, is providing more dynamism to the labor market. The strengthening of this performance will increase labor demand and therefore, expectations are that from now on, the unemployment rate will start to decline which in tum will entail a resumption of the reductions in the cyclical indicators of the incidence of poverty. Finally, I also want to share with colleagues the central importance that my authorities give not only to the efficiency but also as well, to the level of social expenditures. Thus, while in 1991 social expenditures were $32.4 billion dollars, by 1996 these expenditures had grown to $54 billion dollars which represents 67% of expenditures of the consolidated public sector including social security, provinces and municipalities. IV. The Role of the World Bank Group The most significant roles to be played by the Bank in the near future, will be in the provinces and social sectors and programs 1. Provinces So far on the economic front, the national government has taken a leadership role while the provinces and municipal governments have been more reluctant to introduce reforms. Because too many resources are channeled to unproductive destinations such as excessive staffmg and loss making provincial/municipal enterprises, the social conditions in many parts of the interior of the country have deteriorated. The benefits brought by the reforms implemented by the national government are now becoming apparent to many provincial governments who are seriously considering the introduction of far-reaching structural reforms. The momentum has also gathered strength with the support of some important WB projects including the "Provincial Reform I" and the "Provincial Bank Privatization". As the implementation of reform programs are considered by an increasing number of provinces, we are convinced that projects such as the proposed "Provincial Reform II" will bring significant benefits and what is most important, will improve the conditions required for increasing the returns of investments in social projects most of which are also supported by crucial loans of the Bank. 2. Social sectors and programs The role of the WB in our efforts to improve the efficiency of investment in the social sectors have been and will continue to be of great importance. In particular, I want to stress the crucial role of the Bank in the health sector where its contribution to understanding of the problem through ESW and financing of structural reforms and investment programs, have The electronic version of the document is provided for convenience. (The official record is the version printed by the Corporate Secretariat). 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 the consent of the Executive Director concerned.  6 implied a dramatic change that is showing in greater competition and quality of delivered services. The role ofBank projects in many social programs have also been of importance. As an example of what I have in mind, I would like to single out the "Maternal and Child Health and Nutrition Project I" and the one we are considering today and simply to say that the outreach efforts they entail have brought important benefits to many people and poor mothers and children in particular. In addition to the existing pipeline, my colleagues will soon be considering other proposals of social programs that have been developed in close collaboration between Argentina's officials and Bank staff. 3. Other areas My authorities are also expecting that the collaborative work with the Bank will continue to strengthen in other areas including the infrastructure sector where still much remains to be done. Also, the Bank's ESW has been managed with great professionalism and I want to stress that several contributions have been crucial in moving forward the public debate on important economic and social reform policies. We are expecting that the Compact will revert the decline in budget that ESW have suffered in the recent past as we expect that a strong ESW program, will continue to yield high returns to the Bank and to Argentina. Finally, in addition to the IBRD staff, I also want to express a word of appreciation from my Government to the significant contribution made in recent years by IFC and MIGA. They were both there at the crucial moment when the Government needed the support from different sectors of the community and the contributions made by the IFC and MIGA in facilitating the transition of many enterprises to a more competitive economy, clearly contributed to this. I also want to assure my colleagues that the Government shares the Bank's goal of ensuring a good track record of project implementation and performance. Although the crisis of 1995 implied a setback, the Government is committed to remedying the remaining problems. Let me conclude by stressing that Argentina's economic reform program has benefited by the important support offered by the Bank. Mutual trust and a clear spirit of partnership have been and continue to be crucial ingredients in the collaborative work between the Government of Argentina and the World Bank Group. The electronic version of the document is provided for convenience. (The official record is the version printed by the Corporate Secretariat). 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 the consent of the Executive Director concerned.  7 Figure I Figure 2 Annual Inflation Rate GDP Growth Rate (CPI) 0.1 1990 1991 1992 1993 1994 1995 1996 1991 1992 1993 1994 1995 1996 Figure4 Figure 3 Trade Flows: 1991-1996 Unemployment Rate (nominal dollars) (%) 30 23.8 .. 25 21.8 20.0 20. t4< ll 20 , •.• 15:.!~ ,,.f ~ 1•.• 15 12.0 ,, ~ ~ I'~· ~ ~ ~ ·~ I 10 . 5 0 1991 1992 1993 1H4 ! I 1995 1~ loExporta•lmportal Oct.91 Oct.92 Oct.93 Oct.94 Oct.95 Oct.96 Figure 6 Figure 5 Bank Deposits: 1991-1996 Stock Market Index <'> (billion of dollars) Merval Index 700 650 600 / 550 ~ / / / 500 450 / ""' ~ 400 350 1992 1993 1994 1995 1996 1991 1992 1993 1H4 1995 1996 Source: Central Bank of Argentina The electronic version of the document is provided for convenience. (The official record is the version printed by the Corporate Secretariat). 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 the consent of the Executive Director concerned.