Argentina - Third Provincial Reform Adjustment Loan Project

Report No. PID9574 Project Name Argentina-Third Provincial Reform... Adjustment Loan Region Latin America and Caribbean Sector PREM Project ID ARPE44447 Borrower Argentine Republic Implementing Agency The Implementation Units in the Ministry of Finance of the beneficiary provinces. Date PID prepared May 12, 1999 Appraisal Date September 15, 1999 Proposed Date of October 28, 1999 Board Presentation Background 1. Argentina's public sector is highly decentralized. The 24 provincial governments are responsible for almost half of public sector expenditures, including over 90% of public spending in health and education. However, on the revenue side, provinces collect less than 20% of the public sector revenues and their "own-source revenues" average less than 40% of provincial expenditures. The gap between expenditures and revenues is filled by transfers and shared revenues from the central government, 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 infrastructure and housing programs. 2. Fiscal Performance. Provincial fiscal performance has often 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 again soon after due to proliferate spending. The financial 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$3.5 billion or 1.3% of GDP, about half of the consolidated public sector deficit. Out of 24 provinces, only four had balanced fiscal accounts. Most of the others faced important liquidity shortages, increased borrowing, accumulated arrears. Some provinces resorted to printing their own money. 3. In 1997, the provincial fiscal situation improved. Revenues recovered with economic activity, expenditures were curbed in response to increased fiscal discipline. On the one hand, the central government increased its selectivity in bailing out bankrupt provinces, leading to severe social  problems whenever public workers were not paid. On the other hand, the generation of Governors who won the 1995 elections promising major reform changes were now ready to move forward. In the context of increased confidence, some large provinces were successful in issuing debt abroad and refinancing their expensive domestic debt. With the effects of the Asia crisis, fiscal performance in 1998 is not expected to be as robust, due to declining economic activity, lower than expected revenues, and increased financial costs. 4. Structural Reforms: During 1992 and 1993, the Federal Government negotiated two agreements with the provinces to promote structural economic changes. The provinces agreed to improve own-source mobilization, restructure provincial taxes and eliminate distortionary taxes, privatize public enterprises, including the provincial banks and utilities, deregulate the provincial economy, and transfer the provincial pension funds to the national system. In exchange, the federal government guaranteed a shared-revenue floor to each province, sheltering them from any down swings in revenue. It also provided a Transformation Fund, which helped finance those reforms and provide technical assistance and advisory services. 5. Progress was achieved in many areas (See 2/). Almost half of the provincial public enterprises had been privatized, 18 out of the 31 provincial and municipal banks were fully privatized, and many others are currently being privatized. Many provincial utility services are now run by the private sector. Many of the distortionary provincial taxes have been removed, and eight provinces have transferred their pension funds to the national government. Provincial Reform Programs 6. In 1996, the federal government recognized the need for a second phase of provincial reforms. These reforms would help the Governors to improve efficiency in public spending, reduce the size of their central administrations, secure and maintain fiscal balance, reduce debt stock and debt service to manageable proportions, and enhance responsiveness, quality and equity in the provision of social services. Several governors had requested Bank technical and financial assistance to carry out these types of actions. During the Country Assistance Review in November 1996, the Argentine Government gave high priority to Bank assistance for the reform of selected provinces in the context of a structural adjustment operation. The Bank's report (See 3/) on the Argentine provincial finances provided the analytical framework for the operation. 7. The national government and the Bank jointly agreed on the eligibility criteria and the focus of the program. The loans would be available to provinces that: (i) have introduced significant structural reforms in terms of size of the provincial government and privatization of major public banks and other enterprises; (ii) have accepted the transfer of the provincial pension funds to the national system; and (iii) have demonstrated ability and political commitment to further reforms. 8. On the basis of the above criteria and taking into account the support from the Legislature, four provinces were selected -- Salta, Tucuman, San Juan and Rio Negro. These programs are now under way. Together, the four -2 -  provinces account for 6% of Argentina's GDP and 10% of the country's population. 9. The programs agreed with these four provinces are currently being implemented. Although some delays have been experienced, in general the fundamental reforms required are being put in place. The success of these programs has attracted the interest of additional provinces and the proposed operation would seek to respond to this increased demand. Lessons from the ongoing experience suggests that the loan design for a direct relation between the Bank and the provinces is important in enabling the Bank to bring to bear its international experience and in providing a mediating influence between the federal and provincial stakeholders. The participation of provinces not governed by the ruling party has provided an important means of engaging the entire political spectrum in the provincial reform effort. In addition, the provincial approach to promoting needed sector reforms in health and education appears to be a fundamental complement to the Bank's efforts in these areas at the national level. Loan Objectives 10. The objective of these loans is to help the provinces to deepen the reforms and restructure their governments so as to ensure an efficient and responsive delivery of public services (notably social services) within fiscally sound policies. 11. Coordination with Multilateral Institutions. The Bank has worked closely with the IMF in the design and supervision of adjustment operations in Argentina, in formulating country strategy, and in economic and sector work. The IMF shares our concern regarding the need to help improve the provincial fiscal situation. Bank staff will coordinate with the IMF to ensure the compatibility of this loan with the adjustment program negotiated with the IMF. The IDB has cofinanced the Public Sector Reform Loan, Provinces I and the Provincial Bank Privatization Loan. The proposed operation would complement the IDB's provincial work since it is directly financing the provinces of Buenos Aires and Mendoza, and the city of Buenos Aires. Loan Description 12. The proposed loans would support the provinces as they implement their reform programs with a series of fiscal, administrative and social measures. As with the ongoing loans, major components would include public finances, and reforms in health and education spending. Measures in public finance would focus on reducing the level of personnel expenditures to provide for more investment spending, achieving a sustainable equilibrium in current spending, improving own resource mobilization and improving debt management and levels. Reforms in health would focus on improving quality and efficiency in spending and improved targeting by separating financing and delivery and decentralizing public hospital management. For education, measures would seek to increase spending on educational materials and facilities and support implementation of the federal education reform law. While these activities would remain as the core objectives, as in the ongoing loans, other possible components focusing on supporting private sector development would be reviewed during preparation, depending on the specific needs of the individual provinces -3-  13. Borrower and Loan Amount. The borrower of the adjustment loans would be the Argentine Republic. The beneficiaries will be the provinces to be selected during preparation. Currently, four provinces have shown interest in preparing reform programs, Catamarca, Chubut, Misiones and Buenos Aires. The amounts of each loan would be determined as a function of the population of the province, needs of adjustment and depth of each program. Disbursements for each loan would be conditioned on Board approval (effectiveness) and subsequent positive evaluations of the compliance of provinces with reform actions agreed during negotiations. While the formal tranche-release actions will be limited to key measures, the full program of each province is detailed in the draft Letters of Provincial Reform (LPR). 14. Tranche disbursement. Given the various stages of reform in each of the participating provinces, the Bank's support has been packaged in separate loans. The loans will first disburse--as provincial compliance is confirmed-- into a fund to be managed by the National Ministry of Economy, the fund borrower. The fund will, in turn, quickly disburse the agreed tranches to the complying provinces. The first tranche disbursement would be released promptly after loan effectiveness, since actions required for disbursement will have been implemented prior to Board presentation. The second tranche disbursements would be released in about 6-12 months, depending on the speed of the reform following a positive review of the second (and third, in some provinces) tranche compliance. Environmental Aspects 15. The provincial reform programs are not expected to have an adverse environmental impacts, and would be classified in the "C" environmental impact category. 1/ Including the city of Buenos Aires, which is larger in population than most provinces. 2/ The Bank assisted these reforms with several loans: Provincial Development Loans I and II and the Provincial Reform Loan I have helped the federal government to begin promoting provincial reforms. The ongoing Provincial Bank Privatization Loan helped the provinces to privatize their banks and the Provincial Pension Reform Loan supporting the transfer of the Pension Funds from provincial governments to the central government. 3/ Argentina Provincial Finances Study - Issues in Fiscal Federalism, July 12, 1966, Report No. 15487-AR. Contact Point: The InfoShop The World Bank 1818 H Street N.W. Washington, D.C. 20433 Telephone No.: (202) 458-5454 Fax No.: (202) 522-1500 - 4 -  Note: This is information on an evolving project. Certain components may not necessarily be included in the final project. This PID processed by the InfoShop during the week ending October 13, 2000. - 5 -