Argentina - Cordoba Provincial Reform Loan Project

Report No. PID9380 Project Name Argentina-Cordoba Provincial Reform Loan Region Latin America and Caribbean Sector PREM Project ID ARPE68344 Borrower Argentine Republic Implementing Agency Ministry of Economy. Date PID prepared July 20, 2000 Appraisal Date July 24, 2000 Proposed Date of October 17, 2000 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 percent of public spending in health and education. However, provincial fiscal performance has often been poor, as has been the quality and efficiency of public expenditures in health and education. During the 1980s, high inflation rates, lack of budgetary discipline, easy access to borrowing and reliance on the Federal Government for transfers and bailouts all contributed to persistent fiscal deficits. The situation improved in 1992, due to the reforms that the Federal Government had initiated under the Convertibility Plan, and a major national tax effort. However, this deteriorated again soon after due to excessive spending by the provinces, given their inability to manage the rapid increase in the funds transferred from the center. The financial crisis of 1995 aggravated the critical situation of the provinces, once again, when the pool of total public revenues fell dramatically. In 1995-96, out of 24 provinces, only four had balanced fiscal accounts. Most of the others faced important liquidity shortages, increased borrowing, and accumulated arrears. While the situation improved as Argentina saw considerable growth in 1997, it deteriorated once again as a result of the external shocks emanating from the crises in East Asia, Russia and Brazil. The aggregate deficit for the provinces reached an estimated $3.2 billion in 1999 (excluding privatization of $640 million) and some provinces now faced high debt burdens. 2. Recognizing the importance of provincial finances to macro-stability in a federal state, provincial reform has been a priority for the Federal Government since the early 1990s. The provinces have 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 has guaranteed a shared-revenue floor to each province, sheltering them from any downfalls in revenue, and has offered to help several smaller, more deprived provinces address their debt load. It also provided a Transformation Fund, which helped finance those reforms and provide technical assistance and advisory services. While a number of provinces began implementing a program of  reforms during 1993-94, it was not until the financial crisis of 1995 that a number of provinces began to reform in earnest. The latest recession has once again impressed upon the provinces the need to take action. 3. The situation today is vastly different than it was ten years ago despite the need to continue with reforms. Progress has been achieved in many areas. Almost half of the provincial public enterprises were privatized, including 18 out of the 31 provincial and municipal banks. Many provincial utility services are now run by the private sector and eight provinces have transferred their pension funds to the national government. The Bank actively supported these efforts through a series of successful completed operations, including First Provincial Development Project (Ln. 3280), First Provincial Reform Loan (Ln. 3836), Provincial Bank Privatization Loan (Ln. 3878), and Provincial Pension Reform Loan (Ln. 4116). All provinces are also engaged in various ways in improving the delivery of basic health, social protection, and education services, often with the support of complementary loans from the World Bank and IDB. The Provincial Reform Program 4. By 1996, the federal government recognized the need for a second phase of provincial reforms beyond what was already started to reorient the role of the state and to improve fiscal management. In particular, it was seen as highly desirable that these reforms would help the Governors to improve efficiency in public spending, 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. 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. In 1997, the first of these loans were approved for the provinces of Salta, Tucuman, San Juan and Rio Negro, and a new set of loans are in preparation in Buenos Aires and Santa Fe as well as Cordoba. Cordoba Provincial Reform Loan Objectives 5. The objective of this loan is to support the Province of Cordoba in its comprehensive reform program which seeks to reestablish fiscal discipline, restructure government, and improve social sector operations so as to achieve a more efficient, effective, and transparent delivery of public services. Since Cordoba has not participated extensively in the earlier round of reforms, its program covers some aspects of first generation reforms, combined with those of second generation. The case of Cordoba also presents a particular challenge because of its strategy to reduce taxes as a way of making the province more competitive. The three main components of the Province's program are: Public Finance. The Provincial Government is committed to reaching a sustainable fiscal situation. Specific aims are to: (a) achieve a balanced budget; (b) strengthen tax administration; (c) reform municipal finances and debt; (d) set the government's pension system on a sound financial basis in line with national policies; and (e) incorporate private capital into banking and electricity distribution to improve services and reduce the burden on the - 2 -  province's fiscal position. These fiscal objectives are to be achieved while protecting spending for vital social services and reducing tax rates in order to better promote investment needed for increased growth in Cordoba. Public Administration. An important complement to the government's longer term goals of fiscal stability and economic growth is to improve the efficiency, effectiveness, and transparency of government services to citizens. This will be attained through a series of activities relating to government financial management, increasing transparency and accountability, and reforms in human resource management. Social Sectors. Efficient and effective health care, education, and protection for the poorest citizens are necessary investments to strengthen Cordoba's competitive position and better meet the needs of its people. Programmatic policy reforms will be pursued in all these sectors. The education program for the coming years involves a series of actions to generate improvements in administrative efficiency and education quality. Selected reforms include actions to allow for class consolidation, control of absenteeism, reduction of overhead costs, conversion of public teacher training institutions; and new subsidies systems for the private schools. In health the provincial strategy is oriented towards ensuring the coverage of the population, particularly uninsured indigents, with a package of public health benefits and personalized medical care; improving the population's choices; ensuring the financial feasibility, efficiency and quality of the public health system; and modernizing the role of the Ministry of Health. Efforts will also be undertaken to strengthen the government's social protection programs in order to provided greater stability in resource flows, equity, and improvements in selected social indicators. 6. Borrower and Loan Amount. The borrower of the loan would be the Argentine Republic, which would on-lend the proceeds of $300 million on the same terms to the Province of Cordoba. The loan would disburse in several tranches the size and amount of which are still to be determined. The first tranche 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 the province will be detailed in a Letter of Provincial Reform. Environmental Aspects 7. Although this type of operation is not formally subject to an environmental rating, the Provincial authorities will conduct an environmental audit of the inclusion of private capital in the electricity distribution system. Benefits and Risks 8. Benefits. The main benefit of the loan would be improved public finances, a strengthened provincial competitive position, better public services to citizens, and a series of reforms in education, health, and social assistance consistent with budgetary constraints. 9. Risks. Risks include the reversibility of some of the reforms in case of political changes or a deterioration in the macroeconomic environment. -3 -  However, the program is designed to be fully implemented during the early years of the provincial administration's four-year term. One advantage of the proposed operation is the very high level of engagement and leadership by the Governor of the Province. This has proven to be a success factor in previous provincial operations. He was closely involved in preparation activities, has obtained comprehensive legislation supporting the program, and his government has already initiated several reforms. Experience suggests that strong political commitment and the general acceptance of the need for policy reforms (i.e., fiscal discipline, privatization, decentralization) have enabled the provinces to sustain their reform efforts even during the current economic downturn. A further risk involves fiscal performance relating especially to the Province's ability to meet revenue collection targets despite reductions in selected tax rates. A vigorous effort to improve tax administration has already begun and the authorities believe this, along with positive supply side responses, will offset the rate changes. Coordination with Multilateral Institutions 10. The Bank has worked with the IMF in the design of adjustment operations in Argentina, in formulating country strategy, and in economic and sector work. The IMF shares the concern regarding the need to improve the fiscal situation of many provinces. The IDB has co-financed the Public Sector Reform Loan, Provincial Development I and the Provincial Bank Privatization Loan, and is preparing a separate loan in Cordoba which would complement the proposed World Bank project. 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 Note: This is information on an evolving project. Certain components may not necessarily be included in the final project. Processed by the InfoShop week ending August 4, 2000. - 4 -