Transcript of meeting of the Executive Directors of the IBRD and IDA, held on Thursday, June 16, 1977 : Argentina - Industrial Credit Project

1 STRICTLY CONFIDENTIAL DF/er_ INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION ~ashington, D. c. Thursday, June 16, 1977 The meeting of the Executive Directors of the International Bank for Reconstruction and Development and \ the International Develo-ment Association was convened at 10 a.m., in the Board Room, 1818 H Street, N.w., Mr. Roberts. McNamara, President, presiding as chairman.  2 STRICTLY CONFIDENTIAL C O N T E N T S STRICTLY CONFIDENTIAL 50 May we then turn to the next agenda item, a proposed  51 STRICTLY CONFIDENTIAL I :I ii i I loan in the amount of $100 million equivalent to the Argentine 'I i1 I I for an industrial credit project. I will ask Mr. Ludvik to present this to us. MR. LUDVIK: Mr. Chairman, Members of the Board: After a hiatus of over five years, the Bank reswned lending to Argentina in September 1976, following the new i Government s impressive initial success in dealing with the tw~ 1 most immediately serious problems that it had inherited: hyperinflation and a rapidly deteriorating international financial position. The inflationary spiral was broken throug a combination of appropriate incomes, fiscal and monetary policies, and an impending external financial crisis was averted as the Government successfully refinanced substantial external obligations. Progress continues to be made in stabilizing the economy and the Argentine authorities have increasingly turned their attention to achieving longer term development objectives. During the preparation and design of this project which we are presenting to you today, Bank staff have been keenly aware of the importance of supporting the Argentine Government in its efforts to carry out a major shift in the country's development strategy, namely, to open up the economy to outside competition. Emphasis is placed on  52 STRICTLY CONFIDENTIAL I !I Ji / revitalizing the agricultural sector which, for the foreseeable ,,, future, is expected to be the prime generator of foreign !j i exchange. In the industrial sector this strategy implies j adoption of an export-oriented growth strategy to replace the l prior emphasis on import substitution. Argentina's policymakerr expect industry increasingly to provide employment opportunitid, to support agriculture through promotion of supplier and processing industries, and to contribute to the country's foreign exchange earnings. The opening up of the economy is being implemented through various measures: the effective exchange rate for exports has been increased, the first stage of a major tariff reform carried out, and most import prohibitions eliminated. The trade and payments systems have been liberalized to bring the internal price structure more into line with international prices, and foreign investment is being promoted. These policies, which would encourage industry to specialize in those subsectors in which it has a comparative advantage, will be strongly supported by BANADE since it will use stringent economic and financial feasibility criteria in its lending operations. Industry's needs are great as it emerges from several years of postponing necessary investments, and BANADE's influence on the direction of industrial investmen  53 STRICTLY CONFIDENTIAL I should be significant since it remains, for the time being, I 1 11 industry's principal source of medium- and long-term credit. I The proposed industrial credit would assist BANADE by providing scarce long-term funds and accompanying technical assistance designed to help improve its sectoral and project work. Bank staff have worked closely and continuously with BANADE's capable new management team in the transformation and rehabilitation of the institution. Only a year ago, BANADE was nearly paralyzed as a consequence of inappropriate policies, diffuse operations and weak management. Today, the institution stands ready to provide critical support to the Government's industrial development plans. A realistic and sound framework of policies and procedures has been created. BANADE's staff resources have been welded into a team capable of implementing an ambitious program of operations and managem has moved forcefully to mobilize adequate financial resources. A firm base for resource mobilization was establishe when the Government contributed over US$200 million equivalent to the recapitalization of BANADE. The institution will base its future operations largely on resources it can raise in local and international capital markets. The Government's policy of introducing positive real interest ratews and the enactment of new banking legislation should free the financial  I\ I STRICTLY CONFIDENTIAL 54 I I I market from past constraints and help to revitalize the 11 I domestic financial system. Although it will probably take so~ time for a domestic term market to develop, BANADE intends to tap domestic resources whenever appropriate and to contribute o the development of the local capital market. Substantial external resources however will be required to meet the medium- and long-term financial needs of the Argentine industrial sector. The Bank would help in Providing these resources, directly through the proposed loan and further by collaborating with BANADE in reestablishing access to international capital markets. In connection with the proposed industrial credit, we are recommending that the enter into a cofinancing agreement with a European and a U.S. bank which are willing to provide a complementary second US$100 million Eurodollar credit. In the last week the terms of this credit have been defined and we have just been advised of those. The terms of the cofinanced loan are seven years final maturity, three years grace and an interest rate .:fl"' of 1-5/8 percent over LIBOR, the London Inter-Bank Offered Rate. In other words, BANADE was able to obtain the cofinanced loan through the private sector at a lower interest rate, longer maturities and longer grace period than has been the case in recent Eurodollar financing for Argentina.  55 STRICTLY CONFIDENTIAL In summary, the proposed loan is designed to provide badly needed long-term funds to industry, help consolidate the reorganization of one of Argentina's most important public lending institutions and will act as a catalyst in mobilizing complementary private funds on favorable terms. Thank you. MR. McNAMARA: Thank you, sir. May I have your questions and comments? Yes, Mr. Looijen. MR. LOOIJEN: Mr. Chairman, today inflation is on my mind and the same point here. If we look at the record of the present Argentine Government, they have done something quite impressive, as we see in paragraph 5. They succeeded in one year to bring down inflation about a quarter, or less than a quarter of what it was the year before. But still it is 160 percent, and that thought makes me a bit unquiet about the conditions of the loan which is said the subloans will be denominated in dollars, which means, in effect, that the exchange risk for the industry involved and with such an inflation of course, it will be reduced further, I am convinced of that, but it will still be high. It means that the industry gets squeezed on the one hand through the efforts of the Government to reduce inflation and on the other  1 11 56 STRICTLYlIi CONFIDENTIAL II I hand their own necessity to go on increasing prices probably in pesos anyway to be able to go on paying for the loan, apart from the fact that also it is foreseen, so far as I can see, that also the domestic loans will be indexed, J1obt: b..,.-deq which means that the •• may even be greater. Up to now it seems to work because labor is prepared to accept under the circumstances a reduction in real wages. But how long does this go on? I think industry gets into a difficult position. I would like some comments on this point, Mr. Chairman. There is another point which interests me. this one we see there is a kind of share of foreign exchange risk because the Government would assume the risk of loss resulting from changes in the exchange rat.s between the·u.s. dollar and the currency repayable to the Bank. Because it only talks about the risk of loss, it seems to assume that the dollar will go down in respect to the other currencies which are involved and that may not always be the case in the many years which are following. So my question is who gets the profits if at a certain moment the ;,ilder or the Deutsch / /\ mark or whatever it is goes down vis-a-vis the dollar and there is no loss for the Government. It has not been foreseen  I 57 STRICTLYI CONFIDENTIAL I ,, l1 ,; I i as far as I can see. MR. McNAMARA: Thank you. Mr. Ludvik, two questions: First, will this contribute to inflation by pushing the foreign exchange risk on the ultimate borrower? MR. LUDVIK: BANADE lends its medium- and long-term resources in two ways, as you mentioned, through the indexed Gc."e_. ... ,,,e.,..t 's pesos which are annexed to the •• partial wholesale price list, or in U.S. dollars as in the case with this particular subloan. In the U.S. dollar loan, of course, it will depend v,ery much on how the exchange rate will be managed, and one anticipates that the exchange rate will be managed properly. MR. McNAMARA: Mr. Wiese, do you want to add to that? MR. WIESE: The Government is certainly committed to a policy of adjusting the exchange rate to match the difference between the inflation rate of Argentina's major trading partners and the internal inflation rate. Within this framework and given the ability, of course, of the potential borrowers to adjust their prices in their own markets any 0 ther system would result in the opposite of i,·hat you seem to bs afraid of, namely, it would create windfall profits on th art of the entrepreneurs, and this particular system is suppos d  59 STRICTLY CONFIDENTIAL i I to ensure that there will be neither undue penalties nor undue '1 I, windfall profits accruing to the borrowing industrial enter- prises because of the much higher rate of domestic inflation as compared with the, let's say, average international rate of inflation. MR. McNAMARA: While we are on that point, who gets the profit if the rates don't -- MR. WIESE: The Government would take the risk and get any gains that would be deriving from a differential rate of devaluation between the dollar and other foreign currencies./ MR. McNAMARA: Right. Are there other comments or questions with respect to this? Mr. Reynolds. MR. REYNOLDS: Mr. Chairman, I found what Mr. Ludvik had to say in support of this proposal very encouraging ana very much to be welcomed indeed. There are, however, a number of dimensions to economic and social development, and as I noted last March when we considered, as I recall, a transportation loan to Argentina, my Government is concerned about the human rights situation in that country. That concern continues, and in accordance with it, I have been instructed to abstain on this  59 STRICTLY CONFIDENTIAL loan today. The abstention underscores the very serious 11 commitment of my Government to human rights worldwide. This is a commitment which my Government has discussed with a numbe of other governments, including the Government of Argentina, an~ this respect it is very heartening indeed to note t.~at there have been a number of recent indicators which suggest that the situation in Argentina may be improving for the bette. It is my Government's very strong hope that further improvemen~ will make it possible for us to support future loans to Argentina. I I Thank you. I MR. McNAMARA: Thank you, Mr. Reynolds. Mr. Martinez. MR. MARTINEZ: Thank you, Mr. Chairman. On a previous occasion this chair has expressed the views that this Board is not the appropriate forum for the airing or the discussion, the consideration of issues other than the economic and financial merits of projects. And on this occasion I would like to reiterate the position of this chair that we think that projects should be considered in accordance with the Articles of Agreement of this institution nly on the financial and economic merits. Thank you, Mr. Chairman.  60 STRICTLY CONFIDENTIAL MR. McNAMARA: Thank you, Mr. Martinez. Mr. El-Naggar. MR. EL-NAGGAR: May I join Mr. Martinez, Mr. Chairman, in also saying that the question of human rights, as much as it is important, should not be a criteria for considering any project in this Board. This view I have expressed before, and also I would like to repeat it because if this question of human rights is raised with respect to projects, this may lead us into a kind of debate which is not very helpful in the proceedings of this Board. For this reason, Mr. Chairman, I think that the project should be considered on its own merits. And if it is to be considered on its merits, I would like to express my strong support for it. The Argentinian Government has been doing a tremendous amount of effort in order to improve the economic managament of their economy and the management of their economy. This is reflected in many indicators, in the reduction of the rate of inflation from 740 percent only on~ year, two years ago, to an average of 160 percent, which i a real f~~ ..Pe ~1:. / Also, it is reflected, the effort of the Argentinian Government, in the improvement in the balance of payments, in the improvement of the foreign exchange reserves, and in the  61 STRICTLY CONFIDENTIAL structure of its external debt. Within this general framework, which shows quite a substantial progress in coping with the very difficult problems of the Argentinian economy. The industrial sector plays an especially important role since within the strategy of development of this sector the Argentinian Government is in the process of opening up the economy,as mentioned by the staff so that the Argentinian industry will become more competitive, will become more export-oriented. BANADE plays a special role in this, and I think this project is well timed and well placed However, I have a few points of clarification, Mr. Chairman. The first point that struck my attention, there was no attempt in this project to estimate the rate of return. I realize, of course, that in a project of that nature that parhaps it is difficult to estimate a rate of return, but as far as I remember, loans to DFCs that we considered before, they did include an attempt to estimate the rate of return. There is nothing, as far as I remember, in this project about a rate of return. I also notice that BANADE will not be required to estimate the rate of return on subprojects except if they involve $500,000 or more of Bank funds. Would it not have been more conducive to efficiency  62 STRICTLY CONFIDENTIAL if an estimation of the rate of return is required on all projects or at least on important projects, based not on what amount of money is given from the proceeds of the loan, but on the cost, on the total cost of the project financed by BANADE. Another point, Mr. Chairman, is that priority in this project will be given to the medium type of industry with an average size of about $8 million. I am wondering if this kind of project is not the occasion also to give some sort of supper to small-scale industry and why there was no provision apart from a very general reference, but no obligation at all, why there was no general provision for support to be given to small-scale industry. MR. McNAt.\1.ARA: Thank you, Mr. El-Naggar. I am going to ask Mr. Knapp in a moment to comment on your points relating to ratas of return. But., first, let me call on Mr. Ludvik to comment on should not the project have had a special component for financing of small-scale industry. MR. LUDVIK: Yes. I think we have to look somewhat at past operations and what BANADE has to work with today. They have in fact worked with smaller scale industry primarily in the interior of Argentina through a very extensive branch network. It covers all of the Provinces. And in this area,  63 STRICTLY CONFIDENTIAL if one looks at their lending -- you may recall we pointed out · to that much of the lending was/state enterprises. But discounting the lending to state enterprises and considering the lending to private industry, nearly half of the amount of their lending and, I believe, about three-quarters of the number of projects were channeled through relatively small loans in the interior. Now, when the new management took over, of course, they were faced with some very serious problems in turning the entire institution around, and since they were preoccupied with resolving these very fundamental problems and preoccupied with a need for fulfilling industry 1 s need, fulfilling industry 1 s requirement for new equipment which had been neglected for many years, they have not been, at least at the time of the appraisal, able to develop a new comprehensive plan for small-scale industry lending. They are very conscious of the need. This is an objective that is stated in the revised charter, and they will be turning their attention to it. But it simply was not far enough advanced for our purposes at this time. Now, we do not have any minimum amounts on our loan and w~ certainly in our conversations with them have encouraga them to direct our funds to the smaller scale industries. STRICTLY CONFIDENTIAL MR. McNAMARA: Thank you. I see Mr. Gordon here. Mr. Gordon, would you respo d on the rates of return. What is our practice with respect to DFCs? Do we nonnally provide estimated rates of return on our loans to DFCs? MR. GORDON: No, we have not been able to do so because, of course, we don't know precisely what subprojects will be financed in advance. We do make an attempt ex post to calculate a rate of return or to estimate a rate of return on a representative sample of the projects that have been financed from our loans. MR. McNAMARA: Secondly, with respect to the limit of $500,000, what is our practice there? Is it common to require rates of return on subprojects? And, if so, do we express the requirement in terms of dollar limits or types of projects or total cost, as Mr. El-Naggar was suggesting? MR. GORDON: Well, it has been done both ways, but usually it relates to the use of our funds., the amounts from our funds. MR. McNAMARA: Why? MR. GORDON: Well, because this is where we have the clearest right to set conditions on which the funds are used. If our funds are used in only a very small proportion  ii 'I Ii 65 STRICTLY!1:1 CONFIDENTIAL ! 11 I to the size of a major project, our leverage becomes a little 11 '1 marginal. MR. McNAMARA: I think the fact that perhaps some members of the Board aren't aware of this, the development banks historically have not estimated rates of return, and we have be~..n working with them over the past several years to introduce a system of rates of return calculations in development banks. And it is through provisions such as this that we are insisting that that system be introduced. I think ultimately the suggestion that Mr. El-Naggar makes is a very reasonable one. We should move toward it. Dr. Sen. DR. SEN: Mr. Chairman, I would like to associate myself with what Mr. Martinez has said and record my strong support for this project. MR. McNAMARA: Thank you, sir. Are there others who wish to speak to this? Mr. Conesa. MR. CONESA: Thank you, Mr. Chairman. I wish to thank my colleagues for approval of this loan to Argentina. I would like to pay a special tribute on this occasion to the staff that made the appraisal of this project and worked hard hand in hand with the Directors and  66 STRICTLY CONFIDENTIAL with the staff of the National Development Bank of Argentina. Now, thanks to this splendid cooperative effort BANADE is becoming a very efficient institution, almost like a small World Bank. I also wish to commend those staff members who at the macro-economic level had very positive, constructiv~ talks with my authorities. The World Bank economic report for Argentina is an objective, precise, professional piece of economic work that has contributed to the impressive improveme t ? e.z. le I-+ z. / in economic policy-making that my Governor, Mr. MartinG(;. is introducing in Argentina, and we expect to continue this dialogue with the Bank in the context of the new economic report coming soon. I Would like to stress that this chair strongly supports the technocratic professional integrity of the World Bank staff against any intent of politization. On this latter I point, politization, Mr. Chairman, I wish to ratify my statement of March 22 made on the occasion of the fourth highway loan to Argentina. At the same time I do propose that we have a full-scale debate in the Board on the subject next m ntl when we discuss the future role of the Bank. I think it is essential to decide whether we are going to be in the futur~ an international bank for human rights or are we going to be  67 STRICTLY CONFIDENTIAL an international bank for reconstruction and development. Thank you, Mr. Chairman. MR. McNAMARA: Thank you, Mr. Conesa.