Argentina - Reforms for price stability and growth (Vol. 2 of 2) : Volume two

Report No. 7994-AR Argentina: Reforms for Price Stability -,ind Growth On Two Volumes) Volume 11 September 8,1989 Latin America and the Caribbean Region Country Operatiorns Department IV FOR OFFICIAL USE ONLY Docwnent of tltiWorld Bank~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ *hi douethIarsrce itiuinadmybiue yrcpet only in the 136ft--l"ance of theWafficial duties. its contents may not otherwise~~~~~~~~~~~~~~ be disclosed withoutWorld Bank~~~~~~-' auhoiztin  TABLE OF CONTENTS Page Nos. GLOSSARY OF ACRONYMS COUNTRY DATA EXECUTIVE SUMMARY i - xxi VOLUME I - MAIN REPORT CHAP.LR Is STATE-LED GROWTH AND INFLATION . A. Background. 1 B Growth, Investment and Savigs. 1 C. Adjustment and External Transfers. 3 D. Public Sector Deficits and Inflation. 6 CHAPTER II: STABILIZATION EFFORTS AND EMERGENCE OF HYPERINFLATION ............. ,...,.......... 12 A. Stabilization Efforts from 1984 to 1987 .............. 12 B. The Plan Primavera: August 1988-February 1989 ....... 15 C. Performance Under the Program (August 1988- February 1989).17 FeDrupme i5; ...... r e........................................ 1 D. Recent Developments: Emergence of Hyperinflation .... 19 E. Main Short-Term Problems ............................. 22 F. Short-Term Options ................................... 24 CHAPTER IIIs FISCAL POLICY AND PUBLIC FINANCE ............. 30 A. Introduction ......................................... 30 B. The Public Sector: Struggling with the neficit ...... 30 C. The Tax System: Problems and Reforms ................ 34 D. Federal-Provincial Relationships ..................... 40 E. Finances of the Social Security System ............... 41 F. Public Sector Enterprises ............................ 43 G. Recommendations ...................................... 45 CHAPTER IV: MONETARY POLICYs DEALING WITH FISCAL AND QUASI-FISCAL DEFICITS ....................... 52 A. The Central Bank in the Financial System ............. 52 B. Dealing with the Quasi-Fiscal Deficit: 1985-1989 ..... 55 C. Constraints on the Operation of Monetary Policy ...... 58 D. Recommendations ...................................... 61 CHAPTER Vs MEDIUM-TERM PRICE STABILITY AND EXTERNAL FINANCE 63 A. Domestic Macroeconomic Objectives ..64 B. External Financing .72  VOLUME II - ANNEXES PUBLIC SECTOR ANNEX CHAPTER I: PUBLIC ENTERPRISES .. 1 A. Main Issues .......................................... 1 B. Revenues: Pricing Policy ............................ 7 C. Exipenditures ......................................... 10 D. Transfers ............................................ 17 E. Buigetary Process and Control ........................ 23 F. Performance Issues in 1988-89 ........................ 25 G. Po:.icy Recommendations ............................... 26 ANNEX CHAPTER IIs PROVINCIAL GOVERNMENT FINANCE .......... . 30 A. Overview ............................................. 30 B. Intergovernmental Fiscal Relations ................... 32 C. Provincial Revenues .................................. 35 D. Provincial Expenditures .............................. 37 E. Deficit/Surplus and Sources of Credit ................ 40 F. Recommendations ...................................... 40 ANNEX. CHAPTER III: SOCIAL SECURITY .. 43 A. Introduction ......................................... 43 B. Pendion Program ...................................... 43 C. The Social Funds and Health Services ................. 49 SECTORAL ISSUES ANNEX CHAPTER IV: FINANCIAL SECTOR ........................ 51 A. Overview ............................................. 51 B. The Present Structure of the Financial System ........ 53 C. Financial Liberalization and Centralization .......... 55 D. Principal Financial Sector Policy Issues ............. 59 E. Recommendations ...................................... 64 ANNEX CHAPTER V: EMPLOYMENT AND LABOR. ........... ........ 68 A. Introduction ......................................... 68 B. Productivity, Wage Trends, and Wage Determination .... 68 C. Employment and Unemployment Trends ................... 72 D. Labor Market Regulation and Efficiency ............... 74 E. Protective Regulations and Equity .................... 75 F. Recommenidations ...................................... 75  ANNEX CHAPTER VI: TRADE POLICY .................... ....... 77 A. Trade Performance .77 B. Import-Substitution Strategy .77 C. Policy Reform .80 ANNEX CHAPTER VII: INDUSTRIAL POLICY ...................... 88 A. Sector Performance .88 B. Policy Impact .89 C. Recent Developments .90 ANNEX CHAPTER VIII: THE ENERGY SECTOR .93 A. Overview ........... . ................................ 93 B. Energy Subsidies, Pricing,and Txation .95 C. Petroleum and Gas Supply .99 D. N4atural Gas Utilization .101 E. Refining Operations .104 F. Electric Power Sector .106 G. Energy Planning .108 ANNEX CHAPTER IX: AGRICULTURE .110 A. Agriculture in the Economy .110 B. Agricultural Potential ............................ ?10 C. Disincentives to Agricultural Investment .112 D. Principal Policy Requirements ..113 ANNEX CHAPTER X: ANALYTICAL APPENDICES A. Medium-Term Projections .116 B. Macroeconomic Consistency .123 STATISTICAL APPENDIX Tables 1.1 - 9.4 .132-215  ANNEX CHAPTER Is PUBLIC ENTERPRISES A. Main Issues 1.01 The public enterprises in Argentina have, in the aggregate, con- stituted the most persistent and important source of deficit spending in the public sector. About half of the fiscal deficit can be attributed to the largest public enterprises (PEs). Repeated attempts to improve their performance have failed due to a combination of adverse political and eco- nomical circumstances, partially within the state enterprise sector but also related to the broader macroeconomic environment. The Government has been trying to reduce- the financing needs of the PEs but has continued to impose a number of noncommercial objectives and to use the price of public production in the pursuit of its anti-intlationary policy. At the same time special interests have created a regulatory environment that paralyses the PEs and that gives rise to a complex system of inefficient transfers. The Deficit of the PEs 1.02 In the last eight years, the deficit of the PEs before transfers ranged between 2.2 and 6.9 percent of GDP. These deficits represented between 40 and 60 percent of the overall nonfinancial public sector (NFPS) deficit (Annex Figure 1.1 and Annex Table 1.1). The magnitude of these deficits should be interpreted against the size of the major PEs. Annex Table 6.2 shows that the total value of public production has averaged around 11.5 percent of GDP. Its share in GDP has been derlining during the last two years. The output of YPF (the State Petroleum Company) equals about 5 percent of GDP while the electricity companies represent 2 percent and the communications and transportation sector each around 1.5 percent of GDP. 1.03 In the recent past, the deficit of the PEs has fallen in absolute value due to some cost reductions but, more importantly due to cuts in capital spending. In the period 1986-88, the deficit averaged at 2.6 per- cent of GDP while in the period 1980-85, its average was 5.4 percent. 1.04 The fuels sector has been responsible for the observed changes in the total deficit. Since 1986, both YPF and the gas company (GdE) have reduced their deficits to below 0.4 percent o' GDP from more than 2 percent in 1984 (Annex Table 1.3). The three electricity companies (AyEE, SEGBA, and HIDRONOR) have had a constant deficit of 1 percent of GDP. In the transport sector, Ferrocarriles (the railroad company) is responsible for a deficit of 1 percent of GDP as well. A striking observation is the fact that the deficit of Ferrocarriles is twice as high as its operational income. Though most of the other companies' financial borrowing require- ments are due to investment Ferrocarriles' total operational expenditure has been twice as high as its revenue. Institutional Environment 1.05 Public enterprises in Argentina are present in almost all areas of the domestic economy. In addition to the 13 most important enterprises under the supervision of the Public Enterprise Board's (DEP) and the  -2- Annex Figure 1.1 ARGENTINA: PUBLIC ENTERPRISES DEFICIT Percent of GDP 20 - 15 10 5- 0- 1980 1981 1982 1983 1984 1985 1986 1987 1988 PE Deficit =l Fiscal Deficit Source: Ministry of Economy  -3- A_S Table 1.1z MGOOTUA - PWLKC UIIUPRISE ACCOUWTS AID T FISCUL OEICIT */ (Pereest ) 1960 1961 1982 19S 1904 1986 l"0 1987 1b Current Account -1.24 -1.91 -5.07 -2.67 -1.44 -1.51 0.45 0.00 0.87 Revenue 0.04 10.27 9.72 11.05 10. 58 15.57 12.06 11.46 11.45 Expenlture 9.87 12.11 18.69 18.60 11.96 15.08 11.01 11.45 10.68 Personnel S. 2.96 2.20 8.05 8.21 8.06 2.91 2.71 2.62 Good and Services 8.77 4.65 6.11 7.22 6.86 8.91 6.76 6.48 6."0 Interest 1.65 8.62 4.09 2.46 2.08 2.52 1.54 1.20 1.40 Other 1.19 1.15 1.19 1.07 0.80 0.56 0.78 o.60 0.60 Capital Account -8.05 -8.88 -8.04 -8.78 -8.48 -2.75 -2.66 -8.J5 -4.19 Revenue 0.21 0.16 0.86 0.15 0.14 0.19 0.11 0.10 0.06 Expenditure 8.57 8.49 8.41 8.68 8.67 2.94 2.7 8.45 8.25 Financing Requirement (1) 4.59 6.24 0.91 0.80 4.67 4.26 2.20 S.86 2.22 Fiscal D9ficit (2) 7.48 1s.26 15.11 16.06 12.64 6.09 4.80 7.46 5.00 (1)/Ct) 0.61 0.40 0.46 0.89 0.89 0.70 0.61 0.46 0.44 Tronsfers from: Treaury 0.72 0.77 1.24 6.20 2.87 1.96 1.65 3.59 1.11 Special fund. 0.76 0.76 0.67 0.64 0.67 0.61 O." 0.30 0.90 Source- Minittry of Economy and DEP. a, Includes 18 WEP enterprioe and binatlonale ,/ Prelilnary 08-Mar-69  -4- Annex Table 1.2: ARGENTINA - TOTAL (UTPUT OF DEP ENTERPRISES (Percent of GDP) 1984 1985 1986 1987 1988 Combustibles 5.44 7.80 6.23 6.29 6.12 YPF 4.26 6.10 4.68 4.97 4.76 GdE 1.16 1.62 1.48 1.27 1.29 YCF 0.02 0.08 0.07 0.05 0.07 Electricity 1.91 2.17 1.95 1.92 1.92 AyEE 0.73 0.87 0.78 0.73 0.68 SEGBA 1.06 1.14 1.03 1.03 1.07 HIDRONOR 0.12 0.16 0.14 0.16 0.17 Communications 0.94 1.27 1.75 1.41 1.48 ENTEL 0.70 0.96 1.40 1.07 1.23 ENCOTEL 0.24 0.31 0.35 0.34 0.25 Transportation 1.65 1.78 1.58 1.59 1.64 FA 0.50 0.49 0.43 0.34 0.40 AA 0.72 0.85 0.81 0.89 0.84 ELMA 0.32 0.31 0.27 0.29 0.32 AGP 0.11 0.13 0.07 0.07 0.08 TOTAL 9.94 13.02 11.51 11.21 11.16 Source: DEP and company accounts.  Annez Table 1.3t ARGENTINA - SELECTED PUBLIC ENTERPRISE D mCITS (Deficit-+) 1984 198S 1986 1987 1988 Percent of GDP YPF 1.25 1.57 0.17 0.08 0.15 GdE 0.76 0.44 0.z4 0.28 0.09 AyEE 0.37 0.50 0.44 0.46 0.33 SEGBA 0.26 0.26 0.16 0.40 0.20 HIDRONOR 0.24 0.23 0.18 0.15 0.18 rerrocariles 1. 42 1.02 0.98 0.96 0.81 ENTEL 0.14 -0.07 -0.19 0.33 0.3Z Percent of enterprise revenue YPF 29 26 4 2 3 GdE 66 27 16 22 7 AyEE 51 57 56 63 48 SEGBA 25 23 16 39 is HIDRONOR 200 144 129 94 105 Ferrocariles 284 208 228 282 200 ENTEL 22 8 14 31 26 Source: DEP and company accounts. 03-Kar-89 I  -6- bi-national entities, the Central Government owns nearly 100 smaller enter- prises including radio and televisiorn, hotels and airlines. Provincial and municipal governments own albout 80 enterprises, and national and local governments share the ownershiv of other 30 enterprises. Some of these enterprises were acqui- I to prevent their liquidatio.., while others were acquired for social and political reasons which may have long since lost relevance. 1.06 It has been difficult for the Government to improve control over the public enterprises. Most of the changes in the institutional environ- ment have been short-lived and did not lead to a durable improvement in the performance of the public enterprises. Since the beginning of 1988, DEP operates as a holding for the 13 largest public enterprises and controls the execution of the budgets of these ;3 enterprises. This institution revives the idea of the Corporation of National Enterprises (CEN) that functioned between 1974 and 1979. A political struggle with the different Secretariats in the Ministry of Public Works ultimately led to the abolish- ing of the CEN. The DEP faces the same problem, but has the additional disadvantage that it was established by executive decree rather than by law. The DEP has functioned independently in the first half of 1988, but thereafter became subordinate to the macroeconomic policy of the Central Government. 1.07 Although the creation of the DEP in its present form has helped to improve the efficiency of the PEs, it has not led to financial autonomy because of the continuing application of inefficient rules and regulations governing operations. Many of the public enterprises must keep a large amount of workers on their payroll, disregarding changes in business condi- tions under which they operate. They all must comply with the Compre Argentino law that regulates procurement -nd amounts to a subsidy of the private domestic industry. Social cor .rations keep prices of some public production deliberately low to - aidize particular consumer groups and there is a complex scheme of inter-enterprise subsidies and transfers within the public sector generally leading to inefficient investment deci- sions. Links with Macroeconomic Policy 1.08 On top of the intrinsic inefficiencies created by the over-regu- lated environment and the problems with budgetary control, the Government has been using the public enterprises for two macroeconomic objectives: (i) balance of payments financing, and (ii) lowering inflation. Public enterprises incurred large amounts of foreign debt during the period 1978-82 in order to satisfy the Government need for foreign exchange. The burden of the ensuing debt service became so overwhelming that the Govern- ment decided to take over the debt service in 1983. Unfortunately, this foreign debt is still present in the enterprises' accounts, preventing them from obtaining independent financing and distorting their financial picture. Repeatedly the Government used the price of public production to mitigr -e accelerating inflation. As a result real prices have been very vola _le and their manipulation is linked to the size of the operational def'cits of the public enterprises. Consequently, sources of deficit can be found on both revenue and expenditure side of the PE accounts.  -7- B. Revenues: Pricing Policy 1.09 The Central Government has often overruled the price settLng power of other iistitutions within the framework of its attempts to lower infla- tion. Under normal circumstances, the Secretariat of Energy sets energy prices while the DEP makes recommendations for all other companies under its purview. The Ministry of Public Works subsequently endorses the recom- mendations of the DEP. This implies that the Secretariats of transport and communication have lost their role in the pricing policy concerning the enterprises in their sector. 1.10 Even if one abstracts from periods in which prices of public pro- duction are used as an instrument of anti-inflationary policy, prices do not adequately reflact the cost of efficient resource allocation in the Argentine economy. They are often set to obtain specific targets related to the PE deficits or to a particular subsidy policy of the Government rather than in relation to costs. As such, these prices are not adequate to guide investment decisions in the domestic economy. 1.11 The anti-inflationary policy of the Government has induced a cyclical pattern in the real price evolution over the period 1980-88 (Annex Figure '.2). After a period of falling real prices of public production, the need to mitigate the PE deficits or the failure of the anti- inflationary program led to a recuperation of these prices. The period 1980-1988 is marked by three such episodes (Annex Figure 1.2): (i) in 1982, real prices fell by almost 2t percent below their average 1981 level and took more than two years to recover; (ii) in the second half of 1986 and throughout the first three quarters of 1987, prices of the public enterprises were used once again to try to reduce inflation. In the first half of 1988, reai prices were allowed to recoup their past loss and in the second quarter of 1988 reached again their average 1985 level; and (iii) since the implementation of the Plan Primavera in August-September of 1988, real prices have deteriorated again during the Government's renewed attempt to reduce inflation. The Government anticipates a substantial increase in the real output price in mid-1989 to correct the current situa- tion. In terms of the enterprises' own cost, real prices fell in 1987 by about 5 percent and started to fall again in the third quarter of 1988 (after recuperating by 10 percent) as a result of the Plan Primavera (Annex Table 1.4).1I 1.12 These fluctuations in real prices translate almost by definition into similar fluctuations in the PE current account. The real price reduc- tion of 1982 is associated with a fall in PE savings by 2 percent of GDP, 1/ The real price index computed in Annex Table 1.3 overstates the volatility of the actual real output prices because it uses the nonagricultural wholesale price index as a proxy for the cost evolution in the public enterprises. A large part of these costs, inter-company deliveries, interest payments and salaries, do not evolve according to that index. Unfortunately, comparable data using this weighted cost index are available only for 1987 and 1988.  AM Figure 1.2 ARGENTINA PUBLIC ENTERPRISES REAL OUTPUT PRICE (Net of Taxes) Index 1981-100 150' 50 1 7 1 7 1 7 1 7 1 7 1 7 1 7 1 7 1 10 81 1 82 1 3 1 84 85 1 86 1 87 l8 -Total - F=19 ....... .. Tr, & Comm. Soumv: 8ICBP and DEP . I~~~~~~~~~~~  9 - I n in Nw l ,IV r l~~~~~~~~~E 118,30 104 82 10Q.48 i1X12o. 7] L14fiao.824 ift103 llS :Lg. I N-I- ~~~~105.9 91.4 124.8 2.5 vss.4 14C.s 105 Im.54 =.Is to.*? 14-6 t. s 054 147.