Argentina - Second Public Enterprise Reform Adjustment Loan (PERAL II) Project

Docmt of The World Bank FOR OMCiAL USE ONLY M 1KrE I ('HF ! F'Y ep.lt N. .: F - r.8 1 - AT- TN.,: ( PF Ti~ t. le: ',-5EC:l'ND} PFUICL- ENT:FF.FRRTF: P 'FFlP Author: KAFPIfi, AML ......7. Report No. P-5811-AR Ext.- t;3 99 3 R,- mI: f; 1439 Dre,t.. r.A 4TF REPORT AND RECONEDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXESCUTIVE DIRECTORS Ol1R A PtROPOSED SECOND PUBLIC ENTERPRISE REFORM ADJUSTMENT LOAN (PERWL II) IN AN AMOUNT EQUIVALENT TO US$300 MILLION TO THE ARGENTINE REPUBLIC DECEMBER 10, 1992 Trade, Finance and Private Sector Development Division Country Department IV Latin America and the Caribbean Regional Office 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 World Bank authorization.  Currencv Arfentine Unit - Peso (ARS) Since April 1, 1991, the exchange rate has been, by law, ARS1.OO = US$1.00 Fiscal Year January 1- December 31 Princinal Abbreviations and Acronyms AA Aerolineas Argentnas Argentine Airlines AFNE Astilleros y Faibricas Navales del State Naval Shipyard Estado AGP Asociaciddn Genenl de Puertos General Ports Association AMC Area MateriQ C6rdoba C6rdoba (Mlitary) Goods Complex AyEE Agua y Energfa Electic Water and Electric Power Company AHZ Altos Hornos Zapla Steel Company BANADE Banco Nacional de Desarrollo National Development Bank BCRA Banco Central de la Repdblica Central Bank of Argentina Argentina BONEX Bonos Externos External Bonds CNT Comisi6n Nacional de Telecomunicaciones National Telecommunications Commission DDSR Debt and Debt Service Reduction DEP Direcci6n de Empresas Pibllcas Directorate of Public Enterprises DGFM Dlrecci6n General de Fabricacdones Directorate for Military Militares Factories DGI DLweccl6n General de Impositiva Internal Revenue Office ECA Fibrica Militar de Vainas y Conductores Military Plant of Electrical Elctricos Cables and Conductors EFF Extended Fund Facility ELMA Empresa de Lfneas Maritimas Maritime Lines Enterprise ENCOTel Empresa Naclonal de Correos y National Mail and Telegraph TelEgrafos Entity ENTel Empresa Naclonal de National Telephone Telecomunicacdones Entity FA Ferrocarriles Argentinos Argentine Railways FM F.4brica Militar Mltary Plant FMAS FM de Acido Sulfrco Military Sulfuric Acid Plant FIMRT FM Rio Termero Military Plant, Rio Tercero FMSF FM San Francisco Military Plant, San Francisco FMSM FM San Marn Military Plant, San Martin FM"S FM Tolueno Sintdtico Militar Plant, Synthetic Toluene  FOR OMCIL USE ONLY GA1T General Agreement on Tariff and Trade GdE Gas del Estado State Gas Company HIDRONOR Hidroelctica North Patagoa Norpastag6nca Hydroeectrc Compay HIPASAM HMe Patagnlco de Sierra Grande Steel Company of Siea S.AM. Grande, Patagona MD Mlnlsterio de Ddensa Mnistry of Defense ME Mnilsterio de Economfa Mi of Enomy MERCOSUR Mercado Comun del Cono Sur Southers Cone Commo Market MOSP Minsterlo de Obras y M stry of Public Servicos Pdblicos Works and Services MV Monomeros Vilkces Vinyl Monomers OSN Obras Sanitarlas de Ia Nacl6n The National Water and Sewerag ComPanW PBB Petroqufmlca Bala Blancs, SA. Bahia Blanca Petrochemical Company PE Public Enterprise PERAL Public Enterprise Reform AdJusment Lean PEREL Pubik Enterprise Reform Execuion Loan PGM rofca General MosconD, S.A. General Mosconi Petrchemial Company PRT Peroumica Rfo Tercero Ro Tercero Petrocemical Company QRs Quantitatve Restrictons SEGBA Servicdos Electricos del Greater Buenos Aires G(ra Buenos Aie Power Company SIGEP Sindicatura General de External Auditor of Empresas Publcas Public Enterprises SOMISA Socedad Mixt Siderug Argendna Aentie Steel Company TAE Tecnologia Aeroespacdal Aespace Technology TAMSE Tanque Argentino Mediano Argentine Tank Company VAT . Value Added Tax VERs Voluntar Export Restrictions YCF Yacimientos Carboniferos Fiscales State Coal Company YPF State Petroleum Company This document has a restricted distribution and may be used by recipients only in the performance of their oflicial duties. Its contents may not otherwise be disclosed without World Bank authorization.  ARGENIA PULNUC ENTERPRISE REFOBR ADJUSTMENT LOAN If Table of Contents Loan and Program Summay .......... ......................i L RECENT ECONOMIC DEVELOPMENTS AND PROSVECIS 1 A. Background .1 B. aCroeconomic Consolidation. 2 C Medium Term Prospecx and Fmancing Requirements 3 D. Alternative Possible Developments .5 B. Extemal Environment. 7 IL PUBLIC ENERPRSES IN ARGE1.. . 8 A The Public Enterprise (PE) Sector. 8 B Reform Progress of PEs under the Ministry of Economy 9 C ReDrm Pogress of Other PEs .11 L PE REFORM PROGRAM OF THE MINISIRY OF DEFENSE 12 A. Introduction ...................................... 12 B Composition of PEs within the Defense Complex ..... .... 12 C Fmancial Performnance ........... .................. 13 D. Me Privatization Program ......... .................. 14 IV. THE PROPOSED LOAN ......... .................... 17 ARatonale for Bank hinvoement ................... ... 17. B. Ie Proposed Loan ................................ 17 C. Ptoject Implemetaon............................. 17 D. Loan Conditions .................................. 19 F. Enironental Aspec ............................. 20 F. Social Implicamons ................................. 20 G. Benefts and Riks ................................. 21 V. CDOUNTRY ASSSTANCE STRATEGY AND OPERATIONS 22 A. Main Objective and IBRD Lending Progam ............ 22 B Medium Term Assistance Objecties ...... ............. 22 C IFC and h GA Actvities ......... .................. 24 D.Remmendations ................................. 25 This report is based on the fdings of an appral missio whi visited Argent bMar/April 1992. The princpall mission members Inclded Messs MU1 Kapur (ask Mavagw), Richard Newrmer (LA4CO), Belir Onursal (IATEN), Roger Boner, Adolf Gessner (Consultants), and Ms Mna Novaes (LA4TF). The mson was assted by Mes Cais BerStao and Fernando Vinefli (LEG). Ih loan was approved by Messs Pod Meo (Divsion Che LA4TF) and PinCheug Loh (Dirctor, LA4DR).  ANNEXES Annex I. Argentina - Key Macroeconomic Indicators Annex IL Argentina - Cash Realized and Debt Reduction from Major Privatizations Annex III. Argenti - Ministgy of Economy - Status of Restructuring and Priatizatlo Pgrm Annex IV. Argentina - Job Reducdon Plan for the Ministry of Economy Privatization Progrm - June 1991 _ Annex V. Argentina - Inventory of PEs Under Mhistry of Defense Annex VI. Argentin - Financdal Performance of PEs Under Ministry of Defense Annex VI. Argentli A- Technical Assistance for the Ministqy of Defense Reform Program Aex VIII. Afgenthia. Job Reduction Plan for the Ministry of Defense Privatization Program Annex IX Agentia - Policy Matrix Annex X Argentina - Letter of Development Policy (LDP) Ae Xl. Argentina - The Status of IBRD Operftions Annex XIL Argenthia - Statement of IFC Investments Ann XIIL Agentia - SupplementarLoan Data Sheet  ARQfN PUBLIC ENTERPRSE REFORM ADJUSTMENT LOAN II Loan and ram Summarv The Argentine Republic Beneilclar": The Argentine Republic Amount: US$300 million equivalent Terms: Repyable in 17 years, including 4 years of grace, at the standard variable rate. Objectives: The proposed loan which is an integral part e 'the Bank:s support for the Argentine Government's adjustment program wfll assist in: (i) privatizing/restructuring of public enterprises (PEs) in the Ministry of Defense; (ii) reducing public finance deficits; and (iii) improving the environment for competitive private sector activity and investment. Benefts ad Eskk: The proposed loan would achieve the 'ollowing benefits for the economT. (i) an improvement in public finances resulting from governmental labor reductions and the elimination of subsides to PEs. The PE losses in the Defense Complex were almost US$500 million in 1991, after subsidies of about US$200 million; and (ii) growth in industrial activity stemming from increased and more efficient private sector output and investment under a competitive business environment. To ensure the private sector takes advantage of this expanded scope, and some fiscal savings go to meet key social sector needs, the authorities plan to retain Defense outlays at their present low share of national income. There are three types of risks associated with the delivery of the progm. First in the short term, there are macroeconomic risks stemming from continued domestic inflation and the fixed exchange rate. senior management changes have occasionally undermined the program. Further changes could jeopardize the timetable or even the programm. 1bir due to the continued perception of a high level of county risk and the poor operating status of some PEs, there might be limited interest by the international private inmestors in some of these PEs.  Estlmated Disbursement: Ile loan would be disbursed in two tranches of US$200 million and US$100 million. The first tranche includes a set-aside amounting to US$100 million in support of Argentina's DDSR operation. Non set- aside funds would be disbursed against eligible imports. The first tranche would be available for disbursement following loan effectiveness. The second tranche would be conditioned on continued maintenance of macroeconomic performance, open trade regime, and utilization of sales proceeds from the Defense area as previously agreed, as well as specific sectoral actions: (i) forward satisfactory anti- trust legislation to Congress for consideration; (ii) issuance of tax credits to steel producers after accounts have been audited by Direcci6n General de Impositiva; (iii) commence work on environmental clean-up of closed PEs (METIOR and HIPASAM); (iv) sell or dispose of the assets of SOMISA; (v) sell PGM and PBB; and (vi) sell or close ten additional PEs in the Ministry of Defense. Finad: Retroactive financing up to US$40 million (20% of the loan amount allocated to the adjustment program) is recommended for eligible i'nports paid since June 1, 1992, about six months preceding expected loan signing, in view of the Government's need for time to gather the nece=sary import documentation for this loan while assembling similar docu'mentation for other Bank and IDB SECALS &bedule of -US$ million- Disbursements: Bank FY93 FY94 Annual 200 100 Cumulative 200 300 Rate of Return: Not applicable. Apuralsal RenoL N/A  REPORT AD RECOMMMNDATION OF THE I ESIDENT OF=THE INTENATIONA BANK F)R RECONSTRUCTION AND DEVELOPME TO THE EXECUTIVE DIRECTORS ON A PROPOS SECOND PUBLIC ENTERPRISE REFORM ADJUSTMENT LOAN IN AN AMOUNT EOUIVALEIT TO US300 MLON THE ARGEN REPUBLIC 1.01 I submit for your approval the following report and recommendation on a proposed second loan to the Argentine Republic for the equvalent of US$300 milion to support an expanded program of reform of public enterpnses; in particular those under the control of the Ministry of Defe Included in the loan, them would be a debt set-aside amounting to US$100 million in support of Argentina's DDSR operation. Te loan would be at the Bank's standard variable interest rate, with a maturity of 17 years, including 4 years of grace. L RECENT ECONOMIC DEVELOPMNTS AND PROSPECTS A. Baclground 1.02 Upon taking office during the July 1989 hypeinflation, the Menem Government recognized that rversing Argentina's economic decline required structura reforms to address the source of endemic inflation, disinvestment and productivity declines. These included reforms to eliminate chronic fiscal deficits, divest non-core fimctions of the public sector while improving the supply of essential public goods, and teminate inefficient intervetions in markets. 1.03 ITe Govemnment launched major structural reforms in the federal govenment and monetary authority, supported by the Bank's Public Sector Reform Loan (July 1991). These affected revenue mobilization, expenditures, and financing of the public sector The VAT was extended to viually all sectors in 1989-90. Tax rolls were reconstructed and tax administration was improved substantially, producing higher revenues. Taxes on exports and (later) bank checks were eliminated or reduced. Tax subsidies to industrial firms were brought under fiscal control and reduced. New expenditure controls were enacted, and discretionary transfers to the provinces and to public enterpises were reduced. The Government cut the size and scope of the federal public administration-including a net retrenchment of positions of about 15 pecent and a transfer of about 40 percent of positions to the provinces-while modernizing the civil service. A Law of Public Financial Management, passed by Congress in 1992, recast the basis for budgeting, internal control and auditing. The Government also eliminated the quasi-fiscal deficit of the Central Bank by a forced conversion of short-term, high-interest deposits into long-term dollar bonds bearing LEBOR-based rates in January 1990, this reduced confidence in the financial sector for a short period. The recently passed Central Bank charter reenforces the Convertiblity Law (see below), and paves the way for an independent, disciplined monetary authority. 1.04 The Government also launched a major privatization program, supported by the Bankls Public Enterprise Reform Adjustment Loan (February 1991). The first two laws enacted by the Menem government suspended costly subsidies and provided authority to privatize virtually all public enterprises. The measures in 1990-sae of 70 percent of telephone system, sale of hydrocarbon concessions, and deregulation oi the hydrocarbon sector-lent much-needed early credibility to the development strategy. The prvatization program continues, affecting the railways, the state oil company, the power and water companies, ports, the merchant fleet, and enterprises under the Ministry of Defense.  .2- 1.05 Tte Menem Government also implemented a trade liberalization program that was started by the Altonsin Government in 1987, with the support of two Trade Po-icy Loans (1987 and 1988). Export taxes were eliminated and indirect tax reimbursements for exports established; quantitative import restrictions were removed except for automobiles; specific import duties were abolished, and the anti-dumping regime brought n line with the respective GA1T Code; the maximum a valorem tariff rate was reduced to 20 percent. Beginning in 1991, the Govemment also deregulated the supply and marketing of numerous goods and services, including professional, transport and port services, thus reducing significantly the costs of doing business in Argentina. Legislation increasing labor flexibility and improving collective bargaining has been enacted, and further legislation is pending. B. Macroeconomic Consolidation 1.06 By 1990, although inflation was still high and variable, the Gvernment had turned an overall public sector primary deficit-6 percent of GDP in 1988--into a slight surplus. International reserves rose significantly throughout 1990. Though a rise in inflation and a sharp devaluation occurred at year-end, the pubi.s sector was much better positioned for the next stabilization program than at any time during the 1980s. 1.07 The new stabilization program, begun in February 1991, included tax measures to raise the fiscal surplus to a levesl obviating the need for inflationary financing, and further trade iiberaLization to increase price discipline. In March 1991, the Government passed a Convertibility Law that legally fixed the exchange rate at one peso to the US dollar, formally deindexed contracts, facilitated the use of US dollars in transactions, and, most importantly, required the Central Bank's mcnetary liabilities (the money base) to be matched by its international reserves. Money growth therefore became effectively constrained to inflows in foreign capital, ending Central Bank financing of deficits. 1.08 The policy package led to large capital inflows and a substantial fall in interest rates. The expectations of exchange rate stability and the openness of the economy produced a sharp deceleration in inflation, remonetization and, together with the fall in interest rates, an expansion of consumer credit. Confidence was further bolstered in July 1991 with an IMF Standby and the Bank's Public Sector Reform Loan; and later in the year with major advances in deregulation. Nominal deposit rates fell to 10 percent per annum, the lowest level in 30 years. Stock market prices and secondary market prices for Argentine external debt increased sharply, reflecting increased confidence and declining intemational interest rates. The higher private capital inflows in 1991 financed a US$4 billion rise in imports (and corresponding reduction of the trade surplus) and an increase of US$2.7 billion in Uquid reserves. Led by consumption, the economy grew by 8.5 percent in 1991. 1.09 To provide a medium-term macroeconomic framework, the Government reached an agreement with the International Monetary Fund (IMF) on a three-year program under the Extended Fund Facility (EFF) in early 1992. The EFF program was designed around a primary surplus before privatization (i.e., operational primary surplus) of about 2 percent of GDP. Together with the debt and debt service reduction (DDSR) and with privatization proceeds, this would be sufficient to meet debt service obligations without recourse to the inflation tax Fiscal performance to date has exceeded EFF targets; tax revenues surpassed 25 percent of GDP in the third quarter of 1992, compared to 15 percent in :988. The quarterly targets for the operational primary surplus were met, and privatizations pushed the primary surplus over 3.5 percent of GDP. About US$2 billion was  -3- realized from the sale of the Government's remaining 30 p<,rcent minority share in the telephone companies. LIO To regularize its financing, the Government began negotiations with its commercial bank creditors about a debt agreement in January 1992.' 1e Government also began regularizing arrears with pensioners, suppliers, and the health system, as well as compensating taxpayers for changes in the loss carry-forward provisions of the income tax through a new domestic bond (BOCON). These measures have raised its domestic debt from about US$2.3 billion at end-1991 to about US$18 billion at end-1992. Funds from the privatization of the state oil company are intended to be used for repurchasing a major part of these bonds. Furthermore, an agreement with the provinces has provided the Government with resources for increasing pension payments to legaly mandated levels, ending the accumulation of arrears with pensioners. The Government has also presented to Congress a social security reform law, which would introduce mandatory private pension funds. 1.11 These policies were expected to generate about 6.5 percent real growth in 19M Inflation, measured by the combined consumer and wholeprice index witl be about 12 percent for the year, down from 2000 percent in 1990. Additional capital inflows have financed an increase in reserves and a further US$6 billion rise in imports. Exports, however, grew at a slow pace. and the trade balance, US$4.0 bitlion in 1991, may be negative in 1992 by more than US$1 billion. 1.12 The November 1992 Package. The large capital inflows--a product of low international interest rates and new confidence in Argentine policy-produced a real appreciation of the peso of about 20 percent (based on the combined price index since the beginning of the stabilization). Concerns about the trade balance prompted the Government in late October 1992 to increase indirect tax reimbursements for exports from an average of 8 percent to 13 percent and rais import tariffs-including ad valorem tariffs and a fiat statistics tax-from an average of 17 percent to 23 percent, while also reducing tariff dispersion. Reductions in fuel taxes further improved the competitiveness of domestic producers. These measures produce an effective real devaluation of about 5 percent. C. Medlum-Term Prnspects and Financing Requirements 1.13 Following the economic recovery in 1991-92, the Government projects growth to decline gradually to a long-term rate of about 4 percent annually, based on continued productivity growth and new investment attracted by low inflation, an improved incentive structure, and reduced country risk due to the implementation of the debt agreement. This outlook, however, depends on continued fiscal improvement, and a smooth transition to a sustainable balance of payments as presented in the EFF program.2 For a mor detailed discussion, see the President's Report on a prposed Debt and Debt Service Reduction Loan (Report No. P-5914-AR) dated December 10, 1992. 2 The program is predicated upon consummating the Debt Agreement and these projections take into account the Agrement.  .4- 1.14 Fiscal and Monezary Pclicv. The Government projects its operational puimary surplus to increase from US$2.4 billion in 1992 to about US$4.4 billion in 1993, about 2.6 percent of GDP (Table 1.1). This level would be sufficient to service interest payments, and to eliminate the need for inflationary financing, given foresesable foreign and domestic borrowing. Identified finance to the public sector would virtua}ly close the financing gap in 1993-2000, leaving only about 0.4 percent of GDP in unidentified new borrowings, mainly in the outer years. Net domestic financing is expected to be positive through 1996, and then turn sharply negative. This is because the consolidation bonds (BOCONs) have a grace period on both principal and interest payments which expires in 1997. Projected foreign financing, discussed below, is also expected to turn negative in the middle of the decade. Howe-er, price stability and an improved payment record would allow the Government to tap other private markets abroad and at home to finance any remaining gap in the out-years. Argentina has already returned to voluntary borrowing througn bond issues in international capital markets. Moreover, the Government also can expect to mobilize considerable resources through the pension funds that would be generated by the social security reform. 1.15 The Government anticipates no change in its monetary and exchange rate policy, which will continue to be disciplined by the Convertibility Law and the new Central Bank charter. A tight fiscal stance, continuing import competition, and new entrants in heretofore oligopolistic markets would drive domestic inflation to international rates. Table 1.1: Argentina - Key Macroeconomic Indicators (US$ million) AvOW Aea_ 1990 1991 1992 1993 199S 1996.2 Pdowy S-rha 2.012 2.857 4389 5.4 5.AW Inmtpaym_ 5,459 4.8 2.731 3.860 4.468 Deutic 7A9 322 160 717 1,222 pFovlg 1/ 5230 4.264 2.572 1.143 S.26 FhfcuMmfot a rmmc'ag 0 0 .0 1.236 0 B9.m. (- -dew4 0..44) (.720) 90 (1.4S) S37 Dcmuldc Fiuag 4.483 (897) (573) 430 O992 Forip FIuaig 2/ (1.3 2.626 483 979 455 TAi Bd_m 8.151 4.007 (1.139) s9 2.5 CunvamtAco"Balmom 1.754 (2.748) (6.771) (5.531) (5.704) CptWA Mco 161 4.330 1.0W8 7.327 5.739 Puble SecW (1.036) 2A 483 97 455 JsRD S 169 1S3 248 675 73 me 3/ 225 242 527 460 345 Bomb (226 395 (233) (54 (23 IMP 3 (185 (661) s38 348 (764) CoomeBomb (1.2X9) 0 (127) (175) (69* usimu. 3UpIS ad OibuSt 41 270 2.512 27 219 1,731 Ptivt Sco 1.197 1.704 9.725 6.349 5,234 GDPkvmveseAu mwFh 0.4 S.5 6.5 .7 4.2 GDP (US$ bMi 10S.5 USA 153.2 182.6 248.6 Toew hntUf(% GP 8.4 12.5 14.0 16.0 18.0 Nadosu Savap (S GDP) 10.0 10.4 9.6 13.0 15.7 Pw,au SavInu4(% GDP) (1.6) 2.1 4.4 3.0 2.S 1/ include qusslhod bml Inlin of C.tre .an 21 Inchud M ficag. 3t lwA* add mMJfemilg g il 1993 for _ pwy nfp=.rd9su. 4t nlue *_ ie.tfhdthwig o0.4% ofGD?Petyerfre 1991-2000.  1.16 Balance of Eayments. The Government's program relies on private capital inflows and increasing private dlomestic savings to finance investment. Tight fiscal policy and passive but predictable monetary policy would continue to make the investment in Argentine financial and real assets attractive. Domestic interest rates would remain above international rates in real terms, while domestic investment, wsth a rich unrealized potential, would otfer high returns for years. The authorities view the estimated US$50.60 billion in private savings of Argentine residents held abroad as a reliable source of future capital inflow, though perhaps slowing in 1993. 1.17 The commercial policy measures in November 1992-which increased the price of imports and exports in pesosare intended to help switch resources from nontradeables back to tradeables as demand for imports declines and demand for competing domestic goods and export demand increase. This switch would be strengthened by continued productivity growth in the tradeable sector due to the deregulation measures. Nominal wages in the nontradeable sector would fail relative to the tradeable sector. Capital inflows would slow gradually. As the demand for consumer credit weakens, credit would be channelled into investment in productive activities that satisf the new demand in net exports and internationally competitve domestc activities. This smooth process would not require a realignment of the nominal exchange rate. Growth could be maintained, though at a lower level than during the 1991.92 recovery, and tax buoyancy would allow the Govemment to attain revenues objectives. The resultng trade balance-and real exchange rate- would be a reflection of capital inflows to finance imports and the demand for Argentine assets. Reduced capital inflows in 1993 and beyond would imply lower import demand, and explain some portion of the reductions in the growth rate. The Government anticipates that the trade balance will improve progressively beginning in 1993. 1.18 External Einancing to the Balance of Payments. The capital account in the balance of payments reflects the projectod changes in the net foreign asset position of the public and private sectors. Ihe public sector's net external borrowing requirement is to be financei' from net increases in ewosure from the international financial institutions, while bondholders and Paris Club members reduce their exposure through partial rollovers. Much as with Mexco after its turning point in the late 1980s, the World Bank would increase its exposure in Argentia, but not substantially after the mddle 1990s, nor would the rDB. The IMFs exposure would decline after the expiration of the extended afrangement. Private bondholders, including holders of BONEX, will be net recipients of funds, though the Government expects to refinance roughy three-quarters of bonds coming due. Commercial banks wfll be net recipients t3r funds on the debt that replaces existing arrears under the DDSR agreement. 1.19 Ihe private sector is projected to increase substantially its net investment in Argentina. Foreign direct investment is expectd to increase at about 8 percent annually, to average about US$2.7 billion. Private short-term capital flows are projected to average about US$3.3 biUion-about 1.5 percent of GDP-to satisfy the demand for additional imports and domestic assets; this would finance the projected current account deficit over 1993-2000. Since the Government has identified virtually all of its financing, the actual financing requirement for the balance of payments wil be a function of the desired savings-inestment balance in the private sector. D. Atlative Possible Developments 1.20 The above scenario is attainable if the Government continues to improve its fiscal position, and if the private markets allow a smooth transition to a sustainable balance of payments  -6- and growth path. However, even with adequate ex ante fiscal adjustment, it should be recognized that the Government may be unable to realize its growth projections. Slower growth or even a reession could come about through two related mechanisms. On the one hand, an "overshooting" of capital Inflows may drive up import volumes and prces of non-tradeables and domestic assets to unsustainably high levels; then, as the correction ensued, private capital flows would taper off or even reverse, pusing up domestic interest rates. (Rising international Interest rates, discussed below, could also slow capital inflows shaply.) The higher domestic interest rates would dampen or even extinguish growth. At the same time, domestic prices may be slow to converge to competitive intenational levels, also contributing to the recession. Price setters, long used to mark-up pricing in oligopolisc environmes, might take several months of slow sales before starting to cut prices to the degree necessary to adjust the overall price level. Nonetheless, slower growth eventually would produce the price convergence necessary to sustain the exchange rate regime and rekindle export-led growth. 1.21 Rliks. A recession would create added fiscal pressure, with consequences that are difficult to predict with cerainty. As revenues feil and the domestic interest bill roce, the speed of the central government adjustment in reducing expenditures would determine the size of any increase in the Government's net borrowing requirement. Any increase in the borrowing requirement would make it more difficult for the Government to achieve the projected partial rollover of its domestic debt with bondholders. A short recession would probably pose nDO major threat to the Government's macroeconomic program, though modifications may be required; it would be unlikely to derail the program of strucual reforms. 1.22 It also has to be recognized that a worsening macroeconomic panorama-or political events-could trigger a speculadve attack on the p . Ithe ease of capital mobility between reences and across borders, superimposed on a small monetary base, means that the economy is unsually vulnerable to sudden changes in private expectations and portfolio shifts. A sudden cycle of den on, very high interest rates and deep recession could produce cracks in the financial system. The Government might then be forced to choose between: (D providing emergency liquidity to prevent the collapse of the financial system, thereby putting pressue on the exchange rate and violating the convertbility law, and (ii) letting financi institutions collapse with some depositors sufferig losses, while shap increases in interest rates drive the economy into recession. In these cicmstcs, ithe economic team would be under great pressure to change the policy framework. 3 1.23 The probability of these adverse events occurring declines as the Government progresses on reforms that improve the fundamentals of public finance, and as the implementation of the debt agreement strengtens confidence. Also, reserves are the highest in a decade and cover A mai-devaluoa would have negatv impacs on ath scad acounts. The public sectr would suffer the wea koss fiom h fact that the pren value of its futue sam reeues is valued in pes while more than 85 percent of its db is denomibad in forign uri; tis will be manifiet with a higher share of revenues ng devoted to nterst paymens. (If the Govment held a law sok of international rerves-s it does at pmsent-bhe wealt- lss deots would be subsantially mitigated.) Also, inflation, despito ipovements in reducing paymeat ags and tax adminiron, would tend to reduce real revenues thugh the Tanzi effict and tax losses associated with the opaquaes of ridly shilig prices. Moreover, provincial pveme and the pubic fiacial setor generaly would be docimatd and demand finning. The ficl squeeze would be reduced to the extent that such financing coiud be limited and govanmet expeditur cut in dolar terms. Also, seirag rvenues would provide sone of st to the fisca squeeze.  the monetary base (although not the deposit base). The high level of reserves tends to deter a speculative attack on the peso. Regardless of any near-term turbulence, the emerging policy regime would of necessity focus on maintaining fiscal balance and policies conducive to private investment. Perhaps most important, recent history augurs well for the future economic management: the country has enacted serious and difficult structural reforms; these have immense public support; the political groups supporting the 1940-83 policies have seen their power dwindle; and the lack of alternatives to fiscal discipline and price stability is widely accepted. These facts are powerful ballast that is likely to keep the ship of structural adjustment headed in the same direction, even in a financial storm. E. External Environment: Assumptions and Risks 1.24 Three aspects of Argentina's external environment affect the probability of realizing the Government's scenario: the growth of the world's markets, commodity terms of trade, and the cost of international capital. During the next 12 months, world growth is expected to recover at a moderate pace. Following the stagnation of 1991, world output is projected to rise by 1 percent in 1992, and by 3 percent in 1993. ' Consequently, the volume of world trade slowed in 1991, but the prospects for 1992-93 are better and with them the demand for Argentina's exports, which the Government expects to grow at about 7 percent annually for the rest of the decade. Important impeduments to a stronger performance remain. Several industrial countries require balance sheet adjustments to unwind the effects of earlier speculative excesses in real estate and other asset markets. In addition, the persistence of large budgetary imbalances in a number of countries adversely affects business and consumer confidence. Divergences in economic policies among leading countries is also contributing to discontinuities in selected financial and foreign exchange markets. Major efforts to reduce fiscal imbalances are urgently needed in many countries to strengthen global economic prospects, which would in turn provide greater opportunities for Argentina's exports. 125 Argentinaes terms of trade, after a 3 percent deterioration in 1992-93, are projected to improve gradually as a result of the global demand conditions, according to Bank commodity price forecasts. Real agriclltural and raw material prices have been relatively stable over the last three years, hovering around 80 percent of their 1987 peak. The weakness in nonfuel commodity prices is attributed to the recent decline in inflation worldwide, but grain demand is projected to rise because of the increased demand for wheat in the CIS countries and low world grain stocks. Because Argentina is energy self-sufficient, expected changes in fuel prices will have relatively small macroeconomic effect. 1.26 Conditions in world credit markets will also affect Argentina's fiscal and balance of payments position. A one percentage point change in international interest rates would produce a US$600 million annual increase or decrease in its public interest bill. Although the demand for credit has remained high because of persistent fiscal imbalances in the US, Germany, and other OECD countries, the recession sharply reduced private credit demand; this, together with an easing of monetary policy, brought interest rates to new lows in 1992. The IIBOR in 1992 was 3.8 percent, half the 8.4 percent prevailing in 1990; the Bank projects a long term rate averaging 6.8 percent in 1993-2000. Reductions in the public demand for credit may ease the upward pressures on long-term rates if the added fiscal efforts reduce existing budget deficits in she OECD countries. These external 4 Tlis sedon is basd upon the analysis provided in the IMP's World Economic Outloo0 October 1992.  -8- rslks are mnageable, and are offset by the stronger domestic policy in Argentina and the DDSR agreement which wilt fix the interest rate on nearly US$14 billion of Argentinaes extemal debt. IL PUBLIC ENTERISES IN ARGENTINA A. The Public Enterprise (PE) Sector. 2.01 Whle PEs in Argentina did not account for a disproportionate share of the economy (about 10 percent of GDP in the late 1980s) compared with other Latin American countries, their inefficiencies and heavy losses had a profound economic Impact Furthennore, durng the past 40 years, government policies regarding PEs have created uncertaint, as they varied-from nationalization, creation and growth, to a reduction of the public sector. 2.02 As of October 1991, there were about 220 PEs in Argentina, with about 26 percent in the Federal Government (of which about 45 PEs were in the Defense Complex) and the remainder under the ownership of provincial governments (65 percent) and municipal authorities (9 percent). The PEs of the Federal Government were concentated in three major sectors: (a) HIIDcarbons and E:ner. Yacimientos Petroliferos Fiscales (after corporatization named *YPF"); Gas del Estado (GdE); Yacimientos Carboniferos Fiscales (YCF); Servicios Electricos del Gran Buenos Aires (SEGBA); Agua y Energia Electrica (AyEE); and Hidroelectrica Norpatgonia (HIDRONOR). SEGBA has been sold in segments; anl other PEs in this sector are at various stages of implementing privadzatlon strategies; (b) Transport and CoFtlon Feriles Argentinos (FA); Empresa Nacional de Correos y Telegrafos (ENCOTel); Empresa de Lineas Maritimas (ELMA); and Asociacion Geal de Puertos (AGP). Privatizons were completed with respect to Aerolineas rgentinas (AA) and the national telephone company (ENTel); the others are at various stages of pdvatzaton; and (c) Ildustrl and Service Sectors: PEs in the steel, petochemical, shipyards, aviation, and other industrial entitles under the ownership of the Minstry of Defense; the prvtization of these PEs is the subject of the proposed loan. 2.03 The supeisy framework for PEs in Argentina has been constady evolving, but by 1991, viruay all Federa PEs are under the direction of two Mnistries -the Mistry of Economy controlling the most important block (roughly 90 perceat of revenues), and the Ministry of Defense (rougly 7 percent of revenues). 2.04 Much of the inefficiency of the PEs in Argentia stems from their diverse interests. Foremost among the Interested patties are private suppliers or purcss that have enjoyed mnmerous privileges; these have enabled them to extract the maximum "rentsfrom PEs. Labor unions have extracted special privileges from PEs, and political parties have used PE appointmet as rewards for party affiliations and financing. During the 1980s, expditues, particularly investment by PEs, mirrored the general economic decline. Public nvestnent as a percent of Gross Domesdc Investment (GDI) has been dedlfning. In 1988, public investment represented 54 percent of GDI;  - in 1991 it was less than 35 percent. Initial efforts by the Covernment to implement its public sector reform program are now showing positive results: the PEs' borrowing requirement in 1991 was 1.5 percent of GDP (about US$ 2 billion), while for 1992 it is projected at 1.1 percent of GDP. 2.05 Aware of previous failures of partial reform measures, the Govcrnment concluded that success in PE reform required wholesale changes in contractual relationships between PEs, customers, suppliers, labor unions, and the central government. Such radical change left no option but to tackle vested interest groups head-on and to press for results on an accelerated timetable. Ihe Argentine Government (and President Menem personally) has made the sale and closure of PEs a centerpiece of its efforts to reform the structure of the economy, President Menem has demanded that all PEs be privatized before the end of 1992. Indeed Argentina is engaged in one of the most ambitious privatization programs in the world. The objectives of the program are to: (a) reduce the size of the state, public debt, and deficits; (b) increase production efficiency and improve the quality of services; and (c) promote private sector investment. 2.06 The 1989 Law for the Reform of the State (Law 23,696) empowered the Government to reorganize, privatize, or liquidate PEs principally under the control of the Ministry of Economy. Each of these activities has been executed by the responsible secretariat-in-charge of the assets; the Congress now supervises the process through a Bicameral Commission consisting of six members from each Chamber. In 1991, Congress extended the Reform Law to include PEs under the Ministry of Defense (Law 24,045). 2.07 As of September 1992, the privatization program had collectively contributed to a debt reduction of US$7.7 billion, about 20 percent of total commercial bank debt outstanding. In addition, the cash realized amounted to US$4.5 billion (Annex II). The biggest contribution to the National Treasury has resulted from the privatization of the telephone and oil enterprises. B. Reform Progress of PEs under the Mnistry of Ecanomy 2.08 Unlike most other countries, the Argentine Government started its restructuring and privatization program with four of the largest PEs-ENTel, AA, YPF, and FA--which collectively account for two-thirds of total PE employment and revenues and half of the total public enterprise operating deficit. The sale of the first two PEs served as "demonstration cases' and proved the Government's commitment to reform. 0 2.09 Early privatizations experienced some difficulties with the investor community. In the case of ENTel, the consortium of Bell Atlantic and Manufacturers Hanover failed to meet its payment deadline and was forced to pull out. In the case of AA, the consortium led by Iberia initially failed to meet both the deadline for its second down payment of US$130 million and the delivery of US$1.6 billion of debt paper for the 85 percent shareholding in the airline. While these problems were subsequently resolved, Iberia (the only bidder) had strong leverage during the negotiations. 2.10 Based on its demonstration cases, the Menem Government has further deepened the reform program to eatend to other major infrastructure PEs (Power, Water Supply, Ports and Shipping) for which it also requested Bank assistance. Beyond supporting PE privatizations under the first PERAL, the Bank is assisting the Government with the privatization of SEGBA, Obras Sanitarias de la Nacion (OSN), as well as concessions of the toll roads. IDB is assisting the  - 10- Government with a quick-disbursing, policy-based loan of US$314 million (including US$14 million of technical assistance) for two PEs in the power sector-HIDRONOR and AyEE. 211 Annex Im shows the status of the Ministry of Economy's PE privatizations. A summary of the efforts and results is as follows: * In the hydrocarbon sector, Congress has approved two laws - uLy de Federalizacion de Hidrocarburos y Transformacion de YPF" and a law which provided for the establishment of a regulatory framework for the gas sector. Sale of YPFs oil reserves to-date has yielded about US$1.5 billion. In the case of Gas del Estado, sales memoranda have been issued for the North and South gas pipeline transmission systems and eight distribution centers. Sale of Gas del Estado is to be completed in the first quarter of 1993. * In the power and public services sectors, the privatization of SEGBA has been concluded; two generation plants have already been sold for about US$180 million representing 60 percent of the stock value, and 51 percent of the transmission and distrbution companies-EDENOR and EDESUR-created by the spin-off of SEGBA have been sold to consortia of private investors on August 31, 1992. The Technical Commission in charge of privatization of "Obras Sanitarias de la Nacidn" on September 11, 1992, prequalified four private consortia interested in operating the water system in Buenos Aires. The concessions are expected to be awarded by end- December 1992. * In the transport sector, concessions have been awarded for the Rosario-Bahia Blanca, General Mitre, Urquiza, San Marti, and Roca railway cargo lines, and 25 percent of the interurban highway system has been turned over to private toll operations. In the case of the metropolitan railroad system of Buenos Aires (including the Metro), the Government is in the process of evaluating bids from private investors. In addition, about 9,000 kilometers of railroads are being transferred to the provinces for their direct operation or concession to third parties. The sales memorandum for ELMA (the national shipping company) was issued and no offers were received. The Government re-issued the sales memorandum in October 1992 for its second calL If there are no interested bidders for the second call, the Government would liquidate the PE. o In the communications sector, the authorities have decided to partially divest the mail system, ENCOTel (51 percent of the shares will be retained by the State). A consulting firm has been selected to advise ENCOTel on preparing a restructuring plan for partial divestiture. 2.12 By June 1991, the total labor reductions associated with restructuring of the PEs within the control of the Ministry of Economy were about 21,000. The Ministry estimates about 77,300 more employees will become redundant when the process is completed. This represents a 35 percent reduction from June 1991 PE employment levels, and will cause a labor indemnity cost of about US$750 million. Annex IV shows the labor reduction for each of the PEs within the Ministry of Economy.  - 11 - 2.13 It is still too early to analyze increases in production efficiency, improvements in the quality of services, and the promotion of private sector investment activity stemming from the selected privatizations completed-ENTel, AA, FA and petroleum reserves. Three lessons have been learned, however; (i) establish a functioning regulatory agency (if required) and clarify "rules of the game" prior to sale; (ii) ensure competition from multiple bidders; and (iii) credit highly the importance of an honest and committed senior management. Table 2.1 below shows the key lessons learned for each of the major PEs: Table 2.1: Summary of Lessons Learned from East Privatkations ENTed YPF/Gas del Esado P FA AA 0 Mirnmize delay in the * Despite excllenet Restmucue entprise * Avey promote functioning of the managanent skdlls, process into viable business units to investor interests to generate regulatory agency. took longer than maximize investor interests. multiple bidders. anticipated. l Sales contract needs to 0 Clarify 'rules of the * Walk away when deal be included with offering 0 Success of process game' in bidding contraces not appropriately strutured. document. greatly dependent on senior (cargo concession lines). management's commitment. . Proactively promotel investor interests to generate multiple bidders. * Process for labor redundancies time consuming and vulnerable to soia 2.14 The problems created by a lack of appropriate regulatory agency/framework before privatization are exemplified by the telecommunication sector: decisions related to tariffs review, cellular telephone licenses, satellite services and radio-frequency spectrum management are still awaiting decision by the Comisidn Nacional de Telecomunicaciones (CNI). After ENTel's privatizaton CNT did not operate effectively, so the Government intervened and relieved the Commissioners. A new Subsecretary of Telecommunications was appointed, who with Bank support retained consulting firms to temporarly undertake the responsibilities of CNT. New Commissioners appointed since then are building up the staff and the capacity of the commission. C. Reform Progress of Other PEs 2.15 Another group of PEs are public financial institutions and PEs under the management of provincial governments and municipal authorities. These PEs are also being restructured, liquidated and privatized under the overall mandate of the reform program. For instance, the National Development Bank (BANADE) is being liquidated (operations halted; staff reduced; most branches closed); the Savings and Insurance Bank (Caja Nacional de Ahorro y Seguros) is being privatized, and the Mortgage Bank (BHN) is being converted into a second-tier institution. Banco de la Nacion is being rationalized and is undergoing major staff reductions. The Government is committed to encourage privatization and reorganization of other financial institutions, while the Central Bank will provide temporary liquidity  - 12 - credit only to solvent banks. Bank technical assistance has supported these actions as well as restructuring by some provincial banks. A Financial Sector Adjustment Loan has been negotiated with the Argentine Governent to support these reforms. Provincial and municipal authorities, which collectively account for 74 percent of the PEs, are also downsizing their portfolio through privatizations, and these actions are expected to be supported by a forthcoming Bank loan. ImI. PE REFORM PROGRAM OF THE MI1NISJRY OF DEFENSE A. Introduction 3.01 Argentina's Ministry of Defense is undertaking the restructuring and privatization of virtually all enterprises within the Defense Complex. In October 1991, the Ministry was reorganized, consolidating responsibilities and fimctions under two Secretares - the Secretary of Military Affairs and the Secretary of Planning. The Secretary of Planning will concentrate on the PE reform program. The Under Secretary of Restructuring and Asset Management, who reports to the Secretary of Planning, is responsible for liaising with the Bank on the defense reform program. 3.02 A large number of PEs came under the tutelage of the Defeise Complex due to their "strategic' importance and the evolving role of past Military Governments. Although the PEs are in disparate industrial sectors, the unifying theme is that these PEs are related in both their defense and regional activities. For instance, Altos Hornos Zapla and HIPASAM were established in the frontier provinces of Jujuy and Rio Negro respectively to meet the military's needs for the supply of specialized steel products. Because of their original strategic importance, these PEs were not subjected to the rigors of the marketpidce and most of the senior management appointments were filled with non-commercially oriented military staff. B. Composition of PEs within the Defense Complex 3.03 The proposed loan addresses 24 of the total 45 PEs whithin the Defense portfolio. Annex V shows the overall list of PEs within the Ministry. The twenty-one PEs excuded from Bank support are: (a) six PEs liquidated prior to March 1991 (before the Bank's involvement); (b) eleven PEs that are strictly defense related, although they are subject to privatization under Law 24,045/91; and (c) four PEs that had their shares recently transferred from the Air Force to the Ministry of Defense (Decree 161/92). 3.04 The 24 industrial-oriented PEs are grouped under four broad sectoral activities: (a) steel; (b) petrochemicals; (c) shipyards; and (d) other manufacturing enterprises. These industrial PEs are the most important in terms of economic activity within the Ministry of Defense: their assets, employees and sales account for about 90 percent of the total portfolio. Amongst them, the steel sector is the most important, accounting for about 50 percent or more of the employees, assets and sales of the combined Defense PEs. Furthermore, the steel sector is the most complex in terms of labor unions, vested private sector interests, and policy distortions. Figure 1 shows the sectoral allocation of selected financial indicators:  - 13 - Figure 1: Sectoral Allocation of Selected Indicators (as of December 31, 1991.) 70- 50 ~40- 20- 10 *...* EMPLOYMENT ASSETS SALES *STEEL PEs MOTHER IND. PEs ~OEPENSEP. C. Financial Performance 3.05 The main obstacles to privatization has been the PE-s' poor financial performance, overstaffn, and the assessment of still-high country risk faced by prospectve investors. The finacial information excludes PEs sold/liquidated prior to March 1991, and Area Materia Cordoba, an aircrft company, which was not legally organized as a corporation. During 1991, the losses of Defense PEs for which data are available amounted to about US$480 million, of which US$250 million was for SOMISA alone. These losses were about 0.3 percent of 1991 GDP and equalled 16.4 percent of the total required borrowings from the Government in 1991. Of the 22 PEs for which financial, data are available, only 6 PEs were profitable; PBB showed a profit of US$75.5 million for 199 1. The book-value of their assets was US$4.2 billion, and their liabilities were US$ 1.8 billion; however combined sales last year were only uStSoo million, less than one-fifth the asset value. Annex VI shows the finacial performance of the major PB within the Defense Minstry. Some of the reasons for poor financial performance are: (a) the elimination of the budget transfers from the Treasury, which increased inter-PE payment obligations; (b) selected private firms have not paid some PEs for their purchases; (C) the near collapse of the domestic market has necessitated exports at below cost prices in some cases; and (d) overstaffig and limited investments have forced cerain enterprises into obsolescence and uncompetitive cost positions. Figure 2 shows the financial performance of the PEs within the Defense Complex:  - 14 - Figure 2: Operating Losses of Defense PEs (Calendar 1991) *Steel PEs IOther nd. PEs IDefense PEs -300 -250 -200 -150 -100 -50 0 50 11S$ Millions Financi Results Steel PEs -286.4 Other Ind. PEs -54.6 Defense PE6 -t36.5 3.06 There is also the burden of strictly defense-related outlays on the budget. In 1988, Argentina allocated 3.1 percent of GDP to defense expenditures, compared to 3.3 percent for health and education combined. Faced with growing social hardship and slow growth, the Government embarked on an ambitious program to reduce its defense expenditures (excluding pensions) to only 1.9 percent of GDP in 1991, with a lower level budgeted for 1992. All public expenditures, of course, have fallen relative to GDP during the past few years, but military expenditures have fallen faster. Defense spending was US$1.9 billion in 1985 and was reduced to US$582 million in 1990 (constant 1985 dollars), a decrease of 69 percent. The Government's strategy is that as public outlays rebound, military expenditures will grow much more slowly, so the increment can be passed to the civilian, especily social, sectors. D. The Privatizathon Program. 3.07 The Government has decided that virtually all PEs within the Ministry of Defense's purview will be privatized i.e. sold, or closed. Due to the complexity and multiplicity of these PEs, the Government requested Bank assistance-technical and financial-to achieve a broader set of objectives beyond the reduction of state activity. Based on lessons learned from the privatizations completed, the Minister of Defense, formerly Minister of Economy, appointed a Secretary for Planning who is responsible for the day-to-day management of the reform program. The Secretary of Planning is assisted by two Under Secretaries-Privatization and Restructuring and Asset Management. This senior management team is supported by govermnent staff and technical consultants. To the extent issues of economic policy arise (e.g., competitiveness, environment), other areas of Govermsent have also been involved as well.  - 15 - 3.08 Due to the poor financial performance of most of the PEs and their relative unatactiveness, the Government has developed a two-pronged approach. First, a number of PEs in financial distress but which may be viable were rationalized (without investments) prior to privatization. Second, those PEs with no hope of viability, even after rationalization, were closed. The Ministry's rationalization efforts are limited to assuming liabilities resulting from labor indemnity costs, write- down or assumptions of debt, and settlement of inter-PE transfers. Beyond these liabilities, the Government wuill not incur additional investments to improve the value of the PEs prior to sale. 3.09 The labor reduction of PEs within the Defense Complex is estimated at about 19,600 of a total 32,300 staff; a reduction of about 60 percent relative to September 1991 levels. At an average indemnity cost of US$15,000 per worker, the total cost of indemnification for Defense PEs is US$286.2 million. As of September 1992, 70 percent of the total labor reduction has been accomplished, mainly due to a US$181.9 million bridge loan received from Banco de la Nacion. Other rationalization costs, associated with plant closures, including satisfactory environmental cleanups would be identified on completion of environmental audits or will be identified (for plants already closed) by Government consultants. 3.10 On completion of the PEs' rationalization, or in cases where PEs are already viable, the Government has retained the services of international consultants or merchant bankers to assist in the preparation of the sale. The selection of these financial advisors has been undertaken in an open and transparent manner and according to international practices. 3.11 Following is a description of the Ministry's privatization program in each of the four major sectors: Steel: The Defense Ministry will end its interest in all three steel PEs. HIPASAM has been closed due to non-viability. Because of prior pollution problems, the Government will undertake an environmental audit of HIPASAM and incur the required outlays for its environmental cleanup. The Government, with the assistance of IFC as its financial advisor, has sold AHZ to an international consortium of Aubert and Duval, Societe IndustriaDe de MetalturgLe Avancee (SIMA), Citicorp Venture Capital, SA Pensa, S.A. and Penfin, SA The total value of the sale was US$33.2 million, 10 percent in cash and the balance in debt conversion instruments. Ihe third steel PE--SOMISA--is the largest integrated steel mill in Argentina with an instaDed capacity of 2.2 million tons producing both flat and non-flat steel products, about 60 percent of the country's total capacity. The Government retained the services of an international merchant banker to assist in the privatization of SOMISA under Bank financing. The sales memorandum was issued in August 1992, and a consortium of local and regional steel firms that bid US$152.1 million was awarded the company in November 1992. Chemicals and Petrochemicals: There are fourteen chemical and petrochemical related PEs under the control of the Ministry of Defense; the Gowvernment plans to sell or close all of them. Argentina has a comparative advantage in this sector due to the ready availability of gas feedstock and a sophisticated indristrial base. The most important PEs in terms of size and assets are PBB and PG?VL  -16- PBB, a manufacturer of ethylene, is 51 percent owned by the govemment, while the remaining shares are owned by the downstream private producers Although PBB is competitive, its current installed capacity of 230,000 tons is considered sub-scale by most international investors, even though it dominates the Argentine ethylene market. Using Bank financing, the Government has retained the services of an international merchant banker to assist in the privatization of PBB. An arbitration process has been underwav for sometime between the Government and the downstream private owners to resolve pending legal issues, involving unpaid bills and credits. Nevertheless, the Government has issued the sales memorandum in November 1992, without resolution of the arbitration issues, and has ensured that any adverse decision will be absorbed by the Government, not by the new owners. Sale is to be completed by the second quarter of 1993, particularly if the arbitration decision is agreed by early 1993. PGM, a manufacturer of olefins and aromatic petrochemicals, is totally government-owned with the Ministry of Defense owning 50 percent and YPF the remainder. An international merchant banker has been selected to assist the Government in its privatization; it is being financed by the Bank. The sales memorandum was issued in mid-October 1992, and the sale is to be completed by the first quarter of 1993. Five PEs in which the Government had minority ownership interests already have been divested to the existing private shareholders. One otLer PE-METEOR-hus been closed due to non-viability. Because of previous major pollution problems, the Government will undertake an environmental audit of METEOR and incur the required outlays for its environmental cleanup. The Government has issued sales memoranda and evaluated bids for three other PEs-Carboquimica, Fo4ia, and FM Tolueno-and has awarded winning bids to the respective private investors. Shipyards: There are three shipyards--Tandanor, AFNE, and Domecq Garcia. Tandanor has been sold to an international consortium consisting of Banco Holandes Unido, CIAMAR, and Sud Marine Enterprises for a price of US$59.8 million. One other shipyard, Domecq Garcia, contains partia completed submarines which the Argentine Navy now neither wants nor needs. AFNE, a diversified shipyard facility located on Rio Santiago, constructed oil tankers principaly for YPF, frigates for the Argentine Navy, and small size cargo ships ranging in size from 8,000 - 15,000 tons capacity. Because of high labor costs and obsolete technologies, demand for Argentine ships has declined. Furthermore, given their military orentation, the Government has been working with the Navy and the provinces in determining their future privatization options. In the case of AFNE, a resolution was issued in October 1992, that permits the continued reduction of its workforce. Other Industrlal PEs: There are six other major industrial PEs-Area Material Cordoba, FM ECA, FM San Francisco, FM San Martin, TAMSE, and Domingo Matheu. At leat four are to be privatized. In the case of FM ECA, the Government has retained the services of IFC to assist in its privatization. The sales memorandum was issued in October 1992 and the PE is to be sold by the fist quarter 1993. In the case of Area Material Cordoba, the Government is in the process of retaining an investment banker to assist in its privatization. Since this entity was an administrative part of the government, not a legal corporation, the Government has completed the required legal steps for its incorporation. For the remaining four PEs, Government staff will prepare the necessary documentation for their privatizations.  - 17 - IV. THE PROPOSED OAN A. Rationale for Bank Involvement 4.01 This proposed US$300 million SECAL would support the privatization of all civilian Defense PEs and those in advanced stages of conversion to civilian use. PEs supported by the PERAL II account for 97 percent and 91 percent respectively of all sales and empityment, within the Ministry of Defense. It would not include technical assistance components. Part of a prior Japanese Grant has been allocated to this program; in addition the Government of Japan recently approved another 1168.75 million (about US$1.4 million equivalent) grant specificaDly for TA to the Defense Complex. The Public Enterpnrse Reform Execution Loan (PEREL) also includes US$1,750,000 in technical assistance funds for the Defense PE reform program. The combined TA funds available to the Ministry of Defense from PEREL and Japanese Grant Facilities amounts to about US$4.2 million. The utilization of these technical assistance funds for the various initiatives is delineated in Annex "IL 4.02 The Bank has a comparative advantage for such work because of its: (a) prior knowledge of the major sectors within the Defense portfolio; (b) ability to help develop competitive policy environments for private sector participation; and (c) ability to design greater transparency and credibility in the privatization process. Over the years the Bank has been involved in developing restructuring strategies for three major industrial PEs in the Defense Complex--SOMISA, PBB, and PGM-representing more than two-thirds of the Complex's total book value. Bank staff and consultants have made special efforts to assist in both improving the competitive environment for the affected sectors and ensuring environmental dangers are avoided. Without Bank technical assistance and the financial support under the proposed loan, the Government might not have begun or expected to complete the restructuring and privatization of PEs within the Defense complex. B. The Pr6posed Loan 4.03 The US$300 million loan would be disbursed in two tranches; a first tranche of U ;$200 million, including a debt set-aside amounting to US$100 million, and a second tranche of US$100 million. PERAL II wil focus on reducing the role of the state in key industries under the tutelage of the Defense complex. In order to increase the enterprises' privatization potential, a large number of PEs need to be rationalized without new investnents by the govenment prior to privatization. The Ministry of Defense will reduce the labor force by an estimated 19,600 workers (Annex VIII). C. Project Implementation 4.04 Executing Authority. The Borrower would be the Argentine Republic; the Ministry of Defense would be the Executing Agency. The Under Secretary of Restructuring and Asset Management, Ministry of Defense, would be responsible for coordinating and liaising with the Bank on the reform program. Furthermore, the Under Secretary would be responsible for maintaining all records pertaining to the Ministry of Defense's staff reduction program. At the PE level, the respective chief executives ('Interventors") will be responsible for implementing the reform program.  .18- 4.05 Disbursement and Procurement. Excluding the set-aside funds, the proposed loan would finance 100 percent of the CIF costs of general imports, excluding luxuwry goods, military equipment, petroleum products and foodstuffs above US$50 million, and enivironmentally hazardous products defined under the Standard International Trade Classification (ST). Imports prior to June 1, 1992, and expenditures for goods procured under contracts costing not less than US$5,000 equivalent would not be eligible for Bank financing. This threshold would be consistent with satisfactoty access by small- and medium- size importers, and the operation would still remain manageable from an administrative point of view. Retroactive financing would be acceptable up to US$40 million (20 percent of the loan amount allocated to the adjustment program) for eligible imports since June 1, 1992, about six months preceding expected loan signing in view of the Government's need for time to gather the required import documentation necessary for this loan while assembling similar documents for other Bank and IDB SECALc. For commodity imports under existing contracts, relevant expenditures would qualify for reimbursement under the loan in an amount not to exceed the reference average per unit FOB price published in international commodity markets, as applicable on the date of loading. The closing date of the loan would be June 30, 1994. 4.06 In December 1991, a Bank mission reviewed procurement procedures related to the Bank's adjustment operations in Argentina. It concluded that the public sector, Government Agencies, Autonomous Entities, and large private frins follow competitive procurement practices fully acceptable to the Bank However, small and medium sized firms with limited international exposure do not normally follow acceptable procurement procedures. 4.07 Therefore, imports of the Ministries, public enterprises, and private importers of US$5 million equivalent or above would be procured through simplified ICB procedures in accordance with Bank guidelines. This threshold would be consistent with the anticipated sizes of contracts and the experience of the borrower with Bank procedures. Procurement for contracts below this threshold will be as follows: (a) public sector contracts below US$5 million equivalent may be carried out according to the standard procedures of the purchasing institutions; and (b) private sector contracts below US$5 million equivalent may follow established commercial practices acceptable to the Bank and require a minimum-price quotation by eligible suppliers from at least two countries Direct contracting is appropriate only under the conditions specified in the Bank Group's procurement guidelines. 4.08 Accounting and Auditing: The Ministry of Economy would be responsible for maintaining loan accounts, and for preparing and submitting withdrawal applications. Disbursements from the proposed loan would be made on the basis of a summary from the Ministry of Economy detailing individual import transactions in each relevant period, together with a certificate of payment of the amount involved and of eligibility under the loan. Applications for withdrawals will be consolidated and submitted in amounts not less than US$1 million. Contracts valued at above US$5 million equivalent would be disbursed against full documentation; disbursements would be made against statements of expenditures for contracts below that sum. The Ministry of Economy will maintain separate accounts to record and monitar loan disbursements and repayments. All records and accounts will be audited in accordance with generally accepted auditing standards and submitted within six months following the end of the financial year.  -19 D. Loan Condltions 4.09 The proposed loan is conditioned on three sets of actions: (a) satisfactory economic environment, both of macroeconomic performance and key sectoral economic conditions; (b) privatization of the steel sector, and (c) privatization of all industrial civilian-related PEs. The policy matrix in Annex IX provides the specific, proposed conditions. The three major sets of loan conditions are: (i) Satisfactory Economic Environment. First, the Government would maintain satisfactory macroeconomic performance and a public expenditure program consistent with the IMs EFF and the detailed Letter of Development Policy (Annex X). A series of important sectoral conditions, which also support the goals of the EFF program, were or are supported in the undisbursed tranches of the Provincial Loan, PSRL, PERAL I, and the proposed Financial Sector and Provincial SECALs. The proceeds of asset sales will be used to reduce debt (extemal and internal) or for labor indemnification rather than spent on recurrent costs. Secondly, there are some key sectoral economic conditions that must be met if the privatization process and private sector development is to succeed. First, the current competition policy of Argentina was limited in its enforcement capabilities and scope. The law does not sufficiently address issues related to market conduct and structure. To further strengthen the competitive policy environment, the authorities retained a team of intemational consultants who drew up revised anti-trust legislation which will be forwarded to Congress for approvaL Moreover, another way to ensure keen competition is to retain an open trade account, particularly for such homogeneous products as steel and petrochemicals. It was agreed with the authorities that the low maximum tariffs would not be increased and that no new QRs will be issupd, particularly on steel and petrochemical products. The MERCOSUR (Argentina, Brazil, Paraguay, and Uruguay) agreement is being implemented. Already two regional tariff cuts have occurred, and free regional trade is expected to occur by January 1995. The authorities have reiterated their intention to move towards free regional trade in the Letter of Development Policy. In addition, the generous fiscal incentives given to existing steel producers must also be reduced if new purchasers are to be attracted to these sectors. Ihis latter issue is also being addressed in the PSRL under the Industrial Promotion Control Program. The Government has already issued a Decree No. 27.513 which outlined the elimination of the fiscal incentive program. (i) PrIvatization of the Steel Sector. The steel sector is treated separately because of its importance in the Defense portfolio. All three PEs in the steel sector have been or will be privatized or closed. The Government has already issued a deregulation decree liberalizing barriers to entry and reducing non-tariff restrictions and has undertaken major steps in rationalizing SOMISA (halved the workforce, curtailed the production of loss-making product lines, placed auxiliary unproductive assets for sale, and overcome strong resistance from unions, suppliers, and purchasers). The Government, with the assistance of IFC, has sold AHZ and closed HIPASAM In the case of SOMISA, the authorities issued the sales memorandum incorporating the  -20 - principles of competitive strategy consistent with its obligations under the MERCOSUR treaty. (l) Privatiatloon of all other PEs and the Conversion of Defene-related Activities ito Civllian Use within the Defense Complex. To date, six PEs have been sold and a number of others are in the final stage of privatization. In the case of three PEs- Carboquimica, Foria, and FM Tolueno-bids submitted by private investors are being evaluated. In at least four of the PEs-TAMSE, ECA, FM San Francisco, and FM San Martin-their conversion from military to civflian use have been completed and sales memoranda have been issued. -he most important PE in terms of industial structure is PBB. Therefore, its sales memorandum has been prepared so as to incorporate the principles of competitive strategy consistent with Argentine obligations under the MERCOSUJR treaty. Fmally, PGM's sales memorandum has also been issued. 4.10 The conditions for second tranche release are: (a) continued maintenance of the 3- year macroeconomic program-including fiscal targets, open trade policies, and use of privatization sales proceeds--and compliance with the budget; (b) forward satisfactory 'competition" legislation to Congress for consideration; (c) issuance of tax credits to steel producers after accounts have been audited by DGI; (d) commence work on environmental clean-up of selected closed PEs; (e) sale/disposal of SOMISA's assets; (f) the sale of PGM and PBB; and (g) the sale/closure of at least 10 other PEs. E. Environmental Aspects. 4.11 A number of PEs within the Defense Complex have caused adverse environmental effects. New legislation and enforcement mandating better environmental standards are pending, possibly making the PEs financially less attractive to potential private investors. The Ministry of Defense in conjunction with the newly appointed Secretary of the Environment would undertake environmental audits of most PEs to be sold. The financial advisors and technical consultants for each of the selected PEs to be sold would identify, as part of their work plan, the PEs' environmental performance relative to the required environmental standards of Argentina. These environmental clauses would be incorporated into the sales memorandum requiring the new owners to follow a program to address the environmental deficiencies. Furthermore, the Ministry of Defense has decided to commit US$10 million from the counterpart of PERAL II for the environmental cleanup of closed facilities (i.e., METEOR and HIPASAM). F. Social Implications. 4.12 The gains of the program will accrue to taxpayers and consumers; the costs will be mostly borne by fired workers. Most of the labor declared redundant within the productive PEs of the Defense Complex is skilled and could be absorbed by the private sector. In spite of the large number of labor redundancies associated with the public sector reform program, the unemployment rate in the Metropolitan Area of Buenos Aires has decreased from 8.8 percent in May 1990 to the 6 percent range in 1991, and was 6.6 percent in May 1992, as economic activity recovered. A new employment law (No. 24,013), passed in November 1991, was designed to assist the unemployed. Nevertheless, where PEs are located in provinces with a low level of economic activity, or where the  - 21 - PEs are the major employer, the social adjustment process could be severe. Severance payments are part of the agreed program and would provide a transition period until workers find new jobs. A study of the impact of the Reform Program of the Public Sector (including PEs) on the labor market- -particularly in Patagonia and Jujuy, where relatively large PEs were closed with limited employment options--is scheduled to start in March 1993 under funding from PEREL. Tle authorities hope this study will provide them with data that can be used to ameliorate these specific problems and thus dampen any negative social effect of the reform program. G. Benefits and Risks. 4.13 The proposed loan would provide two major benefits for the economy: (a) improvements in public finances resulting from labor reductions and the elimination of past subsidies to PEs; and (b) growth in industrial activity stemming from increased and more efficient private sector output and investment under a competitive business environment To ensure the private sector takes advantage of this expanded scope and that some fiscal savings are transferred to meet key social sector needs, the authorities plan to keep defense outlays at the currently low share of GDP. 4.14 Potential gains from the Defense Ministry's reform program cannot be precisely quantified. Many of the companies lack appropriate accounting procedures and past price cross- subsidies were not transparent or properly recorded. The sale of these PEs could possibly generate an average of only 20-30 percent of original book value, amounting to about US$1-1.5 billion. After the settlement of PE liabilities, net cash realized would be small, especially if debt reduction is included in the deals. Worker indemnities alone are expected to equal almost US$300 million. Major benefits to the fiscal budget are expected to be realized by ending Defense PEs' losses, which amounted to about US$480 million in 1991. Furthermore, additional savings would be realized by the elimination of indirect subsidies to the private sector in the form of inputs (estimated at US$200 million for non-flat steel products and ethylene alone), increased tax revenues from the expanded private sector, and reductions in debt payments. 4.15 However, there are three types of risks associated with the delivery of the program. First, in the short term, there are the macroeconomic risks described in paras. 1.21-1.26. In addition, there are political risks that could slow the pace of the reform program. Second senior management changes have occasionally undermined the program. Further changes could jedpardize the timetable or even the program itself Iibird due to the continued perception of a high level of country risk and the poor operating status of some PEs, there might be limited interest by the international private investors in some of these PEs. However, proceeding with the proposed program and PERAL II is vital, as it offers the Government its first real opportunity to tackle groups of PEs that have been a major cause for Argentina's industrial deficiencies in the past. The Government may find it difficult to continue with the proposed reforms without timely Bank support; it would lack the implicit certification of the transparency and objectivity of the reform process. The risk of proceeding at this time is counterbalanced by the Government's continued courageous commitment to the reforms.  -22 - PART V. COUNTRY ASSISTANCE STRATEGY AND OPERATIONS A Main Objectves and IBRD Lending Program 5.01 Argentina joined the Bank in 1956, but was not a major borrower for many years. Of the US$5A billion committed to date (net of cancellations), some 80 percent was committed between FY81 and FY90, particularly in the latter half of the period. Bank involvement intensified beginning in 1986, when the Government requested sectora} adjustment loans for reforms in agriculture, trade and finance, and technical assistance loans (TALs) for rebuilding economic management capacity, in addition to the ongoing investment loan program. Successive failed stabilization programs helped to clarify the kinds of structural reforms needed, and through economic and sector work (ESW) and other support through 1988, the Bank helped the Government articulate such a medium-term reform agenda. During the hyperinflation crises, considerable resources were devoted to ESW, supervision, and development of proposed operations, using these activities as vehicles for intensive policy dialogue in lieu of new lending. 5.02 The Bank's main country assistance objective since 1989 has been to improve public finances so as to eliminate the persistent structural deficit that has caused economic instability, slow growth and increased poverty over the last decade. The emphasis is on public sector adjustment, supplemented by investment and technical assistance loans, is based on extensive ESW in public finances and a strong dialogue on macroeconomic policy. Major loans have supported reforms in both the Federal Government and public enterprises (see paras. 1.04 and 1.05). 5.03 Portfolio Perfomance. The implementation of investment and technical assistance loans approved prior to 1989, has suffered from macroeconomic instability, counterpart funding constraints, and changes in policy orientation when the present government came to office. Also, the Government's implementation capacity was limited because of poor management. As the economy has stabilized, these difficulties hav lessened. The Government has improved its savings mobilization, relieving the constraintr en counterpart funding. Second, it has steadily improved its investment programm hing trough preparation of an investment program tightly linked to the budget. Third, though the civil service reform and associated salary increases, management in the public sector has been gradually improved, though much remains to be done. Improved performance can be seen in agricultural sector operations, in technical assistance for gas utilization, power engineering, public enterprise, tax administration, the social sectors, as well as in the municipal and provincial development projects. B. Medium-Term Assistnce Objectives (FY93-97) 5.04 The Government should be able to consolidate fiscal stability within the next two years and begin moving toward restoring public functions critical for the sustained growth of the private sector and for social development. Effective Bank support therefore requires some shift in medium- term assistance objectives and strategy. The Bank would continue to support the strengthening of macroeconomic management and the completion of the reform program, focusing on fiscal stability, modernization of the state and further market deregulation. At the same time, the emphasis would increasingly be on three additional objectives: the improvement of savings mobilization and intermediation; the restoration and development of public productive services and physical  -23 - infrastructure; and the improvement of basic social services for the poor and natural resource management. The latter two objectives would be carried out primarily throxugh operations at the provincial leveL The entire lending program would remain contingent on satisfactory macroeconomic performance during FY93-97, since any renewed fiscal disorder would make it difficult to realize objectives of any loans. 5.05 Assuming strong macroeconomic and policy performance, Bank lending to Argentina over the next five years would be on the order of about US$5.0 billion. Half of the FY93-94 program would be devoted to adjustment lending, whereas investment and social sector operations would account for all of the FY95-97 program. 5.06 Completion of the Reform Promgam. Adjustment Loans would focus on new and complex areas, such as the divestiture of defense-related public enterprises, financial sector adjustment, and provincial finance reform, as well as debt reduction. The Public Enterprise Reform Adjustment Loan I, would extend the production program to all public enterprises within the defense complex-a total of 45 enterprises in steel, petrochemicals, shipyards, and various industrial and defense-related activities. The proposed Financial Sector Adjustment Loan would support, inter alia reduction of public sector involvement in banking (through privatization, closures, and bank restructuring), and the promotion of competitive and efficient financial intermediation (improved credit eligibility, supervision, etc.). Finally, a proposed provincial adjustment loan would support fiscal and structural reforms at the provincial level in tax collection, reductions in staffing, privatization of provincial enterprises, and reduction of current expenditures. 5.07 Resource Mobilization and Intermediation. Decades of high inflation have left Argentina with a shrunken cap tal market and a banking sector geared to financing the public sector. Bank lending for financial inte., nediation, discontinued because of high inflation, would resume with a focus on banking sector reform, capital market development and improving access of small farmers and newly privatized infrastructure suppliers. Proposed financial sector loans would support capital market development and the restoration of lending with longer maturities. The program would include cooperation with the IFC in the development of capital market institutions. Since the needs for private investment financing are likely to be much greater, particularly until Argentina's access to international capital markets is fully restored, the program may also include additional support for credit lines and to improve farmers access to commercial banks. Newly-privatized infrastructure firms may also need assistance, with guarantees of non-commercial risks, consistent with the ECO policy paper, to enhance their access to intemational capital. 5.08 Public Productive Semces and Infrastructure. The deterioration of public services has led to a loss of competitiveness by local producers. Two operations (for agricultural and industrial services respectively) are planned to help restore the supply of research, quality control, vocational training, and other services with information externalities. A group of six loans would help the provinces cope with their extended responsibilities for infrastructure in the aftermath of public sector reform. In the roads sector, where the establishment of competent planning agencies is important, as is increased expenditure on road maintenance, a proposed road maintenance project is scheduled for FY94. 5.09 Social Services and Environment. Education and Health services and social assistance to vulnerable groups have siffered from the austerity measures of the 1980s and from the general decline in the quality and efficiency of p blic sector management. The neglect of basic health  - 24 - services and the lack of social assistance targeting have resulted in higher maternal and infant mortality and in malnutrition, particularly in the poverty belts surrounding the cities of Buenos Aires and Rosario and in the less developed northern provinces. The ongoing Social Sector TA loan has helped the Government develop coherent strategies for education, health and social assistance, and would provide the analytic base for the Bank's first forays into the social sector in Argentina. Beginning in FY94, lending would help the provinces provide better health and nutrition assistance to mothers and children, followed by support for secondary education. 5.10 As the economic crisis recedes, the Government is becoming more aware of the adverse long-term environmental impact of existing patterns of natural resource use and industrial and urban waste disposaL Soil erosion, water pollution and the degradation of forests and other ecosystems are already constraining development and creating health hazards. Projects in the pipeline include activities in soil conservation, forest and water management and urban waste. Future ESW would focus on areas to support the Government in developing a legal framework that would allow for effective regulation and market-based solutions. 5.11 Povertv Alleviation. The post-adjustment phase in Argentina, with more emphasis on investment lending and the decentralization of most public services to the provinces, will place greater demands on the implementation capacity of the government and on Bank resources. Experience workdng with the provinces under ongoing projects suggests that many provinces do not have the required capacity and need substantial institutional strengthening. This puts a premium on designing projects with focussed objectives and activities, as opposed to complex nationwide programs involving all the provinces. Even then, however, limited implementation capacity outside the main urban areas will require greater supervision intensity on the part of the Bank. 5.12 Various of the activities described above would help to address important dimensions of poverty in Argentina. Increased price stability would reduce the fluctuations of real wage and pension income, against which poor households are unable to hedge. Private sector development would expand employment opportunities in the formal sector and, in the medium term, increase real wages. Several operations would specificaly contribute to poverty alleviation; a poverty study is expected to increase the effectiveness of our assistance in this regard; the maternal and child health project would target vulnerable groups in the urban poverty belts and the underdeveloped northern provinces; the restoration of basic health services and improved access to secondary education would improve living conditions for the poor, as would better environmental management, water supply, and municipal services in the urban poverty belts. 5.13 Cooperation with Other Multilateral Institutions. The Bank has worked closely with both the IMF and IDB in the design and execution of adjustment operations, in formulating the lending strategy, and in economic and sector work. For example, since 1989, Bank and Fund staff have exchanged information and views in the preparation of major public sector reform operations being undertaken by the Bank. There has also been extensive consultation with the IDB, which has co-financed a number of projects, including adjustment operations. C IFC and MIGA Activities 5.14 IFCs investment strategy in Argentina is to support export-oriented investments and privatization within the limits of its current exposure. IFC would seek mechanisms to mitigate the country and payment risk (e.g. outside guarantees, external escrow accounts). Furthermore, under  v25 - the present conditions, IFC would only finance those projects with strong export orientation. In addition, IFC would support privatization or restructuring projects through fee-based advisory services and foreign resource mobilization. To serve this objective, IFC is participating in the management of a privatization fund and is considering the establishment of an underwriting fund to facilitate the placement of equity and debt, as well as helping to setup brokerage houses, venture capital funds and bond rating agencies. IFC has made 42 investments in Argentina, totaling US$746.4 million, of which US$324.1 million has been repaid, canceled or sold. In FY92, there were investments in chemicals, capital markets, energy, slaughtering, railroads, food and agribusiness, and malt production. MIGA has also been very active in Argentina. Including projects in the pipeline, most of the countrys allotment of $US150 million has already been committed to operations in banking and in pulp and paper. D. Recommendations 5.15 I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and would be consistent with the approved guidelines for Bank support. The recommendations for the inclusion and release of the debt set-aside amounting to US$100 million in this proposed loan has been recommended in the President's report No. P-5914-AR dated December 10, 1992 on Debt and Debt Service Reduction Loan. Lewis T. Preston President Attachments December 10, 1992 washington, D.C.  AINNEXI 0 (Is pewesA t3Ne NAb.,e paS log0 1;91 1993 1993 1994 199S it9" 199 1998 1999 2000 GO gwou:ht 0.4 4.5 C.S 3.0 4.0 4.1 4.1 4.3 4.3 4.3 4.4 iowinb .8 par qapitt phivle consumption (1.3) 5.5 9.8 (1.8) 0.8 1.7 1.7 1.7 1.8 1.7 1.6 GOP (PS$ blJ.ie) 105.$ 135.4 153.2 148.4 18S2. 194.9 211.9 122.8 :47.0 268.9 288.8 2 Ibars, of ca11 Total Iav.est6et 8..s 12.3 14.0 15.5 18.0 18.5 17.0 17.5 1I. 18.S 19.0 private S4~~~~5. 10.9 13.4 13.5 14.3 14.7 1.3.1 15.3 15.8 14.2 18. PUblid 1.9 1.4 1.8 3.0 .. 1.7 1.4 1.9 2.0 3.2 2.3 2.5 nagtion" Sav5agt 10.0 10.4 9. U13. 13.1 13.7 14.2 14.9 Is.? 18.4 17.2 Iwivate 12.0 11.3 6.3 9.6 11.9 13.4 U2.? 13.1 13.4 13.7 14.1 Public (3.0) (0.9) 1.4 2.3 1.3 1.2 1.5 1.6 3.3 2.6 3.1 P.we4a Saviage (1.8) 2.1 4.4 3.3 2.9 2.6 3.8 2.8 3.3 2.1 1.8 lOOP (1*4.4d) 21.3 1.4 1.9 4.7 3.9 3.9 4.0 4.0 4.2 4.3 4.3 Public Seotow (.aS% basis as 2 .8 utw.m GOP) I Total OUwweot Seww..u. 13.0 14.1 17. 18.1 18.4 46.4 1MS 38.3 18.4 18.4 16.3 Total cunawetwKeudituree a1 15.9 13.2 14.1 15.3 13.5 1U.$ 15.7 13.6 15.3 13.1 14.9 Znutowet KzPeadtuwea 5.2 3.4 1.8 2.0 3.4 2.4 2.4 2.4 3.3 2.0 1.8 SocIa Security Swoa(0.3) (0.1) 0.3 (0.6) (1.4) (1.5) (1.3) (1.1) (0.6) (0.) (o.4) 06 fto.tateweeaStyl 1.2 0.3 0.3 0.5 (0.0) (0.0) (0.0) (0.0) (0.0) (0.0) (0.0) Pubict Swvics (M.0 (0.9) 1.4 .3. 1.3 1.2 1.5 1.6 2.3 2.6 3.1 Capital. *w*maes 0.8 1.3 1.3 0.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Capital Zzpedtftuwe 1.9 1.8 1.4 2.0 1.7 1.6 1.9 2.0 3.2 2.3 2.5 S.Smotalal Public $ector (3.3) (C.A) 1.1 0.6 (0.4) (0.8) (0.4) (0.3) 0.1 0.4 0.8 q4et-tL4ati, Stnep. 0.0 0.0 (0.03) 0.1 0.2 0.2 0.3 0.3 0.3 0.4 0.4 overall Saleft. (3.3) (1.3) 1.1 0.9 (0.3) (0.3) (0.1) 0.0 0.4 0.6. 1.0 Meeot uiu.qmc Surplia. 1.9 2.1 2.9 3.6 2.0 4.9 2.0 3.1 3.3 2.4 2.4 primary SugplUs (U9$ .1111.) 3.013 2.857 4.389 4.753 3.488 3.487 4.124 4.854 5.552 4.509 8.954 opwAttiemal fctmar~ Suap3.a (US$ million) 1.379 1.231 2.413 4.403 3.846 3.687 4.394 4,864 5.512 4.509t ' .954 ZaOtewst zxp.o8itUv. (VS$ .4131.) 5,498 4.850 2.645 3.425 4.385 4,750 5.133 5.482 5.376 5.315, 5.301 pwtmaxq "usplaa Cvrso g.ats. hi 34.4 d1.4 163.5 138.8 68.0 74.7 43.9 68.4 103.3 W2.5 133.7 Sae. of Payments$ ampong GM1 (we Sa n%rou we:.) 18.1 2.2 1.7 6.3 9.2 8.4 4.7 4.7 4.8 8.6 C.S Eaports of GMIC/OMMc GOP 14.1 11. 10.2 10.3 t0.? 10.9 1U. 11.4 Lt.? 13.0 12.3 Zmpowte GM1 (weal, poth rae.) (2.8) 85.7 43.3 1.3 3.3 4.8 4.? 4.4 4.8 4.6 4.9 Zmpowt. at 05Ysic.awweZ GOP 8.? S.? -11.5 11. 10,? 10.7 10.8 10.8 10.9 10.9 11.0 Trade SLalem (05$ mllS..) 6,151 4.007 (1.139) (384) 576 981 1.422 1.923 2.311 3.179 3.938 Cuwwemt Ae.0mm: lal... (05 .11L