Transcript of meeting of the Executive Directors of the IBRD and IDA, held on Tuesday, January 5, 1993

nm STRICTLY CONFIDENTIAL 1 NM/AH INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION Tuesday, January 5, 1993 Washington, D.C. The meeting of the Executive Directors was convened at 10:05 a.m. in the Board Room, 1818 H Street, N.W., Washington, D.C., Mr. Ernest Stern, Chairman, presiding. MILLER REPORTING CO., INC. 50·1 C Street, N.E. Washington, D.C. 20002 ( 20 2) 546-6666  STRICTL CONFIDENTIAL ah 181 MR. STERN: Okay. Let us turn to the Argentine operations, and we'll take the Debt and Debt Reduction operation and the Public Enterprise Reform operation together. Mr. Meo, do you want to start us off? MR. MEO: Thank you, Mr. Chairman, ladies and ·- . gentlemen of the Board . The loans before you are part of the Bank's support for both Argentina's very ambitious reform program and the recent deal signed by Argentina and its commercial creditors. About 98 percent of the eligible debt has already been committed. Full participation is expected by the closing date, April the 7th. We hope to present a Financial Sector Adjustment Loan next month that would include a final set-aside for the deal, and use that occasion to discuss in far more depth the Bank's strategy with Argentina. On this occasion, we thought - you would wish to learn more about the program and the debt MILLER REPORTING CO., INC. :icr; C Street, N.E. Washington, D.C. 20002 (202) :!46-6666 STRICTLY CONFIDENTIAL 182 deal we hope you will support. The details of Argentina's program are in the President's Reports before you. So far, ·the economy has I: responded quite strongly to these reforms. Growth during the ,, past few years has averaged about 7.5 percent. Investment and savings rose even faster. While slower growth is expected in the immediate future as Argentine prices return to more competitive levels, we believe the country has a good chance now to return to a sustained growth potential not seen since the 1950s. The Bank has supported these reforms quite strongly, first through economic and sector work and technical assis- tance and then, in 1991, with a pair of sector adjustment ·1 loans. Both of them are doing well. The second tranche of 11 the Public Enterprise Reform Adjustment Loan was disbursed in I' I December, and the last tranche will probably be disbursed 11 next month. The Second Public Enterprise Reform Loan for US$300 million will support the privatization or closure of 24 productive enterprises within the defense complex. This is an area that clearly needed reform but that had been beyond the reach of higher previous governments. Running these companies cost the Argentine Treasury almost $500 million J,. INC.  STRICTLY CONFIDENTIAL 183 ah annually. However 1 the benefits of privatization extend far beyond the relief from massive annual subsidies. The sales of these enterprises, together with an end to other market restrictions, will permit entry into these areas and make industrial performance far more competitive. The proposed Debt and Debt Service Reduction Loan for US$450 million will support the debt agreement reached between Argentina and its commercial bank creditors. The agreement, which will halve debt service obligations to commercial banks in the next few years, has terms very comparable to the Mexican debt deal. The Argentine deal is unique, however, in its emphasis on par bonds--about 65 percent of the commercial debt, excluding arrears--and the relatively large amount of arrears. Because of these arrears, Argentina's cash require- ments for debt service will also increase. The good progress of its program, the strong fiscal effort under way, and the benefits of reentry into the financial community indicate this unique situation is both sustainable and beneficial to Argentina. To conclude the deal, Argentina must provide an estimated US$3.9 billion in enhancements 1 more than three- quarters of it provided by the World Bank, the IMF, IDB, and MILLER REPORTING CO., INC. 50"i C Street, N.E. Washington, D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 184 ah the Export-Import Bank of Japan. Indeed, the IMF EDS 1 approved only a few days ago the second year s program of an ongoing EFF. Via the proposed loan, the Bank would provide $450 million to finance interest and principal collateral for par bonds; it would also provide set-asides of $100 million from the PERAL II and up to $200 million from the proposed Financial Sector Adjustment Loan. Our emphasis after this year will move to improving financial markets, since the newly expanded private sector in Argentina will have an awesome need for capital, and to enhancing the quality of resources Argentina has ignored for some time--its human resources. Neither task will be easy. Much of Argentina's infrastructure is now in private hands, and the Bank may find it hard to support its expansion. Education and health are now the responsibilities of very weakened provincial governments. We hope to discuss these issues with you in February as well as our approaches to these challenges. Thank you. MR. STERN: Thank you, Mr. Meo. Mr. Kodera? MR. KODERA: Thank you, Mr. Chairman. First of all, I would like to congratulate the MILLER REPORTING CO., INC. 50i C Street, N .E. Washington, D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 185 ah Government of Argentina for the successful arrangement of the debt reduction package, which will restructure about half of the Argentina public and public guaranteed external debt. In a sense, it is long overdue, since my Government formulated the Ex-Im parallel lending package in quick response to the Brady Plan four years ago. As stated in the paper, the Ex-Im Bank of Japan is prepared to extend cofinanc ing up to US$800 million in aggregate with the proposed two loans and the upcoming Financial Sector Adjustment Loan as well as the Fund's extended arrangement and IDB's Investment Sector Loan. The successful arrangement of the debt reduction package is based on the remarkable economic recovery as evidenced by the high level of the GDP growth rate, the sharp decline in inflation, and the primary surplus over 3.5 percent of GDP. Here, I would like to stress that the compliance with all the performance criteria with the Fund's EFF is the crucial factor in regaining the market confidence in the Government's economic promise. For now, I will limit myself to comments on the Second Public Enterprise Reform Loan. I welcome the com- prehensive and ambitious privatization plan carried out under the leadership of President Menem, and the operations planned MILLER REPORTING CO., INC. 50·; C Street, N.E. Washington, D.C. 20002 (202) 546·6666  STRICTLY CONFIDENTIAL 186 ah under PERAL II are especially welcome because they are aimed at full privatization of the public enterprise within the defense complex, which has been providing key products such as steel and petrochemicals. I also welcome the Government's strategy to reduce military expenditures in the long run so that increments can be passed on to the civilian population, especially the social sectors. This will allow the Government's budget to be allocated to proper objectives which are truly in need of it and which will also improve the credibility of the Government's fiscal program. I am also glad to know that the environmental aspects accompanying sales and closure of the public enterpr- ise are also going to be taken care of through environmental audits. To make sure that the necessary environmental cleanu will actually be pursued, I would like to stress the impor- tance of the systematic monitoring by the Government. Having said this, all in all I think the privatiza- tion trend in Argentina is moving in a positive direction. However, I would like to send a signal of caution on the privatization. For instance, last July, the Government repurchased a once privatized airline company stock. This not only cost MILLER REPORTING CO., INC. 50', C Street, N .E. Washington, D.C. 20002 ( 202) 546-6666  STRICTLY CONFIDENTIAL 187 ah a lot for the Government Treasury, but also gives some sort of impression that the Government may come back to the once privatized company. Also, we have some concern with respect to the privatization of SOMISA, the largest steel mill in Argentina. I fear that the sale of stock to the largest private steel mill in the country might lead to an emergence of a monopoly in this particular industry. So it may be necessary to lay down in the future some sort of rule of thumb to ensure that a competitive market environment will be maintained when an enterprise with large market share is to be privatized. I have two more questions. This has nothing to do with the privatization issue, but on the import tariff. Last October, the Government decision was made to raise import tariffs. This is referred to in Section 1.12 of the debt reduction paper. I am afraid that this might contradict its policy to deregulate and open up the economy, and I would like to hear the staff's views on this point. Lastly, coming back to the privatization, the rationalization measures sought under the programs are focused mainly on the rationalization of the labor force. In order to assure competitiveness of the privatized company, it MILLER REPORTING CO., INC. 5ffi C Street, N.E. Washington, D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 188 ah would also be important to improve the efficiency of the facilities as well as the updating of the obsolete tech- nologies. So I would appreciate further elaboration on the proposed measures to be taken in this respect. Lastly, I am very much looking forward to discussin the next Financial Sector Adjustment Loan as soon as possible. Thank you, Mr. Chairman. MR. STERN: Thank you, Mr. Kodera. Mr. Potter? MR. POTTER: Thank you. I will deal just with the Debt and Debt Service Reduction Loan, not because I don't welcome the Enterprise Reform Loan--I do--but it seems to me to be a good piece of work to which I have nothing to add. Turning to the DDSR transaction, let me start by saying that I think this is a particularly well-prepared piece of work, and there are three things that I like about it which I hope we will see henceforth in transactions of this kind. The first is the inclusion of a cash flow analysis, and in this case, one which demonstrates a break-even in an attractively short period of time. The second thing which I liked, which I hope we MILLER REPORTING CO., INC. 50'1 C Street, N .E. Washington, D.C. 20002 ( 202) 546-6666  STRICTLY CONFIDENTIAL 189 ah will see regularly henceforth, is information on domestic as well as external debt. That gives rise to a question which maybe Paul Meo might like to talk about at some point, and that is in cases in which domestic debt is rising sharply, clearly, it gives rise to the question of the effectiveness of the DDSR assumptions. I wonder if you might elaborate a bit on those. The third compliment which I would like to shower on Mr. Meo is the fact that he and his colleagues have included information on the unreschedulable, the inflexibilit factor, if you like, of the remaining stock of debt, which I think is useful stuff to show. But again this gives rise to a question which I would like him to maybe talk about a little, and that is as the ratio of unreschedulable debt rises, you have to think about what then becomes an adequate level of international reserves, and you might be prepared to talk about that a little. Now, moving away from compliments, I was surprised to see that there was not a new money option. When I had a chance to talk to Mr. Meo last night, though, he explained in what I thought was a pretty good fashion why there isn't; I now understand why there isn't, but I think it is fair to say that the "why" is not as well set out in the document as it MILLER REPORTING CO., INC. 50-i C Street, N.E. Washington, D.C. 20002 ( 202) 546-6666  STRICTLY CONFIDENTIAL 190 ah was in our meeting last night. I think the argument in the document, frankly, is a bit baffling. That got us into the subject of free riders, but I am told now that in fact there are very few left, that something like 98 percent of the debt is going to participate. The reason that he and I got together last night was because I was going to roll out the heavy artillery on the subject of the country assistance strategy, because there is something in here--in both documents, as we know--that is labelled "country assistance strategy," but it is not a country assistance strategy. And I won't dwell on it because we are going to see that when we look at the next loan in a month or so, and I won't dwell on its breathtaking brevity. I will only ask that we pay assiduous attention to Operationa Directive 211 and that when we see this country assistance strategy in February or March that we really try to set a standard that lives up to the other qualities of this document. By that, I have in mind particularly some intrinsi weakness in country assistance strategies that we still have not dealt with satisfactorily, in my opinion, and I would include a discussion of the external environment, key policy issues for Board consideration, and finally, my favorite--the criteria by which progress is to be judged, that nettlesome MILLER REPORTING CO., INC. 50', C Street, N,E. Washington, D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 191 ah category which we all like to duck but which I hope you will address squarely next time around. Another thing that I noticed was that there wasn't any mention of a couple of adjustment loans which showed up in the recently quarterly report where tranche releases had been delayed. You mentioned one that is, I think, since back on track, but unless I have misunderstood, there is still a policy-based loan in which there is a tranche release outstanding, and if there is an adjustment loan in that category, I think clearly it deserves to be talked about. I think I will leave it at that, Chairman, but rather than end on a negative note, I want to say again that I really do appreciate some of the ground that this document has broken and hope that when we see the country assistance strategy in a month that it will be a partner to it. Thank you. MR. STERN: Thank you, Mr. Potter. Mr. Coady? MR. COADY: Mr. Chairman, to continue the love fest, I would like to congratulate the country and the Bank staff for the substance and quality of the work and achieve- ments in making themselves available for questions prior to today's Board meeting, and I certainly join Mr. Kodera and MILLER REPORTING CO., INC. 50'1 C Street, N .E. Washington, D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 192 ah Mr. Potter in their comments. We first of all like the degree of cooperation, at least as we see it, among the IMF and the Inter-American Development Bank, in pulling all this together. And, corning up on the fourth anniversary of the Brady Plan, it is nice to see Argentina come to some kind of conclusion here with savings to the country and, in terms of collateralization, putting aside debt outside the obligations to the Argen- tineans. On the Public Enterprise Reform Loan, this has been preceded in 1991 by a similar operation which focused on telecommunications, energy and railway, and it seems like progress has been very good under this. The second tranche has been released, and I understand the third tranche is likely to be released in a timely fashion. The loan today focuses on 24 of 45 public enterpri- ses in the defense portfolio and the rationalization of these enterprises, remarkably, without new investment. It appears that the Argentines understand that these companies must be viable in order to attract private sector investment. We like that there is this demonstrated commitment to a defense privatization process. These measures include the rationalization and award of SOMISA, the sale of petro- MILLER REPORTING CO., INC. 5ff, C Street, N.E. Washington, D.C 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 193 ah chemical companies, and the conversion of other firms from military to civilian. In fact, it was quite striking to see the variety in the list of enterprises that were involved; it was quite interesting. But there are many risks inherent in this process, and we do support the conditionality for the second tranche release as it requires continuance of sound macroeconomic, environment, competition legislation and cleanup. And we like the idea of some $10 million of funds committed to cleanup. It is hard to judge whether that is more or less or enough, and we would be interested in any additional comments you could make today with regard to METEOR and HIPASAfL Argentina has the capacity to achieve the benefits in the loan, notably the fiscal improvement, but in order to achieve them, they must continue on the path of responsible economic management and well-managed defense privatization. We are confident that Argentina will do so. It seems to us Argentina is a success story in the privatization process for the Bank, and it would be very nice, without making too big of a deal of it, if on a very informal basis, those Board members who wanted to join in a discussion with Bank staff on it just to take stock of some of the lessons learned, or at least I would be interested in MILLER REPORTING CO., INC. 5ffi C Street, N.E. Washington, D.C, 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 194 ah that. We are trying to get out of the business of calling for complicated new papers, but it seems that there is some very interesting work done and achievements that have been made here. On the country assistance strategy as it is identified in the paper, obviously it is not in compliance with the traditional scope of what we are talking about, and we are looking forward to the Financial Sector Adjustment Loan. We are particularly interested in the capital market development, particularly encouraging the provision of term credit to small and medium enterprises. We would like to continue to urge that cooperation with the IFC is integral to this process and have continued to be--it would be very helpful if the IFC and the World Bank could spend a little more effort in describing how they are working together and what is going on. It seems to me in some cases there is not much of a story to tell, but in a case here where it is probably the largest part of IFC's portfolio historically and a major privatization process, and there is a lot going on, there is a story to tell, and it would be helpful if it were told with some flamboyance and credit, rather than having to be kind of dug out or not told. And there may be more opportunities for the IFC to have played a strong supporting MILLER REPORTING CO., INC. 50'1 C Street, N.E. Washington, D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 195 ah role. It is not really clear. IFC is active there, and there are some cases where they have created a fund--there are certainly some good parts to the story, but it seems like there is an opportunity for them to make a real contribution, and I'm just not clear whether they have or not. I guess this chair cannot be silent when the word ECO guarantees pops up, and we would just like to continue to be on record that we have misgivings about the program and wonder how this might play out in Argentina. On the other hand, we fully support the increased emphasis on poverty alleviation, including education and health, accompanied by decentralization of public services to the provinces, improved natural resource management. One other point in here--it seems that the energy sector is a particularly important sector and has been important within the management of the economy by the Argentines in the past. Anyway, I think the country assistance strategy could go deeper in this sector when we talk about it in the future. It has also been a sector the IFC has played a strong role in, so I think that when we get to the country assistance strategy, it would be very helpful if that particular sector had a deeper discussion than maybe some of the others. The difficult subjects of social security and labor MILLER REPORTING CO., INC. 5ffi C Street, N.E. Washington. D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 196 ah market reform, and commitment to a reform process per se, are obviously important, and we hope the Argentines can continue to work hard on this. My colleague at the Fund on December 30th particularly highlighted that area, and I noted in today's Financial Times there were various concerns expressed as to whether that program was weakening, so it is obviously important to keep that on track. To wind up, I did note that there were still a larg amount of although fairly recent loans in Argentina which have been approved but are undisbursed, leaving aside tranche release, and the IFC had a number of loans, some of them going back to 1991, which are unsigned or uncommitted. And picking up on the theme for the day, it might be interesting how you see the Argentine portfolio at this point in time, looking forward, and also looking forward with respect to the IDB and the IFC, how we can continue to work together. Thank you very much. MR. STERN: Thank you, Mr. Coady. Did you have in mind something more than is found in Annex 11? There are only two that are unsigned, Yacyreta and Flood Rehabilitation -unless that is wrong. Yacyreta signed already, so there is only one left. That doesn't sound too bad. MR. MEO: And that, we are signing this week. MILLEA REPORTING CO., INC. 50·1 C Street, N.E. Washington, D.C. 20002 ( 202) 546-6666  STRICTLY CONFIDENTIAL 197 ah MR. STERN: Okay. So that is cleaned up. Mr. Snoy? MR. SNOY: Let me offer a few remarks on four topics--the country strategy, the lessons of the past, the evaluation of the debt agreement, and restructuring and privatization of defense industries. On the first point, there is no doubt that over the last three years, Argentina has established an exceptional record of fiscal reforms, privatization, and deregulation of foreign trade and domestic markets. In response to this performance, I think the World Bank is right in emphasizing its country strategy on reduction, on anything that may contribute to the reduction of the fiscal deficit, the improvement of fiscal performance, and the attack on two of the main sources of the deficit in the past, namely, the drain of public enterprises on public finance and the excessive burden of the public external debt. At the same time, we are witnessing a revolution in the role of the World Bank and, of course, in the respective roles of the World Bank and the IFC. In this, I was inter- ested in the remarks of Mr. coady, and I think that the IFC is right to develop to the maximum its role in Argentina in whatever concerns the development of the private sector, MILLER REPORTING CO., INC. 507 C Street. N.E. Washington, D.C. 20002 (202) 546,6666  STRICTLY CONFIDENTIAL 198 ah privatization, and the increasing role that the private sector is even led to play in areas such as the development of infrastructure. So the World Bank should rightly concentrate besides this reduction of the fiscal deficit on enhancing the administrative capacities both at the federal and at the provincial levels for the crucial roles that have to be played by the authorities in social sectors, in poverty alleviation, as well as in areas such as research, quality control, vocational services, and other services with information externalities. Last but not least, substantial efforts will be needed to rebuild capital markets, resource mobilization and intermediation, which had been devastated by years of high inflation. In these areas, the Bank and IFC again have to cooperate, and special attention needs to be given to improving access to finance of small farmers, small and medium enterprises, and newly privatized infrastructure suppliers. The second point, let's keep in mind the lessons of the past. Of course, with those two operations, particularly the debt reduction operation, we are dealing with the legacy - of the past, particularly the high external debt. We, of MILLER REPORTING CO., INC. srr, C Street, N .E. Washington, D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 199 ah course, are delighted that the Brady deal could be worked out for Argentina, but we would have appreciated perhaps in those reports more retrospective considerations as to how this huge external debt burden was created--to what extent it was due to adverse external circumstances, and unfortunately in the case of Argentina, how much it was due to inadequate macro- economic and structural policies and inadequate debt manage- ment. In reading the report on debt reduction, I was struck by a figure which is given in paragraph 19, and I think it is repeated in the other paragraph, which suggests that Argentine residents are holding abroad between $50 and $60 billion of private savings. By the way, that figure is not very different from the size of the public external debt of Argentina. And of course, we have to keep in mind that as a result of inadequate macroeconomic policies and particularl inadequate exchange rate regimes in the past, a substantial part of the proceeds of public borrowings, public external borrowings, was used to finance domestic deficits and that the foreign exchange made available by these foreign loans was used by the same private residents to build up their private savings abroad. This is a paradox that we have to keep in mind and which should induce us to be very vigilant MILLER REPORTING CO., INC. 50'1 C Street, N .E. Washington, D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 200 ah on the structural causes of those past situations and to make sure that the World Bank and the IMF are in agreement on the macroeconomic stance and particularly on key matters such as the exchange rate regime, which for a long time has been one of the key weaknesses in economic management. On the debt agreement, I agree that Argentina should be considered to have satisfied all the conditions of Bank support for its debt and debt service reduction program, and I can also support the limited waiver of the negative pledge clause. This operation will help restructure about half of Argentina's public and publicly guaranteed external debt. It will be crucial for strengthening the political consensus on reforms and for maintaining domestic and external confidence in the sustainability of the adjustment program and of the fiscal and external balance. We can see that the debt reduction equivalent achieved for the commercial debt is the equivalent of 37 percent and for the debt as a whole about 15 percent, which is comparable to what has been done for Mexico, and I would like to commend the staf .f for the extremely interesting analysis which is provided in the report on all the aspects of this operation and all its impact, both on the financial prospects and the development prospects of the country. MILLER REPORTING CO., INC. 50·, C Street, N.E. Washington, O.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 201 ah However, we have to keep in mind that the exposure risk of the World Bank will increase and will be significant in case adverse events would lead again to debt servicing difficulties. Of course, debt service under the agreement is projected to be fiscally sustainable, but of course, that only if the reform program is sustained. I was somewhat surprised--but perhaps it is due to my lack of familiarity with those deals in the past--to find that in the case of the transitory difficulty, the interest collateral could be used to pay up to 12 months in interest on the discount bonds and the par bonds, and that under the terms of the agreement the Government would in such case not be obligated to replenish the interest collateral account. Of course, the more serious risk is that the economy remains vulnerable to shocks. Three categories of shocks are mentioned: a reversal in capital flows, insuffi- cient convergence of domestic to international prices and wages, and a speculative attack on the peso. We should make sure that the deepening of the structural reforms and the maintenance of flexibility in the amount and timing of public investment expenditures could create a cushion to protect the country and its creditors, in particular the World Bank, against such shocks. MILLER REPORTING CO., INC. )ff, C Stteet. N.E. Washington, D.C. 20002 (202) )46-6666  STRICTLY CONFIDENTIAL 202 ah Finally, Mr. Chairman, a few remarks on the restructuring and privatization of defense industries. I think this is a very interesting pioneering project. I was interested to see that it includes enterprises which are in the production of tanks, TAMSE; in the production of sub- marines, Domecq Garcia; and in the production even of marine frigates, AFNE. I think that if this project is a success, we could gain very interesting experience for the restructur- ing of the so-called military-industrial complex which is so important in Central and Eastern Europe, and I hope that perhaps similar operations could be worked out in those countries. I noted the particular problems with respect to the steel industry. The report is not very clear on the impact on the restructuring and privatization of the trade regime, particularly how well steel can be traded in the MERCOSUR system, and also what are exactly the issues surrounding the tax incentives--how big are those incentives? How transparen are they? Would they be consistent with the GATT rules in other terms? Will the restructuring and the privatization of the army's steel industry take place in an undistorted environment? Perhaps also we should look at what is the impact on this privatization of the steel industry of the MILLER REPORTING CO., INC. 5ffi C Street, N.E. Washington, D.C 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 203 ah appreciation of the peso and of the package of measures taken last November. Thank you for your attention. MR. STERN: Thank you. Mr. Costa? MR. COSTA: Thank you, Mr. Chairman. As has been pointed out in the paper before us, the implementation of the proposed Debt and Debt Service Reductio Loan requires that the Government of Argentina remain strongly committed to the stabilization program and structura reforms agreed upon with the international financial institu- tion. In the last years, Argentina has made an unprece- dented effort toward the macroeconomic stabilization and consolidation of structural reforms. The rigor imposed on th economy by the stabilization maneuver has been quite extreme. In this connection, the variables for the success of the economic plan are represented by a continuing social consen- sus, despite the hardship of the reforms, and by the recovery of productive investment. We are aware that the authorities, with the adoption of the Currency Board arrangement and the convertibility law of March 1991, were able to substantially lower inflation and, as a consequence, recovered confidence MILLER REPORTING CO., INC. 50'; C Street, N.E. Washington, D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 204 ah has allowed strong capital reflows that helped finance investment growth and advancement in the privatization efforts. However, in the second semester of 1992, the economic environment in Argentina experienced some problems which could slow down the implementation of the program-- namely, an inflation rate of around 18 percent on an annual basis in November, the over-valuation of the peso and the resulting trade deficit, the fall in the value of stock market of around 70 percent, and the reduction in consumer demand. It is also regrettable that the reform of the social security system to move it toward a self-funded basis has suffered a further delay, although we recognize that an agreement on such a matter needs to be achieved through the full consensus of all social and political parties. Concerning the monetary fears, the pace of capital inflows is predicted to decline following the completion of the privatization process and other internal and even external developments. The implementation of the NAFTA Agreement may be a case in point, for it will probably tend to shift large capital flows into other parts of the American continent. MILLEA REPORTING CO., INC. 5ffi C Street, N.E. Washington, D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 205 ah The financial instability in other major neighborin countries may indirectly also pose a threat to the continua- tion of massive capital inflows that Argentina has been experiencing. In spite of these recent less favorable develop- ments, we support the operation being discussed today. The agreement reached with the commercial banks regarding a ? for the debt reduction package ? the Government to resolve the country's ? We believe this agreement is a good deal for Argentina which deserves our support. The ambitious schedule for the debt and debt service restructuring contained in the arrangement is very comprehensive and cost-efficient. Nevertheless, as stated above, we are particularly concerned by the prospect for a diminished reliance on capital inflow on the eve of such an important agreement for Argentina, and we would appreciate staff's conunents on the effects of this development on the stability of the financial system in the country. Thank you. MR. STERN: Thank you, Mr. Costa. Mrs. Maury? MRS. MAURY [INTERPRETED FROM FRENCH]: Thank you, Mr. Chairman. MILLER REPORTING CO., INC. 5ff1 C Street, N.E. Washington, D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 206 ah I would like to make a few comments on macroeconomi issues, the external debt, and the privatization of part of the defense industry that we are looking at today. I should like to congratulate the staff for the very high quality of the macroeconomic developments which are contained in the report. On the Argentina situation, Argentina today enjoys confidence of the markets. Actual macroeconomic improvements have been recorded. Growth investments are on the increase. The budgetary situation has been strengthened and firmed up. Inflation was one-digit inflation at the end of 1991. Foreign exchange reserves have gone up thanks to inflow of capital on a large scale. Relationships with external creditors have been normalized. There is an agreement with the Paris Club for the reschedulin of deadlines out to March 1995, and a very high-quality agreement has been worked out with commercial banks. Finally, courageous decisions have been taken in the struc- tural field, liberalization of trade, modernization of the financial sector, and privatization. The trends and policies adopted must be pursued with great vigor. The key for strengthening the macroeconomi situation is in compliance with strict budgetary discipline, which entails an effort to mobilize receipts, but control MILLER REPORTING CO., INC. 50·1 C Street, N .E. Washington, D.C. 20002 ( 202) 546-6666  STRICTLY CONFIDENTIAL 207 ah salaries and pension plans. Monetary policy must be monitore closely in order to close the gap of monetary aggregates. As far as the external debt is concerned, Argentina is committed in strong terms not to present ? for external creditors, public and private. This commitment makes it possible for Argentina to have access to regularly- scheduled external financing at market terms, and we are quite pleased to see this. The ? situation in Argentina will now be sanctioned immediately in terms of new capital flows, particularly the permanent quotation of bonds represe- nting the ? of Argentina. This is an essential stage for the economic policy which must first of all maintain con- fidence in investors. Privatization is a key element of structural policies. On the program we see today, which for the first time deals with defense, I should like to have some clarifica tion on the following points. First, in the social area, I observe that costs tied to personnel policies in privatizatio reached $280 million, which is almost the entirety of the Bank's loan if we exclude enhancements. Would it not have been possible to commit ourselves on a more ambitious social policy? I should like to have some clarification on the use of privatization receipts. Will they be used to reduce MILLER REPORTING CO., INC. 50-i C Sueet, N .E. Washington, D .C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 208 ah external and internal debt? What creditors will benefit from this reduction of the debt? And finally, my third question. If some enterprise would not find any purchasers, what will be the decision then. Finally, Mr. Chairman, the situation of the economy of Argentina and the need for financing of the Bank debt reduction operation justifies a substantial adjustment loan, which I approve without any reservation. I am fully aware of the importance that the staff as well as Argentine authoritie will attach to a very strict macroeconomic framework. Thank you. MR. STERN: Thank you, Mrs. Maury. Mr. Hosny? MR. HOSNY: Mr. Chairman, the two President's Reports and the consolidation testify to the strong commitmen of the Argentine authorities to a comprehensive restructuring and institutional reform agenda with emphasis on macroeconomi stability and an outward-oriented growth strategy to diversif the economy. The strategy has so far enabled Argentina to achieve a remarkable annual GDP growth rate, at the same time as it succeeded in lowering inflation from 2,000 percent in ,-. 1990 to 12 percent during 1992, a considerable achievement by MILLEA FIEPOFITING CO., INC. 50-1 C Street, N.E, Washington, D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 209 ah all measures. Mr. Chairman, my specific conunents on the Debt and Debt Service Reduction operation have been overtaken by previous interventions. Therefore, the following comments will focus on the proposed Public Enterprise Reform operation, which will serve a basic objective of the Bank assistance strategy for achieving improvements in public finances resulting from labor reductions in the public sector and elimination of substantial subsidies to the public enterprise companies, while enhancing their efficiency. Our major preoccupation is that the weak local implementation capacity in economic management and developmen administration, together with shortages of skilled manpower in required specializations could jeopardize the timely implementation of the proposed public enterprise reforms. Additionally, the Government has to face the daunting challenge of implementing an ambitious public employment retrenchment program and simultaneously increasing the public sector's ability to attract and retain efficient and experienced professionals and managers, while modernizing the overall civil service system at the federal and provincia levels. Therefore, in designing and implementing the MILLER REPORTING CO., INC. 50i C Street, N.E. Washington, D.C 20002 ( 202) 546-6666  STRICTLY CONFIDENTIAL 210 ah reforms, priority consideration needs to be given to policies and incentives conducive to building institutional capacity and an incentive structure together with upgrading local managerial and technical capabilities to sustain long-term effectiveness of the project objectives. In addition to the above major preoccupation, I would appreciate clarifications by staff of the following concerns with regard to the public enterprise reform opera- tion. First, it is mentioned that by June 1991, total labor reductions associated with the restructuring of the public enterprises within the control of the Ministry of Economy were about 21,000. About 77,300 additional employees and laborers are expected to become redundant when the process is completed. This represents a 35 percent reduction from the June 1991 public enterprise employment levels and is expected to cause a labor indemnity cost of about US$750 million, as mentioned in paragraph 2.12. Furthermore, the labor reduction of public enterpr- ises within the defense complex is estimated at about 19,600 positions, representing a reduction in emplo:yment in this sector of about 60 percent relative to the September 1991 - levels. The total indemnity cost for the defense public MILLER REPORTING CO., INC. so·, C Street, N.E. Washington. D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 211 ah enterprises is $286 million, as estimated in paragraph 3.09. My question is whether the proceeds from the privatization of public enterprises are expected to be sufficient to cover the labor indemnity costs in addition to other liabilities of the privatized public enterprises. Also, what are the expected overall financial implications of the privatization process--that is, will there be a net plus or a net minus in terms of the budget resources? My second question is with regard to the study referred to in paragraph 4.12, which is scheduled to start in March 1993 under funding from the public enterprise reform operation, on the impact of the reform program of the public sector on the labor market, particularly in Patagonia and Jujuy, where relatively large public enterprises were closed, with limited employment options. This study is intended to provide data that can be used to dampen any negative social effect of the reform program. We would have indeed preferred that such an important study would have been undertaken earlier, so that at least preliminary remedies could be in place as the employment retrenchment process is implemented. My third concern is with regard to the status of the Government's proposed social security reform law presente - to the Argentine Congress recently, introducing mandatory MILLER REPORTING CO., INC. 5ff1 C Street, N.E. Washington, D.C. 20002 ( 202) 546-6666  STRICTLY CONFIDENTIAL 212 ah private pension funds, as mentioned in paragraph 1.10, as well as the status of the revised antitrust legislation mentioned in paragraph 4.09. My fourth question that I would seek elaboration if possible by staff is whether specific mechanisms and instru- ments are envisaged by the Argentine authorities to attract much or a major part of the estimated $50 to $60 billion in private savings of Argentine residents held abroad, as mentioned in paragraph 1.16. Are there some preliminary estimates also of the magnitude of the expected inflow for this potentially important source of finance? My final observation is that growth is projected to decline gradually and stabilize at a long-term rate of about 4 percent annually. This projection is based on the expected behavior of several variables mentioned in paragraph 1.13 to 1.24 of the memorandum, including growth of world markets for Argentine exports, Argentina's terms of trade, and the cost of international capital. Are we not assuming too many variables of which some important points lie beyond the control of the Argentine authorities? In this respect, the President's Report rightly states in paragraph 1.24 that, and I quote here, "Major efforts to reduce fiscal imbalances are urgently needed in many countries to strengthen global MILLER REPORTING CO., INC. 50-i C Street, N .E. Washington, D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 213 ah economic prospects, which would in turn provide greater opportunities for Argentina's exports." I think this paragraph as a whole, Mr. Chairman, underlines the importance of the external environment for our projections. Thank you, Mr. Chairman. MR. STERN: Thank you. Mrs. Herfkens? MRS. HERFKENS: Thank you, Mr. Chairman. I've got four pages here, but by now, at this stage of the debate, I can quickly associate myself with a couple of previous speakers. First, on the DDSR, I would like to associate myself with the congratulations Mr. Coady gave, not only to the Bank staff, but to this whole complex of Bank, Fund, IDB and Japanese Ex-Im Bank, to put together such a complex operation. On the technical side of the DDSR, I share the concerns which Mr. Potter expressed on the inflexibility of the debt stock, particularly where by the year 2000 the country's foreign debt will remain at the same level, the current $60 billion. Then, I had the same mistake as Mr. Potter, that I thought this was the country assistance strategy, so also I MILLER REPORTING CO., INC. 5ff1 C Street, N.E. Washington, D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 214 ah felt it was not really--it is impressive, but I will keep those remarks until February. By the way 1 as so many of us made that mistake, maybe it would be useful if we could have a list of when we discuss what countries--or maybe we did get it, but I did not see it; but I know I am not the only one making that mistake. Then 1 on the other loan, Mr. Coady made the remark that Argentina was such a success story in privatization. Personally 1 I feel that that remains to be seen. It is certainly a very radical and dramatic privatization policy 1 but the proceeds appear to be quite small 1 although I realize that that is not the only objective of privatization, but indeed the social costs are quite high. Mr. Hosny has elaborated the figures on the layoffs and the impacts on employment. And furthermore, I very much agree with each and every word Mr. Kodera said on this, particularly also on the issue of monopolistic environment, and in this context I think that the early enforcement of the envisaged competition and antitrust legislation is extremely important. Thank you. MR. STERN: Thank you 1 Mrs. Herfkens. - Mr. Stanton? MILLER REPORTING CO., INC. 50'1 C Street, N.E. Washington, D.C. 20002 (202) H6-6666  STRICTLY CONFIDENTIAL 215 ah MR. STANTON: Thank you, Mr. Chairman. I have very little to add to what has been said, but I would like to commend staff for these proposals and for the analysis in these papers, and I would like to commend the Argentine authorities on the turn-around in their macro- economic performance. On that, I would simply make the point that the focus will need to continue to be on fiscal improvement and the convergence of domestic cost to international levels if confidence is to be maintained. The preview that we have of the Bank's lending strategy complements this macroeconomic strategy well. I particularly welcome the proposed financial sector loans, and I look forward to the fuller discussion that we will have of the Bank's strategy on that occasion. I would only make one point in that regard at this stage, and that is to say that I hope that further attention can be paid to the labor market, which remains the one area where little structural reform seems yet to have been achieved. On the Debt and Debt Service Reduction loan, I find the staff's evaluation clearly sets out the benefits of the deal to Argentina's medium-term position, not least as a MILLER REPORTING CO., INC. 50'1 C Street. N.E. Washington, D .C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 216 ah contribution to the further development of investor con- fidence, provided, of course, that the right domestic framework is maintained. On the Public Enterprise Reform loan, I would like to say how encouraging it is that the authorities are keen to keep up the momentum of their privatization policy, par- ticularly by tackling the defense sector, which is often a sensitive and controversial task. Mr. Hosny has asked the one question that I would have had in this regard. I note that closure may well be the most common result of this particular exercise, and it would be important to keep a close watch on the costs of this, especially labor indemnitie and environmental cleanups and so on, and I wondered whether the staff had estimated what revenue gains might accrue from the sales. Finally, I was pleased to see that there was an evaluation of lessons learned from previous privatizations. I noted that there was no mention of how one key problem in the past--that is to say, the lack of an adequate regulatory framework--was to be tackled in this case. In a way, I wasn't surprised because that is often thought of as more relevant to utilities than to this sort of industry, but as Mr. Kodera has pointed out, we may well finish up with a MILLER REPORTING CO., INC. 50-1 C Street, N.E. Washington, D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 217 ah steel monopoly, and therefore the question of how that is going to be controlled is a relevant consideration. Thank you, sir. MR. STERN: Thank you, Mr. Stanton. Mr. Malan, do you want to wind this up? MR. MALAN: What a responsibility, Mr. Chairman. In fact I had some detailed technical comments and questions about the analysis of the Argentine debt deal, which I would skip now and raise bilaterally with the staff, given the lateness of the hour. So I will be brief. My Brazilian authorities have instructed me--as if there were such a need--to express strong support for the Argentine Debt and Debt Service Reduction operation and for the proposed World Bank involvement in this $150 million stand-alone loan and to set-asides of $300 million coming from two extra quick-disbursing loans. The implementation of the Debt and Debt Service Reduction operation by clearing away the debris of the past and affecting expectations and adding to confidence will help sustain the remarkable performance of Argentina in terms of short-term macroeconomic management and structural reforms, widely and rightly supported by the Bank. I agree with previous speakers that it is a high- MILLER REPORTING CO., INC. 50-i C Street, N.E. Washington, D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 218 ah quality report for which I would like to commend Mr. Husain and his staff. My comments will be addressed later on, bilaterally. We also endorse the loan supporting the privati zation and restructuring of public enterprise in the Ministry of Defense, as well as the Argentine request for a waiver of the negative pledge by the World Bank. Thank you. MR. STERN: Thank you, Mr. Malan. Mr. Meo? MR. MEO: Thank you very much, Mr. Chairman. I will also try to be very quick and very brief. I think the Aerolineas Argentinas deal was the first of the privatizations in Argentina, and we have all learned from that. We both hope this will not end up as the symbol or the model of what occurs. There has been some concern expressed about the steel plant, SOMISA, which is extremely large. It produces about half of Argentina's steel production. It was sold in December to a consortium which includes a very large Argentin steel plant as well. To ameliorate the effects of a potentia monopoly, the authorities did prohibit in the sale memorandum the joint consortia of two Argentine steel firms, so they are - foreign firms associated with the Argentine firm. MILLER REPORTING CO., INC. 5ff, C Street, N.E. Washington, D.C. 20002 ( 202) 546,6666  STRICTLY CONFIDENTIAL 219 ah The second thing is they have reiterated their desire to maintain an open trade account. The increase in the statistical tax also referred to was across-the-board; it was not in favor of steel. And finally, they are preparing, as some of you have said, a draft anti-monopoly law or competition law. This has been prepared with the assistance of Bank finance experts and consultants. They are now reviewing it within the administration, and to present the law to their Congress will be a condition of the second tranche disbursement. We hope the combination of a continued open trade regime, association with foreign firms, and an anti-monopoly law will help ameliorate any monopoly views. The import tariff has been discussed. It is an increase in what is called a statistical tax which is across- the-board, from 3 to 10 percent. It affects all imports. Argentina now has a fixed exchange rate by law, and the flexibility of a small economy, then, is a bit restricted. In the middle of a very major adjustment program, affected by some fairly strange currency changes of its trading partners, it was forced to use this tax, across-the-board import tariff, essentially--something which occurred, you may remember, in the United States in 1971. The Argentine MILLER REPORTING CO., INC. 50'i C Street, N.E. Washington, D .C. 20002 (202) )46-6666  STRICTLY CONFIDENTIAL 220 ah authorities have undertaken and have clearly stated this is a temporary thing, and they plan to remove this as soon as they possibly can. They regret having to take that action. The domestic debt now is quite similar to the foreign debt when you have a fixed exchange rate regime. In fact, some of the domestic debt is denominated in U.S. funds or currency. Unfortunately the vast majority of it involuntary debt, so it does have non-floating exchange rates. It is around LIBOR plus one, LIBOR plus two, which is comparable to the foreign debt. It is not usually floating, if you will; it is contractual. And the authorit have - then taken some of the domestic debt in the sale of the assets. It is fairly common often to see the sale of an asset which will be a fixed amount in cash and then half foreign debt instruments and half in other instruments or domestic debt instruments. IFC has been very helpful in Argentina. They are restricted a bit because they do have substantial equity ownership, and they get into an issue of conflict of interest occasionally. But they did sell one of the steel plants in this thing, Altos Hornos Zapla, and their entrance was very salutary. It forced the consortium, which had earlier bid to increase its sales price offer by 100 percent. They are in MILLER REPORTING CO., INC. 5ffi C Street, N.E. Washington, D.C. 20002 ( 202) 546-6666  STRICTLY CONFIDENTIAL 221 ah the midst of trying to sell now a cable plant, which is called ECA, which is your loan here, and they have done, in our view, an excellent job so far. The retrenchments are very substantial indeed. Your figures are very correct, Mr. Hosny; they are very substantial. The overall figures include the railways of Argentina, which are being reduced from over 90,000 to probably below 35,000. The steel plant alone was retrenched by 8,500. The oil firm probably will be retrenching by 20,000 individuals. The civil service has been dropped by 122,000. The point here, of course, is this is almost over. It is almost done. And the unemployment rate, surprisingly enough, has not increased; it has dropped. The reason is unique not to Argentina, but to many of these economies--the low wages meant that a substantial amount of the staff of both enterprises and in the civil service had other jobs, and as the economy recovers, they have found employment fairly quickly. The cost is quite high because Argentina by law must provide them with legal severance pay. We have insisted on that, and they have complied, and they are eager to comply with that. It quite high. But that is the answer to your MILLER REPORTING CO., INC. 5ff, C Street, N.E. Washington, D.C. 20002 ( 202) 546-6666  STRICTLY CONFIDENTIAL 222 ah other question, where are the proceeds of the privatization going. They are going to go to reduce the debt, the Brady deal, and to pay off these retrenchments. And they are not cheap, as you pointed out. However, the sums before you are a bit obsolete now. They did sell the gas complex in December. That produced in cash equivalent US$2.5 billion. There are substantial funds available to pay these retrench- rnents beyond our loans, of course. Nevertheless, the costs are high. They don't know what the net receipts will be yet because they have contingent liabilit throughout. There is always the supplier who shows up with the old bill, labor issues, union strikes, et cetera. Nevertheless, the net fiscal gain is not what they are going to get from the sale, in their view; it is the relief on the fisc for the future and the economic impact it will have on the economy to have heretofore enterprises--22 out of the 45 state enterprises had accounts in the defense area; six of them earned a profit in spite of monopoly positions. They expect these to be very productive in the future, and the economic impact will be strong. Some of you expressed concern that the social security law and the antitrust law proceed apace. I can assure you the authorities share this concern. The Argentine MILLER REPORTING CO., INC. 5ffi C Street, N.E. Wl!Shington, D.C 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 223 ah congress is independent, autonomous, and remains very much so. That explains the slight delay in some of the disburse- ment of the tranches of the Publ Sector Reform loan and PERAL tranches I and II. we have disbursed the railway tranche in December, as I told you, and we expect within a few weeks to disburse the hydrocarbon tranche, since the Congress had to first pass the law of YPF which gave them the authority to sell the oil firm. That has now been passed, and they are proceeding very speedily in that area. The PSRL is proceeding very strongly, and we hope to put something before you there also in the near future. The growth estimates are indeed low. I think I was here before you nine years ago with a Chile deal, the Baker Plan at that time. We had projected only 3 percent for Chile because we were firmly convinced, the IMF and us, to proceed with a moderate--you should not be optimistic on growth and the fiscal impact. The Argentines are being conservative in this case. We hope that they will grow faster. There will unfortunately be adjustment, we suspect, in the near future to the price issue a few of you have discussed. The labor market--again, they have a law which will MILLER REPORTING CO., INC. 5ffi C Street, N,E. Washington, D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 224 ah deregulate the labor markets. That again is a sensitive one and is being considered in Congress very carefully. I think those are some of the major concerns addressed. MR. STERN: Mr. Snoy? MR. SNOY: I'm sorry, perhaps I missed Did you explain what are those famous tax incentives, whether they are consistent with GATT rules? MR. MEO: Yes, of course. I am very sorry. Argentina gave fiscal incentives investment in certain sectors and in certain areas. Somehow, they grew like Topsy. As part of the Public Sector Reform Loan, they are trying to eliminate these. They have dropped a substantial majority of them. The remainder, they have a contractual obligation, so they are going through them one by one to ensure that those who received a credit live up to their contractual obligation. These are now being substituted for a more neutral tax credit, an overall tax credit. This will mean that those who purchase assets, particularly in steel, in the future will not have a pr ty or an incent compared to a ign investor who hadn't received a prior tax credit. This is proceeding well. They have agreed on the system, and the vast MILLER REPORTING CO., INC. 5ffi C Street, N.E. Washington, D.C 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 225 ah majority of general tax credits to replace the incentives have been distributed. We hope they will complete that very soon. At our request, they have given a higher priority to reviewing the steel industry first, to ensure that there is no preference for those who were grandfathered in the past. MR. STERN: Thank you, Mr. Meo. Mr. Snay? MR. SNOY: Another technical question which I raised--is it customary in these types of debt agreements that if the country has deficit difficulties and is led to use the collateral that has been set up for interest payments, it should not be obligated to replenish it? MR. HUSAIN: That has been the practice, yes. MR. SNOY: Thank you. MR. STERN: Did you get a deal like that, Mr. Malan. MR. MALAN: Of course. [Laughter.) MR. STERN: Mr. Hosny? MR. HOSNY: I am just wondering whether there are any particular incentives or mechanisms to attract accounts b Argentina itself abroad, because this could be useful to other countries. MR. STERN: Well, I would actually hope not. If MILLER REPORTING CO., INC. 5Wi C Street, N.E. Washington, D.C. 20002 (202) 546-6666  STRICTLY CONFIDENTIAL 226 ah one has an open capital flow system and a stable exchange rate, then nature should take its course. Well, ladies and gentlemen, we will note your MILLER REPORTING CO., INC. SO"i C Street, N.E. Washington, D.C. 20002 (202) 546-6666