Argentina - Provincial Reform Loan Project

/,L JdfS A -- ,LZ) Document -of The World Bank FOR OFICIAL USE ONLY Rqput No P-6414-AR REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTiWE DIRECTORS ON A PROPOSED PROVINCIAL REFORM LOAN IN AN AMOUNT EQUIVALENT OT US$300 MILLION TO THE ARGENTINE REPUBLIC DECEMBER 30, 1994 Public Sector Modernization and Private Sector Development Division Country Department I Latin America and the Caribbean Region. This document has a restricted distribution and may be sed by recipients only in the performance of their official duties. Its contents may not othenvise be disclosed without World Bank authorization.  CUlRRENCY EQUIVALENTS Currency Unit: Argentine Peso (Arg$) Arg$l = US$1 ACRONYMS ANID ABBREVIATIONS ATN - Treasury Grants (Aportes del Tesoro Nacional) BCRA - Central Bank (Banco Central de la Republica Argentina) BNA - National Bank of Argentina (Banco de la Nacion Argentina) DDSR - Debt and Debt Service Reduction DGI - National Tax Agency (Direccion General de Impuestos) EFF - Extended Fund Facility FDR - Regional Development Fund (Fondo Regional de Desarrollo) FEDET - Electricity Development Fund (Fondo Especial de Desarrollo Elec.rico del Interior) FONAVI - National Housing Fund (Fondo Nacional de Viienda) FSAL - Financial Sector Adjustment Loan FY - Fiscal Year GAIT - General Agreement on Tariffs and Trade GDP - Gross Domestic Product IBRD - International Bank for Reconstruction and Development IDB - Inter-American Development Bank IEC - International Economics Department IFC - International Finance Corporation IMF - International Monetary Fund MERCOSUR - Southern Cone Trade Bloc (Mercado del Cono Sur) PERAL - Public Enterprise Reform Adjustment Loan PERAL II - Second Public Enterprise Reform Adjustment Loan PSRL - Public Sector Reform Adjustment Loan PSRTAL - Public Sector Reform Technical Assistance Loan SAREP - Secretariat for the Economic Reform of the Provinces (Secretaria de Asistencia para la Reforna Economica Provincial) SIGEN - Internal Government Auditor (Sindicatura General de la Nacion) SOE - Statement of Expenditure YPF - YPF Oil Company (Yacimientos Petroliferos Fiscales)  FOR OFFICIAL USE ONLY -ARGENTINA PROVINCIAL REFORM LOAN Loan and Program Summary Borrower: The Argentine Repubiuc. Beneficia: Not applicable. Poverty Not applicable. Commitment Fee: 0.75% on undisbursed loan balances, beginning EO days after signing. Amount: US$300 million equivalent. U=lms: Repayable in 15 years, at the standard variable rate, with a five-year grace period and level repayments. Economk Rate of Return: Not applicable. This document has a resicted ditribtn and may be ud bycients on in th pebmmn of he ld ut Its contet n otoerwbe dsd v thwut WorldBak authato  ARGENTINA PROVINCIAL REFORM LOAN TABLE OFCONTEWTS I. THfE ECON~OM~fY' . . . . . . . . . . I Historical Persecve ...................................... 1 Recent Ecnomic Perforanme , * 2 Mlacroeconomiic Ptrospects . ...... 4 External Environment . 5 Risks . 6 II. ISSUESINPROVINCLLFINANCE. 7 Background .. 7 R-evenues .. 8 Expenditures.. 9 Provincial Banks and Deficit Financing ..11 Il. THE PROGRAM TO REFORM PROVINCIAL FINANCES . .13 improving Revenue Mobilization ..15 Improving Expenditure Efficiency .1.7.... 17 Reducing the Size of the Provincial Public Banking Secto . .19 Cunrent Status of the Program in Partcipatng Provinces ..20 IV. TIE PROPOSED LOAN... . 21 Objectives ... 21 Rationale for Bank Involvement and Str.te.y .22 Experience with Adjustment Operations in Argentina . .22 Coordination with Multilateal Institutions .. 23 Loan Conditions ..................... 23 Impact, Benefits and Risks ..27 V. RECOMMENDATION .28 This Report is based on the findings of the Appraisal Mission of July 1994. Missian members included Mesrs. M. Hagerstrom (Mission Leader and Task Manager), J. Morisset (Eoomist), C. Fort (Financil Analyst), and 0. Reid (Fiscal Economist). Messrs. P. Levy (rdcipal Economist) and S. Alber (Principa Finoa} Analyst), and Ms. F. Pena (Resident Mission) contributed to the report Mr. G. Carter and Ms. A. Blackdmrst processed the report. Mr. G. Nankani (Director), Mr. 0. Grimes (Proect Advisor) and Ms. Bernard (Division Chief) have endorsed the project.  Table of Contents (Contsd) Page, No- -ANNEXES I Macroeconomic Indicators . .. ..... 29 Ir Basic Data on the Provinces .^ ... 30 III Status of Bank Group Operations - .... ..... 32 IV Statement of IFC Investments -....... . -.. . .... .33 V Letter of Development Policy . .. 35 VI PlicyMatri.........P.... . .. - 43 VJITI...... . Transformaation Fun... .nd 45 VIII Federal Transfers to Provinces S 1....... . ... IX Reforming Provincial Tax Systems .... .57 X Public Employment in the Provinces ....60 XI The Current Situation of Pro.vincialBanls. ... 67................ 67  REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAFL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTI DRECTORS ON A PROIOSED PROVINCAL REFORM LOAN IN AN AMOUNT EQUIVALENT TO US$300 MILLION TO THE ARGENTINE REPUBLIC 1. I submit for your approval the following report and recommendation on a proposed Provincial Reform Loan to the Argentine Republic for the equivalent of US$300 million to support fiscal reforms in the provinces. The loan would be at the Bank's standard variable interest rate, with a five-year grace period and level repayments, and would have a maturity of 15 years. L. THE ECONOMY Historical Perspective 2. By the early part of this century, Argentina had become one of the most developed countries in the world. However, after the Great Depression, reliance on statist and inward- looking growth. strategies resulted in massive public sector deficits, accelerating inflation, and economic stagnation. Pervasive growth of the state eventually brought public expenditures to over 50 percent of GDP. Although industrial promotion programs were iritially popular among the growing pool of urban workers, they ultimately led to an onerous taxation of agriculture, Argentina's prime source of wealth, and contributed to major misallocations of resources. The debt crisis of the early 1980s led the Government to resort to money creation to meet its financial responsibilities. To avoid a growing inflation tax, Argentines withdrew their resources from the financial system, saving and investing abroad at record levels. Economic stagnation ensued. By the end of the 1980s, labor productivity had faUen, social services and basic infrastructure had deteriorated, and poverty had become a serious and growing problem. 3. When the Menem Administration took office in July 1989, Argentina was gripped by recession and monthly inflation of up to 200 percent. To eliminate the fiscal deficits that were fueling the inflationary spiral, in 1991 the Administration began implementing a series of profound structural reforms remarkable both for their scope and the speed with which they were implemented. During 1991-93, fedeal employment was reduced by over 103,000 (about 15 percent), with another 284,000 positions transferred to the provinces; costly subsidies were suspended; and nearly all public enteiprises at the national level were privatzed. The base of the value-added tax was expanded, inefficient taxes on exports and financial intermediation were removed, and tax administration was modemnized. To strengthin incentives for private investment, trade liberalization and deregulation of markets for goods and services were accelerated. Primary responsibility for future price stability was shifted to the monetary authority. At end-1989, the Centrad Bank's (BCRA) quasi-fiscal deficit was eliminated through the forced conversion of short-term, high-interest deposits into long-term dollar bonds. The April 1991 Convertibility Law fixed the exchange rate at the equivalent of one peso to the US  -2- dollar, deindexed contracts, facilitated a dual currency system, and required the monetary base to be fully backed by international reserves. The Bank has played an important supportive role in the reform effort through close economic dialogue based on extensive economic and sector work, and a series of adjustment operations in public and financial sector reform, privatization, and debt and debt service relief. Recent Economic Performance 4. Argentina's current macroeconomic program has brought price stability and economic growth unknown for several decades. Following growth rates of 8.9 and 8.7 percent in 1991 and 1992, respectively, GDP grew by 6 percent i, 1993 and is expected to reach 5-6 percent for the whole of 1994. As a result of the economic recovery, poverty levels have declined significantly since 1990. Nevertheless, economic restructuring in the framework of a rigid labor market has resulted in increased unemployment: over 12 percent of the labor force by late 1994. Stability and declining interest rates have contributed to the recovery of investment, albeit from a low base. Inflation has decelerated, from a monthly 200 percent in July 1989 to an annual rate of 7.5 percent in 1993, and is expected to be less than 4 percent for 1994. The Argentine peso appreciated in real terms by about 23 percent from the beginning of the Convertibility Law regime to August 1994. However, after adjusting for tax reductions and other reforms, losses to export competitiveness may be approximately one-third of that. 5. The fiscal performance of the Federal Government was broadly satisfactory in the first two years of the IM's Extended Fund Facility (EFF), which expires in March 1995. EFF targets were exceeded in 1992 and performance under the EFF agreement remained broadly satisfactory in 1993, when the primary fiscal surplus reached 2.7 percent of GDP. In early 1994, the Government, in agreement with the IMF, indicated that it would not draw down the final two EFF tranches, as its access to the international financial markets had improved. Third- quarter 1994 fiscal performance, however, deteriorated due to lower than expected revenues while expenditures continued to increase. The social security system accounts, in particular, deteriorated with the transition costs of introducing the new optional private pension system, a reduction in employer's wage taxes, and the absorption of three financially-troubled provincial social security systems. The Government has initiated a program of remedial measures to increase tax collections and further reduce spending. With these measures the Government expects to bring the fiscal accounts close to equilibrium by the end of 1994 and to achieve a fiscal balance in 1995. The IMF's assessment is that on the basis of the measures adopted and proposed, there are good prospects that Argentina will further consolidate its macroeconomic policy achievements in 1995. While the overall fiscal accounts should be approximately balanced in the short term, the allocative efficiency of provincial finances is poor. Mounting pressure to increase the provincial share of co-participated revenues or to provide bailouts could put pressure on the fiscal balance in the medium term. Addressing the poor fiscal performance of the provinces is the number one priority of the Federal Government, and would be supported by the proposed program. For the Loan, the Government of Argentina has committed to achieving a cash equilibriun in the public finances for the 1995-97 period, and would implement policies and progms in accordance with the Law of Convertibility and Central  3 - Bank Law, as detailed in the Letter of Development Policy (Annex V)t which has been developed In close cooperation with the JMF. 6. In 1993, the trade defiit rea hed US$3.7 billion, about 40 percent higher than one year earlier, although the rate of increse in imports decelerated compared to the previous two years, and exports grew at 7.1 percent, after a slight decline in 1992. Doing the first three quarters of 1994, the deficit in the trade balance reached US$4.3 bil}^lio However, following three years of anemic performance, export performance has been improving. During the first three quarters of 1994 exports increased by 15.3 percent as a -result of growing -industrial exports, better international prices for grains, and improved economic conditions in Brazil.' At the same time, however,, imports continued to grow at the fast pace of 33.7 percent. of capital goods are leading the expansion in 1994, indicative of the acceleration in investment and the restructuring of the economy. Financing this deficit has not been diffictlt, given Argentina's improved access to international financial markets, but the situation with regard to future capital inflows warrants close monitoring. 7. With the increased accumulation of international reserves, and the reduction in bank reserve requirements earlier in 1993, monetary aggregates expanded at a fast pace. Bank credit grew at an even faster rate, reflecting the sub-par, but fast improving, monetization of the economy. Interest rates on peso deposits have declined from 25 percent in December 1992 to 8.3 percent by August 1994. Interest re spreads, although also declining, remained high, reaching 13 percent, indicative of the continued segmentation and shallowness of the financial system. Continued capital inflows have sustained the growth in aggregate demand. Liquid international reserves at mid-October 1994 stood at US$14.8 billion, a significant net increase since the end of 1992. Nonetheless, the general instability in world financial markets, which started in the first quarter of 1994 and was aggrvated by regional events in December 1994, has had a negative impact on A2gentina's financial markets. As a result, reserve accumulation and credit expansion deceletated substantially during 1994. 8. The extemal debt agreement with commercial creditors, concluded in April 1993, ended the accumulation of arrears, regularied existing arrars, reduced interest obligations from a projected US$2-3 billion to US$1.4-1.6 billion in the initial years following the agreement, and limited international interest obligations as intemnational rates rebounded. Debt-equity conversions in 1990-92 recuced public debt by about US$14 billion. The successful privatization of the state-owned oil company (YPF) in July 1993 also enabled the Government to partially cancel domestic obligations to pensioners by US$2.7 billion and to oil-producing provinces by US$1.2 billion. 9. In August 1994, Argentina reached an accord with its MERCOSUR partners to establish by January 1, 1995, common extenal tariffs (with some significant exceptions), moving closer to the establishment of a regional common market, which should provide an impetus for growth. Since Argentina's trade in MERCOSUR is primarily with Brazil, its best prospects are closely tied to the stabilization of the Brazilian economy (which accounts for 20 percent of Argentina's  -4- total trade) and resumption of sustainable economic growth. Argentina also announced a desire to eliminate its statistical import tax (cufrently at 10 percent). Uacroeconomic Prospects 10. The Government's central macroeconomic objective is to achieve robust long-term growth, while expanding employment and holding inflation to international levels. The Argentine econonmy could grow at a medium-tenn rate of about 4-5 percent annually (see Annex I), assuming that domestic inflation continues at inional levels and efforts to expand the country's export base are successful. Continued private capital inflows will be needed to ensure a smooth transition to a sustainable balance of payments. In this regard, recent developments in intemational financial markets have underscored Argentina's vulnerability to extemal shlocks and the critical importance of enhancing its export performance. Improved competitiveness through economic restructuring, growing investment, and slower increases in domestic consumption would help switch resources from non-tradeables to tradeables. Deceleration in the growth of domestic consumption will reflect both the slowdown in exogenous capital inflows associated with the privatization program, and the attainment of a new, higher and sustainable level of income resulting from structural adjustments. Slower growth in the domestic market would shift niore production towards exports, aided by deregulation and other measures to enhance productivity in the tradeable sector, and changes in relative prices. The private sector would be the leading expansionary force, while public investment would grow from its depressed levels, but be concentrated in fewer activities. I1. Macro consistency would require that gross national savings increase from 14.9 percent of GDP in 1993 to 17 percent in the 1994-97 period. Such an increase should not be difficult to obtain. Public savings have been significant during the initial phase of recovery, but private national savings are expected to increase as continued macroeconomic stability and the deepening of Argentina's financial system encourages residents to hold financial assets domesticaly rather than abroad. In 1993 alone, national savings increased by about 2 percent of GDP due to higher private sector savings, and further gains are being made in 1994. More particularly, future contnbutions to the new capitalized pension fund system are unrdly to be offset by reduced savings in other instruments, because of a likey reduction in evasion given the closer link between expected benefits and contributions. Furthermore, the ongoing deepening of the capital markets, resulting from the new pension fund system, could further contribute to the increase in private savings. Another reason suggesting a future increase in savings is that the low savings rates in the 1991-93 period reflected a one-time consumption adjustment to higher levels of income. Consumption growth rates attenuated in 1993, and future consumption trends could moderate even more. 12. The consolidated public sector accounts are projected to be basically balanced during the 1995-97 period. This is consistent with macroeconomic objectives and projected net financing needs of the public sector. A target of achieving a primary surplus that meets or exceeds interest obligations of the Federal Government is desirable in order to: (i) help strengthen national savings and private investment; (ii) moderate the gross financing requirements of the  Federal vovernment with its substantial debt amortization refinancing needs, reflecting limitations in accessing forign savings; and (ii) help sustain the fixed exchange rate regime with the only effective macroeconomic policy instrument (fiscal policy) available to the Goverment in the context of the Convertibility Plan. This fisc target is more moderate than the 1.6 percent to GDP overall surplus of 1993, due to: (a) the substantial completion of the privatization progam by end-1994; (b) the fiscalost of the transition to a capitalized pension system, and (c) higher capital expditures. Moreover, increaing transfers to the provinc and the elimination of seval distortionary taxes as well as tariffs within MERCOSUR are expected to reduce Federal Government revenues. In contrast, provincial finances are expected to improve over the 1995-97 period, as a result of the new revenue-shaiing agreement and reforms that would reduce or stabilize personnel expendite. 13. The adjustment process has progressively shifted the needs of external financing from the public to the private sector. Therefore, financing the balance of payments will be mainly a function of desired savings and investment levels in the private sector. Improved international financing of private investment, the renewed ability to roll over maturing intenational obligations, and growing foreign direct investment, should moderate the impact of the expected slowdown in privatization proceeds from abroad observed during the past three years. The World Bank and IDB will increase their exposure in Argentina, but not substantially so after the mid-1990s. The IMF's exposure will decline after the expiration of the EFF. Foreign direct investment should remain relatively stable in the 1994-97 period, with the share deriving from privatzations declining significantly. Over the 1995-98 period, private capital inflows, including trade credits and foreign direct investment, would average about US$11 billion per annum to finance the projected current account deficit With consistent macroeconomic policies, a stable extemal environment (both international and regional, as became amply evident during 1994), and the continuous financial assistance of multilateral organizations, Argentina's external financing requirements for sustainable growth are likely to be met. External Enviromnent 14. Three interrelated aspects of the external environment affect Argentina's macroeconomic prospects: (i) the growth of the world economy; (ii) developments under international and regional trade agreements, and Argentina's terns of trade; and (iii) the cost of international capital. World economic growth is expected to recover from the stagnation of 1991-93 at a moderate pace of 2.4 percent in 1994, and then average 3 percent for the 1993-2002 period (IEC projections). Consequently, the demand for Argentina's exports should strengthen and facilitate the financing of sustainable economic growth. With respect to international and regional trde agreements, prospect for higher global economic growth have been strengthened with the conclusion of the Uruguay round of GATr negotiations. The regional common market with Brazil, Uruguay and Paraguay-the MERCOSUR area-should also provide an impetus for growth. Finally, Argentina's terms-of-trade, near their lowest level in this century, are projected to gradually increase in the next few years.  -6 - 15. The narrow base of Argentine exports brings foreign debt service to 50 percent of goods and services exports, and makes Argentina quite susceptible to international interest rate fluctuadons. Each percentage point change in international intest rates would produce a change of about US$600 million in international interest payments (average for the 1994-96 period), t-he equivalent of 2.8 percent of the period's aveage estimated exports of goods and services, or 3.2 percent of international reserves. Private debt-service requirements, however, may be somewhat overestimated since at least some part of recent significant capital inflows is repatriated Argentine caital (for which no accurate data are available) that would not have the debt servicing characteristics of othe forms of capital inflows. The DDSR agreement, which limits interest rate increses on a substantial (US$13.6 billion) portion of Argentina's external debt, softens the direct impact of higher international interest rates. The indirect impact of higher international interest rates on capital inflows could be mitigated through the automatic adjustment features of the Convertibility Plan, as well as by domestic economic policies. Risks 16. Several risks, both external and domestic, could alter Argentina's economic horizon. On the external front, higher than expected international interest rates could slow the inflow of foreign capital, which would raise domestic interest rates and moderate economic growth. A moderate, extemally induced slowdown in capital inflows may be absorbed by the economy, as was the case in early 1994, but a reversal in capital inflows could result in a sharp economic contraction. This would strain a still weak financial system and public finances, as well as the Government's political will to accept a rising rate of unemployment and the economic hardship required to sustain the current economic model. 17. Secondly, even in the absence of an external shock, improving the competitiveness of Argentine exports is essential in the context of a fixed exchange rate regime. Given the appreciation of the peso in 1991-93, if current efforts to increase productivity through lower taxation and factor market improvements fail to raise exports sufficiently, then improved longer- term economic growth prospwects may require an effective realignment of prices between tradeables and non-tradeables. However this policy carries its own inflationary risks in a highly dollarized economy. Although domestic inflation has converged to intenational inflation, the further deterioration in the trade deficit has highlighted the risk of a slow recovery in exports on the sustainability of the current economic program. 18. Finally, unforeseen political developments and the deterioration of provincial finances could threaten the sustainabiity of the current fiscal equilibrium. In such an event, high capital mobility could produce a sharp decline in intemnational reserves, severely testing the convertibility program, as the temptation to engage in a more expansionary monetary policy would be strong. However, memories of the 1989-90 hyperinflation and the economic chaos of the preceding years make it unwlily that populist policies would easily undermine the hard-won gains in fiscal discipline. Provincial election results, even in areas of traditional  -7- opposition to the ruling party, suggest widespread acceptance of the basic tenets of the Government's economic program, which bodes well for its future sustainability. H. ISSUES IN PROVINCIAL FINANCE Background 19. The Argentine Republic comprises 23 provinces that vay widely in population, physical endowment, and institutional capacity. Thrughout the 1980s, deficits generated by provincial governments were major contributors to the chronic instability of the Argentine publc sector.Y' Fiscal adjustment, essential to the recovery of the economy, occurred at the federal level. While consolidated public finances improved from a deficit of 2.5 percent of GDP in 1990 to a surplus of 1.7 percent in 1993, the operational primary deficit (overall fiscal balance less net interest payments and capital revenues) of the provinces was reduced from 1.6 percent of GDP in 1990 to 0.3 percent in 1992 due largely to windfall transfers from improved federal tax collection. However, the provincial deficit is estimated to have risen again to 0.8 percent in 1993, or about US$2 billion, mainly because of the continued inability of provincial governments to contain current expenditures and to increa sufficiently their own-source tax revenuesY The provincial deficit has been only partially financed, contributing to an unstable economic and social situation in many of the northern provinces. Fiscal difficulties led to violent demonstrations in several provinces during 1993, which caused Federal authorities to intervene in one province to restore order. 20. At the samne time that provincial governments have lagged in maldng necessary fiscal adjustments, their role within the economy has grown as a result of decention and the privatization of many federal functions. In 1993, provincial governments (including the Municipality of Buenos Aires) accounted for half of public expenditure for goods and services and employed more than 1 million people (about 40 percent greater than federal employment). Provinces are now the major providers of core public services in health, education, security, water and sanitation, electricity, and other infrasucture. Provinces also have their own banks and a large variety of public enterprises. 21. Yet, most provincial governments are-ill pred to fulfill their ineasingly important role, with potential negative implications for economic growth and poverty reduction. The 1/ Basic social and fiscal data on the provinces are found in Annex R. A more detailed review of provincial public finances during the 1980s and early 1990s may be found in Areentina - Public Finance Review: From Insolvency to Growth (IBRD Report No. 10827-AR, February 11, 1993). 2/ Because of the variety of accounting procedures used by provincial governments, in particular the varying treatment of capital revenues and financing, and the recent large level of exceptional flows, the operational primary balance provides a better indicator of provincial fiscal performance than the primary balance. Reliable data on 1994 fiscal performance will not be avilable until the 2nd quarter of 1995.  -- Argentine federal system provides a poor match between responsibilities and finncig. Federal transfers provide litde mcenive for efficient spending and provincial taxes ae poorly collected and generally distortive. Provincial budgeting mechanisms are lacking, ad inadequate administrative controls have contributed to substantial overstaffing. Provincial public enterprises are largely inefficient and rely on high tariffs, trnsfen from prvincial treasudes, or soft loans from provincial public banks, a increaing number of which have become insolvent. Revenues 22. Provincial revenues, which amounted to US$25.2 billion in 1993, are characterized by low revenue mobilization from provincial sources and a correspondingly high dependence on revenue transfers fom the Federal Government. Federal transfers financed on average 60 percent of total provincial spending, ranging from a high of 92 percent of total expenditures in La Rioja to a low of 50 percent of spending in the Province of Buenos Aires in 1992. Transfers include co-participated funds (71 percent), discretionary grants (11 percent), royalties (4 percent) and other transfers (14 percent). ' 23. Coeawiipated lniners. Revenue-sharing in Argentina dates back to the mid-1930s, and is currently governed by the Federal Revenue Sharing law of 1988 (see Annex VII). These transfers represent 56.7 percent of the sum of the most important taxes collected by the Federal Government, such as the VAT, income and asset taxes, and excise and fuel taxes. Secondary dist ibution among provinces, codified by the Revenue Sharing Law, is based on a senes of bilateral agreements reached during the mid-1980s which largely based the level of transfers on the size of the provincial public sector. Current fixed shares among provinces tend to favor sparsely-populated ones, underdeveloped provinces at the expense of the more developed, densely- populated with a higher number of the nation's households having unsatisfied basic needs. High levels of co-participated transfers have allowed many lesser developed provinces to sustain income levels by providing public employment in the face of stagnating local economies. 24. Discretionary Grants. These transfers amount to US$1.6 billion in 1992, or about 6 percent of total provincial revenues, and have been particularly insidious in rewarding poor fiscal performers among the provinces and distortng resource atlocation. Such transfers include those to finance the provincial deficits and the Housing Fund (FONAVI). FONAVI is the most important, representing about 20 percent of non-coparicipated transfers in 1993. It was established to finance housing projects in the provinces, but its average loan recovery rate is only 3 percent. Thus, nominally reimbursable, FONAVI has been a de facto grant. 25. Revenue from Provinciat Sources. Local revenues fluctuated markedly dunng the last decade due to changing macroeconomic conditions. The recent economic recovery has fueled an increase in these revenues from 2.7 percent of GDP in 1990 to 3.6 percent of GDP in 1992 3/ The latter includes mostly transfers earmarked for specifi