Argentina - Capital Market Development Project

-V -> f C;' -7- Documst of The World Bank FOR OFMCLAL USE ONLY Rqwt No P-6161-AR OF THE PRESIDENT OF THE INTERNATIONL BANK FOR RECON0SC AD ADE TO THE EXCTVE DIRECTORS ON A PROSED SINGLE CURRENCY LOAN IN THE AMIINT OF US$500 MILLION TO THE ARGENTINE REPUBLIC FR A CAPItAL MARKEZ DEVELOPMENT PROJECT BRUARY 4j 1994 MICROGRAPHICS Report No: P- 6161 AR Type: HOP This doemot has a resticted dilbibntio Mad may be nsed by epiet only In th pouace o f tdeir offical duties. Its cone may lWt othewis be dilosed widxtt Wold Bank *utworiztko.  CRECY EQMl)PM Crreny Unit = Peso US$1.0 = Peso $1.0 GLOSSAR-Y OF ABRDEIAIO_N_S BANAf)E Banco Nacional de Desarrollo National Development Bank BCRA Banco Central de la Repliblica Argendna Cental Bank of Argentina BICE Banco de Inversi6n y Comerio Exterior Investen and Trade Bank BF pacilidad de Respaldo Fancieo Backstop Facility BHN Banco Hipoario Nacional National Mortgage Bank BNA Banco de a Naci6n Argentina Bank of the Argentia Nation BPBA Banco de la Provincia de Buenos Aires Bank of the Province of Buenos Aires DON Bonos con Respaldo del Fondo Bonds under Backstop Commitments BONEX Bonos Extemos. External Bonds CNAS Caja Nacional de Ahorro y Seguros Nationa Insurance and Savings Bank CMTAL Pr6stamo de Asistencia Tecnica al Capital Market Technical Assistance Darrllo del Mercado de Capitales LOa CNV Comisi6n Nacional de Valores National Securities Commission CPI Indice de Precios al Consmidor Consumer Price Index FON Bonos Adquiridos por el Fonldo Bonds purchased by Backstop Fund FI Instituci6n Financiera Financial Insttuton PSAL Pr6stamo Sectorial Financiero Financial Sector Adjustmen Loan GDP Producto Interno Bruto Gross Domestic Product INDER Insdwo Nacional de Reaseguro National Reinsramce Instite LFE Ley de Entidades Financieras Law of Financial Eniies ON Obligacin Negociable Negotiable Obligation OTC Mercado Exrabursail Over-the-Counter Market PAYG Pago por Sislema de Reparto Pay-as-you-go PB Banco Participante Participating Bank PE 1mpresa PNblica Public Enterprise SCL Pro en Moneda Unica Single Currency Loan TEL Pr6stamo a Tennino Elegible Term Eligible Loan  IOL OFFICIAL USE ONLY ARGENIN CAPfAL ACARIGB DEVELODPNMEN PIIET L4*9 and Prec &M_ Borrwer: Argentite Republic. Bugdwg cvm: The Fund, an independent corporation to be esablished by the Government. The fancial manager of the Fund would be an inernational financial instidon witfi a proven sucessfu record. The o de Inr Comercio Exteror (BICE), a Government-owned second-tier bank, would perform adm=stratve and oversight nctions. endidaries. Prime-rated commercial bank, medium and smal private enterprises in all sectors, and buyers of new commercial or residential buidings. US$500 million. Terms US dollar, single-currency loan, repayable over 15 years at the Bank's standard LIBOR-based vaiable interest rate for US dollar, single-cur y loans. Grace period: 7 years. QjleIiing The Argntine Republic would onlend the proceeds of the Bank loan to the Fund. The Fund would implement a Backstop Facilty (BF) that would offer prime-rated banks the option to sell to the Fund medim-term US doll-denominated bonds issued to roil over prior dollarn ed bonds that banks had issued to support thir longer term loans for productive purposes. Otr i: A companion Capital Marlkt Development Technical Assistance Loan (CMTAL) would provide complementary support (see to n below) in the amount of US$8.5 million equivalent. IDB has approved a credit line in the amount of US$300 million for productive purposes, that will be cofinanced by the Export- Import Bank of Japan in an equivalent amount. This document has a resctted distribution and may be wed by recipients nlb in th e of their oficil du#'s. Its contents may not othorwis be disclosed without Wold udto on.  -}i- QkIectIi": The proposed operation aims to accelerate capital market development to help Argentina meet growing investment demand. Deption: The operation includes the Backstop Facility (see Qhndldng), and an agreed policy and institutional development progrm. The Backstop Facilit would support long-term lending for productive purposes, by ensuing liquidity to banks in the event of bond market disruptions. An agreed policy and institutional develoment rom, including macroeconomic stability, freely determined interest rates, the removal of exitig interst rate subsidies, and stre-gthened capital market regulation, supervision and enforcement, would also help increase market conidence. Progress i the agreed policy and istitutional development progrm would be reviewed during two paLses in commitments, to be implemented after 30 percent and 60 percent of the loan has been committed or after 18 and 36 months of effectiveness, whichever comes first. The accompanying CMTAL would help finance inprovements in capital market supervision and regulation; training of commercial banks' staff in project financing; and implementation and operation of the new, reformed pension system. The main benefit of the project would be development of the capital market, includig increased availability of long term financing for private sector investment, longer bond maturities, development of rating agencies, increased liquidity of the bond market, and improved quality of commercial banks. RiLsks: The main risks are resumption of sustained macroeconomic instability, including further strain on the banking system; extended government interventions to lower interest rates; weak progress in bank supervision; weak demand for the Backstop Facility; and non-development of BICE. Estimated Coht: The total amount of bank bond issues that the Backstop Facility would support over the life of  -iii- the Bank loan depends on the maturities of the backstopped bonds and the percentage of backstop commitments exercised by banks. The longer the maurities and the higher the percetage of total bonds sold to the Fund, the lower the amount of bond issues that the Fund would be able to support. l sing Pian: Not applicable. Financing of bond purchases would mateialize only in the event of a possible financial disruption or market developments that undermined a PB's ability to rollover its bonds at a rate below the backstop price. lie of Return: Not Applicable. Not Applicable.  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AN) DEVELOPNT TO THE EXECUTIVE DIRECTORS ON A PROPOSED SINGLE CURRENCY LOAN IN THE AMOUNT OF US$500 MILLIOk TO THE ARGENTINE REPUBLIC FOR A CAPITAL MARKET DEVELOPMENT OPERATION 1. I submit for your approval the following memorandum and recommendation on a proposed loan to the Argentine Republic in the amount of US$500 milion to help finance a project for the dev'~lopment of the capital market in &rgentina. The loan would be a Single Currency Loan in dollars at the LIBOR rate, with a maturity of 13 years, including seven years of grace. Part I: COUNTRY ASSISTANCE ST1RATEGY A. Historidal lPersec0tve and Recent Eoonmic Peormance 2. By the early part of this century, Argentina had become one of'the more develdped counries in the world. Its per capita icome, inftrtr and institutions rivalled those of many European and North American countries; its vast fertile pampas and migrt-based work force held the promise of increasing prosperity. However, since the Great Depression, reliance on increasingly statist and inward-looking growth stategies gradually resulted in masive public sector deficits, accelerating inflaton, and economic stagnation. Pervasive growth of the state eventally brought public expenditures to over 50 percent of GDP. Although industrial promotion programs were initially popular among the growing pool of urban workers, they ultimately led to an onerous taxation of agriculture, Argentina's prmne source of wealth, and contributed to major misallocation of resources. The debt crisis of the early 1980s led the Government to resort increasingly to money creation to shoulder its mushrooming financial responsibiliies. To avoid a growing inflation tax, Argenies withdrew their resorces from the financial system, saving and investing abroad at record levels. Economic stagnation ensued. By the end of the 1980s, labor productivity had fallen, social services and basic infrastructure deteriorated, and poverty had become a serious and growmg 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, the new Government initiated profound structral reforms that were remarkable both for their scope and the speed with which they were implemented. Over the following 2-3 years, the public admistation was stramlined by reducing the total number of federal employees by over 103,000 (about 15 percent of total), and transferring another 284,000 positions (40 percent of total) to the provinces; legislation suspending costly subsidies  2 was enacted; and nearly all public enerprises at the natuonal level were privatized. The base of the value added tax was expanded and inefficient taxes on exports and fmancial inediaton were removed; tax administation was modernized. To stengthen incentives for private investment, trade liberalization and deregulation of market for goods and services were accelerated. Primary responsibility for future price stabilt was shifted to the monetary authority. At end-1989, the Central BWnk's 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 U.S. dollar, formally deindexed contracts, facilitated a dual currency system, and required the monetary base to be fully backed by intemational reserves. Receut Economic Developments 4. The curmnt macroeconomic program has brought to Argentina 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 is esfimated to have grown at about 6 percent in 1993. Stability and decining interest rates have cnntibuted to the recovery of investme, albeit from a low base. Inflation has decelerated from a monthly 200 percent in July 1989, to an anmal rate of 7.5 percent in 1993. The Argentine peso has appreciated by about 30 percent since the begining of the C^avertibility Law regime, but adjusting for tax riductions, efficiency gins and productivity improvements Jp the economy, losses to expi competitiveness may be less than half that .5. Fical performance at the-level of the national governmnt continued being _ d satisfactory into the third year of the adjustment program. EFF targets were 40 0 exceeded in 1992 and privatizations pusbed the primary surplus to .2.2 percent of GDP; .0 performance under the EFF agreement has remained broadly satisfactory in the first three quarters of 1993. However, the allocative efficiency of provincial finances E w remains poor; addressing this isspe is now -to one of the national Government's top . 1 10 180 13 1803 priorities. In August 1993 a new two-year. - -l revenue sharing agreement was announced, as r__ _ __-_ _ a fis step towards stengthening the adjus,tment process at the provincial level. Finally, in September 1993 social Lewrity reform was approved, introducing an optional capitalized private pension system. 6. The external debt agreement with, commercial creditors, consummated in April 1993, ended the accumulatiofi of arrears, regularized existing arrears, reduced interest obligations from a projected US$2-3 billion to US$1.4-1.6 billion in the initial years, and wiUl sharply limit international interest obligations if international rates rebound from their present low levels. Debt-equity conversions in 1990-92 reduced debt by about US$14 billion. The successful privatization of the state-owned oil company (YPF) in July 1993 also enabled the Government .. .~~~~~~~'  3 to cancel domestic obligations to pensioners (about US$2.7 billion) and to oil producing provinces (about US$1.2 billion). 7. Continued capital inflows have sustained the growth in aggregate demand. LMOf .. R Gross intervational reserves at mid-December ,7 stood at US$15.4 billion, a US$2.9 billion net increase since the end of 1992. With the increase in reserves, and the reduction in O bank reserve requirements earlier in the year, monetay aggregates have been expanding at a fast pace. Bank credit has grown at an even faster rate, reflecting the sub-par, but fast ioving, monettionof the economy. .. E E Interest rates on peso deposits declined to 8.9 percent by end-1993 (Amex E). Interest rate |*W*_" za,of St] sreads, although also declining, remained high, reaching 12 percent, indicative of the segmentation and contnued shallowness of the finanil systm. 8. In the first nine months of 1993, the trade deficit reached US$1.9 billion, about 20 percent higher than one year earlier. However, the rate of increase in imports decelerated vis-a- vis the prvious two years, and exports grew at 6.3 percent, after a slight decline in 1992. Low international interest rates have contributed to improvement in net factor -wO I,^ / \ 200 . payments. The current account deficit this year is rnning below last year's rat, at low Te bono , . .approximately 3.3 percet of GDP. ,eoo 1 1, l ~ --at,*w Fina g this deficit has not been difficult,