Argentina - Country assistance review

Report No. 15844 Argentina Country Assistance Review June 28, 1996 Operations Evaluation Department Document of the World Bank Abbreviations and Acronyms ARPP Annual Review of Project Performance CAR Country Assistance Review CAS Country Assistance Strategy CEM Country Economic Memorandum CIDA Canadian International Development Agency CNV Comision Nacional de Valores (National Securities Commission) CPP Country Program Paper CSP Country Strategy Paper DDSR Debt and Debt Service Reduction loan DCB Divisional Country Brief EBY Entidad Binacional Yacyreti ECON Economic Analysis of Projects (Reports on quality at entry) ESW Economic and sector work FONAVI Fondo Nacional de la Vivienda FSAL Financial Sector Adjustment Loan GDP Gross Domestic Product GUTA Gas Utilization and Technical Assistance project IBRD International Bank for Reconstruction and Development ICR Implementation Completion Report IDB Interamerican Development Bank IMF International Monetary Fund JAC Joint Audit Committee JNC National Meat Board LAC Latin America and the Caribbean OED Operations Evaluation Department OPR Operations Policy Department OSN Obras Sanitarias de ]a Naci6n PAR Performance Audit Report PCR Project Completion Report PERAL Public Enterprise Reform Adjustment Loan PEREL Public Enterprise Reform Technical Assistance PSRL Public Sector Reform Loan SAR Staff Appraisal Report SECAL Sector Adjustment Loan SEGBA Servicios Electricos del Gran Buenos Aires SOMISA National Steel Company TA Technical Assistance TPL Trade Policy Loan TPL2 Second Trade Policy Loan UNDP United Nations Development Programme VAT Value added tax YPF Yacimientos Petroliferos Fiscales The World Bank Washington, D.C. 20433 U.S.A. Office of the Director-General Operations Evaluation June 28, 1996 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Argentina: Country Assistance Review Attached is the report Argentina: Country Assistance Review prepared by the Operation Evaluations Department. This country assistance review (CAR) is one of the new type of country- focused studies that, for each country concerned evaluate (i) the relevance of the Bank's overall country assistance strategy; and (ii) the efficacy of various lending and non-lending instruments of Bank assistancel. The objectives are to establish accountability, derive lessons of experience, and provide recommendations for future actions. The Argentina CAR evaluates Bank assistance during an initial period characterized by several failed attempts at adjustment (1985-89), followed by a remarkably successful but still vulnerable program of structural reform (1990-95). The study finds that the Bank's assistance strategy to Argentina was relevant throughout the ten-year period covered, but that the effectiveness and efficiency of the Bank strategy was poor during 1985-89. Adjustment lending in particular was overoptimistic regarding the Government's willingness and ability to carry out the necessary reforms, and overall project performance was very poor as a result of the difficult economic environment that ensued. Economic and sector work, however, was of good quality and proved useful when a new government undertook more drastic reforms in the 1990s. During 1990-95 the Bank supported the government's successful program and contributed to restructure the country's external debt and restore access to private capital markets, privatize public enterprises, improve fiscal finances, reform the financial sector and analyze the capital and labor markets. The study also finds, however, that the Bank was slow in restoring lending in 1990-91, and anticipated the end of adjustment lending prematurely in 1994. In the early 1990s, insufficient attention was paid to the social sectors and to the Federal Government transfer of responsibilities to province-level governments without an adequate assessment of their financial and institutional capacities. The study recommends that future assistance continue to be centered on the fiscal performance of provincial governments, the social security system and the level and efficiency of expenditures in the social sectors. Financial sector reform is also a main area of priority. The study also recommends improving portfolio performance management, the quality of projects at entry and the use of performance indicators-especially to monitor the structural fiscal deficit. The Region should also prepare contingency plans to deal with the main risks identified in each lending operation and in the country assistance strategies. Attachment The first two in the series, the CARs on Ghana (Report No. 14547) and Zambia (Report No. 15675) were published on June 1, 1995 and June 3, 1996 respectively. Contents Preface 3 E xecutive Sum m ary............................................................................................... 5 1. Bank Assistance Strategy: Towards A Sound Policy Dialogue.................. 13 A bout the A nalysis............................................................................................ 13 The 1985-89 Period: Persistent Macroeconomic Instability............................ 15 The 1990-94 Period: Initial Caution, and Increased Lending Later in the Period................................................. 21 The 1994-95 Period: Helping the Government Deepen Its Reforms................ 30 2. An Evaluation of Instruments: Economic and Sector Work..................... 35 O verview ........................................................................................................... 35 ESW : Strategy and Levels ............................................................................. 35 Quality and Relevance of Economic and Sector Work..................................... 38 The 1985-89 Period: ESW Recommendations Fell Short of Needs.......... 38 The 1990-94 Period .................................................................................... 46 R em aining Issues ......................................................................................... 54 3. An Evaluation of Instruments: Lending ...................................................... 55 Contribution to Argentina's Financial Needs: A Delayed Response.............. 55 Quality of Lending Portfolio: 1985 to 1995..................................................... 57 The 1985-89 Period........................................................................................... 5 This report was prepared by Luis Ramirez (Task Manager). Contributors included Enrique Lerdau, Luis Alvaro Sinchez, Gary Wells (Consultants) and Ren6 Vandendries (OEDD2). Chitra Bhanu, Vassilis Alexandris and Carlos Reyes L6pez (Consultants) provided research assistance at different stages of the research. Norma Namisato, Alejandra Sarmiento and Geri Wise provided administrative support. The report was issued by the Country Policy, Industry and Finance Division (Manuel Pefialver, Chief) of the Operations Evaluation Department (Francisc. Aguirre-Sacasa, Director) and Robert Picciotto, Director General, Operations Evaluation. 2 The 1990-95 Period: From Cautious Policy to H igh Levels of A ssistance .......................................................................... 61 4. C onclusions and R ecom m endations............................................................. 73 Conclusions ..................................................................................................... 73 Recom m endations ........................................................................................... 77 O n Key Strategy Issues............................................................................... 77 M ore Effective Instrum ents........................................................................ 79 A ppendix ............................................................................................................ 81 Preface 1. This is a Country Assistance Review (CAR) of World Bank assistance to Argentina during 1985-1995. The CAR is a countrywide evaluation that concentrates on the relevance, efficacy and efficiency of the Bank's whole program of assistance to Argentina. As such, it is similar to an OED project evaluation which reviews the relevance of the project objectives, the degree to which they were achieved (efficacy) and the cost effectiveness of the resources used (efficiency). In the case of the CAR, the unit of account is the overall country assistance program, including lending and nonlending services. 2. The CAR on Argentina is one of the new type of country-focused studies endorsed by the JAC Informal Subcommittee on OED Reports in 1994'. The CAR is issues oriented and is geared toward current decisionmaking. As such, the CAR is selective as to time span, instruments and issues covered. The starting point of the Argentina CAR is the mid-1980s because it coincides with an intensification of the Bank's involvement in Argentina. 3. Why Argentina. The selection of Argentina for a CAR provided an opportunity to evaluate Bank strategy in a country experiencing successive failed attempts at adjustment (1985- 89), followed by a remarkably successful but still vulnerable program of structural reform (1990- 95). . 4. Sources andAckowledgments. The study is based on Bank reports such as Country Program Papers, Divisional Country Briefs, Country Strategy Papers, Country Assistance Strategy Papers, Country Economic Memoranda, Project Completion Reports, Performance Audit Reports, and project and leap files. Results on the quality of economic analysis at entrance of Argentina projects were extracted from two studies prepared by OED and OPR in 1991 and 2 1993 (ECON I and II) . Background reports were prepared by consultants on Economic and Sector Work, Regulatory Framework of Privatized Enterprises and an Extension of the ECON analysis applied to projects approved in 1990-94. The study is also based on interviews with Bank staff and with Argentine officials and private sector spokemen interviewed during a joint evaluation mission of IDB and the Bank in October 1994. Their kind cooperation and valuable assistance is gratefully acknowledged. The first two in the series, the CARs on Ghana (Report No. 14547) and Zambia (Report No. 15675), were published on June 1, 1995 and June 3, 1996, respectively. 2 Economic Analysis ofProjects: Towards a Results-oriented Approach to Evaluation, June 30 1992; and A review of the Quality ofEconomic Analysis in StaffAppraisal Reports for Projects Approved in 1993, May 5, 1995. Executive Summary Introduction 1. This 1996 Country Assistance Review examines the Bank's assistance strategy in Argentina from 1985 to 1995. It concentrates on issues relevant to the Bank's current decision making. The starting point is the mid-1980s, which coincides with an intensification of the Bank's involvement in Argentina. The report distinguishes three sub-periods having a bearing on the Bank's strategy: (a) the years 1985-89, during which the Bank's involvement took place in an environment of extreme financial instability in the country; (b) the years 1990-94, during which reforms intensified and economic recovery was impressive; and (c) the current period, when sustainability of the recovery is the issue. 2. The Bank formally reviewed its country assistance strategy for Argentina approximately every two years since 1985, when an increased lending program was adopted. The Bank strategy was articulated in six major documents. They are a Country Program Paper (CPP) in 1985, a Divisional Country Brief (DCB) in 1987, two Country Strategy Papers (CSP) in 1990 and 1992, and two Country Assistance Strategies (CAS) in 1994 and 1995. The story of the evolving relationship yields several salient lessons about the dynamics of managing the Bank's assistance strategy in a country whose political dynamics and economic policies have changed markedly and swiftly. In the following sections, we summarize: (i) the main developmental constraints and changes in economic policies as they transpired in Argentina in 1985-95; (ii) the Bank assistance strategy during the period; (iii) an evaluation of that assistance; and (iv) the recommendations derived from the analysis. (i) Developmental Constraints in Argentina: 1985 to 1995 1985 to 1989: The Government Fails to Muster the Political Will to Overcome Its Developmental Constraints 3. Taking advantage of the enormous potential for growth of the country's abundant resources remained an elusive goal in Argentina for many decades. By 1985, the country was suffering from the legacy of extensive government intervention in the economy-declining productivity, rising inflation, and, in turn, a dearth of both private capital and external assistance. At the heart of Argentina's languishing economy was long declining productivity, reflected in a growing reliance on import substitution, government control over relative prices, a bloated public enterprise sector, and inefficient sectoral resource allocation, culminating in macroeconomic instability, excessive fiscal deficit, and heavy external debt. 4. To redress its poor economic performance, the Government of President Alfonsin launched the Plan Austral in June 1985, the first of three major economic reform plans attempted by his administration during the late 1980s (box 1.3). The Plan sought to improve public finances-primarily with measures to increase fiscal revenue and reduce overall expenditures- and to contain spiraling inflation-primarily with an unorthodox program of foreign exchange controls and wage and price freezes. But what proved to be the downfall of the Plan Austral, and of the two stabilization programs that followed it, was the failing of measures to rein in the public sector deficit, particularly that generated by public enterprises, the social security system 6 and the provincial governments. Failure to control the fiscal deficit ultimately led to the country's worst episode of hyperinflation in 1989. 1990 to 1995: A New Government Ushers in Promising Sustainable Reform 5. By mid-1989, the trauma of extended recession and hyperinflation had eroded confidence in the Alfonsin Government and had created a fertile ground for reform. The country needed to face three urgent problems as a precondition for in-depth economic transformation: One was the pervasive fiscal disequilibrium caused by the deficits of the Federal Government, the public enterprises, the province-level governments, and the social security system. Another pressing deficiency was a strained financial system, reflected in a large proportion of insolvent banks and a poor regulatory system, problems that became critical in 1989. The third structural deficiency came from an ailing social service system-educational, health, and social assistance services. The neglect of basic health services and inadequate social assistance had increased already high rates of infant mortality and malnutrition among the general population. 6. As the new government of President Menem assumed office in mid-1989, it announced a new economic program, with the enactment of the Law of the Reform of the State in July and the Law of Economic Emergency in September, 1989. The Government's reform agenda included comprehensive privatization, inflation-reduction measures and fiscal reform-all of which were packaged later as the Government's Convertibility Plan, in April 1991 (box 1.5). After a period of economic turmoil during the first year of the new administration, the Plan finally boosted confidence in the economy and attracted an influx of private capital. In turn, the stronger economic climate enabled Argentina to reach agreement with commercial banks to settle arrears and reduce debt service to fiscally sustainable levels. By the end of 1993, the reform program had brought Argentina growth and price stability that it had not witnessed in decades. Growth averaged 8 percent in real terms in 1991-93. Inflation decelerated from 200 percent monthly as of July 1989 to 7.5 percent annually by 1993. Yet much of the Plan's success was predicated on the privatization initiative and monetary policy. Other deficiencies-province-level financing, the social security system, social services and financial sector weaknesses-still remained. 7. Two other concerns surfaced. First, the privatization process was being implemented in the absence of an adequate regulatory framework for governing monopolistic behavior by enterprises, an issue that is still on Argentina's agenda. Second, despite the success of the Convertibility Plan at halting inflation, its adoption in 1991 increased Argentina's vulnerability to a sudden reversal of capital flows, since wage and price inflexibilities under the fixed exchange rate regime would exacerbate the recession needed for adjustment. In late 1994, the financial crisis that rocked Mexico sent shock waves throughout Latin America. As a result, Argentina witnessed a reversal of the flow of capital that it had attracted earlier, but eventually succeeded in overcoming the main consequences of the crisis. Yet, the economy remains vulnerable to exogenous shocks. Today, the structural fiscal deficit-the deficit that would remain after transitory factors in fiscal revenue and expenditures are adjusted for-remains the major obstacle to ensuring sustainability of the Convertibility Plan. In addition, Argentina's long-term development depends heavily on its capacity to expand private-sector competitiveness. Several actions are now required: (i) consolidate the reforms to the financial system; (ii) address labor market inflexibilities and unemployment; (iii) improve implementation of the regulatory framework of privatized enterprises; (iv) modernize the legislative and judicial system; (v) improve social services, and (vi) improve the infrastructure for private sector development, especially transport, water and sewerage, and environmental management and protection. 7 (ii) Overview of Bank Assistance 8. The 1985-89 Period. The Bank approved a high lending program in June 1985. This program represented a fourfold increase, from an average US$160 million a year in FY80-84 to an average of US$640 million a year in FY85-89. The 1985 CPP argued for a large increase in lending and ESW to "support the process of opening the economy and attracting private investment." Lending was made contingent on compliance with the macroeconomic targets of a stabilization program, the Plan Austral, which had just been adopted by the government. The 1987 DCB endorsed continuation of the high level of support, based on the inaccurate assessment that the reforms attempted had "partially" succeeded. Lending focused on export diversification, financial reform, energy development, industry development, and fiscal deficit reduction. Again, lending was made contingent on successful stabilization, this time based on a new stabilization plan, the Plan Australito (February 1987). Unsuccessful stabilization again led the Bank to review its assistance program, this time on the basis of a new plan, the Plan Primavera (August 1988). This plan was controversial because some internal Bank reviewers warned that the plan did not close the external or domestic accounts, and the IMF decided that it would not endorse the plan because the Government was not making a sufficient fiscal effort. The Bank support to the Primavera plan led to a strained relationship with the IMF (Box 1.4). In the end, the concerns of some Bank reviewers and the IMF were borne out. The Plan Primavera was insufficient to bring about macroeconomic stability, and in fact its failure led to a severe hyperinflation crisis in early 1989. As a consequence, the Government of President Alfonsin was forced to leave office before the end of its term in July 1989, the Bank reduced its lending program in Argentina but continued, or intensified, its policy dialogue, and the respective roles of the Bank and the Fund were clarified through a concordat whereby the Fund agreed to take the lead in short-term macroeconomic programming and monitoring, while the Bank agreed to deal with the institutional underpinnings of macroeconomic policy. 9. The 1990-94 Period. By 1990, a major turnaround in macroeconomic management occurred after the new, democratically elected Government of President Menem took charge. Learning from past experience, the Bank initially adopted a cautious lending strategy, opting for prudence in lending until proof of success in macroeconomic management was visible. As a consequence, the Bank did not approve any new loans between October 1988 and December 19901, partly because economic performance remained uneven, and the IMF stand-by, approved in November of 1989, had to be modified in November 1990. The 1990 CSP proposed to limit lending to no more than one major operation a year in FY91 and FY92. Nonetheless, the Bank participated intensively in the reform process: non-lending services (particularly informal ESW and policy dialogue) intensified and contributed to the success of the reforms. The Bank opened an office in Buenos Aires in September 1989; provided extensive economic advice at the Government's request; restructured old loans and reformulated ongoing technical assistance to finance studies; and continued to prepare loans that became essential to the success of the public sector reform, including the privatization program, the reform of the Central Bank and other reforms to the fiscal and financial sector implemented later. 10. By 1992, a new assistance strategy was adopted, this time recommending to go back into high lending levels. The Government of Argentina had demonstrated clear ownership of a highly successful reform program, including the Convertibility Plan, which was adopted in April Except for a technical assistance loan for Tax Administration of $6.5 million approved in January 1989, (prior to the elections) which remained inactive for the most part until 1991. 8 1991. At the same time, the 1992 CSP's risk analysis was remarkably prescient regarding the vulnerability of Argentina's economy to potential reversals of capital inflows, although it did not propose an explicit action plan to cover this risk. Since 1993, after contributing to the Brady Plan for debt restructuring, the Bank has continued supporting the Government of Argentina with a significantly enlarged lending and non-lending assistance program. 11. The Current Period. The Bank strategy was again reviewed in 1994. This time good economic performance led to overoptimism about the future, in spite of the risk analysis of the CAS: the diagnosis of the 1994 CAS was clear about the vulnerabilities of the Convertibility Plan, but the recommendations anticipated the end of adjustment lending and included a discussion of possible graduation for Argentina. By 1995, the strategy was reviewed again in the face of the uncertainties created by the external shock faced by Argentina after the 1994 crisis in Mexico. The Bank's answer this time was swift and fast: a new CAS in April 1995 discussed the specific problems posed by the crisis in Argentina's context and good analysis was accompanied by quick action: in 1995 the Bank approved 12 loans to Argentina, for a total of US $2.1 billion. 12. By April 1996, the Bank prepared a progress report to review the achievements of the Government in meeting the challenge of the regional financial crisis and to examine the role of the Bank support. The main conclusion is that "Argentina appears to have weathered the worst of the crisis, although important risks remain". The country still faces the aftermath of the crisis, including high unemployment, and the need to strengthen its financial system and public finances. The financial situation of the provinces continue to be serious, burdened by bloated bureaucracies, financially weak pension systems and inefficient public banks and enterprises. Also, Argentina's debt service ratio has grown from 42 percent in 1993 to an estimated 56 percent in 1995, and is expected to continue growing before peaking in 1997. Argentina will have to lengthen the maturity of its foreign borrowing. The progress report also concluded that the Bank assistance strategy continued to be on track as the Government continued to take the actions required to meet the above challenges. (iii) Relevance, Efficacy and Efficiency of Bank Assistance (1985-1995) 13. This CAR concludes that the Bank's assistance strategy to Argentina was relevant throughout the ten-year period covered, especially ESW, but that the effectiveness and efficiency of the strategy was poor during 1985-89. It is too early to fully evaluate effectiveness and efficiency of the strategy in the 1990-95 period because sustainability of the reforms can only be partially assessed, the impact of some policy reforms is not yet fully known, and most projects are still ongoing. The challenge today is to achieve sustainability of the economic recovery in Argentina and to complete the agenda for public sector reform, especially in the provinces, and private sector development. Other major findings include: * the high levels of lending in the 1985-89 period were not justified by the policy reforms taken by the Government, or by a realistic risk analysis of the chances of success of consecutive attempts at reform. This was, moreover, inconsistent with the Bank's stated strategy which had set out strict conditions for continuing high levels of adjustment lending (Country Program Paper of June 1985); 9 * ESW was relevant (i.e., good diagnosis and adequate objectives) but not effective in the 1985-89 period. ESW provided useful information and policy advice all throughout the decade, and was very effective particularly in the initial years of the Menem Government (1989-92) when new lending was substantially reduced; * the Bank was slow in providing financial support when the reforms started, in the 1989-92 period (partly due to the experience with the failure of the Primavera Plan). More recently, however, the Bank reacted quickly following the external shocks of December 1994: lending has been timely and quality has improved; * project outcome ratings in Argentina have been among the lowest in LAC and Bank- wide (less than fifty percent satisfactory by end FY95). While this was largely affected by poor policies in the 1980s, high risk projects continue to exist in the portfolio (e.g. Yacireti). * the major contributions of the Bank in 1990-1995 include: * support for external debt restructuring and for restoration of private capital market access; * finance and advice for the most far-reaching public enterprise privatization program ever carried out by a developing country; * assistance for revenue mobilization, public expenditures management and Central Bank reorganization, measures which were instrumental in implementing the Convertibility Plan; * analyses of the fiscal problems of the provincial governments and the social security system; * finance and advice for financial sector reform; * studies to enhance competitiveness in capital and labor markets (included in CAS 95). * the main weaknesses in this five-year period include: * insufficient attention to the social sectors, in spite of a good analysis-and lending proposals-in the 1990 CSP. Although responsibility for the delays (or abandoning) of most of these loans rests mostly with the Government, which was devoting nearly exclusive attention to fiscal and economic reforms, the Bank should have positioned itself more clearly in support of increasing attention to social issues. In the absence of Government's interest to borrow for the social sectors, the Bank's contribution was forced to be limited to studies financed through technical assistance and ESW; * transfer of responsibilities to province-level governments without an adequate assessment of their financial and institutional capacities. The Bank supported the Federal governments decision to transfer these responsibilities to the provinces to help the fiscal situation of the Federal Government. It was 10 expected that improvements in tax administration, which had increased revenues by about 27 per cent a year to the provinces in 1991 and 1992, would be sufficient to finance their new responsibilities. However, no assessment of the financial and institutional capabilities of the provinces was done. * overoptimism of the 1994 Country Assistance Strategy that anticipated the end of adjustment lending with only one such loan (for Provincial Reform) in FY95. This overoptimism was in contrast with the more sober (and, in retrospect, prescient) assessment of the 1992 Country Strategy Paper discussion of Argentina's vulnerability to a sudden reversal of capital flows, which recognized the weaknesses of the domestic financial sector; 14. An additional and more generic issue emerging from the Argentine experience refers to a potential conflict for SALs and particularly SECALs, between the objective of resource transfer to achieve macroeconomic purposes and the sectoral or subsectoral reform objectives. A clear example of this conflict appeared in Argentina when the second tranche of the Agricultural Sector Adjustment Loan was disbursed in late 1987 to achieve the resource transfer objective but in the absence of the agreed sectoral reforms. This conflict has appeared also in other countries and could be faced again in Argentina in connection with the package of the SECALs approved in 1995. (iv) Recommendations 15. The main lesson of this CAR is the need to avoid high levels of lending in the absence of a well designed and credible policy reform, as it happened in Argentina during the 1985-89 period. The specific lessons and recommendations for the future assistance strategy to Argentina are that the Bank should: * Continue supporting policy reform. Although the situation has improved, the country has not yet achieved full access to the institutional financial markets, as have Chile or Colombia. Therefore, the Bank should continue to support policy reform with a variety of lending and non-lending instruments, and to facilitate private sector development in collaboration with IFC and MIGA. * Focus on afew areas of high priority. Given the high levels of technical capabilities in Argentina, the Bank should focus on a limited set of issues of high developmental priority and where the Bank's involvement may make the biggest difference. The 1995 Bank assistance strategy, involving province-level reform, municipal development, financial sector strengthening, export promotion, poverty reduction, health, education, energy, and environmental reform may be too comprehensive. * Concentrate on the fiscal problems of the provincial governments and of the social security system. These are among the highest priorities for reform. But both of them are intertwined with the continuing need to address health and education services (mainly provided by the provinces) as well as welfare needs of the poorest groups (including old-age pensioners). Concentrating on these social services will have the double effect of ameliorating poverty and addressing fiscal issues of the provincial governments. This is now at the core of the objectives of economic stabilization 11 (addressed in the April 1995 CAS) as well as of poverty alleviation and political feasibility of reform. Two other areas of importance (also addressed in the 1995 CAS) are the expansion of a competitive private sector and the recovery from the aftershocks of the 1994 Mexico crisis. While the Bank should certainly be engaged in these two areas, the first group of issues (social services, finances of the provinces and social security) should continue to be the highest priority. * Avoid changing the focus of the Bank's development assistance strategy in response to transitory changes in capitalflows or macroeconomic results. The main elements of the development agenda for Argentina in 1995 were not significantly different than in 1994 or in 1992, while the focus of the Bank's assistance strategy changed significantly. While additional lending was appropriate to deal with the financial crisis of 1995, the areas of Bank attention should remain more stable to maximize sustainable impact. * Have clear and simple objectives for each instrument. The unsatisfactory outcomes of some past lending operations was due to a multiplicity of objectives to be achieved with a limited number of lending instruments, and particularly to the coexistence of resource transfer objectives for macroeconomic purposes, together with sectoral or subsectoral objectives in the same operation. Oftentimes, the latter were sacrificed to the former (e.g. the Agricultural Sector Adjustment Loan of FY86). New lending instruments should be piloted to induce responsiveness and flexibility in lending in response to unforeseen circumstances without compromising sectoral objectives. * Treat ESW as a distinctive instrument with its own objectives (not just a prelude to lending) and evaluate its impact. ESW should be integrated in the CAS as an independent instrument with its own objectives, only one of which is to provide the analytical basis for lending when so required. The relevance, efficacy, and efficiency of ESW for furthering the objectives of the CAS should be subject to ex post evaluation. * Sustain progress towards better economic analysis ofprojects. Two recent Bank- wide studies (ECON I and ECON II) included a sample of projects in the Argentina portfolio as part of their Bank-made sample. The findings regarding the Argentina projects were worrisome as the quality of economic analysis was found to be poor or marginal for projects accounting for 52 percent of the volume of lending. This CAR, however, extended the ECON-type analysis to a much larger sample of projects in the Argentina portfolio (for projects approved in the 1990-95 period) and found significantly better results, with poor or marginal economic analysis in 29 percent of the lending volume. Although it has improved, the Region needs to continue to make efforts to enhance the quality of economic analysis of projects further. * Improve project supervision and country portfolio reviews. Improvement in country portfolio performance is of high priority and prompt corrective action is needed. Monitoring progress in this area can take place by looking at completion ratings in the near future and by measuring trends in the historically high disconnect (the difference between the number of projects that are rated as problem project during their last year of implementation and those whose outcomes are rated as unsatisfactory at 12 completion). This disconnect is, in Argentina, among the highest in the Bank at 47 percent. The overoptimism in assessing the portfolio (evidenced in the past by the high disconnect) needs to be fully eradicated. * Assess and manage risks clearly and explicitly. OED's review of lending operations and of country strategy documents in this CAR concludes that the lack of timely reaction to identified risk was a characteristic of most lending operations and country strategies reviewed. Often, risk was acknowledged but contingency plans to deal with risks were not made. * Use explicit performance indicators to guide program implementation. Assessment of progress in achieving priority objectives requires monitorable performance indicators. For fiscal performance, reduction and measurement of the structural deficit was correctly noted as important by the Region but no subsequent efforts have yet been made to track it. Other indicators should also be developed to follow-up on the provincial finances, health and education objectives, and social security as well as in other areas. 1. Bank Assistance Strategy: Towards A Sound Policy Dialogue 1.1 This chapter details the evolving relationship between Bank assistance and the Argentine Governments' reform policy over the entire 1985-95 period. The story suggests an often uneven balance between the Bank's objectives and the instruments used by the Bank to support these objectives. But it also suggests that the sound diagnosis of Bank management and its persistent financial and analytical support eventually paved the way for the strong collaborative relationship that exists today. In the end, a frequently rocky relationship yielded fruit: Argentina's success is also the Bank's success. About the Analysis 1.2 The analysis of Bank assistance operations examines three distinct periods: 1985-89, in which vigorous Bank assistance was continually stymied by disappointing attempts by the Government to redress the country's macroeconomic instability; 1990-94, in which the Bank's initially cautious assistance agenda intensified deliberately as another presidential administration made impressive strides toward economic reform; and the current period (1995-96), in which Bank assistance must now help Argentina address its remaining economic priorities so that the country can sustain its solid economic recovery. The analysis itself encompasses three broad components: * Measures of Performance. The analysis examines the relevance and efficacy of Bank assistance strategy.' The assistance strategy has relevance if its objectives are based on a correct diagnosis and if the instruments of the strategy are adequate for achieving those objectives. The assistance strategy has efficacy if the assistance instruments actually achieve the objectives. * The Assistance Instruments. The analysis examines the two main components of the Bank's assistance package-lending and economic and sector work (ESW). Lending encompasses financial assistance in the form of structural adjustment, investment, and technical assistance targeted at specific developmental objectives. ESW and technical assistance encompass analytical work targeted at supporting subsequent lending operations, or to assist policy dialogue. * Assessment of Outcome. The criteria to determine effectiveness of ESW was based on a judgment of: (i) soundness of the technical analysis, given (a) knowledge at the time, and (b) present understanding; (ii) congruency with Government thinking at the time; and (iii) action orientation of the analysis. The effectiveness of lending was judged on the basis of the assessment of outcome after project completion reflected in Project Completion Reports (PCRs), Implementation Completion Reports (ICRs) and/or Performance Audit Reports (PARs). To judge projects that are still ongoing and/or have not yet been subject to evaluation in PCRs, ICRs or One other analytical dimension of operational management-efficiency-provides a useful measure for assessing the comparative costs of assistance projects; but because data for its analysis are available only for a handful of completed assistance projects, our assessment of efficiency provides merely illustrative material in this chapter. 14 PARs, OED expanded the analytical methodology of research recently undertaken under ECON I and ECON II studies to evaluate the quality of economic analysis at entrance.2 Box 1.1. Argentina At A Glance Argentina is an upper middle income country, with a population of about 33 million (86% of which lives in urban areas), located in the south-east coast of South America. Its land area is about four times the size of Texas (US). Per capita GNP in 1993 was $7,220 (World Bank Atlas Method). Average life expectancy is 72 years and the literacy rate is about 95 percent. The economic structure. Argentina has impressive human and natural resources. It has reserves of petroleum and natural gas. It is well endowed in minerals such as lead, zinc, tin, copper and iron. Rich temperate plains known as pampas are Argentina's richest natural resource, producing large quantities of wheat, corn, sorghum, soybeans, and sunflower seeds. The pampas also provide year-round pasturage for Argentina's cattle industry. The country is one of the world's largest exporters of foodstuffs. Agriculture is about 15 percent of GNP, but about 70 percent of exports. Industry is about 23 percent of GNP, concentrated mainly on food processing, motor vehicles, consumer durables, textiles, metallurgy, and chemicals. Political developments. Argentina was ruled by several military regimes during most of the century with brief civilian governments in between. In 1983, Argentines elected Rafil Alfonsfn as president in a democratic election. He stayed in office for six years until democratic elections in 1989 in which Carlos S. Menem was elected. President Menem won re-election for a second term in office in 1994. Next presidential elections are scheduled to be held in 1998. Economic developments. Argentina had suffered from decades of economic mismanagement when the new democratically elected government of President Alfonsin took office in 1983. After seveial failed attempts at stabilization during his administration, the economy ended with a severe hyperinflation crisis in 1989. Newly elected president Carlos Menem took office in mid-1989 and moved rapidly to implement a sweeping adjustment program, initiated immediately after inauguration. The core of the program was a comprehensive privatization agenda, inflation-reduction and price stabilization measures, tax reform, and other fiscal policies-all of which was packaged later (in April 1991) as the Government's Convertibility Plan (box 1.5). The Convertibility plan was successful in controlling inflation and reestablishing growth. Inflation moved from extreme hyperinflation in 1989 to an annual inflation rate of 3.9 percent in 1994; and growth moved from stagnation to an annual average of about 8 percent in real terms in 1991-93. However, the fact that Argentina's economy had a weak financial system and rigid labor markets made the plan extremely vulnerable to shocks. The Mexican crisis of 1994 made evident the vulnerability of the Convertibility plan. The prompt response to the crisis by Argentina's government, however, was able to quickly reestablish the credibility of the economic program. But the crisis strengthened the necessity for deeper financial and labor reforms, as well as for public administration reforms, particularly at the provincial level. 1.3 In the early 1980s, Bank assistance to Argentina averaged about US $160 million annually in loans and about 100 staffweeks annually in economic and sector work-comparatively modest amounts given the size and prominence of the country in Latin America. The Bank had decided not to risk excessive involvement in a country with so many negative economic indicators, even if the country did hold high potential (box 1.2). The country 2 Economic Analysis ofProjects: Towards a Results-oriented Approach to Evaluation, June 30 1992; and A review of the Quality of Economic Analysis in StaffAppraisal Reports for Projects Approved in 1993, May 5, 1995. 15 was suffering from the legacy of extensive government intervention in the Argentine economy since the early 1960s, which had inhibited productivity and fueled inflation. But when the democratically elected government of President Alfonsin assumed office in June 1983, pledging that it would tackle its economic woes, the strength of his commitment offered newfound optimism that the donor community could substantially increase its assistance to the country with productive results. The IMF seized upon the opportunity immediately; two years later, the Bank joined in with increased lending. Box 1.2. Argentina. High Potential but Poor Performance High Potential Argentina Brazil Korea Portugal Population 1983 (million) 28.8 129.7 40.0 10.1 GNP per capita 1983 2,030.0 1,890.0 2,010.0 2,230.0 % Agriculture in GDP 1983 15.3 12.7 14.0 8.0 % Industry in GDP 1983 35.4 32.7 39.0 40.0 % Services in GDP 1983 49.2 54.6 47.0 51.0 Poor Performance Real GDP Growth Rate 1973-83 0.4 4.8 7.5 n.a. Gross Domestic Investment/GDP 1983 14.2 18.1 27.0 29.0 Exports GNFS/GDP 1983 14.7 11.3 37.0 32.0 Resource Balance/GDP 1983 5.7 1.9 -1.0 -13.0 Gross National Savings/GDP 1983 10.9 9.6 24.4 11.4 Debt Service Ratio 1983 70.6 47.4 13.6 26.7 Reduced Lending Program Nominal IBRD (US$ million) 805.0 5,323.0 2,844.5 574.3 Annual Lending per capita (US$) 5.6 8.2 14.2 11.2 Annual Constant per capita 1985 (US$) 6.8 9.5 16.6 14.0 Source: Argentina Country Program Papers 1985; World Development Indicators. The 1985-89 Period: Persistent Macroeconomic Instability Bank Strategy in 1985-89. Stabilize the Economy by Supporting Export-Led Growth 1.4 Bank management decided to reconfigure its assistance strategy in Argentina in 1985 because, as the 1985 Country Program Paper recognized, "The turn to a democratically elected and stable Government has improved the prospects for constructive Bank cooperation." The Bank's objective was to release significantly greater net disbursements to Argentina because the country lacked access to private international lenders, and to support the process of opening the economy and attracting private investment. The approach was to promote Government efforts to stabilize and reactivate the economy by pursuing export-led growth and increasing the availability of foreign exchange. In essence, Bank management correctly judged that the ability of the Government to achieve macroeconomic stability was essential to the country's future growth and development, and made its assistance contingent on successful progress on this economic front. Yet its assistance instruments were not targeted at stabilization, allowing the IMF and the Government itself to pursue stabilization objectives. In fact, short-term fiscal, monetary, and balance-of-payments targets had been set under a Standby Agreement with the 16 Fund, so the Bank's role in these areas was expected to be supportive but passive. Thus, the Bank pursued structural adjustment and investment objectives. Its first lending instruments sought to strengthen the export capacity and competitiveness of agriculture and industry, rationalize the development and use of hydrocarbon resources, reform public-sector management, support reforms in the banking sector, and provide some limited support in infrastructure and human resource development. 1.5 For its part, Argentina's strategy was to improve public finances, primarily with emergency measures to increase fiscal revenue and reduce overall expenditures, and to implement a heterodox program to control inflation with foreign exchange controls and wage and price freezes. It promulgated these objectives in the Plan Austral, the first of four stabilization plans attempted by the Government during the 1985-89 period (box 1.3). Yet the Government (and the Bank) did not focus on perhaps the most crucial ingredient of successful macroeconomic stabilization-changing the overall structure of the public sector, especially the ownership of public enterprises. 1.6 The Bank approved lending of US $3.2 billion for FY85-89; about half (48 percent) was for structural adjustment. This vigorous program of Bank assistance included a phased approach linked to the Government's commitment to stabilizing the economy. Bank management conditioned the disbursement of assistance "on the basis of compliance with the targets of the stabilization program, success in expediting disbursements of existing loans, initial performance under new operations, and receptivity to the Bank's advice" (CPP, June 10, 1985). It thus devised its assistance program in two phases, the second one to start in FY87 if the Plan Austral achieved macroeconomic stabilization. 1.7 Stabilization was not achieved, despite the Bank's pronouncement that the Plan Austral was a "qualified success." In fact, all macroeconomic indicators pointed to its failure. Yet, rather than withdrawing its support, the Bank supported another Government attempt at policy reform in early 1987, (the Plan Australito). This plan contained many of the same policy elements that were at the heart of the previous plan, and the Bank was targeting similar objectives. The specific stated objectives of the lending strategy were export diversification, financial reform, energy development, industrial development, and fiscal deficit reduction (Divisional Country Brief, February 1987). Within less than two years, however, the Government failed to muster the political will to meet the loan conditions attached to the Plan Australito-most particularly, timely compliance with specific actions designated as part of its reform program. The Bank urged the Government to try yet again to achieve macroeconomic stability and reduce its excessive fiscal deficit and external debt-and this time becoming involved directly in the planning and preparation of the program. The third major effort at reform-the Plan Primavera-was adopted in August 1988. The Plan was different, in several respects, from the earlier attempts at reform. Its new aspect was its link to the Bank's belief that the underlying causes of Argentina's deficit would have to be resolved only over the long term; as such, rationalization of the public sector was an essential element. But the Plan lacked a strong fiscal package to address the short-term internal and external financing problems, counter to what the IMF was recommending and contrary to initial Bank strategy. The specific objective of the Bank's lending Other minor efforts included a wage and price freeze in October 1987 and two failed efforts in 1989: the "BB Plan" (July 1989), based on price agreements with the private sector and foreign exchange controls; and the "BONEX Plan," based on restrictive monetary policy and free foreign exchange market with managed floating. 17 Box 1.3 Economic Programs and Bank's Lending Policies (1985-1989) Argentine Policies Bank Lending Policies Plan Austral Price Policy: Wage and price freeze. Country Program Paper (June (June 1985) Mandatory conversion scale for existing 10,1985) contracts. Exchange Rate Policy: Lending Strategy: Approval of Foreign Exchange Control. Fixed fourfold increase, from average exchange rate first and crawling-peg US$160 million a year in FY80-84 to afterward. Monetary Policy:Active in average US$640 million a year in the beginning and passive later. Eial 1985-89. Objectives: Reactivate Policy: Restrictive. Emergency economy through export-led growth, measures to increase fiscal revenues. increase availability of foreign exchange, and stabilize the economy. Conditions: Strict compliance with targets of stabilization program. Lending to be reviewed in 1987. Plan Australito Price Policy: New wage and price Divisional Country Brief (February (February 1987) freeze. Exchange Rate Policy: Fixed 1987) exchange rate first and crawling-peg Lending Strategy: Increase lending to afterwards. Monetary Policy: No average US$900 million a year in change. Fiscal Policy: No change. FY87-91 Objectives: Export diversification, financial reform, energy development, industrial development, and fiscal deficit reduction. Conditions: Timely compliance with action program. Will reassess lending if Government is unable to bring inflation down and if reforms to banking and trade sectors are delayed. Plan Primavera Price Po . Agreement to Trade Policy Loan (October 3, 1988) (August 1988) progressively reduce private and public Lendine Strategy: Continue lending at sector prices. Exchange Rate Policy: about US$1 billion per year (package Multiple rates for commercial of US$1.25 billion approved in transactions. Free market for financial October). Objectives: Support transactions. Plan to gradually unify the country's reforms in trade rate, starting in April 1989. Monetw liberalization, financial system, public Policy: Very active: policy would be sector rationalization, industrial calibrated to hold the parallel exchange development, and energy development. rate at 20-25 percent above the official Conditions: Disbursements of the exchange rate- Fiscal Policy: No fiscal US$1.25 billion package limited to up package. to US$150 million (first tranche of Trade Policy Loan) if the program went off track. Presiden New government takes office on July 8, Country Strategy Paper (June 28, Menem's 1989. Announces new economic 1990) Program. program on July 9, 1989: Privatization Lending Strategy: Situation in (July 1989) laws get enacted: Law for the Reform of Argentina perceived as fragile. the State (uly 17, 1989) and Law of Strategy recommends that prudence be Lconomic Fmergency (September 1, adopted and that flexibility be built into i989j. Stahilization based on targeted the lending program. No more than primary iici surplus of 6% of GDP. one large lending operation a year. Objective: Support reform efforts through dialogue and the preparation of SALs. Conditions: Review progress by 1991. 18 strategy in support of the Plan Primavera was to support the country's reforms in trade liberalization, financial system, public sector rationalization, industrial development, and energy development (Trade Policy Loan, October 3, 1988). In the end, the real culprit of the fiscal deficit and macroeconomic instability was the ownership structure of public enterprises-a problem that would ultimately be tackled by the Government itself. 1.8 Support for the Plan was controversial within the Bank and between Bank and the IMF, who argued that the Government was not serious enough about progress on the fiscal front. Some internal reviewers warned that the plan did not close the external or domestic accounts. In the end, Bank reviewers and IMF fears were borne out. The Plan Primavera was insufficient to bring about macroeconomic stability, and in fact its failure led to a severe hyperinflation crisis in early 1989. Ultimately, the Bank's decision to support implementing the Plan Primavera provided the cornerstone for an agreement between the Bank and IMF about areas of responsibility for assistance (box 1.4). Box 1.4. The Plan Primavera: A Contentious Issue among the Bretton Woods Institutions In August 1988, a few months before presidential elections, the Government of President Alfonsfn made what would be its third and final effort to stabilize the economy-the Plan Primavera. Bank management was eager to support the stabilization plan, and was thus involved directly in preparing and implementing it. But support for the plan was controversial both within the Bank and out; some internal reviewers, notably the Office of the Vice President and Chief Economist, warned that financing for the plan did not close the external or domestic accounts, and the IMF decided that it would not endorse the plan because the Government was not making a sufficient fiscal effort. The extremely high risk of failure would normally have led Bank management to reject the plan before negotiations, but it chose not to in this case. Evidence suggests that pressure exerted by the Bank's major shareholder and urgency for Argentina to repay a bridge loan from the U.S. Treasury were economic and political considerations that favored financing the plan. Amid intense discussions, the Bank's Executive Directors approved a package of four loans, with one negative vote and two abstentions plus one abstention on one of the loans. The package included a total of US $1.25 billion to support a Second Trade Policy Loan, a renegotiated Banking Sector Loan, a Housing Sector Loan, and a Power Sector Loan, all of them quick-disbursing. But the Bank did recognize the risks involved, and deliberately designed the package so that disbursements would be limited to US $150 million if the program were to go off track. (The major findings of a performance audit of several of these loans are summarized in Report No. 13223 of June 28, 1994 and in Pr6cis No. 69 of June 1994.) When the Plan Primavera did not stabilize the economy and in fact led to the country's worst episode of hyperinflation ever in 1989, the Bank was forced to cancel 54 percent of the lending approved to support the plan; in fact, of the rest, 22 percent was rated as unsatisfactory. But perhaps the positive lesson here comes from the intense negotiations among the donor community about whether the plan should be financed. The discussions and the final outcome of the plan had weakened the relationship between the Bank and the Fund. This resulted in a formal clarification of their respective roles with the signing of an agreement (Concordat) on Bank-Fund collaboration, whereby the Fund takes the lead in short-term macroeconomic programming and monitoring, while the Bank deals with the institutional underpinnings of macroeconomic policy. After this episode, there was greater collaboration and consultation between the two institutions, as well as joint missions and policy briefs. 1.9 Shortly thereafter, Argentina's presidential elections led, in mid-1989, to a new Government, headed by President Carlos Menem. Without assurance that its lending would be targeted at urgent structural reform, the Bank decided that it was time to pull back-that it could not approve further lending risking unsatisfactory results later on. The Bank strategy was 19 formally presented to the Board on June 28, 1990 and recommended that prudence be adopted and that flexibility be built into the lending program. Paradoxically, this early period of a serious, committed Menem administration was ripe for a greater influx of Bank lending assistance, which, however, did not materialize until the next phase of the Bank's assistance operations in Argentina. Lending had become difficult to achieve because the Bank found it hard to lend without IMF in place after the failure of the Primavera Plan and the resulting concordat with IMF. Yet the Bank did maintain its long-term relationship with the country in the form of ESW-backed policy dialogue-which would be crucial to the Bank's renewed involvement in the country just a couple years later. Relevance of the 1985-89 Strategy: A Correct Diagnosis but Insufficient Treatment 1.10 Although the Bank correctly diagnosed the core problem with Argentina's economy in the 1985-89 period-the absence of private-sector investment in the face of macroeconomic instability, and a heavy fiscal deficit and external debt that was inhibiting sustained investment and economic growth-the design of the Bank strategy was flawed, because it failed to seek fundamental changes in the existing institutional framework. In particular, although Bank strategy recognized the weakness with the ownership structure of enterprises, it sought merely to improve public sector management, improve public investment planning, and extend emergency measures to increase fiscal revenue and to reduce expenditures, but without encouraging the Government to change the ownership of public enterprises. And although the exchange rate policy varied over time, it essentially remained within the existing institutional setting. Monetary policy was also active at times and passive at others, but the nature of the Central Bank's functions and limitations were not changed. In summary, although the diagnosis of the problems and the objectives sought were adequate, most of the recommendations were weak, possibly because the Bank often perceived that the changes were not politically feasible. Within this framework, it became impossible to achieve macroeconomic stability, and the climate for successful lending deteriorated. 1.11 The Bank continued its financial assistance during the Plan Primavera despite evidence of many failed earlier attempts by the Government to stabilize the economy. But the Bank decided to support the Plan Primavera, not so much because it was optimistic that the Government would embark on large-scale reforms, at the end of its electoral mandate but because it wanted to maintain a sound policy dialogue on the Argentina's economy, largely in fears that if the economy became uncontrollable the Government could default on its external loans. In the view of a participant in the Bank's decision-making process, "Management backed the plan mainly because the Bank foresaw the risks if the government lost control of the economy a full year before elections."4 The same participant concluded that the Bank was taking a calculated risk that "allowed the country to buy time to maintain its electoral calendar broadly intact, while building a constituency for structural reforms, preventing default to the Bank, delaying the accumulation of arrears to the Fund, and taking incipient steps in tax reform and administration that later served the new Government well." This CAR analysis agrees with the view that support for the Plan Primavera helped maintain its relationship with the country while minimizing exposure, so that the Bank was ready to help when the opportunity arose. The support was indeed provided in the context of a "calculated risk" strategy that was to minimize Internal Bank Document. 20 (and did minimize) disbursements in case of an early derailment of the program. But the advisability of taking such high risks is open to question. Moreover, the failure of the Plan Primavera forced the Bank to adopt a cautious lending strategy at a time when, as it turned out, the Government could have benefited from more assistance. The burden of proof for further loans was placed on Argentina, and the Bank decided "to monitor the progress made in Argentina's discussion with commercial banks" (CSP, June 28, 1990). By 1992, proof of success had been demonstrated. Efficacy of the 1985-89 Strategy: Ineffective Outcomes but a Basis for Future Support 1.12 The efficacy of lending strategy of the 1985-89 period was low: most of the already evaluated loans (84 percent of the amount) did not achieve their objectives. Some lending instruments (16 percent) did achieve their objectives, but only after loans that were performing poorly were reformulated during the Menem period. Most of the nonlending strategy also had a low level of efficacy in the short term because, although most of the economic and sector work was relevant, it failed to provide a foundation for structural reform. It is worth noting, however, that passing judgment about the effectiveness of the Bank's advice on the basis of ESW alone is misleading. Much of the better economic advice was often the result of studies financed through project preparation and technical assistance. These studies, for example, were essential for assisting the successful effort at privatization initiated by the Government of Argentina in 1989 (discussed in depth in chapter 2). When the Government showed a clear determination to go ahead with its reform program, the Bank diverted funds by restructuring old loans and reformulating ongoing technical assistance to finance studies that were fundamental to the implementation of the reforms. 1.13 Main Positive Results. The outcome of two major loans approved during 1985-89 were rated as satisfactory-the Second Trade Policy Loan (TPL II) for US $300 million, approved in October 1988, and the Gas Development project for US $180 million, approved in 1985. But the positive outcomes of TPL II came largely when its second tranche disbursement was released as fiscal policies improved in 1990, during the initial months of the Menem administration. Those of the Gas Development project came largely in the form of funds for expertise and studies that ultimately proved useful when the Menem Government embarked on a privatization program early in the 1991-94 period (discussed in depth in chapter 2). Two smaller technical assistance loans also yielded satisfactory results-one for public-sector management, approved in June 1986, and one for tax reform, approved in January 1989. These technical assistance loans also provided grist for later reform efforts and successes. It appears that the more intense dialogue, expert studies, and technical assistance throughout this period yielded more positive results than did the Bank's lending. 1.14 Main shortcomings. During the 1985-89 period, the Bank continued to increase its exposure despite the absence of macroeconomic stability-in contradiction to the approved strategy to make the Bank's assistance contingent on successful stabilization. For example, in 1985-86, the Bank lent US $296 million to support efforts to rationalize the development and use of hydrocarbon resources, but the assistance yielded disappointing results: the outcome of a Gas Development Project for US $180 million was declared satisfactory only after it was reformulated during the Menem administration, and the outcome of a Refinery Conversion project for US $116 million was declared unsatisfactory because it did not follow through on its strategic design. Both loans faced problems because the financial situation of the executing 21 agency, Yacimientos Petroliferos Fiscales (YPF), deteriorated severely under the country's general macroeconomic situation (PAR no. 14784, June 30, 1995). Lending to support agriculture, US $350 million in 1986, was a failure (PAR no. 11925) because it did not introduce the required policy changes; yet it was fully disbursed because of "resource transfer objectives" (PAR no. 11925, August 28, 1993). A water supply project, approved by the Board on June 1985, is still ongoing and has faced difficulties. 1987 loans to support small scale industries (US $125 million) and to restructure the port of Bahia Blanca (US $50 million) were canceled due unsatisfactory performance. A trade policy loan for US $500 million was approved in May 1987 and was fully disbursed, but its outcome was rated as unsatisfactory because the policy reform it supported-trade liberalization with the lowering of import duties-was reversed when the Government was forced to increase taxes to reduce the fiscal deficit. Lending to support the electric power sector in 1987, SEGBA V, is still ongoing and faces the difficult task of rescuing the Yacyretf Hydroelectric project, whose outcome has thus far been rated as unsatisfactory. Efficiency of the 1985-89 Strategy: Too Expensive per Unit of Output 1.15 An analysis of the efficiency of Bank assistance is possible only for the 1985-89 period, because not enough time has elapsed to evaluate the efficiency of projects for later periods. The evidence corroborates what the analysis has suggested thus far. If the strategy for the 1985-89 period is assessed against the outcomes it achieved during that period only, it would have to be considered very expensive per unit of output, and even more so per unit of satisfactory output. Lending and supervision averaged 251 staffweeks per project approved in 1985-89 (902 staffweeks per satisfactory project approved) and 377 staffweeks if other costs, such as economic and sector work, aid coordination, and program support, are added. The 1990-94 Period: Initial Caution, and Increased Lending Later in the Period Bank Strategy in 1990: Flexibility to Address Uncertainty 1.16 By 1989-90 the trauma of extended recession and hyperinflation had created fertile ground for serious, committed reform in Argentina. It was to come, to most observers' surprise, from the newly elected, populist administration of Carlos Menem, who assumed office in 1989-six months before President Alfonsin was officially required to step down. By that point, the Bank was skeptical that meaningful reform would ever be undertaken by the country, and, initially, it retreated to the sidelines. But the new president did in fact swiftly tackle the country's long-ailing economy. Immediately after his inauguration (July 8, 1989), President Menem announced a new economic program. The core of the program was a comprehensive privatization agenda launched with the enactment of the Law for the Reform of the State (July 17, 1989) and the Law of Economic Emergency (September 1, 1989). By 1991 an economic transformation had occurred, founded on solid government (and country) ownership of a far- reaching reform program. At the heart of the program was an ambitious privatization initiative, inflation-reduction and price stabilization measures, tax reform, and other fiscal policies-all of which culminated in the Government's "Convertibility Plan" of 1991 (box 1.5). The Plan quickly arrested the spiraling inflation rate, which in turn boosted confidence in the economy, attracting an influx of private capital. 22 1.17 Meanwhile, the Bank responded cautiously to this changing political and economic climate, reintensifying the dialogue but keeping its lending program low given the marginal creditworthiness of Argentina's still fragile economy and the increased Bank exposure through the high lending volumes of 1985-89. In essence, despite the first positive signs of economic recovery in the country, Bank management did not want to risk being stung again; yet it did not want to abandon its presence in Argentina either. 1.18 There were several positive signs like the enactment of the Law for the Reform of the State in July 1988, the Law of Economic Emergency in September 1989 and the approval of a Fund Stand-by for SDR 1.1 billion in November 1989, but the fiscal situation worsened in early 1990, inflation returned to about 95 percent in March 1990, and the Fund Stand-by needed to be modified in November 1990. Thus, the 1990 CSP recommended a prudent assistance strategy, calling for "only one adjustment loan [a year in FY91-92], unless [Argentina's] adjustment is truly remarkable." The Bank was placing the burden of proof for further loans on Argentina, and decided "to monitor the progress made in Argentina's discussions with commercial banks" to determine whether the country was making meaningful efforts to clean its financial house by reconfiguring its commercial debt (Country Strategy Paper, June 28, 1990). 1.19 Bank assistance in 1990 was mainly devoted to restructuring old lending, reformulating technical assistance, and providing expert analytical advice to the Government. New commitments for FY91-93 were oriented heavily toward structural adjustment or technical assistance linked to structural adjustment to reduce the fiscal deficits. In essence, the Bank believed that slow progress on the fiscal front risked jeopardizing the sustainability of the macroeconomic gains that were being made by the new Government. 1.20 The Bank's strategic decisions in 1990 were influenced by the poor economic track record of the country, the unlikelihood of a viable external financing plan, a risk rating that had just been downgraded to marginally creditworthy, and the perception that the political climate of the country was still uncertain. In particular, Argentina suffered from three critical shortcomings that were recognized by the Bank in its ongoing dialogue with the new Government: * Fiscal deficit. The most critical economic issue facing Argentina, was as it had been for many decades, the fiscal deficit. As part of its initial economic and sector work (ESW) strategy, the Bank provided the Government with detailed analytical studies of fiscal issues. In addition to traditional tax and expenditure issues, the studies correctly diagnosed three sources of the pervasive fiscal disequilibrium in Argentina: the deficits of public enterprises, the deficits of the province-level governments, and the deficits of the social security system. * Financial sector. The other pressing structural need was to strengthen the financial system of Argentina, also a long-standing problem. The Bank's failed attempt at supporting a reform of the banking system in 1988 and the hyperinflation crisis of 1989 further increased the urgency of dealing with financial sector problems. The Bank responded with several ESW and technical assistance studies that pointed out to weaknesses in the financial sector, and particularly with province-level banks and the capital market. 23 Box 1.5. The Convertibility Plan: The Menem Government's Answer to the Country's Economic Woes The Convertibility Plan gets its name from the Convertibility Law of 1991, but it represents a much wider set of measures aimed at the complete and permanent adjustment of the economy. The main pillars of the Convertibility Plan are: (a) Monetary Reform, through the Convertibility Law, subsequently supplemented by the Charter of the Central Bank; (b) Fiscal Reform, initially through a sharp improvement in the administration of the tax system and later through a redefinition of tax instruments and rates; (c) State Reform, through an ambitious and successful plan of privatization and deregulation of factor and product markets; (d) Social Security Reform, allowing for a new capitalization mechanism operated by the private sector; and (e) Trade Reform, through the elimination of export taxes and most quantitative restrictions on imports, and; reduction of the level and range of import tariffs. The Convertibility Law The Convertibility Law of April 1991 fixed the rate of the Austral at 10,000:1 to the dollar. On January 22, the Austral was replaced by the Peso at the fixed rate of 1:1 to the US dollar. The Law also established that the monetary base could not exceed the dollar value of international reserves, and prohibited all indexation in the goods and labor markets. The Convertibility Law, in practice, made the Central Bank into a Currency Board by mandating a 100 percent international reserve requirement for high-powered money. Under this system, variations in international reserves have a direct impact on the economy through changes in the money supply and the real interest rate. The Central Bank can exert discretion through the use of variable bank reserve requirements, and excess international reserves. To ensure the full reserve backing, the Law set other conditions on the behavior of the monetary authorities through the new Charter of the Central Bank. This Charter, approved by Congress on September 1992, established the independence of the Board of Directors, all of whom are ratified by Congress, and provides fixed terms of tenure for the appointees, including the president. This Plan also encourages prudent fiscal management, since there is no significant scope for monetizing fiscal deficits. The Central Bank Charter permits a maximum of 20 percent (in emergencies raised to 33 percent) of reserves backing the monetary base to be in dollar-denominated government bonds (e.g., BONEX). Issuing base money against BONEX allows the Central Bank to regulate short run fluctuations in market liquidity through swaps. Additionally, the Charter dictates that the Central Bank cannot take any new interest earning liabilities, and it cannot remunerate reserve requirements. These measures eliminate the possibility of generating Central Bank liabilities other than those used to acquire international reserves; the Charter does not allow the Central Bank to significantly guarantee commercial bank deposits (i.e. deposit insurance). This substantially reduces the role of the Central Bank as a lender of last resort, both for the peso and for the domestic dollar deposits system. Nevertheless, in an emergency the Central Bank can provide for a limited time, liquidity up to 100 percent of a bank's capal. An important feature of the Convertibility Plan is its bi-monetary nature, which permits the use of foreign exchange for market transactions, or the holding of foreign exchange denominated liquid assets in the domestic financial system. Dollarization has contributed to enhancing the credibility of exchange rate policy, since it reduces vulnerability under a fixed exchange rate, because portfolio shifts from domestic to foreign currency denominated deposits, or vice versa, would not necessarily involve a reduction in total domestic bank deposits. Under a dollarized system, where fractional reserve requirements are in effect, the concept of lender of last resort takes on a different dimension, since part of the liabilities of the banking system are dollar denominated, and the Central Bank cannot print dollars to fulfill that function. In a crisis, high bank reserve requirements, excess international reserves, or a foreign lender of last resort are needed to fulfill that function. Source: Country Assistance Strategy, Report No. 142278-AR, April 10, 1995. 24 Social services. Education, health services, and social assistance had long suffered from the economic crises of the 1980s and from the general decline of public sector management. The neglect of basic health services and the lack of social assistance targeting increased already high maternal and infant mortality rates and the incidence of malnutrition. Yet social issues were one area that had not been the target of attention in the Bank's lending policies. The government, on its part, was devoting most of its attention to fiscal and economic reforms. In the absence of government's interest to borrow, the Bank's contribution was mainly through studies financed through technical assistance and ESW. 1.21 Although the Bank supported efforts to diagnose the cause of these problems, it did not provide substantial lending to support the Government's effort to try and remedy them. In fact, the Bank strategy was to commit to only one major loan each year for FY91-92. Moreover, its assistance focused almost exclusively on a few important but insufficient components of the fiscal deficit, consisting primarily of four related operations: a Public Enterprise Adjustment Loan (FY91) and its related Technical Assistance Loan (FY91), which supported a comprehensive privatization program; and a Public Sector Reform Adjustment Loan (FY92) and its related Technical Assistance Loan (FY91), which enhanced tax collections, reduced expenditures, and limited the financing capacity of the Central Bank. Also as part of the reforms supported by the public sector reform loan, responsibility for secondary education was transferred to the province-level governments to reduce federal-level expenditures. Yet, to prevent the provincial governments from engaging in inflationary financing, the Government cut off their access to the Central Bank.5 Bank Strategy in 1992: High Lending and Good Diagnosis 1.22 By 1992, Argentina seemed finally to have achieved macroeconomic stability. In turn, the Bank adopted a new assistance strategy, which recommended to go back to business at full speed given the much improved political and economic climate. The Bank recognized that sustaining macroeconomic stability and economic growth would require efforts to address fiscal fundamentals, particularly the deficits generated by the social security system and province-level financing. As these fiscal areas were addressed, financial sector reform and renewed emphasis on social services would follow suit. The Bank approved an increased lending program of up to US $5 billion for FY93-97 (CSP, April 29, 1992). Most of the lending planned for the period sought to help the Government implement reforms to eliminate fiscal deficits, reduce external debt, enhance the functioning of the financial system, and improve social welfare indicators. In the Bank's (correct) view, these issues were crucial to the sustainability of the economic gains made by the Government. Yet, despite this commitment to an all-encompassing attack on the fiscal, financial, and social issues that were still on Argentina's reform agenda, the Bank's actual assistance package fell short of addressing three issues that would prove vexing later on-the growing deficits of the social security system and the province-level governments, and rapidly deteriorating social welfare indicators. Although improvements in tax administration had increased provincial revenues (see para. 1.23). 25 1.23 The Government's program to privatize several public enterprises (including petroleum and telecommunications) and rationalize public sector management was beginning to address the country's fiscal deficits. Along with the Convertibility Plan, whose fixed exchanged rate system enabled the country to curb its spiraling inflation rate, the reform measures helped stabilize the economy, and the Government began to enjoy credibility about the seriousness of its reform program. The strong economic climate enabled the Government to reach agreement in principle with commercial banks to settle arrears and reduce debt service to fiscally sustainable levels; it also negotiated with the IMF for a three-year extended arrangement. Wanting to retain a strong presence in the country, Bank strategy shifted to more vigorous assistance conditional on the Government's maintaining an operational fiscal surplus of 2 percent of GDP, which was considered necessary to obviate the need for inflationary financing (CSP 1992). The Bank also decided to provide up to US $750 million to enhance an upcoming "Brady deal" to support a debt and debt service reduction effort with commercial banks. The proposed amount of lending was to increase the Bank exposure by increasing Argentina's share of the IBRD portfolio to about 4.3 percent from the existing 2.8 percent, which the Bank considered ajustified and manageable risk. 1.24 But the lending effort to support fiscal-oriented structural adjustment came at the expense of other ingredients necessary for sustainable economic recovery, and it was also oblivious to other difficulties lurking on the horizon. First, the Bank was neglecting the social sector, by dropping some planned projects (see table 1.1), and it was doing nothing to address the fiscal deficits of the social security system. Although final responsibility for dropping social projects rests mostly with the government, the Bank should have positioned itself more clearly in support of increasing attention to social issues. Second, the design of the otherwise strong Public Sector Reform Loan was flawed in two important respects: it did not provide a clear analysis of the capacity of the province-level governments to handle the additional financial responsibility for secondary education, and, by closing their access to the Central Bank, it was forcing them to find other sources of financing for their deficits. The Bank expected that improvements in tax administration, which had increased revenues by about 27 percent a year for the provinces in 1991 and 1992, would be sufficient to finance their new responsibilities. However, no assessment of the financial and institutional capabilities of the provinces was done. Moreover, despite the success of the Convertibility Plan at halting inflation, its adoption in 1991 added a new dimension to financial sector reform-increasing Argentina's vulnerability to a sudden reversal of capital flows. In fact, the Country Strategy Paper of April 29, 1992, provided early warnings of its dangers-as well as of the absence of assistance in general to support financial sector reform. As the 1992 CSP put it: Real variables would not be affected if higher interest rates generated by capital outflows lead to a renewal of inflows quickly, as is entirely possible. A reduction in deposits and higher deposit rates would, however, strain still-weak domestic financial institutions, in turn leading to demands for the Central Bank to intervene as lender of last resort. This would put additional pressure on reserves, raise interest rates further and depress aggregate demand. The October 1991 reduction in the coverage of deposit insurance has reduced the Central Bank's legal obligations, but the policy response to a bank run ultimately will reflect political pressures. Over the medium term, efforts to strengthen the financial system should reduce this risk further. Table 1.1. Bank Lending Strategy: Objectives and Instruments Areas of Action of the Bank Strategy Country Strategy Paper 1990 Country Strategy Paper 1992 Country Assistance Strategy 1994 Country A ssistance Strategy 1995 1. Completion of the Structural PuLic S Rform: Base Public Sector Reform: a) Public Enterprise Public Sector Reform: Public Sector Refor: a) Provincial Reform Program Case: a) Public Enterprise Reform TA Reform II (FY93; USS300m.) b) Provincial a) Provincial Reform (Proposed strategy Reform (FY95; US$300m.); Municipal (FY91, US$23m.) b) Provincial Finance Reform (FY95; USS300m.). recommends this to be the last adjustment Development 11 (FY95; US$210) Development. (FY91, USS200 m.); operation in Argentina ) Financial Sector a) Financial Sector Financial Sector: a) Provincial Banks plus, Adjustment (FY93; US$400m). Enhancing Competitiveness: Capital Market Privatization (FY95; US$500m.); Banking Dev. TA (FY94: US$8.5m.) Sector Reform (FY96; US$500m.) /High Case: Public Enterprise Reform Enhancin Competitiveness: a) Capital Market Adjustment (FY91; USS300m ); Public Development I (FY94, USS500); b) Capital Enhancing Competitiveness Sector Reform (FY92; US$325m.)] Market Development U; c) Agricultural Credit Public Investment TA (FY96; US$I6m); .Export Promotion (FY96; US$38.5); Judicial Reform; Airport Privatization 2. Poverty Reduction and Poverty Reduction: Social Emergency Poveny Reduction: None Poverty Reduction: None PoverN teduction: a) Social Safety Net Strengthening Social Services Program (dropped later) (FY96; US$I52m.); b) Maternal and Child Health: Halth: Nutrition il; c) Rural Poverty Project. Health: a) Maternal and Child Nutrition Project (FY94; a) Provincial Health Project. a) Water Supply (FY91, USS100m.) b) USSIOOm.) Health.: a) Provincial Health Sector Health Reform II (dropped later); c) Education: a) Secondary Education Project Development (FY96; USS101.4) Health Sector Reform (dropped later). Education: None (FY95; US$190m.); b) Higher Education b) Health Sector Development II. Reform Project. Education: None Education: a)Secondary Education II (FY96; US$ 115.5); b) Higher Education (FY96; US$165m.) 3 Rebuilding Infrastructure Agricltur : a) Agric. Services and Energy and Power. Yacyreta II (FY93; Agriculture: a) Agricultural Services. Energy and Power: a) Restructured Segba Institutional Development (FY91; USS300m.). V (FY87; USS276m.); c) Prov. Develop. USS33.5m.); b) Provincial Agric. Enerpy and Power: a) Provincial Power. II (FY95; US$225m.). Development (dropped later). Grain Tran5Wt: Road Maintenance (FY93; Marketing (dropped later). US$340m.) Trants Tran pg: a) Provincial Transport I & II; a) Road Maintenance; b) Transport Sector BA Mass Transit. Energy and Powe: a) Electric Power I Roads. (dropped later). b) Power Sector III Water and Sewerage: a) Provincial Agric. (dropped later); c) Oil and Gas (dropped Water and Sewera: Development; b) Flood Protect. project; c) later); Energy Sector II (dropped later). a) Water Supply and Sewerage. Water Supply I. raaspgt: a) Road maintenance (FY93; Environmental Maagment and USS340m.) b) transport I (dropped later) Protection: a) Mining Sector Development (FY96; USS30m.). Forestry Development Industry: Industrial Finance (dropped (FY96; USS16m.); b) Industrial Pollution later) and Solid Waste Project Note: Projects approved by the Board as indicated by (FY; US$). 27 Relevance of the 1990-94 Strategy: Sound Diagnosis and Coherent Lending, But Delayed Treatment 1.25 The Bank Provided an Excellent Diagnosis of the Problems Facing Argentina. The Bank strategy documents accurately assessed the problems confronting Argentina just before and after President Menem took office. Sound diagnosis started with the economic and sector work and project preparation process of the earlier period, which provided an analytical basis for assessing the comprehensive reforms initiated by President Menem's administration. In particular, the earlier ESW studies supplied data that provided functional input for the Government's privatization program, and provided justification for the Bank to begin lending later in the period to help finance the effort. 1.26 The Bank strategy also acknowledged correctly that the sustainability of the reforms was predicated on the capacity of the government to deal with its urgent, fundamental fiscal problems-the deficits generated by public enterprises, social security, and province-level finances, and a weak financial sector. The 1992 Country Assistance Strategy focused accurately and justifiably on these issues, although it could be faulted for neglecting the less favored social sectors for which specific operations had been planned in the 1990 Country Strategy Paper but were dropped later. 1.27 Similarly, the Bank's analysis correctly recognized the importance of the different economic measures undertaken by the Menem administration in eliminating inflation, especially the Convertibility Law. It also recognized that wages and prices might not prove flexible enough to support the fixed exchange rate without a recession (Country Strategy Paper, April 29, 1992). In hindsight, the risk analysis of the Bank proved to be remarkably prophetic, warning of the political and economic perils that would eventually lead to a crisis in 1995. 1.28 The Lending Program Was Coherent. The major strength of the Bank's assistance strategy for Argentina in 1990-94 was its close connection to the overall reform program of the Government. About 70 percent of the lending during the period was structural adjustment lending or technical assistance linked to structural adjustment. While most of these loans have not been completed and/or evaluated, this CAR concludes that each individual operation was closely linked to the overall reform program, particularly the public sector fiscal deficits addressed with privatization. This tie to the reform program is evident as assistance operations flowed from to most critical to less critical issues of structural change. But, as discussed below, investment lending to address shortcomings in the social sectors would come only much later in the period. 1.29 Delayed Action on Several Fronts Threatened the Sustainability ofReform. With the benefit of hindsight, OED concluded that the Bank's assistance to a strong and coherent reform program contained a few weak links. In all cases the main obstacle seems to have been limitations imposed by the political feasibility of some of the reforms, particularly in the case of the lack of attention paid to social issues; the treatment of some aspects of fiscal policy (the fiscal finances of the province governments and the lack of support for reform of the social security system); the timing of financial sector reform; and the management of risk factors: * Social issues. The Bank's Country Strategy Paper of April 1992 recognized that although the speed at which the reform program advanced in Argentina was a 28 positive factor, it also posed political risks. Specifically, it recognized that "Argentina's reform process has not gone on anywhere near as long as Chile's or Mexico's, providing less time for the beneficiaries of reform to coalesce against the losers." But the design of an action plan to deal with social issues was not as comprehensive and clear as the diagnosis of the problem. The Bank's assistance strategy in 1992 merely contemplated a poverty study in 1993; it did not seek poverty-oriented action. A loan for Maternal Child Health was programmed for approval in 1994, and an educational development loan for approval in 1995. Also, a Social Emergency Loan originally proposed for FY91 as part of the core lending program was dropped, due primarily to doubts in the Bank about institutional capacity to implement it effectively. Social security. Despite diagnosing the problems of the deficits generated by a financially inviable social security system, neither the Bank nor the Government addressed the problem head on with any immediacy. Ttley thus risked the sustainability of all fiscal reforms. Social security financing was an integral cause of the structural fiscal deficit in Argentina (Argentina: Public Finance Review-From Insolvency to Growth, February 11, 1993). A mandatory public pension program had already become financially inviable during the 1980s. Pensions were out of line with worker contributions for many years, and the retirement age had been kept relatively low. Only in July 1994 did the Government start to implement a major reform of the national security system, but it did not seek Bank's assistance to support the reform. The reform implies transitional fiscal costs averaging about 0.5 percent of GDP over 1995-98. * Province-levelfinances. Transferring responsibility for secondary education to the province-level governments created financial pressures on already overburdened local agencies. The Bank is, however, currently aware of the fiscal problems of the provinces and of the threat that their deficits imply for the sustainabili,y of the overall reform program. Several lending operations are currently dealing with these problems. Despite the delayed treatment, it is conceivable that earlier participation by the Bank might not have prevented the difficult situation at present, since the province-level governments are constitutionally autonomous, and some seem to lack the political will to reform. * Financial-sector reform. The diagnosis of the problems in the financial sector suggested urgency, and the possibility of capital outflows suggested vulnerability. The Bank approved a Financial Sector Reform Loan in February 1993; and only in 1995, after the Mexican crisis, did it approve two loans to help reduce the role of the province-level banks, privatize government banks, and reform the banking system. In hindsight, the delayed financial sector reform could have put the overall sustainability of the Convertibility Plan at risk. Fortunately, the Government reacted energetically to the external shock created by the Mexican crisis by accelerating the reform of the province-level banks and by encouraging the merger or closure of the weakest banks. The final outcome, however, is still uncertain, as discussed in the section on the 1994-95 period. * Management of risk factors. OED's review of lending operations in this CAR concludes that the lack of timely reaction to identified risk was a characteristic of 29 most lending operations reviewed. Often, risk was acknowledged but either ignored or treated in a fashion difficult to ascertain effectiveness. The Bank should have developed specific action plans to deal with the risks identified. Efficacy of the 1990- 94 Strategy: Progress on Fiscal Issues 1.30 The Lending Strategy. It is too early to judge whether the objectives of the lending strategy of 1990-94 have been achieved because most projects are still ongoing. The main achievement, however, was the successful conclusion of the Debt and Debt Service Reduction operation, which ended an external debt problem that seemed insoluble during the 1980s. The Bank's contribution to financing the collateral required for a major debt and debt service reduction agreement under the Brady Plan in 1993 had an enormous positive impact. The financial contribution of the Bank complemented the ability of the Government to achieve macroeconomic stability by helping to regularize the country's debt problems and allowing private capital markets to support the financial needs of Argentina. Consequently, the country now has access to private capital markets, although there still progress to be made to achieve full rating in the institutional financial markets. A second important achievement has been the success of the Government at reducing the fiscal deficit by implementing important tax and expenditure measures and by privatizing major public enterprises. The remaining task on fiscal matters is to reduce the contribution of the social security system and the province governments to the deficit. The Bank contributed directly to these achievements with several lending operations, only a few of which have been evaluated. A summary of these evaluations is provided below, and a more detailed discussion is provided in chapter 3. 1.31 The outcome of the only operation approved in the 1990-94 period and evaluated by OED thus far was rated as highly satisfactory. PERAL supported the Government program to privatize public enterprises in telecommunications, railroads, and hydrocarbons (discussed more fully in chapter 3). OED gave this project a high rating despite the fact that a regulatory system has not yet been implemented to discourage monopolistic behavior by the privatized companies. (The Bank is currently addressing issues associated with the absence of a regulatory regime.) OED concluded that the reform of public enterprises with the support of PERAL was among the most far-reaching ever carried out by any country, and that the alternative of delaying privatization until an adequate regulatory framework was in place would have threatened the implementation of the privatization program itself, indefinitely prolonging the burden of the deficits of the privatized enterprises. Privatization provided substantial benefits to Argentina even if in a less-than-ideal competitive framework with the absence of a regulatory framework. The early experience with privatization has also prompted the Bank and the Government to increase their attention to the problems of imperfect regulatory frameworks to reduce monopolistic behavior in the postprivatization environment. 1.32 Two structural adjustment loan operations approved in the 1990-94 period have been the subject of self-evaluations at their completion. OED rated their outcome as satisfactory. One was the Public Sector Reform Loan (PSRL), approved in FY92 for US $325 million, and targeted at revenue mobilization, expenditure reduction, and a reorganization of the Central Bank. The loan has helped the Government improve the efficiency of its tax structure and tax administration, rationalize the federal administration, and streamline the budgetary process. Most important, the reorganization of the Central Bank played a key role in stabilizing prices. But the Government did not enact and implement its planned Public Procurement Law to address possible abuses of and manipulation of contracting procedures, and it reduced potential VAT 30 revenue by granting exemptions for industrial promotion. Moreover, the transfer of secondary education to the province governments and a reduction in federal employees increased the deficits of the provinces and may have created unintended negative impacts on employment that have not yet been fully assessed. The sustainability of these reforms was rated as uncertain, since fiscal performance began to falter during the second semester of 1994 and because the Government still faces risks that may threaten fiscal equilibrium. The second loan-The Debt and Debt Service Reduction Loan (DDSR), approved in FY93 for US $450 million-was part of a package of external assistance to finance collateral required for a major debt and debt service reduction agreement under the Brady Plan. The outcome of the loan was rated as satisfactory primarily because it generated indirect benefits when it was combined with other structural reforms. The successful conclusion of the DDSR Agreement reduced uncertainty and increased confidence among investors by reinforcing the positive impact of other structural changes in Argentina. In particular, it significantly increased the country's external creditworthiness. The loan also had direct debt reduction benefits, but the estimates of these benefits cannot be considered very reliable given the difficulty of establishing realistic counterfactuals. 1.33 The Nonlending Components. The economic and sector work during 1990-94 achieved most of its objectives (an in depth discussion of this topic is presented in chapter 2). In particular, the work focused on general macroeconomics, especially on fiscal issues, and was highly effective at helping the Government understand the magnitude of the inefficiencies of public enterprises and the fiscal deficits of both the provinces and the social security system. All these studies contributed significantly to the public sector reforms initiated by the Government during this period. The diagnosis derived from nine financial sector studies during 1990-94 formed the basis for the ongoing comprehensive reforms of the financial sector and has led to four lending operations between 1993 and 1995. Most of the recommendations of a sector report on the steel industry were adopted by the Government, and helped the Bank define actions while providing lending to support the Government's privatization program. And, finally, most of the recommendations of the Country Economic Memorandum of September 8, 1989, Reforms for Price Stability and Growth, coincided with most of the reforms undertaken later by the Government and represented vigorous support by the Bank to Argentina's policies. The 1994-95 Period: Helping the Government Deepen Its Reforms The Assistance Strategy in 1994: Good Performance Leads to Overoptimism 1.34 By the end of 1993, the reform program had brought Argentina growth and price stability that it had not witnessed in decades. Following growth rates of 8.9 and 8.7 percent in 1991 and 1992, respectively, GDP grew at about 6 percent in real terms in 1993. Inflation had decelerated from 200 percent monthly as of July 1989 to 7.5 percent annually by 1993. Optimism prevailed both in Argentina and among Bank staff. Although the economy had become vulnerable to movements in capital flows, the Bank took a reduction in the BOP current account deficit of 3.3 percent of GDP in 1993 as a positive sign;6 Argentina's terms of trade were also expected to improve in the near future, and regional trade agreements offered much promise to Argentina's exports (Country Assistance Strategy, February 4, 1994). The Bank recognized 6 From 5.2 percent of GDP in 1992 according to the Country Brief, June 30, 1993, or from 3.7 percent of GDP in 1992, according to the Country Assistance Strategy of 1994. 31 the economic risks of higher-than-expected international interest rates, but minimized this risk on the grounds that the direct impact would be softened by the DDSR agreement, which limited interest rate payment increases; it also believed that any indirect impact on capital flows "could be mitigated through the automatic adjustment features of the Convertibility Plan, and by domestic policies." 1.35 The 1994 CAS proposed a lending strategy that no longer targeted structural adjustment operations. The last structural adjustment loan-a Provincial Reform Loan for US $300 million for FY95-would support structural reforms in province-level public finances, including the privatization of provincial banks and of other services now performed by public enterprises. The strategy was presented to the Board together with an innovative, US $500 million Capital Market Development project. The Bank's optimistic perception of the economy was reflected in its Assistance Strategy: Argentina had achieved credible stabilization as a result of the Convertibility Law. . . . [S]tabilization had increased resource mobilization and decreased interest rates .... [R]educed public sector borrowing had increased credit to the private sector and increased portfolio quality ... . [A]nd a new Central Bank Charter had encouraged banks to operate more soundly. .. . [In addition], regulation and enforcement of capital adequacy and provisioning requirements were undergoing improvements that would contribute to a healthier banking system. 1.36 The strategy also discussed the possibility of graduating Argentina. If Argentina continued "to experience success on the macroeconomic front and improved access to international capital markets over the next few years, it would be appropriate to initiate discussions concerning the phasing down of Bank assistance." With the end of structural adjustment lending, the Country Assistance Strategy proposed that, after the last operation to support reform at the province level, all lending operations would be for investment lending. The Country Assistance Strategy did not prioritize sectors explicitly, but called for investment lending in road maintenance, water supply, health, education, hydroelectricity, agriculture, forestry, mining, and the alleviation of rural poverty. In addition to macroeconomic monitoring and other analytical work, ESW would include studies on health, education, environmental clean-up, the public finances of the provinces, and regulatory issues underlying the privatization process. The Assistance Strategy in 1995: A Quick Response to the Crisis 1.37 In late 1994, the financial crisis that was affecting Mexico sent shock waves throughout Latin America, and particularly to Argentina with the reversal of capital flows. The Bank reacted promptly to help the Government of Argentina adjust to the external shocks. It took less than four months to prepare a new strategy and a new lending program after the crisis developed. As noted earlier, the Bank had identified the risk of a shock in the Country Assistance Strategy of 1992; but, after identifying the same risk again, it ignored it without providing a contingency plan in the Country Assistance Strategy of 1994. CAS94 was overly optimistic after the positive economic results of 1993. In retrospect, it would have been wiser to propose a contingency plan to cover the risk, i.e., to prevent rather than react to the crisis. But the swiftness of the Bank's reaction and the assistance program it developed were extremely laudable-and were positive 32 signs of the maturation and strengthening of the relationship between the Bank and the Government. 1.38 On April 10, 1995, The Bank's Country Assistance Strategy was reviewed in light of the impact of the Mexico crisis on Argentina's economy. Argentina had become vulnerable because of its comparatively high reliance on inflows of foreign capital, the inflexibility of its exchange rate regime, and its need for a strong financial system under the Convertibility Plan. The Bank recognized, correctly, that "since reserve requirements are less than 100 percent, M2 is about 3.5 times the stock of international reserves." It also recognized that, "under the Convertibility Plan, the Central Bank has more limited resources than other countries to confront a run against bank deposits." Thus, the Mexican crisis confirmed the significance of the risk analysis undertaken in the Country Assistance Strategy of 1992. The 1995 strategy recognized correctly that "an economy with weak financial system and rigid labor markets is even more vulnerable to shocks, particularly under a fixed exchange rate regime where changes in capital flows could be more pronounced." And that "capital movements usually affect the weakest financial institutions first, creating problems that subsequently affect the entire financial system, thus reinforcing the effect of negative capital movements." 1.39 The 1995 assistance strategy called for deepening the adjustment process, particularly with the implementation of reforms at the province level and with the banking system; reducing poverty and developing human resources, particularly with the reemergence of a proposal for creating a social safety net project and with the addition of new proposals for health reform, rural poverty alleviation, and the rationalization of higher education; enhancing competitiveness with the implementation ofjudicial reform, export promotion schemes, airport privatization, and agriculture, forestry, and mining development projects; and rebuilding the deteriorated infrastructure base, particularly with the implementation of projects in province-level transportation, mass transit, flood protection, water supply, and industrial pollution. The Bank substantially increased its lending program again to an annual average of US $1.4 billion for FY95-96, from an annual average of about US $830 million proposed earlier for FY95-97 in the 1994 Country Assistance Strategy. 1.40 By April 1996, the Bank prepared a progress report to review the achievements of the Government in meeting the challenge of the regional financial crisis and to examine the role of the Bank support. The main conclusion is that "Argentina appears to have weathered the worst of the crisis, although important risks remain". The country still faces the aftermath of the crisis, including high unemployment, and the need to strengthen its financial system and public finances. The financial situation of the provinces continue to be serious, burdened by bloated bureaucracies, financially weak pension systems and inefficient public banks and enterprises. Also, Argentina's debt service ratio has grown from 42 percent in 1993 to an estimated 56 percent in 1995, and is expected to continue growing before peaking in 1997. Argentina will have to lengthen the maturity of its foreign borrowing. The progress report also concluded that the Bank assistance strategy continues to be on track as the Government continues to take the actions required to meet the above challenges. Relevance of the 1994-95 Strategy: Beginning to Address the Remaining Issues 1.41 Due to the excellent country performance at the end of 1993, the Bank's assistance strategy for Argentina in 1994 was overoptimistic and the recommendation to phase out 33 structural adjustment lending was premature. This recommendation, however, was in harmony with a general tendency at the Bank to shift away from structural adjustment toward investment lending. The Bank quickly revised its diagnosis by designing a new assistance program targeted at completing structural adjustment and alleviating poverty. In the process, the Bank's exposure is projected to rise to about 5 percent of the Bank's portfolio by 1996, a manageable risk if the outcome of reforms in the banking sector yield quick positive results. In the medium term, progress at ameliorating the social cost of adjustment and at reforming the finances of the social security system and the provinces will be crucial to the sustainability of reforms. Bank support to these reforms, however, may require additional financing of about US $1 billion, to a total of US $3.3 billion in 1997-99 compared with US $2.3 billion programmed in the Country Assistance Strategy of 1995. This higher level of funding would increase the Bank's exposure to about 6 percent by 1998. 1.42 The sustainability of the reform program remains uncertain. Sustainability will depend on how quickly the Government can make headway on the remaining issues-alleviating poverty, improving the financial performance of the social security system and of the provinces, reforming the financial sector, and restructuring the banking system. 1.43 Risks of the new strategy. The increase in Bank commitments to Argentina in 1995 was a direct consequence of the financial crisis in Mexico. However, the focus of the Bank's development strategy should not be allowed to change too often, and should not oscillate in response to fluctuations in private capital flows. The Bank has not yet developed a lending instrument fully appropriate for financing these types of exogenous short-term fluctuations in capital markets. The presence of the Bank in Argentina is essential for enabling Argentina to balance accounts and restore confidence in private financial markets. This objective is fundamental but risky: it can restore confidence (with continued disbursements) but it might do so at the expense of achieving some of the specific objectives of loans for poverty reduction, health, education, the environment, and energy. This problem occurred in Argentina when an agricultural sector loan, approved in FY86, was fully disbursed to achieve the resource transfer objective but without achieving the agricultural sector objectives (see para. 3.15). 2. An Evaluation of Instruments: Economic and Sector Work Overview 2.1 The quality and impact of the Bank's economic and sector work (ESW) on Argentina are assessed here in relation to the timeline of political and economic developments discussed in greater depth in chapter 1. The analysis addresses the strategy underlying ESW and how planned amounts of ESW translated into actual amounts as the Bank was dealing with the Government's efforts at economic reform. But the analysis focuses primarily on the relevance of ESW-whether the Bank's diagnosis of and solutions for the country's ongoing economic difficulties were adequate, and whether the Bank's ESW provided analytical justification for the Bank's subsequent policy dialogue and lending activities. 2.2 The analysis underscores a somewhat dissonant relationship between Bank assistance activities and the Government's reform efforts: planned ESW was often out of sync with actual ESW, and ESW analysis sometimes bore little relationship to lending activities or to development events. It also indicates that the early Bank's ESW, although mostly correct in its diagnosis of the problems, did not provide a proper framework for inducing the Alfonsin administration to undertake meaningful economic reform, and that the later ESW often lagged behind the more in-depth economic reforms undertaken by the Menem administration during the Alfonsin period. ESW recommendations often validated existing policies rather than forcefully promote reform, possibly because the Bank often perceived that the changes were not politically feasible. Later on, ESW recommendations lagged behind the comprehensive reforms of the Menem administration, primarily because past failures called for future prudence. 2.3 But this judgment about the effectiveness of the Bank's advice on the basis of ESW reports alone is misleading. Much of the better economic advice was often the result of studies financed through project preparation and technical assistance or, according to participants on both sides, of informal discussions and policy dialogue. The former, for example, were essential to the successful effort at privatization initiated by the Government of Argentina in 1989. When the Government showed a clear determination to go ahead with its reform program, the Bank diverted funds by restructuring old loans and reformulating ongoing technical assistance to finance studies that were fundamental to the implementation of the reforms. ESW: Strategy and Levels 2.4 In the early 1980s, the Bank's ESW in Argentina was comparatively modest (at about 100 staffweeks annually), despite the importance of the country in Latin America. Yet the low level of ESW was enough to satisfy the operational requirements of the Bank at that time, since its lending was also modest. Bank management had originally planned a somewhat higher level of ESW and lending (table 2.1), but made this level of assistance contingent on the country's meeting clearly defined economic performance criteria, which it did not. The LAC Region, disappointed with 36 economic performance in Argentina, lowered its level of activity without even discussing a Country Strategy Paper formally with the Bank's top management.6 Table 2.1. A Mismatch Between Planned and Actual Lending and ESW: 1980-89 Lending (annual average) ESW (annual average) (US $ million) (staffweeks) Period Planned Actual Planned Actual 1980-84 245 161 136 98 1985 - 180 - 205 1986-87 430 755 170 360 1987 539 965 388 428 1988 1,090 627 398 479 1989 1,125 887 400 555 Source: Appendix 1, Table 3. 2.5 When the new, reform-minded government of President Alfonsin assumed office in 1983, promising to attack the pervading economic problems of the country, the political climate seemed ripe for greater Bank involvement. The Bank reacted positively to the change in Government, although it was cautious at the beginning. Throughout the 1985-89 period, the Bank's ESW was substantial and purposeful, but its recommendations went largely without effect in the face of the unsuccessful attempts at reform. ESW in this early period did provide, however, analytical data that served as a benchmark later as the Menem Administration embarked vigorously on a reform program. But when the Menem administration assumed office in 1989, the Bank had essentially curtailed any new planned ESW, adopting a wait-and-see approach to the new Government's pledge to restore the economy. As Menem's reform effort proved successful, the Bank's ESW accelerated, but planned and actual ESW during the 1990-94 period largely fell short of supporting the progress that was made by the new Government. ESW Strategy During 1985-89: Planned andActual Work 2.6 In FY86-87, the Bank planned to triple lending and double ESW, to an annual average of US $430 million and 170 staffweeks, respectively (table 2.1). This higher level of activity was made contingent on compliance with the macroeconomic targets of a stabilization program, the Plan Austral, which the Government had adopted in June 1985. With unfounded optimism, the LAC Region reported that the Plan Austral was a "qualified success." In response, the Bank's actual lending and ESW went well beyond their already high planned levels, to an annual average of US $755 million and 360 staffweeks, respectively, in FY86-87 (table 2.1). 2.7 In February 1987, when the Government was compelled to introduce a new stabilization plan, the Plan Australito, a Bank's Divisional Country Brief (DCB) proposed an even larger program of lending and ESW for FY87-91, stating inaccurately that "the first phase of the Bank's assistance program for Argentina as outlined in the CPP of June 10, 1985 . . . has been completed. The Government has met the conditions we had set for an expansion of our program in a second phase starting in FY87." It then proposed that lending be increased to an annual average of about US $1.0 billion, and that ESW be maintained at about 400 staffweeks annually during 1988-90. 6 Although in 1979 the President of the Bank had asked to be informed biannually about lending activities and performance, a CPP was not discussed until 1985. 37 2.8 In 1987, actual lending and ESW were indeed higher than planned, at US $965 million and 428 staffweeks, respectively (table 2.1). Yet, as the Bank recognized the Government's inability to implement meaningful reform, it sharply cut actual lending below the very high level initially planned in 1988. In contrast, it maintained actual ESW at levels higher than planned, justified largely by the fact that several studies were already being undertaken as a complement to technical assistance and investment loans financed by the Bank. 2.9 In 1988-89, the level of ESW remained intense, although it captured only a fraction of the work actually undertaken, since project preparation and technical assistance financed also several studies in this period. Despite the sharply curtailed lending in 1990, resources devoted to preparing lending projects added at least 50 percent to the cost of ESW spent on studies in Argentina during 1987-91. The Project Preparation Facility, CIDA, the Japanese Trust Fund, the Government, and other minor sources provided a total of about US $7 million for ten studies. Assuming a cost of about US $300,000 per staff annually, approximately 1,100 staffweeks would be added to the 2,015 staffweeks spent on ESW during FY87-91. However, because the priorities were changing rapidly in favor of supporting the privatization efforts initiated by the Government, the composition of this comparatively intense program of studies deviated from original plans. In particular, several studies proposed for 1987-91 were dropped-a Technology Study for 40 staffweeks in FY88, an Energy Restructuring Study for 35 staffweeks in FY90-91, an Industry Restructuring Study for 80 staffweeks in FY90-91, an Energy Strategy Document for 40 staffweeks in FY88-89, a Health Sector Study for 30 staffweeks in FY87, a Public Sector Investment Planning Study for 20 staffweeks in FY90-91, a Social Security System Study for 60 staffweeks in FY90-9 1, a Resource Mobilization Study for 80 staffweeks in FY91, and a Labor Study for 70 staffweeks in FY91. The immediate urgency to support privatization had forced the Bank to disregard some of its other long-term concerns, which may have been why the Bank postponed dealing with some of these problems until after the crisis of 1995. Strategy in 1990-94: Planned and Actual Amounts 2.10 ESW planning became much less articulate after 1990. Rather than providing input estimates and presenting detailed rationales, both the 1990 and the 1992 Country Strategy Papers indicated only areas of interest and expected years of delivery for particular reports. OED could not determine whether the absence of detailed ESW planning was due to the fact that the plans bore little relationship to actual work in the past, or to the fact that the existence of large extrabudgetary ESW resources made control of the output difficult. But the Bank did increase its actual ESW progressively throughout the period, even if ESW fell to less than half its level two years earlier. Somewhat paradoxically, the decrease seems to have been the consequence of the large-scale expansion in lending after 1991. But it is also curious that the pattern of planned and actual lending, which flip-flopped throughout the 1990-94 period, contrasts sharply with the progressive increase in actual ESW (table 2.2). 38 Table 2.2. Lending and ESW: 1990-94 Lending (annual average) ESW (annual average) (US S million) (stafiweeks) Period Planned Actual Planned Actual 1990 900 0 410 347 1991 406 680 n.a. 206 1992 715 373 n.a. 283 1993 1,000 1,960 n.a. 316 1994 1,050 609 n.a. 435 Source: Appendix 1, Tables 3 and 5. Quality and Relevance of Economic and Sector Work The 1985-89 Period: ESW Recommendations Fell Short of Needs 2.11 ESW during 1985-89 focused predominantly on macroeconomic and financial-sector studies, mirroring the objectives of the country strategy ui the time (table 2.3). The core of the strategy, formulated by the Bank in 1985, was to help the Government of Argentina "reactivate the economy through export-led growth, increase the availability of foreign exchange and stabilize the economy." Stabilization was key to the country's future growth and development. The Country Program Papers stipulated that ESW was also to form the basis for lending: "All ESW would necessarily be preceded by demonstrated Government interest and concrete evidence that our analysis can form the basis for future lending" (Country Program Paper, June 1985). Table 2.3. Composition of ESW Studies: 1985-89 Sector No. ofStudies General Macroeconomics 12 Financial Sector 9 Industry 7 Energy and Power 4 Social Sectors 4 Agriculture 3 Transport 2 Urban Development 1 Other SAL related, non-classified 7 Total 49 2.12 The many ESW studies and their recommendations in the 1985-89 period were of limited valuefor that period per se; only later under the Menem administration did these reports provide assistance for policy reform, even if the policy reforms were more substantive than the recommendations themselves. * With the benefit of hindsight, the Bank's recommendations in 1985-89 did not go far enough in recommending solutions to the country's most severe structural problems. The Bank, for example, recommended that monetary management be changed, but 39 primarily in an effort to reactivate the economy (it suggested reducing reserve requirements); it paid scant attention to the absence of either Central Bank independence or, alternatively, binding rules for the Central Bank. It did not mention foreign trade and protection at all, despite the programmatic objective to enhance the country's export competitiveness. It did not question the viability of the basic economic organization of the country; it focused on making existing institutional structures work more effectively. And although the Bank focused correctly on public sector management as a pressing issue, it recommended primarily that public investment be better allocated and that enterprises be made more efficient, not that their operational structures be privatized. It also did not recognize that inefficient public or private monopolies or oligopolies (for example, hydrocarbons and much of the protected capital goods sectors) were stifling the introduction of competition into the sectors. * On the whole, ESW analysis did not provide specific support or recommendations for the Bank's strategy to back the Alfonsin Government's economic programs. Neither the First Trade Policy and Export Diversification Loan (TPL 1) of May 1987 nor the Banking Sector Loan (BSL) of March 1988 were backed by any thorough sectoral analysis; the objective in both cases was seemingly to shift financial resources to Argentina for stabilization purposes, thus outweighing the objective to reform the two sectors. * Not all ESW served as a basis for lending. Several studies did not adhere to the guidelines of the 1985 Country Program Paper, which required that "all economic work would necessarily be preceded by demonstrated Government interest and concrete evidence that [the Bank's] analysis can form the basis for future lending" (Country Program Paper, June 10, 1985). In retrospect, however, these guidelines seem particularly restrictive and inappropriate. Macroeconomic Studies: Recommendations Did Not Address Fundamental Problems 2.13 During 1985-89, the Bank undertook twelve studies of macroeconomic issues (table 2.4). The main study was Argentina: Economic Recovery and Growth (Report No. 6467-AR), published in May 1987. Seven other studies provided updates of the macroeconomic situation, projections from macroeconomic modeling efforts, and assessments of the quasi fiscal deficit (i.e., the deficit originating in the activities of the Central Bank). The other four were public expenditure reviews. 2.14 OED concluded that the recommendations of the Bank's 1985-89 macroeconomic studies did not measure up to the magnitude of the macroeconomic crisis. The Economic Recovery and Growth report was predicated on the assumption that a devaluation cum wage/price freeze in February 1987 would stabilize the economy to the point at which deeper, structural reform, "especially in trade, finance and the public sector," would have sufficient time for reviving the economy. In hindsight, much more radical structural reforms were necessary for achieving the desired stabilization outcomes. 40 Table 2.4. General Macroeconomic ESW: 1985-89 Project ID Project Name FY 22754 Public Sector Investment Review 1986 22755 Recovery and Growth 1986 22756 Update of Economic Situation 1986 22761 Public Investment Planning/BTOR 1987 22762 Economic Monitoring/BTOR 1987 22765 Economic Modeling 1987 22773 Public Sector Investment Plan 88-C 1987 22758 Public Expenditure Review-C 1988 22766 Update Economic Memo 88-C 1988 22770 Macro Assessment I 1989 22774 Quasi-Fiscal Deficit 1989 22781 Macroeconomic Modeling 1989 2.15 The main recommendations of the 1987 report included: * Fiscal. Lowering the public sector deficit steadily over time both by reducing net transfers to the public enterprises to zero, with a net return on equity to Government for some enterprises; and by increasing tax revenue, particularly from value added. Privatization was not on the agenda. * Monetary. Using only externally financed credit; seeking moderately positive real deposit rate first, and then a positive real lending rate later; and reducing inflation gradually. Changing the role of the Central Bank was not on the agenda. * Relative prices. Tilting toward tradables and continuing with the mini-devaluations, "allowing the effective exchange rate to improve gradually." (Convertibility at a fixed exchange rate was not on the agenda.) 2.16 The weakness of the 1987 analysis is most evident in its positive evaluation of the outcomes of the Plan Austral: "After nearly two years the verdict on the Plan is perhaps one of qualified success," because it broke Argentina's hyperinflation. The report did not discuss the limited meaning of price and wage indexes to measure inflation when price and wage controls were in force, and did not examine the underlying inflationary pressures that still existed. The report mentioned that a "substantial improvement in the fiscal accounts was achieved almost completely on the revenue side," but it failed to recognize the latent structural problem of an inflated public sector. And it did not recommend that the privatization of public enterprises be an option for reducing the structural fiscal deficit. 2.17 Finally, the 1987 Report called for increasing confidence by the business sector, but it fell short of a realistic plan for doing so. It proposed the "formation of various informal groups on such areas as industrial strategy, export promotion, and regional development, with broad participation. [They] would work toward a clear articulation of the rules of the game." The report also called for- A statement at the highest level of Government to clarify what the policy framework is for the short and medium term and what type of economic structure can be expected . . 41 . at least for the term of the present administration. This could include broad fiscal objectives; the role of the Central Government, provincial governments, and public enterprises; financial sector policy ... on the exchange rate; whether it is the intention to tilt gradually toward the traded sectors; trade policy [including] which industries can be expected to face stiff competition [and] which sectors can ... expect. . . incentives, and which. . . privatization. 2.18 In retrospect, these recommendations appear simplistic. While greater specificity behind many of the issues would have been a positive step toward improving the business environment, greater strides would have required a more fundamental strategy. Certainly in light of Argentina's history, what mattered most was confidence in the fairness and stability of how the rules were administered and how they could be modified, revised, and implemented. Expediting case turnover in courts, ensuring access to the judicial system, and enforcing judicial decisions were thus probably more important than statements about exchange rate policies. And it is far from certain that declarations of intent by a government can carry much weight, or that anything other than a solid performance would enable a Government to create confidence in the business environment. Industry and Finance: Practical but Unfocused Recommendations 2.19 Nine financial and industrial sector studies were undertaken during 1985-89 (table 2.5). Six of the studies provided a solid diagnosis of the myriad problems facing small and medium industries, including their financing constraints; the other three examined the financial markets specifically. Two studies are noteworthy: Argentina's Securities Market and Main Non-Bank Financial Institutions (July 14, 1988, Report No. 7374-AR) and the Financial Sector Review (October 1989, Repert No. 11673-AR). Table 2.5. Financial Sector ESW: 1985-89 Project ID Project Name FY 22942 Medium and Small Scale Industries 1986 22943 Financial Sector Study. 1986 22944 Industrial Trade and Finance 1986 22946 Banking Sector 1987 22947 Industrial Sector Study 1988 22952 Non-Traditional Exports 1988 22953 Small and Medium Industries Study 1988 22956 Industrial Technical Development 1988 22964 Provincial Banks Analysis 1989 2.20 The Financial Sector Review summarized the major issues underlying Argentina's financial markets, and it contained many specific recommendations. It noted, correctly, that a financial-sector policy reform package would work only when a stabilization program was in place and inflation had been controlled. The recommendations covered many areas: * Securities markets. Clarifying the legal and regulatory framework for negotiable corporate bonds; providing tax neutrality and other equitable treatment for public and private bonds; allowing mutual funds greater operational freedom and improving their 42 pricing rules; increasing the authority of the Securities Commission over the Exchanges; and "considering" the creation of a private bond rating agency. * Pension funds. Making structural changes in the National Social Security System, to allow contributors to invest part of their freed-up resources in private complementary funds; and ending the monopoly of the insurance companies over pension funding.7 * Insurance market. Abolishing the monopoly position of the National Reinsurance Institute; limiting the Government's direct intervention in insurance; strengthening the finances of the insurance companies; and shifting the role of the Superintendent of Insurance from economic regulation (tariff setting, for example) to prudential regulation. * Other financial intermediaries. Encouraging mergers and/or the liquidation of finance companies; raising the capital requirements of financial companies; and setting up a Government-sponsored mechanism for second-tier financing, as well as introducing an "element" of competition in the mortgage funding market. 2.21 The recommendations were sensible and practical, but provided a weak basis for eventual SECALs because they were not prioritized. During the 1990-94 period, however, the Menem Administration did prioritize them and acted upon some of these recommendations. Some of them were eventually built into SECALs. The Financial Sector Adjustment loan (FSAL) of February 1993, for example, required that progress be made in the sa!e of Caja Nacional de Ahorro y Seguro and that effective, newly enacted regulations regarding provisioning for bad debt be maintained. By that time, the new Mutual Funds Law of May 1992, which allowed for both open and closed funds and clarified the responsibilities of funds management, had already been enacted, as had the July 1991 amendments of the Negotiable Obligations Law of 1989, which provided the basis for issuing and trading in corporate bonds. 2.22 The Menem Government also later implemented the Bank's vital recommendation to increase the authority of the Securities Commission (CNV) over the stock exchange. In early 1993, the FSAL President's report wrote that "CNV has now reorganized to strengthen investor protection and capital market development functions. Under the new organization CNV will improve its control procedures through better coordination between the legal clearance and inspection functions. A specialized judicial area will strengthen enforcement and regulatory development." A year later, in the context of another operation, a SAR wrote that CNV was now regulating "futures and options markets, over-the-counter markets, price movement limits on stock exchanges, [and the] establishment and operation of securities clearing and custody companies." It also reported that CNV "had streamlined approval processes for public offerings and automatic authorization of additional shares and debt securities and strong reporting, disclosure and auditing requirements" (Capital Market Development Project, SAR, February 4, 1994, Report No. 12328-AR). In conclusion, the 1989 Financial Sector Review identified actions that should have been, and later with The Financial Sector Review notes that, "in order to go beyond the satisfaction of their basic needs, workers should build up private savings in private pension funds or other contractual savings schemes." It is noteworthy that the Report calls the process of handling existing claims a major issue, but does not provide an answer for what has indeed become a problem of macroeconomic dimensions. 43 clear government ownership were, taken by the Government and applauded by the Bank, although some reforms were left undone until after the financial crisis of 1995. Social Sectors: A Sound Basis but Inadequate Follow-Up 2.23 Of four sectoral studies, two related reports form the core of the analysis of the social sectors-Social Sectors in Crisis (July 1987, Report No. 6900-AR) and Argentina: Population, Health and Nutrition Review (October 1987, Report No. 6555). Together with a Water and Sewerage Sector Study (May 1, 1987, Report No. 6768) they constitute a sizable effort in the "social" sectors, well above that foreseen in the FY85 program for 1986-87. 2.24 Social Sectors in Crisis is an excellent guide to the maze of institutions comprising the health sector. Unfortunately, it was already badly outdated when it appeared in 1987, containing few figures more recent than 1984. The report contains descriptive critiques of various Government programs (primary health, the National Food Program, laboratory services, and the Food and Drug Administration), but focuses largely on the health care system. Its central conclusion was that the existing system was inequitable and inefficient. First, each "social fund" (Obra Socialy-an insurance fund managed by professional or labor groups-managed its own finances; consequently, the wealthiest groups (those of business executives, for example) spent up to nine times more per member than lower-income groups (those comprising workers). Second, the proliferation of some 300 social funds had led to an expensive configuration of facilities, reducing bargaining power with providers. 2.25 The Population, Health and Nutrition Review expanded upon the same themes for the health sector, but also covered housing and education. It is written as if meant to be a foundation for a SECAL for the three sectors, but neither the 1985 Country Program Paper nor the 1987 Divisional Country Brief had proposed that the report be configured as such. The Divisional Country Brief had proposed only a social sector technical assistance loan for establishing "a series of policy oriented studies to define action programs, administrative reforms to improve budgetary and policy analyses, and training programs for federal and provincial social sector managers. 2.26 The heavy input of Bank resources into the social sectors studies served primarily to enhance the Bank's understanding of the main institutions and issues. This understanding was valuable; the recognition that the housing program of Fondo Nacional de la Vivienda (FONAVI) was disastrously ineffective was salutary, although subsequent Bank-Government dialogue did not yield any proposals for abolishing this institution.8 I The Report indicated, for example, that FONAVI had the resources to build 80,000 units annually, but managed to construct only 20,000; it also suggests, somewhat unpersuasively, that efficiency could be improved, but it is absent rigorous recommendations, which presumably led to the aborted 1989 Housing Sector Loan. 44 2.27 Finally, the low-key, low-cost Water Supply Sector study (a three-person mission), contained a series of operationally relevant policy and institutional recommendations for change. But neither lending nor other discussions contain any evidence of follow-up.9 2.28 Education was revisited the following year in Argentina: Reallocating Resources for the Improvement of Education (October 17, 1988, Report No. 7471). The report summarized the updated results of a large ongoing study financed by the Government, UNDP, and the Bank's Loan 2984,10 and deals with a broad range of major issues in the sector. In primary education, the Report focuses primarily on the transfer of administrative and financing responsibility to the provinces in 1978 and its adverse effects on the comparative caliber of education in the wealthy and poor provinces. Moreover, high teacher-student ratios were said to be lowering teacher salaries but increasing educational costs. In secondary education, the Government still maintained the bulk of responsibility, but was in the process of increasing the burden on the provinces; the Report also notes that the share of vocational education in secondary education seemed unduly high (at 60 percent), especially given "the very low rate of return" in this subsector. As for university education, the Report identified a crisis situation-an explosive growth in enrollment, accompanied by per capita spending that was equivalent to the level in primary and secondary education, and sharply deteriorating quality standards. 2.29 The Report offered four recommendations: that access to primary education be made more equitable, essentially with measures that would deter poor students from dropping out (for example, school lunch programs); that secondary education be decentralized to the provinces, a recommendation based on a severe criticism of the capacity of the Ministry of Education to provide a quality education and by calls to restrict the Ministry to setting standards and managing the system; that higher education be made more relevant, a recommendation based on a dramatic description of the dilemmas facing the system, but falling short of action plans to rectify them; and that the Ministry of Education provide a Technical Assistance Service to the provinces to help them enhance their implementation capacity. 2.30 The Bank did not follow up immediately on its involvement in the sector. A few years later, however, the reform package of the Menem Administration included measures that substantially changed the respective revenue and expenditure functions of the federal and province-level governments. But it did so more in the context of reducing the fiscal burden that the provinces imposed on the federal government than in the context of improving the quality of education. 9 Several other key recommendations included, for example, that province-level governments make equity contributions to the sectoral enterprises. The Report argues sensibly against using tax revenue-as opposed to user charges-to finance the sector, and proposes a national financial agency that would on-lend externally borrowed funds to local sectoral enterprises; the enterprises would be committed to recovering full investment costs, including equity contributions from the provinces. The calculation of investment requirements is simplistic, but it does not in itself invalidate the recommendations, except to the extent that the necessary tariffs may be even higher than assumed. 10 The eleven papers comprising the study are not easily accessible in the Bank and were not reviewed for this study. 45 Transport Sector: Improving Efficiency without Privatization 2.31 Two reports constitute the Bank's analysis in the transport sector, Transport Sector Public Enterprises (October 21, 1988, Report No. 7496-AR) and the 1985 Transport Sector Strategy report, which was the foundation for the 1988 report. 2.32 Transport Sector Public Enterprises sought "to explore measures to improve efficiency in the transport sector, which in turn would contribute to enhance the country's international competitiveness, increase domestic resource mobilization and improve public sector management." To this end, the study recommended four policy and institutional reforms-that transport enterprises adopt a more commercial orientation, that they improve their operational efficiency and financial viability, that a mechanism be established for monitoring their performance, and that the Government reduce its intervention in and subsidization of the sector. 2.33 As an indication of the Bank's thinking at the time, the Report is cautious about privatization. Its recommendations center primarily on how existing public transport enterprises can be made to operate more efficiently as public entities. It calls merely for "a review by the Government of the reasons why some degree or form of privatization might be advisable, and of the potential for such action." The report highlights some points that would be an incentive to the transport sector to accept privatization-the advantage of sharing the financial risk and managerial burden of operating enterprises, the greater opportunities for financial diversification, a more conducive managerial environment than would be provided by the Government as the major shareholder, and the availability of alternatives to changes in ownership (for example, leasing and within-enterprise divestitures). 2.34 But, on the whole, the report indicates that Bank staff believed that privatization was an intellectually strong but politically futile concept, a position reported in interviews with staff active in the Region at the time. At the same time, it indicates that the Bank did not yet believe that privatization might be the only effective solution to the problems of the enterprises; and that some of the modal specialists, railroads, in particular, were lukewarm toward change in ownership." 2.35 Railroads. The report called for placing all intercity railway passenger traffic under a single authority, and discontinuing uneconomic services unless the Government was willing to pay for them. These recommendations are in sharp contrast to the measures adopted eventually by the Menem Administration, which closed uneconomic intercity passenger lines unless the provinces were willing to cover the losses, and which withdrew federal subsidies.12 In fact, the Bank's recommendations envisaged a complex and sophisticated subsidy system, involving several quite questionable elements--distributing subsidies on a "per unit sold" basis, differentiating subsidies for different products transported, and reducing subsidies gradually, regardless of the efficiency behavior of the enterprises. In short, the Report included a package consistent only with a moderately demanding approach to remedying a public-sector railroad system that had already given The response of railroads was tepid despite the Bank's involvement in this subsector. As the Report states, in May 1988, a task force had been formed to review all options for improving Ferrocarriles Argentinos financial performance, and the Bank's Railroad Advisor was a member. It added: "Unfortunately, the task force is working under conditions of limited information, political opposition and impending elections, which will make accomplishments of their goals difficult if not impossible." 12 An exception was the Buenos Aires urban passenger service, for which the amount of the required federal subsidy was made a key requirement for proposal bids when the system was concessioned off. 46 ample evidence that it was terminally ill. And while the Bank also made a valid recommendation that the Ferrocarriles Argentinos (FA) reduce redundant staff, the institutional changes that it proposed. 2.36 Ports. The Bank's recommendations about ports were closer to those adopted later by the Menem Administration-to establish a legal framework for governing private port ownership and/or operations, create an autonomous central port administration, improve sector and subsector planning, and encourage port administrations and other government agencies to rationalize both tariffs and the staffing of port and river transport operations. 2.37 Airlines. The Bank adopted a cautious approach toward privatizing the airlines. As negotiations were under way with Scandinavian Airlines to provide managerial and financial support to Argentine Airlines, the Report observes merely that "it would not be helpful to speculate" on the outcomes of negotiations; it argued, moreover, that ownership per se was less important than were measures to make Argentine Airlines more efficient. The 1990-94 Period 2.38 1989 was a watershed year in several respects. In July, in the midst of a serious economic crisis, the Alfonsin Government handed power over to its elected successor before it was constitutionally required to do so. The Menem Government used its public mandate to stabilize its macroeconomy; the unprecedented reforms undertaken by the Government flowed from a new Bank diagnosis based on the lessons of the Plan Primavera crisis. Bank staff and the new Government quickly developed a professional rapport. But in quantitative terms, 1989 marked the peak before the beginning of a sharp decline in the volume of the Bank's ESW in Argentina, from 555 staffweeks (the highest level ever reached in Argentina) to 206 in 1991, the lowest point throughout the 1985-95 period. 2.39 ESW during 1990-94 focused largely on general macroeconomics (particularly fiscal issues and the macroeconomic environment), structural reform (largely the efficiency of public enterprises), the fiscal deficits of the provinces, public enterprises, and social security system, exchange rate policy, agriculture, and industry (table 2.6). ESW work addressed the right issues, but its relevance was eclipsed by the more indepth, substantive reforms that were ultimately undertaken by the Menem administration. Perhaps most evident of this lag is the public enterprise issue: while the Bank was calling for improving the efficiency of public enterprises, the Government of Menem embarked on a comprehensive privatization program immediately upon assuming office. Also, as the Bank was preparing its ESW during the transitional period from the Alfonsin to the Menem administration, the new Government was embarking swiftly on some of its most radical structural reforms, including the divestiture of public enterprises, the suspension of fiscally ruinous and economically distorting industrial promotion schemes, a shift toward greater reliance on the VAT (and heavy penalties for tax evaders), and independence for the Central Bank and limitations on its ability to increase the money supply and shrinkage of the (highly inefficient) public banks. The Government had already implemented a short-term stabilization program, which included a large devaluation (50 percent in real terms against the average 1987 rate), the continuation of export taxes, the suspension of tax expenditures through export rebates, large increases in public sector prices (including a price freeze at the new levels), and a price reduction negotiated with leading industrialists at 20 percent below the July 15 levels. 47 Table 2.6. Composition of ESW Studies: 1990-1995 Sector No. of Studies General macroeconomics 15 Financial sector 9 Industry 3 Energy and power 4 Social sectors 9 Agriculture 2 Transport 4 Environment 3 Other SAL related, non-classified 7 Total 56 2.40 The fact that the Bank had prepared several of its ESW studies and recommendations during the transitional period affected their relevance. Although the new government had been planning deeper reforms than those that were ultimately recommended by the Bank's ESW studies early in the period, the Bank was heading, however tentatively, in the same direction that the Menem Government. Yet, it can be argued that the new Governm -t gave greater force to the general tenor of these early ESW recommendations. Later in the period, however, the Bank's ESW provided sound guidance to the Government's reform efforts, particularly in the agricultural and industrial sectors. 2.41 The analytic breakthrough during the period was the recognition that previous stabilization efforts had failed because they had been predicated on the belief that they had to precede structural reform, which, as a long-term measure, could wait. The new approach postulated that stabilization could be achieved only if certain structural issues were addressed immediately and with vigor. While this distinction may sound scholastic or even semantic, it had profound implications for public policy. Particularly with respect to fiscal policy issues, it forced recognition that several issues still had to be dealt with-the deficits of the public enterprises; the transfer of fiscal and quasi-fiscal resources to the provinces; and the deficits of the social security system. In addition, the general cost-inflating effect of the protectionist "Compre Argentino" Law was also put into a new perspective. Macroeconomics Work 2.42 During 1990-94, the Bank prepared fifteen studies classified as general macroeconomics. The studies focused primarily on fiscal issues and the overall macroeconomic environment (table 2.7). The first report produced during the period, Reforms for Price Stability and Growth (September 8, 1989, Report No. 7994-AR), was actually "completed on the eve of the transition ... [and was] based on a macroeconomic mission that visited Argentina from January 31 through February 14, 1989." The Report was significant because it broke with previous Bank diagnoses and recommendations. Fiscal work was also undertaken during the transition period, culminating in two major reports. The first, Argentina: Tax Policy for Stabilization and Economic Recovery, was based on the findings of an April-May 1989 mission to Argentina during the Alfonsin regime, but was issued in 1990 during the Menem Administration. The second was Argentina: Provincial Government Finance Study (April 3, 1990, Report No. 8176-AR), based on a mission that visited Argentina one week after President Menem's inauguration but whose two consultants had prepared six province-level case studies in the preceding twelve months. 48 2.43 Structural Issues. The Reforms for Price Stability and Growth report is an interesting midpoint between the Bank's previous position that public enterprises could and should be made more efficient and its later position that public enterprises should be abolished because as public enterprises their ills were largely incurable. The Report offers a long list of recommendations for improving the financial viability of public enterprises--changing their price levels and structure, improving budgetary oversight by the Government, rationalizing their labor force, making any subsidies fully transparent in the federal budget, defining their institutional frameworks (as regulated monopolies, market-oriented ventures, and so forth), and developing a more transparent legal framework for managers. It ends its list of recommendations, however, with two that hint at the future course of Government policy-to accelerate and expand the privatizationframework, and to establish legal processes that will ensure an unbiased selection process for private investors. Table 2.7. General Macroeconomic ESW: 1990-95 Project ID Project Name FY 22768 CEM 90 1990 22775 Macro Assessment II 1990 22783 Tax Policy 1990 22790 Monetary and CR Reform 1990 23024 Provincial Government Financing 1990 22767 CEM 91 1991 22772 Fiscal Reform 1991 22782 Economic Modeling 90 1991 22785 Debt Update 1991 22786 Investment and Growth 1991 22787 Macro Consistence Model 1991 22788 Macro Assessment 1 1991 22789 CEM: Public Finance 1992 22792 Public Finance Review 1993 22795 Macro Options 1993 2.44 Structural Fiscal Deficit. All three macroeconomic reports correctly identified public enterprises, the provinces, and the social security system as key determinants of the structural fiscal deficit (see extended discussion in chapter 1). The Tax Policy for Stabilization and Economic Recovery report set the objectives of tax reform: to increase federal revenue by between 3 and 4 percent of GDP; restore the (badly eroded) tax elasticity of the system; and enhance neutrality in the resource-allocating effects of the system (especially by eliminating promotional exemptions and "tax handles"). It also proposed tools for achieving these objectives: revenue would accrue from a small number of taxes, with the broadest possible base and moderate rates, and the income tax, a national property tax, and the VAT would constitute the core of the system. Together, these measures were to yield about 50 percent in federal revenue; half of the remainder would come from a moderate uniform import duty, as well as (high) taxes on cigarettes, alcohol, and energy products. The rest would come from social security taxes in a totally reformed system. The Report also recommended that revenue earmarking be limited when the reforms were fully in place, and that the coefficient of coparticipation in taxes shared with provinces be modified to offset the effects of reforms on the tax bases of the provinces. This recommendation derives from the Coparticipation Law of 1988, which was an attempt to limit discretionary Treasury transfers to the provinces to 1 percent of GDP and to 49 close the rediscount window of the Central Bank to the province-level banks (which were financing the province governments). 2.45 Provinces. All three reports noted that, despite increasing the provinces' share of affected revenue from 48.5 to 57.5 percent, the Coparticipation Law was a failure because the provinces did not adjust their own finances sufficiently; in fact, they had needed additional funding twice in 1988. Since the core of the problem was political-the inability of the federal Government to force the provinces to reform and its reticence to support the provinces as they moved towards bankruptcy-it is not surprising that the recommendations of the Provincial Government Finance Study, in particular, miss the point. In essence, the Report recommended merely that the Government enforce the provisions of the law that had hitherto been ignored. Yet province-level financing is one exceptional area that was not addressed effectively by the Menem Administration, and the reforms made in the federal-province relationship did not go far enough to prevent a resurgence of a fiscal crisis in 1994. Fiscal mismanagement by the provinces continued to exert pressure on the Central Bank and Treasury. The Report discussed the nature of the problem at length: Dramatic improvements may be attained from quite simple reforms in provincial revenue and expenditure planning, budgeting and administration. These reforms were not adopted in the past due to the perverse incentives in the system of intergovernmental transfers . .. as well as inadequate controls of rediscounting by provincial banks. National Government officials have expressed a firm commitment to the elimination of these perverse incentives, and provincial government officials have expressed strongly their desire for increased financial and political autonomy. Sustainable increases in provincial autonomy will require, however, significant improvements in financial management. 2.46 The Tax Policy for Stabilization and Economic Recovery report is quite specific about the range of actions that provinces could and should adopt, from revenue enhancing measures (more effective cadastres and the privatization of billing and collection for delinquent taxes) to expenditure reductions (more effective personnel management systems and links with payroll systems to detect double employment), to improved fiscal planning and budgeting (inflationary adjustments, formal identification and evaluation of new projects, and the abolition of the "Compre Argentino" Law, which granted special treatment to local producers). The Report also tries to define the specific tools to be used: "The Central Bank is to continue to limit rediscounts to provincial banks (which were financing the deficits of the provinces), and intergovernmental transfers should largely be limited to the legally prescribed (coparticipation) revenue sharing, with discretionary grants being reserved to genuine emergencies." In short, the spigots through which resources flowed to finance the deficits of the provinces were to be shut off, in the hopes that doing so would force the provinces to adopt the reform measures. This proposed strategy was very similar to what was adopted, in principle, by the Alfonsin Government and recommended by previous Bank missions-in essence, to attempt persuasion by inanition. But the strategy failed under Alfonsin, and it failed under the Menem Government. The provinces in fact found new spigots leading to the Central Bank, the commercial banks. And political and electoral imperatives were also stronger than the ability of the Treasury to resist the pressure for discretionary transfers. The Bank's technical advice was not capable of dealing with what was essentially a power problem. 2.47 Social security. The 1989 Argentina. Reforms for Price Stability and Growth report offered two alternative recommendations, one conventional and the other innovative, to deal with a virtually insolvent system that would need unaffordable fiscal infusions to survive, yet whose collapse would 50 have severe social consequences. The Report recognized that the structural problem would deteriorate as the population aged: the ratio of the over-age-60 population to the working-age population would rise from 24.1 percent in 1980 to 28.6 percent by 2020, and the evasion of contributions to the system was already reducing the amount of social security funds available. 2.48 The conventional solution was to mobilize more resources and reduce benefit obligations by, for example, increasing formal sector employment, increasing the wage tax on the self-employed, reducing the transfer of social security income to the health insurance fund for retirees, increasing the retirement age, reducing the rate of salary replacement, and using an extended salary base for calculating pension rights, rather than merely the last salary. The Report actually embraced the novel alternative with greater enthusiasm: Another option would be to de-link pension from wage; to offer a basic stipend only, and to enact legislation to facilitate private contractual savings institutions under public regulation... [T]his alternative would provide a monthly benefit of US$100 to each of 3.6 million qualifying persons because of age, disability or widowhood.... The estimated cost would be about 5.2 percent of GDP ... compared to a current system costing over 8 percent of GDP.... In converting from the present arrangement, which provides pension entitlement to many persons at a level far above the assumed basic monthly stipend of US$100, the Government would presumably have to finance transitional costs of an estimated US$720 million in 1990 (and even larger amounts in subsequent years) to provide for these higher acquired benefits. . . . But even with these additional costs, this more equitable package would demand less public resources than the present arrangement. 2.49 It is this second alternative that is closer to the eventual policy thrust of the Menem Administration, and, in that sense, Bank thinking and Government thinking, whether causally related or not, were largely harmonious. Whether the costs of the transition will become much higher than those estimated in the report-a possibility, given a recent decision by the Judiciary to increase the cost of pensions-and whether the social and economic consequences of the new, semiprivatized system will be socially acceptable cannot yet be judged. But is also unclear that any other solution, the "conventional" alternative of the Bank, for example, would have been any better given the magnitude of the dilemma. 2.50 Stabilization. The basic tenet of the Argentina: Reforms for Price Stability and Growth report-that structural reform could not await macrostabilization because stabilization could not in fact be achieved or sustained in the absence of structural reform-is a solid advance over most previous Bank work on Argentina.13 It is also the tenet that was adopted by the Menem Administration soon after it took office. Its relevance is particularly clear in fiscal matters: sustained reductions in the deficit required addressing the underlying structural issues, especially public enterprises, province-level financing, and social security, as well as an overstaffed general administration and public sector cost inflation under the Compre Argentino law. Not only would 13 This position differs from the position adopted by the Bank in its dispute with the IMF in 1988. At the time, the Bank argued that, given the time-consuming process of structural reform, fiscal deficits could be reduced only gradually and that the Plan Primavera-despite the existence of gaps in its external and internal financing plans-should thus be supported. The Bank's new position was that major structural reform was required immediately, because a feasible and credible stabilization program could not be adopted in its absence. (See chapter 1 for a more in-depth discussion). 51 these elements have a direct impact on expenditures and the deficit, but they would also be the source of inflation; if not addressed, they would perpetuate inflationary expectations, thus undermining stabilization efforts. 2.51 For the same reason, the Report recommended that monetary expansion be allowed only against an expansion in international reserves, and that a stable exchange rate be the anchor of price stability.14 Here, too, the Report departs fairly radically from previous Bank work on Argentina, which had usually been predicated on the assumption that inflation could be reduced only gradually, and that exchange rate management should thus seek primarily to ensure that the tradables sectors remain competitive internationally. The long list of failed Argentine programs in the three previous decades demonstrates either that the model was misconceived, because it implied that the monetary authorities would be able to affect the real exchange rate, or that the Governments failed to apply the model properly, by waiting too long between devaluations and thus creating periodic balance-of- payments and/or employment crises, as well as expectations that led to distortionary resource allocations. Alternatively, the model may also be viewed as a mixture of both. What is of interest here is that the incoming Administration adopted essentially the same approach suggested by the Bank's 1989 Report. Financial Sector: Concordance Between Recommendations and Policy 2.52 A total of nine industrial and financial sector studies were prepared during the 1990-94 period (table 2.8). But the major product, the Financial Sector Review (October/November 1989, Report No. 11673-AR), was part of the intensive ESW of 1989. The analysis focused on the relationship between macroeconomic stabilization and the health of the financial system. In 1988, the Bank had released a report on Argentina's Securities Market and Main Non-Financial Intermediation, July 14, 1988 (Report No. 7374-AR), which concluded that the system could not be expected to become an efficient intermediary of accumulated private-sector savings until macrostabilization had been achieved. In the 1989 report, the conclusion is that although the anchor of stabilization is a stable exchange rate, the potentially large public and Central Bank debt held by the banks required that they pay high enough interest rates to induce depositors to maintain the bank deposits necessary to fund the debt. The Financial Sector Review indicates that- Otherwise the exchange rate cannot be maintained. The commercial bank assets that back deposits consist overwhelmingly of Central Bank obligations. (Only the Central Bank can readily issue the obligations at such high interest rates, ultimately because [it] alone has the power of currency issue; the private sector, by contrast, cannot pay such high interest rates and is therefore crowded out.) 14 Domingo Cavallo had advanced the idea of Central Bank financing of government deficits in its 1984 book Volver a Crecer, but was not explicit on exchange rate policy. 52 Table 2.8. Financial Sector ESW: 1990-95 Project ID Project Name FY 22744 Financial Sector TA Study 1990 22778 Provincial Banks 1990 22951 Financial Sector and Capital Market-C 1990 22960 Provincial Bank Study 1990 22777 Social Security 1991 22965 Provincial Banking. 1991 22967 Financial Sector Strategy 1991 22793 Provincial Finance. Reform 1992 22972 Capital Markets 1994 2.53 In addition to the above issue-the exigencies created by the Central Bank's enormous "quasi-fiscal" liabilities-the report addresses the much more significant, structural issue of Central Bank independence. On this, the Report recommended that a reformed Central Bank not be allowed to accommodate the Treasury without restriction, a policy later pursued with even greater regulatory rigor by the Menem Administration. The Report also made several other recommendations for reforming the Central Bank's charter, mandate, organization, and financial structure; the Menem 15 Government also pursued these policies later. Agricultural Sector: ESW Provides a Foundation for Reform 2.54 Still another large-scale ESW effort came to fruition in 1989, the Agricultural Sector Review (June 30, 1989, Report No. 7733-AR). Its purpose is not altogether clear. The Report does not seem to be a suitable basis for sector policy reforms and did not lead to adjustment lending for the sector. One of its principal authors reports that its furpose was twofold-to update the Bank's knowledge of the sector, which was ten years out of date, and to forge a lending program. But the lending program ultimately was limited; as of 1994, the Bank had made only a small Agricultural Services and Institutional Development Loan (US $33.5 million in February 1991), and two other Bank operations were merely under preparation. The Report is heavily descriptive, despite some attempts to be policy-prescriptive. Some of its policy recommendations are surprising: although documenting the incompetence of the National Meat Board (JNC), the Report asserts that "an expanded role of the JNC in promotion and market research is . .. essential." And, in general, after having lauded the long-term market prospects of oilseeds, beef, fruit and vegetables, forestry, fisheries, and cereals-that is, of all major products except wool-it notes that the main constraint to export growth is marketing expertise, which is to be remedied with "coordinated public and private sector efforts to improve export marketing and promotion of non-traditional exports." 15 The mission that was working on the Financial Report and the Government committees that were preparing laws and regulations on financial matters seem to have had substantial two-way communication. The concurrence of views may thus reflect mutual-not one-way-processes of persuasion. 16 The PCR of the failed Agricultural Sector Loan of 1986 (Report No. 9913-AR of September 1991) strongly supports this view that the Region's sectoral knowledge was deficient. It derived from a 1984 CEM, which the PCR describes as a "blueprint, largely preselecting the policy issues and the loan concept." 53 2.55 Even when the Report made plausible and precise recommendations for research, animal health, and plan protection, it did not convey a sense of comparative priorities. And its recommendations for macrosectoral policies were generic-that exchange rates be made "economic" and tax systems "neutral," that import restrictions be "eliminated," and that subsidies be "transparent" and "targeted." These recommendations, all of which have merit, did not emerge from new sectoral analysis, but rather from the Bank's general macro and microeconomic framework. 2.56 It is remarkable that, despite the high cost and low returns of agricultural sector ESW in 1989, another major effort in the same direction was launched the following year with The Grain Subsector report (June 22, 1990, Report No. 8784). According to one of the staff members responsible for planning ESW at that time, its purpose was to lay the foundation for privatizing the National Grain Board with associated (sectoral) lending. Although lending never materialized (for extraneous reasons), the Board was indeed abolished, a measure that reportedly derived heavily from the Bank's analytic work.'7 2.57 The Grain Sector Report may thus have been more timely and more effective than the Agricultural Sector Review. It was also somewhat more action-oriented, having focused on a narrower range of priority measures to be taken. It leaned heavily on Argentine calculations of the costs of distortions and of equivalent producer subsidies and equivalent consumer subsidies; it indicated that during 1960-85 the sector received high negative protection, and that consumers received large, untargeted subsidies. The recommendations of the analysis are not surprising-to reduce inflation so that it does not distort investment decisions; create a neutral and liberal trade regime; remove quantitative restrictions and export quotas; keep tariffs uniform and low; remove grain export taxes; rely on federal income and local land taxes; liberalize and reform regulations that drive up transport costs; remove restraints on private investments in fertilizer plants; replace generalized bread subsidies with targeted programs; return the trading functions of the National Grain Board to the private sector; establish a new regulatory body, the Argentine Grain Commission; and continue to finance and support technological improvements. Industrial Sector: The Government Adopts the Bank's ESW Recommendations 2.58 A Sector Report on the Steel Industry (October 25, 1991, Report No. 10043) was prepared at the request of the new Government. Its purpose was to anaiyze the policies that had undermined the sector's competitiveness and develop strategic options for privatizing the National Steel Company (SOMISA), based on its true long-run competitiveness. The mission had a considerable impact; its preliminary finding was that it would be difficult for SOMISA "to attain acceptable economic and financial value and [should] thus be sold." It also contributed to Bank lending; a Public Enterprise Reform Loan II (loan 3556, January 5, 1993 for US $300 million) included action on privatizing steel. 2.59 The management of the enterprise was replaced; the new management engaged international consultants to prepare a turnaround and privatization strategy. It acted upon many of the Bank's recommendations-reducing the labor force from 14,500 to 9,500; shifting product mix from the international to the domestic market, and concentrating on flat products; renegotiating major 1 The official with the most direct responsibility for privatization in the Secretarla de Agricultura had cooperated closely with the Bank's mission in his previous assignment with the National Grain Board (NG). 54 purchase and sales contracts; and closing down its blast furnace. Eventually, SOMISA was indeed privatized. Remaining Issues 2.60 The Provinces: Helping to Better Understand Their Fiscal Problems. The new analytical framework laid the foundation for more in-depth macroeconomic work, much of it in the fiscal arena. In particular, the Bank provided studies of province-level financing in both 1990 and 1992, and developed a great deal of interesting information. On balance, however, the attempt to develop a seamless continuum from analysis to prescription, from prescription to reform measures, and from reform measures to Bank lending failed. The basic problem-improvident province governments that either borrowed from province-level banks which rediscounted with the Central Bank or clamored for Treasury transfers in addition to their legal share in certain taxes-could not be resolved. The Government's attempt alternatively to cut the flow of funds to the provinces by forbidding the Central Bank to rediscount provincial bank papers or to increase the flow by changing the Coparticipation Law while transferring new secondary education and health responsibilities created new expenditure and financing problems in the provinces. Cut off from credit but with the added responsibilities, most provinces began to borrow from commercial banks, which saw their bad debts increasing; but the commercial banks were too important to allow the federal Treasury to stand by and let them become insolvent. Consequently, the provinces, by creating insolvency in the banking system, continue to threaten financial stability at the federal level. The problem is a political one that is deeply imbedded in Argentine history, and neither the Bank nor the Government have found a fully satisfactory solution. But the Bank's work has helped illuminate the nature of the reforms that the Provinces could make, the extent of the numbers involved, and the significant 18 differences among various provinces; it has also provided a basis for some adjustment lending. The federal government, in turn, has been pursuing a strategy which the Bank is supporting in several areas including lending, ESW, advisory services to limit the ability of the provinces to finance their current deficits and to promote the need to reduce and improve the efficiency of their expenditures. Given the autonomy of the provinces there is a lot of give and take in the process, but the agenda has moved forward. 2.61 Social Security: Exploring the System's Fiscal Problems. The Bank's ESW focused heavily on the social security system and on the Menem Government's reform of a system that was both inequitable and broke. As noted above, in 1989, the Bank presented two alternative reforms-a conventional one, consisting primarily of benefit reductions, eligibility tightening, and contribution increases, and an unconventional one, consisting of a basic stipend and an opportunity for private contractual savings institutions under public regulation . The Bank clearly preferred the later, which was actually closer to what the Government finally began to adopt in July 1994. Whether the social and financial implications will be such to make the system sustainable, cannot yet be determined. 19 The reform implies transitional fiscal costs averaging about 0.5 percent of GDP over 1995-98. In the absence of financing, these transitional costs affected fiscal results in the second half of 1994, risking the sustainability of the overall reform program. 18 In December 1990 the Bank made a Provincial Development Loan for US $200 million, which at the end of 1994 was not yet fully disbursed. Nevertheless, given the Governments compliance with its provisions and the adoption of reform programs by some provinces, a second loan was prepared and was scheduled for Board presentation on January 24, 1995. The outcome of these loans is not yet known, since they are both still ongoing. 19 Some recent judicial decisions have called into question the Government's approach toward limiting its obligations to contributions to the previous system. This issue has large financial implications; it has not yet been resolved. 3. An Evaluation Of Instruments: Lending 3.1 In the past ten years, the Bank's loan portfolio in Argentina has increased tenfold, from US $503 million in 1984 to US $4.7 billion in 1995-indicating not only the attractiveness of Argentina as a Bank client, but also the Bank's commitment to the country. Still, Argentina's indebtedness to the Bank is relatively small, increasing over the period from 1 percent of the country's total debt in 1984 to about 5 percent in 1995. 3.2 This chapter assesses the Bank's lending performance, judged by both its overall contribution to the country's financing needs and the overall quality of the portfolio. Lessons about consistency with strategic objectives and managing risk were discussed in chapter 1. Combined with the information in this chapter, the analysis indicates that the Bank has improved the quality of its portfolio in the 1990s (from its low level in the 1980s) and is now supporting the country's efforts to tie up the loose ends of its economic reform agenda. Contribution to Argentina's Financial Needs: A Delayed Response 3.3 The response of the Bank to Argentina's financing needs over time is summarized in figure 3.1, together with those of IMF and the Interamerican Development Bank. The Bank's response appears to have lagged at two crucial points-when Argentina first showed signs of a commitment to economic reform (in 1983), and when the Menem Government took over and embarked swiftly on economic reform (the 1989-91 period). At the same time, it could be argued that the big increase in 1987 took place at too late a stage in the Alfonsin Government period because its policies were too little, too late, and that the second large increase (1993) was also too late because private capital flows had already recovered by that time. These lags are often a reflection of the "normal" lags in the disbursement of Bank funding and, therefore, not necessarily peculiar to Argentina, but often diminish substantially the Bank's ability to provide timely financing to support policy reforms. 3.4 In 1983, the international community perceived that the newly elected government of President Alfonsin was showing a genuine interest in initiating comprehensive reform. The IMF immediately provided financing to assist the Government's stabilization efforts. But the Bank was cautious, increasing its commitments only when the Government initiated the Plan Austral in 1985. In 1986, the IMF felt that economic reform had failed to materialize and quickly withdrew its support. In contrast, Bank disbursements increased and those of IDB remained reasonably flat. These funding movements offset each other: in 1986, the net availability of funds to Argentina from these three sources was negligible. 3.5 When economic reform also failed to materialize under the Plan Australito in 1987, all three sources reduced disbursements. The IMF's net contribution dropped sharply, as it chose to withdraw totally from providing financing for the next attempt at economic reform in 1988, the Plan Primavera. In contrast, net disbursements from the Bank and the IDB continued to be positive-not only from loans that had been approved in the two previous years, but also from loans approved to support this third economic reform plan by the Alfonsin Government. This declining trend for all three institutions continued (except for a minor increase in Bank disbursements in 1990) until 1992. The net result was a negligible net availability of funding to 56 Argentina from 1988 to 1990, and a negative net availability of funding in 1991 and 1992 (figure 3.1). Figure 3.1. Argentina-Net Disbursement Flows (1985-93) World Bank, International Monetary Fund, and Interamerican Development Bank 1OD M I/I EIR 4D 0 1_I kn 0 r- 00 (ON - C 00 00 00 00 00OWN N O 1985 1986 1987 1988 1989 1990 1991 1992 1993 IMF 1000 -237 622 23 -480 -260 -591 -74 1229 IBRD 75 273 662 299 96 172 109 -211 1173 IBRD + IDB 221 349 710 365 441 350 308 -202 1976 IMF = purchases minus repurchases. IBRD = World Bank net disbursements. IBRD + IDB = World Bank plus IDB net disbursements. Source: World Debt Tables. 3.6 The Bank's decision to adopt a highly cautious lending strategy for 1990 and 1991 seems, in retrospect, inadequate. The Menem administrati"n embarked on structural economic reform in 1989 (Law of the Reform of the State in July 1989 and Law of Economic Emergency in September 1989). The IMF approved an SDR 1.1 billion Stand-by Agreement in November 1989. Subsequently, the Government adopted the successful Convertibility Plan in April 1991. As a result, Argentina's economy rebounded to the point where it started to attract private capital before the Bank (as well as the IMF and IDB) managed to reverse the downward trend in disbursements. Paradoxically, given the Bank's caution in 1989-91, combined with the disbursement lag in loans approved during those years, net disbursements by the three institutions became negative in 1991 and 1992, precisely at the time when the country's economic reforms could have benefited from assistance. 57 3.7 Since 1993, the Bank has resumed positive net disbursements. Their direct impact, however, has been overshadowed by the availability of the enormous amount of private capital through 1994. That is not to say that Bank disbursements (and commitments) did not have any impact; to the contrary, the financial contributions of the Bank, including the "signals" sent by loan approvals even before disbursements start, helped the Government to achieve macroeconomic stability by helping to regularize the country's debt problems and allowing private capital markets to support the financial needs of Argentina. And although it is still too early to determine whether the continued contributions of the Bank have been effective (most loans are still ongoing), the strong economic climate of Argentina and return to prominence in the region suggests that Bank funding is now making headway toward sound management of operations in progress. Sectoral Distribution of Loan Commitments 3.8 Total Bank commitments during FY85-95 were US $7.3 billion.21 About 60 percent of all loan commitments approved during the ten-year period supported reforms in the financial sector, energy (including power), and public sector management (table 3.1). More than 50 percent of loans in the first half of this period (FY85-89) were for trade policy and energy; almost 65 percent in the second half of the period (FY90-95) were for financial sector reform and public sector management. Table 3.1. Loan Commitments: FY85 to FY95 FY85-89 FY90-95 Total over period Sector No. of Per- No. of Per- No. of Per- loans Amount' centage loans Amount' centage loans Amount centage Agriculture 2 456.5 14.2 1 33.5 0.8 3 490 6.7 Socialb 1 28 0.9 2 290.0 7.1 3 318 4.3 Power and energy 5 838 26.1 2 328 8.0 7 1,116 15.3 Transport 1 50 1.6 1 340 8.3 2 390 5.3 Urban 2 420 13.1 2 370 9.0 4 790 10.8 Water supply I 60 1.9 1 100 2.4 2 160 2.2 Financial sector' 2 525 16.4 4 1358.5 33.0 6 1,803.5 25.8 Trade policy 2 800 25.0 - - -- 2 800 10.9 Public sector 2 25 0.8 7 1201 31.4 9 1,226 16.8 management Total 18 3,202.5 100.0 20 4,111.0 100.0 38 7,313.5 100.0 Source. IBRD, Financial Data Base, Commitments report Note. Data are as of the end of February 1995. 'Commitments (US$ million) blncludes education, health, and social management. includes loans targeted at small and medium-size industry, the banking sector, capital market development, financial reform DDSR activities, and financial sector adjustment. Quality of Lending Portfolio: 1985 to 1995 3.9 The rest of this chapter assesses the quality of the Bank's portfolio for the two subperiods used throughout this report: 1985-89 and 1990-95. During the first period, the 21 These loans represent approvals up to January 1995. The Bank approved three more loans after January in FY95. Municipal Development II for US $210 million in March; Provincial Development II for (US $225 million) in May, and Provincial Banks privatization for US $500 million, also in May. In FY96, nine more loans were approved between July and December 1995, for a total of US $1.1 billion. 58 portfolio was affected by extremely unstable macroeconomic conditions, which stifled the climate for successful lending and thus the outcome of the Bai's projects. The second period was much more conducive to good outcomes, as evidenced by the increasingly stronger lending portfolio of the Bank. Yet it is still too early to determine whether Bank lending in this second period has been effective (and sustainable), since most projects are still ongoing. The 1985-89 Period 3.10 When the Alfonsin Government assumed power in 1983 after years of economic mismanagement, the Bank was optimistic that the country was primed to tackle its economic situation. Thus, the Bank decided to assume a major role as the provider of both capital and economic policy advice. 3.11 Bank commitments during the next five years were indeed substantial, consisting of 18 loans for a total of US $3.2 billion during the FY85-89 period (table 3.1). Commitments were more than twice the level planned in the 1985 CPP (see table 3 in Appendix) but comparable to annual per capita amounts for other heavy Bank borrowers (table 3.2 ). Table 3.2. Annual IBRD Commitments per Capita: FY85-89 (selected countries) 1987 Annual per capita Population GNP per capita commitments (US$) (million) (USS) Mexico 20.0 81.9 1,840 Philippines 6.0 58.4 590 Turkey 17.5 52.6 1,220 Korea 8.5 42.1 2,900 Colombia 15.1 29.5 1,240 Argentina 20.6 31.1 2,410 Morocco 18.8 23.3 620 Chile 29.8 12.5 1,360 Ecuador 12.6 9.9 1,060 Tunisia 27.3 7.6 1,190 Source. Financial data base; World Bank Atlas 3.12 The Bank's strategic objectives in 1985 were to strengthen the country's export capacity, both in agriculture and industry, help rationalize the energy sector, reform public sector management, support the banking sector, and provide some support for infrastructural and human resource development. As the macro-situation deteriorated further, Bank lending shifted more towards structural adjustment loans than originally foreseen, primarily in pursuit of stabilization objectives. Nevertheless, the overall composition of the 1985-89 commitments did roughly correspond to original objectives that seemed appropriate at the time. Adjustment lending accounted for 49 percent of the total, focusing on agriculture, trade policy and industry, and banking; 7 percent of commitments were financial intermediary loans; 2 percent were technical assistance loans; and 42 percent were specific investment loans, covering power and energy (25 percent), transport (2 percent), water and sewerage (2 percent) and urban development (13 percent) (table 3.3). 59 Table 3.3. Loan Commitments: 1985-89 Loan/ Commit. Canceled Credit Board Amount Amount FY Number Project Name Date (US$M) (USS) 1985 L25920 Gas Development - YPF 25-Jun.-85 180.0 14.6 1986 L20321 Refinery Conversion 20-May-86 116.0 - 1986 L26410 Water Supply 10-Dec.-85 60.0 15.2 1986 L26750 Agricultural Sector Loan 03-Apr.-86 350.0 0.04 1986 L27120 Public Sector Mgmt. TA 03-Jun-86 18.5 - 1987 L27510 Power Engineering 16-Sep-86 14.0 - 1987 L27930 Small & Medium Scale Ind. 14-Apr-87 125.0 64.2 1987 L28050 Bahia Blanca Port I 05-May-87 50.0 42.8 1987 L28150 Trade Policy 19-May-87 500.0 4.0 1987 L28540 Segba V 23-Jun-87 276.0 - 1988 L29200 Municipal Development 22-Mar-88 120.0 - 1988 L29230 Banking Sector Loan 29-Mar-88 400.0 400.0 1988 L29700 Agricultural Credit II 23-Jun-88 106.5 - 1989 L29840 TA for Social Management 26-Jul-88 28.0 1989 L29960 Trade Policy Loan II 27-Oct-88 300.0 - 1989 L29970 Housing Sector I 27-Oct-88 300.0 278.3 1989 L29980 Electric Power Sector I 27-Oct-88 252.0 - 1989 L30150 TA for Tax Reform 24-Jan-89 6.5 - Total FY85-89 3,202.5 819.14 Quality of Portfolio: Poor 3.13 The contradiction between the Bank's lending commitments and the absence of effective economic reform (combined with the abandonment of the Bank's strategic objective to make lending conditional on achieving macroeconomic stability) had a devastating impact on the quality of the Bank's portfolio. This can be gauged by the amount of cancellations, by the outcomes of evaluated projects, and by preliminary assessments for those not yet evaluated. 3.14 As of December 1995, the Bank had canceled 26 percent of the total amount approved during the 1985-89 period. About half of a Small and Medium-Scale Industries Credit project was canceled because the National Development Bank was suffering a financial crisis and its management strongly resisted the Bank's restructuring; the crisis would ultimately force the bank's liquidation. More than 90 percent of the First Housing Sector loan (to provide financing for low-income housing) had to be canceled because its design underestimated the weaknesses of the institutional structure and aggravated the uncertainty of the economic environment. A planned Banking Sector Loan to increase the efficiency of the financial sector was never even signed, because the fiscal impasse made compliance with some of the loan conditions impossible. 3.15 Of the 18 loans committed during the FY85-89 period, OED has evaluated 12; the remaining 6 loans are either under implementation or no PCR or ICR has been produced (table 3.4). Of the 12 evaluated projects, the outcomes of only 5 (16 percent of the total loan amount committed) are rated as satisfactory. Of the satisfactory outcome projects, the two largest-the Gas Utilization and Technical Assistance project (GUTA), for US $180 million, and the Second Trade Policy Loan (TPL2), for US $300 million -implementation flowed over into the early 1990s, when policy changes improved the 60 environment for both investment and adjustment operations. In the case of GUTA, it was a problem project until it was reformulated. The project reformulation allowed funds to be diverted towards financing consultants and studies to support the new government's privatization efforts, a goal not originally contemplated in the design of the project. In the case of TPL2, the (delayed) release of the second tranche took place in July 1990-two years after the original program derailed (box 3. 1). By the time the second tranche was released, fiscal reform was well underway and the earlier trade reform objectives were put back on track. 3.16 Two large SECALs, the First Trade Policy Loan of FY87 (US$500 million), and the Agricultural Sector Loan of FY86 (US$350 million) were fully disbursed and their outcome was rated unsatisfactory. In the case of the Agricultural Sector Loan, the Project Audit Report (PAR) notes that the second tranche was released in late 1987 (after a heated debate at the Board) in spite of the fact that the major sector conditions had not been met. In the words of the PAR, "The release had secured the resource transfer objective while abandoning a major policy reform objective" (Report No. 11925 of May 28, 1993). 3.17 A review of the six projects that have not yet been subject to PCR evaluation also suggests that the outcome of five of them is likely to be rated as unsatisfactory (table 3.4). Table 3.4 OED Reviews of Project Outcomes: 1985-89 Latest Total Impact on OED Report Amount Sustain- Institutional Approval ID Project Description Type (million) Outcome' abilityb Development' Date L25920 Gas Development - YPF PAR 180 S LIK MOD 06/25/85 L20321 Refinery Conversion PAR 116 U LIK MOD 05/20/86 L26750 Agricultural Sector Loan PAR 350 U UNL SUB 04/03/86 L27120 PS Management TA Proj. PCR 18.5 S LIK SUB 06/03/86 L27510 Power Engineering Proj. (TA) PCR 14 S LIK SUB 09/16/86 L27930 Small & Med. Scale Ind. PCR 125 U UNL MOD 04/14/87 L28150 Trade Policy Loan PAR 500 U LIK MOD 05/19/87 L29230 Banking Sector Loan PAR 400 U UNL NEG 03/29/88 L29960 II Trade Policy Loan PAR 300 S LIK MOD 10/27/88 L29970 First Housing Sector PCR 300 U UNL NEG 10/27/88 L29980 Electric Power Sector I PAR 252 U LIK MOD 10/27/88 L30150 TA for Tax Reform PCR 6.5 S LIK SUB 01/24/89 2562 Projects Without PCRs Total Undisbursed Approval Closing Probable Amount Balance Date Date Outcome L26410 Water Supply 60.0 8.8 12/10/85 06/30/95 U L28050 Bahia Blanca Port I 50.0 -- 05/05/87 08/09/91 U L28540 Segba V 276.0 101.8 06/23/87 12/31/98 U L29200 Municipal Development 120.0 -- 03/22/88 06/30/95 U L29700 Agricultural Credit II 106.5 -- 06/23/88 06/30/95 U L29840 TA for Social Mgmt. 28.0 0.06 07/26/88 06/30/95 S 640.5 110.66 Total FY85-89 3,202.5 Source. OEDD2, TMW/MIS Database. 'S = satisfactory; U = unsatisfactory. 'LIK = likely, UNL = unlikely; UNC = uncertain. CSUB = substantial; MOD= moderate; NEG = negative. 3.18 Although Bank lending in 1985-89 did not yield the results envisioned, it was not entirely without success. For example, three technical assistance loans (for a total of US $61 61 million) can truly be rated as satisfactory for the FY85-89 period itself. The success of the TA loans-satisfactory outcomes, likely sustainability, and moderate to substantial impact on institutional development-owes much to the persistence of the Bank at keeping its dialogue alive during economic turbulence, the relative insulation of the TA loans from the country's macroeconomic difficulties (since most TA funds were used to finance studies), and, again, to their "spill over" implementation into the Menem Government. The Power Engineering project (FY86) successfully supported Government efforts to identify and address key functional and technical problems affecting electricity distribution. The Public Sector Management TA project (FY86) supported Government efforts to generate much-needed information systems. The Social Sector Management TA project, approved in FY88 but not implemented until the early 1990s, supported the efforts of the more reform-minded Administration to develop a structure for defining priorities and an analytical basis for major legislative and institutional changes that have since improved resource use in critical areas. The Technical Assistance for Tax Reform loan (FY89) was successfully reformulated after President Menem took office, supporting efforts to modernize and expand tax administration information systems. Box 3.1. Trade Policy Loan (TPL I): The Impact of Macroeconomic Distortions The negative impact of the country's deteriorating economic climate on projects in the late 1980s can be illustrated by the experience of any number of projects. The outcome of TPL I is one such example. The government policy objective was to restore growth by turning the inward- looking and state-led economy into a more open and market-based system. Trade reform was seen as the first step. The TPL I, approved in May 1986, was to help promote and liberalize exports. During 1987, the Government largely met the sectoral policy conditions of TPL 1: a temporary admissions regime for exporters was expanded and made more efficient, export taxes on manufactures were eliminated, and an indirect tax reimbursement scheme was broadened. In other words, the objective of granting free trade status to industrial exporters had been achieved. Compliance with the sectoral policy conditions of the loan, together with initial stabilization efforts (which led to IMF approval of the macroeconomic program), led the Bank to approve the release of the second tranche. The loan was fully disbursed by the end of 1987. Yet the weakness behind this process was that most fiscal measures at the heart of compliance with the macroeconomic program were merely promised. In the ensuing months, Argentina's fiscal situation steadily deteriorated. By February 1989, the adjustment program collapsed, due primarily to an untenable fiscal situation. In April of that year, an explicit across-the-board export tax of 25 percent was introduced, and prior approval of advance import declarations as a condition for import financing was reintroduced. Major progress under TPL1 was thus nullified. The 1990-95 Period: From Cautious Policy to High Levels of Assistance 3.19 The Bank was influenced by the country's poor policy environment and project implementation of previous years and the perception that political uncertainty still prevailed in the country. Thus, the 1990 Country Strategy Paper recommended a prudent lending policy until progress in macroeconomic management and debt reduction with the commercial banks had been achieved. It had no new lending in FY90, and it planned for only one large loan for each year during FY91-92. Yet it continued its economic dialogue with Argentina, to position itself to step 62 in if the new Government managed to reverse the Bank's initial doubts by actually reforming the economy. 3.20 As the Government proved its commitment to reform-achieving macroeconomic stability and reaching agreement in principle with the commercial banks to restructure its debt by 1992-the Bank increased its lending program, with commitments of US $2.6 billion for nine loans in FY93-94. Annual per capita commitments throughout the FY91-95 period were US $30.1, an amount that was now much higher than other Bank borrowers at a similar stage of economic development (table 3.5). Table 3.5. Annual IBRD Commitments per Capita: FY91-95 (selected countries) Annualper 1993 capita commitments Population GNP per capita (US$) (million) (US$) Mexico 19.5 86.7 3,750 Philippines 7.0 65.8 830 Turkey 7.2 59.5 2,120 Korea 6.6 44.1 7,670 Colombia 8.8 35.7 1,400 Argentina 30.1 33.5 7,290 Morocco 14.8 26.7 1,030 Chile 10.7 13.8 3,070 Ecuador 15.2 11.3 1,170 Tunisia 26.4 8.6 1,780 Sources: Financial Data Base; World Bank Atlas Composition 3.21 The Bank recognized that sustained stability and growth required continued attention to the fiscal fundamentals-primarily efforts to reduce the deficits of the federal government and of public enterprises, facilitate province-level financing, and overhaul the social security system. Early Bank operations in 1991 were thus devoted to supporting Government efforts to attack the most important of these problems. The Public Enterprise Reform Adjustment Loan supported Government efforts to privatize the telephone, oil, and railway public enterprises, which accounted for about 50 percent of the total operating deficit of all state-owned enterprises. The Public Sector Reform Loan supported Government efforts to improve its fiscal situation by strengthening revenue mobilization, reducing expenditure and reforming the Central Bank. And the Provincial Development Project supported the Government's province level reform effort to improve institutional development and finance a time-slice of province expenditures. 3.22 As fiscal conditions improved, the Bank's lending priority shifted to financial sector reform and, later, to improve social services for the poor. In FY93, a large financial package was put together, including an IMF three-year extended arrangement, an agreement with commercial banks (a Brady-type deal) to settle arrears and reduce debt service to fiscally sustainable levels, and three Bank adjustment operations for US $1.15 billion (of which up to US $750 million would be used to enhance the Brady deal to restructure Argentina's commercial debt). This was part of the Bank's lending program of up to US $5 billion for the five-year FY93-97 period to continue supporting the privatization program, financial sector reform, finance reform at the 63 province level, improvements in credit to the agriculture sector, a program to develop capital markets, the restoration of productive services, and infrastructure redevelopment. The condition set for the assistance program was that Argentina maintain an operational fiscal surplus of 2 percent of GDP to obviate the need for inflationary financing. Overall, 52 percent of the commitments approved during FY91-95 were for adjustment lending (table 3.6). Table 3.6. Loan Commitments: 1990-95 Loan/ Commit. Cancelei Credit Board Amount Amount FY Number Project Name Date (USSM) (USSM)h 1991 L32800 Provincial Development Project 18-Dec-90 200.0 - 1991 L32810 Water Supply II 18-Dec-90 100.0 - 1991 L32910 Public Enterprise Reform Adj. 12-Feb-91 300.0 - 1991 L32920 Public Enterpr. Reform Exec. 12-Feb-91 23.0 - 1991 L32970 Agric. Services & Inst. Devt. 28-Feb-91 33.5 - 1991 L33620 Public Sector Reform TA 25-Jun-91 23.0 - 1992 L33940 Public Sector Reform 30-Jul-91 325.0 - 1992 L34160 Hydrocarbon Engineering 19-Nov-91 28.0 19. ' 1992 L34600 Tax Administration 11 14-Apr-92 20.0 - 1993 L35200 Yacyreta II 29-Sep-92 300.0 - 1993 L35210 Flood Rehabilitation 29-Sep-92 170.0 - 1993 L35550 DDSR Support 05-Jan-93 450.0 - 1993 L35560 Public Enterprise Reform II 05-Jan-93 300.0 - 1993 L35580 Financial Sector Adjustment 16-Feb-93 400.0 - 1993 L361 10 Road Main. & Rehab. Sector 03-Jun-93 340.0 - 1994 L36430 Maternal & Child Health 03-Aug-93 100.0 - 1994 L37090 Capital Market Development 01-Mar-94 500.0 - 1994 L37100 Capital Market TA 01-Mar-94 8.5 - 1995 L37940 Secondary Education I 15-Sep-94 190.0 - 1995 L38360 Provincial Reform 24-Jan-95 300.0 - Total FY91-95 4,111.0 19.7 a Note: This tables does not include projects approved after February 1995: Municipal Development 11 (US $210 million); Provincial Bank Privatization (US $225 million); and Provincial Bank Privatization (US $500 million Quality of Portfolio: Major Improvement 3.23 There is only limited evaluation of the outcomes of Bank lending to Argentina in the 1990-94 period, because few operations have been completed. Twenty lending operations were approved for a total of US $4.1 billion of which OED has audited only one, the Public Enterprise Reform Adjustment Loan (PERAL) (FY91, US $300 million) and reviewed the Region's self- evaluations of two projects. OED rated PERAL's outcome as highly satisfactory (table 3.7). The other two projects were structural adjustment loans, representing 18 percent of total lending during the period, and their outcomes were also rated satisfactory. The Public Sector Reform Loan (FY92, US $325 million) provided financial support to Government efforts to mobilize additional revenue, reduce expenditures at the federal level, and reorganize the Central Bank. The Debt and Debt Service Reduction Loan (FY93, US $450 million) was part of a package of external assistance to finance collateral required for a major debt and debt service reduction agreement under the Brady Plan. 64 The Debt and Debt Service Reduction Loan (FY93, US $450 million) was part of a package of external assistance to finance collateral required for a major debt and debt service reduction agreement under the Brady Plan. -3-24 The remainder of the projects approved in the period-about 75 percent of all lending 22-are ongoing and/or have not yet been subject to evaluation in project completion or audit reports. To evaluate these projects (with the exception of those for technical assistance), OED expanded the methodology of research recently undertaken under the ECON I and ECON II studies (ECON).23 The two ECON studies used samples that included four of the ongoing projects in Argentina's portfolio. Their findings for the Argentina projects were that 56 percent of lending was poor or marginal at entry (US $434 million of US $774 million; table 3.7). This CAR expanded the ECON methodology to all projects in Argentina's portfolio and found more reassuring results: 29 percent of lending was rated as poor or marginal at entry (US $628 million of US $2.2 billion evaluated; table 3.7). Public Sector Management Projects 3.25 The fiscal deficit has been the most critical long-term structural issue facing Argentina for many decades. Hyperinflation in 1989 was primarily a result of the Government's inability to muster the political will to tackle the fiscal deficit. As detailed in chapter 2, the Bank provided several analytical studies of fiscal issues in Argentina since 1987. These studies identified the three most urgent, permanent sources of disequilibrium affecting the structural fiscal deficit- the deficits of the public enterprises, the deficits of the province-level governments, and the deficits of the social security system. 3.26 Consistent with its diagnosis, the Bank devoted almost one-third of loans approved in FY90-95 (US $1.2 billion) to support adjustment related to public-sector management (table 3.2). Early operations supported the Government's efforts to privatize the three state-owned enterprises that accounted for about 50 percent of total operating deficits among all public enterprises, telephone, oil and railways, and to improve the revenue and expenditure balance of the federal government. Two loans supported privatization: the Public Enterprise Reform Adjustment Loan for US $300 million in FY91, and the Public Enterprise Reform TA loan for US $23 million in FY91. Three loans helped reform the Government's financial operations: the Public Sector Reform loan for US $325 million in FY92; Tax Administration I for US $20 million in FY92; and the Public Sector Reform TA loan for US $23 million in FY91. Continuing with support for privatization, in January 1993, the Bank approved a Second Public Enterprise Reform Loan for US $300 million; this loan was part of the package to support a Brady Plan. And in January 1995, the Bank approved a Provincial Reform Adjustment Loan for US $300 22 These loans represent approvals up to January 1995. The Bank approved three more loans for FY95 after January 1995: Municipal Development II for US $210 million in March; Provincial Development II for US $225 million in May; and Provincial Banks privatization for US $500 million, also in May. 23 The purpose of the ECON analysis was to evaluate the quality at entry-that is, at the moment the projects were approved. The results of ECON may be useful for predicting the probability of poor project performance shortly after project approval. Previous evidence collected in the ECON studies indicates that a project is seven times more likely to be rated as poor three years after approval if the results of economic analysis in initial staff appraisal reports are poor than if they are good. Economic Analysis ofProjects: Towards a Results-oriented Approach to Evaluation, June 30 1992; and A review of the Quality of Economic Analysis in Staff Appraisal Reports for Projects Approved in 1993, May 5, 1995. 65 million to improve the financial performance of the provinces and their capacity to deliver public services. Table 3.7 OED Reviews of Project Outcomes: 1990-1994 Latest Impact on OED report Total Sustain- institutional Approval ID Project description type amount Outcome a ability development date L3291 Pub. Enterprise. Adj. Loan PAR 300 HS LIK SUB 2/12/91 L3394 Pub. Sector Reform PCR 325 S UNC SUB 7/30/91 L3555 DDSR Project PCR 450 S LIK MOD 1/5/93 Subtotal 1,075 Projects without PCRs ECON Total Undisbursed Approval Closing overall amount balance date date ratingd L3280 Provincial Devt. Project 200 141.1 12/18/90 12/31/96 Me L3281 Water Supply 11 100 96.1 12/18/90 6/30/98 P L3292 Pub. Enterprise Reform TA 23 1.3 2/12/91 6/30/95 - L3297 Agric. Serv. & Inst. Dev. 34 14.5 2/28/91 6/30/98 Me L3362 Pub. Sector Reform TA 23 7.9 6/25/91 6/30/95 - L3416 Hydrocarbon Engineering 28 --- 11/19/91 07/31/95 M L3460 Tax Administration II 20 4.7 4/14/92 2/28/97 - L3520 Yacyreta 11 300 34.8 9/29/92 12/3198 M L3521 Flood Rehabilitation 170 65.1 9/29/92 3/31/96 A L3556 Pub. Enter. Reform II 300 26 1/5/93 12/31/95 A L3558 Financial Sector Adj. 400 --- 2/26/93 12/31/95 Af L3611 Road Maint. & Rehab. Sect. 340 259.2 6/3/93 6/30/00 A L3643 Maternal & Child Health 100 89.6 8/3/93 12/31/99 Mf L3709 Capital Market Devt. 500 500 3/1/94 6/30/96 G L3710 Capital Market TA 9 7.8 3/1/94 6/30/98 - L3794 Secondary Education 1 190 190 9/15/94 6/30/00 A L3836 Provincial Reform 300 300 1/24/95 6/30/98 P Subtotal 3,036 1738.1 Total 4,111 Source. OEDD2, TMW/MIS Database. 'HS = highly satisfactory; S = satisfactory. b LIK = likely; UNC = uncertain; ' SUB = substantial; MOD = moderate. dG = good or better; A = average or acceptable; M = marginal or barely acceptable; P = poor. c Evaluated by ECON I.f Evaluated by ECON II 3.27 Thus far, the outcome of these loans appears to have been highly satisfactory or satisfactory. The main accomplishment has been a substantial reduction in the fiscal deficit, which the Government has achieved under its three-pronged reform efforts-a comprehensive privatization program; a radical reform to limit the capacity of the Central Bank to finance public deficits; and a broad program of revenue mobilization and expenditure reduction in the federal government. Despite this success, however, obstacles to ensuring the sustainability of the reforms remain-in particular, serious weaknesses with the regulatory framework governing privatized enterprises, and the still huge fiscal deficits in the provinces and the social security system. 3.28 Public Enterprise Reform Loans. In 1989, the Government initiated a massive privatization effort to eliminate the deficit created by state-owned enterprises (public enterprises 66 then accounted for about 50 percent of the total deficit in the public sector). The privatization program was unique in the world since it covered all major enterprises and it was accomplished in record time (about four years).24 The privatization enterprises included: the national airline, banks, railways, fuel, natural gas, electricity, telecommunications, ports, water and sewerage services. and manufacturing including steel, various assembly operations and defense related industries. By 1993 the market value of privatized assets was estimated to be at least US $18 billion.- The privatization program had significant impacts on the economy by 1993, it generated over US $8 billion in cash and reduced public external debt by over US $10 billion at face value and over US $4 billion in cash equivalents. It eliminated the bulk of subsidies and resulted in higher tax revenues, greater investment in infrastructure and improved quality of public services. The Government began in 1989 by restructuring and privatizing the three largest public enterprises, telecommunications, hydrocarbons, and railways. Two Bank loans supported this initial effort, the Public Enterprise Reform Loan (PERAL) and the Public Enterprise Reform TA (PEREL). 3.29 OED rated the outcome of PERAL as highly satisfactory, despite shortcomings on the regulatory front (box 3.2). OED concluded that the public enterprise reform undertaken with the support of PERAL was among the most far-reaching privatization efforts ever carried out by any country. The alternative of delaying privatization until an adequate regulatory framework was in place w ould have jeopardized the privatization effort, prolonging the burden of public enterprise deficits indefinitely. The loan and technical assistance were a product of the extensive dialogue on the role of public enterprises in the fiscal problems of Argentina that Bank staff had maintained since early 1990. Although the Bank had promoted public enterprise reform, not privatization, in the late 1980s, Bank-Government dialogue played a key supportive role in the planning and execution of the reforms that eventually led to privatization. The withdrawal of the state from major productive sectors provided substantial long term-benefits to Argentina even if in a less-than-ideal competitive environment. The experience of the early privatization process in Argentina has yielded important lessons that are applicable to improving the regulatory framew ork in other Bank-supported privatization efforts and has prompted the Bank and the Government of Argentina to focus their attention on reducing the ability of newly privatized enterprises to engage in monopolistic behavior under an imperfect regulatory framework. - 30 The Government undertook several measures to prevent ownership concentration and reduce the opportunity for monopolistic behavior of the privatized enterprises. Most of these measures consisted on bidding restrictions applied to each privatization episode; but the overall concentration of assets by local conglomerates has not been tackled explicitly and remains a 26 contentious issue in the public debate. In SEGBA., bidders were prevented from obtaining more than ten percent of total installed electricity generation capacity. Also, investors in SEGBA were prohibited from selling these shares for five years and need approval of the regulatory agency to sell them afterwards. In the case of gas, no single bidder was allowed to acquire a majority share in more than one transmission company or buy two distribution Hafeez Shaikh. with Manuel Asdala, Christina Keppez, Peter Lauter and Alfredo Visinatini, Argentina PriNatization Program, a Review of Five Cases, CFS Discussion paper series No. 117, January 1996. M,rna Alexander and Carlos Corti, Argentina's Privatization Program, CFS Discussion Paper Series No. 103, uu 1992. 6 Hafeez Shaihh, Op. cit., page 23. 67 companies, or one transmission and one distribution company. Also, buyers could not purchase shares or controlling interest of the large distribution companies. In the case of petroleum, BOX 3.2. The Regulatory Framework of Privatized Enterprises The regulatory framework. The establishment of appropriate regulations has been the main concern of the Bank as it assisted Argentina to privatize its SOEs. Privatizations were initiated before an adequate regulatory framework was in place, but this was an unavoidable consequence of the failure at reforming state enterprises the years before. A long history of failed attempts to reform SOEs had led to unsustainable fiscal deficits which forced privatizations as the only alternative to eliminate these deficits, even if privatization was done in less than ideal conditions. The quality and transparency of the later privatizations program improved over time in Argentina as lessons were learnt by doing. Quality and transparency were inferior in the early privatizations (e.g., airlines, telecommunications) than in the latter ones (e.g., electricity, gas, water). Without an appropriate regulatory framework prior to privatization, a controlling share of the telephone company (ENTEL) was sold and three bidders offered prices deemed to be very low. This is normal in the absence of appropriate regulatory institutions. Because of the nature of their assets, public utilities are vulnerable to expropriation by governments, generating only limited interest in private buyers, so bidders offer what is perceived to be "low" prices. But a modern regulatory system was enacted in Argentina after the telephone company had been sold, "generating significant capital gains to the two foreign consortiums that won the initial bidding.' The privatization of the airlines was also inferior: only a single offer was received during the bidding process to privatize Aerolineas Argentinas. This led a study by the World Bankb to conclude that "the preferred option might have been to reject the single offer and repeat the process with revised bidding documents and increased promotion." The quality and transparency of the later privatizations improved significantly. Electricity's regulatory body, the Ente Nacional Regulador de Electricidad (ENRE) has high quality technical expertise and its method of financing provides the required autonomy, although these are still areas of overlapping authority with the Secretariat of Energy. Energas, the agency regulating transmission and distribution of natural gas is well established, but still needs to improve in defining the authority of several new provincial branches. The oil industry continues to be regulated by two different ministries, with occasional overlapping of functions. And OSN (Obras Sanitarias de la Naci6n), the new regulatory agency dealing with water and sewerage services, appeared to be well structured and its authority well defined. a Sebastian Edwards, Latin America and the Caribbean a Decade after the Debt Crisis, World Bank, July 12, 1993. b Myrna Alexander and Carlos Corti, Argentina's Privatization Program, CPS Discussion Paper Series No. 103, August 1992. winners of joint ventures (with equity of between 35 and 50 percent) could not transfer their joint-venture rights to third parties without YPF's approval. In spite of these preventing measures, however, a small number of local conglomerates acquired controlling packages in many of the privatized firms (Techint Group, Perez-Compania, Comercial La Plata-Soldani, and 27 Astra group). As Edwards put it, 27 Sebastian Edwards, Op. cit., page 6-30. 68 "this has increased industrial concentration, especially in public utilities. Although the government is trying to speed the modernization of the regulatory framework, including price-setting mechanisms, it is too early to know whether monopolistic practices will be avoided. That makes it important to monitor new regulatory framework closely to see whether it fosters the development of natural monopolies in private hands. . . the new regulation is likely to become operational only slowly. And it is likely that mistakes will be made on the way. More generally, it takes time to build credible institutions, making it especially important to lay the foundation for new institutions early on and to be alert to the need for making corrections when problems arise." 3.31 OED has not yet rated the outcome of PERAL II, since its closing date is too recent (December 31, 1995), but it has reviewed the project documentation to determine the quality of economic analysis at entry (the ECON analysis). Its main conclusion is that the quality of the project was average or acceptable at entry. The objectives of the project were well defined and adequately linked to the Country Assistance Strategy-to privatize/restructure public enterprises in the Ministry of Defense, reduce the fiscal deficit, and improve the environment for competitive private-sector activity and investment. However, several conditions attached to the loan were ambiguous, making an assessment of whether they are being met arbitrary and difficult. One condition requires that the Government of Argentina commence work on environmental clean-ups of selected public enterprises that have been closed. The Government could meet this condition even by merely "commencing" the work, without undertaking substantive environmental clean-up. While the condition for "commencing" the environmental clean-up might be measurable, it might not be meaningful without guidelines governing the nature and extent of the clean-up. The loan documentation noted merely that "the Ministry of Defense has decided to commit US $10 million from the counterpart of PERAL II for the environmental cleanup of closed facilities" (memorandum of the President, Report P-581 1-AR, December 10, 1992, p. 20). But it did not address whether this level of commitment was adequate, despite the fact that the environmental degradation at one site was classified as "major." Conditionality governing the substantive issue of competition among the privatized enterprises was also without force; the related condition for disbursement, for example, required that the Government "forward satisfactory 'competition' legislation to Congress for consideration." The Government may also be able to satisfy this condition even without substantively improving the competitive environment. This action will be successful only if meaningful legislation is enacted and implemented. 3.32 Public Sector Reform Loan. As discussed in chapter 1, radical reforms in state ownership were accompanied by the Convertibility Plan of April 1991 (see box 1.3 in chapter 1), which encompassed monetary, fiscal, social security, and trade policy reform. The Bank supported this effort with a Public Sector Reform TA loan (PART) for US $23 million in FY91, and a Public Sector Reform Loan (PSRL) for US $325 million in FY92. The PSRL, in particular, supported reforms to enhance revenue mobilization, reduce expenditures, and reorganize the Central Bank. A project completion report for the PSRL indicates that it was successful at supporting efforts to improve the efficiency of the tax structure and of tax administration, to reorganize the administrative structure of the federal government, and to improve the budgetary process. More important, the loan supported a reorganization of the Central Bank, a move that was instrumental in implementing the Convertibility Plan and in helping to stabilize prices. There were, however, a few shortcomings. The Government did not 69 enact and implement a planned Public Procurement Law to curb contracting abuses, and it reduced potential VAT revenues by granting exemptions for industrial promotion. Reductions in federal government employees and the transfer of secondary education to the province-level governments may have also created unintended negative impacts that have not yet been fully assessed. The sustainability of the reforms was rated as uncertain, since fiscal performance began to falter during the second semester of 1994, and because the Government still faces risks that may threaten fiscal equilibrium. 3.33 Province-Level Reform. Fiscal studies dating back to at least 1987 stressed that the provinces were a major source of fiscal deficit in Argentina. Complicating the problem is that the federal government has no direct jurisdiction to effect reforms in province-level public finances. The Bank, however, provided financial support to promote adjustment at the province level in 1990, with a Provincial Development Loan. Progress on this loan has been minimal thus far; by February 1995, US $141 million had not been disbursed, a result consistent with the complexity of the political and economic issues associated with decentralizing responsibility to the provinces, and with the conclusion of the ECON I analysis that the quality of economic analysis at entry was marginal or barely acceptable. The fiscal problems of the provinces were aggravated by the reforms undertaken by the Government (with support from the Public Sector Reform loan), in which responsibility for secondary education was transferred to the province- level governments without a clear analysis of their capacity to handle this additional burden. The provinces are now the major providers of health, education, security, and water and sanitation services, but are not prepared to finance these services locally or to provide quality services. 3.34 To deal with these problems, the Bank approved a new loan in January 1995, the Provincial Reform Loan, for US $300 million. It is too early to evaluate the effectiveness of this loan, since disbursements are just beginning. OED, however, used the ECON methodology to evaluate the quality of economic analysis at entry. Its main conclusion is that, overall, the quality of the analysis was poor. Although the general objectives of the loan were clearly linked to the Country Assistance Strategy, the specific objectives to deepen fiscal reforms were vaguely defined, making them difficult to monitor on the basis of performance indicators. Consequently, assessing whether the objectives have been met will be difficult and subjective. Also, some of the loan conditions for disbursement are of a "preparatory" nature and could be met even in the absence of substantive reform. One condition, for example, required that the Government "draft" legislation to reform financial management at the province level and establish revenue sharing with the municipalities before the second tranche of the loan would be disbursed; it must then "submit" both pieces of legislation before the third (and last) tranche is disbursed. But, as pointed in several OED reports, a legislative reform can be successful only if meaningful legislation is enacted and implemented, not merely drafted and submitted. Financial Sector: Mostly Satisfactory Preliminary Results 3.35 During 1985-89, the Bank produced at least nine studies related to the financial sector (see chapter 2). Argentina's Securities Market and Main Non-Bank Financial Institutions (1988) and the Financial Sector Review (1989) were the most notable, providing a detailed analysis of major regulatory and nonregulatory issues in the financial markets and making specific recommendations covering securities, pension funds, insurance markets, and other financial intermediaries. The Financial Sector Review contained enough specific recommendations to become the basis for a SECAL, but it emphasized, correctly, that its policy recommendations 70 would work only after a stabilization program was in place and inflation had effectively been controlled. Given the effectiveness of the 1991 Convertibility Plan at controlling inflation by 1992, the Government was able to implement a comprehensive Financial Sector Adjustment Reform in February 1993. The Bank supported this effort in the context of three loans that were part of the Bank's support for the debt and debt service reduction effort with the commercial banks early in 1993. A total of four loans for a total of US $1.4 billion, or 33 percent of commitments (table 3.2), were devoted specifically to the financial sector during 1990-95: a Debt and Debt Service Reduction Loan (DDSR) for US $450 million in FY93; a Financial Sector Adjustment Loan (FSAL) for US $400 million, also in FY93; a Capital Market Development Loan (CMDL) for US $500 million in FY94; and a Capital Market Technical Assistance Loan (CMTA) for US $8.5 million, also in FY94. 3.36 Summary Assessment of Performance. OED reviewed the Project Completion Report of the DDSR loan and the quality of economic analysis for the FSAL and the CMDL at their entry. (It is too early for OED to evaluate the FSAL, whose closing date was December 1995, or the CMDL and the CMTA loans, whose closing dates are June 2006 and June 1998, respectively.) The results thus far are highly satisfactory. The DDSR and a set-aside of US $200 million of the FSAL successfully supported a debt reduction operation with the commercial banks in early 1993. OED also found that the CMDL was a highly innovative operation that will reduce risks in the capital market at relatively low cost. The main concern pertains to the vulnerability of financial markets in Argentina to fluctuations in capital flows and the risk of losing macroeconomic stability if the fiscal deficits of the social security system and of the provinces are not addressed in the near future. 3.37 The outcome of the DDSR was rated as satisfactory, primarily because it yielded indirect benefits by combining a DDSR program with other structural reforms. The successful conclusion of the DDSR Agreement reduced uncertainty and increased the confidence of investors by reinforcing the positive impact of other structural changes in Argentina, thus increasing the country's external creditworthiness. It also had direct benefits, helping to reduce the country's debt, but the estimates of these benefits cannot be considered reliable given the difficulty of establishing realistic counterfactuals. 3.38 Financial Sector Adjustment Loan. The objectives of this operation are clear and concise: The proposed loan, another building block of the Bank's support for the Government's ambitious structural adjustment program, will assist in (i) reducing the role of the state in the financial sector, (ii) strengthening the banking sector and its supervisory framework, and (iii) providing resources for Argentina's debt and debt service reduction arrangements. (Memorandum of the President, Report No. P-5862-AR, January 25, 1993). 3.39 The loan is for US $400 million, with up to US $200 million available for a DDSR set- aside. Any unused portion of the set-aside was to be reallocated to the first tranche. Up to US $80 million qualified for retroactive financing based on "significant structural reforms already carried out and the need for the government to assemble import documentation" (MOP, p.35). "The Second and Third Tranches would be conditioned on the Government maintaining a satisfactory macroeconomic performance as detailed in the Letter of Development Policy and a 71 public expenditure program consistent with the IMF's Extended Fund Facility. The Development Policy Letter further details financial sector issues affecting Banco de la Nacion, Provincial Banks, Superintendency of Banks and Deposit Protection" (MOP, pp. 35-36). From this a detailed set of second and third tranche requirements were prepared. 3.40 OED concluded that the quality of analysis at entry and the design of the project were average or acceptable. The design of the loan included detailed requirements that dealt directly with the objectives delineated for this operation. In addition, most of these requirements are measurable and confirmable. But some requirements have ample scope for interpretation. Several tranche requirements, for example, call merely for the "liberalization of interest rates" or monitoring of the "effectiveness of regulation on provisioning." Other requirements are more stringent and specific, such as "closure of BANADE" (the national development bank). Overall, if these tranche requirements are met, then substantial progress would be made toward the financial sector reforms outlined in the MOP. 3.41 The risks section indicated two concerns-a return to economic instability and bureaucratic lethargy. To offset these concerns, the loan documentation states that "the strong support, to date, in the executive and legislative branches for the Convertibility Law and the new Central Bank Charter diminish the probability of these events in the short term" (MOP, p. 39). Dealing with the first area of risk is the underlying objective of this operation. It appears that the tranche disbursement requirements are best suited for dealing with the second area of risk, although disbursement conditionalities have not been set. Still another potentially serious unstated risk is the impact of the financial sector reform on the financing capabilities of the province governments. While the adjustment operation dealing with province-level reform would not be presented to the Board for another year, the Country Strategy Paper indicated clearly that the risks associated with province governments were becoming evident as early as this operation. The documentation, however, does not indicate an attempt to factor in this risk. 3.42 Capital Market Development Project. OED concluded that this very innovative operation is well designed. The loan seeks to "accelerate capital market development to help Argentina meet growing investment demand" (MOP, p. ii). "The objective is to encourage the holding of medium and long term securities by investors and bankers and longer term lending by prime-rated commercial banks." This objective is to be supported with the creation of a Backstop Facility (BF) that ensures liquidity to banks in the event of bond market disruptions. The operation seeks to establish an independent institution managed by an internationally recognized financial firm. This institution (the Fund) :s meant to be a facilitator rather than a director. The innovative feature of the Fund is that lags in the disbursement schedule are desirable; that is, funds are disbursed only if a problem arises, such as a spike in interest rates. The operation is designed to reduce risks that might otherwise arise. For example, the Fund will be fully dollar denominated. That is to say, revenues and costs will be in dollars. In addition, because the operation is based on interest rate spreads, should not be affected adversely by unfavorable shifts in interest rates. Finally, the Fund will be open only to banks that have an A rating or higher; banks that drop below a triple B will not be eligible. Energy and Power: Yacyretd 's Problems 3.43 In 1978, when Argentina embarked on the YacyretA Hydroelectric Project it was looking for a cost-effective energy source. The project would satisfy future demand while reorganizing the fragmented energy sector. The expected completion (late is June 1998, nearly eight years 72 behind the original schedule. The project cost is 59 percent greater than the appraisal estimate. A recent Project Audit Report (Report no. 14056) concluded that the project should have been stopped as early as 1982 before any major civil works had begun. 3.44 Problems with Yacyreti began as early as 1981. EBY (Entidad Binacional Yacyreti), in charge of the construction, had a dispute over procurement services with the Bank. As a result, works did not begin until 1983. By that time, actual demand for electricity was lagging 25 percent behind the original forecast, with no signs of recovery. By 1986, Argentina's deep financial problems postponed an important part of the project, population resettlement, which significantly increased overall costs. Uneven quality of EBY's management between 1989-1991 increased costs even further. The Bank provided three additional loans to support Yacyretd after 1986 on the grounds that the economic rate of return of the additional investment was high due to the already large sunk cost (a questionable argument since many of the costs incurred were preventable if problems had been tackled on time). 3.45 The Project Audit Report also yields some important lessons. First, the Bank should be careful in its evaluation of the borrower's demand forecasting and investment planning decisions, especially for large infrastructure projects. Second, Public Investment Reviews can be used effectively for portfolio management purposes only if they can be followed by the urgent actions that emerge from them. Third, financing of a project of the magnitude of Yacyretd should not rely on assumed future financial improvements of notoriously poorly performing sectoral entities. Fourth, covenanted actions are a precarious way to ensure the viability of a financing plan. And, fifth, success in carrying out institutional and financial reforms in a period of protracted economic instability is uncertain. 4. Conclusions and Recommendations Conclusions 4.1 This CAR has sought to provide an assessment of Bank assistance strategy and implementation in Argentina from 1985 to the present. The mature, robust relationship that exists between the Bank and Argentina today suggests that the Bank's management of operations in progress in the country has been constructive. The conclusions of this CAR suggest that the Bank's assistance strategy and implementation was poor in the 1985-89 period and highly (but not universally) successful in the 1990-95 period. These findings also suggest recommendations that can help the Bank and Argentina sustain their relationship and make it even more fruitful in the years to come. Towards a Good Policy Dialogue 4.2 During the 1985-89 period, the Bank continued to provide financial and advisory support to Argentina despite the country's several failed attempts at stabilization. Although the Bank provided a sound diagnosis of the problems confronting the country, it tailored its advice much too narrowly to the perceived constraints of political realities and financed reform programs that were both too narrow and poorly implemented. The consequence was inconsistent counsel and unsatisfactory lending outcomes. But the Bank's ongoing support did turn into strong policy dialogue by the end of the decade when the political conditions changed. Given the absence of an historical counterfactual, it is difficult to determine whether the eventual success of this intensive policy dialogue could have been obtained without the lending, even if the lending was unsatisfactory. But the ensuing 1989-92 period suggests that sound policy dialogue can be achieved with minimal lending, although with intensive economic and sector work and technical assistance. The ESW and technical assistance analysis of the Bank during 1989-92 supported and gave credibility to the radical reforms initiated by a new Government. Consequently, the policy dialogue today reflects an increasingly experienced partnership that can successfully address the remaining items on the developmental agenda. The Policy Dialogue in 1985-89: Excellent Diagnosis, but Insufficient Treatment 4.3 Although the Bank correctly diagnosed the core problem with Argentina's economy during the 1985-89 period-an absence of private-sector investment in the face of macroeconomic instability, and a heavy fiscal deficit and external debt that was inhibiting sustained investment and economic growth-the design of the Bank strategy was flawed because it did not seek fundamental changes in the existing institutional framework. In retrospect, it proved impossible for Argentina to achieve macroeconomic stability without changing the ownership structure of public enterprises and the institutional framework of the Central Bank. The Bank continued to disburse its loans in 1985-89 because it perceived that the transfer of resources was a prerequisite for the macroeconomic stabilization objective. But the Government failed to deal with the fundamental problems that created the macroeconomic disequilibriums. The Bank's strategy recognized the weakness with the ownership structure of enterprises, but sought merely to improve public sector management, make public investment planning more effective, extend emergency measures to increase fiscal revenue, and reduce public expenditures; 74 but it did not recommend that the ownership of public enterprises be restructured. Moreover, the Bank's advice on monetary policy did not recommend radical changes to the nature of the Central Bank's functions and limitations. Within this framework, it became impossible to achieve macroeconomic stability, and the climate for successful lending deteriorated. A Delayed Response to Early Reform Efforts but Excessive Lending in the Late 1980s 4.4 The contribution of the Bank to Argentina's financial needs lagged at two crucial points: when Argentina first showed signs of a commitment to economic reform in 1983 and when the Menem Government took office in 1989 and embarked swiftly on economic reform. This delayed response had a negative impact on the Bank's ability to finance reforms when Argentina could have benefited from Bank financing the most. During the 1983-89 period, the lagged response and the normal lags in disbursements made financing available only as the net disbursements of other contributors were negative. Moreover, the increased lending in the FY87-89 period came late, at the time when the reform efforts were becoming more short-term oriented and proved unsuccessful. During the 1990-94 period, net financing was insignificant in 1990-91 and negative in 1992, precisely when the country was making the strongest efforts at economic reforms and could have benefited from financial assistance. When the Bank's financial assistance increased after 1993, it was small when compared with the enormous inflow of private capital. Ownership of the Reforms Was Argentine 4.5 Argentina's experience confirms again that ownership of the reform process is a prerequisite for success. By 1991, an economic transformation had occurred, founded on solid government (and country) ownership of a far-reaching reform program. At the heart of the program was an ambitious privatization initiative, inflation-reduction and price stabilization measures, tax reform, and other fiscal policies-all of it packaged as the Government's "Convertibility Plan." The main seeds of the Plan had been planted long before in a 1984 book by Domingo Cavallo, Volver a Crecer, which reflected "the work on the Argentine economy which was undertaken over the last eight years of research by the Economic Research Institute of Fundacion Mediterranea" (Volver a Crecer, ed. Planeta Espejo, 1984, p. 69). The genesis of these policies was clearly Argentinean. The advice of the Bank reflected in the 1989 CEM included explicit policy recommendations similar to those adopted by Mr. Cavallo when he assumed office as Minister of Economy in 1991. The Bank, in full concordance with the policies, supported them vigorously. The Bank Helped Regularize Argentina's Debt Problems and Restore Access to Private Capital Markets 4.6 Argentina's debt problems seemed insoluble during the 1980s. The Bank's contribution to financing collateral required for a major debt and debt service reduction agreement under the Brady Plan in 1993 had an enormously positive impact. The financial contribution of the Bank complemented the efforts of the Government to achieve macroeconomic stability by helping to regularize the country's debt problems and allowing private capital markets to support the financial needs of Argentina. Consequently, the country now has access to private capital markets, although has not yet achieved full rating in the institutional financial markets, as have Chile or Colombia. 75 Excellent Bank Support for a Broad-Ranging Privatization Effort, but Weak Leadership in the Social Sectors 4.7 The Bank cautiously observed the outcomes of the sweeping reforms initiated by the Government in 1989, but vigorously supported the Government's privatization effort. The Bank shifted its former priorities and restructured old loans to finance studies and other activities to support the privatization process. And it did so primarily with studies and technical assistance, not with lending. As the Government moved swiftly with its privatization program in 1991-92, the Bank followed by moving quickly to its high-case lending to support public-enterprise and public-sector reform. In the process, however, the Bank reduced its planned assistance to the social sectors and infrastructure, thus compromising the leadership it had sought initially in these areas. Economic and Sector Work Was Available When Needed 4.8 The Bank's ESW later in the 1985-89 period was available and useful to the new Government's economic thinking. In particular, a series of major studies commissioned from consultants in 1988 and 1989 proved highly relevant to the Government's privatization effort, despite the fact that their intent was to improve the efficiency of public enterprises without necessarily changing their public status. Studies of the railroad, telecommunications, and oil and gas industrial sectors, which had been financed from previous loans and from various trust funds and bilateral sources, proved adaptable to the new approach. Here, the Bank played an exceedingly supportive role in the execution of new economic policy-it supplied relevant economic information, even if produced for different purposes, and its analytic apparatus was moving in the same direction as that of the Government at just the right time. The Bank Helped Provide a Better Understanding of the Fiscal Problems of the Provinces 4.9 The Bank provided studies of province-level financing in both 1990 and 1992, and developed a great deal of interesting information. On balance, however, the attempt to develop a seamless continuum from analysis to prescription, from prescription to reform measures, and from reform measures to Bank lending failed. The basic problem-improvident province governments that were either borrowing from provincial banks (which in turn rediscounted with the Central Bank) or clamoring for Treasury transfers in addition to their legal share in certain taxes-could not be resolved. The Government tried to cut borrowing by provinces by forbidding the Central Bank to rediscount provincial bank papers, and to increase their resources by changing the Coparticipation Law. But the simultaneous transfer of new secondary education and health responsibilities imposed further expenditure and financing problems on the provinces. Cut off from credit but with the added responsibilities, most provinces began to borrow from commercial banks, which then experienced an increase in bad debts; but the commercial banks were too important to allow the federal Treasury to stand by and let them become insolvent. Consequently, by creating difficulties in the banking system, the provinces continue to threaten financial stability. The problem is deeply imbedded in Argentine political history, and neither the Bank nor the Government have yet found a fully satisfactory solution. But the Bank's work has helped illuminate the nature of the reforms that could be pursued by the provinces, as well as 76 the extent of the numbers involved and the significant differences that exist among the provinces; it has also provided a basis for some adjustment lending28 The Bank Also Helped Deal with the Fiscal Problems of the Social Security System 4.10 The Bank's ESW focused heavily on the inequitable and an insolvent social security system and on the Government's attempts to reform the system. In 1989, the Bank presented two alternative reforms-a conventional one, consisting primarily of benefit reductions, eligibility tightening, and contribution increases, and an unconventional one, consisting of a basic stipend and an opportunity for private contractual savings institutions under public regulation. The Bank clearly preferred the more innovative alternative, which was actually closer to what the Government finally began to adopt in July 1994. Whether the reforms will make the system sustainable cannot yet be determined.29 The reform implies transitional fiscal costs averaging about 0.5 percent of GDP from 1995 to 1998. In the absence of financing, these transitional costs had already affected fiscal outcomes in the second half of 1994, threatening the sustainability of the overall reform program. The Focus of the Lending Strategy Has Been Flexible, but Has Changed too Often 4.11 The Bank has changed its lending strategy in Argentina over time. In 1985, when the Bank decided to increase lending and ESW fourfold, operations focused initially on infrastructure for strengthening exports and on structural adjustment in agriculture. By 1987-88, the Bank began focusing on trade liberalization, the financial sector, and the energy sector. The outcomes of most of that lending were unsatisfactor., and the Bank again had to shift the focus of its lending strategy. By 1990, the main concern of the Bank was to build flexibility into its lending program, given the fragile economy of Argentina. Following the Government's efforts to privatize public enterprises and reform the public sector, Bank strategy shifted quickly toward supporting the Government's efforts. By 1992, the Bank was continuing to focus on public sector reform, but it also began to provide greater support for infrastructure and to plan for financial sector reform and assistance to alleviate malnutrition. By 1993, private capital inflows had become the main source of external financing in Argentina. By 1994, the Bank proposed to end structural adjustment lending with one last operation to support public-sector reform in the provinces and to provide additional support to secondary education; it also recommended that, "if Argentina continues to experience success on the macroeconomic front. . ., it would be appropriate to initiate discussions concerning phasing down of Bank assistance (CAS94, para. 52)." But by 1995, the Bank increased the amount of its lending significantly (mainly for 28 In December 1990 the Bank made a Provincial Development Loan for US $200 million, which at the end of 1994 had not been fully disbursed. Nevertheless, given the Government's compliance with its provisions and the adoption of reform programs by some provinces, a second loan was prepared and was scheduled for Board presentation on January 24, 1995. The outcome of these loans is not yet known, since they are both still ongoing. 29 Some recent judicial decisions have called into question the Government's approach toward limiting its obligations to contributions to the previous system. This issue has large financial implications, and it has not yet been resolved. 30 The Region flagged the issue of graduation because Argentina had just been reclassified as a Category V Borrower after a new set of national accounts established that the country's per capita income for 1992 had been calculated at US$ 6052. There was no need to flag the issue, however, unless the Region foresaw graduation as possible. The Board had discussed graduation policies several times after the relevant OD 3.10 was issued, and concluded that 77 adjustment) after Argentina experienced external shocks from the financial crisis that gripped Mexico in December 1994. The Bank's development strategy became much more encompassing, involving province-level reform, municipal development, financial sector strengthening, export promotion, poverty reduction, and health, education, energy, and environmental reform. The Quick Response to the 1995 Financial Crisis Is Restoring Confidence and Deepening Reforms 4.12 The Bank reacted with remarkable swiftness to the Government's efforts to adjust to the external shocks created by the financial crisis in Mexico. It took less than four months to prepare a new strategy and a new lending program after the crisis developed. The rapid Bank reaction and the assistance program it developed are extremely laudable-and represent the culmination of a decade-long road towards the solid relationship that exists today between the Bank and the Government. Recommendations On Key Strategic Issues Consistent and Focused Strategic Assistance 4.13 The Bank should continue to assume its current role of supporting appropriate policies owned by the client. This role is especially relevant today in Argentina, in which ownership of the reforms is clearly indigenous and technical capabilities at the local level are high. The Bank should complement local capabilities by identifying a few feasible areas of involvement in which the Bank has comparative advantage, and it should focus the bulk of its assistance strategy to those few areas. The Bank should also avoid changing the developmental focus of the Bank's lending strategy too often. In particular, its developmental strategy should not be allowed to oscillate in response to fluctuations in the flow of private capital. The increase in Bank commitments to Argentina in 1995 was a direct consequence of the financial crisis in Mexico. The presence of the Bank in Argentina was appropriate and essential for enabling Argentina to balance accounts and restore confidence in private financial markets. But the remaining development agenda for Argentina in 1995 was not significantly different than in 1994 or in 1992, while the focus of the Bank's assistance strategy changed significantly. Flexibility should be allowed in the margin-possibly through lending instruments that make funds readily available in emergencies-but it should not be the core of the strategy. If the strategy requires conditional lending, conditionality should be transparent and adhered to; today, it should concentrate on a few core issues that remain on the developmental agenda. Clarity and Simplicity of Objectives 4.14 The Bank should minimize lending for objectives that are not directly pertinent to the primary goal of a loan. The unsatisfactory outcomes of most loans during 1985-89 (at 84 percent of projects) were caused largely by the Bank's decision to transfer financial resources in an graduation was not an automatic Bank policy based on per capita income. Graduation would be discussed by the Board on a case by case basis at the discretion of the Region (if the Region foresaw graduation coming). 78 unstable macroeconomic environment and by the occasional absence of transparency in lending operations. But many loans were disbursed because the objective of transferring resources took precedence over the specific sector conditionality. Focus on Main Remaining Issues 4.15 Reducing the structural fiscal deficit-the deficit that remains after transitory factors in fiscal revenue and expenditures are adjusted for-continues to be a major task in the effort to ensure the sustainability of the thus far successful Convertibility Plan. The major sources of this deficit were the public enterprises, the social security system, and the province governments. The Government has successfully eliminated the deficits created by public enterprises. But reducing the deficit from the other two sources remains a difficult challenge. With Bank assistance, the Government is currently attempting to reform the social security system, a reform for which structural adjustment lending by the Bank is justifiable. The provinces present the more difficult challenge: in addition to the fiscal deficit, the main issue pertains to the role of Government in alleviating poverty. The provinces are now the major providers of health, education, and water and sanitation services, but are not prepared to finance these services locally or to provide services of adequate quality. The Bank is aware of the fiscal problems of the provinces and of the risks that their deficits pose for the sustainability of the overall reform program, and several lending operations are currently addressing these problems (see chapter 3). A major effort is now required to ensure that social services can be delivered within a framework of fiscal responsibility. 4.16 Argentina's long-term development depends heavily on its capacity to expand a competitive private sector. The Bank correctly identified the main bottlenecks to this goal in its Country Assistance Strategy of April 10, 1995. While actions on many fronts are required (to consolidate the ongoing structural reforms, reduce poverty, improve social services, rebuild infrastructure, especially power, transport, water and sewerage, and environmental management and protection), the Bank does not need to be involved in all remaining items on the developmental agenda. It should target a few areas selectively and leave the rest to the private sector or to the Government with private sector support. In some areas, rather than direct involvement, the Bank should consider the possibility of expanding its guarantees to strengthen private-sector participation. 4.17 The increase in Bank commitments to Argentina in 1995 was a direct consequence of the financial crisis in Mexico. The presence of the Bank in Argentina was essential for enabling Argentina to balance accounts and restore confidence in private financial markets. But the "signalling" effect and increased disbursements objective should not detract from the specific objectives of poverty reduction, health, education, environment, and energy. Management of Risk 4.18 The Bank should prepare specific action plans to deal with risks as it develops its assistance strategy. Often, the Bank acknowledged risks but either ignored them or treated them in a fashion that made it difficult to ascertain effectiveness. For example, the risk analysis of the Bank in 1992 predicted a crisis if capital flows reversed, due primarily to the weaknesses with Argentina's financial system and the vulnerabilities of the Convertibility Plan. Although the Bank had identified this risk in 1992, the Country Assistance Strategy of 1994 dismissed the risk 79 prematurely, having been overly optimistic after the positive economic results of 1993. Thus, no contingency plans were ready when the external shock reached Argentina after the crisis in Mexico in December 1994. It would have been wiser to prevent rather than react to the crisis, but the swiftness of the Bank's reaction and the assistance program it developed are laudable. Indicators of Performance 4.19 The Bank should develop indicators to monitor-long term development objectives and prepare action plans to correct deviations from those objectives as they occur. For example, the Bank identified the risk to sustainable macroeconomic stability if the structural fiscal deficit did not improve. The Bank recognized, correctly, that the structural fiscal deficit depended on the finances of the public enterprises, the provinces, and the social security system. The Bank, however, has not yet developed an indicator that measures the size of the structural fiscal deficit in Argentina, and some of the improvements recently achieved in the fiscal deficit are clearly transitory. The targets in 1995, for example, were reportedly achieved in part because the profits from privatization were included in the revenue account. Such indicators should be an essential part of the CAS, not only in the macroeconomic performance, but in all sectors of Bank involvement. More Effective Instruments Economic and Sector Work Should be Budgeted Independently From Lending (and Evaluated ex post) 4.20 The amount of ESW done in a country should not necessarily be linked to the amount of lending received by the country in the same period of time. In Argentina, the 1985 CAS planned a fourfold increase in ESW parallel to a fourfold increase in lending. With the benefit of hindsight, most of the lending to Argentina in 1985-89 was unsatisfactory while a good proportion of ESW was relevant. This was a fortuitous result because the 1985 CAS had specifically insisted that ESW be linked to future lending (para. 2.13). Moreover, ESW also fell drastically in the 1990-92 period, when lending fell. The practice at the Bank is often to link ESW levels to lending, although OD 2.00 explicitly rejects this approach: "sector studies are important even where the Bank is not lending in the sector." Consequently, the amount of ESW should be planned and monitored on the basis of its expected impact but not necessarily through lending. At the same time, the actual impact of ESW should be evaluated ex post and lessons should be learned as it is done for lending. The Regulatory Framework ofPrivatized Public Enterprises Should Receive Priority 4.21 The Bank has explicitly identified institutional weaknesses that impede reform in Argentina and has developed specific plans to correct those institutional weaknesses. But it has addressed some aspects of institutional development comparatively slowly. For example, the Bank correctly identified weaknesses with the regulatory framework of monopolistic configurations after privatization, but has been slow to support developing the institutional setting necessary to implement the new regulatory framework. The Bank was also somewhat tardy in supporting efforts to improve the institutional capacity of the provinces to carry out their expanded function. It began its support well after responsibilities for education were transferred 80 from the federal government to the provinces. Attention to these issues could be achieved not only through lending but also through ESW. Lending Should Concentrate on Health and Education in the Provinces 4.22 Assistance strategy for Argentina-both lending and non lending-should focus on health and education in the provinces. Concentrating on these social services will have the double effect of ameliorating poverty and addressing fiscal issues of the provincial governments. The Bank may consider selecting the most promising provinces for demonstrating best social service practices that would help motivate reform in other provinces. The Quality of Economic Analysis of Projects Should be Improved 4.23 The experience of the Bank in Argentina confirms that the recommendations of the ECON studies about the quality of economic analysis at entrance should be implemented-that is, to establish a mechanism for certifying the quality of economic analysis in projects (and programs), to enhance the review process, and to conduct periodic postapproval reviews. It is worth noting, however, that although ECON studies found that the quality of economic analysis of the Argentine projects included in the studies was poor or marginal in 52 percent of the lending, in a much larger sample (of projects approved in 1990-95) OED found that the economic analysis was poor or marginal in a smaller share: 25 percent of the lending (chapter 3). The Annual Review of Project Performance Should be Improved 4.24 The Annual Review of Project Performance (ARPP) in Argentina should be strengthened. For projects completed and evaluated, OED found that the "disconnect" between supervision ratings in the last year of each lending operation and ex post evaluation is as high as 47 percent. The ARPP should include intermediate measurements of specific indicators of performance, similar to those that will be used later to evaluate ex post results. The indicators should measure progress towards specific targets underlying the main objectives of each loan. The absence of monitorable indicators during implementation in Argentina may have contributed to the high frequency with which projects outcomes were rated as satisfactory throughout supervision, only to be downgraded to unsatisfactory after completion. 81 Appendix Table 1: ESW Program Presented in 1979 (SWs) 1979 1980 1981 1982 1983 1984 1980-84 Monitoring Macroeconomic Development 6 6 8 8 8 8 38 Long-Term Analysis 22 68 40 50 60 60 278 CPP 12 8 8 8 8 8 40 Public Sector Enterprises 20 20 Efficiency Pricing 26 10 10 Financial Sector Survey 25 10 35 Technology in Industry 32 Mining & Basic Industry 10 10 20 Transport 15 29 29 Agriculture: Updating 1 25 30 56 Energy: Updating 15 10 25 Industry: Updating 35 35 Regional Study 41 6 6 Water Supply 6 Employment, Wages, Income Distribution 20 20 Education & Manpower 20 20 Social Sector Analysis 10 20 20 50 TOTAL 160 158 171 151 76 126 682 (Annual Average, 1980-84) (136) Source: CPP, December 1978. Appendix 82 Table.2: Manpower Allocated to Argentina, FY1975-1994 (SWs)a Aid Technical Country Overhead FY Lending Supervision ESW Coord Assistance Program & Other Total 1975 83 31 32 - - 1 - 147 1976 42 31 13 - - 2 - 88 1977 472 41 174 - 4 8 - 699 1978 399 85 269 - 1 10 - 764 1979 384 90 138 1 9 23 1 646 1980 458 107 117 1 4 3 2 692 1981 382 141 84 - 6 6 - 619 1982 105 131 107 1 2 2 3 351 1983 97 178 61 - - 2 4 342 1984 133 139 120 - 5 - 397 1985 428 174 205 - 13 23 1 844 1986 525 225 291 - 2 17 25 1,085 1987 610 221 428 2 1 52 40 1,354 1988 800 287 479 9 3 30 14 1,622 1989 835 416 555 22 4 17 127 1,976 1990 633 480 347 20 16 46 23 1,565 1991 581 325 206 5 2 19 16 1,154 1992 460 468 283 16 5 61 26 1,319 1993 621 480 316 4 49 32 18 1,520 1994 905 521 435 1 17 43 37 1,959 a. Excluding Trust Funds. Local staff discounted 75%. Source: PBD. 83 Appendix Table 3: Actual and Planned Lending to Argentina in Selected Periods (Annual Average, US$ million) Planned in: 1987 1990 FY Actual 1979 1985 (Base Case) (Base Case) 1992 1975 1976 - 1977 320 1978 165 1979 96 306 1980 237 175 1981 68 230 1982 400 320 1983 100 200 1984 - 300 1985 180 1986 544.5 385.0 1987 965 475.4 539 1988 626.5 325.0 1,090 1989 886.5 300.0 1,125 1990 - 150.0 900 1991 679.5 825 406 1992 373.0 715 1993 1,960.0 650 1,000 1994 608.5 600 1,050 Annual Average 1975-1979 116.2 1980-1984 161.0 245 1986-1990 604.5 327.1 1987-1991 631.5 895.8 1991-1994 905.3 592.75 1993-1994 1,284.3 1,025 Sources: Actual: PBD Database; Planned: CPPs of 1979 and 1985; Divisional Country Brief of 1987, Country Strategy Papers of 1990 and 1992. Appendix 84 Table.4: ESW Program Presented in June 1985 (SWs) Total 1985a 1986 1987 1986-87 Est. Actual Planned Country Economic Memo - 30 36 35 71 Public Sector Investment Review 91 - 27 - 27 Social Development & Poverty Alleviation - - - 60 60 Updating CEM - - - 12 12 Medium & Small Industry Review - 28 - - - Financial Sector Study - 10 - - - Water & Waste Sector - - 20 - 20 Urban & Municipal Management Review - - 20 - 20 Export-Oriented Industry Study 37 - 21 - 21 Power Sector - 2 - - - Transport Sector - 8 - - CPP 13 20 - 17 17 Other Economic Work 12 19 12 12 24 Other Sector Work 6 4 6 6 12 Hydrocarbon Development - - 20 - 20 Fertilizer Sector Review 0 0 15 - 15 Technology Assessment - - 20 - 20 Energy Assessment - 80 - - - Total 159 201 197 142 339 (Annual Average, 1986-87) 170 " Note than "Planned" is much closer to the "Actual" figure for 1985 (205 SWs) on Table 2.2 than the "Estimated Actual". Source: CPP, June 1985. 85 Appendix Table 5: ESW Program Presented in February 1987 (SWs) Managing Total Division FY87 FY88 FY89 FY90 FY91 Task . Regionally Managed A. Economic Reports (ERA) I. Recovery and Growth LC2AR 21.0* - - - - 21.0 2. Updating Economic Memorandum LC2AR - 40.0* 40.0* 40.0* 40.0* 1600 3. Economic Monitoring LC2AR 17.0* 10.0* 10.0* 10.0* 10.0* 57.0 4. Public Expenditure Review LC2AR 68.0* 17.0* - - - 85.0 5. Public Expenditure Study LC2AR - - - 30.0* 60.0* 90.0 (Non-Central Government) 6. Public Sector Investment Planning LC2AR 9.0* 10.0* 10.0* 10.0 10.0 49.0 7. Social Sectors Review LC2AR 64.0* - - - - 64.0 8. Poverty Study LC2AR - - 50.0* 30.0* - 80.0 9. Social Security System LC2AR - - - 40.0 20.0 60.0 10. Fiscal Incentives LC2AR - 60.0* - - - 60.0 11. Resource Mobilization LC2AR - - 80.0 - - 80.0 12. Labor LC2AR - - - - 70.0 70.0 Subtotal 179.0 137.0 190.0 160.0 2100 876.0 B. Sector Reports (SRA) 1. Agriculture - Agricultural Sector Brief LCPAG - 40.0* - - - 40.0 2. Environment - - - 50.0 50.0 - Environmental Study LCPAG - 3. Industryffrade/Finance -Industrial Sector Study LCPIDF 40.0* 10.0* - - - 50.0 - Banking Sector Study LCPIDF 32.5* - - - - 32.5 - Capital Markets Study LCPIDF 20.0* 25.0* - - - 45.0 - Direct Foreign Investment Study LCPIDF - 10.0* 35 0* - - 45.0 -Small Industries Study LCPIDF - - - 50.0* - 50.0 - Retail Marketing Study LC2AR - 11.0* - - - 11.0 - Non-Traditional Exports LCPIDF - 10.0* 50.0 - - 60.0 4. Water Supply and Sewerage - Water Supply and Sewerage Review LCPWS 12.0 - - - 35.0* 47.0 5. Transport - Sector Review LCPTR 15.0* - - 40.0* - 55.0 6. Education - Higher Education Mgmt. and Finance LCPED 10.0 20.0 - - - 30.0 - Secondary Education LCPED - - 40.0 - - 40 0 7. Urban - Housing LCPUR 15.0 - - - - 15 0 - Sector Review LCPUR - - - 50.0 - 50.0 8. Energy LCP - - 20.0 - - 20.0 Subtotal 144.5 126.0 145.0 140.0 85.0 640.5 Appendix 86 Table 5: ESW Program Presented in February 1987 (SWs) (Cont.) Managing Total Division FY87 FY88 FY89 FY90 FY91 Task C. Other Economic Work (EWO) LC2AR 24.0* 25.0* 25.0* 25.0* 25.0* 124.0 Subtotal 24.0 25.0 25.0 25.0 25.0 124.0 D. Other Sector Work (SWO) LC2AR - 10.0 10.0 10.0 - 30.0 Subtotal - 10.0 10.0 10.0 - 30.0 Total 347.5 298.0 370.0 335.0 320.0 1,670.5 II. COPD Managed A. IndustryfTrade 1. Technology INDSP - 40.0 - - - 40.0 2. Energy Restructuring INDRE - - - 15.0 20.0 35.0 3. Industry Restructuring INDRE - - - 30.0 50.0 80.0 Subtotal - 40.0 - 45.0 70.0 155.0 B. Health 1. Sector Study PHN 30.0 - - - - 30.0 Subtotal 30.0 - - - - 30.0 C. Energy 1. Energy Strategy EGYD2 - 30.0 10.0 - - -40.0 Subtotal - 30.0 10.0 - - 40.0 Total 30 70 10 45 70 225 Ill. Total ESW 377.5 368.0 380.0 380.0 390.0 1,895.5 IV. CPP/DCB A. Workout Paper LC2AR - 10.0* 10.0* 10.0* 10.0* 40.0 B. DCB 10.0* 10.0* - 10.0* 30.0 Total 10.0 20.0 10.0 20.0 10.0 70.0 V. Aid Coordination LC2AR - 10.0 10.0 10.0 10.0 40.0 Total - 10.0* 10.0* 10.0* 10.0* 40.0 Grand Total 387.5 398.0 400.0 410.0 410.0 2,005.5 *Core program. Source: DCB, 1987. 87 Appendix Table 6: ESW Core Work Program Prescribed I. February 1987 (SWs) 1987 1988 1989 1990 1991 Total I. ECONOMIC WORK Updating & Monitoring 17 50 50 50 50 217 Public Expenditure Review & 77 27 10 - - 114 Investment Planning Non-Central Government Public - - 30 60 90 Expenditure Review Recovery & Growth 21 - - - - 21 Fiscal Incentives - 60 - - - 60 Social Sector Review & Poverty 64 - 50 30 - 144 Studies Total Economic Work 646 II. SECTOR WORK Agricultural Sector Brief - 40 - - - 40 Industrial Sector Study 40 10 - - - 50 Banking Sector Study 33 - - - - 33 Capital Markets Study 20 25 - - - 45 Direct Foreign Investment Study - 10 35 - - 45 Small Industries Study - - - 50 - 50 Retail Markets Study - 11 - - - 11 Non-traditional Exports - 10 50 - - 60 Transport Sector Review 15 - - 40 - 55 Water Supply & Sewerage Review - - - - 35 35 Total Sector Work 424 (Subtotal I & II) (1,070) III. OTHER Other Economic Work 24 25 25 25 25 124 CPP/DCB (Workout Paper, etc.) 10 20 10 20 10 70 Aid Coordination - 10 10 10 10 40 Total, Other 204 TOTAL (I & H & II) 1,274 Table 7- Argentina - ESW/Project Preparation Expenditures Late 1980s to Early 1990s (US$'000) Japanese Consultant Regional PPF for PPFfor PERAL PPFfor 2712-AR 2592-AR Grant Trust Funds for PERAL prior to subsequent to PEREL prior Government Components PSMTA GUTA CIDA Facility ESMAP Funds Environment AppraisaP aprL to appraisal Part Total Financial Management Information System 170 20 90 280 Performance & Evaluation Program 130 130 Restructuring of YPF 1,100 500 100 1,700 Restructuring of FA 600 200 400 170 1,370 Privatzation of ENTel 500 25 500 500 150 1,675 Establisunent of CNT 100 100 Labor Management Strategy 50 250 250 60 610 Central Coordinating Unit 120 50 170 Gas Regulatory & Tariff Study 650 100 50 8o Environmental Assessment 15 15 TOTAL 1,320 1,100 200 1,150 100 45 15 750 750 750 670 6,850 0 The PPF before appraisal was arranged under the then proposed PERL Subsequently, PERL was split into two separate loans; (PEREL/PERAL) the initial PPF will be repaid under PERAL Sourre LAC files. 89 Appendix Table 8: Summary of Planned and Actual ESW and Lending, 1975-94 Annual Average or Year Lending (US$M ESW (S Ws) Planned Actual Planned Actual 125 1975-79 n.a. 116 n.a. 1980-84. 245 161 136 98 1985-89b 333 624 1986-87b 430 760 170 360 LOH BM High LHigh Actual 1987-91c 286 896 1,126 631 247 379 403 1990-94 n.a. n.a. n.a. 724 n.a. n.a. 317 1991-95d 604 924 1993-97e 1,000 1989 887 555 1990 - 347 1991d 405 1,005 679 206 1992d 715 965 373 283 1993e 1,000 1,960 316 1994e 1,050 608 435 Planned in 1979 CPP. b. Planned in 1985 CPP. ' Planned in 1987 DCB. d Planned in 1990 CSP. Planned in 1992 CSP. 、令 州“臘 胞·＇膩 、