Argentina - Provincial Pension Reform Adjustment Loan

Report No. PIC4901 Project Name Argentina-Provincial Pension(&) Reform Adjustment Loan Region Latin American and Caribbean Sector Public Sector Management Adjustment Project ID ARPE4445 Borrower The Argentine Republic Implementing Agency Subsecretaria de Programacion Regional Ministerio de Economia y Obras y Servicios Publicos Hipilito Yrigoyen 250 1086 Buenos Aires, ARGENTINA Date PID was prepared March 11, 1997 Appraisal Date June 1996 Board Date December 11, 1996 1. Background. Argentina reformed its pension system in mid- 1994, when it substituted the old pay-as-you-go system with a new mixed public/private two-pillar structure. The prior system suffered from a very high dependency ratio that was, in turn, caused by widespread evasion, low retirement ages, and lax disability rules. Other problems were the promise of very high indexed pensions relative to wages, and the prevalence of special regimes that allowed for early retirement and encouraged evasion Understandably, the system ran deficits during the 1980s. 2. The new integrated pension system is compulsory for all workers including the self-employed. It has two pillars: the First Pillar is a public, defined-benefit system financed by employers' contributions (16w of wages), earmarked taxes and budgetary allocations; and the Second Pillar is financed by an 11t contribution rate by employees, who have the option to invest it in a defined contribution pension fund managed by a pension fund administrator (AFJP); or to contribute to the public system. 3. The National Social Security Administration (ANSeS) is responsible for the old pension system, the public component of the new integrated pension system, and other protection schemes. By end-1995, ANSeS had 7,472,000 affiliates of which only 58.8w were active contributors and pension payments amounting to US$13.9 billion. ANSeS' new leadership has initiated a vigorous reform effort, adopting a two-pronged strategy which involves the development and implementation of an "Emergency Plan" to achieve a necessary level of control over the institution in the short-run, and a "Transformation Plan", to be implemented over the next two years, to transform ANSeS into a streamlined organization, designed to reward performance and meet customer and shareholder needs. Currently, ANSeS requires large subsidies from the government to cover its expenditures (on the pension side alone, contributions covered only 50t of expenditure in 1995). Although the government  has earmarked a number of revenue sources for ANSeS, expenditures exceeded revenue in 1995 by about 18%. ANSeS' deficits have been exacerbated by a fall in revenue due to employees' choice of individual capitalization accounts over the public option of the second pillar (as of early 1996, about 6 million workers had chosen to join one of the AFJPs, representing 64% of all eligible workers and over 70% of affiliated workers); the lowering in 1994 of employer contribution rates; and the economic downturn in 1995. 4. In the short term, the outlook for ANSeS is for a slight increase in revenues and a reduction in expenditures as a result of the resumption of economic growth and the effect of the pension reforms. The current deficits of the public pension system will disappear as measures to reduce evasion and irregularities and lower pension expenditures take effect. Two studies done in Argentina concluded that ANSeS will run surpluses by year 2014 in one case and as early as 2003 in the other, depending on assumptions of evasion reduction, the percentage of contributors who choose the AFJPs and several other factors. However, in the longer-run, the pension system in ANSeS may again show deficits 5. The Provincial Pension Funds (PPFs). Most of the pension schemes for the benefit of provincial employees (about 10% of the economically active population) remain outside ANSeS' administration. Under the Fiscal Pact of August 1993, the Federal Government agreed to receive the PPF of any province that has passed a law authorizing the transfer. In the long run, such a move will be beneficial to the economy as a whole because most provinces have made financially unsustainable promises, generously granting lower retirement ages and higher replacement rates, and because the provincial civil servants will have the option of choosing the private pension scheme. 6. It is expected that 14 provinces will transfer their PPFs to the national system during 1996 and 1997 (another two provinces may transfer in 1998). This transfer has important financial implications for ANSeS and for the provinces. A model was developed by the Ministry of Economy in cooperation with the World Bank and the IDB to measure the additional costs to ANSeS resulting from the transfers. It shows that as a result of the transfer of seven PPFs, ANSeS' 1996 deficit increased by US$582 million. Another seven PPFs to be transferred in 1997, will increase ANSeS' deficit by an additional US$317 million (the total incremental deficit generated by the transfers in 1997 would be US$864 million). The transfer of 14 PPFs will continue generating decreasing deficits for ANSeS for several years. Initially, ANSeS will bear the full burden of the current deficit of each transferred PPF, but the deficits will become smaller over time, and at the end of the third year the deficit in ANSeS would be smaller than the deficits that would occur in the provinces without the transfer. By the eighth year the transferred pensions would no longer generate deficits for ANSeS. The transfer of the PPFs will have an important positive effect on the provinces' finances. The combined fiscal deficit of the provinces expected to agree to the transfer amounted to US$2.5 billion in 1995, of which about 30% corresponded to the - 2 -  consolidated deficit of their PPFs. 7. The transfer of the PPFs would also have important institutional implications for ANSeS, because it would increase ANSeS' contributors by 33% and beneficiaries by 15%. There is a need for a strong effort by ANSeS to audit the PPFs and review the files of contributors and beneficiaries to eliminate irregularities and errors. It is clear that the capability of ANSeS to carry out the verification and absorption of the PPFs is closely linked to its own reform process. 8. Strategy for Pension Reform. The Government is aware of the long-term issues facing the public pension system. But, before tackling these issues, its strategy is to reduce the burden of the system on the budget by: transferring the PPFs to the national system, and by reorganizing ANSeS to reduce irregularities and operating costs--where there is a large savings potential. The Bank's strategy for pension reform assistance to Argentina is to support the Government's efforts through adjustment and technical assistance lending. 9. The Program of Provincial Reforms. The provinces play a key role in the delivery of public services, financing in 1994, 97% of primary education, 92% of sanitation, 84% of social welfare, and executing 459 of total public expenditures. Therefore, provincial reforms are crucial to improving the efficiency, equity, and macroeconomic stability of the federal system as a whole. Since 1995, a combination of the financial crisis in the provinces and the entry of newly elected or reelected provincial governors has greatly accelerated the velocity of provincial reforms supported by two Bank adjustment loans: the Provincial Reform Loan-PRL (Ln. 3836-AR) and the Provincial Bank Privatization Loan (Ln. 3878-AR). 10. Project Objectives. The loan supports the Federal Government's effort to promote the reform of provincial finances and the improvement of the consolidated social security system. Provincial finances would improve with the transfer in two ways. First, the transfer itself would reduce the provinces' consolidated fiscal deficit during the first year of transfer by nearly 30%. Second, for the program to finance the deficit caused by the transfer of a specific PPF, the province would have to meet eligibility criteria in terms of its commitment to structural reforms, and will have to show improved fiscal performance as a result of the transfer in terms of reduced budget deficits. Similarly, the project would help improve the consolidated social security system in two ways. First, the absorption of the PPFs by the national system will eliminate a number of special pension regimes and privileges in the provinces and adjust the high pension levels and short length of service required for retirement of provincial employees to the more reasonable parameters of the national system. Second, a technical assistance loan associated with this adjustment operation will support ANSeS' institutional reform program, which will have a large pay-off in terms of lower expenditures through the reduction of irregularities and lower administrative costs, and better services to the participants. - 3 -  11. The FY95 CAS for Argentina, discussed by the Board of Executive Directors on May 4, 1995, and the CAS Update discussed on April 25, 1996, emphasize the Bank's desire to further the adjustment process by extending fiscal and economic reforms to the provinces. Bank support for the transfer of the PPFs to the national system will contribute to this objective by helping to reduce the provinces' fiscal deficits and by providing this support to provinces committed to a reform agenda. The Bank is in a very good position to support Argentina with this operation, for several reasons. First, the Bank is already playing a very important role in support of the reform effort of Argentina's provinces through several loans. Second, the Bank is increasingly involved in social security reform projects in Eastern Europe and elsewhere in Latin America, and is, therefore, in a position to bring to this project a great deal of expertise and experience on what has worked and what has not worked in other countries. Finally, Bank support for ANSeS' institutional strengthening program, through a parallel technical assistance loan, while ensuring the capability of that institution to absorb the PPFs, will allow the Bank to provide effective support to further improvements of the public pension system. 12. Coordination with Multilateral Institutions. The Bank has worked closely with the IMF in the design and supervision of adjustment operations in Argentina, in formulating country strategy, and in economic and sector work. The IMF shares the Bank's concern regarding the need to help finance the deficit that will be caused by the transfer of the PPFs to the national system. The cofinancing arrangements with IDB for this loan are based on a close working relationship and cofinancing arrangements in a variety of fields. 13. Project Description. A Bank loan of US$300 million and an IDB loan of US$320 million will help finance part of the deficits to be generated by the transfer of the PPFs to the national system during 1996 and 1997. During the loan disbursement period, the expectation is that about 14 provinces will transfer their PPFs to the national system, out of 16 provinces that are candidates for transfer. The loan was signed on December 17, 1996 and became effective on December 20, 1996. Half the Bank (US$150 million) and IDB loans were disbursed in calendar year 1996 and the other half will be disbursed in calendar year 1997 in two tranches of US$75 million each. Both loans will cover two thirds of the incremental cost of the transfers in 1996 and about one-third of the incremental cost of the transfers in 1997. The rest is being financed by Government funding, including proceeds from privatizations. The Bank and IDB loans are disbursed on the basis of an estimated full first-year deficit caused by each transferred PPF, independently of when during the disbursement period they are transferred. 14. Given the stock of already existing eligible provinces and their performance track record, the minimum time between the first and the second tranches will be three months, and the minimum time between the second and third tranches will be six months, to be able to review compliance with the loan conditions. - 4 -  15. Loan Conditionality. The loan has conditionality for the Federal Government and for ANSeS, and has eligibility/conditionality for provinces transferring their PPFs. 16. Conditionality for the Federal Government. The Government has presented a Letter of Development Policy outlining ANSeS' strengthening program and the proposed Federal Government strategy for the development of the provinces. Maintenance of sound macroeconomic conditions, consistent with the policy objectives described in the Letter of Development Policy, is a condition of tranche disbursement under the loan. 17. The Bank has received assurances of the Government commitment to: (i) include explicitly the budgetary expenditures to cover ANSeS' deficits resulting from the transfer of the PPFs into the 1997 and 1998 federal budgets, as well as other expenditures related to adjustment operations; (ii) make the necessary budgetary allocations to cover ANSeS' needs for the next three years; and (iii) continue to support ANSeS' institutional strengthening. 18. Eligibility/Conditionality for the Provinces. The use of Bank funds to cover part of ANSeS' deficits produced by the transfer of the PPFs of specific provinces is subject to eligibility criteria concerning the provinces' track record in structural reforms and their willingness to adopt measures to reduce their deficits and expenditures. Since there is no direct agreement between the Bank and the provinces which transfer their PPFs, it has been agreed that the Government will monitor the provinces' compliance with eligibility criteria, the transfer conditions; and the fiscal adjustment targets to be met by the provinces after the transfer. 19. Conditionality for ANSeS. Conditionality directed at ANSeS aims at ensuring that it implements the organizational reforms required to make the flow of money transparent, improve services and establish an efficient and cost effective organization; and that it takes the necessary measures to validate the transferred PPFs. 20. Tranche Disbursements. The first tranche was disbursed based on evidence that provinces with PPFs annual deficits of at least US$290 million had met eligibility criteria and of ANSeS' satisfactory implementation of agreed actions under its restructuring plan. The second and third tranche disbursement are conditioned to: evidence that additional provinces, or groups of provinces, with PPFs annual deficits of at least US$155 million are eligible according to loan eligibility criteria; documented maintenance of a sound macroeconomic framework consistent with the policy objectives described in the Letter of Development Policy; maintenance of budgetary allocations to ANSeS within the agreed financing program; ANSeS' compliance with administrative performance targets; and positive assessment of compliance of provinces in previous tranches with deficit and expenditure reduction targets. - 5 -  21. Environmental Aspects. The program is not expected to have any environmental impact; it thus has a "C" rating. 22. Benefits. The benefits of this loan are the following: At the national level, the transfer will produce a net benefit to the consolidated public sector deficit of US$1.2 billion over an eight year period. This will be achieved through lower social security costs (by eliminating special pension regimes and privileges in the provinces and adjusting the benefits to the more reasonable parameters of the national system), and by improved pension administration. At the provincial level, reduction of the consolidated fiscal deficit by about 30% in the first year of the transfer, and elimination of arrears in pension payments which affect the most vulnerable groups in the provinces. Incentive for further provincial reforms through provincial eligibility criteria in terms of their commitment to structural reforms and improved fiscal performance Provincial public employees will be able to join the private pillar of the social security system, increasing their labor mobility. The technical assistance loan will have a large pay-off in terms of lower expenditures (by reducing irregularities) and lower administrative costs. 23. Risks. The risks of this loan are the following: The risk that the provincial savings from the transfer be used to escape adjustment would be minimized by conditions of eligibility based on the provinces' reform track record and by linking tranche releases to evidence of improved fiscal performance. The risk that the Government may find it difficult to finance the incremental deficit generated by the transfer of the PPFs would be mitigated by the Government commitment to include explicitly the expenditures to cover these deficits in the 1997 and 1998 budgets; by its commitments in the Letter of Development Policy; and by Bank close monitoring. The risk that ANSeS may be ill equipped to assimilate the PPFs would be reduced by conditioning tranche disbursements upon ANSeS' meeting agreed restructuring targets and by supporting ANSeS' reform program through a TA loan. Contact Point: Public Information Center The World Bank 1818 H Street N.W. Washington, D.C. 20433 Telephone No.: (202) 458-5454 Fax No.:(202) 522-1500 Note: This is information on an evolving project. Certain components may not necessarily be included in the final project. - 6 -  NB: 1. The above information is based on final Board documents. 2. This PID has not yet been cleared by the borrower. Processed by the Public Information Center week ending April 4, 1997. - 7 -