Argentina - Structural Adjustment Loan Project

Report No. PID10602 Project Name Argentina-Structural Adjustment Loan... (SAL) Region Latin America and the Caribbean Region Sector PREM Task Manager David Rosenblatt Project ID ARPE73591 Borrower Argentine Republic Environmental Category Not Applicable Implementing Agency Ministry of Economy Address: H. Irigoyen, 250 Capital Federal, Argentina Contact: Mr. Luis Lucioni, (54-11-4349-5611) Date PID Prepared August 9, 2001 Projected Board Date August 28, 2001 Background The 1990s were a decade of sweeping economic reforms in Argentina, resulting in strong economic growth, averaging 4.8 percent per year during the period. But over the past three years, Argentina has been hit by a series of external shocks: the Asia crisis (1997), the Russian default (1998), the Brazilian devaluation (1999), the US dollar appreciation and low commodity prices. As a result, the economy shrank by 3.4 percent in 1999, followed by a drop of 0.5 percent in 2000. The key to restoring growth rests with measures to increase productivity, reduce the fiscal drain on the economy and restore investor and consumer confidence. In late 2000, in reaction to deteriorating access to international capital markets and continuing lack of growth, the Government initiated a new set of economic reforms to strengthen its fiscal position, including that of provincial governments. To provide a financing cushion and to bolster confidence, the Government negotiated a package of international financial support of $39.7 billion, with about half from the private sector. The package also included an augmented stand-by arrangement of approximately $13.7 billion with the IMF. The Bank pledged a contribution of about $2.5 billion, with up to $900 million in quick-disbursing adjustment lending. The announcement of the international package provided immediate relief into early 2001, as country risk and interest rates fell. However, fiscal performance in the first three months of 2001 did not meet expectations. The Minister of Economy resigned in early March 2001 and a new economic team was brought in. By mid-March, this economic team too was replaced. Country risk spreads jumped once again, and the urgency in addressing Argentina's economic difficulties mounted. The new team is headed by Minister of Economy, Domingo Cavallo, previously Minister during the 1991-1996 period and the architect of the Convertibility Plan. Minister Cavallo has put in place an economic recovery strategy based  on three pillars: (a) strengthening political cohesion and support for reform; (b) securing financing to dispel risks of default; and (c) promoting economic policies that address fundamental fiscal and economic growth challenges. Congress granted the Executive Branch special powers to enact economic measures by decree. A debt swap was implemented to lower debt service obligations over the next five years, with much of the savings accruing during the next eighteen months. To stimulate growth, a number of sectoral agreements were reached to lower fiscal and regulatory impacts on external competitiveness. In addition, the Government has embarked on a concerted effort to strengthen tax administration, and improve key social services to address better the needs of the poor and to reinforce investment in human capital. At the same time, provincial governments will continue to accompany the Federal Government in reducing fiscal deficits. Recently, additional complementary measures were announced, aiming to: (a) increase competitiveness through a trade compensatory system of fiscal incentives and disincentives; (b) stimulate consumption and growth through the reduction of income taxes to low and medium-income persons; and (c) improve the collection of past-due taxes and reduce evasion. In addition, the Government has initiated a zero-deficit policy to immediately address the fiscal deficit and lower the government's financing needs. The Reform Program to be Supported by the Proposed SAL To some extent, the macroeconomic shocks described above are a function of fiscal vulnerability, due to fiscal imbalances at both the federal and provincial levels. Efforts to assist vulnerable groups throughout the economic cycle is also dependent upon the highly decentralized public sector's ability to deliver a steady stream of basic social services. Thus, the proposed operation supports the ambitious program to improve the administration of those social programs that are under its own responsibility (including the pension system, family allowances, and the delivery of social assistance); improve the structure and regulatory environment of the national health insurance system; improve the administration of the tax system that finances social expenditures at all levels of government; and stabilize provincial transfers and provincial fiscal management, including improved transparency, budgeting and planning. In terms of social services, the central government is focused on regulation of the national health insurance system, income transfers and health care for the elderly and a wide range of targeted social protection programs. The provinces are responsible for primary and secondary education, public hospitals and clinics, housing and a variety of social protection programs. Social expenditures comprise about 53 percent of provincial budgets. Financing of recurrent expenditures in the social sectors for both levels of government depends on tax revenues that are largely collected by the federal government (82 percent of consolidated public sector tax revenues). This SAL could be the first in a series of loans, totaling $900 million, to support the Government as it progresses in the various stages of the reform program. Borrower and Loan Amount The Borrower of the loan would be the Argentine Republic. The amount is expected to be approximately $400 million to be disbursed in two tranches of $200 million each. The first tranche would be conditioned on Board approval, and declaration of effectiveness of the Loan Agreement, including subsequent affirmative evaluations of the compliance of the Government with reform actions agreed during negotiations. While the actions to be completed for each tranche will be limited to key measures, the full program of the Government will be detailed in a Letter of Development Policy. - 2 -  Environmental Aspects Through a review of the reform actions, it was determined that negative environmental impacts from the reform measures are not anticipated. Benefits and Risks. Benefits. Expected benefits include: (a) improved fiscal stability across levels of government; (b) improved stability in the level of social services provided by the public sector especially those targeted to the poor; (c) improved efficiency, equity and quality of health insurance services; (b) improved quality of education services through a clearer role of the federal ministry; (c) improved effectiveness of federal and provincial social protection programs in reaching the poor; (d) improved equity and financial sustainability of the national social security (pension) system; and (d) improved efficiency of tax administration. Risks. The reform program involves a complex variety of actions by several federal agencies and the provinces. Given the currently fragile economic environment, the breadth and depth of reforms remain critical factors to restoring external and domestic investors' confidence in the future of the Argentine economy. The pace of reforms will also depend upon the need to secure broad public support for these actions. External or domestic economic shocks could occur, leading to problems in the implementation of the program. Political events in Argentina could pose a challenge for sustaining reforms. Coordination with Multilateral Institutions Over the past decade, the Bank has worked with the IMF in the design of adjustment operations in Argentina, in formulating country strategy, and in economic and sector analysis. The IDB is supporting similar reforms in the social sectors and federal-provincial fiscal relations. David Rosenblatt Task Manager (202)473-7930 -3-