1 INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT INTERNATIONAL DEVELOPMENT ASSOCIATION INTERNATIONAL FINANCE CORPORATION Thursday, July 19, 2001 Washington, D.C. The joint meeting of the Executive Directors of IBRD and IDA and the Board of Directors of IFC was convened at 2:34 p.m. in the Board Room, 1818 H Street, N.W., Washington, D.C., Mr. Sven Sandstrom, Chairman, presiding. 2 CONTENT S ITEM PAGE 1 Argentina: Country Assistance Strategy Progress Report 3 2 Proposed Loan to Argentina - 3 Provincial Reform Adjustment Loan Opening Remarks by Ms. Alexander 3 Opening Remarks by Mr. Masuoka 11 Ms. Fernandez 12 Mr. Balduino 16 Mr. Stek 19,84 Ms. Grandolini 24 Mr. Yoshida 27 Mr. Schaffer 29 Mr. Zhu 30 Mr. Alyahya 35 Mr. Moulin 40 Ms. Stevenson 44 Mr. Peeters 46 Ms. Geiser 51 Mr. Hyden 53 Mr. Jonck 57,83 Mr. Soto-Platero 87 Chairman's Summary 88 PROCEED INGS 3 MR. SANDSTROM: Good afternoon. I think we should start. The first item on the agenda is the joint IBRD/IFC CAS Progress Report for Argentina. And the second item is the proposed Provincial Reform Adjustment loan of $330 million. And we will take up these two items together. And yesterday you also received an update on developments in Argentina. And we have six written statements -- from Ms. O'Leary and Mr. Abdul Aziz, Mr. Abraham, Mr. Miagkov, Mr. Singh and Mr. Toure. And Myrna Alexander and Toshiya Masuoka will introduce. Myrna, please. MS. ALEXANDER: Thank you very much. Clearly the situation remains fragile in Argentina and regaining market confidence will take some time. As we highlighted in the note circulated to the Board summarizing events as of July 17th, there was sharp deterioration in financial variables starting in early July, prompted mainly by the tepid response by the local capital market on July 10th to the most recent of the 4 government's short-term borrowings. In response to that, the government proposed even more stringent fiscal measures. What we are now seeing in the markets is a continuation of volatility, as the exact form and timing of the latest measures is decided. As we noted, the provinces have agreed to accompany the federal government in this but there are concerns from other sectors, notably the labor unions. In addition, the government must secure legislative approval for the deficit reduction measures. Thus, the way ahead still has some uncertainties. In terms of recapping the present situation, I would like to share with you some of the important statistics. First, the federal government's deficit for the year to end June 2001 is reported to stand at about $4.9 billion, in line with expectations, as compared to the fiscal target agreed with the Fund of $6.5 billion for the whole year. The Fund will shortly be in Argentina to review the last quarter performance. Second, the withdrawal of banking deposits was $4.3 billion or 5 percent of the total on a base of about $86 billion since the end of June 2000; this represents 5 an accumulation of 9 percent loss since the end of 2000. Reserves have dropped more sharply by 15 percent since the end of June, and more importantly by $9 billion or 29 percent since the end of the year 2000 on a base of about $32 billion. It is important to note that the trends on banking deposit, withdrawals and on the loss of reserves seems to be accelerating from the last couple of days. Thus, it is evident that the continuing recession and the seemingly lack of consensus for the way ahead are gradually taking its toll, reinforcing the need for the strong action now by the government and for strong political support. In that context, we are encouraged by the government's latest measures and agreements with the provinces. One of these measures is the intention to reach a zero deficit. Fiscal adjustment is an essential prerequisite for restoring growth and reducing poverty over the medium-term. This measure follows on earlier ones designed to improve the debt profile, through a significant voluntary debt swap and to secure financing for the rest of the year. These measures should lay the basis for fiscal stability. At the same time, the authorities continue to 6 focus on needed structural reforms in order to enhance the quality and sustainability of the country's fiscal performance and reduce the vulnerability to external shocks, as well as to continue to pursue policies and programs which would preserve and enhance human capital. Although the situation requires close monitoring and we would expect to report to the Board again on progress in relation to future proposed operations, we believe that the CAS objectives remain appropriate. In this regard, the proposed Santa Fe Provincial Reform Adjustment Loan before you today represents our ongoing effort to support reforms in the provinces, which play a fundamental role in supporting fiscal stability and ensuring basic social services for assistance and human resource development to reduce poverty and improve equity. In addition, we intend to continue to support new efforts at the federal level to improve governance through public sector reform and to better focus the resources of the public sector on the more vulnerable groups. This support would continue to be under the base case of the CAS. In particular, we would like to note that instead of a programmatic approach, which would 7 imply triggering the high case, we would propose to pursue a structural adjustment operation of $400 million as our first of a series of loans to support further reforms in the public sector and social protection. Such a first operation would be developed with a longer-term vision that could accommodate further lending if the high case were to be triggered in the future. Finally, we are pleased to inform you that the government has authorized the Bank to make the Progress Report public. In response to the various questions raised by the Executive Directors, I will start with the question raised by Ms. O'Leary on the delays in the health and education projects. The new authorities indeed responsible for these areas required some time to reach agreement with the priorities and needed actions, but we are currently engaged in identification and preparation. In the meantime, current operations are providing support. As regards to the Repurchase Facility, the authorities have not indicated their intention to draw on it now. In response to the question by Mr. Abraham, although about 90 percent of Argentines live in urban 8 areas, we share his concerns for rural poverty. Surveys undertaken by the Bank several years ago suggested that poverty rates in rural areas are at more than double those in the urban areas. We are currently supporting efforts by the government to improve on the collection of rural poverty indicators. The ongoing Small Farmers Development Project is providing grants to support improving incomes among poor farmers, and the Provincial Agricultural Project is providing financing for rural infrastructure, including irrigation and feeder roads. We have also recently approved a learning and innovation loan for indigenous peoples. Recently completed and ongoing studies in rural reproductive health and rural infrastructure would provide the basis for possible future operations to support poverty reduction in rural areas, an anticipated in the country assistance strategy. Mr. Abraham also raised a question on counterpart funding. We have been working with the authorities on this and on improving the consistency of budget allocations with implementation needs. Admittedly, it is difficult to plan ahead when adjustments are being made frequently. One of the major 9 steps will be to start working on multi-year budgets which will clearly help to address the issue of how to introduce new operations into the budget and how to address the issue of significant variations in budget requirements from year to year. In response to the important issues raised by Mr. Singh on the expected impact of the zero deficit measure, we have sought further clarification from the authorities and understand that details are still being worked out particularly with respect to the impact of the fiscal tightening on social expenditures including pensions. We understand that pension payments of $300, which is the minimum payment, would be exempt, and that internal discussions are underway to reduce further the impact on vulnerable groups, although this will have to be compensated for in other areas in order to attain the zero deficit objective, as fiscal adjustment is an essential prerequisite for restoring growth and reducing poverty over the medium-term. In response to Mr. Abdul Aziz's concern about the possible need for reforms in the agricultural sector, we recognize that agriculture remains the backbone of the Argentine economy. Over the years, the Bank has worked 10 extensively on agricultural policies and institutions at the federal level through past loans which successfully addressed key issues such as animal health, export promotion, quality control, extension services, research and investigation. By and large, most of the critical reforms in the sector have already been put into effect. We are now focusing on provincial institutional capacities as well as critical investments in irrigation, as noted before, and support for animal health, including foot and mouth disease, the needs of small farmers, and sustainable forestry development. Our future plans include more efforts on rural infrastructure, disaster and crop insurance, and soil conservation with GEF support. Mr. Miagkov asked for comments on the benefits of simultaneously pursuing fiscal measures and structural reforms. We believe that this will be productive in the case of Argentina. Short-term fiscal measures are needed to stabilize the situation and to restore confidence in the face of the lack of access to markets for financing. On the other hand, structural measures are needed to ensure the sustainability of the fiscal position and debt solvency over the medium-term; thus working on dimensions 11 at the same time is mutually reinforcing. My colleague from IFC will now make a statement and respond to questions concerning IFC. MR. MASUOKA: Thank you, Myrna. IFC has been working very closely with our colleagues at the Bank and MIGA in Argentina, and is pleased to join the presentation of the CAS Progress Report. Argentina is currently the country with the largest IFC portfolio and one where we have had many innovations and learned many globally applicable lessons. given the current conditions in the country, we expect the demand for our services to be even stronger, and would like to respond to that demand as much as we can to support the Argentine private sector recovery with due consideration for the quality of our portfolio. We would like to thank Mr. Toure for his support for our focus in Argentina, and Mr. Abraham for his positive comments on IFC strategy and the Bank Group coordination. We agree with Mr. Abraham on the importance of drawing lessons from our successful experiences in Argentina and applying them to our work in other countries. 12 We are pleased to report that we have been doing so. The private sector strategy annex of the last year's CAS described our experiences in supporting private infrastructure transactions that followed the Bank assisted privatization program, private pensions funds, the social sector and housing finance. These experiences have been useful for our work in other countries. For example, we have recently applied our experience in housing finance to a similar project in Colombia, and are looking at projects in this sector in Peru and Mexico. We will continue to seek opportunities for replication in other regions, including Africa. Thank you. MR. SANDSTROM: Thank you very much, Toshiya and Myrna. Maria Fernandez, please. MS. FERNANDEZ: Thank you, Mr. Chairman. At the outset, I would like to commend the staff and management for their good work in providing the Argentinean authorities with the continued valuable and most needed support under the difficult economic circumstances they are confronted with. The Bank's continued assistance within the context of close 13 collaboration with the IMF and the IDB is indeed an essential element to help the country reenter a path of sustainable economic growth capable to meet a mounting number of development challenges. Unfortunately, this year is turning to be extremely difficult with no signs of economic recovery. The deterioration of financial conditions registered in the first quarter and again last week has shown that, despite the strong economic measures taken by the government, the markets still lack the necessary confidence to give a positive response. Attaining a comprehensive internal political support to the authorities' economic program is a key condition to reverse this lack of confidence from the market and, in this respect, we sincerely welcome the public endorsement that the Provincial Governors have given to the government by signing the recent agreement on the zero deficit. There shouldn't be any frictions. Disagreement is a critical step in the process of fiscal consolidation and also a very important signal to the markets of internal cohesion to the authorities' economic package that hopefully will start to bear the fruits. 14 Needless to say that this period of economic recession has already and will continue to have serious social consequences in terms of increasing levels of unemployment as latest figures confirm, poverty and reduce resources for the implementation of long-term development goals. It is in this light that the sound implementation of the CAS becomes all the more important. We welcome the fact that after one year of implementation of the present CAS and despite the number of setbacks, progress has been attained in many areas. We still concur that the Bank's development strategy establishing the CAS continues to be appropriate. However, were things to change significantly, a comprehensive update will turn out to be necessary. We welcome the strategic actions envisaged to support those necessary reforms directed to enable all levels of government to address their structural deficits and execute an enhanced public expenditure management. From the revenue side, the priorities are adequately focused in pursuing the improvement of tax collection and the fight against tax evasion. In fact, even as they are, the current problems of the economy deeply rooted in the lack of fiscal discipline, we encourage the Bank to 15 work closely with the authorities so as to be able to effectively implement a comprehensive fiscal reform. Under present circumstances, the social development agenda, particularly those actions aimed at ensuring the funding of safety net programs, improving poverty analysis, monitoring and targeting of social assistance and ensuring enhanced efforts in education and health, become critical and diverse. As of the latter, we think the authorities' major objectives of regaining economic growth, human development has to play a key role. We strongly support management's intentions to present soon a first structural adjustment loan that could be followed by a second one at the end of next year, as it is the right approach to correctly the implementation of those reforms in the fiscal, social and institutional area that will contribute to creating a sound investment climate conducive of private activity, productivity, competitiveness and economic growth. One concern we would like to raise is the fact that the Bank could not raise a PRL with the Province of Buenos Aires. Given its importance and economic weight within the country and the effectiveness of this 16 instrument in the pursuit of social enhancement and fiscal discipline, we strongly encourage the staff and management to explore all possible ways to be able to attain future compromises. Finally, I would like to reiterate our strong support to the Argentinean authorities in this period of major economic difficulties. We are convinced that the authorities' commitment to implement with determination the economic program completed as it has been in recent months with a number of key measures directed to regain fiscal discipline and competitiveness will finally succeed in taking the country out of the financial crisis, regaining market confidence, and reinitiating the path of economic recovery. With these remarks, I wish the authorities success and support the President's recommendation to approve the next loan. Thank you. MR. SANDSTROM: Thank you very much, Maria. Luis Balduino, please. MR. BALDUINO: Thank you, Sven. Just a few comments. First, I would like to ask whether it would be possible to receive the introductory 17 by staff. And we fully support the CAS and compliment the Bank and IFC for the preparation. I think there are a few points that we should have in mind in considering the situation in Argentina. I think the first is that since the convertibility plan in 1991, the Argentine economy has been transformed through a sweeping set of structural reforms that altered the monetary system, liberalized the trade regime, redefined the role of the state. The economic results of the government's program during the 1990s were quite positive with economic growth averaging 4.8 percent. Inflation was eliminated. There was privatization and a strengthening of the financial system. So this shows that the country has an extraordinary track record, and its reform efforts have been praised and supported by the international community at large and the Bretton Woods institutions in particular, and the country has been almost ten years under IMF programs. And such support has been critical and allowed positive results amidst unfavorable international environment marked by financial crises in several emerging markets since 1994. 18 Now there is a continued difficulty in the external front characterized now by the slowdown in the world economy, a substantial adverse realignment of the US dollar against other currencies, declining confidence and limited access of emerging markets to international financing, coupled with a continued deterioration of prices of Argentina's main export commodities. Country risk perceptions remain above their pre- crisis levels which may be a signal that the international capital markets are reaching a limit of their financing of the country's fiscal deficit. Now the Argentine Government has continually demonstrated that it knows perfectly well their domestic weaknesses and the external challenges faced by the country and seeks to address them. The agreement with the provinces for a zero deficit policy and recent innovative swaps are just two clear example of this. If there is continued domestic political support and the provinces remain committed to implement the recently announced pact and legal hurdles are overcome, the conditions for a turnaround can indeed be created.. The issue of the convertibility plan, which 19 sometimes is raised, may not be a real option, given the fact that the exports are only about 10 percent of GDP and high dollar liabilities in both public and private sector would make the costs far exceed the benefits. Now the issue is that there is an importance then, given what I have just outlined, for continued support from the Bank and IMF and international community to the country to restore market confidence. And this is my most important point. The perception of this support is important both for Argentina and for the markets, and here I would like to praise the Bank's leadership in this. And I think David's trip to Buenos Aires a few days was quite critical in this regard. Therefore, we support the CAS and also the Santa Fe loan and look forward to the coming operation that Myrna has referred to to continue to support the country. Thank you. MR. SANDSTROM: Thank you very much. I suggested to Dave that he may want to travel more frequently. It seems to work. Pieter Stek, please. MR. STEK: Thank you. 20 It struck me how interesting it is to learn of all of this pressure on the IMF to be preventative and to see how difficult it is in practice. We all know what is wrong and it is nonetheless extraordinarily difficult to be effective in the short-term and to be sure that we have turned the corner and that the Argentinean authorities will be able to cope. They are not to blame and the international community cannot easily be blamed, but it is simply a very tough situation. So being preventative is not easy. I think this is typically a case of a country where the necessary conditions for return to sustainable growth as opposed to unsustainable non-growth lie largely, if not wholly, in the macroeconomic sphere, given the efforts at structural reform that have already been very significant in the past. So it is all about the general government budget balance, and we have heard very good news about that recently, and the efforts to achieve that balance. It is about debt and debt service sustainability related to the budget balance but also to other things. And it is about competitiveness. And very closely linked are the conditions for reestablishing confidence. 21 I believe that by far the most important step towards restoring growth and confidence lies in this recent agreement with the provinces, enabling the budget for central and local government to move towards balance sooner rather than later, I hope. I am certainly not on the side of those who believe that the Keynesian effect, demand effects will dominate in this situation. My question may be a bit detailed, and I am not quite sure about the Argentinean statistics, but what is the expected outcome between the past year and the next few years for general government? Are there differences between the public authorities in the narrow sense and general government? What will happen to that deficit? I note that several measures to improve competitiveness have been taken. I admire the ingenuity of some of these measures, and I do have a few questions which perhaps I should have looked at more carefully if there had been more time myself. But, first of all, the differentiated tax measures for imports and for exports. It is not a criticism, but I would like to know are these in conformity with WTO obligations? And are they or are they not a de facto multi-currency practice in IMF terms? 22 Probably not, but I would just like confirmation. And do they not in themselves undermine the effort to reduce tax evasion and corruption? That would also be a question I have. Then, is the new tax on financial transactions of a size of be a disincentive to business? I don't have an opinion myself at all. It is just a real question. It is not meant to be suggestive. And I understand that the trade tax measures are temporary and the financial transactions are not meant to be temporary, if I am not mistaken. Then, as for the role of the Bank, I agree with continued support as proposed within the CAS limits. I would have felt very uncomfortable with the continued high case if the budget agreement had not been achieved. I do have a sense -- let's put it as a question. The language is very much tilted towards the social effects of what we are doing. Wouldn't it be more appropriate, given the problems of Argentina, to tilt at least the language but perhaps also the content more towards growth and investment stimulation? I wonder, for example, whether a greater effort to increase and diversify exports might not be in place with this rather closed 23 economy. But I am not quite sure whether this is a question of balance or of language, balance of the CAS, as it is, and the changes or of language. Then, I think Girmai had the same concern, as a matter of fact, in what he wrote. I noted that in a sentence that he wrote in his piece. Then, I do think that the additional ESW, as described in the summary in front, is focused on the right things. That it is focused on growth and trade relations and fiscal and debt sustainability. So I also welcome that. I also welcome the IFC program which I think has the right focus from the point of view of job creation and growth. And finally, I am in favor of the loan. I think it is a very good one and I wish the Argentinean authorities the necessary "sans frois", "sangre fredo" [phonetic], I don't know whether that exists in Spanish, combined with determination. And I wish everybody a stronger Euro. Thank you. [Laughter.] MR. SANDSTROM: Thank you, Pieter. 24 Gloria Grandolini, please. MS. GRANDOLINI: Thank you, Mr. Chairman. First of all, we would like to commend staff on a good progress report and we also appreciated the update to the CAS Progress Report which was distributed a couple of days ago. We endorse the program, as presented in the Country Assistance Strategy Progress Report, and we also support the proposed Provincial Reform Adjustment Loan. In the short-term, we look forward to the strong implementation at all levels of government, of the additional measures recently announced by the authorities to address the financial crisis. Political support is a necessary but not sufficient condition for attenuating market skepticism at the authorities' policy statements. In the longer-term, recent turmoil runs the risk of seriously undermining the three pillars of the government's economic recovery strategy, as presented in the CAS -- strengthening political cohesion and support for reform, securing financing to dispel risks of default, and promoting economic policies that address fundamental fiscal and economic growth strategies. Our main concern is, although short-term 25 measures may alleviate fears of an immediate default risk, market perception is that longer-term risks continue to loom large. As stressed by the CAS Progress Report, sustained growth is key to ensure solvency. The Bank should focus its efforts on helping Argentina enter a virtual circle of improving public finances, restoring market confidence, bringing down interest rates and reactivating growth which in turn will further improve public finances. Thus, we reiterate the opinion expressed by many chairs at last year's CAS discussion that the success of the Bank's strategy should be judged to higher levels of sustainable economic growth and indications of declining poverty. Also, we strongly believe that the Bank should intensify its focus on measures to mitigate the social costs of adjustment associated with implementation of the additional reforms. We would appreciate further elaboration from staff on the specific targets for the high case and on the possibility of expanding the lending volume beyond the proposed level in the eventuality that those triggers are met. 26 In this context, it is important to keep in mind that unfortunately, given the current financial situation of the Bank, we should not expect large increases in our exposure to Argentina. We welcome the focus on provincial issues and on the provinces' reform efforts, given their large contribution to total public spending. The Bank should also intensify its support to the strengthening of the governance of provincial governments, together with more stringent targets on subnational state budget deficits. We would like staff to elaborate further on the criteria that the Bank will apply to allocate support among provinces going forward. Also, we are concerned, as mentioned by another chair, about the failure of Bank efforts to engage Buenos Aires in a reform program, given its large contribution to the consolidated provincial deficit. Regarding non-lending services, we welcome the focus on social and poverty issues and on provincial reforms. We also look forward to the finalization of the FSAP. Finally, we wonder whether the analytical work on the sources of growth which is currently scheduled for 27 FY01-03 could be accelerated. We look forward to continued close monitoring by staff of a very volatile and fragile situation, and we would appreciate further elaboration on the timetable and specific actions being considered in the first structural adjustment operation currently being prepared. We believe the Bank Group should maintain a cautiously supportive stance and should retain flexibility in the program to ensure a rapid and appropriate response to changing circumstances. We expect an assessment of the impact of recent events on IBRD's and IFC's portfolios, and we look forward to a further update of the CAS. In conclusion, we wish the Argentine authorities success in implementing the proposed reforms, restoring market confidence and reactivating growth. Thank you. MR. SANDSTROM: Thank you very much, Gloria. Masanori Yoshida, please. MR. YOSHIDA: Thank you, Mr. Chairman. The challenge in Argentina remains to restore growth and establish fiscal equitable, as the Progress Report rightly points out. At the outset, I would like 28 to emphasize that whatever the political and economic situation may be, the strong fiscal constraint and sound fiscal management is essential. The goals set out in the current CAS such as consolidating structural reforms, enhancing social development, strengthening social services and social safety nets and improving public sector capacities are still very relevant, and needs for specific actions are even more imminent under the current recession. We believe that most hard hit under the current recession are small and medium-sized enterprises, which form and provide the main sources of employment. In this regard, we welcome such efforts as the Bank's contribution towards SMEs via ESW and IFC's credit line for SMEs in the Province of Santa Fe. As for the lending program, this chair supports the proposed changes in the pipeline with a view to the fact that immediate action is necessary. At the same time, I would like to caution the use of the PSAL and welcome the comment in the footnote on page 24 saying that the fiduciary underpinnings are being reviewed under the ongoing CFAA and CPAR. We hope that these reviews are well reflected and designed in the PSAL. 29 With these comments, I would like to endorse this CAS Progress Report and also support the proposed provincial reform adjustment loan which is in line with the strategy spelled out in the paper. Thank you. MR. SANDSTROM: Thank you very much. Helmut Schaffer, please. MR. SCHAFFER: Thank you, Mr. Chairman. Let me be very brief, as it is late, and previous speakers and writers have already covered the most important issues. I especially share the general remarks Pieter made some minutes ago in the beginning of his statement. I would like to thank management for the preparation of these two excellent documents. We completely agree with the Bank's assessments of Argentina's current political and economic situation, as well as with the conclusions deducted in the CAS. We endorse the recommendations as to maintaining the focal areas set out in the previous CAS on structural reforms in order to improve public sector capabilities and social development. We agree with the lending volume and the set-out triggers as well as with the mix of lending instruments. 30 Argentina needs to regain soon the confidence of the financial markets through structural reforms, productivity gains and increasing competitiveness in order to generate economic growth and to get back on a solid path of growth. In this context, we welcome that the announcement of moving to a zero deficit made by the central government was supported by Provincial Governors in achieving a similar fiscal outcome to that of the federal government. Finally, we support the provincial reform adjustment loan and we wish the Government of Argentina well in implementing the proposed reforms and projects. Thank you. MR. SANDSTROM: Thank you very much. Zhu Guangyao, please. MR. ZHU: Thank you, Mr. Chairman. We also welcome this CAS Progress Report and fully support the proposed project. And we really hope that after some policy reforms and economic situation, Argentina will become stable and return to growth. Having said that, I have some points and special comments and would like to listen to the response from management and staff. 31 My point number one is that Argentina indeed is a very important country. That is not only because it is important in the region, that is exports and imports and direct investment linkage in Latin America and in the world, but also because some very important policies adopted by Argentina will have a global influence. Among others, I would like to emphasize two items. One is the railway reform. And we thought that was very successful. Just last week, my government sent a Railway Minister to Argentina to learn something to promote reforms in railways in China. We really hope that Argentina will give us experience to promote reforms in China for railways. And another policy which we thought is very important is the Currency Board. And in the current world, just a few countries carry out that policy like Argentina with a full Currency Board policy. Just like Pieter Stek, I also welcome some policies adopted by Argentina here reflected in paragraph 20. It would alter the currency mix to include the Euro in equal amount to the US dollar. That means Argentina not only is just linked with the US dollar and also another very important currency, the Euro, but that means the international 32 view, the global view is a very important policy in Argentina. So in this connection, I will have some questions next, but here I just would like to emphasize that it is a very, very important policy. My point number two is that experience and lessons shown by Argentina projects is that World Bank's middle-income strategy is very important too. And we really hope this case can demonstrate a very good example how to successfully implement the World Bank's middle-income countries strategy. Indeed, Argentina's per capita GNP is high; that is $7,550, which is much, much higher than the average. But that is the current situation. The country is in difficulty. There is real need that the Bretton Woods system give support, give help to help the country stabilize the economy. That shows that the World Bank can contribute and can cope with Argentina to make the contribution to development. In this sense, we really welcome this policy, support that the Bank continue to play a role in the country. My point number three is in this country there is a close linkage between economic growth and poverty reduction, just because the figures show that the per 33 capita GNP is higher than average of middle-income countries, but in the recession and also people suffer from the recession. The paper gives the close link between economic slowdown and poverty people increase. So that tells us very clearly it is not a very poor country. Even if a middle-income country couldn't handle economic growth smoothly, poverty will remain. So we should be very careful to support economic growth and maintain this momentum to promote poverty reduction. My point number four is the market reaction and relationship between international financial markets and local financial markets. This told us there is a very close link between international financial markets and local financial markets, particularly capital account liberalization -- the situation of capital account liberalization. We can see if the spread of Argentina's international bond becomes very wide or if the international financial markets closes the door to the country -- [buzzer on clock] I am sorry, but I have some special points today. Domestic interest immediately increases, and the domestic financial market becomes more important. 34 So that reminds us to think something must be comprehensive from the international financial market and also domestic market and to work out an economic development policy based on country reality. My comment number five is especially related to the Currency Board. I have a question about the Bank view here. One is in paragraph 11 and that is the Bank mentioned that foreign exchange reserves in Argentina now is $25.4 billion. The conclusion is fully backed by the money supply, a requirement to maintain convertibility and the integrity of the Currency Board system. My question is here: This amount of foreign exchange reserves compared with money supply one, unfortunately from this document I didn't get the amount of money supply one, but I did get the figure of money supply two; that is 33 percent of GDP. The country's total GDP here is $285 billion and 33 percent basically equal to $94 billion, $95 billion. So if we reduce this amount from M-2, that is $30 billion, and it is still $60 billion. So that is one dollar to one peso. And my question is whether this is a real Currency Board or something other. I hope it can be clarified. 35 My last point is that, due to Argentina being a very important country and has global influence, we hope that during the crisis the international society can give full support to the country. Here, the situation is very difficult, particularly external debt, and the figures show the debt service ratio is 479 percent, and the debt ratio is 94 percent and debt to GDP ratio is 51 percent. That is equal to $150 billion. On the other hand, we got the figure from this paper that the IMF gives standby support to Argentina and now totally it is about $13 billion and another $10 billion from the private sector. My question is whether the other countries can provide support during the very serious situation in Argentina. Thank you. MR. SANDSTROM: Thank you. You tested the eight-minute limit and we hesitated. Yahya, please. MR. ALYAHYA: Thank you, Sven. But inasmuch as I try not to have the noise from the clock, I sincerely don't like it. [Laughter.] I think we have to really reconsider the bell. 36 We don't mind the light but I think the bell can be a nuisance. Well, Mr. Chairman, let me join my other colleagues by basically first thanking staff for the written update, for the bilateral, very useful discussions we had, as well as the opening statement, which I hope will be distributed as well. Clearly, the situation in Argentina remains very fragile, and the country performance is kept under close scrutiny by the financial markets and the country's creditors. As the government recognized, there are two main challenges facing the country. The first is to restore growth and the second challenge is to establish fiscal equilibrium. The long recession has set back progress towards achieving Argentina's development goals with particular impact on unemployment and poverty levels. Under the convertibility plan, the options left to restore growth are limited, and largely rest on strengthening competitiveness through increasing productivity and reducing prices and wages. The main elements of the government's new economic recovery strategy, which are elaborated in the Progress Report and 37 which have been agreed with the IMF, are essentially sound, and intelligent implementation of the program will be essential. Fiscal slippages and tensions between the federal government and the provincial governments have negatively affected expectations and raised country risk. As the Progress Report mentions, the international capital markets may, and I quote, "have reached the limit of their financing of Argentina's fiscal deficit", end quote. Nonetheless, the most recent announcement of moving to a zero fiscal deficit, which is supported by provincial governments, is indeed encouraging. Strict implementation of the needed revenue and expenditure measures and continued political cohesion will be critical to the restoration of market confidence and access to international capital markets. Argentina's external indebtedness in relation to GDP is moderately high. But given its small export base, its debt service ratio at around 90 percent, it is one of the highest among emerging markets. Long-term solvency, therefore, rests critically on restoring growth and fiscal equilibrium to reduce the cost of borrowing and 38 increase external competitiveness. Indeed, the simulation exercise for the Progress Report shows that a real economic growth of about 3 percent accompanied by fiscal equilibrium would be necessary for stabilizing debt ratios. Progress in implementing the CAS has been uneven and characterized by a number of delays in implementation and signing of loans. The recent commitment by the authorities to accelerate the signing of loans is welcome, and continued efforts to avoid such delays would send a positive signal. I agree with management's proposal to proceed with the parameters of the program as outlined in the original CAS and updated in this Progress Report. I have noted that the Bank committed in FY01 less than half of the planned lending program under the CAS. Under normal circumstances, this would be regrettable, but under the current circumstances this actually allows the Bank to restructure its lending program to meet the needs of the country as they evolve and to give enough flexibility to provide larger support in the current fiscal year. Of course, the Bank may need to continually reassess its support of Argentina as the situation 39 continues to evolve, and in this context the Progress Report spent substantial space to explain the planned PSAL of $900 million under the high case, while the update that we received yesterday, as well as the introductory remarks today, have redefined this as two adjustment operations, a $400 million one and a $500 million one. And I may have missed the reasoning underlying this during the introductory statement. I have a question: Has anything changed in the objectives besides changing the instrument? I would appreciate elaboration on that. Turning to the proposed provincial reform adjustment loan, it is in line with the CAS objective of supporting reforms in the provinces. [Clock buzz sounded.] I don't like that. MR. SANDSTROM: I gave you an extra minute because of your introductory remarks. MR. ALYAHYA: I actually deliberately took my time to test the clock in order to tell you that I don't like it. Well, I can, therefore, support the proposals. I have, however, just a quick question. I have noted that the proposed loan amount is more than double the 40 amount that was proposed under the original CAS. I would like staff to explain the reasons behind this increase. Finally, regarding IFC, given its very high exposure in the country, the focus should indeed be on managing the current portfolio and supporting its existing clients in Argentina. And finally, I want to extend my appreciation to the team, management and staff for their efforts and to wish the authorities every success to put the economy back on track. Thank you. MR. SANDSTROM: Thank you very much. Emmanuel, please. MR. MOULIN: Thank you, Sven. We support this strategy of the Bank in Argentina, and we support the Argentine authorities in their efforts. But I cannot help to feel quite uneasy discussing this CAS Progress Report at a time like this, as the extreme volatility of recent developments make it hard to concentrate on medium-term development issues in a meaningful manner. Let me be clear. I don't criticize staff or management for putting forward this country assistance strategy. It was written at a time when the 41 situation was different. But indeed, whether the latest adjustment measures succeed or not, it seems likely that major revisions to our assistance program will be needed, either to adjust to the extreme austerity required or to address the major disruptions which their failure would entail. Another cause for uneasiness about today's discussion is that I understand the CAS Progress Report will be released to the public. And, as it stands, I am a little bit concerned that it may in some way affect our credibility by expressing a degree of optimism which regrettably is no longer warranted at this point. And I am concerned especially by some of the wording of paragraph 75. Setting these reservations apart, let me comment briefly on the proposed assistance strategy. The priorities set out in this CAS continue to be relevant, in particular the strong focus on revamping social assistance programs and the basis social security system, which we hope will not be affected by the intended strong shift in favor of adjustment lending. Incidentally, while we appreciate the recent 42 economic condition shift to quick-disbursing lending, we note, as Mr. Alyahya already noted, that the purpose of such a shift has been partly defeated today by the lengthiness of the authorities' loan signing procedures. And we urge the authorities to address that problem swiftly. We also welcome plans to expand the provincial reform loan series to new provinces, and we gladly support the Santa Fe loan submitted for our approval today. Going forward, like other speakers, especially Maria and Gloria, we would encourage staff to attach the greatest priority to reaching an agreement with the Province of Buenos Aires on such a reform loan. This is not meant to suggest that staff should be prepared to compromise on the quality of the underlying reform and adjustment plans, but rather that the sheer size of the province and its fiscal imbalances make it a key determinant of whether or not the Bank's efforts to put the Argentine fiscal house in order will be successful. Turning to the proposed PSAL, which is a cornerstone of our emergency assistance, as regards to the substance, the emphasis on improving the financing 43 and delivery of social services is fully appropriate and so are the directions outlined in the CAS Progress Report to reach that objective. However, it seems at this stage that a clear agreement with the authorities on the details of the reform to be undertaken is still lacking or not precise enough. And based on our experience in Mexico, I would caution against committing funds without such a clear agreement on the reform programs in order not to affect the effectiveness of our lending. I understand that we are not anymore in a programmatic approach, and I welcome this because it was a little difficult to understand how we could combine the programmatic approach on the base and high-case scenario. So I think it is a good move to have that operation as a regular operation, non-programmatic SAL. Finally, I would appreciate some clarification regarding the risks faced by the Argentine economy at this stage and the implication of this risk for the Bank's portfolio and for that of IFC. On the first part of the question, we are all aware of the macro risks at the federal level, but perhaps staff could elaborate maybe on the risks emanating from the public banks, from the corporate 44 sector and from the provinces. On IFC, I would also be interested to know the assessment of the risks especially on the equity portfolio. With these comments, I wish to assure the Argentine authorities of our sympathy and support in their endeavor to overcome current challenges. Thank you. MR. SANDSTROM: Thank you very much, Emmanuel. Rosemary, please. MS. STEVENSON: Thank you. Before I start on Argentina, I can say I am glad to see all of our flags are back today. I missed them on Tuesday. We welcome the authorities' commitment to promoting fiscal discipline and stability and intention to continue with the IMF program. We believe the recent package of measures designed to achieve a zero fiscal deficit represents a serious and determined attempt to address the deep-rooted fiscal problems. We very much welcome the fact that the government has been working constructing with the main political parties and provincial governors to secure agreement to the package. 45 Turning more specifically to the Bank's role, we agree there is a good case for continuing Bank assistance targeted at improving public administration and the underlying fiscal position, in particular federal/provincial relations. Equally, there is a clear case for assistance targeted at strengthening social provision, given the increase in unemployment and the consequent poverty arising since the start of their session. So for these reasons, we entirely support the continuation of the CAS, though, like Maria, Emmanuel and others, we think it will be necessary to look again at the details when the position is more clear and stable. Can I just ask a couple of questions on the Santa Fe loan? The first one is: What is the rationale for choosing Santa Fe for a program that is targeted on reducing poverty, given that it is not one of the poorest provinces and, in fact, there seems to be uncertainty about the level of poverty and the lack of reliable statistics? And looking at that more generally, if it is the case that the poorest provinces have got the worst track records and are therefore furthest away from meeting the 46 criteria, how can we actually best tackle poverty at provincial levels? That was one. The second one is a kind of similar sort of approach to do with the focus on strengthening fiscal management. Again, the paper notes that Santa Fe already, quote, "has enjoyed one of the better and most consistent fiscal performances", unquote. If we are really looking at addressing the fiscal problems facing Argentina, mightn't we be better to engage with those provinces that actually most need assistance rather than those who are not doing too badly? And how best could we do this? Now I guess you might reply saying there is a kind of lesson-learning element here, and that is fine. But I would like to see how we get to the next stage of tackling of those where the problem is a bit more difficult. Thank you very much. MR. SANDSTROM: Thank you very much. Philippe Peeters, please. MR. PEETERS: Thank you. I cannot help comparing the discussion we had not long ago on Turkey and today's discussion on 47 Argentina. First, we are discussing the difficulties of a country where GDP per capita is three times higher than in Turkey. And second, the discussions on Turkey were proposed because of the composition of the Turk Telekom Board. And as a representative of Turkey, I should say rightly so. But here we have, I guess, less detail and intrusive conditions. And third, whereas the discussion on Turkey was around structural reforms, today we are mainly addressing macroeconomic concerns. And indeed, reforms in Argentina have started in the early 1990s but also, at the same time, reforms cannot have sustained effects if the macroeconomic fundamentals are not right. As mentioned in the document, Argentina is now confronted with the problem of competitiveness, fiscal vulnerability and uncertainty. But also, all fundamentals are luckily not as bad. Inflation is rather low. The average level of budget deficit and also the debt to GDP ratio are still manageable and would be manageable in many countries, but in the case of Argentina, what is very specific and very surprising is the very low export base relative to GDP and also 48 relative to the debt service. This poor export performance, coupled with the relatively under-developed capital market, cannot create enough foundation for debt financing. I would like to quote one sentence in the beginning of the Progress Report. "Since the path by which the economy reacted to shocks is constrained under the convertibility plan, there are few options. Fiscal policies constitute the main instrument at the government's disposal with the economy responding to changes in prices, wages and employment". It is very nicely written, but I am not sure that this is as palatable when you are in the country. Indeed, the three-pillar strategy is heavily based on fiscal adjustment, particularly with the zero deficit target at the national and provincial levels. But although we are not in the Fund Board, I think that we may advise the authorities to find a way out of the convertibility plan which might have been very helpful early on in bringing inflation down, but does not respond to the current situation I think. And in this respect, I would like to mention that countries attracted to dollarization should rather 49 realize that this is not a means to achieve a stable macroeconomic development, but rather a measure that may come after macroeconomic stabilization has been achieved. But make no mistake, if you replace dollarization by Eurozation, my statement will remain the same. Other issues that must be addressed in my view vigorously by the country are tax evasion and capital outflows which have only been compensated in the early and mid-1990s by foreign direct investment, but still remain a very important problem. Like Pieter Stek, I guess I am also rather concerned. I would like to have some explanation by staff that the current measures to increase tax revenues to balance the budget may be working in contradiction with the goal of fostering growth. Coming now to the Bank strategy, under the circumstances, I think that the goals set out in the CAS are still valid. Indeed, the reforms are much more needed now than before. Even in this difficult fiscal situation, focusing on social development is I think essential to get broad support from society. And without improving public sector capacity, there is no change either to overcome the crisis or to achieve sustainable 50 progress. We, therefore, strongly endorse the basic strategy to concentrate heavily on provincial reforms, in particular, because a strong subnational government could play an important role in reducing the vulnerability of the Argentine economy. Meanwhile, we would agree to support the PSAL. Here I would like to emphasize, as I did in the past, the prerequisite must be a very strong and committed ownership and well elaborated reform action plan with well defined triggers. In this respect, I should say that the links between specific triggers and the high-case scenario in the Progress Report are not as obvious as we would like. We support particularly the provincial reform adjustment loan to Santa Fe. Its objectives are essential. Under the independent pact signed by the provincial governors, the zero define policy, the Province of Santa Fe, like others, had to cut spending drastically. The danger is certainly that these cuts will principally harm that part of society whose ability is the weakest and that some essential development objectives will be sacrificed to immediate pressure. The adjustment loan combines in our view a wide 51 set of actions aimed at supporting the province's reform program in the area of health and education, with special emphasis on the needs of the poorest section of the society. Indeed, as the figures in the report show, the poverty and liquidity targets in the province were not sufficiently addressed in the past and, for this reason, we believe that the proposed loan is very much justified. Thank you. MR. SANDSTROM: Thank you very much. Barbara Geiser, please. MS. GEISER: Thank you, Mr. Chairman. I believe Mr. Hyden may have been up before me, but I will go ahead and not have the U.S. be last for once. We too welcome this discussion and we share some of the uneasiness with our French colleague in terms of the timing, not that it is anyone's fault but it definitely makes medium-term planning more difficult. Nonetheless, we do very much recognize the difficult situation the Argentine authorities are in, and we very much support the efforts they have taken, particularly in recent days, and the agreement recently that has been 52 come to. We understand the very difficult and painful steps but we understand that options are very limited. We share some of the questions others have raised in their written statements, particularly regarding how the fiscal targets, the new fiscal targets would affect viability of ongoing priorities, social spending and the existence of the counterpart funding. And I realize that staff responded to some degree in their introductory remarks but we still have some concerns there. We also share some of Pieter Stek's and others' concerns about the impact of the tighter fiscal stance which is obviously greatly needed, but in terms of the growth prospects which is definitely going to be difficult going forward. This all said, we very much support the Bank's proposal and think it is appropriate not to deviate from the current CAS, but we also agree with others that an updated CAS, should conditions change significantly, would very much be necessary. Notwithstanding comments about growth, we also are concerned about the disturbing picture on poverty and social indicators and very much urge the Bank to be 53 paying close attention here. And we agreed with Mr. Abraham's urging more economic and sector work here, particularly going forward, since in times of uncertainty the poor are often hit first. We can support the provincial reform loan presented today as Santa Fe has already shown itself as committed to reforms. In that regard though, I do share Rosemary's question about subnational lending. It reminds me in some cases of some of the states of India and the choices that the Bank makes in terms of supporting reforms, yet trying to use it as a demonstration effect. So I am very interested in the responses to her questions. That all said, we very much wish the best to the Argentine authorities. Thank you. MR. SANDSTROM: Thank you very much. Neil. MR. HYDENjonck: Thank you. First, let me join with Rosemary in welcoming the return of the flags after they have done emergency service for Mr. Bush. I notice that they have been restored in the reverse order that they were in before 54 and I wonder whether there is any significance in that. Turning to Argentina, I noticed particularly Mr. Miagkov's question or comment about how it is that the Bretton Woods institutions with their long involvement in Argentina haven't seen this coming more clearly. And I fear that part of the answer is not that the evidence wasn't there but that we didn't want to see it because we have become so hooked into the policies and framework that is there. And of key importance of that, of course, is the Currency Board and dollarization, which were effective in the very necessary efforts to stop inflation and to rebuild growth. But I think it may have outlived the usefulness. In any case, they have removed the key shock absorber that most economies have for dealing with external shocks. And that is very evident from the language of the paper which talks about the options being so constrained, but it is because of what has been done there. And it puts all the burden of adjustment on deflation, on adjusting the domestic price level and on fiscal and monetary policies. I note the references to changing the currency link to a basket with the Euro at some distant or maybe 55 not so distant point when the Euro returns to parity with the dollar, but that could be a long way off. And there is any case a question as to whether that is sustainable with the extent of dollarization of the economy for the same sort of reasons that are raised about why the basket on the system cannot be abandoned. It is not clear whether this is part of an exit strategy for the government or whether it is seen as a more permanent strategy. It would seem to me to be of rather doubtful sustainability. Secondly, the policies which the paper refers to euphemistically as heterodox policies and which it quite properly says need to be reversed promptly, sometimes we do need to do things in an emergency situation which are less than optimal. But I do very much endorse the paper's and the staff's view that these policies need to be reversed before they do too much permanent damage. It is understandable, I think, given those elements of the situation that markets are nervous. And we all need to give Argentina what support we can I think to try and help reestablish stability. It is essential, given the limited options available to reduce the deficit and expand exports. I welcome the recognition in the CAS 56 of the needs to provide social support during the crisis, but I think I also endorse Pieter Stek's question about is the Bank doing enough to support growth in these current circumstances. It is very clear from the papers that what the poor themselves want in their answers to questions and comments is very much growth and jobs, rather than social welfare. I also had some questions as Rosemary about the selection of Santa Fe for the provincial loan. So I won't repeat those. It did seem to me unclear as to why we are going ahead in this particular way and whether we are really targeting our assistance where it is most needed. And finally, on Emmanuel's questions about the wisdom of releasing the CAS Progress Report to the public if it is out of date and not in tune with the current situation, I think we need to be extremely careful not to do anything that might aggravate the situation, given the skittishness of markets and the fact that things aren't always interpreted in the way that they are meant, and we should be careful that we don't unintentionally add to the problems. 57 Thank you. MR. SANDSTROM: Thank you, Neil. On your last point and Emmanuel's, I think we should take another look at the report together with the authorities, including paragraph 75 also. So we will do that. Finn, please. MR. JONCK: Thank you, Sven. Well, let me first apologize for being late so that I missed the introduction by staff. On the contrary, then I have benefited very much from bilateral talks with staff, and I appreciate that. I think it is clear, as many other speakers have already pointed out, that Argentina is caught in a very unpleasant dilemma, so to speak. On the one hand, there is a clear need to stimulate economic activity and increase growth, but, on the other hand, it is necessary to have a tight fiscal policy to close the fiscal gap, as it is not possible to use monetary policy. I think it is difficult to see how this will work out, and I hope that the reform measures that are envisaged really can live up to this challenge. I don't see any other options as far as the Bank 58 is concerned than to support strongly these reforms measures in spite of the risks that have been clearly identified. And from this chair, we can, therefore, broadly endorse this CAS with the changes proposed to the lending program. We also agree with what is said that Argentina is currently in the base-case lending scenario. In spite of the positive progress earlier this week to secure political support for the government's latest austerity measures, the situation remains very unstable and unclear, as has been said by others. And we join others in urging management to continue to monitor the situation closely and promptly report to the Board if there are slippages in the program or need further changes in the lending program. We welcome that the poverty focus has been enhanced in this CAS, but, like on previous occasions, we are somewhat concerned that the social dimension in the government's development strategy remains weak. In the 1990s, income equality deteriorated and the poverty rate went up even at the same time as overall welfare improved and GDP per capita increased. We do not recent poverty figures, but we urge 59 the Bank to give this issue due attention in its lending program. It is important that adjustment measures are combined with sound and social policies that aim at a fairer distribution of income, improved tax collection and enhanced measures to reduce unemployment. Now subject, of course, to our assessment of the project document itself, it seems to us that the proposal to move ahead with the $400 million structural adjustment loan in this fiscal year is justified. Let me just say in this context that it is not quite clear to me whether there is a full consistency between the text in the Progress Report and the Table B3 on the proposed lending program. In paragraph 10, it is said that with these adjustments the social program for this fiscal year stands at about $1 billion to $1.5 billion, depending on project preparation, of course, and on whether triggers for the high-case lending scenario are met. But if we look at Annex B3, the lending projections, we already here are at 1.58, as a matter of fact, including the SAL loan. This is described as the base case, but does it means that the SAL is linked to the high-case triggers? 60 Otherwise, I cannot really make the figures add up. So if you could have a look at that. Proceeding with a second SAL will require, of course, moving to the high-case lending scenario. That is clear. And we stress the importance of adhering to the program triggers if and when this step will be taken. But I must say that the triggers outlined in the box could in my view be a little more transparent or more specific. They do not really seem to provide so much guidance to the Board on what is really required. Finally, on the Santa Fe loan, we agree that support to the reform agenda in the provinces should be an important part of the Bank's program in Argentina, and we support the Santa Fe provincial reform adjustment loan, as we welcome its focus on social protection and health and education reform. We do have the same questions that the three previous speakers raised about the selection of Santa Fe, although we welcome it. But we would also like to know how the Bank plans to engage the other and more poor provinces and particularly the provinces with a very weak track record and weak capacity in the reform process. Thank you very much, Mr. Chairman. 61 MR. SANDSTROM: Thank you very much, Finn. Are there any other comments? [No response.] If not, Myrna, do you want to start? You don't have much choice, I guess. MS. ALEXANDER: Let me take a moment here to organize myself a little bit. Let me start perhaps with the questions on the choice of provinces, the reason for selecting Santa Fe and the reason for the change in the amount, and some comments on our relationship with the Province of Buenos Aires. First, on criteria, explaining a little bit that we have been working with the provinces in Argentina since the late 1980s and have progressively worked through an agenda with the provinces. And we have a rather full range of activities with provinces. And so while we started with a technical assistance combined with small rehab investments eligible for all provinces to participate, we then moved from that to dealing with groups of provinces on what is called first generation reforms, principally privatization. We helped 13 provinces, including some of the poorest provinces, in the privatization of provincial 62 banks as an example. And this was all through to the mid-1990s. In 1997, we had entered into a third phase of working with the provinces, which was indeed more selective than the previous relationships. That was considered to be kind of the elite group of performers where they would have a one on one relationship with the Bank in contrast to the other avenues that are open to the provinces, which is largely through the central government. In selecting provinces for this final stage of relationship, we did indeed look for provinces that had the political willingness and capacity to undertake prior reforms. We looked for provinces that had been implementing other operations, whether they be technical assistance or education or health. And we looked for provinces that had a handle on their finances, since it indeed is rather difficult juggling structural, sectoral reforms of a rather specific nature with broad macro problems. We also looked for provinces where we could have a demonstration effect. And so those are the criteria principally that we outlined in the CAS Progress Report in paragraph 68. 63 That indeed does not necessarily exclude the poorest of the poor provinces. The criteria don't bias one way or the other specifically. And if you look at the past, we have helped the first round in the 1997 provincial reform loans Salta, which happens to be one of the poorest provinces in Argentina, and when we look at the ICR for that operation, we see how the political will, the capacity, the organizational capability even in a small poor province managed to carry off reforms very successfully. We are now working with the Province of Catamarca, which was a loan approved in September of last year, I believe, and so it is not mutually exclusive that we are not working with the poorest of the poor provinces. But, indeed, it is quite correct that there are still many provinces out there, including many of the poorest provinces but not exclusively, that don't meet the criteria for this rather, as I said, more special relationship with the Bank. With those provinces, we do have an array of loans that support them. We have one loan which is the Provincial Development II loan which provides all 64 provinces with the support they need to put in place the basic underpinnings of sound financial management, planning and budgeting, including cadastres, as well as other elements that would fit within a capacity building fiscally oriented program. We additionally helped all the provinces with health policies and we helped all the provinces in education programs. Particularly in the northern provinces, which do tend to be the poorest, we have several social protection operations running. One is called FOPAR, which is a Fund for Social Community Development. We have an indigenous loan, which was mentioned before, working in two very poor provinces. And then, we have the small farmer operation directly helping small farmers, largely in the poor areas. This was particularly over the past couple of years where there were severe dislocations of the small farming community because of massive funds in 1998-99 period. So we have an array of instruments available for poor provinces. Just because they are not included necessarily all of them in this kind of operation doesn't mean that we are not working with them and trying to build the capacity for them to undertake similar reforms 65 in the future. Santa Fe indeed is not among the richest provinces nor is it among the poorest provinces. It is the third largest province in Argentina, and with a relatively high unemployment rate, particularly in the main center of Rosario and with the other dislocations that have occurred in the economy, it is not necessarily a robust province and has been encountering a number of social problems, and it does have a relatively high level of overall unsatisfied basic needs which we use as a proxy for poverty. So it is not at the bottom end, but it is at the lower middle end of the array of provinces. It is a province which has been working with us before. When we say as a province which has been relatively speaking among the better fiscal performers, in fact, it does reflect our earlier activities with the province in the earlier 1990s when we worked with them on a lot of the fundamental fiscal reforms. So it meets the criteria of having a fairly long-standing relationship with us and showing a demonstrated capacity to be able to undertake reforms. There are other provinces which we are working with now, trying to prepare for the continuation of the 66 series of provincial reform loans. We mention one or two of them in the CAS Progress Report. They will all meet the criteria that we have outlined. Turning to the Province of Buenos Aires, this is a province that falls a bit short on the criteria. We started working with the province with the expectation of having a loan with the province in 1999. We advanced considerably in the policies in education and in health reforms where we had very good dialogue with the ministries and we were able to progress very well. Where we got stuck was on the fiscal side, and I don't think we should be apologetic for not advancing in this particular operation, given the unwillingness at the time of the leadership in the province to undertake more serious fiscal reforms. Indeed, I think if they had followed some of our advice during 1999 and in the year 2000, perhaps they would have been able to deter some of the more drastic measures that the province is faced with today. So again, I wouldn't close the door. We are very glad to reopen discussions with the province, particularly under the new circumstances and particularly because we have quite a solid basis of understanding with them on the 67 social side and, if we can combine that now with the fiscal side, it would be a viable package. Let me turn now to the questions of triggers, on expanding lending and updating. These fit together I think quite well in terms of the volatility and the uncertainty we are facing. Specifically on triggers, these are the same triggers that we had in the original CAS that was discussed last year. We are progressing on those, particularly in the areas of reform that would be required for the high case. Some comments were made that they weren't perhaps as explicit. We believe that the general substance of those is clear. I don't know if it is appropriate at this point in time to provide much more details, and perhaps we can carry this on on a bilateral basis. There was a query about our ability to expand lending. Again, I think this is in the same vein of the need to be attentive to the needs of Argentina, close monitoring of the situation, taking it somewhat one day at a time and seeing where we come out. I think the support around the table today for helping Argentina, should the circumstances warrant it, taking into 68 consideration the risks, burden-sharing and the quality and the nature of the macroeconomic framework and the nature of the reforms we would all want to consider for the future. With that said, we concur with many of the chairs. We have said that close monitoring and updating is needed in light of the many changes in the economy in the country. We propose to do that in the coming operation, now instead of proposed first of a series of PSALs, the first of structural adjustment loans and, in any event, if conditions do change rapidly and drastically, we would come back to the Board with an oral briefing as we did in November/December of 2000, pending a more thorough update of the country assistance strategy. And turning to the question on where are we with the new operation and its content, the question of the right balance between growth and social sectors, let me say in timing we are advancing quite well. After a number of delays that have been noted by several speakers, we are advancing rapidly and we will hope to present the loan as fast as we can without it making any strong commitments on specific timing, but we are 69 thinking that we could present it in August if all things go well. On the balance in the new operations and the Bank support between growth and the social sectors, I think we need to take the specific operation in context of the other activities that are underway in the country and the potential for us to help in the future in different ways. We are looking at the social sectors and the fiscal, particularly the tax evasion, reinforcement of the efficiency of overall spending, as very two strong pillars. You cannot deliver good social services if you don't have the money and so you need to have the fiscal house in order. So we see it as a great deal of complementarity between the strategy we are following on the social side with the current government efforts and our efforts to help them on the fiscal side. That leaves whether or not we should be actively promoting more measures that would be directly growth promoting. We are of the view that the fiscal uncertainties have a direct impact on investor confidence and that by reducing the fiscal uncertainties, we would be unleashing, hopefully quite rapidly, investor interest 70 and confidence in Argentina, which would then lead to growth. So we are following very strongly that particular linkage, as some speakers have suggested, in terms of a virtuous circle. We do recognize, however, that there continue to be many bottlenecks on production, on investment, on the generation of employment. On the one hand, the proposed operation would be addressing that through modernization of the state; tax reform in and of itself, the way the government interfaces with the private sector, reducing transaction costs, increasing efficiency, elements of new procurement laws, e-government are all enhancing of the productive sector's ability to move more faster and more quickly in its interactions with the government. So we believe that that also would be growth enhancing. The remaining agenda for us, we have on the table or we are considering now helping on the transport side, in the financing of private infrastructure, which is one of the pieces of the pipeline for FY02. We have economic work underway on identifying bottlenecks in the transport logistic chain. We believe there is ample opportunity there to reduce costs, which would be growth enhancing. There may be much more we can do in terms of 71 small and medium enterprises. That study is nearing completion and we would like to build on that. Therefore, although we may not right now be seemingly directly promoting growth, we think we will be doing a considerable amount both on the fiscal side, modernization of the state, and we are quite prepared to look at other measures in the area of transport, particularly as well as SMEs, depending on how this works out. I would like to add that the Inter-American Development Bank is working with the government in this area, and so one of the areas we need to look at is the complementarity between what we could do and what the IDB is currently doing. We agree with some speakers that the sources of growth studies obviously in this context is a very important one. We had it programmed for FY03, and think that that could easily be advanced in terms of work in FY02. We could also include in that a number of the issues I have just talked about in terms of transport or SMEs and also would look at export issues and diversification, which has been mentioned by some 72 speakers, as part of the macro problem that Argentina is facing. Just to refer a little bit more between the balance of growth and the fiscal measures, maybe we can take Mr. Stek to have a conversation with some of the people in Argentina because there are some figures in Argentina who do believe that in a neo-Keynesian way that the fiscal measures will be dampening of demand and, therefore, dampening of growth. I think our interpretation is that it is the reverse. We are more inclined to think that the fiscal is a drag on the reactivation of the economy and the faster we can eliminate that drag, the better we would be off in terms of growth. Let perhaps other economists debate that one, but that is where we come out, at where I come out on that. Let me see if we are missing anything here. On Mr. Stek's questions as well on some of the new measures and the heterodox nature, perhaps I will ask my colleague, Paul Levy, to respond a bit more on that one. Specifically in the case of the trade measures and whether or not these comply with WTO conformity, I 73 will let Paul handle that one in a minute. There is a clarification requested on the Currency Board and our statement on the reserves fully backing the money supply. Indeed, under the Currency Board system in Argentina, the reserves back money in circulation, not M-1. So the circulation is much lower than the figures that you had mentioned in terms of M-1 and M-2. On railway reforms, just so we don't forget some of the success stories of Argentina while we are here today, I think indeed railway reform is one of the cases, examples of which Argentina can be proud. Electricity is another area. There are many areas where Argentina had been at the forefront, and we continue to see the very substantial benefits of the privatization process and the deregulations that took place in the early 1990s on efficiency, on tariffs, on productivity in those sectors. So hopefully, you will not be deterred by what is happening in Argentina today on your railway reform. Clarification was asked for on why we changed from a PSAL to a SAL and some of the adjustments in the lending program. Indeed, as we looked at Argentina over the last couple of weeks, in reviewing internally the 74 proposed operation, we felt more comfortable having a traditional SAL of $400 million clearly within the base case, and dealing separately with the issue of the triggers and the remaining $500 million. We also though acknowledge very much the beneficial effect of having some overarching programmatic approach linking reforms over time. We wanted to give the program continuity and, therefore, we are retaining as much as we can of the feature of a programmatic lending strategy while clearly divorcing the first operation from the next series and the triggers, so that we have a clear decision point on where we stood on that. Just to reassure speakers, we don't anticipate any changes in the objectives of the operation. As I mentioned, we are working quite well and advancing quite rapidly. These are complex reforms, a lot of institutional change and, therefore, having the programmatic vision definitely will help to guide us and help to guide the Argentines through the next phase of the reforms. I guess I forgot to mention in the case of Santa Fe why the amount was changed. Let me come back to that one then. 75 Indeed, when we did the CAS originally a year-and- a-half ago, we put in $150 million as an indicative amount thinking that the Province of Santa Fe might not be interested in much more. As we worked with the province, however, it became clear that the quality of engagement we could have with the province, their willingness and capacity to go deeper in reform areas warranted a larger loan. And looking at the parity or the comparability between the Province of Santa Fe and what we had recently done with the Province of Cordoba, we felt that a comparable figure would be warranted. And in the last stages of the discussions with the Santa Fe authorities, we moved even further on some of the reforms, particularly in the tax area, and that is how we came out with the final amount. There was a question here now on risks, something on IFC and the corporate sector. Let me turn now to the questions here on the fiscal measures and their impact on counterpart funding. Indeed, counterpart funding figures obviously is an important issue in our ability to implement loans at both the provincial and federal level. I had a quick conversation last night with the authorities as they are 76 designing how they will be putting in place the zero deficit measures. What they will be doing is on the first order of business will be reducing payments to a variety of expenditures, salaries as well as suppliers. In the case of suppliers, they know that they have contractual obligations which they will have to honor in the future. So it may not be a loss, if you want, in that sense but a deferment of payments. In the case of bidding, contracting which is in process, they are looking at the contracts that are being considered which have not yet been let, seeing whether there are opportunities to reduce the scope of the bidding process. And they are working with the project units and the line agencies on lowering the level of activity. So what we see here is an impact on probably this pace and magnitude of implementation of projects over the next few months which we will take a more in-depth look at to see whether or not projects continue to be implemented in a satisfactory way or whether more restructuring is needed. So I think we are entering a little bit into uncharted territory and need some time to work these things through. But it was very clear from my 77 conversation last night that the authorities are very aware of the linkage or the impact that the fiscal measures may have on project performance. Paul, would you like to discuss some of the questions, the heterodox measures? MR. LEVY: Right. To address some of these policies that euphemistically are called heterodox, I will touch upon three sets of policies. One is in the international trade area; the second is on competitiveness agreements that have been announced by the government; and finally, the financial transactions tax. Let me start with the trade compensation mechanism which has raised some concerns about questions whether it constitutes a multiple exchange rate regime. Although it appears de facto to operate as such, the IMF has evaluated this system and has concluded that it does not constitute a multiple currency practice, because the subsidy tariff system will be paid outside of the exchange rate system and on the base of trade recommendation. Regarding the WTO, there is an ongoing evaluation of this system. The Argentine authorities may 78 decide to present their case to the WTO, which to my understanding as of now has not been done. Another opportunity for the WTO to make a ruling on this case is if another country presents a complaint to the WTO. So at this point, we don't have a formal official ruling of the WTO, although we are in contact with them and we are discussing the case. The durability of the trade compensation mechanism, of course, theoretically is transitory in the sense that it will depend on the parity between the dollar and the Euro. Automatically, the way it is structured, once a parity is achieved, the subsidy tariff component becomes automatically zero. But, of course, there are no guarantees when that will take place. Other deviations in the trade area have been committed by the government to be eliminated before the year 2002. Regarding the second set of policies, the competitiveness agreements that have been announced by sector and by region, again we have sought assurances that they are of short-term duration and there are exit policies to those agreements. The authorities regard them as such, particularly as they see them as a 79 transition phase towards a consolidated tax system that will be unified to two tax instruments, the value-added tax and the income tax system. So in the process of converging, of consolidating the tax system into those instruments, the transition really would benefit according to the government from those competitiveness agreements in the sense that they will be able to extract concessions from labor unions, a greater flexibility in labor agreements in the transition to the new system. So that also is a transitional measure. The third element is the financial transaction tax. Clearly, at this time it is a crucial instrument for generating in the short-term revenues. Clearly, we recognize the deficiencies of the tax collection agencies, and we are working very closely with the administration, equally the International Monetary Fund in revamping this agency. However, we are also realistic that results will not be provided overnight. So, consequently, under the current circumstances, getting this tax would provide the necessary revenues to helping balance the system. While we don't have assurances on the elimination of the system, the authorities are also very 80 aware on the limitations of that system, in the sense that evasion could likely increase over time. So there is a sense of realism. This is a short-term measure that has a limited duration. MS. ALEXANDER: Just to elaborate on that point a little bit. My understanding of the government's plans is that they wouldn't necessarily eliminate the financial transaction tax per se, but they would use it as a kind of withholding tax against which corporations and individuals would be able to credit taxes of VAT and income taxes, so that it would become a very powerful, because it captures all the transactions through the financial system, that you will have a record of the flow of monies in the economy, and it will be very useful then for evasion. So they wouldn't necessarily eliminate the mechanism even though they might eliminate the tax per se, and then they would be using it as a withholding tax against which they could credit. For us, it seems, given Argentina's high rate of tax evasion, the more you can put through a documented stream like the banking sector, the better off it probably will be. And so that is the future strategy. 81 MR. SANDSTROM: Toshiya. MR. MASUOKA: I think the question from Mr. Moulin is about risk on the IFC's portfolio and particularly on the equity. IFC's portfolio for our own account in Argentina is about $1.1 billion including the loan and equity. And the equity side is about $150 million on the disbursed basis. We are very closely monitoring, and my answer is also in response to the point raised by Mr. Alyahya about the importance of focusing on the management of the portfolio. We are closely monitoring and we, in fact, are sending out our team down there as we speak to have a closer consultation with our existing clients, listening to their conditions and what kind difficulties they are facing and also what new needs they have. We also have run what we call a stress test on their portfolio on the assumption of some shocks, something like default or devaluation conditions. And on the equity side, right now our specific reserves for the equity is about 14 percent and in the scenario of the devaluation we have to bring it up to somewhere around 24, 25 percent, which we believe is something which we 82 can absorb. I have to also qualify this number because there are numerous scenarios we can think of or imagine in the case of shocks. So this is a ball park on some assumptions on the devaluation. And one more point on the railway reforms, the point by Mr. Zhu, this is also the sector IFC invested in the early 1990s in the privatized railways. And, in fact, we had two investments following the Bank's reform program. MR. SANDSTROM: Thank you very much. Finally, Myrna, with some clarification on lending volume. MS. ALEXANDER: Yes. I think we are being a little bit cautious, given the situation on Argentina. It is clear from FY01 that we were only able to deliver not even half of what we had anticipated. In terms of FY02, there is the case of possible slippage of loans that we have in the pipeline plus the possibility of moving to the high case. So it could be, if everything worked out perfectly well, that we could be as high as $2 billion, but it equally is likely that something will slip and we will end in the range, as I mentioned, 83 between $1 billion to $1.5 billion. It could be a little higher than that, but again that was simply some caution on our side, anticipating that there is some doubt on triggering of the high case but there is also some doubt in some of the operations that we had in the pipeline, particularly to mention one which is the private infrastructure financing, which is to be a guarantee mechanism with the private sector, a mobilizing private sector financing. With the current state of the markets, this is the kind of operation which may not move forward unfortunately. MR. SANDSTROM: Thank you very much. Any further comments, questions? Finn. MR. JONCK: Just one comment. When responding to the questions about balancing social policy and fiscal policy, I think we got the answer which is I think common that we cannot pursue better social policies before we have a fiscal order. I just want to make the point here that social policies is more than just the volume. I mean, it is also the question of the distribution and quality and 84 certain consideration to the needs to the poorer part of the population can be taken even within a shrinking budget for social policies. And I hope that will be taken account of. At least, that was my point in raising this. MR. SANDSTROM: We agree fully. Do you have anything else to say? That is straight-forward; okay. Any other comments? Pieter. MR. STEK: We don't have the figures for general government? MS. ALEXANDER: Yes, we do. The numbers that we had been working with, a little bit of background to explain, the latest program, medium-term program had a balanced budget for both provinces and the federal government by the year 2005. That was the working scenario that Argentina would be able to do a gradual convergence, growth picking up some of the revenues and a gradual process of an expenditure reduction converging on balance in 2005. Clearly, the markets have responded in saying we think that is too long and we are not going to finance the deficit in the intervening period. So the government is accelerating that process. 85 Now we don't quite know when they say zero deficit, what does that mean for the end of the year. But the original projections -- the starting point for 2001 was a federal government deficit minus 2.1 percent of GDP and a provincial deficit of 1 percent of GDP for an aggregate of 3.1 as the aggregate consolidated deficit for 2001. For 2002, it was a consolidated 2.4 deficit with 1.5 for the federal government, 0.9 for the provinces, for 2003 a minus 1.8 with 1.2 for the federal government and 0.6 for the provinces; in 2004 was a minus 1.2, the federal government 0.8, the provinces 0.4, and then both converging in 2005 at a balanced budget, if you want. Now, as I said, this is going to be considerably accelerated. What you note in there is that the federal government's deficit exceeds the provincial aggregate deficits by a factor of 2. There are lots of reasons, among which are the very heavy debt burden of the federal government in relative terms to the provinces, so that the expenditures and debt servicing are considerably higher at the federal level than they are at the provincial level. And the other thing is that the federal 86 government carries the burden of the national pension system which costs them about 1, 1-1/2 percent of GDP. So that is not excusing the federal government but still recognizing that there are differences in comparing the fiscal effort needed on both sides. MR. STEK: Sorry. I was going by the definition of general government as being central plus local government, plus local authorities. I didn't hear anything about municipalities. But on top of that, social funds, that is the definition of general government. Is there nothing outside the central government and the local authorities that also needs to be added up to get a full picture of the government? MS. ALEXANDER: Yes. Indeed, municipalities are not included here. They are financial statistics on the performance. The municipalities are not collected and aggregated nationally. So it is quite difficult to get a picture of where the municipalities are. We do know from spot data that is available that there is a growing problem of municipal deficits, depending upon the province, depending upon the situation in the province, depending upon, to a certain extent, how 87 the burden of adjustment is passed through in terms of transfers of revenues. The municipalities in Argentina receive a certain share from the provinces for their funding. So if the province has fiscal problems, they transfer that onto the municipalities. The good thing in aggregate is that the municipal spending is about 8 percent of the total, and so it is unlikely that it is a huge amount relative to what we have here at the federal and provincial level. On social funds, I must say social funds are not -- in the case of Argentina, on the deficit at the federal level, there are agencies which are off-line, if you want. One of them is PAMI which is the health insurance for the elderly, and has a deficit currently of about $400 million a year. There may be a few other agencies decentralized which are not included. Paul now tells me that PAMI will be in the budget. MR. SANDSTROM: That's it? [No response.] Thank you. If so, the loan is approved on the terms proposed. Mario, please. 88 MR. SOTO-PLATERO: Just to say that following Alex Shakow's orders, I am not going to speak at the end of the discussion. Thank you. MR. SANDSTROM: You take his instructions very well. Thank you. We will also circulate the introductory remarks, as we had promised. We will take another look at the wording of the Progress Report together with the authorities to make sure that it doesn't create problems when it is released. Let me try the concluding remarks. The Executive Directors welcomed the timely discussion of the Progress Report on the joint IBRD-IFC CAS for Argentina and its frank assessment of the country's situation. Directors welcomed the recent announcements by the Argentine authorities indicating their intentions to pursue further fiscal adjustment. Directors recognized that strong and decisive adjustment is fundamental for regaining market confidence as reflected in the recent market reaction to the government's latest measures and its agreements with the provinces. These measures are critical parts of a 89 virtuous circle, leading to restoration of growth, reduction in poverty, and lower vulnerability to external shocks. At the same time, however, Directors were concerned about the potential short-term impact of recent measures on poverty, income inequality and unemployment. They encouraged the government to protect essential social expenditures directed at the most vulnerable groups and to continue to pursue policies and programs which would preserve and enhance human capital. Directors were supportive of the proposed assistance program and believe that, despite the recent setbacks, the long-term goals and the strategy remain valid and appropriate, focusing on consolidating structural reforms, enhancing social development and improving public sector capacities. They emphasized the importance at this time of analytical work on poverty and sources of growth. They welcomed the Bank's focus on public sector reform and social sectors under proposed future lending and, in particular, welcomed the focus on strengthening the institutional and fiscal capacities of the provinces. They encouraged the extension of reform loans to more 90 provinces, including Buenos Aires. Directors particularly emphasized the importance of sound and strong implementation of the strategy. Directors indicated that lending triggers could be more specific and more transparent. Directors noted that risks remain significant and cautioned against over-optimism in the assessment of the macroeconomic situation. They agreed that changing circumstances required close monitoring and reporting back to the Board as appropriate. Directors commended the collaboration among IBRD, IFC and MIGA. They noted that IFC's portfolio in Argentina would require careful management and stressed the importance of the role that IFC would continue to play in helping the Argentine private sector sustain access to financing. Directors also stressed the importance of continued strong coordination among Argentina's development partners, including IMF and IDB. That's it? [No response.] All right. Thank you.
Группа Всемирного банка · Transcript
Transcript of Meeting of the Executive Directors of the IBRD, IDA, and IFC held on Thursday, July 19, 2001
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