Argentina - Economic Recovery Support Structural Adjustment Loan Project : Argentina - Economic Recovery Support Structure Adjustment Loan Project

Document of The World Bank FOR OFFICIAL USEONLY Report No.27271-AR INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT PROGRAMDOCUMENT FORA PROPOSEDLOAN INTHEAMOUNT OFUS$500MILLION TO THE ARGENTINE REPUBLIC FORAN ECONOMIC RECOVERY SUPPORT STRUCTURAL ADJUSTMENT LOAN November20,2003 Finance PrivateSector andInfrastructure Department Argentina, Chile, Paraguayand Uruguay Country ManagementUnit LatinAmerica and the CaribbeanRegion This document has a restricted distribution and may be usedby recipients only inthe performance of their official duties. I t s contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit: The ArgentinePeso EXCHANGERATE AR$2.85 =US$1 FISCALYEAR January 1-December 31 ABBREVIATIONS AND ACRONYMS ANPCyT - - National Agency for the Promotion o f Science and Technology AFIP - - Federal Administration of Public Revenues (Tax and Customs Authority) AFJP - - Private Pension FundAdministrators BCRA - Central Bank of Argentina BICE - Bank for Investmentand Trade CAS - - Country Assistance Strategy CFAA - - Country FinancialManagement Assessment CICyT - Inter-institutional Council for Science and Technology CNEA - - National Atomic Commission COFECyT = FederalCouncil for Science and Technology CONICET = Science andTechnology Research Council CPAR - Country Procurement Assessment Report CREARCyT = Promotionof Risk CapitalProgram ENAC - - National Accreditation Entity o f Spain FDI - Foreign Direct Investment FOGAPyME = Guarantee Fundfor SMEs FONCyT - National Fundfor Researchin Science and Technology FONTAR - - National Technology Fund FUNDES - Development ResearchFoundation(FundacidnPara el Desarrollo Sostenible en Ame'ricaLatina) Free Trade Agreement National Scienceand Technology Cabinet Gross Domestic Product InteramericanAccreditation Cooperation InternationalAccreditation Forum Inter-American Development Bank InternationalLaboratory Accreditation Cooperation Intellectual Property Institute National Institute for Agricultural Technology National Institutefor Industrial Technology Norms and Standards Institute Vice President Davidde Ferranti CountryDirector Axel van Trotsenburg Sector Director DannyLeipziger Sector Manager SusanGoldmark Sector Leader Juan Gaviria Task Manager MariluzCort6s I  FOROFFICIAL, USEONLY IMF International Monetary Fund LDP Letter o f Development Policy MECON Ministryo fEconomy MERCOSUR Common Market o f the South MRECIC Ministryo fForeignRelations OAA Argentine Accreditation Organism PACE Programto Support External Trade PEN National Executive Branch R&D Research and Technology S A L Structural Adjustment Loan SECAL Sector Adjustment Loan SETCyP Secretariat for Technology, Science and Innovation SME Small and MediumEnterprise SENASA National Service of Health and Agricultural Food Quality SGRs Mutual Guarantee Funds SSPyME Subsecretariat for SMEs SICyPyME Secretariat for Industry,Commerce and SMEs W T Unitso fTechnologicalLinkages VAT Value Added Tax This document has a restricteddistribution and may be usedby recipients only in the performance of their official duties. I t s contents may not be otherwise disclosed without W o r l d Bank authorization.   ARGENTINA PROGRAMDOCUMENT PROPOSEDECONOMICRECOVERY SUPPORTADJUSTMENT LOAN Table of Contents PageNo . I THESETTING . ..................................................................................................................... 1 A. Economic Context andRecent Developments.................................................................... 1 I1. FROMCRISIS TO STABILIZATIONAND REMAININGCHALLENGES ..........2 A. Growth andModernization inthe 1990s. and Failures............................. Achievements 2 B. C. Transition Challenges: Strengtheningthe InvestmentClimate for Sustainable Growth....47 Crisis, Stabilization andthe UnfinishedReformAgenda................................................... I11. THE GOVERNMENT PROGRAMFORECONOMICRECOVERY .................... 22 A. Improvingthe Business Environment............................................................................... 23 B. 24 C. Strengthening Policies and Programs for SMEs............................................................... Strengthening Export Development.................................................................................. 27 E. D. FutureReformAgenda to promote Competitiveness and Growth................................... Strengthening the Innovationandthe Standardsand Quality Control Systems...............26 30 I V. BANKASSISTANCE STRATEGY FOR ECONOMIC RECOVERY ..................... 34 A. 34 B. Bank Experience with AdjustmentLendinginArgentina................................................ BankAssistance Strategyfor Argentina........................................................................... 36 37 V .C THE . Coordination with Multilateral Institutions ...................................................................... PROPOSEDLOAN ................................................................................................... 37 A. Loan Objectives andDescription...................................................................................... . . 37 B. 38 D. Impact, Benefits andRisks............................................................................................... C. Fiduciary Arrangements.................................................................................................... 41 Commitments Underthe ProposedLoan.......................................................................... 42 ANNEX I Matrix of Policy Actions.............................................................. 44 ANNEX I1 Letter of Development Policy......................................................... 48 ANNEX I11 Status o f Bank Group Operations..................................................... 72 ANNEX IV 74 Argentina Financial Position inthe IMF ............................................. Statement of IFC Portfolio ......................................................................... ANNEX V 77 ANNEX VI 79 Argentina Selected Economic Indicators ............................................ FundRelationsNotice .................................................................. ANNEX VI11 Argentina at a Glance................................................................... ANNEX VI1 84 86 This operation was preparedby a team composed of: Mariluz Cortes (Team Leader). Jose L.Guasch (Regional Advisor Competition and Regulation). Reynaldo Pastor (LEGLA). Rafael Herz. Isabel Sanchez. Pilar Sanchez. Guillermo Rozenwurzel and Gabriel Bezchinsky. Assistance was provided by Mauricio Cifuentes. I11  ARGENTINA ECONOMIC RECOVERY SUPPORT STRUCTURAL ADJUSTMENT LOAN LOANAND PROGRAMSUMMARY Borrower: The Argentine Republic PovertyCategory: Not Applicable Amount: US$500.0 million Terms: Fixed-Spread Loan (FSL), U S dollar denominated, payable in 15 years, including 3 years grace period with commitment-linked repayment schedule and annuity principal repayment, at the standard variable interest rate for U S dollar FSL. Front-EndFee: 1 percent o f principal amount capitalized. CommitmentCharge: 0.85 percent o f undisbursed balance beginning 60 days after loan signing but not including the fourth anniversary o f such date, and standard charges o f 0.75 percent on undisbursed loan balances thereafter. Objective: The objective o f this proposed structural adjustment loan is to support Argentina's efforts to consolidate economic recovery, ensuring long term growth and increasing employment through the expansion o f domestic enterprises. This will be accomplished through the improvement o f the investment climate and the enhancement o f competitiveness and export potential o f existing and new enterprises through systematic productivity gains, quality improvementsand innovation. Description: The proposedloanwould be disbursedintwo tranches: A First Tranche would support: the creation o f a number o f government programs to: (i)improve the competitiveness environment for several industrial sectors; (ii) facilitate exports by reducing exchange controls and improving reimbursement o f taxes and duties to exporters; (iii) promote linkages between large and small and medium enterprises and among the latter to accelerate learning for exports and quality improvements; (iv) increase transparency in the selection o f judges; (v) reorient government efforts in science and technology towards helping producers to become more competitive in the local and external markets; and (vi) increase policy coordination among different government IV  agencies and levels o f government. A Second Tranche would support: (i) the implementation o f some o f the recently created programs, with specific targets in terms o f number o f enterprises assisted; (ii)measures to improve transparency in government actions and decisions; and (iii)enactment o f regulations to implementtwo approved laws: the Multi-modalTransport Law and the Science, Technology andInnovationLaw. Benefits: The Government o f Argentina faces the need to consolidate the incipient economic recovery and ensure long term growth and employment creation. This requires addressing pending structural reforms, as well as short and longer term policy actions to help ensure that enterprises, particularly small and medium enterprises, increase production with high value added, and improve their competitiveness and export potential. The proposed loan would help improve the competitiveness o f new and existing enterprises by supporting actions to: (i) improve the investment climate; (ii) better coordinate government policies and programs in support o f small and medium enterprises and export development; and (iii) focus Government science and technology programs on improving the quality and competitiveness o f Argentine products. The measures supported by the proposed loan are an initial step, and further reforms are needed to improve the investment climate, eliminate remaining anti-export bias, and rationalize policy interventions. Moreover, these reforms must be complemented by major reforms to improve human capital and skills o f the Argentine labor force. Risks: First, there is the risk that Argentina will not complete comprehensively, and in a timely manner, pending structural reforms, including the reform of the banking sector, the renegotiation of the public and private debt, and the renegotiation of contracts with the privatized public service andinfrastructureconcessions. The Government has taken some initial steps in trying to renegotiate its public debt and has announced its intention to address the pending structural problems. The Bank has linked future adjustment support loan to Argentina to progress inthese areas. Second, there is the risk that the Government may not go beyond the reforms supported by this operation, and thus fall short of a comprehensive reform agenda to improve competitiveness and the creation of new enterprises. To limit this risk, the Bank intends to maintain a continuous dialogue with the authorities and the private sector on the reform and growth agenda for private sector development. V  Third, there is the riskthat Argentinacouldreturnto a growth strategy based on import substitution, not giving enough emphasis to exports. Some of the measures supported by this operation are aimed at increasing export orientation and competitiveness. Early successes in this area may help generate more positive attitudes towards exports in the public sector and among producers. Fourth, there is the risk that the institutional changes needed to increase policy coherence among Government agencies at the federaland provinciallevelwill nottake place. Argentina's strong federal system can be an obstacle to greater policy coordination among different levels o f government. However, one of the top priorities o f this Government is to increase policy coherence and coordination. Finally,there is the riskthat Argentinacouldreturnto the past policies of strong government participation in the economy through public banks and corporations. This possibility is mitigated by the fact that the Government does not have the resources to take over these activities and publicly states that it only intends to intervene inthe regulatory area. FinancingPlan: Not Applicable Net PresentValue: Not Applicable ClosingDate: December 31,2004 ProjectIdentificationNo.: PE-P083982-LEN-BB VI   INTERNATIONALBANK FORRECONSTRUCTIONAND DEVELOPMENT PROGRAMDOCUMENT FOR A PROPOSEDECONOMICRECOVERY SUPPORTSTRUCTURAL ADJUSTMENT LOANTO THE REPUBLIC OF ARGENTINA 1. This Program Document describes a proposed structural adjustment loanto the Republic of Argentina for US$500 million to support Argentina's efforts to consolidate its economic recovery, ensuring long term growth and increasing employment. I.THESETTING A. ECONOMIC CONTEXTAND RECENTDEVELOPMENTS 2. The Argentine economy is emerging from the deepest recession in generations, with its GDP having fallen by 20 percent in the last four years and by 10.9 percent in 2002 alone. Per capita income at the end of 2002 stood at an estimatedUS$2,695, down from over US$8,000 in the 1997/98 period'. Poverty has increased to 55 percent with indigence levels affecting 26 percent o f the population or about 9 million. Unemployment, although below its peak, i s still high at about 21 percent.2 3. The culmination of this crisis i s associated with the collapse of the Convertibility Plan, which extracted an increasingly and finally unsustainable high social and economic cost.3 Compounding this was the declaration of default on Argentina's public debt, the ill-prepared devaluation, the asymmetric "pesification" of the financial system, the fall inreal terms of fixed earnings, the freezing in pesos of most tariffs, and growing uncertainty on the enforceability o f commercial contracts, all of which have had damaging effects on macroeconomic management, viability o fthe financial system, credibility of government action, andthe rule of law. 4. After an initial period of heightened economic, social, and political uncertainty, the Argentine economy displayed signs of bottoming out around the middle of 2002. Since then, indications of an incipient recovery based on improved consumer sentiment and import substitution have multiplied, with positive developments becoming clearer during the first half of 2003. These were reflected inthe trend of quarterly GDP, whichhad contracted since mid-2001, and declined by over 16 percent during the first quarter o f 2002 (comparedto the same period of the previous year), but improved thereafter on a seasonally adjusted quarter to quarter basis, leading to a 5.4 percent recovery inthe first quarter and 7.6 percent inthe second quarter of 2003 (compared to the same quarters o f 2002)4. Industrialproduction also showed an accelerating positive monthly trend since the second quarter of 2002, with year on year indicators signaling According to the Bank's Atlas methodology,per capitaGNI in2002 declinedto US $4,060 fromU S $8,030 in 1998. Excludingthe employment effects ofthe Government's Heads ofHouseholdSubsidyprogram. For an evaluationofthe causesofthe Argentine crisis pleasesee "Argentina; A RetrospectiveReview", distributedto the BoardinJuly 2002. Quarterly growth figures for 2002-2003 were -16.3 percent, -13.5 percent, -9.8 percent7-3.6 percent, 5.4 percent, 7.6 percentinthat order. 1  positive inter-annual growth starting in the fourth quarter o f 2002. By July 2003, industrial production was 16.6 percent higher than a year before, albeit from very low levels. 5. The transition Government that took office in early 2002, and the new Government o f Nestor Kirchner that took office in May 2003, have made important strides towards reversing some o f the negative impact o f the crisis under very difficult social and political conditions. The new administration is attempting to address the structural causes that led to the crisis as well as trying to mitigate its short term effects. Key to these achievements has beenthe control over the fiscal situation as well as the pursuit o f a prudent monetary policy. Cumulative inflation for the January to October 2003 period subsided to a cumulative 3.1 percent, and trade balances exhibited large surpluses. Fiscal performance improved further, fuelled by income tax and value added tax (VAT) collections, as well as by distortionary export and bank transaction taxes. Exchange controls have been further eased, and banking deposits liberalized. The Government launched a program for monetary unification, and by mid-November, 85 percent o f AR$7.7 billion o f federal and provincial quasi-monies had already been recovered. Between the beginning o f the year and mid-November 2003, the peso appreciated by 11 percent, and internationalreserves continued to buildup by US$3 billion, reaching about US$13.5 billion. 6. Argentina's output i s projected to recover 7 percent in 2003, favored by an improving fiscal situation (abstracting from debt service arrears) and monetary prudence. The significant output recovery during 2003 reflects the depth o f the output decline o f the last four years and the opportunities provided by the sharp devaluation of the currency. The economy is expected to continue growing at 4-5 percent in 2004, driven primarily by domestic sources o f aggregate demand. However, with reduced scope for a further impact from import substitution and domestic demand, sustaining the recovery beyond 2004 will require further accelerating the pace o f reform to strengthen export and. investment growth; consumption growth will follow as incomes and consumer confidence improve. 7. A broad and substantial agenda for structural reforms remains to be tackled; progress in these reforms i s crucial to strengthen investor and consumer confidence that will, inturn, ensure that the recent signs o f economic improvement can be sustained and accelerated during the medium term. Reforms in areas such as the financial sector and corporate restructuring, income distribution, tax collection, social security, public safety, reduction o f corruption, renegotiation o f public utilities' contracts, public sector management, reform in fiscal relations with the provinces, external debt restructuring, and strengthening o f the investment climate are important challenges for the new administration. 11. FROM CRISIS TO STABILIZATION AND REMAINING CHALLENGES A. GROWTHAND MODERNIZATION INTHE 1990s -ACHIEVEMENTSANDFAILURES 8. Under the Currency Board regime Argentina achieved fast economic growth. Growth resultedfrom one o f the most far reaching reform experiences inany emerging economy, which included trade liberalization, financial sector development along market lines, and infrastructure deregulation and privatization. As a result, there was a very rapid modernization o f the service sectors: financial and infrastructure services, and retail structures. As described below, though, 2  due to a combination o f external factors, pro-cyclicalfiscal policies and incomplete labor market andregulatory reforms, fast growthwas haltedandultimatelya major crisis ensued. 9. The years of "convertibility" (one to one exchange rate betweenthe Argentine peso and the U S dollar) saw an important increaseand improvement inproductivity (a 50 percent increase in manufacturing labor productivity), particularly in the tradeable sector, resulting from substantial capital investment and massive introduction of new technology. The exchange rate regime favored importedcapital goods, not only inthe privatizedpublic utility firms, but also in some sectors that were aiming at exporting value added goods basedon Argentina's rich natural resource endowment (petrochemicals, agroindustry, steel, aluminum, mining, pulp and paper) and which had improved their competitiveness by investing in "top-tier" machinery and technology. Yet total factor productivity on average did not show significant improvements and unemployment climbed to almost historical records near 18 percent in 1995, partially as a result of a rigid labor market structure that favored quantityadjustments over wage adjustments. 10. This newly acquired competitiveness stimulated an important growth of exports in the 1990s, although Argentina remained short of being an open economy with an export to GDP ratio of 15 percent (compared with about 20 percent for Chile). An average annual increase in exports of close to 9 percent (as opposedto only 2 percent inthe 1980s) was mainly ledby more traditional exports such as grains, nutritional oils, petrochemicals, steel, and pulp and paper; although other non traditional exports also increased such as mining, dairy products, and wine, transport material, and electrical material. This export growth was accompanied by a similarly fast increase inimports signaling increasedpurchasesof capital goods. 11. Against this background, the pace and scope of structural reforms did not suffice to ensure macroeconomic consistency and led to one of the worst default-devaluation episodes in recent history. Pro-cyclical fiscal policies - particularly in the provinces - and an overvalued exchange rate led to a rising debt-GDP ratio which eventually could not be sustained inthe face of external shocks (the steep rise inrisk aversion following the 1998 Russian crisis, the 1999 real devaluation and the 2000-01 dollar appreciation); and domestic shocks (institutional disruption in2001-02: interference withcentralbank autonomy, anddestabilizationoftwo presidents). 12. A fiscal adjustment in 2000-01, aimed to reverse the explosive debt-GDP ratio trend without addressing the unsustainable convertibility regime, was too little and at the end futile. Deflationary adjustment - which ultimately could have eliminated the exchange rate misalignment - was slowed down by slow nominal wage disinflation, contract regulations inthe service sectors that peggedtariffs to U S dollar inflation, and a lack o f political support inside and outside the ruling coalition to undergo the needed fiscal adjustment, while country risk premia were spiraling up andcapital markets driedup. 13. Many of the key convertibility institutions were severely exposed to default and devaluation risks - specially banks and public services and infrastructure. The two main weaknesses of an otherwise healthy financial sector - zero weight provisioning for public debt and no exchange rate risk prudential regulations - became evident as default hit sovereign debt holdings (around 30 percent of bank assets at the end of 2001) and the (at the peak) 300 percent devaluation impaired the banks' ability to collect domestic dollar loans. 3  14. Regulation o f public service and infrastructure concessions was established during the 1990s, but with the exception o f energy and telecommunications, not sufficiently developed. Dollarization o f tariffs impliedthat, inthe event of a devaluation, users would find it difficult to absorb the increase intariffs. While most private operators achieved significant efficiency gains, few o fthese gains were shared withusers. 15. Deregulation was neither complete nor, in many cases, well designed or implemented. The small and medium enterprise sector remained exposed to lengthy and expensive entry and exit procedures, costly tax and regulatory transactions, information failures and limited and/or costly access to finance and export markets. Despite efforts, labor market reforms and labor flexibility remained limited. Training programs remain government and supply driven, resulting in low effectiveness. As a result, the unemployment rate remained high, rising to about 18 percent in 1995, and as o f 2003 it was hovering around 17 percent. B. CRISIS, STABILIZATIONAND THE UNFINISHEDREFORM AGENDA 16. Crisis. The collapse in economic activity started in2001. The loss o f credibility inthe Currency Board prompted massive capital flight (around US$20 billion o f deposits left banks, which put enormous pressure on the banking system and its ability to finance the government), domestic illiquidity and spiraling country risk premia. The explosive debt dynamics and the fixed exchange rate culminated with default and devaluation. The Government opted for de- dollarizing the economy voiding dollar contracts and declaring asymmetric "pesification" o f bank's assets and liabilities. The freeze o f demand deposits in December 2001 (corralito) was followed inearly 2002 by the involuntary reprogramming o ftime deposits (corraldn). While the alternative to these schemes may have been the collapse o f many banks - with depositor losses beingeven greater -the costs o f exitingthe scheme was to be entirelycoveredbythe State. The Government also froze public service and infrastructure tariffs, wages o f public sector employees and pensions. It ordered the indexation o f mortgage loans to wages, and suspended mortgage and loan executions. These measures have induced substantial wealth transfers that not only distort the incentive structure and impair market discipline, but also impose a huge contingency liability by leading affected parties to initiate claims. As a result o f arrears, new debt, and the peso depreciation, at the end o f 2003 the public debt-GDP ratio i s projected to reach around 150 percent. 17. Stabilization. Despite the sharp drop in output, the transitional Government that took office in early 2002 managed to pursue a successful stabilization strategy and improve the primaryfiscal surplus, but fundamental structural reforms were left for the next government. On the revenue side, stabilization was possible partly due to inflation and the introduction of extraordinary and distortionary taxes - bank transactions tax and export taxes. O n the expenditure side, tight control on nominal expenses also helped. The exchange rate misalignment - aggravated by the debt overhang and overall uncertainty - was eliminated without igniting persistent high inflation. The credit crunch, recession, tight public expenditure control and prudent monetary policy (sterilized rediscount credit, sale o f reserves) aided the stabilization. The first signs of economic recovery emerged in mid-2002. The recovery in the second half o f 2002 was driven by import substitution activities - imports contracted almost 60 4  percent - and to a lesser extent higher income of exporters. Still, GDP fell about 11percent in 2002. 18. The overshooting of the dollar, stabilization achievements, and the growing perception that a new systemic banking crisis could be avoided, fed the demand for domestic financial assets. With free time deposits growing and demand deposits at or close to transactional requirements, the transition Government was able to undo the corralito and virtually eliminate the corraldn. 19. Following over a year o f negotiations, the transition Government reached a transitional agreement with the International Monetary Fund (IMF) - until August, 2003. This provided critical breathing space for the new elected Government, which took office on May 25,2003 ina relatively more calm macroeconomic environment. It also ensured that the 2003 budget embeddedtransitional fiscal requirementsnegotiated with the IMF. InSeptember 2003, the IMF approved a new 36 month Stand-By arrangement5that centers on fiscal, monetary and financial policies. It envisages the following: (i) achievement of a primary fiscal surplus target of 3.0 percent of GDP for 2004 (2.4 percent for the national Government and 0.6 percent for the provinces); (ii)monetary expansion in line with nominal GDP growth through end-2004 - towards the end o f 2004, the Government plans to shift to an inflation-targets monetary regime; and (iii)various fiscal reforms including: a new revenue-sharing agreement between the provinces and the nation, broadening the VAT tax base, strengthening tax administration, and progress in bank restructuring (including settling of bank compensations originated in asymmetric "pesification", individualbankaudits and acceptable individualplans to comply with prudential regulations). 20. Social Impact of the Crisis. The social impact of the crisis has been devastating. During 2002, poverty trends worsened dramatically. The share of population considered poor grew by roughly 20 percentage points while the number of extreme poor nearly doubled. The economic crisis has had a strong negative impact on the access and use of education and health services, andthere i s growing evidence of the deterioration inservice deliveryandkey indicators of well-being. Many of the social problems have existed before inArgentina. What i s different i s that events in 2002 made the social situation even more difficult for the majority of the population and the need for action has become more urgent. Discussions and reform proposals to correct the underlying problems have been ongoing for several years without reaching a conclusion as a result of specific interests involved, insufficient political support and lack o f social consensus. The Government now faces a particularly difficult challenge o f increasing demands for social assistance inthe context of falling fiscal resources and limited administrative capabilities to innovate and coordinate responses. 21. Recognizing the seriousness of the social situation, the Government moved decisively to expand key safety net programs, including the Heads of Household Program, prioritizing spending on them and consolidating social programs around a smaller number of key initiatives. In addition, the recent creation of the National Coordination Council for Social Policies constitutes an important step inthe direction of improvingthe effectiveness o f social policies as it allows for better coordination among the various actors at the national level and between For the equivalent of SDR 8,981 million(equivalentto about US$12.5 billion). 5  different jurisdictions. Nevertheless, Argentina will only be able to properly address the social needs o f its population in the context o f renewed economic growth and increased employment creation. 22. The Unfinished Reform Agenda. With fundamental structural reforms still to be addressed, both investors and consumers still face significant uncertainty and very limited access to credit. In the absence of normalization of relations with the international financial community, which would require both a debt restructuring and a sustainable fiscal framework, the reestablishment of a functioning financial system, corporate restructuring, eradicating corruption, and renewed credibility to public institutions, the ongoing economic recovery i s unlikely to translate into sustained economic growth. 23. Reform of the banking sector. The Argentine banking system has been significantly weakened first by the massive withdrawal o f deposits in 2001, the loss o f confidence resulting from the partial freeze o f bank accounts, the forced conversion o f dollar deposits, and associated policy decisions. With over 50 percent o f bank assets currently held inthe form o f government bonds, the future viability o f the banking system depends, among other factors, on the outcome o f the public debt workout, and valuation of such bonds, and private banks' commitment to recapitalize their institutions. Depositors, as well as owners o f assets, financial and non- financial, have suffered significant losses, and economic dislocations with the imposition o f restrictions on access to banking deposits. Although private bank deposits rose (approximately 10 percent in inflation-adjusted terms during the first half o f 2003) when the restrictions were liberalized, the financial intermediation process has been severely disrupted with the stock o f credit declining 40 percent in real terms during 2002 alone and a further 12 percent in the first half o f 2003. Banks continue to suffer operational losses and remain technically insolvent - due to the steep rise in non-performing loans and loss in value o f government assets held. The weakening o f the bankingsystem andthe continuous decline incredit (despite a small increase in October 2003) associated with significant contraction o f investment are limiting factors to a sustained economic recovery o f domestic demand. 24. Renegotiation of the public and private external debt. The Government has defaulted on various domestic and most international obligations. Consequently, Argentina has no access to the international financial markets. The authorities have begun the long process o f reaching out to international creditors and presented a proposal for debt restructuring in late September 2003, during the Annual Meetings. The proposal involves a write-down o f 75 percent o f the principal and the waiving o f interest payments not made since the December 2001 default. If accepted, this would reduce outstanding public debt from US$179 billion to around US$lOS billion. The process o f debt renegotiation will be complex and arduous, and some creditors have initiated legal action to attach Argentine assets abroad. Inthe process o f "pesification", massive wealth transfers have occurred from creditors to debtors and, in particular, from the state to debtors. As a result o f the compensation to banks and depositors the state has already issued sizable amounts o f new debt (about US$20 billion in2002-03), increasing the difficulties for the future servicing o fdebt indefault. 25. Renegotiation of contracts with the privatized public service and infrastructure concession operators. The freezing o f public service and infrastructure concession tariffs i s a 6  key constraint to the viability o f the services and the regulatory frameworks. Without a credible business plan, service providers face difficulties in planning to cover operations and maintenance, and cannot service their debts. While there are claims that a number o f the operators did not comply with contract stipulated obligations -the Government raises this as an issue to be addressed within the context o f renegotiation o f contracts -- care should be exercised to distinguish non-compliance as a result o f the freeze o f the tariffs versus non-compliance prior to the devaluation and freezing o f tariffs. The risk i s not just interruption o f service -- with a negative impact on production -- but also de facto re-nationalization o f various services (if private operators abandon the provision o f the service), which may be unsustainable fiscally, will send a strong negative signal to domestic and international investors and will further cause deterioration o f the investment climate. The sharp contraction inreal income, particularly o f the poor, has had negative effects on their access to basic infrastructure services. c. TRANSITION CHALLENGES: STRENGTHENINGTHE INVESTMENT CLIMATE FOR SUSTAINABLE GROWTH 26. The most significant change in the economic outlook after the crisis has been the improvement in the relative price o f tradable goods brought about by the peso devaluation, the beginning o f a process to increase transparency and efficiency to the judicial process, improvements inpublic safety, and a commitment to eradicate corruption. As a result, increases in consumption and import substitution are becoming a main source of production recovery. According to a study6carried out in the first half o f 2002, import substitution "explained" an estimated 40 percent o f the fall in total imports, which had experienced a drop o f over 70 percent. Export performance has begun to react to the change inrelative prices and the external competitiveness o f several productive sectors, including many without previous export background, has improved dramatically7. Another positive development has been the gradual normalization o f intra and inter-industry linkages between firms, including payment conditions, the incipient comeback o f commercial credit, the adaptation o f productive processes to the availability o f domestic inputs, and the reemergence and development o f local suppliers. 27. Nevertheless, the current recovery has still to surmount important challenges to consolidate and become sustainable: First, though the system's liquidity grew substantially, bank credit and other jnancing mechanisms remain virtually nonexistent, thus imposing a severe constraint to any business expansion. Even without taking into account the consequences o f "pesification", outstanding bank credit to the private sector suffered a dramatic contraction: it went from 24 percent o f GDP before the crisis to 7 percent o f GDP at present (even with a small increase inOctober 2003). 0 Second, the renegotiation of public service and inf?astructure concessions needs to be conducted in a manner that isperceived asfair and transparent with specijk milestones for each of the next 12 months. Further delays inreaching agreement on long-term tariff CEP ("Centro de Estudios de la Produccibn", Ministry o fProduction). Infact, the "Export Profitability Index" estimatedby CEP, with 1993= 100 as the baseyear,jumped ftom 95 inthe last quarter of 2001 to 145 inthe samequarter of 2002. 7  trajectories will harm the viability o f the concessions and chances for the operators to renew investment in these sectors even further, with adverse consequences on the maintenance and future expansion o f economic infrastructure and, therefore, on systemic competitiveness. 0 Third, Argentina has not received the inflow o f foreign direct investment (FDI) that normally follows a maxi-devaluation, as multinationals take advantage o f the tremendous change in relative prices. The main reason for the dearth o f FDI in Argentina are investors' perceptions that Argentine has yet to return to a path o f sustainable growth; the slow progress inaddressing the crisis inthe financial sector, as a result o f the devaluation; and the government's violation o f property rights that removed critical incentives for foreigners to invest inArgentina. 0 Finally, recovery so far is linked to the high level of idle installed capacity following several years of recession. Once that idle capacity is utilized, it will become increasingly difficult to maintain growth, unless investment, fueled at this stage mostly byincreases indomestic savings, becomes a reality. 28. There is, therefore, a risk that firms that enter or expand under current market conditions, despite doing well initially, will be unable to compete in the future. Such a situation could lead to an unsustainable short lived export (and import substitution) boom followed by intense pressure for protection, as the exchange rate advantage subsides and firms drop out o f export market or find it difficult to compete with cheaper imports. 29. To avoid such a scenario requires short and longer term policy actions to help ensure: (i) greater expansion in domestic enterprise and employment uptake in the short run; (ii) that enterprises increase production with highvalue added; and (iii) that new and existing firms can remain competitive by enhancing their competitiveness through systematic productivity gains, improving their production processes, reducing costs and improving quality through investing in innovation andtechnology. 30. The rest o f this section describes constraints in areas identified in the Bank's "Notes o f Economic Policy for Argentina" (May 2003) as having the greatest impact to support the takeoff of the Argentine economy'. These are: (i) investment climate and business environment; (ii) export development and financial instruments for exports; (iii) policies for SME assistance and development; and (iv) innovation, standards and quality control systems. C1. IssuesAffectingthe InvestmentClimate 31. Argentina's business environment suffers from a high degree o f institutional rigidities, which partly explains why nearly one third o f economic activity i s performed in the informal sector and only half o f the labor force is registered with the social security. Registration and creation o f a legal entity i s a costly and time-consuming process. Tax and fees procedures are cumbersome and compliance i s complicated by lack o f coordination across the different levels o f Argentina -Policy Notes, Sec M 2003 -0301, datedJune24,2003 8  jurisdiction -- federal, provincial and municipal. Other constraints such as lack o f access to credit; judicial insecurity; limited transparency in government actions and decisions, and high transport and logistic costs, make doing business costly and difficult. These constraints increase the risks faced by investors, particularly foreign investors who tend to be less knowledgeable o f how to overcome redtape. 32. Cumbersome entry and exit procedures for entrepreneurs: The high level o f un- employment and the destruction o f formal jobs during the crisis have resulted ina large swelling in the pool o f people who are entrants or potential entrants into entrepreneurial activity. Unfortunately, current practices, including long, difficult and expensive registration processes, strongly discourage these new entrepreneurs from formally registering their new business. In 2000, for example, a study by FUNDES (Fundacidn Para el Desarrollo Sostenible en Ame`rica Latina) and the Inter-American Development Bank (IDB) estimated that to get all registrations, licenses and permits needed to legally operate a business took between 130-150 days in Argentina, well above estimates for Chile, Colombia or Uruguay. The issue is not only the length o f time but also the high cost o f the procedures in financial terms. Since most o f these costs are fixed (do not vary by firm size) their importance is much higher for smaller firms. A recent study o f small and medium enterprises (SMEs) carried out by the World Bank in 2002 found that the costs o f registration were 72 percent o f monthly valued added for a firm o f 2-5 employees, for example. 33. A result o f the highcosts of entry and doing business is that there are strong incentives for new firms to operate informally. In fact, informality has been growing in recent years particularly innew smaller firms. Without rapid reform o f these processes, along with access to ancillary programs encouraging formalization, there i s a strong possibility that Argentina will face increasing informality o f its economy inthe future. 34. Lack of judicial security: Lack o f an efficient, honest and rapid court system i s a serious problem in Argentina. The effects o f judicial uncertainty are pervasive across the productive sector because it undermines the utility and security o f contracts, a fundamental tool o f commerce. A 1999 survey o f nearly 600 SMEs across Argentina found that nearly 50 percent o f the respondents said that judicial uncertainty was seriously affecting their ability to do business'. The problem was particularly manifest in difficulties in contract enforcement, including high costs and the long time needed to resolve conflicts incourts. This i s an institutional issue which is unlikely to be resolved inthe short term. 35. Limited Transparency of Government Actions and Decisions. Activities by the executive branch o f government are sheltered from public scrutiny by a lack o f access to information by Argentine citizens. That reduces accountability and facilitates abuses. Some evidence are the multiple cases and legal suits on alleged corruption grounds against former government officials from each new administration duringthe last decade. Such an environment where the executive branch i s not subject to public scrutiny is conducive to abuses, hampers private investors' confidence and weakens property rights. This, in turn, increases risk premia and worsens the business environment and investment climate. FUNDES(1999). 9  36. Limited access to credit. Bank credit inArgentina is both scarce and expensive. Banks lend mostly through current account overdrafts and charge interest rates above 30 percent for short-term peso loans. This situation i s likely to persist untila solution is found for the problems o f the banking sector. In the meantime, enterprises are finding non-traditional ways to obtain financing. The most common i s through the issuing o f trust funds to obtain funding from the capital markets. These trusts, backed by receivables, were initially used by exporting agro- industries, but are now being used by other enterprises including concessionaries o f public services. 37. Labor market rigidities. The most important institutional obstacles and constraints hampering the efficient functioning o f the labor market include the following: (i)a highly centralized collective bargaining system that inhibits individual firms from adapting their contractual arrangements to geographical and sub-sector or firm specific conditions, and indoing so hampers employment creation; while the last labor legislation reform provided avenues for firm level negotiations, the process and clearances embedded in the legislation presents some obstacles; (ii)the practice of ultractivity that allows expired collective bargaining agreements to continue in force, even after the agreed period has expired, as long as a new one has not been signed; while that clause was eliminated for future agreements in the last reform o f the labor legislation, there are still a large number of "ultractive" agreements that need to be renegotiated; (iii) ergo-ommesclausethatextendsagreementssignedbyacentraluniontoallfirmsand the workers inthe sectors, regardless o f whether or not they were a signatory party; (iv) a significant level o f non-wage labor costs that increase labor cost by over 30 percent, and by even more when measured in terms of labor cost efficiency per unit time; (v) an expensive severance payments system which is riddled with legal uncertainties that increases cost significantly (doubled its costs for the crisis period) and which coexists with an ineffective unemployment insurance scheme that, all together, induces a 7 percent to 9 percent increase in labor costs; (vi) a broad interpretation o f dismissal without cause which includes economic and productivity reasons, with expensive compensation attached to those dismissals; and (vii) restrictions on contractual forms. 3 8. Infrastructure constraints. A favorable business environment for infrastructure services is a key element o f sustainable growth and the investment climate in general. Although Argentina undertook one o f the most comprehensive reform and privatization programs in infrastructure, logistic costs remain one o f the highest inthe region. The transport sector remains a constraint to economic expansion. There are very limited numbers o f multi-modal services or operators. The offer o f freight transport services remains highly fragmented with limited high quality and specialized providers. A key problem i s that there i s no integrated transport policy making and planning due to the failure to implement the Multi-modality Law and the absence o f an autonomous regulatory body to oversee sector developments and concessions and tariffs according to contracts. To a large extent, current problems are due to the uncorrectedpolicies of thepast that gave very limitedattentionto network andinter-modal competitionissues. 39. In the case o f water, the existence o f multiple regional regulators and the lack o f coordination and learning from the earlier concessions, has led to costly and often inefficient decisions. In particular, the legal and institutional framework to effectively manage water resources i s among the weakest in the region. The current problems in energy are particularly difficult. Since the Emergency Law o f January 6, 2002, wholesale and retail o f public services 10  concessions tariffs have been pesified and frozen. As a result, investments needed to maintain production levels have not taken place. A lack o f supply problem, and thus energy shortages, can be envisaged inthe mediumterm that could hamper the economic recovery. C2. Issues Affecting a RenewedExport-Led Growth 40. The sharp devaluation o f the Argentine peso creates a competitive environment for exports that i s a necessary but not sufficient condition for sustained export-led growth. The real devaluation experienced inDecember 2001 did not, initially, have the expected effect on exports. Exports in 2002 were US$25.3 billion, 5 percent less than in 2001, with industrial exports dropping by 8.5 percent, and imports diminishingdramatically to less than half o f their level in 2001, (totaling slightly less than US$9 billion). As a result, the yearly trade surplus reached US$16.4 billion in 2002, the highest in the country's history. Export performance improved in 2003. Preliminary data indicates that inthe eight months to August 2003, the U S dollar value o f primaryproduct exports, which are mainly agricultural, increased by 28 percent; agro-industrial exports increased by 24 percent and exports o f fuel and energy increased by 18 percent. However, inthat period, the value o f manufacturing exports decreased by 3 percent. 41. The main factors that have limited a greater export response to the devaluation include the anti-export bias o f some o f the policies implemented during the crisis, limited financial instruments for export-led growth, increased imported input prices, limited export supply response, fragmented sector production, limiteduse of internationally required quality norms and standards, dispersed and incoherent institutional arrangements for export promotion, and limited export market access. Another factor is the MERCOSUR context since Brazil i s growing very slowly and Uruguay and Paraguay have experienced negative growth. 42. Remaining anti-export bias. An export-led growth process will require the elimination o f the remaining anti-export bias resulting from specific export-related taxes (which range anywhere from 5 percent for industrial goods to up to 25 percent for the main exportable agricultural products) In addition, the Government has implemented slow and cumbersome procedures for duty drawback, as well as for returningthe VAT on imported inputs. All o f these are argued to be necessary within the fiscal efforts to achieve a surplus. However, rather than a distorted tax and revenue system that discriminates against exports, there is a need for a workabletax andtax collection regime. 43. Limited financial instrumentsfor export-led growth. The expected export response after the devaluation has been hampered by lack o f export financing. In the absence of a functioning financial system, even enterprises with export orders find it difficult to get trade financing. To cover part o f the export credit needs, in the last 18 months, the International Finance Corporation (IFC) committed US$180 million inthree trade finance facilities (including US$90m for syndications) for three leading Argentine agro-exporters, respectively. The first o f these transactions took place inJune 2002 and was the IFC's first investment inthe country since the onset o f its economic crisis. SMEs, which are playing an important role in activating manufacturing exports, have extremely limited access to financing for exports, especially for post-shipment schemes needed to allow for a permanent export strategy. Many o f these enterprises finance their export activities through their own cash flow derived from internal sales 11  that are paid on an immediate cash basis. This is clearly inefficient and not sustainable. There is an urgent need to facilitate access to credit to firms with export orders or potential. 44. Pre- and post-shipment financing o f exports is the fastest way to reactivate some type o f financial intermediation, be it through the banking sector or instruments in the capital markets. Pre-export financing i s a self liquidating transaction with relatively low risk. However, untilthe overall "default" crisis is resolved, international trade financing lines will not be available to Argentine companies. On the other hand, credit from the formal banking sector will take some time to be established even to finance export activities. Thus, creative new ways for export financing schemes are emerging in Argentina. Some had already the legal and institutional foundations before the current crisis, but are seeing a renewed interest because o f the crisis conditions. Other schemes are the result of the crisis itself. The legal framework for such instruments as factoring, leasing, warrants, and some aspects o f securitization exists and i s up-to- date with respect to international practice. While incipient and still not in high demand, export credit insurance is available by the initially publicly promoted CASCE (Compaiiia Argentina de Seguros a la Exportacidn), as well as more recent fully private schemes. 45. Export-oriented trust funds are becoming an interesting investment possibility for institutional and even personal investors and, at the same time, provide credit to exporting companies. These trust funds are o f interest for investors because: (i) they work outside the bank's balance sheet; (ii)investments are directly linked to the export sector and often guaranteed with the exported goods; and (iii) the funds are limited in time and provide short- term, attractive, and relatively secure, investment opportunities. From the perspective o f the companies, these trust funds provide immediate and fast pre- and even in some cases post- shipment financing. Several banks are acting already as fund administrators for funds provided by the BICE (Banco para la Inversidn y el Comercio Exterior). Other commercial banks are actively pursuing to establish their own trust funds either linked to a product (rice, nutritional oils) or just as an open export finance instrument. The debt instruments emitted by the funds, when they fulfill the required regulations, become tradable in the secondary market and can constitute an attractive investment for AFJPs (private pension funds) that are the main institutional investors inArgentina. 46. Dispersed and uncoordinated institutional arrangements for export promotion. Argentina has a number o f schemes and instruments for both export promotion and export financing that are largely uncoordinated and ineffective. At the federal level, there is lack o f coordination among the many government dependencies that are involved inthe design o f export policies or strategies, as well as those that undertake export promotion activities. There are overlapping, duplicating and dispersed activities comprising, among others, several areas o f the Ministry o f Foreign Relations (MRECIC), several areas within the Ministry of Economy and Production (MECON), the Fundacidn Export.Ar, BICE, as well as some other sector ministries. Inaddition, several Provinces have developed their own export promotion schemes, in addition to, or many times ignoring, the Regional Development Agencies. While initially created to implement SME development programs with participation o f the regional Chambers o f Commerce and Industry, these agencies could become agents o f export development ifthey were to implement regional export-based strategies and create channels o f coordination between the Provinces and the Federal Government. To make these programs more effective requires more 12  coordination betweenthe public and the private sector on the one hand, and between the federal and the provincial levels on the other. In addition, there is a need for a rethinking of responsibilities and institutional strengthening. 47. Limited export-market access. At least two important challenges remain with respect to a strategic export market access by Argentina. MERCOSUR has ceasedto be the most important export market with around 18 percent o f exports directed towards that market (its importance i s greater for smaller exporters). However, it has become clear over the last decade that without a more coordinated effort with Brazil, especially in terms o f institutionalized mechanisms for the resolution of trade conflicts and exchange rate and macroeconomic policies, both countries will face cyclical downturns, as demonstrated by the sharp drop in exports to Brazil after the devaluation o f the Brazilian Real in 1999 and again in2002. 48. A second challenge is related to free trade negotiations with the USA and the European Union. These negotiations represent an important opportunity in terms of increased market access for Argentina, but also a challenge interms of negotiation strategy. Therefore, free trade agreements will require a prepared public sector, not only interms o f individual negotiators, but also in terms o f institutional coordination within different ministries. Currently, the MRECIC leads international free trade negotiations with inputsfrom the MECON. C3. Constraintsto SmallandMediumEnterprise development 49. SMEs are critical to the Argentine economy both from a growtWefficiency and equity standpoint. They account for about 70 percent o f employment and 61 percent o f production. They also account for 13 percent o f total manufactured exports within three sectors - agro- industry, plastics and metallurgy (capital goods) - being the most relevant. Foods (26 percent), chemical products (20 percent) and metallurgy - capital goods (18 percent) are the most representative export sectors o f SMEs. Most exporting SMEs actually supply both, the domestic market and direct some o f their productionto export markets, mainly MERCOSUR. 50. SMEs cannot realize their potential, partly because o f their own deficiencies, but also because o f constraints they face due to government policies andthe problems currently affecting economic activity. Hence, the current predicament o f SMEs i s also a challenge. Once those constraints are properly tackled, one can expect SMEs to substantially contribute to economic growth and employment. Moreover, they can constitute the basis for the reconstruction o f a network o f national dynamic firms and entrepreneurs. The evidence in many developing economies suggests that lack o f a national entrepreneurial basis can be a source o f macroeconomic and even institutional instability, and also that its presence is crucial for taking full advantage of the benefits derived from FDI and other aspects of the current process o f globalization. Some o f the longstanding constraints to the development o f SMEs in Argentina are discussed below. 5 1. Productivity gap between largejirms and SMEs. Throughout the convertibility period, economic growth was unevenly distributed between regions, sectors, and economic agents, and the productivity gap across the macroeconomic cycle between SMEs and large firms remained significant. Among manufacturing firms, labor productivity for larger firms was two to four 13  times higher than that o f smaller firms, when size was measured both by number o f workers or gross production value. The same dramatic difference by size o f firm occurs interms o f capital productivity. That gap persists today, signaling unrealized opportunities o f SMEs as a potential source o f dynamism, flexibility and growth diffusion as well as employment. 52. Limited access to market information. A common problem for SMEs, i s the difficulty in accessing information that would allow them the opportunity to identify and capitalize on opportunities to expand their market presence. This is true for example in the case o f governmental (local, provincial or national) bidding process where SMEs frequently encounter difficulties in getting information on upcoming procurement processes in which they could participate. The absence o f linkages between SMEs and large firms limit their access to knowledge o f market demands interms o f quality and standards. In some cases, large firms are already beginning to create these linkages, assuming many o f the up-front costs in helping their SME suppliers or potential suppliers. However, this does not appear to be widespread and the Government has decided to implement some targeted interventions to lower the search costs to firms. One angle currently being pursued by the Secretariat for Small and Medium Enterprises (SSPyME) is to create easily accessible databases with certified companies along particular product lines to facilitate linkages with large firms. Expanding this database across more industries and ensuring inclusion o f firms from all provinces and encouraging large and medium enterprises to register their upcoming procurement needs inthe database would be a first step. 53. Lack of sufficient production volumefor exports. One problem facing SMEs relates to the production volumes required to be competitive inexport markets. Single enterprises cannot, in most cases, respond to the requirements of the volumes required by their clients. This limitation can be overcome through the creation o f linkages or associative schemes and consortia among SMEs and among large enterprises and their client SMEs, to enable them to face and overcome the challenges imposed by the requirements o f export markets. Since in Argentina there i s no strong tradition o f cooperation among producers, the Government has adopted policies and programs to promote and assist the creation o f export groups. 54. Limited access to credit. SMEs received, on average, about 9.8 percent o f bank credit during 1998-2000, but they contributed to about 61 percent o f total value added. SMEs face restrictions to get finance. Most SMEs, when they can get formal credit at all, get very expensive short-term loans via credit cards or from current account overdrafts. In 1999, about 42 percent o f SMEs with access to the banking system were using overdrafts in their current account. Moreover, a survey by the Industrial Producer's Association in 2000, found that about 50 percent o f industrial SMEs were resorting to overdrafts, paying at that time, on average, an interest rate o f 2.7 percent per month or 38 percent annually, while prices were stable. On top o f that, SMEs have been much more affected than larger firms by the severe credit contraction causedby the banking crisis in2001. 55. Information problems limit the access o f SMEs to bank credit. Many o f the smallest firms do not have audited financial statements that can be used by banks. Moreover, they maintain parallel accounting books to circumvent government regulations and tax requirements, renderingaudited financial statements useless to assess creditworthiness. Lack o f detailed micro data on small businesses i s likely a major reason why banks have not developed large SME 14  portfolios, as these firms often cannot credibly convey their risk quality to banks without offering collateral. 56. SMEs in Argentina are resorting to non-traditional financing mechanisms. Capital market oriented instruments are appearing as part o f new intermediation schemes circumventing the formal banking sector. Examples include short-term value debt instruments, which are up to one year financing instruments for SMEs traded inthe stock exchange as securitizedinstruments. More recently, plans exist to create the secondary market for post-dated checks. These instruments, usedby larger companies to pay SMEs for inputsthat are yet to be delivered, allow for pre-shipment financing through the short-term capital market. Also, withinproductive chains larger enterprises are providing financing and administrative support to key suppliers and clients o f small size. 57. Two relatively new instruments targeted towards financing exports of SMEs either as direct or as indirect exporters include the Mutual or Reciprocal Guarantee Entities (Sociedades de Garantia Reciproca SGR) and export-oriented trust funds. The SGRs are collateral providers for participating SMEs (socio participe) and include the provision o f financial guarantees. Investors see inthese guarantee providers an investment option that entails fiscal benefits. Also, large enterprises find it useful to create their own SGRs to facilitate access to credit to their SME suppliers. While many of these mutual guarantee funds are within vertically integrated companies, some open funds exist and might gain further importance under the current strain in the financial market. 58. Constraintsto the acquisition of knowledge. The ability to incorporate lessons and new ideas i s a key factor to remain competitive in the new economic environment. Most SMEs in Argentina do not use training and technical assistance because services available are usually directed towards large firms and are too expensive for them. Moreover, the nature o f knowledge of markets, technologies, and supplies implies that such knowledge would still require substantial effort on the part o f the firm to assimilate it and SMEs lack, in many instances, the capacity to use the knowledge efficiently. Again, linkages between larger and smaller enterprises, as well as associative schemes among SMEs might help to promote the access to knowledge andtechnology requiredto become and stay competitive ina global environment. 59. Lack of coordination among programs to support SMEs. Argentina has a myriad o f specially designed programs to offer training and technical assistance, human resource management, technological and export capacities, as well as financial support to SMEs. According to the SSPyME," Argentina has approximately 300 programs and lines o f credit to support SMEs. Despite the growth of technical assistance and training programs inthe 1990s, a small number o f SMEs use any of the non-financial programs. The existing evidence reveals that SMEs have low access or low motivation to use such services. For example, a recent study "shows that only 38 percent of SMEs received consulting services in 1997-1998 (public institutions, including municipalities, provided 16 percent of all consulting services). loCreated in 1997 under the Presidencybut moved in 2000 to the Ministry of Economy, and again in 2002 to the Ministry ofProduction., currently the Ministry ofEconomyandProduction. l1by FUNDES. 15  60. Most SME programs, whether federal, provincial or municipal, are characterized by a lack o f strategic vision and coherence. They also lack adequate monitoring, supervising and assessment mechanisms, making it almost impossible to evaluate their cost-effectiveness and impact. The result i s not only an excessive number of uncoordinated and overlapping programs, but also low coverage and poor outcomes. All this reveals two significant flaws inthe current policy approach: first, the lack o f a national business development strategy and; second, the inadequacy o f the institutional policy framework. Leaving aside macro considerations, these are among the main reasons why the many attempts made inthe last years to improve SME policy outcomes have proved faulty, unsustainableor both. C4. Constraints in the National Innovation and on the Standards and Quality Control Systems 61. Technological innovation i s a key source o f economic income and employment growth. As shown in De Ferrantiet al- Closing the Gap in Education and Technology- (2003), most of the fastest growing economies over the last two decades owe their growth, inlarge part, to their ability to foster high levels of innovation in their economies by facilitating access to, and assimilation and adaptation of, foreign technology. The report also shows that the Latin American region as a whole does not have a good track record in technological innovation and that Argentina is significantly underperforming relative to countries with similar economies. There are two critical factors. One factor is the lack of a coherent and effective National Innovation System, and of a coherent and systemic public policy to stimulate innovation in Argentina. The result i s aninsufficient private researchand development (R&D) effort. Another factor i s the lack of interest of the productive sector in innovation and quality control activities due to economic instability and uncertainty. The main determinants of this situation are discussedbelow. 62. Scarce economic and human resources dedicated to R&D. Argentina dedicates considerably less resources to R&D than other countries with similar GDP per capita (both before and after the devaluation). During the 1990s, investment in R&D in Argentina was around 0.37 percent of GDP, much lower than in Brazil (0.87 percent) and Chile (0.54 percent) in South America, and much lower than the OECD average of 2.1 percent and some of the industrialized countries such as USA (2.66 percent), Japan (3.04 percent) or Germany (2.46 percent). As shown in De Ferranti et. al., not only does the share of GDP dedicated to R&D in the average country increase with income per capita, but several high growth comparator countries - Ireland, Finland, Korea, and Israel -- had dramatic take-offs relative to this benchmark, a path which China and India appear to be attempting to follow, but not Argentina. Disappointingly, the average effort of five middle-income Latin American countries (Brazil, Chile, Costa Rica, and Mexico, and particularly Argentina) i s substantially below trends of countries with similar GDP per capita. 63. Argentina's human capital dedicated to R&D or with technological skills, while better than in other LatinAmerican countries, remains relatively low for its level o f income per capita. In 2001, the whole set of national institutions for science and technology (S&T), including universities, employed some 33,700 researchers (only 60 percent of them full-time), 6,700 researchassistantswith fellowships, and 11,800 supporting andtechnical staff. Inthe same year, 16  in the business sector there were some 1,200 firms conducting R&D, employing 3,000 researchers, 900 research assistants with fellowships and 2,400 supporting staff. Interms o f an equivalent full time scale, the 25,656 researchers plus assistants working in Argentina are notably less than the corresponding personnel in Brazil (49,702), Spain (61,568) or Canada (88,330). The number corresponding to Germany, Japan and USA multiply the Argentine human resources in R&D by 9, 26 and 43, respectively. When normalized by population or economy size, and as o f 2002, these figures are the highest inthe region, but low by developed countries standards; researchers per 1000 residents are 2.1 for Argentina, 4 for Spain, 9 for the USA 1.8 for Chile and 1.3 for Mexico. 64. As i s the case in all Latin America, Argentina's major universities (especially the University o f Buenos Aires) receive the bulk o f research funding going to higher education. These universities turn out relatively few research-trained scientists and engineers because o f relatively small graduate programs in these areas. In addition, high quality graduate programs may have trouble expanding because o f the limited number o f high quality trained undergraduates (those that graduate from the few "high quality" institutions). Few scientists and engineers are employed inproductive activities. Two out of three S&T researchers are located in universities with weak links to business, and only 6 percent operate inprivate companies. This compares to more than a third in leading OECD countries with a tradition o f close firm- universitycollaboration inresearch. There are few incentivesto engage inproductive-type R&D for public sector researchers, thus the predominance o f basic R&Drather than productive R&D. 65. This situation reflects in part the deficit in higher education (PhD and master degrees, particularly intechnical fields) in Argentina. Only 60 percent o f researchers in universities and 35 percent in public institutions have a higher education degree. In the business sector the proportion i s only 11 percent. The situation i s not going to improve substantially in the near future, since the number o f master or doctoral students i s very l o w (only 4 out o f 100 students in large public universities). L o w salaries and poor working conditions and material resources contribute to the lack o f interest inR&D as a professional activity. As a result, there has been a progressive increase o f the average age o f researchers, with more than 30 percent o f them over the age o f 50. 66. Limited participation and investment of the private sector in R&D activities. Unlike most technologically successful countries, public funding accounts for the bulk (about three- fourths) o f total R&D expenditure, with the private sector accounting for the remaining 25 percent. Moreover, inthe period 1998-2001, private sector expenditure inR&D decreased by 34 percent. Most firms do not engage in any kind o f innovative activity, and when they do, their efforts are generally of a short-term nature. Even in medium tech sectors such as pharmaceuticals, auto parts and machinery, the intensity o f innovation is low compared with other countries. About two-thirds of private expenditures in R&D deal with experimental development and testing; the remaining one-third i s applied research, the opposite o f the technologically successful countries. Moreover, the bulk o f R&D efforts are executed by public institutions including universities and research centers. 67. Missing linkages and technological cooperation amongfirms to promote innovation. Supply chain integration in Argentina i s very limited as well as cluster development with 17  innovation focus. Missing elements are, among others: (i)facilitating environment and institutional leadership; (ii) organization and engagement o f experts to identify and create critical links; (iii) provision o f public good type services and assistance inlight o f coordinating failures; (iv) risk equity finance; (v) ready access to markets; (vi) integration of the stakeholders; and (vi) public awareness about innovation and entrepreneurship. A few "proto-clusters" exist, such as the Polo Tecnolbgico Constituyentes inBuenos Aires, and the clusters o f Rafaela (agro-industry) and Mar del Plata (chemistry and metal-mechanical) with some limited success. Other emerging clusters can be found in food and beverages, petroleum and chemicals, textiles and apparel, materials and metals, and forest products; but again they have little value added. 68. Lack of efficient technological dissemination. Although Argentina had large amounts o f FDI in the 1990s (ranking third in the region, after Brazil and Mexico), the country did not benefit much from technological spillovers. The main contributions o f FDI to productivity and efficiency was inthe introduction of modern management, organizational methods and personnel training, but not many R&D activities and technology spillovers were generated. Also, the impact o f FDI on local suppliers has been so far very limited, with the partial exception o f the automobile industry. Transnational corporations gave little attention to promote and diffuse R&Dwithinthe country, consistent with theory and evidence found elsewhere (De Ferranti et a1 2003). Moreover, the limited integration o f supply chains and the lack o f public sector assistance, limit significantly the dissemination o f technological information. 69. Argentina not only has a significant technological gap with more advanced nations; it also has huge technological disparities among its regions. One o f the barriers i s the weak technology dissemination and diffusion system. Furthermore, most o f the elite technology institutes and universities are located inthe Buenos Aires area. This geographical concentration preventstheir researchresults from beingwidely disseminated throughout the country. 70. Uncoordinated economic incentives for R&D. In Argentina public policy focus and priorities for institution building and the use o f appropriate incentives to support and develop S&T are still very limited. Past efforts were usually scarce and occasional, with little coherence and accumulation of past experience and know-how. Inmany cases, policies were launched and discarded without real attempts at their evaluation, modification and enhancement. As a result, no learning process has taken place in the public sector in the design, assessment, and improvement o f S&T policies. The creation o f the National Agency for the Promotion o f Science and Technology (ANPCyT) in 1996 was a positive step. Its objective is to promote research and technology innovation through the administration o f two funds, FONCyT (National Fund for Research on Science and Technology) and FONTAR (National Technological Fund). The first finances research groups that undertake R&D projects, mainly through subsidies; the second i s mostly geared towards firms and other private institutions and provides partial subsidies, credits and fiscal incentives12. l2 From 1996 to 2002 FONTAR funded 358 projects on technological modernization, 351 on technological development, 55 on technological services and 80 on technical assistance and training. As a whole, almost 900 f m s were involved, with FONTAR providing funds for nearly $170 million and mobilizing resources for about $430 million, including private sector matching funds. Unfortunately there i s no independent evaluation o f the results o f these efforts. 18  71. Argentina's experience with tax credits to stimulate private R&D started in 1998 under Law 23877. During the 1998-2000 period, 359 projects were approved for about US$199 million (US$58.6 million o f which were covered by tax credit certificates). These incentives were mostly used by industrial SMEs, which had preferential treatment, and there is little evidence o f positive impact. N o good evaluation and assessment mechanisms for the use of the credits exists, and even very small adaptations and improvements are treated as "innovations". In addition, lack of well-defined standards and procedures to allocate funds often discourage firms from applying. 72. Lack o f venture capital limits the rate o f creation of new firms, in particular those o f high-tech. During the 199Os, several private investment funds invested in local firms, but few were interested in SMEs, and none o f them provided venture capital. There have been some isolated investment projects financed by foreign funds or ''angel investors" that may be considered as venture capital, for instance in software and Internet services, but Argentina is far away from having an institutionalized venture capital activity. 73. Limited links between S&T institutions and the productive sector. In Argentina, the three key players in the innovative system (government institutions, both at the national and provincial levels, universities and the business sector), are practically disconnected and tend to operate separately. Neither the universities, nor the main public research institutions: the National Science and Technology Research Council (CONICET), the National Institute for Agricultural Technology (INTA), the National Institute for Industrial Technology (INTI), and the National Commission o f Atomic Energy (CNEA), are well aligned with the needs o f the productive sector. 74. In fact, the technological needs of production have been basically met by licensing, technology imports and by local absorption and adaptation o f technical knowledge by private andpublic firms. The main contribution o f universities has beenthe formation o f professionals, while government labs have been mostly confined to supplying technical services. Most o f the R&D expenditure (85 percent) inpublic research institutions and universities is oriented to basic and applied research (38 percent and 45 percent respectively), while the remaining 15 percent is related to technological development. 75. Argentina is underperforming in investment inR&D and on innovation outputs and this applies to both commercial patents and scientific publications. The number o f patents and publications in Argentina are below the average for countries with similar levels o f economic development. In 1999, 1,241 patents were granted in Argentina, from which only 12 percent corresponded to residents in the country. In relative terms, there were 0.29 patent applications filed by residents for each 10,000 people inthe population. This figure is very low if compared with the corresponding one in Brazil (0.45), Spain (0.59), Canada (1.28), Australia (4.20) or Germany (5.76). And when evaluating the efficiency o f Argentina using R&D, as measured by patent production, Argentina underperforms with respect to countries with similar income ~evels'~. l3 as reported inLederman and Maloney (2003). 19  76. Inthe past few years, several programs have been launched to facilitate the interactions between the scientific community and the productive sector with the aim o f promoting technological transfer. The Technology Counselors' Program, launched in 1998, provides funds to pay for the services o f technology advisors (internships for young engineers or expert advice to groups o f firms, mostly SMEs, with common needs). Also, the Units o f Technological Linkage (UVT) were introduced by Law 23877 to identify, select and formulate R&D projects, technology transfer andtechnical assistance. The impact o f these programs is very limited due to narrow coverage (they do not include managerial and marketing aspects) and short-term counselors' contracts. 77. Lack of coordination in Governmentsupportfor innovation. InArgentina there are lots o f ineffective and duplicate technology efforts at different federal ministerial levels, and at provincial and local levels. Although some programs achieve some positive results, the overall performance i s quite poor. The Government has tried to improve coordination among the various policies and programs, through several institutional instances but with very limited success. With this purpose, the Federal Council for S&T (COFECyT), the Interinstitutional Council for S&T (CICyT) and the National Cabinet for S&T (GACTEC), were created inthe last decade. COFECyT coordinates programs and activities undertaken at the national and regional level and CICyT tries to articulate and provide coherence to the activities o f the different R&D public institutions. Although each institution has committed to undertake a critical review and define a strategic plan, the actual implementation has been very slow. GACTEC is supposed to coordinate policies and institutional activity developed at different federal government ministries and must preliminarily approve the National Plan o f Science and Technology. This plan is later approved by Congress through passage o f the annual budget. The first National Plan o f Science and Technology covered 1998-2000. It has since then been updated every year. These plans represent a good effort to diagnose the evolution o f the Innovation System and to set priorities, but have not been effectively followed due to lack o f resources or changes in the political environment. 78. Weak standardization and accreditation system. Another important aspect o f the innovation infrastructure i s the system o f norms and standards, certification and accreditation. Compliance with internationally demanded standards is today a necessity to remain competitive and to access foreign markets. In Argentina, this remains an issue, hampering country competitiveness and export development. The system o f standardization and accreditation was created in 1994 with the setting up o f two main bodies: the Norms and Standards Institute (IRAM)and the Argentine Accreditation Organization (OAA), which gives formal accreditation to testing or calibration laboratories or certification bodies. The National Council o f Norms, Quality and Certification has oversight over these two bodies. Lastly, patents are issued by the Intellectual Property Institute (INPI). 79. The current system lacks coherence, consolidation and requires significant expansion o f service provision particularly at the provincial levels. Also, the private sector does not play a significant role in accreditation and certification. There are no National Quality Plans, nor a public policy to enhance and support the newly established system. The Metrology regulatory framework i s incomplete and the competence to regulate is diffused among the different institutions. The National Authority to enforce the Legal Metrology Law i s the Secretary o f 20  Antitrust and Consumer Defense, which has to set the technical requirements that must be fulfilled by measuring instrumentsmarketed inthe country, andapprove the different measuring instruments. This Secretariat is not fully responding to this task. For example, it has not yet finished regulating standardmeasures for telephone rates, petrol pumps, and some utilities such as power, gas and water, which prevents the authorization of some measuring instruments. In addition, there are no support programs to help industryto get patents or certifications. Very few dissemination programs to inform producers of the advantages of certification or the value of patenting have been implemented. There i s no public register of all the accredited entities which would facilitate the certification and patenting. Perhapsas a consequencethe proportion of firms andproducts complyingwith internationally acceptedstandardsis very low. 80. Weak accreditation and standardization bodies. Although the OAA provides accreditation inArgentina, it has not beenitself accredited by any international body, or signeda Mutual Recognition Arrangement with any of them, which hampers the effectiveness of its certification. The OAA has accredited 31 testing laboratories; 10 calibration laboratories; 6 entities for system certification; and 8 entities for product certification in Argentina, but these accreditations are not internationally recognized. INTI has 29 laboratories intotal, 24 of which are accredited by Spanish, German, and English accreditation bodies. Up to now, IRAM has issued 7,500 norms and 200 different organizations are incharge of studying new norms. IRAM has been certifying and assessing the conformity of its norms with international standards since the 196Os, when it was accredited by the National Institute of Metrology, Normalization and Industrial Quality of Brazil. It has signed a Mutual Recognition Agreement for electric products with Brazil and Uruguay. Not only IRAMcan issue norms, but the National Service of Health and Agricultural Food Quality (SENASA) and the Secretariat of Antitrust and Consumer Defense can too. But while IRAMacts inthe voluntary area, the other two act inthe mandatory areas, mainly inthe phytosanitary and metrology fields. 81. Limited and highly centralized certification infrastructure. Argentina has fewer accredited entities than it needs and the figures show fewer certificates in Argentina than in competitor countries. Only Mexico and Chile are in a worse situation. In2002, Argentina had 2,324 certificates of I S 0 9000 norms, while Brazil had 9,489; Spain had 17,749; Korea had 17,676; USA had 37,026; and the United Kingdom had 66,760. In addition, the accreditation and certification system is highly centralized. In 2002, 60 percent of certifications issued by INTI were in Buenos Aires and Ciudad de Buenos Aires, and 75 percent if Mendoza and Cordoba provinces are included. However, these four provinces export only 52 percent of total Argentine exports. SENASA's laboratories are next to the production areas, but they are not accredited either inthe voluntary field by any national or international body. 82. Costly and lengthy accreditation andpatentingprocess. The minimal accreditation cost i s around 6,200 pesos, including the permit to use the OAA brand and it takes between6 and 9 months. This cost may be higher as the process becomes more complex. The accreditation is in force for three years, but for the second and third, a fee of 1,200 pesos i s required. The fee for every renewal is similar to the initial process, although the time to issue it is usually shorter. As far as the cost o f patents i s concerned, the level i s high and similar to the cost in Europe, where the average cost of a patent is 25,000 euros and a little less than inJapan andthe USA. 21  111. THE GOVERNMENTPROGRAMFORECONOMIC RECOVERY 83. After 17 quarters o f continuous fall inproduction and growing unemployment, the main objectives o f Argentina's new Government are twofold: (i) to establish the basis for recovery o f production in industry, agriculture, mining and services, taking advantage o f Argentina's comparative advantages in many o f these sectors; and (ii)to expand employment to levels compatible with a more equitable income distribution. 84. To consolidate the ongoing economic recovery based on import substitution, it i s necessary to achieve a shift to a more genuine source of competitiveness and to aggressively expand exports. This requires an extension in business planning horizons and a significant increase in investment, particularly in technology, to improve quality and compliance with international standards. There i s a need to promote o f new financing mechanisms and instruments, particularly for SMEs, and to facilitate the reduction inproduction costs inflated by a distorted tax structure, excessive and complex regulations and bureaucratic procedures to entry, exit o f firms costly information gathering and inefficient logistics and infrastructure, among others. There i s also a need to facilitate the creation o f supply chain integration, and to increase linkages between large enterprises and SMEs to enhance dissemination o f knowledge, technology and innovation. 85. Central elements o f the strategy o f the new Government to achieve these objectives are the following: Establishing a process o f modernization o f the State with growing articulation o f the different areas o f government incharge o f policy making and implementation; Creating close links between the State as regulator and facilitator and private producers; Facilitating identification o f key obstacles for increased competitiveness at the aggregate and sectoral levels and providing remedies, with a focus on key sectors, taking into consideration traditional comparative advantages and productive excellence, but concentrating inareas with higher value added; Promoting the adoption o f quality norms, standards, and processes and investment in R&D, developing a coherent National Quality System andNational Innovation System to improve international competitiveness; Promoting the development o f efficient SMEs as the main source o f employment and competitiveness in a world with increasing demand for short-run products with cultural character; Reducing bottlenecks infrastructure, and associated services that increase logistic costs and limit expansion o f production and distribution (for the local and export markets); and Promoting the development o f exports, with particular emphasis in inserting SMEs into the export chain, in export related financial instruments and in reducing processing and transaction costs. The rest of this section describes insome detail the policy actions that the Government o f Argentina i s taking, or will take inthe near future, to promote growth and competitiveness inthe 22  context o f this proposed operation. Recognizing that the measures that the Argentine Government is taking inthis area are only an initial step inthe desired direction, this section also discusses the future reform agenda that the Government needs to implement to achieve growth and competitiveness. A. IMPROVING THE BUSINESSENVIRONMENT 87. The Government is taking and will take in the near future a number o f measures to improve the business environment and investment climate, including the following: 88. SimpZzjTcation ofprocedures. The authorities of the Secretariat o f Industry, Commerce and SMEs (Secretaria de Industria, Comercio y Pymes -- SICyPyME) are trying to simplify procedures and reduce the time involved in establishing a new enterprise. They are in the process o f reviewing the existing procedures and will, in the next few months, adopt a plan o f action to reduce them, at least at the federal level. 89. Improvement in the competitiveness environment: sectoral approach In an effort to promote competitiveness and facilitate growth in the manufacturing sector, the SICyPyME i s identifying sectors that could lead the transformation process. It has already identified nine sectors, based mostly on their strategic importance for the country, comparative advantage, and signs o f excellence. Some involve traditional chains o f production, such as leather and its manufactures, and others, such as software and biotechnology, that are in an incipient phase but have good prospects for growth and consolidation. With this aim, the National Competitiveness Fora within Industrial Productive Chains Program (Foros Nacionales de Competitividad Industrial de las Cadenas Productivas) was initiated in 2003. Each Forum is supposed to organize discussion panels bringing together representatives from the specific business sector and public sector officials from different levels o f the Administration. 90. The objectives o f this program are to enhance export and import substitution potential o f the enterprises in each sector. Each Forum will seek to identify leading projects that would improve the productive chain's competitiveness; explore possible means o f financing and promotion; and define and coordinate specific policy instruments that contribute to successful implementation. The nine selected sectors to implement this program are: forestry and furniture; leather and its manufactures; compressed natural gas; agricultural machinery; software and computing services; culture related industries; biotechnology; textiles and garments and civil construction machinery. The Forum for the forestry and furniture sector has completed a diagnosis and agreed on an action plan to improve competitiveness with its correspondent chronology o f measures. In the next few months the Secretariat expects to receive the action plans of, at least, another seven established Fora with their corresponding chronology o f measures to improve competitiveness. 91, Improving transparency and regulatory coordination. The authorities have taken some steps to improve transparency in public office and in the selection o f functionaries. These reforms aim at improving business environment and strengthening the credibility o f government institutions. One o f the most important measures to improve transparency i s the issuing o f a Decree inJune 2003, modifying the system to propose the designation o fjudges to the Supreme 23  Court. The Decree introduces public audiences, and allows civil society to give an opinion about the SupremeCourtjudges before their appointment. 92. Inmid-2002, a bill on Free Access of Information was presentedto Congress and it has been partially approved by the Senate. In addition, the Authorities intend to issue, in the next few months, a Decree to introduce rules to improve transparency of decisions and activities of the executive branch of government, including, inter alia, the following: (i) right of citizens the to have access to information about the activities and actions of the executive branch, in order for them to participate in and monitor government actions; (ii) regulation of lobbying activities requiringthe publicationof meetings betweengovernment officials and lobbyists; (iii) regulation of public audiences extending their use in areas other than the regulatory entities for which public audiences currently exist; and (iv)publicparticipation in the elaboration of norms, giving citizens the right to give their opinion on these draft norms. 93. To improve coordination of policy making in the executive branch, the MECON has createdthree Cabinets involving secretariats and other government agencies dealing with related policy issues. The Production Cabinet deals with issues related to the productive sector and i s composed of the Secretariats of Economic Policy; SICyPyME and Agriculture. The Fiscal Cabinet deals with issues related to fiscal policies and regulations and i s composed of the Secretariats of Economic Policy andFinance. Finally, the Financial Cabinet deals with financial policies and regulations and i s composed of the Secretariat of Economic Policy, AFIP, BCRA andthe Insurance regulator. 94. To reduce the high logistic costs faced by enterprises the Government intendsto issue the regulations for the Multi-modal Transport Law (Law No. 24.921) approved in January 1998. This Law establishes the legal framework that governs the multi-modal transport o f goods and those cases in which the international transport o f goods has as its final destination any o f Argentina's ports of entry. The regulation ofthis Law i s necessary for its implementation. B. STRENGTHENING EXPORT DEVELOPMENT 95. Reducing anti-export bias. The Government has taken some measures to reduce the anti-export bias of some of the policies adopted after the crisis. These include the gradual elimination of exchange controls and improved fiscal administration aspects such as VAT return and duty drawback. However, for fiscal reasons export taxes will begin to phase-out only from 2005 onwards. At this stage, they continue to represent around 15 percent o f total tax revenues. Further elimination of the export taxes is, however, imperative to allow for exports to become a dynamic element of the Argentine economic recovery. 96. Some improvements have been achieved also as of late in the reimbursement o f duties and VAT. The Government has recently passed regulations that establishes the procedures to determine the amounts owed for debts related to repayment of VAT denominated in U S dollars, as well as with respect to the amounts owed related to the Convergence Factor (US/Euro exchange rate adjustments required after the change to a currency basket approach to establish the fixed exchange rate for the Argentine peso). The AFIP has also agreed to reimburse the stock of VAT owed to exporters before the end o f calendar year 2003. Inaddition, some recent 24  resolutions have accelerated the reimbursement of duties and VAT for certain types o f inputs, butthis clearly needs to be extended to all goods and services. 97. A recently adopted (February 2003) trade facilitation mechanism is the establishment o f the so-called "Factory Customs" (aduanafactoria), which allows for the payment o f taxes on inputs for exports only when the products are sold in the internal market. This mechanism operates only for the automotive industry, but the Government is considering expanding it to other industries. In addition, the Government has issued a Decree simplifying the procedures and steps for the temporary import process for export production. The Government intends to initially reduce the reimbursement period for duties and taxes to no more than 2 months after the initial request. 98. Recent regulations issued by the Central Bank (BCRA) have made foreign exchange restrictions more flexible for the international trade process. Important improvements have been achieved with the elimination o f export surrender requirements in May 2003, as well as additional flexibility (extending the time period to 90 days) for the sale o f foreign currencies derived from exports. Imports can now also be paid inadvance byjust showing their entry within 180 days o f the payment. It is, however, important that remaining foreign exchange restrictions continue to be gradually eliminated, thus creating the conditions for sustained improvements in financing the trading process. 99. Institutional framework for export promotion. Some steps towards improving coordination within the Central Government have been implemented as o f late. The establishment, in April 2003, o f the Subsecretariat for Trade Policy and Management (Subsecretaria de Politica y Gestidn Comercial) as the coordinating entity for export promotion and trade policy is a move in the right direction o f trying to reduce overlapping and repetitive actions. On the other hand, the creation of the International Trade Council (Consejo de Comercio Internacional) as a consultative body for trade policy design with participation by the private and academic sector i s trying to involve important players in the formulation o f policy and strategy in this area. Comercio Exterior - PACE), which exchanges short-term work assignments between the public In addition, the Foreign Trade Support (Programa de Apoyo al and the private sector in areas related to export promotion and export strategy, is an effort to increase coordination with the private sector. A number o f agreements have been signed so far with private enterprises within the PACE and more are earmarked for signature within the next six months. The Government plans to create a Foreign Trade Cabinet to strengthen institutional arrangements for export promotion, and coordinate the policies and programs o f the different entities of the executive branch involved inexport promotion. 100. Access to markets. Certain tangible improvements have been achieved at the level o f coordination within MERCOSUR. The creation o f a Technical Secretariat and the soon to be established Monetary Institute could contribute to cooperation in macroeconomic policy design and implementation. This might help to reduce the exchange rate differentials and moves betweenBrazilandArgentina that have caused many problems for a long-term export strategy in Argentina. The opening up o f new markets has been on the agenda through the negotiation o f Free Trade Agreements (FTAs). MERCOSUR has signed an expanded agreement with Chile and i s likely to negotiate very soon FTAs with bothVenezuela and Peru. Inaddition, Argentina 25  has concluded a bilateral agreement with Mexico in the automobile industry. Within the multilateral system, Argentina is playing an active role in establishing a developing country perspective and position to negotiate with the US and the European Union the opening up o f the services sector. The Government expects to be able to reach FTAs with South Africa and India inthe near future. C. STRENGTHENINGPOLICIES AND PROGRAMSFOR SMES 101. Strengthening linkages between large firms and SMEs and among SMEs. The SSPyME i s sponsoring associative agreements between firms to help SMEs to improve their access to knowledge, insertion into the production and export chain, and to capture economies o f scale. One program recently established by this Subsecretariat (November 2003) supports the creation o f Export Linkages between large enterprises and their client SMEs to accelerate the learning process for exports. Up to now, one agreement has been signed between a large enterprise and 40 o f its SME clients. The agreement involves technical assistance programs in topics such as quality, management, and product development. There are plans to expand the program in the near future linking another 5 large enterprises with 50 associated SMEs. Likewise, SSPyME plans to promote and finance the formation o f 20 sectoral groups with 200 member companies to enhance competitiveness and foster exports inthe SME sector. 102. Measures tofacilitate SME exports. The SSPyME has created a program to provide technical assistance to first-time SME exporters (November 2003). A pilot phase will be conducted with two agreements for the provision o f training to be signed with educational entities experienced in foreign trade. The SSPyME intends to extend the program to about 30 SMEs inthe next six months. Another measure to facilitate exports by SMEs i s the creation o f a "Roster o f Exporting SMEs" with information about the export capabilities o f the registered enterprises. 103. Facilitating SME financing. The Government has implemented several programs to facilitate financing for SMEs. One program aims at creating the conditions for the reestablishment o f financial flows to the SME sector through the provision o f a 3 percent subsidy on the interest rate charged by the banks. The subsidy i s allocated through a transparent bidding process with participation of the banking institutions. In August 2003, 14 banks participated in the first bidding and the resulting interest rate was below the minimum proposed by the SSPyME. The authorities estimate that in the next six to eight months they will be able to leverage up to 500 million pesos in loans to SMEs though this mechanism. Also, the SSPyME intends to sign an agreement with the Buenos Aires Stock Exchange in order to facilitate SME access to the capital market (i.e. simplified registering process, trading o f checks used as pre- funding mechanismissuedby larger companies). 104. To promote wider use o f the SGRs, the Government has allocated 100million pesos from Banco Naci6n and BICEto the Guarantee Fundfor SMEs (FOGAPyME), which acts as a second level fund in order to provide guarantees when SGRs grant guarantees to SMEs above 80 percent of the risk fund. A new contract model for FOGAPyME guarantees i s being developed for approval by the Administration Committee o f FOGAPyME. 26  105. Institutional framework for SME policies. While many programs directed towards supporting SMEs continue to coexist in Argentina, some efforts at rationalizing, consolidating and optimizing these programs have recently been implemented. One effort in this direction is the merger o f the Export Development Program (PRE) cofinanced by the IDB and the fiscal credit program established by the SSPyME. Also, the SSPyMEi s inthe process o f signing inter- institutional agreements with the Ministry o f Social Development and the Ministry o f Labor to coordinate assistance programs directed towards SME's. Inaddition, 22 agreements betweenthe Central Government and the Provinces to coordinate policies through the Productive Development Agencies will be ratified once the new provincial governments take office. Finally, two Productive Development Agencies have been created intwo provinces where there were none before: Capital Federal and Tierra del Fuego. These Agencies allow for the Programs developed and funded through the National Government to be channeled through these local offices, increasing access at the provincial level and allowing for effective coordination with the Provincial Governments. support SMEs -- the budget i s plentiful and sufficient -but the better use o f that funding. To this 106. The issue, recognized by the Government, i s not shortages o f resources allocated to end, the SSPyME intends to produce an action plan, with an implementation timetable, for the consolidation o f its support programs andtheir coordination with the Provinces. D. STRENGTHENINGTHE INNOVATIONAND THE STANDARDSAND QUALITY CONTROL SYSTEMS 107. Increasing public resources for R&D and the share earmarked to promote business innovation. Inaccordance with the priorities spelled out inhis presidential campaign, President Kirchner has announced that his government will make an important budgetary effort in2004 in the areas o f education, science and technology. Inparticular, the annual funds administered by SECyT are expected to increase by 90 percent (depending on Congressional approval o f the budget), making it the only department in the government that almost doubles its budget with respect to previous years14. Although in absolute terms this amount only represents, at most, 10 percent o f the total budget for R&D in public institutions, it is a key instrument to set strategic guidelines and redirect scientific and technological efforts. This budgetary effort conveys a strong signal o f the Government's commitment to the subject, because it i s the main budgetary entry that is fully dedicated to finance R&D expenditures relatedto projects, while the rest o fthe R&D public institutions' budgetmostly covers salaries and operating expenses. 108. Not only the budget will increase in 2004, but the resources will be reoriented towards programs with impact inthe productive sector and initiatives undertaken by groups, networks or consortia, so as to promote association between firms and R&D institutions. The fact that in percent -- sends signals to the R&D community for them to shift their efforts towards the 2004, 64 percent o f the funds will be dedicated to applied research -- in 2003 it was only 37 resolution o f problems that have a direct impact on the productive sector and on the quality o f life of the citizens. Examples o f the strategic programs financed inthe applied research chapter are those o fProductive Competitiveness, Incubators and Technological Poles. l4 CONICET will also benefit from an important increase of more than 13 percent. 27  109. Developing more effective economic incentivesfor innovation. There i s a range o f instruments that the Government has been using since the creation o f FONTAR in 1996 to promote private sector R&D and technological innovation. Among them, the fiscal credit programissues certificates that have validity o fthree years and can help finance up to 50 percent o f the cost o f various types o f R&D projects including applied and pre-competitive research, technological adaptation and improvements. The recent call for projects published in September 2003, introduces changes inthe design o f this programto better target the needs o f different size firms and have more impact on innovation. Thus, while large firms can only apply for R&D projects, SMEs may also get support ifinterested inincorporating improved technologies to their products and processes, or improve quality standards. The other support line i s for technological services demanded by SMEs and developed inR&D institutions or universities. 110. To stimulate investment in venture capital funds, the Government is taking actions in several fronts. It has approved a Decree that regulates the fiscal incentives that will benefit those creating fiduciary funds for risk capital. To be eligible, investments must be geared towards R&D projects developed by young SMEs, or to the creation of new enterprises in the area of science, technology and innovation. This program i s complemented by a seed capital fund specially oriented to projects emanating or sponsored by entities that provide technical assistance to entrepreneurs, technological poles or firm incubators. Moreover, SECyT will organize an institutional network for the promotion o f capital risk, seminars to bring together entrepreneurs andinvestors, andtraining programs. 111. Strengthening the linkages among R&D institutes, universities and industries. Two programs developed in Argentina to promote cooperation between firms and research centers to boost technology transfer to the productive sector are the UVTs and the Technology Counselors. Bothprograms were launched a few years ago, but their potential has not been fully developed, partly because of funding, but also because o f lack o f institutional recognition and clear objectives. The National R&D Plan for 2004 has some provisions to improve their staff capacities as strategic technological managers and to convert those interested UVTs in agents o f industrial property. The program for Technology Counselors, promotes cooperation among micros and SMEs, requiring firms to apply as a group to qualify for the funding; it focuses on specific common technological problems shared by at most 6 firms; it requires co-financing by the group (at least 20 percent); and it provides more stability by extending the length o f the counselors' participation to 10 months. This support line, typically instrumented by subsidies, will instead provide fiscal credits when the group consists o f a leader firm and a group o f small firms that could be its clients or input providers. In this case, the counseling services may last for 12 months. 112. A recent step to facilitate researchers' awareness o f the private sector's needs has been taken by CONICET through formal recognition o f the position o f "Researcher inan Enterprise". This allows its staff researchers to work full time in private enterprises for a limited number o f years in order to perform development and innovation activities and to contribute to human capital training. The enterprise i s responsible for paying at least half o f the salary o f the researcher. This program complements two others providing incentives to CONICET researchers for technological transfer in which researchers are granted credit for this type o f 28  activities in placements and promotions and are allowed to appropriate at least one third o f the benefits obtained from patenting, applicability or sale of their innovation. 113. Improving the coordination and assessment of S&T public policies and institutions towards a coherent National Innovation System. The Law of Science, Technology and Innovation (Law 25.467), approved in 2001, provides legal structure to the National Innovation SysteminArgentina. To makeit operational, a Decree to regulate it will soonbe approved. The regulation introduces advances in the specification of the organization and working procedures of the different coordinating instances such as GACTEC, COFECyT and CICyT. It also clearly designates the SETCyP (Secretariat for Technology, Science and Productive Innovation) as the authority o f application of the Law with the capacity to make the strategic planning and to issue norms to articulate the National InnovationSystem. Finally, it creates ANPCyT as the agency in charge of organizing and administering the instruments for the promotion and evaluation of R&D and innovationactivities. 114. To improve the effectiveness of CONICET, which gets almost 25 percent of the total budget dedicated to public R&D institutions (including SETCyP), it was subject to a recent external institutionalevaluation. The results of this evaluation have beenmade public with their publication in the web page of CONICET. An ad-hoc committee has studied the recommendations o f the report and will prepare a plan of action to implement the recommendations. The plan includes actions concerning CONICET's structure and programs. Two other institutional evaluations will be finalized by next year, those of the National Institute of FishingR&D (Instituto Nacional de Investigacidn y Desarrollo Pesquero INIDEP) and of the National Institute of Agricultural Technology (Instituto Nacional de Tecnologia Agropecuaria INTA). 115. Consolidatingthe standards and quality system. The system o f norms and standards i s a key instrument for improving the quality of domestic products and opening foreign markets. The Government has already taken some steps to increase the awareness of the productive sector in this respect. It has started focusing on sectors whose export potential can be enhanced if their products are certified to meet international standards. This is the case for example of the National Quality Planfor wheat created in2003. 116. Strengthening the infrastructure that provides accreditation and certification. The OAA is in the process of seeking accreditation by three international institutions: the International Accreditation Forum (IAF), the International Laboratory Accreditation Corporation (ILAC) and the Inter-American Accreditation Cooperation (IAAC). The three institutions have already finished a joint pre-evaluation o f OAA. Accreditation would allow automatic recognition of certifications of laboratories accredited by OAA in all the countries parties to those networks. The OAA can advance in its consolidation as more laboratories obtain their accreditation to certify products and processes from it. An important step in this direction will be to promote the accreditation by the OAA of those laboratories that have already been recognizedby international institutions as capable of evaluating conformity. 117. Eleven o f INTI'S centers (laboratories and research centers) were accredited by the National Accreditation Entityof Spain (ENAC) in2003. For the certification process to become 29  more generalized across the country, one important element i s to have accredited certification laboratories relatively close to production-which i s not the case now. At the moment, most o f the accredited laboratories are concentrated in the Buenos Aires area. This situation may improve in the near future, since 39 out o f 81 newly approved projects to accredit laboratories (under the PROCAL program sponsored by IDB), are inthe interior o fthe country. 118. Improving and speeding up the brand and patent processes. INPI has launched a Strategic Plan for 2003 ("Carla Compromiso del Ciudadano") to reduce the time it takes to process the different types o f applications for patents, brands and other industrial property rights. It has implemented a productivity plan that reduces notably the average processing time for brands from 36 to 8 months. This plan will be accompanied by the digitalization in2004 of all brand, model, and design files existing at the INPI register. It is estimated that currently there are about 800,000 active files. INPI is also taking measures to facilitate the patenting o f innovations, including: (a) reducing the processing time, now unreasonably lengthy, for patent applications; and (b) sharing the cost o f patenting an innovation. For this, INPI, incollaboration with FONTAR, will offer financial support to those firms interested inobtaining patents both in Argentina and abroad. E. FUTURE REFORMAGENDA TO PROMOTECOMPETITIVENESSAND GROWTH 119. The reforms that the Argentine Government is implementing under the proposed loan, aimed at achieving sustained economic growth and increase employment, are an initial step to improve the investment climate and business environment. However, to secure this objective, more profound reforms are needed in all four areas o f intervention described above. Moreover, these reforms must be complemented by major reforms to improve the human capital and skills o f the Argentine labor force, as well as the allocation o f human capital resources. The latter requires reforming the labor market and structure and introducing incentives for training programs as well as a new framework for advanced education. 120. Business environment. More efforts are needed in the near future to reduce the cost in time and money of establishing new enterprises and o f exiting economic activity-bankruptcy. These would require greater coordination among the different levels o f government (federal, provincial and municipal) with respect to the requirements to set up new enterprises, and exit economic activity. One way to reduce the time and cost o f establishing new enterprises would be through the adoption o f "one stop shops" for registration and issuance o f permits to new enterprises. Also, the experience o f the "Casu del Empleador" inCordoba, where the permits to operate new enterprises are given on an ex-post basis, should be implemented on a pilot basis in other provinces. 121. Another key area o f reform to improve the business environment in Argentina i s to reduce the lack o fjudicial security and enforcement o f contracts that affects negatively all kinds o f business transactions. An initial step in this direction would be to develop an alternative dispute resolution mechanism for private transactions such as arbitration tribunals, which can facilitate contract enforcement without further encumbering the financial system. It is also important to accelerate the start-up o f operations o fthe Tribunal for the Defense o f Competition. 30  This will require the issuing o f regulations for the operation o f the Tribunal and the nomination o f its president. 122. Labor market. In the current environment, many o f the more costly labor market restrictions are either not observed or not binding and, in addition, the recent sharp drop in real wages associated with the peso devaluation has de facto created substantial (downward) real wage flexibility, which otherwise existing market institutions may have not allowed. While this may render the discussion o f labor institutions reform less relevant, the fact that many restrictions are currently less binding may present an opportunity to tackle needed reforms, that have been so elusive trough the decade o f the 1990s, before, or in the event that as the economy recovers, they become bindingagain, hamperingfuture economic and employment growth. 123. The following reforms are needed to improve labor market efficiency and foster formal job creation: (i) eliminating severance payments' double indemnity not only for new employees (as is the case since June 2003), but for all workers, reducing indemnityback to one month wage per year o f service; (ii) renegotiatingthe old expired "convenios" under the current Law, defacto eliminating the principle o f ultractividad; (iii)facilitating the option o f collective bargaining at the firm level; (iv) reducing the steps needed to register a worker; (v) accelerating the reinsertion o f the unemployed into the active labor force by reforming the existing and ineffective unemployment insurance scheme To this end, the Government has created an Unemployment Working Group to reviewthe Unemployment Insurance Program; (vi) assessing the right level o f labor taxes to the extent that the financial base o f social insurance programs i s changed (e.g. increasingthe share o f general revenues allocated to social programs). However, these measures need to be considered as part o f a fuller review o f basic social security and basic health programs. 124. Transport constraints and logistic costs. There i s a need for reforming the policy and regulatory framework in the transport area to reduce transport constraints and logistic costs to facilitate economic growth. Important steps would be to: (i)create by law a single Transport Sector Regulatory Agency with jurisdiction over all transport subsectors; (ii) prioritize network and multi-modal services and operators; (iii)approve new generation o f inter-urban road concessions based on networks rather than isolated links; and (iv) ensure that rehabilitation, operation and maintenance of existing infrastructure i s granted via incentive concession contracts. 125. Export promotion. The export-led growth process envisaged will require a major effort ineliminating the remaining anti-export bias as soon as possible. Specific export-related taxes and foreign exchange controls that increase costs and reduce international price competitiveness should be phased out as soon as the fiscal limitations allow it. With respect to export taxes, a phased approach could contemplate first the elimination o f those taxes for higher value added industries, and later, after the introduction of a fiscal reform package, taxes on exports o f agricultural products should be also reduced and later eliminated. Prompt restitution o f indirect taxes on inputs for exports is a necessary condition to regain export competitiveness. Thus, the adoption o f an automatic, fast (electronic) duty drawback and VAT devolution system is necessary. The reimbursement period for duties and taxes in pesos should be reduced to days rather thanweeks or months. 31  126. The Government's export promotion efforts need to be reoriented to involve more the private sector intheir designand implementation. Assistance programs directed mainly towards SMEs require a professional, market-based approach, with professional services provided for with paying clients. Any definition o f export promotion services will require direct participation o f the private sector from its inception through its implementation. Suggested export promotion services based on demand by paying private companies in Argentina could concentrate on such aspects as (a) country and/or sectoral marketing campaigns, (b) market information on access and demand structures in target destinations, (c) participation in trade fairs, and (d) sectoral analysis on competitive advantages and possible integration o f supply chains. 127. The Argentine Government has an important role to play in opening access to external markets. It is critical that discussions within MERCOSUR continue to identify areas o f closer cooperation and establish institutional mechanisms within a firm timetable to move towards deepened integration. This includes both possible integration efforts at a macroeconomic level, as well as along production chains within productive sectors. Internally, the Government should go the next step, and establish a single point o f responsibility for international free trade negotiations, rather than multi-layered negotiating capabilities and responsibilities within several ministries. The challenges ahead with respect to FTA's will require to builda highly trained and experienced negotiating team as a single unit for upcoming negotiations within MERCOSUR, the Free Trade Agreement o f the Americas, andthe EuropeanUnion. 128. SMEpoZicies andprograms. The Argentine authorities need to go further intheir efforts to remove constraints to SME development, particularly in the areas o f simplification o f procedures and deregulation o f the economy. There i s also a need to consolidate and improve the large number of assistance programs for SMEs at the federal, provincial and municipal level, to make them more effective tools for SME development. Some o f the measures needed to develop a more coherent assistance program are the following: (i)development o f a set o f indicators to measure performance o f SMEs and SME programs; (ii)elimination o f the large number o f ineffective programs and consolidation o f the rest by key objectives and implementation mode; (iii) introduction o f principles o f cost recovery and benchmarking; (iv) introduction o f reward linkages within the supply chain; (v) participation o f clients inthe design o f the assistance programs; (vi) introduction o f incentive-driven components and private sector participation; and (vii) promotion o f collective learning o f SMEs. 129. To improve SMEs access to credit, once the problems o f the financial sector have been addressed, a centralized credit record system should be implemented to complement or add to the existing credit scoring system for corporate borrowers and to reconcile the various inconsistencies across decentralized record keeping systems for SME credit histories. A credit reporting system would require, through the use o f technology, the consolidation o f dispersed records o f SME credit into an integrated database that could be accessed (as well as populated) by financial institutions. 130. Science, technology and innovation. There i s a need to further increase coordination and streamline technology efforts and R&D funding at the different governmental levels and across different public institutions. Public research programs should be centrally coordinated and assessedat the federal level, but with a fair level o f decentralization intheir implementation. 32  Inthis sense, the implementation of the National R&D Plan should be coordinated by a single entity, with well definedmedium term objectives, priorities and instruments that will encompass not only the public resources administered by SECyT, but all the public funds provided to all the R&D public institutions that depend from different ministries. A key step inthis respect would be to undertake a profound institutional reorganization to put all these institutions under the coordination and leadership o f one Ministry or relevant institutionto achieve consolidation o fthe fundingand alignment o f objectives. 131. R&D support programs should be reshaped to provide better incentives in several directions to favor and remunerate projects by type o f alliances and objectives: (a) to encourage greater interaction among and betweenfirms, universities, public research institutions, and other local actors such as business chambers and knowledge-oriented non-profit organizations; (b) to facilitate technological cooperation and joint ventures, not only domestically but with foreign knowledge-base institutions, so that productive (innovation) clusters develop particularly incorporating SMEs; (c) to increase and redirect research in the public R&D institutes towards activities o f productivity-enhancing use; and (d) to support and build from the "islands"-sectors or firms- of technological excellence diffusing their knowledge to associated firms. All that ought to be supported and complemented by an environment that protects intellectual property rights andthat requiresthe strengthening o f the current patent law. 132. Quality standards and norms. The Government has a role to play inpromoting greater quality o f Argentine products, in close collaboration with the private sector. First, it should increase awareness and provide information about the benefits o f product certification and quality improvements- so as to develop a culture o f quality. For example, the government could take a more direct role inthe spread o f the quality system by requiringthat all public purchases satisfy certain quality norms. The government could also facilitate the development o f a private- public National Quality Council. Second, the government should lead the compulsory certification procedures and facilitate the voluntary ones. It is critical to involve the private sector in the issuance o f norms and quality standards by IRAM, in the certification and accreditation process and in the negotiation o f international agreements o f mutual recognition, particularly inkey export markets. Increasing the number o f laboratories accredited and signing Mutual Recognition Agreements by the Argentine accreditation agencies with different countries or networks are important challenges for the OAA. 133. It is also critical that the accreditation and certification services be timely and offered as close to the demand as possible, particularly for the compulsory certification o f safety and o f agricultural products. This requires increased capacity o f the public certification agencies and an acceleration o f the decentralization process in the provision o f those services. Some provinces have taken some actions to improve the certification and accreditation system. For instance, in the province of Entre Nos, the Institute o f Science and Technology o f the province commissioned a report from the local university for the assessment o f the technical capacity in testing and calibration o f all laboratories in and around the province. The evaluation concluded that there is plenty o f capacity available to do this work but it i s not accredited yet. This initiative could be generalized to other provinces, specially those more export oriented such as Mendoza, Santa Cruz, Neuquen or Chubut, as a first step to push forward the accreditation process. The private sector should have a major role inthe process o f certification o f norms and 33  standards, both for voluntary compliance and for the compulsive compliance, but obviously whenproperly accredited. IV. BANK ASSISTANCE STRATEGY FOR ECONOMIC RECOVERY A. BANKASSISTANCE STRATEGYFOR ARGENTINA 134. The Bank's Country Assistance Strategyfor Argentina. The last Argentina Country Assistance Strategy (CAS) was discussed by the Board on June 27, 2000, and was subsequently updated ina CAS Progress Report dated October 1, 2001. The main strategic guidelines derived from those documents were overcome by the dramatic events at the end o f 2001 and their impact on the country's economic, political and social conditions. The Bank has since then adjusted its proposed strategy to respond to the needs emerging from the acute increase in poverty and to support the transition towards the normalization of the social and economic conditions. The Bank staff has regularly briefed the Board on developments in the country and on the Bank's assistance initiatives during the emergency period. The CAS being presented to the Board together with this proposed adjustment operation presents the proposed Bank assistance strategy for the period FY04-08, and a returnto the Bank's normal development role. 135. The Bank is committedto assist the stabilization andrecovery ofthe Argentine economy. The Bank's response to the post crisis situation has included four major steps thus far. In2002, US$270 million were re-allocated from existing projects to emergency social programs in the area of nutrition, health and education. Second, inJanuary 2003, the Board approved the Heads of Household loan for US$600 million, which constituted the main program of the Transition Administration to assist the unemployed, benefiting inthe order o f 2 million households. Third, in May 2003, the Board approved a US$500 million Economic and Social Transition Loan to support the recovery of the quasi moneys issued by the federal government and the provinces and ensure continued execution of programs dealing with the provision of essential social services. Fourth, in October 2003 the Bank approved a US$750 million Provincial Maternal- Child Health Sector Structural Adjustment Loan, supporting a programthat, among other things, aims at reducing infant mortality. This loan responds to the urgent health needs o f the poor, particularly uninsured mothers and children, while simultaneously assisting the Government to modify the health policy environment in response to new macro-economic conditions, introducing much needed health financing and system changes in the national and provincial framework. 136. The Inauguration in May 25, 2003 of Nestor Kirchner as the democratically elected presidentendedthe political transition periodthat started with President De la Rua's resignation inDecember 2001. The new administration faces as one of its key challenges the design of a long-term development agenda that would put the country on a path of sustainable growth with social inclusion and improved governance. The process leading to the definition by the new administration of a comprehensive longterm development strategy is still on-going. 137. The Bank has contributed to this policy debate by producing a set of Policy Notes focusing on policies, institutions and development issues in three areas - the economy, 34  governance and social issues - identified as critical for the long term economic and social development o f Argentina, which was delivered to President Kirchner and key governmental authorities. Inaddition, the Bank has prepared economic and sector work in a number o f areas, focusing primarily on the themes of economic growth and poverty reduction. Reports recently completed include a Public Expenditure Review", a Health Sector Strategy16 and a Poverty Update17. All these reports have been delivered to the relevant sectors and are at various stages of review and comment at different levels o f Government. 138. The Bank's Strategy for Supporting Economic Recovery and Competitiveness. It i s important to view this operation as part of a concerted effort by the international community to (i) thecountryintheeconomicrecoveryprocessandlaythefoundationsforlongerterm help reforms; and (ii) meet the large financing needs o f the country. Inthe past two years, Argentina, for its part, passed through an economic collapse that was almost without precedent in the Region in terms o f the extent o f economic contraction, banking sector disintegration, and the widespread default on internal and external debt obligations, including delays in repaying the Bank. 139. Recently, the Bank and the Government have identified areas that both consider important to promote economic growth. Inthis context, the Bank follows a two track approach inits support for economic recovery inArgentina. The first track focuses on the needto find a solution to the macro aspects such as the normalization o f relations with the international financial community, which would require both a debt restructuring and a sustainable fiscal framework; the reestablishment o f a functioning financial system; and the renegotiation o f contracts with the privatized public utility firms. Without these reforms, and the recovery o f confidence in public institutions, the ongoing economic recovery is unlikely to translate into sustained economic growth, as recognized explicitly inthe triggers under the new CAS. 140. The second track provides the Bank a re-engagement strategythat improve the likelihood that the reforms in the areas mentioned above will come to eventual fruition. The second track focuses on the need to address the constraints inthe investmentclimate that the Administration i s ready at this point to undertake, particularly with respect to SMEs, in order to improve their competitiveness and export potential. The second track i s the focus o f this operation. With this proposed loan, the Bank also signals the importance o f restoring private sector development as a key pillar for sustainable growth. The proposed operation would cover some initial steps inthis area that need to be complementedby longer term measures. 141. The Government of Argentina is implementing a number o f policy reforms to improve the investment environment and increase the competitiveness of local producers, in particular SMEs. Although these measures are a first step in addressing the constraints to growth and competitiveness o f the private sector in Argentina, there i s also a future reform agenda (as described above) that needs to be implemented to remove the constraints faced by the private l5Argentina: Reforming Policies and Institutions for Efficiency and Equity of Public Expenditures. Economic Report No. 25991, September 10,2003. l6 Argentina: The Health Sector in Argentina, Current Situation and Options for Improvement. Sector Report No. 26144, July 21,2003. l7 Argentina: Crisis and Poverty 2003, a poverty assessment. Economic ReportNo. 26127, July 24,2003. 35  sector. The strategy o f the Bank i s to continue the policy dialogue with the Argentine authorities on the reform agenda that has not yet been addressed, both at the level o fthe macro issues and o f further reforms o fthe investmentenvironment. 142. Rationalefor Adjustment Lending. The justification for a quick disbursing operation in support o f Government measures to restore growth and competitiveness i s based on fiscal needs. The Government's macroeconomic program envisages continued expansion o fthe economy with GDP growing at about 4 percent per year during 2004-2006. Although the Government expects a slow recuperation o f FDI, the capital account will probably present external financial gaps o f about US$4.3 billion in the remainder of 2003, and o f US$13.0 billion during 2004-2006, as a result o f the need to pay the external and internal public and private debt and to reconstitute the reserves. The Government expects that the financing gap will be covered by a combination of: (i)restructuring o f the external debt; (ii) reprogramming o f the old and current payments to the Paris Club and the bilateral creditors; and (iii) continuous support from the IMF, World Bank, and IDB. The Government expects that the IFIs will maintain their exposure during the 2004/2006 period" and that Argentina will pay the interests on the debt to these entities with its own resources. B. BANKEXPERIENCE WITH ADJUSTMENT LENDING ARGENTINA IN 143. The deep economic and social crisis has affected the composition of the Bank's lending program. The CAS o f 2000 initially envisaged that adjustment operations would amount to about 37 percent o f the base lending program with a gradual phasing-out from FY02 onwards. That strategy changed very little in the CAS update o f 2001. However, actual outcomes were radically different. Adjustment lending during the FYO1-04 period accounted for 78 percent o f total lending; emergency social lending (Le. the Heads o f Household program) for 20 percent; and new investment lending for only 2 percent. The changed composition o f lending was directly related to Argentina's loss o f access to international capital markets and the pace at which events unfolded. In addition to losing access to the international financial markets, Argentina's system o f payments collapsed and counterpart funding was unavailable, which led to major problems o f project execution. Those developments prompted the Government to seek increased amounts o f adjustment lending to cover its obligations vis-&vis the IFIs, including the Bank. The Bank responded positively but delays in the preparation and implementation o f operations caused disbursements to fall short o f expectations. 144. The most recent experience with adjustment lending that could be relevant for the proposed operation is the "Economic and Social Transition Loan", approved and fully disbursed in May 2003. This loan supported the recovery o f quasi-moneys issued by the federal government and the provinces. The redemption o f these quasi moneys has progressed ''Deteriorating macroeconomic conditions in Argentina and difficulties in achieving consensus between the Government and the Bank on the direction of policy reform resulted in the Bank's significantly reducing its exposure over the three year periodCYOO-02. Excludingthe settlementof arrears from the previous calendar year, net flows duringthat periodwas marginallypositive, keepingthe Bank's exposureto Argentina to US$7.9billion. The Bank intendsto work closely with the Argentine authorities with a view to keepinga similar levelof exposure duringthe CYO3-06period. 36  satisfactorily, with close to 80 percent having been eliminated by end October, and constitute an important element o fthe Government's program o f fiscal reforms. C. COORDINATION WITH MULTILATERAL INSTITUTIONS 145. The Bank has maintained a constant dialogue with the IMF andthe IDBonthe strategy to support Argentina's transition to sustainable economic growth. Close coordination between Bank staff and management, the IMF, and the Board helped to build an understanding o f and strong support for the objectives o f the Bank assistance to Argentina in the aftermath o f the crisis. The Board has expressed its appreciation for frequent briefings by the staff and management throughout the post-crisis period. 146. An interim IMF program for the period between January and August 2003 covered the transition to the newly elected Administration that took office in May 2003, and was complemented by a Bank program. The IMF has recently (September 2003) approved a new 36 month Stand-By for the equivalent o f SDR 8,981 million (equivalent to about US$12.5 billion). The stand-by arrangement envisions that multilateral lenders would maintain their exposure constant through 2006 and the Bank intends to work closely with the Argentine authorities so that this will be possible. V. THE PROPOSEDLOAN A. LOAN OBJECTIVESAND DESCRIPTION 147. The proposed structural adjustment loan would support the country's efforts to consolidate the incipient economic recovery, ensuring long term growth and increasing employment through the expansion in domestic enterprise. This will be accomplished through the improvement o f the investment climate and the enhancement o f competitiveness and export potential o f existing and new enterprises through systematic productivity gains, quality improvements and innovation. 148. The proposed SAL o f US$500 million would disburse intwo equal tranches: one tranche upon effectiveness o f the Loan Agreement and a second tranche following compliance with agreed conditions. A First Tranche would support the creation o f a number o f government programs to: (i) improve the competitiveness environment for several industrial sectors; (ii) facilitate exports by reducing exchange controls and improving reimbursement o f taxes and duties to exporters; (iii) promote linkages between large and SMEs and among the latter to accelerate learning for exports and quality improvements; (iv) increase transparency in the selection o fjudges; (v) reorient government programs inscience and technology towards helping producers to become more competitive inthe local and external markets; and (vi) increase policy coordination among different government agencies and levels o f government. A Second Tranche would support: (i) the implementation of some o f the recently created programs, with specific targets interms o f number o f enterprises assisted; (ii) measures to improve transparency in government actions and decisions; and (iii)enactment of regulations to implement two 37  approved laws: the Multi-modal Transport Law and the Science, Technology and Innovation Law. 149. Program Management and Loan Administration. The Argentine Republic would be the Borrower of the proposed loan. The MECON would be the principal executing agency and have overall responsibility for coordination and overseeing all aspects o fthe program. 150. Letter of DevelopmentPolicy. A Letter of Development Policy (LDP) datedNovember 18, 2003, was presentedto the Bank, describing the program o f actions, objectives and policies that the Government i s following for the restoration of growth and competitiveness inArgentina. B. COMMITMENTSUNDERTHE PROPOSEDLOAN BoardPresentation/FirstTrancheActions 151. A first tranche of US$250 million would be disbursed upon loan effectiveness based on the following actions already taken by the Argentine authorities inthe following areas: 0 Reforms to improvethe business environment: Measures to improve the competitiveness environment: (i)Resolution No. 148/03 of November 2003,issued by SICyPyME creating the program "National Competitiveness Fora of Industrial Productive Chains" (Foros Nacionales de Competitividad Industrial de las Cadenas Productivas), inviting private sector enterprises and public sector (federal, provincial and municipal level), in nine productive sectors, to participate in the program for purposes of enhancing export and import substitution potential o f the enterprises in each o f said sectors. Measures to improve regulatory coordination and transparency: (i) Decree No. 222103 of June 19, 2003, modifying the system to propose the designation o f judges to the Supreme Court, introducing public audiences and allowing the opinion of civil society about the candidates; and (ii) Resolution No. 20 of June 5, 2003 issued by the MECON creating three coordination cabinets grouping different secretariats dealing with related policy issues: (a) Fiscal Cabinet, (b) Production Cabinet, and (c) Financial Cabinet. Reforms to improve exportperformance: Measures to reduce anti-export bias. (i) Resolutions 90, 91, 92 of April 4, 2003, issued by the SICyPyME typifying those goods for which the immediate repayment of draw back would be facilitated; (ii)Joint Resolution (14/03) and General Resolution (1424/03) of the SICyPyME and AFIP, of January 17, 2003, regulating the "factory customs system" (aduana factoria created by Decree 688102 of April 2002) providing for payment of taxes on inputs for exports only when sold inthe internal market; and (iii) regulations issuedby the BCRA (between January and September 2003) with more flexible credit conditions for imports in U S dollars, more flexible foreign exchange regulations for the export process, as well as eliminating export surrender requirements. 38  Measures to strengthen the institutional fiamework for export promotion. (i) Resolution No. 207/03 of April 24, 2003, establishing the Undersecretariat for Trade Policy and Management (Subsecretaria de Politica y Gestidn Comercial) as coordinating entity for foreign trade policy; (ii) establishment of the Council for International Trade (Consejo de Comercio Internacional, created through Ministerial Resolution No. 2188/02 of November 21, 2002 ) with participation of the academic and private sectors; and (iii) implementation of the Foreign Trade Support Program (Programa de Apoyo a1 Comercio Exterior - PACE created through Presidential Decree 1069 of June 20, 2002) establishing a mechanism to increase private sector participation in areas o f foreign trade, through the signing of 12 separate agreements betweenthe MRECIC andprivate enterprises in2003. eReforms to strengthenpolicies adprogramsfor SMEs. Measures to promote linkages among firms: (i)Norm No.22 (Disposicidn) issued by SSPyME in November 17, 2003, establishing a program to promote export coordination between big companies and commercially linked SMEs (Programa de Articulacidn Exportadora entre Grandes Empresas y Pymes vinculadas) to enhance the SMEs competitiveness andpromote and support their insertion inforeign markets. Measures tofacilitate SME exports: (i) No. 25 (Disposicidn) of November 19, 2003, Norm issued by SSPyME establishing the Program of Support for the First Export for SMEs (Programa de Apoyo a la Exportacidn), providing information and technical support to SMEsto prepareand implementexport businessplans. e Reforms to strengthen the Innovation and Quality systems Measures to increase public resources for R&D and reorient them towards productive activities: (i) issuance o f invitation to enterprises to present R&D and innovationprojects to benefit from the Program of Fiscal Incentives (SECyT Resolution No. 268 of September 9,2003); (ii) Resolution No. 452/03 of April 4, 2003, issued by CONICET creating and regulating the positionof "Researchers inEnterprises"; (iii) issuance by SECyT inSeptember 2003 of invitation to enterprises to present projects within the "Program of Technological Consultants" ANPCyT BoardResolution No. 54 of September2, 2003); and (iv) approval on November 18, 2003 of the National R&D Plan for 2004 by the Science and Technology Cabinet. The plan reorients expenditures towards programs with impact on the productive sector and initiatives undertaken by groups, networks or consortia so as to promote associations betweenfirms and R&D institutions. Measures to improve coordination and evaluation of Science and Technology policies and institutions: (i) disclosure inweb page inNovember 20, 2003, o f the evaluation report public of CONICET; (ii) approval by Resolution of INPI of its Strategic Plan for 2003 (Carta Compromiso del Ciudadano) and actions satisfactorily met for the third calendar quarter of 2003. The Plan details measures to improve the processing of brands, patents and other industrial property rights applications. 39  Measures to strengthen the accreditation and certzjkation infiastructure: accreditation during 2003 o f 11 of INTI'Scenters by an international accreditation organization (ENAC - Spain). Second Tranche Actions 152. A second tranche of US$250 million would be disbursed once the following conditions have beenmet: Reforms to improve the business environment: Measures to simplzfiprocedures: (i) presentation to the Bank of a planby the SICyPyME to reduce the number of steps andtiming involved inthe processof establishing an enterprise. Measures to improve the competitiveness environment: (i)presentationto the Bankof separate action plans and schedules of implementation, issued by seven Fora to improve the productivity and competitiveness o fthe enterprises ineach sector. Measures to improve regulatory coordination and transparency: (i) establishment of the legal framework governing, inter alia,: (a) the public's free access of informationconcerning the actions and activities carried out by the executive branch and entities and/or agencies, (either public or private) under the jurisdiction or regulated by the executive branch; (b) lobbying (gestidn de intereses) activities; and (c) participation of the public inthe elaboration of norms within the executive branch and (ii) issuance of regulations of the Multi-modal Transport Law. Reforms topromote exports: Measures to strengthen the institutional fiamework for export promotion: (i) creation of the Foreign Trade Cabinet for the effective coordination of export promotion programs and policies within the executive branch. Reforms to strengthenpolicies andprogramsfor SMEs: Measures to promote linkages between and amongfirms: (a) signature o f at least 5 separate agreements: (i)between the Borrower and an equal number of large companies; and (ii) among the Borrower, an equal number of large companies and an equal number o f groups of SMEs representingat leas 50 SMEs inthe aggregate, withinthe framework ofthe Programto Promote Export Coordination; and (b) each of these agreements is in full force and effect; and (ii) presentation to the Bank by SSPyME o f plan of action for the consolidation of programs to support SMEs and coordinating the consolidated programs with the Provinces. Measures to facilitate financing for SMEs: (i)approval o f a model contract by the Administration Committee of FOGAPyME to provide FOGAPyME guarantees, and 40  provisiono f at least 5 FOGAPyME guarantees infavor of an equal number of SGRs; and (ii) signature o f an agreement between SSPyME and the Buenos Aires Stock Exchange to facilitate access of SMEs to the capital markets. Reforms to strengthen the Innovation and Quality System Measures to increase public resources for R&D and reorient them towards productive activities: (i) approval of the National R&D Plan for 2004 and its budget. The budget shall, inter alia, provide for an annual allocation of at least 50 percent o f the amount of said budget for applied research; (ii) approval by the SECyT of at least 10 projects detailed in the NationalR&D Plan for 2004; and (iii) establishment of a program of fiscal incentives for risk capital investments inscience andtechnology inArgentina. Measures to improve coordination and evaluation of Science and Technology policies and institutions: (i)issuance of regulations to Law 25.467 on Science, Technology and Productive Innovation; and (ii) presentation to the Bank o f an action plan to implement (a) the recommendations to be issued by the ad-hoc committee (Comite` ad-hoc) concerning CONICET's structure and its programs; and (b) said action plan i s being implemented in accordancewith its terms. Measures to strengthen the accreditation and certification in+astructure: (i) presentation by OAA o f official request for completion of the evaluation process performed jointly by IAF, ILAC and IAAC, so that O M can become an international accreditation institution. C. FIDUCIARY ARRANGEMENTS 153. Flow of Funds Arrangement. Disbursementarrangements would follow the simplified procedures for SALsISECALs approved by the Board on February 1, 1996. The Borrower would open a specific separate deposit account inthe Central Bank o f Argentina. Once the Bank formally notifies the Borrower that a tranche is available for withdrawal, the Borrower may submit a withdrawal application so that the proceeds of the tranche is deposited by the Bank in this specific account to be usedinaccordancewith the LoanAgreement. Although there are no particular concerns about the flow of funds through the Central Bank, the Bank'sright to request an audit of the deposit account would be retained. 154. Financial Management. The Argentina Country Financial Management Assessment (CFAA) was completed in 2002. A Financial Management Fiduciary Risk Assessment i s scheduled to be completed this fiscal year, complementing the CFAA. On the basis of this assessment and updates from the review of project financial management and inputsgathered for the Argentina Public Expenditure Review chapter on budgeting, a "modest" financial management risk i s assigned to the National Government's central administration. The proceeds will be disbursedto the Central Administration, which is supported by effective management of the Treasury single account anda well functioning centralizedfinancial managementinformation system. 41  155. Procurement. Following the recommendations o f a Country Procurement Assessment Report (CPAR) completed in 2001, Argentina has amended its Procurement Law to incorporate elements to improve transparency and competition inpublic sector tendering. The Procurement Law also provides a point o f reference for provincial procurement laws. The Bank is assisting procurement modernization in Argentina through the State Modernization Project (Loan 4423- AR) focusing on regulation as well as on development and implementation of an e-procurement system. Also, considerable assistance was provided for restructuring o f ongoing contracts inthe aftermath o f the financial crisis. Overall the procurement risk in Argentina is assessed as 6Gaverage". D. IMPACT, BENEFITSANDRISKS 156. Social Impact The proposed operation would support policy actions needed to consolidate the incipient economic recovery and ensure long term growth. Restoration o f economic growth is fundamental to reduce the poverty levels that increased dramatically as a result o f the crisis. Although the current Government is taking measures to improve access to health and education services and to improve help for the unemployed, Argentina will only be able to properly address the social needs o f its population in the context o f renewed economic growth and increased employment creation. 157. EnvironmentalImpact This loan focuses primarily on economic recovery, and no environmental issues are foreseen. As this is a Structural Adjustment Loan for which Operational Directive 8.60 applies, no environmental category rating is required. 158. Benefits. The Government of Argentina faces the need to consolidate the incipient economic recovery and ensure long term growth and employment creation. This requires addressing pending structural reforms, as well as short and longer term policy actions to help ensure that enterprises increase production with highvalue added, improve their competitiveness and penetrate export markets. The proposed loan would help improve the competitiveness and export potential o f new and existing enterprises by supporting actions to: (i)improve the investment climate; (ii) better coordinate government policies and programs in support o f SMEs and export development; and (iii)focus Government science and technology programs on improving the quality and competitiveness o f Argentine products. The measures supported by the proposed operation are an initial step and deeper reforms are needed to improve the investment climate, eliminate remaining anti-export bias, and rationalize policy interventions in support o f SMEs, exports and science and technology. Moreover, these reforms must be complemented by major reforms to improve human capital and skills o f the Argentine labor force. 159. Risks. There are several significant risks associated with this operation. The greatest risk is that Argentinawill not completecomprehensively,and in a timely manner, pending structural reforms, including: the reform of the banking sector, the renegotiation of the public and private debt, and the renegotiation of contracts with the privatized public service and infrastructure concessions. Investors and consumers still face significant uncertainty and very limited access to credit. Ifthe country fails to normalize relations with the international financial community, reestablish a functioning financial system, and restore 42  confidence in public institutions, the improvements in the investment environment and other reforms supported by this operation may to be insufficient to ensure that the ongoing economic recovery translates into sustained economic growth. Although failure to address these reforms i s a possibility, the Argentine Government has indicated its intention to work towards normalization o f the financial sector, public debt and concessions. The Bank has linked any future adjustment loans to Argentina to specific reform measures inthese areas. 160. There is also a risk that the Government may not go beyondthe reforms supported by this operation, and thus fall short of a comprehensive reform agenda to improve competitivenessand the creation of new enterprises. To limit this risk, the Bank intends to maintain a continuous dialogue with the authorities and the private sector on the reform and growth agenda. 161. There is the risk is that Argentina could return to a growth strategy based on import substitution, not giving enough emphasis to exports. Argentina's economy has always been inwardlooking, with exports, other than agricultural products, taking place mostly as a result o f specific temporary circumstances such as exchange rate depreciation or contraction of local demand. These exports do not create a client base abroad and are difficult to maintain over time. There i s a need for a change in attitudes towards exports in the public sector and among producers. Also, it i s very important that the Government proceeds to eliminate the remaining anti-export bias in its policies, as soon as the fiscal situation allows. Some o f the measures supported by this operation are aimed at increasing export orientation and competitiveness. Early successes in this area may help generate more positive attitudes towards exports in the public sector and among producers. 162. There i s the risk that the institutional changes needed to increase policy coherence among Governmentagencies at the federal and provinciallevelwill not take place. A major problem in Argentina i s the lack o f coherence o f policies among and between all levels o f government: federal, provincial and municipal. Although the strong federalism o f Argentina often weakens coherence inpolicy design and implementation at different levels o f government, one o f the top priorities o f this Government i s to increase policy coherence and coordination at all levels. 163. Finally, there i s the risk that Argentina could return to the past policies of strong government participation in the economy though public banks and corporations. The financial crisis has strengthened the relative position o f the public banks relative to the private banks and i s putting into question the ability o f the privatized utilities to survive. This possibility i s mitigated by the fact that the Government does not have the resources to take over these activities, and, publicly, states that it only intends to intervene inthe regulatory area. 43  U Ezzc  0  e, e, v1 YC Y2 m -.-.- e, > c m Ya m i) .- Y, L PL M > .e Y S e, e e e e * I e e e e   ANNEX11: Letter of Development Policy I Seiior James D. Wolfensohn Presidentedel Banco Mundial Washington DC Ret ?&statno deAjuste en Apoyo a la Recuperacidn Econdmica Estimado Sr. Wolfensohn: Esta Carta de Politica describe 10s objetivos del programa de reformas del Gobiemo de Argentina para promover la competitividad y crecimiento de la economia, unica via sustentable de superaciondel desempleo, la pobrezay la indigencia.Para implementar esas reformasestamos solicitando asistencia financiera del Banco Intemacional de Reconstmccion y Foment0 (el Banco). La asistencia del Banco es importante porque contribuye a llevar a la practica la politica de flujo neutro de divisas acordada oportunamente entre 10s Organismos Multilaterales de financiamiento y este Gobierno; como consecuencia, se podra disponer de reservas adecuadas para la continuidad del normal fbncionamiento del mercado cambiario y el creciente flujo de importaciones requeridas por el crecimiento economico nacional. Quisieramos aprovechar esta oportunidad para tambien describir el marco macroeconomico que sirve de base para este programa de reformas. PrincipalesLineamientosde la PoliticaEcon6mica Luego de la crisis economica mis profunda que haya conocido la Argentina, el nuevo Gobierno de la Republica Argentina se encuentra plenamente comprometido con la reconstruccion de una economia que permita el crecimiento sostenido en un marco de equidad social. Est0 requerka un amplio espectro de reformas economicas, sociales e institucionales tendientes arestablecer la prosperidad del pueblo argentino y afirmar la posicion y el prestigio de la Argentina dentro de la econom'a mundial. La mejor manerade lograr estos cambioses a traves de un marco de politicas de mediano plazo que cuenten con el respaldo de la comunidad intemacional. Para ello el gobiemo ha4stablecido un nuevo programa economico de mediano plazo para el period0 que va hasta el 2006 que se basa en continua con politicas macroeconomicas prudentes combinadas con una ampliacion y profbndizacion de las reformas emcturales y una reestructuracion ordenada de la deuda soberana. Los elementos clave del programason 10s siguientes: 48  Una combinacion de politicas macroeconomicas-_que profhdice el crecimiento y afirme la estabilidad de 10s precios; Un marco fiscal solido que permita anclar la disciplina fiscal a nivel nacional y provincial, brinde recursos suficientes para las politicas sociales y la inversion publica y permita un nivel de ahorro publico compatible con la normalizacion de las relaciones con 10s acreedores; Una reestructuracion ordenada de la deuda publica que sombinada con el esherzo fiscal previsto- ayde a avanzar hacia una deuda sostenible y le permita a la Argentina volver a tener acceso a 10s mercados intemacionales de capitales de manera responsable; Una estrategiacontinua de fortalecimiento del sistema bancario -tanto en la banca privada como publica- que facilite mayor expansion del credito, lo cud es hndamental para mantener el impulso de crecimiento; Reformas que establezcan una mayor independencia y controles en la implementacion de la politica monetaria -1levando a un sistema de metas de inflacion- y en el desarrollo de la actividad de supervision del sector financiero; y Medidas tendientes a1 mejoramiento del clima de inversiones, que aseguren un marco juridico previsibie, una estrategia para las empresas de servicios publicos privatizadas, y un marcojuridico e institucional adecuado para facilitar la pronta reestructuracion de las deudas empresarias en dificultades. Durante el primer aiio del programa, el gobiemo continuara con la disciplina fiscal, se encaminara rapidamente hacia un acuerdo de reestructuracion de la deuda con 10s acreedores, implementara una estrategia de compensacion y recapitalizacion de 10s bancos comerciales para contribuir a1 crecimiento del credito y comenzara a eliminar gradualmente la tolerancia de la morosidad en las reglamentaciones bancarias; realizara auditorias y revisiones estrategicasde 10s principales bancos publicos, adoptara una estrategia integral para las empresas de servicios pliblicos y establecera un marco para la reestructuracion de la deuda empresaria. Durante este periodo, tambien tendran lugar 10s preparativos para las reformas estructurales e institucionales implementar durante el segundo y tercer afio del programa, incluyendo las reformas fiscales estructurales necesariaspara dar una base sostenible a las finanzas publicas. El marco macroeconomico de mediano plazo, en el que se basa el programa del gobierno preve que continue la expansion de la economia a un ritmo sostenido, mientras que la inflacion subyacente continuaria en la fianja de un digito. Se espera que la produccion crezca entre un 5 y 6% durante el 2003 y para el periodo 2004-2006 se preve un crecimiento que se situaria en aproximadamente un 4%, mientras se fortalece el product0 potencial. En cuanto a 10s precios, mientras que es probable que la inflacich subyacente aumente respecto de su bajo nivel actual, la politica monetaria apuntara a que la inflacion vuelva a sus niveles actuales (4-7%) para el final del periodo del programa. 49  Con la recuperacion economica sostenida y UR modesto fortalecimiento del tipo de cambio real, se proyecta que el superavit del comercio exterior y servicios no atribuibles a factores disminuya gradualmente durante el periodo del programa, aunque seguiria siendo relativamente alto con alrededor del 6,5% del PBI en el aiio 2006. En la cuenta de capital, a pesar de la mejora proyectada en 10s flujos netos de capital privado, se preven brechas de financiamiento extern0 por un monto de US$4.300 millones durante lo que resta del 2003 y de aproximadamente US$ 13.000 millones por afio durante el periodo 2001-06, reflejando principalmente la necesidad de poner fin a 10s atrasos en 10s pagos de la deuda publica y privada y de reconstituir las reservas para que alcancen niveles mas holgados. Confiamos en que se puedan cerrar dichas brechas mediante una combinacion de: 1) reestructuracion de la deuda publica y privada; 2) reprogramacion de 10s pagos atrasados y obligaciones corrientes con el Club de Paris y 10s acreedores bilaterales; y 3) apoyo continuado del FMI, Banco Mundial y BID. La exposicion del FM, Banco Mundial y BID se mantendra como minimo constante durante el periodo del programa y la Argentina abonara intereses a las entidades financieras intemacionales con recursos propios. Una condicion esencial para el exito del programa es el respaldo adecuado de 10s bancos multilaterales de desarrollo durante el periodo del programaa fin de ayudar a cerrar las brechas de financiamiento extemo proyectadas. Esto permitiria brindar mayor certeza, especialmente respecto de la capacidad del gobierno de hacer frente a las necesidades de desarrollo de proyectos, sectoriales y sociales, luego de 10s considerables pagos netos de sewicio de deuda redizados a 10s Bancos Multilaterales de Desarrollo inmediatamentedespues de la crisis. El ordenamiento en el context0 de un herte crecimiento sustentable, creacion de empleo y reduccion de pobreza, es un componentecentral de 10s planes del gobierno para hacer frente a1 alto nivel de endeudamiento. El objetivo para el 2004 sera lograr un superavit primario consolidado del 3% del PBI. En 10s aiios subsiguientes - ZOOS y 2006 la politica asegurara la - extensionde la tendencia iniciada en el aRo 2002 y reforzadaen el aiio 2003 y en el aiio 2004 de manera de alcanzar niveles suficientes para cubrir 10s pagos netos de la deuda que se encuentran en estado normal, y con 10s acuerdos de reestructuracion de la deuda a 10s que pudiere llegarse. Consecuentemente, el superavit fiscal primario brindara bases solidas para ayudar a ordenar las relaciones con 10s acreedores, restaurar el acceso a1 mercado y asegurar la sustentabilidad de la deuda, al tiempo que se cumple con 10s objetivos de crecimiento, empleo y equidad social. Con base en el marc0 de mediano plazo, se preve que el coeficiente deuda/PBI pueda reducirse gradualmente de su nivel de aproximadamente 150% del PBI proyectado para diciembre de 2003. Una vez finalizada'la reestructuracion de la deuda publica, el gobiemo tiene la intencion de mantener ai minimo el nivel de nuevo endeudamiento. . Con 10s niveies de pobreza aun altos, el gobiemo adjudica una imponancia clave a1 vmantenimiento de una herte red bisica de contencion social, que se ha visto fortalecida 50  recientemente con la incorporacion de un nuevo programa de ayuda alimentaria y un nuevo programa de desarrollo comunitario ("Manos a la Obra") y el otorgamienio de un subsidio a las personas mayores de 70 aiios que no tienen jubilacion (Plan Mayoies). El gobiemo seguira trabajando para mejorar la eficiencia y distribucion de 10s planes para Jefas y Jefes de Hogar, 1) asegurandose de que 10s beneficios se mantengan debidamente por debajo del nivel salarial de baja calificacion; 2) implementando una estricta supervision del proceso de inscripcion; 3) haciendo cumplir 10s requisitos de trabajo, al mismo tiempo mejorando la utilidad de las actividades de la fuerza laboral; y 4) mejorandoel proceso para responder a reclamosy a desvios. Elgobierno desarrollarauna estrategia de asistencia social a mas largo plazo para fines del 2003, en consonancia con su estrategia mhs amplia de alivio de la pobreza, incluyendo una Clara identificacion de las responsabilidades de 10s distintos niveles de gobierno en lo atinente al financiamiento e implementacionde 10s programas sociales. Asimismo se dara un fberte apoyo a la proteccion de la salud de 10s grupos mas vulnerables, especialmente con el Programa recientementeaprobado por westro Banco y que constituye un muy valioso apoyo a la politica social del Gobiemo. El ordenamiento fiscal a nivel provincial, ademas de incluir la finalizacion del rescate de las cuasi monedas, quedara fijado en 10s acuerdos bilaterales anuales, que seguiran fimcionando hasta que se introduzcan reformas mas amplias de las finanzas intergubemamentales. Los acuerdos bilaterales del 2004 incluiran objetivos de superavit primario y se complementarh con acciones para mejorar la administracion impositiva a traves de un intercambio de informacion mas amplio y controles cruzados entre las administracionesimpositivas federales y provinciales. Cualquier desvio de las metas de superavit fiscal primario como resultado de desembolsos de 10s BancosMultilaterales mayores a lo proyectado sera contrarrestado, en cas0 de ser necesario, con correccionesa nivel federal. Los planes de gastos de las provincias para el 2004 no incluiran el reconocimiento de gastos de deuda, que representan un 0.4% del PBI, y el repago de 10s atrasos, equivalente a1 0.1% del PBI. Se espera que la firma de 10s acuerdos bilateralespor parte de 10s principales gobemadores provinciales tenga lugar a mediados de febrero de 2004, y que la ratificacion por parte de sus legisladoresprovincialesse produzcahaciafines de marzo de 2004 A fin de fortalecer el potencial del sector exportador, examinaremos la evolucion de 10s factores que afectan las exportaciones. En este sentido se evaluarhn 10s efectos de reducciones gradualesde 10s impuestos de las exportacionesy la eliminacion de demoras en 10s reintegrosdel IVA, estando la magnitud de 10s mismos contingente la evolucion de 10s precios intemacionales de las exportacionesy de la apreciacioncambiariareal. -7' REFORMASESTRUCTUEWLES Los niveles de superavit fiscal primario seran aquellos compatibles con la sustentabilidad fiscal, la cual a su vez debe asegurar la consistencia entre la evolucion del crecimiento de la il 51  produccion y el empleo y 10s precios relativos de bienes y servicios de factores productivos compatibles de la competitividad y garantizar que 10s niveles de gasto publico permitan cumplir con 10s objetivos de reduccion de pobreza. Para tal objetivo se implementaran refomas en la politica fiscal impositiva, administracion impositiva, administracion del gasto publico, seguridad social y relacionesentre el gobiemo nacionaly las provincias. L a reforma impositiva se orientara a hacer que el sistema fomente mas el crecimiento y a la eliminacion gradual de 10s impuestosde caracter distorsivo que se introdujeronen el marco de la emergencia. La reforma impositiva se iniciaria a mediados del 2004 y un primer paso seria la reduccion del impuesto a las transacciones financieras. Se considerara la posibilidad de permitir que el impuesto se acredite parcialmente a1 impuesto a las ganancias durante el period0 de eliminacion gradual. Luego de este primer paso, se presentara al Congreso legislacion mas abarcativasobre reforma impositiva, paraseptiembre de 2004, la que entre otras asas incluira: la ampliacion de la base del IVA; mejor alineamiento de 10s impuestos intemos con 10s niveles regionales; una mejor definicion y mayor equidad en el pago de impuesto a las ganancias; una simplificacion administrativa, sometiendo 10s ingresos por intereses y dividendos a retencion final; una eliminacion gradual del impuesto a las exportaciones, a partir del lade enero de 2005; importantes simplificaciones de las leyes impositivas, a fin de facilitar el cumplimiento impositivo y reducir las cargas administrativas. Las reformas de gestion del gasto publico incluiran: 1) la incorporacion gradual de 10s organismos que efectiian 10s gastos que actualmenteno se encuentran consolidados en el sistema presupuestario y de tesoreria de la administracion central 2) la incorporacion de 10s pasivos contingentes y gastos impositivos,al presupuesto; y 3) la adopcion de normas comunes para coberturapresupuestaria, clasificacion y contabilizacionen todos 10s nivelesde gobiemo. Elpunto centralde la reforma de las relacionesentre 10s gobiernos sera con relaciona las modalidadesde coparticipacion, la introduccion de limites vinculantes de deuda y deficit para 10s gobiemos provinciales, reformas tendientes a1 fortalecimiento de las capacidades de recaudacion -impositiva de las provincias y la creacion de un ente de federalism0 fiscal con capacidad para guiar las relacionesintergubernamentaleshturas. Existe un compromiso por parte del gobiemo para garantizar la sustentabilidad y desempeiio a largo plazo del sistema de seguridad social. En este sentido, se esta preparando un paquete de reformas de seguridad social con el fin de ampliar la cobertura y aumentar la eficiencia del sistema. La legislacion se presentara a1 Congreso para marzo de 2004, con el objetivo de que se apmebe para septiemgredel 2004. Los elementos clave de la estrategia para el sector bancario son 10s siguientes: 1) fortalecimiento del marc0 institucional; 2) fortalecimiento de la solidez del sistema bancario; y 3) determinacion del rol de 10s bancos publicos, poniendolos sobre bases financieras solidas. El IJ 52  gobiemo trabajara rapidamente para tratar 10s efectos ifetos de la indexacion asimetrica (CVS- CER) en el sistema bancario. El Gobiemo nonitoiea de cerca la fortaleza del sistema bancario y evaluara el impacto por sentencias judiciales. En el futuro proximo el gobierno identificara las medidas para fortalecer el sistema en interes de 10s depositantes, 10s tomadores de credit0 y 10s bancos. Unobjetivo clave del programaconsisteen fortalecer 10s bancos y facilitar unaumento en el otorgamiento de prestamos por parte de estos. Existen varias medidas que contribuirana1 logro de dichos objetivos, entre ellas: 1) el pago de tasas de interes basadas en el mercado, a fin de alentar el refinanciamientode 10s titulos publicos en poder de 10s bancos; 2) la reducciongradual prevista del impuestoalas transacciones financieras; y 3) la reduccion del alto nivel de encaje, en un context0 de politica monetariaprudente.Dichas medidas se complementarb con 10s esfiierzos propios de 10s bancos para: 1) aumentar el nivel de prestamos; 2) reducir sus altos costos operativos; y 3) la pronta reestructuracion de la deuda privada. El BCRA utilizara su autoridad cuando ello sea necesario para sanear a 10s bancos a traves de una combinacion de hsiones y adquisicioneso su saneamiento de acuerdo alo establecido por laLey de EntidadesFinancieras. Para la renegociacion de las concesiones de servicios publicos y de infiaestmctura,el gobierno actuara de acuerdo a 10s siguientes principios: 1) el impacto de las tarifas en la competitividad de la economia y la distribucion del ingreso; 2) la calidad del servicio y 10s programas de inversioq cuando se establezca contractualmente; 3) el interes de 10s usuarios y el acceso a 10s servicios; 4) la seguridad de 10s sistemas y 5) la rentabilidad de las empresas. Se preve extender el period0de renegociacionhasta fines del 2004. La reestructuracion de la deuda empresaria en el marco del programa economico de mediano plazo se realizara con un marco voluntario basado en el mercado y determinado por 10s acreedores y 10s deudores. En dicho proceso, no se pondrhn a disposicion recursos fiscales para apoyar la reestructuracionde la deuda empresaria. El gobiemo desempefiara unrol limitado pero importante, mediante: el desanollo de principios, no por via de ley, para renegociacionesque ~ incorporen las mejores practicas intemacionales, para su utilizacion en las negociaciones sobre reestructuracion; se implementarb reformas adicionales a medida que la experiencia en materia de reestructuracionde deuda identifique otros impedimentosregulatorios. El gobierno reconoce que la confianza en el estado de derecho y la proteccion de 10s derechos de propiedad se han visto afectados negativamente por la crisis economica. Los compromises en cuanto a 10s derechw de 10s acreedores constituyen un paso importante para mejorar la confianza de 10s inversoresy establecer un entorno legal m k predecible. MQsa116 de eso, analizaremos el campo que existe para reformas mas amplias tendientes a garantizar mayor previsibilidad y certeza contractual en la Argentina. Para fines de 2003 se establecera una comision de constitucionalistasy expertosjuridicos destacados con el fin de considerar el tema y formular recomendacionesapropiadas parajunio de 2004. 53  -_. El gobierno esta comprometido con el aumento de la transparencia y eficiencia del sistema judicial. En este sentido, el Ministerio de Justicia lanzo un programa para mejorar la eficiencia y el acceso a1 sistema judicial mediante: 1) la reduccion del proceso judicial; 2) la descentralizacion geografica de 10s tribunaies y 3) la capacitacion del personal judicial y 4) la profundizacion de las auditoriasjuridicas. Programade ReformasparaPromoverla Competitividady el Crecimiento Conforme Argentina se recupera de la crisis, 10s principales objetivos de nuestro Gobierno son hacer la recuperacion sustentable, llevar la economia hacia un camino de crecimiento sostenido y expandir el empleo promoviendo una distribucion del ingreso mas equitativa. Nuestro Gobiemo esta consciente de que para consolidar la recuperacion economica es necesario llevar la economia hacia unas bases genuinas y permanentes de competitividad, fortalecer la inversion y expandir las exportaciones. Esto requiere rehabilitar las capacidades de 10s pequeiios y medianos empresarios fuertemente dafiadas por la sobrevaluacion cambiaria y luego por la crisis, extender el horizonte de planificacion de 10s negocios e incrementa significativamente 10s niveles de calidad y las inversiones, particularmente en innovacion y tecnologia. Pensamos que en forma inmediata el Gobiemo tiene un papel importante en la promocion de nuevos mecanismos e instrumentos de financiamiento, patticulmente para las pequenas y medianas empresas CpyMEs) y para exportadores; en la simplificacion de t r h i t e s de registro para que se estimule la expansion y creacion de empresas; en la reduccion de costos de logistica y de obtencion de informacion. Asi mismo el Gobiemo puede facilitar la creacion de vinculos asociativos entre empresas grandes y PyMEs dentro de cadenas productivas para mejorar la competitividad y la capacidadexportadorade las empresas participantes. Los elementos centrales en la estrategia de nuestro Gobiemo para promover la zompetitividad y el crecimiento de nuestraeconomia son 10s siguientes: Establecer un proceso de modernizacion del Estado con creciente articulacion de las diferentes ireas de gobiemo a cargo de elaboracionde politicas y de su implementacion; Crear estrechos vinculos entre el Estado como regulador y facilitador y productores privados; Promover y participar en la iderilificacih de 10s principales obstaculos para una mayor competitividad a nivel agregado y a nivel sectorial, y proveyendo [os medidas para salvar dichos obstaculos, tomando en consideracion ventajas comparativas tradicionales y excelenciaproductiva, pero concentrindose en ireas de alto valor agregado; 54  Promover la adopcion de normas de calidad -7 de produccion, y las inversiones en investigacion y desarrollo, creando un Sistema Nacional de Calidad y un Sistema Nacional de Innovacion coherentes que ayuden a promover la competitividad . intemacional; Promover el desarrollo de PyMEs eficientes como la principal fiente de empleo y competitividad en un mundo con demanda creciente por productos de corta escala y con contenido cultural; Reducir 10s cuellos de botella en infraestructura y sewicios relacionados que aumentan 10s costos de logistica y limitan la expansion de la produccion y distribucion para 10s mercados localesy de exportacion; Promover el crecimiento de las exportaciones con enfasis particular en la insercion de PyMEsen la cadena exportadora, en 10s instrumentosde financiacion de las exportaciones y en la reduccionde costos de financiamiento y de transaccion. Nuestro Gobierno esta implementado esta agenda de reforma en etapas. En la primera etapa estamos tomando las medidas que podremos implementar en 10s proximos seis a ocho meses, dentro de 10s limitantesimpuestospor las necesidades fiscales de nuestro Gobiemo. En un plazo mas largo, nuestra intencion es implementar una reforma de mayor alcance para asegurar .el crecimiento y la competitividad de nuestrossectores productivos. Reformas para mejorar el clima de inversiones Simp1ificacid.nde Tramites.Nuestro Gobiemo reconoce que 10s t r h i t e s largosy costosos para establecer nuevas empresas contribuyen a1 alto nivel de informalidad de nuestra economia. Por esta razon, tenemos como objetivo reducir 10s pasos y el tiempo de procesamiento para crear nuevas empresas y obtener 10s permisosnecesarios para operar. Mejora en el ambiente de competencia "nfoque sectorial. La Secretaria de Industria, Comercio y Pymes ha organizado recientemente un numero de paneles de discusion (Foros de Competitividad de Cadenas Productivas) que agrupan empresas de sectores productivos especificos, oficiales de agencias del sector publico, asi como de institutos de investigacion y desarrollo (RyD) y de instituciones financieras. El objetivo de estos foros es hacer un diagnostic0 de 10s principales obstaculos para mejorar la competitividadproductividad de las empresas del sector y producir un plan de accion con un calendario de implementacion para reducir dichos obstaculos. Hasta ahorqse han convocado foros en siete sectores seleccionados. Esperamos poder implementar pronto las recomendacionesde politicapropuestaspor esos foros. Mejora en la lransparencia y coordinacibn regulatoria. Nuestro Gobiemo ha hecho importantes avances en mejorar la transparencia en el sector publico y en la seleccion de hncionarios. Esasreformas tienen como objetivo mejorar el ambiente de negocios y fortdecer la 55  credibilidad de nuestras instituciones. Una de las medidas mis importantes en este sentido ha sido la modificacion, a mediados de este ano?del sistema para proponer la designacih de jueces a la Corte Suprema y a1 Sistema Federal, introduciendo audiencias publicas y permitiendo a la sociedad civil dar su opinion sobre 10s jueces antes de su nombramiento. Tambien a mediados - del 2003, se present0 a1 Congreso un proyecto de Ley Para el Libre Acceso a la Information, el cual tiene ahora media sancion del Senado. En 10s prbximos meses se emitira un decreto con reglas para mejorar la transparencia en las actividades y decisiones de las agencias del Poder Ejecutivo, incluyendo entre otros: el derecho de 10s ciudadanos a1 acceso a la informacion sobre las actividades y acciones del Poder Ejecutivo, la regulacion de las actividades de "lobby", y la regulacion de audiencias publicas, extendiendo su us0 a keas diferentes a fas entidades reguladas, paralas cuales ya existen estas audiencias. Una de nuestras mayores preocupacioneses mejorar la coordinacion de las decisiones de politica a nivel del Poder Ejecutivo. Con tal proposito se han fonnado recientemente tres Gabinetes de Coordinacion que agrupan Secretarias y otras agencias de gobiemo que tratan aspectos de politica relacionados. Estos son: el Gabinete de la Produccion, que trata sobre aspectos relacionadoscon el sector productivo; el Gabinete Fiscal trata aspectos relacionadoscon las politicas y regulaciones fiscales; y el Gabinete Financier0 trata sobre politicas y regulaciones financieras. En el fbturo cercano pensamos establecer el Gabinete de Comercio Exterior, para coordinar politicas en esta iirea. Fortalecimiento del Desamollowortador Mecanismos para facilitar las exportaciones. El Gobiemo ha tomado importantes medidas para disminuir el impacto de algunas medidas que fueron imprescindibles adoptar en razon de la gravedad de la crisis que eclosion6 en diciembre de 2001. Se han eliminado 10s controles de cambio que afectaban a 10s exportadores y se han reducido 10s impuestos a la exportacion, 10s cuales son ahora aproximadamente el 15% de 10s recaudos fiscales. Marc0 institucional para la promocidn de exportaciones. Hemos hecho importantes avances en fortalecer la coordinaci6n de las politicas en apoyo a las exportaciones dentro del Gobiemo Central. Estos avances incluyen el establecimiento de la Subsecretaria de Politica y Gestion Comercial, como ente coordinador de las politicas de exportacion y el Consejo de Comercio Intemacional, como grupo consultivo, con participacion del sector privado, para el disefio de esas politicas. Tambien hemos establecido el Programa de Desarrollo del Comercio Exterior bajo el cual se hacen interca%bios temporales de personal entre la administracion publicay las empresas exportadoras. Hastaahora se hanfirmado 17 convenios de intercambio de personaly se piensan firmar varios mas. 56  Hemos alcanzado mejoras importantes a nivel coordinacion dentro de MERCOSLT con la creacion de la Secretaria Tecnica y el Instituto Monetario que se va a establecer pronto. Estamos tambien trabajando para abrir mercados extemos para nuestras exportaciones mediante acuerdos de libre comercio dentro del MERCOSCX y acuerdos bilaterales. Ya se ha firmado un acuerdo de libre comercio con Mexico y esperamos llegar pronto a acuerdos similares con Canada, Sudafiicae India. Las acciones comprendidas dentro del programa descrito en 10s pirrafos anteriores y las que se adopten en el hturo se correspondenplenamente con 10s diferentes tratados y convenios intemacionalesde comercio exterior en que la RepublicaArgentina es parte. Programa de apoyoa las PyMEs Fortalecimiento de los vinalos empresariales. La Subsecretariade Pequeiias y Medianas Empresas SSPyME, esta patrocinando un numero de acuerdos asociativos entre PyMEs y entre empresas grandes y PyhEs, con el objetivo de permitirle a estas ultimas mejorar su competitividad e insertarse en el comercio ex-terior. Asimismo, en dicha subsecretaria se encuentra bajo implementacion el Programa de Articulacion Exportadora para PyMEs, bajo el cual se firman convenios entre la Secretaria y grandes empresas con sus PyMEs clientes, para mejorar la capacidad exportadorade estas Gltimas. La Subsecretariaesta implementandounProgramade Apoyo a la PrimeraExportacion de PyMEs que provee asistencia tknica para la primera exportacion. La fase piloto se ha iniciado con la frma de acuerdos con dos instituciones educativas con experiencia en comercio internacional. h4ejora del acceso a1crediro. Estamosimplementadovarios programascon el objetivo de reestablecer10s flujos de financiamiento hacia el sector de PyMEs a traves de unsubsidio del 3% a1 credito bancario, otorgado de manera transparente y con la participacion de todo el sector .financiero. Laprimerasubasta de fondos h emuy exitosay se logo que participasen11bancos y que se llegaseaunatasa menor que el minimo propuestopor la Subsecretaria. Adicionalmente, la Subsecretaria firmara un acuerdo con la Bolsa de Buenos &res para facilitar el acceso de las PyMEs a1 mercado de capitales que incluye el us0 de cheques posdatadoscomo mecanismos de pre-financiamiento. Finalmente, estamos trabajando para ampliar el us0 de las Sociedades de Garantias Reciprocas (SGRs) como vehiculos de facilitacion del credito. En este sentido, el Banco Centralhareconocidoel caracter de `Referidas A" de esas garantias, y la Subsecretaria va a adoptar una nueva regulacion para facilitar la creacion de SGRS abiertas. Tambien se esta trabajando en un modelo de contrato de redianzamiento para el hncionamiento del fideicomiso ,, de reaseguracion de las SGRs. ',I 57  Coordinacion de politicas de apoyo a las PyMEs. Uno de 10s objetivos de nuestro Gobierno es fortalecer la coordinacion y consolidar 10s diferentes programas de apoyo a las . PyhEs. Esfberzos en esa direccion incluyen la fixion del Drograma de Reestructuracion Empresarial (PRE) y el programade creditos fiscales, ambos administradospor la SSPyME: Fortalecimiento del sistema de innovaciciny de control de calidad Aumento de recursospara cienciay tecnologia. Nuestro Gobiemo ha decidido hacer un importante esfberzo presupuestarioen el 2004 en las areas de educacion, ciencia y tecnologia. El Plan Nacional de RyD para el 2004 contempla un incremento del 90?6 en 10s fondos anuales administrados por la Secretaria de Ciencia y Tecnologia, haciendo de este el unico departamento del gobiemo que casi duplica su presupuesto con respecto al ano anterior. Este esherzo presupuestario demuestra nuestro compromiso a fortalecer esta area. Este mayor presupuesto se ha reorientado hacia investigacion aplicada (64% del presupuesto) y a apoyar esherzos tecnologicos del sector privado, particularmente hacia proyectos con impacto en el sector productivo. Desarrollo de incentivos mas efectivos para la innovacidn. Estamos implementando un numero de instrumentos para promover la investigacion aplicada y el avance tecnologico en el sector privado. Estos incentivos incluyen programas de creditos fiscales que pueden financiar hasta el 50% del costo de varios tipos de proyectos de RyD, incluyendo investigacion aplicada, de pre-competitividad y de adaptacion tecnologica. Estamos tambien tomando accion para estimular inversionesen fondos de capitalde riesgo para proyectos de tecnologia avanzada. Fortalecimientode los vinculos entre las imtituciones de RyD, universidades e inhustria. Estamos tomando medidas para fortalecer la cooperacion entre empresas y centros de investigacion. Dos programas previamente existentes: el de Unidades de Vinculacion Tecnologica y el de Consultores Tecnologicos, se estan reenfocando con objetivos mas claros. Estamostambien tomando medidas paraque 10s investigadoresen el sector publico se involucren -mas en las necesidades del sector privado. Pare esto estamos promoviendo que estos investigadorestrabajen por tiempo limitado en las empresas haciendo desarrollos tecnologicos y que se les reconozca ese trabajo para promociones. Este programa complementa otros que le permiten a 10s investigadores del sector publico apropiarse de a1 menos un tercio de 10s beneficios de patentamientoy aplicabilidad de sus innovaciones. Mejora de la coordinacionde lafolitica pliblica con respecto a cienciay tecnologia. El nuevo PlanNacional de RyD, establece claramenteque la Secretaria de Ciencia Tecnologia es la autoridad gubemamental a cargo de implementar el plan y de emitir normas para articular el sistema nacional de innovacion. Para hacer mejor us0 de 10s recursos dedicados a esta kea, hemos iniciado la evaluacionde las actividades de 10s institutos publicosde RyD, empezando por el CONICET, el cual recibe casi 25% del presupuesto del sector. Unreporte sobre 10s resultados v 58  de esta evaluacion se hara publico en 10s proximos meses. Siguiendo las recomendaciones del reporte, en el CONICET se llevara a cabo un programa de reorganitacion institucional y de consolidacion de institutos. En 10s proximos meses se haran evaluaciones de otros institutos, incluyendo le Instituto Nacional de Investigaciony Desarrollo Pesqueroy el JnstitutoNacional de Tecnologia Agropecuana. Coiwolidacion del sislema de nor", estmidaresy calidad Consideramos que el sistema de normas y estandares es un instrumento clave para mejorar la calidad de 10s productos domesticos y para abrir mercados extranjeros. Un paso importante para reforzar el sistema es la acreditacion intemacional de 10s laboratorios publicos de certificacion y acreditacion. El Organism0 Argentino de Acreditacion ( O M ) esta en proceso de obtener acreditacion por parte de tres institutos intemacionales. Esta acreditacion intemacional le daria reconocimiento automatic0 intemacional a las certificacionesdadas por laboratorios nacionalesacreditados por la OAA. Tambien estamos tomando medidas para acelerar 10s procesosde marcas y patentes y para dar apoyo financier0 a la obtencion de patentes en Argentina y en el exterior. Las medidasde refoma antes descritas son un paso inicial importante en nuestro esfuerzo para mejorar el clima de inversion en nuestro pais. Es nuestra intencion profbndizar en el hturo las reformasy complementarlascon medidas paramejorar el capital humano y capacidades de la mano de obra Argentina. Las orientaciones que presidiran las decisiones a adoptar en el hturo tendrin en cuenta que las transformaciones hacia una economia de produccion y pleno empleo incluyen un rol decisivo de 10s agentes organizadores y decisores de la produccion: 10s empresarios. Para ello se apoyara y estimulara la reconstitucion de un empresariado nacional con vocacion por la produccion de bienes y servicios reales y se promovera la creacion de un ambiente de negocios que facilite la rentabilidad razonable. En especial se promoveranaquellas medidas que eliminen las bmeras de entrada que hoy encuentran muchos pequeiios y medianos empresarios para promover nuevos emprendimientos. Se fomentara la transparencia y competitividad en 10s mercados, evitando las tendencias monopolicas y las maniobras - oligopsonicas, la colusion de intereses y toda forma de actividades empresariales prebendarias. Deberanestimularselas inversiones directas que asuman riesgos, evitando formas embozadas de garantiascontraperdidaspatrimoniales. Pensamos continuar mejorando el clima de inversion a traves de medidas para reducir el cost0 en tiempo y dinero de establecer nuevas empresas, o de cesar de operar. Para est0 esperamos lograr mejor coordinacion entre 10s diferentes niveles de gobiemo (federal, provincial y municipal) con respecto a 10s requerhientos para obtener 10s permisos para operar. El Estado tendra un rol activo en la orientacion de la asignacion de recursos hacia el sistema educativo, cientifico y tecnologico y las vias de su eficiente transformacion en capital humano y acumulacion de progreso tecnologico reflejado en el incremento de la productividad total de 10s factores. v 59  8 Finalmente, reiteramos nuestra confianza en que el Banco continuara apoyando 10s f esfbertos de Argentina por superar la crisis e inaugurar un sender0 de crecimiento sustentable con equidad. Saludo a ud con mi consideracionmas distinguida. ./ RobertoLavagna 60  Mr.JamesD.Wolfensohn President The World Bank Washington DC REF: ECONOMIC RECOVERY ADJUSTMENTLOAN -_ Dear Mr.Wolfensohn: This Policy Letter describes the objectives of the reform program of the Argentinean Government for promoting competitiveness and economic growth, which i s the only sustainable way of overcoming unemployment, poverty, and indigence. In order to implement such reforms we are requesting financial assistance from the International Bankfor Reconstruction andDevelopment (the Bank). The Bank's financial assistanceis important because it would contribute to put into practice the policy of neutral foreign currency flow agreed between the International Financial Institutions and this Government; as a consequence, adequate reserves for continuing with the normal operation of the exchange market, and the growing imports flow required for national economic growth will be available. We would like to take this opportunity to describe as well the macroeconomic framework that constitutes the basis of this reform program. I. MainLinesoftheEconomicPolicy After the deepest crisis ever known inArgentina, the new Argentinean Government is fully committed with the reconstruction of an economy that permits sustainable growth within the framework of social equity. This will demand a wide range of institutional, social andeconomic reforms, aimed to re-establish prosperity for the Argentinean people, and reaffirm Argentina's position and prestige in the worldwide economy. The best way to achieve these changes is by means of a framework of medium-term policies, with support of the international community. Inorder to attain this goal, the Government has established a new medium-term economic program for the current period until 2006, basedon the continuation of sound macroeconomic policies, combined with an expansion and deepening of structural reforms, as well as with and orderly restructuring of the sovereign debt. The key elements of the program are the following: A combination of macroeconomic policies that will deepen growth and will secure price stability; A solid fiscal framework that will permit strengthening of fiscal discipline at a national and provincial level, provide sufficient resources for social policies and public investment, and allow for a leve1,of public savings compatible with the normalization of relationships with creditors; An orderly public debt restructuring that -in combination with the planned fiscal effort- will contribute to make progress towards achieving a sustainable debt, and 61  allow Argentina again to have access to international capital markets in a responsible way; A continuous strategy of strengthening the banking system -of private as well as of public banks- that will facilitate a wider expansion of credit, which i s vital for keeping up the growth trend; Reforms that will establish more independence and control o f the implementation o f the monetary policy- leading to a system of inflation targets- and the development of the financial sector supervision activity; and Measures tending to improve the investment climate, which will ensure a predictable legal framework, a strategy for the privatized public service enterprises, and an adequate institutional and judicial framework to facilitate the prompt restructuring of the debts of enterprises in trouble. During the first year of the program, the Government will keep up fiscal discipline, will quickly address the issue of reaching a debt restructuring agreement with creditors, will implement a compensation and re-capitalization strategy for commercial banks in order to contribute to the growth of credit, and will start to gradually eliminate tolerance to arrears in banking regulations; it will carry out audits and strategic reviews in the main public banks, it will adopt an integral strategy for public service enterprises and will establish a framework for restructuring the corporate debt. During this period, preparations will also be made for structural and institutional reforms to be implemented during the second and the third year of the program, including the structural fiscal reform necessary for providing a sustainable basis to public finances. Inthe medium-term macroeconomic framework, on which the Government program i s based, it i s estimated that the expansion of the economy will continue at a sustained pace, while the underlying inflation will remain within the single-digit range. Production i s expected to increase between 5% and 6% during 2003, and a growth of about 4% i s estimated for the 2004-2006 period, while the potential product is strengthened. As prices are concerned, while the underlying inflation i s likely to increase in relationship with its current low level, monetary policy will aim at making inflation return to its present levels (4-7%) by the end of the program's period. With sustained economic recovery and a modest strengthening of the real exchange rate, it i s estimated that the trade and services surplus that cannot be attributed to factors will gradually be reduced during the program's period, even though it will remain relatively high, at about 6.5% of GDP in the year 2006. In the capital account, in spite of the estimated improvement in private capital net flows, external financing gaps by an amount of US$4,300 million are expected during the rest of 2003, and of approximately US$13,000 million per year during the 2004-06 period, mainly reflecting the need to put an end to overdue payments of the public and private debt, and o f reconstituting reserves for them to reach more comfortable levels. We trust that these gaps can be closed by a combination o f 1) restructuring o f public and private debt; 2) reprogramming of overdue payments and current liabilities with the Paris Club and bilateral creditors; and 3) continuous support from the IMF, the World Bank and the IDB. The exposure of the IMF, WB and IDB will be kept, at the least, constant during the life of the program, and Argentina will pay interests to international 62  financial institutions with its own resources. An essential condition for the success of the program i s an adequate support from multilateral development banks during its implementation, in order to close the estimated external financing gaps. This will allow for more certainty, especially regarding the Government's capacity to face the needs of development, sectoral and social projects, after the considerable net debt services paid to Multilateral Development Banks immediately after the crisis. Fiscal restructuring, in the context of a strong sustainable growth, employment creation and poverty reduction, i s a central component of the Government's plan to face the high level of indebtedness. The goal for 2004 will be to achieve a consolidated primary surplus of 3% of GDP. In the following years -2005 and 2006- the policy will ensure the extension of the trend that got started on 2002, and strengthened in 2003 and 2004, so as to reach sufficient levels in order to cover net payments of the debt that i s in a normal state, and the debt restructuring agreements that might be entered into. Consequently, the primary fiscal surplus will bring solid basis to help bring order to the relationships with the creditors, restore access to the market and ensure the sustainability of the debt, while at the same time meeting the objectives of growth, employment and social equality. On a medium-term basis, it i s expected that the debt/GDP coefficient will be gradually reduced from the level of about 150% of GDP projected for December 2003. Once the public debt restructuring i s finalized, the Government intends to keep the level of new indebtedness at a minimum. With poverty levels still high, the Government assigns key importance to maintaining a solid basic network of social containment, which has been recently strengthened by the addition of a new program of food aid and a new program of community development ("Manos a la Obra"), as well as by grantinga subsidy to persons older than 70 years who do not have a pension or retirement benefits ("Plan Mayores"). The Government will continue working to improve efficiency and distribution of the Heads of Household subsidies, 1) ensuring that benefits are kept below the salary level of the less qualified; 2) implementing strict supervision of the registration process; 3) enforcing work requirements, and at the same time improving the usefulness of the labor force activities; and 4) improving the process to respond to claims and deviations. The Government will develop a longer-term social assistance strategy by the end of 2003, in line with its wider poverty reduction strategy, including clear identification of responsibilities at several levels of government regarding financing and implementation of social programs. Likewise, strong support will be given to protecting the health of the most vulnerable groups, especially by means of a Program recently approved by your Bank, that constitutes a highly valuable support to the Government's social policy. Fiscal restructuring at the provincial level, besides including the conclusion of the quasi-monies rescue, will be stated in the annual bilateral agreements, that will continue operating until wider reforms of inter-governmental finances are introduced. The 2004 bilateral agreements will include primary surplus objectives and will be complemented with actions for improving tax management by means of a wider exchange of 63  information, and by performing cross-checks among federal and provincial tax administrations. Any deviation from the primary fiscal surplus targets as a result o f disbursements of Multilateral Banks in excess o f what was projected shall be offset, if necessary, with corrections at the federal level. Provincial expenditures plans for 2004 will not include the recognition of debt expenditures, which represent 0.4% of GDP, and the repayment of arrears, equivalent to 0.1% of GDP. It i s expected that bilateral agreements will be signed by the main provincial governors by mid February 2004, and that provincial legislators will ratify them by the end of March 2004. Inorder to strengthen the potential of the export sector, we will assess the evolution of the factors that deter exporters. Inthis sense, the effect of the gradual reduction of the export taxes and the elimination of the delays in VAT reimbursements will be evaluated, being their magnitude contingent to the evolution of the international prices of exports and the real appreciation of the exchange rate. STRUCTURALREFORMS The levels of primary fiscal surplus will be those compatible with fiscal sustainability, which in turn must ensure the consistency between the evolution of production and employment growth and the relative prices of goods and services of the factors o f production, compatible with competitiveness and guarantee that the public expenditure levels will allow meeting the objective of poverty reduction. With this objective, we will implement reforms in the fiscal and tax policy, the tax administration, the administration of public expenditures, social security, and the relationship between the national government and the provinces. The tax reform will be aimed at making the system to promote more growth and the gradually eliminating distorting taxes that were introduced during the emergency period. Tax reform would begin by mid 2004, and a first step will be to reduce the tax on financial transactions. The possibility of allowing the tax to be partially credited to the income tax during the period of gradual elimination will be considered. After this first step, more comprehensive legislation on tax reform will be presented to Congress b y September 2004, which among others, will include the following issues: widening of the VAT base; better alignment of internal taxes with regional levels; better definition and more equity in the payment of the income tax; administrative simplification, making income by interests and dividends subject to final retention; gradual elimination o f exports taxes, as from January 1" 2005; important simplification of tax laws, so as to facilitate fiscal compliance and to reduce administrative costs. Reforms in public expenditures management will include: 1) the gradual incorporation of institutions that incur in expenses that are not currently consolidated in the budget and treasury system of the central administration; 2) the incorporation of contingent liabilities and fiscal expenses into the budget; and 3) the adoption of common rules for budgetary coverage, classification and accounting at all levels of government. The central issue of the reform on relations between governments is related to the modalities of co-participation, introduction of binding debt and deficit limits for 64  provincial governments, reforms to strengthen the tax collection capacity o f the provinces, and the creation of an office of fiscal federalism with capacity to guide future intergovernmental relations. The Government i s committed to guaranteeing sustainability and long-term performance o f the social security system. In this sense, a package of social security reforms i s being prepared, aiming at widening coverage and increasing the efficiency of the system. Legislation will be presented to Congress by March 2004, with the objective of having it passedby September 2004. The key elements for the banking sector strategy are the following: 1) strengthening of the institutional framework; 2) strengthening of the banking system solvency; and 3) determination of the role of public banks, puttingthem on solid financial bases. The Government will work fast to address the net effects o f asymmetric indexation (CVS-CER) in the banking system. The Government monitors closely the strength of the banking system and will evaluate the impact of judicial judgments. In the near future, the Government will identify measures to strengthen the system in the interest of deposit-makers, credit-takers and banks. A key objective of the program consists of strengthening the banks and facilitating an increase in their lending. Several measures will contribute to achieve said goals, among them: 1) payment of market-based interest rates, in order to encourage re- financing of public securities held by banks; 2) gradual reduction on financial transactions tax; and 3) reduction of the high level o f minimum reserves, in a context of prudent monetary policy. Said measures will be complemented with the efforts of the banks to: 1) increase lending levels; 2) reduce high operating costs; and 3) prompt restructuring of private debt. BCRA will use its authority when necessary in order to put banks on a solid footing by a combination of mergers and acquisitions, or by virtue of the Financial Institutions Act. For the renegotiating infrastructure and public services concessions, the Government will act according to the following principles: 1) the impact of tariffs on competitiveness of the economy and income distribution; 2) the quality of service and investment programs, when established by contract; 3) consumers' interests and access to services; 4) the system's security; and 5) profitability of the enterprises. It i s expected that the negotiations period will span until the end o f 2004. The restructuring of corporate debt within the framework of the medium-term economic program will be carried out on voluntary terms, based on the market and determined by creditors and debtors. In said process, fiscal resources will not be available to support corporate debt restructuring. The Government will play a limited, but important role, through the development of principles, not by means of the law, for the negotiations on but incorporating best international practices to re-negotiations, so they can be used in the restructuring process; additional reforms will be implemented as the experience in debt restructuring identifies other regulatory obstacles. 65  The Government acknowledges that trust in the rule of law and on protection o f property rights have been negatively affected by the economic crisis. The commitment with respect to creditors' rights constitute an important step towards restoring confidence of investors and for establishing a more predictable legal environment. Furthermore, we will analyze what room i s available for wider reforms to guarantee more predictability and contractual certainty in Argentina. By the end of 2003, a commission of constitutionalists and prestigious legal experts will be established in order to consider the subject and to formulate appropriate recommendations by June 2004. The Government i s committed to increase transparency and efficiency of the judicial system. In this sense, the Ministry o f Justice launched a program for improving efficiency and access to the judicial system by: 1) reduction of the judicial process; 2) geographical decentralization of courts; 3) training of judicial staff; and 4) deepening of judicial audits. IV. ReformProgramto Promote Competitivenessand Growth As Argentina recovers from the crisis, the main objectives of our Government are to make this recovery sustainable, to take the economy towards a path of sustained growth and to expand employment, promoting a more equitable distribution of income. Our Government i s aware that in order to consolidate economic recovery, i t i s necessary to take the economy to genuine and permanent bases of competitiveness, strengthen investments and expand exports. This requires rehabilitating the capacities of small and medium entrepreneurs, who have been seriously harmed b y the overvalued exchange rate, and -after the crisis- extending the horizon of business planning, particularly on the innovation and technology areas. We consider that the Government has a very important role to play in the immediate term to promote new financing tools and mechanisms, particularly for small and medium enterprises (SMEs) and for exporters; in simplifying registration proceedings, so as to stimulate expansion and creation of enterprises; in the reduction of logistic costs and access to information. Likewise, the Government can facilitate the creation of associative links between big enterprises and SMEs within productive chains, in order to improve competitiveness and the exporting capacity of participant enterprises. The central elements of our Government's strategy to promote competitiveness and growth of our economy are the following: 0 To establish a process of State modernization, with increasing articulation of the different areas of government in charge o f policy-making and implementation; 0 To create close links between the State as regulator and facilitator, and private producers; 0 To promote and participate in the identification o f the main obstacles for greater competitiveness at an aggregate and at a sector level, and providing the measures 66  to overcome said obstacles, taking into account traditional comparative advantages and productive excellence, but focusing on the areas with more value added; To promote the adoption of quality and production norms and standards, and investments in research and development, creating a coherent National Quality System and a National Innovation System to help to foster international competitiveness; To promote the development of efficient S M E s as the main source of employment and competitiveness in a world with an increasing demand for short-scale products with cultural content; To reduce bottlenecks in infrastructure and related services that increase the logistic costs and limit the expansion of production and distribution for local and exports markets; To promote export growth with particular emphasis on SMEs' insertion in the export chains, in export financing tools and in the reduction o f financing and transaction costs. Our Government i s implementing this reform agenda by stages. Inthe first stage, we are taking measures that we will be able to implement in the next six to eight months, considering the restrictions imposed by the fiscal needs o f our country. Ina longer term, our intention i s to implement a wider reform in order to ensure growth and competitiveness of our productive sectors. Reformsto improvethe investmentclimate Simplification of procedures. Our Government recognizes that long and expensive proceedings for establishing new enterprises contribute to the highlevel o f informality o f our economy. For this reason, our objective i s to reduce processing steps and time for creating new enterprises and for obtaining the necessary permits to operate. Improvement in the competition environment -sectoral approach. The Secretariat of Industry, Trade and SMEs has recently organized a series of discussion panels (Productive Chains Competitiveness Fora) that group enterprises of specific productive sectors, officers of public sector agencies, as well as of research and development and financial institutions. The goal of these fora i s to make a diagnosis of the main obstacles to improve competitiveness/productivity of enterprises of the sector, and to produce an action plan with an implementation schedule for reducing said obstacles. Up to now, eight selected sectors have participated in forums. We expect to be able to implement soon the policy recommendations proposed b y these forums. Improvement in transparency and regulatory coordination. Our Government has made substantial progress in improving transparency in the public sector, and in the selection of public officials. These reforms aim at improving the business climate and at strengthening the credibility of our institutions. One of the most important measures in this sense has been the modification, in the middle of this year, of the system to propose designation of Justices for the Supreme Court and the Federal System, introducing public 67  consultations and allowing civil society to give its opinion on the Justices before they are appointed. Also in mid-2003, a bill for a Free Access to Information Act was presented to Congress, which now has been partially approved by the Senate. Inthe next months, a decree with rules for improving transparency in the activities and decisions of the Executive Branch agencies will be issued, including, among others: citizens' rights to have access to information on activities and actions of the Executive Branch, regulation of lobby activities and regulation of public consultations, extending its use to other areas besides the regulated agencies, for which said sessions already exist. One o f our major concerns i s to improve the coordination of policy decisions at the Executive Branch level. With that objective, three Coordination Cabinets have been created, which group Secretariats and other related government agencies that deal with related policy issues. These are: the Production Cabinet, which deals with issues related to the productive sector; the Fiscal Cabinet, which deals with fiscal policies and regulations; and the Financial Cabinet, which deals with financial policies and regulations. We are thinking of establishing a Foreign Trade Cabinet in the near future to coordinate policies on this area. Strengthening of Exports Development Mechanisms for facilitating exports. The Government has taken important measures for reducing the impact of some actions that had to be adopted due to the magnitude of the crisis that broke out on December 2001. Exchange controls that affected exporters have been eliminated, and exports taxes have been reduced, which currently amount to 15% o f fiscal revenues. Institutional framework for exportspromotion. We have made important progress in strengthening policy coordination to support exports within the Central Government. These advances include establishing an Undersecretariat o f Policy and Trade Management, as coordinating agency of exports policies, and the International Trade Council, as a consultative group -with private sector participation-, for the design of said policies. We have also established a Foreign Trade Development Program, under which staff of public administration agencies and exports enterprises are temporarily exchanged. Up to now 17 staff exchange agreements have been signed, and several others are also expected to be signed. We have achieved substantial improvements at the coordination level within MERCOSUR, with the creation of the Technical Secretariat and the Monetary Institute, which will soon be established. We are also working on opening external markets for our exports by means of free trade agreements within MERCOSUR and by bilateral agreements. A free trade agreement with Mexico has already been signed, and we hope to be reaching soon similar agreements with Canada, South Africa and India. The actions comprised within the above-described program and those to be taken in the future are fully aligned with the different international foreign trade treaties and agreements subscribed by the Argentine Republic. 68  SMEs supportprogram Strengthening of entrepreneurial links. The Secretariat for Small and Medium Enterprises, SSPyME, i s sponsoring a series of associative agreements between SMEs and between big enterprises and SMEs, aiming at allowing the latter to improve their competitiveness and to participate in foreign trade. Also, this Undersecretariat i s implementing a Program of Export Articulation of SMEs, under which agreements are signed between the Secretariat, large enterprises and their SME clients to improve the export capability of the latter. The Undersecretariat i s implementing a Program to support the First Export of SMEs, which provides technical assistance for the first export. The pilot stage has begun with the signature o f agreements with two educational institutions with experience in foreign trade. Zmprovement in access to credit. We are implementing several programs with the objective of re-establishing financing flows to the SMEs sector through a 3% subsidy to bank credit, granted in a transparent way and with participation of the whole financial sector. The first auction for funds was very successful, 14 banks participated and an interest rate lower than the minimum proposed by the Undersecretariat was reached. Additionally, the Undersecretariat will sign an agreement with the Stock Exchange o f Buenos Aires to facilitate SMEs access to the capital market, including the use of post- dated checks as a pre-financing mechanism. Finally, we are working in order to expand the use of Reciprocal Guarantee Societies (RGSs), as vehicles for facilitating credit. In this sense, the Central Bank has recognized the "A Preferential" nature of these guarantees, and the Undersecretariat will adopt a new regulation for facilitating the creation of open RGSs. We are also working on a model reinsurance contract for the operation of the RGSs reinsurance trust fund. Coordination of SMEs support policies. One of the objectives of our Government i s to consolidate and to strengthen the coordination of several SMEs support programs. Efforts to this end include the merger of the Entrepreneurial Restructuring Program and the fiscal credit program, both managed by SSPyME. Strengthening of the innovation and quality control system Increased resourcesfor science and technology. Our Government has decided to make an important budgetary effort in 2004 on the education, science and technology areas. The National R&D Plan for 2004 considers a 90% increase o f the annual funds managed by the Science and Technology Secretariat, being this one of the only departments that will almost double its budget in relation to the previous year. This budgetary effort shows our commitment to strengthen this area. This increased budget has been reoriented towards applied research (64% o f the budget), and to support technological efforts of the private sector, particularly on projects with impact on the productive sector. 69  Development of more effective incentivesfor innovation. We are implementing a number of tools for promoting applied research and technological advances in the private sector. These incentives include fiscal credit programs that can finance up to 50% of the cost of several type of R&D projects, including applied research, pre-competitiveness and technological adaptation. We are also taking action to foster investments in venture capital funds for advanced technology projects. Strengthening of links between R&D institutions, universities and the industry. We are taking measures to strengthen cooperation between enterprises and research centers. Two previously existing programs, the Technological Link Units and that o f Technological Consultants are being refocused with more clear objectives. We are also taking measures for researchers of the public sector to get more involved in the needs of the private sector. To this end, we are fostering that these researchers work for limited period in enterprises making technological developments, and recognizing this work for getting promotions. This program complements others that allow public sector researchers to appropriate at least one third of the benefits of the patent sand application of their innovations. Improvement on public policy coordination conceming science and technology. The new R&D National Plan clearly establishes that the Secretariat of Science and Technology i s the government authority in charge of implementing the plan, and responsible for issuing rules to articulate the innovation national system. In order to make better use of the resources assigned to this area, we have initiated the evaluation of the activities of the public R&D institutions, starting by CONICET, which receives almost 25% of the sector's budget. A report on the results of this evaluation will be disclosed to the public in the next months. Following the report's recommendations, CONICET will carry out a program for institutional reorganization and consolidation of centers. In the next few months, other institutes will be evaluated, including the National Institute of FishingResearch and Development and the National Institute of Agricultural Technology. Consolidation of the system of norms, standards and quality. We consider that the system of norms and standards is a key tool for improving the quality of domestic products and for opening foreign markets. One important step towards strengthening the system i s the international accreditation of the public certification and accreditation laboratories. The Argentine Accreditation Organization (OAA) i s in the process o f obtaining accreditation from three international institutes. International accreditation would give automatic international recognition to the certifications granted by national laboratories accredited by the OAA. We are also taking measures to accelerate the trademark and patent process, and for granting financial support to obtain patents in Argentina and abroad. The above-described reform measures are an important initial step in our effort to improve the investment climate in our country. It i s our intention to deepen the reforms in the future, and to complement them with measures to improve the humancapital and 70  skills of the Argentine labor force. The orientations that will guide the decisions to be taken in the future will consider that transformations towards a production and full employment economy, must include a decisive role for the agents that organize and take decisions about production: the entrepreneurs. For this reason, support will be given to the reconstitution o f a national entrepreneurship with inclination to the production of real goods and services, and the creation of a businessclimate that facilitates a reasonable profitability will be promoted. In particular, measures will be fostered to eliminate entry barriers that many small and medium entrepreneurs face to promote new undertakings. Market transparency and competitiveness will be promoted, preventing monopolic tendencies and oligopsonic maneuvers, collusion of interests and all forms of prebendary entrepreneurial activities. Direct investments entailing risks should be stimulated, avoiding undercover ways of granting guarantees against capital losses. We intend to continue improving the investment climate through measures to reduce the cost in time and money in order to establish new enterprises, or to cease operations. To this end, we expect to be able to achieve a better coordination among different levels of government (federal, provincial and municipal), with respect to the requirements to obtain operating permits. The State will play an active role in orienting the assignments of resources to the education, scientific and technological system, and to the efficient ways of turning this into human capital and accumulation o f technological progress reflected inthe increase of the total productivity of factors. Finally, we reiterate our confidence that the Bank will continue supporting Argentina's efforts to overcome the crisis, and to initiate a path of sustainable and equitable growth. Yours sincerely, Roberto Lavagna 71  ANNEX111: Status of Bank Group Operations Brazil Operations Portfolio (IBRD/IDA and Grants) As Of Date 11/20/2003 ClosedProjects 86 IBRDKDA * Total Disbursed(Active) 2,377.13 of which has beenrepaid 385.59 Total Disbursed(Closed) 14,412.73 of which has beenrepaid 9,566.16 Total Disbursed(Active + Closed) 16,789,861,680.46 of which has beenrepaid 9,95 1,743,953.56 Total Undisbursed(Active) 1,740.33 Total Undisbursed(Closed) 0.00 Total Undisbursed(Active + Closed) 1,740,328,260.00 - . * . PO39584 AR B.A.URB.TSP U U 1997 200 ELOPMENTLIL ODELCOURTDEV. UNICDEVTI1 PO05980 ARPRO 72  .- r . i FY IBRF, IDA G M C8I'lCOl. Und. n X I AR- SecondSecondary PO64614 EducationProject S S 2001 56.99 13.03878 13.038784 11.91931 a. Intendeddisbursementsto date minusactual disbursementsto date as projectedat appraisal 73  ANNEXIV: Statement of IFC's Portfolio (As of 7/31/2003 / InUS$million) Held Disbursed NApproval ComPaoY Loan Equity Quasi Participate Loan Equity . QonSi aPartieipate 2000 ASF 20 0 0 20.5 20 0 0 20.5 1998 AUTCL 5.22 0 0 0 5.22 0 0 0 Aceitera 1994102 General 30 0 0 30 30 0 0 30 196019519719 9 Acindar 47.22 0 0 0 47.22 0 0 0 1994195196 Aguas 0 0 0 0 0 0 0 0 197718418618 8194196 Alpargatas 0 0 0 40.5 0 0 0 40.5 1999 AmericanPlast 5 0 0 0 5 0 0 0 1993 Arg Equity Inv. 0 2.79 0 0 0 2.79 0 0 Argentina 2000 SMMC 18.78 12.5 0 0 18.78 12.5 0 0 1994199 BGN 0 0 0 0 0 0 0 0 2001 BSFE 4.08 0 0 0 4.08 0 0 0 1996199 BancoGalicia 50 0 0 245 50 0 0 245 1996 Bansud 1.13 0 0 0 1.13 0 0 0 2000 BcoHipotecario 25 0 0 102.5 25 0 0 102.5 1996 Brahma- ARG 2.14 0 8.5 0 2.14 0 8.5 0 1997 Bunge-Ceval 7.5 0 5 0 7.5 0 5 0 1996 CAPSA 10.35 0 0 15 10.45 0 0 15 1999 CCI 0 20 6 0 0 20 6 0 1995 CEPA 6.67 0 3 1.2 6.67 0 3 1.2 2000 Cefas 10 0 5 0 6 0 5 0 Correo 1999 Argentino 52.18 6.82 5.18 0 52.18 6.82 5.18 0 0193 EDENOR 0 0 0 0 0 0 0 0 1998 F.V. S.A. 6.75 0 4 0 6.75 0 4 0 1998 FAID 0 1.21 0 0 0 1.21 0 0 2000 FAPLAC 10 0 5 0 10 0 5 0 1997 FRIAR 10 0 2.5 7 10 0 2.5 7 1996 Grunbaum 6 0 2 3.33 6 0 2 3.33 HSBC 1995197 Argentina 16 0 0 0 16 0 0 0 Hospital 1998 Privado 9.06 0 0 0 9.06 0 0 0 1992 Huantraico 0 17 0 0 0 0. 0 0 1995197 KleppelCaldero 6 0 0 0 6 0 0 0 74  . * Disbursed miiy . e - .. rticipate' `~opn Quasi 'Partid ,, . _ . 1992/93/96 Malteria Pampa 0.5 0 1 0 0.5 0 1 0 0 SIDECO 0 15 0 0 0 15 0 0 1995 SanCor 8.74 0 20 0 8.74 0 20 0 0 0 15 0 0 0 0 5 15 0 0 6.5 0 0 0 1995/00 Tower Fund 0 5 0 0 0 3.89 0 0 Tower Fund 1995 Mgr 0 0.05 0 0 0 0.05 0 0 1996197 Transconor 0 0 0 0 0 0 0 0 2001 USAL 10 0 0 0 7.3 0 0 0 1997103 Vicentin 30 0 0 30 30 0 0 30 1993 Yacylec 3 5.04 0 0 3 5.04 0 0 1996 Zanon 17.67 0 0 0 17.67 0 0 0 564.7 Approvals PendingCommitment 75  Held Disbursed FY Approval Company Loan Equity Quasi Participate Loan E q u ~ Quasi Partieipafe 1998 SuquiaCL 2.5 0 0 0 Total Pending Commitment: 85.5 0.35 0 500 76  ANNEXV: ArgentinaFinancialPositioninthe IMF Argentina: Financial Position in the Fund As of September 30,2003 I.MembershipStatus:Joined:September20,1956; Article VI11 11. GeneralResourcesAccount: SDR Million %Quota Quota 2,117.10 100.00 Fundholdingsof currency 12,754.48 602.45 ReservePosition 0.05 0.00 HoldingsExchangeRate 111. SDR Department: SDR Million %Allocation Net cumulativeallocation 318.37 100.00 Holdings 844.65 265.31 IV. OutstandingPurchasesand Loans: SDR Million %Quota ExtendedArrangements 555.06 26.22 Stand-by Arrangements 10,082.35 476.23 V. LatestFinancialArrangements: Approval Expiration Amount Approved Amount Drawn Tvpe Date Date (SDR Million) (SDR Million) Stand-by Sep 20,2003 Sep 19,2006 8,981.00 1,830.00 Stand-by Jan 24,2003 Aug 31,2003 2,174.50 2,174.50 Stand-by Mar 10,2000 Jan 23,2003 16,936.80 9,756.31 of which SRF Jan 12,2001 Jan 11,2002 6,086.66 5,874.95 VI. ProjectedPaymentsto Fund (ExpectationBasis)' (SDR Million; based on existing use of resourcesand present holdingsof SDRs): Forthcoming ~ _ 2004 _ 2005 2003 _ _ _ 2006 _ _2007 _ _ ~ Principal 191.25 4,397.76 2,794.69 2,023.60 1,230.11 Chargeshterest 103.20 255.74 115.94 56.09 __ 15.42 Total 294.44 4,653.50 2.910.63 2,079.68 1.245.53 'This schedule presents all currently scheduledpayments to the IMF,including - repaymentexpectations and repayment obligations.The IMFExecutiveBoardcan extend repayment expectations (within predetermined limits) uponrequest by the debtor country if its external payments position is not strong enough to meet the expectations without undue hardship or risk ,repavment schedules and IMFlending for details). ProjectedPaymentsto Fund; (Obligation Basis)2 (SDR Million; based on existing use of resourcesand present holdingsof SDRs): ..' Forthcoming ~ 2003 _ 2004 _ _2005 _ 2006 _ 2007. ~ _ Principal 191.25 3,714.12 2,132.82 1,366.87 2,002.25 Chargeshnterest 98.04 256.70 146.57 91.09 55.64 Total 289.29 3,970.81 2,279.38 1,457.96 2.057.89 77  FinancialPositionin the Fundfor Argentina As of September30, 2003 'This schedule is not the currently applicable schedule o f payments to the IMF. Rather, the schedule presents all payments to the IMFunder the illustrative assumption that repayment expectations-except for S W repayment expectations- would be extended to their respective obligation dates by the IMFExecutive Board upon request of the debtor country (see repayment schedules and IMFlending for details). SRF repayments are shown on their current expectation dates, unless already converted to an obligation date by the IMFExecutive Board. VII. Implementationof HIPC Initiative: Not Applicable Preparedby Finance Department The information provided is for your convenience and i s not intended to replace other official IMFreports and statements. A 78  ANNEXVI: FundRelationsNotice On January 8,2003, the Executive Board of the International Monetary Fund(IMF) concluded the Article I V consultation with Argentina.' Background Since the last Article IV consultation, which was concluded in September 2000, far-reaching developments in Argentina have transformed its economic situation and prospects. A complex set of factors resultedin the massive loss of domestic and foreign confidence that forced Argentina's sovereign default in late 2001, and the abandonment o f its decade-long currency board arrangement inearly 2002. At the macroeconomic level, the currency board arrangement was not adequately supported by the rest of the policy framework. Inflexibilities in many sectors o f the economy could not compensate for the real appreciation experienced during the 1990s partly reflecting the strong U.S.dollar and the depreciation of the Brazilian real after 1999. Inparticular, fiscal policy grew progressively inconsistent with the demands of the currency board regime and a sizable public debt was built up during the second half o f the 1990s. On the external front, reduced appetite of foreign investors for emerging market debt caused a sharp slowdown of capital inflows to Argentina, leading to a sudden and significant increase in the marginal cost o f borrowing that weakened the prospects for economic growth and debt rollovers. Originsof the Crisis The role of fiscal policy was central to the crisis. Persistent cash deficits and "off-budget'' debt-creating expenditures added to a mainly dollar-denominated public debt. Even in the years of high growth following the reforms of the early 1990s, the fiscal effort was insufficient to produce adequateprimary surpluses. These fiscal problems were the product of vested interests, and resistance to fiscal reforms in the provinces. The sustainability of the higher public debt ratio depended on maintaining healthy growth, strengthening the fiscal primary balance, and ensuring access to international capital. Inthe event, none of these conditions came to apply. The prolonged recession that preceded the crisis reflected both falling confidence and a lack of flexibility in the economy that was incompatible with the currency peg. The steady real appreciation of the peso could not be accommodated in an orderly fashion given structural rigidities in the labor market and fiscal policy. Eventually, the brunt o f the adjustment fell on domestic prices and employment, placing the economy on a deflationary path and making it difficult to get the political support to re-orient economic policies. High dollarization o f the economy meant that any exit from the convertibility plan was bound to be very costly and disruptive. As a consequence, successive governments have shown a high degree of reluctance to consider an orderly transition to another exchange rate regime. Not only was fiscal solvency tied to the currency peg, but also that of the financial system. Banks were heavily exposed to losses from a government default and to credit risk in the event o f a devaluation, as a result of making U.S. dollar- denominated loans to clients whose earnings were denominated mainly inpesos. At a more general level, the dominance of the nontradable sector and narrow export base were fundamentally at odds with a liberalized capital account, and a high reliance on dollar-denominated borrowing. Developments in 2001-02 In2001, the economy entered the third consecutive year of negative growth. After a cumulative decline of 4% percent in 1999-2000, real GDP fell by 4% percent in 2001, and prices continued to decline. Inthe first nine months of 2002 real GDP is estimated to have fallen by 13 percent (reflecting large declines in consumption and investment), although economic activity appears to have stabilized since then. B y October 2002, the unemployment rate i s estimated to have risen to about 23 percent and there was a large increase in the number of people living in poverty. The price deflation of earlier years was reversed in 2002 following the sharp depreciation of the peso. Monthly i n p t i o n peaked in April at 10% percent, and slowed sharply from mid-2002. The public finances deteriorated sharply in 2001, at both the federal and provincial level, with the overall cash deficit of the consolidated public sector increasing by 2% percent of GDP to 6% percent of GDP. The position improved in 2002, owing mainly to the implementation of a revised revenue-sharing agreement 79  with the provinces and tight control over spending. The cash fiscal position, however, conceals the extent of the underlying deterioration in the public finances, as there were large debt-creating expenditures, such as bond issuance in connection with the banking crisis, and the capitalization o f interest payments. A comprehensive measure would bring the augmented primary and overall deficits of the consolidated public sector in 2002 to 11%percent and 25% percent of GDP, respectively. The public debt-to-GDP ratio is estimated to have risen to 119 percent by June 2002. Financing difficulties and the collapse of economic activity shifted the external current account from a deficit o f about US$4.5 billion in 2001 to a surplus of about US$9 billion in 2002. The adjustment was driven by a sharp contraction in imports, while exports were flat. Private net capital outflows in 2001-02 are estimated at about US$38 billion, while gross international reserves fell b y US$20 billion to about US$lO billion. In 2002, external payments arrears reached about US$8.25 billion, including to multilateral and bilateral creditors. Executive Board Assessment Executive Directors regretted that, since the last Article IV consultation in September 2000, Argentina has faced an acute economic and social crisis. Argentina's situation has been fundamentally transformed, with the economy contracting and the poverty and unemployment situation deteriorating. A complex set of economic, institutional, and political factors has led to a massive loss of confidence, default on the foreign debt, and abandonment of the decade-long currency board arrangement. Against this background, Directors expressed their conviction that Argentina will need to formulate and implement-with support of the international community-a strongly-owned program of stabilization and wide-ranging reforms to resolve deep-seated institutional, macro-economic and financial problems, restore confidence, and rebuild economic growth and financial sustainability. They expressed the hope that a transitional program, that could build a bridge to such a comprehensive program, could be agreed at an early date. In particular, Directors hoped that the transitional program will include credible commitments in the area of fiscal and monetary policies, actions to strengthen the banking system, and measures to strengthen Argentina's cooperation with the international community and dialogue with the private sector, in ways that will facilitate a workable transition to a comprehensive program. Directors had a wide-ranging discussion o f the crisis that engulfed Argentina at the end of 2001. They were of the view that Argentina's currency board arrangement was ultimately undermined by its lack of support from the domestic policy framework and by unfavorable external circumstances. Inparticular, a deteriorating fiscal performance (including off-budget expenditures, persistent provincial deficits, and revenue mismatch in the pension reform) resulted in rising public debt, while structural rigidities, including in the labor market, prevented adjustment to an appreciating real exchange rate. Argentina's vulnerability to external shocks was further compounded by the small size and relatively undiversified structureof its export sector relative to the increasing openness of its capital account and reliance on external financing. Some Directors also drew the conclusion that, while the currency board may initially have served Argentina well, it had not been an adequateexchange rate regime choice given the fiscal choices made in Argentina and unfavorable external developments. More broadly, Directors underscored the critical importance of addressing vulnerabilities before they become severe, and the important role that Fundsurveillance and conditionality have to play in focusing early and sufficiently on sustainability issues. They considered that timely action to correct vulnerabilities, which in the case of Argentina would likely have included an orderly exit from the currency board arrangement, might very well have prevented a crisis that-in the absence of strong domestic ownership of policies crucial for sustainability-became inevitable. Some Directors also noted that the Argentina crisis highlights the importance of properly integrating external factors, including regional dimensions, into Fund surveillance. The Executive Board will have further opportunities to come back to these issues in the broader context of the ongoing effort to strengthen survei!lance and focus conditionality. Turning to the authorities' initial response to the crisis, Di'rectors regretted the time it had taken to develop a consistent policy response that would have enabled Argentina to move toward a Fund-supported program during 2002. Initial failure to build a strong political consensus toward resolving the crisis in an orderly and equitable way-admittedly a difficult task given the severity of the situation-had contributed to policy reversals that greatly added to the social cost of the crisis. Inparticular, Directors noted that early 80  government actions during 2002-such as the decisions to convert banks' foreign currency denominated assets and liabilities into pesos at asymmetric exchange rates, and amendments to the insolvency law that tilted the balance sharply against creditors-had exacerbated the economic situation and impeded recovery. Directors were nevertheless encouraged by signs o f a return to economic stability in the second half of 2002. Following a sharp decline inreal GDP, economic activity has stabilized inrecent months; inflation has slowed sharply from its April peak; the external position shows some signs of improvement; and the banking system as well as market indicators have been relatively stable. Directors welcomed the fiscal spending restraint that has contributed to achieving this stability, but cautioned that it also reflects controls on foreign exchange transactions and on utility prices. They were concerned that, with fiscal and banking solvency still to be assured, and indications of repressed inflation, stability -.. i s still fragile, and needs to be put on a firm footing. Directors considered that, in building an enduring recovery, reversing rapidly rising poverty trends, and achieving external and fiscal sustainability, Argentina will need to address five major challenges inthe context of a sustained medium-term restructuringeffort. These are, first, giving reassurances about legal certainty and the political consensus for reforms; second, establishing a robust fiscal framework encompassing the provinces; third, continued progress inresolving the monetary overhang and restoring confidence in the banking system; fourth, undertaking structural reforms to further liberalize the economy and increase trade openness; and fifth, restructuringdebt and reestablishing orderly relations with creditors. While a credible programof core measures, including strong fiscal and monetary performance, can facilitate the transition period to a new government, Directors stressed that only full implementation o f a comprehensive program, based on strong domestic ownership, can achieve lasting results. Inthis context, some Directors called for a broad-based public debate to forge the political, economic, and social consensus that will be needed to support the required reforms. Directors underscored the urgency of restoring legal certainty in Argentina-as a precondition to reviving new credit flows, investment, and growth. They noted that, even after the reversal of earlier measures, creditors continue to face uncertainties about the enforcement of their contractual rights, and urged the authorities to work expeditiously toward improving the investment environment. Directors hoped that market concerns about the continuity of economic policies following the political transition could be quickly addressed, and looked forward to continued actions inthe institutional sphere to improve governance and secure the respect for the rule of law. Directors viewed the restoration of fiscal solvency as a sine qua non of a sustainable economic program, and noted that this task will require a fundamental break with the past involving several dimensions affecting both the federal government and the provinces. Inthe short run, both levels of government will inevitably need to rely on tight control over primary spending, and Directors saw expenditure restraint as key to achieving the targeted consolidated primary surplus o f 2.5 percent of GDP in 2003 and closing the financing gap without monetization. At the same time, it will be important to ensure that social safety net programs are adequately funded and become fully operational. Going forward, Directors agreed that rebuilding tax administration and a culture of compliance will be essential to raising revenues and attaining the higher primary surpluses that will help sustain the public finances ih the medium term. Inthis context, some Directors noted that Argentina's revenue effort is below several other countries in the region. Directors urged the authorities to plan the needed tax reforms without further delay and build consensus for them, and welcomed recent legislation eliminating the ability o f the executive to grant tax amnesties as a key step toward a comprehensive reform of the tax system. They also called for continued efforts to eliminate remaining Competitiveness Plans, and looked forward to the re- instatement of the recently cut VAT rates to their previous levels at the end of the 60-day reduction period. Directors were strongly of the view that provincial governments need to be firmly anchored in the adjustment effort in order to achieve fiscal sustainability._Work should begin as soon as possible toward a comprehensive reform o f intergovernmentalrelations thaf would draw upon the lessons from Argentina's poor fiscal performance inthe 199Os,and that would be supported by an incentive structure that ensures fiscal discipline and responsibility at all levels of government. Inthe short run, Directors urged the authorities to seek early ratification by provincial legislatures o f the bilateral agreements that would underpin the 2003 fiscal targets for the provinces, and to make additional efforts to improve the 81  transparency, quality, and timeliness of the data reported on the provincial finances to ensure effective monitoring. They also saw as essential for monetary and fiscal discipline that provinces end the issuance of all new quasi monies. Turning to monetary control issues,'Directors considered the consolidation of a credible monetary anchor as crucial to maintaining macroeconomic stability. They commended the central bank's efforts in building its instruments of monetary control, but a number of Directors cautioned about the risks associated with potentially significant leakagesrelated to the amparos and the reprogrammed time deposits to be released in2003. Some other Directors, however, saw this risk as rather low, given the experience thus far and the relatively robust demand for money. Directors welcomed the recent stability and rise o f bank deposits and expressed the hope that a credible short-term economic program would reinforce this stabilizing trend. They noted, however, that the pending ruling by the Supreme Court on the constitutionality o f the pesoization of bank deposits is adding to uncertainties, and underscored the importance of resolving this issue in a manner that does not undermine establishing a credible monetary anchor. Directors discussed several other steps that would more fully restore depositor confidence, limit the fiscal costs of the crisis, and rebuild a sound banking system-all of which are necessary to promote domestic saving, investment, and growth. They urged the authorities to work in close cooperation with the Fundstaff on bank resolution issues and in implementing an orderly strategy to identify and resolve weak banks according to consistent principles. Directors looked forward to early strong efforts to further strengthen confidence in the banking system, which will be key to ensuring lasting economic stability. They also encouraged the authorities to reaffirm their commitment to safeguarding and strengthening central bank independence, and looked forward to early approval o f legislation that would protect public officials carrying out their duties in the bank resolution process. Directors welcomed the authorities' efforts to strengthen the central bank's system of internal controls, and encouraged them to stand ready to take further actions as needed in line with the Fund'ssafeguards assessment. On structural issues, Directors considered that the greater stability in the economy provides the opportunity to liberalize the exchange controls that had been imposed in 2002 at the height o f the crisis, and to initiate wide-ranging reforms necessary to revive investment and growth. They welcomed, in this regard, the steps recently taken, including those announced immediately prior to the Board meeting, to remove most of the remaining Article VI11exchange restrictions and ease export surrender requirements. Directors looked forward to early further steps to liberalize the restrictive compulsory export surrender requirement which would help rebuildconfidence. Most Directors noted with concern that the situation regarding utility pricing could be putting a large burden on price adjustments in 2003, and regretted that the recently decreed tariff increases for gas and electricity companies, as well as the public hearings on tariff increases, have been halted by the courts. Directors underscored the urgency of an early joint IMF/World Bank diagnostic mission to assess the financial situation of the utility companies and develop an appropriate regulatory framework that will secure their financial and operational viability, while ensuring that the social impact o f price adjustments is properly taken into account. Among other structural reforms, Directors saw a need for a renewed emphasis on trade liberalization and diversification, given Argentina's relatively low level o f trade integration. They encouraged the authorities to further lower trade barriers, and seek improved market access for Argentina's products in the context of regional and multilateral trade negotiations. In the short-term, efforts should focus on reducing administrative obstacles to exports, and, over time, phasing out export taxes. Directors underscored that, in order to strengthen Argentina's medium-term outlook, the authorities face the key challenge of restructuring Argentina's public debt in a manner that will help normalize relations with private creditors and begin the process of attracting capital flows back into the country. They welcomed the authorities' recent steps to initiate contacts with private cyeditors, and their intention to intensify this dialogue with the assistanceo f external debt restructuring advisors. Directors looked forward to continued progress, particularly with institutional investors, in this area, and urged the authorities to make'all necessary efforts toward advancing a constructive dialogue with private creditors on a debt restructuring, consistent with the "good faith" criterion under the Fund'spolicy for lending into arrears. While noting that 82  significant net payments had been made by Argentina to the international financial institutions in 2002, Directors regretted Argentina's decision to fall into arrears with the World Bank and urged the authorities to eliminate them as soon as possible. This will clear the way for implementation o f the Bank's program o f social support under the Heads of Household program. Directors urged the authorities to remain current on their obligations to the international financial institutions. Directors noted that, even with the maintenance of a substantial fiscal adjustment effort, Argentina's medium-term debt outlook appears very difficult. Debt ratios will remain very high and financing needs very large, while prospects for regaining market access will likely improve only gradually. They urged the authorities to work closely with the international community and to strengthen their efforts to reach a cooperative solution with private creditors to secure financing and achieve k a l and external sustainability over the medium term. 83  ANNEXVII: Argentina SelectedEconomic Indicators Est. 1998 1999 2000 2001 2002 (Annual percentage changes; unlessotherwise indicated) National income and prices Real per capita GDP 2.6 -4.6 -1.7 -5.6 -10.8 GDP at constant prices 3.8 -3.4 -0.8 -4.4 -11.0 Consumption 3.1 -2.6 0.2 -4.4 -13.6 Investment 6.5 -12.6 -6.8 -15.7 -39.0 Net exports (contribution to growth) 0.0 1.4 0.3 2.1 6.4 Industrial production (average) 1.6 -6.5 -0.3 -7.6 -12.0 Consumer prices (average) 0.9 -1.2 -0.9 -1.1 25.9 Consumer prices (end-of-period) 0.7 -1.8 -0.7 -1.5 41.9 External sector (in terms of U.S. dollars) Exports, f.0.b. 1.0 -12.6 13.2 0.9 0.2 Imports, c.i.f. 3.1 -18.7 -1.2 -19.5 -55.1 Export volume 11.6 -0.7 2.8 4.5 4.3 Import volume 8.7 -13.8 -1.2 -16.8 -55.8 Terms of trade (deterioration -) -5.5 -5.9 10.2 -0.6 -1.1 Real effective exchange rate, average (depreciation -) 3.5 12.4 -0.7 6.0 -57.3 Real effective exchange rate, year-end (depreciation -) 0.3 12.6 1.7 2.9 -54.7 Money and credit Banking system Net domestic assets 14.6 4.7 3.3 5.O ... Of which: credit to private sector 10.8 -2.1 -3.8 -17.6 -37.5 Money (M2) 24.7 -2.4 -2.5 10.7 -9.4 Velocity (GDP relative to M2) 8.0 7.6 7.8 8.1 7.8 Interest rate (30-day deposit rate, in percent) 1/ 7.6 8.0 8.3 16.2 41.8 (In percent of GDP) Public sector savings -0.5 -2.6 -2.2 -4.7 -2.0 Federal government cash primary balance 0.9 0.4 0.9 0.1 0.5 Federal government cash overall balance -1.3 -2.5 -2.5 -4.4 -9.4 Consolidated public sector cash primary balance 0.6 -0.7 0.4 -1.4 0.0 Consolidated public sector cash overall balance -2.0 -4.1 -3.6 -6.8 -10.3 Gross domestic investment 19.9 18.0 16.2 14.2 10.7 Gross national savings 15.2 13.8 13.1 12.5 18.8 Current account deficit -4.8 -4.2 -3.1 -1.7 8.1 Public sector external debt (end-of-year) '' 27.8 29.9 29.7 32.8 83.6 84  (Inpercent of exports of goods and nonfactor services; unless otherwise indicated) Public sector debt service 38.0 49.6 54.8 65.7 47.4 Of which: interest payments 17.5 .22.4 21.7 21.0 22.4 Outstanding use o f Fund resources (in percent of quota at end-of-period) 251.5 154.1 183.2 525.3 499.8 Gross foreign exchange reserves 21 8.2 10.1 9.8 6.6 8.6 Sources: Ministry o f Economy; and IMFstaff estimates. -_ 1/ Average interest rate on 30- to 59-day time deposits in national currency. The rate i s weighted by deposit amounts. 21Inmonths of imports of goods and nonfactor services. Under Article IV of the IMFk Articles of Agreement, the IMFholds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views o f Executive Directors, and this summary is transmitted to the country's authorities. ?' 85  ANNEXVIII: Argentina at a Glance Latin Upper- POVERrY and SOCIAL America middle- Argentina 6 Carib. Income Develom" diamond` 2002 Population, mid-year (millions) 37.9 527 331 GNI per capita (Atlas method, US$) Lifeexpectancy 4,080 3.280 5,040 GNI (Atlas method, US0billons) 154.7 1,727 1.668 - Average annual growth, 199642 Population (%) 1.2 1.5 1.2 Labcrforce (%) 2.2 2.2 1.8 Most recent estimate (latest year available, 199642) capita Poverty (% of populationbelownationalpoverfy line) 55 `..1/ enrollment Urban population (% of totalpopulation) 88 76 75 Life expectancy at birth (years) 74 71 73 1 Infantmortality (per 1,OOO live births) 17 27 19 Childmalnutrition(% ofchildren under 5) 5 9 Access to improvedwater source Access to an improvedwater source (% ofpopulation) 86 90 Illiteracy(% ofpopulation age 15+) 3 11 7 Gross primary enrollment (% ofschookage population) 120 130 105 -Argentina Male 120 131 106 -Upper-middleincome group Female 120 128 105 KEY ECONOMICRATIOSand LONG-TERM TRENDS 1982 1992 2001 2002 Economic ratios. GDP (US$ billions) i 84.3 228.8 268.7 102.2 Gross domestic investmenVGDP 21.8 I 16.7 14.2 12.0 Exportsof goods and ServicedGDP 9.1 6.6 11.5 27.7 I Trade Grossdomestic savingdGDP 24.3 15.2 15.5 27.2 Gross nationalsavingdGDP 13.6 12.5 21.3 Currentaccount balancelGDP -2.8 -2.5 -1.7 9.4 InterestpaymenWGDP 6.7 2.1 4.5 9.8 Total debt/GDP 51.8 29.9 52.2 131.4 Total debt servicelexports 50.0 27.6 109.6 102.5 Present value of debVGDP 54.7 Present value of debVexports 401.3 Indebtedness 1982-92 199242 2001 2002 200246 (average annualgrowth) GDP 1.5 1.7 -4.4 -10.9 0.5 -Argentina GDP per capita 0.2 0.4 -5.6 -12.1 -0.7 -Upper-middleincome group Exports of goods and services 4.1 8.1 2.7 3.2 3.7 STRUCTURE of the ECONOMY 1982 1992 2001 2002 I (W of GDP) Growth of investmentand GDP (`A) Agriculture 9.6 6.0 4.8 10.6 ` 4 0 - I Industry 41.1 30.7 26.6 31.9 Manufacturing 31.4 21.9 17.0 21.3 Services 49.3 63.3 68.6 57.4 Private consumption 81.9 73.9 64.8 General government consumption 3.6 10.6 7.9 ! Importsof goods and services 6.5 8.1 10.2 12.5 I I 1982-92 199242 2001 2002 (average annualgrowth) Growth of expom and imports (X) Agriculture 0.7 3.2 1.1 -2.3 1 4 0 ; I Industry 0.0 2.1 -6.5 -13.5 Manufacturing 0.1 1.1 -7.4 -10.5 Services 1.1 3.3 -4.0 -9.2 Private consumption 1.9 4 . 8 -15.1 General government consumption 1.9 g . 1 -5.1 Grossdomestic investment 0.6 0.8 -15.7 -36.1 Importsof goods and services 8.1 6.3 -13.9 -49.7 Note: 2002 data are preliminaryestimates. * The diamonds show four key indicators in the country (in bold) comparedwith its income-group average. If data are missing, the diamondwill be incomplete. 86  Argentina PRICES and GOVERNMENTFINANCE 1982 1992 2001 2002 Domesticprices Inflation1%) (% change) Consumerprices 164.8 24.9 -15 41.0 D ImplicitGDP deflator 207,6 11.9 -1.1 30.8 Governmentfinance i o (% d GDP,includes current grants) 0 Current revenue 18.7 17.1 19.0 17.0 -io Current budget balance -2.4 2.1 -2.3 -0.8 Overall surpluddeficit -9.6 1.3 -3.3 W G D P deflator -3.0 +CPl TRADE 1982 1992 2001 2002 ( U S mMons) Export and importlevels (US$ mlll.) Total exports(fob) 12,393 26,610 25,709 Food 1,548 2,355 2,275 40w0 1 Meat 767 946 914 Manufactures 2,023 15,770 15,733 Total imports(cif) 14,982 20,321 8,909 Food Fuel and energy 510 841 480 Capital goods 6,479 4,102 1,319 Export pnceindex (1995=100) 07 83 import pnce index (1995=100) 84 82 Terms of trade (7995-100) 104 1 BALANCEof PAYMENTS 1982 1992 2001 2002 ( U S mllons) Currentaccountbalanceto GDP (%) Exports of goods andservices 9,185 15,382 30,940 28,643 imports of goods andservices 6,514 19,335 27,456 13,010 T Resourcebalance 2,671 -3,952 3,484 15,633 Net income -5,058 -2,473 -8,243 -6,457 Net currenttransfers 0 770 281 414 Current account balance -2,387 -5,655 -4,477 9,590 Financingitems (net) 1,710 8,932 -16,929 -13,377 Changesin net reserves 669 -3,337 21,406 3,787 Memo: Reservesincluding gold ( U S mlons) 16,516 14,546 10,492 Conversionrate (DEC /cca/NS$) 1.0 1.0 3.1 EXTERNALDEBTand RESOURCEFLOWS 1982 1992 2001 2002 ( U S mdhons) Compositionof 2002 debt (US) mill.) Total debt outstanding and disbursed 43,634 68,345 140,242 134,247 IBRD 504 2,505 9,440 8,513 IDA 0 0 0 0 74835 8512.826 Total debt swvice 4,076 4,882 24,012 5,826 IBRD 98 611 1,388 1,870 IDA 0 0 0 0 Compositionof net resource Rows Official grants- 1 42 6 0 Official creditors 58 760 10,492 -1,851 Privatecreditors 2,755 38 -27,974 137 Foreigndirect investment 678 1,836 3,380 1,741 Portfolioequity 0 13 -9 -27 84595.424 World Bank program 79 Commitments 0 1,W4 436 250 A IBRD E Bihteral - Disbursements 120 460 1,329 424 8 IDA D hhermulblateral - F- Prwate Pnncipalrepayments 46 351 676 1,353 C IMF --- G Shon-term - Net flows 74 109 653 -928 Interestpayments 36 216 968 512 Net transfers 30 -107 -15 -1,441 DevelopmentEconomics 91403 87