Docent of The World Bank

FOR OFFICIAL USE ONLY Public Disclosure Authorized

Report No. 13457

PROJECT COMPLETION REPORT

ARGENTINA Public Disclosure Authorized

PUBLIC ENTERPRISE ADJUSTMENT LOAN (LOAN 3291-AR)

AUGUST 17, 1994 Public Disclosure Authorized Public Disclosure Authorized

Trade, Finance and Private Sector Development Country Department IV Latin America and the Caribbean Regional Office

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS

Currency Unit = Argentinean Peso

Exchange Rate

I US Dollar = 1 Peso

(Since April 1, 1991, the exchange rate has been established by law)

GOVERNMENT OF ARGENTINA FISCAL YEAR

January 1 - December 31

ABBREVIATIONS AND ACRONYMS

ADELCO = Non profit Consumer Advocate Organization "Accion del Consumidor" ATAM = Urban Transit Railway Authority for Buenos Aires CNT = Comisi6n Nacional de Telecomunicaciones EFF = IMF's Extended Fund Facility ENTEL = Empresa Nacional de Telecomunicaciones FA = Ferrocarriles Argentinos FEMESA = Ferrocarriles Metropolitanos Sociedad An6nima GdE = Gas del Estado IMF = International Monetary Fund OSN = Obras Sanitarias de la Naci6n PE = Public Enterprises PERAL = Public Enterprise Reform Adjustment Loan PEREL = Public Enterprise Reform Execution Loan SFM = Servicios Ferroviarios Metropolitanos YPF = YPF Sociedad Anonima (The new name of the National Oil Company) FOR OFFICIAL USE ONLY

THE WORLD BANK Washington, D.C. 20433 U.S.A.

Office of Director-General Operations Evaluation

August 17, 1994

MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT

SUBJECT: Project Completion Report on Argentina Public Enterprise Reform Adiustment Project (Loan 3291-AR)

Attached is the "Project Completion Report on Argentina - Public Enterprise Reform Adjustment (PERAL) Project (Loan 3291-AR)" prepared by the Latin America and the Caribbean Regional Office, with Part II prepared by the Borrower.

The PERAL, approved in February 1991, was aimed at supporting the Government's program to privatize most of Argentina's inefficient public enterprise sector. In addition to broad overall macroeconomic management conditions, the Loan included conditions related to the telecommunications, railroads, and oil and gas sectors, as well as provisions for the preparation of privatization plans for PEs in other sectors and the repeal of legislation granting unlimited domestic preference in PE's procurement policies. Actions provided under the program were supported by a companion Public Enterprise Reform Execution Loan (PEREL). The loan was closed ten months earlier than scheduled as most of the loan objectives and conditions were achieved in a timely manner and even exceeded in certain key areas (e.g. early privatization of the power and port utilities). Argentina's telecommunications, gas, and oil companies were successfully privatized in record time, providing useful models for other countries. Hydrocarbon prices were deregulated. Progress was made, albeit more slowly, in the privatization of railroads and on the regulatory front.

By drawing on the vast amount of sector work carried out in the targeted sectors before the inception of the privatization program, the Bank was able to respond quickly to the Government's request for assistance. An interesting and innovative feature of this operation was that it financed substantial severance payments to staff of privatized PEs. Strong Government ownership of the programs and the existence of a very effective Project Unit also contributed to project success. Both the Bank's and the Borrower's performance are considered to have been very good.

The reform of the PE sector undertaken by the Argentine Government with the support of the PERAL was among the most far-reaching ever carried out by any country. Based on results thus far, the project has been very successful and its institutional impact can be considered substantial. Likewise, its sustainability is considered likely and its overall outcome is judged as highly satisfactory. The PCR is very thorough and informative. An audit is planned.

Attachment

This docunent has a restricted distribution and may be used by recipients onLy in the performance of their officiaL duties. Its contents may not otherwise be discLosed without World Bank authorization.

FOR OFFICIAL USE ONLY PRJETCOMPLETMON REPOR

ARGENTINA

TABLE OF CONTENTS

Page Preface ...... i

Evaluation Summary ...... n-ix

FAKI1

A. The Program ...... 1 B. Background ...... 1 C. Loan Objectives ...... 3 D. Overall Conditions and their Fulfillment ...... 4 E. The Sectors: Iblecommunications ...... 5 F. The Sectors: Railroads ...... 9 G. The Sectors: Oil ...... 15 H. The Sectors: Natural Gas ...... 17 I. Evaluation ...... 19

PAR II

A. Introduction ...... 26 B. Achievements in Meeting Commitments ...... 27 C. Institutional Development of a Telecommunications Regulatory Authority . 27 D. Commitments to Action in the Hydrocarbons Sector ...... 27 E. ResultsintheRailway Sector ...... 30 F. Results under Supplemental Letters ...... 32 G. Evaluation ...... 33 H. Borrower Performance ...... 34 I. Project Relationship ...... 35 L Lessons Learned and Conclusions ...... 35 K. Summary ...... 38

PARIr W

Statistical Thbles A. Related Bank Loans...... 39 B. Project 'limetable ...... 40 C. Loan Disbursements ...... 40 D. Dates of Tranche Disbursements ...... 40 E. Project Costand Financing ...... 41 F. Status of Covenants ...... 42 G. UseofBankResources ...... 44 H. Project Preparation Funding ...... 45

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

-1-

ARGENTINA

PROJECT COMPLETION REPOR

PUBLIC ENTERPRISE REFORM ADJUSTMENT LOAN PERAL I (LOAN 3291-AR)

PREFACE

1. This is the Project Completion Report (PCR) for that part of the public enterprise privatization program of Argentina for which Loan 3291- AR was approved on February 12, 1991. The Loan was fully disbursed and closed on February 17, 1993, ten and a half months ahead of schedule.

2. The PCR was jointly prepared by the Tade, Finance and Private Sector Division of Country Program Department IV of the Latin America & the Caribbean Regional Office (Preface, Evaluation Summary, Parts I and III) and the Borrower (Part II).

3. Preparation of the PCR started in May 1993, and is based, inter alia. on the Staff Appraisal Report, the Loan Agreement and Supplementary Documents, the Supervision Reports, various consultants' studies and reports, correspondence between the Borrower and the Bank, internal Bank memoranda and a short evaluation mission to Argentina which included discussions with agencies of the Borrower involved with the program, as well as discussions with selected clients of these agencies, i.e., some of the intended ultimate beneficiaries of the operation.

4. StaffAssignments:

(a) During Loan Preparation (up to July 1990)

Division Chief and Task Manager: Peter R. Scherer Department Director: Pieter Botellier

(b) From Post Appraisal through Project Completion

Thask Manager: Stefan Alber Division Chief: Paul Meo Department Directors: Pieter Botellier/Ping-Cheung Loh

- 11-

ARGENTINA

PROJECT COMPLETION REPORT

PUBLIC ENTERPRISE REFORM ADJUSTMENT LOAN PERAL I (LOAN 3291-AR)

EVALUATION SUMMARY

A. Loan Objectives and Structure

1. The US$300 million PERAL I Loan to the Government of Argentina, approved on February 12, 1991, was designed to support a part of President Carlos Menem's new (August 1989) Administration's program to privatize most of the country's public enterprises (PEs). These had been a heavy drain on Argentina's economy for many years, both because of their inefficiency (the microeconomic burden) and because of their losses, covered by the Treasury (the macroeconomic cost).

2. The Bank's role was to offer financial (including the visible use of Loan counterpart funds for labor redundancy payments), technical (including a broad program of T.A. through a companion Loan, PEREL) and moral (through assistance to market access, etc.) support. The privatization programs receiving direct support under the Loan were those in the 'Iblecommunications, Railroads and Hydrocarbons (Oil and Gas) sectors. Ultimately, the Government's total program went much further; it included, inter alia, airlines, ports, electricity, water, shipping and many industrial enterprises. Eventually, the Loan became part of a much larger Bank adjustment lending program of an additional US$1.5 billion, directed at public sector institutions, enterprises of the defense complex, the financial sector and foreign debt reduction (the so-called "Brady Deal").

3. The Loan was structured so as to be disbursed in three Ianches: US$150 million upon Effectiveness and the remainder in two US$75 million "floating" (i.e., not time dated) sectoral tranches upon achievement of specified objectives and measures in the Railway and Hydrocarbon sectors, respectively. These disbursement conditions were chosen on the basis of either being intrinsically crucial for the program or of being broadly representative of overall progress. In addition to the sectoral conditions, both "floating" tranche disbursements were made contingent on the meeting of some broad overall economic management conditions. - 111 -

B. Implementation Experience

4. The great majority of the disbursement conditions were fully met in a timely manner, so that the Railway and Hydrocarbon Tranches were released, respectively, in December 1992, and in February 1993, leading to a Loan Closing in the latter month, a full ten and a half months before the date estimated originally. The main economic management and sectoral experiences are summarized below.

C. Overall Conditions

5. The principal one was the maintenance of an economic framework consistent with the overall Program. Since Argentina met or exceeded the targets of its 1992 EFF Agreement with the IMF, this condition was considered met. Two other conditions, the presentation of further plans for privatization and of performance criteria for other PEs, became moot when these PEs actually were privatized. And repeal of the obligation of PEs to procure domestically regardless of price (Compre Argentino), was considered accomplished, in spite of some cavils about its legal adequacy, because the virtual disappearance of PEs made it, too, moot.

D The Overall Conditions and their Fulfillment

6. Below are listed the overall economic management conditions, together with their implementation record.

(a) Maintenance of a macroeconomic poliev framework consistent with the objectives of the Program. This condition was considered fulfilled principally on the basis of Argentina's meeting or exceeding the targets specified in the Extended Fund Facility Agreement entered into with the IMF in early 1992. The Government's Letter of Development Policy, which constituted part of the legal documentation, provided a broad framework for the Bank's judgement.

(b) Implementation of a system of performance agreements for four major PEs (not those covered by the Loan). This condition soon became overtaken by events.It had been based on the assumption that the enterprises in question' would, for the time being, remain PEs; when later the Government decided to privatize them forthwith, the condition ceased to be relevant.

(c) Formulation of plans for further privatizations of major infrastructure enterprises. This condition, too, became moot when the Government instead of producing plans, produced the

1. Agua y Energia, YPF, HIDRONOR, Servicios Metropolitanos Ferroviarios. - iv -

actual privatization of the PEs in question; it greatly surpassed its covenant obligation.

(d) Repeal of the legislation mandating (practically) unlimited domestic preference in the procurement policies of PEs. This condition was considered fulfilled after a certain amount of hesitation in the Bank, since the legislation in question - the Compre Argentino Laws - in the view of the Bank's Legal Department had been suspended rather than repealed. Since, however, the Loan Agreement had a "...or other action satisfactory to the Bank..." clause in this covenant and since, in any event, the widening scope of the privatization program meant that soon very few PEs would remain, the issue was considered settled.

E. Tlecommunications

7. The privatization of ENTEL, the major PE of the sector, had been a condition for Board presentation. Thus, it was not felt necessary to include sectoral disbursement conditions in the Loan Agreement. ENTEL had a wholly unsatisfactory service record and.there was a large unmet demand for lines. ENTEL was broken up; two private Regional (North and South) operators were licensed under open tender for telephone service (with exclusivity guaranteed for a certain number of years); most other telecommunications services were deregulated. An autonomous regulatory body, Coinision Nacional de Telecomunicaciones (CNT), was created to monitor the adherence to the concession agreements of the licensees for the years of exclusivity, rule on proposed tariff changes and perform most other normal public utility commission functions.

8. Although CNT was legally created in a timely manner, it was not able, initially, to function as needed, and still is doing so only in part. The Bank was instrumental in alerting the Government to the problem; eventually the Management was changed and progress is now being made, through, inter alia, substantial technical assistance help under PEREL. But unquestionably, and perhaps inevitably, the privatization itself has run ahead of the creation of the institution that was judged necessary to ensure satisfactory and competition-like results in a market with necessarily substantial monopoly power. CNT as yet has only an imperfect data flow from the two licensees, and is still in the process of creating an adequate accounting and financial analytical framework.

9. Nevertheless, the privatization program itself seems to be quite successful so far. Service data from the licensees suggest notable improvements; investments, profits and tax revenues are up sharply.

2. SEGBA, Administraci6n de Puertos, Obrs Sanitarias de la Naci6n. -v-

F. Railroads

10. Ferrocarriles Argentinos (PA) had been the largest loss maker among the PEs and a major cause for Argentina's chronic macroeconomic management difficulties. It was greatly overstaffed and politicized and several previous reform efforts had failed. Under the Program, its freight services were to be concessioned by open bidding to private operators. The Buenos Aires rail passenger service was to be hived off to a new company owned by the central, provincial and local governments and plans were to be made to limit its subsidy; other uneconomic rail passenger services were to be closed. Before privatization FA's labor force was to be greatly reduced. An autonomous regulatory body was to be set up.

11. Under the Bank Loan a number of critical milestones in the program were identified as disbursement conditions for the "floating" Railroad Sector Tranche:

(a) The fiscal transfers to the railroads were to be at or below US$350 and US$250 million in 1991 and 1992 respectively. This condition was not met by a wide margin, and the Board was so informed. It was also informed that the reasons for the overrun, a delay in the freight privatization and B.A. passenger rail transfer, had been overcome, and that the 1993 budget foresaw only US$140 million in transfers. This budgetary allocation has proved over optimistic; by May 1993 the figure already had exceeded US$150 million. The privatization and transfer delays have continued.

(b) At least 30,000 workers of FA were to be retired. In the Letter of Development Policy, the Government agreed that counterpart funds generated under the Loan would be used for severance payments. Since average payment per worker was about US$12,000, the resulting US$360 million exceeded the total loan. The retirement target was slightly exceeded and was strictly monitored by the Borrower to prevent reemployment. The settlements were considered generous so that the program could be carried out without significant labor union opposition.

(c) For three specified major freight lines, concession agreements were to have been executed. This was not achieved; by the time of the Railway Tranche disbursement only one of the cited cargo lines actually was executed (plus one that had not been covenanted and one that had already existed at Effectiveness). The Board was so informed but was given to understand that the delay would be made good shortly so that "...in sum, cargo line concessioning has gone much further than expected at the time of approval...". This, as already noted, turned out to be moderately optimistic; regarding concessioning of freight lines, the additional agreements were executed in January and March 1993 respectively. - vi -

(d) A plan acceptable to the Bank, to reduce the Buenos Aires passenger subsidy, was to have been agreed by the three levels of government and the railroads. This condition was considered met when the new company, Ferrocarriles Metropolitanos Sociedad Anonima (FEMESA), instead of operating, decided to concession the service, and to evaluate bids on the basis of the least required subsidy. An award was made and transfers are in progress. Thus, the eventual outcome is likely to exceed Loan objectives greatly, but in the short term the budgetary benefits of the lower subsidies have been delayed.

(e) An Urban Transit Railway Authority for the Buenos Aires Metropolitan Area was to be established. This was done; the new Authority (ATAM) also has jurisdiction over subways, buses, parking, etc. There is no experience yet on how it operates.

(f) A plan to rationalize interurban passenger services and the elimination of all uneconomic lines was to be adopted. In July 1992, a Decree announced the latter, and the Bank considered the Loan condition fulfilled even though the Government decided that Provinces wanting to take over uneconomic passenger services could do so. Four Provinces have opted for this.

(g) An independent national railway authority was to be established. This was done, but it is not yet operational and its functions, visa vis those of the Ministry, remain uncertain.

12. The only freight line that has operated for more than two years under concession is making losses because traffic is much less than expected. Poor traffic prospects also seem to account for some of the operator-induced delays in executing the other concession agreements. Some of the causes, like this year's disastrous floods, are clearly temporary.

G. QH

13. The PE YPF was substantially slimmed down by shedding non-core activities and reducing labor redundancy. By way of share offerings in international markets, by September 1, 1993, all levels of government together will have only a minority stake of about 32 percent. The "floating' sectoral Tranche disbursement conditions focussed on price deregulation, the maintenance of free trade in crude and products, execution of production sharing agreements with private firms, divestiture of non-core assets, a new charter for YPF and the setting up of a policy making and regulatory body. They were all met in substance.

H. Natural Gas

14. The gas transporting and distributing PE, Gas del Estado (GdE), was eventually replaced by two private transmission companies and eight private - vii - distribution companies. An objective of the new structure was to introduce as much competition as possible into the sector and to create incentives- previously absent-to minimize transport costs and to let field-market distance influence the choice of gas sources. The "floating" tranche conditions focussed on completing the privatization of at least two distribution companies, gas prices (at least 90 percent of international levels of fuel oil equivalent at user level) and the setting up of an independent regulatory authority. The conditions were met, although the new authority (Ente Regulatorio) has begun to function only in recent months and actual regulations are still in the hands of the Secretariat of Energy. Whether competition will eventually function remains to be seen, since prices can remain regulated until mid-1994.

I. Evaluation

15. Most, though not all, Loan objectives have been achieved and accomplishments in some important areas have exceeded the original aims and were achieved faster than originally projected. This is all the more remarkable as this was a high risk operation for the Bank; there was little successful past experience to draw on; judged by historical experience the subject of PEs in Argentina was explosive and the danger of great public embarrassment for the Bank in case of failure could not be overlooked. Among the main reasons for the largely successful outcome are:

(a) The initiative to privatize was entirely the Government's. The Bank was vital in providing financial and technical support, but never set the basic policy objective. This would seem to be a lesson of wide a"oicabilit

(b) The Bank prudently kept a low profile; in spite of a ubiquitous Bank presence, privatization never became a "World Bank Program" in the eyes of political or public opinion. This too would seem to constitute a generally applicable lesson.

(c) A large amount of relevant sectoral work had been done by the Bank before there was any indication that a privatization program might be possible. Since at the time the chances for any lending resulting from this work were quite low, it may well be thought of as a very high risk gamble. But it paid off; without this technical work it would have been difficult for the new Government to seize the moment and push ahead with privatization at the point where a pervasive sense of national crisis gave it the needed political support. It is far from clear whether this fortunate outcome offers a good basis for a general policy of undertaldng costly sector work when lending chances are low: the law of large numbers suggests that the results would. on the long run. not warrant the cost. But the experience suggests that a certain diffidence in evaluating lending chances is warranted. - viii -

(d) Implementation was greatly enhanced by a highly effective Project Unit. The fact that the Head of the Unit had participated. from the beginning. in Loan discussions and in formal negotiations. enabled the Unit to play a constructive role during implementation, since he was fully aware of the backgrounds and rationales of the often complex issues and of the actions required from the many agencies involved. This practice probably should be replicated in most similar operations.

(e) The Bank's investment in Loan Formation and Administration was heavy (about 612 SW) but vital. Without it, the program might have come to a stop at critical junctures. If budgetary concerns make such unstinting support impossible. it may be better not to enter into operations of this kind.

(f) The Bank's imaginative use of adjustment lending, in allowing visible application of counterpart proceeds to finance severance payments, was decisive in making railroad privatization feasible. But its justification hinged on two circumstances: monitoring to prevent rehiring or replacement and, even more important, imminent privatization, after which the pressures to overstaff would, presumably, largely disappear. Only similar circumstances in other cases would seem to warrant a similar policy posture.

16. A relatively unsatisfactory feature of the PERAL I experience is the degree to which privatization outran the functioning of the regulatory institutions, even though, mostly these were crated in a timely manner. It raises the question whether either the privatization program should have been delayed or whether more should have been done to accelerate the full development of the regulatory institutions. The former was clearly impossible; the political moment in which the new Government could count on national support for this most controversial new departure had to be seized; there is every reason to believe that a year later would have been too late. No doubt, more attention should have been paid early on to the steps needed subsequent to creating the Authorities, but the possibilities of what might have been achieved should not be exaggerated. The attention of the limited number of responsible policy makers could not but be focussed primarily on the critical privatization issues first; had it been otherwise these might not have been resolved and regulation would have been a moot issue. An appropriate conclusion for future cases would seem to be that the Bank ought to keep the Argentine experience in mind and *lean against the wind" as much as possible to ensure that these issues are attended to early. but ought not to be overly sanguine about the chances for full success.

17. The disappointments under the Loan, namely the pace of progress in meeting some of the specific Railway Sector conditionality and the effectiveness of the regulatory bodies that were to be set up, are linked by a common thread. It is that well before either issue was resolved, the Bank no longer was an important player. The Loan was closed in February 1993, Supervision ceased and the Bank was not in a position to help, warn, cajole or press for remedial action when things seemed to be going wrong, because it was no longer so close to the program. There is a basic structural problem in financing programs of five or more years' implementation with loans that are to be disbursed in one or two years. and unless special precautions are taken. the risk of underachievement of objectives is serious. These precautions may be of several kinds: follow-up project (or even follow-up sector) Lmans, larger Adjustment Loans with more Tranches, etc. Butithe central goal. to permit the Bank to accompany the adjustments that are the object of its Loan in the first place. for long enough to help ensure the robustness of the institutions needed to make them function, and to do so without an undue inflation of its Supervision costs per dollar lent. is critical. ARGENTINA

PROJECT COMPLETION REPORT

PUBLIC ENTERPRISE REFORM ADJUSTMENT LOAN PERAL I (LOAN 3291-AR)

PART I: PROJECT REVIEW FROM BANK'S PERSPECTIVE

A. The Progrm

1.1 The first Public Enterprise Reform Adjustment Loan - PERAL I - (Loan 3291-AR) to Argentina, for US$300 million, was designed as a relatively quick disbursing balance of payments support operation with the specific objective of providing financial, technical and moral support for an important part of the Government's program of profound structural economic reforms. The Government was in the process of privatizing many (eventually it became virtually all) Public Enterprises (PEs); PERAL I was designed both to support the genera policy and to give very direct support to spifi privatization operations in the telecommunications, railways and oil and gas sectors.

B. Backeround

1.2 Since the 1940s, the Argentine State had developed a pervasive presence in the economy. For various reasons that go far back into history and politics, state enterprises had become dominant in virtually all public services and had also gained important footholds in manufacturing industry, banking and other financial services, etc. Since through much of the period parliamentary institutions had been weak and unstable, the public accountability of these PEs was minimal and most had become heavily politicized, with overstaffing, inefficiency and absence of concern with commercial criteria in investment and operating decisions being common.

1.3 As a result, governments were continuously being put under pressure to finance the growing operating losses as well as the investments of the enterprises, either from the national budget or by using the State's limited foreign borrowing capacity for them. In response, a number of attempts had been made in earlier years to sanitize the most egregious loss making PEs, especially the railroads. These attempts, which had, at times, been supported by Bank loans, had mostly failed because the political cost of closing uneconomic services and reducing labor redundancy sufficiently, had proved to be too high.

1.4 It had thus gradually become clear to increasingly wide segments of opinion makers as well as of the population at large that the inefficiency of the PEs was a dead weight on the economy in two ways: on the one hand because the railways, electricity, telephone, ports and other public services were unsatisfactory and created high costs for the industrial and agricultural -2- sectors (the microeconomic burden), and on the other hand because the drain which the PEs produced on the national budget made sound macroeconomi management for any length of time virtually impossible. The latter was evidenced by the fact that over the years one economic stabilization plan after another failed, with increasingly short intervals between them.

1.5 The coming to power of President Menem in 1989 coincided with the latest and most dramatic of these failures. The collapse of President Alfonsin's economic management and the initiation of hyper-inflation caused the transfer of power to President Elect Menem to be pushed forward by five months by mutual agreement. There was an unprecedented general sense of national crisis and, consequently, a greater willingness than in many decades to abandon past formulas and to take radical remedial measures.

1.6 The new Regime responded very fast with a National Economic Emergency Law and a Law to Reform the State. Together they contained the elements for a virtually new beginning in the organization and management of the Argentine economy. The role of the state would be reduced to ensuring that markets operated as competitively as possible, that Argentina would be fully integrated into the international economy (itself a major guarantor of competitive pressures) and that some basic social services would be provided. The state would cease to be a producer or a trader of goods and most services.'

1.7 The atmosphere of crisis in which the new policies were born implied also an extreme sense of urgency on the part of the Government, both for objective reasons - the deficits had to be dealt with fast if the economy was to be stabilized - and because the political support for drastic measures could not be expected to last indefinitely unless major actions and results were shown promptly. Consequently, a number of major decisions regarding both scope and method of the privatization process were only made in the course of program implementation; the process had beg=n without a detailed blueprint. Moreover, in different enterprises quite different methods were adopted; while in part this responded to differences in the nature of the enterprises and their problems, in part it also was the result of adaptive learning from the experiences of the first privatizations and of a pragmatic willingness to experiment in the absence of many instructive precedents.

3. Subsequently, equally dramatic changes were made in the monetary and financial system. The creation of money was firmly tied to the level of international reserves, full peso-dollar convertibility at par was instituted and the indexing of contracts in pesos was invalidated. Thus, the usual contemporary system of monetary and exchange rate management discretion was replaced by a system of nles akin to those of the Pro- World War I Currency Boards. -3-

C. Loan Objectives

1.8 The Bank had long recognized the key role of the PEs in both the micro and the macro-management of the Argentine economy. As noted, it had in the past tried to help improve their efficiency through reform programs tied to specific investment loans, not only in railroads but also in the electric power, water and ports sectors. The success of these attempts had been very limited. Between 1987 and 1989 the Bank, in collaboration with the Alfonsfn Government, had been engaged in preparing a broad gauged program to improve the efficiency of the public enterprises in general, but without any thought of necessarily changing the basic conditions of ownership.

1.9 When the new Government announced its intention to do away with most or all PEs, it also sought the assistance of the Bank for this process. Much of the technical work done in connection with the plans referred to above then provided a highly useful foundation for the privatization program.

1.10 The Bank was quick in deciding to accede to the request for assistance. It recognized that micro and macroeconomic issues were involved which were quite critical for Argentina's future; also it was thought that the Bank's detailed knowledge of many of the sectoral issues, as well as its overall experience could make a valuable contribution. Moreover, by the time of post-appraisal, it became clear that the short-term impact on the public finances of paying for the retirement of many thousands of redundant workers and employees would be so heavy, that the Bank's financial presence could also play a direct enabling role.

1.11 The Bank's support to both the Alfonsin and Menem governments was characterized by an extraordinary manpower effort lead by Division Chief level staff and other senior sectoral professionals. Another eminent feature was the Bank's ability to rise to the occasion and make available to the authorities project preparation funds, well beyond the normal limits of the Bank's project preparation facilities, to finance the government's needs for sectoral specialists, investment bankers, auditors and attorneys, all needed to pave the way for the privatization of targeted public enterprises. In all, the Bank facilitated about US$7 million, tapping several existing Bank loans, three Project Preparation Facilities, some special funds including US$1.1 million in Japanese Grant funds (see Part III, Section H) Argentine officials acknowledged that without the Bank's continuous technical and financial support, the ambitious reform program would not have been launched.

1.12 After much internal debate, it was agreed to focus the Bank's participation in the privatization effort on the telephone, railroads and oil and gas sectors. Technical assistance would be provided through a parallel, related loan (Public Enterprise Reform Execution Loan - PEREL - 3292-AR) which will be fully committed by the first semester of CY 1994. PERAL I disbursements would be tied to the fulfillment of two types of conditions: -4- geneal ones pertaining to economic management and sector scific ones pertaining to the sectoral institutions covered by the Loan. One half of the Loan would be disbursed upon effectiveness and the rest in two equal "floating" (i.e., not time-specific) sectoral tranches upon fulfillment of particular sector specific conditions.

1.13 Eventually, the Loan became part of a much larger Bank adjustment lending program of an additional US$1.5 billion, directed at public sector institutions, enterprises of the defense complex, the financial sector and foreign debt reduction (the "Brady Deal").

D. The Overall Conditions and their Fulfillment

1.14 Below are listed the overall economic management conditions, together with their implementation record.

(a) Maintenance of a macroeconomic policy framework consistent with the objectives of the Program. This condition was considered fulfilled principally on the basis of Argentina's meeting or exceeding the targets specified in the Extended Fund Facility Agreement entered into with the IMF in early 1992. The Government's Letter of Development Policy, which constituted part of the legal documentation, provided a broad framework for the Bank's judgement.

(b) Implementation of a system of performance agreements for four major PEs (not those covered by Loan). This condition soon became overtaken by events.It had been based on the assumption that the enterprises in question' would, for the time being, remain PEs; when later the Government decided to privatize them forthwith, the condition ceased to be relevant.

(c) Formulation of plans for further privatizations of major infrastructure enterprises. This condition, too, became moot when the Government instead of producing plans, produced the actual privatization of the PEs in questions, i.e. greatly surpassed its covenant obligation.

(d) Repeal of the legislation mandating (practically) unlimited domestic preference in the procurement policies of PEs. This condition was considered fulfilled after a certain amount of hesitation in the Bank, since the legislation in question - the Compre Argentino Laws - in the view of the Bank's Legal Department had been suspended rather than repealed. Since,

4. Agua y Encrgia, YPP, HIDRONOR, Servicios Metropolitanas Ferroviarios.

5. SEGBA, Administraci6n de Puertos, Obras Sanitarias de I Naci6n. -5-

however, the Loan Agreement had a "...or other action satisfactory to the Bank..." clause in this covenant and since, in any event, the widening scope of the privatization program meant that soon very few PEs would remain, the issue was considered settled.

E. Tlecommunications Sector

1.15 Before privatization, the PE Empresa Nacional de TIblecomunicaciones (ENTEL) served about 90 percent of all subscribers to public networks in Argentina. Service levels were quite inadequate; only 47 percent of all urban call attempts and 23 percent of all interurban and long distance ones were completed; a 70 percent figure is considered the minimum that a well developed system should achieve. As the PE's generation of funds had been insufficient, investments had been lagging behind requirements for decades; estimates were that there was an unmet demand of one million lines and waiting periods of many years were common for new subscribers.

1.16 The Law of the Reform of the State of August 1989 made ENTEL privatizable and the Implementation Decree of September 1989 laid down detailed guidelines. Basic telephone service was to be provided under exclusive rights (fbr 5 years after an initial 2 years for organization. Renewable for three more years if certain service targets are met) by two private zonal (North and South) operators whose licenses were to be awarded by public tender. Non-basic services and terminal equipment were to be open to competition. Two other companies initially would be owned jointly by the two licensees: one to provide international phone, telex, data and leased satellite circuits, and another to provide national telex and data services and maritime mobile radio, all under competitive conditions. The joint ownership of these companies by the two operators was considered necessary because it was foreseen that for a number of years these services would have to cross-subsidize some of the basic ones.

1.17 Since the two licensees would have substantial degrees of monopoly power, an autonomous Regulatory Authority (Comision Nacional de Tblecomunicaciones - CNT) was to be created. It would monitor the performance of the operators under their license agreements which included a number of specific targets regarding the expansion of the system and the quality of the service and were conditions of maintenance of the exclusivity.

1.18 CNT would analyze and oversee tariff setting. During the exclusivity period the basic criterion for rate making was to be a pulse rate expressed in dollars, with adjustments according to the U.S. cost of living index. So far, the system has worked quite well but the licensees consider it potentially onerous because of the fixed dollar/peso parity and the danger that their costs-mostly pesos--could rise faster than the reference (dollar) index which determines revenues. -6-

1.19 CNT further was to monitor the finances of the operators, review cost of service estimates and their methodology, establish performance indicators and systems to monitor them, assess the licensees' investment, depreciation and procurement policies, establish technical standards for network and terminal equipment and provide advice and support to ensure that efficient operations underlay any proposed tariff increases. It was, in short, to perform the highly complex economic and technical functions of a typical Public Utility Commission in a sector with advanced and rapidly evolving technology.

1.20 It should be noted that, although CNT was charged with ascertaining the licensees' financial rates of return, these were deliberately rejected as the basis for rate making. In part this was done because of the unfamiliarity of the rate of return approach to legislators, journalists and the public and because of real difficulties in establishing a proper valuation of existing assets. In part it was also based on the fact that, since it was assumed that the whole large expansion program had to be financed out of internally generated funds, the target rate of return that would have to be set, of at least 16 percent, might be too controversial.

1.21 The existing collective bargaining agreement between ENTEL and its labor union was rescinded before privatization; it may well be that otherwise no bidders might have presented themselves. As it was, out of eleven prequalified bidders, three finally submitted bids. Eventually, the awards went to 'Iblecom Argentina for the Northern Zone and Iblef6nica de Argentina S.A. for the Southern Zone. The former has a French/Italian, and the latter a Spanish operating company.

1.22 As noted, ENTEL was one of the first privatizations to be undertaken, and it was urgent for the Government to proceed apace. Hence, by the time the Bank's Loan began to take shape, many of the fundamental decisions had already been taken and the program was well on its way, which is not to say that the earlier Bank work on the sector had not been a major input into the Government's decision making'. The finalization of the privatization of ENTEL was made a condition of Board presentation; what remained to be done was mainly the large task of making the newly created system work. This involved primarily the provision of technical support and expertise.

1.23 For that reason no telecommunication sector-specific conditionality was included among the tranche disbursement conditions of PERAL I; rather the Bank's covenants on telecommunications are to be found in the Letter of Development Policy and in PEREL, which will only be reported on when it is closed. At the same time, however, the fact that the ENTEL privatization

6. See, for example, the November 18, 1988, Letter of Transmittal by Mr. P. Scherer, Chief of the Trade, Finance and Industry Division of LAC Country Department IV, of the Report of a Bank Technical Group regarding a possible joint venture between ENTEL and Telef6nica do Espahia. -7- began earlier than the others included in the Loan, permits at least a very preliminary look at some of the early results of the process, i.e. at issues going beyond the compliance with covenants or the timeliness of implementation.

1.24 One issue on which there is a wide measure of agreement in the Government and among other interested parties--e.g. consumer groups and licensees--is that, in spite of the prompt IWa9 creation of the Regulatory Authority (Comision Nacional de Iblecomunicaciones, or CNT), it was not ready to perform its role when it was first needed and, in spite of definite improvements, still is doing so only in part. Initially it was staffed by ENTEL and Ministry of Communications personnel without any clear conception of the function of an independent regulatory body. It lacked not only all data but also a conceptual framework for obtaining relevant data; it lacked the accounting, legal, financial, economic and technical basis needed for its work, and it lacked the orientation of public service.

1.25 The Bank played an active role in alerting the Government to this problem, which could only be addressed after the first Management of CNT was changed in January 1992. Some information--mainly financial--is now flowing from the operators to CNT. CNT organization has been assisted by consultants under a US$1.5 million contract, financed through PEREL. On April 15, 1993, CNT finally issued the service quality regulations (Reglamento de Calidad de Servicio) which laid down the licensees' service obligations in far greater detail than the license contract. Even now, however, CNT does not yet have a complete and current information system regarding all aspects of the licensees' performance.

1.26 While CNT clearly had responsibility for monitoring performance under the license agreements, it has only recently accepted that part of its mandate concerns the licensees' responsiveness to individual complaints (one of ENTEL's most deficient aspects). In May 1992, CNT signed a contract with a non-profit consumer advocate organization (Accion del Consumidor, or ADELCO), to represent complaining consumers before the licensees and before CNT, channelling complaints first to the licensees and then, if needed, to CNT, and monitoring implementation of any remedial action that CNT may resolve. ADELCO carries statistics of complaints received since the initiation of the contract; they are inconclusive but do not suggest any pronounced trend. In any event, no statistics about how complaints were disposed of exist.

1.27 More data on service performance are available directly from the licensees. Iblef6nica de Argentina (Southern Zone), for example, carries monthly statistics on its own performance under the principal quantitative targets of the license agreements (but reports these to CNT only when requested, which seems to be annually). Some of these are: -8-

Table 1 - Telef6nica's Adherence to License

LICENSE ACTUAL OBLIGATION Percent of Calls Completed

Local Intraregional 70.00 98.91 Interurban Intraregional 60.00 98.27 Percent of Calls Not Completed

Local Interregional 43.00 4.55 Interurban Interregional 59.00 2.03 Operator Service (%)

Information; response under 10 sec. 67.00 74.80 Repairs; response under 20 sec. 67.00 64.18 Interurb. calls; assit. under 10sec. 67.00 84.88

Delay in Repairs in Local Netw. (Days) 7.00 3.29 Waiting Period for New Lines (months)' 12.00 11.36

1.28 Thus, most of the service minima established in the license agreements have been exceeded to date. ADELCO reports less progress than these figures suggest with respect to responsiveness to individual complaints, but its reporting period is still very short. Residential connection charges have been reduced from US$1,200 in 1990 to US$900 by November 1991 and US$750 by November 1992. For November 1993, a further reduction to US$500 is planned and a last one, to US$250 has been ordered for November 1995.

1.29 The two licensees appear to be increasingly profitable. From their published accounts, the following figures can be extracted; they probably overstate net worth because of overvaluation of assets; if so the true rate of return on equity would be higher than shown here.

7 Measured by dividing current monthly number of installations of new lines by total backlog of requests. Thus it does not pretend to reflect either past or future actual waiting periods, but only what the average waiting period for presently outstanding requests would be if the current rate of installation continued in the future. -9-

Table 2 - Profitability of Privatized Tlephone Companies

Telecom Telef6ica

(US$ million)

Profits Before Taxes 1991 92.8 160.1 1992 182.3 293.2 Profits After Thxes 1991 55.2 121.2 1992 150.3 219.1 Net Worth 1991 1,743.8 2,418.9 1992 1,844.0 2,524.1 Average 1991-1992 1,793.9 2,471.5 Profits in 1992 as % of Net Worth in Average 1991-1992 Before Taxes 10.2 11.9 After Taxes 8.3 8.9

Source: Profits and Net Worth from company accounts provided by CNT.

1.30 Good progress is reported by CNT with respect to cellular telephones. Two systems already exist in Buenos Aires. The rest of the country has been divided into two zones for this purpose, and tendering is under way. Nine bidders have been qualified; bids are to be evaluated on the basis of speed of installation and scope of service rather than of price only.

E Railroads Sector

1.31 Ferrocarriles Argentinos (FA), the PE owning and operating the national railway network of some 35,000 km. had been a major drain on the national Treasury for many years, requiring an average annual subsidy of over US$500 million between 1986 and 1990. For more than 15 years, its wage bill alone had exceeded its total revenues. It was, moreover, in the throes of a vicious circle; its lack of internally generated funds prevented adequate maintenance and improvement investments; this, in turn, caused a deterioration of equipment and service and continuing loss of customers, mainly to the trucking industry. Thus freight traffic fell from 15 billion T/Km in 1970 to under 9 billion in 1988 and passenger traffic, in the same period, from 7 billion P/Km to 6 billion in the Buenos Aires Metropolitan Area and from 5 billion P/Km to 4 billion for interurban traffic. Since much of Argentina's exports consist of bulky agricultural commodities, the shift to trucking as the preferred mode of transport involved a heavy economic cost on the agricultural sector. - 10 -

1.32 The main causes of FA's problems included overstaffing and archaic work rules enforced by politically powerful labor unions which also interfered with management decisions; maintenance of uneconomic lines to accommodate not only labor but also provincial political interests and urban passengers; lack of concern with commercial criteria which resulted, ine aia, in underallocation of locomotives to the more economic services; procurement restrictions (such as the Compre Argentino rule) and high import tariffs; the already cited insufficiency of funds for maintenance and investments; and tariff regulations which prevented flexible pricing and efficient adaptation to market situations.

1.33 The formula chosen to achieve the privatization of FA--derived from a Bank sponsored study--was to divide the PE into various segments and to issue concessions, through competitive bidding, for the potentially profitable ones, to private operators. These segments would include cargo networks, some interurban passenger services, railway workshops and rolling stock. The Buenos Aires metropolitan rail passenger service, a major loss maker which, however, had some economic justification because of urban congestion problems, would be separated from FA and run as a separate company under a regional authority, with plans, to be agreed, on the fiscal subsidies that it could receive. All uneconomic--i.e. unprivatizable-- interurban passenger services would be closed or offered to the provinces to run at their expense. FA's large real estate holdings would be developed and/or sold and the proceeds would constitute a fund to help finance the urban passenger service subsidy. Surplus labor would be reduced appreciably before privatization.

1.34 The Bank's role in this process was of several quite distinct natures. On the one hand it provided a critical input to accomplish the program as a whole, inasmuch as the cargo lines could not have been privatized if bidders had to take on the redundant labor. Since the labor that had to be shed needed adequate severance pay, the immediate financial cost to FA--or rather to the Government, since FA had no money--was heavier than might have been supportable in a setting of fiscal crisis. The Bank Loan removed this obstacle, not only de facto' but, importantly, even in appearance, as Loan counterpart funds had been agreed to be channeled for the payment of retirement benefits.

1.35 The other form in which the Bank Loan became a structural component of the program was that the Borrower and the Bank agreed on a series of measures that were considered either in themselves critical for the future attainment of program objectives, or that were viewed as broadly representative of the pace of progress achieved. These steps would constitute formal prerequisites for the disbursement of the "floating" railway loan tranche.

8. Since money is fungible, any transfer of funds to the Government not offset by corresponding additional expenditures would have relieved the strain on the fisc. - 11 -

1.36 These conditions and the degree to which they were met, are described below.

(a) Transfers to the railroads from the Central Government budget were not to exceed US$350 million and US$250 million in 1991 and 1992. respectively 9 When, in December 1992, the Bank informed the Board of Directors that the Railway Tranche release conditions had been met, it was noted that these particular targets had not been achieved and that transfers had been closer to US$500 million and US$700 million in the two years. But it was said that the causes of this underperformance had been overcome and that the Government's budget request then before Congress for 1993 amounted to only US$140 million for such transfers.

1.37 Budgetary expectations will not be met by a substantial margin during 1993. In the first five months of 1993, US$152.8 million had already been received by the railroads (FA and FEMESA, see below), and the authorized ("librado") amounts for the same period are even higher (US$193.6 million).

1.38 The main reason for the performance shortfall is that the pace of the privatization of the freight lines and of the adoption of the new order for the Buenos Aires passenger service has continued to lag considerably. At the time of the Railway Tranche release, it looked as if the main cause for these lags was that the new initiative of the Government (to concession the service instead of having the new company operate it) added a major new structural reform dimension. This new dimension strained temporarily the Government's capacity to manage the process"o and caused delays in concessioning the freight services as well.

1.39 While this explanation was, no doubt, correct, it now appears that other causes were at work as well, including delays caused by some of the winners of concessions when it appeared that immediate traffic prospects were less favorable than had been assumed at bidding time. Floods, the delay in complementary infrastructure investments--especially the expected rehabilitation of the port of Bahfa Blanca--and even second thoughts about contract clauses seem to have played a role.

1.40 It is noteworthy that the financial transfer condition was not met even though what was considered the most important prerequisite for it, the shedding of redundant labor, was. A Side Letter to the Loan Agreement

9. Because of its macroeconomic importance, in the Loan Documents this is actually treated as one of the "overall" conditions but for purposes of analysis of the experience in the railways sector, it seems more suitable to deal with it here.

10. See Memorandum from the President to Executive Directors, of December 17, 1992 (SecM92-1566). - 12 - specified minimum targets of number of workers who were to be shed by particular dates; by Tranche release time the total would amount to 30,000. The Borrower closely monitored this program and the number in question was, in fact, somewhat exceeded. Moreover, further progress has, in this respect, been made since Tranche release; if one counts not only participants in the "voluntary" retirement program but also natural attrition and other causes, the total railroad staff by June 1993 was some 66,000 lower than at the initiation of the program. Since the "voluntary" retirees received, on average, severance pay of US$12,000, the cost of these 30,000 workers alone was US$360 million, i.e., more than the Bank Loan.

(b) For three of the major freight lines (Urquiza. Mitre, and San Martin-Sarmiento). oncession agreements were to be actually executed." At the time of the Tranche release only the Mitre line agreement had actually been executed, and the Board was so informed. It was also informed that: "The San Martin- Sarmiento and Urquiza Lines have been pre-awarded, final contract negotiations are under way and contract execution is expected by the end of December. The Government's strong reform action is further supported by the recent contract executed for another major cargo line (Roca)... Further, in respect to the Belgrano line... railroad employees are bidding for the concession. Negotiations are expected to be concluded in the next few weeks. In sum, cargo line concessioning has gone much further than expected at the time of approval."

1.41 This reading has proved moderately optimistic. The additional expected agreements had actually been executed by January and March 1993 respectively.

(c) The reorganization of the Buenos Aires metropolitan passenger rail services and the legal establishment of a separate (i.e.. independent of FA) company to operate the metropolitan rail y.stem. The condition was met when on March 25, 1991, Ferrocarriles Metropolitanos Sociedad An6nima (FEMESA) was created by Decree #502 to operate the metropolitan rail service. As specified in the Loan Agreement, the new company was owned by FA, the Province and the City of Buenos Aires. Three months later it was decided that, rather than operate the system, FEMESA would concession it to a private operator by competitive bidding.

(d) The formal approval by the Borrower and the relevant provincial and local authorities of a plan acceptable to the

11. This was in addition to the Rosario-Bahia Blanca Line, for which an agreement had already been executed by the time the Loan became effective, and which therefore was not included in the list. - 13 -

Bank for the gradual reduction below the 1990 levels of the public subsidies for the Buenos Aires metropolitan rail passenger service. This condition was considered as more than fulfilled when on June 14, 1991, by Decree #1143 the decision to concession the service by public tender was issued, since the bid evaluation was to consider the level of the required subsidy as the price variable (i.e., the qualified bid demanding the lowest subsidy would, ceteris paribus, be considered as offering the best price). However, as already noted, although the bidding took place and awards were made, actual transfers to the concessionaires by July 1993 had not yet taken place. Therefore, even though the eventual outcome may exceed Loan objectives, the subsidy level contained in the bid was not yet operative through mid-1993. This is one of the reasons why the global transfer ceilings to the railroads continued to be exceeded.

(e) The establishment of a railway transit authority. with functions and responsibilities satisfactory to the Bank. to regulate the provision of suburban passenger services in the Buenos Aires metropolitan area. This condition, too, was fulfilled by Decree 1143 which also went further and created ATAM, with authority to advise on metropolitan rail but also bus and subway services, parking and other urban transport related activities in Buenos Aires. It is too early to assess the way in which ATAM is actually exercising its functions.

(f) Agreement between the Borrower and FA on a rationalization plan for interurban railway services "...including elimination of all non-essential and unprofitable services," The Bank considered this condition fulfilled by the issuance of Decree #1168 on July 10, 1992. In it the Government announced that all interurban passenger services other than Buenos Aires-Mar del Plata, which would be concessioned to the private sector, were to be abandoned, although those provinces that wished to maintain particular services at their own expense (after December 12, 1992) would be given 30 year concessions to do so. While the Government would remain owner of real estate and infrastructure, the concessionaires would take over the rolling stock, the personnel and responsibility for maintenance. So far, four provinces, Buenos Aires, Rio Negro, Tucumin and La Pampa have made use of this exemption. Thus, the original purpose of relieving the tax payers of the burden of subsidizing uneconomic lines will not be achieved in full; instead, part of the burden (admittedly on a much reduced - 14 -

scale as services were reduced to about one third) will shift from the Central Government's to the provincial budgets."

(g) The establishment of a national railway authority with functions and responsibilities satisfactory to the Bank. to regulate the provision of railway services throughout Arzentina. Decree #2339 established the Ente Nacional de Regulaci6n Ferroviaria on December 4, 1992, thus fulfilling the Tranche disbursement condition. Since then, progress of the regulatory authority has been slow; selection of members of the Board have been made, but the Authority by July 1993, was not yet functioning. Instead, regulatory activities continued to be in the hands of the Direcci6n de Transporte Ferroviario, i.e., a sub-division of the Transportation Secretariat (Ministry). Moreover, there was in preparation the creation of yet another regulatory body, the Comisi6n de las Concesiones Ferroviarias, a direct dependency of the Ministry, which would be responsible not only for safety but also for monitoring the adherence of the private operators to their concession agreements. This latter function had been intended to be a major task of the more autonomous Ente.

1.42 It is difficult to predict how the national regulatory scheme will work; on its face it looks as if there might be both a significant overlap in functions between "Ente" and "Comision", and a diminution in the role of the more autonomous regulatory agency.

1.43 TIb date, there is, of course, only the most limited experience of how the privatized railways are faring. The Rosario-Bahia Blanca Line (Ferro Expresso Pampeano S.A.), the one that has been in private hands longest, is not doing well so far. Even though it has managed to raise rail's share of freight traffic in their corridor from 32 to about 50 percent-a notable achievement-traffic has been much less than forecast and over two years they have lost about US$15 million on billings of about US$42 million. Some of their problems may be of their own making, while others, e.g. the delay in the rehabilitation of Bahia Blanca's port facilities, may be the Government's responsibility and still others, such as disastrous floods, may be ordinary business risks. It has requested relief from the Government from some of the investment obligations assumed with its concession, arguing that new traffic projections make some of these investments uneconomic. It has also requested relief, for two years, of obligations regarding rent payments on the rolling stock used. It is in the disposition of requests of this kind that

12. Given the high level of intragovernmental transfers through tax sharing and other devices in Argentina, even this change may be more apparent than real.

13. Even the Ente's autonomy will be only limited; its budget is part of that of the Ministry. - 15 -

the question of whether the regulatory authority is to be politically independent or not acquires special relevance.

G. The Oil Sector

1.44 The PE Yacimientos Petrolfferos Fiscales (YPF) in 1990 accounted for the direct production of 65 percent of Argentina's crude oil and 80 percent of its natural gas. Moreover, it was the nation's largest refiner and had in its hands about 50 percent of the distribution and sale of petroleum products. It had the rights to large sedimentary areas, and it administered about eighty contracts with private companies for exploration and production.

1.45 It had a strong labor union and considerable overstaffing, but it also had a technically very competent core staff. Since it essentially produced for the domestic market, price restrictions--together with the high cost imposed by the protection of the domestic capital goods industry (Compre Argentino) and heavy taxation--had prevented sufficient internal generation of funds for all required exploration and development investment. Nevertheless, its intrinsic financial situation was much better than that of most other PEs and it had therefore been used by the Government to borrow some US$4 billion abroad on the Government's behalf for balance of payments purposes. The Government's dependence on YPF resources meant that the PE was given little autonomy; most important financial and operational decisions were made by the political authorities instead. This also included provincial governments able to force YPF to undertake uneconomic drilling programs to create local employment.

1.46 The Government of President Menem considered breaking up YPF completely and transferring all the constituent parts to the private sector. This option, which initially had strong private sector support, was discarded for several reasons; the most important one seems to have been the consideration that, with the impending exhaustion in the next few decades of Argentina's oil reserves', it would be useful to maintain in existence an Argentinean integrated company that could, in due time, transfer its search for reserves reliably available to Argentina, abroad. Another option, a sectoral government holding company, was also discarded, mainly because of the fear to create a new and ultimately unviable bureaucracy.

1.47 But major reforms were to be undertaken nevertheless, both in sectoral policies and in the scope and nature of YPF. Regarding the former, it was decided to remove price controls, free trade in crude oil and enhance the opportunities for private sector operations in areas held by YPF. And regarding the latter, the PE was to shed many of its non-core activities (aviation, shipping, social programs, etc.), eliminate redundant labor and then begin to sell shares in the market, eventually reducing the Government's

14. Proved reserves are the equivalent of only nine years of present production levels. - 16 - role to that of a minority shareholder in a slimmed down, commercially run enterprise.

1.48 The Bank Loan supported this program. As in the railroad sector, a series of key steps were chosen, either for their intrinsic importance or because they were deemed good indicators of general progress, and were made conditions of disbursement of another "floating" sectoral tranche of US$75 million". In addition, a good deal of 'Tchnical Assistance was provided to the sector under PEREL. The conditions in question follow.

(a) Maintenance of the policy of fully deregulated prices and free imports and exports of petroleum products (and natural gas. This condition was met. Prices had already largely been deregulated as a condition of Board presentation; it is notable that the deregulation took place during the Gulf war in spite of strong fears in Argentina of sharp, war-induced price rises. Initially crude and product prices were tracked monthly by YPF and reported to the Bank, in accordance with a detailed classification scheme embedded in a Side Letter to the Loan Agreement. However, in September 1991 the Bank informed the Government that henceforth it would focus on crude prices only: "...so long as crude oil prices are not below international parity prices, the Bank will consider as met the oil market deregulation commitments of the Borrower..."".

(b) Execution of production sharing contracts in four YPF central aras. This condition was met in the first semester of 1991, i.e., shortly after Board approval. Indeed, it may be considered over-fulfilled since YPF opted for retaining only a minority stake in the four areas, which had not been required by the Loan Agreement.

(c) Achievement of satisfactory progress in divestiture and privatization as evidenced by divestiture by YPF of assets with a sales value of at least US$200 million. The condition was more than achieved; the assets in question included refineries, pipelines, and transportation, industrial and drilling equipment. There was a certain amount of hesitation by the Bank to declare the condition fulfilled because the Loan Agreement clause referred to "cash sale value", and on that basis the condition would not have been met, but this point was dropped. It is not clear what the purpose of the cash concept (not included in the earlier drafts of the Loan Agreement) was.

15. Together with the natural gas-related conditions to be described in Section H below.

16. See letter of September 13, 1991, from the Director of Country Department IV, Mr. Ping- Cheung Loh to the Minister of Economy, Dr. Domingo Felipe Cavallo. - 17 -

(d) Approval of a new YPF charter providing for financial and operational autonomy and increasing participation by the p This condition was met when Law 24.145 was approved by Congress September 24, 1992. The Law confirmed an earlier Decree--drafted in consultation with the Bank--laying out the restructuring and divestiture plan for YPF and confirming that the Central Government and the provinces would sell a majority of the share capital. At the time of the Tranche release the Board was informed that a first share offering was planned in international financial centers during the second semester of 1993. In fact, the share offerings accelerated and, by September 1, 1993, 58 percent of YPF shares were in private hands.

(e) Restructuring of all policy making and regulatory agencies in the oil and gas sectors in terms satisfactory to the Bank. including the enactment of appropriate legislation to ensure the administrative, financial and political independence of such agencies and to enable them to secure qualified staff in adequate numbers, remunerated in terms substantially equivalent to private counterparts in such sectors. The condition was declared as met, even though the Board was informed, without comment, that "...Iblicy making in the oil and gas sectors and sectoral promotion is managed by the Subsecretariat of Fuels..." The sought for autonomy thus was not achieved. But it should be noted that the Loan condition, to the extent that it referred to regulatory functions was more applicable to the gas sector (where different arrangements were made, see below) in which a substantial degree of monopoly power in transportation as well was production would remain, than in the oil sector where, with free trade, prices would be market determined. And broad policy making, as distinct from regulatory functions, probably always had to remain a Government prerogative, in spite of the formulation in the Loan Agreement.

1.49 No comments were made in the report to the Board regarding the remuneration condition (which is more germane to the gas sector than to oil). It does not seem to have been supervised or adhered to closely; it is not yet possible to judge whether this is going to be a source of difficulties.

H. The Natural Gas Sector

1.50 While YPF controlled most of Argentina's production of natural gas, another PE, Gas del Estado (GdE) was in charge of all gas transport and distribution. As a secondary activity GdE also produced and marketed LPG, ethane and natural gasoline. It made large losses (US$ 650 million during - 18 -

1985-88). Regulated and irrationally set prices were its major problem. The Subsecretariat of Energy would fix the transfer price of gas from YPF to GdE on a monthly basis; the distribution price was determined by the transfer price plus a fixed treatment, processing and transportation margin, while the price to the final consumer was based on the type of user, location and volume, and included 50-55 per cent in taxes shared by the Federal, provincial and local governments and pension funds. In spite of the tax burden, final consumer prices were not only much too low--50 percent below comparable international prices in August 1990 and even less for residential consumers--so that petrochemical feedstock purchasers received large subsidies, but they also were set so as to offer no incentive to economize on transportation costs by drawing more heavily on the fields located closest to the major markets.

1.51 The Government's objective was to integrate the sector as much as possible into the international economy and to introduce the maximum possible degree of competition into what might have been thought a naturally monopolistic sector, i.e., the transportation of gas through pipelines. In the design chosen for the industry, Bank staff and Bank-financed consultants played a major role.

1.52 GdE was eventually broken up into ten companies; two transmission line enterprises and eight distribution companies. The former were regional (Northern and Southern Trunk Lines) but were so located as to offer transportation alternatives for gas to be sent from the largest fields--in the Neuqudn Region in Central Western Argentina-to the largest market, i.e., the Buenos Aires area. The distribution companies would, eventually, compete with others--entry into the industry would be free--and would have an incentive to buy gas in the fields closest to their markets at the lowest (wellhead plus transport) price. GdE would disappear; prices would be fully deregulated after a transition period and a regulatory authority would exert vigilance on the maintenance of competitive practices. Some gas sector specific conditions were included in the Loan Agreement as prerequisites for the disbursement of the "floating" oil and gas Tranche. They are described below.

(a) Natural gas prices were to reach at least 90 per cent of the corresponding international levels. This condition was met by early 1992, and continued to be monitored and met until the Tranche was released. Subsequent developments, since loan closing, have not been followed by the Bank as the Loan is no longer being supervised.

(b) Privatization of at least two gas distribution systems was to be completed and tendering for the transmission and remaining distribution systems was to have been initiated. Ten per cent of Argentina's gas production was also to have been privatized. The condition was met an exceeded since by the - 19 -

end of 1992, the entire system--including the required ten per cent of production--was in private hands. In general, this privatization--tendering, bid evaluation, contract awarding and signing--was accomplished more smoothly and frictionlessly than any of the others. One important feature accounting for this was that the contracts themselves had to be accepted (price excluded) at the time of presenting bids; subsequent bargaining about contracts was thereby virtually ruled out.

(c) The condition regarding policy making and regulatory authority for the oil sector was. as noted also applicable to the gas sector. For gas it was fulfilled when, in mid-1992 an Ente Regulatorio was created. Since then, top management positions have been filled. But there is no experience as yet with how it will work since, under the terms of the program agreed with the Bank, prices are still being set by the Subsecretariat of Fuels and may continue to be so set until June 1994.

(d) Sales prices of natural gas to be maintained in each calendar month at a level of 90 per cent of fuel oil equivalency. The condition was met before privatization took place, precisely to make it possible. It was monitored by the Bank until Tranche disbursement took place.

I. EVALUATION

1.53 Most, though not all, of the Loan objectives have been achieved and accomplishments in some important areas have exceeded the original aims and were achieved faster than originally projected. This is all the more remarkable as this was a high risk operation for the Bank; there was little successful past experience to draw on; judged by historical experience the subject matter of PEs in Argentina was explosive and the danger of great public embarrassment for the Bank in case of failure could not be. overlooked.

1.54 It would seem that the following are critical elements accounting for the successful aspects of the operation:

(a) The most important one is that the very basic policy decision. to privatize all important PEs. emanated from the Government without pressure from the Bank. There was no significant element of "persuasion by dialogue" regarding the fundamentals, although the Bank played a vital role in helping the Government carry out the program and in many cases helped prevent costly mistakes or delays. It was, rather, the Government that had to persuade the Bank that it could, and - 20 -

would, stay the course, and it was the Bank that made it possible for the Government to do so.

CONCLUSION: There is little reason to doubt that this lesson would have wide applicability in other countries as well.

(b) Combined with the above was the very prudent behavio[ DD the part of the Bank in keeping a low profile. In spite of its ubiquitous presence through technical assistance financing and through direct staff advice on many occasions, privatization at no time became a "World Bank program" in the eyes of either political circles or the public and the press. It is difficult to exaggerate the importance of this factor in Argentina.

CONCLUSION: This, too, would seem to constitute a lesson applicable to such programs generally.

(c) The large amount of sectoral work done by Bank and consultants in prior years, specifically in the last years of the Alfonsfn Government, proved to be invaluable. At the time when it was done it might have been considered an imprudent and wasteful use of Bank resources; Argentina's lack of creditworthiness on the one hand and the bad experience with the PEs on the other made it seem quite unlikely that this work would lead to any lending. But as things turned out, it provided the incoming Administration of President Menem with a wealth of sectoral diagnostic and prescriptive information--e.g in the telecommunications and hydrocarbons sectors--which helped it to convert its initial policy decisions rapidly into detailed action programs.

CONCLUSION: Thus, making this costly investment in sector work in the late eighties was a gamble that came offin spite of low odds; no one predicted that a future Government- and least of all a Peronist one--would adopt the course that President Menem chose. Whether this is a good basis for the Bank generally taking such gambles in future is. given the law of large numbers. rather questionable.

(d) The perceived, and actual. high quality of the Bank's technical MVk--by staff, by Bank hired consultants and by Bank financed T.A. (under PEREL)--and the Bank's willingness to put unusually large resources into loan formation and administration also played an important role. Ib this must be added the existence of a highly effective Project Unit. the manager of which had participated in the loan negotiations and preceding discussions, and thus was fully conversant with the intricacies of the issues involved. - 21 -

CONCLUSION:

(i) While the need to protect the technical excellence of such work is self evident and applicable to all cases, the need for a wholehearted commitment of resources once such an operation is undertaken by the Bank--without excessive concern about budgetary costs--may not be. If this is not possible, it may be better not to undertake it at all.

(ii) The advantage of engaging the Head of the Project Unit in loan formation and negotiation from the beginning also seems one that is generally applicable. In the Argentine case, in which many agencies were obliged to act in complicated and difficult ways, it was crucial to have a central focal point which could do much more than merely transmit the Bank's messages. Thus, the Unit was able to play a constructive role to obtain the right kinds of actions in a timely manner, because it fully understood their relation to the overall design of the program.

(e) Related to the above is that the Bank's presence helped short circuit many otherwise protracted or even insoluble internal arguments. Disputes on such formal matters as procurement rules and policies, but also on substantive matters of sector organization and policies could often be settled by reference to the Bank's policies or views, essentially because these were viewed as being technical, objective and disinterested and because the Bank was generally willing and able to respond rapidly and constructively when consulted.

CONCLUSION: This role, as noted, could only be played because, the Bank combined a low profile with a ubiquitous, unstinting presence and high technical standards. While the may not always be sufficient conditions for success. there is every reason to believe that they are necessary conditions.

(f) The Bank's willingness to innovate adjustment lending and adapt its usual policies by not objecting to the visible use of loan funds for severance pay played a critical role in permitting the railroad privatization program to proceed.

CONCLUSION: Before inferring that such adaptation of policy is warranted generally, it should be noted that the context was:

(i) that very close watch was kept over the total numbers and over the individuals retired, so that re-hiring was virtually impossible, and, even more importantly, - 22 -

(ii) that it was firmly assumed that shortly after the retirement program the railroads would be in private hands and not subject to the political pressures that had led to the overstaffing of FA in the first place.

Absent these circumstances, it is questionable whether the visible use of Bank loan counterpart funds for severance pay would have made much sense.

1.55 While the successes of the operation are impressive, and greatly outweigh its shortcomings, they are not total or unqualified. The more disappointing aspects, and their reasons, are explored below.

1.56 As was noted, railroads are the sector in which several specific Tranche release conditions were not really met. The Board was correctly informed of this but was given to understand that matters were sufficiently in hand to expect compliance shortly. Events then turned out differently; the budgetary transfers to the railroads in 1993 again will be larger than expected and the actual privatization of freight services took a few months longer than expected. Progress in the reduction of Buenos Aires passenger service subsidies has also slowed down. Ultimately, however, the Railway Reform Program is expected to be completed.

1.57 Regarding the regulatory agencies, most forn conditions were met, but essentially these only concerned the legal creation of these agencies. None of them is. as yet. functioning at an adequate level". i.e.. is fulfilling the purpose for which they were set up. Here privatization ran ahead of the institutions that were thought necessary to oversee what are, after all, businesses with a good deal of inevitable monopoly power (telecommunications and gas transport especially, railroads less so). Moreover, even the regulatory legal framework is still fluid; as noted in railroads the functions of the "autonomous" regulatory body may shortly be reduced in favor of those of a dependency of a ministry.

1.58 In principle, this experience would seem to suggest that work on the buildup of the regulatory agencies should have started earlier and should have been more intensive both before and immediately after the Loan was made. Alternatively, one might argue, that if it was impossible to accelerate the creation of effective regulatory bodies, the privatization program itself, and the Bank Loan, should have been delayed. In other words, they should not have been allowed to outrun the buildup of institutions deemed necessary for their effective functioning.

17. It should, perhaps, be repeated, that this is not so much a matter of not complying with Loan covenants, as with observing events after the Loan was closed. But the Rurpo of the covenants was to create functioning re7gulatory agencies. - 23 -

1.59 However attractive and logical the second alternative may sound, it would not, in fact. have been a viable option, even if it had been considered. As indicated, the political dynamics of the moment would have made a delay of, say, one year, in the privatization program self-defeating, however good the regulatory bodies that might have been created in the meantime. It was the sense of driving urgency, in a moment of national crisis, which the Government demonstrated and which the Bank supported, that made the program possible at all.

1.60 So the real question is whether more could or should have been done to create. endow, structure. staff and train the regulatory agencies within the time available. In retrospect, there is little doubt that something more than was done should have been attempted, both by the Government and by the Bank. But the possibility of achieving very much better results should not be exaggerated. Both sides were deeply involved in the innumerable daily, burning and immediate questions of privatization. These could not but absorb the attention of the--after all, limited number of--policy makers. It would have been extremely difficult to argue, at the time, that less attention should be devoted to the privatization itself and more to the quick buildup of the regulatory institutions; it is not clear that then the former would have succeeded, which would have made the latter redundant.

1.61 Of course, this is a matter of degree and of rather subjective expRs. judgments. In future, similar situations, the Argentine experience in this respect should certainly be borne in mind, and attempts should be made to focus more attention on what steps must be taken early on not only to create the Authorities but to have them fully operational by the time that they are needed, But it should be understood that, while the Bank's role here may be to "lean against the wind" a little, so as to ensure that this claim on the Government's attention does not lose out totally, there is a practical limit to the priority which regulation can be given before the big privatization issues are settled. It is important that the Bank try to sretch this limit as far as possible; the danger of having weak or inoperative independent regulators at the beginning is that this may set a pattern that will be difficult to reverse later. But it should not be expected that this limit can be removed entirely.

1.62 There is a common thread to the two disappointments under the Loan, the pace of meeting specific railroad conditionality (and related financial impact) and the poor showing of the regulatory agencies. It is that the Bank was no longer a major player well before either issue was resolved, Once the Loan was disbursed, officially Loan Supervision ceased. The progress (in the areas mentioned) expected at the time of disbursement did not take place, but the Bank had no official role any more to either help or warn, cajole or press for action. Nor did it have an incentive to devote sizable further staff time to what are, essentially, Project Implementation activities.

1.63 Similarly, the way the disbursement conditionality was structured, lbz Bank bowed out before the regulatory agencies were to be operational. It is - 24 - true that some further conditionality exists under PEREL but (a) the money involved is relatively little and (b), more important, it makes little sense to interrupt studies and other T.A. activities by delaying disbursements. in order to achieve compliance with substantive Loan conditions. The Bank now has little say in the achievement of one of the important objectives of the Loan: the creation of effective autonomous regulatory agencies to ensure that privatized former PEs with significant degrees of monopoly power yield results reasonably akin to those of competitive markets."

1.64 There is no wholly satisfactory solution to this dilemma as long as quick disbursement remains one of the objectives of such operations. Continued full supervision after disbursement is not only unacceptably expensive for the Bank but also questionable on grounds of Bank-country relations.

1.65 One way to achieve both objectives, of quick transfer of resources and of full Bank oversight, would be to:

(a) make the Loan larger;

(b) generate more critical events triggering tranche disbursements ; (c) structure these so that they cover a longer time period and thus, (d) have more disbursement tranches, but of no smaller size each than under the present formula.

1.66 Specifically, in the case of PERAL I this might have meant a Loan of US$450 million with the same US$150 million disbursement on effectiveness, the same two "floating" sector tranches of US$75 million each and an additional two (or three) tranches of US$75 million (or US$50 million) each, releasable against specified events in the sectors, particularly in the institutionali2ation of the regulatory agencies, (such as, for example, the issuance of the Reglamento de Servicio of CNT). It would permit the Bank to supervise the Loan for another 12 to 18 months. without an increase in Supervision costs per dollar lent,

1.67 This is not an ideal solution; a PERAL I Loan of US$450 million would have been even more venturesome and controversial than one for US$300 million. And the definition of appropriate targets or actions for the regulatory bodies, to serve as suitable disbursement triggers, may be something of a challenge. But the present system. which forces the Bank to withdraw before the job is fully done. is fraught with the danger of stagnation or backsliding, and of eventual underachievement of the Bank's and the Government's objectives, even if all covenants were fulfilled,

18 In the meantime, to re-create Bank presence, the preparation of a new regulatory loan has been initiated. - 25 -

1.68 There may be other, more ad ho ways of coping with the problem, which is essentially to make Loans disbursing in one or two years, for programs whose true execution period may be five or more years. One such way might be to follow the Sectoral Adjustment Loan with a related new Project Investment Loan and tie some of the critical institutional actions into covenants in the new Loan. It remains to be established, on a case by case basis, whether the sectors involved with their now privately owned firms, offer scope for such Investment Loans.

1.69 PERAL I has, as was indicated above, far more success than failure to record, and even in the Railways sector the retirement of 66,000 workers - about half of them under a Bank covenant and with Bank financing - is a macroeconomic advance of major proportions for Argentina. But successes like the privatization of much of Argentina's public sector are not guaranteed to be permanent unless a framework with robust institutions is created, in which the new system can operate. It would seem vital that the Bank stay with such programs until some real indications of the required robustness have appeaed. - 26 -

PART II: PROJECT REVIEW FROM BORROWER'S PERSPECTIVE

A. Introduction

2.1 The Public Enterprises Reform Program was initiated in an atmosphere of clear awareness of the problem created by the deficit history of these bodies, its serious consequences for the country's macroeconomic performance, and the fact that the population was inadequately supplied with goods and services.

2.2 'Tlephone, railway, power supply, port and other services provided by public enterprises (PEs) were highly inefficient and created heavy costs for the industrial and agricultural sectors. Furthermore, the resource drain on the national budget created by the growing PE deficit made sound economic and financial management a virtual impossibility.

2.3 In order to cover the financial requirements of this Program, the Government first of all approached the World Bank for support. Two missions, one by the World Bank to Buenos Aires in October 1990 and the other by the Argentine Government (represented by Dr. Luis Prol, Deputy Secretary for Public Enterprises) to Vashington the following December, culminated in agreement between the parties on the key points to be incorporated in the PEREL and PERAL loan documents. These, together with other materials for presentation to the Executive Directors of the Bank, were then drawn up in final version.

2.4 In the course of Loan Agreement negotiations, the Argentine Government committed itself to actions in five spheres:

(a) Actions affecting the public enterprises in general.

(b) Actions for institutional development of a telecommunications sector regulatory authority.

(c) Actions in the hydrocarbons sector.

(d) Actions in the railway sector.

(e) Supplemental Letters spelling out commitments regarding reductions in the PE work force, pricing policies in the gas sector, and the economic policy program to be instituted. - 27 -

B. Achievements in Meeting Commitments

2.5 PE Secto

Undertakings to evaluate the performance of certain PEs (A y E, YPF, HIDRONOR, Metropolitan Railways) and to develop privatization plans for others (SEGBA, the Ports Administration, OSN) were quickly rendered moot by the Government's action to privatize them in fact. This change in plans was readily consented to by the World Bank.

C. Institutional Development of a UIlecommunications Regulatory Authorit

2.6 Under the conditions of privatization, various powers and functions associated with regulation, monitoring, verification and supervision were delegated to the regulatory authority. In 1990, prior to signature of the transfer contracts, Decree No. 1185 created the National Iblecommunications Commission, an entity whose degree of specialization and autonomy of judgment were to guarantee the development of telecommunications and protection of the public interest.

2.7 At the present time, CNT is attempting to forge a style that will enable it to strike a balance among the legal, economic and social interests at stake: legal predictability, investments in the public network, encouragement of competition, and customer protection. Its regulatory activities are expected to consist in the issue of simple, clear and predictable standards that will enable operators to take economic decisions in an atmosphere of certainty for the long term-the whole process being not only open and transparent but also as rapid and flexible as governmental procedures will permit.

2.8 CNT has introduced a system of public hearings as an efficient alternative for the treatment of institutional rights which have an impact on and are of concern to the community. This same process may possibly be used also as a medium for mediating conflicts-for instance, between providers and users of services.

2.9 In other words, it is anticipated that regulations prescribing formal mechanisms by which the public can participate in the supervision process, as called for under Article 30 of Decree No. 1185/90, will be issued and put into practice.

D. Commitments to Action in the Hydrocarbons Sector

2.10 Situation prior to deregulation and privatization

When the deregulation and privatization process began in the oil and gas sector on October 10, 1989, oil production had been stagnant for 20 - 28 - years at an average annual figure of approximately 25 million m'. YPF, directly and indirectly responsible for 97.6% of Argentine crude output and 100% of gas output, had lost US$620 million over the preceding decade. The market for gas had expanded by an astonishing 82% between 1982 and 1990, or at an average annual cumulative rate of 6%. Gas represented 40% of the country's energy resources, with demand continuing to increase. However, while it was being vented in the rich fields in the north for lack of pipelines and storage capacity, in the cities-especially Buenos Aires-Gas del Estado, the government-owned monopoly distribution concern, had to impose rationing during the winter months (when demand is heaviest) because of insufficient supply.

2.11 The main reason for such poor performance was none other than he authorities' exaggerated and illogical over-regulation of the sector, monopolized by the two official enterprises and controlled by the Secretariat of Energy, which decided not only crude, gas and gasoline prices but also the profit margins allowed all parties active in the sector. In 1990, he government oil company bought 66 million barrels of crude from its contractors at US$17.93 per barrel, while its selling price to third parties was US$15.44. Both prices were set by the Secretariat, and in the process YPF lost US$164 million.

2.12 The Secretariat of Energy was regulating the industry without any regard to international hydrocarbon prices-not even in the case of crude, an international commodity whose price is the benchmark by which oil companies worldwide judge whether their production costs are feasible or not. Up until roughly two years ago, the oil business in Argentina was an entirely domestic one, in which YPF production costs were a State secret and the Secretariat of Energy set prices in the light of Treasury needs or the power of the lobby formed by officials or private contractors.

2.13 Deregulation of the market

Between October 1989 and January 1, 1991, the Government deregulated the country's oil industry completely, relying on the 1967 Hydrocarbons Act (which empowered the State to grant exploration and extraction concessions to the private sector) and on four specific decrees.

2.14 Sale of secondary zones

Between 1990 and 1992, the Secretariat of Energy, in the course of three separate bidding procedures, awarded a total of 255 marginal zones (in five basins) grouped into 86 blocks, granting the new licensees 25-year extraction permits.

2.15 Fifty-nine companies took part in the process, forming a series of consortiums; although the majority were Argentine firms, there were several international bidders such as BRITISH GAS and REPSOL. - 29 -

2.16 The consortiums bid US$490 million for 209 million m' or 126 million barrels, with the Treasury finally collecting US$450 million.

2.17 Partnerships in central zones

In 1991 and 1992, YPF organized a series of international competitive bidding procedures in a search for Argentine or foreign oil companies with which to enter into partnerships for the development of its richest deposits, known as "central zones." Each grantee consortium was required to pay a lump-sum "association fee" before being permitted to begin operations in its grant zone. Each concession contract, with a duration of 25 years, allocates output of crude between YPF and its partner in the same proportion as their percentage holdings in the joint venture.

2.18 Conversion of oil contracts

YPF converted 25 of these development contracts into private concessions, which account for daily output of 19,703 m3 from deposits involving a total surface area of 10,140 km2 .

2.19 Reorganization and privatization of YPF

Before part of the capital stock of the state-owned oil company was offered for sale to the public, a radical internal reorganization took place. The number of employees was reduced from approximately 40,000 to a mere 10,000, and a further 2,000 were to be retrenched by the end of 1993. Chronic losses were replaced by profits-US$255 million in 1991 and US$259 million in 1992. The reorganization and downsizing process also involved the sale of pipelines, refineries, storage facilities, and a huge and unnecessary mercantile fleet.

2.20 Beginning in July, YPF shares were listed on the New York and Buenos Aires Stock Exchanges. Sale to the public of 160 million shares, or 45.32% of capital stock, netted the Argentine Government US$3.04 billion. IL war the largest initial public offering ever seen on the New York Stock Exchange, where demand exceeded supply by 3 to 1. In Argentina itself, demand from underwriters exceeded supply by 10 to 1, an indication of the success of the offer.

2.21 0-a

The privatization of Gas del Estado was more like the sales of other PEs. Since the distribution of gas is inevitably a monopoly-type public utility service, the Government decided to subdivide the state-owned enterprise into eight regional companies ir. order to foster competition. Within its particular zone eacL of these. companies held exclusive distribution rights. Not only welb-hea gar pricer bu also those paid by residential and commercial - 30 - consumers are set by the Secretariat of Energy. The Government also created two gas transmission companies.

2.22 The privatization of Gas del Estado was a success in terms of the number of bidders and the value of their offers. Awards were made in December 1992, after international calls for tenders. 'Ibn consortiums purchased the two transporting/distributing companies for a total of US$1.541 billion in external debt instruments and US$300 million in cash.

2.23 Although the main goal of this reform was to convert the highly regulated gas sector into a market-oriented one, it was recognized that there should be an entity to monitor, arbitrate and oversee compliance with the terms of reference governing the licensees. ENRG (Ente Nacional de Regulacidn del Gas), answerable to the Ministry of the Economy and Public Works and Services, was therefore created pursuant to Article 50 of Law 24076. It is responsible for: (a) protecting consumer interests; (b) promoting competition in the sector; (c) encouraging efficient operation of the energy industry; (d) ensuring that sector firms meet their financial commitments; and (e) protecting the environment through rational utilization of natural gas.

2.24 The general direction and management of ENRG is in the hands of a board of directors consisting of a president, vice president and three other members. Its key functions are to give effect to and enforce legal and regulatory provisions governing matters within its jurisdiction, establish internal administrative systems, recruit and prescribe the functions of its staff, and impose penalties as stipulated under Law 24076.

2.25 Decree 477/93, issued pursuant to Law 24076, has approved the nominations of an economist, a lawyer and an engineer as the president and first and second directors, respectively, of ENRG. A vice president and the third director have yet to be selected. Board members may be removed from office only by decision of the President of the Republic and for unsatisfactory performance.

E. Results in the Railway Sector

2.26 Argentina's railway operated a 35,000 Km system, and its reforms stemmed from an annual deficit in excess of US$500 million and a staff corps numbering roughly 90,000. Not surprisingly, this PE drew the authorities into a pattern of spiraling borrowings and losses which finally required radical and innovative solutions.

2.27 The Government committed itself to writing concession contracts with private sector investors to operate the Urquiza, Mitre and San Martin/Sarmiento freight lines. Contract award dates were as follows: the Urquiza line, to Consorcio Ferrocarriles Mesopotdmicos, January 13, 1993; the Mitre line, to Consorcio Nuevo Central Argentino, which began - 31 -

operations on December 23, 1992; and the San Martfn/Sarmiento line, to Consorcio FerrocarrilCentral, on December 29, 1992.

2.28 In addition, although this was not part of loan conditionalities, concession of the Roca line was awarded to Consorcio FerrosurRoca on March 12, 1993, while significant progress has been made toward concession of the Buenos Aires-Mar del Plata corridor.

2.29 Metropolitan passenger rail services were made the responsibility of a new company, FEMESA, which is managed and operated independently of FerrocarrilesArgentinos. The new company was then subdivided into seven units for privatization. Over the period December 1992-January 1993, the following pre-awards were made: the Mitre, Sarmiento and Urquiza/SBASE lines, to Consorcio B. Roggio; the Roca and San Martfn lines, to Consorcio Trainmet; the Belgrano North line, to Consorcio Caminhos de Ferro Portugueses; and the Belgrano South line, to Consorcio ftinmet.

2.30 As far as the establishment and consolidation of rail sector regulatory agencies is concerned, the most progress has been made with the National Railway Regulatory Commission, created by Decree 2339 of December 4, 1992. In February 1993, the Government announced an open competition for the three director posts on the Commission, attracting 200 candidates; specialized consultants (Price Waterhouse) were retained to make the selection, and decisions are expected to be announced shortly. As a separate matter, the Ministry of the Economy and Public Works and Services now has under consideration a decree creating the National Rail Transport Commission.

2.31 The Government has sought expert assistance in deciding how to structure these two new agencies. For instance, throughout 1992 it had the advice of the U.S. Federal Railroad Administration on all aspects of railway safety, and more recently, in 1993, that of a U.S. consulting firm, National Economic Research Associates. In June 1993, this firm submitted its final report, entitled "Recommendations for the Organization and Structure of the National Railway Regulatory Commission and National Rail Transport Commission," a document which sets out the mandate and functions of each agency in detail, provides a professional profile and job description for every post, prescribes the agency's structure and staffing, and formulates a plan of action for its first year of activity.

2.32 With regard to rail concessions in the Buenos Aires Metropolitan Area, the Government, through Decree 1143 of June 3, 1991, ratified the Agreement between the Ministry of the Economy and Public Works and Services and the Municipality of the City of Buenos Aires, an instrument calling for creation of a Buenos Aires urban transit authority, to be responsible inter alia for monitoring and supervising the suburban rail concessions. As the tripartite character of such an agency (State/City of - 32 -

Buenos Aires/Province of Buenos Aires) required that it be created by act of Congress, the necessary Bill was submitted to the legislature in the 1992 second half, has been passed by four Senate committees (including that with jurisdiction in transport matters), and is now due to be debated in full session.

2.33 In conclusion, Argentina's railway reform program has been a most profound railway transformation. Four years into the reform program, the following was achieved:

* Freight services were concessioned to five different private concessionaires without any government subsidy. The sixth railway freight operator still is a state-owned corporation;

* highly subsidized intercity passenger services were reduced by two thirds, in terms of train-km, and transferred to the provinces;

* the suburban passenger services in the Buenos Aires Metropolitan Region were being transferred (pre-awards already made) to three private concessionaires;

* total railway employees had been reduced to 30,000, considering both private and public operators; and

* the National Government's subsidy to the railway system projected for 1994 was cut to a fraction of what was required five years before.

E Results under Supplemental Ittters

2.34 Economic policy commitments

In February 1991, following a period of economic instability, the Government instituted a stabilization and reform program more radical and far-reaching than any attempted previously. It was described in the Economic Policy Memorandum sent to the IMF on June 28, 1991 (EBS/91/107) in support of a request for EFF benefits.

2.35 These commitments were largely the same ones the Government had entered into with the World Bank, which had been endorsed in Economic Minister Domingo Cavallo's Letter of Development Policy to the Bank on March 6, 1991. - 33 -

2.36 Commitments to downsize PE staff

Undertakings were given to cut 30,000 from the staff of Ferrocarriles Argentinos by March 1992, and a further 6,000 from other PEs by the same date. Actually, there will be nearly 100,000 voluntary retirements from PEs by the end of 1993, not counting attrition and transfers to the private sector.

2.37 Commitments on gas prices

The goal of bringing natural gas prices to at least 90% of international levels was achieved by early 1992.

G. Evaluation

2.38 Bank Performance

oect apprriateness

The Bank's conception of the project was extremely sound, in the sense that the appropriate and well-timed support that was consistently available made it possible to meet project goals effectively.

2.39 Design. organization. management

The fact that the design of this large-scale project, as well as its organization and management, were successful can be attributed not just to the Bank's experience in this sphere but also to the degree of job stability among the Bank staff responsible for the managerial and administrative aspects of the loan, which meant consistency in the way the operations committed to by both parties were carried out and in the way results were evaluated.

2.40 Interim goals achieved at the various stages of the action programs the Government was committed to were correctly evaluated, eliciting judicious and level-headed comments from Bank staff in all instances, an attitude they also displayed when making recommendations for remedial action or commenting on steps taken by the Government beyond what loan conditionality required.

2.41 Bank staff monitored progress with the project continuously and directly, through daily telephone conversations and frequent aide-memoires throughout the execution period. In addition, the Coordination Unit was treated by both Bank and Government as an essential communications link. These factors in combination gave rise to ongoing dynamic feedback, which enhanced decision-making and the development of a consensus view. - 34 -

2.42 Another important factor in the success of the project was the technical assistance financed by the Bank through the Public Enterprise Reform Execution Loan (PEREL). In utilizing the proceeds of this lending operation, the Government followed the guidelines for World Bank borrowers on the hiring of consultants. It was also able to rely at all times on advice and guidance from the Bank on how to ensure the best use of technical assistance resources; this meant that help was available when needed not only with consulting contracts and related arrangements but also with design and technical aspects of the various actions to which it had committed itself.

H. Borrower Performance

2.43 Approach. coordination. management

The Government discharged its responsibilities with very considerable success. Its general approach was one of determination to achieve project objectives and comply with loan conditionalities. The fact that objectives and goals were achieved with rapidity and thoroughness can be attributed to the resolve and firmness of purpose with which it took necessary policy decisions.

2.44 Section 2.03 of the Public Enterprise Reform Adjustment Loan (PERAL) Agreement set December 31, 1993, or a subsequent date consented to by the Bank, as the project closing date. However, all loan commitments had been met and the final disbursement of loan proceeds made on or before February 12, 1993, 10 months prior to the date estimated originally.

2.45 Nevertheless, in a number of instances, where progress made had considerably exceeded set goals, the Government was reluctant to adapt its actions to commitments assumed. Accordingly, the Bank was asked to be flexible in evaluating overall achievements, which went beyond what the Government had committed to. This was understandable, given the magnitude and scope of the project, the degree to which its constantly new effects were interrelated, and the requirements attaching to loan conditionality.

2.46 Structur

The Government's task was made easier with the appointment of an alternate to the national project director, who was a Secretary or Deputy Secretary in the Ministry of the Economy. This meant that the program could be carried out in a more dynamic and less time-consuming fashion, even though a series of appointees served in the director position. In addition, combination of the coordinator and alternate director functions meant it was no longer necessary to have the signature of a Secretary of State before administrative decisions essential to project progress could be obtained. - 35 -

2.47 Execution and management

The Government performed adequately where project administrative and managerial requirements were concerned. As commitments were met, information and confirmation to this effect were forwarded to all operational and administrative units concerned, together with supporting audit data. This broad range of information, whether provided at once or at regular intervals, was instrumental in making a consistent whole of the varying expectations of officials involved in the project.

I. Project Relationship

2.48 The relationship between the Government and the Bank was one of mutual understanding, especially regarding the Government's determination to push ahead with the Public Enterprise Privatization Program. The general similarity of views among members of the project economic team, and the fact that there was little turnover among the Bank staff assigned to the project originally, were important contributions to the easy relation between the parties.

2.49 Another major element in the positive outcome of this whole venture was the technical assistance program, which played such a large part in successful identification of the technical problems that would have to be solved during the course of the project.

2.50 From the project management viewpoint, Bank staff aide-memoirs and Government progress reports, given the interaction they created, contributed very largely to the climate of understanding between the parties and helped to vitalize the project execution process. Every progress report was distributed simultaneously to all government departments and agencies involved in the program and to the World Bank. This meant that all parties concerned were kept abreast with the status of the project and aware of what activities were to be undertaken to ensure that commitments were fully met.

J. Lessons Learned and Conclusions

2.51 The main lessons learned at different points in the course of this project, with possible implications for other projects, were as follows:

2.52 As initially formulated, the conditions on which the loan was based were acceptable and defined within the framework constituted by the program the Government had undertaken to carry out. However, the overall objectives of Public Enterprise Reform were considerably expanded to include more actions than had initially been agreed to with the Bank. Thus expanded, the project program, while incorporating objectives more ambitious than the original ones, postponed some of the original goals - 36 - specified in the clauses of the Loan Agreement. In other words, whereas it had actually achieved broader objectives than originally planned, the Government appeared not to have fully met goals it had committed itself to contractually. The commitments to privatize the Urquiza, Mitre, San Martin and Sarmiento freight lines were rapidly outstripped by the privatization of other freight lines; however, although in practice more kilometers of line had been privatized than the terms of the contract specified, the World Bank reported a failure of compliance.

CONCLUSION: In future, loan conditionality clauses should be drafted in such a way that results can be analyzed in terms of actual accomplishments rather than under a restrictive interpretation of one isolated condition. This is particularly clear in the case of Schedule 4, Clause I(a), which refers to privatization of the Urquiza, Mitre, San Martin and Sarmiento freight lines but makes no reference to similar operations affecting other freight lines.

2.53 The Government, in a Supplemental Letter, undertook to retrench 30,000 PE staff as a prerequisite for disbursement. This created financing difficulties which led into a vicious circle: loan proceeds were available but could not be accessed for lack of means to fund voluntary severance arrangements.

CONCLUSION: Clauses of this type require either that the Government clearly provide a financial solution in its budget as a prior requirement, or that the Bank make partial disbursements in step with the Government's progress in meeting such a condition. Had it been possible to make monthly retrenchments of railway personnel and receive commensurate disbursements at the same time, execution of this component of the project would have gone ahead more rapidly and efficiently, while the social impact of such drastic measures would have been mitigated.

2.54 The Government undertook to rescind or amend its Compre Argentino legislation, which meant that the Congress had to pass a Bill to this effect in order for proof of compliance to be available.

CONCLUSION: As far as possible, future loans should not include clauses when compliance with them would depend on actions to be taken outside the sections of the Executive Branch from which the project has originated, as this gives rise to delays and requires the use of practices and procedures not well understood in other sections, with the result that lengthy and burdensome negotiations become necessary.

2.55 Under a Management Service Agreement between the Government and the United Nations Development Programme (ARG/91/R01), the latter provided assistance with project components linked to implementation of the Public Enterprise Reform Execution Loan (PEREL), which in turn supported implementation of the Public Enterprise Reform Adjustment Lean (PERAL). - 37 -

Consequently, one of these programs cannot be examined unless the other is also taken into account.

2.56 The pace of privatization which the Government imposed made it difficult to comply strictly with UNDP procurement standards in obtaining consulting services. Over the course of the project, efforts were made by the Government, the World Bank and UNDP to reconcile that pace with the established standards and procedures. However, on a number of occasions steps taken by the Coordination Unit to facilitate decisions and goal achievement inevitably resulted in failures in this regard.

2.57 These failures can also be attributed in part to high staff turnover in the UNDP office in New York that was dealing with the Coordination Unit, and to the limitations under which UNDP's Procurement Services Office must function, particularly the lack of delegation of decision-making authority to the local UNDP office.

CONCLUSION: In light of this experience, it would appear that Management Service Agreements with UNDP should be relied on only to the extent that their operational clauses can be successfully negotiated with the agency.

2.58 From the time that disbursement of loan proceeds began, the project had the services of a Coordination Unit, headed by the alternate project director, an arrangement which not only helped save time whenever the project director position was vacant but also meant that business could be transacted without recourse to higher authorities.

CONCLUSION: Under future projects, the head of the Coordination Unit should be involved in negotiations from the outset, in addition to serving as alternate project director. If at the same time the operating functions of that Unit are clearly indicated in its terms of reference, then there is a very good chance the execution process will prove successful.

2.59 As noted above, the Loan Agreement was considered to be completed roughly a year prior to the date anticipated originally, and therefore Bank supervision missions as well. Although this can be interpreted as a mark of successful performance, the view in some government circles was that it amounted to a premature withdrawal of necessary World Bank support for the achievement of goals which, while not matters of direct contractual obligation, were certainly logically connected with the program as a whole.

CONCLUSION: Under any future Loan Agreement associated with the execution of a specific program, thought should be given to providing for the Bank's commitment to continue for a period dictated more by the requirements of full program development than solely by the strict letter of the Loan Agreement itself. - 38 -

2.60 The privatizations achieved have pointed up the need for definitive solutions in the case of such important matters as residual entities, regulatory agencies, and last but not least disposal and liquidation of the surplus assets and remaining real estate holdings of FerrocarilesArgentinos.

CONCLUSION: The Government and the World Bank should consider developing new programs consisting of actions needed as a direct consequence of the policies that have been instituted, since the present vacuum in this regard is creating problems for the Government. Such programs would focus on:

(a) technical assistance with disposal of the residual entities;

(b) technical assistance for the regulatory agencies;

(c) technical assistance with developing uses for and/or organizing the sale of government-owned real estate.

K. Summary

2.61 Only with hindsight will it be possible to form an accurate opinion as to the real achievements and reach of the Public Enterprises Reform Program undertaken by the Argentine Government during the Menem presidency. However, some of its immediate consequences may be noted:

(a) elimination of the fiscal deficit as a result of the reduction in Teasury transfers to PEs;

(b) higher investment levels and higher technology levels in the privatized sectors;

(c) far-reaching changes in the public sector, greater rationality in the utilization of resources, and more efficient management in those areas which are the natural preserve of government. - 39 -

ARGENTINA

PROJECT COMPLETION REPORT

PUBLIC ENTERPRISE REFORM ADJUSTMENT LOAN PERAL I (LOAN 3291-AR)

PART II: STATISTICAL INFORMATION

A. Related Bank Loans (in US$ millions)

3.1 Loans Approved Prior to or Concurrent with Loan 3291-AR

Loan Fiscal Amount less Undiburs # Year Borrower Purpose cancellations ed'

2592 1985 Yacimientos Petrolfferos Fiscales Gas Utilization and TA 180.00 10.10

2712 1986 Argentina Public Sector Mgmt. 18.50 0.00

3292 1991 Argentina Public Enterprise Reform 23.00 12.55 Execution Loan 3362 1991 Argentina Public Sector Reform TA 23.00 19.28

3394 1991 Argentina Public Sector Reform 325.00 0.00

TOTAL 569.50 41.93

As of June 30, 1993.

3.2 Loans Approved After Loan 3291-AR

Loan Fiscal Borrower Purpose Amount less Undisburs # Year cancellations ed' 3556 1993 Argentina Second Public Enterprise Reform 300.00 100.03 3558 1993 Argentina Financial Sector Adjustment 400.00 194.83

TOTAL 700.00 294.8

As of June 30, 1993. -40-

B. Prject T1metabl

ITEMS DATE DATE PLANNED ACTUAL Identification (EPS) Early 1988 1987-1990 Appraisal Mission Late 1988 Oct. 90 Loan Negotiations Dec. 10, 1990 Board Approval Mid 1989 Feb. 02, 1991 Loan Signature Aug. 04, 1991 Loan Effectiveness Jun. 21, 1991 Loan Closing Feb. 17, 1993 Loan Completion Feb. 1 1993

C Loan Disbursements

CUMULATIVE ESTIMATED AND ACTUAL DISBURSEMENTS (US$ million) FY91 FY92 FY93 Appraisal Estimate 150.00 225.00 300.00 Actual 144.98 151.57 300.00 Actual as % of Finance 96.70 67.40 100.00

D). Dates of Tranche Disbursements

TRANCHE DATE First Jun. 21, 1991 Railway Dec. 17, 1992 Hydrocarbon Feb. 17, 1992 - 41 -

E. Project Costs and FInancing

3.3 Project Costs (in US$ million)

APPRAISAL ESTIMATE ACTUAL 7Ibtal' 300.0 360.0

1 Costs were represented by severance payments for railway staff. Such costs were financed by the counterpart proceeds of the Bank loan. -42-

Ir

i. i. i i. III' It1 i i i illj lii

I* I

& ~vt

q b I ti F -43- I i'

___ II [I i; I ~ i Tfrfrr i"' B. I i ~I ~ I[II Ii I 1111111

B.i~~ d~m i e ~' *i~'Iltiii! I v vv r v v *1

= * = * - - = * - -- - -44-

G. Use of Bank Rm mes

3.4 Stafflapus On Muff wee)

Stage of Project Cycle Planned Final

M-nouh Appaisal 23.0 491.9

Appadsal Mllosgh Boazd Approval 132.0 47.2

Boad Approval lrough Effectiveness 7.0 10.9

Supervision 46.0 503

TOIb 208.0 612.3

3.5 Missions

Stage of Project Cycle Month/Har Number of Days in Specialiation Performance Persons Field' Represead' Rating Status

9/88 8 14 a,c,b,e,f.g

10/8 2 7 b

11/8 13 19 a,c,b,e,f,g Thwig:h Appasal 4/89 . I 8 f

8/89 1 10 e

10/89 8 17 a,b,d,h

6/90 1 9 h Appealel Though Boad Approval 10/90 1 5 1 1/91 2 2 ij

Boad Appmoal Though 3/91 5 5 a,e,b,c,g 2 Effectiveness 5/91 6 6 b N.A.

7/91 2 10 a,b N.A.

11/91 4 11 a,b,e,d 2

Supervision 5/92 1 2 b N.A.

7/92 1 7 * N.A.

11/92 2 7 e,a 1

'Refers to TM/Mission Leader 2KOy to Specialization: a. Thak Manager b. Hydrocarbons Expert c. Telecornunnications Expert d. Telecommunications Regulatory Expert e. Railway Expert f. Financial Analyst g. Industrial Economist h. Industrial Specialist i. Division Chief j. Country Department Director Anna l

H. frtect repationnding (in US$ thousand)

7712,R 2592R JAp9n Caub Egmmi PPP h~ PPP iPEAL. PPP fr Ca MNMAL GUTA MA_ ESMAIM PSTA_UA mflEP ae Trut- Pmma farK PERALm pioar~ subsequestN ~m a PEREL piar~ 0meft Pwiilty__ _ P d Envimmnt t Appmisal' appraiual w appraisa hit

ami M%~ 170 20 90 280

orfoma Evdh 130 130

kuuct ad YPP 1,113 5 5100 1,700

Redtrrg d Pl e 200 400 170 1,370

Priamizåin d ENfU 500 25 50 500 150 1,675

Esmbfid~ima dCHT lo Iw

Labar Mag ek 50 250 250 60 60

~ c~o U.a 120 50 170

oas Eury 1if 650 100 50 80 &Udy

Erm I Aam 15 15

1urAL 1,320 1,10D J0 .150 100 45 15 750 750 750 670 6,8350

'Ile PPF before appraisal was arranged under the then proposed PBRL. Subsequently, PERL was split into tw separate loans; (PEREUPERAL) the initial PPF will be repaid under PERAL.