Document of The World Bank Group
For Official Use Only
Report No. 27340-AR Public Disclosure Authorized
MEMORANDUM OF THE PRESIDENT
OF THE
INTERNATIONAL BANK FOR
RECONSTRUCTION AND DEVELOPMENT
AND
Public Disclosure Authorized THE INTERNATIONAL FINANCE CORPORATION
TO THE
EXECUTIVE DIRECTORS
ON A
COUNTRY ASSISTANCE STRATEGY
OF THE
Public Disclosure Authorized WORLD BANK GROUP
FOR
THE ARGENTINE REPUBLIC
January 29,2004
COUNTRYMANAGEMENT UNIT ARGENTINA, CHILE, PARAGUAY AND URUGUAY LATINAMERICA AND THE CARIBBEAN REGION
Public Disclosure Authorized THEINTERNATIONAL FINANCECORPORATION LATINAMERICA AND CARIBBEAN DEPARTMENT
This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its content may not otherwise be disclosed without World Bank authorization. The last Country Assistance Strategy (CAS) for Argentina was discussed by the Executive Directors on June 27,2000 (Report N. 20354, dated September 8,2000). A progress Report was discussed on July 19 2001, and subsequently updated (Report No.22049-AR, dated October 1,2001). A previous version of the proposed new Country Assistance Strategy was distributed to the Board on December 2,2003 (Report N0.27340-AR)
CURRENCY EQUIVALENTS Currency Unit : Argentine Peso
EXCHANGE RATE December 3 1,2003 Argentine $2.94= US$l
WEIGHTS AND MEASURES Metric System
FISCAL YEAR January 1 - December 3 1
ABBREVIATIONS AND ACCRONYMS
AAA Analytical and Advisory Assistance AGN General Auditor’s Office (Auditoria General de la Nacidn) ANSES National Social Security Administration (Administracidn Nacional de la Seguridad Socia4 AFIP Federal Tax Administration Agency (Administracidn General de Ingresos Ptiblicos) APL Adaptable Program Loan ARP Argentina Recovery Project BA Buenos Aires CAS Country Assistance Strategy CDD Community Driven Development CEM Country Economic Memorandum CIF Cost, Insurance and Freight CFAA Country Financial Accountability Assessment COFESA Federal Health Council (Consejo Federal de Salud) CPAR Country Procurement Assessment Report CPI Consumer Price Index cso Civil Society Organization CY Calendar Year DO Development Objectives ECLAC Economic Commission for Latin America EGB General Basic Education (Educacidn General Bcisica) EPH National Household Survey (Encuesta Permanente de Hogares) ESW Economic and Sector Work FDI Foreign Direct Investment FOB Free on Board Cost FOPAR Participatory Social Investment Fund (Fondo Participativo de Inversidn Sociao FSAP Financial Sector Assessment Program FY Fiscal Year GDP Gross Domestic Product GEF Global Environment Facility GNFS Goods and Nonfactor Services GTONG Grupo de Trabajo de Organizaciones no Gubernamentales sobre el Banco Mundial HD Human Development ICSID International Center for Settlement of Investment Disputes IDA International Development Association IDB Inter-American Development Bank IDF Institutional Development Fund FOR OFFICIAL USE ONLY IFC Intemational Finance Corporation IMF Intemational Monetary Fund IBRD Intemational Bank for Reconstruction and Development IDF Institutional Development Fund IDGs Intemational Development Goals IF1 Intemational Financial Institutions IMR Infant Mortality Rate LAC Latin American and the Caribbean LCU Local Currency Unit LEN Lending MDGs Millennium Development Goals MIGA , Multilateral Investment Guarantee Agency NEA North East ofArgentina (Noreste Argentino) NGO NonGovernmental Organizations NOA North West ofArgentina (Noroeste Argentino) OECD Organization €or Economic Cooperation Development OED Operations Evaluation Department PAM1 Integrated program €or medical care PER Public Expenditure Review PISA Program for Intemational Study Assessment PIU Project Implementation Unit PFO Financing agreements between provinces and the federal government PRL Provincial Reform Loan PROMIN Program for Matemal and Child Health and Nutrition SAL Structural Adjustment Loan SECAL Sector Adjustment Loan SINTyS Social and Fiscal National Identification System Program (Sistema Nacional de Identification Tributario y SocinT) SME Small and lMedium Enterprises SPN Supervision SSAL Special Structural Adjustment Loan SWAP Sector Wide Approach S&T Science and Technology TB Tuberculosis TDO Total Debt Outstanding and Disbursed TDS Total Debt Service TI Transparency Intemational UNDP United Nations Development Program VIGIA Public Health Surveillance and Disease Control Project WB World Bank WBI World Bank Institute WPI Wholesale Price Index XGS Export ofGoods and Services
~~ IBRD Vice President David De Ferranti Country Director Axel van Trotsenburg Lead Economst (Acting) Daniel Oks Lead Country Officer Felipe Saez Task Manager Frank Earwaker IFC Vice President Assaad Jabre LAC Director Bemard Pasquier Unit Manager Toshiya Masuoka Country Manager Yolande Duhem
This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization.
Argentina: Country Assistance Strategy
TABLE OF CONTENTS
Executive Summary ...... i-iv I. Introduction: The Operational Environment ...... 1 I1. Implementation of last CAS-FYO1-04: Preliminary Assessment ...... 2 Key Lessons Learned ...... 5 1II.The Underlying Country Context ...... 6 Economic Issues...... 6 Social Issues ...... 9 Governance Issues ...... 12 IV.The Government’s Strategy ...... 13 V . Bank Group Assistance Strategy ...... 15 Strategic Objectives ofthe CAS ...... 15 Consultations with Civil Society and Private Sector ...... 19 Portfolio Performance ...... 20 The Scenarios ...... 23 Lending Levels and Instruments ...... 28 The IFC Program ...... 33 MIGA ...... 34 ICSID ...... 35 Bank Partners ...... 35 Fiduciary and Procurement Management ...... 35 Risk Management ...... 37
Figures:
Fig. 1. Economic Indicators ...... 8 Fig. 2 . Argentina: Evolution ofUnemployment and Poverty Rates (in percent) ...... 12
Table . 1. Monitoring Progress: Projected vs . Latest Estimates ...... 3 Table 2 . Lending: Program vs . Actual Outcomes ...... 4 Table 3 . Macroeconomic Indicators...... 7 Table 4 . Poverty Characteristics ...... 10 Table 5 . Social Indicators ...... 12 Table 6 . Argentina Portfolio Improvement Action Plan...... 22 Table 7 . Proposed Lending & ESW Program - Base Case Mid FY 04-08 ...... 31 Table 8 . Argentina Trigger Matrix FY mid 04-FY08 ...... 32 Boxes
Box 1. Tracking the poverty impact ofthe crisis ...... 9 Box 2 . Investing for Growth with Equity...... 24 Box 3 . Social Protection as an Integral Part of Social Inclusion ...... 26 Box 4 . Investments for Improved Governance...... 27
Annexes:
Annex A . CAS Program Matrix...... 42 Annex B. 1. Argentina at a Glance ...... 54 Annex B.2. Selected Indicators of Bank Portfolio Performance and Management ...... 56 Annex B.3. IBRD/IDA Program Summary ...... 57 Annex B.3. IFC & MIGA for Argentina ...... 58 Annex B.4. Summary of Non Lending Services...... 59 Annex B.6. Key Economic Indicators ...... 60 Annex B.7. Key Exposure Indicators ...... 62 Annex B.8. Operations Portfolio (IBRDIIDA and Grants) ...... 63 Annex B.9. IFC for Argentina ...... 64 Annex C . Sovereign Debt Restructuring ...... 66 Annex D. Status Report on Millennium Development Goals...... 70 Annex E. Summary of Consultations with Civil Society ...... 78 Annex F. Joint WB - IFC Private Sector Development Strategy ...... 83 Annex G. The proposed Operations Program ...... 98 Annex H. Comments from the Government of Argentina on the CAS ...... 107
The World Bank Group greatly appreciates the close consultations with the Argentine government in the preparation of this CAS . The document has benefited from extensive discussions with and contributions from govemment representatives at the federal and provincial levels. civil society representatives in five regions and in the Capital and various meetings with a wide range of private sector participants . The preparation of this CAS has truly been a team effort. which included hands-on involvement of the entire Argentina country team. plus staff from other units of the World Bank Group . Many team members and other staff made substantial contributions - in drafting parts of this document. in providing comments and advice - to jointly develop the strategy presented here . Executive Summary
Country Context
Argentina ’s economy has stabilized, and production and employment are recovering from the deepest crisis in recent memory. But many challenges remain. More than half of the population are in poverty, up more than twenty percentage points in the last year or two. The number of extreme poor is twice its pre-crisis level. Open unemployment has begun to fall but remains at high levels. Key social indicators, such as infant mortality, are deterioratingfor the first time in thirty years.
A new administration, elected through fair and orderly elections, emerged from 2003 much strengthened by buoyant popular support and congressional, provincial, and local renewal. Economic policies have been disciplined, and high-proJile initiatives to combat corruption and bring to account those responsible for past abuses have proven popular and the Government enjoys high approval ratings. As the administration now moves beyond its initial months, it will need to further articulate and implement strategies to address a number of key issues left by the crisis.
Four of these issues are particularly important. First, the default on public debt totaling US$106 billion needs to be resolved. Second, the financial system needs to be rehabilitated, after its insolvency following the abandonment of the dollar peg and the conversion of assets and liabilities into devalued pesos at different exchange rates. Bank deposits have now been freed and the government has made signiJicant progress on compensating banks for asymmetric pesijkation and indexation. Further progress needs to be made on bank restructuring. Third, public service and infrastructure concessions need to be renegotiated because the crisis, together with a freeze on targfs, have rendered previous contractual arrangements inoperative. Fourth, corporate debt also needs to be restructured. Without substantial progress towards resolving these four issues it will be dfficult, in the Bank’s view,for Argentina to sustain growth and achieve a substantial reduction in poverty.
Conscious of the signijkance of these issues, the new administration’s strategy emphasizes rebuilding the economy with a view to delivering sustained growth within a framework of social equity. Reversing the regressive trend in income distribution of the last 25 years is considered a priority. To these ends, the administration is attaching importance to: (i) maintaining macroeconomic stability, including a disciplined monetary policy, a market-driven exchange rate and fiscal policies that will result in sustained primary surpluses; (ii) ensuring that internal and external demand respond to an adequate incentive framework, thereby increasing capacity utilization and stimulating new investments; and (iii) fostering productivity gains in the productive sectors that are equitably shared. Within this context, the Government has acknowledged the need to address problems confronted by the financial sector, public service and infrastructure concessions, and issues of private sector development. The Bank’s Assistance Strategy
Within the overarching goal of contributing to reducing the extent and severity ofpoverty as Argentina recovers from the crisis, the Bank’s program willfocus on: (1) sustained economic growth with equity, (2) social inclusion, and (3) governance. These three pillars of the CAS are congruent with the government’s priorities as just noted.
Under sustained economic growth with equity, the CAS recognizes, as the government does, not just that growth is essential, but also that it is needed over sufficiently long periods and with sufficiently pro-poor impacts such that all segments of the Argentine population can seek notable improvement in their lives and livelihoods. Argentina will need to significantly improve the investment climate in order to restore investors and creditors ’ confidence and attract much needed investment to support sustained long-term growth, particularly in infrastructure and productive activities. For this, Argentina needs to concentrate on ensuring that all restructuring processes (debt, concessions, etc.) be conducted in a manner that is perceived as fair, transparent, and a fair burden sharing among all parties. At the same time, concerns about inequality in the distribution of the economy’s benefits in the past, which has become a salient issue for Argentina today, will need to be addressed.
Under social inclusion, the CAS concentrates on the need for strengthened and more effective efforts to reach the most vulnerable groups - the indigentpoor, the elderly, the rural poor, indigenous populations and the large number of youth who are neither employed nor in school. Emergency programs, such as the Head of Households program, have successfully provided assistance during the crisis, but they need now to be redirected to serve the medium and longer-term development agenda, including employment generation. In addition, basic social services have to be restored for millions of Argentines, and setbacks in the coverage and quality of education and health need to be rectiJed.
Under governance, the CAS stresses the need for determined efforts for improvements, accompanied by institutional and structural reforms to ensure the sustainability of those efforts over time. Vital dimensions of this include: improving the effectiveness of provincial governments, Jighting corruption, increasing the transparency of public institutions (including the judiciaryl, and establishing the organizational and institutional infrastructure to administer property rights.
Extensive consultations were held with civil society and the private sector as part of this CASprocess, to ensure that the real concerns and aspirations in Argentina are listened to, and that the direction and quality of the Bank’s support benefits from that input. Lessons from experience, including the last CAS and the progress of the portfolio, have also been examined carefully.
Three alternative scenarios - base, high, and low - are presented. The base case would be predicated on:
.. 11 0 Maintenance of a satisfactory macroeconomic framework. 0 Steadily improving performance, particularly with structural reforms. 0 Implementation of social reform and fostering of social inclusion. 0 Stepped-up efforts to improve governance. 0 Improving portfolio management and implementation.
The Bank would engage in an active dialogue with the authorities on all of the topics noted in this CAS as vitalfor the country’s progress. Where there is strong consensus between the government and the Bank, lending and other support wouldproceed, providing assistance to the authorities in carrying out agreed plans and effective actions. Where there is not consensus, the Bank would seek to maintain an active dialogue, with the aid of analytical work as needed. Where the dialogue bears fruit, lending would then begin.
The base case calls for a lendingprogram of up to US$5 billion for the period mid-FY04 through end-FY08. This would represent a measured increase in support for needed investments and reforms. The resulting disbursements would be sufficient to cover amortizations. The CAS would move the Bank away from short-term crisis management and back to a longer-term assistance framework.
It is the government’s view, shared by civil society, that, at the present juncture, investment lending is more in keeping with Argentina’s development requirements than adjustment lending and the authorities have therefore requested a Bank program in which investment lending constitutes 60- 75 percent of the total.
The IFC, from the onset of the crisis, has focusedprimarily on portfolio management - to arrest, to the extent possible, the adverse effects of the crisis upon its clients. IFC’s strategy will continue to center on supporting export-oriented investments with a focus on alleviating the credit crunch faced by export-driven companies, and engaging in selective investments in new operations with returns commensurate to their risks.
Risks
Although the situation in Argentina has stabilized in many respects, there still remain many risks and uncertainties. Close monitoring and reporting ofprogress - and problems - has therefore been built into the proposedprogram. Staff will continue briefing the Board regularly. Specifically, staff willprovide a briefing to the Board no later than June 30, 2004 on the definition of those structural reforms where the Government is planning to seek Banksupport. There would also be a CASprogress report in 2005 to assess progress and to validate, or as needed to mod&, the Bank’s assistance strategy to Argentina.
... 111 Government Letter
The Government in a letter dated December 2, 2003, has indicated its agreement with the proposed assistance strategy and provided comments to some aspects of the CAS Report (see Annex H).
iv MEMORANDUM OF THE PRESIDENT OF THE IBRD AND THE IFC TO THE EXECUTIVE DIRECTORS ON A COUNTRY ASSISTANCE STRATEGY OF THE WORLD BANK GROUP FOR ARGENTINA
I. Introduction: The Operational Environment
1. The economic and social position ofArgentina has changed radically since the previous CAS was issued in September 2000, and since a Progress Report was considered by the Board in July 200 1. In the following months, Argentina was plunged into a crisis which, in many respects was more broad-ranging and severe than anything experienced in the past.
0 The economic crisis followed upon several years ofrecession and culminated in a default on public debt and a collapse ofthe currency board arrangement. The dollar peg was abandoned. GDP fell by some 11 percent in 2002 bringing the overall decline since 1998 to some 20 percent and unemployment rose to more than 20 percent. 0 A social crisis was induced by widespread unemployment and an unprecedented fall in real incomes. More than half the population ofArgentina is now poor. 0 A governance crisis ensued when public confidence collapsed and left the body politic in disarray. Governments fell in rapid succession. Many government decisions have been challenged in court and some ofthem have been overturned. At the same time, an institutional crisis was precipitated by the abandonment of the dollar peg because, for many years, business structures as well as commercial and private contracts had been predicated upon the premise that the peso and the dollar were interchangeable. While the new administration currently enjoys wide support, it will be an uphill battle for the Government to restore public confidence in its institutions.
2. The Government is continuing to follow the disciplined fiscal and monetary policy that enabled Argentina to stabilize the economy relatively quickly and bring under control the inflationary pressures which were unleashed by a massive devaluation ofthe peso. The economy is continuing to recover from the very low levels of2002 but high growth rates are unlikely to be sustained without structural reforms and firm action to redress the serious financial imbalances that were precipitated by a default on public debt and the abandonment of the dollar parity.
3. At the present juncture, the Government is still in the process ofarticulating a comprehensive medium-tenn economic strategy. Based upon its actions and pronouncements since taking office in May 2003, however, it would appear that the Government intends to exercise strong macroeconomic discipline. Monetary policies are to be based -- after 2004 -- on an inflation targeting regime. For 2004, monetary policy will be based on an indicative low inflation range; there will be a flexible exchange rate
1 and the target for the primary fiscal surplus has been set at 3 percent ofGDP. The Government is in the process ofworking out a structural adjustment agenda for the medium term. However, a more interventionist approach to sector issues is discemable as well as a cautious attitude towards markets and private investors. In the dialogue between Government, the private sector, extemal investors and creditors there have been unease, misunderstandings and sometimes distrust. In that context, the Government’s firm stand on economic issues has sometimes been perceived as confrontational. The Bretton Woods institutions have also been a prominent target ofcriticism and of allegations that they were complicit in failed policies which contributed to economic collapse.
4. All ofthis points to a difficult operational environment for the Bank. The difficulties have been aggravated by “reform fatigue” which makes it difficult to reach an understanding on policy or institutional changes and by a deterioration in project implementation capacity following the economic crisis. Fully half ofthe Bank’s project portfolio in Argentina now has an unsatisfactory performance rating as compared with only 12 percent ofthe portfolio before the crisis.
5. The challenges for this CAS are, therefore, to identify’inrealistic terms: (i)a Bank program that will contribute effectively to Argentina’s development objectives within a difficult policy and operational environment; (ii)a lending program that, in content, reflects the outcome ofextensive consultations with Government, private sector, and civil society and that, in size, responds to the financing requirements ofthe Government; and (iii)the risks and opportunities that may arise in the future as Argentina strives towards sustained growth and improved social conditions. It is unavoidable that the program will face a high degree ofuncertainty. This uncertainty will require that Bank assistance be furnished within the context ofa flexible roadmap for the next four and a half years and be reviewed and adjusted in line with the Government’s performance on structural reform and project portfolio implementation.
6. The remainder ofthis paper is organized as follows: Section I1provides a preliminary assessment ofthe implementation ofthe last CAS. Section I11 discusses the underlying current economic, social, and governance issues. Section IV deals with the emerging Government strategy. In the last section, the proposed Bank Group assistance strategy is discussed.
11. Implementation of last CAS -FY01-04: Preliminary Assessment
7. The last Argentina CAS was presented to the Board on September 2000. It focused on the poor and sought to promote equitable, sustained growth. In that context, the Bank emphasized three themes: (i)enhancing social development, including poverty alleviation and human resource development; (ii)improving the perfonnance ofthe state, particularly at the sub-national level; and (iii)consolidating structural reforms.
2 8. The CAS program was overtaken by events during the last quarter of2001 when there was a disorderly end to the convertibility system, and a massive default on public debt held by private creditors. The 2000 CAS had contemplated a possible collapse of the Convertibility Plan without fully developing the implications ofsuch scenario other than what the Bank’s response should be to such an eventuality. The CAS indicated that “the Bank would refocus on social protection, restructuring ofthe economy and the financial system”, which indeed have been at the core ofthe Bank’s response during the emergency. Nevertheless, the enormity ofthe impact ofthe crisis on the economic and financial system as well as on unemployment and poverty rendered the CAS targets obsolete as the table below shows.
Table 1. Monitoring Progress: Projected vs. Latest Estimates
Initial Values Medium-term Targets Latest ValueslEstimates I. Economic and Financial Real GDP Growth -3.4% (1999) +4.5% p.a. ll -5.4% p.a. (2000-02) Credit Rating BB for S&P Investment grade for gv’t paper Default
II. Social Indicators Unemployment 13.9% 9. Since early 2002, the Bank has adopted a rapid and flexible response to a highly fluid economic, political, and social situation. Staff and management have briefed the Board on a regular basis conceming the latest developments in the country, the Bank’s support activities, and those ofour partners, especially the IMF. The key elements ofour assistance strategy have been (i)emergency social support by restructuring the existing investment portfolio and by furnishing a new loan for the Government’s Heads of Household program; (ii)technical assistance in areas such as financial sector restructuring, corporate restructuring, and the renegotiation ofpublic services and infrastructure concessions; (iii)support for selected structural reforms in 2003, including the elimination ofquasi-monies and health sector reform; and (iv) identification ofkey challenges for the incoming administration through the preparation ofPolicy Notes. * 10. The deep economic and social crisis also affected profoundly the Bank’s lending program. Although the Bank committed US$3 billion by October 2003 as programmed, the composition ofthe lending program changed significantly: The CAS of2000 initially envisaged that adjustment operations would amount to about 37 percent ofthe base lending program with a gradual phasing-out from FY02 onwards. That strategy changed very little in the CAS update of2001. However, actual outcomes were radically different. Adjustment lending during the FYO1-04 period accounted for 78 percent of Argentina - Policy Notes, SecM 2003-0301, dated June 24,2003. 3 total lending, emergency social lending (Le. the Heads ofHousehold program) for 20 percent, and new investment lending for only 2 percent.2 Table 2. Lending: Program vs. Actual Outcomes (In US$ millions andpercent) Update CAS 2o01 CAS - Related Lending Post-Crisis Lending CAS 2000 Actual (FYOI-02) Actual (FY03-04 (Nov.)) US$mn. % US$mn. % US$ mn. % US$ mn. % 1100 37 1318.7 44 1103 94 1250 68 .Adiustment__, __ .. . . -. . . -Loans - -. .- PRLsiSALs in FYO1-02 1100 1253.7 1103 SALsiSECALs in FYO3-04 65 1250 Emergency Investment Loan 0 0 0 0 0 0 600 32 (Jefas y Jefes) 1900 63 1670 56 67 6 0 0 Investment Loans 3000 100 2996.7 100 1170 100 1850 100 TOTAL 1 1. The changed composition oflending was directly related to Argentina’s loss of access to intemational capital markets and the pace at which events unfolded. The original CAS and the CAS update assumed that the country would have continued access to capital markets and that was a key justification for reducing Bank exposure. Especially important in that context was the implicit assumption that Argentina would have substantial negative net transfers to the Bank during the CAS period and, particularly, in 2002-03 when large amortizations fell due on Special Structural Adjustment Loans. 12. In addition to losing access to the intemational financial markets, Argentina’s system ofpayments collapsed and counterpart funding was unavailable which led to major problems ofproject execution. Those developments prompted the Government to seek increased amounts of adjustment lending to cover its obligations vis-a-vis the IFIs, including the Bank. The Bank responded positively to these requests, preparing adjustment loans in the post-crisis period ofUS$1.25 billion and an emergency social assistance credit ofUS$600 million. However, disbursements on the investment portfolio fell short ofexpectations notwithstanding attempts to improve project performance by restructuring. In addition, the Bank was cautious about lending into a crisis situation, especially since the Government’s capacity to design and implement adjustment loans was not assured. As a result, Bank exposure fell by more than US$1.9 billion between the end of200 1 and December 2003, 13. The crisis had a major impact on the Bank’s investment portfolio. The implementation of investment projects deteriorated to such an extent that about half of them had to be qualified “unsatisfactory” with regard to implementation in 2003. Bank staff have been proactively working to reverse the poor portfolio performance, restructuring operations and amending agreements to accommodate the changing * Under the original CAS, it was planned to prepare 18 investment operations, a number which was retained under the CAS update. The actual outcomes were 3 investment loans that were approved during FYOl and the Heads of Household loan approved in FY03. 4 circumstances. There was excellent cooperation from government staff in project implementation units. An external advisory panel was convened to review portfolio restructuring and two portfolio reviews took place during the last year. There was constant follow-up by task teams. Even so, a full normalization ofportfolio performance is not expected before 2004/5. It will take until then to resolve major issues such as the release of counterpart funding, new staffing for project implementation units, and bidding with revised price methodologies. 14. A positive experience that emerged from the crisis has been the close and effective coordination between Bank staff and management and the Board. There was also close collaboration with key external partners, including the IDB and the IMF. The result was strong support for Bank assistance to Argentina in the aftermath ofthe crisis. Key lessons learned 15. Because ofthe economic crisis, the objectives ofthe previous CAS could not be achieved. Our country dialogue was compromised because throughout 200 1 the convertibility plan was becoming increasingly unsustainable as evidenced by mounting capital flight and steadily eroding creditworthiness. It became difficult to sustain a meaningful country dialogue when there were major differences ofviewpoint conceming the viability ofthe macroeconomic framework (especially the sustainability ofthe exchange rate). Although, for internal contingency purposes, Bank staff had undertaken considerable analytic work on a possible default scenario, the work could not be operationalized when it came to dealing with a disorderly devaluation and asymmetric pesification. 16. The massive deterioration in project performance that resulted from the economic crisis went far beyond expectations. It was also not anticipated that the project pipeline would be so seriously disrupted. Efforts to repair the situation by such measures as sharply reducing cost-sharing requirements (on an exceptional and temporary basis) proved to be insufficient. Portfolio improvement remains as an urgent priority, particularly since a shift in the structure oflending towards investment operations is envisaged. 17. During the crisis, the Bank was able to adapt quickly to changing circumstances. It provided both technical assistance and advice on key issues relating to the crisis. Financing was provided for emergency social programs as well as other needs in May and October 2003. With the CAS inoperative as ofearly 2002, staff and management intensified the frequency ofBoard briefings as they adjusted the program to better address the needs ofArgentina and help it grapple with the consequences ofthe crisis. 5 111. The Underlying Country Context Economic Issues 18. The Argentine economy is emerging from the deepest recession in generations, with GDP having fallen by about 20 percent in real terms between 1998 and 2002. However, the economy was quickly stabilized after the collapse ofthe Convertibility Plan and an economic recovery has been steadily gaining strength. Real GDP growth is now estimated at 8 percent for 2003. In fact, macroeconomic performance was much better than initially anticipated at the beginning of2003. Key to this achievement have been the improvement in the fiscal accounts (aside from issues arising from the default on public debt) and the pursuit of a prudent monetary policy. Fiscal improvements were due to a strong recovery in tax revenues and Government’s restraint on public expenditures. Monetary policy has accommodated an increase in demand for money consistent with low inflation. Moreover, quasi-monies have been almost totally retired in an orderly manner. 19. The economic rebound that took place in 2003 may well extend into 2004 if the external environment remains favorable and macroeconomic discipline is sustained. There still remains some slack industrial capacity that could permit a further increase in production in response to expansionary policies such as the recent increase in minimum wages. Growth in the order of 6.5 percent is therefore po~sible.~Once slack capacity has been taken up however, further growth will depend upon investment which, in tum, will not be forthcoming unless steps are taken to improve the investment climate. 20. Fiscal management is the key to a viable macroeconomic framework without which growth will be impossible. The Government has targeted a consolidated primary fiscal surplus of3 percent of GDP for 2004. However, recent buoyant revenue growth has depended upon distortionary taxes which should be dismantled and replaced in a way that does not jeopardize the primary surplus target. The retirement ofall quasi-monies by end-2003, with Bank support from an Economic and Social Transition Loan, will make the management ofmonetary policy much ea~ier.~It is envisaged that the Government would adopt an inflation-targeted monetary policy after 2004 and that, in tum, should help keep interest rates low. In September 2003, the Government reached agreement with the IMF on a three year stand by arrangement, and the first review ofthis arrangement was completed in January, 2004.5 Prospects for a well-managed macroeconomic framework are, therefore, better than they have been for many years. 21. Nevertheless, converting recent achievements into a sustained economic and social recovery remains a challenge. A number of important issues--critical for restoring growth and the confidence ofinvestors, creditors, and consumers--have yet to be A concensus forecast published by the Central Bank in January 2004 estimates growth for 2004 at 6.5 percent. Argentina: Economic and Social Transition Loan. Report No.25860-AR, dated May 2,2003. See government and IMF websites: www.mecon. ~ov.arifinanzas/sfimanh-acuerdo.htm and www.i~nf.org/extemallnplloii2003Jargl03lindex.htm 6 resolved. Challenges still pending for the new administration include continuing restructuring the financial system and the public debt, restoring the financial viability and sustainability ofpublic services and infrastructure concessions as well as corporate debt restructuring. Also, Argentina needs to concentrate on ensuring that all restructuring processes (debt, concessions, etc.) be conducted in a manner that is perceived as fair and transparent, and respect a fair burden sharing among all parties. Annex F discusses in greater detail key private sector issues. Improving public sector management, and reforming the fiscal relationship between the central government and the provinces will also be central. In the absence of a satisfactory resolution ofstructural issues and the removal ofinfrastructure bottlenecks, Argentina could face a major slowdown from 2005 onwards. 22. In addition, it will be important to reach agreement with external creditors for a resolution ofthe default on public debt. Failure to do so would likely affect both future capital flows and overall investment. In September 2003, the Minister ofEconomy announced the general parameters for a debt work-out, with a reduction in the nominal value ofthe debt (or “haircut”) of75 percent and the cancellation ofall interest in arrears. Reception ofthe offer by creditors was generally negative. The debt situation is further complicated by the fact that the federal public debt is projected to increase by some US$41 billion between 2001 and end-2003, because of new liabilities assumed by the public sector to compensate banks’ balance sheets and accrued interest in arrears. This increase will raise the debt to GDP ratio by end-2003 to an estimated 150 percent. A more complete account ofthe situation with respect to sovereign debt restructuring can be found in Annex C. Table 3: Macroeconomic Indicators (In percent of GDP or annual percentage change; unless otherwise indicated) 2001 2002 2003 e 2004 National Accounts GDP real growth -4.4 -10.9 8.0 6.5 GDP (in US$ bn.) 269 102 125 147 Investment/GDP 14.2 12.0 14.8 17.4 Savings/GDP 12.5 21.4 21.2 22.4 Current AccounUGDP -1.7 9.5 6.4 5.1 Prices Consumer prices (avg) -1.1 25.9 13.4 8.3 Consumer prices (eop) -1.5 41.0 3.7 10.5 Exchange rate (Ar$/US$) (eop) 1.o 3.4 2.9 ..... REER (depreciation -) 5.9 -55.9 14.2 ..... Consolidated Public Sector RevenuesiGDP 23.7 22.9 26.1 25.3 Primary ExpendituresIGDP 25.0 22.0 23.4 22.3 Primary BalanceiGDP -1.3 0.9 2.8 3 .O of which Federal govemment 0.2 , 0.9 2.4 2.4 External Trade (In US$ bn.) Exports 26.5 25.7 29.0 30.0 Imports 20.3 9.0 13.5 15.5 Trade Balance 6.2 16.7 15.5 14.5 e estimated projected Note: GDP growth rates for 2003 and 2004 are based on latest estimates as of end-January 2004. Sources: IMF. 7 Figure 1. Economic Indicators GDP and Industrial Production Cummulative Primary Balance of the Federal (Jan 01 - Dec 03) Government OIndustnalProduction, y-0-y % change, lefl axis (Jan 01 - Nov 03, cash basis, ARS billion) -GDP, real index 1997=100, rightaxis 30 T T 130 2001 - - - 2002 - I 20 120 10 110 0 100 -10 90 -2 0 80 Interest Rate on TimeDeposits Consumer and Wholesale Prices (Jan 01-Dec 03, dommrr., annual % rate, ) (Jan 01-Dec 03, monthly % change) 80 - --- CPI inflation -WPI mflation 60 -- 40 -- IO 5 20 - I’ --... 0 oi, , I,,I,, , , , , , , , , , I,,I I,,, , , , , , , , , , , si,,, , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , Peso-Dollar Exchange Rate Exports and Imports of Goods and International Reserves (Jan 01-Nov 03, US$ billions) (Jan 01-Dec 03) -Exports -Nominal exchange Rat, pesos/doUar, left axis - - - Imports -- - International Reserves, US%biUions,right axk ‘1- Ts Credit and Deposits Deposits in the Financial System (Jan 01-Dec 03) (Jan 01-Dec 03, ARS billions) -Creditto the private ~ctor,consantprices, Jan 01 = 100 -- - Domestic Currency (leflaxis) -- - TotalDeposits, mnsantprices, Jan 01 = 100 -Foreign Currency (leflaxis) 100, 8 Social Issues 23. The social impact ofthe crisis has been devastating. During 2002, poverty increased dramatically. The number ofpoor grew by roughly 20 percentage points to more than half ofthe total population while the number ofextreme poor nearly doubled. In rural areas the situation is even worse, with almost three out offour people being poor today. At the core ofthis massive increase in poverty was the economic crisis which led to an increase ofopen unemployment to 21 percent in May 2002 (see Table 5). While about 1.3 million new jobs have been created since, about half ofwhich are directly related to workfare programs, unemployment remains at very high levels. Formal private sector employment fell dramatically and even within the informal sector, there was a marked shift to short-term and more instable work relationships. In addition to the loss of family income through unemployment, real wages declined by an average ofone-fifth in the course of2002. Key indicators ofwell-being, such as infant mortality, are deteriorating for the first time in thirty years. While the incidence ofpoverty has recently stabilized it still persists at a high level (see Figure 2). Box 1. Tracking the poverty impact of the crisis As the crisis unfolded, the Bank closely monitored indicators of poverty and social development in Argentina. To this end, the Bank conducted two nation-wide Monitoring Surveys (in May and November 2002) to obtain information on poverty, hunger, access to basic services, and the use of education and health facilities. Using data from the surveys, staff prepared a number of techpal papers that were disseminated widely in Argentina and posted on the Bank’s Argentina web-site. The Bank made an assessment of the impact of the crisis upo~the provision of public services and infrastructure and it also produced a full poverty assessment update. In addition, and together with other intemational organizations, the Bank has supported efforts by civil society to monitor the implementation of emergency programs. A consortium ofNGOs covering the entire national territory has been organized to assess the transparency and effectiveness of these programs. That initiative has provided a vehicle for dialogue between NGOs and the intemational community on monitoring methodologies and best practice. The results of those efforts will be presented to the authorities in due course. * http:llwww.bancomundial.org.ar ** Argentina: Crisis and Poverty 2003, Report No. 26127-AR 24. Apart from its direct employment impact of the economic crisis, the crisis also had a strong negative effect on the delivery ofbasic services and infrastructure to the poor. About 12 percent ofthe Argentine population lost their health insurance coverage, putting additional pressure on already over-stretched public hospitals and health centers. The poor reduced their consumption ofpublic services significantly and many fell behind in paying their bills. Although there were no widespread disconnections, expenditures by the poorest quintile on utility services still account for an unsustainable 22 percent of household income. Parents tried as much as possible to keep their children in education and drop-out rates in primary and secondary school were low, but about 70 percent of families had to reduce expenditures for school materials. In at least six provinces, most ofthem in the poorer northern region, schools were closed for part ofthe year for lack of basic services. The crisis also caused public housing projects, flood protection and 9 provincial road construction to be suspended because public expenditures were reallocated to finance emergency safety net schemes. That too will have a negative impact on the poor in years to come. An overview of the situation with respect to poverty in Argentina is presented in Table 4 below, combining both the underlying long-term characteristics of poverty and the exacerbating effects ofthe recent crisis. Progress towards the millennium development goals is discussed in Annex D. Table 4: Poverty Characteristics Sector Poverty Characteristics Historical low formal sector growth; low production intensity of low and unskilled workers Reduction in formal private sector employment by 13 percent due to crisis, now only Formal private sector representing one-fourth of labor force. 3 1 percent of formal sector workers poor (end 2002). Poor depend mainly on informal sector for their main source of income. Their income is unreliable and they fall outside the social security system. As consequence of crisis, stable Informal Sector wage income in the informal sector was reduced by 17 percent. 62 percent of informal sector workers are poor as of end 2002 Poverty rate for children (age 0 to 14) rose from 45 to 70 percent over the 1998-2002 period. Unemployment affects the youth and the aging workers particularly hard. Social Protection and As crisis response, creation ofHeads of Households workfare program (now has 1.8 million vulnerable groups beneficiaries). Unemployment impact limited as half of participants inactive before joining program. Formal pension coverage declining (33 percent of elderly without coverage in 2001 and even more now). Only 50 percent of 18 years old population complete secondary education and only 23 percent of those from the poorest income quintile. Education Public transfers to private schools (at provincial level) and public transfers to universities (at national level) disfavoring the poor. High geographical inequalities in public resource distribution, disfavoring poorer areas. Formal health insurance coverage only around 50 percent end 2002, having been reduced by 12 percent during crisis as population lost insurance coverage together with formal sector jobs. During crisis, 37 percent of households with children below 12 reported having reduced & Health Nutrition frequency of child medical check-ups; medicament supply decreased in 2002. Poor rely mainly on public health facilities where efficiency and equity ofresource use low as largely going to tertiary care. Infant mortality rate rising for first time in 30 years. Significantly higher rural than urban poverty incidence rates, reaching 72 percent in non- dispersed areas after the crisis. Deep pockets of rural poverty particularly in the northeast and northwest and among Agriculture and Rural indigenous populations. Poor farmers often lack land titles, access to inputs, and access to markets (roads and other logistic infrastructure). Ofpoorest quintile of population, 60 percent (Metropolitan Buenos Aires) and 30 percent (urban interior) lack access to sanitation services; 30 percent lack access to water in Public Services (water, Metropolitan Buenos Aires. electricity, sanitation) Population in poorest quintile pays 22 percent of income for basic service consumption With freezing of utility tariffs, no new investment in infrastructure by private operators, jeopardizing future service supply. High regional disparities in favor of wealthier areas in transport investment, including roads, passenger railroads. During crisis, further delays in transport investment, including Public Infrastructure provincial and rural roads. and Housing Housing deficit for 1.2 million poor. Public housing construction for 120,000 people was interrupted during crisis. 10 25. Recognizing the seriousness of the situation, the Government moved decisively to expand key safety net programs, including the Heads ofHousehold workfare program. Expenditures were consolidated around a smaller number ofkey initiatives. An in-depth impact evaluation by the Bank has shown that the program has performed well in reaching the poor. However, it has not reduced unemployment as much as expected because some half of all participants were not in the labor force to begin with. The recent creation ofthe National Coordination Council for Social Policies constitutes an important step towards improving the effectiveness of social initiatives through better coordination between the various actors at the national level and between different jurisdictions. 26. Recently the economy has been recovering so that the social situation, while still a cause of concern, is slowly improving. Emergency programs have helped to limit the impact ofthe crisis on the poor but Government and its partners are now seeking an exit strategy from those programs and to develop new programs that will address more effectively the fundamental structural issues ofpoverty reduction. Central issues that must be tackled include: 0 A slow expansion of formal private sector employment. 0 The weak asset base ofthe poor with 1.2 million poor living in precarious housing conditions even before the crisis and 28 percent ofthem in flood-prone areas. e Limited access to public services with 60 percent ofthe poorest having no access to sanitation services in the Greater Buenos Aires area and 30 percent similarly disadvantaged in other urban areas. 0 Vulnerability ofthe poor due to limited health and pension insurance coverage. e Inequitable access to education. 0 Shortcomings in the effectiveness of secondary education, which is characterized by high drop-out rates. e A multiplicity ofoverlapping social assistance programs which do not provide a closely-knit safety net. 0 Poorer regions are not well integrated into the national economy. 27. Argentina today has a degree ofincome inequality that is now among the highest in Latin America. The distribution ofincome deteriorated even during the boom years of the 1990s and it has been further exacerbated by the recent crisis. Such high inequality not only creates social tensions but makes poverty reduction more difficult. The new Government has assigned a high priority to improving the distribution ofincome and wealth. 11 Figure 2: Argentina - Evolution of Unemployment and Poverty Rates (in percent) 60 0 Unemployment rate 50 Poverty (population) 40 30 20 10 0 Table 5. Argentina: Social Indicators 1/ 1992-1995 1996 1997 1998 1999 2000 2001 2002 2003 May October May October May Unemployment rate 11.3 17.3 13.7 12.4 13.8 14.7 16.4 18.3 21.5 17.8 15.6 (without Plan Jefes) 21 ...... 23.6 21.4 Households below Poverty Line 16.3 22.9 21.1 20.8 21.3 23.2 26.2 28.0 41.4 45.7 42.6 Extreme Poverty Line 3.7 6.4 5.6 5.4 5.5 6.4 8.3 9.4 18.0 19.5 17.9 Population below Poverty Line 22.0 31.2 28.5 28.6 29.6 31.8 35.9 38.3 53.0 57.5 54.7 Extreme Poverty Line 5.0 8.7 7.5 7.9 7.8 9.0 11.6 13.6 24.8 27.5 26.3 Gini Coefficient 31 0.434 0.457 0.457 0.470 0.462 0.478 0.489 0.497 0.512 0.505 0.503 GDP, real growth 41 1.5 5.5 8.1 3.8 -3.4 -0.5 .... -4.5 .... -10.9 8.0 51 Source: Official Household Survey (Encuesta Permanente de Hogares EPH), for total urban areas. 1/ Data were compiled during the month of October, unless otherwise stated. 2/ Official estimation considering as unemployed all employed whose main activity is the Head of Household Program., 3/ Using family income adjusted by adult equivalent. 41 Annual rate of growth 2003 is a projection. 51 Estimates of the GDP for 2003. Governance Issues 28. The institutions of governance in Argentina have changed substantially in the recent past. Since 1983 the country has moved from an authoritarian polity and state- centered economy to elected leadership, an enlarged role for the private sector, and a more elaborate set of constitutional guarantees and guidelines. Centralized control by the executive has ceded to a more active and independent role for the judiciary and Congress, and greater responsibilities for provincial authorities. Argentina has withstood two major financial crises without military intervention, has effected four transitions of administration, and managed the political crisis of 2001 and the early exit of the De la Rua government within the constitutional framework. Competition within and among political parties remains unrestricted, and the country has seen increased activity by civil society. 29. Unfortunately, long-standing problems ofcorruption, clientelism, inefficiency, bureaucratic formalism, and non-inclusive policy-making did not disappear automatically 12 when traditional state activities were cut back or reorganized. The new administration has pledged to introduce substantial changes in governance practices, particularly with respect to transparency and inclusion. This will present great challenges that will require unprecedented commitment and determination. IV. The Government’s Strategy 30. The new administration’s strategy emphasizes rebuilding the economy with a view to delivering sustained growth within a framework ofsocial equity. Reversing the regressive trend in income distribution ofthe last 25 years is considered a priority. To these ends, the administration is attaching importance to: Maintaining macroeconomic stability, including a disciplined monetary policy, a market-driven exchange rate and fiscal policies that will result in sustained primary surpluses. Ensuring that internal and external demand responds to an adequate incentive framework, thereby increasing capacity utilization and stimulating new investments, Fostering productivity gains in the productive sectors that are equitably shared. Within this context, the Government has acknowledged the need to address problems confronted by the financial sector, public service and infrastructure concessions, and issues ofprivate sector development. 31. These objectives are reflected in the Government’s September 2003 memorandum to the Fund, setting out its economic and financial policies: “A macroeconomic policy mix to enhance growth and entrench price stability; A robustfiscal framework that will anchorjkal discipline at both the federal and provincial levels, provide adequate resources for social policies and public investment, and allow a level ofpublic savings consistent with normalizing relations with creditors; An orderly public debt restructuring that - combined with the envisaged fiscal effort - will help lead to debt sustainability, and allow Argentina to regain responsible access to international capital markets; Steadily strengthening the soundness of the banking system - both in the private and public banks - which willfacilitate greater credit expansion, essential to maintaining the growth momentum; Reforms to provide for greater independence and accountability in the implementation of monetarypolicy - leading to an inflation targeting regime - and in conductingfinancial sector supervision; and 13 Measures to improve the investment climate, including assuring a predictable legal framework, a strategy for the privatized utility companies, and an appropriate legal and institutional framework to facilitate the speedy restructuring of troubled corporate debts. The proposed agenda is ambitious, but measures have been carefully sequenced to ensure widespread consultation and secure the necessary broad support for the program. During the first year of the program, the Government will continue withfiscal discipline, move quickly to a debt restructuring agreement with creditors, implement a strategy for compensation and recapitalization of commercial banks to help expand credit and begin phasing out forbearance in bank regulations, carry out audits and strategic reviews of the leading public banks, adopt a comprehensive strategy for the utilities, and establish a corporate debt restructuring framework. During this period, preparations will also be underway for structural and institutional reforms which will be implemented during the second and third years of the program, including the structural fiscal reforms needed to put the public finances on a sustainable basis. ” 32. The administration has been using its initial months in office to develop the building blocks for its pursuit ofits strategic objectives as described above. Its progress thus far is summarized in the following paragraphs. Further details are provided in Annex A, along with performance indicators and a staff assessment ofwhat remains to be clarified or redefined to better advance the prospects for success in reaching sustained growth and poverty reduction. 33. In the area of economic policy, the Government has successfully stabilized the economy. At the present juncture, fiscal policies are disciplined, inflation is well under control, and production has recovered strongly from the very low levels of2002, with GDP growth reaching an estimated 8 percent for 2003. Growth beyond a period of partial recovery will not be possible without decisive and early action on structural reforms. What is needed is a clear articulation of specific measures for achieving the goals set out in the September memorandum as well as a time-bound implementation program. That emerges clearly from the program matrix in Annex A. For example, with respect to the renegotiation ofpublic service and infrastructure concession contracts, the program matrix indicates that the Bank would favor a stepped up effort that provides equal treatment to all investors and users with specific milestones agreed for each ofthe next 12 months in the renegotiation process. Further delays in renegotiations would postpone yet further the resumption ofinvestment in key areas ofpublic service and infrastructure, thereby potentially j eopardizing growth. Similarly, with respect to the recovery ofthe financial system, the program matrix stresses the need for a time bound plan to eliminate all regulatory forbearance according to international standards. The matrix also flags the pressing need to strengthen the trust and cooperation between the Government and the private sector. 14 34. In the area ofsocial policy, the Government’s agenda is becoming more clearly defined. As an immediate response to the crisis, Government strengthened the social safety net to help alleviate poverty, albeit in a blanket fashion that does not fully meet the needs ofparticularly vulnerable groups. Plans to restructure the several programs that comprise a social safety net make sense, although, as indicated in the program matrix of Annex A, the Government should move cautiously in establishing employment programs that may prove unproductive and non-sustainable in the long-run. Likewise, plans to improve the quality of education through better teacher training and other measures are sound. However, they would be more effective if accompanied by results-based financial policies designed to encourage provincial govemments and universities to increase the efficiency and pedagogic efficacy oftheir educational services. The Government’s agenda for improving the delivery ofhealth services by rationalizing the complex and overlapping responsibilities ofthe federal govemment, provincial governments and health insurance companies is especially welcome and merits full Bank support. At the same time, it is encouraging that the Government understands the fundamental importance of economic policies for poverty reduction. In his inaugural speech to the Legislative Assembly, President Kirchner noted that “To reestablish the upward social mobility which previously characterized Argentina, it must be understood that problems ofpoverty cannot be solved by social policies but rather by economic policies ”, 35. In the area of governance, the administration has made a decisive beginning. It has already started dealing with some longstanding issues such as the politicization ofthe Supreme Court and the perceived immunity ofthe military after human rights abuses in the seventies. It has taken action to investigate terrorist attacks upon the Jewish community in the mid-nineties and also to investigate some infamous cases ofcorruption. It has reformed procedures for selecting Supreme Court justices allowing for consultations with civil society which may result in greater independence ofthe judiciary. In addition, it has focused on broader issues ofpublic sector efficiency. A tax administration reform has been introduced with the objective ofreducing tax evasion and improving voluntary compliance. Many public services have been devolved to provincial and municipal governments which means that much ofthe action in terms ofpublic sector modemization will reside outside the national government. It is encouraging that the administration is promoting federal commissions as a tool to foster a federal- provincial consensus on public policies involving the provinces. However, much still remains to be done in addressing longstanding govemance issues. V. Bank Group Assistance Strategy Strategic Objectives of the CAS 36. The CAS’ overall objective of helping reduce the extent and severity ofpoverty in Argentina is no easy challenge, given the recent crisis. As previous sections have indicated, the setbacks in terms ofpoverty and social well-being have been considerable. Bringing the incidence ofpoverty down to 20 percent by 2015 will require lifting some 12 million people out ofimpoverishment. 15 37. The CAS will set about this challenge by focusing on: (1) sustained growth with equity, (2) social inclusion, and (3) governance. These three pillars ofthe CAS are consistent with the key priorities ofthe Government as outlined in the preceding section. 38. Sustained economic growth with equity is critical for Argentina. The CAS recognizes, as the Government does, not just that growth is essential, but also that it is needed over sufficiently long periods and with sufficiently pro-poor impacts such that all segments ofthe Argentine population can seek notable improvement in their lives and livelihoods. Concerns about inequality in the distribution ofthe economy’s benefits in the past are a prominent issue in Argentina today. 39. Equally important will be social inclusion in view ofthe high degree of inequality. The CAS concentrates on the need for strengthened and more effective efforts to reach the most vulnerable groups - the indigent poor, the elderly, the rural poor, indigenous populations and the large number ofyouth who are neither employed nor in school. Emergency programs, such as the Head of Households program, have successfully provided assistance during the crisis, but they need now to be redirected to serve the medium and longer-term development agenda, including employment generation. In addition, basic social services have to be restored for millions of Argentines, and setbacks in the coverage and quality ofeducation and health have to be rectified. 40. With regard to governance, the CAS stresses the need for determined efforts for improvements, accompanied by institutional and structural importance ofdetermined efforts accompanied by institutional and structural reforms to ensure their sustainability over time. Vital dimensions ofthis include: improving the effectiveness ofprovincial governments, fighting corruption, increasing the transparency ofpublic institutions (including the judiciary) and establishing the organizational and institutional infrastructure to administer property rights. 41. The Bank has already undertaken extensive analytic work on these issues, providing a strong foundation for the CAS. When the new administration assumed office in May 2003, the Bank submitted to it a series ofPolicy Notes containing the Bank’s analysis ofthe situation facing Argentina and its ideas and suggestions for a policy agenda. The CAS reflects the strategic thinking that underlies the Policy Notes, focusing selectively on those areas where the Government and civil society are most responsive and supportive. 42. The chart below conveys, in diagrammatic form, the conceptual linkage between the overall guiding principles ofthe CAS, its objectives and its sub-themes. 16 17 43. In the new administration’s initial months in office, progress has been uneven, with some areas advancing more quickly than others. Among the critical issues requiring further attention are: 0 Establishing an enabling environment for corporate restructuring. 0 Renegotiating public service and infrastructure concessions contracts. 0 Restructuring the financial sector. 0 Renegotiating debt in default. 44. On corporate restructuring, there has been increased activity where companies are undertaking great efforts to restructure their liabilities. The renegotiation ofpublic service and concessions contracts has advanced in a few cases but is still lagging in most others. Financial sector restructuring is moving along with pending actions in bank restructuring and the renegotiation ofdebt in default is moving forward more slowly. The prospects for sustained growth and poverty reduction hinge on a resolution ofthese issues. 45. In view ofthe importance ofthese issues and ofothers also crucial for the success ofthe Government’s and CAS’ strategy and the recovery, and in view ofthe widespread interest in and concern about these matters among the Bank’s member countries, two special steps are being included as part ofthe CAS commitments: 0 Staff will brief the Board no later than June 30,2004, on the progress ofthe Government’s articulation ofthose structural reforms where it will be seeking Bank support (see also para. 86). 0 Staff will present a CAS Progress Report to the Board in 2005, further reviewing progress on these issues and outlining the implementation status of the CAS. Thus, the Board will receive two evaluative updates, the first within the first six months ofthe CAS, and the second in the following year. If satisfactory and substantial progress is not being made, the staff would propose to the Board appropriate action including, if needed, reassessing the pace and/or level ofthe Bank’s support. 46. The duration ofthis CAS runs from February 2004 through June 2008, punctuated by regular updates and mid-course progress reports as needed. This approach reflects the following considerations: 0 Proceeding with a new full CAS is important given the significant passage oftime and the substantial changes in the country situation since the last CAS, and given also the views indicated in Board sessions in 2003. 0 The proposed duration will bring the CAS process back into harmony with the electoral cycle, so that when the next Argentine President assumes office in December 2007, the Bank will have six months to prepare another full CAS. 0 The full-term CAS as proposed here will help the Bank move from short-term crisis management towards a longer-term assistance framework for Argentina. 18 And it will signal to the Argentine authorities the weight that Bank attaches to the transition from recovery to sustained growth. 0 At the same time, because the CAS covers a 4% period, significant mid-course corrections may be required in line with the Government’s performance on structural reform and project portfolio implementation. For this reason, oral updates will be provided periodically to the Board and a CAS progress report will be prepared in 2005 as described above. Consultations with Civil Society and Private Sector 47. To better ensure that the Bank’s assistance strategy reflects the real concerns and aspirations in Argentina, extensive consultations were held with civil society and the private sector. The consultations helped strengthen the quality ofBank support by hearing directly from a wide range of organizations, many ofthem representing those most affected by the crisis. Annex E describes the consultations with civil society. Annex F details issues on private sector development. 48. A number ofperceptions and themes emerged forcefully throughout the consultations. There was broad recognition that Argentina’s problems were mainly homegrown and required homegrown solutions. Participants were critical ofprevious governments for paying too much attention to outside advice which, they believed, did not serve the best interests ofArgentina. Many were ofthe view that the crisis had its roots in the misguided policies ofthe nineties when Argentina liberalized its economy and reduced state ownership of productive assets. Many also believed that a mounting reliance on external financing, weak regulatory systems, and a lack of accountability contributed substantially to the crisis. 49. In the consultations with representatives ofcivil society, there was a generalized desire for a more interventionist state role in the economy, particularly at the local and provincial level. Many emphasized that the overriding job ofthe state would be to protect domestic markets and create economic growth that is more equitable and widely shared than in the past. Government should focus on stimulating internal demand, supporting small and medium size domestic enterprises, and creatingjobs. In this regard, many felt that the Bank could best support this process by shifting away from adjustment lending to investment loans for projects carried out as close to the local level as possible, even through civil society groups themselves. 50. In consultations with representatives ofthe financial and productive sectors, and private concessionaires ofpublic services and infrastructure, there was broad consensus that uncertainty would remain as long as key issues (banking sector, external debt, concessions, etc.) remain unresolved. Furthermore, sustainable growth would only be attained if social needs are addressed, export-oriented sectors continue to expand and create jobs, and investment in infi-astructure resumes. On the social front, participants supported the need for actions to mend the social fabric that has been severely damaged during the last years. Participants saw a role for multilaterals in financing investments, both public and private, particularly for small and medium enterprises (SMEs). They saw 19 the Bank Group as an entity that could perhaps foster public/private partnerships that could attract long-term investment in infrastructure and public services sectors. In their view, and along these lines, the Bank could also serve as a conduit to emphasize the message to the authorities that actions need to be taken to improve the investment climate and attract the much needed funds for the investment requirements. Participants also shared their view of a need to have legal security and proper legal and regulatory frameworks. Furthermore, their opinion was that in some cases, there might be a need for changing regulations, and even laws. In others where the regulatory framework was working fine, the focus should be on strengthening implementation. Portfolio Performance 5 1, The CAS has been designed with a recognition that the economic crisis has had a profound impact upon portfolio perfonnance. Budgetary authorizations were interrupted as a result ofthe crisis, and counterpart funding was not forthcoming. Many contractors and consultants suspended operations when it became apparent that the terms oftheir contracts would change when the Convertibility Plan was abandoned. Many parts ofthe public administration ceased to function until new rules could be established. As a result, over half ofBank supported projects now have an unsatisfactory rating as compared with only 12 percent prior to the crisis. Bank staff have been actively engaged in restructuring operations and in seeking ways to compensate for a lack of counterpart support. Yet project execution continues to lag behind the pre-crisis level and there may be additional delays as the portfolio is reactivated and realigned with the new priorities ofthe incoming administration. Project delays have already led to increasing portfolio obsolescence. The average age ofprojects is now 5.7 years compared with an average of4 years for the Region as a whole. Yet the Government, mindful ofits restricted access to new sources ofexternal capital, does not want to see loans cancelled. Instead it seeks to extend closing dates, reactivate and complete ongoing projects and, where appropriate, reallocate undisbursed loan balances to other related needs. 52. Among the factors that have compromised the effectiveness ofBank assistance are funding problems stemming from a seriously constrained fiscal situation and weak institutional arrangements for project implementation. Project management in Argentina has often relied on parallel institutional structures that may have facilitated project implementation but, at the same time, have impeded the formation ofa solid mainstream institutional capacity in the public sector. The institutional development impact ofBank operations in Argentina was below the regional average even during the pre-crisis period. There have also been systemic weaknesses in the audit function which compromises the soundness ofthe country's overall fiduciary framework. 53. Improved portfolio implementation remains an important goal for the Bank. Until the public finances recover from the effects ofthe recent crisis, continued funding problems must be anticipated. So far, the Bank, with approval from the Board, has reallocated US$270 million from five existing loans to support emergency needs. It has also reduced counterpart financing in eight operations. Looking ahead, Bank management shares the authorities' assessment that flexibility in setting counterpart 20 funding percentage shares and reallocating funds from project cost savings will remain critical for the successful implementation ofmany investment projects and indeed for overall effective portfolio management. In view ofthe positive experience to date, Bank management intends to continue applying this approach through the end ofFY06 in order to achieve the portfolio improvement targets. 54. As ofNovember 2003, the undisbursed balances on investment loans already committed amounted to about US$1.2 billion. Some 45 percent ofthose undisbursed balances pertained to problem projects and must, therefore, be considered at risk. Staff have been working continuously with the authorities on an action plan to improve portfolio balances pertained to problem projects and must, therefore, be considered at risk. Our target is to reduce the proportion ofundisbursed balances at risk to 25 percent by June 2004. 55. The possibility ofusing sector wide approaches (SWAps) will also be explored in Argentina. This would be applicable where the Bank has reached agreement on sector wide strategies and is satisfied that country systems can meet core fiduciary and safeguard requirements - or where there exist viable action plans to improve them. In these cases, a reliance on country systems in-place could greatly enhance project implementation effectiveness and institutional sustainability. Some infrastructure programs at the federal and provincial level could be used as pilot programs to test out this new approach. Social protection and health programs could follow. In exploring SWAps, a careful assessment ofthe adequacy of country systems will be key, as will the identification of areas where there may be gaps and a judgment whether and where it is appropriate to rely on country systems, or to support planned improvements in country systems as part of or in preparation for a SWAP. 56. Lending to the provinces has had its share ofdifficulties. Currently most ofthe Bank’s provincial portfolio is considered to be at risk. While the Bank’s dialogue at the provincial level has been very good in many cases, the effectiveness ofBank-supported operations could benefit from closer federal-provincial cooperation. 57. The demand from provinces for direct Bank support could be substantial and it would be important for the Bank to have clear selection criteria. They would include: (i) a sound fiscal situation, consistent with criteria established by the federal government; and (ii)a demonstrated commitment to reforms, including those reforms that would enable them to meet agreed fiduciary and safeguard standards and to develop the institutional capacity need for successful program implementation. In addition, Bank support for the provinces would focus on operations that foster poverty reduction. 21 Table 6. Argentina Portfolio Improvement Action Plan InitiativelActions in 200212003 New Proposals Expected Results Social Emergency Reallocation of loan funds to meet Phase-out the provision of US$104 m. disbursed by 12/04. emergency needs in health and emergency assistance in health. Begin to implement the productive education in 2002, with US$270 US104 million with pending support component by 6/04. million reassigned. procurement processes. US$166 million disbursed through Development of a productive December 2003. support pilot component under the Heads of Household Program (US$30 million). Budgetary allocations and countemart funding. CY03 budget restrictions limited 2004 Budget reflects a 30 percent Increase in the level of budgetary appropriations to about 60 percent increase in budgetary allocations execution and increase in of the potential portfolio execution from CY03. disbursement ratio of not less than capacity leading to a CY03 Seek further flexibility of 30 percent in CY04 and thereafter. annualized disbursement ratio of counterpart funding requirements in Minimize project implementation about 20 percent. line with Bank policies. restrictions derived from 8 projects amended to increase counterpart fund requirements. Bank financing and reduce counterpart fund requirements. Contract renegotiation Resolution issued defining the All remaining civil works methodology for adjusting civil contracts renegotiated by March works contracts to accommodate 2004. the devaluation. Resolution to define methodology 75 percent of civil-works contracts for adjusting consultant contracts. under Bank-financed projects have been renegotiated (approximately US$500 million). Strategic Portfolio Management Joint Portfolio Reviews conducted Establishment of a Joint Portfolio Improved dialogue and smoother in November 02, February and Task Team to assess periodically decision making in bringing the September 03. progress in portfolio improvement portfolio back to normality. Extension of closing dates in line targets and extensions of closing Projects with unsatisfactory with Bank policy. dates. performance will be reduced to Board approved a reallocation of Semiannual joint portfolio reviews. about 35 percent of portfolio by cost savings to better respond to Increased selectivity in closing date end 2004, to about 25 percent by crisis conditions. extensions: non-performing projects end 2005 and to less than 15 Six projects, representing require comprehensive percent by end 2006. aggregate commitments of US$600 restructurings and contingent to million have been restructured. compliance with detailed action plan. Restructuring of remaining unsatisfactory projects. Imuroved oortfolio suuervision * External Panel Review of Portfolio 1 Continued efforts to improve the Realism and proactivity in project conducted in September 2002. realism of portfolio supervision and supervision should be 70 percent * Ratings on realism and proactivity manage it proactively. and 85 percent respectively by of Bank supervision increased 12/04. from 50 percent in 2002 to 75 percent in 2003. 22 The Scenarios 58. Given all ofthe above (the strategic objectives, the results ofthe consultations with civil society and the private sector, the state ofthe portfolio, and the lessons from experience), the CAS provides for three alternative scenarios -base, high, and low - for the Bank’s program going forward. The Base Scenario 59. The base scenario would be predicated on: 0 Maintenance ofa satisfactory macroeconomic framework. 0 Steadily improving perfonnance, particularly with structural reforms, 0 Implementation ofsocial reform and fostering of social inclusion. 0 Stepped-up efforts to improve governance. 0 Improving portfolio management and implementation. 60. The Bank’s support would concentrate in the areas ofthe three strategic objectives outlined above, as described below and shown in Table 7 (and elaborated further in Annex G). Individual operations would in some instances contribute to more than one ofthe three objectives, but for purposes ofpresentation are classified under the primary area they serve. 61. The Bank would engage in an active dialogue with the authorities on all ofthe topics noted in this CAS as vital for the country’s progress. Where there is strong consensus between the Government and the Bank, lending and other support would proceed, providing assistance to the authorities in carrying out agreed plans and effective actions. Where there is not consensus, the Bank would seek to maintain an active dialogue, with the aid of analytical work as needed. Where the dialogue bears fruit, lending would then begin. 62. The area of sustained growth with equity would feature prominently in the base case support (and in the other cases too) for the reasons previously noted - i.e., because economic recovery and job creation are so crucial for progress in all areas, including especially for poverty reduction, as the Government’s strategy underscores. The Bank’s assistance would proceed on multiple fronts, using both investment and adjustment operations. An already prepared operation (the proposed Economic Recovery Support SAL) would support efforts to consolidate the economic recovery, ensuring longer term growth and increasing employment through the expansion ofdomestic enterprise. At the same time, the Bank would engage in a broader policy dialogue with the Government on more far reaching structural issues. Instrumental to that effort, the Bank would undertake analytic work on the sources offuture growth, the investment climate and environmental strategy as well as on other important sector-specific issues, that could include trade, trade integration, and fiscal sustainability. Depending upon progress with the policy dialogue, the lending program provides space for additional lending that may advance yet further the policy agenda for growth with equity. 23 63. In keeping with the Government’s expressed desire, investment lending is envisaged to be the principal vehicle for advancing the growth agenda both directly and indirectly. As indicated in the CAS matrix (Annex A), the Bank and the Government share common objectives with respect to social inclusion, and governance reform. There is also a large area ofcommon ground with respect to the importance ofinfrastructure, notwithstanding differences ofapproach to public-private partnerships. In the program of investment lending, the Bank would focus primarily on support for infrastructure investments that still lie within the purview ofthe public sector. An integral part of project design will be to target poor communities and either furnish them with infrastructure and public services in cases where they are not yet served or upgrade existing sub-standard services. At the same time, since many ofthese investments are local in nature, they afford an opportunity to strengthen the interface between authorities at the federal, provincial and municipal level and thereby also contribute to more effective governance. 64. The proposed lending program would strengthen the prospects for sustainable growth by increasing the skills and the productivity ofthe labor force through investment operations in education and life-long learning. By focusing on facilities that serve poorer communities and by offering training to people whose lack ofskills confine them to the margin ofthe labor force, investments in education and training can foster both growth, equity and social inclusion at the same time. In parallel, the human resource base will be further strengthened through investments in higher education, science and technology. Box 2: Investing for growth with equity Investments in both human and physical infrastructure would constitute an important part of the proposed Bank program in support ofgrowth with equity. A proposed higher education project illustrates well the importance attached by both the Bank and the Government to human capital development. It would address regional disparities and other inequities of access to post-secondary education. It would encourage efficiency by establishing a linkage between performance and the allocation of resources to institutions of higher education and it would improve the linkage between tertiary education, the labor market and the national innovation system ofArgentina. In the area of physical infrastructure, a proposed national highway management project would provide technical assistance to strengthen the institutional capacity of the National Roads Directorate. It would extend an output-based public-private contracting system for maintenance to the entire non-concessioned road network and it would review the fiduciary fund mechanism with a view to improving the reliability of maintenance finance. Annex G provides further details of other proposed operations in support ofgrowth with equity. 65. Analytic work on the investment climate and related issues such as labor market reform is expected to provide insights into private sector development. Since private investment must continue to be the principal engine for growth as it has been in the past, AAA in this area will help to identify critical policy issues that need to be fixed. 24 66. In rural areas, lending for rural and forestry development would help to increase output and exports in a sustainable manner while, at the same time, focusing on the broader social needs ofthe rural poor. As far as growth is concerned, these operations will build not only on the rural sector strategy, but on the economy-wide studies related to growth, exports, and investment climate. In terms ofpoverty reduction, the operations will address the increasing polarization ofthe rural sector into modern and subsistence sectors through CDD-type provision of services and financing to small-scale producers and indigenous communities. The strategic focus ofthis work will be in the northern regions where the deepest pockets ofpoverty are to be found. 67. Sustainable growth will depend upon maintaining the integrity ofthe environment and a number ofoperations are envisaged to support Government efforts in that direction. Operations in water resources and flood management, land degradation, forestry, and urban waste management will all build on a sector strategy that will establish clear priorities for action. Institutional and regulatory issues will be addressed in the short term through ongoing operations and technical assistance, leaving open the possibility of other policy-based financing (including GEF and carbon finance). Priorities will be set based on the poverty, growth, and ecological impacts ofthe problems. 68. Finally, with respect to the growth agenda, the program envisages a number of operations to enhance the efficiency ofthe public administration by supporting improvements in organizational structure, budgeting and management at the federal, provincial and municipal levels. At the same time, the human resource base for growth would be strengthened through investments in higher education, science and technology. 69. In the area ofsocial inclusion, there is substantial commonality ofinterest between the Bank and the Government, including on the issues ofpoverty reduction and equity. The recent economic crisis provoked a situation of social emergency, which focused the country dialogue quite sharply on issues ofsocial protection, in particular. Now that an economic recovery is in progress, the Government needs to design an exit strategy from emergency workfare programs because they are financially unsustainable as presently structured. The proposed Bank program would provide both analytic and financial support to the Government in its effort to improve the efficiency and effectiveness ofsocial assistance and to foster new employment opportunities for the unemployed. In that context, close coordination with the Inter-American Development Bank would be essential because the IDB is also supporting a conditional transfer program in Argentina. 25 Box 3: Social Protection as an integral part of Social Inclusion The proposed Bank program includes a social protection project that would help the Government replace the Heads of Household emergency workfare operation with a viable long-term program aimed at improving the efficiency and effectiveness of social assistance. It would draw upon a skills building analysis that would examine who are the unemployed today, what is their educational background and what possibilities can be developed for integrating today’s unemployed into the labor market through training and incentives. In parallel to that effort, a social security study would focus especially upon the elderly poor who are without pensions or other forms of income support and who must be included in the new safety net. 70. Operations focusing on other basic social services will be central to the Bank’s support for social inclusion. Compensatory financing schemes to reduce inequalities in the education system, particularly with respect to school materials, nutritional supplies and scholarships, would remain central to the new Government’s education strategy, with Bank support. Increased use of incentive-based financing arrangements that would encourage autonomous universities to improve the quality and effectiveness oftheir programs would also be supported. In that way, the proposed program would contribute both to social inclusion and to growth with equity. 71. The particular needs ofvulnerable populations would also be targeted. In the case ofthe rural poor and indigenous groups, particularly in the northern provinces, the Bank will develop a community-driven development (CDD) program for decentralized local economic and community development. Issues ofurban poverty will be addressed by infrastructure projects targeted specifically at improving the provision of infrastructure and other public services to poor communities. The program will also include analytic work to address the needs ofArgentina’s youth between the ages of 16 and 25, ofwhom over 2 million are neither working nor in school. That work will be employed to pursue a government policy dialogue and, possibly, investment operations. The specific financial concerns ofthe elderly will be addressed through work on pension access and reform. 72. Finally, health is another area where issues of social inclusion are paramount. More than half ofthe population is without health insurance coverage today. Most ofthe uninsured are poor and they must rely on the provincial public health services which are biased towards the provision oftertiary care. There is a need for nation-wide, incentive- based financing instruments to reduce regional inequalities and to make health services more accessible to the poor. At the same time, the leadership role ofthe Ministry of Health needs to be strengthened with respect to the formulation and implementation of national health policy priorities. Bank lending would support those efforts. 73. On governance, the third pillar ofthe Bank’s focus, the prevailing public distrust ofgovernment calls for major improvements in the efficiency ofpublic administration, including anti-corruption, accountability, and the rule of law. The Bank has already acquired a body of experience in Argentina since a number oflending operations have contained initiatives that bear upon governance. They have included support for 26 capacity-building in key systems ofbudgeting, human resource management, and justice. The Bank and Government can use these existing programs to design and commence new initiatives responding to opportunities and needs as they arise. An especially important focus could be to strengthen sub-national governments where the Bank has been active through multi-sector Provincial Reform Loans that promote improvements in tax and budget administration, human resource management, service delivery, procurement, and other governance related issues. These relatively quick disbursing operations have been complemented by sector, investment and technical assistance loans aimed at administrative reforms, municipal services, infrastructure, poverty alleviation, and human capital. The possible new PRLs could have a more integrated regional focus and use a menu approach to better respond to change opportunities and political commitment across provinces. 74. In keeping with the declared priorities ofthe new administration, the proposed program would also finance investments in judicial reform, anti-corruption and other related initiatives. Analytic work in public expenditure management and in the financial sector could also lead to investment or adjustment operations depending upon progress with the country dialogue. Box 4: Investments for improved governance. In keeping with priorities established by the new administration, the proposed Bank program includes an anti-corruption and state modemization project in support of reforms at the federal level to enhance transparency, efficiency and effective governance. The project would seek to improve the organization and Performance ofservice delivery agencies in the public sector by simplifying procedures, training staff at the federal and provincial level and by introducing new technologies of e-government. It would also strengthen the federal agencies that are responsible for combating corruption and assist in building a network of offices across the federal bureaucracy and at the provincial level. 75. Overall, this base case program would include substantially enhanced attention to infrastructure and human development needs that are critical for poverty alleviation and/or for sustaining the recovery. A good part ofthe planned operations in FY04-08 would draw directly from the poverty monitoring work undertaken by the Bank during the crisis as well as a recently completed poverty assessment update. The High Scenario 76. If the Government were to undertake a more substantial program ofstructural reforms and establish a track record ofimproved policy performance, the Bank would have headroom to respond with a high case lending program. The performance indicators that would trigger shifting to a high case scenario are specified in Table 8. They are based on the policy analysis contained in the CAS matrix ofAnnex A. A transition from the base case to the high case should be viewed as a continuum so that increasing compliance with performance indicators across the board could trigger a progressively higher level oflending. Under the high case, lending would be increased by up to US$1 billion with a strong emphasis on restructuring the financial system, support for private 27 sector development, fundamental reforms in fiscal relations, and reforms in public sector management that would, inter alia, address corruption, tax administration and results- oriented management. 77. Under a high-case lending scenario, a governance adjustment operation supporting major anti-corruption, budgeting, accountability, co-participation, tax administration, and service delivery improvements could add leverage to the Government’s governance agenda. Since the success of governance operations depends on the confluence of commitment, stakeholder ownership, technical support, and political momentum, the Bank must be flexible and ready to adjust the timing and amount ofits support to adapt to emerging opportunities. It will also review and integrate within all its operations the Government’s core governance focus on transparency, accountability, and results-oriented management. The Low Scenario 78. The Bank would shift to a low case lending program if the base case criteria were not met, i.e. if there were to be significant shortfalls from the macroeconomic program, a persistent weakening ofthe structural reform agenda, continued poor portfolio performance or a combination ofthose factors. The performance indicators that underlie the base case program are specified more explicitly in Table 8. A transition to the low case could be managed either as a continuum, whereby flagging compliance with performance indicators across the board would trigger a progressively lower level lending or, in the event of a major failure in the macroeconomic framework, as a much more rapid retreat to a substantially reduced core program. Lower lending would be accompanied by a strong emphasis on social sector lending focused on poverty reduction. Bank support would not include adjustment lending without adequate macroeconomic policies. Lending Levels and Instruments 79. The base case calls for a lending program ofup to US$5 billion for the period mid-FY04 through end-FY08. This is lower than some earlier periods, but higher than the immediately recent past. On an annualized basis, lending could average about US$l. 1 billion, although particular years could be well above or below that figure depending on how rapidly operations are prepared. 80. This level ofbase-case lending would represent a measured transition from the recent past, providing appropriate support for the actions needed in the covered period, in accordance with the Government’s strategy and with the three pillars ofthe Bank’s strategic objectives. The resulting disbursements would be sufficient to cover amortizations. 8 1. In table 7, proposed Bank operations during the first two years ofthe CAS program are grouped together. Ten investment loans are envisaged in the two years FY04-05 amounting to some US$1.9 billion in total. In the remainder ofthe CAS period 28 (FY06-08) twelve investment loans are envisaged amounting to some US$1 . 1 billion in total. A relatively greater number ofinfrastructure projects accounts for the larger amount oflending in the first two years. However, circumstances call for the Bank Group to adopt a flexible strategy that may be adapted to changing circumstances. The high degree ofrisk and uncertainty concerning the future of Argentina will require that implementation ofthe CAS be closely monitored. 82. A major challenge in the design and delivery ofthe proposed assistance program will be to accommodate the country’s request for relatively more investment lending than in the past. It is the Government’s perception that investment lending is more in keeping with Argentina’s development requirements at the present juncture, and the authorities have requested a program in which investment lending constitutes 60-75 percent ofthe total. This perception was also shared by most ofthe groups from civil society that participated in the CAS consultations. It may also reflect the relatively low priority attributed by the Government to some ofthe structural reforms which the Bank considers essential in order for the on-going recovery to be sustained. 83. The existing investment portfolio will be virtually depleted by 2004-05. Thus, a swift build up ofnew operations will be required to respond expeditiously to Argentina’s infrastructure and social investment needs. A strengthened investment pipeline is also important to generate sustained disbursements from the second year ofthe CAS period onwards. There will need to be a substantial front loading ofprojects to rebuild the pipeline and to ensure that disbursements from a portfolio dominated by investment lending will be sufficient. The Government has stated its agreement with the list of projects in Table 7 below. It has, however, indicated the need to maintain some flexibility to be able to substitute some ofthe project proposals within the agreed strategic pillars. The Government and the Bank will assess on a semi annual basis progress in developing the proposed program and make necessary adjustments as needed. 84. New investment lending is unlikely to suffer from the portfolio performance problems that were inflicted upon the existing project portfolio by the recent economic crisis. Most ofthose problems were ofa “once-only’’ nature (provoked by the abandonment ofthe dollar link). Prior to the crisis, project performance was, by and large, solid. New projects will build on the lessons learned from the current portfolio. The financial structure ofnew projects will take into account the fiscal realities facing Argentina today. Project management also will reflect realistically the administrative structures and constraints that prevail in post-crisis Argentina. 85. It is envisaged that many new investment operations will be designed and implemented at the provincial and municipal level. The successful implementation of those operations will be a challenge because it will require close cooperation between federal, provincial and municipal authorities. However, the Government has already devolved to the provincial authorities the responsibility for delivering many public services. The operational implication ofthese developments is that future program design will need to ensure: (i)enhanced intergovernmental cooperation and coordination, 29 and (ii)increased delegation ofproject design and implementation to the government level where prime responsibility for project execution rests. 86. As far as adjustment lending is concerned, further discussions with the Government will be necessary before specific proposals for any additional lending can be defined beyond the proposed Economic Recovery Support Loan. These discussions will take place during the first half of2004. Staff will brief the Board no later than end June 2004 on the definition ofthe structural reforms where the Government plans to seek Bank support. Proposals for adjustment operations would be based upon perceived opportunities to address critical developmental issues. Current indications are that financial sector restructuring and reforms to improve public service and infrastructure provision, and reform ofintergovernmental finances, pension or tax reform and improvements in the investment climate could become areas for policy based lending. They would be undertaken only where there is strong ownership ofthe reform agenda within Argentina and good prospects for implementation and a clear poverty impact. The program ofanalytical work would be adjusted as needed to support policy-based operations as they become more clearly defined. 87. Since, at present, a sustained economic recovery is by no means assured, the strategy for the 4% year period will enable the Bank Group to manage the considerable risks and uncertainties. This will call for a continuation ofthe present flexible approach, whereby the Bank Group is able to seize opportunities as they arise to assist most effectively in the recovery process. 30 Table 7. PROPOSED LENDING & ESW PROGRAM Base Case Mid FY 04-08 CAS Theme F Y04-FY05 F Y06-FY08 New Lending Advisory Services New Lending Advisory Services Adjustment: Adjustment: - Economic - Sources ofGrowth - SALPRLs t.b.d. - Competitiveness Recovery Suppo~ - Investment (CW - SALIPRLs t.b.d. Climate - Agricultural - Environmental Finance and Growtl. Investment: Strategy Investment: - Transport Sector Sustained - National - Rural - Solid Waste Strategy Growth with Highway Infrastructure Management - Policy Notes Management - Rural Sector Equity - Sustainable - Bs. As. City Strategy Forestry Mgt. Infrastructure - Financial Sector - Higher Education - Floodand Report Science and Drainage Technology Infrastructure - Water Resource Management - Maternal-Child - Provincial - Provincial Roads - Public Expenditure Health APLl Finances - Maternal-Child Review - Social Protection - Social Security Health APL2 - Education Review - Secondary - Social Policy - Water Sector - Policy Notes Strengthening Education Review (APL 2) - Poverty Assessmen Social - Province Bs. As. - Skills Building - Lifelong - HumanDev. Inclusion Infrastructure Learning Strategy - Municipal - Urbanpoverty - Social Inclusion Services - Rural Poverty and Infrastructure - Provincial - Financial Sector - Federal - CFANCPAR Development I11 Assessment CourtsIJudicial - Decentralizing Promoting Program (FSAP) Reform Environmental Mgt. Better - Anti Corruption - Policy Notes - Public Expenditure Governance - Property Rights/ Registry Review Note: Individual operations may contribute to more than one strategic theme of the CAS but, for purposes of presentation, they are classified under the primary goal they serve. Memorandum Lending Amounts (US% bn.) FY04-05 FY06-08 Total Investment 1.9 1.1 3.0 SALSI PRLs I SWAPS ...... 2.0 Identified 0.5 .... 0.5 To be identified t.b.d. t.b.d 1.5 GEF grant financing of 5-6 projects; funding estimated at USSl 30 million. Source: Annex A (Program Matrix) 31 Table 8. Argentina CAS Trigger Matrix FY mid-04 - FY08 Incremental Trieeers Moving to CAS Objectives, Sub-Themes BASE CASE HIGH CASE Sustained Economic Growth with 1 -eater Equity Macroeconomic Stability Maintain a satisfactory macroeconomic Implement new revenue-sharing framework, by (i)reaching primary surplus agreement between the federal targets, including 3 percent of GDP for and provincial govemments. 2004, and (ii)maintaining a monetary Significant progress in tax reform, program consistent with low inflation. including in elimination of Move toward inflation targeting system by distortionary taxes. end-2004. Significant progress in structural Improve Investment Climate: reforms, especially in the following areas: Recovery of Financial System Settle bank compensations before end-2004; Bank restructuring, including eliminate forbearance on loan classification improved governance and risk and provisioning; and promote equal management of public banks. treatment for all banks. Medium-termstrategy for capital market development and pension Promotion of Private Sector Establish principles for voluntary corporate funds. Development debt restructuring based on intl. best practice. Full respect of investor and creditor rights. Public-Private Partnerships Complete renegotiation and strengthen Satisfactory implementation of regulation of public service-infrastructure revised regulatory frameworks as concessions by 2004 within a transparent evidenced by renewed private framework; introduce social tariff for poor. investment. Maintaining and Improving Progress in addressing infrastructure Infrastructure bottlenecks, including e.g. improving and maintaining road network and ensuring continued provision of electricity and gas. Strengthening Social Inclusion Reaching vulnerable groups Reduce significantly participants in Improve effectiveness of social workfare programs from current levels as assistance programs, incl. its altemative employment schemes expand. consolidation and harmonization of identification of beneficiaries. Building an inclusive health Maintain vaccines coverage at a minimum Increased use of incentive-based system of 85 percent; and expand coverage of financing of education and health matemal-child health insurance to about 20 programs at the provincial level. percent of eligible population by 2005 and about 40 percent by 2008. Preparing a better educated Decrease dropout rates in secondary level workforce. with a steady increase in graduation rates frompolimodal level to about 70 percent by 2008. Promoting Better Governance I Promoting accountability and Improve govemment fiduciary management Implementation of public sector transparency in procurement and financial management. management reforms that improve govemability and reduce corruption. Improving portfolio Reduce projects with unsatisfactory ratings Projects with unsatisfactory rating management to about 35 percent by end-2004, to about 25 less than 10 percent of total percent by end-2005, and less than 20 portfolio. percent by end-2006 and significantly reduce the number of overdue audits of Bank financed projects. 32 The IFC Program 88. The IFC has had a prominent operational presence in Argentina for many years. As of September 2003 its net exposure was close to US$1 billion, ofwhich US$135 million were equity investments and the remainder loans. The B loan program amounts to US$0.8 billion. The performance ofthe IFC portfolio has suffered from the recent economic crisis and the main efforts ofthe staff are aimed at restructuring both the Corporation’s own exposure and that ofparticipating banks to accommodate new realities. IFC has restructured some major non-performing loans (NPLs) particularly in general manufacturing; however, a sizable part ofthe non-performing portfolio is in the infrastructure (32 percent) and financial sectors (25 percent), which await utilities sector reform and financial sector reform. 89. As a consequence ofthe economic crisis, the IFC experienced an increase in the percentage ofnon-performing loans from 12 percent as of end-FYO1 to 35 percent at end- FY02, and 67 percent as of end-FY03. From the onset ofthe crisis, IFC’s strategy has focused primarily on portfolio management to arrest, to the extent possible, the adverse effects ofthis crisis affecting its clients. 90. Early in 2002, IFC’s Management established the Argentina Recovery Project (ARP), a small group of Investment Officers, based in Buenos Aires, with strong expertise in the financial sector, privatized service companies, manufacturing sector and workouts to handle the crisis proactively from the field. Under the leadership ofthis team, IFC is working closely with all the clients to help them overcome the difficulties caused by the adverse macroeconomic environment. IFC has taken a leading role in some ofthe major restmcturings particularly in the financial and manufacturing sectors. In the financial sector, IFC’s proactive approach has helped to maintain, as going concems, two major locally owned financial institutions. IFC expects to close various large restructurings in the non-utilities sectors by calendar year end and accordingly will register a notable decrease in the level ofnon-performing loans. It will not be possible, however, to reduce NPLs to pre-crisis levels unless there is progress in the renegotiation process ofthe privatized service companies, which represent a significant portion of IFC’s exposure. It should be highlighted that the exposure ofparticipants ofIFC’s B loan program to privatized service companies is high. The high level ofnon-performing loans will accordingly continue to hamper IFC’s ability to provide new financing as well as the Corporation’s capacity to raise funds through its B loan program. 91. IFC’s strategy for Argentina in the last two years has centered on (i)portfolio management, (ii)supporting export-oriented investments with a focus on alleviating the credit crunch faced by export-driven companies, and (iii)engaging in selective investments in new operations with retums commensurate to their risks. IFC will continue working closely--on a case-by case basis--with clients who are deemed to be long-term viable but are currently facing liquidity problems, on restructuring programs consistent with the clients medium and long-term viability under the current economic conditions and perspectives. So far, IFC has already closed rescheduling with five clients for a total amount of about US$230 million including participants’ account, or about 12 33 percent ofthe overall portfolio. While these operations have been part ofoverall restructuring ofthe companies’ outstanding debt, they have also been expected to have a demonstration effect as well as contribute to restoring business confidence in Argentina. 92. New undertakings during FY02-03 have included three pre-export finance facilities for leading local exporters ofoilseeds and its byproducts. Supporting these clients has been very important given the wide impact their activities have on the country’s agricultural sector as well as large number offarmers across the country. The first ofthese operations was structured in June 2002 and marked the first time a foreign commercial lender re-engaged in lending to Argentina. The amount ofthese operations reached US$180 million, including US$90 million in B-loans. IFC has been exploring similar operations with other export-oriented agribusinesses. IFC has also provided support to other exporters via pre-shipment export financing lines through trust structures with the local financial system. Moreover, these innovative transactions are expected to highlight commercial opportunities for securitized trade finance loans as a new asset class that may become increasingly attractive for domestic institutional investors. 93. Moving forward, LFC will continue implementing its on-going strategy outlined above. As the market reopens, IFC will seek emerging opportunities for providing long- term finance while trying to bring other commercial lenders into this market. In addition, IFC will continue seeking equity transactions with special attention - but not exclusively- on export-oriented and with returns commensurate to their risks. It should be highlighted that IFC’s ability to continue to be active (both for its own account and through its B loan program) in Argentina will be related to progress on (i)the restructuring ofthe financial sector; (ii)the renegotiation process ofthe privatized service companies; and (iii)the faimess to all parties involved and transparency in these restructuring and renegotiation processes. MIGA 94. The outstanding portfolio ofMIGA in Argentina consists of20 contracts of guarantee with a gross exposure ofUS$3 18.5 million and a net exposure of US$153.7 million. Argentina is the third-largest host country for MIGA-insured investments, accounting for 5.8 percent ofMIGA’s total gross exposure and 4.3 percent ofits net exposure. The total estimated amount offoreign direct investment facilitated to date by MIGA is US$3.5 billion. In developing its pipeline ofguarantees, MIGA is working on ways to support several export oriented projects during FY04, specifically the expansion ofagro-industrial production (food oils) and mining to help attract investment and promote export led growth. 95. MIGA received a claim in July 2002 for a project insured in Argentina for which the guarantee holder elected cover ofUS$5 million. Two additional claims for losses in Argentina were received in March 2003 under contracts for which guarantee holders elected cover ofUS$1.4 million and US$5.8 million, respectively. All three claims are under review for determination ofMIGA’s liability. 34 ICSID 96. Currently there are 24 arbitration proceedings pending before ICSID in which investors allege that measures adopted by the Argentine authorities in 2002 are in violation oftheir contractual rights. In particular, the claims relate to the suspension of agreed tariff adjustments, the nullification of agreements that permitted tariffs denominated in US dollars to be converted into Argentine pesos at prevailing market exchange rates, the prohibition ofcapital transfers and the freezing ofbank deposits. 97. Proceedings are at a preliminary stage and half ofthe arbitration tribunals have yet to be constituted. Under the rules ofICSID, plaintiffs are not required to quantify the amount claimed at the start ofthe proceedings. It is anticipated, however, that the claims will be substantial. Bank Partners 98. The Bank has coordinated closely with the IMF and IDB, the two main partners providing assistance for Argentina’s development effort. The IMF has supported the efforts ofthe Argentine Government to normalize the economy with two operations. A Transition Program covering the period January- August 2003 was brought successfblly to completion. A three year stand-by arrangement was approved in September 2003 with macroeconomic performance criteria and structural benchmarks clearly specified for the first year and greater flexibility indicated for targets in the later years. Exposure ofthe IMF would remain constant over the program period. Bank collaboration with the Fund has centered on the renegotiation ofpublic services and infrastructure concessions and on plans for strengthening public and private sector pension schemes. Previous collaboration on financial sector restructuring was discontinued when the authorities decided not to seek further Bank assistance in this field. 99. Collaboration with the IDB has focused most recently on the coordination ofour respective responses to the social emergency. The initial response ofboth institutions has been to reallocate portfolio resources to meet critical needs ofthe poor, particularly in health, education and social protection. This has involved close collaboration and the sharing ofinformation on our respective plans. The IDB embarked on new quick disbursing lending to Argentina early in 2003 with a US$1.5 billion loan to protect social expenditures. That operation is expected to be followed by a second for about US$500 million. IDB’s exposure in Argentina is expected to remain constant for the 2003-2006 period. In the coming months, the collaboration will be focused in ensuring continued harmony in our short-term assistance strategy while both institutions decide upon their respective medium-term assistance strategies. Fiduciary and Procurement Management 100. The Bank concluded a Country Financial Accountability Assessment (CFAA) for Argentina in 2002, a Country Procurement Assessment Report (CPAR) in 2000 and a 35 Public Expenditure Review (PER), including a chapter on public sector budgeting in the national government, in 2003. Procurement in Governm en t-wide Systems 101. The CPAR of2000 confirmed that the procurement system was fragmented, inefficient and in need ofmodemization. Since then the Government has taken a number ofmeasures to improve the situation. A common legal framework has been established for the procurement ofgoods and services and for the selection ofconsultants. A national procurement regulatory body has been established and improvements have been made to the principles and procedures governing public procurement. The Government is also introducing an Electronic Government Procurement System (EGP) to publicize bidding opportunities and related information, and to enable bids to be submitted on-line. The Bank has supported both the modemization of the legal framework and the EGP through a SAL and a State Modemization Project. More recent efforts have focused on ensuring that advertising procedures are followed for Bank-financed projects and that new legislation is compatible with Bank guidelines. 102. In general, public procurement is still subject to cumbersome procedures and to lengthy processes ofevaluation and decision-making that may take a year or more. Delays stem from a lack of standard documentation, unclear evaluation criteria and time consuming bureaucratic procedures. The high turnover and deficient training ofpublic sector staff also contribute to delays. No visible progress has been achieved in that respect recently. Overall Public Expenditure Management Systems 103. The CFAA of2002 indicates that, by and large, the federal government has appropriate policies. The legal and institutional framework is satisfactory and systems and procedures are in place to provide reliable and timely information on public finances. There is also an appropriate control environment to insure compliance. The current situation owes much to reforms introduced in 1992 with the passage of a Financial Management Law that placed Argentina at the forefront ofpublic sector management improvements at that time. Since then, there have been further continuous improvements. Notwithstanding these achievements there is still a need to update the integrated financial management system and to add procurement and public investment modules. 104. Risks related to the appropriate and authorized use ofpublic funds in the federal government are considered moderate in view ofthe above considerations. To mitigate the remaining risks, it is expected that financial management systems will be updated and improved under the Public Investment Strengthening Project. Similarly, further diagnostics are planned in the CAS period. A new CFAA and CPAR will cover the sub- national governments which receive Bank funds either through direct lending or through the provincial component ofprograms managed by the federal government. 36 Procurement under Bank-financed projects 105. Procurement under Bank-financed projects, is comparatively more efficient and expeditious. Complaints regarding procurement generally relate to restrictive specifications, award delays or cancellation ofthe bidding process. Procurement supervision has focused on ex post reviews, which have generally not found major issues related to compliance. Mis-procurement was declared only once in the last two years. Financial Management and Disbursements in Bank supported operations 106. Bank projects are managed by dedicated project units in the responsible agencies. This has generally resulted in an acceptable quality offinancial management as evidenced by a survey ofthe entire portfolio in FY2003 and by the findings ofexternal auditors in annual project audits. The transaction cost implicit in the use ofindependent Plus, however, is high. This approach to project implementation also delays the incorporation of financial information into the central fiscal accounts and makes it difficult to develop project skills in the line ministries or other executing agencies. Given the projected growth in investment lending, the Bank should encourage the transfer of project administration from special Project Units into the responsible line ministries. A step has already been taken in that direction by placing all externally financed projects under a single office in some ministries (the Ministry ofHealth for example). The next step will be to incorporate those offices into the mainstream ofthe Ministries. The mainstreaming ofproject management will be supported by the Public Investment Strengthening Project. 107. Lastly, the problem of late external audits on the projects would also be mitigated by the mainstreaming ofproject administration. The Bank would recognize the financial statements ofthe line ministry and the audit review ofthe line ministry as sufficient for compliance with the project audit requirements. In addition, the Bank has approved an IDF grant to build audit capacity in the Supreme Audit Institution (AGN) which would contribute to improving the timeliness of audit reports. 108. In view ofthe above considerations, the fiduciary risk related to portfolio performance is adequately managed through the Bank’s current procedures on project preparation and supervision. Fiduciary risks may be further reduced with the mainstreaming ofproject administration. Risk Management 109. As a result ofthe 2001 economic crisis and its aftermath, Argentina now faces exceptional risks at a country level and at an operational level. The risks are particularly high in the following areas: 37 Debt sustainability 110. Debt sustainability remains an open question in Argentina. As a result ofthe default, some US$106 billion of debt will eventually be restructured on terms that have yet to be negotiated (see also Annex C). In addition, there is a large stock ofdebt amounting to US$78.5 billion that is not subject to restructuring (including multilateral debt) or that was issued after the default to satisfy court mandated compensations. The prospects for debt sustainability will be driven by the outcome ofthe debt restructuring, by economic growth, by the real effective exchange rate and by the size ofthe primary surplus which, in the case of2004, has been targeted at 3 percent ofGDP. As long as the external debt restructuring has not been completed, staff will not be able to judge the robustness ofArgentina’s medium-term debt sustainability. The Bank, therefore, will keep monitoring developments in the debt renegotiation process and their impact in government finances and economic prospects. Bank Group credit risk 11 1. When Argentina abandoned the Convertibility Plan at end-2001, the Bank had to manage its country exposure with great care in order not to exacerbate the difficulties already faced by the government, while at the same time, containing the Bank’s exposure. That task was further complicated by an exceptional bunching ofprincipal repayments from two SSALs in the period immediately following the economic crisis. Debt service payments to the Bank averaged US$2.6 billion in 2002 and 2003 compared with only US$0.5 billion in the previous four years. To better manage the situation, the Bank adopted a flexible approach to lending which took into account the financing requirements ofthe government. Overall exposure has come down from a peak of US$9.4 billion to US$7.5 billion in December 2003. Exposure should be easier to manage in 2004 and in subsequent years when debt service to the Bank will average about US$1.3 billion a year.6 Projected debt service payments would be in the order of4 percent ofexport earnings and 0.7 percent ofGDP and should be manageable if the current macroeconomic discipline is maintained. In addition, the Bank proposes to follow the understanding adopted in a recent agreement reached by the Government with the IMF whereby multilateral lenders would maintain their exposure constant through expiration ofthe stand-by arrangement in 2006. 112. Thus far, Argentina has observed the preferred creditor status ofthe Bank Group. There have, however, been instances in which government authorities have engaged in public discussion about the appropriateness ofthis status. Ifthe country situation were to deteriorate to a point where the Bank was unable to continue its support, the prospect of default could rise rapidly. At the present juncture, the country situation is far from that point but the risk ofpolitical or economic failure remains. Principal repayments to the Bank will fall from an estimated US2.9 billion in 2003 to US0.8 billion in 2004. They will again increase in subsequent years to USO.9 billion in 2005 and will average US$l.l billion in 2006-07. 38 113. The IFC as well faces special risks in Argentina. IFC’s exposure as of September 2003 totaled US$998 million for its own account (US$133 million in equity and US$865 million in loan and quasi-equity) and US$860 million for account ofparticipants banks. The percentage ofnon-performing loans stood at 66 percent and provisions for IFC’s equity and loan portfolios at 71 percent and 48 percent, respectively. As the crisis continued to unfold during 2002 and early-2003, arrears started to mount as more and more clients faced severe cash-flow constraints inhibiting their ability to fulfill their financial obligations. This continuing deterioration in portfolio performance reached a low point in spring 2003 but since then has stabilized, partly due to the rebound ofthe economy, and to a larger extent, to the proactive stance IFC has taken on its portfolio. Given these events, portfolio performance is now expected to improve and likely to show better numbers by the next quarter or two as indicated earlier on. Bank Group program risks 114. It will not be easy for the Bank to achieve its targeted lending program which is largely focused on investment lending. The previous CAS envisaged that two thirds of loans would be in support of investment projects but failed to achieve that target because project preparation and implementation were undermined by the economic crisis. While there has been some improvement in project execution, it has not yet recovered to pre- crisis levels. Even if project implementation improves further, as expected, it may not be possible for the Bank to achieve desired resource transfers with a program that is heavily concentrated on investment lending. Thus, the Bank will need to complement investment lending with continued support for adjustment lending. Political risks 1 15. The serious political crisis that culminated in the resignation offormer President De la Rua is a reminder ofhow political conditions can deteriorate in Argentina. Currently, however, the risk ofpolitical instability is quite small. The political transition was well managed by former President Duhalde and Argentina was able to elect a new president peacefully and democratically within the framework ofthe Constitution. Moreover, the current administration has been able to build strong political support for its policies. 116. Restoring confidence in public institutions is a major challenge for the administration and a political risk could rise if measures to improve public governance fall short ofexpectations. The Government is very much aware ofthis and has started many initiatives precisely in this area, such as, fighting corruption in the police force, changing the nomination and selection procedures for Supreme Court and federal judges and measures to combat tax evasion. 117. Weaknesses in the political system, especially the complex federal-provincial relations, have in the past frequently led to failures ofmacroeconomic discipline that have been a cause ofeconomic instability in Argentina. That prospect still poses a risk. In particular, a lack offiscal discipline has been a point ofvulnerability in the past. At 39 the present juncture, macroeconomic policies are sound and the central government and the provinces have agreed to annual financing programs (PFOs) that have instilled fiscal discipline at the provincial level. It is expected that the Government and the provinces would negotiate a new revenue-sharing framework in the course of2004. 118. A positive investment climate and strong private sector confidence will be necessary if Argentina is to establish sound prospects for long-term growth. Early and decisive government action to restructure the financial sector, establish an enabling environment for corporate restructuring, renegotiate public service and infrastructure concessions and renegotiate the public debt in default will all be critical indicators of progress towards that goal. Economic and social risks 119. Although the economy has stabilized, indeed has rebounded from the exceptionally low levels ofproduction that prevailed in early 2002, it still has a long way to go before it fully recovers. There are questions concerning the sustainability ofthe recovery beyond 2004 unless action is taken on many issues ofrestructuring and economic reform. Thus far the Government has taken a measured approach to reform. Domestic political developments may open the door for a more resolute stance. With a major electoral cycle coming to an end in December that has strengthened the power base ofthe administration and with strong economic growth in 2003 and good prospects for 2004, the Government will probably face a more favorable economic and political environment that could facilitate the undertaking ofoverdue structural reforms. 120. Poverty and unemployment continue to be the most important issues facing Argentina today. They are also a potential source ofsocial tension. The Heads of Households Program helped calm the situation in 2002. The Government now intends to move away from social emergency programs towards more medium-term development programs in education and health as well as initiatives that promote employment creation. This could further improve social conditions. However, social tensions will remain high unless progress can be made towards a more equitable distribution ofincome. 12 1. Argentina remains vulnerable to adverse changes in the international environment. While the country benefits currently from low interest rates in the debt being serviced (and potentially on its defaulted debt once restructured), interest rates may well increase to levels observed in the past. Such increases could have a major impact in the fiscal situation ofthe country. Price declines ofthe country’s primary commodities could also have a major impact. Some ofArgentina’s main agricultural exports are subject to major protection barriers in OECD countries and prevent the country from realizing its full export potential. One effective way for Argentina to reduce such vulnerabilities would be to develop new markets as well as embrace economic policies of structural reform that will sustain its economic recovery and ability to compete internationally. 40 122. It is vitally important that Argentina should continue to enjoy international support for its development effort. Notwithstanding substantial financial losses on the part offoreign investors and bond holders, the international community still continues to be supportive of Argentina as it grapples with the consequences ofthe economic crisis. So long as Argentina continues on a path of economic and social recovery, international support is likely to continue. However, without determined and sustained action to address the economic and social situation effectively, international support would likely weaken, which would negatively affect the ability ofthe Bank to pursue its program. James D. Wolfensohn President By: Shengman Zhang Peter Woicke Washington, DC January 29,2004. 41 4% Eti E 42 0. e e e 43 45 P 3 r: r: P *. *. 44 45 8 8 8 8 8 8 46 E8 E 47 4% M r r 48 49 P e a 50 2 % 0 4 ** 51 4 4 52 53 CAS Annex B1 Country at a Glance As of Date 10/20/2003 Argentina at a glance 10/20103 Latin Uooer. POVERTY and SOCIAL America mlddie- Argentina & Carlb. Income Development d iamon 20 02 d' Population. mid-war (mlllons) 37.9 527 331 GNI per capita (Atks method, US$) 4,060 3,280 5,040 GDP per capita (us$) 2,695 Lde expectanq GNI (Atlasmethod. US$ blllbns) 154 1,727 1,666 Average ann ua I growth, 1 996 -2 002 T Popuiatiwn I%) 1 .2 1.5 1 .2 Labor force (%) 2.2 2.2 1 .6 GNP Gmss per primary Most recent estimate (latest war available, 1995.20021 capta - -enroliment Povertv I% ofmoulalan below natlonalDovertvlne) 55 68 76 75 Urban population f% oftotaf DODUlatbn) I Life expectancy at birth (years) 74 71 73 Infant mortaiitv (per 1,000 /be births) 17 27 19 Child malnutdtion 1% ofchidren under 5) 5 9 9 Access to safe water Access tosafewater(% of DoDulatlon) 86 90 llllteracy [% ofpopulatanage 15+) 3 11 7 Gross onmaw enmltnent (% ofschool-age iooouiatlonj 120 130 105 -___I.Argentina Ma B 120 131 106 Female 120 128 105 Up permd die-mom e group KEY ECONOMIC RATIOS and LONG.TERM TRENDS 1982 1992 2001 2002 Economic ratios' GDP (US$ billions) 84.3 228.8 268.7 102.2 Gross domestic hvestmentiGOP 21.8 16.7 14.2 12.0 Exports of goods and servEeslGDP 9.1 6 .8 11.5 27.7 Trade Gross domestic savlnqsiG DP 24.3 15.2 155 27.2 Gross national savingslGDP 13.6 125 21.3 Current acwunt balanceIGDP -2.8 . .2.5 -1.7 9.4 1 Interest paymen ts1GDP 6.7 2.1 4.5 98 Total debVGDP 51.8 29 9 52.2 131.4 Total debt servicelexports 50.0 27.6 109.6 102.5 Present value of debtiGDP 54.7 Present va b e of debtiexports 401.3 International reserves at centra banklUS$ bn.) 11.2 14.5 10.5 Indebtedness 198242 19B242 200 1 2 002 2002.06 (avg annual growth) GDP 1.5 1.7 -4.4 -1 0.9 14 -- Argentina GDP per capita 02 04 -5.6 -1 2.1 0.2 ~ Upper-middle-income group Exports of qoods and servces 41 61 27 3.2 5.1 STRUCTURE ofthe ECONOMY 1% of GDP) 1/ Agnculture 96 60 Industry 41 1 30 7 Man ufa durin q 31 4 21 9 170 21 3 Services 49 3 63 3 686 574 Private consumptan General government wnsumption imports ofgoods and Services 65 61 1982-92 199242 2001 2002 (average annual growth) Agriculture 07 32 industry 00 21 Man ufa durin g 01 Sewices 11 Private consumptbn General government wnsumption Gross domestic nvestment 06 Imports Ofgoods and Sewices 81 Note' 1998 data are prelim nary estima tes. 'The diamonds Show four keyindicators in the country [in bold) compared with its Income-qroup average. If data are missing. thedbmond will be hcomplete. IIChangein sharesto GDPin2002 relativeto 2001 is parttftheresultofrealcurrencydepreciation 54 CAS Annex B1 (continued) rgen tina ~ A ~~ PRICES and GOVERNMENT FINANCE 1982 1992 2001 2002 1 Inflation Domestic prices I (%change) 50 Consumer prices 164.8 24 9 -1 5 41 0 40 Implicit GDP deflator 207.6 11.9 -1 1 30 8 30 Government Finance 20 (%of GDP, includes current grants) 10 Current revenue 18 7 1 17 190 17 8 0 Current budget balance (cash basis) -2.4 21 -2 3 -0 8 Overall surpiusldeficit (cash basis) -9.6 1.3 -3 3 -3 0 -10 ---GDP deflator -CPI TRADE I 1982 1992 2001 2002 (US$ millions) Exports and Imports Total exports (fob) 12,399 26,610 25,709 (million US) Food 1,548 2,355 2,275 35,000 , Meat 767 946 914 30 000 Manufactures 2,823 15,770 15.7 33 25 000 Total imports (cil) 14,982 20,321 8.989 Food 20 000 Fuel and energy 510 841 480 15 000 Capital goods 6,479 4.182 1,319 10 000 5 000 Export price index /1983= 1001 95 90 1 99 00 01 02 00 01 02 import price index (1983=100) 90 87 Exports .Imports Terms of bade ~1993=10Ol 106 104 BALANCE ofPAYMENTS 1982 1992 2001 20 02 (US$ miilions) Current Account BalancelGDP 1%) Exports of goods and services 9,185 15,382 30,940 28.643 imports ofgoods and services 6.51 4 19.335 27,456 13,010 Resource balance 2,671 -3,952 3.484 15.6 33 l5T Net income -5.058 -2.473 -8,243 -6.4 57 Net current transfers 0 770 281 414 Current account balance -2.387 6.655 -4,477 9.590 Financing items (net) 3,492 2.381 16,561 -5,074 Changes in net reserves -1,105 3.274 -12 ,083 -4,516 Memo: 10 1 Reserves including gold (US$ millions) 16,516 14,546 15,633 Conversion rate (DEC, locai/US$) 1 .o 1c 31 EXTERNAL DEBT and RESOURCE FLOWS 1982 1992 2001 2002 (US$ miiiionsl Total debt Outstanding and disbursed 43,634 68,345 140,242 134,247 Composition of Total Debt iBRD 50 4 2,505 9,440 8,513 (US$ m.) ID A 0 0 0 0 Total debt service 4,876 4.882 21.379 4,213 iBRD 98 611 1,388 1.870 IDA 0 0 0 0 Composition of net resource flows Official grants 1 42 6 0 Official creditors 58 760 10,492 -1.851 Private creditors 2.755 38 -27,974 137 Foreign direct investment 678 1,836 3,380 1,741 Portfolio equity 0 13 -9 -27 F 44 915 World Bank program Commitments 0 1,004 436 2 50 Disbursements 120 460 1,329 4 24 Principal repayments 46 351 676 1.353 4-IBRD E .Bilateral Net flows 74 109 653 -928 0. IDA D .Other multiateiai F - Pivate Interest payments 36 216 668 512 C . IMF G -Short-term Net ban sfers 36 -107 -15 -1 441 Development Economics 55 CAS Annex B2 Selected Indicators* of Bank Portfolio Performance and Management As Of Date 10/20/2003 Indicator 2001 2002 2003 2004 Portfolio Assessment Number of Projects Under Implementation a 39 37 33 35 Average Implementation Period (years) 3.8 4.7 5.3 5.6 Percent of Problem Projects by Number 15.4 32.4 54.5 48.5 Percent of Problem Projects by Amount 14.8 30.2 31.4 30.8 Percent of Projects at Risk by Number 15.4 67.6 81.8 75.8 Percent of Projects at Risk by Amount a, 14.8 78.0 87.1 75.4 Disbursement Ratio (%) e 24.9 13.1 35.9 9.0 Portfolio Management CPPR during the year (yes/no) Yes Yes Yes Yes Supervision Resources (total US$) 2,745 2,782 2,892 2,746 Average Supervision (US$/project) 65 70 76 78 Memorandum Item Since FY 80 Last Five FYs Proj Eva1 by OED by Number 73 22 Proj Eva1 by OED by Amt (US$ millions) 12,826.5 4,831.6 % of OED Projects Rated U or HU by Number 31.9 36.8 % of OED Projects Rated U or HU by Amt 44.7 72.8 a. As shown in the Annual Report on Portfolio Performance (except for current FY). b. Average age of projects in the Bank's country portfolio. c. Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP). d. As defined under the Portfolio Improvement Program. e. Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the beginning of the year: Investment projects only. * All indicators are for projects active in the Portfolio, with the exception of Disbursement Ratio, which includes all active projects as well as projects which exited during the fiscal year. 56 CAS Annex B3 - IBRDDDA Program Summary As of date 10/20/2003 Proposed IBRDDDA Base-Case Lending Program a Programl US$ Strategic Implementation Name Project (million) Rewardsb(H/M/L) Risksb(H/M/L) - Economic Recovery Support 500 H H Adjustment - SAL/pus t.b.d...... - National Highway Management H L - Bs.As. City Infrastructure H M - Flood and Drainage Infrastructure - Province Bs. As. Infrastructure Investment - Municipal Services and M M M M H H - Social Protection H M H M I FYO6-08 Mid FYO4-08 Adjustment 2.000 Investment 3.000 Total 5.000 a This table presents the proposed program for the next four fiscal years. For each project, indicate whether the strategic rewards and implementation risks are expected to be high (H), moderate (M), or low (L) 57 CAS Annex B3 (IFC & MIGA) for Argentina Argentina - IFC and MIGA Program, FY 2001-2004 2001 2002 2003 2004 IFC approvals (US$m) 95.0 65.0 84.0 10.0 Sector (YO) Agriculture & Forestry 46 24 Education Services 18 Finance & Insurance 26 5 100 Food & Beverages 71 Utilities 43 54 Wholes. & Retail Trade 13 Total 100 100 100 100 Investment instrument (YO) Loans 91 77 100 100 Equity 5 Quasi-Equity 3 23 Other 1 Total 100 100 100 100 MIGA guarantees (US$m) 694 591 293 58 CAS Annex B4 - Summary of Non-lending Services As of date 10/20/2003 Product Audience a Objective Completion Mid FYO4-OS I Completion FY06-08 a Government, donor, Bank, public dissemination. Knowledge generation, public debate, problem-solving. 59 CAS Annex B6 - Key economic Indicators As of Date 11/07/2003 Page 1 of 2 Key Economic Indicators -Argentina Actual Estimate Indicator 1995 1996 1997 1998 1999 2000 2001 2002 2003 National accounts (% of GDP) Gross domestic product 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Agriculture‘ 8.7 6.0 5.6 5.6 4.7 5.0 4.8 10.7 10.1 Industry’ 28.0 28.4 29.1 28.6 27.8 27.6 26.6 32.0 32.0 Servicesa 66.3 65.6 65.3 65.8 67.4 67.4 68.6 57.3 58.0 Total Consumption 82.5 82.6 82.9 82.6 83.7 84.4 84.5 73.1 73.5 Gross domestic fixed 17.9 18.1 19.4 19.9 18.0 16.2 14.2 12.0 15.6 investment Government investment 2.2 2.0 2.0 2.0 1.9 1.4 1.4 0.9 0.8 Private investment (Includes increase in 15.8 16.1 17.3 17.9 16.1 14.8 12.8 11.1 14.8 stocks) ~xports(GNFS)~ 9.6 10.4 10.5 10.4 9.8 10.9 11.5 27.7 25.1 Imports (GNFS) 10.1 11.1 12.8 12.9 11.5 11.5 10.2 12.8 14.2 Gross domestic savings 17.5 17.4 17.1 17.4 16.3 18.6 15.5 26.9 26.5 Gross national savings’ 15.9 15.6 15.2 15.0 13.8 13.1 12.5 20.9 21.1 Memorandum items Gross domestic product (US$ bn, current prices) 258.0 272.1 292.9 298.9 283.5 284.2 268.7 102.0 127.6 Gross national income per 7380.0 7750.0 8160.0 8030.0 7570.0 7450.0 6980.0 4060.0 3410.0 capita (US$, Atlas method) Real annual growth rates (%, calculated at 1993 prices) Gross domestic product at market prices -2.8 5.5 8.1 3.9 -3.4 -0.8 -4.4 -10.9 8.0 Gross Domestic Income -2.8 5.5 8.1 3.8 -3.4 -0.8 -4.4 -10.6 7.7 Real annual per capita growth rates (?h,calculated at 1993 pric:es) Gross domestic product at market prices -4.2 4.2 6.8 2.6 -4.6 -2.0 -5.6 -12.1 6.9 Total consumption -4.9 4.7 6.7 1.8 -3.8 -1.0 -5.6 -14.5 6.0 Private consumption -5.6 5.4 7.6 1.8 -4.8 -1.1 -6.0 -16.1 4.3 Balance of Payments (USSm) ~xports(GNFS? 24979 28381 30928 31137 27862 31106 30940 28643 32037 Merchandise FOB 21162 24043 2643 1 26434 23309 26341 26543 25709 28781 Imports (GNFS~ 26038 30149 37414 38667 32763 32928 27456 13010 17361 Merchandise FOB 18804 22283 28554 29531 24103 23889 19158 8470 12442 Resource balance -1060 -1767 -6485 -7530 -4900 -1822 3484 15633 14676 Net current transfers 584 448 464 406 397 355 281 414 443 (including official current transfers) Cwent account balance -5175 -6822 -12239 -14830 -11900 -8839 -4477 9590 7775 (after official capital grants) Net private foreign direct -2925 3630 10313 6658 1775 1622 -12733 -12021 -17344 investment Long-term loans (net) 10146 10280 12705 15505 483 6073 7863 -1480 7664 Official 3516 2027 645 2349 1143 1957 11695 -3551 322 Private 6630 8253 12060 13156 -660 4116 -3832 2070 7342 Other capital (net, including -2047 -7089 -10778 -7633 9642 1144 9347 3911 1904 errors and omissions) Change in reserves id 0 0 0 0 0 0 0 0 0 Memorandum items Resource balance (“A of -0.4 -0.6 -2.2 -2.5 -1.7 -0.6 1.3 15.3 11.5 GDP at current market prices) Real annual growth rates (1998 prices) Merchandise exports (FOB) 25.3 6.4 13.7 11.7 -0.8 2.9 4.4 -0.1 2.1 Primary 29.0 8.0 -1.6 22.6 -0.8 -1.8 22.0 -67.3 25.8 Manufactures 27.9 5.8 13.8 1.6 -11.0 4.4 -1.3 -39.6 4.2 Merchandise imports (CIF) -11.4 19.9 31.2 8.9 -13.4 -1.1 -17.3 -54.5 56.0 60 CAS Annex B6 - Key economic Indicators (continued) page 2 of 2 Key Economic Indicators - Argentina Actual Estimate Indicator 1995 1996 1997 1998 1999 2000 2001 2002 2003 Public finance (Oh of GDP) Current revenues 19.0 17.2 18.7 18.8 19.6 19.8 19.0 17.8 20.2 Current expenditures 18.8 18.1 19.1 19.1 21.2 21.3 21.4 18.6 19.3 Current account surplus (f) 0.2 -0.9 -0.4 -0.3 -1.5 -1.5 -2.3 -0.8 0.9 or deficit (-) Capital expenditure 1.2 1.3 1.3 1.3 1.1 1.o 1.0 0.7 0.8 Foreign financing 2.4 3.2 2.3 3.2 3.6 2.6 -1.1 2.9 -0.4 Monetary indicators M2IGDP (at current market 20.8 23.7 27.9 32.1 36.1 38.7 36.0 12.9 14.2 prices) Growth of M2 (%) -4.3 20.0 26.9 17.1 6.9 7.5 -12.1 -58.4 30.2 Private sector credit growth / -21.7 98.2 106.6 135.0 -93 141.2 -820.1 100.0 100.0 total credit growth (%) Price indices( 1993 =loo) Merchandise export price index 108.8 115.9 111.9 100.3 89.1 98.0 94.7 90.4 99.1 Merchandise import price index 106.9 105.6 103.2 97.9 92.4 92.4 89.7 87.2 82.1 Merchandise terms of trade index 101.8 109.8 108.4 102.5 96.4 106.1 105.6 103.7 120.7 Real exchange rate (US$/LCU)f 182.98 182.46 192.75 198.76 200.89 206.13 209.95 96.64 104.08 Consumer price index (% growth rate) 1.6 0.1 0.3 0.7 -1.8 -0.7 -1.5 41.0 3.7 GDP deflator (?hgrowth rate) 3.2 -0.1 -0.5 -1.7 -1.8 1.0 -1.1 30.6 10.7 a IfGDP components are estimated at factor cost, a footnoote indicating this fact should be added Chnages afier 2002 partly reflect real currency depreciation b "GNFS" denotes "goods and nonfactor services " c Includes net unrequitedtransfers excluding official capital grants d. Includes use of IMF resources e Should indicate the level ofthe government to which the data refer f "LCW denotes "local currency units." An increase in US$/LCU denotes appreciation 61 Annex B7 Key Exposure Indicators As of Date 11/07/2003 Key Exposure Indicators - Argentina Page 1 of 1 Actual Estimate Indicator 1995 1996 1997 1998 1999 2000 2001 2002 2003 Total debt outstanding and 99.1 110.6 125.1 141.9 145.3 146.6 140.2 134.2 151.6 disbursed @DO) (USSbn)” Net disbursements (USSbn)a 13.2 11.5 14.4 16.9 3.4 1.3 -6.3 -60 17.3 Total debt service (TDS) 8.9 11.0 16.1 19.0 23.1 24.1 21.4 4.2 (US$bn)a Debt and debt service indicators (% 1 TDO/XGSb 396.9 389.7 404.3 455.8 521.5 471.2 453.3 468.7 473.1 TDO/GDP 38.4 40.6 42.7 47.5 51.2 51.6 52.2 142.6 122.9 TDSIXGS 35.6 38.9 52.2 61.0 82.9 77.6 69.1 14.7 ConcessionaliTDO IBRD exposure indicators (%) IBRD DSipublic DS 6.4 5.5 3.9 3.8 4.3 5.1 6.5 44.4 78.6 PreferEd creditor DSipublic 32.4 25.6 17.1 18.7 22.7 DS IBRD DSIXGS 2.3 2.1 2.1 2.3 3.6 4.0 4.5 6.5 10.3 IBRD TDO (US$mld 4913 5372 5494 7188 8314 8789 9440 8513 Ofwhich present value of 245 238 238 guarantees (US$m) Share of IBRD portfolio (%) 4.3 4.9 5.1 6.1 7.0 7.4 8.0 7.0 7.0 IDA TDO (US$m)d 0 0 0 0 0 0 0 0 0 IFC (USSm) 788 799 914 880 1019 1196 1095 1008 Loans 655 658 628 592 716 822 723 660 Equity and quasi-equity ic 133 141 286 288 303 374 372 3 48 MIGA MIGA guarantees (US$m) 150 122 169 236 438 431 694 591 a. Includes public and publicly guaranteed debt, private nonguaranteed, use of JMF credits and net short- term capital. Source: Ministly ofEconomy andGlobaJ Development Finance, WorldBank. b. “XGS” denotes exports of goods and services, including workers’ remittances. c. Preferred creditors are definedas IBRD, IDA, the regional multilateral development banks, the JMF, and the Bank for Intemational Settlements. d. Excludes present value of guarantees. e. Includes equity and quasi-equity types ofbothloanand equity instruments. 62 v a Y P 4 63 CAS Annex B9 (IFC) for Argentina MIS I nromdicral Finance Corponttoii AS Of 09Na2003 Statement of IFC‘s Held and Disbursed Portfolio Updated Montflly Pmotim in U5 Dollar IYlitliMts csunry xrgentina Page t 20w 20 cc 3 c 2CM 20w 0 0 2053 i9ga 522 00 0 522 0 0 0 1994/2002 30 00 003000 3000 0 0 3000 f ~04199511997H999 71 94 t5M) tOOD 11 00 7194 15 00 10 00 11 eo i994/1W5/1W6 46 82 B 95 0 7563 4662 6 55 G 75 e3 t977/1084119mlW8/19w%m 0 OW G 48 79 0 0 00 0 48 79 1999 5 00 019 0 500 0 0 0 1993 0 2 xi 0 002 79 0 0 2000 17 86 12 50 0 0 ??e8 12 50 0 0 t99411Zi99 0 0 000 00 0 000 0 2001 4 08 00 0 405 0 0 0 19mfklsyy 65 00 0024500 65W 0 0 245 00 19m ? 13 00 0 113 0 0 0 2000 25 00 0010250 25Oa 0 0 102 w 1996 2 14 0 850 0 214 0 e50 0 1BP7 7 50 0 500 0 750 0 500 0 7 9% 5 45 0 500 1500 545 0 500 15 00 i9% 0 2000 600 0020 00 6W 0 1995 6 67 0 300 120 667 0 300 120 2000 10 00 0 5M) 0 600 0 5W 0 1999 52 18 682 518 0 52118 fi a2 5 la 0 I954 3 12 0 1500 0 312 0 1500 0 2004 100 OD 0 100 0 0 0 isme 6 75 0 4M) 0 675 0 400 a see 0 USO 0 00050 0 a 2000 10 00 0 5w 0 l0W 0 500 0 1097 10 00 3 250 700 lD00 0 250 70 1996 6 00 0 200 333 800 0 200 3 33 19QWS97 16 00 0 2000 0 3800 0 20 00 0 1998 am 00 o am 0 0 0 1992 0 27W 0 00 0 0 0 f99YlW7 10 21 00 0 1021 0 0 0 199211C393i 998 2 50 0 100 0 250 0 I00 D 19Q712W 6 21 503 1007 164 621 2 89 1G 07 1.m 197B11881119m~lE)87/199~/~~3 iaoi 0 1235 4560 feoi 0 22 35 45 80 19931994PLM3 30 00 555 0 3000 3000 5 55 0 30 00 t 995 8 82 00 0 882 0 0 0 19WIW 0 31 # G 008 84 0 0 1993 0 300 0 003 00 0 U 1998 206 0 100 0 206 0 IW 0 1998 0 $4 97 0 0 0 7 95 0 0 10% 182 00 0 i 82 0 0 0 1994 4 00 00 0 400 0 0 0 1932 5 33 100 0 167 533 100 0 1 e7 1999 7 4R 00 0 748 0 0 D 19w 0 15W 0 0015 00 0 0 1995 956 0 2000 0 856 0 20 00 0 t 999 626 001500 626 0 a 15 00 1997/1S8f1999PzD33 36 00 0 1000 0 38W 0 1u 00 0 1997 6 $1 0 500 1313 611 0 500 13 13 64 CAS Annex B9 (IFC) for Argentina (continued) MIS Intwnabctnal Financo Corporation As 01 omo/m3 Statement of IFCs Held and Disbursed Portfolio Updated MmMly Amounls in US kllar Millimns Cnbntry krgencina Page 2 3 00 oc 0 300 a 0 0 0 1983 0 0 0 3872 0 0 ~ 0 005 0 0 0 005 C 0 L.Ka” 20 29 0 t787 15758 2029 0 $787 15758 iisty 10 00 oc 0 770 0 0 0 !Ll%sm 45 03 0 0 3000 4563 0 0 3000 raw% 225 504 0 0 225 504 0 0 996 2Ulx ‘707 00 2 1:s: 0 C 0 Totel Pmfao 69780 192.43 17346 88025 68%50 13260 173.48 86025 65 Annex C. Sovereign Debt Restructuring I.The Stock of Public Debt 1. The stock ofdebt increased US$41 billion since the default was announced end- December 2001. Official estimates put the stock ofpublic debt as of end 2003 at US$185.2 billions, about 150 percent ofGDP. The increase in debt over the 2001-03 period is explained by interest in arrears and by new bonds issued to compensate losses in the financial system caused by the asymmetric pesification of assets and liabilities of banks. Table 1. Public Debt Stock Estimate as of end 2003, in US$ billions Debt Past-Due Total Yo Stock 1\ Interests Debt Eligible for Restructuring 88.0 18.7 106.7 57.6 Bonds 81.2 18.2 99.4 53.7 Bilateral 4.9 0.4 5.3 2.9 Commercial 1.6 0.1 1.7 0.9 Oth& creditors 0.3 0.0 0.3 0.2 Non-eligible Debt 78.5 0.0 78.5 42.4 Guaranteed Loans 14.6 0.0 14.6 7.9 Guaranteed Provincial Bond 2\ 10.0 0.0 10.0 5.4 Bonds issued after Default 3\ 20.6 0.0 20.6 11.1 International Organizations 30.8 0.0 30.8 16.6 Other 2.5 0.0 2.5 1.3 Total 166.5 18.7 185.2 100.0 Source: Ministry of Economy, Argentina. 1\ Includes amortizations in arrears. 2\ Correspond to phase Irestructuring of domestic public bonds of November 2001. 3\ Includes bonds issues to compensate banks and depositors after the asymmetric devaluation of January 2002, the elimination of quasi-monies, and compensation of civil servants for the forgone wage payments which occurred as a result of the 13% nominal wage cut enacted in the second half of 2001and again lifted in 2003 2. The Government has determined that 58 percent ofthe total public debt will be subject to a restructuring. The defaulted debt principally consists ofbonds that have been issued before December 3 lSt,2001 which is the “cut-off’ date established by the Government. Of the bonds that have been defined as “eligible” for restructuring, 56.5 percent are held by institutional investors and 43.5 percent by retail investors. It can be seen from table 2 that the key features of this “eligible” debt are as follows: Number of Bonds: This debt consists of 152 different bonds that can be grouped in seven bond types. Global bonds represent 45 percent oftotal. 66 0 Currency: The bonds have been issued in seven different currencies, with 53 percent being denominated in US dollars, 30 percent in Euros, and 10 percent in domestic pesos. Governing law: The bonds have been issued under eight different jurisdictions. Table 2. Features of Bonds to be Restructured Breakdown (in % of eligible debt) by Currency Governing Law Type of Bond Dollar 53 New York 51 Global 45 Euro 33 England 18 German 17 Peso 11 10 Germany 17 Euro 14 Yen 3 Argentina 11 Pesos 10 Other 21 1 Japan 2 Brady 6 Other 1 Samurai 2 Other 6 All 100 All 100 All 100 1/ Arg. Peso and Arg. Peso indexed. 2/ Pound Sterling and Swiss Franc. 3. The Government has been able to determine the geographical distribution ofthe eligible bonds except for 13 percent unidentified as of September 2003 (see chart below). According to the Government, more than 50 percent ofthe eligible debt is in the hands of Argentine citizens, with investors, mainly pension funds, holding 3 8 percent (as identified in the chart). The remainder are overseas holdings. Geographical Distribution Argentina Germany 67 11. The Debt Restructuring Proposal 4. The authorities announced a debt restructuring proposal at the IMF-World Bank annual meetings in Dubai in September 2003. The debt restructuring proposal aims to achieve the following key objectives: 0 Reducing debt to sustainable levels compatible with economic growth and social development. 0 Ensuring the servicing ofinterest and repayments obligations consistent with existing and future fiscal policy. In this context, the Government is projecting a primary surplus of3 percent ofGDP for 2004. For the subsequent years, the Government will set the primary surplus targets as a function of “sustainable growth, job creation, and poverty reduction”. e Ensuring inter-creditor equity. 5. The Government proposes to reduce by 75 percent the nominal value ofeligible debt with no recognition ofpast-due interest. In net present value terms the proposal amounts to an unprecedented - for middle income countries - debt reduction close to 90 percent. 6. The debt exchange offer includes a menu ofoptions. First, the Government proposes to reduce the number ofcurrencies and jurisdictions governing the old bonds. It proposes new bonds in four currencies (US$, Euro, Yen, and Ar$) and in four different jurisdictions (New York, English, Japanese and Argentine). Secondly, bonds with larger face value reductions have lower interest rates and are shorter in maturity. The choice of instruments are expected to be equivalent in net present value terms. While details are not yet known, it is possible that capitalization bonds will also be included in the menu. It is also possible that variations ofthe above bonds will be offered, with options displaying lower interest rates and a premium related to the growth rate ofGDP. The bond coupon component related to the GDP growth would be separable from the rest ofthe bond and could float in the market. The characteristics of possible bond options are summarized in table 3. Table 3. Bond Menu Options Principal Coupon Interest Average Type of bond reduction type rates life Discount 75% Step up 1-5% 8-32 years Par Bond 0% Fixed 0.5 -1.5% 20-42 years Quasi-Par Bond 3 0% Fixed 1-2% 20-42 years Source: Ministry of Economy, Argentina. 68 7. The large number ofcreditors - scattered across various countries - are organized in several consultation groups in Europe, the United States, Japan and Argentina. In October and November 2003, the Government has held a series ofmeetings with these groups. In this context, creditors have generally reacted negatively to the Government proposal. 8. The negotiations will be led by the Government ofArgentina. As the global coordinator ofthe negotiation process, the Government will be assisted by four regional managing banks. Various international banks and three local banks have been invited to present themselves as potential regional managing banks'. The selection among these banks is expected to be defined in November 2003. These banks will have to (1) assist the authorities in the elaboration ofa final menu ofbond options, (2) design a strategy for negotiations in each region, (3) prepare the required documentation, (4) select (jointly with the Government) the banks that will conduct the restructuring operation, and (5) coordinate the marketing efforts among banks. Among the banks that have expressed an interest, are seven international banks (ABN Amro, Barclays, Dresdner KW, Goldman Sachs, Lehman Brothers, Morgan Stanley, UBS Warburg) and three Argentine banks (Banco FrancCs, Banco de Galicia , and Banco de la Naci6n). 69 Annex D. Status Report on Millennium Development Goals Background 1. The Millennium Development Goals (MDGs) were agreed to by the leaders of all 189 United Nations member countries in September 2000 in the Millennium Declaration, as modifications ofthe Intemational Development Goals (IDGs) originally established by the OECD Development Assistance Committee in 1996. Seven ofthe goals focus on specific aspects ofthe multiple dimensions ofpoverty and the eighth focuses on strengthening the support ofthe intemational community to achieve these goals. Many of the goals specify quantitative targets and indicators to measure progress toward reaching those targets. 2. This note summarizes the progress and challenges faced by Argentina to achieve the MDGs. Although Argentina has a well developed statistical system, the coverage of survey data (mostly urban areas) does not permit a full account ofthe country's overall progress toward some ofthe goals. Moreover, in some cases there is no unique data source to effectively track progress for some ofthe indicators. The United Nations is committed to reporting the progress ofreaching the MDGs in collaboration with other institutions, including the World Bank, the IMF, OECD and other regional agencies.' For this report we rely on government statistics and recent assessments made by UNDP, the World Bank and ECLAC.2 3. Argentina made significant progress toward reaching the MDGs during the 1990s. However, the intemal and extemal shocks experienced by the country have resulted in a decline or halt in progress with respect to many social indicators. Argentina now faces a large extemal debt, much higher poverty rates and still fragile GDP growth, all ofwhich threatens future advancement and the preservation ofprogress already achieved. Below we provide a succinct overview ofthe country's progress and the key challenges to meet each ofthe goals. 1. Reduce Extreme Poverty and Hunger by half Target: Cut in halffrom1990 to 2015 the fraction of the population in extreme poverty 4. The recent economic crisis, and particularly the peso depreciation, led to a sharp reduction in GDP per capita from around US$8,210 in 1998 to an estimated US$2,700 in ' Implementation ofthe United Nations Millennium Declaration; Report ofthe Secretary General, United Nations General Assembly, 2002. see Annex 1. The World Bank projections are made using the SimSIP program, which include assumptions about the rate ofpopulation growth, urbanization growth, estimates of the elasticity ofpoverty and other social indicators, as well as GDP growth between 1998 and 2015. The population and urbanization growth assumptions are based on UN projections and the elasticities are calculated from world and LAC panel regressions. See Hicks and Wodon (2002). 70 2002. Whereas Argentina used to be the region’s richest country, it now ranks among the low/middle income countries. 5. Extreme poverty in major urban areas using a US$l/day PPP poverty line doubled from 2 percent to 4.14 percent between 1990 and 2000. Since an income ofUS$l/day is not sufficient to buy the basic national food basket the national indigence line is a more appropriate indicator for the hunger goal. Measured with the national indigence line3 extreme poverty increased from 7.9 percent in 1995 to 9.6 percent in 2000 and jumped to over 25 percent in 2002. Meanwhile total poverty increased from 29.4 percent in 1995 to over 50 percent in 2002. The associated poverty gaps for each ofthe three poverty lines have also increased, along with the GIN1 coefficient, which climbed from 0.454 in 1990 to 0.51 in 2000 and 0.532 by late 2002. Many factors have contributed to these rising poverty rates, including a sharp rise in the price of food and other wage goods, a deterioration in the level and quality of employment, and declining nominal incomes resulting from the recession. 6. It should be noted that the national household survey (EPH) does not cover rural areas (about 13 percent ofthe overall population) or inhabitants ofsmall-cities and semi- urban areas (23 percent). Therefore, poverty and inequality figures probably understate the relative position ofArgentina to meet the MDG poverty goal and with respect to other countries. Efforts are underway to expand the coverage ofthe surveys. 7. Argentina may still have reasonable chances to meet the MDG goal ofcutting extreme poverty by half by 2015. A recent country report by UNDP concludes that the crisis will likely delay rather than reverse the progress achieved during the 1990s. World Bank SimSIP simulations find that a halving ofextreme poverty is likely by 2015, and reducing the poverty headcount by half is also possible. ECLAC’s recent assessment also suggest that the goal could be within reach for Argentina although the country would need to post growth rates above the average ofthe first half ofthe 1990s and achieve a reduction in inequality. 8. Argentina’s challenges to recover the path to meet the MDG poverty goal lie in resuming sustained economic growth but also in improving income distribution and social integration. Since a significant fraction ofthe increase in poverty incidence in the last two years is attributed to the real increase in basic food prices (which increased by about 29 percent compared to the 18 percent rise in the CPI) maintaining price and exchange rate stability can significantly improve the prospects to meet the poverty MDG. Actions to significantly strengthen fiscal and financial sector management, governance, labor market reform, safety net coverage and effectiveness, and access to quality basic services are needed to recover the prospects for achieving the MDG poverty target. Ongoing efforts to improve the regular data collection for poverty measurement, to extend the coverage ofsurveys to uncovered areas and to move from income measures to a consumption aggregate, should be continued. Income below that needed to buy the basic basket of food sufficient to meet nutritional and caloric needs. 71 2. Universal Primary Education Completion Target: Ensure that all children complete the cycle of basic education by 2015 9. In the beginning ofthe 1990s, Argentina extended the years of compulsory schooling (basic education) from 7 to 10 years. Primary education in Argentina consists ofthe three cycles of General Basic Education (EGB) which cover the first 10 years of schooling. There are no recent data on net enrollment rates in EGB. However, the completion rate seems on track toward achieving this target, increasing from 84.2 percent in 1996 to about 88 percent in 2000 in the first two cycles ofEGB (EGB1-2) and from 60 percent in 1996 to about 75 percent in 2000 in the third cycle. However, the situation is less favorable in the poorer provinces, for example, one third ofthe children in Misiones do not complete EGB 1-2 while this is the case for about one fourth of children in Chaco, Formosa and Santiago del Estero. 10. The existing evidence suggests little effect ofthe crisis on educational output indicators. However, the quality of schooling might have deteriorated, particularly as the decline in federal transfers to provinces led to higher arrears on teacher salaries and consequently to lost of school days from teacher strikes. This in turn might have had a negative effect on student academic performance, particularly among poor families. 11. While the country seems to be on track toward achieving the MDG education goals, it is recognized that more education is even more important now. In fact, some jurisdictions have already extended compulsory schooling to 13 years, including the first 3 years ofthe so-calledpolimodal. This poses greatest challenges since by 2000 about half of children and adolescents at this age are yet to obtain a college education. 12. The policy agenda to continue educational progress in Argentina includes increasing the access ofthe poor to quality secondary education, reforming ofthe financing of higher education, improving the efficiency of public spending and the delivery of education services. In light of severe fiscal constraints and the greater reliance on provincial govemments for the delivery ofeducation services, strengthening public expenditure and delivery systems at a provincial-level is key. A recent study for the Santa Fe province found that income levels had a small effect on school enrollments and public expenditures had virtually no link to education indicators (Miller et al, 2003). The analysis concluded that specific and targeted approaches are needed to further improve the MDG education indicators, and particularly that improving efficiency ofexpenditures could maintain or even improve educational outcomes without increasing spending. Among the main challenges identified to improve education service delivery in Argentina are promoting greater transparency and accountability, through the adoption of performance incentives and monitoring and evaluation, and strengthening autonomy in decision-making at local and school level with greater citizen participation. 72 3. Gender Equality and Empowerment of Women Target: Ensure gender equality in access to all levels of education by 201 5 13. The targets for this goal include equality in education, greater economic participation and civic participation ofwomen. Argentina has already achieved the target for equality in education, the ratio of girls to boys in all levels ofeducation and literacy rates is at 100 percent. Muchprogress has been made to improve the status ofwomen in the Argentine society; however, gender gaps still exist in the economic, political and civic spheres. Women have increased their non-agricultural economic activity recently, mainly in social or financial services that have expanded. However, there remains significant vertical and horizontal job segregations. In 2000, 35.2 percent ofthose employed in the Buenos Aires Metropolitan area region were women. Along with job segregation, a wage gap of about 30 percent also persists between men and women. 14. A recent law mandating that at least 30 percent of all elected positions must be filled by women has resulted in a large increase in female civic participation. Such progress is the continuation ofa slow process of change in Argentine society toward the equality ofwomen. With maintained support for existing legislation, women gaining more and more education, as well as becoming more economically and politically active, the trend towards greater empowerment ofwomen in Argentina is expected to continue. 4. Reduce Mortality of Children under 5 Target: Cut in two thirds from1 990 to 201 5 the under 5 mortality rates 15. The Millennium Development Goal calls for a 2/3 reduction ofthe mortality rates ofchildren under 5 years old. The indicators for this goal include infant mortality (deaths per 1,000 births) and under 5 child mortality (deaths per 1,000 births). Both indicators declined by about 33 percent between 1990 and 2000 reaching rates of 16.6 and 19.3, respectively. However, progress has not been uniform across regions. The rates in 2000 were three times higher in Chaco and Jujuy than in Greater Buenos Aires compared to having been twice as high in 1990. 16. Using pre-crisis data and projecting past progress linearly into the future, Argentina was on track to reach the MDG child mortality goals by 2015. Similarly, the recent UNDP assessment is optimistic about Argentina’s track to reaching the mortality targets by 2015. 17. However, the recent economic crisis raises some concerns as poverty has increased and malnutrition has worsened. These factors have increased the prevalence of low birth weights, which increases the risk ofinfant mortality. Also, the recession and economic crisis has reduced central and provincial budgets and led to an increase in the cost of imported medications and biomedical inputs, limiting the ability to deliver the services and care needed to prevent infant and child deaths. Data from the Bank’s PROMIN project point a decline in the coverage and quality ofmother-infant services in poor areas between 2000 and 2001. Evidence from a recent Bank survey measuring the impact ofthe crisis indicates that families, especially the poorest, have taken their children to preventive medical controls less frequently since late 200 1. 73 18. Ifproper measures are not taken to mitigate any negative effects from the economic crisis, it may be very difficult for Argentina to achieve the child mortality goal. The SimSIP simulations indeed find that the country is unlikely to reach the infant mortality target and very unlikely to reach the under 5 mortality rate target in light ofthe recent economic crisis. 19. A recent study estimated that infant mortality rates could have increased by about 2 points due to the impact ofthe crisis on malnutrition and low birth weights, changes in service provisions, changes in demand for services and other impacts on infant mortality (Blake, 2003). The study found that there are many preventable causes ofinfant mortality that can be tackled with cost-effective interventions. 20. The key challenges to resume progress toward reaching this MDG goal include reducing preventable deaths (which account for almost 2 out ofeach 3 deaths in 2000) as well as regional differences in death rates. Many factors contribute to child mortality, including underweight births and malnutrition as well as lack ofclean water and immunizations against diseases. While the country has initiated many projects to reduce deaths due to these causes, more effort is still needed to expand coverage and improve quality in many under-serviced areas. It is necessary to expand health services, including basic vaccinations, with improved training ofhealth professionals as well as expanded medical capacity in the most disadvantaged areas. Again, strengthening public expenditure and delivery systems at a provincial-level is key (Miller et al, 2003) addressing the differences between provinces in financing capability, management capacity, quality assurance, incentives and accountability (especially when health spending is already high). Continued expansion ofthe coverage ofprivately provided water services can also have a significant impact on reducing infant mortality rates (Galiani, Gertler and Schargrodsky, 2002). Finally, it needs to be determined if the economic crisis has had any negative effects on infant mortality rates and whether complementary policies and programs are needed to mitigate these negative effects and further reduce the infant mortality rate. 5. Reduce Maternal Mortality Target: Cut in three fourths from1990 to 2015 the maternal mortality rate 21. The goal is to reduce maternal mortality by 75 percent between 1990 and 2015. The maternal mortality rate decreased by 33 percent from 52 per 100,000 live births in 1990 to 35 in 2002. Therefore, the rate must decrease faster if Argentina is to reach this goal by 2015. Moreover, there are large geographic disparities in the rates, with the poorest provinces having rates 20 times higher than those with lower rates. 22. Underlying the high maternal mortality rates are factors such as unregulated abortion and complications with pregnancy. Abortion-related mortality accounts for around half ofall maternal deaths thus family planning is a key intervention. In 2002 the National Sexual Health and Responsible Procreation Law was approved to support several measures to address the problem ofunregulated abortions, particularly the prevention ofunwanted pregnancies by introducing modem contraceptive options through the public assistance network nationally. Full implementation ofthis law is 74 essential. The expansion ofhealth services to improve prenatal care and general women’s health is also necessary to reach the MDG on matemal mortality. While the country has near 100 percent ofall births attended by skilled health care workers, more than 80 percent ofpregnant women receive less than 5 prenatal checks and there is a high level of cesarean births (more than 30 percent). These factors contribute to increased risks during birth, some ofwhich could be more easily reduced or avoided with increased prenatal care. Policies and programs to address the risk factors in the poorer provinces are needed. 6. Combat HIV/AIDS, malaria and other diseases 23. Since malaria is less of a problem in Argentina, especially in urban areas, the country has identified Tuberculosis and Chagas as diseases to combat by 2015 along with HIV/AIDS. The incidence oftuberculosis and Chagas have been declining due to successful intervention programs. However, AIDS cases continue to rise and there is little data to completely monitor the spread in the country. 24. The incidence oftuberculosis declined from 38.1 per 100,000 habitants in 1990 to 3 1.8 in 2000. Mortality rates have also declined by 50 percent during this period. However, recent data from the World Health Organization show that Argentina is among a handful ofcountries with multi-drug resistant TB rates above 3 percent (the only country with in the Americas). This suggests problems with the country’s TB treatment programs. The prevalence of Chagas also declined significantly among children less than 15 years old and pregnant women during the 1990s, although the risk ofinfection has not yet been fully eradicated in Santiago del Estero, Formosa, Chaco and La Rioja. 25. On the other hand, the incidence ofHIV increased from 1,546 per 100,000 habitants in 1990 to 5,085 in 2000 while the mortality rate increased from 8.8 to 39.7 per 100,000 habitants during this period. The problem is more severe in major urban areas, especially in the city ofBuenos Aires. Several legislations were passed during the 1990s to strengthen the response ofthe State to this problem, including the coverage ofHIV treatment in public and private health insurance. However, the provision ofmedications has suffered from the severe budget cuts and the country still lacks an effective system of monitoring and prevention to control the expansion ofthe disease. 7. Ensure Environmental Sustainability Target: Reduce by half the proportion of population without access to safe drinking water or sanitation. 26. This goal includes integrating sustainable development practices into policies, and increasing access to safe drinking water and sanitation and improve the lives of slum dwellers. To monitor progress, the targets call for reducing by half the proportion of population without access to safe drinking water, while targets for the other areas are yet to be defined. 27. According to census data in 2001 approximately 89 percent ofthe population in Argentina had access to safe drinking water (public network or pumped water) up from 75 78 percent in 1990. This increased coverage ofwater services is in part associated to privatization (Galiani, Gertler and Schargrodsky, 2002). About 42.5 percent had access to secure sanitation services up from 36 percent in 1990. This proportion increases to about 68 percent if other, less secured means ofsanitation are considered with virtually no improvement over the decade. Since more than 90 percent ofthe country’s population lives in urban areas, these figures present large health risks. The lack of adequate sanitation is more severe in Misiones, the Greater Buenos Aires area, Formosa, Salta and Jujuy. The expansion ofirregular settlements and slums (villas miserias) has likely aggravated this situation. 28. The main challenges to expanding water and sanitation services is that those areas without access are the most poor and households already devote significant resources to pay for these services. Nominal tariffs have remained frozen since 2002 raising questions about the financial sustainability ofprivate operators and reduce the incentives to expand coverage. Existing subsidy schemes are not well targeted towards the poor. The implementation ofprogressive fee structures and public subsidies directed to reduce the substantial connection charges to poor households are essential to continue improving access to water and sanitation to under-serviced populations. Summary 29. To summarize, the crisis suffered by Argentina has not severely compromised the achievement ofmost ofthe Millennium Development Goals. Due to the crisis the country is currently off track to meet the poverty goal but if strong and sustained labor intensive growth resumes, this goal is still within reach. The country has already met the primary education and gender equality goals. Areas in which progress has been slower than necessary and/or the crisis has put severe strains to reach the goal are infant and matemal mortality. Progress towards meeting the water and sanitation goals require renewed efforts to maintain and expand the achievements ofthe reform process. 76 References Blake, Andrea, 2003, “Tendencias y Proyecciones en Mortalidad Infantil en Argentina”, mimeo . CEPAL (Comisi6n Econ6mica para Amkrica Latina y el Caribe) (2003), Panorama social de Amkrica Latina, 2002-2003, Santiago de Chile. Publicaci6n de las Naciones Unidas, Node venta: S.Ol.II.G.141. ECLAC, IPEA, UNDP, 2002, Meeting the Millenium Poverty Reduction Targets in Latin America and the Caribbean. Santiago de Chile. Hicks, N. and Wodon, Q., “Reaching the Millennium Development Goals in Latin American: Preliminary Results?”, En Breve, September 2002, No. 8. World Bank, Washington, D.C. Miller, M., Ruwan, J., White, E., and Q. Wodon, 2003, “Reaching Health and Education Targets in Argentina: A Provincial Level Analysis”, in EfJiciency in Reaching the Millennium Development Goals, ed. Ruwan, J., and Q. Wodon, World Bank Working Paper No. 9. The World Bank, Washington, DC. Ryan, B. and Wodon, Q., forthcoming, “Will Latin American Countries Reach the Millennium Development Goals?” World Bank, Washington, D.C. Galiani, Sebastian, Paul Gertler, and Emesto Schargrodsky, “Water for Life: The Impact of the Privatization of Water Services on Child Mortality,” unpublished mimeo, (2002). United Nations, 2002. Implementation of the United Nations Millennium Declaration; Report of the Secretary General, United Nations General Assembly. UNDP, 2002, The Millennium Declaration’s goals for development and poverty eradication: How many countries are on track?. Human Development Report 2002: New data release, 18 March 2002. World Bank, 2003, Argentina, Crisis and Poverty 2003: A Poverty Assessment Update. Processed, The World Bank, Washington, D.C. 77 Annex E. Summary of Consultations With Civil Society - 2003 Argentina CAS 1, Preparation for this Country Assistance Strategy for Argentina has posed particularly acute challenges for the World Bank. The economic crisis ofrecent years has raised fundamental questions for Argentina about which factors contributed to the collapse ofthe economy and the deep human and social damage that ensued. It has also brought into sharp relief the role played by Argentina’s extemal partners, including the Bank. 2. Developing a CAS which attempts to reflect adequately the scope and complexity ofthe challenges facing the Argentine people and their government, while identifying a role in which the Bank can provide effective support for sustained economic recovery and poverty reduction, has been a tall order. To ensure that the analysis on which its assistance strategy would be based is as sound, and reflective as possible ofthe experiences ofall Argentines, the Bank turned to its partners in civil society. Building on what has been an increasingly productive and open relationship with leading civil society organizations (CSOs), the Bank carried out an ambitious program ofconsultations throughout the country in preparation for the CAS in particular, and for its future relationship with the country more generally. 3, The purpose ofthe consultations was straightfonvard: to strengthen the quality of the Bank’s support by hearing directly from grass-roots organizations, many ofthem representing the poor who were most harmed by the crisis and remain most vulnerable to its persistent effects. Such opportunities provide a direct and valuable source ofideas, and criticism, which otherwise generally reach Bank staff via the filter ofgovernment officials, powerful international advocacy groups, or the press. The value to the World Bank ofthis direct exchange with civil society in highlighting problems at the local and country level, as well as with respect to institutional policies more generally, has been made abundantly clear in recent years, and has proven so in this CAS. This is true - as is the case in every serious discussion with thoughtful civil society groups - even when differences can not be resolved and specific suggestions, or philosophical positions, can not be adopted by the Bank. Indeed, in the consultations described here both sides acknowledged this reality as evidence ofthe seriousness ofthe discourse, and as a basis for future debate. Consultation Process 4. The consultation process started in November 2002, nearly a year before development ofthe CAS. This first phase ofdiscussions with civil society was dedicated to identifying the full dimensions ofthe social crisis, and to exploring how the Bank could be more effective in responding to the deteriorating poverty situation. Beginning in August 2003, in a second phase ofintensive discussions designed to prepare for the CAS in greater detail, the Bank, in partnership with its key interlocutor in civil society, Grupo de Tvabajo de ONG’s sobve el Banco Mundial (GTONG), organized and conducted six 78 day-long meetings in different parts ofthe country with more than 1,500 participants representing 20 ofthe country’s 24 provinces. I GTONG The consultations on the Bank’s strategy were co-organized by Grupo de Trabajo de ONGs sobre el Banco Mundial (GTONG). This group was created in Argentina in 1998 to coordinate and intensify the Bank’s dialogue with civil society organizations at a regional level, and follows a model ofsimilar groups established in US and Europe. GTONG has local chapters in each of the 6 regions of Argentina, i.e., Metropolitan Area ofBuenos Aires, Central Region, North East, North West, New Cuyo and Patagonia. GTONG and the WB have centered the CAS consultation in the following topics: privatizations and their impact on the poor, employment and globalization, participation and public sector reform, social monitoring of the emergency, and evaluation of the WB portfolio. The GTONG annual program for the year 2003 has five main components: (i)CAS consultations; (ii)how to build social capital; (iii)Relationship between business community, civil society organizations, multilateral organizations and the Government; (iv) Integration and Commerce and (v) the Social auditing mechanism. Additional information can he consulted in the web naee of the moun www.CrTONCrAreentina.ore.ar 5. In both sets ofdiscussions, the Bank worked to broaden the consultations beyond the specialized NGOs with expertise on how the World Bank and other multilateral financial institutions work, to include a broad spectrum of civil society representing faith groups, academics, unions, organizations ofunemployed workers, environmental organizations, and others. Government officials from the local, provincial and national level also participated in the meetings, providing a critical perspective on important policy issues. 6. To increase the contribution the findings ofthese consultations would have on the Bank’s assistance program, the meetings, particularly those during the second phase, were designed to generate actionable proposals on the core issues to be addressed in the CAS: (i)Economic Growth, (ii)Social Inclusion, and (iii)Governance. Each ofthe consultations during this second phase included open discussion in plenary, as well as three-to-fours hours ofintensive discussion in self-selected break-out groups on these three themes. Main Issues and Perceptions Among Participants 7. A number ofperceptions and themes emerged forcefully throughout the consultations. With respect to the intemal factors which contributed to the economic crisis, there was broad recognition that Argentines themselves are primarily responsible for what happens in their country, and that home-grown solutions are required for home- grown problems. Participants said that Argentina is not a poor country, but has been poorly run. This sense ofresponsibility is significant, as it tied to a deep mistrust of 79 public institutions and growing frustration with what is felt to be high levels ofcorruption and lack ofaccountability. 8. Convincing evidence ofthe serious weaknesses in Argentina’s public sector for many Argentines was the economic experience ofthe 1990s, and the crisis that followed in 2001. It is well understood that Argentina liberalized its economy and reduced state ownership ofproductive assets during this period. Equally well known is that during this “experiment” with liberalization, the country grew more, not less, unequal, and that the growth that did take place during these years did little to reduce poverty. Privatization in particular is now seen as having compounded an already unequal distribution ofwealth, as it is perceived to have rewarded “insiders” and those with connections. Overall, the majority ofconsultation participants believed that the market policies followed during the 1990s, the mounting reliance on external financing, and the weak regulatory and social system in which these policies were carried out, contributed substantially to the crisis. 9. While the civil society participants looked first to Argentina in ascribing responsibility for developments in their country, external actors are seen as having exacerbated internal weaknesses. Although the precise role ofthe World Bank, or indeed the scale ofits role, was not well understood, there was a general sense that the Bank actively supported the “neo-liberal” or “Washington Consensus” economic model in 1990s Argentina. In particular, there was a broad perception that the Bank pushed these policies through structural adjustment lending. 10. In addition to a generalized complaint about the nature ofadjustment lending, many participants voiced concern that even investment projects with readily appreciated social merit were hurting Argentina because oftheir perceived lack ofresults and the growing debt left behind. In this context, many asked staff about possible misuse of Bank funds, and about what they perceived was an inability, or unwillingness, to monitor loans to ensure that resources provided by the Bank were used for their intended purpose. Suggestions for Future Engagement: Growth, Social Inclusion, and Governance 11. In terms of economic growth, the frustration ofmany participants with the outcome ofthe 1990s economic policies was accompanied by a generalized desire for a more interventionist State role in the economy, particularly at the local and provincial level. Many emphasized that the overriding job ofthe state would be to protect domestic markets and create economic growth that is more equitable and widely shared than has been experienced in the past. Government should focus on stimulating internal demand, supporting small and medium size domestic enterprises, and creating jobs. In this regard, many felt that the Bank could best support this process by shifting substantially away from adjustment lending to investment loans for projects carried out as close to the local level as possible, even through civil society groups themselves. 12. In the area ofsocial inclusion, civil society participants in every meeting provided moving and important testimony about the hidden damage caused by the crisis, in terms ofdomestic violence, spiraling school drop-out rates, increased levels ofalcohol 80 and drug dependence, a growing HIV/AIDS problem, and the wrenching fragmentation offamilies and communities. In some discussions, the special problems faced by indigenous and other vulnerable and excluded groups were raised with equal effect. And in all meetings participants spoke about the need to improve social support to keep young people in school, increase access to health care, and support infrastructure projects and basic social service delivery, such as in water and sewerage. Throughout these discussions, the theme ofself-assistance was clear, and many participants noted with interest the Bank’s support ofa project which helped poor people in flood protected areas build their own houses, and asked about scaling-up this program. 13. One prominent message to come out ofthe meetings was that the Bank could improve its effectiveness, particularly in its support ofkey social areas, through a closer understanding oflocal issues, and discussants welcomed the ongoing and productive dialogue with staff toward this end. In this context, the subject ofthe Jefes y Jefas de Hogar (Heads ofHouseholds) project was raised frequently. Many participants genuinely appreciated the Bank’s support ofthis emergency self-help program, which provides financial benefits to heads ofhouseholds engaged in work or job training. They also, however, indicated the inherent problems with such programs, particularly in an environment ofweak and opaque public administration, and referred to reported cases of corruption. Many also expressed concern that the program may have an unintended disincentive for beneficiaries to seek work, and recommended that in any follow-up to Jefes, the Bank move away from a subsidy-based approach to one more likely to build longer-term job creation. 14. With respect to governance, the issue ofreturning decision-making to the local level appeared repeatedly, and CSOs asked to play a role in this process of decentralization. They asked that the Bank convey to the Government - and stressed to public officials when present - their demand for a more transparent budget process and for a seat at the table, especially in setting priorities in health, education and other social issues. They also asked the Bank to improve its supervision and monitoring ofthe resources provided to the Government to ensure as much as possible that its support actually reaches the people. Similarly, civil society representatives expressed hope that consultations would continue with the Government and all ofArgentina’s external partners, involve their participation in the preparation and implementation ofBank supported projects, and include training and capacity building for CSOs to be able to contribute more effectively in such cooperative efforts. Conclusion: Continue the Close Working Relationship with Civil Society 15. The nearly year-long program ofconsultations with civil society have contributed significantly to the shape and direction of the present country assistance strategy. 0 First, this CAS envisions a pronounced shift in its lending away from adjustment programs to specific investment projects aimed at establishing more equitable, job-driven economic growth. While adjustment lending over the past three years reached nearly 80 percent (substantially driven by the reprogramming 81 necessitated by the crisis) this CAS seeks to cut this percentage by half. A combination ofinfrastructure loans, particularly for provincial road construction and flood prevention, and support for public private partnerships, support a growth strategy broadly consistent with the expressed vision ofthe Argentine authorities and civil society. Second, social protection projects designed to improve education, increase access to health care and attack poverty, both rural and urban, respond directly to the persistent social crisis. With regard to the Jefes program, the follow-on to this emergency social operation will, as suggested by so many discussants, focus on sustainable employment creation. 0 And third, support to the public sector in the areas ofjudicial reform, property right registration, public auditing of social sector outcomes, and anti-corruption efforts, are aimed at helping Argentina achieve its goal ofa stronger, more transparent and accessible government. 16. This CAS has substantially benefited from, and is reflective ofthe intensive year- long dialogue with Argentine civil society and public officials described above. As such, it brings together the essential elements necessary for the Bank to be as effective as possible in its assistance to Argentina. Staff are grateful for the contributions of so many representatives ofcivil society, as well as for the support and active participation ofthe Government. 17. Finally, the perceptions ofhow the Bank operates and the role it has played in Argentina have been enormously useful, first in pointing to practices and policies that have had limited effectiveness, and second in underscoring the need for even greater communication with Argentine civil society in all ofits representation. Staff are pleased with the willingness ofCSO representatives to deepen - and broaden where possible - this dialogue. And the Bank is working to be more systematic in its collaboration with key audiences to ensure important information, and opportunities for cooperation in projects, are exchanged in as accurate and timely a fashion as possible. In this context, staff intend to publish the CAS on the Bank’s website (subject to approval by the Government), which will allow the participants to see how their views have been addressed. Beyond information-sharing, steps are underway to respond for requests from CSOs for training and capacity building, including a recent Institutional Development Fund grant to support grass-roots organizations, and it is hoped by all that the future will continue to present opportunities for the Bank and its partners to work together for a better future for all of Argentina’s people. 82 Annex F. Private Sector Development Strategy (prepared jointly by IBRD and IFC)' 1. Prospects for sustainable longer-term growth will depend critically on a dynamic private sector development which will require a significant improvement in the business environment. In the aftermath ofthe crisis, the environment would need to be improved in five key areas: financial intermediation, confident corporate entities, satisfactory completion ofthe renegotiation ofpublic service and infrastructure concessions, general enhancements in investment climate, and removing infrastructure bottlenecks. This annex elaborates on these areas. 2. After four years ofconstant decline, investment and private consumption are starting to increase but remain at low levels. 1Vh 160,033 - 3. Industrial production has increased steadily since early 2002 but credit to the private sector is still at record lows (despite a slight increase in the third quarter of2003). Industrial Production (1993=100) Credit to Non-financial Private SectorIGDP 130.0 , I I 120.0 25% A k 20% 110.0 - Y 1m.o - 90.0 - I 5% 4. With the recovery ofindustrial production and private consumption, and the improved macroeconomic indicators, the country's consumer and government confidence Joint IBRDAFC except for sections on public service and infrastructure concessions prepared by IBRD. 83 indexes have steadily improved since the record low levels of2002 (see graphs below). Since June 2003 there is a slight reduction in the consumer confidence index which may indicate there are opportunities to further consolidate the recovery Index of Consumer Confidence (m.01- Oct.03) ~ 60.0, I 4.0 - 50.0 - 3.0 - 0.0Xov- Jan- Mar- May- Jul- Sep- Nov- Jan- Mar- May- Jd- Sep- Mar- Mar- Mar- L Jm Sep- Dec- Jm- Sep- !20 Jm- Sep- 01 01 01 01 02 02 02 02 03 03 03 01 02 02 02 02 02 02 03 03 03 03 03 5. The key challenge ahead is to sustain the currently favorable developments and transform them into longer term private sector development (PSD). To this end, a possible PSD strategy could draw upon economic sector work undertaken by Bank staff as well as technical assistance on financial sector reform, corporate debt restructuring, and restructuring ofpublic services and infrastructure concessions. In addition, Bank and IFC staff have benefited from an on-going dialogue with the private sector. 6. The implementation ofinitiatives to improve investment climate hinge on avoiding future infringements to the fundamental property rights ofkey stakeholders. This will have an impact on all aspects ofprivate public partnerships, including contract enforcement, financial intermediation, public service provision and infrastructure. 7. From analytical work and on-going consultations with the private sector, five areas are considered key for an effective PSD strategy: 0 Restructuring ofthe financial system. 0 Establishing an enabling environment for corporate debt restructuring. 0 Renegotiating private service and infrastructure concessions. 0 Reconstructing the investment climate. 0 Maintaining and developing infrastructure assets to support growth. Restructuring of the Financial System 8. Argentina’s banking system has been deeply affected by the 2001-2002 crisis. Liquidity difficulties began with a massive run on deposits during 2001 which led to a The elements of the PSD Strategy draw upon economic and sector work (ESW) prepared by the Bank during 2002-2003 including: Argentina’s Challenge: Growth, Social Inclusion and Governance (SecM2003-0301, June 24,2003), Small and Medium Enterprises ESW (Report No. 22803-AR, August, 2002), Banking Sector Strategy (FY2004), “Social Impact of the Crisis on Infrastructure and Public Service Provision” (Working Document 5/03), Public Expenditure Review (Doc. No. 2599 1-AR, June 2003). 84 rapid loss ofintemational reserves, Central Bank intervention and eventually a freeze of sight deposits and a re-programming oftime deposits - respectively named “corralito” and “corral6n”. The use ofthe banking system to supply compulsory finance to the public sector prior to default, the subsequent default and - specially - the asymmetric “pesification” ofassets and liabilities ofbanks were root factors ofthe massive losses incurred during 2002 - around US$5.7 bn. or 5.6 percent ofGDP. Losses continued (albeit at around half that pace) in the first half of2003. Those losses do not include capital losses due to the fall in market value ofgovernment assets held by banks - these assets represented over 50 percent by the end of 2002 (up from 17 percent at the end of 2000). As a result ofthe crisis, the share ofbank credit to the private sector declined from around 24 percent ofGDP in 2000 to an estimated 7 percent ofGDP in 2003. 9. It is clear that the banking sector must be restructured to regain solvency and to reestablish its financial intermediation role. The mobilization ofsavings and their allocation to the most efficient investments is critical to ensure the continuity ofthe economic recovery and sustained economic growth. It is noteworthy that the depositors’ worst fears have been calmed down and that - with the (partial) retum ofdepositors to the system -banks were able to emerge from the “corralito” and “corralon”. As a result ofthis and ofthe contraction in credit, banks have been able to regain liquidity along with significantly lower interest rates. 10. However, key structural weaknesses still have to be addressed: banks not only need to regain solvency - which, with the Government in default, will necessarily take time -but also still need to show that they can make profits. Annualized losses in the first half of2003 were AR$7.5 billion (about US$2.6 bn.). Lending must be restarted and the quality ofprivate assets must be improved - both ofwhich hinge on a sustained recovery and effective corporate restructuring; and cost-cutting including downsizing and asset divestiture. Downsizing has indeed intensified with the number ofemployees contracting around 15 percent and the branch network 10 percent since 2001. 11, Addressing the stock problem requires - aside from sovereign debt restructuring - settling pending “compensations” related to the asymmetric “pesification” and putting an end to the “amparos” -judicial injunctions whereby the banks are obliged by courts to repay deposits in their original currency (US dollars) until the Supreme Court decides on the merits ofsuch repayment^.^ The Government needs to avoid further measures that may be challenged in court and possibly lead to additional court-mandated compensations. That can best be accomplished by proceeding in a consultative manner that is perceived to be fair and transparent. 12. However, even after sizable downsizing and after all pending compensations are paid most, if not all, banks will still be technically insolvent. To restore solvency, non- viable banks need to be identified at an early stage and prepared for restructuring, merger Since virtually all time deposits have been reprogrammed, so-called “first generation amparos” have already taken place; however, there is a new round of so-called “second generation amparos” which consist ofjudicial injunctions that oblige banks to return dollar deposits to depositors who have already withdrawn their deposits at less preferential terms. 85 or liquidation. It is clear at the present juncture that, even in a context ofeconomic recovery, Argentina may well end up with a much more consolidated banking system. Amongst the actions required to facilitate the process ofbank restructuring, the following merit particular note: 0 Banks must resume financial reporting in a timely, accurate and consistent manner. 0 A prompt and complete analysis is needed ofthe financial condition ofall banks. 0 Regulatory forbearance should be granted to individual banks only in the context ofan agreed plan for financial recovery including the provision offresh equity capital. 0 A clear exit strategy must be devised for banks that are found to be unviable and for which no other prospect exists such as merger or acquisition; similarly, the rules for new bank entry should be clear and transparent. 0 To secure the continued engagement ofprivate banks on a level playing field, public banks should not receive favorable treatment in terms ofregulatory forbearance; this implies that the Government should pursue swiftly to ensure that public banks to improve their efficiency commensurately with private banks. 0 While the lifting ofthe “corralon” has been positive it has increased the maturity mismatch between assets and liabilities. Banks should seek to lengthen the maturity oftheir liabilities, e.g., by issuing longer term indexed deposits. 0 The issue of such deposits could simultaneously help to reduce the mismatch between inflation indexed assets (primarily government paper) and liabilities. 0 The autonomy ofthe Superintendent should be strengthened and prudential regulations should be revised to be consistent with a post-convertibility environment. 0 Facilitate mechanisms for the restructuring ofbank corporate clients by “fast- track” out-of-court settlements. These have to be led by highly reputable individuals. Corporate Debt Restructuring 13. Compared to other systemic crises, the process ofcorporate debt restructuring has had a slower evolution. The importance ofprivate (non-financial) sector debt is substantial and amounted to some US$46 billion in March 2003 (close to 46 percent of GDP in 2002). About 68 percent ofthat debt is with foreign creditors, including US$19 billion that has entered a restructuring process. As ofJuly 2003, about 47 percent of interest payments and 69 percent ofprincipal payments from negotiable obligations had not been met. 14. In that context, the solvency ofmany corporate entities continues to be negatively affected by the devaluation ofthe peso, since, after the convertibility law was abandoned, many corporations that borrowed in foreign currency could not meet their obligations with revenues that are mainly denominated in pesos. The problem is heavily concentrated in a limited number oflarge companies. It is estimated that almost half of all corporate debt is held by the largest 80 companies and three quarters ofthat debt was 86 denominated in foreign exchange and held by foreign creditors. The public service and infrastructure concessions account for about US$11 billion ofthe total debt. The problems faced by all companies were not caused by inefficiency or poor corporate governance. Given the limited prospects for local finance, many ofthem had a financial structure that was appropriate under convertibility laws. Creditors have little to gain by taking control ofthese companies or by triggering bankruptcy. The problem, therefore, is to align outstanding claims on companies with their reduced repayment capacity. In recent months some pre-packaged restructuring plans (“Acuerdos Preventivos Extrajudiciales”) have been filed and are under consideration (after the amendment ofthe Insolvency Law ofMay 2002). An option that has been preferred elsewhere to assist corporate debt restructuring in a scale commensurate with the job at hand is to adopt a consensual out-of-court workout rather than rely upon the already overloaded, slow and unpredictable judicial system. 15. The Government has agreed to support corporate restructuring that is implemented under a voluntary, market-based framework and driven by creditors and debtors. In this context, the Government is committed to develop, by March 2004, in collaboration with debtor and creditor groups, non-statutory workout principles based on international best practices for use in the debt restructuring negotiations. Renegotiation of Public Service and Infrastructure Concessions 16. Public service and infrastructure concessions financed and operated by private operators are now the core service providers to 9 million households in Argentina. After the crisis, these concessions experienced additional difficulties over and above other corporate entities. The devaluation ofthe peso and the subsequent conversion oftariffs from dollars to pesos at par greatly reduced the income ofinfrastructure operators who, in addition, have had to contend with increasing arrears, particularly from public sector clients. Coming after several years ofrecession, the dramatic fall in operators’ income has paralyzed investment and reduced service to a minimum. Basic maintenance has also been cut-back which is concerning because it can lead to costly rehabilitation at a later date. The future cost of dealing with deferred maintenance could exceed the increase in tariffs needed for timely maintenance today. There is a risk that service may be interrupted in strategic sectors where investment has been brought to a halt. There is also a risk that, if infrastructure operators are driven to bankruptcy, the function of service provider will once again fall upon the Government which is not financially able to discharge that responsibility. Also, the continuity ofservices where there has been a deficiency in investment is a matter of concern. 17. The renegotiation ofpublic service and infrastructure concessions needs to take place within a more stable, transparent and predictable framework based on the rule of law. In sectors where a sound regulatory framework already exists, renegotiation efforts should be devolved to the corresponding regulatory body which is best able to assemble a credible business plan for concessionaries, creditors and users alike. In other sectors (notably transport) prior efforts are needed to construct an appropriate regulatory framework within which contracts can be effectively renegotiated. 87 18. In the Table below the key indicators ofstatus ofnegotiations for the 63 major public service and infrastructure concessions is summarized. 88 I U L 0 Y 2 89 19. Process of Renegotiations. The Government is still in the preliminary phase of the renegotiation with all 63 operators of concessions and licenses and expect to complete negotiations by December 3 1,2004. The new Government has defined a revised negotiation procedure. Following the approval ofLaw 25790 of2003, the Government will carry out a renegotiation which aims at (i)agreeing interim adjustments, and/or (ii) restructuring each concession. Before each contract renegotiation starts, the Government assigns the Renegotiation Unit to prepare a renegotiation proposal consisting of(i) a detailed assessment ofcontract compliance for each concession and license based on data collected from regulators and concessionaires, (ii)a renegotiation approach, and (iii)a draft contract amendment “Acta Acuerdo” reflecting the proposal and confirming the long term commitment of Government to support sustainable public-private partnerships. Once the proposal is ratified by the two Ministers heading the Unit ofRenegotiation the renegotiation starts, and the assessments and proposals are shared with the operators of concessions or licenses. Once an agreement is reached there is a public hearing before the proposed contract amendment is sent ,to Congress for ratification. 20. Information from the Renegotiation Unit indicates they have prepared renegotiation proposals in the areas ofwater (l),river water way (l),urban (4) and inter- urban toll roads (13), freight railroads (9,ports (4), and bus terminal (l),this accounts for 29 contracts out of 63. The contracts for which proposals have been prepared amount to about AR$2.5 billion in annual revenues or 15 percent ofthe total annual revenue estimated for the 63 concessions under renegotiation (see graphs below). In addition, the Government has requested the gas and electricity concessionaires to agree on an agenda for renegotiations on November 28 (gas) and December 2 (electricity). Gas and electricity concessions account for 38 percent oftotal revenues and also for 45 percent of the foreign debt ofthe 63 concessionaires (see charts below). Revenues in 2002 Foreign Debt Transpor Transport ’ 8% 7% 21. Timetable. The Government expects to complete renegotiation of 54 concessions and licenses before June 30,2004 including the following concessions and licenses: water (l),electricity and gas (22), freight railways (9,waterway “hidrovia” (l),ports (4), airports (l),bus terminal ofBuenos Aires (l),inter-urban road concessions (13 are re- 90 concessioned, and 2 remain), and urban road access (4). The Government expects 9 concessions to require further time for the renegotiation to be completed during the second semester of2004 including: telephone (2), mail (l),public transport and passenger railroads (6). 22. Regulatory Frameworks. Law 25790 of2003 suspends those aspects of regulatory frameworks which are related to tariff adjustments and renegotiations. The Government expects to revert to the previously established regulatory frameworks after December 2004, and also to introduce modifications to the frameworks as required by the outcome ofthe renegotiations. In general, the renegotiation process will require a companion effort to strengthen the regulatory entities to develop regulatory accounting capabilities. 23. Role of the Bank. The World Bank provided advice during 2002 and 2003 to the Government on the global experience with renegotiations ofconcessions, restructuring regulatory frameworks, and social tariffs. At present, the World Bank and the Government have started consultations to define jointly the exact role expected from the World Bank as advisor in the renegotiation program. A joint aide-memoir will define the possible technical assistance and advise expected from the World Bank, which would not relate to specific contract negotiations, and may include: (i)providing technical assistance under existing projects to strengthen the technical teams ofthe Renegotiation Unit and the regulators (e.g., experts on regulatory accounting, reassignment ofrisks), (ii) reviewing the draft General Regulatory Framework (under preparation by Government) and proposed modifications to the existing regulatory frameworks, (iii)reviewing the milestones and monitoring the detailed program ofrenegotiation, and (iv) assisting with the implementation of a social policy for the public service and infrastructure concessions. 24. Social Policy for Tariff Design. The Government is concerned about the difficulties faced by low income households to remain connected to basic electricity, gas and water services. For this reason, as part ofthe renegotiation, the treatment ofsocial policy in tariff design will be considered with the operators and the regulators. The Government intends to redesign tariff structures that affect basic service access and affordability for low income households. The proposed social tariff instruments could be better designed within a fiscal neutral environment that preserves economic efficiency, substantially improving their targeting and reach, complementing efforts and interests of Government and concessionaires. 25. Guiding Principles. A main guiding principle in the remaining renegotiation should be to restore the confidence ofprivate investors and creditors because their support will be vital if the investment needs ofthe infrastructure sector (estimated at over 3 billion dollars a year) are to be met. At the same time, the renegotiation process needs to ensure that there is a fair burden sharing between investors, creditors and consumers, and that essential services remain affordable for the lowest income groups. There is now a broad consensus that a “social tariff’ is important, not only to facilitate a resolution of the present crisis, but also to enhance the longer-term regulatory framework by ensuring 91 that poor households have access to essential services. However, given the parlous state ofgovernment finances, a “social tariff’ should not depend upon fiscal support only but should be designed as a self-contained cross-subsidy, where possible. A separate, albeit closely related, issue that also needs to be resolved as a matter ofurgency concerns the balance sheets of infrastructure operators which have been seriously weakened. It will not be possible to articulate a credible business plan for concessionaires or reach agreement on long-term tariff structures without a clarification of asset values. The current administration will need to reach an agreement on how to reconstitute a new asset structure for each concession because the future investment climate ofArgentina and the ability to attract from private sources the significant funding needed to maintain and expand the infrastructure will depend critically upon the outcome ofthe renegotiation. In dealing with that issue, the administration will also need to formulate a policy with respect to 24 claims (see paragraph 96 ofCAS) that have already been initiated for international arbitration on this and related matters. A relatively rapid resolution ofthese claims acceptable to the interested parties is not only needed for reestablishing a viable environment for maintenance and expansion investment, but also for sending the right signals to provincial concessions whose processes are stalled awaiting resolution of the federal cases. Reconstructing a positive investment climate 26. Despite the severe crisis that Argentina suffered after the end ofthe convertibility plan, there are opportunities to refocus and relaunch economic activity. The current trend ofimport substitution has permitted a relatively swift increase in production that accounts for some ofthe current recovery, but a lack of finance could limit future prospects. Care should be taken to ensure that import substitution leads to high quality products and increasing productivity. Likewise the devaluation has provided ample opportunities for an effective export-led recovery. Action to foster a sustained growth in exports ought to be a key priority for the Government. However, access to financing remains very limited: demand from SMEs remains low, interest rates remain high, lending is available only on short terms if it is available at all. Even short-term financing for working capital is not available for most companies, particularly SMEs. Hence the Government should seek ways to revitalize the financial system, including through measures mentioned in paragraph 12. 27. Efforts are needed to improve the investment climate. These hinge on rebuilding confidence in the individual, fundamental property rights by: (i)strengthening contractual security and transparency in the legal processes; (ii)fostering a constructive dialogue between the private sector and the authorities; (iii)reestablishing foreign confidence by ensuring fair treatment of current foreign investors in Argentina; and, (iv) achieving significant and prompt progress in restructuring the banking sector and renegotiating concessions. 28. In order to implement the dual strategy ofefficient import substitution and export led growth several policy measures are needed. There is a risk that firms that enter or expand under current market conditions could end-up being unable to compete in the 92 future if they are not capable of adapting. A short lived export (and import substitution) boom could be followed by intense pressure for protection as the exchange rate advantage diminishes and firms drop out ofthe export market or find it difficult to compete with cheaper imports. New and existing firms can remain competitive in the long-run by improving their production and productivity, reducing costs and investing in innovation and technology. Finally the current crisis should provide an opportunity to rethink and push forward a coherent absolute quality program and develop the National Innovation System, much needed in Argentina. 29. To consolidate the ongoing economic recovery a Private Sector Development Strategy should aim at promoting competitiveness and expanding exports. Such a strategy would require an extension in business planning horizons and a significant increase in investment, particularly in technology, to improve quality and compliance with intemational standards. There is a need for new financing mechanisms and instruments, particularly for SMEs, and for reducing production costs which are currently inflated by a distorted tax structure, excessive and complex regulations, bureaucratic obstacles to the entry and exit of fimis, costly information gathering and inefficient logistics and infrastructure. There is also a need to facilitate supply chain integration, and to increase linkages between large enterprises and SMEs to enhance the dissemination of knowledge, technology and innovation. 30. Certain elements ofPrivate Sector Development Strategy (which the proposed Economic Recovery Support SAL would support) include: 0 Defining more clearly which areas of government are responsible for making and implementing private sector development policy. 0 Creating close links between the state as regulator and facilitator, on the one hand, and private producers and public-private partnerships on the other. 0 Identifying obstacles to increased competitiveness and provide remedies, with a focus on key sectors, taking into consideration traditional comparative advantages and productive excellence, but concentrating in areas with higher value added. e Promoting the adoption ofquality norms, standards, and processes and investment in R&D, developing a coherent National Quality System and National Innovation System to improve intemational competitiveness. 0 Promoting the development of efficient SMEs as the main source of employment and competitiveness in a world with increasing demand for short-lived products with cultural character. 0 Reducing bottlenecks in infrastructure and associated services which increase logistic costs and constrain production and distribution (both for the local and export markets). 0 Promoting exports, with particular emphasis on SMEs, by fostering export related financial instruments and by reducing processing and transaction costs. 31. The present regulatory framework for doing business in Argentina is overly complex and is in need ofsimplification. The problem is compounded by infrastructure bottlenecks, which result in logistic costs that are among the highest in the region and 93 which hamper the country’s growth potential. The cumbersome regulations affecting business activity predate the recent crisis. In the table below, a comparison ofpre-crisis data with regional partners and OECD countries compares indicators ofthe regulation of business entry, employment relations, and procedures for contract enforcement in the courts. Table 1 - Indicators on Business Regulations and their Enforcement South Argentina Brazil Mexico Thailand Poland Africa Starting a Business - Days to start a business 68 152 51 42 31 38 - Cost to start a business (% of 8 11.6 18.8 7.3 20.3 8.9 income per capita) Hiring and Firing Workers4 - Flexibility ofHiring Index* 71 78 81 78 33 42 - Condition ofEmployment 81 89 81 73 92 36 Index* Enforcing a Contract - Days to enforce a contract 300 380 325 210 1000 207 - Cost to enforce a contract (% 8.5 2.4 10.0 29.6 11.2 16.7 ofincome per capita) - Procedural complexity 80 54 65 56 index* * Getting Credit - Legal Creditor Rights 1 1 0 3 2 3 Index** Closing a Business - Years for insolvency 2.8 10.0 2.0 2.6 1.5 2.0 - Cost ofinsolvency (% of 18 8 18 38 18 18 Estate) Source: Doing Business in 2004: Understanding Regulation * A higher number means more regulated conditions or less flexibility. ** A higher number means more complexity/ protection. 32. Across all jurisdictions, federal, provincial and municipal alike, there are many steps required to establish a business. The table above indicates that it takes at least 70 days to get basic business registrations, well above the time required in countries of similar income levels. The time estimated to obtain all necessary registrations, licenses Currently, emergency regulations affect the practice oflabor law and contract enforcement. As regards employment relations, Emergency Law 25,561, passed in January 2002, prohibited the firing ofworkers for a period of 180 day, when such firing is without justification. Should employers fire workers during that period oftime, severance payment are to be doubled in order to compensate employees (recently extended to Dec. 2004). As regards contract enforcement, Emergency Law 25,561 temporarily suspended public auctions ofimmovable property, affecting the ability of creditors to be repaid. Law 25,737 extended the effect ofthis emergency regulation until September 2003. Congress approved in November a new Law establishing a mortgage refinancing system that maintains restrictions on foreclosures. In addition, all judicial remedies that affect the normal development of defaulted businesses were also suspended in order to protect their essential corporate assets. The continued existence ofsuch emergency regulations inhibits new investment. 94 and permits in Argentina is 130-150 days, which is also substantially above the required time in other countries in the regi~n.~Also for those businesses that fail, the long and costly process ofwinding-down a firm is even more onerous (2.8 years). The institutional rigidities ofthe Argentina business environment explain, in large part, why at least one third ofeconomic activity lies outside the formal legal framework and only half the labor force is registered with the social security. Forceful simplification is in order together with a restructuring of the regulatory environment to make it market- and growth-oriented. Box 1. Achievements of Infrastructure Reform The privatization program achieved substantial fiscal savings. First, the 86 infrastructure transactions during the 1990s raised proceeds of US$12.1 billion. Second, about US$3.0 billion of public debt was transferred to the private concessionaires. Third, the federal government was able to eliminate about US$l.8 billion worth of subsidies that it had been making to public providers of infrastructure services. Fourth, the newly privatized infrastructure providers generated direct and indirect tax revenues ofUS$2.5 billion in 2001 alone - equivalent to about 1 percent of GDP. Finally, the federal government benefited from the payment of canon for some concessions - primarily in the transport sector - and received dividends on its residual shares in these companies, many of which were making losses before privatization. As a result of these reforms, consolidated public expenditures on economic services fell from about 7 percent of GDP in the late 1980s to 1.8 percent of GDP in 2001 and 1.4 percent of GDP in 2002. Over the same period, economic services’ share of total public expenditure fell from 25 percent to around 5 percent, which created the necessary fiscal space for the share of public expenditure allocated to social objectives to rise from around 50 percent in the 1980s to over 60 percent in the 1990s. In the 2003 budget, public expenditure on infrastructure services stood at just ofUS$3 billion, ofwhich two-thirds is allocated to the transport sector for the construction and maintenance ofroads, and about half is executed at the provincial level ofgovernment. Beyond these fiscal achievements, the Argentine reforms have enhanced the efficiency, coverage, and quality of service in the infrastructure sectors. One study finds that the Argentine privatization program created efficiency gains whose present value is estimated at 1 percent of GDP. Other studies find total factor productivity gains in different infrastructure sectors to range between 2 and 4 percent. Labor productivity gains were 250 percent on average in a sample ofthe largest private operators. Much of the gains came major cutbacks in the workforce, which fell to 25 percent of pre-privatization levels. Large gains also occurred in the provinces. For example, with private participation in water services, labor productivity almost doubled in both Corrientes and Santa Fe. The reforms have brought indirect benefits such as increased competitiveness in several industries due in part to lower logistic costs (e.g. the agribusiness industry). There have also been substantial improvements in coverage and quality of service. In the telecom sector, the average waiting time for a new line fell from nearly 8 months to barely 3 days between 1994 and 1999, while its cost fell from US$1,500 to US$200. Moreover, the digitalization rate ofthe network rose from 13 percent to 100 percent, and the number of faults per 100 lines per year fell from 42 to 17 during the 1990s. In the City of Buenos Aires, electricity outages have dropped by over 65 percent, while the percentage ofcustomers with inadequate water pressure has fallen from 85 percent to 56 percent. The times in other countries in the region for all registrations, licenses and permits are: Chile (12), Bolivia (15-30), Brazil (3 1-60), Colombia (40-70), Ecuador (60-75), Uruguay (75-go), Mexico (42-142), Argentina (130-150), Guatemala (179), Venezuela (170-310). Source: ESW Small and Medium Enterprises (Report NO.22803-AR, August 2002. 95 33. Shortcomings in the judicial system are another significant impediment to business in Argentina. A lack ofefficient and transparent legal mechanisms makes it difficult to enforce contracts and increases both the cost and the time needed to resolve commercial conflicts in court. This is a complex institutional issue which will take time to resolve. Nevertheless, it is important to begin the process and, to the extent possible, foster other mechanisms such as arbitration for the settlement ofprivate and corporate disputes. Maintaining and developing infrastructure assets for growth 34. The economic crisis has had a seriously damaging effect upon the condition of infrastructure and services in Argentina which, if not repaired, may halt or even reverse the substantial progress made in the recent past, and is threatening to become a hindrance to growth. Privatization in the 1990s led to major infrastructure investments which increased both the quality and the coverage ofservices in transport, energy, telecommunications and water supply (see Box 1). Much ofthe investment was financed by the private sector within the framework ofconcession contracts. However, at present, the level ofpublic and private investment in infrastructure is at an all time low. Moreover, the financing ofimportant infrastructure facilities which still remain in public hands is no longer predictable or reliable as a result ofthe economic crisis. The needs in Argentina for infrastructure investment are significant in terms ofcoverage and amounts, and will require an increase in the amount and quality ofinvestment by public and private sectors. Private sector investments will only resume after a successful resolution ofthe renegotiation ofconcessions, whereby a stable, predictable and transparent framework is re-established for investors and creditors-foreign and local. Moreover, there has been a criticism ofthe concessions (see Box 2) which includes aspects that will need to be resolved in the restructuring ofthe concessions. 35. Over and beyond the renegotiation ofinfrastructure concessions, there are other structural issues that need to be addressed so that the development potential of infrastructure may be fully mobilized in the medium-term. 0 Further measures are needed to ensure greater consistency in the performance of regulatory agencies which currently varies widely from sector to sector. 0 A proliferation ofextra-budgetary financing mechanisms for infrastructure needs to be consolidated and rationalized in the interests oftransparency. Only then will it be possible to secure dependable financing for national and provincial non- concessioned infrastructure. 0 There is a need to control burgeoning sector subsidies that are financed with fiduciary funds for railways, inter-urban roads and urban transport. They distort efficiency and impose an undue burden on the public finances. 96 Box 2. Critiques of the reform Notwithstanding substantial achievements, public discontent with the infrastructure reform process has grown throughout the 1990s. Indeed, a regular poll conducted by Latinobarometro found that in the year 2000, 78 percent of Argentines disagreed with the statement that “privatization of state companies has been beneficial to the country”, up from 50 percent in 1998. One of the principal critiques of the Argentine infrastructure reform relates to the equity with which the efficiency gains resulting from privatization have been shared between consumers, investors, and the government (Estache, 2003). This can ultimately be attributed to weaknesses in the regulatory system and concession design, which often failed to translate cost reductions into tariff reductions. In addition, the popular perception is that regulators repeatedly gave in to renegotiation pressures from the private sector. , Furthermore, the growing tax burden on the infrastructure sectors has sometimes prevented consumers from perceiving real reductions in the underlying tariffs. The weakness of regulatory institutions varies by sector. In electricity and gas, where there are independent regulators, the experience has been good. In the transport sector, where there are no independent regulators, most contracts were renegotiated. A recent study finds that 42 percent ofinfrastructure contracts in Argentina were renegotiated within a two-year period, outside of the normal mechanisms established in the contract. This compares with a rate of 28 percent for Latin America as a whole. Renegotiation rates ranged from 80 percent for water and transport, to 0 percent rate for energy and telecom. This variation is entirely consistent with experience elsewhere in Latin America, except that the renegotiation rate for the transport sector is substantially higher in Argentina than elsewhere in the region. Many ofthe past renegotiations have primarily taken the form ofreductions in canon payments, reductions in tolls or tariffs, and increases in subsidy. A common complaint among Argentine consumers is that prices of services are high by international standards, and that, in their view, this is attributable to excessive profits by the private sector, as well as indexation to the US CPI, which investors demanded because indexation of contracts to domestic inflation indices was illegal. The US CPI grew by over 15 percent between 1995 and 2001 - a period when domestic inflation in Argentina was close to zero. Although regulators mandated tariff reductions for many sectors, on average these have been significantly lower than the corresponding gains in total factor productivity. Nonetheless, many of Argentina’s tariffs are low by international comparisons. Before devaluation, gas tariffs were among the lowest in the region, electricity and water tariffs were towards the middle ofthe range observed around the region, and telephone tariffs were among the highest. Nowadays, with tariffs fixed in pesos and at an exchange rate of three to the dollar, Argentina’s utility tariffs are among the lowest in Latin America. Argentina is an outlier in the indirect tax rates levied on utility bills. These typically amount to about 28 percent ofresidential bills for water and energy. Owing to wide variations in provincial and municipal taxes, they can be as high as 50 percent in some jurisdictions. Based on comparisons with 20 OECD countries, Argentina has the highest indirect tax rates ofall in the water sector, and is in the top five indirect tax rates for the energy sector. These high indirect tax rates go some way towards explaining consumer perceptions of high utility prices. 36. There is a need for reforming the policy and regulatory framework in the tvansport area to reduce transport constraints and logistic costs to facilitate economic growth. Important steps would be to: (i)create by law a single Transport Sector Regulatory Agency with jurisdiction over all transport sub sectors; (ii)prioritize network and multi-modal services and operators; (iii)approve new generation of inter-urban road concessions based on networks rather than isolated links; and (iv) ensure that rehabilitation, operation and maintenance of existing infrastructure is granted via incentive concession contracts. 97 Annex G. The Proposed Operations Program 1. The Bank has recently conducted substantial analytical work in areas which are deemed crucial for dealing with the crisis in its economic growth, social inclusion and govemance dimensions. The Policy Notes presented to the new administration provide the basic conclusions and recommendations arising from the knowledge accumulated by the Bank Team through its on going portfolio dialogue and via specific analytical work - Le., Health Sector Strategy, Public Expenditure Review, Financial Sector Strategy, Transport Infrastructure, Poverty Update and Public Service and Infrastructure Concessions. 2. In addition, we plan to undertake a significant number of analytical and advisory activities which would fill existing knowledge gaps, prepare the Bank in case ofa higher case scenario, and ensure the Bank fulfills its core fiduciary and corporate responsibilities. The proposed AAA in the areas ofgovemance (Institutional & Governance Review), social policies (Social Security, Skills BuildingILabor Markets, HD Strategy), environmental and social inclusion (Environmental Strategy, Rural Sector Strategy, Agricultural Finance and Growth, and Social Inclusion) and infrastructure (Provincial Finances, Transport Sector Strategy and Rural Infrastructure) are geared to underpin our sector dialogue. Secondly, the FSAP, Investment Climate, Sources of Growth, Competitiveness and Public Expenditure Review, and Poverty Update are geared to support the dialogue on macroeconomic and overall economic growth and poverty alleviation issues and to prepare the basis for the undertaking by the new administration of structural reforms that would move the assistance strategy to a high case scenario. Thirdly, the balance ofidentified studies are aimed to meet bank core fiduciary and corporate needs, i.e. the proposed CFAAKPAR. 3. The completed and planned analytical work presents the basis for our sector dialogue and the strategic orientations for our lending operations outlined below. Economic Recovery 4. The foremost task of Argentina today is to consolidate the incipient economic recovery and to set the country on a path to long-term growth with equity. That can only be accomplished by improving the investment climate and by enhancing competitiveness. The aim should be to increase efficiency and reduce costs by fostering innovation, technological progress and quality control. The Bank will support policies to improve competitiveness in the context ofan Economic recovery Structural Adjustment Loan that is presented for Board consideration together with this Country Assistance Strategy. Rural Development and Environment 5. Rural development is especially important for poverty reduction in Argentina as the deepest pockets of poverty are found in rural areas, particularly in the northern regions. The average income in some rural areas is only ten percent ofthe level in urban 98 areas and upwards of 70 percent ofthe population is below the poverty line. Poverty amongst indigenous groups without title to land is especially severe. 6. To address Argentina’s range ofrural development issues, a two-pronged approach is proposed in support ofboth growth and poverty alleviation. First, in support ofgrowth, a range ofnew Bank-financed projects will address the planning and financing ofprovincial and rural infrastructure, especially in the areas ofroads (Provincial Roads), flooding (Flood and Drainage), and water resource and irrigation management (Integrated Water Resources Management). Recently completed sector work (FY04) has drawn from over 100 local workshops to identify priorities in accordance with local needs. In addition, serious animal and plant health problems will be addressed: it is estimated that these problems cost Argentina US$500 million per year in lost exports. Improved product surveillance, farm practices, and access to biotechnologies will be key to that endeavor and those issues will be addressed in both ESW and in the proposed Rural Poverty Project. 7. Second, poverty alleviation will be targeted primarily through the Rural Poverty Project. This project will include CDD-type provision ofservices and finance to small- scale producers and indigenous communities in the northern regions, with a strategic and geographic focus similar to the successful approaches taken in North-east Brazil and southern Mexico. The strategy will also support reforms in local agricultural extension services, programs to improve local management ofnatural resources and the resolution of long-standing land registration problems that burden poor and indigenous peoples. In addition, other social service-oriented projects, such as in education (Secondary Education) and health (Maternal and Child-Health APL) will also maintain a poverty focus in the poorer northern provinces. 8. The environmental agenda is closely related to the rural development strategy, particularly when it comes to sustainable resource management, and to conservation efforts in water, soil, forests, fisheries, and biodiversity. Ineffective river basin and irrigation management in the past has led to excessive downstream flooding, soil degradation and groundwater depletion, as well as a deterioration in the quality ofwater. The water resource management project noted above will address those environmental problems. To strengthen natural resources management by small farmers, “blended” GEF financing will be introduced into ongoing small-farmer and indigenous communities projects (see the box on global environmental financing, below). Another area of concern is forestry where commercial production is fast developing. Government regulatory guidance and oversight over a growing forestry industry will be essential. Government protection ofnative forests is also important, because many ofthem are being degraded by agricultural clearing, unsustainable extraction ofwood for timber, and livestock grazing. An ongoing and a future forestry investment operation (Sustainable Forestry Management Project) address those issues. Lastly, a number of ongoing and possible future GEF operations will address issues ofbiodiversity, the conservation of fishery resources, and renewable energy and energy efficiency. 99 The Global FinancinP of Environment Investments in Areentina In Argentina, the Bank currently supports efforts financed through global concessionary financing, including Bank-managed projects in the areas of: Coastal and marine preservation in Patagonia; Improved ecosystem management by indigenous communities; Support to agricultural strategies to combat land degradation and desertification among small farmers; Support to Argentina's analysis of its climate change risk, adaptation strategy, mitigation strategy, capacity, and public awareness; Renewable energy and energy efficiency in rural areas, particularly solar energy in schools, health centers and off-grid communities; Improved regional management ofthe Guarani aquifer, the largest aquifer in LatinAmerica; Biodiversity conservation in national parks; Guidance on improving biodiversity information and education. Building on this active base, the strategy for the next CAS period is to deepen the Bank's contribution in two key ways. First, with an expanded investment pipeline, the potential for GEF- financed "blended" projects is strong, particularly in the areas of: (a) biodiversity, sustainable land management, and possibly biosafety associated with the rapid adoption of GMO seed stock (through forestry and agricultural lending); (b) climate change (primarily through lending for urban solid waste management, transport, land use planning, renewable energy and energy efficiency); (c) intemational waters (through improved watershed management, particularly in the Rio Plata basin); and (d) chemicals management (by addressing the new priority area ofPOPS). Argentina is very active in international forum on global environmental issues, and is becoming a strong partner with the Bank in these areas. Nevertheless, selectivity will applied, primarily in terms of institutional capacity to implement, availability of financing, suitable policy environment, and links to the evolving IBRD program in Argentina. In parallel with these activities, strengthened collaboration with NGOs, the private sector, and vulnerable groups (such as indigenous communities) will be sought through strategic use of stand-alone medium-size grants ofup to US$l million. 9. A second focus ofthe environmental agenda relates to the management of pollution that is associated with urban growth and industrialization. Critical issues of pollution management include: (i)the disposal ofmunicipal solid waste, which has reached near-crisis proportions in some city areas; (ii)a deterioration ofwater quality due to poor urban sanitation and to a number of industrial "hot-spots" which have insufficient pollution control; and (iii)a deterioration ofair quality in large cities, combined with a lack ofmonitoring or regulation. To help address these problems, a municipal Solid Waste Management Project is proposed that will incorporate concessionary carbon financing to capture methane fi-om landfills. Concerning other water and air pollution issues, the Bank is already actively supporting a number ofpublic-private partnerships related to cleaner technology, air pollution monitoring, and sewage treatment. While the performance of Argentina with respect to environmental management is characterized by sound policies -- including recent "framework" legislation designed to simplify previous laws - implementation is weak. The Bank will continue to assist the Government in dealing with regulatory issues through its sector work and technical assistance. 100 Infrastructure 10. Infrastructure bottlenecks are serious and may hamper growth. There is almost no investment in energy generation, and the concessions for transmission and distribution of gas and electricity are under stress due to the tariff freeze and await progress with the renegotiation. The deterioration ofnational, provincial and municipal road networks due to lack ofmaintenance and investment is increasing; Argentina has one ofthe region’s highest logistic costs (27 cents of every dollar exported compared to 7 cents in the OECD) reducing competitiveness of regional economies. The poor’s access to urban transport systems is limited and pollution is increasing. There has been no significant investment in railways in the last 5 years and concessions need to be revamped and regulatory capacity established. There is limited access to safe water and sewage, particularly among the poor. The demand for flood management infrastructure (28 percent ofthe poor live in flood prone areas) is substantial and the recurrence offloods is increasing. Finally, there is an enormous housing stock deficit increasing at more than 60,000 units per year for the poor. 11. Infrastructure investments will be of crucial importance if Argentina is to achieve its objectives ofgrowth and poverty reduction. The economic crisis has had a seriously damaging effect upon the provision ofinfrastructure and public services in Argentina which, if not repaired, may halt or even reverse the substantial progress made in the recent past. Private sector investment in infrastructure under existing concessions has come to a standstill and the problem is compounded by the under-funding and poor management ofinfrastructure that still remains in public hands. In comparative terms Argentina still remains a poor performer among middle-income countries in terms ofthe low proportion ofpopulation having access to safe water and sanitation in particular. 12. Two key factors have combined to undermine the performance ofpublic service and infrastructure concessions. First, during the prolonged recession before the crisis, demand was depressed and few investments were being made after 2000. Thereafter, the disorderly devaluation undermined the financial integrity ofinfrastructure concessions with a reduction in the revenue and asset base. Second, many public service providers were subject to a govemment-mandated freeze in prices and, in addition, they had to contend with increasing arrears and a loss ofreal income ofmost clients, as the economy collapsed. Public service concessions have received little relief from the Government to help them cope with the situation. Only the passenger railways and inter-urban transport have received subsidies financed through fiduciary funds. 13. Coming after several years ofrecession, the dramatic fall in operators’ income has paralyzed investment and reduced service expansion to a minimum. Basic maintenance has also been cut-back and that is particularly worrisome because it can lead to costly rehabilitation at a later date. The cost tomorrow of dealing with deferred maintenance will greatly exceed the increase in tariffs needed for timely maintenance today. There is a clear danger that, if infrastructure operators are driven to bankruptcy, the function of service provider will once again fall upon the Government which is not financially able to discharge that responsibility. 101 14. A commission to renegotiate concession contracts was established in 2002 but progress has been slow and uneven. To assist with the renegotiation ofconcessions the Bank proposes to furnish technical advise and follow-up. AAA support would also be provided to address regulatory reforms and to devise an appropriate strategy for public- private partnerships in the post-crisis context (see Annex F on Private Sector Development). 15. In the transport sector, the Government has requested support in restructuring road and railroad concessions, and assistance in strengthening the institutional capacity of the National Roads Directorate. A National Highway Management Project would include technical assistance for that purpose and which would extend an output-based public-private maintenance contracting system to the entire non-concessioned road network. This project would review the fiduciary fund mechanism to address the reliability ofmaintenance financing. 16. At the provincial level a key challenge will be to protect assets and to foster significant and sustainable levels of infrastructure investment within the limits of fiscal realities. The Province ofBuenos Aires requested Bank support for a Buenos Aires Province Integrated Infrastructure Project. The proposed project would provide for the maintenance and improvement of important provincial roads as well as investments in sewage and flood prevention. The Government has also requested a second Provincial Roads Project which will strengthen the capacity ofprovincial governments to manage both provincial and municipal roads. In doing so, it will draw upon policy recommendations from Transport Sector and Rural Infrastructure sector work. 17. Water supply and sanitation will also figure in the proposed operational program. In the context ofa Water Sector Reform Loan (APLl) and a proposed APLZ, the Bank will continue working with private public partnerships for water supply to smaller communities. It will also seek ways to facilitate access by the poor to water supply and sanitation services. 18. The broader issues ofwater resource management, flood management and urban drainage, will continue to require attention because flooding continues to exact a heavy toll. In addition to on-going operations in flood management and prevention, the program includes a Flood Management and Urban Drainage Project which will focus on strategic planning at the provincial level, infrastructure investments in flood management, urban drainage, slum upgrading and self-help housing. Under this project, there would be an expansion of ongoing successful programs for the construction of low- cost, self-help housing in flood prone areas generally inhabited by the poor. 19. Also at the sub-national level, a Buenos Aires City Integrated Infrastructure Project would finance improvements in mass transit for the poor, as well as infrastructure for flood management. The project will build on experience gained from an on-going Urban Transport project with respect to community consultation. It would also draw upon a master plan for flood management that was developed in the flood management project. 102 20. With respect to municipal services, the Bank and IDB have already helped with institutional improvements and investments -- in the case ofthe Bank in 500 selected smaller municipalities. Building on that work, and on recent ESW on Municipal Services and Finance, the Bank will support a Municipal Sewices and Finance Project which would improve the disposal ofmunicipal sewage, urban drainage, slum-upgrading, and urban services for the poor through municipalities. Human Development 2 1. Education has proven to be a key determinant ofpoverty and risk in Argentina as in many other countries. While the quality ofprimary education gives cause for some concern, especially in remote rural areas, it is at the secondary level that repetition and dropout rates are very high. On average, fifty percent of students entering secondary school actually complete it. Ofthe poorest quintile, only one out offour children complete their studies and thereby receive the necessary certificate for acceptance to institutions ofhigher education. Public financial support for private schools and for universities disfavor the poor and there is little use ofincentive-based financing to improve outcomes. Management and administration reforms, including policies for the development ofhuman resources, are needed at the provincial level to improve efficiency and effectiveness. Management and financing reforms are also needed at the university level where only one out ofevery five entrants actually graduates. 22. The new Government is structuring its education strategy around compensatory financing schemes which would reduce inequalities in the education system. Compensatory policies in the areas .of school materials, nutritional supplies and scholarships, would be accompanied by an in-depth and continuous evaluation of education quality through the application ofnational and international tests. Particular attention would be paid to teacher training. As yet, however, incentive-based financing is not part ofthe strategy except in the case of autonomous universities. 23. The Bank’s program ofeducation assistance in the coming years would support the central role of compensatory financing arrangements. A proposed Secondary Education Project would assist the national government and the six ofthe provincial governments to improve the efficiency, quality and equity ofsecondary education, especially in poorer rural areas. The aim is to target high-risk schools in those jurisdictions and address their problems in a comprehensive manner. A follow-on Higher Education Project would (a) address inequities and regional disparities ofaccess to post- secondary leaming; (b) encourage efficiency by establishing a direct link between performance and the allocation ofresources; and (c) enhance the linkages between tertiary education, the labor market and Argentina’s national innovation system. 24. The proposed program in education would also respond to the need ofthe unemployed and the poor for training. First, together with the Ministries ofEducation and Labor, the Bank is investigating the nexus between Argentina’s education system and the labor market. A Skills Building Analysis will examine whether formal schooling and 103 training systems (i)enable graduates to find good and stable employment; and (ii)enable firms to satisfy their recruitment requirements with regards to both quantity and quality. A subsequent investment project, the Lifelong Learning Project, would aim to increase lifelong education and training opportunities for adults, especially for the unemployed and the poor. It would also upgrade the skill levels ofthe workforce. 25. Related to the needs ofthe unemployed, a Social Inclusion study will analyze the needs ofArgentina’s most vulnerable populations, especially youth between the ages of 16 and 25, ofwhom over 2 million are neither working nor in school. Options for reducing this large number ofpotentially “lost” youth will be folded into the Lifelong Learning project, as well as into other social service delivery activities. Options to assist other vulnerable groups, such as the elderly through pension reform and indigenous peoples through targeted service delivery, will also be considered and mainstreamed to the extent possible in the overall lending program 26. Health is another area where efforts are being made to improve services to the public. The new Government has started to implement a comprehensive, well-designed and poverty-focused health strategy that fundamentally differs from earlier reform efforts. Building on a number ofdiagnostic studies, among them a Bank Health Sector Report ofFY03, the new strategy would address major shortcomings in the health sector. Amongst those shortcomings, the following are particularly important: (i)more than half ofthe population is without health insurance coverage; (ii)most of the uninsured are poor and they must rely on the provincial public health services which are biased towards the provision oftertiary care; (iii)there is a lack ofnation-wide, incentive-based financing instruments to reduce regional inequalities and to make health services more accessible to the poor; (iv) the health system is fragmented and the regulatory framework is weak; (v) the national government does not exercise sufficient leadership in key areas ofpublic health such as surveillance and prevention; and (vi) the cost oftreating injuries and non- communicable diseases is becoming increasingly burdensome. 27. The new 15-year strategy centers around the establishment ofhealth regions comprising several provinces each. It introduces an incentive-based, results-orientated financing system at both the national and provincial level based on the health needs of each region. The aim is to shift public health expenditures more towards primary care including a basic health package delivered through maternal-child health insurance that will benefit the currently uninsured poor. The strategy also aims to strengthen the coordination between the national government and provinces by revitalizing the National- Provincial Health Council and by fostering the leadership role ofthe national Ministry of Health. The fight against HIV/AIDS is given a prominent role both through prevention and education as well as through the provision ofdrugs for those who are already infected. 28. The Bank’s proposed health support program is closely aligned with the new Government’s strategy. The building blocks ofthe strategy, especially the creation of maternal-child health insurance for the uninsured poor, is already being supported through a recently approved Maternal-Child Health Sectoral Adjustment Loan (FY04). 104 That loan will be complemented by two Maternal-Child Health Investment Loans (designed as adjustable program lending) which would provide technical assistance to both national and provincial governments as they seek to implement an incentive-based transfer system. In addition, the Bank will work closely with Government to identify how it can address possible additional financing requirements for the fight against HIV/AIDS. Lastly, over the next two years, the Bank will support core public health functions ofthe National Ministry ofHealth, as well as its emerging stewardship role, through two ongoing operations. Potential additional assistance in this area will be considered at the time ofthe mid-term CAS review. 29. Social protection has received a great deal of attention recently because the economic crisis created additional needs for emergency assistance. Now that the crisis has receded, the new administration is actively reassessing and redesigning its strategy and it has adopted a three-pillar approach. First, a more closely knit safety net would be established for the poor. The Government is considering to integrate the various existing income transfer programs (including the Heads ofHouseholds project) into a single coordinated and well-targeted conditional cash-transfer scheme. A second pillar ofthe program would focus on supporting local economic development by providing incentives and financing for productive employment. That would be complemented by technical capacity building to make job creation more sustainable. Lastly, the Government plans to review existing nutritional programs including communal soup kitchens and school lunches, with a view to integrating them into a broader strategy for nutritional education and monitoring. 30. The Bank agrees with the Government on the need to design an exit strategy from emergency workfare programs. The Heads ofHouseholds program now serves 1.8 million beneficiaries, 90 percent ofwhich are poor. It has significantly mitigated the social impact ofthe recent economic crisis. However, it failed to reduce unemployment as much as expected because many participants in the program were not part ofthe labor force to begin with. A proposed Social Protection Project would assist the Government replace it with a broader program aimed at improving the efficiency and effectiveness of social assistance and fostering new employment opportunities for the unemployed. In that endeavor, close coordination with the Inter-American Development Bank would be essential because the IDB also is supporting a conditional transfer program in Argentina. The project design would draw upon the findings ofthe Skills Building Analysis (referenced above) which will examine (i)who are the unemployed today; (ii)what is their educational background; and (iii)what possibilities exist for integrating today’s unemployed into the labor market through training or incentive policies. Finally, a Social Security Study will focus especially on the elderly poor who are without pensions or other forms ofincome support and who must be included in the new safety net. The Bank would also respond to a request by Government to learn from the experience ofother countries such as Chile, Colombia, and Brazil that have undertaken social assistance reforms. 105 Govern an ce 3 1. Governance is an area of special significance at the present time in Argentina. It is also an area where the Government has clearly indicated its intention to take decisive action on a number offronts. The proposed base case lending program makes provision for investments operations in support ofjudicial reform, the registration ofproperty rights and anti-corruption. It is anticipated that analytic work on decentralization and public expenditure management would also advance the policy dialogue on matters of governance. That work may also lead to additional investment or adjustment operations if the dialogue progresses as envisaged. 32. The proposed lending on governance includes the Federal Courts and Judicial Reform Project to support: (i)reform among members ofjudiciary, civil society, and professional groups; (ii)improve judicial management, (iii)construction ofjudicial archives and improvement of archiving systems, and (iv) development of “casas de justicia” to provide multi-door services to poor clients. It will also include the Property Rights and Business Registry Modernization Project which would fund: (i)studies for the modernization ofthe national and provincial legal and institutional frameworks; (ii)the strengthening offederal and provincial entities in charged ofproperty rights and business registries; (iii)the improvement ofregistry information; and (iv) and the design and implementation ofmechanisms to use property rights and business information for taxation purposes. 33. The Third Provincial Development Project would promote provincial economic development consistent with overall pubic sector reform goals ofefficiency, effectiveness, and transparency at provincial level. It would aim at (i)modernization of public sector management and service delivery; (ii)physical investments; (iii)resource management improvements; and (iv) provincial judicial administration, including policy making, service delivery, responsiveness to clients, and access to the poor. 34. The Anti-Corruption (AC) State Modernization Project will complete major reform initiatives at federal level to support transparency, efficiency, and effectiveness. Possible components include: (i)modernization oforganization and improvement of performance of service delivery agencies, through activities for the administrative simplification ofprocedures, e-government, procurement and training in federal and provincial agencies; and (ii)anti-corruption with federal AC Office as main counterpart, build network of anti-corruption offices and officers across federal bureaucracy and at provincial level. 106 Annex H. Comments from the Government of Argentina on the CAS 107 108 109 Buenos Aires, December 2,2003 Dear Mr. President: By means ofthe present letter Ihave the pleasure ofexpressing our agreement with the general outline ofthe Country Assistance Strategy for the next four years prepared by the World Bank, as well as with the agreements for monitoring its implementation. The document “Country Assistance Strategy” makes an analysis ofArgentina’s recent past, the progress made by the present Administration and the country’s possible future. In this regard, and in conjunction with our consent to the dissemination ofthe CAS, we would like to present some ofthe Government’s positions which differ from the Bank’s views. The Bank seems to consider that there are certain problems which constitute prerequisites to entering into a process of sustainable growth with equity. The Government understands that these problems, though important, are not prerequisites for this growth with equity, nonetheless, it has addressed them with the promptness, speediness and opportunity they deserve. Let me refer to each ofthem: 0 The Government has taken significant and important steps in order to renegotiate in an orderly and comprehensive manner the public services and infrastructure concessions. For that purpose, it has established a transparent and appropriate regulatory framework. Progress is being made continually in order to establish new conditions for these concessions before the end of2004. In some cases, some concessions have been re-tendered to the private sector, in some others the contract has been rescinded due to visible non-compliance and in some others negotiations are proceeding in due course. 0 The process ofrestructuring ofthe financial sector has been clearly delineated in the agreement with the International Monetary Fund and is being carried out in adequate time and form. There has already been significant progress in the normalization of the financial sector and it is envisaged it will be strengthened with activities by non-bank financial intermediaries. 0 The “defaulted” portion ofArgentina’s public debt (approximately half ofthe total debt) is in an active process ofrestructuring. It is widely known that the Government is making its best efforts and permanently moving forward in order to attain a solution that is in line with the country’s possibilities and the agreements reached with respect to multilateral financial institutions. 0 Private sector is rapidly renegotiating its external debt and in practice, the larger part ofit has already been restructured, is in the process ofbeing restructured or is being serviced promptly. 110 Iwould also like to share our vision on the collapse ofthe convertibility scheme that pegged the peso to the dollar. In particular after the Russian crisis ofAugust 1998, Argentina plunged into a prolonged recession intensified by an increasing debt and an overvalued rate of exchange ofthe peso vis-a-vis the dollar. Extemal factors, more specifically the sudden stop of capital flows to emerging markets triggered the contraction ofthe economy, deepened the overvaluation ofthe money and made more arduous the servicing ofthe debt. Ofcourse, the rigidity ofthe convertibility scheme made the country more vulnerable to strong capital flows. Some intemal structural factors, such as the mismatch in the denomination of financial assets and liabilities or the lack offiscal discipline, contributed to amplify the effects ofthe external “shocks”. Various economic authorities tried to restore growth, underestimating the increasing weight ofthe debt as part ofthe trap in which the economy had fallen. After several attempts, the growing uncertainty regarding the sustainability ofthe debt and ofthe exchange rate led to a vicious circle that ultimately collapsed. As regards to debt sustainability, this will be govemed by the evolution ofthe primary fiscal outcome, by the potential rate of growth and by the path ofthe real exchange rate. Debt sustainability will require a certain consistent evolution ofthese variables, and it is not subject to any sort of combination. Sustainability requires among other things, basically not retuming to the relative prices ofthe convertibility period. There is no doubt that the relative prices of the convertibility were not sustainable. Therefore, we should not undertake debt projections exercises which lead to real appreciation at levels similar to those ofthe convertibility period. Thus, we understand that the guidelines for debt restructuring that are presented in the CAS as part ofa sustainable solution. Lastly, Iwould like to express my appreciation to the Bank teams who, working together with our teams, made possible the strategic guidelines outlined in this document. Sincerely, Roberto Lavagna Ministry ofEconomy and Production 111