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Introduction
1. This 1996 Country Assistance Review examines the Bank's assistance strategy in Argentina from 1985 to 1995. It concentrates on issues relevant to the Bank's current decision making. The starting point is the mid- 1980s, which coincides with an intensification of the Bank's involvement in Argentina. The report distinguishes three sub-periods having a bearing on the Bank's strategy: (a) the years 1985-89, during which the Bank's involvement took place in an environment of extreme financial instability in the country; (b) the years 1990-94, during which reforms intensified and economic recovery was impressive; and (c) the current period, when sustainability of the recovery is the issue.,
2. The Bank formally reviewed its country assistance strategy for Argentina approximately every two years since 1985, when an increased lending program was adopted. The Bank strategy was articulated in six major documents. They are a Country Program Paper (CPP) in 1985, a Divisional Country Brief (DCB) in 1987, two Country Strategy Papers (CSP) in 1990 and 1992, and two Country Assistance Strategies (CAS) in 1994 and 1995. The story of the evolving relationship yields several salient lessons about the dynamics of managing the Bank's assistance strategy in a country whose political dynamics and economic policies have changed markedly and swiftly. In the following sections, we summarize: (i) the main developmental constraints and changes in economic policies as they transpired in Argentina in 1985-95; (ii) the Bank assistance strategy during the period; (iii) an evaluation of that assistance; and (iv) the recommendations derived from the analysis.
(i) Developmental Constraints in Argentina: 1985 to 1995
1985 to 1989: The Government Fails to Muster the Political Will to Overcome Its Developmental Constraints
3. Taking advantage of the enormous potential for growth of the country's abundant resources remained an elusive goal in Argentina for many decades. By 1985, the country was suffering from the legacy of extensive government intervention in the economy--declining productivity, rising inflation, and, in turn, a dearth of both private capital and external assistance. At the heart of Argentina's languishing economy was long declining productivity, reflected in a growing reliance on import substitution, government control over relative prices, a bloated public enterprise sector, and inefficient sectoral resource allocation, culminating in macroeconomic instability, excessive fiscal deficit, and heavy external debt.
4. To redress its poor economic performance, the Government of President Alfonsin launched the Plan Austral in June 1985, the first of three major economic reform plans attempted by his administration during the late 1980s (box 1.3). The Plan sought to improve public finances-primarily with measures to increase fiscal revenue and reduce overall expenditures and to contain spiraling inflation-primarily with an unorthodox program of foreign exchange controls and wage and price freezes. But what proved to be the downfall of the Plan Austral, and of the two stabilization programs that followed it, was the failing of measures to rein in the public sector deficit, particularly that generated by public enterprises, the social security system and the provincial governments. Failure to control the fiscal deficit ultimately led to the country's worst episode of hyperinflation in 1989.
1990 to 1995.- A New Government Ushers in Promising Sustainable Reform
5. By mid-1989, the trauma of extended recession and hyperinflation had eroded confidence in the Alfonsin Government and had created a fertile ground for reform. The country needed to face three urgent problems as a precondition for in-depth economic transformation: One was the pervasive fiscal disequilibrium caused by the deficits of the Federal Government, the public enterprises, the province-level governments, and the social security system. Another pressing deficiency was a strained financial system, reflected in a large proportion of insolvent banks and a poor regulatory system, problems that became critical in 1989. The third structural deficiency came from an ailing social service system-educational, health, and social assistance services. The neglect of basic health services and inadequate social assistance had increased already high rates of infant mortality and malnutrition among the general population.
6. As the new government of President Menem assumed office in mid-1989, it announced a new economic program, with the enactment of the Law of the Reform of the State in July and the Law of Economic Emergency in September, 1989. The Government's reform agenda included comprehensive privatization, inflation-reduction measures and fiscal reform-all of which were packaged later as the Government's Convertibility Plan, in April 1991 (box 1.5). After a period of economic turmoil during the first year of the new administration, the Plan finally boosted confidence in the economy and attracted an influx of private capital. In turn, the stronger economic climate enabled Argentina to reach agreement with commercial banks to settle arrears and reduce debt service to fiscally sustainable levels. By the end of 1993, the reform program had brought Argentina growth and price stability that it had not witnessed in decades. Growth averaged 8 percent in real ten-ns in 1991-93. Inflation decelerated from 200 percent monthly as of July 1989 to 7.5 percent annually by 1993. Yet much of the Plan's success was predicated on the privatization initiative and monetary policy. Other deficiencies-province-level financing, the social security system, social services and financial sector weaknesses-still remained.
7. Two other concerns surfaced. First, the privatization process was being implemented in the absence of an adequate regulatory framework for governing monopolistic behavior by enterprises, an issue that is still on Argentina's agenda. Second, despite the success of the Convertibility Plan at halting inflation, its adoption in 1991 increased Argentina's vulnerability to a sudden reversal of capital flows, since wage and price inflexibilities under the fixed exchange rate regime would exacerbate the recession needed for adjustment. In late 1994, the financial crisis that rocked Mexico sent shock waves throughout Latin America. As a result, Argentina witnessed a reversal of the flow of capital that it had attracted earlier, but eventually succeeded in overcoming the main consequences of the crisis. Yet, the economy remains vulnerable to exogenous shocks. Today, the structural fiscal deficit-the deficit that would remain after transitory factors in fiscal revenue and expenditures are adjusted for-remains the major obstacle to ensuring sustainability of the Convertibility Plan. In addition, Argentina's long-term development depends heavily on its capacity to expand private-sector competitiveness. Several actions are now required: (i) consolidate the reforms to the financial system; (ii) address labor market inflexibilities and unemployment; (iii) improve implementation of the regulatory framework of privatized enterprises; (iv) modernize the legislative and judicial system; (v) improve social services, and (vi) improve the infrastructure for private sector development, especially transport, water and sewerage, and environmental management and protection.
(ii) Overview of Bank Assistance
8. The 1985-89 Period, The Bank approved a high lending program in June 1985. This program represented a fourfold increase, from an average US$160 million a year in FY80-84 to an average of US$640 million a year in FY85-89. The 1985 CPP argued for a large increase in lending and ESW to "support the process of opening the economy and attracting private investment." Lending was made contingent on compliance with the macroeconomic targets of a stabilization program, the Plan Austral, which had just been adopted by the government. The 1987 DCB endorsed continuation of the high level of support, based on the inaccurate assessment that the reforms attempted had "partially" succeeded. Lending focused on export diversification, financial reform, energy development, industry development, and fiscal deficit reduction. Again, lending was made contingent on successful stabilization, this time based on a new stabilization plan, the Plan Australito (February 1987). Unsuccessful stabilization again led the Bank to review its assistance program, this time on the basis of a new plan, the Plan Primavera (August 1988). This plan was controversial because some internal Bank reviewers warned that the plan did not close the external or domestic accounts, and the IMF decided that it would not endorse the plan because the Government was not making a sufficient fiscal effort. The Bank support to the Primavera plan led to a strained relationship with the IMF (Box 1.4). In the end, the concerns of some Bank reviewers and the IMF were bome out. The Plan Primavera was insufficient to bring about macroeconomic stability, and in fact its failure led to a severe hyperinflation crisis in early 1989. As a consequence, the Government of President Alfonsin was forced to leave office before the end of its term in July 1989, the Bank reduced its lending program in Argentina but continued, or intensified, its policy dialogue, and the respective roles of the Bank and the Fund were clarified through a concordat whereby the Fund agreed to take the lead in short-term macroeconomic programming and monitoring, while the Bank agreed to deal with the institutional underpinnings of macroeconomic policy.
9. The 1990-94 Period. By 1990, a major turnaround in macroeconomic management occurred after the new, democratically elected Government of President Menem took charge. Learning from past experience, the Bank initially adopted a cautious lending strategy, opting for prudence in lending until proof of success in macroeconomic management was visible. As a consequence, the Bank did not approve any new loans between October 1988 and December 1990 1, partly because economic performance remained uneven, and the IMF stand-by, approved in November of 1989, had to be modified in November 1990. The 1990 CSP proposed to limit lending to no more than one major operation a year in FY91 and FY92. Nonetheless, the Bank participated intensively in the reform process: non-lending services (particularly informal ESW and policy dialogue) intensified and contributed to the success of the reforms. The Bank opened an office in Buenos Aires in September 1989; provided extensive economic advice at the Government's request; restructured old loans and reformulated ongoing technical assistance to finance studies; and continued to prepare loans that became essential to the success of the public sector reform, including the privatization program, the reform of the Central Bank and other reforms to the fiscal and financial sector implemented later.
10. By 1992, a new assistance strategy was adopted, this time recommending to go back into high lending levels. The Government of Argentina had demonstrated clear ownership of a highly successful reform program, including the Convertibility Plan, which was adopted in April 1991. At the same time, the 1992 CSP's risk analysis was remarkably prescient regarding the vulnerability of Argentina's economy to potential reversals of capital inflows, although it did not propose an explicit action plan to cover this risk. Since 1993, after contributing to.the Brady Plan for debt restructuring, the Bank has continued supporting the Govemment of Argentina with a significantly enlarged lending and non-lending assistance program.
11. The Current Period, The Bank strategy was again reviewed in 1994. This time good economic performance led to overoptimism about the future, in spite of the risk analysis of the CAS: the diagnosis of the 1994 CAS was clear about the vulnerabilities of the Convertibility Plan, but the recommendations anticipated the end of adjustment lending and included a discussion of possible graduation for Argentina. By,1995, the strategy was reviewed again in the face of the uncertainties created by the external shock faced by Argentina after the 1994 crisis in Mexico. The Bank's answer this time was swift and fast: a new CAS in April 1995 discussed the specific problems posed by the crisis in Argentina's context and good analysis was accompanied by quick action: in 1995 the Bank approved 12 loans to Argentina, for a total of US $2.1 billion.
12. By April 1996, the Bank prepared a progress report to review the achievements of the Government in meeting the challenge of the regional financial crisis and to examine the role of the Bank support. The main conclusion is that "Argentina appears to have weathered the worst of the crisis, although important risks remain". The country still faces the aftermath of the crisis, including high unemployment, and the need to strengthen its financial system and public finances. The financial situation of the provinces continue to be serious, burdened by bloated bureaucracies, financially weak pension systems and inefficient public banks and enterprises. Also, Argentina's debt service ratio has grown from 42 percent in 1993 to an estimated 56 percent in 1995, and is expected to continue growing before peaking in 1997. Argentina will have to lengthen the maturity of its foreign borrowing. The progress report also concluded that the Bank assistance strategy continued to be on track as the Government continued to take the actions required to meet the above challenges.
(iii) Relevance, Efficacy and Efficiency of Bank Assistance (1985-1995)
13. This CAR concludes that the Bank's assistance strategy to Argentina was relevant throughout the ten-year period covered, especially ESW, but that the effectiveness and efficiency of the strategy was poor during 1985-89. It is too early to fully evaluate effectiveness and efficiency of the strategy in the 1990-95 period because sustainability of the reforms can only be partially -assessed, the impact of some policy reforms is not yet fully known, and most projects are still ongoing. The challenge today is to achieve sustainability of the economic recovery in Argentina and to complete the agenda for public sector reform, especially in the provinces, and private sector development. Other major findings include:
- the high levels of lending in the 1985-89 period were not justified by the policy reforms taken by the Government, or by a realistic risk analysis of the chances of success of consecutive attempts at reform. This was, moreover, inconsistent with the Bank's stated strategy which had set out strict conditions for continuing high levels of adjustment lending (Country Program Paper of June 1985);
- ESW was relevant (i.e., good diagnosis and adequate objectives) but not effmflve in dw 1985-89 period. ESW provided useful information and policy advice all throughout the decade, and was very effective particularly in the initial years of the Menem Government (1989-92) when new lending was substantially reduced;
- the Bank was slow in providing financial support when the reforms started in the 1989-92 period (partly due to the experience with the failure of the Primavera Plan). More recently, however, the Bank reacted quickly following the external shocks of December 1994: lending has been timely and quality has improved;
- project outcome ratings in Argentina have been among the lowest in LAC and Bankwide (less than fifty percent satisfactory by end FY95). While this was largely affected by poor policies in the 1980s, high risk projects continue to exist in the portfolio (e.g. Yacireta).
- the major contributions of the Bank in 1990-1995 include:
- support for external debt restructuring and for restoration of private capital market access;
- finance and advice for the most far-reaching public enterprise privatization program ever carried out by a developing country;
- assistance for revenue mobilization, public expenditures management and Central Bank reorganization, measures which were instrumental in implementing the Convertibility Plan;
- analyses of the fiscal problems of the provincial governments and the social security system;
- finance and advice for financial sector reform;
- studies to enhance competitiveness in capital and labor markets (included in CAS 95).
- the main weaknesses in this five-year period include:
- insufficient attention to the social sectors, in spite of a good analysis--and lending proposals-in the 1990 CSP. Although responsibility for the delays (or abandoning) of most of these loans rests mostly with the Government, which was devoting nearly exclusive attention to fiscal and economic reforms, the Bank should have positioned itself more clearly in support of increasing attention to social issues. In the absence of Government's interest to borrow for the social sectors, the Bank's contribution was forced to be limited to studies financed through technical assistance and ESW;
- transfer of responsibilities to province-level governments without an adequate assessment of their financial and institutional capacities. The Bank supported the Federal government's decision to transfer then responsibilities to the provinces to help the fiscal situation of the Federal Government. It was expected that improvements in tax administration, which had increased revenues by about 27 per cent a year to the provinces in 1991 and 1992, would be sufficient to finance their new responsibilities. However, no assessment of the financial and institutional capabilities of the provinces was done.
- overoptimism of the 1994 Country Assistance Strategy that anticipated the end of adjustment lending with only one such loan (for Provincial Reform) in FY95. This overoptimism was in contrast with the more sober (and, in retrospect, prescient) assessment of the 1992 Country Strategy Paper discussion of Argentina's vulnerability to a sudden reversal of capital flows, which recognized the weaknesses of the domestic financial sector;
14. An additional and more generic issue emerging from the Argentine experience refers to a potential conflict for SALs and particularly SECALS, between the objective of resource transfer to achieve macroeconomic purposes and the sectoral or subsectoral reform objectives. A clear example of this conflict appeared in Argentina when the second tranche of the Agricultural Sector Adjustment Loan was disbursed in late 1987 to achieve the resource transfer objective but in the absence of the agreed sectoral reforms. This conflict has appeared also in other countries and could be faced again in Argentina in connection with the package of the SECALs approved in 1995.
(iv) Recommendations
15. The main lesson of this CAR is the need to avoid high levels of lending in the absence of a well designed and credible policy reform, as it happened in Argentina during the 1985-89 period. The specific lessons and recommendations for the future assistance strategy to Argentina are that the Bank should:
- Continue supporting policy reform. Although the situation has improved, the country has not yet achieved full access to the institutional financial markets, as have Chile or Colombia. Therefore, the Bank should continue to support policy reform with a variety of lending and non-lending instruments, and to facilitate private sector development in collaboration with IFC and MIGA.
- Focus on a few areas of high priority. Given the high levels of technical capabilities in Argentina, the Bank should focus on a limited set of issues of high developmental priority and where the Bank's involvement may make the biggest difference. The 1995 Bank assistance strategy, involving province-level reform, municipal development, financial sector strengthening, export promotion, poverty reduction, health, education, energy, and environmental reform may be too comprehensive.
- Concentrate on the fiscal problems of the provincial governments and of the social security system. These are among the highest priorities for reform. But both of them are intertwined with the continuing need to address health and education services (mainly provided by the provinces) as well as welfare needs of the poorest groups (including old-age pensioners). Concentrating on these social services will have the double effect of ameliorating poverty and addressing fiscal issues of the provincial governments. This is now at the core of the objectives of economic stabilization (addressed in the April 1995 CAS) as well as of poverty alleviation and political feasibility of reform. Two other areas of importance (also addressed in the 1995 CAS) are the expansion of a competitive private sector and the recovery from the aftershocks of the 1994 Mexico crisis. While the Bank should certainly be engaged in these two areas, the first group of issues (social services, finances of the provinces and social security) should continue to be the highest priority.
- Avoid changing the focus of the Bank's development assistance strategy in response to transitory changes in capital flows or macroeconomic results. The main elements of the development agenda for Argentina in 1995 were not significantly different than in 1994 or in 1992, while the focus of the Bank's assistance strategy changed significantly. While additional lending was appropriate to deal with the financial crisis of 1995, the areas of Bank attention should remain more stable to maximize sustainable impact.
- Have clear and simple objectives for each instrument. The unsatisfactory outcomes of some past lending operations was due to a multiplicity of objectives to be achieved with a limited number of lending instruments, and particularly to the coexistence of resource transfer objectives for macroeconomic purposes, together with sectoral or subsectoral objectives in the same operation. Oftentimes, the latter were sacrificed to the former (e.g. the Agricultural Sector Adjustment Loan of FY86). New lending instruments should be piloted to induce responsiveness and flexibility in lending in response to unforeseen circumstances without compromising sectoral objectives.
- Treat ESW as a distinctive instrument with its own objectives (not just a prelude to lending) and evaluate its impact. ESW should be integrated in the CAS as an independent instrument with its own objectives, only one of which is to provide the analytical basis for lending when so required. The relevance, efficacy, and efficiency of ESW for furthering the objectives of the CAS should be subject to ex post evaluation.
- Sustain progress towards better economic analysis of projects. Two recent Bankwide studies (ECON I and ECON II) included a sample of projects in the Argentina portfolio as part of their Bank-made sample. The findings regarding the Argentina projects were worrisome as the quality of economic analysis was found to be poor or marginal for projects accounting for 52 percent of the volume of lending. This CAR, however, extended the ECON-type analysis to a much larger sample of projects in the Argentina portfolio (for projects approved in the 1990-95 period) and found significantly better results, with poor or marginal economic analysis in 29 percent of the lending volume. Although it has improved, the Region needs to continue to make efforts to enhance the quality of economic analysis of projects further.
- Improve project supervision and country porffolio reviews. Improvement in country portfolio performance is of high priority and prompt collective action is needed. Monitoring progress in this area can take place by looking at completion ratings in the near future and by measuring trends in the historically high disconnect (the difference between the number of projects that are rated as problem project during their last year of implementation and those whose outcomes are rated as unsatisfactory at completion). This disconnect is, in Argentina, among the highest in the Bank at 47 percent. The overoptimism in assessing the portfolio (evidenced in the past by the high disconnect) needs to be fully eradicated.
- Assess and manage risk clearly and explicitly. OED's review of lending operations and of country strategy documents in this CAR concludes that the lack of timely reaction to identified risk was a characteristic of most lending operations and country strategies reviewed. Often, risk was acknowledged but contingency plans to deal with risks were not made.
- Use explicit per of progress in achieving priority objectives requires monitorable performance indicators. For fiscal performance, reduction and measurement of the structural deficit was correctly noted as important by the Region but no subsequent efforts have yet been made to track it. Other indicators should also be developed to follow-up on the provincial finances, health and education objectives, and social security as well as in other areas.
1/ Except for a technical assistance loan for Tax Administration of $6.5 million approved in January 1989, (prior to the elections) which remained inactive for the most part until 1991. |