ARGENTINA
Argentina has experienced slow economic growth
since the 1940s.
By the mid-1970s
long-term growth declined noticeably, and in
the last half of
the 1980s the country suffered its longest
period of
stagnation in the century. Savings and investment
rates fell
precipitously from the mid-1970s until 1989.
Argentines,
responding to the unstable macroeconomic
environment,
increasingly saved and invested abroad. Labor
productivity fell
ang poverty worsened. This economic
performance was
tranceable to chronic public sector deficits and
endemic
inflation. Public sector deficits in the late 1970s
ranged from 10 to
14 percent of GDP, and in the early 1980s
surpassed IS
percent of GDP. After the return to constitutional
democracy in
1983, public demands to control inflation were
translated into
four successive stabilization programs. All
failed to
eradicate inflation, and each ended in a more virulent
inflation than
the one preceding it. The main reason for these
failures was the
inability of the stabilization programs to
redress rapidly
and permanently the public sector structural
deficit. Structural deficits emerged from the post-war
organization of
the economy. Economic policy from the 1940s was
used to propagate
rules and transfers favoring the interests of
private groups
with access to power. By the early 1980s public
expenditures
approached 40 percent of GDP. Unionized labor
benefitted from
high wages, guaranteed employment, and rigid
rules governing
hiring and dismissals. Industry benefitted from
highly protected
markets, tax exemptions through special
promotion
regimes, subsidized credit-or effective grants, as
many loans were
not collected-subsidized inputs from public
enterprises, and
high prices on sales to public enterprises.
Housing
contractors and middleclass home buyers benefitted from
enormous public
transfers through earmarked taxes and effective
grants through
the Housing Bank. Tobacco growers, sugar growers,
the merchant
marine, and other small interest groups enjoyed
special tax
breaks. Consumers enjoyed below-cost tariffs from
public enterprise
and lax collectioll practices. Provincial
governments could
avail themselves of costless credit from the
provincial banks,
which the central bank reimbursed. The
military enjoyed
expanding budgets, especially over 1976-82, as
well as
management perquisites in state companies they
controlled. By
1989 subsidies through the budget, tax
exemptions,
agriculcural regulations, public enterprise tariffs,
and central bank
rediscounts were estimated to amount to roughly
8 percent of
GDP--the equivalent of some $8 billion. The growth
of the state and
concomitant rents and subsidies, along with the
capital flight
provoked by an inconsistent exchange rate policy,
were financed
during the late 1970s largely by external
borrowing through
the expanding Eurodollar market at low or even
negative real
international interest rates. This permitted the
government to run
large deficits and sustain a revalued exchange
rate with
relatively low levels of inflation in the second half
of the 1970s. An
abrupt end to voluntary foreign commercial
credit in the
early 1980s and the sudden rise in real
international
interest rates provoked a financial collapse and
placed additional
pressure on public finances. The situation was
complicated by
the South Atlantic War. The loss of external
finance and lack
of adjustment meant the treasury had to resort
to increased
inflationary finance through monetary creation. The
private sector,
in an effort to avoid the resulting inflation
tax, gradually
withdrew its resources from the financial system
and reduced its
real holdings of currency ; this, together with
the negative
effects of inflation on real tax collections, made
Argentina's
economy progressively more unstable in the 1980s.
Even though the
deficit fell from near 20 percent of GDP in the
early 1980s to an
average of about 10 percent over 1987-89, the
base for the
inflation tax shrank even faster--efforts to reduce
the deficit were
not fast or permanent enough to convince the
private sector
that savings in domestic currency would not be
eroded by
inflation. Inflation became high and unpredictable,
and the main
impediment to the recovery of private savings and
investment. The
decade ended with two episodes of hyperinflation
in 1989.
Post-1989
Structural Reforms
Tbe present
administration took office in July 1989 during a
traumatic
hyperinflation--July inflation alone was 200 percent.
This culminated a
decade-long crisis in public finance. The new
team inherited
weak public institutions accustomed to deficit
spending and with
an institutionalized reliance on the inflation
tax. In addition,
claims on state revenues were far greater than
its capacity to
mobilize resources-in short, the Argentine state
was insolvent.
The government undertook stabilization programs
in 1989 and 1990.
Neither succeeded, principally because of the
intractability of
the fiscal deficit. The first terminated in a
new hyperinflation
at the end of 1989 and in early 1990. The
second lasted
from March 1990 to December 1990 and ended in a
new inflationary
outburst but, unlike the previous breakdowns,
the economy did
not spin into hyperinflation. Instead, a new
fiscal package in
February 1991 was sufficient to close the
remaining fiscal
gap. This was followed by the April 1, 1991 Law
of Convertibility
fixing the local currency to the dollar and
effectively
proscribing money creation other than to buy net
foreign reserves.
The convertibility program disciplines
monetary policy
and limits the power of the government to
finance its
deficit through inflation. The law markedly reduced
the foreign
exchange rate risk to investors and the inflation
risk to business
and labor--as long as the fiscal fundamentals
are in place to
support it. The February 1991 program was able
to close the gap
in large measure because the government's
sustained
structural reform efforts had progressively improved
the foundations
of public finance. The government had undertaken
difficult to
reverse reforms in the legal framework,
institutions, and
policies. These included institutional reforms
of the federal
government, public enterprises, and
federal-provincial
fiscal relations, and restructuring
liabilities with
domestic and foreign creditors to adjust them
to serviceable
levels. Other reforms have helped elicit
efficient private
investment, notably trade, deregulation, and
financial sector
reform.
Federal Government
The government undertook a major effort to
improve revenues
through the
implementation of a much-broad- ened and uniform
value added tax
first to goods in February 1990, and later
extended to
services in Novem- ber 1990. The government also
improved the
efficiency of the tax administration in 1989,
establishing a
control system for the largest taxpayers that
took effect in
February 1991. The tax penalty law, adopted by
Con- gress in
1990, provided much needed sanctions for tax
non-compliance.
The tax package of February 1991 improved the
quality of
revenue mobilization substan- tially because it
eliminated export
taxes, reduced pro- gressively during 1990 and
early 1991,
deducted higher taxes on financial transactions from
the income/asset
tax, and removed several minor taxes. In
December 1992
subsidies to industrial promotion were
substantially cut
by replacing self-monitored tax deductions
with a tax bond
program. These efforts cumulatively produced
dramatic rises in
tax collections from the third quarter of 1991
on. The increase
in value added tax collection allowed the
government to
eliminate inefficient taxes, such as the fuel tax
and the stamp
tax, in November 1992, and several specific sales
taxes in May
1993. Federal employment decreased from 671,000 to
284,000,
including 103,000 layoffs and 284,000 teachers and
health workers
transferred to provincial payrolls. This effort
was based on a
ministerial reorganization that focused federal
activities on
core objectives, and improvements in the civil
service system
through an improved salary structure and
efficiency
measures. The government was able to increase average
salaries and
partially restore salary differentials. The
government took
several measures to strengthen budgeting
procedures and
expenditure controls. By 1993 it had eliminated
105 of the 151
earmarked accounts extant in 1990, and reduced
the coverage of
earmarked taxes. The September 1992 Law of
Public Financial
Management will permit comprehensive budgeting,
effective internal
expenditure control, and provide for new
external
auditing The government has embarked on
several
reforms to
separate the central bank from the nonfinancial
public sector and
establish it as an effective independent
monetary
authority. The elimination of the central bank's
domestic
short-term interest-bearing obligations by means of
their conversion
into external treasury bonds in January 1990 in
effect was a
first step toward recapitalizing the central bank.
The Law of
Convertibility established a money-creation rule that
effectively
limits monetary policy and central bank inflationary
financing of
public sector deficits. Since early 1991 the
central bank has
published financial statements that reveal its
balance sheet;
since April 1991 it has published its reserve
position weekly
so the public can monitor implementation of the
Law of
Convertibility. In
September 1992 a
new law
strengthened the central bank's autonomy, and further
restricted its
ability to extend credit to the government and
the banking
system. This measure reinforces the convert- ibility
law, and paves
the way for an independent, disciplined, monetary
authority. In
addition, the cen- trai bank intends to complete
the process of
removing functions ancillary to the functions of
a monetary
authority by transferring legal authority for failed
institutions to
the courts.
Public Enterprises
The government has carried out one of the
most impressive
privatization
programs in the Western Hemisphere. The objective
was to reduce the
budgetary burden of the enterprises, make the
firms more
competitive, and increase the volume and efficiency
of new
investment. The privatization program began in earnest in
1990 and gained
credibility with the sale of national
telecommunications
company in November 1990. The program removed
politics from
price setting in the formerly vast segment of the
economy covered
by the state. The change in the institutional
organization of
these sectors cut off public subsidies to
consumers and
labor groups benefitting from high wages and
excess staffing,
and transfers for investment. The program also
improved public
finances: about $9 billion in capital receipts
helped close
fiscal accounts in 1991 and 1992 and external debt
was reduced by
$12 billion. Major privatizations included
television
stations, the telephone company, Aerolineas
Argentinas, gas
distribution and transmission, and the majority
of the national
oil company. It granted road and railroad
concessions to
the private sector, privatized long distance
cargo lines, and
sharply reduced the railway's work force. The
government
privatized other public enterprises, including
defense
industries, the nation's largest distributor of
electricity, ports
and maritime transport, reinsurance, and the
entire power
sector. Future privatization plans include the
national airport
system.
Fiscal
Relationships with the Provinces
The government
also sought to restructure fiscal relation ships
with the provinces.
The Coparticipation Law of 1988, fixed the
share of federal
revenues automatically transferred to the
provinces at 58
percent. In August 1992 a portion of tax
revenues was
assigned to the social security system before
computing revenue
sharing. At the same time, the resources
provincial
governments could access were limited by
progressively
terminating central bank lending to provincial
banks. The
government also reduced extra-coparticipation
transfers through
the budget. To offset aggregate increases in
resources as
national tax collection improved, the government
also transferred
expenditures to provincial administrations,
notably secondary
education and hospitals, and to the social
security system
in August 1992.
Debt
Restructuring
The final step in
dealing with the government's insolvency
involved
restructuring its debt obligations. The government had
financed its
deficit through borrowing from the financial
system,
suspending payment to external creditors, and
accumulating arrears
with pensioners and suppliers.
Restructuring
each of these required major initiatives. Although
the government
ended new rediscounts to the housing and
industrial banks,
and liberal rediscounts to provincial banks in
1988, the central
bank continued money emission to finance the
treasury and its
own deficit. In late December 1989, faced with
rising central
bank deficits and the renewed threat of
hyperinflation,
the government took the drastic step of
converting
domestic, short-term (mainly seven-day),
interest-bearing
obligations of the central bank into $3.5
billion 10-year
dollar-denominated treasury bonds. This
virtually
eliminated the central bank's quasifiscal deficit and
the monetary
emission necessary to finance it-at the cost of
penalizing savers
and reducing already low confidence in the
financial system.
In April 1988 the government suspended payment
on its external
debt to commercial creditors. By 1992 it had
accumulated $8
billion in arrears as part of a $32 billion
medium-term
commercial bank debt. Public external debt was $61
billion. The
government re-initiated partial payments in June
1990, and
established a consistent record of paying about 25
percent of
interest due. At the same time, it allowed external
debt to be used
in exchange for the sale of assets, which
reduced the debt
stock by $7 billion. The progressive
improvement in
fiscal fundamentals in 1990/91 allowed the
government to
begin negotiations with commercial banks on a debt
reduction deal.
An external debt agreement signed on April 7,
1993, reduced $28
billion in commercial bank debt by
approximately 37
percent, and eliminated interest arrears. This
debt deal is
expected to improve Argentina's creditworthiness.
The agreement
formalized arrears in a 12-year uncollateralized
bond at LIBOR
plus 13/16 with a 3-year grace period, after a
$700 million
downpayment. Existing debt was exchanged for
collateralized
par bonds with a fixed interest rate, or
collateralized
discount bonds at 65 percent of face value paying
LIBOR. The new
collateralized bonds will have a 12-month rolling
interest
guarantee. For most of the last decade, the government
has paid only
about half the legally mandated pensions owed
social security
recipients. Arrearages were not recorded in the
fiscal accounts,
but are estimated to be as high as $7 to 10
billion. To stop
the accumulation of arrears, the government
modified
coparticipation in tax revenues in favor of the social
securiry system
in August 1992. Since then, the social security
system has run a
small operating surplus. The government also
accumulated
arrears in 1990 with suppliers through formal
suspension of
payment on goods and services already provided,
and the health
funds have arrears with their service providers
that will also
result in new debt. Finally, the government, as
part of its
income tax reform, suspended poorly designed loss
carry forward
deductions for the corporate income tax, and
agreed to issue
compensatory bonds. To settle these claims,
Congress
authorized the government to issue consolidation bonds.
The service of
this debt will be capitalized until 1997, but
payments on the
order of $3 billion will be required in the last
years of the
decade. The federal government's share of the
proceeds of the
privatization of the state oil company is
earmarked for
repurchasing some of the consolidation bonds.
Social Security
Reform
The government
has moved towards replacing a failed public
pension system.
In mid-1992 it submitted a law introducing a
combined
state/private system: the state would supply a uniform
basic pension
financed on a pay as you go basis while the
private sector
would supply pension funds. Membership in both
schemes would be
mandatory. The lower house of the Argentine
Congress passed
the law-with significant modifications--in May
1993. The
government expects the legislative process to be
completed before
the end of the year, allowing a new system to
be established in
mid-1994.
Trade,
Deregulation and Financial Reforms
In 1991 the
government accelerated and largely completed a trade
liberalization
program that began in laIe 1986, but had suffered
temporary
reversals in 1989. Virtually all export taxes and
quantitative
restrictionsexcept for automobiles--were
eliminated. The
maximum ad valorem tariff was reduced from 115
to 35
percent. The deterioration in the trade
balance in 1992,
a consequence of
massive capital inflows motivated government to
use commercial
policy to achieve effective devaluation within
the fixed
exchange rate regime. Exporter rebates were raised
from 8 to 13
percent. On the import side, the tariff band was
narrowed to O to
20 percent. The government also increased a
flat tariff
surcharge, called a statistical tax, from 3 percent
to 10 percent on
a temporary basis. This led to an effective
depreciation of
about 5 percent. In May 1993 the government
eliminated both
tariffs and the statistical tax on capital goods
imports, but in
July it provided protection to some paper and
textile products
through temporary import quotas and tariff
surcharges. A
major domestic deregulation decree in October 1991
ended a series of
market-impeding rules, dissolved several
regulatory
bodies, and unified pension and health insurance
payments to
reduce evasion. Subsequent decrees have deregulated
pharmaceutical
impons and ports. The industrial promotion
program and
subsidies to Tierra del Fuego were markedly reduced
in November 1992.
The publicly-owned housing and development
banks, long subject
to political influence and dependent on
government
financial support, are undergoing major
restructuring.
Branches of the National Development Bank and the
National Housing
Bank have been closed since March 1990 and
their staffs have
been reduced by almost 75 percent. The
government is
liquidating the development bank and closing the
housing bank's
retail functions. It has established a second
tier bank to be
managed, and ultimately owned, by the private
sector to
mobilize financing for its investment needs. In
response to a
short-lived run on the peso in mid-November 1992
the authorities
strengthened their commitments to the fixed
exchange rate
regime by permitting reserve requirements to be
met either in
foreign or domestic currency, and equalizing
reserve
requirements on foreign and domestic
currency-denominated
checking accounts in domestic transactions.
In February 1993
these measures were complemented by lowering
reserve
requirements and further deregulating commercial bank
lending to the
private sector. Term deposits under 30 days were
eliminated to
increase the average maturity of deposits in the
domestic
financial system and reduce the risks of a run on the
banks. Finally,
since April 1993, bank compliance with reserve
requirements is
based on a four-week moving average, which
should reduce the
volatility of short-term interest rates .
Over the last six
months Argentina has taken meas- ures to
reduce interest
rates and stimulate investment. In October 1992
it imposed a 2
percent per month ceiling on loans made by public
banks, a measure
also aimed at stimulating restructuring of
these banks. In
March 1993 it began auctioning subsidy credits
to banks, with
the winner of the subsidy being the bank that
offers to charge the
lowest rates to final medium- and
small-scale
industrial borrowers. In May 1993 the authorities
an- nounced the
extension of the Banco de Nacion's credit
lines-the largest
official bank--and a reduction in its lending
rates from 1.8
percent to 1.6 percent per month. They also
declared that the
bank's credit policy will be oriented toward
export-oriented
activities as well as agriculture, industry,
mining, and
tourism.
Recent Macroeconomic Developments
In 1992 the authorities continued to adjust
the economy,
extending the
recent good economic performance. GDP grew by 8.7
percent, and
industrial production grew in the 12 percent range
for the second
year in a row. Employment rose by about 10
percent and
investment expanded briskly in 1992, rising from
12.5 percent to
14.5 percent of GDP. The increased investment
was financed by
external savings, with gross national sav- ings
declining
moderately to 9.3 percent of GDP. Public savings rose
by about 2
percentage points of GDP, while private
savings
fell. Fiscal performance has improved notably in
the last two
years. The
overall balance moved into surplus in 1992 for the
first time in
decades with an operational primary surplus of 2.0
percent of GDP.
Tax revenues increased from 13.5 percent of GDP
in 1989 to nearly
24 percent between in 1992. In the same
period, public
expenditures fell as a percent of GDP. Capital
spending and
non-privatization receipts both declined slightly.
The fiscal
surplus also was improved by the drop in dollar
interest rate,
which cut accrued interest obligations by 1.3
percent of GDP.
However, interest obligations still exceeded the
operational
primary surplus slightly in 1992. Inflation
continues to
decelerate. The annualized inflation rate in the
last quarter of
1992 was about 9 percent, compared to over 20
percent a year
earlier. Nonetheless, inflation still exceeds
international
rates, which is necessary to sustain the fixed
exchange rate
regime . During 1992 capital inflows, jointly with
the economic
expansion, contributed to an 84 percent increase in
imports; exports
rose by 1 percent. As a result, the current
account deficit
for 1992 reached 5.2 percent of GDP, up from 2
percent a year
ago. Capital inflows of $12.0 billion, mostly
private, more
than offset the current account deficit, allowing
a $3.4 billion
accumulation of reserves. After signs of slowdown
in economic
activity during January and February 1993,
industrial
production recovered in March and April, with the
first quarter of
1993 marking the eleventh consecutive month of
economic
expansion. Capital inflows recovered in the first
quarter of 1993,
further strengthening the level of
international
reserves. The monthly inflation rate between
January and March
1993 averaged 0.7 percent, about the same as
the last quarter
of 1992.
Medium-Term
Prospects
The government
projects real growth averaging 6.5 percent over
1992-95. Over
this period its fiscal program for aims at
generating a
primary surplus sufficient to finance interest
obligations, thus
eliminating the need for the inflation tax.
This involves
efforts to raise the primary balance from about
$3.3 billion in
1991 to about $4. 1 billion in 1995. The success
of this program
will largely depend on medium-term reforms to
improve the
structural underpinnings of public finance, such as
social security
legislation, labor reforms, and the evolution of
the fiscal
relationships with the provinces, given the
increasing
decentralization of power and responsibilities from
the center to
provincial governments . This scenario is
attainable if the
government continues to improve its fiscal
position, and if
private markets generate a smooth transition to
a sustainable
balance of payments and growth path. There are
significant risks
to this program. The probability of adverse
events affecting
the convertible peso declines, however, as the
government
progresses on reforms that improve the fundamentals
of public
finance. Past reforms in the public sector anchor
stabilization and
are unlikely to be reversed during any
financial
turbulence. Also, reserves are the highest in a decade
and cover the
monetary base (although not the deposit base),
which would deter
a speculative attack on the peso. Even if
problems give
rise to pressure to alter the policy framework, in
all likelihood
any emerging policy regime would of necessity
focus on
maintaining fiscal balance and policies conducive to
private
investment. Over the last few years Argentina has
enacted serious and
difficult structural reforms with
considerable
public support. The lack of alternatives to fiscal
discipline and
price stability, and memories of the
hyperinflation of
1989/90, have made stability politically
popular. These
facts are powerful ballast that is likely to keep
the ship of
structural adjustment headed in the same direction,
even in a
financial storm.
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