Document of The WorldBank FOROFFICIAL USE ONLY ReportNo. 34015-AR INTERNATIONAL BANK FORRECONSTRUCTIONAND DEVELOPMENT AND INTERNATIONALFINANCE CORPORATION COUNTRYASSISTANCE STRATEGY FOR THE ARGENTINE REPUBLIC FORTHE PERIOD2006-2008 May4,2006 Argentina, Chile, ParaguayandUruguay CountryManagementUnit LatinAmerica andthe CaribbeanRegion This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. The last Country Assistance Strategy for Argentina was discussed by the Executive Directors on April 15, 2004 (Report No. 27340-AR dated January 29, 2004) and the SupplementalNote(WOO3 -0207/27datedApril 5,2004). CURRENCYEQUIVALENTS (ExchangeRateEffectiveApril 30,2006) CurrencyUnit=Argentine Peso AR $1=US$0.33 FISCAL YEAR: January 1-December31 IBRD IFC Regional Vice President: Pamela Cox Acting Vice President: Declan J. Duff Country Director: Axel van Trotsenburg Director: Atul Mehta Task Team Leaders: James Parks and Regional Manager: Yolande Duhem Anthony Gaeta Task Managers: Junk0 Oikawa and Eduardo Wallentin ABBREVIATIONS AND ACRONYMS AAA Analytical and Advisory Activities ADR Alternative Dispute Resolution AGN General Audit Authority AML Anti Money Laundering ANSES National Social Security Administration A P L Adaptable Program Loan BA SIDP Buenos Aires Province Sustainable Infrastructure Development Project BIT Bilateral Investment Treaty CAS Country Assistance Strategy CFAA Country Financial Accountability Assessment CMS Gas Transmission Company COFESA Federal Health Council CPAR Country Procurement Assessment Report CSR Corporate Social Responsibility D P L Development Policy Loans EMBI Emerging-Market Bond Index ERSAL Economic Recovery Support Loan ESW Economic and Sector Work FM FinancialManagement FPSI Finance, Private Sector and Infrastructure FSL Financial Sector Loan GDP Gross Domestic Product GEF Global EnvironmentalFacility GOA Government o f Argentina HIV/AIDS Human Immunodeficiency Virus/ Acquired ImmuneDeficiency Syndrome IADB Inter-American DevelopmentBank IBRD International Bank for Reconstruction and Development ICSID International Centre for the Settlement o f Investment Disputes IFC International Finance Corporation IF1 International Financial Institution IMF International Monetary Fund ISDA International Swaps Dealers Association M&E Monitoring and Evaluation MDG MillenniumDevelopment Goals Mercosur Common Southern Market MIGA Multilateral Investment Guarantee Agency NGOs Nongovernmental Organizations OECD Organization for Economic Co-operation and Development PER Public Expenditure Review PFM Public Financial Management P I U Project ImplementationUnit R&D Research and Development ROSC A&A - Reports on the Observance of Standards and Codes for Accounting and Editing S A L Structural Adjustment Loan SECAL Sectoral Adjustment Loan SIL Specific Investment Loan SMEs Small and Medium Enterprises SWAP Sectonvide Approach SYNTIS National Social and Fiscal Identification System TAL Technical Assistance Loan TFP Total Factor Productivity UN UnitedNations VSL Variable Spread Loan WBI World Bank Institute FOROFFICIAL USE ONLY 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. COUNTRY ASSISTANCESTRATEGY FOR THE ARGENTINE REPUBLIC TABLE OF CONTENTS EXECUTIVE SUMMARY ......................................................................................................................................... i I INTRODUCTION . .................................................................................................................................................. 1 A . OVERVIEW....................................................................................................................................................... 1 I1 COUNTRY CONTEXT AND.RECENTDEVELOPMENTS . ........................................................................... 3 A. POLITICALCONTEXT ....................................................................................................................................... 3 3 I11 THE GOVERNMENT'SDEVELOPMENTAGENDA .B. ECONOMIC SOCIAL CONTEXT.................................................................................................................. AND ................................................................................. 10 IV DEVELOPMENT CHALLENGES:RISKS AND OPPORTUNITIES . ........................................................ 13 A. SUSTAINABLE GROWTH ................................................................................................................................. 13 B. SOCIAL INCLUSION ........................................................................................................................................ 20 C . IMPROVED GOVERNANCE .............................................................................................................................. 22 V MACROECONOMIC OUTLOOK 26 VI THE BANKGROUP'S ASSISTANCEPROGRAM .. ................................................................................................................... ...................................................................................... 30 A. RATIONALE FORBANKSUPPORTTO ARGENTINA .......................................................................................... 30 B . Sustained Growth with Equity................................................................. STRATEGICOBJECTIVES OF THE C A S ............................................................................................................ .............................. 30 32 Poverty Reduction and Social Inclusion ................................................. .............................. 35 Improved Governance............................................................................. .............................. 36 C 37 D .. THEBANK'S .............................. CIVIL SOCIETY STRATEGY ............................................................................................................................. ANALYTICAGENDA............................................................ 38 E. C A S PREPARATIONPROCESSAND LESSONS LEARNED .................................................................................. 39 CAS Consultations ...... ........................................................................... 40 F INDICATIVE ................................................................................................. IBRDPRO 42 G IBRDPORTFOLIO PERFORMANCE .................................................................................................................. 44 H... IFC................................................................................................................................................................ 45 I. 46 MIGA.............................................................................................. THEROLEOFMIGA, WBIANDICSID.......................................................................................................... .......................................................... 46 WBI............................................................................................................................................................... 47 ICSID............................................................................................................................................................ 48 VI1 LENDING SCENARIOS AND PERFORMANCEINDICATORS . ............................................................. 49 VI11 IMPLEMENTING THE CAS . ........................................................................................................................ 51 A . PARTNERSHIPS ............................................................................................................................................... 51 B. FIDUCIARYASSESSMENT ............................................................................................................................... 53 C. 56 D . .............................................................................................................. 56 E. IBRDFINANCIALPRODUCTS......................................................................................................................... COUNTRYFINANCINGPARAMETERS CAS RESULTS FRAMEWORK .......................................................................................................................... 57 F. RISKMANAGEMENT ...................................................................................................................................... 57 Economic and Social Risks ......................................................... 58 Political Risks . ....................................................... 59 Bank GroupProgram Risks ...................................................................................... 59 TABLES TABLE1:MACROECONOMIC INDICATORS ...................................................................................................................... 5 TABLE2: GOVERNMENT'S MEDIUM-TERM MACROECONOMICE W O F ~ RK ............................................................... 26 TABLE3: FINANCINGPROJECTIONBASEDON2006 GOVERNMENT .......................................... TABLE4: IBRDINDICATIVE CASE)................................................................................ BUDGET FRAMEWO RK 28 TABLE5: IBRDPORTFOLIO PROJECTIONS (2006 -2008) ............................................................................................ PROGRAMSUMMARY (BASE 43 50 BOXES BOX 1: SNAPSHOTOF POVERTY CHARACTERISTICS: PROGRESS SINCE THE CRISIS ........................................................ 8 Box2: EASE DOINGBUSINESS OF ................................................................................................................................ 18 Box3: HEALTH Box4: MAINSTREAMING ENVIRONMENTALFACILITY (GEF)ANDCARBON FINANCEINARGENTINA..........21 POLICY INNOVATIONS INARGENTINA ................................................................................................ GLOBAL 34 BOX 5: FINDINGSOF THE CLIENT RESEARCH ............................................................................................................... 40 Box6: BASE CASETRIGGERS ...................................................................................................................................... 50 Box7: WORLDBANK-IADBCOLLABORATION........................................................................................................... 52 BOX 8: FIDUCIARYACTION PLAN ................................................................................................................................ 55 FIGURES FIGURE1:OUTPUT COLLAPSEAND RECOVERY.............................................................................................................. 4 FIGURE2: GROWTH ........................................................................................ 6 FIGURE3: SOCIALOUTCOMESOF THERECOVERY......................................................................................................... PATTERNOF THE ECONOMIC RECOVERY 7 FIGURE4: INTERNATIONAL ENVIRONMENT .................................................................................................................... 9 FIGURE5: LONG TERMTRENDSINOUTPUTANDINFLATION ....................................................................................... 13 FIGURE6: FISCALPERFORMANCE, INFLATIONANDPUBLICDEBT FIGURE7:FEDERAL GOVERNMENT TAXESANDEXPENDITURES.................................................................................. 15 ............................................................................... 14 FIGURE8: INVESTMENT ........................................................................................................................... 16 FIGURE9: LONG TERMPOVERTYTREND..................................................................................................................... INDICATORS 20 FIGURE10:GOVERNANCE ............................................................................................................................................ 22 FIGURE11:REGULATION............................................................................................................................................. 23 FIGURE 12: CORRUPTION ............................................................................................................................................. 24 FIGURE13:PROJECTEDDEBT AND ROLLOVER REQUIREMENTSBASEDONTHE 2006 GOVERNMENT BUDGET FRAMEWORK ...................................................................................................................................................... 29 ANNEXES Annex A: Economic Policy Guidelines Annex B: Sovereign Debt Restructuring and Debt Profile Annex C: Banking Sector Update Annex D: Private Sector and Investment Climate Annex E: Public Service and Infrastructure Concessions Renegotiation Annex F: Poverty and Social Development Annex G: Status Report on Millennium Development Goals Annex H: Proposed Operations Program Annex I: Argentina Client Research Annex J: Argentina Country Financing Parameters Annex K: CAS Results Matrix Annex L: CAS Completion Report Standard CAS Annexes: Annex A2: Argentina At a Glance Annex B2: Selected Indicators o f Bank Portfolio Performance and Management Annex B 3: IBRDProgramSummary Annex B 3: IFC and MIGA Program Summary Annex B4: Summary o fNonlending Services Annex B6: K e y Economic Indicators Annex B7: K e y Exposure Indicators Annex B8: Operations Portfolio (IBRDIIDAand Grants) Annex B8: Statement of IFC's Held and DisbursedPortfolio MAP: IBRD33362 EXECUTIVESUMMARY Argentina continues its rapid recovery from the economic and social crisis o f 2001-2002. . Effective macroeconomic management, focused on the generation o f primary fiscal surpluses, has helped to establish three years o f fast and pro-poor growth. Poverty and unemployment, while still high, have fallen substantially from the peaks during the crisis. Progress has been evident throughout the economy. On the political front, President Kirchner further consolidated hisbuoyant popular support inthe legislative elections ofOctober 2005. The four years since the depth o f the crisis have seen the outlines o f a new development agenda emerge inArgentina, and the substantial rejection o f that which predominated inthe 1990s. The past two Governments have reacted to long standing social and economic problems that were exacerbated, and brought to the fore, by the crisis, such as structural poverty, inequality and deep social exclusion. While progress has been made toward establishing a clearly defined policy framework incertain sectors (health and education), such progress has yet to be achieved inother important sectors, most notably, public services. The current environment presents Argentina with important opportunities, but also risks. The opportunity i s to translate the fast recovery and current political stability into sustainable economic and social development for the long term. This would represent a significant break with the country's history o f slow growth, recurrent crisis and increasing social exclusion. Continued prudent macroeconomic management will require, inter alia, sustained fiscal discipline at the federal and provincial levels. Equally important i s a commitment to structural reform, including in investment climate, institutional strengthening, the rule o f law, and public services, Argentina can continue to buildon the progress achieved inkey social areas of poverty reduction and social inclusion. The risks o f not tackling these challenges could weaken the recovery andundermineArgentina's social and economic development for the long term. The objective o f the new IBRD-IFC Joint CAS i s to seek opportunities to build an investment partnershipto support Government efforts to transition from crisis recovery to sustained, private sector-led growth with improved equity and reduced structural poverty. A successhl transition requires a long-term development strategy incorporating feasible policies to reduce social exclusion and strengthen governance. The three pillars o f the 2004 CAS-sustained growth with equity, social inclusion and improved governance-remain valid and provide the foundation for the new CAS. The IFC i s prepared to complement support from IBRD by providing long-term financing and structured finance products to companies and projects in strategic sectors, with an emphasis on groups expanding on a South-South basis and export-oriented or export facilitating projects. IFC's ability to support private sector engagement ininfrastructure and public services projects will depend on the adoption o f a clear and stable policy framework restoring the conditions for private sector participation in infrastructure both in terms of existing and future investments inthis area. Supporting medium-term development goals will continue to challenge the Bank as long as Argentina's reform commitment remains uncertain. In2004, the Bank addressed this uncertainty by, on an exceptional basis, truncating the CAS from 5 years to,20 months and conducting a structural review with the Government (on which staff briefed the Board in June 2004). The CAS incorporates the key lessons from the 2004 CAS. First, the limitedpolicy dialogue with the i Government and the lack o f an active IMFprogram have made it difficult to sustain policy based lendingandthereby the envisaged level o fresources. Second, the shift to investment lendinghas increased the emphasis on performance and underlined the challenge o f strengthening the Government's project implementation capacity. Third, while the basis for investment lending has been laid in several key areas, achieving a hll-fledged investment partnership requires a longer time horizon than the truncated 2004 CAS. The assistance strategy reflects constructive consultations with the Government, and builds on the extensive consultation held in preparation for the 2004 CAS. The 2004 CAS presented an approach whereby the Bank would seek to engage in active dialogue, and, where there was consensus, proceed to lending operations; where consensuswas pending, the Bank would seek to maintain engagement, including through analytical work. The CAS maintains this approach, with substantial new lendingplanned for roads, health, income support for the poor, and public sector strengthening. Dialogue with civil society and the private sector has been very productive, including a Development Marketplace on Youth and Values held in Buenos Aires in mid 2005 and economic work on the dynamic relationship between growth, poverty and equity. The CAS covers three years (2006 to 2008) and presents a base case o f US$3.3 billion exclusively for investment operations. This scenario is appropriate provided macroeconomic stability continues. Should the Government request policy based lending and establish adequate conditions (including a satisfactory macro framework), up to 25 percent o f the base-case envelope could be reallocated to policy based loans. A range of low cases i s also possible if macroeconomic policies were to deteriorate, growth falter, and portfolio management weaken. A CAS progress report will be prepared mid-way through the CAS period. Moreover, management proposes to provide periodic briefings to the Board on ongoing economic developments and the mediumterm outlook. This i s a performance based CAS that confirms the emphasis on concrete government action established under the 2004 CAS. It formalizes the transition by the Bank from the coordinated effort to maintain exposure of the IFIs while Argentina recovered from the crisis. The shift to 100 percent investment lending highlights the challenge for the Government to significantly increase its implementation capacity, which i s still beingrebuilt after the crisis. This investment based approach has implications for Bank exposure, which fell to US$6.9 billion by end-2005, compared to US$7.5 billion at end-2003, when the 2004 CAS was prepared. The CAS includes concrete measures to help strengthen the operating environment for Bank projects, A fiduciary action plan will promote public awareness, enhance Bank supervision, and ensure more transparent and competitive procurement. The Bank i s engaging the authorities to address fiduciary concerns in specific areas where weaknesses have been identified and increasing supervision resources for operations at risk. The CAS includes assistance to bolster project management. TKe broader emphasis on strengthening governance puts the Bank's efforts into a strategic context. Argentina presents exceptional challenges to effective Bank support. A number o f important risks must be acknowledged. Concerns regarding fiduciary management, a lack o f engagement on structural issues (including investment climate and private sector participation), and a slowing .. 11 of the economy are important risks for which mitigating measures, including lending triggers, have been incorporated into the CAS. Executive Directors may wish to discuss, among other things, whether the assistance strategy correctly incorporates the lessons learned from the 2004 CAS and strikes the right balance between pursuingopportunities and mitigatingrisks. ... 111 I.INTRODUCTION A. Overview 1. Argentina's recovery from the economic and social crisis o f 2001-02, one o f the most severe losses o f income and downturns in living standards on record, has been impressive. After three years o f fast growth, GDP in 2005 reached the pre-crisis peak o f 1998, with per capita output expected to recover to peak levels in 2006. Export earnings are higher, tax revenues have increased substantially, fiscal accounts are in surplus, and the Government has restructured three quarters o f its debt in default. The recovery has been pro-poor. Poverty has been cut markedly from the depths of the crisis, but still remains above the level prior to the onset o f the recession in 1998. Unemployment has also fallen. Although informality remains widespread, formal employment is rebounding, withjob growth inthe formal sector beginning to outpace jobs inthe informal sector. Inequality, which has been on a long-term upward trend in Argentina, was exacerbated by the crisis and has yet to show a substantial response to the recovery. The social advances during the recovery have been from a low starting point and large segments o f the population continue to face great hardship. 2. The challenge for Argentina i s to build on the strong recovery to establish the foundation for sustainable, more equitably shared private sector-led economic growth over the medium term. This would represent a significant break with Argentina's history o f protracted slow growth, recurring periods of crisis and increasing social exclusion. Prudent macroeconomic policies have played a central role in the recovery. A successful transition to sustained growth will require, in addition to continued prudent macroeconomic management, a combination o f longer-term strategy and pro-active policies to promote private investment, expand social inclusion to tackle growing problems o f structural poverty and excluded populations, and strengthen governance under a sound institutional framework. The window for policy action is not open-ended. After remaining subdued in 2003-04, inflation accelerated to double digits in 2005. Many o f the factors that have contributed to the recovery-the normal and transitory effects of a rebound from crisis-are reaching their natural limit. The largely benign external environment that has prevailed inthe international economy over recent years cannot be counted on to be sustained. 3. Argentina's long-term interests will be well served by the development o f a longer term- strategy and policy framework that i s supported by strong institutions. The outline o f a new development agenda has emerged in recent years in which the Government i s assuming a more proactive role in addressing long-standing issues o f poverty and social exclusion, problems which are perceived to have been exacerbated by the policies o f the 1990s. Since the crisis, the Government has taken direct action in two areas. First, emergency social transfer programs for the poor have been extended to a significant proportion o f the entire population. Second, the state has become much more directly involved in decisions affecting the provision of infrastructure and public services, including the control o f tariffs and investments to increase access. While progress has been made toward establishing a credible policy framework in certain sectors (health and education), such progress has yet to be achieved in other important sectors, most notably, public services. 1 4. The main objective o f the IBRD-IFC Joint CAS i s to seek opportunities to build an investment partnership to support Government efforts to make the transition from emergency response and crisis recovery, with an emphasis on reducing the extent and severity o f poverty, to sustained growth with improved equity and reductions in structural poverty and an appropriate policy framework for private sector development. The three pillars o f the 2004 CAS' - sustained growth with equity, social inclusion and improved governance-remain valid, in fact even more so as the country shifts from a focus on crisis response to medium-term growth. In terms o f operationalizing the strategy, the Bank's approach, as it was under the 2004 CAS, will continue to be opportunistic in terms o f actively searching for areas o f consensus with the Government, and then developing these areas through knowledge and lendingwork. 5. The IFC proposes to complement IBRD's strategy in Argentina by providing long term financing and structured financial products to companies andprojects instrategic sectors, with an emphasis on groups expanding on a South-South basis and to export-oriented or export facilitating projects. The IFC will focus on a number o f key criteria when considering new projects, including corporate social responsibility (CSR) and sustainability, as well as the track record with respect to honoring contractual obligations. Strategic sectors include oil, gas and mining, agribusiness and forestry products; and the financial sector, with an emphasis on high impact projects such as housing and support o f export oriented small and medium-size enterprises (SMEs). The IFC will also consider on a selective basis projects in other highimpact areas, including the social sector and financial restructuring. While there i s a compelling need for investments in the utilities sector to support capacity expansion and growth, IFC does not expect to be active in this area until there i s satisfactory progress on the renegotiation o f public service contracts, the adoption o f a clear and stable policy framework, and the establishment o f appropriate conditions for private sector participation. 6. A strong and active partnership between Argentina and the international community, including the multilateral financial institutions, can help ensure a successful transition to sustained growth with equity. Inthis context, the CAS emphasizes: 0 A lendingprogram geared to builda full-fledged medium-terminvestmentpartnership. 0 Analytical work and other AAA to help reach consensus with the Government and assist inarticulating selected areas ofitsprogram. 0 Continued outreach to broader civil society. 0 Support for the private sector incoordination with IFC and MIGA. ' ReportNo. 27340-AR. 2 11. COUNTRYCONTEXTAND RECENTDEVELOPMENTS A. PoliticalContext 7. The Kirchner Administration has by and large maintained the broad popular support it enjoyed at the time of the presentation o f the previous CAS, in April 2004, when it was approaching completion of its first year in office. Strong economic growth, the promising recovery in social conditions, progress towards restructuring o f the public debt, movement on historically sensitive domestic political issues such as human rights, and an assertive stand with respect to international creditors and holders o f public services concessions, as well as in multilateralfora, have contributed to the administration's continued popularity. The President's party recorded a solid victory in the congressional election of October 2005. The victory included Buenos Aires province, which was considered the critical battleground as the nation's most populous and economically important province. This was the first electoral contest for the Administration since it took office in May 2003, and President Kirchner stated publicly before the election that he viewed the vote as amajor test ofhis governing stance. Presidential elections are next scheduled for 2007. 8, The Government nevertheless faces important political and social challenges, including restoring citizen trust in governance. There is a notable consensus o f findings from public surveys and analytic studies undertaken by domestic and international organizations indicating the degree to which the crisis undermined confidence inpublic institutions. B. Economicand Social Context 9. After three years of fast growth (averaging approximately 9 percent during 2003-05), GDP has recovered to, and in fact surpassed, the pre-crisis peak o f 1998 (Figure 1.a). The Argentine crisis was deeper than other recent crisis episodes (Figure 1.b). Per capita GDP as measured in Argentine pesos (Figure 1.c) i s projected to recover to its pre-crisis peak in 2006. Nevertheless, per capita GDP inU S dollars has declined to less than one half the levels reached prior to the crisis, to an estimated US$4,500 in 2005 (Figure lad),largely as a result o f the massive currency depreciation. 10. The Government's macroeconomic policies have played a central role in the rapid economic recovery, leading to improved competitiveness and confidence levels which have underpinned increases in exports, investment and consumer spending. Other factors which have contributed to the strength o f the recovery include the typical rebound effect, which was magnified by the exceptional depth of the crisis that left the economy with substantial excess productive capacity and record high unemployment, and a generally favorable external environment. 3 Figure 1: Output Collapse and Recovery a. GDP has recovered to pre-crisis levels. b. The Argentine crisiswas exceptionally deeo. I I Real G D P Crisis and Recovery in Selected Countries (inbillion ofAR$ at constantpricesof 1993,1997.2005) (4-quartersmoving average ofreal GDP, t-20 = 100) 1 320 1 I 150 140 130 I20 110 100 90 80 Lamporndunngtherims .-'rc+r' _ - I 70 I I I I I I , I I I I I I I I I , I I I : ,I I I I , I I t.20 1-16 t-12 1-8 1-4 I 11.4 tt8 -Argentma, FIQ02 *CbZ'Korea, Rep, t-4Q98 k4Q02 *Malaysia, F l Q 9 9 220 4 I -Uruguay, *Turkey, e4QOl 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source Ministy of Economy, Argentina. Source World Bank IFS and CcnualBanks G D P per capita in Real Terms GDPper capita In US% (basedon GDP at constantprices of 1993, 1997- 2005) (1997 2005) - 8,000 8,000 7,000 7,500 6,000 7,000 5,000 4,000 6 500 3,000 6,000 2,000 1997 1998 1999 2000 2001 2002 2003 2W4 2005 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source Ministyof EconomyandWorld Bank Source M~~llstrjEconomy and World Bank of 11, Macroeconomic policy since 2003 has emphasized tight fiscal discipline, improved external competitiveness and a rebuilding o f international reserves (Table 1). The Federal Government recorded a primary surplus o f 2.3 percent of GDP in2003, 3.9 percent in2004, and an estimated 3.7 percent in 2005. At the provincial level, a primary surplus of 0.7 percent of GDP was achieved in2003, increasing to 0.9 percent in2004, and is estimated at 0.5 percent in 2005. Inflation remained well under control in 2003-04, despite the massive devaluation during the crisis, although price pressures reemerged in2005 with inflation reaching 12.3 percent by the end of the year. The exchange rate was maintained ina narrow range around AR$2.9 to the US dollar through most of 2005, and is now trading in a range o f about AR$3.05 to the U S dollar. The devaluation o f the Peso has helped restore competitiveness, underpinned a sharp turnaround inthe trade balance, and supported abuildup ofinternational reserves. Another important factor in the reserve buildup was the suspension of most public debt service payments between December 2001 when the sovereign default was announced and June 2005 when the debt 4 exchange covering about three-quarters of this debt was completed. In early January 2006, Argentina prepaid 100 percent o f its obligations to the IMF of SDR 6.7 billion (US$9.7 billion) which reduced international reserves from approximately US$28 billion to US$18.5 billion. The Government has since pursued a strategy to restore these reserves, which by February had already surpassed US$20 billion with active Central Bank intervention. Table 1: Macroeconomic Indicators (inpercentage, unless otherwise indicated) 2001 2002 2003 2004 2005e National Accounts GDP real growth -4.4 -10.9 8.8 9.0 9.2 Investment/GDP 14.2 12.0 15.1 19.2 21.5 Prices Consumer prices inflation (e.0.p.) -1.5 41.O 3.7 6.1 12.3 Consolidated Public Sector Primary BalanceIGDP 1\ -1.2 0.5 3.0 4.8 4.2 O.W. Federal Government 0.5 0.7 2.3 3.9 3.7 Public Debt/GDP 2/ 53.7 149.9 137.9 124.9 85.8 Balance of Payments Current AccounUGDP 31 -1.2 8.5 6.2 2.1 2.9 International Reserves, US$ bn. 14.6 10.5 14.2 18.9 27.2 Social Indicators Unemployment 4\ 18.3 17.8 17.7 14.5 11.4 Real wage index -23.7 8.1 3.0 8.0 Poverty rate 5\ 38.3 57.5 47.8 40.2 33.8 Inequality 6\ 0.513 0.528 0.528 0.506 0.501 ~ ~~ eindicates estimated. 1\ As reported by the Ministry o f Economy. 2\ Public debt includes debt restructuringholdouts. 3\ Starting in 2002 the Current Account includes accrued interest on non-performing debt. 4\ There is a change inmethodology of calculation o f the unemployment rate starting in 2003. Unemployment rates reported in 2003, 2004 and 2005 include as unemployed the recipients o f the heads o f households program that are searching for ajob. Reported unemployment rates are as o f fourth quarter o f the year. 5\ Poverty rates reported in 2001 and 2002 are as o f October. Starting in2003 poverty rates are as o f the second semester. 6\ Gini coefficient, a higher value indicates an increase ininequality. 2001-2003 Gini are as o f May; 2004 and 2005 Gini are as o f the second semester. Source: Ministry of Economy and Production and WorldBank staf estimates. International Reservesfrom the International Financial Statistics. 12. The currency depreciation of 2002, the improvement in the terms of trade and the reduction in wages restored Argentina's competitiveness (Figure 2.a). The result, as was to be expected, was an increase in net exports (6 percent in 2002), reflecting, by and large, a sharp decline in imports. This rise in net exports boosted growth in the initial phase o f the recovery. After this initial spark, consumption spending started to expand, leading to a demand led recovery (Figure 2.b). The recovery in domestic demand generated a rebound in merchandise imports following the crisis-induced collapse in 2002. This rebound in imports has reduced the surplus of current account of the balance of payments; after peaking at a surplus of some 8.5 percent of GDP in2002, the current account surplus is estimated to have declined to the range o f 5 2-3 percent o f GDP in 2004-05 (Figure 2.c). Inparallel, exports have continued to grow, with merchandise exports almost 50 percent higher inUS dollar terms in 2005 than they were before the crisis. Figure2: GrowthPatternofthe EconomicRecovery a. Devaluation and real wage decline improved competitiveness. b. Domestic demand is now leading the recovery. Real EffectiveExchangeRate and Real Wage Indexes Contribution to Growth of Consumption, Investment (December 2001 = 100, 1997 2005) - and Net Exports (1997- 2005) lo I ' ,- - -.-. 5 - ', 0 - ..... 1 -5 - -Consumption 1 8 v 1 40 ] I =- - Investment 8 1 Net Exports ' 8 , ; -10 204 I 1997 1998 1999 2000 2001 2002 2003 2004 2005 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source lndecandIMF Source:Minisinof Economv. c. Imoort demand has brought down the current account surdus. d. The recovery has generated demand for labor. I Merchandise Trade and the Current Account LaborAbsorptionand Contributionto Growthby Sector (US$billion, 1997 2005) - 120 50 1 Educationand RetailServices MerchandiseExports 40 t 1 IC3MerchadiseImports I P w -' ( 0.5 1 1.5 2 5 -20 -40 - Public -20 J 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source:Minisby of Economy 13. The recovery has been characterized by a qualitative change in the structure o f the economy and the allocation o f resources. The currency depreciation was favorable to tradeable sectors, notably manufacturing. In addition, the reduction in labor costs that accompanied the currency devaluation and the recovery in domestic demand fueled growth in construction and retail sectors, These sectors, which have led the recovery, have been labor-absorbing (Figure 2.d). They have also been more intensive in the utilization o f less skilled workers than the sectors that were the most dynamic in the 1990s; the growth pattern o f the 1990s relied more heavily on higher skilled workers, for example, infinancial services. 6 14. The pattern of economic recovery has resulted in growth that has been pro-poor in that incomes o f the poor have generally grown faster during the upturn than the average for the population as a whole. As the sectors leading the recovery have employed more workers, unemployment rates have declined. Given the relatively highdemand o f low-skilled, often poor, workers, the recovery has also contributed to a downturn in the levels o f poverty and inequality from the historical peaks reached duringthe crisis. Unemployment fell to 11.4 percent (counting Jefes program beneficiaries that are participating in workfare and searching for employment as unemployed) as of the fourth quarter o f 2005 (Figure 3.a). Significantly, unemployment i s now on par with the level observed in 1998. The urban poverty rate dropped to 33.8 percent by the second half o f 2005, down from 48 percent observed in 2003 (Figure 3.b), but well above the level prior to the recession. Data on inequality tell a similar story. Figure 3: Social Outcomes of the Recovery a. Unemployment has fallen... b. ...underpinningdeclineinpoverty. Unemployment (inpercentageoflabor force, 1998-200544) Povertyand Inequality 034 , O J 0 i -New methodology. beneficiariesof HHpropm counted a4 employed -New methodology. bcncRciaricrof HHprogramthat are searchingfor n 49 I jobs count& as unwloyed 15. The reduction inpoverty during the recovery has been accompanied by improvements in broader social outcomes. Box 1 provides an update o f the poverty characteristics table presented inthe 2004 CAS, tracking the evolution ofkey social development indicators between2002 and today, Very importantly, the rise in infant mortality witnessed during the crisis (a first inseveral decades in Argentina) has been reversed, dropping significantly from 16.8 per thousand life births in2002 to 14.4 in2005. Health insurance coverage o f the social security system i s slowly rising again in parallel with the increase in formal sector jobs. Completion rates in secondary school are on the rise; though remain low inabsolute terms at only 61.5 percent. However, large segments o f the population continue to face great hardship and vulnerability. Children are at highrisk o fpoverty and youth are at highrisk o funemployment when comparedto other groups insociety; the poverty rate ofchildren is still20 percent higher andthe youth unemploymentrate i s 13 percentage points higher than the respective national averages. 7 Box 1: Snapshot of Poverty Characteristics: -ogresssince the Crisis End 2002 FirstSemester 2005 (or indicated) (or indicated) Reduction in formal private sector Formal private sector (salaried) employment employment by 13 percent due to crisis, rose by 4 percent since 2"dsemester o f 2003. Formalprivate sector representing one-fourth o f labor force. I-- 31 percent o f formal sector workers are poor. 13 percent o f formal workers are poor. 62 percent o f informal sector workers are 48 percent o f informal sector workers are Informal Sector poor. poor. Poverty rate for children (age 0 to 14) rose Poverty rate for children (age 0 to 14) is 56 from 45 to 70 percent over the 1998-2002 percent. period. Unemployment affects the youth and the aging Unemployment rate for the youth (age 16 to workers particularly hard. 25) i s 26 percent - 13 points higher than the overall unemployment rate. Social Protection and vulnerablegroups As crisis response, creation of Heads of Heads o f Household Program still large but Households workfare program (November job creation (and better controls) reduced rolls 2003 with 1.8 million beneficiaries). to 1.4million (February 2006). Unemployment impact limited as half o f participants inactive before joining program. Formal pension coverage declining (33 percent 32 percent o f population older than 65 without o f elderly without coverage in2001). coverage. Gross enrolment rate 90.4 percent at secondary Gross enrolment rate for children (age 12 - level (2003) but dropout rate 50 percent. 17) 91.6. Education Completion rate o f secondary school or higher o f 19/20 year olds 56.2 percent (2003). Completion rate o f secondary school or higher o f 19/20 year olds 61.5 percent. I Formal health insurance coverage only around 57 percent o f the population has formal health 50 percent end 2002, having been reduced by coverage. 1 12 percent during crisis as population lost insurance coverage together with formal sector Health & Nutrition jobs. Infant mortality rate rising for first time in 30 Infant mortality rate reduced to 14.4 (per years (to 16.8 per thousand live births in thousand live births) in2004. 2002). O f poorest quintile o f population, 60 percent These indicators remain unchanged. Public Services lack access to sanitation services, and 30 (water, electricify, percent lack access to water (Metropolitan sanitation) Buenos Aires). Transport infrastructure conditions Capital expenditures at the federal level on deteriorating due to deferred maintenance and road transport increased from 0.1 1 percent of lack o f financing for basic rehabilitation. GDP 2003 to 0.25 percent in2005 (estimated). During crisis, further delays in transport Aggressive program o f rehabilitation and investment, including national and provincial maintenance o f national provincial roads. roads affecting the poor disproportionately the Government finances public transport subsidy Public Infrastructure poor. Poorest quintile o f population dedicating to maintain tariff fixed innominal terms. and Housing important share o f disposable income for transport services in urban areas. Housing deficit for 1.2 million poor. Public Government has re-launched pro-poor housing housing construction for 120,000 people was programs, reaching 178,786 new housing Linterruptedduring crisis. starts, and 152,128 housing improvemen1 contracts, in 2005. 8 16. The economic recovery has been aided by a favorable international environment, Terms of trade have showed a positive trend, largely reflecting significant improvements in export prices, particularly soy and petroleum (Figure 4.a). The international financial environment has also been benign, with ample international liquidity. International interest rates remain at low levels by historical standards (Figure 4.b). Moreover, sovereign spreads for emerging markets showed a declining trend. The EMBI+ index declined from over 1,000 basis points in 1998, the year of the Russia crisis, to the 200 basis point range by the endof 2005. Figure4: InternationalEnvironment a. Terms of trade have improved, contributing to economic b. International interest rates remain at low levels by historical recovery. standards. International Financial Environment I1400 110 - ___ Terms of Trade 120 -- - - 8 -soy # * < * 110 - 100 - / 8 8 .. ......I O year US TreasuryBill Rate, lef? axis, annualpercentageyield] (-Emerging MarketsBondIndex Spread, rightaxis,basispoints 1 I 704 I 1998 1999 2000 2001 2002 2001 2004 2005 1998 1999 ZOO0 2001 2002 2003 2004 2005 Source: Minisbyof Economy. Source:Bloomberg 9 111. THE GOVERNMENT'SDEVELOPMENTAGENDA 17. When President Kirchner took office inMay 2003 he outlined the principal goals o f his administration in an address to the National Assembly. He stressed the need for continued economic stability with sustained growth in the order o f 4-5 percent such that would generate employment and enable real incomes to double in the space o f fifteen years. Mindful that the 2001 government default on public debt was the result o f excessive borrowing and faulty economic management, he pledged to follow prudent fiscal policies that would secure fiscal surplus on a consistent basis. In that context, special mention was made o f the need for tax reforms that would broaden the tax base, reduce special exemptions and increase tax collection. 18. At the same time, he envisaged a strong government role in guiding economic growth within a context o f "national capitalism ". Government would participate actively in the provision o f infrastructure, broadly defined to include housing as well as health and education facilities. Social services would be upgraded with the objective o f increasing both coverage and quality. And measures would be taken to address the corruption o f the 1990s. However, while acknowledging the need for a robust social safety net, President Kirchner was quite explicit in stating that "the problems of poverty cannot be solved by social policies but rather by economic policies ". The Government has been consistent inits pursuit o f these goals and articulate intheir elaboration in successive official documents and public speeches, including in the authorities' development vision described inAnnex A o fthis CAS. 19. A little more than a year after taking office, in June 2004, the Government submittedto the Bank (as part of the Economic Recovery Support Loan2), the Administration's development agenda, After a lengthy and comprehensive criticism o f the policies pursued during the 1 9 9 0 ~ ~ the document, ina section called "Guidelines o fthe longterm scenario", describes a vision very much in line with that set out to the National Assembly. The Argentine economy would be based on fiscal discipline and exchange rate competitiveness to achieve broader based growth. This growth, the document stated, would result in a "new configuration o f relative prices that would enable strengthening o f advances already observed.. .in the labor market, and., .in other social indicators". As has infact happened, the Administration anticipated that this new scenario would contribute to more labor intensive production and a broader distribution o f income. 20. Three months later, the Government reiterated these principles in the prospectus for its debt restructuring offer, which it submitted to the United States Securities and Exchange Commission in September 2004.3 It stated that the main goals o f the Administration's economic program are as follows. 0 To increase growth and solidify price stability through macroeconomic policy. 0 To increase spending on social programs and investments inpublic infrastructure. 0 To restructure Argentina's public debt and to achieve fiscal discipline at the federal and provincial levels with the goal o f achieving sustainable debt service obligations. 0 To implementtax reform measures designed to deter tax evasion. 0 To reform the social security system. Report No. 27271-AR. RegistrationNo. 333-117111. 10 0 To reach a sustainable revenue sharing systemwith the provinces. 0 To increase lending by strengtheningthe stability o f the financial system; phasing out o f certain bank regulations implemented during the economic crisis and conducting audits and strategic reviews o f the leading public banks to ensure their efficiency. 0 To increase the Central Bank's independence, while increasing its accountability in the supervision o f the financial sector. 0 To implement an inflation-targeting monitoring system. 0 To attract private investment by creating a predictable and efficient legal framework to restructure corporate debts. 21, The Administration has in fact pursuedmany o f these economic goals, although in a way consistent with its overarching principles o f an assertive role for government and an emphasis on social considerations. With respect to attracting investment, for example, the President frequently reiterates that Argentina needs infrastructure investment, but that such investment must be different in nature and result than the investment patterns o f the 1990s, and, as he said recently, have a "clear Keynesian and heterodoxy4vision that generates growth, employment, social inclusion and equity. 22. The Administration has been similarly consistent in the area o f social policy, Beginning in May 30, 2005, in marking its first two years in office, the Kirchner administration began outlining publicly a set o f ambitious goals, with clear and measurable targets, to be reached at the end o f its first term in2007. Chief among these goals is to reduce unemployment and p~verty.~ To reach these goals, President Kirchner has identified housing construction and improving the quality o f education as two key initiatives; he has also focused on the challenges for youth, particularly with respect to the high poverty rate among youth. Toward this end, the President has publicly called for broad reforms and new funding for education and technical training. In October, he submitted a proposal to Congress that called for lengthening the school day, eliminating illiteracy and increasing the accessibility o f computers and technology. The proposal also calls for a substantial increase in funding, with funds allocated by federal and provincial governments to education, science and technology to rise from 4.3 percent o f GDP in 2005 to 6 percent by 2010. 23. In the area of governance, the Kirchner Administration has prepared preliminary proposals for improved public sector management, including in 2004, a publication by the Ministry o f Economy and Production, "Argentina 21: Argentina Facing the 21st Century" `. This document contains a vision o f the state intendedto make the country compete and grow in the global economy o f the 21st century. It aims at improving the governance and the investment climate by strengthening linkages between the public and private sector, public and private investment and reducing barriers to investment. Emphasizing increased coordination between levels o f government for improved public expenditure management, it focuses on promoting October 27, 2005 (www.presidencia.gov.ar). The President as reported inLa Nacidn, May 22,2005. For the Government's most recent formulation o fits poverty and unemployment objectives, see Objetivos de Desarrollo del Milenio, Repliblica Argentina, Informe Pais, 2005. Argentina: Facing the 21st Century, Buenos Aires 2004 (www.jgm.gov.ar). 11 regional growth through the design of a policy on so-called territorial economic development to stimulate local economic development at the municipal and provincial levels. 24. A concise version of the authorities' development vision is also included inAnnex A o f this CAS: "Economic Policy Guidelines". In it, the Government restates the principles and priorities that it has identified over the past three years, and underscores the goal of promoting a strong state to foster equitable and inclusive development based on employment. To reach this goal, the document sets out a comprehensive agenda built on promoting investment, strengthening competitiveness, and revitalizing public institutions, including ensuring the stability o f the "rules of the game" to promote the private sector. The Government identifies key challenges as ensuring adequate energy supplies, lowering inflation, strengthening the country's ability to withstand external volatility, and consolidating the social recovery. 12 IV. DEVELOPMENT CHALLENGES:RISKS AND OPPORTUNITIES 25. The rapid recovery since the crisis provides Argentina with the opportunity to break with its history o f low growth and volatility to beginto reverse long-term trends of growing structural poverty and inequality. Seizing this opportunity will require determined action across a range of development challenges under the three pillars o f equitable growth, social inclusion, and improved governance that form the basis o fboththe previous and the new CAS. A. SustainableGrowth 26. Achieving high growth over the medium term i s a serious challenge for Argentina given its historical track record. While the fast growth over the past three years has helped to recover the ground lost during the crisis, Argentina's growth over the past 30 years has remained stagnant. After peaking in 1974-80, per capita GDP declined by 22 percent during the 1980s, increased by 42 percent through 1998, declined by 22 percent through 2002, and recovered following the crisis. All in all, per capita GDP in 2004 was about the same level as in 1974 (Figure 5.a), although it i s now close to the peak level recordedin 1998. Figure 5: LongTerm Trends inOutput and Inflation a. Incomeper capita has stagnatedover the past 30 years b. Argentina hasa history of highinflation Real GDP per Capita Consumer Inflation (1974= 100, 1974-2005) - 15 (Logarithmic scale, 1974 2005) 0000 05 Average 1974 2005 - 1000 100 95 10 85 1 75 0 In 1999-2001inflationwasnegative,averaging-1.1 percentperyear, andas a resultit can not be represented in a logarithms.Source: Indec. 27. A recently completed Bank study on sustained growth with social equity7, prepared in close cooperation with the authorities, presents a selected set o f government policies that have beenfound to be effective indelivering highgrowth. The report also examines their likely effect on poverty and inequality in Argentina. The pro-growth policies discussed in the study encompass: (i)fiscal policy as a cornerstone of macroeconomic stability, (ii) infrastructure investment to address existing and potential bottlenecks to expanded economic activity and exports, (iii) sector development to ensure a more favorable environment and attain a private more competitive position, (iv) trade policies centered on creating new trade opportunities for 'Argentina- SeekingSustainedGrowthandSocialEquity,ReportNo. 32553-AR, October 21,2005. 13 Argentina including in agriculture, and (v) education policies to build the skilled labor force needed for tomorrow's economy. Determinedaction on these policy fronts would help underpin the improved competitiveness following the 2002 devaluation and support the transition from economic recovery to sustained and equitable growth over the medium term. 28. Maintaining macroeconomic stability. Medium-term macroeconomic stability hinges on the continuation o f a sound fiscal position centered on sustained primary fiscal surpluses. This would represent a major change for Argentina. Between 1965 and 2001, the average primary fiscal balance on a consolidated basis (including the provinces) as a percentage o f GDP was negative 2.4 percent, and the overall balance was negative 4.6 percent. Fiscal deficits contributed substantially to macroeconomic instability in the past, as evidenced by Argentina's experience with hyper-inflation and boom-bust cycles (Figure 5.b) which have consistently hurt the poor and led to a ratchetingup o f the poverty rate (para. 40). Figure 6: Fiscal Performance,Inflationand Public Debt a. Fiscal performance has been solid both at the Federal... b....and at the Provincial levels. FederalGovernmentFinances Consolidated Public Sector Primary Surplus (as apercentageof GDP, 1997 2005) - (as a percentageof GDP, 1997 2005e) - PrimaryExpenditures 5 22 4 3 2 1 0 I -2 I 1997 1998 1999 2000 2001 2002 2003 2004 2005 1997 1998 1999 2000 2001 2002 2003 2004 2005e Source:MinisW ofEconomy. Source Minisby ofEconomyand WorldBank Consumer Inflation and Nominal ExchangeRate Public Debt 250- - - - 200 - - - -In US$billion,leftaxis CPI inflation, 40 -- left axis 200 . as a percentageof GDP, right axis .160 3o .--Nominal 2 5 Exchange Rate,right 150. - 120 axis 20 - * ? 9 8 8 I E '* I 100 - -.80 1.5 I I _ , "- ~ 1997 1998 1999 2000 2M)I 2002 2003 2004 2005 ~ 0.5 o I o 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source: MinisbyofEconomy. Source:Ministry of Economy. 14 29. Sustainingprimarysurpluses over the mediumterm i s inline the Government's policy o f fiscal discipline and will help underpin its objective o f maintaining a competitive exchange rate. Since the 2001-02 crisis, fiscal performance has been solid both at the federal and provincial levels (Figure 6.a and Figure 6.b). A continuation o f this strong fiscal performance will help contain the inflationary pressures that emerged in 2005 (Figure 6.c) which, in the context o f a broadly stable Peso, can result in pressure on the real exchange rate to appreciate. Prudent macroeconomic policies centered on sustained primary surpluses, and targeting low and stable inflation as well as the maintenance o f external competitiveness, will support debt sustainability as the country emerges from default (Figure 6.d). Primary surpluses are not only important to ensure that public debt declines as a percentage o f GDP in the long term, but also as a financing source in the medium term. The Government faces significant medium-term debt servicing requirements, despite the reduction in the public debt following the debt exchange completed in June 2005 and the early repayment to the IMFcompletedinJanuary 2006 (Annex B). 30. The improvements in fiscal performance have been achieved through a combination o f improved tax administration and the introduction o f specific export and financial transaction taxes in response to the crisis. Tax revenues have increased across the full range o f tax instruments, from income taxes to VAT (Figure 7.a). However, the export tax and the financial transactions tax have played a key role in the large primary surpluses recorded since 2003. The nature o f these taxes can have negative effects on growth, as they constrain the development o f the financial system and discourage investment in export sectors. The resources obtained from the export tax depend on the degree o f external competitiveness and developments in international commodity prices. Were relative prices to change, the result could put pressure on export tax revenues. Medium-ternmacroeconomic stability would be greatly enhanced were the Government to work towards to a strategy for reducing the dependence o f fiscal performance on export and financial transactions taxes. Figure7: FederalGovernmentTaxes and Expenditures a. New specifictaxesintroducedin the 2001-02 crisis are b. Government expenditureshave increased luivalentto the currentprimary fiscal surplus. significantly since 2002. Tax Revenuesas a Share of GDP I FederalGovernmentExpenditures (percentage, 1997 2005) - (shares ofGDP, 1997- 2005) 25 Trans. Exports 20 20 0VAT (net) 0Goodsand Services 15 8Profits I5 0Fuels 8Social Secui 10 0Labor 10 Transfers 5 0Imports 5 0Other 0 8Capital 1997 1998 1999 2000 2001 2002 2003 2004 2005 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source: Ministry of Economy. 1 Source: Ministryof Economy. 15 3 1. Federal and provincial governments have exercised discipline on the expenditure side as well, though primary expenditures have grown significantly since 2002 (Figure 7.b). Containing expenditures in the future may prove challenging. The Government is facing strong pressures for wage and pension increases, a factor that i s compounded by the reemergence o f inflation. Also, the Government will need to ensure the fiscal space to accommodate planned increases in capital expenditures, in particular for public housing infrastructure. The case o f Buenos Aires province, which according to preliminary data ran a small primary deficit in 2005 generated in large part by higher public sector wages, illustrates the nascent resurfacing o f spendingpressures at the provincial level. Figure8: InvestmentIndicators a. Productivity growth has been highly variable. b. Key sectors are operating at almost full capacity. ~~ Historical Evolution of Total Factor Productivity Capacity Utilizationin Selected Industries (Annualpercentagegrowthinproductivity) (As apercentageoftotal installed capacity, average 2005) 8 4 0 4 V 8 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 Food Textiles Paper Oil Vehicles Metals All Source: Mala and Kweitel(2003). Source: Indec. Refinery Industries c. InvestmentlGDP has recovered to pre-crisis levels... ....and itis close to regional standards. InvestmentRates Gross Domestic Fixed Investment (In percentage, 1997 -2005) I - .- - (as apercentageof GDP, 1997.2004) 24 ---- Investment / GDP (current prices) ' . . - * .........** .. ......-..._. -... . e -* I . e . 22 Investment / GDP (constant prices of 1993) -9 20 20 18 16 k 16 14 12 10 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 12 1997 1998 1999 2000 2001 2002 2003 2004 Source:Ministry of Economy. Source: IFS andWDI. InvestmentinArgentinaas reportedbythe Ministry o f Economy. 32. Meeting the investment challenge. Sustaining economic growth will require a combination o f higher investment and steady productivity growth. Achieving medium term 16 growth rates on the order o f 3 percent per year would require investment rates in the 20-22 percent range, assuming total factor productivity (TFP) grows at about 1percent per year. While higher TFP increases have been achieved in the past, zero, or even negative, TFP increases can not be disregarded as a possibility either, as these have also been observed through prolonged periods (Figure 8.a). Most dynamic sectors through the recovery period are already operating at near full productive capacity (Figure 8.b). Investment has recovered significantly since the crisis to an estimated level o f about 21.5 percent o f GDP in 2005; however, real investment, that is, investment measured inphysical units, still remains below the peak o f the 1990s (Figure 8.c). A t 1993 prices, estimated investment in2005 was about 20 percent o f GDP, which is lower than the peak o f over 21 percent in 1998. Argentina's current investment level i s converging to that o f other Latin-American countries (Figure8.d). 33. CZosing the infrastructure gap. It has long been recognized that an adequate supply o f infrastructure services is an essential ingredient for productivity and widely shared growth. Argentina's history, however, suggests that underinvestment in infrastructure has contributed to the opposite outcome-slowing growth and increasing poverty and marginalization. In the 1 9 8 0 public investment in infrastructure (defined as water and sanitation, transport, energy and ~ ~ telecommunications) averaged around 3 percent o f GDP. During the 1990s this fell to about one-half o f one percent, and by 2000 to one-quarter o f one percent. This collapse in public investment was only partially offset by private sector investment, which amounted to about 1.2 percent of GDP during this period (and o f this over half went to telecommunications), leaving total investment in infrastructure at about 2 percent o f GDP. The impact on Argentina's competitiveness has been substantial. Logistics costs, for example, are estimated to be the second highest in Latin America and nearly three times higher than the OECD average. Recent analysis' suggests that improving infrastructure stocks to the level o f the regional leader (Costa Rica) could result in an increase in the GDP growth rate o f 1.3 percentage points; improving stocks and performance to the East Asian median could add 3 percentage points to annual growth, The same study finds that it would have a similarly marked effect on poverty; the impact for Argentina o f improving its infrastructure performance to the level o f Costa Rica would be a reduction o f its Gini coefficient by 0.04. 34. Fundamental issues remain to be addressed to meet the investment challenge. The Government has taken steps to increase investment through real capital expenditures (largely allocated to infrastructure and public housing), and plans to continue to increase public investment in the future. However, private investment in specific infrastructure and public services sectors, especially those that expand installed capacity (e.g., electricity and gas), has not been sufficient to meet the requirementso f growing domestic demand and to sustain growth in the medium and long term. Concrete measures to restore the incentive framework for private investment in infrastructure and public services will be crucial, including completing renegotiations o f public service, re-establishing an appropriate regulatory framework, and diversifying the export base in both agricultural and other markets. In addition to the level o f investment, the historical trends in total factor productivity highlight the need for action to ensure the quality o f investment and the efficiency o f resource allocation ingeneral. This points * Calderon ~~ and ServCn, "The effects o f Infrastructure Development o n Growth and Income Distribution", The World Bank, 2004. 17 again to the importance o f an adequate incentive framework which promotes competition and helps align relative prices with underlying costs. 35, Restoring financial intermediation. While progress has been made in revitalizing the financial sector, which was devastated by the crisis, further strengthening i s necessary for the sector to order to play an effective financial intermediation role. The banking sector has recovered significantly since the crisis; deposits have been growing, bank profitability i s up and capital increases are helpingto improve solvency. The Government has eliminated withdrawal restrictions and has, to a large extent, completed the compensation to the banks for policy induced losses. Banking regulation and supervision are returning gradually to international standards. Consumer and commercial credit i s recovering, while asset quality has improved significantly. However, credit to the private sector i s still equivalent to only 10 percent o f GDP and the supply o f long-term credit remains low. Argentina can help complete the recovery o f the financial sector by strengthening the legal and regulatory environment to improve contract enforcement and creditors rights, and developing an institutional environment conducive to a climate of trust in financial intermediation(Annex C). 36. Enhancing the investment climate. Box 2: Ease of DoingBusiness Policymakers face major challenges to improve Argentina's investment climate and promote economy Ease of... rank private sector development. Streamlining Doing Business 77 bureaucracy and improving transparency are key challenges. The 2005 Global Competitive Index Starting a Business 85 by the World Economic Forum, for example, Dealing with Licenses 103 ranked Argentina 72nd out o f 117 countries, Hiring and Firing 132 while the Bank Group's publication, Doing Registering Property 65 Business in 2006 ranks Argentina 77thout o f 155 Getting Credit 42 countries in terms o f "ease o f doing business" Protecting Investors 51 (Box 2). These rankings put Argentina in the Paying Taxes 143 "middle o f the pack", andpoint to policy options for improvement. The private sector i s looking Trading Across Borders 43 to the Government to establish clear rules- Enforcing Contracts 91 including ending the recurring extensions o f Closing a Business 52 emergency legislation-ensure enforcement o f contracts, and remove unnecessary barriers to Source; "Doing Business in 2006. Removing Obstacles to business development. While some specific Growth", World Bank 2005. http://www.doingbusiness.orglEconomyRankingsl. initiatives have beenlaunched, a more concerted, broad-based strategy i s required to improve the productivity, quality and product mix o f Argentine exports; increase productive innovations; promote supply chain integration; stimulate linkages between large companies and small and medium enterprises (SMEs); and increase investment in R&D and innovation. Perhaps most important, substantial gains could be realized through determinedpolicy efforts to expand human capital through formal education and lifelong learning (Annex D). 37. Re-establishing a framework for publicbrivate partnership infrastructure and public services, The Government has taken steps to address certain basic infrastructure needs, such as road maintenance, but substantial new investment i s needed to expand the capacity o f energy, 18 transport, water and sanitation networks in order to avoid the emergence o f growth bottlenecks. Infrastructure investment, by boththe public and private sector, declined precipitously duringthe recession in the late 1990s and then all but collapsed during the crisis. While public investment has more than doubled since 2002, reaching 1.5 percent o f GDP in 2004, constraints on fiscal space and the Government's implementation capacity indicate that the role o f the private sector remains crucial. However, the private sector's participation innew investments ininfrastructure has been limited. Pending issues and delays in the renegotiation o f public service and infrastructure concessions are underminingthe incentives for broader private sector participation (Annex E). The Government's decision inDecember to extend the emergency law through 2006 delays further the re-establishment o f a functioning regulatory framework for public services and infrastructure. 38. Developing extractive industries. The challenge o f establishing an adequate legal and regulatory framework is exemplified by the contrasting situations in the energy and mining sectors. Although Argentina has large natural gas reserves (the fourth largest in the region) the country has experienced gas shortages since 2004. Price controls imposed duringthe crisis have kept prices low, promoting an increase in energy demand, outstripping supply. Argentina reduced gas exports to Chile, initiated domestic rationing, and began importing gas from Bolivia. The Government undertook measures to stimulate production, including establishing a new state energy company, incentives for investment indownstream infrastructure, and plans to eventually liberalize energy prices. However, these partial measures have not led to increased production. Industryanalysts believe that increasingdomestic natural gas supply will requiremore structural changes, notably reducing government intervention with a view to restoring a financially viable environment with long-term predictable rules. In the meantime, Argentina is expected to become increasingly dependent on external gas supply. The development o f the mining sector, on the other hand, has benefited from a stable legal framework supportive of private investment. Mininglegislation, for example, allows investors to apply for special benefits, including30-year stability intaxes on investments; duty-free imports o f machinery, spare parts and mining inputs; tax deductions and `value-added tax refunds on exploration investments; and a 3 percent cap on provincial miningroyalties. These incentives, combined with rising metal prices and the impact o f the currency devaluation, have helped to reactivate Argentina's nascent mining industry, including a three-fold increase in mininginvestments between 2003 and 2004 and a doubling o f its contribution to GDP since the crisis, from 2.5 percent in2001 to 5.2 percent in2004. 39. Moving towards sustainable agriculture and rural development. A stronger, more competitive agriculture sector hinges on strengthening national and regional institutions, particularly those responsible for agricultural technology, innovation, and finance. Stronger collective action i s also required to strengthen shared public and private interests, such as irrigation management, productive chains, and regional plant and animal health. Agriculture i s critical to Argentina both as a dynamic source o f export revenue but also as an entry point to address rural poverty and natural resource degradation. In 2004, the agriculture sector represented 9 percent o f GDP, and contributed 58 percent o f total goods exports (40 percent o f which was primary and 60 percent processed goods). When backward and forward linkages are included, the sector assumes even greater importance and employs about 36 percent o f the total labor force. Favorable market conditions in recent years have boosted production-grain production has almost doubled since the mid-1990s and reached 84 million tons in the 2004/05 season-but not without costs. Inthis context, resource degradation is a growing challenge for 19 Argentina, ranging from deforestation linked to the current soy bean boom, land degradation associated with poor water resources management, and environmental health issues related to pesticide management. Soy plantations have displaced native forests and traditional crops, with major environmental impacts and related effects on poverty. The Government has set out plans for land use management, forest conservation, and broader environmental protection. The Doha Round o f trade negotiations remains a critical pending issue, as its successful conclusion, including liberalization o f trade in agricultural products, would significantly expand Argentina's trading opportunities. Given the low labor absorption o f much agricultural production, mitigating high rural poverty levels will depend on continued growth in the non-traditional regional economies, both on-and-off-farm, and improved access to and quality o f rural education and other services. B. Social Inclusion 40. Reducing structural poverty. The economic recovery and political stability that have prevailed since the crisis place Argentina in a favorable position to begin to reverse the deepening trend o f structural poverty and inequality that has taken root in recent decades as the country endured successive periods o f economic turbulence. Indeed, a review Figure 9: Long Term Poverty Trend of the past thirty years demonstrates the effects o f high inflation and financial Poverty has ratchetedup with each crisis episode. turbulence on the poor, with poverty spiking before and dropping after each Urban Poverty Rate incident, but each time resulting in (1974 200.5) - 60 substantially higher levels o f poverty as compared to before the preceding crisis 50 - (Figure 9). Poverty stood at roughly 5 percent o f the population in 1980, shot 40 - up to 40 percent after the hyperinflation 30 - of the late 1980s before dropping to below 20 percent by the mid 1990s, 20 - increased to 25 percent after the Mexico devaluation in 1995, leveled off before 10 - trending upward after the Southeast Asian and Russian crises o f the late 1990s, and then exploded to above 55 percent in 2003, before falling back to 33.8 percent at end 2005. During each period o f recovery, poverty remained significantly above its previous levels. Inequality has followed a similar pattern with the Gini coefficient increasing from 0.42 in 1986 to nearly 0.53 by2003 before easing to about 0.50 in2005. 41. The effects o f crises have been particularly hard on the poor given the weaknesses inthe social protection system in Argentina. This was especially evident in the 2001-02 crisis, and underscored the importance o f addressing long-standing problems insocial protection. First, the system, as in other countries in the region, is fragmented, with programs aimed at different groups o f the population. These programs are inadequately integrated and coordinated with the 20 key institutions, resulting inoverlap, but much more important, gaps incoverage. Given the rise of informal employment over the past two decades (and again duringthe recent economic crisis), the proportion o f the labor force without access to social insurance has grown by nearly 30 percent since the early 1990s, representing nearly two-thirds o f workers by 2004. Expanding the reach o f social insurance coverage will be crucial for improving the effectiveness o f the entire social protection system. 42. Second, as a result o f the failure o f the formal social protection system, Argentina established other programs to provide protection to informal workers when unemployment started to grow in the1990s, and later in response to the 2001 crisis. Traditionally, such social assistance programs were relatively small in scope, and meagerly financed. The emergency Heads o f Household workfare program, established in response to the crisis, marked a larger scale and critical response, increasing coverage substantially (to 2 million beneficiaries in May 2003 and about 1.4 million today). The Government has defined a transition strategy based on the re-integration o f its beneficiaries into the labor market (through education, training and active employment policies) or to a conditional cash transfer linkedto families' investment ineducation and health services. A similar transitioning out o f the emergency mode i s still pending for the large food programs, which acted more as an additional income support mechanism than to attain nutritional objectives (Annex F). 43. Improving health outcomes. The Government has introduced important policy changes geared to improve Argentina's health indicators, which remain below comparable middle- income countries in the region. Life expectancy trails regional neighbors and inequalities in maternal and infant mortality between regions o f the country are pronounced. This performance has been due to a combination o f structural problems inthe health sector (i.e., fragmentation and lack o f coordination o f health policy among provinces in a highly federal country, delays at the provincial level to introduce incentives for providers to improve efficiency) as well as the impact o f the recent crisis on the availability of key inputs for the delivery o f essential health services (i.e,, vaccines and medications). The Government has implemented a wide range o f policy actions to overcome the challenges on boththe structural and inputsrelated issues (Box 3). Box 3: HealthPolicyInnovationsinArgentina Since 2002, the Argentine Government has implemented a wide range o f policy actions to overcome both the structural and the input challenges inrecent years. Such actions have included a substantial revision o f drugs policy to increase the availability o f generic drugs as well as an emergency provision o f essential drugs to the poor (Remediar program), Also, the Government achieved a significant break-through with the passing o f the Sexual and Reproductive Rights Law-the law provided the basis for a long awaited and much needed policy and regulatory framework. This is crucial as Argentina has one o f the lowest levels o f family planning among middle-income countries inthe region, particularly among the poor. Third, a revival o f the Federal Health Council (COFESA) took place and the council is now an effective coordinating mechanismbetweenthe federal and provincial levels. Lastly, and most prominently, the Government launched, with Bank support, the maternal-child insurance program (Plan Nacer). This program has been designed to respond simultaneously to the immediate health care needs o f the poor and introduce incentives for structural reform in the provider-consumer relationship at the provincial level through the use o f results-based fbding provided by the national Government. 44. Ensuring quality education for all. Argentina faces a complex policy agenda to ensure that all children complete quality basic education, while at the same time addressing the 21 challenge o f adult education. The system has done well in terms o f ensuring access to early childhood and primary education, especially in comparison to the region and other developing countries. However, repetition and drop-out rates remain high at the secondary level. On average, fifty percent o f students entering secondary school do not graduate; for families in the poorest population quintile, only one infour students graduates. Quality o f learning is a concern as manifested l o w scores on standardized assessments. Management and administration reforms, including policies for the development o f human resources at the provincial level, can help improve the effectiveness o f the education system. Financing and accountability reforms would address overlapping expenditure responsibilities between different government levels and link federal education funding (outside o f revenue sharing arrangements) to counterpart financing and specific results to be achieved by provincial administrations. 45. Towards greater social inclusion. Perhaps the greatest challenge facing Argentina, as the country attempts to move fkom crisis recovery to growth with equity, is to generate sustainable sources o f opportunity for the most marginalized groups in society. Social exclusion and marginalization have become increasingly acute. By end 2004, the national headcount poverty rate among children was 56 percent, reaching more than 70 percent incertain regions o f the country. Working women were less likely to have permanentjobs, and substantially less likely to be eligible for social security and employment offered health plans. As for indigenous people, the long history o f marginalization has contributed to poverty rates in excess o f two times the rate o f non-indigenous Argentines. There is no simplistic answer to the challenge o f creating a new generation o f economic and social policies and programs which, while responding to immediate needs, also move towards greater equality o f opportunity in Argentina (For additional information on Poverty and Social Development see Annex F, and for Millennium Development Goals, see Annex G). C. ImprovedGovernance Figure 10: Governance 46. Meeting the governance GovernmentEffectiveness challenge. Addressing long standing (2004) governance concerns in Argentina 4RGENTINA involves coordinated efforts across a range o f areas, including RUSSIA improvements in basic government effectiveness and efficiency, INDIA transparency and accountability, and M W C O in terms o f meeting the challenges o f Argentina's federal system. Three TURKEY clear challenges stand out: (i) I strengthen the efficiency and BRAZIL transparency o f public expenditure CHINA management; (ii)improve service delivery outcomes and restore citizen 0 20 40 60 80 100 trust in government; and (iii) the make Source: K a u h n n , Kraay and MastrulLi(2005): "Governance Matters IV public sector more responsive to GovernanceIndicatorj for 1996-2004". citizens and the private sector. 22 Governance has long been a major issue in Argentina with serious implications for both sustainable growth and social equity. While citizen support for the Administration remains high, buildingtrust inpublic institutions will take time and persistent political will; perceptions based on years, if not decades, o f experience will be hard to alter. According to WBI indicators, Argentina's governance and regulatory quality indicators lag behind the average for upper middle income countries (Figure 10); in particular, government effectiveness stands at 42.2 out o f 100, behind Russia, Turkey and China, and well behind its neighbors Chile (87), and Brazil (58.2), and Uruguay (68.8). 47. Modernizing the state Figure 11: Regulation administration. Although steady progress i s being made to put inplace modernpublic Regulatory Quality administration systems, the challenge i s to ( 2 W expand their coverage and, more importantly, integrate the use o f these systems into actual governance practice. INDIA The current Administration has eschewed a comprehensive approach to institutional RUSSIA reform at the national level, preferring a ~ CHINA more incremental strategy focused on I improving specific institutions as "islands TL'RKEY o f excellence". Over the past decade, financial management systems have been implemented in more than 50 percent of m c o public agencies, representing more than 80 percent o f central government expenditure; 0 20 40 60 80 100 parallel efforts are being undertaken at the Source: Kaufmann, Kraay andMastruzzi(2005): "Governance provincial level. Progress has also been Matters I V Governance Indicators for 1996-2004". made towards greater integration o f the budget accounting and treasury functions and-improvement of control systems. The Public Investment System (BAPIN) is now being implemented in over 110 national public administration agencies and 19 provinces, However, drawing the full benefit o f these investments inmodern public management information systems will hinge on further improvements in coverage and integration, together with a renewed emphasis on results orientation, and monitoring and evaluation. Regarding delivery o f public services, the incremental approach at the federal level has produced some concrete results, Institutional strengthening of the national social security administration (ANSES) has generated more than US$600 million in savings; the National Social and Fiscal Identification System project (SINTyS) has recorded US$128 million in savings through improved fiscal management and targeting o f social programs. 23 48. Towards greater Figure 12: Corruption transparency and public trust. The challenge for CorruptionPerceptionIndex Argentina i s to move (Scale: 10 = no corruption; O= highest corruption; 2000 2005) - beyond the perception and reality o f problems inpublic management and 3.0 accountability that over 4'0 years have contributed to persistent levels o f low 2.0 public trust. According to the Transparency International 2005 1.0 Corruption Perception Index, Argentina scores 0.0 under 3 (Figure 12), rating it 2000 2001 2002 2003 2004 2005 97 out o f 158 countries. The Perceptionsofthe degree of comption by bussmesspeopleand country authorities have stated their analysts.Source:InternationalTransparency. commitment toward more transparent and accountable public institutions, and indeed, some important steps have been taken, The creation o f a national anti-corruption office and o f similar bodies in some provinces, changes in control procedures and agencies, increasing use o f asset declarations by public employees, and growing use of the procurement register and the internet to publish procurement information all represent advances. The creation o f a Financial Intelligence Unit, a public agency responsible for collecting, analyzing and disseminating information on suspicious transactions which may indicate money laundering activities, i s also an important step. 49. Nevertheless, more needs to be done. Cross-cutting areas where the greatest transparency gains are to be made-such as competitive procurement, civil service, and public expenditure management-can produce results, provided there i s firm political leadership. Strengthening supreme audit institutions, the anti-corruption office, and social accountability mechanisms can complement these efforts. Normative changes, such as the ratification and implementation o f the UN Convention against Corruption, progress in the implementation of the OECD convention, and a framework for access to information and whistleblower protection, would help strengthen the legal framework for effective action and broaden alliances. Above all, as in all countries, concrete gains in transparency and the fight against corruption and money laundering depend fundamentally on sustained political will to translate technical changes into real improvements in administrative practice, together with outreach efforts to buildpublic trust. 50. Strengthening thejustice system. Improving judicial performance, as inmany countries in the region, continues to be a long-term challenge for Argentina. The return to democracy inspired significant efforts to improve qualitative and quantitative aspects o f thejustice system's performance. The federal and provincial authorities have increased judicial budgets, introduced new forms o f judicial governance, revised basic codes (most notably those governing criminal justice), and expanded the use of alternative dispute resolution. Argentine courts generally handle large caseloads, publish their decisions, and make available statistics on progress in keeping up with demand. Nevertheless, complaints about judicial performance-inefficiency, 24 delays, corruption, limited access, and politicization-continue. There is also a perception, based on disputes arising from the asymmetric peszjkation (Le,, conversion o f foreign exchange bank loans and deposits at different exchange rates) and other policies adopted during the economic crisis, that the system provides insufficient protection for property rights and contract enforcement. The legal community and other stakeholders have renewed demands for reform, focusing on fuller enactment o f the earlier legal changes and additional measures to increase efficiency and broaden access. Progress at the federal level has been uneven. Progress at the subnational level has also varied; several provincial judiciaries have reduced delays, expanded services, and adopted alternative disputeresolutionprograms. 5 1, Making the federal system work: decentralization and regional development. Unlocking the development potential o f Argentina's highly federalized system has challenged administration after administration. Important progress has been made in specific areas of state modernization at the provincial level, such as tax administration and financial management. The authorities are continuing to pursue this incremental approach where entry points exist, such as in sub-national public expenditure management, institution-building, and promotion of public private partnerships. In addition, limited initiatives have been taken in certain central government transfers, e.g., under the Plan Nacer for maternal and child health. However, the limitations with respect to the current Government's attempt to reform the revenue-sharing system (coparticipacidn) illustrates the difficulty o f introducing the more fundamental changes, particularly with regard to intergovernmental transfers, necessary to establish broad-based incentives for improved fiscal sustainability, service-delivery and competitiveness at the sub- national level. 52. The Kirchner Administration did achieve a potentially important step forward with the approval o f the Fiscal Responsibility Law in 2004, which establishes general rules for fiscal performance and for ensuring greater transparency in fiscal accounts. So far, 19provinces out o f 24 have voted to adopt the Law, representing over 75 percent o f total provincial spending. While the FRL could prove to be an important milestone, additional steps would be needed to address (i) lackofhardconstraints onsub-national spendingandborrowing, (ii)theexclusionof the important parts o f the budget (such as capital expenditures and IFI-financed expenditures), (iii) the establishment o f mechanisms to ensure sub-national budgets are consistent with aggregate fiscal objectives, and (iv) the continued ability o f provinces to pledge their co-participation receipts against future debt service. 25 V. MACROECONOMIC OUTLOOK 53. The strong track record o f three straight years o f high growth has instilled new confidence in the economy and reduced substantially the exceptional uncertainty o f the crisis period. The short-term economic outlook remains broadly favorable, with the main concern being inflation. The degree o f uncertainty increases markedly when considering the medium- term-outlook. Onthe one hand, increases incapacity utilization and other considerations point to the need for structural reforms to underpin sustained growth, in particular to consolidate the fiscal adjustment and promote investment in infrastructure and public services. On the other hand, the Government has not committed to these reforms and has become much more directly involved in decisions regarding the level o f investment and its allocation. A wide range o f macroeconomic outcomes i s therefore possible, depending in large part on what policies the Government actually implementsinpractice. Table 2: Government's Medium-termMacroeconomic Framework 2006 2007 2008 GDP growth, percentage 4.0 3.5 3.5 Investment / GDP, percentage 21.5 21.7 21.7 Federal Government Primary Surplus I GDP, percentage 3.3 3.4 3.4 Consumer Inflation, percentage, period average 9.1 8.1 7.5 Exports o f Goods, fob, US$ billion 41.3 44.4 47.3 Imports o f Goods, cif, US$ billion 31.5 34.9 38.0 Source: As reportedinthe 2006 FederalGovernmentbudgetsent to the Congress in October 2005. 54. The projections prepared by the Government in the context o f the 2006 budget, summarized in Table 2, serve as a useful point o f reference for characterizing the range of macroeconomic scenarios consistent with the base case program o f the new CAS. The 2006 Budget projections are consistent with the medium-termprojections in the "Economic Policy Guidelines" prepared by the Government for the CAS (Annex A).The overriding macroeconomic objective is to move forward with the transition from recovery to sustained growth. The Government i s projecting 4 percent growth in 2006, decelerating slightly to 3.5 percent in 2007- 08, This medium-term growth i s supported by a projected increase in the investment to GDP ratio to the 21-22 percent range and steady expansion o f external trade. The Government's growth forecast appears conservative, particularly given the strong performance in 2005, and actual medium-term growth could well be higher, notably if the Government were to strengthen its reform commitment. Private sector GDP growth forecasts for 2006 are considerably higher, on the order o f 6.5-7 percent'. 55. The Government is projecting a gradual decline in inflation following the re-emergence of price pressures in2005. The authorities have beennegotiating administrative price agreements BCRA Survey, January 2006. 26 with specific groups of producers and retailers. The authorities' view is that, within a broader anti-inflation strategy that includes efforts to stimulate investment and slow down the expansion o f private demand, these price agreements serve as a temporary anchor for expectations in the context o f inflation which they see essentially as a transitory process o f adjustment o f relative prices. The authorities also view the agreements as a substantial element o f the Government's income policy that contributes to limit increases in domestic prices for products which have benefited from temporary increases in international prices. For its part, the Bank is concerned that higher inflation reflects primarily excess demand, heled inter alia by the increase in primary government spending and the large increases in the money supply that have resulted from the partial sterilization o f foreign exchange purchases by the Central Bank. The money supply increased rapidly in nominal terms over the course of 2005-28 percent for currency in circulation and 26 percent for broad money (M2). Inflation expectations for 2006 are well above 10 percent. Inthe Bank's view, curtailing inflation will hinge on a tighteningo f macroeconomic policies - specifically monetarypolicy - inorder to ensure that aggregate demand i s aligned with supply, A keypolicy variable for maintaining macroeconomic stability over the mediumterm is the primary surplus which the Government projects to remain inthe 3-3.5 percent o f GDP range. 56. Based on the macroeconomic framework envisaged in the 2006 government budget (Table 3), financing needs o f the Federal Government are projected by the Bank to be on the order o f US$12-13 billion in 2006 and in the range o f US$13-14 billion p.a. in 2007-08. The financing o f these obligations under this baseline scenario would entail bond issues on the order of US$2 billion in 2006, rising to US$4 billion in 2007-08. The financing plan for 2006 incorporates a cash build up (pre-financing) o f some US$1 billion in 2005 as bond issuance last year exceeded financing requirements. As a result, the bond rollover rate i s projectedto be about 50 percent in 2006. ,Bond rollover rates would increase to some 100 percent in 2007-08, signaling tighter financing conditions over the medium term in the absence o f renewed policy lending from the IFIs. These projections reflect the early repayment in January 2006 o f Argentina's full US$9.7 billion outstanding debt to the IMF which effectively lowered the Federal Government's medium-term financing needs by over US$10 billion." lo As part ofthis operation, the Government issuedto the CentralBank a note with a ten year bullet maturity, denominated inUS dollars and paying an interest rate equivalent to the average yield o n international reserves. 27 Table 3: FinancingProjectionbasedon 2006 Government BudgetFramework (InUS$billion, 2006-2008) FinancingNeeds 13.0 13.6 14.1 Interest' 5.0 5.5 5.8 Amortization 1\ 8.0 8.1 8.3 FinancingSources 13.0 13.6 14.1 Primary Surplus 6.3 7.1 7.6 Bonds 2.0 3.7 3.9 Multilateral 2\ 2.8 1.9 1.8 O.W. IBRD31 0.5 0.7 0.8 Other 4\ 1.9 1.o 0.8 Memo items: Debt stock, percentageof GDP 5\ 78 72 66 Debtstock, US$ billion5\ 153 153 154 Debtservice, percentageof GDP 6.4 6.2 5.9 GDP, US$ billion 204 221 238 Rollover ratio, percentage 48 95 97 I\Includesmediumandlongtermbonds,repaymentstomultilateralorganizations,guaranteed provincialdebt, bilateraldebt, guaranteedloans, commercialbanksandobligationswith suppliers. BilateralDebt is assumedto berestructuredon Classic Terms (10 years maturity, 5 years grace, annualinterestrate 4.5 percent).Excludesearlyrepaymentof US9.7 billionto the IMFwhich was paidout ofCentral Bankreserves. 2\ No new IMFprogramis assumed. 3\ IBRDdisbursementsprojectedas inthe base case lendingscenariointhis CAS. 4\ Includesbilateraldebt, commercialbanks, suppliers, net advances fromthe CentralBank, net increaseinshort termdebt andprefinancing inthe order ofUS$1billionin2005. 5\ IncludesUS$23.6 billioninbondholdouts from the debt exchange for whichnorestructuringassumptionismadeinthis projection. Source: World Bank staff estimates based on the macroeconomic framework of the 2006Budget prepared by the Government. 57. Under the baseline projection, gross public debt would remain broadly stable through the CAS period in US dollar terms, and decline to the range o f 65 percent o f GDP by 2008. However, as with the macroeconomic framework itself, the degree o f uncertainty regardingthe public debt path and financing plan remains significant. Under a high case scenario where growth rates and the primary surplus were one percentage point higher than in the baseline and the real exchange rate were to appreciate 10 percent relative to the baseline, the projected debt would decline to the 55 percent o f GDP range by 2008 (Figure 13.a), and bond rollover rates in 2007-08 would be significantly lower (Figure 13.b). On the other hand, in a low scenario incorporating lower GDP growth and primary surpluses (1 percentage point below the baseline scenario) and 10 percent real exchange rate depreciation relative to the baseline, the debt to GDP ratio would remain above 75 percent by 2008 androllover rates would increase sharply. 28 Figure 13: ProjectedDebt and Rollover Requirementsbasedon the 2006 Government Budget Framework a. The degree of uncertainty regardingthe publicdebffGDP b. Rollover needs are also uncertain and could becomea ratio remainssignificant. risk factor. ProjectedPublicDebt/ GDP ProjectedBondRolloverRequirements (Percentage, 2005 2008) - 90 .....LowScenario SO 140 .` ,. 70 -2006 Government 60 -ReformScenario \ .....LowScenario 50 200s 2006 2007 2008 Source: World Bank staff estimates. 58. Argentina's recovery has been faster and stronger than expected, and substantial progress has been made in a number o f areas since the crisis, particularly with respect to the pro-poor effects o f the growth on lower poverty and unemployment levels. While the near-term outlook for continued growth remains favorable, given the continued uncertainty in the direction in which the authorities may steer policy, the medium-term outlook for sustaining growth cannot be assured, and the basis for policy based lending cannot be considered to be adequate at this time. 29 VI. THE BANK GROUP'S ASSISTANCE PROGRAM A. Rationalefor BankSupportto Argentina 59. The rationale for continued World Bank support to Argentina remains compelling, and is consistent with the Bank's strategy for assistance to middle income countries described in the Board Report, Enhancing World Bank Support to Middle Income Countries (SecM2004-0071). First, the Bank has a key role to play in helping Argentina-to the extent its policy framework can be supported-tackle a massive development agenda for sustaining growth, reducingpoverty and promoting improved governance. At nearly 34 percent of the population, poverty in Argentina i s high, and, after successive periods o f fast growth and deep recession, i s becoming increasingly structural. Moreover, this national average masks severe geographical and demographic inequalities. A visitor to Buenos Aires' broad avenues would hardly know that social conditions in some parts o f the country-including just miles from the capital city-are virtually indistinguishable from the poorest parts o f any area in the developing world. Tackling these problems will require substantial and sustained investments in many areas, and the long- term resources available from the Bank Group-including IFC-can be particularly relevant ina country that has suffered from a high degree o f volatility in its external financing. Second, the Bank remains an important global interlocutor with the Argentine authorities, and maintains extensive outreach to the private sector and civil society. The dialogue that has been carried out in relation to the 2005 study on sustained,growth and social equity suggests the value o f the Bank's global perspective to Argentina. As client research conducted for the CAS indicates, the private sector and civil society believe that the Bank can play a role as a neutral voice in the national debate on economic and social issues. Finally, with some US$7 billion in exposure to Argentina, the Bank has a large financial stake inhelpingthe country secure its future. B. Strategic Objectivesof the CAS 60. The overall objective o f the new CAS is to seek opportunities to build a medium-term investment partnership to support the transition from crisis recovery to sustained growth with continued poverty reduction and improved equity. Inthis context, the interventions are designed to advance the three pillars established under the 2004 CAS: (1) sustained growthwith equity, (2) social inclusion, and (3) improvedgovernance. To provide the kind o f cross-cutting and mutually reinforcing support necessary to achieve progress in these pillars, the Bank's interventions are designedaround three core principles which help anchor each proposed activity under the CAS to selected focus areas where it is expected that the Bank can make significant contributions. The principlesare: 0 The Bank's support is performancebased. The program has clear triggers, including portfolio Performance and fiduciary management, which will determine the level o f Bank lending. At the sector level, the quality o f the policy framework and implementation performance will determine the pace and extent o f new lending. At the project level, Bank interventions are designed around clear development outcomes and incorporate incentives to progress toward those outcomes. 0 The Bank's support is selective. The Bank is a relatively small player inArgentina. It i s therefore crucial to seek partners, and not claim results beyond the Bank's capacity to support change and deliver results. Where productive dialogue does provide 30 opportunities to affect sector policy more broadly, such as the health sector, the Bank will seek to leverage its impact, recognizing the inherent risks. 0 The Bank's support focuses on poverty alleviation. The interventions outlined inthe CAS are oriented to reach the poorest and most vulnerable populations; promote equality of opportunity; stimulate growth that i s sustainable, pro-poor and equitably shared; and strengthen governance and public service administration to improve access to public services by all Argentines inevery part o f the country. 61. As was the case in the 2004 CAS, the Bank will continue to seek engagement with the authorities across the full range o f development challenges, while providing lending and other support where there i s an adequate degree o f consensus on policies and objectives. To date, four specific areas, distributed across the pillars, stand out where the Bank has reached consensus with the Government on key policies and where the bulk o f new investment lending has materialized. These areas are: 0 Infrastructure, including (i)transportation, including road network management, rehabilitation and maintenance through performance-based contracts, (ii) water supply and sanitation targeting priority municipal level investments and maintenance with poverty criteria, and (iii) urbanflood and drainage. 0 Health, notably maternal and child health but also including support for broader sector reforms. 0 Income Transfer Programs, through support to the emergency Heads o f Household program and its transition towards a more streamlined and sustainable social safety net. 0 Public Sector Strengthening,particularly with respect to institutional strengthening at boththe federal and provincial levels. 62. The new CAS features significant new lending that aims to build on progress achieved in these four specific areas with a view to consolidating the investment partnership. This encompasses second phase APLs and other follow-up projects; it also includes new lending designed to expand the scope o f the existing consensus, for example, going beyond road rehabilitation and maintenance to broader sector issues in transportation. The CAS also incorporates investments in areas where new lending has started, or where active dialogue i s underway and consensus i s within reach. Key areas in this context include education, innovation, water resource management, rural development and the environment. Another strategic area the Bank i s trying to expand i s its direct lending to the provinces, as is the case with an urban flood and drainage project and in other infrastructure projects (for example, the closure of three provincial reform loans approved prior to the 2004 CAS and the preparation o f new investment operations inthese sameprovinces under the new CAS-see Section VII). 63. On important issues where consensus i s not yet in sight, the Bank will continue to monitor and seek to develop, or expand, active dialogue-with the aid o f analytical work as appropriate. The objective i s to establish the foundation for consensus and, where appropriate, possible new lending in the future. The Bank plans to maintain close monitoring o f macroeconomic developments; to open a dialogue on selected financial sector issues, e.g., cooperative and SME credit; and to expand engagement on poverty to address important issues o f informality and labor market dynamics, rural poverty issues and urban challenges, including water. 31 64. The CAS continues the strong emphasis on portfolio management and fiduciary control, with the level and pace of lending depending on government performance. The CAS includes targeted AAA to support the fiduciary action plan (Box 8), with CFAAs and CPARs (at both federal and provincial levels) as well as a ROSC envisaged during the CAS period. The program also features technical assistance to help build institutional capacity at the local, provincial and national levels. 65. Within the three pillars, Bank support underthe new CAS is concentrated on a limitedset o f core objectives which have emergedfrom the analysis of Argentina's development challenges, the progress achieved under the 2004 CAS-notably inthe four areas mentionedabove-and the CAS consultation process. The core objectives and the highlights o f Bank support are summarized below under each o f the CAS pillars. A more extensive presentation on the proposed operational program i s provided in Annex H. Indicative outcome indicators are presented inthe CAS Results Matrix (Annex K). 66. A CAS Progress Report will be prepared mid-way through the CAS period (end-FY 2007), evaluating progress toward the CAS objectives with respect to the overall program and results indicators. Based on this evaluation, the Progress Report would propose adjustments to the program as appropriate. Management also proposes to provide periodic briefings to the Board on ongoing economic developments and the medium term outlook. SustainedGrowthwith Equity 67. The CAS recognizes that the recovery achieved since the crisis has beennotjust rapid but also pro-poor. The Bank seeks to help to build on this progress and support Argentina's efforts to sustain equitable growth over the mediumterm. Inaddition, IFC and MIGA will complement the Bank's support for this pillar in their areas o f respective comparative advantage, as described in Section VI. The core objectives under the sustained growth pillar encompass: (a) infrastructuredevelopment with a focus on expanding access of the poor to basic services, (water supply and sanitation, urban transport, regional transport), reducing vulnerability to urban flooding and drainage problems, and removing logistics and transportation bottlenecks including an improvement o f the country's road system through performance-based management contracts to facilitate the expansion o f trade and growth; and (b) rural development and the environment with a focus on promoting agricultural growth, reducing rural poverty, and improving environmental management-all o f which stand out as critical and relatively unaddressed concerns. The growth pillar o f the CAS also features important initiatives to maintain and broaden dialogue including: (i) at the macroeconomic level, efforts to build on the positive results achieved through the growth and social equity analysis, and maintain close macro-monitoring;and (ii) re-establish a dialogue on the financialsector and the investment climate centered on selected issues related to restoring its financial intermediation role, as well as continue the on-going monitoring of financial sector developments. 68. Constructive dialogue and a broad degree o f consensus set the basis for moving forward on infrastructure development. The CAS program will seek to: (i)leverage the progress achieved in infrastructure, by scaling up support for transport asset development and management, expanding the road rehabilitation and maintenance program (at the federal and provincial levels) and broadening the scope o f Bank support to encompass regional transport 32 corridors, logistics improvements and urban transport; (ii) improve access to basic water supply and sanitation, and (iii) implement proposed interventions inurban flood protection and drainage at the municipal level, and develop an integrated water resources management strategy. In the context o f Bank support for infrastructure and public services, the Bank will ensure that appropriate steps have been taken to secure the economic and financial sustainability o f the operators, including resolution o f investor conflicts and establishment o f appropriate regulatory frameworks. 69. The Buenos Aires (BA) Province Sustainable InfrastructureDevelopment Project (SIDP) APL provides a good model for future infrastructure support at the provincial level, including a framework for ensuring sustainability. * The project i s improving the provision o f infrastructure services, including road rehabilitation and maintenance, water supply and sanitation, and flood prevention as a means o f supporting sustainable growth, alleviating poverty, and increasing social equity. Jointly with the provincial authorities, the project has supported the development and monitoring o f a fiscal framework to help ensure the sustainability o f the proposed investments, Other models, coordinated at the federal level (including national projects or provincial level projects with subsidiary agreements), will be implemented to improve infrastructure and reduce logistic costs (e.g., provincial roads and national highway assets through performance-based contracts executed by the private sector). The CAS includes possible lending for regional infrastructure including inter alia freight corridor upgrades and logistic node improvements which would tap into regional opportunities, expand productivity and lower logistic costs. Urbantransport interventions would aim to increase the mobility o f the urban poor and vulnerable groups. Additional lendingwill seek to build on these investments by focusing on support for municipalities inbasic services and transport. 70. In the area o f water, the Bank will continue to support strategic investments geared to improve access o f the poor to basic water supply and sanitation services as in the province o f Buenos Aires under the BA SIDP APL and in other municipalities across Argentina under the Basic Municipal Services 1 and 2 projects. The BA SIDP APL seeks to help expand water and especially sewage coverage by subsidizing access to approximately one-half million low income people living in areas o f high sanitary or environmental vulnerability. As has been the case with the BA SIDP APL, Bank support for water supply investments will continue to be based in a sound policy framework which provides for the economic and financial sustainability o f the operations. Flooding i s a major natural hazard for Argentina. The Bank has provided important support to the City of Buenos Aires with the Urban Flood Prevention APL, and will continue under the second phase to expand the assistance to other eligible provinces at risk. The project seeks to increase the country's resilience to floods through protection o f critical urban infrastructure, and to introduce a risk management approach to investments o f provincial and municipal governments. Key goals are to increase population awareness and preparedness to the threat o f floods as evidenced by improvements in flood protection levels, a reduction in the population living in areas at risk o f flooding, and a reduction in damage to properties by storms. Discussions have been held with the Government with respect to expanding the construction o f low-cost, self-help housing in flood prone areas generally inhabited by the poor. Broader river- '' For an update on the project, see Report to Executive Directors, Argentina: Buenos Aires Infrastructure Sustainable Development Project, Progress Report, SecM2006-0061. 33 basin wide planning and investments will be provided under the Integrated Water Resources Management project. 71. The CAS seeks to build on existing operations and promising dialogue on rural development and initial new lending on the environment into new areas o f investment partnership. The rural growth agenda encompasses supplemental financing under the existing PROSAP operation as part o f a regional program to combat foot and mouth disease. The longer- term strategy includes support under a follow-up operation (PROSAP 2) for expanded rural infrastructure, improved technical services to producers, and increased access to export markets through improved product innovation, quality and marketing. The rural poverty agenda includes targeted support to small farmers, community driven development (CDD) type financing to rural communities (including inindigenous areas), and the strengthening o f service delivery across the many agencies active in rural areas. The CAS also aims to support the Government's effort to strengthen the environmental agenda in Argentina. In this context, an Environmental Management APL i s planned that will provide strategic support to Argentina's brown (pollution), green (natural resources), and land use agendas. The APL will build on a Country Environmental Assessment, and will incorporate the use o f GEF and carbon finance resources to the full extent possible. It will also build on two targeted environmental projects: the Solid Waste Management Project approved by the Board in February 2006 and the Mining Decontamination Project for which preparation has been extended to allow for expanded consultations. Box 4: MainstreamingGlobal EnvironmentalFacility(GEF) and Carbon FinanceinArgentina The current World Bank GEFMontreal ProtocoVCarbon Finance program in Argentina amounts to six operations with a total funding level o f US$40.2 million. Operations take place in biodiversity, climate change, international waters, ozone depletion, and carbon financing o f municipal waste. Given Argentina's size and Government priorities, there i s potential for deepening the program. The Bank's GEF strategy inArgentina is to blend GEF-financed activities with Bank loans, not only to better leverage GEF resources but to better mainstream global environmental concerns incountry programs. The proposedBank program includes GEF co-financing in all rural and environment projects, including in the Environmental Management APL (in biodiversity, climate change mitigation and adaptation, marine resources, persistent organic pollutants, transport); Rural Growth and Poverty (sustainable land management), and Integrated Water Resources Managemenl (international waters, integrated ecosystems). There is one free-standing GEF project on Energy Efficiency in the pipeline. Regional GEF activities are focusing on both shared water (both surface and the Guarani aquifer) and terrestrial resources (grasslands) shared by the Mercosur countries. Finally, the Argentina decentralized medium- sized grants program (FY 2006-08), a world-wide GEF pilot, will finance the most innovative responses to national environmental priorities from civil society. The Argentine Carbon Fund was launched by President Kirchner in September 2005 in order to maximize the incorporation o f carbon finance inboth public and private sector investments. However, constraints remain before carbon finance can be substantially scaled-up in Argentina, such as the country's investment risk, limits o n the availability o f credit and institutional support from the financial sector, and the need to define a medium-term path for electricity tariffs. The World Bank i s supporting this activity intwo important ways: (a) technical assistance in the design o f the Fund and in the development o f carbon finance eligible projects (specifically, under the Clean Development Mechanism o f the Kyoto Protocol), and (b) offering to be the lead buyer for up to one-third o f the viable assets put on the market, especially inwaste management, agro-forestry, industrial and energy sectors. I I 34 PovertyReductionand Social Inclusion 72. The reductions in poverty and inequality that have taken place since the depth o f the crisis are welcome, but inboth cases current levels remain higher than before the recession, and higher than a decade ago. Much work remains to address the longer term trend o f increased poverty and inequality that has taken root in Argentina, and particularly with respect to the unique challenges facing rural areas, and o f marginalized groups such as indigenous, the elderly, and youth. The CAS emphasizes the following objectives: (i) supportingthe creation of more permanent safety nets and fostering employment, notably making the transition from emergency income programs to initiatives that foster employment and establishing more permanent safety nets geared to provide direct support to vulnerable groups; and (ii) better health and education outcomes by supporting efforts to improve health service delivery at the provincial level; and raise school completion rates and improve learning outcomes, especially for children from disadvantaged families. The social inclusion pillar also aims to deepen the dialogue on poverty through programmatic analytical work initially focused on informality, as well as continued work on the specific challenges inherent inaddressing rural andurbanpoverty. 73. The coming years will likely see a major shift to emphasize employment promotion policies while winding down emergency assistance programs. Inthe new CAS period, the Bank would support this emphasis through activities including implementation o f the Heads o f Household Transition project, which links income-support to beneficiaries participating in training and education courses as well asjob interviews and active employment search supported by municipal employment officers. To complement this, the CAS includes support for a national Lifelong Learning and Skill Improvement project which would aim to develop flexible learning opportunities for the unemployed and poor workers to acquire labor-market relevant skills. While many o f the current beneficiaries o f income support programs will be able to reintegrate themselves in wage-or self-employment, a more permanent safety net will be needed for the structurally poor in Argentina. Such a safety net would not only cover today's beneficiaries o f social assistance programs, but ideally would also reach out to the extreme poor that do not have access to such support (60 percent o f the extreme poor i s not covered). The CAS envisages Bank support for this restructuring o f the social safety net, as well as helping to address the particular challenges confronting the rural poor. IFC plans to back this pillar through "linkages" technical assistance that would enhance private sector development andjob creation inareas linked to IFC investments. 74. WBIplans to support this restructuring effort through a program o ftraining and "just-in- time" policy advice, aimed at drawing on best practice from around the world, including from the OECD countries. This will consist o f a combination o f awareness raising, consensus building, knowledge sharing and capacity development interventions. As a first stage WBI envisages sharing experiences and lessons learned from OECD and relevant middle income countries on safety net programs and supporting services designed to help household graduate out of poverty. The first stage would culminate ina highvisibility policy conference designed to initiate the reform process by raising awareness and gathering consensus around future orientations, In a second stage, WBI intends to design and deliver customized training courses and workshops targeted to key counterparts in the design, implementation and evaluation o f safety net interventions. WBI will also aim to facilitate access to experts and practitioners from 35 other countries for just-in-time "how-to" advice on design and implementation o f safety net programs. 75. The CAS seeks to buildon the success that hasbeenachieved inimproving healthservice delivery under the Provincial Maternal-Child Health SECAL and APL, with the second and third phases o f the APL to be combined into a single operation. The authorities have been successful in reversing the increases in the national rate of infant mortality seen after the crisis and the Bank's strategy aims to build on this outcome. Closely complementary, new lending for an EssentialHealth Functions project i s proposed that would replicate the incentive and governance structures introduced under the Plan Nacer to public health functions at the provincial level. To help Argentina improve access and raise the quality o f rural education, the Bank recently approved a Rural Education Project. This project supports the strategic orientation o f the Government in(i) establishing results-based contracts between the national andprovincial levels; and (ii)linking funding at least partially to results. Looking forward, the CAS envisages a Provincial Preschool and Basic Education project which would finance results-oriented preschool and basic education investments in poor areas o f one (or potentially two) o f those provinces with the largest education needs. ImprovedGovernance 76. The Government has committed to strengthening public sector performance within Argentina's strongly federal system, with a view towards improving the effectiveness o f basic service delivery, and building transparency and trust. The CAS seeks to support these twin objectives primarily through building on the notable progress achieved in Bank support for institutional strengthening at both the national and sub-national levels. New investments would be complemented by analytical work on intergovernmental fiscal relations, fiduciary management (CFAA) and possibly economic work at the sub-national level. Initial steps to establish a dialogue through ongoing AAA could also lead to support for strengthening the judiciary to help improve the accessibility, impartiality and effectiveness o f the justice system. Should the dialogue result inconsensus on needed reforms, WBI would support the reform effort through an action-learning program to address topics such as: the role o f the judiciary in improving government performance; the role of the judiciary in fighting corruption; mechanisms for promoting judicial independence; and mechanisms for promoting effective and equitable access to justice for all. 77. The CAS will seek to both broaden and deepen the emerging investment partnership in favor of institution strengthening in selected areas o f public sector management including expenditure management, transparency, and service delivery. The Bank will continue its support of projects that have delivered concrete results in specific institutions at the national level, such as the work on the National Social Security Administration (ANSES2), and the National Social and Fiscal Identification System project (SINTyS, APL2). Support at the sub-national level would continue to operate through two channels: (a) institutional support for public expenditure management in the context o f direct provincial investment loans building on the model o f the Buenos Aires Province APL, and (b) support for broader public sector management initiatives in selected provinces under stand-alone operations following up on the Sub-national Governments Public Sector Modernization project. The latter, approved in December 2005, aims to improve the institutional capabilities o f provincial governments to effectively manage their resources and 36 implement sound fiscal policies, while also improving the quality o f service delivery to citizens and creating better conditions for accountability and transparency. Public sector strengthening will be further supportedby the Governance 21 and Basic Municipal Services (1 and 2) projects; the former includes investments to expand the integrated financial management information system (SIDIP) at the national level and the public investment management system (BAPIN) at the sub-national level, while the latter includes institutional support to improve service delivery at the local level. 78. Support for these projects will be complemented by WBI learning programs focused on building capacity of municipal governments. Programs will include the "municipal headstart" program, which i s targeted to newly elected mayors and their teams, and has been used successfully in other countries to improve quality o f public sector management at local level. WBI will also facilitate sharing o f relevant experience from other countries in the Region, looking, inter alia, at initiatives such as Brazil's fiscal responsibility law, and Mexico's system of municipal planning councils which have been successful in professionalizing public administration at sub-national level. The CAS will also seek to help the Government improve and harmonize social sector statistics as they relate to monitoring Argentina's progress in achieving the MDGs and other social objectives. The national statistical agency has expressed interest in Bank support, possibly through a statistical capacity buildingprogram (STATCAP), and this request is under discussion with the Government. WBI will work with the Government to establish a baseline for benchmarking and monitoring progress on improving governance at both national and sub-national level. Depending on results o f a review o f available data (from Government and from civil society groups such as Transparency International), WBI may recommend a country governance diagnostic survey effort, which can form the basis for an action plan. C. The Bank's Analytic Agenda 79. As indicated above, the Bank will seek to support Argentina with investment operations where engagement with the authorities has been strong, such as in the health sector, and where there i s substantial agreement on approach. In those key areas where engagement remains undeveloped, such as macroeconomic policy and the financial sector, or where there are opportunities to deepen the engagement, such as poverty, the Bank will seek to develop analytical products that could open the way for new or broader dialogue, while continuing to monitor progress. The report "Seeking Sustained Growth and Social Equity", which was prepared in coordination with government authorities and others, i s an example. Key areas o f analytical work planned for the CAS include the following areas, which underpinthe CAS pillars and advance the Bank's understanding o fthe country incrucial areas: 0 A programmatic poverty assessment will build on the success o f the growth with equity study, The study will be a three-phase programmatic approach focused on the links between informality, poverty, and inequality. The first phase involves an in-depthstudy of trends o f informal employment, characteristics o f informal firms and workers, its determinants and welfare implications. The second phase i s expected to focus on issues related to rural poverty and policy options which will require new household survey work inrural areas. The third phase is envisaged to focus on urbanpoverty issues including 37 access to basic services such as water supply. Additional outputs o f the programmatic poverty assessment include regular poverty monitoring and dissemination events. 0 A programmatic social protection study will analyze policy options to support the transition from the Heads o fHousehold program to a more permanent social safety net. 0 An Institutional and Governance Review (IGR), nearing completion, looks at the experience o f public sector reform at both the national and provincial level to identify where significant progress has been made and where impediments have proved to be an obstacle to progress. WBI will support the IGR effort by drawing on lessons from other countries and assisting with dissemination. 0 A study on environmental management in Argentina using the Country Environmental Analysis approach will aim to provide a better understandingo f the economic impacts o f degradation. It will seek to offer a systematic framework for assessing costs and benefits and a strategic approach for establishing national policy and investment priorities. The study can also serve as a useful instrument for dialogue with Government and civil society on environmental management issues across sectors. 0 Economic and sector work at the provincial level will center around Provincial Economic Memoranda combining public expenditure analysis with growth and poverty studies. 0 Analytical work and monitoring o f the fiscal space for public investment and social programs will build on the progress achieved under the previous CAS with establishing fiscal frameworks under Bank operations to support public investments ,at the provincial level. 0 Other identified studies aim to meet Bank core fiduciary and corporate responsibilities, i.e., the proposed CFAAs, CPARs, and ROSC. D. Civil Society Strategy 80. After close and ongoing dialogue with civil society throughout the country, the Bank i s focusing its outreach efforts with civil society on the two themes o f Youth and Transparency. These subjects have emerged as central to the Bank's interlocutors over recent years, including in the CAS consultations for the 2004 as well as the 2006 CAS. The Bank's work on youth builds on extensive experience in supporting civil society organizations working with young people in Argentina and throughout the other countries o f the Southern Cone (Chile, Paraguay and Uruguay). The most important o f these past initiatives were the Development Marketplace in2005 andthe Small GrantsProgram 2004. Currently an ESW on Youth inArgentina is being undertaken. The challenge going forward i s to find new ways to support and interact with young Argentines to think together on the key issues, especially employment-a major concern for Argentina's young people. Ongoing and proposedprojects aim at a closer interaction with youth and at providing venues where youth can express their views. 81. The other key issue that emerged in the Bank's outreach to civil society is transparency and governance. The Bank will seek to build on its partnership with civil society in this area through varied approaches. One is through the Small Grants Program, "Promoting Transparency", which will support activities that empower citizens to take initiatives to enhance and influence development outcomes. This year's initiative seeks to identify innovative projects of civil society organizations that promote transparency and social accountability. Another key initiative will be to involve the participation o f civil society inthe implementation o f the Bank's 38 Fiduciary Action Plan (Box 8). How governments secure and spend Bank financing has been a major interest o f civil society groups and a consistent theme o f past consultations. Bank staff have initiated discussions with a key NGO, Poder Ciudaduno, to utilize the model pactos de transpurencia in World Bank financed procurement. The Bank will continue to work with civil society to increase the availability o f information and ensure that NGOs' can effectively monitor the transparency o f biddingunder Bank financed projects. WBI will complement these efforts through learning programs on social accountability and citizen oversight aimed,at enhancing the role o f civil society in promoting transparency at both federal and sub-national level. A key emphasis will be on preventing "clientelism" insocial programs and cash transfer schemes. E. CAS PreparationProcess andLessonsLearned 82. CAS Completion Report. The CAS Completion Report (Annex L) notes that the significant shift from development policy lendingto a predominantly investment-led strategy has been successful, but has also posed challenges for the Bank and the Government. The 2004 CAS explicitly acknowledged that this shift would test the Government's limitedproject management capacity. The Bank will continue to work with the authorities to identify possible areas where staff can partner with the Government to improve its project implementation capacity. Efforts are underway to integrate in a phased manner enclave project implementation units (PIUS)into regular line units within the public administration. 83. The CAS Completion Report also notes that the abbreviated 20 monthperiod o f approved lending under the 2004 CAS has proven to be sub-optimal with respect to the development o f the investment project pipeline. Inthe period 2004-05, Bank staff were able to develop new projects insectors where there were ongoing operations. The operational strategy made use of the APL as an instrument that would enable the Bank to work within the limited resource envelope corresponding to a short period o f lending authorization. A strong project pipeline requires the adoption of a medium term perspective and to work on a broad front with multiple initiatives. Implicit in this i s a CAS envelope o f sufficient size and forward vision that would allow for longer-term planning on the part o f the Bank and the Government. 84. The CAS Completion Report also notes that policy dialogue on overall economic management between the Bank, the Ministry o f Economy and Production, and other core ministries of the Federal Government has been minimal except for useful meetings held with senior level authorities in mid-2005 in connection with the findings o f a Bank study on growth and equity. In addition the private sector has been receptive to a dialogue with the Bank. The Bank will continue to seek opportunities for engagement at all levels o f government and with the private sector. One entry point i s to identify analytical work that responds to the interests and needs of government counterparts and o f the private sector. 39 Box 5: Findingsof the Client Research Client Research:MainFindings andLessons T o better understand the environment in Argentina and how the World Bank is perceived by its main interlocutors and other stakeholders, the Bank commissioned two research tools to be carried out prior to preparation o f the CAS, a client survey o f Bank stakeholders and interviews with leading opinion makers from politics, business and the media. Below are some key findings (see Annex Ifor more detail). The bulk o fthe data below comes from the wider client survey, but inmost cases those findings were supported by the qualitative interviews. Familiarity: Respondents knew the Bank fairly well. Some 65 percent o frespondents hadthree or more years experience working with the Bank, while an additional 20 percent had between one and three years. It should be noted, however, that the interviews that formed the basis o f the qualitative survey reveal that for many respondents, particularly those with limited direct experience working with the Bank, the extent and accuracy o ftheir knowledge o f the Bank varied. Where is Argentina? Some three quarters o frespondents said that Argentina is "currently headed in the right direction". Those from government were substantially more optimistic than those from the private sector and civil society. Growth Priorities: Respondents to the survey identified education and infrastructure as the two leading priorities for sustaining the rapid growth. Development Priorities:Expanding the question to "development challenges" more broadly, 44 percent o f respondents chose job creation as the most important or second most important priority. Poverty reduction, education and governance dominated the remainder o f selections. The Bank Group's Role: There was strong consensus that the Bank should provide financial resources for education, infrastructure, and governance; and to stay involved. More than 80 percent o f respondents believe that the Bank should maintain or increase its level o f involvement inArgentina. Effectiveness:The survey rating was relatively low for overall effectives (5.6 out o f lo), and there is a disconnect between what the Bank is perceived to be good at (infrastructure, health) and what boththe Bank and respondents together believe i s most important (poverty reduction, corruption). Lessons: The Bank suffers from an image problem as a result o f its association with the policy orientation o f the 1990s. Nevertheless, respondents want the Bank to work on challenges raised in the survey, such as the issues o f overall effectiveness and with respect to the priority and effectiveness mismatch in particular. It should also build on its perceived strengths, including through continued investment in infrastructure, health and the environment. Finally, clear - - opportunities exist to strengthen ties with the private sector and civil society. I CAS Consultations 85. Inaddition to its regular contacts with NGOs, private sector and academia, inNovember 2005, the World Bank carried out five CAS-specific consultations with civic leaders at the regional and national level together with a network o f Argentine NGOs (GTONG). The Country Director and other senior staff met with business associations, trade unions, religious leaders, journalists, NGOs, private sector representatives and academics to explore the priorities civil society see as crucial for Argentina's development. The consultations provided the team with a wide range o fperspectives on key areas, and insight into where the Bank can be most strategic in its support, including open and frank input with respect to the limits o f the Bank's role. These discussions build on the extensive consultations held throughout Argentina in July and August 2003 inpreparationfor the CAS that was presented to the BoardinApril 2004. 40 86. Following are some o f the salient and common opinions expressed during the consultations. Two things stand out about the common themes that emerged from these consultations. First, they are broadly consistent with the ideas and guidance expressed in 2003 (see Annex E o f 2004 CAS). Second, they also complement the themes identified in the client research conducted for the present CAS (Annex I). 87. One key sentiment expressed by many o f the participants was that the Bank would be most effective by supporting Argentina's development agenda, rather than implementing a recipe of reforms developed in Washington. In the same context, while welcoming the Bank's contribution to the economic and social discourse inArgentina, many participants suggested that the Bank exercise caution innot dominating the discussion. Others indicated that a more subtle role would help prevent against knee-jerk resistance to positions, solely because they are associated with the World Bank. This discussion was linked to the Bank's operational role, with an overwhelming number o f participants arguing that the Bank should limit support to specific investment operations and less, if at all, to development policy lending. 88. Interms of where the Bank should provide support, participants from across the country and among the different groups identified education and support for small and medium enterprises (SMEs) as the two most important priorities for the Bank. Support to education should focus mainly on the quality o f the system, and should address primary, secondary and tertiary. Support to SMEs is seen as keyto promote employment creation and to start developing innovative links to enhance production. Access to credit and technical support were mentioned as the key areas most needed by SMEs. 89. On more specific issues that relate to the Bank's portfolio, the Bank's support for infrastructure development was widely welcomed, as well as the assistance to the income support programs; the latter was extremely highly regarded as a major contribution, especially in the poorer provinces o f the northern part o f the country. Moving forward, many participants asked the Bank to focus on employment creation in order to achieve real social inclusion for the beneficiaries o f cash transfer programs. 90. Participants also welcomed Bank support for the environment, as well as assistance to indigenous people and other marginalized groups. One interesting comment that emerged throughout the consultations was the multicultural nature o f Argentina and how development . policy needs to take this into account to prevent social exclusion and inequality. Related to this in the minds o f many o f the participants was the need to address pension and social security concerns. The Bank, it was widely thought, was well suited to establish this concern on the country's agenda. 91. ICSID was mentioned a number o f times due to the economic impact that awards rendered against Argentina might have for the country. There i s also a limited understanding o f the ICSID dispute settlement mechanism and an impression that Argentina might face serious 41 challenges inthis context. There i s finally a perception that civil society has no role or voice to present inthis forum12. 92. Overall, many participants felt that the Government has failed to articulate where the country is heading in the medium term, in contrast to optimism regarding the short-term. One common theme was the sense that many felt that although the country recovered well from the crisis o f 2001-02, it was not clear what lie ahead or whether there was a strategic orientation for the development of Argentina. There was broad agreement o f the need for a highly federal country like Argentina to establish a strategy with strong participation of the provinces. In this context, there was strong and broad support for the Bank to work more closely with the provinces. Finally, as was the case in the consultations leading up to the 2004 CAS, transparency, and governance more broadly, were prominent on the minds o f the participants, both in terms o f monitoring the use o f funds under World Bank projects and by demanding a need for the Bank to finance and support institutional development. F. Indicative IBRD Program 93. Table 4 summarizes the Bank's proposed lending and ESW program for the CAS period. The specific investment projects to be supported and the studies under the ESW program may change as the Government fine tunes its priorities for Bank support. l2Only inone ICSID case regarding Argentina has a group of non-governmental organization requested participationas a third, interested, party. The Tribunal inthat case, ina decision issued inM a y 2005, acknowledged ICSID Tribunal's inherent power to accept such requests, provided compliance with certain requirements. 42 Table 4: IBRDIndicativeProgramSummary (I ie Case) LENDING ECONOMIC& SECTOR WORK Fiscal vear Proi ID UWM) Onpoint Studies in Italics DrogrammaticPoverty I (Informaliw) ~~ 2006 AR Governance21 $25 AR UrbanFloodPrevention(APL2) $70 31d Age Weyare and Social Security AR Basic Municipal Services 1 $110 Logistics and Transport Sector, Competitiveness 'nfrastructure Finance Sural Strategy Total FY 2006 $205 htitutional Governance Review 2007 AR Provincial Agricultural Development(supplemental financingfor PROSAP) $30 AR Mining Decontamination(PRAMU) $35 AR CordobaProvincial InvestmentLoan $75 Youth at Risk AR Santa Fe Provincial InvestmentLoan $125 CFAA (Federal Level) AR Catamarca Provincial InvestmentLoan $25 FiscalSpace for Public Investment AR Maternal-Child HealthInsuranceFunctions (APL2+3) $300 ProgrammaticPoverty2 (Rural) AR EssentialHealthFunctions $200 ProvincialEconomic Memorandum 1(Central Region) AR StateModernization2 $25 CPAR (FederalLevel) AR Provincial Preschooland Basic Education $100 ROSC AR Urban Public Transport $200 Total FY 2007 $1,115 2008 AR SINTyS (APL2) $15 Programmatic.Poverty3 (UrbanandWater) AR Environment Management(APL1) $75 ProgrammaticSocial Protection (Options to Transition from Heads of HouseholdProgram) Provincial Economic Memorandum2 (Northern AR National Highway Asset Management(APL2) $200 Region) AR BA SIDP (APL2) $150 Country EnvironmentalAnalysis AR Income Support for the Poor $300 Policy Notes AR Infrastructure(LogisticsNode of Rosario Port) $100 CPAR (Provincial Level) AR ProvincialAgricultural Development(PROSAP 2) $150 CFAA (Provincial Level) AR Lifelong Learning $100 AR IntegratedWater ResourcesManagement(APLl) $100 Total FY 2008 $1,190 2009 AR Provincial Roads 3 $150 Provincial EconomicMemorandum 3 (Buenos Aires) ImpactAnalysis of Reformin Educationand Health AR Infrastructure (Freight Comdors) $175 Sectors AR Environment ManagementAPL2 $75 Social Accountability AR Sub-NationalGovernmentsPublic SectorModernization 2 $40 Private Sector Development AR Early Childhood Development& Community Services $90 Energy Review AR Innovation $100 Innovation Study AR Basic Municipal Services 2 $60 Financingof Development AR RuralPoverty& Growth $70 AR ProvincialPublic MgmtLoan $30 Total FY 2009 $790 Overall Result $3,300 43 G. IBRD Portfolio Performance 94. At the time the Boardconsidered the 2004 CAS, the Bank and the Government were well advanced in tackling the serious problems in portfolio performance that arose from the crisis, most notably a substantial drop in disbursements and over half o f pending commitments being classified as risky. This required intense collaboration with the Government on almost every area o f portfolio management, including ensuring adequate budgetary allocations and resolving numerous project restructurings. 95. The results have beeninline with the targets that were set for the 2004 CAS with respect to the investment portion o f the portfolio. Disbursements have followed the high case scenario, with the average disbursement ratio for FY 2004-05 in the range o f 40 percent of undisbursed commitments per annum, Le., substantially above pre-crisis levels. The portfolio i s also stronger. The percent o f projects at risk by amount was reduced from 84 percent inFY 2003 to 19.5 percent in FY 2005, and reached 25 percent in April 2006. Similarly, the percentage of problem projects declined from 36 percent in 2003 to 4 percent in FY 2005 before turning up slightly to 8 percent inApril 2006. Progress indevelopment policy lending has been much less strong, with some 62 percent o f projects (by amount) classified as unsatisfactory in FY 2005. The Bank and the Government have, however, taken steps to address this problem. In March 2005, three Provincial Reform Loans were closed and the remaining tranches cancelled. These are scheduled to be replaced with new investment operations inthe same provinces. Both sides have agreed to build on this experience in deciding how to address the remaining outstanding policy loans inthe framework o f the new CAS. 96. The most important challenge to continue to strengthen the investment portfolio will arise from the increased lending volumes as the assistance strategy continues the marked shift towards investment lending. As mentioned in the 2004 CAS, Argentina has relied heavily on project implementation units (PIUS). As the Bank expands public investment and its role in the provision o f public goods and services, a systematic and deliberate effort will be pursued in the coming years to assist the Government to reinforce its capacity in the formulation and implementation o f public investments. Although limited progress was made under the previous CAS in mainstreaming institutional capacity and in reducing parallel project management structures, the Government now supports this process with the view to maintain institutional memory and to ensure that the transfer o f technology and knowledge i s inthe hands o f the State and not independent consultants. 97. As discussed in the fiduciary assessment section, recent developments point towards increased concerns in the fiduciary environment and its impact on Bank operations. The CAS will incorporate the implementation o f a Fiduciary Action Planaimed at addressing the increased perceivedrisks derived from the prevailing control environment inArgentina. 44 H. IFC 98. Since the last CAS dated January 2004, IFC has committed US$533 million (including US$175 million for syndications through the B-loan program) with efforts focused on financing companies with strong fundamentals. IFC played an important counter-cyclical role for these companies and aimed for demonstration effect on other investors. The commitments financed eight projects in five diverse sectors, including agriculture, food and beverages, the financial sector, retail, and hydrocarbons, with a focus on backing the export sector. As o f December 2005, IFC's committed portfolio stood at US$1.029 billion for IFC's own account, and an additional US$672 million for participants' accounts, with oil and gas, agribusiness, food and beverages, and the financial sector accounting for a largepart. 99. In agriculture, IFC committed a US$lOO million loan (including US$30 million for syndications) to a leading soy oil export company. This was the first long-term loan to an Argentine company since the onset o f the crisis. In food and beverages, the aggregate US$65 million term loan (including US$10 million for syndications) was provided to two leading agribusiness exporters. One o f these beneficiaries, Molinos, for instance, was able to more than double its exports. On the environmental side, with the support o f IFC, another beneficiary, San Miguel, has implemented the first phase o f an innovative waste treatment system for its lemon operations. In addition, the other company, AGD, was able to complete its purchase program, supporting a large network o f farmers and intermediaries in rural areas owing to IFC's prompt structuring o f a U S 6 0 million emergency pre-export finance seasonal facility in 2002. The subsequent 2004 loan is supporting the expansion program. In2005, the company processed 26 percent more than in 2002, and this should further increase by 29 percent following its capacity expansion. The majority o f its revenues i s expected to come from exports. 100. IFC's investments in the financial sector during the period included a US$25 million warehousing loan that promoted the origination and securitization o f trade and mortgage receivable assets, and a total o f US$47.5 million loan to support a leading local bank. IFC has taken a leading role in important restructuring o f Banco Galicia as chair o f the creditors committee, as well as in restructurings o f Banco Hipotecario and Acindar. The restructuring o f Banco Galicia was a critical step inthe bank's planto improve its competitiveness as it emerged from a difficult environment. IFC also made a US$40 million equity investment in a leading retail company (when risk capital was generally scarce inthe country). 101. Finally, in the oil and gas sector, IFC provided US$255.5 million (including US$135 million for syndications, and up to US$5.5 million exposure ina risk management product) to an Argentine branch of a leading multinational oil and gas producer to support part o f its 2005 capital expenditure program. The syndicated loan, with a seven-year tender, the longest raised for an Argentine borrower since the country's economic crisis in2001, was oversubscribed. 102. IFC has made significant progress in restructuring its exposure to Argentine companies, with the exception of the public service concession projects where concerns continue that the renegotiation process be conducted in a manner which i s perceived as fair, transparent and with fair burden sharing among all parties. During the last CAS period, the percentage o f its non- performing loans declined from 66 percent to 20 percent. The fragile situation o f the financial 45 sector, the energy crisis, and other factors such as evolution o f the price o f commodities, require enhanced portfolio supervision beyond the recovery work on the nonperforming loans. 103. Looking forward, IFC will support the Bank Group assistance strategy, primarily contributing to the pillar o f "sustained growth with equity", in the area where IFC has comparative advantage. Credit access by the private sector has improved over the last year, though available credit has mainly been short term. Long-term credit available to the private sector is increasing at a moderate pace, but is still at a low level to a large extent and concentrated with the blue chip companies. Inthis context, IFC has beenshifting its focus from short-term lines, where there i s good liquidity at reasonable prices, to providing long-term financing both for its own account and through its syndication program. For instance, this was the case with the above mentioned agribusiness and oil and gas sector operations. 104. In addition to providing long-term financing, IFC's priorities for its direct investments will be to provide structured finance products to companies andprojects instrategic sectors with an emphasis on groups expanding on a South-South basis and export-oriented or export facilitating projects. Important criteria that IFC will focus on when considering new projects are the corporate social responsibility (CSR) and sustainability aspects, as well as the track record with respect to honoring contractual obligations. By promoting CSR, using such instruments as IFC's SME linkages technical assistance, IFC plans to complement the Bank's assistance for the second CAS pillar o f "Poverty Reduction and Social Inclusion". IFC i s also supporting ten awardees o f its own from the Southern Cone Development Marketplace, organized by the Bank. Strategic focus sectors are: oil, gas and mining; agribusiness and forestry products; and the financial sector with a focus on high impact projects such as housing and support o f export- oriented SMEs. IFC will also consider on a selective basis projects in other high impact areas, including the social sector and financial restructuring. 105. IFC's ability to resume its operations inutilities i s constrained by unresolved issues inthe sector. There i s significant concern from the private sector and from potential foreign investors with respect to the lack o f satisfactory progress in the renegotiation o f public services concessions, as well as macro and the regulatory uncertainties and the impact thereof on investments needed to ensure the adequacy o f supply. This is especially applicable on the energy front in terms o f supporting capacity expansion plans and growth. While there is a compelling need for investments in the utilities sector, IFC does not expect to be active in this area until there is: (i)satisfactory progress on the renegotiation o f public service contracts, (ii)the establishment o f appropriate conditions for private sector participation, and (iii) clarity on the regulatory framework. IFC will continue to monitor the situation closely for developments that would trigger its involvement. I. TheRoleofMIGA,WBIandICSID MIGA 106. MIGA's exposure in Argentina as of December 31, 2005 stood at US$53.5 million, or about 1 percent of MIGA's portfolio (exposure net o f reinsurance amounting to US$33.5 million or about 1percent o f MIGA's net exposure). This exposure marks an importantreduction from the levels at the end o f FY 2001, when exposure stood at US$693.6 million and Argentina was 46 the country with the second largest exposure inMIGA's portfolio. The fall in exposure during these four years has been due mostly to reductions in coverage as a result o f guaranteed loans being amortized (and where MIGA's guarantee, in most cases, exempted the guarantee holders from capital controls imposed in early 2002 and subsequently lifted), and cancellation o f guarantee contracts. 107. InFY 2005 MIGA recognizeda Claim to an investor for a loss incurred on expropriation grounds for a total amount of US$1.4 million and paid US$0.5 million o f this amount. The remaining amount will be paid by MIGA provided a number o f contractual requirements are met by the guarantee holder. While discussions between MIGA and the Argentine authorities are on- going, as o f January 31,2006 no agreement had yet beenreached on recoveries arising from the payment by MIGA o f a claim. Pending resolution between MIGA and the Argentine authorities, MIGA will not be ina position to guarantee additional foreign investmentprojects inArgentina. 108. Intwo additional projects which MIGA has guaranteed, guarantee holders have notified MIGA that, under their interpretation, the events in early 2002 could construe a loss under the contract o f guarantee. One case i s currently being examined by international arbitrators and, in the other case, a resolution and final assessmenti s pending. WBI 109. Over the past five years, approximately 4,200 representatives from Argentine government agencies, civil society organizations, academia, and the private sector participated in WBI courses, conferences, GDLN dialogues, and other learning programs. Programs delivered in Argentina during the previous CAS period included courses on environmental management, infrastructure regulation, carbon finance, integrated water resource management, knowledge and innovation, and financial services. Several o f these programs were delivered inpartnership with local training and research institutions, including the Center for Financial Stability, University o f Buenos Aires, and the Foundation for the Environment and Natural Resources. 110, Beginning in FY 2007, Argentina is slated to become a WBI Focus Country (1 o f 6 in LAC) and as such WBI will work with the Country Team to develop a program that is aligned with the overall World Bank country assistance strategy. Focus will be on addressing learning and capacity development needs inthe sectors where the Bank is engaged inlending activity, and on providing access to international knowledge and experience, particularly in the context o f ESW activities. WBI's assistance will be primarily focused on three sectors: governance, environment, and social assistance programs. In another selected group o f sectors (financial servicedcapital markets, innovation policy, and infrastructure regulation), WBI will provide a forum for policy discussion and debate, and an entry point for the Bank to remain engaged on issues that are critical to the country's economic and social development. WBI will also explore opportunities to link Argentina with other middle income countries to share experience on issues such as certification o f country systems and capacity building o f sub-national governments, and will support potential regional or sub-regional initiatives on issues such as infrastructure and regional integration 47 ICSID 111. As o f April 2006, there were 35 arbitration proceedings institutedby foreign investors against Argentina before ICSID (two cases have been discontinued). All o f these proceedings have been initiated under bilateral investmenttreaties (BITs) concluded by Argentina during the 199Os, providing for investor-State dispute settlement under the ICSID Convention. In 32 o f these proceedings the claimants contest the measures adopted by Argentina in 2002-the devaluation and/or freezing o f utility tariffs-which allegedly violated investors' rights under the BITs. Many o f the claims concern concessions for public services and infrastructure (Annex E). Certain o f these claims have been suspended by an agreement between the foreign investors concerned and Argentina, as part o fthe concession renegotiationprocess. 112. In May 2005 an arbitral award was rendered against Argentina in the arbitration proceedings instituted by CMS Gas Transmission Company (CMS) against the Argentine Republic under the ICSID Convention. CMS i s a 30 percent shareholder o f the Argentine gas transmission company TGN, which obtained a license from the Argentine authorities to operate in the national gas transmission market. CMS claimed that actions by the authorities in and leading up to 2002 in essence changed the terms o f the license in a manner prejudicial to CMS' interests. Although it ruled that there was no expropriation in this case, the arbitral tribunal did decide that CMS suffered damages in the amount o f US133.2 million, based principally on findings that Argentina's failure to abide by the terms o f the license breached the provisions o f the US-Argentina BIT that guarantee fair and equitable treatment o f foreign investors and its so- called "umbrella clause" requiring Argentina to meet its obligations regarding foreign investment, In September 2005, Argentina filed a request with ICSID for annulment o f the award rendered in the CMS case. In accordance with the ICSID Convention, an ad hoc Committee o f three persons has been appointed to decide Argentina's annulment application. This Committee has the authority to annul the award or any part thereof on any o f the specific grounds foreseen by the Convention. Ifthe award is annulled the dispute shall, at the request o f either party, be submitted to a new Tribunal constituted in accordance with the ICSID Convention. If, however, the award i s upheld, it shall become final and binding on the parties. 48 VII. LENDINGSCENARIOS AND PERFORMANCEINDICATORS 113. Base Case Lending. The CAS envisages a base case lending scenario o f US$3.3 billion in performance based investment lending over the three year period covering mid-FY 2006 through mid-FY 2009. The proposed lending program i s made up exclusively o f investment operations at the request o f the authorities. However, if the Government were to request policy based lending and conditions for such assistance were to materialize, up to 25 percent o f the lending envelope could be reallocated to policy based loans through normal channels o f review. These conditions include a satisfactory macro framework, as evidenced by, for example, an active IMFprogram. 114. Given the emphasis on performance and the current state o f the Government's project implementation capacity, which i s still recovering from years o f disuse and crisis, IBRD exposure to Argentina could decline further over the near term. Under a set o f specific assumptions, including a five year disbursement profile for new lending, IBRD exposure i s projected to decline under the base case from US$6.9 billion at the end o f 2005 to US$5.9 billion by the end o f 2008 (Table 5). However, the actual extent o f the decline will depend on several factors, including the authorities' performance in achieving concrete improvements in project implementation capacity-which would be reflected infaster disbursement rates-and the fate o f pendingdevelopment policy loantranches. 115. There was US$876 million in committed development policy lending as o f end-2005 (including the Economic Recovery Support Loan, a Health SECAL, and three provincial reform loans). In agreement with the Government, the three provincial reform loans, which were approved prior to the 2004 CAS, were closed on March 31 2006, and undisbursed tranches totaling US$226 million were cancelled. These loans are planned to be replaced with new investment operations in the provinces concerned. The commitments for these new provincial investment loans have been included within the proposed US$3.3 billion CAS envelope. The Bank has agreed with the Government that, given such conditions, both sides would seek to build on the experience o f replacing the PRLs in deciding how to address the remaining outstanding policy loans in the framework o f the new CAS. Were the conditions to occur that would trigger the disbursement o f the remaining US$650 million in existing development policy loans, Bank exposure would decline more slowly than projected inTable 5. 49 Table 5: IBRD Portfolio Projections (2006 - 2008) (In US$ billion) CAS CY05 CY06 CY07 CY08 Jan06 Dec08 - Debt Outstandingand Disbursed - - - - 6.9 6.3 6.0 5.9 Commitments 1\ 0.5 1.6 31 1.1 1.o 3.73\ Disbursements 1 & 2\ 0.4 0.5 0.7 0.8 2.0 DevelopmentPolicy Loans 0.0 0.0 0.0 0.0 0.0 InvestmentLoans 0.4 0.5 0.7 0.8 2.0 Repayments 0.9 1.o 1.1 1.o 3.1 Net Disbursements -0.6 -0.5 -0.3 -0.2 -1.0 Debt Service 1.2 1.4 1.4 1.3 4.1 Notes: 1\ Assumes no new commitmentsbeyond the new CAS in FY09. 2\ Asssumes new investment loans are dibursed within a five year periodat disubursementrates o f 5 percent inthe commitment year andthen 15,25,25 and 30 percent inthe followingfour years. 3\ IncludesUS$390million incommitmentsunder the 2004 CAS. Source: World Bank staff estimates. 116. Low Case. There i s also a range o f low-case scenarios depending on broader economic developments and portfolio performance. The spectrum of possible scenarios includes the possibility o f an abrupt and severe deterioration o f the macroeconomic environment, Le., a hard landing leading to a significant reduction in fiscal space for public investment. Another scenario would involve continued macroeconomic stability and growth, but an unexpected, significant decline inportfolio performance, perhaps arising from a sharp increase in fiduciary risks. Either o f these two scenarios would lead to a substantial reduction in new Bank lending. It is not possible to pinpoint a priori what level o f Bank investment lending would b e appropriate across the range o f low-case scenarios. In practice, Bank support will be calibrated to government performance and economic outcomes, leading in effect to automatic adjustments inthe size and pace o fnew investment lending. 117. Argentina CAS Triggers. Box 6 below sets out the triggers corresponding to the base case lending program described above. Box 6: Base Case Triggers Base Case Maintenance o f a macroeconomic framework consistent with the Government's projections for growth and fiscal performance (as presentedinTable 2), and leading to improvements inpublic debt indicators (as per the baseline projections inTable 3). Satisfactory implementation o f the Bank's investment project portfolio as determined by twice annual portfolio reviews and inline with the portfolio Performance indicators presented inthe CAS results matrix. 50 VIII. IMPLEMENTINGTHE CAS A. Partnerships 1.18. International Monetary Fund. On January 3, 2006 Argentina prepaid its entire outstanding obligations to the IMF, amounting to SDR 6.7 billion (about US$9.7 billion) and canceled the September 2003 Stand-By Arrangement. Argentina has indicated that it expects to maintain normal relations with the Fund. By way o f background, the second review o f the Stand-By Arrangement agreed between the Government and the IMF in September 2003 (SDR 8,981 billion) was completed in March 2004. However, the third review was postponed indefinitely by the Government in August 2004. Following the closing o f the debt exchange offer inJune 2005, the Government and the Fundheld Article IV discussions inWashington, and the report was issued in June 2005. The report noted the rapid recovery and political stability that has prevailed since the crisis, but observed that inflation emerged as a short term risk, noted the lack o f progress on structural reforms and toward arriving at a forward looking strategy to address remaining arrears to private sector creditors, and cautioned that a slowing o f growth can be expected as capacity constraints are reached. Between 2002 and September 2005, Argentina made some SDR10.3 billion inrepayments to the IMF (about US$14.9 billion). 119. Inter-AmericanDevelopmentBank. IADB's country strategy for Argentina for 2004- 2008, approved in November 2004, sets the guidelines for the IADB to support the Government's development priorities in the areas o f governance, competitiveness and poverty reduction, within a framework o f macroeconomic stability. The target lending scenario amounts to US$5 billion over the five-year period and entails a higher concentration in investment loans. Inthis scenario, the IADB's exposure inArgentina wouldremainvirtually unchanged. 120. Implementation o f the strategy during the past year has focused on actions to improve portfolio execution and to expedite the country's transition from emergency interventions to a more comprehensive and sustainable social inclusion policy. To that end, inDecember 2004 the IADB approved a US$500 million policybased loan to create the conditions for a consolidation of social safety-net programs implemented during the emergency. This loan was to be followed by a string o f investment programs aimed at strengthening the provision o f basic social services and by a US$700 million investment loan to support the design and implementation o f Plan Familias, a program o f conditional subsidies targeting poor and indigent families. The latter was approved in late October 2005. In March 2006, the IADB approved a US$500 million policy based loan that seeks to improve public financial management. 121. An update o f the Country Strategy for Argentina is currently under preparation for presentation to the Board o f Directors inmid-2006. This update will assess progress inthe areas defined in the country strategy, in particular, portfolio execution, mid term public investment program and reform agenda, and based on that, will further specify the areas where IADB resources should be channeled for the 2006-2008 period. 51 Box 7: World Bank-IADB Collaboration The Latin America and Caribbean vice presidency o f the Bank and the IADB continue to advance collaboration and coordination formalized in two memoranda o f understanding (2001 and 2004). Specific areas o f cooperation identified by the Bank and the IADB include reciprocal representation ineach others' Boards; periodic consultations at the senior management level and other consultations, country-specific cooperation, including the joint financing o f selected projects, and cooperation with respect to selected themes and sectors. These include, among others, fiduciary assessments, regional integration, the environment and rural development, and work related to infrastructure, and analytical studies. Bank-IADB collaboration in Argentina has been effective in these and other areas. Below are some examples. Infrastructure: Good collaboration is underway between the two institutions with respect to road network management and improving Argentina's competitiveness through enhanced transport logistics both within Argentina and across its borders. Productive collaboration has also been achieved in ensuring the fiscal sustainability o f infrastructure investments, particularly at the provincial level. Inthe Buenos Aires Province Sustainable Investment Development project, for example, the Bank prepared the fiscal framework which accompanied the loan, and has worked closely with the IADB in order to apply the same fiscal framework for their social investment loan in the same province. The two institutions have combined efforts to monitor jointly implementation o f the provincial fiscal framework throughout the lifespan o f the projects. Social Protection: Collaboration between the Bank and IADB is expanding, and supports some o f the most critical elements o f the country's development agenda. One key example i s the transition from the Heads o f Household emergency project, which will focus on reintegrating beneficiaries into the labor market. A US$350 million World Bank loan to support the workfare part o f the program and the provision o f employment services to eligible participants was presented to the Board on March 23, 2006 under the 2004 CAS. Heads o f Householdbeneficiaries with two or more children are to transfer to the Familias conditional cash transfer program which aims to prevent the inter-generational transmission o f poverty by linking the income transfer to education and health investments in children. InOctober 2005, the IADB approved a US$700 million loan to fmance the expansion and implementation o f Familias. Rural Developmentand Environment: The Bank and IADBare collaborating inthe form o fjoint financing o fthe unit within the Secretariat o f Agriculture supporting provincial investments in agricultural services and irrigation. Both institutions are also working to provide assistance to Argentina in the area o f solid waste management, and are applying the same eligibility criteria for municipal and provincial borrowing in complementary loans. Public Sector Management: The two institutions have worked closely with the Argentine authorities over the past decade to help municipal governments enhance basic public management skills, rebuild deteriorated infrastructure, and mobilize resources needed for public investment. The Bank and IADB coordinated with authorities at the federal and subnational level to ensure that all eligible provinces were covered, working separately in some provinces and together in the four largest, Buenos Aires, Cordoba, Mendoza and Santa Fe. Financial Management: The Bank and IADB are working together on CFAAs, and substantial benefits have been gained through the use of the same procurement procedures. Private Sector: IFC has coordinated closely with the private sector department o f the IADB and developed ajoint approach inprojects in which both institutions had investments. 52 B. FiduciaryAssessment 122. The overall Bank portfolio fiduciary risk has increased from moderate at the time o f the 2004 CAS to substantial in late 2005. The financial management portfolio risk i s moderate at federal level and ranges from moderate to substantial at sub-national level, depending on the institutional capacities o f each Province. The procurement portfolio risk i s substantial at both federal and sub-national levels. This assessment takes into consideration past and current diagnostics o f country public financial management (FM) and procurement, the structure o f the Bank's portfolio and its shift towards increased investment lending with renewed emphasis on the sub-national level, and the continuing exclusive reliance on Bank fiduciary systems for project implementation in Argentina. The heightened fiduciary risk i s largely a result o f the impact o f the crisis, which weakened the overall control environment by introducing increased fragmentation o f procurement rules and budget execution, and from the limited progress obtained in implementing the proposed regulatory and institutional reforms. To deal with this increased fiduciary risk, the Bank will implement duringthe coming years a fiduciary action plan which will aim to: (i) increase the transparency in Bank financed projects and create incentives for civil society organizations to monitor and evaluate Bank portfolio performance; (ii) improve the strategic focus and coverage o f existing Bank supervision tools geared towards evaluating fiduciary risks in our operations; and (iii)ensure increased transparency and competition practices inpublic procurement. Discussions have beeninitiated with the Government, the audit authority and civil society groups to ensure their involvement in the various components o f the Fiduciary Action Plan, and to work together toward achieving the expected outcomes. 123. Financial Management. At the federal level, a perceived weak control environment, derived mostly from the limited effectiveness o f the institutional checks and balances, has reduced the effectiveness o f otherwise sound legal and systemic frameworks-including integrated budgeting, treasury and accounting functions, and automated information processing through the SIDIF system. The limited capacity o f control entities contributed to lower rule enforcement and incentives for accountability. 124. At the sub-national level, the FM systems usedby highly autonomous and decentralized governmental units are generally perceived to be weaker than those at the federal level. Nevertheless, there i s a highdegree o f variance among the financial management capacity o f sub national governments. The assessment o f sub-national entities i s based mostly on the Bank's fiduciary work linked to project development and implementation. Specific analytical work to provide a more systematic assessment o f financial management risks at the provincial level i s planned for FY 2007. Overall, the high degree o f dependence from federal resources at the sub- national level constitutes a disincentive for accountability and fiscal discipline. 125. Within the framework o f the Country Fiduciary Action Plan, a dialogue was developed between the Bank, the Ministry o f Economy and AGN to improve the current level o f audit compliance for the portfolio. The compliance target for the 2005 audit i s 65 percent o f timely delivery. The overall objective for the new CAS period (2006-2009) i s 85 percent. Measures to improve level o f compliance include (i) more efficient planning and use o f AGN resources, (ii) use o f private sector audit to complement AGN resources when necessary (this option has been utilized this year with regards to two projects) and (iii) implementation o f the pilot operation (Bank IDF grant) to improve AGN efficiency. Causes o f non compliance will be analyzed and 53 appropriate corrective measures will be taken in accordance with relevant Bank policies, in particular OP-BP 10.02. 126. Fiduciary analytical work. The Bank will also address fiduciary risk through a multi- annual program of fiduciary analytical work aimed at strengthening the policy dialogue in financial management and procurement sectors (particularly at the provincial level) and raising general awareness. This program will consist o f (i)federal level CFAA and CPAR; (ii) provincial level financial management and procurement ESW; (iii) notes on specific areas policy of interest to the Government; and (iv) an Accounting and Auditing ROSC. These analytical products will be conducted inclose coordination among all relevant sectors. The main emphases of the federal level CFAA, currently in progress, will include the assessment o f the control environment, aid management and the budget process. In FY 2007 provincial level PFM and procurement ESW will aim to design relevant indicators and measure fiduciary performance at the sub-national level. The Bank will aim at conducting the provincial ESW jointly with the Government. The Accounting and Auditing ROSC will review Argentina's private sector accounting and auditing practices, with emphasis on compliance with international standards and codes. 127. Procurement. Country procurement rules and practices are fragmented. Separate statutes govern the procurement o f (i) goods and services, (ii) works and (iii) civil consultants, The new procurement law13was originally adopted in 2001 and amended in 2003.14 It contains policies and guidelines which are, by and large, consistent with Bank procurement policies. There has been limited action, however, to implement the new law and the issuance o f the regulations required to bring the law into full force i s still pending. An Electronic Government Procurement system has also been developed and tested at the pilot level. However, its scope o f application i s limited mostly to recurrent government supplies. The Bank has stepped up efforts to monitor the impact o f competition and transparency conditions o f procurement under Bank projects, and to act quickly to engage the authorities when necessary. l3Decreto de Necesidad y Urgencia 1023/2001- This type of decree i s equivalent to a law. l4Decreto de Necesidad y Urgencia 66612001. 54 Box 8: Fiduciary Action Plan The objective o f the Plan is to ensure effective management o f the increased risk in Argentina's fiduciary performance by increasing public information on Bank financed projects, promoting civil society participationinthe monitoring and evaluation o f the Bank's portfolio, enhancing the strategic focus and coverage of Bank supervision tools geared toward evaluating fiduciary risks in operations, and ensuring increased transparency and competition practices inpublic procurement. The Fiduciary Action Plan will consist o f the following main components: RaisingPublicAwareness Extensive disclosure of project procurement information to thepublic via the Bank's external web site. All contractsfinanced by the Bankfor eachproject will be included in a data base including: (i) Contract objectives and procurement method; (ii) estimated and actual cost o f contracts and level o f execution; (iii) estimated and actual date o f contract award; (iv) bidders and contractor; and (v) main contract changes. The information will be presented ina user friendly manner for general public use. Outreach to civil society with regard to implementation/impact analysis of World Bank portfolio. This component will seek to elicit involvement by civil society organizations and think tanks dealing with transparency, public goods and related areas inthe monitoring andor evaluation o f the Bank's portfolio. Stimulate civil society and development partners' involvement on fiduciary matters: (i) public Make aware o f the existence o f `whistle-blowers' mechanisms such as the Bank international hotline to report incidents o f corruption; (ii)Intensify relations with NGO dealing with transparency matters; (iii) Enhance the fiduciary coordination and harmonization effort with IDB. BolsterinPBankFiduciarvMonitoring Improve timeliness of external audit compliancefor Bank supported operations with on-time compliance targets of 60percent in F Y 2006, 75percent in F Y 2007 and 80percent in F Y 2008. Meeting this target will require: (i)continued engagement with the Supreme Audit Authority reflected inAudit Plans for each fiscal year completed by end November in each year containing timetable for audit completion o f Bank financed operations, level o f private sector support and budget requirements; and (ii) continued support to AGN efforts to enhance its capacity to ensure timely and quality audit performance and effective follow up on audit recommendations. Increase strategic focus and coverage of supewision tools assessing fiduciary risk in operations: (i) Undertake integrated fiduciary risk assessments for each project in the portfolio with a target to cover 75 percent o f portfolio in CY06 and 100 percent inCY07; (ii) Establish a traffic light rating system reflecting the fiduciary risk o f each project in the portfolio and publish the relevant information on the Bank's external web; (iii)Produce and publish an annual report on fiduciary risk o f the Bank portfolio to be disseminatedto the Government, as well as to key actors inthe control community and civil society groups; and (iv) Continue to share with the Integrity Department the fiduciary assessments, and seek theiI participation inhighrisk cases where irregularities are identified. Further complementary actions: (i) Deliver training by the end o f FY 2006 to all relevant Bank staff on procurement and financial management matters related to the current fiduciary risks faced by the Argentina portfolio, and familiarize staff with the fiduciary challenges faced across the portfolio; (ii)Supporl strengthening o f oversight institutions through grant assistance and knowledge sharing; (iii)Supporl streamlining and harmonization o f fiduciary processes and reliance o n country systems when these meei adequate fiduciary standards. IncreaseTransparency and CompetitionPracticesinPublic Procurement Establish a proactive dialogue with the Government and relevant agencies to improve transparency ana procurementpractices in public procurement, including: (i) implement (by end CY06) a price monitoring mechanism and alert system based on reliable and up to date cost-estimates; (ii) reach understandings with the Government on contract aggregation strategies that will improve competition and innovation. This will include analytical work to have a better grasp o f current market and competition conditions; (iii) promote the use o f transparency instruments such as integrity pacts, public hearings and comparative prices; and (iv: continue to apply a zero tolerance policy in the investigation o f perceived irregular practices anc application o f all available remedies. 55 C. Country FinancingParameters 128. The Government agreed to the new Country Financing Parameters in early 2005 (Annex J), and has welcomed the increased flexibility that the new Bank policy provides with regard to eligible expenditures. However, the degree to which the Government would like to use the increased flexibility depends largely on its strategy for funding development needs. The degree to which the Bank will use the increased flexibility will in turn depend on the Bank' overall exposure, as well as the impact on the Bank's ability to find other projects under the CAS and the potential to reduce transaction costs. 129. Interms o f cost sharing, the new parameters propose flexibility for the Bank to finance up to 100 percent of total project costs, when this would result in substantially reduced transaction costs and in a substantial impact on poverty alleviation. Inother cases, flexibility in cost sharing will depend upon the Bank's overall lending envelope, and subject to satisfactory ownership o f the overall program and at the sector level. The Bank's financing share o f individual projects i s however expected to continue at current levels. 130. With regardto Bank financing of recurrent costs, the newparameters propose no country- level limit. From an economic perspective, sound fiscal management and the fact that Bank financing is fully integrated in the budget and taken into account in fiscal and debt targets indicate that financing o f recurrent costs would not jeopardize overall fiscal or debt sustainability. Therefore, no country-level limit on recurrent cost financing i s proposed. From a project perspective, financing o f recurrent costs under Bank projects i s likely to continue to take place only in exceptional cases, although in the future increased flexibility may be applied when there are special emergency andproject-related circumstances. 131. In terms of local cost financing, the requirements for Bank financing of local expenditures are met, and the new parameters allow financing o f local costs in the proportion needed in individual projects. The change in policy i s not expected to represent a major deviation from the prevailing practice in local cost financing in Argentina, since the Bank has been financing substantial local costs in the past. With respect to taxes and duties, the new financing parameters allow the Bank to finance all taxes and duties associated with project expenditures with the exception o f import tariffs above 28 percent, which i s the average o f the Mercosur common external tariff. At the project level, the Bank would also consider whether taxes and duties constitute an excessively high share o f project costs. D. IBRD FinancialProducts 132. IBRDoffers a fillarray of financing andrisk management products. The IBRDfinancial products could provide flexibility to Argentina in managing its debt, including the ability to change the financial characteristics o f existingand future loans as to better manage the financial risks relating to currency, interest rate, rollover and commodity price volatility. Thus, and for instance, Argentina has a substantial portfolio o f FSL loans with the IBRD, but i s yet to take advantage o f the embeddedrisk management tools included inthe FSLs to manage currency and interest rate risks. Furthermore, and since Argentina also has a considerable portfolio o f VSL loans, the Government might want to consider signing an ISDA Agreement with IBRD, thus gaining access to a range o f IBRD financial products to manage the interest rate and currency 56 risks o f these VSL loans. Within this context, the Government may want to consider engaging staff o f the World Bank's Treasury to become better aware o f IBRD's financial products and services available to it, and may also want to consider taking advantage o f IBRD's technical assistance in designing and implementing a broad strategy for public debt management aimed at reducing both market risks and overall costs o f funding. E. CAS ResultsFramework 133. Inkeeping with the focus on evaluating CASs based on results linkeddirectly to Bank support, the indicators for the investment program are largely derived from the development outcomes already agreed with the authorities under key activities. The Results Matrix also includes indicators on portfolio performance. The results framework o f this CAS i s based on the following four elements. 0 The Bank's dialogue with the Government i s focused on projects, and with clearly identified Government counterparts. At the project level, supervision dialogue will be at the sector level and be led by Buenos Aires based sector staff. The broader dialogue, particularly with respect to the overall portfolio management, will take place between the C M U and the Ministry o f Economy and Production, and revolve around twice-yearly portfolio reviews. 0 The indicators which havebeen selected for use inthe ResultsMatrix and elsewhere have been chosen on the basis o f their effectiveness to demonstrate progress and outcomes as well as their availability to the Government. The data exist and should prove robust to provide a clear picture o f where Argentina stands with respect to various indicators. At this stage, the ResultsMatrix features mainly quantitative indicators-reflecting the early stage o f development o f the new investment partnership with Argentina. As the investment program matures, additional emphasis will be given to identifying robust and measurable indicators o f investment quality and impact. 0 Primary responsibility for statistics within the Government is with INDEC and the line ministries; in the Bank responsibility resides with the task teams. The Bank i s planning to provide technical assistance to Argentina to address shortcomings in statistical capacity where they exist (e.g., on poverty, in the three phase Programmatic Poverty study). 0 Given uncertainty about Argentina's policy framework, especially in outer years o f the CAS, the results o f new activities cannot yet be specified. The Bank will further delineate the country results framework as data becomes available, including the introduction o f additional quality based indicators as feasible, and will provide an update inthe CAS Progress Report. Management also proposes to provide regular briefings to the Boardon economic developments andthe mediumterm outlook. F. RiskManagement 134. Argentina faces a number o f difficult challenges, and effective Bank support to Argentina faces a number o f important risks, across a range o f areas. Many o f these are risks that were pointed out in the last CAS, and many have been identified by the Government as recently as early 2005 inthe prospectus for the sovereign debt exchange offer. 57 Economic and Social Risks 135. Inflation is the key macroeconomic policy concern in the short run. The inflation rate at the end o f 2005 o f 12.3 percent for the CPI represents a three-fold increase since 2003 and inflationary expectations have increased sharply. The outlook i s for inflation to remain indouble digits in 2006. The Government is relying on a combination o f price agreements and increased investmentto contain inflation. However, the rise ininflationary pressures is generalized, inpart reflecting the closing o f the output gap during the robust three year recovery as well as robust domestic and external demand, and i s likely to require significant tightening o f macroeconomic policies. A delayed policy response raises the risk of accelerating inflation and eroding competitiveness, thereby increasing the likelihood o f a hard economic landing which-if history i s a guide-would likelydisproportionatelyhurtpoor andvulnerable groups. 136. The risk of a sharp slowdown in growth remains the main medium-term concern. Argentina's economy will not continue to grow at current rates o f 9 percent per year indefinitely. Indeed, as the Government stated inits prospectus for the debt exchange, the country's history o f volatility and protracted periods o f low or negative growth indicate that a substantial slowdown cannot be discounted. Economic growth depends on a range o f factors, including macroeconomic stability, the investment climate, the external environment, and confidence in public institutions. Pursuit o f a determined reform agenda by the Government to support progress inthese areas-including fiscal reforms to underpin the primary surplus and reforms to restore financial intermediation and promote private participation in public services and infrastructure-would help to sustain growth and limit the negative effects o f any future internal or external shocks. Conversely, in the absence o f further reforms, the medium-term sustainability o f growth i s at risk. 137. Notwithstanding the debt restructuring o f June 2005 and the overall improvement in Argentina's debt profile, debt sustainability will remain a concern and an important source o f risk. Even after the debt restructuring and repayment to the IMF, Argentina's total public debt remains high and the public debt service burden in the medium term significant, in the US$13 billion range per year. The US$24 billion in holdouts, US$3 billion in Paris club arrears, and contingent liabilities arising from the cases before ICSID all represent sources o f potential increases in the debt service burden in the future, although the timetable for their resolution remains unclear. The 35 percent reduction in international reserves resulting from the early repayment o f the IMF reduced the country's external liquidity, but reserves remain adequate to cover 100 percent of the money base and are again accumulating with continued Central Bank purchases o f foreign exchange. Under the Government's medium-term macroeconomic framework, the public debt to GDP ratio i s projected to decline steadily over the medium-term. Rollover rates on debt to private creditors are projected to be on the order o f 100 percent in 2007-08. A scenario in which delayed structural reform contributes to a slowdown in growth could put pressure on fiscal performance, forestall a decline in the debt-to-GDP ratio, and increase the rollover risk. 138. Poverty and unemployment, while improved significantly since the depths o f the crisis, remain deep structural problems for Argentina. Street protests, the piquetero movement, concerns about crime and violence, and a weakened sense o f security that has emerged in Argentina since the crisis could conceivably make it politically difficult for the Government to 58 pursue economic reforms and generate renewed popular demands vis-a-vis Argentina's public debt, especially if the economy were to slow substantially and recent positive trends inpoverty and unemployment were to reverse. 139. Argentina remains vulnerable to adverse changes in the international environment. Rising global interest rates or a fall in the price o f its primary commodities could have a pronounced effect on the country's growth prospects. A slowing o f growth inits primary export markets, such as Brazil or China, could also affect Argentina. PoliticalRisks 140. President Kirchner's popular support and political strength were fortified as a result o f the October 2005 legislative elections. The Administration appears to be ina solid position for the time being. Nevertheless, Argentina's history suggests that political fortunes can fluctuate suddenly and substantially. With its current level o f support, the Administration has not sought to engage inextensive consultation and debate with the broader civil and political society, raising the possibility o f sharper political divisions. Presidentialelections are slated for 2007, raising the possibility that, within the CAS period, the emergence o f a campaign environment could distract senior officials and make the development challenges presented in Section IV o f the CAS more difficult to tackle. BankGroup ProgramRisks 141. The Bank faces a number o f important risks in Argentina, in the policy environment, in terms o fproject implementation, and with respect to fiduciary management. 0 Policy Environment Risks. The Bank faces two major policy challenges in Argentina. The first challenge relates to the medium term framework. The Government's view i s that its development agenda, as presented in Section I11above and further elaborated in Annex A, i s adequate to ensure sustained growth over the period o f the CAS and beyond. While acknowledging the track record o f three years o f strong growth since the crisis, the Bank remains concerned with the wide range o f possible macroeconomic outcomes as a finction o f the policies the Government actually implements in practice. The second challenge i s the limited policy dialogue with the Government on overall economic management and structural reform. There are opportunities for the Bank to exchange views with the authorities, as for example during preparation o f the CAS itself; however, the degree o f consensus on key issues remains limited. The uncertainty that results from these two challenges has important implications for the Bank's operations. The CAS i s designed specifically to respond to this uncertainty and seeks to mitigate the first o f these risks by presenting an all investment lending program with clear triggers on the macroeconomic framework and portfolio performance. It also addresses the second risk, the limited policy dialogue, by setting out an active AAA agenda that will seek out opportunities to build engagement on issues crucial to Argentina's development where there i s not yet a consensus betweenthe Government and the Bank. 0 Project Implementation Risks. The shift to a performance based investment led CAS in a country with limited project implementation capacity presents the risk that the Bank will not be able to maintain a consistent positive net flow o f resources with Argentina. 59 This could result in tension between the Bank and the authorities. The CAS includes a numbero f areas that will seek to mitigate these risks. First, the Bank is working with the Government on a framework o f principles that would guide a progressive shift o f personnel from PIUs to line ministries. Second, the Government i s undertaking initiatives aimed at building up institutional capacity to respond to the requirements posed by the scaling up o f the public investment program. The Bank's program features a number of institutional strengthening projects that aim to assist the authorities to improve administrative capacity to manage public investment, for example, the Buenos Aires Sustainable Infrastructure Development project. A delay or failure to build additional institutional capacity could lead to project implementation constraints and a slowdown o f disbursements. 0 Fiduciary Risks. The control environment has been evaluated as fragile in the most recent fiduciary assessments. Contributing factors include: (i) a complex budget structure with exceptions such as fiduciary finds and inter-governmental fiscal mechanisms with a significant degree o f discretionality, (ii) a civil service which faces difficulties to attract and retain professional staff, and (iii) limited effectiveness o f institutional checks and balances at both the federal and provincial levels. The shift towards a 100 percent investmentpartnership, as proposed under the CAS, will place increasingdemands on the control environment to ensure the fiduciary adequacy o f projects. The fiduciary action plan agreed with the Government is designed to mitigate fiduciary risks and offset the perceived fragilities inthe control environment through a focus on increased transparency and accountability. 0 IFCPortfolio Risk. There is a riskthat the quality and level o fIFC's Argentina portfolio may decline over the short-to-medium term should one or more o f the following concerns materialize. They are: (i)a negative evolution o f the investment climate, including continued impasse in the renegotiation o f the public service concessions; (ii)a considerable drop in commodity prices; and (iii) real foreign exchange rate appreciation. The investment climate would affect IFC's ability to continue to increase its long term lending activity to Argentine companies while commodity prices and real foreign exchange rate appreciation could affect the performance o f IFC's portfolio clients that are primarily commodity-based and/or export-oriented. 60 Annex A EconomicPolicyGuidelines dc REF.:CAS.- ANEXOI SEfiOR DIRECTOR: Tengo el agrado de dirigirine austeda efectos de poner a su disposicihn el documento relativo a orientacionesde politica econtjmica del Gobierno National que corn0 h e x 0 Iacompaflarala Estrategiade Asistencia a1 Pais de vuestro Banco. Sinotro particular, saludo a ustedatentamente .AI, SmOR DIRECTOR SUBKEGIONilL PARA ARGENTINA, CHILE, PARAGUAYY URUGUAY DELBANCOMUNDIAL s. Dodor Axel Van TROTSENBURG f D. 61 Annex A EconomicPolicyGuidelines ECONOMICPOLICY GUIDELINES A. General Principles Argentina's economy has initiated a process o f sustained growth. What was initially interpreted by analysts as a temporary recovery may already be considered the start o f a new stage inthe mode o f operation o f the country's economy. Fiscal discipline, reduction o f the debt burden, monetary prudence, external surplus, increased reserves, vigorous growth and exports diversification, greater productive investment, reversal o f capital flight, creation o f millions o f genuine jobs, recovery o f the purchasing power o f salaries, reduction o f poverty and indigence, commencement o f reversing the deterioration inincome distribution, these are only some o f the characteristic features that mark the start o f this new stage that should result in a genuine development process to leave behind long years o f persistent decline. Under the premise that foreign policy and international economic relations are inseparably linked to who we are as a country and to the type o f country we wish to build, Argentina participates in an active and constructive manner in favor o f a more balanced new world order, capable o f taking into consideration the interests and needs o f developing countries, able to guarantee a sustainable development strategy with social inclusion. We foster the opening o f the country to the world in a realistic manner, within the framework of deepening regional integration policies, in particular through the MERCOSUR, in the understanding that said framework i s the best strategic answer to drive regional development and confront the new challenges stemming from globalization and technological and scientific progress. To that end it is indispensable to be integrated into the world, emphasizing the absolute advantages o f national production and within a framework o fregional integration. Our Latin American policy seeks to consolidate a network o f physical, commercial and cultural relations on a par with the excellent political dialogue that we hold with all sister countries. Inthat context, the recent agreements made with our major partner in MERCOSUR, reflected inthe competitive adjustment mechanism, will enable a healthy integration o f production and a well-balanced and dynamic expansion o f regional trade. Such agreements are an eloquent sign o f the priority our Administration attaches to the process o f reindustrializing the country and recovering the original spirit that guided the design o f the first integration agreements. MERCOSUR, at the recent Mar del Plata summit, gave a true example o f unity, cohesion and defense o f the regional interests, which points to mediumand long term foreign economic policy guidelines inan open economy such as Argentina's. Interms o f international financial relations, the margin o f maneuver and degrees o f freedom recovered as a consequence o f the restructuring o f the foreign debt will make it possible to develop a responsible policy. Argentina lost its place among the prosperous nations decades ago and it i s still an impoverished country. This situation i s the starting point to begin reversing history and reinstating once again the notion o f progress and social cohesion inour homeland. 62 Annex A EconomicPolicyGuidelines A key long term policy objective is securing an efficient energy supply to satisfy the demand generated by the sustained growth o f GDP that has and will continue being recorded in the coming years. The medium term measures that are contemplated include the installation of 1,600 megawatts through mixed investments by the generators and the National State; the partial raising o f the level and completion o f the Yacyreth dam complex, the completion o f the Atucha I1Nuclear Power Plant and the expansion o f the high voltage electric power transmission system, to which end there are plans for the construction o f approximately 4,550 kilometers o f 500 kV lines, representing an expansion o f the existing facilities by over 43 percent. There are regional projects for the sector such as the "Energy Ring", a joint initiative o f the Governments o f Argentina, Brazil, Chile, Paraguay, Peru and Uruguay, with Bolivia participating as an observer, and the "Natural Gas Interconnection - Argentina, Brazil and Venezuela" destined to establish a South American network o f gas pipelines. The Northeast Argentine Gas pipeline, for its part, i s a bilateral initiative between the Governments o f Argentina and Bolivia that has the capacity o f reasonably complementing our country's supply, by permitting the provinces o f Chaco, Corrientes, Formosa and Misiones to incorporate, once and for all, the use o f natural gas intheir territory, with the improved quality o f life that this implies, and that the provinces o f Cordoba, EntreNos, Salta and Santa Fe see an improvement intheir level o f gas supply. Interms ofpublic services andthe corresponding renegotiations of the contracts, the policy adopted incorporates into the profit equation-logical inanybusiness-criteria such as: the defense o f public interests, the defense o f citizens and the defense o f public service users; with a view to contracts that ensure the best possible service, their universal extension and increased investments to accompany the country's growth. As a result o f this negotiation the competitiveness o f our economy will be enhanced, jobs will be created and adequate services will be provided making a profit for the companies involved. The objective being sought is to make public and private interests compatible, something which could be facilitated if those who represent the concessionaires take a look at the numbers o f our recovery and the future flows o frevenues andprofits. The state will perform its core role as social articulator but also, with the MillenniumDevelopment Goals as a target, we will strengthen the capacity o f society as a whole to exercise social responsibility. Although initially, in view o f the seriousness o f the situation we faced, it was necessary to continue with plans designedto respond to the emergency, we have gradually developed initiatives designed for social inclusion, to repair and rebuilt the social fabric, enabling many Argentines to recover their projects and life. In that sense, the objective i s to promote individual and collective social development; whereas assistentialism produced clients, insertion should promote citizenship. The intent i s to reduce gradually direct aid and assistance systems to a minimum,becausewe believe employment to bea collective aspiration. The long term strategy can be characterized as one o f economic development with inclusion and implies promoting investment and a continuous increase o f productivity through a dense innovation network that makes it possible to add to the production 63 Annex A Economic PolicyGuidelines processes skilled labor and innovations based on research and development. To this end, the work o f institutional reconstruction will continue to strengthen the role o f the state, endow it with high skills and a fill-fledged vocation o f service, ensuring stable rules o f the game for everyone and the effective possibility o f meeting the contractual commitments that are undertaken. But economic development should be-above all else-synonymous o f equity in the distribution of the h i t s o f economic growth through the sustained creation o f opportunities for genuine employment and the continuous improvement o f incomes, not as a result o f an always elusive "trickle down" o f said fruits, but as an indispensable prerequisite for the start up and realization o f growth itself. These are the mainstays o f the current medium and long term policy framework. B. Short and Medium Term Development Objectives After the successful conclusion ofthe debt restructuringprocess, the current phase of consolidation o f sustained growth aims for three fundamental objectives: (a) preserving price stability, (b) sustaining the competitiveness o f domestic production and, based on these two, (c) continuing and accelerating the process o f recuperation o f the difficult social situation. Interms of the first objective,the Government is acting firmly to preserve the low inflation environment that characterized the stage o f recovery from the crisis, which will make it possible for relativeprices to play an adequate role inthe process o fresource allocation. To that end, a set o f policies has been implemented that may be divided into two groups: (i) that relate to the inter-temporal consistency o f the current program those and (ii)those designed to confront mechanisms that could contribute to a price acceleration inan open small economy, even ina context o f fiscal and external balance. Among the former we may mention the role o f the fiscal, monetary and external policies that have been implemented since the collapse o f the Convertibility regime, designed to disactivate the fundamental mechanisms o f the inflation phenomenon. There i s no doubt that the strong macroeconomic imbalances that characterized our country during the last decades had a preponderant role inthe development o f the highinflation regime that afflicted the Republic o f Argentina for so long. Inthe new macroeconomic environment, not only has there been a significant improvement in the condition o f the public accounts based on fiscal discipline, but also and furthermore, starting with the successful restructuring o f the public debt, the road became open to ensure inter-temporal fiscal stability. On the external front, the new relative prices have translated into substantial current account surpluses, after having suffered systematic deficits duringthe 1990's. At the same time, the new macro context has led to a systematic reduction o f private capital outflows. Both developments allowed for an important accumulation o f reserves by the Central Bank o f Argentina (in Spanish, Banco Central de la Repziblica Argentina - BCRA) that contributed to significantly improving the soundness o f the economic system. 64 Annex A EconomicPolicy Guidelines The current stock o f reserves, within the framework o f a policy o f reducing public sector debt, made it possible to decide to pay off the total debt that our country owed to the International Monetary Fund. Thanks to this operation, there will be financial savings estimated around US$800 million, resultingfrom the difference between the interest rate as agreed with said institution and the yield on international reserves held by the BCRA for the almost US$10 billioninvolved inthe transaction. Regarding the second group of policies, a series o f reasons that justify an active economic policy response may be noted. Firstly, in a context o f strong economic growth with expansion o f employment and rising salaries, it is not surprising to have a vigorous recovery o f consumption. Under this circumstance, the response by the National Government i s based on promoting and stimulating a higher rate o f investment, contributing to increase the economy's growth potential. Secondly, the requisite increase inthe degree o f tradability o f some food products in a context o f a favorable real exchange rate also induces price increases, to which we should add that an eventual rise in international prices could generate a phenomenon o f "imported inflation," not originating in an excessive domestic demand. The policies implemented to minimize this impact on prices include the establishment o f export taxes, which have made it possible to mitigate the effect o f the greater tradability on domestic prices. At the same time, the policy o f voluntary price agreements has managed to smooth the impact o f the volatility o f such prices on the Consumer Price Index (CPI.) Thirdly, after the sharp change inrelative pricesthat took place in2002, the prices o f some non-tradable products (basically services) have lagged behindthose o f tradables. To the extent that growth has began to extend to all sectors o f the economy in general, this "overshooting" should tend to be compensated through transitory price increases in those sectors that lagged behind; such adjustment will lose impetus on its own as relative prices complete their adjustment to the new equilibrium. Finally, in an economy with a long "inflation history" such as Argentina's and with a production structure that in some sectors is characterized by a certain degree o f concentration and corresponding market power, the possible inertia effects on the evolution o f prices o f expectations for price increases on the part o f price makers should not be minimized. This problem has been tacked on several fronts: first, by reinforcing compliance with the legislation in force relating to the defense o f competition and second, by establishing price agreements with those sectors where it i s possible to observe market power. Additionally, an anti-cyclical fiscal fund will be established not only to smooth eventual excess aggregate demand, but also to address punctual negative shocks on our economy. The second objective, that o f securing competitiveness, requires a continued deployment of prudential policies to manage the favorable juncture experienced by the external sector of the economy in a reasonable manner, to avoid short cycles o f "excessive optimism" that could give rise to the accumulation o f economic and financial imbalances that when corrected could lead to an abrupt interruption o f growth. To that 65 Annex A Economic Policy Guidelines end, in the first place, as a form o f anchor for the formation o f expectations o f medium term revenues by economic agents, the current macroeconomic conditions o f strong fiscal and external surplus are beingpreserved and private agents are receivingpermanently the signal that these surpluses will tend to be sustained through time. Inthe last 40 years, this i s the first time that for three consecutive years there are twin surpluses both at the global fiscal level and inthe current account of the balance o fpayments. It i s foreseen that both surpluses will continue during the foreseeable future. In fiscal terms, revenues have grown as a consequence of the quicker pace of economic activity and o f a notable increase in the collection effectiveness (which inpart is due to the adequate inter-temporal signals that are currently provided by the macro environment). The sharp reduction intax evasion allows fiscal policy to be more effective inachievingmacroeconomicobjectives. Furthermore, the anti-cyclic fundwill also imply higherpublic savings. At the monetary level, the policy o f reserves accumulation has allowed the Central Bank o f Argentina to maintain today, even when taking into account the cancellation o f the debt with the International Monetary Fund, a significant stock o f foreign currency, that will continue growing inthe coming years, so that our country i s in a position to address any eventual downturns in the international environment. At the same time, establishing the establishment o f mandatory reserves for capital inflows makes it possible to prevent waves o f excessive optimism becoming validated by an unsustainable increase in foreign debt, which in turn may create doubts about the sustainability o f its counterpart, the current account. A prudent policy regarding capital inflows that stimulates the inflow o f medium and long term funds, reduces the risks o f these being "pro-cyclical" and ensures a greater degree o f stability during sporadic periods o f low confidence. These preconditions, complemented with specific sectoral policies that are being implementedby the Federal Government, give rise to a gradual but systematic recovery of social indicators and will ensure a reduction o f the still high poverty indexes and a substantial improvement inincome distribution. Inthe current context o f growth based on stimulating external competitiveness, the withholding taxes on exports play a central role to ensure that the growth o f our external sales i s a process that takes place within a framework o f social equity. In that sense, it i s reasonable, in general terms, for the sectors that benefit the most from the change inrelative prices to also contribute more to the supply o f public goods by the National State. At the same time, the withholdings operate to creating a wedge between the domestic and the international prices o f commodities, that cushions the impact that the new profile o f prices could have on the basic consumptionbasket, which could otherwise impact negatively on the real income o f lower income families. On the other hand, the resources obtained from such taxes do and will continue to contribute to the implementation o f social policies, infrastructure investments and sectoral stimulation to help expand supply of those activities on which the domestic and external demand has had an important impact. 66 Annex A EconomicPolicyGuidelines Far from having been damaged by the export tax withholdings, the primary productive sectors have benefited from the current scheme o f a competitive real exchange rate, and have experienced remarkable growth that shows no signs o f being depleted. As for their external performance, exports have shown a notable evolution in the last three years duringwhich their rate o f growth has increased. Preserving an environment o f macroeconomic and financial stability and o f the incentives to production, investment and employment that are provided by the current economic policy framework, in a context o f ongoing reduction o f the debt burden, are indispensable requirements to consolidate the sustained growth path exhibited by the Argentine economy. The continuity o f growth and employment, the recovery o f salary levels associated to productivity gains and to the specific situation o f profitability o f the various sectors o f activity, together with adequate public policies, will make it possible to achieve a sustained reduction o fpoverty and indigence and to improve the distribution o f income, after the profound deterioration experienced by all social indicators during the last decade and the recent crisis. The resolution o f this crucial problem, through the achievement o f continuous progress at the social level and the sustained improvement o f well-being is the fundamental objective o f the National Government's economic policy and actions as a whole. C. Indicators and Goals Table 1 shows the targets for the period 2006-2008 for GDP and its main components at current prices, together with the nominal and real growth rates (at constant 1993 prices) corresponding to the same period, as well as the projection o f the price indexes implicit ineach o f the major macroeconomic aggregates. 2006 Million current AR$ 593,974 441,453 127,976 138,401 113,103 Real variation (%) 4.0% 3.5% 7.9% 4.2% 10.2% 2007 Million current AR$ 658,426 492,763 142,602 151,557 127,743 Real variation (%) 3.5% 3.7% 4.8% 4.9% 8.9% 2008 Millioncurrent AR$ 729,180 548,249 158,579 166,399 143,295 I Real variation (%) 3.5% 3.7% 4.4% 4.2% 6.9% Table 2 summarizes the evolution o f the Consumer Price Index (CPI) and the Nominal Exchange Rate, while Table 3 shows the evolution o f Imports and Exports expressed in millions o f dollars. This set o f projections reflects a pattern o f sustainable growth with the economy converging towards its long term growth rate, which for the 67 Annex A EconomicPolicyGuidelines purpose o f the budget exercise i s assumed to be moderate. Its slowdown with respect to the levels observed for the last three years results from the gradual closing o f the large output gap generated with the collapse o f convertibility. Thus it i s expected that the economy will gradually reach growth rates consistent with long term sustainability, where investment will attain levels compatible with the required accumulation o f long term capital stock and the real exchange rate will slowly tend towards its long term equilibrium value, which will result in a gradual reduction o f the actual current account surplus. As a reference, the average real exchange rate inthe last four decades has been around 1.6 against a value o f 1 inDecember 2001, and the sustainability studies are based on mediumterm values for the real exchange rate o f approximately 10 percent above that average. In order to realize this gradual convergence, it will be important to avoid that a pressure towards nominal appreciation o f the exchange rate generates expectations that would reinforce a trend towards hrther appreciation, inducing a sudden loss of competitiveness, or that an acceleration o f inflation produces a faster than required convergence of the real exchange rate towards its long term equilibrium level. The gradual convergence towards a more appreciated exchange rate and with low levels o f inflation can be achieved starting from a strong fiscal position that, on the one hand, makes it possible to smooth the growth of aggregate demand while, at the same time, contributing to a sustained nominal parity through an additional demand for foreign currency by the Treasury in case o f eventual excess supply in the foreign exchange market. The balance that has been achieved inthe public accounts has created a marginfor monetary policy to accompany the process o f economic growth, responding to the evolution o f the private demand for money. In order to assist in preventing a possible rebound o f inflation expectations, starting in January 2005 the BCRA decided to moderate gradually the monetary stimulus generated by the expansion o f the monetary base, It should be reiterated that the cumulative inflation o f the years 2004 and 2005 remained within the ranges projected in the respective budgets, and that said projections took into account an adjustment o f the relative prices that had "lagged behind" since the devaluation. Inthis respect, it should be noted that the pass through o f the devaluation to prices was, at the end o f the 36 months since the exchange rate adjustment, approximately one half of that observed in equivalent experiences in other emerging countries. 2005 2006 2007 2008 Inflation (Fourthquarter vs. fourth quarter, %) 10.6 8.6 8.0 7.2 NominalExchange Rate (Average for the period, per US$) 2.9 2.97 3.03 3.08 68 Annex A EconomicPolicyGuidelines Table 3 Millions o fUS$ 2005 2006 2007 2008 Exports FOB 39,212 41,275 44,4 13 47,341 Imports CIF 28,508 31,513 34,922 38,043 As for the fiscal targets, it should be noted that during the years 2003-2005 a sustained surplus was generated in the public accounts, something unprecedented in the last 50 years. This surplus was the result o f the sharp increase in fiscal revenues, while expenditures have followed a more moderate path, initially driven by programs that were required to address the social emergency and, more recently, to finance a public policy o f infrastructure investment directed at sustained growth. This behavior will be maintained duringthe next three years. The provinces continue to operate in the framework o f Law No. 25,917 o f the Fiscal Responsibility Federal Regime, regulated by Decree No. 1731 o f December 7, 2004. It is estimated they will end 2005 with a total surplus equivalent to around one percent (1%) o f GDP. The budgetprojects a slightly higher surplus for 2006. With the objective o f ensuring the greatest effectiveness for the current fiscal policy, there are plans to modernize Financial Management tools by implementing a results-oriented budget management, and strengthening both the Public Investment System and the Public Debt Management System. D. Macroeconomic Policies and Reform Program to attain the Targets Inorder to avoid repeating the boom and bust patterns that are characteristic of the past and achieve the targets set out above, it is necessary to preserve the basic macroeconomic balances, while stimulating the convergence o f the macro aggregates towards proportions that ensure sustainable growth rates in a stable environment. As opposed to what occurred in the past, the solid surpluses in the fiscal and external accounts currently in place, the foreign exchange policy, and a well-balanced territorial growth open up opportunities to achieve lasting economic growth. One aspect that contributes to sustainability i s the growing share o f the tradable sectors inthe economy: while in 1998 the tradable sectors accounted for only 26 percent of GDP at current prices, by the end o f 2004 these sectors represented more than 40 percent. At the same time, total trade, exports and imports, more than doubled as a percentage o f GDP, which implies that the recovery has taken place within the framework o f an effectively open economy. All this should translate into stable growth duringthe periods o fnormality, and into an economy better preparedto deal with adverse changes in the environment, avoiding profound crisis episodes with devastating social and production consequences. Another element o f sustainability is the equitable 69 Annex A EconomicPolicyGuidelines development of the country's various regions. In that sense, although the new macroeconomic environment has been extremely favorable for the recovery o f primary production and the regional economies, the Government has pursued a series o f policies to stimulate regiohal production. The economic authorities consider that today it is essential to extend the reforms carried out since 2002, through a social and political commitment to sustain the transformations pursued, since, as already explained, these form a consistent and coherent ensemble. In that sense, although there still remain important medium and long term challenges related to the necessary process o f improving the institutions that govern economic life in Argentina, the reforms that have been implemented have made it possible to realize a macroeconomic environment that i s suitable to address such challenges. Thus, more than a listing o f short term pending reforms, Argentina's economy today faces a series of policy challenges (detailed in the first part) different from those that existed untilnow. Inparticular, the nature o f the problems that need to be addressed by economic policy in the current circumstances requires a renewed "fine tuning" in the management of policy instruments, that will confirm the current path o f the evolution of Argentina's economy. The Argentine Government, however, is aware that a sustainable macroeconomic context i s a necessary but not sufficient condition to attain a degree of economic and social development historically compatible with the aspirations o f Argentine society. That i s the reason why, while continuing to implement social safety policies, measures are being taken to improve the quality o f the labor factor o f production, inorder to foster greater social mobility. At the same time, a series o f policies have been developed to extend and modernize the infrastructure, and stimulate private investment. Inthat sense, and taking into account that the evolution o f investment (both in physical and human capital terms) i s a priority o f the Federal Government, a series o f policies to strengthen investment have been pursued, as detailed inthe following section. E. The Government's Vision of the Role of the Private Sector in the Growth Strategy The role that the current environment poses for the private sector, both domestic and international, in the growth strategy is fundamental. For the private sector's role to be effective inpursuingthe objective o f growth with equity, it is necessary to ensure that private investment flows are stable through time, that they provide the country with access to new technologies, and that they open up the possibility o f taking advantage of financing opportunities in international markets in terms that are beneficial to the country. The recent restructuring o f the public debt and the efforts to strengthen the public accounts have positive effects on the levels o f private profitability. As for the business climate, the definition o f demanding but achievable fiscal and external commitments 70 Annex A EconomicPolicyGuidelines provides certainty to the future path of key macroeconomic variables (tax pressure) and relative prices (exchange rate). Further, the reordering o f public finances and the definition o f a sustainable fiscal scenario would induce-by reducing volatility-a greater projected profitability and a scenario o f more certainty for the private sector. On the financial front, the ongoing policies, by contributing to a progressive reduction o f the public debt burden, produce a "crowding in" effect for the private sector, providing it more space to access domestic and external financing. In turn, the lower needs of financing o f the public sector and the reduction o f the country-risk premiumwill make it possible, other things being equal, to reduce the costs o f financing for private projects in the internationalmarkets. Table 4 FederalPublicSector BalanceSheet andFinancing (in millionsof Argentine Pesos and as YOof GDP) had a higher interest rate than yield on the reserves used for the payment. Thus, by clarifying the prospects and eliminating a factor o f uncertainty, the successful debt restructuring has had a positive impact on expectations, contributing to reinforcing the fundamentals o f the current macroeconomic configuration, and improving the prospects for sustainable, regionally balanced and socially inclusive growth. 71 Annex A EconomicPolicyGuidelines This is reflected in the behavior o f investment Table 5 since the exit from convertibility, which compares very Investmentrate favorably with other national and international external .at currentprices adjustment episodes. For example, while in the period 2003-2004, 52 percent o f the growth could be explained Investment/ GDP by the behavior of investment, in the two periods of sustained growth in the 1990's (1991-1992 and 1996- ("/I 1997) the share o f investment was 39 percent and 37 1994 19.9 percent, respectively. The increased investment observed between 2003 and 2005 was ledby the private 1995 17.9 sector, especially by Small and Medium Enterprises, and by the agro-industrial sector, with a strong impulse I 1997 I 19.4 in construction as well, both public and private. Table 5 shows the series Investment/GDP at current prices since 1994 and including projections up to 2008. Although the economic growth recorded since the second half o f 2002, the enhanced certainty resulting from macroeconomic policy, and the favorable relative prices are the major factors that explain this process, the Government o f Argentina considers that this favorable environment needs to be complemented with active policies with the aim o f ensuring a sustained increase in investment as a share o f GDP. In particular, use has been made o f fiscal incentives and sectoral schemes that contribute to stimulating private investment. Among the instruments employed the following may be highlighted: (i)the advanced reimbursement o f VAT on capital goods; (ii) the accelerated depreciation o f investments; (iii)the reimbursement o f the technical VAT upon making new investments; and (iv) a zero tariff for the import o f capital goods (and a compensatory bond for local manufacturers). At the same time, sectoral laws were passed to promote the software and auto parts industries, while similar laws corresponding to the biotechnology and biofuels sectors are currently inthe legislative process. Additionally, there have been initiatives for the development o f humancapital and labor training, including, inter alia, the following: (i) approval o f the Law o f Technical- Professional Education and (ii) legislative processing o f the draft for a Law o f Education Financing, that will increase from 4% to 6% of GDP the share o f education, science and technology inthe Federal and Provincial Budgets. Inthe area of public services, instruments relating to the legal frameworks have been developed, including: (i) the redefinition o f the Private Initiative Regime and (ii) the creation o f the Public-Private Partnership Regime. Inparallel, an intensive work has been 72 Annex A EconomicPolicyGuidelines going on in connection with the renegotiation o f utility contracts. In that sense, as at October 2005, out o f a universe o f 64 contracts being renegotiated, 15 had been concluded and 49 were inthe process o f beingrenegotiated. O f the latter, 51 percent had signed agreements, 31 percent were in process and only the remaining 18 percent were lagging behind. The information on the individual renegotiations, including the Final Report o f the 25 Public Hearings that were held during 2005, is available at: www.uniren.gov.ar. F Financing Requirements The successful conclusion o f the restructuring o f the portion o f the public debt that was in default, besides underpinning future expectations, enables the orderly financing o f the fiscal accounts for medium term sustained growth, fundamentally because the new commitments undertaken are strictly in line with the economy's future payment capacity, based on realistic forecasts regarding the historical development capacity o f Argentina's economy. At the same time, to give those bond holders who accepted the debt exchange the opportunity o f sharing in the benefits o f economic growth, the option of GDP-linked payments was included. Although initially many operators assigned a close to nil value to this option (in part as a consequence o f the complexity o f calculating a precise estimate o f the price o f a contingent asset that i s relatively new for the market), currently it has a significantly positive value. It should be noted that all the exercises analyzing the sustainability o f the debt on which the Argentine offer was based included the total debt that was originally in default. Inother words, the funds budgeted based on such exercises were calculated as if 100percent o f the eligible private creditors had accepted the offer, so that the percentage o f debt not exchanged i s not considered a budget saving. In fact, the surplus funds budgeted are being used to repurchase performing public debt. Inline with the experience o f other debtors, at the conclusion o f the restructuring process o f the defaulted debt, the Republic o f Argentina informed the Paris Club o f its willingness to begin the negotiation o f said bilateral debt immediately. After the debt exchange there has beena substantial improvement inseveral o fthe usual indicators o f vulnerability and solvency, as shown in Table 6. All o f this implies that the public debt service, although it will demand sustained fiscal efforts during a very extended period, should stop operating as a generator o f systemic vulnerability that induced permanent uncertainty and inhibitedthe growth o f the economy in the medium and longterm. The financing policy for 2006 is based on a primary surplus as well as on extending the credit operations in the domestic market that began in 2005 in order to meet the commitments payable during the period, fundamentally Bodens, Guaranteed Loans and the newly restructured debt. Additionally, financing from the BCRA will continue. 73 Annex A EconomicPolicyGuidelines At the end o f the year, the Republic o f Argentina paid the Table 6 (based on the real exchange rate of December2004) ,International Monetary Fund in Solvencv indicators 1Dec. 2001 I 2005 advance its total outstanding debt of US$9.81 billion. This debt was a constant vehicle o f intromission, because it was subject to periodic reviews and was the source o f 113% 69% demands upon demands that were 1Net public debt / GDP I 94% 148% contradictory and opposed to the objective o f sustainable growth. 5.44 times This repayment was part o f the strategy o f reducing the debt to a level compatible with the possibilities o f growth and payment, moreover it generated additional degrees o f freedom for the country's decision making. Regarding the multilateral credit agencies that have the objective o f long term financing o f development, the premise i s one o f neutral flows o f nominal resources (excluding interests). Overall, the projections o f the multi-annual budget for 2006-2008 present a primary surplus o f 3.3-3.5 percent o f GDP, which compared with interest payments o f around 2 percent o f GDP, allow for an overall fiscal surplus o f 1.3-1.5 percent o f GDP that will be used (as has been the case inrecent years) to reduce the nominal debt stock. From a longer term perspective, the total public debt, that before the restructuring amounted to over 120 percent o f GDP, i s projected to decline to around 50 percent o f GDPbythe second halfo fthe next decade, under very moderate assumptions. Certainly, despite ample primary and overall (after interest payments) surpluses, Argentina still has financing needs to fund part o f the principal payments o f its debt. However, our country has proved based on successive emissions o fnew debt that, in spite o f the dramatic crisis experienced between 1998 and 2002, credit markets have regained confidence in the public sector. This sign o f confidence from the private sector i s a demonstration o f the medium and long term credibility that economic agents accord to the inter-temporal fiscal situation. Since the current financial requirements are lower than the capital payments on the public debt, the current macroeconomic policy implies a program o f net debt reduction, consistent with the official strategy o f sustained growth. In this context, financing by international agencies or other alternative sources available is determined more by public debt management policies (searching for better alternatives regarding terms and interest rates, risk diversification, etc.) than by a need for financing due to shortfalls inthe domestic or international private markets. 74 Annex A EconomicPolicyGuidelines Of course, the IFIs financing is also necessary to address specific projects that contribute to increasing the productivity of the public sector and the economy as a whole. Inthat sense, financing investments with future returns is within the so-called "golden rule" of public investment spending, according to which investments should be financed with debt and not with current expenditures, so that each generation will contribute in accordance with the benefits it receives. 75 Annex B SovereignDebt RestructuringandDebtProfile 2005 Table 1 LargestDebtRestructuringinHistory Debt Stock before and after Restructuring InUS$billion Before After 1. On December 23, 2001 Argentina suspended Exchange I\Exchange2\ payment on some US$80 billion worth o f sovereign Total Public Debt 191.3 149.8 InternationalOrganizations 30.6 27.4 bonds, making it the largest sovereign debt default in Oficial Organizations 6.9 6.5 GuaranteedLoans 14.6 15.1 history. At end 2004, Argentina had some US$190 ProvincialGuaranteedBond 10.2 11.0 billion in sovereign debt, equaling nearly 126 percent Bonds 123.3 60.5 Bonds issuedafter default 17.8 19.6 o f GDP (Table 1). Of this, some US$102 billion- Bonds issuedin debt restructuringI\ 0.0 37.7 Bondseligible for restructuring 102.6 0.0 amounting to nearly 70 percent o f GDP-was in the Other bonds 2.9 3.2 form o f bonds and past due interest slated for Holdouts 0.0 23.4 Other 5.6 6.0 restructuring. Argentina launched its formal debt Memo:Total excl. holdouts 191.3 126.5 restructuring offer in January 2005. In June, 1\ As o f December3 I2004. following the conclusion o f pending legal action, the 2\ As of June 3 I,2005. The Governmentofficial debtdata after the debtexchange doesnot Government announced that the debt exchange offer includeholdouts. was completed. Source:Ministryof Economy. Figure 1 2. The total amount o f bonds tendered in the Public DebtStock exchange was US$62.3 billion, implying an (As ofendofyear, 1994-2WS) acceptance rate o f 76.1 percent o f eligible principal in default (Table 2). Tendered bonds were exchanged for US$35.3 billion in new bonds, including US$15 billion inPAR bonds (which have no face-value "hair cut" but include sharp reductions in interest rates and ,I 1 35 years maturity), US$l1.9 billion in Discount Bonds (with significant face value hair cut but relatively shorter inmaturity and with higher interest 40,0001 ...*.,., ,I,.....'"- *.......r'. , , , , , , , , , rates), and US$8.3 billion in Quasi-PAR bonds 0 (denominated in Argentine pesos and hlly allocated 1994 1995 1996 1997 1998 1999 2000 2001 2WZ ZW3 2004 2W5 to domestic pension administrators). In addition, the Source:Ministry ofEcononyandWorld Bankstaffesthtes.The 2005 esthte includes USS23.4billion ofdebtrestructuringholdouts. Government issued 62.3 billion units o f GDP-linked warrants, correspondingto one unit for each dollar o f Table 2 ArgentinainDebt Exchange Result new bonds issued, which promise positive interest US$ Million payments only in favorable states o f the economic growth cycle, The operation resulted in a hair cut o f Total amount indefault 102566 about 75 percent in net present value terms, and EligibleDebt 81835 implieda reduction inthe public debt from US$l91.3 Interest arrears 20731 billion as o f end 2004 to US$149.8 billion as o f June 2005 (including debt restructuring holdouts for about ExchangedDebt 62248 US$23.6 billion and excluding the GDP-linked in % of eligible debt 76.I warrants) (Figure 1). New Debt issued 35238 3. Measured as a percentage o f GDP, public Par Bonds 15000 Discount Bonds 11909 debt declined from 126 percent as o f end 2004 to Quasi-parBonds 8329 about 85 percent using the 2005 GDP (about 73 percent excluding holdouts). In addition, the debt Source: Ministryof Economy. exchange resulted in an improved debt profile. 76 Annex B SovereignDebtRestructuringand Debt Profile 2005 Fieure2 Average bond maturity, including bonds issuedinthe BondRepaymentsbeforeandafter DebtExchange debt exchange and all other bond instruments (InUS$billion,2M)6 2015) - outstanding, increased from about 10 years before the - - - exchange to 18 years (Figure 2, Table 3). This has helped to ease rollover risks in the medium term, 8BeforeFxhange After Exchange reducing by about US$30 billion repayments due through 2005-2010. 4 4. The debt restructuring also improved the currency diversification o f the public debt, especially 2 - b, in terms of increasing the share of debt in domestic 0 currency, which reduces the vulnerability to real 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 exchange rate swings (Table 4). Debt in domestic currency increased from 24 percent to 37 percent Table 3 after the debt exchange. Finally, the exchange Maturity of Debt before and after Debt Restructuring reduced interest payments significantly, as a result o f (Inyears) Before After Exchange 1\ Exchange 2\ both lower interest rates on new bonds issued and also interest capitalization for the first ten years on Total Public Debt 7.8 11.8 Quasi-Par and Discount bonds. Bonds 9.7 18.3 Loans 5.5 5.7 International Organizations 3.9 4.2 Backto the Markets Official Organizations 2.6 2.4 Guaranteed Loans 4.6 4.3 5. After the debt restructuring, the Government Guaranteed Provincial Loan 6.0 5.8 Commercial Banks 3.2 3.0 has accessed domestic capital markets on three Other creditors 2.0 1.7 occasions and obtained credit risk rating upgrades by Central Bank advances 1.o 1.2 major international rating agencies. 1\ As o f December 31,2004. 2\ As o fJune 31,2005. 0 On May 4, 2005 the Government issued Excludes interest and capital in arrears. voluntary debt for the first time since the Source: Ministryo f Economy. default, with AR$1 billion o f 10-year maturity bonds, promising an interest rate of 2 percent Table 4 inexcess ofinflation. Demand outstrippedthis CurrencyCompositionof PublicDebt amount by more than 2-1 at an interest rate o f As apercentage of total debt stock Before After 6.51 percent plus inflation. Later in July the Exchange 1\ Exchange 2\ Government issued an additional AR$2 billion o f the same instrument. As in the first issue, USdollars 45.7 46.7 the auctions were oversubscribed, at interest Arg peso 24.4 36.7 Euro 24.0 11.9 rates o f 5.51 and 5.2 percent plus inflation in Yen 4.2 3.2 two consecutive auctions. British pound 1.1 1.o Swiss Frank 0.5 0.5 Beginning in June, major international credit Other 0.1 0.1 0 agencies upgradedArgentina's sovereign credit 1\ As o f December 31,2004. from default status, and sovereign spreads were 2\ As o f June 31,2005. inthe 430 basispoint range,just above Brazil. Source: Ministryo f Economy. 0 On July 18, the Government issued US$1 billion o f dollar-denominated bonds of eight 77 Annex B SovereignDebtRestructuringand DebtProfile 2005 Table 5 years maturity. The cut-off price o f the auction Amounts Tendered in 2005 Debt Exchangeby Currency was 91 cents per dollar issued, which resulted InUS$ million inan annualized implicit returno f 8 percent on Eligible Exchange Accepted/ Debt Acceptance Eligible (%) average. The total demand was 54 percent higherthan the amount issued. US$ 46655 39397 84.4 EUR 30393 19083 62.8 JPY 3 143 2978 94.8 0 Argentina experienced a rise in sovereign AR$ 1027 296 28.8 spreads o f about 100 basis points inDecember Other 619 495 80.0 2005 to the range o f 500 basis points. Total 81836 62248 76.1 Subsequently, spreads declined to about 380 Source: Ministry of Economy. basis points by mid February. This recent decline in spreads is possibly associated with a broader market trend, as sovereign spreads o f Table 6 other emerging economies continued to decline Amounts Tendered in 2005 Debt Exchangeby Legislation (inUS$ million) in 2006, including Mexico and Brazil (Figure Eligible Exchange Accepted/ Debt Acceptance Eligible (YO) 3). Argentina 10833 9344 86.3 0 InMarch2006 the Government issued US$500 New York 36011 29306 81.4 million o f Bonar V bonds in a market-priced London 15032 10215 68.0 Frankfurt 17194 11014 64.1 auction. The Bonar V i s a bullet bond Tokyo 1793 1693 94.4 denominated in U S dollars o f five years o f Other 973 677 69.5 maturity. The auction resulted in an implicit Total 81836 62248 76.1 annual interest yield o f 8.4 percent. About 80 Source: Ministry of Economy. percent o f the new bonds were acquired by foreign banks. The total amount o f bonds issued in 2006 as o f end o f March i s US$2 Table 7 billion. This includes the Bonar V and an Public Debt by Type of Interest Rate additional US$1.5 billion o f Boden 2012 As a percentage oftotal debt stock issued to the Venezuelan Government. Before After Exchange 1\ Exchange2\ DebtRepaymentto the IMF Fixed Rate 69.5 62.5 Variable Rate 30.5 37.5 Libor 15.1 19.2 6. O n December 15, 2005 Argentina announced IMF 7.4 8.9 its intention to make an early repayment o f its entire Time deposit 0.7 0.1 outstanding obligations to the IMF, amounting to Other 7.3 9.3 SDR 6.656 billion, about US$9.7 billion (Table 8). 1\ As of December 31,2004. The authorities explained the prepayment as a means 2\ As of June 31,2005. Source: Ministry of Economy. to achieve more independence in macroeconomic management and the structural reform agenda. The repayment was made using Central Bank reserves, which declined to US$18 billion after the repayment. To compensate the Central Bank, the Government issued a bond denominated in U S dollars, which has a 10-year bullet maturity and pays the same interest rate obtained for international reserves. As a result, the operation does not affect the Federal 78 Annex B SovereignDebtRestructuringand DebtProfile 2005 Figure 3 Government's debt stock, as it entails the exchange Recent Evolutionof SovereignSpreads o f a liability with the IMF for a liability with the 600 , (EmergingMarketsBond Index July 2W5 -March 2006) I Central Bank o fthe same value (Table 9). 7. International reserves recovered to US$20 billion as of February 2006, which is over 100 percent the monetary base required by law, equivalent to 8 months of imports and also equivalent t , . to two times the amount o f Argentina's private and ............................................................ ....... public external obligations maturing in2006. . - ......iI I .EMBI+ -Argentina1 I.' .......Medco Debt Sustainability ~ (a) Debt Sustainability under 2006 Government Budget macroeconomic assumptions and following Source Bloombag repayment to the IMF Table 8 Obligations with the IMF before the Repayment 8. The debt restructuring has significantly Total 2005 2006 2007 2008 20062008 improved debt sustainability prospects inthe medium term. Based on the macroeconomic framework Repaymentsto the IMF,USS billion Expectationbasis 4.0 4.7 4.5 0.4 9.1 projected by the Government in the 2006 budget, Obligationbasis 3.5 1.6 4.2 3.5 9.1 Interest to the IMF,US$billion debt ratios would show a declining trend through the Expectationbasis 0.5 0.4 0.1 0.0 0.5 Obligationbasis 0.5 0.4 0.3 0.1 0.8 CAS period, to about 66 percent of GDPby end 2008 Debt Servlee to the IMF, US$billion Expectationbasis 4.5 5.1 4.7 0.4 10.2 (Figure 4). The underlying macroeconomic Obligationbasis 4.0 2.0 4.5 3.6 10.5 assumptions of the Government scenario are: (i) GDP Based on USSISDRexchangerate of 1.46. growth rate declining gradually to 3.5 percent by Source: IMF. 2007 and 2008; (ii) primary surplus of the Federal a Table 9 Government of 3.4 percent o f GDP; and (iii) a real Public Debt Stock Before and After IMF Repayment exchange rate appreciation of 17 percent. However, in US$billion Without With debt sustainability would remain subject to some IMFRepaynent IMFRepayment degree o f rollover risk. Projected rollover rates on Total Public Debt excl. holdouts 125.1 125.1 maturing bonds through 2007-2008 (the ratio of bond International Organizations 16.0 ;;;;\ issuance required to cover the financing needs to O.W. IMF 0.0 GuaranteedOrganizationsLoans Oficial bond repayments) are on the order o f 100 percent Provincial Guaranteed Bond 10.4 I::: (Figure 5). Bonds 64.0 64.0 Central Bank 4.9- a 9. The IMF repayment operation had a positive Other 1.3 1.3 impact on financing needs through 2006-8, as it Holdouts 23.4 23.4 reduced total debt service by US$10.3 billion through Total including holdouts 148.5 148.5 that period. The reason for this i s mainly the 10 year I\IncludesinterestcapitaliaztionuptoMarch52005. maturity of the bond issued by the Government to Basedon estimated Public Debt stock as of end 2005. compensate the Central Bank. Source: World Bank estimate. (b) Debt sustainability in a reform scenario 10. The possibility that medium-term economic performance i s better than projected in the 2006 79 Annex B Sovereign Debt Restructuring- and Debt Profile 2005 Table 10 budget cannot be discounted, as better performance Impact on PublicDebt Projectionof Repaymentto the IMF has beenobserved in the past. Substantial progress in 2005 2006 2007 2008 the reform agenda outlined in this CAS could trigger DebVGDP, percentage a virtuous cycle o f improved fiscal performance, Before repaymentto IMF 85.8 77.6 71.7 66.5 higher investment and growth and increased capital After repaymentto IMF 85.8 77.6 71.7 66.4 Debt Service, US$ billion inflows. This scenario could also be associated with Before repaymentto IMF 13.2 17.9 18.1 After repaymentto IMF 13.0 13.6 more real exchange rate appreciation. To evaluate ,14.1 Debt ServieelGDP, percentage the debt sustainability implications of this possibility, Before repayment to IMF 6.5 8.1 7.6 After repaymentto IMF 6.4 6.2 5.9 an upside scenario has been prepared. With respect to Bond rollover ratio the projections o f the 2006 Government budget, the Before repaymentto IMF 54 204 178 After repaymentto IMF 48 95 97 upside scenario assumes: an increase in GDP growth o f 1 percent, an increase in the primary surplus o f 1 percent o f GDP, and a currency appreciation o f an Figure 4 additional 10 percent by 2008 in real terms. This Projected Public Debt I GDP scenario results in significant improvements in debt (Percentape, 2005 .2008) sustainability prospects. Debt ratios would decline to about 57 percent o f GDP by the end o f 2008. Moreover, rollover ratios would decline to very low 80 - levels. (c) Debt sustainability in a low scenario 70 - 11. The possibility o f economic performance -2006 Government 6o remaining below the 2006 budget projection cannot 1 -BudgetScenario Scenario Refom ....... scenario 1 be discounted either. Lack o f reform could trigger a vicious cycle o f deteriorating fiscal performance, 50 4 2005 2006 2007 2008 lower GDP growth, lower capital inflows and a more Source WorldBankstaff stmates depreciated real exchange rate, resulting in weaker public sector creditworthiness and increased rollover Figure 5 risks. For example, starting with the assumptions o f Projected Bond Rollover Requirements the 2006 budget, if growth were projected to be 1 l v ! - l l (Bond issues as a shareof bond repayments,in percentage, 2006.2008) percent lower each year starting in2006, the primary -2006 Government Buds SCRlari surplus were projected to be 1 percent o f GDP lower, -Reform SEPnaio ................. and the real exchange rate were to show 10 percent ~ 140 less o f an appreciation by 2008, debt ratios would still decline but at a slower pace, remaining at about .....,,..' 76 percent o f GDP by end-2008, that is, only 10 percentage points lower than the 2005 estimate. The 2 o l l l 60 rollover risks would increase significantly. Such a scenario would require rollover rates of about 150 percent through 2007-8. .20 -- Debt sustainability will also require fiscal Source WorldBankstaffestimates discipline at the provincial level 12. Provinces have obligations to the Federal Government totaling US$16 billion. These 80 . Annex B Sovereign Debt Restructuringand Debt Profile - 2005 Figure 6 obligations result from Federal Government bailouts Projected Debt Service / GDP through the 2002 economic crisis, and include (percentape, 200s. 2008) US$lO.9 billion o f provincial guaranteed bonds (resulting from the Federal Government's responsibility for provincial debt service obligations, serviced through coparticipation withholding), US$1.3 billion issued to finance the repurchase o f quasi-monies (several provinces issued their own currency to pay expenditures before the collapse of -Refom! Scenario the Convertibility in December 2001), and US$3.7 .......LowScenario I billion in loans from multilaterals (guaranteed by the Federal Government). 2005 2006 2007 2008 Source WorldBank staff stirnates 13. Following the steps o f the Federal Government, the provinces o f Mendoza and Buenos Aires have restructured their provincial public debt in Table 11 default. The province of Mendoza restructured debt National and Provincial Debt Restructurings in October 2004, for a total amount of US$250 Amount in million in provincial bonds in default, which were Participation Estimated Default I\ in debt exchange NPV reductionZ\ (US$bn.) exchanged for an equivalent amount o f new bonds o f (percentage) (percentage) additional 10 years o f maturity and about half the Federal Government 102.6 76 75 interest rate. Definitive data on the outcome o f the Province ofBuenos Aires 3.1 94 48 Mendoza exchange i s not available. Based on Province of Mendoza 0.3 64 21 preliminary data, the exchange conditions implied a ~~1\ Includescapital and interest in arrears reduction in net present value (NPV) terms o f about 2\ Based on discountrates of I O percent. Source:NationalandProvincial authoritiesand World Bank staff estimates. 21 percent using 10 percent discount rates (Table 10). Acceptance o f the offer was 64 percent. InDecember 2005 the province o f Buenos Aires completed the exchange o f US$2.7 billion in provincial bonds in default. The offer recognized past due interests for US$0.4 billion, resulting in a total amount o f recognized debt in default o f US$3.1 billion. The offer consisted o f a menu o f three bonds, including two Par bonds o f different maturities and interest rates and discount bonds with a reduction in principal. The estimated NPV reduction was an estimated 48 percent, and participation was 94 percent. 81 Annex C BankingSector Update' 1. Inthe last four years, the banking sector has been able to overcome some o f the effects o f the 2001-2002 crisis. Deposits have maintained a growing Figure 1. FlnancialSystem Deposlts trend since the third quarter o f 2003 in ARB billion (Figure 1) and private sector credit +Total deposits +Private sector deposlts started to recover in the second half o f 2004 (Figure 2). The quality o f bank assets (Figure 3) and bank profitability have improved, and new capital increases are helping to improve ."--- solvency. For its part, the Government , I has eliminated withdrawal restrictions 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source: Siobcdculaflon on BCRA dam imposed during the crisis and has, to large extent, completed the compensation to the banks for policy induced losses. Banking regulation and supervision i s also returning to normal. There are, however, some remaining vulnerabilities such as the high exposure o f the banks to the public sector, balance 8 sheet mismatches, and low capitalization 20 gx levels. Improving the efficiency o f I 5 public banks, which remain burdenedby I O high operating costs and weak loan 5 portfolios, remains a challenge. The 0 1996 1997 1998 1999 2000 2Wl 2W2 2003 2004 2005 biggest challenges for the future are to Source:Srafledcularton 0" BCRA dsh increase long-term credit to the private sector and improve access to financial services to under-served groups o f the population, including small and medium Flgure3. Non-Performingloans enterprises, low-income households, I OProvlrionr i NPLa +NPLs i Privale sector grauloans (right axis) I small farmers and microenterprises. The 2001-2002 banking crisis and its effectson the system 2. Prior to the crisis, the banking system exhibited strengths and vulnerabilities. As o f 2000, Argentine 1996 1997 1998 1999 2WO 2WI 2W2 2003 2004 2005 Sourcp: Sfaflcdcdafion ON BCRA dsE banks were well capitalized (with capital adequacy ratios averaging 20 percent duringthe 1993-2000 period) and liquid. However, their profitability was low, due to operational inefficiencies. 'Previous updates were prepared in the last Argentina Country Assistance Strategy (January 2004) and in the Argentina Economic Recovery Support Structural Adjustment Loan (June 2004). The data has been updated up to end-2005 where possible. 82 Annex C BankingSector Update 3. Argentina's social and economic crisis o f 2001-2002 led, from early 2001 onwards, to capital flight and mounting deposit outflows. The authorities' response to the run on the banks further reduced confidence in the system. Restrictions on cash withdrawals o f Figure 4. Bankingsystem prontabiiity after crisis deposits (Corralito) were imposed in Emerging countriescomparison December 2001, and the maturities o f time deposits (Corraldn) were extended in February 2002. Following the end o f Convertibility in January 2002, the balance sheets o f the banks were _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ dedollarized at asymmetric rates, and the assets and liabilities o f the banks were subjected to asymmetric indexation. i=.I 1 = 0 1 = I 1 - 2 1 = 3 1=4 1 = 5 Sources; BCRA and Globd FinmeMSl#bil@ Repm (IMF). 4. The policy measures generated significant losses for the banks (Figures 4, 5). The asymmetric pesification, which determined that banks had to pay 1.4 pesos per dollar on dollar deposits versus 1 peso per dollar on dollar loans, generated losses to the banks that the BCRA estimated (for compensation Figure 5. Bankingsystem profltabllity after crisis purposes) at AR$29.6 billion. The Emerging counfries comparison asymmetric indexation, in which deposits were indexed to the rate o f consumer price inflation while certain loans were indexed to wage inflation, generated additional losses estimated at AR$77 million. A number o f banks also suffered losses as a result o f some depositors being able to use judicial rulings (amparos) to release frozen deposits at the market exchange rate of over 3 pesos per dollar. 5. To prevent a systemic collapse, the Government took the decision to compensate the banks for the policy induced losses. In May 2002, the Government decided to compensate the banks for losses incurred due to the asymmetric pesification, and in April 2003 the Central Bank (BCRA) allowed 83 Annex C BankingSector Update for the amortization o f amparos over five years. Rules governing the compensation for asymmetric indexation were issued inNovember 2003. 6. Regulatory forbearance was also required to prevent a systemic collapse. Confronted with a generalized insolvency problem in the banking Figure 6. Public sector assetsvs. Private sector loans sector, the BCRA suspended capital % of TotalAssers [ +PubileSector Asset5 -+PrlvateSeetor Loans I adequacy requirements and relaxed I regulations on loan classification and provisioning to take into account the effects o f the financial crisis. Inaddition, the banks were allowed to operate during 2002 without presenting signed balance sheets and financial projections. Lack o f access to external financing (capital markets and multilaterals) for bank recapitalization required a gradualist approach aimed at sustaining bank profitability while the economic recovery was not yet underway. 7. Banks' exposure to public debt increased. Liquidity assistance by the BCRA and compensation for policy Figure 7. Private Sector Loans vs. Private Sector Deposits as a % ofGDP induced losses helped banks to recover, notwithstanding their shortage o f capital. This assistance, combined with a sharp fall in private sector demand for credit, increased banks' exposure to public debt to 50 percent o f total assets (Figure 6). The low market value o f public debt during the default increased the uncertainty over the viability of the sector. 8. The crisis led to a drastic fall o f lending to the private sector (Figure 6, 7). The stock o f credit declined 40 percent in real terms during 2002 alone and a hrther 12 percent in the first half o f 2003. The reduction in lendingwas in part the result o f a drop inthe demand 84 Annex C Banking Sector Update Flgure 8. Change In the number of entitlesand employees. From 2001 IO Seprember 2005 tystem PlForilgn bsnlo .Finanre rompsnlu ONsflonslprlvaubanlo OPvbllr bank for credit by the corporate sector, due to lack of new investments, and to greater reliance on internal sources o f financing for the purchase o f current assets. Also, firms that were heavily indebted in dollar loans from external sources were seriously affected by the devaluation, had repayment problems and were, therefore, unable to borrow locally. On the other hand, the supply o f term lending by the banks was limited by the Flgure 9. Towards a smaller Ilnanclal system short term nature o f their deposits and .. - T "' their capital shortages. 9. The crisis changed the structure and degree o f concentration o f the bankingsystem. As a result o f the crisis, several foreign banks left the Argentine market and others reduced their operations in the country (Figures 8, 9). Overall, foreign banks' market share o f assets and deposits fell in 2000-2005, while public banks increased their share o fboth (Figures 10, 11). In the last three years, the banks have overcome many of the effects of the crisis A. The banking business has recovered, although at a lower level of activity 2000 2005 Source:Slnffrdrulaliana~BCRA dale 10. Public and private sector deposits have grown as confidence inthe banking sector increased. The outflow o f bank Figure 11. Banks deposits market share. deposits reversed in the second half o f B! Public IForeign 0 National private 2002, allowing the BCRA to eliminate withdrawal restrictions o f sight deposits in December 2002. Total deposits increased 70 percent in real terms between December 2002 and December 2005, despite the negative interest rates that they earn. One possible explanation for this fast growth i s that depositors may have expected a capital gain from 85 Annex C BankingSector Update real exchange rate appreciation. Flgure 12. Flnanclal System Deposlts However, measured as a percentage o f as %of COP (I GDP, deposits are still below the pre +Total deposits crisis level (Figure 12). Until the first half o f 2004, public sector deposits led ' Ot -cC Private sector deDosits the growth, but since then they have slowed down, while private sector deposits have continued to increase (Figure 13). Deposits are still very short term. More than 70 percent o f the deposits are for less than 60 days, which limits the capacity o f the banks to Figure 13. Deposlts dlstrlbutlon by sector [0Private . provide long-term credit (Table 1). sector deposlts sector deposits 0 Publicsector depositsI . . ...... -. . .. -Financial . ... .-... ............... ...... 11. Consumer and commercial credit 27% i has recovered, but long-term credit remains depressed. Consumer lending has already exceeded its pre-crisis level, due to the massive development o fcredit card lending (Figure 14). Mortgage and corporate sector portfolios, instead, have 2000 2002 1005 remained at approximately 74 and 72 Sourer: SillfJcdculalion on BCRA dda percent o f their 1997 level. As a ratio to GDP, private sector credit remains Flgure 14. Private sector loans by type. below 10 percent compared to the 23 70 I percent prior to the crisis. M) 50 .Consumer 12. Asset quality has improved j40 5 OMortgage and significantly with the recovery. The ratio 30 Collateral OCommerclal of non performing loans (NPLs) to total 20 loans fell from 34 percent in December 10 2003 to 19 percent in December 2004, n and to 8 percent in December 2005. 2000 2001 2002 2003 2004 2005 Source SrwJ'c.dculanon on BCRA da4 I Provisions now cover around 120 percent o f NPLs. Both private and state owned banks have been successful in Table 1. Time vs Saving-Sight deposits improving the quality o f their assets. 2000 2001 2002 2003 2004 2005 share (in %) Total deposits 13. Banks have reduced significant Saving and sight deposits 29.2 37.8 40.2 48.0 55.0 55.I Timedeposits 63.6 55.2 48.7 44.6 39.7 39.6 balance sheet mismatches (interest rates, Lessthan 60days 3 4 8 3 6 3 19.5 275 223 19.3 More than 60 days currency and The foreign 2 8 8 term). 18.9 29.2 1 7 2 1 7 4 203 Other 7.3 7.0 11.1 7.3 5.3 5.3 currency mismatch by end-2005, for Source: Staffcalculation on BCRA data example, was 40 percent below its pre crisis level in terms o f net worth. Nevertheless, despite the growth o f 86 Annex C BankingSector Update indexed time deposits, there i s still a mismatch in indexed instruments, which implies a vulnerability to real interest risk. 14. Operating costs have also been Figure 15. Banking system profitability reduced. The reduction in intermediation %of assets 1 has required a parallel reduction of eSZOO2 02003 .ZOO4 02005 I - 0 9 operating costs, particularly among private banks, which have reduced the number of branches and employees (Figure 15). 15, Banks' profitability has improved and new capital increases are helpingto improve solvency (Figures 15, 16). The low cost o f deposits, the decreasing level of new loan loss provisioning, and asset revaluations, have all contributed to improved bank profitability. In 2005, the banking system net results amounted to AR$1.9 billion, compared to -AR$0.5 billion in the same period o f 2004 and -AR$5.5 billion in2003. Banks have made capital increases of almost AR$12.6 billion since the crisis, of which AR$2.3 billion have been made in 2005. A significant portion o f this capital increase has taken place inforeign banks. 16. Since the public debt restructuring, in June 2005, the market value o f public bonds has increased, benefiting the banks. The improvement in public bond prices will alleviate the impact on banks' balance sheets of the transition from book to market based valuation o f government paper. 87 Annex C BankingSector Update B. Compensation to the banks for policy induced losses is ending, remaining constraints on deposit maturities have been eliminated and BCRA assistance received during the crisis is being canceled 17. Banks are beingcompensated for losses incurred as a result o f the asymmetric pesification. By end-October 2005, 85 banks had received compensation for the asymmetric pesification o f domestic dollar denominated liabilities, representing 90 percent o f the total amount o f compensation recognized by the BCRA (i.e,, AR$18.8 billion). In addition, 48 percent o f the compensation for foreign issued liabilities (Cobertura Bonds), estimated by the BCRA to be AR$10.8 billion (US$3.6 billion), had been delivered to the banks. The Government has also agreed to issue bonds for Figure 18. Money in circulation 100 AR$77 million to compensate one bank % of Private sector loans (rlght axis) and five finance companies for losses 80 due to asymmetric indexation. The flow 60 of new amparos i s declining and will end with the coming to maturity in 2006 40 o f the last deposits held at the time o f the 20 crisis. 0 18. Deposits whose maturity had 1996 1997 1998 1999 2000 2001 2002 2003 2004 ZOOS Sourer: Siaflcaieuiuion on Miniado de Eeonomlo dua been extended with the corraldn (CEDROS) have expired (Figure 17). By end 2005, the value o f the stock o f deposits, whose maturity had been extended by decree in February 2002, has fallen to zero, eliminating any remaining constraint on the deposits' maturities. At the same time, preference for liquidity remains very high and has not shown signs o f reverting to pre-crisis levels (Figure 18). 88 Annex C BankingSector Update 19. In the last two years, mostly in 2005, banks have been canceling the BCRA assistance received during the Figure 19. Banking system debt to the BCRA crisis. By end-2005, the banking system 27 debt to the BCRA was AR$14 billion 14 (including CER adjustment) compared to 21 I S AR$21 billion in December 2003. I S Besides, the number o f entities indebted 1'. 9 declined from 24 to five. More than 80 6 percent o f the cancellation was done 3 0 during 2005, when the B C R 4 added the possibility to anticipate future installments o f the matching scheme source: BCR4 (Figure 19). C. Banking regulation and supervision is returning to normal 20. Prudential regulations are being reinstated. A process o f gradual phasing out o f regulatory forbearance started in 2003 and has continued with only minor delays with respect to the initial plan, notably the extension from December 2004 to December 2005 of the favorable classification criteria for restructured debt and for fixed assets required to ease the transition to the new solvency ratios. Both extensions are intended to avoid a shortfall o f regulatory capital. The B C R 4 i s also currently completing its first round o f full on-site inspections, and the banks' reporting system has returned to normal. D. Special rules established for the valuation of government securities protect banks' solvency 21. With almost half o f bank assets currently held inthe form o f government bonds, valuation o f these securities has a major impact on banks' solvency. Given the low and volatile market value o f these securities, it would be detrimental to banks' solvency to mark-to-market 89 Annex C BankingSector Update Figure 20. Public Sector Exposure (including BCRA papers). them. The BCRA allows banks to book 3 month moving overage 1X Pubilrbanks them in the held to maturity portfolio. f NationdPrlvatebanks *Forelpi banks -=-Total Banks Since March 2003, the BCRA has allowed banks to discount the flow of funds for government exposure at an increasing rate until2007 and, starting in June 2008, at the market discount rate. The rules for booking the bonds received from the debt exchange make the time it would take for their book value to adjust to market values dependent on the trends Figure 21. Interest rates for the market valuation for government in ARd, nominal terms --1 exposure. -c- LendingInterestrate Remainingvulnerabilities E. "The high degree of'exposure to credit risk from the consolidatedpublic sector is perhaps one of the weakest points of thefinancial system ''' 22. Banks' exposure to the public sector, including BCRA papers, was Figura 22. Tasa de lnterks de depdsitosa plszo fijo en AR$* % anual en lermrnos reales reduced by only 6 percentage points I since December 2003, reaching 44 percent in December 2005 (Figure 20). The BCRA has established a limit o f 40 percent o fbank exposure to public sector assets (excluding BCRA papers) by 2006. 23. The large gap between lending and borrowing interest rates may not be a permanent feature o f the system. The Figure 23. Lending interest rates in A R V banking sector has benefited from high Annual % in real ferns I -c-Commerclsl 9 Consumer -X-MorIgsgrsnd Collslrrsl1 interest rates on consumer lending 1 (which in nominal terms are above 25 percent) and low, even negative in real terms, deposit rates (Figures 21, 22, 23). This situation may change if banks continue to reduce their high level o f liquidity, which may lead to higher deposit rates. "Financial Stability Bulletin, second semester 2004, page 9, BCRA. 90 Annex C BankingSector Update 24. The tax on financial transactions The major challenges for the financial is impeding the banks' recovery to their sector are to increaselong-termcredit central role in the administration o f the to the private sector and improve payment system. The financial access to financial services to transaction tax lowers the demand for underservedgroups of the population payment services and reduces banks' fee-based income. However, given its 26. A major challenge is to increase importance in fiscal revenues, it i s the domestic supply o f long-term credit unlikely that this tax will be eliminated to the private sector. Credit to the private in the foreseeable future. The financial sector shrunk considerably as a result o f system may be able to increasingly avoid the crisis, and has not yet recovered, this tax, as other countries have done, except for the strong increase in through financial innovation in products consumer lending. Argentina's and services. experience coincides with the international experience, which is that 25. Restructuring o f the public banks following a deep financial crisis, GDP remains a challenge. While public banks tends to rebound surprisingly fast, while have strengthened their role as fiscal investment and credit to the private conduits and increased their share o f sector remain depressed for a longer intermediation activity with the public period o f time. While time i s needed for sector, they remain burdened by high long-term credit to recover, measures operating costs and weak loan portfolios. need to be taken to reconstitute domestic What happens to these banks will have long-term funding and reduce the risks an impact on the whole financial sector. o f long term lending. A key question will be whether the future role o f these banks should be: (i) 27. There is a need to reconstitute commercial banks that compete with long-term funding in local currency. private banks, (ii)agencies in charge o f Prior to the crisis, long term funding developing financial markets, or (iii) came mostly from abroad in foreign some type o f hybrid. Whatever their currencies (i.e. banks would issue future role, they need to improve liabilities in international markets). This solvency by further strengthening the generated distortions because much o f quality of their portfolios and further this funding was used to give credit to reduce operating costs. The solution to the non-tradable sector, thereby fuelling the problems o f public banks-due to mismatches that were at the heart o f the their size, governance, and balance sheet cost o f the crisis. Long term peso composition- involves important fiscal funding will, in the end, have to come and political considerations. Public from pension funds (AFJPs) and annuity banks' compliance with the BCRA providers (life insurance companies). solvency rules will require substantial This requires the strengthening o f recapitalization plans over the next healthy links between the banking and decade. non-banking sectors and improvement in the investment and credit environment. 91 Annex C BankingSector Update Figure 24. FinancialTrust Funds damaged by debtor-biased decisions o f the judiciary in the aftermath o f the crisis. There i s also a need to further improve the role o f the already strong credit information system on debtor households and enterprises. 30. A major challenge is to broaden access to financial services to the under- 1996 1997 1998 1999 ZMKl 2WI 2W2 2W3 2004 2005 Source:SII1/Jedcul&on on Balm de Comerdode Bumnor AIws dola served. This i s a big challenge because low income households, small farmers and microenterprises have very little 28. Trust funds (j?deicomisos access to financial services inArgentina. financieros) are new instruments linking In fact, Argentina lags behind other banks and long term investors. Trust countries in the region in the hnds are beginning to replace the banks development o f a self-sustaining as main sources o f financing, microfinance industry. Credit to small Institutional investors are the main and medium enterprises i s also a big investors in the growing number o f challenge. Legal and regulatory changes financial trust funds that are being are needed to regulate intermediaries created in Argentina (Figure 24). The such as credit cooperatives, or new trusts manage funds or securitize streams instruments such as microcredit, to o f income to finance a wide variety o f extend credit to a large section o f the public and private investments (they population that cannot be reached by account now for almost 10 percent o f commercial banks. private sector loans). Although most trusts are administered by banks, they are not part of the bank's assets, which guarantees their protection from banks' creditors. Other forms o f growing non- bank intermediated financing in Argentina include financing o f agricultural exports through international and local suppliers. 29. Recovery of long term lending also requires reducing creditor risks. Legal and regulatory changes to improve contract enforcement and creditors' rights are needed to reduce the risks o f long term lending. In this context, it i s important to recompose the contractual integrity o f credit guarantees and the credibility and reliability o f the processes o f execution o f guarantees and repossession o f collateral, which was 92 Annex D PrivateSector andInvestmentClimate (preparedjointly by IBRD andIFC) 1. This Annex analyzes the following topics: (i)key private sector ~~ Figure 1. How do you considerthe current situationof the trends, (ii)constraining factors, (iii) following issues comparedto last 12 months? issues affecting Argentina's Better B4Same 0Worse competitiveness, and (iv) key issues to facilitate private sector development looking forward. PrivateSector Trends 2. Recent surveys of leadingprivate sector firms confirm a generalized perception that the economic environment for business has improved. For instance, a survey o f leading companies undertaken by Deloitte (October 2005) states that 63.4 percent o f those surveyed believe that the ~ Fiwc2.lnvatmcnli GDP (end-quanu, 1993 wnstantprice) economic environment has improved in the past 12 months (Figure 1). This trendreflects the improvements inmacro fundamentals exhibited in Argentina in recent years. Moreover, recent .................................... developments in investment, private ..................... consumption, industrial production, credits to the non-financial private sector and the confidence index also illustrate a Souxe: Mlnlsido de Economia general recovery trend after the crisis. 3. Investment and Consumption. As shown in Figure 2, the investment trend has reversed, with investment as a share o f GDP increasing fiom about 10 percent in 2002 to more than 20 percent inthe second halfo f 2005, a level above the pre-crisis period. At the firm level, 55 percent o f the surveyed firms' indicate they have made investments in the past 12 months (31.6 percent incorporatednew capital goods, and 26.3 percent expanded installed capacity). Souree:Mlnisren'o de Efonomla 1 'Deloitte, October2005. 93 Annex D PrivateSector andInvestmentClimate (preparedjointly by IBRD andIFC) In addition, private sector consumption has also recovered since 2002, Figure 4. Why have you not increased your installed capacity? increasing it to levels similar to that o f the pre-crisis period (Figure 3). CON ornnsncing 0.0% 4. I nstalled Capacity. Capacity utilization remains at the 80 percent Lsek orerlticd Inputs level. Among firms suweyedthat did not expand capacitf (Deloitte, October 2005), 62.5 percent indicated that they 6t.lTh did not need additional capacity to grow (Figure 4). With the present installed capacity, industrial production has increased almost 68 percent since 2002, reaching about the same level as the pre- crisis one (Figure 5). 5 . Private Sector Credit. Credit to the non-financial private sector as a percentage o f GDP remains below 10 percent, still a record low (Figure 6). The absolute level of credit has recovered since 2004, but still falls short o f the demands o f sustainable strong GDP growth. Long-term credit remains scarce and i s available at reasonable rates only for top tier companies. SMEs do not appear to have needed significant amounts of credit as the shortening of terms o f payments following the crisis and credit concerns, as well as taxes on financial instruments, have reduced the availability o fworking capital financing. CorporateDebtRestructuring 6. In the last two years, the corporate sector has made important 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Source: Smffedrulalian on BCRA d4IQ I progress restructuring its debt. Based on "AGM Finanzas" database3. As of September 2005, about 87 percent o f ~ ~~ ~ Deloitte, October 2005. Aguirre, Gonzalez, Marx and Associates. The database includes 60 companies, each with debt 94 Annex D PrivateSector and InvestmentClimate (preparedjointly by IBRD and IFC) o f corporate debt had been regularized (i.e,, "no modifications" + "closed negotiations"), compared to 67 percent in December 2004 and 53 percent in December 2003 (Figure 7). However, regarding the 13 percent which i s still under process, almost 85 percent is still categorized as "less advanced negotiations", most of it corresponding to utilities companies. 7. The progress in restructuring corporate debt has varied depending on the type o f firm. According to AGM dataset, at end-September 2005 all igure 8. Debt restructuring situation by type of companies exporter companies' debt and 94 percent of non-exporter companies' debt have UNOmodifications OClosed negotiations been normalized. On the other side, Advanced neeotiations ELess advancednegotiations utilities companies have satisfactorily renegotiated 73 percent of their debt but almost 22 percent has shown slow progress, mostly because o f the uncertainty about the regulatory framework and tariffs, added to a broader dispersed debt among creditor groups (Figure 8). Non-exporters 89% 8. The restructuring proposals have varied widely, from simple extensions of maturity dates to complex restructurings including cash tender, new debt instruments (Par and Discount bonds), equity instruments and cash-flow Public utilities 5% sweeps. Regarding past-due interest, most o f the arrangements include the payments o f some or all past-due interest, either in the form o f cash or capitalizing it and including it in the burce: Aguirre, Gonzalez, M a m and Associates. overall restructuring. 9. Consumer Confidence and Confidence in Government. Along with over US$lOO million, representing about 60 percent the recovery inkey economic indicators of the total debt o f the non-financial private sector described above, the country's consumer (US$27.4 billion, at end-2003). 95 Annex D PrivateSector and InvestmentClimate (preparedjointly by IBRD and IFC) and government confidence indexes4 have improved since the record low levels o f 2002 (Figure 9 and lo), but continued efforts will be required to Figure9. InckxofConsumerConfidence buildon the initial gains. "..Mi"+I 70 1 60 ...................................................................... Concerns and Constraints 50 ................................... 10. In contrast to the above detailed ............................................................. improvements, recent private sector surveys reveal perceptions that in 40 30 .................................................................. matters related to investment climate, rule o f law, regulatory environment, government effectiveness, transparency and governance, less progress has been Source: Universidad Torcuaro di T d a . achieved. 11. Investment Climate.' Even though there i s a favorable external Figure10. IndexofConRdence in Gowrnment(0-5) environment boosted by increased commodity prices and completion of the I::: ....................................................................... I::::::::::::::::::::::::::-, ......................................................................... debt restructuring, only about 21 percent o f leading private sector firms stated that the investment climate has improved in the past 12 months (Figure l), only and 24 percent expect it will improve in the 1.0 .................................................................. , I next 12 months (Figure 11); 2.4 percent 0.5 ........ ......................................................, , , , , , , believe corruption issues are improving. 0 0 w,, ....................................................................... ~ 2.0 ...................................................................... ...................................................................... i 12. Rule oflaw. Inthe same survey Source: Univerridod Torcuato di Tella. by Deloitte, only 14.6 percent o f leading firms state that rule o f law has improved. In addition, in another survey by SEL Figure 11. How do you consider the future situationof the Consultants6, 55 percent o f respondents following issues in the following 12 months? from small; medium and large firms W% , mBener BSsme OWorse identified poor rule o f law as the primary En% 70% a% 50% Universidad Torcuato di Tella. 40% While the investment climate can entail 10% diverse, broad areas, especially including znw judicial, financing, and infrastructure, this I"% section focuses o n the judicial aspect. The other 0% areas are dealt with in other sections; within this annex, the following section discusses key infrastructure bottlenecks, including energy provision. SELConsultores, June 2005. 96 Annex D PrivateSector andInvestmentClimate (preparedjointly by IBRD andIFC) constraint for business de~elopment.~ Figure 12. Control of Corruption and Ruleof Law Respondents acknowledged that while Argentina compared with Upper Middle Income Countries, 2004 progress in the investment climate has OUpper Middle Income OArgentina been achieved over the past year in many areas, little has been seen in the Conlrol of corrupnon rule o f law. The main concerns encompass, broadly, legal and regulatory aspects; specifically, (a) constant RYk or L.W changes in rules; (b) breach o f private contracts; (c) conflicting laws; and (d) corruption in the judicial sector. Based on Kaufmann et a1 (2005)*, compared to other regional middle income countries, such as Mexico and Brazil, Argentina i s well behind regarding the rule o f law Flgurel3.Contrd ofCorruprionsndRuleofLaw (Figure 12 and 13). AiFenrlna cornnand I o selected coumrlrs, 2004 13, Regulatory Environment and Conlml Government Effectiveness. Since the crisis, regulatory quality and government effectiveness have remained at very low levels in Argentina, as reported by Kaufmann et a1 (Figure 14). Moreover, as indicated in Figures 15 and 16, 0 20 40 60 80 compared to other middle income countries Argentina i s distinctively below par on both parameters. These differences result inperceptions o f lower Figure 14. Government Effectivenessand Regulatory Quality standards o f infrastructure provision. Trend 1000.2004 For instance, the recently released World +Government Effeetiveneia -)Regulatory Quality Economic Forum's Growth Competitive Index 2005 scores Argentina low, after Chile, Uruguay, Mexico, Colombia, Brazil and Peru inthe region. 14. Corruption. Transparency International's Corruption Perception Index indicates that the perception o f corruption increased 'Other responses included high unemployment, economic uncertainty, personal safety, and high tax burden. Kaufmann D., A. Kraay, and M. Mastruzzi 2005: Governance Matters IV: Governance Indicators for 1996-2004. 97 Annex D Private Sector and InvestmentClimate (preparedjointlyby IBRD and IFC) Figure 15. Government Effectivenessand Regulatory Quality in the immediate aftermath of the crisis Argentina compared with Upper Middle Income Countries,2004 and, though having seen some OUpper MiddleIncome F1Argendna I improvement, remains a problem compared to other middle-income I I countries (Figures 17 and 18). These perceptions are consistent with the Gavernmenl survey o f leading firmsg (Deloitte, Eflectivenesr October 2005), where almost 70 percent o f surveyed firms believe corruption i s still at the same levels as the previous year, and almost 77 percent believe it will remain the same in the next 12 months (Figure 1and 11). DoingBusiness 15. Perceptions o f a lack o f a clear, dependable, and transparent legal and regulatory environment affect the way firms conduct business. Some o f these factors affect enforcement o f contracts - S.",,, and increase both the cost and the time needed to resolve commercial conflicts in court. In the most recent study of Doing Business 2006, it i s reported that contract enforcement in Argentina takes on average 520 days and 15 percent o f debt value (compared to regional averages o f 461 days and 23 percent), which ranks Argentina 91 among the 155 countries covered in this survey" (Table 1). 16. An IT Kearney FDO Confidence Index survey points to the country's need to develop an overall medium and long-term strategic plan for the country. This plan could include ways to fight tax evasion, reduce or eliminate distorting taxes, develop a more detailed regulatory framework, improve labor market efficiency, encourage more private 9Deloitte, October 2005. loUnder the "enforcing contracts" category. 98 Annex D PrivateSector and InvestmentClimate (preparedjointly by IBRD andIFC) sector engagement in research and the key issues looking forward, development, and foster a constructive prioritizing key interventions to increase dialogue between the private sector and the investment and sustainable growth". authorities. The main issues are: Key Issues to Facilitate Private Sector Institutions: Successful Development countries have based their development on strong and 17. The key challenge ahead i s to sustain healthy institutions. A the currently favorable developments and predictable institutional and legal tackle some o f the constraints indicated framework at all government above. Longer-term growth requires levels is needed in order to dynamic private sector development, which promote dynamic private sector will in turn require a significant development. This should entail: improvement in the business environment. (i) securing the independence o f In the aftermath o f the crisis, the control and regulatory environment would need to be improved in institutions, (ii)strengthening three key areas: public trust in public and private contracts, (iii)establishing an 0 Investment climate; efficiently functioning and 0 Financial intermediation; genuinely independent judiciary, 0 Infrastructure, removing key and (iv) strengthening public bottlenecks through efficient and sector management and sufficient investment, addressing transparency. security o f energy provision and Infrastructure and Public resolving the concession Services: Resolving the current renegotiation. controversies is o f utmost importance to sustain 18. These areas generally conform to development o f Argentina's an effective private sector development important infrastructure; this i s strategy along the lines suggested in the particularly urgent in the energy consultations with the private sector and in sector. the analytical work carried out during the A well defined regulatory preparation o f this CAS. The financial framework will be vital to intermediation and the renegotiation o f provide the basis for public private service and infrastructure services activities inArgentina. concessions are dealt with in Annex C and Investments and participation o f Annex E, respectively. This annex the private sector should be elaborates on the progress in the investment fostered, including through an climate. intensified dialogue between the private sector and the Agenda andKey Issues 19. The "Asociacidn Empresaria " See: "Una Agenda Empresaria para la Argentina" prepared a useful summary o f Inversion y el Crecimiento Sustentable", June 2005. 99 Annex D PrivateSector andInvestmentClimate (preparedjointly by IBRD andIFC) Government, as well as through the 0 The strong economic recovery is active exploration o f possibilities to creating business opportunities create public-private partnerships. for new investments, both in the 0 Public services companies should industrial and services sectors, operate efficiently and maintain or but they critically depend on the improve the quality of the services, stability o f the rule o f the game with access to financing investments and on the availability o f long- and to necessary growth so as to term financing. meet supply demands, obtaining 0 The development o f new, reasonable profitability and internationally competitive assuming the business risk inherent productive facilities makes it inall economic activities. Regulatory critical to make further progress frameworks o f public services need in the opening of the external to be strengthened in order to markets. perform their control fimction. 0 Investment: Argentina i s facing the challenge o f undertaking major investments required to deal with bottlenecks arising from the economic recovery, including infrastructure and production. 100 Annex D PrivateSector andInvestmentClimate (preparedjointly byIBRD andIFC) Argentina Region Brazil Mexico Thailand Poland South Africa Starting a Business - Times (days) 32 152 I 33 I 38 Getting Credit - Strengtho f LegalRightsIndex (0-lo)** 3 4 2 2 5 3 5 Closinga Business - Time (years) 3 4 10 2 3 1 2 - Cost ( percent of Estate) 15 17 9 18 36 22 18 Trading Across Borders -Documentsfor exportslimports 617 8/11 7114 618 9/14 617 519 Paving Taxes - Number o fpayments 35 I 48 I 23 I 49 1 44 I 43 1 32 Source: World Bank, DoingBusinessin 2006: CreatingJobs. *A highernumber meansmore regulatedconditionsor less flexibility. **A higher number meansmoreprotection. 101 Annex E PublicServiceandInfrastructureConcessionsRenegotiation* Background was: (i)suspension o f all public service and infrastructure concession contracts; 1. The exit from the convertibility (ii)devaluationoftariffs; (iii)180day a regime in January 2002, the devaluation, freeze on tariffs (successive extensions and the changes in the regulatory have meant that the vast majority o f tariffs framework contributed to severe have remained frozen for more than 48 contractual challenges to federal level months); (iv) modification o f the existing public service and infrastructure legal and regulatory regimes; (v) concessions. Progress toward elimination o f contractual indexation; and renegotiation o f the affected concessions (v) a call on the executive to renegotiate has beenlimited. all existing contracts. 2. Of the original 64 contracts o f 4. The Emergency Law established federal-level regulated public service and a set of guiding principles for the infrastructure concessions that required renegotiationof contracts: (i) impact the renegotiation, 28 have reached an o f the tariffs on the competitiveness o f the agreement' with the Executive. In economy and on the distribution o f addition, the Government allowed 13 toll income; (ii) the quality o f the services and roads to expire, partially cancelled one investment plans; (iii) interest o f the the railway contract, and cancelled 3 contracts consumers; (iv) safety; and (v) the (postal service, communication and water profitability o f the companies. supply and sanitation), over which it has since assumed ownership and control. 5. Following the crisis and during Four years after the freezing o f tariffs and the interim Duhalde administration, devaluation through emergency powers, efforts to advance the renegotiation 20 contracts still await a permanent process under a modified legal solution, including strategic concessions, framework proved difficult. Attempts which include the largest gas and by the authorities to provide temporary electricity concessions (transport and relief through interim tariff adjustments to distribution). the concessionaries by decree at the end o f 2002 and early 2003 were challenged in RegulatoryChanges Affecting court. RegulatedConcessions 6. The Kirchner administration, 3. On January 6, 2002, Congress which took officeinMay 2003, sought to passed an Emergency Law (Law 25.561) strengthen the legal basis for the granting extensive powers to the renegotiation process. Congress passed executive. The main impact o f the law law 25.790 on October 1, 2003. The new law extended the renegotiation timeframe ' until December 31, 2004, and also This means that a draft agreement has been strengthened the legal powers for the signed by the concessionaire and the renegotiation unit (UNIREN)which carries the renegotiation on process. It assigned joint responsibilityfor behalf o f the Ministries o f Economy and the renegotiation to the ministries o f Production, and Federal Planning, Public Services federal planning and economy that would and Infrastructure. have to be coordinated through the * This annex builds on the following reports: (i) "Argentina: Staff Comments o n Proposed Public Service and Infrastructure Concessions", SecM2004-0367, July 30, 2004; (ii) "Argentina: Staff Comments o n Proposed Public Service and Infrastructure Regulatory Framework Law", SecM2004-0367/1, October 4, 2004; and (iii) Article IVpreparedby IMF, July 2005. 102 Annex E Public Service and Infrastructure Concessions Renegotiation UNIREN.2 The Government issued new buses), (iv) railroad freight transportation, regulations' to introduce a fast-track (v) road concessions, including access process approval by Congress of the final routes to the city o f Buenos Aires, (vi) agreements. In addition, other key aspects national airports, (vii) postal services, were to: (i)enable the Government to (viii) port services and river transportation introduce partial amendments to systems, and (ix) provision o f water and concession agreements and interim tariff sanitation services. I adjustments; (ii)allow the regulatory agencies to decide on these same matters 9. The concessions affected by the under their own regulatory frameworks, renegotiations (see Tables 1, 2 and 3) are (iii)clarifythat therenegotiationprocess federal level concessions in sectors that may involve "public hearings" or "public had a regulatory regime inplace at the end consultations". o f 2001a4Tariffs have, for the most part, been frozen, and an important number o f 7. The new law has guided the concessions had a significant amount o f negotiations since November 2003. foreign debt obligations. Corporate During 2004 it supported three interim workouts now cover more than 85 percent agreements (water and telecoms) which o f debt in arrears after the crisis, with most expired at the end o f December 2004. outstanding renegotiations part o f debt Thereafter the law has been successively held by concessionaires. extended until December 2006, and has allowed the Government to reach 10. The estimated total amount of the agreements with 28 concessionaires, 24 o f investment by the public service and which have been subject to public infrastructure concessions totaled about audience, and 19 o f which have completed US$35 billion, and as Figure 1 indicates, the review process by Congress (see revenues totaling more than US$5 billion details in table 1 and Appendix 2), and for in 2002, and corporate debt of at least seven of which the Executive has signed US$11 billion. Most o f the debt i s Decrees authorizing the amendments accounted for by the telecoms and energy including the tariff increases. companies. These companies have also been an important source o f tax revenues The sectors affected by the to the Government, once privatized, renegotiation contributing up to 1 percent o f GDP in taxes in 2001 (or 5 percent o f total federal a. Regulated sectors Government revenues). 8. The sectors affected by the b. Non-regulated sectors renegotiation o f contracts were set forth in Decree 293/02 o f February 12, 2002 and 11. Three non-regulated sectors include: (i)transport and distribution o f were also affected by the Emergency gas and electricity, (ii)fixed line Law and the renegotiation process: gas telecommunication services, (iii) extraction, electricity generation, and passenger transport (railways, metro, and mobile telecommunications. The two upstream energy sectors, which had been UNIRENis responsible for the renegotiations of all affected contracts. Decree 31112003 and Joint Resolution 188/2003 The applicability of the regulatory regimes was and 4412003. suspendedby the Emergency Law. 103 Annex E PublicService and InfrastructureConcessionsRenegotiation de-regulated in the mid-1990sYhad their Figure 1 linking them from global prices, and Number of Concessions: 64 Transport 48% 18% I ~ Revenues: US$5.3bn ( 2002) I ~~ Debt: US$11bn (2002) Public Services 54% Source: World Bank Staff estimates. 104 Annex E PublicService andInfrastructureConcessionsRenegotiation Table 1. Argentina: Summary of Contracts Affected byRenegotiations Number Sector of Income Majority 1 Type of contract 1 1 Contracts Investor 1 Electricity Transport Foreign Owns Fixed assets Distribution ti: Foreign Owns Fixedassets ~ Gas Transport Owns Fixed assets Distribution AR$ & US$ AR$&US$ I?;?;$; ~ Owns Fixedassets Water AR$ Foreign Owns fixed assets Urban access roads 4 AR$ Foreign & domestic Owns fixed assets Inter-urbanroads I 16 I AR$ I Domestic Telecommunications 2 AR$ Foreign Owns fixed assets ~ Railroads II 11 11 AR$ I Domestic Ports I 4 1 AR$ &US$ I Foreign Manages Dredging 1 US$ Domestic & foreign Owndrents Postal services 1 AR$ Domestic Airports 1 AR$ Domestic BusTerminal I 1 1 AR$ I Domestic Manages 1 I ~~ Total ~ Table 2. Source: UNIRENand World Bank staffestimates. 105 Annex E PublicService andInfrastructureConcessionsRenegotiation Progressin advancingthe residential users) and a commitment by renegotiationof contracts the Government to conduct an integral 12. The Government has signed tariff revision in 2005 with the aim o f Letters o f Understanding' with 286out o f implementing the agreed adjustments in a total o f 64 concessionaires included in 2006. The four agreements for urban the decree (Tables 2, 3). This includes access roads were interim through 2005 the agreement reached with both telecom and require an additional negotiation to companies. Fourteen have gone through be permanent. Finally, all the companies the Congressional review/approval where agreements have been reached process (one approved by voting and the have had to agree to suspend their rest on a no objection basis, or "sanction litigation in the international arbitration jcta", after 60 days in Congress), and tribunals, and to withdraw their claim the rest are now under examination in once the integral tariff revision is the joint Congressional committee for completed and has gone through the the renegotiation o f contracts. The 28 public hearings.* agreements include eight (4 ports and 4 freight railways) which are permanent 13. Factors affecting long term agreements and do not include tariff sustainability remain a main concern. adjustments, but instead improve the Several gas concessionaires have yet to economic conditions o f the firms reach renegotiation agreements, and the through adjustments in the investment electricity concessions which were programs and by clarifying some other renegotiated still await an integral tariff contractual conditions' The authorities review. The two major fixed line consider the 10 contracts agreed with the telephone companies reached electricity distribution and transport agreements in principle that are now companies and one contract agreed with subject to public audiences and a gas distribution company as permanent ratification by Congress. The contracts contracts, although the programmed for urbanaccess roads require an integral tariff agreements for 2006 have been put tariff revision and inter-urban road on hold. Instead, these contracts have a concessions still require permanent tariff adjustment for 2005 (non- renegotiations. In the water sector, the only federal level concession in the metropolitan area o f Buenos Aires, s Agreement in this context refers to a Letter o f Aguas Argentinas, was rescinded by the Understanding signed between UNIRENand the concessionaire, followed by a public audience as Government in March, 2006, after the required by Law. The Letter o f Understanding i s Government and concessionaire failed to followed by a signed Agreement between the reach a renegotiated agreement. In the parties incorporating any required changes after latter case the Government has the public audience. The agreement in the case established a new state company which o f the railroad ALL (2 concessions) still has not gone through public audiences. started operating the company after the Thirteen road concessions reached their closing concession was rescinded. date in October 2003 and Government rescinded the postal service concession. 'The 8 It is unclear how the agreements will deal with 64 contracts exclude the contract for the cases where the minority shareholders in the Bus Terminal inRetiro TEBA (No. 19 in Table company decide to pursue the litigation in the 3). For example, in the case o fports the contracts international arbitration tribunals. Most o f the establishes that the currency o f denomination o f cases are in the ICSID, and 2 cases in the rates will be the U S dollar. UNCITRAL(Paris). 106 Annex E PublicService andInfrastructureConcessionsRenegotiation Table 3. Status of FederalConcessions under Renegotiation - E N E R G Y li I I I 1 I I II II II I I 107 Annex E Public Service and Infrastructure Concessions Renegotiation Table 4. Argentina: Foreign companies leaving public service concessions Foreign Argentine Market Share New Owner company company Sector Action Date I (percent) 11 France Telecom Telecom Fixed line telephones Sold Sept.03 45.0 Domestic investor CMS TGN Gas Transportation Sold Mar.04 53.8 Domestic investor EDF Distrocuyo Electricity transport Sold May.04 6.5 Domestic Edenor Electricity distribution Announcement Apr.05 34.2 investor Suez Aguas Water and Sewage Concession rescinded Mar. 06 39.93 Government National Grid Transener Electricity transport Sold Sept.04 57.4 Domestic investor I Province o f 1 PSEG 1 Edeersa Electricity distribution Sold Apr.03 1.4 j Entre Rios Concession Province o f Barcelona Suez' Aguasde Aguas Santa Fe Water and Sewage rescinded 1 Jan'06 1 90'0 i SantaFe 1 I ~ li Inthe case of energyI companies, the market sharesrefer to the companies share inthe sector's total supply.Inthe case of Telecom the market share 1 , I is on total sales (fixed line sales only). Finally, in the case ofwater of Santa Fe, the market share i s basedon population served (in Santa Fe). 14. Key foreign operators have 15. However, there has been some decided to sell their shares in concession limited progress in liberalizing non- companies (Table 4). The departure o f regulated energy sector prices. The gas foreign shareholders leaves the production companies reached an Government with substantial contingent agreement with the Government in March liabilities as most o f these investors have 2004 that allowed their prices to be started litigation in the international gradually brought back in line with the arbitration tribunals, and once they have international prices by December 2006. sold their stakes in the companies they are These price adjustments for gas extraction likely to continue with their legal have also resulted in the need to increase action^.^ electricity generator prices (also a non- regulated sector, but one that saw its prices frozen and converted to local currency). 'CMS gas Transmission (US) sold its shareholding The gas price increases only affect inTGNArgentina but continued with its claims in industrial users and the electricity ICSID. In M a y 2005, an ICSID tribunal found in generators. In turn, the electricity favor o f CMS Energy's subsidiary, CMS Gas generators have been allowed to increase Transmission, and awarded compensation in the amount o f US$133 million, plus interest. The their sale price to the wholesale market interest calculated to date brings the amount o f the regulator company (CAMMESA). award to US$149 million which is half o f the Despite the wholesale electricity price original claim. The tribunal found Argentina increase, CAMMESA has not increased its breached its treaty obligations, including its sale price to the electricity distribution obligations to treat C M S fairly and equitably, under the bilateral investment treaty between the United companies, as the tariffs for final States and Argentina. consumers have remained frozen. This 108 Annex E PublicService andInfrastructureConcessionsRenegotiation has created a large deficit o f the The draft law would significantly stabilization fund (AR$l.15 billion at end undemine incentives for private July 2005), requiring growing government operators (local or foreign) to subsidies. In addition, the Government invest in infrastructure. The draft issued a resolution creating a trust fund to law does not establish a regular and buildtwo new 800 MW power generators. predictable process for updating With few alternatives, and after protracted tariffs to reflect changes in negotiations, 95 percent o f all generation economic conditions. companies which had outstanding claims on CAMMESA decided to subscribe to the 19. The main recommendations for Government initiative to swap debt for future consideration o f this framework stock instead o f being paid in energy were included in a Board report." bonds. WorldBank SuggestedPrinciples The Draft Public Services Law 20. Between 2002 and the beginning o f 16. In August 2004 the Government this CAS period, the World Bank was submitted a general framework law for the requested by the Government to provide regulation o f utilities and infrastructure. advice on the renegotiation process. Joint To date, the Draft Bill has not advanced IMF/IBRD missions identified and through the congressional process. The suggested to the Government a set o f core period to discuss the draft legislation does principles that emerged from key not expire untilAugust 2006. stakeholders o f the renegotiation process, as well as international experience. These 17. The draft framework law will be included: applicable to all public services, and will modify all the existing sectoral regulatory Maintain continuity o f affordable laws (such as gas and electricity). It aims services at prices and levels at strengthening the role o f the Argentine commensurate with the current state as the titleholder o f public services, social and economic environment; assuming the responsibility and the Ensure transparent negotiation o f authority to regulate and control utilities consensual adjustments to and other public services activities. concession; Consider interests o f all 18. The World Bank, European stakeholders, including customers Union, foreign governments and other and shareholders, the ability o f the interested parties have made extensive poor to pay, the viability and comments on the draft law. The general sustainability o f concessionaires; consensus i s that the law could be Retain the benefits o f competition improved by striking a better balance during the emergency period, between consumer protection and the need where applicable; to ensure the continued participation o f the private sector in the provision o f public Where economically feasible, services, In particular, the World Bank facilitate urgent expansion o f services; indicated: loReport to the Board(No. SecM2004-036711). 109 Annex E PublicServiceandInfrastructureConcessionsRenegotiation Encourage participation o f all affected stakeholders; 23. IBRD investment lending for Preserve productive capacity and infrastructure in areas covered by existing employment where feasible; concessions is conditional on ensuring the Balance short and long term sustainability o f the proposed investments. objectives; and The Buenos Aires Sustainable Establish principles for Infrastructure Development Project determining a reasonable return on (ISDP), approved by the Board in capital appropriate for each sector December 2004, supports provincial roads after the emergency period. and water and sewerage in areas of high poverty. 21. After four years o f renegotiations, a lingering concern i s that if these 24. Bank financing o f water and principles are not applied, the resulting ad sewerage investments in areas where hoc solutions will likely prolong concessionaires are operating will require uncertainty about the rules o f the game. reaching a prior comprehensive and long- The status o f application o f these term agreement between the Government principles was assessed in detail in the and the concessionaire/operator, which report to the Board dated July 30, 2004 will enable the financial viability o f the SecM2004-0367. This review concluded concession to be restored. that the lack o f progress overall, and the differential treatment o f concessionaires Assessment andConclusions by origin, was a concern. The application o f the above principles i s still not the 25. The Government has taken a norm. number o f steps to advance the renegotiation process started in February ICSID andUNCITRAL 2002. In several cases, the agreements, once ratified by Congress, will increase 22. Significant contingent liabilities the control by Government o f tariff stem from the on-going arbitration adjustment and investment plans. The tribunals in ICSID and UNCITRAL." most pressing challenge will be to restore Several shareholder and parent companies long-term investment, the continued o f concessionaires in Argentina have absence o fwhich remains a concern. logged claims with ICSID based on bilateral investment treaties. Inthe first 26. The wholesale energy price resolved case, an ICSID tribunal inMay o f increases during the past two years 2005 found in favor o f CMS Energy's represent a step towards the restoration subsidiary, CMS Gas Transmission, and of normality in the upstream energy awarded compensation in the amount of sectors. However, they still fall short o f US$133 million, plus interest (total of US$ addressing the existing deficit o f the 149 million) compared to an original wholesale electricity stabilization fund US$260 million claim. (CAMMESA) and do not enhance sufficiently the revenue stream o f the 22 Bankprojectsin concessionsareas concessions responsible for energy transport and distribution. "Not all claims are by shareholders in the 63 concessions. 110 Annex F Poverty and Social Development Poverty, Inequality, and Growth Figure 1. PowrtyRates 1. Argentina's overall record in GreaterBuenos Aires reducing poverty and inequality in the last 60 1 three decades has been disappointing. The country no longer ranks among those with the lowest poverty and inequality rates in the region. Poverty and inequality increased largely as a result o f low average growth and high volatility resulting in several periods o f extended recession and crisis, but also because o f changes in the structure o f employment and wages that have accompanied the growing integration Source: INDEC based on EPH. into the global economy. Although the largest hikes in poverty have occurred with the macroeconomic crises of 1989 and 2002, poverty rates increased even 1 - Rgure 2. PowtyRates Total urban areas during the economic expansion o f the Poveny --CExtreme poveny 1990s (Figure 1).According to estimations for the national population, between 1992 and 2004, around 11 million persons became poor: slightly less than half in the 1990s (even during the growth episode) and the rest during the 2001-02 crisis alone. The Gini index o f income inequality increased from 0.45 to close to 0.53. 1 Source: INDEC and CEDLAS basedon EPH. 2. Recent developments point to a still uncertain path in the post-crisis poverty and inequality evolution. The Rgure 3. Inequality 2001-2002 crisis significantly increased GiniCoefficient ofper capita i n c o m poverty rates. In 2002, poverty increased 0 54 I 0533 , dramatically, to almost double the level o f the late 1 9 9 0 ~and in October 2002, 58 ~ percent o f Argentines were living in poverty (Figure 2). Also the Gini index rose significantly during the crisis period (Figure 3). The economic recovery has brought an important reduction in poverty 0 4 9 { y I I / 1 and income inequality, although still I 1111111111111111 insufficient to return to the pre-crisis levels. During the second half o f 2005, Source: CEDLAS basedon EPH. 33.8 percent o f the population remained below the poverty line and 12.2 percent below the extreme poverty line. 111 Annex F Poverty and Social Development 3. The recent reduction in poverty is mainly a result o f the recovery and the mitigation impact o f the Heads of HouseholdProgram. Duringthe recovery period beginning in 2003, growth has taken place chiefly in sectors which employ relatively large shares o f less skilled workers such as manufacturing, retail services and construction. These ~ Figure 4. Heads ofHouseholdProgramTargeting Net lncidence after estimted foregone i n c o r n sectors employ relatively more semi- 1 m 2002 2003 skilled workers and registered the largest ~ 5 5 job creation. Moreover, the income 50 1 6 9 45 support provided by the Heads of 40 Household Program, which reached 2 15 million beneficiaries at its peak in 2003, 25 was well-targeted to the poor (Figure 4). 20 15 The program provided substantial income a support to those left most vulnerable by 5 0 the crisis, particularly those that 1 2 3 4 5 Quintile experienced transient poverty (Figure 5). Source: Galasso and Ravallion (2003). 4. However, the "easier" poverty gains may have already been accrued, and further progress in poverty reduction may require tackling the more chronic Figure 5. Growth Incidence Curves 1 components o f poverty. The changes in Household income per capita- total &without transfers poverty rates during and after the crisis 8 have been particularly large because the crisis brought the income levels o f many 8 8 Argentines near the poverty line (AR$233 per month or approximately US$SO in early 2004). Consequently, even small changes in mean income have a large impact on the headcount poverty rate. g , This partially explains the hugeincrease in 0 20 40 60 80 100 ----_2001-2002 percentiles poverty during the crisis and the sharp fall ----_2001-2002 - 2002-2003 ** w/o trans -2002-2003 w/o trans * brought by the recovery. The most recent figures show that the fraction below the poverty line has continued to decline, ~ ~ ~ ~ ~~ 1 For more details, see Galasso and Ravallion (2003), Social Protection in a Crisis: Argentina's Plan Jefes and Jefus, World Bank Policy Research Working Paper 3165, and World Bank (2005), Argentina: Seeking Sustained Economic Growth with Social Equity, Report No. 32553. 112 Annex F Poverty and Social Development dropping to 33.8 percent inthe second half o f 2005. However, the sustained reduction in poverty, and in particular in its structural component, would require Figure6. Red Wages Index accompanying growth with policies to improve the assets and long-term income RegisteredPrivatc UnregisteredPrivate -Public -Overall generation potential o f the poorer families. 120 5. The long-term effects o f the crisis xi0 are still uncertain. One promising sign i s that unlike in some countries during 8n similar episodes, school enrollment rates remained high during the crisis. While infant mortality rates stagnated during the 60 I crisis, they have since resumed their downward trend, also suggesting that the L Source: INDECbased on EPH. crisis's long term impact may be less severe than expected. However, as discussed below, despite improvements labor market indicators still show weaknesses. In particular, rates o f informal employment, long on an upward trend, leaped upwards during the crisis and remainhigh. The Labor Market 6. The crisis brought a worsening o f labor market conditions on three fronts, and recent trends, while promising, are still weak. At the onset of the crisis, unemployment rose further, the size o f the informal sector continued to increase, and wages fell sharply. Overall employment and real wages have recovered since 2002, but the labor market remains weak. Recently, real wages in the formal private sector have rebounded to pre-crisis levels, but wages in the informal and public sectors still remain about 25 percent below those levels (Figure 6). The rebound in the formal sector is encouraging. However, many Argentines are now employed in the informal sector, where wages remain deeply depressed. It is unclear whether the recovery in labor market indicators will be sustainable. 113 Annex F Poverty and Social Development 7. Unemployment has been closely tied to GDP fluctuations, and unlike many crisis episodes in the region, self- Figure 7. UnemploymentRates employment was not the main cushion for 1 newly unemployed workers. t u n e r n p l o y --CWitholdjefes (A) -+-Withold jefes (6) Unemployment reached its highestpoint in ll the first half o f 2002, when more than 20 percent o f the active population was unemployed. Unemployment fell rapidly duringthe first part o fthe recoverybut at a decelerating rate more recently (Figure 7). Meanwhile, the fraction o f Argentine workers who are self-employed, which remained stable at roughly 20 percent for two decades up through 2001, actually Notes: declined slightly duringthe crisis. With Jefes: Heads of Household beneficiaries are considered as employed only if they are making a 'contraprestacion'. If they receive the benefit without 8. During the recent recovery, having a job, they are considered as unemployed or informality rates declined slightly. inactive,accordingto the usualdefinitions. However, looking at the longer term, Without Jefes (A): Heads of Household beneficiaries who are makinga 'contraprestacion'andlooking for ajob informal salaried employment has been are consideredas unemployed. increasing (Figure 8). In contrast to self- Without Jefes (B): All Heads of Householdbeneficiaries employment, the size o f the salaried who are making a 'contraprestacion' are considered as unemployed. informal sector (defined as those not Source: INDECbasedon EPH. contributing to the social security system) jumped during the crisis, reinforcing a long upwards trend. Nearly half of salaried workers, who comprise three- ~~ Figure8. InformalityRates Percentageo f salariedworkers not paying pension contributions fourths o f total employment, are now 55 informal. While several factors may be I I so - behind the increase in informality, their 4s - relative importance remains unclear. The possible causes include changes in labor p 40 - regulations, the burden o f business 35 . regulations, increased tax evasion, and 30 - structural change in the economy. Further 25 4 , J l work is needed to identify the relative importance o f these causes and to design appropriate policy responses. The broader Source: CEDLAS basedon EPH. effects o f the crisis on human capital and the labor market overall also require hrther study. 114 Annex F Poverty and Social Development HumanDevelopment Issues Health 9. Argentina has stepped up efforts to improve its health outcomes. Mainly as a Flgure9. InfantMortality Rates result o f the deep economic and social (per 1 OOObirths) crisis, they trail those o f countries with similar levels o f development. In 2004, life expectancy in Argentina at birth was 74.9 years, which, while greater than the Latin American average, i s nearly 3.6 years below Costa Rica, 3.4 below Chile, 1.0 below Uruguay, and 0.3 below Panama, countries with similar or lower per capita incomes thanArgentina.' 10. After the crisis, there was a temporary increase in the rate o f infant Source: Ministry of Health. mortality, but in 2004 the favorable trend that had been underway since the mid- 1990s returned, and mortality decreased to 14.4 (per 1,000 live births), which (Figure 9). However, the national average infant mortality rate i s almost twice that o f Chile. In addition, inequities in maternal- and infant mortality between different regions o f the country are significant, with rates up to 25 (per 1,000 live births) in the North West and North East regions. The government is making the challenge o f reducing infant mortality with its Plan Nacer. First evaluations show already a positive result. The Bank i s supporting government efforts through the Maternal- Child Health Insurance project. 11. The health system in Argentina faces four key challenges present in the system long before the latest (2001) socioeconomic crisis, but significantly aggravated by it: (i)the urgent need to ensure access to basic health services for the poor; (ii)the need to effectively PAHO (2005), Health Situation in the Americas. Basic Indicators. 115 Annex F Poverty and Social Development address emerging and serious public health full cycle of lower and upper secondary challenges (particularly Non- education, Argentina has a significant Communicable Diseases, HlV/AIDS, and number of unskilled adults entering the others); (iii)the need to introduce labor market with limited ability to learn structural changes to improve the Federal new skills. Access to training i s not - Provincial relationship in the health equitable in Argentina, and related to sector aimed at improving the incentive several factors: socioeconomic level, framework for efficiency and equity inthe educational level, enterprise size and the allocation o f public subsidies; and (iv) the level employment's level o f formality. It need to further improve and consolidate is important to increase coordination the regulation o f Social Security inhealth, across different authorities responsible for and to improve the incentive framework vocational education and training. for efficiency and equity within the system. Social Protection Education 14. The Social Protection system in Argentina is, as in other countries in the 12. The Argentine education system region, truncated, with programs aimed at has been built on several strengths. It has different groups o f the population ensured universal entry o f 5 and 6 year-old inadequately integrated and coordinated children to compulsory pre-school among different institutions, resulting in education, with net enrolment rates higher both overlapping and gaps incoverage. than 91 percent for both boys and girls. This i s an enviable situation compared to 15. As a result o f the failure o f the many other countries in the region and in formal social protection system to prosper, the developing world. However, national more recently Argentina has established indicators vary between provinces and other `programs to provide protection to regions, and between schools within a informal workers (particularly as their province, even if these share similar share in the labor market began to rise socioeconomic conditions. At the same during the last two decades) when time, the educational system has notable unemployment rates also began to rise weaknesses regarding the quality o f during the latter half o f the 1990's and student learning that are manifested most more recently, in response to economic readily in high dropout and repetition and social emergencies. Currently, the rates, and low scores o f students on Heads of Household Program is the main standardized assessments. As a result, the program reaching this group, but there are country exhibits some o f the lowest also other smaller programs run by the returns to education inthe region3 Central Government and by provinces and municipalities. At the same time, on a 13. The education needs o f less smaller-scale up to now, Argentina has educated adults present an additional begun to implement a conditional income challenge. With only half o f those transfer program oriented to promoting entering secondary schools completing the investment by families in the human capital o f children, similar to other successful programs being carried out in Perry G. et al. (2006). Poverty Reduction and Growth: Virtuous and Vicious Circles. World Bank several countries in the region, including LatinAmerican and Caribbeanstudies. Mexico, Brazil, and Colombia. The plan 116 Annex F Poverty and Social Development i s to scale-up this Program over the next priority attention in so far as the lack o f several years. In addition, in response to data has limited the capacity to formulate the social and economic crisis in2002, the sound public policies. The lack o f Government increased spending on household survey data for rural areas feeding programs. (approximately 13 percent o f the population according to the Census) Social DevelopmentIssues prevents a full assessment o f rural life conditions and rural poverty. However 16. Argentina faces several challenges recent studies conducted by the World in terms of social inclusion since certain Bank in 2003 and census figures for 2001 segments o f society continue to have indicate that rural poverty i s higher in unequal development opportunities. relative terms than urban poverty. Inequality and exclusion are both According to the national census 33 per hindrances to economic growth and long- cent o f rural dwellers have at least one term development. unmet basic need, a figure almost twice as Youth high as the national average. This shows the importance o f having disaggregated 17. There is growing awareness o f the data for policypurposes. heightened incidence o f youth unemployment and school drop-out. 19. Similarly, research on indigenous According to the 2005 household survey, and afro-descendent populations i s sparse more than half a million young people because the permanent household survey aged 14-18 have dropped from school, does not collect data on the issue o f while 300,000 youth aged 14-24 neither ethnicity. The 2001 National Census study nor work. About 27 percent o f identified 24 indigenous groups Argentine youth and adolescents (14-34 comprising over 1,000 communities with a years old) are unemployed, and this figure total indigenous population estimated at 2 is 10 points higher, or nearly 40 percent, million. UsingCensus data and the unmet for the 18-20 cohort. Seven out o f 10 basic needs approach, poverty young people with a job are in the vulnerability for indigenous groups i s informal market. Around 1.2 million twice the rate for non-indigenous young informal workers make US$lOO as populations (23.5 percent versus 13.8 an average monthly salary. Options for percent). A World Bank sponsored pilot- increasing investments in youth, whether survey on the living conditions o f Afro- through labor policies, education, health, descendants found that they constitute a or various remedial programs, are the vulnerable and marginalized group. Most subject o f an ongoing World Bank ESW to Afro-descendants live in urban slums and be completedinFY07. have precarious jobs and lower levels o f education compared to the rest o f the Rural, Indigenous, and Afro population. DescendantPopulations Gender Equality 18. The expansion o f Argentina's regular household surveys (EPH-C) to 20. Argentina has made great progress cover rural areas and collect ethnicity data towards gender equality through the is a long standing issue that requires strengthening o f women's legal rights and political participation as well as long-term 117 Annex F Povertyand SocialDevelopment commitments towards equal access to and private) and training programs that education and health services. However, incorporate a gender dimension. some challenges remain in the areas o f maternal and reproductive health, 23. Female-headed households register specifically access to contraception and rates o f poverty compared to male-headed pre-natal care. Another set o f challenges single parent households and other male- for gender equality arise from women's headed households. However, poverty increasingparticipation inthe labor market profiles find that after controlling for key as discussed below.4 characteristics such as education levels and age, female-headed households are not 21. Women are increasingly entering more likely to be poor compared to other the labor market but face unequal mono-parental households. Thus, the key employment opportunities relative to men. group for poverty targeting i s mono- Female labor force participation has parental households, both female and male increased in the last two decades as the headed. result o f long-term demographic and education trends (currently 61.4 percent up Crime andViolence from 46 percent in 1992). Most new participants in the labor force are prime- 24. Youth unemployment and lower age semi-skilled women. Female educational achievement present participation registered a sharper increase significant risks to society, including after the crisis, perhaps reflecting a increased crime and violence. Juvenile household strategy to cope with real delinquency increased 142 percent income declines. The gender wage gap i s between 1997 and 2001 inthe Province o f not large, compared to other L A C Buenos Aires. Death by homicide, countries, and has been shrinking. accidents, and suicide are the leading Women's average wage was 87 percent causes o f mortality for youth aged 20-24, that o fmenin2003. with males facing higher risks than females (except for Buenos Aires and 22. However, there i s differential Tierra del Fuego perhaps due to gender access to employment by gender. Women based violence) (Centro de Informacidn y are more affected by unemployment. In Documentacidn, DINAJU). Two factors 2004, the female unemployment rate was contribute to this trend. First, educational 16.8 percent while the male achievement has stagnated since the unemployment rate was 12.3 percent. 1970s. Second, youth unemployment has Women are also disproportionately increased in the last decade (only 58 represented inthe informal sector. Female percent o f youth aged 20-24 are working, unemployment and informality may have Census data). This underscores the both short-term and long-term income importance of improving access to quality generation implications due to the lower education o f poor children and youth and participation o f women in old-age security training programs for drop out youth. schemes. Increasing female participation There i s also room for future scaling-up o f in the labor force and employment ongoing pilot initiatives on crime opportunities could be supported through prevention. improved child care provision (both public 25. Qualitative data and victimization Source: CEDLAS (2,005)based on EPH. surveys show that gender based violence is 118 Annex F Poverty and Social Development an important issue in Argentina (PAHO). Data from DINAJU documents the dimension of this problem inBuenos Aires and Tierra del Fuego (DINAJU). Besides the negative impacts on women's welfare, this situation has implications on children's educational performance. Thus, there i s need to up-scale efforts to address this situation. 119 Annex G StatusReporton MillenniumDevelopmentGoals Background half by 2015. However, additional efforts seem to be needed as poverty reduction 1. In 2005, at the 58th Annual has decelerated during the most recent Conference o f the United Nations, period. Extreme poverty in major urban Argentina restated its commitment to areas using a US$1 poverty line decreased pursue the achievement o f the Millennium from 7.9 percent in 2003 to 5.7 percent in Development Goals (MDGs).' 2004 and 4.7 percent in 2005. Using the national poverty line, progress since the 2. This note summarizes the progress crisis has also been substantial but achieved by Argentina and some o f the decreasing. People living under the prevailing challenges. In general the note poverty line decreased almost 30 percent, covers the evolution since 1990, but to the from 54.7 percent in 2003 to 44.4 percent extent data are available particular in2004 and 33.8 percent byend-2005. attention is given to the years after the 2001-2002 crisis. Argentina has made 4. A number o f factors have significant progress in reducing infant contributed to these diminishing poverty mortality. Primary education and gender rates. Among the most important, first, equality goals have largely been met. has been the rising level o f employment, Areas in which progress has been less particularly in economic sectors that strong include poverty reduction, maternal employ lower skilled workers from the mortality, HIVIAIDS and other diseases, bottom quintiles. Second, the Heads of and access to water and sanitation inurban Household income transfer program was and rural areas. crucial early on inmitigating the effects o f the crisis. Price stability may also have a. Reduce Extreme Poverty and been a significant factor, though rising Hunger by half inflation over the past two years suggests that this factor can not be counted on, and Target: Cut in half from 1990 to 2015 the may be one o f the reasons for the observed fraction of the population in extreme deceleration in poverty reduction during poverty the last year. 3. Argentina's performance in terms b. Achieve Universal Primary o f poverty reduction during the last 30 Education years has beendisappointing. Even during Target: Ensure that all children complete the economic expansion o f the 1990s the cycle of basic education by 2015 poverty rates increased. In 2003 the increasing trend that had been observed since the beginning o f the decade -with 5. The country is currently on track to very highvalues in2001 and 2002- started achieve the MDG goal in education. to reverse and poverty declined. This Primary enrollment rates have been improvement has helped Argentina consistently high during the last decades. reestablish progress toward meeting the Inurban areas, some 99 percent ofprimary MDG goal of cutting extreme poverty by school age children are enrolled. Similar numbersare seeninrural areas as well, but ' Formore details on Argentina's presentation see repetition rates are significantly higher, Presidencia de la Nacidn (2005). constraining progress toward the access to 120 Annex G StatusReporton MillenniumDevelopmentGoals higher education levels. As a result, the 9. However there is more space for Government will implement a targeted improvement when considering the other program to address the particular needs o f dimensions o f gender equality. Gender rural areas. gaps in the labor market continue to be present. Both the labor force participation 6. Regarding secondary education, and the rate o f employment are nearly 30 gaps in coverage remain. In urban areas, points higher for men than for women. In 15 percent o f secondary school age addition, men generally work under better children do not attend school. Comparable labor conditions. Different informality data for rural areas are not available, but indicators show that the percentage o f other sources o f information indicate that informal workers is lower for men than for the percentage o f young people not women. In fact, the percentages of attending school in rural areas i s even working women having social security higher . coverage have been fairly constant during the last two years while that of men have 7. In view of the specific difficulties slightlyimproved. faced by the education system, the Bicentenary Goals, drawn form the MDGs 10. In terms of labor income, the and the Dakar Goals o f Education for All gender gap is continuously present over (EFA), consist o f ten simple but strategic the years and there is no clear sign o f education goals that the country has change. On average, the monthly labor proposed to meet by 2010. income o f male workers i s about 40 percent higher. However, this difference c. Promote Gender Equality and could be entirely explained by work hours EmpowerWomen (men work 10 to 11 hours more than Target: Ensure gender equality in access women) since there i s only a slight to all levels of education by 2015 difference between the hourly wage o f menandwomen. 8. The indicators for this goal include d. ReduceChildMortality equality in education, greater economic Target: Reduce by two-thirds (between participation and civic participation o f 1990 to 2015) the under 5 mortality rate. women. Argentina has already achieved the target for equality in access to education, The ratio o f girls' to boys' 11. The indicators for this goal include literacy rates is at 100 percent and net infant mortality and under 5 child enrollment rates by gender suggest that the mortality. Both indicators showed target has been met at all levels o f moderate decreasing trends over the education. In fact coverage i s higher for 199Os, reaching rates of 16.3 and 18.9 girls and young women than for boys and respectively in 2001. These favorable young men, especially in secondary and trends were interrupted by the recent tertiary education. This fact highlightsthe crisis. In2002 the infant mortality and the persistence o f high dropout rates among under 5 child mortality rate rose to 16.8 boys. and 19.5 respectively. But between 2003 and 2004 both rates improved significantly, decreasing by more than 2 121 Annex G StatusReporton MillenniumDevelopmentGoals points. Figures for the first half o f 2005 e. ImproveMaternalHealth indicate that mortality rates continued to decline during the course o f last year. The Target: Reduce by three-quarters reduction took place in all provinces, and from1990 to 2015 the maternal mortality even more remarkably in the provinces rate facing the most critical social conditions, which helped reduce inequality. As a result, Argentina i s again on its way to 14. Reducing maternal mortality by 75 reaching the MDG child mortality goals percent between 1990 and 2015 i s still a by 2015. challenging goal for Argentina, particularly in light o f the irregular 12. This progress came as a result o f improvement achieved during the last Argentina's efforts to mitigate the effects years. In 2000 the maternal mortality rate o f the economic crisis by implementing a had decreased more than 30 percent since series o f emergency interventions. Some the beginning o f the decade; however towards 2002 the previous progress was o f these interventions were particularly oriented to increase the access to basic substantially reverse an increase o f more health care o f the uninsured, especially than 30 percent. Duringthe last two years, mothers and children, through the maternal mortality rate decreased from the implementation o f Plan Nacer. 46 per 100,000 live births in 2002 to 40 in This program, together with the decision to 2004. Eventhough this improvement i s a protect priority health expenditures, positive sign, Argentina would need to tackled many factors affecting infant strengthen its efforts in order to approach this target. Preventive programs and mortality-such as underweight births, malnutrition, lack of clean water, and regulation policies can make a great contribution since the majority o f maternal deficient immunizations-thus leading to deaths are due to preventable causes. a beneficial impact on mortality rates. 13. As an intermediate step toward the 15. Health authorities have committed MDG goal, the Plan Federal de Salud, to an intermediate target o f reducing created in 2004, aims at reducing the maternal mortality by 20 percent between infant mortality rate by 25 percent 2002 and 2007. Additionally, since between 2002 and 2007. As a result o f the mortality rates are extremely heterogeneous among provinces, they have recent progress, more than 50 percent o f also agreed on reducing provincial that target has already been completed. In inequality as a priority goal to be pursued addition, the Plan sets out to tackle provincial inequality by reducing the Gini through specific interventions in the poorest provinces. coefficient o f the provincial mortality by 10 percent between 1990 and 2015. 122 Annex G StatusReport on MillenniumDevelopmentGoals f. Combat HIV/AIDS, malaria and only decreased half as much. In 2004, the other diseases incidence and mortality rates were 42 and Target:Have halted by 2015-and begun 38 cases per million persons, respectively. to reverse-the spread of HZV/AIDS It is also worth noting the changes interms o f the population affected by HIV/AIDS. Particularly relevant is the recent spread o f 16. Since malaria i s less o f a problem the disease among heterosexuals, mainly inArgentina, especially inurban areas, the women, showing how the pattern o f country has identified Tuberculosis and contagion has shifted. This fact has been Chagas', diseases to combat by 2015 addressed by the public campaigns along with HIVIAIDS. According to through targeted preventive actions for recent data, improvements in these areas vulnerable groups. have been very modest, and Argentina would need significant efforts to meet the g. EnsureEnvironmentalSustainability MDGgoals. Target: Reduce by half the proportion 17. The prevalence o f tuberculosis has of population without access to safe been declining due to successhl drinkingwater or sanitation intervention programs. In2003 there were about 55 people with tuberculosis over 100,000 inhabitants. In contrast, mortality 20. The overall level of access to clean reductions have stagnated and no further water in Argentina i s 94 percent. improvement has occurred since 2000. According to urban data for 2003, the The same applies to the rates o f detection percentage o f people without access to and treatment o f cases, which declined water i s about 1.6 percent, very close to significantly during the 1990s but have the target of 1.5 percent. In rural areas the remained constant duringrecent years. situation i s less favorable, but there i s little new data since 2001. Census data for 18. Improvements in the prevalence of 2001 indicate that approximately 22 Chagas have been geographically percent of the total population had no heterogeneous. Actually, in 2004 only 26 access to safe drinking water (public percent o f the endemic provinces had network or pumped water), which i s a certified the interruption o f the risk of noted improvement from 34 percent in infection. This shows a meager advance 1990. in comparison to the beginning of the decade. 21. Access to sanitation services appears to be more restricted, but the 19. The incidence o f HIV/AIDS has analysis is limited due to lack o f data. been falling in recent years, the same as About 40 percent o f the urban population the mortality rate although at a slower has no access to secure sanitation services. pace. From 2002 to 2004 incidence When rural areas are also taken into decreased by 10 percent while mortality account, the percentage rises to 58 percent. Consequently, more efforts are needed to * meet the MDGgoal. Infection caused by a parasite, which kills some 50,000 people each year worldwide, though is most prevalent inLatin America. 123 Annex G StatusReporton MillenniumDevelopmentGoals Table 1 Goals 1990 1995 2000 2003/4 Target 1 Eradicateextreme povertyandhunger Poverty; percentageof populationbelow $1per day; urban (CEDLAS) 1.4 3.2 4.2 5.1 li 0.7 Omcia1poverty; percentageof populationbelow moderateofficialpovertyline; urban (CEDLAS) 19.7 26.6 32.6 40.2 li n.s. Chlldren under 5 moderately or severelyundemeight; per cent (UNICEFestimates) 5.4 2.0 2 Achieve universalprimaryeducation Education; net primary enrollment ratio; both sexes; urban (CEDLAS) 98 l 99 99 99 a 100 Education; net secondaw enrollment ratio; both sexes; urban (CEDLAS) 65 73 83 80 li n.s. 3 Promotegender equality Girls to boys ratio; secondary education; per cent (UNESCO) 102 107 100 Women to men paritv index; as ratio of literacyrates; aged 15-24(UNESCO) 1.0 1.0 1 4 Reducechild mortality Infant mortality rate (0-1year); per 1,000 live births (MSAL) 26 22 17 14 li n.s. Children under five mortality rate; per 1,000 live births (UNICEFestimates) 28 25 20 20 9 Children 1year old immunizedagainst measles; per cent (UNICEFestimates) 93 99 99 97 n.s. 5 Improvematernal health Maternalmortality ratio; per 100,000 live births (MSAL) 52 44 39 44 13 Birthsattended by skilled health personnel; per cent (WDI) 99 ns. 6 CombatHIV/AIDS, malariaandotherdiseases Tuberculosis prevalence rate; per 100,000 population(WHO) 113 69 55 Tuberculosisdeath rate; per 100,000 (WHO) 10 6 6 ' Tuberculosis; DOTS detection rate; per cent (WHO) 30 65 haltand tegin to Tuberculosis; DOTS treatment success; per cent (WHO) 59 58 7 reverre AIDS; Incidencerate; per 1,000,000 inhab. (MSAL) 16 67 58 42 li AIDS; mortalltv rate; per 1,000,000 inhab. (MSAL) 9 51 40 38 7 Ensureenvlronmentalsustainability C02 emissions; metric tons per capita (CDIAC) 3.4 3.4 3.7 n.s. Ozone-depleting CFCs consumption; In ODP metric tons (UNEP-OzoneSecretariat) 2138 6366 2397 n.s. Water; percentage of populationwith no access; urban (CEDLAS) 3 2 2 2 7 2 Sanitation; percentageof populationwith no access; urban (CEDLAS) 42 40 Source: UN (Smtbtlcs Division), CEDLAS and nmlal data. Fwtnofes ' ' 1992 199516 1997 1999 2M)l 200014 2003 2004 n.5. Not specifled. ... Not avallabk. CEDLAS Center for Distributive, Labor and SocialStudies National Universityof La Plata - MSAL .National ~ Ministry of Health Goal Target 1 Eradicateextremepovertyand hunger 2015 target = halve 1990$1 a day povertyand malnutrition rates 2 Achieve universi primary education 2015 target = net enrollment to 100 3 Promotegender equality 2005 target = educationratio to 100 4 Reducechild mortallty 2015 target = reduce 1990 under 5 mortality by two-thirds 5 Improve maternalhealth 2015 target = reduce 1990 maternalmortality by three-fourths 6 Combat HIV/AIDS, malaria and other dlseases 2015 target = halt, and begin to reverse, the spreadof AIDS and the Incidenceof malariaand other major diseases 7 Ensureenvironmentalsustainability 2015 target = various SoUKe: WD1, 2005. 124 Annex G StatusReporton MillenniumDevelopmentGoals References CEDLAS (Center for Distributional, Labor and Social Studies) (2005), Monitoring the Socio- Economic Conditions in Argentina, World Bank Office for Argentina, Chile, Paraguay and Uruguay, Working PaperN.1/05, Buenos Aires. CEPAL (Comisi6n Econ6mica para AmCrka Latina y el Caribe) (2005), Objetivos de Desarrollo del Milenio. Una Mirada desde Ame'rica Latina y el Caribe, Publicaci6n de las Naciones Unidas,Node venta: S.01.II.G.107, Santiago de Chile. Presidencia de la Naci6n (2005), Objetivos de Desarrollo del Milenio. Un Compromiso con la Erradicacidn de la Pobreza, la Inclusidn Social y la no Discriminacibn. Informe Pais, Buenos Aires. Presidencia de la Naci6n (2003)) Objetivos de Desarrollo del Milenio Argentina. La Oportunidad para su Reencuentro,Buenos Aires. United Nations (2005), The Millennium Development Goals Report 2005, UnitedNations General Assembly, StatisticsDivision. World Bank (2005), World Development Indicators 2005, The World Bank, Development Data Center, Washington DC. 125 Annex H ProposedOperationsProgram 1. As with the 2004 CAS, the Bank advisory activities that can build on will continue to seek to engage in active previous work, fill knowledge gaps and dialogue with the authorities. Where there ensure the Bank meets its core fiduciary i s policy consensus the Bank will proceed and corporate responsibilities. Perhaps the to lending operations. Areas o f agreement most important o f these studies will be a with the Government under the old CAS Programmatic Poverty analysis. This have yielded substantial investments in study is expected to span the full time transport, chiefly roads, health, income frame o f the CAS and cover the three CAS transfer programs, and public sector pillars. It will involve a three phase strengthening. Where agreement on analysis o f the determinants and lending is pending but dialogue i s consequences o f poverty. The three potentially productive, the Bank will seek phases would encompass: (i) informality to maintain engagement, including through and labor market issues, (ii) rural poverty analytical work, with the possibility o f and (iii) urban issues, including access to developing investment operations in the water. Analytic work that would future, In those key areas where specifically support the first pillar o f engagement remains undeveloped, such as sustained growth with equity emphasizes macroeconomic policy and the financial work on infrastructure, including a study sector, or would benefit from expansion, o f Logistics and Transport Sector such as poverty, the Bank will seek to Competitiveness and an Energy Review; an develop analytical products that could Infrastructure Finance study is planned to open the way for new or broader dialogue, help strengthen the dialogue on while continuing to monitor progress. infrastructure development and financial sector intermediation insupport o f growth. AAA Program These studies will be complemented by a broader Private Sector Development report 2. The Bank has recently conducted on the investment climate, and an in-depth important analytical work in an area analysis o f the Fiscal Space for Public crucial to Argentina's development that Investment. This latter study will has helped to provide the framework for capitalize on the fiscal monitoring work Bank support to Argentina as it seeks to underway at the provincial level under the move beyond crisis recovery to recently approved projects supporting sustainable, widely shared economic provincial level investments in roads, growth. The report, entitled Argentina: water, flood prevention and institutional Seeking Sustained Growth and Social strengthening. Equity, Observations on Growth, Inequality and Poverty, was prepared in 4. Analysis o f policy options to coordination with government authorities, support the transition from the Heads o f academics and others in Argentina with Household program to a more permanent insightinto thepersistent problems o fslow social safety net (Programmatic Social growth, volatility, poverty and inequality, Protection - Options for the Transition and options to developing policy direction from Heads of Household Program) for the future. headlines specific analytical work in support o f the second pillar o f the CAS on 3. Lookingforward, the Bank plans to social inclusion. A number o f other undertake a number o f analytical and studies on social inclusion are planned, 126 Annex H ProposedOperationsProgram including a report on Old Age Welfare and 7. Building on this analytical work, Social Security which i s nearing the next section presents the key areas o f completion. A Youth at Risk study i s the sector dialogue and the strategic expected to provide a firm analytical basis orientation o f the proposed lending to address key challenges today, guide this operations under the CAS. This is dimension o f the Bank's civil society followed by a brief summary o f the strategy, and point to possible areas for strategy for engaging civil society. potential future lending. Efforts to deepen the dialogue on health and improve the dialogue on education would be supported I.SustainedGrowthwithEquity by an Impact Analysis of Reform in Education and Health Sectors planned for 8. Private sector investments in later inthe CAS period. infrastructure figured prominently during discussions o f the CAS program with the 5. The third pillar on improved Government. There i s interest in governance will benefit from the ongoing supporting private sector development Institutional Governance Review, which i s through improved financial intermediation looking at the experience o f public sector and an enhanced business climate. The reform inArgentina at both the federal and need for the public sector to step more provincial level. Work is planned to help prominently into supporting broad-based support strengthening o f economic rural development and managing the management at the provincial level under a environment was widely supported. series o f Provincial Economic Memoranda (PEM) which would combine analysis o f 9. Focus areas of support. The growth andpoverty issues with a review o f Bank's proposed program to support the public expenditures in selected provinces CAS pillar o f more sustainable and or regions). The work under the PEMs equitably shared growth in Argentina would be accompanied by the national would focus on the following four areas. scope o f the fiscal analysis under the study The bulk o f lending under the CAS is for o f Fiscal Spacefor Public Investment. To infrastructure development with an complement this work and continue to emphasis on: (i) expanding assets for the strengthenthe financial integrity o f its own poor and improving mobility, and (ii) operations, the Bank i s planning studies to continuing to develop the nation's meet Bank core fiduciary and corporate transport systemto lower logistic costs and responsibilities, Le., the proposed CFAAs, facilitate regional expansion o f trade and CPARs and ROSC. commerce. Investments for rural development and the environment 6. Finally, the CAS plans work on would focus on promoting agricultural the environment and natural resources growth, reducing rural poverty and management, with a Country improving environmental management- Environmental Analysis and dissemination all o f which stand out as critical and o f the just-concluded study called relatively unaddressed concerns. The "Argentina Agriculture and Rural growth pillar o f the CAS also features Development: Key Issues". Both are important initiatives to maintain and under-pinning the design o f the next phase broaden dialogue on macroeconomic o f lendinginthese sectors. 127 Annex H ProposedOperationsProgram policies and strengthening the financial investment in infrastructure has yet to sector and investment climate. recover from the crisis, and a greater share o f the infrastructure stock i s now inpublic InfrastructureDevelopment hands, which will require investment funds and adequate management tools. 10. Much o f the lending under the Improved partnerships between private CAS i s to support the Government's and public sectors will be essential to efforts to rebuild key infrastructure ensure (i)the medium and long term capacity. Investment in key assets to viability and continuity o f the public support growth has been declining for services and infrastructure concessions, some time now. Average total investment and (ii)the resumption and significant in infrastructure during the 1990s increase o f investments inboth public and remained well under 2 percent o f GDP, private infrastructure to support medium- placing Argentina at the lower end among term growth. Latin American countries and far below countries such as Chile and Colombia 13. The CAS centers around three (which invested upwards o f 4 percent per areas of interventionininfrastructure: year in infrastructure over the last decade) and China (6 to 7 percent). 0 Expanding assets for the poor and improving mobility. 11. L o w levels o f investment explain Expanding and maintaining the why Argentina has significantly fewer 0 nation's transport system to lower assets in infrastructure than would be logistic costs and facilitate regional expected given its level o f income and its expansion o f trade and commerce. socio-economic characteristics. Following Developing strategic freight the crisis o f 2001, resource flows for 0 investments to expand production investment dried up. This has resulted in frontiers and tap regional the emergence o f a number o f bottlenecks opportunities, ininfrastructure as the economy continues to recover. Inparticular, growth has been 14. fueled by a surge in agricultural exports Expanding assets for the poor and improving mobility. Key areas in that i s straining the country's transport this context include water, sanitation, infrastructure. Electricity generation, gas production and transport are likely to be urban flood prevention, urban transport, municipal level infrastructure, and insufficient within the next few years to renewable rural energy. meet expected increases in demand. At the same time, the nearly 34 percent o f the 15. Water supply and sanitation (WSS) population that remains under the poverty figures prominently in the proposed line has limited access to infrastructure operational program, as do the issues o f services, and many poor households face water resource management, flood difficulties in paying utility bills even at management and urban drainage. InWSS, frozen tariffs. the Bank will continue to support strategic investments in the province o f Buenos 12. Infrastructure investments continue Aires under the proposed Buenos Aires to be o f crucial importance for Argentina Province Sustainable Infrastructure to achieve its objectives o f growth and poverty reduction. Private sector Development project (BA SIDP APL2). 128 Annex H ProposedOperationsProgram The first phase o f this operation has low-cost, self-help housing in flood prone supported government efforts to improve areas generally inhabited by the poor. the provision o f infrastructure services in Broader river-basin wide planning and Buenos Aires province within a investments would be provided under the framework o f fiscal responsibility to help envisaged Integrated Water Resources return the province and the country to Managementproject APL 1(see below). sustainable growth, poverty alleviation and social equity. The project seeks to help 17. To address mobility concerns o f the provincial authorities implement their the poor in urban areas, the Bank is strategy to expand water, and especially planning investment support for public sewage, coverage by subsidizing access to transport through a proposed Urban Public approximately one-half million low Transport project, which would follow the income people living in areas o f high on-going Buenos Aires Urban Transport sanitary or environmental vulnerability. project with key interventions to address The CAS seeks to complement these the mobility o f the poor and transport efforts in WSS in other provinces under safety issues. These projects could be the envisaged Basic Municipal Services 2 complemented by GEF initiatives to project. support improved urban air quality, such as the recently approved concepts for 16. Flooding i s a major natural hazard GEF-financing in Rosario, Cbrdoba, for Argentina which poses serious Posadas, San Miguel de Tucumhn, and L a challenges to development. Flooding Plata. At the provincial level, the continues to exact a heavy toll and authorities have requested support for the dangerous conditions occur with feasibility study o f a mass transit system alarmingly high frequency. The Bank has between Avellaneda and La Plata provided important support to respond to (Transsur) , following successful this problem in the City o f Buenos Aires experiences elsewhere. with the Urban Flood Prevention and Drainage (APLl), and would continue to 18. Expanding and maintaining the do so under the planned APL2 which aims nation's transport system to lower to expand Bank assistance to other eligible logistic costs and facilitate regional provinces at risk. The project seeks to expansion of trade and commerce. In increase the country's resilience to floods the road transport sector the Bank i s through protection o f critical urban playing a key role to develop nation-wide, infrastructure, and to introduce a risk and in some cases provincial-wide, support management approach to investments o f to develop sustainable road management provincial and municipal governments. programs including the implementation of Key goals are to increase population performance-based contracts for the awareness and preparedness for the threat rehabilitation and maintenance of key o f floods as evidenced by improvements in assets within a budget resource constraint. flood protection levels, a reduction in the The Bank proposes to support the population living in areas at risk o f Government with a variety o f initiatives. flooding, and a reduction in damage to The CAS includes the second phase o f the properties by storms. Discussions have National Highway Asset Management been held with the Government with project (APL2) which supports respect to expanding the construction of implementation o f a national road 129 Annex H ProposedOperationsProgram management strategy through multi-year investments that can expand the frontier o f performance based contracts (CREMA) agricultural production and tap into focused on rehabilitation and maintenance potential integration with neighboring for the priority national road networks economies. Possible areas o f support (non-concessioned). The success o f this include: (i)a project to finance low project would be measured by the altitude tunnels between Chile and percentage o f paved non-concessioned Argentina, and (ii)a project to upgrade roads under the CREMA system, and develop a logistics hub around the port implementation o f a bridge management o f Rosario with railroad and road links to system, and the National Directorate o f facilitate the increasingly large volume o f Highways having effectively developed agricultural exports carried by rail. The actions under the Institutional Renewal proposed program includes a Freight Action Plan. Other roads projects include Corridor Infrastructure project and the the second phase of the BA SIDP APL Rosario Port Logistics Hubproject. These which supports key investments in strategic freight investments would provincial roads, and a follow-up complement the initiatives on national and Provincial Road Infrastructure project 3, provincial roads supported by the which would continue support for scaling Government and the Bank. up improvements and management o f priority provincial road networks, in part Rural Development and the through expanded implementation o f Environment performance-based contracts. These projects would complement the planned 20. Argentina's growth has long been, investment lending operations designed to and will continue to be, based in replace the remaining tranches o f the old significant part on its tremendous natural provincial reform loans (PUS) in the comparative advantages. These include provinces o f Cordoba, Santa Fe and extensive productive land for agriculture, Catamarca. The provincial investment forestry and livestock; mineral resources; a loans for Cordoba and Santa Fe are long coast-line and waters for fisheries; expected to be mostly in support o f and natural beauty throughout providing a provincial road infrastructure, while the strong base for tourism. Over half o f total Catamarca project would emphasis water export earnings and export growth since supply (see below). These provincial 2001 has come from the combination o f investment loans are also expected to primary and processed goods o f the support selected institutional strengthening agricultural sector. Nevertheless, the initiatives as has been the case in the BA country's deepest pockets of poverty are SIDP APL. found inthe rural sector, particularly inthe northeast and northwest regions, including 19. Going beyond the exiting road the indigenous populations in those areas. network, the Bank has a strong role in Given the specific characteristics o f rural helping to develop strategic transport Argentina, the Bank's strategy focuses on and freight investments to expand promoting agricultural growth, reducing production frontiers and tap regional rural poverty, and improving opportunities.To address competitiveness environmental management. and logistics issues, the Government has requested support for strategic freight 130 Annex H ProposedOperationsProgram 21. Promoting rural development regional agricultural trade and animal and reducing rural poverty. The CAS health issues. This work in being done in includes support to expanded rural close coordination with the Bank-wide infrastructure (particularly irrigation and avian flu initiative, and enjoys strong market access), improved technical support from the FAO. services to producers (particularly control o f crop and animal diseases), and 24. Improving environmental increased access to export markets through management. Argentina also faces an improved product innovation, quality and environmental challenge due, in part, to marketing. In this context, supplemental the challenges brought on by recurrent financing to the Provincial Agricultural economic crises. Critical pollution Development Loan (PROSAP l),would be management issues are driven by the high part o f a regional effort to combat foot- level and increasing urbanization o f the and-mouth disease. Pursuit o f the broader country. Municipal solid waste has rural growth agenda would be provided become a concern in some city areas. under PROSAP 2. The CAS also includes Water quality is worsening (both surface a proposed Rural Poverty and Growth and groundwater), especially due to urban operation that would build on the Bank's sanitation problems and certain industrial support for the Government's dual efforts "hot-spots". Air quality i s deteriorating in to promote growth oriented rural major urban areas. The tourism industry, infrastructure while also supporting small while a welcome source o f revenue for the farmers andthe rural poor. country, may be increasingpressure on the natural resources. The CAS supports the 22. The CAS also includes a proposed Government's effort to re-launch the Rural Poverty and Growth operation that environmental agenda in Argentina. The would complement the above efforts to country's environmental management promote growth oriented rural builds on sound policies-including recent infrastructure while also supporting small "framework" legislation designed to farmers and the rural poor. It would simplify previous laws-but there are include targeted CDD-type financing to challenges with respect to implementation. rural communities, including inindigenous Turning sound principles into improved areas, and the strengthening o f service environmental outcomes will require a delivery across the many agencies active national strategy, as well as political and in rural areas. Another area of lending is popular support. In addition to support to small and medium farmer strengtheningmonitoring and enforcement investments in forestry, to be blendedwith functions, both national and provincial GEF financing (see below). An area of governments are increasingly interested in non-lending support would be TA to more clearly incorporating environmental strengthenthe national statistical system to cost-benefit analysis into sectoral regularly collect and analyze primary data policymaking. on rural households. 25. An Environmental Management 23. A final focus area will be an IDF APL i s planned that would provide in support of the Consejo Agropecuario strategic support to Argentina's brown del Sur (the Mercosur Council o f (pollution), green (natural resources), and Agricultural Ministers) to better manage land use agendas. The first phase would 131 Annex H ProposedOperationsProgram build on the Solid Waste Management affected cities and towns in Mendoza, project (approved in February 2006). It Cbrdoba, and Salta. would also promote progress in pollution control in industrial areas (including the Other Areas of Support for Sustained Matanza-Riachuelo hot-spot in Buenos Growthwith Equity Aires), hazardous waste, urban air pollution, and cleaner production. The 27. Strengthening the financial APL would also consolidate three ongoing sector. As requested by the Argentine projects in a new component for authorities, the Bank will continue to Sustainable Forestry Management, with provide assistance towards the the dual objectives o f reducing native strengtheningo f the country's anti-money forest cutting and increasing plantation laundering (AML) and combating terrorist forestry investment and exports. The financing (CFT) apparatus. Based on second APL phase would implement new preliminary discussions with the strategies for land resources management, authorities, the objective o f the assistance land use planning, marine and coastal is to address deficiencies identified in the resources, and tourism development-all Financial Action Task Force (FATF) o f which are important for economic assessment mission as well as by growth, trade, and job creation. The GAFISUD, the FATF-AMWCFT group proposed APL would buildon the Country for South America. In addition to the TA Environmental Assessment, and will program that has been currently incorporate the use o f GEF and carbon implemented in cooperation with the IMF finance resources to the full extent to reinforce Central Bank's AML/CFT possible. supervisory capacity, the Bank will provide support in several areas to help 26. Another key element o f the Argentina build a robust AML/CFT proposed natural resources management system. In particular, assistance may be strategy i s (as mentioned above) an provided, via in-country workshops envisaged Integrated Water Resources addressed to the Banking Industry, Management project which would aim to including, but not limited to, banks, support basin-wide planning, institutional cooperativas de crkdito, casus de cambio reforms, and investments designed to to raise the level o f understanding o f the improve water resources management, relevant AML/CFT international standards reduce sectoral and provincial conflicts, and best practices. Promoting and reduce downstream flooding, and reduce strengthening AML/CFT preventive land and water degradation. This project measures within the financial industry will would build on the experience o f the contribute to reinforce the financial sector Catamarca Provincial Investment project and improve investment climate. The which i s expected to focus on upgrades to Bank will also continue to provide support water supply, irrigation, and water to build technical capacity and prevent resources management in the province. banks and other financial institutions from Separately, a Mining Decontamination being abused by criminals. project would encapsulate low-grade radio-active waste at closed uranium 28. Enhancing the business mines and processing plants in several environment and private sector provinces--an environmental priority inthe development. The main activities 132 Annex H ProposedOperationsProgram identified to support an enhanced business the crisis-excluded from the recent environment and further PSD are related to economic upswing. the implementation o f the Economic Recovery Support Adjustment Loan 30. Focus areas of support. The ERSAL and the proposed Innovation Bank's proposed program under the social project. The thrust o f the ERSAL is to inclusion pillar would focus on selected accompany key measures o f the areas. The social inclusion pillar also aims Government in the area o f small and to deepen the dialogue on poverty through medium enterprises, regulation and programmatic analytical work, as well as financial sector. The loan, which was continued poverty monitoring including approved by the Board in 2004, i s not yet possible support for survey work on rural signed. The Innovation project would be poverty. The focus areas are: developed as a multi-sector effort that would address competitiveness issues, Supporting the transition from particularly with respect to SMEs, as well emergency income programs to as key education issues. The Innovation initiatives that help beneficiaries project could also support institutional find and prepare for work, and strengthening to improve public policies to create permanent safety nets geared promote innovation in Argentina. The to provide direct support to project would be complemented by vulnerable groups. analytical and advisory activities including Improving health and education the planned study on Private Sector outcomes by supporting efforts to Development and a possible Innovation improve service delivery at the study. provincial level. 0 Raising school completion rates and improving learning outcomes, 11. Social Inclusion especially for children from disadvantaged families. 29. Human and social development form the focus o f the second pillar o f the Supporting Creation of More Country Assistance Strategy. Successhl Permanent Safety Sets and Fostering development requires efficient and Employment. equitable institutions that implement social and economic policy, as well as more 31. Progress in this area will involve direct programs to foster social inclusion. supporting (i)the transition from the At the same time, improvements in the emergency income support programs performance of the social sectors have (implemented during the crisis) to foster important linkages to support broad-based employment and (ii)increasing job growth, governance and social advance. opportunities for today's poor in the labor The social inclusion challenges in force. While many current income support Argentina are daunting with poverty still program beneficiaries would be integrated afflicting nearly 34 percent o f the into wage- or self-, employment, structural population; key health and learning poverty will remain. The Bank would outcomes in many parts o f the country seek to support the Government in lagging behind; and segments o f the establishing more permanent safety nets population-already marginalized before for this population group. 133 Annex H ProposedOperationsProgram 32. Transitioning out of emergency participating in emergency workfare income programs and fostering programs i s reduced from 1.4 million (end employment. The next couple o f years 2005) to less than 0.5 million bythe end o f will likely see a major socialpolicy shift in the CAS period. Additionally, the Bank Argentina, as announced by Government, will work with the Government towards to emphasize employment promotion the definition and implementation o f an policies. This will involve designing pro- integrated, inter-ministerial strategy for employment public policies both for lifelong learning and skillbuilding. beneficiaries o f the current income support programs, especially the large Heads o f 34. Establishing more permanent Household (Jefes y Jefas de Hogar) social safety nets and direct support to assistance program, as well as for low- vulnerable groups. While many of the skilled workers in today's labor force. current beneficiaries o f income support During the CAS period, the Bank would programs will be able to reintegrate support this emphasis through a number o f themselves into the workplace, a more activities, including the Heads of permanent safety net will be needed for Household Transition project, presented to the structurally poor inArgentina. Such a the Board in March 2006 under the safety net would not only cover today's previous CAS. This project i s designed to beneficiaries o f social assistance link income-support to beneficiaries programs, but ideally would also reach out participating in tailor-made training and to the large number o f extreme poor that education courses as well asjob interviews currently do not have access to this and active employment search supported support. Through technical assistance, the by municipal employment officers. To Bank has started to accompany the complement this, the Bank will work with Government's efforts to reassign the Ministries o f Labor and Education in beneficiaries from the Heads o f Household the design o f a new national Lifelong workfare program to the Familias Learning project which would aim to conditional cash transfer program. Policy develop flexible learning opportunities for options to broaden the safety net base, the unemployed and poor workers to possibly by expanding the child benefit acquire labor-market relevant skills (today, from the formal social security to informal 10 million Argentine workers do not have sector workers or assigning a role to non- a secondary school degree) in which the contributory pension or unemployment core competencies would be developed in benefits, are analyzed in the Old Age close coordination with industry. Welfare and Social Security study. Policy Underlying both lending operations is action would be supported by the analytical work which the Bank is carrying envisaged Income Support for the Poor out together with the Government (see project. As these reforms are intheir early above), stages, the Bank's goal during the CAS period i s to contribute to the successhl 33. The key benchmark for phasing out o f the emergency workfare transitioning out o f the emergency program and the transition to a new program, for which the Bank has been income transfer scheme, as well as the providing both lending and non-lending definition o f the role o f non-contributory assistance to the Government, would be benefits in Argentina's longer-run social that the number o f beneficiaries policy. 134 Annex H ProposedOperationsProgram 35. The CAS would also continue basic health services to the poor while at support to the Government to promote the same time introducing important direct, demand-driven community structural changes in the incentive programs. Excluded regions and framework for the provincial health communities contain a large proportion o f systems. the country's extreme poor who tend to be located in dispersed rural areas in the 37. The center pillar o f the health Northeastern and Northwestern regions- strategy is implementation o f the an estimated 1.2 million (based on 2003 Provincial Maternal and Child Health survey data)-and have been to some Insurance program (Plan Nacer), which extent "invisible." The average income in the Bank i s currently supporting through some rural areas i s only 10 percent o f the the Maternal-Child Health InsuranceAPL. level in urban areas, and two thirds o f the The Government has launchedPlan Nacer rural population i s below the poverty line. inthe ninepoorest provinces o fArgentina. Findingways to tap into Argentina's rural The second phase o f the Maternal-Child resource base in a sustainable manner i s Health Insurance APL will assist the fundamental to both economic growth and Government to scale-up the Plan Nacer to poverty alleviation. In this context, the the nationwide level. As the Bank is proposed Rural Poverty and Growth comprehensively supporting Argentina's project would approach rural issues in a flagship maternal-child health program o f comprehensive framework, promoting Argentina, the CAS sets a goal o f reducing farm and non-farm activities and their the infant mortality rate from 14.4 per interconnectedness to enhance thousand live births in 2005 to 12.0 per productivity in both areas. Direct thousand by 2009, along with expanding community support to reach the poorest coverage of the maternal-child health regions would also constitute the basis o f insurance from 30 percent (2005) to 50 the proposed Early Childhood (2009) o f the eligible population in the Development and Community Services nine northern provinces. Closely project, which would build on the complementary, new lending for Essential experience the Bank has accumulated with Health Services is proposed that would demand-driven community and social fund replicate the incentive and governance projects in Argentina over the past ten structures introduced under the Plan Nacer years. inpublic health functions at the provincial level. This includes service delivery for key public health programs such as Improving Health and Education vaccination, as well as implementation o f Outcomes provincial health prevention and promotion activities for HIV/AIDS, 36. In the health sector, considerable infectious diseases, and health monitoring. progress has been made since the 2001 crisis to instill greater coordination 38. In the education sector, between the Federal Government and the improving school completion and leaming provinces. Indeed, reforming the outcomes for children from disadvantaged provincial health system and its families remains an important challenge. relationship to the Federal Government i s Problems regarding student learning arise the key priority for ensuring access to from multiple causes, some o f which, such 135 Annex H ProposedOperationsProgram as the socio-economic conditions o f targets as well as learning outcomes, the households, are outside the immediate CAS plans for a Provincial Preschool and ambit o f the education system. However, Basic Education project which would problems in educational policymaking also finance results-oriented preschool and play an important part. The Bank has basic education investments in poor areas worked with the Govemment to address o f one (or potentially two) provinces with some o f the key issues facing education, the largest education needs. The project and the CAS seeks to continue this would likely include the province o f assistance. Buenos Aires which accounts for 40 percent o f school enrollment in Argentina 39. The Government has identified today. Work in both sectors would be education as a major priority in achieving supported by the planned study on the its goals o f poverty reduction and job Impact of Sector Reform in Health and creation, and has proposed a significant Education. increase in funding to ensure improvements are made through the An ExpandedDialogueon Poverty Education Finance Law. The law has been passed by Congress and has important 41. In response to the expressed implications for the level and equity o f interest o f the Government, the Bank is education finance (at the national and following up the 2005 study on growth provincial levels) as well as for the with equity with a Programmatic Poverty governance mechanisms in which the Study on Informality, Poverty, and national and provinces interact. In Inequality. This poverty assessment December 2005, the Board approved a involves a longer-term, three-phase Rural Education Project, which i s programmatic approach based on close complementing the National collaboration with government agencies. Government's strategic orientation in (i) Currently, the first phase o f the work i s establishing results-based contracts being developed in collaboration with the between the national and provincial levels; Ministry of Labor and the National and (ii)linking funding, at least partially, Institute o f Statistics (INDEC). It involves to the completion o f such results. As an in-depth study o f trends o f informal above, the Bank supports the overall employment, characteristics o f informal national Rural Education Program so that firms and workers, and the determinants o f the goal will be to measure success during informality and it welfare implications. this CAS period based on overall rural Under the first phase, an initial desk study, education results. Key targets include (a) to be completed by mid-2006, will be an increase in the number o f children o f 5 complemented with analysis based on a years o f age in rural areas accessing pre- new survey on informality being school, from 80 percent in 2005 to 90 conducted in partnership with INDEC. percent in 2009; and (b) an increase in the The second phase o f the programmatic completion rate for classes 7-9 in rural poverty assessment i s expected to focus on areas from 68 percent in 2005 to 80 an analysis o f issues related to rural percent by 2009. poverty and policy options. This will require new household survey work in 40. Giventhe significant fundingneeds rural areas. The third phase o f the work i s at the provincial level to meet financing envisaged to focus on urban poverty issues 136 Annex H ProposedOperationsProgram including access to basic services such as effectiveness o f the justice system. Also water supply. Additional outputs o f the crucial will be to continue investments in programmatic poverty assessment include building statistical capacity for improved regular poverty monitoring and policy making and results monitoring. dissemination events. StrengtheningPublicSector Institutions 111. Governance 44. Strengthening federal institutions. The CAS will continue to 42. The Kirchner administration deepen the Bank's contribution to the recognizes that strong public sector Government's efforts to strengthen and management, and governance more make more transparent and accountable broadly, is vital to sustain growth, enhance the country's public institutions, competitiveness and promote equity. particularly with respect to those agencies Analysis by external organizations such as responsible for basic social services, such Transparency International, work by WBI, as, for example, the national social and surveys o f Argentine citizens and security system (ANSES). The ANSES 2 opinion leaders all make clear that project is buildingon achievements o f the Argentina faces important challenges first ANSES operation. It aims to enhance across a range o f areas inorder to improve the service delivery o f ANSES by governance. The Government, in improving its efficiency, effectiveness, "Argentina 21: Argentina Facing the 2Ist transparency and accountability through Centuvy", has committed to strengthening institutional reengineering, fraud and error performance with the objectives o f detection, change management and greater improving coherence and efficiency with internal and external oversight. Expected the highly federal system o f government, outcomes include an increase in user increasing effectiveness o f basic service satisfaction o f ANSES as measured by delivery, and enhancing transparency and service-delivery outcomes and by citizen trust inthe public sector. satisfaction surveys. 43. Focus areas of support. The CAS 45. The CAS includes support for the seeks to support the twin objectives o f second phase o f the project to strengthen improving the effectiveness o f basic the National Social and Fiscal Data service delivery, and buildingtransparency Identification System (SINTyS) under the and trust, primarily through building on SINTyS APL2. The SINTyS project i s the notable progress achieved in Bank generating substantial fiscal savings support for institutionalstrengtheningat through improved targeting o f government both the national and sub-national levels. programbeneficiaries, including the Heads New investments in institutional o f Household program. The second phase strengthening would be complemented by o f the APL project would build on SINTyS analytical work on provincial and federal APLl, which identified important fiscal space, as well as fiduciary AAA weaknesses in Argentina's capacity to such as CFAAs and CPARs. Initial steps generate, store and exchange basic data on to establish a dialogue through ongoing the beneficiaries and providers o f the AAA could also lead to support for country's social service programs. The strengthening the judiciary to help SINTyS APL2 would focus on the improve the accessibility, impartiality and 137 Annex H ProposedOperationsProgram institutional, legal, and technological Modernization project which would follow infrastructure needed to consolidate the up on the first project approved in system. With some three-quarters o f all December 2005. These projects aim to public expenditures by federal and improve the institutional capabilities o f provincial governments in Argentina provincial governments to manage directed to social services, addressing resources and implement sound fiscal these weaknesses will be fundamental to policies, while also improving the quality consolidating overall fiscal stability and o f service delivery to citizens and creating improving confidence public institutions. better conditions for accountability and transparency. Measurable outcome 46. The CAS envisages continued indicators include increased use o f support for state modernization at the integrated payroll information systems and federal level under a second State improvements in provincial tax Modernization project. This project would administration. The Bank's work on build on the results and shortcomings of provincial institutional strengthening the existing project. Inparticular, it would would be deepened through support aim to have a strong strategic focus and provided under direct investment loans to robust implementation framework for selected provinces which would support support the Federal Government's public management objectives tailored to modernizationefforts. the conditions and priorities o f each province. In this context, new direct 47. A key component o f the strategy provincial investment loans under the CAS for institutional strengthening which would complement the institution-building encompasses both the federal and support being provided under the Bank's provincial levels i s the proposed existing investment projects operating at Governance 21 project. The project aims the provincial level, either directly or at strengthening the efficiency, through Federal Government on-lending. effectiveness and transparency o f public Where relevant they would also build on expenditure management, and at progress achieved under the earlier strengthening management capacity to provincial reform loans (PFUs). improve coordination between the public and private sector for economic 49. Strengthening the judiciary. development. Among the results to be Lack o f confidence in the efficiency and achieved, the project aims to support: (i) transparency o f the judiciary i s a chronic expansion o f the integrated financial problem for Argentina, with substantial management (SLU/web- SIDIF) system to implications for its economic growth and a broader range o f federal level public long term social development. Since the institutions and (ii)expansion o f the public early 2000s, the legal community, various investment management system (BAPIN NGOs, and judges and other public sector 11)to additionalprovinces. professionals have renewed demands for reform, focusing on the enactment o f the 48. Supporting public sector earlier legal changes and additional modernization at the provincial level. activities to increase efficiency and The proposed lending in support o f broaden access. Progress at the federal improved governance includes a planned level has been uneven. At the subnational Second Subnational Public Sector level, real improvements also vary, but 138 Annex H ProposedOperationsProgram several provincial judiciaries, including improve poverty and social data with the those supported by the Bank's previous national statistical office ( N E C ) and Provincial Development 11 project, have social ministries has brought about reduced delays, expanded services, and positive changes, such as improved adopted their own Alternative Dispute warehousing, analysis and dissemination Resolution programs. Other provinces o f the data, collection o f information on have shown interest in similar support, and the profiles o f beneficiaries of targeted at the federal level, there i s also a new programs, and better data accessibility at potential. The Bank has taken initial steps the unit record level. to establish a dialogue through ongoing AAA that could lead to support for 52. There i s nevertheless room for strengthening the judiciary, to help improvement in the scope and quality o f improve the accessibility, impartiality and the statistical data. For instance, effectiveness o f the justice system. There Argentina does not have a household i s a potential for Bank support at the survey program with a universal coverage federal and subnational levels, especially o f the population. Therefore, data on the with respect to service improvement, as effects of the recent agricultural well in support o f programs to combat commodity price boom on the welfare o f judicial corruption and improve selection the rural population by region is scarce. processes and career development. The lack o f survey data in rural areas limits the comprehensiveness o f the 50. Statistical capacity building is picture o f poverty in the country. There essential for getting relevant and high- are also urgent needs for establishing and quality information in the hands of harmonizing the measurement framework policymakers in a timely manner. Data in the collection, processing and availability i s one of the necessary dissemination o f social sector statistics as conditions for making good policy they relate to monitoring Argentina's decisions. This i s particularly important in progress in achieving the MDGs and other a large country like Argentina which i s social objectives. seeking to improve the effectiveness and transparency o fpublic sector management. 53. In this sense, INDEC's expressed interest in receiving Bank support, 51. Argentina's adherence to possibly through the statistical capacity international standards in official statistics building (STATCAP) program, to has improved steadily, as evidenced for strengthen the statistical system i s example by participation in the IMF's welcome. This could constitute an integral Standard Data Dissemination Standards part o f the Bank program under the (SDDS), thereby improving the quality improved governance pillar o f the CAS. and transparency o f the data being collected and disseminated. This is Civil Society Engagement especially so for the macroeconomic, monetary, fiscal, and real sector statistics. 54. After close and ongoing dialogue Improvement in the quality and with civil society throughout the country, availability o fthe poverty and social sector the Bank is focusing its outreach efforts statistics, albeit steady, has been slower with civil society on the two themes of and more piecemeal. Past efforts to Youth and Transparency. These subjects have emerged as central to the Bank's 139 Annex H ProposedOperationsProgram interlocutors over recent years, including past consultations. Bank staff have in the CAS consultations for the 2004 as initiated discussions with a key NGO, well as the 2006 CAS. The Bank's work Poder Ciudadano, to utilize the model on youth builds on extensive experience in pactos de transparencia in World Bank supporting civil society organizations financed procurement. The Bank will working with young people in Argentina assist in informing civil society with and throughout the other countries o f the regard to NGO monitoring o f the Southern Cone (Chile, Paraguay and transparency o f bidding under Bank Uruguay). The most important of these financed projects. past initiatives were the Development Marketplace in 2005 and the Small Grants Program 2004. Currently an ESW on Youth in Argentina i s being undertaken and a Social Accountability study is envisaged later in the CAS period. The challenge going forward is to find new ways to support and interact with young Argentines to think together on the key issues, especially employment-a major concern for Argentina's young people. Ongoing and proposed projects aim at a closer interaction with youth and at providing venues where youth can express their views. 55. The other keyissue that emerged in the Bank's outreach to civil society i s transparency and governance. The Bank will seek to build on its partnership with civil society in this area through varied approaches. One is through the Small Grants Program, "Promoting Transparency", which will support activities that empower citizens to take initiatives to enhance and influence development outcomes. This year's initiative seeks to identify innovative projects o f civil society organizations, promoting transparency and social accountability. Another key initiative will be to involve the participation o f civil society in the implementation o f the Bank's Fiduciary Action Plan. How governments secure and spend Bank financing has been a major interest o f civil society groups and a consistent theme o f 140 Annex I ArgentinaClientResearch 1. To better understand the however, that the interviews that formed environment in Argentina and how the the basis o f the qualitative survey reveal World Bank i s perceived by its main that for many respondents, particularly interlocutors and other stakeholders and those with limited direct experience opinion-makers, the Bank commissioned working with the Bank, the extent and two research tools to be carried out prior to accuracy o f their knowledge o f the Bank preparation of the CAS. The first varied. instrument was the standard survey which has been used by the Bank inmore than 50 4. One notable finding o f the client client countries. Some 280 representatives survey is how respondents think their o f federal and sub-national government, country is doing four years after the crisis. parliamentarians, the private sector, civil Nearly three quarters said that Argentina i s society and the press responded to the "currently headed in the right direction". written survey questions. The second It is important to note that those from research tool, carried out by an Argentine government were substantially more polling firm, was a more qualitative optimistic than those from the private analysis and featured in-depth interviews sector and civil society. Nevertheless, a with 82 leading opinion makers from majority o f all stakeholder groups politics, business and the media. responded that conditions in Argentina are improving. As would be expected after 2. Although the majority o f the data three years o f fast growth, respondents described below comes from the client identified economic recovery as the area survey, the insight provided by the where Argentina i s doing the best. qualitative analysis supplements, and in Reducing corruption was said to be the most cases strongly confirms, the data area doing the least well. yielded by the client survey. The research reveals information on the Bank's overall 5. In terms o f sustaining the image inthe country as well as on how the impressive growth performance since the respondents viewed Argentina's crisis, the two leading priorities identified development priorities, and the role and by all respondent groups in the main effectiveness o f the Bank's support with survey were access to education and respect to those priorities. adequate infrastructure. Expanding the question to "development challenges" Key Findings more broadly, 44 percent of respondents chose employment creation as the most 3. Respondents knew the Bank fairly important or second most important well, with the average familiarity rating priority. Following poverty reduction and for all categories o f respondents at more education again, issues of governance than 7 out o f 10 (ten being "extremely dominated the remainder o f selections, familiar with the Bank"). Parliamentarians with improving law and justice systems, were the most familiar at 9.5 and civil the business climate and government society the least, at 6.2. Some 65 percent effectiveness all around 20 percent. of respondents had three or more years experience working with the Bank, while Role of the Bank Group an additional 20 percent had between one and three years. It should be noted, 6. The message for the Bank i s mixed. On the positive side, the client 141 Annex I ArgentinaClientResearch survey reveals that more than 80 percent question o f the Bank's overall o f respondents believe that the Bank effectiveness. Participants from local should maintain or increase its level o f government and ministries were the most involvement in Argentina. In a country in favorable, while academics, which the Bank i s perceived to have a parliamentarians and representatives from substantial presence, and in which the civil society were the least. In addition, nature o f that presence has often been there i s a disconnect between what the associated with a policy approach that Bank is perceived to be good at and what prevailed during the 1990s that i s now both the Bank and respondents together widely rejected, this i s significant. The believe i s most important. The biggest interview component o f the research made gaps in this context are poverty reduction, clear that the Bank in 2005 i s competing addressing corruption and improving with an image o f its perceived role as part transparency in governance-areas o f the now much derided "Washington identified as most important for Bank Consensus" o f a decade ago. involvement by respondents, but in which the Bank i s perceived to be relatively less 7. There i s also a fairly good effective. alignment between how the Bank and respondents view the Bank's role in Benefitingfrom the Survey Argentina. There is strong consensus that the Bank should target its resources at 9. Client surveys are a valuable tool education, infrastructure, and governance, inall client countries, but such an exercise and that the goals o f Bank support should can be particularly useful in a country such be to reduce poverty and bring about as Argentina. First, because the country i s growth, strengthen education and health emerging from a severe crisis; second, as care, rebuild infrastructure, reduce stated above, because of the perceived corruption and strengthen social linkage between the Bank and the policies protection. Respondents in both the ofthe 1990s. survey and the interviews were clear that they believe the bulk of Bank support 10. Both research instruments, but should be in the form o f investment particularly the interviews, indicate that lending. The interviews indicate that there is a split between the way official investment operations are viewed as respondents and those from the private delivering concrete benefits while sector and civil society view the role o f the adjustment lending i s seen as loaded with Bank in the national discourse. One view conditions and harder to monitor. The that is more closely aligned to the 2004 CAS centered Bank support on the Government holds that the Bank should kind o f investment lending favored by not state its opinions and respondents. It i s also where assistance recommendations on broad policy reforms. under the CAS is planned. Another view that i s more closely aligned to parts o f civil society, and particularly 8. At the same time, however, the the private sector, holds that the Bank can main survey reveals concerns with respect stimulate important debate by to the perceived effectiveness o f these disseminating its arguments and ideas. interventions. Respondents gave an Those supporting this view feel that the average rating o f 5.6 out o f ten to the Bank i s in a unique position to provide 142 Annex I ArgentinaClientResearch international comparisons on key and 2005, which brought together more sometimes sensitive issues. than 1,700 participants to address the issue o f Youth and Values, i s a 11. More generally, the Bank appears step in this direction. A study to have a better image with civil society, planned for FY07 on Youth at Risk including the private sector, than with will also betimely. government authorities. One possible explanation indicated by the data may be 0 Build on Strengths. The strong that civil society perceives the Bank as emphasis o f the Bank's support on transparent (where the Bank scored infrastructure, health and generally high) and flexible, as well as governance is clearly well targeted open to different opinions, while concerns and welcome. These areas come about the Bank as bureaucracy and too through as the top priorities among technocratic seem to have prevailed respondents in both surveys and among officials. constitute a substantial share o f the Bank's current lending portfolio. 12. The environment for the Bank in Another positive finding o f the Argentina i s likely to remain challenging, main survey i s the quality o f the as uncertainty with respect to the Bank's engagement with Government's long term development stakeholders at the provincial level. strategy continues. In this context, the The efforts made to strengthen this challenge for the Bank i s to use the results engagement have paid off, and the o fthe research to: CAS will continue to expand support at the provincial level. 0 Address weaknesses. There is clearly a need to consider the 0 Seize Opportunities with the issues o f effectiveness raised inthe Private Sector. More than 65 survey, and to look at why in some percent o f private sector cases Bank support i s perceived to respondents believe that the Bank be weakest in high priority areas. should be more involved in The Bank should continue to build Argentina. They are strong on its outreach to address concerns supporters o f the Bank's key raised in both surveys about its objectives, with particular understanding o f domestic political emphasis on governance, education and social dynamics, The Southern and infrastructure. These are the Cone Development Marketplace on three areas o f significant focus in Youth and Values, held in June the CAS. 143 Annex J ArgentinaCountryFinancingParameters I Item Parameter Remarks/ Explanation sharing. Limit on the Up to 100% o f total project On average, the Bank's financing share in future proportion o f individual costs. However, this would projects i s expected to continue at the current limit o f project costs that the Bank apply on a project basis in 60% Under the new policy, the Bank would finance may finance. exceptional circumstances projects where ownership o f the overall program and at based on considerations o f the sector level i s considered satisfactory. The Bank's ownership, leverage and financing share could in such cases go up to 100 transaction cost economies. percent o n a selective basis. The overall level o f World Bank lending i s expected to remain as programmed and will not increase solely on the basis o f the expenditure eligibility policy change Recurrent cost financing. Yes The Bank would apply the increased flexibility in Are there limits that would financing recurrent costs under a framework o f fiscal apply to the overall amount of sustainability provided that some o f the following recurrent expenditures that the circumstances apply: (a) emergency social conditions Bank may finance? that require the Bank to finance some recurrent costs; (b) project specific grounds where there is a clear demonstration o f the need for Bank-financed recurrent activities. In all cases, at the project-level, the Bank would take into account sustainability issues at the project and sector levels. The Bank would continue to monitor the overall fiscal and debt situation and its implications for recurrent cost financing. Local costfinancing. Are the Yes The Bank may finance local expenditures in the requirements for Bank proportions required inindividual projects. financing o f local expenditures met, namely that: (i) financing requirements for the country's development program would exceed the public sector's own resources (e.g., from taxation and other revenues) and expected domestic borrowing; and (ii)the financing of foreign expenditures alone would not enable the Bank to assist in the financing of individual projects? Taxes and duties. Are there The Bank would not finance Argentina's tax system i s reasonable in terms o f tax any taxes and duties that the two distortionary taxes: structure, rates and administration. Two highly Bank would not finance? export tax and financial distortionary taxes were implemented in 2002: an transactions tax. The Bank export tax and a financial transaction tax, which would would not finance import not be financed. Import taxes are reasonable. There duties above 28 percent are, however, some individual cases in which tariffs i.e., double the average o f have been set beyond reasonable levels. At the projecl the MERCOSUR common level, the Bank would consider whether taxes and external tariff rate. duties constitute an excessively high share o f projecl costs. 144 1 51. . . . 0 . . . . . . . . . e W .. . . . . . a a a a a j l m a a a dl >Ia a a a a m a GIa a a m a a a i 3 t a L ! L eL t U 5c ed zI 4 m a 5: c, sc I -8 e, 0 ~ 0 rn 3 . . . . . . Annex L Argentina: CAS CompletionReport Date o f CAS: January 29,2004 Report No. 27340-AR Date o f Supplemental Note April 5,2004 Ref: R2003-0207/2 Summary T h i s documentcontains an evaluationof CAS objectives in Argentinatogether with the respective contributionsof the Governmentandthe Bankduringthe time segment of the CAS (April 2004 through December2005) that was consideredby the BoardinApril 2004. The 2004 CAS was written in exceptional circumstancesat a time when Argentinahadrecentlyemergedfrom the deepest economic crisis inrecenthistory and the Bank was still in the process of establishingan operationalrelationshipwith the newly elected Government of PresidentKirchnerwho assumedoffice inMay 2003. As a result of the uncertaincountry situation, the Boarddate for the CAS was twice postponedand, after consultations with ExecutiveDirectors, managementasked only for endorsement of a20 monthoperations programalthoughthe CAS hadbeendrafted with a4 % year horizoninmind. The truncated20 monthterm of the CAS makes it difficult to identify andevaluateoutcomesover so short aperiod. While the CASwas results based, it did not distinguishclearlybetweenoverallcountry objectives and CAS-specific objectives which adds further to the difficulty of evaluatingoutcomes. Broadly speaking, overall countryoutcomes havebeen very good. During the CAS period2004-05 Argentina further consolidatedits economic recoverywith GDP growthof 9 percent in2004 and an estimated8 percent in2005. Fiscalpolicy has beenwell disciplinedand inflation has beenkept under control although it beganto increaseagain in2005. The resolutionof structural issues left over from the crisis proceededat a slower pace. InJune 2005 the Government completedadebt swap covering76 percentof bonds indefaultbutthat still left US24 billion ofdefaulteddebt outstanding andunresolvedas well as US$4billion of arrearsto the Paris Club. The renegotiationof public utility and infrastructureconcessionsis laggingandhas been complicated in many cases by litigation pendingbefore ICSID. From an operationalviewpoint,the lendingprogramproposedin the 2004 CAS representedaradical break with the past. Whereas adjustment lendinghadpreviouslybeenthe principal vehicle for Bank assistance to Argentina, it was to account for only one quarter of the US$2billion lendingenvelope envisagedfor 2004-05. Consistentwith the wishes of the new Government, investmentlendingwas to account for the remaining75 percent. The shift from adjustment to investment lendingwas achallengefor both the Government andthe Bankbecausethe economic crisis, the precedingrecessionand a downsizingof public sector investment inthe ninetiesall hadseriouslyimpairedthe performanceof the existinginvestment portfolio and weakenedthe project preparationand implementationcapabilityof the Government. Furthermore, the short period andlimited lending authorityconstrainedthe medium-termstrategic frameworkof the CAS and led the Government to questionthe depth of the Bank's commitmentto the program. Working within those constraintswhile, at the same time, pursuinga longer-termsector engagement, staff made use of availableinstruments, including APLs to build-up aprojectpipeline that couldbe sequenced accordingto progresswith the sector policy framework,implementationcapacity and inthe fiduciary environment. At the same time, adetermined and successfuleffort was madeto revitalize portfolio performance. As a result,byNovember2005, significantprogresshas beenmade towards fulfilling CAS operationaltargets and objectives. The Bank has effectively establishedapartnershipwith the Government that will serve as the centerpiecefor an investment-basedCAS going forward. The Bank initially found it difficult to engage the FederalGovernment in apolicy dialogueexcept in a few sectors such as healthand roadtransport. More recentlythe dialoguehas openedup inareas relatingto the linkagesbetweengrowth, poverty and inequalityandthere has also beenagood dialoguewith some of the provinces. However, an EconomicRecoverySupport SAL that was approvedby the Board inJune 2004 remainsunsignedbecause of continueduncertaintiesinthe macroeconomic framework including the indefinite postponementof the IMF third reviewof a stand-by arrangement. The difficulty of proceedingwith adjustment lendingthe absence of a soundpolicy dialoguevindicates the decisionto shift the Bankprogramto investment lendingwhere progresshas beengood. 151 Annex L Argentina: CAS CompletionReport PartA: Long-TermStrategic Goals The Government'sperspective 1. In the post-crisis environment of Argentina, it appears that a new policy framework is emerging. Whereas, throughout the nineties, the role o f the state in the economy was steadily retrenched, that process i s now being reevaluated and, to some extent, reversed. There appears to be a broad consensus that the Government should exercise a more proactive role in addressing the long-standing social problems that were exacerbated by the crisis and that still beset Argentina notwithstanding a strong recovery and good outcomes in terms o f macroeconomic performance. Social transfer programs for the poor were extended to a significant proportion o f the entire population at the time o f the economic crisis. The Government has also become much more directly involved in decisions affecting the provision of infrastructure and public services, including the control o f tariffs and investments to increase access. Government practice has favored discretionary intervention which has not always been exercised within a rules-based framework and the Government has yet to develop a longer term-vision that can be systematically implemented within a credible institutional framework. Therein lies the future challenge. 2. When President Kirchner took office inMay 2003 he outlined the principal goals o f his administration in an address to the Congress. H i s first concern was to consolidate the economic recovery and prepare the ground for sustained growth. Mindful that the 2001 default on public debt was the result o f excessive borrowing and faulty economic management, he pledged to follow prudent fiscal policies that would secure fiscal surplus on a consistent basis. In broad terms, the Government has been successful in that endeavor. Argentina achieved strong growth o f 9 percent in 2004 and about 8 percent in 2005. The primary fiscal surplus o f the consolidated public sector has been in the range o f 3-5 percent o f GDP and poverty has been significantly reduced although it remains above pre-crisis levels. 3. A second objective o f the Government was to spread the fruits o f economic growth more equitably. Social services were to be upgraded to increase both coverage and quality. Efforts would be made to find productive employment in the labor market for those who had lost their source o f income as a result o f the economic crisis and, as poverty declined, emergency programs o f poverty relief were to be restructured to better serve the medium- and long-term requirements for social protection in Argentina. With assistance from the Bank, significant progress has been made towards those goals, albeit at a slower pace than anticipated. 4. A third objective of the Government was to tackle issues o f governance. Responding to a widespread perception that the management o f public affairs had been corrupt in the past, the new administration undertook to fight corruption. As part o f that effort there was to be a reform o f the judiciary, with judicial appointments being subject to greater transparency. At the same time, the efficiency and effectiveness o f the public 152 Annex L Argentina:CAS CompletionReport administration was to be improved. Governance i s an area where quick results cannot be expected but steady progress has been made inthe last two years with assistance from the Bank. The Bank'sprogramof support 5. The program proposed in the 2004 CAS was broadly supportive o f the Government's program while recognizing that progress would depend critically upon the effectiveness with which the authorities pursued structural and policy reform. Staff undertook to prepare regular briefings for the Board on the status o f the Government's reform program so that the Board could reassess the pace and level o f Bank support if necessary. 6. The CAS envisaged three pillars o f Bank support corresponding to the overarching objectives of the Government. The Bank strategy in each o f the three pillars was similar. Lendingwas to be undertaken in areas where a consensus could be reached with the Government on an appropriate policy framework. In other areas where there was not yet a consensus, the Bank would undertake analytic work to help move the policy dialogue forward. 7. Sustained economic growth with greater equity was the first pillar o f Bank support. It was clearly understood that the policy dialogue in this area would present a challenge for the Bank because o f a widespread public perception in Argentina that the 2001-02 crisis was due, inpart, to poor policy advice from abroad. Accordingly, a major study was designed in consultation with the Government' and it has been successhl in rekindling a policy dialogue in areas relating to the nexus between growth, poverty reduction and inequality. The policy consensus has not been sufficient to permit an Economic Recovery Support SAL, approved by the Board inJune 2004, to move forward and the loan remains unsigned. However, the Bank has been able to reach a consensus both at the federal level and at the provincial level on strategies in several areas o f infrastructure that are important for sustained economic growth with equity and, as a result, good progress has been made with new investment lending, particularly in road maintenance, water supply and flood control. The IFC has also been very active in Argentina during the CAS period. It has facilitated financial sector restructuring as well as helping expand production and efficiency in diverse sectors with a special focus on exports. 8. Strengtheningsocial inclusionwas the second pillar o f Bank support. Because o f the economic crisis and its aftermath, social policies figured prominently on the Government's agenda and it was receptive to Bank assistance. A loan to help finance a program o f emergency assistance to unemployed heads o f households (Jefes de Hogares) was already substantially disbursed when the Board considered the 2004 CAS. An important focus o f Bank assistance during 2004-05 was to work with the Government in refocusing the program from emergency assistance to a sustainable program that addresses the longer-term needs o f the poor including higher levels o f labor market "Argentina: Seeking Sustained Growthand Social Equity" Report No. 32553-AR, October 21,2005. 153 Annex L Argentina: CAS CompletionReport participation. To that end, a Heads o f Households Transition Project has beenprepared. It draws upon Bank analytic work on buildingskills for the labor market. The Bank also sustained a fi-uitful dialogue with the Government on health and education policies during 2004-05. Investment loans for maternal and child health care and for rural education, approved in2004 and 2005 respectively, will help advance the Government's program in those areas. 9. Promoting better governance was the third pillar o f Bank support. The Government had announced ambitious plansto improve public administration, uphold the rule o f law and fight corruption. The CAS sought to support those efforts by helping to improve the public administration through the introduction o f management information systems and incremental improvements in specific key institutions. Making use o f ongoing investment loans while, at the same time, developing a new project pipeline the Bank has helped improve procedures for project evaluation and budget administration at both the federal level and the provincial level. The social security administration agency (ANSES) was one focus o f Bank technical assistance aimed at improving efficiency, transparency and accountability through a reengineering o f its structures and procedures to enhance service delivery. SINTyS, the system which coordinates data bases across the Federal Government has also benefited directly from Bank assistance. The Bank has played an important role supporting decentralization in Argentina and a Sub-national Government Public Sector Modernization Project will follow-up on those efforts. ShifttowardInvestmentLending 10. The CAS envisaged an important shift in the composition o f Bank lending as compared with the recent past when adjustment lendinghad dominated the program. The view o fthe new administration was that, ina post-crisis environment, investment lending was more in keeping with Argentina's development requirements, and it requested a program in which investment lending would amount to 60-75 percent o f the total. The shift from adjustment to investment lendingreflectedthe relatively low priority attributed by the Government to some o f the structural reforms which the Bank considered important in order for the on-going recovery to be sustained. It was also consistent with the views o f civil society expressed in CAS consultations that the structural reforms supported by the international community in the 1990s contributed to - or at least did little to prevent the crisis o f 2001-02. - 11. Bank staff and management were aware that a shift in the program towards greater investment lending would pose a challenge. The project preparation and implementation capability o f the Argentine public administration had been seriously impaired by, first, a substantial reduction in public investment during the 1990s and, second, the economic crisis and the recession that preceded it. Progress with the existing investment portfolio had also been seriously disrupted, and project performance would depend indirectly upon the strength o f the macroeconomic framework, which could not yet be considered secure. There was also mounting concern over the slow pace o f structural and policy reform including the resolution o f outstanding infrastructure and public concessions issues, recovery of the financial sector and the settlement o f public 154 Annex L Argentina: CAS CompletionReport debt in default. In addition, the Government and the IMF had difficulty innegotiating a Fund-supported program and, for a briefperiod, Argentina was inarrears with the Fund. 12. Inview of those concerns, Board presentation of the CAS was twice postponed from December 2003 to February 2004 and then again to April 15, 2004. On that occasion, after consultation with Executive Directors, management submitted the CAS for Board consideration together with a Supplemental Note asking only for endorsement o f the April 2004- December 2005 time segment o f the strategy set out in the CAS document although the document itself encompassed a 4% year time frame. A lending program o f U S 2 billion was contemplated for the period through December 2005, o f which 75 percent was to be investment lending. Supportive analytic and advisory work was also contemplated inthe CAS. 13. A program document for an Economic Recovery Support SAL in the amount o f US$500 million had also been distributed for consideration by the Board along with the CAS itself. However, on advice from Executive Directors, the proposed loan was withdrawn and the ERSAL was subsequently renegotiated with the Government to strengthen commitments for reform before being presented again to the Board in June 2005. Further details o f the renegotiated ERSAL can be found in the section in Part B below concerning macroeconomic performance. 14. Directors urged staff to keep the Board informed o f progress towards resolving portfolio performance problems, and, underscoringthe needto identify areas o f structural reform that may merit Bank support, requested a briefing by end June 2004 on the outcome o f discussions with the Government. Part B: CAS Outcomes 15. The 2004 CAS was results based. Explicit country performance indicators were specified in a CAS Program Matrix, which i s reproduced below as Attachment K1along with actual outcomes. N o clear distinction was made inthe CAS between overall country indicators and indicators specific to the CAS itself. Nevertheless, for purpose o f this completion report an attempt i s made to distinguish between country performance indicators and CAS-specific outcomes. Since the CAS was drafted with a 4% year horizon in mind, many o f the performance indicators extended beyond 2005, which makes it difficult to assess progress during the truncated CAS period. It i s sometimes possible to assess progress anticipated as o f end-2005 by pro-rating the outcomes. However, in many cases, progress on the ground does not proceed in a linear fashion. Institutions must first be strengthened and procedures put in place which, once accomplished, will pave the way for measurable results on the ground to emerge later in the period. In addition, much o f the data for 2005 will not be available until later in 2006. 16. The truncated 20 month period o f lending did not receive endorsement from the Argentine authorities and it led them to question the commitment o f the Bank to the country program. It also constrained the headroom for project identification and development at a time when the focus o f the lending program was shifting towards 155 Annex L Argentina: CAS CompletionReport investment operations and a new project pipeline needed to be built up from a low base. Inorder to develop a sufficiently broadportfolio ofnewoperations, the Bank hadto limit the size o f individual loans to less than the amount being sought by the Government in many cases while, at the same time, leaving the door open to possible additional lending at a future date as warranted by the country context and sector performance. Adaptable program lending was used to build up a project pipeline that could be sequenced according to progress with the sector policy framework, implementation capacity and in the fiduciary environment. The alternative o f sequenced sector investment loans was perceived by the Government as falling short in terms o f Bank commitment to the medium-term investmentprogram. Summaryof selected CAS objectives and outcomes: 2004-05 CAS Pillar Situationprevailingin 2003 Progress duringCAS period Sustained - No dialogue on macroeconomicpolicies - Bankstudy "Seeking SustainedGrowthwith Social Economic Growth or on financial sector Equity" rekindleddialoguewith Government. with Greater Central Bankopento reneweddialogue on selected Equity financial sector issues. Gooddialogue with federal andprovincial authorities on roadmaintenance,water supplyandflood - 54.5 percent ofBankportfolio classified -management. Problemprojectsreducedto 30.3 percentin2005. as problemprojects in 2003. - Weak projectpipeline in infrastructure. - Newlendingoperationsinroadmaintenance, - Many IFC clients in financialdistress. - waterportfolio supply and flood management. IFC substantiallyrestructuredandnew in CAS period. Strengthening - GovernmentandBank focus on - commitmentsmade Governmentpreparesstrategy for transitionfrom Social Inclusion emergencypovertyrelief. emergencyreliefto longer-termstrategy for poverty relief and employment generation with Bank - No maternaland child healthinsurance. -assistance. MaternalandChild HealthInsuranceintroducedwith - Educationsystem weak inrural areas. - Strategyto Bank support. strengthenrural education introducedat PromotingBetter - Public administrationat provincial -provincial levelwith assistance fromBank. Improvements intax administration,financial Governance level inneedof strengthening. management, cadastral administration,civil registrationandhumanresourcesmanagement - Socialsecurity administrationneeds - with assistancefrom Bank. Socialsecurityadministrationagency(ANSES) strengthening. - Public - strengthenedwith Bank assistance. Numberof public agencies usingintegratedfinancial expendituremanagementat management systemincreasedfrom 7 in2002 to 52 federal andprovincial level in needof in2005 with assistancefrom Bank. New systemfor strengthening. public investment managementadoptedby 19 of24 provinces and by 110 federal agencies with Bank assistance. 17. The summary matrix above compares CAS targets with outcomes in broad terms during 2004 and 2005. It presents the highlights o f the CAS program matrix. Broadly speaking, it reveals that the Bank has successfully switched to investment lending in Argentina. Portfolio performance has greatly improved and a new pipeline o f operations has been developed. The country dialogue has been successfully pursued in many provinces and a number o f key sectors at the federal level such as health, education, road 156 Annex L Argentina: CAS CompletionReport transport and public administration. Eveninthe area o f macroeconomic policy, where the country dialogue has met with greatest resistance, Bank analytic work has succeeded in making progress. During2004 and 2005 a solid foundation has beenlaid for the Bank to move forward in partnership with the Government based on a program o f investment lendingand analytic work. Pillar I: Sustained economic growth with greater equity Overview 18. Sustaining the recovery from crisis was at the forefront o f the Government's program during 2004-05. It was clearly understood that the recovery could only be sustained if there was concerted action on many fronts. Hence, the first CAS pillar was multi-faceted and the CAS objectives were similarly diverse. The broad outcomes are summarized below. Details are to be found inAttachment K1. 19. Country outcomes were very good during 2004-05. Economic performance exceeded expectations both in terms o f growth and in terms o f poverty reduction. A Bank study on Growth and Equity concluded that fiscal policies were indeed pro-poor.2 However, economic management in other areas fell short o f targets. There still remain unresolved issues concerning the renegotiationo f public service concession contracts and uncertainty about the regulatory framework governing those services. As a result, investment i s recovering only slowly. The financial sector has largely recovered but many banks have closed their doors and the system i s now dominated by publicly owned banks which have not yet been restructured. As far as external debt i s concerned, the Government negotiated a debt swap for 76 percent o f bonds in default but that still left outstanding some US$24 billion o f bonds in default and without any agreement with creditors. In addition, some US$4 billion in Paris Club and other bilateral debt remains inarrears. 20. CAS outcomes during 2004-05 were also positive in many respects. Portfolio performance improved significantly and a pipeline o f new investment projects was built- up inthe infrastructure sectors. Progress was made towards reestablishinga dialogue with the Federal Government and the Central Bank on selective issues o f economic management. The dialogue with many provinces has been good. MacroeconomicPerformance 21. When the CAS was prepared, the Argentine economy was recovering strongly from the 2002 crisis. To a large extent the recovery constituted a rebound from the massive decline in GDP that had taken place during the crisis and that had left the economy with excess productive capacity and record high unemployment. A massive devaluation o f the peso together with a sharp decline in real wages greatly increased the competitiveness o f Argentine tradable goods and services. Net exports increased sharply in2002 due to a major contraction o f imports and a more modest expansion of exports. "Argentina: SeekingSustainedGrowthand Social Equity" ReportNo. 32553-AR, October 21,2005. 157 Annex L Argentina: CAS CompletionReport In addition, merchandise exports benefited from high commodity prices. The boost to growth imparted by net exports in 2002 sparked the initial rebound in GDP which eventually ledto an expansion o f consumptionwhich hrther fueledthe recovery. 22. The recovery progressed even better than anticipated as evidenced by the macroeconomic indicators in Table 1below. Whereas, inthe CAS, real growth had been estimated at 8 percent in2003 and 6.5 percent in 2004, the actual outcomes turned out to be 8.8 percent and 9 percent respectively. Macroeconomic performance in 2005 continued to be good. Growth i s projected to be in the 8 percent range. Trade has also continued to grow, with exports increasing by 17 percent inUS dollar terms in 2004. In 2005 there was a further 12 percent increase in exports and a favorable balance o f trade estimated at some US$9 billion. 23. Within the context o f a strong recovery, fiscal performance has also exceeded expectations. The ratio of revenues to GDP has been buoyant in part because o f strong growth and also because of improved tax collection. The new taxes that had been introduced on exports and on financial transactions after the crisis now account for about 18 percent o f federal revenue. As a result, the primary surplus o f the consolidated public sector reached 5.1 percent o f GDP in 2004 and it is projected at 4.5 percent in 2005. A disciplined fiscal and monetary policy has kept under control the inflationary impact of a massive devaluation so that, after an initial 41 percent surge in prices in 2002 immediately following the devaluation, consumer prices rose by only 3.7 percent in2003 and by 4.4 percent in 2004 (measured year-end). However, with the approach o f congressional elections, the pressure on prices began to increase again in 2005 and inflation i s expected to reach double digits. 24. The recovery has not only been strong, but pro-poor as well. Poverty rates during 2003 and 2004 fell below the rate specified in the CAS country performance indicators. Whereas the CAS program matrix had targeted a reduction in the level o f poverty from 55 percent in 2003 to 48 percent in 2005, the poverty level had already been reduced to 38.5 percent by the third quarter of 2005. Similarly, extreme poverty was already reduced to an estimated 14 percent in the third quarter o f 2005 - well below the 21 percent matrix target. Unemployment was reduced to 17 percent in 2004 (including as unemployed those Jefes program beneficiaries that are participating in workfare and searching for employment) and to a further 12.5 percent as o f the third quarter o f 2005. 25. Yet despite the progress, poverty still remains a problem in Argentina. The 38 percent level estimated for 2005 was still higher than the pre-recession level o f 30 percent in 1998. Likewise, the incidence o f extreme poverty, estimated at 13 percent in 2005, remains high. Inequality has increased, as documented by the Bank study entitled "Seeking Sustained growth and Social Equity" (Report No. 32553-AR). 26. There are other caveats to the overall good economic performance o f the past two years. Particularly worrying is the reemergence o f inflation. Most observers expect a marked deceleration o f growth as the output gap continues to close. Many o f the factors that have contributed to the robust recovery o f the past two years reflect a rebound from 158 Annex L Argentina: CAS CompletionReport crisis, and as such are transitory. As these factors attenuate, it is expected that the economy will settle down to a lower growth rate inthe mediumterm. The Government's own medium-term economic projections indicate a rate o f growth declining to 3 percent over time. 27. InAugust 2004, a stand-byarrangement with the IMF fell into abeyance and the third IMF review was postponed indefinitely. The program will lapse in 2006. The absence o f an active IMF program in Argentina does not necessarily mean that macroeconomic management will be lax. It nevertheless constitutes a shortfall in the CAS country performance indicators which called for annual performance benchmarks and targets to be set by the Government and monitored under an IMFprogram. 28. An Economic Recovery Support SAL in the amount o f US$500 million was distributed for consideration by the Board when the CAS itself was first circulated in December 2003. However, the loan proposal was withdrawn on advice from Executive Directors and renegotiated with the Government to strengthen commitments for reform. Additional conditions were based on the announced government program. When the Board approved the loan in June 2004, Executive Directors indicated that, prior to loan effectiveness, the Bank should be satisfied that that the macroeconomic framework remained sound, taking into account all relevant factors including a third review o f the Fund-supported program. Although all conditions for release o f the first tranche were met by the time of loan approval, the loan has not yet been signed. Little progress has been made towards fulfilling second tranche conditions. Table 1: MacroeconomicIndicators (In percent of GDP or annualpercentage change unless otherwise indicated) CAS January 29th 2004 Latestestimates 2001 2002 2003 e 2004p 2003 2004 2005e NationalAccounts GDP real growth -4.4 -10.9 8.0 6.5 8.8 9.0 8.0 GDP (in US$bn.) 269 102 125 146 130 153 177 InveshnentlGDP 14.2 12.0 14.8 17.9 15.1 19.1 19.9 SavingsiGDP 12.5 21.4 21.2 22.4 21.0 21.3 19.8 Trade BalanceiGDP 2.3 16.4 12.4 9.9 12.1 7.9 5.0 Current ACCOUII~IGDP ' -1.7 9.5 6.0 5.1 5.9 2.2 -0.1 Prices Consumerprices (avg) -1.1 25.9 13.4 8.3 14.8 4.4 10.5 Consumerpricesinflation (e.0.p.) -1.5 41.0 3.7 10.5 3.7 6.1 10.5 Exchangerate (Ar%RTS$) 1.oo 3.40 2.85 .... 2.91 2.96 2.94 REER(depreciation-) 5.9 -55.9 14.2 .... 1.6 -5.0 6.3 Consolidated Public Sector RevenuesiGDP 23.7 22.9 26.1 25.3 26.8 28.9 28.6 PrimaryExpendituresiGDP 25.0 22.0 23.4 22.3 22.8 24.1 24.5 PrimaryBalanceiGDP * -1.3 0.9 2.7 3.0 3.0 4.8 4.1 O.W. FederalGovernment 0.2 0.9 2.4 2.4 2.3 3.9 3.5 Balanceof Payments Exports o fgoods 26.5 25.7 29.0 30.0 29.6 34.6 39.2 Importsof goods 20.3 9.0 13.5 15.5 13.8 22.4 30.3 Trade Balance 6.2 16.7 15.5 14.5 15.7 12.1 8.9 eestimated, projected ' Current account includes interest on non-performing debt. Latest estimates indicate a greater reduction in the current account surplus than projected in the 2004 CAS. The reduction is due in part to a greater-than-expected fall in the trade surplus. Source: Ministryo f Economy and Production, IMF and staff estimates. 159 Annex L Argentina: CAS CompletionReport 29. The ERSAL was presented for Board consideration along with a National Highways Asset Management APL and the staff took opportunity o f that occasion to update the Board on Government progress in defining areas o f structural reform. A number o fpoints o f entry were identifiedinthe briefingthat might leadto possible active Bank support including fiscal reform, trade, territorial development and housing. However, with the exception o fhealth, the policy dialogue has been limitedand the Bank has not pursued new policy based lendingbeyond the ERSAL. 30. A major objective of the Government in the period 2004-05 was to reach an agreement with bondholders that would resolve outstanding issues stemming from the default on public debt. The process was protracted, beginning at the 2003 IMF-Bank annual meetings in Dubai when the Government outlined an initial debt exchange proposal that was poorly received by private bondholders. A somewhat more favorable debt restructuring offer was formally launched by Argentina inJanuary 2005 and, inJune 2005, the Government announced that 76 percent o f all eligible debt had been exchanged, making it the largest debt work-out on record. In NPV terms, the exchanged debt had beenreduced by 75 percent at a discount rate o f 10 percent. As a result, the total public debt was reduced from US$191.3 billion as o f end 2004 to US$126.6 billion as o f April 2005 (excluding capital and interest in default held by debt restructuring holdouts o f about US$24 billion). Measured as a percentage o f GDP, public debt declined from 125 percent as o f end 2004 to about 73 percent using the 2005 GDP estimate. The approach pursued by the Government to debt restructuring was widely perceived as confrontational by bondholders and the settlement still left outstanding some US$24 billion o f bonds in default and without any agreement with creditors. In addition, some US$4 billion in Paris Club and other bilateral debt remains in arrears. Hence, the CAS performance indicator that envisaged the conclusion o f public debt restructuring in2004 was less than fully met. Recoveryof the FinancialSector 31. The economic crisis o f 2001-02 had particularly serious consequences for the financial sector. When the Convertibility Plan was abandoned and the peso fell to one third o f its previous value, many financial institutions were caught with a serious currency mismatch between assets and liabilities. Their plight was exacerbated when, by government decree, dollar-denominated assets and liabilities were converted to pesos at different exchange rates (known as "asymmetric pesification"). Further losses were incurred as a result o f asymmetric indexation whereby deposits were indexed to consumer prices while some loans were indexed to wages. Temporary protection was provided to financial institutions when the Government introduced measures to restrict the withdrawal o f deposits (known as the "corralito" and the "corralon") but that protection came at the cost o f further eroding public confidence in the financial system and it was not water-tight. In some cases, depositors were able to secure court orders (amparos) for the release o f frozen deposits at the prevailing market exchange rate o f 3 pesos to the dollar. 160 Annex L Argentina: CAS CompletionReport 32. When the CAS was prepared, financial institutions were already attempting to restructure and adapt to a radically different post-crisis environment. The Argentine courts had recognized their right to compensation for losses suffered as a result o f asymmetric pesification and negotiations were underway with the Government concerning the amount of compensation due. 33. Acknowledging the central importance of a well-functioning financial sector for sustained growth with equity, the CAS included performance indicators for the recovery o f the financial sector, even though the CAS Program Matrix clearly recognized that the Bank was no longer engaged in a sector dialogue with the Government. Subsequently, the Bank had occasion to partially reopen the dialogue when, on the advice o f Executive Directors, the Economic Recovery Support SAL was renegotiated. That dialogue was not sustained because of the delay in loan signing. However, more recently, the Central Bank o f Argentina has been open to renewed dialogue. Discussions have begun on measures to combat money-laundering and on organizing a seminar to discuss a wide range o f financial sector issues. 34. Good progress is being made with respect to country performance indicators for the financial sector. A short term objective articulated in the CAS was that full compensation should be paid to banks. As o f end-October 2005, banks had received 90 percent o f the AR$8.6 billion in compensation recognized by the BCRA for the asymmetric pesification o f domestic dollar denominated liabilities. Also as o f end- October 2005, the Government agreed to issue bonds inthe amount o f AR$77 million to compensate banks for losses due to asymmetric indexation. The flow o f new amparos i s declining and will end in 2006 when the last deposits held at the time o f the crisis come to maturity. 35. Another of the short-term country performance indicators cited in the CAS was that regulatory forebearance on loan classification and provisioning should be eliminated by end-2003. Inpractice, many banks had not yet fully restructured and their still-weak financial position did enable them to comply with normal regulatory standards. Prudentialregulations are now being reinstated gradually inaccordance with the financial tolerance o f the banking system. However there was a partial relaxation o f regulatory requirements in mid-2005 allowing banks to acquire new bonds that had been issued following the debt exchange. 36. Similarly, compliance with international standards on bank regulation i s constrained by the financial position o f the sector. Following the suspension o f international standards by Argentina in 2003, there has been progress inreinstating them inaccordance with the financial tolerance o fthe banks but full reinstatement is still some time away. 37. It was also a short-term country objective that, by end-2004, an action plan should be drawn up for restructuring publicly-owned banks. This has been done for the Banco Provincia (theprovincial Bank o f Buenos Aires) but not for the other major public bank, 161 Annex L Argentina: CAS CompletionReport Banco Nacidn. In October 2005, the Government announced that it has engaged consultants to prepare an action plan for the Banco Nacidn. 38. The medium-term indicators o f country performance identified in the CAS are also progressing albeit slowly. Financial intermediation is improving albeit from a very low level. As of August 2005, bank intermediation, as measured by total bank assets, increased by 6.5 percent with respect to the previous year. Total deposits increased by some 15 percent in the same period. Private sector deposits accounted for most o f the increase o f bank deposits in 2004, increasing to AR$129 billion. Overall credit to the private sector grew from 7.8 percent o f GDP in 2003 to 8.3 percent in 2004 and to 9.8 percent as o fAugust 2005. Infrastructure 39. The Bank has a long-standing association with infrastructure development in Argentina that continues today. The acute recession which began in 1998 and which culminated inthe economic crisis o f 2001-02 had a serious impact upon the sector. First, the squeeze on budget resources resulted in a sharp reduction o f investment and slower progress with Bank financed investment projects which suffered from insufficient counterpart funding. Second, the crisis itself disrupted infrastructure concession contracts that had been predicated upon the dollar and the peso being interchangeable at par, The issues at stake inrenegotiating infrastructure concessions are examined in detail in the following section. This section is concerned with issues o f investment and maintenance inphysical infrastructure. 40. The CAS program matrix specified a number o f country performance indicators as medium term goals. As far as roads are concerned, the objective was that 90 percent o f national non-concessioned roads and 50 percent o f the provincial road network should be ingood condition within a period o f five years. By 2004, some 92 percent o fnational non-concessioned roads were found to be in "good or fair" condition and the corresponding percentage for provincial non-concessioned roads was 86 percent. A breakdown between "good" and "fair" i s not currently available. Medium-term goals were also specified for water supply, sewerage services, gas and electric power where the emphasis was upon increasing the availability o f service to the poor. Progress with those performance indicators has been slow. At the presentjuncture it i s difficult to compare actual progress with CAS targets because the institutional and policy framework must first be revitalized before results can be seen on the ground. 41. A positive achievement o f the two year period 2004-05 has been to revitalize many investment projects that had fallen victim to the recession and to the economic crisis. An example i s the Buenos Aires urban transport project that was approved by the Board in May 1997. That project, which sought to support infrastructure improvements governed by concession agreements between the Government and the private sector, to assist the improvement o f traffic safety and environmental quality and to help develop an integrated road and rail transport system in the Buenos Aires metropolitan area, languished for many years as a problem project. It has beenturned around inthe last two 162 Annex L Argentina: CAS CompletionReport years and prospects are now good that it will achieve all its development objectives satisfactorily. 42. A notable improvement in portfolio performance enabled the Bank to develop follow-up operations which built upon the experience o f previous investments and extended their benefits to a broader public. In that context o f a 20 month CAS which authorized only limited headroom for lending, the adaptable program loan was the instrument o f choice which enabled the Bank to adopt a sequenced approach based upon progress in the sector policy framework, the fiduciary environment and implementation capacity. The APL became, in effect, a risk management tool in a context o f weak project execution and, at the same time, a tool that permitted multiple initiatives to be taken on many fronts. A loan in the amount of US$200 million was approved in December 2004 for an infrastructure APL in the province o f Buenos Aires. It included components in roads and drainage as well as in water supply and sewerage. Since the province o f Buenos Aires still faces tight fiscal constraints, an important part o f project preparation was to review the fiscal framework and carefully screen investment priorities in the light of resource constraints. Hence, the operation provided a context for addressing issues o f fiscal policy at the provincial level at a time when the CAS was moving away from policy lendingperse. 43. InJune 2005, the Bank also approved a loaninthe amount ofUS$lSOmillion for a provincial road infrastructure project which built upon the accomplishments o f an ongoing provincial roads project. The project was demand-driven and it responded to investment proposals from six provinces. The operation aims at improving the reliability of roads to facilitate market access and to enhance competitiveness. 44. Another example of mobilizing previous operational experience was an adaptable program loan in the amount o f US$200 million for a national highway asset management project which received Board approval inJune 2004. Buildingupon the experience o f an ongoing national highways rehabilitation and maintenance project it expanded the National Highway Directorate's CREMA program whereby the rehabilitation and maintenance o f the non-concessioned primary road network is financed through multi- year performance-based contracts. The Bank i s providing finance for about 8,000 km o f road maintenance corresponding to some 40 percent o f the target network. Other components o f the operation focus on bridge restoration, construction management, road safety and transforming the National Highway Directorate (DNV) into a results-based organization. The results o f the 2005 initial biddinground for the new highways project raised fiduciary concerns that prompted the Government to cancel the round and introduce a number o f corrective actions. The L C R region requested INT participation in support o f this effort. Ifthese initial problems can be overcome, the project could have a significant development impact because, in a post-crisis environment, there i s a large backlog o f road maintenance investment to be satisfied. Meanwhile, good progress i s being made on parts o f the project that relate to strengthening the DNV. Consultants have been engaged to undertake a diagnostic of human resources and a program o f technology modernization is under way. 163 Annex L Argentina: CAS CompletionReport The promotionof public-privatepartnerships 45. Private-public partnerships have been used extensively in Argentina as an instrument for the maintenance and improvement o f infrastructure. In recognition o f their importance, public-private partnerships were an explicit thematic focus o f the CAS and they were incorporated into the renegotiated ERSAL. The financial position o f public utilities and infrastructure concessions had been severely compromised at the time o f the economic crisis because, inmany cases, the tariffs they charged to customers were denominated in (devalued) pesos and frozen by the Government while their balance sheet liabilities and their debt service obligations were denominated in dollars. The Government established a special agency (UNIREN) to renegotiate public service and infrastructure concessions and special "fast track" procedures for Congress to ratify proposed amendments to the concessions. They also introduced a number o f measures in preparation for the adjustment o f some public utility and infrastructure tariffs. 46. For purposes o f second tranche release, the renegotiated ERSAL incorporated a number o f other performance criteria that had been included inthe CAS program matrix, and thereby brought them into an operational context. Specifically, second tranche actions focus on the resolution o f disputes in public-private contracts. They call for UNlREN to reach agreement with at least 39 concessionaires on the renegotiation o f contracts. They also call for progress in strengthening the regulatory framework and for approval and implementation by the Government o f a plan to restore normal operations o f a stabilization fund for the wholesale electric power market. 47. With respect to the regulatory framework, an implementation status report for the ERSAL dated April 2005 noted that, "There is also uncertainty about the orientation of the draft framework lawfor public utilities that waspresented to Congress. The tranche condition specipes that the regulatory framework in the public services and infrastructure sectors should be, inter alia, consistent with the renegotiated concessions and supportive of private sector participation in the provision of these services. The initial draft presented to Congress did notfully comply with the criteria speciped in the Loan Agreement. '' 48. The renegotiation o f contracts i s behind schedule. Of the original 63 contracts that requiredrenegotiation, only 22 had reached an agreement with the executive branch and 7 renegotiated contracts had been approved by Congress as o f October 2005. The Government waited for another13 concession contracts on toll roads to reach their date o f expiration and it cancelled a concession contract for postal services prior to assuming ownership and control. Three years after tariffs were frozen, a further 27 contracts still await resolution. They include concessions in such strategic areas as telecommunications, water, sewerage, gas and power transmission and distribution. Continued delay inrenegotiating public service and utility contracts has serious negative implications for new investment which i s at a standstill inmany cases. 49. Litigation has added to the complexity o f renegotiations in many cases. As o f October 2005, there were 35 arbitration proceedings instituted by foreign investors 164 Annex L Argentina: CAS CompletionReport against Argentina in ICSID. The proceedings have been initiated under bilateral investment treaties (BITs) concluded by Argentina which call for dispute settlement under the ICSID Convention. In 32 cases the claimants contest measures adopted by Argentina in 2002 - devaluation and/or freezing o f utility tariffs - which allegedly violated investors' rights under the BITs. Most o f the claims concern concessions for public services. The Government has indicated that it will not conclude renegotiation o f concessions unless the companies concerned first withdraw from any litigation under ICSID. In May 2005, ICSID issued its first judgment on such cases, awarding compensation to CMS Energy in an amount o f US$133.2 million and the Government appealed the decision in September 2005. Progress towards renegotiating the concessions i s lagging significantly behindthe schedule envisaged inthe 2004 CAS. PrivateSector Development 50. Another endeavor identified in the CAS as being o f central importance for sustained growth with greater equity was the promotion o f private sector development. Inpart that would dependupon government efforts to reduce infrastructure bottlenecks which impair production and distribution to both local and export markets. It would also depend upon broader improvements in the enabling environment through a reduction in red tape and the removal o f financial disincentives such as the export taxes. 51. There has been notable progress in the revival o f the private sector since the economic crisis. Indices o f business confidence produced by the University o f Torcuato di Tella are evidence that the CAS performance indicators have improved greatly. The consumer confidence index stood at 49.9 inSeptember 2005 compared with a low o f 28.4 in September 2002. Similarly, the index o f demand for labor rose from 48 inSeptember o f 2002 to 117 in September 2005. However, most o f the increase in those indices took place in 2003 when a new administration was elected. In 2004-05 the upward trend leveled-off. 52. Other country performance indicators have also shown progress. Private sector investment increased from 13.6 percent o f GDP in 2003 to an estimated 16.6 percent in each of 2004 and 2005. Merchandize exports increased from US$29.6 billion in 2003 to US$34.6 billion in2004 and by a further estimated 17 percent in2005.. Furthermore, new markets were penetrated. Merchandise exports to destinations other than MERCOSUR, NAFTA and the EU have accounted for a steadily increasing share o f the total. They grew by 18.7 percent in2004 and by an estimated 17 percent in2005. 53. Notwithstanding those advances, business indicators continue to reveal a difficult business environment. There i s no dialogue between the Government and the private sector. There i s continued concern about the enforcement o f contract rights and there are many complaints about an uncooperativebureaucracy and the persistence o fredtape. 54. The IFC has been active in Argentina during the CAS period and committed US$533 million, including US$175 million for syndications through the B-loan program. Efforts were focused on financing companies with strong fundamentals striving in a 165 Annex L Argentina: CAS CompletionReport difficult environment, in order to support the ongoing recovery. For those companies the role o f the IFC was counter-cyclical and it also had a demonstration effect for other investors. The commitments financed eight projects in five diverse sectors, including agriculture, food and beverages, the financial sector, retail, and hydrocarbons, with a focus on exports. 55. Inagriculture, IFC committed a US$lOO million loan to a leading soy oil export company (including US$30 million for syndications). This was the first long-term loan to an Argentine company since the onset of the crisis. In food and beverages, loans totaling US$65 million term (including US$lO million for syndications) were provided to two leading agribusiness exporters. One o f these three beneficiaries, Molinos, was able to more than double its exports. Another beneficiary, San Miguel, has implementedthe first phase o f an innovative waste treatment system for its lemon operations. Another company, AGD, was able to complete its purchase program, thereby benefiting many farmers and rural intermediaries, thanks to an IFC seasonal facility o f US$60 million emergency pre-export finance in 2002. A subsequent 2004 loan is supporting an expansion program. In 2005, the company processed 26% more than in 2002, and this should increase by a hrther 29% following an expansion of capacity. Most o f its revenues are expected to come from exports. 56. IFC's investments in the financial sector during the period included a loan o f US$47.5 million to support Banco Galicia and a US$25 million warehousing loan that promoted the origination and securitization o f trade and mortgage receivable assets. As chair o f the creditors committee, IFC has taken a lead role in the important restructuring o f Banco Galicia as well as in restructuring Banco Hipotecario and Acindar. IFC also made a US$40 million equity investment in a major retail company at a time when risk capital was generally scarce inArgentina. 57. Finally, in the oil and gas sector, IFC provided US$255.5 million (including US$135 million for syndications and an exposure o f up to US$5.5 million in a risk management product) to the Argentine branch o f a leading multinational oil and gas producer in support part o f its 2005 capital expenditure program. The syndicated loan had a seven-year term (the longest furnished to an Argentine borrower since the economic crisis) and it was oversubscribed. 58. IFC has made significant progress in restructuring its exposure to Argentine companies, with the exception of public service concession projects and projects that were in jeopardy prior to the crisis. The fragile situation o f the financial sector, the energy crisis and other factors such as the volatility o f commodity prices will, however, continue to require enhanced portfolio supervision in addition to recovery work on non- performing loans. 59. MIGA managed its portfolio inArgentina proactively during2004-05 althoughno new guarantees were issued. When the CAS was distributed to Executive Directors, the outstanding country portfolio o f MIGA consisted o f 20 contracts o f guarantee with a gross exposure o f US$318.5 million and an exposure net o f reinsurance amounting to 166 Annex L Argentina:CAS CompletionReport US$153.7 million. By end-September 2005 MIGA's exposure in Argentina had been reduced to 7 contracts for US$60.9 million gross and US$35.5 net. 60. Three factors accounted for the reduction in MIGA's country exposure. Some contracts lapsed when the underlying loan instruments were fully amortized. In other cases MIGA facilitated a settlement between the clients and their business counterparts whereby the financial interest o f the client was protected without resort to the MIGA guarantee. In some other cases MIGA negotiated directly with the BCRA to secure exemptions for the client from government restrictions that would otherwise have caused the client to suffer losses. 61. In FY05 MIGA recognized the claim o f an investor for a loss o f some US$1.4 million on grounds o f expropriation. US$558 thousand o f the claim has been paid. Discussions between MIGA and the Argentine Government concerning recoveries for that payment are ongoing and there will beno further MIGA contracts issuedwith respect to Argentina until that issue i s resolved. Two other investment disputes are pending, one o f which has been brought before ICSID by the guarantee holder in its claim against Argentina. Inthis instance MIGA i s awaiting a final and binding arbitral award prior to determining ifthe actions would fall under MIGA's contract o f guarantee. 62. The Bank sought to support Government efforts to improve and streamline the enabling environment for private enterprise. The ERSAL o f June 2004 included measures to stimulate exports by expediting the reimbursement o f taxes, duties and drawback, by facilitating foreign exchange transactions and by improving policy coordination. They also included action to enhance competitiveness by such measures as facilitating SME access to credit, promoting R&D, and strengthening quality control. 63. In addition, the Bank's extensive portfolio o f investment loans in infrastructure and public services i s strongly, albeit indirectly, supportive of private sector development. The sustainable use of naturalassets 64. Since the economic crisis, the rural sector has been one o f the most dynamic sectors, contributing over half o f all foreign-exchange earnings and export growth. Agro- based exports grew by an average o f 13 percent in2003 and 2004 and there was a further increase o f 18 percent inthe first eight months o f 2005 compared with the corresponding period o f 2004. Inspite of this, however, Argentina's deepest pockets of poverty are still found in rural areas, particularly in the northern regions. The average income in some rural areas i s only ten percent of the level in urban areas. Upwards o f 70 percent o f the rural population i s below the poverty line. The sustainability o f the natural resource base i s fundamental to both growth and poverty alleviation, whether in the agriculture, water, forestry, biodiversity, or ecotourism sectors. 65. The CAS strategy recognized the complexity of the rural sector by pursuing activities in three areas, Le., agricultural growth, rural poverty, and natural resources 167 Annex L Argentina:CAS CompletionReport management. In support o f growth, the CAS period witnessed the implementation o f projects in irrigation, rural roads, and rural electrification (Provincial Agricultural Support Project, Provincial Roads, Flood Management, and Renewable Energy in the Rural Market Project). In support o f rural poverty alleviation there are ongoing projects for Small Farmer Development and Indigenous Community Development. In support o f the underlying natural resources base there are operations in the fields o f Forestry Development, Native Forest Protection, Biodiversity Conservation, and Marine Pollution Prevention, all o f which are financed with a blend o f IBRD resources and concessional GEF resources. Together, these lending activities have provided institutional support and promoted coordination across the multiple agencies involved (Ministry o f Economy, Secretariat o f Agriculture, Ministry o f Health and Environment, Ministry o f Tourism, National Parks Administration, Ministry o f Foreign Relations). 66. During this CAS period, a new generation o f rural-based post-crisis initiatives took shape. First, Rural Sector analytic work (FY06) provides a diagnostic o f the performance and trends o f the Argentine agricultural economy and developed the basis o f a strategy for new lending. The study identifies needed reforms in irrigation management, local agricultural extension services, fiscal policies at the provincial level, animal and plant health surveillance, and export diversification in the non-Pampean provinces. In parallel to this rural sector work, project preparation has begun in areas related to integrated water resources management, sustainable forestry management, rural education, and rural poverty. Serious animal and plant health problems that Argentina cannot solve without greater regional cooperationwere also addressed with FA0 support. Finally, an active dialogue has been maintained with the Ministryo f Planning, Ministry o f Economy, and the Secretariat o f Environment, on the issue o f territorial development with the objective o f more effectively linking land use planning, infrastructure planning, and local economic development. 67. The environmental program o f the CAS was, and continues to be, closely related to the rural development strategy, particularly when it comes 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 deterioration in the quality o f water. The integrated water resource management project which is currently under preparation will address those environmental problems. In forestry, where commercial production is fast developing, the Bank has supported more effective government regulatory oversight. Bank lending has also supported the protection o f native forests, many o f which have been degraded by agricultural clearing related to the soybean boom. 68. A GEF program inbiodiversity, marine resources, renewable energy and energy efficiency was supplemented during the CAS period with an innovative one-of-a-kind world-wide pilot initiative for "decentralized management o f medium-sized projects" (MSPs). Under that three year pilot initiative, approved by the GEF Council in FY05, GEF resources for MSPs are being allocated locally, based on competitive procedures and managed by a committee comprised o f Government and all three GEF implementing 168 Annex L Argentina: CAS CompletionReport agencies. A regional GEF and carbon finance strategy was completed inNovember2004, andwill be updated annually to guide implementation o fthese complex programs. 69. Another focus o f the environmental agenda relates to the management o f pollution that i s associated with urban growth and industrialization. Critical issues o f pollution management include the disposal o f municipal solid waste, which has reached near-crisis proportions in some urban areas, poor water quality, a deterioration o f air quality in larger cities, and contamination related to mining. To help address those problems, preparation o f a municipal solid waste management project has begun, building on a national strategy supported under the ongoing Pollution Management project, That project incorporates effective approaches to blending carbon finance with more traditional nation-wide investmentoperations inLatinAmerica. 70. Water quality and air pollution are other important issues addressed in the CAS. They are the focus of preparation activities under the integrated water resource management project and the regional GEF-financed Air Quality Management Initiative, respectively. Finally, to address contamination issues related to uranium mining and radioactive waste, the preparationo f a MiningDecontaminationproject i s well advanced. Pillar 2: Strengthening Social Inclusion Overview 71. Issues o f social inclusion and social protection were o f central importance for the incoming administration o f 2003 which had to cope with the aftermath o f the 2001-02 economic crisis. This second pillar o f the CAS was, therefore, responsive to the concerns and the priorities articulatedby President Kirchner at the time he assumed office. At that time, the worst of the crisis had passed and the Government was considering options for converting programs o f emergency reliefinto longer-term structures for social protection. As the recovery gained steam and crisis-driven pressures were reduced, the Government was able to focus once more on longer term issues o f education and health. The CAS sought to support the Government in these endeavors. Details o f CAS objectives and outcomes are to be found inAttachment K1. 72. Country outcomes reveal good progress in2004-05. Employment has expanded so that fewer people need participate inworkfare programs. Inparticular, there has been a reduction in youth unemployment and a reduction o f unemployment for the lowest income quintile. Inthe health sector, the coverage o f vaccinations has beenmaintained at 95 percent and a maternal-child health insurance scheme has been successfully introduced. In education, preliminary data for 2004 indicates that secondary school enrollment has increased and repetition rates have been reduced. 73. CAS outcomes have been very good for this pillar o f the CAS. The Bank has beeninstrumental inassisting the Government with a strategy to restructure programs o f emergency poverty relief to better serve the longer-term requirements for poverty alleviation while, at the same time, fostering employment generation to reduce the 169 Annex L Argentina:CAS CompletionReport numbers o f the poor. There has been a very fruitful dialogue inthe health sector and an adaptable program loan has been approved to support the introduction o f a maternal and child health insurance scheme. In education the Bank has helped the Government to devise strategies for the improvement o frural education. Reachingvulnerable groups 74. A program targeted at heads o f households (Jefes de Hogares) had been introduced in2002 as the Government's principal emergency relief vehicle for addressing crisis induced poverty. About two thirds o f a Bank loan for US$600 million insupport o f the program had been disbursed when the Board approved the 2004 CAS. The program provided cash relief in exchange for work performed under local government sponsorship. It was envisaged that the program would be phased out gradually and replaced by, on the one hand, measures to enhance employment and, on the other hand, an expanded conditional cash transfer program forming part o f a more comprehensive social safety net. 75. By virtue o f support hrnished to the Heads of Households (Jefes) program, the Bank contributed directly to the amelioration o f poverty in Argentina at a critical juncture. The previously cited Bank report on Growth with Equity shows clearly that poverty would have been more pronounced in 2004 had it not been for government transfers, principally through the Jefes program. The beneficial impact o f the program was particularly pronounced at the very lowest end of the income distribution. Indigence would have been some three percentage points higher without government transfers financed, inpart, by the Bank. 76. During the CAS period 2004-05 considerable progress was made towards improving the management o f the Jefes program. At its inception in2002, it hadbeen set up quickly to deal with a dramatic rise inpoverty and it was vulnerable to institutional weaknesses, particularly in governance. Most municipalities were ill-prepared to assume responsibility, virtually overnight, to register large numbers o f beneficiaries and administer so large a program. The LCR Region requested INT participation in project supervision to better monitor progress. Consequently, in 2003, the Bank investigated the enrollment process inone o f the largest municipalities. When a new administration took office in May 2003, it signaled its commitment to improve the management o f the program and, with Bank support, serious efforts were undertaken to restrict the program to eligible beneficiaries by cross-checking data bases to make sure that all beneficiaries complied with program requirements. During 2004, staff from the Ministry o f Labor visited over 1100 municipalities, accounting for halfo f all program beneficiaries. By end 2005 the program calls for all benefits to be paid by bank debit cards rather than by checks, thereby further reducing the scope for the misuse o fbeneficiary payments. 77. Overall, the Jefes program has been very successful in reaching the poor and in ameliorating the impact o f the social and economic crisis. An estimated 10percent o f the participants would have fallen below the food poverty line without the program. A rigorous impact evaluation has shown that targeting was good. About 40 percent of 170 Annex L Argentina: CAS CompletionReport participants came from the lowest quintile o f the income distribution, while about 80 percent came from the lowest two quintiles which compares very well with similar programs elsewhere. 78. An improved Jefes program now provides the basis for a reform agenda that will redirect the program away from emergency relief towards a program that will serve the medium- and long-term requirements for social protection in Argentina. The Bank has undertaken preparation work in support o f a Heads o f Household Transition Project to assist the Government inthis transition. The key underlying strategy is to identify among the current program beneficiaries those who have a higher chance o f re-employment and distinguish them from those who would be better served by a different type o f longer- term safety net, linked to buildingthe human capital o f their children. Policy options for a reform o f the overall social protection system are currently a subject o f public discussion in Argentina. The Government recognizes that formulation and implementation of a reformed medium-to longer-run social protection strategy will evolve only gradually. The proposed new Transition Project will assist the overall Program in testing and evaluating several important strategies to move from emergency programs to sustainable programs that foster social and human development, including higher levels o f labor market participation by the poor. Accompanying analytical work continues to inform the policy debate. It included a study o f the labor market and issues relating to skills building, both o f the young and adult population in Argentina. Other analytic work begun or completed in the course o f 2005 has a direct bearing upon the broader framework o f social protection as well as on issues o f health and education. Income security for the elderly who are not covered by any formal pension system is the subject o f one study. Another study addresses social development issues with respect to the youth o f Argentina with a special emphasis on poverty, exclusion and gender segregation. 79. Interms of country progress indicators relating to vulnerable groups, Argentina has partially achieved the CAS objectives. As a result o f labor market improvements and governance reforms, participants in the short- and medium-term workfare program (the Jefes program) were reduced from a peak o f almost 2 million inmid-2003 to 1.47 million in October 2005. A further reduction is anticipated, but the number of beneficiaries by end-2005 will likely exceed the CAS target o f 1 million. Unemployment among the lowest income quintile has been reduced from 35 percent in 2003 to 29 percent in mid- 2005 but i s still well above the medium-term target o f 20 percent. Likewise, unemployment among the youth fell from 32 percent in2003 to 27 percent in2005. Buildingan inclusivehealthsystem 80. In Policy Notes conveyed to the incoming administration in 2003, the Bank observed that Argentina ranks high among nations o f the world interms o f health related expenditures, the number o f hospital beds and the number of physicians. Yet in 2000, according to data from WHO, Argentina ranked 4gth among nations in health outcomes and only 75th in terms o f the overall performance o f the health system. It was an objective o f the CAS to help Argentina correct the mismatch between the high cost o f 171 Annex L Argentina: CAS CompletionReport Argentina's health system and the modest results that it delivers. A Health Sector Review was completed by the Bank in FY03 and it provided a framework for tackling that issue. In 2004 the Government adopted Plan Nacer, a comprehensive policy framework for maternal and child health care. 81. The Government andthe Bank hadpreviously identifiedmaternal and child health care as a weak point in the system that needed to be strengthened. The principal Bank vehicle for assisting the Government in that endeavor was an adaptable program loan in the amount o f US$135.8 million for a Provincial Maternal and Child Health Investment Project, approved by the Board in April 2004. That operation followed upon an earlier sector adjustment loan which had supported policy reforms inpreparation for a nationally financed but provincially executed, maternal-child health insurance scheme. The investment loan financed the introduction o f insurance to the nine poorest provinces o f the northwest and northeast regions where the rate o f infant mortality stands at 25 per 1000 live births compared with a national average o f 16.8 per 1000. Those nine provinces have the highest proportion o f uninsured and they contain three quarters o f Argentina's indigenous population, traditionally a poor and marginalized group. The operation is preparing the way for future operations that will extend maternal and child health care to other provinces throughout Argentina. 82. Preparationo f the maternal and child health care project was greatly facilitated by the excellent sector dialogue between the Bank, the Ministry o f Health and the provincial authorities. As a result o f that dialogue the project structure incorporated performance based financial transfers that aim to change the operational culture o f provincial public sector health care systems. A new incentive framework is being introduced for health service contracting and management that rewards providers for achievements in increasinghealth care coverage and increasing productivity. 83. Implementation o f the Health APL has progressed well since effectiveness in November 2004 and enrollments in the program are proceeding apace. They exceeded 265,000 by September 2005 - equivalent to some 30 percent o f those eligible compared with a CAS target o f20 percent. The provinces are fully engaged innegotiatingcontracts with healthproviders and an outreach campaignwas launchedinthe second halfo f 2005. The program has already led to significant administrative improvements. Soon after birth, most newborns are now getting the national identification documentation needed for receiving public services whereas previously there were considerable delays. 84. Health services occupy a prominent place inthe social agenda o f the Government and the role o f COFESA, the FederalHealth Council has been revitalized. Good progress is being made in maintaining vaccine coverage at a level o f 95 percent. Ongoing programs financed by the Second Maternal Health and Nutrition Project and by the Public Health Surveillance and Disease Control Project have, in their final year, performed very well. They have contributed to significant improvements in health indicators for Argentina over the last two years since the crisis. Infant mortality per thousand live births fell from 16.8 in2002 to 14.4 in2004. 172 Annex L Argentina: CAS CompletionReport Preparingand maintaininga well-educatedwork force 85. As in other countries, there i s a close inverse correlation between education and poverty in Argentina. Bank support for education has traditionally focused on secondary education where dropout and repetitionrates are very high. On average only fifty percent o f students entering secondary school actually complete it. Among the poorest quintile, only one out o f every four children completes secondary school. 86. Duringthe 2004/2005 period, the Government requested Bank support to reduce existing education inequities, especially with respect to rural education which the Government considers a key link for revitalizing growth in Argentina. The dialogue on education inequities has greatly profited from a skills report which linked education outcomes to labor market participation andindividual earnings. 87. A secondary education project for the Province o f Buenos Aires had been approved in December 2000, but, as with many other Bank-supported projects, implementation was seriously interrupted as a result of the economic crisis and the recession that preceded it. During the 2004-05 CAS, efforts to get the project back on track were successful and implementation i s now proceeding well. However, attainment o f some development objectives has been impaired by the social and economic consequences o f the crisis. Completion rates for the targeted grades 7 through 9 and transition to the next level o f secondary educationhave declined compared with the 2000 baseline. It appears that the poverty impact o f the crisis may have caused the decline, in which case a successful transition from economic recovery to sustained growth should make it possible to regain lost ground. There has been good progress with other development objectives. An extended school day has been established in many schools, the training o f school principals has proceeded successfully and more schools are managing their own budgets. 88. At government request, new initiatives were taken inthe 2004-05 CAS period to extend the scope o f Bank support for secondary education in Argentina. A loan in the amount o f US$l50 million for a project entitled "Education for a more Productive and Equitable Argentina - PROMER" i s planned for Board presentation in late 2005. The principal focus of the project i s rural education. A menu o f options is to be made available to authorities at the provincial level so that they may adopt a pedagogic institutional model that i s tailored to the local context. 89. The project design o f PROMER benefited from the good sector dialogue between the Bank, the Ministry o f Education and provincial governments. As a result o f that dialogue, the disbursement o f project finance will be performance-based. The provincial governments will be signatories to annual agreements with the Ministryo f Education that specify baseline indicators andprogram objectives. There will be an institutional mechanism to evaluate compliance with the agreements and to agree upon corrective action where necessary. Continued participation in the program would be contingent upon satisfactory performance by the provinces. 173 Annex L Argentina:CAS CompletionReport 90. Duringthis CAS period, a new program was begunto address youth issues and support youth organizations. Analytic work to survey and analyze issues relating to youth and to define a future sector strategy i s now underway for delivery in FY07. O f particular importance was the Southern Cone Development Marketplace (DMP) held in Buenos Aires on May 29-3 1,2005. The focus o f the event was "Youth and Values". It consisted o f a 3-day learning program on youth issues and the award o f 100 grants for US$lO,OOO each to youth-oriented service organizations from Argentina, Chile, Uruguay and Paraguay. Of the 100 grant-winners, 47 are based in Argentina, and the scope o f services provided range from the environment, to job training, cultural activities, support to the handicapped, health, education, indigenous peoples, family violence, human rights, and sports. Trust-find resources have been identified to finance follow-up monitoring and evaluation. Pillar 3: Promoting Better Governance Overview 91, It is widely perceived inArgentina that poor governance and corruption inpublic sector management contributed significantly to the economic and social crisis o f 2001-02. At the same time, there was, and still remains, widespread public discontent with a surge inviolent crime andinsecurity. 92. Against that background, the 2004 CAS identified three general areas where action was needed to improve governance in Argentina: accountability and transparency; institution strengthening; and decentralization. Details o f CAS objectives and outcomes are to be found inAttachment K1, 93. Country outcomes are not easy to assess over so short a CAS period. Shortly after assuming office, the new administration took a number o f high-profile initiatives to demonstrate its commitment to fighting corruption and enforcing the law. Steps were taken to lift the immunity to prosecution which had protected members o f the armed forces suspected o f civil rights violations and atrocities in the 1970s. New procedures were introduced whereby judicial appointments and, in particular, appointments to the Supreme Court would be subject to public scrutiny. Other more specific measures will enhance the effectiveness o f those initiatives. The Government has expanded the system whereby public employees disclose their assets. The executive branch is 99 percent in compliance but the judicial and legislative branches are lagging. Progress has been made with expanding the coverage and use o f IFM systems and establishing an integrated personnel registry. 94. CAS outcomes have been positive in many respects. The Bank has effectively assisted ANSES, the social security administration to strengthen the efficiency and transparency o f its operations and it has similarly assisted SINTyS, the federal agency that cross-checks data bases. It has assisted the Government to develop and adopt new systems o f financial management and project evaluation. It has also helped a number o f 174 Annex L Argentina: CAS CompletionReport provincial governments to improve their tax administration, financial management, human resources management and civil registries. Fightingcorruption andpromotingaccountabilityand transparency 95. The Government has taken a number o f well-publicized initiatives to prosecute prominent cases o f past corruption, although most o f these cases have yet to be resolved. The national-level Anticorruption Office has made advances in promoting transparency and accountability with support under a Bank Institutional Development Fund (IDF) grant, It has usedthe automated assets declaration system to identify conflicts o f interest and incompatible job holding throughout the federal Executive Branch. It has conducted an analysis o f procurement vulnerabilities in support o f the new procurement law and it has provided input to proposed new legislation on conflicts o f interest and whistle blower protection. It has also forwarded 1,000 investigations o f suspected corrupted practices to the judiciary, and has initiated its "plan provincias," intended to encourage provincial governments to pursue their own anti-corruption activities. At least four provinces have established, or are inthe process o f establishing, their own anti-corruption offices and the city o f Buenos Aires i s considering setting up an Office o f Ethics. However, setting up such offices i s not enough, effective progress towards eliminating corruption will also depend upon a broad agenda o f administrative, judicial and legislative reforms to improve transparency and streamline procedures. Notwithstanding numerous government initiatives, public perceptions o f corruption have not been dispelled. 96. During the 2004-05 CAS period the Bank supported government efforts to advance its agenda for better governance. Within the context o f an ongoing State Modernization project, an action plan was developed and agreed in 2004 based on the new Government's strategy for enhancing transparency, including e-procurement. The project i s currently being restructured to include a new component to provide continued Bank support to the SINTyS project which coordinates databases across the Federal Government. The SINTyS capacity for cross-checking data bases has already been used to improve the administration and transparency o f the Bank-supported Heads o f Household project. In addition, the WBI has furnished training for Argentine civil servants inmatters o f anticorruption. 97. The CAS program matrix identified two quite specific short-term performance measures that would be indicative o f progress. The first called for the government-wide use o f e-procurement systems but progress towards that goal i s proceeding slowly. Only a few agencies are using e-procurement at the present time. Further progress will depend not only upon new government initiatives but also upon a more generalized use of computerized technologies among the population in general and among suppliers in particular. 98. A second short-term country performance indicator was the adoption o f a well- fbnctioning asset disclosure system for senior public employees. The executive branch o f government, has sustained early progress in that regard and it now has an electronic disclosure system with excellent outcomes. An abbreviated form o f individual assets 175 Annex L Argentina: CAS CompletionReport declarations is also available for public inspection. However, the judiciary and Congress are still not fully complying with legal requirements for public access to financial disclosure 99. Inthe medium-termthe CAS lookedto animprovedpublic perceptionofintegrity as indicated by the ranking o f Argentina within the index o f Transparency International. Between 2003 and 2004 Argentina retained the same 2.5 score within the Corruption Perceptions Index (published each October) but, because o f an increase in the number o f countries considered and an improvement in the score o f some other countries, fell in rank from 92 to 108. The 2005 score was 2.8. Transparency International characterizes a score o f less than 3 points out o f 10 as indicative o f "rampant corruption" which, inturn, is defined as "the use o fpublic office for private benefit". 100. A report by the Argentine undersecretary o fpublic management, also publishedin October 2004, cites the poor professional level o f much o f the public sector as an impediment to effective administration and economic development. Inthe ministries o f health and social development, for example, the proportion o f employees with less than full secondary school education amount to 46 and40 percent respectively. The low level of education is reflected inlow salary levels which may constitute a motive for accepting bribes. 101. On the other hand, other surveys are less negative in their results. According to KPMG consultants "only" 33 percent o f business and civic leaders surveyed claimed to have been the victims o f fraud or corruption in 2004 compared with 55 percent in 2001. Furthermore, only 6 percent considered the present Government to be more corrupt than others inthe previous 20 year period. Strengtheninginstitutions 102. The current Government i s taking an incremental approach to public sector modernization involving a limited number of initiatives in selected agencies, in contrast to the more sweeping, but sometimes unsuccessful reform initiatives o f the past. The Bank i s extending support for a strengthened system o f social security with a second technical assistance loan (TAL) for ANSES, the social security administration, was approved by the Board in July 2005. Building on the results achieved under the first ANSES TAL which closed earlier this year, the project aims at improving the efficiency, transparency and accountability o f through a reengineefing o f its structures, procedures and incentive systems to enhance service delivery. In line with ANSES' strategic plan for 2005-10, the project would foster increased cooperation with other government agencies including SINTyS. 103. Public expenditure management was another area o f focus for the CAS. With support from the Bank, a Public Investment Strengthening Project (FOSP) sought to replace many diverse systems o f financial management within the public administration with a single unified system. The 2004 CAS identified explicit country performance indicators against which progress could be measured. The number o f government 176 Annex L Argentina: CAS CompletionReport agencies using the updated system o f integrated financial management for internal preparation and tracking o f budgets (SLU) was one such indicator which reveals significant progress. The number o f agencies using the system rose from seven in 2002 to 41 in 2004 and hrther to 52 in 2005. The FOSIP project also helped develop a new system for the identification, preparation, management and evaluation o f public investment projects. By end-2005 the new system, known as BAPIN 11, had been adopted by 19 of the 24 provinces and by 110 federal agencies. Training to use the system has beenprovided for 752 public employees and 800 private sector participants. 104. Fiduciary weaknesses in the management o f the FOSIP project were identified during ex-post supervision missions in 2005 and the Bank has engaged the Government to address these. Strengthened fiduciary measures are being incorporated in the follow- up Governance 21 operation planned for Board presentation in early 2006. The Governance 21 project will support further improvements and expansion o f the SLU and BAPINsystems, as well as new government initiatives for territorial development. 105. The completion o f an integrated registry o f government personnel was another indicator specified in the CAS. By end-2005, the Government expects to have all the legal instruments in place to establish the registry and implementation i s set to begin in 2006. However, progress with another short-term indicator - the publication o f institutional objectives and achievements by key government agencies - i s lagging. Enhancingeffectivedecentralization 106. The federal structure o f Argentina and the traditional strength o f provincial loyalties mean that decentralization is an issue o f central importance for effective governance. During the 2004-05 CAS period a determined and successful effort was made to accelerate the implementation o f a Second Provincial Development Project, the principal objective o fwhich was to assist the provinces to implement public management reforms that would permit them to improve fiscal performance. A related objective was to strengthen the capacity o f the provinces to plan, execute and monitor investment programs that are economically efficient, financially sustainable, institutionally manageable and environmentally sound. Over the past two years under the project, new or improved systems were completed for: (i)tax administration in four provinces, (ii) financial management in four provinces, and (iii) cadastre systems in three provinces. Other provinces improved their systems for human resource management, administration, and civil registry. In the absence of nation-wide standards, the Bank project has promoted adoption o f standardized public management systems at the provincial level. 107. The provincial development project has played an important role in supporting decentralization in Argentina. Improved tax administration has led to better tax-payer compliance. The proportion o f locally generated revenue in the total revenue o f provincial governments has risen. The cadastre has been extended to a much more extensive land area. Improvements in human resource management have resulted in lower rates o f absenteeism and more streamlined hiring procedures. The project was closed in June 2005 and a follow-up Sub-national Governments Public Sector 177 Annex L Argentina: CAS CompletionReport Modernization Project that will build upon the administrative and management prototypes established i s planned for Boardpresentation inlate 2005. 108. The Government recognizes the importance o f improved service delivery at the local level and strongly supports provincial administrative reform. It has sought to strengthen the Federal Council for Provincial Relations which has held a number o f meetings to advance its agenda. However, progress towards greater information sharing has been slow. 109. In the aftermath of the 2001-02 crisis, it was anticipated that the Government would enact a new co-participation law governing the distribution o f fiscal revenues between provinces. The enactment o f a new co-participation law was an explicit CAS performance indicator and a draft reform law was prepared by the federal authorities. However, the Government was unable to assemble sufficient support among the provinces for that legislation and the initiative has been shelved for the time being. A Fiscal Responsibility Law (FRL) was enacted in 2004 which establishes general rules for fiscal performance and for ensuring greater transparency in fiscal accounts. The FRL also provides for the monitoring o f fiscal results as well as for possible sanctions. As o f September 2005, 17 provinces and the autonomous city o f Buenos Aires (which has province-like status) had ratified the law. The FRL falls short o f best practice in that it fails to provide hard constraints on sub-national spending and borrowing. It excludes important parts o f the budget (such as capital expenditures and IFI-financed expenditures). It does not contain mechanisms to ensure that sub-national budgets are consistent with aggregate fiscal objectives and it continues to allow provinces to pledge their co-participation receipts for future debt service. However, Argentina's strong federal character puts a premium on some degree o f discretion and on consensus in decision-making, The weaknesses inthe FRLmay reflect that reality. TheBank Contribution 110. InAttachment K1, outcomes are summarized for each ofthe three pillars ofBank assistance, using as a template the Program Matrix o f the 2004 CAS. A comparison o f programmed and actual AAA, and programmed and actual lending i s set out in Attachments K2 and K3 respectively. 111, Duringthe 2004-05 CAS period the Bank had to contend with a difficult working environment in Argentina. There was widespread public perception that the 2001-02 economic crisis was due, in part, to poor policy advice from abroad. The high-profile presence o f the IMF together with a number o f large policy-based loans from the Bank had resulted in"policy-reform fatigue". There was opposition and even outright rejection o f policy advice from the Bank or from any other external players, be they multilateral, bilateral or private. As a result, the new administration showed no interest in a maintaining a broad-based policy dialogue with the Bank. The prevailing sentiment was clearly reflected inthe Government's request that Bank lending should focus primarily on investment operations. 178 Annex L Argentina: CAS CompletionReport 112. The CAS clearly stated the intention o f the Bank "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 of the stand-by arrangement in 2006" (para.111). That understanding fell into abeyance when the third IMF review o f the stand-by arrangement was postponed indefinitely. Giventhe macroeconomic uncertainties created by the absence o f an active IMFprogram, the Bank was not able to disburse policy-based lending such as the ERSAL. Investment lending alone was not sufficient to maintain the Bank's exposure, notwithstanding a successful effort to improve portfolio performance andbuild-upthe project pipeline. As a result, the Bank's exposure inArgentina (borrower obligation) fell from US$7.5 billion at end-2003 to US$7.4 billion at end-2004 andto US$7.0 billion at end-September 2005. 113. Notwithstanding that limitation, the Bank was able to engage in an active and fruithl dialogue with a number of sector ministries and with provincial governments where the Bank had an active operations program. As a result o f that dialogue, the performance o f operations in the Bank portfolio greatly improved. Many problem projects that had languished for years behind schedule were turned around and are now doing well. The overall improvement is clearly indicated inthe table o f indicators below which shows a decisive reduction inthe number o f problem projects in2004-05. 114. Nevertheless, project implementation has suffered from constraints on Government capacity, which has yet to recover from the policies o f the 1990s which de- emphasized public investment (public investment in the 1990s averaged l.5 percent o f GDP, and 1percent in the 2000s, compared to a regional average o f roughly 3 percent) and the subsequent economic crisis, which led to further reductions inthe capital budget. This has raised difficulties for the Bank, particularly in the context o f an investment led strategy inwhich the portfolio o f investment projects is being almost completely rebuilt. It also implies potential problems with respect to maintaining the balance between commitments and disbursements. Project implementation, i s also being affected by the broader governance climate inArgentina. 115. Project implementationhas also been affected by fiduciary concerns to which the Bank has responded vigorously to engage the authorities in corrective actions. Bank support for the Heads o f Household program and a road maintenance project are two examples. The Heads o f Household program has, since its inception, worked to ensure that benefits are deliveredonly to those eligible under the program criteria. The Bank has engaged the Government to address concerns about enrollment, as well as to strengthen compliance with work and training requirements. The Government has responded by establishing more transparent internal controls, implementing more strictly the cross- checking o f beneficiaries, shifting the payment system from monthly checks to bank debit cards, and expanding the scope o f the audit system. In the National Highways project (CREMA), fiduciary concerns have been identified in the course o f project supervision. The Government has canceled the first round o f bids and launched an investigation. The LCR region enhanced supervision o f the Heads o f Household program and the National Highways project, and requested the participation o f INT. More generally, the Bank is assisting with projects to strengthen overall public sector 179 Annex L Argentina: CAS CompletionReport management at the federal and provincial levels. It i s also augmenting its analytical and technical assistance insupport o f financial management andprocurement. Selected Indicators* of Bank Portfolio Performance and Management As Of Date 10/12/2005 Indicator 2003 _... I 2004 1 Porlfolio Assessment Inv. 1 Adj. 1 Overall I Inv. I Adj. 1 Overall Number of Projects Under Implementation a 30 I 3 1 33 I 30 I 5 1 35 Average Implementation Period (years) 5.3 2.4 5.3 5.5 2.2 5.3 5.6 Percent of Problem Projects by Number 50.0 33.3 54.5 28.6 60.0 31.4 30.3 Percent of Problem Projects by Amount ',' 35.8 10.0 31.4 14.1 36.0 18.3 61.6 28.6 Percent of Projects at Risk by Number 73.3 100.0 81.8 35.7 60.0 37.1 45.5 Percent of Projects at Risk by Amount 84.2 100.0 87.1 28.1 36.0 30.8 37.5 Disbursement Ratio (YO)e 35.9 nla 35.9 39.4 nla 39.4 42.2 Portfolio Management CPPR during the year (yeslno) Yes Supervision Resources (total US$'OOO) Average Supervision (US$'OOO/project) Memorandum Item Since FY 80 Last Five FYs Proj Eva1by OED by Number 80 15 Proj Eva1by OED by Amt (US$ millions) 14,275.2 4,986.8 Yo of OED Projects Rated U or HU by Number 31.6 38.5 Yo of OED Projects Rated U or HU by Amt 42.7 69.6 a. As shown in the Annual Report on Portfoiio 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) andlor implementation progress (IP). d. As defined under the Portfolio Improvement Program. e. Ratioof disbursements during the year to the undisbursed balance of the Bank's portfolio at the beginningof 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. 116. The Bank has also been active with analytic and advisory work throughout 2004 and 2005. Policy Notes were delivered to the Government when it assumed office in 2003, but there was not much receptivity. A public expenditure review and poverty assessment also carried out prior to the CAS suffered similar fates. However, more recent studies have been designed to engage the Government under a more explicit participatory approach and have met with some success. A study on Sources o f Growth contemplated in the CAS was successfully completed and distributed to the Board in October 2005 under the title "Seeking Sustained Growth and Social Equity". The shift in emphasis from a growth study to an analysis o f the linkages between growth, poverty and equity was in response to a direct request from the Government. It proved to be an effective vehicle for initiating a dialogue with the Government on issues o f economic policy. A study o f skills buildingfor the labor market was published inMarch 2005 and it established the foundation for a deeper sector dialogue inan area receptive to the Bank. Inaddition, a study o f old age welfare and social security was begun inlate 2005 as well as preparatory work for a poverty assessment that will focus, in particular, on the informal sector. The latter study i s benefiting from close cooperation with the Ministry o f Labor and the statistics agency (INDEC). An Institutional and Governance Review was undertaken in 2004 to assess reforms in financial management, procurement, human resource systems, and measures to advance transparency at the federal and provincial 180 Annex L Argentina: CAS CompletionReport levels, The findings o f the review were discussed with the Government and a report i s scheduled for release late inFY2006. Part C: OverallBankPerformanceand LessonsLearned 117. The Bank i s working to deliver the full program proposed in the CAS, notwithstanding a radical shift in program composition from adjustment to investment lending and a difficult country context. The table below shows that project preparation costs for the Argentine country program compare favorably with other similar countries. Comparative Costs of Bank Program (FY04-05, US$ Thousand) Source: Business Warehouseas of October 24,2005 Average Supervision Average Cost Preparation Average Cost AAA Country SupervisionCost cost of Project cost AAA Report cost per Project Ranking Preparation Ranking Ranking Argentina 89 333 128 Brazil 75 343 131 Chile 76 273 160 Colombia 68 286 187 Mexico 76 402 200 Poland 64 365 136 Thailand 68 307 110 Turkey 91 420 180 RussianFederation 93 461 151 118. Supervision costs, on the other hand, were above average. This reflects the exceptional effort put into transforming a poorly performing portfolio as well as the high level o f caution staff maintained with respect to project implementation given the challenging environment. The cost o f analytic work was also below average although the individual and heterogeneous nature o f economic and sector reports limits the value o f cross-country comparisons. 119. The policy dialogue on overall economic management between the Bank, the Ministry of Economy and Production as well as other core ministries of the Federal Government has been limited. Productive engagement has been possible with some provincial authorities and the private sector has been receptive to a dialogue with the Bank. As implementation o f the CAS progressed, the Bank responded to a constrained policy dialogue by focusing its analytic work on issues where the Government had expressed interest and by undertaking the analytic work in cooperation with the authorities. Within that framework a study on Growth and Equitywas designed with an explicit participatory approach and was well received. Studies in health and social security were also successful inadvancing the sector dialogue. 0 Lesson: The Bank will continue to seek opportunities for engagement at all levels o f government and with the private sector. One entry point is to identify analytical work that responds to the interests and needs o f government counterparts and o fthe private sector. 181 Annex L Argentina: CAS CompletionReport 120. While the interim CAS was realistic in focusing on investment lending for 75 percent o f the proposed portfolio, it was not possible to insulate the CAS from the difficulties o f the policy environment and related events. Progress with the ERSAL was difficult in the absence of a good policy dialogue. As a result o f the suspension o f an IMF-supported program, the first tranche o f the ERSAL and the last tranche o f the Cordoba provincial reform loan (PRL) could not be released despite the fact that the respective tranche conditions were met. 0 Lesson: The maintenance o f country exposure in Argentina proved not to be feasible for the Bank inthe absence o f a broad policy dialogue and an active IMF- supported program 121. The abbreviated 20 month period o f approved lending has proven to be sub- optimal with respect to the development o f the investment project pipeline. Inthe period 2004-05, Bank staff was able to develop new projects in sectors where there were ongoing operations. The operational strategy was adapted to make use o f the APL as an instrument that enables the Bank to work within the limited resource envelope corresponding to a short period o f lending authorization and where the sector framework i s incomplete. 0 Lesson: For the Bank to build up a strong project pipeline it needs to adopt a medium term perspective and to work on a broad front with multiple initiatives. Implicit inthis i s a CAS envelope o f sufficient size and forward vision that would allow for longer-term planning on the part o f the Bank and the Government. The APL instrument has proved to be an effective tool for operating under a constrained CAS envelope and for managing risks when the sector policy framework i s incomplete. 122. The Government's project implementation capacity remains limited. This raises difficulties for the Bank, particularly inthe context o f an investment led strategy inwhich the portfolio o f investmentprojects is being almost completely rebuilt. It could also lead to potential problems with respect to sustaining an appropriate pace o f disbursements. 0 Lesson: The Bank should work with the Government to improve its project implementation capacity. Efforts should be made to integrate enclave project implementation units (PIUs) into regular line units within the Government. There has beensome good progress inthis area. 123. The CAS identified a number o f "exceptional risks" at the country and operational level, including political and systemic risks. It concluded that the fiduciary framework was sound but, in the event, the framework has not been well implemented. As a result, the operational environment o f the Bank-supported program shifted from moderately riskyto highrisk. 0 Lesson: The Bank should continue to focus on systemic issues o f governance and structural challenges in Argentina to the extent permitted by the country dialogue. 182 Annex L Argentina:CAS CompletionReport At the same time it should develop a specific strategy and actionplanto maintain the fiduciary integrity o f Bank-supported projects. 124. Another source o f uncertainty during 2004-05 has beenthe lack of a clear medium- term economic strategy on the part of the Government. In the absence o f a medium-tern perspective, it i s unclear whether the strong economic performance o f the past two years can serve as a guide to fbture growth. The experience o f 2004-05 vindicates the view expressed inthe 2004 CAS (page iiiof Executive Summary) that "Although the situation in Argentina has stabilized in many respects, there still remain many risks and uncertainties. Close monitoring and reporting of progress - and problems - has therefore been built into the proposed program 0 Lesson: The Bank's post-crisis program should be performance-driven in the medium-term. It should focus on those areas where the policy framework and the operational environment, including governance, permit progress and it should continue to provide for the close monitoring andreporting o fprogress. 183 E% Y m 8 e e -x -8e e e e .I m m sEl 0 (d - h ir! z * * .I X 2 Y L 8 E m -A .I cp 0 Y 0 a a a a a a . . * . . * . e e e e e e e e e -r .L v) s a a a a a a a . X .I 3 c, L . e m .. E .I c, 4 3P . 8 8 0 . 8 . . . 8 8 . 0 *-L x 5!E Y U 5 * . '3 B E AttachmentL2 Comparisonof programmedand actuallending2004-05 Program' 1 I I I(million) US$ Project Product envisaged in 2004 CAS (million) Status of Delivery as of Nov. 2005 Mid FYOI-Mid FY06 i Economic Recovery Support 500 Approved June 2004 I 500 Adjustment -- SAL/pms t.b.d. None r-- Maternal-Child HealthAPLl Maternal-Child Health APL 1 135 Approved April 2004 National Highway Management National Highway Asset Management 200 Province Bs.As. Infrastructure Province o fBs.As.Infrastructure UrbanFloodPrev. & Drainage APL 1 ........................ ......... ! ProvincialRoads I1 Approved June 2005 ................................. Institutional Strengthening- ANSES I1 25 Approved July 2005 Subnational Gov. Public Sector 40 Modernization Board Presentation December 2005 Rural Education Improvement Loan 150 Investment II ................................. 1,500 Board Presentation December 2005 I Governance 21 25 Board Presentation January 2006 ................................. Solid Waste Management 50 - Board Presentation February 2006 Floodand Drainage UrbanFloodPrev & Drainage APL 2 70 Infrastructure. Board Presentation February 2006 - Social Protection Heads o f Household Transition Project 350 Board Presentation February 2006 - Municipal Services and Basic Municipal Services Project 75 Infrastructure Under New CAS - Board Presentation March 2006 Mining Decontamination 25 Under New CAS - Board Presentation April 2006 - Water Resources Management Under new CAS I 200 Board presentation 2007 TOTAL 2,000 I 1,955 197 AttachmentL3 Comparisonof programmedand actualAAA 2004-05 and Infrastructure Concessions Products envisaged in 2004 CAS Status of delivery as of Oct. 2005 Social Polic Incorporated into Policy Notes follow-up Comdeted Comdeted I Completed Completed - Study entitled "Seeking Sustained Growth & Social Eauitv" Investment Climate ... Rural Sector Strategy Social Security OldAge Welfare and Social Security Study Draft under review (completion scheduled for January 2006) FSAP Under N e w CAS (FY07) Provincial Finances Federal-Provincial Fiscal Relations - I Under N e w CAS (FY07) Environmental Strategy Prog. DPRAgriculture & Environment - Competitiveness (CEM) Combined into Growth & Equity study Agricultural Finance & Growth Combined into Rural Sector Strategy Transport Sector Strategy Programmed- Two studies: Infrastructure Finance and Logistics & Transport Competitiveness (FY06) Poverty Assessment Programmed- Prog. Poverty I(FY06) HD Strategy Programmed- Building Inclusive Social Policies (FY07) Social Inclusion (youth) Programmed (FY07) CFAMCPAR Programmed(FY07) Policy Notes Programmed(FY08) PER Programmed (FY08) EducationReview N o t included under new CAS 198 CAS Annex A2 Argentina at a glance 4/14/06 Latin Upper- POVERTYand SOCIAL America middle- Argentina &Carib. income 2004 Developmentdiamond* Population,mid-year (milllons) 38.2 541.3 675.9 GNi per capita (Atlas method, US$) 3,720 3,600 4,770 GNi (Atlas method, US$ billions) 142 1,948 2,748 Life expectancy Average annual growth, 1997-2004 T Population (%) 0.9 1.5 0.8 Laborforce (%) 1.9 2.1 1.4 Gross Most recent estimate (latest year available, 1995-2005) Poverty(% ofpopulationbelownationalpoverfylinej 34 capita enrollment Urbanpopulation (% of totalpopulation) 90 77 72 Life expectancyat birth (years) 74 71 69 1 infant mortality (per 1,000 livebirths) 17 28 24 Child malnutrition (% ofchildren under5) 5 9 9 Access to safe water Access to safewater (% ofpopulafion) 94 86 87 Illiteracy(% ofpopulation age 75+) 97 89 94 Gross primaryenrollment (% of school-agepopulation) 119 122 106 Argentina Male 120 124 108 Female 119 121 106 __Upper-middle-incomegroup KEY ECONOMIC RATIOSand LONG-TERMTRENDS 1984 1994 2004 2005 iconomic ratios' GDP (US$ billions) 79.1 257.4 153.1 183.3 Gross domestic investmentlGDP 20.0 19.9 19.2 21.5 Exportsof goods and services/GDP 7.6 7.5 25.3 24.6 Trade Gross domestic savings/GDP 22.8 16.9 26.3 27.0 - Gross nationalsavingslGDP 15.7 20.8 24.0 Currentaccount balanceiGDP -3.2 -4.3 2.1 2.9 interest payments/GDP 5.8 1.5 6.4 3.6 Total debtJGDP 61.8 29.2 113.1 79.6 Total debt service/exports 63.4 25.3 27.1 12.0 Presentvalue of debtlGDP Presentvalue of debtlexports 1984-94 198444 2004 2005e 2005-08 Indebtedness (avgannualgrowfhj GDP 2.4 0.3 9.0 9.2 5.0 Argentina GDP per capita 1.1 -1.0 7.8 8.0 3.8 -Upper-middle-incomegroup Exportsof goods and services 5.3 5.9 8.1 13.8 8.0 I STRUCTUREof the ECONOMY 1984 1994 2004 Growth of Investment and GDP (X) II (% of GDP) Agriculture 8.3 5.5 10.4 Industry 397 29 2 356 3 5 6 I 4 O - Manufacturing 297 195 24 1 232 l z ; Services 51 9 653 540 550 -20 Privateconsumption 69 8 626 61 1 -40 Generalgovernmentconsumption 13 5 11 1 11 9 - 6 0 1 importsof goods and services 4 6 9 3 182 19 1 GDi *GDP II 1984-94 1994-04 2004 2005 (average annualgrowfh) Growth Rate of Exports and Agriculture 1 9 1 7 Imports (%) industry 1 6 -04 134 Manufacturing 1 3 -08 12 0 Services 2 5 0 7 6 8 Privateconsumption -0 2 8 7 Generalgovernmentconsumption 0 8 2 7 6 2 1 .-- -50 Gross domestic investment 3 3 -32 344 227 A Importsof goods and Sewices 138 -25 40 1 203 Exports *imports * The diamondsshowfour key indicatorsin the country(in bold)comparedwith its incomegroup average. if data are missing, the diamond will be incomplete. 199 PRICESand GOVERNMENTFINANCE 1984 1994 2004 2005 Domestic prices (% change) Consumerprices 626.7 -100.0 4.4 9.6 implicitGDP deflator 606.7 2.8 9.2 8.9 Governmentflnance (% of GDP,includescurrentgrants) Current revenue 20.4 16.8 23.4 23.7 Current budgetbalance (cash basis) -3.1 2.6 3.9 3.6 Overall surpius/deficit(cash basis) -5.7 1.6 2.6 1.8 n"'*GDPdeflator *CPi I TRADE 1983 1993 2004 2005 (US$millions) Exports and imports Total exports (fob) 13,269 34,550 40,013 (million USS) Food 1,454 3,058 3,541 45,000 7 Meat 748 1,228 1,422 Manufactures 8,803 16,044 21,039 35,000 Total imports(ci0 16,783 22,445 28,692 Food 25,000 Fueland energy 1,003 1,543 15,000 Capita goods 5,331 7,092 Export price index (1993=100) 5,000 100 109 109 import price index (1993=100) 100 94 98 99 00 01 02 03 04 058 Terms of trade (1993=100) 100 116 imports 111 0Exports BALANCEof PAYMENTS 1984 1994 2004 2005 (US$ millions) Current Account BalancelGDP (%) Exportsof goods and services 9,607 19,387 39,764 48,356 imports of goodsand services 5,961 27,305 28,191 35,308 Resourcebalance 3,646 -7,918 11.573 11,048 loT Net income -6,143 -3,559 -8,923 -6,312 Net current transfers 627 671 Currentaccountbalance -2,497 .10,979 3,277 5,407 Financing items(net) 2,489 10,979 -8,597 -13,645 Changesin net reserves 28 0 5,320 8,436 Memo: Reserves includinggold (US$ miiiions) 1,243 14,327 18,664 18,684 Conversionrate (DEC, /ocal/US$) 0.0 1.o 2.9 2.9 EXTERNALDEBT and RESOURCE FLOWS t984 t994 2004 2005 (US$ millions) Total debtoutstandingand disbursed 48,857 75,139 171,115 Composition of Total Debt 117,210 iBRD 503 4,109 7.447 6,681 (US$ m.) IDA Total debtservice 6,281 5.771 14,518 7,420 IBRD 132 709 1,066 1,216 iDA 0 0 Compositionof net resourceflows Official grants 5 16 0 0 Official creditors -22 731 -2,269 -5,459 Privatecreditors 14 6,464 -1,612 2,567 Foreigndirect investment 266 3,635 3,923 2,963 Portfoiio equity 0 3,116 -41 -91 World Bank program Commitments 100 1,590 1,036 495 F: 88,714 Disbursements 70 1,507 770 362 Principal repayments 40 334 832 928 A . IBRD E. Bilateral Net flows 30 1,173 -61 -586 B. IDA D Other multilateral . F Private interestpayments 36 230 230 282 C-IMF G Short-term -- Nettransfers -6 943 -291 -849 DevelopmentEconomics 200 CAS Annex 82 -Argentina Selected Indicators' of Bank Portfolio Performance and Management AS of Date 4/7/2006 Indicator I 2003 - -- -- Portfolio Assessment )varall - - inv E Inv.& ndi. ndj Overall Number of Projects Under Implementation 33 30 5 35 26 5 5 2 27 Average Implementation Period (years)b 5 3 2 4 5.3 5 5 2.2 5.3 5.8 3 2 3.6 2.0 4.9 Percent of Problem Projects by Number a 50 0 33 3 54.5 28 6 60.0 31.4 20.6 60 0 30.3 16.6 80.0 28.5 16 0 50.0 18.5 Percent of Problem Projects by Amount' 35 6 10 0 31.4 14 1 36.0 18.3 3.6 61 6 28.6 12.1 61.6 31.0 40.0 17.3 Percent of Projects at Risk by Number *" 73 3 100 0 81.8 35 7 60.0 37.1 41.7 60 0 45.5 37.5 80.0 46.4 28 0 50.0 44.4 Percent of Projectsat Risk by Amount *" 64 2 1000 87.1 26 1 36.0 30.8 19.5 61 6 37.5 23.2 61.6 41.3 249 40.0 29.2 Disbursement Ratio (Oh) 36 7 nla 36.7 40 3 nla 40.3 43.2 nla 43.2 19.2 nla 19.2 23 1 nla 23.1 Portfolio Management CPPR during the year (yeslno) Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes -------- - -- 2,527 365 2,892 2,973 306 3,279 2,491 266 2,757 3,142 464 3,606 3,142 464 3,606 75 122 76 93 61 96 85 53 67.3 92.6 88.0 67 3 92.6 88.0 Memorandum Item Since FY 80 Last Five FYS Pro) Eva1by OED by Number 80 15 Pro) Eva1by OED by Amt (US$ millions) 14,275 2 4,965 0 % of OED Projects Rated U or HU by Number 31 6 36 5 % of OED Projects Rated U or HU by Amt 42 7 69 6 a. As shown in the Annual Report on Portfolio Performance (except for current FY). b. Average age of projects in the Bank's Countryportfoiio. c. Percent of projects rated U or HU on development objectives (DO) andlor implementationprogress (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. f.*Includes funding for projects closed by December 31, 2005 and projectsto be approved by June 30, 2006. All indicators are for projects active in the Portfolio, with the exception of Disbursement Ratio. whlch inciudesail active projects as well as projects which exited duringthe fiscal year 201 CAS Annex 83 IBRD Program Summary - Argentina pa Of Date March 15,2006 Proposed IBRD Base-Case Lending Program Fiscal year Pfoj ID U W M ) Strategic Rewards lmpiementation (H/M/L) Risks (H/M/L) 25.0 AR Urban Flood Protection 8 Drainage APL 2 70.0 H Result 95.0 2007 AR ProvincialAgricultural Development(PROSAP) 30.0 H AR MiningDecontamination (PRAMU) 35.0 H AR Cordoba Provincial Development Loan 75.0 H AR Santa Fe Provincial Development Loan 125.0 H AR CatamarcaProvincial Development Loan 25.0 H AR Maternal-ChiidHealth InsuranceFunctions (APL2+3) 300.0 H AR Essential Health Functions 200.0 H AR EnvironmentManagement(APL1) 75.0 H AR ProvincialPre-Schooland Basic Education 100.0 H AR Urban Public Transport 200.0 H Result 1,165.0 2008 AR SlNTyS APL2 15.0 H AR Provincial Public Mgmt Loan (direct) 30.0 H AR National HighwayAsset Mgt (APL 2) 200.0 H AR Bs As Province Infrastructure (APL 2) 150.0 H AR income Supportfor the Poor 300.0 H AR Infrastructure(Logistics Nodeof Rosario Port) 100.0 H AR ProvincialAgricultural Development (PROSAP II) 150.0 H AR Lifelonglearning 100.0 H AR IntegratedWater Resources Management (APL 1) 100.0 H Result 1,145.0 2009 AR Provincial Roads 111 150.0 H AR Infrastructure(Freight Corridors) 200.0 H AR Environment Management(APL 2) 75.0 H AR SubnationalGovernment Public Sector Modernization II 75.0 H AR State Modernization II 25.0 H AR Int. Developmentfor Children& Community Services 90.0 H AR Innovation 150.0 H AR Basic Municipal Services II 60.0 H AR Rural Poverty& Growth 70.0 H Result 895.0 Overall Result 3,300.0 Memorandum FY10 AR IntegratedWater Resources Management (APL 2) 100.0 202 CAS Annex B3 (IFC & MIGA) for Argentina Argentina - IFCandMIGA Program,FY 2003-2006 2003 2004 2005 2006* IFC approvals (USSm) 84.00 172.50 220.50 88-00 Sector (YO) Agriculture andForestry 24 41 CollectiveInvestmentVehicles 6 Finance & Insurance 5 30 18 Food& Beverages 71 25 80 Oil, Gas andMining 57 TransportationandWarehousing 20 Wholesale andRetailTrade 23 Total 100 100 100 100 Instruments(%) Loans 100 59 84 100 Equity 23 Quasi-Equity 12 Other 6 2 Total 100 100 86 100 MIGA guarantees (USJm) 292.98 192.92 0.00 * ThroughJanuary 3 1,2006. 203 CAS Annex 84 Summary of Nonlending Services Argentina - - As of Date February 20,2006 Producf CompletionFY Cost (USSOOO) Audience' Objective Recent completions Rural Infrastructure Study FY04 209 G, D, B, P Investment Climate and PrivateSector DevelopmentReport FY04 170 G, D, B Financial Sector Study FY04 170 G, D, B Seeking Sustained Growth and Social Equity FY05 469 G, D,B, P Building a Skilled Labor Force for Sustainable and Equitable Economic Growth: Education, Training and Labor Markets FY05 176 G, D,B, P Underway Old Age Welfare & Social Security FY06 270 G, D, 8, P Rural Strategy FY06 615 G, D, B, P Programmatic Poverty I (Informality) FY06 215 G, D,B, P Logist. and Transport Sector Competitiveness FY06 170 G, D,B, P Infrastructure Finance FY06 170 G,D,B,P Institutional GonvernanceReview FY06 200 G, D, 8, P Youth at Risk FY07 170 G. D, B, P Planned Programmatic Poverty II (Rural) FY07 250 G,D,B, P Provincial Economic Memorandum I (Central Region) FY07 170 G,D,B,P Fiscal Space for Provincial Investment FY07 250 G, D,B, P CFAA (Federal Level) FY07 90 G,D, B CPAR (Federal Level) FY07 90 G, D, B ROSC FY07 90 G, D, B Programmatic Poverty 111 (Urban &Water) FYO8 250 G, D, 8, P Programmatic Social Protection (Options to Transition from Heads of Household Program) FYO8 170 G, D, B,P Provincial Economic Memorandum II (Northern Region) FYO8 170 G,D,B,P Country Environmental Analysis FYO8 170 G,D,B,P Policy Notes FYO8 400 G, D,B, P CFAA (Provincial Level) FYO8 90 G, D, B CPAR (Provincial Level) FYO8 90 G, D, B Provincial Economic Memorandum 111 (Buenos Aires) FYO9 170 G. D, B, P Impact Analysis of Reform in Education and HealthSectors FYO9 170 G,D,B,P Social Accountability FYO9 170 G,D,B,P Private Sector Development FYO9 170 G,D,B,P Energy Review FYO9 170 G,D,B,P a. Government,donor, Bank,public dissemination. b. Knowledgegeneration, publicdebate, problem-solving. 204 CAS Annex B6 Key EconomicIndicators-Argentina Page 1 of2 Indicator 1999 2000 2001 2002 2003 2004 2005 National accounts (YOof GDP) Grossdomestic product 100.0 100.0 100.0 100.0 100.0 100.0 100.0 Agriculturea 4.7 5.0 4.8 10.7 11.0 10.4 9.4 Industry' 27.8 27.6 26.6 32.0 34.7 35.6 35.6 Servicesa 67.4 67.4 68.6 57.3 54.3 54.0 55.0 Total Consumption 83.7 84.4 84.5 73.1 74.1 73.7 73.0 Grossdomestic fixed 18.0 16.2 14.2 12.0 15.1 19.2 21.5 investment Governmentinvestment 1.9 1.4 1.4 0.9 1.4 1.4 1.6 Private investment(Includesincreasein 16.1 14.8 12.8 11.1 13.7 17.8 19.9 stocks) Exports(GNFS) 9.8 10.9 11.5 27.7 25.0 25.3 24.6 Imports(GNFS) 11.5 11.5 10.2 12.8 14.2 18.2 19.1 Gross domestic savings 16.3 15.6 15.5 26.9 25.9 26.3 27.0 Gross nationalsavings ' 13.8 13.0 13.0 20.1 20.2 20.8 24.0 Memorandum items Gross domesticproduct (US$bn, currentprices) 283.5 284.2 268.7 102.0 129.6 153.1 183.3 Grossnationalincomeper 7590 7490 7020 4280 3840 3720 4200 capita (US$,Atlas method) Realannualgrowthrates(%, calculatedat 1993 prices) Grossdomesticproduct at marketprices -3.4 -0.8 -4.4 -10.9 8.8 9.0 9.2 Gross DomesticIncome -3.4 -0.8 -4.4 -10.4 8.8 9.0 9.2 Realannualpercapitagrowthrates(%, calculatedat 1993 prices) Grossdomesticproduct at marketprices -4.6 -2.0 -5.6 -12.1 7.6 7.8 8.0 Total consumption -3.8 -1.0 -5.6 -14.6 6.3 6.5 5.6 Private consumption -4.7 -1.0 -6.0 -16.2 7.6 7.5 5.7 Balance of Payments (US%m) Exports(GNFS) 28027 31277 31170 28946 34163 39764 46356 MerchandiseFOB 23309 26341 26543 25651 29939 34550 40013 Imports(GNFS) 32933 33108 27647 13358 18753 28191 35308 MerchandiseFOB 24103 23889 19158 8473 13134 21311 27300 Resourcebalance -4906 -1832 3522 15588 15410 11573 11048 Net incomeg -7491 -7548 -7237 -7484 -7970 -8923 -6312 Net currenttransfers 453 399 424 564 579 627 671 (including officialcurrent transfers) Currentaccountbalance -11944 -8981 -3291 8668 8019 3277 5407 (after official capital grants) Netprivateforeigndirect 1835 1767 -13304 -12058 -8402 317 5503 investment Long-termloans (net) 483 6073 7863 -1480 7664 2436 -2669 Official 1143 1957 11695 -3551 322 -2167 -4656 Private -660 41I 6 -3832 2070 7342 4603 1987 Othercapital (net, including 10826 701 -3351 355 -3700 -711 197 errors and omissions) Change inreserves id -1201 439 12083 4516 -3581 -5320 -8438 Memorandum items Resourcebalance(% of -1.7 -0.6 1.3 15.3 11.9 7.6 6.0 GDP at currentmarketprices) Realannualgrowthrates (1995 prices) Merchandiseexports(FOB) -0.8 2.9 4.4 -0.1 6.0 8.1 13.8 Merchandiseimports (CIF) -13.9 -0.9 -17.4 -54.1 53.4 49.6 24.2 (Continued) 205 Key EconomicIndicators Argentina (cont.) - page2 of2 Indicator 1999 2000 2001 2002 2003 2004 2005 Public finance (YOof GDP) Current revenues 19.3 19.4 18.7 17.6 20.5 23.4 23.7 Current expenditures 20.8 20.9 21.0 18.4 19.2 19.6 20.1 Current account surplus (+) -1.5 -1.5 -2.3 -0.8 1.3 3.9 3.6 or deficit (-) Capital expenditure 1.1 1.o 1.o 0.7 0.8 1.3 1.9 Foreignfinancing 3.6 2.6 -1.1 3.6 3.7 3.3 1.6 Monetary indicators M2iGDP (at current market prices) 32.6 33.9 27.8 24.6 29.9 31.8 33.6 Growth o f M 2 (%) 2.3 4.4 -22.6 3.1 45.9 26.6 25.9 Private sector credit growthitotal credit growth (7 -6.0 -1.1 -19.8 -55.7 -13.5 8.2 31.9 Price indexes ( 1993 =loo) Merchandise export price index 89.1 98.0 94.7 91.0 99.7 109.1 108.9 Merchandise import price index 92.4 92.4 89.9 86.7 87.0 93.8 98.2 Merchandise terms o ftrade index 96.4 106.1 105.3 105.0 114.6 116.3 110.9 Real exchange rate (US$LCU)f 180.00 184.72 188.30 79.71 80.95 76.93 83.63 Consumer price index (% growth rate, p.a.) -1.2 -0.9 -1.1 25.9 14.8 4.4 9.6 Consumer price index (% growth rate, e.0.p.) -1.8 -0.7 -1.5 41.0 3.7 6.1 12.3 GDP deflator (%growth rate) -1.8 1.o -1.1 30.6 10.5 9.2 9.9 a. IfGDP componentsare estimatedat factor cost, a footnoote indicatingthis fact shouldbe added.Chnagesafter 2002 partlyreflect real currency depreciation. b. "GNFS' denotes"goods and nonfactorservices." c. Includesnet unrequitedtransfersexcludingofficial capital grants. d. Includesuse of IMF resources. e. Should indicate the level of the government to which the data refer. f. "LCU" denotes"local currencyunits." An increaseinUS$/LCU denotesappreciation. g. Net Incomeincludes net interest, earnings,dividends andyieldon investment. 206 Annex B7 Key ExposureIndicators Argentina - Indicator 1999 2000 2001 2002 2003 2004 2005 Total debt outstanding and 152.6 155.0 166.3 156.7 164.6 171.1 117.2 disbursed(TDO) (US$bn)a Net disbursements(US$bn)8 4.9 2.5 11.3 -9.5 7.9 6.5 -53.9 External public debt service (TDS) 7.1 7.3 8.6 5.9 10.7 10.8 5.5 (US$bn)a Debt and debt service indicators ("h) TDO~XGS~ 544.3 495.6 533.4 541.5 481.9 430.3 252.8 TDOIGDP 53.8 54.5 61.9 166.5 127.2 113.1 66.3 TDSIXGS 25.3 23.3 27.7 20.5 31.5 27.1 12.0 ConcessionaliTDO IBRD exposure indicators (%) IBRDDSkxtemalpublic DS 48.8 57.0 42.9 49.7 87.1 28.7 30.0 Preferred creditor DSkxtemal public DS (%)b c 23.7 19.7 14.5 47.9 38.2 14.3 29.4 IBRD DSIXGS 3.5 4.0 4.5 6.5 9.8 2.7 2.6 IBRD TDO (US$m)d 8552 9034 9686 8513 7508 7447 6881 O fwhich presentvalue of 238 245 246 0 0 0 0 guarantees(US$m) Share of IBRDportfolio Yh) 7.0 7.4 8.0 7.0 6.5 6.7 6.6 IDA TDO (US$m)d 0 0 0 0 0 0 0 IFC (US$m) 1019 1196 1125 1065 1005 661 Loans 714 820 745 700 702 467 Equity and quasi-equity f 305 376 380 365 303 194 MIGA MIGA guarantees(Us$m) 438 431 590 591 270 173 54 a. Includespublic and publicly guaranteeddebt, privatenonguaranteed,use ofIMF credits andnet short- termcapital.Source: Ministryof Economyand Production, Argentina. The stock of debt hi 2005 does not includeholdoutsof the debt resbuchlringoperation that took placeduringthe fust quarterof2005 ExternalPublic Debt service in2005 excludesbondcancellationsas a result of the debt exchange. b. "XGS" denotesexportsof goods and services, includingworkers' remittances. c. Preferredcreditorsare defmed as IBRD, IDA, the regionalmultilateraldevelopment banks, the IMF, and the Bankfor InternationalSettlements. d. Excludespresent value of guarantees. e. Includesequityand quasi-equity types of both loanand equity inshlunents. 207 00 0 N CAS Annex B8 (IFC) for Argentina Argentina Statementof IFC'sHeldand DisbursedPortfolio As of 12/31/2005 (In US Dollars Millions) Held Disbursed FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic 2000 ASF 4 0 0 4.1 4 0 0 4.1 1998 AUTCL 3.95 0 0 0 3.95 0 0 0 2004 Aceitera General 50 0 20 30 50 0 20 30 1995 Acindar 1.85 0 0 0 1.85 0 0 0 1997 Acindar 3.28 0 0 1.63 3.28 0 0 1.63 1999 Acindar 6.98 0 0 0 6.98 0 0 0 1994 Aguas 18.36 0 0 13.97 18.36 0 0 13.97 1995 Aguas 18.82 0 0 44.63 18.82 0 0 44.63 2006 Arcor 70 0 0 210 70 0 0 '210 2000 BACS 0 6.25 0 0 0 6.25 0 0 2004 BACS 25 0 0 0 0 0 0 0 1999 BancoGalicia 61.78 0 0 41.17 61.78 0 0 41.17 2004 BancoGalicia 3.75 0 0 0 3.75 0 0 0 2005 BancoGalicia 40 0 0 0 5 0 0 0 1997 Bunge-Ceval 0 0 5 0 0 0 5 0 1995 CEPA 3 0 0 1.2 3 0 0 1.2 1994 EDENOR 3.75 0 15 0 3.75 0 15 0 1998 F.V. S.A. 1.5 0 4 0 1.5 0 4 0 1996 Grunbaum 2.5 0 0 3.33 2.5 0 0 3.33 Grupo Galicia 0 3.06 0 0 0 3.06 0 0 1998 HospitalPrivado 8.4 0 0 0 8.4 0 0 0 1992 Huantraico 0 27 0 0 0 0 0 0 2004 Jumbo Argentina 0 39.83 0 0 0 39.83 0 0 LDManufacturing 7.93 0 5 0 7.93 0 5 0 Milkaut 0 1.23 0 0 0 0 0 0 1997 Milkaut 5.54 0 9.81 1.49 5.54 0 9.81 1.49 1993 Molinos 0 2.46 0 0 0 2.46 0 0 1994 Molinos 0 0.71 0 0 0 0.71 0 0 2003 Molinos 0 0 0 -20 0 0 0 0 1996 NeuquenBasin 0 26.4 0 0 0 0 0 0 1999 NeuquenBasin 0 5 0 0 0 0 0 0 2006 Noble Argentina 18 0 0 1 8 0 0 0 0 1993 Nuevo Central 0 0.15 0 0 0 0.15 0 0 2005 PAE -Argentine 105.5 0 15 135 103.53 0 15 135 PCR 2.88 0 0 0 2.88 0 0 0 1998 Patagonia 1.76 0 1 0 1.76 0 1 0 1998 Patagonia Fund 0 9.22 0 0 0 2.25 0 0 1999 S.A. San Miguel 4.31 0 0 0 4.31 0 0 0 2005 S.A. San Miguel 20.08 0 0 10 9.83 0 0 5 1995 SanCor 8.83 0 20.19 0 8.83 0 20.19 0 1995 Socma 0.94 0 0 15 0.94 0 0 15 1998 Suquia 0 0 10.5 0 0 0 10.5 0 1997 T61 3.89 0 5 5.63 3.89 0 5 5.63 1997 Terminal 6 3.89 0 0 2.44 3.89 0 0 2.44 1995 Terminales Port. 1 0 0 0 1 0 0 0 1995 Tower Fund 0 -0.17 0 0 0 -0.17 0 0 2000 Tower Fund 0 1.02 0 0 0 0.17 0 0 1995 Tower FundMgr 0 0.05 0 0 0 0.05 0 0 1996 Transconor 20.29 0 17.87 157.58 20.29 0 17.87 157.58 2001 USAL 9.27 0 0 0 7.27 0 0 0 1997 Vicentin 0.94 0 0 0 0.94 0 0 0 2005 Vicentin 20 0 1 5 0 0 0 0 0 1993 Yacylec 0 2.52 0 0 0 2.52 0 0 Total Portfolio: 561.97 124.73 143.37 675.17 449.75 57.28 128.37 672.17 209 MAP SECTIOK'