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