February 14, 2000

1. The performance of the Argentine economy registered a marked improvement during the 1990's. This reflected the macroeconomic discipline required by the convertibility regime, the modernization of the productive structure engendered by the rapid growth of investment, structural reforms, and, for most of the period, a favorable international environment. The last decade also saw the consolidation of the institutions and of the democratic process in Argentina, establishing the conditions for sustainable growth.

2. However, significant disequilibria remained, which in the second half of the decade were reflected in significant volatility in the performance of the economy and contributed to a slowdown in growth. Open unemployment remained high, especially in some regions and sectors of the labor force. The public finances registered deficits throughout the last decade, reflecting ineffective tax enforcement and erosion of the tax base, significant increases and widespread inefficiencies in spending, as well as the initial fiscal cost of the social security reform. As a result, the consolidated public sector net debt rose to an estimated 45.7  percent of GDP by 1999. Although this level is not especially high in comparison with other emerging economies, its rapid growth in recent years gives cause for concern. The current account of the balance of payments also recorded rising deficits in the second half of the last decade. The underlying disequilibria in these areas were exacerbated by the difficult international environment that prevailed in the more recent years, including the Asian, Russia, and Brazil crises, the large (about 13 percentage points) deterioration of Argentina's terms of trade between 1997 and 1999, and the generalized rise in risk premia for emerging markets, which did not spare Argentina.

3. As a result of these external shocks, and of a weakening of policies, especially during the second half of the year, the performance of the Argentine economy deteriorated significantly in 1999. The decline in activity, which had already begun in the second half of 1998, in the aftermath of Russia's crisis, deepened further in the first half of last year, reflecting in particular the decline in demand from Brazil and other countries in the region and tighter financing constraints on the private sector. Although the year ended with indications of a recovery, real GDP is estimated to have declined by about 3 percent in 1999. As a result, the rate of unemployment increased to 14.5 percent by August 1999, before declining to 13.8 percent in the last quarter of the year. The recession in the economy and declines in labor costs were reflected in a 1.8 percent fall in consumer prices in 1999.

4. The significant decline in domestic demand more than offset the adverse impact on the external trade deficit of the sluggish external demand, the depreciation of the Brazilian real, and the terms of trade loss. The recession reduced the trade deficit to US$2.2 billion from nearly US$5 billion in 1998, with a surplus, albeit small, still being maintained vis-à-vis Brazil. Similarly, the current account deficit in the balance of payments narrowed to about US$12 billion (4.3 percent of GDP) in 1999 from US$14.5 billion (4.9 percent of GDP) in 1998. More than half of this deficit was financed by net foreign direct investment (FDI), which rose to a historical peak, and a significant part of private sector financing reflected intercompany loans. Nevertheless, the total external debt (excluding amounts preborrowed and the collateral on Brady bonds) continued to increase, to the equivalent of about 51 percent of GDP, with only 15 percent of this debt in original maturities below one year. On the other hand, the Argentine private sector is estimated to hold financial assets abroad equivalent to some 30 percent of GDP. The gross international reserves of the Central Bank amount to around US$26 billion, covering nearly 100 percent of the monetary liabilities of the Central Bank, and additionally, the banks have a large position in liquid foreign assets.

5. The public finances deteriorated significantly in 1999, reflecting the economic downturn, a further weakening of tax compliance, increased interest payments, and overruns in primary expenditures. As a result, and despite higher than expected revenues from concessions (amounting to 0.6 percent of GDP), the federal government deficit widened to 2.5 percent of GDP in 1999 (2.7 percent, including the deficit of the health service for retirees, PAMI), from 1.3 percent of GDP in 1998, while the consolidated deficit of the provincial governments rose to an estimated 1.3 percent of GDP, from 0.8 percent of GDP in 1998. The total debt of the provinces has risen significantly in recent years, exceeding by 1999 the equivalent of 7 percent of GDP, and its service burden is projected to absorb nearly 13 percent of their combined revenues. In some highly indebted provinces, the debt service burden exceeds 30 percent of their revenues.

6. The banking system maintained the sound conditions achieved during the latter part of the 1990s and was well positioned to withstand the tightening of external financing conditions in 1999. Notwithstanding the domestic recession and the difficult external environment, deposits in the banking system continued to grow in 1999, albeit at a slower pace than in previous years. Argentine banks maintained a cautious lending policy, and raised their holdings of liquid assets to levels well in excess of mandatory liquidity requirements. Nevertheless, the more difficult financing environment and the downturn in economic activity exerted some pressure on the quality of banks' assets. Nonperforming loans rose from 10.3 percent of total risk assets in December 1998 to 11.5 percent of total risk assets in November 1999 (from 4.0 to 4.7 percent net of provisions). The banking system remains, nevertheless, well capitalized, with the capital adequacy ratio (Basle criteria) slightly exceeding 20 percent at end-1999.

7. The new government which took office in December 1999, following a democratic and responsible transition, from the beginning demonstrated its awareness of the difficulties and challenges facing it, and its firm determination to address them quickly and decisively, seeking a broad-based social and political support for this effort. The government is also seeking the support of the international financial community, and in particular of the IMF, through a three-year stand-by arrangement.

8. The government sees as its foremost priority to create the conditions for the sustainable recovery of economic activity that is needed to reduce unemployment and poverty in a lasting manner, with continued price stability. These conditions include a sustained increase in national savings, to finance the needed growth of investment without further raising the external debt burden on the economy; and a progressive improvement of the international competitiveness of local production, within the framework of the convertibility regime to which the government is fully committed. Competitiveness will be strengthened by continued moderation of costs and prices, productivity gains, wide-ranging structural reforms--especially in the labor market, the education and health systems, and the financial system--and by increased competition, as a result of improvements in the regulatory framework.

9. The government believes that a firm implementation of the policies outlined in the paragraphs below will boost confidence both at home and abroad, contributing to increased availability and lower costs of financing for Argentine borrowers. This will enable Argentina to benefit fully in 2000 and beyond from the recovery in foreign demand and improved outlook for its export prices. The government is confident, therefore, that the Argentine economy will record a sustained recovery in 2000, and the official forecast is for real GDP growth of 4 percent. Nevertheless, to strengthen confidence in the feasibility of the targets specified in the program for which the government is seeking the Fund's support, this program is based on a more conservative assumption of real GDP growth of around 3½ percent in 2000. In the absence of adverse external shocks, real GDP growth could average at least 4 percent in the subsequent years. These rates of GDP growth, in conjunction with the elimination of long-standing rigidities in the labor market that is being sought through the reform of the labor legislation outlined below, are expected to lead in the years ahead to a sustained rise of employment, and a significant decline of unemployment.

10. The adverse impact on the external accounts of the rebound in imports that is foreseen to accompany the economic recovery in 2000 and beyond, should be largely offset by the response of exports to the projected more favorable external environment--including renewed growth and some real exchange rate appreciation in Brazil and a pickup in world trade--and the improvement in the competitiveness of Argentine products. The terms of trade are also expected to benefit from the strength of oil prices and the incipient recovery of other commodity prices. The trade deficit is, therefore, expected to decline gradually during the program period, partly offsetting the foreseeable continued increase in net interest payments abroad. Accordingly, the current account deficit in the balance of payments is projected to rise only modestly in relation to GDP, to around 4½ percent of GDP. FDI is projected to continue to cover 40 percent to 50 percent of this deficit. The total external debt is expected to stabilize in relation to GDP during the program period, and to decline gradually thereafter.

11. The government is fully committed to a sustained effort of fiscal consolidation and structural improvement in the public sector finances, which it views as necessary to reduce the growing burden of the public debt on the Argentine economy and on its growth potential. Faced with the substantial deterioration of the public sector finances in 1999, and the risk of a further worsening in 2000 in the absence of early and decisive corrective action, the federal government has moved quickly to strengthen the initial budget proposal for 2000 through selective cutbacks in spending, and has secured the rapid passage by Congress of a package of tax measures, designed to yield Arg$2 billion (0.7 percent of GDP) this year. The tax package includes rate increases affecting the income, excises, fuels, and personal wealth taxes, and a broadening of the base of the value-added and income taxes. Additionally, the government halted the granting of new benefits under long-standing and costly tax incentives regimes for industry and agriculture, and adopted new measures to speed up tax collections. In designing the tax package, the government has endeavored to minimize its impact on the lower income groups and to eliminate distortions. The government has also decided to limit the planned reduction of employer contributions to the social security system to net additions to employment. The government and the provinces have also agreed to a "federal commitment" (compromiso federal) that sets federal transfers to the provinces in 2000 and 2001 at levels below those that would have been implied by the current rules of the revenue sharing system, and specifies other commitments in regards to the reduction in the provinces' expenditures.

12. As a result of these steps, the government is confident that it will be able to contain the federal deficit (including the deficit of PAMI) in 2000 to Arg$4.7 billion (1.6 percent of GDP), in line with the requirements of the fiscal responsibility law enacted in 1999. The government is also committed to reducing the deficit further in 2001 and 2002, reaching equilibrium by 2003, at the latest, as required by the same law. In particular, in 2001 it will seek to limit the federal deficit to under 1 percent of GDP. Given the expected disappearance in 2001 of some temporary factors which are boosting revenues this year, achievement of next year's target will require strong and successful efforts to improve tax compliance, broaden the tax base, streamline the federal administration, and reduce inefficiency and waste in public spending, as outlined below.

13. The government is giving high priority to securing a substantial improvement in tax compliance by reducing tax arrears, avoidance, and evasion. For these purposes, the government: (a) is continuing efforts to strengthen the operational capabilities of the tax and customs administration, including by increasing flexibility in its manpower utilization; (b) has already sent to Congress bills to speed up the judicial treatment of tax cases, including the establishment of a specialized branch of the judiciary to deal with such cases, and of special national and regional secretariats within the court system to handle the collection of tax arrears; (c) has introduced a program to facilitate the payment of arrears on taxes and social security contributions accrued until October 1999 over a period of up to 60 months with no penalty and at an average interest rate of 10 percent, while at the same time, to reduce moral hazard, it has announced the elimination of other existing forms of tax forbearance; and (d) has sent recently to Congress a bill requiring payments larger than Arg$10,000 to be made through bank instruments, rather than in cash.

14. The effort to contain federal spending in 2000 and beyond will center on streamlining the civil service, including in decentralized entities, and on improving cost effectiveness in the delivery of public services. For this purpose, the government has already eliminated a sizeable number of national secretariats; has implemented significant cuts in personnel with temporary contracts, which had grown rapidly, especially in 1999; and is planning a voluntary separation program and a wide-ranging elimination of existing vacancies. As part of the recently submitted "fiscal emergency" law, it is seeking legal powers to facilitate the redeployment of civil servants. A thorough effort has been initiated within each ministry, under the direction of the Vice-President's office, to identify overlapping spending programs, with a view to eliminating duplication of efforts and reducing costs. The government intends to provide public managers greater responsibility in the allocation of their budgeted resources, together with strengthened accountability for results, and for this purpose intends to improve the available indicators of efficiency and effectiveness of spending programs, building on best international practices in this area. The government is also fully committed to eradicating corruption, increasing transparency and accountability of procurement practices. For this purpose, it is seeking a wide-ranging renegotiation of contracts with its suppliers, and intends to present a new modern federal procurement law.

15. The government intends to introduce in the next few months a new reform of the social security system aimed at improving the intertemporal solvency of the system. This reform will center on measures to, on the one hand, reduce the prospective deficit of the public (defined-benefits) component of the system, and, on the other hand, increase competition and promote efficiency in the private (defined-contributions) component of it. The steps that the government intends to take to this effect include: (a) increasing gradually over the next ten years the retirement age for women (currently 60 years); (b) seeking to align more closely the contributive base for the self-employed to their actual incomes; (c) reforming the remaining special pension regimes for selected categories of public employees, with a view to improving equity and reducing their cost to the budget, and (d) strengthening the regulatory framework and oversight for the private pension plans (AFJPs), to promote a reduction in the operating costs of the latter and ensure their long term solvency.

16. In the health area, the government intends to promote the consolidation of existing union-run health organizations, many of which are experiencing financial difficulties, and to stimulate efficiency by fostering more effective competition among the remaining ones, and between them and the private HMOs, following a strengthening of the regulatory and supervisory framework for the latter. As concerns the PAMI--the financial situation and quality of service of which has deteriorated sharply in recent years, requiring emergency federal intervention--the government is committed to enacting quickly comprehensive reforms aimed at ensuring its financial viability and improving the quality and cost effectiveness of its services. As first steps in that direction, the government has required the immediate renegotiation of all contracts with suppliers, reducing unnecessary intermediation, and has cut back significantly non-tenured personnel in the entity. It is also analyzing how best to integrate the PAMI with the rest of the health system as from next year. To promote transparency, the government intends to re-incorporate the operations of PAMI into the federal budget for 2001.

17. The government is seriously concerned about the substantial deterioration of the provincial finances, especially in 1999, and is committed to seeking a sustained improvement in these finances, with full respect of the constitutional autonomy of the provinces. For this purpose, in the context of the "compromiso federal" mentioned in paragraph 11 above, it has secured the agreement of the provinces to enact quickly provincial fiscal responsibility laws, modeled on the federal one, that would ensure a progressive elimination of their budgetary deficits, through the containment of expenditures, improvements in tax enforcement, and increased transparency in their budgetary accounts. A number of highly indebted provinces have already moved to enact fiscal emergency laws, enabling them to cut back excessive payroll and other spending. Other provinces have introduced various revenue-raising measures. The government intends to condition its support of the restructuring of the debt of highly indebted provinces on the latter's agreement for specific and monitorable programs of fiscal adjustment. It will also utilize its authority to approve the resort by provinces to financing in foreign currency (including financing by multilateral organizations), to ensure that new financing is consistent with a sustained decline of provincial deficits in 2000 and beyond. For this purpose, the program establishes indicative ceilings on the consolidated deficit of the provinces equivalent to 0.8 percent of GDP in 2000, 0.5 percent of GDP in 2001 and about 0.3 percent of GDP in 2002. In addition, the program sets a performance criterion for December 2000 for the net change during the year in the debt of the consolidated public sector, including the provinces' debt with commercial banks and that denominated in foreign currency. The existing system of monitoring of various forms of recourse by the provinces to foreign and domestic financing will be rapidly improved, to permit a timely monitoring of compliance with the program targets.

18. The government recognizes the need to reach early agreement with the provinces on a lasting reform of the revenue sharing system to become effective after the expiration of the "compromiso federal" at the end of 2001. This reform of the system will aim, among other things, at simplifying the existing rules by determining tax shares in relation to the total tax revenue excluding import taxes--instead of in relation to individual tax categories, as in the current system--and at smoothing the impact of cyclical fluctuations in the tax base on provincial revenues (e.g., by utilizing a moving average of federal revenues as the base for the calculation of the annual federal transfers to the provinces). The reform of intergovernmental fiscal relations will also focus on the need for broadening the base, and increasing the effectiveness of provincial tax systems.

19. The successful implementation of the fiscal consolidation programs for the federal government and the provinces outlined above should allow a gradual reduction of the ratio of the public debt to GDP during the program period, even after the payment or securitization of government liabilities related to court rulings or to pending court challenges. In order to correctly assess the extent of these liabilities, and facilitate an appropriate defense of the public interest in pending court cases, the fiscal emergency bill recently submitted to Congress calls for a temporary suspension of such cases.

20. The main objectives of the government's debt management policy during the program period are to smooth and lengthen the maturity profile of the debt, minimize its cost through active liability management, and promote the development of the domestic capital market. An active and transparent dialogue will continue to be carried out with market participants, both at home and abroad, to keep them informed of the government's financing plans as they evolve during the year. It is the authorities' intention to increase, as market conditions permit, the average size of government bond issues, in order to increase their liquidity, and also to maintain an adequate pre-financing cushion. Recourse to short-term financing will continue to be limited, in line with the ceilings established in the program. The government intends to continue the sale of its assets, including remaining shares in privatized financial institutions and enterprises in the energy sector, as well as selected real estate in its patrimony. In 2000, these operations are expected to yield Arg$700 million (0.2 percent of GDP).

21. Financial policies will continue to aim at buttressing confidence in the domestic banking system, and creating the conditions for further monetization of the economy and an adequate flow of credit to private sector. The Central Bank (BCRA) intends to keep the coverage of private sector bank deposits with liquid foreign assets at around 35 percent. The strong liquidity position of banks and the continued repurchase of outstanding Fund credit will allow the BCRA to continue reducing its net domestic assets, which are targeted to decline by Arg$1,080 million in 2000.

22. In the area of financial reform, the government intends to seek early approval of proposed changes to the BCRA Charter, to strengthen the ability of the latter to deal with potential troubled financial institutions. The BCRA is reviewing the banking regulatory and prudential framework in order to assess its consistency with international standards and best practices in this area. It is also continuing its efforts to strengthen bank supervision further through cooperation agreements with supervisors in main industrial countries and other relevant financial markets, and through appropriate training of its personnel. A system to provide early warning of changes in terms and conditions of access by commercial banks to external credit lines has been in place since late 1999, and is being further improved. The government will present legislation to allow the transformation of the Banco Nación into a state-owned corporation, to increase the transparency of its operations, and to limit its exposure to individual debtors who have not received adequate credit ratings. Steps also are being taken to ensure that the loan portfolio of the Banco Nación is adequately provisioned, and the bank is sufficiently capitalized. To promote the development of the domestic capital market, the government has set up an interagency committee to review the regulatory framework for banks and nonbank financial intermediaries, with a view better to coordinate and modernize them. It is also seeking to reduce systemic risk and improve the microstructure of the financial system, in particular the trading and settlements systems for securities.

23. In the labor market area, the government considers it necessary to modify the legal and regulatory framework, so as to promote a smooth adaptation of this market to changing patterns of demand and production, and to create the incentives to reduce informality and precariousness in employment. For this purpose the government has recently sent to Congress a new labor legislation reform bill proposing: (a) the gradual elimination over a two-year period of the "ultractividad" clause which extends indefinitely expired labor contracts, in the absence of the parties' agreement on a new contract; (b) a decentralization of labor negotiations, granting contracts at the enterprise level legal predominance over sectoral level agreements; (c) the creation of arbitration and mediation services; (d) allowing for the negotiated modification of labor agreements in cases where the economic stability of the firm is threatened; (e) an extension of the probation period for newly recruited workers to six months; and (f) steps to streamline labor registration procedures and modify the existing presumptive taxation system for microenterprises, to extend it to sectors (such as low-income self-employed, and domestic workers), which are currently characterized by high degrees of informality.

24. The government regards the promotion of competition in domestic markets, especially in the services sector, as crucial to improve efficiency, consumer welfare, and ultimately the competitiveness of the economy. For this purpose, it has already taken the following steps: (a) the creation of a national secretariat for the defense of competition and of consumers; (b) the issuance of implementing regulations for the existing antitrust and antimonopoly law; (c) the proposal to Congress of a framework law for the federal regulatory agencies; and (d) negotiations with providers of services, e.g., in the telecommunications and energy sectors, which currently enjoy market dominant positions, to secure a reduction of tariffs.

25. The government also intends to continue an open trade policy both on a multilateral basis and within Mercosur. With respect to the latter, where trade relations have been affected by the sharp depreciation of the real in 1999, the government is placing increased emphasis on institutionalizing mechanisms for the resolution of trade disputes, and on securing greater macroeconomic convergence, through an improved policy dialogue. In this context, the Argentine and Brazilian governments have recently agreed to a comprehensive independent review of investment subsidies, particularly in the sensitive automotive sector, with a view to leveling as much as possible the playing field and eliminating distortions.

This memorandum presents a detailed definition of the variables included in the quantitative performance criteria table annexed to the Policy Memorandum.

I.  Cumulative balance of the Federal Government. This balance comprises the result of the Federal Government (including PAMI, and excluding transfers of profits from the Central Bank and privatization receipts) and the result of the Central Bank (BCRA). The Federal Government result will be measured from below the line on the basis of: (a) debt information provided by public sector debt reporting system (SIGADE), including all short-term debt of the Federal Government; (b) net asset transactions of the Federal Government as reported by the Secretaria de Hacienda, the Dirección Nacional de Cuentas Internacionales (DNCI), and the Gerencia de Manejo de Reservas Internacionales of the BCRA; and (c) information on bank borrowing and bank deposits provided by the BCRA. The result of the BCRA is defined as interest earnings on gross international reserves (as defined below) plus interest on government bond holdings of the BCRA minus net interest paid on reverse repos.

II.  Cumulative ceiling on primary expenditures of the Federal Government. This ceiling applies to the noninterest expenditure of the Federal Government.

III.  Cumulative balance of the provinces. This balance comprises the consolidated result of the provinces, including the city of Buenos Aires. The result of these jurisdictions will be measured from above the line, with expenditure defined on an accrual basis, according to the information provided by the Sub-Secretaria de Programación Regional (SSPR). This limit will be indicative.

IV.  Cumulative change in the debt of the Federal Government. This debt includes all foreign currency denominated and Argentine peso denominated debt obligations and guarantees of the federal government (including public enterprises, PAMI, Inder, and trust funds). These debt obligations are defined to include those with local and foreign financial institutions, international organizations, bonds, and bridge loans. This limit will be adjusted: (a) downward (upward) for excesses (shortfalls) in privatization receipts relative to the program; (b) upward for amounts related to the restructuring of provincial debt by up to Arg$1.2 billion; (c) upward for debt issued in 2000 for the consolidation of past obligations by up to Arg$1.7 billion, plus debt consolidated by Inder; (d) downward by the net effect of debt cancellations or swaps, and (e) upward for debt issued to finance the Fiscal Stabilization Fund by up to US$385 million in 2000, (f) upward for borrowing up to US$1.3 billion from multilateral agencies on behalf of provinces and official banks (deuda indirecta) in 2000, and (g) with regard to the position in December 2000, upward for borrowing up to US$4 billion related to 2001 financing requirements and deposited at the BCRA. The data used to monitor debt developments will be taken from SIGADE, including all short term debt of the Federal Government. The stock of debt will be valued at end-1999 exchange rates and measured at end-period.

V.  Cumulative change in short-term debt of the Federal Government. It includes all domestic and foreign federal and federally guaranteed debt with an original maturity of one year or less.

VI.  Cumulative change in the debt of the Consolidated Public Sector. This debt includes the sum of the changes in the debt of the Federal Government as defined in IV. above (including the corresponding adjustments) and that of the provincial governments and the city of Buenos Aires, net of changes in intergovernmental debt. The debt of the provincial governments and city of Buenos Aires, will be defined to include obligations to local and foreign financial institutions, to international organizations, and bonds (excluding peso denominated bonds placed outside the financial system). The limit on this provincial debt will be adjusted: (a) downward (upward) for excesses (shortfalls) in privatization receipts relative to the program, and (b) upward (downward) for any increase (decrease) in net deposits of the provinces in the banking system during the year. The upward adjustment on account of an increase in net deposits of the provinces, which allows for over-borrowing, will be limited to Arg$1 billion. The data used to monitor provincial debt will be provided by the SSPR, the SIGADE and the Central Bank. The stock of debt will be valued at end-1999 exchange rates and measured at end-period. This limit will be indicative for the third quarter of 2000 and binding thereafter.

VII.  The net domestic assets (NDA) of the BCRA are defined as the difference between monetary liabilities and net international reserves (NIR) of the BCRA, both measured on the basis of end-of-period data. The monetary liabilities include currency issued, legal bank reserves, liquidity requirements (reverse repos) and public sector deposits (government and Anses) at the BCRA. NIR is defined as gross liquid international reserves of the BCRA less foreign liabilities, and will be valued at exchange rates of December 31, 1999. Gross liquid international reserves include BCRA holdings of gold, SDR's, foreign currency in the form of cash, deposits abroad, and government securities of investment grade of OECD countries and Argentina's net cash balance within the Latin America Trade Clearing System (ALADI), excluding the accounting effects on holdings of reverse repo operations. This definition of reserves excludes central bank holdings of government bonds. Liabilities to the IMF will be valued at US$1.37 per SDR. The limit on net domestic assets will be adjusted upward by the equivalent of purchases from the IMF under the arrangement. Also, the limit for December 2000 will be adjusted upward for up to Arg$200 million on account of temporary liquidity needs reflected in an equivalent increase in repos (pases activos).