1. From 1996 to the first half of 1998 the Argentine economy experienced rapid GDP growth in a context of price stability. More recently, however, the economy has not escaped the contagion from the Russian debt crisis, and has come under pressure. Reduced international capital inflows, combined with an increase in local interest rates and a decline in asset prices, contributed to weaken domestic demand which, together with a drop in exports, led to a decline (seasonally adjusted) in real GDP in the second half of the year. Nonetheless, for the year as a whole, real GDP is still expected to have shown positive growth of about 4 1/2 percent. The rate of unemployment fell further to 12.4 percent in October, 1998, and consumer price inflation has continued below 1 percent per year. Import growth has decelerated in recent months; however, reflecting mainly a marked deterioration in the terms of trade, the trade deficit is expected to increase to US$6 billion in 1998, resulting in a current account deficit of the balance of payments of around 4.5 percent of GDP. Notwithstanding the crisis, the growth of deposits and the buildup of international reserves continued in the second half of the year, albeit at a much reduced pace, and the stock of international reserves, including liquidity requirements held abroad, increased to US$31.7 billion at the end of 1998 from under US$30 billion at the end of 1997.

2. Macroeconomic policies have been kept broadly in line with the program for 1998, and all program targets through September were met. However, the increased pressures that have emerged in recent months, including the slowdown in economic activity, may have resulted in a small deviation in two of the end year targets. The federal government deficit, estimated at Arg$3,850 million in 1998 (1.1 percent of GDP), may have exceeded the program ceiling by about Arg$350 million or around 0.1 percent of GDP. Efforts were made to contain expenditure; in fact, discretionary primary expenditure is estimated to be around Arg$1.5 billion below the program ceiling for 1998, notwithstanding sizable additional costs associated with floods brought about by the El Niño phenomenon. These efforts, however, could not compensate fully for a revenue shortfall that reflected mainly arrears in the payment of VAT, an acceleration of tax refunds in the first half of the year, a larger than anticipated shift of contributors from the public to the private pension system, and delays in the leasing of telecommunications frequencies. The aggregate provincial deficit is estimated also to have exceeded the indicative ceiling envisaged in the program by some 0.2 percent of GDP, reflecting the combined effects of the tax revenue shortfall and higher than programmed expenditures by some provinces. Despite these deviations, the program ceilings on the growth of total and short term public debt for 1998 were met with some margin as, in the context of tighter conditions in international capital markets, a larger than anticipated share of the deficit was financed by a run down of public sector deposits and receipts from asset sales. The ceiling on the expansion of the net domestic assets of the central bank also was met.

3.  As regards structural policies in the fiscal area, the tax reform was approved largely as proposed. This reform will permit a broadening of the taxable base of the VAT, the introduction of a minimum corporate income tax based on firms' assets, improved transfer-pricing rules for tax purposes, and new rules for the deductibility of interest costs from the income tax. The provinces and the federal government have agreed to limit the coparticipation of the yield of the reform of the various taxes, to provide room for the reduction of employers' social security contributions. At the same time, steps have been taken to strengthen tax administration through the introduction of pre-shipment inspection of imports, improvement in tax audit procedures, upgrading of the information system of the Federal Administration of Public Revenue (AFIP), the introduction of a single presumptive tax (monotributo), a tightening of controls on the printing of VAT invoices, and the speeding up of the resolution of court cases in the area of tax enforcement.

4.  Measures were taken to improve further the public expenditure management information system, and to promote cost effectiveness in public expenditure programs. A Public Ethics Office was set up and a new code of ethics of public employees was drafted. With assistance from the World Bank and the IDB, measures were adopted to improve the efficiency, targeting, monitoring, and control of social programs, and the administrative reform of the National Administration of Social Security (ANSES) was implemented as planned. The government leased most of the national airports in 1998, and completed the preparations for the privatization of the National Mortgage Bank and the sale of its remaining stake in the former state oil company (YPF).

5.  In the financial sector, a new bank surveillance system was introduced, reinforcing external auditing procedures. The payment system was overhauled, by introducing a real time gross settlement system and new automated clearing houses, thereby reducing operating costs and the credit risk implicit in the settlement of financial transactions. As a step in the reform of labor market legislation, a law was approved that reduced dismissal costs, while eliminating most forms of temporary labor contracts with reduced social security contributions. In the area of education, efforts are underway to raise the number of years of mandatory basic general education and improve the standards of secondary education. In the judicial area, a National Judiciary Council has been established to manage the appointment of judges and oversee their activities, and steps are being taken to strengthen the State Attorney and Public Defender Offices, the provincial judicial systems, and the operations of the judiciary in the areas of tax enforcement and execution of bank collaterals and guarantees. Regarding health care, the restructuring of the union-run health organizations (Obras Sociales) and the health insurance system for retirees (PAMI) continued, with assistance from the World Bank and the IDB.

6.  As anticipated in the policy memorandum attached to our letter to you of December 3, 1997, the government intends to continue in 1999 to aim its economic policies at promoting sustainable growth of output and employment, addressing priority social needs, and maintaining low inflation and a viable external position. In view of the presidential elections scheduled for October 1999, and in the context of the greater uncertainty associated with the present adverse international environment, the government recognizes the critical importance of maintaining the disciplined and restrained macroeconomic policies of recent years, making further progress in improving the public finances, strengthening the financial system, enhancing competitiveness, and deepening structural reforms. Continued Fund support through the extended arrangement will be important to help attain these objectives. In keeping with the precautionary character of this arrangement, the government intends to maintain the drawing rights accumulated so far under it as last resort borrowing.

7.  The short term macroeconomic outlook is affected by the recent developments in international financial markets and the slowdown in the economies of Argentina's main trading partners. The 1999 program is based on the assumption that the rate of real GDP growth bottomed out in the last quarter of 1998 and will recover significantly in the course of 1999, averaging 2 1/2-3 percent for the year as a whole. The program aims at keeping the annual rate of inflation at less than 1 percent, which is below the average in major trading partners and, together with an expected increase in productivity and the favorable impact of the tax reform on labor costs, will strengthen Argentina's international competitiveness. The external current account deficit is likely to widen to 4.9 percent of GDP in 1999, reflecting the continued weakness of commodity prices, the slowdown in external demand, and the growing external debt service burden.

8.  Fiscal policy will continue to play a key role in raising savings and strengthening confidence in the continued viability of the convertibility regime. The program for 1999 aims at raising the primary surplus of the federal government from 0.7 percent of GDP in 1998 to 1.2 percent of GDP in 1999. With this result, the federal government deficit is projected to decline from Arg$3,850 million (1.1 percent of GDP) in 1998 to Arg$2,950 million (0.8 percent of GDP) in 1999. At the same time, the deficit of provincial governments, including the expenditure of a provincial trust fund for infrastructure, is expected to decline to Arg$1,450 million (0.4 percent of GDP) in 1999. With these outcomes, and taking into account the use of privatization receipts and the effects of the recognition of certain past obligations, in 1999 the federal public sector debt will increase by the equivalent of 0.5 percent of GDP to around 33 percent, while that of the provinces will rise slightly to 4 1/2 percent of GDP.

9.  Despite the planned reduction in employers' contributions to social security, federal government revenue is projected to rise slightly faster than GDP in 1999 because of the tax reform and continued efforts to strengthen tax administration. The tax increases included in the tax reform mentioned in paragraph 3 will come into effect on January 1, 1999, but as the reduction in employers' contributions envisaged in the reform will be implemented gradually throughout the year, the reform is expected to result in a net increase of tax revenue in 1999. The government will continue to work with the provinces on the formulation of a proposal to fundamentally reform the tax sharing arrangement, as mandated by the 1994 constitution.

10.  With respect to tax administration, the federal tax service (AFIP) will continue to implement the program described in the 1997 policy memorandum. In particular, during 1999 the AFIP will: (a) complete the shift to the new electronic tax filing and collection system (OSIRIS); (b) strengthen auditing procedures; (c) propose to Congress a modification of the tax code aimed at tightening time limits for tax audits and resolution of tax disputes, streamlining tax judiciary procedures, and establishing a single tax branch in the Judiciary; (d) submit to Congress a bill to strengthen collection of tax arrears by authorizing AFIP to put a lien on delinquent taxpayers' assets; (e) amend the customs code, following its congressional approval, with a view to incorporating MERCOSUR norms and new WTO valuation rules; change the labor statute for customs' employees; and upgrade the customs information system; and (f) broaden the coverage of the pre-shipment inspection system to include transactions of US$800 or more. The creation of a unified data bank for taxpayers, pensioners, and welfare recipients (SINTYS) also will contribute to strengthening the tax administration.

11.  The 1999 budget approved by Congress envisages a freeze in nominal terms in primary federal spending which, excluding mandated transfers to provinces, will be kept to at most Arg$38,050 million, implying a reduction from 11.2 percent of GDP in 1998 to 10.8 percent of GDP in 1999. This expenditure containment effort will be facilitated by further steps in the area of budgetary reform, to promote efficiency in the use of public resources, including by improving procurement regulations and completing the computerization of procurement procedures, making a more comprehensive use of indicators of efficiency of public expenditure programs, and continuing the expansion of the Treasury's expenditure management information system (SIDIF) to include the operations of decentralized agencies.

12.  Within the overall expenditure containment effort, special attention will be given to improving the efficiency of social spending. In the education area, a law approved in November 1998 provided additional resources of around Arg$300 million to assist provinces in the implementation of the Federal Education Law of 1993 and the Federal Education Pact of 1994, which were designed to improve the coverage and quality of basic and secondary education. As part of these efforts, the federal government will assist the provinces in the reform of the teachers' labor statute, with a view to raising professional standards while generating savings through productivity gains. With respect to tertiary education, steps will be taken in 1999 to restructure the financing of state universities, with emphasis on cost recovery, and to modernize their budgetary practices. To improve the targeting of social protection programs, the government will merge all food programs of the Secretariat of Social Development under a single management unit, will extend the system to register beneficiaries of social programs (SISFAM) to all social programs, and will review the distribution of, and propose new eligibility criteria for, noncontributory pensions. The pluri-annual budget recently approved by Congress contemplates an increase in social spending from 74 percent of primary spending in 1998 to nearly 75 percent in 2001.

13.  Further steps are required to consolidate the reform of the social security implemented in recent years. In particular, the government will seek to replace the minimum universal benefit (PBU)--which at present entails a commitment to provide a common basic benefit to every pensioner--with a means-tested arrangement consistent with the financial viability of the social security system and that would facilitate the redistribution of resources to the lower-income beneficiaries. The government also intends to strengthen the controls and collection procedures aimed at bringing into the system the segments of the population in the informal economy that still lack social security coverage.

14.  A more fundamental change in fiscal policies will occur as a result of a "Fiscal Responsibility Law" which is expected to be approved by Congress in the coming months. This law will set limits on the indebtedness of the government, will constrain the growth of current public expenditure to that of GDP, and establish a Fiscal Stabilization Fund--to be financed by a percentage of tax revenue--to smooth out the impact of cyclical fluctuations and/or external shocks on tax revenue. The proposal establishes penalties on civil servants that fail to implement the budget and calls for mid-year congressional hearings on its implementation. The law also will help fiscal transparency by prohibiting the creation of extra budgetary funds and by requiring a detailed published account of the implementation of the budget. This law will be an essential complement to the Convertibility Law and will contribute to strengthening the basis for sustainable economic growth.

15.  In 1999, the government intends to make further progress in the privatization or leasing of enterprises that remain under government control, together with selling its residual stake in previously privatized public enterprises. In particular, the government expects an early resolution of judiciary challenges that so far have prevented the leasing of telecommunication frequencies, to allow this operation to go through in 1999. Several nuclear and hydroelectric power plants will also be leased in 1999. During the year, the government expects to complete the privatization of the National Mortgage Bank and to sell its remaining stake in YPF and the loan portfolios of liquidated federal banks, such as BANADE. In the case of the last remaining federal commercial bank, the Banco Nación, the government will seek to shift its legal status from a state enterprise to a state-owned corporation, to allow greater disclosure of information on its activities and increased managerial responsibility.

16.  The provinces are expected to strengthen their financial position in 1999 and their deficit is projected to decline from an estimated Arg$1,870 million in 1998 to Arg$1,450 million in 1999. Consistent with this objective, the government will continue to make the granting of federal approval of provinces' foreign currency borrowing conditional on the observance of indicators of financial solvency, while the central bank will continue to enforce existing prudential regulations on the provinces' borrowing from domestic banks. The government will set up a system to collect and publish more up to date information on the finances of the provinces.

17.  The government has recently begun to regain access to international capital markets, and a continuation of this process will facilitate public debt management in 1999. The government intends to limit recourse to short term debt, which will be kept at no more than 1.5 percent of GDP throughout 1999. It will also endeavor, market conditions permitting, to maintain the average maturity of the public debt at around nine years; and will seek to rebuild and maintain during 1999 a liquidity cushion equivalent to the budgetary financing requirements for a representative three-month-period.

18.  Consistent with the convertibility regime, financial policies will continue to aim at strengthening confidence in the domestic banking system. In this context, the central bank will seek a further reduction in its net domestic assets in 1999 in line with the scheduled repurchases from the IMF and a recovery of repos' with the banking system. The central bank is seeking to augment the contingent repo facility with foreign banks, so as to maintain a total coverage of bank deposits with liquid assets (foreign exchange reserves plus the repo facility) at around 33 percent. To strengthen bank supervision further, the central bank will enhance its monitoring of bank risks, by incorporating on- and off- balance sheet items in determining compliance with prudential norms. Also, it will introduce market-risk components into CAMEL ratings, as well as stress analysis of banks' balance sheets as recommended by the new banking supervision manual being prepared by the superintendency of banks.

19.  While the domestic banking system has weathered well the recent turbulence in international capital markets, additional steps will be taken in the area of financial reform in 1999 to strengthen the health of the system even further. In particular, the government will seek congressional approval of the already submitted changes to the Charter of the Central Bank (BCRA) and the Law of Financial Entities,' with a view to bringing them into line with the changed circumstances in financial markets and enhancing the BCRA's capacity to deal with the new challenges it faces. These changes would, inter alia, (a) facilitate the maintenance of adequate capitalization of the BCRA; (b) enhance the regulatory capacity of the BCRA, including over the banks' off-balance sheet operations, their internal and external indebtedness, and the activities of trust funds, mutual funds, and other nonbank entities; (c) simplify the mechanisms of BCRA assistance to financial entities, especially as regards the limits on total assistance and the duration of this assistance, as well as the guarantees involved; (d) facilitate the process of resolution or liquidation of failed financial entities; (e) standardize and regulate the characteristics of financial contracts, including derivatives; and (f) strengthen the legal protection and immunities of BCRA management for actions taken in the performance of their duties. Also in the area of financial reform, the government will revise the legal framework for the insurance sector and strengthen preventive supervision of insurance firms, and it will submit to Congress laws strengthening the legal foundation for leasing activities and for lending on the basis of equipment purchases, inventories, and other secured transactions. In addition, steps will be taken to improve the quality and competitiveness of the rating industry.

20.  The government will promote the further integration of Argentina with Mercosur and other regional trading partners, while at the same time seeking to increase trade with countries outside the region. Sustained high levels of investment, a continuation of the impressive productivity gains, and a reduction of labor costs are expected to help promote the competitiveness of Argentina's exports. During 1999, Argentina will make limited recourse to antidumping measures and safeguards, only to defend against unfair trading practices, and in strict compliance with WTO regulations. As a case in point, the specific duty on textiles and the safeguard regime under which a specific duty is applied on footwear are being phased out, as described in paragraph 27 of the policy memorandum attached to the government's letter of December 3, 1997. The government intends to eliminate the 3 percent surcharge to the common external tariff that was imposed in 1997 by December 1999.

21.  Further initiatives will be taken in the area of labor markets reform, to help improve Argentina's international competitiveness and promote a further decline of unemployment. In addition to the reduction in employers' contributions envisaged in the tax reform, the government will seek to replace special labor statutes with collective bargaining agreements, and introduce enabling regulations for the new law on medium size enterprises. Also, the government will continue to strengthen, in cooperation with the provinces, the enforcement of labor regulations for employers and workers.

22.  The government has launched a comprehensive program to deal with the Y2K problem. Accordingly, the BCRA has put in place a plan to prepare the banking system for this contingency, and nationwide tests of compliance with this plan will be carried out during the first half of 1999. Similar initiatives are being carried out in the tax administration (AFIP), the social security (ANSES), and the Treasury's expenditure management system (SIDIF).

23.  The government remains committed to promoting the opening of markets and to improving the efficiency of economic regulation in the country. In this context, during 1999, a new anti-trust law is expected to be approved by Congress. In addition, the government will take steps, with assistance from the World Bank and the IDB, to rationalize and harmonize the operations of regulatory agencies charged with overseeing private providers of public and infrastructure services. Draft legislation will be submitted to Congress to ensure consistency among these entities in the areas of administrative procedures, economic and technical standards, appeal processes, and the disclosure of information, as well as rules regarding consultations with provinces and consumer groups. Also, as part of continuing efforts towards the modernization of the State, steps will be taken in 1999 to: (a) improve procedures in the areas of control and auditing; (b) expand the training program for public sector personnel working in these areas; (c) set up new rules regarding employment incompatibilities (to avoid potential conflicts of interest), administrative enquiries, and patrimonial responsibilities for misconduct of public employees; and (d) build up, with assistance from the World Bank, the capacity of the Public Ethics Office.

24.  In the health care area, during 1999 the government will take steps, with assistance from the World Bank and the IDB, to help develop a competitive managed care market for providing health care services to pensioners, and to reform the operations of the redistribution fund of the labor-managed health care providers (Obras Sociales), which compensates them for the costs of insuring workers with low income. Also, the government will strengthen the regulatory framework for health insurance, including through the introduction of new prudential and consumer protection norms for private health care providers and through the dissemination of information on the basic characteristics and performance of the different Obras Sociales.

25.  The government remains committed to improving the timeliness and coverage of economic statistics. Important progress was made in this area in 1998 with the production of more frequent labor market surveys, the production of semi annual data on private sector external indebtedness and debt service, and comprehensive revisions to the balance of payments statistics. In 1999, the government intends to complete, as contemplated under the Fund's SDDS, the preparation and publication of quarterly national accounts statistics in current prices. Also, it intends to complete work on a new input-output matrix. In addition, with the strengthening of the data processing system for international trade, it will seek to reduce the lag in the publication of monthly trade data. With assistance from the IMF, the government will establish in the near future a monitoring system for short-term external interbank credits.