Buenos Aires, Argentina
May 10, 1999

Dear Mr. Camdessus:

1.  Notwithstanding the strong performance of its economy in recent years, Argentina has not been immune to the contagion effects of the Russian and Brazilian crises. After three years of rapid economic growth, real activity took a downward turn in mid-1998 reflecting a decline of international capital inflows, higher interest rates, and a drop in export demand. Real GDP fell by 3.5 percent in the last two quarters of 1998 (seasonally adjusted), although for the year as a whole it still grew by 4.2 percent, and is estimated to have fallen by an additional 2.8 percent in the first quarter of 1999. Preliminary indications also point to a decline of employment in recent months, after growing at an annual rate of more than 6 percent in the past two years. Consumer price inflation has been negligible. Import growth has turned negative since the last quarter of 1998 and contributed to a narrowing of the trade deficit from a peak of US$5.9 billion in October 1998 (on a 12-month basis) to US$5.1 billion in February 1999. For 1999 as a whole, the trade deficit is projected to narrow further to under US$4 billion. Nevertheless, reflecting a further significant increase in net interest payments abroad, the current account deficit is expected to improve only slightly to about 4.1 percent of GDP. Foreign direct investment is projected to cover over 40 percent of this deficit.

2.  In contrast to the aftermath of the 1994 Mexican crisis, confidence in the local financial sector has remained strong, with private deposits growing at an annualized rate of around 6 percent since mid-1998, despite the slowdown in economic activity. This factor is expected to facilitate a recovery from the crisis in the second half of this year. There are already some signs that the economy has begun to turn around stimulated in part by improved access to international capital markets, recent positive developments in Brazil, and a more positive outlook for commodity prices. However, while a gradual recovery of the economy now seems likely, real GDP is still expected to decline by 1.5 percent in 1999, compared with the 2.5 percent growth assumed in the program designed last December.

3.  The lower pace of economic activity will have a marked negative impact on the public finances, with federal government revenues now expected to fall short of the original program projections by some Arg$3 billion. The government managed to compensate for the revenue shortfall that occurred in the first quarter of the year, and met all program performance criteria. However, a full offset of the revenue shortfall will not be possible in the remainder of the year without seriously impairing the quality of public services and aggravating the economic downturn. Given the government's demonstrated expenditure restraint in recent years, it considers that there would now be a strong case for accommodating the cyclically induced drop in revenue by allowing a corresponding increase in the program target for the federal deficit. Nevertheless, to ensure that the financing of the deficit does not crowd out private sector borrowing, and to underscore its commitment to fiscal discipline, even under adverse macroeconomic developments, the government intends to take measures to keep the federal deficit to Arg$5,100 million (1.5 percent of GDP). The table attached to this letter presents the modified program targets. To ensure achievement of the new deficit target, noninterest expenditures of the federal government (excluding mandatory transfers to provinces) have been lowered by Arg$450 million with respect to the original program target. The government has maintained access to international capital markets and has succeeded already to secure financing to cover its borrowing needs (including those entailed by the new deficit target) almost through the third quarter of 1999.

4.  The existence of a floor on revenues transferred by the federal government to the provinces will only in part shield the latter from the downturn in fiscal revenues. However, as a result of spending restraint, the consolidated provincial deficit is still expected to decline from Arg$1,875 million in 1998 (0.6 percent of GDP) to under Arg$1,700 million (0.5 percent of GDP) in 1999. The proposed system to monitor the level and composition of financing to the provinces on a more timely basis is being put in place, and is expected to begin operating in May.

5.  The government recognizes the importance, in these times of political transition, of giving clear and strong signals of Argentina's determination to carry forward and deepen the fundamental reform process that the country has been pursuing. To this end, the government remains fully committed to the structural reform program outlined in the letters of December 3, 1997 and January 11, 1999 and is seeking support across the political spectrum to ensure substantive further progress in the implementation of the structural reform agenda. The government is working with the lower chamber of Congress to speed up discussion of the fiscal convertibility law described in the policy memorandum attached to the January letter, and expects this bill to get final congressional approval by August 1999. This law will set limits on the growth of the public debt and public sector spending, and establish a fiscal stabilization fund to smooth out the impact of cyclical fluctuations and/or external shocks on tax revenue. In addition, work is being finalized on a detailed proposal to reform the tax sharing regime with the provinces. This proposal, which will serve as the basis for discussions with provincial authorities and legislators intended to begin in May 1999, seeks to simplify the sharing arrangements between the federal and provincial levels of the government (the primary distribution system); improve equity and efficiency in the distribution of revenues among provinces (the secondary distribution system); and replace some inefficient provincial taxes by a VAT surcharge.

6.  Progress has been, or continues to be made in the implementation of other reforms envisaged in the original program. Measures were put in place further to strengthen tax administration, and a reform of the tax code in being prepared with the intention of presenting it to Congress before November 1999. A substantial package of shares (28 percent) of the National Mortgage Bank was sold in January 1999. The leasing of telecommunications frequencies has been delayed by judicial challenges and is now expected to be completed in the second half of the year.

7.  In the financial sector area, and as described in the aforementioned policy memorandum, the Central Bank continues with its efforts to strengthen bank supervision. The bills to modify the Central Bank charter and the financial entities law are being discussed in Congress, and their passage is expected by end-November 1999. Draft legislation to transform the Banco de la Nacion into a public corporation has been prepared and will be submitted to Congress in May. Also, the Central Bank is working, with assistance from the Fund, to strengthen by end July 1999 the monitoring of conditions of access by commercial banks to external credit lines.

8.  The government has begun work on an important further reform of the social security system aimed at preventing a deterioration of its finances over the medium term. The proposed reform will include a tightening of eligibility requirements for the basic pension benefit (PBU), a sort of minimum pension, by transforming it from a universal to a means-tested benefit. Draft legislation on this reform will be submitted to Congress by end July 1999.

9.  In the area of labor market reform, as envisaged in the program, the government implemented in early 1999, new regulations for the small-and medium-size enterprise law (Ley PYME) designed to enhance labor flexibility in this area. Also, two special labor statutes ("estatutos especiales", that maintain particular privileges in certain sectors) have been abolished and replaced by arrangements involving negotiations between the relevant parties; most of the remaining statutes are expected to be eliminated in the coming months. In addition, the government intends to submit to Congress in coming months a proposal for a new capitalized severance payment system along the lines recently presented to the World Bank in the context of the SSAL program. The reduction in labor taxes included in the tax reform approved in 1998 is contributing to ameliorate the adverse effects on employment of the current downturn in economic activity. The government intends to keep to the schedule of reductions of employers' social security contributions envisaged in the tax reform approved at the end of 1998, but recognizes that present budgetary constraints do not permit other initiatives to promote employment that would carry an additional cost to the budget.

10.  The government of Argentina believes that the policies described in this letter are consistent with the thrust of the economic program for the period 1998-2000 that is supported by the extended arrangement from the Fund. Together with the progress made so far in the implementation of this program, these policies provide a firm basis for concluding the third review under the arrangement. The government will continue to maintain close contacts with the Fund and will consult on the adoption of measures that may be needed, in accordance with the Fund's practices on such consultations. A fourth review of the program will be carried out with the Fund before end-November 1999.