Memorandum of Economic Policies
I. Background
1. As described in detail in the Memorandum of Economic Policies (MEP) of February 14, 2000, the economic program of the Argentine government supported by the stand by arrangement (SBA) from the Fund aimed at creating conditions for a sustainable recovery of output and employment, with continued price stability and improvement in the external accounts, through policies geared to increasing national savings and investment, and promoting further modernization and competitiveness of the economy. Building on the important gains in financial stability and structural reform already achieved under the convertibility regime, these policies centered on a progressive reduction of the public sector deficit (including the provinces) from over 4 percent of GDP in 1999 to under 3 percent of GDP in 2000, with further reductions in subsequent years, to reach equilibrium by 2003; and on a wide-ranging structural reform effort in the public finances, the financial system, the labor market, the health system and other important sectors of the economy.
2. The progress made in the implementation of these policies in the first several months of the government's tenure was outlined in the MEP of September 5, 2000, which also reviewed economic developments in the first half of 2000, and prospects for the rest of this year. Economic indicators available at that time, albeit mixed, provided some comfort that a recovery of domestic demand was under way and, in conjunction with a robust volume growth of exports, especially in manufacturing, would lead to a sustained pickup in output in the second half of 2000 and into 2001. This, together with continued expenditure restraint, was expected to facilitate a strengthening of the fiscal performance, and help reduce the federal deficit from the equivalent of 2.5 percent of GDP in 1999 to 1.8 percent of GDP in 2000, and the consolidated provincial deficit from 1.6 percent of GDP in 1999 to 1 percent of GDP in 2000.
3. In recent months, however, the economy has suffered from a combination of adverse developments, which have affected significantly the prospects for the rest of this year, and will have inevitable repercussions on growth performance into 2001 as well. Political uncertainties in connection with a cabinet reshuffle affected adversely domestic confidence, and hindered the implementation of some of the government's policies. More importantly, the external environment deteriorated significantly, reflecting uncertainties over the course of the U.S. and other major industrial economies; the impact of high oil prices on world growth; and rising borrowing costs, with sharply reduced market access for emerging market economies in general, and Argentina in particular. Spreads on Argentine sovereign bonds rose by more than 200 basis points, and domestic lending rates by over 300 basis points from August to November, contributing to stalling the incipient recovery in domestic demand.
4. As a result of these developments, real GDP growth is likely to be near zero for 2000 as a whole, compared with the 1.7 percent expected at the time of the last review of the program. In 2001, the rate of growth is now projected to be around 2.5 percent on average, but to accelerate during the year as the determined implementation of the strengthened economic policies of the government, and the enhanced international financial support, bolster confidence and promote a more sustained recovery of domestic demand.
5. While the growth performance in 2000 has fallen well short of expectations, the economy has made significant progress in adjusting to the external shocks which affected it in the late 1990s, in particular the terms of trade loss, the strength of the U.S. dollar and the depreciation of the Brazilian real. Domestic costs continued to decline in 1999 and so far in 2000, bolstering competitiveness. Consumer prices dropped by 0.7 percent year-on-year by November 2000, while wholesale prices (in which tradable goods prices have a larger weight) rose by 4.8 percent over the same period, pointing to an increase in the relative price of tradable goods.
6. Reflecting this improvement in competitiveness, and the favorable impact of high energy prices, as well as the stagnation of domestic demand, the trade balance shifted from a deficit of US$1.6 billion in the first ten months of 1999 to a surplus of US$0.9 billion in the corresponding period of 2000. Of particular significance is the 12 percent volume growth of manufacturing exports during the same period. The improved trade performance is expected to more than compensate for the increased interest burden of the external debt, resulting in a significant reduction of the external current account deficit in 2000, to the equivalent of 3.4 percent of GDP from 4.4 percent of GDP in 1999, and nearly 5 percent of GDP in 1998. Notwithstanding the narrowing of the current account deficit—and the fact that some three quarters of this deficit are being covered by foreign direct investment (FDI)—the sharp tightening of external financing conditions in recent months is expected to result in a US$2 billion decline in net international reserves for the year as a whole. Gross international reserves, including the banks' liquidity requirements held abroad, are projected to amount by end-2000 to around US$32.5 billion (nearly 40 percent of M3 or one and half times the country´s short term external debt)
7. The government's effort to reduce the federal deficit in 2000 have been increasingly thwarted by the weakness of domestic demand and the continuing decline in consumer prices. Despite the introduction of a sizable package of tax measures in January, overall tax revenues, including social security contributions, rose by only about 3 percent through November 2000 compared with the 8.7 percent expected initially and the nearly 6 percent projected at the time of the review of the program. As a result, and despite the government's efforts to contain primary spending—including a Arg$300 million cut in the program ceiling on such spending in the second half of the year—the ceiling on the cumulative federal deficit for end-2000 had to be raised by Arg$600 million (0.2 percent of GDP) during the first review of the program, and is now expected to be exceeded by a further Arg$1.4 billion. The government is, therefore, requesting corresponding modifications of the program ceilings on the federal deficit and debt for December 2000. The ceiling on primary spending is expected to be observed, implying a 1.4 percent decline in such spending, compared with 1999.
8. Preliminary information on developments in the provinces' finances in 2000 shows that significant progress was made in reducing their consolidated deficit from the relatively high level reached in 1999, although this progress fell somewhat short of expectations in the program. Current estimates point to a decline of this deficit to around Arg$3.4 billion (1.2 percent of GDP), compared with the 1.6 percent of GDP recorded in 1999, and the 1 percent of GDP envisaged in the program. Accordingly, the government is requesting modifications of the ceilings on the provinces' deficit and the consolidated public sector debt for end-2000. The bulk of the adjustments was carried out by the more indebted provinces which entered into agreements with the federal government for support in the refinancing of their debt, in conjunction with specific fiscal adjustment programs. Significant progress in fiscal consolidation was also made by some of the larger provinces, while in others the deficit remained quite large, indicating an urgent need for strengthened efforts by the latter provinces to improve their own-revenue performance and contain spending.
9. The near stagnation in economic activity, and the increase in the cost of credit, especially in recent months, have been reflected in a continuing decline of domestic bank credit to the private sector, as well as in an increase in the non-performing loan ratio, accompanied, however, by increased provisions. The capital adequacy ratio (Basel criteria) of the banking system remains relatively high, and bank liquidity generally adequate. Private deposits in the banking system rose by 5 percent during the first nine months of 2000, before declining by about 1.8 percent in October-November.
II. The policy framework for 2001 and beyond
10. The government is responding to these worse than expected developments through a strengthened, growth-oriented economic strategy, aimed at promoting a sustained recovery of domestic and external confidence, an acceleration of productivity growth and further improvements in competitiveness. This strategy centers on the maintenance of the convertibility regime, which continues to be viewed by the vast majority of the Argentine people as the fundamental guarantee of financial and price stability; a number of policy initiatives signaling a credible commitment to medium-term fiscal sustainability; and a broadening and acceleration of its efforts at structural reform, modernization and opening up of the economy.
11. The government has taken in recent weeks a number of initiatives to promote a substantial recovery of investment, which has declined by over 16 percent over the last two years. These initiatives include the elimination of the tax on interest payments by corporations in three steps over the next eighteen months; the extension from four to ten years of the period for loss carryover under the minimum income tax for enterprises; the acceleration of payments of VAT credits for new investments; an increase in selected public work programs aimed at easing infrastructure bottlenecks and stimulating activity in the construction sector; and a build, lease and operate program for basic infrastructure, aimed at facilitating financing for private contractors undertaking the construction of these projects.
12. Together with the efforts to boost investment described above, the government is implementing several structural measures aimed at promoting competition in domestic markets and facilitating the allocation of capital and labor resources in the economy. The government will shortly issue enabling regulations to put into effect the Protection of Competition Law, recently approved by Congress, that updates and strengthens antitrust legislation. Also a new regulatory framework will be developed to support the development of the ports system, and the government is proceeding with the implementation of the new regulatory framework for the telecommunications sector, where the work is well advanced and the interest of foreign companies to enter the Argentine market is manifest. To remove some remaining distortions that followed from the privatization process of the early 1990s, the government is reviewing contracts with privatized enterprises in the energy, utility, and transport sectors. Finally, the government has recently completed issuing the regulatory decrees required for the full implementation of the labor market reform that was enacted earlier in the year. These measures, together with the pension and health sector reforms, and the policies to develop the domestic capital markets, more fully described below, are considered fundamental to sustain the expected recovery of output growth,.
13. In conjunction with an expected easing of financing constraints, as confidence is bolstered by the implementation of the government's program and the international financial support package, these measures are expected to contribute to a sustained pick up in domestic demand, particularly of investment, in the course of 2001. Specifically, growth is projected to recover to over 4 percent by the fourth quarter of next year, albeit remaining on average around 2½ percent. Consumer prices are expected to remain broadly stable, and the GDP deflator to record a small rise in reflection of a projected further improvement in the terms of trade. Real GDP growth is expected to be sustained at over 4 percent a year over the medium term, allowing—in conjunction with the increased flexibility in the formal labor market brought about by the implementation of the recent labor legislation reform—for a progressive recovery of employment. Inflation is expected to remain lower than in major partner countries, facilitating further gains in competitiveness over the next few years.
14. The external trade surplus is expected to increase further in 2001 (to around US$2 billion) as the sustained growth of exports resulting from the strengthening of competitiveness and the coming on stream of investments in the energy, paper, and basic metal industries should more than offset the increase in imports associated with the economic recovery. The current account deficit is expected to decline slightly, to the equivalent of around 3¼ percent of GDP, with the improvement in the trade balance partly offset by the rising burden of net interest payments abroad. Net FDI is expected to continue to cover about 70 percent of this deficit. Over the medium term, the current account is projected to narrow further, to well under 3 percent of GDP, reflecting the continued improvement in the trade performance and a deceleration of the growth of net interest payments, in line with the decline of the external debt in relation to GDP, and of interest rates. Some 80 percent of the current account is expected to be covered by FDI, and the remainder by net financial inflows to the private sector, as the public sector gradually reduces its reliance on foreign financing, reflecting the planned fiscal consolidation and the further development of the domestic capital market.
15. A central element of the government's strategy is a continued, and indeed strengthened commitment to eliminating the fiscal deficit at all levels of government over the medium term, with a view to facilitating a sustained reduction of the public debt in relation to GDP, an important condition for securing a lasting decline of the risk premium on Argentine bonds, and consequently of financing costs for public and private borrowers. The revised federal budget recently approved by congress envisages an only modest reduction of the deficit in 2001, in order to avoid a fiscal contraction in the early stages of the economic recovery. But it also includes a binding commitment—through a revision of the fiscal responsibility law—to a linear decline of the deficit in subsequent years, to zero by 2005. This commitment to fiscal consolidation at the federal level is buttressed by similar commitments undertaken by the provincial governments in the recent federal fiscal pact. Projections based on relatively conservative assumptions about GDP growth and the cost of government borrowing over the next few years suggest that such a path of the consolidated public sector deficit should be consistent with a significant decline of the public debt in relation to GDP from 2003 onwards. The fiscal consolidation effort will center on a freeze of nominal primary spending at the 2000 level by both the federal government and the provinces in deficit, and on strengthened structural fiscal reforms, particularly in the tax administration and the social security. These efforts are expected to result in a gradual increase of the primary surplus of the consolidated public sector equivalent to more than four percentage points of GDP during the period 2001-05.
16. The 2001 federal budget supports the growth-oriented strategy of the government by allowing some scope for the automatic stabilizers to work. Specifically, the federal deficit will be reduced by less than envisaged in the original budget proposal submitted to Congress in September 2000, to around Arg$6.5 billion (2.2 percent of GDP), to accommodate the lower growth of revenues entailed by the revised more conservative assumption regarding GDP growth for next year. The revised budget also incorporates the fiscal cost of the measures—referred to in paragraph 10 above—to stimulate investment, and some additional spending (equivalent to about 0.1 percent of GDP) in temporary public employment programs and other social spending aimed at mitigating economic hardship for the most vulnerable groups of society. Federal primary spending is, nonetheless, expected to decline by the equivalent of 0.5 percent of GDP from the 2000 level. As a result, the primary surplus of the federal government is projected to rise to 1.7 percent of GDP in 2001 from 1 percent in 2000, and 0.4 percent of GDP in 1999.
17. To ease recent financing constraints and facilitate the rapid return of Argentina to international capital markets, the government has arranged a financial support package of around US$39 billion from official and private sector sources, including the requested augmentation of the existing Stand-by Arrangement to 500 percent of quota (equivalent to about US$13.7 billion); understandings with the World Bank and the IDB on new loan commitments amounting to around US$4.8 billion in total over the next two years; a loan from Spain of US$1 billion, and substantial underwriting commitments with market maker banks active in Argentina and the local pension funds. Specifically, in 2001, the gross financing requirements of the federal government are projected to amount to around US$27 billion, including the rollover of the US$5 billion outstanding short-term Treasury bills (Letes). Multilateral and bilateral official sources are expected to finance about 36 percent of such requirements. To fill the remaining part, the government has reached agreements with local banks on a rollover of maturing bonds and purchases of new issues in the amount of US$10 billion, and the local pension funds are expected to purchase about US$3.0 billion of new government bonds. The government is also planning other placements in international capital markets, as well as a number of liability management operations. The government's financing requirements are expected to decline over the medium term, as progress is made towards eliminating the deficit by 2005. Public debt management will focus on further smoothing the amortizations profile, as market conditions allow.
18. The provinces are expected to reduce their consolidated deficit from the equivalent of 1.2 percent of GDP in 2000 to around 0.9 percent of GDP in 2001. This improvement is to be achieved through both the agreed freeze on primary spending in those provinces in deficit, and through a strengthened performance of own revenues, while transfers from the federal government will remain stable in relation to GDP. In the federal fiscal pact, the provinces have also committed themselves to introducing in their respective legislatures fiscal responsibility laws mandating the achievement of budgetary balance by, at the latest, 2005, and to improving the quality, timeliness and transparency of their fiscal accounts. The government will inform the public of progress in the implementation of the federal pact through quarterly reports. The government will also continue to work with the provinces on a more permanent reform of the revenue sharing system, with a view to streamlining it, eliminating some of its distortive features, and improving its equity over the medium term.
19. To buttress its commitment to fiscal sustainability, the government is strengthening and accelerating structural fiscal reforms. In the tax administration area, efforts will focus on broadening the coverage and improving the quality of audits, enhancing cooperation and the exchange of information with the provincial tax administrations, and accelerating the collection of tax arrears. These efforts will be facilitated by a rapid implementation of the measures envisaged in the recently approved anti-evasion law, including making fully operational the special tribunal for criminal tax cases. To minimize moral hazard, the government will eschew new amnesties or other payment facilitation arrangements for overdue taxes, and streamline and increase the transparency of existing ones. Efforts will be made to improve internal controls and supervision in the tax and customs administration, to increase efficiency, as well as to minimize opportunities for corruption. The scope for simplifying the tax system and reducing exceptions, special treatments, and loopholes will also be analyzed, with the help of local and outside experts.
20. The government intends to utilize to the fullest extent possible the available instruments to streamline the public administration by eliminating redundant entities and programs, minimizing the overlapping and duplication of functions across administrative units and levels of government, and re-deploying civil servants as needed; revising procurement practices and strengthening the evaluation of the cost-effectiveness of spending programs; and making the public administration more service-oriented. Efforts continue to be made to consolidate and target more effectively a number of small scale social assistance programs, especially in the areas of nutrition, construction of essential sanitary infrastructure, and the management of the impact of natural disasters. To this end, the government has already issued decrees to consolidate three nutritional programs and three programs covering education and health for urban youth into more comprehensive and efficient single programs (Unidos and Solidaridad, respectively). A unified registry of beneficiaries in federal and provincial social programs will be established.
21. With a view to strengthening the intertemporal solvency and equity of the pension system, the government replaced a draft law submitted to congress in June with a new proposal for reform of the system. The new draft bill proposes to: (a) replace the basic universal pension benefit (PBU) with a sliding-scale supplementary benefit (PS) for new pensions lower than Arg$600 per month; (b) introduce a minimum benefit of Arg$100 per month for all citizens of more than 78 years of age who do not have other sources of income; (c) introduce incentives for women to postpone retirement until 65 years, by progressively increasing the age at which they will qualify for the supplementary benefit; and (d) eliminate the option of joining the public pension system for new entrants into the labor force. The government attaches great importance to the rapid approval and early implementation of the key elements of this reform, given their role in ensuring the medium term solvency of the pension system, and sustainability of the overall fiscal position. The Social Security Agency (ANSES) has been intervened in mid-November, with a view to streamlining it and increasing the transparency and efficiency of its operations. The government intends to seek the support of the World Bank in this task. The government has tabled legislation aimed at strengthening competition among private pension funds, reducing administration costs in these funds, and improving their supervision. The government also intends to review the system of family allowances, with a view to streamlining it and reducing the scope for fraud.
22. The deregulation of the union-run health organizations (obras sociales), which aims at promoting competition and increasing efficiency in the provision of health care, will become effective on January 1, 2001. Under the new regime, individuals will be able to choose their health providers among the obras sociales and the private HMOs. All health care providers will be required to offer a basic menu of services at a low per capita premium. They will be allowed to offer additional services for additional voluntary contributions. A redistributive solidarity Fund, funded with mandatory contributions related to the level of income of participants in the system, will be used to finance the automatic subsidy for contributors whose payroll deductions do not cover the basic capita, and for the purchase of insurance for high-cost illnesses. The health system for retirees (PAMI) which was intervened last January is being restructured, and steps are being taken to increase its accountability and transparency of operations. To this end, PAMI is being required to obtain the government's approval of its budget, its staffing policy, and its borrowing operations, and will be made subject to the same control and auditing mechanisms that apply to the rest of the public administration. PAMI is also being required to submit monthly reports on its financial position and budgetary execution.
23. Financial policies will continue to aim at buttressing confidence in the domestic banking system by maintaining, and strictly enforcing the relatively high liquidity requirements of banks, and continuing to strengthen bank supervision. Draft legislation is being prepared to facilitate further the process of bank resolution. With a view to fostering the development of the domestic capital markets, the government will send to Congress by the second quarter of next year a bill on best practices in the financial sector, increasing the transparency and the requirements for public information about financial transactions, and strengthening corporate governance, particularly in regard to minority shareholders' rights. The government is also introducing measures to harmonize taxation across the financial service sector, and has presented a bill to modernize the regulatory framework in the insurance sector. The government has requested a Financial Sector Assessment Program from the IMF and the World Bank early in 2001.
24. The government is seeking agreement with other MERCOSUR countries on a reduction of tariff dispersion and of tariff rates. Agreement has been reached on phasing out the 3 percent surcharge on the Mercosur common external tariff by the end of 2002, thus reducing the average tariff, from 13.3 percent to 10.9 percent. As a first step in this direction, the surcharge will be reduced by 0.5 percentage points on January 1, 2001, and a timetable for further reductions will be announced by June 2001. The government is also placing increased emphasis on institutionalizing mechanisms for the resolution of trade disputes, and has recently taken steps to strengthen convergence with its MERCOSUR partners as well as Chile and Bolivia, through an agreement on common macroeconomic targets and on harmonized statistics, particularly in the fiscal and balance of payments areas.
