IMF Executive Board Concludes 2006 Article IV Consultation with ArgentinaPublic Information Notice (PIN) No. 06/93
August 9, 2006
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On July 28, 2006, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Argentina.1
Argentina's economy has continued to deliver very positive outturns in the period following the 2002 crisis. After three years of around 9 percent growth, real GDP has surpassed its 1998 peak by some 6 percent, led by strong investment and consumption. The economy has benefited from a favorable terms of trade, significant reduction in the debt burden following the 2005 debt restructuring, and a competitive currency. However, inflation has risen steadily ending 2005 at 12.3 percent.
The external accounts have undergone a remarkable transformation in a relatively short period of time, allowing for the early repurchase of the entire stock of Fund credit in January 2006. Favorable global commodity prices and the emergence of Asia as a key export destination have increased earnings from primary and agroindustrial exports. At the same time, net private capital flows turned positive in 2005 for the first time since 1999.
The post-crisis fiscal adjustment is historically unprecedented. In 2005 the overall cash surplus of the consolidated government was 2½ percent of GDP, underpinned by strong revenue performance. However, non-interest spending rose by 11 percent in real terms, leading to an erosion of the primary surplus (to 4½ percent of GDP in 2005, from 5 percent in 2004) despite the high rate of economic growth, providing further demand stimulus. Provincial primary spending has been rising even more rapidly (around 19 percent in real terms in 2005). While the provinces recorded a small overall surplus for the year, they moved into primary deficit in the second half of 2005.
The exchange rate has remained stable amid sustained intervention by the central bank. Interest rates have risen gradually as bank lending has recovered and liquidity conditions have normalized, but short-term interest rates remain negative in real terms. Aided by these negative real interest rates and a stable regulatory environment, the health of the banking system has improved, with gains in both asset quality and profitability.
There has been a demonstrable improvement in social conditions. By end-2005, the poverty rate had declined to 34 percent from the peak of 57 percent reached in 2002, and extreme poverty had more than halved to 12 percent. Other social indicators such as secondary school enrollment and completion rates, as well as formal health insurance coverage, and the infant mortality rate have also seen impressive improvements in the past few years. These results have been helped by direct public intervention through the Heads of Household Program which has provided cash transfers to the unemployed. Nevertheless, the labor market remains highly segmented with a widening gap between formal and informal sector wages.
Early indicators imply that current trends are set to continue this year. Economic indicators show little sign of a slowing of activity in the first quarter. Public sector capital spending continues to rise rapidly, growing at a real rate of over 70 percent in the 12 months to May. Substantial increases in subsidies and discretionary transfers to provinces continue. The strong balance of payments has allowed the central bank to accumulate around US$1 billion of international reserves per month so far this year, and reserves now stand at US$26 billion (having recouped most of January's early repurchase of amounts outstanding to the Fund).
Measured inflation fell to 11 percent at end-June, a result of the government's efforts to dampen price pressures through price agreements with industry and retail groups and a temporary ban on meat exports. Underlying inflation, however, remains high—core inflation is running at 12¼ percent—and end-2007 inflation expectations are around 12 percent. While real wages in the informal sector remain depressed, formal private sector real wages are rising rapidly, and labor markets are tightening.
The combined Ex Post Assessment for Longer Term Program Engagement and Ex Post Evaluation on Argentina's experience with exceptional access was reviewed by the Executive Board. The report found that macroeconomic performance under the two Stand-By Arrangements approved in 2003 was strong and that all procedural requirements of the Fund's policy on exceptional access were met. However, progress on structural reforms to address long-term vulnerabilities was limited, due largely to a lack of ownership and implementation capacity. The report finds that access under the 2003 Stand-By Arrangements was insufficiently linked to balance of payments need. In addition, the arrangements may have hampered the Fund's ability to clearly signal the circumstances under which it would be prepared to provide exceptional access to countries. The report also argues that the programs' lack of a medium-term fiscal and balance of payments framework complicated the application of the Fund's Lending Into Arrears policy.
Executive Board Assessment
They welcomed the strong performance of the Argentine economy and commended the authorities on policies that have contributed to declines in unemployment and poverty, a gradual recovery of the banking system, the strong performance of the external sector, and the recuperation of international reserves following the early repurchase of Fund resources. However, they cautioned that inflationary pressures have emerged.
Most Directors regarded current inflation as more a consequence of aggregate demand growth that was not being met by a sufficiently rapid supply response than as a temporary phenomenon arising from a delayed relative price adjustment after the 2002 crisis. Directors noted that achieving a soft landing for the economy requires a different macroeconomic policy mix as well as reforms to promote investment and supply, especially in areas where bottlenecks are of macroeconomic significance.
Most Directors found that there was an erosion of the fiscal position and noted that monetary policy, while being gradually tightened, remained accommodative. Directors underscored that all of the available policy instruments should be brought to bear to allow for a soft landing with sustainable growth and low inflation. In this respect, most Directors considered that the appropriate response to higher inflation was to reign in the rapid growth in primary expenditure to strengthen fiscal policy, bring the term structure of real interest rates into positive territory, and allow also for a greater upward flexibility in the exchange rate.
Directors cautioned that delaying the policy response could significantly increase the economic costs of reducing inflation and may risk leaving the economy vulnerable to shocks. They cautioned that overly relying on one instrument, while avoiding adjustment in others, could render the tightening of the policy mix unbalanced and ultimately infeasible.
Directors considered that the administrative measures adopted to dampen inflation provide only temporary benefits, although some Directors supported the short-term use of such measures to dampen inflationary expectations. Most Directors advised that such administrative measures should be dismantled as soon as possible, since repressing prices in regulated industries, selective price agreements, and export restraints would ultimately exacerbate capacity constraints in key sectors and undermine the business climate.
Directors noted that structural measures to increase competitiveness and encourage investment—notably in regulated industries—remained vital to ensure continued strong growth. They also encouraged the authorities to consider alternatives to financial transactions and export taxes, to review the functioning of the fiscal responsibility regime, and to allow relative prices in the utilities and energy sectors to adjust so as to unwind the implicit cross-subsidies that pervade the economy. Most Directors expressed concern over the impact that some of these policies were having on the business environment. Directors also encouraged the authorities to seek a consensual solution to the remaining government arrears to both official and private sector creditors, noting that this would be in Argentina's own interest.
Directors agreed that the central bank's approach towards maintaining a stable regulatory framework, while gradually phasing out regulatory forbearance, had delivered positive results, and recommended a continued adherence to this approach. Directors welcomed the authorities' intention to participate in the Financial Sector Assessment Program in 2007.
Directors welcomed the findings of, and the authorities' candid responses to, the ex post assessment of longer-term program engagement (EPA) and ex post evaluation of exceptional access (EPE) and broadly agreed with its conclusions. They noted that there was significant progress in stabilizing the economy and setting in train a rapid recovery, phasing out quasi-currencies, improving tax collection, and implementing a banking sector strategy. In looking at the broader lessons from the EPA/EPE, Directors stressed that full ownership of policies was key to the successful implementation and that the phasing of access should be consistent with balance of payments needs and the implementation of reasonable adjustment policies. Most Directors also noted that the articulation of a full medium-term macroeconomic framework would allow for a clearer application of the Fund's lending into arrears policy and looked forward to a comprehensive review of the policy.