Public Information Notice: IMF Concludes 2002 Article IV Consultation with Argentina

IMF News, July 25, 2003

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Public Information Notice: IMF Concludes 2002 Article IV Consultation with Argentina

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• Published: July 25, 2003

Background

• Since the last Article IV consultation (concluded in September 2000), far-reaching developments transformed Argentina's economic situation and prospects, culminating in sovereign default in late 2001 and abandonment of the decade-long currency board arrangement in early 2002.
• The currency board arrangement lacked adequate support from the broader policy framework; real appreciation during the 1990s (partly reflecting a strong U.S. dollar and depreciation of the Brazilian real after 1999) was not offset by sufficient flexibility in labor markets and fiscal policy.
• Fiscal policy grew progressively inconsistent with the currency board regime, leading to a sizable public debt in the second half of the 1990s.
• Reduced appetite of foreign investors for emerging market debt caused a sharp slowdown in capital inflows, increasing the marginal cost of borrowing and weakening growth and debt rollover prospects.

Origins of the Crisis

• Fiscal policy played a central role:
  • Persistent cash deficits and "off-budget" debt-creating expenditures added to a mainly dollar-denominated public debt.
  • Fiscal effort was insufficient to produce adequate primary surpluses even during high-growth years after early-1990s reforms.
  • Fiscal problems were attributed to vested interests and resistance to fiscal reforms in the provinces.
• Sustainability depended on maintaining healthy growth, strengthening the fiscal primary balance, and ensuring access to international capital—none of which materialized.
• Structural rigidities and prolonged recession:
  • Real appreciation could not be accommodated due to labor market and fiscal rigidities, producing deflationary pressures on domestic prices and employment.
  • High dollarization made exit from convertibility costly and disruptive; banks were heavily exposed to losses from government default and devaluation risk because of dollar-denominated loans to peso earners.
• Structural vulnerabilities included dominance of the nontradable sector, narrow export base, liberalized capital account, and high reliance on dollar-denominated borrowing.

Developments in 2001–02 (macroeconomic and social)

• Output and prices:
  • After a cumulative decline of 4¼ percent in 1999-2000, real GDP fell by 4½ percent in 2001.
  • Real per capita GDP: 1998 = 2.6; 1999 = -4.6; 2000 = -1.7; 2001 = -5.6; 2002 = -10.8 (Est.).
  • GDP at constant prices: 1998 = 3.8; 1999 = -3.4; 2000 = -0.8; 2001 = -4.4; 2002 = -11.0 (Est.).
  • In the first nine months of 2002 real GDP is estimated to have fallen by 13 percent.
  • Monthly inflation peaked in April 2002 at 10½ percent and slowed sharply from mid-2002.
  • Consumer prices (average): 1998 = 0.9; 1999 = -1.2; 2000 = -0.9; 2001 = -1.1; 2002 = 25.9.
  • Consumer prices (end-of-period): 1998 = 0.7; 1999 = -1.8; 2000 = -0.7; 2001 = -1.5; 2002 = 41.9.
• Labor and social conditions:
  • By October 2002, the unemployment rate is estimated at about 23 percent and a large increase in poverty was reported.
• Public finances:
  • Overall cash deficit of the consolidated public sector increased by 2¾ percent of GDP to 6¼ percent of GDP in 2001.
  • Augmented primary and overall deficits of the consolidated public sector in 2002 are estimated at 11¼ percent and 25¼ percent of GDP, respectively.
  • Public debt-to-GDP ratio estimated to have risen to 119 percent by June 2002.
• External sector and reserves:
  • External current account shifted from a deficit of about US$4.5 billion in 2001 to a surplus of about US$9 billion in 2002 (driven by sharp import contraction; exports flat).
  • Private net capital outflows in 2001-02 are estimated at about US$38 billion.
  • Gross international reserves fell by US$20 billion to about US$10 billion.
  • In 2002, external payments arrears reached about US$8.25 billion, including to multilateral and bilateral creditors.

Executive Board Assessment — findings and judgments

• Directors regretted the acute economic and social crisis since September 2000: contraction of the economy, deterioration in poverty and unemployment, massive loss of confidence, default on foreign debt, and abandonment of the currency board.
• Needed response:
  • Argentina will need to formulate and implement—with support of the international community—a strongly-owned program of stabilization and wide-ranging reforms to resolve deep-seated institutional, macro-economic and financial problems, restore confidence, and rebuild growth and financial sustainability.
  • A transitional program, building a bridge to a comprehensive program, was hoped to be agreed at an early date and include credible commitments in fiscal and monetary policies, actions to strengthen the banking system, and measures to strengthen cooperation with the international community and dialogue with the private sector.
• Causes and earlier policy implications:
  • Currency board was undermined by lack of supporting domestic policies and unfavorable external circumstances, especially deteriorating fiscal performance (including off-budget expenditures, persistent provincial deficits, and revenue mismatch in pension reform).
  • Structural rigidities prevented orderly adjustment to an appreciating real exchange rate.
  • Emphasized importance of addressing vulnerabilities before they become severe and the role of Fund surveillance and conditionality; timely action (including an orderly exit from the currency board) might have prevented a crisis.
• Evaluation of authorities' initial crisis response:
  • Directors regretted delays in developing a consistent policy response and the failure to build political consensus, contributing to policy reversals and higher social costs.
  • Early 2002 measures—converting banks' foreign currency assets and liabilities into pesos at asymmetric exchange rates, and amendments to the insolvency law favoring debtors—were noted to have exacerbated the situation.
• Signs of stabilization and fragility:
  • Encouraged by return to economic stability in the second half of 2002: stabilization of economic activity, slowing inflation, some external improvement, relatively stable banking system and market indicators.
  • Fiscal spending restraint contributed to stability but also reflected controls on foreign exchange transactions and utility prices; stability remained fragile given unresolved fiscal and banking solvency and indications of repressed inflation.

Executive Board Recommendations and Priorities (policy recommendations)

• Five major challenges for durable recovery (to be addressed in a sustained medium-term restructuring effort):

1. Give reassurances about legal certainty and build political consensus for reforms. 2. Establish a robust fiscal framework encompassing the provinces. 3. Continue resolving the monetary overhang and restore confidence in the banking system. 4. Undertake structural reforms to further liberalize the economy and increase trade openness. 5. Restructure debt and reestablish orderly relations with creditors.

• Fiscal policy and social protection:
  • Fiscal solvency is a sine qua non; short-run reliance on tight control over primary spending was necessary.
  • Directors saw expenditure restraint as key to achieving the targeted consolidated primary surplus of 2.5 percent of GDP in 2003 and closing the financing gap without monetization.
  • Ensure social safety net programs are adequately funded and fully operational.
  • Rebuild tax administration and a culture of compliance to raise revenues; Argentina's revenue effort noted as below several other countries in the region.
  • Urged planning and consensus-building for needed tax reforms; welcomed legislation eliminating executive power to grant tax amnesties.
  • Called for elimination of remaining Competitiveness Plans and re-instatement of recently cut VAT rates at the end of the 60-day reduction period.
• Provincial finances and intergovernmental reform:
  • Provincial governments must be firmly anchored in the adjustment effort.
  • Begin comprehensive reform of intergovernmental relations drawing on lessons from poor fiscal performance in the 1990s; design incentive structures ensuring fiscal discipline.
  • Seek early ratification by provincial legislatures of bilateral agreements underpinning 2003 provincial fiscal targets; improve transparency, quality, and timeliness of provincial finance data.
  • Provinces should end issuance of all new quasi monies.
• Monetary policy, banking system, and legal issues:
  • Consolidate a credible monetary anchor; central bank efforts to build monetary control instruments were commended.
  • Risks from potential leakages related to amparos and reprogrammed time deposits to be released in 2003 noted; some Directors saw the risk as low given experience and demand for money.
  • Pending Supreme Court ruling on constitutionality of pesoization of bank deposits adds uncertainty; resolving it in a manner that does not undermine a credible monetary anchor is important.
  • Urged close cooperation with Fund staff on bank resolution and an orderly strategy to identify and resolve weak banks on consistent principles.
  • Encouraged reaffirmation and safeguarding of central bank independence, and early approval of legislation protecting public officials in the bank resolution process.
  • Welcomed central bank efforts to strengthen internal controls and encouraged readiness to take further actions in line with the Fund's safeguards assessment.
• Structural reforms and liberalization:
  • Greater stability provides opportunity to liberalize 2002 exchange controls and initiate wide-ranging reforms to revive investment and growth.
  • Welcomed steps to remove most remaining Article VIII exchange restrictions and ease export surrender requirements; urged further liberalization of compulsory export surrender requirements.
  • Concern about halted tariff increases for gas and electricity companies due to court action; urged an early joint IMF/World Bank diagnostic mission to assess utilities' financial situation and develop an appropriate regulatory framework weighing social impacts.
  • Renewed emphasis on trade liberalization and diversification: further lower trade barriers, seek improved market access in regional and multilateral negotiations, reduce administrative obstacles to exports, and phase out export taxes over time.
• Debt restructuring and relations with creditors:
  • Restructuring public debt is key to normalize relations with private creditors and attract capital flows.
  • Welcomed authorities' contacts with private creditors and intention to intensify dialogue with external debt restructuring advisors; urged progress especially with institutional investors.
  • Urged authorities to advance constructive dialogue with private creditors consistent with the "good faith" criterion under the Fund's policy for lending into arrears.
  • Regretted Argentina's decision to fall into arrears with the World Bank and urged elimination as soon as possible to clear way for Bank's social support under the Heads of Household program.
  • Encouraged remaining current on obligations to international financial institutions.
• Medium-term debt outlook:
  • Even with substantial fiscal adjustment, Directors judged Argentina's medium-term debt outlook very difficult: high debt ratios, very large financing needs, and market access likely to improve only gradually.
  • Urged close work with the international community and intensified efforts to reach cooperative solutions with private creditors to secure financing and achieve fiscal and external sustainability.

Argentina: Selected Economic Indicators (Est. values and historical series)

• National income and prices (annual percentage changes; unless otherwise indicated)
  • Real per capita GDP: 1998 = 2.6; 1999 = -4.6; 2000 = -1.7; 2001 = -5.6; 2002 = -10.8.
  • GDP at constant prices: 1998 = 3.8; 1999 = -3.4; 2000 = -0.8; 2001 = -4.4; 2002 = -11.0.
  • Consumption: 1998 = 3.1; 1999 = -2.6; 2000 = 0.2; 2001 = -13.6; 2002 = (blank in table).
  • Investment: 1998 = 6.5; 1999 = -12.6; 2000 = -6.8; 2001 = -15.7; 2002 = -39.0.
  • Net exports (contribution to growth): 1998 = 0.0; 1999 = 1.4; 2000 = 0.3; 2001 = 2.1; 2002 = 6.4.
  • Industrial production (average): 1998 = 1.6; 1999 = -6.5; 2000 = -0.3; 2001 = -7.6; 2002 = -12.0.
  • Consumer prices (average): 1998 = 0.9; 1999 = -1.2; 2000 = -0.9; 2001 = -1.1; 2002 = 25.9.
  • Consumer prices (end-of-period): 1998 = 0.7; 1999 = -1.8; 2000 = -0.7; 2001 = -1.5; 2002 = 41.9.
• External sector (in terms of U.S. dollars)
  • Exports, f.o.b.: 1998 = 1.0; 1999 = 13.2; 2000 = (blank); 2001 = (blank); 2002 = (blank).
  • Imports, c.i.f.: 1998 = -18.7; 1999 = -19.5; 2000 = -55.1; 2001 = (blank); 2002 = (blank).
  • Export volume: 1998 = 11.6; 1999 = 2.8; 2000 = 4.5; 2001 = 4.3; 2002 = (blank).
  • Import volume: 1998 = 8.7; 1999 = -13.8; 2000 = -16.8; 2001 = -55.8; 2002 = (blank).
  • Terms of trade (deterioration -): 1998 = -5.5; 1999 = -5.9; 2000 = 10.2; 2001 = -0.6; 2002 = (blank).
  • Real effective exchange rate, average (depreciation -): 1998 = 3.5; 1999 = 12.4; 2000 = 6.0; 2001 = -57.3; 2002 = (blank).
  • Real effective exchange rate, year-end (depreciation -): 1998 = 12.6; 1999 = 1.7; 2000 = 2.9; 2001 = -54.7; 2002 = (blank).
• Money and credit / Banking system
  • Net domestic assets: 1998 = 14.6; 1999 = 4.7; 2000 = 3.3; 2001 = 5.0; 2002 = ...
  • Of which: credit to private sector: 1998 = 10.8; 1999 = -2.1; 2000 = -3.8; 2001 = -17.6; 2002 = -37.5.
  • Money (M2): 1998 = 24.7; 1999 = -2.4; 2000 = -2.5; 2001 = 10.7; 2002 = -9.4.
  • Velocity (GDP relative to M2): 1998 = 8.0; 1999 = 7.6; 2000 = 7.8; 2001 = 8.1; 2002 = (blank).
  • Interest rate (30-day deposit rate, in percent) 1/: 1998 = 8.3; 1999 = 16.2; 2000 = 41.8; 2001 = (blank); 2002 = (blank).
• Public sector and external debt (in percent of GDP unless indicated)
  • Public sector savings: 1998 = -0.5; 1999 = -2.2; 2000 = -4.7; 2001 = -2.0; 2002 = (blank).
  • Federal government cash primary balance: 1998 = 0.4; 1999 = 0.1; 2000 = 0.5; 2001 = (blank); 2002 = (blank).
  • Federal government cash overall balance: 1998 = -1.3; 1999 = (blank); 2000 = (blank); 2001 = (blank); 2002 = (blank).
  • Consolidated public sector cash primary balance: 1998 = 0.6; 1999 = -1.4; 2000 = (blank); 2001 = (blank); 2002 = (blank).
  • Consolidated public sector cash overall balance: 1998 = -4.1; 1999 = -3.6; 2000 = -10.3; 2001 = (blank); 2002 = (blank).
  • Gross domestic investment: 1998 = 19.9; 1999 = 18.0; 2000 = 14.2; 2001 = (blank); 2002 = (blank).
  • Gross national savings: 1998 = 15.2; 1999 = 13.8; 2000 = 13.1; 2001 = 12.5; 2002 = 18.8.
  • Current account deficit: 1998 = -4.8; 1999 = -4.2; 2000 = -3.1; 2001 = (blank); 2002 = (blank).
  • Public sector external debt (end-of-year): 1998 = 27.8; 1999 = 29.9; 2000 = 29.7; 2001 = 32.8; 2002 = 83.6.
• Debt service and reserves
  • Public sector debt service (in percent of exports of goods and nonfactor services): 1998 = 38.0; 1999 = 49.6; 2000 = 54.8; 2001 = 65.7; 2002 = 47.4.
  • Of which: interest payments: 1998 = 17.5; 1999 = 22.4; 2000 = 21.7; 2001 = 21.0; 2002 = (blank).
  • Outstanding use of Fund resources (in percent of quota at end-of-period): 1998 = 251.5; 1999 = 154.1; 2000 = 183.2; 2001 = 525.3; 2002 = 499.8.
  • Gross foreign exchange reserves 2/ (in months of imports of goods and nonfactor services): 1998 = 8.2; 1999 = 10.1; 2000 = 9.8; 2001 = 6.6; 2002 = 8.6.

IMF EXTERNAL RELATIONS DEPARTMENT, Public Affairs. Public Information Notice: IMF Concludes 2002 Article IV Consultation with Argentina (July 25, 2003).

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