Background. Since taking office two years ago, Argentina’s new administration has made considerable progress in implementing its ambitious policy agenda. Efforts have been focused on establishing sound macroeconomic policies, restoring credibility, and laying the groundwork for inclusive, balanced, and sustainable growth. Price, currency, and trade controls were removed. Restrictions in the foreign-exchange market were lifted, taxes on exports were essentially eliminated, long-standing disputes with private foreign creditors were settled and subsidies in the provision of public services were reduced. Fiscal targets have been set and the central bank adopted an inflation-targeting regime. In parallel, the government put in place an immediate plan to rebuild the official statistics office (INDEC) which recovered its credibility.
These decisive actions are paying off.
Economic activity has been expanding since the second half of 2016 and growth is set to reach close to 3 percent in 2017. The recession that began in the last part of 2015 ended in Q2 2016 and was the mildest in terms of output loss of the recent recessions suffered by Argentina. Up to the second quarter of this year, growth was 2.7 percent year-on-year, and has been led by investment (7.7 percent year-on-year) and private consumption (3.8 percent). The labor market has improved as well, reacting to the increase in output. The unemployment rate declined to 8.7 percent of the labor force in the second quarter of 2017 (from 9.3 percent in the same quarter last year), with more than 200,000 new jobs created. Meanwhile, real wages have increased and the poverty rate decreased to 28.6 percent, from 32.2 percent in the first half of 2016.
Inflation is on a clear downward trend. Inflation has been very high for many years, with peaks up to about 40 percent. It will finish 2017 below 25 percent, more than 10 percentage points below that of 2016.
The size of public spending and the primary deficit are declining. Execution of fiscal policy this year is on target, with a real increase in tax collections and a reduction of primary expenditure in terms of GDP. Between 2015 and 2017, consolidated primary spending of the general government—including provinces—would decline by 2 points of GDP. Utility tariffs are increasing to be aligned with production costs and subsidies have been reduced (by 23 percent in nominal terms during the first 10 months of 2017) and oriented towards those in need. The improvement in macroeconomic conditions was reflected in the credit rating of Argentina’s sovereign debt which was upgraded twice by Moody’s and three times by S&P during the last two years. In line with rating upgrades, the cost of public debt continues declining and is at historical lows.
While the current account remains negative, this is mainly reflecting the strong rebound of investment. Imports of capital goods explain a large share of the trade deficit. Meanwhile, the central bank has built reserves accommodating strong capital inflows. Reserves increased to more than US$ 54 billion, close to 10 percent of GDP and about 10 months of imports.
Banks remain strong with adequate levels of capital and liquidity. Domestic credit availability is increasing, with total bank credit to the private sector growing above 20 percent in real terms over the last 12 months, amid a decline in interest rates, particularly for mortgages, which are at historical lows. The implementation of indexation of long-term loans (mortgages) was a key factor in explaining the decrease in interest rates
Strong social policies remain in place. Income transfer programs continue to be an essential tool for combating poverty, ensuring a minimum income for those who need it most. The Universal Child Allowance is an ongoing program that has been enlarged and enhanced reaching 3.9 million children (7 percent more than in 2015). Moreover, 4.2 million children were reached by the Family Income Policy framework, of which 1.2 million were incorporated in 2017. The National Plan for Early Childhood was launched at the beginning of 2016 to eradicate malnutrition in children under the age of four. In education, the public system has, for the first time, covered all children over the age of three, benefiting more than 638,000 children. Public pensions have been increased through legislation that brought pensions to the levels mandated by law, which were not met by previous administrations. This adjustment will reduce litigation by beneficiaries and contingent liabilities of the public sector.
The top medium-term government priorities.
Building on this success, the authorities continue addressing the top medium-term government priorities. Higher levels of investment are needed to sustain rapid growth and employment to sustainably reduce poverty, the overarching objective of the administration. The economy is expected to grow by 3.5 percent in 2018, a rate among the highest in Latin America. The goal over the medium-term is to maintain this level, supported by lower taxes and productivity-enhancing reforms. At the same time, the government is strongly committed to strengthening institutions and modernizing the state, enhancing the social safety net, and ensuring that social expenditures and public services reach the poorest sectors of society. Following October’s mid-term elections, which resulted in strong support for the administration, President Macri has launched a number of initiatives to address structural problems. These initiatives can be grouped in three main areas: fiscal responsibility and tax reduction; employment generation; and institutional strengthening.
Fiscal responsibility and tax reduction.
The authorities are addressing long-standing issues that have affected public finances and continue to move forward with the objective of reducing the size of the State in the economy, to allow for a decline in the tax burden and a reduction of the deficit of the public sector. A political agreement with provinces has been reached to pass legislation by end-2017 on fiscal responsibility, a fiscal pact, a tax reform, and a social safety net reform. The laws implementing this agreement, described below, are expected to be approved by Congress before year-end.
Fiscal responsibility law. The draft law includes limits to the growth of public spending at the national and subnational levels, with the objective of maintaining real expenditures constant, ensuring a decline in terms of GDP. Importantly, all jurisdictions commit to avoiding an increase of public employment above population growth.
Fiscal pact with subnational governments. Revenue-sharing agreements between the federal and provincial governments have been historically contentious. There are important asymmetries in the distribution of revenue vis-à-vis the economic size of provinces, notably against the province of Buenos Aires, and most jurisdictions have raised constitutional challenges to laws establishing revenue-sharing agreements. As a result, there is a large number of lawsuits pending resolution by the Supreme Court of Justice, with contingent liabilities for the federal government of up to 7 percent of GDP. Congress is considering a law that will rebalance revenue-distribution and most importantly, will result in most provinces dropping the judicial claims against the federal government.
Tax reform. Tax reform aims at reducing the overall tax burden and the most distortive taxes, providing incentives to investment and employment, and adding progressivity to the overall taxation of wage income. The reform now in Congress will further reduce taxes by 1.5 percent of GDP over a period of five years. Key features include: (i) reducing the corporate income tax rate from 35 to 20 percent when profits are reinvested, (ii) accelerated refunds of VAT credits on investment, (iii) elimination of employers’ social security contributions for workers earning less than AR$12,000 (approx. US$685) per month, while eliminating the cap on social security contributions for wages above AR$82,000 (approx. US$4,685) per month, (iv) crediting the financial transaction tax against the corporate income tax, (v) rebalancing excise and fuel taxes, and (vi) taxing individuals’ financial income. To address problems generated by the lack of inflation adjustment of businesses’ income statements on their tax liabilities, a one-off adjustment in the value of corporate assets will be allowed on a voluntary basis, at a cost of 5 percent of such revaluation. In the context of the fiscal pact with subnational governments, provinces are committing to gradually reduce their most distortive taxes over time—mostly Ingresos Brutos, a turnover tax creating cascading effects, and the stamp tax.
Reducing and focalizing subsidies. While domestic oil prices already reflect international parities, utility rates remain below cost. The authorities will adjust electricity, gas, and transport rates, aiming at achieving cost-recovery ratios between 80–90 percent by end 2018 and near 100 percent in 2019. Social tariffs for electricity and gas will remain in place to protect lower income households.
Social safety net reform. Social transfers (pensions, family allowances, universal child allowance) have been indexed in the recent past using a formula combining the growth of tax revenue and salaries, in the absence of reliable inflation data. This adjustment led to distortions. Keeping the objective of at least maintaining the real value of these transfers, a new formula for quarterly indexation will be enacted reflecting inflation (70 percent) and salary growth (30 percent). A fundamental analysis of the pension system and a proposal for reform—addressing sustainability and equity considerations—are expected to be concluded in a couple of years.
Tax administration. The high legal tax burden has resulted in elevated levels of tax evasion and informality. While the tax reform will help address these, the tax administration office (AFIP) continues to make important progress in the fight against tax evasion, with improvements in the administration of taxpayers’ debts, better compliance indicators in key sectors, and enhanced control of electronic invoices. The automatic exchange of information with foreign jurisdictions, as agreed by OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes, has started.
Fiscal projections. As a result of this comprehensive approach, the authorities expect consolidated public spending to decline from 41 percent of GDP in 2017 to 33 percent of GDP in 2023 (assuming the economy grows at 3.5 percent per year). For the federal government, the primary deficit will decline to 3.2 percent of GDP in 2018, with primary spending falling to 22 percent of GDP. The debt of the federal government with the private sector and international organizations will increase to 31 percent of GDP in 2018, among the lowest in the region, and is expected to stabilize at 37 percent of GDP by 2020. Provinces are expected to achieve a primary balance in 2018—from a deficit of 0.5 percent of GDP in 2017—and will use the fiscal space gained over time with the operation of the fiscal responsibility law and the fiscal pact to reduce distortive taxes. According to the authorities’ projections, the total tax burden (federal and provincial) will decline by 3 points of GDP in the next five years, totaling a decline of five points of GDP since 2015.
Reducing inflation. In the monetary area, the central bank will continue operating an inflation-targeting regime, with the objective of reducing inflation to 5 percent over the medium term. Given still high inflation, monetary policy is expected to maintain its contractionary stance through high real policy interest rates.
The second area of the strategy is to spur employment creation in the formal economy, the only sustainable way to inclusion and poverty reduction.
Labor reform. The main measures under discussion include a mechanism to formalize employment relations, reduce the tax wedge on low-income earners (via the announced tax reform), reduce litigation related to labor relations, and expand on-the-job training. To reduce conflicts related to accidents in the workplace, a new law has already been enacted clarifying the framework, to which provinces are expected to gradually adhere.
Expanding access to credit. The authorities are working towards developing domestic capital markets to finance development. The new capital markets law, expected to be approved before year-end, seeks to give strong support to SME financing; increase investor protection; facilitate public offerings of stocks; spur development of the mortgage market and financial inclusion; promote long-term savings; strengthen the infrastructure of capital markets; and improve the independence and oversight capacity of the supervisor (Comisión Nacional de Valores). In parallel, the central bank will work towards maintaining financial stability and pursuing the sound expansion of the financial sector, promoting the use of local-currency saving instruments to finance credit expansion in local-currency at longer maturities and lower rates. In this context, priorities include increasing access to bank services by all segments of society and promoting the use of electronic payments, contributing to the formalization of economic activity.
Modernization of the State. Administrative simplification will help reduce the regulatory burden of the State on the private sector and increase productivity. The main elements of this program include the elimination of redundant requirements for businesses to operate, the possibility of filling these requirements online, the unification of registries across public offices, and the implementation of e-files in the public sector. Online procurement systems have been launched to increase transparency and competition. Procedures for setting up small businesses have been streamlined and it is now possible to register a business in 24 hours. To facilitate international trade, a one-stop online system is being built and currently 80 percent of export and import requirements can be filled online. A plan geared towards setting optimal personnel allocations in the public sector is ongoing, which will serve as a benchmark for rationalizing public employment while maintaining high-quality service.
Rebuilding infrastructure. While much progress has been achieved with better prioritization and efficiency of investment projects undertaken by the public sector, infrastructure needs remain very high. The new law for public-private partnerships approved in 2016 allows for new investment carried out by the private sector with limited fiscal risks and high transparency standards. About 60 projects have been identified (in transport; energy; communications and technology; water, sewage and housing; and health, justice, and education) and included in the 2018 budget to be undertaken under PPPs, resulting in additional investment of about 1 percent of GDP per year in the next three years. Successive budget laws will include clear information about the degree of advance of each project and the fiscal impact through public spending commitments and public guarantees.
The third area of the strategy consists of passing reforms to improve the functioning of the justice system, the electoral system, and prevent and punish corruption. Since December 2015, the administration has focused on implementing anticorruption policies and promoting integrity and transparency in public administration. Transparency will increase with the implementation of the new law of Access to Public Information enacted in 2016. The new Repentant law reduces sanctions to individuals that provide information contributing to avoiding a crime or clarifying facts under investigation. A law is under discussion in Congress to punish private corporations for corruption offenses and make anticorruption policies more effective. At the same time, the executive power has issued decrees clarifying disclosure rules to avoid conflicts of interest in economic relations with the public sector and strengthened financial disclosure of public sector officials.
I hope that with these remarks I have been able to transmit to the Executive Board the fundamental policy change taking place in Argentina. The transit to sustainable macroeconomic policies is being implemented while avoiding any major macroeconomic crisis, so prevalent in Argentina’s history. Continued action is necessary. In the words of President Macri, these are the times of permanent reform, to unleash private sector initiative and sustain development. Argentina has embarked on a transformation to fully integrate into the global economy. While not without risks, the strategy is solid and it is homegrown.
I would like to thank IMF staff for their contributions to policy discussion and the work done during this consultation. Some of the tensions identified by staff are indeed present. Nevertheless, it is the view of the authorities that a faster pace of deficit reduction would put the economic recovery and social cohesion at risk. In the current juncture, the overall level of taxation can only go down, and any significant cut in the wage bill or social transfers, in the order of magnitude and with the timing suggested by staff, would have a large impact on domestic demand and growth. The authorities also believe that staff has overestimated the revenue loss associated with the tax reform. This said, the authorities remain open to considering an acceleration of the pace of fiscal consolidation should upside risks to growth materialize. The stance of monetary policy will continue aiming at achieving a gradual reduction in the inflation rate.
My authorities want to emphasize that their fiscal strategy would lead to a sustained decline in the public debt ratio. Staff assumes that the fiscal position measured by the primary balance remains at a deficit of broadly 2 percent of GDP beyond 2019, while the authorities’ objective is to continue with the 1-percent-of-GDP annual reduction of the primary deficit until a primary surplus is achieved (the authorities’ DSA can be found in the draft budget law for 2018 submitted to Congress). In addition, the authorities expect medium-term growth to stand at 3.5 percent of GDP compared to about 3 percent assumed by staff.
The increase in the external current account deficit calls for vigilance, but is also the natural result of years of financial autarky, as revealed by a positive NIIP, which contrasts with the level that could be expected for a country at Argentina’s stage of development. Exports should improve in the face of better regional growth prospects, notably in Brazil. The authorities are confident that their economic strategy will yield important productivity gains and improve the external balance. One example is the energy sector. Staff rightly notes that, at present, higher oil prices constitute a negative terms-of-trade shock (staff report, Annex I, paragraph 1). This should not hold for long. For many years, Argentina was a net energy exporter and has the resources to return to that position (in the last five years to 2016, the energy trade balance averaged a deficit of 0.8 percent of GDP, which compares with a surplus of 2 percent of GDP in the preceding decade). It only needs time for the right incentives, which are being set in place, to affect supply and demand.