Argentina: Request for Stand-By Arrangement and Request for Extension of Repurchase Expectations

Good progress has been made in stabilizing the economic and social situation since the crisis. Fiscal adjustment over a prolonged period will bring the public finances to a sustainable path. To protect social expenditures and allow higher public investment, a comprehensive tax reform is required. Strengthening central bank autonomy is essential for the successful implementation of inflation targeting and restructuring of the financial system. Full cooperation with the multilateral development banks is important to secure necessary program financing, re-establishing sustained growth, and reducing widespread poverty.


Good progress has been made in stabilizing the economic and social situation since the crisis. Fiscal adjustment over a prolonged period will bring the public finances to a sustainable path. To protect social expenditures and allow higher public investment, a comprehensive tax reform is required. Strengthening central bank autonomy is essential for the successful implementation of inflation targeting and restructuring of the financial system. Full cooperation with the multilateral development banks is important to secure necessary program financing, re-establishing sustained growth, and reducing widespread poverty.

I. Introduction

1. The Argentine authorities have prepared an economic program aimed at reestablishing sustained growth and reducing widespread poverty. Toward this end, the program seeks to address vulnerabilities arising from the massive debt overhang in the public and private sectors, an undercapitalized and unprofitable banking system, and a poor investment environment. The authorities have requested that this program he supported by a three-year Stand-By Arrangement (SBA) in an amount equivalent to almost SDR 9.0 billion (424 percent of quota), to succeed the transitional SBA that expired on August 31, 2003. In addition, they have requested that repurchase expectations arising during the first year of the arrangement (about SDR 1.9 billion) be extended to an obligations basis. Given scheduled repurchases, full utilization of the proposed arrangement would leave Fund exposure broadly unchanged by the end of the arrangement at SDR 10.9 billion, or 517 percent of quota—although exposure is phased to fall in the first year of the arrangement before recovering as structural reforms take hold.

2. The critical condition for the success of the program is adequate political commitment to its implementation. This staff paper begins by reviewing the achievements and lessons from the transitional arrangement, and the political context, as essential background to assessing the prospects for success of the proposed program. Section III of the paper explains the strategic goals of the medium-term framework for 2004-06, especially the outlook for key macroeconomic targets and core structural reforms that are focused in three main areas: structural fiscal reforms, the banking system, and institutional reforms to improve the investment climate. The details of the economic program for 2003-04, the first year of the arrangement, are contained in Section IV. Section V reviews program financing issues, including the key role that is being played by official sector financial support, and points to the risks to the program and, thereby, to the Fund. The staff appraisal, contained in Section VI, expresses staff support for the program, while assessing the manifold risks to it that will require rigorous implementation of planned measures and a generally improved political consensus in Argentina.

II. The Transitional Arrangement: Achievements and Lessons

3. The transitional SBA that expired in August was approved after protracted negotiations in 2002 failed to result in an agreement on a sustainable medium-term program. The transitional program aimed at: (i) maintaining macroeconomic stability through the May 2003 presidential elections; (ii) initiating some structural reforms; and (iii) giving time to the new government to develop a medium-term reform agenda. The program was narrowly focused on fiscal and monetary policies during the first half of 2003, and on initiating a banking strategy and fiscal reforms. To provide breathing room during the political transition, the program aimed at zero net payments to the IFIs, and allowed for the accumulation of arrears on defaulted public debt predicated on good-faith efforts in negotiations with creditors.

4. The transitional program has helped maintain macroeconomic stability. Close implementation of the agreed quantitative fiscal and monetary programs, together with an abatement of political uncertainties, provided the basis for a rebound in confidence and output, and a strengthening of financial variables in 2003 (Figures 1-4).

Figure 1.
Figure 1.

Argentina: Indicators of Real Activity

Citation: IMF Staff Country Reports 2003, 392; 10.5089/9781451801385.002.A001

Sources: Ministry of Economy of Argentina; and INDEC.
Figure 2.
Figure 2.

Argentina: Confidence Indicators

Citation: IMF Staff Country Reports 2003, 392; 10.5089/9781451801385.002.A001

Source: Central Bank of Argentina, Ministry of Economy, and INDEC.
Figure 3.
Figure 3.

Argentina: Recent Monetary Developments

Citation: IMF Staff Country Reports 2003, 392; 10.5089/9781451801385.002.A001

Source: Central Bank of Argentina.
Figure 4.
Figure 4.

Argentina: External Sector Developments

Citation: IMF Staff Country Reports 2003, 392; 10.5089/9781451801385.002.A001

Sources: Argentina Ministry of Finance; and staff estimates.
  • Output and employment have been recovering and inflation has fallen. Real GDP has been growing by 5-6 percent in 2003, driven by a gradual recovery in private consumption, a rebound in investment from a low base and, more recently, by strong growth of agricultural exports. Unemployment has declined to 15½ percent in May 2003 (from a peak of 21½ percent last year), but about 55 percent of the population still remains below the poverty line. The increase in consumer prices so far this year has been contained to 2½ percent, reflecting the still large output gap, the appreciation of the peso, and the continuing freeze on utility tariffs.

  • The peso has appreciated and interest rates have declined. The peso has appreciated by about 15 percent against the U.S. dollar this year, mainly reflecting large trade surpluses (averaging about US$1½ billion a month), a stronger demand for local assets, and continued accumulation of arrears. The central bank has made net purchases of about US$3.8 billion in the foreign exchange market, bringing gross international reserves to about US$13.6 billion at end-August; during January-August, net payments to the IFIs totaled about US$1 billion, Interest rates on three-and six-month central bank paper (lebacs) have fallen to about 4 percent and 7¼ percent, respectively, compared with over 25 percent at the beginning of the year.

  • Tax revenue increased sharply and fiscal spending pressures were resisted. The authorities remain well on course to meet the program objective of a consolidated primary surplus of 2½ percent of GDP in 2003. Indeed, the consolidated primary surplus has been overperforming relative to the bi-monthly targets. This overperformance has reflected stronger-than-expected income tax revenues and tight control over spending at both the federal and provincial levels, while arrears on VAT refunds to exporters have been reduced by over 20 percent.

  • A prudent monetary policy stance contributed to reducing inflation expectations. As confidence and economic activity improved during the first half of 2003, and the peso appreciated, the monetary program was adjusted to accommodate faster growth in base money, which mainly reflected strengthened money demand and more rapid reserve accumulation. These conditions facilitated the liberalization of the bulk of exchange controls, the lifting of most restrictions on bank deposits in April-May,1 and the beginning of the steady redemption of quasi-monies.2 In the first eight months of 2003, private sector deposits grew by 15 percent and the banking system liquidity ratio rose sharply to over 25 percent, reflecting deposit growth, high legal reserve requirements, and lack of new bank lending (private credit is down by 9¾ percent in the year, but the decline appears to be bottoming out).

5. However, progress on structural reforms was limited and there were policy reversals and setbacks. This experience conveys clear lessons about the importance of political consensus for carrying forward structural reforms in Argentina. As indicated above, structural measures under the program were confined to initial steps on bank restructuring, preparation of fiscal reform legislation, and maintaining a measure of legal certainty. Even this streamlined structural reform agenda suffered important delays. There were also a number of setbacks including: (i) the introduction of excessive, albeit temporary, forbearance in bank regulations, which continues to delay the assessment of the true financial condition of banks as well as their restructuring; and (ii) the further erosion of creditors’ rights through a temporary stay on mortgage foreclosures, and the exemption of Argentine-owned media companies from the cramdown provision in the insolvency law.

6. The banking system is currently liquid but continues to generate significant Josses, and credit has still to revive (Annex I). Monthly losses were nearly Arg$600 million during the first half of 2003, after losses of Arg$1.5 billion a month in 2002. Bank losses mainly result from: (i) high nonperforming loans (which average about 50 percent of total loans); (ii) an interest rate mismatch between assets and liabilities; (iii) the asymmetric indexation of bank assets and liabilities; and (iv) the court ordered repayment of deposits (amparos), from which losses are estimated to total about US$2½ billion.3 In August, congress approved amendments to the financial institutions law and the central bank charter that strengthen the bank resolution capabilities of the central bank, introduce limited protection for officials involved in bank resolution, and give greater scope for credit to government associated with payments to IFIs. Argentina’s experience demonstrates again that an unrestructured banking system will find it difficult to revive lending.

7. Preparations have recently advanced for the planned restructuring of public debt.4 Financial advisors were appointed in February 2003 to assist in designing the framework for the debt restructuring and in managing relations with private creditors. A series of meetings with private creditors was held in early June 2003, and selected creditors were subsequently invited to join consultative groups set up by the authorities to share information and better understand investors’ needs and expectations. So far, four creditor consultative groups—representing institutional and retail creditors from the United States, Europe and Japan—have been formed. Nevertheless, some creditors have been frustrated by the limited progress in carrying these initial steps to a decisive stage and by continuing uncertainties about the government’s intentions regarding the restructuring—conveying the clear lesson about the importance of moving quickly to normalize relations with all creditors.

8. There appears to have been little restructuring of private corporate debt. About 65 percent of the roughly US$50 billion (40 percent of GDP) of private corporate debt is estimated to be nonperforming (a large portion of which is accounted for by the utility companies) with creditors mostly being nonresidents (Box 2). Most of the completed deals are reported to be refinancing or rollover operations, rather than the deep restructuring (e.g., debt reduction and debt-to-equity conversions) that is often needed in a post-crisis environment to ensure debt sustainability. The limited progress appears to reflect mainly uncertainties regarding future economic policies, and delays in renegotiating utility companies’ concession agreements and approving interim tariff increases. The lesson from this experience, as well as from the experience of other crisis countries, is the importance of creating the necessary conditions for private debt restructuring in order for investment and growth to revive in a sustained way.

III. Proposed Medium-Term Framework

A. Political Context

9. President Kirchner’s government took office in late May, ending a prolonged period of political uncertainties about the presidential succession. Many observers assess that President Kirchner’s initial actions have given priority to consolidating his popular base with the people. Since the election, the President has enjoyed exceptionally high approval ratings in the opinion polls. The polls indicate particular support for recent actions supporting human rights and attacking corruption and vested interests. Congress has generally supported the President on these measures. Some of the President’s early actions have included: (i) retiring high ranking military officers; (ii) bringing to justice military officers accused of crimes committed during the military regime of 1976-82; (iii) tackling corruption in the federal police and pensioner welfare system; and (iv) supporting the impeachment of Supreme Court Justices.

10. The government’s economic strategy has taken some time to emerge. The President has spoken repeatedly about the importance he attaches to Argentina moving away from crisis-oriented economic measures, and to normalizing economic relations and policies. However, on sensitive issues such as utility tariffs, bank compensation, and external creditors, many in the administration appear to have adopted a relatively hard line.

11. Provincial and gubernatorial elections, concentrated in the August-December period, have kept many political uncertainties alive. Before the end of this year, some 17 provincial governors will be elected along with one-half of the lower house (130 seats) and one-third of the Senate (24 seats). President Kirchner is backing a range of candidates in an attempt to build a center-left political base of his own, and deepen his influence in congress. Thus, the outcome of these elections will be crucial for the orderly implementation of the medium-term economic program because many initiatives, especially involving fiscal and other structural reforms, will require support from congress and provincial legislatures.

B. Strategic Goals

12. The strategic goal of the program is to deepen and broaden structural reforms that are essential for restoring sustained growth and reducing poverty (MEFP ¶3).5 Medium-term growth depends upon strong policy implementation, particularly with respect to achieving sustainable public finances (including through restructuring public debt), advancing implementation of the bank strategy, and making decisive progress in private debt restructuring. These policies need to be supported by other essential structural reforms aimed at institutional strengthening, including of the tax system, intergovernmental relations, central bank independence, and legal predictability. However, a strong political consensus still needs to be developed in these areas. Accordingly, the program’s strategy envisages a carefully sequenced agenda, allowing sufficient time for developing support and implementing it (¶4).

13. The strategic objective for public debt is to reduce the debt-to-GDP ratio from its projected end-December 2003 level of about 150 percent of GDP to a sustainable level—thereby building market confidence and allowing Argentina to regain market access. This requires: (i) a significant increase in the consolidated primary surplus; and (ii) reaching agreement with creditors on a debt restructuring that will need to involve significant debt service relief and the rollover of most maturing domestic debt during the program period. It is important that the authorities move as quickly as possible to complete a restructuring that is both acceptable to creditors and fits within a credible financing envelope, as the longer an agreement is postponed, the greater the threat of litigation against Argentina.

14. Raising the consolidated primary surplus over the medium term is needed to: (i) meet obligations due to multilateral and official creditors, and on currently performing debt (“phase 1” debt, plus bonds issued to compensate banks, depositors, and civil servants);6 and (ii) underpin an early and credible restructuring of defaulted debt, including “phase 2” debt (Annex II). The authorities have yet to quantify the path for the primary surplus of the consolidated public sector beyond the target of 3 percent for 2004, although they have committed to raise the surplus to levels sufficient to meet the above objectives (¶8). However, even primary surpluses in the range of 4½-5 percent of GDP, and a debt restructuring involving a haircut on phase 2 debt deeper than that indicated by current prices of defaulted bonds, would leave the post-restructuring debt ratio at uncomfortably high levels for several years.

15. Fiscal structural reforms are needed to achieve the required primary surpluses. With public spending already compressed, and concentrated largely on wages and pensions at the federal level, there is not much scope for large-scale spending cuts in the short term. Further fiscal consolidation to achieve the required primary surplus must, therefore, be sought mainly by implementing structural fiscal reforms aimed at boosting revenues, limiting expenditure growth and improving its efficiency, and anchoring adjustment at the level of the provinces. These fiscal reforms are anticipated to be developed during 2004 and implemented in 2005.

16. Comprehensive reforms are needed to restore the soundness of the banking system and restart financial intermediation. The priorities are to phase out regulatory forbearance, and rebuild banks’ capital and profitability. The latter is likely to involve further consolidation of the banking system and reform of the public banks. The challenge will be to ensure that bank resolution proceeds in an orderly way, and that fiscal costs do not undermine the public debt objective. Critical measures are planned for the first year of the program.

17. A more predictable legal environment and accelerated restructuring of troubled corporate debt are essential complements to the banking strategy. The primary role of the government would be to improve the legal, regulatory, and institutional conditions needed to facilitate restructuring and normalize relations between creditors and debtors. Advancing the restructuring of utility company debt will be crucial to the success of the debt restructuring strategy. In addition, instilling greater legal predictability is key to a fundamental transformation of the investment climate. The specific measures to achieve these objectives are phased for implementation during the program period; it will be imperative to avoid developing inconsistent initiatives that would adversely affect market assessment of legal predictability.

18. A wide range of institutional reforms is also envisaged. The policy framework in other structural areas includes changes to the central bank charter to strengthen independence and move toward an inflation targeting framework, reform of the regulatory framework for the privatized utility companies (including provisions for tariff increases), further liberalization of exchange controls, improvements in tax administration and budget management, a start on pension reform, and efforts to remove constraints on exports. These reforms have been sequenced for implementation during 2004–06.

C. Macroeconomic Framework

19. The proposed macroeconomic framework aims to lay the basis for sustained growth and low inflation, reduced poverty and unemployment, and restoring a viable debt position (¶5-6 and Annex III). The framework assumes a steady improvement in confidence to reestablish market access for the public and private sectors, and to induce a reflow of flight capital.

  • Growth. The authorities expect growth to remain robust through 2003-06, underpinned by a recovery in investment and a gradual return of private capital flows (Text Table A and Table 4). However, by 2006, real output will still be below the 1998 level.

  • Inflation. Core inflation would be maintained in single digits during the program period, although headline inflation is projected to rise temporarily in 2004 on account of utility tariff adjustments.

  • External. The large trade surplus is projected to decline somewhat, as the output gap narrows and the real exchange rate appreciates (Table 5). The framework provides for additional reserve accumulation of about US$4½-5 billion from current levels, thereby increasing gross international reserves to about US$18½ billion by end-2006 (Table 6).

Text Table A.

Macroeconomic Framework, 2003-06

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Year-on-year percent change

Table 1.

Argentina: Net Debt Service to the IFIs, 2003-06

(In billions of U.S. dollars)

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Sources: IMF, World Bank, and IDB.

For the Fund, January-September.

Figures for the Fund are for the period of the arrangement (September 2003-06).

Assumes an exchange rate of USS1.3875 per SDR.

Repurchases are on an obligations basis.

Preliminary projections.

Table 2.

Argentina: Proposed Schedule of Purchases Under the SBA, 2003-06

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Assumes an exchange Tate of USS1.3875 per SDR.

Alt purchases are subject to adherence to the continuous performance criteria In addition, and for the period that sovereign arrears to private external creditors persist, purchases will be subject to financing assurances reviews.

Table 3.

Argentina: Quantitative Performance Criteria and Indicative Targets, 2003-04 1/

(In millions of Argentine pesos, unless otherwise noted)

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Continuous and structural performance criteria also apply. The performance criteria will be calculated as defined in the Technical Memorandum of Understanding.

Actual figures for end-August 2003.

Includes quasi-monies in circulation.

As described in the Technical Memorandum of Understanding.

Table 4.

Argentina: Selected Economic and Financial Indicators, 1999-2006

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Sources: Ministry of Economy; Central Bank of the Republic of Argentina; and Fund staff estimates.

2003 data are at end-May, other data are end-October.

Includes quasi-monies in circulation.

2003 data are as of end-August.

Excludes interest due on nonperforming debt.

Includes payments on unrestructured public and private debt.

Figures are staff estimates based on authorities’ data.

2006 end-period number reflects the assumption that no successor arrangement is in place after September 2006.

In billions of U.S. dollars. Historical figures include foreign currency securities Tepoed by the BCRA to banks.

Table 5.

Argentina: Summary Balance of Payments, 1999-2006

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Sources: Ministry of Economy and Fund staff estimates.

Inc1udes interest due on nonperforming debt but excludes interest on arrears.

Includes errors and omissions.

Gross. reserves before 2002 include foreign currency securities repoed by the BCRA to banks. Fund repurchases are on an obligations basis. SDR amounts are converted to US dollars at a rate of 1.3875 per SDR.

As percentage of exports of goods and nonfactor services.

In months of imports of goods and nonfactor services.

Table 6.

Argentina: External Financing Requirements and Sources, 2001-06

(In billions of U.S. dollars)

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Source: Fund staff estimates based on BCRA data.

Includes interest on nonperforming debt.

Includes errors and omissions.

Includes project loans by MDBs in 2004-06.

Excludes project loans.

Achieving the macroeconomic objectives will depend upon maintaining disciplined monetary and fiscal policies, successful implementation of the banking strategy, improvements in the investment climate, and the good-faith efforts of Argentina to address the debt overhang.

IV. The Economic Program for 2003–04

A. Fiscal Policy

20. The fiscal program is Centered around raising the consolidated primary surplus from 2½ percent of GDP in 2003 to 3 percent of GDP in 2004 (Text Table B and Tables 7-9).7 In 2003, the primary balance target is expected to be met through continued recovery of tax revenues and tight control of spending at the federal and provincial levels. In 2004, adjustment at the federal level would be achieved mainly through improvements in tax compliance as a result of the administrative reforms expected to be approved by congress by end-November 2003 (Box 3 and ¶29), and reductions in primary spending equivalent to about ¼ percent of GDP (Table 8).

Text Table B.

Fiscal Program

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Table 7.

Argentina: Consolidated Public Sector Operations, 1999-2004 1/

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Source: Ministry of Economy; and Fund staff estimates.

Revenues and primary spending before 2003 include payments with bonds.

Includes interest (arrears) on non-performing debt.

Reflects the settlement of obligations in bonds, often as a result of judicial rulings.

Compensation to banks for asymmetric pesoization and asymmetric indexation of balance sheets.

Real spending is calculated as nominal spending deflated by the consumer price index.

Table 8.

Argentina: Federal Government Operations. 1999-2004 1/

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Source: Ministry of Economy: and Fund staff estimates.

Revenues and primary spending before 2003 include payments with bonds.

Includes interest (arrears) on non-performing debt.

Reflects the settlement of obligations in bonds, often as a result of judicial rulings.

Compensation to banks for asymmetric pesoizarion and asymmetric indexation of balance sheets.

Table 9.

Argentina: Provincial Government Operations, 1999-2004

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Sources: Ministry of Economy; and Fund staff estimates.

Reflects the settlement of obligations in bonds, often resulting from judicial rulings.

Staff estimates.

21. Expenditure plans in 2004 will include new spending initiatives on public infrastructure and the core social safety net. Public investment—mainly infrastructure and housing—is projected to increase by about 0.4 percent of GDP (to about 2 percent of GDP). In addition, the ongoing economic recovery has enabled the authorities to shift the focus of core social safety net spending away from employment support in favor of direct assistance programs for the elderly and children. The spending initiatives are to be absorbed mainly by limiting increases in the public wage and pension bill and in transfers for job support programs. The fiscal program also provides for the elimination, by March 2004, of arrears on VAT refunds that have accumulated to exporters (¶13).

22. Contingency measures will be implemented to ensure achievement of the primary surplus targets. In the event of a shortfall in fiscal revenues, or increased spending by provincial governments related to MDB disbursements, the authorities have agreed to take compensating measures. Such measures could include: (i) including excises into the base of the VAT; (ii) increasing excise duties; and (iii) eliminating cross-crediting of the fuel tax against the VAT and income taxes. These measures are envisaged for eventual incorporation in the planned tax reform (¶28).

23. Provincial adjustment is being achieved through spending controls and limiting borrowing (Table 9). Provincial adjustment in 2004 is to be underpinned by the continued operation of bilateral agreements, which are expected to be ratified by provincial legislatures by end-March 2004 (¶17). The staff places the highest importance on early approval and ratification of the bilateral agreements, which provide orderly financing in exchange for a commitment to increase fiscal savings. The bilateral agreements have proven effective, thus far, in anchoring fiscal adjustment by the provinces.

24. The fiscal financing gap for 2004 is projected to be about US $12 billion, after payments on a contractual basis on nonperforming debt (Table 10). The authorities are aiming for a public debt restructuring that would eliminate the financing gaps and achieve a sustainable debt profile over the medium term. An agreement with creditors would reduce the uncertainty stemming from the threat of litigation, though this has been limited thus far. A normalization of relations with creditors, together with a more sustainable debt level, would allow the authorities to rebuild market confidence and regain market access over time.

Table 10.

Argentina: Projected Fiscal Financing Gap, 2004 1/

(In billions of U.S. dollars)

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Source: Fund staff estimates based on Ministry of Economy and Production data.

Assumes that alt debt service will be paid according to contractual obligations.

Includes IMF repurchases on an obligations basis.

Includes interest and amortization of phase 1 debt, bank compensation bonds, bonds issued in the deposit-bond exchange, tax payments with defaulted bonds, bonds issued in connection with court orders, and other debt-creating expenditures recorded below the line.

Defined as debt service (net of intergovernmental debt service) minus primary cash balance.

Assumes 100 percent rollover of phase 1 debt and bank compensation bonds.

To be financed by debt restructuring and other sources.