Argentina: 2016 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for Argentina
Author:
International Monetary Fund. Western Hemisphere Dept.
Search for other papers by International Monetary Fund. Western Hemisphere Dept. in
Current site
Google Scholar Close
Publication Date:
10 Nov 2016
eISBN:
9781475552621
Language:
English
Keywords:
ISCR; CR; deficit; peso bond; GDP; government; headline inflation; poverty rate; government approval rating; potential GDP; job creation; Inflation; government effectiveness
Download PDF (1.2 MB)

Upon taking office in December last year, Argentina's new government faced pervasive macroeconomic imbalances, microeconomic distortions, and a weakened institutional framework. These encompassed unsustainably high consumption levels, historically low levels of investment, and large fiscal deficits financed by money creation, which led to high inflation. Distortions at the micro level included an extensive network of administrative controls (for example, trade barriers, foreign exchange restrictions, and price controls) and a business environment that eroded competitiveness and undermined medium-term growth. There was also an important weakening of the institutional framework for economic policymaking, perhaps most evident in the loss of credibility of the national statistics agency.

Abstract

Upon taking office in December last year, Argentina's new government faced pervasive macroeconomic imbalances, microeconomic distortions, and a weakened institutional framework. These encompassed unsustainably high consumption levels, historically low levels of investment, and large fiscal deficits financed by money creation, which led to high inflation. Distortions at the micro level included an extensive network of administrative controls (for example, trade barriers, foreign exchange restrictions, and price controls) and a business environment that eroded competitiveness and undermined medium-term growth. There was also an important weakening of the institutional framework for economic policymaking, perhaps most evident in the loss of credibility of the national statistics agency.

2006–15: A Legacy of Unbalanced Growth

1. The last IMF Article IV Consultation with Argentina took place in 2006, just as the rebound from the 2002 crisis was beginning to run out of steam. The 2001–02 crisis was one of the worst economic recessions any country has ever suffered. It left scars on the social, political, and economic fabric of Argentina. About one million jobs were lost, unemployment rose to 21 percent, and poverty jumped to over 50 percent of the population. By 2003, an undervalued exchange rate, high and rising international prices for Argentina’s key exports, and the significant reduction in debt service payments that followed the default fostered a fast economic rebound. However, by the mid-2000s, the economy was showing signs of internal strains, overheating, and rising inflation. At the same time, supply-side weaknesses, including an increasingly interventionist role of the government and important relative price distortions, were eating into growth potential.

A01ufig1

Key Macroeconomic Developments

(Percent change, unless otherwise indicated)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: INDEC, Ministerio de Hacienda, Government of the City of Buenos Aires, private think tanks, and Fund staff calculations.1/ Percent of GDP;2/ Staff estimates based on the INDEC IPC-GBA until 2006, private estimates of inflation from 2006 and 2012, and CPI published by the City of Buenos Aires thereafter.

2. Faced with declining growth prospects, the government supported the economy through expansionary macroeconomic policies. A tailwind of high commodity prices and strong demand for Argentine exports, particularly from China, helped. Despite this, macroeconomic imbalances grew as sizable primary surpluses turned to deficit, and monetary financing pushed inflation upwards (although official statistics showed unrealistically low inflation). By 2012, the terms of trade moved against Argentina revealing the full extent of the underlying imbalances that included an overvalued real exchange rate, high inflation, and a steady decline in international reserves. To hold together the inconsistent and unsustainable policy mix, the authorities progressively deepened administrative controls, including trade barriers, foreign exchange (FX) controls (which led to a parallel exchange market), price controls, and pervasive distortions in both markets and incentives. Even with these efforts, the economy moved into recession in late 2015 with inflation ending the year at 27 percent (based on the City of Buenos Aires CPI).

3. The new government, which took office in December 2015, inherited an inconsistent and distorted economic model. The policies of the past decade had pushed consumption to unsustainable high levels, eroded potential growth and international competiveness, resulted in one of the lowest investment rate among emerging market economies, and left Argentina close to a balance of payment crisis with international reserves virtually exhausted. In addition, the good progress made in reducing poverty and income inequality in the years following the 2001 crisis had moved into reverse after 2011 and, by mid-2016, 32 percent of the urban population were living below the poverty line (see Box 1).

A01ufig2

Poverty Rate 1/

(Percent)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: Pontificia Universidad Católica Argentina (UCA), SEDLAC (CEDLAS and World Bank), and INDEC.1/ Poverty line is US$4 per day for SEDLAC and is based on a consumption basket for INDEC and UCA.

2016: A Well-Managed and Necessary Transition

4. In the first few months of the new administration, bold steps were taken to:

  • Remove the various FX controls and let the exchange rate float, unifying the official and parallel exchange markets, and correcting the overvaluation of the peso through a 40 percent depreciation of the official rate in December 2015.

  • Announce a plan of fiscal consolidation to reach a zero primary balance by 2019.

  • Announce an inflation target of 20–25 percent for end-2016, falling to 5 percent by end-2019, and begin the transition towards an inflation-targeting regime.

  • Regain access to international capital markets by reaching a settlement with creditors. This allowed the federal government, provinces and private corporations to issue about US$37.8 billion in bonds in global markets so far in 2016 (US$9.5 billion of which were used to finance the agreement with holdout creditors).

  • Raise utility tariffs, especially in the Buenos Aires metropolitan area by an average of 250 percent for electricity and subsequently by a 100–300 range for natural gas, water and transportation. The most vulnerable were protected through a social tariff that allowed one fifth of the consumers to receive a fixed amount of free electricity and a significantly subsidized tariff for natural gas.

A01ufig3

Debt Issuance in International Markets

(Billions of U.S. dollars, first nine months)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: BCRA and Fund staff estimates.

Poverty in Argentina

The data on poverty published by the national statistics agency (INDEC) in September 2016 after 3 years of suspension show that, as of mid-2016, 32.2 percent of Argentina’s urban population (about 8.8 million people) lives below the poverty line (defined as the level of income needed to satisfy essential necessities for food, clothing, transportation, education, health). Moreover, 6.3 percent (1.7 million people) of the population lives in extreme poverty (with income below what is needed to satisfy basic food necessities). The data stand in stark contrast to the last published statistic, according to which the poverty rate in Argentina was 4.7 percent in the first half of 2013.

Argentina: Poverty Rate

(Percent, 2016Q2)

article image
Sources: INDEC and Fund staff calculations.

The new data released by INDEC also show that about 23 percent of Argentine households (about 2 million) lives below the poverty line, with their income being on average about 37 percent below the poverty threshold (12,850 pesos or about US$900 per month). About 5 percent of households lives in extreme poverty, with an income that on average is 40 percent below the threshold (4,930 pesos or about US$350 per month). The geographical distribution shows that poverty is particularly high in the Northeast of the country, where the household poverty rate is about 30 percent, compared to slightly below 20 percent in the southern (Patagonica) region. The poverty picture is particularly worrisome when looking at the age distribution, with about 47½ of children living in poverty and nearly one in ten children in extreme poverty. By contrast, only 8 percent of the elderly population lives in poverty.

While different national definitions and data availability make it difficult to compare poverty rates across countries, based on official indicators Argentina’s rate is among the highest in the region. Based on standardized World Bank/CEDLAS estimates of poverty rates (defined as the share of population living with less than US$4 per day) reveals that, using this definition, in 2014 poverty in Argentina was higher than in Chile and Uruguay but lower than Brazil, Mexico, Peru, and Colombia.

A01ufig4

Poverty Rate

(Percent) 1/

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: SEDLAC (CEDLAS and The World Bank), INDEC, and country authorities.1/ As of 2014 except Argentina official (2016Q2), Chile (2013), Colombia official (2015), and Uruguay official (2015).

  • Eliminate export taxes on most agricultural products (only for soybean and soybean products there was a reduced rate of 30 and 27 percent, respectively).

  • Overhaul the national statistical agency (INDEC) leading to the publication of a new CPI and a revised series for GDP, trade, poverty, and labor market data.

  • Unwind in a controlled way the significant increase in foreign currency forward contracts that were entered into by the central bank in the final months of the previous administration.

5. These measures, while necessary to lay the foundation for robust future growth, inevitably had an adverse impact on the Argentine economy which had already began to contract in the last quarter of 2015. The peso depreciation and increase in utility prices have pushed headline inflation (based on the City of Buenos Aires CPI) to 44 percent year-on-year (y/y) by September (core inflation of 40 percent), and household real disposable incomes have fallen, weakening consumption (Figure 1). To reassert control over inflation, the central bank quickly reduced the growth in monetary aggregates which had a contractionary impact. Public capital spending fell sharply in the first half of 2016 as the new authorities reviewed the quality of the ongoing projects with the goal of eliminating waste and corruption. Further headwinds arose from weak trading partner demand, notably Brazil, and bad weather conditions. It is important to emphasize that the measures that were taken were indispensable. While the exact form of the counterfactual is difficult to predict, failing to address the unsustainable path that the Argentine economy was on would have led to even worse outcomes that have been all-too-familiar to Argentina—potentially a run on local currency assets, spiraling inflation, an abrupt fiscal adjustment as financing sources were exhausted, and/or a depletion of foreign exchange reserves and balance of payments crisis.

Figure 1.
Figure 1.

Argentina: Effects of the Transition

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: Instituto Nacional de Estadística y Censos (INDEC), Asociación de Fabricantes de Cemento (ADFC), Ministerio de Economía y Finanzas Públicas, Ministerio de Argricultura, Universidad Torcuato Di Tella (UTDT), provincial statistical offices, Fundación de Investigaciones Económicas Latinoamericanas (FIEL), Confederación Argentina de la Mediana Empresa (CAME), and Fund staff calculations.
A01ufig5

Monetary Aggregates

(Percent change, y/y, monthly averages)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: BCRA and Fund staff calculations.

6. The authorities responded proactively to the downturn with a moderate fiscal stimulus and a steady reduction in policy interest rates in the second half of 2016. Federal primary spending fell by 8 percent in real terms in the first 7 months of 2016 as capital projects were scrutinized, the irregular hiring of about 10,000 public employees was reversed, and utility subsidies were reduced. This was despite an increase in pensions,1 unemployment benefits, and child benefits in the early days of the new administration. By mid-year, efforts were being taken to support the economy through public infrastructure projects, transfers to provinces to fund public works, further increases in pension benefits (including the introduction of a universal old-age pension) and unemployment subsidies, and reducing the tax burden for small- and medium-sized enterprises (Table). To further raise fiscal resources, a tax amnesty program was announced with a 10 percent one-off tax charged on resources declared under the amnesty. Finally, the central bank lowered the policy rate (on 35-day central bank paper) from 45 to 31 percent, in effective terms, as forward-looking indicators of inflation began to fall, maintaining the ex-ante real interest rate in a range between 3 and 6 percent (with ex-post rates exhibiting strong volatility but trailing on average below ex-ante rates since early 2016). As of early October, inflation expectations for December 2017 were slightly above next year’s target band (12–17 percent).

A01ufig6

Real Growth of Federal Primary Expenditures

(Percent change, y/y)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: Ministerio de Hacienda, INDEC, and Fund staff calculations.
A01ufig7

Policy Rate and Inflation Expectations

(Percent)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: BCRA, Consensus Forecast, and Fund staff calculations.1/ Expectations: Consensus until June, BCRA’s REM since July.

Argentina: Fiscal Policy Measures

article image
Sources: Ministerio de Hacienda and Fund staff estimates.

These estimates represent the forgone revenue or savings from the measures implemented in 2016; they are not new measures.

7. The trade balance has returned to a small surplus so far in 2016. The devaluation and the removal of trade restrictions incentivized agricultural producers to sell previously accumulated stocks but adverse weather conditions, weak external demand (notably in Brazil), and lower commodity prices meant that exports were still about 2 percent lower in the first eight months of 2016 than in the equivalent period in 2015 (despite stronger volume growth). The cross-currents from the removal of restrictions on imports, on the one hand, and the depreciation, weak demand, and lower import prices, on the other, left import growth at relatively high levels. The resolution with holdout creditors and a rebound in dividend payments to offshore parent companies (as FX restrictions were lifted) resulted in a modest worsening in the net income account (on a cash basis).

A01ufig8

Goods Trade

(Billions of U.S. dollars, NSA)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: INDEC and Haver Analytics.

8. Capital inflows have maintained the peso within a narrow, market-determined range versus the U.S. dollar. Residents took advantage of the removal of FX restrictions by moving assets abroad in 2016 but these outflows were more-than-offset by public sector external debt issuance. FDI inflows increased modestly (US$1.8 billion in the first nine months of the year, on a cash basis). With a stable nominal exchange rate, the high inflation has appreciated the real exchange rate by 10 percent since the unification of the exchange rate. The external position is judged by staff to be moderately weaker than implied by medium-term fundamentals and desirable policies (Box 2 and Annex I). The authorities have maintained their commitment to a floating exchange rate arrangement, while building reserves opportunistically, mostly through the proceeds of external debt issuances by the sovereign.

A01ufig9

Balance of Payments Flows

(Billions of U.S. dollars)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: BCRA and Fund staff calculations.

Current Accounts and Exchange Rate

Exchange rate and current account developments. Tight controls on balance of payments flows and high inflation caused the real effective exchange rate (calculated using the City of Buenos Aires CPI) to become overvalued by an estimated 50 percent in November 2015. While the removal of FX restrictions in mid-December 2015 resulted in an immediate 40 percent devaluation of the peso, as of August 2016 the real effective exchange rate (REER) was about 10 percent above its early 2016 level. Despite extensive trade and FX restrictions, Argentina’s current account balance deteriorated from near balance in 2012 to -2½ percent of GDP in 2015, reflecting falling commodity prices, strong domestic demand, the real appreciation of the peso, and the sharp worsening of the energy trade balance.

A01ufig10

Real Effective Exchange Rate

(Index, historical average=100)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: Haver Analytics, BCRA, and Fund staff estimates.

Current account and REER assessment. Although there is considerable uncertainty about any estimated range, the real exchange rate appears modestly above the level implied by medium-term fundamentals and desirable policies. The CA-regression approach of External Balance Assessment (EBA) yields a cyclically-adjusted CA norm of about -1 percent of GDP. The desirable fiscal stance subsumed in this estimate is based on a reduction of the overall general government fiscal deficit by about 4 percent of GDP over the medium term (consistent with the authorities’ announced fiscal consolidation plans and staff’s baseline). The assessment also assumes an increase in the FX reserves over the medium term to around US$70 billion. With a 2016 cyclically-adjusted CA deficit of about 2¾ percent of GDP, the current account gap is estimated to be about −1½ percent of GDP. To a considerable extent, this CA gap is explained by the fiscal and FX reserves policy gaps. The external stability (ES) approach suggests that the current account balance needed to stabilize the net IIP position to staff’s estimated steady-state value is about -¾ percent of GDP (see Selected Issues Paper, Chapter 7). Using an estimated elasticity of the current account to changes in the real exchange rate of 0.13 suggests that the REER is overvalued by around 12–15 percent.

Exchange Rate Assessment Tools

(Percent of GDP unless otherwise indicated)

article image
Source: Fund staff estimates.

9. Argentina’s financial system appears resilient to the ongoing macroeconomic transition. Argentina’s financial system is mostly transactional and has generally low exposure to credit or exchange rate risk. Banks are well capitalized (total and tier 1 capital ratios are well above regulatory minimums at 16.2 and 15.3 percent, respectively, as of June 2016), have low non-performing loans (under 2 percent), and relatively large provisions (above 140 percent of nonperforming loans). The liquidity position of the banks appears comfortable, with the liquidity coverage ratio in 2016 well exceeding the minimum set by the Basel Committee. Currency mismatches are low and banks have an aggregate net long FX position which limits risks from a sudden currency depreciation.2 Corporate leverage is generally low since companies mostly lacked access to external funding and the domestic financial system is small. Household debt is also relatively low.

10. The administration’s approval ratings remain high although the political climate is becoming more challenging. Despite the economic recession, the government’s approval rating remains above levels seen during the previous administration, and is one of the highest in Latin America. However, the government does not have a majority in Congress, and passage of legislation is likely to become increasingly complex in the run-up to the October 2017 congressional and gubernatorial elections. A weak economy and high poverty rates are likely to influence the congressional discussion of the 2017 Budget, and high inflation is likely to be at the forefront in the next round of collective wage negotiations (that is about to get underway).

A01ufig11

Corporate Debt

(Percent of GDP) 1/

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Source: BCRA.1/ Data as of 2014, except Argentina as of Dec-2015 (estimated).
A01ufig12

Government Approval Rating and Confidence in Government Index

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: UTDT and Poliarquia.

Outlook and Risks

11. The economy is expected to emerge from recession in late 2016 as the one-off impact of the initial measures to remove macroeconomic distortions begins to fade. Staff is now forecasting growth of −1¾ percent for 2016 as a whole rising to 2¾ percent in 2017, one of the largest growth turnaround in the October 2016 World Economic Outlook. A modest headwind from the planned reduction of the fiscal deficit should be offset by a pickup in private consumption, an improving external environment, and a rebound of private investment. Over the medium term, growth is expected to average around 3 percent as reforms are put in place to strengthen the business environment, encourage investment, lower inflation, and restore order to fiscal finances. However, data challenges and the uncertain process of Argentina’s transition away from its previously unsustainable path create significant uncertainty in the outlook.

12. Inflation will continue to decline at a slow pace due to a relatively high degree of inertia in the determination of wages and prices. Inflation has decelerated sharply since its peak in April, as the pass-through from the exchange rate depreciation and the effects of the tariff adjustment have dissipated. In August and September 2016, official headline inflation was affected by the reversal of the increase in natural gas tariffs, which subtracted about 0.7 percentage points to the index values in both months. Core inflation continued to decline and reached 1½ percent (m/m) in September, consistent with about 20 percent annual rate. However, collective wage bargaining is still likely to inject a backward-looking element into the determination of nominal wages, and this nominal inertia is expected to slow the pace at which inflation falls (Box 3). Headline inflation is forecast to fall to 20 percent by end-2017— assuming nominal wage increases can be held to around 25 percent and energy subsidies are scaled back in line with the budget assumptions—and to single digits by 2021. A faster pace of disinflation appears unadvisable given the significant impact on growth that would accompany such a path for inflation.

A01ufig13

Inflation

(Percent, m/m unless otherwise indicated)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: INDEC, Government of the City of Buenos Aires, and Fund staff calculations and estimates.

13. The primary federal deficit is expected to fall to 4½ percent of GDP in 2017, a close to neutral fiscal stance in cyclically adjusted terms. Based on the authorities’ budget plans, in 2017 spending on pensions and public works is expected to be more than offset by a 1 percent of GDP reduction in transfers to the private sector (half of which reflects lower energy subsidies) and a ½ percent of GDP cut in discretionary transfers to provinces. At 4½ percent of GDP, staff’s forecast of the federal primary deficit is modestly higher than the deficit in the proposed 2017 Budget (4.2 percent of GDP) due to differences in macroeconomic projections. After 2017, the primary federal deficit is expected to improve by around ¾ percent of GDP per year, a result of an elimination of energy subsidies by 2019 and lower spending on goods and services and other current spending. Gross debt of the federal government is projected to fall slowly (from 52 percent in 2015 to 48 percent of GDP by 2021), reflecting the lower deficit and the projected real appreciation of the peso. Despite this adjustment, the gross fiscal financing needs in 2017 are around 11 percent of GDP, which are expected to be met through an increase in external debt, central bank financing of 1½ percent of GDP, and domestic debt issuance. Gross fiscal financing needs are expected to remain substantial over the medium term, averaging 8½ percent of GDP in 2018–19.

A01ufig14

Federal Government: Fiscal Impulse

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: Ministerio de Hacienda and Fund staff estimates.

Inflation, Expectations, and Wages

Some stylized facts. Nominal wages grew at a much faster pace than inflation after the 2001 crisis, allowing real wages to return to pre-crisis levels by 2005. Since then, real wages have been relatively sticky despite recessions in 2009 and 2012. Persistently high inflation and inflation expectations have added to nominal inertia with a wage setting system that is characterized by extensive sectoral wage bargaining and a de-facto high level of wage indexation, despite the lack of formal backward indexation.

A01ufig15

Inflation and Wages

(Percent change, y/y 4-quarter m.a.)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources INDEC, Haver Analytics and Fund staff calculations.

An inflation model. Estimating a small macroeconomic model for Argentina reveals a relatively high degree of persistence in nominal wage growth, inflation, and inflation expectations. Real wages appear to respond relatively weakly to changes in real activity:

p ˙ t = 0.51 p ˙ t e + 0.47 w ˙ t − 0.37 r t + ε p ˙ , t p ˙ t e = 5.4 + 0.57 p ˙ t − 1 e + 0.12 e ˙ t − 0.41 r t + ε p ˙ e , t
w ˙ t = 0.96 w ˙ t − 1 + 0.13 g t + ε w ˙ , t

where p˙t is inflation rate, p˙te inflation expectations, w˙t nominal wage growth, rt the real interest rate, gt GDP growth, e˙t the exchange rate appreciation, and ∊ are shocks.

Model performance and forecasts. The estimated model seems to fit relatively well Argentina’s inflation dynamics over the last decade. Simulating the model forward, shows inflation declining from 39 percent at end-2016 to 20 percent in 2017. This would be accompanied by a further 3¾ percent real appreciation of the peso and 2.7 percent growth in 2017. Using this same model, reducing inflation to 17 percent by end-2017 (the upper end of the central bank’s target band) would require a 400 basis point increase in the path of real interest rates during the course of this year and next, and would result in a one percentage point lower growth in real activity in 2017 relative to staff’s baseline.

A01ufig16

Inflation Model for Argentina

(Percent change, y/y)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Source: Fund staff estimates.

Macroeconomic Assumptions

(Percent change)

article image
Sources: Fund staff estimates and 2017 Budget proposal.

14. The current account deficit is expected to rise steadily to 4¼ percent of GDP by 2021. A steady appreciation in the real effective exchange rate, relatively flat terms of trade, and the swing to sustained growth are expected to add to the current account deficit. This is expected to be financed by higher public debt issuance, some repatriation of offshore funds in 2016–17 (to take advantage of the tax amnesty), and a rise of inward FDI. The central bank is expected to steadily accumulate international reserves from current low levels (to 100 percent of the IMF’s reserve adequacy metric by mid-2018). The reserve accumulation will be largely as a result of converting the proceeds of government external debt issuance into pesos, consistent with the authorities’ commitment to let the exchange rate float freely under the inflation targeting (IT) regime.

15. The outlook is subject to a greater than usual degree of uncertainty but risks appear broadly balanced around the baseline. Argentina is in a process of significant transition to a more market-based economic framework and is simultaneously working to rebuild the statistical information about their economy. The lack of a reliable statistical time series for certain data and the unpredictable consequences of changes in relative prices, the removal of distortions, and a reopening of the economy to international capital flows all add to the uncertainty around future economic outcomes.

16. Upside risks. Staff’s baseline scenario is subject to a number of upside risks (Risk Assessment Matrix Table):

  • A faster rebound in private investment. Argentine companies have relatively low levels of leverage and have neglected investing in new capacity and technologies over the past several years (in large part due to the distortions and policy interventions that the economy faced). Indeed, as of 2015, investment in Argentina is the lowest as a share of output when compared to other economies in Latin America. Under staff’s baseline, the investment rate is expected to pick up gradually over time, consistent with a study of past cases of investment rebounds in advanced and emerging economies, indicating that these rebounds generally take time to build and coincide with an improvement in the fiscal position (see Chapter 1 of the Selected Issues Paper). However, with Argentina re-establishing itself in international markets and with the important efforts to remove domestic distortions already taken this year, private investment (largely financed from abroad and in both tradable sectors and domestic infrastructure) could prove to be much stronger than is assumed in the baseline. This would imply less need for fiscal support to growth and more room for maneuver to both reduce the fiscal deficit and to disinflate the economy with relatively modest output costs.

    A01ufig17

    Gross Fixed Capital Formation

    (Percent of GDP, current prices)

    Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

    Sources: IMF, World Economic Outlookand Fund staff calculations.

  • A more successful tax amnesty. Increased disclosure and information sharing requirements across tax jurisdictions have the potential to create strong incentives to declare assets under the tax amnesty. This would lead to more tax revenues and, insofar as offshore funds of residents are repatriated into government bonds, would meet some of the budget financing needs.

  • A stronger than expected recovery in Brazil. The October 2016 World Economic Outlook assumes Brazil’s growth to rebound to 0.5 percent in 2017 after the 3.3 percent contraction in 2016. Brazil accounts for about 20 percent of overall Argentina’s exports and 50 percent of its manufacturing exports, so each 1 percentage point increase in Brazil’s growth above the 2017 forecast would add an estimated ¼ percentage points to Argentina’s growth.

17. Downside risks. The gradual pace at which macroeconomic imbalances are resolved leaves Argentina vulnerable to both domestic and external shocks:

  • A tightening of external financial conditions. Given the significant gross external borrowing needs of the government, an exogenous tightening of global capital markets could prove very disruptive. At best, a higher cost of financing would worsen debt dynamics and necessitate a stronger fiscal correction over the medium term. At worst, a sudden stop to external borrowing (e.g., owing to higher global risk aversion) could create financing shortfalls. With limited recourse to domestic financing, this could necessitate a more front-loaded fiscal adjustment at a time when external demand would also likely be weakening. Such a downside would create depreciation pressures on the currency and cause the central bank to react procyclically to contain inflation. The relatively high share of short-term foreign currency debt in a few non-financial private sector industries also poses rollover risks (see Annex I).

    Risk Assessment Matrix1/

    article image

    The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path (the scenario most likely to materialize in the view of IMF staff). The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

  • A sudden depreciation of the currency. The continued real appreciation of the peso under staff’s baseline could make the economy vulnerable to an abrupt correction of a currency misalignment. In Argentina’s own history, episodes of a persistently overvalued real exchange rate have eventually led to a sharp devaluation of the currency. Such a sudden correction could lead to a contraction of economic activity and high social costs, as the resulting jump in inflation reduces household’s purchasing power. While the low FX exposure of Argentina’s private sector limits the risk of severe balance sheet effects, the significant (and increasing) FX exposure of the public sector poses a risk to the public debt dynamics. For example, a 10 percent depreciation of the real exchange rate would add about 3½ percent of GDP to the public debt.

    A01ufig18

    Federal Government Gross Debt

    (Percent of GDP)

    Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

    Sources: Ministerio de Hacienda and Fund staff estimates.

  • Higher and more entrenched inflation. Higher nominal wage increases in the forthcoming collective wage negotiations and second-round effects from the increase in utilities tariffs that are scheduled to be implemented would add to inflationary pressures. This could translate into increased concerns about macroeconomic stability, including through a loss of international competiveness, and potentially trigger capital outflows and downward pressure on the currency. Monetary policy would need to react to re-establish a nominal anchor which could further eat into economic activity.

18. Authorities’ view.

  • GDP growth in 2017–19 is expected to accelerate more strongly than in staff’s baseline. Investment and export growth are expected to rebound more rapidly than assumed by staff. The reforms taken in 2016 amount to a significant total factor productivity shock, and are expected to generate a significant rebound of economic activity, reversing the decrease of potential output and income per capita over the past decade.

  • Inflation. Reaching the inflation target 12–17 percent at end-2017 does not look ambitious, as inflation expectations are now at levels consistent with year-over-year inflation being quite close to the central bank’s (BCRA’s) target next year. The authorities noted that the current monetary policy stance is adequate to lower inflation to the target range and that expectations are likely to become more forward-looking as wage and price setters increasingly understand the BCRA’s strong commitment to achieve the announced inflation targets. They also noted that the increase in nominal wages needed to stabilize real wages at last year level varies across sectors. A lower cost of capital and a better economic environment make up space for real wage increases. In short, the authorities do not see a risk to their disinflation path stemming from wage negotiations.

  • Exchange rate. The authorities are confident that the adoption of an IT monetary policy regime with freely floating exchange rate will minimize the risk of currency misalignment as experienced in the past. A strong currency should not deter the rebound of investment, given the improved business conditions, productivity enhancing measures, and the abundance of capital at a time where there is excess saving at a global level.

  • Risks. The authorities view the risks to their outlook as mostly on the upside. Removing the pervasive distortions that were affecting trade and investment has the potential to generate an ever sharper rebound of productivity and investment, which means there is a large upside risk to their growth projections.

Restoring the Foundations for Sustained Growth and Job Creation

A. Fighting Inflation

19. Bringing inflation to a single-digit level is a key priority. The BCRA has managed well the transition to an inflation targeting regime under difficult circumstances, and reconfirmed in September 2016 the inflation targets that were announced early in the year. The pace at which this disinflation is achieved should remain flexible and adapt to circumstances as they unfold, remaining conscious of the economic costs and, particularly, the distributional impact. For example, if inflation inertia remains high, lowering inflation to 5 percent by 2019 could result in sizable output losses (Box 4, and Chapter 4 of the Selected Issues Paper). This is why past episodes of transition from moderately high to single-digit inflation generally occurred over a longer period of time (Box 5 and Chapter 5 of the Selected Issues Paper).

20. To support the central bank’s disinflation efforts, building credibility in the monetary framework will be essential and will serve to lessen the economic and social costs in lowering inflation. Creating robust institutional foundations for monetary policy based on inflation forecast targeting would help build credibility over time and allow price formation to gradually become more forward-looking, lessening the cost of disinflation and lowering the inflation premium that is currently built into the domestic yield curve. The announced establishment of a six-member Monetary Policy Council led by the BCRA Governor and the planned adoption (from January 2017) of the 7-day repo rate as the policy rate are positive developments.3 Other steps that should be taken immediately to strengthen the institutional underpinnings for monetary policy include (see Selected Issues Paper, Chapter 5):

  • Establishing a clear price stability mandate for the central bank with operational independence;

  • Eliminating central bank financing of the fiscal deficit;

  • Moving to less frequent decision points for the policy rate as macroeconomic conditions stabilize (currently rate decisions are taken on a weekly basis); and

  • Continuing to build credibility in Argentina’s inflation statistics.

Inflation Inertia and the Cost of Disinflation

Reducing inflation to a single digit is an essential step to achieve a more efficient allocation of resources, increase savings, reduce income inequality, and ultimately boost the long-term growth potential of Argentina’s economy. Disinflation processes, however, can also have short-term costs on economic activity, which in a large part depend on the credibility of the monetary authorities and the degree of nominal inertia in the economy, or the extent to which wages and prices are set in a forward-looking manner (Blanchard, 1998).1 Using a small macroeconomic model estimated on Argentine data (see Selected Issues Paper, Chapter 4) allows establishing a quantitative link between the degree of nominal inertia in wage and price determination and the output cost of disinflation. With a coefficient on past inflation in the Phillips curve of 0.7, a model simulation bringing inflation from its level in Q1:2016 (33 percent, y/y, based on the City of Buenos Aires CPI) to 5 percent would require real interest rates to peak at 12 percent during the first year, resulting in a cumulative output loss over three years of slightly above 10 percent of potential GDP. However, if a greater weight was placed on forward-looking inflation, the output losses in the same model could be significantly smaller. For example, if the coefficient on lagged inflation in the Phillips curve was 0.5, this would reduce the needed increase in real interest rates by more than 6 percentage points and would halve the 3-year output costs of bringing inflation down to about 5 percent in the model simulation. These results confirm that building credibility about the inflation targets and convincing economic agents to place greater weight on forward-looking inflation in the process of wage and price determination could significantly reduce the short-term output cost of disinflation.

A01ufig19

Output Cost of Disinflation and Inflation Inertia1

(Percent)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Source: Fund staff estimates.1 Maximum annual real interest rate and 3-year cumulative output losses (expressed as percent of potential GDP) in a simulation where inflation is reduced from its level in Q1:2016 to 5 percent using the model described in Chapter 4 of the Selected Issue Papers. The inflation path in the two scenarios is forced to be the same.
1/ Olivier Blanchard, “Optimal speed of disinflation: Hungary”, (1998), in “Moderate Inflation: The Experience of Transition Economies” edited by Carlo Cottarelli and Gyorgy Szapary, IMF and National Bank of Hungary.

Lessons from Past Episodes of Disinflation

Moderate inflation episodes. A sample of 35 episodes of moderate inflation (between 10 and 40 percent, y/y) reveals that, for the bulk (30 cases) it took four years or more to reduce inflation to single rates. In almost half of these cases, it took more than 10 years to get inflation below 10 percent. In many of these cases, the persistence of moderate or high levels of inflation was accompanied by explicit indexation of contracts (which led to a backward-looking process for wage and price formation). As a result, the economic cost of lowering inflation was high, and most countries chose a more extended horizon to bring down inflation. In Latin America, for example, Chile and Colombia defeated inflation over a period of more than 10 years during the 1980s and 1990s, whereas in Mexico it lasted more than four years after the “Tequila crisis.” These countries also saw a significant real appreciation of their currencies during the disinflation process (of about 50 percent in Colombia, 40 percent in Chile, and about 80 percent in Mexico).

A01ufig20

Moderate Inflation Episodes and Convergence to Low Inflation

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Source: Fund staff estimates.

A role for institutions. In many of these cases, reforming the institutional framework for monetary policy was an instrumental ingredient in reducing inflation (see Cukierman and others, 2002, or Jacome and Vazquez, 2008).1 This typically implied granting independence to central banks and assigning them a narrow price stability mandate. Fiscal adjustment also contributed to this effort. For example, Colombia, Chile, and Mexico ran a sizable primary surplus during their disinflation episodes.

A01ufig21

Inflation and Increase in Nominal Wages in Chile, Colombia, and Mexico, 1985–2000

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: Haver analytics and Fund staff calculations.
1/ See Chapter 5 of the Selected Issues Paper for the references.

21. Authorities’ view. The authorities stated that the announced pace of disinflation is appropriate and they expect to achieve the 5 percent per year inflation target by 2019. They noted that many countries that went from moderate to low inflation more gradually over time were facing legal backward indexation (for example, Colombia in the 1990s), which is not the case of Argentina. They also noted that staff is overestimating the output costs associated with disinflation in Argentina. In the past, lower inflation in Argentina was generally associated with stronger, not weaker, economic activity. This suggests that when starting from high and distortionary inflation levels, reducing inflation actually increases economic activity. If expectations were to deviate from the targets announced in September, the authorities would not hesitate to tighten the monetary policy stance as needed to return to the announced disinflation path. Showing the resolution to meet the targets announced (for both inflation and transfers to the Treasury) is an effective way to build the credibility necessary to reduce inflation inertia. The authorities’ position is that changing the monetary policy institutional framework along the lines suggested by staff is effective once credibility has been achieved. Their reading of the experience of other countries was of more mixed results on the role played by such institutional changes. There have been cases where the central bank’s charter was changed after inflation had been reduced, in order to lock-in its benefits, rather than at the beginning of the disinflationary process (for example, the United Kingdom in the 1990s).

B. Restoring Fiscal Integrity

22. The government’s plan to lower the fiscal deficit remains a vital objective. The modest pace of fiscal consolidation for next year implied by the proposed Budget for 2017 seems appropriate given the domestic political and social constraints, and the need to support the economy at a time when the population is still digesting the implications of this year’s costly transition. However, in the event the upside risks materialize, the authorities should take the opportunity to accelerate and frontload the reduction of fiscal imbalances as this would allow for a more accommodative monetary policy stance, ease the upward pressures on the currency, improve the public debt dynamics, and provide more support to the needed rebalancing from consumption towards investment. Similarly, while the pace and composition of the shift in the fiscal position after 2017 will need to remain sensitive to the impact on growth, jobs, and the most vulnerable segments of the Argentine population, frontloading the fiscal correction to the extent allowed by economic, political, and social conditions would be desirable.

23. The needed reduction of the fiscal deficit should be based on a rationalization of government spending. Wages, pensions, and energy subsidies have risen by 11 percent of GDP over the past 8 years. Indeed, public spending in Argentina is now the highest in Latin America and one of the highest among emerging market economies (Box 6). Much can be done to strengthen public expenditure management, improve governance, and increase the efficiency of public spending (see Chapter 2 of the Selected Issues Paper). Specifically, measures should be targeted at:

  • Lowering wage expenditure. A structural reduction in public employment (at both federal and provincial levels) would be facilitated by strengthening payroll management to track and control public employees, undertaking a census to identify ghost workers, and putting in place an attrition-based reduction in government employment. In addition, decisions on nominal wage increases for public employees should be based on forward-looking prospects for inflation.

    A01ufig22

    General Government Expenditure

    (Percent of GDP, 2015)

    Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

    Source: Fund staff estimates.

    Government Spending in Argentina

    Wage bill. Wages are the single largest component of general government expenditure in Argentina. At 12½ percent of GDP in 2015 (over two-thirds of which are paid by the provinces), the Argentine government’s wage bill exceeded not only the regional but also the advanced economy average of 10 percent. Public employment drove the increase in the wage bill over the last decade with the number of public sector employees rising from 2.3 million to 3.9 million persons from 2001–14. Over 80 percent of this expansion was at the provincial and municipal government levels.

    A01ufig23

    Secondary School Teachers and PISA Outcomes 1/

    (Latest value available)

    Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

    Sources: World Bank and IMF staff estimates.1/ Dotted line is LA6 average.

    Education and health spending. About 70 percent of public expenditure in education and health is directed towards employee salaries. On education, while primary and tertiary education expenditure and indicators in Argentina are comparable to regional averages and produce relatively good outcomes, secondary school spending is high compared to peers, and does not appear to produce better education outcomes. On health, Argentina’s public health expenditure amounted to 32 percent of total government expenditure, compared to 15 percent for the LA6 and OECD, and 12 percent for EMs, and efficiency frontier analysis, drawing on the outcomes of a range of other EMs and advanced economies, suggests that there may be room for efficiency gains (although health outcomes may also depend on a series of different factors, including educational attainment and access to sanitation facilities and clean water).

    A01ufig24

    Health Spending Efficiency Frontier 1/

    (Latest available value)

    Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

    Sources: World Bank and Fund staff estimates.1/ Dotted Line is LA6 average.

    Energy subsidies. Energy subsidies have risen dramatically over the past decade and, at 4 percent of GDP in 2015, constitute the bulk of non-pension social transfers. These subsidies are largely regressive, with many poor segments of the population lacking access to the subsidized products (the poorest quintile of households received about 10 percent of residential natural gas subsidies and about 18 percent of residential electricity subsidies; the richest quintile received about 35 percent and 20 percent, respectively).

    A01ufig25

    Incidence of Residential Subsidies by Income Decile

    (Percent of total subsidies)

    Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

    Sources: CEDLAS (May 2015) and Fund staff estimates.

  • Eliminating untargeted energy subsidies. The current system of regressive energy subsidies should be replaced with measures to protect the poor. This would free up significant fiscal resources to be used for more productive purposes while protecting the poorest part of the population. The government’s initial efforts to raise natural gas tariffs for households were reversed by the Supreme Court. This subsequently led the government to consult with the public on a plan to bring residential natural gas tariffs back to cost recovery by 2019, with a social tariff to protect the poorest 1.5 million households. For 2017, under the proposed budget, the government plans to lower gas and electricity subsidies by about ½ percent of GDP (to about 1½ percent of GDP). Staff estimates suggest that, if successful, bringing both electricity and natural gas tariffs to cost recovery while maintaining a social tariff would reduce spending by about 1 percent of GDP.

  • Reduce pension imbalances. Serious scrutiny of the pension system is needed to restore its financial sustainability and reduce the contingent pension liabilities that will inevitably burden Argentina’s young and/or its future generations (Box 7). Spending on pensions increased rapidly over the last decade, from 4.8 percent of GDP in 2008 to 7.4 percent of GDP in 2015.4 This was largely a product of increases in benefits (the dependency ratio during this period was broadly unchanged). The flow imbalance in the pension system will reach 2¼ percent of GDP in 2023 and over 5 percent by 2066 (see Chapter 3 of the Selected Issues Paper). The present value of the pension deficit, net of financial asset holding of the pension fund, is around 29 percent of 2016 GDP. Restoring a sustainable pension system would require parametric reforms, including indexing benefits to inflation, reducing the replacement rate, and gradually increasing the retirement age for women.

24. Authorities’ view. The authorities stressed that gradualism and flexibility are key to a successful process of fiscal rebalancing. They noted that reducing the wage bill at both federal and provincial levels will be a slow process, largely based on attrition, given the social cost associated with reducing public sector employment in the context of a still ailing economy. The review of public sector employment done at the federal level early this year suggests there is ample room for efficiency gains. Efforts to modernize Argentina’s public administration are expected to achieve significant cost savings and better quality of services over time, including by (i) integrating the administration of human resources and purchases of goods and services across Ministries and public agencies; (ii) digitalizing a vast number of administrative procedures; and (iii) reorganizing and improving the utilization of information technology at all levels of the public administration, including provinces and municipalities. On pensions, the authorities recognized that the current system faces important long-term challenges, and noted that they are beginning to study the impact of parametric reforms of the type suggested by staff. The government’s analysis will be a contribution to the recently established commission on the pension reform, that will articulate a comprehensive reform of Argentina’s pension system by end-2019. They noted that the effective women retirement age is 63, which reduces the potential savings from increasing the minimum retirement age to 65.

Argentina’s Pension System: Options for Reform

Background. Pension spending has risen due to the expansion of the number of beneficiaries and the introduction of a basic noncontributory pension. The structure of benefits has, however, been steadily flattened over time. In addition to social security contributions, the system was funded by diverting to the social security fund (ANSES) 15 percent of the national tax revenue pool. The system is partially funded with around 10 percent in GDP in assets held by the Fondo de Garantia y Sustenibilidad.

Long-term projections. The imbalances in the system are exacerbated by:

  • the retroactive adjustment of benefits to past inflation introduced by the Ley de Reparacion Historica (which will increase pension spending by an annual 0.7 percent of GDP over the medium term);

  • the introduction of a universal, minimum pension for the elderly regardless of their contribution history (adding 2 percent of GDP to spending in the long run);

  • the Supreme Court ruling that the withholding of 15 percent of the common pool of tax revenues from provinces was unconstitutional (implying a revenue loss of 1.6 percent of GDP by 2020); and

  • population aging (the old-age dependency ratio will double by 2066).

The cumulative impact of the net present value of pension liabilities over the next fifty years implies an actuarial deficit of the system of around 30 percent of 2016 GDP.1

Options for reform. Correcting this imbalance would require some combination of:

  • Change in the indexation formula. Pension benefits are linked to wage growth and the growth of ANSES revenues per disbursed benefit. This formula causes benefits to increase at rates above CPI inflation, and to rise faster when the growth in the number of beneficiaries slows. Indexing benefits to realized inflation from 2019 onwards would reduce the actuarial deficit by about 20 percentage points of GDP.

    A01ufig26

    Pension Replacement Rate for a Male Earning the Average Wage

    (Percent)

    Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

    Sources: OECD “Pensions at a Glance, 2015” and OECD, IADB, and World Bank “Pensions at a Glance: Latin America and the Caribbean”.

  • Lowering the replacement rate. The replacement rate (the ratio of the benefit to the last wage earned) is about 72 percent of the average wage, well above the OECD average (of 53 percent). Lowering the rate to 60 percent would reduce the actuarial deficit by about 10 percentage points of GDP.

  • A gradual increase of retirement age for women. An increase in the female retirement age from 60 to 65 over the next ten years would reduce the actuarial deficit by 10 percentage points of GDP.

A01ufig27

Retirement Age and Life Expectancy

(Years)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

1/ The actuarial deficit is defined as the present value of the increase in the difference between benefits and contributions relative to 2015. The estimate assumes a discount rate (real interest rate–growth differential) of 2.5 percent over the long run. Using a discount rate of 1 percent would yield an actuarial deficit of 45 percent of 2016 GDP (see Selected Issues Paper).

25. Fiscal space will also be needed to overhaul Argentina’s inefficient and burdensome tax system, to make it more progressive, and to help encourage private entrepreneurship and investment. Argentina’s general government revenue as share of GDP (at 34 percent of GDP in 2015) is one of the highest in Latin America and among emerging market economies. The federal authorities have implemented a number of measures that reduced the tax burden in 2016 by about 1½ percent of GDP relative to 2015, including an increase in the threshold for income that is exempt from the personal income tax, a reduction or elimination of exports taxes, a reduction of the VAT on basic goods for low-income households, and a range of measures to reduce the tax burden on SMEs. The most immediate priorities in tax policy are to:

A01ufig28

Total General Government Revenue

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: Ministerio de Hacienda, OECD, IMF WEO database, and Fund staff calculations.

  • Simplify the overall system. There are over 35 different types of taxes collected, with 15 of them contributing only 1 percent of GDP to overall tax revenues. This imposes significant compliance costs. At the same time, indirect taxes have multiple rates and special earmarking regimes, there is a complex system of cross-exemptions and crediting that vary across the type of activity, the location of that activity, or the type of tax base.

  • Reduce the marginal tax rate on labor. Employee’s and employer’s contributions for health and social security together account for between 40 and 45 percent of wages, although with a cap on employees’ contributions.5 This is above the OECD average, and hampers job creation in the formal economy. A broad-based cut in contribution rates (of 2 percentage points) could be financed by eliminating the current system of exemptions and deductions across provinces (that account for 0.3 percent of GDP).

  • Raise and preserve over time the progressivity of the personal income tax (PIT). High inflation and lack of adjustment of income tax brackets over the past decade meant that the PIT has become less and less progressive. The authorities are about to submit to Congress a legislative proposal that increases the dispersion of income tax brackets and marginal rates (lowering the bottom rates while increasing the top marginal rate from 35 percent to 40 or 45 percent) with an estimated annual fiscal cost of around ¼ percent of GDP (half of which borne by provinces). However, increasing the highest marginal PIT rate above the corporate tax rate (currently 35 percent) could create incentives for tax arbitrage. Going forward, it will be important to ensure that the real value of tax brackets is preserved.

  • Reduce the marginal tax rate on new capital. At 35 percent, the corporate income tax (CIT) statutory rate is one of the highest in the region, and the lack of provisions to adjust depreciation and capital allowances for inflation further increases the marginal tax rate on new capital formation. There are also limited provisions for carrying forward losses, limited allowances for depreciation, and low tax credits for R&D spending that raise the effective burden on incremental investments. To encourage new physical and intellectual capital formation, the CIT rate should be lowered by 5 percentage points, incentives for new R&D spending should be expanded, and new investment should be encouraged through more generous depreciation allowances, longer loss carry-forward, and inflation indexation of costs. The estimated annual cost of these measures would be 0.3 percent of GDP for provinces and 0.2 percent of GDP for the federal government.

  • Phasing out the financial transaction tax. The high marginal rate levied on transactions in checking and saving accounts distorts the payment systems, discourages financial intermediation, and incentivizes payments in cash. Removing this tax would imply a loss for the federal government of about 1 percent of GDP.

  • Replacing the gross turnover tax and increasing property taxes. Provinces should raise the property tax (which yields about 0.3 percent of GDP, well below international and regional levels) 6 and replace the gross turnover tax—a multi-stage sales tax that creates distortions through cascading—with a less distortionary tax on goods and services (the rate and base of which would need to be determined by provinces so that the impact on is revenue neutral).

A01ufig29

Property Tax

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: Ministerio de Hacienda, OECD, IMF WEO database, and Fund staff calculations.

The net effect of all these measures is estimated to imply a loss of revenues of around 1¼ percent of GDP for the federal government (and a further ¾ percent of GDP for the provinces). To minimize the impact on the budget and to support a pickup in private investment, a simplification of the tax system and changes in the PIT and CIT could be implemented first, along with the reduction in social security contribution rates, while the elimination of the financial transaction tax could be phased in gradually. Changes at the provincial level need to be coordinated with the reforms of the national tax system.

26. Authorities’ view. Reducing the high tax burden is essential, but any substantial changes in Argentina’s tax system will need to be phased in gradually, to make sure that the fiscal costs are sustainable. The authorities noted that, together with this year’s increase in the minimum income subject to PIT (which is now one of the highest in the region), the reform proposal that will soon be discussed in Congress will significantly improve the progressivity of the PIT system. The proposal may include a gradual increase of the income tax brackets over the next three years, to preserve progressivity, which the authorities prefer to a formal indexation scheme as this could increase inertia and may not increase the progressivity of the tax during the disinflation process. The financial tax is a distortionary tax that weighs especially on SMEs, but can be eliminated only with caution and within a more general reform of the tax system, given the large amount of revenues that it raises. There is also a general agreement that the gross turnover tax is highly distortive, but replacing it with another tax (such as a VAT or a sales tax at provincial level) could be too costly. These and other tax changes will be reviewed by a special parliamentary commission that will form a proposal for a comprehensive reform of the Argentina’s tax system to be sent to Congress by early 2018. The authorities also expect significant increase in revenues from the ongoing reorganization of the tax administration. In particular, the objective is to reduce VAT tax evasion from the current 30 percent to the 20 percent that had been experienced a decade ago.

C. Rebuilding Fiscal Institutions

27. Introducing a simple, transparent, and credible medium-term fiscal plan that guides expectations would be valuable. Such a fiscal framework should aim to improve the overall management of fiscal policy, strengthen the credibility of fiscal objectives, and improve the identification and management of fiscal risks. Some elements of a fiscal framework are already formally in place in Argentina, under the existing Fiscal Responsibility Law (FRL), but the system lacks credible enforcement.7 A complete revamping of the existing legislation could take time. However, pending a fuller reform, both federal and provincial governments could introduce simple and transparent medium-term fiscal objectives (for example, on fiscal deficits) in a clear and concise policy statement that would be presented alongside the annual budget. That statement would include details on the macroeconomic assumptions underlying the medium-term budget and the key policy measures to be taken to achieve the deficit objectives. Over time, as uncertainty subsides and credibility increases, other measures could be adopted to strengthen the fiscal framework including:

  • Introducing a medium-term debt target, limits on growth of spending, and/or an overall deficit ceiling, with transparent and easy-to-monitor escape clauses that allow deviating from the limits in exceptional circumstances. The new framework would restrict the ability for the Executive to exceed budget expenditure ceilings or reallocate spending beyond certain limits without the approval of Congress. It should also include credible enforcement mechanisms, including a “comply-or-explain” obligation for the federal government and automatic cuts to transfers for provinces in case the limits are exceeded.

  • Develop a fiscal risk analysis framework including the publication of a fiscal scenario analysis and long-term fiscal sustainability analysis.

  • Create a new mid-year fiscal report with updated estimates of fiscal outturns for the year and revised medium-term macroeconomic and fiscal projections.

  • Establish a fiscal council, with legal and operational independence, that evaluates macroeconomic and budgetary forecasts, costs new policy initiatives, assesses fiscal plans, and monitors fiscal performances (including compliance with the FRL).

28. Authorities’ view. The federal authorities agreed that it would be important to introduce a medium-term fiscal framework, and said that they are planning to announce medium-term fiscal targets before the end of the year. They pointed to a number of legislative initiatives that should strengthen the institutional fiscal framework. In the context of the discussion of the 2017 Budget, a proposal will be examined that limits the Executive’s power to increase total spending above Budget appropriations and to move spending across different items (Ley de superpoderes). A proposal is being considered that introduces a Congress Budget Office which would help Congress assess the fiscal impact of legislative proposals. Finally, discussions with provinces are ongoing to reinstate the Fiscal Responsibility Law over the next few months. While the exact contours of the Law are still to be determined, it would likely include caps on current spending growth and fiscal deficit targets. While the enforcement mechanisms are the same as under the old Law (and so based on the federal government’s power to deny new debt issuance to provinces not complying with the limits) the authorities are confident that the greater commitment to fiscal discipline from the federal government will be shared by provinces and lend credibility to the new framework.

29. With about 40 percent of general government spending taking place at the sub-national level, greater efficiency in government spending will require a rethink of Argentina’s fiscal federal structure that:

  • Realigns spending authority and revenue autonomy. Provinces are responsible for a substantial share of spending but enjoy limited tax autonomy and have been depending on the federal government for financing. In 2015, one-third of total provincial resources came from by discretionary federal transfers, and around 35 percent of provincial debt is owed to the federal government. Realigning responsibilities could require returning some spending responsibility to the federal government and/or allocating more revenue sources back to the provinces.

  • Addresses the complicated and inefficient sharing of resources across provinces. With the legislation behind the co-participation scheme unchanged since 1988, intricate layers of patches have been introduced over the years to correct for increasing socio-economic disparities across provinces and to respond to political pressures. The lack of a mechanism to adjust the distribution of revenues across provinces to reflect their changing revenue capacity and spending needs adds uncertainty and volatility to fiscal policy at both provincial and federal levels. As such, the current horizontal distribution of shared revenue and federal transfers across provinces should be re-examined to make it more equitable, transparent, rules-based, and stable.

  • Restricts the borrowing power of provinces. Although provinces appear to have low debt and deficits, these aggregates mask significant heterogeneity and imbalances across provinces (see Public Debt Sustainability Analysis). Debt and deficits are concentrated in a few provinces, and the large share of foreign currency denominated debt poses risks (see Annex I). Consideration should be given to strengthening prudential control mechanisms over provincial borrowing, within constitutional limitations, perhaps to allow for a more active review role for the federal government or to net debt service obligations from transfers to those provinces with weak fiscal positions.

30. Authorities’ view. The authorities agreed that a new legal framework would be needed to strengthen the institutions and rules of fiscal federalism in Argentina. However, delivering fundamental legislative changes in this area will not be easy, as it would require a qualified majority in Congress and approval from all provinces. The gradual devolution to provinces of the 15 percent of co-participation revenues once attributed to ANSES is expected to alleviate the financial difficulties experienced by many provinces last year. Therefore, provinces are expected to reduce their external borrowing going forward. If this were not to happen, the federal authorities are ready to tighten their debt approval policy, or to link it more explicitly to the issuance of debt needed to finance an increase in capital spending. As envisaged in the 2017 Budget, the federal authorities are planning to reduce discretionary transfers to provinces in the future, partly offsetting the increase in co-participated revenues (the proportion of national revenues shared with provinces will increase from 37 percent in 2015 to 40 percent next year).

D. Protecting the Poor

31. Measures need to be taken to protect the most vulnerable from the costs of the ongoing transition. The new poverty data released by INDEC in September describes a critical social condition (see Box 1). The current administration took measures to mitigate the effects of the ongoing transition through an expansion of social programs, an adjustment in pensions, lower VAT on basic goods, increasing the minimum income subject to PIT, and the introduction of a social tariff for electricity and natural gas. Going forward, eliminating the highly regressive energy subsidies and introducing a comprehensive mean-tested transfer program will help provide well-targeted support to the poorest households. While such a safety net is being designed and implemented, the government should maintain a lower tariff structure for low-income consumers. A lower tax on labor would incentivize formal employment and bring more people under the umbrella of existing social programs (including the public health and the public pension scheme).

32. But fundamentally it will be stronger and sustained growth and lower inflation that will help reduce poverty. Sustaining job creation by removing macroeconomic imbalances and securing strong and durable growth will have an important impact on supporting the poor. Using CEDLAS estimate of the poverty level and staff estimate of the elasticity between GDP growth and poverty, suggests that a one percent increase in per capita GDP per year would reduce poverty rate by 0.4 percentage points.8 This implies that, under the staff baseline, the poverty rate would decline by about 3¼ percentage points by 2021. A significant reduction of inflation will also help the protect living standards of low income households. Continued progress in fostering gender equality in the economy and addressing the remaining gender gaps would also contribute to increasing Argentina’s potential growth and economic welfare (Box 8). This could require well targeted gender budgeting initiatives, in particular with a focus on programs that facilitate or promote access of women to educational and preventative health services (IMF, 2016).9

33. Authorities’ view. The authorities emphasized that protecting the most vulnerable from the potential negative impact of the reforms is a key policy objective, and voiced a strong commitment to reduce the poverty rate. In addition to the tax and spending measures taken by the administration during the course of 2016, the authorities noted that their social policy will be based on three main areas: (i) adopting an income policy that prevents excessive labor conflicts and fosters consensus, (ii) improving the quality of public goods (including health and education), and (iii) promoting inclusiveness and social mobility through more efficient and targeted social transfers, which are better linked to active labor market policies. With between 1 and 1.5 million workers receiving less than half of the minimum wage and largely in the informal sector, measures that build job-related skills are needed to help reintroduce this segment of the labor force into Argentina’s formal economy, although only strong growth will produce quality and sustainable employment. The authorities also agreed that disinflation will reduce the inequality of the income distribution, given the disproportionate incidence of the inflation tax on low-income households. In particular, they noted that the inflation tax represents 20 percent of the income of the lowest decile of Argentina’s households but only 3 percent for the top decile.

Gender Gap Issues in Argentina

Argentina’s levels of female education and political representation exceed those observed in the region. Argentina stands out in terms of female school enrollment, vis-à-vis Chile and Uruguay, and even more when compared to the average level of female education in Latin America and the Caribbean (LAC). Argentina is a leader in the region in female political representation and fares well in terms of women’s labor force participation. However, when it comes to indicators of maternity mortality and adolescent fertility, Argentina is lagging behind its neighboring countries.

A01ufig30

Selected Gender Indicators

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: World Bank Equity Lab, Gender Note (2012), and Fund staff calculations.

  • Between 2000 and 2012, female gross tertiary school enrollment increased from 64.7 percent in 2000 to 98.5 percent, surpassing men enrollment by a ratio close to 1.6. Higher education has allowed women to increase their labor participation rate from 43 to 48 percent between 2000 and 2014 and to reduce their unemployment rate from 17 to 10 percent—measured as a proportion of female labor force—over the same period. Nevertheless, in 2010, women’s average earnings were only 77 percent of men’s. Moreover, in a sample of firms with a total of 21,000 employees, women accounted for only 37 percent of managers and directors (World Bank 2012). Female participation in politics is high, as they held 38 percent of seats in parliament, both at the national and subnational levels, in 2010, up from an average of 9 percent between 1990 to 2010, as a result a system of quotas established by the Electoral Law.

  • Female health conditions have improved, but some recent reversals in teen births and levels of domestic violence are worrisome. Health indicators, such as birth attendance by skilled health staff and the number of pregnant women receiving prenatal care show that coverage is close to universal. The maternal mortality ratio—measured by 100,000 live births—declined from 60 percent to 52 percent between 2000 and 2015. However, the adolescent fertility rate—computed as the number of births per 1,000 women ages 15 to 19—has increased by about 4 percentage points since 2007 (while overall fertility has decreased). Women’s health is also impacted by the prevalence of domestic violence in one out of five couples as of 2008.

A01ufig31

Tertiary School Enrolment

(Percent)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: World Bank Equity Lab and Fund staff calculations.
A01ufig32

Adolescent Fertility and Maternity Mortality

(Percent)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: World Bank Equity Lab, and Fund staff calculations.

E. Creating New Institutional Structures

34. Improving governance, increasing transparency, and tackling corruption are key priorities. Strengthening public institutions and clearly articulating their roles and responsibilities will be essential to rebuild private sector confidence in public administration and support investment and growth. Over the past 15 years, Argentina saw the largest decline in ranking of any country in regulatory quality according to the World Bank’s global governance indicators. Argentina also scores poorly in the areas of rule of law, anti-corruption, and government effectiveness. Despite relatively good anti-corruption regulation, enforcement has been uneven and corruption remains pervasive in public institutions, including in public procurement and public works.10 High levels of corruption are also seen by firms as an obstacle to investing in Argentina (World Bank Enterprise Survey, 2015). Moreover, Argentina ranks 121 among 189 countries in terms of ease of doing business, mostly reflecting corruption and excessive bureaucracy.

A01ufig33

Worldwide Governance Indicators, 2014

(Index, -2.5 (weak) to +2.5 (strong) governance performance)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Source: World Bank WGI, 2015 Update.

35. The authorities began taking steps to rebuild public institutions, strengthen anti-corruption controls, and step-up enforcement. These include initiatives to promote open government, reduce bureaucracy, build human and institutional capacity, and increase digital innovation in the public sector. A new framework for public tenders of infrastructure projects has also been announced to increase transparency and prevent collusive practices. Staff welcomes the recently proposed legislative reforms to provide additional tools to prosecute corruption, seize assets linked to corruption, and introduce criminal liability for legal persons. These efforts would be complemented by effectively mobilizing the anti-money laundering (AML) framework. In particular, the authorities are encouraged to strengthen the AML/CFT controls in the financial sector, notably relating to politically exposed persons, and ensure that financial intelligence is appropriately used in advancing and supporting investigations and prosecutions of corruption.

36. Financial deepening will create scope for domestic financing of productive activity, strengthen the monetary transmission channel, and include a greater share of the population in the financial system. Argentina has a relatively small financial system: bank credit to the private sector is only 13 percent of GDP, and stock market capitalization is only 10 percent of GDP. To a large extent, restoring macroeconomic stability is the best contribution that policymakers can offer to the developing of local financial markets. Low inflation and positive real rates are needed to increase the base of long-term domestic currency savings that will allow banks to increase lending to the private sector. In the meantime, some steps have been taken to encourage greater domestic intermediation:

  • Banking sector. The BCRA has eliminated minimum interest rates for time deposits and maximum interest rates for consumer loans, increased information on bank fees, simplified procedures for opening bank accounts, eliminated bank transfer fees and fees to maintain saving accounts. In addition, the central bank has introduced a new inflation-indexed account unit, to create a market for inflation-indexed fixed income instruments (both on the deposit side and, for example, in mortgage loans).

    A01ufig34

    Financial Development

    (Percent of GDP, 2014)

    Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

    Source: Global Financial Development Database.

  • Capital markets. The authorities are working at a reform of the 2012 Capital Markets Law, which aims at developing closed-end mutual funds by equalizing tax treatment with open-end funds; introduce legislation that provides for the enforceability of derivative netting; increases capital requirements for broker dealers; and improves many aspect of corporate governance, including by removing the power of the securities regulator to interfere in decisions approved by the board of listed companies and strengthening its enforcement powers to take on anti-market behavior. Progress has been made in improving capital market infrastructure: the creation of a unified stock exchange (B&MA) will increase liquidity and lower transaction costs by consolidating the trading platform, the central counterparty clearing house and the custodian agency. The new central counterparty clearing house is expected to facilitate the development of an interest rate swap market, currently quite limited in Argentina.

  • Insurance sector. Restrictions on insurance companies (that compelled them to invest in infrastructure projects approved by a political committee and limited foreign investment) were removed. Consideration is given to introducing tax incentives for investment in long-term assets, such as life insurance and annuity products by updating the income tax deduction limits that have been frozen since the early 1990s.

  • Public pension reserve fund. The new administration at ANSES has begun reforming the governance and investment strategy of the public pension fund, which was significantly mismanaged in the past. The objective is to preserve the fund’s capital, investing in projects (mainly infrastructure projects and financial instruments that promote growth and support the development of local capital markets) and using the returns to pay for the increase in pension payments following the 2016 reforms. The authorities are considering utilizing part of the endowment to set up a trust, which would securitize mortgages originated in banks (while asking them to maintain a significant credit exposure) in order to help develop a local mortgage market.

37. There is significant scope to lower trade barriers. Non-automatic import licenses remain for around 1,500 tariff lines (about 10–15 percent of volumes), and there is a broad system of controls on professional services, patents, royalties, and technology transfer contracts. As part of the MERCOSUR trade bloc, in recent years Argentina has lagged behind other regional peers in trade liberalization, such as the members of the Pacific Alliance (Chile, Mexico, Colombia, and Peru).11 A comprehensive effort should be undertaken to scale back existing trade barriers so as to raise competitiveness, encourage new investment, and increase productivity.

A01ufig35

Import Tariff Protection

(Percent)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: World Bank WITS and Fund staff calculations.

38. The poor quality of infrastructure is a major impediment to investment and productivity. Over the past 15 years, public investment grew much less than current spending, while private financing of infrastructure was very limited. This has led to a severe infrastructure gaps, including in transportation and energy production (IMF 2016).12 Access to appropriate infrastructure in terms of roads, railways, ports and energy is especially important for exporting firms outside the central region and metropolitan areas (see Selected Issues Paper, Chapter 6).13 Filling the infrastructure gap will take time and, given the limited scope for a significant expansion of public spending, would require initiatives to improve the institutional and legal framework for private sector participation in infrastructure projects, including by introducing a well-functioning, transparent, and competitive system of concessions.

A01ufig36

Change in Export Market Share and Transport Infrastructure

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: Direction of Trade Statistics and Global Competitiveness Report (2014).

39. Investment could be encouraged by reformulating the regulatory structure for utilities and creating a more competitive crude oil and natural gas industry. The authorities should establish an independent, rules-based regulatory structure for electricity generation, transmission, and distribution, water and sewage, and natural gas. This should include clear, transparent, and predictable mechanisms for adjusting tariffs. In addition, there should be accountability for the quality of services and requirements to maintain the underlying infrastructure.

  • Natural gas. The 3-year plan for increasing natural gas tariffs for residential customers goes in the right direction, and discussions are ongoing to update the old gas plan that fixes the remuneration for natural gas producers and expires at end-2017. The old system (that remunerates investment done before 2012 at prices well below current import prices and gas produced with new investment at prices above current import prices) should be replaced by a plan that guarantees remuneration at international prices, with caps and floors to avoid excessive volatility, for a sufficiently long period of time so as to encourage investment in exploration and production.

  • Crude oil prices are also regulated by agreement between the government, refiners, and the oil extraction companies, with companies currently guaranteed a domestic price of US$67 per barrel. The guaranteed price should be phased out and investment encouraged instead by better governance, a clear long-term roadmap for their development, and mechanisms to ensure transparency, accountability, stability, and the respect for contractual rights.

    A01ufig37

    Crude Oil and Gasoline Prices

    (U.S. dollars)

    Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

    Sources: Energy Secretariat, Haver Analytics and World Economic Outlook.1/ Avg. crude price of UK Brent, Dubai Medium, and Alaska NS Heavy.

  • For electricity, the government plans to double the supply of effectively available electricity in the next decade and reach a target for renewable resources to cover 25 percent of the country’s energy needs. Two public auctions have been implemented so far this year, which awarded 10 years PPAs (Power Purchases Agreements) on thermal energy projects, both of which attracted considerable interest also given the high rates of return offered. In the future, improving the regulatory framework would ensure a more competitive tender process, allowing further reductions in the cost of energy.

40. Argentina fares poorly in the areas of market efficiency and competition. This reflects the existence of anticompetitive regulation and barriers to entry (particularly in network industries), a weak antitrust framework, and significant and unpredictable government involvement in private industry. Important progress is ongoing at the Argentina’s National Competition Commission, which has recently been restructured. A law has been sent to Congress that makes the Commission independent, giving it a clear mandate to conduct investigations, and impose fines, and bring cases to court. The legislation also introduces leniency programs to incentivize whistleblowing; updates the thresholds for fines and merger and acquisition cases (that had not been adjusted for inflation over the past decade); and introduces a special chamber in the judiciary to adjudicate on competition cases. The Commission has already issued a report to Congress on the state of competition in the credit card industry and will follow up with studies on dominant position and collusive behavior in other 13 sectors. The authorities have announced a Plan Productivo Nacional that delineates an active industrial policy, aimed at maintaining or strengthening public support to sectors deemed competitive (such as the automotive sector) and gradually eliminating it for uncompetitive sectors (such as the electronic cluster in Terra del Fuego). The exact contours of the plan have yet to be defined but should avoid an excessively active (i.e., picking-winners) industrial policy. Instead, policy should seek to level the playing field by removing government support across all sectors and lowering the tax burden more broadly.

41. Progress on supply-side reforms could generate significant pay-offs for medium-term growth and jobs. An extensive literature finds that structural reforms, including product market reforms, have a positive impact on growth over the medium and long term (IMF, 2015).14 In Argentina, a number of reforms could be achieved through legislative changes at little or no fiscal cost. Financial liberalization would support both consumption and investment by relaxing credit constraints. Similarly, improving the regulatory framework and reducing barriers to entry and the costs of doing business would stimulate FDI and productivity. Using OECD estimates on the impact (after 10 years) of product market reforms (proxied by an indicator of regulation in network industries) on GDP levels suggests that closing half the gap between Argentina and the OECD average could add 1½ percent to GDP by 2021 and 0.6 percent to employment.15

42. Authorities’ view. The authorities agreed that fundamental supply-side reforms are needed to improve the business climate and create the conditions for a more integrated, competitive, productive, and inclusive economy. A multi-pillar Agreement on Productivity and Jobs has been articulated (following the Plan Productivo Nacional) that aims at establishing a broad consensus on measures to develop local capital markets, reduce cost of production, lower the tax burden, improve labor legislation, foster innovation, increase competition, reduce red tape, and boost infrastructure. While work in these areas has begun already, the authorities stressed that many of the reforms would need to be phased in gradually, taking into account their political and social implications. For example, removing costly and inefficient subsidies and protections for some sectors at a time when the private sector is not creating new jobs could imply excessive social and economic costs. Rather, it is preferable to try and incentivize a reallocation of resources from the least to the most productive sectors, or production processes within sectors. The authorities said they are negotiating with producers, provinces, and unions a gradual reduction of crude oil prices to international parity over the next few months. Regulatory agencies in the energy sector are being redirected to their original function, and new directors are being selected with more independence from political pressure. The authorities intend to launch an ambitious program of infrastructure, increasing government’s capital spending from 2 to 6 percent of GDP in about 8 years, two thirds of which in partnership with the private sector. In order to achieve this objective a new law has been sent to Congress that aims at improving the institutional and legal framework for public-private partnerships, including by setting up a special unit that will assess the social return associated with these projects, as well as their macroeconomic and financial implications. Finally, the authorities are committed to further step-up their anti-corruption efforts. The Anti-Corruption Office has embarked on increasing transparency and accountability of government public officials by making public all financial asset disclosures. Together with financial sectors stakeholders, the authorities have also started utilizing the AML/CFT controls in advancing and supporting investigations and prosecutions of corruption.

Staff Appraisal

43. Upon taking office in December last year, Argentina’s new government inherited a legacy of pervasive macroeconomic imbalances, microeconomic distortions, and a weakened institutional framework. These encompassed unsustainably high consumption levels, historically low levels of investment, and large fiscal deficits financed by money creation, which led to high inflation. Distortions at the micro level included an extensive network of administrative controls (for example, trade barriers, foreign exchange restrictions, and price controls) and a business environment that eroded competitiveness and undermined medium-term growth. There was also an important weakening of the institutional framework for economic policymaking, perhaps most evident in the loss of credibility of the national statistics agency.

44. A necessary and unavoidable transition. Confronted with this difficult situation, the new government began an ambitious and much needed transition toward a better economic policy framework, reversing the serious macroeconomic imbalances and microeconomic distortions inherited from the previous government. Important progress has been made. The peso is now market determined, and foreign exchange controls have been essentially eliminated. The increase in utility tariffs has brought prices more in line with underlying costs. The settlement with creditors has allowed a return to international capital markets by both the private and public sectors. Medium-term fiscal and inflation targets were announced in conjunction with a transition toward a modern system of inflation targeting. Finally, the national statistics agency is being rebuilt, allowing for the publication of improved and credible data on inflation, trade, labor market, and output.

45. Near-term costs but a more favorable future. The reversal of the serious imbalances and distortions inherited from the previous administration, while necessary to lay the foundation for robust future growth, unavoidably had an adverse near-term impact on the Argentine economy. Indeed, the current recession had begun even before the new administration took office. However, the alternative of continuing with the unsustainable policy framework of the past administration was simply not tenable and would have eventually led to a repeat of Argentina’s history of crisis, contraction, and social distress. Staff expects the economy to emerge from recession in late 2016, and the planned fiscal consolidation in 2017 should be more-than-offset by a pickup in private consumption, an improving external environment, and a rebound of private investment. It is no accident that Argentina is forecast to experience one of the largest swings in growth—from negative to positive—in 2017, based on the October 2016 World Economic Outlook.

46. With strong policy action and dramatic changes underway in the Argentine economy, the outlook is subject to greater than normal uncertainty. On the upside, Argentina’s private investment could prove to be more responsive to the measures taken so far to remove domestic distortions, particularly given the clear underinvestment in a range of sectors over the past several years. This would help with the fiscal position and would improve the outlook for long-term growth. On the downside, given the expected reliance on external debt, a tightening of global financial conditions could create pressures on the currency, affect the cost and availability of budgetary financing, and impose a faster pace of fiscal consolidation. Higher inflationary pressures from backward-looking nominal wage increases could lead to a more costly process of disinflation, which would slow the rebound of economic activity that is expected for next year.

47. The government should be commended for its commitment to bring inflation down to single-digit levels. The pace at which this disinflation is achieved should remain flexible and adapt to circumstances as they unfold, remaining conscious of the economic costs and, particularly, the distributional impact. To support these efforts, building credibility in the monetary policy framework, including through strengthening the institutional underpinning for policy will be essential and will serve to lessen the economic and social cost of lowering inflation. Positive steps continue to be taken by the national statistics agency in restoring the credibility of Argentina’s statistics.

48. The government’s plan to lower the fiscal deficit remains a vital objective. The pace and composition of this shift in the fiscal position will need to be sensitive to the impact on growth, jobs, and on the most vulnerable segments of the Argentine population. Frontloading the fiscal correction to the extent allowed by the current economic, political and social constraints would be desirable. Doing so will allow for a more accelerated reduction in interest rates, ease the current upward pressure on the real exchange rate, improve the public debt dynamics, and facilitate the needed rebalancing from consumption to investment-driven growth. There will have to be a rationalization of government spending, which has increased rapidly over the last decade. Much can be done to strengthen public expenditure management, improve governance, and increase the efficiency of public spending. Action is particularly needed on eliminating regressive energy subsidies, protecting the poorest part of the population, addressing actuarial imbalances in the pension system, and overhauling the inefficient and burdensome tax system. A clearer articulation to the public of the policy measures that underlie the targeted reduction of the federal deficit in 2017 as well as a simple, transparent and credible medium-term fiscal policy plan that guides expectations would both be valuable.

49. Rebuilding the foundations for growth. Strong, sustained, and equitable growth will require the implementation of an ambitious agenda of supply-side reforms. Near-term priorities include putting in place a better regulatory framework for energy and utilities, fully realigning utilities tariffs toward cost recovery while maintaining measures to protect the poor, and modernizing financial market infrastructure and regulation. There is also a broader need to scale back government involvement in private industries and create a better governance framework, including by making further progress on the government’s ambitious anti-corruption plans. Such a set of policies will create an environment that is more conducive to private investment and will generate significant medium-term dividends in terms of more and better jobs as well as a steady improvement in the living standards for Argentina’s population.

50. Staff proposes that the next Article IV Consultation take place on the standard 12-month cycle.

Table 1.

Argentina: Selected Economic and Financial Indicators

article image
Sources: Ministerio de Hacienda y Finanzas Públicas, Banco Central de la República Argentina (BCRA), and Fund staff estimates.

On February 1, 2013, the IMF issued a declaration of censure, and since then has called on Argentina to implement specified actions to address the quality of its official GDP data. The new government that took office in December 2015 released a revised GDP series on June 29, 2016. At the IMF Executive Board meeting that took place on August 31, 2016, the revised series was considered to be in line with international standards.

The consumer price data for Argentina before December 2013 reflect the CPI for the Greater Buenos Aires Area (CPI-GBA), while from December 2013 to October 2015 the data reflect the national CPI (IPCNu). The new government that took office in December 2015 discontinued the IPCNu stating that it was flawed and released a new CPI for the Greater Buenos Aires Area on June 15, 2016. Given the differences in geographical coverage, weights, sampling, and methodology of these series, the average CPI inflation for 2014, 2015, and 2016 and end-of-period inflation for 2015 are not reported in the October 2016 World Economic Outlook. On February 1, 2013, the IMF issued a declaration of censure and since then has called on Argentina to implement specified actions to address the quality of its official CPI data. At the meeting that took place on August 31, 2016, the IMF Executive Board noted the important progress made in strengthening the accuracy of the CPI data. The Managing Director will report to the Executive Board on this issue again by November 15, 2016. The Executive Board discussion on this issue will take place on November 9, 2016.

The primary balance excludes profit transfers from the central bank of Argentina. Interest expenditure is net of property income from the social security fund.

Average of LEBAC rates of all maturities.

Table 2.

Argentina: Summary Balance of Payments, 2011–21

article image
Sources: INDEC and Fund staff estimates.
Table 3.

Argentina: Consolidated Public Sector Operations, 2011–211/

article image
Sources: Ministerio de Economía y Finanzas Públicas and Fund staff calculations.

The primary balance excludes profit transfers from the central bank of Argentina. Interest expenditure is net of property income from the social security fund.

Table 4.

Argentina: Federal Government Operations, 2011–211/

article image
Sources: Ministerio de Economía y Finanzas Públicas and Fund staff estimates.

The primary balance excludes profit transfers from the central bank of Argentina. Interest expenditure is net of property income from the social security fund.

Table 5.

Argentina: Summary Operations of the Financial System, 2011–21

(Billions of Argentine pesos, end of period, unless otherwise indicated)

article image
Sources: Banco Central de la República Argentina (BCRA) and Fund staff estimates.

Currency in circulation outside banks plus peso-denominated deposits in checking and savings accounts.

Average interest rate for 1-month time deposits over AR$1 million in private banks.

Average of LEBAC rates of all maturities.

Table 6.

Argentina: External Debt, 2011–21

article image
Sources: Instituto Nacional de Estadística y Censos (INDEC), Banco Central de la República Argentina (BCRA), and Fund staff estimates.
Table 7.

Argentina: Public Debt, 2011–21

article image
Sources: Ministerio de Economía y Finanzas Públicas and Fund staff estimates.

Annex I. External Sector Assessment

Argentina’s external position is judged to be vulnerable to growing imbalances on the current account and exchange rate. The current account deficit is estimated to be about 2 percent of GDP above level implied by medium-term fundamentals and desirable policies. Since the 40 percent nominal devaluation in December 2015, the real exchange rate has undergone an important appreciation as strong capital inflows sustained a largely unchanged nominal exchange rate while a large wage and price inflation differential with trading partners eroded competitiveness. The Argentine peso is estimated to be overvalued by around 10–15 percent in 2016. Reserves are judged to be well below adequate levels, and the significant reliance on debt-creating portfolio capital flows (including to finance the public sector) makes Argentina vulnerable to a disruption to inward capital flows.

A. Current Account

Argentina’s current account (CA) balance deteriorated substantially in recent years, from near balance in 2012 to -2½ percent of GDP in 2015. This reflected falling commodity prices and a nearly 50 percent real appreciation of the peso between 2012 and November 2015, that weakened competitiveness. A sharp worsening of the energy trade balance due to domestic policy distortions was also a factor.

A01app1ufig1

Current Account and Terms of Trade

(Percent of GDP unless otherwise indicated)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: INDEC and Fund staff calculations and estimates.

The worsening of the CA reflected a sharp decrease of national savings even as investment levels fell. The strength in the peso, rising real wages, and accelerating inflation encouraged private consumption while the growth in current spending increased public sector dissaving. However, the true increase in external imbalances was masked by a range of controls.1 These included a tight system of administrative controls to restrict both imports and the access to foreign exchange to make payments for those imports that were approved. The availability of FX to make dividend remittances was also limited. Since the new government took office in December 2015, most of the controls have been lifted (see Annex Table 1) although non-automatic import licenses still apply to a subset of products and services.

A01app1ufig2

National Saving

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: INDEC and Fund staff estimates.
A01app1ufig3

Domestic Investment

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: INDEC and Fund staff estimates.

The CA deficit is expected to worsen over the medium term. The CA balance is expected to improve slightly in 2016 (-2.3 percent of GDP) as the peso devaluation and the removal of trade restrictions and export taxes were offset by weak external demand and higher net income outflows. However, from 2017 onward, the steady upward movement in the real exchange rate, increased dividends from higher FDI stocks, and higher debt service payment (as the public sector builds external debt) will cause the CA deficit to rise to 4.2 percent of GDP by 2021 (5.0 in cyclically-adjusted terms).2

While there is much uncertainty, the CA deficit in 2016 appears to be above levels consistent with medium-term fundamentals and desirable policies. The CA assessment is made relative to the expected 2016 CA position given the significant external payments distortions present in the 2015 CA outturn (which were largely addressed in 2016). The CA-regression approach of using the EBA methodology yields a cyclically-adjusted CA norm of close to 𢈒1 percent of GDP. The desirable fiscal stance assumed in this estimate is based on a reduction of the overall general government fiscal deficit by about 4 percent of GDP over the medium term (consistent with the authorities’ announced fiscal consolidation plans and staff’s baseline). It also assumes an increase in the FX reserves over the medium term to close to US$70 billion. With a 2016 cyclically-adjusted CA expected to be about 2¾ percent of GDP, the CA gap in 2016 is estimated at about -1½ percent of GDP. The external stability (ES) approach suggests that the current account balance needed to stabilize the IIP position to the staff’s estimated steady-state value is about -¾ percent of GDP.

B. Capital and Financial Accounts

Financial account restrictions, which had been building since 2002, reached a peak in 2011–15. Access to foreign exchange for residents—including foreign exchange purchases for savings, direct investment abroad and commercial banks’ foreign exchange position—was severely restricted to contain capital flight. The lack of access to international capital markets meant that foreign financing was largely limited to relatively low levels of FDI. Indeed, over the last 15 years, FDI net inflows to Argentina were almost half that of its peers (reflecting an unstable macroeconomic climate and weak investor confidence) leading to lower levels of leverage among both the public and private sectors.

A01app1ufig4

FDI

(Percent of GDP)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: IMF, World Economic Outlook database and staff calculations.

Despite controls, it is likely that significant capital left through informal channels. Capital account controls likely led to increased circumvention of official channels to move resident assets abroad. While there is no directional bias in balance of payments ‘errors and omissions’, it is likely that substantial over-invoicing of imports payments occurred in the past. Furthermore, resident-held wealth, undeclared to the tax authorities, is thought to be substantial (although it is difficult to assess its evolution over time, given lack of data). For instance, International Investment Position (IIP) data indicates that ‘other investment’ foreign assets were US$210 billion in 2015 (only US$30 billion has been declared to the tax authorities).

A01app1ufig5

Capital Outflows

(Billions of U.S. dollars)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: INDEC and Fund staff calculations.

Foreign exchange controls have all but been eliminated. In December 2015, the authorities rolled back many of the formal and informal controls on foreign exchange transactions, and further steps were taken through August of this year to liberalize the system (see Annex Table 1). These steps not only lifted the restrictive system put in place in 2011 (the “cepo cambiario”) but brought Argentina to its most liberal foreign exchange system since 2001.

In the first half of 2016, the removal of most controls and a return to international markets have led to a significant increase in gross flows in both directions. The removal of capital controls allowed residents to officially move money abroad on a large scale through formal channels for the first time since 2011 (estimated to be US$6 billion in 2016H1). In addition, in the first half of 2016 an agreement with creditors caused the federal government to issue US$19.3 billion of external debt to cover the principal payments on previously un-restructured debt (and the arrears on debt restructured under Argentina’s 2005 and 2010 debt exchange) and for federal budget financing.

For the remainder of 2016, public external debt issuance should subside, and capital outflows will moderate. The authorities are unlikely to issue any substantial new external debt for the remainder of the year. Some external assets are assumed to be repatriated in order to purchase domestically issued debt. This includes inflows from abroad to take advantage of the proposed tax amnesty, which is assumed to be around US$2.2billion in 2016H2 (plus a similar amount from domestically held wealth), and US$1.2bn in 2017H1 (again, with a similar amount from domestic wealth).

Looking forward, public debt issuance and growing FDI will finance the current account over the medium term. The government is expected to rely extensively on external debt issuance to finance its fiscal deficit. Net external federal government bond issuance will average around US$17 billion per year over 2017–21, in addition to around US$5 billion a year from IFIs. Such large-scale issuance will have a crowding out effect on private sector net borrowing. Similarly, the appreciating exchange rate will create a disincentive for net private inflows. FDI is expected to increase gradually from around 1.8 percent of GDP (accruals basis) in 2015 to about 3 percent in 2021, as foreign investors finance an increasingly large proportion of domestic investment and spending.

C. FX Intervention and Reserves

Following the 2001/2 crisis, a shift to significant current account surpluses due to the sharp 50 percent depreciation of the real exchange rate allowed the authorities to amass significant reserves. Gross international reserves peaked in 2010 at US$52 billion (9-months import cover). These purchases helped maintain a competitive exchange rate, and provided buffers to withstand temporary shocks.

A01app1ufig6

Gross International Reserves

(Billions of U.S. dollars)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: INDEC and Fund staff calculations.

Since 2010, external imbalances grew, and this was reflected in a steady decline of reserve coverage. Since 2010, the FX reserves were used to service foreign currency denominated federal government debt, with an overall cost of US$55 billion. Reserves were also used to finance private capital outflows and the growing CA deficit. By end-2015, gross reserves were US$25.6 billion (58 percent of the IMF’s reserve adequacy metric, with capital controls), while net reserves (gross reserve currency assets minus short-term FX obligations) declined to around zero.

However, even this reserve drawdown was insufficient to meet the balance of payments pressures, and the central bank intervened through selling significant amounts of foreign exchange futures. Throughout 2015, the central bank confronted devaluation expectations by building a net short position in foreign exchange futures in the local market (that settle in pesos) that peaked in December at US$17.4 billion. The heavy intervention in the domestic futures market, combined with capital controls that prevented full arbitrage, caused a substantial gap between rates in the local and offshore markets. This led to losses totaling AR$53.7 billion on the central bank’s balance sheet (once the FX controls were lifted, the exchange rate corrected, and the contracts matured).

A01app1ufig7

ARA Metric Decomposition

(Billions of U.S. dollars)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: BCRA and Fund staff calculations and estimates.

Since the floating and unification of the exchange rate in December 2015, there has been relatively little FX intervention, and the central bank has generally allowed the exchange rate to adjust with market forces. The central bank did sell US$0.7 billion in late February to contain an ongoing depreciation of the peso but, since then, has allowed the exchange rate to be determined by market forces. As of end-August, gross reserves were US$31.2 billion amounting to 5.4 months of import cover or 71 percent of the IMF’s reserve adequacy metric. A large part of the reserves (US$11 billion) is from a renminbi swap line with China. In addition, the central bank’s FX assets include around US$11 billion of reserve requirements for FX bank deposits. Other short-term FX liabilities include a US$2.5 billion loan from the BIS and a US$1 billion a repo with foreign banks.

A01app1ufig8

International Reserves

(Billions of U.S. dollars)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: BCRA and Fund staff calculations.

By end-2016, reserves are expected to grow by a further US$2.2 billion, mainly as a result of resident inflows under the tax amnesty program. While the regular net issuance of the provincial and federal government for the remainder of the year will be around zero, the tax amnesty is expected to draw in around US$4.5 billion in 2016 (includes tax payments and investments in bonds/investment fund, from both domestic and external sources). This will help the government build additional reserves of around US$2.2 billion, leaving end-2016 at US$33.3 billion (5.7 months import cover).

Reserves will increase substantially over the coming years funded by large-scale public debt issuance. The significant net public debt issuance is likely to help build foreign exchange reserves to around US$67 billion, or 8.7 months import cover with an assumption that the BCRA will purchase these proceeds from the FX market. The pace of reserve accumulation envisaged in the baseline would mitigate the pressure on the REER and provide important buffers for temporary external shocks.

D. Real Exchange Rate

Argentina’s REER has appreciated significantly in recent years. After the sharp devaluation in 2001 Argentina’s REER began a steady appreciation trajectory that accelerated over the last few years despite a one-off correction in 2014. By November 2015, the REER-CPI had doubled compared to its end-2007 level. The bilateral real exchange with Brazil, Argentina major trading partner, followed a similar trend, with the ULC-based bilateral RER up 75 percent by end-2015 from its end-2007 level (reflecting the greater increase in unit labor costs in Argentina).

A01app1ufig9

Multilateral and Bilateral CPI-based Real Exchange Rates

(Index, historical average = 100)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: Haver Analytics, BCRA, and Fund staff estimates.

The stronger real value of the peso may have hindered external competiveness. Since 2009, Argentina’s share of world export markets has steadily declined, as commodity prices have fallen and non-price competitiveness has weakened. However, this broad trend masks heterogeneity between products. The loss of market shares was greatest for Argentina’s main primary products (cereals, soybeans) and energy products, also reflecting high export taxes, export restrictions, and domestic policies of regulated prices and subsidies that discouraged investment and activity in these sectors (see Selected Issues Paper, Chapter 6).

A01app1ufig10

Bilateral Real Exchange Rate with Brazil, CPI-and ULC-based

(Index, 2002Q1=100)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: Haver Analytics, BCRA, and Fund staff estimates.

The removal of most FX controls in mid-December 2015 resulted in an immediate 40 percent devaluation of the peso. However, since March 2016, debt-creating portfolio inflows (as the economy re-leveraged through external financial markets) have sustained the nominal exchange rate within a narrow range. At the same time, the surge in domestic wage and price inflation contributed to a large real appreciation. As a result, as of end-August 2016 Argentina’s REER was about 10 percent above its early 2016 level in late December.

A01app1ufig11

Argentina’s Export Share in World Exports

(Percent, 4-quarter m.a.)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: IMF Direction of Trade Statistics and Fund staff calculations.

Exchange Rate Assessment Tools

(Percent of GDP unless otherwise indicated)

article image
Source: Fund staff estimates.

While there is significant uncertainty about any estimated range, the REER is judged to be 10–15 percent overvalued. The EBA-lite CA model suggests an overvaluation of about 12 percent (using the estimated CA gap of about -1.6 percent of GDP and an elasticity of the CA to REER of -0.13). Using the CA gap from the ES approach and the same elasticity yields a similar estimate. Measures of Purchasing Power Parities (PPP) also suggest that the peso is overvalued. Indices by PriceStats and World Economics, for example, suggest an overvaluation of between 5–20 percent in August.

E. External Balance Sheet

More than a decade of financial isolation means that Argentina’s gross external assets and liabilities are amongst the smallest among EMs. The net positive IIP position of 9 percent of GDP in 2015 is unusual for an emerging market. The majority of external assets are in the form of debt (‘other investment’), while slightly less than half of liabilities are in the form of FDI. External debt is low (see Annex Figure 1 and Annex Table 2), of which over 50 percent is held by the general government and central bank, while the banking sector has borrowed very little from abroad.

The balance sheet is robust to a nominal depreciation. Argentina’s external assets and liabilities are predominately denominated in foreign currency, and, while individual entities in the economy may have a net open FX position, there is no large net exposure of balance sheets to a depreciation. There may be currency mismatches within particular sectors or agents within the economy, so exchange rate shocks could still cause balance sheet problems that affect the real economy (see Selected Issues Paper, Chapter 7).

A01app1ufig12

International Investment Position

(Billions of U.S. dollars)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: INDEC and Fund staff calculations.

Given that 30 percent of foreign liabilities (US$41 billion) are in the form of short-term debt obligations, this creates an important rollover risk. There appears to be a concentration of short-term foreign currency debt in the non-bank private sector. This borrowing is concentrated in the petroleum and industrial manufacturing industries and predominately appears to be associated with credit lines for import financing. While a sudden stop in such trade financing will have important implications for the ability of business to conduct trade, this may not have the same balance sheet spillovers as a discontinuation of other forms of debt obligations, such as working capital.

By 2021, the external balance sheet is expected to switch from a net asset to net liability position. Gross assets and liabilities are likely to grow in coming years as a more open capital account allows greater foreign investment in Argentina and greater portfolio diversification by residents. In coming years, this expansion is driven primarily by public sector borrowing, which will rely on external financing to fund much of its deficit and rollover needs. However, as fiscal consolidation sets in and crowding out effects diminish, the private corporate sector will become increasingly exposed to international capital markets through borrowing.

Annex Table 1.

Summary of Foreign Exchange Controls

article image
Annex Figure 1.
Annex Figure 1.

Argentina: External Debt Sustainability: Bound Tests 1/ 2/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.4/ One-time real depreciation of 30 percent occurs in 2016.
Annex Table 2.

Argentina: External Debt Sustainability Framework, 2011–21

(In percent of GDP, unless otherwise indicated)

article image

Derived as [r - g - r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Annex II. Potential Cross Border Spillovers

Argentina is a relatively closed economy, with modest trade and small financial linkages with the rest of the world. A significant decline in growth in Brazil, China or the U.S. would, however, have a material impact on exports and growth performance. Food commodity price shocks are also a source of vulnerability. Argentina’s relative isolation from international capital markets, its positive net IIP position, and the absence of large maturity and currency external balance sheet mismatches suggest that vulnerabilities from external financial shocks are limited at present. A few regional economies are highly dependent on imports from Argentina, in particular Bolivia and Trinidad and Tobago.

A. Inward Spillovers

International trade makes up a small component of GDP, and exports are relatively well diversified in terms of market destination. Argentina has the smallest ratio of exports to GDP of all Latin American EMs—12 percent of GDP in 2015, compared to an average of 24 percent across the region. This follows a steady decline in importance of trade in the economy since 2004, when the ratio was 21 percent. Compared to its regional peers, Argentina is fairly well diversified in terms of export market destinations,1 although about 40 percent of its exports still go to its 5 largest export markets (average of 2014–15)—Brazil (19 percent), China (7½ percent), the U.S. (6 percent), Chile (4 percent), and India (3 percent). Lower activity in these economies will have an impact on Argentina’s exports and growth.

A01app2ufig1

Export Market Diversification

(“Export Gini coefficient”)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: IMF, Direction of Trade Statistics and staff calculations.

Cluster analysis suggests that Argentina is connected to the rest of world trade through the United States. Examining the network characteristics2 of international bilateral trade links identifies three major global trade ‘nodes’—the U.S., China, and Germany. Argentina forms part of the U.S. trade cluster. This suggests that second-round effects from U.S. activity are also important—for example, a decline in U.S. growth will also weaken activity in countries such as Brazil, Chile, and Mexico, which will then impact trade with Argentina. The U.S. economy is also likely to be the main conduit for shocks originating in the rest of the world.

Argentina’s export concentration in agricultural commodities exposes it to commodity price shocks. As of 2015, over 60 percent of exports is constituted by agricultural commodities, comprising both primary products and agriculture related manufacturing products (vehicle exports make up a further 10 percent of the total). The degree of diversification has declined since 2005 largely driven by the growing specialization in soy and cereal products. This leaves Argentina vulnerable to shocks to global agricultural prices. For example, a 10 percent decline in global agricultural commodity prices would lead to around a 2 percent decline in overall export values (direct effects only).

Relative isolation from international capital markets shields Argentina from financial spillovers. As discussed in detail in Chapter 7 of the Selected Issues Paper, Argentina has relatively few links to international capital markets, and its positive net IIP position, and the absence of significant currency or maturity mismatches imply that risks from external financial stocks are contained. While 95 percent of portfolio investments are reported to be from the U.S. (CPIS database), the ultimate holders of these liabilities are likely to be more broadly globally diffused.

A01app2ufig2

Network map

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: IMF, World Economic Outlook database, Map equation website and Fund staff calculations.

B. Outward Spillovers

A number of regional economies are reliant on Argentina as an export market. Exports to Argentina from Bolivia and Trinidad and Tobago (mainly liquefied natural gas) account for 17 percent and 13 percent of their total exports, respectively. This suggests that potential outward trade spillovers to these countries could be large. Paraguay, Brazil, and Uruguay supply around 6 percent of their exports to Argentina, suggesting a modest degree of interconnectedness, but not enough to pose a major vulnerability to these economies.

Argentina is unlikely to be a major source of regional financial spillover risk. The crisis in the early 2000s generated regional financial spillovers, especially in Uruguay given its reliance on Argentine resident deposits in the domestic banking sector. These regional financial links are much smaller today, with most financial assets concentrated in global financial centers. Over 80 percent of Argentine portfolio assets (as reported by other economies) are concentrated in the U.S., Luxembourg, Italy, and the United Kingdom. Only 2 percent are reported to be held in Brazil, with virtually no holdings in the rest of the region.

A01app2ufig3

10 Largest Exporters to Argentina

(Percent of exporter total exports)

Citation: IMF Staff Country Reports 2016, 346; 10.5089/9781475552621.002.A001

Sources: Direction of Trade Statistics and Fund staff calculations.
1

In compliance with past rulings of the Supreme Court, the June 2016 “Ley de Reparacion Historica” recognized a debt to current retirees derived from the incorrect calculation of initial benefits and the improper application of the indexation mechanism starting from 2002. The law also introduced a universal old-age pension that extended pensions to all those 65 years and older without a contributory pension.

2

Banks’ gross FX position is also low as it represents around 17.6 percent of assets and 17.7 percent of liabilities (data as of July 2016). Much of the FX assets are very liquid (deposits at the BCRA and cash), with 29.3 percent corresponding to FX loans. But banks can only grant FX loans to those who actually have FX income (mainly exporters) which significantly reduces risks from a depreciation of the peso.

3

The BCRA will conduct liquidity management and introduce standing facilities in connection with the 7-day policy rate.

4

The latter figure excludes pensions of the police and military forces (0.5 percent of GDP in 2015) and disability and other non-contributory pensions under the Ministry of Social Development (1.2 percent of GDP in 2015).

5

The tax base for employee’s social security contribution is capped at an amount that is revised twice yearly according to the pension indexation formula. Currently, the cap is 56,058 pesos per month, which is a little above double the average wage of those contributing to the social security system.

6

Revenues from property taxes amount to 0.5 percent of GDP in Brazil, 0.6 in Chile, 0.7 in Colombia, and 0.7 in Uruguay.

7

The Law, introduced in 2004, was suspended in 2010. It states that primary spending growth in federal and provincial budgets cannot exceed the projected rate of nominal GDP growth. It also imposes limits on debt service ratios at provincial level, and it requires the federal and provincial governments to maintain primary current balances. However, enforcement mechanisms are weak: the only sanction for the federal government is the exclusion from the Federal Fiscal Responsibility Council, a committee representing the federal government and provinces that verifies the application of the law and should coordinate fiscal policy across federal and provincial governments. Sanctions for provinces mainly include suspension from the authorization to issue debt and reductions of discretionary transfers from the federal government.

8

The growth elasticity of poverty is estimated as the percent change in poverty with respect to a one percent change in per capita GDP, using CEDLAS data for poverty and INDEC GDP data for the period 2004–14.

9

Lucía Pérez Fragoso and Corina Rodríguez Enríquez, “Western Hemisphere: A Survey of Gender Budgeting Efforts” (2016), IMF Working Paper n. 153.

10

A government report (“El estado del estado: Diagnóstico de la Administración Pública Nacional en diciembre de 2015”) paints a dire picture of the state of public administration and is expected to be followed by wide-ranging investigations by the Anti-Corruption Office.

11

As just one comparative indicator, Argentina has trade agreements with 43 countries, while Chile has agreements with 91 countries. Colombia, Chile, and Peru, for example, have signed FTAs with the U.S., Canada, the EU, the EFTA, and Korea, while MERCOSUR has been negotiating toward an FTA with the EU for almost 20 years without concluding an agreement. Among the G20, Argentina has an FTA only with Brazil.

12

Valerie Cerra and others, “Highways to Heaven: Infrastructure Determinants and Trends in Latin America and the Caribbean”, 2016, IMF Working paper, n.185.

13

The logistic cost of exporting a 40-foot container by land is US$1,842 in Argentina compared to US$1,000 in Brazil, with data as of 2014 (World Bank, 2015). Countries improving their score by 1 in the logistic performance index (LPI) increase their labor productivity by 35 percent on average (OECD, CAF, and ECLAC, 2013). All references are in Chapter 6 of the Selected Issues Paper.

14

“Structural Reforms and Macroeconomic Performance: Initial Considerations for the Fund”. IMF Policy Paper, November 2015.

15

Sebastian Barnes and others. “The GDP Impact of Reform: A Simple Simulation Framework,” (2011), OECD Economics Department Working Papers, No. 834, OECD Publishing

1

Also, the non-payments to the ‘holdout creditors’ helped mask the current account deficit, as the unpaid interest on this debt was not included in the official current account balance.

2

Prior to the exchange rate unification, staff and market estimates of FX overhang potentially arising from arrears on imports and dividend payments amounted to about US$8 billion and US$9 billion, respectively. However, as FX controls have been reduced since December 2015 and capital inflows to Argentina picked up, there has been little evidence of FX pressures from these sources, suggesting that the estimates of import arrears may have been overstated while dividends have likely been reinvested in the country.

1

As measured by an “export Gini coefficient”, which measures the share of exports by destination market compared to a hypothetical scenario where exports are shared evenly across all possible markets. If exports were spread evenly across all countries (‘full diversification’), then the coefficient would equal zero. If all exports went to one country (‘no diversification’), the coefficient would equal one.

2

This analysis uses Hierarchical Network Navigator application on the MapEquation website. The tool uses an algorithm developed by Rosvall and Bergstrom (2011)—Multilevel Compression of Random Walks on Networks Reveals Hierarchical Organization in Large Integrated Systems.

Same Series

Other IMF Content

Other Publishers

  • Collapse
  • Expand
Cover IMF Staff Country Reports
Argentina: 2016 Article IV Consultation-Press Release; Staff Report; and Statement by the Executive Director for Argentina
Author:
International Monetary Fund. Western Hemisphere Dept.
Volume/Issue:
Volume 2016: Issue 346
Publisher:
International Monetary Fund
ISBN:
9781475552621
ISSN:
1934-7685
Pages:
93
DOI:
https://doi.org/10.5089/9781475552621.002

Key Macroeconomic Developments

(Percent change, unless otherwise indicated)

Poverty Rate 1/

(Percent)

Debt Issuance in International Markets

(Billions of U.S. dollars, first nine months)

Poverty Rate

(Percent) 1/
Figure 1.

Argentina: Effects of the Transition

Monetary Aggregates

(Percent change, y/y, monthly averages)

Real Growth of Federal Primary Expenditures

(Percent change, y/y)

Policy Rate and Inflation Expectations

(Percent)

Goods Trade

(Billions of U.S. dollars, NSA)

Balance of Payments Flows

(Billions of U.S. dollars)

Real Effective Exchange Rate

(Index, historical average=100)

Corporate Debt

(Percent of GDP) 1/

Government Approval Rating and Confidence in Government Index

Inflation

(Percent, m/m unless otherwise indicated)

Federal Government: Fiscal Impulse

(Percent of GDP)

Inflation and Wages

(Percent change, y/y 4-quarter m.a.)

Inflation Model for Argentina

(Percent change, y/y)

Gross Fixed Capital Formation

(Percent of GDP, current prices)

Federal Government Gross Debt

(Percent of GDP)

Output Cost of Disinflation and Inflation Inertia1

(Percent)

Moderate Inflation Episodes and Convergence to Low Inflation

Inflation and Increase in Nominal Wages in Chile, Colombia, and Mexico, 1985–2000

General Government Expenditure

(Percent of GDP, 2015)

Secondary School Teachers and PISA Outcomes 1/

(Latest value available)

Health Spending Efficiency Frontier 1/

(Latest available value)

Incidence of Residential Subsidies by Income Decile

(Percent of total subsidies)

Pension Replacement Rate for a Male Earning the Average Wage

(Percent)

Retirement Age and Life Expectancy

(Years)

Total General Government Revenue

(Percent of GDP)

Property Tax

(Percent of GDP)

Selected Gender Indicators

Tertiary School Enrolment

(Percent)

Adolescent Fertility and Maternity Mortality

(Percent)

Worldwide Governance Indicators, 2014

(Index, -2.5 (weak) to +2.5 (strong) governance performance)

Financial Development

(Percent of GDP, 2014)

Import Tariff Protection

(Percent)

Change in Export Market Share and Transport Infrastructure

Crude Oil and Gasoline Prices

(U.S. dollars)

Current Account and Terms of Trade

(Percent of GDP unless otherwise indicated)

National Saving

(Percent of GDP)

Domestic Investment

(Percent of GDP)

FDI

(Percent of GDP)

Capital Outflows

(Billions of U.S. dollars)

Gross International Reserves

(Billions of U.S. dollars)

ARA Metric Decomposition

(Billions of U.S. dollars)

International Reserves

(Billions of U.S. dollars)

Multilateral and Bilateral CPI-based Real Exchange Rates

(Index, historical average = 100)

Bilateral Real Exchange Rate with Brazil, CPI-and ULC-based

(Index, 2002Q1=100)

Argentina’s Export Share in World Exports

(Percent, 4-quarter m.a.)

International Investment Position

(Billions of U.S. dollars)
Annex Figure 1.

Argentina: External Debt Sustainability: Bound Tests 1/ 2/

(External debt in percent of GDP)

Export Market Diversification

(“Export Gini coefficient”)

Network map

10 Largest Exporters to Argentina

(Percent of exporter total exports)