Argentina: Request for Stand-By Arrangement

Request for Stand-By Arrangement-Press Release and Staff Report

Abstract

Request for Stand-By Arrangement-Press Release and Staff Report

Economic and Political Context

1. President Macri took office in December 2015 at the helm of a country facing pervasive macroeconomic imbalances, microeconomic distortions, and a debilitated institutional framework. At the macro level, large fiscal deficits, predominantly financed by financial repression and money creation, had created an unstable economy where inflation was very high, investment was at historically low levels, and international reserves were virtually depleted. At the same time, an elaborate system of microeconomic distortions was in place, including: administrative controls on prices; large and regressive energy and transportation subsidies; a plethora of trade restrictions; the rationing of foreign exchange (FX); an uncompetitive business environment; the provision of inaccurate official statistics; and corruption. Despite a plethora of social transfers and government interventions into the economy, when President Macri took office, one in three Argentines were living below the official poverty line.

2. Argentina has been engaged in a systemic transformation of its economy. The new government moved assertively on multiple fronts: unifying the exchange rate and allowing the level of the currency to be determined by market forces; putting in place an inflation targeting framework for monetary policy; eliminating FX controls; settling the outstanding FX forward contracts and rebuilding international reserves; beginning the difficult process of realigning utility prices and eliminating inefficient electricity and fossil fuel subsidies; cutting government spending and reducing the most distortive taxes; and reaching a debt exchange agreement with foreign creditors to reopen international capital markets. Finally, with IMF assistance, the government restored credibility to official statistics through a top-to-bottom rebuild of the statistics agency. All of this was achieved with the government holding a minority of the seats in Congress.

3. Not surprisingly, the unwinding of these distortions led to a recession in the first year of the administration. However, the economy recovered in 2017, with strong investment and consumption alongside an acceleration in job creation, and the government’s coalition was able to win Senate races in the five largest population centers in October 2017. Nonetheless, the governing coalition remains a minority party in both houses of Congress. Finally, in November 2017, the government signed a “fiscal pact” with the provinces that settles past provincial claims on the federal government, increases revenue sharing, and finances the pension deficits of certain provinces. In return, the provinces agreed to eliminate certain distortionary taxes and to keep their growth in nominal spending below the rate of inflation.

4. To maintain social consensus the government undertook many of these policy steps—most notably the fiscal adjustment—at a gradual pace. Largely as a by-product of this understandable preference for gradualism, the country was left vulnerable on a number of fronts (these vulnerabilities were highlighted in the 2017 Article IV Consultation):

  • With most of the reductions in energy subsidies offset by lower taxes, greater automatic transfers to provinces, and higher spending on pensions, the primary deficit remained broadly unchanged as a share of GDP through 2016 and 2017. Interest spending, however, increased rapidly, as financing from money creation and financial repression was replaced with public debt, much of it in foreign currency. As of March 2018, about 70 percent of the federal debt stock was denominated in U.S. dollars or other foreign currencies and, since January 2016, the federal government has issued US$56 billion in external debt (with a further US$13 billion issued by provinces). As a result, the overall fiscal deficit and gross fiscal financing needs of the federal budget increased markedly.

  • In parallel, the current account deficit (as a percent of GDP) tripled between 2014 and 2017 as FX controls were released and import compression was reversed. Sizable capital inflows—much of it used to finance the general government—allowed the central bank (BCRA) to rebuild reserves (from US$25.6 billion in gross reserves at end-2015 to about US$55 billion at end-2017; net of short-term external liabilities, reserves rose from −US$1.5 million to almost US$28 billion over the same period). Nonetheless, the higher current account deficit and debt amortization led to a dramatic increase in gross external financing needs (projected to reach about US$94 billion for the remainder of 2018).

  • Second-round effects from the normalization of utility tariffs, an insufficient countervailing force from fiscal retrenchment, continued strong nominal wage growth, and some backward indexation of contracts have resulted in significant inflation inertia. This has disrupted the central bank’s planned path of disinflation.

  • The peso became increasingly overvalued as the pace of disinflation was slower-than-planned and strong capital inflows (much of it to finance the general government budget) put upward pressure on the nominal exchange rate. The 2017 Article IV Consultation Staff Report judged the peso to have been 10–25 percent overvalued relative to medium-term fundamentals and desirable policies.

Market Volatility

5. It is against this backdrop of known vulnerabilities that Argentina began to come under significant capital account pressures. The proximate causes of this shift in market sentiment was an ill-fated confluence of factors including:

  • On December 28, 2017, the government took the decision to reset its inflation targets, raising the midpoint of the 2018 target from a 10±2 percent band to a point estimate of 15 percent. Then, at the following monetary policy meeting, on January 9, 2018, the central bank lowered its policy rate by 75 basis points (bps), and by another 75 bps on January 23. The combined effect led inflation expectations to quickly rise to 22 percent for end-2018 (i.e. by more than the increase in the target), triggering a rapid depreciation of the peso (by about 15 percent from December to February) and calling into doubt both the BCRA’s independence and its commitment to lower inflation. The path for disinflation was further disrupted by utility price increases in the first half of 2018, causing inflation to stall at around 25 percent over the last several months.

  • Global financial conditions tightened. The U.S. dollar strengthened and the U.S. treasury yield curve shifted upwards as markets priced in a faster pace of monetary normalization by the Federal Reserve. This resulted in a reduced appetite for Argentine international bonds, particularly after the federal government placed US$9 billion in debt on January 4 (at historically low yields). Subnational governments have, so far, not issued external debt in 2018.

  • A domestic drought is expected to significantly erode agricultural export revenue. Hot and dry conditions during much of November–March lead to large reductions in crop yields, particularly for soy and corn. Later, heavy rains led to waterlogged fields and hampered efforts to harvest the crop. Estimates suggest that the crop will be 20–30 percent lower than in the previous harvest likely making this one of the worst droughts in recent decades.

    uA01fig01

    Soy Production

    (Millions of tons)

    Citation: IMF Staff Country Reports 2018, 219; 10.5089/9781484367551.002.A001

    Source: Argentine Ministry of Agroindustry.

  • Investing in short-term BCRA paper became a crowded carry trade among foreign asset managers, offering high returns insofar as the exchange rate remained relatively stable.1 However, the steady depreciation of the peso versus the U.S. dollar in the first quarter of 2018 ate into investor returns. By early April, both residents and nonresidents were looking to exit their positions, and the latter were fueled by the expected introduction of a 5 percent withholding tax on interest earned on central bank bills (the measure passed the Congress in December 2017 but was to become effective on April 26). In April, the central bank facilitated this exit out of peso assets by selling US$4.7 billion dollars into the market, effectively setting up a one-way bet for investors. As the run on short-term peso liabilities accelerated, the government faced increasing strains. The situation came to a head on April 25 when the central bank sold US$1.5 billion on that one day alone.

    uA01fig02

    LEBAC Yield Curve, 2018

    (Percent, ARS-denominated bonds)

    Citation: IMF Staff Country Reports 2018, 219; 10.5089/9781484367551.002.A001

    Source: BCRA and Bloomberg.
    uA01fig03

    Interest Rates

    (Percent)

    Citation: IMF Staff Country Reports 2018, 219; 10.5089/9781484367551.002.A001

    Source: BCRA and Bloomberg.

6. What had started as a portfolio rotation out of short-term peso liabilities of the central bank soon became a more generalized run on Argentine assets. The central bank responded to these pressures by raising interest rates by 300 bps on April 27, accompanied by substantial sales of international reserves amidst disorderly market conditions. This was insufficient to relieve pressures on the peso. On May 3, the central bank raised rates a further 300 bps. What was intended as a mechanism to stabilize markets, however, became a source of panic, and investors rushed to offload peso assets. On May 4, the government announced a package of measures to restore investor confidence that included:

  • A further increase in the policy rate by 675 bps (a cumulative increase of 1,275 bps over the space of one week, bringing the mid-point 7-day repo rate from 27¼ percent to 40 percent).

  • A widening of the corridor around the policy rate.

  • A reduction in the ceiling on domestic banks’ net FX long positions from 30 to 10 percent of their net equity or liquidity.

  • A decrease in the 2018 federal government primary deficit target from 3.2 to 2.7 percent of GDP, largely achieved through cuts to capital spending and a real cut in public sector wages. There was no change, however, to the 2019 target (of 2.2 percent of GDP). The government indicated that the reduction in the 2018 primary deficit would lower financing needs by US$3 billion. However, the announcement did not take account of the higher gross fiscal financing needs arising from an increase in the interest bill—due to the higher interest rates and a more depreciated peso. This partly undermined the government’s communication strategy.

7. On May 8, amid continued volatility and pressure in FX markets, President Macri announced that discussions would begin on a high access arrangement with the IMF. On May 11, the currency depreciated a further 2.7 percent, the central bank sold US$1.2 billion, and interest rates on 35-day maturity central bank paper rose to 49 percent. On May 14, the peso lost a further 7 percent. While the private sector accumulation of external assets has accelerated, dollar deposits have remained stable, and there is no evidence of a run on the banking system. The depreciation and higher interest rates are also affecting perceptions of sovereign risk, with average spreads on foreign currency bonds having risen by around 120 bps from mid-April until mid-May (larger increases have been seen on shorter-maturity U.S. dollar bonds). Fitch also decided to lower Argentina’s rating outlook from positive to stable in the wake of this volatility.

uA01fig04

Exchange Rate

(ARS / USD)

Citation: IMF Staff Country Reports 2018, 219; 10.5089/9781484367551.002.A001

Source: Bloomberg.

8. On May 16, the government successfully rolled over US$28 billion in maturing short-term BCRA paper (at a 40 percent annual rate on one-month paper), and pressures on the currency moderated. With the central bank offering up to US$5 billion in foreign exchange at 25 pesos to the U.S. dollar, and with anticipation of an agreement with the Fund increasingly discussed in the local media, pressure on the currency waned and financial markets in Argentina calmed. The exchange rate was stable at around AR$25 per U.S. dollar, the central bank did not undertake spot intervention in the currency market, and interest rates remained high (with one-month central bank liabilities yielding close to 40 percent). Following the announcement of a staff-level agreement with the Fund on June 7, the BCRA removed its FX offer of US$5 billion at an exchange rate of AR$25 per U.S. dollar. In the following two days the exchange rate depreciated by 5 percent and, in June 12, the BCRA sold around US$700 million in spot markets and US$300 million in non-deliverable futures.

9. Following the announcement of staff-level agreement on an exceptional access Stand-By Arrangement on June 7, there are tentative signs of a return of market confidence. Upon news of the announcement, sovereign spreads fell and bond prices appreciated by around 3 percent. The EMBI spread fell from 479 bps to 474 bps while one-year CDS spreads fell by 10 bps (to 178 bps). The stock market index rose by 4 percent.

uA01fig05

Argentina Sovereign Curve, 2018

(Percent, ARS-denominated bonds)

Citation: IMF Staff Country Reports 2018, 219; 10.5089/9781484367551.002.A001

Source: Bloomberg.
uA01fig06

Argentina Sovereign Curve, 2018

(Percent, USD-denominated bonds)

Citation: IMF Staff Country Reports 2018, 219; 10.5089/9781484367551.002.A001

Source: Bloomberg.

A More Accelerated Fiscal Path

10. The authorities’ adjustment program is anchored on the goal of achieving federal government primary balance by 2020. The fiscal effort will be front-loaded with a targeted primary deficit of 2.7 percent of GDP in 2018 and 1.3 percent of GDP in 2019. This represents a bold and ambitious commitment, especially coming from the 3.8 percent of GDP primary deficit outturn of 2017. Such a fiscal path would put the debt-to-GDP ratio on a steady, downward trajectory throughout the duration of the program (falling from about 65 percent of GDP at end-2018 to below 56 percent of GDP by end-2021). On June 7, the Treasury announced their commitment to these new federal government primary balance targets. Staff considers that the completion by the authorities of this action meets the test (i.e., that the upfront implementation of the measure is critical for the success of the program) for a prior action.

11. The program includes a quarterly performance criterion on the primary deficit of the federal government. To aim to ensure that convergence to a balanced budget is matched at the provincial level, an indicative target will be set on the primary balance of the general government. Submission to Congress of a 2019 budget that is consistent with the program will be an end-October 2018 structural benchmark.

12. This realignment of the fiscal position will be underpinned by measures already underway for 2018 and a commitment to implement further steps in the context of the 2019 budget. These include:

  • Delaying implementation of parts of the recently-passed tax reform to 2020 as a means to preserve revenues (i.e., the reduction in employers’ social security contributions and the ability to deduce the financial transaction tax from income taxes).

  • Maintaining the average export tax rate on soy products at 25.5 percent.

  • Further reducing inefficient subsidies for energy and transportation.

  • Rationalizing spending in other goods and services, with a 15 percent cut in real terms in 2018 and continuing in 2019.

  • Reducing the wage bill by reducing public employment through sustained attrition of non-priority employees in 2018 and a hiring freeze in the federal administration (excluding universities) for 2019 and 2020.

  • Capping the nominal growth of public sector wages (including non-wage benefits and payments) to an average of 8 percent during June 2018–June 2019. An agreement with the unions to this effect has already been signed.

  • Cutting transfers to state-owned enterprises by a total of 15 percent by 2019, combined with efforts to strengthen their financial position.

  • Reducing discretionary transfers to provinces by 1.2 percent of GDP by 2019 and ensuring those reductions are offset by cuts in provincial spending on wages and goods and services. The resulting reduction in the federal deficit will, therefore, be reinforced at the subnational level. The identified reductions in provincial spending are designed to preserve social assistance and other poverty alleviation programs that are executed at the provincial level.

  • Reducing capital spending by 0.6 percent of GDP by 2019 with the expectation that private-public partnership projects would protect the overall level of outlays on public infrastructure.

  • Scaling back tax expenditures linked to the corporate income tax.

  • Selling land and amortizing pension fund assets that are currently held by the government to partially finance the government’s payment of past pension claims.2

The government also intends to continue working within the appropriate parliamentary commission toward defining a path to improve the pension system and make it financially sustainable and fairer, for both current and future generations.

13. The government recognizes the uncertainties in the outlook and, in the interests of fiscal prudence, has identified a further 0.2 percent of GDP in contingent measures. These are largely related to reductions in capital spending and would be drawn upon in the event that GDP growth was weaker-than-expected or some other event were to put at risk the achievement of the primary deficit target of 2.7 percent of GDP in 2018. On the other hand, if economic and fiscal outturns evolve in a more positive direction, the authorities would consider a more front-loaded elimination of distortive taxes in order to better support growth and investment (in line with the pace that was outlined in the tax reform that was adopted in late 2017). The fiscal position and implications for policy measures would be assessed at the time of each program review.

Summary of Identified Fiscal Measures

(Cumulative relative to 2017, in percent of GDP)

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Source: Fund staff calculations.

14. The broader budgetary framework will also be strengthened.

  • The annual budget will be complemented with simple and transparent medium-term objectives for the primary balance, cast in a Medium-Term Fiscal Framework (MTFF) that shows the path of expenditure and revenue consistent with these objectives. The annual budget documents will transparently indicate the impact of new measures that will be undertaken to achieve those primary balance objectives (a structural benchmark for end-October 2018).

  • A new mid-year fiscal report will be published by June 2019 that contains updated estimates of fiscal outturns and a revised MTFF, with new macroeconomic and fiscal projections for the medium term.

  • Adequate resources and staffing will be provided to the newly created CBO (Oficina de Presupuesto del Congreso), so that it can effectively (i) evaluate budgetary and macroeconomic forecasts (including those contained in the annual budget and mid-year budget report); (ii) provide independent costing to Congress of new policy initiatives; and (iii) assess the government’s fiscal plans, including the annual budget (a structural benchmark for end-December 2018). There would also be a comprehensive examination of the CBO’s design features to ensure that it is fully able to achieve the government’s desired objectives.

  • Adequate resources will also be provided to the Federal Council of Fiscal Responsibility (FCFR) so that it can effectively fulfill its mandate of monitoring and evaluating fiscal performances of Federal and provincial governments, including compliance with the Fiscal Responsibility Law. There would also be a comprehensive examination of the FCFR’s design features to ensure that it is fully able to achieve the government’s desired objectives.

  • The Budget documents will continue showing a statement quantifying the size and type of tax expenditures.

  • A fiscal risk analysis framework will be developed with a view to be included in the 2020 budget documents. This would include the publication of a fiscal risks scenario analysis, a long-term fiscal sustainability analysis (undertaken for the federal and general government), and an analysis of contingent liabilities (explicit and implicit) including those related to the financing of PPP projects, state enterprises, and unfunded pension obligations of the federal government.

  • Revenue administration will be strengthened through (i) developing a comprehensive taxpayer compliance program with AFIP; (ii) modernizing and integrating AFIP’s information and communication technology with their data management capacity; (iii) improving the functioning of the single taxpayer account; and (iv) improving the administration of the small taxpayers’ (monotributo) regime. There will also be support to the provinces in their effort to modernize their tax administration.

Protections for the Most Vulnerable

15. The authorities are keen to minimize the effects of the adjustment on the most vulnerable. The economic prospects over the near-term are highly uncertain and much will depend on investor confidence. The program, therefore, puts in place safeguards to protect Argentina’s most vulnerable. In addition, contingency measures will provide resources to the poor in the event that social outturns worsen relative to the outlook that underpins the program. These protections include:

  • A program floor on federal government spending on social assistance (a quarterly performance criterion) equivalent to 1.3 percent of GDP (or AR$177 billion) in 2018 and at a level that safeguards program coverage for 2019–20 while allowing benefits to rise according to the existing indexation formula. This represents an effort by the government to ensure that such spending is prioritized and protected within the budget. The focus will be on programs that cover children through the existing social safety net: the universal child allowance program (Asignación Universal por Hijo, AUH) and the allowance for pregnant mothers (Asignación por Embarazo, AUE). Both programs (which together comprise the Asignación Universal para Protección Social) are efficiently administered, have reasonably wide coverage, and have been shown to improve socioeconomic outcomes in the target population. In addition, the floor will protect social spending on contributory family allowances (including allowances to monotributistas which are included under the budgetary program named Asignaciones Familiares). Table 1 provides quantitative information on the nature of coverage and the level of spending on these programs.

    Table 1.

    Priority Social Protection Programs

    article image
    Sources: INDEC, Cuenta de Inversion, Budget 2018, and “Analisis y Propuestas de Mejoras Para Ampliar la Asignacion Universal por Hijo” (ANSES, UBA, CEDLAS, UNICEF).

  • An adjustor to the primary deficit to prioritize additional spending on pre-specified, high-impact social assistance programs. If economic conditions worsen such that the government judges either the benefits under the universal child allowance program to be insufficient or the level of enrollment becomes higher than expected, spending on this specific program can be increased by up to 0.2 percent of GDP (or AR$30 billion) per calendar year.

16. To protect the most vulnerable the government also intends to:

  • Work with the World Bank and IDB to identify measures that can be taken to protect households and individuals that have no children, since this part of the population is insufficiently covered by the existing social safety net and is likely to be affected by any worsening of social conditions.

  • Work with the provinces to integrate the provision of social services to those in poverty, reducing duplication, improving targeting and lowering the administrative costs of their social programs.

  • Following a comprehensive review, revise the social tariffs system to make it better protect the bottom four deciles of the income distribution.

Supporting Gender Equity

17. In addition to the broader social assistance protections that the government has proposed, special attention will be given to provide support to women. There is clear gender inequality in the Argentine labor market, with female labor force participation well below that of other Latin American economies. In Argentina, 39 percent of women work in the informal sector (versus 34 percent of men) and there is a 24 percent wage gap between women and men. This is a macroeconomically relevant bias that has important consequences for growth, income inequality, and broader social cohesion and equity.

18. To help lessen these negative outcomes, the authorities intend to:

  • Eliminate the second-earner penalty in the current tax system which will encourage participation of second-earners in the labor force.

  • Continue investing in publicly-funded infrastructure for childcare and early childhood education.

  • Introduce legislation to equalize maternity and paternity leave.

  • Introduce legislation that requires listed companies to publish data annually on the gender balance on their Board and among their managerial positions.

  • Introduce legislation that will increase penalties on perpetrators of gender-based or domestic violence and provide support networks for victims of such violence.

Monetary Framework Underpinning the Program

19. The reform program will aim to strengthen the credibility of the inflation targeting framework. Argentina adopted inflation targeting (IT) at a time when inflation rates were high and the central bank’s credibility had not yet been fully entrenched. As a result, inflation has repeatedly surprised to the upside, expectations have not aligned with announced targets, and the IT framework has not delivered the nominal anchor it promised. The program will thus support the building of institutional strength of the central bank, reducing the fiscal pressure that undermined prior efforts at disinflation, and ensuring a freely floating exchange rate.

20. Going forward, monetary policy will focus on achieving single-digit inflation by end-2021, within the context of a flexible exchange rate regime. With steps already taken toward renewed independence, the central bank has revised its inflation targets, to reach single digit inflation by end-2021. These targets balance a realistic outlook with an ambitious path for disinflation that is consistent with the macro-framework underlying the program. Program conditionality for monetary policy will include an inflation consultation clause centered on the authorities’ inflation targets. If the 12-month inflation rate were to breach the inner inflation band, this will trigger a consultation with staff on the appropriate policy response. If the outer band were to be exceeded, the authorities will complete a consultation with the Executive Board on their proposed policy response before being eligible for further purchases under the program. Both bands will gradually narrow over time as the inflation process becomes more stable. In addition, to provide additional protections given the uncertainty over both the demand for money and the likely path for future inflation, if net domestic assets of the central bank were to exceed the thresholds established in the program, this same clause would be triggered, requiring a consultation with the Executive Board on the authorities’ proposed policy response before being eligible for further purchases under the program.

Inflation Targets and Consultation Bands

(y/y, in percent)

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21. The BCRA has committed to not loosen monetary policy until there are clear signs of a decline in both end-2019 inflation expectations and in realized year-on-year inflation outcomes. Staff expect domestic nominal contracts to become more forward-looking as targets are met and credibility is re-established. In this regard, it will be important that the government aim to ensure that, over the duration of the program, public sector wage agreements are kept in line with the government’s inflation goals.

22. In addition, the authorities have taken a key set of actions that they view as critical for the successful implementation of their policy plan including:

  • Issuing a memorandum of the Ministry of Finance that ends all new direct or indirect central bank net financing of the government. This constitutes a key step in helping to strengthen the credibility of the BCRA’s inflation targeting framework and in lowering inflation expectations. The program further includes a continuous performance criterion on providing no new central bank net financing to the government, including through the distribution of unrealized gains derived from currency depreciation.

  • Publishing a central bank communication to formally adopt the new inflation targets (specified above). Staff considers that the completion by the authorities of these actions meets the test (i.e. that the upfront implementation of the measure is critical for the success of the program) for prior actions.

23. Lessening the BCRA’s vulnerability from a large stock of short-term, peso-denominated debt (LEBACs) will be a key component of the program. The program includes a plan to reduce the BCRA’s net claim on the government—that includes short-term credits and nontransferable Treasury bonds—by at least US$10 billion by end-March 2019, and by US$25 billion by end-May 2021. Quarterly performance criteria have been established for the first steps in this process (and further quarterly performance criteria will be established at future reviews). This operation will be financed through the issuance of peso-denominated securities in the local market. The repayment of government liabilities held by the central bank will be used to drain peso liquidity, thereby lessening the central bank’s reliance on issuing its own (LEBAC) securities. By end-September 2019, the BCRA will limit its counterparties for sale of LEBACs, open market operations, and repos to local banks to encourage re-intermediation through the banking system and to enhance the BCRA’s control over peso liquidity. By end-May 2021, the central bank is expected to have reduced the stock of LEBACs from the current 10 percent of GDP to about 3.5 percent of GDP. To facilitate these changes will require a closely coordinated approach. In this regard, the government intends to establish a senior-level, debt management coordinating committee between Treasury-Finance-BCRA that would meet weekly and coordinate activities linked to sterilization actions of the BCRA and debt issuance plans of the Finance Ministry (an end-September 2018 structural benchmark).

24. To ensure the central bank’s financial autonomy, the government will provide resources to recapitalize the BCRA. Following an independent assessment of the BCRA’s balance sheet, the government will inject the necessary amount of peso-denominated, interest-bearing marketable securities onto the central bank’s balance sheet to achieve an adequate level of capital by end-December 2019. This will be accompanied by an agreement––to be formalized under the planned revisions to the BCRA charter described below––that distributable central bank profits (excluding unrealized gains) will be remitted each year in the form of a transfer to the Treasury for as long as the central bank’s capital exceeds the adequate level of capital. If its capital declines below that level, the BCRA will be allowed to retain its distributable profits entirely.

25. The central bank is committed to maintaining a floating exchange rate, with foreign currency sales restricted to countering periods of clear market dysfunction. The exchange rate will be allowed to fully adjust to prevailing market conditions.

  • The program will include a floor on the change in net international reserves of the central bank (measured relative to June 4 stock) of +US$5.5 billion by end-June 2018 and remaining at that level for the remainder of 2018. Upon approval of the arrangement, NIR will rise by US$7.5 billion as a result of the IMF’s direct budget support. The NIR floor in the program would rise to +US$7.5 billion by June 2019 and to +US$28 billion by June 2021 as the central bank builds reserves to safer levels. The goal would be for reserves to exceed 100 percent of the Fund’s ARA metric by the end of the arrangement so as to provide sufficient precautionary foreign currency liquidity so as to mitigate potential risks to the balance of payments. An adjustor to the NIR floor will be incorporated to allow for the use of up to US$7.5 billion in budget support to either extinguish foreign currency obligations of the federal government or to sell to the market, in a transparent and pre-announced central bank auction to meet peso expenditure needs of the budget.

  • The program includes a quarterly ceiling on the stock of non-deliverable forwards (NDF). The notional amount of non-deliverable forwards will be gradually reduced from US$2.3 billion on June 4, 2018 to US$1 billion by end-June 2019.

  • The central bank will also initiate a consultation with staff if its net foreign exchange sales in spot and forward markets are excessive. This consultation will involve a general overview of monetary and intervention policies with a goal of identifying how best to allow for greater exchange rate depreciation or to raise domestic interest rates and tighten liquidity conditions in the event of a reduced demand for pesos.

  • Finally, the BCRA will publish, by end-September 2018, a regulation to introduce a foreign exchange auction to intervene in the spot and forward markets.

26. BCRA charter. To strengthen the monetary policy framework and central bank governance, the government will submit a draft of a new BCRA charter to Congress by end-March 2019 (structural benchmark). The details of the required legislative amendments will be specified during the safeguards assessment (to be undertaken prior to the first program review), especially regarding the governance and the status of the BCRA’s official foreign reserves. While passage of this new charter requires congressional approval, the authorities have committed to propose legislation that will:

  • Reinforce price stability as the key objective of the BCRA.

  • Prohibit all new, direct or indirect central bank financing of the Government.

  • Entrust the competence for monetary policy formulation to the new Executive Board including giving the BCRA’s Executive Board the authority to set, in consultation with the Ministry of Finance, the inflation targets for three years ahead.

  • Strengthen the avenues of BCRA accountability with Congress and the Argentine people (including an accountability mechanism for when inflation deviates from the BCRA’s inflation objective by a pre-set amount).

  • Provide for well-defined, and limited, grounds and procedures by which the Governor, Vice-Governor, Board of Directors, and Executive Board members could be dismissed from their posts.

  • Improve transparency by restoring international accounting standards, to ensure a transparent report of the Central Bank’s balance sheet.

  • Clarify the legal status of the BCRA’s official foreign reserves, which should only serve to implement exchange rate and monetary policies.

  • Establish in the charter the adequate level of capital for the BCRA, the process for automatic recapitalization, profit sharing and retention rule, as well as the retention of unrealized gain and losses.

  • Strengthen the central bank governance arrangements to support its autonomy.

In anticipation of approval of this legislation, the administration has indicated its strong commitment to treat the central bank as operationally independent with monetary policy decisions to be taken by the Monetary Policy Council in accordance with the Council’s forward-looking views on inflation prospects.

The Banking System

27. At present, there are no material signs of strain in the banking system. While there has been some modest rotation of deposits out of pesos and into U.S. dollars, there has been no sign of a run on deposits. The Argentine banking system is small (bank credit amounts to only 16 percent of GDP); well-capitalized (regulatory capital was 15 percent of risk-weighted assets at March 2018, with 90 percent of that amount in the form of tier-1 capital); and liquid (liquid assets cover over 45 percent of short-term liabilities). Exposure to the sovereign is limited, especially for private banks, as a result of prudential regulation and the history of monetary financing of fiscal deficits. There are, however, important data gaps including those relating to real estate transactions, cross-border activities, and non-bank financial institutions.

28. Nonetheless, there is a potential for a worsening in both bank and corporate balance sheets that may need to be handled within the program framework. Despite the relatively favorable starting position of the banks, real interest rates are likely to remain high for some time and the economy will slow. This will put upward pressure on nonperforming loans (which stood at 1.9 percent of the loan portfolio in March 2018 and were fully provisioned) and constrain the provision of new credit to the economy. The first review mission will be joined, therefore, by MCM experts who will (i) assess the authorities’ preparedness to handle strains in the banking system (including reviewing Argentina’s bank resolution framework) and (ii) to develop a contingent strategy in the event there are either significant liquidity strains (e.g. from deposit outflows) or a weakening of the balance sheets from a substantial rise in bad loans.

29. As pressures on the capital account grew, the BCRA lowered the limit on net long foreign exchange positions from a monthly average balance of 30 percent to a daily balance of 10 percent of banks’ previous month’s net equity. The measure was implemented in a near-crisis situation amid intense peso depreciation and BOP pressures, and was accompanied by other policy responses to stem capital outflows. However, the measure was designed to limit capital flows and thus constitutes a capital flow management measure. In managing the capital account risks faced by Argentina, a key role was played by macroeconomic policies (notably an increase in policy interest rates, a tightening of the fiscal position, and a depreciation of the peso). As such, this CFM does not substitute for or avoid warranted macroeconomic adjustment but rather has been used to support macroeconomic policy adjustment. The CFM implemented by the central bank is viewed as consistent with the Fund’s institutional view on capital flows.

Macroeconomic Framework and Risks

30. The recent market disruptions and the expected fiscal contraction will lead to a slowdown in 2018. The implied fiscal multipliers underpinning the program, at a one-year horizon, are 0.8 on average for changes to spending (at constant prices) and 0.6 for changes to tax revenues. This is consistent with the range of multiplier estimates for Latin American countries (see chapter 4 in April 2018 Regional Economic Outlook: Western Hemisphere). While high real interest rates and fiscal retrenchment will be a drag on growth, the significant real peso depreciation will be a countervailing force, improving competitiveness and supporting external adjustment. In addition, a strong recovery in the agriculture sector—which is typical in Argentina following a drought—will contribute to growth in the second half of this year. The expected gradual restoration of market confidence should also reverse the drag on activity. The slowdown in 2018 will, however, serve to put downward pressure on core inflation to mitigate the upward pressure from the currency depreciation and the planned faster pace of realigning utility tariffs with international prices (particularly in the context of higher world energy prices and a weaker peso).

31. Steady implementation of policies should, however, spur a growth acceleration into 2019. Growth is expected to be around 1½ percent in 2019. The economy will continue to improve into 2020 with growth eventually rising above potential, to around 3 percent, beginning the process of closing the output gap. The rebalancing of the policy mix will facilitate a broader re-composition of demand from the public to the private sector with consumption and investment being the primary drivers in 2019–20. Further progress in addressing corruption would strengthen the business climate and build public support for reforms. As the government’s commitment to the objectives of the program become entrenched, market confidence should be restored, leading to a progressive reduction in short-term interest rates and a modest rebound in the peso.

32. A lower primary deficit of the federal government and a weaker peso will facilitate a contraction of the current account deficit to 2¼ percent of GDP by 2021. A return of capital inflows, lower government interest payments, and disbursements from the Fund will allow for gradual reserve accumulation. Gross reserves are forecast to reach around US$88 billion (or 115 percent of the ARA metric) by end-2021.

33. Debt is expected to peak at end-2018 and fall steadily thereafter. The fiscal adjustment, economic recovery, and lower real interest rates (as and central bank credibility is established) will all work to place public debt-to-GDP ratio on a steady downward trajectory from 2019 onwards (see DSA). After peaking this year at 65 percent of GDP, debt would fall under the planned fiscal consolidation to below 56 percent of GDP by the last year of the program. Gross fiscal financing needs remain elevated for much of the program period but are not projected to breach the 15 percent of GDP risk threshold in the baseline throughout the medium term.

34. There are still important risks to debt sustainability. The most evident near-term risks are linked to:

  • The size of the gross fiscal financing needs under a stressed scenario.

  • The large share of foreign currency debt (which makes Argentina’s debt dynamics susceptible to a sustained weakening of the real exchange rate) and the large external financing needs (which, based on international experience, have shown to be a strong predictor of a debt crisis).

  • The fact that the proposed fiscal consolidation is ambitious relative to similar country situations (i.e., in the top 13 percent of the distribution of consolidations achieved by program countries).

  • The DSA covers only federal government debt and so could understate the sustainability of general government debt. However, most provinces are running close to a balanced budget, and provincial debt is only 6 percent of GDP.

  • The national government faces contingent liabilities from needing to recapitalize the central bank (this has not yet been built into the DSA given the uncertain size of those recapitalization needs), from loss-making publicly-owned corporations, and from unfunded pensions.

These risks are, however, mitigated by the high share of federal government debt that is held by other public-sector entities and the relatively long maturity of dollar-denominated debt issued on international markets (only about one-fifth of the government’s US$-denominated debt held outside the Argentine public sector will mature by end-2020). Overall, staff assesses that, under the baseline of the program, federal debt is sustainable, but not with a high probability.

35. The macroeconomic framework underpinning the program assumes that Argentina draws the first tranche upon approval of the SBA and treats the remainder of the arrangement as precautionary. The drawing of the first tranche will help bolster market confidence and add to gross reserves. The indication of an intent to treat the Stand-By Arrangement (or a portion thereof) as precautionary does not affect the legal character of the arrangement. As such, this intent is not a binding commitment and does not prevent the member from making such purchases if all conditions set forth in the arrangement are fulfilled. When the member requests a purchase under the Stand-By Arrangement it must, however, represent that it has an actual balance of payments need for such purchase. Given the expected gradual return to markets to finance the federal deficit, one-half of the domestic counterpart of Fund resources in the first tranche will be used for direct budget support. It will be deposited at the Treasury’s account at the BCRA and subsequently withdrawn, as needed, to pay for budget outlays. The determination of this amount of access under the program for budget support was based on the federal government’s gross fiscal financing needs and an assessment about a likely path for new borrowing from the private sector between now and end-2018 (Table 8). Monetary targets in the program will be adjusted at the pace at which this budget financing is drawn down. The authorities have indicated their intention to treat the remaining drawings under the arrangement as precautionary.

36. Under the program gross reserves reach 115 percent of the ARA metric by end-2021 and peak at 121 percent of the ARA metric in 2023. This level of reserves provides some insurance against Argentina’s vulnerabilities that arise from a high degree of dollarization, elevated external debt levels, vulnerability to a potential further tightening of global financial conditions, and still-sizable gross financing needs. Access under the program will also support the authorities’ switch from a reliance on borrowed reserves toward nonborrowed reserves.

37. The path for growth under the program could be viewed as optimistic. The path for the economy shows a short-lived and limited interruption to growth. This is a very mild downturn relative to other Argentine recessions that have occurred since 1992 (excluding the 1999–2002 contraction, see chart). However, the Argentine authorities are confident that, with a rebound in the agricultural sector and the pre-emptive way they have dealt with the current crisis (including approaching the Fund for support), the economic downturn can be contained.

uA01fig07

Real GDP Levels

(Index)

Citation: IMF Staff Country Reports 2018, 219; 10.5089/9781484367551.002.A001

Sources: Haver Analytics; IMF, Global Data Source database; national authorities; and IMF staff calculations.

38. The broad contours of the program would, nonetheless, remain robust to a weaker macroeconomic outlook. A scenario was constructed that assumes fiscal multipliers that are about twice as large as those assumed in the forecasts that underpin the baseline. In this scenario (i) growth would be −0.8 percent in 2018 and 1 percent in 2019; (ii) the nominal exchange rate would be 5 percent weaker at end-2018 and 6 percent weaker at end-2019; (iii) nominal policy rates would rise by 4½ percent at end-2018 containing inflation to the top of the outer inflation consultation band; (iv) an additional ¼ of fiscal measures would need to be identified to maintain a primary deficit-GDP at program target in 2018, although the pace of debt reduction would be slower due to weaker growth. In such a scenario, Argentina would have to draw access under the arrangement until end-2019 and rely on some portion of the domestic counterpart of Fund resources for budgetary purposes. Gross reserves accumulation would reach 83 percent of the ARA metric by end-2019 (lower than would be achieved in the program’s baseline).

An Adverse Scenario

39. There is a low probability that a shift in global financial conditions disrupts the expected return of market confidence. It is possible that a faster-than-expected tightening of global financial conditions will slow the pace at which investors rollover their investments in Argentine assets. To model that scenario, staff assumed (Box 1):

  • Lower rollover rates on Argentine public debt by both residents and nonresidents (see table). These are well above the 25th percentile of historical experience.

  • A more depreciated path for the real and nominal exchange rate, in line with the persistent shock to capital inflows and the reduced demand for peso assets.

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    Source: Fund staff calculations.

  • A higher path for nominal and real interest rates that is calibrated to hold inflation at the top of the inflation target band.

  • A recession in 2018 and a more protracted recovery into 2020. The combination of higher interest rates and weaker confidence would also lower the path for potential growth.

  • A need to find an additional 1 percent of GDP in measures to keep the primary deficit from rising above 2 percent of GDP in 2019 and 1 percent of GDP in 2020. Unfortunately, a lack of fiscal financing in this scenario makes pro-cyclical policies inevitable.

  • A full loss in US$-denominated deposits (around US$7 billion) together with about a 2 percent loss in peso deposits. The magnitude of the shock is similar to the experience during 2008–11 in Argentina. As a share of broad money, the shock is close to the center of the distribution of past outcomes in emerging markets.

    uA01fig08

    Portfolio and Other Investment Assets

    (Probability density, in percent of proceeding 3-year average of broad money)

    Citation: IMF Staff Country Reports 2018, 219; 10.5089/9781484367551.002.A001

    Source: Fund staff calculations.

  • Rollover rates on external debt of the private sector falls from 100 percent to 90 percent.

  • In the baseline forecast, FDI is assumed to remain relatively strong, buoyed by improved investor confidence and PPP projects. In the adverse scenario, FDI drops by 45 percent, putting it at the 25th percentile of historical experience.

40. Under this adverse scenario, federal debt would be 4 percent of GDP higher than in the baseline by end-2021. Gross fiscal financing needs would also be more elevated throughout the projection period. In particular, under the adverse scenario there would be an additional US$35 billion in external financing needs which would be met by Argentina drawing the full amount of access under the Stand-By Arrangement. In addition, even with these drawings, the reserve path would be lower than in the baseline (due to a combination of no new issuances by the federal government on international markets and the assumption that the domestic counterpart of the access drawn under the arrangement would be made available to be used as budget support). In this scenario, it is important to highlight that the federal debt remains sustainable, but not with a high probability.

Argentina and Selected FCL/PLL Countries: Comparing Adverse Scenarios1

Source: Fund staff calculations.1/ The empirical distributions are based on countries’ actual experiences during the crisis year (for all four types of debt rollover rates), or countries’ experiences during the crisis year relative to preceding 3-year average (for FDI). For the presented FCL/PLL country cases, shocks are defined according to the adverse scenario and placed on the kernel curve.

Argentina: External Financing Requirements and Sources in Access Scenario

(In billions of U.S. dollars)

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Sources: Argentinian authorities and IMF staff estimates.

Program Modalities

41. In support of their policy plans, the authorities have requested a 36-month Stand-By Arrangement with a final test date of end-March 2021. The program would aim to restore confidence, reverse the current run on Argentine assets, and guard against concerns that Argentina will be unable to meets its large external financing needs.

42. BOP need. Front-loading of access is warranted since the program seeks to address an actual BOP need in the early stages of the program (including through budget support) as a result of the tightening of external financing conditions that Argentina is currently facing. Under the baseline, further drawing under the arrangement would be unnecessary and it will be appropriate for the authorities to treat the arrangement as precautionary. However, the program is designed to also provide assurances against a potential BOP need that could occur in an adverse scenario where global financial conditions tighten, constraining the government’s ability to issue new debt to meet its sizable gross financing needs.

43. Access and Phasing. Access is proposed to be set at about US$50 billion (1,110 percent of quota, SDR 35.379 billion, or 8 percent of GDP).

  • Under an adverse scenario, the proposed level of access would be sufficient to keep gross reserves from falling below 74 percent of the ARA metric.

  • Thirty percent of access (or SDR 10,613.71 million) would be made available upon approval of the arrangement with the goal of bringing gross reserves to about 100 percent of the ARA metric by end-2018. The remaining access will be made available in equal disbursements upon completion of quarterly reviews of the program. The first review would be considered by the Board in September 2018, based on end-June performance criteria.

  • The program assumes that the first tranche is drawn upon approval of the arrangement, but the authorities will treat the arrangement as precautionary thereafter.

  • One-half of the domestic counterpart of the first tranche (SDR 5,306.855 million) would be made available to be used as budget support. A memorandum of understanding has been established between the central bank and the government on their respective roles and obligations. For the amounts used as direct budget support, the resources would be deposited at the Treasury’s account at the BCRA and then withdrawn, as needed, to finance the budget.

  • The amount of budget support (US$7.5 billion) would be split between FX financing for (i) the net reduction in the stock of domestic-law FX federal liabilities that are held by the private sector (US$7 billion of such debt matures between June and end-September); (ii) repayment of official loans (US$0.6 billion); (iii) service of international-law debt (US$1.7 billion); and (iv) peso financing to cover the primary deficit and any needed debt amortization and interest in pesos.

44. Capacity to Repay. Under the baseline macro scenario, where only one tranche is drawn, Argentina’s capacity to repay is good and reserves would remain adequate (Table 16). Under the adverse scenario, where all tranches are drawn, Argentina’s capacity to the repay the Fund is assessed as adequate, although the Fund’s exposure in terms of certain debt service metrics is at the higher end compared with other exceptional access cases (see the Supplement on the Assessment of the Risks to the Fund and the Fund’s Liquidity Position for details). If all purchases were made as scheduled, Argentina’s projected payments obligations to the Fund would peak in 2023 at SDR 11 billion, or 18 percent of official reserves at a time when gross reserves are projected to be about US$90 billion (Table 17). Public debt in the adverse scenario is expected to be sustainable but not with a high probability and to fall as a share of GDP through the course of the program. International reserves in the adverse scenario would remain adequate (albeit at lower levels than in the baseline). Argentina’s impressive efforts over the past few years to strengthen institutions, improve governance, and increase transparency help provide assurances. Finally, a successful IMF-supported program in Argentina is likely to significantly reduce perceived sovereign and balance of payments risks which will be reflected in lower spreads and more open access to global capital markets.

45. Risks to the Program.

  • These are inherent risks, as outlined in the adverse scenario, linked to the pace at which market confidence can be restored, especially if this was either caused by, or associated with, an abrupt tightening of global financial conditions. In the event markets view the Fund program as an opportunity to exit Argentine assets there would inevitably be a significant real depreciation, much higher real interest rates, and lower growth rates. Such a scenario would increase the risks to debt sustainability.

  • There are somewhat lesser risks that arise from a shift in Argentina’s terms of trade (for example from a fall in global soy prices), disruptions arising from changes in tariff policy by trading partners, or a weakening of the economies of regional neighbors.

  • A rapid return of investor confidence could lead to significant capital inflows and, with still high inflation, result in an appreciation of the real exchange rate that prevents the REER from returning—as is assumed under the program—to a level that is consistent with medium-term fundamentals and desired policies.

  • There are further risks arising from the authorities’ strong political commitment to undertake the needed adjustment. The political pressure on the government, and possibly the social divisions that creates, could be sizable, particularly in the early stages of the program. If this were to lead to an inability to implement their policy plans then, not surprisingly, the framework would not hold together and program outcomes will be far from those that are forecast in this document.

46. Conditionality and Monitoring. Program performance will be monitored by quarterly reviews. The first review would be scheduled for Board consideration in September 2018 based on end-June 2018 targets. Quantitative and structural conditionality will be based on Table 2 and 3 of the authorities’ Memorandum of Economic and Financial Policies.

Table 2.

Macroeconomic Outlook: Baseline and Adverse Scenarios

(Percent unless otherwise indicated)

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Source: Fund staff estimates and projections.
Table 3.

Argentina: Selected Economic and Financial Indicators

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Sources: Ministerio de Hacienda y Finanzas Públicas, Banco Central de la República Argentina (BCRA), 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 before 2016.

Percent of potential GDP.

Includes transfers to municipalities, but excludes municipal spending.

Average of all LEBAC maturities before 2017 and midpoint of the repo corridor starting in 2017; ex ante real rates.

Assumes that entire first tranche would remain deposited at the BCRA. Projections and program targets will be adjusted accordingly upon changes.

47. Financing Assurances. The program is fully financed, given firm commitments for financing for the first 12 months of the arrangement and good prospects for full financing thereafter. This is based on a comprehensive assessment of the gross external and fiscal financing needs for the course of the program and realistic assumptions about the prospects for market issuance in the coming months. The World Bank has provided assurances for new support equivalent to US$1.75 billion in the next 12 months. The Interamerican Development Bank has also provided assurances for new budget support of US$0.6 billion during the same period. These amounts have been incorporated into the baseline under the program.

48. Safeguards Assessment. A safeguards assessment of the BCRA will be completed prior to the first review of the program. The assessment will also review the process of compiling monetary program data, including compliance with the Technical Memorandum of Understanding under the program.

49. Implications for Financial Transactions Plan.3 The disbursement of SDR 10,613.7 million under the emergency financing mechanism represents the largest single purchase under any Fund arrangement. The timely execution of this disbursement, possibly under shortened timelines, will as always, rely on the international and cooperative nature of Fund financing through its creditor members under the Financial Transaction Plan (FTP). In parallel to the Executive Board’s consideration of Argentina’s SBA, staff will issue an amended FTP for the May–October 2018 period, which would augment the quota resources that may be used in transfers during the plan period. The amended FTP will need to be considered at short notice and would only become effective upon approval of Argentina’s SBA.

50. Argentina continues to have outstanding arrears to private creditors and the Fund’s lending into arrears policy will apply.

  • The debt exchange undertaken by the government in 2016 reopened capital markets and resolved the bulk of the arrears that had built up over the past several years with the previous two administrations. However, a residual amount of arrears to private creditors remains unresolved (a total of around US$1.3 billion in principal or US$3 billion including accrued interest).

  • Since taking office on December 2015, the current administration has sought to settle the outstanding claims with the holders of the defaulted bonds. On March 2016, Congress passed a Debt Authorization Law (Ley de Normalización de la Deuda Pública y Acceso al Crédito) which repealed various laws prohibiting payment or settlement on untendered debt, thus allowing the negotiation and settlement with certain debt holders and the issuance of new debt.

  • The Ministry of Finance has designed a debt restructuring and cancellation program with the aim of reducing the amount of outstanding debt arrears. It has also designed several information dissemination campaigns—including in Germany, Japan, and Italy—to try to reach as many debt holders as possible. The Ministry of Finance has continued settling claims with untendered debt holders throughout this period. The terms offered to them are the same as those offered to the creditors who accepted in 2016. Litigation initiated by bondholders that have not responded to Argentina’s settlement proposal (that the bulk of other creditors accepted in 2016) continues in several jurisdictions. As of end-December 2017, the outstanding principal amount of untendered debt that was not subject to a settlement agreement totaled approximately US$1.2 billion.

  • Staff is of the view that, based on the authorities’ actions, they are making good faith efforts as required under the Fund’s Lending into Arrears policy.

Settlement of Untendered Debt as of December 31, 2017

(In billions of US$, unless otherwise noted)

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Source: Ministry of Finance.

51. There are limited outstanding arrears to official bilateral creditors. These arrears, of approximately US$30 million claimed by the French export credit agency, relating to the building of a gas pipeline in the Tierra del Fuego region of Argentina by a French company in the late 1970s. The parties are currently in arbitration in the International Chamber of Commerce International Court of Arbitration.

Exceptional Access Criteria

52. In view of Argentina’s large balance of payments need, exceptional access would be required under the proposed program. An evaluation of the exceptional access criteria finds that:

Criterion 1. The member is experiencing or has the potential to experience exceptional balance of payments pressures on the current account or capital account resulting in a need for Fund financing that cannot be met within the normal limits. The tightening of global financial conditions and a shift in portfolio preferences away from peso assets have led to exceptional capital account pressures. It is expected that, with the credible policy plan presented by the Argentine government and support from the international community, these pressures will dissipate. However, there is a risk that such a reversal in sentiment could occur over a more protracted period. Given the large size of Argentina’s external financing need over the course of the proposed arrangement, this would give rise to a substantial external financing need that would not be able to be met within the normal limits of access.

Criterion 2. A rigorous and systematic analysis indicates that debt is sustainable but not with a high probability; exceptional access is justified as financing from sources other than the Fund improves debt sustainability and sufficiently enhances the safeguards for Fund resources. In the baseline scenario—which assumes a partial draw—Argentina’s federal government debt and gross financing needs are projected to remain below the respective risk thresholds (70 and 15 percent, respectively); and federal debt-GDP, after peaking this year, falls steadily over the medium term. There are, however, risks around this baseline: the large share of foreign currency debt, alongside significant rollover needs, leaves Argentina vulnerable to changing market sentiment; and there are potential contingent liabilities from the broader public sector. In an adverse scenario where events trigger a full draw of the arrangement, debt is likely to stabilize at a later date and at a higher level, with continued risks around this trajectory. Staff’s assessment, therefore, is that debt is sustainable but not with a high probability under both the baseline and adverse scenarios. Exceptional access in such situations requires the existence of non-Fund financing that improves debt sustainability and enhances sufficient safeguards for Fund resources. Staff judges the requisite safeguards to be in place. Notably:

  • (i) The long maturity of Argentina’s privately-held foreign currency-denominated debt improves the prospects of adequate private creditor exposure being maintained throughout the program. Of the outstanding stock of the federal government’s foreign currency debt held outside the public sector ($156 billion), only about one-fifth is expected to mature by end-2020.

  • (ii) Argentina has access to both domestic and foreign financial markets. Provided such access continues to be on favorable terms and fiscal targets are met, debt sustainability should improve. The availability of market financing allows for some smoothing of the adjustment path, supporting higher growth and maintaining political and social consensus for the program. Argentina is expected to maintain substantial market access under a range of scenarios, which reduces the risk of Fund resources being used to pay out private creditors.

Criterion 3. Staff judges that the member has access to private capital markets on a scale that would enable the member to meet its obligations falling due to the Fund. Argentina continues to maintain access to both domestic and foreign financial markets, as evidenced by recent peso- and US$-denominated bond placements in domestic markets and the rollover of 100 percent of the central bank’s paper that came due on May 16. Global and domestic factors have, however, tightened external financing conditions and average yields on Argentina’s external bonds have risen. Staff expects that with the successful implementation of Argentina’s policy program, combined with support from the international community, there should be a steady restoration of confidence and a decline in costs of budgetary financing.

Criterion 4. Staff judges that the policy program provides a reasonably strong prospect of success, including not only the member’s adjustment plans but also its institutional and political capacity to deliver that adjustment. The Macri administration, which took office in December 2015, has shown its adeptness over the past two years in delivering on its policy priorities and unwinding a significant set of distortions while protecting the most vulnerable from the burden of adjustment. The administration is committed to prudent policy making, transparent government, and a strong governance framework. Staff deems the administration’s institutional capacity and technical competence to be strong and fully able to deliver the core elements of the expected reform program. However, there is a concern linked to the government’s ability to build support for possible policy measures that need to be passed by Congress (given that the governing coalition has a minority in both houses of Congress). Building a social consensus around the main elements of the program will be both critical and challenging, particularly given the difficult history of IMF lending to Argentina and very divided social and political views on the net benefits of seeking Fund support. Failing to do so would raise serious questions about the political sustainability of the authorities’ reform efforts. Therefore, strong, sustained and consistent policy implementation will be crucial, and broad societal ownership of the government’s economic plan, including in Congress, will be essential for program success. Discussions with the authorities already point to strong ownership of their policy framework and a high-level political commitment to partnering with the Fund in their efforts. There are, however, already significant domestic criticisms of the Fund’s involvement in supporting Argentina and this is likely to present an ongoing challenge throughout the course of the arrangement.

Staff Appraisal

53. Argentina is confronting a difficult situation in international markets and has come under significant balance of payments pressure. This chain of events has been a consequence of domestic policy choices, unforeseeable supply-side shocks, and a shifting environment in international capital markets. The authorities have responded to these shifts with appropriate policies on both the fiscal and monetary side and are to be commended for their swift action.

54. While capital outflows have stabilized, and pressures on the currency have waned, the situation remains fragile and Argentina is vulnerable, particularly to a further external shock either to the terms of trade or to financial market access. Argentina’s sizable current account deficit, large external financing need, and relatively undiversified source of export earnings make it particularly exposed.

55. The program is based on strong ownership of a policy plan that has been developed by the Argentine government and is custom-tailored for the domestic situation that the people of Argentina face. The core of the program is centered on an ambitious fiscal adjustment over the course of the arrangement, underpinned by measures that are largely designed to contain federal expenditures and realign the government’s outlays to be consistent with the revenue envelope that the country can mobilize. Equally important are steps to reinforce credibility of the inflation targets and to construct an institutional framework for monetary policy that create a well-managed, independent and financially autonomous central bank.

56. The government has emphasized in its policy plans the critical need to maintain social cohesion, move toward gender equality, and protect the most vulnerable. The government’s strong commitment to these principles is clear. It can no longer be the case that IMF supported programs with Argentina are associated with austerity, worsening poverty, and a decline in living standards. The burden of the needed adjustment will be shared fairly across society. Those that are most vulnerable will be assisted by well-designed government support programs. Further, the program is designed to better realize the macroeconomic potential from women’s full participation in the labor force and in the productive economy; these gains are judged to be large. The authorities’ policy plans aim to fully capitalize on this economic potential and to ensure all Argentines are included in the country’s future prosperity.

57. Equally important will be structural measures to strengthen institutions and facilitate stronger growth. These include a range of fiscal measures to improve the budgetary process and to provide a medium-term anchor for fiscal policy and for expectations. In addition, the government intends to redouble its efforts in tax administration and examine carefully the options for strengthening the pension system. Attention will also be paid to ensuring the financial system remains resilient and is well-placed to handle any fallout from a slowing economy and higher real interest rates.

58. The staff supports the authorities request for a 36-month Stand-By Arrangement. The government’s economic plans will address longstanding vulnerabilities and provide time to the administration to undertake the needed realignment of policies. They will help ensure that the debt remains sustainable, that inflation comes down, and that growth and job creation will both increase alongside a path of declining poverty. As such, their plans merit the support of the international community.

Table 4.

Argentina: Summary Balance of Payments, 2014–23

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Assumes that entire first tranche would remain deposited at the BCRA. Projections and program targets will be adjusted accordingly upon changes.

Sources: INDEC, Fund staff estimates and projections.
Table 5.

Argentina: Consolidated Public Sector Operations, 2011–23

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

Include transfers to municipalities, but exclude municipal spending.

Percent of potential GDP.