Report No. 1645-AR A dC64A{ 3754Argentina: Reconstruction and Development(In Two Volumes)

Volume 1: Main Report FILO 'er y.August 31, 1977 ~

Latin America and the Caribbean Regicnal OfficeCountry Programs Department 11

FOR OFFICIAL USE ONLY

Document of the World Bank

This document has a restricted distribution and may be used by recipientsonly in the performance of their official duties. Its contents may nototherwise be disclosed without World E4ank authorization.

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CURRENCY EQUIVALENTS

Currency Unit = Peso ($a)

Exchange Rate Effective August 11, 1977

US$1.00 = $a425

$al,000 = US$2.35

$al,000,000 = US$2,352.94

FOR OFF!CIAL USE ONLY

This report is based on the findings of an economic m:[ssion toArgentina in March/April 1977, composed of:

Fred Jaspersen (Chief of Mission)Nicholas Carter (Macro-Economic Planning Economist)Helen Chan (National Accounts Specialist)Gerard de La Fortelle (Capital Markets Specialist)Manfredo Lirider (Energy Specialist)Lorne Sonley (Agricultural Economist)Gabriel Torres (External Debt Specialist)Manuel Trucco (External Debt Specialist)Colin Warren (Energy Consultant)Peter Wogart (General Economist)Sonia Lopez-Balboa (Staff Assistant)Juan Belt (Agricultural Economist, Consultant)Lucio Reca (Agricultural Economist, Consultant)Alfredo Soto (Trainsport Economist, Consultant)

Dolores Velasco participated in the preparation of the StatisticalAppendix.

Thisdocument has a restrcted distribution and may be used by rcipients only in the perfomanceof their official duties. Its contents may not otherwie be disclosed without World Bank authorization.

-IABLE OF CONTENTS

Page No.

VOLUME I - MAIN REPORT

COUNTRY DATA SHEET

MAP

SUMMARY AND CONCLUSIONS ............................... i - xiii.

I. STRUCTURAL IMBALANCE AND ECONOMIC CRISIS ............... 1

II. STABILIZATION AND PROSPECTS FOR 1977 ................... 3

III. GLOBAL OBJECTIVEIS AND SECiORAL DEVELOPMENT ISSUES 18

The AgricuLtural Sector ............ .. ............. 23The Industrial Sector ............................. 29The Energy Sector ................. ................ 32The Transport Sector .............. .. .............. 37

IV. BALANCE OF PAYMEINTS AND EXTERNAL CAPITAL REQUIREMENTS . 43

VOLUME II - STATISTICAL APPENDIX

pj,ge 1 of 2 pages

COUNTRY DA1A - ARGENTINA

AREA ,/ POPULATION DENSITY2,779,741 km. 25.7 million (c):-19

76) 9.23) Pei kn

Rate of Growth. 1.3 (from 1970to 1976) 14.43 per kn- of arahle lan-1

POPlLATION CIIARAGtERISTICS,(1970-19575) IUEALTH (Crude Birth Ratc (per 1,000) 21.8 Population per phtysician 48( (197Crude Death Rate (per 1,000) 8.8 Population per hospital bed 1/(1 (1971)Inifant Mortality (per 1,000 live births)

INCOli. DISTRIBIr1ITON (1970) DISTRIBUTiON OF LAND UWNEHRSHIP (year)/7 of national ilicome, W est qui-itile 47 % owned by top 10% of owuiers

lowest quintile 5 7. ownied by smallest 10% of owners

ACCESS IO PIPED WATER (year) ACCESS TO ELECTRICITY (1Q60)X of population - urban %.. 7 of population - urban 78

- rural .. - ruiral 78

NUrRITION (1974) EDllCATIONCaloric intake as 7. of requirements 133 Adult literacy ratc7. '43 (197(0)Per capita protein intake llf Primary schiool enrollmienl: 2 iO4 kI912)

CN! PER CAPIIA in 1976 US $ 1,550

GROSS NATIONAL PRODUCT IN 1076 2/ ANNUAL RATE OF GROW'rl (7. constant prices)

US $ MLn. % 1960-65 1965-70 1973-7Z 1974-73 197-?':

GNP at Market Prices 40,196 100.0 4.4 4.1 7.0 -1.5 -3.5Gross Domestic tinvestmentv 8,80) 21.9 2.2 7.0 3.9 -7.2 -5.5Gross National Saving 9,2,,1 23.1 5.3 5.0 -4.8 -20.1 11.1Current Account Balance 611 1.5Exports of Goods, NFS 4,66)3 11.6 5.5 5.5 1.7 -23.9 37.9Imports of Goods, NFS 3,58i 8.9 0.4 5.3 13.7 -0.9 -24.4

OUJPUT, LABOR FORCE ANDPRODUCTIVITY IN L973 3'

4/Value Added Labor Force6 V. A. Per Worker

US $ Mll. % Mln. % US $ °

Agriculture 5,381.: 15.0 1.3 14.4 4,139.0 114.2Industry 16,28' 40.0 2.8 31.1 i,102.0 l28.5Services Ib,071.8 45.0 4.9 54.L :1,280.0 S2.6Un.aitocatel .

Tot.cl/Average 35,737 ; 100.0 9.0 100.0 3,971.0 'O0

GOVERNMENr FINANCE 5/General Government -_ _ Treasulry ___

( a$_ Mt_n) b of GDP ( a$ tlM.) '/ of GDP1976 1976 1974-76 1976 1976 1974-i6

Current Receipts 2,288,69 29.8 28.3 385,880) 5.0 5.2Current Expenditure ,167,780 28.2 30,0 971,L85 1U27 '3_2Cuirrent Stirplus 120,912 1.6 -1.7 -587,o06 -7.7 -8.()Capital Expenditures 987,281 12.9 10.3 63,845 6/ 0.8 1.0External Assistance (net) 48,7iit 0.6 1.5 29,887 (0.4 4 .7

1/ The 1976 GNP per capita is at 1974-76 market prices, calcu:lated by the export and import weighted e:changerate of 1974 and 1976. Conversion technique is the sanme zas the 1977 World Atlas. AJ] other conversionto dollars in this table are at the average exchange rate prevailing duiring the period cOvered.

2/ Exchange rate uised is a$188.06 per US dollars3/ Exchange rate used is a$9.35 per (iS dollar4/ Total labor force; unemployed are allocated Lo sector of their normal occupation. "Unallocaited" consists

mainily of unemployed workers seekinig their filst job.5/ Consolidated public sector6/ Includes capital. conLributions.

not .jji lablelot .Ippli calle

Page 2 of 2 pages

COUNTRY DATA - ARGENTI NA

MONEY CREDIT and PRICES 1 171 1972 1973 1974 1975 1976(Bi3l ion a$ outstanding end period)

Money and Quiasi Money 37.9 48.8 95.2 150.0 347.6 1,564.4

Bank Credit to Public Sector S.9 14.8 30.0 44.1 154.4 304.0

Bank Credit to Private Sector 32.1 47.6 78.7 122.1 317.0 1,376.6

(Percentages or Index Numbers)

Money and Quasi Money as 7, of GDP 24.8 22.2 26.1 3O.2 25.6 20;4

General Price Index (196 = 100) 925.3 1,466.2 2,350.5 2,919.6 8,256.5 46 '116.6

Annual percentage changes in:

General Price Index 34.7 58.5 60.3 24.2 182.8 444.0

Bank credit to Public Sector 45.9 66.3 102.7 47.0 250.1 96.9

Bank credit to Private Sector 50.7 48.3 65.3 55.2 159.6 334.3

BALANCE OF PAYMENTS MERCHANDISE EXPORTS (AVERAGE 1974-76)

1974' 1975 1976 US$ Mln /.

7Millions US $)

Exports of Goods, NFS 4,762 3,669 4,668 Cereals 1,192.1 33.6

Imports of Goods, NFS 4,218 4,518 3,585 Beef 337.3 9.5

Resource Gap (deficit = -) 544 -- 78 17U8T Vegetable Oils 239.8 6.7Industrial Exports 862.0 24.3

Interest Payments (net) -297 -414 -440 All other cormnodities 920.4 25.9

Workers' Remittances - - - Total 3,5 l00 0

Other Factor Payments 'net) -119 -26 -50Net Transfers - 5 18 MEDIUM AND LONG-TERM EXTERNAL DEBT, DEC. 31, 1976Balance on Current Account 128 -f,24 61

US $ Ml

Direct Foreign Investment 10 -

Net MLT Borrowing 256 -71 1,160 Debt of the Public Sector 4,251.2Disbursements 1,020 853 2,173 Debt of the Private Sector 1.988,1Amortization 7e

4 924 1,016 Total Disbursed 6,239,3

Subtotal 266 -71 1,160 1/Capital Grants - _ - DEBT SERVICE RATIO for 1976-

Other Capital (net) ) -438 499 -614 %Other items n.e.i i )Increase in Reserves (+) 44 856 -1,157 Public Debt, incl. guaranteed 1.9. 3

Non-Guaranteed Private Debt 12.3

i.iabilities of Central Bank -94 251 1,192 Total outstanding & Disbursed 31.6

Net Reserves (end year) -50 1,107 35

RATE OF EXCHANGE 3/ IBRD/IDA LENDING, April 30. 1977 (Millioll US $)

Decmber 31.1 9 76 IBRD IDA

US $ 1.00 = a $ 274.50

. $ 1.00 = lIS $ 0.0033 Outstanding & Disbursed 2! 337.6

Undisbursed 1952.1March 31, 1977 Outstanding incl. Undisbursed 4,J7

US $ 1.00= a $ 336.50a $ 1.00 = US $ 0. 0030

1/ Ratio of Debt Service to Exports of Goods anid Nonl-Factor Services.

2/ Exchange Adjustment not included3/ Official exchange rates.

Sou,rce: IFS

[not available

not applicabI e

Date preparedMay 25,1977.

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SUMMARY AND CONCLUSIONS

1. During the past year, the Argentine economy has embarked upon a pathof stabilization and reconstruction. Throughout much of the post-war periodpolicies designed to achieve industrial self-sufficiency through import sub-stitution were pursued. The present Government has reversed this trend andhas instituted a strategy aimed at opening the economy by reorienting tradeand domestic price policies so as to bring internal prices more in line withworld prices and thereby achieve greater economic efficiency throu,gh animproved allocation of resources. A number of vital neasures have been takento implement this policy and these are discussed in detail below. Completionof the process, and tlhe restructuring of the economy which it implies, willrequire continued efforts in the years ahead since the task is difficult andcan only be fully achieved over a prolonged period.

2. During the 1950-1974 period the Argentine economy grew by an averageof 4% annually. Given the relatively low rate of population gr-owth (1.6%annually), this economnic performance might be considered satisfactory in termsof per capita income growth, had it not been for sharp fluctuations in thelevel of ec'onomic activity and recurrent episodes of inflaticn and balance ofpayments difficulties. The country's relatively high per capita income(US$1,550 in 1976) masks deep-seated structural imbalances which have beenaggravated by almost ,ontinuous emphasis on industrializatiorn through importsubstitution. Policies which aimed at providing the urban population with acheap supply of foodstuffs discouraged agricultural production and exports andresulted in transformation of agriculture front a leading sector with a strongexport orientation to a sector primarily producing for the domestic market.Lagging agricultural production and development of a relatively high-cost,inefficient, capital-intensive industrial structure which severely limited thecapacity of industry to compete in world markets, lowered the overall exportcapacity of the economy and the share of exports to GDP fell from 25% in the1920s to 8% in thie early 1970s. Erosion of the country's export capacityresulted in recurring balance of payments difficulties which in turn led toadoption of restrictive fiscal and monetary measures aimed at reducing importsthrough a reduction in internal demand.

3. During 1973 and most of 1974 world prices of grains and beef were atrecord levels and Argentina's balance of payments was exceptionally favorable.With foreign exchange reserves increasing rapidly the Government was able topursue expansionary policies which produced boom conditions and GDP grew byan average 6.5% annually. Toward the end of 1975 and early 1976 Argentinaexperienced the fifth and most severe economic and financial crisis of thepost-war era. Excessively expansionary fiscal and monetary policies resultedin acceleration of the rate of inflation to an annual rate-of almost 1,000%during the first quarl:er of 1976. Weak export performance and a doubling ofmerchandise imports over the 1970-74 average level resulted in a large resourcegap, equivalent to 3% of GDP, and an overall balance of payments deficit ofUS$1.1 billion during 1975, the largest for a single year on record. Severedistortions in product and factor prices and, as a consequence, growing

misallocation of resources gave rise to shortages and wide-spread black marketoperations which culminated in a sharp decline of investment and domesticproduction.

4. In March 1976 wheh the new Government came to power, Argentina wasin the throes of an economic and financial crisis unparalleled in thecountry's history. The magnitude of the reconstruction effcort which facedthe Argentine authorities was formidable. There had been a profounddeterioration of key institUtions, of productive capacity and( of supportinginfrastructure. Basic structural imbalances which had eroded the country'sexport capacity had been aggravated by the policies of the previous adminis-tration. Three serious problems--explosive acceleration in the rate ofinflation, deterioration of thle country's external position, ahd a sharpdecline in the level of economic activity--threatened to bring about thecollapse of the economic system. The new government a&ted swiftly on allfronts to stabilize the economy. To avoid further misallocation of resourcesproduct prices were freed and major distortions in factor prices were elimi-nated. To strengthen the balance of payments, stimulate financial savings,achieve an improved allocation of resources, and reduce inflationary pressurestemming from monetary expansion by reducing velocity of money, the authori-ties introduced positive real rates of interest. To strengthen the peso, a

"gliding parity" exchange rate systen was adopted which consisted of periodicdepreciation of the peso to compensate, among other ,things, the differencebetween internal and external inflation. In order to reduce inflation,aggregate demand was cut through restrictive fiscal management and by laggingofficially authorized wage increases behind inflation. Simultaneously, theGovernment entered into a dialogue withl private firms to keep a higher levelof employees in the work force than would have been justified by reducedproduction levels. The Government was successful in preventing an increase inunemployment and in this way was able to spread the burden of stabilizationmore equitably across all income groups.

5. The Government's program resulted in a sharp reduction in the rateof inflation from 737% during the 12 months ending March 1.976 to 116% duringthe year ending April 1977. These achievements notwithstanding, inflationremains the single most difficult problem the Government has to face. Monthlyrates of increase in the cost of living index during the first quarter of 1977were higher than expected, averaging 10.1% as compared to 7.1% during the -last quarter of 1976. This increase in inflation was the result of: correc-tive upward adjustment of prices of goods and services produced by the publicsector; unusually large increases in the price of beef and some other agricul-tural products which weigh heavily in the consumer price index; and intensifi-cation of inflationary expectations linked to the Government's announcement inlate 1976 that during the coming year it would adopt a more flexible incomespolicy aimed at preventing further deterioration of real wages.. In mid-March,the Government introduced a 120-day period of price restraint aimed at breakinginflationary expectations. The price restraint program and the improved supplyconditions for agricultural products had the desired effect of reducing therate of price increase to an average of 6.7% per month in the second quarter

of 1977. The increase in retail prices as measured by the new cost of livingindex declined from 8.0% in January and 8.3% in I-February to 7.5% in March, 6%in April, 6.5% in Mlay and 7.6% in June.

6. Duririg 1976, substantial progress was maade in reducing the publicsector's fiscal deficit. which, during the preceding frhree years. had becomethe major cause of hyperiAflacion. The overall. public sector deficit reached16% of GDP in 1975 as tax collections lagged and the finan:es of the pro-vincial government and state enterprises deteriorated. By holding wageadjustments well. below th'e increase in prices anci increasing tax collections,the new Government was able to increase public sector savings to -0.2% of GDPin 1976 from -7.1% in 1975 and to reduce the public sector deficit to 11% ofGDP. The Government succeeded in maintaining mon,etary expansion at a moderatelevel by selling indexed bonds and Treasury bills to absorb much of theincrease in liquidity which otherwise would lhave resulted from the fiscaldeficit; it also greatly reduced exchange rate guarantees which had been amajor source of destabilizing monetary expansion in 1975. The monetaryprogram worked out with the IMF in 1976 under a Standby Agreement was strictlyadlhered to and net domestic assets of the Central Bank have continued to bewell within the specified target. The 1977 Budget calls for another year offiscal. austerity in order to place public finances on a soLund footin'ig andlay the basis for simultaneous accel.erated public investment and pricestability in the future. Introduction of new taxes and improved tax adminis-tration are expected to expand revenues sharply and lead to an increase inpublic sector savings to 6.0% of GDP. The national tax burden would increasefrom 16% of GDP in 1976 to almost 20% in 1977, a difficult but feasibleobjective. As a result of, these measures and curbs on current spending,the overall deficit of I:he public sector is expected to decrease to 5.3%O ofGDP and of the Treasury to 3.8%. Central Bank financing of the l'reasury'sdeficit is to fall from 9.0% of GDP in 1975 and 3.7% in 1976 tc, 2.8% in1977, a level which is consistent with a rmonetary program aimed at continuedimprovement in Argentina's external position and sharp reduction of inflation.

7. The Government:'s achievements in the external sector have beendramatic and beyond the most optimistic expectations. During 1976, exportersresponded favorably to reduction of export taxes and adoption cf a "glidingparity" exchange rate. A sharp acceleration of exports, combined with a fallin imports, improved trade and current account balances by US$1.8 billion.Success in obtaining medium-term external credits from private commercialbanks and international financial institutions, and the strong trade perfor-mance made it possible for Argentina to extend the average, maturity of itsexternal debt and simultaneously replenish its foreign exchange reserves bymore than double the increase in total external indebtedness.. Freely dis-posable foreign exchange reserves reached US$1.4 billion by the end of 1976,equivalent to almost five months imports, as compared to US$23 million inMlarch of that year when the new Government came to power. Argentina's balanceof payments has continued to improve this year and net international reservesare projected to increase by almost US$700 million.

- iv -

8. Decline in the level of economic activity was most pronounced in

thie second quarter of 1976 with GDP in real terms failing by 5% below thesame period one year earlier. During late 1976, however, both investment

and production in some of the Yiost depressed sectors of the economy began to

slhow signs of recovery. Real growth of GDP was positive during the first

quarter of 1977 for the first tline since early 1.975 as agriculture, mining

and some branclhes of industry grew rapidly. During 1977, real GDP is proj-

ected to expand by an estimated 4.5% due to recovery of private investment,

reversal of the downward trend in public investnent, strong export growth and

some recuperation in the level of real wages. As private sector economic

activity recovers in 1977, thc Governmient is expected to gradually reduce the

number of public sector employees at a pace consistent withi increased employ-

ment opportunities in thle private sector.

9. The inmmediate objectives of the Government's economic program, were

achieved in large measure during 1976. The Government has now turned its

attention to achiieving its longer-term developmental objectives of increasing

efficiency and eliminating structural imbalances tllrough accelerated develop-

ment of production for export in whiich the couintry has a strong compara-tive advantage. Through a combination of trade and internal pricing policies,

the authorities hiave increased the real effective exchange rate for agricul-tural exports and thereby shifted the internal terms of trade in favor ofagriculture. In late 1976, the first stage of a major tariff teform wascarried out which aims at increasing industrial efficiency through reduction

of effective protecti:on on industrial products and elimination of most import

prohibitions. Thie adoption of a unified "gliding parity" exchange rate wascomplemented by othier measures to simplify and liberalize the trade andpayments system so as to bring the internal price structure more in line witlinternational prices. A new foreign investment law ains at enhancing thecontribution of external capital and technology to Argentina's economicdevelopment.

10. One of th)e major policy innovations by the new adminlistration in

early 1976 was a svstem of positive real rates of interest. During the pre-

ceding years, interest rates were fixed by the authorities at relatively lowlevels. As inflation accelerated, real interest rates became increasingly

negative, distortions in resource allocation grew, and serious erosion ofArgentina's major financial institutions took place. Shiortly after taking

office, the new ',overnment freed short-term rates for certificates of deposit

and initiated more active marketing of Treasury bills and indexea Tovernment

bonds, thereby forcingt up nomirnal interest rates throughout the financialsystem to a level above the expected rate of price increase. The result was

a shift in the conposition of domestic savings away from dollars and hioldings

of inventories in favor of domestic financial assets. Gonitinuation of thispolicy throughout the year was a major contributing factor to the improvement

in the balance of payments and revitalization of the financial system. Activemarketing of Treasury bills and indexed Government bonds permitted some ab-sorption of monetary creation and maintained inflationary pressures at morenmanageable levels. Introduction of positive real rates of interest and re-

duced inflationary expectations resulted in an increase in dermand for monetaryassets, reduced inventory accumulation, and thereby increased the supply of

- 7 -

industrial products coming to market. Adoption of positive reaL interestrates together with "denationalization" of the banking system hias stimu-lated competition for deposits, encouraged fin3ncial savings and streng-thened the role of financial intermediaries. After years of negative realinterest rates and the distortions they generaied, the economy is graduallyadjusting itself to the new regime of positive interest rates.

11. To promote development of Argentina's capital markets and torationalize public sector finances, the Government is currently implementingfar-reaching structural reforms of the financial and fiscal systems. TheArgentine financial system has operated under a high degree of Governmentcontrol and reguilation for protracted periods during which its effectivenessin intermediatirg private savings and in allocating these resources effi-ciently was severely limited.. On June 1, the Government replaced the systemof nationalized deposits intrbduced by the previous administration, with afractional reserve syste<n aimed at producing a more balanced flow of resourcesthrough Argentina's financial system and at providing the authorities withmore effective monetary ,ontrol. Simultaneously, a new law regulating finan-cial institutions was in::roduced which will stimulate capital market develop-ment through broadening of the scope for competition between finarncialintermediaries. The Government is also taking measures to restore the financ-ial viability of provinc:lal governments and state enterprises which have inrecent years accounted for most of the fiscal deficit. Drastic cost reducingmeasures are being impletmented by the Argentine railways which should signifi-cantly cut its large deficit. A new group has been created in the Mlinistry ofEconomy to rationalize public investment planning and to develop a long-termpublic investment prograri. Taken in their entirety, the measures adopted bythe new Government are inmpressive evidence of the seriousness and vigor of thenew Government in implementing well balanced and innovative programs consistentwith their objective of increasing efficiency throughout the economy.

12. Notwithstanding the substantial achievements of the new Government,the problems still facing Argentina are considerable. Continued fiscalrestraint and monetary management consistent with the change in the demand formoney will be required in order to reduce price increases to acceptablelevels. Expansion of the economy will have to be carried out with caution soas to avoid any worsening of inflationary pressure. Net reserves of themonetary authorities are still low; US$120 million as of June 30, 1977 up fromnegative US$555 million at the end of 1976. Structural imb-alances in theeconomy which were aggravated during the previous administration and causedserious erosion of the country's export capacity, still exist. The recon-struction process which the Argentine Government has initiated is focusing onrebuilding the productive capacity of the agricultural sector, rteorienting theindustrial sector toward export markets, removing infrastructure bottlenecks,reorganizing a number of badly deteriorated but vital institutions and accel-erating integration and development of the southern cone of South America.

13. Possibilities for integration of Argentina with its neighbors,especially the low income countries of Bolivia and Paraguay, present both achallenge and a great opportunity. Efforts in this direction have been made

- vi -

at various times but thus far with somewhat limited results. Nevertheless,

some progress has been made in linking the economies of Argentina and its

neighbors. A bridge over the Uruguay River has been a positive step in

transport integration of Argentina and Uruguay. The Argentine and Paraguayan

road systems have been linked, whnich has not only encodraged Argentine tour-

ism to Paraguay, but is also bringing Brazilian tourism and business interests

to Argentina via Paraguay. The gas pipeline from Bolivia to Argentina

has been a milestone in integrating the two economies in the energy field

to the benefit of both countries. Some integration in the transport and

energy fields has also been efftcted between Argentina and Chile. Although

by no means insignificant, all these achievements of physical integration are

merely minor precursors of what!might and should take place in the interests

of both Argentina's economy and the economies of her less-developed neighbors.

Opportunities for additional major integration links in the power field are

numerous and vital. The Yacreta hydroelectric development sponsored jointly

by Argentina and Paraguay is in an advanced stage of preparation. The same

is true of the Salto Grande hydroelectric project between Argentina and

Uruguay and the power interconnection between the two counltries. Expansion of

the gas piepline between Bolivia and Argentina, although less advanced, is also

a real possibility. Joint development of these projects would greatly assist

the economnies of Paraguay and Bolivia as well as relieve Argentina and Uruguay

of the very heavy burdens which petroleum imports from abroad impose on their

respective balance of payments. Improvements in the transport and communi-

cation links between Argentina and Paraguay and Bolivia would serve as a major

impetus to the economic growth of these two landlocked countries and should

enable these countries to raise their low living standards. The integration

highway between Argentitia, Bolivia and Paraguay which would link all three of

them with Brazil is now under active consideration.

14. During the 1960s and early 197t; growth of the agricultural sector

has been almost double that of the early post-war period mainly becauseof a more widespread use of modern inputs, especially improved seeds andintensified mechanization. Growth of crop output accounted for the bulk oftihe improved performance, with little difference being showni between pro-

duction gains in crops in the pampas (grains and oilseeds) and crops in thenon-pampas (sugarcane, cotton, tobacco, fruit, -and wine grapes). In order to

strengthen Argentina's export capacity, a new agricultural policy including

tax, credit, tariff, marketing and exchange rate policies has been introduced.

In August 1976, the export retention tax for wheat was reduced from 40% to 10%

and in November it was eliminated. Simultaneously, an increase in tiL2 rural

land tax was put inlto effect. In December the rates on coarse grains were cut

froom 40% to 10%. By the end of the year, most domestic price conteols on Iagricujltural exports had been removed, the state monopoly on grain trading had

been lifted, cattle slaughter quotas h1ad been withdrawn, and the National Meat

Board was no longer engaged in direct selling abroad. Available evidence

indicates that the agricultural sector has already responded very favorable

to tnese chalnTges by increasing exports of cereal and oilseeds.

15. The outlook for the expansion of agricultural production and exports

is highly favorable, given a continuation of the current policy. There is an

- vi.i -

ample supply of under-used technology in hand, and its widespread adoptionwould sharply increase productivity and production in thie Pampas, as would the

associatecl upgrading of land use toward more emphasis on crops relative to

livestock. For examp:!e, high--yielding varieties of food and feed grains and

oilseeds are available; used jointly witli fertilization (a practice likely to

become increasingly common under the new price policy), sharp increments in

yields are to be expected. The area under ileat-soybean double cropping can

be expanded, perhaps by a factor of three. Minimum tillage and the associated

use of herbicides, a practice which is now beginning to interest farmer,, can

help increase yields slhrough timely planting and the conservation of so0il and

water. Sprinkler irrigation of maize is in prospect; this can result in

dramatic increases in yields.

16. The price incentives for technological zhange are being backed ulp

by appropriate credit, taxation, and marketing policies. A land clearing

program for the non-Piampas is being developed. This will impact directly on

livestock and crop production, and indirectly contribute to an upgrading of

land use in the Pampas. A number of studies are underway with the objective

of further developing the nation's ample water resources for irrigation,

including the completion and/or rehabilitation of selected ongoing projects.

Taken together, these measures, supported by improved research, extension,

policy and program analysis, and inter-agency coordination are likely to

result in a sharp and sustained uptrend in agricultural product:ion if interna-

tional product price Levels are favorable. Ongoing measures to more fully

exploit the rich fisharies resource and activate the forestry sector are

likewise impressive.

17. During most of the post-war period, capital-intensive import sub-

stitution industries were promoted through high levels of industrial protec-

tion. These industries remain heavily protected and are heavily dependent on

intermediate and capital goods imports. Argentina's most int:ensive decade of

import substitution during 1952-62 did not provide a significant number of new

employment opportunities or substantially lower the import coefficient, since

most growth was in "modern" branches of industry (chemicals, rubber, metals

and machinery equipment) which are capital intensive and dependent on interme-

diate and capital goods imports. It was only in recent years as manufactured

exports expanded that labor absorption in industry grew, averaging 3% annually

between 1968 and 1975. Aware of the shortcomings of import substititution,

the authorities initiated a program of export diversification in 1962. During

thte 1967-69 period existing fiscal and monetary incentives were si plemented

by global reimbursemient of income taxes, an export insurance schenme and a more

realistic exchange rate policy. As a result, industrial exports expandedrapidly, reaching 23% of total exports by 1972. As was the case with overall

industrial growth during this period, the rapid increase in manufactured

exports at an average of 20% per year in real terms from 1963 on was led by

the "modern" industries, which reached 40% of total manufactujred exports in

1973/75.

18. Despite the substantial growth of manufactured exports, Argentine

industry continues to be faced with three major problems--inefficiency, depen-

dence on a number of critical high-cost intermediate inputs produced by local

- viii -

industries and low employment creation. The level of efficiency and competi-tiveness of Argentine industry varies substantially between branches. The"modern" industries tend to be technically efficient but relatively high-costproducers principally because many firms have remained too small to developeconomies of scale. Many bf the "traditional" industries, on the other hand,work with obsolete equipmentl and management meth6ds ,which have made it-diffi-cult to sell outside of the domestic market. The majdr cau'ses of the presentlow efficiency levels appear to be lack of comipetition due to high and unevenprotection of import substitution industries, and inefficient, high-cost stateenterprises supplying basic inputs to industry. The current authorities havereversed past policies and are considering (a) opening up the economy tointernational competition by a reduction of import barriers, (b) restructuringmajor industries by merging or eliminating marginal firms in branches whereexcess capacity is high and (c) improving the performance of state enterprises.

19. Argentina is well endowed witlh energy resources, having significantdeposits of coal, oil, natural gas and uranium, as well as a sizeableundeveloped hydroelectric potential. Current use of these resources does not,however, reflect the country's energy resource endowment. While crude oil andnatural gas together account for only 11% of domestic energy reserves, theyprovided about 85% of Argentina's total primary energy consumption in 1976.In recent years about 15% of crude oil and natural gas consumed in Argentinahad to be imported. Hydroelectric energy, estimated to constitute about 60%of Argentina's domestically available energy reserves over the next fiftyyears, only contributed about 4% to meet Argentina's energy demand in 1976.The Government is aware of this situation and is taking steps to achieve amore rational use of available resources through emphasis on hydroelectric andnuclear power plant construction and coal mining expansion. The Government isalso promoting the substitution of natural gas for oil so as to utilize thelarge gas reserves in Tierra del Fuego, expansion of oil and gas explorationaimed at achieving 100% self-sufficiency in oil and 85% in gas in 1985, and

increase of coal output and substitution of coal for oil in electricitygeneration.

20. The Yacyreta Hydropower Project is by far the largest single invest-imerit project presently under consideration by the Argentine Government. Theproject would form the backbone of the Government's least cost solution powerexpansion program for the next twenty years and constitutes the critical stepin the Government's strategy to use Argentina's renewable energy resourcesmore fully and effectively. The project would provide competitive and re-liable energy to support expected rapid economic growth and help avoid break-downs in power supply which have lhad high economic costs in the past. Theproject would also, as secondary benefits, promote development in adjacentareas bothi in Argentina and Paraguay through improved road access and rivernavigation upstream from the site of the dam as well as through large-scaleirrigation systems.

21. As a first step in rationalizing investment priorities in theei rgy sector, the Secretariat of Energy has prepared a global energy balancefor the period 1977-85. Total energy demand implied in the Secretariat'sanalysis is probably too low. Assuming a more realistic growth of energy

- ix -

demand results in a 1985 ernergy "gap" of about 15% of curreni:ly planned

domestic supply per annum. This gap is ten percentage points above the

Secretnriat's estimate of 5%. If the extra 10% of energy were to be imported

in the form of crude oil, the fossil fuel import bill in 198.3 could amount to

;thout US$S.5 bilLion with oL ;.mports increasing frorm the 1976 level of 3.52

nil liori mto 5e2 million m

22. Argentina's transport system is one of the most developed in Latin

America. Its extent and configuration facilitAted an early development of

the country's economy. It also contributed to regional specialization Lf

production and to the primacy of Buenos Aires as the center of economic activ-

ify. Only in the late 1960s, however, was a north-south and east-west network

of trunk highways bui:lt. Some of these routes are still under construction.

T'he railways have an important role to play in the economy as the transport

mode which should carry the heavy, massive, long hauls most efficiently and

at least cost. Operation of uneconomic lines and services, and neglect of

the provision of adequate services to the goods most orofitable to the rail-

ways has resulted in their severe financial and physical deterioration and a

substantial drain on the Government's fiscal resources. Several positive

measures to remedy the very acute problems facing the railways have already

been adopted by the present Government. There has been a substantial increase

in real tariffs, a reduction of the very costly interurban and suburban passen-

ger services has been initiated (36%), a decrease in staffing has been achieved

(17% of the total work force or 23,000 workers); a portion cf the uneconomic

lines have been closed (about 20% of the total) and an agreement to purchase

badly-needed spare parts from foreign countries has been signed. The Govern-

ment is currently preparing a three-year investment plan aimed at tackling the

more fundamental structural problems of the railways by redefining its role in

the transport sector, rationalizing the railway plant and increasing the

efficiency of the system by expanding reliable and modern services. Coordi-

nation and planning have traditionally been the weakest elements of Argentina's

transport sector. The present Government is making a concerted effort to

improve this situation and it has strengthened the Sectoral Transport Planning

Office (STPO) in the Secretariat of Public Works and Transport, by upgrading

and expanding its staff. The recently initiated National Transport Study will

explore measures for further improving planning and coordination in the

transport sector.

23. Maintenance of a high rate of economic growth during the years ahead

will require substantial investment in rebuilding the productive .,pacity of

the economy and in providing the necessary infrastructure so as to ensure that

bottlenecks do not limit growth as has occurred in the past. Much of this in-

vestment is expected to be undertaken by the private sector but the public sector

will of necessity have to play an important role in this process. Because of

the urgency of some of these investments the new Government has increased in-

vestment spending of the public sector from 9.3% of GDP in 1975 to an average

11.3% in 1976-77. T'he authorities have recently made public the broad objec-

tives of their mediutm-term development plan which is to be drawn up during the

next 12 months. With the assistance which the mission received from the

Argentine Government. and based on the recently released development plan

guidelines, indicative projections of public sector investment financing havebeen prepared. The major sources of finance for this investment includesavings of the public sector, domestic borrowing and external capital inflows.Public investment has been projected to maintain a constant share in GDP(11.5%) throughout the period 1977-84. Given the relative increase of totalgross fixed investment in GDP which is expected :Ln the years ahead, thisimplies an expanding role for private investment in Argent'na's developmentprocess. Financing of public investment from net internal borrowing isprojected at a moderate and declining level (from 4% of GDP in 1977 to 0.4% in1982) so as to permit a larger share of an expanded level of financial savingsfor the private sector and simultaneously reduce the inflationary pressures ofthe past few years.

24. The Central Government, including the social security system, isexpected to maintain its share of public sector savings, at aboUt 42%. Theaverage tax elasticity implicit in this projection (1.02) is somewhat higherthan achieved in the past, but given the Government's intention to strengtlientax administration, it appears to be realistic. The state enterprises areexpected to become increasingly self-sufficient in generating savings tofinance their investment and their current account surplus is projected toincrease from 28% of public sector savings in 1977 to almost 50% in 1982. Toachieve this, the enterprises will have to reduce their costs by becoming moreefficient, and rates and prices for the goods and services produced by thestate enterprises will need to be adjusted periodically so as to exceed therate of inflation and permit the enterprises to attain adequate rates ofreturn. Assuming that public sector finances evolve in the manner projected,total public sector savings would increase from $a 1,235 billion in 1977 (6.3%of GDP) to $a 7,420 billion in 1982 (10.5% of GDP). These savings wouldfinance an increasing proportion of projected public investment, rising from51% in 1977 to 85% in 1982.

25. Given the expected continuation of existing exchange rate, pricing,tax and interest rate policies aimed at maintaining a strong external sectorand the likelihood of a favorable international economic environment, Argentina'sbalance of payments performance should be sufficiently strong over the yearsahead to support higher rates of economic growth than the 4.0% average in thepost-war period. Real GDP is expected to increase by 4.5% and 6.5% in 1977and 1978 respectively, and assumed to average about 6% annually thereafter.This rate of growth of GDP would be sufficient to absorb the expected increasein the labor force and permit restructuring of employment away from the over-expanded public sector. With this higher rate of growth of GDP, per capitaconsumption would increase by 4.9% annually. In order to sustain a 6% growthrate, gross investment would have to increase as a share of GDP from 20% in1976 to an estimated 23% in 1982. Continued strengthening of Argentina'sexternal position requires that this increase in investment be matched bya corresponding rise in domestic savings. The Government has alreadyachieved considerable success in initiating reforms which should, when fullyenacted, make it possible to increase domestic savings as a share of GDP from22% in 1976 to between 23% and 24% in 1982.

26. Continuation of the Government's i.'oliczes for expand:ing exportsshould make it possible for exports to increase by almost 7% annually in realtermrls and to expand their share of GDP from an average 8.8% in 1975-76 toover 10% in 1982. Argentine agriculture is in al unusually good position tosubstantially increase its output during this period and .s expected to playa major role in the export drive. Even with considerable acceleration ofagrictultuiral production, however, manufactured products will have to play anincreasingly important role to further expand total exports. While a substan-tial decline of manu::actured exports occurred in 1975, there was a significantrecovery in 1976. Continuation of this trend should make it possible i ,rmanufactured exports to resume strong growth in the years ahead averaging 15%annually.

27. In order to sustain a 6% rate of growth of the economy during the1978-82 period, imports of intermediate and capital goods will have to expandwell above the historical trend. In addition, the easing ol import restric-tions so as to control inflation and increase efficiency will further acceler-ate the growth of import deMand. If the gradual elimination of excess protec-tion of a number of consumer goods industries is carried out:, overall annualgrowth rates of imports could reach about 10% in real terms in the immediateyears ahead. Increasing import prices should lead to outlays reaching US$7billion by the end of this decade and over US$10 bilion in 1982. Because ofthe importance of petroleum in total imports, the projections are quitesensitive to different assum'ptions regarding alternative levels of futureArgentine petroleum production. If current efforts to expand production arenot as successful as anticipated, petroleum imports could constitute a majorburden on Argentina's balance of payments by the early 1980s. Despite therapid growth of imports, the expected strong performance of exports shouldmake it feasible for Argentina to sustain favorable trade balances throughoutthis period. The net outflow of payments for factor services is expected toincrease from US$487 million in 1977 to about US$523 million in 1982. Aboutthree-fourths of the trade surplus generated during 1978-82 will be neededto pay interest and other factor services. This will permit a modest currentaccount surplus which can be used for the necessary rebuilding of Argentina'sinternational reserves. Given the country's resource endowmernt, over thelonger run it should be able to attract large volumes of capital and forthis reason it is expected that Argentina will again become a net capitalimporter.

28. Despite continued expected improvement in Argentina's LElance ofpayments, it will take several years and continuing substantial medium- andlong-term capital inflows to carry out the reconstruction program whilesimultaneously rebuilding net international reserves and restructuring thecountry's external debt. Gross external capital inflows required during1978-82 are projected to be US$7.8 billion or an average of US$1.6 billionannually. Of this total, about US$1.3 billion will be needed annually tofinance external debt amortization. Thus, net capital inflow would averageUS$300 million annually. Of the required US$7.8 billion during 1978-82, aboutUS$860 million is expected to be provided by disbursements on loans whichhave already been nmade to Argentina. External borrowing by the privatesector will finance a portion of the remaining US$7.0 billion but the largest

- xii -

part of this amount will have to be provided by disbursements on new borrow-ing by the public sector, about one-fourth of which is expected to come frombilateral and multilateral sources.

29. At the time the new Government came t- power in March 1976, Argentinawas faced with external debt payments falling due before the end of 1976, esti-mated at US$3.7 billion, equivalent to about two-fifths of Argentina's totaloutstanding external debt. The Government was successful in its efforts toreplace this slhort-term debt with medium-term borrowing from commercial banks.As a consequence of this, the favorable performance of the current accountof the balance of payments, and of the positive real rates of interest intro-duced by the Government which produced an inflow of external capital, Argentinawas able to reduce outstanding foreign exchange guarantees by US$1.5 billionand simultaneously increase disposable foreign exchange reserves by aboutUS$1.2 billion, more than double the increase of aboutt US$590 bnillion in totaloutstanding external debt.

30. Argentina's medium- and long-term external public debt was US$4.3billion at the end of 1976. Medium- and long-term'private external debtamounted to roughly US$2.0 billion. External public and total debt serviceratios during 1976 were 19% and 32%, respectively. Despite the large grossborrowings envisaged over the next several years, and continued use of finan-cial and suppliers' credits, the p,ublic debt service ratio is expected todecline from 22% in 1978, to 13% in 1982 because of the improvement in theterm structure of debt and the expected increase in exports. The total debtservice ratio would decline steadily to 18% in 1982. Provided the authoritiessuccesfully implement their stabilization and development policies and managethe external indebtedness along the lines indicated above, Argentina shouldhave little difficulty servicing the aforementioned external borrowing requiredfor reconstruction and sustained economic growth.

CHAPTER I

STRUCTURAL IMBALANCE AND ECONOMIC CRISIS

Background

1. During the 1950-1974 period the Argentine economy grew by an averageof 4% annually. Given the relatively low rate of population growth (1.5%annually), this economic performance might be considered satisfactory in termsof per capita income growth, had it not been for sharp fluctuations in the

level of econonmic activity and recurrent episodes of inflation and balance ofpayments difficulties. The country's relatively high per capita income

(US$1,550 in 1976) masks deep-seated structural imbalances which have been

aggravated by almost continuous emphasis on industrialization through importsubstitution. Policies which aimed at providing the urban population with a

chieap supply of foodstuffs discouraged agricultural production and exportsand resulted in transformation of agriculture from a leading sector with astrong export orientation to a lagging sector primarily producing for the

domestic market.

2. While import substituting industrialization took place at a rapidpace throughout most of the post-World War II period, much of this was capitalintensive and highly dependent on imported raw materials and on intermediateand capital goods. Latgging agricultural production and development of arelatively high cost industrial structure which severely limited the capacityof industry to compete in world markets, lowered the overall export capacityof the economy and the share of exports to GDP fell from 25% in the 1920s to8% in the early 1970s. Erosion of the country's export capacity resulted in

recurring balance of payments difficulties which in turn led to adoption ofrestrictive fiscal ancl monetary measures aimed at reducing imports through areduction in internal demand.

3. During 1973 and most of 1974 world prices of grains and beef wereat record levels and Argentina's balance of payments was exceptionally favor-able. With foreign exchange rese.rves increasing rapidly the Government wasable to pursue expansionary policies which produced boom conditions. Spurredby growth of consumption resulting from sharp increases in real wages, GDP

expanded by an average 6.5% annually during 1973-74. Increases in real wageswh-ich exceeded productivity gains combined with large budgetary deiicits andrapid monetary expansion produced an increase in inflationary pressure. In

an attempt to reduce -inflation, thie Government introduced a system of pricecontrols. While these controls were partially successful in limiting the

increase of the official price index, black market activities flourished and

scarcities began to occur in established commercial markets.

4. Weakening oi- world beef and grain prices during the second half of1974 and a decline in domestic grain production due to poor weather resultedin a sharp decLine of Argentina's exports. Deterioration of the external

sector coincided with increased social and political unrest following the death

-2-

of Argentina's President. Despite deteriorating terms of trade andcontracting domestic income, noriinal wages were continuously adjusted upwardin a vain effort to maintain thd high level of real wages reached by mid-1974.

Economic Crisis

5. Toward the end of 1975 and early 1976 A-r.entina experienced thefifth and most severe economic and financial crisiti of the post-war era.Collapse of economic management propelled the country toward hyperinflationand caused serious external payments difficulties. Excessively expansionaryfiscal and monetary policies resulted in acceleration of the rate of inflationto an annual rate of almost 1,000% during the first quarter of 1976. Capitalflight and sustained high levels of consumption and aggregate demand resultedin increased pressure on the balance of payments. Weak export performance anda doubling of merchandise imports over the 1970-73 average level resulted ina large resource gap and an overall balance of payments deficit of US$1.1billion 'during 1975, the largest for a single year on record. Severedistortions in product and factor prices and, as a consequence, growingmisallocation of resources gave rise to shortages and wide-spread black marketoperations which culminated in a sharp decline of investment and domesticproduction.

6. Throughout 1975 efforts weie made to stem the deterioration in thebalance of payments and stabilize the domestic economy. Corrective priceand exchange rate measures were adopted early in the year but these were notaccompanied by the necessary incomes, fiscal and monetary policies and failedto improve the situation. In June, a major devaluation and large adjustmentsin prices and rates of public sector goods and services were implemented so asto slow imports, stimulate exports and cut public sector financing requirementsto manageable proportions. Wage adjustments, however, surged ahead of officialguidelines and renewed impetus was given to inflation. With tax collectionslagging seriously behind inflation and inadequate rate increases in the stateenterprises, the public sector deficit reached an unprecedented 16% of GDP,most of which was financed by Central Bank credit. In an effort to combat theinvestment slump, credit expansion to the private sector was maintained at arapid pace which contributed further to accelerating inflation.

7. With the breakdown in fiscal, monetary and incomes policies, aggre-gate domestic expenditures accelerated rapidly, increasing in 1975 by over 180%.Bad weather conditions, widespread distortions within the domestic economy andadverse external developments caused real GDP to decline by 1.4%, the firstcontraction in output since 1963. As a result, inflation accelerated to 185%as measured by the GDP deflator. More rapid growth of consumption than ofgross domestic income resulted in a marked decline in national savings, due inlarge measure to increased current expenditures of the public sector. Nationalsavings as a share of GDP fell from 23% in 1974 to 19% in 1975 due to sharpdeterioration in the current account deficit of the public sector and aresource gap, equivalent to 3% of GDP, developed for the first time in severalyears. Net capital inflows were limited and financing of this gap requiredheavy drawdown of net international reserves.

- 3 -

CHAPTER II

STABILIZATION AND PROSPECTS FOR 1977

8. In March 1976 when the new GoverAment came to power, Argentina wasin the throes of an economic and financial crisis unparalleled in the country shistory. The magnitude of the reconstruction effort which faced the Argentineauthorities was formidable. There had been a profound deterioration of keyinstitutions, of productive capacity and of supporting infrastructure. Basicstructural imbalances which had eroded the country's export capacity had beenaggravated by the policies of the previous administration. Three seriousproblems--explosive acceleration in the rate of inflation, deterioration ofthe country's external position, and a sharp decline in the level of economicactivity--threatened to bring about the collapse of the economic system.

9. The new government acted swiftly on all fronts to stabilize theeconomy. To avoid further misallocation of resources, product prices werefreed and major distortions in factor prices were eliminated, In order toreduce inflation, any pressures stemming from excess aggregate demand was cutthrough restrictive fiscal management and by lagging officia:Lly authorizedwage increases behind inflation. Simultaneously, the Government entered intoa dialogue with private firms to keep a higher level of employees in the workforce than would have been justified by reduced production levels. TheGovernment was successful in preventing an increase in unempLoyment and inthis way was able to spread the burden of stabilization more equitably acrossall income groups.

10. To strengthen the balance of payments, stimulate f[nancial savings,achieve an improved allocation of resources, and reduce inflationary pressurefrom monetary expansion by reducing the velocity of money, the authoritiesintroduced positive real rates of interest. This was achieved through aggres-sive use of Treasury bills with high nominal rates of interest which wereissued so as to set E. floor on short-term rates throughout the financialsystem. The effect was a dramatic rise (415%) in financial savings, definedas money and quasi-money, and an increase in its share of GDP from a low of18% in March 1976 to 23% at the end of 1976. The free market exchange rate,which rose precipitously from 275 pesos per dollar at the end of 1975 to380 pesos peL dollar in March 1976 as external payments difficulties becameacute, was stabilized. To achieve external equilibrium a "gliding Darity"exchange rate system consisting of periodic depreciation of the peso to com-pensate, among other things, the difference between internal and externalinflation was ptut int:o effect.

Impact of the Stabilization Program

11. During the second half of 1976 there was a pronounced decelerationin the rate of inflation reflecting the success of the Government's fiscal,monetary and incomes policies in curbing the major real causes of the infla-tionary spiral which developed during 1975 and early 1976. The major factors

- 4 -

in monetary expansion during early 1976, the fiscal deficit and Central Bankfinancing of exchange rate guarantee schemes, *-ere brought under control andinflation slowed from an annual rate of 659% during the first semester to 166%during the second. Tightening of fiscal policy reduced the Treasury deficitfrom 14% of GDP in the first quarter of 1976 to 6% during the fourth quarter.Exchange losses from "swap" arrangements and the exchange rate guarantee onimports were cuit sharply by reducing the level of such guarantees by US$1.5billion from M4arch to the end of the year.

12. Despite continued improvement in the fiscal situation and effortsto control monetary eXpansion during early 1977 there was an increase in therate of inflation. Monthly rates of inflation averaged 10.1% in the firstquarter of 1977 as compared t) 7.1% during the last quarter of 1976. Imple-mentation of a more flexible incomes policy, and a sharp rise in the price ofbeef, fueled inflatiotlary expectations and resulted in anticipatory priceincreases on the part of industrial firms.

13. The Government reacted swiftly to these unexpected price increasesby entering into discussions with the major industrial enterprises. Thesediscussions aimed at hialting price increases in excess of increased costs andat introducing.a price restraint period of 120 days, retroactively effectiveto February 22. During this period industrial firms were required to justifyprice increases by demonstrating increased costs. Sanctions which appeared inthe decree which authorized the pr:ce restraint program included reduction ofimport duties, the threat of importation to increase supply of criticallyscarce products, and adverse publicity. The price restraint program and the

improved supply conditions for agricultural products had the desired effect ofslowing the rate of price increases. The increase in retail prices as measuredby the new cost of living index declined from 8.0% in January and 8.3% inFebruary to 7.5% in March, 6% in April, 6.5% in May and 7.6% in June. Therate of increase in wholesale prices which could be monitored closely declinedmore rapidly, from 13.8% in January to 6.9% and 3.8% in February and March,respectively. Wholesale prices increased during the second quarter, however,by 5.8% in April, 6.1% in May and 6.5% in June.

Fiscal Policy

14. The cornerstone of the Government's stabilization program has beenfiscal policy. Deterioration of public finances has historically been a majorfactor behind Argentina's recurrent inflationary episodes. During the 1973-75period, progressive erosion of public sector finances had become the principalcause of the explosive inflation of early 1976. Declining tax revenue com-bined with soaring expenditures and drastic deterioration of provincialgovernment and state enterprise finances resulted in a decline in publicsector savings from 0.4% of GDP in 1974 to -7.1% in 1975. Investment spendingincreased moderately in real terms during this period and the deficit of the

consolidated public sector increased during the same period from 7.8% of GDPto 16.2%.

15. Through a combination of reduced spending on public sector salaries,emergency tax measures and adjustment of public utility prices to more realistic

T'ABLE I

PAECE MOVEMENTS(% chartle during period)

Cost of Living b/ Wholesale Prices

General

(Base 74=100) Index Agricult ure Non-Agriculture Imported

1973 43.8 30.8 42.5 37.5 47.2

1974 40.1 36.1 10.0 42.9 41.3

1975 335.0 348.2 144.0 353.5 545.3

1976 347.5 386.2 529.5 489.0 390.8

January 8.9 19.5 24.4 17.9 18.4

February 19.0 28.6 34.2 26.7 53.1

March 37.6 54.1 32.7 61.9 88.5

April 33.9 26.3 23.6 27.1 22.3

May 13.1 4.8 2.1 5.5 -0.5

June 2.7 4.7 11.6 2.8 -2.8

July 4.2 6.1 15.6 3.2 1.7

August 5.5 8.0 14.2 5.9 1.9

September 10.6 8.8 13.3 7.2 2.6

October 8.5 4.7 3.8 4.7 2.1

November 8.0 6.9 7.1 6.8 2.2

December 14.3 6.4 7.6 6.0 9.3

1977

January 8.0 13.8 12.8 14.4 12.1

February 8.3 6.9 5.2 7.6 6.7

March 7.5 3.8 2.4 2.7 17.6

April 6.0 5.8 3.3 4.9 15.7

May 6.5 6.1 9.0 5.3 3.5

June 7.6 6.5 7.3 7.0 0.9

a! Annual data are year end to year end.b/ Seasonally adjusted.

Source: INDEC.

TABLE IT

PUBLIC SECTOR OPERATIO1%5 1973-7

(% of DP',

(Est.)1973 1974 1975 1976 1977

Current Revenue 26.4 29.8 25.3 28.0 31.0(O.W. Taxes) (16.2) (19.3) (14.3) (16.0) (18.5)

Current Expenditures 26.5 29.4 32.4 28.2 25.0

Current Surplus/Deficit -0.1 0.4 -7.1 -0.2 6.0

Capital Revenue 0.1 0.4 0.2 0.2 0.2

Investment Expenditure 7.3 8.6 9.3 l.1.1 11.5

Surplus/Deficit (-) -7.3 -7.8 -16.2 -11.1 -5.3

Financing 7.3 7.8 16.2 11.1 5.3

P--ternal (Net) 0.1 0.9 0.1 0.6 1.0

Borrowing 1.4 1.6 1.0 1.7 1.8

Amortization -1.3 -0.7 -0.9 -1.1 -0.8

Internal Financing 7.2 6.9 16.1 10.5 4.3

Borrowing 0.9 1.0 1.7 2.6 1.8

Central Bank 4.3 5.4 1.0.4 7.9 2.5

Other 2.0 0.5 4.0 )

Source: Ministry of Economy-

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levels, the new Government made substantial progress in reversing the dete-rioration of public sector finances. Total public sector savings improvedsignificantly in 1976 and the overall deficit was reduced to 11% of GDP.Improvement in the Treasury deficit, due for the most part to reduced currentspending stemming froui the decline in real wages in the Central Administration,was even more pronounc:ed, declining from 14% of GDP during the first quarterof 1976 to 5.5% during the first quarter of 1977. Reduction of the Treasurydeficit would have been even greater had it not been for shortfalls in theyield from both emergency and regular taxes and failure of the state oilcompany (YPF) to transfer to the Treasury its share of the fuel tax.

TABLE III

Treasury Operations 1973-1977

1973 1974 1975 1976 1977 Est.

(% of GDP)

Revenue 5.2 5.9 3.8 5.0 6.3Budgetary 5.0 5.7 3.7 4.9 6.3Non-Budgetary 0.2 0.2 0.1 0.1 -

Expenditure 11.6 12.6 16.6 12.7 10.1Budgetary 11.1 11.8 15.0 11.1 10.1Non-Budgetary 0.5 0.8 1.6 1.6 -

Deficit -6.4 -6.7 -12.8 -7.7 -3.8(As of Expenditure) (55.0) (53.2) (77.3) (60.4) (37.6)

Financing 6.4 6.7 12.8 7.7 3.8External -0.3 0.1 -0.1 0.4 -0.1

Credits 0.4 0.4 0.1 0.6 0.2Amortization -0.7 -0.3 -0.2 -0.2 -0.3

Bond Sales 0.5 0.5 1.3 1.7 -0.6Placements 1.0 1.0 1.8 3.2 1.2Amortization -0.5 -0.5 -0.5 -1.5 -1.8

Central Bank Credit 4.3 4.9 9.1 3.7 2.8Other 1.9 1.2 2.5 1.9 1.7

(In Billions of Argentine Pesos)

Revenues 19.0 29.4 51.0 585.9 1,246.4Expenditures 42.2 62.8 225.0 973.5 1,982.4Deficit 23.2 33.4 174.0 387.6 736.0Central Bank Financing 15.7 24.5 124.0 281.9 540.0

Source: Ministry of Economy.

- 8 -

16. Other sources of improvement in the fiscal performance of thepublic sector in 1976 were a substantial increase in revenues and reductionin expenditures of provincial and municipal governments which resulted in areduction in their deficit from 7.0% of CDP in 1975 to 3.4% in 1976. Whilethe state enterprises have been successful in improving their savings perfor-mance through a program of monthly adjustments in prices of publicly producedgoods and services and reduction in current outlays, investment spending in-creased substantially in real terms and their overall deficit increased from5.0% of GDP in 1975 to 5.2% in 1976. The state enterprises account for almosthalf of public sector investment in Argentina and on taking office, the newGovernment found that a large number of state enterprises had signed contractsfor investment projects which in many instances would cost more to abrogatethan to continue. During 1976 most of the real increase in Treasury transfersto the state enterprises were accounted for the Argentine Railways, Agua yEnergia and the Postal Service.

17. The 1977 Budget calls for another year of fiscal austerity with theshare of the public sector deficit in GDP being cut to 5.3%*, one-half the 1976level. To achieve this, major changes in tax collections at both the nationaland provincial levels are to take place through introduction of new taxes anda reduction of evasion of the value added and income taxes through improvedadministration indexation of tax liabilities, and reduction of payment lags ofthe value added and other internal taxes. The new tax measures include aprovincial land tax, a 10% tax on electricity, a 5% tax on gasoline, an 8% taxon revaluation of inventories, an increase in the top marginal rate of thepersonal income tax from 36% to 45%, and a tax amnesty ("blanqueo") that willallow individuals who have evaded taxes in the past to report their currentincome and net wealth making partial payment for evasion in previous years.Revenue measures contained in the Budget are expected to increase the nationaltax burden from 16% of GDP in 1976 to almost 20% in 1977.

18. Reduction in Treasury expenditures by an estimated 2.6% of GDP in1977 is to be achieved through reduced transfers to the state enterprisesand local governments. Revenues of provinces and municipalities are expectedto increase from reassessment of property values, introduction of a localland tax, transfer of the emergency tax on cars from the national to the locallevel, and reintroduction of the turnover tax and some excises. Finances ofthe enterprises are to be strengthened through continued periodic rate adjust-ments. Deficits of the two state enterprises, YPF and the Argentine Railways,which accounted for 80% of the effective net transfers from the Treasury tothe enterprises, 1/ are to be substantially reduced in real terms in 1977.Ambitious targets have been established for the Railways with 20% of the40,000 kilometer national railway network to be shut down by year-end.Reductions in the work force of 17% have already been achieved. YPF's financesare to improve significantly this year as a result of substantial increases

1/ YPF does not receive direct budgetary transfers from the Treasury.During 1976 it received indirect transfers in the form of withheld taxpayments.

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in the price of gasoline and other fuels and this should permit full transferto the Treasury of its share of the fuel tax.

19. The authorities are confident that measures adopted to increaserevenues and curb expenditures will sharply improve the fiscal performanceof the state enterprises, the provincial and municipal governments and bothdirectly and indirectly of the Treasury. Expenditures have recently beenfrozen in nominal terms at all levels of government. If there are difficul-ties in meeting revenue and current expenditure targets specified in theBudget, the authorities have indicated that they are prepared to take addi-tional. measures, in the form of larger rate adjustments of state enterprises,new taxes, or cuts in. investment spending so as to reduce the overall deficitof the public sector to a level which is compatible with a monetary programaimed at reducing inflation to the targeted level by year-end.

MIonetary Policy

20. Credit continued to expand rapidly in 1976 and early 1977, butprivate sector claims on the banking system rose even more rapidly reflectinga return of confidence in the financial system and adoption of realisticexchange and more liberal interest rate policies. To offset the expansionaryimpact of monetary creation resulting from the fiscal deficit and losses fromthe exchange rate guarantee schemes, the Government pursued an aggressiveinterest rate policy aimed at increasing nominal interest rates to a levelabove the expected rate of price increases thereby inducing a significantincrease in the demand for monetary assets. The policy of positive real ratesof interest combined with active marketing of Treasury bills and indexedGovernment bonds perutitted some absorption of monetary creation and maintainedinflationary pressure.s at more manageable levels. Placement of Governmentpaper sharply increased financing of the Treasury deficit by the privatesector and Central Bank financing of the deficit fell from 70% of the total in1975 to under 50% in 1976. Adoption of realistic interest and exchange ratepolicies eliminated pressures on the foreign exchange market and increased thesupply of industrial products coming to market by reducing inventory accumula-tion. The monetary program worked out with the IMF under the Standby Agree-ment was strictly adhered to and net domestic assets of the Central Bankreached $a 585 million, well within the ceiling of $a 625 billion specified inthe Letter of Intent.

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TABLE IV

Monetary Indicators 1974-1976

(Percentage cha'nge during period)

1974 1975 1976

Central Bank /a

Net International Reserves 2 -73 24Other Foreign Assets 2 14 24Net Domestic Assets 279 815 1,253Liabilities to Banks 204 599 1,270Currency Issue 63 187 231

Banking System /b

Net Foreign Assets 2 -25 -3Net Domestic Credit 56 163 278

Credit to Public Sector 13 65 36Credit to Private Sector 36 110 219Other, net +7 -12 23

Liabilities to Private Sector 55 145 336

/a Changes are expressed as a percentage of the stock of currency incirculation at the beginning of the period.

/b Changes are expressed as a percentage of the total liabilities to theprivate sector at the beginning of the period.

Source: BCRA and IMF

Balance of Payments

21. The balance of payments during 1976 was strengthened substantiallyby a strong improvement in the trade account due to the rationalization ofexchange rate and trade policies. The value of merchandise exports increasedby 32% despite declines in world prices of most of Argentina's traditionalexports--meat, vegetable oils, sugar, wool and some grains. Price declinesfor beef, wool, wheat and sorghum were more than compensated by larger ship-ments of these commodities. Exports of manufactured products increasedrapidly (34%) in 1976 and accounted for 20% of total exports. Machinery andequipment, which in the past have generally increased rapidly during periodsof domestic recession, accounted for one-third of the increase of non-traditional exports. Imports fell by about 20% during the course of the yearreflecting the slowdown in domestic production and investment, and a drawdownof stocks of imported intermediate goods. As a result of improvement of trade

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performwnce in 1976, resource and current account balances registered surplusesof US$1.1 billion and US$611 million, respectively, compared with deficits of

US$849 million andl US$10 3 billion in 1975.

22. The cap:ltal account was in deficit by US$647 million in 1976 due to

large repayments of short-term exchange rate guaranteed external borrowing.

Repayrnent of "swaps" was almost entirely offset by inflows of private capitalthrough the free mlarket, which included renewal of loans without exchangerate guarantees and proceeds of dishoarding of dollar assets of residents.The loss of net international reserves was, as a consequernce, held to US$35million, far below the permissible loss of US$500 million established underthe IMF Standby Agreement.

23, The GovErnment successfully refinanced the bulk of short-term

external debt due in the last quarter of the year with a borrowing operationof about US$903 million from commercial banks in the US, Canada, Europe andJapan with maturities of four years and in addition, drew down US$180 millionof the first tranc:he of a Standby Agreement with the 1MF. These operationsper-itted restructuring of Argentina's external debt toward longer termmaturities and simultaneous replenishment of gross international reserves.

Gross disposable reserves which had declined to US$23 million by March1976, were restore.d to US$1.4 billion or five months imports by the end of1976. Total. external debt including short-term debt increased from US$7.9

billion at the end. of 1975 to US$8.4 billion at the end of 1976, substantially

less than the inctease in international reserves.

Z4.4 During 1976 substantial improvement in the real effective exchange

rate took place for grain exports due to the sharp reduction in export taxes

on these commodities. Export taxes on beef were first reduced and then

increased by a lesser amount and the real effective exchange rate increased

and then declined from the second semester on. Fiscal incentives for most

manufactured exports were reduced and then increased slightly at the end of

the year. The net effect was some decline in the real effective exchange rate

for industrial exports as compared to the end of 1975. The authorities arecommitted to a policy of flexible adjustment of the exchange rate which interalia takes into account the difference between domestic and world inflation.This policy, together with maintenance of positive real rates of interest

enhanced the attractiveness of domestic monetary assets and encouraged capital

inflow.

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Table V

BALANCE OF PAYMENTS, 1974-77

(in US$ millions)

1974 1975 1976 a! 1977 -

Exports (incl NFS.) 4,762 3,669 4,668 5,761Imports (incl. NFS.) 4,218 4,518 3,585 4,561Resource Balance 544 -849 1,083 1,200

Net Factor Service Income -416 -440 -490 -487Net Interest payments -297 -414 -440 -414Of whicl. interest on public M&LT l.oans (-233) (-291) (-254) (-290)Direct Inyestment Income -35 -16 -27 -30Other Factor Services -84 -10 -23 -43

Current Transfer (net) - 5 18 7

Balance on Current Account 128 -1,284 611 720

Public M&LT Loans,

Disbursements 776 448 1,908 1,145Amc2rtization -548 -516 -589 -734Net Disbursements 228 -68 1,319 411

Other M&LT Loans

Disbursements 244 405 268 292Amortization -216 -408 -427 -399Net Disbursements 28 -3 -159 -107

Use of IMF Resources -116 216 235 -

Capital Transactions, n.e,i. -312 283 -849 -197

Change in Gross Reserves (- Increase) 44 856 -1,157 -827

Liabilities of Central Bank -94 251 1,192 -150

Change in.Net Reserves -50 1,107 35 -677

Memorandum Items

Level of Net Reserves 587 -520 -555 -122Level of Gross Reserves 1,309 453 1,610 2,437

a/ Preliminaryb/ Estimate

Source: BCRA & Mission Estimates

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TABLE VI

EFFECTIVE EXCHANGE RATES FOR COMMODITY GROUIPS, 1973-77

($a per US Dollar)

Real Effective Exchange Rate!!Machinery

Processed Basic andWheat Corn/Sorghum Beef Food Metal Transport

1973II 5.51 6.90 5.99 11.60 11.53 13.06III 5.59 4.53 6.16 11.43 11.74 13.30IV 5.65 5.48 6.23 11.56 11.87 13.45

1974I 5.95 5.76 6.96 12.17 11.86 14.56II 5.53 5.34 7.58 11.30 11.00 13.52III 5.43 7.48 7.44 11.10 10.80 13.27IV 5.01 5.56 6.87 10.25 9.97 12.25

1975I 3.89 4.32 8.01 9.58 9.46 11.84II 6.57 6.57 8.09 11.73 9.67 13.30

III 5.58 5.58 7.85 12.90 9.57 16.16IV 7.01 7.01 12.63 15.87 18.06 18.32

1976I 4.99 4.99 8.45 10.80 10.28 14.07II 5.87 7.20 11.52 15.64 14.61 17.90

III 6.42 6.42 10.26 13.64 13.24 15.89IV 11.87 10.50 10.81 13.43 15.06 15.55

1977Jan. 11.18 9.89 -10.18 12.65 12.29 14.64

Feb. 11.28 9.98 10.28 12.76 12.41 14.78March 11.83 10.47 10.78 13.39 13.01 15.50

1/ The real effective exchange rate is the nominal exchange rate adjusted by

taxes and fiscal subsidies and deflated by the relative price index.

Source: Central P,ank and International Financial Statist:Lcs.

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Resumption of Growth

25. During 1975 and early 1976, there was a steady and increasinglysharp contraction in the level of economic activity. As the economic situa-tion became more chaotic, private investment declined precipitously throughoutall sectors of the economy. Massive wage increases were immediately reflectedin higher prices and from June 1975 real wages declined as price increasesmade in anticipation of wage adjustments surpassed the rise in nominal wages.The sharpest decline in investment occurred in tho first quarter of 1976. Themo-mentum of the recession continued into the second quarter of 1976 as measuresrequired to stabilize the economy reduced consumption spending. Stocks ofindustrial products, which had been accumulated for speculative reasons during1975 and early 1976, were reduced. This drawdown in stocks temporarilydeepened the decline in industrial production. The automotive industry andproducers of consumer durables and capital goods were especially hard hit.

TABLE VII

Expenditure on Gross Domestic Product 1974-1977

(Percent change over previous 12-month period)

1976 1977Est.

1974 1975 1976 1977 Q1 02 Q3 4 Ql Q2

Gross Domestic Product(at market prices) 6.5 -1.4 -2.9 4.5 -4.5 -5.2 -1.7 -0.2 1.8 4.6

Consumption 13.7 3.1 -8.3 -1.0 -8.1 -10.4 -6.3 -7.3 -8.8 -6.8

Public 4.8 -1.7 -1.2 -3.5Private 14.6 3.6 -8.6 -0.7

Investment +3.9 -7.2 -5.5 27.5 -16.9 -12.6 0.5 5.4 17.0 21.4

Public 37.5 14.3 0.9 34.3Private -14.4 -26.0 -11.7 15.0

Gross Domestic 8.3 0.4 -7.6 3.7 -9.2 -10.7 -4.9 -5.1 - -Expenditures

Exports +1.7 -23.9 37.9 21.8 25.3 32.7 43.8 57.9 100.7 80.8Imports 13.7 -0.9 -24.4 16.0 -39.1 -36.6 -3.5 -3.8 30.0 30.0

Source: BCRA and Ministry of Economy.

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TABLE VIII

Gross Domestic Product by Sector of Origin, 1974-77

(Percent change over previous 12-month period)

1976 1977Est.

1974 1975 1976 1977 Q1 Q2 Q3 Q4 Q1 Q2

GDP (factor cost) 6.6 -1.4 -2.9 4.5 -4.5 -5.2 -1.7 -0.2 1.8 4.6

Agriculture 6.1 3.5 3.5 8.2 7.9 -0.1 0.8 5.7 7.0 16.1Mining 2.0 -4.6 0.8 6.0 -6.0 -2.5 3.3 8.3 9.0 11.7Manufacturing 6.8 -2.8 -4.5 4.3 -6.7 -6.3 -2.9 -2.0 -0.7 1.6Construction 12.2 9.6 -14.1 21.0 -26.7 -15.0 -10.7 -0.3 6.3 9.4Utilities 7.1 6.4 3.4 6.5 4.2 1.6 4.6 3.4 4.3 3.4Commerce 8.4 -1.4 -5.9 3.5 -9.8 -9.2 -2.4 -2.1 2.4 4.2Transport 4.6 -2.9 -4.3 4.2 -5.3 -10.2 -2.0 0.5 4.1 7.0Finance 5.6 6.6 3.7 2.8 5.2 4.0 3.0 2.4 0.2 0.2Government 3.8 4.9 0.2 -3.5 1.1 -0.1 -0.1 -0.1 -0.1 0.5

Source: BCRA and Ministry of Economy.

26. Since June 1976 the situation has improved significantly due to aturnaround in private investment and sharply expanded exports. Responding toimproved price incentives, agricultural production grew by 3.5,' during 1976.The 1976/77 grain crop, a portion of which falls into 1976 production figures,is estimated at 27 million tons, the highest on record. The livestock sectorexpanded strongly. Domestic consumption of beef remained buoyant and the volumeof beef exports doubLed as a result of opening of new markets in Egypt, Israel,Portugal and Spain. Mining output increased substantially in t:he last threequarters of the year due to the change in management of YPF, the state-ownedoil company, and introduction of measures to expand secondary recovery. Whilemanufacturing activis:y fell by 4.5% in 1976 as a result of the declin, in realwages and in demand for non-durable consumer goods, significant: recovery tookplace in some branches of industry particularly in those serving agriculture--tractors, heavy utility vehicles, meat processing, canning and leather.

27. Preliminarv information available for the first two cluarters of 1977indicates substantial, recovery on all fronts. Overall growth of GDP has beenpositive for thie first time in the past 24 months as the expansion of agri-

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culture and mining continued to accelerate and the decline in the industrialand construction sectors was sharply reduced. Continued recovery of theeconomy is expected in the second semester of the year due to increasedinvestment in both the private and public sectors and recovery of real wages.Overall growth of GDP in 1977 is estimated at between 3% and 4.5% with agri-culture, manufacturing, mining and construction all showing substantialincreases over 1976 levels of production.

Outlook for 1977

28. The Government's economic program for 1977 aims at continued streng-thening of the balance of payments, accelerating the pace of recovery ofdomestic production, achieving a substantial reduction in the rate of infla-tion, and further freeing-up of trade and price controls so as to bringthe internal price structure more in line viith world prices. Reactivationof growth of the economy so as to avert any increase in unemployment hasrequired that the Government follow a more flexible incomes policy since therecovery in investment which began to take place at the end of last year wouldnot have continued to extend throughout the industrial sector in the face ofprolonged depressed consumer spending. 1/ The Government has estimated thatwage increases consistent with productivity gains will require a series ofadditional adjustments aimed at increasing real wages to 10% above the June1976 level by end 1977. The private sector will be permitted to grant addi-tional wage increases to compensate tncreases in productivity but if suchincreases exceed 15% of the officialiy permitted increase, firms will not bepermitted to pass the excess cost to product prices or include it as a costfor tax purposes.

29, Incomes policy is closely linked to fiscal policy since wage andsalary payments constitute about 60% of current expenditures of the Treasury.The 1977 Budget establishes reduction of the public sector deficit as a keypriority and there is every indication that this will be achieved. Given theincrease in expenditures stemming from the more flexible incomes policy, theGovernment is relying upon improved revenue performance of the public sectorin general and on strengthening cax collections in particular. Improvedflical performance will make possible restraint in monetary expansion suffi-cient to achieve a aubstantial reduction of inflation. The Government hasrecently renewed the Standby Agreement with the IMF and the targets which areestablished under this Agreement are consistent with these objectives.

30. The outlook for the balance of payments in 1977 is for continuedimprovement with gross reserves projected to increase by about US$800 million.Export growth is expected to be strong (23%) as world beef prices recover andshipments of wheat and manufactured exports increase. Imports are expected

1/ A general wage increase of 45% was granted at the beginning of the yearfor both the public and private sectors and an additional 30% and 25% wasgranted in March and April for the private and public sectors, respec-tively.

- 17 -

to increase sharply (27%), especially during the second half of the year, due.to recovery in industrial production, acceler'tion of public and privateinvestment, and continued liberalization of import payments. Elimination ofremaining "swaps" is expected to be more than offset by an inflow of privatecapital through the free miarket.

31. The monetary program of the Central Bank is designed to be consis-tent with the projected surplus in the balance of payments, the financingneeds of the public sector, the expected increase in the demand for monetaryassets and an annual rate of inflation of about 120%. Currency issue isprojected to grow by about 150% during the year which, given the increase ininternational reserves which is expected, will permit Central Bank financingof the Treasury deficit of about $a540 billion. Expansion of credit by thebanking system to the private sector is expected to be sufficient to permitreactivation of investment and of economic growth. Success of the programwill depend upon continued real increase in the demand for monetary assets andreduction in velocity. To achieve this, the Government has committed itselfto continue to maintain nominal interest rates at levels which exceed theexpected rate of price increase.

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CHAPTER III

GLOBAL OBJECTIVES AND SECTORAL ISSUES

32. The central issue which has faced Argentine Governments throughoutthe post-war period has been how to sustain a rate of growth of output suffi-cient to absorb increases in the labor force and moderate rises in per capitaincome while simultaneously maintaining price stability and external equili-brium. High rates of growth of output and employment have been attained bythe economy in the past when agriculture has fulfilled its role as the prin-cipal provider of foreign exchange. Throughout much of the post-war period,however, inadequate price incentives for agriculture have, during protractedperiods, resulted in reduced investment, output, and shipments abroad ofArgentina's traditional agricultural exports, and the foreign exchange con-straint has emerged to limit overall growth of the economy.

33. In contrast to the protectionist import substituting industrial.development strategies which have prevailed in Argentina during much of

the post-war period, the present authorities are pursuing an export-orientedgrowth strategy with primary emphasis on agriculture and branches of industryin which the country has a strong comparative advantage. Through a combiiia-tion of trade and internal pricing policies, the current Government hasincreased the real effective exchange rate for agricultural exports, and has

improved the internal terms of trade for agriculture by almost 30% since itcame to power in March 1976. This is only slightly above the long-termaverage. Improvement in price incentives for agriculture has already resulted

in increased output and investment in agriculture and production of industrialinputs to agriculture are now leading the recovery of industrial output.

34. During 1976 major changes were made in the trade and paymentssystems aimed at increasing the efficiency of resource allocation by bringingthe internal price structure of the country more in line with world prices.This has been achieved by reducing tariff and non-tariff barriers to tradeand by simplifying the exchange rate system. The multiple exchange ratesystem which included a free market rate, an official rate and various mixingrates, was gradually eliminated and finally abolished in November. Alltransactions are now carried out at the free market rate which is managedby the Central Bank so as to gradually readjust the peso to take into account,among other things, the difference between internal and external inflation.Exchange restrictions have been drastically reduced. Limits on payments fortravel have been eliminated and limits on the sale of foreign exchange for

other invisibles have been reduced. Foreign financing requirements for im-ports of non-capital goods, the obligation for importers to purchase indexedpeso bonds, and the requirement that profit and dividend remittances abroad bemade in the form of dollar-denominated bonds, have been eliminated.

TABLvE IXINTERNAL TERMS OF TRADE 1976-1977

(1960-100)

1976 19,7

JAN. FEB. MARCH APRIL MAY JUNE JULY AUG. SEPT. OCT. NOV. DEC. JAN. FEB. MARCH APRIL MAY JUNE

Agriculturalwholesale priceindex deflatedby Non-Agricul- 86.0 91.1 74.7 72.6 70.3 76.3 85.5 92.2 97.5 96.6 97.0 98.5 97.3 95.8 94.0 93.0 96.5 97.3

tural wholesaleprice index

Agricultturalwholesale priceindex deflatedby Domestic-Non-Agricu,ltural 89.8 97.4 81.8 79.0 75.8 81.6 91.2 97.9 102.8 101.7 101.5 103.4 95.2 100.3 99.9 100.1 103.7 103.8

wholesale priceindex (i.e.excl,,ding importedwJ;olesale price index)

Fi-,rce: 1'mD( anl' lission Estimates

* Cifras pr'yvisionales

- 20 -

35. The first stage of a tariff reform of major proportions, aimed atincreasing efficiency throughout the economy, and especially in industry,throughl reduction of effective protection on most industrial products, wascarried out in November 1976 and important import prohibitions have beeneliminated. Only a few items--automobiles, tractors, and a few nondurableconsumer goods such as whiskey remain on the prohibited list. Tariff ratesfor 4,000 out of the 7,600 positions in the tariff schedule have been reducedby an average 25%. The maximum import duty has been reduced from 200% advalorem to 100%. Since reductions for imported inputs were smaller than forfinal products, the effective protection of a great number of productsdecreased more than the nominal tariff reduction. The tariff reform has beendesigned to reduce effective protection on manufactured consumer goods by thegreatest amount, on intermediate goods by a lesser amount and to maintain thatexisting on capital goods, It is estimated that average effective protectionon consumer and intermediate goods has been reduced from 215% to 150% and from100% to 70%, respectively.

36. A new foreign investment law, judged to be one of the most liberalin Latin America, reverses the restrictive bias of the earlier 1973 law andestablishes a new climate distinctly favorable to private foreign investment.The new law guarantees foreign investors the same rights and obligations towhich domestic capital is subject. The previous foreign investment law hadimposed discriminatory provisions on new investment, including exclusion fromseveral sectors, a schedule for transformation of foreign firms into nationalcompanies, and establishment of absolute ceilings on profit and dividend remit-tances. As a consequence, direct foreign investment had ceased to flow intoArgentina. Profit remittances, which were limited to 12% under the 1972 law,are now unrestricted, but amounts above 12% of registered capital are subjectto taxation. There is no prohibition on the repatriation of capital whichhas been invested for a minimum oL three years, but both profit remittancesand capital repatriation may be controlled in times of foreign exchangestringency. The law permits foreign investment in all sectors of the economy,but investment in some key sectors requires prior approval from the executivebranch.

37. In the area of regional development Argentina is placing considerableimportance on accelerating integration and development of the southern cone ofSouth America. Possibilities of physical integration of Argentina with itsneighbors, especially the low income c6untries of Bolivia and Paraguay,present both a challenge and a great opportunity. Efforts in this directionhave been made at various times but thus far with somewhat limited results.Nevertheless, some progress has been made in linking the economies of Argentinaand its neighbors. A bridge over the Uruguay River has been a positive stepin transport integration of Argentina and Uruguay. The Argentine andParaguayan road systems have been linked, which has not only encouragedArgentine tourism to Paraguay, but is also bringing Brazilian tourism and businessinterests to Argentina via Paraguay. The gas pipeline from Bolivia to Argentina,which the Bank helped finance, has been a milestone in integrating the twoeconomies in the energy field to the benefit of both countries.

M.A?IE go x

TARTIF. "IT PR0DT, ' SD )ODS

Degre o-f fabrication2i 32 4 5 7_ 8 9 0

Consumption goods B;>orn (l) O110 11O 110 120 120 130 130 130 140 140

After (2) 80 80 80 85 85 95 95 95 100 100

Intermediate -oods Before 40 50 60 70 80 90 100 110 120 130

Aftsr .(2' 30 35 45 50 60 65 70 80 85 95

i I

Capital goods Before (L 40 50 60 70 70 80 80 90 9o 100

After (21 30! 35 145 50 50 60 t 60 65 65 70

(1) - Decree 1410/67(2) - Decree 3008/76

5OURCEs Secretaria de Comercio Exterior y Nogociaciones T3',conomiicas Tnte-rnacionales

- 22 -

Some integration in the transport and energy fields has also been effectedbetween Argentina and Chile. Although by no means insignificant, all the'seachievements of physical integration are merely minor precursors of whatmight and should take place in the interest of both Argentina's economy andthe economies of her less-developed neighbors. Opportunities for additionalmajor integration links in the power field are numerous and vital. TheYacyreta-Apipe hydroelectric development sponsored jointly by Argentina andParaguay is in an advanced stage of preparation. The same is true of theSalto Grande hydroelectric project between Argentina and Uruguay and thepower interconnection between the two countries. Expansion of the gas pipe-line between Bolivia and Argentina, although less advanced, is also a realpossibility. Joint development of these projects would greatly assist theeconomies of Paraguay and Bolivia as well as relieve Argentina and Uruguayof the very heavy burdens which petroleum imports from abroad impose on theirrespective balance of payments. Improvements in the transport and communica-tion links between Argentina and Paraguay and Bolivia would serve as amajor impetus to the economic growth of these two landlocked countries andshould enable these countries to raise their low living standards. Theintegration highway between Argentina, Bolivia and Paraguay which would linkall three of them with Brazil is now under active consideration.

38. In order to strengthen domestic resource mobilization, the Govern-ment is currently implementing far-reaching structural reforms of the financialand fiscal systems aimed at accelerating development of Argentina's capitalmarkets and rationalizing public sector finances. Although Argentina has hada relatively well-developed financial system dating back to the turn of thecentury, the system has for protracted periods operated under a high degreeof Government control and regulation which has limited its effectiveness inintermediating private savings and in allocating these resources efficientlyto alternative investment opportunities. The Government has replaced thesystem of nationalized deposits, introduced by the previous administration,with a fractional reserve system aimed at producing a more balanced flow ofresources through Argentina's financial system and at providing the authori-ties with more effective monetary control. Simultaneously, a new law regu-lating financial institutions was introduced which will stimulate acceleratedcapital market development through broadening of the scope for competitionbetween financial intermediaries.

39. Argentina's post-war experience indicates that strengthening of thecountry's fiscal system is required for strong growth of public investmentand simultaneous maintenance of price stability. Basic structural reformof the fiscal system is now in progress which aims at restoring the financialviability of provincial governments and state enterprises which have in recentyears accounted for most of the fiscal deficit. Twenty-six private enter-prises which had been acquired by previous administration to prevent themfrom bankruptcy are to be returned to private ownership or liquidated overthe next 24 months. Ambitious targets for 1977 have been established forthe Argentine Railways which, if implemented, will make a malor contributionto reducing its large deficit.

- 23 -

40. Emergency tax measures introduced in 1976 have been continued in1977 and far-reaching improvements in tax administration have been carriedout. A new group has been created in the Ministry of Economy to rationalizepublic investment planning and to develop a long-term public investmentprogram. Taken in their entirety, the measures adopted by the new Governmentare impressive and represent a major shift in the Argentine developmentstrategy which when fully implemented will lay the foundation for strongeconomic growth in the future.

TheA

410 Including forestry and fisheries, which are presently of limitedsignificaince, the agricultural sector in the period 1965-76 accounted for14% of GDP at 1960 porices. Excluding forestry and fisheries, the totalsectoral output is fairly equally divided between crops and livestock.There are, however, significant regional differences in the composition ofsectoral output, as shown by the following data:

Crops Livestock__ % ----- %----

Pampas /1 38 62

Non-Pampas 71 29

Total 47 53

/1 Includes provinces of Buenos Aires, Cordoba, Entre Rios, Santa Feand La Pampa.

42. Agricultural production in Argentina grew at a rat:e of 1.8% perannum in the period 1953-77. The comparable figure for crops was 2.6%, andfor livestock 1.4%. Growth during the second half of the period was almostdouble that of the earlier part of the period. The higher rate of growth inthe latter period, and particularly in the 1970s resulted from an improvementin the terms of trade for agriculture, and a more widespreacl use of moderninputs, especially Lmproved seeds and intensified mechanization. Growth ofcrop output accounto3d for the bulk of the improved performance, with littledifference being shown between production gains in crops in the pampas (grainsand oilseeds) and crops in the non-pampas (sugarcane, cottonI, tobacco, fruit,and wine grapes). Livestock production expanded at a somewhat slower pacein the 1963-77 period as compared to the earlier period and the rates of growthof livestock have been substantially less than those for crops.

43. Agricultural exports made up 79% of total exports in the 1970-76period, declining in relative importance from 83% in 1970 to 74% in 1976.Between 1970 and 1976, cereals grew from 29% to 31% of totaL exports, meatsdeclined from 21% tD 14% and oilseeds products remained constant at 10% oftotal exports.

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The New Agricultural Policy

44. The growth strategy of the Government aims at strengthening thecountry's external position through accelerated development of sectors inwhich Argentina enjoys a comparative advantage. In line with this strategy,the agricultural policy including tax, credit, tariff, marketing and exchangerate policies has undergone significant change. The ultimate objectives areto bring farm product and input prices in line with international levelsand to establish a tax and credit system which will improve resource use andaccelerate output expansion. Available evidence indicates that the agricul-tural sector has already begun to respond to these changes by increasingexports of cereals and oilseeds.

45. The new policy, announced in April 1976, is being vigorouslyimplemented. Differential nominal exchange rates for many agriculturalexports have been reduced or eliminated. In August 1976, the export retentiontax for wheat was reduced from 40% to 10% and in November the rate was reducedto zero. In December the rates on coarse grains were cut from 40% to 10%.By the end of the year, most domestic price controls on agricultural exportshad been removed, the state monopoly on grain trading had been lifted, cattleslaughter quotas had been withdrawn, and the National Meat Board was nolonger engaged in direct selling abroad.

46. From March 1976 to December 1976, real prices of agriculturalproducts increased by 37%; crop prices increased by 44% while livestock pricesincreased by 23%. In the case of soybeans, prices have risen as a result ofliberalization of the restrictions on the export of unprocessed soybeans. In1976, the Government permitted exportation of 190,000 tons of soybeans andit has established export quotas of 500,000 tons for 1977. As a result, theprice of soybeans has moved in line with international prices for oilseeds.

47. The Government has rejected the proposal to establish a land taxat the federal level, and instead, is encouraging the provinces to increaserevenues from the provincial land tax. The provinces are in the processof revaluing land to 70% of market value, and establishing an annual taxrate equal to 1% of that valuation. There are a number of problems asso-ciated with the implementation of the new land tax system. Market valuesare hard to determine. Inflation requires periodic changes in the taxbase. There may be a tendency for effective tax rates to be lower in thoselarge provinces with more productive land since the provinces with a betterresource base can meet their revenue requirements using lower rates. If thishappens, the land tax will lose much of its effectiveness in promoting moreintensive land use.

Technological Change

48. The new agricultural policy will encourage the use of yield-increasing cultivation practices and modern inputs, and a substantial imme-diate impact on production can be expected. Developed by INTA and the private

sector, there is a considerable supply of under-used technology in hand, andwith more remunerative product pricing there is an incentire for its wide-spread adoption. This incentive will be reinforced by the relative shift inprices of land and modern inputs under the new policy.since modern inputs havehigher supply elasticities and over the medium term, lower price relative to

that of land, thus encouraging the use of these inputs in greater amountsrelative to land.

49. The result should be rapid growth in the use of modern productiontechniques and in the upgrading of land use. The potentia:l gain in output in

the Pampas is impressive. For example:

(a) The wheat-soybean rotation, which enables two crops peryear, can be extended to roughly three times the 1976/77acreage of some 0.5 million ha in the northern Pampas.Such a development would increase total agriculturalproduction on the order of 2% and expand agriculturalexports by 6%.

(b) Widespread adoption of the new hybrid sunflower couldresult in a national agricultural output expansion of2% if the yield potential of the new genetic materialis fully realized through fertilization.

(c) The fertilization of some two million ha of land in thePampas would result in an increase in total-agriculturaloutput which is conservatively estimated at around 5%.Most Government officials, rural leaders and agriculturaltechnicians agree that the more favorable product-fertilizerprice relationship resulting from current agriculturalpolicy, along with the rapidly increasing availability offertilizer responsive varieties (particularly wheat andsunflOWE!r), is increasing farmer interest in fertilization.

The cropped area under fertilization in the Pampas couldreadily reach the above mentioned figure of 2 million hawithin t:he next four or five years under current policy.

(d) Preliminary on-farm data indicate that sprinkler irrigationof maize has an economic potential for some 0.5 millio:; hain the Plampas0 At present product and equipment pricesabout 2.5 ton/ha of maize are required to pay fcr theannual investment and operating costs of sprinkler irriga-tion and fertilization. According to the available data,the typical gain in production has been roughly twice thatrequiredl to pay for the investment and operating costs.Utilization of this technology could produce a net benefit of1.2 mil:Lion tons of maize equivalent to 15% of the averagemaize crop in recent years.

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Land and Water Develop

50. Expansion of the area used for crops aid pastures through landclearing and related investments in infastructure ranks high among governmentpriorities in agriculture. Vast areas located outside the Pampas with widelydiffereht ecological conditions and production potentialities are believedsuitable for land clearing programs. 1/ The Secretariat of Agriculture is inthe process of completing an in-depth study of a US$885 million project tofinance the clearing of 3.8 million hectares and the .nstallation of soil andwater conservation oriented farming systems. The project centers on landclearing in already functioning farm units rather than the opening up of newunexploited territory. In addition to its direct impact on production, itis expected that land clearing will promote the relocation of a part of thebeef cattle industry to areas outside the Pampas, thus releasing land in thePampas for crop production.

51. Development of the national water resource for irrigation can alsohave a substantial impact on agricultural production over the medium term.Among the schemes now at various stages of development are Las Maderas inJujuy, Cabra Corral in Salta, Rio Dulce in Santiago del Estero, Las Pichinasin Cordoba, and small projects for La Rioja, Catamarca, and Paso de lasCarretas in San Luis. A detailed study of the Casa de Piedra, a multi-purposeproject on the Rio Colorado, has just been completed. In addition, there area number of ongoing projects in the p-ovinces of La Pampa, Neuquen, Rio Negro,and Chubut which await completion or rehabilitation. Under the new agricul-tural pricing policy, complementary investment in these schemes may turn outto be attractive, particularly if markets for high value crops are available.

52. To assure that water resource development and management receivesappropriate attention, the Government is undertaking to:

(a) institutionalize the coordination between Secretaria deEstado de Agricultura y Ganaderia, Agua y Energia, Sub-Secretaria de Recursos Hidricos, INPE and the newplanning ministry and the provinces;

(b) complete the collection of information required to evaluatethe economic return to complementary investment in ongoingprojects;

(c) install a system of water charges which would permit adequatecost recovery, and improve the efficiency of use of water.

1/ One such area lies west and north of Santa Rosa in the province ofLa Pampa. The cover of this 2-million ha zone is mainly second growthcalden. Rainfall is in the 400-650 mm range. Various types of dry-farming techniques have been tested on farms, based largely on sorghumand fertilized weeping love grass. It is expected that forage triticalewould become an important part of the rotation. Much of the socialinfrastructure is in place.

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The Beef Industry

53. Argentina's beef industry is vulnerable to developments in foreign

markets, since it must absorb external shifts in supply and demand conditions.

This vulnerabitity has been increased by the EEC decision to minimize price

fluctuations withint the community through strict control of imports. Theresult has been that beef exporting countries experience severe changes in

prices.

54. A recent development of great significance for the future of the

beef cattle industry is the changing response of farmers to shifts in product

prices. The drastilc decline in beef prices which occurred during 1974-75

because of the closure of the EEC market, produced a reduction in cattle

numbers far less than would have been expected on the basis of historic

responses to such price movements. This new phenomenon has important impli-

cations. Under present technology--mainly improved permanent pastures--

producers are apparently better equipped to face a calamitous situation like

that of 1974/75. Over the medium term, fiscal policies can be used to dampen

the beef cycle. Relocation of cattle production should be encouraged since a

shift of the cattle industry out of the Pampas on land of ]ower opportunity

cost would permit intensification of crop production on the Pampas, and

strengthen the ecoaomy's export capacity.

The Outlook

55. The transition from a system of artificially depressed product

prices and subsidized interest rates, which prevailed in Argentina for the

past several, decades, to a system based on the market, may change the nature

of uncertainty faced by producers in the short run. While the outlook for

world prices of Argentina's major agricultural exports is reasonably favorable,

substantial year-to-year fluctuations may occur. Moreover, under present

policy, free product prices are being accompanied by substantially higher real

rates of interest. Farmers will have to learn to use credit more productively

than in the past. In terms of shortrun adjustments, it would be an error to

underestimate costs involved in the transition from the old to the new economic

environment. Time will be required to build confidence within the farmingcommunity and for farmers to acquire the supplies, equipment and knowledge

needed for improved farming methods. Under these circumstances, continuity

of the new policy is essential. In addition, sustained effort will be re-

quired to assure that prices of industrial inputs used in agricu7tureapproximate international levels.

56. Price elasticities in the range of .3 to .4 have been estimated for

the agricultural sector, indicating the relatively strong response of agri-

cultural production to higher product prices. These relatively high price

elasticities suggest that farmers will respond to higher prices with new

investment, which will result in higher output levels through the application

of available new t:echnology. Production response over the immediate years

ahead should be especially favorable given the important stock of techniques

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60. To sustain productlivity and production gains during the decade ahead,more attention needs to be g;iven to the generation of new technologies andfarmirrg systems adapted to each of the widely varying ecological environmentsfound in Argentina. A subst:antial increase in research and extension activi-ties is called for. The creation of regional institutes of research and ex-

tension activities is called for. The creation of regional institutes ofresearch and extension merits consideration, Equally important, is activeand continuous participation of the private sector in the operation of theseinstitutes to ensure an effective degree of communica::ion between scientists,technicians and farmers. In addition, soil and water conservation lnArgentina should receive more attention than in the past. Discussicon of theproposed regionalization scheme for research and extension should irLcludealternative ways of designing and implementing soil and water conservation

activities since a major technical problem facing Argentine agriculture is oneof making better use of the available water supply and conserving soil0 Ascircumstances permit, it would be useful to consider ways of enlarging the

role of the Secretariat of Agriculture in agricultural development policyanalysis and planning, and as a coordinating body for agencies working in the

rural sector. As noted above, a good start in this direction is unclerway in

connection with water resource development for agriculture. Over the mediumterm, the development of rich Patagonian fishery resource is now being

activated. Foreign assistance for the forestry industry, the underclevelopmentof which now accounts for a major outflow of foreign exchange for itaports, is

now being obtained.

The Industrial Sector

61. Industry has been an important sector of the Argentine economy since

the turn of the century, when the share of manufacturing in total olutput reached

about 15%. Industrial growt:h surged ahead during the 1930s and agaLn duringWorld War II,. propelled each time by the substitution of locally manufactured

goods for imported products. After World War II, the Government strengthened

efforts to promote industrial growth through a combination of import: controls,

high tariffs, special tax incentives and exchange rate policy. Growti inmanufacturing value added averaged 4.1% in the fifties, rose to 5.6% in thesixties and accelerated to 7.2% between 1970 and 1974. During this period theindustrial sector's share in GDP increased from 28% to 38%. Average industrial

growth rates in the past conceal wide fluctuations in the annual rates ofexpansion which have ranged from 10% to -5% in the last twenty years.

62. Government efforts to promote industry in most of the post-warperiod aimed at shifting from traditional manufacturing activities to branchesof industry which incorporate modern technology, mainly chemicals, rubber,

metals, and machinery and equipment. The share in total output of metal

products, machinery, and transport vehicles and equipment rose from 16% to 33%between 1950 and 1975, while the share of the traditional industries declined

from 50% to less than 30% during the same period. Argentina became the firstcountry in Latin America in which the value added of these three "modern"

branches of industry exceeded the value added of the "traditionals". Despitetheir dynamic character, however, the new industries are still highly protected

in an economy which was already burdened with too large a number of industriesfacing an only slowly expanding internal market.

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Table XI: INDUSTRIAL DEVELOPMENT, 1950-76

1950 1960 1970 1974 1976

Gross value added of manufacturing 1,923.7 2,878.0 4,977.9 6,571.7 6,087.4Growth rate 4.1 5.6 7.2 -2.8 -4.7Manufacture's share in GDP (3:1) 27.9 31.1 35.3 38.1 36.8

Import to GDP mp b/ 9.8 7.9 7.1 7.8 7.1Imported to total consumer goods 3.2 0.3 0.4 0.3 0.2Imported intermediate goods to

value added of manufacturing 13.4 15.6 17.0 16.7 14.0Imported capital goods to total

domestic investment in machineryand equipment 19.7 19.3 14.0 15.6 d/ -

Manufactured exports (in mill. $) - 27.0 288.6 915.7 956.2Growth rates al 26.7 33.2 -22.0 33.9Manufactured Exports/Total Exports - 1.8 16.3 23.3 25.4

Industrial Employment (in 1000) 1,415.2 1,506.1 1,716.8 1,946.0 1,974.3 d/Growth of ind. employment 0.6 1.3 3.2 1.5 -

V.A. per employee (in 1000 1960 pesos) 1,359.3 1,910.9 2,899.5 3,377.0 3,235.4 a/Growth of labor productivity 3.5 4.3 3.9 -4.2 S/ -

Shares of major industrial groups intotal industrial product 100.0 100.0 100.0 100.0 100.0

Food, beverages and tobacco 26.1 20.0 17.7 16.0 16.2Textiles and wearing apparel 23.8 17.6 11.7 12.2 12.7Wood and wood products 2.5 1.8 1.6 1.4 1.0Paper, printing and publishing 5.5 4.3 4.5 4.1 4.0Chemicals, petroleum, rubber and plastics 11.7 14.7 18.6 18.8 19.8Non-metallic minerals 5.4 4.2 4.8 3.7 4.0Basic metals 2.3 4.1 5.8 6.6 5.3Metallic products, machinery and

transport equipment 15.9 28.2 31.1 33.5 32.8Other industries, incl. handicraft 6.8 5.1 4.2 3.7 4.2

a! All growth rates refer to 1950-60, 1960-70, 1970-74, 1974-75, 1975-76.b/ The import ratios are covering the following time periods; 1945-49; 1961-65; 1970-74; 1974-76,74c/ 1974-75d/ 1975

Source: Central Bank of Argentina and Missions Estimates.

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63. Import substitution policies changed the composition but not thevolume and value of imports, which have grown continuously. Total importsdoubled in value between 1960 and 1974, gr-wing rapidly each time a foreignexchange crisis had been overcome. During the same period, imiports of inter-mediate goods increased from 50% of total imports to 70%. The dependence onimports is stronger in the "modern" branches of the indu';tria. sector.

64. Aware of the shortcomings of import substitution, the authoritiesinitiated a program of export diversification in 1962. Fiscal. and monetaryincentives to stimulat:e industrial exports were introduced but these had littleinfluence in the firs: years because of erratic exchange rate policies. Duringthe 1967-69 period these incentives were supplemented by global reimbursementof income taxes, an export insurance scheme and more realistic exchange rateadjustments. As a result, industrial exports expanded more rapidly, reaching23% of total exports by 1972. As was the case with overall industrial growth,the rapid increase in manufactured exports at an average of 20% per year inreal terms from 1968 on was led by the "modern" industries, which reached 40%of total manufactured exports in 1973/75. Despite the substantial growth ofmanufactured exports, Argentine induistry continues to be faced by three majorproblems--inefficiency, dependence on a number of critical high cost, locallyproduced industrial inputs, and relatively low employment creation.

65. The level of efficiency and competitiveness of Argentine industryvaries substantially between branches. Prices of many Argentine industrialproducts are substantially above those in the industrialized countries andthe level of capacity utilization has been low during much of the importsubstitution process. In addition, there are problems of efficiency in thevarious industrial subsectors. The "modern" industries tend to be technicallyefficient but relative:Ly high-cost producers principally because many firmshave remained too small to develop economies of scale. Many of the "traditional"industries, on the other hand, work with obsolete equipment and managementmethods which have made it difficult to sell outside of the domaestic market.

66. The major causes of the present low efficiency levels appear to belack of competition due to high and uneven protection of imporl substitutionindustries, weak management in many state enterprises supplying basic inputsto industry, and periodic deterioration of public finances, which frequentlyresulted in preemption of credit by the public sector. The current authori-ties have reversed past policies and are (a) opening up the economy to inter-national competition by a reduction of import barriers, (b) restructuringmajor industries by merging or eliminating marginal firms in branches whereexcess capacity is high., and (c) improving the performance of state enter-prises. Substantial reductions in external tariffs were implemented inNovember 1976. The effect of these tariff reductions are now being analyzedby the Government. At the same time, new reductions are being implemented inmutual agreements between the Secretary of Commerce and the major industrialgroups. Restructuring of the automobile industry and its suppliers has beenstudied by a commission, which has elaborated alternative measures to raisethe productivity and lower the prices of that industry.

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67. Argentina's most rapid phase of import substitution has not provideda significant number of new employment opportunities. Total employment in themanufacturing sector grew by 2.2% between 1946 and 1954 and expanded by anannual rate of 1.7% in the following seven years. Between 1968 and 1978employment in manufacturing was stagnant. However, in more recent years,labor absorption in industry has advanced more rapidly averaging 3% annuallybetweeq 1968 and 1975. This would seem to be the result of a strong domesticdemand pull, a gradual expansion of manufactured exports, and a substantialincrease of employment in the state enterprises. As part of its strategy toimprove the efficiency of state enterprises, the Government is expected toshift surplus labor in these enterprises to the private sector. This is tobe achieved by reducing numerous fringe benefits in state enterprises and byconcentrating increases in real wages on individuals who have contributed toimproving productivity. In the medium-term, this shift should be facilitatedby the expected accelerated growth of the private sector.

68. The Government has taken a number of measures which should lead toincreased industrial investment and output in the near future. In general,the emphasis is on expanding the capacity and efficiency of the basic indus-tries, such as steel, petrochemicals, and paper. Specific projects of overUS$1.4 billion, which still fall under the old industrial promotion law, wereapproved in 1976. Firms can now deduct 40% of the income tax, if they re-equiptheir depleted capital stock in 1976/77. Although the credit incentives forexporters have been reduced, the Government has kept the "real effectiveexchange rate" relatively constant so as to continue to encourage exports.Additionally, it has selected food processing in general and the dairy industryin particular to assist in the modernization and improvement of marketingabroad. The new industrial promotion law has been signed. It simplifies theincentive system and limits the total fiscal subsidy to an amount to be deter-mined by the Ministry of Economy. At the same time, it continues to placemajor emphasis on decentralization. A transfer of technology law is expectedto be issued in the near future, which aims at modernizing the industrialsector by increasing the level of technology.

The Energy Sector

69. Argentina is well endowed with energy resources, having significantdeposits of coal, oil, natural gas and uranium, as well as a sizeable undev-eloped hydroelectric potential. Current use of these resources does not,however, reflect the country's energy resource endowment. In 1976, 88% oftotal primary energy consumption, including non-commercial energy, consistedof crude oil and natural gas (15% of which had to be imported), and whichtogether account for only 17% of domestic energy reserves. The Government isaware of this situation and is taking steps to achieve a more rational use ofthe different resources through the construction of hydroelectric and nuclearpower plants, and the expansion of coal mining activity. The Government isalso planning to achieve oil self-sufficiency by 1985 and to this end plans tointensify exploration efforts both by expanding the state-owned YacimientosPetroliferos Fiscales' (YPF) drilling program and by inviting the partici-pation of private oil companies, primarily for secondary recovery and offshoredrilling activities.

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70. Development of oil, gas and coal resources are the responsibilityof two state-owned entities, YPF, and Yacimientos Carboniferos Fiscales (YCF).Both entities report to the Secretariat of Energy which regulates fuel pricesand has authority to direct the planning and investment activities of eachentity. In the past, however, this latter authority has not been fullyexercised, resulting in weak fossil. fuel subsector development policies. YPFhas in the past suffered from high levels of overemployment and low levels ofoperating efficiency. The present Government is attempting to remedy thissituation and has reportedly reduced YPF's work force by about 6% during thelast year, to 48,000. Further cuts to 35,000 are planned. In addition, theGovernment is increasing the flexibility and hopefully the operating efficiencyof YPF, Gas del Estado and YCF by changing their status from that of Governmentdependencies to that of autonomous state enterprises. YPF obtained thisstatus in April 1977.

71. Although the electric power industry is almost completely owned bythe Government, there is considerable dispersion of decision-making power.There are nine major entities involved in the generation, transmission and/ordistribution of electric energy. The Secretariat of Energy controls three ofthese institutions (though it also regulates the tariffs of the only privately-owned institution), the Ministry of Foreign Affairs controls two, the Presidencyof Argentina controls one directly, and provincial governments control theremaining two. This fragmented structure is, in part, responsi'ble for unwiseand unjustified subsector investment decisions which have committed thecountry to an overinvestment in generating capacity in the period 1980-84.The Secretariat of Energy is carrying out a national power subsector organiza-tion study with a view towards overcoming the organizational deficiencies ofthe sector, but there are expected to be difficulties involved iu overcomingthe natural resistance to major changes.

72. The Government, aware of the importance of having a coherent energysupply development program, has formed a small group of competent energyspecialists within the Secretariat of Energy. They have prepared a firstdraft global energy balance for the period 1977-85. The main assumptions ofthis balance are the following:

(a) GDP will grow at an average annual rate of about 5.5% in1977-85, elasticity of demand for energy of .98%, and growthof total energy demand averaging 5.4% annually;

(b) the demand for electric energy will grow at an averageannual rate of 9.8%;

(c)' the development of hydro and nuclear energy will beaccelerated in accordance with projects already committed;

(d) oil will be substituted by natural gas where possible soas to use the large gas reserves in Tierra del Fuego, soonto be made available to the northern markets upon completionof the submarine pipeline linking this island to the mainland(1978);

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(e) oil and gas exploration activity will be geared to achievinga target of complete self-sufficiency in oil production and90% self-sufficiency in gas production by 1985;

(f) increased petroleum production targets are to be achieved bothby intensifying YPF's exploration activities and by opening upnew areas to exploration development by private oil companies.The intention is to use private resources on exploration,secondary recovery and off-shore exploration, to the extentthat resources of state enterprises are insufficient; and

(g) the production of coal will be increased from 0.6 million tonsin 1976 to 2.5 million tons per year by 1985, to be usedmainly in the generation of electricity. Other uses of lowgrade domestic coal will be explored for steel.

Based on these assumptions and a sectoral study of energy requirements, theSecretariat projects a fossil fuel imports bill that declines from the 1976level of US$560 million per annum to about US$170 million by 1985 (end 1976dollars). Of this total bill, coal, liquid gas and natural gas representa constantly increasing share, while oil imports comprise the declining com-ponent of the bill which is to fall close to zero in 1985. The elasticity oftotal energy demand with respect to GDP of 0.98 implied in the Secretariat'sanalysis is probably too low. Applying a more realistic elasticity of 1.05,the average 1960-75 value, and assuming an average GDP growth of 6% resultsin a 1985 energy "gap" of about 15% of currently planned domestic supply perannum, This gap is ten percentage points above the Secretariat's estimateof 5%. If the extra 10% of energy were to be imported in the form of crudeoil, the fossil fuel import bill in 1985 could amount to US$430 million (end1376 dollars), with3oil imports increasing from the 1976 level of 3.52 millionm to 5.2 milllon m

73. The Secretariat is considering devoting more resources to therefinement of their energy planning methodology and to make a comprehensivestudy of alternative means of avoiding the energy bottleneck that coulddevelop if high rates of economic growth are sustained and the relativelyoptimistic assumption of increased petroleum production are not forthcoming.Possible measrlres include increasing the use of coal for thermal generation ofelectric power above currently planned levels, and increasing efforts toexpand petroleum production by accelerating negotiations with private oilcompanies for secondary recovery and off-shore exploration activity. Theenergy expansion plans call for heavy investments during 1977-85 as follows:

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US$ 1l'~lion (end 1976)

Electric Energy 12.0Oil 9.6Gas 2.3Coal 0.5

Total 24.4

74. The Yacyreta Hydropower Project is by far the largest singleinvestment project presently under consideration by the Argentine Government.The project would form the backbone of the Government's least cost solutionpower expansion program for the next twenty years and constitutes the criti-cal step in the Government's strategy to use Argentina's renewable energyresources more fully and effectively. The project would provide competitiveand reliable energy to support expected rapid economic growth and help avoidbreakdowns in power supply which have caused high economic opportunity costsin the past. The project would also, as secondary benefits, promoce developmentin adjacent areas both in Argentina and Paraguay through improved road accessand river navigation upstream from the site of the dam as well as throughlarge-scale irrigation systems.

75. The expansion and investment plans in the electric power and coalsubsectors are reasonable. Lack of information on oil subsector plans andrecent performance precludes precise evaluation of the adequacy of plannedinvestment. Investment in the gas subsector seems reasonable on the basis ofcurrent plans. Included in these plans is the construction of about 1,300 kmof gas pipelines in the central west to tie the Mendoza gas field to thenational pipeline network. Another possible project in this region is that ofa Trans-Andean gas pipeline to connect the Neuquen fields to Concepcion, adistance of about 200 km. Such a connection would allow Chile to use itslarge southern reserves of gas by exchanging gas sold to Argentina in theSouth for gas from Neuquen.

76. An aggregate financing plan exists for meeting the investmentrequirements outlined above. In the electricity subsector a plan has beendrawn up, which under optimistic assumptions of tariff levels, arrives at afinancing gap of about US$3 billion for the period 1977-85. In the case offossil fuels it is estimated that $12.4 billion will be invested to meet theabove stated demand. Of this sum, 43% is expected to be derived from internalsavings of the state enterprises active in petroleum, gas and coal exploita-tion. An additional 11% should come from special tax funds and banks.Historically, 20% of oil investments have been financed by private venturecapital. This would leave 26% or $3.2 billion as a financing gap, which theplanners hope to fill by additional private investment. On the basis of astudy of historical sources of investment in the energy sector, the Secretariatof Energy concludes that total public investment for the entire energy sectorin 1977-85 would not exceed US$16.0 billion and, therefore, it is expectedthat government contributions, international lending agencies, and privateindustry will provide the balance of US$8.4 billion. The Government expectsthat the bulk of the private investment will occur in the oil subsector. Theuncertain nature of future financing for the sector as a whole, coupled with

Table XII: PROJECTED ARGENTINE ENERGY BALANCE, 1977-85

(Millions of Metric Tons of Oil Equivalent (M t.o.e.) /a

Actual1976 1977 1980 1985

DemandIndustry, Mining, Construction - 17.4 20.9 26.1Transportation and Agriculture - 9.8 11.7 14,6

Commerce and Public Services - 2.2 2.9 4.4

Residential - 6.6 7.3 9.0

Total Demand 36.0 42.8 54.1

Primary SupplyHydro Power 1.2 2.1 3.6 5.7Nuclear Power 0.6 0.6 0.6 1.6Vegetable Fuels 1.8 1.8 1.8 1.5Crude Oil and Products /b 24.6 21.6 25.6 32.0Natural Gas 8.3 9.3 12.0 16.3Coal 1.0 1.1 1.7 2.6

Total Gross Primary Supply 37.5 36.5 45.3 59.7Losses /c 4.9 5.6 6.7 8.6

Total Net Primary Supply 32.6 30.4 38.6 51.1

Supply Less Demand (Negative) - (5.6) (4.2) (3.0)

/a Total may not add due to rounding./b Projections of petroleum product imports (other than liquid gas), which totaled

0.6 M t.o.e. in 1976, were not available. These imports are, however, offsetby exports.

/c These consist of the following losses estimated at 13% of gross supply (based on1971-75 data): electricity transmission and distribution losses; gas consumedat well-heads to run drilling equipment a-nd gas- re-injectedAinto wells or flared(where there are no gas pipelines); petroleum consumption during processing.Changes in stocks have not been estimated.

Sources: Secretaria de Energia and mission estimates.

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the large investments required and the large contribution expected fromprivate sources, point; to the need for a more intensive sector planningeffort and for speedir,g up negotiations between YPF and private oil companies.

77. One of the major issues in the energy sector is that of pricingpolicy for the different sector products. Historically, government policyhas been to fix prices on the basis of noneconomic criteria so that priceshave generally been, and are at present, unrealistically low. Electricitytariffs, in particular, have been fixed at levels that do not allow the sub-sector entities to generate sufficient funds for adequate expansion. Gener-ally, these entities have achieved rates of return on unrevalued assets verymuch below the 8% stipulated in their concessions. Coal mining has, sinceits inception, been heavily subsidized. The present price for coal consumedfor power generation (its main use) is about one third of its real cost. Ina similar vein, fuel oil, diesel oil and gas used for power generation arealso subsidized. An 88% increase in the price of gasoline in March 1977brought its level, including taxes (72% of the total), to about US$1.10/gallon,while the prices of other petroleum products were adjusted by smaller percen-tage changes in July 1977. There is a continuous need to survey fuel pricingpolicies both with respect to relative prices and price levels for fuels intheir alternative uses.

The Transport Sector

78. Argentina's transport system is one of the most deveLoped in LatinAmerica. Its extent and configuration facilitated an early development ofthe country's economy. It also contributed to regional specia:Lization ofproduction and to the primacy of Buenos Aires as the center of economic activ-ity. Only in the late 1960s, however, was a north-south and east-west networkof trunk highways built. Some of these routes are still under construction.

79. In 1976 Argentina had a system of around 1.0 million km of roads, ofwhich eight-tenths were earth tracks and feeder roads, and only 4% were paved(around 42,000 km). There were also 39,800 km of railway lines; a river navi-gation system of more i:han 3,000 km and nine main river and ocean ports,handling about 80% of all port cargo; 1,500 airports of all cat:egories ofwhich about 90 are open to civil aviation; and 5,200 km of pipelines for oilproducts.

80. Freight movements in Argentina totalled about 102.2 billion ton-kmin 1976. Of this, about 42% was carried by road, 35% by coastal shipping andriver transport, 12% by pipelines and 11% by rail. The country's portshandled 68.6 million tons of goods in 1975, of which Buenos Aires moved 35%.Inter-city passenger traffic reached a total of 64.1 billion passenger-km ofwhich road transport, both public and private, accounted for 86%, rail for10%, and air transport for the remaining 4%.

Highways and Road Transport

81. The road network expanded very rapidly in the 1960s and early 1970s,including construction of modern limited-access multilane facilities at theentrances to the main urban centers and along a few of the most heavily

- 38 -

travelled routes. With the assistance of the international lending institu-tions, several connections to neighboring countries have also been constructed.As traffic increases, however, expansion of capacity will be required in somecorridors. In addition, general improvement of secondary and tertiary roads,and of international connections to Bolivia and Chile, would be desirable.

82. Road transport has expanded rapidly as a result of an average annualgrowth of 8% in the vehicle fleet between 1961 (1.0 million vehicles) and 1976(3.4 million vehicles). Truck transport is used for long and short hauls andfor practically all commodities. Freight rates are low because of the gener-ally flat terrain, the good level of maintenance of the highway system, andthe use of heavy truck trailers with a low power-to-weight ratio. Competitionof road transport has contributed considerably to a large diversion of trafficfrom rail to road transport.

Railways

83. The railways have an important role to play in the economy as thietransport mode which should carry the heavy, massive, long hauls most effi-ciently and at least cost. However, previous railway administrations havetenaciously defended the operation of uneconomic lines and services, neglect-ing the provision of adequate services to the goods most profitable to therailways. This, coupled with competition of road transport and poor overallmanagement of the railways, particularly during the last administration, hasbrought the railways to a general state of inefficiency and disrepair. As' aresult, the railways constituted a substantial drain on the Government'sfiscal resources in 1975 and 1976. Government subsidies to the Railwaysreached UJS$410 million and US$420 million, respectively.

84. Several positive measures to remedy the very acute problems facingthe railways have already been adopted by the present Government. There hasbeen a substantial increase in real tariffs, reduction of the very costlyinter-urban and suburban passenger services has been initiated (36% reduction),a decrease in staffing has been achieved (17%) and an agreement to purchasebadly needed spare parts from foreign countries has been signed. As a result,the operating ratio will improve from 2.4 in 1976 to 1.8 in 1977.

85, The ultimate objective of the Government is to tackle the morefundamental structural problems of the railways by redefining its ro.e in thetransport sector, rationalizing the railway plant and equipping and increasingthe efficiency of the system by expanding reliable and modern services. Tothat effect, the Secretary of Public Works and Transport, and the ArgentineRail,ways are preparing a five-year investment plan.

Ports and Watarw!ys

86. In the water transport subsector, the main difficulties stem from:(a) the shallowness of the marine platform and the heavy siltation of theParana, Uruguay and La Plata Rivers; (b) inadequate dredging equipment; (c)weak management of dredging operations; (d) cumbersome and inefficient pdrt

- 39 -

management resulting from too many organizations having control of oftenoverlapping areas of responsibility, without proper coordination and a clearline of command; and (e) lack of a port and river navigation national plan,which would clearly define the future expansion and improvement of the watertransport subsector in Argentina, including the need, timing, size and loca-tion of a possible new deep-water port.

87. Clearly, ports and waterways play a ma;-or role in the future develop-ment of Argentina. The Government is well aware of the problems facing thissubsector and has requested external assistance to purchase badly-neededdredging equipment and to provide technical assistance.

Air Transport

88. Argentina's extensive area and the considerable distances separatinga number of its population and commercial centers have made civil air trans-port an important element in Argentina's transport network. Airport infra-structure is highly developed with modern runways and terminals in all majorurban centers. The air transport industry has enjoyed relatively steadygrowth for a number of years. The Government-owned Aerolineas Argentinasprovides internal and international services. The privately-owned Australand Aero Chaco provide national and local regional services respectively.All three airlines seem to be well operated and financially viable. LADE, thedevelopment airline owned and operated by the Air Force, provides subsidizedservices to the southern part of the country.

Pipelines

89. There are large networks of pipelines to transport crude oil,refined products and gas. The pipeline network for petroleum products meetsthe existing needs but there will be a need for expanding these in the futureas new sources of petroleum are brought on stream. The gas pipelines arebeing extended, mainly to interconnect t'e existing independent EvstemS andto increase the distribution capacity in the Buenos Aires area.

Planning and_Coordination

90. Coordination and planning have traditionally been the weakestelements of Argentina's transport sector. The present Government is makinga concerted effort to improve this situation and it has strengthened theSectoral Transport Planning Office (STPO) in the Secretariat of Public Worksand Transport, by upgrading and expanding its staff. Elaboration of a NationalTransport Plan has recently been initiated and this plan will focus, amongother things, on the need to assure adequate coordination and planning in thetransport sector.

Financin ~Public Sector Investment

91. Maintenance oi a high rate of economic growth during the yearsahead will require substantial investment in rebuilding the productive capac-ity of the agricultural and industrial sectors and in providing the necessary

- 40 -

infrastructure so as to ensure that bottlenecks do not limit growth as hasoccurred in the past. Much of this investment is expected to be undertakenby the private sector but the public sector will of necessity have to play animportant role in this process. Because of the urgency of some of theseinvestments the new Government has increased investment spending of the publicsector from 9.3% of GDP in 1975 to an average 11.3% in 1976-77.

92. The authorities have recently made public the broad objectives oftheir medium-term development plan which is to be drawn up during the next'12 months. While sectoral investment priorities have not yet been quantified,it is expected that there will be a shift in emphasis toward agriculture,industry, power, and transpoYtation infrastructure associated with export."The relative increase in the share of these sectors in total public sectoi.investment reflects the development strategy of the new Government, thecentral objective of which is to develop the productive sectors of theeconomy iP order to expand exports and increase employment opportunities..With the assistance which the mission received from the Argentine Governmentand based on the recently-released development plan guidelines, indicativeprojections of the financing of public sector investment have been prepared.The major sources of finance for this investment include savings of the publicsector, domestic borrowing and external capital inflows. The followingassumptions, based on the guidelines for the medium-term development plan,have been made in preparing these projections. Public investment has beenprojected to maintain a constant share in GDP (11.5%) throughout the period1977-82. Given the relative increase of total gross fixed investment in GDPwhich is expected in the years ahead, this implies an expanding role for'rivate investment in Argentina's development process. Financing of publicinvestment from net internal borrowing is projected at a moderate and declin-ing level (from 4% of GDP in 1977 to 0.4% in 1982) so as to permit a largershare c- an expanded level of financial savings for the private sector andsimultaneously reduce the inflationary pressures of the past few years.

930 The Central Government, including the social security system, isexpected to maintain its share of public sector savings, at about 42%. Thetax elasticities implicit in this projection (1.02) are somewhat higher thanachieved in the past, but given the Government's intention to strengthen taxadministrations they appear to be realistic. Current expenditures on wagesand salaries and purchases of goods and services by the Central Governmentare assumed to increase at a slightly lower rate than nominal GDP. Contri-

butions of the social security system are projected to grow at the same rateas the wages bill. Transfers to the departments and municipalities woulddecline steadily in line with the expected improvement in their fiscalperformance.

94. The state enterprises are expected to become increasingly self-!sufficient in generating savings to finance their investment. Assuming con-tinued progress in curbing current expenditures by (a) reducing excessive,employment and increasing efficiency generally; and (b) in increasing currentrevenue, it would appear feasible over the next two to three years to restoretheir finances to the relatively favorable level achieved in the late 1960s.

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To eliminate their overall deficit after transfers, as was-achieved in 1968,while maintaining their relative share of iii'restment spending in GDP andgradually reducing transfers to below the 1977 level, savings of the stateenterprises would have to increase from 1.8% of GDP in 1977 to 4.2% in 1982,equivalent to about half of total public sector savings. To achieve this,tariffs and prices for the goods and services produced by the state enter-prises would need to be adjusted periodically so as to exceed the rate ofinflation and permit them to attain adequate rates of return. Domestic pricesfor diesel fuel, fuel cil and kerosene which have already been adjusted upwardwill have to be increased further in order to maintain petroleum productprices at international. levels and to continue to strengthen YPF's financialposition. Assuming that public sector finances evolve in the manner projected,total public sector savings iwould increase from $a 1,235 billion in 1977 (6.3%of GDP) to $a 7,420 billion in 1982 (10.5% of GDP). These savings wouldfinance an increasing proportion of projected resource requirements, risingfrom 51% in 1977 to 85% in 1982.

Table XIII: PUBLIC SECTOR IN!ESTMENT PROGRAM AND FINANCING, 1977-82

(Billion pesos)

1977 1978 1979 1980 i981 1982

Resource Requirements 2,410.8 3,795.5 4,994.7 6,348.2 7,539.0 8,729.9

A. Gross Public Investment 2,254.0 3.360.8 4,45.6 5.696.3 6,943.7 8,111.61. Central Government 766.4 1,142.8 1,518.5 1,937.0 2,361.1 2,758.22. State Enterprises 904.2 1,348.2 1,791.4 2,285.0 2,785.4 3.253.93. Provincial Gov't & Municipalities 583.4 869.8 1,155.7 1,474.3 1,797.2 2,099.5

B. Amortization (External) 156.8 434.7 529.1 651.9 595.3 618.3

Financing 2.410,8 3.795.5 4,994.7 6,348.2 7,539.0 8,729.9

A. Public Sector Savings 1.234.8 2.151.3 3.133.9 4.405.7 5.789.9 7.420.41. Central Government 514.4 896.2 1,305.5 1,835.4 2,412.0 2.968,22. State Enterprises 351.7 716.9 1,170.3 1,821.4 2,625.3 3,710.23. Provincial Gov't & Municipalities 368.7 538.2 658.1 748.9 752.6 742.0

B. Capital Account Revenues 19.2 61.7 81.2 103.2 122.6 141.9C. Disbursements 1.136.8 1.582.5 1.779.6 1,839.3 1.626.5 1.167.6

1. External 352.8 464.5 620.6 741.5 706.3 873.12. Internal (net) 784.0 1,118.0 1,159.0 1,092.8 920.2 294.5

Source: Mission Estimates.

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CHAPTER IV

BALANCE OF PAYMENTS PROSPECTS AND EXTERNAL CAPITAL REQUIREMENTS

95. During most of the post-war period, Argentine economic growth has

been hampered by recurring balance of payments difficulties brought on by lowgrowth.of production for export, especially in the agricultural sector, high

marginal import requirements, destabilizing short-term capital flows, and the

excessively short-terra structure of the country's external debt. The dramatic

improvement in Argentina's external sector during 1976 was the result both of

exchange rate, pricing, and tax policies aimed at accelerating the growth of

production for export and of an interest rate policy designed to provide an

incentive to investment in domestic financial assets. Given the expected

continuation of these policies and the likelihood of a favorable international

economic environment, Argentina's balance of payments performance should be

sufficiently strong over the years ahead to support higher rates of economic

growth than the 4.0% average in the post-war period. Real GDE' is expected to

increase by 4.5% and '5.5% in 1977 and 1978, respectively, and assumed to

average about 6% annually thereafter. This rate of growth of GDP would be

sufficient to absorb the expected increase in the labor force and permit

restructuring of employment away from the public sector which in recent years

has been overexpanded to the private sector. With this higher rate of growth

of GDP, consumption would increase at 6.3% annually, resulting in a 4.9%

increase in per capita consumption, on the assumption that population would

continue to expand at the current 1.3% annually.

96. In order to sustain a 6% growth rate, gross.investment would have

to increase as a share of GDP from 20% in 1976 to an estimated 23% in 1982.

Continued strengthening of Argentina's external position requires that this

increase in investment be matched by a corresponding rise in domestic savings.

The Government has already achieved considerable success in iniitiating funda-

mental monetary and fiscal reforms which, when fully enacted, should provide

the framework for increased savings and a more efficient allocation of thosesavings into investment. In view of the likelihood that the Government will

be successful in mobilizing increased financial and national government

savings, and the expected improved savings performance of the decentralized

agencies resulting from the implementation of adequate pricing and tariffpolicies, Argentina should be able to increase its domestic savings as a share

of GDP from 22% in 1976 to an estimated 23% to 24% in 1982.

Exports

97. Continuation of adequate incentives for exports and initiation ofprograms to expand production for export are expected to increase exports by

almost 7% annually in real terms and to expand their share of GDP from an

average 8.8% in 1975-76 to over 10% in 1982. Argentine agriculture is in an

unusually good position to substantially increase its output during this

period and is expected to play a major role in the export drive. During

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1976-77 production of cereals responded well to improved price and exchange

rate incentives and in-depth field investigation indicates that over the next

several years substantial additional growth is feasible if the proper measuresare adopted. Corn and wheat exports are expected to increase by 5% annually

in real terms, well above their historical growth of 3% annually. Exports of

vegetable oils and pellets, principally soya and sunflower seeds, and ofsorghum, are projected to grow by 11.5% and 15%, respectively. Projections ofbeef exports, while somewhat less reliable because of the uncertain outlook

for world beef markets, indicate a 4% real growth of such exports over thelong term. Total agricultural exports including nontraditional exports are

expected to sustain a growth rate of about 6% annually through 1982. If

restrictions on imports of beef by the EEC are lifted, and if efforts toimprove application of new technology to beef production are successful,agricultural exports could grow even more rapidly.

98. Even with considerable acceleration of agricultural production,however, manufactured products will have to play an increasingly important

role to further expand total exports. Past growth rates of industrial exportshave been very rapid, averaging over 20% per annum in real terms up to 1974.These figures do, however, reflect the boom of the industrialized countries'

imports in the 1960s and early 1970s and the low base of Argentina's indus-trial exports in 1960-65. While a substantial decline of manufactured exportsoccurred in 1975, there was significant recovery in 1976. Growth in the past

has been concentrated in a few branches of industry such as machinery, trans-

port vehicles and equipment, and chemicals. These products should continueto enjoy a competitive advantage in preferential markets such as LAFTA, albhough

industrialization in other Latin American countries will make competition in-

creasingly difficult. Argentina has recently been successful in exportingseveral "turn key" projects (principally oil processing plants and a tractor

plant) to its less-developed neighboring countries. Continuation of theseefforts should make it possible for manufactured exports to resume strong

growth in the years ahead and average 15% annually in real terms over the long

term.

Imports

99. In order to sustain a 6% rate of growth of the economy during the

1978-82 periou, imports of intermediate and capital goods will have to expand

well above the historical trend. In addition, the Government is expected tocontinue to ease import restrictions so as to control inflation which-will

further accelerate the growth of import demand. If the gradual eliminationof excess protection of a number of consumer goods industries is carried out,overall annual growth rates could reach about 10% in real terms in the

immediate years ahead. As a consequence, the implicit import elasticity forthe 1977-84 period is 1.5. Increasing import prices should lead to outlaysreaching US$7 billion by the end of this decade and over US$10 billion by1982. The only group of imports which are expected to have relatively low

growth rates are hydrocarbon products including coal and natural gas.Argentina is currently expanding its domestic production of these productsand the projections included in this report assume that adoption of the

measures discussed in Chapter III will be successful in limiting imports of

4 5

these products. During the 1977-84 period import payments :for petroleum are

expected to increase from US$560 million i.n 1976 to US$721 mlilion in 1982.Because of the importance of petroleum in total imports, the projections are

quite sensitive to different assumptions regarding alternative levels of

future Argentine petroleum production. If current efforts to expand produc-tion are not as successful as anticipated, petroleum imports could constitute

a major burden on Argentina's balance oL payments by the early 1980s.

100. Imports in current prices are expected to increase at an averageannual rate of 19% through 1982, only slightly more rapidly Lhan the rate of

growth of exports. Despite the rapid growth of imports, the expected strong

performance of exports should make it feasible for Argentina to sustain, favor-

able trade balances throughout this period. The net outflow of payments for

factor services is expected to increase from US$487 million iL 1977 to about

US$523 million in 1982. Thus, about three-fourths of the trade surplus

generated during 1978-82 will be needed to pay interest and other factorservices. As a consequence, current account surpluseu should average overUS$150 million for miost of the late seventies and early eighties0

External Capital Recuirements

101. Despite continued expected improvement in Argentina's balance of

payments, it will take several years and continuirg substantial medium-- and

long-term capital inflows to carry out the reconstruction program while

simultaneously rebuilding net international reserves and restructuring thecountry's external debt. The external capital requirements of the economyover the immediate years ahead reflect the need to supplement domestic savings

so as to enable the Goverinment to carry out the large public sector 1.nvestment

program and to extend the maturity structure of its external. debt: by substi-tuting short- and medium-term debt with longer-term maturities. Gross ex-ternalcapital inflows required during 1978-82 are pro.ected at US$;7,8 billion or an

average of US$1.6 b:illion annually, slightly higher than the average US$1 .5billion annually in 1975-76. Of this total e.hbout US$1.3 billion will beneeded annually to finance external debit amortization. Thuc; net capitalinflow is not expecs:ed to exceed US$300 million annual.}y. 1.ese inflows areexpected to be prov:Lded by direct foreign. investment, by loans from bilateraland multilateral. sources and by financial and suppliers' credit.

102. The projection of external capital requirements included in thisreport assumes sign:lficant increases in net direct foreign :Lnvestmeni:. Suchinvestment would take place mainly in mining and petroleum (on shore) andwould increase from US$6 million in 1977 to US$70 million in 1982. If current

negotiations with foreign oil companies regarding offshore esxploration aresuccessful, substantial additional direct foreign investmen;:, averaging up toUS$150 million a year, could be forthcoming0 Exploration c.nd development of

Argentina's extensive offshore oil potential will require m>assive outlays on

specially-designed machinery and equipment which embody advanced technology

of the type being applied in. the North Sea, much of which will have to be

- 46 -

imported. Direct foreign investment should be sufficient to cover the foreignexchange cost of importing such equipment. These investments are expected tohave long gestation periods and would result in significant crude productiononly in the mid&1980s. The net balance of payments impact from such foreigninvestment are expected to be negligible until the mid-1980s.

103. Of the US$7.8 billion which will be required during the 1978-82period, US$862 million is expected to be provided by disbursements on loanswhich ha-'re already been made to Argentina. The remaining US$7.0 billion,averaging US$1.4 billion annually, will have to be provided from disbursementson new commitments, Approximately 25X of this inflow could come from bilateraland multilateral sources with the rest being provided in the form of suppliers'and financial credits. This pattern of financing would, between now and theearly 1980s, permit substantial improvement in the structure of externaldebt and increase net international reserves from minus US$555 million at theend of 1976 to a reasonably comfortable level of between three and four months'equivalent of imports of goods and non-factor services. With internationalreserves replenished and the substantial restructuring of the external debtwhich is expected in the immediate years ahead, private external sources can,by the early !980s, be expected to supply increasing flows of capital toArgentina on terms which will permit only moderate and fully manageableincreases in the country's external indebtedness.

Debt Service and Creditworthiness

104, At the time the new Government came to power in March 1976, Argentinawas faced with external debt payments falling due before the end of 1976, esti-mated at US03.7 billion, equivalent to over two-fifths of Argentina's tot-aloutstanding external debt. Overall indebtedness included short-, medium- andlong-term obligations of the public sector in the amount of US$4.0 billion,o'swaps" of approximately US$1.3 billion, exchange rate guaranteed importsof roughly US$600 million and miscellaneous other private debt estimatedat US$1.9 billion. In mid-March 1976, disposable foreign exchange reservesamounted to only US$23 million, and the new administration had to arrangeshort-term loans with commercial banks. It obtained a standby credit fromthe IMF of aLout US$300 million of which the first credit tranche of aboutUS$180 million was used in 1976. The Government secured a four-year loan ofapproximately US$902 million from commercial banks in the US, Canada, Europeand Japan. These loans and credits, although needed to make payments on the'previously short-term bank borrowing and rollovers, strengthened Argentina's'foreign exchange position and improved confidence in the peso. Moreover,since the loans and credits from the banks are of a medium-term character,they contributed to an improvement in the external debt structure. As aconsequence of these transactions and of the favorable performance of thecurrent account of the balance of payments, Argentina was able to reduceoutstanding foreign exchange guarantees by US$1.5 billion and simultaneouslyincrease disposable foreign exchange reserves by about US$1.2 billion, moretharn double the increase of about US$590 million in total outstanding anddisbursed external debt,

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105. Argentina's medium- and long-terTm external public debt was US$4.3billion at the end of L976. Medium- and long-term private extetrnal debtamounted to roughly US$2.0 billion. External public and total debt serviceratios during 1976 were 19% and 32%, respectively. Despite the large grossborrowings envisaged over the next several years, and continuedl use of finan-cial and suppliers' credits, the public debt service ratio is expected tofirst rise to about 22% in 1978, as heavy debt r,?ayments fall due, and thendecline to 13% in 1982 because of the improvement in the term structure ofdebt and the expected increase in exports. The total debt service ratio woulddecline steadily to 18,' in 1982. Provided the authorities succesfully imple-ment their stabilization and development policies and manage the externalindebtedness along the lines indicated above, debt service should not proveunduly burdensome. Under these circumstances, Argentina should have littledifficulty servicing the aforementioned external borrowing required forreconstruction and sustained economic growth.

Table XIV: PROJECTED CAPITAL REQUIREMEINTS AND FINANCING, 1975-82(In million of US$)

1975-76 1977 1978 1979 1980 1981 1982

Total Exports 4,168.5 5,761.0 5,863.3 6,865.5 7,989.9 9,220.2 10,740.5Beef 299.4 503.0 582.1 766.4 966.6 1,053.6 1,177.9Other Goods 3,062.5 4,354.0 4,371.8 5,068.1 5,829.2 6,852.5 8,079.2Non-factor Services 806.6 904.0 909.4 1,031.0 1,164.1 1,314.1 1.483.4Total Imports 4,051.0 4,561.0 5,220.2 6,209.2 7,317.6 8,580.9 10,105.9o.w. Non-factor Services 553.0 603.0 691.2 813.3 952.7 1,111.6 1,299.5Resource Balance 117.5 1,200.0 643.1 656.4 672.3 639.3 634.6

Interest on Public Debt -272.5 *-289.3 -328.0 -342.4 -366.1 -393.2 -433.7Other Factor Service Incomes (net) -193.0 -197.7 -125.6 -118.4 -125.9 -115.2 -89.7Current transfers (net) 11.5 7.0 -4.0 -5.0 -5.0 -7.0 -6.0Current Account Balance -336.5 720.0 185.5 190.6 175.4 123.9 105.2Amortization -970.0 -1,133.0 -1,218.6 -1,287.2 1,428.9 -1,246.5 -1,231.8Reserve Accumulation (- = increase) -150.5 -827.0 -445.9 -337.6 -200.4 -460.3 -596.5Capital Requirements -1,457.0 -1,240.0 -1,479.0 -1,434.2 -1,454.0 -1,582.8 -1,723.1 G

Financing (gross) 1,457.0 1,240.0 1,479.0 1,434.2 1,454.0 1,582.8 1,723.1Foreign Investment & Grants - 6.0 39.7 42.2 41.2 60.8 70.0Loans 1,514.5 1,437.0 1,449.3 1,485.0 1,585.8 1,666.0 1,653.2Multilateral and Bilateral 1,178.0 297.6 312.6 382.3 464.1 538.5 555.6Private 336.5 1,139.4 1,136.7 1,102.7 1,121.7 1,477.5 1.097.6Net IMF 225.5 - -10.0 -93.0 -173.0 -144.0 -Short-Term Capital -283.0 -203.0 - - - - -

Public Debt Service Ratio 19.5 17.8 22.1 19.4 18.2 14.2 12.6Total Debt Service Ratio 35.2 29.8 31.2 28.0 26.4 21.2 18.4

Source: BCRA & IBRD

Table XV: COMMITMENTS AND DISBURSEMENTS OF MEDIUM AND LONG -TERM CREDITS, 1975-82

1975/76 1977 1978 1979 1980 1981 1982

Commitments 1,402 1.612 1,712 1,672 1.502

Multi-and Bilateral 397 560 535 730 582 502 452Suppliers and Financial Credits 1,005 842 1,077 1,055 1,130 1,170 1,050

Disbursements ,D515.0 1,436.6 1,449.3 1,485.0 s,8 .o J. a VJ WI

Existing Loans 416.4 841.7 407.5 252.7 117.4 56.4 28.0

Multi-and Bilateral 143.8 267.6 187.8 129.9 80.7 56.4 28.0Suppliers and Financial Credits 272.6 574.1 219.7 122.8 36.7 -

New Loans 1,098.1 571.9 1,041.8 1,232.3 1,468.4 1,609.6 1,625.2

Multi-and Bilateral 17,9 29.9 124.8 252.3 383.4 482.1 527.7Suppliers and Financial Credits 1,080.2 542.0 917.0 980.0 1,085.0 1,127.5 1,097.5

Source: Mission Estimates