Docmt of

The World Bank

FOR OMCiAL USE ONLY

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REPORT AND RECONEDATION

OF THE

PRESIDENT OF THE

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

TO THE

EXESCUTIVE DIRECTORS

Ol1R A

PtROPOSED SECOND PUBLIC ENTERPRISE REFORM

ADJUSTMENT LOAN (PERWL II)

IN AN AMOUNT EQUIVALENT TO US$300 MILLION

TO

THE ARGENTINE REPUBLIC

DECEMBER 10, 1992

Trade, Finance and Private Sector Development DivisionCountry Department IVLatin America and the Caribbean Regional Office

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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Currencv Arfentine Unit - Peso (ARS)

Since April 1, 1991, the exchange rate has been, by law, ARS1.OO = US$1.00

Fiscal Year

January 1- December 31

Princinal Abbreviations and Acronyms

AA Aerolineas Argentnas Argentine AirlinesAFNE Astilleros y Faibricas Navales del State Naval Shipyard

EstadoAGP Asociaciddn Genenl de Puertos General Ports AssociationAMC Area MateriQ C6rdoba C6rdoba (Mlitary) Goods

ComplexAyEE Agua y Energfa Electic Water and Electric

Power CompanyAHZ Altos Hornos Zapla Steel CompanyBANADE Banco Nacional de Desarrollo National Development BankBCRA Banco Central de la Repdblica Central Bank of

Argentina ArgentinaBONEX Bonos Externos External BondsCNT Comisi6n Nacional de Telecomunicaciones National Telecommunications

CommissionDDSR Debt and Debt Service ReductionDEP Direcci6n de Empresas Pibllcas Directorate of Public

EnterprisesDGFM Dlrecci6n General de Fabricacdones Directorate for Military

Militares FactoriesDGI DLweccl6n General de Impositiva Internal Revenue OfficeECA Fibrica Militar de Vainas y Conductores Military Plant of Electrical

Elctricos Cables and ConductorsEFF Extended Fund FacilityELMA Empresa de Lfneas Maritimas Maritime Lines EnterpriseENCOTel Empresa Naclonal de Correos y National Mail and Telegraph

TelEgrafos EntityENTel Empresa Naclonal de National Telephone

Telecomunicacdones EntityFA Ferrocarriles Argentinos Argentine RailwaysFM F.4brica Militar Mltary PlantFMAS FM de Acido Sulfrco Military Sulfuric Acid

PlantFIMRT FM Rio Termero Military Plant, Rio TerceroFMSF FM San Francisco Military Plant, San FranciscoFMSM FM San Marn Military Plant, San MartinFM"S FM Tolueno Sintdtico Militar Plant, Synthetic

Toluene

FOR OMCIL USE ONLY

GA1T General Agreement on Tariff and TradeGdE Gas del Estado State Gas CompanyHIDRONOR Hidroelctica North Patagoa

Norpastag6nca Hydroeectrc CompayHIPASAM HMe Patagnlco de Sierra Grande Steel Company of Siea

S.AM. Grande, PatagonaMD Mlnlsterio de Ddensa Mnistry of DefenseME Mnilsterio de Economfa Mi of EnomyMERCOSUR Mercado Comun del Cono Sur Southers Cone Commo

MarketMOSP Minsterlo de Obras y M stry of Public

Servicos Pdblicos Works and ServicesMV Monomeros Vilkces Vinyl MonomersOSN Obras Sanitarlas de Ia Nacl6n The National Water and

Sewerag ComPanWPBB Petroqufmlca Bala Blancs, SA. Bahia Blanca Petrochemical

CompanyPE Public EnterprisePERAL Public Enterprise Reform AdJusment LeanPEREL Pubik Enterprise Reform Execuion LoanPGM rofca General MosconD, S.A. General Mosconi

Petrchemial CompanyPRT Peroumica Rfo Tercero Ro Tercero Petrocemical

CompanyQRs Quantitatve RestrictonsSEGBA Servicdos Electricos del Greater Buenos Aires

G(ra Buenos Aie Power CompanySIGEP Sindicatura General de External Auditor of

Empresas Publcas Public EnterprisesSOMISA Socedad Mixt Siderug Argendna Aentie Steel CompanyTAE Tecnologia Aeroespacdal Aespace TechnologyTAMSE Tanque Argentino Mediano Argentine Tank CompanyVAT . Value Added TaxVERs Voluntar Export RestrictionsYCF Yacimientos Carboniferos Fiscales State Coal CompanyYPF State Petroleum Company

This document has a restricted distribution and may be used by recipients only in the performanceof their oflicial duties. Its contents may not otherwise be disclosed without World Bank authorization.

ARGENIA

PULNUC ENTERPRISE REFOBR ADJUSTMENT LOAN If

Table of Contents

Loan and Program Summay .......... ...................... i

L RECENT ECONOMIC DEVELOPMENTS AND PROSVECIS 1

A. Background .1B. aCroeconomic Consolidation. 2C Medium Term Prospecx and Fmancing Requirements 3D. Alternative Possible Developments .5B. Extemal Environment. 7

IL PUBLIC ENERPRSES IN ARGE1.. . 8

A The Public Enterprise (PE) Sector. 8B Reform Progress of PEs under the Ministry of Economy 9C ReDrm Pogress of Other PEs .11

L PE REFORM PROGRAM OF THE MINISIRY OF DEFENSE 12

A. Introduction ...................................... 12B Composition of PEs within the Defense Complex ..... .... 12C Fmancial Performnance ........... .................. 13D. Me Privatization Program ......... .................. 14

IV. THE PROPOSED LOAN ......... .................... 17

ARatonale for Bank hinvoement ................... ... 17.B. Ie Proposed Loan ................................ 17C. Ptoject Implemetaon............................. 17D. Loan Conditions .................................. 19F. Enironental Aspec ............................. 20F. Social Implicamons ................................. 20G. Benefts and Riks ................................. 21

V. CDOUNTRY ASSSTANCE STRATEGY AND OPERATIONS 22

A. Main Objective and IBRD Lending Progam ............ 22B Medium Term Assistance Objecties ...... ............. 22

C IFC and h GA Actvities ......... .................. 24D.Remmendations ................................. 25

This report is based on the fdings of an appral missio whi visited ArgentbMar/April 1992. The princpall mission members Inclded Messs MU1 Kapur (askMavagw), Richard Newrmer (LA4CO), Belir Onursal (IATEN), Roger Boner, AdolfGessner (Consultants), and Ms Mna Novaes (LA4TF). The mson was assted byMes Cais BerStao and Fernando Vinefli (LEG). Ih loan was approved by MesssPod Meo (Divsion Che LA4TF) and PinCheug Loh (Dirctor, LA4DR).

ANNEXES

Annex I. Argentina - Key Macroeconomic Indicators

Annex IL Argentina - Cash Realized and Debt Reduction from MajorPrivatizations

Annex III. Argenti - Ministgy of Economy - Status of Restructuring andPriatizatlo Pgrm

Annex IV. Argentina - Job Reducdon Plan for the Ministry of EconomyPrivatization Progrm - June 1991 _

Annex V. Argentina - Inventory of PEs Under Mhistry of Defense

Annex VI. Argentin - Financdal Performance of PEs Under Ministry of Defense

Annex VI. Argentli A- Technical Assistance for the Ministqy of DefenseReform Program

Aex VIII. Afgenthia. Job Reduction Plan for the Ministry of DefensePrivatization Program

Annex IX Agentia - Policy Matrix

Annex X Argentina - Letter of Development Policy (LDP)

Ae Xl. Argentina - The Status of IBRD Operftions

Annex XIL Argenthia - Statement of IFC Investments

Ann XIIL Agentia - SupplementarLoan Data Sheet

ARQfN

PUBLIC ENTERPRSE REFORM ADJUSTMENT LOAN II

Loan and ram Summarv

The Argentine Republic

Beneilclar": The Argentine Republic

Amount: US$300 million equivalent

Terms: Repyable in 17 years, including 4 years of grace, at the standardvariable rate.

Objectives: The proposed loan which is an integral part e 'the Bank:s support forthe Argentine Government's adjustment program wfll assist in:(i) privatizing/restructuring of public enterprises (PEs) in the Ministryof Defense; (ii) reducing public finance deficits; and (iii) improving theenvironment for competitive private sector activity and investment.

Benefts adEskk: The proposed loan would achieve the 'ollowing benefits for the

economT. (i) an improvement in public finances resulting fromgovernmental labor reductions and the elimination of subsides to PEs.The PE losses in the Defense Complex were almost US$500 million in1991, after subsidies of about US$200 million; and (ii) growth inindustrial activity stemming from increased and more efficient privatesector output and investment under a competitive businessenvironment. To ensure the private sector takes advantage of thisexpanded scope, and some fiscal savings go to meet key social sectorneeds, the authorities plan to retain Defense outlays at their presentlow share of national income.

There are three types of risks associated with the delivery of theprogm. First in the short term, there are macroeconomic risksstemming from continued domestic inflation and the fixed exchangerate. senior management changes have occasionallyundermined the program. Further changes could jeopardize thetimetable or even the programm. 1bir due to the continued perceptionof a high level of county risk and the poor operating status of somePEs, there might be limited interest by the international privateinmestors in some of these PEs.

EstlmatedDisbursement: Ile loan would be disbursed in two tranches of US$200 million and

US$100 million. The first tranche includes a set-aside amounting toUS$100 million in support of Argentina's DDSR operation. Non set-aside funds would be disbursed against eligible imports.

The first tranche would be available for disbursement following loaneffectiveness. The second tranche would be conditioned on continuedmaintenance of macroeconomic performance, open trade regime, andutilization of sales proceeds from the Defense area as previouslyagreed, as well as specific sectoral actions: (i) forward satisfactory anti-trust legislation to Congress for consideration; (ii) issuance of taxcredits to steel producers after accounts have been audited byDirecci6n General de Impositiva; (iii) commence work onenvironmental clean-up of closed PEs (METIOR and HIPASAM); (iv)sell or dispose of the assets of SOMISA; (v) sell PGM and PBB; and(vi) sell or close ten additional PEs in the Ministry of Defense.

Finad: Retroactive financing up to US$40 million (20% of the loan amountallocated to the adjustment program) is recommended for eligiblei'nports paid since June 1, 1992, about six months preceding expectedloan signing, in view of the Government's need for time to gather thenece=sary import documentation for this loan while assembling similardocu'mentation for other Bank and IDB SECALS

&bedule of -US$ million-Disbursements:

Bank FY93 FY94Annual 200 100Cumulative 200 300

Rate of Return: Not applicable.

Apuralsal RenoL N/A

REPORT AD RECOMMMNDATION OF THE I ESIDENTOF=THE INTENATIONA BANK F)R RECONSTRUCTION AND DEVELOPME

TO THE EXECUTIVE DIRECTORS ON A PROPOSSECOND PUBLIC ENTERPRISE REFORM ADJUSTMENT LOAN IN AN AMOUNT

EOUIVALEIT TO US300 MLON THE ARGEN REPUBLIC

1.01 I submit for your approval the following report and recommendation on a proposedsecond loan to the Argentine Republic for the equvalent of US$300 milion to support an expandedprogram of reform of public enterpnses; in particular those under the control of the Ministry ofDefe Included in the loan, them would be a debt set-aside amounting to US$100 million insupport of Argentina's DDSR operation. Te loan would be at the Bank's standard variable interestrate, with a maturity of 17 years, including 4 years of grace.

L RECENT ECONOMIC DEVELOPMNTS AND PROSPECTS

A. Baclground

1.02 Upon taking office during the July 1989 hypeinflation, the Menem Governmentrecognized that rversing Argentina's economic decline required structura reforms to address thesource of endemic inflation, disinvestment and productivity declines. These included reforms toeliminate chronic fiscal deficits, divest non-core fimctions of the public sector while improving thesupply of essential public goods, and teminate inefficient intervetions in markets.

1.03 ITe Govemnment launched major structural reforms in the federal govenment andmonetary authority, supported by the Bank's Public Sector Reform Loan (July 1991). These affectedrevenue mobilization, expenditures, and financing of the public sector The VAT was extended toviually all sectors in 1989-90. Tax rolls were reconstructed and tax administration was improvedsubstantially, producing higher revenues. Taxes on exports and (later) bank checks were eliminatedor reduced. Tax subsidies to industrial firms were brought under fiscal control and reduced. Newexpenditure controls were enacted, and discretionary transfers to the provinces and to publicenterpises were reduced. The Government cut the size and scope of the federal publicadministration-including a net retrenchment of positions of about 15 pecent and a transfer of about40 percent of positions to the provinces-while modernizing the civil service. A Law of PublicFinancial Management, passed by Congress in 1992, recast the basis for budgeting, internal controland auditing. The Government also eliminated the quasi-fiscal deficit of the Central Bank by a forcedconversion of short-term, high-interest deposits into long-term dollar bonds bearing LEBOR-basedrates in January 1990, this reduced confidence in the financial sector for a short period. The recentlypassed Central Bank charter reenforces the Convertiblity Law (see below), and paves the way foran independent, disciplined monetary authority.

1.04 The Government also launched a major privatization program, supported by theBankls Public Enterprise Reform Adjustment Loan (February 1991). The first two laws enacted bythe Menem government suspended costly subsidies and provided authority to privatize virtually allpublic enterprises. The measures in 1990-sae of 70 percent of telephone system, sale ofhydrocarbon concessions, and deregulation oi the hydrocarbon sector-lent much-needed earlycredibility to the development strategy. The prvatization program continues, affecting the railways,the state oil company, the power and water companies, ports, the merchant fleet, and enterprisesunder the Ministry of Defense.

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1.05 Tte Menem Government also implemented a trade liberalization program that wasstarted by the Altonsin Government in 1987, with the support of two Trade Po-icy Loans (1987 and1988). Export taxes were eliminated and indirect tax reimbursements for exports established;quantitative import restrictions were removed except for automobiles; specific import duties wereabolished, and the anti-dumping regime brought n line with the respective GA1T Code; themaximum a valorem tariff rate was reduced to 20 percent. Beginning in 1991, the Govemment alsoderegulated the supply and marketing of numerous goods and services, including professional,transport and port services, thus reducing significantly the costs of doing business in Argentina.Legislation increasing labor flexibility and improving collective bargaining has been enacted, andfurther legislation is pending.

B. Macroeconomic Consolidation

1.06 By 1990, although inflation was still high and variable, the Gvernment had turnedan overall public sector primary deficit-6 percent of GDP in 1988--into a slight surplus. Internationalreserves rose significantly throughout 1990. Though a rise in inflation and a sharp devaluationoccurred at year-end, the pubi.s sector was much better positioned for the next stabilization programthan at any time during the 1980s.

1.07 The new stabilization program, begun in February 1991, included tax measures to raisethe fiscal surplus to a levesl obviating the need for inflationary financing, and further tradeiiberaLization to increase price discipline. In March 1991, the Government passed a ConvertibilityLaw that legally fixed the exchange rate at one peso to the US dollar, formally deindexed contracts,facilitated the use of US dollars in transactions, and, most importantly, required the Central Bank'smcnetary liabilities (the money base) to be matched by its international reserves. Money growththerefore became effectively constrained to inflows in foreign capital, ending Central Bank financingof deficits.

1.08 The policy package led to large capital inflows and a substantial fall in interest rates.The expectations of exchange rate stability and the openness of the economy produced a sharpdeceleration in inflation, remonetization and, together with the fall in interest rates, an expansion ofconsumer credit. Confidence was further bolstered in July 1991 with an IMF Standby and the Bank'sPublic Sector Reform Loan; and later in the year with major advances in deregulation. Nominaldeposit rates fell to 10 percent per annum, the lowest level in 30 years. Stock market prices andsecondary market prices for Argentine external debt increased sharply, reflecting increased confidenceand declining intemational interest rates. The higher private capital inflows in 1991 financed a US$4billion rise in imports (and corresponding reduction of the trade surplus) and an increase of US$2.7billion in Uquid reserves. Led by consumption, the economy grew by 8.5 percent in 1991.

1.09 To provide a medium-term macroeconomic framework, the Government reached anagreement with the International Monetary Fund (IMF) on a three-year program under the ExtendedFund Facility (EFF) in early 1992. The EFF program was designed around a primary surplus beforeprivatization (i.e., operational primary surplus) of about 2 percent of GDP. Together with the debtand debt service reduction (DDSR) and with privatization proceeds, this would be sufficient to meetdebt service obligations without recourse to the inflation tax Fiscal performance to date hasexceeded EFF targets; tax revenues surpassed 25 percent of GDP in the third quarter of 1992,compared to 15 percent in :988. The quarterly targets for the operational primary surplus were met,and privatizations pushed the primary surplus over 3.5 percent of GDP. About US$2 billion was

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realized from the sale of the Government's remaining 30 p<,rcent minority share in the telephonecompanies.

LIO To regularize its financing, the Government began negotiations with its commercialbank creditors about a debt agreement in January 1992.' 1e Government also began regularizingarrears with pensioners, suppliers, and the health system, as well as compensating taxpayers forchanges in the loss carry-forward provisions of the income tax through a new domestic bond(BOCON). These measures have raised its domestic debt from about US$2.3 billion at end-1991 toabout US$18 billion at end-1992. Funds from the privatization of the state oil company are intendedto be used for repurchasing a major part of these bonds. Furthermore, an agreement with theprovinces has provided the Government with resources for increasing pension payments to legalymandated levels, ending the accumulation of arrears with pensioners. The Government has alsopresented to Congress a social security reform law, which would introduce mandatory private pensionfunds.

1.11 These policies were expected to generate about 6.5 percent real growth in 19MInflation, measured by the combined consumer and wholeprice index witl be about 12 percent for theyear, down from 2000 percent in 1990. Additional capital inflows have financed an increase inreserves and a further US$6 billion rise in imports. Exports, however, grew at a slow pace. and thetrade balance, US$4.0 bitlion in 1991, may be negative in 1992 by more than US$1 billion.

1.12 The November 1992 Package. The large capital inflows--a product of lowinternational interest rates and new confidence in Argentine policy-produced a real appreciation ofthe peso of about 20 percent (based on the combined price index since the beginning of thestabilization). Concerns about the trade balance prompted the Government in late October 1992 toincrease indirect tax reimbursements for exports from an average of 8 percent to 13 percent and raisimport tariffs-including ad valorem tariffs and a fiat statistics tax-from an average of 17 percent to23 percent, while also reducing tariff dispersion. Reductions in fuel taxes further improved thecompetitiveness of domestic producers. These measures produce an effective real devaluation ofabout 5 percent.

C. Medlum-Term Prnspects and Financing Requirements

1.13 Following the economic recovery in 1991-92, the Government projects growth todecline gradually to a long-term rate of about 4 percent annually, based on continued productivitygrowth and new investment attracted by low inflation, an improved incentive structure, and reducedcountry risk due to the implementation of the debt agreement. This outlook, however, depends oncontinued fiscal improvement, and a smooth transition to a sustainable balance of payments aspresented in the EFF program.2

For a mor detailed discussion, see the President's Report on a prposed Debt and Debt Service Reduction Loan (ReportNo. P-5914-AR) dated December 10, 1992.

2 The program is predicated upon consummating the Debt Agreement and these projections take into account theAgrement.

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1.14 Fiscal and Monezary Pclicv. The Government projects its operational puimary surplusto increase from US$2.4 billion in 1992 to about US$4.4 billion in 1993, about 2.6 percent of GDP(Table 1.1). This level would be sufficient to service interest payments, and to eliminate the needfor inflationary financing, given foresesable foreign and domestic borrowing. Identified finance tothe public sector would virtua}ly close the financing gap in 1993-2000, leaving only about 0.4 percentof GDP in unidentified new borrowings, mainly in the outer years. Net domestic financing isexpected to be positive through 1996, and then turn sharply negative. This is because theconsolidation bonds (BOCONs) have a grace period on both principal and interest payments whichexpires in 1997. Projected foreign financing, discussed below, is also expected to turn negative in themiddle of the decade. Howe-er, price stability and an improved payment record would allow theGovernment to tap other private markets abroad and at home to finance any remaining gap in theout-years. Argentina has already returned to voluntary borrowing througn bond issues ininternational capital markets. Moreover, the Government also can expect to mobilize considerableresources through the pension funds that would be generated by the social security reform.

1.15 The Government anticipates no change in its monetary and exchange rate policy,which will continue to be disciplined by the Convertibility Law and the new Central Bank charter.A tight fiscal stance, continuing import competition, and new entrants in heretofore oligopolisticmarkets would drive domestic inflation to international rates.

Table 1.1: Argentina - Key Macroeconomic Indicators(US$ million)

AvOW Aea_1990 1991 1992 1993 199S 1996.2

Pdowy S-rha 2.012 2.857 4389 5.4 5.AWInmtpaym_ 5,459 4.8 2.731 3.860 4.468

Deutic 7A9 322 160 717 1,222pFovlg 1/ 5230 4.264 2.572 1.143 S.26

FhfcuMmfot a rmmc'ag 0 0 .0 1.236 0B9.m. (- -dew4 0..44) (.720) 90 (1.4S) S37Dcmuldc Fiuag 4.483 (897) (573) 430 O992Forip FIuaig 2/ (1.3 2.626 483 979 455

TAi Bd_m 8.151 4.007 (1.139) s9 2.5CunvamtAco"Balmom 1.754 (2.748) (6.771) (5.531) (5.704)CptWA Mco 161 4.330 1.0W8 7.327 5.739

Puble SecW (1.036) 2A 483 97 455JsRD S 169 1S3 248 675 73me 3/ 225 242 527 460 345Bomb (226 395 (233) (54 (23IMP 3 (185 (661) s38 348 (764)CoomeBomb (1.2X9) 0 (127) (175) (69*usimu. 3UpIS ad OibuSt 41 270 2.512 27 219 1,731

Ptivt Sco 1.197 1.704 9.725 6.349 5,234

GDPkvmveseAu mwFh 0.4 S.5 6.5 .7 4.2GDP (US$ bMi 10S.5 USA 153.2 182.6 248.6Toew hntUf(% GP 8.4 12.5 14.0 16.0 18.0Nadosu Savap (S GDP) 10.0 10.4 9.6 13.0 15.7Pw,au SavInu4(% GDP) (1.6) 2.1 4.4 3.0 2.S

1/ include qusslhod bml Inlin of C.tre .an21 Inchud M ficag.3t lwA* add mMJfemilg g il 1993 for _ pwy nfp=.rd9su.4t nlue *_ ie.tfhdthwig o0.4% ofGD?Petyerfre 1991-2000.

1.16 Balance of Eayments. The Government's program relies on private capital inflows andincreasing private dlomestic savings to finance investment. Tight fiscal policy and passive butpredictable monetary policy would continue to make the investment in Argentine financial and realassets attractive. Domestic interest rates would remain above international rates in real terms, whiledomestic investment, wsth a rich unrealized potential, would otfer high returns for years. Theauthorities view the estimated US$50.60 billion in private savings of Argentine residents held abroadas a reliable source of future capital inflow, though perhaps slowing in 1993.

1.17 The commercial policy measures in November 1992-which increased the price ofimports and exports in pesosare intended to help switch resources from nontradeables back totradeables as demand for imports declines and demand for competing domestic goods and exportdemand increase. This switch would be strengthened by continued productivity growth in thetradeable sector due to the deregulation measures. Nominal wages in the nontradeable sector wouldfail relative to the tradeable sector. Capital inflows would slow gradually. As the demand forconsumer credit weakens, credit would be channelled into investment in productive activities thatsatisf the new demand in net exports and internationally competitve domestc activities. Thissmooth process would not require a realignment of the nominal exchange rate. Growth could bemaintained, though at a lower level than during the 1991.92 recovery, and tax buoyancy would allowthe Govemment to attain revenues objectives. The resultng trade balance-and real exchange rate-would be a reflection of capital inflows to finance imports and the demand for Argentine assets.Reduced capital inflows in 1993 and beyond would imply lower import demand, and explain someportion of the reductions in the growth rate. The Government anticipates that the trade balance willimprove progressively beginning in 1993.

1.18 External Einancing to the Balance of Payments. The capital account in the balanceof payments reflects the projectod changes in the net foreign asset position of the public and privatesectors. Ihe public sector's net external borrowing requirement is to be financei' from net increasesin ewosure from the international financial institutions, while bondholders and Paris Club membersreduce their exposure through partial rollovers. Much as with Mexco after its turning point in thelate 1980s, the World Bank would increase its exposure in Argentia, but not substantially after themddle 1990s, nor would the rDB. The IMFs exposure would decline after the expiration of theextended afrangement. Private bondholders, including holders of BONEX, will be net recipients offunds, though the Government expects to refinance roughy three-quarters of bonds coming due.Commercial banks wfll be net recipients t3r funds on the debt that replaces existing arrears under theDDSR agreement.

1.19 Ihe private sector is projected to increase substantially its net investment in Argentina.Foreign direct investment is expectd to increase at about 8 percent annually, to average aboutUS$2.7 billion. Private short-term capital flows are projected to average about US$3.3 biUion-about1.5 percent of GDP-to satisfy the demand for additional imports and domestic assets; this wouldfinance the projected current account deficit over 1993-2000. Since the Government has identifiedvirtually all of its financing, the actual financing requirement for the balance of payments wil be afunction of the desired savings-inestment balance in the private sector.

D. Atlative Possible Developments

1.20 The above scenario is attainable if the Government continues to improve its fiscalposition, and if the private markets allow a smooth transition to a sustainable balance of payments

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and growth path. However, even with adequate ex ante fiscal adjustment, it should be recognized thatthe Government may be unable to realize its growth projections. Slower growth or even a reessioncould come about through two related mechanisms. On the one hand, an "overshooting" of capitalInflows may drive up import volumes and prces of non-tradeables and domestic assets tounsustainably high levels; then, as the correction ensued, private capital flows would taper off or evenreverse, pusing up domestic interest rates. (Rising international Interest rates, discussed below,could also slow capital inflows shaply.) The higher domestic interest rates would dampen or evenextinguish growth. At the same time, domestic prices may be slow to converge to competitiveintenational levels, also contributing to the recession. Price setters, long used to mark-up pricingin oligopolisc environmes, might take several months of slow sales before starting to cut prices tothe degree necessary to adjust the overall price level. Nonetheless, slower growth eventually wouldproduce the price convergence necessary to sustain the exchange rate regime and rekindle export-ledgrowth.

1.21 Rliks. A recession would create added fiscal pressure, with consequences that aredifficult to predict with cerainty. As revenues feil and the domestic interest bill roce, the speed ofthe central government adjustment in reducing expenditures would determine the size of any increasein the Government's net borrowing requirement. Any increase in the borrowing requirement wouldmake it more difficult for the Government to achieve the projected partial rollover of its domesticdebt with bondholders. A short recession would probably pose nDO major threat to the Government'smacroeconomic program, though modifications may be required; it would be unlikely to derail theprogram of strucual reforms.

1.22 It also has to be recognized that a worsening macroeconomic panorama-or politicalevents-could trigger a speculadve attack on the p . Ithe ease of capital mobility between

reences and across borders, superimposed on a small monetary base, means that the economy isunsually vulnerable to sudden changes in private expectations and portfolio shifts. A sudden cycleof den on, very high interest rates and deep recession could produce cracks in the financialsystem. The Government might then be forced to choose between: (D providing emergency liquidityto prevent the collapse of the financial system, thereby putting pressue on the exchange rate andviolating the convertbility law, and (ii) letting financi institutions collapse with some depositorssufferig losses, while shap increases in interest rates drive the economy into recession. In thesecicmstcs, ithe economic team would be under great pressure to change the policy framework. 3

1.23 The probability of these adverse events occurring declines as the Governmentprogresses on reforms that improve the fundamentals of public finance, and as the implementationof the debt agreement strengtens confidence. Also, reserves are the highest in a decade and cover

A mai-devaluoa would have negatv impacs on ath scad acounts. The public sectr would suffer the weakoss fiom h fact that the pren value of its futue sam reeues is valued in pes while more than 85 percentof its db is denomibad in forign uri; tis will be manifiet with a higher share of revenues ng devotedto nterst paymens. (If the Govment held a law sok of international rerves-s it does at pmsent-bhe wealt-lss deots would be subsantially mitigated.) Also, inflation, despito ipovements in reducing paymeat ags and taxadminiron, would tend to reduce real revenues thugh the Tanzi effict and tax losses associated with theopaquaes of ridly shilig prices. Moreover, provincial pveme and the pubic fiacial setor generalywould be docimatd and demand finning. The ficl squeeze would be reduced to the extent that such financingcoiud be limited and govanmet expeditur cut in dolar terms. Also, seirag rvenues would provide soneof st to the fisca squeeze.

the monetary base (although not the deposit base). The high level of reserves tends to deter aspeculative attack on the peso. Regardless of any near-term turbulence, the emerging policy regimewould of necessity focus on maintaining fiscal balance and policies conducive to private investment.Perhaps most important, recent history augurs well for the future economic management: the countryhas enacted serious and difficult structural reforms; these have immense public support; the politicalgroups supporting the 1940-83 policies have seen their power dwindle; and the lack of alternativesto fiscal discipline and price stability is widely accepted. These facts are powerful ballast that is likelyto keep the ship of structural adjustment headed in the same direction, even in a financial storm.

E. External Environment: Assumptions and Risks

1.24 Three aspects of Argentina's external environment affect the probability of realizingthe Government's scenario: the growth of the world's markets, commodity terms of trade, and thecost of international capital. During the next 12 months, world growth is expected to recover at amoderate pace. Following the stagnation of 1991, world output is projected to rise by 1 percent in1992, and by 3 percent in 1993. ' Consequently, the volume of world trade slowed in 1991, but theprospects for 1992-93 are better and with them the demand for Argentina's exports, which theGovernment expects to grow at about 7 percent annually for the rest of the decade. Importantimpeduments to a stronger performance remain. Several industrial countries require balance sheetadjustments to unwind the effects of earlier speculative excesses in real estate and other assetmarkets. In addition, the persistence of large budgetary imbalances in a number of countriesadversely affects business and consumer confidence. Divergences in economic policies among leadingcountries is also contributing to discontinuities in selected financial and foreign exchange markets.Major efforts to reduce fiscal imbalances are urgently needed in many countries to strengthen globaleconomic prospects, which would in turn provide greater opportunities for Argentina's exports.

125 Argentinaes terms of trade, after a 3 percent deterioration in 1992-93, are projectedto improve gradually as a result of the global demand conditions, according to Bank commodity priceforecasts. Real agriclltural and raw material prices have been relatively stable over the last threeyears, hovering around 80 percent of their 1987 peak. The weakness in nonfuel commodity pricesis attributed to the recent decline in inflation worldwide, but grain demand is projected to risebecause of the increased demand for wheat in the CIS countries and low world grain stocks. BecauseArgentina is energy self-sufficient, expected changes in fuel prices will have relatively smallmacroeconomic effect.

1.26 Conditions in world credit markets will also affect Argentina's fiscal and balance ofpayments position. A one percentage point change in international interest rates would produce aUS$600 million annual increase or decrease in its public interest bill. Although the demand for credithas remained high because of persistent fiscal imbalances in the US, Germany, and other OECDcountries, the recession sharply reduced private credit demand; this, together with an easing ofmonetary policy, brought interest rates to new lows in 1992. The IIBOR in 1992 was 3.8 percent,half the 8.4 percent prevailing in 1990; the Bank projects a long term rate averaging 6.8 percent in1993-2000. Reductions in the public demand for credit may ease the upward pressures on long-termrates if the added fiscal efforts reduce existing budget deficits in she OECD countries. These external

4 Tlis sedon is basd upon the analysis provided in the IMP's World Economic Outloo0 October 1992.

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rslks are mnageable, and are offset by the stronger domestic policy in Argentina and the DDSRagreement which wilt fix the interest rate on nearly US$14 billion of Argentinaes extemal debt.

IL PUBLIC ENTERISES IN ARGENTINA

A. The Public Enterprise (PE) Sector.

2.01 Whle PEs in Argentina did not account for a disproportionate share of the economy(about 10 percent of GDP in the late 1980s) compared with other Latin American countries, theirinefficiencies and heavy losses had a profound economic Impact Furthennore, durng the past 40years, government policies regarding PEs have created uncertaint, as they varied-fromnationalization, creation and growth, to a reduction of the public sector.

2.02 As of October 1991, there were about 220 PEs in Argentina, with about 26 percentin the Federal Government (of which about 45 PEs were in the Defense Complex) and the remainderunder the ownership of provincial governments (65 percent) and municipal authorities (9 percent).The PEs of the Federal Government were concentated in three major sectors:

(a) HIIDcarbons and E:ner. Yacimientos Petroliferos Fiscales (after corporatizationnamed *YPF"); Gas del Estado (GdE); Yacimientos Carboniferos Fiscales (YCF); ServiciosElectricos del Gran Buenos Aires (SEGBA); Agua y Energia Electrica (AyEE); andHidroelectrica Norpatgonia (HIDRONOR). SEGBA has been sold in segments; anl otherPEs in this sector are at various stages of implementing privadzatlon strategies;

(b) Transport and CoFtlon Feriles Argentinos (FA); Empresa Nacional deCorreos y Telegrafos (ENCOTel); Empresa de Lineas Maritimas (ELMA); and AsociacionGeal de Puertos (AGP). Privatizons were completed with respect to Aerolineas

rgentinas (AA) and the national telephone company (ENTel); the others are at variousstages of pdvatzaton; and

(c) Ildustrl and Service Sectors: PEs in the steel, petochemical, shipyards, aviation, andother industrial entitles under the ownership of the Minstry of Defense; the prvtization ofthese PEs is the subject of the proposed loan.

2.03 The supeisy framework for PEs in Argentina has been constady evolving, but by1991, viruay all Federa PEs are under the direction of two Mnistries -the Mistry of Economycontrolling the most important block (roughly 90 perceat of revenues), and the Ministry of Defense(rougly 7 percent of revenues).

2.04 Much of the inefficiency of the PEs in Argentia stems from their diverse interests.Foremost among the Interested patties are private suppliers or purcss that have enjoyedmnmerous privileges; these have enabled them to extract the maximum "rentsfrom PEs. Labor unionshave extracted special privileges from PEs, and political parties have used PE appointmet asrewards for party affiliations and financing. During the 1980s, expditues, particularly investmentby PEs, mirrored the general economic decline. Public nvestnent as a percent of Gross DomesdcInvestment (GDI) has been dedlfning. In 1988, public investment represented 54 percent of GDI;

-

in 1991 it was less than 35 percent. Initial efforts by the Covernment to implement its public sectorreform program are now showing positive results: the PEs' borrowing requirement in 1991 was 1.5percent of GDP (about US$ 2 billion), while for 1992 it is projected at 1.1 percent of GDP.

2.05 Aware of previous failures of partial reform measures, the Govcrnment concluded thatsuccess in PE reform required wholesale changes in contractual relationships between PEs, customers,suppliers, labor unions, and the central government. Such radical change left no option but to tacklevested interest groups head-on and to press for results on an accelerated timetable. Ihe ArgentineGovernment (and President Menem personally) has made the sale and closure of PEs a centerpieceof its efforts to reform the structure of the economy, President Menem has demanded that all PEsbe privatized before the end of 1992. Indeed Argentina is engaged in one of the most ambitiousprivatization programs in the world. The objectives of the program are to: (a) reduce the size of thestate, public debt, and deficits; (b) increase production efficiency and improve the quality of services;and (c) promote private sector investment.

2.06 The 1989 Law for the Reform of the State (Law 23,696) empowered the Governmentto reorganize, privatize, or liquidate PEs principally under the control of the Ministry of Economy.Each of these activities has been executed by the responsible secretariat-in-charge of the assets; theCongress now supervises the process through a Bicameral Commission consisting of six members fromeach Chamber. In 1991, Congress extended the Reform Law to include PEs under the Ministry ofDefense (Law 24,045).

2.07 As of September 1992, the privatization program had collectively contributed to a debtreduction of US$7.7 billion, about 20 percent of total commercial bank debt outstanding. In addition,the cash realized amounted to US$4.5 billion (Annex II). The biggest contribution to the NationalTreasury has resulted from the privatization of the telephone and oil enterprises.

B. Reform Progress of PEs under the Mnistry of Ecanomy

2.08 Unlike most other countries, the Argentine Government started its restructuring andprivatization program with four of the largest PEs-ENTel, AA, YPF, and FA--which collectivelyaccount for two-thirds of total PE employment and revenues and half of the total public enterpriseoperating deficit. The sale of the first two PEs served as "demonstration cases' and proved theGovernment's commitment to reform. 0

2.09 Early privatizations experienced some difficulties with the investor community. In thecase of ENTel, the consortium of Bell Atlantic and Manufacturers Hanover failed to meet itspayment deadline and was forced to pull out. In the case of AA, the consortium led by Iberia initiallyfailed to meet both the deadline for its second down payment of US$130 million and the delivery ofUS$1.6 billion of debt paper for the 85 percent shareholding in the airline. While these problemswere subsequently resolved, Iberia (the only bidder) had strong leverage during the negotiations.

2.10 Based on its demonstration cases, the Menem Government has further deepened thereform program to eatend to other major infrastructure PEs (Power, Water Supply, Ports andShipping) for which it also requested Bank assistance. Beyond supporting PE privatizations underthe first PERAL, the Bank is assisting the Government with the privatization of SEGBA, ObrasSanitarias de la Nacion (OSN), as well as concessions of the toll roads. IDB is assisting the

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Government with a quick-disbursing, policy-based loan of US$314 million (including US$14 millionof technical assistance) for two PEs in the power sector-HIDRONOR and AyEE.

211 Annex Im shows the status of the Ministry of Economy's PE privatizations. Asummary of the efforts and results is as follows:

* In the hydrocarbon sector, Congress has approved two laws - uLy de Federalizacionde Hidrocarburos y Transformacion de YPF" and a law which provided for theestablishment of a regulatory framework for the gas sector. Sale of YPFs oil reservesto-date has yielded about US$1.5 billion. In the case of Gas del Estado, salesmemoranda have been issued for the North and South gas pipeline transmissionsystems and eight distribution centers. Sale of Gas del Estado is to be completed inthe first quarter of 1993.

* In the power and public services sectors, the privatization of SEGBA has beenconcluded; two generation plants have already been sold for about US$180 millionrepresenting 60 percent of the stock value, and 51 percent of the transmission anddistrbution companies-EDENOR and EDESUR-created by the spin-off of SEGBAhave been sold to consortia of private investors on August 31, 1992. The TechnicalCommission in charge of privatization of "Obras Sanitarias de la Nacidn" onSeptember 11, 1992, prequalified four private consortia interested in operating thewater system in Buenos Aires. The concessions are expected to be awarded by end-December 1992.

* In the transport sector, concessions have been awarded for the Rosario-Bahia Blanca,General Mitre, Urquiza, San Marti, and Roca railway cargo lines, and 25 percent ofthe interurban highway system has been turned over to private toll operations. In thecase of the metropolitan railroad system of Buenos Aires (including the Metro), theGovernment is in the process of evaluating bids from private investors. In addition,about 9,000 kilometers of railroads are being transferred to the provinces for theirdirect operation or concession to third parties. The sales memorandum for ELMA(the national shipping company) was issued and no offers were received. TheGovernment re-issued the sales memorandum in October 1992 for its second calL Ifthere are no interested bidders for the second call, the Government would liquidatethe PE.

o In the communications sector, the authorities have decided to partially divest the mailsystem, ENCOTel (51 percent of the shares will be retained by the State). Aconsulting firm has been selected to advise ENCOTel on preparing a restructuringplan for partial divestiture.

2.12 By June 1991, the total labor reductions associated with restructuring of the PEswithin the control of the Ministry of Economy were about 21,000. The Ministry estimates about77,300 more employees will become redundant when the process is completed. This represents a 35percent reduction from June 1991 PE employment levels, and will cause a labor indemnity cost ofabout US$750 million. Annex IV shows the labor reduction for each of the PEs within the Ministryof Economy.

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2.13 It is still too early to analyze increases in production efficiency, improvements in thequality of services, and the promotion of private sector investment activity stemming from the selectedprivatizations completed-ENTel, AA, FA and petroleum reserves. Three lessons have been learned,however; (i) establish a functioning regulatory agency (if required) and clarify "rules of the game"prior to sale; (ii) ensure competition from multiple bidders; and (iii) credit highly the importance ofan honest and committed senior management. Table 2.1 below shows the key lessons learned foreach of the major PEs:

Table 2.1: Summary of Lessons Learned from East Privatkations

ENTed YPF/Gas del Esado P FA AA

0 Mirnmize delay in the * Despite excllenet Restmucue entprise * Avey promotefunctioning of the managanent skdlls, process into viable business units to investor interests to generateregulatory agency. took longer than maximize investor interests. multiple bidders.

anticipated.l Sales contract needs to 0 Clarify 'rules of the * Walk away when dealbe included with offering 0 Success of process game' in bidding contraces not appropriately strutured.document. greatly dependent on senior (cargo concession lines).

management's commitment.. Proactively promotelinvestor interests to generatemultiple bidders.

* Process for laborredundancies time consumingand vulnerable to soia

2.14 The problems created by a lack of appropriate regulatory agency/framework beforeprivatization are exemplified by the telecommunication sector: decisions related to tariffs review, cellulartelephone licenses, satellite services and radio-frequency spectrum management are still awaiting decisionby the Comisidn Nacional de Telecomunicaciones (CNI). After ENTel's privatizaton CNT did notoperate effectively, so the Government intervened and relieved the Commissioners. A new Subsecretaryof Telecommunications was appointed, who with Bank support retained consulting firms to temporarlyundertake the responsibilities of CNT. New Commissioners appointed since then are building up the staffand the capacity of the commission.

C. Reform Progress of Other PEs

2.15 Another group of PEs are public financial institutions and PEs under the management ofprovincial governments and municipal authorities. These PEs are also being restructured, liquidated andprivatized under the overall mandate of the reform program. For instance, the National DevelopmentBank (BANADE) is being liquidated (operations halted; staff reduced; most branches closed); the Savingsand Insurance Bank (Caja Nacional de Ahorro y Seguros) is being privatized, and the Mortgage Bank(BHN) is being converted into a second-tier institution. Banco de la Nacion is being rationalized and isundergoing major staff reductions. The Government is committed to encourage privatization andreorganization of other financial institutions, while the Central Bank will provide temporary liquidity

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credit only to solvent banks. Bank technical assistance has supported these actions as well asrestructuring by some provincial banks. A Financial Sector Adjustment Loan has been negotiated withthe Argentine Governent to support these reforms. Provincial and municipal authorities, whichcollectively account for 74 percent of the PEs, are also downsizing their portfolio through privatizations,and these actions are expected to be supported by a forthcoming Bank loan.

ImI. PE REFORM PROGRAM OF THE MI1NISJRY OF DEFENSE

A. Introduction

3.01 Argentina's Ministry of Defense is undertaking the restructuring and privatization ofvirtually all enterprises within the Defense Complex. In October 1991, the Ministry was reorganized,consolidating responsibilities and fimctions under two Secretares - the Secretary of Military Affairs andthe Secretary of Planning. The Secretary of Planning will concentrate on the PE reform program. TheUnder Secretary of Restructuring and Asset Management, who reports to the Secretary of Planning, isresponsible for liaising with the Bank on the defense reform program.

3.02 A large number of PEs came under the tutelage of the Defeise Complex due to their"strategic' importance and the evolving role of past Military Governments. Although the PEs are indisparate industrial sectors, the unifying theme is that these PEs are related in both their defense andregional activities. For instance, Altos Hornos Zapla and HIPASAM were established in the frontierprovinces of Jujuy and Rio Negro respectively to meet the military's needs for the supply of specializedsteel products. Because of their original strategic importance, these PEs were not subjected to the rigorsof the marketpidce and most of the senior management appointments were filled with non-commerciallyoriented military staff.

B. Composition of PEs within the Defense Complex

3.03 The proposed loan addresses 24 of the total 45 PEs whithin the Defense portfolio. AnnexV shows the overall list of PEs within the Ministry. The twenty-one PEs excuded from Bank supportare: (a) six PEs liquidated prior to March 1991 (before the Bank's involvement); (b) eleven PEs that arestrictly defense related, although they are subject to privatization under Law 24,045/91; and (c) four PEsthat had their shares recently transferred from the Air Force to the Ministry of Defense (Decree 161/92).

3.04 The 24 industrial-oriented PEs are grouped under four broad sectoral activities: (a) steel;(b) petrochemicals; (c) shipyards; and (d) other manufacturing enterprises. These industrial PEs are themost important in terms of economic activity within the Ministry of Defense: their assets, employees andsales account for about 90 percent of the total portfolio. Amongst them, the steel sector is the mostimportant, accounting for about 50 percent or more of the employees, assets and sales of the combinedDefense PEs. Furthermore, the steel sector is the most complex in terms of labor unions, vested privatesector interests, and policy distortions. Figure 1 shows the sectoral allocation of selected financialindicators:

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Figure 1: Sectoral Allocation of Selected Indicators(as of December 31, 1991.)

70-

50

~40-

20-

10 *...*

EMPLOYMENT ASSETS SALES

*STEEL PEs MOTHER IND. PEs ~OEPENSEP.

C. Financial Performance

3.05 The main obstacles to privatization has been the PE-s' poor financial performance,overstaffn, and the assessment of still-high country risk faced by prospectve investors. The finacialinformation excludes PEs sold/liquidated prior to March 1991, and Area Materia Cordoba, an aircrftcompany, which was not legally organized as a corporation. During 1991, the losses of Defense PEs forwhich data are available amounted to about US$480 million, of which US$250 million was for SOMISAalone. These losses were about 0.3 percent of 1991 GDP and equalled 16.4 percent of the total requiredborrowings from the Government in 1991. Of the 22 PEs for which financial, data are available, only6 PEs were profitable; PBB showed a profit of US$75.5 million for 199 1. The book-value of their assetswas US$4.2 billion, and their liabilities were US$ 1.8 billion; however combined sales last year were onlyuStSoo million, less than one-fifth the asset value. Annex VI shows the finacial performance of themajor PB within the Defense Minstry. Some of the reasons for poor financial performance are: (a)the elimination of the budget transfers from the Treasury, which increased inter-PE payment obligations;(b) selected private firms have not paid some PEs for their purchases; (C) the near collapse of thedomestic market has necessitated exports at below cost prices in some cases; and (d) overstaffig andlimited investments have forced cerain enterprises into obsolescence and uncompetitive cost positions.Figure 2 shows the financial performance of the PEs within the Defense Complex:

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Figure 2: Operating Losses of Defense PEs(Calendar 1991)

*Steel PEs IOther nd. PEs IDefense PEs

-300 -250 -200 -150 -100 -50 0 50

11S$ MillionsFinanci Results

Steel PEs -286.4Other Ind. PEs -54.6

Defense PE6 -t36.5

3.06 There is also the burden of strictly defense-related outlays on the budget. In 1988,Argentina allocated 3.1 percent of GDP to defense expenditures, compared to 3.3 percent for health andeducation combined. Faced with growing social hardship and slow growth, the Government embarkedon an ambitious program to reduce its defense expenditures (excluding pensions) to only 1.9 percent ofGDP in 1991, with a lower level budgeted for 1992. All public expenditures, of course, have fallenrelative to GDP during the past few years, but military expenditures have fallen faster. Defense spendingwas US$1.9 billion in 1985 and was reduced to US$582 million in 1990 (constant 1985 dollars), adecrease of 69 percent. The Government's strategy is that as public outlays rebound, militaryexpenditures will grow much more slowly, so the increment can be passed to the civilian, especilysocial, sectors.

D. The Privatizathon Program.

3.07 The Government has decided that virtually all PEs within the Ministry of Defense's purview willbe privatized i.e. sold, or closed. Due to the complexity and multiplicity of these PEs, the Governmentrequested Bank assistance-technical and financial-to achieve a broader set of objectives beyond thereduction of state activity. Based on lessons learned from the privatizations completed, the Minister ofDefense, formerly Minister of Economy, appointed a Secretary for Planning who is responsible for theday-to-day management of the reform program. The Secretary of Planning is assisted by two UnderSecretaries-Privatization and Restructuring and Asset Management. This senior management team issupported by govermnent staff and technical consultants. To the extent issues of economic policy arise(e.g., competitiveness, environment), other areas of Govermsent have also been involved as well.

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3.08 Due to the poor financial performance of most of the PEs and their relativeunatactiveness, the Government has developed a two-pronged approach. First, a number of PEs infinancial distress but which may be viable were rationalized (without investments) prior to privatization.Second, those PEs with no hope of viability, even after rationalization, were closed. The Ministry'srationalization efforts are limited to assuming liabilities resulting from labor indemnity costs, write-down or assumptions of debt, and settlement of inter-PE transfers. Beyond these liabilities, theGovernment wuill not incur additional investments to improve the value of the PEs prior to sale.

3.09 The labor reduction of PEs within the Defense Complex is estimated at about 19,600of a total 32,300 staff; a reduction of about 60 percent relative to September 1991 levels. At anaverage indemnity cost of US$15,000 per worker, the total cost of indemnification for Defense PEsis US$286.2 million. As of September 1992, 70 percent of the total labor reduction has beenaccomplished, mainly due to a US$181.9 million bridge loan received from Banco de la Nacion.Other rationalization costs, associated with plant closures, including satisfactory environmentalcleanups would be identified on completion of environmental audits or will be identified (for plantsalready closed) by Government consultants.

3.10 On completion of the PEs' rationalization, or in cases where PEs are already viable,the Government has retained the services of international consultants or merchant bankers to assistin the preparation of the sale. The selection of these financial advisors has been undertaken in anopen and transparent manner and according to international practices.

3.11 Following is a description of the Ministry's privatization program in each of the fourmajor sectors:

Steel: The Defense Ministry will end its interest in all three steel PEs. HIPASAM has beenclosed due to non-viability. Because of prior pollution problems, the Government willundertake an environmental audit of HIPASAM and incur the required outlays for itsenvironmental cleanup. The Government, with the assistance of IFC as its financial advisor,has sold AHZ to an international consortium of Aubert and Duval, Societe IndustriaDe deMetalturgLe Avancee (SIMA), Citicorp Venture Capital, SA Pensa, S.A. and Penfin, SAThe total value of the sale was US$33.2 million, 10 percent in cash and the balance in debtconversion instruments.

Ihe third steel PE--SOMISA--is the largest integrated steel mill in Argentina with an instaDedcapacity of 2.2 million tons producing both flat and non-flat steel products, about 60 percentof the country's total capacity. The Government retained the services of an internationalmerchant banker to assist in the privatization of SOMISA under Bank financing. The salesmemorandum was issued in August 1992, and a consortium of local and regional steel firmsthat bid US$152.1 million was awarded the company in November 1992.

Chemicals and Petrochemicals: There are fourteen chemical and petrochemical related PEsunder the control of the Ministry of Defense; the Gowvernment plans to sell or close all ofthem. Argentina has a comparative advantage in this sector due to the ready availability ofgas feedstock and a sophisticated indristrial base. The most important PEs in terms of sizeand assets are PBB and PG?VL

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PBB, a manufacturer of ethylene, is 51 percent owned by the govemment, while theremaining shares are owned by the downstream private producers Although PBB iscompetitive, its current installed capacity of 230,000 tons is considered sub-scale by mostinternational investors, even though it dominates the Argentine ethylene market. Using Bankfinancing, the Government has retained the services of an international merchant banker toassist in the privatization of PBB. An arbitration process has been underwav for sometimebetween the Government and the downstream private owners to resolve pending legal issues,involving unpaid bills and credits. Nevertheless, the Government has issued the salesmemorandum in November 1992, without resolution of the arbitration issues, and has ensuredthat any adverse decision will be absorbed by the Government, not by the new owners. Saleis to be completed by the second quarter of 1993, particularly if the arbitration decision isagreed by early 1993.

PGM, a manufacturer of olefins and aromatic petrochemicals, is totally government-ownedwith the Ministry of Defense owning 50 percent and YPF the remainder. An internationalmerchant banker has been selected to assist the Government in its privatization; it is beingfinanced by the Bank. The sales memorandum was issued in mid-October 1992, and the saleis to be completed by the first quarter of 1993.

Five PEs in which the Government had minority ownership interests already have beendivested to the existing private shareholders. One otLer PE-METEOR-hus been closed dueto non-viability. Because of previous major pollution problems, the Government willundertake an environmental audit of METEOR and incur the required outlays for itsenvironmental cleanup. The Government has issued sales memoranda and evaluated bids forthree other PEs-Carboquimica, Fo4ia, and FM Tolueno-and has awarded winning bids to therespective private investors.

Shipyards: There are three shipyards--Tandanor, AFNE, and Domecq Garcia. Tandanor hasbeen sold to an international consortium consisting of Banco Holandes Unido, CIAMAR, andSud Marine Enterprises for a price of US$59.8 million. One other shipyard, Domecq Garcia,contains partia completed submarines which the Argentine Navy now neither wants norneeds. AFNE, a diversified shipyard facility located on Rio Santiago, constructed oil tankersprincipaly for YPF, frigates for the Argentine Navy, and small size cargo ships ranging in sizefrom 8,000 - 15,000 tons capacity. Because of high labor costs and obsolete technologies,demand for Argentine ships has declined. Furthermore, given their military orentation, theGovernment has been working with the Navy and the provinces in determining their futureprivatization options. In the case of AFNE, a resolution was issued in October 1992, thatpermits the continued reduction of its workforce.

Other Industrlal PEs: There are six other major industrial PEs-Area Material Cordoba, FMECA, FM San Francisco, FM San Martin, TAMSE, and Domingo Matheu. At leat four areto be privatized. In the case of FM ECA, the Government has retained the services of IFCto assist in its privatization. The sales memorandum was issued in October 1992 and the PEis to be sold by the fist quarter 1993. In the case of Area Material Cordoba, theGovernment is in the process of retaining an investment banker to assist in its privatization.Since this entity was an administrative part of the government, not a legal corporation, theGovernment has completed the required legal steps for its incorporation. For the remainingfour PEs, Government staff will prepare the necessary documentation for their privatizations.

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IV. THE PROPOSED OAN

A. Rationale for Bank Involvement

4.01 This proposed US$300 million SECAL would support the privatization of all civilianDefense PEs and those in advanced stages of conversion to civilian use. PEs supported by thePERAL II account for 97 percent and 91 percent respectively of all sales and empityment, withinthe Ministry of Defense. It would not include technical assistance components. Part of a priorJapanese Grant has been allocated to this program; in addition the Government of Japan recentlyapproved another 1168.75 million (about US$1.4 million equivalent) grant specificaDly for TA to theDefense Complex. The Public Enterpnrse Reform Execution Loan (PEREL) also includesUS$1,750,000 in technical assistance funds for the Defense PE reform program. The combined TAfunds available to the Ministry of Defense from PEREL and Japanese Grant Facilities amounts toabout US$4.2 million. The utilization of these technical assistance funds for the various initiativesis delineated in Annex "IL

4.02 The Bank has a comparative advantage for such work because of its: (a) priorknowledge of the major sectors within the Defense portfolio; (b) ability to help develop competitivepolicy environments for private sector participation; and (c) ability to design greater transparency andcredibility in the privatization process. Over the years the Bank has been involved in developingrestructuring strategies for three major industrial PEs in the Defense Complex--SOMISA, PBB, andPGM-representing more than two-thirds of the Complex's total book value. Bank staff andconsultants have made special efforts to assist in both improving the competitive environment for theaffected sectors and ensuring environmental dangers are avoided. Without Bank technical assistanceand the financial support under the proposed loan, the Government might not have begun orexpected to complete the restructuring and privatization of PEs within the Defense complex.

B. The Pr6posed Loan

4.03 The US$300 million loan would be disbursed in two tranches; a first tranche ofU ;$200 million, including a debt set-aside amounting to US$100 million, and a second tranche ofUS$100 million. PERAL II wil focus on reducing the role of the state in key industries under thetutelage of the Defense complex. In order to increase the enterprises' privatization potential, a largenumber of PEs need to be rationalized without new investnents by the govenment prior toprivatization. The Ministry of Defense will reduce the labor force by an estimated 19,600 workers(Annex VIII).

C. Project Implementation

4.04 Executing Authority. The Borrower would be the Argentine Republic; the Ministryof Defense would be the Executing Agency. The Under Secretary of Restructuring and AssetManagement, Ministry of Defense, would be responsible for coordinating and liaising with the Bankon the reform program. Furthermore, the Under Secretary would be responsible for maintaining allrecords pertaining to the Ministry of Defense's staff reduction program. At the PE level, therespective chief executives ('Interventors") will be responsible for implementing the reform program.

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4.05 Disbursement and Procurement. Excluding the set-aside funds, the proposed loanwould finance 100 percent of the CIF costs of general imports, excluding luxuwry goods, militaryequipment, petroleum products and foodstuffs above US$50 million, and enivironmentally hazardousproducts defined under the Standard International Trade Classification (ST). Imports prior to June1, 1992, and expenditures for goods procured under contracts costing not less than US$5,000equivalent would not be eligible for Bank financing. This threshold would be consistent withsatisfactoty access by small- and medium- size importers, and the operation would still remainmanageable from an administrative point of view. Retroactive financing would be acceptable up toUS$40 million (20 percent of the loan amount allocated to the adjustment program) for eligibleimports since June 1, 1992, about six months preceding expected loan signing in view of theGovernment's need for time to gather the required import documentation necessary for this loanwhile assembling similar documents for other Bank and IDB SECALc. For commodity imports underexisting contracts, relevant expenditures would qualify for reimbursement under the loan in anamount not to exceed the reference average per unit FOB price published in international commoditymarkets, as applicable on the date of loading. The closing date of the loan would be June 30, 1994.

4.06 In December 1991, a Bank mission reviewed procurement procedures related to theBank's adjustment operations in Argentina. It concluded that the public sector, GovernmentAgencies, Autonomous Entities, and large private frins follow competitive procurement practices fullyacceptable to the Bank However, small and medium sized firms with limited international exposuredo not normally follow acceptable procurement procedures.

4.07 Therefore, imports of the Ministries, public enterprises, and private importers of US$5million equivalent or above would be procured through simplified ICB procedures in accordance withBank guidelines. This threshold would be consistent with the anticipated sizes of contracts and theexperience of the borrower with Bank procedures. Procurement for contracts below this thresholdwill be as follows: (a) public sector contracts below US$5 million equivalent may be carried outaccording to the standard procedures of the purchasing institutions; and (b) private sector contractsbelow US$5 million equivalent may follow established commercial practices acceptable to the Bankand require a minimum-price quotation by eligible suppliers from at least two countries Directcontracting is appropriate only under the conditions specified in the Bank Group's procurementguidelines.

4.08 Accounting and Auditing: The Ministry of Economy would be responsible formaintaining loan accounts, and for preparing and submitting withdrawal applications. Disbursementsfrom the proposed loan would be made on the basis of a summary from the Ministry of Economydetailing individual import transactions in each relevant period, together with a certificate of paymentof the amount involved and of eligibility under the loan. Applications for withdrawals will beconsolidated and submitted in amounts not less than US$1 million. Contracts valued at above US$5million equivalent would be disbursed against full documentation; disbursements would be madeagainst statements of expenditures for contracts below that sum. The Ministry of Economy willmaintain separate accounts to record and monitar loan disbursements and repayments. All recordsand accounts will be audited in accordance with generally accepted auditing standards and submittedwithin six months following the end of the financial year.

-19

D. Loan Condltions

4.09 The proposed loan is conditioned on three sets of actions: (a) satisfactory economicenvironment, both of macroeconomic performance and key sectoral economic conditions; (b)privatization of the steel sector, and (c) privatization of all industrial civilian-related PEs. The policymatrix in Annex IX provides the specific, proposed conditions. The three major sets of loanconditions are:

(i) Satisfactory Economic Environment. First, the Government would maintainsatisfactory macroeconomic performance and a public expenditure program consistentwith the IMs EFF and the detailed Letter of Development Policy (Annex X). Aseries of important sectoral conditions, which also support the goals of the EFFprogram, were or are supported in the undisbursed tranches of the Provincial Loan,PSRL, PERAL I, and the proposed Financial Sector and Provincial SECALs. Theproceeds of asset sales will be used to reduce debt (extemal and internal) or for laborindemnification rather than spent on recurrent costs.

Secondly, there are some key sectoral economic conditions that must be met if theprivatization process and private sector development is to succeed. First, the currentcompetition policy of Argentina was limited in its enforcement capabilities and scope.The law does not sufficiently address issues related to market conduct and structure.To further strengthen the competitive policy environment, the authorities retained ateam of intemational consultants who drew up revised anti-trust legislation which willbe forwarded to Congress for approvaL Moreover, another way to ensure keencompetition is to retain an open trade account, particularly for such homogeneousproducts as steel and petrochemicals. It was agreed with the authorities that the lowmaximum tariffs would not be increased and that no new QRs will be issupd,particularly on steel and petrochemical products. The MERCOSUR (Argentina,Brazil, Paraguay, and Uruguay) agreement is being implemented. Already tworegional tariff cuts have occurred, and free regional trade is expected to occur byJanuary 1995. The authorities have reiterated their intention to move towards freeregional trade in the Letter of Development Policy.

In addition, the generous fiscal incentives given to existing steel producers must alsobe reduced if new purchasers are to be attracted to these sectors. Ihis latter issueis also being addressed in the PSRL under the Industrial Promotion Control Program.The Government has already issued a Decree No. 27.513 which outlined theelimination of the fiscal incentive program.

(i) PrIvatization of the Steel Sector. The steel sector is treated separately because ofits importance in the Defense portfolio. All three PEs in the steel sector have beenor will be privatized or closed. The Government has already issued a deregulationdecree liberalizing barriers to entry and reducing non-tariff restrictions and hasundertaken major steps in rationalizing SOMISA (halved the workforce, curtailed theproduction of loss-making product lines, placed auxiliary unproductive assets for sale,and overcome strong resistance from unions, suppliers, and purchasers). TheGovernment, with the assistance of IFC, has sold AHZ and closed HIPASAM In thecase of SOMISA, the authorities issued the sales memorandum incorporating the

-20 -

principles of competitive strategy consistent with its obligations under theMERCOSUR treaty.

(l) Privatiatloon of all other PEs and the Conversion of Defene-related Activities itoCivllian Use within the Defense Complex. To date, six PEs have been sold and anumber of others are in the final stage of privatization. In the case of three PEs-Carboquimica, Foria, and FM Tolueno-bids submitted by private investors are beingevaluated. In at least four of the PEs-TAMSE, ECA, FM San Francisco, and FMSan Martin-their conversion from military to civflian use have been completed andsales memoranda have been issued. -he most important PE in terms of industialstructure is PBB. Therefore, its sales memorandum has been prepared so as toincorporate the principles of competitive strategy consistent with Argentineobligations under the MERCOSUJR treaty. Fmally, PGM's sales memorandum hasalso been issued.

4.10 The conditions for second tranche release are: (a) continued maintenance of the 3-year macroeconomic program-including fiscal targets, open trade policies, and use of privatizationsales proceeds--and compliance with the budget; (b) forward satisfactory 'competition" legislation toCongress for consideration; (c) issuance of tax credits to steel producers after accounts have beenaudited by DGI; (d) commence work on environmental clean-up of selected closed PEs; (e)sale/disposal of SOMISA's assets; (f) the sale of PGM and PBB; and (g) the sale/closure of at least10 other PEs.

E. Environmental Aspects.

4.11 A number of PEs within the Defense Complex have caused adverse environmentaleffects. New legislation and enforcement mandating better environmental standards are pending,possibly making the PEs financially less attractive to potential private investors. The Ministry ofDefense in conjunction with the newly appointed Secretary of the Environment would undertakeenvironmental audits of most PEs to be sold. The financial advisors and technical consultants foreach of the selected PEs to be sold would identify, as part of their work plan, the PEs' environmentalperformance relative to the required environmental standards of Argentina. These environmentalclauses would be incorporated into the sales memorandum requiring the new owners to follow aprogram to address the environmental deficiencies. Furthermore, the Ministry of Defense hasdecided to commit US$10 million from the counterpart of PERAL II for the environmental cleanupof closed facilities (i.e., METEOR and HIPASAM).

F. Social Implications.

4.12 The gains of the program will accrue to taxpayers and consumers; the costs will bemostly borne by fired workers. Most of the labor declared redundant within the productive PEs ofthe Defense Complex is skilled and could be absorbed by the private sector. In spite of the largenumber of labor redundancies associated with the public sector reform program, the unemploymentrate in the Metropolitan Area of Buenos Aires has decreased from 8.8 percent in May 1990 to the6 percent range in 1991, and was 6.6 percent in May 1992, as economic activity recovered. A newemployment law (No. 24,013), passed in November 1991, was designed to assist the unemployed.Nevertheless, where PEs are located in provinces with a low level of economic activity, or where the

- 21 -

PEs are the major employer, the social adjustment process could be severe. Severance payments arepart of the agreed program and would provide a transition period until workers find new jobs. Astudy of the impact of the Reform Program of the Public Sector (including PEs) on the labor market--particularly in Patagonia and Jujuy, where relatively large PEs were closed with limited employmentoptions--is scheduled to start in March 1993 under funding from PEREL. Tle authorities hope thisstudy will provide them with data that can be used to ameliorate these specific problems and thusdampen any negative social effect of the reform program.

G. Benefits and Risks.

4.13 The proposed loan would provide two major benefits for the economy: (a)improvements in public finances resulting from labor reductions and the elimination of past subsidiesto PEs; and (b) growth in industrial activity stemming from increased and more efficient private sectoroutput and investment under a competitive business environment To ensure the private sector takesadvantage of this expanded scope and that some fiscal savings are transferred to meet key socialsector needs, the authorities plan to keep defense outlays at the currently low share of GDP.

4.14 Potential gains from the Defense Ministry's reform program cannot be preciselyquantified. Many of the companies lack appropriate accounting procedures and past price cross-subsidies were not transparent or properly recorded. The sale of these PEs could possibly generatean average of only 20-30 percent of original book value, amounting to about US$1-1.5 billion. Afterthe settlement of PE liabilities, net cash realized would be small, especially if debt reduction isincluded in the deals. Worker indemnities alone are expected to equal almost US$300 million. Majorbenefits to the fiscal budget are expected to be realized by ending Defense PEs' losses, whichamounted to about US$480 million in 1991. Furthermore, additional savings would be realized bythe elimination of indirect subsidies to the private sector in the form of inputs (estimated at US$200million for non-flat steel products and ethylene alone), increased tax revenues from the expandedprivate sector, and reductions in debt payments.

4.15 However, there are three types of risks associated with the delivery of the program.First, in the short term, there are the macroeconomic risks described in paras. 1.21-1.26. In addition,there are political risks that could slow the pace of the reform program. Second senior managementchanges have occasionally undermined the program. Further changes could jedpardize the timetableor even the program itself Iibird due to the continued perception of a high level of country risk andthe poor operating status of some PEs, there might be limited interest by the international privateinvestors in some of these PEs. However, proceeding with the proposed program and PERAL II isvital, as it offers the Government its first real opportunity to tackle groups of PEs that have been amajor cause for Argentina's industrial deficiencies in the past. The Government may find it difficultto continue with the proposed reforms without timely Bank support; it would lack the implicitcertification of the transparency and objectivity of the reform process. The risk of proceeding at thistime is counterbalanced by the Government's continued courageous commitment to the reforms.

-22 -

PART V. COUNTRY ASSISTANCE STRATEGY AND OPERATIONS

A Main Objectves and IBRD Lending Program

5.01 Argentina joined the Bank in 1956, but was not a major borrower for many years. Ofthe US$5A billion committed to date (net of cancellations), some 80 percent was committed betweenFY81 and FY90, particularly in the latter half of the period. Bank involvement intensified beginningin 1986, when the Government requested sectora} adjustment loans for reforms in agriculture, tradeand finance, and technical assistance loans (TALs) for rebuilding economic management capacity, inaddition to the ongoing investment loan program. Successive failed stabilization programs helped toclarify the kinds of structural reforms needed, and through economic and sector work (ESW) andother support through 1988, the Bank helped the Government articulate such a medium-term reformagenda. During the hyperinflation crises, considerable resources were devoted to ESW, supervision,and development of proposed operations, using these activities as vehicles for intensive policydialogue in lieu of new lending.

5.02 The Bank's main country assistance objective since 1989 has been to improve publicfinances so as to eliminate the persistent structural deficit that has caused economic instability, slowgrowth and increased poverty over the last decade. The emphasis is on public sector adjustment,supplemented by investment and technical assistance loans, is based on extensive ESW in publicfinances and a strong dialogue on macroeconomic policy. Major loans have supported reforms inboth the Federal Government and public enterprises (see paras. 1.04 and 1.05).

5.03 Portfolio Perfomance. The implementation of investment and technical assistanceloans approved prior to 1989, has suffered from macroeconomic instability, counterpart fundingconstraints, and changes in policy orientation when the present government came to office. Also, theGovernment's implementation capacity was limited because of poor management. As the economyhas stabilized, these difficulties hav lessened. The Government has improved its savingsmobilization, relieving the constraintr en counterpart funding. Second, it has steadily improved itsinvestment programm hing trough preparation of an investment program tightly linked to the budget.Third, though the civil service reform and associated salary increases, management in the public sectorhas been gradually improved, though much remains to be done. Improved performance can be seenin agricultural sector operations, in technical assistance for gas utilization, power engineering, publicenterprise, tax administration, the social sectors, as well as in the municipal and provincialdevelopment projects.

B. Medium-Term Assistnce Objectives (FY93-97)

5.04 The Government should be able to consolidate fiscal stability within the next two yearsand begin moving toward restoring public functions critical for the sustained growth of the privatesector and for social development. Effective Bank support therefore requires some shift in medium-term assistance objectives and strategy. The Bank would continue to support the strengthening ofmacroeconomic management and the completion of the reform program, focusing on fiscal stability,modernization of the state and further market deregulation. At the same time, the emphasis wouldincreasingly be on three additional objectives: the improvement of savings mobilization andintermediation; the restoration and development of public productive services and physical

-23 -

infrastructure; and the improvement of basic social services for the poor and natural resourcemanagement. The latter two objectives would be carried out primarily throxugh operations at theprovincial leveL The entire lending program would remain contingent on satisfactory macroeconomicperformance during FY93-97, since any renewed fiscal disorder would make it difficult to realizeobjectives of any loans.

5.05 Assuming strong macroeconomic and policy performance, Bank lending to Argentinaover the next five years would be on the order of about US$5.0 billion. Half of the FY93-94 programwould be devoted to adjustment lending, whereas investment and social sector operations wouldaccount for all of the FY95-97 program.

5.06 Completion of the Reform Promgam. Adjustment Loans would focus on new andcomplex areas, such as the divestiture of defense-related public enterprises, financial sectoradjustment, and provincial finance reform, as well as debt reduction. The Public Enterprise ReformAdjustment Loan I, would extend the production program to all public enterprises within the defensecomplex-a total of 45 enterprises in steel, petrochemicals, shipyards, and various industrial anddefense-related activities. The proposed Financial Sector Adjustment Loan would support, inter aliareduction of public sector involvement in banking (through privatization, closures, and bankrestructuring), and the promotion of competitive and efficient financial intermediation (improvedcredit eligibility, supervision, etc.). Finally, a proposed provincial adjustment loan would support fiscaland structural reforms at the provincial level in tax collection, reductions in staffing, privatization ofprovincial enterprises, and reduction of current expenditures.

5.07 Resource Mobilization and Intermediation. Decades of high inflation have leftArgentina with a shrunken cap tal market and a banking sector geared to financing the public sector.Bank lending for financial inte., nediation, discontinued because of high inflation, would resume witha focus on banking sector reform, capital market development and improving access of small farmersand newly privatized infrastructure suppliers. Proposed financial sector loans would support capitalmarket development and the restoration of lending with longer maturities. The program wouldinclude cooperation with the IFC in the development of capital market institutions. Since the needsfor private investment financing are likely to be much greater, particularly until Argentina's accessto international capital markets is fully restored, the program may also include additional support forcredit lines and to improve farmers access to commercial banks. Newly-privatized infrastructure firmsmay also need assistance, with guarantees of non-commercial risks, consistent with the ECO policypaper, to enhance their access to intemational capital.

5.08 Public Productive Semces and Infrastructure. The deterioration of public services hasled to a loss of competitiveness by local producers. Two operations (for agricultural and industrialservices respectively) are planned to help restore the supply of research, quality control, vocationaltraining, and other services with information externalities. A group of six loans would help theprovinces cope with their extended responsibilities for infrastructure in the aftermath of public sectorreform. In the roads sector, where the establishment of competent planning agencies is important,as is increased expenditure on road maintenance, a proposed road maintenance project is scheduledfor FY94.

5.09 Social Services and Environment. Education and Health services and social assistanceto vulnerable groups have siffered from the austerity measures of the 1980s and from the generaldecline in the quality and efficiency of p blic sector management. The neglect of basic health

- 24 -

services and the lack of social assistance targeting have resulted in higher maternal and infantmortality and in malnutrition, particularly in the poverty belts surrounding the cities of Buenos Airesand Rosario and in the less developed northern provinces. The ongoing Social Sector TA loan hashelped the Government develop coherent strategies for education, health and social assistance, andwould provide the analytic base for the Bank's first forays into the social sector in Argentina.Beginning in FY94, lending would help the provinces provide better health and nutrition assistanceto mothers and children, followed by support for secondary education.

5.10 As the economic crisis recedes, the Government is becoming more aware of theadverse long-term environmental impact of existing patterns of natural resource use and industrial andurban waste disposaL Soil erosion, water pollution and the degradation of forests and otherecosystems are already constraining development and creating health hazards. Projects in the pipelineinclude activities in soil conservation, forest and water management and urban waste. Future ESWwould focus on areas to support the Government in developing a legal framework that would allowfor effective regulation and market-based solutions.

5.11 Povertv Alleviation. The post-adjustment phase in Argentina, with more emphasis oninvestment lending and the decentralization of most public services to the provinces, will place greaterdemands on the implementation capacity of the government and on Bank resources. Experienceworkdng with the provinces under ongoing projects suggests that many provinces do not have therequired capacity and need substantial institutional strengthening. This puts a premium on designingprojects with focussed objectives and activities, as opposed to complex nationwide programs involvingall the provinces. Even then, however, limited implementation capacity outside the main urban areaswill require greater supervision intensity on the part of the Bank.

5.12 Various of the activities described above would help to address important dimensionsof poverty in Argentina. Increased price stability would reduce the fluctuations of real wage andpension income, against which poor households are unable to hedge. Private sector developmentwould expand employment opportunities in the formal sector and, in the medium term, increase realwages. Several operations would specificaly contribute to poverty alleviation; a poverty study isexpected to increase the effectiveness of our assistance in this regard; the maternal and child healthproject would target vulnerable groups in the urban poverty belts and the underdeveloped northernprovinces; the restoration of basic health services and improved access to secondary education wouldimprove living conditions for the poor, as would better environmental management, water supply, andmunicipal services in the urban poverty belts.

5.13 Cooperation with Other Multilateral Institutions. The Bank has worked closely withboth the IMF and IDB in the design and execution of adjustment operations, in formulating thelending strategy, and in economic and sector work. For example, since 1989, Bank and Fund staffhave exchanged information and views in the preparation of major public sector reform operationsbeing undertaken by the Bank. There has also been extensive consultation with the IDB, which hasco-financed a number of projects, including adjustment operations.

C IFC and MIGA Activities

5.14 IFCs investment strategy in Argentina is to support export-oriented investments andprivatization within the limits of its current exposure. IFC would seek mechanisms to mitigate thecountry and payment risk (e.g. outside guarantees, external escrow accounts). Furthermore, under

v25 -

the present conditions, IFC would only finance those projects with strong export orientation. Inaddition, IFC would support privatization or restructuring projects through fee-based advisory servicesand foreign resource mobilization. To serve this objective, IFC is participating in the managementof a privatization fund and is considering the establishment of an underwriting fund to facilitate theplacement of equity and debt, as well as helping to setup brokerage houses, venture capital funds andbond rating agencies. IFC has made 42 investments in Argentina, totaling US$746.4 million, of whichUS$324.1 million has been repaid, canceled or sold. In FY92, there were investments in chemicals,capital markets, energy, slaughtering, railroads, food and agribusiness, and malt production. MIGAhas also been very active in Argentina. Including projects in the pipeline, most of the countrysallotment of $US150 million has already been committed to operations in banking and in pulp andpaper.

D. Recommendations

5.15 I am satisfied that the proposed loan would comply with the Articles of Agreementof the Bank and would be consistent with the approved guidelines for Bank support. Therecommendations for the inclusion and release of the debt set-aside amounting to US$100 millionin this proposed loan has been recommended in the President's report No. P-5914-AR datedDecember 10, 1992 on Debt and Debt Service Reduction Loan.

Lewis T. PrestonPresident

AttachmentsDecember 10, 1992washington, D.C.

AINNEXI

0 (Is pewesA t3Ne NAb.,e paS

log0 1;91 1993 1993 1994 199S it9" 199 1998 1999 2000

GO gwou:ht 0.4 4.5 C.S 3.0 4.0 4.1 4.1 4.3 4.3 4.3 4.4iowinb .8 par qapitt phivle consumption (1.3) 5.5 9.8 (1.8) 0.8 1.7 1.7 1.7 1.8 1.7 1.6GOP (PS$ blJ.ie) 105.$ 135.4 153.2 148.4 18S2. 194.9 211.9 122.8 :47.0 268.9 288.82 Ibars, of ca11Total Iav.est6et 8..s 12.3 14.0 15.5 18.0 18.5 17.0 17.5 1I. 18.S 19.0

private S4~~~~5. 10.9 13.4 13.5 14.3 14.7 1.3.1 15.3 15.8 14.2 18.PUblid 1.9 1.4 1.8 3.0 .. 1.7 1.4 1.9 2.0 3.2 2.3 2.5

nagtion" Sav5agt 10.0 10.4 9. U13. 13.1 13.7 14.2 14.9 Is.? 18.4 17.2Iwivate 12.0 11.3 6.3 9.6 11.9 13.4 U2.? 13.1 13.4 13.7 14.1Public (3.0) (0.9) 1.4 2.3 1.3 1.2 1.5 1.6 3.3 2.6 3.1

P.we4a Saviage (1.8) 2.1 4.4 3.3 2.9 2.6 3.8 2.8 3.3 2.1 1.8lOOP (1*4.4d) 21.3 1.4 1.9 4.7 3.9 3.9 4.0 4.0 4.2 4.3 4.3

Public Seotow (.aS% basis as 2 .8 utw.m GOP) I Total OUwweot Seww..u. 13.0 14.1 17. 18.1 18.4 46.4 1MS 38.3 18.4 18.4 16.3Total cunawetwKeudituree a1 15.9 13.2 14.1 15.3 13.5 1U.$ 15.7 13.6 15.3 13.1 14.9Znutowet KzPeadtuwea 5.2 3.4 1.8 2.0 3.4 2.4 2.4 2.4 3.3 2.0 1.8

SocIa Security Swoa(0.3) (0.1) 0.3 (0.6) (1.4) (1.5) (1.3) (1.1) (0.6) (0.) (o.4)06 fto.tateweeaStyl 1.2 0.3 0.3 0.5 (0.0) (0.0) (0.0) (0.0) (0.0) (0.0) (0.0)Pubict Swvics (M.0 (0.9) 1.4 .3. 1.3 1.2 1.5 1.6 2.3 2.6 3.1Capital. *w*maes 0.8 1.3 1.3 0.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0Capital Zzpedtftuwe 1.9 1.8 1.4 2.0 1.7 1.6 1.9 2.0 3.2 2.3 2.5S.Smotalal Public $ector (3.3) (C.A) 1.1 0.6 (0.4) (0.8) (0.4) (0.3) 0.1 0.4 0.8q4et-tL4ati, Stnep. 0.0 0.0 (0.03) 0.1 0.2 0.2 0.3 0.3 0.3 0.4 0.4overall Saleft. (3.3) (1.3) 1.1 0.9 (0.3) (0.3) (0.1) 0.0 0.4 0.6. 1.0Meeot

uiu.qmc Surplia. 1.9 2.1 2.9 3.6 2.0 4.9 2.0 3.1 3.3 2.4 2.4primary SugplUs (U9$ .1111.) 3.013 2.857 4.389 4.753 3.488 3.487 4.124 4.854 5.552 4.509 8.954opwAttiemal fctmar~ Suap3.a (US$ million) 1.379 1.231 2.413 4.403 3.846 3.687 4.394 4,864 5.512 4.509t ' .954ZaOtewst zxp.o8itUv. (VS$ .4131.) 5,498 4.850 2.645 3.425 4.385 4,750 5.133 5.482 5.376 5.315, 5.301pwtmaxq "usplaa Cvrso g.ats. hi 34.4 d1.4 163.5 138.8 68.0 74.7 43.9 68.4 103.3 W2.5 133.7

Sae. of Payments$ampong GM1 (we Sa n%rou we:.) 18.1 2.2 1.7 6.3 9.2 8.4 4.7 4.7 4.8 8.6 C.SEaports of GMIC/OMMc GOP 14.1 11. 10.2 10.3 t0.? 10.9 1U. 11.4 Lt.? 13.0 12.3Zmpowte GM1 (weal, poth rae.) (2.8) 85.7 43.3 1.3 3.3 4.8 4.? 4.4 4.8 4.6 4.9Zmpowt. at 05Ysic.awweZ GOP 8.? S.? -11.5 11. 10,? 10.7 10.8 10.8 10.9 10.9 11.0Trade SLalem (05$ mllS..) 6,151 4.007 (1.139) (384) 576 981 1.422 1.923 2.311 3.179 3.938Cuwwemt Ae.0mm: lal... (05 .11L±..) 1.754 (2.748) (8.771) (5.543) (5.400) (5.S448 5.) (8.045) (5.762) (5.576) (5.2334Capital Accouct S&l.... (064S .1111.. 704 5.453 9.670 9.351 8.300 6.448 8.757 4,845 8.583 4.378 8.034Public (493) 3.749 145 3.142 (450) (114) (334) 2.029 966 339 (87)Privet. 1.197 1.704 9.725 8,309 .4,49 4.561 7.091 4.618 5.594 4,031 8,101

Cuwweat usouat D&LaaceIOnvuwr GDP 1.? (2.0) (4.4) (3.3) (3.0) (3.9) (2.6) (3.8) (2.3) (2.1) (1.6)

Debt Zndlaatorv,Total. Debt (04 millIon) 83.534 87.399 91.429 91.214 98,364 101.403 104.430 10.6.03 110.399 111.851 111,791Total PubIlo Sector Debt 80.745 83.145 9. 187 75.944 76.363 18.981 77:21 77.139 78.346 74.444 71.751Poweu Debt 57.#39 40.645 40.530 40.103. 59.957 59.763 39.086 80.305 80,771 80.133 56.731Oo.e.tS Debt 2.906 2.300 1S6,37 15.841 14.325 17.176 16.130 14.634 15.573 14,30? 13.020

Tot"l Public ObtlCuwrfot GOP 37.8 44.8 51.7 . 45.0 41.9 39.1 34.4 33.7 30.9 27.9 24.9.tote) Debt SezvtcelCufVent GDP 11.4 6.4 5.0 4.6 5.1 5.3 5.9 8.9 8.3 4.2 8.1

Preferred Creditow DS/GDP a/ 2.7 3.1 3.0 2.8 2.6 2.9 3.0 5.7 3.3 3.3 5.0pwefewwed Creditor 06SIGOv.ment &W.eat 4i 19.3 20.7 14.3 14.0 14.9 15.8 18.2 20.3 17.7 17.3 18.2Ps Coverage Ratie tog Pwef '. Cweditow 138.4 179.3 354.9 397.0 187.2 151.1 184.5 147.5 205.3 249.4 276.3

Domeatit taflatlo ZUdeg (eamal, M) 1902 139 11.3 7.0 3.9 3.6 3.6 3.6 3.8 3.8 3.6tea, Inachase Rate W8as (1867.100) 61.1 89.0 63.9 85.6 83.9 85.9 43.9 85.9 *45.9 65.9 43.9LIMO ./ 6.9 7.3 3.8 4.5 5.6 4.2 8.6 7.0 .' 7.0 7.0 7.0

KllCurent GOP ~~~~ ~~~3.0 5.6 7.0 7.1 7.1 7.1 7.1 7.1 7.1 7.1 7.1

&I Transfer 08 pseifiecal eapondltuwe to the Tweaeuq la 19901 Icluoade PS Inttewet paermleatbi PrlsawY Suwluo/a,Oemaue mas faoreI Interst PeymeateO X.8 thePbIc Sector.a/ Prefecrrd Ot"wedtr ane ViorA Bank. Iff. us, 3015. .04 SG~U. d1 Gove,iut rewome only Ssel.des national, edeilaUtwtlon revenues.'IPeriod *"aveaeL3O

ANNEX NlARGmNMA

COM REDU O FROMt MAO ' -=*8 _Mm

(IOU~~~~~~~~~~~~~~~~~~~

I .TERF'Ries PARTK IPANTS CASH OE81 FORM OFRI__AIA DFn COOEIRSION PRVATIZAnON

i!LECOM -6 % (Pveto Ineseio ledARGENTINA by Stet/Teleoom)(Nwtsmn - 30% Loaslhter. PdvatRegion) Invstwoi

Paste - 10% Evr4lsyase sale2,370. 6,000.0

TELEFONICA -60% (Pihae hwt_ OmupISouhen led by TweronlRegio - 30% Locallinter. Fdvet

kIvestors_ 10% Eu*kye

*Ibeas 1130%) 260.0 1,610.0-Dana. Hspano Amlano (19%) h

Aercin Argets * -Looml Iestos 13% Sale(65%) -Emploe (10%1

_-OA (6%)

YPfIConl AMt .I _Ma 1,100.2 JotVanui

YPF/Seoonday as (5 mgna 410.0 Ouiee.

Ragroads (Dea. Rasuo-BaNs S -. Conce.

I a. .___.

Rdb and Television To 139 . C .

Real Estate 430 buddns and 98.6 _ Sl

ia Liso Hotel Chmop (33%)! C-r a.e bn. 133%)-Co1ps 133%) 3.7 12.0 Sal

SEGMa Centl PUert SA.A Clgeer S.A.. Campania Chlea de 92.2 . Sal

Oltbuclan Es Quint. Regionnd a ChietaGunf Region

* Cental Costane S.A. - Ed... Erneis. kite-Ro holdn estab_shnint. 90.1 Sale of eo0Costan Powe Corp.

* EDENOA, S.A. Asa. ESleolcite de Fanoe, Endf 30.0 397.9 Sa at 51 11* EDESUR. .A. Pa Co-panl. PSI Enrgy Inc.. Ensiur 30.0 481.0 Saeb 'e61 %

_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ ends".

Mbdstrv Of Ddf

* P.toea Art in SaNsBlance

- Pollst *pkko S.A. 14.1 41.0 Sae* Monoame Vinllco. S.M. V-i alo S.A. 0.3 26.5 Sal

Petrpol S.A. - bIAdupa S.A. 4.5 1L2. Slebduc S.A. - bnduPe SA. 17.0 60.6 Sal

C Petqulerla Rio Tes-o -Sung Bomn lAtanuo- 7.3 . Sal

* raaot - sanco Holandes Unddo-CIASAR.Sud Maine 69.8 Sale

Enterprifse 90% 9

* Alto* Manws Zpb - Aubet & Duval S.A.. SIMA. Cilop Vantue 33 29.7 SaleCapil S.A., Pens S.A. V Pe1nfi S.A.

TOTAL ,,._ 4.514.8 7.660.8

' graludesWs u938 nilliun in n a a3A inie nhe m RoONne sowslii ab l In _ _i E e _xcie nrmeta to US$700 niKon In capktal lpOf*`V*efMets ~ 7 yeas.

gi The puma onso,mlum ha ben selected, but the trasfr of *ste hae vet to o°ur.gI Of te twta, USt 7.2 was paid In cash and the balance wil be paid h9 yea9s wiAth 3 ya of gtaSource: Seotetay of Pdvatizatfn, Argntdm Gvn _enn ad Wodd Bank ataf.

ARGEN NASECOND PUBLIC ENTERPRISE REFORM ADJUSTMENT LOAN

MINISTRY OF ECONOMY - STATUS OF RESTRUCTURING AND ERIVAnZATION PROGRAM

mai Pula9tzat Soops of Pladtton Proamn Slctdon of Adviors Amounts Finanin Sourcein 199 2 _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

an del Estado - Conceson of Gas pipenes -Techtia ed Economei Consutants: US$2.0 miion - Eising nk Loa (GtUtAI No.- Gas prooessing Stone & Webstr Pistralli; nd Dian Assoo. 2592-AR- Concesaion of the distibuton syten

-nvestnt Banker: Roths¢h Id ond Sons US$OS nilion - Exisng Bank Loan (GUTA)Ltd/Goldmrn, Sachs & Co.

* Lawys: Marve O'Farral & Miral and US$2.0 nilion Exisenf Bnk Loan lPEPEUAndrews end Kurt

-Other Pocss Co-ordinationl: Dloitte US$1.4 nlion' - Existing Ban Loan (GUTA)_ __ _ end Touche and Azula_

YPF - g 9.8 o ea fieds to be exploied under concession - Vaious technicda. eoonomic, finania and - Total pro*ram Exting Bank Loan GUTA No.regime. leg adisors for each of the privetizton USS28 nidlion 2592-AR- mocleton in ain ollss fis under UTE (JVI. steps- explrtion atea under Houton aes.- expitatdon of selcted oi fideds.- stocks to be sold in domest end nterntiond

- refinew nd mrnkedng oudets.- piplines of conoesslons of o7i transportation of

Sepa - Concession of distrution networks - Tehrical Consutants: Hydro4uebe¢ USS2.3 nmo - Existin Bank Loan. SEGBA V- Pdvoation of Thermal generation (Ague y Energial Loan No. 28S4-AR.

- investment Banker: First BostonKidnwort Benson US$2.7 millon - EAsiteg Bank Loan SEGBA V

- Lawyer: Brons & SalesUS$930,000 -Exsting Bank Loan SECBA V

- Others: None _ _ _ _ _ _ _ _ _ _ _ _

AyE end Hidronor _ Th_mal geration -TA from IDB lUS$14 miiotn)

OSN -Concssion of water treatment - Technicol Consultants: Wilion Hderowe US$1.8 nilrion - Esdting Bank Loan 2641-AR- Water piants & distribution In Buenos Aires. Partnes U

- Investment Banker: Pariba

- Lawyers:to be provided by HeNcrowe andPadbasX

A . and_ _sububnr__ __ _ ._

PA - Freight and sutburban lines

ANNEXtIVARGENTINA

SECOND PUBLIC ENTERPRISE REFORM ADUSTMENT LOANJOB REDUCTION PLAN FOR THE MINISTRY OF ECONOMY PRIVATIZATION PRO1GRAM - June 1991 11

PO UNDER THE PiESENT ESTIMATED COST OF PERCENTMiNiSTRY OF ECONOMY WORKFORCE REDUNDANCIES INDBENITY DISTRIB.

(US9 MUlilon) OF REDUNDANCIES

A. POWER SECTOR

Agus V Energra Eldctrica 11.462 3.000 51.2(AVEE)

HIORONOR 1.691 300 3.1Serviolos ElEotrloos del GranBuenos Aires (SEG6A) 20 672 6 66.1

Subtotal 33.825 8.300 120.4 11%

S. Hydrocurbon & Enrgy

Gas del Estsdo 10.670 2,000 14.4Yacmirentos Carbontferos

wsales (YCF) 3,099 500 2.5Yacimientos PetrolfferosFecales (YP) 37224 20000 230

Subtotal 50.993 22,500 246.9 29%

C. Trarnsprt & Telecomurloations

Administracl6n General dePuertos (AGP) 3.191 2.000 37.3

Empress de Uneas MaiitimasArgentinas (iLMA) 4.506 2.500 32.2

Emprosu Naoconal de Correcsy Telagrafos IENCOTol) 3S.991 10.000 72.0

Ferrocarriles Argentinos (FA) 87.480 29.00 200-0

Subtotal 131,168 43.500 341.5 56%

D. Water & Saniaton

Obras SwnitArias de Is Nadoon(OSN) 8,396 3.000 45.1 4%

TOTAL 224,382 77.300 753.9 100%

.t/ Since the reductions are from June 1991. they omit substantial past reductions.fA has already shed more than 15.000 workors. and YPF more than 6.000.

Source: Miniotry of Econony.

ANNEX VPage 1 of 2

ARGENTINASECON D PUBLIC ENTERPRISE REFORM ADJUSTMENT LOAN

INVENTORY OF PEs UNDER MINISTRY OF DEFENSE(As of March 1992)

L Total number of PEs . ......................................... 45

II. Industrial Oriented PEs ................. ........................ 24

o PEs sold - Law 23,696 .......................................... 7- Polisur- Induclor- Petropol- Monomeros Vinilicos- Tandanor- Petroquimica Rio Tercero- Altos Hornos Zapla

* PEs closed by March 1992 ....................................... 2- Meteor (Decree to be issued)- Hipasam (Decree No. 160)- Sidinox (Decree to be issued)2

* PEs to be privatized - Law 23.696 .............................. 2- Carboquimica Argentina- Fo4ia Argentina

* PEs to be privatized - Law 24.045 ................................ 13- Somisa- Petroquimica Bahia Blanca- Petroquimica General Mosconi- Area Material Cordoba- AF.N.E.- Domingo Matheu- TAMSE- FM de Vaynas y Conductores - ECA- FM San Francisco- FM San Martin- FM Acido Sulfurico- FM Tolueno Sintetico- FM Rio Tercero

1 Includes 4 recently transfered PEs from the Air Force (Decree 161/92 of January 23, 1992).

2 SIDINOX, a 'paper' PE which was never operational, is not included in the totals.

ANNEX VPage 2 of 2

- FM Rio Tercero- FM Domingo Matheu

mII. Other and Defense Oriented PEs ........................................ 21

* PEs under liquidation as of April 1991 .............................. 6- Ind. Mecanicas del Estado (IME)- Empresas de Desarollos especiates SA. (EDESA)- Aceros Ohler- Consultora S.A.- Sidinsa SA- Altos Hornos Zapla Construciones SA

* Defense related PEs .......................................... 11- FM Pilar- FM Azul- FM Luis Beltran- FM Villa Maria- Sa ecna- Domecq Garcia- Sisteval- Tecnologia Aeroespacial S.A. (TEA)- Complejo Industrial Ramallo - San Nicolas- Centro de Exploracion Geologico-Minero- Administracion COMIRSA

* PEs tranfered from kir Fore - Decree 1692. 4- Interbaires- Intergargo S.A.- Empresa de Cargas aereas del Atlantico Sud SA- Integradora Aeroespacial SA (INTESA S.A)

ANNEXVARfENTINA

SECONQD PUBLIC ENTERPRISE REFORM ADJU$TMENT LOAN

FINANCIAL PERFORMANCE OF PEs UNDER MINISTRY OF DEFENSE(As of December 1991, in US$ Millions)

Public FinancialEnterprise Assets Liabilities Sales Result'

A. Industrial Oriented PEs

I. Stee Sector

- Somisa 1933.1 925.5 469.5 -254.4- Altos Hornos Zapla 348.1 179.1 51.8 -32.0

Subtotal Steel 2281.2 1104.6 521.1 -286.4

lI.industrial PEs

- PGM 664.8 202.4 106.7 -93.9- PBB 368.0 48.6 71.5 75.5- Carboquimica 6.5 0.8 5.4 0.1- FM Ac. Sulfurico 14.9 3.3 6.6 4.5- FM Rio Tercero 126.3 30.4 22.2 13.0- FM Tolueno 10.7 12.6 12.9 -5.4-AFNE 31.1 27.5 1.3 -4.8- ECA 117.9 33.7 27.3 -35.1-FM San Fco. 17.9 1.4 2.3 40.2- FM San Martin 55.1 6.8 1.8 5.8* Forja 19.7 28.9 8.9 -2.9- FM Matheu 56.3 6.6 2.3 -5.4- Tamse 381.1 245.4 0.0 -112.2

Subtotal Ind. PEs 1870.3 648.4 269.2 -161.0

Subtotal (I) + (II) 4151.5 1753.0 790.3 -447.4

B. Defense Oriented PEs

- Domecq Garcia 24.7 32.1 1.5 -11.2- FM Azul 17.1 0.8 2.7 -2.4- FM Beltran 46.4 6.3 7.7 -8.6-FM Pilar 8 5 1.6 3.2 0.6- FM V. Maria 3.3 5.5 -8.0- TEA 1.4 0.0 0.1 -0.5-Sisteval 1.9 0.7 2.7 0.0

Subtotal 113.9 44.8 23.4 -30.1

Total 4265.4 1797.8 813.7 -477.5

Note: * The final result includes overhead costs and the effect of inflation.Source: Ministry of Defense.

ANNEVIPage 1 of 2

ARGENTINASECOND PUBLC ENTERPRISE REmRM ADlUSTMNT LOAN

TECHNICAL ASSISTANCE FOR THE MINISRY OF DEFENSE REPORM EROG

TECHNICAL ASSiSTANCE UNDER PEREL US$

Previously Allocated 950,000

Reallocation during Appraisal 800,000

TOTAL 1,750,000

Proposed Assistance Under PEREL for Defenses Privatizations:

PEs AMO STATUS

* PBB 450,000 First Boston; amount fiwed

- PGM 300?000 First Boston; amount fixed

* SOMISA 370,000 Salomon Bros; amount fixed

* REAL ESTATE 180,000

Sub-total 1,300,000

Proposed Assistance Under PEREL for Non-Defense Programs:

ACTIVrllES AMOUNT STATUS

* Draft Anti-Trust 300,000 Team of international and localLegislation consultants selected

* Social Impact of 100,000 Consultants and amountLabor to be determined

3 Environmental 50,000 Consultants and amountAudits to be determined

Sub-total 450,000

TOTAL 1,750,000

Page 2 of 2

ARGETNSCOND PUBLIC ENTlERPRISE REFORM ADJUSTMENT LOAN (PERAL II

TECENICAL ASSISTANCE UNDER JAPANESE GRANTS USS

Previously approved 1,800,000

Under approval by GoA 1,370,000

TOTAL 3,170,000

Proposed Assistance for Defense's Privatization:

m AMO STATUS

* SOMISA Study 700,000 Completed by Braxton Assoc.

- AHZ -.:pxate Study 75,000 Completed by Booz Allen

* Steel Sector Study 25,000 Completed by localConsultant

* AMC 350,000 To be determined

* AFNE 350,000 To be determined

* Real Estate Sales 420,000 To be determined

* Privatization Unit 500,000 To be determined

Sub-total 2,420,000

Proposed Assistance for Non-Defense Activities:

ACrfVIfl AMOUNT STATUS

* Bank Restructuring 500,000 Partially completed

* Privatizations 250,000 To be allocated after approvalin Economia

Sub-Total 750,000

TOTAL 3,170,000

SECOND PUBLIC ENTERPRISE REFORM ADJUSTMENT LOAN

JOB REDUCTION PLAN FOR THE MINISIRY OF DEFENSE PRWATIZATiON PROGRAM(September 1992)

Public Ne.pooyees Panned Redut Esimated Avg Cost Boo de laEnterpdse Sept 1991 Reducion Achieved Cast Indemndty Nacon

(USS 000) (USS 00N)

A. Bank Supported Enterprises

L Steel Sector

-Somsia 13,970 8,467 8,467 169i221 21,153 141,914- Altos Hor k Zapls 3,071 2,189 1,484 24,470 11,179 22,695- Hipasam 1,370 1,370 1,369 12397 11,600 12;396

Subtotal Ste 18,411 12,026 11;120 206,088 17,829 177,00S

- POM 1,094 328 181 10,182 31,043-PBB 383 0 14 0 39,763* Carboqulanca 75 0 0 0 14,S2-* FM Ac Suludco 70 32 19 366 11,441- FM Rio Tercero 1,168 823 247 10lS61 12,832- FM Todweno 135 62 30 670 10,809- Area Materda Cordoba 2,950 1,500 157 9,779 6,519- AFNB 2,246 1,000 140 12,279 12;279 2,400- FM ECA 1,006 373 160 4,032 10,809* FM San Foc. 245 147 S8 1,715 11,60- FM San Martin 498 428 272 4,577 10,695- FBrja 419 419 189 4,494 8,740 2,S00- FM Matheu S63 178 113 2289 12,8S8* Tacs 2S9 259 138 2,S95 10,019

Subtotal Ind. PEs 11,111 S,S49 1,718 63,539 4,900

Subtotal (1) + (11) 29,S22 17,575 13,038 269,627 l15,59 181,905

B. Other Ea not Supported by PERAL 1

. -omecq OGcia 504 S04 6S 3,313 6,578- FM Azul 307 192 141 2,390 12,449-FM Beltran 850 526 247 5,319 10,113- FM Pilar 118 Si 21 903 17,713- FM V. Mara S62 363 IlO 3,508 9,665- TEA S 5 2 52 10,329- Sal 83 83 0 1,094 13,183- DGFM staff 376 286 90

Subtotal 2,805 2,010 666 16,581 10,9S4

Total 32,327 19,58S 13,704 286,208 15,154 18W05

Note: * The toal in this column ealudes US$1.7 million paid to DGFPL

ANNEX IXPage 1 of 3

'I II S I

a III II 00 I

U jill liiiOw

I S

I I.y

aI § Ii 1111 *1 II [ji I JI� �jist �iii *i 1111Id I IJffIi� 0 0

U

IIIIIi I'5

.1 f Ij(!iIJi iii ii iii i Iii

ANNEX IXPage 2 of 3

I

.1.II

S

Ii I�i U I

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II�

I � .rn I1g. 42 00Sf1

ill@00

II79

Ii

ANNEX IXPage 3 of 3

.~ ~ ~ ' . _1

| ffi 13 P lt } ] 1 12] 2~~~~~~~~~~~~~0.

b

I'i,',

Sti£wdealo de a,m/ . : ANNEX x.* y 7-}4wy CfuGctod EzAco} . ~~~~~Page 1 Of 7;

ARGENTINASECOND PUBLIC ENTERPRISE REFORM ADJUSTMENT LOAN (PERAL Il .

LETTER OF DEVELOPMENT POLICY

Mr. Lewis T. PrestonPresidentWorld Bank

* Washington, D.C.

Dear Mtr. Preston:

*- tI. Thist Letter of Development Policy describes theoverall economic reform program of the Argentine Government aswell as specific steps to deepen further the reforms in publicenterprises. To mneet these objectives. the Governmentrequests for cortinued technical and financial asistance fromthe World Bank for its full implementation. We would like -totake this opportunity to alto present the ioacroeconomicframework which compl enents the reform programn.

Mac rof onomic Fro

2. Price uttability remains the centerpiece of theGovern )ent's economic progra. in achieving sustAined ;rowthand productivity. Toward this end, the Government' has madeImportant. progress in 1990 and 1991. Monthly price increases:dropped from over 30' at the beginning of 1991 toapproximately international rates by mid-1992.- Altthoughconsumer price inflation rose in the first quarter of 1992,. asa result of demand pressures associated :with'. the strongrecovery in 1991, the increase in the valuep-added tax (VAT) by2 percentage points, and seasonal factors,, thoe-Governmont hasdesigned its monetary and fiscal po*icies with .the objectiveof reducing Inflation to international levels for t1ieremainder of 1992 and into 1993. The' Gove'rn'mnt intends t^achieve an operational primary surplus (bofore.asset-sales) ofUS$3.0 billion in 1992, IJS$4.4 billion in 1993, and US$3.6billion in 1994. These amounts have-been calculated to besufficion' to service projected interest obligations once a;debt reductIon arrangement has nbeen. conc'luded and areconsistent with projected available finarcing. If theselevels of primary surplus prove insufficient to obNsiateinflationary financing the Governmwnt will undertake. fur,therfiscal adJustments. Monetary policy,, consistervt with the .Law'of Convertibility pa%sed in April 1991, will be designed tou*pand the noney base r.onsistent with increased money demiandresult li,iQ from real growth and. internatlonal Inflation, andthe associated increase in net Internationa-l rwserves.

_ . .~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~A

ANNEX XPage 2 of 7

3. Price stability and sustained recovery of growth will

be achieved only if lasting structural reforms are undertaken

in the public sector. The Government's overall reform program

in achieving its objective of price stability is embodied in

two broad areas: (i) structural improveoents in the public

sector - improvements in fiscal management, revenues and

expenditures, further deepening of the privatization program

extending to public enterprises primarily under the tutelage

of the Ministry of Defense, improved efficiency in provincial

governments, and the reform of the social security system; and

{ii) policy reforms that would foster private sector activity

- continued commitment to maintenance of flexible and open

markets free of domestic regulations and major external trade

barriers, and with a strong financial sector to improve

intermediation.

Structural Improvqiments in the Public Sector

Federal Public Finances

4. The Government has given increasing attention to

structural improvements in public sector revenues and

expenditures.

(a) Federal Revenues. The Government in December 1q89

implemented a major tax reform that improved

efficiency and provided additional revenues from the

VAT; the legislation would be maintained without

allowing additional exemptions. The Government has

provided fiscal bonds for firms, including tho-e in

the steel secto-, that received special promocionaltax incentives and reduced benefits for firm'3 thathave not complied with original contractualobligations under the promotion regimes.

Capital revenues from the privatization of publicenterprises and concessions, which yielded Jb%$3.3billion in cash and an additional US$7.2 billiin in

debt reductions in 1990-91, are expected to generateabout U5$1.9 billion in 1992, and will continue to be

used to reduce debt (external and internal) or for

labor indemnizations rather than spent on recurrent

costs; funds from defense privatizations will be usedfor extinguishing liabilities of the governmentincluding labor indemnization.

(b) Federal Expenditures. The Government has given

increasing attention to restructuring the Federal

Government. The program includes, among other

things: (i) improvements in the incentive system

ANNEX XPage 3 of 7

y vetwiy Q9ewiWeAs Gp4Oae

facing federal workers; (ii) reductions in federalemployment in the central administration anddecentralized agencies other than teachers and net ofincrease in D6I staff of about 120,000 by end 1992,comparing with the 1990 program base; and (iii)establishment of a modern civil service paymentssystem. To improve its expenditure controls andbudgetary processes, the Government has submitted toCongress a modern law of Financial Management andPerformance Control that will provide comprehensivebudget limits for the entire nonfinancial publicsector, and an adequate internal control systems andex post external auditing. The Government intends toimplement the law in 1992. Futhermore, theGovernment is preparing a Law of Public Procurementand Asset Management, which will eliminate many ofthe distortions contained in the Buy Argentinelegislation. At the same time, the Government hasintroduced changes in cash management and accountingsystems, placing government accounts on a moretransparent basis.

For 1992/93, the Government will ensure thatexpenditures are consistent with its projectedprogram, or less, should projected revenues notmaterialize, as provided for by Decree 1823/91. For1993, the Government intends to propose a budget toCongress that maintains current expendituresconsistent with those in its three year program, andthat continues its efforts to improve the quality ofexpenditures.

Public Enterprise Reform

5. The public enterprise sector has long been a sourceof deficits and economic inefficiency in Argentina. Since1989, the public sector has been the object of far-reachingreform which has taken the form of substantial reductions inspending and in the fiscal deficit, as well as rapid andeffective progress in privatizing state companies. Theprivatizations of large public enterprises initiated in 1991,will be completed by 1993 for the Railway and Hydrocarbonsectors.

6. This reform program is now extended to all the publicenterprises within the Defense Complex. In 1988, Argentinaallocated 3.1 percent of GDP to defense expenditures. TheGoverTr-mnt has embarked on an ambitious program to reduce and

n ffi maintain defense expenditures at 2 percent of GDP. To achievethese objectives and efficiency levels, the Ministry ofDefense has decided to privatize virtually all productiveenterprises uInder its auspices, and intends to avoid enteringinto direct production under its tutelage in the future.

ANNEX XPage 4 of 7

QjXs.k h; g'c.tia

Y Awv amw adar

7. These are currently 45 enterprises within the DefenseMinistry in steels petrochemicals, shipyards, and variousindustrial and defense-related activities of which 23 PEs arethe focus of Bank support. The steel sector is the mostimportant, accounting for more than 50 percent or more of theemployees, assets, and sales of the combined defense PCs.Furthermore, the steel sector is the most complex in terms oflabor unions vested private sector interests and policydistortions. Of the total number of PEs, 7 have been sold, 2closed, and the remainder are at advanced stages ofprivatization. SIDINOX, a "paper" created steel PE that wasnot operational, will be legally closed. The remaining 12enterprises will be privatized and/or closed. Theseprivatizations have helped reduce current expendituretransfers to the enterprises and lower the size of the debt assome of the sales have involved debt conversion programs.

8. The administrative reform program has resulted in alarge number of lay-offs. In spite of these redundancies, theunemployment rate in the Metropolitan area of Buenos Aires hasdecreased from 8.9 percent in May 1990 to 5.4 percent inOctober 1991, as economic activity increased. To providecushion for the social labor adjustment, the Government willprovide workers with severance payments as part of the agreedprogram and would provide for a transition period untilworkers find new jobs. However, a large number of publicenterprises were considered of "strategic" importance and werelocated in remote border areas of the country. The Governmentwill study the social impact of the public sector reformprogram on the labor force, with special emphasis in theremote areas where some of the key defense industries arelocated.

9. A number of PEs within the Defense Complex have hadadverse environmental effects. The Government has appointed anew Secretariat for the Environment responsible for draftingnew legislation and enforcing better environmental standards.This Secretariat has undertaken a number of environmentalaudits of selected. PEs (i.e., those most environmentallyunsafe and closed). The sales memorandum of selected largeenterprises has included environmental audit results in makingnew private owners follow an agreed program to addressenvironmental deficiencies. In addition to the privatizationeffort within the Ministry of Defense, the Government intends

ff to undertake reform programs in the military complex includingthe sale of real estate belonging to the armed forces.

10. In addition, three other areas of the reform programf / for 1992-93 include measures to increase efficiencies Inprovincial finances, the social security system and the

ANNEX XPage 5 of 7

y o-ei eV9e-wwiod 9h'cs

financial sector which are being addressed separately underBank assistance.

Provincial Finance

11. Many provincial governments are undertaking their ownfiscal and structural reform programs in tax collection,reductions in staffing levels, privatization of provincialenterpises, and reduction of current expenditures. To supportthese measures, the Government has provided additionalresources as envisaged in existing anp new taxes, maintainedrestrictions on credit to provincial banks, required privatelenders to provincial to governments provision their new loansat 100%, and restricted exceptional transfers to provincialgovernments.

Social Security

12. The Government intends to submit legislation toCongress that would transform the pay-as-you-go system into apartially capitalized system cum minimum pension. The newsystem is anticipated to be in place in 1993. In the shortrun, the Government will improve collection and management ofthe present system, with the objective of raising new revenuesand reducing evasion.

II. Policy Reforms for Promoting Private Sector Activity

Maintenance of an Open and Flexible Economy

13. For the past several years, especially since 1989,Argentina has been engaged in a major overhaul of its economyin order to eliminate tne institutional obstacles that haveconstrained the flexibility and responsiveness of the privatesector. Trade liberalization, public enterprise and openmarket reforms constitute the new direction of the economicprogram.

(a) Trade Liberalization: The Government has made rapidstrides towards opening the economy, both in terms offlows of trade, capital, and technology. The importtariff structure was simplified and lowered; importtariffs are now 22 percent on finished goods, 13percent on production inputs, 5 percent on primaryproducts, and have been eliminated for capitalgoods. Export taxes have also been eliminated,non-tariff barriers to imports and exports have beenreduced, and virtually all restrictions anddiscretionary procedures that slowed the entry of

v' <trade, capital and technology have nearly

\~~~~~~~~~~I

ANNEX XPage 6 of 7

eA nak. we wcanoamia

eoAy ee9 t,uwi e%4&Oa

disappeared. The Government intends to maintain,with no reversal, its open policy of its economy tointernational competition, including steel andpetrochemical product groups, and the antidumpingprovisions will be consistent with the GATTAnti-Dumping Code. Moreover, the MERCOSUR treaty isnow being implemented. Two regional tariff cuts havealready taken place, and it is the Government'sintention, as specified in the Treaty of Asuncion, toreduce all intra-MERCOSUR tariffs to zero by January1995, while eliminating all other intra-market tradebarriers.

(b) Open market economy: The Government has eliminatedsubstantial controls on prices, wages, and interestrates as well as a complex network of subsidies andimplicit taxes. Much still remains to be done onstate reforms and opening of the markets. TheGovernment's reform program is not only to reduce thesize of the public sector, but also to avoid thetransfer of public to private monopolies whenattracting new capital, management and technology.To complement other pro-competitive initiativesalready undertaken-trade liberalization,privatizations, deregulation- the Government intendsto improve the existing competition Law to avoidundue ownership concentration and be more proactiveto ensure a dynamic and competitive private sector.

Financial Sector

14. To accelerate private sector investment, improvefinancial sector performance, and encourage efficiency in theallocation process, the Government intends to undertake majorreforms in the financial sector. Within the financial sector,the Government intends to reduce the size of public sectorinvolvement in banking (through privatizations, closures, andbank restructuring), and will promote competitive andefficient financial intermediation (improved crediteligibility, supervision, etc.). The downsizing of the publicbanking sector will greatly itself contribute to macroeconomicand price stability.

World Bank &5MlZrt

lS. The above presentation demostrates the depth of theGovernment's overall public sector reform program. TheGovernment believes that financial asistance from the WorldBank is essential to implement its public enterprise reforms,especially for PEs within the Defense Complex. In particular,

'A.

ANNEX XPage 7 of 7

sAinialeMp4 de canom/a

ah "y aet?,iriad'A wa.iro

it is the intention of the Government to use the counterpartfunds generated from the loan as one of the sources to financethe Government's staff reduction program, as well as fundsfrom other technical assistance sources to finance thedrafting of new legislation and other technical assistanceneeds required for the success of the program. The Governmentwill also use US*10 million of the proposed loan for theenvironmental cleanup of the Defense Complex's closedfacilities. Finally the loan will clearly assist theGovernment in regularizing its external debt obligations underft/ the recently signed agreement with its commercial creditors.

Sincerel ours, Sincer yours,

Xs ister of Defense er of nomy

December 4, 1992

ARGENNSECOND PBLIC ENTERPRISE REFORM ADJUSTMENT LOAN

THE USATUS OF IBRD OPERAIONS IN ARGENTINASTATEMENT OF BANK LOANS (as of September 30, 1992)

Loan or Amount (lessCredit Fiscal . cancellations) UndisbursedNumber Year Borrower Purpose (US$ million) (US$ million

Fudly disbursed Loas (32) 3,174.9 0.0

2592 1985 YPF Gas Utilization &Tecbn. Assistance 180.0 35.6

2641 1986 Argentina Water Supply 60.0 36.02751 1987 Artenna Power Engineering 14.0 0.22793 1987 Argentina Small & Med. Scale Cr. 68.1 4.32854 1987 Argentina Power Distribution 276.0 169.22920 1988 Argentina Municipal Development 120.0 94.72970 1988 BANADE Agriculture Credit 106.5 1.02984 1989 Argentina Social Sector 28.0 13.02997 1989 Argentina Housing Sector 30.0 0.63015 1989 Argentina Tax Admin. T.A. 6.5 1.03280 1991 Argentina Provincial Development 200.0 195.53281 1991 Argentina Water Supply 100.0 99.03291 1991 Argentina PERAL 300.0 148.43292 1991 Argentina PEREL 23.0 17.73297 1991 Argentina Agricultural Services 33.5 29.93362 1991 Argentina Pub. Sector Reform T.A. 23.0 20.03394 1992 Argentina Pub. Sector Reform (PSRL) 325.0 162.53416 1992 YPF Sociedad Hydrocarbon Engr. 28.0 24.0

Aoliima3460,1/ 1992 Argentina Second Tar Administation 20.0 20.03520 V 1992 Argentina Yacyreta U 300.0 300.03521 V 1992 A.getina Flood Rehabilitaion 170.0 170.0

TOTAL 5,586.Sof which has been repd 1,722.1

TOTAL NOW OUTSTANDING 3,864.4

AMOUNT SOLD 12.8of which has been repaid 12.8

TOTAL NOW HED BY BANK AND IIDA 3,851.6

TOTAL UNDISBURSED 1,542.6= =

1/ Not yet effectiveZ! Not yet signed

ANNEX XIIARGENTINA

STATEMENT OF IFC INVESTMUiN'TAs of September 30. 1992

Orinl Grows Commitment Held Hold by Undisb&rwedFiscal Year IFO IFC Partiel- by Patiol- (IWudingCommitted ObIgW Type of Busins Loan Equity pant Tohl IFC pantB PtcIpant)1960 a/ Acitndr SA. Steel Products 2.90 - 0.78 3.6 - - -1960 a/ PapeleraRioParanaSA. PulpandPaper 3.00 - - 3.00 - - -1961 a/ FadoaaS.A. Motor Veh.&Acces sorio 1.23 - 0.28 1.51 - - -1982 at Pa aSAIC Pelrochemicals 3.05 - - 3.05 - - -1965i72 a/ Celusa Argentina Pulp and Paper 8.25 - 4.25 12.80 - - -1969 al EditorialC*dexSA. Printing and Publishing 4.80 2.00 0.40 7.00 - - -1986975 a/ Oalmino .Sidersa SAIC Iron and Steel 14.75 - 2.25 17.00 - - -1971/73 a] CletaAvellanoda SA. Cemont 5.50 - - 5.50 - - -1977/84/8688 Alpargatas SAIC Texbis and Shoes 37.93 8.00 7.5C. 50.43 19.35 - 1.631977/85 at Soyex SA. Food and Food Process 21.00 - - 21.00 - - -1978I81//82/87/93 Juan Minetti SA. Comont 35.50 4.50 87.50 107.50 16.60 14.53 4.501978i85/87/88/91 MaaauhSA. Pulp and Papw 24.50 4.25 3.00 31.75 18.40 - 0.081979/8V87/92 Ipako SA. Pelrochmlicats 21.00 1.10 9.00 31.10 1.00 8.25 0.001979/83/84 AlpeseaS.A. Food&FoodProces 5.21 1.60 - 0.81 1.61 - -19841U8 Petoimica Cuyo SA. Chemicals & Petochem. 21.00 4.00 21.09 44.09 14.55 11.84 0.401980 Ropasa? Capital Makets - 0.05 - 0.05 0.05 - -1980 a/ AtanorS.A. Chemicals 7.00 1.00 - 8.00 - - -1986/87 Sadicar Capital Markets - 2.05 - 2.05 2.00 - 1.001986/89/91 Banco Robers S.A. Capital Markebt 26.00 2.00 - 28.00 16.57 - 7.401987 GarovaglioyZorraqufr GeneralManufacturing 13.00 - - 13.00 7.58 - -1987/90 Hidra Oil Crude P.tol. & Nat. Gas 80.00 - 27.60 107.60 13.91 3.841987190/91 Tertnbin6SA. PortFaculties 12.50 0.00 0.00 12.50 8.54 0.001988 AdtraCAPSALindero Energy 12.38 - - 12.38 3.75 - -1988 Sung. y Barp Food and Food Process 40.00 - - 40.00 24.00 - -1988 ArcorSAIC Gneral Manufactuting 12.00 - - 12.00 6.00 - -1988193 Bridas Lindero SAPIC Energy 55.60 15.00 60.00 130.60 80.00 - -1988/89 aGN 0ev. Finanoe 20.00 - - 20.00 16.89 - 3.401988192 8anco Rio CL (BRLP) Dow. Finance 50.00 - - 80.00 47.00 - 18.0519888,92 Chlrete Chemiicat & Petrochem. - 6.62 - 6.02 8.61 - 1.881989 Corn. General de Inveariones Financil Services - 0.10 - 0.10 0.10 - 0.091989 Chlhktdos Energy - 4.95 - 4.95 4.95 - 0.121989 AIC SecureiPinanciallnstL - 2.00 - 2.00 2.00 - 2.001989 BancoFances Dev. Finnce 15.00 - - 15.00 15.00 - -1989/92 AstraCAPSA Energy 50.00 - 43.00 93.00 38.8 43.001990 CIP Financial Serices - 0.07 - 0.07 0.07 -1990.91 Petroken ChemicasA&Petrochen. 20.00 - 11.00 31.00 20.00 11.00 -1991 BancodeCreditogArentino FinanciaServlce - 10.00 - 10.00 10.00 - . 5.501992 Polisur Chemicals - 7.00 - 7.00 7.00 - -1992 Petroora Argentirn San Jorge Energy - 17.00 - 17.00 17.00 - 0.861992 MBA Belsa Capil Mrkets - 0.18 - 0.18 0.18 - 0.021992 Frl9iglfloo Rioplatente Slaughtring. PreparIng 12.00 1.00 6.00 19.00 13.00 0.00 6.001992 Oleagnoesa Oee Sunflower S"d Agribus. 20.00 - 15.00 35.00 20.00 15.00

Toal Gro CommItmenft b 654.0 91.47 278.63 1025.00Less: Cancuellats Termintions. Repayment 8 Sales 304.50 19.60 168.16 489.26

Total Commibents Now Hold el 380.40 71.7 113.40 535.73 422. 113.46 82.90

pendina Comm .mets:

Prolera Argentfin San Jorge Energy 15.00 10.00 35.00 60.00(Huentralo Sleek)

Copeto Chomicais&Petrchomica 8.00 - 11.00 19.00Banco Rio CL ZRLP) Development Finance - - 20.00 20.00MaltrFa PampeF AgrIusines 12.00 - 0.00 18.00Farroxupreso,Pnparmo Intrastructure 11.00 2.00 18.00 29.00Arg. Emerging Mwrket Financial Servies - 4.00 - 4.00sub-tob 46.00 18.00 88.00 150.00

Total Com_mte Held and Pnding Co_mmtrent 806.40 87.87 201.4C 6.73Total Um*bwud C_ _pImen5 40.S 10t.0 2.00 52.90

a/ Investnernts which have byu futll cancelled, terminated. written-of, sold. redeemed or repaid.bt Gross Commitment cornestof approved and signed project.ct Hold Commitmet coist of disbursed and undisbued invetmerts.

ANNEX xmf

ARGENTINA

SECOND PUBLIC ENTIRPRISE REFORM AD.JUSTMNT LOAN

Supplementarv Loan Data Sheet

Section I - Timetable of Key Events

(a) Time taken to prepare: 1.5 years

(b) Prepared by: Argentine Goyernment in cooperationwith the Bank

(c) First IBRD mission: March 1991

(d) Appraisal mission departure: March/April 1992

(e) Date of Negotiations: July 1992

(t) Date for Board Presentation: January 1993

(g) Planned date of Loan effectiveness: March 1993

(h) List of relevent PCRs and PPRs: N.A.

Section n: Special hnplementation Arrangements

Nang

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