Once among the world's most prosperous economies, Argentina experienced slow economic growth from the 1940s until the start of the Convertibility Plan in 1991. By the mid-1970s long-term growth had declined noticeably, and in the last half of the 1980s, Argentina suffered its longest period of stagnation in the century. Savings and investment rates fell precipitously from the mid-1970s until 1989. Argentines, responding to the unstable macroeconomic environment, increasingly saved and invested abroad. Labor productivity fell and poverty worsened. This economic performance was traceable to chronic public sector deficits and endemic inflation. After the return to constitutional democracy in 1983, public demands to control inflation were translated into four successive stabilization programs. All failed to eradicate inflation, and each ended in a more virulent inflation than the one preceding it. The main reason for these failures was the inability of the stabilization programs to redress rapidly and permanently the structural deficit of the public sector.

Post-1989 Structural Reform

   A new administration took office in July 1989 during a traumatic hyperinflation—July inflation alone was 200 percent. This culminated a decade-long crisis in public finance. The new economic team inherited weak public institutions accustomed to deficit spending and with an institutionalized reliance on the inflation tax. In addition, claims on the state's revenues were far greater than its capacity to mobilize resources—in short, the Argentine state was insolvent and in crisis. The administration undertook stabilization programs in 1989 and 1990. Neither succeeded, principally because of the intractability of the fiscal deficit. The first terminated in a new hyperinflation at the end of 1989 and early 1990. The second lasted from March to December 1990 and ended in a new inflationary outburst but, unlike the previous breakdowns, the economy did not spin into hyperinflation. Instead, a new fiscal package in February 1991 was sufficient to close the remaining fiscal gap. This was followed by the April 1, 1991 Law of Convertibility, guaranteeing 1 to 1 convertibility of the peso into dollars, and effectively proscribing money creation other than to buy net foreign reserves. The convertibility program, thus, disciplines monetary policy and limits the powers of the government to finance its deficit through inflation. 

Since 1991 the government has sustained structural reform efforts that progressively improved the foundations of public finance. The government has undertaken difficult-to-reverse reforms in the legal framework, institutions, and policies. This process included institutional reforms of the federal government, privatizations, and restructuring of liabilities with domestic and foreign creditors to adjust them to serviceable levels. Other reforms have helped elicit efficient private investment, notably trade, deregulation and financial sector reform. 

The government undertook a major effort to improve revenues through a much-broadened and uniform VAT, first to goods in February 1990, and later extended to services in November 1990. The government in 1989 also undertook to improve the efficiency of the tax administration—establishing a control system for the largest taxpayers and improving audits and controls substantially. The tax penalty law, adopted by congress in 1990, provided much needed sanctions for tax non-compliance. The tax package of February 1991 improved the quality of the revenue mobilization substantially because it eliminated export taxes—which had been reduced progressively during 1990 and early 1991—deducted higher taxes on financial transactions from the income/asset tax, and removed several minor taxes. In December 1992 subsidies to industrial promotion were substantially cut through the replacement of the self-monitored tax deductions with a tax bond program. The increase in VAT collection allowed the government to eliminate inefficient taxes, such as the gas-oil tax and the federal stamp tax, in November 1992. These efforts cumulatively produced dramatic rises in tax collections. 

Because the wage bill dominated expenditures, in 1990 the government set up legal and administrative machinery to reduce the size of the federal bureaucracy. Federal employment decreased from 671,000 to 284,000. Of the 387,000 reductions, 103,000 were layoffs and 284,000 were transfers of teachers and health workers to the provinces. This effort was based on a ministerial reorganization that focused federal activities on core objectives, and improvements in the civil service system through an improved salary structure and efficiency measures. The government was able to increase average salaries and partially restore salary differentials. 

The government has embarked on several reforms to separate the central bank from the non-financial public sector and establish it as an independent, effective monetary authority. The elimination of the central bank's domestic short-term interest-bearing obligations by their conversion into external treasury bonds in January 1990 in effect constituted a first step toward recapitalizing the central bank. The April 1991 Law of Convertibility established a money-creation rule that effectively limits monetary policy and central bank inflationary finance of public sector deficits, much like a currency board. In September 1992 a new law strengthened the central bank's autonomy, and further restricted its ability to extend credit to the government and the banking system. This measure reinforces the Convertibility Law, and paves the way for an independent monetary authority. The central bank intends to complete the process of removing functions ancillary to the functions of a monetary authority by transferring legal authority on failed financial institutions to the courts. 

The October 1993 pension reform law has begun to generate pension fund savings on a large scale, securing a growing demand for capital market instruments. A central element of the reform is the combination of pension funds and pay-as-you-go schemes in an integrated system of mandatory pension insurance with private and public institutions competing to supply these funds. The effort to integrate provincial social security systems into the national system is also accelerating. 

In addition, the government has sought to restructure fiscal relationships with the provinces. An agreement signed in August 1993—the Pacto Fiscal—aims to strengthen the fiscal adjustment in provinces and eliminate distortionary provincial taxes. Progress has been partial, as provincial reforms still require ratification by most provincial legislatures, and the degree of commitment to reform varies across provinces. In return, the national government agreed to forego $0.9 billion in provincial debt, increase transfers, and take over responsibility for provincial social security systems. In January 1994, partially to encourage provincial tax reforms and partially to reduce domestic production costs, the government reduced employer wage taxes in the provinces that carry out the reform. 

In October 1988 the government began opening the economy to import competition by reducing quantitative restrictions narrowing tariff bands, and eliminating the production coverage of industrial export taxes. In 1993 concern about alleged unfair trade practices led to temporary increases in trade barriers—most aimed at Brazil and generally consistent with remedies afforded under the MERCOSUR agreement. Continuation or expansion of such measures could undermine the transparency of the trade regime, although the government has repeatedly emphasized its firm commitment to trade liberalization. 

In August 1994 Argentina reached an accord with its MERCOSUR partners to establish common external tariffs—with some significant exceptions—on January 1, 1995, moving closer to the establishment of a regional common market, which should provide an impetus for growth. Since Argentina's trade in MERCOSUR is primarily with Brazil—which accounts for 20 percent of Argentina's trade—its prospects are closely tied to the stabilization of the Brazilian economy and resumption of sustainable economic growth. 


The government has followed an accelerated timetable for privatization or partial divestiture of nearly all its enterprises to reduce the budgetary burden of the enterprises, make the firms more competitive, and increase the volume and efficiency of new investment. The privatization program, in the works since 1988, gained credibility with the sale of the electricity parastatal in November 1990. The program removed politics from price setting in the formerly vast segment of the economy covered by the state. The change in the institutional organization of these sectors cut off public subsidies to consumers and labor groups benefiting from high wages and excess staffing, and transfers for investment. The program also improves public finances: transitionally with more than $2.5 billion in capital receipts to help close fiscal accounts in 1991 and 1992, more permanently by eliminating transfers and increasing tax revenues. 

The government has sold two television stations, the electric utility, the national telephone company, and Aerolineas Argentinas. In mid-1991 it began the first comprehensive restructuring of the petroleum industry in Latin America by auctioning off parts of the state oil company. It granted road and railroad concessions to the private sector and privatized long-distance cargo lines, and reduced the railway's work force by 15 percent. In 1992 the government privatized defense industries, the nation's largest distributor of electricity, ports, reinsurance and the entire power sector. In July 1993 the privatization of state-owned oil company enabled the government to cancel obligations to pensioners (about $2.7 billion) and to oil producing provinces (about $1.2 billion). 

Recent Economic Developments 

Following average economic growth rate of 7.7 percent over 1991-94, the Argentine economy contracted in 1995, with negative economic growth estimated at 4.4 percent—largely because of the Mexican economic crisis, which reverberated throughout Latin America. The sharp recession caused an increase in unemployment and strained the performance of the financial system. The regional financial crisis was the first severe test of the Convertibility Plan. By the end of 1995 there were signs that Argentina was pulling out of its recession without serious damage. Significant pressures to deviate from the Convertibility Plan were met by efforts to strengthen it during the crisis, indicative of the plan's popularity and staying power. 

The initial 1995 shock, generating a confidence crisis, contributed to capital outflows, which caused a 17.6 percent loss in banking deposits ($8 billion), with liquid international reserves declining by 30 percent ($4.8 billion). Under the Convertibility Plan's stipulation that the monetary base must be fully backed by international reserves, capital outflows resulted in the demonetization of the economy. This demonetization affected both the performance of the financial system and real economic activity. While the economy exhibited real economic growth in the first quarter of 1995 (3.2 percent), a recession set in during the second quarter (-8.1 percent) and third quarter(-7.7 percent). Unemployment rose to 18.6 percent in May and improved slightly to 16.6 percent in October. 

The impact of the shock was moderated by strong trade performance. A combination of good international commodity prices, the contracting domestic economy, the continuous real depreciation of the peso, and the fast pace of economic expansion in Brazil, resulted in a 32.3 percent nominal growth in exports. With the deepening recession, imports (c.i.f.) declined by 6.8 percent, producing a sharp improvement in the trade balance, which shifted from a $5.8 billion deficit in 1994 (exports-f.o.b./imports c.i.f.) to a $0.8 billion surplus in 1995. As a result, the current account deficit was cut to $2.3 billion, less than one-third the 1994 level, or 0.8 percent of GDP. 

Fiscal performance was also detrimentally affected by the recession. Despite efforts to rein in expenditures, the shortfall in revenues generated a fiscal deficit equivalent to one percent of GDP, or $2.7 billion (including privatization receipts of $1.1 billion). Half of that deficit was financed by a tax amnesty program announced in November 1995, and the remainder from other sources. Total federal public sector debt rose by $7.8 billion in 1995, most of it foreign, reaching a level of $88.4 billion. In addition to the federal fiscal deficit, the aggregate provincial fiscal deficit was approximately $3 billion, or 1.1 percent of GDP. In a crisis year, where provincial banks faced disproportionately greater difficulties than the rest of the financial system, provincial deficits were increasingly financed through arrears to suppliers, salaries and pensions. 

The government reacted forcefully to the crisis. During late February and March, it took strong measures to redress the fiscal balance by cutting expenditures on, among others, export subsidies, public sector wages, and social security expenditures, while raising VAT rates and other taxes. Swift action by congress in approving unpalatable emergency measures at the early months of the crisis, added to the credibility of the measures, which were supported by the IMF and World Bank. As the government was announcing these measures in mid-March, it also assembled an international financial package of approximately $11 billion to support the Convertibility Plan. The announcements effectively stopped the accelerated decline in bank deposits. 

The government successfully resisted growing pressures to reverse the economy's liberalization. To its credit, it decided to deepen this process and further accelerate economic adjustment. Congress approved the government's proposed bankruptcy law, a law increasing labor flexibility for small and medium enterprises, and a work-related accidents law. 

Immediately after the crisis erupted, the central bank tightened liquidity to prevent a currency run. It set up first a private facility, and subsequently a facility at Banco de la Nacion financed through the imposition of a 2 percent bank reserve requirement, to assist small banks in crisis. To counter the risk of further bank failures, it also facilitated the use of interbank credit, and reduced temporarily reserve requirements in both dollar and peso deposits, and used rediscounts at a faster pace. In February 1995 a Trust Fund for Privatization was established to handle the workout of provincial banks. In March the authorities increased the liquidity in the financial market further by authorizing commercial banks to use 50 percent of their technical reserves to meet their legal reserve requirements. In April, the government established a Bank Capitalization Trust Fund to handle the recapitalization/restructuring of distressed private banks. To stem capital outflows, the authorities facilitated the further dollarization of the banking system, by further limiting distinctions between dollar and peso deposits. 

At the provincial level—where there had been few meaningful reforms—the national crisis aggravated an already difficult situation. Faced with a serious deterioration in their fiscal affairs, and social unrest in a number of provinces, local governments accelerated their adjustment process: over a dozen provincial banks were privatized (or were far advanced in the process of privatization), social security systems were transferred to the streamlined national system, salaries were cut, and a number of redundant public employees were let go. Additionally, various public enterprises were privatized. 

There is increasing evidence that the Argentine economy ceased to deteriorate in the fourth quarter of 1995. Expectations improved considerably: the stock market index and bond prices rebounded strongly: Argentina was one of the few countries in Latin America where the stock market index at end-1995 exceeded end-1994 levels. Argentina increased considerably its access to international financial markets, and deposits returned to the banking system, recovering nearly all the losses suffered earlier in the crisis. In view of persistent difficulties in the banking system, however, credit expansion remained considerably below end-1994 levels. Liquid international reserves regained all losses suffered in early 1995, reaching $16 billion in December of 1995, contributing to the remonetization of the economy. Consumer price inflation in 1995 was 1.6 percent, the lowest in 51 years. 

The economy has recovered slowly in 1996. Unemployment remains a persistent problem, with the official May survey indicating a 17.1 percent national unemployment rate. 

Medium-Term Prospects 

The government's central macroeconomic objective is to achieve robust long-term growth, while expanding employment and holding inflation to international levels. Continued private capital inflows will be needed to ensure a smooth transition to a sustainable balance of payments. Recent developments in international financial markets have underscored Argentina's vulnerability to external shocks and the critical importance of enhancing its export performance. In the short term, economic prospects are for a cautious recovery. Additionally, the government has indicated its intent to strengthen the adjustment in factor markets by facilitating restructuring of the financial markets, and reforming labor market legislation, and the health insurance system. Reforms progress at the provincial government level, although a high level of indebtedness remains troublesome for some provinces. Following this adjustment and the rebuilding of domestic and international confidence in the economic program, the Argentine economy could grow at a medium-term rate of 4 to 5 percent and inflation should continue at or below international levels. 

Improved competitiveness through economic restructuring, growing investment, and slower increases in domestic consumption would help switch resources from non-tradeables to tradeables. Deceleration in the growth of domestic consumption will reflect both the slowdown in exogenous capital inflows associated with the privatization program, and the attainment of a new, higher and sustainable level of income resulting from structural adjustments. Slower growth in the domestic market would shift more production towards exports, aided by deregulation and other measures to enhance productivity in the tradeable sector, and changes in relative prices. The private sector would be the leading expansionary force, while public investment would grow from its depressed levels, but be concentrated in fewer activities. 

The government projects that consolidated public sector accounts will continue to suffer a deficit in 1996, and return to balance over 1997-98. This initial deficit will be due to continued slow growth in the first quarter of 1996 and the fiscal costs of provincial reform measures, including the transfer of provincial social security systems. Provincial finances are expected to improve slowly but steadily over 1996-98, due both to the reform of their tax systems and civil service reforms that reduce or stabilize personnel expenditures. 

Source: Trends in Developing Economies 1996 

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