Growth Diagnostics for Argentina

Omar Chisari

Eduardo Corso

José María Fanelli

Carlos Romero

Expone: José María Fanelli

Washington, IDB, 20-21 September

Growth Diagnostics for Argentina:

Stylized Facts and Hypotheses

Growth Diagnostics for Argentina: Stylized Facts

(a) Argentina faces severe difficulties to grow fast and for extended periods; growth ignitions often end abruptly.

0

2,000

4,000

6,000

8,000

10,000

12,000

18

75

188

0

188

5

18

90

18

95

190

0

190

5

191

0

19

15

19

20

192

5

193

0

193

5

194

0

194

5

19

50

19

55

196

0

196

5

19

70

19

75

198

0

198

5

199

0

19

95

20

00

2005

Per capita GDP (2002 prices) Hodrick Prescott

GDP per capita (2002 prices) and Hodrick Prescott trend. (1875-2006)

Growth Diagnostics for Argentina: Stylized Facts

(b) The characteristics of the growth process have differed under distinct international regimes.

0.00

50.00

100.00

150.00

200.00

250.00

300.00

350.00

400.00

450.00

1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33

Years

Firs

t Yea

r=10

0

First Globalization (1900-1930)

Autarky (1931-1945)

Bretton Woods (1946-1978)

Second Globalization (1979-2006)

Argentina. Growth under different international regimes

Growth Diagnostics for Argentina: Stylized Facts

(c) Drastic changes in income distribution are frequent and are often associated with crisis episodes.

0

5

10

15

20

25

30

35

19

74

19

76

19

78

19

80

19

82

19

84

19

86

19

88

19

90

19

92

19

94

19

96

19

98

20

00

20

02

20

03

-II

20

04

-II

20

05

-II

20

06

-II

EPH

EPH-Cs/d

s/d

Argentina: 10th decil / 1st decil

Debt Crisis

Hyperinflation

Convertibility crisis

Rodrigazo

??

Source: Gasparini, Marchionni and Sosa Escudero (2001); INDEC

Growth Diagnostics for Argentina: Stylized Facts

(d) There have been several episodes of financial distress and monetary disarray since the mid-1970s. The amount of foreign assets held by residents has increased substantially

External Assets (Mill

USD)

External Assets (%

PIB)

External Liabilities (% PIB)

FDI (% PIB)

1991 66.766,45 35,22 27,62 6,081992 72.106,56 31,52 28,87 7,13

1993 86.460,14 36,56 40,62 7,831994 89.109,97 34,61 40,65 8,711995 102.294,77 39,64 50,12 10,851996 116.998,47 42,99 56,27 12,341997 133.073,52 45,44 62,56 14,371998 140.351,92 46,95 66,42 16,021999 150.242,22 52,99 74,23 21,902000 152.898,89 53,80 75,17 23,852001 132.785,49 49,42 65,54 25,712002 131.888,37 129,29 131,88 42,302003 144.260,33 111,29 112,51 37,262004 153.624,67 100,29 97,88 33,022005 161.150,53 88,00 78,21 29,79

Growth Diagnostics for Argentina: Stylized Facts

(e) Growing fast.

(f) Running twin surpluses.

The country is currently

Specific Hypotheses and GDE-type decision tree

Specific Hypotheses

1. Macro volatility is high in Argentina and growth processes are prone to terminate in collapses.

2. Although the fiscal and the external constraints are not binding, they could become a binding constraint because:

(a) The primary fiscal surplus is partially based on distortionary taxes.

(b) There are still latent social conflicts and property rights conflicts that can potentially affect the equilibrium of the budget.

(c) A fall in the terms of trade or exports could jeopardize external sustainability.

3. Any attempt to improve the distortions must take into account latent social conflicts; key is the impact on the unemployment rate.

4. Policy-induced distortions in relative prices and governance structures can create major bottlenecks in specific sectors, in particular, the energy sector and those tradable sectors that produce goods for domestic consumption by the poor.

5. The lack of financial deepening is likely to be a binding constraint given the extremely low credit to the private sector / GDP ratio that resulted from the 2001-02 crisis.

Macro Volatility and Crisis

(Hypothesis 1)

Average Standard Deviation

Frequency of

Downturns (3)

Frequency of

Downturns (3)

International Regimes

9-Year Window (2) Based on Per Capita GDP

Based on GDP

(%) (%) (%) (Years) (%) (%) (Years) (%) (%)

5.9 21.8 14.5 1.8 5.0 10.9 6.1 5.3 21.8

Autarky 4.6 37.5 25.0 1.5 3.1 12.5 2.3 3.0 6.3

Bretton Woods 4.3 30.3 18.2 1.4 3.4 15.4 3.3 4.2 7.7

5.5 39.2 35.7 2.2 5.4 32.1 2.6 5.1 17.9

Overall Period 5.2 29.7 21.3 1.7 4.3 16.0 3.9 3.8 15.4

Average Duration of Expansions

Average Growth Rate

during

Expansion(6)

Frequency of

Exceptional

Growth(7)

Frequency of Abnormal

Falls(5)

First Globalization

Second Globalization

Average Duration of Recessions

Average Depth of

Recessions (4)

Argentine Aggregate Volatility: Long-Run View and International Comparison

Per Capita GDP and GDP volatility (1960-2005)

0

0.02

0.04

0.06

0.08

0.1

0.12

4 5 6 7 8 9 10 11

Per Capita GDP (log)

GD

P V

ola

tili

ty

Source: World Develompment Indicators.

Argentina

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

1880

1884

1888

1892

1896

1900

1904

1908

1912

1916

1920

1924

1928

1932

1936

1940

1944

1948

1952

1956

1960

1964

1968

1972

1976

1980

1984

1988

1992

1996

2000

Year

GD

P a

nn

ual

St

dev

GARCH variance serie

0.00000

0.00050

0.00100

0.00150

0.00200

0.00250

0.00300

0.00350

1918

1921

1924

1927

1930

1933

1936

1939

1942

1945

1948

1951

1954

1957

1960

1963

1966

1969

1972

1975

1978

1981

1984

1987

1990

1993

1996

1999

2002

2005

nd6.95.3Yes22.6641999

Fall of Convertibility

5.15.66.1No14.9031988Hyperinflation

5.25.85.0 Yes9.5221981Debt Crisis

4.95.74.8Yes20.11319301929 Crisis

7.05.94.8Yes29.8451913First World War

5.76.04.8Yes14.8421892Baring

(c)(b)(a)

Conditional St. Deviation

Associated with International

EventsDepth(3)Duration (2)Starting

YearCrisis(1)

nd6.95.3Yes22.6641999

Fall of Convertibility

5.15.66.1No14.9031988Hyperinflation

5.25.85.0 Yes9.5221981Debt Crisis

4.95.74.8Yes20.11319301929 Crisis

7.05.94.8Yes29.8451913First World War

5.76.04.8Yes14.8421892Baring

(c)(b)(a)

Conditional St. Deviation

Associated with International

EventsDepth(3)Duration (2)Starting

YearCrisis(1)

Aggregate volatility

-1

-0.8

-0.6

-0.4

-0.2

0

0.2

0.4

0.6

0.8

1

1981

1983

1984

1985

1986

1988

1989

1990

1991

1993

1994

1995

1996

1998

1999

2000

2001

2003

2004

2005

Year

CORR(g,s) CORR(g,i) CORR(g,b)

GDP and Consumption Volatility. Latin American Countries

(1990-2005)

0

0.02

0.04

0.06

0.08

0.1

0.12

0.14

0.16

0.18

0.2

Arg

en

tin

a

Bra

zil

Ch

ile

Co

lom

bia

Co

sta

Ric

a

Do

min

ica

n R

.

Ecu

ad

or

El S

alv

ad

or

Gu

ate

ma

la

Ho

nd

ura

s

Nic

ara

gu

a

Pa

rag

ua

y

Pe

rú

Tri

nid

ad

y T

.

Uru

gu

ay

GDP Volatility

Consumption Volatility

•Argentina shows excess aggregate volatility.

•Financial imperfections create a linkage between growth, aggregate investment, and external liquidity because the most expedient way for the country to recompose its liquidity when facing a sudden-stop-like situation is to induce a recession and a fall in investment to save in imports.

•According to Caballero, in dealing with the kinds of financial imperfections that Argentina faces, a country can even decide to induce a “precautionary recession” to avoid liquidity problems.

Fiscal and External Sustainability

(Hypothesis 2)

FISCAL SUSTAINABILITY

The evolution of the fiscal surplus in the past four years has been rather striking in light of recent history. The main factors behind the improvement are: the renegotiation of public debt; a marked increase in tax collection; and favorable changes in relative prices.

-15.0

-10.0

-5.0

0.0

5.0

10.0

1961

1962

1963

1964

1965

1966

1967

1968

1969

1970

1971

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1973

1974

1975

1976

1977

1978

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1980

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1986

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1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

% o

f G

DP

Primary surplus

Total surplus

FISCAL SUSTAINABILITY

The government is currently able to finance the mean historical level of primary public expenditures. The new fiscal situation, nonetheless, does not leave much room for fiscal easiness …

Evolution of total Primary Expenditures (% of GDP)

Figure 2: Evolution of Total Revenues (% of GDP)

0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

Plus One St. Dev. Minus One St. Dev. Total Primary Expenditures

Minimum Expenditures 1982, 1990-91 = 20.7

Maximum Expenditures 1974 = 28.3

0.00

5.00

10.00

15.00

20.00

25.00

30.00

35.00

1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

Plus One St. Dev. Minus One St. Dev. Total Fiscal Revenues

Minimum Revenues 1975 = 14.7

Maximum Revenues 2006 = 29.8

Public debt sustainability

(1) The level of public indebtedness is still considerable and the primary surplus is falling.

-1.0

0.0

1.0

2.0

3.0

4.0

5.0

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95

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II

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06

IV

% o

f G

DP

Observed primary surplus

Required primary surplus

Growth rate = 4.2%

Interest rate = 6.4

(2) Since our diagnostics emphasizes the role of macro volatility and collapses, we have to take into account the role of uncertainty.

-0.20

-0.15

-0.10

-0.05

0.00

0.05

0.10

0.15

0.20

0.25

0.30

19

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Gro

wth

ra

te

-0.10

-0.05

0.00

0.05

0.10

0.15

0.20

0.25

19

91

II

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II

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20

11

II

20

12

II

Re

al i

nte

rest

ra

te

0

20

40

60

80

100

120

140

160

180

19

94

IV

19

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III

19

96

II

19

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I

19

97

IV

19

98

III

19

99

II

20

00

I

20

00

IV

20

01

III

20

02

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20

03

I

20

03

IV

20

04

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20

05

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06

I

20

06

IV

20

07

III

20

08

II

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09

I

20

09

IV

20

10

III

20

11

II

20

12

I

20

12

IV

% o

f G

DP

(3) The increase in tax collection is partially based on distortionary taxes.

17,7%16,7%

16,1%16,9% 17,1% 17,3% 17,7% 17,3%

16,5%

22,3%22,7%

23,3%

3,8%

3,6%

3,6%

3,7%3,9% 3,9%

3,8%3,6%

3,4%

3,8%

4,0%4,1%

4,1%

19,6%

10%

12%

14%

16%

18%

20%

22%

24%

26%

28%

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

% o

f GD

P

Provinces

National

Total

0,0

1,0

2,0

3,0

4,0

5,0

6,0

7,0

8,0

1935

1937

1939

1941

1943

1945

1947

1949

1951

1953

1955

1957

1959

1961

1963

1965

1967

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1971

1973

1975

1977

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1981

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1987

1989

1991

1993

1995

1997

1999

2001

2003

2005

% o

f G

DP

Sales Tax VAT

0,0

1,0

2,0

3,0

4,0

5,0

6,0

1932

1934

1936

1938

1940

1942

1944

1946

1948

1950

1952

1954

1956

1958

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

% o

f G

DP

Income Tax Income Tax*

* New Methodology

0,0

0,5

1,0

1,5

2,0

2,5

3,0

3,5

4,0

4,5

1932

1934

1936

1938

1940

1942

1944

1946

1948

1950

1952

1954

1956

1958

1960

1962

1964

1966

1968

1970

1972

1974

1976

1978

1980

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

% o

f G

DP

Import Tariffs Export Tariffs Others

EXTERNAL CONSTRAINT: One remarkable fact is that the current account surplus has survived the acceleration in growth and the large increase in the investment ratio.

Figure 1. Real Activity Level

Figure 2. Trade Balance Level

Figure 3. Real Investment Level

Source: Ministry of Economy

90,00

100,00

110,00

120,00

130,00

140,00

150,00

-6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19

Hyperinflation Convertibility Crisis

-150

-100

-50

0

50

100

150

200

250

-6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

Hyperinflation 1989:3 Convertibility Crisis 2002:1

0

50

100

150

200

250

300

350

-4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

Hyperinflation Crisis of Convertibility

PeriodInternational Reserves /

Imports

External Debt / Exports

(%) (%)

1994 58.8 500.61995 61.3 448.21996 58.4 442.91997 47.8 471.01998 50.0 508.31999 57.7 560.42000 55.4 492.52001 53.9 487.12002 87.4 529.82003 73.4 442.12004 69.8 396.52005 81.3 217.62006 79.7 196.9

Solvency and Liquidity Indicators

External debt sustainability

-5

0

5

10

15

20

% o

f G

DP

Required trade balance

Observed trade balance

Growth rate = 4.2%

Interest rate = 6.4

0

20

40

60

80

100

120

140

160

19

94

IV

19

95

II

19

95

IV

19

96

II

19

96

IV

19

97

II

19

97

IV

19

98

II

19

98

IV

19

99

II

19

99

IV

20

00

II

20

00

IV

20

01

II

20

01

IV

20

02

II

20

02

IV

20

03

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20

03

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20

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07

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20

08

II

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08

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20

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20

09

IV

20

10

II

20

10

IV

20

11

II

20

11

IV

20

12

II

20

12

IV

% o

f G

DP

Simulation of the external debt

The external debt is likely to fall even if there is an important drop in the trade surplus. However, the situation is not free of vulnerabilities. The probability that the debt ratio increases is around 48 per cent from the first quarter of 2008 onward.

• The evolution of the twin surpluses and debt sustainability reveals a significant

softening of the constraints and, consequently, a window of opportunity has opened for the country to grow without the threat of a macroeconomic crisis interrupting growth, as was often the case in the past.

• There is more room to manage social demands in an orderly fashion. Tax collection can finance the historical level of primary expenditures without increasing the financial vulnerability of the public sector.

• The softening of the external constraint opens the way to stabilize the evolution of imports and domestic absorption; a precautionary recession is not necessary.

• This does not mean, however, that the authorities should not be concerned with macro risks. The simulation exercises indicate that many sources of vulnerability still remain.

Concerns and Challenges: distortions and

distributional effects

(Hypotheses 3 and 4)

According to the growth diagnostics approach a stronger fiscal and external sustainability implies a lower probability of changes in the rules of the game and, consequently, the appropriability problems that have fed micro and macro risks in the past should, ceteris paribus, diminish.

Concerns on the external constraint: The increase in imports

YearAnnual % Change

YearAnnual % Change

YearCapital Account /

Exports

1975 -25 1991 113 1989 -571986 -18 1992 80 2002 -461982 -17 1979 75 1991 -451999 -12 1974 63 1990 -331961 -11 2004 62 1982 -301967 -8 1980 57 2001 -211987 -7 2003 54 1983 -181968 -7 1977 37 2006 -132002 -3 1969 35 1964 -121991 -3 1994 29 1971 -11

Ten Highest Falls in Exports

Ten Highest I ncreases in Imports

Ten Highest Capital Account Reversals

Highest Falls in Exports and Capital Flows and Increases in Imports

Simulation of import / GDP ratio

0

5

10

15

20

25

30

35

4019

94 IV

1995

III

1996

II

1997

I

1997

IV

1998

III

1999

II

2000

I

2000

IV

2001

III

2002

II

2003

I

2003

IV

2004

III

2005

II

2006

I

2006

IV

2007

III

2008

II

2009

I

2009

IV

2010

III

2011

II

2012

I

2012

IV

% o

f GD

P

Primary expenditures

Evolution of Primary Expenditures (% of GDP)

0.00

5.00

10.00

15.00

20.00

25.00

30.00

1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

Public Investment Current Primary Expenditures Total Primary Expenditures

Simulation of public primary expenditure

0

5

10

15

20

25

30

35

401

99

3 I

V

19

94

III

19

95

II

19

96

I

19

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02

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I

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11

IV

20

12

III

% o

f G

DP

CGE SIMULATIONS VARIATION IN TAXES

Exercise IV.A

Exercise IV.B

Exercise IV.C

Exercise IV.D

Exercise IV.E

Exercise IV.F

GDP Growth 3.5 1.2 1.1 3.6 4.4 2.7 Δ Investment (%) 2.4 0.9 0.6 1.9 1.1 1.5 Δ Exports (%) 2.4 0.6 0.6 -0.5 -1.5 -0.3 Δ Imports/GDP ratio 0.1 0.0 0.1 0.5 0.3 0.7 Consumer Price Index (Base year=1) 0.99 1.00 1.00 1.06 1.06 1.06 Real Exchange Rate Index (Base year=1) 1.00 1.00 1.00 1.02 1.01 1.02 Δ Rate of Return Primary Sector (%) 5.4 2.1 1.8 10.7 10.1 11.0 Δ Rate of Return Secondary Sector (%) 4.9 1.7 1.5 6.1 4.9 5.9 Δ Rate of Return Tertiary Sector (%) 3.3 1.2 0.8 1.9 2.7 1.5 Variation in the Gini Coefficient (+) (+) (+) (+) (+) (+) Δ Unemployment (formal market, % points) -1.1 -0.1 -0.8 0.3 -1.4 1.6 Δ Unemployment (informal market, % points) -0.5 -0.2 0.0 -0.5 -0.9 -0.1 1st Decile (Δ equivalent variation, %) -1.1 -0.6 -0.8 -3.9 -6.8 -1.8 2nd Decile (Δ equivalent variation, %) -0.9 -0.6 -0.6 -3.6 -6.1 -1.4 3rd Decile (Δ equivalent variation, %) -0.8 -0.6 -0.4 -3.5 -5.6 -1.0 4th Decile (Δ equivalent variation, %) -0.5 -0.5 -0.2 -3.2 -4.8 -0.7 5th Decile (Δ equivalent variation, %) -0.2 -0.4 0.0 -2.9 -3.6 -0.4 6th Decile (Δ equivalent variation, %) 0.4 -0.3 0.3 -2.6 -2.9 -0.9 7th Decile (Δ equivalent variation, %) 0.9 -0.1 0.5 -2.3 -2.3 -1.3 8th Decile (Δ equivalent variation, %) 1.6 0.2 0.8 -0.5 -0.5 0.3 9th Decile (Δ equivalent variation, %) 2.5 0.7 1.0 1.8 1.2 2.0 10th Decile (Δ equivalent variation, %) 3.4 1.2 1.3 3.0 2.8 3.1 Δ Public Expenditures (%) -6.3 -2.2 -2.6 -11.5 0.0 -20.8 Δ Total Tax Collection (%) -6.8 -2.4 -2.8 -9.9 -9.9 -9.7

We studied the relationship between changes in the tax structure, welfare, and income distribution using a CGE model calibrated for the year 2004.

Distributional issues

CGE SIMULATIONS REAL AND FINANCIAL EXTERNAL SHOCKS

Exercise IV.G

Exercise IV.H

GDP Growth -2.2 - 3.2 Δ Investment (%) -1.7 - 6.7 Δ Exports (%) 0.4 18.6 Δ Imports/GDP ratio -0.6 - 0.8 Consumer Price Index (Base year=1) 0.89 0.86 Real Exchange Rate Index (Base year=1) 1.01 1.05 Δ Rate of Return Primary Sector (%) 0.6 4.9 Δ Rate of Return Secondary Sector (%) - 5.4 -2.4 Δ Rate of Return Tertiary Sector (%) - 2.3 -6.4 Variation in the Gini Coefficient (+) (+) Δ Unemployment (formal market, percentage points) 0.9 1.5 Δ Unemployment (informal market, percentage points) 0.4 0.8 1st Decile (Δ equivalent variation, %) - 2.4 - 10.2 2nd Decile (Δ equivalent variation, %) - 2.4 - 9.1 3rd Decile (Δ equivalent variation, %) - 2.4 - 8.0 4th Decile (Δ equivalent variation, %) - 2.5 - 7.5 5th Decile (Δ equivalent variation, %) - 2.2 - 7.5 6th Decile (Δ equivalent variation, %) - 0.9 - 11.4 7th Decile (Δ equivalent variation, %) -0.5 - 15.1 8th Decile (Δ equivalent variation, %) -0.8 - 9.9 9th Decile (Δ equivalent variation, %) - 2.3 - 4.4 10th Decile (Δ equivalent variation, %) - 1.6 - 6.8 Δ Public Expenditures (%) - 0.1 - 5.6 Δ Total Tax Collection (%) 0.3 - 0.9

The clouds on the fiscal horizon

• In the short run, the main source of concern is that the overall primary fiscal surplus is showing a downward trend. This is associated with latent conflicts of interest that affected the fiscal equilibrium because of the weakness of the conflict-management institutions:

• The increment in public expenditures in the provinces is causing the provincial surplus to disappear.

• The increment in the subsidies to the private sector, particularly those concerning the energy and transport sectors.

• The rapid increase in real wages over the last two years. This is only natural because of the drop in unemployment and the upward trend in private wages.

Financial Deepening and Growth:

Challenges and Opportunities

(Hypothesis 5)

Entrepreneurs engaged in investment and the process of “self-discovery” will require financing and investors with dollarized portfolios could obtain a higher return by financing entrepreneurs.

0%

50%

100%

150%

200%

250%

300%

350%

400%

450%

500%

550%

600%

0% 50% 100% 150% 200% 250% 300%

Bank Credit to Private Sector (% GDP)

Sto

ck M

ark

et C

ap. (

% G

DP

)

Financial Underdevelopment - banks: (<49.5% GDP)

Financial Underdevelopment - Stock Markets

(< 44.1% PBI)

Financial Development in Argentina

•Argentina is currently financially underdeveloped with respect to both banks and markets, even by emerging-country standards.

• Argentina has experienced a reversal in financial deepening and sharp drops in the credit supply over very short-term periods, associated with macroeconomic crisis episodes.

Deposits/GDP Loans/GDP

Beginning Duration (1) Depth (2) Depth (3) Depth (3)

Baring Crisis 1892 Two 14.18 n.d. n.d.

First World War 1913 Five 29.84 -19.33 -15.99

Crisis of ´29 1930 Three 20.11 -26.9 -50.43

Institutional Crisis 1962 Two 6.93 -22.57 -7.3

Rodrigazo 1975 Two 4.28 -25.68 -20.2

Debt Crisis 1981 Two 9.52 -31.3 -59.3

Hyperinflation 1988 Three 14.9 -63.59 -62

Convertibility Crisis 1999 Four 22.6 -26.68 -60.49

(1) Consecutive Years of Recession(2) % Fall in per capita GDP(3) % Change around Crisis

GDP

0

5

10

15

20

25

30

35

40

45

1935

1938

1941

1944

1947

1950

1953

1956

1959

1962

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

% G

DP

Bank deposits

H P trend

The challenges and the opportunities to ease the constraints

0

5 0

10 0

15 0

20 0

25 0

30 0

-4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 1 4 1 5 1 6 17 18 19

20

03

Pri

ce

s

H yperinf lation 1989:3

C onvertib il ity C risis 2002 :1

Private credit at constant prices

1996:I / 2000: IV

2004:I / 2006: IV

Long-Term Bank Credit /K 7,81% 5,02%

Investment / K 6,26% 5,91%

Short Term / Long Term Bank Credit

111,30% 243,15%

The balance sheet of firms

Leverage (Total Debt/Total Assets)

20%

30%

40%

50%

60%

Ma

r-94

Se

p-9

4

Ma

r-95

Se

p-9

5

Ma

r-96

Se

p-9

6

Ma

r-97

Se

p-9

7

Ma

r-98

Se

p-9

8

Ma

r-99

Se

p-9

9

Ma

r-00

Se

p-0

0

Ma

r-01

Se

p-0

1

Ma

r-02

Se

p-0

2

Ma

r-03

Se

p-0

3

Ma

r-04

Se

p-0

4

Ma

r-05

Se

p-0

5

Ma

r-06

Se

p-0

6

Ma

r-07

% TradablesNon TradablesTotal

The balance sheet of firms

Dolarización del sistema financiero

-

10

20

30

40

50

60

70

19

91

19

92

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

Act ivos en USD/ Activos Totales

Pasivos en USD/Pasivos Totales

Assets Den. In Foreign Currency/ Total Assets

Liab. Den. In Foreign Currency/ Total Liabilities

Evolution of Dollarization

Exposition of the Financial sector to the Public sector(% Assets)

0.0 0.0 0.0 0.0 1.95.0

10.015.2 13.4

17.011.5 12.7

9.33.8

18.3

23.1

21.1

20.6

16.3

14.7

9.011.1

13.5 23.6

28.5

20.817.4

13.9

9.69.2

0

10

20

30

40

50

60

1998 1999 2000 2001 2002 2003 2004 2005 2006 Mar-07

Credit to public sector

Public liabilites

Central Bank liabilities

Funds Allocated to the Public and Private Sectors

Loans to the Private Sector and BCRA titles (% Assets)

1.85

5.03

9.97

15.24

13.40

17.02

24.72

20.84

23.18

29.92

35.7236.56

0

5

10

15

20

25

30

35

40

2002 2003 2004 2005 2006 Mar-07

Lebac / Nobac

Loans to private sector andexternal sector

Funds Allocated to the Public and Private Sectors

Shocks in the energy sector, policies,

and distributional impacts

• The energy sector was one of the most dynamic in the 1990s.

• Following the macroeconomic crisis of 2001, the economic authorities implemented a price administration for the energy sector:

First, wholesale prices were totally liberalized through contracts in the natural gas sector.

Second, only partial adjustments were observed for wholesale prices of electricity.

Third, the pass-through of the additional costs, due to the devaluation, was not extended to residential prices.

• Operative costs have increased more than average prices since the macroeconomic crisis. However, the tariff revision programmed for 2002 was not implemented.

• Operative costs were financed partially by the shareholders of energy companies or covered by the public sector itself through direct subsidies.

• The disparity in the evolution of energy supply and demand that the change in the contractual and regulatory framework induced is, indeed, currently increasing.

A brief overview of the imbalances

A brief overview of the imbalances

0

50

100

150

200

250

Ene-93

Jul-93

Ene-94

Jul-94

Ene-95

Jul-95

Ene-96

Jul-96

Ene-97

Jul-97

Ene-98

Jul-98

Ene-99

Jul-99

Ene-00

Jul-00

Ene-01

Jul-01

Ene-02

Jul-02

Ene-03

Jul-03

Ene-04

Jul-04

Ene-05

Jul-05

Ene-06

Jul-06

Cost Index for electricity

Residential Tariff

Average electricity prices

Electricity: Prices and specific cost index (1997=100)

Private participation by sub-sector (2005)Subsector Public* Private*

Electricity

Generation 3.66% 96.34%

Transport 7.43% 92.57%

Distribution 6.13% 93.87%

Gas

Transport 0.00% 100.00%

Distribution 0.01% 99.99%

* As a % of total firms

Source: Own elaboration

0

5000

10000

15000

20000

25000

1992 1994 1996 1998 2000 2002 2004

Installed Power Peak Anual Demand

MW

Installed capacity and peak demand (MW)

30

60

90

120

150

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Capacidad nominal

Inyecci

ó n promedio

2005 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Nominal Capacity Average Injection

2005

MM

m3/

Day

Transportation capacity and average injection of gas

This scenario, with few investment projects, demand growth, and administered prices, is unsustainable and energy availability could become a binding constraint on Argentina’s growth path in the near future.

Future policies will have to address a number of short-

and long-run factors.

Structural factors (long-run) Short-run factors

To change the chosen energy intensity path because it seems unsustainable

To boost investment in the exploration of riskier areas

The short-run factors are related to the distortions created by the subsidy system and price signaling.

Simulation exercises

Basic Scenario: due to the lack of investment, capital productivity in the energy sector is reduced by 20 per cent.

Basic Scenario with Quality Deterioration: loss in productivity of capital is associated with a reduction in the quality of energy.

Long-run effects: (a) an increase in energy intensiveness as a response to capped prices; (b) an increase in the cost of capital; (c) status quo with capital mobility.

CGE SIMULATIONS THE ENERGY SECTOR

Exercises

VI.A VI.B VI.C VI.C’ VI.C’’ VI.D GDP Growth -1.2 0.2 0.5 -0.1 0.0 -3.1 Δ Investment (%) -1.2 0.0 -0.2 -7.5 -0.3 -3.0 Δ Exports (%) -1.5 -0.5 -1.7 14.1 -1.3 -3.6 Δ Imports/GDP ratio 0.1 -0.2 -0.2 -0.4 -0.1 0.3 Residential Price of Energy (Base year=1) 1.39 1.00 1.00 1.00 1.00 1.8 Wholesale Price of Energy (Base year =1) 1.32 1.52 1.54 1.46 1.29 1.7 Consumer Price Index (Base year=1) 1.01 0.99 1.00 0.98 1.00 1.02 Real Exchange Rate Index (Base year=1) 0.98 0.97 0.97 1.00 0.98 0.97 Δ Rate of Return Primary Sector (%) -2.4 -0.5 -0.8 -5.6 -0.4 -3.2 Δ Rate of Return Secondary Sector (%) -1.9 -1.9 -2.3 -9.3 -1.2 -6.2 Δ Rate of Return Tertiary Sector (%) -0.4 1.9 2.4 -10.4 0.8 -1.3 Variation in the Gini Coefficient (-) (+) (-) (-) (-) (-) Δ Unemployment (formal market, % points) 0.3 -0.1 -0.6 -0.4 -0.2 1.0 Δ Unemployment (informal market, % points) 0.5 -0.4 0.3 0.6 0.2 1.2 1st Decile (Δ equivalent variation, %) -0.27 -0.9 0.8 -4.0 0.1 -5.4 2nd Decile (Δ equivalent variation, %) -0.57 -0.9 0.8 -3.2 0.1 -4.7 3rd Decile (Δ equivalent variation, %) -0.25 -0.9 0.8 -2.5 0.1 -4.1 4th Decile (Δ equivalent variation, %) -2.71 -0.9 0.8 -2.0 0.2 -3.9 5th Decile (Δ equivalent variation, %) -2.3 -0.8 0.8 -0.9 0.2 -3.4 6th Decile (Δ equivalent variation, %) -2.0 -0.6 0.7 -0.6 0.1 -3.0 7th Decile (Δ equivalent variation, %) -1.8 -0.5 0.5 -0.2 0.1 -2.4 8th Decile (Δ equivalent variation, %) -1.53 -0.3 0.5 -2.1 0.0 -2.3 9th Decile (Δ equivalent variation, %) -1.1 -0.2 0.5 -5.7 0.0 -2.0 10th Decile (Δ equivalent variation, %) -0.9 0.1 -0.6 -8.5 -0.6 -1.5 Δ Public Expenditures (%) -1.2 -2.0 1.0 -1.2 0.3 -2.9 Δ Total Tax Collection (%) -1.3 0.9 1.1 -1.1 0.3 -3.2

In all cases Productivity in the energy sector is reduced by 20%. Additionally, A: The price of energy is determined by market forces; B: Costs must be recovered with subsidies to companies from the government; C: Costs must be recovered with subsidies to companies from shareholders themselves who must contribute with additional funds to overcome operative deficits; C’: idem F with an increase in country risk; C’’: idem F with international mobility of capital; D: plus a reduction in the quality by the same percentage.

Main conclusions:

• Losses in productivity and quality in the energy sector impact strongly on the economy (a permanent reduction of 3 per cent in GDP).

• Price increases infringe heavily upon the poor through the rate of unemployment, government transfers, and the cost of living.

• Government compensations to energy companies, to recover operative cost, are made at the expense of the provision of public goods.

• Temporary shareholders’ contributions to cover operative deficits help the companies to tolerate caps on their prices, but this will eventually become unsustainable and will further reduce capital productivity and quality.

• Improvements in regulations and capital mobility can induce a substantial positive effect in the long run; but this improvement in efficiency is no free lunch: the short-run impact on household welfare is strong.

• If capping prices results in an increase in the cost of capital, the economy will suffer reductions in activity and welfare levels. This will affect the poor basically through the rate of unemployment.

• With flexible prices, an effective review of tariffs could reveal costs savings that could be passed through to customers.

Conclusions

Three main sets of conclusions follow from our diagnostics for Argentina

1) The country has ignited growth and this is extremely important. The country has been running primary fiscal and external surpluses since 2002. In light of the fiscal, financial and institutional disarrays that accompanied the demise of the convertibility regime in 2001-2002, this performance is remarkable.

2) Despite the ignition of growth, the consequences of the crisis have not been completely overcome and some factors could jeopardize the sustainability of growth.

3) In addition, the current growth path is experiencing difficulties of its own that have to do with inefficiencies in the allocation of investment and distributional conflicts,

Our diagnostics naturally suggests a number of agenda priorities in function of the distortions and growth constraints identified.

1) Protection of the financial soundness of the public sector.

2) Adoption of a risk management approach to deal with the excess volatility constraint on growth.

3) Focus on the design of appropriate governance structures in critical sectors (starting with energy and infrastructure)

4) Reconstruction of the supply of credit to the private sector

5) Prudent modification of the distortions in the tax structure and the allocation of expenditures.