Argentina Public Expenditure Review 2003

Argentina Public Expenditure Review

Infrastructure Chapter

1.Background

Infrastructure is known to be an important determinant of economic growth. Recent estimates of the elasticity of GDP with respect to infrastructure stocks in Latin America report results of around 0.15 for Bolivia, Colombia, Mexico and Venezuela (Baffes and Shah, 1998), 0.23 for Argentina (Fay and Yepes, 2003), and in excess of 0.30 in the case of Brazil (Ferreira, 1996). Moreover, the geographical distribution of infrastructure stocks has also been found to be a significant determinant of convergence between rich and poor regions, both in Argentina and Brazil (Estache and Fay, 1995).

Up until the 1980s, infrastructure services throughout the world were predominantly provided by state owned enterprises, heavily reliant on public subsidies to cover investment needs and operating deficits. Growing dissatisfaction with public infrastructure providerswhich were too often characterized by low productivity, poor quality of service, and limited access to investment financecontributed to a major paradigm shift around 1990. The new model entailed horizontal and vertical restructuring of national monopolies to open the way for competition wherever possible. Operation of services was delegated to the private sector, under a variety of contractual arrangements, and the state was to focus its attention on regulating the natural monopoly elements of the sector, as well as overseeing the transition to a competitive market.

Achievements of infrastructure reform

Argentina was at the forefront of the global reform movement in the infrastructure sectors, undertaking one of the earliest and most comprehensive privatization programs, and achieving a major shift in the roles of the public and private sectors (see Table A1 of the Statistical Appendix). Following the Ley de Reforma del Estado (No. 23696) of 1989, the state owned telephone monopoly (ENTEL), the state owned electricity companies (SEGBA, Hidronor and AYEE), and the state owned natural gas monopoly (Gas del Estado), all underwent major restructuring and were privatized. Over the same period, concessions were awarded for most of the country’s railroad network, and about 30% of the national road network, as well as a considerable number of ports and airports. The Provinces rapidly followed suit with concessions awarded to private companies for electricity distribution in 11 provinces, as well as water and sewerage services in GBA and 13 provinces. (Table A2 of the Statistical Appendix clarifies the extent of their responsibilities in the infrastructure sector.) Overall, Argentina captured 11% of private sector capital flows to developing countries worldwide during the 1990s, more than any other developing country in the world except for Brazil.

Fiscal concerns provided one of the major motivations for the Argentine privatization program, and a number of important results were achieved. First, the 86 infrastructure transactions raised an aggregate US$12,050m for the state in one-time privatization proceeds. Second, some US$3,000m of public debt was transferred to the private concessionaires. Third, the State was able to eliminate around US$1,800m of subsidies that it had been making to public providers of infrastructure services. Fourth, the newly privatized infrastructure providers became liable for a wide variety of direct and indirect taxes which generated aggregate revenues of $4,500m in 2001 (equivalent to about 1% of GDP). Furthermore, the State benefited from the payment of canon for some concessions (primarily in the transport sector), and received dividends on its residual shares in these companies.

As a result of these reforms, public spending on economic services fell from around 7% of GDP in the late 1980s to 2% of GDP in the late 1990s. Over the same period, the share of total public expenditure absorbed by this category fell from 25% to around 5%. This was one of the factors that created the necessary fiscal space for the share of public expenditure allocated to social objectives to rise from around 50% in the 1980s to about 65% in the 1990s. At present, public expenditure on infrastructure services stands at $3,290 million, of which two thirds is allocated to the transport sector for the construction and maintenance of roads, and about half is executed at the provincial level of government (see Table A3, and Figure A1 of the Statistical Appendix).

Beyond these fiscal achievements, the Argentine reforms have had a major impact on productivity, coverage and quality of service in the infrastructure sectors. According to a recent general equilibrium study, the Argentine privatization program created efficiency gains of the order of 1% of GDP (Chisari et al., 1999). Sector by sector studies of average annual gains in Total Factor Productivity find values in the 2%-4% range (Estache, 2003). Labor productivity indices improved 250% on average for a sample of eight of the largest private operators (Figure X(a) adapted from CEER, 2002). This reflects major cutbacks in the infrastructure workforce, which fell to 25% of pre-privatization levels. A similar situation can be found in the Provinces where, for example, following private sector participation, labor productivity almost doubled for water services in Corrientes and Santa Fe.

There have also been substantial improvements in coverage and quality of service. In the telecom sector, the average waiting time for a new line fell from nearly 8 months to barely 3 days between 1994/99, while the cost of the same fell from US$1,500 to US$200. Moreover, the digitalization rate of the network rose from 13% to 100%, and the number of faults per 100 lines per year fell from 42 to 17. In GBA, electricity outages have dropped by over 65%, while the percentage of customers with inadequate water pressure has fallen from 85% to 56%.

In GBA, the number of customers served increased at an average annual rate of 14% for telecom, 11% for metro-rail, and between 2% and 5% for electricity, gas, water and sewerage. As a result, it is estimated that residential service coverage for water and telephony (both fixed and cellular) rose by about 15 percentage points since 1993, while coverage of electricity and gas rose by around 6 percentage points over the same period. Recent household survey evidence indicates that these coverage gains were primarily concentrated in the bottom half of the income distribution, for all services except cellular telephony (Figure X(b) based on OPSM, 2002). Even larger gains in water and sewerage coverage, of the order of 14 to 37 percentage points, resulted from private sector participation in the provinces of Cordoba, Corrientes and Santa Fe.

Figure X: Performance improvements following infrastructure privatization

(a) Labor productivity(b) Coverage gains

The improvements in the infrastructure sectors also had a substantial effect on the competitiveness of the Argentine economy as a whole. The reform of the port sector was critical in facilitating the growth of trade during the 1990s, while the modernization of the telecom sector made a major contribution to the development of the financial sector.

These improvements were made possible due to the substantial increase in investment that took place following privatization (Figure X). During the 1980s, Argentina invested an average of $2,500m per year during the 1980s from public sector sources (Calderon et al., 2003). From the mid-1990s, public investment fell to an average annual value of $1,500m per year, while the private sector invested an annual average of $5,300m, so that overall investments in the sector increased to an annual average of $6,500. Overall, during the 1990s, Argentina succeeded in financing around 75% of its infrastructure investment requirements through the private sector, a proportion that significantly exceeds that of neighbouring countries such as Brazil, 53%, Chile, 65%, Colombia, 29%, and Mexico, 54% (Calderon et al., 2003). However, the percentage of private finance ranges substantially across sectors, from around 40% for roads and water, to almost 100% for electricity, gas, railroads, and telecom (Calderon et al., 2003).

Critiques of the reform

Notwithstanding these substantial achievements, public discontent with the infrastructure reform process has grown throughout the 1990s. Indeed, a regular poll conducted by Latinobarometro found that in the year 2000, 78% of Argentine’s disagreed with the statement that ‘privatization of state companies has been beneficial to the country’, up from 50% in 1998.

One of the principal critiques of the Argentine infrastructure reform relates to the equity with which the efficiency gains resulting from privatization have been shared between consumers, investors and the government (Estache, 2003). This can ultimately be attributed to weaknesses in the regulatory system, which has often failed to translate cost reductions into tariff reductions, and has repeatedly given in to renegotiation pressures from the private sector. Furthermore, the growing tax burden on the infrastructure sectors has sometimes prevented consumers from perceiving changes in the underlying tariffs.

The weakness of regulatory institutions helps to explain the high rates of contract renegotiation in Argentina. A recent study finds that 42% of infrastructure contracts in Argentina were renegotiated within a two year period, outside of the normal mechanisms established in the contract (Guasch, 2003). This compares with a rate of 28% for Latin America as a whole. Renegotiation rates vary dramatically across sectors, ranging from 80% for water and transport, to 0% rate for energy and telecom. This variation is entirely consistent with experience elsewhere in Latin America, except that the renegotiation rate for the transport sector is substantially higher in Argentina than elsewhere in the region.

These renegotiations have typically been in favor of the concessionaires, and primarily take the form of reductions in canon payments, reductions in tolls or tariffs, and increases in subsidy payments (see Table A4 of the Statistical Appendix for further details). The case of the inter-urban toll road concessions is particularly flagrant. The original canon payment was eliminated within a year of signing the original contracts, and replaced by a public subsidy payment. Over the following 12 years, there have been some 20 government interventions outside of the original contractual framework (see Table A5 of the Statistical Appendix), each of which has had the effect of reducing toll rates and raising public subsidies. As a result, the annual volume of subsidy payments has risen from $18m in 1991 to $363m in 2003 (see Figure A2 of the Statistical Appendix). Moreover, although these concessions are scheduled to expire in October 2003, a 40 month extension is currently under discussion. Given the track record of these contracts, any such extension would be highly undesirable.

A common complaint among Argentine consumers is that prices of services are high by international standards, and that this is attributable to excessive profits by the private sector, as well as indexation to the US CPI which grew by more than 15% over the period 1995/01 during which domestic inflation in Argentina was close to zero (FLACSO, 2002). There is certainly empirical evidence that tariff reductions allowed by regulatory agencies, generally in the range –0.60% to –1.75% per annum, have by and large not kept pace with improvements in Total Factor Productivity, generally in the range –1.00% to 3.90% per annum (see Table A6 in the Statistical Appendix). However, international comparisons of utility tariffs with those applied elsewhere in Latin America reveal a more complex picture. Before devaluation, gas tariffs were among the lowest in the region, electricity and water tariffs were towards the middle of the range observed around the region, and telephone tariffs were among the highest (see Figure A3 in the Statistical Appendix). Following devaluation, Argentina has almost the lowest utility tariffs to be found across Latin America.

As to whether utility companies have made excess profits, the empirical evidence is unfortunately limited. Based on some sample calculations, one study finds returns of 7-8% for the electricity distribution sector, 6-11% for the gas distribution sector, 17-18% for the telecom sector, and 22% for the water sector (Estache, 2003). As a point of comparison, ENARGAS has estimated a cost of capital of around 14% for the gas distribution sector, and 12% for the water sector. What this partial evidence suggests is, once again, a mixed picture across sectors, with some apparently receiving less than the cost of capital and others more.

Where Argentina definitely appears to be something of an outlier, is in the indirect tax rates levied on utility bills. These typically amount to around 28% of residential bills for water and energy, and owing to wide variations in provincial and municipal taxes, can be as high as 50% in some jurisdictions. Based on comparisons with 20 OECD countries, Argentina has the highest indirect tax rates of all in the water sector, and is in the top five indirect tax rates for the energy sector (see Figure A4 in the Statistical Appendix). These high indirect tax rates go some way towards explaining consumer perceptions of high utility prices.

2.Current Situation

The devaluation of the peso and subsequent crisis has had very major impacts on the financial situation of the private infrastructure concessionaires. Under the Emergency Law 25,561 of January 2002, infrastructure tariffs (previously expressed in US dollars) were converted to pesos at a rate of 1:1 and frozen in nominal terms. Despite initial plans to conclude the renegotiation process within a 120 days, tariffs have remained frozen throughout 2002, while the peso devalued by 250% and the domestic wholesale price index rose by 90%. There have also been significant impacts on the demand side, with consumption of infrastructure services falling by 10% during 2002, growing levels of debt and disconnection, and proliferating use of quasi-monies to pay infrastructure bills.

As a result, concessionaires have faced a serious mismatch between their declining revenue flows in pesos, and their operating and debt service costs, which are to a considerable extent dollar denominated. This has led at least eleven concessionaires to default on an aggregate debt stock of US$8 billion, which represents approximately half of existing dollar denominated debts, and prompted a downgrading of the S&P rating for the Argentine infrastructure sector from BBB (investment grade) to CCC or D, effectively shutting off all new access to capital. In consequence, all investments barring the most critical have been slashed, with aggregate levels falling dramatically to an estimated level of $200m in 2002.

Public sector infrastructure providers are facing similar problems in servicing international debt obligations, with the important difference that in these cases the responsibility for debt repayment lies ultimately with the State.

Contract renegotiation

Following the Emergency Law, a Commission for the Renegotiation of Concession Contracts was established under the auspices of the Ministry of Economy and charged with the renegotiation of 59 concessions under Federal jurisdiction (Table X). The Commission was originally scheduled to complete the renegotiation process in 120 days, however this deadline has now been extended to XXX, and after 15 months of renegotiation progress has been limited. Similar renegotiation processes are being repeated at the Provincial level. The experience at the Federal level thus far varies significantly between the household utility concessions and the transport concessions.

As regards utility concessions, no agreements have yet been reached. One of the major obstacles to the renegotiation has been the social sensitivity attached to any tariff increases, given the income losses that have been suffered by a large proportion of the population, and the absence of any ‘social tariff’ mechanism to protect the most vulnerable. In the energy sector, there have been a number of attempts to provide interim relief through moderate tariff adjustments of the order of 10% supported by Executive Decree. However, these have been repeatedly overturned in the courts on the grounds that they bypass the renegotiation process managed by the Commission. Another area of legal controversy has been the nature of consumer participation in the renegotiation process. At present, representation is limited to a single consumer advocate on the Commission. Although the Commission has made some attempts to convene public hearings these were subject to legal challenges, and for the time being the channel of engagement has been limited to public consultation documents.

The process has been a little more straightforward for the transport sector. In the case of ports and dredging concessions, which have an international customer base, tariffs were simply re-dollarized. Moreover, although railroad and road concessions are still under renegotiation, they have received significant respite in the form of increased subsidies from the Transport Infrastructure Trust Fund (see Table A7 of the Statistical Appendix for a summary of the status of the renegotiations). Although not formally part of the renegotiation process, metropolitan bus operators have also secured sizeable compensatory subsidies from the Transport Infrastructure Trust Fund. This policy is controversial given that there is an estimated 40% of excess capacity on the metropolitan bus network.

The growing frustration of the private concessionaires with the delays in the renegotiation process has already prompted nine of them to file claims with the International Center for the Settlement of Investment Disputes (ICSID), an affiliate of The World Bank Group (see Table A8 of the Statistical Appendix).It is reported that three more concessionaires have initiated the process of filing claims, while a further 40 are currently in the prior stage of amicable negotiations. Foreign investors acquired the right to file such claims, even before the local course of justice has been exhausted, under numerous bilateral investment treaties that were signed by the Argentine government between 1992 and 2001. However, at the outset of the renegotiation process, the government unilaterally imposed an obligation to refrain from initiating any legal action against the government outside the framework of the renegotiation process.

Although there are no reliable estimates of the magnitude of the contingent liabilities faced by the Argentine Government in the current renegotiation process, it is known that private investors committed at least US$35,000m of capital during the 1990s. Moreover, the nine claims already filed with ICSID total US$4,000m. If the 40 pending cases are filed and turned out to be of a similar magnitude, this would give a figure of the order of US$20,000m. Even if only 10% of these cases proved to be successful, the Argentine government could face claims of the order of US$2,000m.