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Argentina Public Expenditure Review Infrastructure Chapter

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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.

Proliferation of trust funds

Another important trend in recent years has been the growing reliance on extra-budgetary mechanisms for the infrastructure sector, which are financed from a variety of surcharges on energy products (including petroleum, diesel, natural gas, and electricity). These funds jointly accounted for 40% of public expenditure on infrastructure in 2002 (Figure X), and are expected to rise to 50% in 2003. They are primarily used in the energy and transport sectors to direct investment or operating subsidies to private sector operators, and serve to significantly complicate the flow of public funds in these sectors (see Figure A5 of the Statistical Appendix). An important reason for their dramatic growth in the last year has been the decision to use them as a mechanism for providing subsidies to inter-urban road and metropolitan passenger transport concessionaires to compensate for the devaluation.

These extra-budgetary mechanisms take a variety of different forms (see Figure X and Table A9 of the Statistical Appendix). First, there are earmarked funds (fondos específicos) within the general budget, with a total value of $638m in 2002. Important examples include petroleum tax, which is partially earmarked to the National and Provincial Road Agencies, and the wholesale electricity market surcharge that finances the National Electricity Fund for the development of the electricity sector in the Provinces.

Figure X: The phenomenon of extra-budgetary mechanisms

(a) Evolution (b) Sectoral breakdown
Second, there are trust funds (fondos fiduciarios) that build on the framework established by Law 24,441 of 1994. There are currently six infrastructure trust funds, and the creation of a seventh for the water sector is under consideration. The resources channeled to trust funds for the infrastructure sectors doubled from $872m in 2002 to $1,738 in 2003, with about three quarters of these resources going to the transport sector. The most important of these is the Transport Infrastructure Trust Fund, which is financed by a surcharge on diesel, and provides subsidies to inter-urban road concessionaires and metropolitan transport concessionaires. Other significant examples include the Patagonian Gas Trust Fund and the Electricity Transmission Trust Fund.
Third, there are fiscal credits (créditos fiscales), of which the most significant is the diesel price differential for vehicles in the passenger transportation sector, amounting to $240m in 2002. Fiscal credits have also been used to finance social tariffs for electricity in the Province of Buenos Aires, as well as the peri-urban slums of the metropolitan area.
The use of extra-budgetary mechanisms for infrastructure finance has also proliferated at the provincial level. The Province of Buenos Aires alone has three provincial trust funds associated with infrastructure, whose total value was $XXm in 2002. Both the Electricity Transmission Infrastructure Trust Fund (Fondo de Infraestructura de Transporte de la Provincia de Buenos Aires) and the Provincial Electricity Tariff Compensation Trust Fund (Fondo Provincial de Compensación Tarifaria de la Provincia de Buenos Aires) are financed by surcharges on electricity bills, which are used to finance respectively electricity transmission investments, and tariff shortfalls among distribution operators and cooperatives. Similarly, the Province of Misiones has a Public Works Trust Fund (Contratos de Fideicomiso para Obra Pública) financed from 42% of the proceeds of the provincial turnover tax, which channels $42m of resources to the finance and operation of public transport and solid waste collection systems by the private sector.

Subsidies and the poor

Another important trend of the past few years is the growing volume of subsidies to private infrastructure concessionaires (see Table A10 of the Statistical Appendix), which have more than quadrupled during the last five years from $422m in 1999 to $1,876m in 2003 (Figure X). This phenomenon is closely linked to the proliferation of trust funds, given that the proportion of infrastructure subsidies financed from extra-budgetary mechanisms has risen from 45% in 1999 to 98% in 2003. The other striking change is the shift in the relative importance of energy and transport subsidies; transport subsidies accounted for 28% of the total in 1999, growing to 69% of the total in 2003.

This growth is primarily attributable to increasing expenditure on existing subsidy schemes, rather than the creation of new subsidy schemes. Indeed, the only new subsidy introduced over this period is the one to metropolitan bus operators, amounting to $306m in 2002. It is striking that existing subsidy schemes have benefited from substantial increases in resources as the funding source was changed from general budget to extra-budgetary trust funds. For example, when financing of transport subsidies switched from budget to off-budget in 2001, average annual subsidy expenditure increased more than ninefold for road concessions, and more than doubled for rail concessions.
Although these various subsidy schemes collectively absorb a substantial volume of resources, they cannot be said to constitute a coherent social policy for the infrastructure sector. This is particularly unfortunate given the critical need for such a policy in order to mitigate the social concerns raised by the renegotiation process and concomitant need to make tariff adjustments for essential services.

Figure X: Distributional incidence of subsidy schemes in energy and transport

(a) Patagonian gas subsidy (b) Metropolitan urban transport subsidy
About three quarters of the resources channeled to the existing subsidy schemes take the form of supply side subsidies, primarily to transport operators. These are equivalent to an implicit price reduction of $0.09 per bus passenger, $0.14 per metro-rail passenger, and $0.25 per suburban rail passenger. Given that these subsidies benefit all customers, with no particular attempt to target resources to the poor, it is not surprising to find that the distribution of these resources is skewed towards the upper middle income groups (Figure X). A recent study estimates concentration coefficients for subsidies received by metropolitan commuters that range from +0.09 for suburban rail, +0.16 for bus, and +0.36 for metro-rail. (Foster and CEER, 2003b).
Most of the remaining subsidy resources take the form of demand-side subsidies for energy consumption targeted to certain geographical areas, based on criteria that have little to do with poverty (Foster and CEER, 2003b). Thus, 92% of the resources of the Electricity Tariff Compensation Fund go to the smaller Provinces of the interior which have only 44% of the nation’s poor (see Figure A6 of the Statistical Appendix). Similarly, 100% of the resources of the Patagonian gas subsidy go to the far south which has only 3% of the nation’s poor. Moreover, the Patagonian gas subsidy was found to have a concentration coefficient of +0.08, indicating that its effect on income distribution is mildly regressive (Figure X). Seen from a national perspective, the Patagonian gas subsidy excludes 95% of poor gas consumers in Argentina, while 63% of its beneficiaries are non-poor households.

3. Ensuring Sustainability of Infrastructure Services

The current crisis in the infrastructure sector seriously jeopardizes the achievements of the 1990 reforms, raising the real possibility that some concessionaires might withdraw from the country, while others will remain unwilling to invest until the credibility of the regulatory framework is restored. The alternative of a return to public ownership and control is not a realistic or desirable option, given the extent to which Argentina has come to rely on private investment, and the major contribution this has made to the country’s precarious public finances (both in terms of reduced expenditure and increased revenues).

Therefore, unless the short term renegotiation issues and medium term second generation reforms are adequately addressed, Argentina may find itself without access to the resources needed to finance the infrastructure needed to support economic recovery. This is a particular concern given that the infrastructure sectors have a major contribution to make to the recovery of the Argentine economy. In the short term, public works projects can have a significant employment impact, contributing to the reactivation of the economy. For example, 20% to 25% of the costs of road rehabilitation and maintenance projects are related to labor contributions.
Looking further ahead, Argentina has the potential to increase exports of cereals, petroleum, automobiles, timber, meat, fish and produce between 50% and 100%, and double tourism revenues, by 2010 (IDEA, 2001). However, meeting these goals will not be possible without substantial investments throughout the transportation network. The needs range from improving the availability of all weather rural roads to support the extraction of agricultural produce, to increasing capacity on road, rail and river links along the major inter-urban corridors, to improving multi-modal access to major ports as well as enhancing terminal facilities to include cold chain capacity. A recent study estimates that Argentina needs to invest around US$5,150m per year for the period 2005/10 in order to satisfy consumer and producer requirements based on expected GDP growth (Fay and Yepes, 2003). This is approximately the level of investment that was achieved during the boom private investment period of 1993/98.

Concluding renegotiation process

The most urgent need is to conclude the renegotiation process in order to accelerate the return to a normal functioning of the regulatory framework.

One of the key problems with the renegotiation process to date has been the tendency to focus on ad hoc short term measures, without establishing the principles that will govern the longer term adjustment process. This has serious implications, given that concessionaires will be unable to reschedule their debts until a longer term framework becomes apparent. There are two key issues that need to be resolved in that context. The first, is the need to find a new formula for indexing tariffs in the future, given that the US Consumer Price Index is no longer relevant for this purpose. The second, and more complex issue, relates to the procedure to be followed for the gradual restoration of financial equilibrium. The private concessionaires have conceptualized this problem in terms of a ‘regulatory asset’ on their balance sheet, that captures the total debt that consumers have with the operators as a result of the foregone tariff increases, and that could be gradually repaid over time via offsetting adjustments in tariffs and/or tax liabilities.
A related concern is the fact that the existing regulatory agencies have been largely bypassed in the renegotiation process, with their role being limited to an advisory one of supplying information the Commission. In many, though not all cases, the renegotiation process could have been handled within the existing regulatory framework as an extraordinary tariff review. Moreover, in the case of electricity distribution, an ordinary tariff review was already underway in January 2002, but was suspended following the Emergency Law. As the official renegotiation period has been extended, it is currently unclear how the return to the original regulatory framework will be managed, or whether there has been permanent damage to the credibility of the regulatory process.
In the case of the inter-urban toll road concessions, the priority should be to conclude them within the original time horizon of October 2003, in order to terminate the permanent process of renegotiation and the burgeoning subsidy payments to these concessionaires.

Establishing social policy framework

A key factor in enabling the conclusion of the renegotiation will be the establishment of a social policy framework to ensure that any tariff increases that result from this process do not seriously threaten the affordability of essential services by the lowest income groups.

The absence of a social policy framework within which to address the problems raised by the current renegotiation process is a legacy of the 1990 reforms, which were motivated primarily by fiscal and efficiency considerations, and gave very limited attention to social issues. Throughout the 1990s, social concerns about infrastructure pricing have manifested themselves on numerous occasions, prompting the development of a wide variety of ad hoc social policy mechanisms for different sectors in different jurisdictions. This has created a patchwork of federal and provincial social policies for the infrastructure sector, and has engendered subsidy schemes that collectively absorb $940m (see Table A11 of the Statistical Appendix). Although these resources are substantial, empirical evidence suggests that they are not effectively targeted towards the poor, and thus ultimately benefit only a relatively small set of interest groups.
Returning to first principles, user subsidies to support the consumption of basic infrastructure subsidies can sometimes be justified where there is a genuine affordability problem and a clear merit good argument. A household survey conducted in October 2002 found that expenditure on the household utilities alone (namely, water, electricity, natural gas and telephony) has doubled as a share of family budgets relative to the situation that prevailed in 1997 (when the last national expenditure survey was conducted). At present, utility expenditure accounts for 22% of the income of the first quintile, and 16% of the income of the second quintile. These values can be compared with typical international parameters of up to 15%. Clearly any future tariff increases would further raise these income shares, indicating a genuine affordability problem that needs to be addressed.
This situation has led to widespread demands for the development of a social tariff, and a number of specific proposals have been circulated (see Table A12 of the Statistical Appendix). Most rely on providing discounted tariffs for subsistence levels of consumption, or for families that are already beneficiaries of existing social programs, such as the Jefes y Jefas program. However, the limited empirical evidence suggests that neither consumption levels nor existing social programs provide particularly good poverty proxies. Preliminary results from a new study suggest that much better targeting performance could be obtained by using a weighted average of poverty proxies based on housing characteristics (Foster and CEER, 2003). The study finds that reallocating existing infrastructure subsidies based on a poverty proxy of this kind leads to substantial targeting improvements.
Despite extensive discussion of social tariffs, little has been done to estimate the cost of such a policy. In order to provide an illustration of the possible costs, it is assumed that the policy objective would be to keep the cost of subsistence water, sewerage, electricity and gas bills for poor households below 15% of income. At current prices, the total cost of this policy would be around $300m per year, which is well within the current overall subsidy envelope for these sectors. If all prices were to increase by 10%, the cost of the policy would escalate to $XXXm, while a 30% tariff increase would generate a cost of $XXXm.
Looking further ahead, as incomes recover and the affordability concerns raised by the current crisis begin to ease, the social policy framework should also consider measures to promote access to water, sewerage, and natural gas services among the lowest income groups, where substantial coverage deficits still remain. In the case of water and sewerage, there is an evident public health case for seeking to achieve universal access. In the case of natural gas, those who lack access suffer a significant economic disadvantage, given that the closest substitute, LPG cylinders, cost five times as much per effective unit of energy delivered. In both instances, the substantial connection charges and intra-household investments associated with connecting to the network, represent a major barrier to access for low income households. Furthermore, connection subsidies are by far the most effective way of reaching genuinely poor households. Simulations performed in a recent study, find that the concentration coefficient associated with connection subsidies are strongly progressive, with values ranging from –0.30 to –0.40, compared with only –0.10 to –0.20 for even well-targeted consumption subsidies.

Reforming regulatory framework

The present economic crisis provides an important opportunity to initiate a thorough public review of the functioning of the regulatory framework, with a view to building consensus around a package of second generation reforms designed to address the deficiencies identified above. The widely differing performance of regulatory entities across infrastructure sectors, illustrates that sound legal and institutional design make a real difference to subsequent performance, and that the development of sound regulatory agencies is possible within the Argentine political context.

There is considerable variation across sectors as to the solidity of the legal and institutional framework for regulation (see Tables A13 and A14 of the Statistical Appendix). The two energy regulatorsENRE and ENARGASstand out as best practice regulatory institutions in a number of respects.

Table X: Evaluation of Argentine regulatory agencies against

international best practice guidelines


best practice

Argentine energy sector

(electricity and gas)

Other infrastructure sectors in Argentina (water, telecom, transport)

Regulatory framework established by law

Based on electricity and gas sector laws

Established through a variety of Executive Decrees

Autonomous governing body with high technical capacity

Governing body appointed by President, following a competitive process and with Congressional approval

Governing body appointed directly by President

Financially autonomous but publicly accountable

Financed by regulatory surcharges, with budget subject to Congressional approval

Financed by regulatory surcharges, but without budgetary accountability

Consumer participation in regulatory processes

Major decisions are consulted by public audiences, however not very effective in practice

No formal channels exist (except for the water sector in GBA)

First, the national regulatory agencies for electricity and gas were created by means of sector laws. This stands in contrast to all of the other Federal regulatory agencies for water, telecom and transport, which were all of them established by Decree. However, at the Provincial level, the experience of Buenos Aires, Córdoba and Misiones, suggests a greater tendency to institute regulatory agencies by law. The advantage of a sector law is that it provides a clear basis for the authority of the regulatory agency, and limits the extent of ad hoc political interventions.

Second, in common with most other agencies, the energy regulators are governed by a Commission of five to six members usually appointed by the President (or Provincial authorities, where relevant). However, in the case of the energy sector, the candidates must be selected by competition and approved by Congress. These features have helped to ensure a somewhat greater degree of political independence than in other sectors.
Third, while most agencies are financed through sectoral regulatory levies, the energy sector is the only one where agency budgets must nonetheless be formally approved and executed through the Budget process. This helps to strengthen accountability and avoids the conflicts of interest that can arise when the size of regulators’ budgets depend directly on the level of tariffs which they themselves determine.
A further institutional problem that affects all of the regulated sectors, both in Argentina and throughout Latin America, has been the very limited involvement of consumer representatives in the regulatory process. Consumer participation is universally problematic due to the free-rider problem. However, in developing countries this problem is exacerbated by the absence of well developed civil society institutions to represent the consumer perspective. Moreover, the regulatory framework provides only limited channels for this participation to take place. Although some sectors (notably, electricity and gas) provide for public audiences, this mechanism has not functioned very effectively in practice. An interesting counter-example comes from ETOSS, the water regulator in GBA, which has recently introduced a consumers committee that acts an a consultative body for the agency.
Finally, the focus on regulatory reform in the 1990s privatization program often meant that the strategic policy-making function of the State was debilitated or overlooked. This phenomenonwhich is quite commonplace across Latin Americahas resulted in a complete vacuum as regards long term planning and the determination of strategic objectives for the infrastructure sectors. The Argentine transport sector provides a particularly clear example of this problem. The absence of any official vision of the role that transport infrastructure can play in the long term development of the country, means that decisions are taken on a short-term, piecemeal basis, without any consideration of the key synergies and complementarities that exist (for example) between Federal and Provincial infrastructure, or across different modes of transport.

Reforming governance of extra-budgetary mechanisms

The proliferation of extra-budgetary financing mechanisms for infrastructure and the associated burgeoning of sectoral subsidies are a significant cause for concern that will require a major overhaul, once the immediate problems associated with the renegotiation have been addressed.

From a macro-economic perspective, special financing mechanisms are regarded as problematic because they restrict the optimal allocation of scarce public resources among competing social goals. Nevertheless, there are a number of micro-economic arguments that can sometimes justify their use; and in the case of the roads sector, in particular, they have been quite widely advocated and applied. First, they provide a means of ensuring that users pay for the services that they receive, for example, from the road network. Second, they help to stabilize the flow of resources for maintenance expenditure, which may be particularly vulnerable to cutbacks during fiscal downturns. Third, where there is public-private co-financing of infrastructure investments, the use of a trust fund mechanism can provide additional comfort to private investors that public funds will be forthcoming, thereby reducing the perceived risk of participation. Fourth, the creation of an autonomous source of funding can improve managerial incentives by increasing autonomy from unwarranted political interference.
Therefore, to the extent that the Argentine special financing mechanisms focus on funding public good components of the infrastructure network (such as roads and electricity transmission), or socially motivated subsidies to privately operated infrastructure services (such as energy subsidies or public transport subsidies), there appears to be a conceptual case for their use. However, the micro-economic case for extra-budgetary mechanisms is absolutely contingent on the existence of suitable governance arrangements to ensure that funds are effectively protected and used. The experience of trust funds in Argentina reveals a number of governance problems, that in many cases are so severe as to completely undermine any conceptual advantages that these mechanisms may offer.
Therefore, if extra-budgetary mechanisms are to continue to play an important role in the Argentine infrastructure sectors they will need to be radically overhauled. This is particularly true of the Transport Infrastructure Trust Fund, which is by far the largest of the extra-budgetary mechanisms, and also presents the most glaring deficiencies in its design (Table X). Overall, there are a number of obvious areas for improvement, which include weak governance structures, safeguarding of resources for their intended purposes, rules governing the allocation of funds, and mechanisms to ensure accountability (see Table A15 of the Statistical Appendix).
Table X: Evaluation of Argentine Transport Infrastructure Trust Fund against international best practice guidelines

Design feature

International best practice

Argentine Transport Infrastructure Trust Fund

Legal establishment

By separate legislation

By Decree 976/01, with subsequent modifications

Governance arrangements

Autonomous entity with majority road user representation on Board

Direct government administration without any road user representation, initially within Ministry of Infrastructure later transferred to Ministry of Economy

Relation to

public budget

Outside Government Budget

Officially extra-budgetary, but in practice increasingly integrated within Government Budget



Transparent and established rules for allocation between agencies

Allocation rules modified five times in the first year of operation (see Table X for further details)


Published financial regulations and procedures supported by regular technical and financial audits

Accounts must be submitted to Ministry of Economy, National Auditor currently considering need for further measures.

Source: For international best practice Gwilliam and Shalizi (1999) and Potter (1997)
First, there is a need to develop autonomous governing bodies with substantial representation from beneficiary groups, such as the private sector and civil society. At present, the two largest funds (Transport and Hydraulic Infrastructure Trust Funds) have no autonomy whatsoever being administered directly by a unit within the Ministry of Economy. Some of the energy funds have somewhat broader based representation with committees combining members from both Federal and Provincial tiers of government. However, only the governing body for the Regional Infrastructure Development Fund (Fondo Fiduciario de Infraestructura Regional) has some degree of non-governmental representation, albeit a single optional member from the Argentine Chamber of Construction.
Second, there is a need to strengthen the safeguard measures on trust fund resources, both by improving the legal framework and by channeling resources directly to commercial banks. At present, many of the smaller trust funds are legally constituted, however the two largest funds were created by means of Executive Decrees. This combined with their weak governance structure makes them particularly vulnerable to modification and political interference, including the recapture of their resources for the general budget.
For example, the 2002 Budget Law 25,565 responded to a budget surplus in the Transport and Hydraulic Infrastructure Trust Funds by requiring a non-refundable transfer to the Treasury of $100m from the first and a further $70m from the second. Although these transfers were appealed by the fund management, they were ultimately upheld by the Treasury and have subsequently taken place. A further illustration of this phenomenon is provided by Law 25,400 of 2001, which allowed Provinces to divert up to 50% of the resources received from the National Electricity Fund (Fondo Nacional de Energía Eléctrica) to general expenditures, and Law 25,570 of 2002, which further raised this threshold to 100%.
What these incidents reveal is the cyclical political economy dynamics of these special financing mechanisms. These arise initially as a means of providing stable financing for long term infrastructure needs. However, as fiscal pressures increase, the Treasury finds creative ways of recapturing these resources for general budgetary needs; a process that is made all the easier by the institutional weaknesses in the governance of these special funds, as noted above. Nowhere is the cyclical nature of this phenomenon more evident than in the history of road funds in Argentina, which shows how the principle of earmarking resources for a national road fund was established and successfully applied in the 1930-60s, gradually eroded and ultimately abolished during the 1970s-90s, only to be re-established in the year 2000 (see Table A16 of the Statistical Appendix).
Third, there is a need to improve the transparency with which resources are allocated to different purposes. Although all of the funds have clearly defined rules governing the allocation of their resources, in many cases these rules have become subject to discretionary changes over time. The most flagrant example is the Transport Infrastructure Trust Fund, which had its allocation rules modified five times in the space of 12 months, by a series of Decrees and Ministerial Resolutions (see Table A17 of the Statistical Appendix). As a result, this fundwhich was originally intended to finance new road investments via a British style Private Finance Initiativewas first converted into a scheme for subsidizing existing road concessions, and then gradually diverted into a source of finance for rail and urban transport services (see Figure A7 of the Statistical Appendix). A further illustration is provided by the Patagonian gas subsidy, which Law 25,725 of 2003 recently extended to cover gas consumers in the Puna region of the northeast, even though the original trust fund was designed to subsidize only gas consumers in the extreme south Patagonian region.
Fourth, there is a need to strengthen accountability, by creating public oversight mechanisms to monitor the overall need for resources to meet the funds policy objectives, as well as their efficient and appropriate use, and specific rules for dealing with financing shortfalls or surpluses. Since their inception in 1994, there have been a number of moves to improve the transparency and accountability of Trust Funds. Law 25,152 of 1999, obliged Trust Funds to be incorporated into the General Budget, which was done for the first time in 2001. They are also required to submit accounting data to the Ministry of Economy on a regular basis. The Budget Law of 2002, further modified the legal framework so that Trust Funds are explicitly considered as public sector agencies, akin to State Owned Enterprises. However, the numerous reallocations and diversions of resources described above illustrate that the current accountability mechanisms do not appear to be functioning very adequately.
Notwithstanding these recommendations, the question still remains whether measures to improve the functioning of these special financing mechanisms could be effective in the current political environment, or whether (in the absence of a broader overhaul of the public expenditure framework) any such measures would ultimately also be vulnerable to circumvention.


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