Cablegate: Argentina Economic and Financial Weekly for the Week Ending

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DE RUEHBU #1630/01 2022043
ZNR UUUUU ZZH
R 212043Z JUL 06
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC 5326
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUEHRC/USDA FAS WASHDC 2249
RUEHC/DEPT OF LABOR WASHDC
RHMFISS/HQ USSOUTHCOM MIAMI FL

UNCLAS BUENOS AIRES 001630

SIPDIS

SIPDIS

PASS FED BOARD OF GOVERNORS FOR PATRICE ROBITAILLE
TREASURY FOR DAS LEE, RAMIN TOLOUI AND CHRIS KUSHLIS NSC FOR SUE
CRONIN
AND OCC FOR CARLOS HERNANDEZ
USDOC FOR ALEXANDER PEACHER
USDOL FOR ILAB PAULA CHURCH AND ROBERT WHOLEY
USSOUTHCOM FOR POLAD
OPIC FOR GEORGE SCHULTZ AND RUTH ANN NICASTRI

E.O. 12958: N/A
TAGS: EFIN ECON ELAB ALOW AR
SUBJECT: Argentina Economic and Financial Weekly for the week ending
May 21, 2006

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Weekly Highlights
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- Venezuela will buy USD 600 million in Boden 2012 bonds in July.
- ICSID rules against Argentina for USD 165 million.
- May monthly economic activity index up 8 percent y-o-y -- in line
with market expectations.
- Fiscal primary surplus higher than expected, up 8.6 percent y-o-y
on H1.
- Eight Latin-American presidents visit Argentina for annual
Mercosur summit.
- Argentina and Chile will set new gas price during the Mercosur
summit.
- Commentary of the Week: "The tax burden in Argentina is high and
taxes are distortionary"

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Venezuela will buy USD 600 million in Boden 2012 bonds in July.
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1. According to local media, the GOV will buy approximately USD 600
million of Boden 2012 bonds from the GOA through the end of the
month. This will represent the largest purchase by the GOV in such
a short period. Along with USD 1.4 billion deposited by the GOA in
the Banco Nacion, it will be used to pay USD 2 billion of the Boden
2012 capital due. Presidents Hugo Chavez and Nestor Kirchner will
also try to incorporate more countries in their "Bond of the South"
project during this week's Mercosur meeting.

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ICSID rules against Argentina for USD 165 million.
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2. The International Center for the Settlement of Investment
Disputes (ICSID), an independent tribunal associated with the World
Bank, ruled against Argentina in a case filed by US-based Azurix for
USD 165 million, 29 percent of the amount demanded by Azurix.
Azurix won a concession in 1999 to provide water and sewage services
to various districts in Buenos Aires province; the provincial
government rescinded the contract in 2001 due to disagreements over
tariffs and after raising concerns about the water quality and lack
of investments. Azurix then brought a claim against Argentina,
arguing that the government's cancellation of the concession
violated the bilateral investment treaty signed between the United
States and Argentina. There are 36 other lawsuits against Argentina
registered in the ICSID, totaling USD 16 billion in claimed damages,
many of which stem from the government's unwillingness to allow
utility companies to raise tariffs.

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May monthly economic activity index up 8 percent y-o-y -- in line
with market expectations.
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3. The monthly economic activity index increased 8 percent y-o-y in
May -- in line with the BCRA market survey forecast. This marks a
sharp recovery after April, which showed the weakest growth rate
(6.3 percent) in the past eight months, and it represents a reprieve
from the downward trend that followed the 9.1 percent increase in
January. However, slower performance in April and March was in part
due to seasonal effects. May's index growth came from a 6.9 percent
increase in the service sector (mainly from the financial and
communication sectors) and a 5.1 percent increase in goods (mainly
from industry and construction). The latest BCRA consensus survey
estimates 7.7 percent growth in economic activity for 2006,
unchanged from its previous forecast. The monthly economic activity
index is viewed as a reliable leading indicator of GDP.

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Fiscal primary surplus higher than expected, up 8.6 percent y-o-y on
H1.
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4. According to Ministry of Economy figures, public accounts showed
an ARP 13 billion primary surplus in the first semester of 2006, 8.6
percent up against H1 of 2005. This increase was partially offset
by a record in current expenses, reaching ARP 74 billion (+21.1
percent y-o-y) due to debt payments and wage increases. In June,

the primary surplus reached ARP 2 billion (+24.5 percent y-o-y).
The financial surplus (considering debt servicing) reached ARP 8
billion (+38.1 percent y-o-y). The improved performance was a
result of fewer interest payments coming due. The fiscal primary
surplus was a 20.6 percent higher than scheduled and allowed the
Treasury to reach 64.2 percent of the results projected for 2006.

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Eight Latin-American presidents visit Argentina for annual Mercosur
summit.
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5. From July 20-21, eight Latin-American presidents gathered in the
Argentine province of Cordoba. The group consisted of the
presidents of Mercosur member countries (Argentina, Brazil,
Paraguay, Uruguay and the newest member, Venezuela) and the
presidents of Chile, Cuba and Bolivia. Participants discussed a
trade agreement between Mercosur and Cuba under the Common Market
Group (GMC), while other topics like natural gas prices (involving
Argentina, Chile, Brazil and Bolivia) and the pulp mills projects
(involving Argentina and Uruguay) were addressed in bilateral
conversations.

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Argentina and Chile will set a new gas price during the Mercosur
summit.
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6. On July 15, the new price agreement between the GOA and the
Government of Bolivia went into effect, increasing the price of
natural gas from USD 3.20 to USD 5 per million cubic meters through
the end of the year. In light of that increase, the GOA has begun
negotiations with the Government of Chile to determine a new price
for Argentine gas exported to Chile (Chile buys 90 percent of
Argentine gas exports). The final decision will be reached during a
meeting between Argentine President Nestor Kirchner and Chilean
President Michelle Bachelet on July 21. Bachelet will also present
a complaint about a recent GOA decision to raise diesel oil prices
for foreigners purchasing near the country's borders.

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The BCRA announces that inflation will continue falling.
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7. On July 19, the BCRA announced that inflation will continue
falling in coming months. According to the report presented by the
BCRA, this slowdown is caused by the GOA's monetary and fiscal
policies. The BCRA also highlighted other economic indicators,
saying that economic growth will remain solid, the labor market will
continue its recovery and that real wages will continue to rise as
they did last year.

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Minimum, Vital and Mobile Wage Council will meet July 27.
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8. The GOA called a meeting of the Minimum, Vital and Mobile Wage
Council for July 27 in order to consider adjusting workers' basic
salaries. Labor union leaders will propose increasing the minimum
wage from ARP 630 to ARP 870; this 38 percent raise is well above
the 19 percent proposed by the GOA. The Minimum, Vital and Mobile
Wage Council is composed of union leaders, employers and government
employees.

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The GOA will restructure provinces' debt by the end of the year.
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9. The GOA will begin negotiations to restructure the provinces'
debt this year. The debt currently stands at ARP 78 billion, and
the GOA holds ARP 47 billion. This negotiation will take place in
light of financial troubles facing the provinces. The GOA has two
options: stop indexing the debt to the CER index (a CPI-linked
index) or extend the terms of payment. In a recent meeting,
Economic Minister Felisa Miceli urged the provinces to show fiscal
restraint and warned six of them (Chaco, Formosa, San Juan, Jujuy,
Rio Negro and Tucuman) about their high debt-to-income ratios.

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Argentina and United States sign anti-money laundering agreement.
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10. On July 18, the head of the Argentine tax authority, Alberto
Abad, and United States Ambassador Lino Gutierrez signed an
agreement establishing a Trade Transparency Unit (TTU), which will
gather real-time information on imports and exports passing through
both customs houses. The two countries will share information to
improve detection of money laundering operations and tax evasion.
The pan will be operational in 30 days and will provide information
not only on the quantity of goods passing between the countries but
also on their value.

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Argentina holds off on forgiving Paraguayan debt on Yacyreta.
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11. In a surprise move, Argentine President Nestor Kirchner and
Paraguayan President Nicanor Duarte Frutos signed an agreement to
study ways to restructure the debt the Yacyreta power station owes
to the GOA. Just a day earlier, Paraguay had announced that the GOA
would forgive nearly half (USD 5 billion) of Yacyreta's debt.
Instead, over the next 90 days a joint commission will investigate
how to reduce Yacyreta's debt of roughly USD 11 billion owed to the
GOA. Co-owned by the two countries, Yacyreta is one of South
America's largest power projects. The GOA financed the construction
of Yacyreta in the 1980s. Paraguay claims that interest on the debt
was unfairly calculated and fears the company's liabilities could
impede expansion projects in the future. Kirchner has said that any
decision on the power station's debt should be ratified by each
country's legislators.

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June industrial production index up 8.9 percent y-o-y.
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12. The industrial production index increased 8.9 percent y-o-y in
June, well above market expectations of 7.7 percent and marking a
significant acceleration following a 7.3 percent increase in May.
During June, the fastest growing sectors were car production (+32.6
percent), non-metallic minerals (+31 percent), oil refining (+12.1
percent) and base metal industries (+8.5 percent). The index
decreased 0.3 percent m-o-m without seasonal adjustment and
increased 0.9 percent m-o-m seasonally adjusted. The BCRA consensus
survey forecasts 6.9 percent industrial production growth for 2006
-- unchanged from last month's forecast.

13. The industry-wide capacity utilization index reached 71.9
percent in June, up slightly from 71.2 percent in June 2005. The
sectors with the highest capacity utilization rates were metal-based
industries (97.6 percent), oil refining (94.6 percent) and textiles
(87.1 percent). The sectors with the lowest capacity utilization
rates were auto production (54.3 percent), tobacco (60.6 percent)
and non-metallic minerals (63.1 percent).

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Multilateral real exchange rate appreciates 1.2 percent m-o-m in
June.
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14. The BCRA's multilateral real exchange rate index -- which
measures the real exchange rate between the peso and a
trade-weighted basket of currencies -- appreciated 1.2 percent m-o-m
in June. The real appreciation is mainly explained by the
depreciation of the Brazilian real and Euro against the peso,
partially offset by an appreciation of the dollar against the peso.
The index is 3.7 percent above the level twelve months ago and 104.2
percent above its average value during convertibility. [The BCRA's
multilateral real exchange rate index weighs domestic prices and the
exchange rates of Argentina's main trading partners according to
their share of Argentina's exports and imports.]

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BCRA rolls over its maturities. Investors showed great interest in
the BCRA's instruments.
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15. The BCRA received ARP 1.2 billion in bids at its July 18 Lebac
and Nobac auction, compared to ARP 279 million in Lebacs that came

due during the week. It accepted ARP 342 million in Lebac bids and
ARP 644 million in Nobac bids. The yield on the 91-day Lebac was
7.39 percent, the 168-day Lebac remained at 8.50 percent and the
yield on the 238-day Lebac decreased from 10.06 percent to 10
percent. The yield on the longest term instrument, the 357-day
Lebac, decreased from 12.15 percent to 12.05 percent. Lebacs for
maturities of more than 357 days were withdrawn due to lack of
interest by the BCRA. The spread on the one-year Nobac decreased
from 2.10 percent to 2.08 percent and the two-year Nobac spread was
3.78 percent. The Badlar rate (the base rate for Nobacs) is
currently at 9.2 percent. Investors showed great interest in the
BCRA's instruments with bids four times larger then the amount that
came due.

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The peso is unchanged against the USD this week, closing at 3.10
ARP/USD.
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16. The peso remained flat versus the USD this week, closing at
3.10 ARP/USD. The BCRA continued purchasing dollars to keep the
peso from falling against the USD. In the first three days of the
week, the BCRA purchased USD 198 million. The peso exchange rate
has depreciated 1.6 percent since the beginning of the calendar
year. The BCRA's reserves stood at USD 26.1 billion as of July 18,
and have increased USD 7.5 billion, or 40 percent, since the GOA
prepaid its entire IMF debt on January 2.

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Commentary of the Week: "The tax burden in Argentina is high and
taxes are distortionary", by Daniel Artana, from an article
published in Ambito Financiero on June 7.
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17. The above statement should be made carefully. Argentina is a
country with a federal system and the three levels of government
collect taxes, while in unitary countries like Chile or France, the
federal government obtains the bulk of collections. Also, for those
countries that replaced the government pay-as-you-go pension system
with a private system, the tax burden will be lower than in those
countries that maintain a state-run pension system (as is the case
in Brazil).

18. Even more importantly, the tax burden tends to grow with the
level of development. There are various conceptual arguments that
support this statistical regularity. For example, the most
developed countries have deeper financial markets, and this
facilitates the work of the tax administration and, in general, they
have greater formal employment, which allows income taxation to be
more important than in the case of developing countries.
Furthermore, if the desired consumption of public goods increases
faster than the level of income rises, development will be
accompanied with a greater desire for these types of goods (and for
paying taxes to finance them).

19. The attached graphic shows the tax burden on the consolidated
public sector among developed and developing countries. The
regression line shows a positive relationship between the level of
development (measured in GDP per capita adjusted for purchasing
power parity) and the tax burden. Clearly, Argentina's tax burden
(including all three levels of government) is high compared to its
level of development. It is the second-highest in Latin America
after Brazil, and it is much higher than what is observed among
economies with high growth rates, like Chile or countries in Asia.

20. Furthermore, the tax burden is even higher in the private
formal sector. In the case of Argentina, we have estimated it to be
around 40 percent, similar to what is observed in Spain. Clearly,
Argentine businesses do not have the same ease of access to the
European Union market as the Spanish or the same legal security or
institutional pathways.

21. Finally, besides being higher, the form in which collections
are obtained is not optimal. In the case of the federal government,
withholdings and the financial transaction tax contribute around 4
percent of GDP. Other developing countries impose export taxes, but
in a timely manner upon determined export commodities, not in a more
generalized way, as is done in Argentina with an average rate of 10

percent on foreign sales. Also, the financial transaction tax,
which is imposed in only few developing countries, is extremely
high. For example, the effective tax rate in Argentina is three
times higher than in Brazil. (Note: We reproduce selected articles
by local experts for the benefit of our readers. The opinions
expressed are those of the authors, not of the Embassy. End Note.)

LLORENS
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