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FM AMEMBASSY BUENOS AIRES
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INFO RUCNMRC/WESTERN HEMISPHERIC AFFAIRS DIPL POSTS PRIORITY
RUEAIIA/CIA WASHINGTON DC PRIORITY
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UNCLAS SECTION 01 OF 06 BUENOS AIRES 000881
SENSITIVE
SIPDIS
E.O. 12958: N/A
TAGS: EFIN ECON EINV ETRD ELAB EAIR AR
SUBJECT: ARGENTINA ECONOMIC AND FINANCIAL REVIEW, JUNE 16 -
20, 2008
REF: BUENOS AIRES 782
BUENOS AIR 00000881 001.2 OF 006
1. (U) Provided below is Embassy Buenos Aires' Economic and
Financial Review covering the period June 16 - 20, 2008. The
unclassified email version of this report includes tables and
charts tracking Argentine economic developments. Contact
Econoff Chris Landberg at landbergca@state.gov to be included
on the email distribution list. This document is sensitive
but unclassified. It should not be disseminated outside of
USG channels or in any public forum without the written
concurrence of the originator. It should not be posted on
the internet.
----------
Highlights
----------
-- BCRA purchasing GoA bonds; reason and impact unclear
-- BCRA posts ARP 7.8 billion profit in 2007
-- Disappointing May primary fiscal surplus
-- GDP up 8.4% y-o-y in Q1, driven mainly by Investment
-- Inflation and Debt evoke ghosts of the past
-- Investment strong in 2007, but not enough to guarantee
sustained high growth
-- Fifth Annual Financial Summit optimistic about Argentina's
potential for investment and financing in agribusiness and
biofuels
-------
Finance
-------
BCRA purchasing GoA bonds; reason and impact unclear
--------------------------------------------- -------
2. (SBU) Recent press reports allege that the BCRA is buying
Argentine government debt. According to a June 17 "Cronista
Comercial" article, the BCRA used $800 million of its FX
reserves to purchase GoA bonds, while a June 16 "Ambito
Financiero" article reports that the purchases reached $1.0
billion and were concentrated in Peso Discounts, GDP
Warrants, and Bonar X. (While the BCRA does not release
information on its GoA bond purchases, traders interviewed
say there is no doubt the BCRA is the buyer.) As of June 6,
BCRA reserves stood at $47.7 billion after having reaching a
peak of $50.5 billion on March 27. This fall in reserves is
mostly explained by the BCRA intervention in the FX market,
where it sold $2.7 billion reserves from April 1 through June
13. The BCRA's reason for selling dollars sales has been
stave off a run on the peso and ease pressures in the FX
market, (with the peso seeing retail rate lows of 3.25
ARP/USD on May 9). However, analysts find it hard to explain
the BCRA's continued intervention, which brought the peso to
highs of 3.06 ARP/USD on June 18 -- almost a 5% peso
appreciation from the 3.15-3.20 trading band of the beginning
of the year. Some analysts speculate that it may appreciate
further, even surpassing the psychologically important level
of 3.0 ARP/USD.
3. (SBU) Still, it is even harder for the market to
understand BCRA purchases of GoA bonds, and many of Post's
financial sector contacts consider it a waste of resources.
These analysts wonder what the BCRA will eventually do with
the purchased bonds -- i.e., either sell them back to the
market or transfer them to a public entity. The analysts
also note that the BCRA is probably purchasing GoA bonds to
inject peso liquidity (to bring down interest rates), reduced
by the BCRA's dollars sales. However, they argue that the
BCRA could have done this more easily by purchasing its own
short-term debt instruments (Lebacs and Nobacs), rather than
buying the 30-year GoA Discount bonds (apparently the
preferred bond in BCRA purchases). One of Post's banking
sector contacts interprets these purchases as "hidden"
lending to the GoA, since the BCRA uses its reserves to
finance the purchase but without violating the short-term
financing limits (to the GoA) under the BCRA charter.
Regardless, analysts agree that BCRA purchases have not
helped much to sustain bond prices and reduce yields.
4. (SBU) In response to the questions being raised by the
market, BCRA President Martin Redrado stated during a June 18
Latin Finance conference in Buenos Aires that "not selling
BCRA reserves to contain the foreign exchange market would
have been absurd." He also indicated his intention to have
the BCRA continue to inject peso liquidity to cool down
interest rates. (Interest rates have roughly doubled since
March due to BCRA dollar sales.)
BUENOS AIR 00000881 002.2 OF 006
BCRA posts ARP 7.8 billion profit in 2007
-----------------------------------------
5. (SBU) The BCRA transferred one-third of 2007 profits to
the GoA to boost the 2008 primary fiscal surplus. In the
face of decelerating GoA fiscal revenues (and increasing
expenditures), additional BCRA funds may be forthcoming.
6. (SBU) The BCRA earned ARP 7.8 billion ($2.5 billion) in
profits during 2007. This compares to the ARP 3.7 billion it
earned in 2006, according to the BCRA's report on its 2007
financial results, released June 12. The earnings came from
investment of BCRA assets, mainly official reserves, in Euros
and gold, both of which have appreciated strongly against the
dollar, as well as from BCRA holdings of public bonds. The
strong BCRA profits have helped the GoA to boost its primary
fiscal surplus. Just through May, the BCRA has transferred
ARP 2.5 billion BCRA transfer, an amount significantly higher
than the annual transfer of ARP 1.4 million that was included
in the 2008 Budget. (The BCRA is obligated to use earnings
to increase capital or transfer them to the GoA. So far in
2008, the BCRA transferred to the GoA ARP 1 billion in March,
ARP 450 million in April, and ARP 1 billion in May.)
7. (SBU) With the strong 2007 BCRA profits, analysts are
speculating that the BCRA may continue making transfers --
totaling as much as an additional ARP 5 (about $1.7 billion)
-- to the GoA. This would substantially strengthen the GoA's
primary fiscal surplus, which many analysts believe is
increasingly vulnerable (see item below), and would also ease
the GoA's effort to fulfill its 2008 financial needs. (The
decision to transfer earnings to the GoA or re-capitalize the
BCRA is up to the BCRA's Board of Directors.) Private
analysts have expressed concern regarding the vulnerability
of GoA fiscal accounts due to the apparent deceleration of
the economy -- leading to lower tax collection -- and the
increasing pace of subsidies (for details see May 30 Econ/Fin
report), as well as pressures to increase public sector wages
and pensions due to rising inflation.
------
Fiscal
------
Disappointing May primary fiscal surplus
----------------------------------------
8. (SBU) The GoA announced June 19 a record primary fiscal
surplus of ARP 6.0 billion ($1.9 billion) for May, a 13%
y-o-y increase. However, this strong nominal result hides
man ominous trends:
-- May was the first month in 2008 where expenditures grew at
a faster pace than revenues: 40% versus 30% y-o-y (nominal)
increases, respectively;
-- Correcting for a more realistic rate of inflation (around
25%, as opposed to the official rate of 8 - 9%), the primary
fiscal surplus for May dropped 12% y-o-y in real terms;
-- The May primary fiscal surplus would have decreased 6%
y-o-y in nominal terms, when excluding the ARP 1 billion
earning transfer in May from the BCRA (mentioned in item
above); (see clarification below)
-- For the first five months of the year, the accumulated
primary fiscal surplus reached ARP 17.7 billion, up 47%
y-o-y, significantly lower than the 74% y-o-y increase
through April of this year.
9. (SBU) The disappointing May result was due to decelerating
revenues and accelerating expenditures. With regards to
expenditures, which totaled ARP 14 billion, private analysts
are most worried about the increase in subsidies, although
the increase in public sector wages and pensions (and
pressure for even higher increases) is also a major concern.
Subsidies -- mainly for energy, transportation and
agriculture -- increased 80% y-o-y in May to ARP 4.1 billion,
according to the GoA. Note, however, that this does
represent a deceleration from the growth rate seen during the
first quarter (103% y-o-y; for details see May 30 Econ/Fin
Report). Subsidies totaled ARP 16 billion in 2007, and
analysts estimate that, based on current trends, GoA
subsidies could increase 50% in 2008 to roughly ARP 20-23
billion (or 2 to 2.5% of GDP).
10. (SBU) Revenues also performed poorly in May, reaching ARP
20.1 billion, up only 29% y-o-y, only a couple of percentage
points higher than true inflation (estimated at around 25%).
Within tax collection, activity-related taxes (including VAT,
fuels tax, the financial transaction tax) increased 31% y-o-y
in May, compared to 39% y-o-y for the first four months of
BUENOS AIR 00000881 003.2 OF 006
the year, reflecting a deceleration of the economy in May.
Export taxes increased 80% y-o-y in May, compared to an
increase of 110% though April, which indicates the impact of
the Ag conflict. Local consulting group Bein and Associates
estimates that the Ag strike reduced export tax collection by
ARP 1 billion in May. Finally, income-related taxes
(including income and wealth taxes) increased a weak 2% y-o-y
during the month, (compared to 32% y-o-y in the first four
months of the year). This was mainly explained by the poor
income tax collection, despite May being the month when most
companies file their tax forms. Income tax revenue was only
ARP 5.3 billion, almost equivalent to May 2007.
---------------
Economic Growth
---------------
GDP up 8.4% y-o-y in Q1, driven mainly by Investment
--------------------------------------------- -------
11. (SBU) GoA Statistical Agency INDEC (the National Bureau
of Statistics and Census) announced June 18 that GDP
increased 8.4% y-o-y in the first quarter of 2008,
decelerating from 9.1% y-o-y in Q4 2007 and the average of
8.7% y-o-y growth in 2007 (graph below). Investment was the
main driver behind the expansion, growing 20.2% y-o-y (and
accelerating from a 15.2% y-o-y growth rate in Q4 2007).
This was followed by private consumption, up 8.2% y-o-y
(decelerating slightly from 9.3% y-o-y growth in Q4 2007).
The increase in investment, which now stands at 22.7% of GDP
(measured in constant prices), is due to a 34.8% y-o-y
increase in durable equipment investment and a 10.3% y-o-y
increase in construction. The growth in durable equipment
was mainly from foreign sources, up 46.4% y-o-y, compared to
a domestic increase of 16% y-o-y. This increase in imported
durable equipment also partly explains the recent
deterioration in the trade balance (April's trade surplus was
$864 million, down 30% y-o-y). Decelerating private
consumption is attributed to the acceleration of inflation
and the fall in consumer confidence.
12. (SBU) The implicit GDP price deflator for Q1 2008
increased 20.0% y-o-y, higher than the 18.1% increase in Q4
2007. Many analysts are using the GDP deflator as proxy for
the CPI, since the latter is not reliable due to the GoA's
intervention and tampering with the index. For extensive
background, see previous Econ/Fin reports, including Oct 5
and Nov 19 2007; and Jan 18, Feb 8, Apr 18 and Mar 4 2008).
For reference, May's CPI increased 9.1% y-o-y. As an
alternative to the GDP deflator, which includes all
components of demand (investment, exports, private and public
consumption), some analysts prefer to use the private
consumption price deflator, which increased 15.6% y-o-y --
almost 4.5 percentage points lower than the increase in the
GDP deflator. The main shortcoming of using either the GDP
or private consumption deflator as a proxy for inflation is
that the share of tradable goods and services is larger than
in the CPI basket. Thus, these deflators are not exact
substitutes for the CPI index.
13. (SBU) Most analysts agree that the GoA's manipulation of
the price index generates an overestimation of real GDP.
However, there is no agreement of the magnitude of the error,
with analyst estimates ranging from a marginal difference to
as high as a whole one-percentage point of growth. According
to the BCRA consensus, 2008 GDP growth is estimated at 7.5%.
------------------
Debt and Inflation
------------------
Inflation and Debt evoke ghosts of the past
-------------------------------------------
14. (SBU) In a June 2008 working paper entitled "Back to the
Future," Argentine Institutions and Markets Research Center
(CIIMA) from Eseade Business School warns that current GoA
debt and inflation levels raise the ghosts of the 2001
economic and financial crisis. The paper states that despite
the 2005 debt restructuring, GoA debt levels are now higher
than when Argentina defaulted on its debt in 2001 -- the
largest sovereign default in history. GoA debt reached
$144.7 billion, or 56% of GDP, in December 2007, compared to
$144.2 billion, or 54% of GDP, in December 2001. The debt
statistics look even worse when including holdout bondholder
debt, which currently totals about $28.8 billion. Including
holdouts, the public debt stock rises to $173.6 billion,
almost 67% of GDP. (See June 13 Econ/Fin report for a
slightly more sanguine perspective.)
BUENOS AIR 00000881 004.2 OF 006
15. (SBU) The paper claims that inflation is undermining
confidence, investment, and growth. It also argues that
Argentina is facing a new debt crisis because of the GoA's
inability to raise funds internationally (due to holdout
lawsuits and arrears to the Paris Club) or obtain reasonable
interest rates on domestically issued debt. Meanwhile, the
GoA faces large debt payments in years 2009-2011. Despite
the relatively large primary fiscal surplus, which the paper
estimates at 3.6% of GDP for 2008, and the large stock of
BCRA reserves (currently about $48 billion), the paper argues
that the Argentine economy is vulnerable due to its isolation
from international capital markets and the strong
disincentives to investment, especially FDI. The paper
further criticizes the GoA for manipulating INDEC's CPI,
selling debt to Venezuela (instead of raising funds from
markets or IFIs, which have lower costs), increasing
expenditures, and raising the fiscal burden on the Ag sector
(the most efficient sector in the economy).
16. (SBU) The paper predicts a hard landing for the Argentine
economy barring significant changes in the policy
environment, but notes that its intensity will depend on
which of three scenarios plays out:
-- Moderate international crisis while maintaining the
current domestic policy mix: domestic expectations
deteriorate leading to continuous capital flight, which
generate a reduction in the supply of savings and
deceleration of consumption, investment, and growth. In two
or three years, GDP growth stabilizes around 2-3% in the
absence of new productive investment.
-- Domestically originated Crisis: with accelerating
inflation and the population's lack of confidence, peso
demand falls, which feeds back into further acceleration of
inflation. The GoA responds by intervening even more in the
economy, exacerbating shortages. (Comment: Implicit in
scenarios 1 and 2 is the idea that the trade surplus is not
enough to satisfy the dollar demand for capital flight
purposes.)
-- International Crisis: the paper argues that a more severe
international financial crisis would exacerbate domestic
problems, with devastating results (similar impact to
scenarios 1 and 2, but with harsher consequences).
17. (SBU) To avert these scenarios and continue the current
economic expansion, the paper's authors suggest a long to-do
list: improving the investment climate and the quality of
institutions, strengthening the rule of law, recovering
external credit (including settling Paris Club arrears and
holdout debt), and restoring the credibility of GoA
statistics.
----------
Investment
----------
Investment strong in 2007, but not enough to guarantee
sustained high growth
--------------------------------------------- --
18. (SBU) Fueled by investment in production equipment and
construction, aggregate investment hit a 15-year high in
2007. However, low investment in some sectors and an
uncertain investment climate could hamper sustainable growth.
19. (SBU) According to INDEC, investment in 2007 was 22.7% of
GDP in constant 1993 pesos, up from 21.6% in 2006, and 1.6%
percentage points above its peak in 1998. Investment was the
demand component of GDP that grew the most, increasing 14.4%
versus 2006, while exports increased 9%, consumption 7.4%,
and GDP 8.4%. Investment was concentrated in production
equipment (9.4% of GDP) and construction (13.3% of GDP),
while, according to analysts, investment in public services,
energy, transportation, and logistics was low. Average
industrial capacity utilization increased by 23 percentage
points between March 2002 and March 2007 (from 50% to 73%),
an interesting development given that 80% is the generally
accepted limit. High growth continues to attract investors,
but capacity still remains for Argentina to meet its
potential and improve the quality of investment. (The
figures calculate gross investment. Net investment, taking
into account depreciation, is lower.)
20. (SBU) 2007 FDI was low compared to pre-crisis levels, but
has recovered significantly. According to INDEC, 2007 FDI
was $5.7 billion, up 13.1% versus 2006, but 34.4% below the
annual average in 1993-2000. However, following the 70%
BUENOS AIR 00000881 005.2 OF 006
nominal devaluation of the peso in 2002, the "real purchasing
power" of each dollar of FDI increased 30.1% on average
through 2007 (using INDEC inflation rates to calculate the
real exchange rate). FDI as a percentage of total investment
is still significant. Due to high annual real GDP growth of
8-9% for the past five years, FDI has been declining as a
percentage of GDP even while holding steady in nominal terms.
FDI was 2.3% of GDP in 2007, compared to an average of 3.2%
of GDP in 1993-2000. According to CEP's ("Centro de Estudios
de la Produccion" of the Ministry of Economy) database, of
the total "announcements" of FDI in 2007, 33% was for
"greenfield" investment and 67% for purchase of or
enlargement of existing facilities. By sector, 23% of
capital formation went to manufacturing, 34% to
infrastructure, 27% to extractive activities, 16% to trade
and services, and the rest to primary activities and the
financial sector. (Note: CEP's database only provides
partial coverage of existing investments, which may result in
biases in the conclusions drawn.)
21. (SBU) In spite of the strong 2007 performance, investment
prospects face major risks: an uncertain regulatory
environment and volatile political climate, changing export
conditions, a weak judicial system, pervasive corruption,
unstable macroeconomic conditions, and scarce financing.
Together, these factors are inhibiting investment, which may
hamper future growth. The GoA could encourage incremental
investment by further developing domestic capital markets and
attracting funds from other sources (i.e. FDI), improving the
investment climate through clear policies, and implementing
stable and predictable rules -- especially related to taxes
-- to minimize regulatory risk,
Fifth Annual Financial Summit optimistic about Argentina's
potential for investment and financing in agribusiness and
biofuels
--------------------------------------------- -----
22. (SBU) Argentina's efficient agricultural sector offers
the potential for it to lead the way in biofuel production,
but stable rules and an investor friendly climate are needed
to increase investment
23. (SBU) The fifth annual "Cumbre Financiera Argentina" met
June 18-19 in Buenos Aires to discuss financing and investing
in agribusiness and biofuels. Day one dealt with investment
and capital markets, while day two discussed agribusiness and
biofuels. (Background: The International Energy Agency
(IEA) estimates that biodiesel production grew nearly 300%
from 2000 to 2005, and the IEA's 2006 World Energy Outlook
(WEO) forecasts that world output of biofuels will increase
6.3 to 9% annually, meeting 4 to 7% of global demand by
2030.)
24. (SBU) A panel discussion entitled "Understanding the
Complexity of Agribusiness and Biofuel Financing" emphasized
the high risk and high potential involved in investing and
financing in agribusiness and biofuel. Argentina's efficient
agricultural sector and rising commodity prices offer the
potential for high investment returns. However, adverse
weather, cyclical prices, high inflation, and GoA
intervention in the economy create significant risks.
Participants argued that these risks can be mitigated by
hedging in the futures market (which is still underdeveloped
domestically), but also called on the GoA to create stable
rules and forward-looking policies.
25. (SBU) The panel entitled "Investing in Agribusiness and
Biofuels Assets" examined the issues involved in investment
in agribusiness assets, and the strategies that can be used
to access them. Panelists emphasized that Argentina has the
potential to be a leader in biofuel production, but that this
potential is being destroyed by current government policies
that increase the fiscal burden of the agriculture sector.
They commented that macroeconomic stability, lower inflation,
and a more investor-friendly environment are needed to
attract more investment.
26. (SBU) Financing is difficult to obtain locally due to
Argentina's weak capital markets, but participants suggested
emulating Brazil as a strategy to develop the biofuel sector:
Brazilian ethanol sector subsidization in the late 1970s led
to energy self-sufficiency and the doubling of ethanol
production between 1996 and 2006. By using export tax
revenue to fund temporary subsidies, Argentina could develop
the biofuel sector and utilize its comparative advantage in
agricultural production. However, competing with Brazil for
investment will be a challenge as long as Argentina lacks a
BUENOS AIR 00000881 006.2 OF 006
strong legal system and stable and coherent rules.
27. (SBU) Difficulties remain for investors regarding
securing long-term access to feedstock, a critical component
of biofuel production. The three strategies mentioned to
secure feedstock included negotiating a deal with a major
producer, building a relationship with farmers directly, or
using an alternative feedstock. These strategies are
problematic since major Ag producers are often producing
biofuels themselves, farmers are reluctant to sign long-term
contracts, and alternative feedstock such as jatropha have a
three-to-four year production lag.
28. (SBU) Overall, panelists were optimistic about the growth
of the biofuel sector in Argentina. The expected outcome of
the GoA's 2008 Washington International Renewable Energy
Conference (WIREC) pledge is that at least 5% of Argentina's
fuel supply comes from renewable materials by 2011. This is
a step in the right direction, but will be difficult to
accomplish without GoA commitment to addressing the risk
areas mentioned above and ensuring a stable investment
climate, lower inflation, and macroeconomic stability.
KELLY