VZCZCXYZ0002
OO RUEHWEB
DE RUEHBU #1708/01 3531211
ZNR UUUUU ZZH
O 181211Z DEC 08
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC IMMEDIATE 2707
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHRC/DEPT OF AGRICULTURE USD FAS WASHINGTON DC
RUEHC/DEPT OF LABOR WASHINGTON DC
RHMFIUU/HQ USSOUTHCOM MIAMI FL
RUCNMER/MERCOSUR COLLECTIVE
UNCLAS BUENOS AIRES 001708
SIPDIS
SENSITIVE
E.O. 12958: N/A
TAGS: ECON EFIN ETRD EINV AR
SUBJECT: Argentina: World Bank Country Director Cautions on Economy
Ref: (A) Buenos Aires 1703
(B) Buenos Aires 1696
(C) Buenos Aires 1685
(D) Buenos Aires 1682
This cable contains sensitive information - not for internet
distribution.
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Summary
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1. (SBU) The local World Bank (WB) Country Director (protect) sees
the GoA ""walking a tightrope"" in terms of its capacity to maintain
market confidence, stem capital flight, and sustain twin fiscal and
current account surpluses in a context of economic slowdown,
continued high rates of GoA public infrastructure spending, high
inflation, and lower commodity prices. While GoA authorities have
responded to constraints in accessing international financial
markets by buying back debt, announcing their intention to pay down
Paris Club debt and by re-opening talks with holdout creditors, the
impact of these efforts on market confidence has been limited by
investor concern on macroeconomic policy drift and by heavy GoA
spending in the run-up to 2009 mid term elections.
2. (SBU) WB Country Director Pedro Alba told Ambassador December 12
he had personally cautioned Chief of Cabinet Sergio Massa on
Argentina's precarious condition. He advised Massa on the need to
build confidence by announcing -- and following -- a hard fiscal
rule to maintain the primary fiscal surplus; cleaning up GoA
statistics agency INDEC; and addressing concerns on how the GoA will
manage nationalized pension fund resources and equity holdings.
Should capital flight overwhelm the GoA's ability to sustain
confidence in the currency, the WB has developed a contingency
crisis plan that would allocate additional Bank resources to social
safety net programs. Any restructuring of the roughly US$5 billion
in Bank exposure would only come in the context of an IMF program.
Alba estimated that, in a crisis scenario, the GoA would need some
$30 - $35 billion, including to rebuild reserve levels. End
Summary.
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GoA Walking a Capital Flight Tightrope
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3. (SBU) In a December 12 meeting with Ambassador, World Bank (WB)
Country Director Pedro Alba briefed the Embassy on the Bank's
country assistance strategy (Ref A) and on its views on GoA economic
management. Alba's main concern was that the GoA is ""walking a
tightrope"" in terms of its capacity to maintain market confidence
and stem capital flight. While there are sufficient local currency
funds available to the GoA to cover 2009 debt obligations, Alba
said, the question is whether Argentina will be able to attract and
retain sufficient dollar reserves. Roughly US$16 billion of capital
left Argentina's financial system in the first three quarters of
2008 and, if another US$ 8-12 billion of Argentine capital flees,
the GoA will be ""all alone - out on a limb"" in terms of its ability
to sustain needed hard-currency reserve levels. Comment: Former
Economy Minister Roberto Lavagna also flagged the implications of
capital flight to Ambassador and Econ Counselor (Ref B). End
Comment.
4. (SBU) Alba said he had personally cautioned Chief of Cabinet
Sergio Massa on Argentina's precarious condition, but that Massa had
argued that Argentina will muddle through 2009/10. Alba said he
advised Masa that important confidence-building measures are needed
and could include: (1) cleaning up GoA statistics agency INDEC; (2)
announcing and following a hard fiscal rule to maintain the primary
fiscal surplus; and (3) setting out clear and monitorable guidelines
on how recently nationalized private pension fund (AFJP) resources
will be managed and, as importantly, how the GoA will manage the
board seats on a broad range or Argentine and foreign companies that
it inherited as a consequence of the private pension fund
nationalization exercise. Whether and how GoA-appointed company
directors will vote GoA shares needs to be clarified as soon as
possible to regain investor confidence, Alba said.
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World Bank's Crisis Contingency Planning
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5. (SBU) Alba joked that he'd congratulated Massa on the GoA's
impressive ability to keep generating economic and economic policy
surprises. He told Ambassador that, should capital flight overwhelm
the GoA's ability to sustain confidence in the currency, the WB has
developed a contingency crisis plan that would allocate additional
Bank resources to social safety net programs. Any restructuring of
the roughly US$5 billion in Bank exposure, however, would only come
in the context of an IMF program. Alba estimated that, in a crisis
scenario, the GoA would need some $30 - $35 billion, including to
rebuild reserve levels.
----------------------------------------
International Crisis Impact on Argentina
----------------------------------------
6. (SBU) Alba expanded on World Bank views on the Argentine economy
in a subsequent discussion with EconCouns. Alba summarized the
short-term impact of the financial crisis:
-- An uncertain domestic policy environment that has eroded market
confidence has led to a decline in domestic credit and a linked
buildup of liquidity cushions by private local banks. Alba noted
significant deposit outflows and sharp increases in interest rates
and demand for U.S. dollars following the announcement of the
nationalization of pension funds in October.
-- Capital outflows are complicating monetary management. Following
third quarter 2008 capital outflows of roughly US$6 billion (and
roughly US$16 billion for the first three quarters of 2008),
stability is gradually returning to domestic capital markets
following significant late November and early December intervention
by the central bank and GoA regulatory agencies.
-- As gross international reserves have declined, the GoA has moved
to shelter the economy from further financial shocks. In response
to increased financial volatility, the central bank has intervened
frequently in foreign exchange markets to preserve currency
stability. As a result, gross international reserves have declined
from over $50 billion in early 2008 to about $45 billion (nine
months of imports). However, net international reserves (net of
central bank obligations with the BIS and other international
financial institutions) are down to roughly $35 billion.
-- The exchange rate will continue to depreciate gradually following
the sharp 7.8% depreciation in October. According to Alba, the
GoA's primary monetary policy objective is to preserve exchange rate
stability and confidence in the currency. In light of increased
financial volatility, the central bank will continue to allow the
exchange rate to depreciate in an orderly and gradual manner. In
addition to intervening in foreign exchange markets, the central
bank has also tightened capital controls. Comment: Central Bank
President Redrado confirmed these points to Ambassador December 17,
adding that the key in his view is managing an orderly depreciation
without panic in the markets. End Comment
-- The value of Argentine financial assets has been hurt by
increased global risk aversion and eroded market confidence. Bond
and stock prices have fallen sharply since mid-2008, with equity
values down almost 50% year to date. Argentine equity values have
been particularly hard hit as market confidence has been shaken by
the farm crisis and more recently by the GoA takeover of private
pension funds.
-- Argentine country risk premiums remain among the highest and most
volatile in the Latin America. Argentine EMBI and credit default
swap spreads have been in a constant upward trend throughout 2008,
with EMBI spreads peaking at 1965 basis points on November 14, an
increase of roughly 1,290 bps since August 2008. Argentine EMBI
spreads are currently around 1,900 basis points, second only to
Ecuador and among the most volatile in the region.
----------------------------
Medium Term Economic Outlook
----------------------------
7. (SBU) Alba was concerned that the GoA has yet to implement an
adequate mix of monetary and fiscal policies that would allow it to
address inflationary pressures and report credible inflation
figures. It will be increasingly difficult to sustain twin fiscal
and current account surpluses in a context of economic slowdown,
continued high rates of GoA public infrastructure spending, high
inflation, and lower commodity prices. While Alba believes the
primary fiscal surplus should hold at 3.4% for calendar 2008, even
with real GDP growth decelerating to the 6% range by the end of
2008, fiscal accounts will remain vulnerable to lower commodity
prices, declining growth, and GoA expenditure rigidities. The WB is
projecting GDP growth in 2009 at the 2.5% level. The Bank is
particularly concerned at the fiscal situation in many provinces
that remain highly dependent on the federal government for resource
transfers.
8. (SBU) Argentina's current account surplus is falling and Alba
expects it to end 2008 at about 1.8% of GDP (compared to the Central
Bank's consensus estimate of 2.2%). Any further decrease in
commodity prices coupled with a decrease in global demand will
further reduce Argentine exports, and Alba predicted that the
current account is likely to shift into deficit in 2009. He said
that, if this happens, it will set off alarms in Argentina and
internationally. With a capital account deficit also likely in 2008
and 2009, there will be further declines in international reserves.
(Comment: Estimating the direction of the balance of payments is
difficult, given that a significant depreciation of the peso --
which appears likely -- would result in stronger exports and
increasing reserves, along with increasing capital outflows, with
the net effect uncertain.)
9. (SBU) Alba's principal concern is that an increasingly
unfavorable external environment, coupled with uncertainty over the
course of GoA macro policies, will continue to depress market
confidence. On the positive side, GoA authorities have responded to
constraints in accessing international financial markets by buying
back debt and announcing their intention to pay down Paris Club debt
and re-open talks with holdout creditors. These announcements have
been interpreted by markets as signs of the GoA's willingness to
pay. But their impact on market confidence has been limited by
investor concern on policy drift and the GoA's unabashed
determination to use funds to shore up its electoral prospects in
the 2009 mid-term elections. The GoA could better manage the
situation, Alba said, by improving the credibility of inflation
figures and by putting together a stronger and more predictable
program to maintain the primary fiscal surplus.
WAYNE
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