Argentina Economic and Financial Weekly for

UNCLAS BUENOS AIRES 001154

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 19, 2006


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Weekly Highlights
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- Venezuela buys another USD 239 million of Boden 2012
bonds.
- GOA runs an ARP 1.5 billion primary fiscal surplus
in April -- lower than expected.
- Wheat exporters agree to supply the domestic market
to avoid wheat price increases.
- Unemployment fell 1.6 percent y-o-y to 11.4 percent
in the first quarter, but increased q-o-q.
- GOA warns oil companies to invest or lose their
concessions.
- March monthly economic activity index up 7.7
percent y-o-y - weaker than expected.
- Commentary of the Week: "Obstacles to the
'Argentine Miracle." (Note: there will be no Weekly
Report for the week ending May 26 due to American and
Argentine holidays. The Weekly Report will be resumed
with a bi-weekly special edition on June 2. End
Note.]

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Venezuela buys another USD 239 million of Boden 2012
bonds.
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1. On May 11, the GOA sold USD 239 million of Boden
2012 (a USD-denominated bond maturing in 2012),for a
market value of USD 200 million, to the Government of
Venezuela (GOV). The GOA sold the bonds at market
prices that translate into a yield of 7.59 percent.
With this purchase, the GOV will have purchased
Argentine bonds worth USD 1.5 billion (at face value,
or USD 1.2 billion at market value) in 2006. In 2005,
the GOV purchased USD 1.9 billion of GOA bonds (USD
1.6 billion market value).

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GOA runs an ARP 1.5 billion primary fiscal surplus in
April -- lower than expected.
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2. The GOA announced a primary fiscal surplus of ARP
1.5 billion in April, below market expectations of ARP
1.7 billion, and well below the ARP 2.2 billion in the
same month last year. April's surplus brings the
accumulated fiscal surplus for the first four months
of 2006 to ARP 6.4 billion, ARP 1.2 billion above the
ARP 5.2 billion target for the period. The lower-than-
expected April surplus is the result of rapidly rising
spending levels -- mainly debt interest payments,
transfers to provinces, higher salaries and capital
expenditures -- as well as lower revenues due to the
extension of the income tax payment deadline to May.
Ambito Financiero reported that the April surplus
figures were padded by ARP 600 million that the GOA
received from the Central Bank (BCRA) in April for
profits that the BCRA earned in 2005. (No detailed
data is yet available to confirm this report). The
primary fiscal surplus decreased 31% y-o-y. The BCRA
consensus forecasts an ARP 22.3 billion (or 3.5% of
GDP) primary fiscal surplus for 2006.

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Planning Minister De Vido delays negotiations with
Bolivia on gas prices.
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3. On May 18, a spokesman from the Ministry of
Planning stated that Minister Julio De Vido had
postponed his trip to Bolivia to negotiate the price
at which Bolivia will export gas to Argentina. The
Minister's trip had originally been scheduled for May

16. No further details were provided as to when the
Minister will travel, and no further information was
provided on the status of negotiations. Argentina
currently imports 5% of its gas consumption from

Bolivia at a "solidarity" price of USD 3.20 per
million cubic meters, while the international price
ranges from USD 2.00 to USD 8.00 per million cubic
meters. According to reports, the Bolivian government
wants a 65% increase to more than USD 5 per million
cubic meters the price of gas.

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Congress approves the creation of the state-owned
water company AYSA.
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4. On May 17, the Senate ratified a presidential
decree approving the creation of the state-owned water
company AYSA (Agua y Saneamientos Argentinos SA). The
bill received 37 positive votes, 18 negative ones and
one abstention. [The Chamber of Deputies approved the
creation of AYSA at the beginning of April.] AYSA had
been providing water and sewage services to the city
of Buenos Aires and fourteen suburban areas of the
province of Buenos Aires since March, when the GOA
rescinded Aguas Argentinas' concession contract.
According to the decree, 90 percent of AYSA's stock
will belong to the GOA, while the remaining 10 percent
will be given to AYSA's employees union. The company
will have an initial capital of ARP 150 million and
will be managed by the Ministry of Planning, which
also will be responsible for designating its board of
directors.

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GOA sends a bill to Congress to modify UIF's
structure.
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5. On May 16, the GOA sent a bill to Congress that
would modify the structure of the Argentine financial
intelligence unit (UIF). Highlights of the bill
include:
- The UIF will be run by a President and Vice-
President, who will be selected by the President and
confirmed under the same process as a Supreme Court
Justice, including public comment and disclosure.
According to media reports, Abel Fleitas Ortiz de
Rozas, the current head of the Anti-Corruption Office,
will be the GOA's candidate for President of the UIF.
- The UIF will have a Council of Advisors, who will
represent 7 GOA agencies including the Central Bank,
AFIP, SEDRONAR, Ministry of Justice, Ministry of
Economy, Ministry of Interior, and Stock Exchange
Commission;
- The UIF President will make all decisions, after
consulting with the Council of Advisors, but he does
not need to accept their advice;


6. We expect that the bill will be approved without
major opposition. However, there are several other
similar or related bills pending or about to be
introduced, including some that would make terrorism
finance a crime, so it is possible that this bill will
be amended or merged into a larger bill. The UIF
currently is operating with only one of its five
directors in place.

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Wheat exporters agree to limit exports to supply the
domestic market and avoid price increases.
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7. On May 18, local media reported that the GOA was
considering a 30-day freeze on wheat export permits --
similar to the 180-day meat export ban implemented at
the end of March -- to avoid domestic price increases
in bread and flour and thus keep inflation under
control. However, Chief of Cabinet Alberto Fernandez,
denied those rumors later that day. Wheat producers
must register any planned exports with the GOA, which
has the right to temporarily suspend wheat exports to
guarantee domestic needs. The 2005/2006 wheat crop

dropped to 12.5 million tons -- compared to 16.0
million the previous year -- which analysts believe is
not sufficient to supply both exports (mainly to
Brazil) and domestic demand. The slide in wheat
production was partially caused by drought weather
conditions, as well as the increasing switch to
soybeans, a lower cost/more profitable crop. Argentina
exported 8.7 million tons of wheat in 2005. Exports
this year (to May 15) were 3.3 million tons.


8. After a meeting with the Minister of Economy
Miceli on May 18, representatives from the cereal
export association and the flour miller association
committed to supply the domestic market with 5.5
million tons of wheat this year, which should be
sufficient to guarantee that domestic flour prices
remain unchanged.

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March monthly economic activity index up 7.7 percent
y-o-y - weaker than expected.
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9. The monthly economic activity index increased 7.7
percent y-o-y in March -- well below the BCRA market
survey forecast of 8.6 percent. This was the weakest
growth rate in the past eight months, and was a sharp
deceleration from the 9.5 percent increase in
February. However, the index is 37 percent above its
low point in the first quarter of 2003 and 9.8
percent above its pre-crisis high, in the second
quarter of 1998. The growth in the index came from a
7.2 increase in goods (mainly from industry and
construction) and an 8.5 percent increase in the
service sector (mainly from the financial sector).
The index increased 0.1 percent m-o-m. The latest
BCRA consensus survey estimates 7.6 percent economic
activity growth for 2006, a downward revision from
its previous forecast of 8.6 percent. The monthly
economic activity index is viewed as a reliable
leading indicator of GDP.


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Unemployment fell 1.6 percent y-o-y to 11.4 percent in
the first quarter, but increased q-o-q.
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10. The GOA announced that the unemployment rate
dropped 1.6 percentage points y-o-y to 11.4 percent
in the first quarter of 2006. However, unemployment
increased 1.3 percentage points q-o-q from 10.1
percent in Q4 2005 due to seasonal factors. According
to the GOA survey, a total of 1.2 million people are
unemployed out of a workforce of 10.8 million.
Excluding participants in the Head of Households
income supplement plan, the unemployment rate stood at
14.1 percent, versus 12.7 percent in the fourth
quarter of 2005. The GOA projects that unemployment
will be below 10 percent at the end of 2006.

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April industrial production index up 7.7 percent y-o-
y.
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11. Industrial production index increased 7.7 percent
y-o-y in April, slightly above market expectations of
7.4 percent and a slight acceleration following a 7.5
percent increase in March. During April, the fastest
growing sectors were car production (+21 percent),non
metallic minerals (+17 percent),oil refining (+13
percent) and chemicals (+11 percent). There was a
slight decrease in paper and cardboard, which fell 2.2
percent. The index decreased 2.1 percent m-o-m
without seasonal adjustment and increased 0.3 percent
m-o-m when seasonally adjusted. The BCRA consensus
survey forecasts 6.8 percent industrial production
growth for 2006 -- unchanged from last month's

forecast.


12. The industry-wide capacity utilization index
reached 71.6 percent in April, up 0.3 compared to 71.3
percent in April 2005. The sectors with the highest
capacity utilization rates were metal-based industries
(96 percent),oil refining (93.9 percent) and textiles
(83.6 percent). The sectors with the lowest capacity
utilization rates were auto production (50.6 percent),
tobacco production (60.1 percent) and minerals (62.6
percent).

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GOA beef export ban has caused USD 180 million in
losses.
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13. According to the meat industry, the export ban
has caused USD 180 million in losses since it was
implemented at the end of March. The sector estimates
that if the ban remains in effect until September
(when the ban is scheduled to end),losses may exceed
USD 600 million, including USD 60 million from
contracts that were broken by GOA delays in issuing
permits for exports to the European Union under the
Hilton quota and for other products sold before the
ban went into effect, even though both were exempt
from the ban. Chief of Cabinet Alberto Fernandez
recently reiterated the GOA's position that the export
ban will remain in effect until domestic beef prices
stabilize. The export ban has also forced
slaughterhouses to lay off thousands of workers.


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GOA warns oil companies to invest or lose their
concessions.
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14. On May 16, the Energy Secretary, Daniel Cameron
warned oil executives that the GOA will withdraw
concessions on oil fields where companies are not
exploring. The hydrocarbons law (N 17.319)
establishes minimum investments for oil fields,
including requirements to explore fields covered by
the concession. In January, the Energy Secretariat
issued a resolution requiring companies to submit
detailed exploration reports for 2005 and the first
half of 2006. The GOA will withdraw concession from
companies that do not invest or reallocate those
concessions to other companies who are willing to
invest. Oil and gas production dropped 5 percent and
1.4 percent, respectively, in 2005 and reserve
estimates have fallen to 10 years of supply.


15. On May 18, Cronista reported that oil producer
provinces -- especially Neuquen the largest oil and
gas producer province -- envision that cancelled
concessions will be transferred to the provincial
government instead of to the federal government.

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BCRA increases repo rates by 0.50 percent.
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16. The BCRA announced a 0.5 percent increase in its
repo lending rates, bringing its active lending rate
to 7.50 percent (rate at which the BCRA offers
financing and adds liquidity to the system) and its
passive rates to 5.00 percent for one-day and to 5.50
percent for seven days (rates at which the BCRA
borrows funds and absorbs liquidity). According to
BCRA officials, this increase in the repo rates will
not generate an increase in the cost of credit for
individuals and enterprises. This is the first
increase in passive repo rates and the second increase
for active repo rates since the beginning of the year,
and it continues the current upward trend in domestic
market interest rates.


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BCRA may sell its Boden 2011 holdings to sterilize its
intervention in the foreign exchange market.
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17. In an interview on May 12, Central Bank President
Martin Redrado said that the BCRA may sell its
holdings of Boden 2011 to supplement the BCRA's
absorption capacity. The Boden 2011 is a peso-
denominated bond adjusted by CER (CPI-linked index)
with a 3.5 percent coupon. The BCRA received ARP 6
billion of these bonds from the GOA in compensation
for its repurchase of provincial quasi-monies in 2003,
and is the only holder of this bond. Some analysts
have argued that the BCRA may have problems containing
the money supply this year as the BCRA continues its
policy of rebuilding reserves. However, Redrado
downplayed any concerns about the BCRA having
difficulty sterilizing the pesos it emits when as it
intervenes in the FX market.

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BCRA rolls over its maturities and increases rates for
some of its Lebacs.
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18. The BCRA received ARP 1 billion in bids at its
May 16 Lebac and Nobac auction, compared to the ARP
800 million in Lebacs that came due during the week.
Lebac accepted bids totaled ARP 667 million
representing 84 percent of the total, with Nobac bids
accepted for the remaining 16 percent. The yield on
the 28-day Lebac increased 25 basis points from 6.50
percent to 6.75 percent, while the yield on the 63-day
Lebac decreased slightly from 6.86 percent to 6.80
percent and the yield on the 84-day Lebac increased
from 7.00 percent to 7.15 percent. The yield on the
longest term instrument, the 280-day Lebac, was in
10.20 percent. Lebacs for maturities of more than 280-
day were withdrawn due to lack of interest. The
spread on the one-year Nobac decreased from 2.16
percent to 2.14 percent, while the two-year Nobac
remained in 3.39 percent. The Badlar rate (the base
rate for Nobacs) is currently at 8.9 percent.

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Banks present profits of ARP 225 million in the first
quarter of 2006.
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19. Several banks listed on the Buenos Aires stock
exchange presented their balances for the first
quarter of 2006. Most reported profits, including
Banco Patagonia (ARP 76 million, up 216 percent),
Banco Macro Bansud (ARP 73 million, up 20.3 percent),
Banco Frances (ARP 41 million, up 26.2 percent) and
Banco Hipotecario (ARP 64 million, up 27 percent).
However, Banco Galicia reported losses of ARP 29
million, compared to a profit of ARP 17 million in the
previous quarter. Galicia's negative results were
primarily produced by its decision to accelerate its
discount lending repayments to the BCRA.

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GOA reportedly will delay gas tariffs increase for
industrial and commercial users until next year.
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20. On May 16, local media reported that the GOA will
delay gas tariff increases for industrial and
commercial users supplied by Gas Ban -- one of the
main providers of natural gas in the city of Buenos
Aires -- until 2007. This delay comes despite an
April 10 decree that authorized a 15 percent average
tariff increase for Gas Ban customers (including
commercial, industrial and residential consumers).
The same day that the decree was published in the
Official Gazette, a spokesman for the Ministry of

Planning said that tariff increases for residential
consumers would not go into effect until 2007, despite
the published decree. Now it appears that gas tariff
increase will not go into effect for industrial and
commercial users either. Local experts also predict
that the Argentine government will be reluctant accede
to tariff increases in 2007, an election year.

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Business sector reacts negatively to labor reforms.
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21. On May 18, business sector representatives
(including the banking, supermarket, commerce, food,
rural transportation and industrial sectors) met with
deputies from the Labor Committee to voice their
concerns about changes to labor legislation that are
being considered in Congress. The business sector has
two major concerns: (1) an amendment to article 66 of
the Labor Law that would define an employee as being
fired if the employer changes his labor conditions
without his prior agreement, and (2) a bill that would
eliminate the maximum threshold for severance pay in
case of layoffs. After the meeting, the business
associations jointly issued a press release saying
that these proposed changes would negatively affect
employment rates and economic activity.

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Consumer Confidence Index up 5.1 percent m-o-m.
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22. The consumer confidence index -- measured by
Torcuato Di Tella University -- increased 5.1 percent
m-o-m in May to 56.8 points, from 54.0 points in
April. Two of the three index components increased:
consumer willingness to purchase durable goods and
real estate (+15.3 percent m-o-m) and personal
situation (+4.0 percent m-o-m). There was a slight
decrease in the third component of the index --
consumer sentiment towards the macroeconomic
environment -- down -0.7 percent m-o-m. The index
increased 3.3 percent in the first five months of 2006
compared to the same period last year and 10.4 percent
y-o-y. The index is based on surveys of individual
economic sentiment and consumer willingness to
purchase durable goods, houses and cars.

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The peso depreciated 0.3 percent against the USD this
week, closing at 3.07 ARP/USD.
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23. The peso depreciated 0.3 percent versus the USD,
during this week, closing at 3.07 ARP/USD -- one cent
higher than last Friday's close. The peso's
depreciation this week is attributed to the BCRA's
intervention in the foreign exchange market as well as
higher private demand for dollars due to rumors about
a wheat export ban (see story above) and some
contagion effect from international markets. The BCRA
purchased USD 323 million in the FX market in the
first four days of the week, a daily average of USD 80
million and lower than the daily average of USD 102
million during the first three weeks of May. The peso
exchange rate has depreciated 0.7 percent since the
beginning of the calendar year. The BCRA's reserves
now (as of May 16) stand at USD 23.9 billion, and have
increased USD 5.4 billion, or 29 percent, since the
GOA prepaid all of its IMF debt on January 2.

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Commentary of the Week: "Obstacles to the 'Argentine
Miracle", by Miguel Angel Broda from an article
published in La Nacion on May 14
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24. Argentina's economic indicators have turned in a
spectacular performance, with 17 consecutive quarters

of recovery. The cumulative GDP increase during that
time was 39 percent, driven by domestic demand, which
rose 47 percent; it is confirmed by the 43 percent
increase in the volume of exports and the 163 percent
increase in imports, while industrial production has
increased 53 percent and construction 122 percent.
Furthermore, growth for this year is expected to
exceed 7.6 percent.


25. There are various factors that explain this
strong recovery:

- An extraordinary external context, with the world
growing above its historic average rate for the fourth
year in a row, and with favorable terms of trade that
could stay in place for the long term due to the
insertion of China and India in the international
scene as major consumers of primary materials;

- The "technical bounce" that occurs after any
collapse; and

- Correct macroeconomic management by this government.
On one side, the authorities have produced a high
fiscal surplus and sensibly reduced financial
obligations for the next few years in the debt
restructuring. On the other side, they have produced
a high surplus in the current account by maintaining a
high and competitive exchange rate. Thus, the country
has experienced an unheard of three consecutive years
of twin surpluses (fiscal and current).


26. Because of this, and in contrast to what has
happened in the past, Argentina today is not on the
verge of any sort of macroeconomic explosion, nor any
irreversible crisis. In fact, it is in quite the
opposite situation. The Government has the
opportunity to reach an "Argentine miracle." But
there are at least three obstacles to the country
reaching a high and sustained growth rate.


27. First, investment is insufficient. Without a
doubt, the increase in gross investment has been
impressive, increasing from 11 percent of GDP in 2002
to 22 percent today. However, looking at the
functional linkage between the level o investment and
growth in the economy, investment is still
insufficient to sustain a robust rate of growth. In
reality, if we deduct depreciation of the stock of
capital of the economy (13 percent of GDP) from gross
investment (22 percent of GDP),we are left with a net
investment figure (increase in the stock of capital)
of 9 percent of GDP. This flow of investment has a
productivity (marginal and average) of approximately
0.4 (i.e., each 1 percent increase in net investment
produces a 0.4 percent increase in GDP or, inversely,
the ratio of capital to production is 2.5). Clearly,
by investing 22 percent of GDP, we can grow at 3.6
percent ((22-13) x 0.4). However, to grow 6 percent
per year, we would need to invest no less than 28
percent of GDP. In short, we are about 6 percentage
points of GDP short of what we need to grow at a
significant pace (5-6 percent per year),and we are
particularly lacking investments by large companies,
in public service companies, and foreign direct
investment.


28. Concerning investment in privatized public
utilities, the 2001-02 crisis required the breaking of
contracts and the pesification and freezing of
tariffs. Four years later, since we still have not
created a new regulatory framework, the companies have
no other choice but to limit their investments. The
sector today has an inefficient division: old
investments with sunk capital and frozen tariffs run
by the privatized contract holders, while new
investment is being made by the Government, using
money from fiduciary trust funds that receive special
tax and surcharge revenues. This Argentine invention

has all of its incentives backwards. The private
concession holders don't invest due to the lack of
profitability and the risk of an "Evo-ization," while
the State does everything at a much higher cost and
over a longer period of time. It will be very
difficult to improve the productivity of capital and
increase investment with this system of perverse
incentives in place.


29. Concerning foreign direct investment, Argentina's
share of the total flow of foreign direct investment
into Latin America is falling, totaling just 6 percent
of the total versus 14 percent in 1996-2000.
Furthermore, only a fraction -- 13 percent -- of the
profits generated from this investment is being re-
invested, compared to 30 percent in 1996-2000.


30. This lack of significant national or foreign
investment is due to the government's excessive
intervention in the market, the volatility of the
rules of the game, and the lack of judicial security,
all of which prevent a predictable investment horizon.
The response of the Government to this lack of
investment has been to revive the archaic idea of the
State's supplementary role as a substitute for private
investment. The State, instead of planning and
directly making the needed investments, should create
the conditions needed to attract private investment
that would produce a qualitative leap in productivity
and thereby consolidate the strong quantitative growth
of the last few years.


31. Secondly, a number of microeconomic distortions
are accumulating. Particularly worrisome is the use
of the price system and trade policy as anti-
inflationary tools. The current system of "political"
prices and subsidies is perverse because it stimulates
demand and reduces supply, making what is scarce cheap
and what is abundant, expensive. These price
distortions no longer fulfill their role reflecting
the relative scarcity of goods and inputs, creating
disequilibria between supply and demand, disinvestment
and poor allocation of resources, damaging long-term
growth prospects.


32. Lastly, the Argentine State itself is an
obstacle. Countries that have reached high and
sustained levels of growth have governments that: (1)
work from an strategic plan and don't try for short-
term political gains that detract from their long-term
objectives; (2) stimulate social mobility by promoting
equality of opportunity in the education system,
rewarding hard-work, merit and innovation; (3)
increase their investment in research and development;
(4) work actively to obtain greater openness of
foreign markets and to generate externalities for the
development of productive clusters; and (5) create the
mechanisms for the efficient use of resources and
increases in productivity. Unfortunately, the
Argentine State has caused considerable delays in all
of these areas.


33. In conclusion, given the unbeatable external
environment and the macro stability it has reached,
Argentina has the possibility of a brilliant future,
after 30 years of mistakes. Nevertheless, due to the
economic policy of the current government, the country
faces significant barriers to reaching the "Argentine
miracle." I hope I am mistaken. (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.)


GUTIERREZ