Argentina Economic and Financial Weekly for the week ending

UNCLAS BUENOS AIRES 001424 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 June 23, 2006 -------------- -------------- Weekly Highlights -------------- -------------- - Argentina, Bolivia, Chile and Brazil argue over Bolivian gas. - President Kirchner visits Spain. - Spain wants bilateral debt owed by Argentina negotiated outside of Paris Club. - GDP up 8.6 percent y-o-y in Q1 2006. - Buenos Aires Province ran an ARP 28 million primary deficit in the first four months. - The GOA will set up its own livestock reference price system. - Commentary of the Week: "Inflation Under Control or Controls on Inflation?" -------------- -------------- Argentina, Bolivia, Chile and Brazil argue over Bolivian gas. -------------- -------------- ¶1. On June 29, the presidents of Bolivia and Argentina are scheduled to announce an agreement on natural gas exports, but several new issues have arisen. Bolivia is standing firm on its condition that Argentina cannot re-export gas to Chile (Bolivia refuses to sell gas to Chile, seeking to recover its access to the Pacific coast lost in the 19-th century War of the Pacific). Chile, on the other hand, is asking Argentina to fulfill its contracts to supply Argentine gas to Chile. Also, Brazil has asked Argentina not to agree to a large price increase for Bolivian gas imports, which would oblige Brazil to accept a similar price hike. Brazil is Bolivia's largest purchaser of natural gas. Meanwhile, the Bolivian vice-minister of hydrocarbons, Julio Gomez, said June 22 that the Government of Bolivia now wants USD 6 per million cubic meters for exports to Argentina, instead of the USD 5.5 that was agreed at the last meeting. [Argentina currently imports Bolivian gas at a "solidarity" price of USD 3.20 per million cubic meters, while the international price ranges between USD 2.00 and USD 8.00 per million cubic meters.] -------------- -------------- President Kirchner visited Spain. -------------- -------------- ¶2. This week, President Nestor Kirchner visited Spain and met with Spanish Prime Minister Jose Luis Rodriguez Zapatero, King Juan Carlos, and Spanish companies with investments in Argentina. According to press reports, the GOA laid out a plan to repay USD 836 million in aid that Spain loaned Argentina during its economic crisis in 2002 (see following story). During the meetings with Spanish companies, Kirchner announced that the GOA will increase its stake in Aerolineas Argentinas (Argentina's largest airline, majority owned by Spanish investors). Kirchner also stated that Argentina is not an insecure place to invest, asked for "weeks or possibly months" to start increasing utility tariffs and announced new investment projects. -------------- -------------- Spain wants bilateral debt owed by the GOA to be negotiated outside the Paris Club. -------------- -------------- ¶3. On June 23, La Nacion reported that the Spanish government is willing to accept a refinancing schedule of stepped up installments for the USD 830 million lent to the GOA in 2001. However, Spain maintains its position that this debt should not be included in the Paris Club negotiations, arguing that the loan was made in support of, and under the same terms as, an IMF loan, and is thus multilateral in nature, while the Paris deals with bilateral agreements. In conversations prior to this trip, GOA officials have said that the debt to Spain would be included in Paris Club negotiations. -------------- -------------- GDP up 8.6 percent y-o-y in Q1 2006. -------------- -------------- ¶4. The GOA announced that GDP jumped 8.6 percent y-o-y in the first quarter of 2006 -- slightly below the BCRA consensus forecast of 8.8 percent. Growth is mainly coming from stronger domestic demand -- increased investment and higher private and public consumption -- aided by a 6.4 percent increase in exports. During the quarter, investment increased 22.8 percent y-o-y -- with increases of 23 percent y-o-y in construction and 22.6 percent y-o-y in plant and machinery investment. Private consumption increased 8.8 percent y-o-y, and public consumption rose 8.3 percent y-o-y. Goods production and services increased 8.8 percent and 8.4 percent y-o-y, respectively. The BCRA forecasts for GDP growth stand at 7.8 percent for 2006 and 5.9 percent for 2007. -------------- -------------- April monthly economic activity index up 6.4 percent y-o-y - weaker than expected. -------------- -------------- ¶5. The monthly economic activity index increased 6.4 percent y-o-y in April -- well below the BCRA market survey forecast of 7.8 percent. This was the weakest growth rate in the past eight months, and represents a continuation of the downward tendency following the 8.3 percent increase of March. However, slower performance in April and March is distorted by the Easter seasonal effect. The growth in the index came mainly from an increase in industry, communications and transportation and services. The index increased 0.7 percent m-o-m. The latest BCRA consensus survey estimates 7.7 percent economic activity growth for 2006, a slightly upward revision from its previous forecast of 7.6 percent. The monthly economic activity index is viewed as a reliable leading indicator of GDP. -------------- -------------- Buenos Aires province ran a ARP 28 million primary deficit in the first four months of 2006. -------------- -------------- ¶6. The government of Buenos Aires province announced a primary deficit of ARP 28 million for the first four months of 2006; including interest (without taking into account the ARP 603 million paid on public debt capital amortization in that period),the deficit reached ARP 280 million,. This is an accounting deficit and not a budgetary one, but Governor Felipe Sola warned that the province could fall into a budgetary deficit this year and argued that the province is not receiving sufficient transfers from the GOA based on its population. To avoid going into deficit, the province needs an additional ARP 800 million from the GOA. -------------- -------------- The GOA will set up its own livestock reference price system. -------------- -------------- ¶7. The GOA plans to set up its own reference pricing system for livestock trading. The system aims to set a nationwide reference price for cattle trading. However it will not replace the existing Liniers reference price, which is set at the Liniers Market in Buenos Aires, the country's leading livestock market, with 20 percent of the total volume of cattle. Government officials have long complained that prices at Liniers have too much influence over the setting of prices in all of Argentina, and that those prices are subject to "collusive trade practices." The beef sector believes that the new system will be ineffective and complicated. -------------- -------------- BCRA increases active repo rates by 0.5 percent. -------------- -------------- ¶8. The BCRA announced a 0.5 percent increase in its active repo rates (the rates at which the BCRA offers financing and adds liquidity to the system),bringing its active rate to 8 percent for seven days. This is the third increase in active repo rates this year, and it follows a 0.5 percent increase in May. Passive repo rates were increased on June 13 to 5.25 percent for one day and 5.75 percent for seven days. According to private consultants, this decision is in line with the BCRA strategy of increasing its reserves. -------------- -------------- Petrobras sells its 50 percent stake in Transener to Eton Park Capital Management. -------------- -------------- ¶9. On June 14, Petrobras Energy announced it will sell its 50 percent stake in the Argentine power transmission company Transener to the U.S. hedge fund Eton Park Capital Management for USD 54 million. Petrobras held its stake in Transener through its holding company Citilec. Transener currently is controlled by the Dolphin Group, an Argentine investment fund that has made several large investments in the energy sector. -------------- -------------- The GOA signs agreement with bread producers to freeze prices. -------------- -------------- ¶10. On June 15, the GOA announced an agreement with bread producers to freeze bread prices at ARP 2.5 per kg. The freeze will be in force until the end of the 2006, and continues the GOA's strategy of trying to control inflation through voluntary price agreements negotiated with various sectors. -------------- -------------- Controversial Anti-Money Laundering Law passes Chamber of Deputies. -------------- -------------- ¶11. On June 15, the Chamber of Deputies approved and sent to the Senate a GOA-proposed law that would lift bank and stock market secrecy in money laundering investigations by the Argentine financial intelligence unit (UIF). Currently, the UIF needs to get a court order to lift bank and stock market secrecy. The law also would revamp the UIF's structure, replacing the current five directors with a single, presidentially-appointed President, who would have the authority to lift banking and stock market secrecy. Opponents say that the law would give too much authority to a single official, who will be chosen by the executive branch. The bill now passes to the Senate, where it is expected to be approved. -------------- -------------- December local saving reached 25.4 percent of GDP -- a new historic record. -------------- -------------- ¶12. In December 2005, local savings -- the difference between the Argentines' income and expenses -- reached a new historic record at 25.4 percent of GDP, a total of ARP 146 billion. The GOA wants to use different incentives to translate this savings into productive investments and prevent this money from going into speculative activities or leaving the system. For the first quarter of 2006, the ratio between investments and GDP reached 22 percent, and according to the GOA a level of 30 percent is necessary to keep annual growth at 9 percent. -------------- -------------- May industrial production index up 7.3 percent y-o-y. -------------- -------------- ¶13. The industrial production index increased 7.3 percent y-o-y in May, almost in line with market expectations of 7.4 percent, and a slight deceleration following a 7.7 percent increase in April. During May, the fastest growing sectors were non-metallic minerals (+19.8 percent),car production (+19.0 percent),tobacco production (+15.5 percent) and oil refining (+12.6 percent). The index increased 0.9 percent m-o-m without seasonal adjustment and 2.2 percent m-o-m seasonally adjusted. The BCRA consensus survey forecasts 6.9 percent industrial production growth for 2006 -- slightly above last month's forecast of 6.8 percent. ¶14. The industry-wide capacity utilization index reached 70.4 percent in May, down slightly from 70.7 percent in May 2005. The sectors with the highest capacity utilization rates were metal-based industries (95.8 percent),oil refining (93.6 percent) and textiles (84.3 percent). The sectors with the lowest capacity utilization rates were auto production (46.4 percent),minerals (62.0 percent) and rubber and plastic (62.4 percent). -------------- -------------- BCRA rolls over its maturities. Investors concentrate their bids in Lebacs. -------------- -------------- ¶15. The BCRA received ARP 726 million in bids at its June 20 Lebac and Nobac auction, and no Lebacs or Nobacs came due during the week. It accepted ARP 420 million in Lebac bids and ARP 198 million in Nobac bids. The yield on the 84-day Lebac increased 10 basis points from 7.25 percent to 7.35 percent, while the yield on the 182-day Lebac decreased from 8.65 percent to 8.60 percent, and the yield on the 266-day Lebac decreased from 10.35 percent to 10.27 percent. The yield on the longest term instrument, the 350-day Lebac, remained at 12 percent. Lebacs for maturities of more than 350 days were withdrawn due to lack of interest. The spread on the one-year Nobac decreased from 2.11 percent to 2.05 percent and from 3.79 percent to 3.78 percent for the two-year Nobac. The Badlar rate (the base rate for Nobacs) is currently at 8.8 percent. Investors are losing interest in Nobacs and instead are focusing on fixed-rate instruments. -------------- -------------- The peso was unchanged against the USD this week, closing at 3.10 ARP/USD. -------------- -------------- ¶16. The peso remained flat versus the USD this week, closing at 3.10 ARP/USD. The peso exchange rate has depreciated 1.6 percent since the beginning of the calendar year. The BCRA's reserves stood at USD 25.14 billion as of June 21, and have increased USD 6.6 billion, or 35 percent, since the GOA prepaid its entire IMF debt on January 2. During the week, the BCRA purchased USD 194 million. -------------- -------------- Commentary of the Week: "Inflation under control or controls on inflation?", by Esteban Fernndez Medrano from an article published in El Cronista on June 20. -------------- -------------- ¶17. May's consumer price index (IPC) figures were certainly a relief for the government. Although May is not usually a month of high inflation, given that it is not subject to seasonal factors, the 0.5 percent monthly increase was not only below the previous monthly average of around 1 percent and the 0.6 percent increase in May last year, but it was also below the expected rate of inflation. This relief is reflected even more strongly in the poverty and indigence indexes, two indicators closely followed by the government. But despite the apparent success in controlling inflationary pressures, a bitter aftertaste remains when analyzing the details of the results. In fact, doubts persist as to whether government is really succeeding in controlling inflation, or if the latest figures are the reflection, possibly fleeting, of price controls. ¶18. The progressive incorporation of goods into the list of price agreements distorted the typical definition of goods/services regulated by the IPC (goods whose variation in price does not respond to market factors, but rather to regulations or agreements within sectors). Traditionally, the definition of these regulated goods included in the IPC were understood to be public services - gas, water, electricity and public transportation - fuel and cigarettes (the last one as a result of the heavy tax burden on the final price). ¶19. If we redefine this concept, incorporating into the IPC all the sectors that have price agreements, the share of "regulated" goods in the IPC rises from approximately 20 percent in December of 2005 to almost 60 percent in May of 2006. Although this redefinition is more lax than the original, as price agreements generally do not include 100 percent of the products in the group but rather "only" affect the lead products, any way it reflects the fact that the price agreements are widespread throughout the economy. More than the half of the goods and services in the IPC are being affected by price regulations imposed by the government. ¶20. This result becomes even more compelling if one compares the annual change in inflation between the regulated and unregulated goods/services. Disaggregating annual inflation into an index of regulated goods/services and another of unregulated goods/services (starting with the INDEC definition of regulated goods but then adding those sectors with price agreements),one observes a marked divergence between the two sub-indexes. While the annual change in the regulated index in May was only 1.3 percent, the sub-index of unregulated goods/services increased more than 16 percent. ¶21. So long as the regulated index's inflation remains controlled, the annual variation of the IPC as a whole would generally approach this figure (due to the greater weight that the regulated sector in the IPC has had since the beginning of this year). The doubt that remains is, even without direct interferences from the government with respect to the methodology of the IPC calculations, how representative do the inflation figures end up being? In other words, is the increased price stability attained in May, and which is predicted for the coming months, really a reflection of the state of the economy? After all, "unregulated" annual inflation has shown practically uninterrupted growth since the beginning of 2004. ¶22. Considering the glass as half full, one can admit that the new controls were applied principally in sectors whose prices, since devaluation, had grown more than the rest. Taking out public services from the regulated sub-index, which are in all respects behind the rest of goods/services, one observes that this sub-index is 13 percent above the unregulated sub-index. That is, one could attempt to argue that price controls are a mechanism to accelerate the adjustment of relative prices between tradable y non-tradable goods/services, to make sure that the relative adjustment is not confused with a general price increase and to prevent producers of tradable goods/services from raising their prices (in line with the well-known work of Lucas). ¶23. But it is extremely difficult to anticipate whether this government will feel like lifting price agreements when this price difference between regulated (net of public services) and non-regulated prices closes, nor what would be the subsequent response of the affected sectors. What is certain is that even if annual IPC inflation stabilizes in coming months, the sense will remain that this is the effect of the controls on inflation more than a controlled inflation. (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