Argentina Economic and Financial Weekly for the week ending

UNCLAS BUENOS AIRES 001481 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 30, 2006 -------------- -------------- Weekly Highlights -------------- -------------- - Argentina and Bolivia agree to increase price of Bolivian gas imports by 56.25 percent. - President Kirchner announces that unemployment fell to 9.8 percent in May. - Provincial finances deteriorate. - June Government Confidence Index up 8 percent m-o-m -- after two consecutive decreases. - Argentina and Brazil sign new automobile trade agreement. - Commentary of the Week: "Growth is Going to Depend More and More on Productive Investment" -------------- -------------- Argentina and Bolivia reach a 56.25 percent rise on gas price agreement. -------------- -------------- ¶1. On June 29, Argentina and Bolivia finally reached an agreement on Bolivian gas exports to Argentina. The agreement was signed by Argentine President Nestor Kirchner and Bolivian President Evo Morales, and provides for an increase in the volume of gas exported to Argentina. The price will increase on July 15 from USD 3.20 to USD 5 per million cubic meters through the end of 2006, a 56.25 percent increase, and a new price will be renegotiated before the end of the year. Argentina will not be able to re-export Bolivian gas to other countries, a reference to the contracts Argentina has signed to supply gas to Chile. Bolivia and Chile severed diplomatic relations in 1978 and Bolivia wants to recover its access to the Pacific coast lost in the 19-th century War of the Pacific. -------------- -------------- President Kirchner announces that unemployment decreased to 9.8 percent in May. -------------- -------------- ¶2. On June 29, President Kirchner announced that preliminary figures indicate the unemployment rate decreased to 9.8 percent in May -- compared to 11.4 percent in the first quarter of 2006 and 10.1 percent in the fourth quarter of 2005. This would be the first time the rate has fallen to single-digit levels in 13 years, but these figures exclude participants in the Head-of-Household income supplement plan. Their inclusion would increase the unemployment rate by at least two percentage points. However, this represents a remarkable recovery from 2002 when unemployment reached one quarter of the labor force. The BCRA consensus survey forecasts that unemployment will fall to 9.3 percent by the end of 2006. The National Bureau of Statistics (INDEC) will publish the official figures in August. -------------- -------------- Provincial public accounts deteriorate. -------------- -------------- ¶3. According to private consultants, the overall provincial fiscal surplus may be close to zero in 2006. Without savings, the provinces will need an additional ARP 7 billion to make provincial debt payments. The financing needed to close provincial accounts probably will come from the GOA, although the consultants do not discard the possibility of provinces delaying payments to suppliers. This year, the GOA will restructure ARP 4 billion of provincial debt, half of which is owed by Buenos Aires province. In 2006, the provincial primary fiscal surplus is estimated to reach ARP 2.0 billion compared to ARP 2.9 billion last year (down 31 percent). This deterioration of provincial accounts is mainly the result of the increased rate of expenditure, particularly for salaries (which account for 49 percent of total provincial expenditures). Also, interest payments are rising because half of the provincial debt is indexed by CER (a CPI-linked index). Many provinces claim that the solution to the fragile provincial fiscal situation will come only through an integral restructuring of the provincial debt owed to the GOA. -------------- -------------- Government Confidence Index up 8 percent m-o-m in June -- after two consecutive decreases. -------------- -------------- ¶4. The Government Confidence Index increased 8 percent m-o-m in June to 2.69 points, 0.10 above the average during the Kirchner administration and well above the 1.2-point reading in May 2003 when President Kirchner took office. Confidence in the GOA's ability to solve citizens' problems is still the factor generating the most confidence; it increased 1 percent m-o-m. Public opinion of the GOA's general performance, honesty of GOA officials and efficiency of public spending increased 10 percent, 16 percent and 12 percent m-o-m, respectively. The index rose 16 percent y-o-y. [The Government Confidence Index is a survey-based index prepared by Di Tella University. It varies from zero to five points and seeks to measure public opinion of GOA's general performance, efficiency of pubic spending, honesty of GOA officials and the government's ability to solve problems.] -------------- -------------- Argentina and Brazil signed a new automobile trade agreement. -------------- -------------- ¶5. On June 26, Argentina and Brazil signed an agreement to regulate automobile trade between the countries for the next two years. Argentina's car exports to Brazil (its main trading partner),rose more than 30 percent in the first five months of 2006, while Brazil's exports to Argentina rose 15.8 percent in the same period. The signed agreement reduces the amount of automotive products that each country may import tariff-free from the other from USD 2.6 to USD 1.95 for every USD 1 of auto-sector products it exports to the other. -------------- -------------- GOA veto power over Aerolineas Argentinas rejected by Interinvest associates. -------------- -------------- ¶6. Gerardo Diaz Ferran and Gonzalo Pascual of Interinvest (the group that controls Aerolineas Argentinas) have rejected the document signed on June 20 in Madrid by Aerolineas President Horacio Fargosi and GOA Ministers Julio de Vido and Felisa Miceli. Interinvest objects to the provisions in the agreement that establish a GOA veto power after it raises its stake in Aerolineas from 5 percent to 20 percent. The agreement gives the GOA the right to veto strategic decisions such as reductions or elimination of flight frequencies. -------------- -------------- The GOA meets with food companies to discuss adjustments to price restraint agreements. -------------- -------------- ¶7. Secretary of Internal Commerce Guillermo Moreno met this week with several food companies that want to translate their costs increases over the last two months into price increases. The goal of the meetings was to reach an understanding in which the companies can regain their profitability without compromising the GOA's inflation target for the year. Moreno stated that starting July 3, the companies must present a detailed report of their cost structure for every product and the increases they are planning to make. The evaluation may take up to one month. -------------- -------------- President Kirchner praises the Argentinean economic situation. -------------- -------------- ¶8. In a speech on June 27, Argentine President Nestor Kirchner, praised the "permanent growth of the people and of their purchasing power, that gives to the economy a permanent reactivation," and defended the GOA's action to generate investments in infrastructure and housing. The President's remark followed the improvement in several economic indicators -- construction and consumption -- published by the National Bureau of Statistics (INDEC). Consumption rose mainly in response to lower food prices. However, private consultants doubt the sustainability of price controls if consumption continues to grow. -------------- -------------- The GOA to promote pension funds' investment in the energy sector. -------------- -------------- ¶9. The GOA is seeking to promote private pension fund (AFJP) investments in the expansion of the energy sector by offering funds a 7 percent annual return. The GOA and pension fund managers are reportedly negotiating on a capital adjustment index and the long-term return. According to Minister of Planning Julio de Vido, the offered return is "more than interesting." President Kirchner recently said that pension funds should play a stronger role in capital investment instead of worrying about how to increase returns. -------------- -------------- Brazilian BNDES to lend USD 689 million to expand gas network in Argentina. -------------- -------------- ¶10. Undersecretary for Fuels Cristian Folgar announced that the Brazilian National Bank of Development (BNDES) approved a 10-year loan for USD 689 million at the Libor rate plus 2.6 percent to expand the gas transportation network during 2006-2008. This credit will finance the gas network expansion of the Northern Gas Transport (TGN) and Southern Gas Transport (TGS) pipelines, which will expand their capacity by 13 million cubic meters a day. Eight million cubic meters will be destined to the electric sector and the rest to the industrial sector. -------------- -------------- Joint South Korean mission visits Argentina to discuss natural resource development. -------------- -------------- ¶11. The South Korean government has dispatched a joint government-private sector mission to Argentina to discuss ways to develop natural resources. Kim Shing-Jong, deputy minister of energy and resources policy, led the delegation, which included officials from the state-run investment promotion agency Kotra, Daewoo International, Korea National Oil Corporation and the Korea Energy Economics Institute. The ministry said that the GOA had promised to support Korean consortia interested in taking part in copper mining projects in Agua Rica and El Pachon and that it will continue to help Korean firms taking part in oil field development in Argentina. -------------- -------------- Banks to offer time deposit adjusted by Badlar rate with a guaranteed return. -------------- -------------- ¶12. The BCRA will allow banks to offer a Badlar rate (variable rate) time deposit with a guaranteed return. Banks will offer a fixed or variable interest rate, with the obligation of repaying the higher one to the investor. These time deposits will have a minimum term of 120 to 180 days. The BCRA did not detail whether there will be a minimum amount, nor the currency for these deposits. With this measure, the BCRA aims to extend the term of time deposits as well as lower the bank's liquidity risk. -------------- -------------- Balance of payments: Current account surplus of USD 1.2 billion and net capital outflows of USD 8.1 million due to GOA debt prepayment to the IMF in Q1 of 2006. -------------- -------------- ¶13. The GOA announced that its balance of payments results for the first quarter of 2006 show a current account surplus of USD 1.2 billion -- compared to USD 185 million in the first quarter of 2005 and above the market forecast of USD 985 million. The current account increase was driven mainly by lower interest payments following the the GOA debt exchange. Interest payments fell from USD 1.6 billion in Q1 2005 to USD 380 million in Q1 2006. The GOA reported accrued interest on debt in 2005 even though it was not paid, but the report shows no accrued interests in 2006 because the debt exchange has been finalized (and unpaid interest is no longer reflected in the interest account of the balance of payments). Meanwhile, the trade surplus reached USD 2.7 billion, close to the level of the Q1 2005 surplus. ¶14. The capital and financial account showed net capital outflows of USD 8.1 billion -- compared to net capital inflows of USD 137 million in Q1 2005. Outflow were mainly from the non-financial public sector and the BCRA (USD 9 billion),which were partially offset by non-financial private sector inflows (USD 610 million) and by banking sector inflows (USD 299 million). The decrease in capital inflows -- compared to the same quarter last year -- is mainly the result of the GOA payment to the IMF. Without the debt prepayment to the IMF, the financial account would have had a surplus of USD 1.4 billion and reserves would have increased by USD 2.9 billion, according to GOA calculations. -------------- -------------- BALANCE OF PAYMENTS 2006 2005 Difference (USD in M) Q1 Q1 -------------- -------------- (A) CURRENT ACCOUNT 1,180 184 996 1 TRADE BALANCE 2,714 2,746 -32 2 SERVICES -376 -406 30 3 INVESTMENT SERVICES & DIVIDENDS -1,321 -2,303 982 4 TRANSFERS 163 147 16 -------------- -------------- (B) CAPITAL AND FINANCIAL ACCOUNT -8,134 184 -8,318 1 CAPITAL ACCOUNT 11 47 -36 2 FINANCIAL ACCOUNT -8,145 137 -8,282 -------------- -------------- (C) ERRORS AND OMMISSIONS 320 482 -162 -------------- -------------- (D) INTERNATIONAL RESERVES 6,633 -851 7,484 -------------- -------------- OVERALL BALANCE (A)+(B)+(C)-(D)1 1 0 -------------- -------------- -------------- -------------- May construction activity index increased 23.9 percent y-o-y without seasonal adjustment. -------------- -------------- ¶15. The National Bureau of Statistics (INDEC) released its May construction activity index showing an increase of 23.9 percent y-o-y and of 26.9 percent after seasonal adjustment. Construction activity, which is an important component of gross fixed investment, grew 2 percent m-o-m seasonally adjusted and and 7.9 percent without seasonal adjustment. During the first five months of the year, construction activity rose 20.3 percent against the same period in 2005, taking the index to record highs. -------------- -------------- BCRA rolls over its maturities. The BCRA extends the average life of its portfolio. -------------- -------------- ¶16. The BCRA received ARP 1.1 billion in bids at its June 27 Lebac and Nobac auction, compared to ARP 333 million in Lebacs that came due during the week. It accepted ARP 802 million in Lebac bids and ARP 214 million in Nobac bids. The yield on the 77-day Lebac and the 175-day Lebac remained in 7.35 percent and 8.60 percent, and the yield on the 259-day Lebac decreased from 10.27 percent to 10.20 percent. The yield on the longest term instrument, the 343-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 2.05 percent to 2.03 percent and from 3.78 percent to 3.72 percent for the two-year Nobac. The Badlar rate (the base rate for Nobacs) is currently at 9.1 percent. Since December of 2005 to the present, the BCRA has extended the average life of its portfolio (from 247 days to 353 days) by 43 percent, mostly due to larger Nobacs issuance. -------------- -------------- The peso was unchanged against the USD this week, closing at 3.10 ARP/USD. -------------- -------------- ¶17. The peso remained flat versus the USD this week, closing at 3.10 ARP/USD. On Wednesday, the peso depreciated slightly to 3.11 ARP/USD -- the lowest level since March of 2003. The BCRA then made clear that 3.10 ARP/USD level is a ceiling by selling USD 5 million. In the first four days of the week, the BCRA purchased USD 91 million. The peso exchange rate has depreciated 1.6 percent since the beginning of the calendar year. The BCRA's reserves stood at USD 25.3 billion as of June 27, and have increased USD 6.5 billion, or 35 percent, since the GOA prepaid its entire IMF debt on January ¶2. -------------- -------------- Commentary of the week: "Growth is going to depend more and more on productive investment", by Miguel A. Kiguel from an article published Cronista Comercial on June 14. -------------- -------------- ¶18. Once again, world stock markets are slumping, interest rates for emerging markets are rising, gold and silver prices are falling and questions are re-emerging as to whether we are on the edge of an international financial crisis and what impact this situation could have on Argentina. The recent declines in world stock markets seem to be in part a technical correction following a significant increase in the price of financial stocks during the first months of the year, and in part a result of a change in expectations regarding the strong, worldwide growth that has been observed in recent years. ¶19. The repeated increases in the Federal Reserve's interest rates, which taken the Federal Funds Rate from 1 percent to 5 percent over the past two years, finally had an impact on the price of financial stocks and certainly will bring about an economic slowdown in the United States. The relevant question isn't why the increase in interest rates impacts emerging markets, but rather why it took so much time for the policy of the Fed to affect them. ¶20. In the past, changes in interest rates set by the Fed affected the risk premium of emerging market bonds. An increase in rates from 3 percent to 6 percent was the main trigger of the Tequila crisis in 1994 and of devaluations in many countries in the region. The fall in rates since 2001 and the great liquidity that it generated from then on brought about financial euphoria in emerging markets with strong increases in stock markets and large drops in the risk premiums on the emerging market sovereign bond index (EMBI). ¶21. Despite the recent fall in markets and the rise in the EMBI, one cannot speak of crisis (at least for now). In truth, the decreases imply primarily a "re-pricing" (or a readjustment of prices) and suggest that in countries like Brazil, Chile and Argentina, the stock market indexes are returning to their levels at the beginning of the year, while the EMBI still remains at relatively low levels compared with historic figures. ¶22. The impact of this turbulence on emerging economies should not be as great as during the Tequila crisis or the crisis at the end of the 1990s. Most emerging markets today show surpluses in their current account of the Balance of Payments and have elevated levels of international reserves. Furthermore, with very few exceptions, countries no longer have fixed exchange rates, so there does not appear to be a risk of a balance of payments crisis. Certainly this is the case in Latin American countries where the export sector is strong, with international reserves of more than USD 230 billion and current account surpluses of USD 12 billion. ¶23. Meanwhile, there are no significant fiscal problems in the region, and countries depend less and less on international markets to satisfy their financial programs, so it doesn't seem that we are in the waiting room of a new debt crisis. ¶24. In our country, the impact up until now principally has fallen on the value of stocks. The turbulence of markets had an important effect on the price of stocks and of long term bonds; however, it had a relatively small effect on the foreign exchange market, where the Central Bank continued buying reserves in the exchange market, at the same time that short-term interest rates in pesos remained very stable. In reality, there is still great liquidity in the financial market, and there are no pressures on the dollar or on interest rates as was the case in the past. ¶25. This time it appears that the effect will be different, less on the financial sector and more on the real sector of the economy. Argentina is not isolated from the world and therefore if the world economy slows down as a result of the new international scenario, without a doubt it will result in lower prices for our exports, lower international demand and greater financial costs for businesses. This situation will surely affect our economic cycle and could bring about a drop in the growth rate. ¶26. The turbulence in international markets does not seem such that it could cause a new financial earthquake in our economy. However it is warning sign, with an international scenario driven by the increase in the Fed's interest rates, higher market volatility and price decreases for some commodities. It appears that growth is going to be increasingly less aided by luck and is going to depend more and more on productive investment. (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