Identifier
Created
Classification
Origin
06BUENOSAIRES1571
2006-07-14 21:09:00
CONFIDENTIAL
Embassy Buenos Aires
Cable title:  

FISCAL SITUATION IN PROVINCES DETERIORATING

Tags:  ECON EFIN AR 
pdf how-to read a cable
VZCZCXYZ0000
RR RUEHWEB

DE RUEHBU #1571/01 1952109
ZNY CCCCC ZZH
R 142109Z JUL 06
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC 5226
INFO RUEATRS/DEPT OF TREASURY WASHDC
RHEHNSC/NSC WASHDC
C O N F I D E N T I A L BUENOS AIRES 001571 

SIPDIS

SIPDIS

E.O. 12958: DECL: 07/07/2016
TAGS: ECON EFIN AR
SUBJECT: FISCAL SITUATION IN PROVINCES DETERIORATING

REF: 04 BUENOS AIRES 2601

C O N F I D E N T I A L BUENOS AIRES 001571

SIPDIS

SIPDIS

E.O. 12958: DECL: 07/07/2016
TAGS: ECON EFIN AR
SUBJECT: FISCAL SITUATION IN PROVINCES DETERIORATING

REF: 04 BUENOS AIRES 2601


1. (U) Classified by Ambassador Lino Gutierrez for reasons
1.4 b and d.


2. (C) Summary: Provincial finances are deterioriating,
with the provincial contribution to the consolidated surplus
this year projected to be zero. The worsening state of
provincial finances is mainly the result of spending
increasing faster than revenues. Spending is being driven by
salary increases, with public sector unions demanding the
same 19 percent increase given to federal workers. Salaries
account for 50 percent or more of spending in most provinces.
Debt payments also are growing, because 70 percent of
provincial debt is inflation-indexed debt owed to the GOA.
The Fiscal Responsibility Law (FRL) is not being enforced,
and the new Education Financing Law conflicts with the FRL.
This worrisome trend comes on top of an unprecedented four
years of provincial and federal surpluses, and the federal
surplus remains relatively strong. In a political sense,
President Nestor Kirchner stands to gain from provincial
fiscal weakness and has no incentive to reform the fiscal
system, despite its financial and institutional weaknesses.
Provincial finances are based on the Co-Participation revenue
sharing system, whose formulas have not been changed since
1988, and most provinces depend on additional discretionary
transfers from the GOA. Kirchner has been very adept at using
discretionary transfers (or withholding them) to bring
governors into line. It is no surprise that the major
provincial opposition figures all come from provinces
(Neuquen, Salta, San Luis) that have oil or other revenue
sources that are independent of GOA discretionary transfers.
End summary.

--------------
Fiscal Accounts are Getting Weaker
--------------


1. (U) Provinces are projecting a worsening fiscal situation
for 2006, with an overall primary surplus near zero. Felipe
Sola, the Governor of Buenos Aires Province, said in June
that the province, which contains 38 percent of the
population, closed the first quarter in deficit and predicted
an overall primary deficit this year. Broda consulting
firm,s latest estimates put the total primary provincial

surplus at just ARP 274 million (0.4 percent of GDP) for
2006, down from ARP 4.0 billion (0.8 percent of GDP) in 2005.
After accounting for interest payments, Broda predicts a
financial result of ARP -1.9 billion (-0.3 percent of GDP),
compared with a surplus of ARP 2.1 billion (0.4 percent of
GDP) in 2005. Other sources (Economia & Regiones, Fundacion
Mediterranea) have made similar estimates. Provincial
surpluses have been shrinking since their peak in 2004 when,
according to Broda, they had a primary surplus of 1.4 percent
of GDP and a financial surplus of 1.1 percent of GDP.


2. (U) Much of the deterioration in provincial accounts is
due to the rise in provincial expenditures outstripping
revenue growth. Broda calculates that provincial spending
has increased by 31 percent since 2003. Initially following
the devaluation, the increase in provincial tax collections
far surpassed rising spending; first-quarter collections in
2003 were 55.9 percent higher than the year before, according
to the consulting firm Economia & Regiones. They have failed
to keep pace with rising expenditures more recently, however,
as provincial collections rose only 23 percent y-o-y in 2005
and in 2006.


3. (U) Spending on public employees made up nearly half of
the increase in expenditures during the past two years,
primarily through salary increases. Public works spending
has risen at an even faster rate, but its effect on the
overall budget situation has been less pronounced because it
only makes up 11 percent of total provincial expenditures,
according to Economia & Regiones.


4. (U) Broda's budget projections are based on a 19 percent
increase in provincial public sector salaries. The GOA
announced a 19 percent salary increase for its public
employees this year, which drew immediate criticism from
provincial governors who were quick to realize it would be
politically difficult not to follow suit. Kirchner served as
governor of Santa Cruz province for three terms before being
elected president, so he is well aware of the effect the GOA
salary increase will have on provincial finances. The
question is whether he is indifferent or whether he saw the
difficulties it would cause to be politically advantageous,
as provinces in need of GOA funds are unlikely to put up much
opposition to Kirchner's policies.


5. (U) The fiscal situation remains more positive at the
national level, although rising federal government
expenditures outpaced collections in the first quarter of
2006 for the first time during the Kirchner Adminstration.
Between 2003 and 2005, nominal federal expenditures rose 25.6
percent per year and real expenditures rose 16 percent
annually. By comparison, nominal expenditures rose an
average of only 4.8 percent and real expenditures rose 3.8
annually in the nine years leading up to the 2002 devaluation
(1993-2001). Broda predicts that the primary budget surplus
will fall from 3.7 percent of GDP in 2005 to 3.2 percent of
GDP this year. Though the surplus is shrinking, the GOA's
budget is in good shape compared with the large fiscal
deficits that characterize its recent history.

--------------
Debt Payments are Growing
--------------


6. (U) In addition to increasing expenditures, provinces are
still paying off an accumulated debt worth USD 10.9 billion,
according to the Ministry of Economy, held primarily by the
GOA. The provinces owe 70 percent of their debt to the GOA
for external debts the GOA assumed in 2002. Their ability to
repay their loans hinges on their fiscal situation. Economia
& Regiones estimates that provinces will need an additional
ARP 7.0 billion this year in order to make debt payments.
The GOA-assumed provincial debt is indexed to CER (an
inflation-linked index),and this indexation has drawn
significant criticism from provincial leaders as inflation
has doubled in each of the past three years, and is projected
to be near 11 percent in 2006. According to press report,
some provinces managed to renegotiate the terms of their debt
with the GOA to remove this indexation provision, but this is
at the discretion of the GOA and, ultimately, of President
Kirchner.


7. (U) Provinces have also complained that the GOA owes them
ARP 3 billion in collections currently sitting in the
National Treasury Contributions (ATN) fund. Approximately
two percent of tax collections are earmarked for this fund,
which is then handed by the Ministry of the Interior in case
of "emergency situations" or to resolve "financial imbalances
in provincial governments." These guidelines have had little
effect, and often these funds have been used as political
leverage with provincial leaders. Provincial leaders and
members of Congress have called for reforms, but action seems
unlikely in the coming months.

--------------
Fiscal Responsibility Law not Being Enforced
--------------


8. (U) The GOA passed the Fiscal Responsibility Law (FRL) in

2004. In theory, the law holds both provincial and national
governments more accountable for their spending. The law
went into effect in the beginning of 2005 for provinces only,
as the GOA exempted itself from the FRL in the 2005 and 2006
budgets. The FRL requires, among other things, that spending
increase no faster than the rate of nominal GDP growth. One
year later, however, only half of provinces have managed to
meet this requirement. A provision in the FRL for a program
to bring non-complying provinces into compliance has not been
implemented.


9. (SBU) The Education Financing Law, which went into effect
this January, stipulates that provinces must increase
education funding to a level of six percent of GDP in the
next five years. Many provinces say that the Education Law,
by mandating increases in provincial spending, stands in
direct conflict with the FRL. The GOA transferred
responsibility for education and health funding to the
provinces in the 1990s, but there were no adjustments in
co-participation revenues to adjust for this transfer,
because the co-participation system is extremely difficult to
change. Instead, the adjustment mechanism has been National
Treasury Contributions (ATN) funds and annual bilateral
provincial-GOA pacts in which the GOA agrees to transfer
federal resources to selected provinces. Both of these have
been sources of federal fiscal leverage over provincial
governments.

--------------
Comment:
--------------


10. (C) Revenues in Argentina are strongly pro-cyclical. GDP
growth remains strong -- estimated at 7-8 percent for 2006 by
the Central Bank of Argentina -- but it is decelerating. If
collections drop, it may be politically difficult for
national or provincial governments to compensate by reducing
expenditures. Both national and provincial spending tend to
rise in election years, and the presidential elections in
2007 are unlike to deviate from that trend. Four years of
provincial and federal fiscal surpluses in the provinces is
an unprecedented achievement, even if the surpluses are
shrinking.


11. (C) President Kirchner is often lauded for his fiscal
management, but it also is fair to say that Kirchner is a
very good politician, and that he has used the GOA,s fiscal
powers very well to exert political control over governors
and provincial parties. President Kirchner, as a long-time
governor, certainly understood that the 19 percent salary
increase he approved for federal employees would create
financial problems for many provinces to follow. In most
provinces, salaries constitute 50 percent or more of
expenditures. But in a political sense, Kirchner stands to
gain from provincial fiscal weakness. Kirchner has held up
federal transfers promised under bilateral pacts when
governors do things he does not like (e.g., he cut off funds
to La Rioja governor Maza in 2003 after Maza appeared at a
public event with former president Menem, and Maza was unable
to make his payroll; shortly thereafter, Maza became
Kirchner,s candidate in La Rioja). He has also used
provincial indebtedness to the GOA and delays in ATN
transfers to remind governors who controls the money that
they need. This has played in some cases in convincing
Radical Party governors to cross party lines and support
Kirchner. It is no surprise that the major provincial
opposition figures all come from provinces (Neuquen, Salta,
San Luis) that have oil or other revenue sources that are
independent of GOA discretionary transfers.


12. (C) In an institutional sense, Argentina,s
Co-Participation revenue system, in which the GOA collects
all revenues and returns a portion of them to the provinces
through a set formula, has the perverse and undemocratic
effect of divorcing provincial politics from taxation. It
also magnifies the power of the President, since the
Co-Participation formulas have not been adjusted since 1988,
and most provinces therefore depend on additional transfers
from the GOA to balance their books. The 1994 constitution
calls for the Co-Participation formulas to be amended, but
this has proven politically impossible for successive
administrations. Reftel A provides a detailed explanation of
the process of reforming the Co-Participation law, which
requires absolute majorities in both houses of Congress and
ratification by the legislatures every province. While
Kirchner may be the first president since 1994 who has the
political power to push through changes to the
Co-Participation formula, he lacks any domestic political
incentive to do so, and his decision to pay off the IMF
removed the only external pressure for change.


12. To see more Buenos Aires reporting visit our classified
website at: http://www.state.sgov.gov/p/wha/buenosaires.< /a>
GUTIERREZ