K,OMICS REVISITED: KIRCHNER,S ECONOMIC POLICIES

C O N F I D E N T I A L SECTION 01 OF 04 BUENOS AIRES 001624

SIPDIS

SIPDIS

STATE FOR WHA TOM SHANNON, JOHN MAISTO, AND CHARLES SHAPIRO
NSC FOR DAN FISK
TREASURY FOR DAS NANCY LEE
USCINCSO FOR POLAD

E.O. 12958: DECL: 07/21/2016
TAGS: ECON PGOV ENRG ETRD EFIN AR
SUBJECT: K,OMICS REVISITED: KIRCHNER,S ECONOMIC POLICIES
EDGING OFF COURSE

REF: A. BUENOS AIRES 1151

B. BUENOS AIRES 1594

Classified By: CDA a.i. Hugo Llorens for reasons 1.4 (B) and (D)


1. (C) Summary: During the first three years of his mandate,
President Kirchner's rhetoric on economics was worse than his
bite. Despite sometimes inflammatory, nationalist rhetoric,
attacks on the IMF, oil companies, bondholders, various
business sectors and orthodox economists, Kirchner did little
to try to steer Argentina off the fundamentally pro-market,
capitalistic economic model it adopted in the 1990s (even as
he attacked this model repeatedly). Beginning in early 2006,
however, the GOA's economic policies have edged to the left,
and for the first time, are beginning to interfere in a
substantive way with the functioning of the basic model.
This is most clear in the GOA's anti-inflation approach,
where the GOA's policies effectively turn entire sectors into
regulated utilities, with the GOA examining their cost
structures and setting prices based on a "reasonable" profit.
In energy, it is pushing to deepen the state,s role in
energy exploration and production even though its model has
resulted in an effective halt in new exploration and a
significant deterioration in reserves. This increasing state
role is of concern, and the intrusion into the private
sector's pricing decisions is a significant deviation from
the market-led model. The policies are not being driven by
ideology but by the very short-term political focus of the
administration. Fortunately for Kirchner, a market-based
exchange rate regime continues to make Argentina's economy
highly competitive and favorable international prices for key
exports continue to propel economic activity to impressive
new heights. Indeed, exports are at record levels, GDP is
set to rise nearly 9 percent in 2006 for the fourth
consecutive year, and unemployment has dropped from
one-quarter of the work force in 2002 to 9.7% currently.
Kirchner's strong record as someone who delivers results will
greatly benefit him politically in 2007. Ultimately,
however, the economic costs of these short-term policies will
emerge and be paid by someone, somewhere. How Kirchner
allocates those costs likely will be a major theme in his
second term. The private sector, which so far has said very
little in opposition to Kirchner's policies, is likely to
receive much of the bill. End summary.

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Unorthodox Inflation Policy
--------------


2. (C) The GOA's anti-inflation policy is decidedly
unorthodox. First, the Argentine Central Bank (BCRA),whose
statutory mission is fighting inflation, plays no role in the
anti-inflation fight, and in fact, may be accelerating it.
The BCRA's priority is accumulating reserves, as directed by
the President and, secondarily, keeping interest rates low to
stimulate continued growth. As reported reftel A, M2 in the
first quarter surged 26 percent while the economy grew at an
8-9 percent pace.


3. (C) Second, the GOA official in charge of anti-inflation
policy is Guillermo Moreno, now the Secretary of Internal
Trade at the Economy Ministry, even though he openly says
that he continues to work for Planning Minister De Vido, his
long-time mentor. Moreno's job is to negotiate "voluntary"
price agreements with industry sectors that freeze prices for
basic goods (those that affect the Basic Consumption Basket
that is used to measure inflation). Moreno does this by
demanding their books, examining their costs, and then
setting their prices on a cost-plus basis, effectively
turning them into regulated utilities. For the companies,
this means guaranteed profits, no price competition, and no
new entrants to compete against them. The GOA explanation
for this approach is that market-set prices are the result of
oligopolistic suppliers abusing their market power, and that
there is no economic basis for price increases. The BCRA
adds to this explanation that price increases are the result
of the delayed adjustment of relative prices since the 2002
devaluation, and are not being fueled by monetary emissions.


4. (C) In this light, the GOA's imposition of a six-month

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beef export ban on March 8 of this year as part of its
anti-inflation policy was only somewhat less orthodox than
the basic policy. The ban went into effect because Moreno
was unable to reach a price restraint agreement with the beef
sector, which has 200,000 producers that are loosely
organized into several trade groups that cannot bind their
members. Argentina consumes only about 45 percent (by
volume) of a beef carcass. Prior to the ban, all parts not
consumed in Argentina were exported. The ban applies to the
whole carcass, even those parts that would not be consumed in
Argentina, resulting in substantial losses to producers. The
ban had its desired effect - domestic prices of beef fell by
25 percent over several months - but the supply situation
worsened, and the GOA is now trying to give low-interest
loans to increase supplies. The GOA has partially lifted the
export ban, allowing 40 percent of the prior export levels to
be exported, but it also imposed an export permit system that
is not functioning well. Currently, exports are only at
about 20 percent of levels prior to the ban. The end result
is that one of the key sectors of the export-led Argentine
economic recovery has been deeply damaged.


5. (C) The GOA's strongest anti-inflation anchor has been its
fiscal accounts. The GOA is well on its way to its fourth
consecutive primary fiscal surplus, an unprecedented run of
sound fiscal management in modern Argentine history (the
previous record was two years). Yet this is mainly a revenue
story; spending has grown at a 30 percent annual pace under
Kirchner. In the first quarter of 2006, spending exceeded
the growth in revenues for the first time during the Kirchner
administration. At the provincial level, spending has surged
due to wage increases (following in lockstep the 10 percent
increase provided by the GOA). GOA subsidies to industries
have grown to ARP 21.5 billion (USD 7.1 billion) this year,
22 percent of the 2006 budget.


6. (C) As Argentina goes into a presidential election year,
and with inflation running at 12-15 percent, it is hard to
imagine that spending will not continue to grow, regardless
of revenues, or that the GOA will not give public sector
workers a wage increase. The GOA also has stashed
approximately ARP 5 billion into off-budget fiduciary trust
funds for roads, public works and other purposes, and the GOA
is expected to increase spending from these accounts next
year as well. The potential loss of the fiscal anchor would
be a significant, negative signal for the Argentine economy.

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The Growing State Role in Energy
--------------


7. (C) The Kirchner Administration has always wanted a state
presence in the energy sector. In 2004, Energy Secretary
Cameron told Econoffs that the Administration believed that
energy resources should be owned and priced by the GOA to
stimulate growth and employment, but said that they accepted
the private sector-led model. Kirchner created the state
energy holding company, Enarsa, in 2004. While Enarsa
remains mainly a shell, it has a growing role as the holder
of remaining GOA property interests in the energy sector, and
is available as the entity to reclaim portions of energy
concessions that the private sector decides it will not
pursue or develop.


8. (C) The Kirchner Administration knew in 2003 that
Argentine industry faced possible energy shortages. Natural
gas prices had been pesified and frozen at very low levels.
The market was looking for price signals to ramp up
exploration and development, to take advantage of the low
costs of production following the 2002 devaluation. Instead,
the Kirchner Administration,s energy policy was based on
expanding supply from Bolivia (where it was buying gas at a
"solidarity price" of USD 3.2 per million cubic meters) and
kept prices frozen. For the past three years, while
Argentine companies faced sporadic gas and electricity
shortages and mining and industrial investments were being
shelved because of uncertainty about energy supply, the
Kirchner Administration stuck to its Bolivia supply strategy,
while the situation in Bolivia deteriorated. On June 29,
President Kirchner finally signed an agreement with Bolivian

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President Morales that provides for gas at a price of USD 5
per million cubic meters until the end of the year, and for a
major increase in supply if new pipeline capacity is added.
The GOA will now have to figure out how it is going to
allocate this price increase (56 percent),while avoiding an
inflation increase. While the supply side of the agreement
is positive, it doesn't solve the electricity or transmission
problems. Two new power plants need to be built, and a
pipeline to supply them, to alleviate shortages. That will
take another two years.


9. (C) Meanwhile, gas reserves have dwindled to just nine
years consumption. The GOA has offered a carrot (low
interest loans for exploration, so long as Enarsa is brought
in as partner) and a stick (review of concession contracts
and rescissions of contracts where companies have not
complied with investment requirements). But it still will
not offer price signals to stimulate production. Indeed, the
Administration seems to be moving in the direction of a
state-owned energy sector that prices energy to stimulate
employment and growth.

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Politics Uber Alles
--------------


10. (C) Politics and, in particular, Kirchner's focus on
winning the 2007 Presidential elections in the first round,
are the driving force behind these unorthodox economic
policies. This is nothing new. In 2003, prior to Kirchner's
election, then economic advisor De Vido told us that
"economics will be subordinate to politics in a Kirchner
Administration."


11. (C) Kirchner promised in his campaign that he would be
his own Minister of Economy, and he has now made good on that
pledge. As noted in reftel B, Kirchner's authoritarian style
and focus on accumulation of power, as well as a fractured
and inept opposition, have made him one of the most powerful
elected presidents in recent Argentine history. Kirchner's
economic policies also are the result of his closed
management style, where he consults with only a very small
inner circle that has little private sector experience. That
inner circle is made up of lawyers and long-time cronies
whose main focus is domestic politics. These advisors are
loathe to tell Kirchner he is wrong. While Kirchner may
consult with reputable experts from time to time (e.g.,
Finance Secretary MacLaughlin, Central Bank director Luis
Corsigilia),these are not true Kirchner insiders and their
influence is limited.


12. (C) As seen through the prism of short-term domestic
politics, the GOA's energy policy is a win-win: Kirchner gets
to beat up on foreign companies, blame them again for the
1990s, keep utility rates frozen to the benefit of the middle
class and, if the foreign companies decide to pull out, he is
"forced" to re-nationalize the concessions, to 70 percent
approval ratings. Similarly, the GOA beef ban makes
political sense because the beneficiaries are the urban
majority, a major constituency for Kirchner. Targeting
companies for excess profits is also easy, because the GOA
knows that anyone doing business in Argentina now is
demanding very high rates of return (20-45 percent per year)
as a risk premium. Kirchner is offering them a trade-off:
agree to lower prices in exchange for legally fixing prices
with their competitors at a profitable level.

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COMMENT
--------------


13. (C) By attacking private sector price gouging, regulating
their profit levels and, in many cases, using subsidies to
keep prices low, Kirchner is for the first time beginning to
tinker with the delicate internal mechanics of the market-led
economic model. His increasingly state-led energy policy has
not yet produced the supply needed to keep the economy
growing. The policies are not being driven by ideology but
by the very short-term political focus of the administration.
Fortunately for him a market-based exchange rate regime

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continues to make Argentina's economy highly competitive and
favorable international price for key exports continue to
propel economic activity to impressive new heights. Indeed,
exports are at record levels, GDP is set to rise nearly 9
percent in 2006 for the fourth consecutive year, and
unemployment has dropped from one quarter of the work force
in 2002 to 9.7% currently. Kirchner's strong record as
someone who delivers results will greatly benefit him
politically in 2007. Ultimately, however, the economic costs
of these short-term policies will emerge and be paid by
someone, somewhere. How Kirchner allocates those costs
likely will be a major theme in his second term. The private
sector, which so far has said very little in opposition to
Kirchner's policies, is likely to receive much of the bill.
LLORENS