Argentina Economic and Financial Weekly for

UNCLAS BUENOS AIRES 000164

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
USCINCSO 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 January 20, 2006

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Weekly Highlights
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- The peso appreciated 0.3 percent against the USD,
closing at 3.05 ARP/USD.
- Kirchner, Lula and Chavez commit to completing a
South American pipeline project.
- GOA still trying to reach new price-restraint
agreements.
- BCRA will re-launch its market expectations
consensus survey in February.
- December industrial production index up 7.9 percent
y-o-y.
- November monthly economic activity index up 9.1
percent y-o-y, stronger than expected.
- Commentary of the Week: "The Political Dilemma of
the Anti-Inflation Policy"

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MARKETS
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The peso appreciated 0.3 percent against the USD
during the week to close at 3.05 ARP/USD.
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1. The peso appreciated 0.3 percent versus the USD
during the week to close at 3.05 ARP/USD, one cent
below last Friday's close. This week's appreciation
is mainly attributed to higher dollar sales by
exporters, accompanied by the Central Bank's constant
intervention in the FX market to prevent the peso from
appreciating too much. During the week, the BCRA
purchased USD 102 million and EUR 17.5 million,
helping the BCRA rebuild its reserves following the
GOA's prepayment of its IMF debt. The peso exchange
rate is unchanged from the beginning of year.

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ECONOMY / FINANCE
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Kirchner, Lula and Chavez commit to develop a South
American pipeline project.
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2. Argentine President Kirchner, Venezuelan President
Chavez and Brazilian President Lula da Silva met in
Brazil on January 19 and confirmed plans to develop an
8,000-kilometer (5,000-mile) natural gas pipeline
linking Caracas and Buenos Aires, cutting through the
Brazilian Amazon rain forest and parts of Bolivia,
Paraguay and Uruguay. The three presidents committed
their "political will" to complete the project and
will meet again on March 10 in Mendoza (Argentina) to
continue discussions. The project is expected to be
launched publicly in July. Chavez said that each of
the three countries would contribute to financing the
pipeline with an estimated price tag of USD 12-20
billion, and also mentioned that some Asian companies
are interested in participating in the project.

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Lula da Silva wants improved commercial relations with
Argentina.
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3. President Kirchner met Brazilian President Lula Da
Silva in Brasilia on January 18. Lula Da Silva
expressed his interest in contributing to Argentina's
industrial development and to decreasing existing
asymmetries. He also mentioned that Brazil would
consider new proposals to improve the commercial
relationship between the two countries, an apparent
reference to a GOA proposal that would allow Argentina
to take safeguard actions against surging Brazilian
imports.


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Felisa Miceli - there is enough credit in Argentina to
finance companies' investment projects.
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4. During her trip to Brazil, Minister of Economy
Felisa Miceli said that Argentina is offering loans to
companies on better financial terms than Brazil does.
She added that Argentina's financial system is strong
enough to finance every company's investment project.

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GOA is still trying to reach price-restraint
agreements.
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5. GOA officials met again this week with leading
companies in an attempt to reach new price-restraint
agreements. On January 16, the GOA closed an
agreement with chicken producers to maintain chicken
prices unchanged until the end of the year. The GOA
also reached new agreements with cement companies and
dairy producers (until the end-of the year but with bi-
monthly monitoring to adjust prices in case economic
conditions change substantially). The GOA will
continue to press for price-restraint agreements with
firms from different sectors. Its goal is to create a
basket of basic goods with voluntarily-controlled
prices in coming weeks. In an interview on January
19, President Kirchner defended the strategy of using
price-restraint agreements as a middle point between
price freezes and increasing interest rates, which
could jeopardize economic growth. In spite of GOA's
attempts to keep inflation under control with price
restraints, food prices are expected to increase from
0.3 percent to 1 percent m-o-m in January, according
to private consulting firms. The BCRA consensus
survey (from January 4 - the latest release available)
is forecasting a 1.3 percent m-o-m increase in
January.

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BCRA will re-introduce a revised, monthly market
expectation consensus survey in February.
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6. On January 18, the BCRA announced that it will use
a new methodology in its market expectation consensus
survey. The new version will use new variables such as
the 7-day repo rate, the Badlar rate and M2 (currency
in circulation plus checking and saving accounts)
instead of the monetary base. Leading companies with
in-house research will now participate in the survey,
joining the 50 contributing banks, brokers, consulting
firms and universities that already participate. The
first of consensus survey using these new criteria
will be published on February 3 and updated on a
monthly, rather than weekly, basis.

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BCRA maintains Lebacs' interest rates; Demand
concentrated at the short end of the curve.
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7. The BCRA received bids of ARP 1.2 billion in its
January 17 Lebac auction, above the ARP 1.1 billion
announced amount but below the ARP 1.3 billion in
Lebacs that came due during the week. Investors
concentrated 80 percent of their bids for ARP Lebacs
in the short-end of the curve (less than 3 months).
Like the last three auctions, the BCRA was unable to
roll over its maturities, accepting bids for ARP 1.0
billion. The yield on the 49 -day Lebac remained
unchanged at 6.76 percent, while the yield on the 77-
day Lebac dropped 6 basis points to 6.90 percent.
Lebacs for maturities of more than 3 months were
withdrawn again due to lack of interest.

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Banks reduce their exposure to the public sector by 9
percentage points in the first eleven months of 2005.
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8. The BCRA reported that the banking system reduced
its exposure to public sector debt by 9 percentage
points in the first eleven months of 2005, reducing it
to 30.9 percent of total assets. According to the
report, the decrease in exposure is the result of net
sales of GOA debt in bank's portfolios, the re-
valuation by some banks of GOA instruments at market
value, and bank's finally receiving long-pending
compensation in cash. The BCRA report also said that
the financial system posted profits of ARP 170 million
in November, bringing its accumulated profits to ARP
1.7 billion during the first eleven months of 2005.

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November monthly economic activity index up 9.1
percent yoy - stronger than expected.
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9. The monthly economic activity index increased a
strong 9.1 percent y-o-y in November, well above the
BCRA market survey forecast of 8.3 percent, and
bringing the cumulative growth for the first eleven
months of 2005 to 9.2 percent. The index increased
0.9 percent m-o-m, following a 0.8 percent m-o-m rise
in October. The BCRA consensus survey estimates 2005
growth in the index at 8.7 percent. The index is
viewed as a reliable leading indicator of GDP.
Minister of Economy Miceli stated at the end of
December that GDP growth would exceed 8.5 percent in

2005.

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December industrial production index up 7.9 percent y-
o-y.
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10. The industrial production index increased 7.9
percent y-o-y in December, bringing total annual
growth to 7.7 percent for 2005, a strong level of
growth following the 10.7 percent growth in 2004.
During December, the fastest-growing sectors were
textiles (up 21 percent),minerals (up 18 percent),
and plastic and rubber (up 14 percent). The index
decreased 3.8 percent m-o-m.


11. The industry-wide capacity utilization index
reached 69.0 percent in December, compared to 68.5
percent in December 2004. The sectors showing the
highest capacity utilization were metal based
industries (93.7 percent),oil refining (93.4
percent),and paper and carton (77.8 percent). The
sectors with the lowest capacity utilization were auto
production (34.4 percent),metal-mechanical excluding
cars (56.4 percent),and non-metallic minerals (59.2
percent). For 2005, the average industry- wide
capacity utilization index was 71.1 percent.

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January Consumer Confidence Index up 11.9 percent m-o-
m.
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12. The Consumer Confidence Index- published by
Universidad T. Di Tella - jumped 11.9 percent m-o-m in
January to 57.1 points, after dropping 4.4 percent in
December. The significant increase in January is
attributed mainly to highly positive expectations
about consumer's willingness to purchase durable goods
and real estate (16.11 percent increase m-o-m) and
consumers' sentiment towards the macroeconomic
environment (13.71 percent m-o-m),followed by
positive expectations on individual's personal
situation (7.29 percent). The index is now only 5

percent below its all-time high, reached in February
2004 and 2 percent below the 2005 high point, reached
last February. The index increased 0.45 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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Commentary of the Week: "The Political Dilemma of the
Anti-Inflation Policy" by SEL Consultores, December
2005 -January 2006 (Translated and abridged with
permission)
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13. The design and effectiveness of an anti-inflation
policy depends, more than anything else, on the
correct diagnosis of the causes of inflation. If, as
the Ministry of Economy initially argued, the current
inflation is just a re-accommodation of relative
prices (which could be read as saying "the crisis has
ended") there isn't much to do except try to moderate
the speed of the process; prices will re-stabilize
once they reach a new equilibrium.


14. The difficulty with this interpretation ... is
that the growth in CPI continues to be mainly in those
prices that have grown the most since devaluation.
The components of the index that increased the most in
2005 were Housing and Basic Services (16.4 percent
increase),and Education (16.0 percent); but they were
only one-fifth of the increase in the cost of the
basket of goods. If these components had stayed
stable all year, 2005 inflation (through November)
still would have been 8.6 percent, i.e., 2.5 percent
above 2004 ... Meanwhile, the CPI component with the
largest potential for re-accommodation increases --
Regulated Goods and Services, which makes up 20.1
percent of the CPI -- grew only 2.9 percent in 2005,
versus core inflation of 12.5 percent, while in 2004
it grew 5.1 percent versus core inflation of 6.4
percent. In other words, the re-accommodation of
relative prices is still to come.


15. A second diagnosis of the current inflation is
that it results from a scarcity of supply. But that
is difficult to believe in an economy that has grown 9
percent per year for three consecutive years, two of
them with low inflation ... A third diagnosis is that
it results from oligopolistic practices ... but it is
difficult to believe that these could explain economy-
wide price increases, including in the most
competitive sectors. In any case, the main problem
with this diagnosis is that it posits a micro-economic
cause of inflation that can be addressed by
administrative means ... but inflation is a macro-
economic phenomenon that requires macro-economic
tools.


16. This means that we have to look at the rate of
aggregate demand growth and the policies that produce
it. Aggregate demand is, in effect, increasing at a
12 percent annual rate, i.e., three points above the
elevated growth of total supply. This is the result
of a monetary policy aimed at protecting the exchange
rate; the expansion of public spending; and increases
in formal sector salaries. M2 grew 20 percent in 2005
... Primary public spending grew 24.7 percent thru
the third quarter ... average salaries grew 18.8
percent and formal-sector private salaries grew 23.7
percent (at an annual rate through October).


17. It seems likely, therefore, that domestic demand
stimulated by these policies is creating price
pressures. This is happening at the same time as
external demand is growing significantly (13 percent
export growth in the third quarter) which, especially
in food, competes with domestic demand and pushes
consumer prices higher.


18. The classical answer to demand-driven inflation
is to decelerate it through a combination of
restrictive monetary and fiscal policies and a
moderation of salary increases. But this creates a
political problem that is difficult to resolve. A
restrictive monetary policy would require a reduction
in intervention in exchange markets and an
appreciation of the peso. While this would increase
buying power ... it would result in a loss of
competitiveness in tradable goods, especially in
import substitution sectors such as manufacturing.
The political downside of this outweighs the economic
benefit.


19. Similarly, a policy of salary moderation in the
private sector would be rejected by labor unions. ...
While real salaries of formal, private sector salaries
have recovered -- and even exceeded -- their losses
following devaluation ... taking into account all the
segments of the labor market, the real average salary
is almost 9 percent below what it was in 2001 and the
share of real salaries in GDP increased only 12
percent compared to a real GDP growth of 25 percent
during the same period.... in this situation, it is
unlikely that labor unions will accept a policy of
salary restrictions ...


20. The political dilemma, then, is that if the
government uses restrictive macro-economic policies to
control inflation, it will lose the support of the
social coalition that, until now, has been its most
solid base of support, as well as it will reduce the
government's own resources... if the government wants
to continue to receive their support, it will have to
resign itself to maintaining inflation in a tolerable
range ... The question then is, how much inflation is
society willing to accept? [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