Argentina Economic and Financial Weekly for the week ending

UNCLAS BUENOS AIRES 001880 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 August 18, 2006 -------------- -------------- Weekly Highlights -------------- -------------- - June monthly economic activity (GDP) index up 8.2 percent y-o-y -- weaker than expected. - Moody's warns on GOA pro-cyclic macro policies. - GOA threatens to take Chile dairy product conflict to WTO. - Economy Minister Felisa Miceli projects 2006 exports will reach USD 45 billion. - GOA analyzes how to include pension adjustments in 2007 budget. - GOA eases mortgage loans access to keep rising rent prices down. - Commentary of the Week: "The challenge of placing limits on public banking" -------------- -------------- June monthly economic activity index up 8.2 percent y-o-y -- weaker than expected. -------------- -------------- ¶1. The GOA's monthly economic activity index, viewed as a reliable leading indicator of GDP, came out was up 8.2 percent y-o-y in June -- below the BCRA market survey forecast of 8.5 percent. Nonetheless, this continues the recovery since April, which showed the weakest growth rate (+6.3 percent) in the past eight months, and was in line with the May indicator (+8.1 percent). Weaker performance in March/April was attributed in part to seasonality (i.e. Easter effect). Key contributors to first half growth included new investments in car manufacturing and construction. The latest BCRA consensus survey forecasts a 7.8 percent growth in economic activity for 2006, a slight upward revision from its previous forecast of 7.7 percent. -------------- -------------- Moody's senior sovereign debt analyst Mauro Leos warns on Argentina's future. -------------- -------------- ¶2. On August 16, Moody's senior sovereign rating analyst Mauro Leos presented his concerns about Argentina's future economic performance in a Buenos Aires seminar. According to Leos, Argentina is passing through an extended positive "hypercycle" due to favorable world commodity prices and a post-crisis rebound effect. He warned of the risk of Argentina following Venezuela's state-centric model and reminded that this is the time to save, not to increase pro-cyclical expenditures. The analyst did not indicate whether Moody's is considering any change Argentina's sovereign debt rating (currently B3). -------------- -------------- GOA threatens to take Chile dairy product conflict to WTO. -------------- -------------- ¶3. The GOA rejected arguments presented by the GOC to apply an import duty on Argentina's dairy products, and warned that it might take the issue to the World Trade Organization (WTO). According to GOA officials, the GOC can't justify import duties of up to 31 percent on Argentina's dairy products on grounds that Chilean producers are being harmed by these imports. -------------- -------------- Economy Minister Felisa Miceli projects 2006 exports will reach USD 45 billion. -------------- -------------- ¶4. Economic Minister Felisa Miceli said Argentine exports will probably reach USD 45 billion in 2006, increasing Argentina's trade surplus. Total exports reached USD 21.5 billion during the first half of 2006 and were USD 40 billion in 2005, with a 2005 trade surplus of USD 11.2 billion. Miceli stated that this administration "has a clear vocation to integrate with the world economy, but in a balanced manner and without renouncing our industrial development objectives" and that keeping the real exchange rate from appreciating is a key strategy to attract long-term investment to the export sector. -------------- -------------- Multilateral real exchange rate depreciates 0.8 percent m-o-m in July. -------------- -------------- ¶5. The BCRA's multilateral real exchange rate index -- which measures the real exchange rate between the peso and a trade-weighted basket of currencies -- depreciated 0.8 percent m-o-m in July. The real depreciation is largely explained by the depreciation of the peso against the Brazilian real, partially offset by an appreciation against the dollar and the Euro. The index is 5.3 percent above its level twelve months ago and 105.6 percent above its average value during convertibility. [The BCRA's multilateral real exchange rate index weighs domestic prices and the exchange rates of Argentina's main trading partners according to their share of Argentina's exports and imports.] -------------- -------------- GOA analyzes how best to include pension adjustments in the 2007 Budget. -------------- -------------- ¶6. On August 8, the Argentine Supreme Court ruled against selective pension increases set by the GOA, claiming that this action is unconstitutional, particularly for the case of pensions above ARP 1,000 per month. Since then, the GOA has been analyzing how best to include pension adjustments in the 2007 budget, given that private consultants estimate its fiscal cost at approximately ARP 5.2 billion annually, approximately 0.8 percent of GDP. On August 16 Argentine President Nestor Kirchner said he is not going to play "Santa Claus" only to disappoint later, adding that he will be serious and responsible in following the Supreme Court's ruling. The GOA is considering an option of gradually adjusting pensions to keep pace with social security contributions. -------------- -------------- The GOA eases mortgage loans access to control rising rents. -------------- -------------- ¶7. After meeting with players in the real estate sector to discuss rising rent prices, Secretary of Internal Trade Guillermo Moreno proposed "reactivating" the mortgage loan market through via an "incentives" plan. The measure has two objectives, easing mortgage loans' accessibility and providing economic incentives to construction companies. The GOA will allow informal employees access to mortgage loans if they can show an income history; and construction companies will enjoy reimbursement of anticipated VAT (valued added tax) payments. According to the National Bureau of Statistics (INDEC),rents have increased 7.2 percent in 2006, while the CPI increased 4.9 percent. -------------- -------------- Banks' 6-month 2006 profits already exceed full year 2005 profits. -------------- -------------- ¶8. The BCRA published its banks report showing that banks' profits for the first half of 2006 already exceed those of 2005 in its entirety. During the first half of 2006, banks' earnings reached ARP 1.80 billion, vs. ARP 1.79 billion in 2005. According to the report, this confirms continued financial system recovery after the 2002 crisis. 2005 was the first year since then with positive annual earnings for banks. Private bank profits in the first half of 2006 were ARP 1.1 billion, also exceeding their 2005 results. The BCRA report also indicates a reduction in private banks' exposure to the public sector and an improvement in portfolio quality. -------------- -------------- Buenos Aires province to issue a new bond. -------------- -------------- ¶9. According to local media, Buenos Aires province is preparing a bond issuance of ARP 1 billion to meet its financial budget for this year. This will be the first bond offering by an Argentine province since the 2002 financial crisis and could take place between September and October. The province must first seek authorization from the provincial legislature to increase the budget for 2006 and to raise its authorized debt level. The province's public accounts deterioration (its 2006 fiscal deficit is estimated at ARP 0.5 billion),resulting partly from salary hikes and the lack of additional funds from the GOA, led to this decision. -------------- -------------- GOA transfers to provinces 27 percent over-budget in first half ¶2006. -------------- -------------- ¶10. During the first half of 2006, the GOA transferred 27 percent more than budgeted to provinces; the National Treasury committed to transfer ARP 37.1 billion in 2006, but in just the first half, GOA transfers reached ARP 23.6 billion (27 percent over the amount planned for the first half). These additional transfers will permit provinces to fulfill Fiscal Responsibility Law obligations which limit debt service payments to a maximum of 15 percent of current revenues. The Federal Council of Fiscal Responsibility has already warned six provinces (Chaco, Formosa, Jujuy, Rio Negro, San Juan and Tucuman) to reduce their debt exposure. -------------- -------------- Argentina and Bolivia agree on the construction of a gas pipeline. -------------- -------------- ¶11. On August 14, Argentina's Planning Minister Julio de Vido and Bolivia's Vice President Alvaro Garcia agreed to build a USD 1.2 billion gas pipeline linking southern Bolivia to northern Argentina and a USD 250 million gas separation plant near the border. Bolivia committed to boost gas exports to Argentina from 7.7 million cubic meters to 27.7 million cubic meters per day. According to de Vido, the construction bidding process will be completed before the end of the year, and according to local media, construction will take two years. Negotiations on gas prices for 2007 are expected to be completed by October. Argentina's current import gas price agreement of USD 5 per million cubic meters from Bolivia expires by the end of 2006. -------------- -------------- Union leader Hugo Moyano asks for family allocation increase. -------------- -------------- ¶12. On August 16, union leader Hugo Moyano said that Argentina's President Nestor Kirchner committed, in a private meeting, to increase family allocations between October and November. Moyano had already demanded this increase during the Minimum, Vital and Mobil Wage Council meetings that granted a 27 percent increase in the minimum wage; on that occasion, Moyano asked an increase in family allocations from ARP 60 to ARP 75 per child, but according to local media is now asking for a 50 percent increase. -------------- -------------- Argentina, Brazil and Paraguay set up an anticrime border center. -------------- -------------- ¶13. The Governments of Argentina, Brazil and Paraguay set up a joint intelligence center to combat smuggling and money laundering in the region where their borders meet, also known as the Tri-Border area. The center will be located at Foz do Iguacu in Brazil, using facilities of the Brazilian Federal Police. The United States has complained that this area has long served as a venue for illicit activity including drugs, arms smuggling and money laundering, and that part of the large Arab community in the area raised funds for terrorist organization Hizbollah in Lebanon. -------------- -------------- BCRA to reduce bank costs in September. -------------- -------------- ¶14. The BCRA is studying a plan to reduce overall bank expenses, to lessen the impact of recently announced tightening of reserve requirements: Banks' cash holdings will no longer count toward reserve requirements from September, and reserve requirements will rise from 17 percent to 19 percent on demand deposits starting in August. According to BCRA officials, the plan to reduce expenses will focus on banks with branches throughout the country, especially those away from urban centers. Some banks are starting to announce increases between 10 percent-15 percent for commissions charged to their clients. -------------- -------------- JPMorgan upgrades Argentina's sovereign external debt rating. -------------- -------------- ¶15. JPMorgan upgraded Argentina's sovereign external debt to Overweight in its Emerging Market Bond Index Global [an independently maintained and published index composed of debt securities in 27 countries, which includes Brady bonds, sovereign debt, local debt and Eurodollar debt, all of which are dollar-denominated]. The investment firm said it upgraded Argentina in the belief that the Federal Reserve will leave rates unchanged for an "extended window of time", therefore supporting higher risk credits. JPMorgan also forecasted solid fundamentals for Argentina, including strong economic growth, "a slight moderation of inflation, a stable fiscal surplus, and a rising trade surplus". [Overweight means that over the next three months the recommended position is expected to outperform the relevant index.] -------------- -------------- BCRA rolls over its maturities. -------------- -------------- ¶16. The BCRA received ARP 2 billion in bids at its August 15 Lebac and Nobac auction, and no Lebacs or Nobacs came due during the week. It accepted ARP 468 million in Lebac bids and ARP 446 million in Nobac bids. The yield on the 161-day Lebac decreased from 8.50 percent to 8.39 percent and the yield on the 245-day Lebac was 9.95 percent. The yield on the longest term instrument, the 357-day Lebac, dropped from 11.90 percent to 11.75 percent. Lebacs for maturities of more than 357 days were withdrawn due to lack of demand. The spread on the one-year Nobac decreased from 1.57 percent to 1.30 percent and the two-year Nobac from 3.43 percent to 2.98 percent. The Badlar rate (the base rate for Nobacs) is currently at 9.4 percent. Rates fell for the third consecutive week thanks to strong market demand (the BCRA rejected 55 percent of the received bids). -------------- -------------- The peso depreciated against the USD on Friday, closing at 3.10 ARP/USD. -------------- -------------- ¶17. The peso depreciated slightly versus the USD after remaining flat most of the week, closing at 3.10 ARP/USD. The BCRA is still not reporting daily transactions in the dollar market. The peso exchange rate has depreciated 1.6 percent since the beginning of the calendar year. The BCRA's reserves stood at USD 27 billion as of August 16, and have increased USD 8.4 billion, or 45 percent, since the GOA prepaid its entire IMF debt on January 2. -------------- -------------- Commentary of the Week: "The Challenge of Placing Limits on Public Banking", by Nadin Argaaraz and Sofa Devalle, economists at IERAL of the Mediterranean Foundation, from an article published in La Nacisn on July 23. -------------- -------------- ¶18. After achieving a relatively larger flow of loans to the private sector, the Central Bank of Argentina reduced the maximum permitted limit of assistance to public sector banks in its three levels, passing from the current 40 percent of valid stocks to 35 percent as of July 1, 2007 (Communication "A" 4546 of the Central Bank). ¶19. There is no doubt that any action taken to broaden credit to the private sector and reduce the substitution effect that occurs when loans destined for the public sector reduce loanable funds is a measure that strengthens the financial system as a significant means to consolidate private productive investment. ¶20. However, in order to analyze its implications on the ability of the public sector to obtain bank financing, it is necessary to examine the current composition of financial entities' assets, and which would be the entities most affected. ¶21. An important point to clarify is that assistance to the public sector through the form of Central Bank bills and notes would not be included in analysis of the imposed restriction, given that it excludes Central Bank operations. ¶22. Analyzing the composition of the stock of all banks as of April 2006, one observes that 25 percent was allocated to the public sector (excluding operations with the Central Bank),as much for loans as for public stocks. That is, for all banking entities in the country, on average they don't exceed the Central Bank's limit on financial assistance to the public sector. ¶23. However, this conclusion is based on the average of all banks in the country, without considering what differences there may be between them. Disaggregating by distinct types of financial entities, one realizes that the percentage of assets set aside to finance the public sector is higher for public banks than for private banks (32 percent and 19 percent, respectively). Also, public banks' assistance to the public sector is even higher among the group of provincial and municipal public banks, reaching 40 percent of total assets. ¶24. Although the average for banks does not reach the Central Bank's maximum, the situation of provincial public banks is more difficult. -------------- A possible increase -------------- ¶25. This does not mean that provincial public banks must reduce loans to the public sector in absolute terms. The possibility of increasing assistance to the public sector will depend on the magnitude that assets increase. Given the current ratio of 40 percent, if assets increase 20 percent in the next year, assistance to the public sector could rise, but in a ratio of $1 to the public sector for every $9 to the private sector in order to reduce the ratio to 35 percent. On the other hand, if assets increase by less than 15 percent, it would be necessary to reduce credit to the public sector in order to comply with the restriction. ¶26. Considering an economy that maintains its rate of activity, it is reasonable to expect that increasing credit will increase banks' assets as a result. Under this scenario, what behavior must each group of banks assume? Looking at the banking sector as a whole, one observes that for now there is a lack of strong restrictions on credit to the public sector, while in the case of provincial public banks, the situation is more delicate. ¶27. In moments like the present, in which the discussion of closing the accounts of the provinces in 2006 is red-hot, the challenge is raised of how to go about managing the provincial public banks in a scenario in which the public finances of some provinces are compromised. Without going into detail on the individual situation of each bank or province, the governors face an important test in which they must demonstrate that there is a genuine change of behavior toward a greater fiscal discipline in Argentina. In particular, they must show that they are not going to turn to the privileged financing of their banks. (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.) MATERA 2