Argentina Economic and Financial Weekly for the week ending

UNCLAS BUENOS AIRES 001993

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
September 1, 2006

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Weekly Highlights
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- GOA attempts to ease mortgage loan access.
- GOA uses "Superpowers" to reallocate fiscal surplus funds.
- Central Bank President Redrado calls high reserves best defense
against intl. volatility.
- July construction activity index up 27.9 percent y-o-y... record
high.
- GOA seeks to control prepaid medical plan rates.
- US Court of Appeals' ruling favorable to Argentina expected on the
reserve freeze suit.
- Commentary of the Week: "The Real Solution for Mortgages is the
Capital Market"

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GOA attempts to ease mortgage loan access.
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1. On August 17 the BCRA announced it will work to encourage banks
to boost mortgage lending and ease applicant paperwork in an effort
to address rising rents. This initiative follows Secretary of
Internal Trade Guillermo Moreno's proposal to "reactivate" the
mortgage loan market through an "incentives" plan. According to the
National Bureau of Statistics (INDEC),rents jumped 7.2 percent year
to date 2006, while the CPI increased 4.9 percent. Initially, only
government-owned banks Banco de la Nacion Argentina, Banco Ciudad de
Buenos Aires and five provincial banks (Buenos Aires, Santa Fe,
Entre Rios, Santa Cruz and San Juan) announced they would expand
their supply of mortgage credit. On August 30, the GOA announced
that an additional 6 private banks (Macro Bansud, BBVA Frances, Rio,
Galicia, Hipotecario and Credicoop) are also committed to this
project. Media reports note that all these private banks were short
on details, privately skeptical of the government's ability to grow
the mortgage market absent direct subsidies (see Commentary
article),and very concerned about their continuing inability to
foreclose on 2002 crisis mortgage defaults: An emergency ban on
foreclosures has been repeatedly extended by the Congress. The GOA
also announced plans to encourage residential construction through
strategies such as reimbursements on anticipated VAT (value added
tax) reimbursements.

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GOA uses "Superpowers" to reallocate fiscal surplus funds.
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2. The GOA used recently approved so-called "superpowers" to
reallocate ARP 750 million from its 2006 fiscal surplus to public
works projects including road and sewer infrastructure and housing
construction. Parliament recently granted the Chief of Cabinet
power to reallocate budget funds irregardless of the provisions of
the Financial Administration Act or the Fiscal Responsibility Law.
Some estimates show that the reallocation will reduce the projected
2006 fiscal surplus by 4.8 percent.

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Central Bank President Redrado calls high reserves best defense
against international volatility.
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3. On August 29, during an international economic symposium held by
Tel Aviv University, BCRA president Martin Redrado said new economic
configuration is here to stay, with highly volatile global
imbalances, commodities prices, the rapid evolution of international
commerce flows and increased geo-political uncertainly. According
to Redrado, this new configuration augurs for increased volatility
and high reserve stocks are the best strategy to smooth the impact
of inevitable external shocks. Redrado also stated that the BCRA
can comfortably continue its sterilization strategy, with discount
borrowing incomes and from other sources remain above Lebacs and
Nobacs interests payments.

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July construction activity index up 27.9 percent y-o-y (seasonally
adjusted) - a record high.
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4. The National Bureau of Statistics (INDEC) released its July

construction activity index, showing an increase of 27.9 percent
y-o-y seasonally adjusted, the largest annual increase since March

2004. Construction activity, an important component of gross fixed
investment, grew 3 percent m-o-m seasonally adjusted and 1.6 percent
unadjusted. The fastest growing sectors were residential
construction and private building for other purposes, up 26 percent
and 27 percent y-o-y, respectively. During the first seven months
of the year, construction activity rose 21.7 percent against the
same period in 2005, taking the index to record highs.

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GOA seeks to talk down prepaid medical plan rates.
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5. On August 24, Secretary of Internal Trade Guillermo Moreno said
that prepaid medical plan companies will not raise their rates as
they had previously announced. Moreno added that companies which
had already increased prices would have to reimburse their clients.
A number of medical plan companies announced their intent to go
ahead with planned increases. GOA Health Services Superintendent
Hector Capaccioli urged Argentines (of whom some 2.5 millions engage
private prepaid medical services) not to pay increasing rates in
coming months and to file complaints with the Internal Trade
Secretariat.

SIPDIS


6. According to local newspaper El Cronista, Chilean prepaid
medicine provider Clio reported attempted extortion by the GOA
Internal Trade Secretariat and suspended its five-year USD 20
million investment plan. According to this source, Clio General
Manager Horace Galaz said the company would invest only what is
necessary to maintain current services.

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US Court of Appeals' ruling favorable to Argentina expected on
reserve freeze suit.
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7. On August 29, a US Court of Appeals held a hearing on USD 105
million in BCRA deposits frozen in the Federal Reserve of New York
since late 2005. Plaintiffs EM Ltd and NML Capital seek to attach
the BCRA deposits, arguing that December 2005 GOA decrees
authorizing the BCRA to use its reserves to repay IMF credits made
these reserves ineligible for sovereign immunity. Argentine media
anticipates a favorable U.S. court ruling for the GOA in light of
amicus briefs in favor of Argentina's position filed by the USG.

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Manager of second-largest fund group in Argentina keeping money out
of the local stock market.
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8. Banco Santander Central Hispano's executive Ricardo Daud,
manager of the second-largest fund group in Argentina, said he has
limited Argentine equity holdings to only 3.5 percent of his Latin
America fund, with fully 57 percent invested in Brazilian and 29
percent in Mexican assets. According to Daud, GOA policies are
squeezing corporate profits, adding that "even with the Argentine
economy growing at high rates, from the point of view of quality it
is not going as well as in other regions." Daud oversees ARP 2
billion in various funds at the Buenos Aires unit of this
Madrid-based bank

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Former Minister Lavagna warns on impact of a power crisis on
companies' costs of production.
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9. Former Kirchner's Economic Minister Roberto Lavagna warned about
the impact of a future power crisis on companies' costs of
production. According to Lavagna, a power crisis in Argentina is
not a potential risk, but a current and very serious problem. With
private companies already building their own back-up power plants in
anticipation of future grid shortages, Lavagna projected production
costs will rise, putting pressure on prices.

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Tax revenue expected to increase 22 percent y-o-y to ARP 12.5
billion in August.
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10. According to Reuters, a source at the Ministry of Economy said
August federal tax revenues jumped 22 percent to ARP 12.5 billion.
This estimate is in line with BCRA consensus survey projections.
The BCRA forecasts tax revenues of ARP 144.2 billion for 2006.

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Beef producers try to reopen the beef export market.
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11. On August 30, the GOA extended the mechanism to ease the beef
export ban for an additional 30-day period. Manufacturers and
producers are working to persuade Economic Minister Felisa Miceli
that the sector will supply the local market at the agreed prices
even if the beef export ban is fully terminated. According to the
National Food and Animal Health Inspection Service (SENASA),
Argentine beef exports totaled USD 480 million during first half of
2006, down from USD 627 million in the same period in 2005 (-23
percent y-o-y). By volume, beef sales decreased 37 percent y-o-y.
[On March 8, 2006, the GOA imposed a ban beef exports for 180 days
and raised export taxes on boned cuts and heat-processed beef from 5
percent to 15 percent in an attempt to keep local prices under
control. On May 29, the GOA eased the ban via an export quota
system.]

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GOA analyzes pension system reform for 2007 budget.
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12. According to local media, the GOA is working on a pension
system reform to capitalize the pay-as-you-go public retirement
system, easing the impact of pension adjustments to be included in
the 2007 budget. One option is to allow those starting their first
jobs to join and contribute to the public retirement program, if
they have not yet contributed to private pension funds (AFJPs).
Such up-front new hire payments into to the public system could ease
the fiscal burden of anticipated pension payment increases in the
2007 budget. [Currently new hires who don't specifically ask to be
included in the public pension system are automatically incorporated
into the private AFJP system.]

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GOA announces oil exploration incentives for private companies.
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13. The GOA will offer private oil companies the chance to become
"partners" with GOA-owned energy company Enarsa, supplying financing
for hydrocarbon exploration. Budget-constrained Enarsa owns all
exploration permits and production concessions for offshore areas
that were not under license when it was created by law (November 2,
2004). According to a Ministry of Economy resolution dated July 31
of 2006, Enarsa has a staff of 24 employees and a limited
exploration budget of ARP 2.9 million.

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GOA reduces export tariffs on some dairy products.
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14. On August 24, the GOA announced it will reduce export tariffs
on powder milk from 15 percent to 10 percent, and on cheese products
from 10 percent to 5 percent. These taxes were raised July 2005 in
an effort to contain rising domestic dairy product prices. Analysts
attribute this easing to an expected 10 percent-30 percent increase
in milk production.

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GOA reduces import tariffs on Brazilian cars.
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15. On August 24, the Economy Ministry announced a significant
reduction in Brazilian car import tariffs from 70 percent to 35
percent, dropping back to a rate earlier imposed until 2005. This
measure comes as a result of a reduction in Argentina's trade
deficit with Brazil.

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Tourism up 33 percent y-o-y in Q2 of 2006.
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16. The National Bureau of Statistics (INDEC) announced that net
tourism revenues increased 33 percent y-o-y in the second quarter of
2006, with the number of incoming tourists up 20 percent y-o-y to
445,000 partially offset by the number of outgoing tourists up 12
percent y-o-y to 271,000. Preferred tourist destinations include
the city of Buenos Aires, Cordoba Province, and the Atlantic coast,
chosen by 55 percent, 6 percent and 4 percent of tourists,
respectively. Visiting tourists were mainly from the European Union
(22 percent),followed by Brazil (19 percent),the rest of Latin
America (16 percent),and the U.S. and Canada (15 percent).

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GOA promises Japan to deal with holdouts investors "in the future".
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17. On August 29, Argentine Foreign Minister Jorge Taiana and
Japanese Senate president Chikage Oogi met in an attempt to
reestablish "normal" bilateral relations following the GOA default
on sovereign debt obligations in December 2001. They discussed
Japanese holdout investors (those who chose not to participate in
the GOA debt exchange that closed February 2005),who retain
approximately USD 2.5 billion in defaulted GoA sovereign debt.
According to local media, the GOA promised Japan it would reopen the
debt exchange "in the future", but under conditions less favorable
than those granted to investors who accepted the debt exchange. A
similar promise was made to Italian public officials during their
visit last June (Italian holdouts retain approximately USD 5 billion
in defaulted GOA sovereign debt).

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Bolivian strike cuts gas delivery to Argentina for a day.
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18. On August 28, Bolivian protesters closed the valves of a gas
pipeline linking Bolivia and Argentina during a strike against
Argentina's new policy limiting the times Argentines can cross the
border to Bolivia to once per month and capping purchases they can
carry back at USD 50 per trip. According to the strike's leaders,
future gas delivery disruptions are not out of the questions while
they wait for Bolivia's President Evo Morales to offer a solution.
The shutdown prevented the delivery of some 4.9 million cubic meters
of gas.

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Sel Consultores publishes alarming social indicators about the urban
young.
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19. SEL Consultores published a study showing 14 percent of
Argentine youth aged 20-24 (740,000) in the most populated urban
areas are neither working, trying to find a job nor studying. Some
10 percent of the youth aged 20-24 are extremely poor and an
additional 22 percent are poor. For those trying to find a job, the
unemployment rate reaches 24 percent, and this rate grows to 33
percent for those aged 15-19. For those working aged 20-24, 58
percent have informal jobs, and 36 percent have informal jobs that
are highly unstable. These urban youth social indicators contrast
with the promising reduction in unemployment announced by INDEC
recently, down to 10.4 percent in the second quarter of 2006 from
12.1 percent in the second quarter of 2005.

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BCRA rolls over maturities and rejected 82 percent of all Nobac
bids.
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20. The BCRA received ARP 1.2 billion in bids at its August 29
Lebac and Nobac auction. No Lebacs or Nobacs came due during the
week. It accepted ARP 634 million in Lebac bids and ARP 72 million
in Nobac bids. The yield on the 182-day Lebac was 8.50 percent and
the yields on the 231-day Lebac and 343-day Lebac decreased from
9.90 percent to 9.85 percent and from 11.65 percent to 11.55
percent, respectively. The yield on the longest term instrument,
the 623-day Lebac, was 12.25 percent. The 518-day Lebac was
withdrawn because of the BCRA's decision not to validate the yield
proposed by the market. The spread on the one-year Nobac decreased
from 1.15 percent to 1.10 percent and the two-year Nobac increased
from 2.68 percent to 2.73 percent. The Badlar rate (the base rate
for Nobacs) is currently at 9.4 percent. Rates fell (except on the

two-year Nobac) for the fifth consecutive week due to strong market
demand and the BCRA's decision to accept more Lebacs rather than
Nobacs bids (rejecting 82 percent of all Nobac bids).

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Peso depreciates against the USD, closing at 3.11 ARP/USD.
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21. The peso depreciated slightly versus the USD August 28 and
remained at 3.11 ARP/USD for the rest of the week. The peso
exchange rate has depreciated 1.97 percent since the beginning of
the calendar year. BCRA's reserves stood at USD 27.2 billion as of
August 29, and have increased USD 8.7 billion, or 47 percent, since
the GOA prepaid its entire IMF debt on January 2.

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Commentary of the week: "The Real Solution for Mortgages is the
Capital Market", by Miguel Kiguel, from an article published in El
Cronista Comercial on August 30.
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22. These days, there is great interest in finding new solutions to
grow the mortgage market in order to facilitate access to financing
for prospective home owners. There are two key impediments
restricting access to mortgage credit.


23. The first is a colossal gap between property prices and
salaries. Most workers cannot cover a mortgage payment with 30
percent of their salary. On average, property prices have gone up
25 percent in dollars since the devaluation in 2002, while the
equivalent dollar value of salaries has dropped about 30 percent in
the same period.


24. The second problem is that, for the mortgage market to become
an important source of home financing, capital markets - and in
particular institutional investors including pension funds and
insurance companies must play a larger role. Banks, in general,
can only finance a limited volume of long-term fixed rate mortgages
given their liabilities are mostly short-term variable rate
deposits.


25. In most countries, banks originate mortgages taking advantage
of their distribution capacity, with the bulk sold down to the
secondary market. These portfolio sales are done at market interest
rates; therefore a ten-year mortgage would have a slightly higher
rate than a ten-year Treasury bond rate.


26. In Argentina it is difficult to determine what the rate would
be today, since there are no long-term fixed rate instruments. The
closest we can get is through the one-year LEBAC issued by the
Central Bank which has a 12 percent return. The rate for a ten-year
investment would surely be higher, at least 14 percent. This, then,
would be the base rate at which banks could sell mortgages in the
secondary market.


27. What are the alternatives? One is that the banks lend money at
lower rates but maintain their mortgage portfolios on their own
balance sheets. The main constraint of this option is that it sets
a ceiling for growth for the mortgage market. Another option is to
try to lower the interest rate. In some countries, like Spain, this
objective has been achieved by using adjustable interest rates, for
example linking it to the CD rate. Banks prefer this mechanism
because they are protected in case of a rise in interest rates.


28. With lower interest rates, there would be a larger number of
families who could qualify for mortgages, broadening the market.
The main obstacle for variable interest rates that Argentina faces
today is debtors' fears of a possible hike in rates, understandable
given a history of macroeconomic instability and a sustained
two-digit inflation rate.


29. What economic policy measures can be taken in order to remove
this credit holdup? The Central Bank has already made some changes
in regulations allowing banks to finance a larger share of
residential home credits by allowing banks more flexibility in
calculating minimum income requirements for mortgage applicants.



30. However, rather than in issuing more banking regulations, what

is most needed are measures to facilitate the development of capital
markets. Among these measures could be the creation of an interest
rate swap mechanism allowing debtors to take fixed-rate credits and
banks to lend to a variable rate. While this market will eventually
grow on its own, initially it will require Government support.


31. A second measure is the creation of a fund to subsidize monthly
mortgage payments during the first five years so debtors could
qualify for credit. This subsidy should be paid back in full by the
debtor during the out years of a mortgage. The pay-back would be
possible since income is expected to grow at the same rate of
inflation. This mechanism should not have a net fiscal cost.


32. Summarizing, the development of an Argentine mortgage market
depends on the ability to develop capital markets. The economic
policy measures outlined above offer solutions compatible with the
development. (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