Argentina Economic and Financial Weekly for

UNCLAS BUENOS AIRES 000213 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 27, 2006 -------------- -------------- Weekly Highlights -------------- -------------- - The peso depreciated 0.7 percent against the USD, closing at 3.07 ARP/USD. - The GOA issues USD 312 million of Boden 2012 bonds to Venezuela. - GOA increases its efforts to reach price-restraint agreements. - Bondholder attachment of USD 105 million of BCRA reserves awaits final ruling from U.S. Court of Appeals. - Three public hearings on electricity rates suspended. - HSBC purchases Banca Nazionale de Lavoro's subsidiary in Argentina. - Commentary of the Week: "We Don't Have to Play on the Edge of the Abyss" -------------- -------------- MARKETS -------------- -------------- -------------- -------------- The peso depreciated 0.7 percent against the USD during the week to close at 3.07 ARP/USD. -------------- -------------- ¶1. The peso depreciated 0.7 percent versus the USD this week, closing at 3.07 ARP/USD. This week's depreciation is mainly explained by higher dollar demand by banks as well as greater Central Bank (BCRA) intervention in the FX market, where it purchased USD 200 million and EUR 10 million in the first four days of the week. The BCRA's purchases of dollars averaged USD 49 million per day this week, almost double the USD 23 million daily average in the first three weeks of January. The peso exchange rate has depreciated 0.7 percent since the beginning of year. -------------- -------------- ECONOMY / FINANCE -------------- -------------- -------------- -------------- The GOA issues USD 312 million of Boden 2012 bonds to Venezuela. -------------- -------------- ¶2. On January 24, the GOA published a resolution in the Official Gazette, reopening the Boden 2012 for another USD 312 million in bonds, after receiving a bid from the Republic of Venezuela. In 2005, the GOV purchased USD 1.6 billion of GOA bonds, which helped the GOA cover its financial needs. The Venezuelan 
Finance Minister has said that Venezuela is willing to purchase USD 2.5-3.0 billion of GOA bonds in 2006. This would help the BCRA rebuild its reserves after the GOA used USD 9.5 billion in reserves to pay off the IMF. -------------- -------------- GOA increases its efforts to reach price-restraint agreements. -------------- -------------- ¶3. The GOA signed a number of price-restraint agreements this week with several suppliers of goods and services. These agreements are expected to last one year, but also are contingent on the evolution of input prices and - in some cases - are subject to bi- monthly monitoring of any changes in the economic environment. Most of these agreements target food, housecleaning products, toiletries and the tourist sector (the latter is important now, during the summer holidays here),and advance the GOA's efforts to create a basket of basic goods and services with controlled prices. Officials of the Ministry of Economy and President Kirchner himself plan to continue meeting with leading producers and retailers, including major supermarket chains, to close new agreements and broaden the range of products and services subject to the agreements. However, the GOA still faces stiff opposition in the beef industry to a new price-restraint agreement that would keep prices unchanged. On January 24, Chief of Cabinet Fernandez threatened to increase beef export taxes (they are currently at 15 percent) if beef prices continue to increase. Reaching an agreement with the beef sector is key to the GOA's anti-inflation effort because beef prices constitute 4.5 percent of the basket of goods used to measure consumer prices. -------------- -------------- Bondholder attachment of USD 105 million in BCRA reserves awaits ruling from U.S. Court of Appeals. -------------- -------------- ¶4. On December 30, the investment funds EM Ltd. and NML Capital Ltd. obtained an order temporarily attaching USD 105 million in BCRA reserves held at the Federal Reserve Bank of New York (FRBNY). On January 12, Judge Thomas Griesa of the Federal Court for Southern District of New York ruled in favor of the BCRA and overturned the attachment order. According to the GOA's attorney, the court accepted the GOA's argument that the reserves are the property of the BCRA, not the GOA, and therefore immune from attachment and execution under the U.S. Foreign Sovereign Immunities Act. However, the plaintiffs have appealed Griesa's ruling to the U.S. Court of Appeals and Judge Griesa therefore granted their request that the funds remain frozen until the Appeals Court issues its ruling. It is unclear when the U.S. Court of Appeals will decide the appeal, but the BCRA already is able to perform its normal foreign exchange and monetary activities. Most analysts expect that the Court of Appeals will uphold Griesa's ruling. -------------- -------------- Fitch Ratings will raise Argentina's rating from Restricted Default if it reaches an agreement with holdouts. -------------- -------------- ¶5. On January 25, a director of Fitch Ratings stated that Fitch may upgrade Argentina from its "Restricted Default" rating if the country makes a new debt offer that achieves broad acceptance from holdout creditors. A "Restricted Default" rating is for an entity that has failed to make due payments on some, but not all, of its financial obligations and is one step above the "Default" rating. -------------- -------------- Three public hearings on electricity rates were suspended. -------------- -------------- ¶6. On January 23, the ENRE - Argentina's electricity regulator - postponed three public hearings on potential increases in electrical rates for residential users. The public hearings scheduled for February and March were for one electricity transporter (Transener) and two electricity distributors (Distrocuyo and Edelap). Public hearings are a legally required step before rates for residential users can be increased. The utilities reportedly were surprised by the suspensions since they have been trying to re-negotiate their long-term contracts for three years. ENRE said that it needed more time to review the companies' tariff increase proposals. It did not indicate when the public hearings would be re-scheduled. -------------- -------------- The GOA delays - for the third time - privatization of the mail service. -------------- -------------- ¶7. On January 25, the GOA delayed (for the third time) the auction to re-privatize the mail service, this time until June 30. In November 2003, the GOA took over the postal service, Correo Argentino, when the concessionaire - the Macri Group - did not pay the royalties called for in the concession contract. At that time, the GOA said that it would re-privatize the service within six months. However, in June 2004, President Kirchner created a state-owned mail company ("Correo Oficial de la Republica Argentina SA") to operate the concession, and the GOA has delayed repeatedly the planned re-privatization. -------------- -------------- BCRA maintains Lebac interest rates; demand remains concentrated at the short end of the curve. -------------- -------------- ¶8. The BCRA received bids of ARP 1.9 billion in its January 24 Lebac auction, well above the ARP 1.3 billion announced amount and the ARP 1.6 billion in Lebacs that came due during the week. Investors concentrated 70 percent of their bids for ARP Lebacs at the short-end of the curve (less than 3 months). Like the last four auctions, the BCRA was unable to roll over its maturities, accepting bids for ARP 1.6 billion. The yield on the 49 -day and the 70-day Lebac remained unchanged at 6.76 percent and 6.90 percent, respectively. The yield on the 105-day Lebac reached 6.90 percent. Lebacs for maturities of more than 3 months were withdrawn yet again due to lack of interest. -------------- -------------- President Kirchner says unemployment fell to 10.0-10.2 percent in the fourth quarter of 2005. -------------- -------------- ¶9. On January 25, President Kirchner announced that the unemployment rate fell to 10.0-10.2 percent in the fourth quarter of 2005, down slightly from 11.1 percent in the third quarter. INDEC is scheduled to release the official unemployment data on February 28. BCRA President Redrado also predicted that the unemployment rate fell to 10 percent at the end of 2005 and forecasted that unemployment would fall to the single-digit level in 2006. Unemployment peaked at 21 percent in May 2002. -------------- -------------- HSBC purchases Banca Nazionale del Lavoro's subsidiary in Argentina. -------------- -------------- ¶10. HSBC Bank announced it would purchase Banca Nazionale del Lavoro's (BNL) subsidiary in Argentina for USD 155 million. With the acquisition, HSBC will double in size and will jump to seventh place by size of credit portfolio. HSBC's Argentine business has traditionally been oriented to corporations, and the BNL purchase will expand its customer base to individuals and small companies. HSBC will absorb the 1,800 employees from BNL. -------------- -------------- Provinces ask the GOA for funds and renegotiation of provincial debts. -------------- -------------- ¶11. On January 24, Ambito Financiero reported that many provinces are waiting for Minister of Economy Miceli to respond to their demands to restructure provincial debt owed to the GOA and to receive more GOA funds (either money promised during the congressional campaign last October or to pay GOA debt to the provinces). Provincial debt totals ARP 75.2 billion and is adjusted by CER (an inflation-linked index). 70 percent of this debt (or ARP 52.7 billion) is owed to the GOA. Some provinces have proposed a provincial debt restructuring to the GOA, including maturity extension and/or principal reductions that would be used to fund fiduciary trusts to fund provincial infrastructure developments. Some of the fund requests of the provinces include: ARP 65 million for La Rioja province to cover its fiscal deficit and increases in provincial public sector wages; ARP 5 million owed to Mendoza province for the maintenance of federal prisoners; and ARP 78 million promised to Mendoza province by the Federal Housing Plan to construct 4,500 houses. -------------- -------------- U.S. Appeals Court rules in favor of Mendoza's province debt restructuring. -------------- -------------- ¶12. The U.S. Second Circuit Court of Appeals rejected an appeal by Greylock Capital seeking to overturn a New York District Court approval of Mendoza province's 2004 debt restructuring. On January 23, lawyers for the province announced that the Appeals Court ruled in favor of upholding the District Court's decision on the fairness of the terms of the debt exchange. The Appeals Court agreed with the province that the contract regulating the debt exchange allowed for a simple majority of bondholders to accept the province's use of special clauses to repeal its sovereign immunity. Greylock had contended that passage of such amendments required unanimous consent. Mendoza province achieved a 65 percent participation rate in its October 2004 restructuring of its USD 250 million Aconcagua bond debt. The debt exchange extended the maturity of the bonds by eleven years, to 2018, and reduced the nominal interest rate from 10 percent to 5.5 percent, implying a net present value reduction of 50 percent. -------------- -------------- Commentary of the Week: "We Don't Have to Play on the Edge of the Abyss" by Aldo Abram, an economist and director of the Exante consulting firm. [Note: Translated and abridged with permission of the author from an editorial published in La Nacion on January ¶23. End Note.] -------------- -------------- ¶13. When we used 34 percent of the Central Bank's reserves and weakened its ability to confront a crisis, many argued that it wasn't important because they didn't expect any crisis. But it should be said that crises don't announce their arrival and that, in fact, the probability of a more complicated international environment is growing. ¶14. At the beginning of 2005 [the Federal Reserve] appeared to have gained control over the depreciation of the dollar. But ... in the second half the dollar again experienced strong pressure to depreciate. The world began to seek protection in gold ... Today, its value is above USD 550, which is not a good sign, as gold only reaches such high levels before crises or surges of inflation. ¶15. They say that there is no worse blind person than someone who does not want to see. To follow inflation trends, the majority of analysts look at the evolution of consumer price indices that exclude food and energy, which are very volatile. East Asian demand for these commodities has increased greatly and, as a consequence, so have their prices. People have limited incomes. When something in their consumption basket rises in price, they reduce their demand for other goods until their prices adjust and accommodate their lower spending capacity. Thus, the only way that prices for other goods and services won't go down is if there is a generalized price increase, i.e., if inflation generated by the Central Bank allows a relative adjustment of prices as all prices increase. ¶16. Given that analysts are removing from the CPI those components that are increasing for structural reasons and constitute the major weight in the indicator, they are measuring price tendencies with reference to the remaining products, those that have little margin to increase. Conclusion: they don't see the inflation that is indicated by the total index and by the dollar's loss of value. ¶17. The Fed will not be able to ignore a new bout of inflation. Thus, in the second quarter, its reference rates could increase by a half percentage point and reach levels not much below 6 percent. The problem with this is that, each time this has happened before, Argentina has suffered a serious crisis. This is because capital abandons the riskiest economies - like ours - in an unstable international environment. ¶18. In the last few years, the depreciation of the dollar has favored us by raising the prices of the commodities that we export. Also, the government could maintain a "high exchange rate" with the peso devaluing along with the dollar. But in the scenario I've laid out, the Fed's monetary contraction will have as its objective an increase in the dollar's value, which will mean that the winds of fortune will change direction. ¶19. Before paying the IMF, the relation between international reserves and financial instruments of the Central Bank gave an exchange rate of ARP 3.5 per dollar. That meant that, in the event of a crisis, if it had wished to, the Central Bank could have twisted the market's arm before reaching that exchange rate. Now, the relationship is ARP 5.2 per dollar, which implies that the Central Bank's chances of success in preventing a run are at exchange rates above ARP 4 per dollar, at least. ¶20. For this reason, it would be advisable for the Central Bank to give priority to rebuilding its international reserves, minimizing its emission of pesos and, because of this, reducing domestic inflation. It should do this basically through Central Bank debt instruments, fiscal savings and government bond issuance. Then, in the event of an international crisis, the social and economic cost that we will have to pay will be low, if the government understands that the best way to confront it is to maintain fiscal solvency, control inflation and allowing the dollar to rise (for certain, selling reserves). If not, we will, unfortunately, repeat old and sad histories from our past. [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