CENTRAL BANK GOVERNOR ON MONETARY POLICY, GROWTH, TERROR

UNCLAS BUENOS AIRES 002726

SIPDIS

SIPDIS

SENSITIVE

PASS FED BOARD OF GOVERNORS FOR RKROSZNER, PROBITAILLE
PASS USTR FOR SUE CRONIN AND MARY SULLIVAN
WHA FOR WHA/BSC AND WHA/EPSC
E FOR THOMAS PIERCE,
PASS NSC FOR JOSE CARDENAS
TREASURY FOR NANCY LEE AND ALICE FAIBISHENKO
USDOC FOR 4322/ITA/MAC/OLAC/PEACHER
US SOUTHCOM FOR POLAD

E.O. 12958: N/A
TAGS: EFIN ECON AR
SUBJECT: CENTRAL BANK GOVERNOR ON MONETARY POLICY, GROWTH, TERROR
FINANCE, RE-ENGAGING THE IMF AND U.S. COOPERATION

Ref: Buenos Aires 2576
Buenos Aires 2556
Buenos Aires 2486

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Summary
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1. (SBU) Central Bank Governor Martin Redrado, in a December 5 lunch
with the Ambassador, invited a dialogue with USG on GoA monetary
policy which he called conservative, slightly contractionary and
generally misunderstood. Now, five years after Argentina's economic
crisis, Redrado said Argentina remains an "economy in transition"
with the adjustment of non-tradable prices incomplete and
fundamental macroeconomic variables -- including nominal and real
exchange rates and domestic interest rates - yet to settle to a
steady state equilibrium. Redrado called the stabilization of
Argentina's financial sector a major achievement, noting the
progressive reduction of bank exposure to public debt; the
re-opening of bank credit lines to middle market companies; and
steady improvements in bank capitalization. On growth, he agreed
that productive investment to date has been relatively small scale
and incremental and said investment at the 25-26% of GDP level was
necessary to ensure a soft economic landing and underpin sustainable
5-6% medium term real GDP growth.


2. (SBU) Redrado called anti-money laundering and counter-terrorism
finance efforts a central bank priority, asked for additional USG
bilateral technical assistance in these areas, and commented that
the GoA's draft counter terrorism finance law would soon be
submitted to the President's office. He said Argentina is quietly
re-engaging with the IMF and hopes to have First Deputy Managing
Director Lipsky and Western Hemisphere Director Singh visit in late
January. Redrado requested Ambassador's support on his invitation
to have Fed Reserve Governor Kroesner attend the central bank's
annual conference in June 2007. End Summary.

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Argentina's Reserve Accumulation and Currency Strategy
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3. (SBU) Redrado had just returned from an EU/Latin American central
bank governors' conference in Madrid. There he presented a BCRA
research paper "The Economic Policy of Foreign Reserve
Accumulation," which examines the explosive growth of global
international reserves largely driven by emerging economies.
Redrado noted that the paper examined international liquidity
conditions and individual country demand for reserves and concludes
that exchange rate flexibility is not a substitute for reserve
accumulation and that emerging economies have chosen to combine high
international reserve levels with greater exchange rate flexibility
as a strategy to face increasing exposure to exogenous shocks.


4. (SBU) Argentine reserves, Redrado noted, had increased to $30
billion at the end of November, surpassing the $28 billion level
they reached in December 2005 before the GoA paid off its $9.5
billion debt to the IMF. He called Argentina's currency policy
flexible and rejected the "mis-perception" that the currency is
significantly undervalued. Now, five years after Argentina's
economic crisis, Redrado said Argentina remains an "economy in
transition" with the adjustment of non-tradable prices incomplete
and fundamental macroeconomic variables -- including nominal and
real exchange rates and domestic interest rates - yet to settle to a
steady state equilibrium. As a consequence, he concluded, BCRA
policy is not to "fix" the nominal exchange rate at current levels,
but rather to actively manage the peso's real effective exchange
rate against a basket of international currencies. He referred to
Guellermo Calvo's 2001 paper "The Fear of Floating," which argues
that countries that say they allow their exchange rate to float



mostly do not.


5. (SBU) In this context, Redrado called the BCRA's monetary policy
conservative, slightly contractionary and (likely referring to
recent media criticism by renowned Argentine Economist Miguel Angel
Broda) generally misunderstood. He invited a dialogue with USG
officials on the GoA's monetary policy, explaining that Argentina's
financial system had not recovered enough to implement an inflation
targeting regime and arguing that the absence of a reference
interest rate makes it more reasonable for the BCRA to use broad
monetary targets to control inflation. With one-year BCRA paper
trading in the 10-11% range, Redrado said real interest rates are
now marginally positive. He declined, however, to predict how far
the BCRA will permit rates to rise to control inflation. The
central bank, he said, is encouraging banks to raise their CD
deposit rates, currently in the 8% range, to real positive levels to
encourage savings and expanded financial intermediation.

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Putting Financial Service Sector House in Order...
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6. (SBU) Redrado called the reactivation and stabilization of local
credit markets one of his major achievements since taking on the
BCRA governorship in September 2004. A key accomplishment has been
the progressive reduction of commercial bank exposure to public
debt: While maximum permitted exposure to public debt currently
stands at 40% of bank assets (to be reduced to 35 % in July 2007),
current average exposure has dropped to 28%. A second achievement
has been the re-opening of bank credit lines to middle market
companies here: Bank credit to GDP ratios have risen from 8% in
2002 to 11% in 2006. Finally, Redrado noted the steady improvement
in bank capitalization, with a new debt/equity hybrid instruments
under development. The lack of interest reference rates at the
long end of the yield curve is gradually being addressed, Redrado
concluded, with gas pipeline companies TGS and TGN soon to issue a
long term bond that will be purchased by private pension funds.

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...And Targeting a Soft Landing: Need Investment
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7. (SBU) Following four years of GDP growth in the 8-9% range,
Redrado called the key challenge facing the GoA maintaining
steady-state medium term GDP growth in the 5-6% range. While
post-crisis Argentine investment levels have recovered to 21-22% of
GDP, he noted that fully 30% of current investment has been
channeled into real estate development that does not significantly
add to Argentina's productive capacity. Redrado agreed that
productive investment to date has been relatively small scale and
incremental and said that investment at the 25-26% of GDP level -
including significant new Greenfield project investment -- will be
required to underpin sustainable 5-6% medium term real GDP growth
and so ensure a soft economic landing.

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Seeks Greater Bilateral Engagement on Terror Finance
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8. (SBU) Redrado said he had made anti-money laundering and
counter-terrorism finance (AML/CTF)a BCRA priority and had set up a
specialized bank examination unit (under the BCRA's Banking
Superintendency Division) devoted to these activities. (Note:
Redrado announced this initiative in late 2005 and the BCRA recently
completed preparations for establishing the unit. However, it has
not been authorized to begin audits and bank inspections. End
Note).


9. (SBU) Redrado appreciated U.S. technical assistance on AML/CTF
issues via regional GAFISUD initiatives, but asked that the USG put
this higher on the bilateral agenda for engagement with the GoA.
Specifically, he suggested the U.S. work with ASBA ("Asociacion de
Supervisores Bancarios de las Americas," The Association of Bank
Supervisors of the Americas) and consider offering training programs
to bank inspectors and supervisors. He noted that he had raised
this request with Treasury Assistant Secretary Patrick O'Brien, and
had also discussed it with IMF and World Bank representatives.


10. (SBU) With regards to the GoA's draft counter-terrorism finance
law, Redrado stated it was on Economic Minister Felisa Miceli's
desk, after which it would go to Legal and Technical Secretary
Carlos Zannini, the President's chief legal advisor. (Note: Other
sources within the GoA and BCRA say the Justice Minister has already
passed the bill to Zannini. However, there are increasing
indications that opposition is building to the law, particularly
from key supporters of the President, and the word on the street is
that the President may decide not to submit it to Congress before
its December 29 recess. Redrado has commented in past meetings with
Emboffs that failing to present the draft bill to Congress before
the FATF mid-February 2007 deadline would have negative consequences
for the Argentine financial sector, particularly if FATF responds by
issuing a public statement criticizing the GoA for not meeting world
terrorism finance standards. See reftels. End Note).

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Central Bank June Conference
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11. (SBU) Redrado noted that he is inviting U.S. Federal Reserve
Governor Kroszner to speak at the central bank's annual conference
in June. He asked for the Ambassador's support for this effort,
calling the conference the most prestigious in South America.
(Note: Prior to his 2006 appointment to the Fed, Krozner was a
member of the President's Council of Economic Advisers from 2001 to

2003. End Note)

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Re-Engaging with the IMF
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12. (SBU) Redrado noted that the GoA is working to quietly re-engage
with the IMF in order to establish more "normal" working relations.
A first step will be a late January/early February visit by John
Lipsky, First Deputy Managing Director and Anoop Singh, Director of
the Western Hemisphere Department on the margins of an already
planned IMF trip to Brazil, Chile and Uruguay. Low key meetings for
the IMF team are being planned with Redrado, Economy Minister Miceli
and Chief of Cabinet Fernandez.

WAYNE