Argentina Economic and Financial Weekly for

UNCLAS BUENOS AIRES 000273 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 February 3, 2006 -------------- -------------- Weekly Highlights -------------- -------------- - The peso depreciated 0.3 percent against the USD, closing at 3.08 ARP/USD. - Argentina and Brazil agree on a safeguard system to protect domestic industries. - GOA creates registry for beef exports; implementation delays paralyze exports. - GOA reached price-restraint agreements with leading supermarket chains. - Provincial finances becoming more dependant on GOA transfers. - Tax revenue rose 27 percent y-o-y to ARP 11.2 billion in January - above expectations. - GoA runs an ARP 24 million primary fiscal surplus in December - worse than expected. - December trade surplus of USD 1 billion brings 2005 trade surplus to USD 11.3 billion. - Commentary of the Week: "Possible Ways to Develop a Long-Term Bond Market" -------------- -------------- MARKETS -------------- -------------- -------------- -------------- The peso depreciated 0.3 percent against the USD during the week to close at 3.08 ARP/USD. -------------- -------------- ¶1. The peso depreciated 0.3 percent versus the USD this week, closing at 3.08 ARP/USD - one cent lower than last Friday's close. This week's depreciation is mainly attributed to higher dollar demand by banks and Central Bank (BCRA) intervention in the FX market, and comes in spite of higher USD inflows from investors to purchase stocks and GOA bonds. The BCRA purchased USD 139 million and EUR 11 million in the first four days of the week. The peso exchange rate has depreciated 1 percent since the beginning of year. -------------- -------------- ECONOMY / FINANCE -------------- -------------- -------------- -------------- Argentina and Brazil agree on safeguard system to protect domestic industries. -------------- -------------- ¶2. On February 1, Minister of Economy Miceli announced that the GOA had reached agreement with Brazil on an agreement to allow temporary import restrictions in order to protect some industrial sectors. Under the agreement, either country can limit imports of a product from the other country if it can demonstrate that surging imports are damaging their domestic industry. A bi-national committee will analyze complaints from industry groups and allow import restrictions for a period of three years, with the option of a one-year extension. Argentina trade deficit with Brazil reached USD 3.7 billion as Argentine exports to Brazil increased 12 percent, while Argentine imports from Brazil jumped 35 percent. -------------- -------------- GOA creates registry for beef exports; implementation delays paralyze export shipments. -------------- -------------- ¶3. On February 2, the GOA created an Exports Registry to issue permits for beef exports. Beef producers now have to request a permit for all exports, while the GOA determines the cuts to be shipped and the markets. The GOA is attempting to reduce beef exports in order to increase local supply and avoid beef prices increases, following the failure to reach a price- restraint agreement between the GOA and the sector. Meanwhile, beef exports scheduled for this week have been paralyzed while exporters wait for permits. The GOA's focus is on cheaper cuts of meat that are included in the basket of goods that make up the CPI index, and not on more expensive cuts. -------------- -------------- GOA reached price-restraint agreements with leading supermarket chains. -------------- -------------- ¶4. On February 1, the GOA closed a new agreement with the country's seven leading supermarket chains. These new price-restraint agreements aim to maintain prices on 223 basic goods unchanged for one year, but also are subject to bi-monthly monitoring of any changes in the economic environment. This agreement is similar to the agreement the GOA signed with supermarkets in December that lasted until January 31, but also includes supermarket suppliers, meaning that the supermarkets will not bear the entire burden of these price freezes. These agreements advance the GOA's strategy of curbing inflation through price-restraint agreements with producers and retailers. (According to local media, January's CPI is expected to increase 1.3 percent m-o-m. The Ministry of Economy and President Kirchner plan to continue working on new price-restraint agreements.) -------------- -------------- GOA orders execution of ARP 38 million guarantees from Aguas Argentinas due to unpaid fines. -------------- -------------- ¶5. On January 30, the GOA ordered the execution of ARP 38 million in guarantees from the water company Aguas Argentinas (AA) due to unpaid fines. The execution against the guarantees is provided for in AA's concession contract and is a first step towards rescission of its contract, following the same procedures that Santa Fe Province used in rescinding its contract with Aguas de Santa Fe (both AA and Aguas de Santa Fe are controlled by Suez of France). AA stockholders will meet on February 8, when Suez may announce its plans to withdraw from the contract. -------------- -------------- AES suspends its ICSID arbitration claim against the GOA. -------------- -------------- ¶6. The American company AES - the owner of power distributor Edelap - suspended its arbitration claim against the GOA before the International Center for the Settlement of Investment Disputes (ICSID). AES filed its claim in 2002 and sought USD 1.8-2.0 billion from the GOA. According to the ICSID registry, the claim is suspended - not withdrawn - and the company could activate the arbitration process again if the GOA does not comply with an agreement that calls for tariff renegotiations in 2006, as well as investment by AES. AES received a one-time 28 percent tariff increase in 2005. -------------- -------------- BCRA maintains Lebac interest rates and extends Nobac maturities to 9 months. -------------- -------------- ¶7. The BCRA received bids of ARP 1.7 billion in its January 31 Lebac auction, well above the ARP 1.1 billion announced amount and the ARP 1.3 billion in Lebacs that came due during the week. This allowed the BCRA to roll over its maturities for the first time in several weeks, accepting bids for ARP 1.5 billion. The yield on the 77-day Lebac rose 4 basic points to 6.99 percent, while the yield on the 98-day and the 182-day Lebacs reached 7.25 percent and 7.90 percent, respectively. Lebacs for other maturities were withdrawn due to lack of interest. Unlike previous auctions, investors concentrated 50 percent of their bids in Nobacs of more than 9 months, which enabled the BCRA to roll over its maturities and extend the maturity profile of its debt. The BCRA accepted ARP 768 million of Nobacs (50 percent of the accepted amount in the auction) at a yield of 11.04 percent - 18 basis points below the previous auction. -------------- -------------- Banks pay back ARP 1.6 billion in rediscount loans to the BCRA. -------------- -------------- ¶8. On February 2, two banks - Banco Galicia and GOA- owned Banco Nacion - pre-paid ARP 1.6 billion in discount borrowing to the BCRA. This prepayment, plus the banks' payment of a ARP 70.5 million installment of the matching system (under which banks repay the BCRA for financial assistance received during the 2001 financial crisis) will generate a monetary base contraction of ARP 1.7 billion. Following these pre- payments, only four banks - out of twenty-four at the beginning of the crisis - will have outstanding discount borrowing from the BCRA, totaling ARP 9.8 billion. -------------- -------------- Provincial finances become more dependent of GOA transfers. -------------- -------------- ¶9. Abeceb Consulting estimates that the provincial primary fiscal surplus will fall to 0.4 percent of GDP (ARP 2.6 billion) in 2006, from 0.8 percent of GDP (ARP 1.4 billion) in 2005 and 1.4 percent of GDP (ARP 6.4 billion) in 2004. The decrease in the provincial surplus is attributed to salary increases for provincial employees, revenue growth deceleration (both provincial revenue and GOA transfers are slowing down),and the implementation of the new Education Financing Law, which obligates provinces to set aside additional funds for education. The worsening of provincial finances, and the GOA being the provinces' main creditor, is making provinces more dependent on the Kirchner administration, which controls both the amount of discretionary federal funds transferred to provinces each year and the rate of repayment of their debts to the GOA. Provincial debt totals ARP 75.2 billion, 70 percent of which (or ARP 52.7 billion) is owed to the GOA. -------------- -------------- Tax revenue rose 27 percent y-o-y to ARP 11.2 billion in January - above expectations. -------------- -------------- ¶10. January federal tax revenue increased 27 percent y-o-y to ARP 11.2 billion - above market expectations of ARP 10.6 billion. The results reflect strong economic activity, the positive effects of inflation on revenues and improved compliance. Labor contributions jumped 45.6 percent y-o-y due to increases in job creation and salary increases, income tax revenues rose 39.3 percent y-o-y, and VAT and trade tax revenues increased 22 percent and 16.5 percent y-o-y, respectively. According to the GOA, the increase in tax collection is due to income tax revenue, VAT and labor contributions which provided 70 percent of January tax revenue. In real terms, revenues increased 13 percent y-o-y. The BCRA consensus survey forecasts 2006 tax revenue at ARP 135 billion. -------------- -------------- GoA runs an ARP 24 million primary fiscal surplus in December - worse than expected. -------------- -------------- ¶11. The GoA announced a primary fiscal surplus of ARP 24 million in December, well below market expectations of ARP 115 million. The worse-than-expected result was due to the prepayment of end-of-the year bonuses to civil servants, and increased transfers to the private sector and provinces. In December, fiscal resources increased 34.4 percent y-o-y, while expenditures rose 11.8 percent y-o-y. The primary fiscal surplus for 2005 was ARP 19.6 billion (3.7 percent of GDP) - in line with the BCRA consensus forecast - as a result of ARP 126.4 billion in revenues and ARP 106.8 billion in expenditures. The 2005 provincial primary fiscal surplus is estimated to reach ARP 3.7 billion (according to private consultants),which would bring the consolidated primary fiscal surplus to ARP 23.4 billion (4.5 percent of GDP, down from the 2004 fiscal surplus of 5.3 percent of GDP). -------------- -------------- December trade surplus of USD 1 billion brings 2005 trade surplus to USD 11.3 billion. -------------- -------------- ¶12. The December trade surplus reached USD 1 billion, above the BCRA consensus forecast of USD 828 million. Export revenues increased 19 percent y-o-y to USD 3.5 billion, with increases in both quantities (+10 percent) and prices (+9 percent). Exports were driven by an increase in industrial goods (+4 percent y-o-y), primary goods (+29 percent y-o-y),fuel and energy (+20 percent y-o-y) and agro-industrial products (+29 percent y-o-y). Imports increased 18 percent y-o-y on the back of a strong domestic demand to USD 2.5 billion, with increases in both quantities (+12 percent) and prices (+5 percent). Imports were driven by increases in fuel and oil (+85 percent y-o-y), capital goods (+18 percent y-o-y),accessories for capital goods (+6 percent y-o-y),consumer goods (+17 percent y-o-y) and intermediate goods (+14 percent y-o- y),and were partially offset by a drop in other goods (-27 percent y-o-y). In 2005, exports increased 16 percent to USD 40 billion while imports increased 28 percent to USD 28.7 billion, bringing the trade surplus to USD 11.3 billion, slightly above the BCRA consensus forecast of USD 11 billion but below 2004's USD 12.1 billion trade surplus. -------------- -------------- January Government Confidence Index up 16 percent m-o- m. -------------- -------------- ¶13. The Government Confidence index jumped 16 percent m-o-m in January to 2.63 points, and is 0.4 points above the average during the Kirchner administration, and well above the 1.2 point reading in May 2003 when President Kirchner took office. The index increased in all five categories measured. Confidence in the GOA's ability to solve citizens' problems is still the factor generating the most confidence and increased 8 percent m-o-m. The index rose 12 percent y-o-y. [The Government Confidence Index is a survey-based index prepared by Di Tella University. It varies from zero to five points and seeks to measure public opinion of GoA general performance, efficiency of public spending, honesty of GoA officials and the government's ability to solve problems.] -------------- -------------- Employment index increased 9.7 percent y-o-y in December 2005, according to Ministry of Labor survey. -------------- -------------- ¶14. On January 31, the Ministry of Labor announced that its December 2005 employment index increased 9.7 percent y-o-y, well above the 6.8 percent y-o-y rise in December 2004 and the 5.8 percent y-o-y rise in December 2003. The index is based on surveys from the cities of Buenos Aires, Mendoza, Rosario, Cordoba and Tucuman. Although every sector recorded a y-o-y increase of more than 6 percent, construction reported the largest job creation during 2005 (up 33.2 percent),followed by financial services (up 11.3 percent) and manufacturing industry (up 9.1 percent). -------------- -------------- January labor demand index down 0.11 percent m-o-m. -------------- -------------- ¶15. The January labor demand index calculated by Di Tella University decreased slightly, down 0.11 percent m-o-m to 127.12 points. The decrease is mainly due to weaker demand for commercial employees (down 2.34 percent) and administrative personnel (down 2.02 percent). The index is up 25.7 percent y-o-y. [The index is based on comparisons of job vacancy announcements printed in the two largest newspapers of the country.] -------------- -------------- Commentary of the Week: "Possible Ways to Develop a Long-Term Bond Market". By Miguel Kiguel. [Note: Translated with permission of the author from an editorial published in La Cronista on February 1, ¶2006. End Note.] -------------- -------------- ¶16. The creation of a long-term bond market continues to be one of the major challenges that our economy is facing. Among the difficulties in developing this market is the lack of stable, predictable macroeconomic markers for inflation and interest rates over the medium-term. ¶17. In the past, we tried to resolve these problems by issuing financial instruments denominated in dollars. But we have learned from the strong oscillations in the exchange rate in our history that this type of instrument is only useful for exporters or those companies that generate income in dollars. It isn't useful for a government that earns most of its revenues in pesos. ¶18. What are the peso-denominated alternatives? They are fixed-rate debt, variable-rate debt, or debt with indexation clauses linked to prices that cover the risk of unexpected increases in the inflation rate. ¶19. Fixed-rate instruments only work in countries with very low inflation rates. Last year, Brazil was able to issue a 10-year bond at 12 percent per year, but this was after a huge effort to lower inflation to levels of 5 percent per year, and with an inflation targeting regime, which indicates a commitment to maintain those levels over the medium term. Even with all of this, Brazil had to pay a real interest rate on the on the order of 7 percent per year. ¶20. The option of emitting a variable-rate bond (for example, at the market rate plus a spread) could be an attractive option. In this case, the yield of the bond would be connected to the rates set by the Central Bank's monetary policy. This type of instrument has not had much success in industrialized countries. Brazil has used the Selic rate. While this has allowed Brazil to place this type of bond successfully, it has required increases in interest rates to slow inflation, and has generated substantial fiscal costs. Up to now, it has been an expensive financing option. ¶21. The other alternative is to issue indexed bonds. This is the path followed by many countries until recently, including Chile, Colombia and Mexico, to develop their medium- and long-term financial markets. It is worth reviewing the pluses and minuses of this type of financing, especially for the management of public debt. ¶22. Indexed debt allows the investor to know he is protected from the vagaries of inflation, that the value of his indexed bonds won't be eroded as a result of an unanticipated increase in prices. In other words, it isn't easy to destroy their value. ¶23. For the issuer, i.e., the government, the nominal value of the indexed debt increases as prices increase. In principle, this isn't a problem for governments given that nominal GDP also increases with prices (and therefore the debt-to-GDP ratio doesn't increase) and that taxes also increase with the level of prices, meaning that the cost of paying this debt doesn't increase. ¶24. It has been said many times that the cost of indexed debt in Argentina is high, based on adding the inflation rate (the CER rate) to the spread (which, for 5 year bonds, could be 3 points). For a five year bond, with 12 percent inflation, they say that the debt is expensive because the "implicit" interest rate is 15 percent. This line of reasoning is erroneous, because if the government would have issued fixed-rate debt, the interest rate would have been much higher due to the uncertainty that exists about future inflation. ¶25. It also isn't certain that indexed debt will increase in value in dollar terms. This probably is the case now in Argentina, given that our country has an under-valued currency and the dollar is increasing less than prices. But once real exchange rate equilibrium is re-established, the dollar's value certainly will increase with prices and indexed debt therefore will not increase in dollar-value terms. ¶26. The issuance of indexed debt carries some risks. For example, if there would be a strong increase in the price level, it could affect the payment capacity of companies and of wage-earning workers whose income doesn't rise with inflation. This is what we lived through at the beginning of the 1980's. It also could generate greater use of indexing in short-term contracts and salaries, which would limit the economy's capacity to adjust relative prices, and increase inflationary inertia. ¶27. Indexing is a useful tool for developing long- term capital markets, but indexing of short- and medium-term contracts should be avoided, and inflation should be kept to moderate levels (below 15 percent). [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