A SURPLUS 2007 BUDGET DESIGNED TO BOLSTER KIRCHNER

UNCLAS BUENOS AIRES 002798

SIPDIS

SENSITIVE
SIPDIS

E FOR THOMAS PIERCE, WHA FOR WHA/BSC AND WHA/EPSC
PASS NSC FOR JOSE CARDENAS
PASS FED BOARD OF GOVERNORS FOR PATRICE ROBITAILLE
PASS USTR FOR SUE CRONIN AND MARY SULLIVAN
TREASURY FOR NANCY LEE, ALICE FAIBISHENKO
USDOC FOR ALEXANDER PREACHER AND JOHN ANDERSEN
US SOUTHCOM FOR POLAD

E.O. 12958: N/A
TAGS: ECON EFIN EINV AR
SUBJECT: A SURPLUS 2007 BUDGET DESIGNED TO BOLSTER KIRCHNER
ADMINISTRATION'S RE-ELECTION BID


Summary
--------------

1. (SBU) The Argentine Senate approved the 2007 National
Budget December 13, 2006, in the face of opposition criticism
over its growth and inflation assumptions, the continuation
of "superpowers" that allow the GoA to make future fiscal
decisions without Congressional authorization, and the lack
of transparency in disbursement of subsidy payments. The
Budget estimates federal revenues at ARP 128.5 billion
(approx. $41.5 billion or 18% of GDP),and expenditures are
forecast at ARP 121.3 billion (approx. $39.1 billion or 17%
of GDP),achieving an overall balance of 1% of GDP and
primary fiscal surplus of 3.03% of GDP. The Kirchner
administration has tailored the 2007 Budget to help it win
the October 2007 presidential elections. The Budget
underestimates resources, envisions a significant increase in
social expenditures, and considers GoA refinancing of
provincial debt, all of which should win Kirchner votes. End
Summary.

Senate Passes 2007 Budget Bill Into Law
--------------

2. (SBU) The GoA sent its fiscal year 2007 (which corresponds
to the calendar year) Budget bill to Congress September 15 as
required by the Constitution, and Minister of Economy Felisa
Miceli presented it to the Chamber of Deputies for its
approval on September 26. The Chamber passed the bill
November 23 (with 143 votes in favor, 77 against, 6
abstentions),and the Senate approved it without modification
on December 13 (with 41 votes in favor and 22 against).


3. (SBU) During debate in both houses, the opposition
criticized the budget for underestimating both GDP growth and
revenue prospects, setting the stage for the GoA to use
surplus tax revenues to finance discretionary pre-election
social policy and targeted infrastructure development
expenditures. They also criticized the so-called
"Superpowers" Law, which allows the GoA to make subsequent
changes to the budget without prior Congressional approval.
The opposition also expressed concern over increasing
subsidies, mainly to the energy and transportation sectors,
and criticized the lack of transparency in the disbursement
of such funds. (Note: Congress approved the "superpowers"
law August 2 as an amendment to the existing Financial
Administrative Law. The amendment gives te GoA the legal
ability to modify the Budget Law and reallocate funds
regardless of the provisions of the Financial Administrative
Law or the Fiscal Responsibility Law, and without consulting
Congress. Although opposition parties are seeking to repeal
the "superpowers," the GoA's majority support in the House
and Senate makes this unlikely. End Note).

Conservative Macroeconomic Assumptions
--------------

4. (SBU) The Budget's macroeconomic assumptions are
conservative compared to private analysts' economic
forecasts, as measured in the central bank's (BCRA's)
consensus survey from September. GDP is forecast to increase
only 4% in 2007, well below the current BCRA consensus
forecast of 6.3%. The Kirchner administration has used this
strategy of underestimating growth in past budgets --
underestimating revenues by ARP 19 billion (31% of total
revenues) in 2004, ARP 11 billion (13% of total revenues) in
2005, and ARP 14 billion (14% of total revenues) in 2006 --
and it allows the administration to spend excess revenues at
the end of the year with only perfunctory Congressional
approval (Note: The Kirchner administration's solid majority
support in both houses of Congress makes Congressional
approval a sure thing. End Note).


5. (SBU) As in previous years, the opposition in both houses
harshly criticized the growth assumption, claiming it
underestimates revenues by ARP 8 - 12 billion (approx. $2.6 -
3.9 billion, or 6-9% of total revenue). However, Minister
Miceli has publicly defended budget assumptions, arguing (in
a reference to a succession of budget deficits in the 1990s





that required the GoA to increase its borrowing in
international capital markets),that, "generating
expectations for revenues that the GoA cannot fulfill would
be a return to the past." She further explained that the GoA
will prioritize spending of any higher than projected
revenues on education, retirement benefits, and higher wages
for state employees.


6. (SBU) The Budget also lowballs other assumptions. It
estimates CPI inflation at 7.7%, compared to the BCRA
consensus survey forecast of 10.5%. It assumes an average
nominal exchange rate of 3.13 ARP/USD, compared to the BCRA
consensus survey of 3.20 and the 2006 Budget assumption of
3.09. It forecasts export growth of 7.8% and import growth
of 10.7% in 2007 (in real terms),resulting in an $8.1
billion trade surplus ) substantially below the BCRA's $9.6
billion consensus forecast. Finally, the budget forecasts
investment growth of 7.2%, compared to the BCRA consensus
forecast of 13%, with total investment in 2007 reaching 23.3%
of GDP. The budget forecasts nominal GDP to reach ARP 694
billion (approximately $224 billion) by the end of 2007.

Macroeconomic Assumptions For 2007
--------------
Market
Budget Expectations
-------------- --------------
GDP (real growth) 4.0 6.3
Consumption (real growth) 3.3 5.9
Investment (real growth) 7.2 13.0
Exports (USD in billions) 52.6 48.3
Imports (USD in billions) 44.4 38.7
Inflation (average) 7.7 10.5
Nominal Exchange Rate (average) 3.13 3.20
-------------- --------------

Revenues: Increase Driven By Economic Activity
-------------- --

7. (SBU) Federal revenues are estimated at ARP 128.5 billion
(approx. $41.5 billion or a 16% nominal and 9% real increase
over 2006),equivalent to 18% of GDP. Tax revenues account
for 74% of federal revenues, social security contributions
for 20%, and non-fiscal revenues, mainly financial profits
from GoA financial investments, revenues from the sales of
GoA machinery and real estate, and BCRA profits, total ARP 7
billion ($2.26 billion or 5% of total revenues). The fiscal
burden (total tax collection and social security
contributions) will reach 17.5% of GDP in 2007, compared to
16.8% in 2006.


8. (SBU) The Budget estimates total tax revenue at ARP 95.3
billion (approx. $30.7 billion),an increase of 13% in
nominal terms and 6% in real terms over 2006 (Note: this
calculation uses the GoA's 2007 7.7% CPI inflation target.
End Note). This forecast is based on expected nominal price
increases, and strong economic activity, employment, and
trade, as well as an improvement in tax compliance. The
highest increases are: import taxes ( 15.4%),export taxes
( 14.4%),financial transactions tax ( 13.9%),and income tax
( 12.7%).


9. (SBU) Tax revenues account for 64% of the increase in
total revenue. Social Security contributions comprise 28% of
the increase in revenue, and are estimated at ARP 26 billion
(approx. $8.4 billion; a 24% nominal and 16% real increase
versus 2006). This is due to the expected increase in
nominal salaries as well as an increase in the number of
contributors.


10. (SBU) The GoA's 2007 budget does not envision changing
tax regulation, unlike in previous years when it considered
the elimination or phase-out of the export and financial
transactions (FTT) taxes. The IMF -- supported by many in
the opposition -- has consistently advocated the elimination
of both taxes, which represent 28% of fiscal revenue, due to
their distortive impact. However, the Kirchner


administration's congressional majority has refused to
support a reduction of either tax, since that would eliminate
the GoA's primary fiscal surplus. (Note: Export tax revenues
reached ARP 12 billion and FTT ARP 9.3 billion during the
first ten months of 2006, and the primary fiscal surplus
reached ARP 21.2 billion, or 3.5% of GDP on an annualized
basis. 100% of export tax revenues and 70% of FTT revenues
are not subject to co-participation with the Provinces,
offering the Kirchner administration added political leverage
in the allocation/distribution of such revenues. On November
15, Congress approved the extension of the FTT through the
end of 2007. End Note).

Expenditures: Increase Driven By Social Expenditures
-------------- --------------

11. (SBU) The GoA budgets 2007 expenditures at ARP 121.3
billion ($39.1 billion, or a 15% nominal and 8% real increase
over 2006),equivalent to 17% of GDP. The GoA prioritizes
expenditures on social security, education, science and
technology, and economic and social infrastructure with the
overall goal of generating improved income distribution.


12. (SBU) The highest year-over-year increase is spending on
social services -- ARP 78 billion (approx. $25 billion, or an
18% nominal increase over 2006),equivalent to 11% of GDP and
64% of total expenditures. This includes a 13% increase for
pensions in 2007, on top of the 11% increase in 2006, and the
60% increase in unemployment benefits (up from ARP 250 to ARP
400 per month). The bill allows the GoA to increase pensions
further in 2007, as long as excess funds are available.
(Note: The Argentine Supreme Court mandated a minimum 13%
pension increase in a 2006 ruling. End Note).


13. (SBU) Education, science and technology expenditures are
forecast to increase ARP 1.6 billion (17% nominal) to ARP
10.7 billion. This increase is consistent with the GoA's
Education Financing Law, which calls for annual federal
(0.5%) and provincial (0.2%) spending increases through 2010
in order to bring total education expenditure to 6% of GDP.


14. (SBU) Infrastructure spending is comprised mainly (83%)
of transportation (ARP 6.1 billion, or almost $2 billion) and
energy (ARP 5.6 billion, or $1.8 billion) subsidies to the
private sector, to keep energy and public transportation
prices unchanged and control inflation. As noted above, the
opposition and local press have criticized the government for
the increases in such expenditures and also for the less than
transparent way that such funds have been disbursed in the
past.


15. (SBU) Interest payments are estimated to increase from
ARP 12.7 billion to ARP 14.1 billion, or 2% of GDP in 2007.
Interest payments on peso-denominated debt (including
guaranteed loans, Bodens, Bocones, and restructured debt) are
ARP 5 billion. Payments on foreign currency debt (USD
Bodens, restructured debt, and payments to IFIs) are ARP 8.8
billion. (Note: In 2007, the GoA will pay approximately
$650 million in interest on debt included in the 2005
sovereign debt exchange. Post roughly estimates that the GoA
would have paid an additional $230 million/year to holdouts
from the debt exchange, had they accepted the same deal in

2005. This debt represents a potential contingent liability
if/when the GoA eventually reaches an accommodation with
holdouts. End Note)

Fiscal Balance: Positive But Decreasing
--------------

16. (SBU) The 2007 federal government primary fiscal surplus
(revenues less expenditures, excluding interest and principal
payments on debt) is forecasted at ARP 21 billion (approx.
$6.8 billion) or 3.03% of GDP, close to the 2006 forecast of
3% included in the 2006 budget. The consolidated federal
primary fiscal surplus - adding in fiduciary trusts and
social security, but excluding provinces - is projected to
fall to 3.15% of GDP from 3.26% in 2006. The projected
overall balance for the consolidated federal government


totals ARP 7.1 billion (approx. $2.3 billion or 1% of GDP,
compared to 1.15% in 2006).


17. (SBU) The Budget bill does not include a breakdown of
individual provincial finances. However, it notes that the
provincial primary fiscal balance will be "slightly
positive." The consolidated public sector primary surplus,
including provinces, will remain at 3.15% of GDP in 2007
under the budget's best case scenario that provinces have a
neutral primary fiscal surplus. However, the consolidated
public sector primary surplus (including provinces) would
drop to 3.03% of GDP if the Provinces end 2007 with a
0.1%/GDP deficit, as most private consultants forecast.
(Note: This expected provincial deficit is primarily due to
Buenos Aires Province's projected deficit, which the province
plans to finance partially via an international bond issuance
and partially via borrowings from the federal government.
End Note).

Financing: GoA Relying Primarily On New Debt Issuance
-------------- --------------

18. (SBU) The GoA's 2007 financing needs total ARP 73 billion
($23.5 billion),including ARP 57 billion in debt
amortization and ARP 16 billion in "financial investment"
(i.e., lending to provinces for project and deficit finance).
The GoA will finance these needs via:

- ARP 7.2 billion from the federal fiscal surplus;
- ARP 23.5 billion in new debt issuance;
- ARP 7.0 billion in IFI financing;
- ARP 20.4 billion in BCRA financing;
- ARP 9.0 billion domestic demand for GoA debt; and
- ARP 4.8 billion loan repayments (mainly from Provinces).


19. (SBU) Central Bank (BCRA) net financing totals ARP 2.1
billion as a result of ARP 20.4 billion financing and ARP
18.3 billion GoA repayment of short-term BCRA financing. The
Budget assumes the IDB and World Bank will reduce their net
exposure, providing ARP 7 billion total financing, with
scheduled GoA repayments of ARP 4.3 billion to the Bank and
ARP 3.3 billion to the IDB.

Province Debt Renegotiation: Tool To Gain Political Support
-------------- ---

20. (SBU) The 2007 Budget allows the Ministry of Economy to
modify (restructure) the financial conditions of provincial
debt owed to the federal government, although it lacks
details on the terms and conditions of the restructurings.
This is a key provision for the GOA during an election year,
as the Provinces are beginning to face financial difficulties
and this is one way to gain their favor. According to local
think tank, "Economia y Regiones," provincial debt available
for restructuring totals ARP 6 billion (almost $2 billion, or
10% of total provincial debt to the GoA).

Comment
--------------

21. (SBU) The 2007 Budget has clearly been designed to
support the Kirchner administration's re-election bid next
October. The positive (forecasted) fiscal balance and
increased social expenditures, transfers, and subsidies to
the private sector (in order to keep energy and
transportation prices low and control inflation),all serve
to win voter support for the GoA. The Budget's
underestimation of GDP growth will likely result in ARP 8 -
12 billion extra revenue, and the "Superpowers" law will
allow the GoA to use this available cash to target social and
infrastructure expenditures to woo particular constituencies.
End Comment.
WAYNE