Identifier
Created
Classification
Origin
06BUENOSAIRES300
2006-02-08 16:18:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy Buenos Aires
Cable title:  

The 2006 Monetary Program Unlikely to Help

Tags:  EFIN ECON ELAB ALOW AR 
pdf how-to read a cable
VZCZCXYZ0001
RR RUEHWEB

DE RUEHBU #0300/01 0391618
ZNR UUUUU ZZH
R 081618Z FEB 06
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC 3349
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUEHRC/USDA FAS WASHDC 2067
RUEHC/DEPT OF LABOR WASHDC
RHMFISS/HQ USSOUTHCOM MIAMI FL
UNCLAS BUENOS AIRES 000300 

SIPDIS

SENSITIVE
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: The 2006 Monetary Program Unlikely to Help
Reduce Inflation


UNCLAS BUENOS AIRES 000300

SIPDIS

SENSITIVE
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: The 2006 Monetary Program Unlikely to Help
Reduce Inflation



1. (U) Sensitive but unclassified. Not for internet
distribution.

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


2. (SBU) Central Bank (BCRA) President Martin Redrado
presented the BCRA's 2006 monetary program on December

29. It will maintain a moderately contractive
monetary policy, with a small increase in interest
rates. Redrado acknowledged that meeting the 8-11
percent inflation target will be a lower priority than
recovering the USD 9.5 billion in reserves used to pay
off the IMF. Even with GOA help in managing the
exchange market, the BCRA will be challenged to
rebuild reserves, meet its monetary targets, and keep
interest rates low. The BCRA will use M2 as its
monetary indicator this year instead of the monetary
base. The BCRA does not have direct control over M2
so the M2 target will be harder to reach. Nor, as in
2005, will reaching the target guarantee that
inflation will be brought under control. Virtually
all economic analysts are forecasting higher 2006
inflation than the BCRA, averaging 12.3 percent, with
some forecasting a 15 percent floor. End Summary.

--------------
The BCRA Unveils its 2006 Monetary Program
--------------


3. (U) The President of the BCRA, Martin Redrado,
presented the BCRA's 2006 monetary program to the
Senate Treasury and Budget Commission on December 29.
During his presentation, Redrado noted that the 2006
monetary program will no longer focus on the monetary
base but rather on the performance of M2 (cash plus
public and private sector current and saving
accounts). The change in the variable is due to the
increase in credit and resulting increase in the money
multiplier. (Note: Credit expansion increased the
money multiplier -- measured as the ratio of M2 over
the monetary base -- from 1.8 in January 2005 to 2.0
in December. End note.)



4. (U) Redrado argued that the Argentine financial
system has not yet recovered enough to properly
implement an inflation targeting regimen. He defended
the BCRA's policy of relying on monetary targets to
manage inflation, saying that the speed of money
circulation is less volatile than interest rates in
Argentina. Also, the absence of a reference interest
rate makes it more reasonable for the BCRA to use
monetary targets to control inflation. When
questioned about the acceleration of inflation despite
the BCRA meeting its 2005 monetary targets, Redrado
argued that prices were increasing due to an expansive
fiscal policy, salary hikes and supply bottlenecks in
the manufacturing industry. (Note: 2005 inflation
reached 12.3 percent, compared to 6.1 percent in 2004
and 3.7 percent in 2003. End Note.)


5. (U) Highlights and assumptions of the 2006 BCRA
Monetary Program include:

- Real GDP growth of 6.2 percent, similar to the
assumptions in the 2006 Budget.

- Average inflation of 8-11 percent, not including any
utility tariff increases. This is below the average
market forecast of 12.3 percent.

- An increase of BCRA reserves to USD 28 billion by
the end of 2006. This is the same reserve level as
December 2005, before the GOA paid off its USD 9.5
billion debt to the IMF, and indicates that the BCRA
will continue its strategy of accumulating reserves
through intervention in the foreign exchange market.
As of January 19, BCRA reserves stood at USD 18.9
billion.

- Exports increase to USD 43.5 billion and imports to
USD 32 billion, resulting in a trade surplus of USD
11.5 billion. This is expected to be the main source
of foreign currency.

- M2 growth of 11.7-21.2 percent, leading M2 to ARP
116-126 billion by the end of December. M2 is
currently at ARP 105.3 billion and increased 25
percent in 2005.

-------------- --------------
BCRA Monetary Program Targets for M2 (in billions)
-------------- --------------

Mar 2006 Jun 2006 Sept 2006 Dec 2006
-------------- --------------
Lower-Band 104.4 107.8 110.7 116.3
Upper-Band 110.9 115.4 119.3 126.2
-------------- --------------

--------------
What to Expect from the BCRA Monetary Policy
--------------


6. (U) During his presentation to Congress, Redrado
noted that the BCRA would have a moderately
contractive monetary policy in 2006, in coordination
with GOA fiscal policy, aiming to keep control over
the growth of monetary aggregates, and with only
slight increases in interest rates that would promote
higher savings without jeopardizing economic growth.


7. (U) In a press interview on January 17, Redrado
argued that the shift to targeting M2 was a signal of
a potentially more contractive monetary policy. He
further insisted that the shift demonstrated the
BCRA's commitment to control inflation. He admitted,
however, that targeting M2 would be harder for the
BCRA. The desired monetary contraction would likely
be achieved through an increase in banks' reserve
requirements rather than a direct increase in interest
rates, which would have a negative effect on growth.
(Comment: However, increasing bank reserve
requirements will also result in higher interest rates
since it will reduce the amount of funds that banks
have to invest. Reserve requirements currently are 15
percent for checking and saving accounts. There is no
reserve requirement for time deposits of more than six
months. End Comment.)


8. (U) Redrado acknowledged that meeting the 8-11
percent inflation target would be a lower priority
than rebuilding the BCRA's foreign reserves following
the USD 9.5 billion payment to the IMF on January 3.
He recognized the need for the BCRA to recoup those
reserves to insulate the economy from potential
external shocks or financial fluctuations and admitted
that a prudent policy of accumulating reserves will
indeed impact interest rates and the exchange rate,
and may prevent the BCRA from reaching its inflation
target.


9. (U) In a recent publication dated January 2006, the
Exante consulting company argued that the shift to M2
likely was designed to help the BCRA increase its
foreign currency reserves. They argue that if reserve
requirements are raised, banks will have an incentive
to sell their dollar holdings to the BCRA to obtain
the pesos they need to meet the higher requirements.

-------------- --------------
Embassy Scenarios for the Foreign Exchange Market
-------------- --------------

-------------- --------------

A. BCRA Re-purchases USD 6.5 Billion of the Foreign
Exchange Surplus
-------------- --------------


10. (SBU) The private sector foreign exchange surplus
will reach USD 14 billion in 2006, according to a
Banco Frances report. In a scenario in which the GOA
purchases USD 7.5 billion of foreign exchange, the
BCRA would only need to purchase the remaining USD 6.5
billion, well below the BCRA's 2005 purchases of USD
9.4 billion. In this scenario, the BCRA could fulfill
its monetary program without the pressure of
increasing Lebac issuance and increasing interest
rates, since the monetary base expansion of ARP 19.8
billion (USD 9.5 billion times an assumed exchange
rate of 3.05 ARP/USD) could be sterilized with a
reduced amount of Lebacs and a reasonable level of
repo transactions. (Note: in this scenario, the
monetary base and M2 grow at the same rate. The BCRA
absorbed ARP 10 billion from the money supply by
issuing Lebacs in 2005, which were the most
contractive factor for the monetary base. End Note.)

-------------- --------------

B. BCRA Re-purchases USD 10 Billion of the Foreign
Exchange Surplus
-------------- --------------


11. (SBU) However, if the BCRA seeks to rebuild its
foreign exchange reserves by purchasing USD 10 billion
in dollars, the BCRA will be forced to increase its
sterilization efforts, increasing its Lebac issuance
and raising interest rates. In this scenario, the
monetary base (and M2) increase by ARP 28.9 billion.

--------------

C. Rebuilding Reserves in Q1 2006
--------------


12. (SBU) If the BCRA wants to recover its reserves
while inflation is accelerating, it will have to
sterilize large peso emissions to avoid further price
acceleration. Analyzing only the first quarter of
2006, and assuming that the BCRA purchases USD 2.4
billion in reserves in the quarter (one-fourth of the
USD 9.5 billion paid to the IMF),the monetary base
would expand by ARP 7.2 billion (at the exchange rate
of 3.05 ARP/USD). Making the further assumption that
M2 is allowed to expand to ARP 110.9 billion (the
upper limit of the M2 target for March 2006),and
given that currently M2 stands at ARP 105.3 billion,
the BCRA would only need to sterilize ARP 1.6 billion
in the first quarter, which seems manageable at first
blush.


13. (SBU) However, the BCRA's recent policy of issuing
short-term Lebacs will complicate this sterilization.
The BCRA will have to roll over all the ARP 10 billion
in Lebacs coming due in February and March in addition
to sterilizing ARP 1.6 billion issued for reserve
repurchases, the BCRA thus will have to increase its
Lebacs USD 11.6 billion. To accomplish this, the BCRA
likely will have to raise its interest rates,
increasing the BCRA's quasi-fiscal costs. During
January, the BCRA did not raise rates at its Lebac
auctions and managed only to partially refinance its
maturities by issuing very short-term (less than 3
months) instruments. (Comment: the above scenarios
make a key assumption that the monetary base and M2
grow at the same rate. However, if the money
multiplier increases in 2006, the sterilization
challenges for the BCRA will become even more complex.
End Comment.)


14. (SBU) Virtually all domestic and international
analysts forecast higher inflation than the 8-11
percent range projected by the BCRA, suggesting that
the GOA policy of "voluntary" price restraint

agreements will not succeed. The latest BCRA
consensus survey (from January 4) forecast 12.3
percent inflation for 2006, and some analysts are
projecting a floor of 15 percent inflation for the
year.

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


15. (SBU) Redrado has signaled very clearly that the
BCRA's priority in 2006 will be accumulating reserves
rather than keeping interest rates low or inflation
under control. It is not yet clear, but is likely,
that the GOA will use its fiscal capacity to absorb
excess dollars in the foreign exchange market and help
the BCRA avoid an appreciation of the peso. Even with
GOA help, the BCRA will be challenged to find ways to
sterilize a large amount of pesos without raising
interest rates while meeting its monetary target and
rebuilding reserves.


16. (SBU) The BCRA's focus on M2 rather than the
monetary base is viewed positively by most analysts
because it better reflects the money supply. Credit
expansion and stronger financial intermediation have
increased the money multiplier and made the monetary
base a less reliable target. Also, M2 is more closely
aligned with consumer spending and savings patterns,
making it a better inflation indicator. However, many
variables that make up M2 are out of the BCRA's
control, such as the public's willingness to hold
pesos or deposit funds in banks. That will make it
more difficult for the BCRA to meet its M2 target.


17. (SBU) Even if the BCRA meets its M2 target, it in
no way guarantees that the BCRA has inflation under
control. The BCRA complied with its 2005 monetary
targets every quarter, while inflation accelerated.
It managed to meet its 2005 targets only by changing
the definition of the monetary base and changing
regulations to prompt banks to prepay their peso
discount borrowing. The M2 target for 2006 also
offers opportunities for such creative accounting
(although some analysts believe it will be more
difficult with an M2 target). For example, given that
public deposits are included in M2, GOA deposits could
be shifted as necessary to comply with the monetary
targets.


18. (U) To see more Buenos Aires reporting, visit our
classified website at
http://www.state.sgov/p/wha/buenosaires

GUTIERREZ