Argentina Economic and Financial Weekly for

UNCLAS BUENOS AIRES 000635 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 March 17, 2006 -------------- -------------- Weekly Highlights -------------- -------------- - GDP growth was 9.2 percent y-o-y in 2005. - The industrial production index rose 8.8 percent y-o- y in February. - President Kirchner urges Argentines not to buy beef if prices continue to rise. - The Central Bank (BCRA) increases bank liquidity requirements for sight accounts. - The BCRA rolls over its maturities by accepting bids on longer-term Nobacs. - The GOA increases the minimum threshold for paying individual income tax. - The peso appreciated versus the USD this week, closing at 3.09 ARP/USD. - Commentary of the Week: "The Dilemma of Financing New Infrastructure" -------------- -------------- ECONOMY / FINANCE -------------- -------------- -------------- -------------- GDP up 9.2 percent y-o-y in 2005. -------------- -------------- ¶1. GDP increased 9.1 percent y-o-y in the fourth quarter of 2005 - well above the BCRA consensus forecast of 8.4 percent - bringing annual GDP growth for 2005 to 9.2 percent. Growth was mainly driven by investment and strong consumer spending. Investment increased 27 percent y-o-y in the fourth quarter, due to a 26 percent y-o-y increase in construction and a 29 percent increase in plant and machinery, while private consumption increased 8 percent y-o-y. Production of goods grew 9.6 percent y-o-y and services were up 8.4 percent y-o-y. The strong GDP performance at the end of 2005 provides a high 4 percent statistical carryover effect for 2006 GDP growth, which currently is forecast to reach 6.9 percent in the Central Bank (BCRA) consensus survey. -------------- -------------- February industrial production index up 8.8 percent y- o-y. -------------- -------------- ¶2. The industrial production index rose 8.8 percent y- o-y in February, above the BCRA consensus of 7.6 percent. During February, the fastest growing sectors were car production (up 122 percent),tobacco production (up 23.8 percent),and minerals (up 15.3 percent). There was a slight decrease in paper and cardboard (down 7.3 percent). The index increased 0.2 percent m-o-m without seasonal adjustment and 3.1 percent m-o-m when seasonally adjusted. The month-on- month increase in production is mainly explained by an increase in the automobile industry, up 151 percent m- o-m after a poor performance in January affected by plant retooling. The BCRA consensus survey forecasts 6.4 percent industrial production growth for 2006. ¶3. The industry-wide capacity utilization index reached 70.6 percent in February, compared to 69.2 percent in February 2005. The sectors showing the highest capacity utilization were metal based industries (96.5 percent),oil refining (94.5 percent),textiles (80.2 percent),and printing (76 percent). The sectors with the lowest capacity utilization were auto production (46.8 percent) and minerals (58.4 percent). -------------- -------------- President Kirchner urges Argentines not to buy beef if prices continue to rise -------------- -------------- ¶4. The GOA suspended beef exports for 180 days starting March 14 to increase local supply and avoid further increases in domestic beef prices. Beef is a mainstay of the Argentine diet and is a major component of the Basic Basket that determines the poverty, indigence and inflation rates. The price of beef increased more than 25 percent between November 2005 and the beginning of March 2006. On March 13, Ministry Miceli said that the suspension could be extended an additional 180 days if the price of beef did not come down. On March 14, after a 6 percent increase in beef prices in just one day, President Kirchner urged people not to buy beef unless prices went down, to prevent "extortion" by producers. He added that nobody could believe that price increases were solely the result of demand and supply interaction. Beef prices went up an additional 1 percent in wholesale markets on March 15, and further increases are expected due to climatic conditions that complicate the transport of cattle. -------------- -------------- GOA reaches a price-restraint agreement with pork producers. -------------- -------------- ¶5. On March 15, the GOA closed a new price-restraint agreement with pork producers to maintain pork prices unchanged. According to GOA officials, the aim of the agreement is to encourage the consumers to buy pork instead of beef and thus avoid further increases in beef prices. The new accord advances the GOA's strategy of curbing inflation through price-restraint agreements with producers and retailers. -------------- -------------- BCRA increases bank liquidity requirements for sight accounts. -------------- -------------- ¶6. The BCRA issued a circular on March 13, raising bank liquidity requirements for sight accounts (current and savings accounts) by 2 percentage points to 17 percent, and eliminating the 2.55 percent annual return rate that the BCRA pays banks for their minimum reserves. The measure will go into effect at the beginning of April. The BCRA expects the measure to absorb ARP 1.9 billion from the financial system, assuming that private and public sector deposits total ARP 63.9 billion. The aim of this move is to boost productive investment and savings by encouraging banks to pay a higher interest rate for time deposits and, at the same time, take more pesos out of circulation. -------------- -------------- BCRA rolls over its maturities by accepting bids on longer-term Nobacs. -------------- -------------- ¶7. The BCRA received ARP 749 million in bids in its March 14 Lebac auction, less than the ARP 1.7 billion in Lebacs that came due during the week. However, the BCRA received ARP 1.3 billion in bids in its Nobac auction. [Nobacs are longer term instruments than Lebacs and pay a variable rate composed of base rate called Badlar -- the interest rate for deposits of more than ARP 1 million, currently at 7 percent -- plus a spread. The BCRA auctions the spread on its Nobacs, while the Badlar is determined by market conditions.] As in previous auctions, the BCRA was able to roll over its maturities by accepting bids for ARP 1.7 billion (ARP 749 million in Lebacs and ARP 965 million in Nobacs). The yield on the 35-day Lebac decreased from 6.75 percent to 6.70 percent, while the yield on the 63-day Lebac dropped from 6.95 percent to 6.85 percent. The yield on the 91-day Lebac remained unchanged at 7.25 percent. Lebacs for other maturities were withdrawn due to lack of interest. Investors concentrated more than 63 percent of their bids in Nobacs of more than 9 months and the BCRA accepted bids for ARP 965 million of Nobacs (56 percent of the accepted bids in the auction). The spread on the nine-month Nobac decreased two basis points, from 3.09 percent to 3.07 percent, while the spread on the two-year Nobac dropped nine basis points from 5.11 percent to 5.02 percent. Investors are increasing their bids in Nobacs, since these instruments have a variable rate and provide a higher yield (10.9 percent and 12.9 percent for the 9-month and 2-year Nobac, respectively). -------------- -------------- GOA increases the minimum threshold for the income tax. -------------- -------------- ¶8. On March 15, Minister of Economy Felisa Miceli announced that the GOA had decided to raise the minimum threshold for the income tax for both salaried employees and the self-employed. The minimum threshold for the income tax will be increased from ARP 1,835 to ARP 2,400 per month for single salaried employees, and from ARP 2,235 to ARP 3,000 per month for married salaried employees. The minimum threshold also will be also from ARP 835 to ARP 1,000 for single self-employed people, and from ARP 1,235 to ARP 1,800 for married self-employed people. Taxes are paid on income earned that is above this minimum threshold. According to official estimates, this measure will have an annual fiscal cost of ARP 1.5 billion. -------------- -------------- The peso appreciated versus the USD this week, closing at 3.09 ARP/USD. -------------- -------------- ¶9. The peso appreciated versus the USD this week, closing at 3.09 ARP/USD, after reaching its lowest value in three years last week. The peso's appreciation early in the week is mainly explained by lower dollar demand by banks, and by the Central Bank's (BCRA) intervention in the FX market on Monday and Tuesday, when it sold dollars to counteract the effect of its recent large purchases. However, the BCRA purchased USD 57.5 million and EUR 141.5 million in the last three days of the week. The peso exchange rate has depreciated 1.3 percent since the beginning of the calendar year. -------------- -------------- Commentary of the Week: "The Dilemma of Financing New Infrastructure". By Daniel Montamat. [Note: Translated and used with permission of the author, from an article published March 7 in El Cronista Comercial. End Note.] -------------- -------------- ¶10. With sustained annual GDP growth of between 3 and 5 percent, we will need to invest between USD 1.5 billion and USD 3.5 billion in the energy sector alone. A CEPAL study projecting investment in infrastructure to 2010 found that at a growth rate of 3 percent per year, we will need to invest USD 6 billion in infrastructure (part of that in maintenance and replacement, the rest in new investments). Neither public investment nor international financial institution financing will be sufficient. There must be private investment and financing. Because of the intrinsic business risk and the Argentine uncertainty factor, new investment will be either expensive or insufficient. ¶11. Transport, energy and telecommunications infrastructures have high fixed capital costs. As long as capacity exists in the system, the cost of providing additional units is low in relation to the total cost. The problem comes when networks are saturated or the capacity of infrastructure reaches its limit and one has to face new and high fixed costs. Who will invest in these durable capital goods? How will they be financed, and at what cost? And who will pay for these works? ¶12. To resolve these questions, it is important to distinguish between the concept of accounting cost and economic cost. An accountant works with variable and fixed costs from a historical point of view; an economist talking about economic costs is thinking of present alternative uses for the resources used (opportunity cost). Ronald Coase used a simple example to make clear the difference between an accounting view of costs and the economist's concept: An accountant would say that the cost of a machine is its depreciation; the economist would say that it is the income that could have been obtained by using the machine for another purpose. If the machine has no alternative use, the economic cost is zero. Because of this, John Hicks, another Nobel Prize-winning economist, maintained that when an enterprise invests in fixed capital, it "makes itself a hostage to the future." Its capital is sunk because usually there are no alternative uses for fixed capital goods. In turn, while capacity exists in the system, the cost of producing an additional unit is low. This is why, when there is a need to expand or create new infrastructure, investors think not only about the cost of the work, but also the time during which they will be held hostage while recovering his investment. If they lack confidence in the future, they will discount fixed capital investments at high rates to shorten the time needed to recover his investment. High discount rates make public works projects -- and, as well, the mechanism of repayment -- expensive. If the resulting public service tariffs are expensive for the average consumer's budget, the project won't be built, or the State will have to build it with tax revenues that also are taken from the public. But public resources are not sufficient to pay for all the needed investments in infrastructure. ¶13. Accounting was born as a commercial tool when trade did not require large investments in fixed capital. The original principles of accounting did not include amortization of capital expenses. The focus was on variable costs and these old accounting practices were decisive for crystallizing the concept of marginal costs in economics. Accounting principles had to be revised to take capital depreciation into account after the railroad crisis in the United States in the 19th century (until then, accounting rules produced profits that ignored the need to renew fixed assets and resulted in tariff rates that did not even recover marginal costs). When the importance of fixed capital in new manufacturing processes became clear, it became accepted in accounting practice to include their relative weight in total costs. But economic theory continues to cling to the marginal cost paradigm. If a machine can't be put to some alternative use and has the capacity of producing one additional unit, we use it as long as it lasts. Both orthodox and heterodox economists, for different reasons, subscribe to this short-term logic, which is disruptive for long-term capital investments, and which plays into the hand of demagogic politicians. ¶14. Argentina's infrastructure suffers from the lack of a long-term development strategy and is entangled in a short-term viewpoint that drives away investors and raises costs. The State has taken over some infrastructure works that would never have been completed on "auto-pilot" (the Federal Plan for Electricity Transport),and has to create ad hoc rules to force investment with high costs when private companies invest (expansion of gas pipelines). But there is a growing gap between the investment needed and what is being completed and infrastructure is becoming a barrier to sustaining the economic expansion. What is urgently needed is to establish mechanisms that stimulate investments in infrastructure. [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.] ¶15. To see more Buenos Aires reporting, visit our classified website at: http://www.state.sgov.gov/p/wha/buenosaires GUTIERREZ