BOLIVIAN ECONOMY HUMS ALONG DESPITE UNCERTAINTY

UNCLAS LA PAZ 002638

SIPDIS

SENSITIVE
SIPDIS

STATE FOR WHA/AND
TREASURY FOR SGOOCH
ENERGY FOR CDAY AND SLADISLAW

E.O. 12958: N/A
TAGS: ECON EFIN EINV ENRG EPET ETRD BL
SUBJECT: BOLIVIAN ECONOMY HUMS ALONG DESPITE UNCERTAINTY

REF: LA PAZ 2599


1. Summary: Bolivia's GDP grew by 4.5 percent during the
first semester of 2006 due to high international prices for
the country's main exports: hydrocarbons and minerals.
Exports grew by 52 percent in the first six months compared
with the same period in 2005, contributing to an increase in
international reserves to record amounts. However,
investment prospects are poor due to legal uncertainty and
statist GOB economic policies. Inflation increased slightly
during the first eight months, while the boliviano
appreciated marginally. The government had a fiscal surplus
in mid-September, with a projected year-end surplus of 1.5
percent. Bank deposits and loan portfolios increased
slightly during the first eight months. Although the
short-term picture is positive, several risk factors threaten
long-term growth. End summary.

Positive Growth Trend Continues
--------------

2. Bolivia's GDP grew by 4.5 percent in the first half of
2006, surpassing projections of 4.1 percent. (Note: 2005 GDP
was USD 8.7 billion. End note.) This growth was due mainly
to high international prices for the nation's principal
exports -- hydrocarbons and minerals -- and an increase in
domestic consumption of cement and electricity. During the
first semester of 2006, the hydrocarbons sector grew by 12.4
percent, while the mining sector grew by 18.7 percent.
Silver prices increased by 55 percent, gold by 38 percent,
zinc by 114 percent, and natural gas by 58 percent in the
first half of 2006 compared with the same period in 2005.
Bolivia signed an agreement with Argentina in June that
increased the price of Bolivian gas exports to its neighbor
from USD 3.2 per million BTU to USD 5 per million BTU between
July 15 and year-end 2006.

Exports Increase
--------------

3. In the first half of 2006, Bolivia had a USD 498 million
trade surplus. During that period, the value of exports
increased by 52 percent in comparison with the first half of
2005, reaching USD 1.71 billion. The value of natural gas
exports increased by 75 percent, zinc by 145 percent, and
silver by 109 percent in the first six months. Gas export
value increases were due to both higher prices and higher
volumes resulting from greater demand by Argentina and
Brazil. Mineral export value increases were driven mainly by
rising prices. Export growth, along with a 67 percent
increase in remittances from outside the country in the first
semester of 2006 compared with the same period in 2005,
contributed to the increase in net international reserves
held by the Central Bank to USD 2.77 billion at the end of
August 2006.

But FDI Prospects are Poor
--------------

4. Net Foreign Direct Investment reached USD 103.5 million in
the first semester of 2006, compared with negative 23.3
million during the same period in 2005. Although the total
amount of FDI received in the first semester of this year
(USD 210.5 million) was only a slight increase over 2005 (USD
206.9 million),the amount of capital flight in the first
half of 2006 (USD 107 million) was significantly less than
that of the same period last year (USD 230 million). The
mining sector received the largest amount of FDI (USD 118
million),followed by hydrocarbons (USD 47 million) and
industry (USD 25 million). Although the investment picture
has improved compared with 2005, long-term prospects are not
rosy. The GOB's policy of nationalizing hydrocarbons and
tightening state control over several other strategic sectors
has deepened uncertainty and weakened the investment climate.

Inflation Increases, Boliviano Appreciates
--------------

5. The inflation rate decreased from 3.7 percent at the end

of first quarter 2006 to 3.5 percent by the end of June,
within the 3 to 5 percent target range established by the
Central Bank for inflation at year-end. However, inflation
increased to 4.4 percent at the end of August. The Bolivian
Economics Center predicts that inflation will stay fairly
low, around 4 percent, for the year if the GOB manages public
finances well and the currencies of Bolivia's principle
trading partners depreciate. During the first semester of
2006, the Bolivian national currency, the boliviano,
appreciated nominally by 0.25 percent. Money supply (M2)
increased dramatically during the first six months of 2006,
growing by 10.2 percent. Bolivians absorbed the increased
liquidity, sharply increasing their holdings of bolivianos.

First Semester Fiscal Surplus, Public Debt Reduced
-------------- --------------

6. The GOB had a surplus of USD 437 million during the first
semester, which reached USD 578 million by mid-September
2006, according to government sources. The surplus resulted
mainly from high prices received for the country's main
exports and increased tax (including hydrocarbons taxes) and
customs collections. Press reports indicate that the
National Tax Service collected USD 600 million more during
the first semester of 2006 than in the same period of 2005.
Treasury contacts told Econoff that Bolivia's fiscal deficit
will narrow to zero by year-end, while the press quoted the
Finance Minister on September 27 saying that he projects
Bolivia to have a fiscal surplus of around 1.5 percent at
year-end. Bolivia's original projection of a 3.4 percent
deficit was revised due to higher than expected tax revenues
and lack of institutional capacity for executing spending
plans. Foreign external debt was reduced significantly by
IMF and World Bank debt forgiveness during the first seven
months of 2006 to USD 3.15 billion on July 1, compared with
USD 4.7 billion at the end of the first quarter. Internal
debt increased by 17 percent compared with year-end 2005 to
USD 2.99 billion as of June 30.

Banking System Sound in First Semester
--------------

7. Total bank deposits remained stable during the second
quarter of 2006 and increased slightly between June and
August from USD 3.15 billion to USD 3.26 billion. Loan
portfolios grew marginally during the second quarter and
increased from USD 2.65 billion to USD 2.71 billion between
June and August. Loans in default decreased by almost two
percentage points during the second quarter. Bank liquidity
remained high at USD 1.2 billion as of August 31.

Economic Indicators March 31 June 30 Aug 31
-------------- --------------
Inflation rate 3.72 pct 3.5 pct 4.4 pct
Local currency appreciation 0.38 pct 0.25 pct 0.12 pct
Bs/USD exchange rate 8.07 8.06 8.05
Exports (USD) 798.2 mn 1.71 bn
Net International Reserves (USD)2.014 bn 2.47 bn 2.77 bn
Public Sector surplus (USD) 220.8 mn 437 mn 578 mn
Public Debt (USD) 7.002 bn 7.66 bn 6.14 bn
Public Debt (pct of 2005 GDP) 80.2 pct 88 pct 70 pct
Bank deposits (USD) 3.15 bn 3.15 bn 3.26 bn
Bank loan portfolio (USD) 2.60 bn 2.65 bn 2.71 bn
Portfolio in default 12.1 pct 10.4 pct 10.3 pct
Bank liquidity (USD) 1.20 bn 1.11 bn 1.20 bn

Sources: Bolivian Central Bank, UDAPE, INE

Comment: Risks to Growth Projections
--------------

8. (SBU) Although macroeconomic conditions remained positive
during the first semester of 2006, many risk factors threaten
mid and long-term growth. Bolivia stands to lose its U.S.
trade preferences under ATPDEA in December, which implies a
decrease in exports and a loss of thousands of manufacturing
jobs. The GOB's policies of increasing state control in the
hydrocarbons and other key sectors likely mean that private

investment will remain low. Also, the increasing
politicization of the Central Bank could threaten
macroeconomic stability (reftel). End comment.
GOLDBERG