ARGENTINA ECONOMIC AND FINANCIAL REVIEW, JUNE

UNCLAS BUENOS AIRES 001180

SIPDIS

SENSITIVE
SIPDIS

TREASURY FOR CLAY LOWERY, NANCY LEE, AJEWEL, WBLOCK, LTRAN
NSC FOR JOSE CARDENAS, ROD HUNTER
PASS FED BOARD OF GOVERNORS FOR RANDALL KROSZNER, PATRICE
ROBITAILLE
PASS EXIM BANK FOR MICHELE WILKINS
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USDOC FOR 4322/ITA/MAC/OLAC/PEACHER

E.O. 12958: N/A
TAGS: EFIN ECON EINV AR
SUBJECT: ARGENTINA ECONOMIC AND FINANCIAL REVIEW, JUNE
4-12, 2007



1. (U) Provided below is Embassy Buenos Aires' Economic and
Financial Review covering the period June 4-12, 2007. The
unclassified email version of this report includes tables and

SIPDIS
charts tracking Argentine economic developments. Contact
Econoff Chris Landberg at landbergca@state.gov to be included
on the email distribution list. This document is sensitive
but unclassified. It should not be disseminated outside of
USG channels or in any public forum without the written
concurrence of the originator. It should not be posted on
the internet.

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Highlights
--------------

-- Argentina's trade deficit with Brazil narrows 15% due to
strong Real
-- Exports rising, imports increasing faster, but terms of
trade improving
-- U.S. closes antidumping case against Argentina
-- Energy shortages impact growth projections for 2007
-- Are Argentina's reserves and resulting costs of
sterilization too high?
-- GoA issues peso denominated Bonar V at a yield of 11.70%

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Economic Outlook
--------------

Argentina's trade deficit with Brazil narrows 15% due to
strong Real
-------------- ---

2. (U) Argentina's trade deficit with Brazil shrank over the
first five months of 2007, the first such reversal in several
years. Exports to Brazil in that period were $3.9 billion,
35% more than the same period in 2006, led by a 68% increase
in exports of autos and auto parts. Imports were $5.1
billion, 18% higher. The resulting trade deficit of $1.27
billion was 15% lower than the deficit for the same period in
2006 ($1.5 billion). Local analysts attribute the change to
the stronger Real. Argentina had a $2.3 billion surplus with
Brazil in 2002, followed by deficits of $33 million in 2003,
$2.1 billion in 2004, and $4.1 billion in both 2005 and 2006.
Imports from Brazil grew from $2.5 billion to $12.3 billion
during that period, while exports only rose from $4.8 to $8.1
billion.

Exports rising, imports increasing faster, but terms of trade
improving
-------------- -

3. (U) Exports in dollars rose 9% y-o-y in April, to a record
monthly high of $4.261 billion. This increase was due to an
8% y-o-y increase in prices and a 1% y-o-y increase in
quantities, and primarily explained by exports of cereals.
Imports rose 23% y-o-y in April to $3.139 billion, mainly due
to increased quantities (22%). Imports of intermediate goods
and parts of capital goods, accounted for 66% of this
increase. April's trade surplus was $1.162 billion, or 18%
lower than in April 2006. Exports rose 10% y-o-y in the
first four months, to $15.27 billion, while imports increased
24% y-o-y to $12.3 billion. The surplus was $2.97 billion
during the first four months, or 23.8% y-o-y lower than the
equivalent period in 2006.


4. (U) Argentina has benefited from the commodity price boom,
but not to the same degree as many other commodity exporting

countries. Argentina is a world-class exporter of
agricultural products, but is not as significant of an
exporter of petroleum and energy. Petroleum prices in
dollars increased 391.5% between 1998 and 2006, while prices
for most agricultural goods have only increased between 20
and 30% from their highs in the 1990s. Petroleum prices
declined 16.8% between Q3 2006 and Q1 2007, while food prices
increased 6% during the same six months. During that period,
Argentina's terms of trade (price of exports over price of
imports) improved 0.9%, compared to an improvement of 13.9%
since Q1 2005.


5. (U) Between 2003 and 2006, Argentine exports grew 80% in
dollar terms from $25.65 billion to $46.18 billion, while
imports increased about 280% from $9 billion to $34.19 (Note:
imports plummeted by 55.7% in 2002). Argentina still manages
to have a trade surplus, partly due to the more favorable
terms of trade (but also because of increasing volumes,
particularly in agriculture). Although food prices have not
grown as much as those of petroleum, the former exhibit a
growing trend that appears likely to continue in the medium
term, which bodes well for Argentina's ability to maintain
its trade surplus.

U.S. closes antidumping case against Argentina
-------------- -

6. (SBU) A bilateral trade dispute between the U.S. and
Argentina, dating to 1995, appears to be finally nearing the
end. The U.S. has applied antidumping duties to Argentina's
exports to the U.S. of oil country tubular goods (OCTG -
specialized steel pipes used in petroleum fields) since 1995,
and the Argentine government filed WTO complaints against the
U.S. for its sunset reviews in both 2000 and 2005. The
appeal was finalized on April 12, 2007, with both sides
claiming victory, as U.S. sunset procedures were upheld but
the duties in this specific case were unsupported.


7. (SBU) Accordingly, the U.S. announced May 31 that it would
revoke the antidumping duties. However, on May 25 the GoA
had stated its intention to seek $44 million in compensation
for lost exports. Although an Econ Ministry contact says the
GoA claim "should be dropped" if the duties have been
revoked, a Foreign Ministry official familiar with the case
said that the U.S. announcement to revoke duties was "an
excellent signal," but the GoA would wait for the official
revocation before terminating its compensation request.

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Energy
--------------

Energy shortages impact growth projections for 2007
-------------- --------------

8. (U) Dr. Daniel Artana, the Chief Economist of FIEL
(Fundacion de Investigaciones Economicas Latinoamericanas),
one of Argentina's most well-known private think-tanks,
stated during a May 30 presentation that recent gas and power
cuts would adversely impact Argentina's economic growth in

2007. He blamed the cuts on the unusually cold weather in
May, but they are also the expected result of the GoA's
policies since 2002 of controlling utility prices. These
tariff controls have deterred new investment in exploration
(for gas),as well as in generation, transmission, and
distribution of both electricity and gas. Using as a
reference Brazil's experience and energy rationalization
plans enforced at the end of the 1990s, Artana estimated that

energy sector problems would result in a reduction in 2007
real GDP growth of up to one percentage point. However, he
argued that the impact of energy problems in Argentina could
be even worse than they were in Brazil, since the GoA has
enforced rationing on industries and commercial users while
protecting residential users as much as possible. Conversely
in Brazil, Artana stated, all sectors shared the brunt of the
shortages.

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Banking and Finance
--------------

Are Argentina's reserves and resulting costs of sterilization
too high?
--------------

9. (U) During the May 30 presentation, FIEL Chief Economist
Daniel Artana compared the amount of Argentina's official
reserves against those of Brazil and Mexico. He used
different measurements to assess whether Argentina had
amassed an excessive amount of reserves as a result of its
policy of purchasing foreign currency to avoid the nominal
appreciation of the peso. Artana noted that Argentina's
reserves/GDP ratio of 18.5% was high relative to Brazil
(12.1%) and Mexico (7.1%). Argentina also has 14.4 months of
import cover, significantly higher than Mexico's 3.3 months,
although only slightly higher than Brazil's level. Artana
also compared several reserve/debt ratios (including both
public and sector debt),which in most cases show Argentina
as having a margin -- compared to the other two -- to
continue accumulating reserves.


10. (U) The flip-side of the Central Bank's reserve
accumulation policy is the cost of sterilizing the increased
money supply, which it does by issuing relatively short term
bills and notes (Lebacs and Nobacs). According to Artana,
the BCRA still has a margin to continue issuing debt without
incurring a quasi-fiscal deficit (difference between the
interest earned and paid on BCRA assets and liabilities).
However, he argued that this window would close relatively
soon. He commented that Central Bank President Martin
Redrado would not want to be remembered as the one
responsible for running a quasi-deficit, so would soon pursue
alternative ways to mop up (or absorb) excess peso liquidity
(Note: Artana assumes that allowing the peso to appreciate
is not an option). One option would be to increase bank
reserve requirements, which he has already done once in 2007.
A better option would be for the Economic Ministry to use
its own peso reserves from the primary fiscal surplus, which
do not need to be sterilized, to purchase foreign currency.
However, most analysts consider this unlikely prior to the
October Presidential elections.

GoA issues peso denominated Bonar V at a yield of 11.70%
-------------- --------------

11. (U) On June 7, the GoA successfully issued ARP 1.5
billion (approx. $500 million) of the Bonar V (or Bonar
2012),a peso denominated, five-year bond, with a fixed
coupon rate of 10.50%, at a yield of 11.70%. This was the
first time since the 1990s that the GoA issued a fixed-rate,
peso denominated bond without an adjustment for inflation
clause. (Note: The GoA last issued a peso denominated bond
in July 2005, the Boden 2014, but this bond was adjusted by
CER - a CPI-linked index. The GoA also issued
peso-denominated bonds as part of the mid-2005 debt exchange,
but these were also indexed to inflation).



12. (U) The 11.7% yield split the middle of the market's
expected range of 11.25-12.20%. However, traders praised the
result of the auction, given the negative market environment
last week generated by expectations of FED rate increases and
also following continued, high-profile GoA manipulation of
official inflation statistics (Note: The statistical agency,
INDEC, published a 0.4% inflation rate for May, lower than
even the most optimistic private sector estimates).


13. (U) The auction was more than three times
over-subscribed, with total bids of ARP 5.2 billion. Local
and international analysts tell Post that foreign investors
searching for high yields and minimal currency risk purchased
the vast majority (over two-thirds) of the issuance. JP
Morgan Chase, Deutsche bank, and Citibank together purchased
over 50%. In addition to the high yield, the ability to use
the bond to get around capital controls may partly explain
the popularity of the bond (Note: primary issuances are
exempt from the BCRA requirements of a one-year minimum
investment, with a 30% unremunerated deposit).


14. (U) GoA Finance Secretary Sergio Chodos stated publicly
that the goal of the issue was not only to raise funds, but
also to build out a peso-yield curve (which would be used as
a reference for the private sector). With this transaction,
the GoA would only need to raise about $2.6 billion more to
meet its budgeted 2007 financial needs of $5.7 billion.
However, a local think tank (Melconian) argues that the GoA's
increasing expenditures so far during this election year will
require it to raise an additional $2 billion on top of the
$5.7 billion amount. Given the relative success of the
auction, analysts expect the GoA to tap the market again in
the near future (also confirmed by GoA contacts). The GoA
also has up to $1.0 billion more of the dollar-denominated
Bonar X (10-year, fixed rate) available for issuance.
However, most analysts expect the GoA to hold off with
further issuances of dollar bonds, since they have suffered
in recent weeks as a result of rising Treasury rates (Note:
the Bonar X was issued with a yield of 8.44% on May 10, but
it is now trading at 9.20%.)


15. (SBU) To secure the success of the issue, the GoA
apparently attempted to limit competition in the week leading
up to the auction. The CNV (GoA securities regulator)
reportedly tried to block new issues from the private sector
(specifically from the banking and energy sector) to reduce
the upward pressure on the peso (from incoming dollar flows)
and also to keep the market clear for a GoA peso denominated
issue. However, Post's private sector contacts assert that
the GoA quickly backed off and allowed the issuances to go
through. Interestingly, the private sector has been able to
issue peso (and dollar) debt at lower yields than the
sovereign in recent months. Two recent examples are Banco
Macro's early June issuance of a 5-year, peso linked (pays in
dollars but at spot exchange rate) corporate bond for the
equivalent of $100 million at a yield of 10.75%, and Banco
Santander-Rio's issuance in April of a ARP 450 million 3-year

bond at a yield of 11.375%.

MATERA