ARGENTINA ECONOMIC AND FINANCIAL REVIEW, JUNE

UNCLAS BUENOS AIRES 001262

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
PASS OPIC FOR JOHN SIMON, GEORGE SCHULTZ, RUTH ANN NICASTRI
USDOC FOR 4322/ITA/MAC/OLAC/PEACHER

E.O. 12958: N/A
TAGS: EFIN ECON EINV AR
SUBJECT: ARGENTINA ECONOMIC AND FINANCIAL REVIEW, JUNE
12-27, 2007

REF: BUENOS AIRES 1180


1. (U) Provided below is Embassy Buenos Aires' Economic and
Financial Review covering the period June 12-27, 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
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-- FATF approves Argentine terror finance law
-- Energy Shortages Continue
-- GDP growth and industrial production decelerate
-- Strong May primary fiscal surplus thanks to pension funds
transfer

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Banking and Finance
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FATF approves Argentine terror finance law
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2. (SBU) On June 27, member countries of the Financial Action
Task Force (FATF) agreed during the ongoing plenary in Paris
to accept the enactment of Argentina's counter-terrorism
finance (CTF) law as adequate to end FATF's multi-year
follow-up process on this issue. With this decision
Argentina will no longer face the possibility of FATF
sanctions over its non-compliance with FATF's terrorism
finance requirements. During the plenary meeting, GoA
officials stated that the GoA expected to publish the law
next week in the Official Gazette, and it would enter into
force eight days after the date of publication.


3. (SBU) As reported in past Reviews, the Argentine Congress
has been reviewing the GoA's draft counter terrorism and
counter terrorism finance law since President Kirchner
submitted it to the Senate on December 20, 2007. During
FATF's last plenary, in February 2007, FATF members gave the
GoA until the June 25-29 plenary to pass the legislation, or
face the possibility that FATF would issue a public statement
of non-compliance. After several months of inaction, the
Senate passed the bill on June 6, followed rapidly by passage
on June 13 in the Chamber of Deputies.


4. (SBU) Despite some weaknesses, this law represents an
improvement to the legal and regulatory framework. Argentine
lawyers generally argue that the current penal code is
sufficient to address any crime that could fall under the
definition of terrorism or facilitating terrorism, and argue
that the main benefits of this law are to send a signal and
to provide the legal foundation for the Central Bank and
Financial Investigative Unit's enforcement measures.


5. (SBU) The law is not without its detractors. The vocal
human rights NGO, "CELS" (Centro de Estudios Legales y
Sociales),has criticized the legislation, alleging that the
Congress rushed passage only to fulfill the FATF requirement,
and did not give it adequate review. CELS argues that the
law is ambiguous and leaves it open to abuse with respect to

protection of human rights.

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Energy
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Energy Shortages Continue
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6. (SBU) Natural gas and electricity shortages continue to be
front page news in Argentina, and are impacting industrial
production, government operations, and possibly even
sovereign bond prices. Most analysts consider this a
temporary energy "crunch," and not the beginning of an energy
crisis for the time being, and expect warmer weather would be
enough to alleviate the problem. The colder than normal
weather recently, coupled with lower hydroelectric output
(due to below-average rainfall and runoff from snowcaps),
exposed the real crisis -- inadequate energy sector
infrastructure. These supply bottlenecks will likely cause
shortages and rationing, particularly during summer and
winter peak usage periods, for years to come.


7. (SBU) The culprit is the lack of investment that began in
the late 1990s and was exacerbated by the 2001/2002 crisis
and subsequent government price freezes and controls, and
this is unlikely to change until the GoA adjusts its energy
sector policies. So far, the GoA has dealt with the problem
through rationing and short-term fixes (such as rationing,
reducing government operations, and consumer education
programs on energy conservation). The GoA has enforced the
rationing primarily on the industrial sector and has
prioritized energy supplies to residential areas. Many
industries are coping with the shortages by shifting
production to periods when residential demand is low.

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Economic Outlook
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GDP growth and industrial production decelerate
-------------- --

8. (SBU) Industrial production (IP) increased a modest 0.4%
m-o-m and 6.4% y-o-y in May, disappointing the market, which
forecast a 6.9% y-o-y increase. The soft May reading was not
the result of the GoA's recent rationing of natural gas and
electricity, as local media have erroneously reported.
Rather, it is largely explained by labor strikes over higher
wages, technically scheduled work stoppages for maintenance,
as well as by two holidays that shortened production
schedules during May. The negative impact of energy
rationing is yet to come, and will be felt strongly in
June-August (usually the coldest months in the southern
hemisphere). The GoA also reported an increase of only 0.2%
m-o-m in April of the seasonally adjusted EMAE index
(estimador mensual de actividad economica),a proxy for GDP
growth. This was lower than the 0.6% seasonally adjusted
average increase in the first quarter of the year, and may be
an indicator that overall growth is slowing. Nevertheless,
the index increased 8.4% on a year-on-year basis, driven
mainly by the services-related sectors, such as financial
services, retail and wholesale trade, and transport and
communication.


9. (SBU) This winter's colder than normal weather and lower
hydro output could accelerate the decline of IP and GDP
growth. As reported in the last Review, many local analysts

predict growth to decelerate further in coming months due to
the energy shortages, with the worst case scenario of a
reduction in 2007 real GDP growth of one to two percentage
points. However, other analysts discount their impact and
argue that the expected weaker performance of the
manufacturing (industrial) sector (which represents about 22%
of GDP) will be at least partly offset by expected record
grain harvests this year. Even so, energy sector problems
have ancillary costs, including increased power generation
expenditures (through use of diesel generators),increased
government subsidies (that primarily benefit residential
consumers, and which will worsen GoA fiscal performance),and
higher fuel imports (which could dent the trade surplus).
The media also reports that Argentina's bond prices have
fallen, as the market adjusts downwards its expectations of
future growth, so the GoA's cost of financing could also
worsen.

Strong May primary fiscal surplus thanks to pension funds
transfer
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10. (SBU) The GoA announced June 21 a record monthly primary
fiscal surplus of ARP 5.3 billion ($11.7 billion) for May, a
37% y-o-y increase. The primary surplus for the first five
months of 2007 was ARP 12 billion (almost $4 billion). The
strong result in May is explained by rising tax collection
(up 30% y-o-y) and an extraordinary ARP 1.5 billion (roughly
$500 million) transfer from the private pension funds to the
GoA as part of the counter-reform of the pension system
(explained below). The higher surplus also comes in the face
of rapidly increasing primary and capital expenditures (up
45% and 51% y-o-y, respectively) ahead of the October
presidential elections.


11. (SBU) Excluding the one-time pension funds transfer, the
primary fiscal surplus would have only reached ARP 3.8
billion, 2.4% lowerthan in May 2006. According to analysts
from Argentine think tanks FIEL (Fundacion de Investigaciones
Economicas Latinoamericanas) and Ecolatina, the reform of the
pension system will result in transfers of ARP 8 billion
($2.6 billion) in 2007, or about 1% of GDP. This will allow
the primary fiscal surplus to remain at about 3.5% of GDP, as
in 2006. Otherwise it would fall to the range of 2.5% of
GDP. Local analysts consider that the huge revenue cushion
available -- including from pension transfers -- will allow
the GoA to avoid moderating its primary spending growth in
the months leading to the elections.


12. (SBU) Note: the so called counter-reform of the pension
system allows workers in the private sector to transfer back
to the federal government's pay-as-you go system. The May
transfer is a "stock" transfer, (accumulated savings),which
has a one-time impact, as compared to a monthly "flow"
transfer. It is also interesting to note that the transfer
reflects the composition of the pension fund portfolio, which
is only about 5% cash and the remainder in assorted financial
assets (e.g., stocks, government bonds). Therefore, a
significant portion of the transfer booked as GoA revenues
will not provide financing unless the stocks and bonds are
sold. Also important to note is that the transfer from the
private pension system to the government pay-as-go-system
also creates a future liability for the GoA, as it is now
responsible for making future payments to future retirees.
End Note.

WAYNE