ARGENTINA ECONOMIC AND FINANCIAL REVIEW, JUNE 28 -

UNCLAS BUENOS AIRES 001313

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 28 -
JULY 5, 2007

REF: BUENOS AIRES


1. (U) Provided below is Embassy Buenos Aires' Economic and
Financial Review covering the period June 28 - July 5, 2007.
The unclassified email version of this report includes tables
and 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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-- Argentina's Country Risk Premium Hits Highest Level in 2007
-- FDI Flows to Argentina Slows to $624 Million in Q1 2007
-- Moody's calls on GoA to Adjust its Economic Policies
-- Survey Highlights Private Sector Concerns about GoA
Corruption

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Banking and Finance
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Argentina's Country Risk Premium Hits Highest Level in 2007
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2. (SBU) On June 27, Argentina's sovereign risk premium over
equivalent maturity U.S. Treasuries, as measured by JP
Morgan's EMBI index (Emerging Market Bond Index),reached 320
basis points, the highest value during the year. The index
has widened by 136 basis points compared to the end of
January, when it reached a historical minimum of 184 basis
points. The increase in the index, reflecting the fall in
Argentine bond prices, was driven by several internatioal
and domestic factors. Internationally, the uncertainty
around the U.S. economy and FED policy has generated higher
volatility in capital inflows to emerging markets.
Domestically, concerns about economic growth due to the
effect of recent energy shortages are a key factor in
explaining the poor performance of Argentine bonds. Other
areas of concern are the high level of capacity utilization
of many industrial sectors, increasing inflationary pressures
(exacerbated by perceived GoA manipulation of inflation
statistics),declining fiscal surplus (due to high
expenditures),coupled with the normal uncertainty that
generally accompanies an election year. (Note: the EMBI
index includes only dollar-denominated bonds issued under
international law. In the case of Argentina, it includes the
Par and Discount bonds issued during the 2005 debt
restructuring.)

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Economic Outlook
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FDI Flows to Argentina Fall to $624 Million in Q1 2007
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3. (SBU) The GoA's statistical agency, INDEC, reported June
22 that preliminary FDI flows to Argentina were $624 million
in the first quarter of 2007, 54% lower than in the same
period last year. Local analysts were cautious to note that
a three-month performance is not sufficient to identify a
trend. However, local think tank Fundacion Mercado considers

that uncertainly related to the October presidential
elections and the energy shortages are decelerating growth,
which translates to decelerating investment and FDI. Another
prominent think tank, FIEL, explains the decrease in FDI
flows as a result of the private sector's lack of trust in
government policies and the constantly changing rules of the
game in terms of taxes, regulation, and prices.


4. (SBU) An economist from Banco Provincia (second largest
public-owned bank) gives an opposing view, arguing that the
reduction in FDI is mainly explained by strong dividend
outflows for $374 million (based on INDEC data). Similarly,
an Embassy contact at INDEC explained that the preliminary
FDI figure for the first quarter was affected by the timing
in the transfer of dividends to parent companies overseas and
the payment of inter-company debts. This official argued
against projecting that FDI has decreased by half just based
on first quarter data, and predicted that FDI flows would
adjust in future quarters. (Note: the May 18 Review reported
FDI flows to Argentina of $4.8 billion in 2006, 4% lower than
in 2005, based on an ECLAC publication. However, on June 22,
the GoA revised both 2005 and 2006 FDI numbers upwards, with
$5.3 billion in 2005, increasing 4% to $5.5 billion in 2006.)

Moody's Calls on GoA to Adjust its Economic Policies
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5. (SBU) During a July 2 conference in Buenos Aires, Moody's
VP and Senior Credit Officer Mauro Leos stated that Argentina
will have to adjust its policies after the October
presidential elections, given that the post-crisis expansion
phase is wearing out. He stated that the next administration
will face serious challenges with inflation, energy
shortages, and growing primary expenditures. In his
presentation, he argued that Argentina's high growth rate was
explained mainly by high commodity prices and international
liquidity, as well as by the severity of the preceding crisis
(2001/02) and the GoA's expansionary fiscal and monetary
policies.


6. (SBU) Leos acknowledged that Moody's foreign currency
sovereign rating of B3 (six levels below investment grade) is
worse than Standard and Poor's B (four levels below
investment grade) and Fitch's B (five levels below investment
grade). However, he argued that Moody's rating methodology
takes into account quantitative and qualitative factors
beyond the normal measurements of the strength of macro
economic fundamentals. These include the capacity and
willingness to pay debts and the country's reaction under
stress. As an example, he noted Argentina's breach of gas
export contracts with Chile as demonstrating that under
stress the GoA will always favor domestic economic interests
over those of foreign creditors and consumers, regardless of
what domestic or international agreements it may have entered
into, and also heedless of the resulting impact on its
international reputation. He also pointed to Argentina's
refusal to pay its debts to Paris Club member countries,
despite clear evidence of ability to pay (record-level
official reserves and strong fiscal surplus),as a reason for
Argentina's relatively low credit rating (and constraint to
increasing it).


7. (SBU) Daniel Ruas, Moody's Country Manager for Argentina,
noted the possibility of corporates having higher ratings
than the sovereign government. Moody's introduced the
concepts of ceiling ratings, which are like overall country
ratings that assess the probability government interference

in the capacity of other economic agents to repay their debt.
This is different from the government bond rating, which
reflects the risk that a government may default on its own
obligations. Therefore, Moody's could issue a corporate
rating -- reviewing a company's financial strength -- that is
higher than the sovereign debt rating, but equal to or lower
than the overall country ceiling/guideline. (As an example,
in June Moody's rated a local currency bond issued by Banco
Hipotecario -- a private-owned domestic bank -- at Aa1,
significantly higher than the B3 local currency rating of the
GoA.)

Survey Highlights Private Sector Concerns about GoA Corruption
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8. (SBU) El Observador, a supplement to the Argentine Sunday
paper Perfil, published a survey of Argentine private sector
opinions on corruption in Argentina and government
intervention in the economy. Out of the 200 executives
interviewed for the report, six out of ten believe there is a
high level of corruption in Argentina, and 87% believe
scandals such as the one involving the Swedish construction
firm Skanska (over allegations of front companies, fake
billing, and bribes, related to a state-run pipeline project)
is "normal" for the current administration. While most
surveyed did not consider corruption much worse than during
President Menem's administration, a strong majority considers
government intervention in the economy to be worse, and many
advocated for a significantly smaller government. Provided
below are the primary results of the survey.


A. 87% believe Skanska-like corruption cases are typical for
this government, with only 3% considering the Skanska case
"an exception."

B. 59% believe there is a high level of government
corruption, and a further 31% believe there is a medium level
of corruption. Only 1% thought that corruption was minimal.

C. 51% said the government was responsible for most cases of
corruption, with 19% blaming companies, 12% blaming the
Judiciary, and 11% blaming unions.

D. 45% believe that government pressure on the media is the
main reason why more corruption cases are not made public,
with another 20% arguing that corruption is the status quo,
so ignored by the public.

E. Over 50% argue that the judicial system and media are the
main actors to combat corruption, with only 15% arguing that
the government should be the key actor.

F. 70% associate corruption with the style of government in
Argentina, with 22% arguing it is a cultural characteristic
(Note: El Observador considers this figure significant, as
it indicates that most executives do not believe that
institutions -- or lack of them -- are to blame, rather the
"values" of government leaders are the critical ingredient.)

G. Almost 75% believe that the main factors that influence
or allow the high corruption levels are lack of controls,
authoritarianism, structural corruption, and state
intervention.

H. In comparison to Menem's administration, over 60%
considered regulated prices, inflation, international
relations, investment, and salary negotiations to be worse
under President Kirchner's government. Only 19% considered
corruption worse.

I. 70% considered state intervention, judicial uncertainty
(lack of rule of law),lack of (GoA) communication, and lack
of investment to be the largest problems confronting the
private sector in its relations with the government. Small
minorities considered inflation (8%) and corruption (5%)

significant in their relations with the GoA.
WAYNE