ARGENTINA ECONOMIC AND FINANCIAL REVIEW, COVERING

UNCLAS BUENOS AIRES 000242 SIPDIS SIPDIS PASS NSC FOR JOSE CARDENAS PASS FED BOARD OF GOVERNORS FOR PATRICE ROBITAILLE PASS USTR FOR SUE CRONIN AND MARY SULLIVAN TREASURY FOR ALICE FAIBISHENKO, ROSELLEN ALBANOS, LUYEN TRAN USDOC FOR ALEXANDER PREACHER AND JOHN ANDERSEN US SOUTHCOM FOR POLAD E.O. 12958: N/A TAGS: EFIN EINV ECON AR SUBJECT: ARGENTINA ECONOMIC AND FINANCIAL REVIEW, COVERING JANUARY 16 - FEBRUARY 2, 2007 ¶1. Provided below is Embassy Buenos Aires' Economic and Financial Review covering the period January 16 -- February 2, 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. -------------- Weekly Highlights -------------- - GoA agrees to repay $983 million debt to Spain ) outside the Paris Club. - GOA auctions $500 million in Bonar VII bonds at a 7.7% yield; lowest since default. - GoA Treasury to purchase $2 billion to maintain weak peso and control inflation - Moody's upgrades outlook on GoA bonds from stable to positive. - IDB approves $590 million loan to Argentina. - GoA primary surplus reaches 4% of GDP in 2006. - Argentina's country risk premium hits all time low - Concerns over cost to GoA of GDP Warrants - All eyes on January's CPI after dismissal of INDEC Director in charge of CPI index. - GoA announces reform of the pension system. - Wage negotiations heat up. - Argentina's trade surplus reached $12.4 billion in 2006, above market expectations. - Key Economic Indicators -------------- Banking and Finance -------------- GoA agrees to repay $983 million debt to Spain ) outside the Paris Club -------------- - ¶2. On January 31, Economy Minister Felisa Miceli announced that the GoA had reached an agreement to repay $982 million owed to Spain. The Minister noted that since the Spanish loan was received as part of an IMF-led rescue package in 2001, it was being treated separately from other official bilateral debt (included under the Paris Club) that must still be restructured. The GoA has agreed to pay the loan over six years, with payments structured as follows: 10 % in years 1 and 2, 15% in year 3, 20% in years 4 and 5, and 25% in year 6. The interest on the restructured loan will be Libor plus 140 basis points. During the announcement, Miceli thanked the Spanish government for supporting Argentina in such a difficult moment in the nation's history. Local press also reported GoA officials' assertions that they were in discussions with Paris Club creditors on the restructuring of bilateral loans worth approximately $6.2 billion, but also reported that the talks were at a preliminary stage. GOA auctions $500 million in Bonar VII bonds at a 7.7% yield; lowest since default -------------- ¶3. On January 25, the GoA sold $500 million in Bonar VII bonds (a seven-year, dollar-denominated bond with a 7% coupon issued under Argentine law) at a 7.71% yield (287 basis points over comparable Treasuries),which was the lowest yield since the 2002 default. This was the GoA's third Bonar VII auction, following the September and November auctions in 2006 (each of them for $500 million, with a yield of 8.4% and 8.03%, respectively). The GoA received bids for $1.7 billion, or more than three times the auctioned amount. Given the strong demand, the GoA reportedly does not rule out tapping the markets again in the near future. According to a January resolution from the Ministry of Economy, the GoA is authorized to issue up to $1 billion of Bonar VII in 2007. The proceeds of this transaction will serve to fulfill GoA financial needs in 2007, which are estimated at $5-6 billion. GoA Treasury to purchase $2 billion to maintain weak peso and control inflation -------------- ¶4. Argentine press reported January 22 that Economic Minister Felisa Miceli and BCRA President Martin Redrado had agreed that the Treasury (under Ministry of Economy) would purchase with its fiscal surplus approximately $2 billion in 2007 (almost twice as much as in 2006) to help the BCRA prevent peso appreciation and control inflation. (Note: Private analysts are already forecasting a 1.3-1.5% m-o-m increase for January's inflation.) In the first two weeks of January, Treasury already purchased $100 million in foreign currency. Treasury's purchases would lessen some of the pressure on the BCRA to purchase and sterilize the large foreign exchange inflows. The BCRA uses short and medium term instruments (Lebacs and Nobacs) to sterilize FX purchases, and many local analysts are concerned that the BCRA's aggressive sterilization campaign could potentially lead to higher interest rates. Unlike BCRA intervention, Treasury's FX purchases do not expand the monetary base since the GoA purchases dollars with pesos already in circulation, which obviates the need for BCRA sterilization of the FX inflows. In 2005, the Treasury purchased $4 billion in foreign currency. However, it reduced its FX purchases to $1 billion in 2006, forcing the BCRA to increase its purchases of dollars from $10 billion in 2005 to $14 billion in 2006. Local analysts expect the trade surplus plus capital inflows in 2007 to generate a foreign exchange surplus of $13 billion, which the BCRA and Treasury will need to mop up to prevent an appreciation of the peso. (Note: Local analysts estimate official reserves will total approximately $42 billion at the end of 2007). IDB approves $590 million loan to Argentina -------------- ¶5. On January 31, the IDB Board approved a credit line for Argentina for $1.5 billion to improve the quality of life for the poor in urban areas (including in the cities of Buenos Aires, Cordoba and Santa Fe). The first loan of this credit line will be for $350 million and will finance 100 projects, benefiting 47,500 families. The loan has a 24-year maturity, with a 5-year grace period and an adjustable interest rate. The IDB board also approved a $240 million loan to finance economic development projects in five of the nine Norte Grande Provinces (including Jujuy, Catamarca, Santiago del Estero, Tucuman, and Chaco). The program includes financing hydraulic infrastructure projects, water and sewer systems, and institution building projects. The loan has a 25-year maturity, with a 6-year grace period and an interest rate of Libor. Moody,s upgrades outlook on GoA bonds from stable to positive -------------- -------------- ¶6. On January 16, Moody,s rating agency revised upwards the outlook on GoA sovereign bonds (both foreign and local currency) from stable to positive, while maintaining the overall sovereign credit rating at B3 (Note: this is several levels below investment grade; S&P,s rating for Argentina is B , also several notches below investment grade). In its announcement, Moody,s justified the upgrade based on improvements in GoA's fiscal accounts, high economic growth, and foreign currency accumulation. Moody,s stated that it does not expect a downturn in the near-term, but noted that the GoA's unorthodox policies create distortions that could eventually undermine the economy. These include: 1) pro-cyclical fiscal policy; 2) rapidly increasing expenditures (and increasing transfers and subsidies),which will complicate maintaining budget surpluses in the future; 3) distortions in relative prices due to price controls and export taxes and restrictions, creating economic inefficiencies; 4) relatively high debt/GDP ratios; 5) doubts about the GoA's ability or willingness to make necessary fiscal adjustments if/when confronted with adverse economic conditions; and 6) increasing GoA dependence on export tax revenues, which make the fiscal accounts vulnerable to external shocks. (Comment: the Moody's comments track the opinions of most financial sector traders and economists, who are bullish on Argentina over the next 18 months, but who realize that stimulative monetary and fiscal policies, combined with government intervention to control inflation, increase Argentina's vulnerability to falling commodity prices and higher world interest rates in the long-term. End Comment). GoA primary surplus reaches 4% of GDP in 2006 -------------- ¶7. In a press conference on January 22, Minister of Economy Miceli officially announced an ARP 23.2 billion (3.6% of GDP) primary surplus for 2006, above the 3.3% forecast in the 2006 budget. In her statement, Miceli noted that the strong fiscal result would support continued high growth levels. The consolidated primary fiscal surplus, including the provinces, was 4%, comprised of the 3.6% federal primary fiscal surplus and a 0.4% provincial primary fiscal surplus. (Note: In 2005, the consolidated primary fiscal surplus reached 4.4% of GDP, 3.7% from the federal government and 0.7% from the provinces. End Note) Argentina's country risk premium hits all time low -------------- -------------- ¶8. Argentina's country risk premium, as measured by the benchmark J.P. Morgan Emerging Market Bond Index Plus (EMBI plus),fell to 185 basis points (above comparable Treasuries) on January 26, the lowest level since JP Morgan introduced the original Index in 1992. As of February 2, it remained at that level. (Comment: This rating measures Argentine dollar-denominated bonds issued under U.S. law that trade internationally and are highly liquid. It does not reflect the real cost to the GoA of issuing new debt. The Bonar VII is the main financial instrument that the GoA is currently issuing to cover its financial needs. In the GoA's January 25 auction, the Bonar VII was issued at a 287 basis points spread over comparable Treasuries. End Comment). Concerns over cost to GoA of GDP Warrants -------------- ¶9. Following higher than forecast GDP figures in 2006, private sector analysts are expressing concern over the cost to the GoA of the December 2007 payment on the GDP-linked warrants, which the GoA provided to bondholders as an inducement to participate in the 2005 sovereign debt exchange. (Note: All bonds issued in the restructuring came with attached warrants, linked to GDP growth. The warrants pay 5% of the excess GDP growth above a trend forecast, which ranges from about 4.3% in 2005, to 3.2% in 2013, and then stabilizes at 3% starting 2014.) The GoA made the first payment of $400 million in December 2006, based on 2005 growth. Private sector analysts predict the GoA will be forced to make payments of $830 million in 2007 and $1.2 billion in 2008. -------------- Economic Policy -------------- All eyes on January's CPI after dismissal of INDEC Director in charge of CPI index. -------------- ¶10. The Argentine statistical agency, INDEC, reported February 5 that CPI inflation in January was 1.1% month on month, significantly below market expectations of 1.2 - 1.6%, and the lowest inflation rate for the month of January since ¶2003. The markets and local media were closely monitored the release, following Economy Minister Miceli's decision on January 31 to fire INDEC's Director of Prices Graciela Bevacqua. Local media reported that Miceli fired Bevacqua because she refused to provide details on the locations where CPI survey prices are gathered, which would have been a violation of INDEC's confidentiality provisions. She apparently also opposed the Minister's attempts to change the methodology of the index, particularly with regards to the calculation of price increases for health services. ¶11. The issue has been front page news for the last week, with even pro-government commentators raising concerns about government manipulation of statistics. Tensions increased over the weekend, when Internal Affairs Minister Anibal Fernandez accused INDEC employees of being crooks, and unnamed INDEC employees threatened to reveal the "real" CPI figures to the press if the GoA attempted to manipulate the data. Indeed, unnamed INDEC employees issued an "open letter" to the President and public on February 4 calling the GoA intervention a "totalitarian action" and an "institutional coup." Adding further intrigue, INDEC delayed the release from the normal 4:00 PM time to after 7 PM, complicating the media's efforts to report it. The announcement showed much lower than expected price increases for tourism, which increased 3.7% m-o-m, compared to an increase of 16.7% m-o-m in January 2006. INDEC also reported health costs increasing only 2.2%, despite that health care companies are in the process of instituting 22% price increases (Note: health costs comprise 5.5% of the index, and the actual monthly inflation figure would be in the 2.2% range if INDEC used the 22% figure. However, Economic Ministry officials argue that the 22% increase was for "premium services," and not equivalent to the type of service included in the index). ¶12. INDEC has always been considered a relatively independent agency with regards to the collection of data, methodology, and calculation of the index. Nevertheless, there were already questions about the legitimacy of the inflation data, due to the government's use of "voluntary price accords" and export bans. The appearance of government manipulation could have important negative repercussions, because the CPI is a key indicator for calculating poverty levels, is the reference for wage negotiations, and is used to adjust government debt linked to CER (CPI-linked index). Given that 42% of GoA debt is adjusted by CER, the recent developments could have a significant impact on Argentine bond prices and yields. Bevacqua's replacement, Beatriz Paglieri, is reportedly close to Secretary of Internal Trade Guillermo Moreno, who is the force behind the Argentine government's price controls and other heterodox policies to control inflation. GoA announces reform of the pension system -------------- ¶13. On February 1, the GoA sent a bill to Congress that will allow transfers from the private pension system (the so called AFJPs Pension Funds) to the state social security system. Individuals who opt for the private system (which was introduced in 1994) are currently barred from switching back to the state system. According to the announcement, the bill would allow workers to choose between the two systems every five years and would assign new employees to the state-run system by default. Under the current system, new employees that do not specifically choose a pension fund are randomly assigned to one of the eleven private pension funds, whose managed portfolio currently stands at $30 billion.. The bill would also cap the private funds' commission at 1% of a worker's contribution, down from the current 3%. (Note: this figure, which has captured a lot of attention in the press, is misleading. The current 3% commission includes 1.5 percentage points for insurance, which under the new law will be considered a cost. Therefore, the draft bill is actually cutting the commission from 1.5% to 1% -- still a significant 33% cut. End Note) The head of the Anses (Argentine Social Security Administration),Sergio Massa, stated January 25 that the GoA will offer incentives to workers who choose to switch from the private system to the state system. Deputy Agustin Rossi predicted that Congress would approve the pension reform bill during its extraordinary session in February. ¶14. According to press reports, the reform bill states that workers' savings in the private pension system will not be transferred to the state system if a worker switches from the private regime to the public one. Thus, the private pension system's existing funds under management will not be affected by the reform. However, new payments into the state system will likely increase due to switchovers and also due to the undecided workers assigned to the state system. (Note: Under the existing arrangement, only three out of every ten new workers choose a particular system.) This will come at the expense of payments into the private pension system, which will almost certainly decline from the current monthly inflows of $150-180 million. According to local analysts, the increase in Anses' revenues may reach $800 million to $1.3 billion per year (0.4 to 0.6% of GDP). Some local analysts have welcomed the reform, since it expands the choices for workers and lowers commissions. Others comment that the GoA's motivation for the change is to bring more revenue to the State, at the expense of sizable contingent liabilities, in the form of future pension payments. Whether an individual should choose private over public depends on factors including age, salary, and number of years in the workforce. It is likely that younger and high-paid workers will prefer the private system, while older and lower paid workers will choose (or shift to) the state-system. Wage negotiations heat up -------------- ¶15. The local press has reported that Hugo Moyano, the head of the Argentina's largest union (CGT -- Confederacion General de Trabajadores),conveyed to President Kirchner the union's demand for a 20 to 30% wage increase for 2007. This would significantly exceed the GoA's target of capping salary increases in the 12-14% range. Two other unions -- representing railway and electricity employees -- have already begun salary negotiations with the government, and are also asking for 20% to 30% increases. Other sectors -- including meat and flour factory processors -- have also announced that they will seek 20% raises. Businesses are complaining that union demands are unacceptable, especially for those sectors subject to GoA price controls. (Comment: part of the GoA's rationale -- at least privately -- for aggressively intervening to keep CPI inflation under 10% in 2006 was to reduce expectations for large wage increases. Based on labor's pursuit of 20-30% wage hikes, it appears that unions understand that repressed inflation is more likely in the 12-15% range, and likely also realize that the GoA will have to allow utilities to raise prices sharply over the next couple of years. End Comment). -------------- Economic Outlook -------------- Argentina's trade surplus reached $12.4 billion in 2006, above market expectations -------------- --- ¶16. The December trade surplus reached $1.5 billion, well above market expectations of $1 billion. The cumulative trade surplus for 2006 was $12.4 billion, above market expectations of $11.8 billion. In December, exports increased 17% y-o-y to $4.2 billion, while imports increased a mere 10% y-o-y to $2.7 billion. Exports were driven by increases in agribusiness (24% y-o-y) and industrial goods (33% y-o-y),while primary goods remained unchanged and fuel and energy exports decreased 3% y-o-y. Imports were driven by increases in parts for capital goods (25% y-o-y) and consumer goods (16% y-o-y). The BCRA consensus survey expects the 2007 annual trade surplus to narrow to $11.7 billion, compared with $12.4 and $11.3 billion surpluses in 2006 and 2005, respectively. With this expected trade surplus, the BCRA will have to continue intervening aggressively to prevent the appreciation of the peso. ¶17. The better than expected trade surplus in 2006 was mainly the result of decelerating import growth, rather than export growth. Exports increased at an annual rate of 15%, compared to 16.1% growth in 2005, 15% growth in 2004, and almost 17% growth in 2003. Moreover, the growth in export volumes was relatively low at 7%, with price increases responsible for the other 8%. Although imports increased 19% -- a faster rate than exports -- the growth rate is decelerating, with annual import growth of 28% in 2005 and 62% in 2004. WAYNE