EVERYTHING YOU EVER WANTED TO KNOW ABOUT USING

C O N F I D E N T I A L SECTION 01 OF 04 BUENOS AIRES 001303

SIPDIS

E.O. 12958: DECL: 09/16/2028
TAGS: EFIN ECON ETRD PREL AR
SUBJECT: EVERYTHING YOU EVER WANTED TO KNOW ABOUT USING
ARGENTINE CENTRAL BANK RESERVES TO PAY THE PARIS CLUB

REF: A. BUENOS AIRES 1286

B. BUENOS AIRES 1270

C. BUENOS AIRES 1263

D. BUENOS AIRES 1236

E. BUENOS AIRES 1224

Classified By: Ambassador E.A. Wayne for Reasons 1.4 (b,d)

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Summary
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1. (C) Argentine President Cristina Fernandez de Kirchner's
September 2 announcement that the GoA intends to use Central
Bank reserves to pay Paris Club debt has spawned a local
debate over the various legal and financial ramifications of
using reserves for this purpose. The main issues relate to
the legality of using Central Bank (BCRA) reserves, the
availability of sufficient reserves, and the impact on the
BCRA's balance sheet, the payment mechanism between the GoA
and BCRA, and the possible repercussions on the BCRA's
ongoing legal battle with "Holdout Bondholders" over $105
million in frozen BCRA assets. GoA and BCRA officials tell
Post that the GoA will need to issue a new decree amending
the 1991 Convertibility Law to allow use of reserves to pay
bilateral debt. There is disagreement over whether Congress
should ratify this new decree. The BCRA has sufficient
reserves to pay the Paris Club, but it could weaken the
quality of its balance sheet during a time of increasing
global financial uncertainty. BCRA officials believe the
President's announcement will jeopardize the BCRA's case
against holdouts, but believe Congressional approval of the
new decree would strengthen their legal position before New
York courts. End Summary.

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Legal Issues Related to Using BCRA Reserves
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2. (SBU) In her September 2 announcement, and also in the
accompanying presidential Decree 1394 (published September 3
in the Official Gazette),President Cristina Fernandez de
Kirchner (CFK) announced the use of "freely available"
reserves to pay Paris Club (PC) creditors. The GoA defined
these "freely available" reserves in Decree 1599, issued
December 15, 2005. Decree 1599 modifies Argentina's
Convertibility Law (N23.928) to allow the use of "excess"
reserves -- after backing 100% of the monetary base -- to pay
debt to international financial institutions (IFIs),as long
as this payment has no monetary effect (e.g., does not expand
or contract the monetary base). This legal modification
allowed the GoA and BCRA to use reserves to pre-pay
Argentina's entire $9.53 billion debt to the IMF on January
3, 2006 (implemented via Presidential Decree #1601, also
signed December 15, 2005). (Congress ratified Decree 1599 on
December 21, 2005, as Law N26.076, which entered into effect
January 9, 2006. Congress did not ratify Decree 1601.)


3. (C) The problem currently facing the GoA is that the Paris
Club is comprised of bilateral creditors, and does not
qualify as an IFI. Some private analysts -- including at
JPMorgan and Credit Suisse -- speculate that the GoA could
broadly interpret the Convertibility Law, as amended, to
include the Paris Club. However, this is an ongoing debate
within the GoA, with some parties arguing that all that is
necessary is for the President to sign a new decree (a
special "Necessity and Urgency Decree") that defines "IFI" as
including the Paris Club, but many others claim that
Congressional approval is required.


4. (C) The Economy Ministry's Finance Secretary, Hernan
Lorenzino, who has the lead on Paris Club issues for the GoA,
acknowledged officially to EconOff September 15 that the GoA
and BCRA are analyzing whether it is enough just to amend the
December 2005 Decree (#1599) -- thus modifying the
Convertibility Law to allow payment of bilateral debt with
reserves -- or whether Congressional approval is required.
Post has heard through reliable third parties that both BCRA
President Martin Redrado and Lorenzino personally believe a
new decree is necessary. Redrado has apparently indicated
his belief that Congress must ratify such a decree, but
Lorenzino commented earlier this week to Japan's Ambassador
in Buenos Aires that no such ratification is needed. Local
press speculates that Redrado would open himself and the BCRA

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to lawsuits if he were to authorize the release of reserves
without Congressional authorization (especially given the
precedent of having Congress ratify the 2006 IMF payment).


5. (C) Post has consulted directly on this issue with
Argentina's two main public sector experts on debt issues:
Economic Ministry Debt Office Director Norberto Lopez Isnardi
and BCRA Senior Manager of Foreign Exchange Reserves Juan
Carlos Barboza, who until recently was the Economy Ministry's
Deputy Finance Secretary. Lopez and Barboza (STRICTLY
PROTECT BOTH) have privately informed EconOffs that in their
opinion the Paris Club clearly does not fall under the
definition of an "IFI." They say that the only way the GoA
may proceed with the President's initiative in full adherence
to Argentine law is to alter original Decree 1394 (or issue a
new decree),amending the Convertibility Law again to allow
use BCRA reserves to pay bilateral creditors, and/and get
Congress to ratify it.

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Availability of Reserves
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6. (SBU) The BCRA easily has sufficient "freely available"
reserves to pay the full debt owed to PC member countries.
As of end-August, the monetary base stands at 99 billion
pesos (roughly $32.5bn) and total reserves are at 142.6
billion pesos (approximately $47bn),which leaves freely
disposable reserves at about 44 billion pesos, or $14
billion. This is more than enough to pay the roughly $6.7
billion in arrears to the PC, or even the entire $7.9
billion, which includes principal outstanding. (In her
September 2 announcement, CFK stated that the GoA would pay
the PC in full, in a lump sum, and also stated incorrectly
that the total amount due, including principal outstanding,
was $6.7 billion. Economy Ministry and BCRA contacts point
out, to their relief, that the original decree (#1394) does
not cite a fixed amount and does not state that the GoA will
pay in a lump sum. However, it does say that the GoA will
pay the entire PC debt, including principal outstanding.)

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BCRA Limits on Lending to GoA
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7. (SBU) If the GoA succeeds in changing the original decree
to allow PC payment using "freely available" reserves, then
this will not count against the BCRA's normal lending
restrictions to the GoA, as established in the BCRA's
Charter. The Charter currently limits short-term BCRA
lending to the GoA at up to 12% of the monetary base.
Additionally, the BCRA can grant short-term lending to the
GoA of up to 10% of the last 12 months' tax collection, as
long as it is used to pay IFIs.) However, in the unlikely
case that the GoA is unable to issue a special decree or get
Congress to amend the Convertibility Law, the only other
option would be to amend the BCRA's Charter to expand these
limits. Doing so would require Congressional action. As of
the end of August, the GoA has maxed out the BCRA's
short-term lending limits. (GoA short-term debt to the GoA
is currently 21.3 billion pesos, or roughly 21% of the
monetary base.)

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Method of Payment
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8. (SBU) According to media reports, BCRA and Economy
Ministry officials are discussing the financial conditions of
the bond that the GoA will issue to the BCRA in exchange for
reserves. Reportedly, the Economy Ministry originally
envisioned issuing a 10-year, non-tradable instrument similar
to the one issued in December 2005 when the GoA prepaid its
debt owed to the IMF. However, the BCRA prefers a
shorter-term, tradable bond, and the most recent press
reports indicate the two sides are close to compromising with
a longer-term but tradable instrument.

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Implications for BCRA Balance Sheet
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9. (SBU) Although the BCRA can easily pay PC debt using
"freely available" reserves, paying current arrears of $6.7

BUENOS AIR 00001303 003 OF 004


billion could have a negative impact on its overall balance
sheet. (Note: Almost the entire debt of $7.9 billion will
be in arrears after November 2008, so it makes more sense to
calculate the impact of the total due, rather than just
arrears.) As of August 31, 2008, the BCRA states total
assets of 246.28 billion pesos (roughly $81 billion),
including reserves, its holdings of GoA bonds, its short-term
loans to the GoA (mentioned in the preceding paragraph),and
other credits. The BCRA lists liabilities of 226.17 billion
pesos (approximately $74 billion),including monetary base,
debts owed to IFIs, GoA deposits with the Central Bank, and
over $20 billion in BCRA short-term debt instruments. The
BCRA's net wealth is roughly 20 billion pesos.


10. (SBU) The payment in full of Paris Club debt via reserves
would simply involve changes in two BCRA balance sheet asset
categories: a debit of cash or cash-like liquid assets, and
an equivalent credit of additional GoA bond holdings or other
GoA debt obligations to the BCRA. However, market
participants tell us that such a shift will, from their
perspective, notably deteriorate the quality of the BCRA's
balance sheet, and this could raise private sector worries
about the BCRA's ability to respond adequately to potential
domestic liquidity and solvency crises in its role as lender
of last resort. (Comment: This seems to us to be a
legitimate concern, given global financial difficulties and
also that Argentina's country risk spreads are at their
highest point since the 2005 debt restructuring. End
Comment.)

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Implications for Holdout Lawsuits
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11. (C) Many BCRA officials, including reserves manager Juan
Carlos Barboza (PROTECT),are deeply concerned that the
manner in which the GoA has declared it will use official
reserves will undermine the BCRA in its legal battle with
"holdout" bondholders (private bondholders who refused to
accept Argentina's 2005 debt exchange). At this time, $105
billion of BCRA reserves held at the Federal Reserve Bank of
New York (FRBNY) are frozen on account of lawsuits submitted
by EM Ltd (controlled by Kenneth Dart) and NML Capital Ltd
(controlled by Elliott Associates) against the GoA (with the
BCRA as an interested party).


12. (SBU) Plaintiffs EM and NML together hold defaulted bonds
with a combined face value of approximately $737 million.
(The total face value of untendered GoA debt is approximately
$20 billion, or close to $30 billion when including past-due
interest. U.S. bondholders hold approximately $3-4 billion
of the total.) EM already holds and NML seeks a judgment
against the GoA arising out of the December 2001 default.
They sought to attach the BCRA funds held at the FRBNY under
the argument that they were rendered attachable under the
Foreign Sovereign Immunities Act of 1976 (FSIA) following
President Nestor Kirchner's two decrees in December 2005 that
gave the GoA the authority to use BCRA BCRA reserves to pay
Argentina's debts to the IMF.


13. (SBU) The U.S. Court of Appeals for the Second Circuit
ruled January 5, 2007, in support of an earlier ruling by the
U.S. District Court for the Southern District of New York
(Judge Thomas P. Griesa) against the Plaintiffs. The Appeals
Court ruled that "the FRBNY Funds are immune from attachment
under the FSIA because, notwithstanding the issuance of the
decrees, the FRBNY Funds continue to be owned by the BCRA, a
separate juridical entity from the Republic." The Court also
commented that the FSIA only allowed attachment of a foreign
state's property used for commercial purposes in the U.S.,
and "a government's repayment of its debt to the IMF is not a
'commercial activity.'" EM and NML have appealed the case to
the U.S. Supreme Court. (The USG submitted an Amicus Curiae
brief to the Appeals Court in support of this interpretation
of the FSIA.)


14. (C) In part, Barboza believes the PC announcement has
weakened the BCRA's case because of the clear difference
between the IMF payment and the proposed Paris Club payment.
Technically, according to BCRA officials, the BCRA owed the
debt to the IMF, since it passed through the BCRA and then to
the GoA. However, the Paris Club debt is clearly bilateral,
so the GoA decision gives the appearance that the Argentine
State can grab reserves at will, regardless of the legal

BUENOS AIR 00001303 004 OF 004


separation between the two entities. For this reason,
Barboza and other Post contacts say this makes it all the
more important to get Congressional authorization of a new or
amended decree, thus re-strengthening the legal delineation
between the GoA and BCRA. Private sector analysts agree, and
argue for clarifying that the GoA will "purchase" the BCRA
reserves.
WAYNE