RESPONSE: IMPACT OF RISING FOOD/COMMODITY PRICES ON

UNCLAS BUENOS AIRES 000577 SIPDIS STATE FOR ECON WHA/BSC EEB/TPP/ABT/ATP Janet Speck USDA FOR FAS/OA/OSTA/OCRA/ONA/OGA/OTP/OCBD/OAO/OFSO MERCOSUR COLLECTIVE SIPDIS SENSITIVE - NO FOREIGN E.O. 12958: N/A TAGS: EAGR ECON EINV PGOV ELAB PHUM AR SUBJECT: RESPONSE: IMPACT OF RISING FOOD/COMMODITY PRICES ON ARGENTINA Reftel: STATE 39410 ¶1. (SBU) SUMMARY: The Government of Argentina (GOA) has responded to rising international prices by increasing efforts to divorce domestic food prices from international prices. The general policy of the government is to maintain low domestic prices and increase tax revenues by taxing agricultural exports. This policy has led to substantial strife with the rural sector in recent weeks, with agricultural producers holding a 21-day strike in March after the GOA implemented a variable export tax on soybeans, sunflower, corn and wheat. The new measure increased the export tax on soybeans to 44% and will increase or fall based on changes in export prices. Negotiations continue as of this writing between the GOA and the agricultural organizations over modifications of export taxes and other agricultural policy issues. This cable responds to reftel tasking. END SUMMARY. -------------- DEMAND -------------- ¶2. (SBU) Argentina is a major exporter of most agricultural commodities, which has led the government to adopt measures to maintain domestic food prices below international prices. As a result, domestic demand continues to increase despite rising world prices. One of the products most affected by these measures is beef, where exports have been blocked since April 1 to force a reduction in domestic prices. Per-capita consumption of beef is around 67 kilos per year, making Argentines the most voracious beef eaters in the world. Argentina consumes 80% of the beef it produces and exports the remaining 20%. The GOA has also used export restrictions (suspending export registrations) to guarantee domestic supplies of wheat and corn. In addition, dairy exports are also restricted. ¶3. (SBU) In early 2007, the GOA implemented a cross-subsidy system to provide local users of grains and feeds with supports. That system was financed by an increase of 4% to the export tax on soybeans. The subsidies are contingent on the producers and processors maintaining low domestic prices. The subsidies totaled an estimated $500 million in 2007, although there are numerous complaints from producers about delays in receiving the subsidy payments. �A; -------------- SUPPLY -------------- ¶4. (SBU) Agricultural production expanded rapidly in recent years as producers invested heavily in increased production after the major devaluation in early 2002. It appears that these production increases are leveling off just as international prices are peaking due to increased government intervention in the agricultural sector. Soybeans and soybean products are the largest agricultural export of Argentina, and the GOA has responded to increasing world prices by sharply increasing export taxes. The export tax was raised to 35% in November 2007 (shortly after the presidential elections) and again in March 2008 when the GOA imposed a variable export tax on soybeans, sunflower, wheat and corn. The new tax initially increased the export tax on soybeans to 44% (the tax varies as export prices go up or down). Post estimates that current policies are maintaining prices paid to producers between 30 and 45% below international prices for beef, dairy, soybeans, wheat and corn, which is having a significant impact on production. ¶5. (SBU) Argentina has rapidly adopted new technologies such as no-till farming, hybrid seeds, biotech seeds, and an increased use of fertilizer. Uncertainty about government policies and the reluctance of technology providers to introduce new seed varieties (due to lack of effective IPR protection) are, however, expected to have a negative impact on the adoption of new technologies. -------------- POLITICAL IMPACT -------------- ¶6. (SBU) The political impact in Argentina of rising food and agricultural commodity prices has been mixed. Domestic food prices are rising, but they are doing so in the context of an overheated economy and an overall inflation rate that is among the world's highest. Polls show that Argentines are extremely anxious about the erosion of their purchasing power by overall inflation, which is believed to exceed 30% and accelerating. The GOA has sought to cushion consumers from the effects of global commodity price increases on local food prices through export duties and restrictions, price controls, and subsidies. GOA attempts to control food prices and pre-emptive hoarding by consumers have disrupted food supplies, fueling Argentine anxieties about not just the price of food but its availability. ¶7. (SBU) The more immediate political impact of surging commodity prices has been a struggle between the GOA and agricultural producers over windfall profits. Global commodity prices have been a boon for Argentina, which is still recovering from a devastating downturn in 2001-02. President Kirchner and her team view the surge in global commodity prices as a windfall for domestic producers, one to which they are entitled to tax at steadily growing rates. The March 11 announcement established a variable rate based on FOB prices for major commodities (initially set at 44% for soybean exports). The previous increase was just four months earlier. Agricultural producers report that, in some cases, their total tax bill exceeds 70% (including the export tax, income tax, property tax, non-recoverable value added taxes, and other local taxes). ¶8. (SBU) State intervention in the agricultural sector, particularly the March 11 announcement of an increase in export taxes on soy and sunflower, triggered a 21-day farmer's strike until a 30-day truce was called on April 2. The truce ended May 2 without agreement, but farmer organizations have indicated they will moderate protests as long as negotiations continue in good faith. Although the GOA has sought to justify the tax increase and other policies as redistributive efforts to keep food prices down, many Argentine urban consumers sympathized with the agricultural producers and their rejection of state intervention. The Kirchner administration's conflict with the farming sector taps into a decades-long debate over whether Argentina's future lay in agriculture or industrial development. In its rhetoric, the Kirchner administration has sought to pit small producers against large land-owners, the agricultural sector against the industrial, city dwellers against the rural, and the poor against the wealthy. Argentine farmers have long felt underappreciated as the generators of Argentine wealth, and many now resent what they perceive as unfair government targeting of the agricultural sector and the government's refusal to acknowledge the growing costs of agricultural inputs and other problems facing the farming sector. -------------- ECONOMIC IMPACT -------------- ¶9. (SBU) As with all major commodity exporters, record high prices are mostly a boon to Argentina's economy, but also have a double-edged aspect, with the GoA struggling to limit the impact of higher domestic food prices on the Argentine public while also attempting to redistribute some of the gains from commodity exports to other sectors of the economy. Food price pressures have played a role in higher inflation in Argentina, which independent analysts say is running at about 25% on an annual basis. Independent analysts also contend that high inflation, especially for food and beverages, has led to an increase in poverty over the last year. Yet domestic "ag-flation" is only one component of broader problems caused by stimulative GoA macroeconomic policies, which are overheating the economy, and interventionist microeconomic policies, which have complicated doing business in Argentina and are starving the economy of investment. Further complicating analysis is the GoA's manipulation and undestating of official inflation statistics. Therefore, while high commodity prices are having both beneficial and detrimental affects, separating these from broader economic trends is a difficult task. ¶10. (SBU) Over the last few years, and increasing in intensity since mid-2007, the GoA has pursued unorthodox policies to keep domestic prices low and capture part of the windfall gains of commodity exporters. These policies include high export taxes, "voluntary" price controls on basic consumption basket items including food products, and outright export bans. The private sector has been chafing under this combination of punitive tax policies and market interventions, finally resulting in the three-week farm-sector strike that began March 13 in response to the GoA's March 11 decree to increase export taxes on major agricultural export crops. The resulting food shortages led to a spike in inflation. More importantly from a political perspective, the public's inflationary expectations jumped above 30% for 2008, and local surveys show that inflation has recently become the public's top concern. ¶11. (SBU) Many local observers consider the still ongoing farming sector dispute to be the worst crisis of the Kirchner era (i.e., since 2003). Moreover, it is also seen as a major challenge to the Kirchners' economic model of taxing the most productive sectors of the economy (mainly agriculture) to support less efficient industry and to subsidize domestic consumption. High export taxes and other E farm-sector policies, such as price controls on certain products and outright export bans on others, appear to be driven by the following factors: 1) to maintain low domestic food prices as protection for the governments mostly poor political support base; 2) to capture pre-harvest rents from the spectacular run-up in commodity prices; 3) to maintain a 3-4%/GDP primary fiscal surplus in the face of skyrocketing domestic subsidies; and 4) support the Central Bank's policy of maintaining an undervalued currency. While these are mostly understandable goals, the GoA's methods seem to be exacerbating adverse aspects of the commodity price external shock, such as higher inflationary pressures, and have increased the dependency of Argentina's economic growth and fiscal stability on commodity export revenues. (Export taxes account for over 12% of total collection, and are estimated to reach 3.3% of GDP in 2008 -- nearly equal to the primary fiscal surplus.) In a perfect environment, Argentina would muddle through, but international turmoil and increasing domestic inflation pressures due in part to the surge in global food prices have created a high level of uncertainty, and the risk of an inflationary spiral and hard landing are now judged much higher by many experts. -- Impact of food prices on inflation? Since GoA national statistical agency INDEC is reporting annual inflation of under 10%, which most independent analysts consider incorrect and manipulated, it is difficult to accurately gauge the true level of inflation. The calculation of poverty statistics, using INDEC inflation numbers, is also considered suspect by many independent observers. Private analysts are trying to fill the gap with their own surveys, and local consultancy firm Evaluadora Latinoamerica has reported that that food prices for the average consumer living in Buenos Aires grew 95.7% between the first week of January 2004 and the third week of April 2008. However, as noted above, the increase is not just due to increases in international food price increases, but also due to high local inflation and the local distortions caused by local price controls, export taxes, and export prohibitions. -- Impact on Trade balance? High commodity prices have clearly benefited Argentina's trade balance. In 2007, exports grew 20.4% over 2006, due to volumes exported growing at 8% and export prices growing at 11.5%. (2007 Imports grew 31.1% over 2006, due to volumes growing at 21.9% and prices growing at 7.6%.) The resulting trade surplus in 2007 was $11.15 billion. (POST Simulation: using same volumes exported, but 2006 prices, the result is a trade surplus of $8.5 billion, or 23% lower. As industrial good export volumes only grew 3% in 2007, most of the higher trade surplus is attributed to primary commodity price increases.) -- Impact on Balance of Payments (BoP)? Higher food prices' effect is also positive on the overall BoP, although the impact is less easily definable. As the GoA has become more dependent on export taxes to ensure a primary fiscal surplus, while continuing with high public expenditure growth, lower commodity prices would have directly led to lower revenue collection. Given the GoA's restricted access to international capital markets (a lingering consequence of the 2001 default and partial debt exchange in 2005), lower tax revenues would have required the GoA either to issue more expensive local debt or cut expenditures. Cutting expenditures would have slowed the economy, while issuing more debt would have affected the BoP in the long run due to higher debt service. Furthermore, a weaker fiscal and economic situation would likely have caused higher capital flight flows, also affecting the BoP. -- Impact on Poverty? Argentina does not have adequate statistics on poor "net producers," since they are mostly located in rural areas. Food represents approximately 30% of the total value of the average local consumption basket, but increases as a percentage of the total for poorer individuals until reaching almost 100% for the indigent. Food price increases are, therefore, definitely having an adverse impact on net-food consumers, particularly the poor, but then so is overall high inflation in Argentina. Since a large percentage of the population lives at or slightly above the poverty line, poverty increases rapidly in response to rising inflation. While INDEC estimates that poverty levels have fallen from around 50% following the 2001/02 financial crisis to around 25% today, private analysts estimate that poverty has risen back to almost 30% over the last few months, primarily due to higher food prices. -------------- ENVIRONMENTAL IMPACT -------------- ¶12. (SBU) The rapid rise in world prices has caused some increase in agricultural production in more marginal, environmentally sensitive areas. President Cristina Kirchner raised these environmental concerns as one of the reasons for the increase in taxes on soybean exports. Some environmentalists have also blamed the recent grass fires that produced smoke covering the city of Buenos Aires on increased soybean production. These groups claim that soybean production has displaced livestock production onto marginal pastures that producers are burning to clear. Overall, however, the environmental impact has been relatively limited. Increased agricultural production has mainly come from more intensive use of current cropland and conversion of pastures to crop production. -------------- GOVERNMENT POLICY RESPONSE -------------- ¶13. (SBU) Measures adopted by the GOA in response to rising food prices include the following for the most important agricultural products in Argentina. Press reports May 2 suggest there may be liberalizations on beef and wheat as part of ongoing negotiations with the agricultural sector. -- Soybeans: The GOA implemented a variable export tax on March 11, 2008, that was initially set at 44% (the current tax is 40%). The GOA recently announced that it will provide a rebate of part of the export tax on soybeans to medium and small farmers (to bring the net tax back down to the 35% tax in place before the tax was increased in March 2008),although information on how this will work is not available. -- Beef: The GOA limits exports to guarantee domestic supplies. Beef exports have been suspended since April 1 and the government is asking producers to reduce prices on 13 beef cuts for domestic sales. Prior to the suspension, the government maintained an export quota of approximately 40,000 tons per months. Beef exports are subject to a 15% export tax. The GOA also provides some subsidies to feedlot operations to encourage production. --Wheat: Export registrations are currently suspended as the GOA seeks to ensure supplies to domestic flour mills. The GOA provides direct subsidies for wheat used domestically and is currently seeking to implement a system to ensure sales to domestic flour mills at reduced prices. The GOA also applies a variable export tax to wheat exports of 28.3% at current prices. -- Corn: The GOA applies a variable export tax that is currently 23.8%. Export registrations are currently open, but were suspended for extended periods during the last year. --Dairy: The GOA maintains a maximum export price for milk powder of US$2,750 per ton (the government collects any excess in the price above this amount). The GOA also provides subsidies to dairy producers contingent on them selling domestically at agreed prices. -------------- IMPACT ON POST PROGRAMS -------------- ¶14. (SBU) The rise in food prices has not affected post programs. Argentina does not receive food aid from the United States. -------------- POLICY PROPOSALS -------------- ¶15. (SBU) GOA measures to maintain low domestic prices and impose high export taxes are a factor in the rapid increase in world prices. This was particularly true during the farm strike, when exporters were not able to load contracted shipments of soybeans and grains. The GOA does not have any generally available food programs for the poor, relying instead on broad measures to keep food prices down for all Argentines. A more targeted approach of providing direct food subsidies to the most affected populations, instead of maintaining low prices for the entire population, would offer a number of advantages in meeting the needs of the most affected populations and could contribute increased production to relieve part of the current world supply problems. However, implementation could pose a problem given inefficiencies in government bureaucracies here. -------------- RELEVANT REPORTING -------------- ¶16. (SBU) A USDA report on the variable export tax (FAS Attach Report AR8013) can be downloaded at: http://www.fas.usda.gov/scriptsw/attacherep/d efault.asp Additional information is also available in the Semi Annual Livestock Report (AR8008) and the Grain and Feed Annual (AR8016),which are also available at the same website. ¶17. (SBU) Reports on GOA policies and the farm strike are also available in: (A) Buenos Aires 00328; (B) Buenos Aires 00368; (C) Buenos Aires 00379; (D) Buenos Aires 00386; (C) Buenos Aires 0398; Buenos Aires 408; Buenos Aires 415. WAYNE