ARGENTINA ECONOMIC AND FINANCIAL REVIEW, JUNE 6 -

UNCLAS SECTION 01 OF 05 BUENOS AIRES 000816 SENSITIVE SIPDIS E.O. 12958: N/A TAGS: EFIN ECON EINV ETRD ELAB EAIR AR SUBJECT: ARGENTINA ECONOMIC AND FINANCIAL REVIEW, JUNE 6 - 13, 2008 REF: BUENOS AIRES 782 ¶1. (U) Provided below is Embassy Buenos Aires' Economic and Financial Review covering the period June 6 - 13, 2008. 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. -------------- Highlights -------------- -- President Kirchner launches social redistribution program with proceeds from increase in soy export tax revenue, raising fiscal concerns. Farm strike resolution still elusive. -- Private sector deposits fall ARP 6 billion; financial sector's worst month since October 2001. -- GoA unveils new inflation index; underreporting continues and market underwhelmed. -- Consumer expectations lowest since October 2004; inflation expectations balloon to 36.5%. -- GoA public debt totaled $144.7 billion at the end of 2007, similar to pre-default levels, but decreasing in terms of GDP. -------------- Agriculture -------------- President Kirchner launches social redistribution program with proceeds from increase in soy export tax revenue, raising fiscal concerns. Farm strike resolution still elusive. -------------- -------------- ¶2. (SBU) President Cristina Fernandez de Kirchner announced June 9 during a speech in the Casa Rosada that the GoA would use the distribution of the marginal increase of the soy export tax (all tax collection above 35%) to finance a social redistribution program. (This followed the GoA's May 26 unilateral amendment on the export tax sliding scale, which attempted to solve the conflict between the GoA nd the farming sector triggered by the imposition on March 11 of the export tax sliding scale -- for background see April 4 and May 30 Econ/Fin Reports.) ¶3. (SBU) According to the Presidential Decree (N904) published June 10 in the Official Gazette, expected revenue from the increase of soy export taxes above 35% is $800 million in 2008 and $1.3 billion in 2009. The GoA will use these funds to will finance the social redistribution program, administered by the Ministries of Planning, Economy and Health and focusing on building hospitals (60%),housing (20%),and rural roads (20%). It is unclear (as it is not mentioned in the Decree) how these funds will be allocated among the provinces, which has aroused speculation in the press that Governors with a close relationship to the current administration will be the main beneficiaries. Following the speech, in statements to the press, farmers' representative stated that the rural organizations support the GoA's effort's to tackle poverty, but argued that it was unfair that the rural sector alone had to pay for the GoA's new infrastructure programs. ¶4. (SBU) Investment Bank's reaction to the President announcement: -- According to HSBC, the call to dialogue and the tone of the speech were positive. Still, the fact that additional resources will not be saved but rather spent is a concern to credit markets. Nevertheless, if the conflict is actually defused - or moderated - the balance is positive, as normalization of activity is a "necessary condition to revert the ongoing re-dollarization process" (see next item under Finance). HSBC also expects the GoA to announce additional measures favoring farmers, such as widening the definition of small producers to 1000 from 500 tons, thereby increasing those qualifying for compensation (subsidies). -- For CSFB, Cristina's speech was not conciliatory; in its view, her remarks about the farmers were quite harsh. She argued that the farmers were currently reaping very large BUENOS AIR 00000816 002 OF 005 profits while investing "little capital" and hiring very few workers. She continued that despite having so much, the farmers are unwilling to share with those who have very little. She justified the GoA's decision to hike the tax rate on soy exports by noting that it was impossible to reduce poverty in Argentina without taxing those with high incomes. Interestingly, she mentioned that farmers had benefited from the GoA's weak peso policy during recent years, which she claimed had cost the GoA $12 billion. -- According to Citi, Cristina's announcement sought not to solve the conflict with farmers, but to gain the support of the population, mayors, and governors because the execution of the program will be decentralized, with procedures under the supervision of governors and mayors (the same decentralization applies to 93% of the current public works projects, according to the President). (HSBC also emphasized this issue, noting that this initiative results in previously non-shared tax revenue being shared on the margin. Debate over export tax revenues exclusion from the "co-participation" tax sharing arrangement between the central and provincial governments had intensified over the course of the Ag conflict.) ¶5. (SBU) General Market reaction: concern over impact on fiscal accounts. Markets were already concerned about strength of fiscal accounts for the following reasons, and this new plan has generated further uncertainty: -- Questions over how the apparent deceleration of the economy will impact revenue collection; -- The dependence on export taxes and vulnerability to international commodity prices; -- The worrying trend in subsidies, which so far in 2008 are rising at an annual rate of about 103% (y-o-y in the first quarter),with little prospect that the GoA will reduce them soon (for details see May 30 Econ/Fin report); -- Pressure to increase public sector wages and pensions due to rising inflation ¶6. (SBU) NOTE: In June 10 statements to the press, Chief of Cabinet Alberto Fernandez clarified that expenditures generated by this announcement were not included in the 2008 Budget, as the GoA had not included the tax collection generated by the export tax sliding scale. According to Embassy calculations, when including this new social expenditure of $800 million, the 2008 primary fiscal surplus will decline from an estimated ARP 36.0 billion (or 3.6% of GDP) to ARP 33.4 billion (or 3.4% of GDP). (Note: this estimate is based on the BCRA market consensus survey, as of May 2008.) ¶7. (SBU) For reference: the GoA Primary Fiscal Surplus is still at an historically high level in terms of GDP, albeit lower than the post-crisis high of 3.9% of GDP set in 2004. For the first four months of 2008, accumulated primary expenditures reached ARP 53 billion (up 39% y-o-y),while accumulated revenues stood at ARP 65 billion (up 44% y-o-y). This resulted in an accumulated primary surplus of ARP 11.6 billion. According to Argentine consulting company "Economia y Regiones," if revenue and expenditure growth dynamics continue as they have through April, the GoA's 2008 primary fiscal surplus may reach as high as 4% of GDP. This would be significantly above the official 2007 primary fiscal surplus of 3.2% of GDP (equivalent to ARP 25.7 billion or $8.1 billion). (Note: The 2008 estimate appears even stronger compared to 2007 when taking into account that the 2007 primary surplus was only 2.5% of GDP when excluding the one-time transfer of about ARP 7.5 billion that resulted from the 2007 pension system reform.) ¶8. (SBU) Going Forward: When does the conflict end? Most local analysts and commentators seem to agree that the President's announcement erodes the farmers' public support and undermines their ability to continue their protest. However, opinions are still divided on whether the conflict will now subside or continue at current levels. From contacts with farm groups, the Embassy is seeing few signs that the producers are tired of the dispute and ready to give in. If anything, the debate seems to be over whether to take stronger measures. However, Embassy financial sector contacts expect it will gradually diminish in strength, but will continue as a low-intensity conflict for a long time to come. The latest wild card is that groups of truck drivers are blocking roads, demanding that the GoA and farmers resolve the strike. This has intensified concerns over possible food and fuel shortages and over the possible BUENOS AIR 00000816 003 OF 005 escalation of social tensions. -------------- Finance -------------- Private sector deposits fall ARP 6 billion; financial sector's worst month since October 2001. -------------- -------------- ¶9. (SBU) Political uncertainty, accelerating inflation, and the Ag conflict created a move towards the dollar in May at the expense of private peso deposits. ¶10. (SBU) Private sector deposits dropped ARP 5.8 billion (almost $1.8 billion) or 4% of total private sector deposits during May, resulting in the worst month for the financial sector since October 2001. Furthermore, an Embassy banking sector contact estimates that total capital outflow (capital flight) in May was $3.5 billion, compared to the $2.5 billion outflow in April. During the month, savings accounts had the worst performance, falling by 8% m-o-m (ARP 3 billion), followed by current accounts falling by 4% (ARP 1.7 billion). The first three weeks of May saw a rapid and constant drainage of private sector deposits. This partially reversed during the last week of May (see last graph below) helped by rising interest rates and BCRA measures to ease liquidity constraints (for reference see May 30 Econ/Fin report). ¶11. (SBU) According to Argentine daily "Cronista Comercial," retail investors continue withdrawing deposits, while institutional investors are attracted by the high returns and are beginning to increase deposits. Meanwhile, the Badlar interest rate (the reference rate for one-month time deposits over ARP 1 million) reached a high of 17.9% on May 29 (the highest level since February 2003). The Badlar rate eased slightly to end the month at 16.9%, but still representing a huge spike from the 9% levels at the beginning of May. ¶12. (SBU) The fall in deposits and the skyrocketing interest rates represent the flip side of the BCRA's dollar sales in the FX market to satisfy the private demand for dollars (mainly from retail depositors) and keep the peso stable. The peso/dollar retail exchange rate ended May at around 3.10, compared to the 3.20 ARP/USD level of April 30 and the high of 3.25 ARP/USD on May 9. The peso has strengthened further in June, with the retail rate at 3.05 ARP/USD on June ¶12. ¶13. (SBU) The BCRA seems to have set its new "ceiling" level for the peso at about 3.10 ARP/USD. Market analysts speculate that the BCRA continues to sell dollars and strengthen the peso to prove that it can set the exchange rate at the level it desires (following the minor run on the peso over the last few months, and in the face of accelerating inflation -- estimated at an annual rate of 25-30% for 2008) and to assuage the markets' fears of a large peso devaluation (as indicated by the current one-year Non-Deliverable Forward (NDF) rate of 3.34 ARP/USD). (Comment: A mid-level BCRA currency trader stated to the Embassy that BCRA traders believe the objectives of the continued dollar sales are at least in part to punish: 1) speculators; 2) the Ag sector; and 3) the industrial sector (for refusing to sign the President's Social Pact, or "Bicentennial" agreement, before the GoA had resolved the Ag conflict). During May, the BCRA sold $1.7 billion reserves, leaving BCRA reserves standing at $48.6 billion as of May 30, according to BCRA data. According to the June 5 report from Argentine consultancy "Broda y Asociados," the estimate for private sector dollar demand surged to $7.7-9.0 billion in the period April-May. -------------- Inflation and Consumer's Expectations -------------- GoA unveils new inflation index; underreporting continues and market underwhelmed. -------------- -------------- ¶14. (SBU) Argentina's national statistics agency INDEC introduced its new CPI methodology with the publication of May headline CPI inflation. Using the new system, INDEC reported that May inflation was 0.6% m-o-m (0.4% for goods and 0.9% for services) or 9.1% y-o-y (7.6% for food and 11.3% for services). The 0.6% monthly increase was due to some prices increasing due to seasonal reasons by 1.2% m-o-m, BUENOS AIR 00000816 004 OF 005 regulated prices increasing 0.8% m-o-m and the rest (also referred as "core" inflation) increasing 0.4% m-o-m. Private sector estimates of May inflation were at over 1%. ¶15. (SBU) The new CPI methodology (see May 23 Econ/Fin Report for background) includes a new CPI basket that was based on INDEC's Greater Buenos Aires expenditure survey of 2004/5 (replacing the previous 1996 survey),which resulted in new weights for the CPI formulas. The new weights have not been disclosed publicly. "Broda y Asociados" wrote in their weekly report that lack of information on the new weights prevents the private sector from determining (and analyzing) the incidence of each product's price on total inflation. For example, from now on, there will be no possibility to see how the price of beef, a key element for the average Argentine's consumption basket, will affect total inflation. However, INDEC did say that "Goods" account for 62% of the new basket (up from 53% in the previous one),while "Services" are 38% (down from 47%). This is a strange development, as for most economies high economic growth is accompanied by an increase in the share of service consumption by individuals. However, this could have been the result of INDEC only considering consumption from the lower-middle-class to determine the new CPI basket. ¶16. (SBU) The last expenditure survey also resulted in a reduction of the number of goods included in the monthly CPI calculation, down to 440 items from the 818 previously considered. The new list of goods was not published, nor was the reasons for the reduction in the number of items. ¶17. (SBU) The CPI formulas (basically, Laspeyres-based) did not change with the new method. INDEC maintains the same nine price sub-indices. The innovation is that, within each price sub-index, INDEC will use variable weights for the goods and services whose prices exhibit large seasonal variations, or volatility due to quality changes, among other reasons. Well-known Argentine economist Ernest Kritz said to Argentine daily "La Nacion" on June 11 said that the use of variable weights will result "in the institutionalization of political discretion into the CPI," if this is not coupled with periodic surveys on new consumption patterns, providing grounds for the changing weights. ¶18. (SBU) INDEC has not disclosed the new methodology in detail in any official document yet, nor have they provided a disaggregation of the May outcome by product or group of products, which makes the CPI figure less transparent and contributes to confusion. Credit Suisse said that in their view, the new CPI continues to understate significantly the "true" level of inflation, which is probably in the 25%-30% range on a y-o-y basis. JPMorgan's alternative proxies for the CPI suggest that true inflation was advancing in at an annual rate of between 22.6 - 27.2% in May, reflecting a "very mild acceleration". Local consultancy "Evaluadora Latinoamericana" has its own inflation survey, and estimates that CPI grew 0.9% in May m-o-m, and 21.5 y-o-y. Consumer expectations lowest since October 2004; inflation expectations balloon to 36.5% -------------- -------------- ¶19. (SBU) The index of consumers' economic expectations published by TNS Gallup and Argentina's Universidad Catolica (UCA) fell sharply in May to 94 from 100 in April, bringing the index to its lowest point since October 2004. May was the fifth consecutive monthly drop in the index, reflecting consumers' concerns about high inflation and the unsatisfactory handling of the situation with farmers and truckers. All sub-indices that make up this index fell in May relative to April. The largest declines came from the sub-indices tracking consumers' perceptions about the current economic situation, which fell to 107 in May from 115 in April, and the sub-indices tracking consumers' intention to purchase durable goods, which fell to 101 in May from 109 in April. ¶20. (SBU) A key factor affecting consumer sentiment is high inflation, as demonstrated by the public's increasing expectations. Torcuato Di Tella University's index on consumers' inflation expectations for the next 12 months jumped 3.7 percentage points (pp) in May over April, reaching 36.5%. This is a record high for the time series started in August 2006. Higher inflation expectations come from all over the country; no region is exempt from this trend. The BUENOS AIR 00000816 005 OF 005 consensus forecast published by the BCRA, known as REM and which averages approximately 50 organizations estimates of inflation in Argentina for the next 12 months is 9.3% or 27.2 pp lower than consumers' expectations. -------------- Debt -------------- GoA public debt totaled $144.7 billion at the end of 2007, similar to pre-default levels, but decreasing in terms of GDP. -------------- -------------- ¶21. (SBU) In the fourth quarter of 2007, the GoA debt stock (excluding the so-called "holdouts," or bondholders who did not participate in the 2005 debt restructuring) increased $7.6 billion to $144.7 billion, or 56% of GDP. This was due to $3 billion in GoA bond issuances, an $825 million increase in IFI lending (mainly IDB),and $3.2 billion in short-term financing to the GoA (from the BCRA and other public sector agencies). When including holdout debt, currently totaling about $28.8 billion, the public debt stock rises to $173.6 billion, almost 67% of GDP. ¶22. (SBU) Many analysts have criticized the GoA for the fact that current debt levels are similar and even slightly exceed the pre-default level of $144.2 billion (as of December 2001). However, it is worth noting that while the GoA debt stock has increased in dollar terms since the 2005 debt restructuring, it has decreased in terms of GDP every year since 2002 (with or without including holdouts). Compared to other Latin-American borrowers, Argentina's debt to GDP ratio is slightly lower than Brazil's, but higher than Colombia, Peru, Mexico, and Chile. However, Aldo Abram, Director of the Argentine Institutions and Markets Research Centre at Eseade business school points out that the worry is not the nominal amount of debt (or that is decreasing in terms of GDP) but that Argentina does not have access to credit. The GoA is essentially barred from issuing bonds in international capital markets, a consequence of holdout lawsuits, and has been forced to rely increasingly on financing from Venezuela and Argentine public agencies (such as the tax authority ) AFIP ) and Social Security Agency ) ANSES). WAYNE