"Argentinization:" Government Promotes Greater Local

UNCLAS BUENOS AIRES 000836 SIPDIS SENSITIVE PASS USTR FOR DUCKWORTH USDOC FOR 4322/ITA/MAC/OLAC/PEACHER US SOUTHCOM FOR POLAD E.O. 12958: N/A TAGS: ECON EINV ETRD PGOV PREL ENRG AR SUBJECT: "Argentinization:" Government Promotes Greater Local Control of Key Public Services REF: (A) 07 Buenos Aires 1352 (B) 07 Buenos Aires 1819 (C) 07 Buenos Aires 2390 (D) Buenos Aires 572 (E) Buenos Aires 660 ¶1. (SBU) SUMMARY. A decade after its great privatization wave, and followed by the 2001/02 economic collapse, Argentina has undergone a paradigm shift, with the Government of Argentina (GOA) promoting a heavy hand in the economy. While this trend has been much in the news over the GOA's price stabilization efforts, it is also clearly evident in the GOA's advocacy of greater local control - whether by the GOA itself or by local businesses close to the GOA - of key public service entities privatized in the 1990s and largely controlled by foreign interests. The administrations of Nestor and Cristina Kirchner, with strong public support, have accelerated this process, which many here call "Argentinization." Focusing on specific sectors, Argentinization takes several forms: 1) the outright re-nationalization of privatized companies; 2) GoA or local private groups taking equity stakes in foreign-owned companies; and 3) the GoA creating entirely new state firms. We expect more such "Argentinizations." Whether driven by political opportunism, economic nationalism, cronyism, or all three, the trend appears to be here to stay. While this trend may complicate an already difficult investment climate, some observers argue that politically-connected insiders are better at navigating in this heavily-regulated and highly personalized political economy, and can even help to bring in outside investors to some "strategic" sectors. END SUMMARY. -------------- "Failed" 1990s Privatizations, and 2001/02 crisis . . . -------------- ¶2. (SBU) In the 1990s, Argentina was at the forefront of the region's embrace of liberalization, privatizing or granting concessions for many state-owned utilities, including telecoms, airlines, electricity, gas, water, rails, highways, ports, mail service, and airports, with many ending up under foreign control. The GOA took in about $24 billion through the sale or concession of these federal assets, according to the Economy Ministry. (U.S. firms largely stayed out of this process, reportedly out of their concern with the lack of transparency, and GOA officials in the current administration have regularly praised U.S. companies for not participating in what they describe as corruption-filled privatizations.) However, a common denominator for many of these initiatives was their eventual failure and the subsequent deep unpopularity of privatization with the GOA and public. (Although many of these privately owned public service entities initially did well, and there is clear evidence of improvement in most public services, poor regulatory oversight and the 2001/02 economic crisis eventually did them in.) ¶3. (SBU) Following the 2001/02 economic collapse and devaluation, the GOA largely froze most utility rates for public services. Many owners found themselves servicing foreign currency-denominated debt with now-devaluated peso receivables. They fought (and some continue to fight) a largely unfruitful battle with the GOA to adjust rates. However, the Duhalde administration (2002-3) and Kirchner administrations (2003-present) largely refused to consider such requests, arguing that price increases would hurt millions of mostly urban poor, who represent the heart of their Peronist political base. -------------- Helped shift pendulum to more state control of the economy . . . -------------- ¶4. (SBU) The privatization process has since been widely seen by the GOA and public as totally flawed. Conventional wisdom here portrays the process as a succession of slick business deals for the companies that benefited, often with GOA subsidies. Fairly or not, this process has been lumped together with the Argentine government and public's rejection of the "neo-liberal" model and "Washington Consensus." ¶5. (SBU) In 2003, the new Kirchner administration began regularly criticizing these companies for allegedly forsaking commitments related to investment, safety, maintenance, and royalties. The GoA stated its intention to "regain" for Argentina the upper hand in managing these privatized utilities, and reviwed and renegotiated over 60 such agreements. New rules were introduced, and a common tactic was for the GoA to take a golden share in companies in exchange for debt forgiveness. In some cases, contracts were so altered that concession holders were largely reduced to being mere contract administrators, while the GOA made the key investment decisions. Some of these foreign owners decided not to wait for a better climate, and sold their assets, with ownership reverting from mostly European to local control. In some cases, these firms also filed cases with the World Bank's International Centre for Settlement of Investment Disputes (ICSID). -------------- With Strong Public Support for State Control of the Economy -------------- ¶6. (SBU) The trend toward more state control enjoys strong public backing. Argentine polls consistently reveal a widespread view that the state should have a predominant role in the economy, especially in public services, and that the 1990-era privatizations and free market reforms went "too far." According to a February 2008 local Poliarquia poll, 65% of respondents agreed with the statement that "state intervention is the best way to ensure better development and fairness in the distribution of goods," and only 22% agreed that "private initiative in the economy is the best way to assure a better development and fairness in the distribution of goods." ¶7. (SBU) A 2007 State Department INR-commissioned survey found that by 57-35% margin, "Argentines continue to perceive the state as the agenda-setter, safety net, and provider of last resort for economic development, despite acknowledging the shortcomings of state enterprises in terms of inefficiency and quality of service." The same poll indicates that for almost a decade, large majorities state that privatizations were harmful and led to rampant corruption, impoverishment, and the loss of national sovereignty. ¶8. (SBU) The local Ipsos-Argentina polls that track public preferences on the balance between government and the market have seen in recent years a steady support for a "new statist" position that eschews the monopoly of state enterprises and regulation of trade, but still prefers the GOA to act as a buffer against market forces. Currently, as few as a quarter of respondents favor a predominant role for the private sector, while 60-75% favors giving the state a larger role. This holds true even for sectors in which the GOA struggles to provide services, such as electricity, water, petroleum, and natural gas. Noted Argentine economist Rafael Di Tella has said that, for Argentines, "it is either the state or the jungle, and no one believes that capitalism can be a solution for all." -------------- Kirchners' Priority -------------- ¶9. (SBU) The Nestor and Cristina Kirchner administrations have signaled and continue to signal their preference for increased local control of strategic economic assets, while affirming a strong commitment to the "market economy." The Kirchners have also at times been accused of "encouraging" this process by intentionally complicating foreign operators with regulatory problems, frozen tariffs, or export taxes. These measures drive down the values of these enterprises and encourage the foreign firms to exit the market. At the same time, the GOA has strongly disavowed wholesale re-nationalizations. It is also important to note that in some cases where the GOA has taken control of companies that had previously been privatized, there were legitimate concerns about serious flaws or corruption in the concessions. In these cases (as cited in paras 13-17 below),the GOA was left with no choice but to make changes. And not all GOA post-privatization interventions were effected by the Kirchners, Presidents De La Rua and Duhalde both initiated such actions. Also, not all moves toward greater state control have been directed at foreign-owned companies; some locally-owned companies have also been targeted. ¶10. (SBU) Ever since this post-crisis rollback, and perhaps for the foreseeable future, the GOA's populist positions on these (and other) issues leave the impression that local companies or the GOA itself might be better suited for buying into and operating public service (utility) companies. However, one of the original aims of the privatizations - bringing in capital and experienced operators - has been jeopardized, to say nothing about the discouraging impact these interventions have on potential investors. ¶11. (SBU) While this interventionist trend might appear excessive, it is only one of many areas where the GOA believes a larger central government role is necessary than is the norm in most other countries where market forces play a more predominant role. Examples include: setting the exchange rate, major infrastructure investment decisions, setting prices (and thus relative prices) for many goods and services, and regulation of privatized sectors. (For some of us, the policy approach has similarities to France's economic policy from the 1960s through the eighties.) -------------- -------------- Increased GOA Control Falls into Four Categories -------------- -------------- ¶12. (SBU) Analysts have identified four general characteristics of this phenomenon of increased state control: re-nationalizing some entities that were once state-owned and were privatized in the 1990s; the GOA obtaining equity stakes in other such firms; local investors close to the GOA taking increased equity stakes in similar entities; and, in some cases, the GOA creating new state firms altogether. -------------- - Re-nationalizing formerly privatized companies -------------- ¶13. (SBU) In November 2003, the GOA rescinded a 30-year postal service concession granted in 1997 to an Argentine-led Correo consortium, claiming that Correo failed to fulfill several contract conditions, including unrealized investments and non-payment of royalties. Correo's owners argued the company was owed millions for services provided to federal agencies, and that the GOA had failed to reform labor laws as promised. ¶14. (SBU) In 2004, the GOA rescinded a 1997, 15-year, $500 million concession held by France-based Thales to manage the radio spectrum, citing Thales's failure to meet contract conditions and GoA regulatory agencies frequent charges of Thales' corrupt practices. GOA oversight agencies argued that Thales Spectrum failed to collect fees, control frequency usage, pay fines, or invest in or maintain infrastructure. ¶15. (SBU) In September 2005, the GOA rescinded France-based Suez's water and sewage concession (Aguas Argentinas),which serviced 10 million people in greater Buenos Aires. It subsequently created a new state-run firm, AYSA, to provide these services. Suez countered that it was "impossible" to maintain financial stability given the 2002 conversion to pesos and years of frozen tariffs. ¶16. (SBU) In recent years, the GOA has also revised or canceled many train concessions, including the locally-owned Metropolitano commuter train. This was a private consortium formed in 1994 that operated three heavy-volume Buenos Aires commuter lines. In spite of large subsidies, a serious decline in services led to the 2004 rescission of one contract due to "grave breaches of contract" and poor maintenance. In May 2007, the GOA rescinded the other two contracts after excessive cancellations and delays sparked irate commuters to riot. These lines are now operated by two newly-created state companies. ¶17. (SBU) In 1999, the De La Rua administration rescinded the 1991 privatization of Buenos Aires shipyard Tandanor amidst complaints that its owner, the Indarsa company, had invested only a fraction of its pledged amount. The GoA also accused Tandanor of conducting illegal sales of prime downtown real estate. Tandanor workers ran the shipyard until 2007, when the Ministry of Defense was granted full control of operations. -------------- Well-connected local investors taking stakes in firms -------------- ¶18. (SBU) Local ownership is an increasing trend. Critics charge that many foreign-owned companies have sold out to locals due to the increasingly difficult investment climate, which the GOA had done nothing to improve, and done many things to complicate. In 2003, France Telecom sold its 48% stake of the holding company that controls Telecom Argentina to local investment company Werthein Group for $125 million, the first major divestiture of privatized services by a foreign firm in Argentina. ¶19. (SBU) Spanish oil and gas giant Repsol-YPF recently sold a 15% stake in its Argentine subsidiary YPF to Argentine banker and Kirchner insider Enrique Eskenazi for $2.25 billion. The Kirchners openly supported the sale of this emblematic formerly state-owned company. However, it faced criticism locally, with former Economy Minister Roberto Lavagna labeling the sale "crony capitalism." For Repsol-YPF, Argentina's post-crisis energy price freezes, high export taxes, and an unpredictable regulatory climate had made Argentina a less attractive place to do business. Therefore, the sale was reportedly motivated by Repsol's desire to reduce its exposure to the difficult Argentine business climate and improve relations with the GoA by bringing on a well-connected partner. ¶20. (SBU) In 2005, local investment firm Pampa Holdings (with support from U.S. capital) bought a 65% stake in Edenor (Argentina's largest power distributor) from Electricite de France (EDF) for $100 million, a huge drop from the $800 million EDF paid for a 45% stake in 2001 (ref B). (EDF filed an ICSID suit against the GoA following the economic crisis and was unable to negotiate a tariff increase to return to profitability.) Shortly after Pampa's purchase, Edenor obtained a 28% tariff increase. Some analysts speculate that the reason the purchase price was so low was because the GOA favored increased local participation in the energy sector, and delayed the tariff increase until the deal went through. ¶21. (SBU) In October 2007, the GOA exercised an option to increase its share in Argentina's flag carrier Aerolineas Argentinas, majority-controlled by Spain's Marsans Group, from 5% to 20% in exchange for forgiveness of accumulated debt. Frequent strikes, high salaries, a bloated staff, low fares and a poor financial performance (US$200 million debt) continue to mar the airlines' performance. In May 2008, the GOA, Aerolineas, and Argentine ferry operator Juan Carlos Lopez Mena began talks for the latter to take financial and possibly operational control (ref D and E). Notably, the GOA soon thereafter authorized a tariff increase for domestic air travel, the market dominated by Aerolineas Argentinas. -------------- Increased GOA Equity in Firms -------------- ¶22. (SBU) In July 2007, Petrobras sold its 50% stake in Citelec, which controls Argentina's largest power transmission firm, Transener, to Argentina's state-owned Enarsa and private, Cordoba-based Electroingeneria, for an estimated US$55 million. The GOA had earlier rejected a similar offer for this Citelec stake by U.S. investment fund Eton Park Capital Management, ostensibly because of Eton's lack of experience in the power sector (ref A). This decision paved the way for Enarsa and Electroingeneria's purchase. Argentina-based Dolphin fund, a unit of Argentine energy company Pampa Holding, which represents large foreign and local investors, had earlier already taken the other half of Citelec. ¶23. (U) In late 2007, the GOA exchanged an accumulated $400 million debt by airports operator Aeropuertos Argentina 2000 (AA2000) for 20% of the company. An Argentine businessman with many international investments maintains his majority ownership of AA2000 (ref C). -------------- Creation of New State Firms -------------- ¶24. (U) The GOA has not shied away from creating new state firms altogether. In 2004, it created Enarsa, a state oil and gas firm, whose assets are its mostly undeveloped exploitation and concession rights. State airline Lafsa was created in 2003 to absorb some 850 employees of two failed airlines. Most of these employees were later absorbed by LAN Chile when the latter began operations in a GOA trade-off in exchange for access to the Argentine market. Since Lafsa's creation, the GOA has maintained some 100 employees, including pilots and flight crew, but owns no aircraft and has never made a flight. In 2006, the GOA formed new national satellite company, ArSat, with the goal of eventually operating a satellite in the GOA's allotted orbital position. -------------- More "Argentinizations" on the Way? -------------- ¶25. (SBU) The "Argentinization" trend may spreading. Television station Telefe's news content, owned by Spain's Telefonica, could soon be acquired by local interests close to the Kirchners. Argentina's second largest gas distributor, Metrogas, majority controlled by British Gas and Repsol-YPF, recently announced that its 2005 debt-for-equity swap for 30% of the company had fallen apart after the GOA denied regulatory approval. This 30% stake is now for sale, possibly to a local buyer. Petrobras is planning to sell to a local buyer its 50% stake in the controlling entity, Gas Argentino, of Argentina's largest gas transporter, TGS, after the GOA rejected the sale of this asset to the U.K.-based Ashmore Energy Fund. Spanish natural gas distributor Gas Natural BAN recently announced its intention to sell 19% of the company to a local entity, reportedly with "encouragement" from the GOA. ¶26. (SBU) "Argentinization" could be coming soon for some major electricity distributors in Buenos Aires Province, according to media reports and private analysts. U.S.-based AES is reportedly set to sell its controlling stakes in Edelap and EDES, also under GOA "encouragement," possibly to an Argentine-controlled firm. EDEN and Edesur could also be selling their controlling interests. AES had sold its 90% stake in EDEN to the Ashmore fund in 2006, but this transfer has not been approved by the GOA, and AES will now sell this stake, likely to local buyers. Edesur, jointly controlled by Petrobras and Spain-based Endesa, are also reportedly ready to cede control of the firm in response to GOA "encouragement." -------------- GOA Motives: "Digital Economy" -------------- ¶27. (SBU) Some observers see other motivations for this "Argentinization" of the economy. While some cite political and economic nationalism, others see crony capitalism or the ruling first couple's efforts Kirchner moves to preserve their political power base. Some say that the process is in fact not very different than how the Kirchners ran Santa Cruz Province in the 1990s. One local analyst said to Econoff that "I don't know how much of this trend can be explained as economic nationalism and how much of it is just crony capitalism using the banner of nationalism." He added an even more perverse notion: "in some ways, some foreign operators (in strategic sectors) are actually trapped here: if you want out, you either sell low, or you're stuck here." This person gave as an example Exxon's failure in 2007 to sell its Argentine operations, due to the lack of an acceptably high offer, and noted that GoA support for local investors and pressure on foreign owners allows locals to make ridiculously low-ball offers. Perhaps the best explanation of this trend came from one of the successful entrepreneurs who have benefited from the system. He told the Ambassador that the Kirchners want a "digital economy: they can point their digit (finger) and say you get this contract and you don't: It's about control." -------------- Failed privatizations, or poor regulation and oversight? -------------- ¶28. (SBU) Some local economists cite what they say is an important but often overlooked aspect of the "failed privatization" debate. While some of the charges against the privatized companies might have merit, and indeed several federal oversight agencies and the media reported breaches of contract by several concession holders, many privatizations were simply poorly conceived and executed. For them, the "privatization vs. state control" debate is a false dichotomy: the real issue is how well (or poorly) a concession is run. Large-scale privatizations need good oversight, transparency, accountability, enforcement mechanisms, good regulatory agencies imposing efficient and technical policy on regulated sectors, and newly-privatized enterprises need to be put on sound footing before offering them for sale - all which was often lacking. While the public often blames the initial privatization for ensuing problems, the full story is usually more complex. -------------- Comment -------------- ¶29. (SBU) Argentina has undergone a significant paradigm shift. Today, privatization and "neo-liberalism" are widely believed to have failed to deliver stable and equitable growth. Partly as a result, the GOA believes it has a public mandate to play a greater and more direct role in Argentina's economy. At the same time, there is no indication that Argentina is moving towards any form of economic "re-nationalization" in the classic sense of a systematic state takeover of industries. In fact, for many sectors (IT, telecoms, agriculture, mining, to name a few),the GOA appears content to simply tax them. However, in other sectors, particularly traditional utilities (water, transportation, and energy),the GoA is clearly pursuing a policy of "Argentinization." ¶30. (SBU) For better or worse, "Argentinization" is here to stay. Many observers argue that local ownership by a GOA ally enables a business to navigate this heavily-regulated and highly personalized political economy better than foreign owners can. In fact, a number of U.S. investors have supported Argentine players with capital when buying into key companies. Several local entrepreneurs have pointed out that through this process they have substantially eased the entry for international partners. And if "Argentinization" is what the public wants, the GoA will only have themselves, and not foreigners, to blame if the process leads to worse competition, corruption, and lack of investment in public services. WAYNE