ARGENTINE CENTRAL BANK PRESIDENT TO TREASURY DAS

C O N F I D E N T I A L SECTION 01 OF 04 BUENOS AIRES 000984 SIPDIS E.O. 12958: DECL: 07/17/2028 TAGS: EFIN ECON ETRD AR SUBJECT: ARGENTINE CENTRAL BANK PRESIDENT TO TREASURY DAS O'NEILL: CONCERNED ABOUT GLOBAL ECONOMY BUT CONFIDENT IN OWN EFFORTS TO ENSURE LOCAL FINANCIAL STABILITY REF: BUENOS AIRES 712 Classified By: Ambassador E.A. Wayne for Reasons 1.4 (b,d) Summary -------------- ¶1. (C) Argentine Central Bank (BCRA) President Martin Redrado told Treasury Deputy Assistant Secretary Brian O'Neill July 11 that he was greatly concerned about the direction of the U.S. and world economies, and the impact on Argentina and Latin America, and called for stronger G-3 statements of coordination in support of the financial sector. Redrado highlighted Argentine banks difficulties in maintaining relations with U.S. money center correspondent banks due to tough anti-money laundering and counter-terrorism finance (AML/CTF) regulations, and asked for Treasury support for developing regional supervisory standards in the area. He argued that the BCRA is doing "a really good job" reacting to the mini-financial crisis that began in March, and plans to continue intervening to strengthen the currency until confidence in the peso returns. He agreed that a top priority was to reestablish credibility of government statistics, without which he argued it will be difficult for the GoA and IMF to have a normal relationship and conduct Article IV consultations. End Summary. ¶2. (U) Treasury DAS Brian O'Neill met July 11 with BCRA President Martin Redrado, prior to the beginning of the second round of USG/GoA bilateral consultations (septels). Redrado included the BCRA's three top economists, Director Carlos Perez and Chief Economists Hernan Lacunza and Pedro Rebasa in the meeting. Lacunza and Rebasa had just returned from difficult meetings with Wall Street analysts in New York and the IMF in Washington. A representative of the Argentine Ministry of Foreign Relations also participated in the meeting, which took place at the MFA. Concerns about U.S. economy and call for G-3 statement in support of banks -------------- - ¶3. (C) As the meeting took place on the second day of the plunge in Fannie Mae and Freddie Mac stock prices, Redrado started the conversation commenting on the deterioration of the U.S. economy. He noted that the greatest concern seemed to be the difficulty of assigning value to financial and, in particular, real estate assets, which made it next to impossible for the economy to get a sound footing. He thought that the fall-out in the U.S. real estate market had a ways to go, and worried about bank solvency as a result. Redrado argued that Central Banks around the world have been active in using the tools they have available to stabilize and shore up the financial system, and asked what the U.S. Treasury was planning to do. He also called for statements from the major powers (G-3, G-7) assuring that their Central Banks and Treasuries are coordinating to ensure banking sector stability. ¶4. (C) O'Neill said that it was unclear that the U.S. economy would fall into a recession (under the technical definition of two consecutive quarters of decline in real GDP),so at this point the U.S. was experiencing decelerating growth. O'Neill noted that the impact of slowing U.S. growth on the region was mixed, with Canada the most affected due to sharply reduced U.S. imports of autos and wood products. Mexico and other Latin American countries had shown surprising resistance, he added, although Central American and Caribbean countries were clearly the most vulnerable to higher world energy and food costs. ¶5. (C) O'Neill agreed with Redrado's concerns about the U.S. real estate market, noting four States -- Arizona, California, Florida, and Nevada -- were most at risk. O'Neill commented that most of the largest European and U.S. banks were taking steps to recognize losses and shore up their balance sheets, but admitted that high uncertainty was likely to continue for a while and there were more serious concerns about the solvency of some small and medium size financial institutions, of which there are 7.5,000 in the U.S., with a large percentage highly exposed to real estate risk. ¶6. (C) Redrado said the world was facing the perfect storm of increasing inflationary pressures, decelerating growth, and a financial sector crisis, but noted that each region was facing a different mix of challenges, making it difficult to coordinate Central Bank and Finance Ministry policies among regions. With Asia and Latin America more worried about BUENOS AIR 00000984 002 OF 004 inflation, while Europe and the U.S. were more focused on growth and financial sector stability, Redrado said each regional zone was going to have to come up with response appropriate to the challenges faced. Nevertheless, he thought a public statement that the major countries are coordinating would still be helpful and effective. O'Neill acknowledged the "balkanization" of bank regulation at the global level, but reassured Redrado that the G-3 are coordinating policies and regulation. Both agreed on the increasing usefulness of communicating and coordinating with the G-20. Common AML/CTF regulatory standards needed -------------- ¶7. (C) A priority for the BCRA, Redrado said, is to develop regional rules and regulations covering banking sector supervision in the area of money laundering and terrorism finance. Reiterating an argument he has made in the past to the Embassy (Ref A),Redrado said that Argentine and other Latin American banks were facing difficulties maintaining their correspondent relationships with U.S. banks, giving the severely restrictive U.S. regulations (under the Patriot Act). U.S. rules are so tough, he noted, that U.S. banks are unwilling to tolerate Latin American risk. The result is that more and more Latin American banks are taking their business to Europe. To stem this trend, Redrado said regional efforts were needed to identify the problem, improve supervision, and improve the credibility (and lower AML/CTF risks) of the region's banks. ¶8. (C) Redrado noted that the problem in Argentina and the rest of the region is the large informal sector, and acknowledged that the BCRA and other bank regulators in the region needed to work to improve supervision of non-bank foreign exchange houses (although he was comfortable with the level of banking supervision in Argentina). Redrado said he has been discussing a project with IDB President Luis Alberto Moreno to survey the informal financial sector in Argentina and better measure the extent of the money laundering/terrorism finance problem here. ¶9. (C) The goal, Redrado said, would be to separate the problem of informal sector regulation -- which he called mostly "IRS issues" -- from concerns related to money laundering and terrorism finance. The idea would be for Argentina to serve as a pilot project, after which the IDB would expand the program to the rest of the region. The follow-on step would be for the countries of the region to develop common supervision standards, heightening enforcement of AML/CTF rules and regulations and lowering formal financial sector risk levels in this area. He envisioned the development of a report card on individual banks that would facilitate their ability to establish and maintain correspondent relationships. ¶10. (C) Redrado noted that the BCRA has an excellent relationship with the U.S. Treasury in these areas, and is currently negotiating a comprehensive technical assistance agreement on terrorism finance with Treasury's Office of Technical Assistance. However, he commented that Treasury's overall approach has been to bring together the public and private sectors to discuss AML/CTF regulatory issues, and this has not worked to facilitate Latin American financial institutions' access to U.S. financial markets. Redrado asked for O'Neill to pass the message to Treasury that the BCRA is serious about this issue, and also asked for USG support within the IDB for AML/CTF-related projects. BCRA success in stabilizing peso, stemming capital flight -------------- - ¶11. (C) The BCRA has dealt with two mini financials crises over the last year, Redrado noted, the first starting in July-August 2007, sparked by the sub-prime loan crisis in the U.S., and the second beginning in early March when inflation spiked and the farm crisis began (following the GoA's March 11 announcement to increase taxes on major agricultural commodity exports). ¶12. (C) During the first crisis, with foreign banks selling Argentine bonds in search of liquidity, Redrado said the BCRA sold about $2 billion out of its reserves to allow an orderly exit of these bondholders and meet growing demand for dollars. He claimed that the BCRA's actions contributed to financial sector and exchange rate stability in Argentina (and marginally contributed to global financial stability). ¶13. (C) During the recent and still ongoing crisis, Redrado BUENOS AIR 00000984 003 OF 004 noted that almost 7% of deposits flowed out of the financial sector during a short time, with May by far the worst month. He commented that if he had let it go the outflow would have severely compromised the health of the Argentine economy -- so the BCRA intervened immediately and heavily, and has continued to do so. (The BCRA reports that it sold $2.2 billion of reserves from March 11 through July 4 in its effort to bolster the peso and stem deposit flight.) Redrado noted that he is receiving heavy criticism for not pursuing more orthodox monetary and exchange rate policies, but argued that in his opinion the BCRA is doing "maybe not a great job, but a really good job" of responding to the crisis. ¶14. (C) Redrado complained about his critics, who are pushing the "one size fits all" orthodox solution to high inflation, meaning tighter monetary policy, correspondingly higher local currency interest rates, and a more freely floating exchange rate. He argued that the situation was more complicated in Argentina due to the relatively small size of the financial sector. With banking sector credit to the private sector comprising only about 10% of GDP (compared to over 35% in Brazil and over 60% in Chile),he claimed that the interest rate transmission mechanism is not strong enough to have a significant impact on Argentina's 90% cash economy. Fiscal policy has much more impact, he claimed, and he reiterated his traditional argument (made both publicly and privately) that coordinated fiscal, wage, competition, monetary, and exchange rate policies are needed to bring down inflation in Argentina. ¶15. (C) Redrado stated that the slowing of capital outflow from the banking sector was proof positive that he is correct to pursue a "managed float" exchange rate policy. Through BCRA interventions (selling dollar reserves),it has strengthened the peso to about 3 pesos/USD, compared to the rate of about 3.25 pesos/USD in mid-May (the worst point of the mini-crisis). He said he will continue to intervene and keep the peso at current exchange rates until confidence in the peso returns. ¶16. (C) Redrado dismissed rumors that the BCRA (under orders from the Kirchners) has appreciated the peso to the current level and kept it there in part to punish sectors of the economy (the farm sector for striking, the industrial sector for not being more supportive, and the wealthy for pulling their money out of pesos). Instead, he said the appreciation of the peso shows the public that this crisis is not like past one in the 1980s and 1990s, during which the currency rapidly lost value. He said the Argentine public reacts rapidly to economic uncertainty, given the country's past economic mismanagement, and in this context "the managed float is the only reasonable policy." ¶17. (C) Redrado explained that his Chief Economists Lacunza and Rebasa had weathered fierce criticism of BCRA and GoA policies during their visit to New York and Washington. He acknowledged the unhappiness Argentine policies have generated especially among foreign financial sector investors. However, he complained that it is not possible for the BCRA to pursue "inflation targeting" policies, as "we don't have the tools to do it and we can't control Argentine government policies such as high spending, export taxes, and INDEC manipulation." When O'Neill noted that Wall Street certainly believes it essential that the GoA reestablish credibility in INDEC's CPI statistics, Redrado strongly agreed. He added that he was open to suggestions on "how to show openness and confidence in BCRA numbers, which are second to none." ¶18. (C) The BCRA Chief Economists met with IMF officials while in Washington, and Redrado highlighted the excellent relationship between the BCRA and Fund. He lamented that the GoA was unable to improve its relationship with the IMF, noting that the GoA does not need an IMF lending program, but it should work to have more normal interaction. He commented, however, that without credibility of the Argentine inflation indices, it would be difficult for the GoA and IMF to repair the relationship and move forward with Article IV consultations. DAS O'Neill pointed out that the U.S. goes through Article IV's and the IMF criticizes USG policies. He acknowledged, however, a favorite saying of Argentine Ambassador Hector Timerman that the results of the IMF's review of the U.S. is not splashed across the front page of the Washington Post -- unlike Argentina, where IMF comments are always above-the-fold news. ¶19. (U) Treasury DAS Brian O'Neill cleared this cable. BUENOS AIR 00000984 004 OF 004 WAYNE