ARGENTINA ECONOMIC AND FINANCIAL REVIEW, MARCH

UNCLAS SECTION 01 OF 04 BUENOS AIRES 000361 SENSITIVE SIPDIS E.O. 12958: N/A TAGS: EFIN ECON EINV ETRD ELAB EAIR AR SUBJECT: ARGENTINA ECONOMIC AND FINANCIAL REVIEW, MARCH 9-23, 2009 REF: BUENOS AIRES 284 BUENOS AIR 00000361 001.2 OF 004 ¶1. (U) Provided below is Embassy Buenos Aires' Economic and Financial Review covering the period March 9-23, 2009. 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 announces plan to share soybean export tax revenues with provinces -- Disappointing February primary fiscal surplus -- Current account surplus narrows, net capital outflows increase in Q4 2008 -- Peso depreciation continues, hitting 3.7 pesos/dollar March 23 -- GoA public debt $145.9 billion at year-end 2008 -- Consumer Confidence Index decreases 5% m-o-m; inflation expectations remain high -------------- FISCAL -------------- President Kirchner announces tax revenue-sharing plan -------------- -------------- ¶2. (SBU) President Cristina Fernandez de Kirchner unexpectedly announced March 19 that the GoA will share 30% of the soybeans export tax proceeds with provincial governments and municipalities. On March 20 the GoA published in the Official Gazette an emergency and necessity decree (N 206) formally creating a special "Federal Solidarity Fund" to channel the 30% revenue share to the provinces. The funds will be earmarked for infrastructure, housing, schools, and water and sanitation projects. (Note: until now, the GoA kept 100% of export tax revenues.) According to the decree, state-owned Banco de la Nacion will daily and automatically transfer the funds to the provinces. Provincial governments will then be obligated to automatically distribute 30% of what they receive to their own municipal governments. This will leave the provincial governments with approximately US$ 1.2 billion from this new measure, which enters into force April 1. ¶3. (SBU) During the conference, President Kirchner acknowledged that the measure means a reduction of the 
federal fiscal surplus, but added that sustaining the national accounts also means sustaining provincial and municipal accounts. The GoA estimates that, at current international prices, with the new revenue-sharing arrangement, the provinces will receive $1.8 billion annually (ARP 6.5 billion, or about 0.5% of GDP, or 11% of what provinces receive from coparticipation). Although this measure will reduce GoA revenues, analysts do not expect it to worsen the federal fiscal surplus by the same magnitude because they predict the GoA will compensate by reducing discretionary transfers to the provinces. These discretionary transfers reached 1.5% of GDP (about US$ 1.5 bn) in 2008; and analysts had expected such transfers to rise to 2% of GDP (about US$ 6 bn) in 2009. Therefore, if the GoA maintains discretionary transfers at the 2008 percentage level, the net result of sharing soy export tax revenues will be less than half a billion dollars. ¶4. (SBU) The move to share the revenue with the provinces is politically shrewd. First, it attempts to win political support from provincial governors and mayors ahead of the midterm legislative elections (likely to be advanced to June 28 from October 25). Second, it seeks to undermine popular support for farmers' demands to reduce soy export taxes from their current 35% level, since the fund will finance politically popular infrastructure and social programs. Third, it also counters farmers and local governments' allegations that the GoA uses export tax proceeds to fund projects and programs benefiting the Kirchners' urban constituency, neglecting the countryside where soy production BUENOS AIR 00000361 002.2 OF 004 actually takes place. (Note: the main soy producing provinces -- Buenos Aires, Cordoba, Santa Fe, Entre Rios, Santiago del Estero, Chaco -- will still receive a smaller proportion than what they pay in export taxes. According to Argentina's coparticipation scheme, these six provinces will receive 52% of the disbursements from the Solidarity Fund, whereas they contribute 92% of total revenue deriving from export taxes on soybeans, soybean meal, and soybean oil. Farmers' representatives have criticized the President's measure, calling it a "provocation," and announced more protests and roadblocks. They initiated a 7-day strike on March 21. (See BA 331 and 342 for more details.) Disappointing February primary fiscal surplus -------------- ¶5. (SBU) The GoA announced March 19 that the primary fiscal surplus declined 50% y-o-y, from ARP 3.2 billion in February 2008 to ARP 1.6 billion in February 2009, much lower than private analysts' estimate of ARP 1.9 billion. This was the result of weak tax revenue, which increased only 13% y-o-y to ARP 17.7 billion, and higher expenditures, which increased 20% y-o-y to ARP 14.7 billion. Within expenditures, infrastructure spending increased by 28% y-o-y, subsidies to the private sector increased 28% y-o-y (in spite of tariff increases),and salary expenditure jumped 41% (due to both higher salaries and an increase in the number of employees). The year/year decline in the primary fiscal surplus was 97% when excluding the ARP 1.5 billion in revenues derived from the nationalized private pension funds. After interest payments, the overall fiscal surplus for February was ARP 637 million. GoA Secretary of the Treasury Juan Carlos Pezoa acknowledged to local press that 2009 primary fiscal target of 3.27% of GDP may not be achievable. Although Pezoa downplayed the impact of the Federal Solidarity Fund (see above item),he pointed to the deteriorated international environment as the complicating factor. Private analysts estimate the 2009 primary surplus at about 1.7-2.0% of GDP, compared to the 2008 primary fiscal surplus of 3.1% of GDP. -------------- EXTERNAL SECTOR -------------- Current account surplus falls in Q4 2008 -------------- ¶6. (SBU) The GoA Economy Ministry announced March 19 the Balance of Payments (BOP) results for the fourth quarter of 2008, showing a current account surplus of US$ 1.8 billion. This was above the BCRA market forecast of US$ 1.6 billion, but much lower than the US$ 3 billion surplus in the fourth quarter of 2007. The US$ 1.2 billion quarter-over-quarter decrease was mainly the result of lower exports, since imports and dividend remittances remained largely unchanged. The merchandise trade surplus in Q4 reached US$ 3.6 billion, compared to the Q4 2007 trade surplus of US$ 4.6 billion. (Note: exports dropped 6% y-o-y and imports rose 1% y-o-y in Q4 2008, according to INDEC.) Despite the sharp drop in agriculture commodity prices in the second half of 2008, the merchandise trade surplus increased to US$ 16 billion in 2008, compared to a surplus of US$ 13.3 billion in 2007. ¶7. (SBU) Despite the significant deterioration of the current account in Q4 2008, Argentina still posted a US$ 7.6 billion surplus for the full year, up from US$ 7.1 billion in 2007 (largely due to the higher trade surplus). However, the current account surplus did not cover the full-year capital account deficit, which plunged from a US$ 5.3 billion surplus in 2007 to a large US$ 9.2 billion deficit in 2008, as a result of a spike in capital flight. (Note: This was the first year since 2002 where the combined capital and current accounts were in deficit.) The capital account showed net capital outflows of US$ 3.4 billion in Q4 2008, versus net capital outflows of just US$ 186 million in Q4 2007. These outflows are mainly explained by the non-financial private sector, which totaled US$ 3.4 billion. Accumulated non-financial private sector outflows totaled US$ 11.3 billion in 2008 (compared to US$ 1.2 billion in 2007). ¶8. (SBU) The capital outflows reflect growing lack of confidence in the economy and GoA, particularly following the March-July campo crisis and the GoA's decision in October to nationalize the private pension funds. Official BCRA Reserves decreased almost US$ 850 million during Q4 of 2008 BUENOS AIR 00000361 003.2 OF 004 to US$ 46.4 billion (as of December 2008). (Note: the above graph shows a minor increase in reserve levels during 2008 -- roughly US$ 200 million. This is accounted for in the relatively high US$ 1.6 bn figure for "errors and omissions" in the 2008 BOP report, compared to 'errors and omissions of under $800 million in 2007.) The BCRA consensus survey forecasts the current account surplus at only $2.6 billion for 2009, compared to the current account surplus of $7.6 billion in 2008. (Note: the BCRA consensus survey does not present estimates for the capital account.) Assuming capital outflows continue at a high rate in 2009, the much lower current account surplus implies a large reduction in BCRA reserves this year. ¶9. (SBU) Clarification: Do not confuse the BOP data on capital outflows with the US$ 23.1 billion figure that the media reports for capital flight in 2008. The BCRA is the source of the latter figure, which is derived from its Foreign Exchange Balance (FEB) report. The FEB and BOP report have a similar format. However, the former reports purchase and sales of foreign currency without considering the residency of the parties, while the latter reports economic transactions focusing on the residency of the intervening parties. Also, the FEB uses a cash basis methodology, while the BOP uses accrual accounting. The FEB calculates capital flight of $23.1 billion in 2008 (roughly 2.5 times the 2007 level). -------------- FINANCE -------------- Peso depreciation continues in March -------------- ¶10. (SBU) As of March 23, the Argentine peso had depreciated 3% against the dollar since the beginning of March and 6% since the beginning of the year. It closed at 3.70 pesos/dollar on March 23, two cents higher than the March 20 close of 3.68. The BCRA has managed a gradual depreciation of the peso since the beginning of the year. However, the GoA announcement to advance elections, coupled with the announcement on soy export tax revenue-sharing, have spooked markets that are already nervous due to the decelerating national economy, uncertain outlook for the intrnational economy, and resurgence of the GoA conflict with Argentine farmers. (Note: specifically, the worry is that farmers will continue to withhold exports. The combination of lower exports and lower world commodity prices has already drastically reduced the supply of dollars circulating in the economy at the same time that dollar demand has increased.) ¶11. (SBU) Many private analysts have accelerated their estimates peso depreciation during 2009, expecting the exchange rate to reach 4.2-4.3 pesos/dollar by the end of the year, compared to estimates published in early March of 3.8-4 pesos/dollar. For reference: the 6-month and one-year NDF (non-deliverable forward) closed March 20 at 4.24 and 4.86, respectively. The BCRA calculates the six-month peso-dollar forward price at about 3.85 and the 12-month price at almost 4.1. Despite the expected sharper depreciation of peso, analysts expect the BCRA to make every effort to continue the gradual depreciation of the peso at least until the elections in late June (assuming the Senate approves the law to bring forward the elections, which the Chamber of Deputies approved March 18). GoA public debt $145.9 billion at year-end 2008 -------------- -- ¶12. (SBU) On March 13, the Economic Ministry released updated data on GoA debt, current as of December 2008. In 2008, the GoA debt stock (excluding the so-called "holdouts," or bondholders who did not participate in the 2005 debt restructuring) increased only $291 million to $145.9 billion, or 48% of GDP. The increase was due to $770 million in GoA bond issuances, an $1.1 billion increase in bond principal due to the capitalization of interest (mainly on bonds issued during the 2005 debt restructuring),and $4.5 billion due to the increase in CER (CPI-linked index) to which roughly 77% of GoA bonds adjust their principal payments. This increase was mostly offset by the $6.8 billion debt reduction resulting from favorable exchange rate adjustments (mainly the depreciation of the peso and the EURO relative to the dollar). When including holdout debt, currently totaling BUENOS AIR 00000361 004.2 OF 004 about $28.9 billion, the public debt stock rises to $174.9 billion, or 58% of GDP. ¶13. (SBU) The currency composition (excluding holdouts) of the national debt is almost equally divided between foreign-currency-denominated debt (53% or $77 billion) and peso-denominated debt (47% or $69 billion). Within the peso-denominated debt, the 77% adjusted by CER is distorted by the use of the "official" 2008 inflation rate of 7.2%, which is less than half the "true" inflation rate of about 20%, as estimated by private analysts. For 2009, the GoA estimates it will make $24 billion in principal payments and $4 billion in interest payments. Since theprimary fiscal surplus is deteriorating rapidly due to both disappointing tax collection and increased expenditures ahead of the legislative elections, it is as yet unclear how large the GoA financing gap will be in 2009. However, the GoA has engaged in liability management operations to reduce the debt obligations. Aside from the nationalization of the private pension funds and the debt swap of Prestamos Garantizados (see February 27 Economic and Financial Review),the press reports the GoA now plans a debt swap for Boden 2012s. FIEL and Estudio Bein, two well-known local economic consultant firms, estimate that the 2009 financial gap could reach $5 billion. However, the rapid deceleration of GDP could show these estimates to be overly optimistic. -------------- - INFLATION EXPECTATIONS AND CONSUMER CONFIDENCE -------------- - Consumer confidence falls; inflation expectations high -------------- -------------- ¶14. (SBU) Torcuato Di Tella University's consumer confidence index decreased 5% m-o-m to 37.4 points in March. The index accumulated a decrease of 27% from its level of 51.5 points in December 2007, when President Cristina Fernandez de Kirchner took office. (Note: The index is based on surveys of individuals and consumers' willingness to purchase durable goods, houses, and cars.) For reference: the index dipped to below 40 in June during the farm conflict, subsequently recovered slightly, and than began to fall again in October 2008 following the nationalization of the private pension funds. The index has since been highly volatile, with a decreasing long-term trend. In March, all three index components declined: 1) consumer willingness to purchase durable goods and real estate decreased 17%; 2) consumer sentiment towards the macroeconomic environment decreased 2.7%; and 3) consumers' perception of personal economic well-being decreased 0.9%. According to analysts, the deterioration in consumer sentiment is explained by the view that the economy will continue to slow rapidly in the months ahead, with a large impact in unemployment plus continued high inflation. ¶15. (SBU) A key factor affecting consumer sentiment is inflation. Though the median of Di Tella University's inflation expectations index, covering the next 12 months, improved from 25% in February to 20% in March, it is still very high given the contracting economy. For comparison, the BCRA consensus survey estimate for the next 12 month inflation is only 7.1% (reflecting what the market expects the official INDEC figure will be). Most private analysts' estimates for "true" inflation in 2009 hover around mid to high teens. This shows that consumers are overshooting their inflation expectations in the absence of reliable official statistics. (Note: According to INDEC, February's CPI increased 0.4% m-o-m, compared to private analysts' estimate of around 1%. INDEC's estimate for y-o-y inflation remained unchanged at 6.8% in February, versus private estimates of 15-20%.) WAYNE