ARGENTINA'S CURRENCY SWAP WITH CHINA; WILL IT HELP

C O N F I D E N T I A L SECTION 01 OF 03 BUENOS AIRES 000387 SIPDIS E.O. 12958: DECL: 03/31/2029 TAGS: EFIN ECON ETRD AR SUBJECT: ARGENTINA'S CURRENCY SWAP WITH CHINA; WILL IT HELP FORESTALL FURTHER PESO DEPRECIATION? REF: BUENOS AIRES 366 Classified By: Ambassador E. Anthony Wayne for Reasons 1.4 (b,d) -------------- Summary -------------- ¶1. (C) The Argentine Central Bank (BCRA) and the People's Bank of China appear to have reached a preliminary agreement on a currency swap arrangement (Peso-Yuan) for the equivalent of about US$10 billion. However, there may be some internal disagreement on the Argentine side: while BCRA President Redrado reportedly plans to issue a formal press statement April 2, BCRA Vice President Miguel Angel Pesce (PROTECT) calls this premature and says President Cristina Fernandez de Kirchner is uncomfortable with the deal and has not yet authorized it. The swap, China's first in Latin America, will allow both countries to settle commercial transactions in each others' currencies, rather than U.S. dollars. Redrado has also highlighted its potential use for monetary operations, calling it a "contingency line." BCRA contacts expect this agreement to have minimal impact on stemming financial dollarization. Markets appear unimpressed: the peso continues to depreciate this week on both spot and futures exchanges. End Summary. -------------- China Announces US$10 billion Swap with BCRA -------------- ¶2. (SBU) Argentine and foreign media reported extensively over the last few days that the BCRA and the People's Bank of China (PBC) reached a preliminary agreement on the margins of the IDB meeting in Medellin, Colombia, on a three-year currency swap arrangement for the equivalent of about US$10 billion. The reports stem from the PBC's March 30 press release announcing the agreement (published by the official Xinhua news agency). ¶3. (C) Although PBC Governor Zhou Xiaochuan and Redrado both spoke to the press about the swap from Medellin, the Chinese press release seems to have jumped the gun. Senior BCRA officials informed Econoff privately that the BCRA had understood the two countries would simultaneously announce the agreement April 2. That is still the BCRA's plan (although several Argentine newspapers have published what appears to be a leaked draft of the BCRA's release). ¶4. (C) BCRA contacts tell Post that they have been working on this swap arrangement for months and that a BCRA team flew to Beijing last week to negotiate the final details. Although the goal was apparently to have the two Central Bank Presidents sign the agreement in Medellin, BCRA officials tell us that for the moment the two sides have only signed some kind of MOU and that the BCRA Board of Directors will have to approve the swap deal before Redrado can formally sign it. -------------- BCRA Internal Dissent over Swap Deal -------------- ¶5. (C) BCRA VP Pesce (PROTECT),appearing agitated, told Econoff March 31 that Redrado and the PBC's pronouncements are premature and there is still internal disagreement in Argentina over whether to proceed. Pesce, who is reputedly close to President Cristina Fernandez de Kirchner (CFK), claimed that he had spoken directly to CFK about the arrangement, and said she is uncomfortable with it and has instructed the BCRA Board of Directors to do a careful review prior to final signature. ¶6. (C) Pesce explained that there are two ways for the BCRA to approve this kind of deal: obtain full BCRA Board of Directors' approval or expedite it by having Redrado, Pesce, and one other Director sign. Pesce said that Redrado asked him to sign off on an expedited approval for this debt swap and had assured him that CFK had authorized it. However, prior to signing it Pesce spoke to CFK, who told him that while she was familiar with the deal she had not approved it. Pesce said he is irritated that Redrado appears to have "lied" to him, but commented "that is the way he (Redrado) often operates." -------------- -------------- BUENOS AIR 00000387 002 OF 003 Details of Swap Arrangement; Impact on the Peso Unclear -------------- -------------- ¶7. (SBU) Although few specifics are available, the basic idea of the swap is that the BCRA may draw up to 70 billion Chinese Yuan (RMB),or the equivalent of almost 38 billion Argentine pesos (or about US$ 10.2 billion),and agrees to return the Yuan to the PRC (prior to the end of the three-year period). These Yuan will then finance Argentine imports of Chinese products. On the other side, Chinese importers of Argentine products will be able to pay in pesos. The PRC has signed other similar swap agreements, for example with Belarus, Malaysia, South Korea, Hong Kong, and Indonesia, but this is the first such agreement with a country in this hemisphere. ¶8. (SBU) The initial question for local analysts was whether these funds would be available for more than just trade finance, specifically for monetary operations. Redrado and PBC sources have since clarified that the swap facility is available for both trade and financial/liquidity purposes. Redrado stated March 31 that the swap is a "contingency line" that for the moment is not needed. ¶9. (C) Nevertheless, this issue is still unclear for many economists and even BCRA officials, because the Yuan is not a convertible currency and does not qualify as a "reserve currency" under the BCRA's Charter. Whereas some economists argue that the BCRA would have the option of exchanging the Yuan for hard currency (thus increasing reserves),a senior BCRA official noted to Econoff that this would probably require the PBC's at least tacit authorization. Furthermore, the BCRA would eventually have to repay the Yuan, which would require an expenditure of dollars (an equivalent reduction of reserves). (Comment: Argentina also has to worry about exchange rate risk,as it appears likely that the peso will weaken relative to the Yuan over the next three years.) ¶10. (C) The main argment heard in Argentina favoring the swap deal is that it could reduce local demand for dollars, since Argentine importers can use Yuan to purchase Chinese products. This would theoretically bolster the peso, which has depreciated 7% so far in 2008 and 20% from its strongest level in September 2008. This argument makes sense based on 2008 bilateral trade, where, according to official GoA statistics, Argentina exported US$ 6.4 billion (FOB) to China and imported US$7.1 billion (CIF) from China, for a trade deficit of about US$ 700 million. ¶11. (C) However, Argentina's global imports are plummeting this year and the GoA's recently imposed non-tariff barriers, primarily non-automatic license requirements (reftel),appear to target imports from China and Brazil. In contrast, China's imports from Argentina are mostly agricultural commodities and, despite significant drops in commodity prices, the volume of China's demand is so far remaining relatively constant. Therefore, despite major Argentine industrialists' concerns that this swap could foment higher imports from China, most analysts Post conferred with expect Argentina to run a trade surplus with China in 2009. According to a senior BCRA official, if Argentina returns to running a trade surplus with China and Chinese importers take advantage of this swap to pay for Argentine products in pesos, the reduced Chinese supply of dollars could actually exceed the reduced demand for dollars from Argentine exporters. So, the net effect could work against the Argentine peso. -------------- -------------- Possible CFK Concerns Over Political Implications -------------- -------------- ¶12. (C) Pesce notes that the agreement has clear trade and economic development aspects, so any negotiation should be expanded beyond the central banks to include the governments. The fact that the deal has a cross-default clause, which would penalize the BCRA in the event of a GoA default, is further evidence that the GoA needs to be involved. (Under this clause, according to Pesce, the PBC would immediately terminate the agreement, requiring full repayment, in the event of a GoA default on sovereign debt obligations.) However, Pesce's main criticism is that at least during 2009 this deal could result in more pressure on the peso, as noted in para 11 above, since he expects Argentina to run a trade surplus with China this year. BUENOS AIR 00000387 003 OF 003 ¶13. (C) According to Pesce, CFK is also worried about the trade and exchange rate implications of the deal, but is particularly concerned that Argentina will come off as supporting China in its perceived effort to reduce the use of the U.S. dollar. Pesce notes that CFK does not fully trust the Chinese, after the PRC failed to follow through on alleged promises made during the visit of President Hu Jintau in 2004 to invest some US$ 20 billion in Argentina. Therefore, given that the economic benefits are unclear, Pesce surmises that CFK is still considering whether Argentina should be seen to be supporting what Pesce calls a "political move by the Chinese." (Comment: other senior BCRA officials note that China is pursuing these deals with its major trading partners and that the goal seems to be to reduce gradually its usage of dollars in trade, and less so to build support for the eventual replacement of the USD as the world's reserve currency.) -------------- Comment -------------- ¶14. (C) It is as yet unclear whether Pesce's comments reflect actual disagreement within the GoA and BCRA over this agreement, or just personal animosity between the BCRA's top two officials. That should shake out over the next week or so, as the BCRA's Board meets to discuss the arrangement. For certain is that Pesce is not alone in questioning China's goals for signing this swap facility with Argentina. Many local analysts speculate that the PRC is attempting to use Argentina in its campaign to "replace the dollar as the world reserve currency." Other analysts argue the BCRA may try to use the swap to give the appearance that its reserves suffice for it to continue to intervene to slow the pace of peso depreciation. Given complications described above related to the Yuan's limited convertibility, this facility does not appear to be a long-term solution to pressure on the peso. Nevertheless, Redrado may be counting on the short-term perception that this facility will buttress BCRA reserves and strengthen the BCRA's position in preventing further peso depreciation prior to the June 28 legislative elections. Post's other BCRA contacts (aside from Pesce) are skeptical. They downplay the impact of the facility on stemming financial dollarization, which they argue is an understandable response to weak market fundamentals and concerns about GoA policies. Markets appear equally unimpressed, as the peso continues to depreciate this week on both spot and futures exchanges. As of April 1, the peso is at 3.74 dollars and the one-year peso-dollar futures closed March 31 at 4.12. End Comment. WAYNE