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Cablegate: Argentina Economic and Financial Review, January 1-11,

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P 181558Z JAN 08
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC PRIORITY 0082
INFO RUCNMRC/WESTERN HEMISPHERIC AFFAIRS DIPL POSTS PRIORITY
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UNCLAS SECTION 01 OF 05 BUENOS AIRES 000070

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NSC FOR JOSE CARDENAS, ROD HUNTER
PASS FED BOARD OF GOVERNORS FOR RANDALL KROSZNER, PATRICE
ROBITAILLE
PASS OPIC FOR JOHN SIMON, GEORGE SCHULTZ, RUTH ANN NICASTRI
USDOC FOR 4322/ITA/MAC/OLAC/PEACHER

E.O. 12958: N/A
TAGS: EFIN ECON EINV ETRD ELAB AR
SUBJECT: ARGENTINA ECONOMIC AND FINANCIAL REVIEW, January 1-11,
2008

1. (U) Provided below is Embassy Buenos Aires' Economic and
Financial Review covering the period January 1-11, 2008. The
unclassified email version of this report includes tables and charts

SIPDIS
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
----------

-- 2008 Wage Negotiations: a tough road ahead
-- Tax revenues increase 39% in December, bringing full-year
revenues to ARP 200 billion
-- GDP growth estimated to reach 8.5% y-o-y in 2007, leaving a
strong push for 2008
-- Industrial production expected to grow 7.2% y-o-y - one
percentage point below 2006
-- Year of the Auto: Argentine car production hits a record in 2007

-- GoA ban on fuel exports forces energy companies to drop domestic
retail prices
-- BCRA presents 2008 Monetary Program to the Senate
-- Argentine bonds slightly positive in December, supported by local
investors

---------------
Economic Policy
---------------

2008 Wage Negotiations: a tough road ahead
------------------------------------------
2. (SBU) One of the main risks facing the economy in 2008 is the
trajectory of prices and salaries. Attention is focused on upcoming
wage negotiations between unions and private companies, which
generally begin in late-February and March. Union leaders have
stated to local media their intention to seek wage increases on the
order of 20-30%, while private companies argue they can only afford
increases below 20%. A brief review of companies' expectations on
2008 salaries follows. These results are based on a survey that Sel
Consultores (a think tank specialized on labor issues) conducted
with one-hundred and twenty-eight companies operating in Argentina,
employing one-hundred and eighty-four thousand workers.

-- Fifty percent of the companies are preparing to negotiate wage
increases during the first four months of the year. Unions at these
companies are demanding wage increases of 23%. Although these
companies state that they are willing to grant 17% pay increases, on
average, they admitted in the survey that they expect to settle
negotiations at about a 20% increase. The companies want the GoA to
propose a 16% increase guideline for 2008, although they anticipate
that the GoA's guidance will be in the range of 18%. In addition,
35% of company respondents predicted that Unions would reject any
GoA attempts to recommend guidelines for the negotiations. For
reference: in 2006 and 2007, wage bargaining agreements ended with a
22% wage increase (for each year), taking into account increases in
basic wages plus non-remunerative increases. Prior to the
negotiations, the GoA had suggested wage increase guidelines of 19%
in 2006 and 16.5% in 2007. [GoA statistical agency INDEC's latest
release showed that the salary index (CVS - coeficiente de variacion
salarial) increased 22% y-o-y in November.]

-- Neither the companies nor unions considered the "official" CPI
produced by INDEC as a reference for their negotiation. (INDEC
measured the 2007 CPI increase at 8.5% in 2007; however, private
analysts estimate 2007 CPI increased in the range of 18-24%, more
than double the official estimate.)

-- Company respondents were generally of the opinion that the GoA
had backed away from its stated plan to arrange a "Social Pact," in
which the private sector and unions (with government guidance) would
agree to salary increases for all sectors, and would also work to
control price increases. During the 2007 presidential campaign,
then-candidate (now President) Cristina Fernandez de Kirchner
announced the Social Pact as a pillar of her post-election economic
policy program, although she never gave details of how it would be
implemented, although she did refer to Spain's "Moncloa Pact" as a
possible guide. Companies surveyed clearly prefer to avoid the

BUENOS AIR 00000070 002 OF 005


Social Pact structure. In the survey, they expressed a preference
for the negotiation of sector-by-sector wage agreements.

-- The majority of companies surveyed responded that they expect the
negotiations will eventually result in salary at or near 2007
levels, or about a 22% increase. While this would represent a
significant nominal increase in employee incomes, whether it would
also entail higher real incomes depends on whether (actual)
inflation stabilizes or continues accelerating at the pace it did in
the second half of 2007.

Argentine daily newspaper Cronista reported January 11 (without
citing any source) that the GoA believes that the economy can handle
a 20% salary increase without causing excessive inflationary
pressures -- due to the productivity gains companies achieved last
year. This increase is in line with the companies' expectations as
shown in the above survey, and is on the lower end of the range of
the Unions' claims.

----------------
Economic Outlook
----------------

Tax revenues increase 39% in December, bringing full-year revenues
to ARP 200 billion
------------------------------------------
3. (SBU) December 2007 federal tax revenue increased 39% y-o-y to
ARP 19.6 billion, above expectations of ARP 18.8 billion, bringing
full-year revenues to a record of ARP 200 billion (up 33% y-o-y in
nominal terms), or approximately $63 billion. This strong yearly
performance is mainly explained by strong collections of VAT (+33%
y-o-y), income taxes (+27% y-o-y), and export taxes (+39% y-o-y),
which together explain 75% of the tax collection. The
record-setting level of revenues collected, representing 25% of GDP,
was due to a combination of factors: strong economic and consumption
growth, better export performance (coupled with increased export tax
rates, mainly on soy and soy-byproducts, mining, and fuels),
improvement in tax compliance, and high inflation.

4. (SBU) AFIP (equivalent to the U.S. IRS) released a special report
on income tax revenues in 2007, which showed that revenues from
financial intermediation service providers (mainly banks) and the
construction sector increased 94% and 70% y-o-y, respectively,
followed by real estate activities (up 44% y-o-y). The income tax
is the second highest collecting tax (after VAT), providing 21% of
the tax collection in 2007. AFIP also noted that the full-year's
increase in export tax collection (+39% y-o-y) is explained by both
higher quantities of exports (8%) and higher prices for exported
goods (9%). In terms of tax collection on agricultural exports, the
products showing the highest increases in 2007 were: soybeans
(+100%), corn (+93%), soy-oil (+70%), pellets (+50%) and wheat
(+33%).

GDP growth estimated to reach 8.5% y-o-y in 2007, leaving a strong
push for 2008
------------------------------------------
5. (SBU) In the first quarter of 2007, GDP increased 8% q-o-q,
slightly decelerating from 4th quarter 2006, when it increased 8.6%.
However, in the second quarter of 2007, GDP accelerated again,
increasing 8.7% q-o-q, pushed on the supply side mainly by the
agricultural sector, which enjoyed a record year in 2007. On the
demand side, consumption was the growth engine -- a result of
significant increases in 2005 and 2006 in real incomes, as well as
increases in disposable incomes in 2007 following cuts in income
taxes and increased pension payments in GoA transfers to families
(asignaciones familiars). Even though third quarter GDP data is not
yet available, the EMAE (the economic activity index), a reliable
indicator of GDP, increased 9.4% y-o-y in October, indicating that
growth is still running strong. The BCRA consensus survey is
estimating 2007 GDP growth at 8.5% y-o-y (similar to 2006 GDP
growth), which would set a high floor (roughly a 3.3% statistical
drag) for 2008 GDP, which the BCRA consensus survey estimates at
6.9%.

Industrial production expected to grow 7.2% y-o-y ? one percentage
point below 2006
------------------------------------------
6. (SBU) The industrial sector appears to have closed 2007 on a
strong note, with current estimates for annual growth in the sector
of 7.2% y-o-y, after having decelerated strongly during the winter
months (June-August ? the coldest months) due to energy shortages

BUENOS AIR 00000070 003 OF 005


and restrictions. Since September, however, the industrial
production (IP) index returned to a robust pace; in November (the
latest data available), the index increased 9.9% y-o-y.
Nevertheless, after November's IP release, some private analysts
expressed concerns or doubts about the credibility of this index,
given that INDEC, which is allegedly tampering with CPI statistics,
also produces the IP index (See Nov 19, Oct 26, Oct 5, Sep 20, Sep
4, and Feb 2 Econ/Fin reports).

Year of the Auto: Argentine car production hits a record in 2007
------------------------------------------
7. (SBU) In 2007, the domestic car industry had its best year in
history, with production reaching 544,647 units, up 26% from 2006.
Automotive exports reached 316,410 units, also an all-time record,
and comprising about 58% of total production. In 2007, the
automotive industry accounted for almost 20% of Argentina's
manufacturing output and 36% of all manufacturing exports, measured
by value. The Argentine auto association ADEFA (Asociaci"n de
F bricas de Automotores) predicts that the auto industry will mark
another record year in 2008, with estimated production in the range
of 620.000 units (a 14% y-o-y increase), with exports projected at
about 400,000 units.

------
Energy
------

GoA ban on fuel exports forces energy companies to drop domestic
retail prices
------------------------------------------
8. (SBU) On January 7, the GOA announced a new decision to prohibit
exports of gasoline and diesel, and accompanied the declaration by
strongly urging downstream energy companies to return retail prices
at their gas stations to October 31, 2007 levels. Beginning shortly
after the October 10 elections, fuel prices have been increasing
steadily and unevenly throughout the country, due in part to the
holiday season and higher crude international prices, but also a
clear effort of oil companies to increase pump prices from the low
levels prevailing in Argentina. According to a local energy
specialist, in November the domestic gasoline price before taxes was
almost 50% of the average price prevailing in Brazil, Chile, or
Uruguay. In the case of diesel, it was almost 60% cheaper. With
these prices and 2007 record-high sales of new cars, gasoline
consumption increased to 4.9bn liters in 2007, up from 3.5bn liters
in 2006. Before the ban was announced, there were fuel shortages in
several provinces, with cars having to wait in long lines to get
fuel and often with gas stations limiting amounts and refusing to
accept credit card payments. Provincial authorities therefore took
measures to guarantee the supply of diesel and gasoline in their
territories, which included police inspections of gas stations.

9. (SBU) Interior Commerce Secretary Guillermo Moreno, known as the
GoA's price-control czar and the mastermind behind manipulation of
INDEC statistics, announced the ban on behalf of the government. He
publicly based his decision on the so-called Supply Law (ley de
abastecimiento), enacted in 1974 during the last Juan Peron
government, which allows the GoA to take emergency measures to
ensure the adequate domestic supply of just about any product. The
ban was transmitted verbally to the main refineries, and was
reported in the press, but was never published as a regulation.

10. (SBU) On Friday, January 11, the state news agency (Telam)
reported that three oil companies -- Repsol YPF, ESSO, and Petrobras
-- which combined provide about two-thirds of the gasoline and
diesel in the country, had "agreed" to roll down the prices of
liquid fuels back to their October 31, 2007 levels. As a quid pro
quo, the GoA agreed to withdraw the ban on these companies' fuel
exports. [Shell reportedly refused to lower its pump prices, and is
also reportedly still subject to the export ban.] Neither
government officials nor the oil companies specified by how much
gasoline or diesel prices would drop due to this accord. Private
analysts estimate that it could potentially result in a 15-20% cut
from the prices prevailing in late 2007. Some analysts also said
that a negotiated outcome was expected, since the fiscal impact of
the ban due to the reduction in fuel export taxes revenues would
have amounted to an estimated $1.35 billion in 2008. Year to
November, refined fuels exports increased 14% with respect to the
same period of 2006, to US$3.4 billion, largely thanks to a 100%
y-o-y jump in November. This November increase helped to prevent a
deeper fall in external energy sales, which decreased 12% in the
period.

BUENOS AIR 00000070 004 OF 005

-------
Finance
-------

BCRA presents 2008 Monetary Program to the Senate
------------------------------------------
11. (SBU) BCRA President Martin Redrado presented December 26 the
Central Bank's 2008 Monetary Program to the Argentine Senate Budget
and Economy Committees. During the presentation, he noted that
Argentina will face a more hostile international environment
(compared to previous years) due to the deceleration in the U.S.
economy. However, he assessed that Argentina (as well as Latin
America as a region) is well prepared to manage negative external
shocks. He further estimated that global prices of Argentina's
commodity exports will remain high and help the country's economy in
2008. He summarized that the 2008 monetary program will be based on
three pillars: financing the extraordinary Argentine growth,
strengthening the financial system, and reducing the system's
vulnerabilities. Redrado took advantage of the opportunity to
highlight for the Senate the BCRA's accomplishments in 2007,
particularly its success in limiting the impact on the domestic
market of the international financial turmoil that started in July.


12. (SBU) The 2008 program estimates GDP growth of 7.2% (almost
twice the Budget's forecast of 4% and also higher that the BCRA
consensus estimate of 6.9%), an inflation range of 7-11% (on the
lower side of the Budget's 7.3% assumption, and significantly lower
than private sector estimates of about 20%), investment reaching 23%
of GDP (the highest level in the last decade), and M2 growth rate of
18% (below the nominal GDP growth rate and slightly decelerating
from the 18.3% M2 growth rate estimated for 2007). The program also
assumes that the GoA will increase the primary fiscal surplus, the
trade surplus will reach about $9 billion (compared to the $10.2
surplus estimated for 2007), and salaries will continue an upward
trend in the context of strong demand for labor. [As reported in
the Dec 21 Econ/Fin report, with the higher primary fiscal surplus,
the Treasury will reportedly purchase $3-5 billion in the foreign
exchange market, helping the BCRA to fulfill its 2008 monetary
program and also helping the BCRA to maintain the peso at the
current artificially low level of 3.15 ARP/USD.]

13. (SBU) Redrado noted that in an effort to provide higher
certainty, the 2008 monetary program will introduce "private M2" as
an additional target to total M2 [total M2 is defined as cash in
circulation plus private and public sector sight-accounts (savings
and checking); private M2 is equal to total M2 minus the public
sector sight-accounts]. The introduction of private M2, even as an
annual target (compared to total M2, monitored quarterly), should be
interpreted as good news. It prevents the BCRA from using gimmicks
to achieve its monetary targets, as it has done in the past by
shifting public sector deposits from sight accounts to time
deposits. [Note: the BCRA argues that the Argentine financial
sector is not developed enough for the Central Bank to engage in
inflation targeting, and instead targets monetary aggregates. The
BCRA's monetary program targeted the monetary base from 2003 to
2004, but began targeting total M2 in 2005.]

14. (SBU) With 18% expected growth of M2, it is a stretch to call
the BCRA's policies restrictive or contractionary in 2008, since
maintaining the M2 growth rate below the nominal GDP growth rate
does not guarantee either stable or low inflation. Coupled with the
BCRA's policy of maintaining negative real interest rates, many
analysts agree that overall BCRA policies are at least
accommodating, if not fully stimulating, domestic consumption.

15. (SBU) Argentine bonds slightly positive in December, supported
by local investors
-------------------------------------------
The performance of Argentine dollar-denominated bonds (Discount and
Par bonds from the 2005 debt exchange) improved slightly in
December, as measured by JPMorgan's Emerging Market Bond Index Plus
(EMBI+). The Argentine EMBI rating tightened nine basis points
versus a 26 bps tightening in the general index, and 22, 29, 43 and
18 bps tightening in the cases of Brazil, Ecuador, Venezuela and
Mexico, respectively. For comparison, Argentine inflation-adjusted
peso bonds traded an average 7% higher, compared to a 2% increase
for the dollar bonds. This positive trend for the peso bonds is
mainly explained by the private sector insurance companies (AFJPs),
which have started to bring in funds from Brazil and invest them in

BUENOS AIR 00000070 005 OF 005


Argentine assets. [Note: due to a regulation change, AFJPs are
expected to repatriate roughly $2.5 billion of investments in the
Mercosur area by December 2008 ? reported Oct 26 Econ/Fin report.]


EMBI Dec 26 Tightening in December
EMBI General Index 220 -26
Argentina 389 -9
Brazil 200 -22
Ecuador 587 -29
Venezuela 481 -43
Mexico 129 -18

16. (SBU) Financial analysts and traders consider that Argentine
bonds started to perform badly early in 2007 following the GoA's
initial intervention into INDEC's inflation calculations (starting
February, with January's CPI release, and worsening thereafter with
each month's CPI release), and also due to the deterioration over
the course of 2007 of macro fundamentals (e.g., inflation, the
election-year spending boom's adverse effect on the primary fiscal
surplus, and energy shortages). Although private financial sector
contacts held out some hope for change (or at least, "gradual
fine-tuning") following the October 2007 presidential election,
since taking office on December 10 the new administration has
pursued a policy of "continuity" on economic policies. According to
Embassy financial sector contacts, foreign financial sector
investors remain in a "wait-and-see" mode, hoping for positive
economic policy signals that convince them to bring funds into the
country. The market is segmenting, with foreign investors only
cautiously purchasing Argentine financial assets (and generally with
an extremely short-term horizon) and local investors, such as
pension funds, purchasing Argentine financial assets because they
have no alternatives.

WAYNE

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