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Cablegate: Codel Shelby Discusses Financial Crisis, Inflation, Banking

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RUEHRI/AMCONSUL RIO DE JANEIRO 2444

UNCLAS BUENOS AIRES 000422

SIPDIS

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C O R R E C T E D C O P Y - ADDED PARA, SIG

E.O. 12958: N/A
TAGS: ECON EFIN OREP AR
SUBJECT: CODEL Shelby discusses financial crisis, inflation, banking
regulation with Argentina's Central Bank

Ref: (A) 2007 Buenos Aires 1083 and previous

-------
Summary
-------

1. (SBU) During a March 25 meeting with Argentine Central Bank
President Martin Redrado, a CODEL led by Senator Shelby (R-AL)
congratulated the Central Bank for exceeding $50 billion in official
reserves, asked about efforts to bring down inflation, and inquired
about the possibility of an agreement with "Holdout" bondholders.
Central Bank President Martin Redrado highlighted the limited impact
of global financial market turmoil on the local economy and
financial sector, and said there are no/no indications that
inflation in Argentina is spiraling out of control. He said the GoA
is moving out of its "emergency response" mode and into a longer
term strategic planning mode. Both sides discussed their concerns
about proposed changes to banking regulation. End Summary.

----------------------------------------
Focus On Financial Crisis And Regulation
----------------------------------------

2. (U) Senator Richard Shelby (R-AL), ranking member of the Senate
Banking Committee, Senator Judd Gregg (R-NH), Senator Bob Corker
(R-TN), Senator Mike Crapo (R-ID), and Congressman Bud Cramer
(D-AL), met March with Central Bank President Martin Redrado to
discuss the impact of international financial market turmoil and the
state of the Argentine economy. Meetings with Justice Minister and
representatives from U.S. financial institutions reported septels.

3. (SBU) Senator Shelby commended the work of the Central Bank
(BCRA) in supporting the phenomenally high economic growth in
Argentina over the last five years, and also for exceeding $50
billion in international reserves, which happened March 12. Shelby
inquired about BCRA and GoA efforts to contain inflation and also
about the impact to date of the U.S. financial crisis on Argentina's
financial sector and broader economy. Shelby also asked for
Redrado's perspective on the chances of the GoA settling with the
so-called "Holdout" bondholders (who refused to participate in the
2005 debt exchange following the GoA's massive debt default in late
December 2001).

----------------------------
U.S. Financial Sector Crisis
----------------------------

4. (SBU) According to Redrado, the U.S. is now tackling a systemic
solvency crisis as opposed to a simple liquidity problem and so he
hoped the U.S. would follow a "mark to model" vs. a notional "mark
to myth" protocol in valuing mortgage-backed derivative securities.
The package of U.S. Treasury and Federal Reserve measures announced
to date is certainly helpful, he thought, but does not address this
key question of derivative security valuation or -- by extension --
the contingent liability the Fed may eventually have to absorb.
(Note: Redrado did not mention but clearly had in mind the U.S.
Federal Reserve's agreement to take on liquidation risks associated
with $30 billion of Bear Stern's mortgage-backed derivative
portfolio).

5. (SBU) Redrado commented that this is the first time in
Argentina's history that a worldwide crisis has barely affected the
local economy. He credited this mostly to the limited size of the
Argentine financial sector following the 2001/2002 crisis, which has
sheltered the economy somewhat. But he also highlighted the BCRA's
high reserve levels and the flexible exchange rate as been major
factors in allowing the BCRA to make adjustments to protect local
financial markets.

--------------------------------------------- -------
Inflation A Problem But Not Spiraling Out Of Control
--------------------------------------------- -------

6. (SBU) Redrado reviewed his now standard defense of Argentina's
policies to tackle inflation (Reftel). In brief: Argentina is not a
typical emerging market economy and there is no "one-size-fits-all"
prescription to fight inflation. The "2001/2 economic crisis dust
has not yet settled" and Argentina will remain in a post-crisis

"transition phase" through 2010-2012. During this period, standard
anti-inflation tight money/high interest rate policy prescriptions
will not/not be effective. For example, raising domestic interest
rates (from current net negative levels) would not have the same
potential to contain aggregate demand growth as it would have in the
U.S., since the Argentine credit market is extremely shallow,
representing only 10% of GDP, compared to over 100% in the U.S.
7. (SBU) There are no/no indications that domestic inflation is
spiraling up from current levels, and he argued that to "gradually
bring inflation down" the GoA and BCRA must pursue a combination of
policies: fiscal discipline, monetary prudence (i.e. maintaining
nominal M2 growth below nominal GDP growth), a flexible exchange
rate, wage containment (i.e. actively managing inflationary
expectations) and improving market oversight/regulation.

--------------------------------------------- ----
Argentina Overcoming History of Fiscal Profligacy
--------------------------------------------- ----

8. (SBU) According to Redrado, the GoA has successfully overcome a
history of overspending, maintaining a primary fiscal surplus in
each of the past five years. Redrado admitted, however, that fiscal
discipline had "marginally deteriorated" in the 2007 calendar year
leading up to national elections. The nominal rate of increase in
fiscal spending had increased to the 50% range from late 2006
through 2007. The good news, he noted, is that the GoA has reduced
the rate of increase in nominal fiscal spending so far in 2008 to
the 35% level, in order to sustain fiscal discipline. However,
Redrado acknowledged that the fiscal situation had improved mostly
due to higher revenues. Redrado said his personal preference was
for a 25-28% increase in 2008 nominal fiscal spending, which would
result in a 4% primary surplus (compared to the 2.2% primary surplus
in 2007). He said that, while a significant percentage of GoA
expenditures were dedicated to growth-sustaining infrastructure
projects, the majority of increased GoA expenditures over the last
year were a consequence of increased government wages.

9. (SBU) In sum, Redrado said, the GoA and BCRA are providing three
key public goods: stable fiscal policy, prudent and consistent
monetary policy, and stable (albeit flexible) exchange rate policy.
This is a first in Argentina's recent history. That Argentina has
had 55 Central Bank presidents in the past 72 years says much about
the volatility of Argentina's economy and about the volatility of
its economic policy management. Redrado predicted that current
financial sector stability will be sustained and will allow the
Argentine economy to grow sustainably in the future.

---------------------------
Financial Sector Regulation
---------------------------

10. (SBU) Redrado explained that, while the BCRA regulates
commercial banks, separate and independent GoA entities regulate
Argentine securities markets, insurance companies and pension funds.
The latter currently manage over US$ 30 billion in assets. Redrado
and Senator Shelby shared their concerns about the potential impact
of the Basel II bank regulation framework, particularly with regards
to proposals to reduce drastically capital requirements for large
banks.

11. (U) Codel Shelby cleared this message.
WAYNE

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