Cablegate: Argentina Economic and Financial Review, April 21

DE RUEHBU #0622/01 1301850
P 091850Z MAY 08



E.O. 12958: N/A
- MAY 5, 2008

1. (U) Provided below is Embassy Buenos Aires' Economic and
Financial Review covering the period April 21 - May 5, 2008.
The unclassified email version of this report includes tables
and charts tracking Argentine economic developments. Contact
Econoff Chris Landberg at 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.


-- Argentina's Country Risk Premium spikes, indicating ever
growing uncertainty
-- Standard and Poor's revises Argentina's outlook to
negative from stable following Minister of Economy's
resignation; spill over effects to the provinces and banks
-- U.S. Judge delays ruling on the freeze of GoA bonds
-- GoA unveils its 2008 Financial Program
-- Special Report: Argentine Economist Miguel Kiguel on
Argentina's Fragile Economy, Deteriorating Politics


Argentina's Country Risk Premium spikes, indicating ever
growing uncertainty
--------------------------------------------- ------
2. (SBU) On April 25, Argentina's sovereign risk premium over
equivalent maturity U.S. Treasuries, as measured by JP
Morgan's EMBI Plus index (Emerging Market Bond Index),
reached 589 basis points, the highest level since the GoA's
2005 debt restructuring. Argentina's Credit Default Swaps
(CDS) spread jumped up to a record 599 basis points and local
think tank Ecolatina's "Financial Risk Index" (which also
measures peso bonds) closed at a new record of 931 basis

3. (SBU) The factors behind the market's increasing
nervousness and the deterioration in all of these indexes
(which reflect falling Argentine bond prices) include: 1) JP
Morgan's April 2 recommendation to underweight Argentine
financial assets; 2) a similar recommendation by Merrill
Lynch on April 23, recommending investors reduce from 3.4% to
2.3% Argentina's weight in a benchmark portfolio; 3) S and
P's April 25 downward revision on Argentina's sovereign
credit rating from stable to negative (details below); 4) the
April 18 action of U.S. Judge Griesa to block Argentina from
transferring or selling bonds held at the Depository Trust
Company (DTC), following a request by holders of defaulted
GoA debt (details below); 5) Minister of Economy Martin
Lousteau's surprise resignation on April 24 (it was expected
mid-May); and 6) the continuing Ag conflict, which for the
moment seems far from resolved (for background see April 4
Econ/Fin Report).

4. (SBU) These separate actions together reflect widespread
unease with GoA economic policies and increasing concern
about the future of the Argentine economy. The GoA's
policies (price controls, subsidies, loose monetary and
fiscal policy, market interventions, bullying of the private
sector, statistics manipulation) have resulted in the an
overheating economy, as evidenced by inflation that is likely
running at an annual rate of about 25%, and have scared away

5. (SBU) With the sell-off of Argentine assets and increased
capital outflows, savers and investors (both retail and
corporate) have increasingly turned to the dollar as a safe
haven. Demand for dollars has sharply increased in 2008, and
anecdotal evidence indicates that it spiked on April 25 after
Minister Lousteau resigned. (Note: There is a 7-10 day lag
on BCRA reports on currency trades). This increased demand
also occurred simultaneously with reduced supply of foreign
exchange due to lower agricultural commodity exports (a
consequence of the strike), which exacerbated the pressure on
the peso on April 25. However, the BCRA reacted strongly,
selling in the range of US$350 million on April 25 to avoid a
sharp peso depreciation.

6. (SBU) Although the April 25 market closed with the peso at
3.22 ARP/USD, compared to 3.20 ARP/USD two weeks before (a
depreciation of 1.25%), the BCRA sent a strong signal that it

BUENOS AIR 00000622 002 OF 006

is prepared to use its $50 billion in official reserves to
defend the peso. The sell-side rate has stabilized at about
3.20 ARP/USD. Since hitting bottom on April 25, Argentine
bond prices have recovered some ground, but are still highly
volatile. The EMBI Plus index closed April 30 at 584 bps.

Standard and Poor's revises Argentine outlook to negative
from stable following Economy Minister's resignation;
spill-over effects to Provinces and Banks
--------------------------------------------- -----
7. (SBU) Standard and Poor's Ratings Services announced April
25 that it had revised its outlook on its sovereign credit
ratings for Argentina from stable to negative, while
affirming the B plus long- and B short-term ratings on the
country. (Note: A negative outlook indicates that downside
risks to Argentina's ratings now predominate.) According to
S and P, the negative outlook reflects the GoA's failure so
far to implement "corrective" economic policies to cool down
the overheated economy and decelerate inflation, as well as
increased political-economic challenges facing the country in
the wake of the resignation of Economy Minister Martin
Lousteau. Nevertheless, S and P noted that the outlook could
return to stable were the GoA to introduce policies to
address the overheating economy and ensure a more sustainable
level of economic growth.

8. (SBU) Although strong economic activity, rising inflation,
and export taxes have helped support a strong fiscal surplus
(estimated at 3.3-3.8% of GDP for 2008), S and P is still
concerned with wage pressures, distortions in the economy
(subsidies and price controls), the agricultural sector
conflict, deterioration of social indicators (due to the
accelerating inflation), regulation hurting growth prospects,
and eroded GoA's popularity. Together, according to S and P,
these factors increase the challenges for fiscal policy over
the next 18 to 24 months. Furthermore, these factors do not
even consider the potential adverse impact of a negative
external shock, such as the sudden deterioration of the terms
of trade, which would translate into sharply lower fiscal and
external surpluses given Argentina's increasing dependence on
revenues from exports of major commodities. S and P ended
its press release noting that any material fiscal
deterioration would lead it to lower Argentina's rating.

9. (SBU) Following the revised sovereign outlook, S and P
revised from stable to negative the outlook for the Province
of Buenos Aires, Banco Provincia de Buenos Aires, and the
Province of Mendoza, while it revised from positive to
neutral the outlook for the City of Buenos Aires. Similarly,
S and P revised down from neutral to negative the outlook of
Banco Hipotecario and Banco Patagonia.

U.S. Judge delays ruling on freeze of GoA bonds
--------------------------------------------- --
10. (SBU) On April 18, Judge Thomas Griesa -- a federal judge
for the United States District Court for the Southern
District of New York -- blocked the GoA from transferring or
selling a stock of bonds held in the Depositary Trust Co.
(DTC) in New York until the nature and ownership of these
bonds could be clarified. The ruling was issued following a
request by a holder of defaulted Argentine bonds who did not
participate in the 2005 debt exchange, and who is litigating
against the GoA. (Other so-called bond holdouts reportedly
later joined the suit.) The litigant intends to attach the
blocked bonds to satisfy his claim against the GoA.

11. (SBU) Background: The blocked bonds are global bonds
swapped by the GoA in November 2001 (before the default) for
guaranteed loans (Prestamos Garantizados) and kept in an
account as a guarantee to the owners of the guaranteed loans.
This exchange had a critical feature that allowed the
guaranteed loans to revert to the original bonds (the
globals) if the GoA were to default on its obligations (and
not honor the guarantee). Most of the guaranteed loans were
originally issued in dollars. However, the GoA converted the
bonds to pesos in 2002 and linked them to CER (a CPI-linked
index). Since then, they have always been performing debt.
Meanwhile, the global bonds, which belong to series of bonds
that entered in defaulted in 2001 and were later restructured
in 2005, have remained as collateral of the Guaranteed Loans
and not destroyed.

12. (SBU) Judge Griesa announced on April 30 that he would
delay issuing a ruling on this case pending further review of
the arguments and evidence submitted to the court. Key in
this case is to properly assess who has the ownership of the
frozen global bonds. The GoA's lawyers claim that the global

BUENOS AIR 00000622 003 OF 006

bonds do not belong to the GoA but to the owners of the
guaranteed loans, and as a result they cannot be attached by
the holdouts. The plaintiffs claim that GoA decrees in 2002
and 2003 pesifying the guaranteed loans had "stripped"
holders of the guaranteed loans of their ownership of the
globals. Therefore, according to this line of argument, the
globals belong to the GoA and are attachable. (Note: the
global bonds have still a residual value, since untendered
defaulted bonds currently trade at about 30% of face value.)

13. (SBU) Also, in the hearing Judge Griesa granted an order
for discovery (in favor of the litigating
investors/plaintiffs), requiring the GoA and DTC to surrender
information to the plaintiffs about the bonds that are
frozen. However, Griesa denied a motion to broaden discovery
for the purpose of attachment to European jurisdictions (in
favor of GoA's defense). There is not even agreement on the
face value of the bonds tendered in the November 2001 debt
exchange and held in DTC. In their legal briefs, the
plaintiffs claimed that the face value of these bonds is
about $18 billion, whereas the GoA's lawyers argued that the
face value is only $2 billion. According to JPMorgan, which
attended and reported on the hearing, the GoA's defense did a
better job of articulating their arguments. However, the
judge left the door open for the litigating investors, by
providing additional time to bring evidence to support their
claims and establish ownership of the global bonds.

14. (SBU) For the time being, the lack of a ruling represents
an obstacle to the GoA's plan of carrying out a mini-debt
exchange of local debt (including guaranteed loans), in order
to smooth the GoA's maturity profile for 2009-2011. Not only
would the debt swap reduce the GoA's financing needs over
this period, senior Economy Ministry officials expect it
would ease market anxiety over Argentina's ability to roll
over its maturing debt. These senior Economy Ministry
contacts speculate that the bond holdouts do not expect to
win this court case. Their real purpose, they say, is to
delay the debt exchange and highlight the constraints and
costs to the GoA of not resolving the holdout issue. There
is a precedent: the settlement of the 2005 GoA debt
restructuring agreement was delayed almost three months, from
the original settlement date in March 2005 to June 2005 due
to similar holdout bondholder legal actions.

GoA unveils its 2008 Financial Program
15. (SBU) The GoA released its long-promised 2008 Strategic
and Financial Program on April 18, surprising market analysts
who had speculated the GoA would never issue the plan due to
increasing domestic and international uncertainty. The GoA
Economy Ministry had committed itself early in the year to
give details on the types of transactions and markets it
would tap during the year to fulfill 2008 financial needs,
with the objective of improving transparency and
predictability for investors. However, the Ministry had
delayed the release until now to avoid being held to its
publicly presented program during a period of strong market

16. (SBU) According to the program, as of end-April the GoA's
financial needs stand at $6.1 billion, which the Economy
Ministry expects to raise by: a) domestic auctions ($3.6
billion); b) direct private placements ($1.5 billion); and c)
intra-public sector placements ($1.0 billion). Highlights of
GoA's 2008 financial program include:

-- Promoting an active dialogue with market participants, so
as to issue bonds considering investor's needs and GoA's
-- Issuing reference bonds (in pesos, foreign currencies and
at fixed and variable rates), for a minimum amount of $1.0
billion -- to ensure sufficient volume to guarantee liquidity;
-- Promoting strong participation of local institutional
investors with a strong liquidity position, with estimated
potential demand of:

-----$1.9 billion from Pension Funds, Mutual Funds and
Insurance Companies;
-----$1.0 billion from Intra-Public sector agencies; and
-----$700 million from Banks.

-- Coordinating closely with the BCRA;
-- Increased lending from International Credit Institutions;
-- Performing Liability Management transactions (debt swaps)
to smooth the GoA's debt maturity profile.

BUENOS AIR 00000622 004 OF 006

17. (SBU) Preliminary estimates of 2009 and 2010 financial
needs of $11.9 billion and $10.5 billion, respectively.
These figures are significantly higher than 2008 and may
challenge the GoA's ability to meet its financing needs,
absent a debt swap of outstanding Guaranteed Loans, which
face large amortizations in the next three years. (See
background on proposed debt swap in April 4 Econ/Fin Report).

Special Report

Argentine Economist Miguel Kiguel on Argentina's Fragile
Economy, Deteriorating Politics
--------------------------------------------- ---

18. (SBU) Noted Argentine Economist and Business Consultant
Miguel Kiguel offered an April 29 conference call briefing on
the state of the Argentine economy to his clients. Here are

-- Farmers' strike changed political climate and eroded the
GoA's popularity. This was the Kirchners' first political
loss, and they were deeply surprised by the popular support
for the farmers' protests. The middle class joined in due to
their frustration over lack of GoA action to curb inflation.
In the past, the Kirchners have chosen "enemies to attack"
that were not in a position to respond: IMF, bondholders,
large energy companies, USG. This time the conflict was with
300,000 farmers spread throughout the country -- impossible
to control.

-- Economy Minister Lousteau's resignation. Although
Lousteau was blamed for the "retenciones moviles" (sliding
export taxes), it is unclear who was really behind them. It
is not a new idea, and other GoA officials are known to have
proposed them before, including Internal Trade Secretary
Guillermo Moreno. The main goal was to appropriate part of
Ag commodity exporters' windfall gains, but after unexpected
backlash Lousteau was marginalized and scapegoated. Before
resigning, Lousteau presented an anti-inflation program (and
leaked it to media), but this was his way of trying to leave
office with honor after a mediocre tenure as Economy

-- Expectations for new Economy Minister. Minister Carlos
Fernandez is a technocrat who understands the fiscal side but
has no experience in macroeconomic policy, at a time where
the country needs a Minister familiar with exchange rate and
monetary policies. Fernandez will have limited autonomy, and
it appears Guillermo Moreno emerges even stronger. The
perception is that there will be even less reliance on market
forces and interventionist trends -- price controls and
pressure on companies -- will continue and increase. KEY
POINT: At least Lousteau had technical skills and ideas for
controlling inflation and reforming INDEC. Now, there is no
sponsor in the GoA for INDEC reform or rational economic
policies (except, possibly, BCRA President Martin Redrado);
the scope for policy mistakes is wide open and there is no
counter-balance to Nestor Kirchner.

-- Recent depreciation of the peso and how much more to
expect? As a result of increasing uncertainty, there are
growing rumors of further peso depreciation and dual exchange
rate systems. In spite of inflation, the peso is still
undervalued in real terms against the dollar and (even more
so) against a basket of currencies. However, less
competitive industries that are benefiting from the
depreciated peso are demanding further depreciation to
compensate for the real peso appreciation. They are getting
some support from farmers, who see a more depreciated peso as
partially making up for the increased export taxes (although
revenues to most farmers are in pesos). (Post comment: BCRA
economists are openly opposed to further depreciation.)

-- Increases in the CDS and in long-term interest rates,
though short-term rates remain low. Argentina's Credit
Default Swap (CDS) spread has widened to 600 bps, and other
country risk measures (e.g., the EMBI plus) have also
increased. This reflects concerns regarding the GoA policy
mix more than fundamentals, since the GoA's capacity to pay
debts is solid in the medium term. However, the perception
from abroad is that anything is possible with Nestor Kirchner
pulling the economic policy strings, so foreign investors are
rapidly reducing exposure. Long-term peso interest rates are
increasing, but the short-term (BADLAR) rates are only
slightly higher than their pre-strike level in March. Low

BUENOS AIR 00000622 005 OF 006

short-term rates have been supported by two factors:
Argentine banks and insurance companies are currently very
liquid, and local institutional investors are not concerned
about short-term changes to the exchange rate. Both of these
factors are changing (particularly as the soybean crop is
sold and liquidity declines). Expect BADLAR rates to
approach rate of inflation.

-- Outlook for inflation. This is the main problem facing
the GoA, but no one knows the exact number. Annual inflation
was approximately 20% in 2007 and is running at about 25% so
far in 2008. However, there is no reason to expect spiraling
(or hyper-) inflation. Wage increases so far in 2008 have
been relatively conservative, with the major unions accepting
a 19.5% increase (or 23-24% including benefits), which is
similar to 2007. Also, the big jump in inflation took place
in 2007 due to high wage and pension increases, also spurred
by the GoA's 55% annual increase in expenditures. Fiscal is
more conservative now, growing at about a 35% annual rate,
and the primary fiscal surplus is stronger (mostly due to
October 2007 increase in export taxes). While not
contractionary, the GoA's fiscal policy is more prudent and
less inflationary. The BCRA's policies are accommodating
higher inflation, with its management of the undervalued
currency, the large, negative real interest rates, and no
signs of tightening of the money supply. (The BCRA's 2007
target for M2 growth was 18-19%, whereas it is 23.5% for 2008
-- and with private M2 target growth of 26%.)

-- Clearly, the rate of economic growth is above potential,
there is a tight labor market, and there is excess aggregate
demand, all of which lead to higher inflation. However, of
most concern is the total absence of any GoA
anti-inflationary program. There are three essential
components to an anti-inflation plan:

----- Tighter fiscal and monetary policy to bring down
aggregate demand.
----- Institute a Nominal Anchor (could be the money supply
or inflation targeting -- slow economy or adjust the exchange
rate. Right now there is only a relatively stable nominal
exchange rate. Obviously, if the GoA gives in to industry
demands for further depreciation, inflation will jump.)
----- A change in key relative prices, particularly the real
exchange rate and real interest rates (probably need stronger
peso and definitely need higher nominal interest rates).

-- Financing requirements. The GoA only needs to raise about
$4 billion in 2008, which it will do easily by tapping local
pension funds (which have roughly $6 billion they must invest
domestically this year) and the Social Security Agency
(ANSES). Financing needs jump to $9-10 billion in 2009,
which will be more difficult for the GoA but still
manageable. The GoA should be able to raise over $4 billion
easily from domestic capital markets and several billion in
short-term borrowing from the BCRA (which is within BCRA
Charter limits), and will be able to fill the rest with
private placements to domestic agencies (ANSES). (Post
Comment: Venezuela's continuing willingness to purchase
Argentine debt will be an increasingly important factor.) It
is wishful thinking that the GoA will improve its
relationships with capital markets. With the departure of
Lousteau and Finance Secretary Hugo Secondini, the proposed
debt swap of Guaranteed Loans and Bodens is on hold. It
would have been difficult/impossible to do anyway due to the
ongoing Holdouts court case in New York. The new Minister
will likely put emphasis on new financing rather than on
smoothing maturities through a debt exchange. New Finance
Secretary Hernan Lorenzino was involved in the Buenos Aires
Province debt exchange in December 2005, is competent, and
understands financial markets, although he does not have
Secondini's experience.

-- Medium-term outlook. Not too concerned about the
fundamentals, and the twin surpluses (fiscal and trade)
reduce macroeconomic risks. Growth should continue for the
next few years at least in the 4-5% range, as long as the
favorable external environment continues. Financing
requirements and debt sustainability are not concerns.
Inflation is the major problem in the medium term, and the
main downside risk is "stagflation." At this point,
arresting inflation will require a major shift in
macroeconomic policy, absent which inflation will likely rise
by 2009 to the 30-35% range. This high inflation and the
resulting strengthening of the peso in real terms will both
affect production, as will higher interest rates. The result
will not be the typical Argentine crisis, because the GoA

BUENOS AIR 00000622 006 OF 006

will not face problems servicing debt. Rather, real GDP
growth would drop to 2.5-3% per year, low compared to
previous years and also low compared to Argentina's peers in
the region.

-- The biggest questions are political. President Kirchner's
beginning has been highly disappointing for investors, who
had hoped for "gradual fine-tuning" of policies, stronger
institutions, and a more international outlook. Instead, (in
Kiguel's view) the GoA's relations with important allies such
as the U.S. and Spain have deteriorated, Argentina is
becoming closer to Venezuela, and there are few signs of
advancement on key financial issues such as holdout
bondholders or Paris Club. In summary, the economic
situation is deteriorating gradually, the political situation
has deteriorated considerably, the leadership has minimal
economic background, there is no counterbalance to bad
economic policy decisions, and downside risks have increased
dramatically. The best hopes right now are that the fall in
President Kirchner's approval rating may force the
administration to act, and also that the Governors of the
major Provinces are becoming more vocal in support of more
sensible policies.

© Scoop Media

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