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Cablegate: Argentina Economic and Financial Review, May 26 -

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DE RUEHBU #0782/01 1581540
ZNR UUUUU ZZH
P 061540Z JUN 08
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC PRIORITY 1268
INFO RUCNMRC/WESTERN HEMISPHERIC AFFAIRS DIPL POSTS PRIORITY
RUEAIIA/CIA WASHINGTON DC PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
RHEHAAA/NATIONAL SECURITY COUNCIL WASHINGTON DC PRIORITY
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UNCLAS SECTION 01 OF 05 BUENOS AIRES 000782

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: EFIN ECON EINV ETRD ELAB EAIR AR
SUBJECT: ARGENTINA ECONOMIC AND FINANCIAL REVIEW, MAY 26 -
JUNE 4, 2008

REF: BUENOS AIRES 753

1. (U) Provided below is Embassy Buenos Aires' Economic and
Financial Review covering the period May 26 - June 4, 2008.
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
----------

-- GoA announces mostly cosmetic changes to export tax
regime; conflict continues
-- Strong April primary fiscal surplus, despite accelerating
growth rate of expenditures
-- Interest rates skyrocket to 16-17%, while private sector
deposits fall by ARP 6 billion
-- GoA sells $1.0 billion of Boden 2015 to Venezuela at a
record yield of 12.90%
-- Trade booming in 2008, although spike in exports due
mostly to higher prices

-----------
Agriculture
-----------

GoA announces mostly cosmetic changes to export tax regime;
conflict continues
--------------------------------------------- ----
2. (SBU) On May 26, seventy-nine days after the initial
outbreak of the conflict between the GoA and Argentine
farmers, the GoA announced a unilateral amendment to the
"retenciones moviles" (sliding scale export taxes) that had
prompted the conflit in the first place (See April 4
Econ/Fin report and extensive Post reporting for background).
With the amendment, the GoA lowered the export tax rate on
soybean exports when international prices rise above $600 a
ton ($16.33 per bushel), a level far above current prices of
$485 a ton. (Note: The GoA amendment reduced the soy export
tax from 55.9% to 51.7% for prices between $700 and $750 a
ton and from 58.5% to 52.7% for prices above $750 a ton,
while retaining the existing tax rates for prices below
$700/ton.)

3. (SBU) In tandem, the GoA resolution lowered the tax rates
on corn, wheat, and sunflower exports for price levels above
$350, $500, and $800, respectively. With this amendment, the
GoA argued it had corrected problems for the futures market
caused by the high marginal rate at high prices of an
estimated 95% and that this should be enough for producers
who are still making a profit at current export tax levels.
However, this change falls far short of resolving the
conflict, as farmers characterized the amendments as purely
cosmetic. Farm groups stated that, at current world prices,
Argentine exporters of these agricultural commodities will
continue to pay the same tax rate as before, and prices would
have to increase to record levels in order to see any
reduction from the previous requirements.

4. (SBU) On May 28, the day before the GoA announced the
policy change, the main farming groups restarted protests,
including partial road-blocks and withholding grain, oilseed,
and cattle sales, after the GoA canceled planned discussions
with the sector. On June 2, the same organizations agreed to
extend the bans on sales and exports of grains and oilseeds
until June 9, while restoring the sale of cattle for
slaughter to avert disruption to domestic supply. The
withholding of grain and oilseed sales is already affecting
Argentine exports, since exporters (including soybean
crushers) have been working with stocks held at port, which
are being rapidly depleted.

------
Fiscal
------

Strong April primary fiscal surplus, despite accelerating
growth rate of expenditures
--------------------------------------------- ----
5. (SBU) Strong revenue growth so far in 2008 indicate the
primary fiscal surplus will be stronger than during the 2007

BUENOS AIR 00000782 002 OF 005


election year, when expenditures spiked to almost 50%.
However, increasing subsidies are a worrisome trend.

6. (SBU) The GoA announced May 19 a primary fiscal surplus of
ARP 2.8 billion ($889 billion) for April, a 73% y-o-y
increase. This strong April result is explained by rising
revenues (up 55% y-o-y), overwhelming
also-rapidly-accelerating primary expenditures, which
increased 52% y-o-y compared to the March increase of 29%
y-o-y. After growing at a rate of 47% y-o-y in 2007, primary
expenditures decelerated sharply in the first quarter of 2008
to 35% y-o-y. This led most analysts to believe that
President Cristina Fernandez de Kirchner would hold to her
promise of targeting a strong primary fiscal surplus. (Note:
The GoA announced June 4 that May tax collection hit a
historic record of ARP 24.3 billion (up 28.5% y-o-y))

7. (SBU) The decelerating trend reversed in April, raising
the y-o-y increase for the first four months of 2008 to 39%.
Local private analysts speculate that the GoA delayed
payments during the first quarter, in order to demonstrate a
lower growth rate for expenditures, and the April spike
included March expenditures paid in April. (Note: GoA fiscal
accounts are calculated on a cash basis, meaning income and
expenditures are accounted for when they are paid, instead of
on an accrual basis, where income and expenditures are
accounted for when they are realized (and independently of
when they are paid)).

8. (SBU) April's strong primary surplus also included an ARP
450 million transfer from the BCRA to the GoA. (Note: the
BCRA is obligated to either apply earnings to increase its
capital or transfer them to the GoA. The BCRA had already
transferred earnings of ARP 1 billion in March, so with the
April transfer the BCRA has already completed the total
amount of transfers -- ARP 1.4 billion -- included in the
2008 budget (which corresponds to BCRA earnings in 2007). On
June 2, Argentine daily Cronista Comercial reported that the
BCRA may decide to send additional earnings of about ARP 1
billion during 2008. (Note: the decision is up to the
BCRA's Board of Directors.) Private sector analysts estimate
that the BCRA's earnings in 2007 exceeded ARP 2.6 billion,
which would allow the ARP 1.0 billion additional funds
transfer to the GoA, while still allowing for a small portion
to re-capitalize the BCRA.

9. (SBU) In the first four months of the year, accumulated
primary expenditures reached ARP 53 billion (up 39% y-o-y),
while accumulated revenues stood at ARP 65 billion (up 44%
y-o-y). This resulted in an accumulated primary surplus of
ARP 11.6 billion. According to Argentine consulting company
Economia y Regiones, if growth dynamics of revenues and
expenditures continue as they have through April, the GoA's
2008 primary fiscal surplus should reach about 4% of GDP.
This would be significantly above the official 2007 primary
fiscal surplus of 3.2% of GDP (equivalent to ARP 25.7 billion
or $8.1 billion). (Note: The 2007 primary surplus was only
2.5% of GDP when excluding one-time transfers that resulted
from the 2007 pension system reform.)

10. (SBU) Within expenditures, the evolution of subsidies
deserves special focus. Subsidies reached ARP 16 billion in
2007 (explaining one-third of the 47% increase in 2007
expenditures), and analysts estimate that GoA subsidies could
increase by a further 50% in 2008, to roughly ARP 20-23
billion (or 2 - 2.5% of GDP). Subsidies so far in 2008 are
rising at an annual rate of about 103% (y-o-y in the first
quarter), and there is no reason to believe that the GoA will
reduce them soon, since the GoA strategy has been to use
subsidies to avoid the need to increase domestic prices.
And the GoA has not yet indicated its intention to raise
tariffs for energy and transportation, the sectors that
together account for 85% of subsidies. Additionally, new
subsidies, such as those to the agricultural sector, are
increasingly a concern. (Agro subsidies increased almost 50%
in Q1.) Prominent local think tank Bein and Asociados
estimates that, excluding the increase in subsidies to the
private sector, the increase in primary expenditures would
have been only 33% during the first four months of 2008
(compared to the effective increase of 39%) if it excluded
the increase in subsidies to the private sector.

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

Interest rates skyrocket to 17%, while private sector

BUENOS AIR 00000782 003 OF 005


deposits fall by ARP 6 billion
--------------------------------------------- ------
11. (SBU) Political uncertainty, accelerating inflation, and
the Ag conflict created a move towards the dollar in May at
the expense of private peso deposits. However, the BCRA
appears to have succeeded in restoring market stability.

12. (SBU) Private sector deposits dropped ARP 6 billion
(almost $2 billion) during the period May 1 - 23 (latest
available data from BCRA). The BCRA intervened strongly,
selling dollars to stabilize (or even appreciate) the peso
(the retail peso closed at 3.10 ARP/USD on June 2, having
appreciated by 3.7%, from highs of 3.22 on May 9). Some
local analysts concluded that the BCRA continued selling
dollars and strengthening the peso several days longer than
necessary to "punish" investors betting on a peso
devaluation. The BCRA ultimately succeeded in demonstrating
its ability to keep the exchange rate stable. It
accomplished this by selling a total of 1.3 billion from
April 23 to May 23, dropping reserves to $49 billion. Some
analysts estimate that BCRA dollar sales during this period
were actually in the range of $2 billion, but allege that the
BCRA engaged in repo transactions with the BIS to disguise
the lower reserve levels.)

13. (SBU) However, the BCRA took these actions at the cost of
absorbing peso liquidity (with its dollar sales). Coupled
with investor's withdrawals of funds, the BCRA's dollar sales
pushed up interest rates, with the Badlar rate reaching 17%
on May 27, the highest level since February 2003 (Badlar is
the reference rate for one-month time deposits over ARP 1
million). This compares to 14.3% on May 16 and to 8.6% on
March 11, when the GoA imposed the export taxes sliding
scale.

14. (SBU) The BCRA responded to this sharp increase in rates
by announcing two measures on May 29 to increase liquidity in
the financial system. First, the BCRA announced it will
engage in dollar repo transactions (repurchase agreements)
with banks. (Note: Allowing banks to satisfy their dollar
demands by borrowing -- through the repos -- from the BCRA,
instead of buying dollars on the FX market eliminates the
monetary impact, as there is no reduction in peso liquidity.)
Second, the BCRA altered bank supervision regulations to
allow banks to meet deposit liquidity requirements for June
and July on a bimonthly basis, as opposed to a monthly basis.
(Note: The BCRA is doing this in the hopes that liquidity
pressures will ease when the Ag conflict is solved.
Otherwise, some banks would be forced to borrow to comply
with liquidity requirements, thus exerting more upward
pressure on interest rates.) These measures should help
prevent interest rates from rising further.

15. (SBU) Many analysts expect deposits to start returning to
the banking system, attracted by higher rates and the
expectation that the nominal exchange rate will remain
stable. Post Comment: All local analysts known to Emboffs
agree that the BCRA has performed extremely well in handling
the crisis of confidence that began in March, and clearly
learned from its own mistakes made during the financial
turbulence of July-August 2007, when local interest rates
spiked (with the Call, or overnight, rate hitting a high of
22.8% on July 27, 2007, compared to a high of just 12.3% on
May 15, 2008, falling to 9.3% by May 23.).

GoA sells $1.0 billion of Boden 2015 to Venezuela at a record
yield of 12.90%
--------------------------------------------- ----
16. (SBU) The GoA announced in the May 27 Official Gazette
that it sold $1.3 billion (face value), equivalent to about
$1.0 billion cash (effective value), in dollar-denominated
Boden 2015 bonds to Venezuela. (The Boden 2015 is an
Argentine law, 10-year, dollar denominated bullet bond. It
was first issued October 3 2005, matures in 2015, and carries
a fixed 7% coupon rate.) According to the GoA resolution,
the bonds were issued through a private placement and were
priced at market prices. The Bodens were reportedly priced
at $73, resulting in a yield of 12.90%, 247 basis points
higher than the last issuance of the same bond to the GoV in
November 2007, and 202 basis points higher than the December
2007 issuance of the same bond to the Argentine social
security agency (ANSES). This is the first bond sale to the
GoV this year, and was reportedly arranged by new Minister of
Economy Carlos Fernandez during his trip to Venezuela on May
7. However, given the GoA's inability to issue debt
internationally and current unwillingness to test the local
market, local analysts do not discount the possibility of

BUENOS AIR 00000782 004 OF 005


additional GoA sales to the GoV to meet the GoA's 2008
financing needs.

17. (SBU) From May 2005 to the present, the GoV has financed
the GoA for a total of $8.1 billion (face value), equivalent
to $6.6 billion cash (effective value) in over 20 separate
transactions. Most analysts agree that GoA financial needs
for the year are manageable. The GoA still needs to raise
about $5.0 billion (based on the GoA financial program), but
domestic institutional investors -- pension funds, insurance
companies, and banks -- and public sector agencies -- ANSES
and AFIP (Argentine IRS) -- count with ample liquidity. In
its 2008 Financial Program (see May 2 Econ/Fin Report), the
Economy Ministry clearly states its intention to raise
significant funds from these sources, and also indicates the
intention to raise as much as $1.5 billion during 2008 via
private placements, which Economy Ministry sources affirm is
an oblique reference to bond sales to Venezuela.

18. (SBU) According to a May 6 JPMorgan report, 2008 GoA
financial needs of $6 billion are overestimated "due to the
authorities' conservative assumptions...which unnecessarily
include issuance to government agencies" within the gross
debt issuance figures. JPMorgan estimates that actual market
needs are roughly half the total, or only $3 billion.
JPMorgan goes one step further and concludes that demand from
local pension funds will probably cover at least this $3
billion amount, essentially reducing the financing gap in
2008 to zero.

-----
Trade
-----

Trade booming in 2008, although the spike in exports due
mostly to higher prices
--------------------------------------------- -----
19. (SBU) April 2008 exports in dollar terms were up 35%
y-o-y, while imports leapt 61% y-o-y. Industrial exports
rose 41% y-o-y in April, followed by primary goods and
agribusiness, which were both up 33% y-o-y. Exports and
imports in the Jan-Apr. 2008 period totaled $21.6 billion and
$17.8 billion, or 40% and 45% y-o-y increases, respectively.
Argentina's trade surplus for the first four months of 2008
was $3.8 billion, compared to $3.2 billion for the same
period in 2007. On a 12-month rolling basis, the trade
balance was $11.7 billion in April, slightly down from the
$12 billion in March, and almost equivalent to the $11.6
billion trade surplus in April 2007.

20. (SBU) The 40% y-o-y export growth for Jan-April was due
primarily to a 32% increase in prices, and a 5% increase in
volumes. Primary export volumes were up by 7% (while prices
grew 50%), and industrial export volumes were up by 19%
(while prices grew only 8%). However, agribusiness export
volumes fell by 2% (while prices grew 47%) and fuel and
electricity export volumes fell by 23% (while prices grew
64%). The reverse situation was true for imports.
Year-on-year import growth of 45% for Jan-April was led by
volumes, which grew at an average annual 31%, while prices
went up only 11%.

21. (SBU) Harvard-trained economist Juan Carlos De Pablo,
owner of Contexto Consulting and professor at San Andres and
CEMA universities, pointed out during an American Chamber of
Commerce seminar on May 29 that a simulation exercise of
Argentine trade with present volumes and 2007 prices would
result in a trade deficit. One week before the April trade
figures were officially released, Central Bank's President
Martin Redrado wrote for Argentine daily La Nacion "the trade
surplus, close to $12 billion in 2008, guarantees a
structural (italics are ours) supply of foreign currencies
that will more than compensate whatever the current,
circumstantial demand for dollars is, making any speculation
about a nominal devaluation inappropriate." De Pablo's
exercise throws doubt on the accuracy of Redrado's usage of
the word "structural."

22. (SBU) Recent INDEC (national statistics agency) figures
on U.S.-Argentina bilat trade in goods show 39% y-o-y growth
for QI 2008. Argentine exports to the U.S. were $1.4
billion, or 27.5% higher than in QI 2007. Argentine imports
from the U.S. were $1.7 billion, or 50.2% higher than in QI
2007. Total bilateral trade in goods in 2007 was $9.7
billion, including Argentine exports of $4.3 billion (mostly
commodities) and Argentine imports of $5.3 billion (mostly
intermediate capital goods). Total bilateral trade in

BUENOS AIR 00000782 005 OF 005


services in 2007 was $4.0 billion, including Argentine
exports of $1.1 billion (up 6.8% y-o-y) and Argentine imports
of $2.9 billion (up 27.8% y-o-y).
WAYNE

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