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Cablegate: "Argentinization:" Government Promotes Greater Local

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DE RUEHBU #0836/01 1701948
ZNR UUUUU ZZH
R 181948Z JUN 08
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC 1372
INFO RUCNMER/MERCOSUR COLLECTIVE
RHMFIUU/DEPT OF ENERGY WASHINGTON DC
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RUEHFR/AMEMBASSY PARIS 1421

UNCLAS BUENOS AIRES 000836

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E.O. 12958: N/A
TAGS: ECON EINV ETRD PGOV PREL ENRG AR
SUBJECT: "Argentinization:" Government Promotes Greater Local
Control of Key Public Services

REF: (A) 07 Buenos Aires 1352
(B) 07 Buenos Aires 1819
(C) 07 Buenos Aires 2390
(D) Buenos Aires 572
(E) Buenos Aires 660

1. (SBU) SUMMARY. A decade after its great privatization wave, and
followed by the 2001/02 economic collapse, Argentina has undergone a
paradigm shift, with the Government of Argentina (GOA) promoting a
heavy hand in the economy. While this trend has been much in the
news over the GOA's price stabilization efforts, it is also clearly
evident in the GOA's advocacy of greater local control - whether by
the GOA itself or by local businesses close to the GOA - of key
public service entities privatized in the 1990s and largely
controlled by foreign interests. The administrations of Nestor and
Cristina Kirchner, with strong public support, have accelerated this
process, which many here call "Argentinization." Focusing on
specific sectors, Argentinization takes several forms: 1) the
outright re-nationalization of privatized companies; 2) GoA or local
private groups taking equity stakes in foreign-owned companies; and
3) the GoA creating entirely new state firms. We expect more such
"Argentinizations." Whether driven by political opportunism,
economic nationalism, cronyism, or all three, the trend appears to
be here to stay. While this trend may complicate an already
difficult investment climate, some observers argue that
politically-connected insiders are better at navigating in this
heavily-regulated and highly personalized political economy, and can
even help to bring in outside investors to some "strategic" sectors.
END SUMMARY.

----------------------------
"Failed" 1990s Privatizations, and 2001/02 crisis . . .
----------------------------

2. (SBU) In the 1990s, Argentina was at the forefront of the
region's embrace of liberalization, privatizing or granting
concessions for many state-owned utilities, including telecoms,
airlines, electricity, gas, water, rails, highways, ports, mail
service, and airports, with many ending up under foreign control.
The GOA took in about $24 billion through the sale or concession of
these federal assets, according to the Economy Ministry. (U.S.
firms largely stayed out of this process, reportedly out of their
concern with the lack of transparency, and GOA officials in the
current administration have regularly praised U.S. companies for not
participating in what they describe as corruption-filled
privatizations.) However, a common denominator for many of these
initiatives was their eventual failure and the subsequent deep
unpopularity of privatization with the GOA and public. (Although
many of these privately owned public service entities initially did
well, and there is clear evidence of improvement in most public
services, poor regulatory oversight and the 2001/02 economic crisis
eventually did them in.)

3. (SBU) Following the 2001/02 economic collapse and devaluation,
the GOA largely froze most utility rates for public services. Many
owners found themselves servicing foreign currency-denominated debt
with now-devaluated peso receivables. They fought (and some
continue to fight) a largely unfruitful battle with the GOA to
adjust rates. However, the Duhalde administration (2002-3) and
Kirchner administrations (2003-present) largely refused to consider
such requests, arguing that price increases would hurt millions of
mostly urban poor, who represent the heart of their Peronist
political base.

----------------------------
Helped shift pendulum to more state control of the economy . . .
----------------------------

4. (SBU) The privatization process has since been widely seen by the
GOA and public as totally flawed. Conventional wisdom here portrays
the process as a succession of slick business deals for the
companies that benefited, often with GOA subsidies. Fairly or not,
this process has been lumped together with the Argentine government
and public's rejection of the "neo-liberal" model and "Washington
Consensus."

5. (SBU) In 2003, the new Kirchner administration began regularly
criticizing these companies for allegedly forsaking commitments
related to investment, safety, maintenance, and royalties. The GoA
stated its intention to "regain" for Argentina the upper hand in
managing these privatized utilities, and reviwed and renegotiated

over 60 such agreements. New rules were introduced, and a common
tactic was for the GoA to take a golden share in companies in
exchange for debt forgiveness. In some cases, contracts were so
altered that concession holders were largely reduced to being mere
contract administrators, while the GOA made the key investment
decisions. Some of these foreign owners decided not to wait for a
better climate, and sold their assets, with ownership reverting from
mostly European to local control. In some cases, these firms also
filed cases with the World Bank's International Centre for
Settlement of Investment Disputes (ICSID).

---------------------------------------------
With Strong Public Support for State Control of the Economy
---------------------------------------------

6. (SBU) The trend toward more state control enjoys strong public
backing. Argentine polls consistently reveal a widespread view that
the state should have a predominant role in the economy, especially
in public services, and that the 1990-era privatizations and free
market reforms went "too far." According to a February 2008 local
Poliarquia poll, 65% of respondents agreed with the statement that
"state intervention is the best way to ensure better development and
fairness in the distribution of goods," and only 22% agreed that
"private initiative in the economy is the best way to assure a
better development and fairness in the distribution of goods."

7. (SBU) A 2007 State Department INR-commissioned survey found that
by 57-35% margin, "Argentines continue to perceive the state as the
agenda-setter, safety net, and provider of last resort for economic
development, despite acknowledging the shortcomings of state
enterprises in terms of inefficiency and quality of service." The
same poll indicates that for almost a decade, large majorities state
that privatizations were harmful and led to rampant corruption,
impoverishment, and the loss of national sovereignty.

8. (SBU) The local Ipsos-Argentina polls that track public
preferences on the balance between government and the market have
seen in recent years a steady support for a "new statist" position
that eschews the monopoly of state enterprises and regulation of
trade, but still prefers the GOA to act as a buffer against market
forces. Currently, as few as a quarter of respondents favor a
predominant role for the private sector, while 60-75% favors giving
the state a larger role. This holds true even for sectors in which
the GOA struggles to provide services, such as electricity, water,
petroleum, and natural gas. Noted Argentine economist Rafael Di
Tella has said that, for Argentines, "it is either the state or the
jungle, and no one believes that capitalism can be a solution for
all."

-------------------
Kirchners' Priority
-------------------

9. (SBU) The Nestor and Cristina Kirchner administrations have
signaled and continue to signal their preference for increased local
control of strategic economic assets, while affirming a strong
commitment to the "market economy." The Kirchners have also at
times been accused of "encouraging" this process by intentionally
complicating foreign operators with regulatory problems, frozen
tariffs, or export taxes. These measures drive down the values of
these enterprises and encourage the foreign firms to exit the
market. At the same time, the GOA has strongly disavowed wholesale
re-nationalizations. It is also important to note that in some
cases where the GOA has taken control of companies that had
previously been privatized, there were legitimate concerns about
serious flaws or corruption in the concessions. In these cases (as
cited in paras 13-17 below), the GOA was left with no choice but to
make changes. And not all GOA post-privatization interventions were
effected by the Kirchners, Presidents De La Rua and Duhalde both
initiated such actions. Also, not all moves toward greater state
control have been directed at foreign-owned companies; some
locally-owned companies have also been targeted.

10. (SBU) Ever since this post-crisis rollback, and perhaps for the
foreseeable future, the GOA's populist positions on these (and
other) issues leave the impression that local companies or the GOA
itself might be better suited for buying into and operating public
service (utility) companies. However, one of the original aims of
the privatizations - bringing in capital and experienced operators -
has been jeopardized, to say nothing about the discouraging impact
these interventions have on potential investors.


11. (SBU) While this interventionist trend might appear excessive,
it is only one of many areas where the GOA believes a larger central
government role is necessary than is the norm in most other
countries where market forces play a more predominant role.
Examples include: setting the exchange rate, major infrastructure
investment decisions, setting prices (and thus relative prices) for
many goods and services, and regulation of privatized sectors. (For
some of us, the policy approach has similarities to France's
economic policy from the 1960s through the eighties.)

--------------------------------------------- ----
Increased GOA Control Falls into Four Categories
--------------------------------------------- ----

12. (SBU) Analysts have identified four general characteristics of
this phenomenon of increased state control: re-nationalizing some
entities that were once state-owned and were privatized in the
1990s; the GOA obtaining equity stakes in other such firms; local
investors close to the GOA taking increased equity stakes in similar
entities; and, in some cases, the GOA creating new state firms
altogether.

--------------------------------------------- -
Re-nationalizing formerly privatized companies
---------------------------------------------

13. (SBU) In November 2003, the GOA rescinded a 30-year postal
service concession granted in 1997 to an Argentine-led Correo
consortium, claiming that Correo failed to fulfill several contract
conditions, including unrealized investments and non-payment of
royalties. Correo's owners argued the company was owed millions for
services provided to federal agencies, and that the GOA had failed
to reform labor laws as promised.

14. (SBU) In 2004, the GOA rescinded a 1997, 15-year, $500 million
concession held by France-based Thales to manage the radio spectrum,
citing Thales's failure to meet contract conditions and GoA
regulatory agencies frequent charges of Thales' corrupt practices.
GOA oversight agencies argued that Thales Spectrum failed to collect
fees, control frequency usage, pay fines, or invest in or maintain
infrastructure.

15. (SBU) In September 2005, the GOA rescinded France-based Suez's
water and sewage concession (Aguas Argentinas), which serviced 10
million people in greater Buenos Aires. It subsequently created a
new state-run firm, AYSA, to provide these services. Suez countered
that it was "impossible" to maintain financial stability given the
2002 conversion to pesos and years of frozen tariffs.

16. (SBU) In recent years, the GOA has also revised or canceled many
train concessions, including the locally-owned Metropolitano
commuter train. This was a private consortium formed in 1994 that
operated three heavy-volume Buenos Aires commuter lines. In spite
of large subsidies, a serious decline in services led to the 2004
rescission of one contract due to "grave breaches of contract" and
poor maintenance. In May 2007, the GOA rescinded the other two
contracts after excessive cancellations and delays sparked irate
commuters to riot. These lines are now operated by two
newly-created state companies.

17. (SBU) In 1999, the De La Rua administration rescinded the 1991
privatization of Buenos Aires shipyard Tandanor amidst complaints
that its owner, the Indarsa company, had invested only a fraction of
its pledged amount. The GoA also accused Tandanor of conducting
illegal sales of prime downtown real estate. Tandanor workers ran
the shipyard until 2007, when the Ministry of Defense was granted
full control of operations.

-----------------------------------------
Well-connected local investors taking stakes in firms
-----------------------------------------

18. (SBU) Local ownership is an increasing trend. Critics charge
that many foreign-owned companies have sold out to locals due to the
increasingly difficult investment climate, which the GOA had done
nothing to improve, and done many things to complicate. In 2003,
France Telecom sold its 48% stake of the holding company that
controls Telecom Argentina to local investment company Werthein
Group for $125 million, the first major divestiture of privatized
services by a foreign firm in Argentina.


19. (SBU) Spanish oil and gas giant Repsol-YPF recently sold a 15%
stake in its Argentine subsidiary YPF to Argentine banker and
Kirchner insider Enrique Eskenazi for $2.25 billion. The Kirchners
openly supported the sale of this emblematic formerly state-owned
company. However, it faced criticism locally, with former Economy
Minister Roberto Lavagna labeling the sale "crony capitalism." For
Repsol-YPF, Argentina's post-crisis energy price freezes, high
export taxes, and an unpredictable regulatory climate had made
Argentina a less attractive place to do business. Therefore, the
sale was reportedly motivated by Repsol's desire to reduce its
exposure to the difficult Argentine business climate and improve
relations with the GoA by bringing on a well-connected partner.

20. (SBU) In 2005, local investment firm Pampa Holdings (with
support from U.S. capital) bought a 65% stake in Edenor (Argentina's
largest power distributor) from Electricite de France (EDF) for $100
million, a huge drop from the $800 million EDF paid for a 45% stake
in 2001 (ref B). (EDF filed an ICSID suit against the GoA following
the economic crisis and was unable to negotiate a tariff increase to
return to profitability.) Shortly after Pampa's purchase, Edenor
obtained a 28% tariff increase. Some analysts speculate that the
reason the purchase price was so low was because the GOA favored
increased local participation in the energy sector, and delayed the
tariff increase until the deal went through.

21. (SBU) In October 2007, the GOA exercised an option to increase
its share in Argentina's flag carrier Aerolineas Argentinas,
majority-controlled by Spain's Marsans Group, from 5% to 20% in
exchange for forgiveness of accumulated debt. Frequent strikes,
high salaries, a bloated staff, low fares and a poor financial
performance (US$200 million debt) continue to mar the airlines'
performance. In May 2008, the GOA, Aerolineas, and Argentine ferry
operator Juan Carlos Lopez Mena began talks for the latter to take
financial and possibly operational control (ref D and E). Notably,
the GOA soon thereafter authorized a tariff increase for domestic
air travel, the market dominated by Aerolineas Argentinas.

-----------------------------
Increased GOA Equity in Firms
-----------------------------

22. (SBU) In July 2007, Petrobras sold its 50% stake in Citelec,
which controls Argentina's largest power transmission firm,
Transener, to Argentina's state-owned Enarsa and private,
Cordoba-based Electroingeneria, for an estimated US$55 million. The
GOA had earlier rejected a similar offer for this Citelec stake by
U.S. investment fund Eton Park Capital Management, ostensibly
because of Eton's lack of experience in the power sector (ref A).
This decision paved the way for Enarsa and Electroingeneria's
purchase. Argentina-based Dolphin fund, a unit of Argentine energy
company Pampa Holding, which represents large foreign and local
investors, had earlier already taken the other half of Citelec.

23. (U) In late 2007, the GOA exchanged an accumulated $400 million
debt by airports operator Aeropuertos Argentina 2000 (AA2000) for
20% of the company. An Argentine businessman with many
international investments maintains his majority ownership of AA2000
(ref C).

---------------------------
Creation of New State Firms
---------------------------

24. (U) The GOA has not shied away from creating new state firms
altogether. In 2004, it created Enarsa, a state oil and gas firm,
whose assets are its mostly undeveloped exploitation and concession
rights. State airline Lafsa was created in 2003 to absorb some 850
employees of two failed airlines. Most of these employees were
later absorbed by LAN Chile when the latter began operations in a
GOA trade-off in exchange for access to the Argentine market. Since
Lafsa's creation, the GOA has maintained some 100 employees,
including pilots and flight crew, but owns no aircraft and has never
made a flight. In 2006, the GOA formed new national satellite
company, ArSat, with the goal of eventually operating a satellite in
the GOA's allotted orbital position.

----------------------------------
More "Argentinizations" on the Way?
----------------------------------

25. (SBU) The "Argentinization" trend may spreading. Television
station Telefe's news content, owned by Spain's Telefonica, could
soon be acquired by local interests close to the Kirchners.
Argentina's second largest gas distributor, Metrogas, majority
controlled by British Gas and Repsol-YPF, recently announced that
its 2005 debt-for-equity swap for 30% of the company had fallen
apart after the GOA denied regulatory approval. This 30% stake is
now for sale, possibly to a local buyer. Petrobras is planning to
sell to a local buyer its 50% stake in the controlling entity, Gas
Argentino, of Argentina's largest gas transporter, TGS, after the
GOA rejected the sale of this asset to the U.K.-based Ashmore Energy
Fund. Spanish natural gas distributor Gas Natural BAN recently
announced its intention to sell 19% of the company to a local
entity, reportedly with "encouragement" from the GOA.

26. (SBU) "Argentinization" could be coming soon for some major
electricity distributors in Buenos Aires Province, according to
media reports and private analysts. U.S.-based AES is reportedly
set to sell its controlling stakes in Edelap and EDES, also under
GOA "encouragement," possibly to an Argentine-controlled firm. EDEN
and Edesur could also be selling their controlling interests. AES
had sold its 90% stake in EDEN to the Ashmore fund in 2006, but this
transfer has not been approved by the GOA, and AES will now sell
this stake, likely to local buyers. Edesur, jointly controlled by
Petrobras and Spain-based Endesa, are also reportedly ready to cede
control of the firm in response to GOA "encouragement."

------------------------------
GOA Motives: "Digital Economy"
------------------------------

27. (SBU) Some observers see other motivations for this
"Argentinization" of the economy. While some cite political and
economic nationalism, others see crony capitalism or the ruling
first couple's efforts Kirchner moves to preserve their political
power base. Some say that the process is in fact not very different
than how the Kirchners ran Santa Cruz Province in the 1990s. One
local analyst said to Econoff that "I don't know how much of this
trend can be explained as economic nationalism and how much of it is
just crony capitalism using the banner of nationalism." He added an
even more perverse notion: "in some ways, some foreign operators (in
strategic sectors) are actually trapped here: if you want out, you
either sell low, or you're stuck here." This person gave as an
example Exxon's failure in 2007 to sell its Argentine operations,
due to the lack of an acceptably high offer, and noted that GoA
support for local investors and pressure on foreign owners allows
locals to make ridiculously low-ball offers. Perhaps the best
explanation of this trend came from one of the successful
entrepreneurs who have benefited from the system. He told the
Ambassador that the Kirchners want a "digital economy: they can
point their digit (finger) and say you get this contract and you
don't: It's about control."

-------------------------------------------
Failed privatizations, or poor regulation and oversight?
-------------------------------------------

28. (SBU) Some local economists cite what they say is an important
but often overlooked aspect of the "failed privatization" debate.
While some of the charges against the privatized companies might
have merit, and indeed several federal oversight agencies and the
media reported breaches of contract by several concession holders,
many privatizations were simply poorly conceived and executed. For
them, the "privatization vs. state control" debate is a false
dichotomy: the real issue is how well (or poorly) a concession is
run. Large-scale privatizations need good oversight, transparency,
accountability, enforcement mechanisms, good regulatory agencies
imposing efficient and technical policy on regulated sectors, and
newly-privatized enterprises need to be put on sound footing before
offering them for sale - all which was often lacking. While the
public often blames the initial privatization for ensuing problems,
the full story is usually more complex.

-------
Comment
-------

29. (SBU) Argentina has undergone a significant paradigm shift.
Today, privatization and "neo-liberalism" are widely believed to
have failed to deliver stable and equitable growth. Partly as a
result, the GOA believes it has a public mandate to play a greater

and more direct role in Argentina's economy. At the same time,
there is no indication that Argentina is moving towards any form of
economic "re-nationalization" in the classic sense of a systematic
state takeover of industries. In fact, for many sectors (IT,
telecoms, agriculture, mining, to name a few), the GOA appears
content to simply tax them. However, in other sectors, particularly
traditional utilities (water, transportation, and energy), the GoA
is clearly pursuing a policy of "Argentinization."

30. (SBU) For better or worse, "Argentinization" is here to stay.
Many observers argue that local ownership by a GOA ally enables a
business to navigate this heavily-regulated and highly personalized
political economy better than foreign owners can. In fact, a number
of U.S. investors have supported Argentine players with capital when
buying into key companies. Several local entrepreneurs have pointed
out that through this process they have substantially eased the
entry for international partners. And if "Argentinization" is what
the public wants, the GoA will only have themselves, and not
foreigners, to blame if the process leads to worse competition,
corruption, and lack of investment in public services.

WAYNE

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