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Cablegate: Argentina: Fiscal Solvency Concerns Remain,

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TO RUEHC/SECSTATE WASHDC IMMEDIATE 2668
INFO RUEHWH/WESTERN HEMISPHERIC AFFAIRS DIPL POSTS IMMEDIATE
RUEHSO/AMCONSUL SAO PAULO IMMEDIATE 3841
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RUEAIIA/CIA WASHINGTON DC IMMEDIATE
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C O N F I D E N T I A L SECTION 01 OF 04 BUENOS AIRES 001682

SIPDIS

E.O. 12958: DECL: 12/10/2018
TAGS: EFIN ECON PREL PGOV AR
SUBJECT: ARGENTINA: FISCAL SOLVENCY CONCERNS REMAIN,
DESPITE GOA TAKEOVER OF PENSION ASSETS

REF: A. BUENOS AIRES 1680
B. BUENOS AIRES 1643
C. BUENOS AIRES 1667

Classified By: Ambassador E. Anthony Wayne for Reasons 1.4 (b,d)

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

1. (C) The Argentine government's nationalization of the
country's private pension system entered into force December
9, giving the GoA access to about US$25 billion in financial
assets and US$4 billion in annual contributor payments.
Argentine President Cristina Fernandez de Kirchner (CFK) has
already announced plans to tap these assets to fund economic
stimulus projects. Even prior to the President's
announcements, analysts were concerned that these new funds
might not suffice to help the GoA cover future debt
obligations AND significantly increase spending to counter
rapidly slowing growth and buy back political support ahead
of the 2009 mid-term elections. While worries about a
possible default in 2009 are overstated, reckless politically
motivated spending in 2009 could imperil the GoA's ability to
meet debt obligations in 2010 and beyond. As evidenced by
the market reaction since the President's October 21
announcement of the pension nationalization, there is still
great anxiety and uncertainty in the private sector, and
Argentine assets are still priced at highly distressed
levels. End Summary.

---------------------------------------------
GoA plans to use AFJP funds to prime the pump
---------------------------------------------

2. (C) As reported Ref A, President Cristina Fernandez de
Kirchner (CFK) signed into law on December 4 the GoA's
nationalization of Argentina's private pension funds (known
as AFJPs). The law entered into force December 9. The GoA
is already planning for the use of the AFJPs' US$25 billion
in assets and $4-5 billion in annual cash flow, as evidenced
by the President's November 25 announcement of ambitious tax
incentives, export tax reductions, and US$ 21 billion public
works plan (Ref B), and December 4 announcement of a further
US$ 3.9 billion stimulus plan (Ref C).

3. (C) While the additional flows strengthen the GoA's
finances, rapidly decelerating GDP growth and lower commodity
prices are already resulting in lower than expected rvenues,
and this trend is expected to worsen into 2009. The GoA has
limited ability to issue debt at this time due to high yields
on Argentine bonds, limited domestic interest in buying GoA
debt, and lack of access to international capital markets
stemming from the threat of lawsuits from so-called ""Holdout""
bondholders. Since this situation is unlikely to change
soon, there are still concerns in the market place about the
GoA's capacity to meet debt payment obligations during
2009-2011, when its annual debt amortizations increase by
roughly a third over prior years. While the GoA's recent
announcements of increased spending may be welcome news to
Argentine companies and consumers, they exacerbate worries
about GoA finances going forward.

-----------------------------------
GoA Finances Look Adequate for 2009
-----------------------------------

4. (C) There are undeniable fiscal benefits for the GoA of
the AFJP nationalization, in terms of both higher revenues
and lower debt payments. First, the GoA now has greater
access to the AFJPs' US$25 billion in assets and roughly US$4
billion in annual contributor flows. The GoA can tap this
source of financing via bond sales to ANSES, the social
security administration, which under the new law assumes
control over the AFJP assets. Second, the GoA can now also
easily refinance with ANSES the debt amortizations it would
have owed to the AFJPs, as well as the debt buybacks the GoA
is required to make under the terms of the 2005 debt
restructuring.

5. (C) This combination of new flows and reduced debt
payments strengthens the GoA's ability to meet total debt
obligations coming due in 2009. This is especially true when
considering that the GoA also has greater access to borrowing
from the Argentine Central Bank (BCRA) and Banco de la Nacion
(BNA). (In the 2009 budget bill, Congress authorized changes

BUENOS AIR 00001682 002 OF 004


to BNA's charter to allow the GoA to borrow up to 30% of its
deposits held at BNA, and to the BCRA's charter to allow
expanded lending to the GoA, which in theory could be used to
pay sovereign debt obligations.)

6. (C) Doing the math shows that the GoA has the wherewithal
to meet 2009 debt obligations solely through tapping domestic
sources of financing, particularly if it shows reasonable
fiscal restraint. Total scheduled debt service, including
principal and interest, increases to about US$21 billion per
year during 2009-2011, compared to US$16 billion in 2008.
The Central Bank's consensus estimate for the primary fiscal
surplus (before interest payments on debt) is approximately
3% of estimated 2009 GDP, or about US$10.5 billion (at the
current exchange rate of 3.45 pesos/dollar). However, many
economists expect that rapidly falling tax collection -- due
to lower growth rates and much lower commodity prices -- will
reduce the primary fiscal surplus to the 2% range, or about
US$7 billion. While this more conservative estimate leaves a
financing gap of about US$14 billion, the GoA has numerous
means to meet its 2009 financing needs:

-- US$4 billion in approximate new flows from pension fund
contributors following the AFJP nationalization (accessed via
new bond issuances to ANSES).

-- US$1.5-2 billion in savings via rolling over AFJP-held GoA
bonds and GDP warrants, instead of issuing new debt, as
estimated by noted Argentine Economists Miguel Kiguel and
Carlos Melconian (the GoA estimates the savings at US$3
billion).

-- US$2.5 billion in debt buybacks, which the GoA is legally
obligated to do under the terms of the 2005 debt exchange.
(Instead of repurchasing bonds from the market, the GoA can
just buy them from ANSES, in return for new bonds.)

-- US$1.5-2 billion in financing from public agencies,
including the tax authority AFIP, the national lottery, and
ANSES (using flows from contributors that were not AFJP
members).

-- US$6.5 billion estimated lending from the BCRA ($3bn) and
BNA ($3.5bn).

-- US$1 billion estimated net positive funding from the World
Bank, IDB, and CAF (Andean Development Corporation).

7. (C) This totals between US$17-18 billion, easily enough to
cover financing needs in 2009, although also possibly
optimistic, particularly with regards to possible funding
from AFJP flows, BCRA and BNA lending, and IFI flows.
However, in a pinch, the GoA could also attempt to do a debt
swap with local financial institutions of the so-called
""Prestamos Garantizados"" (Guaranteed Loans). The illiquid
PGs comprise US$4bn out of the total $21bn debt amortizing in
2009, and an optimistic assumption is that the GoA could
rollover about US$2-2.5 billion in annual PG maturities over
the next three years, via an exchange for slightly
longer-term and more liquid securities. Regardless, this
accounting demonstrates that the GoA has access to one kind
of financing or another on the order of US$15-20 billion.

8. (C) Analysts remain apprehensive, however. Kiguel and
Melconian both argue that even with the additional funding
from the AFJPs, the GoA can cover debt obligations in 2009
and 2010 only if it pursues moderate fiscal policies.
Assuming low or no real GDP growth and inflation of 15-20% in
2009, with average commodity prices staying at current levels
(i.e., soybeans trading US$300-400/metric ton), and the
Brazilian Real also at its current level (having depreciated
about 40% against the dollar this year), Kiguel and Melconian
predict that Argentina has fiscal space to increase nominal
spending in 2009 by only 10-20% (compared to 28% in 2006, 46%
in 2007, and roughly 35% so far in 2008), while staying
current on debt service in 2009 and 2010.

9. (C) The broader concerns are that the economic downturn
will be more severe than anticipated, or that the GoA will
use up all its various sources of financing to realize a
substantial spending increase in 2009 (to counter the
economic deceleration and win political support prior to
October 2009 mid-term legislative elections), or both. This
strategy would greatly increase the risks of at least a
partial (""selective"") default in 2010. The market's
expectation that the GoA will indeed ramp up spending

BUENOS AIR 00001682 003 OF 004


significantly in 2009 is likely the primary reason why
Argentine financial instruments are still priced at default
levels. The GoA's recent stimulus announcements give
credence to those who argue that the Krichner's plan is to
boost spending.

-----------------------------------
Market Response: Major Thumbs Down
-----------------------------------

10. (C) Without question, local capital markets resoundingly
rejected the President's AFJP nationalization initiative, and
many observers have speculated that the initiative has in
effect killed off local capital markets. CFK's October 21
announcement touched off a month of financial turmoil and
uncertainty, and Argentine asset prices currently trade at
highly distressed levels.

11. (C) While the domestic sell-off coincided with the late
October global sell-off, and also follows 15 months of steady
declines in Argentine asset prices (ever since the global
crisis began in July/August 2007), there are two aspects of
the local crisis that differentiate it from events
transpiring in the world and among Argentina's neighbors.
First, the nationalization removes the largest source of
investment to the private sector, and early indications are
that ANSES will prioritize infrastructure investments, and
direct funding to the GoA over providing financing to the
private sector. The net effect will likely be a significant
crowding out of the private sector.

12. (C) Second, the new regime also gives ANSES significant
ownership of major companies operating in Argentina, and it
is as yet unclear how the GoA will act in this regard.
Choosing to divest these holdings, which in a number of
important local companies exceeds 20% of total outstanding
shares, could affect already beaten-down share prices. A
further complicating factor is that Argentina's Mixed Economy
Companies Law (N 15.349), covering companies that include
both public and private ownership, seems to require that the
GoA appoint the director and at least a third of the Board of
Directors of all companies, and have veto power over Board
decisions. Although GoA officials have reassured companies
that they have no intention of controlling them, it is
unclear how this issue will evolve and the pension
nationalization law exacerbates the uncertainty by not
clarifying the GoA's role. (Comment: Private sector
contacts tell Post that it is clear from their conversations
with GoA officials that they did not contemplate this
situation when drafting the pension nationalization law.)

--------------------
Survey of the Damage
--------------------

13. (C) Neither the reduced access to financing nor the
increased government ownership of companies is good news for
an already beleaguered private sector, and this was reflected
in the plunge in all asset prices, increase in capital
flight, and run on the peso between October 21 and November
20. During this period:

-- The Buenos Aires Stock Market, Merval, dropped 26% and
Argentine dollar-denominated bonds fell on average 35%, while
peso bonds dropped 31%.

-- As a result, the value of AFJP holdings decreased from 94
billion pesos (about US$30 billion) on September 30 to 78
billion pesos (about US$25 billion) October 31.

-- Argentina's sovereign risk rating, as measured by JP
Morgan's EMBI plus, widened 518 basis points to close on
November 20 at 1,913 bps (after peaking at 1,970 bps on
October 22). (For comparison, since January 2008,
Argentina's EMBI has widened 1,511 bps while Brazil's has
widened only 359 bps.)

-- Argentines rushed to pull pesos out of banks and buy
dollars, with total private peso-denominated deposits
plunging 5.2% in October, worse than the 4.4% drop in May
(the worst month of the farm crisis).

-- As a result, the peso depreciated from 3.24 pesos/dollar
on October 20 to 3.34 pesos/dollar November 20, after hitting
3.43 on October 29. One-year peso futures contracts, trading
on local markets, jumped from about 3.5 pesos/dollar to 3.8

BUENOS AIR 00001682 004 OF 004


pesos/dollar, after peaking in early November near 4
pesos/dollar. The one-year non-deliverable forward (NDF,
traded offshore), went from 5.46 pesos/dollar on October 20
to 6.33 pesos/dollar on November 20.

-- In the face of this run on the peso, banks jacked up
interest rates, with BADLAR reference rate on deposits of
over one million pesos rising from an already elevated 17% to
18.75%, but peaking at 26% on November 13.

-- BCRA contacts tell Post that the BCRA sold US$3.5 billion
dollars in October, mostly in the second half of the month,
to stem the run on the peso.

-- Economist Melconian estimates total capital flight, as
measured in the BCRA's Balance of Foreign Exchange, at US$4.7
billion in October. (According to BCRA data, capital flight
reached US$ 8.8 billion in 2007 and almost twice that level
-- US$16.4 billion -- through the third quarter of 2008.
Melconian estimates it will total US$22-24 billion for the
full year.)

14. (C) While Argentine stocks and government bonds have
since rebounded somewhat (in the range of 20%) and are
currently tracking global movements, they are still trading
at distressed levels, and considerable unrest and uncertainty
remains.
WAYNE

=======================CABLE ENDS============================

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