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Cablegate: Argentina Economic and Financial Weekly for the Week Ending


DE RUEHBU #1424/01 1771208
R 261208Z JUN 06





E.O. 12958: N/A
SUBJECT: Argentina Economic and Financial Weekly for the week ending
June 23, 2006

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Weekly Highlights
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- Argentina, Bolivia, Chile and Brazil argue over Bolivian gas.
- President Kirchner visits Spain.
- Spain wants bilateral debt owed by Argentina negotiated outside of
Paris Club.
- GDP up 8.6 percent y-o-y in Q1 2006.
- Buenos Aires Province ran an ARP 28 million primary deficit in the
first four months.
- The GOA will set up its own livestock reference price system.
- Commentary of the Week: "Inflation Under Control or Controls on

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Argentina, Bolivia, Chile and Brazil argue over Bolivian gas.
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1. On June 29, the presidents of Bolivia and Argentina are
scheduled to announce an agreement on natural gas exports, but
several new issues have arisen. Bolivia is standing firm on its
condition that Argentina cannot re-export gas to Chile (Bolivia
refuses to sell gas to Chile, seeking to recover its access to the
Pacific coast lost in the 19-th century War of the Pacific). Chile,
on the other hand, is asking Argentina to fulfill its contracts to
supply Argentine gas to Chile. Also, Brazil has asked Argentina not
to agree to a large price increase for Bolivian gas imports, which
would oblige Brazil to accept a similar price hike. Brazil is
Bolivia's largest purchaser of natural gas. Meanwhile, the Bolivian
vice-minister of hydrocarbons, Julio Gomez, said June 22 that the
Government of Bolivia now wants USD 6 per million cubic meters for
exports to Argentina, instead of the USD 5.5 that was agreed at the
last meeting. [Argentina currently imports Bolivian gas at a
"solidarity" price of USD 3.20 per million cubic meters, while the
international price ranges between USD 2.00 and USD 8.00 per million
cubic meters.]

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President Kirchner visited Spain.
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2. This week, President Nestor Kirchner visited Spain and met with
Spanish Prime Minister Jose Luis Rodriguez Zapatero, King Juan
Carlos, and Spanish companies with investments in Argentina.
According to press reports, the GOA laid out a plan to repay USD 836
million in aid that Spain loaned Argentina during its economic
crisis in 2002 (see following story). During the meetings with
Spanish companies, Kirchner announced that the GOA will increase its
stake in Aerolineas Argentinas (Argentina's largest airline,
majority owned by Spanish investors). Kirchner also stated that
Argentina is not an insecure place to invest, asked for "weeks or
possibly months" to start increasing utility tariffs and announced
new investment projects.

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Spain wants bilateral debt owed by the GOA to be negotiated outside
the Paris Club.
--------------------------------------------- --------

3. On June 23, La Nacion reported that the Spanish government is
willing to accept a refinancing schedule of stepped up installments
for the USD 830 million lent to the GOA in 2001. However, Spain
maintains its position that this debt should not be included in the
Paris Club negotiations, arguing that the loan was made in support
of, and under the same terms as, an IMF loan, and is thus
multilateral in nature, while the Paris deals with bilateral
agreements. In conversations prior to this trip, GOA officials
have said that the debt to Spain would be included in Paris Club

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GDP up 8.6 percent y-o-y in Q1 2006.
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4. The GOA announced that GDP jumped 8.6 percent y-o-y in the first
quarter of 2006 -- slightly below the BCRA consensus forecast of 8.8
percent. Growth is mainly coming from stronger domestic demand --
increased investment and higher private and public consumption --

aided by a 6.4 percent increase in exports. During the quarter,
investment increased 22.8 percent y-o-y -- with increases of 23
percent y-o-y in construction and 22.6 percent y-o-y in plant and
machinery investment. Private consumption increased 8.8 percent
y-o-y, and public consumption rose 8.3 percent y-o-y. Goods
production and services increased 8.8 percent and 8.4 percent y-o-y,
respectively. The BCRA forecasts for GDP growth stand at 7.8
percent for 2006 and 5.9 percent for 2007.

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April monthly economic activity index up 6.4 percent y-o-y - weaker
than expected.
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5. The monthly economic activity index increased 6.4 percent y-o-y
in April -- well below the BCRA market survey forecast of 7.8
percent. This was the weakest growth rate in the past eight months,
and represents a continuation of the downward tendency following the
8.3 percent increase of March. However, slower performance in April
and March is distorted by the Easter seasonal effect. The growth in
the index came mainly from an increase in industry, communications
and transportation and services. The index increased 0.7 percent
m-o-m. The latest BCRA consensus survey estimates 7.7 percent
economic activity growth for 2006, a slightly upward revision from
its previous forecast of 7.6 percent. The monthly economic activity
index is viewed as a reliable leading indicator of GDP.

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Buenos Aires province ran a ARP 28 million primary deficit in the
first four months of 2006.
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6. The government of Buenos Aires province announced a primary
deficit of ARP 28 million for the first four months of 2006;
including interest (without taking into account the ARP 603 million
paid on public debt capital amortization in that period), the
deficit reached ARP 280 million,. This is an accounting deficit and
not a budgetary one, but Governor Felipe Sola warned that the
province could fall into a budgetary deficit this year and argued
that the province is not receiving sufficient transfers from the GOA
based on its population. To avoid going into deficit, the province
needs an additional ARP 800 million from the GOA.

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The GOA will set up its own livestock reference price system.
--------------------------------------------- --------

7. The GOA plans to set up its own reference pricing system for
livestock trading. The system aims to set a nationwide reference
price for cattle trading. However it will not replace the existing
Liniers reference price, which is set at the Liniers Market in
Buenos Aires, the country's leading livestock market, with 20
percent of the total volume of cattle. Government officials have
long complained that prices at Liniers have too much influence over
the setting of prices in all of Argentina, and that those prices are
subject to "collusive trade practices." The beef sector believes
that the new system will be ineffective and complicated.

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BCRA increases active repo rates by 0.5 percent.
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8. The BCRA announced a 0.5 percent increase in its active repo
rates (the rates at which the BCRA offers financing and adds
liquidity to the system), bringing its active rate to 8 percent for
seven days. This is the third increase in active repo rates this
year, and it follows a 0.5 percent increase in May. Passive repo
rates were increased on June 13 to 5.25 percent for one day and 5.75
percent for seven days. According to private consultants, this
decision is in line with the BCRA strategy of increasing its

--------------------------------------------- --------
Petrobras sells its 50 percent stake in Transener to Eton Park
Capital Management.
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9. On June 14, Petrobras Energy announced it will sell its 50
percent stake in the Argentine power transmission company Transener

to the U.S. hedge fund Eton Park Capital Management for USD 54
million. Petrobras held its stake in Transener through its holding
company Citilec. Transener currently is controlled by the Dolphin
Group, an Argentine investment fund that has made several large
investments in the energy sector.

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The GOA signs agreement with bread producers to freeze prices.
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10. On June 15, the GOA announced an agreement with bread producers
to freeze bread prices at ARP 2.5 per kg. The freeze will be in
force until the end of the 2006, and continues the GOA's strategy of
trying to control inflation through voluntary price agreements
negotiated with various sectors.

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Controversial Anti-Money Laundering Law passes Chamber of Deputies.
--------------------------------------------- --------

11. On June 15, the Chamber of Deputies approved and sent to the
Senate a GOA-proposed law that would lift bank and stock market
secrecy in money laundering investigations by the Argentine
financial intelligence unit (UIF). Currently, the UIF needs to get
a court order to lift bank and stock market secrecy. The law also
would revamp the UIF's structure, replacing the current five
directors with a single, presidentially-appointed President, who
would have the authority to lift banking and stock market secrecy.
Opponents say that the law would give too much authority to a single
official, who will be chosen by the executive branch. The bill now
passes to the Senate, where it is expected to be approved.

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December local saving reached 25.4 percent of GDP -- a new historic
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12. In December 2005, local savings -- the difference between the
Argentines' income and expenses -- reached a new historic record at
25.4 percent of GDP, a total of ARP 146 billion. The GOA wants to
use different incentives to translate this savings into productive
investments and prevent this money from going into speculative
activities or leaving the system. For the first quarter of 2006,
the ratio between investments and GDP reached 22 percent, and
according to the GOA a level of 30 percent is necessary to keep
annual growth at 9 percent.

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May industrial production index up 7.3 percent y-o-y.
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13. The industrial production index increased 7.3 percent y-o-y in
May, almost in line with market expectations of 7.4 percent, and a
slight deceleration following a 7.7 percent increase in April.
During May, the fastest growing sectors were non-metallic minerals
(+19.8 percent), car production (+19.0 percent), tobacco production
(+15.5 percent) and oil refining (+12.6 percent). The index
increased 0.9 percent m-o-m without seasonal adjustment and 2.2
percent m-o-m seasonally adjusted. The BCRA consensus survey
forecasts 6.9 percent industrial production growth for 2006 --
slightly above last month's forecast of 6.8 percent.

14. The industry-wide capacity utilization index reached 70.4
percent in May, down slightly from 70.7 percent in May 2005. The
sectors with the highest capacity utilization rates were metal-based
industries (95.8 percent), oil refining (93.6 percent) and textiles
(84.3 percent). The sectors with the lowest capacity utilization
rates were auto production (46.4 percent), minerals (62.0 percent)
and rubber and plastic (62.4 percent).

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BCRA rolls over its maturities. Investors concentrate their bids in
--------------------------------------------- --------

15. The BCRA received ARP 726 million in bids at its June 20 Lebac
and Nobac auction, and no Lebacs or Nobacs came due during the week.
It accepted ARP 420 million in Lebac bids and ARP 198 million in
Nobac bids. The yield on the 84-day Lebac increased 10 basis points

from 7.25 percent to 7.35 percent, while the yield on the 182-day
Lebac decreased from 8.65 percent to 8.60 percent, and the yield on
the 266-day Lebac decreased from 10.35 percent to 10.27 percent.
The yield on the longest term instrument, the 350-day Lebac,
remained at 12 percent. Lebacs for maturities of more than 350 days
were withdrawn due to lack of interest. The spread on the one-year
Nobac decreased from 2.11 percent to 2.05 percent and from 3.79
percent to 3.78 percent for the two-year Nobac. The Badlar rate
(the base rate for Nobacs) is currently at 8.8 percent. Investors
are losing interest in Nobacs and instead are focusing on fixed-rate

--------------------------------------------- --------
The peso was unchanged against the USD this week, closing at 3.10
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16. The peso remained flat versus the USD this week, closing at
3.10 ARP/USD. The peso exchange rate has depreciated 1.6 percent
since the beginning of the calendar year. The BCRA's reserves stood
at USD 25.14 billion as of June 21, and have increased USD 6.6
billion, or 35 percent, since the GOA prepaid its entire IMF debt on
January 2. During the week, the BCRA purchased USD 194 million.

--------------------------------------------- --------
Commentary of the Week: "Inflation under control or controls on
inflation?", by Esteban Fernndez Medrano from an article published
in El Cronista on June 20.
--------------------------------------------- --------

17. May's consumer price index (IPC) figures were certainly a
relief for the government. Although May is not usually a month of
high inflation, given that it is not subject to seasonal factors,
the 0.5 percent monthly increase was not only below the previous
monthly average of around 1 percent and the 0.6 percent increase in
May last year, but it was also below the expected rate of inflation.
This relief is reflected even more strongly in the poverty and
indigence indexes, two indicators closely followed by the
government. But despite the apparent success in controlling
inflationary pressures, a bitter aftertaste remains when analyzing
the details of the results. In fact, doubts persist as to whether
government is really succeeding in controlling inflation, or if the
latest figures are the reflection, possibly fleeting, of price

18. The progressive incorporation of goods into the list of price
agreements distorted the typical definition of goods/services
regulated by the IPC (goods whose variation in price does not
respond to market factors, but rather to regulations or agreements
within sectors). Traditionally, the definition of these regulated
goods included in the IPC were understood to be public services -
gas, water, electricity and public transportation - fuel and
cigarettes (the last one as a result of the heavy tax burden on the
final price).

19. If we redefine this concept, incorporating into the IPC all the
sectors that have price agreements, the share of "regulated" goods
in the IPC rises from approximately 20 percent in December of 2005
to almost 60 percent in May of 2006. Although this redefinition is
more lax than the original, as price agreements generally do not
include 100 percent of the products in the group but rather "only"
affect the lead products, any way it reflects the fact that the
price agreements are widespread throughout the economy. More than
the half of the goods and services in the IPC are being affected by
price regulations imposed by the government.

20. This result becomes even more compelling if one compares the
annual change in inflation between the regulated and unregulated
goods/services. Disaggregating annual inflation into an index of
regulated goods/services and another of unregulated goods/services
(starting with the INDEC definition of regulated goods but then
adding those sectors with price agreements), one observes a marked
divergence between the two sub-indexes. While the annual change in
the regulated index in May was only 1.3 percent, the sub-index of
unregulated goods/services increased more than 16 percent.

21. So long as the regulated index's inflation remains controlled,
the annual variation of the IPC as a whole would generally approach
this figure (due to the greater weight that the regulated sector in
the IPC has had since the beginning of this year). The doubt that

remains is, even without direct interferences from the government
with respect to the methodology of the IPC calculations, how
representative do the inflation figures end up being? In other
words, is the increased price stability attained in May, and which
is predicted for the coming months, really a reflection of the state
of the economy? After all, "unregulated" annual inflation has shown
practically uninterrupted growth since the beginning of 2004.

22. Considering the glass as half full, one can admit that the new
controls were applied principally in sectors whose prices, since
devaluation, had grown more than the rest. Taking out public
services from the regulated sub-index, which are in all respects
behind the rest of goods/services, one observes that this sub-index
is 13 percent above the unregulated sub-index. That is, one could
attempt to argue that price controls are a mechanism to accelerate
the adjustment of relative prices between tradable y non-tradable
goods/services, to make sure that the relative adjustment is not
confused with a general price increase and to prevent producers of
tradable goods/services from raising their prices (in line with the
well-known work of Lucas).

23. But it is extremely difficult to anticipate whether this
government will feel like lifting price agreements when this price
difference between regulated (net of public services) and
non-regulated prices closes, nor what would be the subsequent
response of the affected sectors. What is certain is that even if
annual IPC inflation stabilizes in coming months, the sense will
remain that this is the effect of the controls on inflation more
than a controlled inflation. (Note: We reproduce selected articles
by local experts for the benefit of our readers. The opinions
expressed are those of the authors, not of the Embassy. End Note.)


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