Cablegate: Election-Year Spending Extravaganza Undermines

DE RUEHBU #1995/01 2781831
R 051831Z OCT 07





E.O. 12958: N/A


BUENOS AIR 00001995 001.2 OF 004

This document contains sensitive information. 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.

1. (SBU) Argentine President Kirchner's election-year
spending spree has exceeded expectations and led to
deteriorating fiscal accounts in 2007. Through July 2007,
expenditures increased almost 50% year-over-year, a result of
large increases in pension payments, subsidies, wages, and
capital spending, all with the apparent goal of buying votes
for the October 28 national elections. Estimates for the
2007 federal primary fiscal surplus (before debt interest
payments) are a seemingly healthy 3.1 - 3.5% of GDP.
However, the figure is only closer to 2% after subtracting a
one-time transfer to the GoA from the private pension system.
The provinces, in general, are in worse financial shape, and
will likely require greater federal financial support.
Maintaining current spending levels would risk fiscal
deficits and increasing inflation starting in 2008, and would
also threaten economic growth and the GoA's capacity to make
debt payments. However, there is still time to make
corrections, and Presidential front-runner Cristina Kirchner
appears to realize that fiscal reform is the top priority for
the next administration. End Summary.

Intro: Deteriorating Fiscal Erodes Macro Anchor
--------------------------------------------- --
2. (SBU) The GoA's rapid increase in election-year spending
has resulted in deteriorating fiscal accounts in 2007,
despite record revenues. The GoA's fiscal policy is
pro-cyclical and extremely expansive, contributing to a
consumption-led economic boom and boosting projected
inflation up from under 10% in 2006 to the 15-18% (or higher)
range in 2007, as estimated by numerous private economists.
The GoA's adjusted official inflation number remains below
9%. In light of the Central Bank's expansionary monetary
policy since 2005, the fiscal surplus has been the GoA's
macroeconomic anchor. This anchor has eroded as a
consequence of the Kirchner administration's spending
policies in 2006 and 2007. The apparent goal of these
policies has been to gain political support for a string of
elections this year, culminating in the October 28
presidential and legislative elections.

Expenditures getting out of control
3. (SBU) Private analysts' estimates and predictions on GoA
expenditures vary widely, mainly due to the difficulty in
obtaining reliable statistics, particularly on GoA subsidies.
A senior Economy Ministry official, who is nominally in
charge of budget issues, has admitted to Econoffs that the
GoA has increased expenditure so rapidly in 2007 that total
spending is a "moving target."

4. (SBU) Expenditures through July 2007 have increased an
estimated 50% y-o-y. This was the result of election-year
largesse, particularly increases in pension payments of up to
60% y-o-y. These payment increases were mainly due to a 13%
increase implemented January 2007 and a 12.5% increase
granted in September. However, they were also the result of
the addition of more pensioners following the GoA's pension
system reform (see paras 9-10 below). The GoA has also
granted large increases in public wages (up almost 30% y-o-y)
and transfers (subsidies) to the private sector, mainly for
transport and energy (up at least 46% y-o-y, if not more).
Capital spending has also increased rapidly (37% y-o-y),
albeit at a slower pace than the 65% increase in 2006.
Overall, federal primary spending (not including interest
payments on debt) increased from 13.8% of GDP in 2006 to an
estimated 17% of GDP for 2007.

Cost of Price Controls: Subsidies and Capital Spending
--------------------------------------------- ---------
5. (SBU) In order to alleviate pressure on those private
sector companies whose products are subject to GoA price
control policies, the GoA has steadily increased transfers to

BUENOS AIR 00001995 002.6 OF 004

the private sector as well as public sector capital
expenditures. Both the subsidies and public works
expenditures have been targeted primarily to the energy and
transport sectors, where price controls in place since 2002
have resulted in supply shortages (due to lack of investment
in infrastructure and maintenance -- see reftel).

6. (SBU) Private sector economists estimate 2007 public
transfers at between 11 and 13 billion pesos (roughly $3.5 -
$4.1 billion), or about 1.5% of GDP (compared to subsidies of
0.7% of GDP in 2006). This constitutes a more than 100%
increase over such spending in 2006, which itself represented
a more than 80% increase over subsidies/loans in 2005.

7. (SBU) The purpose of the transfers is to compensate for
the difference in the international price of diesel and
natural gas and the controlled and much lower domestic
prices. The GoA is reportedly also directing a hefty
percentage to subsidize fuel costs in the transport sector
(trains, buses, subways, and air traffic). Of the total,
roughly one billion pesos support agriculture and livestock.

Revenues growing, but at a slower pace
8. (SBU) Tax revenues increased over 38% y-o-y through July.
Although the higher revenues are partly a result of improved
compliance, they are largely due to high growth and
inflation, with nominal GDP growth in the range of 24-26%.
In addition, export taxes on Argentina's rapidly-growing
primary commodity exports are responsible for about a third
of the increase. Note, however, that the GoA recently
announced another pre-election gift to voters, increasing the
non-taxable annual income level that individuals can claim,
resulting in a 1.5 billion peso reduction in income tax
revenue. The purpose of this alteration to the tax code
appears to be to pump up consumer spending prior to the
October 28 elections (Comment: it will also likely pump up

9. (SBU) Through the end of July, total revenues -- including
non-tax revenues -- increased approximately 55% y-o-y.
However, non-tax revenues include one-off transfers to the
GoA from the private pension system (see next section). This
is a consequence of pension reform in early 2007, which
allowed contributors to switch from the private system to the
government pension plan.

Falling Primary Fiscal Surplus
10. (SBU) Private analysts estimate the 2007 federal primary
fiscal surplus in the range of 3.1 - 3.5% of GDP. While this
approximates the 3.5% primary surplus in 2006, and may still
appear healthy, the figure is distorted because of the
one-off pensions transfer. Subtracting this estimated $2.4
billion transfer to the GoA from the private pension system
results in a federal primary surplus of only 2 - 2.4% of GDP,
well below the 3.5% or higher level of 2004-2006.

11. (SBU) Private estimates of the overall federal fiscal
surplus (including interest payments on debt) also vary
widely, but are generally in the range of 1% to 1.5% of GDP,
significantly below the over 2.5% peak in 2004. Note,
however, that the overall federal fiscal surplus approaches a
zero balance when excluding the one-off pension funds

Provincial Finances Also Deteriorating
12. (SBU) Taken as a whole, the Provinces' financial
condition is worsening, although Buenos Aires Province and
City, comprising over a third of total non-federal
expenditures, are in the worst shape and skew the numbers.
Through July, provincial revenues increased 20% y-o-y,
compared to a 25% y-o-y increase in expenditures. Increases
in provincial expenditures have exceeded increases in
revenues every year since 2005. This is mainly due to rapid
increases in salaries, which represent almost 50% of total
provincial expenditures, compared to below 20% for the
federal government (the Provinces have historically used
public sector employment as a source of political patronage).
As a result, for the first time since the 2002 crisis,

BUENOS AIR 00001995 003.3 OF 004

provincial primary spending may exceed total tax revenues in
2007. A likely consequence will be increased demands on the
GoA for financial support to the provinces; payments that are
not included in the above budget calculations.

13. (SBU) Some Argentine economists' predict the provinces
will end 2007 with a slight primary fiscal deficit (of up to
0.2% of GDP), while others expect a tiny surplus, of 0.3% of
GDP or smaller. However, all economists surveyed for this
report expect an overall provincial fiscal deficit, when
including interest payments on debt, of between 0.1 and 0.4%
of GDP. This is a large turnaround from 2004, when the
provinces' overall surplus exceeded 1% of GDP.

Consolidated Surplus Disappearing
14. (SBU) As a consequence of the deteriorated federal and
provincial finances, the consolidated primary fiscal surplus
(including federal and province governments) has fallen
dramatically from its peak of 5.2% in 2004. Including the
one-off pension system transfer, estimates for the 2007
consolidated primary fiscal surplus vary from 2.8% to 3.5% of
GDP, and estimates for the overall consolidated surplus
(including interest payments on debt) vary around 1% of GDP.
However, a key point is that when excluding the pensions
transfer, the consolidated fiscal balance (including interest
payments) may end the year in deficit, for the first time
since 2002.

Large Primary Surplus Needed to Ensure Debt Sustainability
--------------------------------------------- -------------
15. (SBU) Maintaining a large overall surplus is especially
relevant to Argentina, given its current and contingent debt
liabilities. Most analysts estimate Argentina's financing
needs for 2008 at approximately $6-7 billion. Argentina can
manage this debt, even taking into account the GoA's reduced
access to capital markets following international financial
market volatility that began in July. It can raise
sufficient funds from Treasury savings, the government
pension fund agency, and borrowing from the Central Bank.
However, its financing needs will surge in 2009 and beyond,
which may complicate the GoA's fulfillment of its financial

16. (SBU) In addition to its normal financial needs, the GoA
faces significant debt arrears and contingent liabilities.
The GoA is facing roughly $6 billion in debt (including
current arrears of about $4 billion) to Paris Club members,
has approximately $25 billion in outstanding debts to
so-called "holdouts," bondholders that did not participate in
the 2005 debt exchange, and also has roughly $13 billion in
outstanding claims before ICSID, dating to the 2001/2
financial crisis. In addition, in 2007 the GoA has announced
about $14 billion in government-financed infrastructure
projects over the next 2-3 years, mainly in the energy
sector. While these payments will likely be negotiated down
and spread over years, clearly higher fiscal surpluses are a
requisite for the GoA to manage these contingent debts and
finance the envisioned projects. Another important
consideration, given the tight credit market, is that every
percentage point of higher fiscal surplus is equivalent to
$2.5 billion fewer funds that the GoA must raise in the

2008 Scenario: Slower Spending or Fiscal Unravels
--------------------------------------------- ----
17. (SBU) In addition to undermining fiscal accounts and
boosting consumer prices, the GoA's heavy spending has also
contributed to the disproportionate impact of recent
international market volatility on Argentina's country risk
premium. Bondholders punished the GoA for undermining macro
fundamentals and losing control of inflation. Therefore,
local economists surveyed for this report argue that fiscal
reform (reducing the pace of expenditures) is the critical
task for the next administration, in order to regain
credibility and reduce inflationary pressures. Otherwise,
maintaining current spending levels will result in an overall
consolidated fiscal deficit in 2008 and worsening deficits
and inflation in 2009-2011.

18. (SBU) The good news is that a large chunk of the increase

BUENOS AIR 00001995 004.3 OF 004

in 2007 expenditures has a one-time impact, and will not
necessarily carry over into 2008. This includes a
substantial percentage of the increase in pension payments,
and also includes subsidies to the private sector. In fact,
Economy Ministry officials privately point out that cutting
subsidies is the only feasible means to restore the fiscal
balance to near 2004-2006 levels.

19. (SBU) GoA officials appear to have grasped that the
deteriorating fiscal situation adversely affects Argentina's
economic and inflationary outlook and the GoA's ability to
raise financing. President Kirchner has reportedly ordered a
reduced pace of spending following the October 28 elections
and in the 2008 budget (septel). Economy Ministry officials
tell us that they are instructed to pursue the "Kirchner
Rule," which requires expenditures to increase at the same
rate of growth as revenues. Senator and leading Presidential
Candidate Cristina Fernandez de Kirchner has also publicly
voiced concern about the GoA's deteriorating fiscal balance,
and has pledged that as President she would pursue tighter
fiscal policies in 2008.

20. (SBU) Argentina's ability to prevent this year's spending
spree from precipitating an economic crisis down the road
will depend on the next government's willingness to make
quick policy adjustments. However, cutting subsidies would
have major political ramifications for an incoming
administration, as the GoA would likely be compelled to raise
energy and transport tariffs to compensate private companies
for the lost subsidies (and thus avoid severe supply
problems). These higher prices would accompany slowing
growth, surely an unpopular combination for the Argentine
public. The Kirchners have yet to govern during a period of
slowing growth, and it remains to be seen whether the new
president will be willing to make the politically unpopular
decisions necessary to bring down both inflation and growth
to more moderate and sustainable levels. End Comment.

© Scoop Media

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