Cablegate: Argentina Rides Bond-Price Rollercoaster Amid Market


DE RUEHBU #1160/01 2282201
R 152201Z AUG 08



E.O. 12958: N/A
SUBJECT: Argentina Rides Bond-Price Rollercoaster Amid Market
Concerns on Policy Direction


1. (SBU) A series of interrelated events the week of August 4-8,
including the GoA's private sale of US$1 billion in sovereign bonds
to Venezuela at a high yield, prompted a significant drop in GoA
bond prices and a climb in Argentina's country risk premium to 741
basis points. On August 10, the GoA responded by announcing a US$1
billion public debt buy-back program. An estimated US$500 million
in government purchases in the ensuing days helped bond prices
recover much of the prior week's losses, notwithstanding significant
market volatility generated by the August 11 GoA announcement of
less-than-credible July inflation statistics, a downgrade by
Standard & Poor's of Argentina's long-term debt rating from B-plus
to B, and persistent rumors of possible cabinet changes, including
the replacement of Economy Minister Carlos Fernandez and the removal
of Internal Commerce Secretary Guillermo Moreno from his informal
oversight of INDEC. Local market players call the GoA's successful
bond buyback program a reactive and ad hoc response to pervasive
concerns about the GoA's inability to formulate longer term policy
responses to growing macro-economic disequilibria. By and large,
these local market participants and analysts discount any
medium-term default scenario and note that the GoA has the capacity
to fund itself in local capital markets through 2009 absent any
radical drops in global commodity prices. Near-term market
sentiment will likely turn on steps the GoA takes - or fails to take
- in the coming weeks to demonstrate its long-term economic vision
and commitment to fiscal probity. End Summary.

GoA Yields Approach Pre-2001 Crisis Levels...

2. (SBU) During the week of August 4-8, heightened financial market
perceptions of Argentine risk drove up Emerging Market Bond Index
country risk premiums on GoA sovereign obligations to a high of 741
basis points, a level not seen since just prior to Argentina's
December 2001 $93 billion default. The combined impact of a series
of discreet events precipitated this darkening of market sentiment,
beginning with President Cristina Fernandez de Kirchner's August 2
press conference -- the first in her eight-month tenure -- during
which she defended her tough stance during the ag sector strike,
offered unconditional support for Argentina's embattled national
statistics agency INDEC, and backed her controversial Internal
Commerce Secretary, Guillermo Moreno, widely accused of engineering
the gross under-reporting of domestic inflation. Other developments
negatively impacting perceptions of Argentine risk included:

-- a continued decline in global agricultural commodity prices (soy
prices are down roughly 40% since July), on which Argentina's twin
fiscal and trade surpluses have become dependent;

-- the private sale that week of US$1 billion in sovereign GoA bonds
to Venezuela at a yild of 14.87%, a rate not seen since before the
2001/2 economic crisis;

-- Venezuelan banks' rapid re-sale of these GoA securities into the
secondary market which put pressure on bond prices; and

-- media reports that rating agencies Standard & Poor's and Moody's
were contemplating downgrades of Argentine debt ratings.

4. (SBU) This confluence of developments added fuel to longstanding
market concerns on the sustainability of a GoA fiscal policy mix
that includes:

-- heavy government spending on energy and transportation subsidies
(roughly 3% of GDP);

-- inadequate investment in primary infrastructure, particularly in
energy infrastructure;

-- growing evidence that the GoA's still respectable primary surplus
(+/- 3% of GDP) is being propped up by a combination of central bank
profit contributions and non-transparent delayed payments on
GoA-contracted infrastructure projects;

-- the GoA's intervention in INDEC;

-- continued concerns over as-yet-unresolved GoA frictions with the
rural agricultural sector that could lead to further strikes and
market disruptions;

-- the deteriorating finances of key provinces, including Buenos
Aires and Cordoba (which together contribute 42% of national GDP),
that is related to the growing concentration of tax revenues at the
federal level and perceptions that the Kirchner administration is

distributing and withholding promised funds to reward political
loyalty and punish dissident governors; and

-- the lack of any steps towards resolving longstanding claims by
Paris Club sovereign creditors, bond "holdouts," and ICSID
international arbitration claims.

...And GoA Responds with Buy Back Program

5. (SBU) In response to a dramatic decline in GoA bond prices during
the week of August 4-8 (an average drop of 6% in the price of
Argentine sovereign dollar and peso bonds), Interior Minister
Florencio Randazzo attributed the sell-off to manipulation by market
speculators and said it did not reflect the economy's strength. On
August 10, following a rare Sunday economic policy meeting at the
Presidential residence that included CFK, Economy Minister Carlos
Fernandez, Finance Secretary Hernan Lorenzino, Central Bank
President Martin Redrado and Chief of Cabinet Sergio Massa, the GoA
announced it would launch a public debt buy-back program. While the
GoA did not initially announce the size of the program, it said
that, in its initial phase, the program would focus on both dollar
and peso bonds maturing in the remainder of 2008 and 2009. The GoA
subsequently clarified that it had authorized up to $1 billion for
the buyback program - roughly equivalent to the amount it had
received from the recent private debt sale to Venezuela.

--------------------------------------------- ----
S&P Downgrade, Lowball Inflation Darken Sentiment
--------------------------------------------- ----

6. (SBU) On Monday, August 11, GoA bond prices recovered much of
their prior week losses in early trading in response to what market
players estimate was $200 million worth of bond purchases by the
GoA. However, late that afternoon, INDEC announced July inflation
increases of only 0.4% m-o-m, the lowest increase in a year and a
number that market participants found less than credible. In y-o-y
terms, official headline inflation declined to 9.1%, from 9.3% in
June. (The consensus forecast had been that INDEC would report an
inflation rate of around 0.6% m-o-m, flat versus June. Private
sector's estimates put July inflation at 1.0 - 1.5% m-o-m and around
25% in y-o-y terms).

7. (SBU) That same afternoon, Standard and Poor's downgraded
Argentina's long-term debt rating by one notch from B-plus to B
(five notches below investment grade), basing its decision on a view
that GoA fiscal performance will continue to deteriorate due to
slowing real GDP growth and government spending rigidities. The
confluence of both non-credible INDEC data and the S&P downgrade
promoted a sell-off of Argentine debt that halved price gains
recorded earlier in the day.

Bond Prices Recover, but INDEC Concerns Grow

8. (SBU) From August 12 - August 14, GoA bond prices continued to
firm on the strength of GoA purchases, with the Economy Ministry
spending an estimated total of $500 million of the $1 billion
budgeted for buybacks. At the same time, local media focused on
heated debates in congress over the GoA's proposed nationalization
of flag carrier Aerolinias Argentinas and the potential drain this
would cause on budget resources. (Aerolineas has historically been a
poorly performing and heavily subsidized company, with debts
estimated at US$1 billion and operational losses at around US$500
million per year.)

9. (SBU) Also during the week, persistent rumors of possible cabinet
changes, including the replacement of Economy Minister Carlos
Fernandez and the removal of Internal Commerce Secretary Guillermo
Moreno from his (never formally acknowledged) oversight of INDEC
generated column inches of media reports and, according to Embassy
market contacts, significant trading volatility. On Thursday,
August 14, credit rating agency Moody's changed the outlook on
Argentina's B3 sovereign rating (six notches below investment grade)
from "positive" to "stable", citing a more contentious and volatile
political environment that raises concern the GoA may not being able
to fully address economic policy challenges or adequately respond to
potential economic or fiscal shocks. Nevertheless, at OOB Friday
August 15, with the promise of continued GoA bond purchases, GoA
bond prices had recovered almost fully from price declines suffered
the prior week.


10. (SBU) Despite mounting macro-economic stress, including real
inflation estimated in the 25% range, Argentina's current economic
performance remains relatively strong: 2008 GDP growth is projected
in the still very respectable 6% range; the trend in the linked and
closely watched debt/GDP ratio remains downward; the 2008 primary
fiscal surplus, while under pressure, is projected to remain in the
2-3% of GDP range; and the current accounts trade surplus, while
declining, remains fundamentally strong given still very favorable
international commodity price terms of trade and a still undervalued
nominal exchange rate. Markets have taken some comfort from recent
fledgling steps by the Kirchner administration to address growing
budget pressures that threatens the primary fiscal surplus. These
include the recent decision to hike some electricity tariffs and to
eliminate tax exemptions for fiduciary fund financial instruments.

11. (SBU) Despite these solid fundamentals, financial markets
punished GoA debt on the week of August 4, with country-risk
premiums topping 740 basis points, a level not seen since just prior
to the 2001 default. And while the GoA's August 11-15 bond buyback
program appears to have succeeded in restoring debt values and
calming market jitters, our local market contacts characterize the
government strategy as a reactive, ad hoc response to what they see
as the GoA's continued inability to formulate coherent policy
responses to growing macro-economic disequilibria. In particular,
they cite the hermetic silence of Economy Minister Carlos Fernandez
and his team over the past three months and speculate (hopefully,
but without much justification as far as we can tell) that the
Kirchner administration may soon call on either current central bank
president Martin Redrado or former central bank president Mario
Blejer to take over the portfolio in a way that more substantively
addresses market concerns about the GoA's ability to cover debt
maturity peaks in 2009 and 2010.

12. (SBU) Near-term steps that market players and local economists
advocate include further hikes in utility and transport rates to
reduce burgeoning subsidy payments that are a drag on fiscal
accounts, cuts in government infrastructure spending growth to bring
such spending more in line with revenue projections, and concrete
steps to address market concerns about the GoA's ability to fund
concentrations of debt maturities in 2009/2010 via some combination
of debt rollovers with local banks and pension funds, seeking
additional MDB credits, and perhaps tapping central bank reserves.
They are also look for (as are we) a rumored presentation of a
formal debt restructuring proposal to the Paris Club.

13. (SBU) Despite recent rating agency downgrades and significant
increases in Argentina's country risk premium, most Embassy contacts
discount any medium-term default scenario and note that the GoA has
the capacity to fund itself in local capital markets through 2009
absent any radical drops in global commodity prices. Near-term
market sentiment will likely turn on steps the GoA takes - or fails
to take - in the coming weeks to demonstrate its long-term economic
vision and commitment to fiscal probity.

© Scoop Media

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