Cablegate: Argentina: Government Subsidy Increases Could Squeeze


DE RUEHBU #1218/01 2422002
R 292002Z AUG 08




E.O. 12958: N/A

SUBJECT: Argentina: Government Subsidy Increases Could Squeeze
Fiscal Stability

REF: (A) Buenos Aires 1160
(A) Buenos Aires 1053
(B) 07 Buenos Aires 2313
(C) 07 Buenos Aires 2251


1. (SBU) Government subsidies, mostly for energy, transportation,
and food, have been surging in 2008 and threaten to undermine one of
the pillars of the GOA's economic model, a primary fiscal surplus in
the range of 3% of GDP. In the first half of 2008, the GOA spent
over US$4 billion on subsidies, a 215% year-on-year nominal
increase, in an effort to hold down prices of electricity, gas,
train, subway and bus fares, as well as meat, milk, bread and pasta.
While domestic consumption subsidies are generally acknowledged to
be economically inefficient, curbing their growth could prove
politically difficult for the Kirchner administration given that the
subsidies are intended to support the GOA's core constituency, the
urban poor. Conversely, raising taxes to fund subsidies in the wake
of the recent agricultural crisis also appears problematic. Recent
increases in some electricity and airline tariffs are, at best, a
small start at addressing the budgetary burden of expanding
subsidies. With this increasing fiscal squeeze, the primary
surplus, one of the truly successful legacies of the Kirchner era,
could be in jeopardy. So far, the government is pledging to
maintain the surplus. END SUMMARY

Subsidies exploding . . .

2. (SBU) Subsidies, mostly for energy, transportation, and food,
have been surging in 2008 and threaten to undermine one of the main
pillars of the GOA's economic strategy: a primary fiscal surplus in
the range of 3% of GDP. In the first half of 2008, the GOA spent
some US$4.04 billion on subsidies, according to local think tank
Argentine Association of Budgets and Public Finance (ASAP), a 215%
increase in nominal peso terms over the same period as last year,
and largely to keep pace with inflation and to hold down prices of
electricity, gas, train, subway and bus tariffs, as well as food
staples such as meat, milk, bread and pasta. According to ASAP,
about two-thirds of the subsidies go to cover the difference between
GOA-mandated energy tariff ceilings and higher production costs
owing to higher world prices for gas and other fuels. Total 2007
subsidies amounted to US$5.28 billion, or 11.6% of total GOA
expenditures. ASAP and other private sector analysts estimate that
the GOA could spend US$8-US$10 billion on subsidies in 2008, out of
a roughly US$60 billion in 2008 primary outlays, or 13-17% of the
total. This could represent an estimated 107% of Argentina's
primary fiscal surplus, over 3% of GDP, and more than triple the
burden in 2006. According to Ricardo Delgado of Ecolatina, GOA
spending on subsidies will continue to be very strong and there is
no reason to believe that the GoA can or will substantially reduce
them anytime soon, owing to the GOA's need to limit the prices for
these energy, transportation, and food items, for its core political
base, the urban poor.

Squeezing the GOA fiscal account

3. (SBU) Private sector economists have widely commented that the
GoA's ability to maintain a fiscal surplus in its target range of
3-4% of GDP could be compromised in the future. Apart from these
costly and growing subsidies, the GOA also faces "worrying"
increases in public salaries, pensions, and transfers to the
provinces, according to local think tank ASAP. Commodity prices for
major exports have already declined in the last month (for example,
by 23% for soy and 25% for corn). ASAP analysts particularly
highlight the fact that public pension outlays could rise
substantially in 2009 due to Supreme Court rulings that could
(pending congressional ratification) force the GOA to raise payments
for all recipients. (According to ASAP, 2008 pension outlays will
grow 7% in nominal terms over 2007, and could grow 25% in nominal
terms in 2009 over 2008.) ASAP has also noted that the 2009
Congressional elections could be another incentive to increase

--------------------------------------------- ----
Little economic - or political - room to maneuver
--------------------------------------------- ----

4. (SBU) Political and economic analysts note that, while the
chances of the GOA substantially reducing subsidies appear to be
slim, raising taxes is not an easy option either. Although the GOA
did increase taxes in recent months (refs C and D: November 2007
export tax increases for some mining, hydrocarbon and agricultural
products), and recently imposed a 35% capital gains tax on income
from investments in mutual and trust funds, the recent agricultural
crisis makes many analysts believe that there is little room for
substantially higher taxes. The rollback of the increased
agricultural export tax could cost the GOA roughly US$2.6 billion in
potential 2008 revenue, or about 4.4% of primary expenditures,
according to local economist Carlos Melconian. Further, Argentina
has already had a steep rise in tax pressure in recent years, and
federal, state and local tax revenue as a share of GDP has risen
from around 21% of GDP in 2001 to over 32% of GDP in 2007, according
to local consultant Poliarquia.

5. (SBU) While GoA subsidies are intended to support President
Cristina Fernandez de Kirchner's (CFK) core political base, the
largely urban poor, economists and opposition parties contend that
they are an inefficient way of assisting them. A widely-cited
example is the fact that the capital's upper and middle classes
benefit disproportionately from electricity subsidies. On the other
hand, with poverty and inequality rates now reported to be back on
the rise, any subsidy cuts would significantly impact those at or
below the poverty line. Many forecasters put the rate of consumer
inflation in the 25-30% range this year, and real salaries are
struggling to keep up, particularly for the almost 40% (at the end
of 2007, and according to the GOA national statistics agency) of the
workforce that is informal. According to Ernesto Kritz, head of
labor consultancy Sociedad de Estudios Laborales, real wages are now
stagnant at best, and poverty - now at about 30%, according to some
unofficial estimates - and income inequality are on the rise.

--------------------------------------------- ---
Recent tariff increases a start, but more needed
--------------------------------------------- ---

6. (SBU) Recent modest electricity rate hikes for Greater Buenos
Aires (ref B), while easing margin pressures on distributors, are,
according to energy company officials, inadequate to fund needed
investment new distribution capacity and compensate these companies
beset by inflation accumulated since 2002 and rising union wages.
Electricity prices in greater Buenos Aires are still very cheap:
neighboring provinces and countries still pay substantially higher
rates - up to 10 times more in Rio de Janeiro, for example.
Similarly, recent GoA rulings allowing domestic airfares to increase
by up to 40% are welcome, but local sector analysts agree that
further hikes are needed to spur significant new investments, and
allow carriers to be profitable. Nor is it even clear that such
tariff increases will lessen the GOA's subsidy burden, which is one
of the GOA's stated goals for imposing these increases: train and
subway fares were increased an average of 21% in January 2008, yet
subsidies to these sectors actually increased 61% from January-June
2008 over the same period in 2007.


7. (SBU) GOA subsidies are rising at rates that outpace increases in
overall revenue growth. GOA options to either halt subsidy growth
and/or increase taxes appear limited. The combination of declining
GoA popularity, upcoming 2009 Congressional elections, and a more
assertive and restive Congress could increase the temptation to ramp
up spending, making it more difficult to tighten fiscal policy and
contain inflation, which could further strain the fiscal account.
And with the possibility of lower commodity prices and sustained
higher public debt financing costs (ref A), the primary fiscal
surplus - an anchor of Argentina's recent macroeconomic stability
and one of the truly successful Kirchner legacies - could also be in
jeopardy. So far, however, the government is still pledging to
maintain that surplus.


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