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Viewing cable 06BUENOSAIRES300, The 2006 Monetary Program Unlikely to Help

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Reference ID Created Released Classification Origin
06BUENOSAIRES300 2006-02-08 16:18 2011-08-30 01:44 UNCLASSIFIED//FOR OFFICIAL USE ONLY Embassy Buenos Aires
VZCZCXYZ0001
RR RUEHWEB

DE RUEHBU #0300/01 0391618
ZNR UUUUU ZZH
R 081618Z FEB 06
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC 3349
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUEHRC/USDA FAS WASHDC 2067
RUEHC/DEPT OF LABOR WASHDC
RHMFISS/HQ USSOUTHCOM MIAMI FL
UNCLAS BUENOS AIRES 000300 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
PASS FED BOARD OF GOVERNORS FOR PATRICE ROBITAILLE 
TREASURY FOR DAS LEE, RAMIN TOLOUI AND CHRIS KUSHLIS 
NSC FOR SUE CRONIN 
AND OCC FOR CARLOS HERNANDEZ 
USDOC FOR ALEXANDER PEACHER 
USDOL FOR ILAB PAULA CHURCH AND ROBERT WHOLEY 
USSOUTHCOM FOR POLAD 
OPIC FOR GEORGE SCHULTZ AND RUTH ANN NICASTRI 
 
E.O. 12958: N/A 
TAGS: EFIN ECON ELAB ALOW AR
SUBJECT: The 2006 Monetary Program Unlikely to Help 
Reduce Inflation 
 
 
1. (U) Sensitive but unclassified.  Not for internet 
distribution. 
 
------- 
Summary 
------- 
 
2. (SBU) Central Bank (BCRA) President Martin Redrado 
presented the BCRA's 2006 monetary program on December 
29.  It will maintain a moderately contractive 
monetary policy, with a small increase in interest 
rates.  Redrado acknowledged that meeting the 8-11 
percent inflation target will be a lower priority than 
recovering the USD 9.5 billion in reserves used to pay 
off the IMF.  Even with GOA help in managing the 
exchange market, the BCRA will be challenged to 
rebuild reserves, meet its monetary targets, and keep 
interest rates low.  The BCRA will use M2 as its 
monetary indicator this year instead of the monetary 
base.  The BCRA does not have direct control over M2 
so the M2 target will be harder to reach.  Nor, as in 
2005, will reaching the target guarantee that 
inflation will be brought under control.  Virtually 
all economic analysts are forecasting higher 2006 
inflation than the BCRA, averaging 12.3 percent, with 
some forecasting a 15 percent floor.  End Summary. 
 
------------------------------------------- 
The BCRA Unveils its 2006 Monetary Program 
------------------------------------------- 
 
3. (U) The President of the BCRA, Martin Redrado, 
presented the BCRA's 2006 monetary program to the 
Senate Treasury and Budget Commission on December 29. 
During his presentation, Redrado noted that the 2006 
monetary program will no longer focus on the monetary 
base but rather on the performance of M2 (cash plus 
public and private sector current and saving 
accounts).  The change in the variable is due to the 
increase in credit and resulting increase in the money 
multiplier.  (Note: Credit expansion increased the 
money multiplier -- measured as the ratio of M2 over 
the monetary base -- from 1.8 in January 2005 to 2.0 
in December. End note.) 
 
4. (U) Redrado argued that the Argentine financial 
system has not yet recovered enough to properly 
implement an inflation targeting regimen.  He defended 
the BCRA's policy of relying on monetary targets to 
manage inflation, saying that the speed of money 
circulation is less volatile than interest rates in 
Argentina.  Also, the absence of a reference interest 
rate makes it more reasonable for the BCRA to use 
monetary targets to control inflation.  When 
questioned about the acceleration of inflation despite 
the BCRA meeting its 2005 monetary targets, Redrado 
argued that prices were increasing due to an expansive 
fiscal policy, salary hikes and supply bottlenecks in 
the manufacturing industry.  (Note: 2005 inflation 
reached 12.3 percent, compared to 6.1 percent in 2004 
and 3.7 percent in 2003.  End Note.) 
 
5. (U) Highlights and assumptions of the 2006 BCRA 
Monetary Program include: 
 
- Real GDP growth of 6.2 percent, similar to the 
assumptions in the 2006 Budget. 
 
- Average inflation of 8-11 percent, not including any 
utility tariff increases.  This is below the average 
market forecast of 12.3 percent. 
 
- An increase of BCRA reserves to USD 28 billion by 
the end of 2006.  This is the same reserve level as 
December 2005, before the GOA paid off its USD 9.5 
billion debt to the IMF, and indicates that the BCRA 
will continue its strategy of accumulating reserves 
through intervention in the foreign exchange market. 
As of January 19, BCRA reserves stood at USD 18.9 
billion. 
 
- Exports increase to USD 43.5 billion and imports to 
USD 32 billion, resulting in a trade surplus of USD 
11.5 billion.  This is expected to be the main source 
of foreign currency. 
 
- M2 growth of 11.7-21.2 percent, leading M2 to ARP 
116-126 billion by the end of December.  M2 is 
currently at ARP 105.3 billion and increased 25 
percent in 2005. 
 
--------------------------------------------- ----- 
BCRA Monetary Program Targets for M2 (in billions) 
--------------------------------------------- ----- 
 
           Mar 2006  Jun 2006  Sept 2006  Dec 2006 
--------------------------------------------- ------ 
Lower-Band    104.4    107.8     110.7      116.3 
Upper-Band    110.9    115.4     119.3      126.2 
--------------------------------------------- ------ 
 
--------------------------------------------- 
What to Expect from the BCRA Monetary Policy 
--------------------------------------------- 
 
6. (U) During his presentation to Congress, Redrado 
noted that the BCRA would have a moderately 
contractive monetary policy in 2006, in coordination 
with GOA fiscal policy, aiming to keep control over 
the growth of monetary aggregates, and with only 
slight increases in interest rates that would promote 
higher savings without jeopardizing economic growth. 
 
7. (U) In a press interview on January 17, Redrado 
argued that the shift to targeting M2 was a signal of 
a potentially more contractive monetary policy.  He 
further insisted that the shift demonstrated the 
BCRA's commitment to control inflation.  He admitted, 
however, that targeting M2 would be harder for the 
BCRA.  The desired monetary contraction would likely 
be achieved through an increase in banks' reserve 
requirements rather than a direct increase in interest 
rates, which would have a negative effect on growth. 
(Comment: However, increasing bank reserve 
requirements will also result in higher interest rates 
since it will reduce the amount of funds that banks 
have to invest.  Reserve requirements currently are 15 
percent for checking and saving accounts.  There is no 
reserve requirement for time deposits of more than six 
months.  End Comment.) 
 
8. (U) Redrado acknowledged that meeting the 8-11 
percent inflation target would be a lower priority 
than rebuilding the BCRA's foreign reserves following 
the USD 9.5 billion payment to the IMF on January 3. 
He recognized the need for the BCRA to recoup those 
reserves to insulate the economy from potential 
external shocks or financial fluctuations and admitted 
that a prudent policy of accumulating reserves will 
indeed impact interest rates and the exchange rate, 
and may prevent the BCRA from reaching its inflation 
target. 
 
9. (U) In a recent publication dated January 2006, the 
Exante consulting company argued that the shift to M2 
likely was designed to help the BCRA increase its 
foreign currency reserves.  They argue that if reserve 
requirements are raised, banks will have an incentive 
to sell their dollar holdings to the BCRA to obtain 
the pesos they need to meet the higher requirements. 
 
--------------------------------------------- ---- 
Embassy Scenarios for the Foreign Exchange Market 
--------------------------------------------- ---- 
 
--------------------------------------------- ------ 
A. BCRA Re-purchases USD 6.5 Billion of the Foreign 
Exchange Surplus 
--------------------------------------------- ------ 
 
10. (SBU) The private sector foreign exchange surplus 
will reach USD 14 billion in 2006, according to a 
Banco Frances report.  In a scenario in which the GOA 
purchases USD 7.5 billion of foreign exchange, the 
BCRA would only need to purchase the remaining USD 6.5 
billion, well below the BCRA's 2005 purchases of USD 
9.4 billion.  In this scenario, the BCRA could fulfill 
its monetary program without the pressure of 
increasing Lebac issuance and increasing interest 
rates, since the monetary base expansion of ARP 19.8 
billion (USD 9.5 billion times an assumed exchange 
rate of 3.05 ARP/USD) could be sterilized with a 
reduced amount of Lebacs and a reasonable level of 
repo transactions.  (Note: in this scenario, the 
monetary base and M2 grow at the same rate.  The BCRA 
absorbed ARP 10 billion from the money supply by 
issuing Lebacs in 2005, which were the most 
contractive factor for the monetary base.  End Note.) 
 
--------------------------------------------- ------ 
B. BCRA Re-purchases USD 10 Billion of the Foreign 
Exchange Surplus 
--------------------------------------------- ------ 
 
11. (SBU) However, if the BCRA seeks to rebuild its 
foreign exchange reserves by purchasing USD 10 billion 
in dollars, the BCRA will be forced to increase its 
sterilization efforts, increasing its Lebac issuance 
and raising interest rates.  In this scenario, the 
monetary base (and M2) increase by ARP 28.9 billion. 
 
---------------------------------- 
C. Rebuilding Reserves in Q1 2006 
---------------------------------- 
 
12. (SBU) If the BCRA wants to recover its reserves 
while inflation is accelerating, it will have to 
sterilize large peso emissions to avoid further price 
acceleration.  Analyzing only the first quarter of 
2006, and assuming that the BCRA purchases USD 2.4 
billion in reserves in the quarter (one-fourth of the 
USD 9.5 billion paid to the IMF), the monetary base 
would expand by ARP 7.2 billion (at the exchange rate 
of 3.05 ARP/USD).  Making the further assumption that 
M2 is allowed to expand to ARP 110.9 billion (the 
upper limit of the M2 target for March 2006), and 
given that currently M2 stands at ARP 105.3 billion, 
the BCRA would only need to sterilize ARP 1.6 billion 
in the first quarter, which seems manageable at first 
blush. 
 
13. (SBU) However, the BCRA's recent policy of issuing 
short-term Lebacs will complicate this sterilization. 
The BCRA will have to roll over all the ARP 10 billion 
in Lebacs coming due in February and March in addition 
to sterilizing ARP 1.6 billion issued for reserve 
repurchases, the BCRA thus will have to increase its 
Lebacs USD 11.6 billion.  To accomplish this, the BCRA 
likely will have to raise its interest rates, 
increasing the BCRA's quasi-fiscal costs.  During 
January, the BCRA did not raise rates at its Lebac 
auctions and managed only to partially refinance its 
maturities by issuing very short-term (less than 3 
months) instruments.  (Comment: the above scenarios 
make a key assumption that the monetary base and M2 
grow at the same rate.  However, if the money 
multiplier increases in 2006, the sterilization 
challenges for the BCRA will become even more complex. 
End Comment.) 
 
14. (SBU) Virtually all domestic and international 
analysts forecast higher inflation than the 8-11 
percent range projected by the BCRA, suggesting that 
the GOA policy of "voluntary" price restraint 
 
agreements will not succeed.  The latest BCRA 
consensus survey (from January 4) forecast 12.3 
percent inflation for 2006, and some analysts are 
projecting a floor of 15 percent inflation for the 
year. 
 
-------- 
Comment 
------- 
 
15. (SBU) Redrado has signaled very clearly that the 
BCRA's priority in 2006 will be accumulating reserves 
rather than keeping interest rates low or inflation 
under control.  It is not yet clear, but is likely, 
that the GOA will use its fiscal capacity to absorb 
excess dollars in the foreign exchange market and help 
the BCRA avoid an appreciation of the peso.  Even with 
GOA help, the BCRA will be challenged to find ways to 
sterilize a large amount of pesos without raising 
interest rates while meeting its monetary target and 
rebuilding reserves. 
 
16. (SBU) The BCRA's focus on M2 rather than the 
monetary base is viewed positively by most analysts 
because it better reflects the money supply.  Credit 
expansion and stronger financial intermediation have 
increased the money multiplier and made the monetary 
base a less reliable target.  Also, M2 is more closely 
aligned with consumer spending and savings patterns, 
making it a better inflation indicator.  However, many 
variables that make up M2 are out of the BCRA's 
control, such as the public's willingness to hold 
pesos or deposit funds in banks.  That will make it 
more difficult for the BCRA to meet its M2 target. 
 
17. (SBU) Even if the BCRA meets its M2 target, it in 
no way guarantees that the BCRA has inflation under 
control.  The BCRA complied with its 2005 monetary 
targets every quarter, while inflation accelerated. 
It managed to meet its 2005 targets only by changing 
the definition of the monetary base and changing 
regulations to prompt banks to prepay their peso 
discount borrowing.  The M2 target for 2006 also 
offers opportunities for such creative accounting 
(although some analysts believe it will be more 
difficult with an M2 target).  For example, given that 
public deposits are included in M2, GOA deposits could 
be shifted as necessary to comply with the monetary 
targets. 
 
18. (U) To see more Buenos Aires reporting, visit our 
classified website at 
http://www.state.sgov/p/wha/buenosaires 
 
GUTIERREZ