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RR RUEHWEB

DE RUEHBU #0459/01 0581648
ZNR UUUUU ZZH
R 271648Z FEB 06
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC 3621
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUEHRC/USDA FAS WASHDC 2094
RUEHC/DEPT OF LABOR WASHDC
RHMFISS/HQ USSOUTHCOM MIAMI FL

UNCLAS BUENOS AIRES 000459 
 
SIPDIS 
 
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: Argentina Economic and Financial Weekly for 
the week ending February 24, 2006 
 
 
--------------------------------------------- -------- 
Weekly Highlights 
--------------------------------------------- -------- 
 
- The peso was unchanged against the USD, closing 
again at 3.08 ARP/USD. 
- IADB postpones a USD 500 million loan approval for 
Argentina. 
- U.S. Judge rules in favor of two holdout hedge 
funds. 
- Congress approves a bill reforming the Magistrate's 
Council. 
- GOA runs an ARP 1.6 billion primary fiscal surplus 
in January - lower than expected. 
- Private investment increased 30 percent in 2005. 
- Commentary of the Week: "The New Inflation 
Scenario" 
 
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MARKETS 
--------------------------------------------- -------- 
 
--------------------------------------------- -------- 
The peso was unchanged against the USD this week, 
closing again at 3.08 ARP/USD. 
--------------------------------------------- -------- 
 
¶1.  The peso remained flat versus the USD this week, 
closing at 3.08 ARP/USD.  Earlier in the week, the 
peso depreciated one cent to 3.09 ARP/USD after the 
Central Bank (BCRA) purchased USD 92 million in the FX 
market on February 21.  The BCRA then kept up its 
active intervention by purchasing a total of USD 175 
million and EUR 21 million which were neutralized by 
increased exporters' sales as well as inflows to 
purchase domestic bonds.  That allowed the peso to 
recover its lost cent and close the week at 3.08 
ARP/USD -- unchanged from last Friday's close.  BCRA 
daily purchases of FX averaged USD 44 million in 
February, bringing the accumulated purchases to USD 
1.5 billion since the beginning of the year.  BCRA 
reserves stand at USD 21.3 billion, as of February 21. 
The peso exchange rate has depreciated 1 percent since 
the beginning of the calendar year. 
 
--------------------------------------------- -------- 
ECONOMY / FINANCE 
--------------------------------------------- -------- 
 
--------------------------------------------- -------- 
IADB postpones a USD 500 million loan approval for 
Argentina. 
--------------------------------------------- -------- 
 
¶2.  On February 22, the Inter-American Development 
Bank (IADB) board decided to postpone until March 1 
discussions on a USD 500 million loan approval for 
Argentina.  Many IADB representatives asked for more 
time and details about the specific purpose of the 
adjustment loan.  The GOA expects the IADB will 
eventually approve the loan.  If approved, this loan 
would be the first adjustment loan received by the GOA 
without the umbrella of an IMF program.  Meanwhile, 
the World Bank (WB) maintains on hold loans to the GOA 
for USD 875 million. 
 
--------------------------------------------- -------- 
U.S. Judge rules in favor of two holdout hedge funds. 
--------------------------------------------- -------- 
 
¶3.  Judge Thomas Griesa of the Federal Court for the 
Southern District of New York ruled in favor of two 
hedge funds controlled by Greylock Capital.  The hedge 
funds sued the GOA to recover USD 227 million of 
principal and past-due-interest.  In spite of the 
ruling for the holdouts, it will be difficult to 
enforce as the GOA has no sovereign assets to be 
seized. 
 
¶4.  Separately, a German Court rejected the GOA 
argument of financial instability and allowed two 
holdout investors to continue with their claims.  This 
decision could pave the way for further claims for EUR 
1.5 billion, according to press reports. 
 
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GOA considering issuing USD 500 million in 
international markets. 
--------------------------------------------- -------- 
 
¶5.  On February 23, business newspaper El Cronista 
Comercial reported that the GOA is considering tapping 
international markets as early as mid-March for USD 
500 million.  The GOA will seek an additional USD 500 
million at a later date, depending on market 
conditions.  The new instrument would reportedly be a 
USD denominated bond issued under U.S. or U.K. 
legislation, becoming the first issuance under non- 
domestic law after the debt restructuring.  However, 
this transaction could run the risk of attachment due 
to the suits pursued by holdout investors.  GOA 
financial needs for 2006 are limited - as low as US 
1.5 billion according to some financial analysts. 
 
--------------------------------------------- -------- 
Congress approves a bill reforming the Magistrate's 
Council. 
--------------------------------------------- -------- 
 
¶6.  On February 22, the Chamber of Deputies approved - 
- after a nine-hour debate -- a bill to reform the 
Magistrate's Council.  The bill was approved by a vote 
of 148 to 89.  The controversial reform reduced from 
20 to 13 the members of members of the Council that is 
responsible for appointing and removing judges. 
Before the reform, the Council consisted of eight 
legislators (four senators and four deputies), 11 
legal experts, and one representative of the executive 
branch. With the reform, the Council will now consist 
of six congressmen, six legal experts and one 
representative of the executive.  The Senate had 
already approved the bill at the end of 2005.  Critics 
of the bill argue that the reform shifts the balance 
of power in the judicial system in favor of the 
government, casting doubts on the independence of the 
judicial system.  The approval of this bill -- 
introduced by Senator Cristina Fernandez de Kirchner, 
the President's wife -- is viewed as a political 
victory for President Kirchner and shows that the 
President is gaining support in the lower Chamber 
where the administration does not enjoy a majority of 
seats. 
 
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BCRA accepts bids for a record high of ARP 2.2 
billion. 
--------------------------------------------- -------- 
 
¶7.  The BCRA received bids of ARP 2.4 billion in its 
February 21 Lebac auction, well above the ARP 1.3 
billion in Lebacs that came due during the week.  As 
in the last three auctions, the BCRA was more than 
able to roll over its maturities by accepting bids for 
ARP 2.2 billion.  The yield on the 42-day Lebac 
decreased from 6.80% to 6.79%.  The yield on the 77- 
day Lebac dropped 10 basis points to 7.0%.  Lebacs for 
other maturities were withdrawn due to lack of 
interest.  Investors concentrated more than 55% of 
their bids in Nobacs of more than 9 months and the 
BCRA accepted bids for ARP 1.2 billion of Nobacs (54% 
of the accepted amount in the auction).  The yield on 
the nine month Nobac and the two year Nobac remained 
unchanged at 3.13% and 5.57%, respectively.  As in the 
previous auction, investors are showing interest in 
Nobacs, since these instruments have a variable rate 
and provide a higher yield and protection than Lebacs, 
which have a fixed rate and are no longer issued with 
 
CER (CPI-linked index) adjustment.  This shift from 
Lebacs to Nobacs allows the BCRA to extend the 
maturity of its liabilities as Nobacs are longer term 
instruments compared to Lebacs, which were recently 
issued at very short-terms due to the BCRA's rejection 
of higher interest rates. 
 
--------------------------------------------- -------- 
Bank profits totaled ARP 1.9 billion in 2005. 
--------------------------------------------- -------- 
 
¶8.  According to a BCRA report, the financial system 
posted profits of ARP 232 million in December, 
bringing its accumulated profits to ARP 1.9 billion 
for 2005.  Public bank profits totaled ARP 129 million 
while private bank profits reached ARP 93 million in 
December, bringing accumulated profits to ARP 1 
billion and ARP 810 million during 2005, respectively. 
The profits came mainly from interest income due to 
credit expansion, which demonstrates that the 
financial system is returning to it core activity. 
Loans to the private sector increased 37 percent to 
ARP 46.3 billion in 2005 (compared to a 26 percent 
increase in 2004). 
 
--------------------------------------------- -------- 
GOA runs an ARP 1.6 billion primary fiscal surplus in 
January - lower than expected. 
--------------------------------------------- -------- 
 
¶9.  The GOA announced a primary fiscal surplus of ARP 
1.6 billion in January, below market expectations of 
ARP 1.9 billion.  In January, fiscal resources 
increased 30.7 percent y-o-y, at a lower rate than 
expenditures, which rose 37.1 percent y-o-y.  A GOA 
official argued that the higher growth rate of 
expenditures is due to stronger investment 
expenditure.  The primary fiscal surplus decreased 2 
percent y-o-y.  The BCRA consensus forecasts an ARP 
22.6 billion primary fiscal surplus for 2006. 
 
 
--------------------------------------------- -------- 
GOA studying increasing the minimum threshold for the 
income tax. 
--------------------------------------------- -------- 
 
¶10.  The GOA is studying increasing the minimum 
threshold for the income tax from ARP 1,835 to ARP 
2,400 per month for single employees, and from ARP 
2,235 to ARP 3,000 per month for married employees, 
beginning in April.  Taxes are paid on income earned 
that is above this minimum threshold.  According to 
official estimates, this measure will have an annual 
fiscal cost of ARP 530 million.  Additionally, the GOA 
stated that will introduce changes to the deductions 
allowed to compute the income tax, so as to extend the 
benefits to a larger number of tax payers.  However, 
this move requires Congressional approval since the 
GOA is not allowed to change the income tax law by an 
ordinary decree.  The GOA is also considering 
increasing the maximum amount exempt from the assets 
tax, which has not been revised since the 2001 
devaluation in spite of CPI and nominal wage increases 
since December 2001. 
 
--------------------------------------------- -------- 
Private investment increased 30 percent in 2005. 
--------------------------------------------- -------- 
 
¶11.  According to an INDEC report, total private 
investments -- Capital Formation and Mergers and 
Acquisitions - increased 30% y-o-y to USD 14.1 billion 
in 2005, showing a 368% increase from the 2002 level. 
Mergers and Acquisitions totaled USD 4.7 billion, 
while Capital Formation investments reached USD 9.4 
billion (67% of the total).  The highest investment 
level was reached in the infrastructure sector, 
followed by the manufacturing industry and the mining 
 
sector.  Foreign investments were mainly concentrated 
in the manufacturing industry and mining sectors. 
 
--------------------------------------------- -------- 
January industrial production index up 4.7 percent y-o- 
y. 
--------------------------------------------- -------- 
 
¶12.  The industrial production index increased 4.7 
percent y-o-y in January, below the BCRA consensus of 
7.8 percent.  During January, the fastest-growing 
sectors were tobacco production (up 13 percent), 
minerals (up 11.7 percent), and plastic and rubber (up 
10.9 percent), which were partially offset by a sharp 
decrease in car-production (down 42.9 percent).  The 
index decreased 6.4 percent m-o-m non-seasonally 
adjusted.  The disappointing result is mainly 
explained by the low performance in the automobile 
industry affected by plant retooling.  The BCRA 
consensus survey forecasts 6.4 percent industrial 
production growth for 2006. 
 
¶13.  The industry-wide capacity utilization index 
reached 64.9 percent in January, compared to 66.1 
percent in January 2005.  The sectors showing the 
highest capacity utilization were oil refining (92.7 
percent), metal based industries (84 percent), and 
paper and cardboard (76.9 percent).  The sectors with 
the lowest capacity utilization were auto production 
(18 percent), metal-mechanical excluding cars (52.8 
percent), and non-metallic minerals (55.7 percent). 
 
--------------------------------------------- -------- 
Commentary of the Week: "The New Inflation Scenario" 
By Manuel Mora y Araujo.  [Note: Translated and used 
with permission of the author, from an article 
published February 7 in La Cronista Comercial.  End 
Note.] 
--------------------------------------------- -------- 
 
¶14.  Current inflation is higher than had been 
expected one or two years ago.  The society's 
inflation tolerance, however, has been better than 
expected.  The correlation between monthly variation 
in prices and the variation in government approval 
ratings has practically disappeared.  This correlation 
had been nearly perfect for the last 15 years. 
 
¶15.  The reason for the higher inflation is clear: a 
combination of high growth in the economy, strong 
internal and external demand, post-crisis realignment 
of prices, a less tight monetary policy than orthodox 
policy might suggest and, last but not least, possible 
collusion or price fixing by companies.  Insofar as 
the majority of analysts stress the first factors 
mentioned, the government stresses the last one.  The 
government justifies its policy of price agreements in 
response to private sector collusion, plus the need to 
manage inflation expectations. 
 
¶16.  The reason for society's inflation tolerance, 
however, is less clear.  There are two hypotheses. 
First, Argentines' memory of inflation is always the 
1970's, which ended with the hyperinflation of the end 
of the 1980's.  The end result of that period was 
stagflation which later affected most of the world. 
In Argentina, stagflation hit with uncommon force and 
was probably less tolerable as a result of the stalled- 
economy component than because of the inflationary 
component (which is why countries experiencing 
economic growth where able to tolerate inflation much 
better).  In contrast, the current inflation is 
accompanied by high rates of growth and a previously 
unheard-of fiscal surplus and has yet to reach 
dangerous levels.  A majority of the population, 
moreover, believes the inflation will not reach these 
levels. 
 
¶17.  Second, the current inflation has had a distinct 
impact on different sectors of society.  The majority 
of formal workers in the private sector during the 
past three years have had income increases that have 
exceeded the rise of prices.  Although there has not 
been an increase of subsidies for those in the lowest 
income brackets, many have found employment that, on 
average, substantially improves their incomes.  In 
contrast, the middle class, employed in the public or 
informal sector, is the most affected by rising 
inflation.  The central government's efforts, and 
practically all of its public communications, are 
directed to these two sectors to reinforce their trust 
among the poor and the middle class that the 
government is working daily to protect them.  As long 
as the economy keeps growing, private incomes keep 
rising, and trust in the government does not waver, 
there is no reason to expect that the situation will 
change or that the government will change its message. 
 
¶18.  For the government it is clear that the objective 
is not to have the lowest possible inflation but 
rather inflation compatible with high rates of growth. 
 
¶19.  Abroad, particularly in the business community, 
attention is focused primarily on the government's 
approach to managing a problem before it becomes a 
problem itself, because that shows how the government 
will approach future problems.  This approach is 
perceived to be unorthodox and causes concerns; the 
government's communication effort to generate 
favorable expectations is insufficient on the 
inflation front.  All indications are, however, that 
the Government of Argentina is little affected by the 
business community's concern.  The GOA trusts that 
investment rates will continue to be relatively high 
and has confidence in the robustness of its fiscal 
surplus policy. 
 
¶20.  It may be taken for granted that high-risk 
investors who are prepared to operate in competitive 
unregulated markets will think little of Argentina, no 
matter what the current government does (without a 
doubt, that is one reason for the chronically low 
competitiveness of our economy).  Meanwhile, investors 
that are looking for opportunities in secure niches or 
in areas with regulated businesses, with high profit 
and low risk, are driven more by their capacity to 
lobby (both the Argentine government and their own 
government, whose support they expect in order to be 
able to operate in Argentina) than by the 
uncertainties of the country.  For the most part, the 
Argentine government is not worried about investment 
flows. 
 
¶21.  If the government does not have a low inflation 
goal, where does it put a limit on what is acceptable? 
Presumably, it will happen when inflation is on the 
verge of being uncontrollable or when it becomes 
intolerable for society and, thus, turns into a 
political problem. 
 
¶22.  In conclusion, Argentina will probably spend the 
year in the present situation of high growth 
accompanied by high inflation.  This scenario ensures 
political stability as long as the scenario 
experiences no significant changes in either of its 
two elements:  high growth must continue, the rate of 
inflation should not rise.  If this scenario were to 
change for the worse, the consequences would be 
significant: government policy would have to change or 
the political climate would have to change.  It is 
unlikely, however, that this latter variant will 
occur.  [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.] 
 
 
GUTIERREZ