VZCZCXYZ0000
RR RUEHWEB

DE RUEHBU #1223/01 1521956
ZNR UUUUU ZZH
R 011956Z JUN 06
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC 4723
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUEHRC/USDA FAS WASHDC 2190
RUEHC/DEPT OF LABOR WASHDC
RHMFISS/HQ USSOUTHCOM MIAMI FL

UNCLAS BUENOS AIRES 001223 
 
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: BCRA Meets its Monetary Target, but Is Not 
Fighting Inflation 
 
 
¶1. (U) Sensitive but unclassified.  Not for internet 
distribution. 
 
------- 
Summary 
------- 
 
¶2. (SBU) The average M2 level during the first quarter 
was close to the lower end of the Central Bank's 
(BCRA's) Monetary Program target.  Still, M2 increased 
26 percent y-o-y, and would have increased 28 percent 
but for a last-minute transfer of social security 
funds to a time deposit in late March.  The BCRA 
introduced two measures that appeared to signal a 
tightening bias in monetary policy, but real interest 
rates remain negative and fell even further in the 
first quarter, to -6.2 percent on time deposits.  The 
BCRA's priorities continue to be accumulating reserves 
and avoiding peso appreciation, not attacking 
inflation.  So far, the BCRA has been able to 
sterilize its dollar purchases by issuing Lebacs and 
Nobacs and encouraging discount window repayments, 
while avoiding sharp interest rate increases. 
However, in the future the BCRA may have to allow 
interest rates to increase further with the downside 
of eroding the BCRA's quasi-fiscal surplus.  The BCRA 
should be able to meet its M2 target this year, but it 
will have to ignore M3 growth, which may better 
reflect recent growth in the money supply.  End 
Summary. 
 
--------------------------------------------- -- 
BCRA Meets Monetary Target for the 11th Consecutive 
Quarter 
--------------------------------------------- -- 
 
¶3. (U) The Central Bank (BCRA) announced that it 
fulfilled its monetary target for the first quarter of 
¶2006.  According to BCRA data, the average M2 (cash 
plus public and private sector current and saving 
accounts) level during the quarter was ARP 106.2 
billion, close to the lower end of its Monetary 
Program target of ARP 104.4 billion, and well below 
the upper limit of ARP 110.9 billion.  During the 
quarter, M2 increased ARP 2.3 billion (26.5 percent y- 
o-y) to ARP 106.2 billion.  M2 increased 2.2 percent q- 
o-q due to an ARP 1.4 billion increase in public and 
private sector sight accounts and an ARP 900 million 
increase in cash in circulation. 
 
¶4. (U) This was the eleventh consecutive quarter in 
which the BCRA has met its target.  The BCRA shifted 
to an M2 target instead of the monetary base because 
M2 better reflects monetary conditions due to the 
increase in the money multiplier.  The 2006 monetary 
program envisions a deceleration in M2 growth, which 
is expected to increase 21.2 percent in 2006, well 
below the 36 percent, 33 percent and 25 percent 
increases seen in 2003, 2004 and 2005, respectively. 
 
¶5. (U) Economic consultant Miguel Angel Broda recently 
noted that meeting an M2 target is not exempt from 
"creative accounting" by, e.g., asking a public 
institution to transfer its transactional deposits 
(funds held in savings or checking accounts) to time 
deposits.  Broda points out that the social security 
agency transferred ARP 1.5 billion from its sight 
accounts to a time deposit at the end of March. 
Without that transfer, M2 would have increased 28 
percent y-o-y in the first quarter. 
 
------------- 
Monetary Base 
------------- 
 
¶6. (U) The monetary base increased ARP 2.6 billion in 
Q1 to ARP 58.5 billion, mainly due to the BCRA's 
emission of ARP 7.9 billion to purchase dollars to 
 
rebuild its reserves and avoid peso appreciation, as 
well as ARP 2.8 billion in repo transactions.  This 
increase was partially sterilized by ARP 5.0 billion 
in banks' repayments of their discount window lending 
to the BCRA, an ARP 1.7 billion GOA repayment to the 
BCRA for short-term financing, ARP 994 million in net 
issuance of Lebacs and Nobacs, and ARP 300 million of 
other factors.  (Note: As of the end of March, three 
banks -- out of 24 at the beginning of the 2001 
financial crisis-- still owed the BCRA a total of ARP 
6.2 billion for discount window borrowing.  End Note.) 
 
------------- 
BCRA Reserves 
------------- 
 
¶7. (U) BCRA reserves decreased 23 percent in the first 
quarter, to USD 21.5 billion, mainly due to the GOA's 
full prepayment of its USD 9.5 billion IMF debt on 
January 2.  However, the BCRA's steady intervention in 
the foreign exchange market during the remainder of 
the quarter allowed the BCRA to add USD 2.3 billion to 
its reserves, recovering 24 percent of the IMF payout. 
The BCRA's monetary program envisions a complete 
recovery of reserves this year back to USD 28.0 
billion, their level  prior to the IMF payment. 
 
----------------------- 
Time Deposits and Loans 
----------------------- 
 
¶8. (U) Average total time deposits increased slightly 
during the first quarter, from ARP 49.9 billion to ARP 
50.7 billion, due to an increase in private sector 
deposits that more than offset a fall in public sector 
deposits.  Loans to the private sector increased 9 
percent from ARP 43.7 billion to ARP 47.5 billion 
(average of the quarter).  At the end of March, loans 
to the private sector totaled ARP 48.8 billion with 
consumer loans, mortgages and current account advances 
representing 30 percent, 18 percent and 40 percent, 
respectively. 
 
--------------- 
Interest Rates 
--------------- 
 
¶9. (U) The BCRA increased the 7-day active repo rate 
(the rate at which the BCRA offers financing and adds 
liquidity to the system) by one percentage point in 
the first quarter, to 7 percent.  The BCRA maintained 
passive repo rates (the rates at which the BCRA 
borrows funds and absorbs liquidity) unchanged at 4.5 
percent for a 1-day repo and at 5 percent for a 7-day 
repo.  [Note: repo agreements -- repurchase 
transactions -- involve temporary loans of securities 
in return for short-term financing.  End Note.] 
 
¶10. (U) In December 2005, the BCRA ended its policy of 
shortening Lebac maturities to avoid interest rate 
increases.  Since the beginning of the year, the BCRA 
shifted to issuing longer-term Nobacs, which carry a 
variable rate of Badlar (rate for deposits of more 
than ARP 1 million) plus a spread (determined at the 
BCRA auction).  Badlar rates increased from an average 
of 6.80 percent in the last quarter of 2005 to an 
average of 8.20 percent in first quarter of 2006. 
Currently the BCRA is paying interest rates of 12 
percent on the 2-year Nobac, roughly equal to expected 
inflation. 
 
¶11. (U) Lebac interest rates remained almost unchanged 
at the short end of the curve (less than three months) 
at 6.7 percent, 6.8 percent, and 7.2 percent for the 1- 
month, 2-month and 3-month instruments, respectively. 
However, the interest rate on the 6-month Lebac 
increased by 80 basis points to 8.3 percent at the end 
of the first quarter. 
 
 
¶12. (U) While Lebac rates remained almost unchanged 
during the first quarter, it is important to note that 
their relative participation in the stock of BCRA 
paper outstanding decreased sharply during the first 
quarter, from 74 percent to 42 percent at the end of 
March, with a stock outstanding of ARP 11.8 billion. 
At the same time, Nobacs increased their participation 
from 26 percent to 58 percent, with a stock 
outstanding of ARP 16.3 billion.  Nobacs increased 
their participation in tandem with the increase in 
Badlar rates.  Investors shifted to Nobacs because 
they offer better yields and better protection against 
inflation than Lebacs. 
 
¶13. (U) Market rates for time deposits and the call 
interest rate -- the inter-banking lending rate -- 
both increased in the first quarter.  The average rate 
for time deposits jumped 130 basis points from 4.80 
percent to 6.10 percent, while the call rate increased 
90 basis points from 6.00 percent to 6.90 percent. 
 
--------------------------------------------- 
BCRA Sends Mixed Messages on Monetary Policy 
--------------------------------------------- 
 
¶14. (U) The BCRA introduced two measures in the first 
quarter that appear to signal a tightening bias in 
monetary policy.  First, the BCRA increased bank 
liquidity requirements for sight accounts (current and 
savings accounts) by 2 percentage points to 17 
percent.  Second, it eliminated the 2.55 percent 
annual rate that the BCRA paid banks for their minimum 
reserves.  These measures should stimulate a shift 
from M2 and into time deposits and may force an 
increase in interest rates.  However, by themselves, 
these measures do not indicate a turning point in BCRA 
policy. 
 
¶15. (SBU) Monetary data indicates that the BCRA's 
priorities are accumulating reserves and avoiding the 
peso appreciation.  So far, the BCRA has been able to 
sterilize its dollar purchases by issuing Lebacs and 
Nobacs without raising interest rates sharply, aided 
by banks repaying their discount lending to the BCRA. 
That will not be possible indefinitely, and at some 
point, the BCRA may have to allow interest rates to 
reach positive levels.  That will reduce the BCRA's 
quasi-fiscal surplus.  Discount loans are the BCRA's 
best-performing asset, and the rise in repayments 
reduces the BCRA's surplus even further. 
 
¶16. (U) In a recent interview, BCRA President Martin 
Redrado said that the BCRA may sell its holdings of 
Boden 2011 bonds to supplement the BCRA's absorption 
capabilities.  This appears to confirm the concerns of 
some analysts that the BCRA will have problems 
containing money supply growth while rebuilding 
reserves, although Redrado downplayed those concerns. 
[Note: The Boden 2011 is a peso-denominated bond 
adjusted by CER (CPI-linked index) with a 3.5 percent 
coupon.  The BCRA holds ARP 6 billion worth of Boden 
2011 and is the only owner of this bond, which it 
received from the GOA in compensation for the BCRA's 
purchase of provincial quasi-monies in 2003.  End 
Note.] 
 
¶17. (SBU) At first glance these measures appear to 
indicate a turning point in BCRA monetary policy 
towards a tightening.  However, the current level of 
real interest rates suggests a need for a further 
tightening.  For example, real interest rates (based 
on expected inflation as measured by the BCRA 
consensus survey in March each year) were lower in the 
first quarter, y-o-y.  Real interest rates on time 
deposits averaged -6.2 percent at the end of the first 
quarter, compared to -5.7 percent in the first quarter 
of 2005.  This is consistent with the Kirchner 
 
Administration's goal of expanding domestic demand, as 
lower interest rates generally, and negative interest 
rates in particular, give people an incentive to 
increase consumption and decrease savings.  But this 
is not consistent with a monetary tightening to combat 
inflation. 
 
¶18. (SBU) The BCRA's management of the monetary base 
is not an objective in itself but helps the BCRA meet 
its M2 target, since M2 equals the monetary base times 
the money multiplier.  The BCRA measure increasing 
bank liquidity requirements decreased the money 
multiplier, because it requires a higher proportion of 
reserves for each peso in the financial system, 
reducing secondary money creation.  The increase in 
reserve requirements for sight accounts should 
generate an increase in time deposits (and thus reduce 
M2) but this shift may in the end produce an increase 
in the money multiplier for M3 (a wider monetary 
aggregate equal to M2 plus private sector time 
deposits) because reserve requirements for sight 
accounts are larger than for time deposits.  Thus, the 
BCRA will fulfill its M2 monetary target this year, 
but it will have to ignore the likely growth in M3, 
which may be the most appropriate variable as it 
includes private sector time deposits and better 
reflects the growth of money supply.