VZCZCXYZ0001
RR RUEHWEB

DE RUEHBU #1550/01 1932014
ZNR UUUUU ZZH
R 122014Z JUL 06
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC 5194
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/USDOC WASHDC
RUEHRC/USDA FAS WASHDC 2233
RUEHC/DEPT OF LABOR WASHDC
RHMFISS/HQ USSOUTHCOM MIAMI FL

UNCLAS BUENOS AIRES 001550 
 
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 
July 7, 2006 
 
 
--------------------------------------------- -------- 
Weekly Highlights 
--------------------------------------------- -------- 
 
- CPI increases 0.5 percent m-o-m in June -- below market 
expectations.  PPI up 0.8 percent m-o-m. 
- Venezuela joins Mercosur. 
- The GOA renews its request for budgetary "superpowers." 
- The GOA further loosens the beef export ban. 
- Argentina and Venezuela to issue a bi-national "Southern Bond." 
- Banco Nacion will be forced to finance the GOA. 
- Commentary of the Week: "Toward a renovation of the financial 
system" 
 
--------------------------------------------- -------- 
CPI rises 0.5 percent m-o-m in June -- below market expectations. 
PPI rises 0.8 percent m-o-m. 
--------------------------------------------- -------- 
 
¶1.  The Consumer Price Index (CPI) increased 0.5 percent m-o-m in 
June, below market expectations of 0.7 percent, and follows an 
identical increase in May.  The better-than-expected result is due 
mainly to reduced pressure on food prices, which represent almost 
one-third of the Index.  Last month's increase brought inflation to 
4.9 percent in the first half of the year, compared to a 6.1 percent 
increase in the same period last year.  CPI core inflation was up 
0.6 percent, and the seasonal component of the index increased 0.4 
percent, while the regulated component increased just 0.2 percent. 
The categories with the highest price increases were housing (+0.8 
percent), home supplies and maintenance (+0.7 percent) and other 
goods and services (+0.7 percent).  Meat prices (representing 4.5 
percent of the consumer basket) decreased -1.4 percent m-o-m due to 
price restraint agreements between the GOA and the meat sector as 
well as the partial ban on beef exports.  Year-on-year, CPI 
increased 11 percent.  The BCRA consensus survey forecasts 11.5 
percent inflation in 2006, down from last month's forecast of 12 
percent.  The 2006 budget projects a 9.1 percent inflation rate for 
2006, and the Central Bank's inflation target range is 8-11 percent. 
 
 
¶2.  Producer prices increased 0.8 percent m-o-m in June, due to a 
-0.3 percent decrease in primary goods prices and a 1percen 
increase in the prices of manufactured goods prices and electricity. 
 The price of imported goods increased 2.4 percent.  The PPI index 
increased 12.2 percent y-o-y. 
 
--------------------------------------------- -------- 
Venezuela joins Mercosur. 
--------------------------------------------- -------- 
 
¶3.  Venezuela was officially welcomed into Mercosur on July 4 but, 
although Venezuela now has a voice in the organization, it does not 
yet have a vote.  Venezuela's full incorporation will occur only 
after the four member countries (Argentina, Brazil, Paraguay and 
Uruguay) send their legislatures' approval to the Latin America 
Integration Association (ALADI).  After that notification, Venezuela 
will have four years to adopt Mercosur's external tariffs and its 
common nomenclature and rules.  The Mercosur block's next goal is to 
incorporate Bolivia. 
 
--------------------------------------------- -------- 
Venezuela reportedly will buy USD 1.8 billion of Boden 2012 bonds 
through the end of the year. 
--------------------------------------------- -------- 
 
¶4.  According to local media, the GOV will buy approximately USD 1.8 
billion of Boden 2012 from the GOA by the end of the year.  The 
schedule calls for the purchase of USD 200 million of Boden 2012 
every 20 days.  These funds will be used to strengthen the BCRA's 
reserves; the GOA's goal is to reach USD 28 billion in reserves by 
the end of the year (the BCRA's reserves are currently at USD 25 
billion). 
 
--------------------------------------------- -------- 
Argentina and Venezuela announce they will issue a bi-national 
"Southern Bond." 
--------------------------------------------- -------- 
 
¶5.  Argentina and Venezuela also announced that they will release a 
 
bi-national "Southern Bond" in the next 90 days.  In that period, 
the GOV will designate an international bank to release the bond in 
the international market.  Because Venezuela's debt rating is higher 
than Argentina's, the GOA expects to receive a 1.5-point reduction 
in the bond's interest rate compared with the rate that it would pay 
on a regular bond issuance.  Argentina will issue the bond, and 
Venezuela will provide capital and interest warranties in case of 
default. 
 
--------------------------------------------- -------- 
The GOA renews its request for budget "superpowers." 
--------------------------------------------- -------- 
 
¶6.  On June 29, the GOA sent a bill to the Congress that would 
modify the Financial Administration Act and the Fiscal 
Responsibility Law and give the GOA so-called "superpowers" over the 
national budget.  The proposal would give the GOA the power to 
modify the Budget Law and give the Chief of Cabinet the power to 
reallocate funds irregardless of he provisions of the Financial 
Administration Act or the Fiscal Responsibility Law.  These 
"superpowers" were requested in the 2006 budget, but Congress did 
not approve them.  The GOA also has asked for suspension of article 
15 of the Fiscal Responsibility Law, which sets a maximum limit on 
discretionary spending and prohibits budgetary changes that cause an 
increase in current expenses relative to capital expenses.  The 
GOA's intention is to consolidate control of federal resources in 
the executive branch, relegating Congress' role to validating the 
total budget figures, without interfering in spending decisions. 
The bill has been approved by the Senate's Constitutional Affairs 
Committee and will be debated in the Congress on July 12. 
 
--------------------------------------------- -------- 
The GOA further loosens the beef export ban. 
--------------------------------------------- -------- 
 
¶7.  The GOA issued a new resolution stating that exports of 
hindquarter cuts weighing more than 460 kilos (1,012 lbs) and of 
beef used in canned products will be permitted for 60 days, with a 
possible 30-day extension, depending on how this measure affects 
domestic prices.  The GOA partially lifted the near-total ban on 
beef exports beginning June 1, allowing exporters to sell 40 percent 
of the amount of beef they had exported from June to November of 
¶2005.  Economy Minister Felisa Miceli said that "at this time, 
conditions are ripe for opening exports further since demand fell 
after exports were suspended, causing prices to drop in the 
corresponding categories." 
 
--------------------------------------------- -------- 
Banco Nacion bank will be forced to finance the GOA. 
--------------------------------------------- -------- 
 
¶8.  A presidential decree has modified the capitalization regime for 
GOA-owned Banco Nacion (established in the 2006 budget).  Decree 
811/2006 states that during the next three years, Banco Nacion will 
receive five-year bonds indexed by CER (a CPI-linked index) instead 
of cash contributions from the GOA.  Through this change, the GOA 
will have ARP 1.9 billion extra at the end of 2008 and will close 
the 2006 fiscal year with USD 300 million left over.  The GOA 
justified this move as being due to insufficient expected budgetary 
resources.  Banco Nacion is the largest bank in Argentina. 
 
 
--------------------------------------------- -------- 
Banks prepaid more discount borrowings to the BCRA. 
--------------------------------------------- -------- 
 
¶9.  Banks canceled another USD 126 million in discount borrowing to 
the BCRA, which implies a monetary absorption by the BCRA of a 
similar amount.  Since last year, banks have been prepaying their 
debt with the BCRA, mostly acquired during the 2001 economic crisis. 
 During the last 18 months, banks have cancelled 68 percent of their 
loans and the number of banks with outstanding discount debt fell 
from 24 to 3 (Galicia Bank, Provincial Bank of Buenos Aires and 
Bisel).  Banks are rushing to repay their debt because it is indexed 
to CER (a CPI linked index) plus a 3.5 percent annual rate.  Taking 
the relatively high inflation into account, this represents a heavy 
financial burden for the banks. 
 
--------------------------------------------- -------- 
 
Food companies leery about revealing their cost structure to the 
GOA. 
--------------------------------------------- -------- 
 
¶10.  Food companies are evaluating whether they will reveal their 
cost structures to the GOA.  Secretary of Internal Trade Guillermo 
Moreno said last week that those food companies that want to discuss 
price adjustments should present a detailed report of their cost 
structure for every product and the increase they are planning to 
make.  Food companies agreed to this because they feared that the 
GOA otherwise would apply the Supply Law to them (which gives the 
GOA the power to establish maximum prices and penalties).  However, 
some multinational companies are prohibited by their headquarters 
from revealing their production costs, because of the strategic 
value of this information to their competitors. 
 
--------------------------------------------- -------- 
May trade surplus of USD 1.3 billion -- the highest in the last two 
years and above expectations. 
--------------------------------------------- -------- 
 
¶11.  The May trade surplus reached USD 1.3 billion, above market 
expectations of USD 1.2 billion.  Growth of both exports and imports 
accelerated with respect to April.  Exports increased 13 percent 
y-o-y to USD 4.1 billion, a new historic record, following 8 percent 
y-o-y growth in April, with increases in both price (+7 percent) and 
quantity (+6 percent).  Exports were driven by increases in 
industrial goods (+34 percent y-o-y), agro-industrial products (+20 
percent y-o-y) and decreases in fuel and energy (-3 percent y-o-y) 
and primary goods (-7 percent y-o-y).  Imports increased 14 percent 
y-o-y to USD 2.8 billion, accelerating after April's 7 percent y-o-y 
increase, with increases in both quantity (+13 percent) and price 
(+1 percent).  Imports were driven by increases in accessories for 
capital goods (+10 percent), passenger vehicles (+38 percent), 
consumer goods (+39 percent), capital goods (+30 percent) and 
intermediate goods (+7 percent), and a decrease in fuel and oil (-31 
percent).  The accumulated trade surplus reached USD 5 billion 
during 2006 and, according to the BCRA consensus survey, it is 
expected to narrow to USD 9.9 billion at the end of the year 
compared to USD 11.3 billion in 2005. 
 
--------------------------------------------- -------- 
The GOA will eliminate double severance pay in case of layoffs at 
the end of the year. 
--------------------------------------------- -------- 
 
¶12.  Following President Kirchner's announcement that May 
unemployment decreased to 9.8 percent, the GOA is analyzing whether 
to eliminate so-called double severance pay in case of layoffs 
(which is actually 150 percent of the monthly salary for each year 
the employee has worked).  The GOA will wait for the official 
unemployment figures -- expected to be published in August by the 
National Bureau of Statistics (INDEC) -- before eliminating double 
severance pay, but private companies are already asking for a 
quicker determination.  The double severance pay rule was instituted 
at the height of the 2002 economic crisis and is defended by labor 
union leaders who are willing to let it go only in exchange for an 
increase in the minimum wage from ARP 630 to ARP 850. 
 
--------------------------------------------- -------- 
The BCRA slows monetary expansion. 
--------------------------------------------- -------- 
 
¶13.  During Q2 of 2006, the BCRA started to decelerate its monetary 
expansion to keep it in line with the goals set in its 2006 Monetary 
Program.  In the first six months of the year, the BCRA absorbed ARP 
13 billion, 65 percent through anticipated cancellation of discount 
lending and public sector operations.  According to preliminary 
information, the growth rate of M2 -- money held by the public plus 
sight deposits -- slowed by more than 3 percent points compared to 
March. 
 
¶14.  The BCRA is also slowing its purchases of euros.  In June, the 
BCRA bought only EUR 2 million, the lowest acquisition since the 
BCRA entered the euro market in January in an attempt to diversify 
its portfolio.  Argentinean investors have shown little interest in 
the currency because of the lack of liquidity on the Argentine 
market. 
 
--------------------------------------------- -------- 
June labor demand index up 7.18 percent m-o-m. 
--------------------------------------------- -------- 
 
¶15.  The June labor demand index calculated by Di Tella University 
increased 7.18 percent m-o-m to 112.91 points, the index's second 
increase in 2006 after a 1.04 percent increase in April.  So far 
this year, labor demand has decreased 1.03 percent.  The increase is 
mainly due to rising demand for technical employees (+15.49 
percent), commercial personnel (+14.2 percent) and professionals 
(+12.56 percent).  The index is up 7.6 percent y-o-y.  [The index is 
based on comparisons of job vacancy announcements printed in the two 
largest newspapers of the country.] 
 
--------------------------------------------- -------- 
BCRA rolls over its maturities.  Investors concentrated their bids 
in Nobacs. 
--------------------------------------------- -------- 
 
¶16.  The BCRA received ARP 1.4 billion in bids at its July 4 Lebac 
and Nobac auction, compared to ARP 1.1 billion in Lebacs that came 
due during the week.  ARP 475 million came from the fixed peso 
segment and ARP 638 million from the pesos indexed by CER segment. 
It accepted ARP 506 million in Lebac bids and ARP 858 million in 
Nobac bids.  The yield on the 70-day Lebac decreased from 7.25 
percent to 7.10 percent, the 168-day Lebac decreased from 8.60 
percent to 8.50 percent, and the yield on the 252-day Lebac 
decreased from 10.20 percent to 10.18 percent.  The yield on the 
longest term instrument, the 336-day Lebac, remained at 12 percent. 
Lebacs for maturities of more than 336 days were withdrawn due to 
lack of interest.  The spread on the one-year Nobac remained in 2.03 
percent and decreased from 3.72 percent to 3.74 percent for the 
two-year Nobac.  The Badlar rate (the base rate for Nobacs) is 
currently at 9.1 percent.  Investors reversed their tendency towards 
Lebacs and concentrated their bids in Nobacs; this was a response to 
the BCRA's downward movement in the Lebacs yield and to a high 
Badlar rate. 
 
--------------------------------------------- -------- 
The peso is unchanged against the USD this week, closing at 3.10 
ARP/USD. 
--------------------------------------------- -------- 
 
¶17.  The peso remained flat versus the USD this week, closing at 
3.10 ARP/USD.  On Wednesday, the BCRA purchased USD 112 million, a 
10-month record, to keep the peso unchanged against the USD.  In the 
first four days of the week, the BCRA purchased USD 179 million. 
The peso exchange rate has depreciated 1.6 percent since the 
beginning of the calendar year.  The BCRA's reserves stood at USD 
25.8 billion as of July 5, and have increased USD 6.8 billion, or 36 
percent, since the GOA prepaid its entire IMF debt on January 2. 
 
 
--------------------------------------------- -------- 
Commentary of the week: "Toward a renovation of the financial 
system", by Fabio Rodriguez -- Executive Director of Fundacisn 
Capital -- from an article published in Cronista Comercial on June 
¶15. 
--------------------------------------------- -------- 
 
¶18.  There is currently a wide consensus about the need to 
strengthen the current economic growth cycle (which is entering its 
fifth year of expansion) by regenerating deeper credit channels, 
especially for medium and long- term credit.  As demand pressures 
spread and many sectors reach the limits of their installed 
capacity, favoring the largest investments through a financial 
system that completely fulfills its role as a creditor has become a 
priority. 
 
¶19.  Despite the significant expansion of financial activity (which 
for the second consecutive year will make a positive contribution 
and increase at a faster rate than GDP), levels of financial 
intermediation are still lower than pre-crisis levels (e.g. 1997 or 
2000).  In light of this evidence, those who stress a 
glass-half-empty outlook toward the recovery point out that the 
ratio of credit-to-GDP barely rose in the last two years, from 7 
percent to just 10 percent, and that it is still very low with 
respect to the 23 percent ratio before the crisis.  They also 
emphasize that the core of re-intermediation is concentrated in the 
 
short-term and that many activities are supporting the generation of 
internal liquidity for investment and growth.  Finally, they also 
point out that a large part of the improvement in the system's 
performance has come from the strong macroeconomic environment (the 
low real interest rate is the most frequently mentioned, which 
reduces the cost of collecting and increases returns). 
 
¶20.  While still recognizing these points as true in general, I will 
put forward some arguments in favor of recognizing a set of 
improvements that have led to a post-crisis financial system that 
has a very solid foundation and is able to facilitate economic 
growth.  More than anything, it is worth highlighting that financial 
development, measured as a ratio of credit-to-GDP, is not in itself 
a policy variable, but rather the complex result of the process of 
financial intermediation.  Several factors come together and 
interact, from the macroeconomic and institutional environment and 
the regulatory and enforcement capacity, to the behavior of 
depositors, banks, investors and other actors that demand financing. 
 As you will note, several of these aspects are beyond the control 
of policy makers. 
 
¶21.  Concerning assets, their structure is changing, favoring the 
recovery of credit to the private sector, a persistent decrease in 
the banks' exposure to the public sector, and an increase in 
liquidity (including Lebac and Nobac holdings).  After reaching 
nearly 50 percent at the worst point of the crisis, loans to the 
public sector fell to 40 percent by the end of 2004, and to 29 
percent today.  A public sector with a structural surplus, the right 
regulatory moves by the Argentine Central Bank that put limits on 
banks' exposure to the Treasury (holding to a limit of no more than 
40 percent of assets by the end of 2006) and many entities' own 
decision to reduce their holdings of government securities all favor 
the crowding-in of the credit market. 
 
¶22.  With respect to liabilities, the normalization of the funding 
structure continues to show improvement.  Banks' debt to the Central 
Bank (BCRA discount lending to improve banks' liquidity during the 
crisis) is decreasing and the share of deposits (in banks' balance 
sheets) is increasing.  Thanks to diverse mechanisms from 2005 to 
today, among which anticipated cancellation of discount loans stands 
out, financial entities paid back around ARP 12 billion (in terms of 
capital). 
 
¶23.  In terms of net worth, what stands out is the increase in 
solvency of the system thanks to new capitalization (which total 
around ARP 7.5 billion since 2004) and the generation of positive 
results since 2005.  (After registering accumulated losses of more 
than ARP 25 billion between 2002 and 2004, the consolidated system 
produced profits near ARP 2.8 billion for 2005 and the first quarter 
of 2006.) 
 
¶24.  It is also worth mentioning various measures that help to avoid 
new currency mismatches (given that banks are no longer permitted to 
lend dollars to clients who can only repay in pesos) and which 
contribute to strengthening the global solvency of the system even 
more, given that by pesifying their balance sheets, banks became 
less vulnerable to movements in the exchange rate. 
 
¶25.  Up to this point, favorable trends indicate a healthy 
improvement in financial entities' balances and various measures 
that constitute an improved regulatory platform.  All this 
contributes to predicting a financial system that, without repeating 
the mistakes of the recent past, has a pro-growth orientation 
directed to the needs of productive sectors, and not to the niche of 
easy gains from financing the public sector on the backs of the 
private sector (which was the logic that operated from 1998 to 
2001). 
 
¶26.  Of course, the challenges and difficulties that remain are even 
more important when considering financial development that not only 
translates into deeper credit in the economy, but also in a jump in 
its quality.  Today, financing relies primarily on consumption and 
on businesses' short-term labor capital, while financing of medium 
and long-term investment remains scarce. 
 
¶27.  This brings us to a crucial challenge for Argentina, which 
focuses on cutting the Gordian knot that supposes that it is 
impossible to generate channels of savings and credit in pesos and 
for the long-term.  The platform of consistent macroeconomic policy 
 
is a fundamental pre-condition for generating confidence in the 
medium-term.  From a regulatory point of view, the pattern is 
positive given that, as we saw, a financial system is emerging with 
a favorable balance of risks.  (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 
 
 
 
 
 
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