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PASS NSC FOR JOSE CARDENAS 
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PASS USTR FOR SUE CRONIN AND MARY SULLIVAN 
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E.O. 12958: N/A 
TAGS: EFIN EINV ECON AR
SUBJECT: ARGENTINA ECONOMIC AND FINANCIAL REVIEW, COVERING 
JANUARY 16 - FEBRUARY 2, 2007 
 
 
¶1.  Provided below is Embassy Buenos Aires' Economic and 
Financial Review covering the period January 16 -- February 
2, 2007.  The unclassified email version of this report 
includes tables and charts tracking Argentine economic 
developments.  Contact Econoff Chris Landberg at 
landbergca@state.gov to be included on the email distribution 
list. 
 
----------------- 
Weekly Highlights 
----------------- 
 
- GoA agrees to repay $983 million debt to Spain ) outside 
the Paris Club. 
- GOA auctions $500 million in Bonar VII bonds at a 7.7% 
yield; lowest since default. 
- GoA Treasury to purchase $2 billion to maintain weak peso 
and control inflation 
- Moody's upgrades outlook on GoA bonds from stable to 
positive. 
- IDB approves $590 million loan to Argentina. 
- GoA primary surplus reaches 4% of GDP in 2006. 
- Argentina's country risk premium hits all time low 
- Concerns over cost to GoA of GDP Warrants 
- All eyes on January's CPI after dismissal of INDEC Director 
in charge of CPI index. 
- GoA announces reform of the pension system. 
- Wage negotiations heat up. 
- Argentina's trade surplus reached $12.4 billion in 2006, 
above market expectations. 
- Key Economic Indicators 
 
------------------- 
Banking and Finance 
------------------- 
 
GoA agrees to repay $983 million debt to Spain 
) outside the Paris Club 
--------------------------------------------- - 
¶2.  On January 31, Economy Minister Felisa Miceli announced 
that the GoA had reached an agreement to repay $982 million 
owed to Spain.  The Minister noted that since the Spanish 
loan was received as part of an IMF-led rescue package in 
2001, it was being treated separately from other official 
bilateral debt (included under the Paris Club) that must 
still be restructured.  The GoA has agreed to pay the loan 
over six years, with payments structured as follows:  10 % in 
years 1 and 2, 15% in year 3, 20% in years 4 and 5, and 25% 
in year 6.  The interest on the restructured loan will be 
Libor plus 140 basis points.  During the announcement, Miceli 
thanked the Spanish government for supporting Argentina in 
such a difficult moment in the nation's history.  Local press 
also reported GoA officials' assertions that they were in 
discussions with Paris Club creditors on the restructuring of 
bilateral loans worth approximately $6.2 billion, but also 
reported that the talks were at a preliminary stage. 
 
GOA auctions $500 million in Bonar VII 
bonds at a 7.7% yield; lowest since default 
------------------------------------------- 
¶3.  On January 25, the GoA sold $500 million in Bonar VII 
bonds (a seven-year, dollar-denominated bond with a 7% coupon 
issued under Argentine law) at a 7.71% yield (287 basis 
points over comparable Treasuries), which was the lowest 
yield since the 2002 default.  This was the GoA's third Bonar 
VII auction, following the September and November auctions in 
2006 (each of them for $500 million, with a yield of 8.4% and 
8.03%, respectively).  The GoA received bids for $1.7 
billion, or more than three times the auctioned amount. 
Given the strong demand, the GoA reportedly does not rule out 
tapping the markets again in the near future.  According to a 
January resolution from the Ministry of Economy, the GoA is 
authorized to issue up to $1 billion of Bonar VII in 2007. 
The proceeds of this transaction will serve to fulfill GoA 
financial needs in 2007, which are estimated at $5-6 billion. 
 
GoA Treasury to purchase $2 billion to 
maintain weak peso and control inflation 
 
---------------------------------------- 
¶4.  Argentine press  reported January 22 that Economic 
Minister Felisa Miceli and BCRA President Martin Redrado had 
agreed that the Treasury (under Ministry of Economy) would 
purchase with its fiscal surplus approximately $2 billion in 
2007 (almost twice as much as in 2006) to help the BCRA 
prevent peso appreciation and control inflation.  (Note: 
Private analysts are already forecasting a 1.3-1.5% m-o-m 
increase for January's inflation.)  In the first two weeks of 
January, Treasury already purchased $100 million in foreign 
currency.  Treasury's purchases would lessen some of the 
pressure on the BCRA to purchase and sterilize the large 
foreign exchange inflows.  The BCRA uses short and medium 
term instruments (Lebacs and Nobacs) to sterilize FX 
purchases, and many local analysts are concerned that the 
BCRA's aggressive sterilization campaign could potentially 
lead to higher interest rates.  Unlike BCRA intervention, 
Treasury's FX purchases do not expand the monetary base since 
the GoA purchases dollars with pesos already in circulation, 
which obviates the need for BCRA sterilization of the FX 
inflows.  In 2005, the Treasury purchased $4 billion in 
foreign currency.  However, it reduced its FX purchases to $1 
billion in 2006, forcing the BCRA to increase its purchases 
of dollars from $10 billion in 2005 to $14 billion in 2006. 
Local analysts expect the trade surplus plus capital inflows 
in 2007 to generate a foreign exchange surplus of $13 
billion, which the BCRA and Treasury will need to mop up to 
prevent an appreciation of the peso.  (Note:  Local analysts 
estimate official reserves will total approximately $42 
billion at the end of 2007). 
 
IDB approves $590 million loan to Argentina 
------------------------------------------- 
¶5.  On January 31, the IDB Board approved a credit line for 
Argentina for $1.5 billion to improve the quality of life for 
the poor in urban areas (including in the cities of Buenos 
Aires, Cordoba and Santa Fe).  The first loan of this credit 
line will be for $350 million and will finance 100 projects, 
benefiting 47,500 families.  The loan has a 24-year maturity, 
with a 5-year grace period and an adjustable interest rate. 
The IDB board also approved a $240 million loan to finance 
economic development projects in five of the nine Norte 
Grande Provinces (including Jujuy, Catamarca, Santiago del 
Estero, Tucuman, and Chaco).  The program includes financing 
hydraulic infrastructure projects, water and sewer systems, 
and institution building projects.  The loan has a 25-year 
maturity, with a 6-year grace period and an interest rate of 
Libor. 
 
Moody,s upgrades outlook on GoA bonds from stable to 
positive 
--------------------------------------------- ---------------- 
¶6.  On January 16, Moody,s rating agency revised upwards the 
outlook on GoA sovereign bonds (both foreign and local 
currency) from stable to positive, while maintaining the 
overall sovereign credit rating at B3 (Note:  this is several 
levels below investment grade; S&P,s rating for Argentina is 
B , also several notches below investment grade).  In its 
announcement, Moody,s justified the upgrade based on 
improvements in GoA's fiscal accounts, high economic growth, 
and foreign currency accumulation.  Moody,s stated that it 
does not expect a downturn in the near-term, but noted that 
the GoA's unorthodox policies create distortions that could 
eventually undermine the economy.  These include: 1) 
pro-cyclical fiscal policy; 2) rapidly increasing 
expenditures (and increasing transfers and subsidies), which 
will complicate maintaining budget surpluses in the future; 
3) distortions in relative prices due to price controls and 
export taxes and restrictions, creating economic 
inefficiencies; 4) relatively high debt/GDP ratios; 5) doubts 
about the GoA's ability or willingness to make necessary 
fiscal adjustments if/when confronted with adverse economic 
conditions; and 6) increasing GoA dependence on export tax 
revenues, which make the fiscal accounts vulnerable to 
external shocks.  (Comment:  the Moody's comments track the 
opinions of most financial sector traders and economists, who 
are bullish on Argentina over the next 18 months, but who 
realize that stimulative monetary and fiscal policies, 
 
combined with government intervention to control inflation, 
increase Argentina's vulnerability to falling commodity 
prices and higher world interest rates in the long-term.  End 
Comment). 
 
GoA primary surplus reaches 4% of GDP in 2006 
--------------------------------------------- 
¶7.  In a press conference on January 22, Minister of Economy 
Miceli officially announced an ARP 23.2 billion (3.6% of GDP) 
primary surplus for 2006, above the 3.3% forecast in the 2006 
budget.  In her statement, Miceli noted that the strong 
fiscal result would support continued high growth levels. 
The consolidated primary fiscal surplus, including the 
provinces, was 4%, comprised of the 3.6% federal primary 
fiscal surplus and a 0.4% provincial primary fiscal surplus. 
(Note:  In 2005, the consolidated primary fiscal surplus 
reached 4.4% of GDP, 3.7% from the federal government and 
0.7% from the provinces.  End Note) 
 
Argentina's country risk premium hits all time low 
--------------------------------------------- ------ 
¶8.  Argentina's country risk premium, as measured by the 
benchmark J.P. Morgan Emerging Market Bond Index Plus (EMBI 
plus), fell to 185 basis points (above comparable Treasuries) 
on January 26, the lowest level since JP Morgan introduced 
the original Index in 1992.  As of February 2, it remained at 
that level.  (Comment:  This rating measures Argentine 
dollar-denominated bonds issued under U.S. law that trade 
internationally and are highly liquid.  It does not reflect 
the real cost to the GoA of issuing new debt.  The Bonar VII 
is the main financial instrument that the GoA is currently 
issuing to cover its financial needs.  In the GoA's January 
25 auction, the Bonar VII was issued at a 287 basis points 
spread over comparable Treasuries.  End Comment). 
 
Concerns over cost to GoA of GDP Warrants 
----------------------------------------- 
¶9.  Following higher than forecast GDP figures in 2006, 
private sector analysts are expressing concern over the cost 
to the GoA of the December 2007 payment on the GDP-linked 
warrants, which the GoA provided to bondholders as an 
inducement to participate in the 2005 sovereign debt 
exchange.  (Note: All bonds issued in the restructuring came 
with attached warrants, linked to GDP growth.  The warrants 
pay 5% of the excess GDP growth above a trend forecast, which 
ranges from about 4.3% in 2005, to 3.2% in 2013, and then 
stabilizes at 3% starting 2014.)  The GoA made the first 
payment of $400 million in December 2006, based on 2005 
growth.  Private sector analysts predict the GoA will be 
forced to make payments of $830 million in 2007 and $1.2 
billion in 2008. 
 
--------------- 
Economic Policy 
--------------- 
 
All eyes on January's CPI after dismissal of 
INDEC Director in charge of CPI index. 
-------------------------------------------- 
¶10.  The Argentine statistical agency, INDEC, reported 
February 5 that CPI inflation in January was 1.1% month on 
month, significantly below market expectations of 1.2 - 1.6%, 
and the lowest inflation rate for the month of January since 
¶2003.  The markets and local media were closely monitored the 
release, following Economy Minister Miceli's decision on 
January 31 to fire INDEC's Director of Prices Graciela 
Bevacqua.  Local media reported that Miceli fired Bevacqua 
because she refused to provide details on the locations where 
CPI survey prices are gathered, which would have been a 
violation of INDEC's confidentiality provisions.  She 
apparently also opposed the Minister's attempts to change the 
methodology of the index, particularly with regards to the 
calculation of price increases for health services. 
 
¶11.  The issue has been front page news for the last week, 
with even pro-government commentators raising concerns about 
government manipulation of statistics.  Tensions increased 
over the weekend, when Internal Affairs Minister Anibal 
 
Fernandez accused INDEC employees of being crooks, and 
unnamed INDEC employees threatened to reveal the "real" CPI 
figures to the press if the GoA attempted to manipulate the 
data.  Indeed, unnamed INDEC employees issued an "open 
letter" to the President and public on February 4 calling the 
GoA intervention a "totalitarian action" and an 
"institutional coup."  Adding further intrigue, INDEC delayed 
the release from the normal 4:00 PM time to after 7 PM, 
complicating the media's efforts to report it.  The 
announcement showed much lower than expected price increases 
for tourism, which increased 3.7% m-o-m, compared to an 
increase of 16.7% m-o-m in January 2006.  INDEC also reported 
health costs increasing only 2.2%, despite that health care 
companies are in the process of instituting 22% price 
increases (Note:  health costs comprise 5.5% of the index, 
and the actual monthly inflation figure would be in the 2.2% 
range if INDEC used the 22% figure.  However, Economic 
Ministry officials argue that the 22% increase was for 
"premium services," and not equivalent to the type of service 
included in the index). 
 
¶12. INDEC has always been considered a relatively independent 
agency with regards to the collection of data, methodology, 
and calculation of the index.  Nevertheless, there were 
already questions about the legitimacy of the inflation data, 
due to the government's use of "voluntary price accords" and 
export bans.  The appearance of government manipulation could 
have important negative repercussions, because the CPI is a 
key indicator for calculating poverty levels, is the 
reference for wage negotiations, and is used to adjust 
government debt linked to CER (CPI-linked index).  Given that 
42% of GoA debt is adjusted by CER, the recent developments 
could have a significant impact on Argentine bond prices and 
yields.  Bevacqua's replacement, Beatriz Paglieri, is 
reportedly close to Secretary of Internal Trade Guillermo 
Moreno, who is the force behind the Argentine government's 
price controls and other heterodox policies to control 
inflation. 
 
GoA announces reform of the pension system 
------------------------------------------ 
¶13.  On February 1, the GoA sent a bill to Congress that will 
allow transfers from the private pension system (the so 
called AFJPs Pension Funds) to the state social security 
system.  Individuals who opt for the private system (which 
was introduced in 1994) are currently barred from switching 
back to the state system.  According to the announcement, the 
bill would allow workers to choose between the two systems 
every five years and would assign new employees to the 
state-run system by default.  Under the current system, new 
employees that do not specifically choose a pension fund are 
randomly assigned to one of the eleven private pension funds, 
whose managed portfolio currently stands at $30 billion.. 
The bill would also cap the private funds' commission at 1% 
of a worker's contribution, down from the current 3%.  (Note: 
 this figure, which has captured a lot of attention in the 
press, is misleading.  The current 3% commission includes 1.5 
percentage points for insurance, which under the new law will 
be considered a cost.  Therefore, the draft bill is actually 
cutting the commission from 1.5% to 1% -- still a significant 
33% cut.  End Note)  The head of the Anses (Argentine Social 
Security Administration), Sergio Massa, stated January 25 
that the GoA will offer incentives to workers who choose to 
switch from the private system to the state system.  Deputy 
Agustin Rossi predicted that Congress would approve the 
pension reform bill during its extraordinary session in 
February. 
 
¶14.  According to press reports, the reform bill states that 
workers' savings in the private pension system will not be 
transferred to the state system if a worker switches from the 
private regime to the public one.  Thus, the private pension 
system's existing funds under management will not be affected 
by the reform.  However, new payments into the state system 
will likely increase due to switchovers and also due to the 
undecided workers assigned to the state system.  (Note: Under 
the existing arrangement, only three out of every ten new 
workers choose a particular system.)  This will come at the 
 
expense of payments into the private pension system, which 
will almost certainly decline from the current monthly 
inflows of $150-180 million.  According to local analysts, 
the increase in Anses' revenues may reach $800 million to 
$1.3 billion per year (0.4 to 0.6% of GDP).  Some local 
analysts have welcomed the reform, since it expands the 
choices for workers and lowers commissions.  Others comment 
that the GoA's motivation for the change is to bring more 
revenue to the State, at the expense of sizable contingent 
liabilities, in the form of future pension payments.  Whether 
an individual should choose private over public depends on 
factors including age, salary, and number of years in the 
workforce.  It is likely that younger and high-paid workers 
will prefer the private system, while older and lower paid 
workers will choose (or shift to) the state-system. 
 
Wage negotiations heat up 
------------------------- 
¶15.  The local press has reported that Hugo Moyano, the head 
of the Argentina's largest union (CGT -- Confederacion 
General de Trabajadores), conveyed to President Kirchner the 
union's demand for a 20 to 30% wage increase for 2007.  This 
would significantly exceed the GoA's target of capping salary 
increases in the 12-14% range.  Two other unions -- 
representing railway and electricity employees -- have 
already begun salary negotiations with the government, and 
are also asking for 20% to 30% increases.  Other sectors -- 
including meat and flour factory processors -- have also 
announced that they will seek 20% raises.  Businesses are 
complaining that union demands are unacceptable, especially 
for those sectors subject to GoA price controls.  (Comment: 
part of the GoA's rationale -- at least privately -- for 
aggressively intervening to keep CPI inflation under 10% in 
2006 was to reduce expectations for large wage increases. 
Based on labor's pursuit of 20-30% wage hikes, it appears 
that unions understand that repressed inflation is more 
likely in the 12-15% range, and likely also realize that the 
GoA will have to allow utilities to raise prices sharply over 
the next couple of years.  End Comment). 
 
---------------- 
Economic Outlook 
---------------- 
 
Argentina's trade surplus reached $12.4 billion 
in 2006, above market expectations 
--------------------------------------------- --- 
¶16.  The December trade surplus reached $1.5 billion, well 
above market expectations of $1 billion.  The cumulative 
trade surplus for 2006 was $12.4 billion, above market 
expectations of $11.8 billion.  In December, exports 
increased 17% y-o-y to $4.2 billion, while imports increased 
a mere 10% y-o-y to $2.7 billion.  Exports were driven by 
increases in agribusiness (24% y-o-y) and industrial goods 
(33% y-o-y), while primary goods remained unchanged and fuel 
and energy exports decreased 3% y-o-y.  Imports were driven 
by increases in parts for capital goods (25% y-o-y) and 
consumer goods (16% y-o-y).  The BCRA consensus survey 
expects the 2007 annual trade surplus to narrow to $11.7 
billion, compared with $12.4 and $11.3 billion surpluses in 
2006 and 2005, respectively.  With this expected trade 
surplus, the BCRA will have to continue intervening 
aggressively to prevent the appreciation of the peso. 
 
¶17.  The better than expected trade surplus in 2006 was 
mainly the result of decelerating import growth, rather than 
export growth.  Exports increased at an annual rate of 15%, 
compared to 16.1% growth in 2005, 15% growth in 2004, and 
almost 17% growth in 2003.  Moreover, the growth in export 
volumes was relatively low at 7%, with price increases 
responsible for the other 8%.  Although imports increased 19% 
-- a faster rate than exports -- the growth rate is 
decelerating, with annual import growth of 28% in 2005 and 
62% in 2004. 
WAYNE