VZCZCXRO2308
RR RUEHCD RUEHGA RUEHGD RUEHHA RUEHHO RUEHMC RUEHQU RUEHTM RUEHVC
DE RUEHBU #1995/01 2781831
ZNR UUUUU ZZH
R 051831Z OCT 07
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC 9427
INFO RUCNMRC/WESTERN HEMISPHERIC AFFAIRS DIPL POSTS
RUEHSO/AMCONSUL SAO PAULO 3562
RUEAIIA/CIA WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/USDOC WASHINGTON DC

UNCLAS SECTION 01 OF 04 BUENOS AIRES 001995 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
NSC FOR DAN FISK 
PASS FED BOARD OF GOVERNORS FOR KROSZNER, ROBITAILLE 
PASS EXIM BANK FOR MICHELE WILKINS 
PASS OPIC FOR JOHN SIMON, GEORGE SCHULTZ, RUH ANN NICASTRI 
USDOC FOR 4322/ITA/MAC/OLAC/PEACHER 
 
E.O. 12958: N/A 
TAGS: EFIN ECON ETRD AR
SUBJECT: ELECTION-YEAR SPENDING EXTRAVAGANZA UNDERMINES 
ARGENTINA'S FISCAL BALANCE AND ABETS HIGHER INFLATION 
 
REF: BUENOS AIRES 1415 
 
BUENOS AIR 00001995  001.2 OF 004 
 
 
This document contains sensitive information.  It should not 
be disseminated outside of USG channels or in any public 
forum without the written concurrence of the originator.  It 
should not be posted on the internet. 
 
Summary 
------- 
¶1. (SBU) Argentine President Kirchner's election-year 
spending spree has exceeded expectations and led to 
deteriorating fiscal accounts in 2007.  Through July 2007, 
expenditures increased almost 50% year-over-year, a result of 
large increases in pension payments, subsidies, wages, and 
capital spending, all with the apparent goal of buying votes 
for the October 28 national elections.  Estimates for the 
2007 federal primary fiscal surplus (before debt interest 
payments) are a seemingly healthy 3.1 - 3.5% of GDP. 
However, the figure is only closer to 2% after subtracting a 
one-time transfer to the GoA from the private pension system. 
 The provinces, in general, are in worse financial shape, and 
will likely require greater federal financial support. 
Maintaining current spending levels would risk fiscal 
deficits and increasing inflation starting in 2008, and would 
also threaten economic growth and the GoA's capacity to make 
debt payments.  However, there is still time to make 
corrections, and Presidential front-runner Cristina Kirchner 
appears to realize that fiscal reform is the top priority for 
the next administration.  End Summary. 
 
Intro: Deteriorating Fiscal Erodes Macro Anchor 
--------------------------------------------- -- 
¶2. (SBU) The GoA's rapid increase in election-year spending 
has resulted in deteriorating fiscal accounts in 2007, 
despite record revenues.  The GoA's fiscal policy is 
pro-cyclical and extremely expansive, contributing to a 
consumption-led economic boom and boosting projected 
inflation up from under 10% in 2006 to the 15-18% (or higher) 
range in 2007, as estimated by numerous private economists. 
The GoA's adjusted official inflation number remains below 
9%.  In light of the Central Bank's expansionary monetary 
policy since 2005, the fiscal surplus has been the GoA's 
macroeconomic anchor.  This anchor has eroded as a 
consequence of the Kirchner administration's spending 
policies in 2006 and 2007.  The apparent goal of these 
policies has been to gain political support for a string of 
elections this year, culminating in the October 28 
presidential and legislative elections. 
 
Expenditures getting out of control 
----------------------------------- 
¶3. (SBU) Private analysts' estimates and predictions on GoA 
expenditures vary widely, mainly due to the difficulty in 
obtaining reliable statistics, particularly on GoA subsidies. 
 A senior Economy Ministry official, who is nominally in 
charge of budget issues, has admitted to Econoffs that the 
GoA has increased expenditure so rapidly in 2007 that total 
spending is a "moving target." 
 
¶4. (SBU) Expenditures through July 2007 have increased an 
estimated 50% y-o-y.  This was the result of election-year 
largesse, particularly increases in pension payments of up to 
60% y-o-y.  These payment increases were mainly due to a 13% 
increase implemented January 2007 and a 12.5% increase 
granted in September.  However, they were also the result of 
the addition of more pensioners following the GoA's pension 
system reform (see paras 9-10 below).  The GoA has also 
granted large increases in public wages (up almost 30% y-o-y) 
and transfers (subsidies) to the private sector, mainly for 
transport and energy (up at least 46% y-o-y, if not more). 
Capital spending has also increased rapidly (37% y-o-y), 
albeit at a slower pace than the 65% increase in 2006. 
Overall, federal primary spending (not including interest 
payments on debt) increased from 13.8% of GDP in 2006 to an 
estimated 17% of GDP for 2007. 
 
Cost of Price Controls: Subsidies and Capital Spending 
--------------------------------------------- --------- 
¶5. (SBU) In order to alleviate pressure on those private 
sector companies whose products are subject to GoA price 
control policies, the GoA has steadily increased transfers to 
 
BUENOS AIR 00001995  002.6 OF 004 
 
 
the private sector as well as public sector capital 
expenditures.  Both the subsidies and public works 
expenditures have been targeted primarily to the energy and 
transport sectors, where price controls in place since 2002 
have resulted in supply shortages (due to lack of investment 
in infrastructure and maintenance -- see reftel). 
 
¶6. (SBU) Private sector economists estimate 2007 public 
transfers at between 11 and 13 billion pesos (roughly $3.5 - 
$4.1 billion), or about 1.5% of GDP (compared to subsidies of 
0.7% of GDP in 2006).  This constitutes a more than 100% 
increase over such spending in 2006, which itself represented 
a more than 80% increase over subsidies/loans in 2005. 
 
¶7. (SBU) The purpose of the transfers is to compensate for 
the difference in the international price of diesel and 
natural gas and the controlled and much lower domestic 
prices.  The GoA is reportedly also directing a hefty 
percentage to subsidize fuel costs in the transport sector 
(trains, buses, subways, and air traffic).  Of the total, 
roughly one billion pesos support agriculture and livestock. 
 
Revenues growing, but at a slower pace 
-------------------------------------- 
¶8. (SBU) Tax revenues increased over 38% y-o-y through July. 
Although the higher revenues are partly a result of improved 
compliance, they are largely due to high growth and 
inflation, with nominal GDP growth in the range of 24-26%. 
In addition, export taxes on Argentina's rapidly-growing 
primary commodity exports are responsible for about a third 
of the increase.  Note, however, that the GoA recently 
announced another pre-election gift to voters, increasing the 
non-taxable annual income level that individuals can claim, 
resulting in a 1.5 billion peso reduction in income tax 
revenue.  The purpose of this alteration to the tax code 
appears to be to pump up consumer spending prior to the 
October 28 elections (Comment:  it will also likely pump up 
inflation.) 
 
¶9. (SBU) Through the end of July, total revenues -- including 
non-tax revenues -- increased approximately 55% y-o-y. 
However, non-tax revenues include one-off transfers to the 
GoA from the private pension system (see next section).  This 
is a consequence of pension reform in early 2007, which 
allowed contributors to switch from the private system to the 
government pension plan. 
 
Falling Primary Fiscal Surplus 
------------------------------ 
¶10. (SBU) Private analysts estimate the 2007 federal primary 
fiscal surplus in the range of 3.1 - 3.5% of GDP.  While this 
approximates the 3.5% primary surplus in 2006, and may still 
appear healthy, the figure is distorted because of the 
one-off pensions transfer.  Subtracting this estimated $2.4 
billion transfer to the GoA from the private pension system 
results in a federal primary surplus of only 2 - 2.4% of GDP, 
well below the 3.5% or higher level of 2004-2006. 
 
¶11. (SBU) Private estimates of the overall federal fiscal 
surplus (including interest payments on debt) also vary 
widely, but are generally in the range of 1% to 1.5% of GDP, 
significantly below the over 2.5% peak in 2004.  Note, 
however, that the overall federal fiscal surplus approaches a 
zero balance when excluding the one-off pension funds 
transfer. 
 
Provincial Finances Also Deteriorating 
-------------------------------------- 
¶12. (SBU) Taken as a whole, the Provinces' financial 
condition is worsening, although Buenos Aires Province and 
City, comprising over a third of total non-federal 
expenditures, are in the worst shape and skew the numbers. 
Through July, provincial revenues increased 20% y-o-y, 
compared to a 25% y-o-y increase in expenditures.  Increases 
in provincial expenditures have exceeded increases in 
revenues every year since 2005.  This is mainly due to rapid 
increases in salaries, which represent almost 50% of total 
provincial expenditures, compared to below 20% for the 
federal government (the Provinces have historically used 
public sector employment as a source of political patronage). 
 As a result, for the first time since the 2002 crisis, 
 
BUENOS AIR 00001995  003.3 OF 004 
 
 
provincial primary spending may exceed total tax revenues in 
¶2007.  A likely consequence will be increased demands on the 
GoA for financial support to the provinces; payments that are 
not included in the above budget calculations. 
 
¶13. (SBU) Some Argentine economists' predict the provinces 
will end 2007 with a slight primary fiscal deficit (of up to 
0.2% of GDP), while others expect a tiny surplus, of 0.3% of 
GDP or smaller.  However, all economists surveyed for this 
report expect an overall provincial fiscal deficit, when 
including interest payments on debt, of between 0.1 and 0.4% 
of GDP.  This is a large turnaround from 2004, when the 
provinces' overall surplus exceeded 1% of GDP. 
 
Consolidated Surplus Disappearing 
-------------------------------- 
¶14. (SBU) As a consequence of the deteriorated federal and 
provincial finances, the consolidated primary fiscal surplus 
(including federal and province governments) has fallen 
dramatically from its peak of 5.2% in 2004.  Including the 
one-off pension system transfer, estimates for the 2007 
consolidated primary fiscal surplus vary from 2.8% to 3.5% of 
GDP, and estimates for the overall consolidated surplus 
(including interest payments on debt) vary around 1% of GDP. 
However, a key point is that when excluding the pensions 
transfer, the consolidated fiscal balance (including interest 
payments) may end the year in deficit, for the first time 
since 2002. 
 
Large Primary Surplus Needed to Ensure Debt Sustainability 
--------------------------------------------- ------------- 
¶15. (SBU) Maintaining a large overall surplus is especially 
relevant to Argentina, given its current and contingent debt 
liabilities.  Most analysts estimate Argentina's financing 
needs for 2008 at approximately $6-7 billion.  Argentina can 
manage this debt, even taking into account the GoA's reduced 
access to capital markets following international financial 
market volatility that began in July.  It can raise 
sufficient funds from Treasury savings, the government 
pension fund agency, and borrowing from the Central Bank. 
However, its financing needs will surge in 2009 and beyond, 
which may complicate the GoA's fulfillment of its financial 
needs. 
 
¶16. (SBU) In addition to its normal financial needs, the GoA 
faces significant debt arrears and contingent liabilities. 
The GoA is facing roughly $6 billion in debt (including 
current arrears of about $4 billion) to Paris Club members, 
has approximately $25 billion in outstanding debts to 
so-called "holdouts," bondholders that did not participate in 
the 2005 debt exchange, and also has roughly $13 billion in 
outstanding claims before ICSID, dating to the 2001/2 
financial crisis.  In addition, in 2007 the GoA has announced 
about $14 billion in government-financed infrastructure 
projects over the next 2-3 years, mainly in the energy 
sector.  While these payments will likely be negotiated down 
and spread over years, clearly higher fiscal surpluses are a 
requisite for the GoA to manage these contingent debts and 
finance the envisioned projects.  Another important 
consideration, given the tight credit market, is that every 
percentage point of higher fiscal surplus is equivalent to 
$2.5 billion fewer funds that the GoA must raise in the 
market. 
 
2008 Scenario: Slower Spending or Fiscal Unravels 
--------------------------------------------- ---- 
¶17. (SBU) In addition to undermining fiscal accounts and 
boosting consumer prices, the GoA's heavy spending has also 
contributed to the disproportionate impact of recent 
international market volatility on Argentina's country risk 
premium.  Bondholders punished the GoA for undermining macro 
fundamentals and losing control of inflation.  Therefore, 
local economists surveyed for this report argue that fiscal 
reform (reducing the pace of expenditures) is the critical 
task for the next administration, in order to regain 
credibility and reduce inflationary pressures.  Otherwise, 
maintaining current spending levels will result in an overall 
consolidated fiscal deficit in 2008 and worsening deficits 
and inflation in 2009-2011. 
 
¶18. (SBU) The good news is that a large chunk of the increase 
 
BUENOS AIR 00001995  004.3 OF 004 
 
 
in 2007 expenditures has a one-time impact, and will not 
necessarily carry over into 2008.  This includes a 
substantial percentage of the increase in pension payments, 
and also includes subsidies to the private sector.  In fact, 
Economy Ministry officials privately point out that cutting 
subsidies is the only feasible means to restore the fiscal 
balance to near 2004-2006 levels. 
 
¶19. (SBU) GoA officials appear to have grasped that the 
deteriorating fiscal situation adversely affects Argentina's 
economic and inflationary outlook and the GoA's ability to 
raise financing.  President Kirchner has reportedly ordered a 
reduced pace of spending following the October 28 elections 
and in the 2008 budget (septel).  Economy Ministry officials 
tell us that they are instructed to pursue the "Kirchner 
Rule," which requires expenditures to increase at the same 
rate of growth as revenues.  Senator and leading Presidential 
Candidate Cristina Fernandez de Kirchner has also publicly 
voiced concern about the GoA's deteriorating fiscal balance, 
and has pledged that as President she would pursue tighter 
fiscal policies in 2008. 
 
Comment 
------- 
¶20. (SBU) Argentina's ability to prevent this year's spending 
spree from precipitating an economic crisis down the road 
will depend on the next government's willingness to make 
quick policy adjustments.  However, cutting subsidies would 
have major political ramifications for an incoming 
administration, as the GoA would likely be compelled to raise 
energy and transport tariffs to compensate private companies 
for the lost subsidies (and thus avoid severe supply 
problems).  These higher prices would accompany slowing 
growth, surely an unpopular combination for the Argentine 
public.  The Kirchners have yet to govern during a period of 
slowing growth, and it remains to be seen whether the new 
president will be willing to make the politically unpopular 
decisions necessary to bring down both inflation and growth 
to more moderate and sustainable levels.  End Comment. 
WAYNE