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RUEHRI/AMCONSUL RIO DE JANEIRO 2444

UNCLAS BUENOS AIRES 000422 
 
SIPDIS 
 
SIPDIS 
SENSITIVE 
 
C O R R E C T E D  C O P Y - ADDED PARA, SIG 
 
E.O. 12958: N/A 
TAGS: ECON EFIN OREP AR
SUBJECT: CODEL Shelby discusses financial crisis, inflation, banking 
regulation with Argentina's Central Bank 
 
Ref: (A) 2007 Buenos Aires 1083 and previous 
 
------- 
Summary 
------- 
 
¶1. (SBU) During a March 25 meeting with Argentine Central Bank 
President Martin Redrado, a CODEL led by Senator Shelby (R-AL) 
congratulated the Central Bank for exceeding $50 billion in official 
reserves, asked about efforts to bring down inflation, and inquired 
about the possibility of an agreement with "Holdout" bondholders. 
Central Bank President Martin Redrado highlighted the limited impact 
of global financial market turmoil on the local economy and 
financial sector, and said there are no/no indications that 
inflation in Argentina is spiraling out of control.  He said the GoA 
is moving out of its "emergency response" mode and into a longer 
term strategic planning mode.  Both sides discussed their concerns 
about proposed changes to banking regulation.  End Summary. 
 
---------------------------------------- 
Focus On Financial Crisis And Regulation 
---------------------------------------- 
 
¶2. (U) Senator Richard Shelby (R-AL), ranking member of the Senate 
Banking Committee, Senator Judd Gregg (R-NH), Senator Bob Corker 
(R-TN), Senator Mike Crapo (R-ID), and Congressman Bud Cramer 
(D-AL), met March with Central Bank President Martin Redrado to 
discuss the impact of international financial market turmoil and the 
state of the Argentine economy.  Meetings with Justice Minister and 
representatives from U.S. financial institutions reported septels. 
 
¶3. (SBU) Senator Shelby commended the work of the Central Bank 
(BCRA) in supporting the phenomenally high economic growth in 
Argentina over the last five years, and also for exceeding $50 
billion in international reserves, which happened March 12.  Shelby 
inquired about BCRA and GoA efforts to contain inflation and also 
about the impact to date of the U.S. financial crisis on Argentina's 
financial sector and broader economy.  Shelby also asked for 
Redrado's perspective on the chances of the GoA settling with the 
so-called "Holdout" bondholders (who refused to participate in the 
2005 debt exchange following the GoA's massive debt default in late 
December 2001). 
 
---------------------------- 
U.S. Financial Sector Crisis 
---------------------------- 
 
¶4. (SBU) According to Redrado, the U.S. is now tackling a systemic 
solvency crisis as opposed to a simple liquidity problem and so he 
hoped the U.S. would follow a "mark to model" vs. a notional "mark 
to myth" protocol in valuing mortgage-backed derivative securities. 
The package of U.S. Treasury and Federal Reserve measures announced 
to date is certainly helpful, he thought, but does not address this 
key question of derivative security valuation or -- by extension -- 
the contingent liability the Fed may eventually have to absorb. 
(Note: Redrado did not mention but clearly had in mind the U.S. 
Federal Reserve's agreement to take on liquidation risks associated 
with $30 billion of Bear Stern's mortgage-backed derivative 
portfolio). 
 
¶5. (SBU) Redrado commented that this is the first time in 
Argentina's history that a worldwide crisis has barely affected the 
local economy.  He credited this mostly to the limited size of the 
Argentine financial sector following the 2001/2002 crisis, which has 
sheltered the economy somewhat.  But he also highlighted the BCRA's 
high reserve levels and the flexible exchange rate as been major 
factors in allowing the BCRA to make adjustments to protect local 
financial markets. 
 
--------------------------------------------- ------- 
Inflation A Problem But Not Spiraling Out Of Control 
--------------------------------------------- ------- 
 
¶6. (SBU) Redrado reviewed his now standard defense of Argentina's 
policies to tackle inflation (Reftel).  In brief: Argentina is not a 
typical emerging market economy and there is no "one-size-fits-all" 
prescription to fight inflation.  The "2001/2 economic crisis dust 
has not yet settled" and Argentina will remain in a post-crisis 
 
"transition phase" through 2010-2012.  During this period, standard 
anti-inflation tight money/high interest rate policy prescriptions 
will not/not be effective.  For example, raising domestic interest 
rates (from current net negative levels) would not have the same 
potential to contain aggregate demand growth as it would have in the 
U.S., since the Argentine credit market is extremely shallow, 
representing only 10% of GDP, compared to over 100% in the U.S. 
¶7. (SBU) There are no/no indications that domestic inflation is 
spiraling up from current levels, and he argued that to "gradually 
bring inflation down" the GoA and BCRA must pursue a combination of 
policies:  fiscal discipline, monetary prudence (i.e. maintaining 
nominal M2 growth below nominal GDP growth), a flexible exchange 
rate, wage containment (i.e. actively managing inflationary 
expectations) and improving market oversight/regulation. 
 
--------------------------------------------- ---- 
Argentina Overcoming History of Fiscal Profligacy 
--------------------------------------------- ---- 
 
¶8. (SBU) According to Redrado, the GoA has successfully overcome a 
history of overspending, maintaining a primary fiscal surplus in 
each of the past five years.  Redrado admitted, however, that fiscal 
discipline had "marginally deteriorated" in the 2007 calendar year 
leading up to national elections.  The nominal rate of increase in 
fiscal spending had increased to the 50% range from late 2006 
through 2007.  The good news, he noted, is that the GoA has reduced 
the rate of increase in nominal fiscal spending so far in 2008 to 
the 35% level, in order to sustain fiscal discipline.  However, 
Redrado acknowledged that the fiscal situation had improved mostly 
due to higher revenues.  Redrado said his personal preference was 
for a 25-28% increase in 2008 nominal fiscal spending, which would 
result in a 4% primary surplus (compared to the 2.2% primary surplus 
in 2007).  He said that, while a significant percentage of GoA 
expenditures were dedicated to growth-sustaining infrastructure 
projects, the majority of increased GoA expenditures over the last 
year were a consequence of increased government wages. 
 
¶9. (SBU) In sum, Redrado said, the GoA and BCRA are providing three 
key public goods: stable fiscal policy, prudent and consistent 
monetary policy, and stable (albeit flexible) exchange rate policy. 
This is a first in Argentina's recent history.  That Argentina has 
had 55 Central Bank presidents in the past 72 years says much about 
the volatility of Argentina's economy and about the volatility of 
its economic policy management.  Redrado predicted that current 
financial sector stability will be sustained and will allow the 
Argentine economy to grow sustainably in the future. 
 
--------------------------- 
Financial Sector Regulation 
--------------------------- 
 
¶10. (SBU) Redrado explained that, while the BCRA regulates 
commercial banks, separate and independent GoA entities regulate 
Argentine securities markets, insurance companies and pension funds. 
 The latter currently manage over US$ 30 billion in assets.  Redrado 
and Senator Shelby shared their concerns about the potential impact 
of the Basel II bank regulation framework, particularly with regards 
to proposals to reduce drastically capital requirements for large 
banks. 
 
¶11. (U) Codel Shelby cleared this message. 
WAYNE