VZCZCXRO5549
PP RUEHCD RUEHGA RUEHGD RUEHHA RUEHHO RUEHMC RUEHQU RUEHTM RUEHVC
DE RUEHBU #0433/01 0981844
ZNR UUUUU ZZH
P 071844Z APR 08
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC PRIORITY 0653
INFO RUCNMRC/WESTERN HEMISPHERIC AFFAIRS DIPL POSTS PRIORITY
RUEAIIA/CIA WASHINGTON DC PRIORITY
RUEATRS/DEPT OF TREASURY WASHINGTON DC PRIORITY
RHEHAAA/NATIONAL SECURITY COUNCIL WASHINGTON DC PRIORITY
RUCPDOC/USDOC WASHINGTON DC PRIORITY

UNCLAS SECTION 01 OF 04 BUENOS AIRES 000433 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON EINV ETRD ELAB EAIR AR
SUBJECT: ARGENTINA ECONOMIC AND FINANCIAL REVIEW, MARCH 17 
- APRIL 4, 2008 
 
 
¶1. (U) Provided below is Embassy Buenos Aires' Economic and 
Financial Review covering the period March 17 - April 4, 
¶2008.  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.  This document is 
sensitive but unclassified.  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. 
 
---------- 
Highlights 
---------- 
-- Economic Impact of Agricultural Sector Strike 
-- GoA soon to issue ARP 1-2 billion of peso denominated debt 
-- GoA considers debt exchange to alleviate 2009-2011 debt 
service payments 
-- Who holds GoA defaulted debt? 
-- What is going on with the Real Exchange Rate in Argentina? 
-- FIEL criticizes quality of GoA primary fiscal surplus 
 
Economic Impact of Agricultural Sector Strike 
--------------------------------------------- 
¶2. (SBU) Many local observers considered the farming sector 
strike that began March 13 -- in response to the GoA's 
unanticipated March 11 decree to increase export taxes on 
Argentina's major agricultural export crops --to be the worst 
crisis of the Kirchner era (since 2003).  It was also seen as 
a major challenge to the Kirchner's Peronist economic model 
of taxing the most-productive sectors of the economy (mainly 
Agriculture) to support less efficient industry and create a 
social safety net for the roughly 25% of the population that 
lives below the poverty line. 
 
¶3. (SBU) Post has sent in extensive front-channel reporting 
on the ongoing crisis -- which ended April 2 when farmers 
agreed to a 30-day truce -- with a particular focus on the 
political repercussions of the dispute. (See BA 368, 376, 
398, 408 and 415).  The impact of the 20-day strike on 
Argentina's economy and the GoA's budget is less clear at 
this time, but there is much to worry about.  Local media is 
speculating that the cost of the strike so far -- on 
industry, transport, and commerce -- is as high as US$ 1.5bn, 
in the range of 0.5% of GDP (more than the US$1.2 billion in 
expected revenues from the March 11 tax increase).  As a 
consequence, many analysts are considering lowering their 
forecasts for real GDP growth in 2008 (most current forecasts 
range from 6-7%). 
 
¶4. (SBU) While the strike's blockade of the nation's 
transport infrastructure had a direct effect on a number of 
industrial and commercial sectors, of equal concern to 
analysts are the measures the GoA announced March 31 to 
alleviate the impact of the higher taxes on small and 
medium-size farms.  The worry is that these mostly fiscal 
incentives could adversely impact the GoA's finances, leading 
to further uncertainties about the GoA's financing needs, 
interest rates, and stability of the peso. (Export tax 
revenues account for over 80% of the primary fiscal surplus.) 
 
 
¶5. (SBU) Higher subsidies, reduced tax collection due to the 
cessation of cereals and grains exports, and the overall 
adverse impact of the strike on the economy (and on tax 
collection), have led many private analysts to reduce 
forecasts for the GoA's primary fiscal surplus for 2008, 
after having just increased them following the March 11 tax 
increase.  Early reports on March tax collection show that it 
was much lower than expected, due in large part to the double 
blow the GoA received on soy export taxes: soybean prices 
have fallen significantly (nearly 25%) off their high, and 
because of the protests only about 5% of Argentine soybeans 
have been harvested, compared to about 20% standard for this 
point in the harvest season. 
 
¶6. (SBU) Also of increasing concern is the possible spike in 
inflation due to strike-related food price increases, with 
some estimates for year-end inflation as high as 40% 
(although most are in the 25-30% range).  Analysts are also 
closely watching the peso, which has depreciated slightly 
against the dollar (during a period when it usually 
appreciates due to large FX inflows from Ag exports).  There 
is worry that the GoA may consider offsetting lost tax 
revenues with a depreciation of the peso.  This scenario 
could provoke capital outflows, leading to interest rate 
hikes, decelerating consumption and imports, lower tax 
 
BUENOS AIR 00000433  002 OF 004 
 
 
revenues, and increasing uncertainties about the GoA's 
finances.  No doubt due to the increased pessimism resulting 
from these added uncertainties, Argentina's country risk 
rating, as measured by JPMorgan's EMBI plus reached 581 basis 
points, near the post-default high, its Credit Default Swaps 
rate jumped up to a record 594 basis points, and local think 
tank Ecolatina's "Financial Risk Index" (which also measures 
peso bonds) closed at a new record of 785 basis points. 
 
¶7. (SBU) The question is whether this strike is a political 
and economic turning point.  Whether or not the GoA reacts by 
improving its political and economic decision-making, this 
strike may still result in a weakened government and economy, 
leaving Argentina more vulnerable to and unprepared for a 
sharp downturn in global commodity prices. 
 
GoA issues ARP 867 million peso bonds at a yield of 13.30% 
-------------------------------------------- 
¶8. (SBU) In an April 3 auction, the GoA issued ARP 867 
million of Bonar 2013 (Bono de la Nacion) at a yield of 
13.30%, below market expectations of 13.5%-14%.  This is a 
peso-denominated, variable rate, 5-year bullet bond, maturing 
in 2013, with an interest rate of BADLAR plus 350 basis 
points.  (The Badlar, currently at 8.5%, is the wholesale 
interest rate for deposits of more than ARP 1 million 
(approx. $320,000).)  The GoA last issued a 5-year, 
eso-denominated, fixed rate bullet bond in June 2007 
(without inflation adjustment) at a yield of 11.70%. 
 
¶9. (SBU) The GoA is authorized to issue up to ARP 5 billion 
($1.6bn) of this bond.  It received bids for ARP 1.8 billion, 
resulting in a bid cover ratio of 2.1, and raised ARP 827 
million cash value (as the bond was issued at a discount). 
Local media had speculated that the success of this first 
issue was guaranteed, despite international market 
turbulence, because of strong appetite from local investors, 
especially pension funds, banks, and insurance companies. 
The pension funds' high liquidity positions are due to: a) 
the increase from 7% to 11% in employee wage deductions for 
pension contributions; and b) the GoA regulation, issued 
October 2007, forcing Argentine pension funds to repatriate 
their investments from Mercosur countries (primarily Brazil). 
 However, when analyzing the bids for the auction, it is 
clear that the success of this issue was due to Banco la 
Nacion's strong participation, as it purchased 42% (or ARP 
365 million) of the issue.  According to local traders, 
without Banco Nacion's participation, the bond yield would 
have exceeded 14%.  Ambito Financiero speculated that if the 
GoA had issued a fixed rate bond, similar to the one issued 
June 2007, it would be paying a 16% fixed interest rate. 
 
¶10. (SBU) For reference, November 2007 was the last time the 
GoA was able to issue bonds at public auction, and it issued 
$500 million of the Bonar X (ten-year, dollar denominated 
bond, maturing April 2017, with a 7% fixed interest coupon, 
at a yield of 10.5%).  Thereafter, the GoA completed its 2007 
financial needs by issuing debt directly to public sector 
agencies, such as the Social Security Administration, the 
Argentine tax collection agency (AFIP), and the Federal 
Lottery.  GoA financial needs in 2008 are estimated at $6 
billion, and the GoA hints that it intends to raise $4 
billion from public sector agencies (and possibly from the 
Venezuelan government) and $2 billion through local auctions, 
taking advantage of the strong local liquidity.  So far this 
year, the GoA has issued ARP 1.9 billion of short-term debt 
(with a maturity of 6 to 12 months), exclusively to public 
sector agencies. 
 
GoA considers debt exchange to alleviate 2009-2011 debt 
service payments 
-------------------------------------------- 
¶11. (SBU) On March 12, Cronista Comercial reported that the 
GoA is analyzing the launch of a debt exchange to lower GoA 
debt principal and interest payments over the next four years 
(especially 2009-2011, during which GoA debt obligations 
peak).  The secondary motive is to extend the GoA debt yield 
curve.  Cronista reports that the GoA would like to complete 
the mini-exchange during the first half of the year, if 
market conditions allow it.  Although GoA officials declined 
to confirm this transaction to Cronista, Economy Ministry 
officials have confirmed on numerous occasions to Post's 
EconOffs that the GoA wants and needs to do this by mid-year. 
 Details of the transaction: 
 
-- Eligible bonds: mainly Guaranteed Loans with large 
maturities (both interest and principal) concentrated in 
2009-2011 and totaling $8.6 billion.   (Note: Payment is 
 
BUENOS AIR 00000433  003 OF 004 
 
 
guaranteed by tax collection.  The GoA issued them in 
November 2001 as part of a "voluntary" debt exchange, 
intended to extend maturities and reduce interest payments. 
These loans continued making interest and principal payments 
despite the 2001 default.  Originally dollar-denominated, 
these bonds were pesified and linked to inflation in January 
2002.)  Also, the GoA may include dollar-denominated Bodens 
maturing in 2012 and 2013, with total debt service payments 
of $8.8 billion due between 2009 and 2011.  (Note:  Bodens 
were originally issued after the 2001 default in a swap for 
reprogrammed bank deposits trapped by the corralito or 
corralon, and to banks in compensation for asymmetrical 
pesification.  However, afterwards, the GoA continued issuing 
Bodens for financing purposes.) 
 
-- New bonds:  Local media speculate that the new 
dollar-denominated bonds (presumably to be exchanged for the 
USD Bodens) would have a maturity of 5-10 years, while the 
peso-denominated bonds (to be exchanged for the guaranteed 
loans) would have a variable interest rate (based on the 
Badlar rate, currently at 8.5%) and no inflation adjustment. 
Many investors may find the exchange of guaranteed loans 
attractive since it would enable them to exchange an illiquid 
(not tradable) instrument for a tradable one. 
 
Who holds GoA defaulted debt? 
----------------------------- 
¶12. (SBU) Determining who holds the $28 billion in so-called 
"holdout" debt -- GoA defaulted debt that was not tendered in 
the 2005 GoA debt restructuring -- is more art than science, 
since defaulted debt is still being traded. Currently, most 
of the untendered debt quotes at 32-35 cents on the dollar. 
It is interesting to note that: 
 
-- As of the third quarter of 2007, GoA untendered debt 
totaled $28 billion, of which 29% ($8.3 billion) has not yet 
matured.  Of the remaining 71% ($19.8 billion) that has 
already matured, there is $11.7 billion in principal arrears 
and $8.0 billion in interest arrears. 
 
-- Most holdout debt is in foreign currency (98% of total, or 
$27.4 billion) and issued under international law (also 98% 
of total).  Peso and Argentine law holdout debt (with and 
without CER ) CPI linked index) totals only about $650 
million.  See below detailed table with the split between 
arrears and unmatured debt. 
 
-- Of the $27.4 billion holdout debt denominated in foreign 
currency (non-ARP), 38% ($10.4 billion) is USD denominated 
and 61% ($16.7 billion) is in EUR denominated.  The remaining 
1% ($176 million) is JPY denominated.  There is a negligible 
amount denominated in Swiss Franks (CHF) and British Pounds 
(GPB). 
 
-- According to American Task Force Argentina (AFTA), 
Americans hold $3.0 billion, or 11% of GoA holdout debt and 
almost 30% of dollar-denominated holdout debt. 
 
What is going on with the Real Exchange Rate in Argentina? 
--------------------------------------------- ------------- 
¶13. (SBU) A depreciated Real Exchange Rate (RER) has been a 
key element of GoA economic policy since the 2002 crisis and 
devaluation, and, the GoA asserts, a foundation of 
Argentina's high export growth in recent years.  In 
Argentina, the RER was relatively "low" during the 1990s, 
undermining the manufacturing sector.  In contrast, the 2002 
devaluation fueled domestic production of industrial goods 
and commodities.  In particular, in the case of agricultural 
commodities, the devaluation was complemented by: 1) 
Argentina's comparative advantages in these goods; 2) 
record-high international demand; and 3) the resulting run-up 
in global commodity prices.  Although the exchange regime is 
officially "flexible," since April 2003 the GoA and Central 
Bank's exchange rate policy objective has been to prevent the 
nominal appreciation of the peso, in order to protect 
domestic industry. 
 
¶14. (SBU) Local media reports that on March 11 
representatives of UIA (Argentine Industrial Association), 
the country's leading industrial association, met with 
President Cristina Fernandez de Kirchner and Economic 
Minister Martin Lousteau to discuss the energy crisis and the 
loss of local industry's competitiveness as a result of a 
declining RER (i.e., a real appreciation of the peso).  UIA 
said their competitiveness in international markets was being 
undermined by the relatively stable nominal exchange rate (at 
around 3.15 ARP/USD), coupled with increasing domestic 
 
BUENOS AIR 00000433  004 OF 004 
 
 
industrial salaries and higher costs in general (due to the 
annual inflation of approximately 20%).  The press speculated 
that the UIA was pushing the GoA to devalue the peso. 
 
¶15. (SBU) With actual inflation of over 20% (compared to 
official inflation of 8.5% in 2007), the Central Bank's 
informally fixed peg to the dollar is resulting in a real 
appreciation of the peso.  Although the RER against the 
dollar (i.e., the purchasing power of the pesos needed to buy 
one dollar in Argentina) is relatively stable when using 
official inflation numbers, when using independent measures 
of inflation, the RER would have been falling (i.e., the peso 
appreciating).  However, this gives an incomplete picture, 
since Argentina has a diversified export profile and trades 
with many countries in the world.  Brazil represented 19% of 
Argentine exports in 2007, followed by the EU (18%), China 
(9%), Chile (7%), and the U.S. (7%).  So, from a trading 
perspective, the roles of the Euro and the Real are more 
relevant than the role of the dollar.  Since most of 
Argentina's trading partners' currencies have appreciated 
significantly against the dollar in recent years, Argentina's 
multilateral RER has stayed relatively stable, despite high 
inflation.  The Central Bank's estimate of the multilateral 
RER for Argentina's main trading partners, using the official 
inflation rate, shows the peso depreciating.  Even using much 
higher independent inflation estimates, the multilateral RER 
is relatively stable or appreciating slightly. 
 
FIEL criticizes quality of GoA primary fiscal surplus 
--------------------------------------------- -------- 
¶16. (SBU) Buenos Aires-based Latin American Economic 
Foundation -- FIEL -- reports that Argentina's fiscal primary 
surpluses in recent years have arisen from extraordinary 
circumstances, with the implication that the GoA would not 
enjoy such sound finances were it to follow more traditional 
tax policies and global commodity prices were closer to their 
long-term averages.  (Note: FIEL is a highly regarded, 
independent Argentine think tank devoted to economic and 
social research on Argentina and Latin America.) 
 
¶17. (SBU) FIEL contrasts the GoA's conventional fiscal 
primary with its estimated "structural" primary surplus, 
which estimates revenues based on three-year moving averages 
for international commodity prices and local export taxes, a 
financial transaction tax following the traditional Brazilian 
rate of 0.38%, rather than the Argentine tax of 1.2%, and 
also eliminates one-off transfers such as the $2.5 billion 
transferred from the private pension funds system to the GoA 
in 2007.  FIEL analysis delivers a fiscal primary deficit of 
around 0.5% of GDP for 2007 and 0.6% for 2008, even 
considering that public expenditure growth has slowed to a 
nominal annual rate of 36% so far in 2008, compared to the 
over 50% expenditure growth rate in 2007.  (Note: the actual 
primary surplus was 3.2% of GDP in 2007 including one-off 
transfers, or 2.2% excluding them, and private estimates for 
2008 range from 3.5 to 4% of GDP, depending on revenue 
collection from export taxes.) 
WAYNE