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UNCLAS SECTION 01 OF 06 BUENOS AIRES 000622 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON EINV ETRD ELAB EAIR AR
SUBJECT: ARGENTINA ECONOMIC AND FINANCIAL REVIEW, APRIL 21 
- MAY 5, 2008 
 
¶1. (U) Provided below is Embassy Buenos Aires' Economic and 
Financial Review covering the period April 21 - May 5, 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 
---------- 
 
-- Argentina's Country Risk Premium spikes, indicating ever 
growing uncertainty 
-- Standard and Poor's revises Argentina's outlook to 
negative from stable following Minister of Economy's 
resignation; spill over effects to the provinces and banks 
-- U.S. Judge delays ruling on the freeze of GoA bonds 
-- GoA unveils its 2008 Financial Program 
-- Special Report: Argentine Economist Miguel Kiguel on 
Argentina's Fragile Economy, Deteriorating Politics 
 
------- 
Finance 
------- 
 
Argentina's Country Risk Premium spikes, indicating ever 
growing uncertainty 
--------------------------------------------- ------ 
¶2. (SBU) On April 25, Argentina's sovereign risk premium over 
equivalent maturity U.S. Treasuries, as measured by JP 
Morgan's EMBI Plus index (Emerging Market Bond Index), 
reached 589 basis points, the highest level since the GoA's 
2005 debt restructuring.  Argentina's Credit Default Swaps 
(CDS) spread jumped up to a record 599 basis points and local 
think tank Ecolatina's "Financial Risk Index" (which also 
measures peso bonds) closed at a new record of 931 basis 
points. 
 
¶3. (SBU) The factors behind the market's increasing 
nervousness and the deterioration in all of these indexes 
(which reflect falling Argentine bond prices) include: 1) JP 
Morgan's April 2 recommendation to underweight Argentine 
financial assets; 2) a similar recommendation by Merrill 
Lynch on April 23, recommending investors reduce from 3.4% to 
2.3% Argentina's weight in a benchmark portfolio; 3) S and 
P's April 25 downward revision on Argentina's sovereign 
credit rating from stable to negative (details below); 4) the 
April 18 action of U.S. Judge Griesa to block Argentina from 
transferring or selling bonds held at the Depository Trust 
Company (DTC), following a request by holders of defaulted 
GoA debt (details below); 5) Minister of Economy Martin 
Lousteau's surprise resignation on April 24 (it was expected 
mid-May); and 6) the continuing Ag conflict, which for the 
moment seems far from resolved (for background see April 4 
Econ/Fin Report). 
 
¶4. (SBU) These separate actions together reflect widespread 
unease with GoA economic policies and increasing concern 
about the future of the Argentine economy.  The GoA's 
policies (price controls, subsidies, loose monetary and 
fiscal policy, market interventions, bullying of the private 
sector, statistics manipulation) have resulted in the an 
overheating economy, as evidenced by inflation that is likely 
running at an annual rate of about 25%, and have scared away 
investment. 
 
¶5. (SBU) With the sell-off of Argentine assets and increased 
capital outflows, savers and investors (both retail and 
corporate) have increasingly turned to the dollar as a safe 
haven.  Demand for dollars has sharply increased in 2008, and 
anecdotal evidence indicates that it spiked on April 25 after 
Minister Lousteau resigned. (Note:  There is a 7-10 day lag 
on BCRA reports on currency trades).  This increased demand 
also occurred simultaneously with reduced supply of foreign 
exchange due to lower agricultural commodity exports (a 
consequence of the strike), which exacerbated the pressure on 
the peso on April 25.  However, the BCRA reacted strongly, 
selling in the range of US$350 million on April 25 to avoid a 
sharp peso depreciation. 
 
¶6. (SBU) Although the April 25 market closed with the peso at 
3.22 ARP/USD, compared to 3.20 ARP/USD two weeks before (a 
depreciation of 1.25%), the BCRA sent a strong signal that it 
 
BUENOS AIR 00000622  002 OF 006 
 
 
is prepared to use its $50 billion in official reserves to 
defend the peso.  The sell-side rate has stabilized at about 
3.20 ARP/USD. Since hitting bottom on April 25, Argentine 
bond prices have recovered some ground, but are still highly 
volatile.  The EMBI Plus index closed April 30 at 584 bps. 
 
Standard and Poor's revises Argentine outlook to negative 
from stable following Economy Minister's resignation; 
spill-over effects to Provinces and Banks 
--------------------------------------------- ----- 
¶7. (SBU) Standard and Poor's Ratings Services announced April 
25 that it had revised its outlook on its sovereign credit 
ratings for Argentina from stable to negative, while 
affirming the B plus long- and B short-term ratings on the 
country.  (Note: A negative outlook indicates that downside 
risks to Argentina's ratings now predominate.)  According to 
S and P, the negative outlook reflects the GoA's failure so 
far to implement "corrective" economic policies to cool down 
the overheated economy and decelerate inflation, as well as 
increased political-economic challenges facing the country in 
the wake of the resignation of Economy Minister Martin 
Lousteau.  Nevertheless, S and P noted that the outlook could 
return to stable were the GoA to introduce policies to 
address the overheating economy and ensure a more sustainable 
level of economic growth. 
 
¶8. (SBU) Although strong economic activity, rising inflation, 
and export taxes have helped support a strong fiscal surplus 
(estimated at 3.3-3.8% of GDP for 2008), S and P is still 
concerned with wage pressures, distortions in the economy 
(subsidies and price controls), the agricultural sector 
conflict, deterioration of social indicators (due to the 
accelerating inflation), regulation hurting growth prospects, 
and eroded GoA's popularity.  Together, according to S and P, 
these factors increase the challenges for fiscal policy over 
the next 18 to 24 months.  Furthermore, these factors do not 
even consider the potential adverse impact of a negative 
external shock, such as the sudden deterioration of the terms 
of trade, which would translate into sharply lower fiscal and 
external surpluses given Argentina's increasing dependence on 
revenues from exports of major commodities.  S and P ended 
its press release noting that any material fiscal 
deterioration would lead it to lower Argentina's rating. 
 
¶9. (SBU) Following the revised sovereign outlook, S and P 
revised from stable to negative the outlook for the Province 
of Buenos Aires, Banco Provincia de Buenos Aires, and the 
Province of Mendoza, while it revised from positive to 
neutral the outlook for the City of Buenos Aires.  Similarly, 
S and P revised down from neutral to negative the outlook of 
Banco Hipotecario and Banco Patagonia. 
 
U.S. Judge delays ruling on freeze of GoA bonds 
--------------------------------------------- -- 
¶10. (SBU) On April 18, Judge Thomas Griesa -- a federal judge 
for the United States District Court for the Southern 
District of New York -- blocked the GoA from transferring or 
selling a stock of bonds held in the Depositary Trust Co. 
(DTC) in New York until the nature and ownership of these 
bonds could be clarified.  The ruling was issued following a 
request by a holder of defaulted Argentine bonds who did not 
participate in the 2005 debt exchange, and who is litigating 
against the GoA.  (Other so-called bond holdouts reportedly 
later joined the suit.)  The litigant intends to attach the 
blocked bonds to satisfy his claim against the GoA. 
 
¶11. (SBU) Background: The blocked bonds are global bonds 
swapped by the GoA in November 2001 (before the default) for 
guaranteed loans (Prestamos Garantizados) and kept in an 
account as a guarantee to the owners of the guaranteed loans. 
 This exchange had a critical feature that allowed the 
guaranteed loans to revert to the original bonds (the 
globals) if the GoA were to default on its obligations (and 
not honor the guarantee).  Most of the guaranteed loans were 
originally issued in dollars.  However, the GoA converted the 
bonds to pesos in 2002 and linked them to CER (a CPI-linked 
index).  Since then, they have always been performing debt. 
Meanwhile, the global bonds, which belong to series of bonds 
that entered in defaulted in 2001 and were later restructured 
in 2005, have remained as collateral of the Guaranteed Loans 
and not destroyed. 
 
¶12. (SBU) Judge Griesa announced on April 30 that he would 
delay issuing a ruling on this case pending further review of 
the arguments and evidence submitted to the court.  Key in 
this case is to properly assess who has the ownership of the 
frozen global bonds.  The GoA's lawyers claim that the global 
 
BUENOS AIR 00000622  003 OF 006 
 
 
bonds do not belong to the GoA but to the owners of the 
guaranteed loans, and as a result they cannot be attached by 
the holdouts.  The plaintiffs claim that GoA decrees in 2002 
and 2003 pesifying the guaranteed loans had "stripped" 
holders of the guaranteed loans of their ownership of the 
globals.  Therefore, according to this line of argument, the 
globals belong to the GoA and are attachable.  (Note: the 
global bonds have still a residual value, since untendered 
defaulted bonds currently trade at about 30% of face value.) 
 
¶13. (SBU) Also, in the hearing Judge Griesa granted an order 
for discovery (in favor of the litigating 
investors/plaintiffs), requiring the GoA and DTC to surrender 
information to the plaintiffs about the bonds that are 
frozen.  However, Griesa denied a motion to broaden discovery 
for the purpose of attachment to European jurisdictions (in 
favor of GoA's defense).  There is not even agreement on the 
face value of the bonds tendered in the November 2001 debt 
exchange and held in DTC.  In their legal briefs, the 
plaintiffs claimed that the face value of these bonds is 
about $18 billion, whereas the GoA's lawyers argued that the 
face value is only $2 billion.  According to JPMorgan, which 
attended and reported on the hearing, the GoA's defense did a 
better job of articulating their arguments.  However, the 
judge left the door open for the litigating investors, by 
providing additional time to bring evidence to support their 
claims and establish ownership of the global bonds. 
 
¶14. (SBU) For the time being, the lack of a ruling represents 
an obstacle to the GoA's plan of carrying out a mini-debt 
exchange of local debt (including guaranteed loans), in order 
to smooth the GoA's maturity profile for 2009-2011.  Not only 
would the debt swap reduce the GoA's financing needs over 
this period, senior Economy Ministry officials expect it 
would ease market anxiety over Argentina's ability to roll 
over its maturing debt.  These senior Economy Ministry 
contacts speculate that the bond holdouts do not expect to 
win this court case.  Their real purpose, they say, is to 
delay the debt exchange and highlight the constraints and 
costs to the GoA of not resolving the holdout issue.  There 
is a precedent: the settlement of the 2005 GoA debt 
restructuring agreement was delayed almost three months, from 
the original settlement date in March 2005 to June 2005 due 
to similar holdout bondholder legal actions. 
 
GoA unveils its 2008 Financial Program 
-------------------------------------- 
¶15. (SBU) The GoA released its long-promised 2008 Strategic 
and Financial Program on April 18, surprising market analysts 
who had speculated the GoA would never issue the plan due to 
increasing domestic and international uncertainty.  The GoA 
Economy Ministry had committed itself early in the year to 
give details on the types of transactions and markets it 
would tap during the year to fulfill 2008 financial needs, 
with the objective of improving transparency and 
predictability for investors.  However, the Ministry had 
delayed the release until now to avoid being held to its 
publicly presented program during a period of strong market 
volatility. 
 
¶16. (SBU) According to the program, as of end-April the GoA's 
financial needs stand at $6.1 billion, which the Economy 
Ministry expects to raise by: a) domestic auctions ($3.6 
billion); b) direct private placements ($1.5 billion); and c) 
intra-public sector placements ($1.0 billion).  Highlights of 
GoA's 2008 financial program include: 
 
-- Promoting an active dialogue with market participants, so 
as to issue bonds considering investor's needs and GoA's 
objectives; 
-- Issuing reference bonds (in pesos, foreign currencies and 
at fixed and variable rates), for a minimum amount of $1.0 
billion -- to ensure sufficient volume to guarantee liquidity; 
-- Promoting strong participation of local institutional 
investors with a strong liquidity position, with estimated 
potential demand of: 
 
-----$1.9 billion from Pension Funds, Mutual Funds and 
Insurance Companies; 
-----$1.0 billion from Intra-Public sector agencies; and 
-----$700 million from Banks. 
 
-- Coordinating closely with the BCRA; 
-- Increased lending from International Credit Institutions; 
-- Performing Liability Management transactions (debt swaps) 
to smooth the GoA's debt maturity profile. 
 
 
BUENOS AIR 00000622  004 OF 006 
 
 
¶17. (SBU) Preliminary estimates of 2009 and 2010 financial 
needs of $11.9 billion and $10.5 billion, respectively. 
These figures are significantly higher than 2008 and may 
challenge the GoA's ability to meet its financing needs, 
absent a debt swap of outstanding Guaranteed Loans, which 
face large amortizations in the next three years.  (See 
background on proposed debt swap in April 4 Econ/Fin Report). 
 
-------------- 
Special Report 
-------------- 
 
Argentine Economist Miguel Kiguel on Argentina's Fragile 
Economy, Deteriorating Politics 
--------------------------------------------- --- 
 
¶18. (SBU) Noted Argentine Economist and Business Consultant 
Miguel Kiguel offered an April 29 conference call briefing on 
the state of the Argentine economy to his clients.  Here are 
highlights: 
 
-- Farmers' strike changed political climate and eroded the 
GoA's popularity.  This was the Kirchners' first political 
loss, and they were deeply surprised by the popular support 
for the farmers' protests.  The middle class joined in due to 
their frustration over lack of GoA action to curb inflation. 
In the past, the Kirchners have chosen "enemies to attack" 
that were not in a position to respond:  IMF, bondholders, 
large energy companies, USG.  This time the conflict was with 
300,000 farmers spread throughout the country -- impossible 
to control. 
 
-- Economy Minister Lousteau's resignation.  Although 
Lousteau was blamed for the "retenciones moviles" (sliding 
export taxes), it is unclear who was really behind them.  It 
is not a new idea, and other GoA officials are known to have 
proposed them before, including Internal Trade Secretary 
Guillermo Moreno.  The main goal was to appropriate part of 
Ag commodity exporters' windfall gains, but after unexpected 
backlash Lousteau was marginalized and scapegoated.  Before 
resigning, Lousteau presented an anti-inflation program (and 
leaked it to media), but this was his way of trying to leave 
office with honor after a mediocre tenure as Economy 
Minister. 
 
-- Expectations for new Economy Minister.  Minister Carlos 
Fernandez is a technocrat who understands the fiscal side but 
has no experience in macroeconomic policy, at a time where 
the country needs a Minister familiar with exchange rate and 
monetary policies.  Fernandez will have limited autonomy, and 
it appears Guillermo Moreno emerges even stronger.  The 
perception is that there will be even less reliance on market 
forces and interventionist trends -- price controls and 
pressure on companies -- will continue and increase.  KEY 
POINT:  At least Lousteau had technical skills and ideas for 
controlling inflation and reforming INDEC.  Now, there is no 
sponsor in the GoA for INDEC reform or rational economic 
policies (except, possibly, BCRA President Martin Redrado); 
the scope for policy mistakes is wide open and there is no 
counter-balance to Nestor Kirchner. 
 
-- Recent depreciation of the peso and how much more to 
expect?  As a result of increasing uncertainty, there are 
growing rumors of further peso depreciation and dual exchange 
rate systems.  In spite of inflation, the peso is still 
undervalued in real terms against the dollar and (even more 
so) against a basket of currencies.  However, less 
competitive industries that are benefiting from the 
depreciated peso are demanding further depreciation to 
compensate for the real peso appreciation.  They are getting 
some support from farmers, who see a more depreciated peso as 
partially making up for the increased export taxes (although 
revenues to most farmers are in pesos). (Post comment:  BCRA 
economists are openly opposed to further depreciation.) 
 
-- Increases in the CDS and in long-term interest rates, 
though short-term rates remain low.  Argentina's Credit 
Default Swap (CDS) spread has widened to 600 bps, and other 
country risk measures (e.g., the EMBI plus) have also 
increased.  This reflects concerns regarding the GoA policy 
mix more than fundamentals, since the GoA's capacity to pay 
debts is solid in the medium term.  However, the perception 
from abroad is that anything is possible with Nestor Kirchner 
pulling the economic policy strings, so foreign investors are 
rapidly reducing exposure.  Long-term peso interest rates are 
increasing, but the short-term (BADLAR) rates are only 
slightly higher than their pre-strike level in March.  Low 
 
BUENOS AIR 00000622  005 OF 006 
 
 
short-term rates have been supported by two factors: 
Argentine banks and insurance companies are currently very 
liquid, and local institutional investors are not concerned 
about short-term changes to the exchange rate.  Both of these 
factors are changing (particularly as the soybean crop is 
sold and liquidity declines).  Expect BADLAR rates to 
approach rate of inflation. 
 
-- Outlook for inflation.  This is the main problem facing 
the GoA, but no one knows the exact number.  Annual inflation 
was approximately 20% in 2007 and is running at about 25% so 
far in 2008.  However, there is no reason to expect spiraling 
(or hyper-) inflation.  Wage increases so far in 2008 have 
been relatively conservative, with the major unions accepting 
a 19.5% increase (or 23-24% including benefits), which is 
similar to 2007.  Also, the big jump in inflation took place 
in 2007 due to high wage and pension increases, also spurred 
by the GoA's 55% annual increase in expenditures.  Fiscal is 
more conservative now, growing at about a 35% annual rate, 
and the primary fiscal surplus is stronger (mostly due to 
October 2007 increase in export taxes).  While not 
contractionary, the GoA's fiscal policy is more prudent and 
less inflationary.  The BCRA's policies are accommodating 
higher inflation, with its management of the undervalued 
currency, the large, negative real interest rates, and no 
signs of tightening of the money supply.  (The BCRA's 2007 
target for M2 growth was 18-19%, whereas it is 23.5% for 2008 
-- and with private M2 target growth of 26%.) 
 
-- Clearly, the rate of economic growth is above potential, 
there is a tight labor market, and there is excess aggregate 
demand, all of which lead to higher inflation.  However, of 
most concern is the total absence of any GoA 
anti-inflationary program.  There are three essential 
components to an anti-inflation plan: 
 
----- Tighter fiscal and monetary policy to bring down 
aggregate demand. 
----- Institute a Nominal Anchor (could be the money supply 
or inflation targeting -- slow economy or adjust the exchange 
rate.  Right now there is only a relatively stable nominal 
exchange rate.  Obviously, if the GoA gives in to industry 
demands for further depreciation, inflation will jump.) 
----- A change in key relative prices, particularly the real 
exchange rate and real interest rates (probably need stronger 
peso and definitely need higher nominal interest rates). 
 
-- Financing requirements.  The GoA only needs to raise about 
$4 billion in 2008, which it will do easily by tapping local 
pension funds (which have roughly $6 billion they must invest 
domestically this year) and the Social Security Agency 
(ANSES).  Financing needs jump to $9-10 billion in 2009, 
which will be more difficult for the GoA but still 
manageable.  The GoA should be able to raise over $4 billion 
easily from domestic capital markets and several billion in 
short-term borrowing from the BCRA (which is within BCRA 
Charter limits), and will be able to fill the rest with 
private placements to domestic agencies (ANSES).  (Post 
Comment: Venezuela's continuing willingness to purchase 
Argentine debt will be an increasingly important factor.)  It 
is wishful thinking that the GoA will improve its 
relationships with capital markets.  With the departure of 
Lousteau and Finance Secretary Hugo Secondini, the proposed 
debt swap of Guaranteed Loans and Bodens is on hold.  It 
would have been difficult/impossible to do anyway due to the 
ongoing Holdouts court case in New York.  The new Minister 
will likely put emphasis on new financing rather than on 
smoothing maturities through a debt exchange.  New Finance 
Secretary Hernan Lorenzino was involved in the Buenos Aires 
Province debt exchange in December 2005, is competent, and 
understands financial markets, although he does not have 
Secondini's experience. 
 
-- Medium-term outlook.  Not too concerned about the 
fundamentals, and the twin surpluses (fiscal and trade) 
reduce macroeconomic risks.  Growth should continue for the 
next few years at least in the 4-5% range, as long as the 
favorable external environment continues.  Financing 
requirements and debt sustainability are not concerns. 
Inflation is the major problem in the medium term, and the 
main downside risk is "stagflation."  At this point, 
arresting inflation will require a major shift in 
macroeconomic policy, absent which inflation will likely rise 
by 2009 to the 30-35% range.  This high inflation and the 
resulting strengthening of the peso in real terms will both 
affect production, as will higher interest rates.  The result 
will not be the typical Argentine crisis, because the GoA 
 
BUENOS AIR 00000622  006 OF 006 
 
 
will not face problems servicing debt.  Rather, real GDP 
growth would drop to 2.5-3% per year, low compared to 
previous years and also low compared to Argentina's peers in 
the region. 
 
-- The biggest questions are political.  President Kirchner's 
beginning has been highly disappointing for investors, who 
had hoped for "gradual fine-tuning" of policies, stronger 
institutions, and a more international outlook.  Instead, (in 
Kiguel's view) the GoA's relations with important allies such 
as the U.S. and Spain have deteriorated, Argentina is 
becoming closer to Venezuela, and there are few signs of 
advancement on key financial issues such as holdout 
bondholders or Paris Club.  In summary, the economic 
situation is deteriorating gradually, the political situation 
has deteriorated considerably, the leadership has minimal 
economic background, there is no counterbalance to bad 
economic policy decisions, and downside risks have increased 
dramatically.  The best hopes right now are that the fall in 
President Kirchner's approval rating may force the 
administration to act, and also that the Governors of the 
major Provinces are becoming more vocal in support of more 
sensible policies. 
WAYNE