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P 302125Z MAY 08
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC PRIORITY 1221
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 05 BUENOS AIRES 000753 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON EINV ETRD ELAB EAIR AR
SUBJECT: ARGENTINA ECONOMIC AND FINANCIAL REVIEW, MAY 6 - 
23, 2008 
 
REF: BUENOS AIRES 622 
 
¶1. (U) Provided below is Embassy Buenos Aires' Economic and 
Financial Review covering the period May 6 - 23, 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 
---------- 
 
-- Capital flight accelerates due to increasing political 
uncertainty 
-- Who are the "Holdouts"? 
-- Debate over poverty statistics 
-- INDEC seminar and announcement of new CPI 
-- FIEL raises concerns about taxes, expenditures, revenues, 
and salaries 
 
Capital flight accelerates in first quarter due to increasing 
political uncertainty 
--------------------------------------------- ----- 
¶2. (SBU) Capital flows out of Argentina's financial system 
(by the non-financial private sector) reached $2.2 billion in 
the first quarter of 2008, according to the BCRA's quarterly 
foreign exchange report (published April 25).  Following a 
neutral balance in the first quarter of 2007, there is a 
clear trend in the non-financial private sector towards 
taking hard currency out of the financial system, with 
outflows of $5.2 billion in QIII 2007 and $3.4 billion in QIV 
¶2007.  Capital outflows have been more than compensated for 
by the strong trade surplus, which reached a record $4.0 
billion in QI 2008, compared to a $3.3 billion surplus in QI 
¶2007.  Embassy banking sector contacts confirm that the 
tendency so far in 2008 in both the retail market and with 
companies is to dollarize peso portfolios. 
 
¶3. (SBU) The move into dollars is partly a reaction to the Ag 
sector conflict, which began March 11 when the GoA imposed a 
sliding scale export tax on agriculture exports, and it has 
been exacerbated by the GoA and Ag sector's apparent 
inability to resolve it.  However, Post's banking sector 
contacts emphasize that the mini-run on the peso began in 
early March, with the recognition that inflation was 
accelerating.  The combination of high and accelerating 
inflation and the continuing strike is stoking rumors and 
fears of a peso devaluation.  The Ag strike also aggravated 
the deteriorating situation in the FX market, since lower Ag 
commodity exports reduced the supply (inflow) of hard 
currency at the same time that demand was increasing.  (Ag 
exports, mainly wheat, corn and soy and soy sub-products, 
provide 35% of the dollar supply from exports.) 
 
¶4. (SBU) Highlights of the Foreign Exchange Balance report: 
 
-- A surplus of $3.6 billion for the current account of the 
Foreign Exchange Market for the first quarter, compared to 
$2.6 billion the same period last year. (This is the net 
inflow of FX from all trade transactions, including 
merchandise, services, and investment income.); 
 
-- A deficit of $96 million for the capital account in QI 
2008, compared to a surplus of $2 billion in QI 2007.  The 
deficit in the capital account was generated by the $2.2 
billion capital outflow from the non-financial private 
sector, which was partially compensated by $1.2 billion 
inflows from foreign direct investments (mainly for oil, 
agriculture, car, steel and mining sector) and $720 million 
inflows from loans and credit lines to the private sector. 
 
-- BCRA reserves reached a record of $50.6 billion at the end 
of QI as a result of the BCRA net purchases of foreign 
exchange of $2.6 billion. 
 
-- In order to pay foreign currency debts, the Treasury 
purchased $1.5 billion in QI 2008, compared to $619 million 
in QI 2006 and $400 million in QI 2007. 
 
-- (Note: the Foreign Exchange Balance (FEB) and the Balance 
of Payments (BOP) report have a similar format.  However, the 
former reports purchase and sales of foreign currency without 
 
BUENOS AIR 00000753  002 OF 005 
 
 
considering the residency of the parties, while the latter 
reports economic transactions focusing on the residency of 
the intervening parties.  Also, the FEB uses a cash-basis 
methodology, while the BOP uses accrual accounting.) 
 
¶5. (SBU) So far in the second quarter, the unresolved Ag 
conflict, accelerating inflation, and the President's 
plummeting approval rating have increased the level of 
pessimism about the future of the Argentine economy, spurring 
greater dollar outflows.  However, the BCRA's heavy 
interventions in May, selling dollars in both the spot and 
futures markets, succeeded in bringing the nominal exchange 
rate down to a trading range of 3.14-3.16 ARP/USD (wholesale) 
by May 23.  This proved to the market that for the time being 
the BCRA has sufficient firepower to keep the exchange rate 
at whatever level it desires.  Due to the 7-10 delay in the 
release of BCRA data, it is still unclear how deep the BCRA 
has had to dip into reserves to date, but as of May 16 the 
BCRA had sold $1.2 billion, and reserves had fallen to $49.1 
billion, below the psychologically important $50 billion 
level. 
 
Who are the "Holdouts"? 
----------------------- 
¶6. (SBU) There has been a lot of reporting about the 
so-called "holdouts" -- holders of GoA defaulted debt not 
tendered in the 2005 GoA debt restructuring -- but not much 
is known about who they are.  Determining who holds the $28.8 
billion amount outstanding (as of December 2007, according to 
GoA debt statistics) -- and roughly $3 billion held by U.S. 
investors -- is more art than science, since defaulted debt 
is still being traded (currently at about 32-34 cents). 
However, it is possible to identify those holdouts that have 
engaged in legal actions to recover the whole value of their 
defaulted bonds.  These holdout bondholders cannot sell the 
bonds as they need to show ownership of the bonds when going 
forward with legal proceedings. 
 
¶7. (SBU) Holdouts have not succeeded in their efforts to 
recover investments, but they have caused major difficulties 
for both the GoA and BCRA: 1) holdout lawsuits delayed the 
2005 GoA settlement by almost three months; 2) $105 million 
of BCRA reserves held at the Federal Reserve Bank of New York 
(FRBNY) are frozen on account of a holdout lawsuit; 3) a 
recent holdout lawsuit resulted in the freezing of $2 billion 
of Global bonds held at the Depository Trust Company (DTC) 
and backing Guaranteed Loans (GLs); this lawsuit has 
effectively blocked the GoA's plan to conduct a debt swap of 
the GLs and smooth out the 2009-2011 debt amortization 
schedule (see May 5 Econ/Fin report); 4) the GoA must resort 
to complex legal structures every time it makes an off-shore 
payment; and 5) the threat of holdout lawsuits has virtually 
eliminated the GoA's ability to raise fund through bond 
issuances under international law, raising financing costs by 
an estimate 50 to 100 basis points. 
 
¶8. (SBU) Based on a detailed analysis of the public 
information available in Lexis-Nexus database: 
 
-- There are 70 bondholder cases filed against the GoA in 
U.S. courts, all of which are in the court of Judge Thomas 
Griesa, U.S. District Court for the Southern District of New 
York. 
 
-- These 70 cases are claiming a total face value of almost 
$2 billion, without considering past due interest, penalties, 
or other compensation for delay in payment. 
 
-- Many of the cases where filed by multiple bondholders 
(including both physical persons and companies), so the total 
number of investors involved exceeds 70. 
 
-- The average claim is almost $30 million.  The smallest 
claim is for $133,000, whereas the largest is for $595 
million.  Only five cases comprise almost 70% (or $1.3 
billion) of the total claimed.  These five plaintiffs are: EM 
Ltd, Greylock, GMO, NML Ltd, and BNP Paribas.  These 
plaintiffs (and their lawyers) are also the most vocal of all 
outstanding U.S. holdouts. 
 
-- In two out of the 70 cases, the lawsuits are against both 
the GoA and the Province of Buenos Aires. 
 
-- The status of most of the cases is that the Judge granted 
the plaintiff motion for summary judgment. (Note: There are 
possibly many other cases in the pipeline, for which a Judge 
has not issued a ruling.  It is also possible that some of 
 
BUENOS AIR 00000753  003 OF 005 
 
 
the 70 cases have had partial advances -- such as beginning 
the assets discovery process, in order to identify attachable 
GoA assets -- but Judge Griesa has not made a final public 
ruling.) 
 
¶9. (SBU) Economy Ministry contacts confirmed the freeze on 
BCRA reserves is still in place.  The two plaintiffs in this 
case are E.M. Ltd, covering defaulted bonds with a face value 
of $595 million, and NML Ltd, with a face value of $142 
million.  The plaintiffs argued for attaching the BCRA's $105 
million reserves held in its FRBNY account, following two GoA 
decrees allowed the use of BCRA funds for repayment of 
Argentina's debt to the IMF.  The plaintiffs and the GoA are 
currently debating the definition of reserves and whether 
BCRA reserves have been used for commercial purposes (as 
defined under the Foreign Sovereign Immunities Act of 1976) 
and are, consequently, attachable. (The USG submitted a 
Statement of Interest in 2004 and an Amicus Curiae brief in 
2006, related to the attempts to attach BCRA assets.) 
 
¶10. (SBU) ICSID Holdout cases:  Apart from cases filed in 
U.S. Courts, other investors (mainly Italian) have filed two 
claims before the World Bank's International Centre for 
Settlement of Investment Disputes (ICSID).  According to the 
ICSID website: 
 
-- The first case was filed under the name Giovanna a Beccara 
in February 2007, and ICSID accepted the case and constituted 
a "Tribunal" in February 2008; 
 
-- The second case was filed under the name Giovanna Alemanni 
in March 2007, and ICSID has not yet constituted a Tribunal. 
ICSID has not released details on the amounts involved. 
However, according to Argentine media, the first case was 
filed by Task Force Argentina (TFA), a bondholder group that 
claims to represents 195,000 Italian bondholders holding 
about $4.4 billion (face value) of GoA defaulted bonds. 
(Note:  The majority of the Italian bondholders are retirees 
who lost significant portions of their savings in the 
December 2001 default.) 
 
Debate over poverty statistics 
------------------------------ 
¶11. (SBU) President Cristina Fernandez de Kirchner (CFK) 
announced May 12 a decline in Argentine poverty levels to the 
20.7% level, down from roughly 23% in late 2007 and down 33 
percentage points from its post-crisis peak of 54% in 2003. 
CFK said this drop should be a source of national pride for 
all Argentines.  Her statements provoked a passionate debate 
over the real level of poverty in the country, with many 
analysts arguing that poverty is expanding rather than 
declining. 
 
¶12. (SBU) Many independent economists put current poverty 
levels at a significantly higher 30%, and estimate that 
poverty rolls increased by 1.3 million citizens in 2007 
alone.  These economists blame rising inflation -- 
particularly increases in the costs of food and basic 
services -- for the increasing poverty.  They attribute the 
substantial difference in independent vs. GoA poverty 
measures to the GoA's manipulation of inflation statistics 
since February 2007.  Local analysts predict that the 
political fallout on the CFK government of this rise in 
poverty will be significant.  They argue that this is the 
reason why the Kirchners have in recent weeks switched from 
denying that inflation is a serious problem to blaming it on 
the "socially irresponsible" striking rural agricultural 
sector. 
 
INDEC seminar and announcement of new CPI 
----------------------------------------- 
¶13. (SBU) Argentina's National Statistics Agency (INDEC) 
hosted an international seminar on the CPI May 7 on 
"International Experiences with the CPI: Certainties and 
Challenges."  INDEC invited experts from Spain and France, as 
well as Walter Lane, Chief of the Branch of Consumer Prices 
in the Office of Prices and Living Conditions at the U.S. 
Bureau of Labor Statistics.  Lane and other foreign 
representatives participated during the first session, 
focusing mainly on methodological aspects of the CPI.  INDEC 
staff members and union leaders also spoke during the first 
session, all making the same call for a CPI that supports the 
"local economic model for development" (meaning, growth with 
income redistribution).  INDEC used the second session to 
announce features of the new Argentine CPI: 
 
-- INDEC will frequently rebalance products in the new CPI, 
 
BUENOS AIR 00000753  004 OF 005 
 
 
and criteria for rebalancing will be based on: i) 
seasonality; ii) points of sales; iii) quality changes; and 
iv) patterns of consumption.  (Comment: This turns the CPI 
into a cost-of-living index, rather than a means to measure 
inflation; this will not facilitate private indexation 
decisions, such as salary increases.) 
 
-- The new CPI will only cover the second and third quintiles 
of the income distribution (lower-middle-class), which means 
that the CPI will be biased to lower income patterns of 
consumption (and will, therefore, under-weight areas of high 
recent price increases, e.g., private schools, private 
medicine). 
 
-- INDEC will incorporate consistency analysis and data 
filtering, to avoid the inclusion of outliers. 
 
-- The new index will see a reduction in the number of 
varieties included. 
 
¶14. (SBU) In a private note for clients, HSBC analysts 
pointed out that bondholders should keep in mind that this 
new methodology will consistently result in lower consumer 
price inflation than the methodology used prior to 2007, even 
with the same inputs.   These analysts say it is impossible 
to know at this stage how much lower inflation will be, and 
that it will depend on the government commitment to a 
credible index.  Their base scenario is that the new index 
will report around 8% - 9% annual inflation until further 
evidence is available.  The fact that the government is 
institutionalizing a method that reports lower inflation than 
a conventional CPI is bad news for the bond market, though 
markets have most likely fully priced this news into current 
prices. 
 
FIEL raises concerns about taxes, expenditures, quality of 
revenues, and salaries 
--------------------------------------------- ------- 
¶15. (SBU) Renowned Buenos Aires-based Latin American Economic 
Foundation -- FIEL -- raised the following concerns during a 
May 21 Seminar. (FIEL is a highly regarded, independent 
Argentine think-tank devoted to economic and social research 
on Argentina and Latin America.) 
 
--  Argentina's fiscal burden is much higher than in the 
past.  It has increased in each of the last six years, and is 
currently at about 33% of GDP when including federal, 
provincial, and municipal taxes.  This is higher than during 
the 1990s, when it averaged 21-22%, and much higher than 
during the 1980s, when it was below 20%.  Argentina's fiscal 
burden is now comparable to Brazil's, which is the highest in 
the region (followed by Uruguay at 30%).  The agricultural 
sector conflict is the first tax rebellion, and FIEL believes 
others could follow. 
 
-- GoA expenditures: April primary expenditure increased 52% 
y-o-y, compared to an increase of 38% y-o-y for the first 
quarter.  However, FIEL argues that the GoA under-reported 
March's expenditures.  In order to reduce the average of the 
quarter, the GoA pushed forward some expenditures due in 
March to April.  In this way, the GoA avoiding showing a low 
primary fiscal surplus in March, since March revenues were 
weak.  Elasticity of expenditures: per every increase of 1% 
of GDP in expenditures, the primary surplus falls 0.9% of 
GDP. 
 
-- GoA Revenues- extra help from BCRA: In March and April, 
the BCRA transferred earnings of ARP 1.4 billion (the total 
budgeted for the year) to the GoA, which helped improve the 
GoA's reported revenues and primary fiscal surplus for the 
first quarter.  The BCRA transferred ARP 1 billion in March 
and the remaining ARP 400 million in April. 
 
-- Salaries: March 2008 formal-sector salaries measured in 
dollar terms (considering only salaries and not other 
benefits) are higher in nominal terms than salaries from 
October 2001 for many sectors of the economy.  However, when 
including benefits and the salary increases granted in 
negotiations so far this year, 2008 salaries in dollars are 
higher in nominal terms than the ones from 2001 for all 
sectors.  (2008 salaries are still lower in real terms than 
equivalent salaries in 2001.) 
 
-- Increase in Argentine risk (as measured by the JPMorgan 
EMBI plus) to record levels indicates concerns over the GoA's 
willingness to pay, not concerns over its capacity to pay. 
Data Manipulation: FIEL strongly believes the GoA is 
 
BUENOS AIR 00000753  005 OF 005 
 
 
manipulating the EMAE (monthly economic activity index) and 
GDP, in addition to the CPI (which was severely manipulated 
in March, particularly for food items). 
 
-- Devaluation expectations: with true inflation somewhere 
between 20-30% and nominal peso devaluation of 1.5-2% per 
year, the GoA model of maintaining industrial competitiveness 
through an undervalued currency does not seem to be 
sustainable.  This is what is driving market expectations 
that the GoA will eventually devalue the peso. 
 
WAYNE