VZCZCXYZ0015
RR RUEHWEB

DE RUEHBU #1160/01 2282201
ZNR UUUUU ZZH
R 152201Z AUG 08
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC 1801
RUCNMER/MERCOSUR COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHRC/DEPT OF AGRICULTURE WASHINGTON DC

UNCLAS BUENOS AIRES 001160 
 
SIPDIS 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD EINV EAGR AR
SUBJECT: Argentina Rides Bond-Price Rollercoaster Amid Market 
Concerns on Policy Direction 
 
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Summary 
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¶1. (SBU) A series of interrelated events the week of August 4-8, 
including the GoA's private sale of US$1 billion in sovereign bonds 
to Venezuela at a high yield, prompted  a significant drop in GoA 
bond prices and a climb in Argentina's country risk premium to 741 
basis points.  On August 10, the GoA responded by announcing a US$1 
billion public debt buy-back program.  An estimated US$500 million 
in government purchases in the ensuing days helped bond prices 
recover much of the prior week's losses, notwithstanding significant 
market volatility generated by the August 11 GoA announcement of 
less-than-credible July inflation statistics, a downgrade by 
Standard & Poor's of Argentina's long-term debt rating from B-plus 
to B, and persistent rumors of possible cabinet changes, including 
the replacement of Economy Minister Carlos Fernandez and the removal 
of Internal Commerce Secretary Guillermo Moreno from his informal 
oversight of INDEC.  Local market players call the GoA's successful 
bond buyback program a reactive and ad hoc response to pervasive 
concerns about the GoA's inability to formulate longer term policy 
responses to growing macro-economic disequilibria.  By and large, 
these local market participants and analysts discount any 
medium-term default scenario and note that the GoA has the capacity 
to fund itself in local capital markets through 2009 absent any 
radical drops in global commodity prices.  Near-term market 
sentiment will likely turn on steps the GoA takes - or fails to take 
- in the coming weeks to demonstrate its long-term economic vision 
and commitment to fiscal probity. End Summary. 
 
--------------------------------------------- 
GoA Yields Approach Pre-2001 Crisis Levels... 
--------------------------------------------- 
 
¶2. (SBU)  During the week of August 4-8, heightened financial market 
perceptions of Argentine risk drove up Emerging Market Bond Index 
country risk premiums on GoA sovereign obligations to a high of 741 
basis points, a level not seen since just prior to Argentina's 
December 2001 $93 billion default.  The combined impact of a series 
of discreet events precipitated this darkening of market sentiment, 
beginning with President Cristina Fernandez de Kirchner's August 2 
press conference -- the first in her eight-month tenure -- during 
which she defended her tough stance during the ag sector strike, 
offered unconditional support for Argentina's embattled national 
statistics agency INDEC, and backed her controversial Internal 
Commerce Secretary, Guillermo Moreno, widely accused of engineering 
the gross under-reporting of domestic inflation.  Other developments 
negatively impacting perceptions of Argentine risk included: 
 
-- a continued decline in global agricultural commodity prices (soy 
prices are down roughly 40% since July), on which Argentina's twin 
fiscal and trade surpluses have become dependent; 
 
-- the private sale that week of US$1 billion in sovereign GoA bonds 
to Venezuela at a yild of 14.87%, a rate not seen since before the 
2001/2 economic crisis; 
 
-- Venezuelan banks' rapid re-sale of these GoA securities into the 
secondary market which put pressure on bond prices; and 
 
-- media reports that rating agencies Standard & Poor's and Moody's 
were contemplating downgrades of Argentine debt ratings. 
 
¶4. (SBU) This confluence of developments added fuel to longstanding 
market concerns on the sustainability of a GoA fiscal policy mix 
that includes: 
 
-- heavy government spending on energy and transportation subsidies 
(roughly 3% of GDP); 
 
-- inadequate investment in primary infrastructure, particularly in 
energy infrastructure; 
 
-- growing evidence that the GoA's still respectable primary surplus 
(+/- 3% of GDP) is being propped up by a combination of central bank 
profit contributions and non-transparent delayed payments on 
GoA-contracted infrastructure projects; 
 
-- the GoA's intervention in INDEC; 
 
-- continued concerns over as-yet-unresolved GoA frictions with the 
rural agricultural sector that could lead to further strikes and 
market disruptions; 
 
-- the deteriorating finances of key provinces, including Buenos 
Aires and Cordoba (which together contribute 42% of national GDP), 
that is related to the growing concentration of tax revenues at the 
federal level and perceptions that the Kirchner administration is 
 
distributing and withholding promised funds to reward political 
loyalty and punish dissident governors; and 
 
-- the lack of any steps towards resolving longstanding claims by 
Paris Club sovereign creditors, bond "holdouts," and ICSID 
international arbitration claims. 
 
----------------------------------------- 
...And GoA Responds with Buy Back Program 
----------------------------------------- 
 
¶5. (SBU) In response to a dramatic decline in GoA bond prices during 
the week of August 4-8 (an average drop of 6% in the price of 
Argentine sovereign dollar and peso bonds), Interior Minister 
Florencio Randazzo attributed the sell-off to manipulation by market 
speculators and said it did not reflect the economy's strength.  On 
August 10, following a rare Sunday economic policy meeting at the 
Presidential residence that included CFK, Economy Minister Carlos 
Fernandez, Finance Secretary Hernan Lorenzino, Central Bank 
President Martin Redrado and Chief of Cabinet Sergio Massa, the GoA 
announced it would launch a public debt buy-back program.  While the 
GoA did not initially announce the size of the program, it said 
that, in its initial phase, the program would focus on both dollar 
and peso bonds maturing in the remainder of 2008 and 2009.  The GoA 
subsequently clarified that it had authorized up to $1 billion for 
the buyback program - roughly equivalent to the amount it had 
received from the recent private debt sale to Venezuela. 
 
--------------------------------------------- ---- 
S&P Downgrade, Lowball Inflation Darken Sentiment 
--------------------------------------------- ---- 
 
¶6. (SBU) On Monday, August 11, GoA bond prices recovered much of 
their prior week losses in early trading in response to what market 
players estimate was $200 million worth of bond purchases by the 
GoA.  However, late that afternoon, INDEC announced July inflation 
increases of only 0.4% m-o-m, the lowest increase in a year and a 
number that market participants found less than credible.  In y-o-y 
terms, official headline inflation declined to 9.1%, from 9.3% in 
June.  (The consensus forecast had been that INDEC would report an 
inflation rate of around 0.6% m-o-m, flat versus June.  Private 
sector's estimates put July inflation at 1.0 - 1.5% m-o-m and around 
25% in y-o-y terms). 
 
¶7. (SBU) That same afternoon, Standard and Poor's downgraded 
Argentina's long-term debt rating by one notch from B-plus to B 
(five notches below investment grade), basing its decision on a view 
that GoA fiscal performance will continue to deteriorate due to 
slowing real GDP growth and government spending rigidities.  The 
confluence of both non-credible INDEC data and the S&P downgrade 
promoted a sell-off of Argentine debt that halved price gains 
recorded earlier in the day. 
 
-------------------------------------------- 
Bond Prices Recover, but INDEC Concerns Grow 
-------------------------------------------- 
 
¶8. (SBU) From August 12 - August 14, GoA bond prices continued to 
firm on the strength of GoA purchases, with the Economy Ministry 
spending an estimated total of $500 million of the $1 billion 
budgeted for buybacks.  At the same time, local media focused on 
heated debates in congress over the GoA's proposed nationalization 
of flag carrier Aerolinias Argentinas and the potential drain this 
would cause on budget resources. (Aerolineas has historically been a 
poorly performing and heavily subsidized company, with debts 
estimated at US$1 billion and operational losses at around US$500 
million per year.) 
 
¶9. (SBU) Also during the week, persistent rumors of possible cabinet 
changes, including the replacement of Economy Minister Carlos 
Fernandez and the removal of Internal Commerce Secretary Guillermo 
Moreno from his (never formally acknowledged) oversight of INDEC 
generated column inches of media reports and, according to Embassy 
market contacts, significant trading volatility.  On Thursday, 
August 14, credit rating agency Moody's changed the outlook on 
Argentina's B3 sovereign rating (six notches below investment grade) 
from "positive" to "stable", citing a more contentious and volatile 
political environment that raises concern the GoA may not being able 
to fully address economic policy challenges or adequately respond to 
potential economic or fiscal shocks.  Nevertheless, at OOB Friday 
August 15, with the promise of continued GoA bond purchases, GoA 
bond prices had recovered almost fully from price declines suffered 
the prior week. 
 
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Comment 
------- 
 
¶10. (SBU) Despite mounting macro-economic stress, including real 
inflation estimated in the 25% range, Argentina's current economic 
performance remains relatively strong: 2008 GDP growth is projected 
in the still very respectable 6% range; the trend in the linked and 
closely watched debt/GDP ratio remains downward; the 2008 primary 
fiscal surplus, while under pressure, is projected to remain in the 
2-3% of GDP range; and the current accounts trade surplus, while 
declining, remains fundamentally strong given still very favorable 
international commodity price terms of trade and a still undervalued 
nominal exchange rate.  Markets have taken some comfort from recent 
fledgling steps by the Kirchner administration to address growing 
budget pressures that threatens the primary fiscal surplus.  These 
include the recent decision to hike some electricity tariffs and to 
eliminate tax exemptions for fiduciary fund financial instruments. 
 
 
¶11. (SBU) Despite these solid fundamentals, financial markets 
punished GoA debt on the week of August 4, with country-risk 
premiums topping 740 basis points, a level not seen since just prior 
to the 2001 default.  And while the GoA's August 11-15 bond buyback 
program appears to have succeeded in restoring debt values and 
calming market jitters, our local market contacts characterize the 
government strategy as a reactive, ad hoc response to what they see 
as the GoA's continued inability to formulate coherent policy 
responses to growing macro-economic disequilibria.  In particular, 
they cite the hermetic silence of Economy Minister Carlos Fernandez 
and his team over the past three months and speculate (hopefully, 
but without much justification as far as we can tell) that the 
Kirchner administration may soon call on either current central bank 
president Martin Redrado or former central bank president Mario 
Blejer to take over the portfolio in a way that more substantively 
addresses market concerns about the GoA's ability to cover debt 
maturity peaks in 2009 and 2010. 
 
¶12. (SBU) Near-term steps that market players and local economists 
advocate include further hikes in utility and transport rates to 
reduce burgeoning subsidy payments that are a drag on fiscal 
accounts, cuts in government infrastructure spending growth to bring 
such spending more in line with revenue projections, and concrete 
steps to address market concerns about the GoA's ability to fund 
concentrations of debt maturities in 2009/2010 via some combination 
of debt rollovers with local banks and pension funds, seeking 
additional MDB credits, and perhaps tapping central bank reserves. 
They are also look for (as are we) a rumored presentation of a 
formal debt restructuring proposal to the Paris Club. 
 
¶13. (SBU) Despite recent rating agency downgrades and significant 
increases in Argentina's country risk premium, most Embassy contacts 
discount any medium-term default scenario and note that the GoA has 
the capacity to fund itself in local capital markets through 2009 
absent any radical drops in global commodity prices.  Near-term 
market sentiment will likely turn on steps the GoA takes - or fails 
to take - in the coming weeks to demonstrate its long-term economic 
vision and commitment to fiscal probity. 
WAYNE