VZCZCXYZ0000
RR RUEHWEB

DE RUEHBU #1218/01 2422002
ZNR UUUUU ZZH
R 292002Z AUG 08
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC 1915
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/USDOC WASHINGTON DC
RUEHC/DEPT OF LABOR WASHINGTON DC
RUEHRC/DEPT OF AGRICULTURE WASHINGTON DC
RHMFIUU/HQ USSOUTHCOM MIAMI FL
RUCNMER/MERCOSUR COLLECTIVE
RUEHCV/AMEMBASSY CARACAS 1865

UNCLAS BUENOS AIRES 001218 
 
SIPDIS 
SENSITIVE 
 
USDOC FOR 4322/ITA/MAC/OLAC/PEACHER AND SABOTTA 
USDOC for 3134/ITA/USFCS/OIO/WH/RD/LEBLANC 
 
E.O. 12958: N/A 
 
TAGS: ECON EFIN PGOV EINV EAGR ENRG ETRD AR
SUBJECT: Argentina: Government Subsidy Increases Could Squeeze 
Fiscal Stability 
 
REF: (A) Buenos Aires 1160 
     (A) Buenos Aires 1053 
     (B) 07 Buenos Aires 2313 
     (C) 07 Buenos Aires 2251 
 
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Summary 
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¶1. (SBU) Government subsidies, mostly for energy, transportation, 
and food, have been surging in 2008 and threaten to undermine one of 
the pillars of the GOA's economic model, a primary fiscal surplus in 
the range of 3% of GDP.  In the first half of 2008, the GOA spent 
over US$4 billion on subsidies, a 215% year-on-year nominal 
increase, in an effort to hold down prices of electricity, gas, 
train, subway and bus fares, as well as meat, milk, bread and pasta. 
 While domestic consumption subsidies are generally acknowledged to 
be economically inefficient, curbing their growth could prove 
politically difficult for the Kirchner administration given that the 
subsidies are intended to support the GOA's core constituency, the 
urban poor.  Conversely, raising taxes to fund subsidies in the wake 
of the recent agricultural crisis also appears problematic.  Recent 
increases in some electricity and airline tariffs are, at best, a 
small start at addressing the budgetary burden of expanding 
subsidies.  With this increasing fiscal squeeze, the primary 
surplus, one of the truly successful legacies of the Kirchner era, 
could be in jeopardy.  So far, the government is pledging to 
maintain the surplus.  END SUMMARY 
 
------------------------- 
Subsidies exploding . . . 
------------------------- 
 
¶2. (SBU) Subsidies, mostly for energy, transportation, and food, 
have been surging in 2008 and threaten to undermine one of the main 
pillars of the GOA's economic strategy: a primary fiscal surplus in 
the range of 3% of GDP.  In the first half of 2008, the GOA spent 
some US$4.04 billion on subsidies, according to local think tank 
Argentine Association of Budgets and Public Finance (ASAP), a 215% 
increase in nominal peso terms over the same period as last year, 
and largely to keep pace with inflation and to hold down prices of 
electricity, gas, train, subway and bus tariffs, as well as food 
staples such as meat, milk, bread and pasta.  According to ASAP, 
about two-thirds of the subsidies go to cover the difference between 
GOA-mandated energy tariff ceilings and higher production costs 
owing to higher world prices for gas and other fuels.  Total 2007 
subsidies amounted to US$5.28 billion, or 11.6% of total GOA 
expenditures.  ASAP and other private sector analysts estimate that 
the GOA could spend US$8-US$10 billion on subsidies in 2008, out of 
a roughly US$60 billion in 2008 primary outlays, or 13-17% of the 
total.  This could represent an estimated 107% of Argentina's 
primary fiscal surplus, over 3% of GDP, and more than triple the 
burden in 2006.  According to Ricardo Delgado of Ecolatina, GOA 
spending on subsidies will continue to be very strong and there is 
no reason to believe that the GoA can or will substantially reduce 
them anytime soon, owing to the GOA's need to limit the prices for 
these energy, transportation, and food items, for its core political 
base, the urban poor. 
 
-------------------------------- 
Squeezing the GOA fiscal account 
-------------------------------- 
 
¶3. (SBU) Private sector economists have widely commented that the 
GoA's ability to maintain a fiscal surplus in its target range of 
3-4% of GDP could be compromised in the future.  Apart from these 
costly and growing subsidies, the GOA also faces "worrying" 
increases in public salaries, pensions, and transfers to the 
provinces, according to local think tank ASAP.  Commodity prices for 
major exports have already declined in the last month (for example, 
by 23% for soy and 25% for corn).  ASAP analysts particularly 
highlight the fact that public pension outlays could rise 
substantially in 2009 due to Supreme Court rulings that could 
(pending congressional ratification) force the GOA to raise payments 
for all recipients.  (According to ASAP, 2008 pension outlays will 
grow 7% in nominal terms over 2007, and could grow 25% in nominal 
terms in 2009 over 2008.)  ASAP has also noted that the 2009 
Congressional elections could be another incentive to increase 
spending. 
 
--------------------------------------------- ---- 
Little economic - or political - room to maneuver 
--------------------------------------------- ---- 
 
¶4. (SBU) Political and economic analysts note that, while the 
chances of the GOA substantially reducing subsidies appear to be 
slim, raising taxes is not an easy option either.  Although the GOA 
did increase taxes in recent months (refs C and D: November 2007 
export tax increases for some mining, hydrocarbon and agricultural 
products), and recently imposed a 35% capital gains tax on income 
from investments in mutual and trust funds, the recent agricultural 
crisis makes many analysts believe that there is little room for 
substantially higher taxes.  The rollback of the increased 
agricultural export tax could cost the GOA roughly US$2.6 billion in 
potential 2008 revenue, or about 4.4% of primary expenditures, 
according to local economist Carlos Melconian.  Further, Argentina 
has already had a steep rise in tax pressure in recent years, and 
federal, state and local tax revenue as a share of GDP has risen 
from around 21% of GDP in 2001 to over 32% of GDP in 2007, according 
to local consultant Poliarquia. 
 
¶5. (SBU) While GoA subsidies are intended to support President 
Cristina Fernandez de Kirchner's (CFK) core political base, the 
largely urban poor, economists and opposition parties contend that 
they are an inefficient way of assisting them.  A widely-cited 
example is the fact that the capital's upper and middle classes 
benefit disproportionately from electricity subsidies.  On the other 
hand, with poverty and inequality rates now reported to be back on 
the rise, any subsidy cuts would significantly impact those at or 
below the poverty line.  Many forecasters put the rate of consumer 
inflation in the 25-30% range this year, and real salaries are 
struggling to keep up, particularly for the almost 40% (at the end 
of 2007, and according to the GOA national statistics agency) of the 
workforce that is informal.  According to Ernesto Kritz, head of 
labor consultancy Sociedad de Estudios Laborales, real wages are now 
stagnant at best, and poverty - now at about 30%, according to some 
unofficial estimates - and income inequality are on the rise. 
 
--------------------------------------------- --- 
Recent tariff increases a start, but more needed 
--------------------------------------------- --- 
 
¶6. (SBU) Recent modest electricity rate hikes for Greater Buenos 
Aires (ref B), while easing margin pressures on distributors, are, 
according to energy company officials, inadequate to fund needed 
investment new distribution capacity and compensate these companies 
beset by inflation accumulated since 2002 and rising union wages. 
Electricity prices in greater Buenos Aires are still very cheap: 
neighboring provinces and countries still pay substantially higher 
rates - up to 10 times more in Rio de Janeiro, for example. 
Similarly, recent GoA rulings allowing domestic airfares to increase 
by up to 40% are welcome, but local sector analysts agree that 
further hikes are needed to spur significant new investments, and 
allow carriers to be profitable.  Nor is it even clear that such 
tariff increases will lessen the GOA's subsidy burden, which is one 
of the GOA's stated goals for imposing these increases: train and 
subway fares were increased an average of 21% in January 2008, yet 
subsidies to these sectors actually increased 61% from January-June 
2008 over the same period in 2007. 
 
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Comment 
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¶7. (SBU) GOA subsidies are rising at rates that outpace increases in 
overall revenue growth.  GOA options to either halt subsidy growth 
and/or increase taxes appear limited.  The combination of declining 
GoA popularity, upcoming 2009 Congressional elections, and a more 
assertive and restive Congress could increase the temptation to ramp 
up spending, making it more difficult to tighten fiscal policy and 
contain inflation, which could further strain the fiscal account. 
And with the possibility of lower commodity prices and sustained 
higher public debt financing costs (ref A), the primary fiscal 
surplus - an anchor of Argentina's recent macroeconomic stability 
and one of the truly successful Kirchner legacies - could also be in 
jeopardy.  So far, however, the government is still pledging to 
maintain that surplus. 
 
WAYNE