VZCZCXYZ0002
OO RUEHWEB

DE RUEHBU #1708/01 3531211
ZNR UUUUU ZZH
O 181211Z DEC 08
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC IMMEDIATE 2707
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEHRC/DEPT OF AGRICULTURE USD FAS WASHINGTON DC
RUEHC/DEPT OF LABOR WASHINGTON DC
RHMFIUU/HQ USSOUTHCOM MIAMI FL
RUCNMER/MERCOSUR COLLECTIVE

UNCLAS BUENOS AIRES 001708 
 
SIPDIS 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON EFIN ETRD EINV AR
SUBJECT: Argentina: World Bank Country Director Cautions on Economy 
 
Ref: (A) Buenos Aires 1703 
     (B) Buenos Aires 1696 
     (C) Buenos Aires 1685 
      (D) Buenos Aires 1682 
  
 This cable contains sensitive information - not for internet 
 distribution. 
  
 ------- 
 Summary 
 ------- 
  
 ¶1. (SBU) The local World Bank (WB) Country Director (protect) sees 
 the GoA ""walking a tightrope"" in terms of its capacity to maintain 
 market confidence, stem capital flight, and sustain twin fiscal and 
 current account surpluses in a context of economic slowdown, 
 continued high rates of GoA public infrastructure spending, high 
 inflation, and lower commodity prices.  While GoA authorities have 
 responded to constraints in accessing international financial 
 markets by buying back debt, announcing their intention to pay down 
 Paris Club debt and by re-opening talks with holdout creditors, the 
 impact of these efforts on market confidence has been limited by 
 investor concern on macroeconomic policy drift and by heavy GoA 
 spending in the run-up to 2009 mid term elections. 
  
 ¶2. (SBU) WB Country Director Pedro Alba told Ambassador December 12 
 he had personally cautioned Chief of Cabinet Sergio Massa on 
 Argentina's precarious condition.  He advised Massa on the need to 
 build confidence by announcing -- and following -- a hard fiscal 
 rule to maintain the primary fiscal surplus; cleaning up GoA 
 statistics agency INDEC; and addressing concerns on how the GoA will 
 manage nationalized pension fund resources and equity holdings. 
 Should capital flight overwhelm the GoA's ability to sustain 
 confidence in the currency, the WB has developed a contingency 
 crisis plan that would allocate additional Bank resources to social 
 safety net programs.  Any restructuring of the roughly US$5 billion 
 in Bank exposure would only come in the context of an IMF program. 
 Alba estimated that, in a crisis scenario, the GoA would need some 
 $30 - $35 billion, including to rebuild reserve levels.  End 
 Summary. 
  
 -------------------------------------- 
 GoA Walking a Capital Flight Tightrope 
 -------------------------------------- 
  
 ¶3. (SBU)  In a December 12 meeting with Ambassador, World Bank (WB) 
 Country Director Pedro Alba briefed the Embassy on the Bank's 
 country assistance strategy (Ref A) and on its views on GoA economic 
 management.  Alba's main concern was that the GoA is ""walking a 
 tightrope"" in terms of its capacity to maintain market confidence 
 and stem capital flight.  While there are sufficient local currency 
 funds available to the GoA to cover 2009 debt obligations, Alba 
 said, the question is whether Argentina will be able to attract and 
 retain sufficient dollar reserves.  Roughly US$16 billion of capital 
 left Argentina's financial system in the first three quarters of 
 2008 and, if another US$ 8-12 billion of Argentine capital flees, 
 the GoA will be ""all alone - out on a limb"" in terms of its ability 
 to sustain needed hard-currency reserve levels. Comment: Former 
 Economy Minister Roberto Lavagna also flagged the implications of 
 capital flight to Ambassador and Econ Counselor (Ref B). End 
 Comment. 
  
 ¶4. (SBU) Alba said he had personally cautioned Chief of Cabinet 
 Sergio Massa on Argentina's precarious condition, but that Massa had 
 argued that Argentina will muddle through 2009/10.  Alba said he 
 advised Masa that important confidence-building measures are needed 
 and could include:  (1) cleaning up GoA statistics agency INDEC; (2) 
 announcing and following a hard fiscal rule to maintain the primary 
 fiscal surplus; and (3) setting out clear and monitorable guidelines 
 on how recently nationalized private pension fund (AFJP) resources 
 will be managed and, as importantly, how the GoA will manage the 
 board seats on a broad range or Argentine and foreign companies that 
 it inherited as a consequence of the private pension fund 
 nationalization exercise.  Whether and how GoA-appointed company 
 directors will vote GoA shares needs to be clarified as soon as 
 possible to regain investor confidence, Alba said. 
  
 ---------------------------------------- 
 World Bank's Crisis Contingency Planning 
 ---------------------------------------- 
  
 ¶5. (SBU) Alba joked that he'd congratulated Massa on the GoA's 
 impressive ability to keep generating economic and economic policy 
 surprises.  He told Ambassador that, should capital flight overwhelm 
 the GoA's ability to sustain confidence in the currency, the WB has 
 developed a contingency crisis plan that would allocate additional 
 Bank resources to social safety net programs.  Any restructuring of 
 the roughly US$5 billion in Bank exposure, however, would only come 
 in the context of an IMF program.  Alba estimated that, in a crisis 
 scenario, the GoA would need some $30 - $35 billion, including to 
 rebuild reserve levels. 
  
 ---------------------------------------- 
 International Crisis Impact on Argentina 
 ---------------------------------------- 
  
 ¶6. (SBU) Alba expanded on World Bank views on the Argentine economy 
 in a subsequent discussion with EconCouns.  Alba summarized the 
 short-term impact of the financial crisis: 
  
 -- An uncertain domestic policy environment that has eroded market 
 confidence has led to a decline in domestic credit and a linked 
 buildup of liquidity cushions by private local banks.  Alba noted 
 significant deposit outflows and sharp increases in interest rates 
 and demand for U.S. dollars following the announcement of the 
 nationalization of pension funds in October. 
  
 -- Capital outflows are complicating monetary management.  Following 
 third quarter 2008 capital outflows of roughly US$6 billion (and 
 roughly US$16 billion for the first three quarters of 2008), 
 stability is gradually returning to domestic capital markets 
 following significant late November and early December intervention 
 by the central bank and GoA regulatory agencies. 
  
 -- As gross international reserves have declined, the GoA has moved 
 to shelter the economy from further financial shocks.  In response 
 to increased financial volatility, the central bank has intervened 
 frequently in foreign exchange markets to preserve currency 
 stability.  As a result, gross international reserves have declined 
 from over $50 billion in early 2008 to about $45 billion (nine 
 months of imports).  However, net international reserves (net of 
 central bank obligations with the BIS and other international 
 financial institutions) are down to roughly $35 billion. 
  
 -- The exchange rate will continue to depreciate gradually following 
 the sharp 7.8% depreciation in October.   According to Alba, the 
 GoA's primary monetary policy objective is to preserve exchange rate 
 stability and confidence in the currency.  In light of increased 
 financial volatility, the central bank will continue to allow the 
 exchange rate to depreciate in an orderly and gradual manner.  In 
 addition to intervening in foreign exchange markets, the central 
 bank has also tightened capital controls. Comment:  Central Bank 
 President Redrado confirmed these points to Ambassador December 17, 
 adding that the key in his view is managing an orderly depreciation 
 without panic in the markets. End Comment 
  
 -- The value of Argentine financial assets has been hurt by 
 increased global risk aversion and eroded market confidence.  Bond 
 and stock prices have fallen sharply since mid-2008, with equity 
 values down almost 50% year to date.  Argentine equity values have 
 been particularly hard hit as market confidence has been shaken by 
 the farm crisis and more recently by the GoA takeover of private 
 pension funds. 
  
 -- Argentine country risk premiums remain among the highest and most 
 volatile in the Latin America.  Argentine EMBI and credit default 
 swap spreads have been in a constant upward trend throughout 2008, 
 with EMBI spreads peaking at 1965 basis points on November 14, an 
 increase of roughly 1,290 bps since August 2008.  Argentine EMBI 
 spreads are currently around 1,900 basis points, second only to 
 Ecuador and among the most volatile in the region. 
  
 ---------------------------- 
 Medium Term Economic Outlook 
 ---------------------------- 
  
 ¶7. (SBU) Alba was concerned that the GoA has yet to implement an 
 adequate mix of monetary and fiscal policies that would allow it to 
 address inflationary pressures and report credible inflation 
 figures.  It will be increasingly difficult to sustain twin fiscal 
 and current account surpluses in a context of economic slowdown, 
 continued high rates of GoA public infrastructure spending, high 
 inflation, and lower commodity prices.  While Alba believes the 
 primary fiscal surplus should hold at 3.4% for calendar 2008, even 
 with real GDP growth decelerating to the 6% range by the end of 
 2008, fiscal accounts will remain vulnerable to lower commodity 
 prices, declining growth, and GoA expenditure rigidities.  The WB is 
 projecting GDP growth in 2009 at the 2.5% level.  The Bank is 
 particularly concerned at the fiscal situation in many provinces 
 that remain highly dependent on the federal government for resource 
 transfers. 
 ¶8. (SBU) Argentina's current account surplus is falling and Alba 
 expects it to end 2008 at about 1.8% of GDP (compared to the Central 
 Bank's consensus estimate of 2.2%).  Any further decrease in 
 commodity prices coupled with a decrease in global demand will 
 further reduce Argentine exports, and Alba predicted that the 
 current account is likely to shift into deficit in 2009.  He said 
 that, if this happens, it will set off alarms in Argentina and 
 internationally.  With a capital account deficit also likely in 2008 
 and 2009, there will be further declines in international reserves. 
 (Comment: Estimating the direction of the balance of payments is 
 difficult, given that a significant depreciation of the peso -- 
 which appears likely -- would result in stronger exports and 
 increasing reserves, along with increasing capital outflows, with 
 the net effect uncertain.) 
  
 ¶9. (SBU) Alba's principal concern is that an increasingly 
 unfavorable external environment, coupled with uncertainty over the 
 course of GoA macro policies, will continue to depress market 
 confidence.  On the positive side, GoA authorities have responded to 
 constraints in accessing international financial markets by buying 
 back debt and announcing their intention to pay down Paris Club debt 
 and re-open talks with holdout creditors.  These announcements have 
 been interpreted by markets as signs of the GoA's willingness to 
 pay.  But their impact on market confidence has been limited by 
 investor concern on policy drift and the GoA's unabashed 
 determination to use funds to shore up its electoral prospects in 
 the 2009 mid-term elections.  The GoA could better manage the 
 situation, Alba said, by improving the credibility of inflation 
 figures and by putting together a stronger and more predictable 
 program to maintain the primary fiscal surplus. 
  
 WAYNE 

 =======================CABLE ENDS============================