VZCZCXYZ0000
RR RUEHWEB

DE RUEHBU #0436/01 1041413
ZNR UUUUU ZZH
R 141413Z APR 09
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC 3535
INFO RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUCNMER/MERCOSUR COLLECTIVE

UNCLAS BUENOS AIRES 000436 
 
SIPDIS 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PREL AR
SUBJECT:  Argentine Central Bank Joins Government in Objecting to 
Post's Investment Climate Statement 
 
Ref: Buenos Aires 387 
 
------- 
Summary 
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¶1. (SBU) In an April 6 letter to the Ambassador, Argentine Central 
Bank (BCRA) President Martin Redrado objected to Post's 
characterization in the latest Investment Climate Statement of BCRA 
policies' contribution to rising inflation (text provided below). 
During a subsequent telephone conversation, Redrado and the 
Ambassador agreed BCRA economists and Econoffs should discuss ways 
the Embassy can modify future statements to explain the full range 
of factors that created the high-inflationary environment between 
2006 and 2008.  Changing topics, Redrado said he planned to announce 
the formal currency swap agreement with China the week of April 13. 
End Summary. 
 
------------------------------ 
BCRA:  Inflation Not Our Fault 
------------------------------ 
 
¶2. (SBU) In a lucid and well-written April 6 letter to the 
Ambassador, Redrado objected to the Embassy's assessment of BCRA 
policies in the recently-published Investment Climate Statement 
(ICS).  He argued that the statement in the ICS that the BCRA "has 
managed monetary and currency policy in support of the economic 
expansion, maintaining an undervalued or 'competitive' exchange rate 
and negative real interest rates," is "a shallow evaluation" of 
current circumstances.  The letter then outlines the arguments that 
Redrado has made numerous times over the last three years in 
meetings with USG officials. 
 
¶3. (SBU) Redrado's main points, reported many times in Post cables, 
are: 
 
-- 1) there is "no-one-size-fits-all" policy; 
-- 2) the small size of the Argentine financial sector limits the 
BCRA's ability to use monetary transmission channels to control 
inflation; 
-- 3) fiscal and wage policies have a more powerful impact on prices 
(in Argentina); 
-- 4) monetary policy has gradually become tighter (and increasingly 
counter-cyclical) in recent years, as reflected by higher interest 
rates [albeit still negative in real terms]; 
-- 5) a managed float is required in a country where everyone 
calculates value in dollars and flees the peso at the first sign of 
trouble; and, 
-- 6) anti-inflation policy requires coordinated fiscal, wage, 
competition, and monetary policies.  (This last point is his most 
frequent refrain.) 
 
¶4. (SBU) During a follow-up telephone conversation on April 8, the 
Ambassador defended the ICS assertions, noting that many prominent 
local economists agree with our assessment that expansionary 
monetary policy and an undervalued currency are contributing causes 
of high inflation in Argentina in recent years.  Nevertheless, the 
Ambassador agreed that as currently drafted the ICS gives the unfair 
perception that the BCRA is the main culprit.  He also acknowledged 
the many other contributing factors, and agreed that Post's Econoffs 
and BCRA economists should meet to discuss ways the Embassy can 
provide a more complete explanation of the causes of inflation in 
future statements. 
 
¶5. (SBU) Redrado responded that the GoA's fiscal and wage policies, 
in particular, have had an inflationary impact in recent years.  He 
reiterated that the BCRA has sought to pursue counter-cyclical 
monetary policy, and emphasized that monetary growth over the last 
year has slowed considerably.  Redrado also repeated the request 
from his letter that the Embassy publish the BCRA letter along with 
the ICS.  The Ambassador explained that this would not be possible, 
but agreed to include a link to the BCRA website at the end of the 
ICS (along with other already existing links to other institutions 
and GoA agencies).  Redrado said he would likely publish some form 
of formal rebuttal on the BCRA site. 
 
¶6. (SBU) Comment: In our opinion, the inflationary impact of BCRA 
policies is indisputable, and widely accepted as so among local 
economists.  Nevertheless, Redrado is correct that many other 
factors -- such as fiscal expansion, rapid wage growth, and high 
commodity prices -- have played key roles in stimulating consumption 
and overheating the Argentine economy.  Despite its contribution to 
the excessive expansion of the economy since 2003, there is also no 
question that the BCRA has played the most responsible policy role 
of any Argentine institution over the last few years, and continues 
to be the linchpin keeping the Argentine economy's decline from 
spinning out of control.  Post would argue nonetheless that BCRA 
monetary policies have tended towards being more pro-cyclical, 
rather than counter-cyclical, as evidenced by the 25-35% growth in 
the monetary base in past high-growth years, contrasted with current 
sub-10% money growth at a time when the economy -- and probably the 
rate of inflation -- is contracting sharply. 
 
--------------------------- 
BCRA-China Swap Coming Soon 
--------------------------- 
 
¶7. (SBU) Redrado also noted that he will formally announce the 
currency swap agreement (reported Reftel) between the BCRA and the 
People's Bank of China (PBC) the week of April 13.  (BCRA Vice 
President Miguel Angel Pesce told Econoff April 13 that the BCRA's 
Board of Directors formally approved the swap agreement April 8.) 
Redrado said he sees it exclusively as a contingency "liquidity 
pool" and downplayed its commercial applications.  Explaining the 
local drama following the PBC's premature announcement of the 
agreement on March 30, he said he had explained to his counterpart 
(PBC Governor Zhou Xiaochuan) that he needed to return to Argentina 
to explain the benefits of the deal and work it through the 
bureaucracy.  Redrado noted the irony that for once it was not the 
Argentines who leaked the agreement to the press.  (Comment: Post's 
understanding, taken from conversations with official contacts, is 
that the swap arrangement has a strong commercial focus.  Therefore, 
the Chinese may take exception to Argentine views that its purpose 
is only to strengthen the BCRA's ability to deal with the ongoing 
slow-motion run on the peso and help it deal with liquidity crises. 
End Comment.) 
 
¶8. (SBU) Begin Text of BCRA President Redrado's letter: 
 
I am writing you regarding the recent publication of the 2009 
Investment Climate Statement of Argentina by the U.S. Department of 
State.  In this document, it is stated that "Argentina's Central 
Bank has managed monetary and currency policy in support of the 
economic expansion, maintaining an undervalued or "competitive" 
exchange rate, and negative real interest rates".  Unfortunately, 
this statement unveils a shallow evaluation, which does not consider 
the objective circumstances under which monetary policy is 
conducted.  The recent global financial crisis shows that there is 
no "one-size-fits-all" policy and, therefore instruments which are 
valid for deep and mature credit markets are not available in our 
country, particularly after the collapse of 2001-2002. 
 
Liquidity and solvency rations plus the dividend payout exhibited in 
the last three years shows that the business climate in the monetary 
and financial arena is quite healthy; in particular, in a world 
where government intervention has shown the weakness of the banking 
sector.  The soundness of our monetary and financial system is not a 
matter of coincidence but the patient and persistent policies 
followed in the last years.  Our strategy entails the pursuance of 
preventive action to reduce the likelihood of occurrence of adverse 
shocks or to minimize their potential impact on the economy, 
including the validity of its four main pillars: (1) a robust 
monetary policy that ensures the equilibrium between supply and 
demand in the money market; (2) countercyclical scheme to mitigate 
vulnerabilities; (3) a managed floating exchange rate regime; (4) a 
tight regulatory and supervisory framework. 
 
Your assessment of our monetary policy is, therefore, incorrect and 
inconsistent with the robustness shown in recent years.  In a 
context of an economy that is still in transition towards its 
long-term equilibrium and where the power of traditional monetary 
policy instruments is limited, it is mistaken to analyze the 
monetary policy approach based upon solely on the level of policy 
rates.  Monetary policy must be assessed together with the stance of 
other policies that affect inflation in a powerful way such as 
fiscal, wage, income and competition policies. 
 
It is important to understand that, given the history of 
macroeconomic volatility, fiscal and external dominance and 
financial crises faced by different emerging market economies, not 
all countries are at the same stage in the path towards their stable 
equilibrium.  Thus, there are economies approaching their long-term 
cruising speed in others, however, the convergence is still 
incipient.  In Argentina, despite a notable recovery, several 
features of the current macroeconomic performance enable us to infer 
that the economy is still heading towards a new long-term 
equilibrium.  Neither in our history nor in the international 
experience is it possible to find precedents for the 2001-2002 
crisis.  Unlike the case of Brazil, Mexico or Southeast Asia, the 
abandonment of the convertibility regime included simultaneously an 
institutional breakdown, a huge devaluation, the destruction of the 
financial system and the default on the public debt.  This 
particular economic history and idiosyncrasy in transition phases 
not only affects the power of the instrument of the different 
branches of economic policy but also influences the way economic 
agents react to incentives and policies.  Just to give you an 
example, economic agents markedly favor, since the crisis, liquid 
forms of money to the detriment of wider monetary aggregates. 
 
As a consequence, while the traditional role of monetary policy in 
dealing with inflation is evident in the case of more mature 
economies where transmission channels (the credit channel, in 
particular) are deep enough to have a direct impact on aggregate 
demand, in Argentina monetary transmission channels are weak. 
Credit to the private sector accounts only for 12% of GDP after 
reaching levels of about 25% during the nineties.  This is also well 
below the average for Latin America (roughly at 30%).  Firms' access 
to the capital market tends to be restricted.  This leads to a low 
relative effectiveness of the Central Bank's reference interest rate 
as a tool to manage aggregate demand, and with it, pressures on 
prices.  Therefore, there is no room to take shortcuts: we need to 
patiently regain the power of the monetary instruments to being able 
to effectively manage aggregate demand. 
 
Same happens with the exchange rate channel.  A managed floating 
regime that provides predictability for investment, saving and 
consumption decisions but without providing "exchange rate 
insurance" is the only possible one at this point in time for 
Argentina.  And this has to do with how our history and devaluations 
and dollarization has (sic) affected the behavior of economic 
agents.  At any minimum external or domestic turbulence and abrupt 
adjustments in currency values triggers a significant overreaction 
with changes in portfolios that take place for precautionary 
reasons, as opposed to what happens in neighboring countries. 
 
Therefore, the need to prevent a new crisis becomes a priority 
objective.  Under these circumstances, it is imperative to generate 
buffers and to take into account both macroeconomic and financial 
stability when conducting monetary policy.  While building such a 
much-needed buffers (foreign reserves accumulation and solvent and 
highly liquid financial system) that are helping us to weather the 
international financial crisis today, the commitment of the Central 
Banks is to pursue a robust monetary policy through the strict 
control of the growth of the means of payment. 
 
Monetary aggregates have been growing at diminishing rates since 
2004 to stabilize at single digit levels for the trailing 12 months, 
consistently with the Monetary Program presented every year before 
Congress, which aims at maintaining the equilibrium between supply 
and demand in the monetary markets.  The strict control of M2 has 
led to a gradual but persistent increase in interest rates.  The 
control of the growth of M2 is based upon deep sterilization policy 
that distinguished our current monetary policy from an accommodative 
(completely passive) monetary policy such as the monetary policy 
pursued during the Convertibility years.  Gradually but in a 
sustained manner, the stance of monetary policy has been 
contractive: in the last three years, interest rates managed by the 
Central Bank, increased significantly. 
 
Moreover, in a still cash-intensive economy, the power of fiscal and 
wage policy to affect aggregate demand and expectations is 
significant.  Therefore, in making a judgment about expansionary 
policies, it is critical to track the recent evolution of fiscal and 
wage policy.  During this phase, inflation must be tackled using all 
the tools of economic policy.  In this framework, anti-inflationary 
policy has to do with joint and coordinated fiscal, wage, 
competition, and monetary policy actions.  It is therefore, not fair 
to analyze the stance of our monetary policy based upon solely on 
the level of policy rates.  The monetary policy stance must be 
assessed together with the stance of other policies that affect 
inflation such as fiscal and wage policies. 
 
To summarize, it is necessary to make a more meticulous analysis to 
better understand recent inflation process in Argentina.  Given our 
idiosyncrasy, the tools available at this particular stage the 
argentine economy is going through, the power of fiscal and income 
(mainly, wages) policies is key to affect the dynamic of inflation. 
From the Central Bank we have proved our commitment (with the 
limited instruments that we have at this point) and we have 
contributed providing monetary and financial stability given in the 
framework of an economy that is still in transition to its long-term 
stable equilibrium. 
 
Please, do not hesitate to contact me should you need further 
clarification and I look forward to having this letter published at 
the U.S. Department of State website together with the Statement. 
 
Martin P. Redrado 
Presidente 
 
End Text. 
 
Kelly