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### Viewing cable 08BUENOSAIRES1708, Argentina: World Bank Country Director Cautions on Economy

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
08BUENOSAIRES1708 | 2008-12-18 12:12 | 2011-04-19 06:06 | UNCLASSIFIED//FOR OFFICIAL USE ONLY | Embassy Buenos Aires

`

    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============================

`