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### Viewing cable 08BUENOSAIRES1682, ARGENTINA: FISCAL SOLVENCY CONCERNS REMAIN,

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Reference ID | Created | Released | Classification | Origin
--- | --- | --- | --- | ---
08BUENOSAIRES1682 | 2008-12-11 18:06 | 2011-04-19 06:06 | CONFIDENTIAL | Embassy Buenos Aires

`

    VZCZCXRO4025
    OO RUEHAO RUEHCD RUEHGA RUEHGD RUEHHA RUEHHO RUEHMC RUEHMT RUEHNG
    RUEHNL RUEHQU RUEHRD RUEHRG RUEHRS RUEHTM RUEHVC
    DE RUEHBU #1682/01 3461808
    ZNY CCCCC ZZH
    O 111808Z DEC 08 ZDK
    FM AMEMBASSY BUENOS AIRES
    TO RUEHC/SECSTATE WASHDC IMMEDIATE 2668
    INFO RUEHWH/WESTERN HEMISPHERIC AFFAIRS DIPL POSTS IMMEDIATE
    RUEHSO/AMCONSUL SAO PAULO IMMEDIATE 3841
    RUEATRS/DEPT OF TREASURY WASHINGTON DC IMMEDIATE
    RUEAIIA/CIA WASHINGTON DC IMMEDIATE
    RUCPDOC/USDOC WASHINGTON DC IMMEDIATE
    RHEHNSC/NSC WASHINGTON DC IMMEDIATE

` `

    C O N F I D E N T I A L SECTION 01 OF 04 BUENOS AIRES 001682

    SIPDIS

    E.O. 12958: DECL: 12/10/2018
    TAGS: EFIN ECON PREL PGOV AR
    SUBJECT: ARGENTINA: FISCAL SOLVENCY CONCERNS REMAIN,
    DESPITE GOA TAKEOVER OF PENSION ASSETS

    REF: A. BUENOS AIRES 1680
          ¶B. BUENOS AIRES 1643
          ¶C. BUENOS AIRES 1667

     Classified By: Ambassador E. Anthony Wayne for Reasons 1.4 (b,d)

     -------
     Summary
     -------

     ¶1. (C) The Argentine government's nationalization of the
     country's private pension system entered into force December
     9, giving the GoA access to about US$25 billion in financial
     assets and US$4 billion in annual contributor payments.
     Argentine President Cristina Fernandez de Kirchner (CFK) has
     already announced plans to tap these assets to fund economic
     stimulus projects.  Even prior to the President's
     announcements, analysts were concerned that these new funds
     might not suffice to help the GoA cover future debt
     obligations AND significantly increase spending to counter
     rapidly slowing growth and buy back political support ahead
     of the 2009 mid-term elections.  While worries about a
     possible default in 2009 are overstated, reckless politically
     motivated spending in 2009 could imperil the GoA's ability to
     meet debt obligations in 2010 and beyond.  As evidenced by
     the market reaction since the President's October 21
     announcement of the pension nationalization, there is still
     great anxiety and uncertainty in the private sector, and
     Argentine assets are still priced at highly distressed
     levels.  End Summary.

     ---------------------------------------------
     GoA plans to use AFJP funds to prime the pump
     ---------------------------------------------

     ¶2. (C) As reported Ref A, President Cristina Fernandez de
     Kirchner (CFK) signed into law on December 4 the GoA's
     nationalization of Argentina's private pension funds (known
     as AFJPs).  The law entered into force December 9.  The GoA
     is already planning for the use of the AFJPs' US$25 billion
     in assets and $4-5 billion in annual cash flow, as evidenced
     by the President's November 25 announcement of ambitious tax
     incentives, export tax reductions, and US$ 21 billion public
     works plan (Ref B), and December 4 announcement of a further
     US$ 3.9 billion stimulus plan (Ref C).

     ¶3. (C) While the additional flows strengthen the GoA's
     finances, rapidly decelerating GDP growth and lower commodity
     prices are already resulting in lower than expected rvenues,
     and this trend is expected to worsen into 2009.  The GoA has
     limited ability to issue debt at this time due to high yields
     on Argentine bonds, limited domestic interest in buying GoA
     debt, and lack of access to international capital markets
     stemming from the threat of lawsuits from so-called ""Holdout""
     bondholders.  Since this situation is unlikely to change
     soon, there are still concerns in the market place about the
     GoA's capacity to meet debt payment obligations during
     2009-2011, when its annual debt amortizations increase by
     roughly a third over prior years.  While the GoA's recent
     announcements of increased spending may be welcome news to
     Argentine companies and consumers, they exacerbate worries
     about GoA finances going forward.

     -----------------------------------
     GoA Finances Look Adequate for 2009
     -----------------------------------

     ¶4. (C) There are undeniable fiscal benefits for the GoA of
     the AFJP nationalization, in terms of both higher revenues
     and lower debt payments.  First, the GoA now has greater
     access to the AFJPs' US$25 billion in assets and roughly US$4
     billion in annual contributor flows.  The GoA can tap this
     source of financing via bond sales to ANSES, the social
     security administration, which under the new law assumes
     control over the AFJP assets.  Second, the GoA can now also
     easily refinance with ANSES the debt amortizations it would
     have owed to the AFJPs, as well as the debt buybacks the GoA
     is required to make under the terms of the 2005 debt
     restructuring.

     ¶5. (C) This combination of new flows and reduced debt
     payments strengthens the GoA's ability to meet total debt
     obligations coming due in 2009.  This is especially true when
     considering that the GoA also has greater access to borrowing
     from the Argentine Central Bank (BCRA) and Banco de la Nacion
     (BNA).  (In the 2009 budget bill, Congress authorized changes

     BUENOS AIR 00001682  002 OF 004

     to BNA's charter to allow the GoA to borrow up to 30% of its
     deposits held at BNA, and to the BCRA's charter to allow
     expanded lending to the GoA, which in theory could be used to
     pay sovereign debt obligations.)

     ¶6. (C) Doing the math shows that the GoA has the wherewithal
     to meet 2009 debt obligations solely through tapping domestic
     sources of financing, particularly if it shows reasonable
     fiscal restraint.  Total scheduled debt service, including
     principal and interest, increases to about US$21 billion per
     year during 2009-2011, compared to US$16 billion in 2008.
     The Central Bank's consensus estimate for the primary fiscal
     surplus (before interest payments on debt) is approximately
     3% of estimated 2009 GDP, or about US$10.5 billion (at the
     current exchange rate of 3.45 pesos/dollar).  However, many
     economists expect that rapidly falling tax collection -- due
     to lower growth rates and much lower commodity prices -- will
     reduce the primary fiscal surplus to the 2% range, or about
     US$7 billion.  While this more conservative estimate leaves a
     financing gap of about US$14 billion, the GoA has numerous
     means to meet its 2009 financing needs:

     -- US$4 billion in approximate new flows from pension fund
     contributors following the AFJP nationalization (accessed via
     new bond issuances to ANSES).

     -- US$1.5-2 billion in savings via rolling over AFJP-held GoA
     bonds and GDP warrants, instead of issuing new debt, as
     estimated by noted Argentine Economists Miguel Kiguel and
     Carlos Melconian (the GoA estimates the savings at US$3
     billion).

     -- US$2.5 billion in debt buybacks, which the GoA is legally
     obligated to do under the terms of the 2005 debt exchange.
     (Instead of repurchasing bonds from the market, the GoA can
     just buy them from ANSES, in return for new bonds.)

     -- US$1.5-2 billion in financing from public agencies,
     including the tax authority AFIP, the national lottery, and
     ANSES (using flows from contributors that were not AFJP
     members).

     -- US$6.5 billion estimated lending from the BCRA ($3bn) and
     BNA ($3.5bn).

     -- US$1 billion estimated net positive funding from the World
     Bank, IDB, and CAF (Andean Development Corporation).

     ¶7. (C) This totals between US$17-18 billion, easily enough to
     cover financing needs in 2009, although also possibly
     optimistic, particularly with regards to possible funding
     from AFJP flows, BCRA and BNA lending, and IFI flows.
     However, in a pinch, the GoA could also attempt to do a debt
     swap with local financial institutions of the so-called
     ""Prestamos Garantizados"" (Guaranteed Loans).  The illiquid
     PGs comprise US$4bn out of the total $21bn debt amortizing in
     2009, and an optimistic assumption is that the GoA could
     rollover about US$2-2.5 billion in annual PG maturities over
     the next three years, via an exchange for slightly
     longer-term and more liquid securities.  Regardless, this
     accounting demonstrates that the GoA has access to one kind
     of financing or another on the order of US$15-20 billion.

     ¶8. (C) Analysts remain apprehensive, however.  Kiguel and
     Melconian both argue that even with the additional funding
     from the AFJPs, the GoA can cover debt obligations in 2009
     and 2010 only if it pursues moderate fiscal policies.
     Assuming low or no real GDP growth and inflation of 15-20% in
     2009, with average commodity prices staying at current levels
     (i.e., soybeans trading US$300-400/metric ton), and the
     Brazilian Real also at its current level (having depreciated
     about 40% against the dollar this year), Kiguel and Melconian
     predict that Argentina has fiscal space to increase nominal
     spending in 2009 by only 10-20% (compared to 28% in 2006, 46%
     in 2007, and roughly 35% so far in 2008), while staying
     current on debt service in 2009 and 2010.

     ¶9. (C) The broader concerns are that the economic downturn
     will be more severe than anticipated, or that the GoA will
     use up all its various sources of financing to realize a
     substantial spending increase in 2009 (to counter the
     economic deceleration and win political support prior to
     October 2009 mid-term legislative elections), or both.  This
     strategy would greatly increase the risks of at least a
     partial (""selective"") default in 2010.  The market's
     expectation that the GoA will indeed ramp up spending

     BUENOS AIR 00001682  003 OF 004

     significantly in 2009 is likely the primary reason why
     Argentine financial instruments are still priced at default
     levels.  The GoA's recent stimulus announcements give
     credence to those who argue that the Krichner's plan is to
     boost spending.

     -----------------------------------
     Market Response:  Major Thumbs Down
     -----------------------------------

     ¶10. (C) Without question, local capital markets resoundingly
     rejected the President's AFJP nationalization initiative, and
     many observers have speculated that the initiative has in
     effect killed off local capital markets.  CFK's October 21
     announcement touched off a month of financial turmoil and
     uncertainty, and Argentine asset prices currently trade at
     highly distressed levels.

     ¶11. (C) While the domestic sell-off coincided with the late
     October global sell-off, and also follows 15 months of steady
     declines in Argentine asset prices (ever since the global
     crisis began in July/August 2007), there are two aspects of
     the local crisis that differentiate it from events
     transpiring in the world and among Argentina's neighbors.
     First, the nationalization removes the largest source of
     investment to the private sector, and early indications are
     that ANSES will prioritize infrastructure investments, and
     direct funding to the GoA over providing financing to the
     private sector.  The net effect will likely be a significant
     crowding out of the private sector.

     ¶12. (C) Second, the new regime also gives ANSES significant
     ownership of major companies operating in Argentina, and it
     is as yet unclear how the GoA will act in this regard.
     Choosing to divest these holdings, which in a number of
     important local companies exceeds 20% of total outstanding
     shares, could affect already beaten-down share prices.  A
     further complicating factor is that Argentina's Mixed Economy
     Companies Law (N 15.349), covering companies that include
     both public and private ownership, seems to require that the
     GoA appoint the director and at least a third of the Board of
     Directors of all companies, and have veto power over Board
     decisions.  Although GoA officials have reassured companies
     that they have no intention of controlling them, it is
     unclear how this issue will evolve and the pension
     nationalization law exacerbates the uncertainty by not
     clarifying the GoA's role.  (Comment:  Private sector
     contacts tell Post that it is clear from their conversations
     with GoA officials that they did not contemplate this
     situation when drafting the pension nationalization law.)

     --------------------
     Survey of the Damage
     --------------------

     ¶13. (C) Neither the reduced access to financing nor the
     increased government ownership of companies is good news for
     an already beleaguered private sector, and this was reflected
     in the plunge in all asset prices, increase in capital
     flight, and run on the peso between October 21 and November
     ¶20.  During this period:

     -- The Buenos Aires Stock Market, Merval, dropped 26% and
     Argentine dollar-denominated bonds fell on average 35%, while
     peso bonds dropped 31%.

     -- As a result, the value of AFJP holdings decreased from 94
     billion pesos (about US$30 billion) on September 30 to 78
     billion pesos (about US$25 billion) October 31.

     -- Argentina's sovereign risk rating, as measured by JP
     Morgan's EMBI plus, widened 518 basis points to close on
     November 20 at 1,913 bps (after peaking at 1,970 bps on
     October 22).  (For comparison, since January 2008,
     Argentina's EMBI has widened 1,511 bps while Brazil's has
     widened only 359 bps.)

     -- Argentines rushed to pull pesos out of banks and buy
     dollars, with total private peso-denominated deposits
     plunging 5.2% in October, worse than the 4.4% drop in May
     (the worst month of the farm crisis).

     -- As a result, the peso depreciated from 3.24 pesos/dollar
     on October 20 to 3.34 pesos/dollar November 20, after hitting
     3.43 on October 29.  One-year peso futures contracts, trading
     on local markets, jumped from about 3.5 pesos/dollar to 3.8

     BUENOS AIR 00001682  004 OF 004

     pesos/dollar, after peaking in early November near 4
     pesos/dollar.  The one-year non-deliverable forward (NDF,
     traded offshore), went from 5.46 pesos/dollar on October 20
     to 6.33 pesos/dollar on November 20.

     -- In the face of this run on the peso, banks jacked up
     interest rates, with BADLAR reference rate on deposits of
     over one million pesos rising from an already elevated 17% to
     18.75%, but peaking at 26% on November 13.

     -- BCRA contacts tell Post that the BCRA sold US$3.5 billion
     dollars in October, mostly in the second half of the month,
     to stem the run on the peso.

     -- Economist Melconian estimates total capital flight, as
     measured in the BCRA's Balance of Foreign Exchange, at US$4.7
     billion in October.  (According to BCRA data, capital flight
     reached US$ 8.8 billion in 2007 and almost twice that level
     -- US$16.4 billion -- through the third quarter of 2008.
     Melconian estimates it will total US$22-24 billion for the
     full year.)

     ¶14. (C) While Argentine stocks and government bonds have
     since rebounded somewhat (in the range of 20%) and are
     currently tracking global movements, they are still trading
     at distressed levels, and considerable unrest and uncertainty
     remains.
     WAYNE

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