Argentina - iuj.ac.jp · The president, NØstor Kirchner of the Partido Justicialista (PJ, or...

Country Report

Argentina

December 2004

The Economist Intelligence Unit15 Regent St, London SW1Y 4LRUnited Kingdom

Argentina at a glance: 2005-06

OVERVIEWThe president, Néstor Kirchner of the Partido Justicialista (PJ, or Peronists), willcontinue to emphasise his government!s departure from the free-marketorthodox policies of the 1990s and will adopt a robust style in negotiationswith the IMF and Argentina!s foreign creditors. Mr Kirchner will attempt toincrease his level of control over the PJ. There will be a more active role for thestate in economic policy, with plans for higher infrastructure spending. Thegovernment plans to launch an offer to holders of defaulted foreign bonds inJanuary 2005. Refusal by a significant minority of bondholders would make itmore difficult for Argentina to renew its agreement with the Fund. Thegovernment will run a primary surplus of over 3% of GDP over the forecastperiod. Growth will slow during 2005-06, as spare capacity is exhausted andthe rebound of consumption from the country!s post-crisis lows slackens.

Key changes from last month

Political outlook• Public confidence in the government has risen in each of the last three

months. Despite protests from the opposition, Congress has voted to extendthe cabinet chief!s powers to alter budget allocations unilaterally untilDecember 2005.

Economic policy outlook• The 2005 budget, targeting a primary fiscal surplus of 3.9% of GDP, has

undergone its final approval in the Senate. The swap of external debt hasbeen postponed until January 2005 after the bank handling the operation inthe US pulled out, and foreign securities regulators failed to approve theoffer in time for the original end-November deadline.

Economic forecast• The Economist Intelligence Unit has raised its forecast for inflation in 2005

on the strength of consumer demand.

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Argentina 1

Country Report December 2004 www.eiu.com © The Economist Intelligence Unit Limited 2004

Contents

Argentina

3 Summary

4 Political structure

5 Economic structure5 Annual indicators6 Quarterly indicators

7 Outlook for 2005-067 Political outlook8 Economic policy outlook10 Economic forecast

13 The political scene

16 Economic policy

23 The domestic economy23 Output and demand25 Employment, wages and prices27 Financial indicators30 Agriculture32 Sectoral trends33 Energy

35 Foreign trade and payments

List of tables10 International assumptions summary10 Gross domestic product by expenditure12 Forecast summary17 Non-financial public-sector accounts24 Gross domestic product growth by demand25 Gross domestic product growth by sector25 Consumer and producer prices27 Social indicators30 Foreign-exchange reserves and monetary aggregates, 200430 Agricultural output33 Monthly index of industrial output, 200435 Primary production36 External trade, 200437 Major exports and imports40 Balance of payments

2 Argentina


List of figures13 Gross domestic product13 Consumer price inflation22 Interest rates26 Nominal index of wages in the registered and informal private sector30 Soybean prices31 Beef prices38 Real exports and imports

Argentina 3


ArgentinaDecember 2004

Summary

The president, Néstor Kirchner of the Partido Justicialista (PJ, or Peronists), willcontinue to emphasise his government!s departure from the free-marketorthodox policies of the 1990s and will adopt a robust style in negotiationswith the IMF and Argentina!s foreign creditors. There will be a more active rolefor the state in economic policy. The government plans formally to launch anoffer to holders of defaulted foreign bonds in January 2005, and, assuming it isaccepted by a convincing majority of bondholders, to renew its agreement withthe Fund. The government will run a primary surplus of over 3% of GDP overthe forecast period. Growth will slow during 2005-06, as spare capacity isexhausted and the rebound of consumption from its post-crisis lows slackens.

Mr Kirchner�s public approval rating, having fallen in the third quarter, hasrecently proved more resilient. The opposition has undergone further internalconflicts. Mr Kirchner has mended fences with civil society groups. A SupremeCourt justice has resigned. A new Central Bank president has been appointed.

The public-sector finances have run a cumulative surplus equivalent to 5% ofGDP in January-September. The government has raised the minimum wage.The tax on financial transactions has been partially eliminated. Thegovernment has sent a widely criticised framework public services law toCongress. The offer to holders of the government�s defaulted external debt hasbeen postponed until January. The 2005 budget has been approved. Theauthorities have intervened to maintain a weak real exchange rate.

GDP growth slowed in the second quarter, although activity is thought to haveaccelerated in the third quarter. Investment has grown and more jobs havebeen created. Inflation has risen since mid-year, with core inflation rising aboveconsumer price inflation. The monetary base has contracted. Lending to theprivate sector has continued to recover. Deposits have risen, and there has beena shift towards term deposits. Interest rates have risen. The government hasmoved to assure future gas supply.

Imports have continued to grow more quickly than exports. Argentina hasbegun to run a deficit with the rest of Mercosur. In the second quarter, thecurrent-account surplus contracted. On the capital and financial account, therehave been net positive inflows from the non-financial private sector.

Editors: Charles Seville (editor); Fiona Mackie (consulting editor)Editorial closing date: December 1st 2004

All queries: Tel: (44.20) 7830 1007 E-mail: [email protected] report: Full schedule on www.eiu.com/schedule

Outlook for 2005-06

The political scene

Economic policy

The domestic economy

Foreign trade and payments

4 Argentina


Political structure

Republic of Argentina

Federal republic

The president is head of state and commander-in-chief of the armed forces; elected for afour-year term; can be re-elected for one consecutive term; the president appoints acabinet and a chief of cabinet, who can be removed by a majority vote in each chamber

Bicameral Congress: 257-member Chamber of Deputies, directly elected for a four-yearterm; one-half of the lower house stands for re-election every two years; 72-memberSenate; directly elected for a six-year term; three senators are elected per state, two fromthe leading party and one from the runner-up; one-third of the Senate stands forre-election every two years

23 states and an autonomous federal district; states and the federal district retain thosepowers not vested in the national government and elect state legislators, governors andlocal officials

Federal judges appointed by a Council of Magistrates; Supreme Court system bothnationally and in the provinces; national Supreme Court members require theendorsement of two-thirds of the Senate

One-third of the Senate and half of the Chamber of Deputies are due to be elected inOctober 2005. Next presidential election due in 2007

The president is currently Néstor Kirchner of the Partido Justicialista (PJ, or Peronists), whowas sworn in as president on May 25th 2003

Government: Partido JusticialistaMain opposition: Unión Cívica Radical (UCR), Frente del País Solidario (Frepaso); otherminor parties include Afirmación para una República Igualitaria (ARI),Movimiento Federal Recrear (MFR) and several provincial parties

President Néstor Kirchner (PJ)

Cabinet chief Alberto FernándezDefence José PampuroEconomy & production Roberto LavagnaEducation Daniel FilmusForeign affairs & worship Rafael BielsaHealth Ginés González GarcíaInterior Aníbal FernándezJustice Horacio RosattiLabour Carlos TomadaSocial development & the environment Alicia Kirchner

Martín Redrado

Key ministers

Central Bank president

Main political organisations

National government

National elections

Regional legislatures

National legislature

The executive

Form of state

Legal system

Official name

Argentina 5


Economic structure

Annual indicators2000 a 2001 a 2002a 2003 a 2004 b

GDP at market prices (Ps bn) 284.2 268.7 312.6 375.9 424.6GDP (US$ bn) 284.3 268.8 102.0 129.6 145.1

Real GDP growth (%) -0.8 -4.4 -10.9 8.8 7.8Consumer price inflation (av; %) -0.9 -1.1 25.9 13.4 4.4Population (m) 37.0 37.4 b 37.8b 38.2 b 38.7

Exports of goods fob (US$ bn) 26.3 26.5 25.7 29.6 34.1Imports of goods fob (US$ bn) 23.9 19.2 8.5 13.1 20.9

Current-account balance (US$ bn) -9.0 -3.9 9.1 7.8 4.7Foreign-exchange reserves excl gold (US$ bn) 25.1 14.6 10.5 14.2 17.6Total external debt (US$ bn) 145.9 136.7 132.3 142.5 b 158.2

Debt-service ratio, paid (%) 70.8 66.0 18.2 49.5 b 36.8Exchange rate (av) Ps:US$ 0.999 0.999 3.063 2.901 2.926

a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2003 % of total Components of gross domestic product 2003 % of totalAgriculture, forestry & fishing 11.0 Private consumption 63.2Mining 5.8 Government consumption 11.4

Manufacturing 24.0 Investment 15.1Construction 3.3 Stockbuilding -0.5

Electricity & water 1.7 Exports of goods & services 25.0Commerce 54.1 Imports of goods & services -14.2

Principal exports fob 2003 US$ m Principal imports cif 2003 US$ mProcessed agricultural products 9,991 Intermediate goods 6,264

Manufactures 7,703 Capital goods 2,517Primary 6,460 Consumer goods 1,736Fuel and energy 5,412 Fuels 548

Main destinations of exports 2003 % of total Main origins of imports 2003 % of totalBrazil 20.8 Brazil 22.1Chile 11.7 US 19.4US 10.6 Germany 5.8

China 8.4 Italy 3.9

6 Argentina


Quarterly indicators2002 2003 20044 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr

Non-financial public sector finance (Ps m)Revenue excl privatisation 16,623 16,311 20,444 19,624 20,836 22,693 30,188 26,603Expenditure 16,437 16,509 18,822 19,241 20,837 20,317 23,521 23,232 Interest payments 1,729 1,986 1,521 1,842 1,534 1,614 1,190 1,611Balance 186 -198 1,622 382 -1 2,376 6,667 3,371

OutputGDP at constant 1993 prices (annual rates; Ps bn) 240.4 228.6 265.4 261.5 268.6 254.3 283.9 n/aGDP at constant 1993 prices (% change, year on year) -3.4 5.4 7.7 10.2 11.7 11.3 7.0 n/a Manufacturing at constant 1993 prices

(annual rates; Ps m) 38,952 36,841 40,647 44,771 45,550 42,655 46,005 n/a Manufacturing (% change, year on year) 2.4 18.4 12.6 16.2 16.9 15.8 13.2 n/aIndustrial production index (seasonally adjusted;

1997=100) 84.8 83.6 89.1 95.9 97.3 95.3 98.5 105.6Industrial production index (% change, year on year) 1.9 20.0 14.8 15.7 14.7 14.0 10.6 10.1

PricesConsumer prices (1999=100) 137.2 140.2 140.7 141.1 142.3 143.6 146.4 148.7Consumer prices (% change, year on year) 40.3 35.7 14.5 5.2 3.7 2.4 4.1 5.4Producer prices (1993=100) 217.6 216.8 210.6 211.4 218.2 223.7 228.8 234.2Producer prices (% change, year on year) 123.6 87.5 21.6 0.7 0.3 3.2 8.6 10.8

Financial indicatorsExchange rate Ps:US$ (av) 3.5 3.1 2.8 2.8 2.9 2.9 2.9 3.0Exchange rate Ps:US$ (end-period) 3.3 2.9 2.8 2.9 2.9 2.8 2.9 3.0Deposit rate (av; %) 24.6 18.3 13.9 4.6 3.9 2.4 2.3 2.7Lending rate (av; %) 42.7 27.6 24.3 13.9 10.8 9.1 6.3 5.9Money market rate (av; %) 10.7 6.8 4.8 1.8 1.6 1.3 2.2 2.1M1 (end-period; Ps m) 28,272 28,257 32,404 35,819 42,942 45,654 48,201 n/aM1 (% change, year on year) 78.4 22.8 37.9 51.2 51.9 61.6 48.8 n/aM2 (end-period; Ps m) 87,294 91,469 99,684 105,678 113,166 118,440 124,978 n/aM2 (% change, year on year) 19.7 11.3 25.0 26.1 29.6 29.5 25.4 n/aMerval stockmarket index (end-period; Jun 30th

1986=US$0.01) 525.0 566.5 765.6 827.7 1,072.0 1,201.7 945.5 1,142.5Merval stockmarket index (% change, year on year) 77.7 29.9 118.3 109.4 104.2 112.1 23.5 38.0Sectoral trendsISAC construction activity index (seasonally adjusted;

1997=100) 63.8 71.1 77.3 80.7 88.5 94.5 94.6 n/aISAC construction activity index (% change, year on year) -5.4 35.3 38.6 38.8 38.6 32.9 22.3 n/aCrude oil production (m barrels/day) 0.79 0.78 0.79 0.79 0.77 0.78 0.77 0.76Crude oil production (% change, year on year) -4.8 -3.7 -2.5 -1.3 -2.5 0.0 -2.5 -3.8

Foreign trade (US$ m)Exports fob 6,446 6,556 8,124 7,550 7,335 7,353 9,347 8,911Imports cif -2,470 -2,502 -3,336 -3,712 -4,284 -4,637 -5,443 -5,990Trade balance 3,976 4,054 4,788 3,838 3,051 2,716 3,904 2,921Balance of payments (US$ m)Merchandise trade balance fob-fob 4,111 4,188 4,968 4,028 3,266 2,880 4,104 n/aServices balance -272 -456 -363 -460 -280 -599 -450 n/aIncome balance -1,569 -1,903 -1,886 -2,152 -2,084 -2,163 -2,171 n/aNet transfer payments 209 131 165 146 155 151 201 n/aCurrent-account balance 2,480 1,960 2,883 1,561 1,055 269 1,685 n/aReserves excl gold (end-period) 10,489 10,539 12,183 13,430 14,153 14,627 16,926 17,501

Sources: Ministerio de Economía; IEA, Monthly Oil Market Report; IMF, International Financial Statistics; Instituto Nacional de Estadística y Censos.

Argentina 7


Outlook for 2005-06

Political outlook

Ideologically, the administration of the president, Néstor Kirchner, marks abreak with the pro-market government policies of the 1990s, which themajority of Argentinian voters view as discredited, following the economiccollapse and maxi-devaluation of 2001-02. Mr Kirchner�s administration aims toconsolidate the recovery, while placing more emphasis on social policies thanprevious administrations. Mr Kirchner is well-placed to carry out hisgovernment�s programme. A populist touch has kept his approval rating high at60%. The PJ has a commanding position in both houses of Congress; 41 of the71 seats in the Senate and 116 of the 254 seats in the lower house) and holdsmost of the provincial governorships. None of the opposition parties has anational organisation to rival the PJ, and they will remain weak. However,Mr Kirchner cannot count on the unconditional support of his party, which isfractious and divided on regional lines. The main fault line in the PJ will be thatbetween Mr Kirchner and the former interim president, Eduardo Duhalde(2002-03). Relations between the two have recently improved. Mr Duhalde hasreiterated that he has no electoral ambitions, and he will be keen to protect hisreputation as a former president, both of which point to his cooperating withMr Kirchner. He will remain the undisputed leader of the PJ machinery in theprovince of Buenos Aires, a strong influence over Peronist provincial governors,and a defender of the interests of his economically dominant region.

Mr Kirchner�s robust, sometimes combative approach towards the IMF, foreigninvestors and the holders of Argentina�s defaulted foreign debt have playedwell to his domestic audience. A successful exchange of Argentina�s debt in thefirst half of 2005 could provide a further boost to Mr Kirchner. The presidenthas benefited from rapid economic growth ever since he took office. As thecountry emerges from economic crisis, the front on which Mr Kirchner faces themost pressure is law and order. For crime to be effectively tackled, institutionalreforms are required and progress will be slow.

In elections due to be held on October 23rd 2005 (provided Congress approvesa change to the electoral timetable), voters will renew one-third of the Senateand one-half of the Chamber of Deputies. These elections will be the firstmajor test of Mr Kirchner�s administration. The opposition parties will remainextremely weak, although they will score a few successes in some regions. Themain centre of support for anti-Peronist parties is the city of Buenos Aires,which will elect 12 deputies in 2005, likely to include some oppositiondeputies. Although there has been talk of an electoral alliance between the twomain centre-right opposition parties, Compromiso por el Cambio, led byMauricio Macri and Recrear, led by Ricardo López Murphy, no concrete stepshave yet been taken. Mr Kirchner is likely to have more problems withelements of his own party. He is expected to run for the presidency of the PJ,which is currently vacant. Assuming he wins, he could use this position toextend his influence over the party. The relationship between the federalgovernment and the provinces will remain difficult to handle. Because Peronist

International relationsDomestic politics

8 Argentina


congressional candidates are selected at provincial level, provincial governorsplay a large part in the process and retain influence over congressmenrepresenting their region. The president needs their support in order to passlegislation. The government�s comfortable fiscal position tilts the balance infavour of Mr Kirchner.

Despite his nationalist rhetoric, Mr Kirchner will strive to maintain goodrelations with the US government. He will maintain friendly relations withcentre-left governments elsewhere in Latin America. The tenor of relations withthe EU will depend on how much progress is made in renegotiating contractswith privatised utilities (most of which are in European hands), and onreaching a settlement with bondholders. As part of the Mercado Común delSur (Mercosur), the southern cone customs union, Argentina will also pursue afree-trade agreement (FTA) with the EU, which the Economist Intelligence Unitexpects to be completed by early 2005. Argentina�s recent imposition of tradebarriers to some Brazilian manufactures appears to be part of an attempt toforce its larger neighbour to address policy asymmetries that have hamperedthe integration process.

Economic policy outlook

The results of the government�s attempts to reduce its debt by offering a swapto holders of bonds in default will be decisive for the economic policy agendaover the forecast period. Until the debt swap is completed, the governmentcannot renew its stand-by arrangement with the IMF and will struggle toaddress other pressing economic policy issues. The government plans to openits offer to holders of around US$100bn (principal and past-due interest) indefaulted foreign-currency bonds in mid-January 2005, a target date that hingeson obtaining approval for its proposal from foreign regulatory authorities. Agulf remains between the proposal offered by the government so far, whichinvolves a reduction of around 70% in net present value of the debt accordingto the government�s advisers, and the demands of bondholders. At rates ofacceptance of above 70%, the exchange is likely to be considered a success bythe government, although holdouts are likely to launch legal action and theFund may demand greater compliance. The government plans to renegotiatetargets with the Fund and sign another arrangement after the debt swap,perhaps in April 2005. Renewing the IMF arrangement will be necessary ifArgentina is to continue to roll over repayments due to the Fund. Until anagreement is signed it will meet repayments from its own resources.

The government must also renegotiate contracts with foreign owners ofprivatised public utilities, whose contracts were broken in 2002. Without a newregulatory framework, owners of power, telecommunications (telecoms) andenergy utilities will have little incentive to invest, and this will cause bottlenecksin the economy. Other reforms are needed to lay the basis for sustainable long-term growth, including the reform of the financial sector, and theimplementation of a new fiscal pact between the federal and provincialgovernments in order to underpin fiscal sustainability. The government alsoneeds to make social policy more transparent and efficient by eliminating red

Policy trends

International relations

Argentina 9


tape, corruption and clientelistic practices. The Economist Intelligence Unitexpects that Mr Kirchner!s administration will advance gradually in therebuilding of sound economic institutions, but the confidence of investors willnot be fully restored within the forecast period. The government and the BancoCentral de la República Argentina (BCRA, the Central Bank) will work tomaintain a stable but competitive real exchange rate in order to assist exportsand the domestic tradeable goods sector.

The government will aim to run a consolidated, non-financial public-sector(NFPS) primary surplus of 3-4% of GDP in 2005-06, consistent with its offer toforeign bondholders. The 2005 budget passed by Congress in November set atarget of a primary fiscal surplus for the NFPS of 3.9% of GDP. The amountdevoted to debt-servicing will rise by 43%, and public investment will rise byaround a quarter. Given that the central government�s average primary surplusin 1993-2003 was 1% of GDP, maintaining a 3% of GDP primary surplus in themedium term will constitute a major challenge. To achieve it, the governmentwill need to make revenue collection more efficient and to improve controls onspending. The excellent fiscal performance of the past 18 months (thegovernment is expected to record a surplus of 4-5% of GDP in 2004) will not beeasily maintained in the future. The export levy and the Impuesto sobre losCréditos y Debitos en cuenta Carriente Bancaria or Impuesto al Chaque, thefinancial transactions tax, have been important to this performance. Althoughthe government will be keen to maintain these emergency taxes over theforecast period, the IMF will be likely to demand a commitment to scrap themin return for its support. The government will face a greater challenge to meetits fiscal targets in 2005, which is an election year. The ability of the provincesto spend beyond their means, long the weak link in the public finances, willneed to be brought under permanent control.

The Central Bank will maintain the float of the peso, but will intervene in orderto smooth volatility. In the short-term, this will mean intervening to prevent thecurrency from appreciating by buying dollars in the market. Although currencymarket intervention will expand the money supply, growth in the monetarybase will remain subdued. Contractionary factors affecting the money supplyinclude the accumulation of public-sector deposits at public banks, and theongoing repayment by commercial banks of loans to the Central Bank. Oncethe debt-restructuring is completed and foreign-currency outflows havereturned to more normal levels, intervention in the currency markets maybecome more two-sided. We expect the authorities to target the repo rate as amore reliable tool of monetary policy than targeting fluctuating monetaryaggregates. Inflationary pressures will grow over the forecast period and willprobably necessitate a tightening in monetary policy.

Fiscal policy

Monetary policy

10 Argentina


Economic forecast

International assumptions summary(% unless otherwise indicated)

2003 2004 2005 2006Real GDP growthWorld 3.9 5.0 4.3 4.1EU25 1.1 2.4 2.3 2.3Brazil -0.2 4.5 3.7 3.5

Exchange rates¥:US$ 115.9 108.2 98.0 100.0US$:� 1.132 1.239 1.340 1.300SDR:US$ 0.714 0.676 0.645 0.656Financial indicators� 3-month interbank rate 2.33 2.10 2.10 2.65US$ 3-month commercial paper rate 1.10 1.48 3.25 4.64Commodity pricesOil (Brent; US$/b) 28.8 39.3 37.5 29.0Soybeans (% change in US$ terms) 23.2 16.1 -20.1 -3.2Food, feedstuffs & beverages (% change in US$ terms) 6.6 9.0 -6.0 -1.5Industrial raw materials (% change in US$ terms) 12.8 20.2 -0.3 -4.2

Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.

The strong expansion in global output began to slow in the third quarter of2004. Having expanded at an estimated 5%"its fastest rate for 20 years"in2004, global GDP growth, measured at purchasing power parity, will slow to4.3% in 2005 and 4.1% in 2006. We expect US monetary policy, currently loose,to be tightened, and forecast world interest rates will rise. There are significantdownside risks to the growth outlook. Chief among these is the risk of adisorderly slide in the US dollar, which would cause the US to raise interestrates more sharply than we forecast. There is also the possibility that attemptsby policymakers to cool the Chinese economy could result in a sharper thanintended slowdown, which would hit both global demand and commodityprices. Argentina�s terms of trade will deteriorate slightly in 2005-06 as pricesfor grains and soybean trend downward from the highs recorded in 2004.Having pulled out of recession in 2004, Brazil, Argentina�s main trading partner(particularly in manufactures), will grow by an average of 3.6% in 2005-06.

Gross domestic product by expenditure(Ps bn at constant 1993 prices; % change year on year in brackets unless otherwise indicated)

2003a 2004 b 2005c 2006c

Private consumption 168.0 182.2 189.5 193.8(8.2) (8.5) (4.0) (2.3)

Public consumption 34.3 35.0 35.9 36.8(1.5) (2.0) (2.5) (2.5)

Gross fixed investment 36.7 48.4 54.7 60.1(38.2) (32.0) (13.0) (10.0)

Final domestic demand 238.9 265.6 280.0 290.7(10.8) (11.2) (5.4) (3.8)

Stockbuilding 2.4 1.5 1.5 1.5(0.5)d (-0.3) d (0.0)d (0.0)d

International assumptions

Economic growth

Argentina 11


Gross domestic product by expenditure(Ps bn at constant 1993 prices; % change year on year in brackets unless otherwise indicated)

Total domestic demand 241.3 267.1 281.5 292.2(11.2) (10.7) (5.4) (3.8)

Exports of goods & services 35.1 36.6 37.8 39.1(6.0) (4.3) (3.3) (3.3)

Imports of goods & services -20.4 -27.8 -31.1 -33.1(37.6) (36.6) (11.6) (6.6)

Foreign balance 14.7 8.8 6.8 6.0(-1.5)d (-2.3) d (-0.7)d (-0.3)d

GDP 256.0 275.9 288.3 298.1(8.8) (7.8) (4.5) (3.4)

a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.d Contribution to real GDP growth.

Growth is estimated to reach 7.7% in 2004, owing mainly to a rebound inprivate consumption and in investment. Unemployment will be slower to fallover the forecast period than in 2002-03, placing a brake on consumptiongrowth. The economy will cool in 2005-06, but owing to the statisticalcarryover from 2004, our forecast of 4.5% growth in 2005 could easily beexceeded. The authorities� commitment to maintaining a competitive exchangerate will benefit goods producers servicing both domestic and export markets.Exports will continue to grow, but net exports will form a negative contributionto growth as imports recover from depressed levels in 2001-02. Investment willhelp to overcome capacity constraints, but industrial production growth is stillexpected to moderate from recent high levels. Factors such as the slow pace ofrenegotiation of contracts with foreign firms, and other policy uncertainties, willweigh on investment decisions in the medium term, particularly at larger,foreign-owned firms. A failure of the proposed debt swap being offered toholders of defaulted debt in early 2005, or a prolonged stand-off with the IMF,with which Argentina must agree performance and policy targets once the swapis completed, would hurt investment. Rising global interest rates in 2005 andslower growth will provide a less supportive external backdrop.

Average inflation, having risen steadily during 2004, is expected to rise in 2005to average around 6%, owing to higher domestic demand (fuelled by recentwage settlements) and phased adjustments to frozen public-utility rates. Higherwholesale price inflation will also be passed on to consumers. Cautiousmonetary policy should help to ensure that inflation remains under control,and we expect it to fall in 2006. The major risk to this forecast stems frompossible turbulence in the foreign-exchange market. Consistent and sustainablefiscal and monetary policies will be central to underpinning confidence in thepeso and containing inflation.

During 2004, the peso has traded between Ps2.80:US$1 and Ps3.00:US$1 in adirty float, under which the Central Bank and the Treasury have intervenedheavily to prevent the currency appreciating. At its current level, the peso isaround 50% weaker than in the late 1990s and 2000-01, when it wasconsidered overvalued. A real appreciation is likely to occur, especially once thedebt swap is concluded, as foreign inflows increase, but the authorities will be

Inflation

Exchange rates

12 Argentina


keen to avert a significant strengthening of the peso. Keeping the nominalexchange-rate stable against the dollar will entail a slight real exchange rateappreciation in 2005-06, given the inflation differential between Argentina andthe US. Argentina�s competitiveness in the EU market will benefit from USdollar weakness against the euro.

In the outlook period, export earnings will continue to expand, withmanufactures proving the most dynamic category, but the trade surplus willdecline as import spending, driven by investment and private consumption,rises more quickly. The expansion of the services deficit will be restrained, asfavourable relative prices increase tourism receipts and contain outgoings. Thebalance on the income account will be negative, but will benefit from reducedinterest charges following a debt restructuring and higher interest income fromthe expanding stock of reserves. Lack of access to international capital marketswill force the economy to run a current-account surplus. However, given thenarrowing in the trade surplus, we expect the current-account surplus tonarrow to an average of 1.1% of GDP in 2005-06.

Forecast summary(% unless otherwise indicated)

2003a 2004 b 2005c 2006c

Real GDP growth 8.8 7.8 4.5 3.4Industrial production growth 16.2 11.0 7.0 5.0

Gross agricultural production growth 6.9 2.6 2.0 2.0Unemployment rate (av) 17.3 13.5 11.8 10.1

Consumer price inflation (av) 13.4 4.4 6.3 5.4Consumer price inflation (year-end) 3.7 5.9 6.8 4.3Short-term interbank rate 19.1 6.8 11.0 12.0

NFPS balance excl privatisation (% of GDP) 0.5 2.7 1.7 1.0Exports of goods fob (US$ bn) 29.6 34.1 34.4 35.4

Imports of goods fob (US$ bn) 13.1 20.9 24.9 26.8Current-account balance (US$ bn) 7.8 4.7 1.7 1.4Current-account balance (% of GDP) 6.0 3.3 1.1 0.8

External debt (year-end; US$ bn) 142.5b 158.2 126.5 120.1Exchange rate Ps:US$ (av) 2.90 2.93 2.95 2.93

Exchange rate Ps:¥100 (av) 2.503 2.705 3.010 2.932Exchange rate Ps:� (year-end) 3.664 3.779 3.984 3.744

Exchange rate Ps:SDR (year-end) 4.32 4.41 4.62 4.45

a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

External sector

Argentina 13


Argentina Latin America

Gross domestic product% change, year on year

Argentina Latin America

Consumer price inflationav; %

-12-10

-8-6-4-202468

10

2000 01 02 03 04 05 06

-5

0

5

10

15

20

25

30

2000 01 02 03 04 05 06

The political scene

One third of the way into his term, Néstor Kirchner�s public approval rating hasfallen from its heights, but is proving resilient. One indicator of public opinion,the Government Public Confidence Index regularly compiled by theUniversidad Torcuato Di Tella, contracted by 38% between February andAugust. But although the long-term trend is downwards, public confidence asmeasured by the index recovered in September and October to 10% above thelevel recorded in August. Strong public approval helped Mr Kirchner toconsolidate his power in the presidency at the start of his term when he didnot enjoy the whole-hearted support of the ruling Peronist party (PartidoJusticialista, or PJ). However, with the economy having stabilised, the public�sattention is turning back to deep-rooted problems such as unemployment,poverty and crime. With the worst of the economic crisis over, public opinionnow demands from the government efficient policy responses to long-standing problems.

Around 55% of the public still approves of the government. The government�ssupport is most solid among low-income groups, the main beneficiaries ofsocial plans largely administrated by the Peronist party, such as the Plan Jefes yJefas de Hogar, the programme of subsidies to unemployed heads ofhousehold. Scepticism about Mr Kirchner is however rising among the middle-class, who initially backed the government. The main concerns of the middleclass have been crime and the proliferation of public demonstrations androadblocks by piquetero (picket) groups. In the interior of the country, wheredemonstrations have been less disruptive and where crime is lower, supportfrom the middle class is firmer. The effects of the economic recovery on theprosperity of the agricultural sector have also helped bolster the government�spopularity in the interior, where many people�s livelihoods are tiedto agriculture.

The upper-middle classes, including business elites, are the group mostsuspicious of the president. Despite having made immediate economic gains,high-income groups are alienated by the government�s left-wing rhetoric, calls

Mr Kirchner holds on to publicapproval

14 Argentina


for redistribution and anti-business policies such as the changes introduced tolabour laws, and the delays in renegotiating contracts with public utilities.

Mr Kirchner has adopted a more conciliatory stance in recent months, softeningthe rhetoric and confrontational style that sought to establish him as a reformerand mark a break with the prior Peronist administration of Eduardo Duhalde.The cabinet chief, Alberto Fernández, and the interior minister,Aníbal Fernández, who used to take time to rebut many of the criticisms aimedat the government, have taken a lower profile, and have sought to publicise theadministration�s achievements instead. To convey the image of a practicalgovernment, Mr Kirchner has publicly announced that his main priorities arepublic works, education, employment, tackling crime and renegotiating theexternal debt in default.

The president and the interior minister have pressured the police to achievebetter results, with apparent initial success. Police forces have recently solved anumber of high-profile criminal cases and made arrests (one case was a well-publicised abduction that lasted for nearly three weeks). From August, thegovernment also adopted a tougher stance towards the piqueteros, notablyordering the police to break up a demonstration which coincided with the visitof the IMF chief, Rodrigo Rato, to Buenos Aires at the end of August. Thegovernment also arrested one of the main piquetero leaders.

Mr Kirchner has also changed his approach towards the rest of the Peronistparty. At the beginning of his term, the president included opposition figures inhis cabinet, in an attempt to consolidate his support outside the party. The aimwas to build a support base to counter the control his rival, Mr Duhalde, hasover the party apparatus in Buenos Aires. However, relations between MrKirchner and the powerful provincial governors within the Peronist party haveimproved (governors are keen to secure part of the burgeoning governmentsurplus for their regions) and Mr Duhalde�s public statements have becomenoticeably warmer towards Mr Kirchner. The former president has confinedhimself to his role as Argentina�s top representative to the Mercado Común delSur (Mercosur), the Southern Cone customs union. The new understandingbetween the two main Peronist leaders has reduced the risks of governabilityproblems. Both leaders will want the Peronist party to run as a united force, buthave yet to hammer out an agreement to decide which candidates will standfor the PJ in the different Senate and Deputies contests. How Mr Duhalde reactsin the event that Mr Kirchner�s wife, Cristina Fernández de Kirchner, runs forone of the Senate seats representing the province of Buenos Aires in preferenceto one of his own candidates # as seems likely - will be a decisive test ofrelations between the two.

The opposition is fragmented and the Unión Cívica Radical (UCR) has beenunable to emerge from the deep crisis it suffered after the collapse of theadministration of Fernando de la Rúa at the end of 2001. A group of rebelmunicipal politicians # the so-called Grupo de Olavarría - has threatened tomake alliances with other political forces, a stance strongly opposed by theparty authorities. The conflict is particularly acute in the province ofBuenos Aires, where the UCR is still relatively strongly represented in local

Fragmentation in the Radicalparty

Administration adopts moreconciliatory style

Argentina 15


government. The chief of the Radical party in the province of Buenos Aires,Margarita Stolbizer, backed a decision in the UCR convention held in Octoberby which all agreements with other parties will need the permit of provincialauthorities. Unlike the Peronists, the Radicals hold primary elections to selectall their congressional candidates, thereby publicising their internal differences.

Since 2002, when Congress passed legislation facilitating the creation of newpolitical parties, the number of small political parties has mushroomed. In 2003a total of 122 new parties were formally registered, taking the total number ofpolitical organisations at the federal level to an unprecedented 696. This trend isthreatening to transform the bipartisan system typical of Argentina into onewith an entrenched governing party faced by numerous, much smallerchallengers. Opposition parties such as Recrear (led by Ricardo López Murphy)and ARI (led by Elisa Carrió) still look far from ready to take the place ofthe Radicals.

The president has mended fences not only with the Peronist party, but alsowith the trade unions, the armed forces and the Catholic Church. Mr Kirchnerencouraged the unification of the trade union leadership and convened theMinimum Wage Council, in order to decide the new level of the minimumwage (see Economic policy). Mr Kirchner could have raised the minimum wagethrough an executive decree, but by convening the Minimum Wage Council,which includes representatives of business and labour, he improved hisstanding with the trade unions, one of the traditional pillars of Peronism. Aftera long period of frosty relations with the armed forces, Mr Kirchner has begunto participate in military ceremonies and has refrained from criticising themilitary�s past role in human rights abuses. Early in his term, the presidentmoved to overturn the amnesty that had prevented the military from beingprosecuted for human rights abuses under the dictatorship in 1976-81, andsacked many high-ranking officers. With a visit to the Argentinian Bishops�Conference held in September, Mr Kirchner smoothed relations with theCatholic Church, with which he had also quarrelled.

Constitutionally, the executive is extremely strong relative to Congress, and inpractice it is even more so because the PJ is united and the opposition is weak(the PJ has 41 of 71 seats in the Senate and 116 of the 254 seats in the lowerhouse, almost twice as many as the next largest party, the UCR). Under theconstitution of 1994, the president can issue decrees in exceptionalcircumstances, putting them to a vote in Congress at a later date. The economicemergency law of 2002 extended these powers by granting the executive theability to enact decrees in the area of economic policy, such as the restructuringof the financial system, the renegotiation of contracts with privatised utilities,and negotiations over the external debt. Since the start of Mr Kirchner�s term in2003, the executive has made extensive use of these powers. It has been themain proponent of new legislation, and it has passed more than seventyemergency decrees. The 2005 budget law, in common with previous budgetlaws, gave special powers to the cabinet chief to reallocate governmentexpenditure, altering the amounts approved by Congress. This means thatCongress has little effective influence over how the budget is finally spent.

Congress extends theexecutive's emergency powers

16 Argentina


Some observers also considered the replacement of the president of the BancoCentral de la República (BCRA, the Central Bank), Alfonso Prat-Gay, as an over-extension of executive powers and an encroachment on the independence ofthe monetary authority. Mr Prat-Gay was appointed in December 2002 tocomplete the six-year term initiated by Pedro Pou, which was scheduled to rununtil September 2004. Since Mr Pou was removed by a Congressionalcommittee in 2001 after clashing with then economy minister,Domingo Cavallo, the Central Bank has had four presidents. Mr Prat-Gaywanted to be re-appointed for his own six-year term with the approval of theSenate, but the president was inclined to extend his tenure only temporarily.Differences of opinion on this, the composition of the Central Bank board andabove all the independence of the Central Bank led to the replacement ofMr Prat-Gay by Martín Redrado, the former secretary of international tradenegotiations within the Economy Ministry.

The president has also successfully promoted significant changes in theSupreme Court. In early September, a Supreme Court judge, Adolfo Vázquez,resigned in anticipation of his removal by Congress. Since June 2003, fourjustices of the Supreme Court appointed by former president, Carlos Menem,have now resigned under pressure from Congress. Mr Kirchner has proposedRicardo Lorenzetti as Mr Vázquez!s replacement, but his confirmation by theSenate is still pending. If Mr Lorenzetti is appointed, the Kirchneradministration will have appointed four out of nine Supreme Court judges. Theother three are Eugenio Zaffaroni, Elena Highton and Carmen Argibay (who isyet to take office). One other Supreme Court judge, Antonio Boggiano, is undercongressional investigation. Mr Kirchner is thought to be lukewarm about theimpeachment of Mr Boggiano, presumably fearing that if he too is replaced"making a majority of five of the nine members of the court appointed underMr Kirchner # the government would be vulnerable to charges of packing thecourt with sympathetic judges.

Economic policy

During the third quarter of 2004 the public-sector finances recorded a strongsurplus, continuing the trend established in the first half. Primary governmentspending rose"pushed up by higher transfers to the provinces, the increase inpublic-sector wages and higher infrastructure spending # but at a lower ratethan revenue. The overall non-financial public sector surplus (NFPS) for thethird quarter (on a cash basis, and including transfers to the provinces) wasPs5.0bn. The cumulative primary surplus for the first nine months wasPs16.8bn, equivalent to 5% of GDP.

In January-September, total government revenue increased by 41% year on year,largely on the strength of higher tax collection. The annual growth rate of totaltax receipts has slowed since reaching a peak of 73% in May, but tax revenue isstill growing more quickly than total output. Tax receipts which have increasedthe fastest are those dependent on the level of economic activity, such as VAT(which grew by 58%), income tax (62%) and social security contributions (33%).The treasury is also becoming less dependent on the emergency taxes, such as

Public sector continues toaccumulate massive surplus

Further personnel changes onSupreme Court

Argentina 17


export taxes and the Impuesto al Chaque, the financial transactions tax. InJanuary-October, these taxes accounted for less than 10% of the growth in taxrevenue. In the same period of 2003, they accounted for over a quarter of thegrowth in revenue.

During the first nine months primary spending (excluding interest payments)reached Ps62.7bn, a 27.3% rise year on year. Excluding transfers to the provinces,the increase in discretionary spending was a modest 15.8%. In contrast, transfersto the provinces rose by 54%, mainly as a function of higher collections ofincome tax, a share of which is automatically transferred. Increases in spendingon some social programmes, education, and higher transfers to the governmentof Buenos Aires also effectively raised transfers to the provinces.

Interest payments fell by 17.5%, with most of the fall accounted for by lowerinterest payments on performing external debt.

Non-financial public-sector accountsa

(Ps m; Jan-Sep)

2003 2004 % changeRevenue 56,379 79,484 41.0 Taxes 44,049 63,168 43.4 Privatisation 3.9 21.4 448.7

Expenditure 54,573 67,070 22.9 Interest payments 5,349 4,415 -17.5Balance incl privatisation revenue 1,806 12,414 587.3

Balance excl privatisation revenue 1,802 12,392 587.6Primary balance excl privatisation revenue 7,151 16,807 135.0

a Excludes provinces.

Source: Secretaría de Politica Económica, Ministerio de Economía.

The rapid increase in tax collection has been a mixed blessing for thegovernment, since it raises the floor from which to negotiate the new targets for2005 with the IMF. The government is barred from explicitly transferringsurpluses recorded in one year to count towards revenue in the next year. Oncourse to record a primary surplus far in excess of what was agreed with theFund under the stand-by arrangement signed in September 2003, whichArgentina suspended in July, the government is seeking to distribute or toreduce the surplus, and to prolong the recovery. The government will probablyrecord a primary deficit in the fourth quarter as a result.

In addition to the rise decreed"which will push up the public-sector wage bill"the economy minister, Roberto Lavagna, postponed the advanced payment ofthe income tax due at the end of 2004 to the first quarter of 2005. Thiseffectively transfers an expected Ps1.1bn in revenue from 2004 to 2005. Theauthorities also decided to disburse in December (rather than January) theaguinaldo, or year-end salary bonus, received by public-sector employees andpensioners and decreed a special, one-off bonus of Ps200 for pensioners.

With the background of positive fiscal results, the authorities have striven tostimulate the economy through an expansion of domestic demand. In mid-yearthey convened the Consejo de Empleo, la Productividad y el Salario Mínimo

National minimum wage israised

Government seeks to reducesurplus

Government raises minimumwage

18 Argentina


Vital y Móvil, the National Employment, Productivity and Minimum WageCouncil, in order to produce a decision about a rise in the minimum wage foremployees in the public and private sectors. The Council, convened by thelabour ministry, is composed of 32 representatives from business and labourorganisations. Mr Kirchner had already announced that, if the Council failed toreach a consensus, the government would decree an increase in the minimumwage from Ps350 to Ps450 (US$153) per month. In the event, a majority of 24members of the council voted to increase the minimum wage to exactly thisamount at the beginning of September.

In early October, the authorities lifted the tax on financial transactions (the so-called Impuesto al Cheque) made between term and current accounts. Inaddition to reducing the financial surplus of the public sector, this is intendedto encourage an increase in term deposits. The financial transactions tax willstay in place for other transactions, but the authorities plan to reduce the rate ofthe tax in the future. In May the rate at which the tax was applied to depositswas cut by o.2 percentage points to 0.4%, while it remains at 0.6% onwithdrawals. The tax is hard to evade and cheap to administer, but isconsidered distortionary, and conducive to an increase in unregistered activity.

The regulation of public utilities has been a major issue for the government.Progress in this area, however, has been extremely slow. The only recentprogress has been the submission to Congress in August of the so-called LeyMarco de Servicios Públicos (framework public services law), a bill that createsa uniform regulatory framework for all public utilities. The bill is designed toset out parameters for the individual contracts to be renegotiated. The mainproposals of the law are that:

• The government has the right to set investment plans during the period ofthe concession.

• To supply any public service, a firm will have to make a public bid, andsubmit to the regulator.

• Concessions, licences or permits cannot be renewed temporarily. If thebidding process for the assignment of the right to provide a utility serviceexperiences delays, the state will undertake the provision of services.

• Disputes will be settled in the domestic courts. Foreign shareholders ofpublic utility firms will lose their right of recourse to foreign jurisdictions orarbitration mechanisms.

• A Solidarity Fund is to be established to ensure that the pooresthouseholds have access to basic services. The Fund will pool contributions fromthe federal government, 2% of total sales and a contribution made by publicutility firms equivalent to 10% of the total benefits to be granted.

• Public utility rates cannot be adjusted automatically. Any rate increase willhave to be the result of improvements in efficiency, seasonal factors, anexpansion of services not contemplated in the original contract or otherunforeseen factors that may affect costs or profits.

Financial transactions taxpartially scrapped

Government sends utilitiesregulation bill to Congress

Argentina 19


The bill was roundly criticised by the Fund, the World Bank and businessassociations as unduly interventionist. Critics argue that the framework doesnot address the main deficiencies of the situation post-privatisation, inparticular a lack of power to intervene to ensure competition. The companiesbelieve that the ban on the automatic adjustment of rates leaves them littleincentive to invest or to improve efficiency. Unusually, the bill also proposedthat utility rates be adjusted every five years, instead of every year. EvenMr Lavagna expressed disagreements with the proposal, which was sponsoredby the planning ministry. The bill looks unlikely to be passed by Congress;meanwhile, no progress is being made on renegotiating contracts withindividual firms. At the end of November, the government said it wouldconsult with interested parties on amendments to the bill.

In two successive rulings in mid-September, the Supreme Court declaredunconstitutional two articles of the law governing industrial relations,threatening to increase businesses� costs in both cases. In the first decision, thecourt determined that the legal cap on severance payments wasunconstitutional. In the second, it ruled that one of the articles of the Ley deRiesgos de Trabajo (the law governing employers� obligations towardsemployees injured at work) was unconstitutional. As a result, in the event of anaccident, an injured employee, in addition to receiving the benefits set out bythe company�s insurance policy, will also have the right to sue the firm fordamages. Protests from employers are likely to lead the government to clarifythe position.

Preparations for the debt swap have dominated the government�s economicpolicy agenda in recent months. Under the swap, holders of defaulted externaldebt will be offered new bonds of lower value in a bid to end almost threeyears of default. The government submitted a prospectus for the debtrestructuring to the US Securities and Exchange Commission on November 1st.The same proposal was later presented to other foreign regulatory authorities.The Argentinian government has so far failed to find a financial institutionwilling to act as a trust fund to undertake the debt-exchange operation in Japan,where there are an estimated 30,000 retail investors in the defaulted debt.Further complicating matters, in mid-November the Bank of New Yorkunexpectedly pulled out, making it impossible for the government to launchthe exchange operation in the US on the original November 29th deadline andcomplete the first phase of the debt swap before year-end. On November 24th,the government decided to postpone the opening of the swap period untilJanuary 17th; the offer will close on February 25th.

The authorities reached an agreement with local pension funds in October. Theexchange of US$15.2bn in pension funds� holdings of Argentinian external debtin default for new quasi-par bonds will imply a loss of nearly 30% in US dollars(quasi-par bonds are pesified at Ps1.40 per each dollar plus adjustment forinflation as measured by the Coeficiente de Estabilización de Referencia, orCER). Since pension fund account holdings are already expressed in pesifiedvalues, this discount will not be reflected in a contraction in the value ofpersonal accounts. To sweeten the offer, pension funds were allowed to

Supreme Court rules againstlabour law

Debt swap postponed toJanuary 2005

20 Argentina


exchange their holdings of defaulted treasury bills (Letes) # in which they wereforced to invest US$1.6bn in 2001 - for performing domestic debt in the form ofBoden 2014, with a higher market value. The agreement with pension fundshas ensured the government a floor acceptance of about 20% for the externaldebt swap. Of the defaulted external debt, 48.7% is in the hands of residents, ofwhich just over half are held by institutional investors such as pension fundsand banks. Apart from the pension funds, the government is likely to reach anagreement with other domestic institutional bondholders such as banks,insurance companies and investment funds.

The main features of the global offering are the following:

• The total debt to be restructured reaches US$81.8bn. It is in the form of 152different bonds issued under eight jurisdictions and denominated in sixcurrencies. One improvement over the original offer was that the interest dueprior to the default (31/12/01) was considered eligible debt (for a total ofUS$2.1bn). The new debt to be issued will be at most US$38.5bn if the rate ofacceptance of the debt exchange offer is equal or less than 70% and US$41.8bn ifthe rate of acceptance is higher than 70%. The newly issued debt will includenine bonds, four jurisdictions and four currencies.

• The debt exchange offer includes a clause stipulating that if thegovernment decides new restructuring in the next ten years for the bonds indefault that do not enter in this debt exchange offer, those participating in thepresent offer may also take part.

• Any excess payment capacity that Argentina may have will be used torepurchase performing debt.

• Higher than forecast real output growth will benefit those taking part inthe debt-exchange operation: as of 2006 a special growth-related coupon will bepaid to those taking part in the debt-exchange operation.

• The date of issue of the new bonds was set on December 31st 2003 insteadof June 30th 2004. This means that the holders of the new bonds will receiveimmediate interest payments worth an additional US$450m.

The lower interest rate on long term US Treasury bonds and the lower riskpremium on the yields of emerging markets bonds has made the offer moreattractive by reducing the discount rate used to calculate the present value ofthe debt. The improvement in the offer may still be insufficient to generatewidespread acceptance, but optimism has increased. The government believesthe bondholders� difficulties in bargaining as a group, due to the size anddispersion of the investor base, and the improvements made to the originaloffer will be enough to bring a sizeable majority of creditors on board. Theauthorities are reluctant to make the offer more generous, insisting that thepresent deal is the best offer that is truly sustainable under realisticassumptions about medium-term economic growth.

What degree of acceptance will constitute a success from the point of view ofthe IMF and the Argentinian authorities tends to differ. The Fund sees a rate ofsupport below 80% as insufficient to restore Argentina�s access to internationalcapital markets, whereas the government would welcome a rate of 60-70%. For

Argentina 21


the government, being able to borrow again on international capital markets isnot a priority, as the Kirchner administration is determined to avoid pastmistakes by amassing foreign debts again. However, if private lenders do notconsider that the swap marks an end to the default, the operation willhave failed.

The stand-by agreement of Argentina with the Fund has been suspended sinceAugust. The postponement of the debt swap means that a renegotiation oftargets, originally pencilled in for January, is unlikely to take place before March.Argentina faces SDR2.47bn (US$3.7bn) in amortisations and interest paymentsto the Fund during 2004. A total of SDR528m (around US$792m) in principalpayments are due to the Fund during the first quarter of 2005. Argentina hasadditional commitments to the World Bank and the IDB.

IMF staff and the Argentinian authorities continue to maintain differences ofopinion. IMF staff believe the Argentinian government needs to address anumber of pending structural problems. In particular, the Fund remainsinsistent that the government should: achieve a sustainable framework forrevenue-sharing between the federal government and the provinces;renegotiate contracts with the owners of utilities who have suffered losses as aresult of tariffs being frozen and converted into pesos in 2002, and define acourse of action for the commercial banks under state ownership. Thegovernment would prefer the Fund to set macroeconomic targets only,refinancing the majority of upcoming repayments without imposing extensiveeconomic policy conditionalities and allowing Argentina gradually to repay themultilateral the SDR9.48bn (US$14.2bn) it owes.

In some areas, the government is moving closer to the Fund�s position. The2005 budget projects a primary consolidated budget surplus of 3.9% of GDP,extremely close to the 4% demanded by the Fund. The budget proposal wasgiven its final approval by the lower house of Congress in late November. Themain notable features of the budget were the increases in the amounts devotedto debt servicing (at Ps9.6bn, this was 43% higher than in the 2004 budget) anda 29% rise in projected capital spending. The budget proved controversialbecause it concentrates special powers in the cabinet chief, currentlyAlberto Fernández. These include the ability to change the allocation of fundsacross budget items, in contravention of the Financial Administration Law andthe Fiscal Responsibility Law passed in August. Congress, against the wishes ofthe opposition and some dissident Peronists, also voted to support theexecutive�s request to extend until the end of 2005 the special powers grantedto the executive by the Economic Emergency Act of 2002, as requested toCongress in October. This allows the administration to enact economiclegislation by decree, and as a corollary, maintains the doubling in severancepay included in the original law.

As far as monetary policy is concerned, during the third quarter the authoritiessucceeded in maintaining a competitive real exchange rate, combined withrapid output growth and low inflation. The Central Bank attempted to preventthe peso from appreciating against the dollar, and thereby keep the exchange

2005 budget approved

Renewed accord with IMF willbe delayed

Authorities keep exchangerate weak

22 Argentina


rate highly competitive, maintain low interest rates and sterilise the resultingmonetary expansion. The new Central Bank president, Martín Redrado, whotook office in September (see The political scene) has pledged policy continuity,although he also wants to give higher priority to stimulating the provision ofbank credit to the private sector.

0

5

10

15

20

25

30

Jan2003

Mar May Jul Sep Nov Jan04

Mar May Jul Sep

Deposit rate (30-59 day term)

Lending rate (30 day)

Interest rateslocal currency; %

Source: Instituto Nacional de Estad�stica y Censos.

In the first nine months, the Central Bank�s short-term monetary liabilities (themonetary base plus repos) rose by 10.9%. This increase was the result ofPs15.3bn intervention in the foreign exchange market, only partiallycompensated for by sterilisation operations for Ps10.2bn. The main means ofsterilisation was the sale of US dollars to the Treasury, which used the proceedsto cancel foreign-currency obligations. The Central Bank also continued to placeits own bills. During the third quarter, short-term monetary liabilities increasedby 5.1%, well within the range established by the monetary programme.

The Central Bank increased its foreign currency purchases from an average ofUS$20m in September to US$30m in October. The private sector�s demand forforeign exchange fell as capital flight reversed and the sale of soybean held byspeculators increased the supply of foreign currency. The increase in the rate ofofficial foreign currency purchases was not enough to prevent the peso fromappreciating slightly, from an average of Ps2.99:US$1 in August to Ps2.95:US$1in October.

During the third quarter the repo market continued to operate actively,reflecting the transition from a scheme of quantitative intermediate targetstowards one focused on reference interest rates. At the end of November, ahigh-ranking Central Bank official confirmed that the institution was planningto move to a system of targeting a reference rate for the financial system as themain tool of monetary policy. The intervention of the Central Bank in the repomarket was encouraged by the sustained increase experienced by the call ratein May, when some financial institutions were short of liquidity. Moreover, inJune the monetary authorities eliminated the compensation paid on excessbank reserves, encouraging these funds to be transferred to the repo market. Asa result, during the third quarter the daily average value of transactions in therepo market reached Ps859m, experiencing more than a threefold increase over

Repo market becomes moreactive

Argentina 23


June. These interventions had a contractionary effect on the broad monetarybase of Ps4.2m, becoming the main factor of absorption.

The domestic economy

Output and demand

Between the first quarter of 2002, when output touched its post-devaluationlow, and the first quarter of 2004, real output grew by an average of 1.9%quarter-on-quarter, seasonally adjusted. In the second quarter this growth rateslowed to just 0.5%. After three consecutive quarters of double-digit year-on-year growth, GDP increased by a more modest 7% year on year in the secondquarter. The slowdown was accounted for by two factors. An energy crisisdepressed manufacturing production and construction, particularly duringApril. In May and June, annual income tax payments fell due, curbingconsumption and investment. The second quarter of 2003 also served as amore challenging base of comparison.

Among the components of domestic demand, the slowdown was most markedin the case of investment. After six consecutive quarters of average growth of10.5% quarter on quarter, investment grew by just 2.6%. The contribution ofinvestment spending to total output growth slipped into second place behindconsumption after two quarters in which the recovery was investment-led.

Since investment spending rose more quickly than total aggregate demand(which was negatively affected by the performance of net exports), the share ofinvestment in GDP increased again in the second quarter, to reach 17.1%. At thislevel, the share of investment in GDP exceeded that recorded in 2001, prior tothe economic crisis. However, the investment ratio is still below the 19.9%recorded in 1998. Since bottoming out in the third quarter of 2002, realinvestment has recorded an accumulated increase of 87% (seasonally adjusted).In the last three quarters, net real investment has been positive.

The elasticity of investment spending to GDP is higher than that displayed inthe recovery from the last recession in 1995. Seven quarters into the presentrecovery, the output elasticity of investment reached 5.5%, as opposed to 2.4% inthe previous episode. The 1999-2002 recession was much deeper, but on bothoccasions durable equipment was the investment component most severely hitby the crisis, but also the one experiencing the fastest recovery. In this recovery,the increase in investment has been financed by domestic rather thanexternal savings.

The slowdown experienced by consumption is visible both in quarter-on-quarter and year-on-year figures. The payment of annual tax commitmentsplayed a role, but there were also other factors such as a slowdown in thecreation of new jobs, scarce credit and slow growth in real wages (seeEmployment, wages and prices) that affected consumption.

Economic growth slows in thesecond quarter

Consumption slows insecond quarter

Output increase brings greaterinvestment

24 Argentina


During the second quarter, the negative contribution of net exports to totalaggregate demand increased markedly. Real exports contracted for the first timeon a quarter-on-quarter basis since the second quarter of 2002, whereasimports grew rapidly. Net external demand subtracted 0.8 percentage pointsfrom total output growth. After playing an important role in growth in 2002,since the last quarter of 2002 net exports have been displaced by domesticdemand. The negative contribution of net external demand was mainlyaccounted for by the rapid growth of imports, which have increased by anaccumulated 75% since the fourth quarter of 2002 as they recover from post-devaluation lows. Exports, by contrast, have grown by a modest 4%.

The second-quarter slowdown appears to have been transitory, andpreliminary information for the third quarter suggests that - in the absence ofthe temporary factors such as tax payments and energy shortages - economicgrowth picked up. Estimates for growth in the third quarter will be published inDecember. In July-September the Estimador Mensual de Actividad Económica(EMAE), the seasonally adjusted monthly estimator of economic activity (aproxy for GDP) rose by an average of 1% month-on-month, compared with anaverage of just 0.1% in the second quarter. Evidence of higher growth in thethird quarter also comes from supermarket sales, which, during July andAugust, experienced the largest seasonally adjusted rise (at constant prices)since February 2003 (1.3% and 1.7% respectively). Supermarket sales fell by 1.8%in September, however. The Indicador Sintético de Servicios Públicos (ISSP), ameasure of the output of utilities, recorded a strong 4.3% seasonally adjustedgrowth in August, posting the highest rate of increase of the year.

Gross domestic product growth by demand(% change, quarter on quarter, or year on year in the case of calendar years)

2003 20043 Qtr 4 Qtr Year 1 Qtr 2 Qtr

Private consumption 2.9 2.8 8.2 2.2 0.6Public consumption -3.0 -0.2 1.5 0.8 0.5Gross fixed investment 8.4 12.5 38.2 11.3 2.6

Exports of goods & services 0.7 1.4 6.0 2.1 -3.1Imports of goods & services 9.5 13.0 37.6 11.0 3.9

GDP 3.4 3.0 8.8 1.5 0.5

Source: Ministerio de Economía.

On the supply side, the growth slowdown affected all sectors during thesecond quarter. Primary-sector output contracted year on year as adverseweather caused lower agricultural output and petroleum extraction fell.Manufacturing and construction continued to expand strongly, although theirrate of growth was lower than in the first quarter. In the services sector, retail,transport, storage and communications expanded, whereas financialintermediation output contracted. For the first time since the end of 2001, in thesecond quarter of 2004 the contribution of services to total output growthoutstripped that of goods-producing sectors (54% compared with 46%).

Supply-side slowdown evenlyspread

Growth appears to havepicked up in third quarter

Argentina 25


Gross domestic product growth by sector(% change, year on year)

2003 20043 Qtr 4 Qtr Year 1 Qtr 2 Qtr

Agriculture, livestock & forestry 6.7 9.2 7.0 9.0 -11.6

Fishing 6.6 9.9 1.2 -5.7 -11.7Mining & energy 5.4 6.7 3.7 2.7 -2.7

Manufacturing 16.2 16.9 16.0 15.8 13.2Electricity, gas & water 9.6 8.5 6.9 9.3 8.3Construction 42.8 45.9 34.4 41.4 32.4

Services Hotels & restaurants 4.3 6.3 6.0 6.4 5.6 Transport, warehousing & communications 9.9 12.2 8.2 14.1 10.1


Employment, wages and prices

Rapid output growth has led to a moderate but sustained increase in priceinflation, as some sectors have begun to reach full capacity utilisation. Duringthe first quarter, consumer price inflation reached 2.4% year-on-year; it rose to4.1% during the second quarter and to 5.4% during the third.

The Instituto Nacional de Estadística y Censos (INDEC), the national statisticsinstitute, now publishes a version of its inflation data with regulated andseasonal prices removed, excluding goods and services whose prices arestrongly influenced by seasonal factors, or high taxes, or are officially regulated.This leaves core products and services, which jointly account for 70.6% of theconsumer price basket. In January-September core prices increased by 4.9%, 2.1percentage points higher than the overall consumer price index (CPI). Somecomponents of the core inflation rate index have accumulated double-digitrises since December 2003. Many officially regulated prices, such as those forutilities, have not been increased during the period, helping to explain whycore inflation has exceeded overall inflation.

Wholesale prices inflation has also accelerated: during the first quarterwholesale prices increased by 2.2% year on year, to reach 7.6% in the secondquarter and 10.5% in the third. Between January and September, the largest risein wholesale prices was recorded by electricity, whose price rose by 35.4%.Manufacturing prices rose by 7.8%, more rapidly than primary product prices(7.2%) and imported product prices (5.6%).

Consumer and producer prices(% change)

2003 2004Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct

Consumer pricesMonth-on-month 0.6 0.2 0.2 0.4 0.1 0.6 0.9 0.7 0.6 0.5 0.3 0.6 0.4Year-on-year 3.9 3.6 3.7 2.7 2.3 2.3 3.1 4.3 4.9 4.9 5.3 5.9 5.7Year-to-date 3.2 3.4 3.7 0.4 0.5 1.1 2.0 2.7 3.3 3.8 4.1 4.8 5.2

Inflation starts to rise again

26 Argentina


Consumer and producer prices(% change)

2003 2004Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct

Wholesale pricesMonth-on-month 0.5 1.0 1.7 -0.3 1.4 0.4 0.8 1.3 0.2 0.9 2.4 0.2 0.6Year-on-year -2.9 -0.2 2.0 1.2 2.2 3.4 6.1 8.2 8.6 9.6 10.7 11.2 11.3Year-to-date -0.8 0.2 2.0 -0.3 1.1 1.5 2.3 3.6 3.9 4.8 7.3 7.6 8.3

Source: Instituto Nacional de Estadística y Censos.

Employment growth slowed in the second quarter, probably owing to theeffects on hiring of the uncertainty created by the energy crisis. During thesecond quarter, the unemployment rate also increased by 0.4 percentage points,after contracting by 0.1% in the first quarter and by 1.9% in the fourth quarter of2003. The increase in the unemployment rate was partly a result of higherparticipation rates: in contrast with the trend recorded during 2003 and the firstquarter of 2004, in the second quarter activity rates increased. This rise,combined with a slowdown in the rate of new job creation, led to an increasein the unemployment rate. During the second quarter, the Labour DemandIndex calculated by Universidad Torcuato Di Tella (based on the number of jobvacancies advertised) contracted by 22%, after recording continued rises sinceMarch 2002. Unemployment statistics are not yet available for the third quarter,but a fall to around 13% was strongly hinted at by Mr Lavagna at the endof September.

Measures of poverty have improved in recent months, although poverty ratesare still far in excess of their level at the end of the 1990s. The improvement inpoverty indicators was the result of the higher rate of new job creation and arise in households� real incomes. During the first half of the year, the share ofthe population below the poverty line fell to 44.3% (compared with 47.8% in thesecond half of 2003). Similarly, the share of the population classed as indigent #defined as those unable to meet the most basic necessities - reached 17%, downfrom 20.5%.

90

100

110

120

130

140

150

Oct2001 02 0403

Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug Oct Dec Feb Apr Jun Aug

Private Private non-registered

Nominal index of wages in the registered and informal private sectorQ4 2001=100


The authorities are also helping to raise real incomes through targetedmeasures, such as the increase in minimum wages from Ps350 to Ps450 in

Argentina 27


September. Even after the rise, one minimum wage is still insufficient tomaintain a four-person family above the poverty line (the income necessary forthis is Ps730). Moreover, the increase in the minimum wage has not translatedinto higher incomes for informal-sector workers: the increase in the minimumwage has been ten times higher than that experienced by informal-sectorsalaries. The informal sector is also growing, and now accounts for around halfthe workforce, according to INDEC. The increase in minimum wages probablyaccounts for most of the increase recorded in wages� real purchasing power,since workers earning more than the minimum wage have experiencedextremely modest nominal wage increases. In these cases, real purchasingpower is well below the levels recorded prior to the devaluation.

Social indicators(% of economically active population, unless otherwise indicated)

2003 2004

3 Qtr 4 Qtr 1 Qtr 2 Qtr

Unemployment 16.3 14.5 14.4 14.8

Underemployment 16.3 16.3 15.7 15.2

Poverty (% of population)a 47.8 47.8c 44.3 44.3

Extreme poverty (% of population)b 20.5 20.5c 17.0 17.0

a Defined as too poor to afford the basic food basket plus a narrow range of services includingtransport, clothing and health. b Defined as too poor to afford the basic food basket. c Data for thepoverty is compiled twice a year.


Financial indicators

At the end of September the Base Monetaria Amplia (BMA), the broadmonetary base, reached Ps46.4bn, equivalent to a 8.7% increase year on year but3.4% below the level recorded at the end of the preceding quarter. During thethird quarter, Central Bank repo operations made the largest contribution to thecontraction of the money supply (for a total of Ps4.2bn). Central Bank activity inthe repo market is part of an effort to create a short-term reference interest rate(September 2004, page 22). In repo operations, the monetary authority sellsTreasury bills to financial institutions with a repurchase agreement at a futuredate. Sales of bills in the repo market reduce the money supply temporarily,although when the Banco de la República Argentina (BCRA, the Central Bank)repurchases the security, the money supply is increased again. Comparing theCentral Bank short-term monetary liabilities (BMA plus repos) with the targetsset by the monetary programme indicates that the latter is being met. InSeptember the Central Bank�s short-term monetary liabilities reached a total ofPs51.1bn, within the monetary targets set out in the IMF programme.

The Central Bank�s placement of short-term bills (Lebac and Nobac) in theprimary market also served to contract the monetary base during the thirdquarter, but only by a modest Ps200m. Other contractionary factors wererepayment to the Central Bank by private banks of Ps0.6bn in assistance. Thepublic sector made net repayments to international financial institutions,running down its deposits in the domestic banking system by Ps1.5bn. Net

Monetary base contracts in thethird quarter

28 Argentina


purchases of foreign currency from the private sector were the onlyexpansionary factor, adding Ps4.7bn to the monetary base during thethird quarter.

The stock of peso-denominated loans to the private sector recovered quickly inthe second and third quarter, growing by 18.6%. Trade and commercial loansgrew most quickly, followed by consumer loans. In addition, during Septembersecured lending increased for the first time since December 2000 (growing by0.3%), triggered by higher sales of agricultural machinery and vehicles. Thestock of mortgage loans continued its steady fall, although the rate ofcontraction is falling. Although real output has been growing since the firstquarter of 2003, credit has followed with a one-year lag. The economicrecovery has been largely self-financed, although the scope for this may bereaching its limits, threatening the sustainability of the recovery. Longer-termcredit has been discouraged by the failure of real wages to recover from the cutscaused by the devaluation. Nonetheless, a modest increase in the terms oflending has been visible in recent months.

Lending to the retail and industrial sectors recovered fastest after thedevaluation of the peso, increasing by 13.1% and 35.6%, respectively, during thefirst half. These sectors were also among the fastest to recover from therecession. Machinery and equipment was the industrial sub-sector thatexperienced the largest increase in the demand for credit. Among services, thesale of motor vehicles, motorcycles and fuels were the sub-sectors whichexperienced the largest increase in the demand for credit. Construction-relatedloans increased by a more modest 5.4%. Construction has relied heavily on self-finance. Despite the recovery of credit, the stock of loans to industry, trade andconstruction is still between two-thirds and one-half of levels inDecember 1999.

The increase in deposits in the financial system is explained mainly by thepublic sector depositing its significant fiscal surpluses. Private savings, bycontrast, have been channelled only partially towards the banking system.During the first nine months, public-sector deposits increased by 79.4%,whereas private-sector deposits rose by a modest 1.3%. This contrastingperformance is also affecting the liquidity of private- and public-sector banks.The government�s strong cash position means that, while loans to the privatesector increased by 19.2% during the period, loans to the public sectorcontracted by nearly 1%.

During the third quarter, the stock of demand deposits increased by 5%, sevenpercentage points lower than in the preceding period. The government receivedlower tax payments and, of these, a higher share was placed in term deposits.The private sector also shifted its holdings to term deposits, encouraged byhigher interest rates. Term deposits increased by 8.1% as a result. Term depositshave been encouraged by the introduction of inflation-adjusted instruments,which are available for deposits at terms of 90 days or more. During the firstnine months, term deposits adjusted by CER increased by Ps3.2bn. At thebeginning of the year, term deposits with maturities between 90 and 360 days

Demand deposits increaseslows

Lending to private sectorincreases

Argentina 29


accounted for 17% of the total; by the end of September their share hadreached 25%.

Although the average maturity of banking liabilities has increased, it is stillshorter than before the 2001-02 crisis. Demand deposits represent more thanhalf of total deposits, compared with close to a third before the crisis,demonstrating a continued shortfall of confidence in the financial system.Nevertheless, the position is reasonably encouraging given that the mostpessimistic forecasts in the wake of the crisis suggested that confidence in thedomestic financial system had been irreparably destroyed.

Deposit rates have gradually risen, probably in the expectation that banks willneed to attract higher deposits in order to fund the slow recovery of credit.Interest rates have increased in both public- and private-sector banks, but theincrease has been higher in the latter. Private-sector banks have not benefitedfrom the influx of funds from the government surplus. By the end ofSeptember, a substantial gap had emerged between the average interest ratepaid by public-sector banks - 2.25% - and the 4.8% paid by the private-sector banks.

Lending rates fell again during the third quarter of 2004 to reach levels belowthe average recorded in the 1994-2000 period, both in nominal and real terms.In the inter-bank and in the private swaps market, interest rates continued toconverge towards the range established by the Central Bank, which borrowsfrom financial institutions at 2.5% and lends to them at 3.5%, mostly with 7-daymaturities. The monetary authorities have encouraged this market in order tocreate a short-term reference interest rate.

The peso liquidity of the banking system (cash in the banks, current accounts inthe Central Bank and the stock of Central Bank repos) reached 22.6% of totaldeposits in September, lower than in January. The slow recovery of credit andthe intervention in the repo market have reduced liquid funds in excess ofreserve requirements to only 1.8% of total deposits, more than six percentagepoints below the level recorded last December. After the losses suffered in2002, the commercial banks are making operating profits. During the secondquarter, commercial banks recorded total profits of US$317m. These profits werenot in the main the result of financial intermediation, but of a weaker exchangerate (banks have more dollar than peso-denominated assets), higher fee income(which covered nearly 50% of administrative expenses) and lower provisionsfor non-performing loans.

The trade-weighted real exchange rate, as computed by the Central Bank,depreciated by 4% during the third quarter, and weakened by 3.4% in the yearto September. The Central Bank, under the presidency of Martin Redrado, whotook over in mid-September, has pledged to maintain a competitive realexchange rate, as well as stimulating a recovery in credit to the private sector, inorder to maintain the pace of the economic recovery in the future.

Interest rates rise

Banks handling less cash

Argentina 30


Foreign-exchange reserves and monetary aggregates, 2004(end-period unless otherwise indicated)

Jun Jul Aug Sep OctInternational reserves (US$ bn) 17.4 18.1 18.1 18.2 18.6Financial liabilities (Ps bn) 48.6 47.1 47.4 47.5 45.9

M1 (Ps bn) 59.8 60.6 59.4 58.8 59.1Peso savings & time deposits (av; Ps bn) 57.1 58.3 60.4 62.1 72.4

Source: Banco Central de la República Argentine.

Agriculture

During the first quarter of 2004 real agricultural output increased by 9% year-on-year, only to contract by 12% during the second quarter. Overall, agriculturaloutput fell during the 2003/04 campaign, as adverse weather conditionslowered yields. The area sown with soybean increased by a remarkable 12.8%,encouraged by the high world prices prevailing during the sowing season. Thetotal area sown with all crops increased by 2.4%, but it was not enough tocompensate for lower yields, and crop output for 2003/04 fell by 4.2% over theprevious campaign. The sharpest contraction in output was recorded by corn,sunflower, soybean and sorghum. By contrast, wheat production increased.

According to preliminary estimates, during the 2004/05 campaign the areasown with wheat will increase by 2.7%, and the area under corn will grow by10%. Despite the increase in the area sown with wheat, drought in the central-northern region may reduce output. The drought is also leading to delays insowing corn. Soybean output forecasts are uncertain. The Bolsa de Cereales, themain exchange for grains and oilseeds, based in Buenos Aires, predicts that thearea sown with soybeans will increase by 1.4-2.1% over the previous campaign.This could be higher if the drought persists, as this could encourage someproducers to abandon wheat and corn production and shift to soybeancultivation. Although soybean yields are likely to rise in 2004-05, soybeans arethreatened by a new disease (roya asiática), and there is a risk that this willlower yields. According to private estimates, during the next campaign thedisease may affect as much as 25% of the total area sown with soybeans (3.5mhectares). The area sown with sunflower is expected to remain constant,although much will depend on how weather conditions evolve.

Agricultural output(area sown='000 ha; output='000 tonnes)

Area sown Output2001/02 2002/03a 2003/04a % changeb 2001/02 2002/03a 2003/04 a % changeb

Sunflower 2,050 2,378 1,835 -22.8 3,843 3,714 3,100 -16.5

Corn 3,064 3,084 2,807 -9.0 14,710 15,040 13,000 -13.6Sorghum 592 593 544 -8.3 2,847 2,685 2,160 -19.6

Soybeans 11,639 12,607 14,226 12.8 30,000 34,800 32,000 -8.0Wheat 7,109 6,300 6,036 -4.2 15,300 12,301 14,530 18.1

Other 3,038 2,760 2,930 6.2 2,909 2,556 3,314 29.7Total 27,492 27,722 28,378 2.4 69,609 71,096 68,104 -4.2

a Provisional. b 2003/04 on 2002/03.

Source: Secretaría de Agricultura, Ganadería, Pesca y Alimentación.

Crop output falls on loweryields

200

250

300

350

400

450

Jan2003

Apr Jul Oct Jan04

Apr Jul Oct

Soybean priceUS$ per tonne; Rotterdam

Source: IMF, International Financial Statistics.

Argentina 31


The most recent forecasts released by the US Department of Agriculture (USDA)for the 2004/05 campaign revised upwards the output forecast for wheat (a 1.2%increase equivalent to 14.7m tonnes). Corn output is forecast to reach 15.7mtonnes, equivalent to a 20.8% increase over 2003/04. The USDA forecast forsoybean is much higher than the 37.6m tonnes forecast by local analysts. TheUSDA forecast for sunflower also predicts a 29% increase in output, to reach 4mtonnes in 2004/05.

Agriculture was one of the sectors that benefited most from the devaluation ofthe peso. Since the 2001/02 growing season, average profits per hectare (thedifference between revenue and cost) have averaged US$125.4/ha, more thandouble the average margin recorded between 1991/92 and 2000/01, a periodwhen profit margins on some crops occasionally turned negative. Since2001/02, farmers have enjoyed a combination of a competitive real exchangerate and high world commodity prices. However, lower international pricesand higher production and transportation costs are set to reduce profits.According to the Bolsa de Cereales, average profits per hectare may fall toUS$63.9. This profit margin would be lower than the US$72 average recorded inthe last thirteen years.

In the first eight months of 2004, the slaughter of cattle increased by 16%, andbeef production rose by 14.4% to reach 1.94m tonnes. The increase in outputwas triggered by rapid demand growth, both at home and abroad, but theupward trend in domestic demand for beef may be brought to a halt if pricescontinue to increase. Exports have soared, rising by 64% by volume and 75% interms of dollar export earnings in January-August. Higher exports to non-traditional markets, such as Russia, and the recovery of others, such as Chile,which was negatively affected by sanitary problems, accounted for most of theincrease. Russia has now become the single biggest market for Argentina�sbeef exports.

Higher beef production has come partly at the cost of reducing herds, and is notsustainable at its present rate of growth. The liquidation of stocks may havebeen a result of the shifting of cattle production to less fertile land to make wayfor soybean cultivation, a trend that looks largely to have run its course. Grossprofit margins on beef production are recovering relative to those on soybeansas the price of cattle increases (the price of livestock in US dollars increased by8.5% in the first eight months) and the price of soybeans falls (the average priceof soybeans in the third quarter was 19% lower than in the second quarter, atUS$265 per tonne). The gross profit margin on soybean has fallen below the1988-2003 average.

The output of the dairy industry also increased by 22% during the first eightmonths, owing to greater supply of raw milk for processing. Much of the higheroutput was exported, with export earnings almost doubling year-on-year on thestrength of higher volumes and prices. Three quarters of all exports were in theform of powdered milk. Rapid export growth was accompanied by adiversification of export outlets, with Algeria (33% of exports), Venezuela (15%)and Brazil (10%) the main destination markets.

Dairy output higher

Livestock output up

Agricultural margins set toretrace gains

70

80

90

100

110

120

130

Jan2000

Jul Jan01

Jul Jan02

Jul Jan03

Jul Jan04

Jul

Beef pricesUS$ per lb; Australia

Source: IMF, International Financial Statistics.

Argentina 32


The poultry sector is also recovering fast. During the first eight months, outputincreased 24.5%, recovering to pre-crisis levels. The increase in output wasencouraged by higher domestic demand (encouraged by the increase in beefprices) and exports. During 2004 poultry exports are likely to reachrecord levels.

Sectoral trends

During the second quarter, seasonally adjusted industrial activity (measured bythe Estimador Mensual Industrial, EMI) contracted by 1.3% over the precedingquarter. However, in July-September it rose by 2%. The level of industrialactivity at the end of September therefore recovered to the level of March.Industrial output is equivalent to 1997 levels. In the first three quarters of 2004,industrial output increased by an accumulated 11.5%.

The fastest-growing industries in the first three quarters have been motorvehicles (which grew by 53.4%), other metal-mechanic industries (15.3%) andnon-metallic minerals (20.3%). In September motor vehicle output reached apeak for the last three years. Despite the recent contraction in sales on thedomestic market, in 2004 local vehicle manufacturers gained market share atthe expense of imports. Higher production of capital goods, mainly agriculturalmachinery, has contributed to a rise in output in the metal and machinerysector. The production of cement and other construction materials has beenencouraged by growth in private-sector construction. The production of thetextile sector also grew in the third quarter, in response to rising domesticdemand. However capacity utilisation in textiles reached 84.2% in Septemberand the sector is running into capacity constraints. Investment has so far reliedmainly on self-finance, but future expansion of capacity will necessitate arecovery of credit.

Industrial profit margins have risen significantly since the collapse of thecurrency board at the start of 2002. While the Indice de Costos Industriales(ICI), calculated by Universidad Argentina de la Empresa (UADE), rose by108.9% since the collapse of the currency board, wholesale industrial prices(measured by the Índice de Precios Internos Básicos Mayoristas (IPIBM),produced by the Instituto Nacional de Estadística y Censos (INDEC)) haveincreased by 19 percentage points more. The gap between the two indices hashas broadened markedly in recent months. During the third quarter, industrialcosts increased by 3.1% (compared with the first quarter), and industrial pricesrose 4.8%. Profit margins rose most quickly in areas benefiting from higherworld prices, such as steel, non-metallic minerals, chemical products andpetrochemicals. In contrast, petroleum refining costs increased much faster thanfinal prices. This was the result of higher oil prices and the commitment of therefineries not to pass on that increase in full to domestic consumers. InDecember 2001-September 2004 refining costs increased by 65.3%.

Higher industrial output pushed capacity utilisation to 71.6% in the thirdquarter. Without continued growth in investment, the present pace of outputgrowth will rapidly lead to supply bottlenecks and inflationary pressures. The

Industrial output picks up afterslow second quarter

Industrial profit marginshave risen

Argentina 33


increase in industrial production has also shown up in the rising demand forlabour. The output-elasticity of employment in the manufacturing sectorincreased during 2003 to reach 1% (compared with 0.4% before the crisis). Theshare of industrial employment reached 18% of the total during the first half.The share was similar to that reached in early 1999, before the ratio plunged to16.6% in 2000. Although the share of industrial employment in totalemployment is low compared with that of services, which account for 69% oftotal formal employment, the growth of labour demand in industry has had abigger impact upon the economy. The increase in the number of industrial jobscreates employment directly and indirectly, by leading to higher demand forinputs from the primary sector and for services. The number of formal jobs inindustry is 1.2% higher than in the first quarter of 2001, when total formalemployment reached a peak. However, employment in industry was higher in1994, when industry�s share in total formal employment reached 24%.

Monthly index of industrial output, 2004(% change, year on year)

Jan-Sep SepFood & drink 7.4 5.9

Tobacco products -6.1 -10.4Textiles 7.3 15.1

Paper & cardboard 10.9 11.1Petroleum refining 2.3 9.2Chemical products 11.9 9.7

Rubber & plastics 11.2 13.9Non-metallic minerals 20.3 16.3

Base metals -0.9 0.2Cars 53.4 53.9

Metal-mechanics excl cars 15.3 15.6Total 11.5 10.4


Energy

The slowdown in the electricity, gas and water sector during the second quarterwas less pronounced than that of output as a whole. The sector grew by 8.3%,compared with 9.3% in the first quarter. Energy shortages in the second quarterwere caused not by a sudden dip in supply, but rather by strong growth inenergy use, and a seasonal rise in energy use over the winter. The crisis wasovercome owing to mild weather and some emergency measures (such as thereduction of exports). However, the structural problems affecting the supply ofenergy are still present.

The fall in the relative price of energy caused by the freeze of public utilityrates, and rapid economic (especially industrial) growth has caused a sharpincrease in the demand for natural gas and electricity. During the winter,suppliers of energy proved unable to meet fully the extra demand. Thegovernment has blamed the private sector for not investing enough. However,private firms argued that the freeze in natural gas prices, and transportation anddistribution fees, had left them unable to invest.

Economy surmounts energycrisis

Argentina 34


Argentina, which has natural gas reserves of 0.66 trn cu m, around 11 years ofconsumption at 2003 levels, looks likely to have to import gas in the mediumterm. The government signed a protocol with Bolivia in mid-October toincrease fivefold imports of natural gas, to reach a total of 20.5m cu m per dayin 2007. At that level, imports from Bolivia would represent a quarter of totalconsumption at 2003 levels. The agreement has not fixed a price for the gas, butit effectively allows the tender to build the north-eastern gas pipeline to goahead. This pipeline will demand an estimated investment of US$1.0bn (seeprevious report). The construction of the new pipeline was postponed until thebeginning of next year. This means that construction works will have toproceed fast if the new pipeline is to help to keep the supply of natural gas inpace with expected growth of demand by 2006.

To increase natural gas transport capacity, in November the government alsosigned a letter of intent with Brazilian state-owned oil company Petrobrás toexpand the capacity of the San Martín pipeline between Patagonia and BuenosAires operated by Transportadora de Gas del Sur (TGS). The expansion, in theform of a new pipeline which will run alongside the existing one, will costUS$285m and is designed to meet the future needs of industrial users in theBuenos Aires metropolitan area. However, TGS will have to supply only aroundUS$40m, with the rest coming from a trust set up by the Argentinian authoritiesand including financing from the Banco Nacional de DesenvolvimentoEconômico e Social (BNDES), the Brazilian Development Bank.

The authorities signed a letter of intent with Repsol-YPF in mid-November inorder to expand the transportation capacity of the Gasoducto del Norte,operated by Transportadora de Gas del Norte (TGN) between Campo Durán inthe north-western province of Salta and San Gerónimo in the province ofSanta Fé by 1.8m cu m per day. This project, which will cost US$169m, willallow greater volumes of natural gas to be imported from Bolivia. The twoprojects will be financed by Petrobrás, Repsol-YPF, BNDES and the firmsoperating each pipeline (TGS and TGN). Investment will be recovered through aspecial charge to be applied on large users (industry, electricity generators andcompressed natural gas stations). The investment would probably not havecome about without government intervention.

The rapidly growing demand for electricity, which increased by 9.3% in the firsthalf, will also necessitate new investments. However, new investment has beendelayed by the failure of the authorities to convince power-generating firms tocontribute to a recently created trust fund. The trust fund is expected to financethe building of two new thermal stations to supply a total of 1,600 mw ofelectricity by 2007. The private firms have not yet accepted the official proposalto exchange the obligations that they hold against the wholesale distributingcompany (Cammesa) for shares in the new generating stations. Private firms arekeen to see the result of the government�s bid to reform the regulatoryframework for public utilities.

During the first half of the year, petroleum output contracted by 6.5%, andexports fell by 15.3%. The contraction was even sharper compared with theoutput recorded in 2001, compared with which output and exports fell by 9.6%

Government acts to ensurefuture gas import capacity

Oil production falls in thefirst half

Argentina plans to importmore gas from Bolivia

Argentina 35


and 30.8% respectively. Investments in oil exploration and extraction have beeninsufficient to prevent a fall in output. Although oil production fell, the sale offuels to the domestic market increased by 9.3% year-on-year during the first halfof 2004 and are slightly above the level recorded in 2001. According to privatefirms, the variable export levy currently applied to oil exports (the export taxrate rises in step with world prices) has discouraged new investments, as itnegates the effect of higher prices. As well as providing resources to thegovernment, by keeping the price of fuel down, the export tax on petroleumand refined products has increased profit margins in industry and agricultureand has lowered the relative price of energy for residential consumers. This hascome at the cost of distorting the domestic energy market. The authorities havefound it difficult to encourage domestic oil producers to supply crudeto refineries.

Together with the passage of the new regulatory framework for public utilitiesand the 2005 budget, the government created the energy state firm, EnergíaArgentina S.A. (Enarsa). Congress finally passed the law creating Enarsa inOctober, including some modifications to the executive proposal. Thesechanges strengthened the control of the state over the future of the firm. Theofficial initiative was received with scepticism by the private sector, whichregards it as void of substantive content (the firm has a broad focus #oil, naturalgas, electricity and other energy products- and lacks significant assets).

Primary production(real % change, year on year)

2003 20044 Qtr Year 1 Qtr 2 Qtr

Mining 6.7 3.7 2.7 -2.7

Manufacturing 16.9 16.0 15.8 13.2

Electricity, gas & water 8.5 6.9 9.3 8.3

Construction 45.9 34.4 41.4 32.4


Foreign trade and payments

During the first nine months of 2004, imports grew four and a half times morequickly than exports. The value of exports increased by a modest 15%, andalmost nine-tenths of the rise was accounted for by higher prices. However,after staying flat during the first half of the year, export volume growthaccelerated during August and September, increasing by 16% and 9%respectively. Higher exports of soybeans to China accounted for most of theincrease in export volumes during the third quarter. The increase was in part astatistical effect following the dip in soybean exports in June-July when healthsafeguards were imposed by the Chinese authorities.

The 2002 devaluation of the peso has been slow to stimulate exports. During2002 export volumes grew by just 1%, and in 2003 by a modest 5%. In January-September 2004, export volumes increased by just 2%. One of the reasons is thestill relatively low investment rate and the rapid recovery experienced by

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domestic demand. Inadequate export promotion policies have preventedbusinesses from making the most of export opportunities.

External trade, 2004(US$ bn unless otherwise indicated)

Mar Apr May Jun Jul Aug SepMerchandise exports fob 2.6 3.0 3.4 2.9 3.0 2.9 3.0 % change, year on year 16.6 22.9 20.3 1.9 6.1 25.1 25.3Merchandise imports cif 1.7 1.6 1.8 2.0 2.0 2.0 2.0 % change, year on year 81.4 47.6 64.0 77.5 55.4 78.0 52.7Trade balance 0.9 1.4 1.6 0.9 1.1 0.9 1.0


During the first nine months, export earnings increased across all majorproduct categories. However, volumes rose only in the case of industrial andagricultural manufactures (by 9% and 6% respectively). Earnings from primaryproducts and fuels and energy only rose because of higher international prices;volumes declined by 9% and 8% respectively. The most dynamic export sectorwas agricultural manufactures. Soybean products (flour, pellets and edible oils)account for the bulk of these, but beef and dairy products have grown rapidly.Industrial manufacturing exports grew rapidly as well, encouraged by therecovery in Brazil, which bought 31% of total manufacturing exports. Steelexports did not share in the rising growth, as the industry is close to fullcapacity. Excluding steel exports manufacturing exports grew by 23% inJanuary-September.

Lower exports of soybeans, corn and unprocessed fish dragged down exportsof primary products. However, the fact that export taxes are levied at higherrates on unprocessed exports may have encouraged firms to increase the shareof their products shipped in processed form, for example as edible oils andprocessed fish products. Fuel and energy exports increased, apart from crudeoil, exports of which contracted by 2%.

Growth in the import bill of 68% during the first nine months of the year waslargely accounted for by higher volumes. Import prices increased by a modest9%, less than export prices, leading to a terms of trade gain worth US$1.6bnduring the first nine months.

The fastest-growing categories of imports were capital goods and motorvehicles, which rose by 138% and 192% respectively. Capital goods imports werenot all investment goods: they included cellular phones, imports of whichincreased tenfold year on year. Among vehicles imports, trucks and agriculturalmachinery accounted for a majority of imports by value, although automobileswere the fastest-growing category. Automobile imports from Brazil have becomea major source of the bilateral trade deficit. The resurgent demand for vehiclesin Argentina has particularly benefited producers of small and medium-sizedvehicles based in Brazil. Fuel imports also increased, triggered by the energycrisis and higher oil prices. Imports of intermediate inputs for industry havereached levels similar to those at the end of 1998, before the onset of recession.

Import volumes grow strongly

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Following the devaluation of the peso, the share of intermediate goods in totalimports increased remarkably, accounting for nearly half of total imports in2002-03. During 2004 this share contracted to 39%, a level similar to thatrecorded in 2001. The share of capital goods in imports, which initially fell, hasgrown to 23% of the total in 2004, slightly higher than in 2001. The share ofconsumer goods imports, having fallen precipitously during the crisis, is just 11%of total imports, 9 percentage points below the 2001 level. In consumer goods,there has been a high degree of import substitution, whereas imports ofintermediate products and capital goods are harder to replace withdomestic production.

After many years of trade surpluses, Argentina is now recording a deficit withits Mercosur trade partners. Mercosur is the only significant trade partner withwhich Argentina is recording a trade deficit, largely because of an increase of69% in imports from Brazil in January-September. Imports from Brazil areincreasing more than six times as fast as trade in the opposite direction, andfaster than the overall rate of import growth. Textiles, agricultural machineryand household appliances imports rose especially quickly. Argentina�smanufacturing exports to Brazil increased, but sales of primary products andenergy contracted.

Major exports and imports(US$ m unless otherwise indicated; Jan-Sep)

2003 2004 % change, year on yearExports fob 22,230 25,610 15.2 Primary products 5,482 5,612 2.4 Manufactures 12,761 15,550 21.9 Agricultural origin 7,174 9,000 25.5 Industrial origin 5,587 6,550 17.2 Oil & fuel 3,986 4,449 11.6Imports cif 9,550 16,069 68.3 Capital goods 1,559 3,718 138.5 Intermediate goods 4,560 6,294 38 Oil & fuel 410 782 90.7 Capital goods parts & accessories 1,551 2,605 68 Consumer goods 1,154 1,763 52.8 Vehicles 306 895 192.5 Other 9 11 22.2Trade balance 12,680 9,541 -24.8


Trade deficit opens up withMercosur

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-2-1012345678

Q1 Q22002

Q3 Q4 Q2 Q4 Q2Q103

Q3 Q104

Real exports and imports% change, year on year


Exports Imports

-60

-40

-20

0

20

40

60

Q1 Q2 Q4 Q2 Q4 Q22002

Q3 Q103

Q3 Q104

During the second quarter, the current-account surplus continued to fall asimports recovered and profit remittances climbed. Domestic demand growthand the restoration of profitability on the part of foreign investors wereimportant to these trends. On the capital account, the major change during thesecond quarter was the shift from a positive to a negative balance on transfersby the non-financial private sector for the first time in nearly three years.Capital flight was therefore reversed, and the private sector made the largestcontribution to net capital inflows. The capital account stayed in surplus in thesecond quarter.

Aggregating over the first half, the current account surplus was lower year-on-year. The main cause was the fall in the trade surplus brought about by therapid growth in imports. The deficit in factor services also increased, as netprofits and dividend payments increased by a factor of four and a half. Thesehigher outflows were partly compensated for by lower net interest payments,influenced partly by ongoing private-sector debt restructuring. The deficit innon-factor services increased as the larger volumes of foreign trade pushed upfreight costs.

Except for the third quarter of 2003, the capital and financial account has beenin deficit since 2001. However, after recording a small surplus in the firstquarter, the positive balance trebled in the second quarter. Most of the changeexperienced during the first half (81%) was accounted for by the performance ofthe non-financial private sector, particularly the US$0.7bn surplus recordedduring the second quarter. This account had recorded deficits for the last threeyears. One reason for the change may have been the repatriation of foreignassets in order to meet annual tax payments due in May and June bycorporations. During the second quarter, the surplus was not just the result of areduction in foreign asset formation, but also of an increase in foreign liabilitiesowing to higher inflows of direct investment and short-term trade finance. Thissuggests a modest and gradual recovery in confidence on the part offoreign investors.

The public sector also contributed to the capital-account surplus, but moremodestly than the non-financial private sector. However, the main source of

Capital-account surplusconsolidated

Current-account surpluscontracts in second quarter

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foreign finance was involuntary: the accumulation of capital and interestarrears. These sources of funds were partially compensated for by netpayments made to international organizations. During the first half, netprincipal repayments reached US$0.6bn, and the total net flow of fundsrecorded a US$1.2bn negative balance. The financial sector continued to recordnet deficits owing to the cancellation of debt and the sector�s negative results.

During the first half, foreign direct investment (FDI) rose ninefold comparedwith the first half of 2003. However, the increase was largely accounted for bysubsidiaries� higher liabilities with parent firms. This category had recorded anegative balance during the first half of 2003, but returned to surplus in January-June 2004. The negative balance on profit reinvestments contracted by 40%, asforeign firms obtained better results. The Centro de Estudios para la Producción(CEP) at the economy ministry estimates that foreign firms� total fixed capitalformation will increase by 118% in 2004 over the year-earlier period.

The Banco de la República Argentina!s (BCRA, the Central Bank) internationalreserves have increased by 30% in the nine months to the end of September.However, reserves levelled off from July onwards at around US$18bn.Purchases from the private sector fell and the government made higher netpayments to multilateral lenders. In the period between July 2002 andSeptember 2004 the stock of international reserves increased by US$9.2bn. Themonetary authorities are investing reserves in a range of currencies, as well asgold, in an attempt to maximise returns and diversify away from the US dollar.

The total external public-sector debt reached US$108.4bn at the end of thesecond quarter, US$0.7bn up on the level in March. Interest arrears of US$1.3bnaccumulated, while residents sold US$0.5bn in bonds to non-residents, andthere were other miscellaneous transactions worth US$0.2bn. These increaseswere partially compensated for by net principal repayments of US$0.5bn andforeign exchange rate gains for US$0.7bn. Foreign debt of the financial sector(excluding the Central Bank) continued to fall, reaching US$7.8bn at the end ofJune, 12% less than at the end of the first quarter. Pending a revision of the data,there is no updated information on the stock of debt and arrears of the non-financial private sector.

During the first half, Argentina accumulated US$8.2bn in capital and interestarrears on foreign debt. By June, the public sector had built up US$27.8bn inarrears since the end of 2001, equivalent to a quarter of total public-sectorexternal liabilities. The flow of arrears of the financial sector fell from a positivevalue of US$6m during the first quarter, to a negative flow of US$1.2bn duringApril-June. The shift was owing to the successful restructuring of the debt heldby Grupo Financiero Galicia and Banco Hipotecario.

Central Bank accumulatesreserves

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Balance of payments(US$ m; Jan-Jun)

2003 2004 % changeExports fob 14,680 16,567 12.9Imports fob 5,525 9,582 73.4

Trade balance 9,156 6,985 -23.7Non-factor services (net) -819 -1,049 28.0

Factor services (net) -3,789 -4,335 14.4Unilateral transfers 295 352 19.2

Current-account balance 4,843 1,954 -59.7Banking sector -1,368 -1,407 2.9 Banco Central de la República Argentina -307 -498 62.2 Other financial institutions -1,061 -909 -14.3Non-financial public sector 1,681 2,469 46.9Non-financial private sector -2,529 568 -122.4

Other 32 4 -88.9Capital-account balance -2,183 1,633 -174.8Errors & omissionsa -933 -134 -85.6Change in international reserves 1,727 3,453 100.0

a Includes capital movements unclassified by resident sector.


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