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Argentina
SEB MERCHANT BANKING COUNTRY RISK ANALYSIS 25 February 2008
 
important
 
your attention is drawn to the statement on the back cover of this report which affects your rights.
Analyst: Rolf Danielsen. Tel 
 
: +46 8 
 
763 8392. E-mail 
 
: rolf.danielsen@seb.se An acrymonous dispute over statistical estimates of consumer prices will come to a head this fall as trade unioins seek compensation for a rate of inflation they believe is really 10-20% higher than officially admitted. Such an outfall could trigger a wage-price spiral and raise the specter of new financial instability, although larger reserves mitigates the risk of a worst case scenario.
Country Risk Analysis
The economy continues at high speed, but with growing signs of overheating.
For the fourth consecutive year the vigor of the Argentine economy astonished outside observers as well as inside policy makers. In 2007, the economy grew at a clip of 8,7%, buoyed by both external and domestic demand including a pre-election fiscal spending spree. That was some 3-4 percentage points more than expected by most observers, beating by a whisker the similar performance of the preceding year which also had outperformed most projections. For 2008, observers are again beating the retreat and predicting a sharp slowdown to about 6% followed by continued deceleration into 2009. While we see reasons they once again may prove wrong, we also see warning signals that temper our optimism.
1) Catching up effect is over 
.
 First of all, the recovery from the financial and economic collapse that followed in the wake of the largest sovereign default of 2001-2002 in history has now run its course. In terms of income per capita, Argentines are back to the level from before the crisis, around $7000, more or less at par with Russia and Brazil, but with a more even income distribution, in particular compared with its northern neighbor.
Income per capita
020004000600080002001 2003 2005 2007
    U    S    $    m    i    l    l    i   o   n   s
 
2) The external environment may turn sour 
. Argentina’s exports have been favored by high commodity prices of recent years, but may suffer as that boom comes to an end. World market prices of soy-beans (25% of exports) are already declining, and that will now combine with draught to lower production. Total export value may still see a small
 
SEB Merchant Banking Country Risk Analysis February 25, 2008
2
rise this year, and the picture could improve again in 2009, barring adverse climatic conditions, but the spectacular 23% increase in 2007 is unlikely to be repeated.
3) The government will wind down pre-election pork-barrel policies.
 Now that the Kirchener family has secured a new four-year term in the Pink House, as Ms. Kirchener last spring won by a landslide victory to succeed her husband into the president palace, the fiscal stimulus should be reduced. It appears that the government plans to raise the primary surplus back to 3%/GDP or more after temporarily falling below 2% (discounting the government’s cosmetic change to save its official target).
4) Spat over official CPI numbers could take its toll on the government 
.
 Last fall in May, serious allegations emerged that the government had been leaning on the country’s official statistical services to produce CPI numbers supportive of government policies but grossly understating realities on the ground. The seriousness of the situation was underscored as employees of the statistical services, who supported the allegations, were fired. The immediate result was a sell-off of sovereign debt, the newly 75% reconstructed part of the defaulted debt of 2002, more than doubling the spread to some 450 basispoints, because the yield on a part of this debt had been linked to the official inflation rate. Even though the government may not be heavily dependent on international capital markets in the near term, the sovereign spread is often used as a benchmark for private borrowing terms and may now increase the borrowing costs for Argentine companies. As importantly, the uncertainty about the real inflation suggests trade unions will raise wage demands more than would have been the case otherwise. In a tightening labor market -- unemployment is down to less than 9%, trade unions are being emboldened to demand 20-30% higher wages in line with last year’s increase in public-sector wages. Such an outcome, would probably bring an immediate stimulus to private demand, meaning higher growth for 2008, but could return with a vengeance for growth prospects in 2009 and beyond. However, while it is very regrettable that the government has not yet come clean on these statistical issues, the claims by trade unions and investors that official CPI numbers seriously underestimate real inflation, are not really borne out by available information on monetary developments. Monetary statistics for 2006 and 2007 do not give hard evidence of high double digit inflation. 20-25% annual money growth is high but would normally be considered insufficient to support more than 10-15% inflation keeping in mind high real GDP growth of more than 8%pa. (Conf. chart.)
Money, GDP and prices growth
 Consumer Prices, Total, Index Money supply, M2, ARS
Source: Reuters EcoWin
 janmarmajjulsepnovjanmarmajjulsepnovjanmarmajjulsepnov050607
   %   c   h  a  n  g  e  a  y  e  a  r
581013151820232528
CPIGDPM2
 
Risks mitigated by strengthened macro fundamentals
. Against the looming risk of a wage-price spiral in the making combined with ongoing uncertainties in the global
 
SEB Merchant Banking Country Risk Analysis February 25, 2008
3
economy, the central bank can mobilize relatively large reserves in the defense of financial stability. The government can also point to a much improved fiscal position to the same ends. Robust, albeit declining, external current account surplus and substantial capital inflows have enabled the central bank to build reserves to more than $40 bill. or more than 10 months of imports. That is, of course, because the central bank, have intervened to keep the peso undervalued in line with government policies aimed at supporting the export sector. The government on its side has persevered with primary surpluses, albeit not always in line with targets, to reduce the debt/GDP ratio, which has fallen to 62% (54% excluding defaulted non-restructured debt).
Reserves
010 00020 00030 00040 00050 0002002200420062008
   U   S   $  m   i   l   l   i  o  n  s
 - * -
Argentina has improved notably since the unsustainable policies of the late 1990s, which were followed by default and economic morass. The government could now crown its success by entering into new negotiations with the holders of non-restructured defaulted debt and settle outstanding Paris Club claims. Unfortunately, the new Kirchener government have followed in the footsteps of the previous Kirchener government and have chosen a more confrontational path by refusing the IMF program needed for a Paris Club settlement and by not coming clean on the disagreement with large parts of the Argentine and foreign communities on the statistical issues regarding the consumer price development, rather trivial affair in most other countries. That may not bode well for the present presidential term and heightens the risk for the country’s creditworthiness in the medium term.
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