Argentina - iuj.ac.jp · Mr Kirchner and the former interim president (2002-03), Eduardo Duhalde, on the make-up of the list of candidates for deputy and Senate seats representing

Country Report

Argentina

June 2005

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. Mr Kirchner will attempt to increase his level ofcontrol over the PJ in preparation for the legislative election in October. Therewill be a more active role for the state in the economy. Argentina will seek anIMF stand-by arrangement that would allow it to refinance the majority of itsupcoming repayments. The government will run a primary surplus of over3.5% of GDP in the forecast period. Growth will slow from the high ratesrecorded in 2003-04 during 2005-06, as spare capacity is limited and therebound of consumption from the country�s post-crisis lows slackens. The tradeand current-account surpluses will narrow, as imports continue to growstrongly, and by 2006 the current-account balance will have slipped into deficit.

Key changes from last month

Political outlook• The chances have receded of an agreement being reached between

Mr Kirchner and the former interim president (2002-03), Eduardo Duhalde,on the make-up of the list of candidates for deputy and Senate seatsrepresenting Buenos Aires province and the federal district. Tensions withinthe Peronist party are set to increase.

Economic policy outlook• A solid fiscal performance in the first quarter should enable the

government�s fiscal target for 2005 to be met. Talks have begun with theFund on a new lending agreement. Repayments due in the remainder of2005 have been postponed, taking the pressure off Argentina to reach anagreement quickly.

Economic forecast• The Economist Intelligence Unit has made no substantial change to its

economic forecast.

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Argentina 1

Country Report June 2005 www.eiu.com © The Economist Intelligence Unit Limited 2005

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

17 Economic policy

23 The domestic economy23 Output and demand26 Employment, wages and prices29 Financial indicators31 Agriculture33 Sectoral trends34 Energy36 Construction

37 Foreign trade and payments

List of tables10 International assumptions summary10 Gross domestic product by expenditure12 Forecast summary18 Non-financial public-sector accounts24 Gross domestic product growth by demand25 Gross domestic product growth by sector27 Consumer and producer prices29 Social indicators30 Foreign-exchange reserves and monetary aggregates31 Agricultural output34 Monthly index of industrial output, 200536 Production38 External trade38 Major exports and imports39 Balance of payments

2 Argentina


List of figures

13 Gross domestic product13 Consumer price inflation28 Unemployment28 Nominal index of private-sector wages for registered and informal workers33 Industrial capacity utilisation

Argentina 3


ArgentinaJune 2005

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. Mr Kirchner will attempt to increase his level ofcontrol over the PJ in preparation for a legislative election in October. There willbe a more active role for the state in the economy. Argentina will seek an IMFstand-by arrangement that allows it to refinance the majority of its upcomingrepayments. The government will run a primary surplus of over 3% of GDP inthe forecast period. During 2005-06 growth will slow from the high ratesrecorded in 2003-04 as spare capacity is limited and the rebound ofconsumption from the country�s post-crisis lows slackens. The trade andcurrent-account surpluses will narrow as imports continue to grow strongly.

Measures of confidence in the government have remained high over the pastquarter. Mr Kirchner has forged alliances with both Peronist and non-Peronistcandidates for deputy and Senate seats to be contested in the Octoberlegislative election. Two parties on the centre-right have joined forces for theelection. A controversial Supreme Court judge has yet to be replaced.

The public finances have continued to perform strongly in the first quarter of2005, boosted by export tax revenue and consumption growth. Provincialfinances have deteriorated. Talks have begun with the Fund on a new lendingarrangement. Talks with foreign-owned utilities have proceeded slowly. Thegovernment has granted investment incentives. The Central Bank has tightenedmonetary policy, but kept the exchange rate above Ps2.90:US$1. Thegovernment has made temporary pacts with producers to hold down prices ofsome new goods.

During the fourth quarter of 2004 real output increased by 9.1% year on year,driven by domestic demand. Industrial output growth and retail sales haveslowed so far in 2005. The soya crop from the 2004/05 harvest is estimated tohave grown by 20%. Inflation has risen in the first four months of 2005. Thepace of job creation has slowed, and unemployment rose in the first quarter.

Export earnings grew by 12.5% in the first quarter, while the import bill rose by28.5%. The current-account surplus narrowed to 2% of GDP in 2004, as the tradesurplus was eroded. The capital and financial account posted a surplus ofUS$2.2bn, or 1.5% of GDP in 2004. Foreign direct investment has increased andreserves have risen.

Editors: Charles Seville (editor); Ondine Smulders (consulting editor)Editorial closing date: June 2nd 2005

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

Foreign trade and payments

The domestic economy

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 onOctober 23rd 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 Justicialista (PJ, the Peronist party)Main opposition: Unión Cívica Radical (UCR), Frente del País Solidario (Frepaso); otherminor parties include Afirmación para una República Igualitaria (ARI),Movimiento Federal Recrear (MFR), Compromiso por el Cambio, and severalprovincial parties

President Néstor Kirchner (PJ)

Cabinet chief Alberto FernándezDefence José PampuroEconomy & production Roberto LavagnaEducation Daniel FilmusEnergy Daniel CameronForeign 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 a

GDP at market prices (Ps bn) 284.2 268.7 312.6 375.9 447.3GDP (US$ bn) 284.3 268.8 102.0 129.6 153.0

Real GDP growth (%) -0.8 -4.4 -10.9 8.8 9.0Consumer 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 b

Exports of goods fob (US$ bn) 26.3 26.5 25.7 29.6 34.5Imports of goods fob (US$ bn) 23.9 19.2 8.5 13.1 21.2

Current-account balance (US$ bn) -9.0 -3.9 8.6 7.4 3.0Foreign-exchange reserves excl gold (US$ bn) 25.1 14.6 10.5 14.2 18.9Total external debt (US$ bn) 147.5 154.1 150.0 166.2 182.9 b

Debt-service ratio, paid (%) 70.8 42.9 16.6 37.9 b 30.0 b

Exchange rate (av) Ps:US$ 0.999 0.999 3.063 2.901 2.923

a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2004 % of total Components of gross domestic product 2004 % of totalCommerce 53.7 Private consumption 62.9Manufacturing 24.2 Investment 19.1

Agriculture, forestry & fishing 10.5 Government consumption 11.1Mining 5.7 Stockbuilding -0.3

Construction 4.2 Exports of goods & services 25.3Electricity & water 1.7 Imports of goods & services -18.1

Principal exports fob 2004 US$ m Principal imports cif 2004 US$ mProcessed agricultural products 11,932 Intermediate goods 8,630

Manufactures 9,522 Capital goods 5,378Primary 6,828 Consumer goods 2,501Fuel & energy 6,171 Fuels 1,003

Main destinations of exports 2003 % of total Main origins of imports 2003 % of totalBrazil 20.7 Brazil 22.1Chile 11.6 US 19.4US 10.6 Germany 5.8

China 8.4 Italy 3.9

6 Argentina


Quarterly indicators2003 2004 20052 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr

Non-financial public-sector finance (Ps m)Revenue excl privatisation 20,444 19,624 20,836 22,693 30,188 26,603 25,542 26,915Expenditure 18,822 19,241 20,837 20,317 23,521 23,232 26,507 24,386 Interest payments 1,521 1,842 1,534 1,614 1,190 1,611 1,288 1,738Balance 1,622 382 -1 2,376 6,667 3,371 -965 2,530OutputGDP at constant 1993 prices (annual rates; Ps bn) 265.4 261.5 268.6 254.3 284.4 284.4 293.0 n/aGDP at constant 1993 prices (% change, year on year) 7.7 10.2 11.7 11.3 7.2 8.7 9.1 n/a Manufacturing at constant 1993 prices (annual rates; Ps m) 40,647 44,771 45,550 42,655 46,242 49,250 49,569 n/a Manufacturing (% change, year on year) 12.6 16.2 16.9 15.8 13.8 10.0 8.8 n/aIndustrial production index (seasonally adjusted; 1997=100) 89.1 95.9 97.3 95.3 98.4 105.7 105.6 101.1Industrial production index (% change, year on year) 14.8 15.7 14.7 14.0 10.5 10.2 8.5 6.1

PricesConsumer prices (1999=100) 140.7 141.1 142.3 143.6 146.4 148.7 150.5 155.3Consumer prices (% change, year on year) 14.5 5.2 3.7 2.4 4.1 5.4 5.7 8.2Producer prices (1993=100) 210.6 211.4 218.2 223.7 228.8 234.2 236.5 237.7Producer prices (% change, year on year) 21.6 0.7 0.3 3.2 8.6 10.8 8.4 6.2Financial indicatorsExchange rate Ps:US$ (av) 2.8 2.8 2.9 2.9 2.9 3.0 2.9 2.9Exchange rate Ps:US$ (end-period) 2.8 2.9 2.9 2.8 2.9 3.0 3.0 2.9Deposit rate (av; %) 13.9 4.6 3.9 2.4 2.3 2.7 3.0 2.8Lending rate (av; %) 24.3 13.9 10.8 9.1 6.3 5.9 5.8 5.5Money market rate (av; %) 4.8 1.8 1.6 1.3 2.2 2.1 2.3 2.2M1 (end-period; Ps m) 32,404 35,819 42,940 45,764 48,459 47,833 55,923 56,588M1 (% change, year on year) 37.9 51.2 51.9 62.0 49.5 33.5 30.2 23.7M2 (end-period; Ps m) 99,684 105,678 113,164 118,549 125,322 127,891 137,406 143,528M2 (% change, year on year) 25.0 26.1 29.6 29.6 25.7 21.0 21.4 21.1Merval stockmarket index

(end-period; June 30th 1986=US$0.01) 765.6 827.7 1,072.0 1,201.7 945.5 1,142.5 1,375.4 1,400.4Merval stockmarket index (% change, year on year) 118.3 109.4 104.2 112.1 23.5 38.0 28.3 16.5Sectoral trendsISAC construction activity index

(seasonally adjusted; 1997=100) 77.1 81.1 88.4 93.5 94.2 94.9 98.2 98.5ISAC construction activity index (% change, year on year) 38.8 38.0 38.3 32.2 22.2 17.0 11.1 5.3Crude oil production (m barrels/day) 0.79 0.79 0.77 0.78 0.77 0.78 0.77 0.75Crude oil production (% change, year on year) -2.5 -1.3 -2.5 0.0 -2.5 -1.3 0.0 -3.8Foreign trade (US$ m)Exports fob 8,124 7,550 7,335 7,353 9,347 8,911 8,842 8,273Imports cif -3,336 -3,712 -4,284 -4,637 -5,443 -5,990 -6,252 -5,952Trade balance 4,788 3,838 3,051 2,716 3,904 2,921 2,590 23,321Balance of payments (US$ m)Merchandise trade balance fob-fob 4,968 4,028 3,266 2,937 4,186 3,234 2,909 n/aServices balance -353 -450 -199 -518 -406 -530 -279 n/aIncome balance -1,931 -2,194 -2,137 -2,185 -2,315 -2,356 -2,354 n/aNet transfer payments 161 141 149 148 199 151 207 n/aCurrent-account balance 2,845 1,526 1,079 382 1,664 499 484 n/aReserves excl gold (end-period) 12,183 13,430 14,153 14,627 16,926 17,501 18,884 19,587

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 a majorityof Argentinian voters blame for the economic collapse and maxi-devaluationof 2001-02. Mr Kirchner�s administration will prioritise growth and povertyreduction over cultivating relations with foreign investors. The president hasbenefited from Argentina�s rapid economic growth ever since he took office,and over two-thirds of the population believe that the government is capableof solving the country�s problems. A populist touch, accompanied bynationalist rhetoric, has kept the president�s approval rating high, while hisruling Partido Justicialista (PJ, or Peronist party) has a commanding position inboth houses of Congress. It holds 41 of the 71 seats in the Senate and 116 of the255 seats in the Chamber of Deputies (the lower house), as well as most of theprovincial governorships. None of the opposition parties has a nationalorganisation to rival the PJ, leaving the Peronists as the dominant political forceover the forecast period. Mr Kirchner will concentrate power in the presidencyand Congress will play a diminished role. A promised political reform thatwould increase accountability is unlikely to materialise for as long asMr Kirchner benefits from the status quo. Provided legislative election inOctober 2005 show strong results for the Peronist party, Mr Kirchner shouldremain firmly in control.

Although strong in numbers, the Peronists are fragmented and dominated bypowerful regional leaders. The main faultline in the PJ will remain thatbetween Mr Kirchner and the former interim president (2002-03),Eduardo Duhalde. Mr Duhalde will remain the leader of the PJ machinery inthe province of Buenos Aires, wielding a strong influence over Peronistprovincial governors, and a defender of the interests of his economicallydominant region. An open clash between the two heavyweights of the Peronistmovement has so far been avoided, but in the legislative election due onOctober 23rd Mr Kirchner�s favoured candidates may run against official PJcandidates selected by the Duhalde-controlled Peronist machine inBuenos Aires. This would constitute an open assault on Mr Duhalde�s powerbase, and would increase friction within the party.

In the election due to be held on October 23rd voters will renew one-third ofthe Senate and one-half of the Chamber of Deputies. This will be the firstmajor electoral test of Mr Kirchner's administration. The opposition parties willremain extremely weak, although they will score a few successes in someregions. The main centre of support for anti-Peronist parties is the capital city,Buenos Aires. The two main centre-right opposition parties�Compromiso porel Cambio, led by Mauricio Macri, and the Movimiento Federal Recrear (MFR),led by Ricardo López Murphy�announced an electoral alliance in May, whichcould become the second political force to the Peronists in Buenos Aires andthe surrounding province. Although he will take note of the opposition,Mr Kirchner will devote most attention to ensuring that as many deputies and

Domestic politics

8 Argentina


Senators as possible are elected who support him, be they Peronists or fromoutside the party.

Relations between the federal government and the provinces will remaindifficult to handle. Because Peronist congressional candidates are selected atprovincial level, provincial governors play a large part in the process and retaininfluence over congressmen representing their region. The president needs theirsupport in order to pass legislation, but the government�s comfortable fiscalposition will tilt the balance in his favour in the short term.

Despite his nationalist rhetoric, Mr Kirchner will strive to maintain goodrelations with the US government. He will also devote attention to smoothingrelations with Brazil, which have been strained, not only by the usual tradeissues, but by differences over foreign policy in the region. The tenor ofrelations with the EU will depend on how much progress is made inrenegotiating contracts with privatised utilities (most of which are in Europeanhands). The accumulation of arbitration awards against Argentina in the WorldBank�s International Centre for Settlement of Investment Disputes (ICSID) willrequire careful diplomatic handling. As part of the Mercado Común del Sur(Mercosur, the southern cone customs union), Argentina will also pursue a free-trade agreement (FTA) with the EU, but the Economist Intelligence Unit expectsthis to be delayed until at least 2006, given agricultural trade sensitivities.

Economic policy outlook

The debt swap offered to holders of US$81.8bn in principal and past-dueinterest to end-2001 (in addition to over US$20bn of past-due interest paymentsaccumulated between the default and 31st December 2003), and accepted byholders of 76% of the debt, has concluded, with the new securities listed at thebeginning of June. The government�s next priority is to reach an agreementwith the IMF to replace the stand-by arrangement that was suspended in mid-2004. Renewing the IMF arrangement will be necessary if Argentina is tocontinue to roll over repayments due to the Fund in the medium term. Until anarrangement is signed, it will meet repayments from its own resources. TheFund allowed Argentina to postpone some of its repayments due in 2005 into2006, reducing its financing requirement this year. An arrangement will besome time in coming because of the differences over policy issues between thetwo sides.

The government will attempt to prolong the strong economic recovery and seekto redress some of the loss of workers� purchasing power since the economiccrisis of 2001-02. Other economic priorities include renegotiating tariff levelswith foreign investors in the privatised energy and water industries. Some tariffrises will be granted in 2005, but a definitive solution will not come before2006. The firms lost money when tariffs, formerly denominated in US dollarsand linked to US inflation, were converted into pesos at a below-marketexchange rate and frozen in early 2002. Until a stable new framework isreached, water and energy firms will have little incentive to invest, and energyshortages could restrict economic activity. Despite Mr Kirchner�s relatively strong

Policy trends

International relations

Argentina 9


position, a durable reform of the fiscal relationship between the federalgovernment and the provinces, a long-standing IMF recommendation, will provedifficult to secure and will not be tackled before 2006, if at all. However, thefederal government will be able to exercise some control over provincialfinances by means of a special council, which will include representatives ofboth provincial and federal government.

The government appears committed to running a responsible fiscal policy in2005-06. The 2005 budget, passed by Congress in November 2004, set a targetof a primary fiscal surplus for the non-financial public sector (NFPS) of 3.9% ofGDP. The rebound in tax income will lose momentum as the economy slowsand commodity prices ease. Government consumption will also grow morequickly in 2005 as spending increases before the legislative election in October.Given that the central government�s average primary surplus in 1993-2003 was1% of GDP, maintaining a primary surplus of 3-4% of GDP in the medium term,as set out in the plan presented to bondholders, will constitute a majorchallenge. To do so, the government will need to make revenue collection moreefficient and improve controls on spending. The central government recorded aprimary surplus (excluding interest payments) of 4.1% of GDP in 2004. Thisstrong performance has rested in part on the maintenance of the export levyand the Impuesto sobre los Créditos y Débitos en Cuenta Corriente Bancaria,the financial transactions tax, which together accounted for 16% of revenue in2004. The Fund will advocate that all emergency taxes be phased out, asenvisaged under the suspended stand-by arrangement, although thegovernment will try to keep them. The government will face pressure toincrease spending ahead of the October election. We expect the primarysurplus to end 2005 at 3.8%, and to stay at similar levels in 2006. The ability ofthe provinces to spend beyond their means, which has long been the weak linkin the public finances, will need to be brought under permanent control.

The Banco Central de la República Argentina (BCRA) will maintain themanaged float of the peso, intervening heavily to prevent the appreciation ofthe peso beyond Ps2.90:US$1. This intervention will require the monetaryauthorities to sterilise the issue of domestic currency. The authorities will haveto head off other inflationary pressures stemming from a projected increase inpublic utilities tariffs in 2005-06. The government will also have to issue moredebt on the domestic market to finance itself. For these reasons, interest rateswill rise over the forecast period. The Central Bank will try to move away fromtargeting monetary aggregates in the medium term, toward using the repo rateas the main tool of monetary policy. A lengthening in the minimum stay forportfolio capital from 180 to 360 days decreed in May is an attempt todiscourage short-term capital inflows, which could add to upward pressure onthe peso.

Fiscal policy

Monetary policy

10 Argentina


Economic forecast

International assumptions summary(% unless otherwise indicated)

2003 2004 2005 2006Real GDP growthWorld 3.9 5.1 4.3 4.0EU25 1.2 2.4 1.8 2.1Brazil 0.5 5.2 3.7 3.1

Exchange rates¥:US$ 115.9 108.1 103.4 94.3US$:� 1.132 1.244 1.320 1.395SDR:US$ 0.714 0.675 0.653 0.628Financial indicators� 3-month interbank rate 2.33 2.13 2.10 2.15US$ 3-month commercial paper rate 1.10 1.48 3.31 4.63Commodity pricesOil (Brent; US$/b) 28.8 38.5 46.0 40.0Soybeans (% change in US$ terms) 23.2 17.9 -22.6 -3.3Food, feedstuffs & beverages

(% change in US$ terms) 6.6 9.2 -6.5 -1.5Industrial raw materials (% change in US$ terms) 13.0 21.0 3.9 -7.0

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

Having expanded at an estimated 5.1%�its fastest rate for 20 years�in 2004,global GDP growth, measured at purchasing power parity, will slow to around4% in 2005-06. We expect the cycle of US monetary policy tightening thatbegan in mid-2004 to continue. Higher interest rates will lead to increasinginterest payments on the floating-rate portion of Argentina�s debt. There aresignificant downside risks to the growth outlook. Long-term US rates havebarely responded to progressive tightening of short-term rates so far, but theycould move suddenly. Other risks include a disorderly slide in the US dollar,which would cause the US to raise interest rates more sharply than we areforecasting. The Chinese economy could slow down more sharply than forecastin response to policymakers� attempts to cool growth, removing a prop forcommodity prices and impetus for world GDP growth. Argentina�s terms oftrade will be less advantageous in 2005-06 than in the exceptional year of 2004.Grain and soybean prices have fallen substantially from their highs and weexpect the price of the latter to be one-fifth below 2004 levels. After pulling outof recession in 2004, Brazil, Argentina�s biggest trading partner (particularly inmanufactures), will grow by an average of 3.4% 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 a 2005b 2006b

Private consumption 168.0 183.8 194.8 203.2(8.2) (9.4) (6.0) (4.3)

Public consumption 34.3 35.2 36.7 37.4(1.5) (2.7) (4.0) (2.0)

Gross fixed investment 36.7 49.3 57.2 62.1(38.2) (34.5) (16.0) (8.5)

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)

2003a 2004 a 2005b 2006b

Final domestic demand 238.9 268.3 288.6 302.6(10.8) (12.3) (7.6) (4.9)

Stockbuilding 2.4 1.2 1.1 1.5(0.5)c (-0.5) c (0.0)c (0.1)c

Total domestic demand 241.3 269.5 289.7 304.1(11.2) (11.7) (7.5) (5.0)

Exports of goods & services 35.1 38.0 40.1 41.8(6.0) (8.2) (5.6) (4.2)

Imports of goods & services -20.4 -28.5 -32.1 -35.1(37.6) (39.8) (12.5) (9.7)

Foreign balance 14.7 9.5 8.1 6.7(-1.5)c (-2.0) c (-0.5)c (-0.5)c

GDP 256.0 279.0 297.8 310.8(8.8) (9.0) (6.7) (4.4)

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

After reaching 9% in 2004 on the strength of a rebound in private consumptionand investment, real GDP growth will moderate to 6.7% in 2005 and 4.4% in2006. Consumption growth will be underpinned by higher real incomes. Thepace of job creation will slow and monetary policy is also expected to tighten,but the authorities� commitment to maintaining a competitive exchange ratewill benefit goods producers servicing both domestic and export markets.Exports will continue to grow, but net exports will make a moderately negativecontribution to growth, as imports recover from depressed levels in 2001-02.Investment will continue to grow strongly, and will begin to overcome capacityconstraints in areas where capacity is stretched. Government incentives forinvestment will help. The biggest threat to ongoing growth is a possible energyshortage, caused by demand (especially for natural gas) outgrowing supply.Larger, foreign-owned firms will proceed cautiously with investment plansbecause of uncertainty over government policies. Investment in the agriculturalsector will be curbed by falling profitability caused by lower commodity prices.

The Central Bank will target inflation in a range of 5-8% in 2005, but will missits objective. Having risen steadily during 2004, inflation is expected to rise in2005 to 10% at year-end, owing to higher domestic demand (fuelled by recentwage settlements) and phased adjustments to frozen public utility rates.Producers will attempt to pass on to consumers the higher wholesale priceinflation experienced in 2004. Cautious monetary policy should help to ensurethat inflation remains under control, and we expect it to fall in 2006. Newinvestment should also come on stream, increasing potential output andreducing inflationary pressure. Consistent and sustainable fiscal andmonetary policies will be central to underpinning confidence in the peso andcontaining inflation.

Inflation

12 Argentina


The government will stick with a policy of intervening to maintain stability inthe exchange rate against the US dollar, targeting an exchange rate of nostronger than Ps2.90:US$1. At its current level, the peso is around 50% weakerthan in the late 1990s and 2000-01, when it was considered overvalued, but thereal exchange rate will appreciate slightly on the inflation differential betweenArgentina and its trading partners. The supply of foreign exchange will beaffected by competing factors: higher inflows resulting from the end of default,and the narrower trade surplus. On balance, without intervention, the nominalexchange rate would appreciate. The fiscal surplus will allow the governmentto purchase foreign exchange in order to help weaken the peso.

During the outlook period, export earnings will continue to expand, withmanufactures proving to be the most dynamic category. However, the tradesurplus will decline as import spending, driven by investment and privateconsumption, rises more quickly. The expansion of the services deficit will berestrained, as favourable relative prices encourage tourism and contain outwardtravel. The balance on the income account will be negative, but the deficit willdiminish now that the debt restructuring has concluded, and as interest incomefrom the expanding stock of reserves rises. Involuntary financing in the form ofarrears will be replaced to some extent by real capital inflows. We expect thecurrent-account surplus to narrow in 2005 and to become a slight deficit in2006, as import growth reduces the trade surplus.

Forecast summary(% unless otherwise indicated)

2003a 2004 a 2005b 2006b

Real GDP growth 8.8 9.0 6.7 4.4Industrial production growth 16.2 10.7 7.5 5.5

Gross agricultural production growth 6.9 -1.5 4.0 2.0Unemployment rate (av) 17.3 13.6 11.7 10.0Consumer price inflation (av) 13.4 4.4 8.8 7.7

Consumer price inflation (year-end) 3.7 6.1 10.0 6.5Short-term interbank rate 19.1 6.8 8.0 10.5

NFPS balance excl privatisation (% of GDP) 0.5 2.6 2.4 2.4Exports of goods fob (US$ bn) 29.6 34.5 37.3 38.5

Imports of goods fob (US$ bn) 13.1 21.2 26.3 29.9Current-account balance (US$ bn) 7.4 3.0 1.7 -0.1Current-account balance (% of GDP) 5.7 2.0 1.0 0.0

External debt (year-end; US$ bn) 166.2 182.9 c 142.6 138.9Exchange rate Ps:US$ (av) 2.90 2.92 2.92 2.94

Exchange rate Ps:¥100 (av) 2.503 2.704 2.822 3.123Exchange rate Ps:� (year-end) 3.664 4.006 4.015 4.133Exchange rate Ps:SDR (year-end) 4.32 4.60 4.60 4.73

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

External sector

Exchange rates

Argentina 13


Argentina Latin America

Gross domestic product(% change, year on year)

Argentina Latin America

Consumer price inflation(av; %)

-15

-10

-5

0

5

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

After two years in office, public support for the Kirchner administration isholding up well. The strong leadership style and nationalist stance of thepresident, Néstor Kirchner, on economic issues continue to appeal to voters. Hispopularity, which increased after the announcement of the successful debtrestructuring in March, has fallen somewhat in April and May as the publicbecomes more concerned about energy shortages, higher inflation andpersistently high rates of unemployment and poverty, despite recent strongoutput growth. However, it remains high and the majority still have a positiveimpression of Mr Kirchner. According to the latest survey used by theUniversidad Torcuato di Tella to compile the Indice de Confianza en elGobierno (Index of Confidence in the Government) in May, around 68% ofthose interviewed believed the government was capable of solving thecountry�s problems.

The administration has made only modest progress on some central policyissues, especially institutional reform. The collapse of the De la Rúaadministration in 2001 confirmed the need for a strong presidency, and in thisregard Mr Kirchner has delivered. However, the country�s institutions are weak,and the president has taken advantage of this. The executive has dominatedCongress during Mr Kirchner�s term, with the president making extensive useof decrees to achieve his legislative goals, despite the fact that the PartidoJusticialista (PJ, the Peronist party) controls both houses of Congress. TheEconomic Emergency Law passed in the middle of the 2001-02 crisis to dealwith extraordinary circumstances has been successively renewed (March 2005,The political scene). As if to confirm the passive stance of legislators, Congresshas yet to override a presidential veto.

The central government has also gained power relative to provincialgovernments, which had been in the ascendancy for several years withinArgentina�s federal system of government. This is an indirect result of thedeclining relevance of Congress in decision-making. Provincial governors

Voter concerns emerge, butMr Kirchner�s position is firm

Executive dominates Congress

14 Argentina


typically control the selection of senators and deputies representing theirregion, and exercise part of their power through them. The comfortable fiscalstance of the federal government has also strengthened its hand, giving itresources to offer to compliant governors. National political parties have frayed,encouraging many local leaders to forge alliances with the president, even ifthey do not belong to the PJ.

After successfully pushing for the renewal of the Supreme Court, the presidenthas clashed with the judiciary. In May a criminal court ruled that the remand incustody of Omar Chabán, owner of the Cromagnon music venue, where 196young people died in a fire in December 2004, was illegal, and ordered him tobe released. A public official, Julia María Alsogaray, awaiting trial for corruptiondating from the presidency of Carlos Menem (1989-99), was also released fromdetention. Both decisions caused a public outcry and Mr Kirchner attacked thejudges responsible. He was met with a terse response from several SupremeCourt judges, who pointed out that court decisions should not be influencedby the executive or the state of public opinion. The episode illustrates thegreater independence of the Supreme Court since four of its members were re-appointed, and shows that the judges appointed by Mr Kirchner cannot beexpected to act in a way that suits the government.

Mr Kirchner has also clashed with the Catholic Church. The president removeda bishop attached to the armed forces, Antonio Baseotto, after outspokenremarks in February about the health minister, after the latter suggested thatabortion should be decriminalised. The Church responded by challenging thepresident�s authority to remove a bishop and refused to appoint a new one; thecase is still not settled. Amid the controversy, Mr Kirchner stayed away from thefuneral of Pope John Paul II in Rome in April.

Impeachment procedures in the Senate against the last Supreme Court judgedating from the Menem presidency, Antonio Boggiano, are ongoing. Incommon with four other discredited Supreme Court judges who have beenremoved or who have resigned since Mr Kirchner came to power in May 2003,Mr Boggiano faces charges of incompetence. Congress has delayed a decision,and the case is under consideration by a Senate commission chaired by thepresident�s wife, Cristina Fernández de Kirchner. Mr Boggiano�s temporaryreprieve owes much to his support for pesification, the forced conversion ofdollar-denominated bank deposits and loans into pesos, which took place inearly 2002 under the administration of Eduardo Duhalde (2002-03). TheSupreme Court is still undecided over the legality of pesification, and issued acontradictory verdict on it in October. One judge voted that pesification waslegal, but only for sums above US$70,000. This ruling failed to give judgespresiding over lower courts clear guidance and the issue will have to beclarified by a new Supreme Court vote. Pesification faces numerous legalchallenges in the lower courts from investors attempting to recover their lostsavings. The government would prefer the Supreme Court to defendpesification and keeping Mr Boggiano in place would increase the chances ofthe government obtaining the verdict it wants. Installing a new judge wouldraise the risks of a contrary ruling. Other recently appointed judges (four of the

Mr Kirchner clashes with thejudiciary

Supreme Court judge remainsin place for now

Argentina 15


nine judges have been appointed since May 2003) have often failed to voteaccording to the expectations of the administration.

Mr Kirchner owed his victory in the 2003 presidential election to the support ofMr Duhalde (the former president backed him in order to thwart his arch-rival,Mr Menem), but this marriage of convenience has become increasingly tensesince Mr Kirchner became president. The approach of October�s legislativeelection has further strained relations. The main battle for influence over the PJwill take place in the province of Buenos Aires, which has long been thestronghold of Mr Duhalde, who controls the PJ, and well-entrenchedclientelistic networks there. Mr Kirchner wants to challenge this party structure,and his wife, Fernández de Kirchner, is expected to spearhead this task. Hercandidacy for a Senate seat representing Buenos Aires province has yet to beannounced (she currently represents Santa Cruz province), but she recentlybegan campaigning in the province, and may run against Mr Duhalde�s wife,Hilda. Buenos Aires province and the federal district accounts for 50% of totalvotes and 38% of seats that are up for election in the Chamber of Deputies (thelower house of Congress). The outcome of the election in these districts willhave a big impact of the future composition of Congress.

The legislative election of October 23rd 2005

Voters will elect one-third of the Senate seats (24 of the 72) and around one-half (127of the 257) of the Chamber of Deputies (the lower house) on October 23rd, mid-waythrough the presidential term. The result of the legislative election will be crucial toNestor Kirchner's ability to govern. Previous presidents, whose parties haveperformed poorly in the elections, have struggled to govern thereafter.

The provinces that will elect senators (three each) are Buenos Aires, Formosa, Jujuy,La Rioja, Misiones, San Juan, San Luis and Santa Cruz. Of the 127 deputies to beelected, 35 will come from Buenos Aires province and 13 will represent the federaldistrict (or metropolitan area) of Buenos Aires. Provinces containing the two otherlargest cities, Rosario (in Santa Fé province) and Córdoba, account for nine seatseach, and no other province accounts for more than five. Half of the 24 provinceswill also elect some of the senators and deputies who sit in their provinciallegislatures (Catamarca has already done so in March 2005). In Corrientes, voterswill choose a new governor (Santiago del Estero has already done so inFebruary 2005).

In the contest for the Senate, each party puts up two candidates for the three Senateseats to be filled representing each province. The party gaining the largest share ofthe vote takes two seats and the second-placed party takes the remaining seat,according to the so-called �2+1� formula. This system was introduced in the 1994constitution to ensure a balance of representation in the Senate. On this occasion, insome districts both the winning and second-placed parties may be nominallyPeronists, if different factions of the PJ compete against each other.

The contest for the deputies� seats is more straightforward; seats are assigned withinthe electoral districts by proportional representation.

Internal Peronist factionscompete for power

16 Argentina


Mr Kirchner has presented the forthcoming legislative election as a referendumon his performance in office. He will support candidates friendly to thegovernment, regardless of whether or not they are members of the PJ. A newmovement, Frente para la Victoria (FV), will field pro-Kirchner candidates. InBuenos Aires, Misiones, San Luis, the city of Córdoba and La Rioja thepresident will back non-Peronist candidates, but in many other areas he willback the official PJ candidates. Some ministers are likely to become candidatesin order to strengthen the electoral chances of the government, notably theforeign minister, Rafael Bielsa, the minister of justice, Horacio Rosatti, and thegeneral secretary of the presidency, Oscar Parrilli.

For some non-Peronists, supporting Mr Kirchner is expected to bring dividendsas the president remains comparatively popular. In the province of BuenosAires, followers of the current governor, Felipe Solá, a Peronist and ally of MrKirchner, are expected to run against the official PJ candidates close toMr Duhalde, and will do so with the support of the president. The governormust decide before the end of June whether his favoured candidates will run inthe Peronist primary elections. These are scheduled to be held on August 7th2005, but may not take place. The government�s decision to make the primaryelections open to all voters will make it much more difficult for Mr Duhaldeand the party apparatus to control their outcome. It is quite likely that thecandidates for FV, the Solá/Kirchner group, will run against official candidatesselected by the Duhalde-dominated Buenos Aires PJ in the October election,unless there is a last-minute compromise between the two sides.

After lengthy negotiations, Ricardo López Murphy and Mauricio Macriannounced in May that they had agreed to form a coalition to compete for thecentre-right vote in the October legislative election. The alliance could beextended to the presidential election in 2006. Mr López Murphy, who was theleading non-Peronist candidate in the 2003 presidential election, heads theMovimiento Federal Recrear, whereas Mr Macri�s party is Compromiso por elCambio. Under the agreement, Mr López Murphy will run for a Senate seatrepresenting the province of Buenos Aires, and Mr Macri will head the list ofdeputies for the city of Buenos Aires, where, as owner of one of the city�s twoleading football teams (Boca Juniors), he is popular. Neither party has anational presence, but by fielding candidates in the two biggest electoraldistricts they will gain exposure to around one-half of the electorate. Bothparties are on the pro-business right of the political spectrum, and the coalitionis expected to perform well in the Buenos Aires metropolitan area. It couldbecome the leading non-Peronist group, but the strong identification of thesetwo parties with their leaders may make it difficult to consolidate alasting alliance.

Left-wing and centre-left forces will find it more difficult to form a similarcoalition. Some small parties, (such as the Partido de la RevoluciónDemocrática, headed by Miguel Bonasso) support the president, whereasothers oppose him. These minority groups are also unlikely to reach anagreement with Elisa Carrió�s Afirmación para por una Republica Igualitaria(ARI). ARI has ruled out any new alliances, although it will honour existing

Ricardo López Murphy andMauricio Macri form coalition

The left is still divided

Mr Kirchner seeks supportfrom all quarters

Argentina 17


agreements in some electoral districts. ARI has ten deputies, four of whom areup for re-election in October, and no senators. Mrs Carrió will face the difficulttask of competing against Mr Macri in the deputies� election in the city ofBuenos Aires, while ARI will field the former teachers� union leader,Martha Maffei, against Mr López Murphy in Buenos Aires province.

The Radicals (Unión Cívica Radical, or UCR) won local elections for thegovernorship of Santiago del Estero at the end of February and for locallegislators in Catamarca in March. These victories, however, were largelyattributed to divisions among the Peronists. Divisions within the Radicalsthemselves have postponed the selection of candidates in several districts, suchas the province of Buenos Aires. In the province of Buenos Aires, one of thecandidates for the Senate is supported by a former president (1983-89), RaúlAlfonsín. Some party members believe Mr Alfonsín is the only figure capableof bridging differences within the party. The other candidate is supported bythe party�s president, Margarita Stolbizer. Given the electoral importance of theBuenos Aires city and provincial electoral districts, the outcome threatens toreduce still further the UCR�s role as a political force. Rather than a nationalparty, the Radicals increasingly resemble a federation of local organisations.

Aside from the usual trade-related frictions, relations between Argentina andBrazil relations have suffered other setbacks in recent months. At the end ofMay Mr Bielsa described as �elitist� Brazil's bid to take a permanent seat on anenlarged UN Security Council, an aspiration that it shares with India, Japan andGermany. Argentina opposes an increase in the number of permanentmembers, instead favouring the creation of additional seats to be held on arevolving basis by UN member states. Brazilian public diplomacy in SouthAmerica, including its stance during the crisis in Ecuador, has also ruffledfeathers. The Argentinian government recently submitted to its Braziliancounterpart a number of proposals to reactivate bilateral co-operationprogrammes in several areas, although it remains to be seen whether theArgentinian initiative will lead to warmer relations.

Economic policy

Having posted a record primary surplus in 2004, the public finances continuedto perform strongly in the first quarter of 2005. The primary surplus was 6.5%higher year on year in nominal terms. The strong performance is mainly theresult of the way the economy has responded to the devaluation in 2001-02and several transitory and distortionary factors, rather than the fruit of anyreform to the public finances. Taxes on exports and financial transactions arestill in place, with a commodity price surge helping to boost revenue. Theauthorities have maintained a relatively prudent fiscal stance. Whether a strongprimary surplus is maintained in the future, as Argentina gradually recoversaccess to international financial markets, will be a test of the government�scommitment to fiscal austerity.

During the first quarter of 2005 government revenue increased by 18.6%, whilespending rose by 20%. Capital spending grew three times as quickly as overall

The Radicals struggle to namecandidates

Disagreements with Brazilincrease

Public finances performstrongly in the first quarter

18 Argentina


spending. Although it remains rapid, revenue growth is slowing (it was 39% inthe first quarter of 2004), so spending will also have to be kept under control inorder that primary surplus targets are met.

The budget approved for this year forecasts a primary surplus of 3.9% of GDP,resulting from a 15.9% increase in government spending and a 14.5% risein revenue.

The increase in revenue in the first quarter of 2005 was based on a 26% rise intax collections. Income tax collections rose in tandem with rapid growth inpersonal incomes and business turnover, and because the deadline for incometax payments due at the end of 2004 was postponed. Collections of importtariffs and export taxes were encouraged by rapid trade growth and the impactof higher tax rates on petroleum exports (the tax rate on crude petroleumexports moves upward in step with world prices, in order to maintain aconstant incentive to supply the domestic market, even when world prices rise).However, growth in other taxes, especially value-added tax (VAT), slowedcompared with 2004, as household spending growth cooled.

Non-financial public-sector accountsa

(Ps m; Jan-Mar)

2004 2005 % changeRevenue 22,658 26,871 18.6 Taxes 16,681 21,011 26.0 Social security contributions 3,602 4,459 23.8 Privatisation 7 25 261.4Expenditure 20,317 24,386 20.0 Interest payments 1,614 1,738 7.7Balance incl privatisation revenue 2,376 2,530 6.5

Balance excl privatisation revenue 2,369 2,504 5.7Primary balance excl privatisation revenue 3,982 4,242 6.5

a Excludes provinces.

Source: Secretaría de Politica Económica, Ministerio de Economía.

Two-thirds of the increase in primary spending during the first quarterstemmed from an increase in discretionary spending. The remainder was theresult of larger mandatory transfers to the provinces as a result of revenue-sharing. Discretionary spending was driven up by transfers to the private sectorto purchase fuel oil, subsidies granted to prevent price rises, the payment ofobligations dating from 2004, higher social and infrastructure investmentspending and a higher wage and pensions bill. As a share of GDP, primaryspending is estimated to have accounted for around 19%, consistent with thelevels recorded since the end of 2003 (except in the last quarter of 2004, whenprimary spending rose to more than 20% of GDP).

In 2004 the fiscal position of the provinces was less comfortable than that ofthe federal government. The provinces� primary surplus increased from 0.9% ofGDP in 2003 to 1.4% of GDP in 2004, but the aggregate accounts showed agradual worsening throughout the year. The province of Buenos Aires, thelargest fiscal district, had a major influence over these results. According to thelatest available data, the provinces closed 2004 with a 1.9% deficit in the fourth

Uneven growth in taxcollection

Discretionary items boostspending

Provincial finances worsenduring 2004

Argentina 19


quarter, produced by a spectacular increase in primary spending. Theconsolidated primary surplus (federal government and provinces) reached 4.9%of GDP in 2004.

On March 18th the government announced the results of the debt restructuringproposal launched in late 2004. The offer was accepted by holders of 76.15% ofthe defaulted debt of US$81.8bn (excluding US$20.7bn in interest arrears builtup since the end of 2001, which were not officially recognised in the proposal).The new bonds most in demand were the par and quasi-par bonds (December2004, Economic policy). Par and quasi-par bonds were oversubscribed by 36%and 26% respectively. Excess demand was met via the placement ofdiscount bonds.

The new debt set to be issued in exchange for the defaulted bonds tenderedwill be worth US$35.2bn, equivalent to a nominal reduction of 43.5% (65.2% innet present value terms). The debt reduction has placed Argentinian externaldebt indicators more in line with the country's ability to pay. By April 2005total public-sector debt was US$19.2bn, or 13.3%, lower than in December 2001.Since December 2001 real GDP in US dollars has increased by more than one-third, exports have risen considerably and the level of international reserveshas recovered. Moreover, tax revenue collection has improved significantly.These factors combined have greatly improved Argentinian debt sustainabilityindicators. The debt-service ratio (interest payments as a percentage of goodsand services exports) fell from 38% in December 2001 to 9% in April 2005,while the stock of public-sector debt as a share of total exports contracted from544% to 364%. The debt burden remains extremely high, although the debt-service burden is much more manageable than before the crisis. Interestpayments account for 2% of GDP, compared with 8% before the economic crisis.

As well as reducing the total debt stock, the restructuring reduces the share ofpublic-sector debt denominated in foreign currency from 97% to 63%. Similarly,the share of public-sector external debt under Argentinian law has increased to53.4% in April from 8% in December 2001. As a result of the debt restructuring,the effective interest rate has fallen from 9.7% in September 2001 to 3.6% in2005. Similarly, the term structure of amortisations has been made morefavourable by the restructuring, as the newly issued bonds have long graceperiods for the repayment of principal.

The debt exchange was delayed by an embargo request presented before aNew York court by lawyers acting for NML Capital, a Cayman Islands-basedhedge fund. In a bid to recover the money they were owed by the Argentiniangovernment, they demanded an embargo on US$7bn of defaulted bondsdeposited in the Bank of New York (the bank hired by the Argentiniangovernment to manage the debt swap) pending exchange for the new bonds.The judge ruled against the plaintiffs, but held up the debt swap while theyappealed. On May 13th a New York Appellate Court confirmed the lowercourt�s decision and the embargo was lifted, thus clearing the last obstacle tothe debt exchange. Argentina argued successfully that the old bonds that theinvestors sought to embargo belonged to creditors and not to Argentina, andthat if the embargo went ahead all those that had participated in the debt

Debt restructuring accepted by76% of investors

Embargo delays exchange ofsecurities

20 Argentina


restructuring would be damaged. Investors were due to receive the first interestpayments on the new debt at the beginning of June.

The court�s decision paved the way for negotiations to start with the IMF over anew lending arrangement. The previous arrangement with the Fund had beensuspended in mid-2004 by Argentina until the debt-restructuring process wascompleted. The Fund required that debts with private-sector creditors needed tobe resolved �in good faith� according to the Fund�s charter, before it couldapprove fresh lending to the country. Moreover, IMF staff had emphasised thatArgentina�s debt-exchange offer needed to generate a high rate of acceptance fornegotiations to be reopened. The 76.15% participation rate was higher than thatexpected by the Fund and many analysts. However, the Fund and the G7 havelobbied the Argentinian government to address the concerns of holders of the23.85% of debt that was not tendered in the swap. This debt is not beingserviced, and under a law passed by Congress, the offer made to holders ofdefaulted debt cannot be reopened to include them. The Argentiniangovernment has accepted that the hold-outs remain an issue to be dealt with inthe future. The law may be amended to allow the holdouts to receivecomparable treatment, but this would carry a political cost, and might bedeferred until after the end of the current presidential term in 2007.

Before the government can reach an arrangement with the Fund, it mustovercome differences over fiscal policy, the regulatory framework governingprivately owned utilities and utilities tariffs. The last issue is the mostcontroversial: although the Argentinian authorities have renegotiated contractswith some public utilities, there has been no definitive answer to foreigninvestors� demands for an adjustment in tariffs on a scale that wouldcompensate them sufficiently, following their forcible conversion into pesos atbelow-market rates and subsequent freezing. The differences on fiscal policyseem bridgeable: whereas the Fund has suggested that the government raise theconsolidated primary surplus to 4.5% of GDP in 2005, the authorities aretargeting a surplus of 3.9% of GDP. In 2004 the consolidated primary fiscalsurplus reached 5.3% of GDP, but this was an extraordinary performance, reliantin part on high export tax revenue. In the realm of monetary policy, the Fundhas some reservations over the combination of currency intervention tomaintain a competitive exchange rate, and low interest rates.

The approach of the October legislative election will encourage the governmentto postpone politically costly decisions. In May Argentina requested, and wasgranted, the postponement by one year of US$2.6bn in payments due to theFund in 2005, moving them from the expectations schedule to the obligationsschedule in Fund terminology. This will alleviate the government�s financingneeds for the remainder of 2005, and will reduce the pressure on Argentina tocome to an agreement. The Fund is also proceeding cautiously in undertakingthe revision agreed under Article IV; a final assessment may be reached inlate June.

Negotiations between the authorities and foreign-owned public utilities haveprogressed slowly. Three firms (Gas Natural, Pioneer Natural Resources and

Election will complicatereaching a deal with the Fund

Talks with foreign-ownedutilities proceed slowly

Talks have begun with the IMF

Differences with Fund overfiscal policy and utilities

Argentina 21


AES) have agreed to withdraw their lawsuits from the World Bank�sInternational Centre for the Settlement of Investment Disputes (ICSID) in returnfor a promise from the government to negotiate a new contract. However, otherfirms have launched new arbitration procedures, taking the total of pendingcases to 34. At the beginning of May, ICSID arbitrators ruled against Argentinain the case brought by a US energy firm, CMS Energy, ordering the governmentto pay US$133m in damages for having infringed the bilateral investment treatybetween Argentina and the US. The tribunal rejected Argentina�s argument thatthe measures were taken in a �state of necessity�. Three other cases will bedecided in the near future, and the rulings are likely to go against Argentina.The government has appealed the decision. If the appeal fails, the governmenthas threatened to challenge the validity of the arbitrators� judgement before theSupreme Court.

Negotiations with privatised public utilities have dragged on for more thanthree years, but the government needs to reach agreement, especially withenergy firms, in order to stimulate badly needed investments. In May 2004,threatened by the prospect of protracted energy shortages, the governmentsubmitted an energy plan for 2004-08 (June 2004, Economic policy), whichinvolved a combination of energy-saving steps and new investments. The planis behind schedule and will not be fulfilled unless more investment iscommitted than seen so far.

In May 2005 the authorities announced a plan to expand natural-gas transportcapacity by up to 20m cu metres a day through the San Martín, Neuba I and II,Central West and Northern pipelines. The planned expansion will require newinvestments totalling US$800m, although it is still uncertain where the fundingwill come from. The project would represent a sizeable increase in transportcapacity, which currently totals 127m cu metres/day. The construction workcurrently under way (the expansion of the San Martín and Northern pipelines)will add only 4.7m cu metres/day.

The energy secretary, Daniel Cameron, also recently submitted a bill grantingfinancial incentives for oil and natural-gas exploration and production. Theplan aims to help reverse the decline in oil production since 1998 and thefailure of natural-gas production to rise quickly enough to meet domestic andexport demand. Reserves/production ratios for both oil and gas have dwindled,to 10.5 years and 13.5 years respectively. The plan aims to increase reserves byencouraging exploration in a list of 19 unproductive fields. The incentivesoffered include:

• eligibility for the Régimen de Promoción de Inversiones en Bienes deCapital y Obras de Infraestructura, under which firms are granted refunds ofvalue-added tax (VAT) paid on capital goods and are allowed accelerateddepreciation of assets to set against income tax (September 2004, The domesticeconomy: Sectoral trends);

• exemption from the minimum presumed income tax;

• duty-free imports of capital goods and equipment;

New gas transport projects

Financial incentives for oil andnatural-gas exploration

22 Argentina


• access to areas adjacent to those covered by new contracts when there isgeological continuity.

To qualify for these benefits, firms will have to create joint ventures withEnergía Argentina SA (Enarsa). The intention is to give the recently created stateoil firm a more substantive role in the energy market.

In order to reduce electricity consumption, the authorities also relaunched thePlan para el Uso Racional de la Energía Eléctrica, but under more stringentterms than in 2004 (June 2004, Economic policy). The plan offers financialincentives for residential consumers to reduce their energy consumption on ayear-on-year basis. The authorities also announced new transfers to theCompañía Administradora del Mercado Eléctrico Mayorista (Cammesa) theentity that controls the electricity market, to subsidise the import of fuels inplace of natural gas and lifted duties on diesel imports. The authorities hopethese measures will reduce the impact of the energy shortage on industryand agriculture.

In April the Ministry of the Economy also announced across-the-boardmeasures aimed at stimulating investment, including:

• the refund of VAT on purchases of capital goods made between November2000 and November 2004; the amount refunded will be determined by thelevel of investment commitments; total refunds will be capped at Ps500m(US$171m), to be evenly distributed between small and medium-sized firms andlarger firms;

• the creation of a foundation to administer research projects, especially inthe medical, motor vehicle and optical industries.;

• the repayment of government debts with motor vehicle firms arising fromthe Plan Canje, on condition that new investments are made; under the PlanCanje launched in 1999 the government and manufacturers jointly subsidisedthe purchase of new cars to stimulate consumption;

• invitation for new applications for the Régimen de Promoción deInversiones en Bienes de Capital y Obras de Infraestructura, launched in 2004.Last year, the Ps1.2bn (US$410m) allocated to this programme was fullyexhausted. Firms that fail to meet 70% of investment commitments will bepenalised.

The 2005 monetary programme announced by the Banco Central de laRepública de Argentina (the Central Bank) in December set out an inflationtarget of 5-8%. Given the upsurge in inflation in the first four months of 2005(accumulated inflation reached 4.5% to the end of April), this target will bedifficult to meet. The Central Bank�s survey of private forecasters found that themean forecast for average inflation over 2005 was 9.7%. To keep inflationwithin the target range, price rises will have to be kept to 0.4% a monthbetween May and December.

Power demand managementmeasures introduced

Central Bank struggles to meetmonetary policy goals

Economy ministry aims tostimulate investment

Argentina 23


The Central Bank has also adopted as an informal objective keeping theexchange rate above Ps2.90:US$1, to preserve export competitiveness. Theauthorities have achieved this by intervening in the foreign-exchange market (inMay foreign-exchange purchases by the Central Bank were the highest for twoyears). During the first quarter, the peso appreciated by 5% in real terms againsta trade-weighted basket of currencies (the Brazilian Real, the euro and the USdollar) as the inflation differential between Argentina and these marketsincreased. In April the peso depreciated again in real terms, but it was clearfrom the first quarter that higher domestic inflation has the potential toundermine efforts to maintain a competitive real exchange rate.

In order to prevent foreign-exchange market intervention from endangering theinflation target, the Central Bank has sterilised its operations. Apart from risinginterest rates on repos, Letras del Banco Central (Lebacs) and Notas del BancoCentral (Nobacs), the Central Bank encouraged commercial banks to repayrediscounts ahead of schedule. As a result, the monetary base contracted by1.5% in the first quarter, although it still almost breached the ceiling establishedin the monetary programme for March. It will be difficult to meet the monetarybase target in June, given the fact that May and June tend to see a seasonalexcess supply of foreign exchange as agricultural export proceeds surge. TheCentral Bank also faces repayments of Lebacs and Nobacs in those months,which will tend to boost the money supply. The same pressures will affect M2and M3, which surpassed their targets in March, with the expansion of bankcredit�itself considered desirable by the government�an additional source ofupward pressure.

The Central Bank wants to foster the development of a long-term credit market.It has encouraged commercial banks to raise long-term funds in order to reducematurity mismatches (deposits are mostly sight deposits, whereas lending islonger-term). The Central Bank has recently eased regulations governing accessto credit for small and medium-sized firms and consumer loans, in an effort topush lending growth towards 20% for 2005. Credit has increased, but it stillaccounts for only 8.3% of GDP, significantly lower than the 23% recordedin 1998.

The domestic economy

Output and demand

During the fourth quarter of 2004 real output increased by 2.7% (on aseasonally adjusted basis) quarter on quarter, or by 9.1% year on year. Afterfalling in the second quarter of 2004, growth accelerated in the second half ofthe year, stimulated by expansionary fiscal and monetary policy and lowercapital outflows. Overall, the economy grew by 9% in 2004. This vigorousperformance has almost closed the potential output gap, which is currentlyestimated to be 1-4.5%. Immediately after the abandonment of the currencyboard and the deep recession in 2002, the potential output gap approached20%. Total output is close to the peak recorded in the second quarter of 1998.

Central Bank loosens creditrestrictions

Output increases by 9%in 2004

24 Argentina


Domestic demand was again the engine of growth in 2004, contributing 11.5percentage points to real GDP growth. Net trade, by contrast, continued to makea negative contribution equivalent to 2 percentage points, as imports grew fasterthan exports. However, during the second half of 2004, net exports made apositive contribution to total output growth for the first time in two years.Agricultural exports, usually shipped during the first half, were delayed into thesecond half, pushing up export volumes.

Real investment increased by 34.5% year on year, taking investment as aproportion of GDP to 17.7% (measured at constant prices). Given the rapidnarrowing of the output gap, this investment rate will not be enough to sustainoutput growth at recent high levels. Argentina�s investment ratio (realinvestment as a share of real GDP) was 3.4 percentage points below its peak in1998, and 0.6 percentage points below Brazil�s. Argentina�s investment ratioplunged to 11.3% of GDP in 2002, compared with a low of 17.4% in Brazil in2003. Both countries share a volatile economic cycle and low savings rates,which conspire against long-term planning and investment.

The quality of investment improved in 2004, with the share of durableequipment investment (the type of investment most likely to lead to futureoutput growth) making up 50% of the total in 2004, compared with 36.9% in2003. By comparison, in the US the share of durable equipment in totalinvestment spending is over 56%. The contribution of construction spending fellby 13 percentage points to 50.2%. Only 60% of construction investmentspending contributes to the stock of productive capital; the remainder mainlycaptures residential construction.

Gross domestic product growth by demand, 2004(% change, year on year)

1 Qtr 2 Qtr 3 Qtr 4 Qtr YearPrivate consumption 11.7 8.3 8.9 9.1 9.4

Public consumption 0.8 -0.8 4.1 6.5 2.7Gross fixed investment 50.3 36.8 33.6 23.9 34.5

Exports of goods & services 7.7 -0.2 9.2 16.8 8.2Imports of goods & services 55.8 42.5 38.2 27.8 39.8GDP 11.3 7.1 8.7 9.1 9.0

Source: Ministerio de Economía.

During 2004 household consumption grew by 9.4%, slightly more quickly thanoverall GDP. Since the end of 2002 household consumption growth has beendriven by rising real incomes and employment. The government hasencouraged consumption by trying to increase the income of sectors with ahigh propensity to consume: pensions, family subsidies and the minimumwage were all raised. The effect of these policies was noticeable in the secondhalf of the year. The gradual recovery of credit has also underpinnedhousehold spending. However, credit-funded purchases are still a smallproportion of total private consumption.

Government consumption has grown more slowly than private consumption,by just 2.7% in 2004, but it did not contract as markedly during the crisis. Theshare of real government consumption in real GDP was 12.6% in 2004,

Strong householdconsumption growth

Argentina 25


compared with 12.2% in 1998, whereas private consumption is 3.7 percentagepoints lower over the same period. The growth of government consumptionaccelerated throughout the year, reaching 6.5% year on year during the fourthquarter of 2004. The government increased spending once it became clear thatdeficit targets would be comfortably exceeded. As such, December was the onlymonth in the year in which the central government recorded a primary deficit.

Retail sales, a leading indicator of private consumption, have grown during thefirst few months of 2005, albeit more slowly than before. Sales in shoppingcentres, patronised by middle and high-income consumers and foreign tourists,grew especially quickly. The Instituto Nacional de Estadística y Censos (INDEC,the national statistics office) estimates that, during the first quarter of 2005,shopping centre sales grew at above 16% in real terms in each month during thefirst quarter, falling to 9.4% in April. Supermarket sales growth slowed to 12.7%year on year in the first quarter, cutting short a period of accelerating growththat began in the third quarter of 2003. Growth in consumption of publicservices, except for mobile-phone services, also slowed in the first quarterof 2005.

Inflation fears eroded consumer confidence and slowed growth inconsumption during the first quarter. In April the Indice de Confianza en elGobierno (the Consumer Confidence Index), compiled by the UniversidadTorcuato Di Tella, fell by 10.5% on the previous month, the largest fall in the last12 months.

During 2004 goods-producing sectors continued to grow more quickly thanservices (expanding by 10.4%, compared with 6.8%). However, growth in thetradeable and non-tradeable sectors has been gradually converging. In 2004goods-producing sectors accounted for 37% of total output growth, comparedwith 50% in 2003, whereas the contribution of services increased to 47%. Theservice sector was the most severely hit by the change in relative prices broughtabout by the maxi-devaluation of the peso in 2002.

Construction, which grew by 29.4%, and manufacturing continued to bedynamic. The primary sector, combining agriculture, fisheries and mining,contracted. As in 2003, the fastest-growing service sectors were retail trade andtransport. Financial services output contracted during 2004, but returned togrowth in the last quarter for the first time since early 2001, when the financialcrisis started to bite.

Gross domestic product growth by sector, 2004(% change, year on year)

1 Qtr 2 Qtr 3 Qtr 4 Qtr YearAgriculture, livestock & forestry 9.0 -11.1 3.0 6.8 -1.0

Fishing -5.7 -12.1 -29.7 -29.8 -19.0Mining & energy 2.7 -2.4 -2.3 0.5 -0.4

Manufacturing 15.8 13.8 10.0 8.8 11.9Electricity, gas & water 9.3 8.2 2.8 6.4 6.6Construction 41.4 32.6 26.4 21.7 29.4

Retail sales post strong growth

Growth in tradeable and non-tradeable sectors converges

26 Argentina


Gross domestic product growth by sector, 2004(% change, year on year)

1 Qtr 2 Qtr 3 Qtr 4 Qtr YearServices Hotels & restaurants 6.4 5.7 8.0 7.6 6.9 Transport, warehousing & communications 14.1 9.8 13.4 16.2 13.4GDP 11.3 7.1 8.7 9.1 9.0


Employment, wages and prices

Consumer price inflation ended 2004 lower than forecast in the Central Bank�smonetary programme, but since December inflation has accelerated. In Januaryconsumer prices were up by 1.5% month on month, the highest monthly risesince August 2002, and this was equalled in March. In April, however, month-on-month inflation slowed to a more moderate 0.5%, raising hopes that thefirst-quarter result was a one-off. The government came to agreements withproducers of some basic goods in order to halt price rises, and these had animpact on April�s inflation figure.

Since February 2005 �core� inflation (which excludes changes in the price offuel and seasonally sensitive prices, but includes 71% of the consumer priceindex) increased more quickly than other components of the price index.Between December and April core inflation reached 5.5%, compared with a2.6% increase in seasonally sensitive prices and a 1.9% rise in regulated prices.The major factors behind the increase in core inflation were beef and dairyprices (see Agriculture), health insurance and private education. Goods pricesincreased more slowly than services prices, which are still recovering theground lost immediately after the devaluation.

The authorities attribute the increase in prices to ongoing adjustments inrelative prices (the price of tradeable goods increased by much more than theprice of non-tradeable services following the devaluation, and are still catchingup), higher world commodities prices and the emergence of supply bottlenecks.However, the loosening of monetary policy towards the end of 2004, togetherwith a more expansionary fiscal policy, undoubtedly had an impact. In 2005the government has tried to bring inflation under control through priceagreements and direct subsidies, while maintaining a wide fiscal surplus. TheCentral Bank has since tightened monetary policy slightly in order to guideinflationary expectations towards the range of 5-8% in the 2005monetary programme.

Wholesale price inflation also accelerated during the first quarter, afterremaining practically flat during the last quarter of 2004. In April wholesaleprice inflation increased by 1.5%. Wholesale price increases have been led byprimary products, particularly fish products, petroleum and natural gas.Manufacturing prices have been driven mainly by higher margins, with factory-gate prices increasing more than industrial costs. This trend is likely to continue,as more sectors move towards full capacity utilisation. Costs are likely to rise asnatural-gas shortages force the use of more expensive alternatives.

Inflation rises in thefirst quarter

Authorities attempt to controlprice rises

Argentina 27


Consumer and producer prices(% change)

2004 2005Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr

Consumer pricesMonth-on-month 0.9 0.7 0.6 0.5 0.3 0.6 0.4 0.0 0.8 1.5 1.0 1.5 0.5Year-on-year 3.1 4.3 4.9 4.9 5.3 5.9 5.7 5.4 6.1 7.2 8.1 9.1 8.8Year-to-date 2.0 2.7 3.3 3.8 4.1 4.8 5.2 5.2 6.1 1.5 2.4 4.0 4.5

Wholesale pricesMonth-on-month 0.8 1.3 0.2 0.9 2.4 0.2 0.6 -1.2 0.9 -1.0 1.1 2.0 1.5Year-on-year 6.1 8.2 8.6 9.6 10.7 11.2 11.3 8.8 7.9 7.2 6.8 8.5 9.2Year-to-date 2.3 3.6 3.9 4.8 7.3 7.6 8.3 6.9 7.9 -1.0 0.1 2.1 3.6

Source: Instituto Nacional de Estadística y Censos.

Employment growth has slowed in recent months. During the last quarter of2004, 88,000 new jobs were created, half the number recorded in the previoustwo quarters. In the last quarter of 2004, employment was 40.4% of theworking age population, just 0.3 percentage points higher quarter on quarter.Total jobs created in 2004 reached 399,000, around half the amount created in2003. Growth in the demand for labour, as measured by the Indice deDemanda Laboral (IDL, an index compiled by observing job advertisements inthe press), computed by Universidad Torcuato Di Tella, faltered in Decemberafter growing steadily throughout 2004. Between December 2004 and March2005, the IDL contracted by 21%, partly on seasonal factors, but it increasedagain in April, suggesting that no definitive trend is yet established. What is notin doubt is that the output elasticity of employment has increased remarkablysince the crisis; that is, economic growth has become more dependent onincreased use of labour. The sectors where job creation was strongest weremanufacturing, retail and construction. The labour market remains plagued byproblems such as job instability and informality. During the last quarter of2004, informal (non-registered for tax) workers accounted for a record share of48.9% of total employment. This is one reason why higher growth has beenslow to translate into better social indicators. Informal employment remains30% above its pre-crisis levels.

During the last quarter of 2004 unemployment reached 12.1%, a fall of 1.1percentage points on the previous quarter. Employment increased modestly,whereas the participation rate declined. Without taking into account thebeneficiaries of government income support, the unemployment rate was16.2%. In the first quarter of 2005, the unemployment rate rose to 13%, partlyowing to a seasonal fall in the demand for labour. The president, Mr Kirchner,sought to cushion the bad news by anticipating yet-to-be-published data, whichhe said showed unemployment falling below 12% in April.

Employment growth hasslowed

Unemployment up in thefirst quarter

28 Argentina


0

5

10

15

20

25

Q12003

Q2 Q3 Q4 Q104

Q2 Q3 Q4 Q105

Unemployment(% of economically active population)

Source: Economist Intelligence Unit.

Job creation has been accompanied by rising real wages. The governmentdecreed a Ps100 (US$34) increase for all workers (except public-sectoremployees earning more than Ps1,250/US$428 a month) effective from January1st 2005. During the first quarter, real wages in the formal private sectorincreased by 3.8%, and public-sector real wages rose by 1.8%. Informal sectorreal wages, in contrast, fell by 3%. This divergence in wages between formal andinformal sectors is one of the major factors behind rising income inequality. Inthe fourth quarter of 2004, 18% of informal workers earned less than Ps150 permonth, whereas only 1% of formal workers were in a similar situation.Similarly, 29% of formal sector workers earned wages higher than Ps1,000,whereas only 6% of informal sector workers earned equivalent salaries.

At the beginning of June, after a meeting of the national wage council, whichgroups government, labour and business representatives, the governmentannounced that the minimum wage would rise to Ps630 per month from Julyonward. The effect on workers� pay packets will be limited, as this simplyincorporates into the minimum wage the rises already decreed in 2004.Workers earning above Ps630 are unaffected.

80

90

100

110

120

130

140

150

160

170

Jan03

Mar May Jul Sep Nov Jan04

Mar May Jul Sep Nov Jan05

Mar

Private registeredPrivate informal

Nominal index of private sector wages for registered and informal workers(Q4 2001=100)

Source: Instituto Nacional de Estad�stica y Censos.

Real wages rise, albeitunevenly

Argentina 29


The latest survey, covering the second half of 2004, shows rates of poverty andextreme poverty falling. By the end of 2004 there were 9.3m people livingbelow the poverty line, 3.2m of which were living in extreme poverty. Thisrepresents a 1.7m contraction in the number of people living in poverty, and a1.2m reduction in the number of those in extreme poverty, compared with thesecond half of 2003. However, poverty still remains much higher than beforethe crisis. Faster economic growth has had little impact on pockets of endemicpoverty, especially in the north of the country. In regions with higher averageincome, such as Patagonia, faster economic growth has had a more tangibleeffect on poverty rates.

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

2004 2005

2 Qtr 3 Qtr 4 Qtr 1 Qtr

Unemployment 14.8 13.2 12.1 13.0

Underemployment 15.2 15.2 14.3 12.7

Poverty (% of population)a 44.3 40.2 40.2 n/a

Extreme poverty (% of population)b 17.0 15.0 15.0 n/aa Defined as too poor to afford the basic food basket plus a narrow range of services including transport.clothing and health. b Defined as too poor to afford the basic food basket.


Financial indicators

The acceleration in inflation in the last quarter of 2004 and the beginning of2005 focused attention on monetary policy. To counteract the risk of higherinflationary pressures, the monetary authorities increased their sterilisinginterventions (issuing bonds to reduce the money supply) and raisedinterest rates.

During the first quarter of 2005 the monetary base contracted by 1.5%, but stillreached Ps49.9bn (US$17.1bn), only 0.1% below the maximum target. On thedemand side, the contraction was accounted for by a reduction in the stock ofbank reserves, following the decision taken by the Central Bank to reduceminimum reserve requirements. On the supply side, the impact of moneycreation to purchase foreign exchange was exceeded by the amount taken outof circulation by sterilisation operations. Central Bank intervention in theforeign-exchange market gradually diminished throughout the quarter, to thepoint that the issuance of domestic currency to purchase foreign exchange was38% lower than in the previous quarter. That trend, however, was reversed inApril, when Central Bank intervention in the foreign-exchange market grew:dollar purchases increased from a daily average of US$15m to US$83m in thelast week of April. A lengthening in the minimum stay for portfolio capital from180 to 360 days decreed in May was a further attempt to alleviate upwardpressure on the peso by discouraging short-term capital inflows.

The Central Bank issued short-term bills to sterilise growth in the moneysupply, which pushed up short-term interest rates. There was a glut ofamortisations due on these instruments in April and June. The financial system

Inflation concerns sparkmonetary policy tightening

30 Argentina


also exercised a contractionary influence via the repayment of rediscounts tothe Central Bank. According to the Central Bank, the high level of the monetarybase was an unexpected result of repo transactions by private banks, whichoffset Central Bank sterilisation and the repayment of rediscounts. The impactof the public sector as a whole was less contractionary than in the past becausethe treasury purchased dollars directly in the foreign-exchange market insteadof directly from the Central Bank. If the Treasury purchases foreign exchange inthe foreign-exchange market, then there is no monetary contraction, but if itmakes purchases directly from the Central Bank, domestic currency is taken outof circulation.

In March liquidity (commercial banks� deposits held at the Central Bank, pluscash in the banks and repos) reached 21.5% of total deposits in pesos, 2.4percentage points less than in December 2004. Bank reserves and repos fell,and banks used resources to increase lending and repay rediscounts. Butcommercial banks still show excess liquidity (holding more deposits at theCentral Bank than necessary) estimated at around 6.6% of total peso deposits.This is one reason why deposit rates continued to fall in the first quarter, adownward trend maintained until February in the case of long-term rates anduntil March for short-term rates. Those trends were reversed by a seasonalstrengthening in money demand from businesses. Lending interest ratesremained flat, both in nominal and real terms. However, interest rates on someshort-term loans rose modestly during the first quarter.

Other monetary aggregates overshot targets set by the Central Bank. A rapidincrease in term deposits, on the basis of economic growth and an upturn inconfidence, led M3 to increase by 2.6% in the first quarter, exceeding its target byPs3.1bn. M2 contracted by 0.9%, but still exceeded its target by Ps200m. Thecontraction of M2 was explained by the performance of current and savingsaccounts, which fell sharply in February, partly because of major withdrawalsof funds by the public sector.

During the first quarter peso-denominated lending to the private sector grew by3.5% quarter on quarter, representing a slowdown in overall credit growth.Consumer lending growth was robust, rising in step with the increase inincomes, but growth in lending to businesses slowed, partly on seasonal factors(firms reduce the pace of activity in the southern hemisphere summer). Inaddition, a marked increase in sales in the fourth quarter helped reduce firms�needs for working capital. The stock of mortgage lending continued to shrink asborrowers� repayments of outstanding loans outweighed granting of new credit.

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

2004 2005Dec Jan Feb Mar Apr

International reserves (US$ bn) 19.6 20.1 20.8 20.3 20.9Financial liabilities (Ps bn) 52.5 49.4 49.7 50.2 49.8

M1 (Ps bn) 66.3 65.0 63.6 64.6 67.6Peso savings & time deposits (av; Ps bn) 74.4 76.5 78.1 78.4 80.2

Source: Banco Central de la República Argentina.

Broader monetary aggregatesovershoot targets

Argentina 31


Agriculture

Real agriculture, livestock and fisheries output contracted by 1% during 2004,mainly owing to a 2% fall in the 2003/04 crop harvest. The fall in agriculturalproduction was partly compensated for by growth in beef and dairyproduction. The Secretaría de Agricultura, Ganaderia y Pesca (the departmentof the economy ministry responsible for agriculture) believes that the 2004/05harvest, which is nearing completion, will grow by around 20% to a recordoutput of 83.5m tonnes, mainly on the strength of improved yields caused bybetter weather. Expectations for the beef and dairy sectors are more mutedthan in 2004.

The latest available data indicate that output of soybeans will near record levelsfor the 2004/05 harvest, increasing by 20.3% year on year to around 38mtonnes. This improved performance is the result of a sharp increase in yields, asthe area under cultivation contracted slightly.

The 2004/05 wheat harvest, which is now complete, reached a record 16mtonnes, a 9.9% increase on the 2003/04 harvest. Strong wheat output wasfollowed by a sharp increase in exports, as traders rushed to sell their stocks inthe first quarter in the expectation of a fall in prices. The government forecastsa modest fall in the total area sown with wheat to 6.26m hectares, after it grewby 3.6% in 2003-04. Low rainfall and higher input costs are likely to make wheata less attractive crop for the 2005/06 harvest.

Corn output increased to 19.5m tonnes. This will directly translate into higherexports, since domestic consumption of corn tends to be relatively stable.Sunflower and sorghum production also increased markedly.

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

Area sown Output2002/03 2003/04 2004/05a % changeb 2002/03 2003/04 2004/05a % changeb

Sunflower 2,378 1,850 1,941 4.9 3,714 3,160 3,600 13.9

Corn 3,084 2,988 3,430 14.8 15,040 15,000 19,500 30.0Sorghum 593 545 628 15.2 2,685 2,160 2,900 34.3Soybeans 12,607 14,525 14,400 -0.9 34,819 31,577 38,000 20.3

Wheat 6,300 6,040 6,260 3.6 12,301 14,560 16,000 9.9Other 2,760 2,537 2,403 -5.3 2,142 2,837 3,057 8.4

Total 27,722 28,485 29,062 2.0 70,700 69,278 83,057 19.9

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

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

Following sharp falls from mid-2004, international agricultural commodityprices have stabilised in recent months. Soybean spot prices were little changedduring the first quarter of 2005, before falling again in April. However,compared with the first quarter of 2004, wheat prices have fallen by 27%, cornprices by 25% and soybean prices by 31%. Lower agricultural prices have hurtagricultural profitability, and the effect has been compounded by the soaringcost of agro-chemical products. In the case of wheat, direct input costs in May2005 were 18.7% higher year on year, whereas market prices were lower by

Lower commodity prices willhit farm investment

Agricultural output contractsin 2004

32 Argentina


around one-quarter. Declining profitability will affect future sowing plans andinvestment in productivity-enhancing technology. The head of the ArgentinianChamber of Producers of Farm Machinery forecast at the end of May that salesof farm machinery would fall by 15% in 2005.

After a strong performance in 2004, when it increased by 13.8% to over 3mtonnes, the production of beef (in thousand tonnes) fell by 1.3% year on year inthe first quarter. The number of slaughtered animals fell by 4.1%, but beefproduction was maintained by fattening beef cattle to a higher average weight.Farmers took advantage of the low relative price of corn to feed animals forlonger periods. The average cattle to corn relative price increased from 8.6 kg in2004 to 11.6 kg in January-April 2005, the highest rate for over a decade. A 44%increase in export volumes pushed up domestic beef prices. In the first fourmonths of the year, the average price of beef to the consumer rose by 14.2%.

Some long-term factors point to a reduction in the number of beef cattleavailable for slaughter over the forecast period. One is the gradual displacementof cattle from the most productive lands by arable crops. Producers have alsoresponded to a sharp recovery in domestic beef consumption (in 2004 beefconsumption reached 64 kg a head, 9% higher than in 2002) by slaughteringmore of their herds. External demand has also increased rapidly, based on theopening of new markets and the reopening of markets closed during theoutbreak of foot and mouth disease.

During the first quarter of 2005 dairy production increased by 8.9% year onyear, encouraged by rapid export growth (exports were up by 58% by value).Powdered milk plants have been working at full capacity, and rapid growth inexternal and domestic demand have led farmgate prices for milk to rise by10.5% in the first four months of the year. Although new export-oriented dairyinvestments have been announced, there will be a lag before they are ready todeliver higher volumes. In the meantime, domestic prices will continue to bepressured upwards by strong export demand. The government forecasts thatdairy output will reach 10bn litres in 2005, 26% above its 2003 lows. More than1,000 farms closed during the crisis, but the industry has recovered.

The impact of rising dairy and beef prices on consumer prices has led theauthorities to make price agreements with the private sector. Under theseagreements, producers pledge to fix prices for a limited period. However, theyare unlikely to be sustainable over the medium term.

Dairy production up

Beef production is littlechanged in first quarter

Argentina 33


Sectoral trends

During the first quarter of 2005 the Encuesta Mensual Industrial (EMI, theindustrial activity survey) compiled by INDEC indicated growth of 3% quarteron quarter on a seasonally adjusted basis. Year-on-year growth in industrialactivity fell to 6.1%, the lowest since the first quarter of 2003. Strong growth inexternal demand and high international prices for important export productssuch as steel, aluminium, edible oils, beef and dairy products allhelped industry.

Growth would have been stronger, but for the high year-on-year base forcomparison in 2004, whereby producers brought forward production from thesecond quarter to the first, fearing energy shortages. In 2005 some firmssuspended production during the first quarter in order to carry outmaintenance, thereby lowering industrial output.

Nevertheless industrial output growth, which rebounded sharply from the2001-02 crisis to grow by an average of 13.6% in 2003-04, is slowing down, aswould be expected. By comparison, the average annual growth rate recordedbetween the second quarter of 1996 and the third quarter of 1998 (a periodbookended by the Tequila Crisis and the onset of the recession that precededthe 2001-02 crisis) reached 7.2%.

65

66

67

68

69

70

71

72

73

Jan2004

Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan05

Feb Mar Apr

Industrial capacity utilisation(use of installed capacity, %)

Source: Instituto Nacional de Estad�stica y Censos.

The automotive sector was the fastest-growing sector in the first quarter,expanding by 30.5% on the strength of domestic and export demand,particularly from Brazil. The recovery of vehicle manufacturing has lagged thatof industry as a whole, and it still boasts plenty of spare capacity. Stronggrowth in the auto industry helped to push up overall industrial activitygrowth by 1 percentage point. Cigarette manufacturing continued to be theworst-performing sector, contracting by nearly 18% year on year, following asharp increase in prices at the beginning of 2004. Output remains 18% belowthe 1994-2000 average.

Basic metal and petroleum-refining industries have been operating close to fullcapacity for over a year, limiting the scope for output growth. Rates of capacity

Automotive sector growingrapidly

Industrial output growthsettles down

34 Argentina


utilisation have reached 98.4% and 90.5% respectively. In the case of the steeland aluminium industries, Acindar, Aluar and Taselli announced newinvestments, which will allow output to expand in the medium term. Therewill also be new investments in energy.

In March 2005 the level of capacity utilisation for industry as a whole reacheda moderate 71.1%. The persistence of spare capacity in some sectors, and therecent announcement of new investment projects in sectors where capacity isstretched, have lifted expectations for industry in 2005-06. Firms in theautomotive and automotive-parts sector, the chemical industry and in food andbeverages have already begun to add capacity. However, energy shortagesduring the winter could affect industrial growth (see Energy).

Business fears that profit margins may be eroded by government-decreed wagerises and business lobbies have insisted that wage increases must be inaccordance with productivity gains. Since 2002 average real wages in industryhave grown by 5.3%. In contrast, productivity measured per employed workerand per hour worked have increased by 14% and 9.7%, respectively. The increasein productivity has outpaced the increase in real wages in many sectors, such asnon-metallic minerals, basic metal industries, motor vehicles and machineryand equipment, whereas in others, such as tobacco products, textiles, officemachinery and furniture, the reverse is true. Citing these disparities, businessgroups want the government to abandon the policy of imposing across-the-board wage increases on the private sector.

Monthly index of industrial output, 2005(% change, year on year)

Jan-Mar MarFood & drink 4.7 3.3Tobacco products -17.7 -26.7

Textiles 5.4 10.8Paper & cardboard 4.9 5.5

Petroleum refining 0.5 0.1Chemical products 6.9 6.0Rubber & plastics 5.2 10.0

Non-metallic minerals 10.0 5.2Base metals 5.2 9.3

Cars 30.5 30.1Metal-mechanics excl cars 5.6 2.3

Total 6.1 5.9

Source: Instituto Nacional de Estadísticas y Censos.

Energy

Energy shortages in 2004 were overcome without serious harm to theeconomy, but new concerns have surfaced in 2005. During 2004 the demandfor electricity increased by 1.1 percentage points less than supply, but in the firstquarter of 2005 electricity demand grew by 5.3%, while net electricitygeneration grew by 4.8%. A hot summer stoked electricity demand, whilehydroelectric output was affected by low water levels. Some electricity-

New energy concerns as gasdemand outpaces supply

Business fears escalating wagedemands

Argentina 35


generating plants (such as Salto Grande, Yacyretá and those in Patagonia) had tocontend with water levels close to historic lows. Electricity demand was met byincreased output from thermal generators, which operated close to their limits.In May interruptions to service were reported, although widespread disruptionto service has been avoided so far.

A remarkable increase in the use of natural gas to generate electricity drove upnatural-gas demand by 5.9% year on year during January-February, butproduction fell. The cumulative drop in natural-gas output was 7.5% in the firstquarter. The imbalance between supply and demand was particularly critical inJanuary, when a 22.1% rise in demand for natural gas for electricity generationforced a reduction of exports to Chile. The chances of severe energy shortagesoccurring in 2005 will depend partly on weather conditions.

Low energy prices are encouraging consumption (although the government�ssanctions in the Plan Uso Racional de Energía are designed to address thisproblem) and discouraging investment in oil and gas exploration. However,supply itself is not the only constraint. Even if natural-gas production, includingBolivian gas, is enough to meet demand, transportation capacity may fall short.The expansion of the Transportadora Gas del Norte (TGN) and TransportadoraGas del Sur (TGS) natural-gas pipelines has been delayed, and unrest anduncertainty in Bolivia have held up construction of the Gasoducto del Nordeste(the northeast pipeline), the most important element of the government�s planto increase the supply of gas. The pipeline is planned to run from the southernBolivian town of Tarija, near the centre of the country�s gasfields, to theArgentinian province of Santa Fé, transporting around 20m cu ft/day of naturalgas. By the end of 2004 imports from Bolivia were running at around 7m cuft/d. Work on the project has been suspended. A recent law in Bolivia raisingtaxes on oil and gas to punitive levels would make gas imports from thecountry an expensive option.

In the event of gas shortages, industrial users and thermal electricity-generatingplants will bear the brunt of adjustments. The most intensive users of naturalgas are distilleries, chemical and petrochemical plants, the steel industry andthe food industry. Lower residential consumption may help to alleviate theshortage faced by industries and electricity, but the government will bereluctant to impose higher prices or rationing on households ahead of theOctober legislative election. It seems likely that, in order partly to compensatefor the shortage of natural gas, thermal electricity-generating plants will have toswitch temporarily to imported fuel oil, raising their costs. Another likelyconsequence will be a reduction in natural-gas exports to Chile. The authoritieshave launched incentives to encourage new gas exploration and an increase intransport capacity.

Repsol YPF, Spain's largest oil company, also announced it would investUS$6.5bn in 2005-09, an increase of 32% on the previous five-year period,mainly to increase crude oil and production, with some investment also goinginto refineries. Overall investment in petroleum-refining has so far beeninsufficient to ensure sustained output expansion, discouraged by theapplication of export taxes on crude petroleum (at a base rate of 25%, adjustable

Industry may have to reducegas use

Repsol YPF announces newinvestments

36 Argentina


in line with world crude oil prices), gasoline (5%) and compressed natural gas(20%) and government controls on domestic fuel prices.

Production, 2004(% real change, year on year)

2 Qtr 3 Qtr 4 Qtr YearMining -2.4 -2.3 0.5 -0.4

Manufacturing 13.8 10.0 8.8 11.9

Electricity, gas & water 8.2 2.8 6.4 6.6

Construction 32.6 26.4 21.7 29.4


Construction

Construction was the most dynamic economic sector in 2003-04, but itstagnated in the first quarter of 2005. The Indicador Sintético de la Actividad dela Construcción (ISAC, the construction activity index) fell by 0.2% over thepreceding quarter on a seasonally adjusted basis. Year on year, first-quarterfigures indicate a sharp slowdown: construction activity grew by just 3.4%,much lower than the average over the last two years. In the first quarter of2005 the level of construction activity was slightly higher than in the firstquarter of 2000, but was still 10% below the peak recorded in the third quarterof 1998.

Business representatives believe the slowdown is transitory, and attribute it tosupply bottlenecks in input-producing sectors (such as steel and ceramics) and ashortage of qualified labour. The supply of steel inputs is forecast to increasefollowing the announcement of new investments by domestic steel producers.As far as labour supply is concerned, higher wages negotiated in the newsectoral labour agreement are likely to encourage new workers to enterconstruction. Extra labour is needed; by the end of 2004, the number of formalemployees in goods-producing sectors had practically regained its historicalpeak, but in construction the level of employment was still 24% below its peak.

The fastest-growing area of activity in the first quarter was road-building,followed by other infrastructure works. Commercial and residential buildingconstruction grew more slowly, by just 3%. Real estate continues to be afavoured investment vehicle since the devaluation of the peso. Three years afterthe crisis, the demand for prime office space, luxury hotels and high-endresidential property is also starting to expand. Oil and gas industry constructionfell by 1.2%.

However, construction industry players are confident about the future,according to a survey by the Encuesta Cualitativa de la Construcción (thequalitative construction survey). Planned construction projects, measured bythe area covered by the issuance of construction permits in the city of BuenosAires and other urban areas, increased by 28.5% during the first quarter. The2005 budget allocated a total of Ps6.3bn for public works, a 50% increase overthe 2004 budget, while private-sector construction is also expected to beboosted by a recovery in mortgage lending. The building of new office space,

Construction industry playersare confident

Construction growth subsides

Argentina 37


which has remained depressed since the economic collapse, will contribute to arebound of construction activity.

Construction firms are suffering spiralling costs, with the Índice del Costo de laConstrucción (ICC, the construction cost index) up by 8.3% in the first fourmonths of 2005, as labour and materials costs rise. In April 2005 theconstruction price index stood 88% higher than in December 2001.

Foreign trade and payments

The share of goods exports and imports, measured in US dollars, reached arecord 36.4% of GDP in 2004, 20 percentage points higher than in 2001. Exportsand imports have both grown during this period, whereas the value of nationaloutput measured in US dollars has contracted sharply. In volume terms, realGDP data show that the share of goods and services exports and imports inGDP is around 24%, similar to the figure for 1998. Real exports have increasedsince 1998, but real imports are lower.

In the first quarter of 2005, export earnings grew by 12.5%. In volume terms,exports grew by 18.9%, but export prices fell. Between the last quarter of 2002,when exports started to recover, and the second quarter of 2004, export pricesgrew more quickly than export volumes, but since the third quarter of 2004 thereverse has been the case. The fall in export prices in the first quarter of 2005was explained mainly by falls in the prices of agricultural commodities fromtheir record levels in early 2004.

In volume terms, the fastest-growing exports in the first quarter were primaryproducts and processed agricultural goods. The performance was helped by thedelayed sale of 2004 wheat harvest stocks and the bringing forward of thisyear�s wheat harvest sales owing to fears of lower world prices. Oilseed andbeef exports also increased in volume terms. Industrial manufactures exportearnings have increased rapidly, helped by higher prices for products such asmetals, plastics and chemicals. Fuel and energy exports have been sliding forthe last six quarters, mainly as a result of lower crude oil shipments. Highexport tax rates and the natural depletion of oil wells have reduced theexportable crude oil surplus.

During the first quarter of 2005 the total import bill increased by 28.4%, pushedup by higher volumes and prices oil derivatives. The pace of growth slowedcompared with 2004. Imports of capital goods were up by 16.2%, comparedwith the 114.7% recorded in 2004. However, the base of comparison wasparticularly high. The fastest-growing capital goods imports categories includecellular phones and personal computers, which do not directly increaseproductive capacity, although they could increase productivity. Spending onimports of intermediate goods grew by 30%. The purchase of steel pipes fornatural-gas pipelines accounted for a sizeable share of this increase, while otherintermediate goods prices rose. The import bill for fuel and energy (particularlyelectricity and natural gas) grew most rapidly, owing to declining domestic oilproduction. Spending on imports of consumer goods rose by 25%.

Trade growing faster thanoutput

Import bill rises steeply

38 Argentina


External trade(US$ bn unless otherwise indicated)

2004 2005Sep Oct Nov Dec Jan Feb Mar

Merchandise exports fob 3.0 2.8 3.0 3.0 2.8 2.6 2.9 % change, year on year 25.3 16.5 24.3 20.8 19.1 8.2 10.7Merchandise imports cif -2.0 -2.0 -2.2 -2.1 -1.9 -1.9 -2.2 % change, year on year 52.7 36.0 64.5 38.9 17.9 37.3 31.1Trade balance 1.0 0.9 0.8 0.9 0.9 0.7 0.7


The combination of lower export prices and higher import prices worsenedterms of trade by 12% compared with the first quarter of 2004. The fall inagricultural prices, however, has taken place from the highest level reached inover 25 years. Rising export prices were a feature shared by the two precedingeconomic upswings (1991-94 and 1996-98).

In contrast with the 1990s, when Argentina used to record a trade deficit withthe world and a trade surplus with the Mercado Común del Sur (Mercosur orthe southern cone customs union), in the last two years the trade balance withMercosur has turned negative, while the overall trade balance has shifted intosurplus. The trade deficit with Brazil has been rising since mid-2003, and inMarch 2005 Argentinian exports to Brazil recorded their first fall in 12 monthson lower wheat and fuel sales. During the first quarter of 2005 total exports toBrazil increased by a meager 6.8% (after rising by 19% in 2004). Nevertheless,exports of industrial manufactures grew by 28% year on year, and Brazil is thebiggest market for these exports. Brazilian exports to Argentina grew by 35.6%,pushed by higher exports of manufactures. Argentina accounts for only 8.3% oftotal Brazilian exports; for Argentina the Brazilian market represents 16% ofits exports.

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

2004 2005 % change, year on yearExports fob 7,352 8,273 12.5 Primary products 1,355 1,661 22.6 Manufactures 4,634 5,221 29.5 Agricultural origin 2,680 2,714 1.3 Industrial origin 1,955 2,507 28.3 Oil & fuel 1,363 1,393 2.1

Imports cif -4,637 -5,953 28.4 Capital goods 1,163 1,355 16.5 Intermediate goods 1,861 2,416 29.9 Oil & fuel 143 250 74.1 Capital goods parts & accessories 739 958 29.6 Consumer goods 522 652 24.9 Vehicles 206 310 50.2 Other 3 12 250.0Trade balance 2,715 2,320 -15.8


A trade deficit with Mercosuropens up

Terms of trade worsen

Argentina 39


In 2004 the current-account surplus narrowed, as the massive trade surplusinherited from 2004 was run down. However, the impact on the overallbalance of payments was limited by the return of the capital and financialaccount to surplus. This is a departure compared with the last two years, whenthe current-account surplus financed deficits on the capital and financialaccount. Although the current-account surplus declined, it still represented 2%of GDP. In addition to the lower trade surplus, both interest payments andprofit remittances by foreign investors increased. Excluding unpaid interest for atotal of approximately US$6.1bn, the current-account surplus would havereached almost 6% of GDP, compared with 10% in 2003.

The capital and financial account posted a surplus of US$2.2bn, or 1.5% of GDP,in 2004, compared with a deficit of 3% of GDP in 2003. This was partly theresult of involuntary financing stemming from the accumulation of interestarrears on public-sector debt. Excluding interest arrears, the capital and financialaccount still recorded a net capital outflow of US$3.8bn, although this waslower than in 2003. The steady flow of private-sector capital outflows declinedin the latter part of 2004, until in December 2004 there was a net capital inflowof US$523m. Net capital outflows from the non-financial private sector fellsharply in 2004. The rate of accumulation of foreign assets slowed and therewas an increase in financing from abroad. Net capital inflows to the publicsector contracted as the government made repayments to internationalinstitutions such as the IMF and World Bank.

During the last year, foreign direct investment (FDI) inflows increased markedlyto US$4.3bn, more than double the level in 2003. Excluding acquisitions, netFDI inflows reached levels similar to those recorded in 1997-98. The increase innet inflows was mainly in the form of debt incurred by Argentiniansubsidiaries with parent companies and, to a lesser extent, by reinvestment ofprofits. Capital contributions fell by 26.4%. An improvement in the performanceof foreign firms led to a fourfold increase in profits compared with 2003. Onlyone-third of that total was reinvested, while the remaining two-thirds weresent abroad.

The surplus on both the current account and the capital and financial account,the product of a gradual reduction in capital flight, has enabled the BancoCentral de la República Argentina (the Central Bank) to accumulate foreignreserves in 2004. Reserves have continued to grow in 2005 to reach US$20.9bnby late April, equivalent to a US$1.2bn higher than at the end of 2004.

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

2003 2004 % changeExports fob 29,566 34,453 16.5

Imports fob -13,118 -21,185 61.5Trade balance 16,448 13,267 -19.3Non-factor services (net) -1,448 -1,733 19.7Factor services (net) -8,208 -9,210 12.2Unilateral transfers 578 705 21.9

Current-account balance 7,370 3,029 -58.9

Capital and financial accountreturns to surplus

FDI on the increase

Reserves accumulationcontinues

Current-account surplusnarrows

40 Argentina


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

2003 2004 % changeBanking sector -3,001 -3,097 3.2 Banco Central de la República Argentina -868 -1,990 129.3 Other financial institutions -2,133 -1,107 -48.1Non-financial public sector 4,637 4,955 6.9

Non-financial private sector -4,647 291 -106.3Other 70 45 -36.5Capital-account balance -2,941 2,194 n/aErrors & omissionsa -848 97 -111.4Change in international reserves 3,581 5,320 48.6

a Includes capital movements unclassified by resident sector.


Total external debt reached US$172.8bn, or 114% of GDP at the end of 2004,according to Ministry of the Economy figures; these diverge slightly from theEconomist Intelligence Unit's external debt figures, which are based onestimates by the World Bank. The successful restructuring of external publicdebt totalling over US$100bn brings a reduction in the total debt stock toaround 80% of GDP. Since 2002 the stock of external debt has been increasingbecause of a build-up of arrears on interest and principal, and because of thedepreciation of the US dollar, which together have outweighed net payments tointernational organisations. External debt owed by the private sector fellslightly as the restructuring of existing liabilities was partly offset by newsuppliers� credits. Total debt of the financial sector contracted as foreign loanswere repaid, continuing the trend observed since the currency and financialcrisis of 2001-02.

Restructuring reducesforeign debt

Argentina - iuj.ac.jp · Mr Kirchner and the former interim president (2002-03), Eduardo Duhalde, on the make-up of the list of candidates for deputy and Senate seats representing

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