Consulado y Centro de Promocion Argentino en Shanghai

ARGENTINA ECONOMIC OVERVIEW Nº 29

(July 2004)

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* After strong growth in the first quarter (annual 11.2%), the economy is expanding at a slower, yet still fast, pace in the second quarter. The country can look forward to GDP growth of no less than 6% for this year.

* In the first quarter, employment grew practically at the same rate as the economy, while unemployment fell to 14.4%.

* In May the tax revenue reached a record $ 12.4 billion, which allowed the Government to almost comply the "annual" primary surplus target.

* Inflation remained low during the first five months of the year, although with a slight tendency to rise. For 2004, inflation is expected to be higher than in 2003 (annual 8% compared to 4%).

* In this context, growth in investment will be the key to sustain the expansion of the economy without inflationary pressures.

* Government efforts to end public debt restructuring process, consolidate fiscal surplus, implement a monetary policy including inflation targets, renegotiate contracts with privatized companies and recover long-term credit are aimed at strengthening the notable dynamism of investment in the first few months of the year.

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Details on national accounts have finally confirmed the strong growth which first became evident in the partial indicators of economic activity in the first quarter, with GDP growth of 11.2% p.a. On the supply side, this expansion was led by manufacturing industry (+16% p.a.) and construction (+41% p.a.) in production of goods; and by trade (+15% p.a.), transport, storage and communications (14% p.a.), in the case of services.

On the demand side, private consumption and investment were responsible for most of the expansion in economic activity, with growth rates of 12% and 51% p.a. respectively. In spending on investment, the purchase of machinery and equipment grew at an annual rate of 80%, mainly driven by the acquisition of imported products (which are generally associated with the incorporation of new technology). Meanwhile, exports performed well at the beginning of the year, with an 8% annual increase, thus explaining a 10% of the GDP growth in the first quarter.

The dynamism of the economy was reflected in the labor market, with employment growing almost at the same pace as economic activity (10% p.a.). The unemployment rate dropped to 14.4% in the first quarter of the year, against 20.4% in the same period of last year. Meanwhile, underemployment, another form of instability in the labor market, which includes persons who work fewer than 35 hours per week but wish to work more, reached 15.7% (17.7% in the first quarter of 2003), thus the total number of persons with employment problems in urban centers surveyed by the INDEC reached 3.15 million (unemployed plus underemployed).

However, in April the economy decelerated quite markedly, with a (seasonally adjusted) fall of 1.5% compared to March and a lower annual growth rate than in the first few months of the year (+6.3% p.a.), as a result of the poor performance of manufacturing industry and construction, two of the recent drivers of recovery of activity. This deceleration can be explained in part by the fact that the high growth rates of the last quarter of 2003 and the first quarter of 2004 are difficult to maintain over time, and a certain cooling of activity was expected in the rest of the year, but also by the appearance of the energy crisis.

In this context, the measures taken by the Government to mitigate the effects of problems in the energy sector (see Argentina Economic Overview Nº27) seem to have begun to normalize the situation in May, with a recovery in manufacturing production (a seasonally adjusted +1.7%, and +11% p.a.), after the significant fall in April. However, accumulated growth in the industry during the first five months of 2004 was 12% (p.a.), below the 14% rate of the first quarter. This reveals a certain trend towards an slower growth than at the beginning of the year. The construction sector showed similar dynamism, with a better performance in May but with lower annual growth rates than in the first quarter. All the same, for the moment the great dynamism of the economy in 2003 and the first quarter of 2004 raises the expectations of high growth for this year, no lower than 6% (p.a.).

On the fiscal front, the good performance of the economy allowed the Government to achieve record tax collection in May of $ 12.4 billion (after previous monthly values between $ 6 and $ 7 billion), with a growth rate of 73% p.a. This remarkable increase in tax receipts was basically explained by the Income Tax and Wealth Tax, although there were also good returns from taxes related to domestic consumption (such as VAT, excise and fuel taxes) and those related to foreign trade. Thus in the first five months of 2004 the national public sector accumulated a primary surplus very close to the annual target of $ 10 billion agreed upon with the IMF.

The record tax collection of May was reflected in the financial system, with a pronounced fall in private deposits (mainly savings accounts and current accounts), which partially recovered in June. Despite the high level of liquidity in the banking system, the large amounts received in payments of taxes generated a fall in the level of liquidity of private banks (which lost deposits as taxpayers met their obligations), together with an increase in the level of liquidity of public banks (which received the tax payments). This produced greater activity in the interbank loans market and led to an increase in the call rate (interbank interest rate), which went from 1.5% to 6% p.a. during May, slipping back to 2% in mid-June, and was also reflected in a slight rise in interest rates on fixed-term deposits of around one percentage point (from 2% to 3% p.a.).

In relation with bank credit, private sector loans continued to show good growth in the second quarter, with an increase of 7% p.a. in June. Although most of the growth was still concentrated in short-term loans (advances on current accounts, discount of instruments, personal loans), between March and June there was an incipient recovery in longer-term credit, in particular of loans to buy vehicles.

Meanwhile, retail prices rose 2.7% in the first five months of the year. Although inflation is still low, it has shown a slight upward tendency in the last few months: the annual inflation rate rose from 2.3% in March to 4.3% in May. So for this year consumer price inflation is expected to be higher than last year (8% against 4% p.a.), due to a certain recovery of public and private sector salaries, an adjustment in some public service prices (in particular gas and electricity) and the significant increase in commodity prices in the last part of 2003 and the start of 2004.

One variable related to possible inflationary pressures is the level of use of installed capacity of the economy. In industry, together with the recovery of productive activity, this indicator has risen, reaching 69% in May against 64.2% in the same month of 2003. In general terms, this level still leaves room for economic expansion without putting pressure on domestic prices, although there are several sectors, such as the steel industry and oil refining, in which installed capacity is being used close to its maximum.

In this sense, the use of productive capacity is relevant for the determination of monetary policy. So far, the Central Bank (BCRA) has been expanding money supply by purchasing dollars, in order to avoid a strong appreciation of the local currency that could affect the growth rate of the tradable sector and the level of tax collection on foreign trade. Consequently, between mid-March and the beginning of April, the BCRA increased the rate at which it was buying foreign currency (from USD 20 million to USD 45 million per day), which together with the limited impact of international financial turbulence (see International Economic Overview Nº21), took the dollar from $ 2.81 in mid-April to $ 2.96 in mid-June, while international reserves in the hands of the monetary authority reached USD 17.5 billion, their highest post-devaluation level.

Although the monetary authority partially compensated the expansion in the amount of money generated by the purchase of dollars by issuing bonds, with the payment of rediscounts by the financial institutions and the payment of debt maturities by the national government, the monetary base continued to grow, although within limits imposed by the monetary program and in accordance with the targets agreed with the IMF.

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In this context, the dynamism shown by investment will be key, both from the point of view of the expansion of installed capacity and the incorporation of new technology (to allow productivity increases), in order to sustain expansion of the economy over time without inflationary pressures. Thus, the generation of conditions for investment will constitute a central point of economic policy in the coming months. The government's efforts to end the public debt restructuring process, consolidate the public accounts surplus, implement a monetary policy with inflation targets, renegotiate contracts with utilities and recover long-term credit point precisely in that direction, and will help to strengthen the considerable investment expansion of the first months of the year.

In this regard, the Ministry of Finance recently published details of the debt restructuring proposal offered to creditors at the end of the last year and started approval procedures for the new bonds in the national security commissions of the United States and Argentina (see Argentina Economic Overview Nº28). Meanwhile, the Executive Power presented the Law of Fiscal Responsibility to Congress. It includes limits on the increase in public spending and indebtedness, requirements for more detailed information on provincial public accounts and economic sanctions for jurisdictions that do not comply with regulations. And will soon present the second anti-tax evasion package designed to improve tax administration in the areas of social security and customs.

In the case of public services, the Government will hold public hearings between August and September in order to accelerate the renegotiation process of contracts with the privatized companies. So far, of the 63 contracts only a transitory agreement has been made with Aguas Argentinas. Of the rest, the sectors that have advanced most in defining the contracts of concession are telephony, cargo trains, highways and waterways, while renegotiation with the electricity and gas companies appears to be the most complicated.

Finally, the mission sent by the IMF in mid-June to conduct the third review of the agreement signed at the end of last year concluded their work and returned to Washington with a first draft. Compliance with fiscal and monetary goals, an announcement on the details of the debt renegotiation proposal and presentation to Congress of the Law of Fiscal Responsibility are points in favor of securing approval of the third review. In the coming days the Finance Ministry will continue its negotiations with the representative of the Fund in Argentina, John Dodsworth, to advance with the text of the letter of intention and achieve approval by the entity's board of directors.