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July 1, 1984
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Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 X1 Directorate of Intelligence Argentina's Debt: Financial Imperatives in a Struggling Democracy July 19$47 4 Copy 5 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Directorate of Secret Intelligence Argentina's Debt: Financial Imperatives in a Struggling Democracy Secret ALA 84-10074 July 1984 25X1 25X1 with a contribution from African and Latin American Analysis. It was coordinated with the Directorate of 25X1 Operations. 25X1 Comments and queries are welcome and may be directed to the Chief, South America Division, ALA, Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Secret Argentina's Debt: Financial Imperatives in a Struggling Democracy Key Judgments President Raul Alfonsin took office in December with an electoral mandate Information available that would have permitted him, in our view, to fulfill his pledge to reconcile as of 10 July 1984 differences with foreign bankers and the International Monetary Fund was used in this report. over Argentina's debt. He has failed to show much progress on this front largely because his administration's principal political goals have conflicted with foreign creditors' insistence on austere economic adjustment policies. The first elected civilian president after eight years of military government, Alfonsin is primarily concerned with reestablishing democratic rule, which in his view necessitates maintaining strong popular support for his administration. Thus, he. has pressed reform of the military, pledged to improve living standards for workers, and sought to avoid giving his political opponents-principally the Peronists-opportunities to attack him. He believes foreign creditors and.the IMF should be sensitive to the fragility of Argentine democracy and ease the debt repayment burden. Despite the difficulties to date, we believe there is a strong chance that Ar- gentina will conclude an economic stabilization accord with the IMF this year. Even with an IMF accord, however, we believe Buenos Aires will make only partial progress in arranging with foreign banks the debt rescheduling and new loans necessary to resolve financial difficulties. This would leave Argentina with an overhang of past-due debt, while the delay in obtaining new loans would probably prevent the normalization of debt payments. These circumstances would hinder the chances for Argentina's economic recovery and cause political troubles for Alfonsin but probably would not be serious enough to destabilize the government. We believe there is still some chance that Argentina will fail to conclude an agreement with the IMF, causing the. collapse of debt talks with foreign banks.. In addition, a rapid rise in interest rates could result in a new clash with. lenders over repayment terms, with similar consequences. In this scenario, the inevitable- payments moratorium could snowball into an outright debt repudiation with grave consequences for the Argentine economy, the civilian government, and world bankers. Secret ALA 84-10074 July 1984 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85S00317R000200040003-2 Secret Beyond 1984, Argentina will remain vulnerable to the resurgence of cash problems: ? We expect that Buenos Aires will be clearly out of compliance with the Fund stabilization program by early 1985. ? This breach would again cut Argentina's access to fresh flows of foreign exchange, resulting in another moratorium on debt payments. ? Our research also indicates that Argentina will probably face a large bulge in payments during 1986-87 when government bonds covering private-sector debt come due, which will only add to the increasing interest burden resulting from past heavy borrowing. Even under favorable economic conditions, we expect Argentina's borrow- ing needs would exceed bankers' willingness to provide new loans. Conse- quently, we believe bankers may need to voluntarily offer Argentina substantially stretched out repayment terms in order to avoid demands from Buenos Aires for some innovative form of relief from interest payments. We believe Buenos Aires expects the US Government to bolster Argentine democracy by taking extraordinary steps to help resolve its financial difficulties, such as restraining interest rates and soliciting cooperation from US bankers. If the Argentines perceive that Washington is being supportive, we believe this would increase their willingness to make compromises necessary to keep financial talks on track. Under these conditions, US bankers would benefit from the normalization of payments, US exporters would probably have easier access to the Argentine market, and bilateral ties would be strengthened. Alternatively, a rapid rise in interest rates or the perception that the United States is pressing Alfonsin to adopt economic policies he regards as politically detrimental could lead to trouble. In these cases, Buenos Aires could retaliate against US interests, resulting in diminished trade, strained political ties, and a cutoff in payments to US banks. Alfonsin would probably also seek to gain a following of other Latin American debtors to act in concert against lenders. Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85S00317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Secret Key Judgments Civilians Take Charge of the Debt The Roadblocks to Financial Progress 3 Political Pressures Against Austerity 3 Technical Difficulties and Disagreements Over IMF Targets 4 Tensions in the Negotiations 5 Challenges Ahead 5 Outlook for Debt Negotiations 7 Bank Negotiations Drag On 8 Longer Range Prognosis 10 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85S00317R000200040003-2 Secret Argentina's Debt: Financial Imperatives in a Struggling Democracy Introduction In December 1983 the popularly elected government of Raul Alfonsin and the Radical Civic Union took office in Argentina, ending eight years of military rule. Among the most pressing problems facing the civilians was managing the $45 billion foreign debt inherited from their military predecessors. President Alfonsin and his Economy Minister Bernardo Grin- spun soon followed through on campaign pledges to seek easier repayment terms and use the savings to stimulate the economy. Foreign bankers, meanwhile, were pushing for. an austerity program they believed necessary to cut inflation and improve Argentina's ability to repay its debt. These differences have yet to be resolved and have nearly precipitated an interna- tional financial confrontation. Alfonsin's strong stand against bank-imposed auster- ity, his continuing criticism of increases in US interest rates, and his role in convening the Cartagena confer- ence ' have pushed Buenos Aires to the forefront of those LDCs seeking to change borrower-lender rela- tions. With the third-largest foreign debt among LDCs, international lenders fear that an Argentine failure to meet contractual obligations while pushing for unified action against creditors will undermine financial rescue programs worldwide. Bankers, more- over, perceive Buenos Aires-because of its self- sufficiency in food and fuel-as the most likely of the major debtors to repudiate its obligations, thereby forcing large losses on them. Roots of the Debt Problem Starting in 1976, Argentina became one of the Third World's major borrowers. Financial reforms under- taken by the military-under the previous Peronist government the Argentine economy was character- ized by stagnant growth, accelerating inflation and mounting payments problems-restored the country's economic health and reopened access to world capital markets. Between 1976 and 1978, according to IMF ' Latin American foreign and finance ministers met during 21-22 June in Cartagena, Colombia, to discuss their common concerns on and World Bank reports, the total foreign debt rose 50 percent to $12 billion as the government undertook a major public investment program to diversify the economy. On top of this, the Argentines increased borrowing during 1979-81 to cover persistent pay- ments deficits. In this period, Buenos Aires deliber- ately held exchange rate devaluations below prevail- ing inflation to encourage the import competition seen as necessary to revitalize domestic industry. The overvalued peso encouraged private-sector firms to borrow overseas, mainly in short-term markets, to pay for imports. Public-sector corporations also continued borrowing to sustain investments and shore up the external accounts. Consequently, Argentina's foreign debt tripled to $36 billion by 1981. Lender confidence in Argentina began to decline in 1981 in the face of the sharp deterioration in the payments accounts and growing repayment obliga- tions. New loans became harder to obtain, forcing Buenos Aires to draw down reserves from a peak of $9.5 billion in 1980 to $3.3 billion in December 1981 to avert payments problems. Moreover, rising world interest rates added to the cost of both old and new borrowing. The London Interbank Offered Rate, the base from which most of Argentina's interest pay- ments are calculated, increased from an annual aver- age of 8.7 percent in 1978 to 16.4 percent in 1981. Taken together, Argentina's debt-servicing burden- principal repayments and interest charges jumped from $2.6 billion in 1978, equivalent to 40 percent of exports, to $6.3 billion in 1981, or 70 percent of export earnings. With exports restrained by the'slow pace of devaluation and reserves dwindling, Argentine bor- rowers became more vulnerable to external shocks. Disruptions stemming from the Falklands war in early 1982 caused the debt to become unmanageable. Em- bassy reports and the financial press indicated that foreign bankers, unsettled by the war and Argentine Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85S00317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85S00317R000200040003-2 Secret political turbulence, ceased new lending and demand- ed repayment of maturing loans. With its exports disrupted by the conflict, Buenos Aires faced serious liquidity strains by August. Argentine Economy Min- ister Jorge Wehbe set up a financial rescue program under IMF auspices in late 1982, but, because the military government hesitated to remove financial sanctions against British firms, bankers and the Fund delayed loan disbursements. Without these funds, Buenos Aires could not make scheduled interest pay- ments, putting them out of compliance with the IMF accord by September 1983. In October, pressure from Argentine Air Force officers caused a federal judge to rule illegal the model agreement for the rescheduling of the public sector's debt. The US Embassy reported that simultaneously the military relaxed fiscal disci- pline in its remaining days in office in order to increase public spending and grant wage increases aimed at preventing popular protests against the government. The incoming civilians thus inherited a collapsed IMF agreement, a de facto moratorium large arrearages, and depleted foreign reserves. Civilians Take Charge of the Debt Raul Alfonsin's electoral victory by a 52-percent majority in October 1983 gave promise of political stability, which buoyed world bankers' expectations that the new administration would tackle debt prob- lems decisively. Alfonsin reinforced these expectations by publicly committing the new government to paying the debt. Most observers believed his strong election mandate gave him the opportunity to seize the initia- tive and impose the austerity measures widely regard- ed as necessary to begin the financial adjustment process. As a show of support, bankers pledged finan- cial backing even before the new administration took office in December. The honeymoon, however, masked the different approaches both parties brought to the negotiating table. Alfonsin's Plans. In pre- and postelection speeches, Alfonsin consistently committed his administration to pay all foreign debt properly registered at the Central Bank. The US Embassy reported that Buenos Aires also publicly promised an economic program that seemed to respond to creditor concerns for adjust- ment. The new administration emphasized, however, that it would not accept recession in return for loans or reschedulings. Instead, Alfonsin indicated that Argentina must generate repayments by stimulating economic growth, which he saw as necessary to preserve political stability. To complement this objec- tive, Alfonsin called for lenders to extend interest rates and other repayment terms on a par with the most favorable agreements achieved by other Latin American debtors. In practice, Alfonsin has generally ignored his oppor- tunity to initiate economic adjustments and subordi- nated debt management to his political goals. Accord- ing to press and US Embassy reports, he repeatedly stressed that the first 100 days of the new administra- tion were crucial for establishing the institutions of a democratic Argentina. Alfonsin turned his immediate attention to prosecuting military officers for human rights abuses and bringing the armed forces under civilian control, while attempting to break the back of union opposition and reform its leadership. Attention to these efforts, in our opinion, impeded progress in framing and implementing a comprehensive debt management strategy. Indeed, Alfonsin stated in his unprecedented letter in June proposing a program directly to the IMF-instead of to its negotiating team-"Strengthening constitutional freedoms and institutions, and the system of constitutional represen- tation is the main objective of the Argentine govern- ment's policy." 25X1 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85S00317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Secret The Roadblocks to Financial Progress Alfonsin announced upon assuming office his inten- tion to secure a package of new loans and reschedul- ings under IMF auspices by June. Instead, the gov- ernment's slow movement toward an agreement with the IMF and an economic plan quickly soured rela- tions with bankers. It also created an image of Argentina as the most recalcitrant of the major debtors, and nearly precipitated a financial show- down. In our view, the social democratic philosophy of Alfonsin's Radical Civic Union, inexperience in deal- ing with creditors, and domestic political pressures combined to impede progress in resolving debt diffi- culties. Alfonsin '5 Sense of Ethics. US Embassy reporting was quick to indicate that Alfonsin and his Radical Civic Union's economic policies operated against an ethical background that would bedevil any quick agreement with the banks and the IMF. For example, Alfonsin's strong commitment to improving the living standards of Argentine workers worked against his willingness to accede to banker demands for austerity. He publicly indicated his belief that the traditional adjustments advocated by the IMF were neither relevant nor politically feasible for Argentina. In- stead, Alfonsin believes-as manifest in his speech- es-that debt servicing must be reconciled with the need to create more jobs and to raise real wages to maintain social peace. According to the US Embassy, Alfonsin planned to implement these philosophical convictions by increased spending for social services such as health, education, and low-income housing. As a result, devising budget compromises with the IMF would be difficult. tial interest rates from creditors. Alfonsin's view, reports the US Embassy, typifies the Argentine perception-contrary to Western economic thought-that the earning of interest is somewhat immoral. This has translated into Argentine domestic policies aimed at keeping real interest rates negative, and it has drawn the Argentines into conflict with the IMF. Moreover, it has led Alfonsin to seek preferen- Finally, a commitment to honesty-while it contribut- ed to the Radical consensus that international debts 25X1 must be repaid-also led the Radicals to believe that their election produced a more trustworthy Argentina and bankers should show more flexibility in negotia- tions. According to the US Embassy, the Radicals also believed they deserved an IMF program at least as favorable as that accorded the previous military regime. Because the IMF approved a 5-percent growth target as an integral part of that program, it became a minimum negotiating position for the Al- fonsin government. Political Pressures Against Austerity. A public opin- ion survey taken in mid-May indicates that, despite soaring inflation, the majority of Argentines approved of Alfonsin's management of the economy, especially his belief that IMF remedies would put at risk Argentina's fragile democracy. While boosting his domestic position, he has created high public expecta- tions regarding easier debt repayment, according to various Embassy and press reports. He has been susceptible to political pressures-from within his electoral coalition as well as from rivals-that have generated considerable confusion and administration indecisiveness about debt management. Alfonsin's own party is divided over the debt issue, inhibiting coherent policymaking and progress on an 25X1 25X1 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85S00317R000200040003-2 Secret The Peronists-the leading opposition party, which is fragmented but dominates organized labor-have been even more troublesome. The US Embassy re- ports that Peronists in general have vowed to resist IMF and lender pressures for austerity measures and are insisting that Alfonsin honor his commitment to economic growth and real wage increases. In late June, for example, an estimated 90,000 people dem- onstrated in the streets in Buenos Aires against "international usury" and the IMF. Alfonsin, fearing political unrest, has thus far acceded to their demands for wage increases. Even so, opposition to Alfonsin's economic policies has helped the splintered Peronists at least superficially to. unite their party leadership and regain the support of many workers who had defected to the Radicals. As a consequence, according to a variety of reporting, the Peronist leadership has been reluctant to moderate its tough stand against austerity. Labor rank and file has been even more vocal in demanding economic conces- sions-such as reinstituting monthly indexation of wages to offset inflation-and local strikes have in- creased dramatically since mid-May. Congress has yet to exercise a direct role in the IMF negotiations but is pressing for increased government spending. In mid-March the administration promised to consult the legislators on debt negotiations and, according to the US Embassy, hinted that they could comment on any IMF agreement. Alfonsin has since backed away from allowing formal congressional re- view with the right of veto, but he did submit the June letter of intent for legislative endorsement. More important, however, Congress must approve the feder- al budget, which is the linchpin for any accord with creditors. The budget, as submitted in late June, was already out of line with banker requirements, accord- ing to the press, in part because Congress was insist- ing on increased public spending, especially for social welfare programs. Technical Difficulties and Disagreements Over IMF Targets. Since coming to office, the Alfonsin govern- ment has publicly indicated a willingness to undertake economic adjustments aimed at battling down infla- tion and reconciling with creditors. According to the US Embassy, Economy Minister Grinspun publicly espoused a set of economic steps-tax increases, reduction in the public deficit, continued devalua- tions-that were consistent with IMF prescriptions without being seen as a threat to political stability in Argentina. Grinspun stated that such adjustments would enable the Alfonsin government to grant real wage increases and spur growth while reducing infla- tion and improving the payments accounts. Grinspun's ambitious economic plans, however, proved difficult to carry out. For example, according to the US Embassy, the government has been unable to pull together the technical data required to imple- ment these complex financial plans. Economy Minis- ter Grinspun has had to work with little assistance in responding to bank requests for comprehensive infor- mation supporting a stabilization plan. The US Em- bassy also reported that Central Bank President Gar- cia Vasquez's poor health also hampered efforts to develop a realistic budget. These difficulties were compounded, according to recent Embassy reports, by bureaucratic resistance to Grinspun's requests for detailed spending and investment plans from public- sector agencies. Since discussions began in February, the IMF has been skeptical about the Alfonsin government's ability to reconcile conflicting goals. According to various sources, the most difficult issue bogging down the IMF discussions has been the target for the size of the public-sector deficit this year-measured as a share of GDP. Grinspun has abandoned his initial, optimistic position that the deficit could be cut to 4 percent in 1984 in favor of an 8-percent target because of the political difficulties encountered in cutting expendi- tures and raising taxes. Although the IMF has agreed to a higher target, press and US Embassy reporting indicate that Grinspun has had trouble developing a draft budget acceptable to the Fund. Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85S00317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Secret Argentine wage policy has proved to be another sticking point. Alfonsin has sought to placate labor by setting monthly salary hikes to fulfill his campaign pledges to boost real wages. Because this policy fuels inflation, it has proved unacceptable to the Fund. According to recent US Embassy reports, presidential adviser Prebisch was sympathetic to IMF arguments and supported a modified wage policy to cut the inflationary spiral, which is now near 600 percent annually. Even the modified wage policy, Buenos Aires has been unable to resolve several other policy disagreements with the Fund. US Embassy and press reporting indicate that these include clashes over exchange rate, credit, and commercial policies: ? Although the policy of small daily devaluations remains in effect, the IMF is pushing for a large devaluation to correct for the overvaluation of the peso caused, in part, by the appreciation of the US dollar. ? Despite the IMF's desire for tight monetary policies, Grinspun contends that credit expansion must be commensurate with supporting economic recovery. ? Because of rules against discrimination among its members, the Fund is insisting that Buenos Aires lift restrictions on remittances to UK banks and businesses and work toward a workable plan for clearing interest arrearages. ? The Fund's request for gradual phaseout of subsi- dies for exports and controls on imports have also Under pressure, Grinspun has become aggressive and even combative in negotiations. As the 30 March US regulatory deadline for reviewing the status of Argen- tine loans approached, creditors insisted that Argenti- na pay past-due interest and set forth a stabilization program. Grinspun reacted angrily, and refused to use Argentine reserves to When it became clear that the Argentines would not have an IMF agreement by the end of March, Grinspun announced publicly that Buenos Aires 25X1 25X1 25X1 would not be able to repay its overdue interest. In 25X1 retaliation, creditors refused to bend and disburse the funds. Direct intercession by President Alfonsin, how- ever, and a Latin lending consortium averted a last- minute confrontation that would have caused a col- 25X1 lapse in the debt negotiations. Challenges Ahead Alfonsin's inability to move the IMF discussions along rapidly has precluded any progress in commercial bank negotiations. An accord with the Fund is essen- tial, in our view, for Buenos Aires to reschedule 1982- 84 outstanding debts, and raise new loans necessary to close the projected balance-of-payments gap for 1984. The Argentines are continuing efforts to reconcile with the Fund but are still insisting that a stabiliza- tion plan must not jeopardize Argentine democracy. The Financial Stakes. I we estimate the Argentines still have some $17 billion in external debt that requires rescheduling in order to lengthen the repayment profile to ease foreign ex- change outlays in the future. Although Buenos Aires 25X1 25X1 25X1 25X1 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Secret The Latin Financial Rescue Operation In March of this year, Mexico devised a $500 million bridge loan to Buenos Aires to help settle past-due interest payments and avert a confrontation with US banks over past-due interest payments. Press and US Embassy reporting indicate that Mexico and Venezu- ela contributed $100 million each while Brazil and Colombia provided $50 million each. The bank steer- ing committee also contributed $100 million, while the Argentines used $100 million from their reserves. The US Treasury agreed to loan Argentina $300 million against a firm IMF letter of intent to assure the Latin lenders of a more rapid repayment. While the rescue package solved an immediate prob- lem for US banks-and resulted in a big boost for US-Argentine relations because of the favorable pub- licity-it did not result in a quick reconciliation with the Fund. Negotiations for an IMF-endorsed stabili- zation program have dragged on since March. Be- cause bankers refused to resume new lending and the United States canceled the guarantee in June, the Argentines were moved to try to resolve the stalemate with the IMF. has publicly agreed to honor the terms of the model debt rescheduling plan arranged last year for the state airline, the government will probably press for a more lenient restructuring of the remaining public-sector debt. We expect the Argentines will request a stretchout of repayment terms to 10 years with five years of grace, comparable to terms for other Latin debtors such as Peru and Brazil. We also believe the Argentines will petition for a reduction of front-end fees and the interest rate spread in order to blunt higher US interest rates. We expect the Argentines also will request about $3.5 billion in new money this year, although the US Embassy calculates that as much as $4.5 billion might be required to cover the payments deficit. At a recent banking conference, most lenders recognized the need to extend fresh credit but indicated that any new lending would only be in support of an IMF program. Even so, these bankers also believe that it will be quite Table 1 Argentina: Current Account Statistics Trade balance 2.3 3.5 3.3 Exports (f.o.b.) 7.6 7.7 8.0 Oil 0.5 0.4 0.4 Nonoil 7.1 7.3 7.6 Imports (f.o.b.) 5.3 4.2 4.7 Oil 0.8 0.5 0.5 Nonoil 4.5 3.7 4.2 0.5 0 0 Current account balance -2.5 -2.0 -2.2 Arrearages 2.9 2.5 0 Principal repayments c 2.7 0 12.0 Foreign financing requirements d 5.2 4.9 16.7 Debt servicing to export e 105 71 219 Interest payments to exports 70 71 69 Interest payments and arrears to exports 108 104 69 a Embassy estimates. b Scheduled interest payments minus arrears. e Principal repayments of medium- and long-term debt. d Foreign financing requirements equals current account balance plus the previous year's interest arrearages plus principal repay- ments on medium- and long-term debt. e Interest payments and principal repayments. rThese ratios are probably not meaningful given the sharp inflation and exchange rate movements as they would heavily reflect mone- tary changes. difficult to get all 320 banks in the consortium to agree to any substantial increase in exposure because of the ill will toward the Argentines stemming from past negotiations 25X1 25X1 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Secret Reconciling With the IMF. Although bankers contin- ue to report that an agreement with the IMF is essential to breaking the financial impasse, President Alfonsin's unprecedented move to propose a program directly to IMF management in June has made a resolution more difficult. The US financial press tended to view the Argentine move as a "take-it or leave-it" proposition, but we judge it was merely another unconventional negotiating tactic aimed at extracting concessions on IMF conditionality. Argen- tine press reports also indicate the letter was meant to serve as a basis for continuing negotiations for a standby program. Moreover, we believe Alfonsin's proposal was intended to bolster his domestic position against Peronist critics of the administration's posi- tion on the debt and give him leverage with the IMF. To avoid undermining incentives to cooperate with the Fund, however, the IMF Executive Board refused the proposal. Instead, another round of negotiations was begun in mid-June to resolve technical disputes, prob- ably centering on Argentine wage policy and the size of the budget deficit. President Alfonsin indicated toward the end of the month that he would be more flexible in order to reach an IMF accord. We judge the Argentines are willing to make addi- tional compromises necessary to reconcile with the Fund. On 29 June, for example, the Central Bank announced a sharp increase in interest rates as the first concrete measure taken in support of Alfonsin's efforts to reach an agreement with the IMF. This move was followed by hikes in gasoline prices and transport fares aimed at eliminating subsidies to public-sector corporations. Although he continues to assure workers that their interests will be protected, Alfonsin also announced a 12-percent ceiling on private-sector pay raises for July, an increase that we expect to fall well below prevailing inflation. We believe the IMF will compromise with the Argentines on wage increases-the Fund acceded to Brazil's more generous wage settlements last year-but will insist on additional spending cuts to control the deficit. In the end, we believe this stumblingblock will be hurdled through higher taxes. A Hard Sell at Home. We and the US Embassy believe that convincing the Argentine electorate to accept any IMF agreement will be very difficult. We believe it will require substantial expenditure of Al- fonsin's political capital and almost certainly entail concessions to Peronist labor bosses. He will be under pressure to demonstrate that the program is growth oriented-a tactic the military used to sell the 1983 IMF agreement-and leaves room for real wage 25X1 increases and social welfare spending. Hints of Alfon- sin's emerging strategy surfaced in late June, when a new round of high-level talks with Fund officials began following the Cartagena debtors conference. In a national address, Alfonsin claimed that further public sacrifices would be required to resolve debt problems, but he stated that the adverse impact of any 25X1 austerity measures would be blunted for the poor. We expect Alfonsin's carrot and stick strategy to buy him the maneuvering room required to reconcile with the IMF. His personal popularity-90 percent of those polled in early May approved of his perform- ance-and appeals for national unity will give him some protection from opposition attacks. Additional concessions to labor bosses probably will also temper their opposition to an IMF program. Moreover, the Peronists are badly fractured and suffering from a tarnished public image. Thus, we judge that the Peronist factions will disagree over whether to try to block an IMF accord and leave themselves vulnerable to charges of destabilizing Argentina by blocking access to funds needed to sustain economic recovery. Outlook for Debt Negotiations The Alfonsin government's current willingness to compromise makes an IMF accord likely. We believe formal approval will be time consuming, and the Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85S00317R000200040003-2 secret Argentines may even falter temporarily when it be- comes necessary to enact legislation to secure final approval of the Fund program. Consequently, we judge it may be necessary for creditors to provide another bridge loan at the end of September to prevent writeoffs of Argentine credits. Even when an IMF accord is finally in hand, however, we believe that progress in completing debt agreements with commercial banks will be slow and uneven. In the meantime, Buenos Aires will continue to struggle to keep its payments current in order to maintain access to trade financing. Bank Negotiations Drag On. We believe there is a strong chance that the Argentines will be unable to conclude their debt restructuring and new money negotiations with commercial banks in 1984. Even if an accord with the IMF is reached before the end of September-when US bankers will be legally obligat- ed to set aside loan loss reserves-serious talks with the bank advisory committee will likely be only beginning. We expect, however, that, as soon as a letter of intent is agreed upon in principle, bankers would probably release frozen loans to.enable Buenos Aires to settle past-due interest payments. The imme- diate cash transfusion would also enable Buenos Aires to increase imports to reactivate industry. The com- pletion of a "growth-oriented" IMF program would also provide a temporary lift for the government by moderating opposition attacks on adjustment policies. At this point, however, the foreign bank advisory committee would then begin to develop a plan for providing new financing in support of the Argentine IMF program, which we believe will prove difficult to assemble.. Even if both sides cooperate fully, the restructuring of some.$12 billion in loans will require protracted. negotiations, because the Argentines have already indicated publicly .they expect softer repayment terms. Should bankers resist substantial easing of terms, Alfonsin, dismayed at recent interest rate hikes, would probably toughen his negotiating stance. We believe that only partial progress would be made in completing debt rescheduling this year. Similarly, negotiations for new money will be tough. As noted, the size of the package will prove to be contentious, and the loan will be difficult to syndicate. This year, Brazil, Mexico, and Chile-all complying with Fund programs-have encountered long delays in assembling new credits, mainly because of the reluctance of smaller banks to take part. In Argenti- na's case, numerous regional bankers already have reported that they will refuse to participate in such new lending. Protracted negotiations for new money will impede domestic economic recovery in 1984. Difficulties in obtaining trade financing would continue to curtail imports necessary for industrial reactivation and in- creased employment. The country would experience temporary cash flow difficulties in the face of seasonal export declines. The Argentines would probably again resort to temporary suspension of payments to ease financial strains later in the year. Politically, we believe that protracted debt negotia- tions would erode Alfonsin's popular support and limit his maneuvering room on a range of noneconomic issues. With an electorate anxious for economic im- provements, the Peronists could profit from an appar- ent financial deadlock. Labor and the media would probably begin to question the wisdom, of continuing economic sacrifices for few apparent benefits. Mem- bers of Alfonsin's own party may also press him to. abandon the program to preserve social peace and avoid losses in the congressional elections in Novem- ber 1985. They would also probably argue that squan- dering his limited political capital on the debt issue would prevent him from pressing his case in Congress in such military reform and foreign policy. Governing would become more difficult for Alfonsin, although the strains probably would not be serious . enough to destabilize the government. Debt Talks Collapse. We believe there is still some.' chance that the Argentines will be. unable to conclude an IMF.agreement, causing its debt talks with foreign banks to collapse. The major danger, in our view, stems from the Argentine penchant. to react impetu- ously to unanticipated events. If. the volatile Grinspun has trouble concluding an IMF accord, he could in.a fit of pique advise Alfonsin to halt negotiations abruptly. The President will also remain vulnerable to congressional attacks on the IMF agreement during 25X1 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85S00317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Secret the period before its formal approval by the Fund's Executive Board. Resurgent labor unrest could cause Alfonsin to scuttle a wage policy favored by the IMF. Without an IMF program, we believe foreign lenders would drag out financial discussions in an effort to press the Argentines to submit to IMF discipline-a tactic still being employed against the Venezuelans. Consequently, the Argentines would again be forced into a de facto moratorium. Continued rises in international interest rates could also cause financial negotiations to collapse. President Alfonsin and the leaders of other major parties recent- ly attacked the increases in the US prime rate as a danger to their democracy and social peace. If rates continue to rise, we believe Argentine negotiators will exert even stronger pressure on creditors to reduce concessions would increase materially. spreads and lending charges for new loans and for rescheduling of 1982-84 maturities. We judge that bankers will be only partially responsive to such requests, because they typically offer eased repayment terms only as a reward for successful economic adjust- ments. Under these circumstances, the chances that 25X1 the Argentines would walk out of the talks to force strains would be mounting, Argentina would be fur- ther encouraged to employ tough tactics. The likeli- hood that Buenos Aires would repudiate its debt would increase sharply. The Argentines might first publicly threaten such an action in an effort to convince banks to extend new credit needed to cover interest payments. Although bankers have gone to great lengths in the past to avoid declaring a default A breakdown in financial negotiations-probably ac- companied by a temporary moratorium-would entail major dangers, in our opinion. Alfonsin's inclination to attack lenders would probably increase, straining foreign bank and IMF willingness to support the rescue program. We judge that he would also become more assertive in coordinating joint action by Latin American debtors, further increasing tensions with bankers. Because these developments probably would cause banks to resist new lending at a time when cash and may cut a deal with Buenos Aires, we believe that such a threat would only heighten the current ill will bankers privately express against Argentina. Under these conditions, we fear bankers would be increasing- ly likely to declare Buenos Aires in default and seek to attach Argentine assets abroad. In the worst case, the 25X1 groundwork would be laid for an economic war that could easily involve other Latin debtors and threaten to disrupt the international financial system. A collapse of the Argentine financial program would probably result in creeping paralysis in the domestic economy. Although Argentine agricultural exports would be difficult to disrupt by legal action and some 25X1 may even be redirected toward the Soviets, we believe that import bottlenecks would exert an increasingly adverse impact on the economy. Even with substantial foreign exchange earnings and reserves, we believe Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85S00317R000200040003-2 Secret Argentine businesses would have difficulty maintain- ing a consistent flow of imports because of a near cessation of trade financing and legal actions taken to seize Argentine assets. We expect that industrial activity in the chemicals and metals sectors-heavily dependent on inputs from abroad-would begin to contract and cause disruptions in manufacturing, while spot shortages of key imported commodities would add to inflation. Moreover, the lack of external funds for investment would probably lead the govern- ment to undertake excessive monetary expansion to buoy the economy. Although these stimulants would probably sustain economic activity temporarily, they would contribute to hyperinflation that would para- lyze the economy in the longer run. In our view, Argentine businesses would react to monetary expan- sion and runaway inflation by again diverting invest- ment into speculation and away from production.. Should there be a major confrontation with creditors, we believe that Alfonsin would quickly mount a domestic political campaign to rally support by at- tacking international lenders. He would probably call for greater sacrifices from workers in an economic war with what he would portray as outside forces trying to destabilize Argentina. This approach would probably succeed, at least in the short run, in uniting various political groups behind the government's stand. We believe, however, that the unity would quickly give way to political dissension, resulting in a return of political instability over the longer run. Longer Range Prognosis Given the challenging economic goals common to Fund programs, we expect that Buenos Aires will remain -vulnerable to cash flow problems beyond 1984. We believe that the Alfonsin government will have trouble meeting IMF targets and is likely to be seriously out of compliance early in 1985. Failure to receive IMF drawings would in turn probably stall bank disbursements and cause payments to be sus- pended. Once such a self-perpetuating process began,. it would probably lead to another prolonged payments moratorium. Even if Argentina can reschedule its 1982-84 maturi- ties and eliminate its current interest arrearages, we believe the external debt will remain a problem throughout the rest of the 1980s. Several studies by Chase Econometrics, Data Resources, Inc., and Wharton Econometrics project that interest payments alone will continue to outstrip yearly trade surpluses, thus necessitating substantial new bank lending.2 While bankers expect developing countries to be net borrowers, we do not believe that they will favor continually increasing their exposures in Argentina solely to keep interest payments current. Instead, we expect bankers to maintain pressure on Buenos Aires to enact austerity measures in hopes of reducing projected new borrowing needs. Gaining cooperation on the Argentine side will be difficult. Buenos Aires has a history of being unable and unwilling to maintain austerity policies and could easily require a greater flow of foreign funds than current projections indicate. We believe that the present approach to handling the debt crisis shows little promise of long-run success for Argentina. The continuous need for new borrowing to pay interest suggests that measures beyond the re- scheduling of principal payments will probably be necessary to prevent insolvency. In our opinion, banks may voluntarily have to forgo a portion of their expected interest earnings and extend repayment peri- ods well beyond the terms currently offered. Failure to do so, in our opinion, would set off sharp reactions to force easier repayment terms by Buenos Aires. As noted, the political climate in Argentina cannot en- dure continuous austerity to meet foreign financial obligations without generating stronger antilender reaction. Given Argentine nationalism, the Alfonsin government may yet lose the economy to the West-including debt repudiation, closer ties with the Communist Bloc, and willingness to rely on cash purchases of necessary imports. ' Estimates of Argentine debt figures by econometric services do not take account a future bulge in foreign payments that could precipitate a second-round crisis. During 1981-82 the government offered exchange rate guarantees for private debts, thereby acquir- ing an obligation to provide the foreign exchange to cover some $9 billion in payments for which they have issued bonds. As the bonds mature in 1986-87, they will put pressure on Argentina's exchange position and its ability to meet its rising debt servicing. This bulge in repayments will renew the need for extraordinary foreign 25X1 25X1 25X1 25X1 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85S00317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85S00317R000200040003-2 Secret Table 2 Argentina: Debt Projections a a Projections based on varying sets of assumptions. b Published April 1984. c Published March 1984. d Published May 1984. e Favorable economic conditions scenario published by the Office of Global Issues. 25X1 25X1 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85S00317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85S00317R000200040003-2 Secret Implications for the United States We believe that Buenos Aires expects the US Govern- ment to help bolster Argentine democracy by taking extraordinary steps to resolve its financial difficulties. In our opinion, the Argentines believe Washington has the power to elicit cooperation from bankers and to control the interest rates banks charge. We believe this perception made Buenos Aires responsive to US demarches in March and June to take actions to prevent the debt talks from collapsing. On the other hand, as the negotiations progress unevenly, develop- ments that the Argentines perceive as detrimental to their financial or democratic interests-such as a rapid rise in interest rates-could cause Buenos Aires to attempt to take retribution against US banks. Bank and Commercial Interests. Should Argentina reach an IMF agreement by 30 September, we would expect interest payments to get back on track and remain reasonably current through the end of the year. The earnings of US banks and the integrity of the international financial system would escape seri- ous damage. Even under these conditions, however, we are concerned that large money center banks will face growing pressure to lend more to Argentina. Small banks with relatively limited exposures are increasingly tempted to write down their loans, leav- ing the task of meeting Argentina's borrowing needs too concentrated in large banks. Alternatively, if the IMF financial program derails, US banks would see only a trickle of payments from Buenos Aires and would probably begin writing off Argentine credits, a move we believe would impose significant, but not critical, losses on some US money center banks. Trade and Investment. Under our most likely scenar- io, we expect a greater availability of financing for bilateral trade. This would enable US exporters to retain their share of the Argentine import market, which was about 20 percent last year. Direct invest- ment, however, would probably continue to languish because of economic uncertainties, persistent high inflation, and continuing problems with dividend and profit remittances stemming from tough exchange controls. If the refinancing program collapses, howev- er, we would expect trade with the United States to diminish because of a lack of credit and Argentine retaliation. Communist nations might then be some- what more successful in their attempts to expand trade-from a negligible base-with Buenos Aires, particularly the USSR, which is seeking sales to Argentina to offset the large exchange imbalance resulting from grain trade. Political Ties. The 30 March rescue loan drew public praise from President Alfonsin and the media for the constructive US role. More recently, however, rising US prime rates have produced strong criticism of Washington from a cross section of the Argentine populace. Despite this, we agree with the US Embassy that Buenos Aires is likely to be generally supportive on political issues. If a bank or IMF confrontation arises, however, and Alfonsin believes that the United States is not moving strongly enough to help the fledgling democracy, he would probably reduce bilat- eral and multilateral cooperation with the United States on a range of issues. The Cartel Issue. Should Argentina and its creditors reach a financial impasse, we expect Alfonsin would quickly call on other Latin debtors to act in concert against lenders. We believe that he would receive support from hardliners in several Latin countries- such as Bolivia, Ecuador, and Peru-although Mexico and Brazil would probably continue to resist radical actions. In the worst case, Alfonsin would be success- ful in forming a limited cartel embracing some Latin American debtors to work in concert against lenders. Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85S00317R000200040003-2 Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2 Secret Secret Declassified in Part - Sanitized Copy Approved for Release 2012/02/10: CIA-RDP85SO0317R000200040003-2