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To:jeff.skilling@enron.com, a..shankman@enron.com, ben.glisan@enron.com,rick.buy@enron.com
Subject:FW: ENA Research: Argentina default and devaluation risk rises.
Date:Tue, 17 Jul 2001 01:28:51 -0700 (PDT)

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Conditions in Argentina have improved slightly overnight as government and =
opposition forces have agreed, in principal, to reduce the budget deficit (=
Gwyn's fourth bullet point). However, I'm concerned about Gwyn's third bul=
let point that bank deposits are being converted to dollars as well as bein=
g withdrawn from the banking system. I've heard market rumors supporting t=
his latter point.



-----Original Message-----
From: =09Hickerson, Gary =20
Sent:=09Monday, July 16, 2001 9:29 AM
To:=09Hannon, Kevin; Lavorato, John; Fastow, Andrew
Cc:=09Buy, Rick; Shankman, Jeffrey A.; Mcconnell, Mike
Subject:=09FW: ENA Research: Argentina default and devaluation risk rises. =
Brazil feels the effects of the contagion=20


This is a good review about the financial risks in the Southern Cone. Thou=
ghts in the market last week involved a special Fed meeting about Argentina=
but no information was provided to the public. Brazil's currency is the s=
econd worst performing currency thusfar this year, right behind Turkey.



-----Original Message-----
From: =09Koepke, Gwyn =20
Sent:=09Friday, July 13, 2001 2:52 AM
To:=09Hickerson, Gary; Shahi, Pushkar; Stuart III, William; Port, David; Go=
rte, David; Zipter, Rudi; Buy, Rick; Kaminski, Vince J
Cc:=09Raymond, Maureen
Subject:=09ENA Research: Argentina default and devaluation risk rises. Bra=
zil feels the effects of the contagion=20

Date: 12 July 2001

From: Maureen Raymond-Castaneda
Gwyn Koepke

We believe that the risk of an Argentine debt default has increased and pes=
o devaluation risk has also risen substantially in the last several days.

Due to recent economic and fiscal developments in Argentina, we believe:

Argentina lacks the fiscal and monetary maneuverability to lift itself out =
of a 3-year recession (exacerbated by a global slowdown) and a strong peso.=
Argentina's fiscal position has weakened substantially due to economic we=
akness that limits government revenue receipts needed to balance the fiscal=
deficit and pay off the country's debt service. A loss of investor confid=
ence has caused spreads to widen despite Argentina's need to rollover about=
$8bn of short-term Letes (Argentine government debt) by the end of the yea=
r. Yields paid at this week's Treasury auction are at levels that are not =
sustainable over the medium-term. Three-month Treasury yields are 14.01% (=
versus 9.1% paid at auction on June 26 and 7.89% on June 12). In addition =
to suffering from widening yields, Argentina was forced to shorten the teno=
r of debt from a mix of 6-month and 1-year bonds issued previously to only =
3-month securities at this week's auction due to increased risk aversion to=
longer-term government paper by local investors (pension funds and banks).=
The sharp increase in Letes yields, and the inability to issue longer mat=
urities, is highly indicative of the difficulty the Argentine government wi=
ll have in rolling over $8bn in short-term paper over the remainder of the =
year at sustainable rates, which further weakens its fiscal position due to=
higher interest payments. =20
The recession has been exacerbated by the strong peso caused by the persist=
ently strong US dollar, which has hurt Argentina's export competitiveness e=
specially vis-a-vis the Brazilian real that has depreciated about 25% relat=
ive to the USD since the beginning of the year. As a result to these facto=
rs, we believe the risks of Argentine debt default and peso devaluation are=
mounting. =20
Argentina is increasingly vulnerable to a run on the banking system. Argen=
tines are switching from peso to dollar deposits. Argentina's limited fore=
x reserves constrain the central bank's ability to support the peso, if pri=
vate sector deposits are withdrawn or converted into U.S. dollars. Private=
sector deposits of $74bn are 33% peso-denominated, or $25bn, and 67% are f=
oreign currency-denominated deposits, which dwarf Argentina's official fore=
x reserves of $25bn. Total private sector deposits fell about $5bn (from $=
77.5bn to $72.4bn) between February and end-April this year before stabiliz=
ing at $74bn as of July 6th. =20
Political uncertainty is very high and throws into serious doubt Economic M=
inister Cavallo's ability to win opposition support for a new fiscal auster=
ity program announced late yesterday. Cavallo needs to win approval for hi=
s fiscal agenda not only at the national level, but also at the provincial =
level, which will not be easy considering the 3-year contraction. Failure =
to gain this support to cutback spending will worsen Argentina's fiscal woe=
s, and cause a further deterioration of investor confidence.
These external and internal pressures leave the exchange rate vulnerable to=
speculative attack and threaten the 1-to-1 dollar peg, especially in light=
of the country's limited foreign exchange reserves. Today, Argentina's 1-=
month NDF traded at P1.15, implying risk of a 15% devaluation, while yester=
day, the 1-month NDF traded at P1.05 (implying an increased probability of =
devaluation since yesterday). Also today, the 1-year NDF traded at 1.25, i=
mplying a 25% devaluation. As a result of these above internal and externa=
l pressures, we believe the risk of peso devaluation has increased substant=
The danger of a steep devaluation is that private sector firms that hold do=
llar-denominated debt and are long pesos and short dollars will suffer from=
sharply higher debt payments. This could cripple an already tenuous econo=
mic situation by causing a further deterioration in government revenue thro=
ugh lower tax receipts.

Developments in Argentina impact Brazil through 3 main channels:

Currency Volatility: Contagion from Argentina has lead to a substantially w=
eaker Brazilian real. Triggered by a general sell off of Argentine stocks,=
bonds and currency, the real has depreciated 24% since the beginning of th=
e year to close today at R2.55. To stem the real's recent decline, central=
bank President Fraga hiked interest rates 150 bp and simultaneously interv=
ened in the forex market June 22, which stemmed the real's depreciation for=
about one week (see GMM, 29 June). Recent currency volatility could resul=
t in further central bank intervention by drawing on Brazil's forex reserve=
s. Fraga has indicated the central bank will intervene to support the real=
's value. A weak real will also translate into higher inflation expectatio=
ns in Brazil.
Emerging market credit spreads: Argentina represents about 25% of total eme=
rging market debt traded. Current investor concern about Argentina has con=
sequently widened emerging market debt spreads. Wider spreads put upward p=
ressure on overnight rates in Brazil, reducing liquidity and increasing cos=
ts of debt service in Brazil.
Trade mechanism: Further downward pressure on economic output in Brazil (al=
ready aggravated by the drought-induced energy crisis) brought on by weaker=
export market growth to Argentina. Also, the weaker Argentine peso would =
reduce Brazil's export competitiveness within the Mercosur trade bloc.

This week's GMM will contain more details on the contagion effects on Brazi=
l as well as Argentina's disappointing Treasury bill auction, the trend in =
private sector deposits, Cavallo's new fiscal measures to cut spending, Arg=
entina's heightened political risk associated with the need for fiscal aust=
erity amid concerns over provincial political support and S&P's debt downgr=
ade to "B-", which is one notch below Moody's rating of "B2".=20

The link to the GMM website is: http://enaresearch.corp.enron.com/research/=
framework/default.asp, pull down Sovereign and FX Risk, Global Markets Moni=

Recent issues of GMM with coverage on Argentina and Brazil:

GMM, 29 June ---------- Brazil's COPOM intervenes in the forex market to st=
em real's decline and bolsters reserves to defend currency in future
GMM, 22 June ---------- Argentina introduces new exchange rate system for t=
raded sector. Impact on the peso discussed.
GMM, 15 June ---------- Brazil's energy crisis and its impact on the growth=
GMM, 8 June ------------ Argentina completes its successful debt swap
GMM, 8 June ------------ Brazil energy rationing mandate and its impact on =
output of key Brazilian commodities