MIXED SIGNALS ON LOCAL CURRENCY-DENOMINATED TRADE WITH

UNCLAS SECTION 01 OF 02 BRASILIA 001655 SIPDIS SIPDIS SENSITIVE STATE PASS USTR - MSULLIVAN USDOC FOR 4332/ITA/MAC/WH/OLAC/MWARD USDOC FOR 3134/ITA/USCS/OIO/WH/RD/SHUPKA USTDA FOR AMCKINNEY AID/W FOR LAC TREASURY FOR OASIA E.O. 12958: N/A TAGS: ETRD EFIN BR SUBJECT: MIXED SIGNALS ON LOCAL CURRENCY-DENOMINATED TRADE WITH ARGENTINA ¶1. (SBU) Summary. According to the local press, on July 20 Brazilian Finance Minister Guido Mantega met with Argentine Economy Minister Felisa Miceli on the margins of the Mercosul Summit meeting to discuss ways to conduct trade between the two countries in local currency (reais/pesos) instead of dollars. Such proposals have been floated unsuccessfully in the past, and Argentine Embassy and Brazilian Central Bank (BCB) contacts tell us that the two countries are currently far from any agreement on de-dollarizing their trade relations, although an exploratory meeting between the two countries' central banks is planned for August 14. Meanwhile, we were told, Brazil plans to double down on the issue by proposing that all five Mercosul countries use local currency for intra-bloc transactions. Given the complexity of the issues, it is unlikely that the GOB would be able to get its bloc partners to agree on this before its short five-month Mercosul presidency ends in December. End Summary. ¶2. (SBU) At various times in the past, Brazil and Argentina have been perhaps only one or two steps away from dollarizing their economies (either de jure or de facto). However, in 2003 the shortage of dollars in both markets pushed the two governments in the opposite direction, i.e., towards greater reliance on local currencies. That year the Sao Paulo Futures and Mercantile Exchange (BMF) proposed to then-Argentine Central Bank President Alfonso Prat Gay the idea of real/peso denominated trade. However, negotiations between Brasilia and Buenos Aires tailed off in 2004 and later stalled completely in 2005 when former Brazilian Finance Minister Antonio Palocci became enmeshed in unrelated scandals. Now current FinMin Mantega and his Argentine counterpart have revived the idea. ¶3. (SBU) In 2005, Brasil exported US$9.9 billion worth of goods to Argentina, while Argentina sent US$6.2 billion to Brazil. Under the contemplated local currency mechanism, payment for these transactions would be made in reais and pesos. Proponents argue that such a move would strengthen both countries by: a) making the two currencies more widely accepted, and b) lowering operational costs. To the extent that trade flows match, reliance on reais/pesos to make payments would be foreign exchange neutral as the respective Central Banks and currency futures trading via the BMF could be used as a conduit to allow exporters to recycle the local currency to importers. Still unanswered, though, is the question of whether the two central banks would purchase businesses' excess pesos or reais. Given that Brazil over recent years has run a consistent trade surplus with Argentina, the BCB could expect to have to purchase pesos from Brazilian businesses, presumably for immediate resale to the Argentine Central Bank. And if the BCB did so, what currency would it use to effectuate payment? ¶4. (SBU) An advisor to the Board of the BCB told us that the idea echoes in many ways currency settlements mechanisms created in the 1970s (and then abandoned in the early 1980's) to facilitate trade between hard-currency starved countries. In those arrangements, the central banks served as clearing houses, purchasing the foreign currency (zlotys, pesos, etc) from local exporters using local currency (e.g. Reais) and then settling accounts quarterly or so with the counterpart central bank. The central banks bore the exchange rate risk until the settlement took place and any surplus that one side had was paid in hard currency. According to our BCB contact, the arrangements collapsed in large part because the central banks could not continue to bear the exchange rate risk as more and more countries liberalized capital movements and moved to flexible or floating exchange rates. While overcoming this problem would be the biggest challenge for the renewal of such local currency settlement mechanisms, the BCB advisor noted that it could be done to the extent that the currency risk was hedged immediately (by the exporter or importer) using BMF futures contracts. BRASILIA 00001655 002 OF 002 ¶5. (SBU) Argentine diplomats tell us that, based upon their conversations with GOA Central Bank staffers, the idea of conducting bilateral trade in reais/pesos is one that is not yet ripe. Notwithstanding Miceli's initial contact with Mantega, the true demandeur on this issue, they say, is Brazil. The BMF, they note, would gain by selling peso/real currency futures to businesses as might Brazilian small and medium-sized enterprises which sometimes find the cost of conducting dollar-based transactions, which entails two currency trades (from Reals to dollars and then to pesos or vice versa),too expensive. However, in the short-term Argentine exporters want to keep the dollars they receive from Brazilian buyers and thus may look at the scheme askance. Meanwhile, a technical-level meeting between staff of the two countries' central banks is scheduled for August 14 in Sao Paulo for what a BCB contact said are "very preliminary" discussions. According to our contacts, no concrete proposals are likely to be floated; instead, the two sides will take the opportunity to "brainstorm." ¶6. (SBU) Notwithstanding the fact that bilateral Brazil-Argentina local currency trade may not be ready for prime-time, we were told that Brazil intends to move further and propose that all Mercosul transactions be conducted in local currency. Our Argentine Embassy contacts speculated that Brasilia was charging forward on this because it wanted to local currency trade to be one of its highlight achievements during its current 5-month Mercosul presidency, which terminates at the end of 2006. ¶7. (SBU) Comment. While local currency trade within Mercosul is a laudable goal, post does not see it coming to pass anytime soon. The lion's share of commerce is between Brazil and Argentina. If those two countries can't agree on the concept, it will be all the more difficult to forge consensus with Uruguay, Paraguay and Venezuela. End Comment. Sobel