MERCOSUR - LOVE IT OR LEAVE IT? URUGUAY'S QUANDARY

,C O N F I D E N T I A L MONTEVIDEO 000254

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TAGS: ECON ETRD PREL PGOV PINR AORC UY
SUBJECT: MERCOSUR - LOVE IT OR LEAVE IT? URUGUAY'S QUANDARY

REF: A. MONTEVIDEO 229

B. MONTEVIDEO 207 AND PREVIOUS

Classified By: Charge d'Affaires James D. Nealon for reasons
1.4 (b) and (d).


1. (C) Summary: The GOU's perception of Mercosur has
undergone an extraordinary change over the past year, going
from wide-eyed enthusiasm to deep disillusion to even
questioning the wisdom of full membership. After initial
declarations prioritizing the ""deepening of Mercosur"", the
GOU experienced a series of disappointments, from a
lackluster presidency pro tempore to recurring market access
problems with its larger neighbors. It also witnessed the
increasing tendency of Brazil and Argentina to negotiate
bilateral agreements without consulting the other Mercosur
members, and the emergence lately of Venezuela as a third
member of this axis. The severe paper mills dispute with
Argentina, possibly one of the worst crises ever between the
two countries, has severely strained Mercosur, as has
Brazil's conspicuous silence on the issue and lack of
leadership.


2. (C) While some in the political opposition long questioned
the relevance of Mercosur membership, the debate is now
permeating the Frente Amplio (FA) itself, with prominent GOU
members questioning whether the status of associate member
would not be more appropriate. Additionally, the emergence
of the U.S. as Uruguay's leading export market has generated
a broad-based discussion over the usefulness of a Free Trade
Agreement (FTA) with the U.S., with some couching the debate
in terms of a choice between Mercosur and the U.S.
President Vazquez himself confirmed to us privately that he
wants to start discussions on an FTA (ref A). Seen from
Uruguay, Mercosur is probably at its most moribund state
ever. FTA negotiations between Uruguay and the U.S. would
affect the dynamics of Mercosur and may break down the Summit
of the Americas anti-FTAA ""consensus"". In the end, however,
Uruguay will almost certainly remain a Mercosur member but
will push hard for more freedom of action in international
trade negotiations. End Summary.

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The initial euphoria
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3. (C) Although Mercosur was already showing strains when the
FA took office in March 2005, it was clearly the FA's number
one foreign affairs priority (8 out of 25 foreign policy
points in the FA's platform called for a stronger Mercosur).
The number two priority was Latin American solidarity. In
his inaugural speech before a joint session of Congress,
President Vazquez emphasized his ""committment to Mercosur and
to integration as a strategic priority in Uruguay's
international agenda...this administration wants more and
better Mercosur."" He also called for Latin American
brotherhood, stressing that ""we will actively develop our
relations with all other Latin American countries, without
exception, for we feel we are equal brothers."" Vazquez's
first foreign trip upon being elected was to Argentina, and
his first outside trip after taking office was to Brazil.


4. (C) Enthused by the prospects of a stronger and expanded
Mercosur, which would join together the ""progressive""
governments of the region, ForMin Gargano gushed that a
virtual arc of progress"" was taking shape, from the
Caribbean (Cuba and Venezuela) through Brazil, Argentina,
Uruguay and Chile. Vazquez's first actions were to renew
relations with Cuba and to sign agreements with Venezuela,
Argentina and Brazil. Presidents Kirchner, Lula and Chavez
were shining stars. However, Gargano's initial notion that
Cuba could somehow join Mercosur was quickly shot down, after
the other Mercosur members and his own GOU pointed out that
Cuba did not meet the ""democracy clause"" necessary to join
the bloc. Gargano backed out in humiliation, having to admit
Cuba's lack of democratic credentials.

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Reality bites back
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5. (C) In the meanwhile, economic integration --Mercosur's
raison d'etre-- was taking the back seat. There were
numerous meetings, hyperbolic talk of a South American
Community of Nations and of a Mercosur Parliament, but little
was done in terms of trade facilitation. Little was achieved
either during Uruguay's pro tempore presidency of Mercosur,
apart from the institution of a new dispute settlement
mechanism (which, incidentally, was not activated for the
paper mill dispute between Argentina and Uruguay). There was
no progress on the harmonization of the Common External
Tariff (CET),a crucial issue. The highlight of Uruguay's
presidency, from ForMin Gargano's standpoint, was the
induction of Venezuela into Mercosur as a ""member in the
preparatory stages of accession"". Chavez appears content
with this status, which allows him access to a bigger bully
pulpit to express his views. He does not seem in any haste
to implement the hard measures necessary to comply with
Mercosur's CET. High-level contacts at the Mercosur
Secretariat and at the GOU's Economy and Foreign ministries
view suspiciously Venezuela presence within Mercosur and
doubt that Chavez will ever bite the bullet to become a full
member.


6. (C) Uruguay's presidency also saw the GOU becoming
increasingly irrelevant to its two large neighbors.
Presidents Lula and Kirchner picked without consultations
Argentina's Chacho Alvarez to replace Duhalde as Mercosur
President. They also repeatedly met and negotiated bilateral
agreements, without consulting the GOU. All in all,
Argentina and Brazil held eight bilateral working-level
meetings in 2005, which resulted in the signing of 30
bilateral protocols, and in the creation of a bilateral
commercial safeguard mechanism (MAC) in January 2006. GOU
contacts tell us that the governments of Argentina and Brazil
negotiated the entry of Venezuela into Mercosur on a
bilateral basis, and that ForMin Gargano tried to take the
credit for a fait accompli. There is now some evidence of a
tri-lateral axis emerging between the GOA, GOB and GOV, which
met five times without Uruguayan participation. Meanwhile,
repeated problems of market access for Uruguayan exports into
Argentina (bicycles, tires) and into Brazil (rice) continued
to highlight the dysfunctionality of the trading bloc and
perceived bullying by its larger members.


7. (C) Finally, the serious crisis with Argentina over the
building of giant paper mills on the Uruguayan side of a
joint river (ref B) exacerbated the relationship between the
two neighbors and glaringly exposed Mercosur's failings.
Vazquez is incensed that Kirchner allowed the bridges leading
into Uruguay to be blockaded, thus disrupting the free flow
of goods between the two countries and violating the first
article of the Treaty of Asuncion establishing Mercosur.
Compounding the offense is the fact that Argentina currently
holds the presidency pro tempore of Mercosur. The conflict
has caused significant damage to the Uruguayan economy by
reducing the flow of Argentine tourists at peak summer season
and hampering the flow of goods and imports of raw materials.
Some estimates put the amount of damage at $200 million so
far.


8. (C) With pretensions to regional leadership, Brazil has
historically been the guiding force of Mercosur and has used
it extensively as a tool in international trade negotiations.
From the four plus one mechanism with the U.S. to
negotiations with the EU to Mercosur's position vis-a-vis the
FTAA, officials from this and previous governments in Uruguay
tell us that Brazil called the shots. The GOU willingly went
along, as membership in such a large trade bloc was perceived
as providing added weight in negotiations. No significant
trade agreements have materialized, however, with this
policy. Mercosur rejected the FTAA at the recent Summit of
the Americas and the perrenial negotiations with the EU are
at a standstill. The increasing perception in Uruguay is
that following Brazil's lead has not generated any advance
with Uruguay's major markets. It appears that Brazil's
leadership has waned over the past few months, as President
Lula is absorbed with his re-election efforts. Lula does not
appear to be putting much effort into re-launching Mercosur
but prefers to appease Kirchner and accept Chavez. Brazil,
the traditional leader of Mercosur, has also remained
conspicuously silent in this paper mill dispute, when it
would have, in better times, offered and/or provided
mediation. Ex-GOU Finance Minister Alfie recently declared
that ""Brazil's position in this, as the most important member
of Mercosur, has been absolutely tepid.""


9. (C) While Mercosur may have benefitted its larger members
in many aspects over time, it has been a wash for Uruguay.
Uruguay's initial thoughts when joining the trading bloc were
that its tiny market would expand sixty-fold and that foreign
direct investment (FDI),especially from Brazil, would devlop
its industrial base. The reality is that sales to Mercosur
peaked seven years ago and FDI never really occurred. The
percentage of Uruguayan exports going to Mercosur
(principally Brazil and Argentina) is now practically where
it was in 1993. Exports to Mercosur peaked in 1998 at 55% of
total exports, but shrunk to 22% by 2005, a mere 12% above
1993 levels in dollar value. Meanwhile, the economic and
financial crisis of 1999-2002 resulted in a diversification
of Uruguay's foreign trade to extra-zone markets, in
particular NAFTA, which absorbed 30% of exports in 2005 (with
the U.S. taking in a whopping 24% of total exports). Exports
to the U.S. in 2005 were 412% up from their 1993 levels. The
new reality is clear: Uruguay sells more to the outside
world, without trade agreements, than to Mercosur within the
framework of the CET. This new reality is sinking in fast,
not only with the opposition, which has doubted the benefits
of membership for a while, but also within the GOU and the
FA.

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Where do we stand?
--------------


10. (C) Starting from such a basis of euphoria made the
letdown even harder for Uruguay. While Mercosur has had its
ups and downs with successive GOUs, for the first time the
disappointment appears to be generalized within public
opinion. The opposition, opinion leaders and even average
Uruguayans are incensed at the way Uruguay has been treated
by Argentina and Brazil. As when it was launched in 1992,
Mercosur has turned into an everyday topic of discussion, but
for other reasons. Most sectors of the FA, and Vazquez
himself, realize that the ""virtual arc of progress"" has
failed to deliver. At the same time , the most active
proponents of Mercosur, Gargano in the lead, are being blamed
for the organization's failures. Gargano has become the
laughing stock of politicians, journalists and even officials
within his own ministry.


11. (C) Economy Minister Astori started a debate early in the
year by advocating negotiation of a Free Trade Agreement
(FTA) with the U.S. The idea of ""going with the U.S."" is
gaining strength, the more so as Mercosur's failings become
apparent. Even Vazquez made a surprising remark to his
Cabinet about the benefits that an FTA with the U.S. brought
to Vietnam. (Note: He privately told us that he wants an FTA
with the U.S. and will pitch it to POTUS at their May 4
meeting in Washington. End Note. See ref A). Discussion of
the benefits of an FTA with the U.S. has made front-page news
for the past three months in Uruguay.

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What comes next
--------------


12. (C) In this broad-based discussion engulfing the country,
politicians and commentators have staked their positions as
to what Uruguay's future should be. They range from leaving
Mercosur to becoming an associate member like Chile or
Bolivia to staying within the bloc but with freedom to
undertake bilateral trade talks with outsiders. Pablo
Mieres, leader of the small Independent Party, advocates that
Uruguay plainly leave Mercosur. He admits having gone
full-circle, from his beginnings as a fervent proponent of
Mercosur. Mieres lists four factors that led to his
turnaround: 1) the paper mills conflict with Argentina 2)
the growing bilateral and exclusive relationship between
Brazil and Argentina 3) the increasing number of exceptions
to the CET which benefit the larger countries and harm
Uruguay's exports to the region 4) Uruguay's declining
overall trade with Mercosur. Uruguay is straight-jacketed
within Mercosur, Mieres claims, and the only way forward is
to negotiate bilaterally with other markets, whether Mercosur
partners like it or not.


13. (C) Ex-Finance Minister Alfie, a prominent Colorado
Senator, advocates that Uruguay change its status from full
member to that of associate member. He argues that Mercosur
membership is a hindrance to the country's development, as
Uruguay cannot pursue an independent trade policy and carries
no weight within the organization. For Blanco Party leader
Senator Larranaga, ""Mercosur has never been in as bad a shape
as it is now"". Ex-ForMin Abreu, also a Blanco, sees Mercosur
as a ""process stuck in neutral"", with diverging views among
its members regarding even its essence. Still, Abreu does
not believe that leaving Mercosur is an option for Uruguay.


14. (C) President Vazquez recently admitted that ""Mercosur is
going through one of its worst moments"". He stressed that
Mercosur is not a club where there are VIP members and
others. Integration is not built (...) with bullying (...)
or with deals under the table."" Economy Minister Astori
believes that Mercosur's priorities are erroneous: ""The
regional parliament is a very important objective,"", he says,
but it will only be achieved when the commercial and
economic problems are resolved."" Meanwhile, a group of
factions within the Frente Amplio prepared a draft document
to be discussed in the FA's March 25 plenary. According to
press reports, the document criticizes the functioning of
Mercosur and is sharply critical of GOA/GOB bilateralism.
While stating that Mercosur is undergoing a profound crisis,
it recommends that Uruguay remain in the bloc but proposes
the opening of trade negotiations extra-zone, in particular
with the U.S. If approved by the plenary, the document would
significantly alter the original FA platform, which rejected
bilateral trade negotiations and the FTAA.

-------------- --------------
Comment: Uruguay to stay but press for more freedom to act
-------------- --------------


15. (C) The momentum towards bilateral trade agreements,
whether it be with the U.S., with China or with other
important trade partners for Uruguay, appears unstoppable
--except, of course, if such partners declined the offer.
Argentina's Kirchner declared early this year after meeting
with Brazil's Lula that Uruguay was ""free to negotiate an FTA
with the U.S. if it wished to"". While Mercosur Decision 32
of 2000 prohibits members from negotiating individually
without prior consent from the other members, it is unlikely
that, if officially asked, Kirchner would deny Vazquez this
opportunity, given his previous declaration and the fact that
do so would throw oil on the fire of an already extremely
tense relationship. Neither would Lula, who by doing so
would seriously jeopardize his leadership. Brazil has been
willing to give away significant advantages to Argentina in
order to preserve Mercosur's cohesion. It would most
probably be willing to do the same for Uruguay.


16. (C) It is likely, then, that Uruguay will continue as a
full member of Mercosur, but will press for special
exemptions to negotiate one or two bilateral trade agreement
with its major outside trade partners. A status of associate
member in the medium-term is not to be excluded, but the
likelihood of pulling out from the bloc is probably nil.
Mercosur will continue to limp along, with Venezuela with one
foot in and Uruguay with one foot out, and may emerge as a
weakened trade bloc. Paradoxically, it may become stronger
in the foreign policy arena, where members still tend to
coordinate their votes on major issues.


17. (C) Uruguay's own evaluation of Mercosur has made us
ponder whether a USG evaluation of Mercosur's usefulness to
our own national security goals may not be warranted. An
assessment of our relationship with the organization may be
called for in light of Mercosur's decided anti-FTAA stance,
its increasing political rather than economic focus, and the
emerging bilateral and sometimes tri-lateral axis between
Argentina, Brazil and Venezuela. End Comment.
Nealon