SCENESETTER FOR SECRETARY OF TREASURY HENRY M.

C O N F I D E N T I A L MONTEVIDEO 000629

SIPDIS

SIPDIS

TREASURY ALSO FOR OASIA FOR DDOUGLAS AND MMALLOY
DEPT ALSO FOR WHA/BSC AND EB
DEPT PASS USTR FOR EEISSENSTAT AND SCRONIN
COMMERCE FOR ITAITA/MAC/WBASTIAN
NSC FOR DFISK AND GTOMASULO

E.O. 12958: DECL: 07/01/2017
TAGS: EFIN OVIP ECON OTRA ASEC UY
SUBJECT: SCENESETTER FOR SECRETARY OF TREASURY HENRY M.
PAULSON, JR'S VISIT TO URUGUAY


Classified By: Ambassador Frank E.Baxter
for reasons 1.4 (B) and (D)

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Summary and Introduction
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1. (C) American Embassy Montevideo and I warmly welcome you
and the other members of your distinguished delegation to
Uruguay. Your July 12-13 visit comes at an especially
auspicious time: only three months after the historic POTUS
visit and right on the heels of U/S Burns' and A/S Shannon's
political mission here. The Uruguayans will be keen to learn
your perspectives on U.S. economic and financial policies and
objectives for the region and elsewhere around the globe.
Uruguay's democracy is strong and its economic recovery from
the 1999-2003 financial crises seems generally assured. But
Uruguay needs to invest more in its people and should be
persuaded to change the prevailing statist, commodity-based
mind set so that it can face the global challenges ahead and
become a knowledge-based society. Uruguay also needs to do
more to enhance its security, including by cooperating more
closely with us.


2. (C) Though led by a leftist government, Uruguay continues
to share many of our basic values, and it remains an island
of democratic stability and good governance in a frequently
turbulent region. Uruguay also plays a pivotal role in Latin
America, where a number of countries have perilously
distanced themselves from the U.S. After Uruguay's historic
political shift to the left in the October 2004 elections,
the USG focused on engaging the initially wary Frente Amplio
(FA) government through a dialogue on trade. In large
measure, this approach was successful and helped to produce
our presently healthy bilateral relationship. The May 2006
visit by President Tabare Vazquez to the White House and
President Bush's reciprocal visit to Uruguay in March 2007
symbolized mutual understanding at the highest levels. Almost
unimaginable just two years ago, the visits also sent a
powerful message to the region that the U.S. is less
concerned with ideological labels than it is in working with
governments who respect democracy, human rights and the rule
of law.


3. (C) The contrast of Uruguay's solid democracy helps to
highlight the fallacies and economic recipes of the populist
regimes in countries such as Venezuela, Bolivia, Cuba,
Nicaragua and Ecuador -- and to some extent Argentina.
Vazquez's model appears to be Chile and he enjoys a
privileged relationship with Chilean President Bachelet. A
few months ago, a survey by the magazine "the Economist"
rated Uruguay as the only country in South America to enjoy
"full democracy." The GOU is seeking U.S. market access and
investment, but it is vulnerable on energy supplies (to
Venezuela) and remains very preoccupied about its pulp mill
dispute with Argentina. Uruguay also faces a long-term
demographic problem; a low birth rate (except among the poor)
is exacerbated by the brain drain of mostly young people who
emigrate abroad in search of jobs. An estimated 600,000
Uruguayans live or work abroad, mostly for economic reasons.
To the extent that we can, we need to re-assure the
Uruguayans that we are their friends, expose them to more
modern economic and commercial ideas and try to encourage
them to cooperate more assertively on security issues. End
Introduction and Summary.

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The Economy, Trade and Investment
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4. (U) Uruguay is a small, stable, democratic nation of 3.3
million people, almost half of them residing in its capital,
Montevideo. Once known as "the Switzerland of South
America," it has long been one of Latin America's wealthiest
and most egalitarian countries, with per capita GDP exceeding
$6,000 during periods of growth. However, a four-year
recession, which ended in 2003, cut this figure nearly in
half and lowered Uruguay's historically excellent
socio-economic indicators. Uruguay's economy has been
recovering well over the past three years, and GDP per capita
is back to around $5,800. Economy Minister Astori has been
pursuing orthodox macro-economic policies to control

inflation (6.4% in 2006) and to promote growth (7.0% in 2006)
and investment. The GOU has also paid off its debt to the
IMF early and has regularly issued bonds on favorable terms
in the international financial markets, thus lowering its
debt service costs. The debt to GDP ratio was down to 71% at
the end of 2006, from over 101% in 2004. Unemployment is now
in the single digits for the first time in 5 years. The
country risk stood at 159 points in May 2007. Most observers
believe that Uruguay seeks to emulate Chile's economic model.
Vazquez and Bachelet, both physicians, enjoy a close
relationship and common views on economic and social goals
and the means to achieve them.


5. (U) Uruguay is a major agricultural producer. Agriculture
and agro-industry account for 23% of GDP and over 75% of
total exports. The major Uruguayan exports are meat (over $1
billion this year),long-grain rice, dairy products, wool and
soybeans. Forestry has surged over the last decade, due to
favorable investment conditions and a favorable climate,
where eucalyptus grows almost twice as fast as in the U.S.
Uruguay does not import agricultural products but does import
processed foodstuff. It applies a 6.6% average tariff on
agricultural goods and does not impose any kind of import
quota. There are no subsidies to agricultural production or
exports. Given the importance of this sector for the
economy, Uruguay has been active in bilateral and
multilateral fora to push for trade liberalization, and U.S.
agricultural subsidies are a hot topic. The GOU's trade
policy on agriculture has generally been in line with
Mercosur's policies, and Uruguay is a member of the G-20
group of countries calling for the elimination of
agricultural subsidies. The GOU threatened last year to file
a case with the WTO on U.S. rice subsidies, but Embassy
intervention allowed for the opening of a bilateral dialogue
instead, in an attempt to resolve the issue. Talks are
ongoing, but the threat of an impending WTO case still
remains on the horizon.


6. (U) Uruguay has diversified its trade to a considerable
extent since the 1999-2003 crisis. Over 55% of Uruguayan
exports were destined for Mercosur countries in 1998, but
this had dropped to about 25% by 2006. At the same time,
exports to the U.S. skyrocketed and the U.S. was Uruguay's
first market in 2004 and 2005, primarily due to beef exports.
Favorable beef prices in Russia caused exports to the U.S.
to drop in 2006, but it appears that 2007 will once again see
the U.S. as Uruguay's leading export market on a par with
Brazil. This growing importance of the U.S. market has
provided us with some leverage with the GOU and is a primary
reason for its interest in expanding the trade relationship.
Uruguay exported $521 million to the U.S. in 2006 (mostly
beef, leather and gasoline) and imported $331 million (mostly
machinery, power plants, and medical and computer equipment.)
Other sectors of the economy besides agro-business are
seeing significant growth. Uruguay is developing a dynamic
software sector and is already the largest exporter of
software in the region, most of it proprietary. Call
centers, financial services and tourism are also dynamic
sectors where significant investment is taking place.


7. (C) Still, Uruguay has a heavy debt burden and no known
hydrocarbon deposits, so that Venezuelan oil and money
provide considerable temptation to boost the economy.
Uruguay's state oil monopoly ANCAP recently signed a deal
with Venezuela's state-owned PDVSA to help fund oil
exploration in the Orinoco region of Venezuela in return for
a proportional share of the resulting oil. Details of the
agreement remain murky, and observers are skeptical if the
endeavor will result in significant gains for Uruguay. As
for PDVSA's pledge, a year and a half ago, to fund a $600
million refurbishing of Uruguay's refinery to allow it to
process Venezuela's heavy oil, it still remains to be
implemented. There is also much interest in natural gas from
Bolivia, but delivery through the existing pipelines would
necessarily have to pass through Argentina, and thus be
subject to the vagaries of Argentine power needs. Venezuela
has also invested in several failing firms in Uruguay and has
promised to do more. So far, except for oil at preferential
prices, much of Chavez's promises to Uruguay remain
unfulfilled. The GOU has also been the most wary of the

Mercosur countries regarding Venezuela's Banco del Sur
project, though in late June, Uruguay decided to join in on
the project, over the objections of Minister Astori.

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Social Factors in Economic Development
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8. (C) Uruguay still needs to resolve its philosophical
quandary between economic dynamism and socialist
egalitarianism. Many elements for strong economic growth are
in place. The traditional pillars of its economy --
farming, tourism and finance -- are all doing well, and
foreigners are increasingly investing here. But four things
hold Uruguay back. The first is that Uruguay is part of
Mercosur, which now includes Venezuela. Mercosur has
increasingly devolved from an imperfect customs union into a
more political organization, with anti-American overtones.
Uruguay might need the consent of its Mercosur partners if it
were to negotiate a Free Trade Agreement (FTA) with the
United States, though many here argue that no authorization
is needed. Second, the current Frente Amplio government
still harbors hard-line Socialists, Communists, ex-guerrillas
and powerful trade unionists. While in the minority, these
groups are nevertheless quite vocal and influential. Third,
many ordinary Uruguayans seem content to leave large segments
of their economy, including telecoms, power generation, oil
imports and several banks, in state hands. Finally,
Uruguayan culture still values professions that are not
particularly useful or marketable in the global economy.
Universities here graduate too many architects and lawyers
and not enough IT experts, entrepreneurs and engineers. As
with the labor unions, the Communists have considerable
influence among the teachers and in education. Still, an
educated population, strong respect for the rule of law, a
comparatively low crime rate, and a good infrastructure make
Uruguay one of the more attractive destinations in the region
for foreign investment.

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Bilateral Relations: Key Issues
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9. (C) Expanding the trade relationship and encouraging
investment have been the foundation of our engagement with
the moderate segment of the GOU. On May 4, 2006, President
Tabare Vazquez met with President Bush in the Oval Office
where both leaders agreed to deepen our trade relationship.
After this meeting, a series of visits by USTR officials
examined the possibility of FTA negotiations, but the
discussions did not immediately bear fruit. Instead, DUSTR
John Veroneau traveled to Uruguay to sign a Trade and
Investment Framework Agreement (TIFA) on January 25, 2007.
An FTA and Trade Promotion Authority (TPA) issues were
discussed again during President Bush's visit to Uruguay in
March 2007. While President Vazquez is sometimes hesitant to
utter the words "Free Trade Agreement" in public, he and his
administration have repeatedly stressed their eagerness to
maximize bilateral trade. In private, they have made it
clear that their objective is to negotiate an FTA with the
U.S. You may wish to broach the subject of an FTA in your
private meeting with President Vazquez and Economic Minister
Danilo Astori. We advise against raising it with Foreign
Minister Gargano if you meet him, however, because he is
clearly opposed to an FTA with the United States.


10. (C) Aside from trade, we also need to intensify bilateral
cooperation in areas such as counter-terrorism,
counter-narcotics, mil-to-mil cooperation, container
security, border controls, the upgrade of Uruguay's civil
aviation authority to Category 1, alternative sources of
energy (especially wind, bio-diesel and ethanol),
phytosanitary issues and science and technology cooperation.
We also believe that investing in people, through more
cultural exchanges and support to English language training
programs, can make a difference towards changing the
socialist mindset in Uruguay.


11. (C) Following the POTUS visit last March, the NSC sent
taskers to various agencies and bureaus for the purpose of
strengthening our bilateral ties. We have made progress in
several areas, notably bio-fuels cooperation, promoting

entrepreneurship and innovation, and phytosanitary issues.
On June 10-13, Industry Minister Lepra and a group of leading
entrepreneurs from Uruguay were invited by Commerce Secretary
Gutierrez to the first Americas Competitiveness Forum in
Atlanta. The GOU has offered to host a follow-up symposium
on innovation, to be held in Punta del Este in April 2008.
We also arranged for a visit by a high-level Uruguayan
delegation to Texas A&M and North Carolina State University,
two leading universities at the forefront of biofuels
research. Promising cooperation agreements and work plans
were reached with both universities, and with the University
of Minnesota, to develop biofuels in Uruguay. As for
phytosanitary issues, Uruguayan blueberries are close to
being certified for export to the U.S., and there is progress
on the certification of lamb and citrus.

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President Vazquez
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12. (C) A practicing physician (every Tuesday),President
Vazquez is a cautious and prudent man who is sometimes shy in
international settings. He appears to style himself after
Chile's ex-President Ricardo Lagos, and his mild leadership
style sharply contrasts with the bombast of Venezuela's Hugo
Chavez, Argentina's Nestor Kirchner and Bolivia's Evo
Morales. Vazquez is also a pragmatist, and what he most wants
for Uruguay is jobs, investment and growth. At home and
abroad he has been caught between the competing demands of
radicals and moderates in his own coalition, and he often
faces a tremendous challenge to balance these opposing
forces. His leadership style is predictable: he tends to stay
above the fray and allow competing factions in the FA to
debate an issue to exhaustion and then weighs in with a final
decision. Vazquez' adroit and pragmatic leadership, along
with Uruguay's strong institutions and the basically
conservative nature of Uruguayan society prevented the
radical tilt some observers predicted during the 2004
electoral campaign. The contradictions between the radicals
and moderates inside the Frente Amplio will probably have to
be resolved if it is to win the 2009 national elections,
since in the last elections the FA won only 50.1 percent of
the vote. President Vazquez recently declared that he would
not seek to modify the Constitution in order to run for a
second term as President.

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Domestic Politics
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13. (C) Vazquez and his coalition Frente Amplio (FA)
government have been in power for over two years and have
continued to receive high ratings (a June 18, 2007
"Interconsult" poll shows Vazquez with a 59 percent approval
rating.) The moderates in his cabinet, especially Economy
Minister Danilo Astori and Energy Minister Jorge Lepra, have
also enjoyed favorable approval ratings and the President's
confidence, and therefore they exercise considerable sway in
foreign policy and the economy. The radicals within the FA
coalition have challenged Vazquez more seriously than the two
debilitated opposition parties (Blancos and Colorados) who
ruled the country during the past century. Vazquez still
relies on a relatively small cadre of experienced officials
to get things done, including his cabinet-level Chief of
Staff Gonzalo Fernandez. A key ally in domestic politics has
been Agriculture Minister and ex-Tupamaro guerrilla leader
Jose Mujica who, despite his violent past, has often
countered the extreme ideologues on the far-left. (Note:
Mujica is a possible Presidential candidate. His MPP faction
represents about 38% of the Frente Amplio, but many
Uruguayan's distrust his Tupamaro past. A recent poll shows
a 38% approval rating for him among the Frente Amplio and 13%
among non-FA respondents. End Note.)


14. (C) Vazquez has also been able to appease many of the
far-left radicals when he addressed the human rights abuses
committed during the "dirty war" period of the military
dictatorship, uncovered the buried bones of disappeared
persons, and prosecuted some of the perceived worst human
rights abusers. Economy Minister Danilo Astori is another
probable Presidential candidate. Because of his orthodox
economic policies and his past rivalry with Vazquez, he is

not well liked within the Frente Amplio, though his appeal
outside it with swing voters is much greater than Mujica's.
Astori's latest poll figures show a 28% approval rating among
the Frente Amplio and 61% among non-Frente respondents.
Astori is grappling with implementing the recent tax reform
and resisting pressures to spend more in the public budget.
He may quit his post if he firmly decides to run for
President.


15. (C) The opposition Blanco (Nacional) and Colorado parties
are still recovering from their historic defeats suffered
during the 2004 elections, when they received only 34% and
10% of the vote respectively. The likely presidential
candidates in the next (2009) election for the Blanco Party
are Senator Jorge Larranaga ("Alianza Nacional" faction) and
former President Luis Alberto Lacalle ("Herrerismo" faction),
though the latter has recently said that he will not run. For
the Colorado party, Pedro Bordaberry ("Vamos Uruguay" group),
son of incarcerated ex-President Juan Bordaberry seems to be
the only viable candidate at this time, though former
Presidents Julio Maria Sanguinetti ("Foro Batllista") and
Jorge Batlle ("Lista 15") cannot entirely be ruled out. Both
opposition parties are betting on swing voters and that the
Frente Amplio will remain vulnerable on high taxes and soft
on crime.

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Foreign Policy
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16. (C) Uruguay's foreign relations have historically
reflected the efforts of a small nation wedged between two
powerful neighbors to advocate self-determination, respect
for human rights and the rule of law, the pacific settlement
of disputes, and economic cooperation. While Uruguay does
not see eye-to-eye with the U.S. on many international issues
ranging from Kyoto to Cuba to the war in Iraq, both countries
value freedom and independence. Uruguay has always punched
above its weight in foreign affairs, but the ideological
divisions within the Frente Amplio also explain its sometimes
ambiguous foreign policy over the last two years. For
example, the anti-American, pro-Venezuelan Foreign Minister
Reinaldo Gargano was virtually absent from all the
substantive bilateral trade discussions with the U.S. He has
also been a non-player in Uruguay's number one foreign policy
concern: the long-running, serious dispute with Argentina
over the construction of a giant pulp mill on a shared river.


17. (C) By far, the GOU's most serious foreign policy problem
has been the severe bilateral dispute with Argentina over the
construction of a Finnish-owned paper mill on a shared river
-- not only because of soured bilateral relations with
Uruguay's closest neighbor, but also because of the
implications to foreign investment, an independent foreign
policy, the influence of radical NGOs and relations with
Mercosur. At $1.2 billion, the plant's construction cost
represents 6% of Uruguay's GDP and its operation is expected
to generate exports worth 2% of Uruguay's GDP. It represents
the largest Foreign Direct Investment in Uruguay's history.


18. (C) On the other hand, Argentine government officials,
some inhabitants of the Province of Entre Rios across the
river, and environmental activists claim the plant would harm
fishing, farming, and tourist areas along the
Uruguay-Argentina border. Argentina also claims that Uruguay
violated the 1975 Uruguay River Treaty. Aspects of the case
have gone before the International Court of Justice in The
Hague and a Mercosur Tribunal, but Uruguay has sought little
redress with the OAS. The U.S. voted to support the World
Bank's IFC loan to the project. Protesters from Argentina
have blocked bridges between Argentina and Uruguay off and on
since December 2005 at great cost to Uruguay's trade and
tourism revenues. The Uruguayans have felt bullied by
Argentina's treatment and disappointed by Brazil's
indifference. The pulp mill dispute is part of a
schizophrenic relationship with Argentina, as Uruguay
explores possible cooperation on an LNG facility and perhaps
even nuclear power in the long term. The pulp mill dispute
has indirectly (some would say ironically) contributed to
Uruguay's tilt towards the U.S.

19. (C) Uruguay's robust participation in international
peacekeeping operations (PKO) can be partly explained by its
dedication to and faith in international organizations.
(Uruguay has the highest per capita contribution PKO among
participants). Uruguay has stationed over 1,000 peacekeepers
in Haiti and another 1,000 in the Congo. However, Uruguay's
enthusiasm for international PKO is not matched in other
areas of security cooperation, such as UN Security Council
resolutions on Iran, WMD proliferation, and the like. We
expect that so long as the Socialist Foreign Minister remains
at his post, we will continue to experience minimal
cooperation on these types of issues. Uruguay has a growing
drug problem, however, and would like more counter-narcotics
cooperation with the U.S.

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Comment
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20. (C) Though Uruguay is unlikely to ever become a strategic
partner of the U.S., it can be a valuable friend in a region
that has significantly distanced itself from us in many
instances. Uruguay's orthodox macroeconomic policies,
serious debt management and strong respect for the rule of
law place it squarely among other like-minded countries in
the Hemisphere, such as Chile. Uruguayans of all stripes and
political parties remember with gratitude the U.S. Treasury's
$1.5 billion bridge in 2003, considered by most to have saved
the country in the midst of its financial crisis. President
Vazquez went out of his way to thank President Bush for this
crucial assistance in a time of dire need. Over the last two
years, we have been able to build a remarkable level of
confidence with President Vazquez through enhanced trade
initiatives and other confidence-building measures. Now is
the time to clearly define where we want our trade dialogue
to lead us and if an FTA is our shared ultimate goal. It is
also the time to engage Uruguay beyond trade to other areas
of bilateral cooperation including regional stability,
security cooperation, incentives to private enterprise and
investing in people. I believe that we can help Uruguay to
make progress in these areas, but it will take time and
resources. Meanwhile, your visit serves as a very important
building block for deepening our overall engagement with
Uruguay. End Comment.


Baxter