THE VAZQUEZ ADMINISTRATION AT THE HALFWAY MARK

C O N F I D E N T I A L MONTEVIDEO 000917

SIPDIS

SIPDIS

DEPT FOR WHA A/S SHANNON AND EB A/S SULLIVAN
DEPT PLEASE PASS USTR
TREASURY FOR OASIA
COMMERCE FOR ITA/MAC/WBASTIAN
NSC FOR FISK
SOUTHCOM FOR POLAD

E.O. 12958: DECL: 10/23/2017
TAGS: PGOV PREL ECON EINV ETRD SOCI ELAB PINR UY
SUBJECT: THE VAZQUEZ ADMINISTRATION AT THE HALFWAY MARK

REF: MONTEVIDEO 0853

Classified By: Ambassador Frank E. Baxter
for reasons 1.4(b) and (d)


1. (C) Summary: The Frente Amplio (FA) government of
President Vazquez passed its halfway mark last month. This
cable provides our assessment of the first half of the
Vazquez administration as it relates to foreign relations,
economic policy and domestic issues. Our overall assessment
is positive and one that bodes well for the stability of
Uruguay and for the bilateral relationship with the U.S.
That said, we believe that Uruguay's traditional moderation
should not be taken for granted and continued engagement is
of the essence, as the FA still contains radical and old-line
socialist elements.


2. (C) Since March 2005, Uruguay's Foreign policy has been
characterized by pragmatism, some confusion and a much closer
relationship with the U.S. than had been initially expected,
culminating in Vazquez's visit to Washington in May 2006 and
President Bush's visit to Montevideo in March 2007. The key
to this engagement has been trade, but we are now expanding
our dialogue to other issues such as security. Uruguay's
relations with Mercosur have been tense, and Vazquez's talk
of "more and better Mercosur" has not materialized. The pulp
mill dispute with Argentina brought relations with this close
neighbor to their lowest point in decades. The relationship
with Cuba has been minimal. As for Venezuela, there have
been some business deals --mostly oil with favorable
financing terms and barter agreements--, lots of unfulfilled
promises by Chavez, but not much else. The GOU's involvement
in Telesur is also minimal, but the station broadcasts a
continuous stream of anti-U.S. propaganda in Uruguay. On
military matters, the GOU continues its strong participation
in PKO, in particular in Haiti and the Congo. There remains a
reluctance to allow exercises with "U.S. boots on the ground."


3. (C) Orthodox macroeconomic policies, good debt management
and high commodity prices have fostered continued strong
growth, with inflation under control and dropping
unemployment. Foreign trade is more diversified than ever
and has reached record levels. The forestry sector is taking
off as one of Uruguay's leading exports in the near future,
with very significant foreign investments in the billions of
dollars. Brazilian investment in agro-industry has been
quite strong. On the micro side, initial moves favoring
labor unions backfired, leading to several occupations of
plants. The GOU appears to be backtracking. The most
controversial initiative has been the tax reform spearheaded
by Economy Minister Astori, which instituted for the first
time a personal income tax. The middle class is being hit
particularly hard and the opposition has seized on this
unpopular tax as a major issue for the next election
campaign.


4. (C) The FA administration started out by playing both
government and opposition, as various ministers publicly
voiced opposite views and claimed to speak for the
government. This made for contradictory signals in both
foreign and domestic policy over the first year of
government. Over time, Vazquez's repeated interventions have
brought about a more consistent and predictable expression of
the government's policies. However, while disagreements are
not expressed in public as often as they used to be, strong
differences of opinion remain among Cabinet ministers. The
relationship with the opposition parties remains tense, and
the opposition has tended to be obstructionist as a "payback"
to the FA for when it was in opposition. Human rights issues
dating back to the dictatorship have taken less of a role in
recent months, though the far-left continues to beat this
drum. Finally, while the next election is still two and a
half years away, potential candidates both within the
government and in the opposition, are seriously beginning to
position themselves. Vazquez has pledged he would not run
for re-election (this would require a constitutional
amendment),but some insiders tell us that he may do so in
the end, as no other candidate appears to have the requisite
appeal needed to hold the FA coalition together. End Summary.

--------------
FOREIGN POLICY: POSITIVES
--------------


5. (C) Constructive relationship with the U.S.: President
Vazquez is proving to be a pragmatic leader, bent on building
a constructive relationship with the U.S. The positive state
of current bilateral relations would have been unthinkable
before the traditionally "anti-imperialistic" Frente Amplio
took office. Vazquez's visit to Washington in May 2006 and
President Bush's visit to Uruguay in March 2007 cemented a
rapprochement at the highest levels. Several high-level
visits followed, including U/S Burns, A/S Tom Shannon,
Treasury Secretary Paulson and Commerce Secretary Gutierrez.


6. (C) Trade and investment agreements: President Vazquez
personally signed a Bilateral Investment Treaty (BIT) with
President Bush in Mar del Plata in November 2005, and
obtained quick ratification by the Uruguayan Parliament. The
BIT entered into force in November 2006. After coming close
to initiating talks on a Free Trade Agreement (FTA) in
September 2006, the GOU agreed to a Trade and Investment
Framework Agreement (TIFA),which it signed in January 2007.
A first meeting of the Trade and Investment Council (TIC)
subsequently took place in Washington in April, where eleven
working groups were tasked with discussing issues that do not
require congressional notification. A stocktaking meeting of
the next TIC is tentatively set for late November in Uruguay,
to determine the way forward.


7. (C) Rapprochement with Chile: In April 2007, President
Vazquez traveled to Chile with four ministers and a large
delegation of businessmen. Presidents Bachelet and Vazquez,
both of them physicians, have developed an excellent personal
rapport. Finance Minister Astori also has a good rapport
with his Chilean counterpart Andres Velazco, who suggested to
Secretary Paulson that Uruguay be included in the Secretary's

SIPDIS
meetings of like-minded countries. One such meeting, uniting
the Finance Ministers of Chile, Mexico, Uruguay and the U.S.
took place in July in Montevideo. In the ministers, private
meeting, Astori highlighted the similarities between Chile's
and Uruguay,s economic policies.


8. (C) Business deals with Chavez, not much more: While he
visited Venezuela and hosted Chavez on several occasions,
Vazquez has carefully avoided supporting Chavez's populist
policies for Latin America. Chavez himself tends to be
subdued when he visits Uruguay, where he has not been
provided a venue for large gatherings, as has been the case
in other countries. The GOU eventually joined Chavez's Banco
del Sur, but has expressed some misgivings about the
organization, indicating its clear preference for
multilateral financial institutions. In Vazquez's words,
"Uruguay must be present, but the exact nature of its
participation has yet not been defined." Agreements with
Chavez have been business deals, mostly oil purchases at
preferential rates and barter deals exchanging Uruguay's agro
expertise and software for Venezuelan oil. Venezuela's bank
Bandes also bought out a failed Uruguayan financial
institution. Vazquez has not endorsed Chavez's revolution,
nor accepted his leadership in the region, and Uruguay is not
taking part in ALBA, Chavez's project to counter the FTAA.
Still, in his capacity as Mercosur's pro-tempore president,
Vazquez has publicly stated his support for Venezuela's
integration into Mercosur.


9. (C) Minimal relations with Cuba: Vazquez's first
political act upon taking office was to restore diplomatic
relations with Cuba. There has not been much contact with
the Cuban regime since then. While he has repeatedly been
invited to visit the island, Vazquez has consistently
declined the offer, blaming his busy agenda. Only the
Minister of Health and the Minister of Social Development
(Communist leader Marina Arismendi) have traveled to Cuba.
The GOU sent over 1,800 patients for eye-surgery in Cuba, a
controversial move that drew loud protests from local
ophthalmologists. This program has now been terminated.


10. (C) Pol/mil cooperation and PKO participation: Uruguay's
participation in UNITAS exercises and peace-keeping
operations (PKO) were controversial at the beginning.
Uruguay participated in UNITAS operations in 2005, but turned
them down in 2006. Still, the country took part in Panamax
2007, and the Minister of Defense has started a discussion on
participation in the 2008 UNITAS exercises. Uruguay
continues to be the highest contributor to PKO on a
per-capita basis, with important contingents in both Haiti
and the Congo.

--------------
FOREIGN POLICY: NEGATIVES
--------------


11. (C) Low marks for Gargano: Minister of Foreign Affairs
Gargano gets the lowest marks. In spite of disagreements
over foreign policy issues, Vazquez has kept Gargano in
office, so as to maintain the delicate balance between the
factions of his coalition. Vazquez has, however, excluded
Gargano from important issues, such as the paper mill
negotiation with Argentina and trade talks with the U.S. An
old-fashioned Socialist, Gargano is generally hostile to the
U.S. and is the main opponent to an FTA with the U.S. He
demonstrated this during his speech at the UNGA. Gargano was
also the driving force behind the GOU's support for
Venezuela's accession to Mercosur and the subsequent
ratification of this accession by the Uruguayan Parliament.
He strongly supports Bansur and Parlasur as tools for closer
political and economic integration.


12. (C) Deep disappointment with Mercosur: The relationship
with Mercosur remains tense and the GOU is deeply
disappointed with the bloc's failure to address Argentina's
perceived aggression against Uruguay in the pulp mill
dispute. The business community continues to be vocal in its
criticism of Mercosur, and there is a clear cut within the
GOU. While Foreign Minister Gargano is an adamant supporter
of Mercosur, Economy Minister Astori is very critical of the
bloc's inaction and of Brazil's lack of leadership. Astori
has repeatedly pressed Mercosur for a decision on granting
Uruguay the flexibility to negotiate an FTA with the U.S. He
has pledged to keep pressing during Uruguay,s current pro
tempore presidency and has warned that Uruguay's patience is
limited. President Vazquez's position has also been quite
critical of Mercosur, but he has never explicitly stated an
intent to leave the bloc altogether.


13. (C) An ineffective Parlasur: Mercosur's Parliament has
so far failed to vote on relevant issues, such as the ongoing
pulp mill conflict, the integration of Venezuela into the
bloc or Chavez's decision not to renew RCTV's license. In
the first Parlasur meeting, the Argentine delegation
unexpectedly left the floor ) allegedly to catch their
flight ) when Uruguayan parliamentarians motioned to discuss
the RCTV case. Venezuela's entire delegation did not show up
at the second meeting, allegedly because they could not find
seats on commercial flights. Everyone was present at the
third meeting, however, when an Uruguayan Representative
finally tabled the RCTV issue, prompting an irate reaction
from the Venezuelan representatives.


14. (C) Strained relations with Argentina: The conflict with
Argentina over the pulp mills has greatly deteriorated the

relationship between the two neighbors. The ongoing conflict
has sometimes reached extremely tense peaks, something
unthinkable before Vazquez took office, given the
traditionally strong bonds between the two countries.

--------------
ECONOMIC POLICY: POSITIVES
--------------


15. (C) Sound economic policy: Uruguay has continued to enjoy
robust growth rates of 6.0%-7.0% per year, thanks to strong
macroeconomic policies, renewed market confidence, and a
booming world and regional economy that has propelled
exports. Uruguay's external sector remains strong, with
buoyant exports and import growth driven by large foreign
direct investment projects. Real wages rose 11% since the FA
took power, especially in the private sector, which was hit
hardest by the 1999-2002 crisis. Unemployment has dropped to
under 10% in mid-2007. In a recent speech to commemorate the
halfway mark of his administration, Vazquez pledged that
"there will be no change in economic policy."


16. (C) Sound debt and fiscal management: Abundant
international liquidity has allowed the GOU to apply good
debt management policies. Since March 2005, the GOU has
extended the time structure of its debt and managed to slash
the debt/GDP ratio from 100% in 2003 to its current 70%.
Risk rating firms have upgraded Uruguay's credit rating
several times, and the country risk now stands at about 200
points. Despite a significant increase in public
expenditure, fiscal accounts remain strong with primary
surpluses averaging about 4% of GDP since 2004.


17. (C) Good relations with the IFIs and a recovering
financial system: In late 2006, the GOU made an early
repayment of its entire debt with the IMF ($1 billion) and
canceled its stand-by program. However, contrarily to
neighboring Argentina, the GOU sought to preserve a working
relationship with the Fund. The IMF recently praised
macroeconomic developments and assessed that "Uruguay has
largely reduced its economic vulnerabilities." The financial
system continues to recover from the 2002 banking crisis.
Deposits and credits are on the rise, delinquency rates are
falling, and banks' balance sheets show positive figures.


18. (C) Growing foreign investment: Uruguay is receiving
large amounts of foreign direct investment (FDI). Brazilian
investors have been particularly active of late and now
control about 30% of Uruguay's beef exports. FDI was 4.3% of
GDP in 2005 and hit 7% of GDP in 2006, way above the
historical average of 1.5% of GDP. The GOU sent positive
signals of standing up for contracts and the rule of law by
consistently defending Botnia's pulp mill from Argentina's
attacks. The plant's operations should start within the next
month.


19. (C) Expanding bilateral trade with the U.S.: The U.S.
was Uruguay's first export market in 2004 and 2005, and is
now its second largest, slightly behind Brazil but 70% larger
than Argentina. U.S. exports to Uruguay have also increased
significantly, exceeding in the first 7 months of 2007 their
total for the entire year in 2006.

--------------
ECONOMIC POLICY: NEGATIVES
--------------


20. (C) Distortions in labor market and a bias towards
unions: The most negative facets come from the Ministry of
Labor, headed by an ex-MPP leader. The FA has strengthened
existing unions and provided incentives for the creation of
new ones. The labor Ministry is perceived as biased against
business, and various laws have strengthened workers' rights.
Several plants were occupied by workers in the early stages
of the FA government, but it appears that the GOU is now
backtracking, after realizing the negative impact of these
situations on the rule of law and property rights. The
number of labor conflicts has come down significantly, as new
regulations are being implemented to control excesses.


21. (C) Fears of inflation and some meddling with prices:
Inflation picked up in 2007, due to a combination of external
and internal factors. The 12-month inflation through August
2007 was above 9%, well above the Central Bank,s range of
4.5%-6.5%. Minister of Agriculture Mujica has been pressing
the private sector to control prices, while Astori has
resisted any attempt at price controls.


22. (C) Negative signal on land ownership: In 2007, the GOU
passed a law limiting the ability of corporations to own
land. The law does not discriminate between foreign or
national investors, but is certainly a deterrent to major
investors. The GOU later met with executives from
Weyerhaeuser, the largest U.S. holder of forested land, to
assure them that they would be exempted from the law. The
real targets of the law appear to be shell companies and in
some cases pension funds.


23. (C) A controversial tax reform: In mid-2007 the GOU
instated a major tax reform that instituted for the first
time a personal income tax (a central campaign proposal from
the Frente Amplio.) The new personal income tax only affects
incomes generated in Uruguay (income generated abroad is
exempt),with progressive rates ranging from 10% to 25%.
Given the extremely limited number of deductions, this
personal income tax close to a tax on wages. The impact on
middle class families has been severe and is bound to affect
savings and consumption. The tax reform lowers corporate
taxes, however, and offers incentives for investment.

--------------
DOMESTIC ISSUES: POSITIVES
--------------


24. (C) The FA coalition remains intact: President Vazquez
has done a good job at holding together his coalition, an
heterogeneous grouping of seven large factions. In his
non-confrontational and pragmatic style, Vazquez tends to
come in with his decision at the last moment, after the
factions have fought it out among themselves to exhaustion.
The coalition then rallies around his decision. He has
managed to garner parliamentary support for all of his
initiatives.


25. (C) Old human rights issues have been contained: The FA
came to power pledging to expose the truth about human rights
abuses during the dictatorship and going after the people
responsible for these actions. The issue of the
"desaparecidos" (missing persons) was at the top of the
agenda, and so was the eventual repeal of the "Ley de
caducidad" (the amnesty law). In the end, what could have
turned into a frenzy for revenge was handled in a slow and
deliberate Uruguayan way, with just enough progress on the
issue of the missing persons, and a decision by the President
not to repeal the amnesty law. The public in general appears
to approve the decision not to reopen a painful past.

--------------
DOMESTIC ISSUES: NEGATIVES
--------------


26. (C) A tense relationship with the opposition: Throughout
the first half of his term in office, Vazquez and his
government have had a rough relationship with the opposition.
At first shocked by their defeat, opposition parties have
started to be more aggressive on issues such as the tax
reform, the deals with Venezuela, alleged malfeasance in
public casinos, and in general making life as difficult for
the GOU as the FA used to make it for them. The Blanco Party
has been particularly aggressive, as it appears to have the
best chances against the FA in the 2009 contest. Popular
support is falling for the Frente Amplio and growing for the
Colorados.


27. (C) Cracks are appearing within the FA: The MPP, the FA's
major faction that got 39% of votes in the past elections,
recently split when Fernandez Huidobro left the group led by
radical leader Marenales to create a new faction called
CAP-L. Mujica's leadership had been so far undisputed, but
the excision could create more internal frictions within the
MPP. This is relevant since Mujica has acted as a key
articulator amongst FA's factions and has so far remained
loyal to President Vazquez. As the proponent of the recent
tax reform, Astori has lost ground with the middle class and
has been criticized within the FA itself. There seems to be
an open season on Astori within the FA.

--------------
COMMENT: A MODERATE AND PRAGMATIC GOVERNMENT
--------------


28. (C) At its halfway mark, the FA government has proved to
be surprisingly pragmatic, having made few significant
changes to the foreign or economic policy of the previous
governments. There have not been any of the marked shifts so
common to the region, with constituent assemblies,
nationalizations or populism. The reasons probably lie with
Uruguay's strong middle class -the largest in proportion to
the population in Latin America, with the best income
distribution- and the profoundly conservative nature of its
society, which prizes stability and civility and abhors
radical change. The Uruguayan proclivity to civil discourse
made the strident and threatening tone of the Argentine
protests in the paper mill dispute all the more shocking to
Uruguayans. The GOU was deeply disappointed by Mercosur's
inaction and Brazil's lack of leadership in trying to resolve
this dispute. As for relations with populist regimes,
symbolic gestures were made to Cuba early on, and the GOU has
been civil with Chavez, negotiating business deals when
convenient. Bolivia's Morales and Ecuador's Correa have been
more or less ignored. The most welcome development has been
the positive and broad relationship developed with the U.S.,
a move that further isolates the most anti-American members
of the ruling coalition.


29. (C) The very nature of the FA, a broad coalition ranging
from the extreme left to the moderate center-left, seems to
have prevented any radical moves. Vazquez has had to tack
constantly from one side to the other, trying to maintain a
course that increasingly appears aimed at emulating Chile's
model of development. However, the incessant -but
politically necessary- tacking has made progress
painstakingly slow and has led to missed opportunities, such
as that of initiating FTA talks with the U.S., a real
possibility in early 2006.


30. (C) As we move to the second half of Vazquez's term, the
next election looms larger. Vazquez has pledged he would not
run for re-election (this would require a constitutional
amendment),but some insiders tell us he may do so in the
end, as no other candidate appears to have the appeal to hold
the FA coalition together. Already pre-candidates are
positioning themselves. Astori, the heir apparent, may have
seriously damaged his chances with his unpopular tax reform.
Not one to lose an opportunity, ex-President Batlle recently
called on the opposition to agree on a thematic program
(reftel) that includes a repeal of the personal income tax.
There is now talk of Vice-President Nin Novoa as the possible
FA candidate, with Interior Minister Tourne (a Socialist)
possibly as his running mate. On the opposition side, Blanco
candidates are also positioning themselves, with ex-President
Lacalle and Senator Larranaga the ones with the best chances.
For the Colorados, senators Abdallah and Bordaberry lead the
pack. Polls indicate that there would probably be a second
round in the 2009 election, and that the opposition may have
a shot at winning it, but it is still very early in the game.
Overall, the seamless transition to a leftist government and
the responsible way in which this administration has governed
clearly highlight Uruguay's strong democratic principles,
solid institutions and stable society. End Comment.

BAXTER
Baxter