SCENE-SETTER FOR LUGO INAUGURATION

C O N F I D E N T I A L ASUNCION 000535

SIPDIS

STATE FOR WHA/FO CKELLY, WHA/BSC MDRUCKER, BFRIEDMAN,
KBEAMER, S/CPR FOR RMARTINEZ, JPEARON, COMMERCE FOR
SECRETARY GUTIERREZ, SENIOR ADVISOR LGUTIERREZ, TMICHAEL,
ENEWLIN, ADRISCOLL, SCOOK

E.O. 12958: DECL: 08/02/2028
TAGS: PREL ECON PGOV SNAR PA
SUBJECT: SCENE-SETTER FOR LUGO INAUGURATION

Classified By: A/DCM Joan Shaker for reasons 1.4 (b) and (d).

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SUMMARY
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1. (C) Embassy Asuncion warmly welcomes Secretary of Commerce
Carlos Gutierrez and members of the U.S. delegation attending
the August 15 inauguration of President Fernando Lugo. The
Lugo administration represents the first interruption in
Colorado Party rule in 61 years. Your visit provides an
opportunity to promote U.S. interests in strengthening
bilateral commercial ties; combating corruption; shoring up
democratic institutions and respect for the rule of law;
promoting sound economic policies and good governance; and
disrupting criminal organizations. Many Paraguayans support
closer U.S. ties; Lugo privately assures the Embassy that he
wants strong relations, but he has sent some mixed signals on
his possible foreign policy. Your visit demonstrates strong
USG interest in the bilateral relationship and U.S. support
for the new Paraguayan government at a critical moment in
Paraguayan history. END SUMMARY.

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THE POLITICAL SCENE
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2. (C) During his five years in office, outgoing President
Nicanor Duarte Frutos dealt with a pressing fiscal crisis and
put Paraguay's economy on a stable course. Despite his
economic successes, he leaves offices with a 5 percent
approval rating. Duarte -- in an attempt to win the populist
vote -- shifted his government and the ruling Colorado Party
to the left, formally declaring (to wide derision) the
Colorado Party as "socialist." Duarte repeatedly criticized
President Bush and expressed appreciation for Venezuela's
"commitment" to the region.


3. (C) President-elect Fernando Lugo won 40.8 percent of the
vote in the April 20 national elections, 10.2 percent more
than his nearest rival, Colorado presidential candidate
Blanca Ovelar. Lugo's Patriotic Alliance for Change (APC),
including the Authentic Radical Liberal Party, won a large
block of seats in Congress (17 of 45 seats in the Senate; 31
of 80 in the Lower House). Lugo's decisive victory gave his
government a mandate for political, economic, and judicial
reform. He assembled a diverse team of politicians and
technocrats to serve in his cabinet. Lugo, a former Catholic
bishop, pledged to make corruption and de-politicization of
public institutions centerpieces of his new administration,
and expectations are high that Lugo will successfully reform
the government.


4. (C) Embassy officers have had regular contact with Lugo
for the past several years, and have cordial relations with
him and many of his ministers and advisors. Lugo has
expressed interest in U.S. assistance programs, including the
MCC Threshold Program, and has privately assured the Embassy
that he wants close ties. However, his public rhetoric
(including at Venezuelan President Chavez' side on a July
trip to Nicaragua) and his decision to name Foreign Minister
Alejandro Hamed Franco as Foreign Minister over U.S.
objections, send mixed signals.

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THE ECONOMIC REALITY
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5. (U) Paraguay has a predominantly agricultural economy,
with a struggling commercial sector. The country has vast
hydroelectric resources, including the Itaipu hydroelectric
dam built and operated jointly with Brazil. The government
welcomes foreign investment in principle, but widespread
corruption and a weak judicial system are major deterrents to
investment. The economy is heavily dependent on exports of
soybeans, cotton, grains, cattle, timber, sugar, and
electricity.


6. (U) Paraguay's real gross domestic product (GDP) in 2007
of USD 12.8 billion (in 2000 dollars) represented an increase
of 30.6 percent from USD 9.8 billion in 2006. Per-capita GDP
rose to USD 1,928 in current U.S. dollar terms in 2007, up
from USD 1,546 in 2006. In 2007, Paraguay had a current
account deficit of USD 73 million, derived from a small
deficit in the trade of goods, but accompanied by a
significant increase in agriculture exports and services
(electricity). In 2007, official foreign exchange reserves
rose to USD 2.4 billion, an increase of 41 percent over 2006.
Inflation in 2007 was 6.0 percent, down from 12.5 percent in

2006. Agricultural activities represent about 21.9 percent
of GDP and employ just under half of the workforce. More
than 250,000 families depend on subsistence farming
activities and maintain marginal ties to the larger
productive sector of the economy. In addition to the
commercial sector with retail, banking, and professional
services, there is significant activity involving the import
of goods from Asia and the United States for re-export to
neighboring countries. The underground economy, which is not
included in the national accounts, may equal the formal
economy in size, although enforcement efforts by the tax
administration and customs are having an impact on the
informal sector.


7. (U) The domestic labor force included an estimated 2.73
million workers in 2006. Total unemployment for 2006
officially stood at 11.4 percent, up from 9.4 percent in

2005. Total underemployment for 2006 stood at 24.0 percent,
down from 25.1 percent in 2005. With a population growth
rate above two percent annually, a key challenge is the
creation of enough jobs to meet increasing demand. While the
supply of workers is relatively large and growing, experts
cite the lack of a skilled work force as a major obstacle to
economic growth.


8. (U) Bilateral trade with the United States has increased
over the last six years. Although U.S. imports from Paraguay
were only USD 68 million in 2007, up from USD 58 million in
2006, U.S. exports to Paraguay in 2007 were USD 1.2 billion,
up from USD 910 million in 2006. More than a dozen U.S.
multinational firms have subsidiaries in Paraguay, and some
75 U.S. businesses have agents or representatives in
Paraguay. Cargill, ADM, Coca Cola and Exxon Mobile are the
largest U.S. companies operating in Paraguay. As of March
2007, the total foreign direct investment in Paraguay stood
at USD 1,602.52 million. The United States was the largest
foreign investor in Paraguay, with USD 616.50 million,
followed by Brazil with USD 230.85 million. Foreigners
invested a total of USD 110.98 million in Paraguay in 2006,
up from USD 34.79 million in 2005. The largest foreign
investors in 2006 were the United States with USD 67.37
million, followed by Brazil with USD 31.10 million.


9. (U) Political realities render outright privatizations of
state-owned enterprises unlikely in the short term, although
Lugo's economic team is discussing public-private
partnerships to reform state-owned enterprises. The large
state-run companies most attractive to foreign buyers (such
as the telecom and electricity distribution companies) employ
thousands of potential voters and are outlets for political
patronage. The telephone and electricity companies were in
the process of being privatized when the government suspended
privatization in June 2002, bowing to political pressure.
The following are presently state-owned monopolies: rail,
oil and gas, cement, steel, electricity, water, and basic and
long distance land-line telephone services.


10. (SBU) Paraguay and the United States annually discuss
investment and commercial issues via the Joint Council on
Trade and Investment (JCTI). Key trade and investment issues
in the last JCTI, held in December 2007, included U.S.
certification of Paraguayan beef; technical assistance and
investment in biofuels; FDA approval of Paraguay's natural
sweetener stevia, and Paraguay's request to be given
preferential U.S. treatment such as under the Andean Trade
Preference and Drug Eradication Act (ATPDEA) or the African
Growth Opportunity Act (AGOA). In 2006, Paraguay entertained
the idea of a Bilateral Trade Agreement (BTA),but efforts
stalled because Paraguayans felt they were not ready. Post
has not receive any further formal expressions of interest in
a BTA.

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SOCIAL SERVICES NEEDS
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11. (SBU) Inefficient, state-run institutions dominate
Paraguayan social services and public works programs,
including education, health care insurance, and pension
systems. Social services spending increased during the
Duarte administration; however, most spending augmented
employees' salaries. Public schools run two daily shifts of
classes; students typically receive 20 hours of schooling
each week. Student absenteeism and illiteracy are chronic
problems. In addition, many Paraguayans lack basic access to
health care facilities, particularly in rural areas, and many
more are uninsured. The Social Welfare Institute (IPS),
Paraguay's largest insurance and pension provider, disburses
inadequate social security payments and substandard health
care. The Ministry of Health and Social Welfare, Ministry of
Public Works and Communications, and state-owned enterprises
provide basic public services, but access is limited and
services have deteriorated in quality. Lugo has pledged to
improve social services spending and make health care and
education a priority.

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PUBLIC SECURITY CHALLENGES
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12. (SBU) Crime, especially violent crime, is increasing in
Paraguay, and the public generally believes that security is
weak and that Paraguayan security forces do not meet their
security needs. A culture of corruption and distrust hampers
security forces' ability to tackle rising concerns about
public security. Paraguay's National Police are disparaged
by the general population as incompetent and corrupt.


13. (SBU) The "landless" peasant movement has increasingly
taken to protesting and "land invasions" -- illegally
occupying large farms owned in some cases by Brazilians or
Paraguayans of Brazilian descent -- in agitating for agrarian
reform. On some occasions, protests and "land invasions"
have turned violent and resulted in injuries. These
movements are gaining momentum, and Lugo has said land reform
will be a priority, including a national land survey.

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INTERNATIONAL CRIME AND ILLICIT TRADE
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14. (C) Disrupting criminal organizations in the Tri-Border
Area (TBA) of Paraguay, Argentina and Brazil is a primary USG
concern. Lax border controls make the TBA a hub for
trans-national criminal activity including drug trafficking,
trafficking in persons (TIP),arms trafficking, intellectual
piracy, and money laundering. Paraguay is a major
transshipment point for cocaine from Colombia and Bolivia to
Brazil. Much of the northwestern part of the country is
barren and uninhabited, and authorities experience
difficulties enforcing the law because of hostile geography,
corruption, chronic understaffing, and the political and
judicial power some drug traffickers wield. Paraguay is also
a major source of money laundering run by organizations that
frequently have ties to the Middle East. The United States
has had limited success in convincing Paraguay to take a firm
stand on law enforcement issues such as terrorist finance.
While Paraguay has demonstrated political will to expand law
enforcement cooperation with the United States on drugs and
pirated goods, such political will is limited, and is often
hampered by judicial corruption. Echoing Brazil, Paraguay is
highly sensitive to "satanizing" the TBA, and Lugo has spoken
about the "myth of terrorist finance in the TBA," indicating
that cooperation on these issues may be more difficult under
his administration.


15. (U) Paraguay is recognized as a regional distribution and
manufacturing center for counterfeit merchandise. The
re-export trade to Brazil is rife with piracy. Based on the
seriousness of industry concerns, Paraguay was designated as
a Priority Foreign Country in January 1998 by the U.S. Trade
Representative and is subject to Section 306 Monitoring. In
November 2007, the USG and Paraguay signed a two-year
Memorandum of Understanding (MOU) detailing Paraguay's plans
to protect intellectual property rights (IPR) and combat IPR
violations. Paraguay enacted trademark and copyright laws in
October 1998, and the Senate passed a patent law in April
2000, which was again modified in June 2005. Paraguay
ratified all the Uruguay Round accords, including TRIPS, in
late 1994, and has ratified two WIPO copyright treaties. In
the last three years, the Paraguayan government's seizures
and destruction of counterfeit and pirated goods have
increased, and the government has cooperated closely with
industry groups to help fight piracy and counterfeiting. In
addition, Brazilian measures to control the trafficking of
pirated goods coming in from Paraguay are having a
significant positive effect. Nevertheless, IPR crime remains
a major source of illicit income in Paraguay.


16. (SBU) The Paraguayan government approved a revised penal
code June 23 that includes anti-money laundering, IPR and TIP
statutes, and will go into effect in mid-2009. Although the
Chamber of Deputies passed counter-terrorism (CT) legislation
as part of the criminal code, the Senate -- faced with rising
public protests fearing potential abuses -- removed it from
the final version. Without terrorism finance legislation,
the Egmont Group could suspend Paraguay next year.

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CORRUPTION AND WEAK INSTITUTIONS
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17. (U) One of the most serious problems facing Paraguay is
corruption. Weak state institutions, the lack of a rational
civil service system, and uneven political will impede
efforts to fight corruption. Bribery is a crime, but is
rarely prosecuted. Paraguay has signed the UN Convention
Against Corruption, but is not a party to the OECD Convention
on Combating Bribery. The USD 35 million Millennium
Challenge Threshold Program (Plan Umbral),administered by
USAID and slated to end this year, has focused on improving
Paraguay's corruption indicators and formalizing its economy.
The program provides financial assistance and technical
support to Congress, the Finance Ministry, Customs, the
Comptroller, local governments, justice sector institutions,
and civil society organizations. Although Paraguay did not
qualify in 2007 for full participation in the MCC Millennium
Challenge Account because of its corruption indicators, the
Lugo administration is preparing its proposal for Phase II of
the Threshold Program, which will begin later this year.


18. (U) The judicial sector is weak, inefficient, and
corrupt. The slow pace of judicial reform and continued
impunity are barriers to development. Historically,
Paraguay's judicial system has been characterized by a lack
of independence. While efforts are underway to strengthen
the rule of law and make the judicial process more
transparent, unbiased and fair, prominent features of the
current judicial system are patronage and bias.

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BILATERAL MILITARY RELATIONS
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19. (SBU) Paraguay's military is a small force struggling to
redefine its mission. The Army is the largest of the three
services (6,000),followed by the Navy (2,000) and Air Force
(1,200). The military's primary missions are to protect
Paraguay's territorial integrity, defend the constitutional
authorities, and cooperate in civil defense. When called,
the military supports law enforcement activities and public
health campaigns. However, the military's infrastructure and
equipment are obsolete and in desperate need of repair or
replacement. Despite these challenges, the military has
stepped up efforts to professionalize under the guidance of
Military Forces Commander General Bernardino Soto.


20. (C) President Duarte declined to extend Status of Forces
Agreement (SOFA) protections to U.S. military personnel in
October 2006. U.S. military cooperation with Paraguay has
continued, albeit scaled back and under a lower profile. As
a stop-gap measure, the USG concluded a 505 Assurance
Agreement in April 2007 with the government. USG financial
and manpower support for the Paraguay Military Forces is
second to only that of Colombia in South America. U.S. Armed
Forces provided the military's Joint Immediate Response Unit
(DCEI) with more than USD 4.0 million in funding for weapons,
equipment, and training in fiscal years 2007 and 2008. The
U.S. Armed Forces provides financial and technical assistance
to Paraguay's United Nations Global Peace Keeping Operations
Program (UNPKO). The USG committed USD 4.1 million in Global
Peace Operations Initiative (GPOI) funds to help Paraguay
refurbish its Joint Peace Operations Training Center; train
three company sized Multi-role Engineer Companies to deploy
on UNPKO missions under Paraguayan flag; and increase its
capacity to train officers and soldiers. We also facilitate
joint humanitarian assistance and disaster relief exercises
in conjunction with the military and National Emergencies
Secretariat (SEN). The Embassy will seek to negotiate a new
defense cooperation agreement with the Lugo government.
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OTHER U.S. ASSISTANCE TO PARAGUAY
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21. (U) USAID/Paraguay's FY08 budget is USD 7.8 million.
USAID's current strategy focuses on four broad areas:
Economic Growth, Sustainable Management of Natural Resources
and Protected Areas, Democratic Strengthening, and Improved
Health Care. USAID's Economic Growth program works with 30
local firms in the poorest regions of the country to help
them sell their products. The program, called Paraguay Vende,
has generated over USD 60 million in additional sales and
over 30,000 full-time job equivalents in the past four and a
half years. The Economic Growth program is also negotiating
with two local banks to establish US Treasury loan guarantees
to encourage them to make loans in development sectors where
they would otherwise not be active. Via CIPE, a U.S. NGO
which supports private sector initiatives around the world,
USAID is also encouraging dialog between the private sector
and the government-elect on economic growth. In the
environment sector, USAID continues to support improved
management of protected areas. This program, which was
scheduled to end in FY2009, will continue as Latin American
earmarks for biodiversity continue. The Democracy program
accounts for almost one-third of USAID/Paraguay,s budget,
and focuses on national reforms to fight corruption, giving
civil society a voice at the local and national level, and
promoting decentralization and municipal development.
Finally, USAID's health program supports decentralization of
health services, improved maternal and child care services,
and a greater capacity to deliver family planning services.


22. (U) Through its global agreement with Citibank, the
Overseas Private Investment Corporation (OPIC) committed USD
95 million in credit guarantees to local banks. Banco
Regional (USD 15 million),Interbanco (USD 45 million),and
BBVA (USD 45 million) each received an OPIC credit guarantee
to increase lending to small and medium-sized enterprises.


23. (U) The Justice Department's Resident Legal Advisor (RLA)
was instrumental in working with Congress to pass Paraguay's
new penal code legislation. The RLA is now working with
Congress to develop a new criminal procedures bill to
accompany the revised penal code. Advisors from the Treasury
Department's Office of Technical Assistance (OTA) work
behind-the-scenes to assist the Finance Ministry and Central
Bank with customs enforcement, budgeting, and monetary
policy. The Peace Corps also operates in country and has 180
volunteers serving throughout Paraguay. They play a key role
in promoting local institution building.


24. (C) State's International Narcotics and Law Enforcement
(INL) bureau, along with DEA and U.S. Special Forces, assists
Paraguay's Anti-Drug Secretariat (SENAD) in combating
narcotics trafficking, money laundering, IPR violations, and
trafficking in persons. Working closely with the USG, SENAD
has effectively targeted major drug trafficking organizations
and continues to break its own record seizures of marijuana
and cocaine each year. SENAD has made a number of
significant arms seizures with evidence signaling links to
Brazil's Capital First Command (PCC) narco-organization and
Colombia's FARC in PJC and Asuncion. Presently, SENAD is
hard-pressed to meet challenges due to a lack of resources
(its national annual budget is just USD 2 million). SENAD
inaugurated a new operating base and helipad in PJC with USG
assistance in April 2007 and USG assistance has been critical
to SENAD's K-9 (canine) inspection unit at ports of entry in
Asuncion, Pedro Juan Caballero, and Ciudad del Este.


25. (SBU) The Embassy's leading public diplomacy effort is
its English language scholarship program, started in 2006,
which aims to identify academically outstanding young
Paraguayans from families with limited resources. Since the
program's inception, the Embassy has awarded over 500
scholarships, enabling Paraguayans to compete in the
worldwide marketplace and qualify for other U.S. government
programs that require English language skills. Other public
diplomacy programs include Youth Ambassadors, the
Ambassador's Fund for Cultural Preservation, book donations,
and the International Visitors Leadership Program.

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COMMENT
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26. (C) The USG supports President-elect Lugo's stated goals
to fight corruption and improve health and education
services. More so than any other president in modern
Paraguayan history, Lugo has an opportunity to affect real
change. However, he will have many challenges. Lugo does not
have political or governmental experience, or even his own
political party. His diverse alliance represents a wide
spectrum of political persuasions, and Lugo will have a
difficult time navigating the constant political pressures
and infighting to find his own neutral course. Lugo has
stated that both Chile and Uruguay will serve as his models;
we would like to encourage him in that vein, and to assure
him of U.S. support. When meeting with Paraguayan
interlocutors, you should emphasize the USG's long history of
friendship with Paraguay, and that we will work with the Lugo
government to further our mutual interests. END COMMENT.

Please visit us at http://www.state.sgov.gov/p/wha/asuncion

Cason