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Cablegate: Argentina's Growing Trade Deficit with Brazil Spotlights

VZCZCXYZ0000
RR RUEHWEB

DE RUEHBU #1116/01 2221601
ZNR UUUUU ZZH
R 091601Z AUG 08
FM AMEMBASSY BUENOS AIRES
TO RUEHC/SECSTATE WASHDC 1754
RUCNMER/MERCOSUR COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHRC/DEPT OF AGRICULTURE WASHINGTON DC

UNCLAS BUENOS AIRES 001116

USDOC for 4321/ITA/MAC/OLAC/PEACHER

SIPDIS
SENSITIVE

E.O. 12958: N/A
TAGS: ETRD ECON EINV EAGR AR BR
SUBJECT: Argentina's Growing Trade Deficit with Brazil Spotlights
Uncompetitive Argentine Industrial Sector

Ref: (A) BUENOS AIRES 1089, 1079
(B) BUENOS AIRES 860

-------
SUMMARY
-------

1. (SBU) President Lula's August 3-4 visit to Argentina has focused
attention on Argentina's 62-month-long string of bilateral trade
deficits with Brazil. Brazil is Argentina's number one trading
partner and this bilateral merchandise trade deficit, up 47% y-o-y
to US$ 3 billion in just the first six months of 2008, stands in
stark contrast to Argentina's agricultural commodity-driven global
trade surplus, which totaled nearly US$ 11.1 billion in 2007 and US$
5.1 billion in the first half of 2008. In 2007, Argentina sent 19%
of its merchandise exports to Brazil and received 32% of its imports
from Brazil. 2007 trade in goods with Brazil totaled more than
Argentina's combined trade in goods with its next three trading
partners (China, U.S., Chile). The enormous growth in Argentine
imports of Brazilian manufactured goods, despite a 60% appreciation
of the Brazilian real vis the Argentine Peso since July 2003, speaks
volumes about the relative lack of competitiveness of Argentina's
manufacturing sector. Local economists attribute Argentina's
uncompetitive industrial base to uncertainties created by frequent
GoA economic intervention, a shortage of long-term public sector
credit, an appreciating real exchange rate since 2003, outdated
infrastructure, particularly in transportation and power, and
inadequate investment in new infrastructure.
END SUMMARY.

---------------------------------------
62-MONTH-LONG TRADE DEFICIT WITH BRAZIL
---------------------------------------

2. (SBU) Brazil, the 11th largest economy in the world, is
Argentina's number one trading partner. In 2007, Argentina sent 19%
of its merchandise exports to Brazil and, in turn, received 32% of
its imports from Brazil. 2007 Argentine bilateral trade in goods
with Brazil totaled US$ 25.0 billion, more than Argentina's total
trade in goods with numbers two through four (China, U.S., Chile -
US$ 10.3, US$ 9.7, and US$ 4.9 billion, respectively) combined. In
2007, total merchandise imports from Brazil reached US$ 14.5
billion, up 24% since 2006, 88% since 2004, and 209% since 2003.
Argentina's exports to Brazil reached US$ 10.5 billion in 2007, up
29% since 2006, 87% since 2004, and 125% since 2003. Imports of
Brazilian products have risen at a faster pace than the increase in
Argentine exports to Brazil every year since 2003 and Argentina has
sustained a growing trade deficit with Brazil for the past 62
consecutive months. This bilateral trade deficit stands in stark
contrast to Argentina's global trade surplus, which totaled nearly
US $11.1 billion in 2007 and US $5.1 billion in the first half of
2008.

3. (SBU) During the first six months of 2008, Argentina's trade
deficit with Brazil continued to rise and reached US$ 3.0 billion,
47% higher than the same period in 2007. The June deficit of US$
666 million (US$ 1.6 billion in Brazilian imports versus US$ 941
million in Argentine exports) was a 92% increase over June 2007.
Maximiliano Scarlan, an analyst at a Buenos Aires economic
consulting firm, told Argentine press July 2 that the growth in the
bilateral trade deficit, can be attributed to recent Argentina's
export restrictions on wheat (Ref B and see para 7), and GoB
encouragement of its export sector by providing soft national
development bank (BNDES) credits to firms that expand
internationally. GoA Economy Ministry officials and Argentine
business leaders have long complained to Econoffs that such BNDES
credits represent an effective subsidy to Brazilian industry that
places Argentine industry at a comparative disadvantage.

---------------------------------------------
ARGENTINA'S MERCOSUR TRADE A FOOTNOTE TO BILAT BRAZIL TRADE
---------------------------------------------

4. (SBU) Total Argentine trade within the Mercosur bloc has grown
154% since 2003 (imports grew 151% while exports grew 156%) In 2007,
Mercosur trade accounted for 36% (or US $16.0 billion) of Argentine
imports and 22% (or US $12.4 billion) of its exports (Note:
Argentina's trade with Brazil makes up 88% of its total Mercosur
trade.) Brazil and Argentina, the only auto producers in Mercosur
(not including Venezuela, whose full membership is pending
approval), have substantial auto and auto parts trade under a
managed trading system. In 2007, auto sector trade made up 18% of
total intra-Mercosur trade, and Argentina-Brazil auto product trade
in 2006 totaled over US $4 billion. According to many observers,
the managed trade auto pact has played a fundamental role in
sustaining Argentina's support for Mercosur over the years.


-------------------------------
AUTOMOBILES PROPEL TRADE GROWTH
-------------------------------

5. (SBU) The dramatic rise in Argentine imports from Brazil (a 209%
increase since 2003) is due primarily to expanded imports of
vehicles (30% of total imports, a 24% increase from 2006 and 341%
increase from 2003); machinery, reactors, boilers (12% of total, a
25% increase from 2006 and 211% from 2003); electrical machinery
(10% of total, a 11% increase from 2006 and 390% from 2003); plastic
(6% of total, a 26% increase from 2006 and 162% from 2003); and iron
and steel (5% of total, a 26% increase from 2006 and 298% from
2003).

6. (SBU) Argentine exports to Brazil have increased at a slower pace
than imports, rising 125% since 2003. Higher exports are led by
vehicles (29% of total, a 57% increase from 2006 and 450% increase
from 2003); oil (16% of total, a 21% increase from 2006 and 83% from
2003); cereals (12% of total, a 24% increase from 2006 and 40% from
2003); plastic (6% of total, a 4% increase from 2006 and 72% from
2003); and machinery, reactors, boilers (4% of total, a 31% increase
from 2006 and 78% from 2003). While all of the top five Argentine
imports from Brazil are manufactured goods, including vehicles,
machinery; reactors/boilers, electrical machinery, and iron and
steel, commodity exports account for the single largest share of
Argentine exports to Brazil, some 28% of total exports. Imports
from Brazil also include a significant share of capital goods, which
have helped fuel strong growth in Argentina's industrial and
agricultural sectors in recent years.

-----------------------------------------
ARGENTINE WHEAT EXPORTS TO BRAZIL DECLINE
-----------------------------------------

7. (SBU) Since November 2007, GoA restrictions on wheat exports (Ref
B) have led Brazil to source wheat from other countries, including
the U.S. and Canada. However, since Brazil typically relies on
Argentina for 80% of its annual wheat imports, analysts predict that
Brazil will return to Argentina for wheat once supplies are
available and that the GoA's restrictive policies will not trigger a
long-term change in Brazil's buying habits. (Brazil was a
significant buyer of U.S. wheat until the formation of the Mercosur
trade bloc in 1991, which allowed grain to move between member
countries duty-free.) As of late May, Argentina had exported 3
million tons of its 2007-2008 wheat crop to Brazil, far short of the
5.1 million tons normally exported to Brazil each year. Since wheat
is Argentina's number three export to Brazil (making up 11% of total
2007 exports), restricting wheat exports contributed significantly
to the increase in Argentina's bilateral trade deficit in the first
half of 2008.

---------------------------------
PLAN TO TRADE IN LOCAL CURRENCIES
---------------------------------

8. (SBU) Argentina and Brazil's Central Banks have announced they
will implement a new bilateral payment system in September 2008 to
enable the countries to trade bilaterally in their own currencies,
rather than the current method of trading in U.S. dollars. Under
the announced system, there will be a unified exchange rate between
the real and peso, the so-called "reference rate," which will be
applied by the countries' central banks at the end of each day. On
June 26, the GoA's Official Gazette published Executive Order
1003/2008, stating that the plan seeks to "deepen regional
integration, increase the exchange of goods, and reduce financial
costs among its members." On June 27, Brazilian Finance Minister
Guido Mantega told Argentine press that the new payment system will
reduce transaction costs and benefit small and medium size
businesses. The first stage of the plan includes only Brazil and
Argentina, the largest of the four Mercosur members, but could be
expanded to include Uruguay and Paraguay. The Venezuelan government
has expressed interest in this initiative. However, it is unclear
whether Venezuela's request to participate in the new payment system
will be permitted given that its full Mercosur membership is pending
approval by the Brazilian and Paraguayan parliaments.

-------
COMMENT
-------

9. (SBU) The enormous growth in Argentine imports of Brazilian
manufactured goods, despite a 60% appreciation of the Brazilian real
against the Argentine Peso since July 2003, speaks volumes about the
relative lack of competitiveness of Argentina's manufacturing
sector. Local economists attribute Argentina's un-competitive

industrial base to uncertainties created by frequent GoA economic
intervention, a shortage of long term public sector credit, an
appreciating real exchange rate since 2003, outdated infrastructure,
particularly in transportation and power, and inadequate investment
in new infrastructure. Argentina's industrial sector also lacks the
scale provided by Brazil's large domestic market (with 4.8 times the
population and five times the GDP) which offers Brazilian industry
substantial production economies of scale.

10. (SBU) While GoA officials openly complain that soft public
development bank (BNDES) financing for its exporters offers
Brazilian industry an unfair competitive advantage, the Brazilians
reasonably note that Argentine domestic energy subsidies, which
leave electricity and natural gas prices a fraction of those in
Brazil, offer unfair advantages to Argentine producers.

11. (SBU) Brazilian President Luis Inacio Lula da Silva on May 12
announced Brazil's 2008-2010 Program of Productive Development,
defining the country's economic goals and how they will be achieved.
The program's primary objectives are to position Brazilian firms
and production systems among the five largest world players, to
become one of the principle exporters of durable consumer goods and
capital goods, to specialize in areas of high density technology,
and to strengthen Brazilian brand names in the world market. In
contrast to Brazil's well-articulated industrial development policy,
many economic analysts here argue that GoA industrial sector
economic planning remains ad hoc and consummately protectionist.
Industrial sector contacts at the August 4 Brazil-Argentina trade
and investment conference in Buenos Aires (Ref A) commented to
Econoffs that Argentina has much to learn from Brazil, and they hope
Argentina learns it soon, before Brazilian competitors buy out their
firms! On the other hand, a top Argentine banker recently told
Ambassador that the presence of Brazilian firms in Argentina is
having the positive effect of generating more attention to long-term
strategy, in contrast to the very short-term focus of many Argentine
business leaders.

12. (U) Septel will analyze the products involved in the bilateral
trading relationship in greater depth.

WAYNE

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