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DE RUEHBR #1655/01 2231727
ZNR UUUUU ZZH
R 111727Z AUG 06
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TO RUEHC/SECSTATE WASHDC 6317
INFO RUEHRI/AMCONSUL RIO DE JANEIRO 2639
RUEHRG/AMCONSUL RECIFE 5255
RUEHSO/AMCONSUL SAO PAULO 7709
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RUEHAC/AMEMBASSY ASUNCION 5581
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RUEHSG/AMEMBASSY SANTIAGO 5675
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RUEHLP/AMEMBASSY LA PAZ 4768
RUEHBO/AMEMBASSY BOGOTA 3878
RUEHME/AMEMBASSY MEXICO 2021
RUCPDO/USDOC WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS SECTION 01 OF 02 BRASILIA 001655 
 
SIPDIS 
 
SIPDIS 
SENSITIVE 
 
STATE PASS USTR - MSULLIVAN 
USDOC FOR 4332/ITA/MAC/WH/OLAC/MWARD 
USDOC FOR 3134/ITA/USCS/OIO/WH/RD/SHUPKA 
USTDA FOR AMCKINNEY 
AID/W FOR LAC 
TREASURY FOR OASIA 
 
E.O. 12958:  N/A 
TAGS: ETRD EFIN BR
SUBJECT:  MIXED SIGNALS ON LOCAL CURRENCY-DENOMINATED TRADE WITH 
ARGENTINA 
 
 
¶1.  (SBU) Summary.  According to the local press, on July 20 
Brazilian Finance Minister Guido Mantega met with Argentine Economy 
Minister Felisa Miceli on the margins of the Mercosul Summit meeting 
to discuss ways to conduct trade between the two countries in local 
currency (reais/pesos) instead of dollars.  Such proposals have been 
floated unsuccessfully in the past, and Argentine Embassy and 
Brazilian Central Bank (BCB) contacts tell us that the two countries 
are currently far from any agreement on de-dollarizing their trade 
relations, although an exploratory meeting between the two 
countries' central banks is planned for August 14.  Meanwhile, we 
were told, Brazil plans to double down on the issue by proposing 
that all five Mercosul countries use local currency for intra-bloc 
transactions.  Given the complexity of the issues, it is unlikely 
that the GOB would be able to get its bloc partners to agree on this 
before its short five-month Mercosul presidency ends in December. 
End Summary. 
 
¶2. (SBU)  At various times in the past, Brazil and Argentina have 
been perhaps only one or two steps away from  dollarizing their 
economies (either de jure or de facto).  However, in 2003 the 
shortage of dollars in both markets pushed the two governments in 
the opposite direction, i.e., towards greater reliance on local 
currencies.  That year the Sao Paulo Futures and Mercantile Exchange 
(BMF) proposed to then-Argentine Central Bank President Alfonso Prat 
Gay the idea of real/peso denominated trade.  However, negotiations 
between Brasilia and Buenos Aires tailed off in 2004 and later 
stalled completely in 2005 when former Brazilian Finance Minister 
Antonio Palocci became enmeshed in unrelated scandals.  Now current 
FinMin Mantega and his Argentine counterpart have revived the idea. 
 
 
¶3.  (SBU) In 2005, Brasil exported US$9.9 billion worth of goods to 
Argentina, while Argentina sent US$6.2 billion to Brazil. Under the 
contemplated local currency mechanism, payment for these 
transactions would be made in reais and pesos.  Proponents argue 
that such a move would strengthen both countries by: a) making the 
two currencies more widely accepted, and b) lowering operational 
costs.  To the extent that trade flows match, reliance on 
reais/pesos to make payments would be foreign exchange neutral as 
the respective Central Banks and currency futures trading via the 
BMF could be used as a conduit to allow exporters to recycle the 
local currency to importers.  Still unanswered, though, is the 
question of whether the two central banks would purchase businesses' 
excess pesos or reais.  Given that Brazil over recent years has run 
a consistent trade surplus with Argentina, the BCB could expect to 
have to purchase pesos from Brazilian businesses, presumably for 
immediate resale to the Argentine Central Bank.  And if the BCB did 
so, what currency would it use to effectuate payment? 
 
¶4. (SBU) An advisor to the Board of the BCB told us that the idea 
echoes in many ways currency settlements mechanisms created in the 
1970s (and then abandoned in the early 1980's) to facilitate trade 
between hard-currency starved countries.  In those arrangements, the 
central banks served as clearing houses, purchasing the foreign 
currency (zlotys, pesos, etc) from local exporters using local 
currency (e.g. Reais) and then settling accounts quarterly or so 
with the counterpart central bank.  The central banks bore the 
exchange rate risk until the settlement took place and any surplus 
that one side had was paid in hard currency.  According to our BCB 
contact, the arrangements collapsed in large part because the 
central banks could not continue to bear the exchange rate risk as 
more and more countries liberalized capital movements and moved to 
flexible or floating exchange rates.  While overcoming this problem 
would be the biggest challenge for the renewal of such local 
currency settlement mechanisms, the BCB advisor noted that it could 
be done to the extent that the currency risk was hedged immediately 
(by the exporter or importer) using BMF futures contracts. 
 
 
BRASILIA 00001655  002 OF 002 
 
 
¶5.  (SBU)  Argentine diplomats tell us that, based upon their 
conversations with GOA Central Bank staffers, the idea of conducting 
bilateral trade in reais/pesos is one that is not yet ripe. 
Notwithstanding Miceli's initial contact with Mantega, the true 
demandeur on this issue, they say, is Brazil.  The BMF, they note, 
would gain by selling peso/real currency futures to businesses as 
might Brazilian small and medium-sized enterprises which sometimes 
find the cost of conducting dollar-based transactions, which entails 
two currency trades (from Reals to dollars and then to pesos or vice 
versa), too expensive.  However, in the short-term Argentine 
exporters want to keep the dollars they receive from Brazilian 
buyers and thus may look at the scheme askance.  Meanwhile, a 
technical-level meeting between staff of the two countries' central 
banks is scheduled for August 14 in Sao Paulo for what a BCB contact 
said are "very preliminary" discussions.  According to our contacts, 
no concrete proposals are likely to be floated; instead, the two 
sides will take the opportunity to "brainstorm." 
 
¶6.  (SBU)  Notwithstanding the fact that bilateral Brazil-Argentina 
local currency trade may not be ready for prime-time, we were told 
that Brazil intends to move further and propose that all Mercosul 
transactions be conducted in local currency.  Our Argentine Embassy 
contacts speculated that Brasilia was charging forward on this 
because it wanted to local currency trade to be one of its highlight 
achievements during its current 5-month Mercosul presidency, which 
terminates at the end of 2006. 
 
¶7. (SBU) Comment.  While local currency trade within Mercosul is a 
laudable goal, post does not see it coming to pass anytime soon. 
The lion's share of commerce is between Brazil and Argentina.  If 
those two countries can't agree on the concept, it will be all the 
more difficult to forge consensus with Uruguay, Paraguay and 
Venezuela.  End Comment. 
 
Sobel