• GB Davis

Geopol: Brazil Wields a Strong Hand (Mercosur) and Front to Argentina

Anyone watching the Argentinian CDS Market YTD? Last-52?? $EWZ? Check-in.

"Brazilian Foreign Minister Ernesto Araujo has arrived in Argentina for a two-day visit to present a proposal for eliminating the common external tariff of the Common Market of the South (Mercosur), Filo News reported April 9. Brazilian President Jair Bolsonaro has proposed amending the Mercosur charter to allow its member states to freely sign free trade agreements with other countries outside the bloc. The charter in its current form only allows collective negotiation and signature of such agreements.

Negotiations between Argentina and Brazil over Mercosur tariffs are expected to be contentious as Buenos Aires will likely call for a more gradual tariff reduction, compared to a more rapid proposal by Brasilia. If negotiations experience a major delay, other trade reform proposals, such as amending Mercosur members' ability to sign free trade agreements independently, may also become threatened.

Mercosur was founded as a protectionist trade bloc and has a common import tariff of up to 35 percent on certain products to shield domestic manufacturing from foreign competition. This protectionism has allowed member states to create profitable manufacturing clusters for the automotive and aviation sectors in the face of stiff global competition, but it has hamstrung their ability to sign free trade agreements with other countries and blocs. Mercosur is an agricultural powerhouse — particularly in livestock and sugar — and that considerable production raises fears in trading partners protective of their farming sector and also leads to slow, complicated and cumbersome talks.

Uruguay, a strongly export-oriented bloc member, began suggesting changes to the charter as early as 2015. Unlike Brazil and Argentina, Uruguay has few key domestic manufacturing industries to protect, and agricultural products such as beef are its main source of export revenue. Bilateral negotiations would make it easier for it to take advantage of the growing demand for its agricultural goods.

Argentina and Uruguay appear to favor granting members waivers to negotiate new deals, but the incoming Bolsonaro administration seems to favor killing the restrictive 2001 clause. Under the Argentina-Uruguay proposal, individual nations would receive exemptions to begin negotiations that other members would have the option of joining. For example, Brazil could open talks with the United States, and Argentina and Uruguay would be allowed to be a part of the discussions and final deal.

Argentines weary of utility price hikes, high inflation and the country's economic slowdown could easily bring a populist Peronist administration to power. A Peronist government could resist amending the policy and push Brazil into taking more drastic measures. In response, Bolsonaro could threaten to withdraw from the bloc as a pressure tactic.

Under Mercosur's charter, a member state can leave the bloc simply by giving 60 days' notice and repealing the legislation implementing its membership. Bolsonaro's threat would raise uncertainty for investors and even citizens of Mercosur states, since Brazil's future trade ties and political relationship with the rest of South America would be unsettled. If Brazil did withdraw, it would have to decide whether to remain an associate member — enjoying the trade and travel benefits of Mercosur membership but without the bloc's common external tariff or bilateral trade restrictions.

Macri's successor will also inherit a country in the midst of a recession, with sky-high inflation and a steep collapse in imports — making broad, long-term trade reforms an even tougher political sell. Any new administration will likely be reluctant to agree to measures that could make Argentina's domestic manufacturing base even more vulnerable to foreign competition. And Bolsonaro's proposed amendment has the potential to do just that by allowing bilateral trade deals between Brazil and other nations to occur without Argentina. Such negotiations could, in theory, expose Buenos Aires to heavier imports, as well as erode its exporters’ share in the Brazilian market. With Uruguay and Paraguay likely maintaining their pro-reform support, Bolsonaro’s push to bend Mercosur to his will largely rides on maintaining Argentine support.

Thus, there's a good chance that Brazil’s private sector and Congress would align against any move by Bolsonaro to withdraw from Mercosur. In doing so, Congress could even hold key pieces of legislation that his administration wants to pass, such as security reforms, hostage until Bolsonaro steps down from leaving the bloc. Bolsonaro's government, therefore, ultimately may be forced to either reduce its trade demands to more modest aims, or desist entirely." via Stratfor.

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