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Chavez Diplomatic Coup Deepens Rift in Brazil-Led Trade Pact

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July 31 (Bloomberg) -- Hugo Chavez’s back-door entry into the Mercosur trade bloc led by Argentina and Brazil casts doubt on the future of a pact that has fueled a tenfold boom in commerce between South America’s two biggest economies.

Chavez is attending today’s ceremony in Brasilia welcoming Venezuela as a full member of the world’s third-biggest free trade area after Paraguay was suspended last month over lawmakers’ ousting of President Fernando Lugo. Paraguay’s refusal to ratify Venezuela’s admission had held up since 2006 the country’s entry into the four-nation group, which also includes Uruguay.

Paraguay has contested Venezuela’s membership, winning support from top Uruguayan officials and Brazil’s opposition, who say Chavez’s human rights record and seizure of foreign-owned companies is anathema to a group founded to promote democracy and trade. With Chavez lobbying for a more politicized Mercosur to advance his anti-U.S. agenda, his entry may isolate the group from a trend toward greater openness in the rest of Latin America, former Brazilian diplomat Marcos Azambuja said.

“Mercosur will become less effective and less relevant with Chavez,” Azambuja, who was ambassador to Argentina as well as deputy foreign minister when the bloc was created, said by phone from Rio de Janeiro. “He’s not destroying Mercosur, but he’s making the road ahead slightly bumpier.”

Losing Momentum

The creation of the free trade zone two decades ago was a driver of trade between Argentina and Brazil just as South America’s longstanding economic rivals were emerging from decades of military rule. Trade between the two countries surged to $32 billion in 2010 from $3 billion when Mercosur took effect in 1991, according to data from the United Nations’ Economic Commission for Latin America and the Caribbean.

Manufacturers such as Fiat SpA and Volkswagen AG also set up cross-border supply chains to get around an external tariff wall of 35 percent and gain access to a market that now comprises 280 million consumers. With a combined gross domestic product of $3 trillion, Mercosur is the world’s third-largest free trade area after the European Union and North American Free Trade Agreement that includes the U.S., Mexico and Canada.

Uruguayan President Jose Mujica at today’s meeting said that Venezuela’s entry into Mercosur represented a historic triumph for the cause of Latin American integration after decades of foreign domination of the region.

‘Vision of Giants’

“In the past there were great men, with a vision of giants, but they were condemned to defeat because the historical conditions didn’t favor them,” Mujica, a former member of the Cuban-inspired Tupamaros guerrilla movement, said while standing alongside Chavez. “For too long we’ve looked at the rest of the world instead of at each other.”

Still, Mercosur’s push to reduce trade barriers has lost momentum, and even gone into reverse as Argentina and Brazil haggle over everything from trade in shoes to pork amid a slowdown in economic growth. The bloc’s share of global foreign direct investment, after surging to 6 percent in 1997 from 2 percent in 1991, has since retreated to 4 percent in 2010 despite rising Chinese demand for the region’s raw materials, according to World Bank data.

One reason for the decline is weak investment safeguards. Argentina faces more compensation claims from companies at the World Bank’s International Centre for Settlement of Investment Disputes than any other country. Venezuela is ranked second.

Trade Deficit

Last year, as Argentina’s trade deficit with Brazil widened to $4.5 billion, tensions between the two countries escalated. Argentina began delaying the processing of import licenses to slow shipments, said Mauricio Mesquita Moreira, chief trade economist at the Inter-American Development Bank. President Dilma Rousseff’s government then retaliated by reducing imports of cars and other goods.

“This clearly goes in the opposite direction of the ambitions of the Mercosur agreement” to replicate the European Union’s free flow of goods and people, Moreira said by phone from Washington. “Either you have a common market or you don’t.”

Steering Venezuela’s entry into Mercosur was Argentine President Cristina Fernandez de Kirchner, one of Chavez’s top allies.

Fernandez’s seizure in April of Spanish-owned oil producer YPF SA and inflation that analysts estimate exceeds 20 percent have put the two countries on a similar economic track, with investors demanding 1,000 basis points in extra yield to own their government debt instead of U.S. Treasuries. In contrast, Brazil’s country risk has narrowed 36 basis points this year to 189, according to JPMorgan Chase & Co’s data.

Leading Growth

Still, thanks to a surge in spending by Chavez ahead of October’s presidential election, Venezuela is the fastest-growing of the three, forecast to expand 4.95 percent this year compared with 2 percent and 2.15 percent growth for Argentina and Brazil respectively, according to a Bloomberg survey of economists.

Venezuela risks diverting Mercosur even further from its mission given Chavez’s support for protectionism, said Michael Shifter, president of the Inter-American Dialogue in Washington.

Venezuela’s “burdensome” import rules and corruption makes it one of the world’s most closed economies, beating out only by Burundi and Chad, according to a 2012 report by the Geneva-based World Economic Forum that ranked 132 nations for trade openness. Argentina is ranked 96th and Brazil is 84th.

Five of the six top-ranked Latin American nations fall outside Mercosur, including Chile, Mexico and Peru, which all have trade deals with the U.S. and are members of the fledgling Pacific Alliance trade group created this year with Colombia. While Mercosur has managed to implement a single free trade accord with Israel, Chile alone has pacts covering 18 countries.

‘Foreign Tutoring’

Businesses in Paraguay, disappointed with Mercosur’s move to suspend their country and welcome Venezuela, are studying whether it’s possible to exit the pact and sign a treaty with the Pacific Alliance, Eduardo Felippo, president of the nation’s biggest industrial lobby group, said by phone from Asuncion.

“The problem with Mercosur isn’t Paraguay, it’s Venezuela,” Paraguay’s President Federico Franco told Argentina’s La Nacion newspaper in an interview published July 29, adding that his country didn’t need any “foreign tutoring” on how to conduct its affairs.

Uruguay’s Foreign Minister Luis Almagro and Vice President Danilo Astori also stated their disagreement with the way Venezuela gained entry into Mercosur.

Paraguay Suspension

In retaliation for Lugo’s impeachment with barely 24 hours to mount his defense, leaders at an emergency summit last month in Argentina suspended Paraguay from partaking in any of Mercosur’s decisions until it holds a presidential election in April 2013. At the same time, the group welcomed Venezuela as a member, bypassing ratification that had cleared every member state’ except Paraguay’s Senate.

Franco’s office and Argentina’s Foreign Affairs Ministry didn’t respond to telephone calls seeking comment. A press official with Brazil’s Foreign Ministry, who can’t provide his name due to internal policy, said that Venezuela’s entry complied with the pact’s guidelines.

Mercosur will gain some strategic clout by accepting South America’s largest oil producer as a member, Rubens Barbosa, a former Brazilian ambassador to the U.S. who helped negotiate the creation of the bloc, said by phone from Sao Paulo. Argentine and Brazilian exporters stand to benefit from Venezuelan demand for imports of manufactured products and food, he said.

Trade Deficits

Venezuela last year posted trade deficits of $1.2 billion and $2.9 billion respectively with Argentina and Brazil. Venezuelan tariffs on Argentine and Brazilian manufactured goods may fall to as low as zero if Chavez’s government adheres fully to the bloc’s terms of free trade.

The benefits of Chavez joining Mercosur may not be reciprocal as Venezuela’s dependence on oil for 95 percent of its exports has weakened its manufacturing base. The self-declared socialist today said he wants to diversify Venezuela’s economy by developing industries from agriculture to tourism.

Mercosur leaders will establish a working group to negotiate details of Venezuela’s membership, including a timeframe for reducing tariffs.

Chavez said July 17 that his government was mindful of the risks entailed by joining Mercosur and vowed to protect local companies from Argentine and Brazilian imports.

Still, that hasn’t stopped him from trumpeting his ascension to Mercosur as a victory for Venezuelan diplomacy, and a defeat for the U.S. after its attempt to broker a free trade agreement stretching from Alaska to the tip of Patagonia broke down in 2005.

“Mercosur without a doubt is the most powerful engine we have to preserve our independence and accelerate our comprehensive development,” Chavez said today. “Our north is the south.”

To contact the reporter on this story: Randall Woods in Santiago at rwoods13@bloomberg.net.

To contact the editor responsible for this story: Joshua Goodman at jgoodman19@bloomberg.net.