EXCLUSIVE - Fight between U.S. and Brazil threatens trade

WASHINGTON/BRASILIA Thu Aug 5, 2010 6:00pm IST

U.S. Secretary of State Hillary Clinton (L) shakes hands with Brazil's President Luiz Inacio Lula da Silva during a meeting in Brasilia March 3, 2010. The road to rock bottom for relations between Brazil and the US, a dispute that now threatens business ties between the two economic giants, began in Brasilia in March. REUTERS/Ricardo Moraes/Files

U.S. Secretary of State Hillary Clinton (L) shakes hands with Brazil's President Luiz Inacio Lula da Silva during a meeting in Brasilia March 3, 2010. The road to rock bottom for relations between Brazil and the US, a dispute that now threatens business ties between the two economic giants, began in Brasilia in March.

Credit: Reuters/Ricardo Moraes/Files

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WASHINGTON/BRASILIA (Reuters) - The road to rock bottom for relations between Brazil and the United States, a dispute that now threatens business ties between the two Western Hemisphere economic giants, began in Brasilia in March.

U.S. Secretary of State Hillary Clinton was trying to convince Brazilian President Luiz Inacio Lula da Silva to drop or postpone his controversial efforts to negotiate a nuclear deal with Iran, and support a new round of sanctions instead.

Lula refused. Then, he dropped a diplomatic bombshell, telling Clinton he was worried Iran would become another Iraq -- that is, that the United States was on a path to war, according to sources familiar with the exchange.

Clinton bristled, replying that Lula wasn't taking into account the fact that Barack Obama was now president, rather than George W. Bush, the sources said on condition of anonymity because of the sensitivity of the talks.

The meeting ended badly. Two months later, Lula was standing in Tehran alongside Iranian President Mahmoud Ahmadinejad, trumpeting a fuel swap deal for Iran's nuclear program -- an agreement that was immediately ignored by the United States and most other major world powers, who pursued sanctions anyway.

Graphic on trade flows link.reuters.com/gab43n

Reuters Insider link.reuters.com/cec43n

Today, the fallout from Iran remains worse than either side will acknowledge publicly.

Brazilian officials complain in private that their good-faith efforts to broker a peace deal were brushed aside, with little regard for Brazil's status as an emerging power. Meanwhile, officials in Washington are angry that an ostensible regional ally interfered on an issue they feel is one of the biggest long-term threats to global security.

The bottom line, and the issue of most concern to investors, is that there is now a real risk of a longer-term drift between Brazil and the United States that could have a negative effect on bilateral trade and business.

"I worry about it," Representative Eliot Engel, the Democratic chairman of the U.S. House Foreign Affairs subcommittee that covers Latin America, said in an interview. "I think it's Lula's policy to try and push the countries apart. He wants the U.S. to be less influential."

Nerves between the two countries were already raw following other disputes including a narrowly averted trade war this spring over U.S. cotton subsidies; differences over the handling of last year's coup in Honduras; and the disappointing outcome of the climate summit in Copenhagen in December.

The clashes have been especially disappointing since both sides had anticipated improved ties under Obama, who made a point of fawning over Lula last year, calling him "my man" and "the most popular politician on earth."

These days, an upper-level source in Brasilia described the chill in bilateral ties this way: "They're in the freezer."

TRADE TIES SUFFER

The countries' diplomats still have regular, polite contacts, and investment flows in both directions at ever-greater numbers. Yet there are signs that the bad blood is starting to damage business ties:

* The U.S. Congress is now less likely to reduce tariffs on imports of ethanol, of which Brazil is the world's No. 2 producer behind the United States, Republican and Democratic sources on Capitol Hill told Reuters.

Lobbyists for the U.S. corn ethanol industry including retired Gen. Wesley Clark have seized on the Iran issue as a reason to leave tariffs in place. Clark told an industry conference in June that it was a mistake to buy energy from any

country -- specifically, Brazil -- that doesn't "see eye to eye" with the United States on national security issues.

"This would have been a tough issue under any circumstances," one source said. "After Iran, it's become almost impossible" to lift the tariff.

* Negotiations have stalled for a Trade and Investment Framework Agreement, or TIFA, between the U.S. and Brazil. A TIFA basically provides a road map for more in-depth free trade negotiations between countries, and the issue has been a priority for diplomats for both countries for some time.

A source who closely follows U.S.-Brazil trade negotiations called the delay the "first real casualty" of the Iran dispute.

Nkenge Harmon, a spokesperson for the Office of the U.S. Trade Representative in Washington, confirmed that the TIFA talks have suffered delays and offered no timeline for when a deal would get done. Asked whether Iran was a factor, Harmon replied via e-mail: "I have no reaction to that."

* Recent developments could also contribute to the removal of some or all Brazilian goods from a program that gives preferential tariff and duty levels to products from poorer countries. The General System of Preferences (GSP) list covers about $3 billion worth of annual Brazilian exports to the United States, or roughly 15 percent of the total. It must be renewed by Congress this year.

Brazil's GSP status has often been used as a political tool. Senator Charles Grassley, the senior Republican on the Senate Finance Committee, threatened to modify the list in 2006 unless Brazil helped move Doha trade talks forward. Since then, Grassley has said that richer developing countries such as Brazil may no longer need GSP status.

Arturo Valenzuela, the Obama administration's top diplomat for Latin America, denied that the Iran incident is bleeding into business ties.

"Our disappointment with the handling of that particular issue ... will not preclude us from working together on the numerous and significant issues of mutual interest that we share," Valenzuela, the assistant secretary for Western Hemisphere affairs, said in an e-mailed statement to Reuters.

Nevertheless, Steven Bipes, the executive director of the U.S. Section of the Brazil-U.S. Business Council, said he was "frustrated" at recent developments that have hampered bilateral trade.

"Congress needs to realize that this isn't just what Brazil wants -- these issues help with American jobs, too," he said.

INFLUENCE SHIFTING TOWARD CHINA

On the Brazilian side, there are no overt signs of retaliation at the moment, but instead, indications of a longer-term shift away from the United States.

U.S. companies have already lost market share in Brazil in recent years. In 2009, China supplanted the United States as Brazil's biggest trading partner, with $36 billion in bilateral trade -- triple the level five years prior. Brazil's trade with the United States plummeted by nearly a third in 2009 amid the U.S. recession, and has lagged China again this year.

Ill will toward Washington has seeped into parts of Brazil's Congress, where the superpower has always been viewed with suspicion, particularly by members of Lula's leftist Workers' Party. The bad relations come at a time when Brazil's

government is taking an ever more active role in economic management, with billions of dollars in new infrastructure contracts to be awarded in coming years.

"The worrisome aspect of this situation is that the poisonous climate has gone beyond the executive (branches) in both countries," said Paulo Sotero, head of the Brazil Institute at the Wilson Center think-tank in Washington.

The chill comes at a critical time for U.S. businesses. With Brazil's economy set to grow about 7 percent this year, its fastest pace in more than a decade, its booming consumer market has become hugely important to U.S. companies such as General Motors GM.UL that face slow sales at home.

Mark Smith, president of bioenergy firm Claren Power and a former managing director at the U.S. Chamber of Commerce, said that worries about America's receding influence in Brazil are overblown. He pointed out that China buys mostly commodities from Brazil, while the United States buys added-value goods.

"How much influence can you really get from buying iron ore?" Smith said. "Last I checked, we're still importing planes and services. That's where the future is, and that's where the power is in Brazil, too."

Engel, the subcommittee chairman, said that the October presidential election to replace Lula may offer an opportunity for better relations. "That would be a very good time for us to try to be smart and reach out to them."

The problem with that strategy is that the front-runner in the election is Lula's former chief of staff, Dilma Rousseff. She is likely to staff her foreign ministry with many of the same officials who worked on Lula's Iran initiative.

Even as his largely triumphant two-term presidency draws to a close, there are signs Lula still hasn't quite moved on. At a campaign rally this weekend, with Rousseff standing nearby, Lula lashed out at Washington's role in the Middle East peace process, saying it should allow more parties -- including the Palestinian group Hamas, which has received funds from Iran -- to sit at the negotiating table.

"Often, the Americans don't know how" to solve problems, Lula told the crowd. "They create problems."

(Editing by Kieran Murray)

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