Recent Economic Developments

The paper examines the extent to which the recent evolution of the consolidated public sector balance in Uruguay reflects the business cycle. Fiscal policies have generally been cautious, even though some structural reforms, the electoral cycle, and recessions in recent years increased the deficit. Bank soundness indicators differ substantially between private and public banks in Uruguay. The private banking system appears sound. Public banks did not fare as well during the recession, and their soundness needs to be addressed.


The paper examines the extent to which the recent evolution of the consolidated public sector balance in Uruguay reflects the business cycle. Fiscal policies have generally been cautious, even though some structural reforms, the electoral cycle, and recessions in recent years increased the deficit. Bank soundness indicators differ substantially between private and public banks in Uruguay. The private banking system appears sound. Public banks did not fare as well during the recession, and their soundness needs to be addressed.

Uruguay: Basic Data

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Sources: BCU, Ministry of Finance and Fund staff estimates.

I. Overview

1. The Uruguayan economy is gradually emerging from the 1999-2000 recession, after growing by about 3 percent a year OH average during the 1990s (Figure 1). Economic activity grew steadily during the first half of the 1990s, but was interrupted by a decline in 1995 associated with the effects of the Mexico crisis. Output growth rebounded in 1996-98 at 5 percent a year on average (Statistical Appendix Tables 4-7). This performance stemmed from the implementation of cautious macroeconomic policies and structural reforms, as well as from a recovery of regional economic activity. In 1999 and 2000, however, the economy was affected by a number of adverse shocks, including the devaluation of the Brazilian real, a drop in the terms of trade, a drought, and concerns about the stalled recovery and uncertainties in Argentina. Real output contracted by 3.2 percent in 1999 and a further 1.3 percent in the year through September 2000. The unemployment rate increased from 11.4 percent at end-1999 to 14.4 percent in November 2000.

Figure 1.
Figure 1.

Uruguay: Output and Inflation

Citation: IMF Staff Country Reports 2001, 047; 10.5089/9781451839241.002.A001

Source: Central Bank of Uruguay.

2. Fiscal policies have generally been cautious, even though some structural reforms, the electoral cycle, and the recessions in 1995 and 1999-2000 increased the deficit. The deficit was eliminated in the early 1990s, but spending grew sharply with the general election in 1994 and the deficit returned to 3 percent of GDP in that year. In subsequent years, the government benefited from a strong rebound in growth and was able to reduce the deficit, despite the costs associated with the reform of the social security system and the state.1 Deficit reduction stalled in 1999 with a new electoral cycle and as revenues declined in light of the recession. Indeed, the deficit reached 4.1 percent of GDP in 1999, and public spending needed to be cut again by the administration that took office in March 2000.

3. Inflation was cut dramatically during the 1990s, using gradualist policies. Twelve-month inflation was reduced from 130 percent in 1990 to 5 percent in 2000 (Statistical Appendix Table 18). Inflation expectations were guided down by gradually slowing the rate of depreciation of Uruguay’s adjustable exchange rate band. The most recent installment of this strategy occurred in April 1998, when the authorities lowered the pace of depreciation of the band from 0.8 percent a month to 0.6 percent (7½percent on an annual basis), and narrowed the width of the band from 7 to 3 percent. This form of disinflation was supported by generally cautious fiscal and wage policies, and some structural reforms.

4. The structural reforms implemented during the 1990s comprised trade liberalization, a far-reaching reform of the social security system, a first installment of reform of the state, and the development of the domestic capital market, including the creation of new instruments such as mutual funds, a market for negotiable obligations, mortgage paper, factoring, etc.. Also, the authorities have been moving progressively toward increased private sector participation in activities previously reserved for public enterprises, such as in the markets for cement, alcohol, cellular phone services, mortgages, insurance, the outsourcing of some public services, the construction and management of toll roads, etc. These reforms have underpinned confidence, assisted growth, and helped to achieve an orderly slowing of the rate of adjustment in the exchange rate band and in inflation. At the same time, the pace of reforms has been very gradual and there remains much to be done, including opening up further to private sector participation some key industries that are still reserved for public sector entities, including petroleum importation and refining; several telecommunication services; electricity transmission and distribution; and some financial and insurance services where state banks hold the overwhelming share of the market.

5. The external current account shifted from a surplus in 1990-91 to a deficit of just over 2 percent of GDP in recent years. Net deposit flows from the region were positive—and they tended to rise during periods of regional economic uncertainty—and the financial account has been strong, with Uruguay steadily gaining net international reserves. Uruguay’s access to financial markets remains good and the government enjoys an investment grade credit rating on its debt.

A. The Real Economy

For the 1990s as a whole, the real economy grew well as the result of reforms and prudent policies. However, economic activity was hit several times by adverse external shocks. In the context of the relatively firm exchange rate regime, which was the anchor for inflation expectations, this led to occasional slowdowns in output, and higher unemployment.

Aggregate supply

6. Output growth was not evenly distributed across sectors during the 1990s. The services sector has expand while the manufacturing sector has contracted, in relative terms, while the share of agriculture in output remained roughly constant (Figure 2). On the cost side, wages deflated by consumer prices increased by 1.3 percent a year on average, but in U.S. dollar terms their growth averaged 11 percent a year. Meanwhile, the price of imported capital goods was about flat in U.S. dollar terms, causing the price of machinery and equipment relative to wages to fall by 55 percent. Despite the cost advantage, fixed capital formation has been relatively low in Uruguay, averaging 14-15 percent of GDP during the 1990s, in part reflecting the unfinished agenda of structural reforms noted above.

Figure 2.
Figure 2.

Uruguay: Sectoral Output and Adjustments in Manufacturing

Citation: IMF Staff Country Reports 2001, 047; 10.5089/9781451839241.002.A001

Source: National Institute of Statistics.

7. The service sectors, which now form the core of private economic activity in Uruguay, have progressed most under regional integration and internal deregulation. The share of services in nominal GDP rose from 60 percent in 1990 to 72 percent in 1999, while the share in total employment increased to 77 percent. Service sectors with a large tradable content expanded the most, driven by growing demand with the rapid integration of the MERCOSUR. For instance, value added in the transport and communication sector grew by 110 percent, related to Uruguay’ central location in the MERCOSUR region. The commerce, restaurant, and hotel sector grew by 65 percent in real terms from 1990 to 1999, owing to buoyant activity in tourism with growing per capita incomes in the region. By contrast, construction, a typical nontradables sector, and with heavy public sector involvement (in part through the state-owned Banco Hipotecario), grew by a more subdued 35 percent, in line with real GDP. During 1990-99, the price of services, relative to manufacturing, increased by 33 percent as measured by sectoral GDP deflators.

8. Manufacturing, which had been protected prior to the 1990s, lost market share, especially in the early years of trade liberalization. At the beginning of the decade (between 1990 and 1993), trade liberalization and the real appreciation of the peso increased import competition and caused manufacturing output to contract by nearly 11 percent. Firms began to adjust by shedding labor in favor of less expensive imported machinery and equipment, thereby increasing labor productivity, and subsequently found opportunities in niche areas of the MERCOSUR and other markets. Growth resumed in processed agricultural products, paper and pulp, and specialty chemicals and plastics, where industrial restructuring and modernization were fastest. This helped manufacturing output to grow by 23 percent from 1994 to 1998 (Statistical Appendix Table 13). In early 1999, the devaluation of the Brazilian real dealt a new blow to the sector, and output fell by 10 percent while hours worked declined by 12 percent. Overall, manufacturing has not been able to regain its output level from the beginning of the decade, and its share in nominal GDP has declined from 28 to 17 percent, although labor productivity more than doubled over the decade (output per man-hour rose 107 percent) (Statistical Appendix Table 15).

9. While global deregulation in agricultural trade is slow, trade liberalization already has stimulated specialization in agricultural sectors where Uruguay has a substantial potential. Resources were shifted towards cereals that Uruguay produces efficiently, including rice, sunflower seeds, and barley, and the production of meat and dairy products. Other crops, such as sorghum, sugar beets, sugar cane, and linseed are declining. Overall, acreage devoted to ten main crops increased by 12 percent over the decade, and yield per acre by 32 percent.2

10. Rice, a key “nontraditional” export (destined primarily for Brazil) is mainly cultivated in the country’ northern part where newly irrigated land has become available. Between 1990 and 1999, acreage more than doubled, increasing rice’ share of cultivated land to a quarter of the total. Production grew nearly three-fold, and yield per acre by 44 percent.

11. Trade liberalization also stimulated growing sunflower seeds, with acreage increasing by 129 percent from 1990 to 1997, boosting its production nearly five-fold3. Acreage devoted to barley also increased, raising its share in total to a fifth, and barley production and yield per acre both increased substantially.

12. Trade liberalization has also benefited the beef industry, encouraging developing new pastures and technologies, including artificial pastures and feed lots. These techniques permit cattle to be slaughtered and sold at a younger age, with higher turnover, output, and more flexibility in a given year’ cycle, thus increasing productivity. Between 1990 and 1999, beef production grew by 20 percent, and the sector has good potential as witnessed by a surge in beef exports to the Nafta countries in 2000. At end-2000 beef production (and exports) were briefly interrupted by a local outbreak of foot and mouth disease, but strong remedial action by the authorities quickly removed the disease again, and the markets for beef were being re-established in early 2001. The milk sector has been spurred by increasing trade with Brazil, and between 1990-99 production increased by 54 percent.

Domestic Demand and Saving

13. Consumption expenditure was supported by the recovery in activity, higher per capita incomes, and the appreciated real exchange rate.4 Total consumption grew by 56 percent in real terms between 1990 and 1999, and the ratio of private consumption to GDP increased from 70 to 73 percent of GDP during this period. Moreover, and notwithstanding the fiscal adjustment undertaken by two successive administrations, the ratio of public consumption to GDP is higher now than in the early 1990s, in part as municipal governments increased spending in real terms. Imports of consumer goods rose from 2.6 percent of GDP in 1991 to 4.5 percent of GDP in 1999, in part in response to the increased purchasing power of the peso, and also reflecting the import needs of the rapidly growing tourism sector.

14. Gross domestic investment in constant prices grew by 95 percent between 1990 and 1999, followed by a sharp decline estimated for the recession year 2000. Private investment expanded more vigorously than public investment, increasing its share in GDP by 2 percentage points. To a large extent, this reflects efforts to modernize production techniques and improve labor productivity, especially in manufacturing firms in the private sector. Since 1990, the share of capital spending has increased by about 2 percentage points of GDP, to an estimated 14 percent of GDP in 2000—relatively low in view of high unemployment in the economy.

15. Gross national savings have declined from 14.2 percent of GDP in 1990 to 12.7 percent in 1999. This was mainly due to the deterioration in public saving towards the end of the period which coincided with an election year and a recession. Private savings have been flat over the same period, with a temporary increase during election years, in which, apparently, households adopt a “wait and see” attitude. At the same time, Uruguay sustained externally induced economic shocks in 1995 and 1999, coinciding with the election periods and inducing more cautious household spending. On the structural side, Uruguay has a relatively elderly population, and private saving rates are correspondingly low; this underscores the importance of public sector saving in the economy.

Tabulation: Gross National Saving Rates in Mercosur Countries 1/

(In percent of GDP)

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Average saving rates for the period 1990-1999.

The sum of country saving rates weighted by the share of each country’ GDP in Mercosur GDP.

Unemployment and Wages

16. Despite strong growth during much of the decade, unemployment remains high. Unemployment reached 14.4 percent in November 2000, compared with the highest yearly average of 14.7 percent in 1983. The increase reflects the structural adaptation taking place in the economy, and a faster increase in labor supply than demand, and the effects of the current recession. Indeed, the recent increase is to an extent cyclical, as the recession has added about 5 percentage points to the unemployment rate since early 1999. A similar shock in 1995-96 led to an increase in the unemployment rate by about 3 percentage points, which lasted for almost two years (Figure 3).

Figure 3.
Figure 3.

Uruguay: Labor Market Indicators

Citation: IMF Staff Country Reports 2001, 047; 10.5089/9781451839241.002.A001

Source: National Institute of Statistics.1/ 2000 figure is for November.

17. Nevertheless, even without the cyclical component, Uruguay’ underlying unemployment rate tends to be high. The unemployment rate barely fell below 10 percent at the cyclical peak in early 1998, after rising from 8¼ to around 9¼ percent during the years of the most rapid economic growth between 1990-94 (Statistical Appendix Table 17). The shifts in the economy related to the trade liberalization and technological change no doubt led to some increase in the skill mismatch between jobs and employees. At the same time, Uruguayan labor is generally well educated with strong sector-specific skills, and a recent survey revealed that 27 percent of the unemployed were not willing to consider a change in profession in order to find a new job—a structural rigidity. Unemployment among manufacturing workers has risen most sharply over the last ten years, from around 8 percent in 1990 to 18 percent in early 2000.

18. On the supply side, the participation rate rose from 58 percent in 1990 to around 62 percent in early 2000. Participation of women increased the most, from 46 to 53 percent. Indeed, unemployment has increased the most among second-wage earners, such as women and youth. Women below 24 years of age had an unemployment rate of 36 percent during the first semester of 2000, compared with 5.5 percent for (male) heads of households. The increase in jobs by around 10 percent over the last decade has thus been outstripped by the entry of women and youth in the labor force.

19. As the output composition changed, the allocation of labor between sectors changed as well. While the share of employment in the manufacturing sector fell from 24 percent in 1990 to 15½ percent in early 2000, the share of services rose by about 8 percentage points. In part in the context of a reform of the state, implemented between 1996-1999, the share of public employment in total employment dropped from about 20 percent in 1995 to just over 18 percent in 1999.

20. Wages in the private sector are determined freely, but the public sector affects wages in the health sector where it is a large purchaser of services. Also, both sectors are influenced by some rigidities and distortions, such as a relatively high fixed health care premium which inhibits entry (because the fixed premium is a large percentage of entry wages), strong union opposition to labor reductions, especially in the banking sector, and public sector employment tenure rules. Wage setting in the public enterprises is determined in collective bargaining agreements; that in the government is subject to negotiation and a law on periodic wage adjustments. In principle, such wage adjustments are determined in conjunction with with overall fiscal policy and inflation objectives (there is not a fixed formula but the frequency of wage adjustment is determined by law). In December 1997, Congress approved a new indexation law that shifted the adjustment interval for government wages from four to six months, and to 12 months when the inflation rate remains below 10 percent in every month since the last adjustment. This has been the case lately, and government wages in 2000 were adjusted in January, and no further changes were scheduled during the year.

21. Average real wages deflated by consumer prices increased by 13.7 percent between 1990 and 1999 (1.3 percent a year), with average increases in the public and private sectors broadly the same (Statistical Appendix Table 20). While the wage increases during the 1990s do not seem excessive in terms of relative domestic prices, wages have increased substantially in U.S. dollar terms when the real exchange rate appreciation in the 1990s is taken into account. In 1999-2000, real wages, and wages measured in dollar terms, have began to decline as a consequence of high unemployment and the gradual (real) depreciation of the peso vis-à-vis the U.S. dollar.

B. The Public Finances

22. The consolidated public sector in Uruguay comprises the central government including the extrabudgetary operations by ministries (Fondos de Libre Disponibilidad), local governments (Intendencias), the public social security system (Banco de Prevision Social or BPS), nonfinancial public sector enterprises, and the quasi-fiscal result of the Central Bank of Uruguay (BCU). Taxes are collected by the General Tax Unit (Directión General de Impuestos, or DGI), with several exceptions such as custom duties collected by the customs authorities, and the payroll withholding tax (IRP) collected by the BPS. Uruguay’ public sector is comparatively large, with general government noninterest expenditures at about 33 percent of GDP, and interest payments of about 2 percent of GDP (Figure 4). In addition, expenditure by the nonfinancial public enterprises accounts for about 15 percent of GDP, and the public sector also directs resources through the public sector financial institutions.

Figure 4.
Figure 4.

Uruguay: Public Sector Finance Indicators 1990-2000

(In percent of GDP)

Citation: IMF Staff Country Reports 2001, 047; 10.5089/9781451839241.002.A001

Source: Ministry of Economy, Central Bank of Uruguay; and staff estimates.

23. The public finances weakened markedly at the end of the 1990s, with the overall deficit rising from 1 percent of GDP in 1998 to 4.1 percent of GDP in 1999 (about US$860 million; Statistical Appendix Table 21). A significant part of the slippage resulted from the operations of automatic stabilizers as Uruguay was confronted by external shocks which caused a cyclical downturn in economic activity. However, there also were some one-time election expenses, and the government granted special assistance to sectors most affected by the recession. The new incoming administration in March 2000 promptly introduced spending cuts to limit the deficit. Nevertheless, as the level of economic activity remained weak throughout 2000, revenues remained depressed and, under these adverse circumstances, the deficit could be reduced only marginally to 3.7 percent of GDP in 2000.

The central government

24. The central government comprises two-thirds of the public finances with its revenue reaching 21 percent of GDP in recent years and expenditure some 24 percent of GDP (Statistical Appendix Table 22). The central government and the social security system together account for over 40 percent of public employment and pay about three-quarters of the public wage bill. (Statistical Appendix Table 30).

25. During the second half of the 1990s, central government policy focused on limiting growth in real expenditures, while letting revenue rise with the expansion of economic activity to help shrink the deficit (Figure 5). To this end, in early 1995, the government adopted a five -year budget for its term in office. The budget focused on revenue measures to address the ballooning public sector deficit, while spending priorities were shifted to education and remunerations for teachers and the police. Discretionary current expenditure was reduced in relation to GDP.

Figure 5.
Figure 5.

Uruguay: Sectoral Fiscal Balances

(In percent of GDP)

Citation: IMF Staff Country Reports 2001, 047; 10.5089/9781451839241.002.A001

Source. Ministry of Economy, Central Bank of Uruguay; and staff estimates.1/ Includes social security system, cost of reform, and extrabudgetary operations.

26. There were some structural measures during this government period, most notably the reform of the social security system in mid-1996. The social security system was in dire financial straits, and its reform aimed at slowing the growth of benefits, reducing employer payroll taxes, and improving benefits administration. To this end, the authorities established a complementary private capitalized pension system alongside the public pay-as-you-go system. This led to a shift of some contributors from the public to the private system, implying an up-front reform cost in the form of foregone income for the budget, which required additional transfers from general revenue to cover the deficit in the public social security system. The reform costs rose from 0.3 percent of GDP in 1996 to 1 percent of GDP as of 1998. In a separate effort, the government also implemented a reform of the state which reduced public sector employment by 8 percent between 1995-99, consolidated offices and bureaus, and improved productivity. The cost of severance payments and incentives under this program amounted to 0.3 percent of GDP on average during this period.

27. The jumps in the deficit during the election years, the costs of the social security and state reforms, and the adverse effects on the deficit of the recessions in 1995 and 1999-2000 have caused the public debt-GDP ratio to rise significantly in recent years. The gross debt of the consolidated public sector increased from around 30 percent of GDP in the early 1990s to 46 percent of GDP by end-2000.

The social security system

The deficit of the social security system before transfers from the central government rose from 2½ percent of GDP in 1990 to 8 percent in 1999 (Statistical Appendix Table 23). Expenditures increased by nearly 6½ percentage points of GDP, while revenues increased by less than 1 percentage point. Spending increased rapidly during the disinflation years as benefits are indexed to lagged take-home wages (which rose in real terms). Moreover, the social security reform of 1996 improved benefits administration, eliminating a backlog of claims, while a wave of new elderly signed up for benefits out of fear they would be left out of the reformed public system otherwise. The relative weakness in revenues reflected the loss of personal contributions to the new capitalized pension system, and various reductions in employer social security contributions to lower labor costs and help ease unemployment. The growing financing needs of the social security system were covered by general tax resources. Recently, the administration of social security revenues has improved with the issuance of semi-annual statements to workers, and there has been a slowing in the pace of new retirees accruing to the pay-as-you-go system. In addition, the reform mandated a gradual increase in the retirement age for women and provided incentives to remain in the labor force, which have helped to stabilize the number of contributors.

28. The reform of the social security system has been more successful than was anticipated. Nearly 600,000 individuals (over one-half of all affiliates) have switched from the state system to one of seven private pension funds (AFAPs).5 Thus far, AFAPs have been limited to invest their capital in public sector securities and cash and other highly liquid assets. Recently, the authorities approved a framework that would permit these funds to hold private sector instruments also, provided they carry an appropriate credit rating, and investments in any one entity or private group are limited. Pension funds are not allowed to invest in foreign assets.

Local governments (Intendencias)

29. Local governments have thus far played a limited role in the public finances In Uruguay and their revenue and expenditure have been slightly above 3 percent of GDP (Statistical Appendix Table 24). Their main revenue consists of taxes on real estate and property, including automobiles. With little access to borrowing, their deficits have been small in the order of 0.1-0.2 percent of GDP. In 1999, however, the deficit reached 0.4 percent of GDP owing to expenditure overruns associated with elections and revenue shortfalls in the recession. The revenue shortfall continued in 2000, and there are some arrears to the state-owned electricity company, the social security system and suppliers.

The state-run enterprises

30. In Uruguay, some economic activities are dominated by state run enterprises (SREs). The main SREs are the electricity company (UTE), the alcohol, cement and petroleum company (ANCAP), the telecommunications company (ANTEL), the water and sanitation company (OSE), the railways (AFE), and the port authority (ANP).

31. Combined revenue of the SREs averaged about 13 percent of GDP in the 1990s, while noninterest expenditures (including capital outlays) were about 12 percent (Statistical Appendix Table 25). Interest payments are small as the SRE’ have little debt. Their accounts showed a consolidated surplus of½ percent of GDP on average over the decade. Their operating balance, prior to capital expenditures and transfers to the central government, averaged 6.4 percent of GDP between 1990 and 1994, rising by nearly ½ percentage point of GDP from 1995 to 1999. The rising surplus reflected higher tariffs, personnel cuts, and efficiency improvements. However, there was a drop in the operating results in 1999-2000, as public enterprise tariffs were adjusted with a delay for the higher oil costs, and spending overruns occurred in ANTEL.

32. SREs remit their surplus to the central government in the form of taxes and transfers that have averaged 3.6 percent of GDP between 1990-94, and 4.2 percent between 1995-99. ANCAP provides the largest sum, about 2 percent of GDP a year, while transfers from ANTEL have risen to 1½ percent of GDP in 1999, owing to strong demand for wireless and fixed line services, and those from UTE also have increased, to 1.3 percent in 1999 reflecting improved efficiency. Discretionary transfers to the central government are determined in annual negotiations, to supplement the profit-tax remittances.

33. During the decade, the SREs faced rapidly changing market conditions and have made significant efforts to increase their efficiency. Total employment in the public enterprises fell by nearly 40 percent, from about 42,000 persons in 1990 to 25,750 in 1999. Individual SREs have adjusted their operations in different ways. ANTEL expanded its system for both voice and data communication, and eliminated waiting lists for telephone installation, with the assistance of foreign telecom-equipment providers. While outright privatization of the telephone system was rejected in a 1992 referendum, there is private participation in, for instance, cellular telephone service. This has helped align Uruguay’ telephone rates with other countries in the region.

34. The electricity market is arguably furthest along in deregulation. The electricity market was deregulated in 1998, allowing competition in electricity generation (transmission and distribution are still state monopolies). A regulatory agency was established in 2000 to oversee competition in the market. Electricity may now be imported directly from neighboring countries, or generated locally by private companies.6

35. ANCAP is preparing for the opening of the petroleum market. At this moment, the producer price of its main product, gasoline, exceeds the regional average. ANCAP’ strategy is to face competition by expanding the scale of operations through joint ventures in the areas of gasoline distribution, cement production, the manufacture of lubricants, and alcohol. As part of these plans, ANCAP intends to expand its refinery in Montevideo.

36. In assisting the government to meet its fiscal objectives, the SREs incur some costs that are not present in the private sector. The SREs pay a social security contribution of about 12 percent of payroll (a surcharge) in addition to the standard employer contributions paid by the private sector. In addition, only SREs are assessed a 2 percent tax on foreign exchange transactions.7

The quasi-fiscal result of the Central Bank of Uruguay

37. The quasi-fiscal result of the BCU is declining gradually, due both to amortization of debt, and larger interest receipts on its growing stock of international reserves (Statistical Appendix Tables 26). The quasi-fiscal result reflects operating costs, and the responsibility for certain external debt service payments in the BCU. At the beginning of the decade, the quasi-fiscal deficit amounted to over 3 percent of GDP reflecting a combined deficit in the BCU, the National Mortgage Bank (BHU), and in intervened banks. It declined to about 0.5 percent of GDP by 1996 as a result of debt rescheduling agreements with external creditors in 1991, and the transfer to the Treasury of obligations previously undertaken by the BCU, including operations to shore-up troubled banks, and concessional loans to the BHU. In 2000, the quasi-fiscal deficit of the BCU measured 0.4 percent of GDP, thus continuing its slow decline of recent years.

C. Money and Financial Intermediation

38. Money and credit markets in Uruguay are heavily influenced by international financial conditions. There are no restrictions on capital movements in or out of the country.8 The exchange rate fluctuates within a narrow 3 percent band. Under these circumstances, interest rates, particularly those applied to foreign currency loans and deposits, closely follow international rates. Local currency deposit rates, adjusted for expected currency depreciation, also follow international rates. However, interest rates charged on local currency loans significantly exceed comparable international rates (adjusted for devaluation expectations), owing to a thin and not very competitive market (see below) and to the higher risks and operating costs associated with local currency loans.

39. The Uruguayan economy is highly dollarized. Almost 90 percent of deposits are denominated in foreign currency, of which about one third are held by nonresidents. The trend towards dollarization began in the 1970s and intensified in the 1980s due to years of high and variable inflation. Yet, as inflation subsided during the 1990s, the share in demand for pesos did not return to its previous levels.

Market structure

40. The financial system consists of the Central Bank (BCU), the state-owned Bank of the Republic (BROU, a commercial and development bank), the National Mortgage Bank (BHU), and 21 private banks (mostly foreign owned; three are locally owned but two of them are currently under public management following the government’ intervention). There are also 9 finance houses, 6 cooperative savings banks, and 11 offshore institutions. There are two small stock markets (in Montevideo), and seven private pension funds (AFAPs, the products of the 1996 social security reform). The system is supervised and regulated by Banking Superintendency which is part of the BCU. Banking regulations are forward looking in their risk assessment, based on the CAMEL system, and consistent with the Basel criteria, including a minimum capitalization requirement of 10 percent on a risk-adjusted basis.9

41. The public financial institutions are important players in the financial sector. The two state-run banks together account for about half the system. Their role in the market is facilitated by several regulatory advantages (monopolies on some activities; tax exemptions for others) intended to compensate them for quasi-fiscal activities undertaken at the public sector’ request. However, these advantages also imply distortions which are limiting the share of private banks in the financial system. The share of the public banks is especially high in the peso market, where they have little competition. Further, the public sector currently controls two other banks (Banco La Caja Obrera and Banco de Credito) that were intervened to avoid their closure. The private commercial banks handle about 40 percent of the market, and have concentrated their lending operations in short-term foreign currency denominated credit, directed mostly to prime borrowers. Offshore financial institutions, which are not permitted to lend their resources domestically, hold about 5 percent of the system’ assets. Finance houses, AFAP’, and cooperatives control the remaining 5 percent of the market.

42. The BROU, the country’ largest bank, maintained its relative size over the past decade and, although some of its regulatory advantages have been curtailed, it does not yet fully face all the obligations imposed on private financial institutions. The BROU handles the bulk of the Central Government’ domestic financial transactions, and it is the largest provider of long-term credit in the economy. It holds about 35 percent of the system’ deposits and 30 percent of credit. Lending is concentrated in agriculture (41 percent of its portfolio), industry (17 percent) and consumer loans (17 percent). Since 1995 the BROU has been modernizing its operations, and overhauling its accounting systems, and in 2000, it is undergoing an independent external audit, in part to review subsidies and preferential treatment to specific sectors, and to review its credit manuals and procedures. These reforms would place the bank on a more level playing field with other banks. While there is a need to eliminate some regulatory advantages the BROU has (for instance it is exempt from charging value added tax on consumer loans), it also needs relief from some quasi-fiscal burdens and obligations that are unique to the BROU.10

43. The state-owned mortgage bank (BHU) is the largest provider of housing credit in Uruguay, but its financial structure has suffered from currency mismatches and a high rate of delinquency in its loan portfolio. BHU makes long-term loans for housing construction and purchases, guaranteed through mortgages, and raises funds of short-and medium-term maturities. Until 1993, the BHU had a monopoly on mortgage financing in the country, but nowadays private banks are permitted to compete, and they do so in the high income segment of the market. BHU’ share of the overall mortgage market is around 90 percent, partly because it is exempt from VAT on its loans and also because it provides loans at rates below those required to cover its costs. Its share of the total credit market declined from 31 to 24 percent between 1994 and 2000. The majority of its loan portfolio is denominated in “adjustable units” (“unidades reajustables” or URs, an index linked to average wages in the economy), while its deposits are increasingly denominated in U.S. dollars. This currency mismatch generated large accounting profits during the first half of the 1990’ when real wages grew faster than the exchange rate, but is currently producing losses in the bank as real wages are declining with the recession. To limit losses, beginning in 2000, the BHU switched to granting new loans exclusively denominated in U.S. dollars. Nevertheless, given the outstanding stock of loans, it will take long to correct the currency mismatch.

44. Private banks concentrate their lending in creditworthy industrial and commercial companies, and in trade credit. They have began to compete in the consumer segment of the market, despite their disadvantage vis-à-vis the BROU. In September 2000, the private banking system accounted for 46 percent of total credit to the private sector (from 39 percent in 1994) and for about 65 percent of total deposits (from 59 percent in 1994). Private banks are almost all subsidiaries or branches of large multinational foreign banks; there is one important domestic private bank.

45. Finance houses, cooperatives, AFAP’ and offshore financial institutions are a relatively small segment of the total market, representing less than 10 percent of total assets of the system. Finance houses and offshore institutions are allowed to receive funds only from nonresidents. The latter may lend only to nonresidents. Cooperative saving banks are only allowed to do operations with their shareholders, with other cooperatives and with the banking system. AFAPs were originally permitted to purchase only public securities, but, as of April 1998, they also can devote some of their portfolio to corporate debentures subject to a minimum credit rating. In November 2000, AFAPs had US$790 million (4 percent of GDP) under management, an increase of 40 percent in U.S. dollar terms in 12 months.

Recent developments in the credit market

46. Credit markets expanded rapidly during the second half of the 1990s. Real credit to the private sector increased about 2 percentage points faster than GDP during the first half of the decade, and accelerated further from 1995 onwards, expanding by more than 11 percent per year in real terms. This expansion was associated with the increased competition in some areas of lending, particularly mortgages and consumer lending, which resulted in a sharp pick-up in the growth rates of credit to businesses and households from private banks. This acceleration mostly reflected the growth in collateralized lending (i.e., automobile and mortgage loans), but it is also related to the entry of banks into the credit card market. The share of credit from private banks devoted to households rose from 9 percent in 1991 to over 24 percent in 1998. The rapid increase in credit to the private sector became a concern of the authorities in 1998 and, during the second half of that year, the banking Superintendency increased minimum capital requirements on banks and other financial institutions from 8 to 10 percent of risk-weighted assets (phased in through early 2001). At the same time, the risk weights on consumer credits were increased. With the slowdown of the economy, real credit growth declined to a little over 2 percent in 1999.

Interest rates

47. Deposit interest rates have gradually converged towards international rates (Statistical Appendix Table 42). An open capital account coupled with dollarization has increasingly linked Uruguayan and world financial markets. Also, more competition in the domestic banking sector, and the decline in demand caused by the 1999-2000 recession, helped bring Uruguayan interest rates to world levels. On the deposit side, Uruguayan and world interest rates are nearly equal, reflecting the close substitutability between foreign and domestic deposits under free capital mobility. Indeed, as Uruguay functions as a regional and offshore banking center, during the uncertain and regional hyperinflationary period of the 1980s, domestic interest rates on dollar deposits averaged about 2 percent less than their world (LIBOR) counterparts. This discount emerged as nonresidents from neighboring countries preferred to keep part of their savings in Uruguay where financial conditions were more stable. The difference declined to about 1 percent in the 1990s with the return to financial stability in Argentina and Brazil. For peso deposits, the returns (expressed in U.S. dollar equivalent) have sometimes diverged substantially from dollar returns on international instruments, but this variability has diminished recently with the drop in Uruguayan inflation.

48. Lending interest rates have been less closely linked to world interest rates, even though there has been convergence in some market segments. In the dollar segment, the premium of the prime lending rate over its U.S. counterpart used to be substantial and variable. However, with the increase of competition in the banking system, and as a result of a weak demand for loans, the rate on dollar denominated credit for prime borrowers has now converged to its equivalent U.S. level (between 8-8½ percent since 1996). In the peso segment (only about 10-15 percent of the total market), the credit market remains segmented and dominated by the public banks, and less established consumers and small enterprises cannot obtain loans at the equivalent of world interest rates. Adjusted for exchange depreciation, the prime peso rate has fallen during the decade, from a peak of 36 percent in 1993, to an average of 13.2 percent in the first half of 2000. However, the average peso lending rate for nonprime commercial borrowers, while coming down over the decade, still remains high at 39 percent in U.S. dollar terms.11

49. Financial intermediation spreads, the difference between lending and borrowing rates, have fallen significantly during the 1990s, although in some cases they remain high by industrial country standards. In June 2000, spreads between U.S. dollar prime lending and tune deposit rates averaged about 3 percentage points, down from 9 percentage points at the beginning of the decade and 5 percentage points in 1995. For nonprime dollar borrowers, the spread was about 8 percentage points and did not change substantially during the 1990s. Spreads in the peso market reflect the higher risk attributed to these operations, partly because it was in this segment that legislators intervened in the past to impose forced concessions and rescheduling on borrowers. Operations in the peso market also tend to be smaller, hence unit costs are higher. Nonetheless, spreads have declined in recent years. In the case of prime borrowers they averaged about 8 percentage points in mid 2000, down from 23 percentage points in mid 1995. And for non-prime borrowers, average spreads declined from about 50 percentage points in the mid-1990s to 35 percentage points currently.

50. The growth rate of nominal monetary aggregates has declined with falling inflation. (Statistical Appendix Table 31). The growth rate of narrow money (Ml) declined from 70 percent to 2 percent between 1992 and 1999, while that of the broadest aggregate (M3), which includes all foreign currency deposits, and the liabilities of the Mortgage Bank, slowed from 45 to 9 percent over the same period.12 The degree of monetization remained fairly stable at about 6 percent of GDP for the narrow money aggregates throughout the decade. For broad money it decreased during the early part of the 1990’, but gradually recovered its level by 1995. It continued to increase to 47 percent of GDP in mid 2000, from less than 40 percent of GDP in 1995.13 Money holdings in real terms have increased across the board since 1995, for peso and U.S. dollar deposits alike, and as held by residents and nonresidents.

51. Net domestic assets of the financial system increased from 34 percent of GDP in 1995 to 39 percent in mid 2000, reflecting growth of credit to the private sector. Growth in local and foreign currency credit to the private sector in real terms was less than 3 percent a year through 1994, in part reflecting the large share of credit denominated in U.S. dollars and the real appreciation of the peso during this period. With the convergence of inflation and the depreciation of the exchange rate band, credit in real terms showed a much sharper increase of about 12 percent a year during the period 1994-98, but declined to below 6 percent in 2000 reflecting the low growth of economic activity (Statistical Appendix Tables 32 and 33).

Financial sector reform14

52. Since the banking crisis in the early 1980s, Uruguay has gradually reformed its financial system. Several measures have made financial intermediation more transparent and competitive, including the Financial Intermediation Law of 1992 which strengthened bank regulation and applied the 1988 Basel capital adequacy criteria; and the Law of Capital Markets and Securities of 1996, which provides a framework for self-regulation of the stock exchanges, clear definitions of instruments, disclosure standards, and penalties for violation of rules by brokers and dealers. Both laws are administered by the Central Bank. In recent years, public banks have increased the transparency of their accounts, as balance sheets and profit and loss statements are now made available to the public.

53. To develop the domestic capital market and enhance competition in the financial system, in recent years the authorities have issued regulations for the establishment of the market for securities and negotiable obligations, the establishment and operation of mutual funds, and liberalizations of both the insurance market, and the mortgage market. Also, the reform of the social security system and the establishment of the private pension funds have helped deepen the domestic capital market. To help supervise the new markets and improve the information infrastructure in the economy, since 1998 the Central Bank authorized the operation in Uruguay of commercial credit rating agencies. Moreover, the authorities are implementing new regulations to improve further the disclosure in financial markets; adopt internationally accepted accounting principles; and establish a nongovernmental nonprofit registry for basic corporate operational and financial information.

54. The quality of loan portfolios is poorer in public than in private banks. In June 2000, 9 percent of private bank loans were classified as “poor” quality, (7 percent in 1995)15 This ratio for the BROU and BHU was 17 percent, (11 percent in 1997). These figures indicate that the recessionary period has been more difficult for the public than for the private banks. This reflects the concentration of credits from public banks in sectors more vulnerable to the slowdown of economic activity (agriculture, small businesses). There may also be some adverse selection at play as public banks sometimes are mandated by Congress to offer bailouts and loan refinancing for hard hit borrowers, which encourages loan delinquency.

D. The External Sector

55. After recording surpluses in 1990 and 1991, the external current account slipped into a deficit for the remainder of the decade. The deficit widened to over 2 percent of GDP at the peak of the growth cycle in 1994 and 1998, and narrowed to 1 percent in between. Despite the recession, the deficit widened further to 2.9 percent in 2000, as a result of negative shocks to competitiveness and the terms of trade (Figure 6, and Statistical Appendix Table 44). Brazil and Argentina are the largest trading partners of Uruguay, with a combined share of more than two thirds in merchandise and services exports and around 50 percent in imports (Statiscal Appendix 50). Other major export markets include Europe, the United States and China. Capital inflows have been strong and Uruguay has gained net international reserves, covering over seven months of imports of goods and services.

Figure 6.
Figure 6.

Uruguay: Balance of Payments Indicators

Citation: IMF Staff Country Reports 2001, 047; 10.5089/9781451839241.002.A001

Source: Central Bank of Uruguay.

56. Uruguay has liberalized international trade during the decade. In 1990, the maximum import tariff was cut from 55 to 20 percent, import quotas were eliminated, and anti-dumping, domestic content, and compensatory export measures were reduced. The average applied rate has come down to 12.2 percent in 1998, with protection for inputs being lower (9.2 percent) than for finished goods (13.4 percent). In early 1994, Uruguay, along with Argentina, Brazil, and Paraguay, established the MERCOSUR common external tariff (CET). Initially, the average and maximum tariff rates under the CET were 12 and 20 percent, applicable to most goods, but in late 1997, the MERCOSUR countries introduced a 3 percentage point surcharge on the CET. This surcharge will be cut by 0.5 percentage points in January 2001. Capital flows are unrestricted, but Uruguay does not permit private sector investment in certain sectors that are reserved for public enterprises.

Merchandise trade

57. Uruguay’ U.S. dollar merchandise exports grew by 65 percent between 1990-98, with an expansion in volumes close to 80 percent and a drop in export prices of around 10 percent. Growth in merchandise exports was sluggish at the beginning of the decade, hampered by a strong real appreciation of the peso. However, exports gained pace with the establishment of MERCOSUR. Whereas Argentina and Brazil bought less than ⅓ of the country’ exports in 1990, they absorbed ⅔ in 1999. At the same time, total exports expanded swiftly, recording an average growth rate of 12 percent a year between 1994-98.

58. Merchandise exports dropped by 25 percent in 1999 to about US$2.3 billion, or 11 percent of GDP. The contraction was both the result of sharply falling prices for Uruguay’ main export commodities, and a decline in volumes (8 percent) which contracted in the wake of the Brazilian real devaluation and the recession in Argentina.

59. Uruguay’ dependence on “traditional” exports, primarily meat and wool, has declined in recent years as their share of total exports declined by one-quarter to 26 percent in the decade through 1999. In this period beef exports grew by 38 percent, with substantial year-to-year fluctuations. Uruguay has achieved high growth in beef exports to Brazil since the establishment of the Mercosur and, more recently, gained access to the Japanese market. Beef exports have done particularly well to the Nafta countries in 2000. Beef prices have been volatile, especially in 1995-96 (Statistical Appendix Table 46).

60. Wool exports have declined by almost 60 percent over the period 1990-1999. Wool prices have fluctuated widely over this period, falling by about 40 percent between 1990 and 1992, almost completely recovering in 1996, before again falling by about 55 percent since then. The 1997 Asian crisis was a factor in world wool markets, reducing both demand in several Asian markets (Korea, People’ Republic of China), and prices of wool from New Zealand, an important competitor in this market.

61. In agriculture, rice has become Uruguay’ principal “nontraditional” export, destined mainly to Brazil, after substantial investments in acreage and improvements in productivity, and a 12 percent rise in prices. The share of rice in total exports is now around 10 percent.

62. Beyond being a supplier of raw materials, Uruguay’ primary sector remains pivotal for the country’ exports. Agricultural, forestry and meat products are increasingly transformed into manufactured goods. The forestry sector has grown substantially since 1990, with the area planted increasing almost tenfold, and production and exports expected to increase rapidly during the next few years. A subsidy to the planting of trees on land deemed unsuitable for agriculture was provided by the Forestry Law of 1987. The climatic, topographic and soil conditions of Uruguay are favorable to rapid-growing species like eucalyptus, which enjoy growing world demand. Manufacturing exports of industrial origin are modest in Uruguay, but there have been increased exports of specialty products in selected industries, such as automobile parts and vehicles, especially within the MERCOSUR.

63. Between 1990 and 1998, the dollar value of imports increased by 184 percent. Import growth was particularly strong early in the decade when the currency appreciated in real terms and domestic demand grew strongly. External shocks and the onset of the recession in 1999 caused imports to drop by 12 percent to US$3.2 billion (15 percent of GDP), ending the long period of expansion.

64. The growth in imports of consumer goods between 1990 and 1999 was more than double that of overall import growth, occurring mainly between 1990 and 1994. As a share of total imports, consumer goods rose from 15 percent in 1990 to 28 percent in 1999 (Statistical Appendix Table 48). The figures on growth in consumer goods imports, however, somewhat overstate the consumption of imported goods by Uruguayans, since a part of such imports is used in the tourism sector, and is thus essentially re-exported. Capital goods, and in particular transportation equipment, also grew quickly, increasing their share from 13 percent in 1990 to 19 percent in 1998, before dropping back to 16 percent in 1999 (Figure 7).

Figure 7.
Figure 7.

Uruguay: Merchandise Trade

Citation: IMF Staff Country Reports 2001, 047; 10.5089/9781451839241.002.A001

Source: Central Bank of Uruguay.1/ Traditional exports include meat and wool; nontraditional exports include rice and forestry products.

65. While Uruguay typically incurs a deficit in its external trade account, its nonfactor service balance is positive. The major components are tourism and transportation. Tourism receipts nearly trippled between 1990 and 1999, resulting from new investments in Punta del Este and the interior, and related to the rebound in per capita incomes in neighboring countries, especially Argentina, during the 1990s. Gross receipts from tourism leveled off in 1999, when Argentina entered a recession and the devaluation made Brazil more competitive. However, it recovered again in 2000 and gross receipts are close to 3.5 percent of GDP.

Capital flows, debt, and reserves

66. Capital flows turned from negative to positive within the 1990s. Net capital flows were negative early in the decade, reflecting amortization of public debt and commercial bank outflows. Later in the decade these flows turned positive and grew steadily, driven principally by government borrowing, nonresident deposit inflows, and, to a lesser extent, by foreign direct investment. Uruguay attracts nonresident deposits mainly for differential tax reasons, but also as a safe haven during uncertain economic times. Both in 1995 and in 1999/2000, Uruguay received several hundred million dollars in net foreign deposits. In 1996, when the regional uncertainties abated, some deposits flowed back (mainly to Argentina), and some deposit reflow is again bound to occur in 2001. Also, in recent years, the government has been placing most of its borrowing needs abroad, at an average amount of some US$400 million a year (2 percent of GDP). Foreign direct investment is relatively small, at less than 1 percent of GDP, and is mainly directed at forestry, specialized manufacturing and services (tourism, restaurants, and shopping malls).

67. Uruguay has good relations with external creditors and the ratio of gross external debt to GDP, excluding nonresident deposits, stood at 42 percent in June—2000, of which public sector external debt was about 29 percent of GDP, and private sector debt was 13 percent of GDP (Statistical Appendix Table 51). Including the nonresident deposits, the overall gross external debt ratio was 68 percent of GDP by June 2000. As a fraction of exports of goods and services, the external debt service ratio of the nonfinancial public sector has ranged between 25-30 percent in recent years. Uruguay has received an investment grade rating from international credit rating agencies, and in 2000 the government placed bonded debt abroad at a average spread of 290 basis points—less than half the spreads incurred by the neighboring countries during 2000.


68. Uruguay’s real effective exchange rate (REER) appreciated by 39 percent between 1990 and mid—1995 as the exchange rate was used as a nominal anchor to help bring inflation down (Figure 8 and Statistical Appendix Table 56). A turning point arose in 1994- 95 with the adoption in Brazil of the stabilization program which led to an appreciation of the Brazilian currency and a relative improvement in competitiveness for Uruguay. The peso was stable in real terms from 1995 until January 1999, as consumer prices converged with the nominal exchange rate (wholesale prices and the exchange rate converged somewhat later). Together with the modest deficits in the external current account, this suggests that the economy was adjusting well to the higher real exchange rate of the early years of the decade.

Figure 8.
Figure 8.

Uruguay: Real Exchange Rate Indicators (Jan 1986=100) 1/

Citation: IMF Staff Country Reports 2001, 047; 10.5089/9781451839241.002.A001

Source: INS1/ Data through October 2000.

69. However, the devaluation of the Brazilian real by almost 55 percent in January/February 1999 dealt a blow to Uruguay’s regional competitiveness. Inflation in Brazil has since been somewhat higher than in Uruguay and by September 2000, the real bilateral appreciation of the peso vis-à-vis the real was brought down to 26 percent remaining. The bilateral real exchange rate of Uruguay vis-à-vis Argentina is virtually constant, as the inflation advantage in Argentina has offset the 7.5 percent pace of depreciation of the nominal exchange rate band in Uruguay. The measures of the real effective exchange rate referred to above do not take into account any productivity differentials between Uruguay and partner countries. Productivity growth in manufacturing industry (measured as output per man-hour) has averaged over 6 percent a year since 1990. Estimates for the economy as a whole indicate gains in labor productivity by 24 percent over the 1990s. This improvement in productivity has helped to limit the external current account deficits in the last decade.

II. Cyclically Adjusted Fiscal Balance in Uruguay16

70. This note examines the extent to which the recent evolution of the consolidated public sector balance in Uruguay reflects the business cycle. The cyclically adjusted fiscal position is calculated by excluding from the actual Fiscal balance the impact of cyclical factors. The analysis suggests that fiscal policy in Uruguay has been in general cautious, but with a proclivity toward higher deficits during presidential elections. Following strong fiscal adjustment in the early 1990s, these gains were lost in 1993-94, and the fiscal stance generally remained expansionary thereafter. Combined with the short-term impact of an important reform in the social security system, this contributed to a sharp increase in Uruguay’s public debt-GDP ratio in recent years.

Potential rate of output growth

71. The cyclical element of the fiscal balance is linked to the size of the output gap, the difference between actual and potential output. When actual output is below potential (negative output gap), some weakening of the fiscal balance is generally considered warranted, as a function of automatic stabilizers, to accommodate the adverse impact of economic downturns on revenue and added costs on the expenditure side such as unemployment insurance and other forms of income smoothing. Conversely, when actual output is above potential (positive output gap), the fiscal balance would need to improve with the strength in activity. A deterioration (strengthening) in the fiscal balance in excess of the effects of automatic stabilizers is called expansionary (contractionary).

72. To separate the cyclical component of the fiscal balance from the policy induced effects, there is a need to estimate potential GDP and its rate of growth. In addition, key elements of revenue and expenditure policy need be considered to capture any significant changes in the underlying structure of the fiscal balance.

73. The Hodrick-Prescott (HP) filter17 was applied to Uruguay’s time series data of real GDP for the period 1985-2005. The HP technique fits a trend through the observations of real output by allowing nonlinear and time varying regression coefficients. It is based on a decay function that places higher weight on more recent observations along the sample. To limit the end-point bias,18 the sample period was extended to include projections through 2005, assuming a recovery from the 1999-2000 recession with annual growth of 2, 4, and 4 percent, respectively, for the period 2001-3 and 3 percent for 2004-05. The results of this analysis suggest a growth of about 3 percent on average over the whole period, with the trend, or “potential”, rate of growth declining during the 1990s from 3½ percent in the early years to 2½ percent by 1999-2000 (Figure 9). This decline is consistent with the evolution in external conditions during the 1990s. The country benefited with the recovery from the debt crisis coming out of the 1980s, and the parallel rebound in output growth in Brazil and Argentina. This support dwindled as the debt in the countries in the region, including Uruguay, rose again, and external conditions became less favorable toward the end of the decade.

Figure 9.
Figure 9.

Uruguay; Actual and Trend Output and Output Gap

Citation: IMF Staff Country Reports 2001, 047; 10.5089/9781451839241.002.A001

Source: Central Bank of Uruguay and staff estimates.

Base year

74. A base year needs to be chosen where the potential and actual level of GDP are equal. In this base year, the output gap is zero, thus the actual fiscal deficit reflects the cyclically neutral deficit. In turn, the base year also defines the cyclically neutral parameter values of revenue and expenditure in relation to GDP, i.e., those parameters that would prevail if the economy were to grow smoothly along the trend or potential output path. Figure 9 suggests that actual and trend output were approximately equal in 1993, 1995, and 1999. One potential complication that needs to be considered is that the cyclically neutral revenue and expenditure parameters may not be constant over a longer period of time if the government introduces reforms that permanently alter the relationship between some revenue or expenditure components and GDP. The cyclically neutral parameters would need to be adjusted for such structural shifts. As a result, the parameters in this note were adjusted to reflect two reforms, viz. (1) the impact on the fiscal balance of the tax increases in 1995 (VAT and payroll tax (IRP); the cyclically neutral revenue parameter was increased slightly) and, (2) the reform in the social security system of 1996 (to reflect the phased entry into effect of this reform, the cyclically neutral revenue parameter was reduced by 0.3 percentage points in 1996,0.8 in 1997,0.9 in 1998, and 1 percentage point of GDP from 1999 onward).19 Thus the calculations for the cyclically neutral fiscal balance for the first half of the 1990s are based on slightly different parameter values than those for the second half of the 1990s, and from 1999 onward.


75. Cyclically neutral revenue is derived from the revenue parameters as indicated above and assuming that taxes, social security contributions, and the current surplus of public enterprises are unit elastic with respect to actual output. Nontax revenue is not adjusted for the cycle and taken “as is” or as projected by staff for the medium term. Cyclically neutral expenditure is calculated by holding noninterest expenditures constant with respect to potential output. Interest expenditure is not adjusted for the cycle. There are no explicit adjustments for “cyclical” expenditures in this note, i.e., those expenditures that could be sensitive to the economic cycle such as unemployment insurance and welfare support, because such expenditures are relatively small in Uruguay.

76. The cyclically neutral fiscal balance can then be computed from the neutral revenues and noninterest expenditures, as defined above, and actual nontax revenues and interest expenditures. At any point in time, the fiscal stance compares the level of the actual fiscal balance vis-à-vis the cyclically neutral balance, indicating how far the actual fiscal balance has drifted away, if at all, from the cyclically neutral fiscal balance of the base year. If the actual deficit is larger than the cyclically neutral one, the fiscal stance is expansionary.

77. The fiscal impulse describes the year-on-year change in the fiscal stance and as opposed to the fiscal stance it does not depend on the base year. The fiscal impulse indicates whether fiscal policy in a given year is expansionary or contractionary relative to the previous year.


78. The output gap shifted from negative in the early 1990s to positive in 1994. Following a small negative gap in 1995, it turned positive again as the economy grew above trend from 1996 through 1998. The deep recession in 1999, however, virtually eliminated the positive gap, and it turned negative again in 2000. In 2001, the real GDP growth is expected to recover to 2 percent. Since this is slightly below the estimate of potential output growth, the output gap is projected to widen somewhat further, to around 3 percent of potential GDP. In the outlying years the economy recovers fully from the recession and the output gap closes.20

79. The above estimates, and comparing the actual with the calculated cyclically neutral fiscal balance, suggest that during 1990-92, the fiscal stance was contractionary (Table 1 and Figure 10, top and center panels). However, with the presidential elections in 1994, the fiscal stance and impulse turned strongly expansionary as the deficit rose to nearly 3 percent of GDP in conditions of high GDP growth and a positive output gap. Given that output reached above its trend level in 1994, the cyclically neutral position instead would have been a small surplus. In 1995, the economy was buffeted by an external shock in the form of the Mexico crisis and economic growth turned negative. The drop in output would have led to a widening of the deficit, on the basis of automatic stabilizers, but the new government took strong measures to reduce the deficit and, as a result, the fiscal impulse marked a sharp turn around of 6 percentage points of GDP, from the expansionary stance in 1994 of 3 percent of GDP to a contractionary one of equal amount, in 1995.

Table 1.

Uruguay: Fiscal Stance and Impulse

article image
Sources: Ministry of Finance and staff estimates
Figure 10.
Figure 10.

Uruguay: Fiscal balances and Debt

Citation: IMF Staff Country Reports 2001, 047; 10.5089/9781451839241.002.A001

Source: Central Bank of Uruguay, Ministry of Finance and Fund staff estimates.

80. The fiscal deficit narrowed further in the subsequent years to 1 percent of GDP in 1998. Nonetheless, the fiscal stance was slightly expansionary in these years, even when allowing for the widening of the cyclically neutral deficit that resulted from the introduction of the social security reform. Indeed, with the strong rebound in growth in 1996-98 and the level of economic activity reaching above trend output, the cyclically neutral position would have implied a stronger adjustment in the fiscal balance in those years. This episode was followed by a significant deterioration again in the public finances in 1999, with the deficit rising to 4.1 percent of GDP. A part of the fiscal slippage resulted from the operations of automatic stabilizers to absorb the effects of the cyclical downturn in the wake of the devaluation of the Brazilian real. At the same time, however, it reflected the growing spending pressures associated with the electoral cycle. Both the stance and the impulse were expansionary.

81. The new government that took office in March 2000 introduced spending cuts to reverse the deficit overrun from 1999, and the fiscal impulse swung from expansionary to contractionary in 2000, a virtual repeat of the experience with the election cycle in 1994-95. The simulations for 2001-2005 are consistent with the medium-term budget outlook proposed by the new government. Based on the growth forecast for the medium term, and the intended budgetary policies, by 2003 the government is expected to achieve the turning around of the increase in the debt-GDP ratio, and begin to restore the fiscal stance to its position at the beginning of the 1990s—i.e., establish a fiscal position that is structurally stronger than what it has been on average during the 1990s.

82. When considering the medium term fiscal outlook, and the budget plan for 2000- 2005 as proposed by the new government, one can see that the debt dynamics are motivating the authorities to strengthen the underlying fiscal stance. As noted, the fiscal stance is weaker at present than at the outset of the 1990s. This evolution reflects growing underlying expenditure pressures, and a consequent shift in the “neutral” fiscal deficit from about 1 ½ percent of GDP in 1995 to 2 percent in 1999 and to 2½ percent of GDP in 2005. The social security reform described above accounts for about 1 percent of GDP in this widening. At the same time, the stock of public debt has increased, giving rise to higher interest payments which have increased from 2 percent on average during 1994-99 to 2½ percent of GDP in 2000. Thus, the inevitable increases in net social security costs and in interest payments have slowly crowded out other expenditures, and widened the “neutral” fiscal deficit. Moreover, notwithstanding the planned reduction in the fiscal deficit, the debt ratio would continue to rise through 2002 (Figure 10, bottom panel).

Some Pitfalls of Cyclical Fiscal Analysis

83. Cyclical fiscal analysis is a valuable tool in gauging whether fiscal policies add or subtract to the growth impulse of the economy, especially in the short term. However, it should not be the only tool to gauge the appropriateness of fiscal policy as the technique has important limitations:

  • Cyclical fiscal analysis limits itself to studying the public sector; it says nothing about behavior, or confidence, in the private sector. Thus, it may occur that the economy is weak owing to a lack of private sector confidence. From the narrow point of view of cyclical fiscal analysis, this could result in a call for budgetary stimulus to “get growth going”. However, a private sector pull-back in spending, because households may be concerned about future public obligations thus incurred, can easily outweigh the stimulus, triggering the perverse effect of more debt and an even weaker economy. The reason for the weakness in private sector economic activity needs to be considered before recommending fiscal expansion.

  • It was noted above that the cyclically neutral position takes into account only the effects of the business cycle on the noninterest, ox primary balance, not the interest bill. Thus, an economy may return to a cyclically neutral stance after many years of expansionary policies, and yet wind up with a much larger deficit because the intervening stimulus has cumulated in the stock of debt, yielding a correspondingly higher public sector interest bill. The analysis of debt sustainability is essential as a complementary tool to cyclical fiscal considerations.

  • The cyclically neutral fiscal balance says nothing about the appropriate structural fiscal balance in a general equilibrium context. Thus is may occur that the policy makers diligently pursue neutral fiscal policies over the cycle, and yet the current account of the balance of payments keeps widening, or the rate of unemployment stays high for extended periods of time. Indeed, if the economy needs added saving and investment to absorb the pool of unemployed labor, the fiscal balance may need to be strengthened considerably, and for an extended period of time, to help provide those savings, reduce current spending, and crowd in an expansion of the capital stock. Arguably, this is the case in Uruguay, where the decade of the 1990s has been favorable for growth, yet saving and investment were relatively weak, and unemployment correspondingly high (Figure 11). The fiscal stance may need to be contractionary, relative to the base year periods chosen from the 1990s, to shift towards a more sustainable “structural” fiscal balance for the medium term.

Figure 11.
Figure 11.

Uruguay: Inflation and Unemployment

Citation: IMF Staff Country Reports 2001, 047; 10.5089/9781451839241.002.A001

Sources: Central Bank of Uruguay and National Institute of Statistics.

III. Banking Sector Trends in Uruguay21

A. Introduction

84. This note presents an overview of various indicators of profitability, capital adequacy, efficiency, and general soundness of Uruguay’s banking sector. It considers aggregated micro-prudential indicators of groups of institutions, and the main macroeconomic variables that have a bearing on the system’s performance.22

85. The analysis is based on inter-temporal comparisons of different financial indicators. Time series comparisons also make it possible to integrate more easily into the analysis the changing macroeconomic settings under which the financial sector was operating.

86. The note covers the second half of the 1990s, during which there were few institutional changes in Uruguay’s banking sector. It was, however, a period when the economy experienced sharp changes in its rate of growth, and the country had to confront external shocks of considerable magnitude. These shocks put to test the banking system’s capacity to adapt to changing circumstances, and the analysis provides elements to draw tentative conclusions on the system’s soundness and on possible policy actions to confront weak areas.23

B. Main Macro-financial Trends During the 1990s

87. During 1994-2000, GDP growth was uneven but, on average, satisfactory, while inflation declined significantly. The economy started off the period with an impressive 7.4 percent overall growth in 1994, but stumbled into a recession in 1995 reflecting the regional effects of the 1994 Mexican crisis. Growth revived in 1996 and remained strong until 1999 when new external shocks pushed the economy into a recession that extended itself into 2000. Inflation, which had reached a peak in 1990, steadily declined throughout the decade, and by 1999 had stabilized in the 5-6 percent range. The external shocks of 1999, including the large devaluation of the Brazilian real and the increase in world oil prices, broke the declining inflation trend, but the weak economy avoided a resurgence of more widespread inflationary pressures.

88. With the steady drop in inflation, significant financial deepening took place in Uruguay since 1994. The ratio of domestically held broad money (which includes foreign currency deposits) to GDP, increased from 40 percent in 1994 to 47 percent by mid 2000, while a broader monetary indicator, that includes the deposits held by nonresidents, shows its ratio to GDP increasing from 55 to 71 percent. Credit intermediated by the banking system increased from 38 percent of GDP in 1994 to 51 percent of GDP by mid 2000 (Statistical Appendix Table 31).24

89. Dollarization, the shift of preferences towards the dollar and away from local currency, which had been underway for many years, continued during the second half of 1990s. The proportion of foreign currency deposits in total deposits (of residents and nonresidents) held in the system, increased from 84 percent in 1994 to 88 percent in June 2000. For residents’ deposits only, the proportion of dollar deposits increased from 77 percent in 1994 to 82 percent in June 2000. Credit aggregates also became further dollarized, with their share of total credit in the banking system increasing from 52 percent in 1990 to 62 percent by mid-2000. These trends took place in the context of a consistent and significant decline in the rate of inflation, from 128 percent in 1990 to 4.8 percent in June 2000, and of a marked decline in the rate of depreciation (vis-à-vis the U.S. dollar), from 97 percent in 1990 to less than 7 percent in 2000. In other words, despite a currency far more stable today than 10 years ago, the Uruguayan shift in preferences towards the U.S. dollar did not abate, apparently because the overall monetary services provided by dollar assets continue to be greater than those provided by peso assets.25

90. Trends in interest rates differed markedly between those in local currency and in foreign currency. Rates denominated in pesos declined as inflationary expectations subsided, but they remained high in real terms at around 14 percent, reflecting a rather thin market, higher costs associated with small local currency loans and little competition, since most local currency lending is made by the publicly owned BROU and BHU. Moreover, rates in pesos most probably include a risk premium for a market segment where, on occasion, Congress has acted to provide debt relief at creditors’ expense. Deposit rates in pesos in real terms are about 4 percent at present. Lending rates in the dollar market for prime borrowers followed international rates, averaging about 250 basis points above LIBOR. Those for dollar deposits have tended to be around 100 basis points below LIBOR (Statistical Appendix Table 42).

C. Trends in Banking Soundness Indicators26

Profitability and Asset Quality for the banking system as a whole27

91. After-tax bank profits were relatively stable until 2000 when they declined sharply, mostly reflecting the effects of the recession on the system’s loan portfolio. Return on equity for the banking system (adjusted for inflation) fluctuated within a relatively narrow band (equivalent to about 3.5 percentage points of equity) during 1994-1999. In contrast, during the recession period, losses appeared for the public sector banks, while profits for private banks were halved. Losses for the system as a whole were equivalent to 6.2 percent of equity (on an annual basis) during the first nine months of 2000 (Table 2). This reflected a deteriorating portfolio, as the ratio of non-performing loans to total loans increased from an average of about 10 percent during 1994-1998 to 16.1 percent in 1999- 2000. Moreover, although loan provisions remained high during the recession years, the ratio of loan provisions to past due loans fell to 39 percent, from a high of 63 percent two years earlier.

Table 2.

Uruguay: Banking Soundness Indicators 1/

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Source: Central Bank or Uruguay-Banking Superintendency.

Comprising private banks; Bank of the Republic and National Mortgage Bank; and two intervened banks.

Except where noted, the profitability indicators are not adjusted for inflation bias; September 2000 figures are annualized.

As of end-1998, minimum was 8.5 percent, to increase to 10 percent by 2001.

92. The deterioration of bank profits was much greater in the public banks. Profits declined in both bank groups (private, public), but they did so much less in the private than in the public banks. Profits in private banks declined from an average of 13.2 percent of equity during 1994-1999 to 7.4 percent in 2000. In contrast, the BROU’s result changed from a profit of, on average, 5 percent in 1994-1999 to a loss of 0.3 percent in Sep. 2000, while that of the BHU fell from an average profit of 2.3 percent to a loss of 21 percent during the same period (Table 2).

93. Overall asset quality worsened less in the private banks than in the public sector banks. The proportion of non-performing loans in total loans in private banks increased from 6.5 percent to 8.7 percent between 1994 and 2000; in the BHU it increased from 13 to 16 percent, and in the BROU it tripled from to 35 percent (Table 2). The deteriorating trends are reflected in the supervisors’ ratings of the loan portfolios. In private banks, loans rated as “1” or “2” (highest rankings), declined from 93 percent of total loans in 1995 to 91 percent in June 2000. For public banks (as a group) the ratio declined from 83 percent in 1997 to 69 percent, Thus, while the recession affected the overall quality of the Uruguayan banking sector’s assets, the deterioration was concentrated in the public banks, with the quality of private bank’s portfolio holding up fairly well.

94. Profitability of the system as a whole, as measured by the return on equity, is relatively low but appears adequate if only the (nonintervened) private banks are considered. Average return on equity for the system fell slightly from 7 to 6 percent during the 1994-2000 period. The latter figure corresponds to annualized results through September 2000 and is heavily influenced by the large negative results of the BHU and the weakness in the BROU. In contrast, profitability in the private system28 fluctuated around an average 14 percent until 1998, above comparable indicators in neighboring countries.29 It declined, however, to 7 percent in September 2000, reflecting the effects of the sharp slowdown of economic activity.

Capital Adequacy

95. The Uruguayan banking system is adequately capitalized, but capitalization ratios have shown significant volatility. The ratio of capital to unadjusted assets dropped from 20 percent in 1994 to 15 percent in 2000, while the ratio of capital to risk adjusted assets dropped from 31 percent in 1994, to a still high 23 percent in June 2000. Legislation enacted in 1998 increased minimum capital requirements for banks, from 8.5 percent to 10 percent of risk adjusted assets by early 2001.

96. In the case of the public banks, capital may not be as high as the available figures suggest at first glance. This is particularly true of the Mortgage Bank (BHU), where the large capital base largely stems from the accounting rules of the bank which up until recently specified that mortgage loans would be indexed to wages (with the UR) while most deposits were in U.S. dollars. This currency mismatch worked in favor of the BHU when wages were increasing in dollar terms, but recently this relationship has been reversed and the bank is now incurring valuation losses on its mortgage portfolio. Furthermore, the UR mechanism also at times led to increases in the size of the loan vis-à-vis the corresponding collateral, thus inducing arrears on loans, and defaults. Apparently, few provisions have been made at BHU to confront possible loan portfolio deterioration arising from these issues,30 which suggests caution in interpreting the true level of capitalization of the BHU. In the case of the Bank of the Republic (BROU), which repeatedly refinances borrowers in distressed sectors, there may also be an overstatement of the quality of the portfolio and, thus, of the underlying level of the bank’s capital base.31 Independent audits, currently underway, will assist both the BROU and the BHU to shed light on their true level of capital.

97. Public banks have a higher capital ratio than private banks. With the above caveats, bank capital is well above required minimums at the public banks, and particularly at the Mortgage Bank (BHU). As of December 1999, private banks had a ratio of capital to risk adjusted assets of 12.3 percent, above the required minimum of 10 percent that will go into effect in early 2001. The banks under public sector management, the intervened banks, are not, at present, meeting minimum capitalization requirements.

Efficiency Indicators

98. Total employment in the Uruguayan financial sector decreased significantly during 1994-2000. Total employment in the banking sector fell by 5 percent between 1994 and 2000. However, employment trends diverged for different segments of the market. Employment in the private banks expanded while that in the public institutions and those under public sector administration decreased. The BROU reduced its workforce by 19 percent during this period, as part of its efforts to reduce operating costs (Table 3). The reductions in total employment have occurred mainly through attrition (retirements, nonreplacements, etc.), and occurred despite efforts by the powerful Bank Employees Union (AEBU), to defend employment in the sector at all cost. For instance, the union tends to go on strike when layoffs are in the offing, or if a bank wishes to exit Uruguay—until other banks absorb the released employees. Employment increases in private banks have come about in part through the hiring of nonunionized workers in related activities, such as credit card services where manpower costs are correspondingly lower.

Table 3.

Uruguay: Employment in the Banking Sector

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Source: Central Bank of Uruguay Banking Superintendency

99. Although the curtailment of employment in public banks has been significant, in terms of productivity they still lag behind private sector banks. In 1994, the deposits per employee in the public banking system was approximately US$0.5 million, in contrast to over US$1.1 million in private banks. In 2000, deposits per employee had increased to about US$ 1 million in public banks, while those in private banks had increased to US$2 million, maintaining the relative efficiency gap. Public banks offer their services not only in urban areas, as do most private banks, but they also have a presence in the many small and distant rural communities, which increases their overhead costs and partly explain the persistent gap in deposits per employee.

100. Other indicators also suggest lower efficiency in public banks. The ratio between the operating margin and operating costs shows how much financial margin a bank tends to produce for each peso it spends on operating outlays. This ratio stood at 1.68 in 1994, indicating that for every peso destined to operating expenditures, banks were generating 1.68 pesos in margin. The ratio persistently decreased since then, and by June 2000 it stood at 1.0, a 40 percent decline in 6 years. Disaggregating the ratio sheds some light on the origins of the decline. The ratio for public banks declined from 2.07 to 1.13 (BROU), from 4.66 to -0.49 (BHU), but increased from 1.01 to 1.10 for private banks. A possible explanation for the observed trends may be found in the level of the capital of public banks. As the proportion of (low cost) capital dwindled in public banks, it became increasingly difficult for them to keep their margins. This points in the direction of the need for further operating cost control.

D. Conclusions

101. Bank soundness indicators differ substantially between private and public banks in Uruguay. Overall soundness tends to be weaker in public banks, and potential vulnerabilities larger. This occurs despite a much higher (but declining) degree of capitalization of public banks.

102. The private banking system appears sound. Private banks fared well during a period characterized by the volatility of external economic conditions, a sharp decline in inflation and, recently, a prolonged recession. The system did not seem to be affected significantly by the 1995 aftermath of the Mexican crisis, grew well, and generated adequate profit rates when the economic conditions were favorable. During the recession years private banks were adversely affected, as might be expected, but they managed to maintain a positive level of profits.

103. Public banks did not fare as well during the recession and their soundness needs to be addressed. The revenue deterioration confronted by public banks was more pronounced than in the private banks. This has led to significant losses that have been buffered by the large initial capital bases of both institutions. With the help of the external audits, it will be important to ascertain the true equity levels in these two banks.

104. Provisions have been weakened by the recession. Uruguay’s overall banking system strengthened its provisions during the years 1994-1998, and maintained adequate profits, but there is now some weakening as revenues and profits have fallen during the 1999 2000 recession. This has led to a decline in the ratio of loan provisions to past due loans to below their 1994 level. It will be necessary for the system to step-up its provisions.

105. Efficiency indicators also indicate relative weaknesses in the public banks. Despite labor shedding in recent years, public banks will need to reduce further their operating costs if they are to be competitive. As their (low cost) capital dwindles, as it did over the past six years, increasing pressure will be placed on these institutions to restructure their operations in order to boost profitability.


Table 4.

Uruguay; National Accounts

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Source: Central Bank of Uruguay
Table 5.

Uruguay: National Accounts at Constant Prices

(In thousands of Uruguayan pesos at 1983 prices)

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Source: Central Bank, of Uruguay

Contribution to GDP growth