Second Review Under the Stand-By Arrangement, Requests for Modification and Extension of the Arrangement, and Waiver of Nonobservance and Applicability of Performance Criteria, and Exchange System — Staff Report; Staff Supplements; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Uruguay

This paper examines Uruguay’s Second Review Under the Stand-By Arrangement, Requests for Modification and Extension of the Arrangement, and Waiver of Nonobservance and Applicability of Performance Criteria and Exchange System. Progress on the structural front has been mixed. The macroeconomic framework is based on a return to economic growth. Notwithstanding the risks to the program, the IMF staff recommends completion of the second review and approval of the authorities’ requests for waivers, extension of the arrangement, and rephasing of purchases.


This paper examines Uruguay’s Second Review Under the Stand-By Arrangement, Requests for Modification and Extension of the Arrangement, and Waiver of Nonobservance and Applicability of Performance Criteria and Exchange System. Progress on the structural front has been mixed. The macroeconomic framework is based on a return to economic growth. Notwithstanding the risks to the program, the IMF staff recommends completion of the second review and approval of the authorities’ requests for waivers, extension of the arrangement, and rephasing of purchases.

I. Background and Recent Developments

1. Since 1998, Uruguay has experienced a severe downturn in economic activity—the sharpest in Latin America, after Argentina. Following average annual rates of growth of 3½ percent during 1990-98, real GDP contracted by 7½ percent during 1999-2001 and by a further 11 percent in 2002 (Table 1 and Figures 1 and 2). This decline reflected primarily the weakening in the regional economy, the Argentine crisis, and the lack of access to credit. While inflation reached 26 percent in 2002, private sector wages remained virtually flat in nominal terms, in a context of high unemployment rates (18.6 percent by year-end).1 Imports contracted sharply in U.S. dollar terms (36 percent), and the external current account balance shifted from a deficit of 2.9 percent of GDP in 2001 to a surplus of 1.2 percent (Table 2).

Table 1.

Uruguay: Selected Economic and Financial Indicators

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Sources: Data provided by the Uruguayan authorities; and Fund staff estimates.

Evaluated at the accounting exchange rate of Ur$29/US$ for2003.

Defined as changes in reserve assets.

Defined for combined public sector.

Excludes nonresident deposits.

Residual maturity. Does not include nonresident deposits.

Figure 1.
Figure 1.

Uruguay: Selected Economic Indicators

Citation: IMF Staff Country Reports 2003, 116; 10.5089/9781451839227.002.A001

Figure 2.
Figure 2.

Real Exchange Rate Indicators

Citation: IMF Staff Country Reports 2003, 116; 10.5089/9781451839227.002.A001

Table 2.

Uruguay: Summary Balance of Payments, 2000–04

(In millions of U.S. dollars)

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Sources: Central Bank of Uruguay and Fund staff estimates.

2. In 2002, the economic recession was compounded by a financial crisis. Initially confined to non-residents, deposit outflows accelerated in March, spreading to resident depositors as a result of problems at two local banks and events in Argentina. Growing concerns about financial sustainability led to a sharp downgrade in Uruguay’s sovereign credit rating. To help stabilize the banking system, in June and August the Fund approved two substantial augmentations of access (totaling SDR 1.5 billion) under the stand-by arrangement. In early August, the central bank suspended the operations of four private domestic banks; reprogrammed foreign currency time deposits in public banks by up to three years; and established a Fund for the Stabilization of the Banking System (FSBS) designed to fully back existing foreign currency sight deposits at domestic banks. This strategy, supported by additional financial assistance from the Fund, the IDB, and the World Bank, helped stop the deposit outflows during the remainder of the year. Private sector deposits with the banking system bottomed out in early October 2002 and rose by US$235 million (3 percent) in the last quarter. The end-December NIR and NDA performance criteria were observed (Table 3).

Table 3.

Uruguay: Performance Under the 2002 Economic Program 1/

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Sources: Ministry of Economy and Finance; and Central Bank of Uruguay.

As defined in the Technical Memorandum of Understanding.

Indicative target.

Cumulative from end-June 2002.

Adjusted for upwards/downwards for any increase/decrease in disbursements from the World Bank and IDB.

All maturities. Adjusted for debt issued for recapitalization of banks.

Cumulative from end-December 2001.

Uruguay: U.S. dollar deposits (changes)

(In millions of U.S. dollars)

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Sources: Central Bank of Uruguay.

3. A new round of deposit outflows took place in late January, but it has now stopped. Concerns about the status of the government’s economic program as well as rumors of pesification of bank deposits and loans prompted renewed deposit outflows, partly reversing the reflows registered in the last quarter of 2002. Reflecting these outflows as well as public sector market debt payments, gross official reserves fell to about US$540 million by end-February 2003, equivalent to only half the domestic reserve liabilities of the central bank. Despite the recent volatility in deposits, the exchange rate has remained relatively stable.

4. In recent months, exchange rate stability has led to a steady decline in short-term peso interest rates. Peso bill rates have fallen from over 150 percent last September to 55 percent at end-February 2003. The government has also resumed U.S. dollar bill auctions, albeit of very limited sizes and maturities. Since the beginning of this year, it has built up a stock of US$35 million of the U.S. dollar bills, auctioned at average interest rates of between 6 and 9 percent.


Urgency: Exchange rate and inflation

Citation: IMF Staff Country Reports 2003, 116; 10.5089/9781451839227.002.A001

5. In 2002, the improvement in the primary balance of the combined public sector was less than expected. The primary balance is estimated to have shifted from a deficit of 1.1 percent on GDP in the first half of 2002 to a surplus of 1.6 percent in the second half (Table 4). However, for the year as a whole, the improvement was lower than envisaged under the program, with an estimated surplus of 0.3 percent of GDP compared with 1.4 percent. Tax collections fell short of program projections despite the adoption of two tax packages in February and May 2002, which included an increase in the tax on wages and pensions, new excise taxes on the tariffs charged by public utilities, and a broadening of the VAT base. The operating surplus of public enterprises was also lower than programmed, mainly because tariff adjustments lagged behind the increases in costs (a large share of which is linked to exchange rate variations). As noted in paragraph 13 and Box 1, significant adjustments in public tariffs are to take place in 2003.

Table 4.

Uruguay: Public Sector Operations, 2000–04 1/

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Sources: Ministry of Finance; and Fund staff estimates.

Program figures including extra budgetary operations.

Excludes contributions that are transferred to the private pension funds.

Includes central government transfers to BPS, Caja Militar and Caja Policial.

Preliminary figures suggest that the PC on the cumulative overall balance was missed. This result might be reverted pending submission of the official below-the-line fiscal data.

6. Expenditure restraint, together with lower interest payments, helped limit the fiscal shortfall. In 2002, public sector wages and salaries were raised by only 1½ percent, compared with an end-of-period inflation rate of 25.9 percent. Total non-wage expenditure declined by an average of 12 percent in real terms, but central government social expenditure (including education, health, and housing) was largely protected, falling only by 7 percent in real terms while real unemployment benefits rose by about 10 percent. Interest payments were significantly lower than expected, in part due to a less depreciated exchange rate than envisaged under the program. Below-the-line data are not yet available to assess the end-2002 performance criteria on the combined public sector deficit and the nonfinancial public sector debt stock. Preliminary data indicate that, during 2002, the public sector debt ratio (including the debt to the Fund) rose sharply, to close to 90 percent of GDP, reflecting in part the additional debt incurred to support the banking system and the depreciation of the peso against the U.S. dollar.

7. Progress on the structural front has been mixed. The government only took gradual and partial steps to increase private sector participation in areas previously reserved for public enterprises (including port management, construction and operation of toll roads, cellular phone services, and insurance). Progress was made toward reforming the public bank BROU, with the launching of a long-term restructuring program, alignment of its capital requirements with those of private banks, and a strengthening in its management. Structural benchmarks on the presentation to congress of a reform of the pension system for the military and a reform to rationalize and simplify the tax system were observed, the former with a delay. However, other benchmarks (weekly publication of bank data, reform of the pension fund for bank employees, and measures to foster competition in the telecommunications and oil sectors) were not met, and have been included in conditionality for 2003.

8. The political and social situation has remained calm, despite the hardship caused by the economic recession. In this context, the existence of a relatively broad social safety net, and the government’s efforts to shield priority social expenditure from adjustment have helped mitigate the adverse impact of the recession (Box 1). Although in November 2002 the National Party withdrew its ministers from the cabinet, the government has been able to garner congress’ support for its main policy initiatives. While no longer in the cabinet, the National Party has reaffirmed on a number of occasions its willingness to continue supporting the government in Congress. However, as the date for the presidential elections (scheduled for late 2004) approaches, the political environment is expected to become more challenging for the government.

Uruguay: Poverty and Social Safety Nets

Uruguay, with a population of 3.3 million, has traditionally enjoyed strong social indicators: 90 percent of the population has access to primary education; infant mortality (14.1 per 1,000 live births) is among the lowest in Latin America; and poverty levels declined during the 1990s while income distribution improved. Estimates for 2001 show that only 12 percent of the Uruguayans were living below the poverty line1 and less than 2 percent in conditions of extreme poverty. However, poverty increased in 2002, due to the sharp decline in output and income.

Uruguay has a wide range of social protection schemes. Social spending is explicitly protected by law from budgetary cuts, and the authorities have aimed at prioritizing spending towards the programs that are best targeted. Protection of social spending is also a key element of ongoing World Bank and IDB loans.

  • In education, emphasis is being placed on: (i) enhancing the school food program (PAE) which currently provides coverage to 45 percent of children in public schools; (ii) ensuring the provision of adequate preschool and primary education to children living in poor environments (via longer school days, improved school infrastructure and equipment, teacher training and the purchase and distribution of educational material); and (iii) a program to improve secondary education, favoring youth employment.

  • The public health system targets the poor, by classifying users by income levels. Unlike the private system (financed through social security contributions and direct fees), the public system is financed with government revenue. Priorities include: (i) health facilities, specifically those for primary and secondary care; (ii) spending under the Family Medicine Program that targets the poorest mothers and children; and (iii) public health programs such as the Expanded Immunization Program (PA1), the Program for Epidemiological Control, and the AEDES Campaign to prevent dengue fever.

  • Social security is administered by the BPS, with a range of programs targeted at both contributors and noncontributors. The BPS spends over 5 percent of GDP a year on social benefits (excluding normal pensions) to protect the most vulnerable groups: low-income households, single-parent households headed by women, low-income adults without access to the contributory pensions system, and the unemployed. Coverage includes; (i) unemployment insurance; (ii) family allowances and healthcare services, which originally covered only affiliated workers and their families but have recently been expanded to the unemployed, low-income households, and single-parent households; (iii) old age and disability pensions, available to low income adults over the age of 70 or with handicaps; and (iv) social development programs for retirees and pensioners. There is also a minimum pension of Ur$l, 344 a month, equivalent to 112 percent of the minimum wage.

1/ Data obtained from the Economic Commission for Latin America and the Caribbean (ECLAC).

II. Policies for the program

A. Macroeconomic Framework

9. The macroeconomic framework is based on a return to economic growth. Although most economic indicators remain depressed and real GDP is projected to decline by 2 percent in 2003, the most recent export data (for December) are encouraging and there are early signs that the economy will bottom out this year. The recovery is expected to gather strength during 2003, leading to projected real GDP growth rates of 4-4½ percent in 2004-05. The monetary program aims at limiting inflation to about 26 percent in 2003, taking into account projected increases in utility prices, and targets a decline to single-digit level beginning in 2004. A key objective of the program is to reinforce the basis for medium term debt sustainability.

Text Table A.

Macroeconomic Framework. 2002-05

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Sources: Uruguayan authorities; and Fund staff estimates.

B. Monetary and Fiscal Policies

10. Following the move to a floating exchange rate regime in mid-2002, the central bank has adopted base money growth as its intermediate monetary target. Consistent with the inflation objective, base money is projected to rise by 25 percent during 2003 (Table 5). Building on progress made so far, the central bank plans to strengthen its open market operations, with a view to creating a deeper and more liquid market for short-term peso debt instruments. Over time, the authorities intend to move to an inflation-targeting framework for the conduct of monetary policy.

Table 5.

Uruguay: Summary Accounts of the Banking System, 2000–03 1/

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Sources: CentralBank of Uruguay; and Fund staff estimates.

Includes the Bank of the Republic (BROU), the National Mortgage Batik (BHU), private banks and cooperatives. Does not include off-shore banks.

Text Table B.

Monetary Program, 2003

(In billions of Uruguayan pesos

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As defined in the Technical Memorandum of Understanding end evaluated at program accounting rates.

11. The authorities’ economic program seeks to credibly improve public finances in 2003, and to provide the basis for a sound medium-term fiscal position. The authorities are committed to raising the primary surplus of the combined public sector to 3.2 percent of GDP in 2003, consistent with a reduction in the overall deficit from 4.3 percent of GDP to 3.1 percent. They agreed with the staff that achieving these objectives will require both an enhanced revenue effort and expenditure restraint. Over the medium-term, the primary surplus is projected to grow to about 4 percent of GDP.

12. In 2003, the authorities intend to firmly control the growth of primary spending, especially wages and pensions. Overall, primary spending is projected to rise by only 14 percent in nominal terms, or about half the rate of inflation. Goods and services outlays will be streamlined under recently-established centralized procurement mechanisms for the purchase of medical supplies and food. Savings under these schemes (0.2 percent of GDP) will be used to make room for an increase in public investment, which has been sharply retrenched since 1999. As in 2002, the authorities plan to protect non-wage expenditure in priority social programs.

13. In 2003, public sector revenue is conservatively assumed to decline by ½ percent of GDP. Part of this decline would reflect lower tax collections on income and profits associated with weak economic conditions. The projections also take into account weaker-than-expected tax collections in the second half of 2002 and the full-year impact of the fiscal packages approved last year. The decline in tax revenue will be partially compensated by adjustments in public tariffs which, together with cost savings, would lead to an improvement of 0.7 percentage point of GDP in the operating surplus of public enterprises (Box 2). The authorities also plan to enhance revenue collection by reforming the tax refund scheme to exporters, and by taking steps to strengthen revenue administration and control.

14. The authorities are committed to strengthen the tax reform package submitted to Congress in December 2002. The current draft law aims at increasing efficiency and facilitating tax administration, through a broadening of the VAT base and a gradual reduction in rates; eliminating several low-yielding taxes to incorporate them into the main excise tax; and generalizing the corporate income tax to all productive sectors. Assuming that the envisaged reduction in rates were to be handled with caution, the reform would be broadly revenue neutral. In an effort to improve the revenue outcome, staff suggested that the authorities strengthen the proposal through: (a) expanding the VAT base to agricultural inputs and real estate rentals, and unifying the two main VAT rates; (b) incorporating the taxes on bank assets and net worth into the generalized enterprise income tax; and (c) eliminating revenue earmarking. The authorities have requested technical assistance from FAD in the design of a revised tax reform proposal, and will not push for passage until there is a revised proposal. Presentation to congress of revised tax reform legislation by end-June is a structural performance criterion under the program.

Public Enterprises

The fiscal program includes an increase in the operating surplus of public enterprises from 2.3 percent of GDP in 2002 to 3 percent in 2003. This improvement would return the operating surplus to the level registered in 2001, correcting for the weak performance observed in 2002 (mostly due to tariff adjustments that lagged behind the rise in operating costs). Two main factors will support the projected recovery:

Tariff adjustments. The four main public enterprises increased their tariffs by 10-26 percent in January and February 2003, and are scheduled to implement two further adjustments in May and August, to reach cumulative increases of 23-49 percent by year-end. These adjustments will help improve revenue by the equivalent of 1.5 percent of GDP.

Tight controls on operating expenditure. Total current outlays of public enterprises are expected to increase only by about 0.6 percent of GDP from 2002 to 2003, supported by wage restraint and implementation of early retirement programs.

15. Over the medium term, the consolidated public sector primary surplus is targeted to gradually rise to about 4 percent of GDP. The authorities explained that they plan to rely on the revenue improvement associated with the gradual recovery in economic activity, expenditure restraint, and the dampening effect on outlays deriving from the 1997 social security reform to achieve this objective. The staff noted that achieving and sustaining such primary surplus would also require additional efforts on the revenue side. As noted in paragraph 7 of the MEFP, the authorities are committed to broaden the forthcoming tax reform to yield additional revenue over the medium term, and to complement it through a significant strengthening in tax administration.2

C. The Banking System

16. The authorities are proceeding with the resolution of the four banks suspended in August 2002. In the discussions, staff emphasized the risks associated with reopening weak banks in the current difficult economic and financial environment, and the importance of ensuring that any reopened bank was viable. The authorities generally agreed, but also noted that they attached a high importance to minimizing the disruption in credit flows to the economy and to the need to protect depositor confidence. The main steps of the action plan of the government are as follows:

  • In December 2002, congress approved several amendments to the banking law, aimed at strengthening the powers of the central bank in the area of bank resolution and establishing that the government would attempt to protect deposits in the liquidated banks up to US$100,000.

  • In the coming weeks, the authorities plan to create a new bank (Nuevo Banco Comercial-NBC) with the good quality assets of three suspended banks. These banks were placed in liquidation in January 2003, and trust funds have been created to manage their assets. In late February, the NBC purchased the good quality assets of the liquidated banks from the trust funds, in a competitive bidding process. It will pay for the assets with its own CDs, carrying a 2 percent interest rate and repayable over six years and, in turn, the trust funds will distribute these CDs to all the general creditors, including the government.

  • The authorities are firmly committed to ensure that any new or reopened bank will have to be viable and meet all prudential norms, so that it does not pose risks to the rest of the banking system or to public finances. To that effect, over the next two-to-three weeks, the government is committed to evaluating—jointly with Fund staff—the business plan and viability of NBC before it is allowed to operate.

  • To partially cover the losses of depositors, the government plans to give up part of its claims. It will transfer part of the CDs that it will receive to private depositors (some US$215 million), to help meet the US$100,000 protection, and use the remaining proceeds (US$125 million) to capitalize the new bank. As a result, the recovery of assets by the government will be significantly lower than envisaged earlier (the government had lent US$1 billion to the three banks).

  • The new bank will be government-owned, although it will operate under the legal framework of private banks. The government plans to sell its equity shares in the bank as soon as conditions permit. However, with the new bank initially fully government-owned, over 55 percent of total banking system assets would be in the hands of the government.

  • Discussions with the minority shareholder on the resolution of the fourth suspended bank have stalled, and on February 28 the government announced the liquidation of the bank and the creation of a trust to facilitate the disposal of its assets. The staff remains in close touch with the authorities for appropriate and timely disposal of the bank’s assets and other aspects of liquidation.

17. In the rest of the banking system, progress has been mixed. The restructuring process for the mortgage bank BHU has been slow. In December, congress approved a new charter transforming the BHU into a nonbank housing institution. As part of the reforms undertaken under the World Bank SAL I operation, BHU is developing and implementing a plan to reduce its operational costs, improve asset recovery, and complete a comprehensive audit of its portfolio.

18. Beginning in August 2003, repayment of the first tranche of reprogrammed deposits will become due. The government has reaffirmed its intention to repay deposits on schedule (US$510 million fall due during August-December), which will require the public bank BROU to have sufficient liquidity to cover potential deposit withdrawals. In recent months, BROU has been accumulating liquid assets for that purpose. The deposit reprogramming gives rise to an exchange restriction under Article VIII, as it captures nonresident deposits that could have been derived from current international transactions.

D. Financing Assurances

19. A large part of the 2003 financing requirements is to be covered by program loan disbursements from the World Bank, the 1DB, and bilateral creditors. Total financing requirements for 2003 are estimated at US$1.4 billion, of which US$660 million are to be covered by the World Bank and the IDB. Program loan disbursements from the World Bank are projected to amount to US$250 million, under both the ongoing SAL I operation and a new operation in support of reforms to foster competition and improve efficiency in the provision of public services. This new operation (SAL II) is expected to be presented to the Executive Board of the Bank in April 2003. IDB program disbursements are projected to amount to US$325 million, in support of reforms in the social, financial, and health sectors. Disbursements from bilateral creditors are projected to amount to US$50 million.

20. The remaining financing needs for 2003 (USS700-720 million) are expected to be met through a debt operation and modest bond placements in the domestic markets. The authorities are presently working to fill this gap. As part of these efforts they are preparing a debt proposal with their financial and legal advisors—the details of this proposal will be provided after the authorities have made a shelf filing with the U.S. Securities and Exchange Commission and consulted with bondholders. The authorities have agreed that, before Board consideration of this review, they will issue a supplementary LOI elaborating on the debt proposal. Based on this LOI, a supplement to the staff report will provide an assessment of the medium-term outlook and debt sustainability. In addition to the debt operation, gross debt placements in the domestic market, including to the private pension funds, are expected to amount US$250 million in 2003 (just over 2 percent of GDP).

III. Program Modalities and Risks

A. Access to Fund Resources and Program Monitoring

21. Access. The current 24-month stand-by arrangement, in an initial amount equivalent to SDR 594.1 million (193.8 percent of quota), was approved in March 2002 and augmented on two occasions (June 25, 2002 and August 8, 2002), to SDR 2,128 million (694.4 percent of quota). Undisbursed access under the stand-by arrangement, which total SDR 1,016.6 million, would, under the proposed rephasing, be disbursed over the extended period through March 2005 (Table 6). Upon completion of the current (second) review, a purchase of SDR 218.5 million (71 percent of quota) would become available. In addition, it is proposed that repurchase expectations under the SRF arising in 2003 (SDR 128.7 million) be converted to an obligations basis.3 Repayment of the SRF could cause undue hardship at a time when the authorities are taking firm action to strengthen the balance of payments.

Table 6.

Uruguay: Proposed Availability of Purchases 1/