Uruguay: 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—Supplementary Information

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. Introduction and Background

1. Context. As anticipated in the Staff Report (EBS/03/27, Supplement 1), this supplement provides additional information on the authorities’ debt proposal and financing assurances for the 2003 program, and discusses the implications of this proposal for Uruguay’s medium-term outlook. A supplementary Letter of Intent covering the debt proposal is attached.

2. Stand-By Arrangement. As explained in the main staff report, the current Stand-By Arrangement was approved in March 2002 and augmented on two occasions in June and August 2002. Completion of the second program review, initially contemplated for October 2002, has been delayed, primarily because of insufficient progress in the resolution of suspended banks and in addressing large residual financing needs for 2003 and the medium term. Recent progress on the suspended banks is reported in the Staff Report. The authorities have been working on a debt proposal aimed at eliminating the residual financing needs over the next few years and achieving a sustainable debt profile over the medium term. A consensus seems to be emerging in Uruguay on the need for a debt restructuring and, so far, the political reception to the government’s initiative has been supportive.

3. Performance Criteria. Staff is still assessing whether the end-December performance criteria on the nonfinancial public sector debt stock and the cumulative public sector overall balance were met. Partial data for the cumulative public sector balance would indicate that the performance criterion may have been exceeded by a small margin and, for this reason, a waiver of nonobservance is needed (for the performance criterion on the public sector debt stock, the authorities have asked for a waiver of applicability).

II. The Debt Proposal

4. On March 11, 2003 the authorities filed the necessary preliminary securities documentation for a voluntary debt exchange with the U.S. Securities and Exchange Commission. They plan to start to consult with bondholders shortly, to seek their views on a comprehensive public debt exchange operation. They see this process of consultation as an important element of their cooperative and market-friendly approach. They intend to conduct it over the next three weeks, and to launch the exchange in the first half of April 2003, for completion in the first half of May.1 A supplement to the registration will be filed at the time the exchange offer is launched, specifying the detailed terms of the new securities which will be offered.

5. While specific details of the exchange offer will be developed in the consultation process, the basic strategy aims at significantly extending maturities while broadly preserving the existing coupon rates on outstanding securities. The focus of the operation is on clarity and simplicity, with a view to maximizing the participation of both institutional and retail investors. Most of Uruguay’s market debt was contracted in recent years at relatively low market spreads, when Uruguay enjoyed an investment grade rating.2 Extending maturities at roughly the existing coupon rates, therefore, offers both cash flow relief and medium-term debt reduction in net present value terms (compared with a scenario in which securities would be refinanced on maturity at the market yields for Uruguayan securities). The main features of the planned exchange are described in Box 1. Within this framework, the features may be amended as part of the consultation process, but the authorities intend to preserve the targeted overall financing benefits and reduction in the debt burden.

Preliminary Outline of the Government’s Planned Debt Exchange

  • The debt exchange would cover most foreign-currency government securities (both international-law and domestic-law governed bonds). The total amount of debt that could be exchanged is around US$4 to US$5 billion. Detailed information on Uruguay’s market debt is presented in Table 1

  • The operation would offer to exchange the old securities for a mix of new securities with longer maturities. The maturity extension would be consistent with an elimination of the financing gaps in 2003-07 and achieving a sustainable debt service profile thereafter.

  • There could also be a small upfront cash payment to investors in bonds with the shortest maturities (2003 and 2004). Given their cash constraint, the authorities estimate that the total amount of the cash payments would be small in comparison with the amount of outstanding bonds with these maturities.

  • Participation in the exchange would be voluntary, for both international-law and domestic-law governed bonds. Completion of the international and domestic parts of the exchange would be made contingent on each other to preserve inter-creditor equity.

  • The authorities are developing a variety of features and mechanisms designed to deliver a high investor participation rate.

Table 1.

Uruguay. Structure of Public Sector Debt as of end-2002 1/

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Sources: Central Bank of Uruguay and Fund staff estimates.

Includes the central bank but excludes state banks from the definition of “public sector”. Excludes deposit liabilities of the public sector.

Assumes that all multilateral loans (apart from IMF), bilateral loans and “other” debt are in US dollars.

Assumes that all domestic securities are held by residents, unless reported as held in custody by domestic custodians for non-residents. Also assumes that one-third of the international securities for which the residence of the owner is not reported are held by residents, and two-thirds by nonresidents. (This differs from the balance of payments classification which makes the stylized assumption that all securities for which the residence of the holder is not reported are held by non-residents. Under the balance of payments classification, residents’ share of market debt is 41.4 percent)

Assumes that all multilateral, bilateral and “other” debt is floating.

6. The authorities agreed with the staff that achieving a high investor participation rate in the exchange is critical for the viability of the operation. They expressed confidence that the design of the operation will help them reach a minimum level of 85 percent participation, and are projecting that they will actually achieve 90 percent. The specific terms are still being defined and will be designed, in consultation with bondholders, to enhance investor participation in the new bonds. For example, with respect to the domestic bonds, of which there are at present a large number of small issues, the new domestic bonds would have greater liquidity, as the small old issues would be aggregated into larger new ones.

III. Financing Assurances and Medium-Term outlook

7. Assuming a 90 percent participation rate, the debt exchange would eliminate residual financing needs in 2003-07 (Tables 2-4). Before the exchange, the gross market financing needs of the government, after World Bank and IDB disbursements, are estimated at US$720 million in 2003 and at an average of US$1 billion a year in 2004–05. The debt operation would help reduce these financing needs by US$470 million in 2003 and about US$800 million a year on average in 2004-05. The authorities are confident that the remaining needs (US$250 million3 and US$130 million, respectively) can be financed through the placement of securities in the domestic market.

Table 2.

Uruguay: Nonfinancial Public Sector Cash Flow1/

(In millions of U.S. dollars)

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

After debt operation.

In 2002, excludes disbursements from World Bank and IDB to the FSBS.

Includes bilateral creditors and project loans by the World Bank and IDB.

Table 3.

Uruguay: Public Sector Debt Sustainability 1/

(In millions of U.S. dollars)

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Sources: Ministry of Finance, Banco Central del Uruguay, and Fund staff estimates.

After debt operation.

Includes commercial bank loans, cash payments to investors and assistance to banks (US$1.6 billion in 2002)

Includes privatization proceeds, asset recovery, and use of reserves minus IMF amortizations.

Table 4.

Uruguay: Medium-Term Outlook

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Sources: Central Bank of Uruguay; and Fund staff estimates.

8. The medium-term scenario aims at a return to moderate growth. With a reduced debt burden and sustained improvement in the macroeconomic framework, the economy is projected to recover from the current large output gap during 2004-06 and, subsequently, to grow at a rate of 2½–3 percent, closer to Uruguay’s estimated long-run potential. The peso is also projected to recover partially from the recent large real depreciation against the U.S. dollar, but its real value is assumed to settle some 25 percent below its end-2001 level. The external current account should be in surplus over the next five years, although this surplus would gradually narrow as the economy recovers and the real exchange rate strengthens. Gross reserves are targeted to rise significantly over the next few years, from the critically low present levels, to provide some cushion against shocks and for improved coverage of future debt service payments (including to the Fund).

9. The projections assume continued large primary surpluses as well as multilateral support over the medium term. As noted in the staff report, the authorities aim to raise the primary surplus of the combined public sector to close to 4 percent of GDP over the medium term, which will require sustained expenditure restraint and a further strengthening of the revenue effort. The World Bank and IDB would make gross disbursements totaling around US$500 million a year in 2003-04; after that, disbursements are assumed to gradually fall back to maintain net exposure levels over the next ten years. Given the large repayments to the Fund from 2006 onward, the scenario assumes that, contingent on the normal applicable requirements for Fund support including a satisfactory policy stance, Fund financial support to Uruguay would continue for some time after the end of the current arrangement, albeit on a gradually declining scale.

10. Under this scenario, and with the debt operation as outlined above, Uruguay’s medium-term market financing needs and debt profile appear manageable. The extension of maturities on Uruguay’s market debt at interest rates well below current or projected future market yields strongly improves the debt dynamics, resulting in a significantly lower debt and debt service profile than if the government were financing itself in the market without conducting an exchange (Figures 1 and 2). The debt-to-GDP ratio would fall from 100 percent in 2003 to 58 percent by 2010.

Figure 1.
Figure 1.

Uruguay: Debt Service

Citation: IMF Staff Country Reports 2003, 116; 10.5089/9781451839227.002.A002

Figure 2.
Figure 2.

Uruguay: Residual Financing Needs

Citation: IMF Staff Country Reports 2003, 116; 10.5089/9781451839227.002.A002

IV. Risks and Program Monitoring

11. The medium-term projections are subject to significant risks. In particular, achievement of the targeted fiscal primary surplus will be crucial, as will be the implementation of structural reforms to create the conditions for renewed growth in Uruguay. If the primary surplus were to be at 3 percent of GDP over the medium term instead of the average of close to 4 percent assumed in the baseline scenario, the debt-to-GDP ratio would be close to 70 percent by 2010 (compared with 58 percent in the baseline scenario). If the real exchange rate (measured against the U.S. dollar) were to be some 10 percentage points more depreciated than envisaged in the baseline scenario, the debt-to-GDP ratio would also be about 70 percent by the end of the period.

12. There are also risks associated with the debt operation. These risks reflect, in particular, potential problems in implementation, the difficult economic environment which leaves little or no room for maneuver in case of unforeseen developments, and the impact of the operation on the banking system. Taken together, they make for a fragile outlook that can be derailed by any unforeseen shock.

  • Implementation. The financing of the program and medium-term sustainability hinge critically on the debt exchange achieving the targeted high participation from bondholders. At this stage, there is inevitable uncertainty about the likely participation rate, as the bondholder consultation process is only just beginning. Staff agrees with the authorities that, to achieve a high participation rate, creditors will have to be assured about a viable medium-term outlook and the authorities’ commitment to the program. In addition, after consulting with their creditors, the authorities might have to consider including specific terms to increase the attractiveness of the new bonds versus the old bonds, while remaining within the broad framework of the operation.

  • Market financing. Even with a successful exchange, some (albeit modest) market financing needs would still exist for 2003-05, and these would gradually rise over time (see Figures 1). While staff agrees with the authorities that these needs are manageable, gaps would re-emerge if access to markets is less than expected.

  • Banking system. As noted in the staff report, the situation in the banking system remains highly fragile, and any shock or slippage in program implementation risks triggering renewed deposit outflows. Although bank holdings of government bonds are relatively low, at less than 5 percent of total assets of banks, the debt operation needs to be managed very carefully. In particular, the authorities should be prepared to implement contingency measures to stem further outflows and loss of reserves, if necessary.

  • Capacity to repay the Fund. Even if the debt exchange is implemented as anticipated, there will likely be a need for continued Fund support after the end of the current Stand-By Arrangement. If such support does not materialize, presumably because government policies are not adequate, repayments to the Fund would be at significant risk.

13. Because of the substantial risks, close monitoring of the debt operation and financing assurances is essential. Attaining the objectives of eliminating residual gaps for 2003-05 and ensuring a sustainable debt and debt service profile over the medium term, as envisaged under the debt operation, will be a condition for completion of the next (third) review under the arrangement. A sensitivity analysis shows that, if participation in the exchange were to be of only 50 percent, financing gaps equivalent to 2½ percent of GDP would remain during the 2003-05 period (Table A). Financing assurances will be reviewed at each of the program reviews.

Table A.

Uruguay: Sensitivity of Debt Analysis

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Source: Fund staff estimates.

V. Staff appraisal

14. In the staffs view, the proposed exchange is a bold and innovative attempt to address Uruguay’s financing gaps and debt sustain ability through a cooperative approach with existing creditors. The proposed exchange is designed to be comprehensive, simple, voluntary, and NPV-reducing at market yields and, if successfully implemented, it provides reasonable assurances that the program is fully financed and medium-term debt sustainability can be achieved.

15. Nevertheless, the debt operation and the associated financing assurances are subject to substantial risks. There is uncertainty as to how many investors will actually participate in the exchange, partly because there are few previous examples (and none on this scale) of a preemptive debt restructuring that avoids an interruption of payments while asking investors to accept a reduction in net present value terms. This uncertainty is compounded by the wide range of instruments involved in the exchange and the diverse creditor base. The staff therefore urges the authorities to work vigorously toward timely completion of the exchange with a near-universal participation rate, along with steadfast implementation of all other key program elements. Failure to achieve the targeted participation rate would reopen financing gaps and concerns over debt sustainability, and thereby question the viability of the authorities’ proposed approach.

16. Despite those risks, the staff believes that the proposed debt exchange, if fully implemented and in combination with the other program policies, provides reasonable assurances that Uruguay’s financing needs under the program can be met in a sustainable manner. The entire program, including the proposed debt exchange, represents a balanced effort of adjustment and financing, including from official and private creditors. The staff therefore reaffirms its recommendation in the staff report for completion of the second review and approval of the authorities’ requests for waivers, extension of the arrangement, and rephasing of purchases. The staff also supports the request for a waiver of nonobservance for the cumulative balance of the combined public sector for end-December 2002.


Montevideo, Uruguay

March 12, 2003

Dear Mr. Köhler

This supplement to our Letter of Intent dated February 24, 2003 is to inform you that the Government of Uruguay is preparing a comprehensive debt exchange program. This operation is an important element of our economic program which is designed to restore sustained economic growth, stable public finances, and a strong external position.

To this end, the Government of Uruguay has filed the relevant securities documentation with the U.S. Securities and Exchange Commission in order to initiate consultations with the private sector creditor community. We intend to launch exchange offers in early April 2003 and expect to complete the debt exchange by early May 2003. The key objectives of the operation are to: (i) provide sufficient cash flow relief in order to fully eliminate any residual financing needs during 2003-05; and (ii) achieve a sustainable debt and debt service profile over the medium term, under the economic assumptions contemplated in the Letter of Intent. We understand that achieving the above-defined key objectives is a condition for the completion of the third review under the stand-by arrangement.

Together with the targeted improvement in the primary surplus close to 4 percent of GDP over the medium term, the debt-to-GDP ratio is projected to decline to a manageable level of less than 55 percent by 2012 under the assumptions contemplated in the program. In turn, the improvement in the profile of the debt service and clear prospects for medium-term debt sustainability should enable a gradual return to market access, strengthen investor confidence, and support a durable recovery of growth.

As noted, we are consulting our private creditor community in designing the details of the exchange. On a preliminary basis, we expect the operation to have the following broad features: (1) the exchange offer will include almost all outstanding government securities denominated in foreign currencies having an original term of more than 12 months; (2) assure, as far as possible, the equal treatment among creditors; (3) the exchange will maintain the original currency of the old bonds and will extend maturities compared with the old bonds; and (4) participation in the exchange will be voluntary. Nevertheless, to ensure the financing of our program and medium-term cash-flow relief, we are aiming for a high level of participation by creditors in the exchange.

While we believe that we will be able to implement this debt exchange, the government stands ready to take, in consultation with the Fund, any additional measures that may be necessary to ensure successful implementation of the program.

  • Sincerely yours,

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Mr. Horst Köhler

Managing Director

International Monetary Fund

Washington, D.C. 20431


The operation will be conducted by Salomon Smith Barney, after another advisory bank removed itself citing a conflict of interest.


Uruguay was investment grade until February 2002.


Total net placements of short-term securities in the domestic market amounted to US$93 million from January 1,2003 through March 6, 2003.

Uruguay: 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
Author: International Monetary Fund