Uruguay
2003 Article IV Consultation and Third Review Under the Stand-By Arrangement and Request for Modification and Waiver of Applicability of Performance Criteria—Staff Report; Staff Supplement; Staff Statement; Public Information Notice and Press Release on the Executive Board Discussion; and Statement by the Executive Director for Uruguay
Author:
International Monetary Fund
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Publication Date:
07 Aug 2003
eISBN:
9781451839258
Language:
English
Keywords:
ISCR; CR; bank; deposit; economy; debt exchange; banking system; exchange rate; factor cost; consumer confidence; inflation-indexed government; Exports; Public enterprises; Credit
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Uruguay's performance under the Stand-By Arrangement (SBA) has been favorable, and commendable progress has been achieved in containing the crisis and stabilizing the economy. Executive Directors welcomed this development, and stressed the need to implement policies in the fiscal, banking, and structural areas. They commended the floating exchange rate regime, and the efforts of political and legal institutions in dealing with the financial crisis. They agreed that Uruguay has successfully completed the third review under the SBA, and approved waiver.

Abstract

Uruguay's performance under the Stand-By Arrangement (SBA) has been favorable, and commendable progress has been achieved in containing the crisis and stabilizing the economy. Executive Directors welcomed this development, and stressed the need to implement policies in the fiscal, banking, and structural areas. They commended the floating exchange rate regime, and the efforts of political and legal institutions in dealing with the financial crisis. They agreed that Uruguay has successfully completed the third review under the SBA, and approved waiver.

I. Background and Recent Developments

1. Uruguay experienced relatively high economic growth during most of the 1990s (Appendix I). This expansion followed a long period of adjustment in the aftermath of the 1982 crisis, and was underpinned by significant stabilization gains and trade liberalization. Inflation fell sharply and regional integration fueled a significant expansion of trade with neighboring countries and triggered healthy productivity growth. At the same time, however, important structural weaknesses remained (such as an oversized public sector), and new vulnerabilities emerged, including increasing financial dollarization, currency overvaluation, and growing dependence on the region. Beginning in 1999, the economy entered into a prolonged recession, driven to a large extent by exogenous shocks and contagion. The impact of these shocks on the domestic economy was compounded by the structural weaknesses that had remained unaddressed during the period of solid economic performance (Box 2). There are signs that activity bottomed out in early 2003, and the economy is expected to recover gradually in the months ahead.

uA01fig01

Financial Intermediation in the Banking System

Citation: IMF Staff Country Reports 2003, 247; 10.5089/9781451839258.002.A001

A. Economic Expansion in 1990–98

2. Uruguay’s economy grew by 3.9 percent a year on average during 1990–98, significantly above long-term trends (2 percent during 1960–2000). Growth was fueled by domestic demand, mainly consumption, while the contribution of net exports was negative (Table 1).1 Private consumption was boosted by strong credit growth in the wake of economic stabilization, as bank intermediation recovered from a severe depression in the previous decade. Credit to the private sector doubled as a share of GDP, to 50 percent in 1998. Export performance benefited from strong rates of growth in Brazil and Argentina and from the creation of the Mercosur. Although Uruguay’s exports of goods and services rose by 90 percent during the period, imports rose twice as fast (170 percent).

Table 1:

GDP Growth 1990-2002

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Uruguay: Structural Weaknesses and Systemic Risks

Although Uruguay grew well above historical averages during most of the 1990s, a number of fragilities built up that made the economy increasingly vulnerable to exogenous shocks.

  • The economy had become highly exposed to the region. The Mercosur treaty opened growth opportunities for the economy, but heightened the dependence of Uruguay’s tradable sectors on Brazil (traditional exports) and Argentina (nontraditional exports and services). Much of the trade involved regional goods (e.g., fresh products and tourism), with limited scope for demand substitution from countries outside Mercosur. These links heightened the contagion risks from lower growth or exchange rate adjustments in neighboring countries. In addition, the redirection of exports towards other markets after Brazil’s devaluation in 1999 was hindered by the real appreciation of the peso against non-Mercosur currencies.

uA01fig02

Real Effective Exchange Rate

(Jan. 1990=100)

Citation: IMF Staff Country Reports 2003, 247; 10.5089/9781451839258.002.A001

  • The large and heavily regulated public sector has been a drag on competitiveness and has limited the ability of the economy to adjust to external shocks. Expenditure by the nonfinancial public sector is close to 40 percent of GDP; total public sector employment represents almost one quarter of total employment; and about 60 percent of total deposits and half of total credit are intermediated by public financial institutions.

  • Currency mismatches accumulated in corporate, household, and public sector balance sheets. Dollarization of bank lending grew from 58 percent of total lending in 1995 to 87 percent in 2002, thus creating significant currency risks in households and corporations with local currency earnings. Similarly, the public sector’s financing relied almost exclusively on issuance of foreign currency instruments. While this enabled the government to benefit from low financing costs after Uruguay obtained an investment grade rating in 1997, it also increased exposure to currency risk. For instance, the public mortgage bank BHU was seriously exposed to currency and interest rate risk as it funded its long-term local currency lending with short-term foreign currency deposits.

  • Weak banking regulations contributed to the crisis of the domestic banking sector. Some private banks accumulated large exposures to Argentina. At the same time, while nonresident deposits had risen sharply, the regulatory framework did not establish stringent liquidity requirements. The public sector banks’ balance sheets had been weakened by high nonperforming loan ratios and quasi-fiscal activities, accommodated by regulatory forbearance.

  • The scope for active fiscal and monetary policy responses to shocks was severely constrained. Persistent fiscal deficits had contributed to substantial public sector borrowing requirements and a rising debt burden, increasing dependence on capital market access. The high degree of dollarization of bank deposits (90 percent in 2002) seriously limited the lender-of-last-resort capacity of the central bank, and large currency mismatches in private and public sector balance sheets constrained the scope for exchange rate flexibility.

3. Growth was concentrated in services. Regional trade integration and strong private consumption boosted the demand for financial services, tourism, and retail trade. As a result, the share of services in GDP grew from 58 percent of GDP in 1990 to 65 percent in 1998. Manufacturing declined considerably, in part reflecting the loss of competitiveness associated with a significant appreciation of the peso in real effective terms during this period. The primary sector’s share remained broadly stable, at about 10 percent of GDP (Table 2 and Appendix II). Despite the strong economic growth, unemployment remained relatively high throughout the period, at almost 10 percent on average.

Table 2:

Sectoral Composition of Real GDP Growth

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4. The strong growth performance was supported by an exchange rate-based stabilization effort. Beginning in 1992, the authorities allowed the domestic currency to move within a crawling currency band that was depreciated at a declining rate. This policy helped anchor inflationary expectations and brought inflation down from over 100 percent in 1990 to 11 percent in 1998. However, it also contributed to an appreciation of the peso in real effective terms, particularly in the early stages of the currency band. Although the appreciation was less than in neighboring Mercosur countries, it contributed to a sharp rise in imports.

5. The opportunity to deepen fiscal consolidation was largely missed. Although the overall deficit of the combined public sector was moderate, averaging 1.4 percent of GDP during 1990–98, the fiscal stance was expansionary in most years (Appendix III). Expenditure rigidities rose significantly, including through the indexation of pension benefits to wages and the transition costs of pension reform.2 Overall, noninterest expenditure grew by 5 percent of GDP. In response, the authorities raised the (already quite high) tax burden on the private sector. The public sector deficit was financed to a significant extent from abroad, both through bonds and IFI loans. This helped free domestic resources which, however, fueled mainly consumption growth, while adding to vulnerabilities by increasing the share of public sector debt in foreign currency. Other net capital inflows, including FDI, were relatively modest during the period (½ percent of GDP on average) as important sectors of the economy remained reserved for the public sector.

uA01fig03

Capital Account 1990-98 (in percent of GDP)

Citation: IMF Staff Country Reports 2003, 247; 10.5089/9781451839258.002.A001

6. Progress on the structural front was mixed. Significant trade liberalization had taken place in the second half of the 1980s, contributing to strong productivity growth in the 1990s. In addition to the pension reform noted above, the authorities took partial steps to allow private sector participation in sectors previously reserved to the state, including in the markets for cement, cellular phone services, mortgages, insurance, port management, and the construction and management of toll roads. However, more decisive attempts to privatize failed after a law for the partial privatization of the state telecommunications company Antel was repealed by referendum in 1992. As a result, important parts of the economy remained reserved for, or dominated by, the state.

B. Recession and Financial Crisis in 1999–2002

7. The strong growth performance stopped in the late 1990s, when the economy was exposed to a series of shocks. The devaluation of the Brazilian real and the recession in Argentina depressed Uruguay’s exports and domestic investment, and the primary sector suffered from the impact of a severe drought and a sharp decline in international prices for several of its export products. As a result, the economy entered into recession in early 1999, with private consumption following soon thereafter as unemployment surged. An incipient recovery of economic activity in early 2001 was halted by the outbreak of foot-and-mouth disease, which led to the closing of important meat export markets. At the same time, the deepening crisis in Argentina further weakened business and consumer confidence. Uruguay’s real GDP declined by a cumulative 7½ percent during 1999–2001, and the deficit of the consolidated public sector rose to 4 percent of GDP as revenue suffered from the economic downturn while structural rigidities limited the scope for expenditure reduction.

8. In 2002, real GDP contracted further by 10.8 percent as the country experienced a severe financial crisis. The impact of external shocks affecting Uruguay during 1998–2002 may have been magnified by growing internal disequilibria, particularly the changing structure of bank balance sheets as a result of large inflows of nonresident deposits. Following the imposition of a deposit freeze and capital controls in neighboring Argentina, cash-strapped Argentine depositors began to withdraw their funds from Uruguay’s banking system. The run on deposits rapidly extended to resident depositors, after problems developed in two large private banks with strong links to Argentina. Uruguay’s sovereign debt rating suffered successive downgrades, and access to foreign capital markets was lost. The loss of reserves, driven by deposit outflows, forced the authorities to float the peso in June. A package of fiscal, monetary, and banking reform measures was adopted in early August, that helped stabilize the situation together with large financial support from IFIs (more details are presented in the companion report on the 2002 banking crisis).

9. The steep contraction in output was partly due to a severe credit crunch associated with the banking crisis. The liquidity squeeze resulting from sustained deposit outflows prevented banks from lending: in U.S. dollar terms, credit to the private sector fell by 31 percent during 2002. Economic activity declined in all sectors, except agriculture.3 Investment dropped by one-third in real terms. Private consumption also fell sharply, with private savings rising by 4 percentage points of GDP.4 Net exports, in turn, contributed positively to GDP growth, with a sharper contraction in import volumes (28 percent) than in exports (11 percent).

10. The increase in inflation following the float of the peso was moderate. During 2002, consumer prices rose by 26 percent while the peso depreciated by 85 percent against the U.S. dollar. The moderate price increases reflected the weakness of domestic demand and the lack of wage pressures—wages rose by only 3 percent in nominal terms during 2002. In real effective terms, the peso depreciated by 13 percent, as Uruguay’s regional trading partners experienced sharper rates of depreciation.5 In early 2003, the peso depreciated further by about 18 percent in real effective terms, reflecting mostly the appreciation of other regional currencies and the weakening of the U.S. dollar.

11. Public debt dynamics deteriorated significantly in 2002, raising concerns about sustain ability. The debt-to-GDP ratio of the consolidated public sector jumped from 54 percent in 2001 to 94 percent in 2002, reflecting the sharp depreciation of the peso against the U.S. dollar, the cost of government assistance to stabilize the banking system, and the fiscal deficit. In addition, the government faced a bunching of debt amortization in 2003–07 without reasonable prospects for regaining access to international markets. To address these problems, the authorities undertook a comprehensive debt exchange in May 2003, which extended the average maturity of virtually all market debt by about five years while maintaining the low interest rates contracted in previous years when Uruguay enjoyed investment grade ratings.6

12. Developments in 1999–2002 highlighted the presence of a number of macroeconomic and structural weaknesses that made the Uruguayan economy vulnerable to external shocks. These fragilities included: heightened dependence on the Mercosur region; large and rising asset and liability dollarization of the banking system and a significant increase in nonresident deposits; weak bank regulations and balance sheet weaknesses; insufficient fiscal consolidation; and vulnerabilities associated with the crawling peg exchange rate regime (see Box 2). These weaknesses left the country highly vulnerable to the sharp deterioration in the external environment that occurred during 1998–2002.

II. Policy Discussions

13. The authorities and staff concurred that, under current policies, the output gap would gradually narrow while medium-term potential growth would be lower than during the 1990s, at 2½–3 percent a year. This outlook is based on the recognition that, while successful stabilization will allow the economy to recover from the sharp recession, a number of structural and external conditions will likely be less favorable than during the past decade. In particular, Uruguay is expected to face a less supportive external environment and weaker contributions of labor and capital accumulation to growth.

14. Against this background, the discussions centered on the kind of policies and reforms needed to achieve higher and less volatile economic growth over the medium term. There was broad agreement between the staff and the authorities on the need for policies to stimulate productivity growth by promoting the reallocation of resources toward more productive uses, and to reduce financial and structural vulnerabilities in order to improve resilience to shocks. To achieve these goals, the staff encouraged the authorities to build political support for a comprehensive reform agenda that would seek to promote sound macroeconomic policies; encourage private sector development through a reduction of the size of the state; and further strengthen Uruguay’s institutional framework and investment climate.

A. Constraints to Economic Growth

Less supportive external environment

15. Uruguay’s external environment will likely be more challenging in the period ahead than in the 1990s. Economic conditions in the Mercosur region are expected to be less supportive than during the last decade. Developing new sources of growth will be all the more challenging as private capital flows to Latin America—FDI particularly—are expected to be lower, with foreign investors focusing on other regions of the world. It is thus likely that regional demand for Uruguay’s exports (a mainstay of growth in the 1990s) will remain subdued. Similarly, the financial sector’s ability to mobilize and intermediate savings will likely recover only gradually, and it will probably not regain its position as a main engine of growth, at least for some time.

16. Uruguay therefore needs to diversify its export base. The Mercosur agreement had resulted in a reorientation of exports to the region, with Brazil becoming the most important destination for Uruguay’s agricultural goods, and Argentina the main client for Uruguay’s key service industries (tourism and banking) and nontraditional exports (manufactured goods). While exports to Mercosur increased from 35 percent of total exports in 1990 to 55 percent in 1998, exports to Europe, the second largest destination for Uruguayan products, declined from 33 percent to 18 percent. Although the relative importance of exports outside Mercosur has risen again in recent years, this has been mostly due to the reduction in exports to Mercosur rather than increased exports to other markets. In recent months, the strengthening of the euro has boosted competitiveness vis-à-vis Europe, but export growth to this region is limited by binding quotas for Uruguay’s chief agricultural exports, particularly beef.

uA01fig04

Uruguay: Exports by Destination

(in percent of total exports)

Citation: IMF Staff Country Reports 2003, 247; 10.5089/9781451839258.002.A001

17. Further trade liberalization will be key to product and market diversification for exports, as well as FDI and technology transfer. The authorities are pursuing free trade negotiations, within the framework of Mercosur, with the United States and the European Union, and bilaterally with Mexico. The staff supported these efforts, noting that trade integration with industrialized countries should accelerate the structural modernization of the economy through its links to innovation, FDI, and the transfer of technology. The staff encouraged the authorities to also play an active role in the multilateral trade discussions under the Doha Round.7

18. The authorities noted that recent improvements in external competitiveness should support a broad-based recovery in exports. Extra-Mercosur competitiveness has improved sharply since the floating of the peso in mid-2002. Nevertheless, improvements in export performance to markets outside Mercosur have so far been concentrated in agricultural goods (traditional exports), which benefited in part from a relaxation of health controls on Uruguayan beef. Further market expansion in these products will face persistent obstacles in the form of quotas, competition with other Mercosur exports, and nontariff barriers for many products (dairy products, rice, meat). The staff also noted that, moreover, while competitiveness outside the Mercosur region has improved markedly, the same has not been observed within the region, where more depreciated exchange rates may constrain Uruguay’s export buoyancy.

Adverse demographic trends

19. Uruguay’s population is ageing and the contribution of labor to growth will be less important than in the 1990s. Uruguay has the oldest population in Latin America, with the ageing trend continuing, including because of increased emigration in recent years (Box 3). The labor force grew somewhat faster during the 1990s than in the previous decades, due to increased participation rates for women. This trend is believed to have reached a limit and, as a result, the growth of the active population is expected to remain relatively low compared with other countries in the region, at 0.7 percent a year on average. This development takes into account emigration flows, which have increased sharply in recent years, due to the high unemployment rates and falling real wages.

Uruguay: Trends in Demography and Migration

Uruguay has the oldest population in Latin America. Official estimates show that 17½ percent of the population is 60 years or older, compared with 8 percent on average in Latin America, while 24 percent of the population is 15 years or younger, compared with a regional average of 31 percent. Projections by the U.N. Economic Commission for Latin America and the Caribbean suggest that the population below 15 years of age will fall to nearly 20 percent by 2030, while that over 60 will rise to 20 percent.

Chart 1.
Uruguay- Demographic Ageing
A01bx03ct01

Uruguay’s ageing process has been led for some time by declining birth and mortality rates and, more recently, by emigration. Statistics from the U.S. Immigration and Naturalization Service show that the number of Uruguayan immigrants to the United States has risen sharply in recent years, after having fallen during the second half of the 1990s. Data on the number of nationals entering and exiting the country in 2002 through the international airport of Carrasco point to a net exodus of about 1 percent of the country’s population. Anecdotal evidence suggests that emigration is primarily toward the United States, Europe, and Mexico.

20. Uruguay’s active population remains well qualified, an important asset for growth. Education levels are high, and income distribution is more even than in other Latin American countries. However, the recent wave of emigration may impact the quality of the labor force and put further strain on the social security system, as there are indications that emigrants are on average younger and with higher education levels than the population at large. In addition, the surge in child poverty and youth unemployment registered in recent years could lead to a deterioration of Uruguay’s human capital base if not addressed in time through well-targeted policies.

Constraints to capital accumulation

21. With bank credit expected to remain depressed and access to international capital markets limited, the staff noted that it would also take time before capital accumulation could again support GDP growth. Although the existence of spare capacity after the long recession can initially provide room for a recovery in economic activity, several years of high investment growth would be needed to reverse the contraction in the capital stock of the past years. The investment outlook is constrained by low domestic savings (related partly to the ageing population), the weakened banking system, and challenges to attracting FDI. In particular, the capacity of the banking system to intermediate savings will recover only gradually, as capital positions and confidence in the banking system need to improve before broad-based credit growth can be expected to resume.

22. Informal financing is expected to be available for certain sectors, but its cost will likely remain high. The creation of direct vehicles of intermediation, such as specialized investment funds, could help speed-up a recovery of credit. In this context, the staff noted that prompt congressional approval of the draft law on trust funds and warrants would establish a legal framework for the operation of such vehicles. The staff also encouraged the authorities to accelerate the disposal of remaining assets from liquidated banks, to prevent the deterioration of credit culture and maximize the government’s recovery of previous financial assistance to these banks.

B. Policies to Enhance Growth Prospects

23. In the near term, growth will be guided chiefly by traditional sources, mainly production and exports of agricultural goods. This will be supported by the maintenance of sound financial policies and progress in banking system reform. The banking system is still recovering from the 2002 financial crisis, and remains fragile, due to weaknesses in the public banks. Hence, the reform of the BHU needs to be stepped up, particularly given its links to BROU’s financial soundness. Furthermore, the authorities concurred with staff that moving ahead with the reform of the public bank BROU is crucial to re-starting private sector credit and boosting economic activity.8

24. The medium-term scenario envisages a return to moderate growth, with a reduced debt burden and enhanced financial stability. As noted in the staff report for the third review, output is projected to grow at 2½–3 percent a year over the medium term, predicated on the maintenance of sound economic policies and the firm implementation of structural reforms, discussed below. The external current account would be in surplus over the medium term, but this surplus would gradually narrow as the economy recovers (Table 16). Gross reserves are targeted to rise significantly over the next few years, to provide some cushion against shocks and improved coverage for future debt service payments. Although debt servicing needs appear manageable over the next few years, they will start rising substantially over the medium term. Moreover, a sensitivity analysis9 shows that debt sustainability is highly vulnerable to deviations from the assumed macroeconomic framework. Taken together, these factors illustrate that there is little room for policy deviations in the medium term.

Table 1.

Uruguay: National Accounts at Current Prices

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Source: Central Bank of Uruguay.
Table 2.

Uruguay: National Accounts at Constant Prices

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Source: Central Bank of Uruguay.

Contribution to GDP growth

Table 3.

Uruguay: Gross Domestic Product at Current Prices

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Source: Central Bank of Uruguay
Table 4.

Uruguay: Gross Domestic Product at Constant Prices

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Source: Central Bank of Uruguay.
Table 5.

Uruguay: Savings and Investment

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

Defined as overall balance of the public sector plus capital expenditures; private savings is residual.

Table 6.

Uruguay: Consolidated Public Sector

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Source: Ministry of Finance.

Financing balance after 1994. Discrepancy added to goods and services.

Table 7.

Uruguay: Central Government 1/

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Source: Ministry of Finance.
Table 8.

Uruguay: Social Security (BPS)

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Source: Ministry of Finance.

Financing balance after 1994, Discrepancy added to goods and services.

Table 9.

Uruguay: Public Enterprises

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Source: Ministry of Finance.

Financing balance after 1994. Discrepancy added to goods and services.

Table 10.

Uruguay: Quasi-Fiscal Operations of the Central Bank

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Source: Ministry of Finance.

Financing balance after 1994. Discrepancy added to goods and services.

Table 11.

Uruguay: Monetary Survey 1/

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Source: Central Bank of Uruguay, IFS.

IFS definitions. Foreign currency items are evaluated at end-of-period exchange rate.

Table 12.

Uruguay: Central Bank Balance Sheet 1/

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Source: Central Bank of Uruguay, IFS.
Table 13.

Uruguay: Balance Sheet of Commercial Banks 1/

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Source: Central Bank of Uruguay, IFS.
Table 14.

Uruguay: Balance of Payments

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Source: Central Bank of Uruguay
Table 15.

Uruguay: Public Debt 1/

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Source: Central Bank of Uruguay.

Official figures are only available since 1999 due to a change in the methodology to calculate the debt stock.

Includes: AFE, ANCAP, ANAP, ANCO, ANTEL, INC, OSE y UTE.

Includes Intendencia de Montevideo and other intendencias.

Includes BPS and BSE

Includes IDB, World Bank and IMF.

Includes AFAPs, stock exchange, investment funds, Caja de Notaries, Caja de Empleados Bancarios, private insurance companies, IFEs and CND. It also includes bond holdings by non-resident financial institutions.

Includes holdings of public bonds by non-residents.

In 2002, includes US$32 million from ANCAP’s advanced sale.

Table 16.

Uruguay: Medium-Term Outlook

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

Sound financial policies

25. The authorities and the staff agreed that, over the medium term, fiscal consolidation was crucial to achieving strong economic growth while reducing vulnerability. The primary surplus of the combined public sector is projected to rise gradually to about 4 percent of GDP and to remain at that level over the medium term. Sustaining these surpluses will help keep the government’s near-term financing needs manageable, ensure medium-term fiscal sustainability, and avoid crowding out of credit to the private sector. Over time, the composition of fiscal adjustment will need to shift from expenditure compression to efficiency gains on both the revenue and expenditure sides.

26. The authorities are committed to reforming the tax system to improve its efficiency and buoyancy. Following a recent FAD technical assistance mission, they are finalizing revisions to draft legislation that will broaden the tax base and rationalize the tax system. The staff urged the authorities to build the necessary consensus to ensure rapid congressional approval of this reform, which should include broadening the VAT base while avoiding adjustments in the VAT rates that might generate a revenue loss; eliminating several low-yielding taxes to incorporate them into the main excise tax; and extending the corporate income tax to all sectors of the economy. The authorities also agreed with the staff that revenue administration needed significant further strengthening.

27. Uruguay’s large social safety net needs to be reformed. The staff commended the authorities’ efforts to protect priority social programs from budget cuts. Nevertheless, poverty is estimated to have risen sharply in recent years, from 11 percent in 1999 to almost 24 percent in 2002, with half of the children less than 6 years old living below the poverty line. The authorities recognized the need to streamline social spending and redirect it to the poorest.10 The mission encouraged the authorities to quickly implement the social protection reforms supported by the World Bank and the IDB, including an overhaul of the unemployment insurance scheme, a restructuring of national health funding instruments, and measures to improve the management of the educational sector.

28. The staff welcomed the introduction of a transparent monetary policy framework based on money targets. The authorities saw the new framework as an important tool for anchoring public expectations and building a track record for monetary policy credibility. Nevertheless, they noted that conducting active monetary policy in a highly dollarized environment poses particular challenges, especially as the links between monetary aggregates and inflation are not yet well established. There was agreement between the authorities and staff that it would be desirable to move toward an inflation targeting framework over the medium term, once monetary transmission channels become more robust. This, however, will require reducing the degree of fiscal dominance and strengthening the operational autonomy of the central bank, broadening the range of monetary policy instruments, and developing the secondary market for government debt.

29. The staff stressed the importance of maintaining the floating exchange rate regime. The floating exchange rate regime introduced in 2002 has served Uruguay well, particularly in helping to restore external competitiveness. As Uruguay is a small open economy, this exchange rate regime seems best suited for dealing with the frequent external shocks to which the economy is subject and for facilitating structural change. Nevertheless, the authorities noted that Uruguay is likely to remain highly dollarized in the near term; for this reason the system could bring undue volatility at times. Hence, limited central bank intervention may occasionally be warranted to avoid excessive fluctuations in the exchange rate.

30. Further steps need to be taken to address balance sheet risks in the economy. In this context, the staff advised the authorities to further strengthen the regulatory framework for the banking sector to better account for the risks stemming from dollarization and nonresident liabilities. The mission also encouraged the authorities to continue promoting the development and use of peso instruments in the financial sector, including through broader issuance of inflation-indexed government securities. While this strategy will necessarily take time and could—at least initially—result in higher domestic lending rate premia, the authorities agreed that it was an essential component in the reduction of vulnerabilities.

Increasing the role of the private sector

31. Reducing the size of the public sector and improving its efficiency will play a critical role in making the economy more competitive. The staff urged the authorities to consider opening activities currently reserved for the state to the private sector to help create new investment opportunities. While the authorities recognized the benefits associated with expanding private sector activity through concessions and privatizations, they noted that the experience with concessions had been mixed and that there remains strong domestic opposition to the sale of public assets and to private involvement in public enterprises.11 Instead, the authorities are pursuing a strategy to gradually deregulate and open these sectors to competition. They agreed with the staff that such a strategy required the creation of strong independent regulatory institutions and significant improvements in governance, autonomy, and incentive structures of public enterprises (Box 4). Efforts to create strong regulatory agencies are being supported by the World Bank, in the context of its SAL II operation.

Uruguay: Restrictions and Policy Directives to Public Enterprises

State-owned enterprises (SOEs) are subject to management restrictions and policy directives in pricing, investment, and employment that do not allow them to compete at the same level with the private sector:

  • The central government controls the SOEs most relevant economic and financial decisions, including planning, budgeting, and indebtedness. With some exceptions, SOEs’ purchases must follow the same procedures as those of the central administration. Price increases need to be approved by the central government for those enterprises not subject to competition.

  • Board appointments are based on political affiliation. SOEs are required to follow managerial procedures desired to facilitate supervision by the central authorities, but which are often cumbersome and outdated.

  • SOEs face strong legal restrictions to seeking strategic partnerships with the private sector. They are also required to operate within the public sector realm, by: (i) maintaining all their accounts at the public bank BROU; (ii) channeling at least 10 percent of their public announcements through state media; and (iii) being subject to more cumbersome regulations for direct purchases from private enterprises than from other public enterprises.

  • Employees have the same legal status as civil servants. In particular, most hiring and lay-off restrictions applying to the civil service also apply to SOE’s.

32. Measures to improve the efficiency of public expenditure and reduce its rigidity need to be stepped up. Close to 75 percent of government expenditure is for wages and social security payments. Steps have been taken to achieve a gradual but lasting decline in the wage bill.12 In addition, the authorities expect a decline in pension benefits over the medium term due to savings generated under the 1996 pension reform. Measures have also been taken to improve the efficiency of public procurement by creating centralized purchase mechanisms for medical supplies and foodstuffs. The staff welcomed the progress achieved, and urged more decisive steps to modernize the public sector and reduce surplus employment. The staff also noted that there may be room for a second-generation reform of the generalized pension system, including by further increasing the regular retirement age from 60 to 65 years and reducing the replacement rate for advanced-age pensions.

Further improving the institutional framework and investment climate

33. The prominent role of consensus in the decision-making process may delay the adoption of critical measures needed to improve growth prospects. Without any doubt, Uruguay’s strong political institutions constitute a major asset and, in recent months, both the government and congress have shown a capacity to take decisive action to address the crisis. However, consensus-building on major political decisions, while ensuring that all sectors have a voice, also sometimes leads to substantial delays in enacting important reforms. In December 1992, a privatization bill, which would have opened important sectors of the economy to private sector investment, was rejected in a referendum. It is difficult to envisage faster medium-term growth without the opening of opportunities for private sector investment through greater liberalization and privatization.

34. The quality of the legal framework and governance are perceived as being relatively strong. Perceived corruption is relatively low compared to other countries in the region, although pockets of corruption are sporadically exposed.13 Local experts agree that Uruguay’s legal framework provides for strong protection of property rights and well-established insolvency procedures. The judiciary is generally perceived as independent, but actual enforcement of property rights, including the possession of collateral by secured creditors, can be time-consuming due to lengthy court proceedings. The authorities are firmly committed to combating the laundering of proceeds from crime and the financing of terrorism.

35. The authorities are pursuing active policies to generate favorable investment conditions. A “one-stop-window” was recently created for accessing benefits under the country’s investment promotion law, intended to limit the processing time to no more than 60 days.14 One remaining problem is FDI promotion, which lacks a clear strategy and focus since it is split among several institutions. In addition, the authorities have not implemented plans to set up an investors’ relations office.

36. The authorities are committed to subscribe to the Special Data Dissemination Standard (SDDS) in the near future. The staff considers data provided to the Fund to be broadly adequate for surveillance purposes. There are, however, several areas in need of improvement, including: (i) the timeliness of financial data submission by the BROU and BHU to the central bank; (ii) the coverage of public sector operations (above line) to include local governments; and (iii) data collected on the private sector corporate debt.

III. Staff Appraisal

37. The protracted recession and the financial crisis in 2002 were triggered mainly by external shocks, but their impact on the economy was compounded by weaknesses in the domestic economy. Growth had become increasingly dependent on the region, and rigidities in the economy did not allow prompt adjustment to adverse shocks. The banking system was highly vulnerable from currency mismatches in the balance sheets of households, corporations, and the public sector, and the large nonresident deposit base became a channel of contagion, especially from Argentina. At the same time, little room existed for countercyclical policies due to the weakened fiscal position and the high degree of dollarization in the economy, which also constrained timely exchange rate adjustment.

38. While progress has been made in recent months in containing the crisis and stabilizing the economy, there is no room for complacency. Fiscal adjustment, stabilization of the banking system, and successful completion of a comprehensive debt exchange have been important steps towards restoring confidence and growth. However, the financial sector remains fragile, the pickup in economic activity is still tentative, and social indicators have worsened. Strict adherence to the economic program supported under the Stand-By Arrangement will, therefore, be essential to consolidate the stabilization gains and set the basis for a durable recovery.

39. Conducting the Article IV discussions in the current post-crisis environment posed special challenges in light of the overwhelming short term pressures facing the authorities. Nevertheless, they concurred with staff on the challenges facing Uruguay over the next several years and the need to continue the implementation of sound policies and structural reforms.

40. A return to sustained economic growth will take time and depend on continued structural reforms. Policies should focus on measures to facilitate the reallocation of resources toward higher-productivity sectors and the reduction of systemic vulnerabilities to make the economy more resilient to shocks. These policies, coupled with better targeting of social support and institutional capacity, would significantly help improve living standards. Nonetheless, building political support for the implementation of such a strategy will be a challenge in the context of the approaching presidential elections and persistent differences among the main political parties on the appropriate scope and pace of reforms. The challenge of building political support in this context and avoiding delays in moving ahead with key reforms will be particularly acute in light of Uruguay’s consensus-based decision processes.

41. Fiscal discipline must be a cornerstone of any economic strategy. An important permanent strengthening of the primary balance will be needed to ensure sustainable debt dynamics, support a competitive exchange rate, avoid crowding out of credit to the private sector, and regain the capacity to undertake counter-cyclical policies. This will require a strengthening of the revenue effort, including through a tax reform to streamline the tax system and improve revenue administration. Expenditure rigidities will need to be reduced, especially in wages and pensions, and efficiency increased. The strong commitment of the authorities to fiscal responsibility is welcome and will be particularly important in the forthcoming election year.

42. The introduction of a clear and consistent monetary policy framework is welcome. Base money targets will provide an anchor to inflationary expectations in the context of the floating exchange rate regime, which should be maintained. The staff supports the authorities’ intention to move, over time, to inflation targeting. To achieve this objective, the central bank will need to broaden the range of monetary instruments, further build technical capacity, and strengthen its operational and administrative autonomy.

43. Competition and the room for private sector activity in the economy should be expanded to promote growth. Further efforts towards trade diversification will be key in this regard. In addition, the staff urges the authorities to work toward achieving a domestic consensus for further opening to private activity those sectors of the economy that are currently reserved for the state, including through privatization. These measures would help improve resource allocation, raise the level of investment, and increase the flexibility to adjust to changing economic circumstances.

44. While progress has been made in stabilizing the banking system, further work is needed to address balance sheet vulnerabilities in the economy and restore a sound financial system. The prudential supervisory framework for the financial sector should be applied rigorously to all institutions, including those owned by the state. Further steps should be considered to foster the creation of local currency-denominated financial instruments and credit that could provide balance sheet hedges to households and corporations. The government can make a strong contribution in this area by broadening the use of inflation-indexed government debt instruments.

45. Although reform efforts in different areas of the economy should help the government in attaining its medium term objectives, the outlook carries significant risks. As a small open economy in a turbulent region, Uruguay will continue to be vulnerable to a wide array of financial and real shocks. Moreover, the ability to conduct active fiscal policy over the next few years will be constrained by a heavy debt burden. For these reasons, the need for vigilance and vigorous movement on structural reforms cannot be overemphasized.

46. Uruguay’s political institutions have proven effective in dealing with the financial crisis. The steadfast commitment to safeguard the rule of law and private contracts is commendable and will contribute to the recovery of confidence. Now that the situation has stabilized, it will be crucial for both the executive and the legislative powers to maintain the consensus on prudent macro policies and move forward with the structural reform agenda.

47. The staff commends the progress made by Uruguay in improving data transparency. The commitment of the authorities in this area is underscored by their intention soon to subscribe to the SDDS. The staff welcomes the steps taken to improve anti-money laundering and combat terrorist financing.

48. The staff also recommends approval of the exchange restriction under Article VIII arising from the reprogramming of deposits in public banks, given that this measure is temporary and non-discriminatory. It is proposed that the next Article IV consultation be held in accordance with the provisions of the decision on consultation cycles approved on July 15, 2002.

Table 17.

Uruguay: Vulnerability Indicators

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

Due to the liquidation of several banks in the survey sample, this data series is no longer available.

By remaining maturity.

For 2003, as of mid-June.

For 2000, the data reported are the spread of the 2009 bond; for 2001’02, the 2012 bond; and for 2003, the 2033 bond. Data for 2003 are as of end-June.

Table 18.

Uruguay: Basic Data

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

APPENDIX I Uruguay—Sources of Growth1

1. Over the past 40 years, economic growth in Uruguay has been relatively low, averaging 1.7 percent a year over 1960–2001. In per-capita terms growth averaged only 1 percent a year. Annual growth rates fluctuated widely, and expansions rarely lasted more than two consecutive years. Indeed, the most significant events in Uruguay’s growth record are two long and deep recessions, the first in 1982–83, and the second from 1999 to the present. Compared with other countries in the region, in 1970–2001, Uruguay’s real per capita income grew by 55 percent less than in Brazil and 45 percent less than in Chile, although it still outperformed Argentina.

Chart 1:

Real GDP Growth 1960–2001

(in percent)

A01app01ct01

2. The long-run stagnation in per-capita output was largely due to a lack of productivity growth and little factor accumulation. During 1960–2001, capital and labor grew at average annual rates of just 2 percent and 1.6 percent respectively. Total factor productivity (TFP) did not improve at all during this period. The contribution of these factor inputs to growth varied considerably. The accumulation of labor and capital contributed significantly to growth during the 1970s. However, during the same period TFP growth was negative.2 On the other hand, during the 1990s growth was driven to a significant extent by TFP and, in the latter part, by capital accumulation.

Chart 2:

Input Factor Contribution to Real GDP Growth 1960–2001

A01app01ct02

3. Episodes of strong capital accumulation were generally short and followed periods of economic reform and low inflation. A first spurt in investment took place in the late 1970s after the country opened its capital account and implemented a program of exchange-rate based stabilization (the tablita). However, the crisis of the mid-1980s abruptly ended this boom. Investment remained subdued during the rest of the decade. Capital accumulation only recovered in the 1990s, after the country integrated into Mercosur and brought inflation under control. This time, investment was directed toward machinery, improving efficiency in manufacturing, and stimulating the reallocation of resources towards the service sector.

Chart 3:

Capital Stock 1960–2001

A01app01ct03

4. The contribution of labor to GDP growth has generally been small and declining. Population growth has traditionally been low in Uruguay compared to other countries in the region, averaging 0.7 percent over the last 40 years. However, the labor force grew at about twice this pace due to increasing participation rates, especially among women. The rise of the share of women into the workforce probably also contributed to an improvement in the human capital endowment of labor.3 However, this process may have reached its limits, and future labor force growth should be expected to be more subdued.

Chart 4:

Labor Force 1960–2001

A01app01ct04

5. TFP stands no higher today than in the 1960s. Uruguay’s high level of TFP during the 1960s and early 1970s, and its subsequent decline was closely linked to the evolution of the terms of trade. However, the gains in productivity during the 1990s appear to reflect true improvements in efficiency, since the terms of trade were rather weak during this period.4

Chart 5:

Productivity and Terms of Trade

A01app01ct05

6. Growth prospects for Uruguay appear to hinge on a new productivity boost. The current recession is causing a decline in both the capital stock and TFP. While the latter is partly driven by cyclical slack, investment may remain depressed for some time, particularly since the financial sector has severely shrunk. In these circumstances, TFP growth must be revived through structural reforms, aimed at repeating the growth pattern of the early 1990s, when higher factor productivity led to increased profits, and over time to a recovery of capital accumulation. In contrast, the existing demographic trends suggest that labor cannot be expected to play a large role in a future upturn.

Growth Accounting

The analysis in this Appendix is based on a simple growth accounting framework, which tracks long-run changes in the production function and helps to identify different sources of growth based on data for employment and the capital stock.

Since Uruguay does not produce official data on the capital stock, it was estimated using the perpetual inventory method using long time-series data on real investment. The perpetual inventory method starts with the computation of an initial capital stock. It then accumulates real investment data and assumes a fixed rate of depreciation (here 7.5 percent). The initial capital stock is constructed by using the fact that over the long run (in the steady state), the growth rates of output and capital tend to be equal. Using the real GDP value for 1960, an average investment share of 14.1 percent of GDP (1960–2001) and an average growth rate of 1.7 percent per year, yields an initial capital stock of around 200 billion Pesos in constant prices of 1983.

The estimate of TFP is obtained by subtracting employment and the capital stock from real GDP (the Slow residual). The calculation assumes an income share of capital of 0.55, in accordance with the long-run average in national account statistics on the cost components of GDP. This value is significantly higher than in industrialized countries, where the capital share is typically around 0.25. In general, a negative correlation is found between the capital share and per-capita income.

APPENDIX II Urugcay—The Rise of the Service Economy1

1. Uruguay experienced a substantial shift toward a service-based economy in the past two decades. The share of services in GDP (at factor cost) rose from 54 percent to 70 percent between 1985 and 2001, while the share of manufacturing declined from 27 percent to 15 percent. As a result, the service sector generated over 80 percent of total GDP growth during the last 20 years. The most dynamic subsector was real estate, which increased from 10 percent to 17 percent of GDP, followed by transport and communication and tourism. The restructuring was accompanied by a general increase in unemployment, as capital and specialized skills in manufacturing became obsolete.

Chart 1:

Sectoral contribution to real GDP growth

(in percentage points)

A01app02ct01

2. High inflation favored production in labor intensive sectors. High inflation in the 1980s made credit scarce and expensive, but also led to a decline in real wages. With relatively cheaper labor, firms shifted to more labor-intensive production, fostering the expansion of the service sector.

Chart 2:

Real Wages and Inflation

A01app02ct02

3. Regional trade integration and a shift in domestic consumption patterns boosted the demand for skill-intensive services. Trade protection declined significantly in the second half of the 1980s and the early 1990s, and average tariff rates dropped from 17 percent in 1986 to 4½ percent in 2002. With a relatively inexpensive but highly educated labor force, Uruguay enjoyed a comparative advantage in high-skill services. Finance, tourism and transport attracted growing regional demand, especially from Argentina. In addition, the emergence of credit cards and other instruments of consumer credit stimulated domestic demand for services. Overall, these factors led to an increase in the price of services relative to manufacturing by more than 30 percent as measured by sectoral GDP deflators during the 1990s, stimulating the observed structural change on the supply side.

APPENDIX III Fiscal Policy Stance During the 1990s1

A. Introduction

1. Uruguay’s public sector registered small deficits for most of the past decade, but larger ones in recession years. However, the overall public sector balance may not be the best indicator of a country’s fiscal policy. This is due to the presence of automatic stabilizers, which move in a countercyclical fashion even without any government action. Thus, estimating an economy’s “true” fiscal stance requires decomposing the deficit into a cyclically adjusted balance, which moves passively in line with output, and a balance that reflects the policymakers’ discretionary actions.

Figure 1.
Figure 1.

Uruguay: Fiscal Performance

Citation: IMF Staff Country Reports 2003, 247; 10.5089/9781451839258.002.A001

2. Applying this analysis to Uruguay suggests that fiscal policy was procyclical during the 1990s. There was some tendency to implement expansionary policies during election periods, regardless of the state of the economic cycle. More important, however, fiscal policy was procyclical as a result of constrained access to market debt financing. Because of the significant risks that such policies pose to long-term sustainability, the staff have advised the authorities to pursue a structural strengthening of budgetary institutions.

B. Methodology

3. A standard decomposition method calculates the fiscal stance and the fiscal impulse. The fiscal stance is a measure of discretionary fiscal policy. This indicator can be extracted from the public sector balance after purging from it the components linked to output trend and cycle. A positive fiscal stance is expansionary, a negative one is contractionary. A measure of the impact of fiscal policy on economic activity is the fiscal impulse, which is calculated as the change in the fiscal stance. The fiscal impulse provides a measure of the initial stimulus to aggregate demand arising from fiscal policy.

4. The above methodology was applied to Uruguay to estimate its fiscal stance during the 1990s. Potential output was calculated by applying the Hodrick-Prescott filter to real GDP in 1960–2008, with 1992 set as the base year for the calculation of the structural expenditure and revenue parameters for the cyclically adjusted balance.2 In addition, two adjustments were made to account for the impact of structural reforms that took place during the 1990s: (i) the tax increases of 1995 and 1997 (particularly, for the VAT and the wage and pension tax rates); and (ii) the reform of the social security system in 1996, to reflect the forgone social security contributions to the private pension funds.

C. Analytical Results

5. The results suggest that, during the 1990s, fiscal policies were procyclical.3 In all years except 1999, the fiscal impulse moved in line with output. The fiscal expansion during the recession year of 1999 may have been related to the presidential election campaign (fiscal policy had also been largely expansionary in the previous election year, 19944). The procyclicality of fiscal policies exacerbated the recession in 2000–02. In 2002, the fiscal impulse became contractionary, to compensate for the large fall in revenues. Program policies envisage a further negative fiscal impulse in 2003, given the need to achieve medium-term sustainability.

Figure 2.
Figure 2.

Uruguay: Cyclicality of Fiscal Policy

Citation: IMF Staff Country Reports 2003, 247; 10.5089/9781451839258.002.A001

6. Evidence suggests that fiscal procyclicality in Uruguay is linked to the country’s market access. Using Uruguay’s ranking by Standard & Poor’s as a proxy for financing constraints, it was found that this index is correlated with the fiscal impulse. As the chart suggests, Uruguay’s fiscal policies tended to be expansionary when it was easy to obtain market financing, but were adjusted drastically when access to markets was closed.

Figure 3.
Figure 3.

Uruguay: Fiscal Policy and Access to International Markets

Citation: IMF Staff Country Reports 2003, 247; 10.5089/9781451839258.002.A001

7. An important part of public expenditure is indexed to nominal wages. Benefits under the old pay-as-you go pension system were indexed to average wage increases in the economy. Together with public salaries, they made up almost 60 percent of public expenditure on average during the last decade. This contributed significantly to the procyclical behavior of the fiscal impulse, as real wages were highly procyclical.

Figure 4.
Figure 4.

Fiscal Impulse and Real Wages

Citation: IMF Staff Country Reports 2003, 247; 10.5089/9781451839258.002.A001

D. Policy Guidelines for the Medium Term

8. The procyclical behavior of fiscal policy appears to be closely related to the availability of resources for budget financing. While governments would ideally pursue countercyclical policies to soften the impact of exogenous shocks on economic activity, they are often unable to do so due to the volatile nature of market financing, which tends to decrease during economic downturns. Under a tight budget constraint, fiscal adjustment can be seen as a signal of continued commitment to sound policies, and a means to recover market access in the future.

9. While procyclical adjustment may be the best response in the face of liquidity constraints, its pursuit during economic upturns may increase fiscal vulnerability. Deficits during upturns tend to enlarge public sector indebtedness, and highten exposure to exchange rate risk and other exogenous shocks, while creating structural rigidities (e.g. through tax reductions or spending programs) that become hard to reverse during a downswing. Procyclicality may also contribute to macroeconomic volatility and uncertainty.

10. Several elements are required to create a resilient fiscal structure with strong budgetary institutions. These are mostly related to reforms to improve the revenue and expenditure institutions and the targeting of discretionary policy. In particular:

  • Strengthening tax policy and revenue administration, to reduce revenue volatility. Generally, revenue capacity should not be fully utilized to leave enough room for responding to negative shocks, whether permanent or transitory.

  • Reducing structural expenditure rigidities, so that budget expansions that are deemed necessary during downturns can be easily reversed as real output reaches the high part of the cycle. This mainly includes measures such as: (i) reducing the wage and pension bills, and (ii) ensuring that a well-targeted social safety net is in place. In particular, pension benefits should be indexed to prices instead of wages, to remove an important part of the procyclical behavior that is structurally built into the Uruguayan fiscal sector.

11. In the case of Uruguay, near-term program policies follow a procyclical pattern, reflecting the financing constraint as well as the need to signal the authorities’ commitment to a sustainable fiscal stance. However, the program also supports fiscal reforms that focus on the achievement of a budgetary structure that in the longer term can operate in a moderately countercyclical manner.

APPENDIX IV Uruguay-Fund Relations

(As of May 30, 2003)

I. Membership Status: Joined March 11, 1946; Article VIII

E. Financial Relations

II. General Resources Account:

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III. SDR Department:

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IV. Outstanding Purchases and Loans:

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V. Financial Arrangements:

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VI. Projected Obligations to Fund: (Obligation Basis) (SDR millions; based on existing use of resources and present holdings of SDRs):

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F. Nonfinancial Relations

VII. Safeguards Assessment: Under the Fund’s safeguards policy, the Central Bank of Uruguay (BCU) was subject to a safeguards assessment with respect to Uruguay’s current Stand-By Arrangement (approved on April 1, 2002). An on-site assessment of the BCU was conducted in July 2002, and the final safeguards assessment report was approved by management on January 16, 2003. The assessment identified a need to strengthen the control and oversight framework within the BCU, in particular in the external audit area. To this end, staff recommended the establishment of an audit committee and the hiring of a private audit firm with international affiliation and a strong expertise in commercial or central bank audits to perform a financial audit of the BCU in accordance with International Standards on Auditing. In addition, it was recommended that similar external audit procedures be established for the FSBS. The authorities are committed to the implementation of all the safeguards recommendations, including the completion of an external audit of the FSBS by September 30, 2003.

VIII. Exchange Rate Arrangement: The currency is the Uruguayan peso (Ur$). Uruguay follows an independently floating exchange rate regime. On June 26, 2003, buying and selling interbank rates for the U.S. dollar, the intervention currency, were Ur$26.40 and Ur$26.45 respectively. Uruguay’s exchange system is mostly free of restrictions on payments and transfers for current international transactions. The reprogramming through December 2005 of time deposits at BROU and BHU gives rise to an exchange restriction under Article VIII, as it prevents nonresidents affected by the reprogramming from transferring abroad proceeds of recent current international transactions. Staff has recommended approval of the exchange restriction, given that this measure is temporary and does not discriminate among Fund members.

IX. Article IV Consultation: The 2001 Article IV consultation was concluded by the Executive Board on February 14 (EBS/01/17). Uruguay is on the standard 12-month cycle. Discussions for the 2002 Article IV consultation were initiated in September 2002, deferred because of delays in concluding the program review, continued in January–February 2003, and completed in May.

X. FSAP participation, ROSCs, and OFC Assessments: The ROSC-module on fiscal transparency was published on March 5, 2000. A ROSC-module on data dissemination practices was published on October 18, 2001. The authorities have requested participation in an OFC assessment for early 2002. The FSAP exercise started in November 2001; its completion has been delayed until the situation stabilizes.

XI. Technical Assistance: A STA mission on money and banking statistics took place in March 1999. A multisector STA mission took place in November 1999 which developed an overall action plan for statistics management in Uruguay, including detailed recommendations for bringing Uruguay’s data dissemination policies and practices into line with the Fund’s SDDS. Technical assistance in the areas of tax and customs administration had been provided by the FAD in 1996. In June 2000 and May 2001, FAD provided technical assistance in the area of quasi-fiscal activities in the public sector. In December 2001, STA provided technical assistance to help Uruguay subscribe to the SDDS. In September 2002, FAD provided technical assistance in the areas of tax policy and revenue administration to prepare a comprehensive tax reform. In April 2003, STA provided technical assistance on adequate recording of the loans funded by the FSBS.

XII. Resident Representative: Mr. Andreas Bauer

APPENDIX V Relations with the World Bank Group

In the past, Bank project lending has been focused on infrastructure and agriculture developments. In addition, in the late 1980s, the Bank began providing support through structural adjustment lending. The first SALs of 1987 and 1989 supported export growth through incentives and tariff reform; strengthening public finances and the social security system; improving public investment programming; and strengthening the banking sector. A stand-alone debt and debt service reduction operation (DDSR) was also approved in 1991.

In the 1990s, the Bank continued to support infrastructure development oriented towards exports of natural resource-based goods (e.g., forestry). In addition, the Bank supported programs in basic education and institutional development of the health sector. An adjustment loan supported reforms that established the multi-pillar social security system.

The Bank’s recent lending has continued to support the social sectors and selected infrastructure investment, with a focus on reforming public enterprises and the regulatory system. During 2000, two loans were approved: a Financial Sector Adjustment Loan (FSAL) - that supported actions to strengthen the framework for the functioning of the financial system - and a Water Sector Adaptable Program Loan. In early 2001, a technical assistance loan was approved to help establish a public utility regulatory department. In end-July 2001, the Board approved the Foot and Mouth Disease Emergency Recovery Project, financing livestock vaccinations. In October 2002, the Bank approved a $300 million SAL/SSAL operation. A second SAL/SSAL for $250 million focusing on improving public services was approved on April 8, 2003.

The last Portfolio Performance Review took place in December 2002. At that time, the portfolio comprised eight investment projects for a total of US$382 million in commitments (of which US$182.9 million are undisbursed) in addition to one SAL and SSAL. The investment projects concentrate primarily in the infrastructure sector, with five out of eight projects totaling an amount of US$293.5 million in commitments (or 76.7 percent of the portfolio). In addition, the portfolio of investment projects comprises two operations in the education sector, and one emergency project in the agriculture sector. The portfolio exhibited a marked fall in disbursements in 2002, indicating growing difficulties in project implementation, due to budgetary constraints.

Financial Relations with the World Bank Group

(In millions of U.S. dollars)

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Sources: World Bank (IBRD data); and IFC (IFC data).

APPENDIX VI Relations with the Inter-American Development Bank

The most recent IDB Country Strategy for Uruguay focuses on the following priority areas for the Bank’s action, by providing support to: (i) initiatives that enhance the regional and international competitiveness of domestic output and encourage private investment, where production is based on the country’s comparative advantages and the use of modern technology, in order to foster healthy competition and allow for integration with both the regional and international markets; (ii) the further reform of the State, its modernization and improvements in governance, with a view to diminishing the role of the State in the economy; increase its efficiency; rationalize expenditure and target its interventions; and reduce its role in the production of domestic goods and services; and (iii) improving social welfare and increasing equity, particularly to those families and children living in poverty, allowing them to participate in the development process; reforming education and the health sectors, as well as developing social safety nets for families at risk, particularly in the poorest sectors. Support will also continue to be given to ongoing actions in the fields of citizen safety, housing, sanitation and potable water supply.

In 2002, the IDB approved four loans: (i) in the competitiveness strategic area, a Multisector Global Credit Program for US$180 million, providing medium and long term financing for investment by private enterprises; (ii) in the public sector reform area, a loan for Improvement in Municipal Management (TMM), for US$3 million; and (iii) in the welfare and equity, a loan for Infancy, Adolescents and Families at Risk, for US$40 million. In addition, the special operation for Social Protection and Sustainability was approved in August 2002, for US$500 million, thus supporting the financial package provided by the multilateral organizations. The Lending Program for 2003 anticipates a Financial Sector Loan for US$200 million, in support of reforms in the sector, as well as a Development and Management Program for the Municipalities for US$60 million.

As of June 15, 2003 the Bank’s active portfolio in Uruguay includes 20 loans for the financing of investment projects; two sector loans, for Health Reforms and for Modernization of Public Management respectively; and 27 nonreimbursable technical cooperations. The lending portfolio amounts to US$1,282.4 millions, of which US$427.1 million are pending disbursements.

Financial Relations with the Inter-American Development Bank

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Source: Inter-American Development Bank.

As of June 15, 2003

Excludes Program for Social Protection and Sustainability

Bank estimates for the year, as of June 15, 2003

APPENDIX VII Uruguay: Statistical Issues

The statistical database in Uruguay is generally adequate for the assessment and monitoring of macroeconomic policies. The multisector mission of November 10–24, 1999 developed an action plan that includes recommendations for bringing Uruguay’s data dissemination policies and practices into line with the Fund’s Special Data Dissemination Standard (SDDS). The authorities have made significant progress in implementing the mission’s recommendations, both with respect to timeliness of dissemination of the SDDS data categories, and in terms of methodological changes to improve data quality. During a staff visit to Montevideo (April 5–6, 2001) to present the findings of the data module of the Report on Observance of Standards and Codes (ROSC), the Uruguayan authorities reiterated their commitment to subscribe to the SDDS in the near future. An SDDS mission visited Montevideo (December 5–14, 2001) to assist the authorities in finalizing their work toward subscription to the SDDS. A key pending issue for subscription to the SDDS is the dissemination of the template on international reserves and foreign currency liquidity. Recently, however Uruguay submitted the Template on International Reserves and Foreign Currency Liquidity for review to STA.

Real sector

National account statistics have a number of shortcomings, including the use of an outdated benchmark year 1983, limited coverage of the enterprise survey, long publication lags, inadequate information on the informal economy, and incomplete quarterly accounts. The BCU compiles and disseminates annual GDP estimates in current and constant prices by production and expenditure approach, as well as quarterly constant price GDP estimates by production and expenditure approach. Gross national income, gross disposable income and gross savings are also available annually. The November 1999 multisector mission recommended a range of improvements including the completion of the revision of data and methods that had already been partially carried out, introduction of annually chained volume measures, incorporation of new benchmark survey data, and compilation of quarterly estimates of GDP at current prices.

The authorities do not provide trade price and volume indices for publication in the IFS.

Both the consumer and wholesale price indices are reported on a regular and timely basis for publication in the IFS. The consumer price index has a base period of March 1997 =100, and the wholesale price index has a base of January 1988=100. The coverage of the CPI is limited to the capital city.

Government finances

Official data on the central administration, the state enterprises and the social security system are complete and current, but there are problems with the currentness of the data on the local governments; there are also problems with the currentness of the financing and debt data reported for inclusion in the Fund’s statistical publications. The multisector mission that visited Uruguay in November 1999 reviewed the sources used for the compilation of central government financing and identified sources of information for local governments. The mission made recommendations for the compilation of these data and their reporting to STA. The information reported for publication in the Government Finance Statistics Yearbook includes data on the central government; however, annual central government debt data have not been reported for periods after 1994 and data on local governments have not been reported for periods after 1997.

Monetary accounts

Two STA money and banking statistics missions visited Montevideo in July 1998 and March 1999. The missions reviewed the currentness, coverage, and classification of the monetary accounts for the banking system and developed a unified system for reporting data to the Fund. The 1999 multisector mission continued work on improving the basic source data and the methodology for compiling monetary statistics, and recommended a new reporting system, which has since been adopted by the Central Bank. The mission developed a database that contains the data needs for publication in IFS and for operational use by WHD.

The STA mission that visited Montevideo in April 2003 provided recommendations for the adequate recording of the loans funded from the Fund for the Stabilization of the Banking System in the Central Bank’s balance sheet. The mission’s recommendations have been implemented and were reflected in the IFS June 2003 issue.

Balance of payments

Balance of payments statements are compiled and published on a quarterly basis. Data are compiled following the recommendations of the Balance of Payments Manual (5th edition). The authorities have made significant progress in implementing the mission recommendations in order to improve the coverage and quality of the balance of payments estimates. The directory of direct investment enterprises have been updated and measures have been introduced to improve the survey on inward investment; quarterly surveys have been introduced in the case of services, and other activities not currently covered; the coverage of reserve assets has been revised to exclude certain assets that are not available to finance balance of payments needs. Uruguay compiles and reports to STA annual data on balance of payments and the international investment position (IIP). The new surveys would also allow for improved coverage of the private sector in the IIP.

URUGUAY: Core Statistical Indicators as of May 30, 2003

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1

Gross domestic investment also rose significantly, but from a low level and thus contributed relatively little to GDP growth. In addition, important improvements in human capital took place, with an increase in the average education level of the labor force.

2

In 1996, the government introduced a complementary second pension pillar based on fully funded individual savings accounts, which are administered by private pension funds.

3

Growth in the agricultural sector mainly reflected a recovery of beef exports (15 percent of total exports) from the impact of foot-and-mouth disease and a strong expansion in the cattle population.

4

Households experienced sharply negative income and wealth effects as real wages declined by 20 percent, unemployment rose to almost 20 percent, real estate prices plummeted, and bank deposits were reprogrammed.

5

While the peso depreciated by some 30 percent in real terms vis-à-vis the U.S. dollar and the euro, it lost only 17 percent vis-à-vis the Brazilian real and appreciated by 70 percent vis-à-vis the Argentine peso.

6

Further details on the debt exchange and its economic implications are presented in the accompanying staff report for the third review under the Stand-By Arrangement.

7

Uruguay has a liberal trading system, as reflected by its rating of 2 in the Fund’s index of aggregate trade restrictiveness. In keeping with its tradition of trade liberalization, Uruguay has persistently urged tariff reduction and liberalization within Mercosur. Although there are no quantitative trade restrictions within Mercosur, occasional trade disruptions have occurred when the region experienced economic difficulties. There have been no major recent changes in the status of Uruguay’s trade regime.

8

This issue is dealt with in greater detail in the accompanying staff report for the third review under the Stand-By Arrangement.

9

See the staff report for the third review, paragraph 23 and appendix III.

10

According to a 2001 World Bank report, the incidence of social spending in Uruguay varies, with expenditure in health and education being relatively progressive (except for tertiary education). However, social security outlays are quite regressive because access is largely limited to those working in the formal sector.

11

Currently, the political opposition is seeking a referendum to prevent the state oil company ANCAP from entering into strategic partnerships with the private sector.

12

These measures included setting limits to public sector wages; early retirement schemes in public enterprises and the central administration; enforcing mandatory retirement ages in public financial institutions; extending the prohibition of new permanent hires; and introducing fixed-term labor contract similar to the private sector.

13

Uruguay ranked 32 out of 102 countries in the 2002 Corruption Perception Index compiled by Transparency International, with the second-best ranking in Latin America.

14

The investment promotion law provides generous tax benefits to local and foreign investors in the agricultural, industry and tourism sectors, including VAT exemption and a 50-percent rebate on import duties for inputs, a 10-year exemption from the asset tax, and accelerated depreciation for the corporate income tax.

1

Prepared by Benedikt Braumann (WHD)

2

During the spurt of activity in 1976–81, GDP growth resulted mainly from higher capital and labor inputs. Investment in particular responded to a financial bubble, but bore little relation to long-term business projects. A construction boom, largely in the Punta del Este resort area, actually reduced total factor productivity in the economy. Thus, from an efficiency point of view, this growth pattern was not sustainable.

3

Due to data limitations, the impact of human capital endowment is not being captured separately in the growth accounting framework on which the analysis in this Appendix is based (see Box 1).

4

During the late 1980s, Uruguay’s economy picked up cyclical slack and filled spare capacities. A more lasting increase in productivity began in the early 1990s, which was likely related to the opening of the economy that took place. Import competition marginalized uncompetitive firms, most notably in manufacturing. Productivity more than doubled in this sector during the 1990s, while it increased by 45 percent in services. This led to a rapid improvement of profits. The net operating surplus, a measure of profits in the national accounts, increased from 43 to 47 percent of GDP between 1986 and 1992. Higher profits accelerated capital accumulation, which took over as the main engine of growth towards the end of the 1990s.

1

Prepared by Benedikt Braumann (WHD).

1

Prepared by Maria González (FAD).

2

The parameters were estimated as the ratios of the relevant revenue and primary expenditure items to GDP in that year; actual interest payments were used in the computation.

3

The correlation index between the fiscal impulse and real GDP growth between 1992 and 2008 is 78 percent.

4

See Cyclically Adjusted Fiscal Balance in Uruguay, by K, Honjo, Uruguay—Recent Economic Developments, International Monetary Fund, SM/01/26, February 2001.

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Cover IMF Staff Country Reports
Uruguay: 2003 Article IV Consultation and Third Review Under the Stand-By Arrangement and Request for Modification and Waiver of Applicability of Performance Criteria—Staff Report; Staff Supplement; Staff Statement; Public Information Notice and Press Release on the Executive Board Discussion; and Statement by the Executive Director for Uruguay
Author:
International Monetary Fund
Volume/Issue:
Volume 2003: Issue 247
Publisher:
International Monetary Fund
ISBN:
9781451839258
ISSN:
1934-7685
Pages:
164
DOI:
https://doi.org/10.5089/9781451839258.002

Financial Intermediation in the Banking System

Real Effective Exchange Rate

(Jan. 1990=100)

Capital Account 1990-98 (in percent of GDP)

Uruguay: Exports by Destination

(in percent of total exports)
Figure 1.

Uruguay: Fiscal Performance
Figure 2.

Uruguay: Cyclicality of Fiscal Policy
Figure 3.

Uruguay: Fiscal Policy and Access to International Markets
Figure 4.

Fiscal Impulse and Real Wages