Fourth Review Under the Stand-By Arrangement and Requests for Modification of the Arrangement and Waiver of Nonobservance and Applicability of Performance Criteria, and Extension of Repurchase Expectations in the Credit Tranches—Staff Report; Supplementary Information; Press Release on the Executive Board Discussion; Statement by the Executive Director for Uruguay; and Statement by the Authorities of Uruguay

This paper examines Uruguay’s Fourth Review Under the Stand-By Arrangement and Requests for Modification of the Arrangement. The macroeconomic framework is broadly on track, but progress with structural reform has lagged. With regard to the quantitative performance criteria, there was a small deviation from the target on the combined public sector primary balance. The restructuring of the public banks and the disposal of assets of liquidated banks are taking longer than expected. The authorities have reaffirmed their commitment to the primary surplus targets for 2004 and beyond.


This paper examines Uruguay’s Fourth Review Under the Stand-By Arrangement and Requests for Modification of the Arrangement. The macroeconomic framework is broadly on track, but progress with structural reform has lagged. With regard to the quantitative performance criteria, there was a small deviation from the target on the combined public sector primary balance. The restructuring of the public banks and the disposal of assets of liquidated banks are taking longer than expected. The authorities have reaffirmed their commitment to the primary surplus targets for 2004 and beyond.

I. Background

1. The completion of this review (the fourth) has been delayed because the authorities needed more time to formulate and adopt a robust bank restructuring strategy. Building on the successful completion of the debt exchange last May, the authorities are proceeding with the needed restructuring of public banks while further strengthening the fiscal accounts.

2. With the October 2004 elections approaching, the political environment is becoming more challenging (Box 1). The campaign for the primaries has already started, risking a weakening of support in congress for the government’s structural reform agenda. In December 2003, a referendum sponsored by the opposition led to the recall of a law that would have made it possible to eliminate the state monopoly in the fuel market and for the state oil company ANCAP to engage in partnerships with the private sector. Most political observers believe that this outcome reflected a protest vote against the government, due in part to the hardship caused by the country’s long recession. However, the result also reconfirmed the reluctance of large parts of the electorate to allow increased private sector participation in activities run by the public sector.

Institutional and Political Context

  • ANCAP referendum. The December 7 referendum repealed the government-supported ANCAP law by 62 percent of the vote.

  • Elections. The primaries for the October 2004 presidential and congressional elections are planned for late-June 2004. The new government is scheduled to take office in March 2005. Municipal elections will be held in May 2005.

  • Support for the government. During 2001–02, President Batlle’s cabinet included members of both the Colorado and the National parties. In November 2002, the National Party left the government while continuing to provide support for its economic program in congress. This support has weakened in recent months.

  • Main political forces. Uruguay has a tradition of institutional and political stability. The Colorado Party and the National Party have alternated in power during most of the period since independence in 1830. They are now being seriously challenged by the Encuentro Progresista-Frente Amplio (EP-FA) opposition, a coalition of left-leaning parties, which is currently ahead in the polls. In mid-December, the EP-FA endorsed a moderate platform for the forthcoming elections.

II. Recent Developments and Performance under the Program

3. Economic recovery is now well under way. Real GDP grew by 3 percent (q/q, s.a.) on average during each of the first three quarters of 2003, driven mainly by net exports and, more recently, also by a recovery in consumption. Estimates for 2003 as a whole point to a slight increase in GDP, instead of a 1 percent decline projected at the time of the third review (Country Report No. 03/247). The unemployment rate fell from a peak of 19.8 percent in November 2002 to 15.4 percent in December 2003; initially, the drop in unemployment was primarily due to a fall in labor force participation, but recent data point to an increase in employment. Nevertheless, reflecting the still large output gap, wage pressures in the private sector have remained modest, with 12-month increases at 5.1 percent by end-November 2003.

Uruguay: Selected Macroeconomic Indicators

(12-month percentage change, unless otherwise indicated)

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Sources: BCU, and Fund staff estimates.

4. Inflation has been falling faster than envisaged under the program. Consumer price increases averaged 0.6 percent a month during April–December (1½ percent in the program). Consequently, year-end inflation was only 10.2 percent, well below program projections (20 percent). In real effective terms, Uruguay’s currency depreciated by 14 percent during the first 11 months of 2003, on top of a 13-percent depreciation during 2002.

5. Financial indicators have also improved. Gross international reserves have quadrupled since mid-March, to US$2.1 billion at end-December (equivalent to 9¼ months of imports), reflecting increased bank liquidity holdings at the central bank, purchases from the Fund (US$0.5 billion), higher deposits of BROU following drawings from the Fund for the Stabilization of the Banking System (US$0.3 billion), and foreign-exchange purchases by the central bank. Net international reserves were still negative by US$0.7 billion (program definition) at end-December, but significantly better than envisaged under the program (by US$0.6 billion) (Table 3). Private sector foreign currency deposits in the banking system have continued to grow, and now significantly exceed their level at end-July 2002, on the eve of the bank holiday. Prudential bank indicators have also improved, as banks have increased their liquidity positions and provisions, and nonperforming loan (NPL) ratios have begun to recede. In June–July, the authorities released the first tranche of reprogrammed deposits at the public bank BROU (US$570 million). So far, most deposits have remained with BROU, albeit predominantly in the form of sight and savings deposits. Finally, Uruguay’s sovereign spread (EMBI) has dropped from almost 900 basis points at end-May 2003 to about 620 basis points in early-February 2004, broadly in line with regional trends.

Table 1.

Uruguay: Selected Economic and Financial Indicators

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

Evaluated at program exchange rates for 2004.

Part of the sharp drop is due to the removal of the three liquidated banks from the database in May 2003.

Defined as changes in reserve assets.

Defined for combined public sector.

Excludes nonresident deposits.

Residual maturity. Does not include nonresident deposits.

As of November 2003.

Table 2.

Uruguay: Summary Balance of Payments

(In millions of U.S. dollars)

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Sources: Central Bank of Uruguay and Fund staff estimates.
Table 3.

Uruguay: Performance Under the 2003 Economic Program 1/

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

As defined in the Technical Memorandum of Understanding.

Cumulative changes from end-December 2002.

Adjusted upward/downward for changes in transfers to the AFAPs, as defined in the TMU.

Preliminary figures.

Adjusted upward/downward for changes in program disbursements from the World Bank and IDB, as defined in the TMU.

All maturities. The 2002 base includes US$294 million of unsecuritized debt arising from an agreement between the Ministry of Economy and Finance and BROU. For September and December, the debt ceiling has been adjusted upwards to reflect the transfer of Brady bonds from the central bank to the government.

Adjusted upward/downward for changes in interest payments, as defined in the TMU.

Cumulative change from December 2002 average.

Table 3.

Uruguay: Performance Under the 2003 Economic Program (continued)

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

Beginning with data for March 31, 2003.

Uruguay: Changes in Dollar Deposits Held by the Banking System

(in US$ million)

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Sources: BCU, and Fund staff estimates.

6. The fiscal program is broadly on track. The end-September PC on the primary surplus of the combined public sector was not observed by a small margin. For the entire year 2003, preliminary data suggest that the primary balance shifted from zero in 2002 to a surplus of about 2.8 percent of GDP. The relatively small shortfall from the program target (a surplus of 3 percent of GDP) was due mainly to a lower-than-projected surplus of state-owned enterprises, offset in part by higher central government revenue. The government financed its deficit chiefly through multilateral disbursements and short-term domestic debt, taking advantage of lower interest rates after the May debt exchange. In October, access to international markets was reestablished, with the placement of a US$200 million issue of three-year, peso-denominated, inflation-indexed bonds.

7. Efforts to restructure the banking system made little progress during the second half of 2003. The end-August structural benchmark on the adoption of a restructuring plan for the public bank BROU was observed only in December. Progress with the World-Bank supported reform of the state-owned mortgage company BHU, which remains burdened by high operating costs and poor loan recovery, has also lagged. Also, progress in the disposal of the remaining assets of liquidated banks remained slow. The end-July structural PC on outsourcing the disposal of at least two asset groups was not observed. The authorities have since then revised their strategy in this area, with a view to outsourcing the entire stock of assets all at once. Developments at Nuevo Banco Comercial (NBC), created in March with the good assets of three liquidated banks, have been broadly in line with its business plan, although its wage bill has exceeded projections.

8. Implementation of structural reforms in other areas has also been difficult. Although congress approved a legal framework for trust funds and the government successfully awarded the operation of the Montevideo airport to the private sector through competitive bids, the September structural benchmarks on legislative approval of the reforms of the special pension funds for the police and the military were not observed. Work on reforming the pension fund for bank employees (a December structural benchmark) has also been delayed, and there has been no progress on the reform of the tax system, submitted to congress in June. The authorities remain committed to these reforms, but explained that they needed more time to secure their approval. As a result of delays in structural reforms, multilateral loan disbursements fell short of program projections by US$175 million during 2003, a shortfall that was offset by recourse to short-term borrowing.

Uruguay: Program Loan Disbursements 1/

(in millions of U.S. dollars)

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Consistent with schedule of disbursements in the TMU for June 2003 and February 2004.

III. Policy Discussions

9. Policy discussions mainly focused on bank restructuring, fiscal policy, and the macroeconomic framework for 2004. The authorities and the staff agreed that, in the aftermath of the 2002 crisis, it was critical to address the remaining vulnerabilities in the banking system. A particular priority for reform is BROU, which accounts for about half of total bank deposits and has a large stock of nonperforming assets. In the fiscal area, the authorities emphasized the significant adjustment that took place during 2003 and reaffirmed their commitment to the primary surplus targets for 2004 and beyond.

10. Discussions took place against the background of much improved macroeconomic prospects. Based on the most recent indicators, including a strong export performance, the authorities and the staff agreed that, under conservative assumptions, real GDP would grow by 5 percent in 2004 (Box 2). Year-end inflation is projected at 8 percent, building on the declining trend in 2003. The external current account surplus is forecast at about ½ percent of GDP, helped by favorable terms of trade and the recovery of demand in the region. The authorities agreed that further reforms would be needed to strengthen growth prospects for the medium term. They noted that significant actions had already been taken, but that building a new medium-term agenda for growth, in which the role of the private sector would be increased, required consensus which, realistically, could only be pursued after the forthcoming elections.

Growth Developments and Outlook

  • GDP is recovering from the sharp contraction registered during 1999–2002 (18 percent cumulatively). The 2002 financial crisis caused a sharp drop in consumer spending, mostly due to a wealth effect as households suffered losses on their holdings of deposits, sovereign bonds, and real estate. The resolution of the banking crisis and the successful government debt exchange contributed to a recovery in consumer confidence in 2003.

  • Higher net exports were at the heart of the economic recovery in 2003. A more competitive exchange rate and the reopening of overseas markets for meat boosted exports, while imports recovered more slowly. As is also common in V-shaped recoveries, a gradual rebound in private consumption contributed to the resumption of growth, especially in the second half of 2003, as evidenced by sharp increases in VAT and excise tax collections.

  • However, signs of a recovery in investment remain weak, which raises questions about the sustainability of the recovery. Investment slumped after the 2002 financial crisis, as credit dried up and economic prospects deteriorated sharply. Construction has remained sluggish, and imports of capital goods, although picking up in recent months, are estimated to have fallen by close to 20 percent in U.S. dollar terms during 2003.

  • The deep recession of 2002 caused significant shifts in income distribution. The income share of labor declined by an estimated 8 percentage points of GDP between 2001 and 2003, reflecting the fall in real wages and higher unemployment.

  • The growth outlook for 2004 is favorable. Real GDP growth is projected to reach at least 5 percent. Merely sustaining the level of activity reached in the last quarter of 2003 would imply average growth close to 4 percent in 2004. In addition, early indicators point to a promising tourism season, with visitor arrivals in late-2003 and early-2004 up by almost 40 percent. Significant growth is also expected in agriculture and industry.

  • For the medium term, potential output is projected to grow modestly at 2½-3 percent per annum. Investment is likely to remain depressed for some time, particularly since the financial sector has shrunk. The last Article IV consultation emphasized the need to revive structural reforms aimed at increasing the role of the private sector and improving the institutional framework and business climate.

A. Bank Restructuring

11. As anticipated, BROU’s restructuring is the centerpiece of efforts to strengthen the banking system.1 In mid-December, BROU’s Executive Board approved a strategic plan that aims at instilling sound banking practices (Appendix II). The bank intends to focus its business on the export sector, retail banking, and the development of peso-denominated financial products. Under the plan, BROU’s balance sheet will be strengthened, operational costs lowered, and risk management and credit monitoring processes improved. The restructuring aims at ensuring that BROU complies with all prudential norms and is viable, with performance indicators that are in line with comparator banks. The main components of the reform are as follows:

  • Nonperforming assets. The authorities are committed to removing a large part of the NPLs from BROU’s balance sheet, with a view to cleaning up the balance sheet of the bank and strengthening the modalities for asset recovery. In December, all Category 5 loans above US$100,000 (with a book value of US$370 million) were transferred to a fiduciary trust owned by a subsidiary of BROU.2 All remaining Category 4 and 5 loans on BROU’s books are to be transferred to the trust during the course of 2004, following the schedule defined in paragraph 10 of the MEFP. In exchange for the NPLs, the fiduciary trust will issue interest-bearing, government-guaranteed notes. The notes will pay interest of 1½ percent, roughly equivalent to the cost of deposits. The amortization schedule is still being determined, and is expected to be closely linked to the asset recovery schedule. The staff welcomed the commitment by the authorities to maximize the recovery of NPLs, noting that the operations of the fiduciary trust should be managed transparently and according to international best practice, to minimize the amounts that might eventually be called under the government guarantee on the trust’s notes. Accordingly, an outside manager is being retained to run the trust and implement asset recovery, with appropriate incentive targets.

  • Operational performance and risk management. To reduce operating costs by some 15 percent over the next two years, the number of employees will be gradually reduced, including through early retirement schemes, and the bank’s branch network rationalized. Interest rates on deposits will be better aligned with market levels to improve net interest margins. Credit risk administration will be bolstered with the implementation of improved risk management systems, including a credit scoring mechanism for small credits, improved credit risk assessment for medium-sized and large credits, and the development of consistent credit monitoring procedures.

  • BHU notes. At end-December 2003, arrears amounting to US$170 million were cleared on the note issued by BHU to compensate BROU for taking over its reprogrammed time deposits (see Footnote 1). With the clearance of arrears, BHU’s obligation to BROU has fallen to US$610 million.

12. The authorities and the staff concurred on the merits of maintaining a cautious approach to managing the liquidity risks facing BROU. The bank will continue to build liquidity to ensure the timely repayment of reprogrammed deposits (Box 3). The authorities are committed to consulting closely with the staff on the treatment of these deposits. The authorities and staff concurred that the interest rate on these deposits would need to be reduced in line with market trends, but the authorities believed that they would be able to do so only in the context of advancing the release of the second tranche. Advancing the release of the remaining tranches should wait at least until BROU’s restructuring is well under way. The staff had urged keeping the 100-percent reserve requirement on sight and savings deposits as a key safeguard for the bank while in crisis. However, as the restructuring progresses, reducing the reserve requirement is appropriate. BROU’s restructuring plan assumes that the requirement will be reduced over time.

Reprogrammed U.S. Dollar Deposits

Amounts. In August 2002, at the time of the banking crisis, all U.S. dollar time deposits with public banks, amounting to US$2.2 billion (including US$0.8 billion deposits of BHU that were transferred to BROU), were reprogrammed, with extended maturities of up to three years.

Repayment schedule. The schedule contemplated the repayment of 25 percent of principal (US$0.6 billion) during the period August 2003-July 2004; 35 percent (US$0.8 billion) during August 2004–July 2005; and the remaining 40 percent (US$0.9 billion) during August 2005-July 2006. Reprogrammed deposits were to carry interest rates slightly above market interest rates; this rate was initially set at 6 percent, and has remained unchanged, even though market rates have since then declined significantly.

First tranche release. In June-July 2003, the authorities advanced the release of the first tranche of reprogrammed time deposits. To date, BROU has been able to retain most of these deposits, although mostly in the form of sight and savings deposits.

13. Progress is also being made in other areas of bank restructuring.

  • Liquidated banks. The launch of bids to outsource asset disposal for the three liquidated banks is a prior action for the review, and the final selection is a structural PC for end-February. With regard to the fourth liquidated bank, Banco de Crédito (BDC), in November the former minority shareholder completed the repayment of its outstanding liabilities by transferring government bonds with a face value of US$93 million to the liquidation fund. The auction of a large portion of the remaining assets of BDC was held in late-January, advancing its liquidation.

  • Nuevo Banco Comercial (NBC). The government is in the process of soliciting equity investments by the IFC and other institutional investors in this government-owned bank. Effective end-December 2003, NBC exercised its option to return to the liquidation funds all remaining nonperforming assets. The bank has been successful in attracting new deposits, and its operating results have been broadly in line with its business plan.

  • Mortgage company BHU. BHU’s restructuring is being accelerated during 2004. Due diligence on its portfolio was completed in December, and implementation of its restructuring plan has started, including downsizing, functional reorganization, and financial restructuring. The BHU’s arrears to BROU have been cleared, and the payment terms of its remaining liabilities were brought in line with the authorities’ expectations for BHU’s earnings capacity.

14. The authorities continue to make progress in strengthening banking regulation. Prudential regulations are being aligned with international best practices, and the supervisory capacity of the BCU is being increased, with technical and financial support from the IDB and the Fund. The authorities are also taking steps to promote gradual dedollarization. Reserve requirements on peso deposits have been lowered relative to those on foreign currency deposits, and the BCU is working to adjust provisioning requirements to reflect more appropriately the risk of foreign currency loans to borrowers whose earnings are in local currency.

B. Fiscal and Monetary Policies

15. Uruguay’s primary fiscal balance improved significantly during 2003, although the end-year target was likely missed by a small margin. Preliminary data indicate that the primary surplus in 2003 reached 2.8 percent of GDP, slightly less than the program target (3 percent of GDP) but still a major improvement from 2002. Both social security revenue and the operating surpluses of public enterprises fell short of expectations, but were partly offset by higher tax revenue. The overall deficit was smaller than program projections (by 0.3 percent of GDP), owing to lower interest obligations.

16. The authorities reaffirmed their strong commitment to achieving a primary surplus of 3.2 percent of GDP in 2004. Achievement of this target will be helped by the cyclical recovery of tax and social security revenue and further adjustments in public tariffs.3 In early-January, the authorities raised utility tariffs by 6 percent on average, and they are committed to adjusting them further during the year, in line with cost developments. The government is also committed to keeping a tight grip on expenditure. To that effect, the wage increase granted in January was limited to 4 percent and, for 2004 as a whole, increases will not exceed 10 percent, broadly in line with projected inflation. The budget still provides some room for a recovery in public investment and for the one-time expenses associated with the elections, while protecting priority social expenditure.

17. Prospects for tax reform remain elusive, but steps are being taken to strengthen tax administration. A revised tax reform bill, aiming at eliminating several low-yielding taxes and broadening the VAT base, was submitted to congress in June 2003, in line with the program. The authorities reaffirmed their commitment to seek to build consensus for an early passage of the reform, but recognized that the process may take more time than expected, given the approaching elections. This reform is important to help rationalize the tax system and boost collections; in the meantime, the authorities reaffirmed their commitment to achieving the program objectives through appropriate expenditure restraint. The staff regretted the lack of progress on tax reform, but welcomed the approval in November of a law that provides additional resources to the Tax Administration Department (DGI) and enhances its ability to reform its internal structure. The planned modernization of the DGI, which is in line with FAD advice and supported with funds from the European Union, includes an overhaul of the DGI’s processes and systems, significant retraining and improved incentives for its staff, and the creation of a Large Taxpayer Unit by end-September 2004 (a structural benchmark). At the same time, efforts are being intensified to fight tax evasion, including shifting responsibility for the supervision of tax-free zones from the Trade Department in the Ministry of Economy and Finance (MEF) to the DGI in the MEF.

18. The authorities and the staff concurred on the crucial importance of maintaining a sound fiscal position over the medium term. Achievement of a primary surplus of close to 4 percent of GDP by 2007 and maintaining it at this level in subsequent years would, assuming the realization of all contingent liabilities associated with bank restructuring, lead to a decline in the debt-to-GDP ratio to about 66 percent by 2012 (Box 4). Alternatively, if there were no additional costs of bank restructuring, the ratio would fall to 60 percent by 2012. The authorities noted that, if medium-term economic growth were to turn out higher than currently anticipated, they would favor attaining even higher primary surpluses, targeting a zero overall balance for the combined public sector. The authorities also agreed to keep the adequacy of the fiscal target under continuous review, to ensure that it is sufficient to achieve debt sustainability, even with possible additional costs arising from contingent fiscal liabilities in connection with the restructuring of the public banks.

Public Debt Sustainability Analysis

Uruguay’s high public debt stock continues to be a source of vulnerability, notwithstanding the successful debt restructuring of May 2003 and a significant drop in interest rate spreads. A key source of vulnerability lies in the banking sector, as the government faces large contingent liabilities reflecting potential calls over time on government guarantees in the restructuring of the public banks (up to US$1.3 billion, or about 10 percent of GDP). These costs are related to the transfer of BROU’s NPLs and the servicing of the BHU note, and include the interest cost of these guarantees. In a conservative approach, to ensure that all of these costs are captured, staff has constructed a scenario in which these contingent liabilities are fully realized. This is contrasted with a scenario in which these contingencies are excluded from the DSA.

Figure 1.
Figure 1.

Uruguay: Public Debt, 2001-12

(In percent of GDP)

Citation: IMF Staff Country Reports 2004, 172; 10.5089/9781451839234.002.A001

Source: Uruguayan authorities and Fund staff estimates.

If the government guarantees were to be called in full, the public debt-to-GDP ratio would reach 66 percent by 2012. This compares with 60 percent in the scenario where no restructuring costs are realized. The debt-to-GDP ratio declines in all cases, assuming potential GDP growth of 2½ percent, an average primary surplus of 3½ percent of GDP, and a modest appreciation of the real exchange rate. Financing gaps—emerging in 2005—are assumed to be closed through a combination of market and multilateral financing, possibly including the Fund.

Uruguay’s public debt position is highly sensitive to macroeconomic shocks, as evidenced by the sensitivity tests presented in Appendix III (these shocks have been applied to the stock of debt including the costs of bank restructuring). However, it is important to recognize that Uruguay recently experienced such shocks and has adjusted its policies in response. The continued implementation of sound policies, along with deepening structural reforms, especially in the banking sector, will thus be crucial to minimize the likelihood of macroeconomic shocks and further improve prospects for debt sustainability.

Figure 2.
Figure 2.

Uruguay: Sensitivity Tests for Public Sector Debt, 2003–08 Includes Costs of Bank Restructuring

(In percent of GDP)

Citation: IMF Staff Country Reports 2004, 172; 10.5089/9781451839234.002.A001

Source: Uruguayan authorities and Fund staff estimates.

19. The central bank will continue to target base money under the floating exchange rate regime. Staff commended the authorities for the sound conduct of monetary policy under difficult circumstances. Consistent with the goal of containing inflation, interest rates rose significantly in the first part of 2003, before gradually declining in the second half of the year. The authorities noted that forecasting money demand has been challenging, given the short period during which the floating exchange rate regime has been in place (Box 5). The authorities have announced a monetary program for 2004 that targets an expansion of base money of about 15 percent, consistent with a moderation in the remonetization process and a modest buildup in NIR (US$100 million). Over the medium term, the authorities intend to move to inflation targeting; in January, a regular survey of inflation expectations was initiated.

Monetary Policy Implementation in 2003

  • In June 2002, Uruguay adopted a floating exchange rate policy and, in September 2002, began targeting base money.

  • During 2003, base money developments were broadly in line with program projections. However, the growth in bank reserves was higher than initially expected, and currency in circulation lower. The growth of broader monetary aggregates was also lower than programmed.

  • Furthermore, money demand turned out to be stronger than anticipated and, consequently, inflation ran well below expectations. An important component in the formation of inflation expectations in Uruguay is exchange rate developments, and the broad stability of the peso against the U.S. dollar during 2003 helped keep inflation at low levels.

  • While the experience with base-money targeting in 2003 suggests that monetary policy could move toward inflation targeting (IT), the foundations for successful adoption an IT regime do not yet seem to be in place: (i) Uruguay is still in the process of fully restoring a strong fiscal position, macroeconomic stability, and the full functioning of its financial system; (ii) given the shocks that the economy and financial system have experienced, the monetary transmission mechanism is still in flux or not well established; (iii) the required institutional framework still needs to be established, including closer coordination between the foreign exchange and open market operations desks and sufficient availability of instruments; and (iv) central bank operational independence would need to be further strengthened.

C. Trade Policies and Other Structural Reforms

20. Uruguay is deepening its integration into the global economy. A comprehensive bilateral free trade agreement with Mexico was signed in November which, once ratified by both congresses, will free about 93 percent of imports from tariffs and provide increased quotas and tariff discounts for a number of sensitive products such as beef, dairy products, and textiles. Uruguay is expected to further benefit from the recent free trade agreement between Mercosur and the Andean countries, although the precise calendar of tariff reductions still remains to be negotiated. The authorities are committed to the multilateral framework of trade liberalization and strongly support the early resumption of the Doha round. In early-2004, they also began to unilaterally phase out specific duties on textiles, foodstuffs, and chemical products.

21. Steps are being taken to foster an environment conducive to private sector-led investment and growth. The authorities noted that the protection of property rights in the resolution of the economic and financial crisis had helped improve investor sentiment toward Uruguay. They were encouraged by strong regional direct investment in the Uruguayan agricultural sector. Their efforts focus on promoting Uruguay’s transformation into a regional distribution and logistics hub through: (i) a number of private concessions and public investments in the area of transport infrastructure (ports, airports, and railways); (ii) the recent approval by Mercosur of more generous rules of origin for goods in transit; and (iii) the extension until 2010 of Uruguay’s regime for temporary admissions. Investment projects which were delayed because of the economic crisis will qualify for fiscal incentives for an additional two-year period. Finally, the authorities have initiated formal negotiations on a bilateral investment treaty with the United States.

22. The authorities reiterated their commitment to structural reforms in other areas. The staff expressed concern about delays in a number of areas, and reiterated the urgency of advancing structural reform to underpin a rebound in employment and medium-term growth. The authorities shared this concern, but noted that building the necessary political support had been time-consuming and would become more difficult as the elections approach. Nevertheless, they would continue working to secure congressional approval of the reforms of the pension funds for the police and the military by end-June 2004 (structural benchmarks). They are also committed to seeking progress in reforms supported by program loans from the World Bank and the IDB.

IV. Program Financing, Monitoring, and Risks


23. The program remains fully financed in 2004. Total disbursements from multilateral development banks are projected at US$270 million in 2004, broadly in line with amortization. The government also plans to draw on a financing cushion of about US$200 million accumulated at end-2003. Assuming close adherence to the fiscal program, residual market financing (after rolling over short-term debt) would be kept at US$200–300 million, which the government is confident can be largely secured through issuance abroad of medium-term bonds. The stock of short-term debt would remain broadly unchanged during 2004 (Box 6). If market conditions permit, the authorities plan to issue more long-term debt in order to reduce the stock of short-term debt.

Government Short-Term Debt

  • The stock of short-term Treasury bills rose sharply in 2003, from US$190 million to US$810 million (7.2 percent of GDP). The increase mainly reflected Uruguay’s difficulties in placing longer-term paper in the domestic and international markets in the aftermath of the 2002 crisis. After rising during the first three quarters of the year to close to US$850 million, the stock of treasury bills declined slightly during the fourth quarter.

  • Despite the high volume of issuance, maturities of Treasury bills lengthened and interest rates declined during the course of the year. Treasury bill maturities now reach up to 9 months, compared with 1–2 months in early-2003. Consequently, the average residual maturity of the stock of Treasury bills has risen to about three (four) months for peso (dollar) denominated bills. Interest rates have also declined significantly, to about 12 percent (3 percent) on 6-month bills in pesos (dollars). The currency denomination of the bills remains about evenly split between pesos and U.S. dollars.

  • The program for 2004 assumes virtually no increase in the stock of short-term debt. The projected fiscal deficit and the maturing long-term debt are expected to be broadly covered by official financing and moderate access to long-term market financing.

Access and monitoring

24. Because of delays in completing the fourth review, a rephasing of access is proposed, with original access maintained for this review. Since the fourth review was originally scheduled for October, the authorities have requested a modification of access under the program, as set out in Table 8. The proposed rephasing reflects the weight given to safeguarding Fund resources in light of policy slippages. In addition, it is proposed that the repurchase expectations arising during 2004 (SDR 227 million) be moved to an obligations basis.4 Repurchases could cause undue hardship at a time when the authorities are taking firm action to further strengthen the balance of payments and bolster confidence.

Table 4.

Uruguay: Combined Public Sector Operations

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Sources: Ministry of Finance; and Fund staff estimates.

Program figures including extra budgetary operations.

Excludes contributions that are transferred to the private pension funds.

Includes extrabudgetary operations from 1998.

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

Includes the following bank-restructuring costs: US$ 33 million of capital transfers for bank recapitalization, US$ 564 million of liquidity supplied by BCU, US$ 444 million for the Fondo de Fortalecimiento del Sistema Bancario (FFSB), and US $ 993 million for the FSBS.

Table 5.

Uruguay: Cash Flow of the Nonfinancial Public Sector

(In millions of U.S. dollars)

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Includes release of principal and cash payments due to debt exchange.

Held outside the banking system.

Includes use of financial assets, assistance bonds to banks, and intra-quarter float.

Table 6.

Uruguay: Summary Accounts of the Banking System 1/

(In millions of Uruguayan pesos, unless otherwise indicated)

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

Presentation used for program monitoring. May differ from presentation and definitions used in IFS.

The Banco de la Republica Oriental de Uruguay (BROU), Banco Hipotecario de Uruguay (BHU; mortgage institution), private banks, and cooperatives.

Excludes nonresident deposits.