Uruguay
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
Author:
International Monetary Fund
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Publication Date:
24 Jun 2004
eISBN:
9781451839234
Language:
English
Keywords:
ISCR; CR; liquidity condition; NPL ratio; BROU; SDR; short-term debt; debt exchange; monetary policy; interest expenditure; broad money
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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.

Abstract

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

Financing

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.

Table 7.

Uruguay: Medium-Term Outlook

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Sources: Central Bank of Uruguay; and Fund staff estimates.
Table 8.

Uruguay: Proposed Schedule of Purchases

(In millions of SDRs)

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Source: Fund staff estimates.

25. While the broad monitoring framework under the program remains unchanged, waivers and modifications are being requested. In the attached Letter of Intent, the authorities describe their policies for 2004 and request waivers of: (i) nonobservance of the end-December quantitative PC on the primary surplus of the combined public sector; (ii) nonobservance of the end-July structural PC on outsourcing the disposal of at least two asset groups from the liquidation funds; and (iii) applicability of the end-December quantitative PCs on the nonfinancial public sector gross debt and on general government noninterest expenditure. As noted, some of the structural benchmarks were observed with delays and others are still outstanding. The following remedial steps have been established as prior actions for completion of the fourth review: (i) a call for bids to outsource the management of the remaining assets in the three liquidation funds; (ii) selection of the general manager of the fiduciary trust handling the NPLs from BROU; and (iii) issuance of an unconditioned government guarantee on the performance of the notes to be issued by the fiduciary trust in exchange for loans transferred from BROU. The entering into a contract by the fiduciary trust with providers of specialized asset recovery services and the transfer of all Category 4 loans above US$100,000 that have become Category 5 from BROU to the fiduciary trust will be structural PCs for end-March 2004, and all new and remaining Category 4 and 5 nonperforming loans will be transferred by end-2004 (Appendix I, Attachment I, Tables 1 and 2). A continuous structural PC has also been specified, providing for timely service of BHU’s government-guaranteed obligation to BROU. Finally, approval by congress of the reforms of the special pension funds has been rescheduled as structural benchmarks for end-June (police and military) and end-December (bank employees).

26. Total debt service obligations to the Fund would peak at close to 7 percent of GDP in 2006 (Table 9). The high level of debt service may require Fund involvement beyond the present arrangement. In turn, it is critical to provide for close monitoring of Uruguay’s performance under the program and prompt corrective action in case of shocks or policy slippages. Quarterly reviews will therefore continue under the program.

Table 9.

Uruguay: Projected Payments to the Fund and Indicators of Capacity to Repay the Fund 1/

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Sources: Finance Department; and Fund staff estimates and projections.

Assuming that all scheduled purchases are made and that repurchases under the SBA and SRF are made on an obligations basis. On March 17, 2003, the IMF Executive Board converted the two remaining SRF repurchases to an obligations basis.

Projections are based on current rates of charge, including burden-sharing where applicable, for purchases in the GRA. The current SDR interest rate is assumed for net use of SDRs.

Program risks

27. The overall balance of risks has somewhat improved from the third review, but substantial short- and medium-term vulnerabilities remain, leaving no room for complacency. The successful debt exchange in May has provided breathing space, which should be used to adopt measures to ensure fiscal sustainability and fully restore the banking system’s viability.

  • Attaining the primary surplus objective of the program will be challenging. As the 2004 presidential and congressional elections approach, pressures on the government to loosen the fiscal stance may rise. Failure to comply with the programmed surplus would create additional financing needs and raise doubts about the feasibility of the primary surpluses that will be required over the medium term to ensure debt sustainability. In this context, if additional fiscal costs related to the restructuring of BROU were realized, Uruguay’s prospects for debt sustainability would worsen.

  • The envisaged restructuring of the public banks may be strongly resisted by vested interests. In particular, it is critical that the fiduciary trust to which BROU’s NPLs are being transferred be independently managed, to ensure effective recovery. While this would represent a major break from past practices, failure to proceed with the restructuring would risk creating significant additional liabilities for the government, further increasing the debt burden. BROU’s progress in achieving financial viability will be closely monitored under the program, and will constitute a key element for completion of future reviews.

  • The need to roll over significant amounts of short-term debt during 2004 makes Uruguay vulnerable to reversals in market sentiment. It will be essential to avoid slippage in program implementation and to maintain consistent communication with the markets in the run up to the elections, in order to sustain investor confidence. Favorable market conditions should be used—as intended by the authorities—to increase the maturity structure of the debt.

  • Deposits are flowing back into the banking system, but mostly in the form of sight and savings deposits.

  • Delays in disbursements from multilateral development banks could weaken the financing outlook and require higher recourse to market financing. It will therefore be essential to implement structural reforms in a timely and consistent fashion.

28. A number of buffers help mitigate—but do not fully eliminate—these vulnerabilities. The flexible exchange rate provides some support against external shocks, although the balance sheets of the government, private firms, and households remain significantly exposed to currency depreciation. Gross international reserves have been substantially rebuilt, but still do not provide much room for lender-of-last resort assistance. The banking system is cushioned by a high level of liquidity and improved credit quality, but both bank profitability and credit flows to the economy have yet to be restored.

V. Data, Safeguards Assessment, and Other Issues

29. Uruguay’s statistical database remains generally adequate for the assessment and monitoring of macroeconomic policies. The authorities have begun submitting data toward subscription to the SDDS, starting in October 2003 with dissemination on the BCU website of the data template for international reserves and foreign currency liquidity (an end-September structural benchmark). They are planning to formalize Uruguay’s subscription to the SDDS in early-2004. Monthly bank balance sheet data are being published with a lag of no more than two months (a continuous structural benchmark). While the timeliness of data provision by BROU and NBC has improved, the state mortgage company BHU continues to provide balance sheet data with a long delay. The staff has also expressed concern about recurrent delays in reporting below-the-line fiscal data. The authorities are committed to improving the timeliness of reporting and to developing a more user-friendly presentation of above-the-line fiscal information for the general public.

30. In line with the recommendations of the 2002 Safeguards Assessment mission, an external audit of the FSBS was conducted in 2003 (an end-September structural benchmark). A supplemental audit, focusing on the use of FSBS resources by recipient banks, was initiated in early-2004. In addition, the BCU has retained an internationally reputable auditing firm to perform an external audit of its 2003 accounts. The authorities reaffirmed their commitment to combating money laundering and the financing of terrorism, noting the recent ratification by congress (in October 2003) of the UN International Convention for the Suppression of the Financing of Terrorism.

VI. Staff Appraisal

31. After four years of recession, Uruguay’s economy has started to recover. The adoption of prudent macroeconomic policies, skillful resolution of the 2002 banking crisis, and the successful debt exchange in early-2003 have been key to the economy’s turnaround. The pace of the recovery gathered momentum during 2003, and the rate of growth is expected to further pick up in 2004, with inflation continuing on a downward trend. This performance has been supported by a more favorable external environment, including higher demand and prices for Uruguayan exports and improved financing conditions for emerging market economies. It will be important to develop a medium-term agenda for sustained growth, which should include an increased role for the private sector.

32. However, the recovery remains fragile, and its consolidation will require continued sound policy implementation, particularly in the fiscal area and bank restructuring. The authorities’ continued strong commitment toward achieving the primary surpluses targeted under the program for 2004 and beyond is welcome. While these targets are demanding, achieving them will be necessary to bolster market confidence and ensure sustainable debt dynamics.

33. The staff welcomes the steps taken to modernize tax administration, but regrets the lack of progress with tax reform. Improving the efficiency of both tax policy and tax administration is important to underpin fiscal management and provide a level playing field for private sector activity. The staff therefore encourages the government to continue its efforts to forge a consensus on tax reform.

34. Monetary policy implementation has been prudent, and the staff supports maintenance of the flexible exchange rate regime. The programmed expansion in the monetary base for 2004 is consistent with a further decline in inflation, while allowing some further remonetization of the economy. The staff welcomes the initiation of regular surveys of inflation expectations, and encourages the authorities’ intention to move toward inflation targeting in the medium term.

35. Restructuring of the public banks and swift disposal of the remaining assets in the liquidation funds are crucial for banking system stability and the revival of credit flows. Timely implementation of the planned reforms at BROU is critical to ensure its viability and will contribute to improving creditor discipline and reducing moral hazard. BROU’s remaining NPLs should be quickly transferred to the fiduciary trust, and required actions should be taken to achieve the targeted cost savings and to strengthen risk management. In addition, given the structure of the fiduciary trust, which will be owned by BROU, it will be critical to ensure that it is managed independently and in line with international best practice, so as to maximize recovery from NPLs and avoid additional costs to the government.

36. BROU’s liquidity should continue to be conservatively managed. The reform of BROU should proceed with all deliberate speed. Until the restructuring of the bank is well under way, the staff recommends maintaining the original schedule for the unfreezing of reprogrammed deposits. As BROU’s restructuring progresses, a reduction of the 100-percent reserve requirement on sight and savings deposits to 90 percent during 2004 is appropriate.

37. The staff is concerned about the delays with several other important structural reforms. Moving from the present recovery stage toward sustained growth will require acceleration of reforms, including further steps to boost the investment climate. The staff therefore urges all stakeholders to remain engaged in building an environment that is conducive to private-sector investment, as a basis for sustained growth. Approval of a number of structural reforms that are presently in congress and supported by the World Bank and the IDB would be an important step into the right direction.

38. Progress has been made in strengthening data reporting, but further improvement is needed. The staff welcomes the recent publication of the foreign reserve template and expects Uruguay soon to be able to fully subscribe to the SDDS. The availability and presentation of banking data have also improved markedly. The staff urges the authorities to take the necessary steps to improve the timeliness and presentation of fiscal data.

39. The program remains fully financed. Residual market financing needs should be manageable provided that the primary surplus target is achieved and structural reforms are implemented on schedule to unlock program lending from the World Bank and the IDB. Maintaining sound policy implementation and good communication with the markets during this election year will remain critical, particularly in view of the need to roll over a substantial amount of short-term public debt.

40. Despite the progress achieved to date, program risks remain sizeable. Vulnerabilities stem mainly from the still-large public debt and its increased short-term component; the short maturity of bank deposits; sizeable contingent liabilities in the public banks; remaining balance sheet vulnerabilities; and the danger of policy reversal in an election year. The debt burden, while declining, will remain high for a significant period of time and the need for Fund involvement beyond the current arrangement is likely. Close program monitoring remains essential in view of these risks.

41. Notwithstanding these vulnerabilities, the staff recommends completion of the fourth review, approval of the authorities’ request for waivers, and extension of repurchase expectations arising during 2004. Policy implementation in the banking area is broadly back on track, and the authorities have demonstrated and reaffirmed their strong commitment to the program objectives.

Figure 1.
Figure 1.

Uruguay: Activity and Prices

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

Sources: Central Bank of Uruguay; Ministry of Economy and Finance; CERES; and Fund staff estimates.
Figure 2.
Figure 2.

Uruguay: External Sector Indicators

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

Sources: Central Bank of Uruguay; Ministry of Economy and Finance; CERES; and Fund staff estimates.
Figure 3.
Figure 3.

Uruguay: Financial Indicators

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

Sources: Central Bank of Uruguay; Ministry of Economy and Finance; and Fund staff estimates.
Figure 4.
Figure 4.

Uruguay: Fiscal and Monetary Indicators

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

Source: Central Bank of Uruguay; Ministry of Economy and Finance; and Fund Staff estimates.
Table 10.

Uruguay: Vulnerability Indicators

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

For 2003, data are as of end-September.

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

By remaining maturity.

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

APPENDIX I

Montevideo, Uruguay

February 6, 2004

Dear Mr. Köhler:

Since the completion of the third review under the Stand-By Arrangement last July, the Uruguayan economy has continued to strengthen, and financial indicators have further improved. The government of Uruguay remains firmly committed to achieving the objectives of the program, through fiscal consolidation and structural reforms. Available data indicate that all quantitative performance criteria under the program for end-September have been observed, except for a small shortfall in the combined public sector primary balance, which was more than offset in the overall balance by lower interest payments.

The attached Memorandum of Economic and Financial Policies presents the policies of the government of Uruguay for 2004. In support of its program, the Government of Uruguay requests: (i) completion of the fourth review under the Stand-By Arrangement, with availability of a purchase equivalent to SDR 93.2 million; (ii) rephasing of all remaining purchases under the arrangement, in an amount equivalent to SDR 559.2 million (Table A); (iii) a waiver of nonobservance of the end-July 2003 structural performance criterion to outsource to third parties the disposal of the assets of liquidated banks in at least two asset groups; (iv) a waiver of nonobservance of the end-December 2003 quantitative performance criterion on the cumulative primary balance of the combined public sector; and (v) waivers of applicability of the end-December 2003 quantitative performance criteria on the nonfinancial public sector gross debt and on general government noninterest expenditure. These waivers are requested on the basis of the strong policies that will be maintained for 2004, in line with the original design of the program. We also request that the repurchase expectations arising during 2004 be moved to an obligations basis. There will be four program reviews in 2004, to be held in February, May, August, and November.

Table A.

Schedule of Remaining Purchases Under the Stand-By Arrangement

(In millions of SDRs)

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We are confident that the policies set out in the attached Memorandum will ensure the success of the program and justify the requested waivers and completion of the review. The continued support of the international financial institutions will be fundamental in underpinning economic recovery. The government stands ready, in consultation with the Fund, to take any additional measures necessary to ensure the success of the program.

Sincerely yours,

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Mr. Horst Köhler

Managing Director

International Monetary Fund

700 19th Street, N.W.

Washington, D.C. 20431

Attachments: Memorandum of Economic and Financial Policies Technical Memorandum of Understanding

ATTACHMENT I Memorandum of Economic and Financial Policies for 2004

I. Background

1. In recent months, Uruguay’s economy has gained significant strength and financial indicators have continued to improve. On a seasonally adjusted basis, real GDP expanded by over 3 percent (quarter-on-quarter) during each of the first three quarters of 2003, and partial data point to a further strengthening in activity during the fourth quarter. For 2003 as a whole, growth is estimated to be about 1 percent, reflecting strong export performance and a recovery in domestic demand. Inflation has declined to about 10 percent, bank deposits have continued to increase, and gross international reserves have risen fourfold since mid-March, to US$2.1 billion at end-December (equivalent to 9¼ months of imports of goods and services). All end-September quantitative performance criteria under the program have been observed, except for a small shortfall in the combined public sector primary balance, which was more than offset in the overall balance by lower interest payments.

II. Economic Program for 2004

2. The government has laid out policies for 2004 aimed at consolidating the gains made in 2003, with a strong improvement in economic activity, a further reduction in inflation, and a strengthening in external balances. The economy is assumed to grow by 5 percent, led by the ongoing recovery in exports and domestic demand, and inflation is projected to decline to 7-9 percent by year-end. The external current account surplus would improve slightly in 2004 to about ½ percent of GDP, and the program aims at a modest increase (US$100 million) in net official international reserves.

3. Toward these ends, the program will maintain prudent fiscal and monetary policies and take further steps toward ensuring banking sector soundness, while adopting structural reforms to underpin medium-term growth. Its main components are: (i) the 2004 budget, which seeks to achieve a primary surplus of the combined public sector of 3.2 percent of GDP; (ii) a monetary program aimed at limiting base money growth to about 15 percent; and (iii) a deepening of the restructuring of the banking system, with emphasis on the public bank BROU. The performance criteria are set out in Table 1 and defined in the attached Technical Memorandum of Understanding, and Table 2 presents the prior actions and structural benchmarks under the program. The government will also observe the standard performance criteria regarding exchange restrictions, multiple currency practices, and import restrictions for balance of payments reasons.

Table 1.

Uruguay: Performance Criteria and Indicative Targets Under the 2004 Economic Program 1/

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As defined in the Technical Memorandum of Understanding (TMU).

Indicative targets for end-September and end-December 2004.

Cumulative changes from end-December 2003.

Adjusted upward/downward for changes in social security contributions, as defined in the TMU.

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

Stock of debt at the end of the period; all maturities. The 2003 base includes all loans guaranteed by the government.

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

Cumulative change from December 2003 average.

Table 2.

Uruguay: Structural Conditionality Under 2004 Economic Program

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III. Fiscal and Monetary Policies

4. The government is firmly committed to achieving the primary surplus objectives of the program, as a key component of our strategy to ensure debt sustainability. During 2003, the primary balance of the combined public sector improved significantly, shifting from equilibrium in 2002 to a surplus of close to 3 percent of GDP. Building on this achievement, the primary surplus is projected to increase to 3.2 percent of GDP in 2004, rise further to about 4 percent of GDP by 2007, and remain at about that level over the ensuing several years. To ensure debt sustainability, however, we will keep the adequacy of the fiscal surplus target under continuous review to ensure that it is sufficient to address the additional fiscal costs that could arise from contingent fiscal liabilities associated with the restructuring of the public banks. Over the medium term, if economic growth turns out to be significantly higher than presently envisaged, the government would be ready to further improve the primary surplus of the combined public sector, to ensure that the overall balance is in equilibrium.

5. In 2004, expenditure restraint will remain at the core of the fiscal program. In nominal terms, the growth in central government noninterest expenditure will be limited to about 9 percent, or close to projected inflation. This increase includes one-time expenses of about 0.4 percent of GDP to cover the cost of the national elections and provide for the payment of deferred expenditures, including food vouchers granted in 2003. Wage and pension increases will remain moderate, and the wage bill of the central government will amount to Ur$15 billion in 2004. The program, however, allows for some room in discretionary spending if tax revenue turns out to be higher than envisaged, provided that the program objectives are met. Social expenditure will be protected, and capital expenditure is programmed to recover somewhat in 2004.

6. Revenue of the consolidated public sector is projected to increase slightly as a proportion of GDP, to 30.6 percent in 2004. This performance will be supported by a current surplus of public enterprises of 3.3 percent of GDP (excluding interest), reflecting adjustments in public tariffs consistent with changes in operating costs. Steps have been taken to strengthen tax administration. To reduce evasion, responsibility for supervising the tax-free zones has been transferred from the Ministry of Economy and Finance to the Tax Administration Department (DGI). In November 2003, congress approved a law providing additional resources to the DGI and enhancing its ability to modernize its internal structure, in line with FAD technical assistance recommendations. As part of its modernization, the DGI will complete a master plan to reengineer its processes and systems, and will establish a Large Taxpayer Unit by end-September 2004 (a structural benchmark).

7. The government remains committed to a floating exchange rate policy. To improve the transparency of exchange market operations, the Central Bank of Uruguay (BCU) has separated its foreign exchange operations from those of the central government. In October, the BCU began conducting most of its foreign exchange operations through preannounced auctions on the electronic stock exchange.

8. The BCU will continue to implement monetary policy in line with targeting base money growth, to anchor inflation expectations and further enhance monetary policy credibility, thereby paving the way for future adoption of inflation targeting. For 2004, base money is targeted to grow by 15 percent, consistent with the macroeconomic framework and a moderation of the remonetization process. Quarterly base money targets are being announced, in line with the desired annual path, and short-term monetary instruments are being used to minimize intra-month volatility. To improve the transparency of monetary policy, the BCU will continue to publish daily information on base money developments. In January 2004, the BCU initiated a regular survey of inflation expectations. The BCU will also continue to promote the use of peso instruments, including inflation-indexed notes. The NDA and NIR performance criteria of the program are presented in Table 1.

IV. Restructuring of the Banking System.

9. Reform of the public banks and disposal of the remaining assets in the liquidation funds are key priorities under the 2004 program. A comprehensive plan for restructuring BROU was finalized in December 2003. The main elements of this plan are to: (i) strengthen BROU’s commercial focus and redirect its operations toward business segments where it has a competitive advantage; (ii) improve credit risk management and loan monitoring; (iii) reduce operating costs through the implementation of a rationalization plan; and (iv) provide for the phased removal of nonperforming loans. Progress in the implementation of this plan, designed to ensure BROU’s sustained viability and continued compliance with all prudential norms and obligations, will be monitored under the program reviews.

10. BROU is committed to achieving financial viability by end-2004. In mid-December 2003, BROU’s Executive Board declared its intention to move all nonperforming loans in Category 5 and most loans currently in Category 4 into a special workout vehicle (fiduciary trust). The main lines of the action plan are as follows:

  • A first tranche, including all Category 5 loans above US$100,000, has been legally removed from BROU’s balance sheet by end-December 2003, and transferred to the fiduciary trust. The book value of these loans is estimated at US$370 million.

  • All Category 4 loans above US$100,000 that fall into Category 5 during January-March 2004 will be transferred to the fiduciary trust by March 31, 2004 (a performance criterion). In addition, all Category 4 and 5 nonperforming loans above US$50,000 will be transferred to the fiduciary trust by June 30, 2004 and all new and remaining Category 4 and 5 nonperforming loans, regardless of amount, will be transferred to the fiduciary trust by December 31, 2004 (performance criteria).

  • As required under Uruguayan prudential norms, the value of all assets in the fiduciary trust will be reassessed within six months by an internationally reputable audit firm.

  • The fiduciary trust, established in December 2003, will be administered by an entity owned by BROU. To allow for effective asset recovery, the manager of the trust will contract the specialized services of professionals experienced in dealing with nonperforming loans to implement the government’s asset recovery strategy (an end-March performance criterion).

  • In return for the loans it receives, the entity in charge of administering the fiduciary trust will issue notes which will be fully backed by a government guarantee. These notes will be amortized over a four-year period under a schedule determined by loan recovery expectations, and pay interest. The government guarantee, provided upfront, will cover the entire book value of the loans to be transferred.

11. BROU will continue to build up liquidity for the repayment of reprogrammed deposits. The government will continue to use the resources of the Fund for the Stability of the Banking System (FSBS) as originally envisaged—to provide backing for sight and savings deposits at qualifying banks. The government is also taking steps to ensure that the claim of BROU on Banco Hipotecario del Uruguay (BHU), originating from the 2002 transfer of reprogrammed time deposits, is serviced on time. In December 2003, all arrears were cleared, and the timely service of this note (consistent with the government guarantee, if necessary), restructured in line with BHU’s payment capacity, is proposed as a continuous performance criterion under the program.

12. Progress is being made in the resolution of the assets of liquidated banks. Nuevo Banco Comercial (NBC), the government-owned bank created in early-2003 with part of these assets, has proven quite successful at attracting new private sector deposits, and has been able to make significant progress in the restructuring of its NPL portfolio. As envisaged, NBC has fully exercised its option to return to the liquidation funds all loans that are not performing by December 31, 2003. Meanwhile, the government is completing the sale of the remaining assets of Banco de Crédito, which had been liquidated in February 2003. The government continues to intend to outsource the administration of the remaining assets of the other three liquidation funds. To that effect, several private entities have been prequalified to participate in a competitive bidding to administer these assets, with final selection scheduled for no later than end-February 2004 (a performance criterion).

13. The recommendations of the on-site Safeguards Assessment completed by the Fund in 2002 are being implemented. In particular, an external audit of the 2003 central bank accounts is under way, and the BCU has asked an external audit company for additional work on the FSBS audit completed last August. This supplemental audit, which will focus on use of FSBS funds by recipient banks, is to be completed by end-March 2004. In October 2003, Uruguay also ratified the International Convention for the Suppression of the Financing of Terrorism.

V. Structural Reforms and Data Provision

14. To foster the return to sustained economic growth, the government is deepening reforms aimed at encouraging investment, strengthening the role of the private sector, and furthering Uruguay’s integration into the world economy. Toward these ends, we are implementing the following measures:

  • The government will continue to promote a business climate that facilitates investment. Efforts to promote foreign direct investment will build on the successful award in August 2003 of the concession to operate the Montevideo airport. Negotiations on a bilateral investment treaty have been initiated with the United States. A two-year extension of fiscal incentives has been granted for investment projects that were delayed during the economic crisis in 2002.

  • Recently approved legislation, providing a legal framework for trust funds, will help foster the development of new instruments for corporate financing, including in the export sector. Equity investments in NBC are currently being solicited, including from the IFC and other international investors. The government also plans to present legislation to congress aimed at improving the efficiency and coverage of the existing unemployment insurance scheme.

  • A free trade agreement with Mexico has been signed, and further trade reform measures are being implemented, including reductions in tariffs on capital goods for equipment and telecommunications, information technology, and agricultural inputs from 6–9 percent to 2 percent, effective January 1, 2004 for a seven-year period. At the same time, the government will continue to phase out a number of specific import duties on textiles, foodstuffs, and chemical products.

  • The government is promoting Uruguay’s transformation into a regional distribution and logistics hub. Concessions have been awarded to the private sector to operate the Montevideo and Nueva Palmira ports, two new private ports are being developed, and a tender has been issued for the rehabilitation and maintenance of the public railroad network. In addition, more generous rules of origin that were recently approved by Mercosur will enhance activity in the sector of goods in transit.

15. The government will continue to work toward building consensus for adoption of tax and pension reforms during 2004, in advance of the 2005 budget. In late-June, the government submitted a revised tax reform proposal to congress, aimed at improving the efficiency of the tax system and strengthening tax collection through the elimination of several low yielding-taxes and the broadening of the VAT, excise, and corporate income tax bases. In 2003, congress approved the reform of the specialized pension fund for university professionals, and the government will continue to work actively toward securing congressional approval for the reform of the pension funds for the police, the military, and bank employees during 2004.

16. The process of subscription to the SDDS has been initiated, and data reporting and transparency will be improved. Monthly bank balance sheet data will continue to be published with a lag of no more than two months. Measures are also being taken to improve the timely provision and presentation of fiscal data for program monitoring purposes, including through improved coordination between data sources and the BCU and the allocation of more resources for data collection and analysis.

VI. Financing Assurances

17. The program remains fully financed. Residual financing needs for the near term have been addressed to a large extent by the debt exchange in May. The continued implementation of structural reforms is expected to ensure a significant flow of IFI disbursements, projected to amount to US$270 million in 2004, broadly in line with amortization. In addition, the government plan to use in 2004 part of a cushion built in 2003 with multilateral disbursements and the recent issuance of a US$200 million three-year, inflation-indexed, bond in the international market. Any remaining financing needs for 2004, which appear manageable (around US$200-300 million), are expected to be covered through placement of bills and bonds in the domestic and international markets.

ATTACHMENT II Technical Memorandum of Understanding

This memorandum presents the definitions of the variables included in the quantitative performance criteria and quantitative benchmarks annexed to the Memorandum of Economic and Financial Policies.

1. Cumulative primary balance of the combined public sector. The combined public sector comprises the central administration (including as defined in “Article 220” of the Constitution, Salto Grande, and the funds managed directly in the ministries (Fondos de Libre Disponibilidad), the social security system (Banco de Previsión Social, Caja Militar, and Caja Policial), the local governments (Intendencias), the public enterprises (ANCAP, ANTEL, UTE, OSE, AFE, ANP, INC, and ANCO), and the quasifiscal balance of the Central Bank (BCU). The public sector primary balance, excluding valuation adjustments, will be calculated as the overall balance measured from below the line minus interest payments measured from above the line.

  • The below the line overall balance will be measured on the basis of information provided by the BCU on: (i) the change in the nonfinancial public sector debt (defined below), including all short term debt, in foreign currency and pesos; (ii) change in net bank credit to the nonfinancial public sector in foreign currency and pesos; (iii) other nonbank financing including privatization; and (iv) the quasifiscal balance of the BCU (defined below).

  • The floor on the primary balance of the combined public sector will be adjusted downward (upward) by the amount by which the actual social security contributions to the private pension system exceeds (falls short of) the projected amounts in the program, specified in Schedule A.

Schedule A

(in millions of Uruguayan pesos; cumulative basis)

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2. Cumulative balance of the combined public sector (indicative target). The combined public sector balance is calculated as the sum of the primary balance of the combined public sector described in 1 and interest payments. Interest payments are defined to exclude commissions and fees. The floor on the balance of the combined public sector will be adjusted downward (upward) by the amount that the interest payments exceed (fall short of) the projected amounts in the program, specified in Schedule B for end-March, end-June, and end-September, and end-December.

Schedule B

(in millions of Uruguayan pesos; cumulative basis)

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3. The quasifiscal balance of the BCU is defined as interest earnings on gross international reserves, as defined below, and other earnings including those on other foreign and domestic assets minus operating expenses, commissions paid, and interest paid on domestic and foreign debt administered by the BCU.

4. Cumulative ceiling on general government expenditure applies to total (current and capital) noninterest expenditure of the central administration (includes Fondos de Libre Disponibilidad but excludes transfers to the social security system, automatic transfers to the private pension funds (AFAPs), and earmarked revenue) and the social security system (BPS).

5. Cumulative changes in net domestic assets (NDA) of the BCU is defined as the difference between end-of-period monetary base and net international reserves (NIR) of the BCU as defined in 6 and 7 below. The flow of NIR will be valued at the accounting exchange rate of Ur$31 pesos per US$1. The limit on the change in the NDA will be adjusted by the difference between actual program loan disbursements by the World Bank and IDB and scheduled loan disbursements as reflected in Schedule C:

  • The NDA ceiling at end-March, end-June, end-September, and end-December will be adjusted upward in the event of shortfalls compared with projected program loan disbursements, up to a limit of US$50 million.

  • The NDA ceiling will be adjusted downward in the event of excesses over projected program loan disbursements by their full amount.

Schedule C

(in millions of U.S. dollars; cumulative basis)

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6. Monetary base (indicative target) is defined as the sum of (i) currency issue; (ii) nonremunerated and remunerated peso sight deposits of BROU, BHU, private banks, and other institutions defined below at the BCU; and (iii) call deposits of BROU, BHU, private banks, and other institutions at the BCU. Other institutions include pension funds (AFAPs), local governments, public enterprises, trust funds of the liquidated banks (FRPB), investment funds, offshore institutions (IFEs), insurance companies, exchange houses, stock brokers, and the nonfinancial private sector. The monetary base excludes central government deposits held at BROU subject to a 100 percent reserve requirement. The indicative target is defined as the cumulative change calculated using the monthly averages relative to the base month average.

7. Cumulative changes in net international reserves (NIR) of the BCU. NIR is defined as the difference between the gross international reserves and BCU reserve liabilities. Gross international reserves include all foreign exchange assets that are in the direct effective control of the BCU and are readily available for such purposes of the BCU as intervention or direct financing of payment imbalances. Such assets may be in any of the following forms, provided that they meet the test of effective control and ready availability for use: currency, bank deposits in nonresident institutions and government securities and other bonds and notes issued by nonresidents (with a rating not below “A” in the classification of Fitch and IBCA and Standard and Poor’s or “A2” in the classification of Moody’s). In addition, holdings of SDRs or of monetary gold would be included under gross international reserves (provided they meet the test of effective control and ready availability of use) as would the reserve position in the IMF.

  • Excluded from gross international reserves are all foreign currency claims arising from off-balance sheet transactions (such as derivatives instruments), claims on residents, capital subscriptions to international financial institutions, any assets in nonconvertible currencies, claims on any nonresident Uruguay-owned institutions, or any amounts (in all components of assets, including gold) that have been pledged in a direct or contingent way.

  • Also excluded from gross international reserves are foreign exchange assets in the escrow account at the BCU created to provide backing to sight and savings deposits at the public banks and the closed domestic banks (the escrow account at the BCU). Funds not used to support banks will be invested in highly liquid and secure international assets to be reported daily to the IMF and will be subject to periodic special audits.

  • BCU reserve liabilities include all foreign currency-denominated liabilities of the BCU with original maturity of one year or less to residents and nonresidents, all certificates of deposit used to constitute reserve requirements against bank deposits, the use of Fund resources, any net position on foreign exchange derivatives with either residents or nonresidents undertaken directly by the BCU or by other financial institutions on behalf of the BCU.

  • For the purpose of the NIR calculation, (i) the gold holdings of the BCU will be valued at the accounting rate of US$42 per troy ounce; (ii) liabilities to the IMF will be valued at the rate of US$1.395 per SDR; (iii) gains or losses from gold swaps and other operations will be excluded; and (iv) non-U.S. dollar denominated foreign assets and liabilities will be converted into U.S. dollars at the market exchange rates of the respective currencies as of December 31, 2003.

8. The NIR floor will be adjusted by the difference between actual program loan disbursements by the World Bank and IDB, and scheduled loan disbursements by the World Bank and IDB as reflected in Schedule C, in the following manner:

  • The NIR floor at end-June, end-September, and end-December will be adjusted downward in the event of shortfalls compared with projected program loan disbursements, up to a limit of US$50 million.

  • The NIR floor will be adjusted upward in the event of excesses over projected program loan disbursements by their full amount.

9. The nonfinancial public sector gross debt refers to the outstanding stock of gross debt in domestic and foreign currency owed or guaranteed by the nonfinancial public sector, excluding the BCU.1 Debt in the form of leases will be calculated as the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair or maintenance of the property.2 The nonfinancial public sector debt ceiling will exclude the government guaranteed BHU note (estimated at US$610 million at end-December 2003) and the government guarantee covering notes issued by the fiduciary trust associated with the transfer of BROU’s NPLs (estimated at US$370 million at end-December 2003). It will include debt issued by the Megaconcesión that has a guarantee of the government.

10. The overall nonfinancial public sector debt ceiling will be adjusted upward (downward) by (i) the upward (downward) revisions made to the actual nonfinancial public sector gross debt stock at end-2003; (ii) the difference between the actual and projected amount of social security contributions that are transferred to private pension funds according to Schedule A, i.e., the debt ceiling will be adjusted upward (downward) by the amount that social security contributions exceed (fall short of) those specified in Schedule A; (iii) the difference between the actual and projected interest payments, specified in Schedule B for end-March, end-June, and end-September, and end-December, i.e. the debt ceiling would be adjusted upward (downward) by the amount that interest payments exceed (fall short of) those specified in Schedule B; (iv) the difference between actual and scheduled program disbursements by the World Bank and IDB as reflected in schedule C above, i.e. the debt ceiling will be adjusted upward (downward) by the amount that program loan disbursements exceed (fall short of) those in Schedule C, and any downward adjustment will be limited to US$50 million; (v) the amount of the government guarantee on the BHU note that is called in 2004, excluding the clearance of existing arrears of BHU to BROU, i.e., the debt ceiling will be adjusted upward by the amount of new debt issued by the government to cover its guarantee (principal plus interest) on the BHU note; and (vi) the amount of the government guarantee on the transfer of BROU’s NPLs to the fiduciary trust that is called in 2004, i.e., the debt ceiling will be adjusted upward by the amount of new debt issued by the government to cover its guarantee on the schedule of principal and interest payments owed by the trust to BROU; and (vii) the debt ceiling will be adjusted upward to reflect overperformance with respect to the targets on the BCU’s net international reserves up to a limit of US$250 million.

11. The data for assessing observance of the quantitative performance criterion on net international reserves will be provided by the BCU no later than one week after each test date. The data for the assessment of all other quantitative performance criteria and indicative targets will be provided by the BCU no later than two months after each test date.

APPENDIX II BROU: Financial Condition and Proposed Restructuring

Financial condition

1. The state bank BROU accounts for a substantial part of the Uruguayan banking system. The bank holds about 50 percent of deposits and 44 percent of all loans. As a result, its financial condition has significant implications for the soundness of the banking sector and the public’s confidence. In addition to its role as a commercial bank, BROU serves as the fiscal agent for the government and is a cornerstone of the payment system.

2. By any measure of bank soundness, BROU’s financial condition is poor. At end-September 2003, BROU suffered operating losses, had a nonperforming asset to total asset ratio of 33 percent, had capital barely above adequacy requirements, and faced potential liquidity problems. BROU has stock problems on both sides of the balance sheet, which are compounded by serious operating inefficiencies.

3. BROU has an excessive volume of NPLs and other nonperforming assets. Its lending to the private sector has been severely impacted by the economic downturn, the banking crisis and poor credit policies, resulting in an NPL ratio for its private sector loans of about 60 percent.

4. The second tranche of reprogrammed deposits will fall due during the second half of 2004.3 Although BROU built up liquidity during 2003, it would not suffice to cover all the deposits falling due during August 2004-July 2005. Furthermore, BROU will need to build up additional liquidity to meet the deposits falling due starting August 2005. In addition to the liquidity concerns, these reprogrammed deposits currently carry an interest rate of 6 percent, well above market rates and a significant drag on earnings.

5. BROU suffers from high operating costs that are due to excess personnel and branches. The bank estimates that the return on total assets for 2003 was negative by 1½ percent. The bank barely meets its capital adequacy requirements. Its year-end estimate of capital to total assets only reaches 4.4 percent, leaving little room for a resumption of lending.

Restructuring plan

6. The authorities have developed a restructuring plan to address the balance sheet problems of BROU and assure its viability. The plan addresses the poor quality of assets, the high costs and liquidity issues related to the reprogrammed deposits, and deficiencies in credit controls and monitoring. The plan also refocuses the business of the bank toward peso loans and deposits and seeks to reduce operating expenses.

7. The key elements of the restructuring plan are:

  • An asset management company has been established through the creation of a fiduciary trust, which although owned formally by BROU, will operate independently. The trust will issue notes to purchase NPLs from BROU at their net book value. It will operate for five years and will be required to recover the NPLs within four years to redeem the notes.

  • All nonperforming Category 4 and 5 loans will be removed from BROU’s balance sheet and replaced by an interest-earning note issued by the fiduciary trust and guaranteed by the government. This will help clean up the balance sheet and eliminate the negative impact on earnings stemming from the transferred assets.

  • The government has cleared the arrears on the BHU note and is committed to keep this note current. This will help BROU meet its upcoming obligations on the reprogrammed deposits and avoid the need for BROU to set aside provisions for the BHU note.

  • The interest rate on reprogrammed deposits will be reduced, and a program will be implemented to reduce noninterest expenses.

  • Improved credit review and control procedures will be introduced to reduce the rate of nonperformance on its loans.

  • BROU will focus new lending and deposit activities mainly in the peso market. Dollar-denominated loans will only be extended to clients with dollar earnings.

APPENDIX III Debt Sustainability Analysis

Background

1. Even after the comprehensive May 2003 debt exchange, Uruguay’s debt situation remains a source of vulnerability. At end-2003, Uruguay’s debt-to-GDP ratio was close to 100 percent of GDP, more than double its level at end-2001. This sharp increase reflected the large depreciation of the currency following the abandonment of the exchange rate peg in mid-2002, large disbursements from multilateral institutions in support to the banking system after the banking crisis, and financing associated with fiscal deficits.

2. The 2002 financial crisis as well as the debt exchange have led to important shifts in the composition of Uruguay’s debt. The financial support package provided by multilateral institutions significantly increased their share in Uruguay’s public debt stock. The successful debt exchange of May 2003 helped reduce the financing needs of the nonfinancial public sector and improve the debt-service profile over the medium term. During the first half of 2003, however, Uruguay’s limited access to international capital markets forced the government to increase its stock of short-term debt to finance its fiscal deficit, thus increasing vulnerabilities related to the public-debt maturity structure.

3. During the second half of 2003, the improvement in Uruguay’s overall macroeconomic situation, together with the success of the debt exchange and the authorities’ commitment to a tight fiscal position, have helped improve confidence in international markets. Spreads of Uruguayan bonds fell from a high of nearly 2,000 basis points in mid-2002 to around 600 basis points in early 2004. In late 2003, Uruguay successfully floated a US$200 million inflation-indexed, peso-denominated bond in the international market.

Cost of bank restructuring

4. The revised debt sustainability analysis (DSA) includes revised macroeconomic projections and assumptions regarding the cost of restructuring the public banks. The Uruguayan government is facing large contingent liabilities related to the cost of restructuring these banks, estimated at US$1.3 billion (about 10 percent of GDP, including interest).4 This debt reflects the government’s guarantees on: (i) a US$610 million BHU note to BROU; and (ii) an estimated US$400–570 million of BROU’s NPLs that are to be transferred to a fiduciary trust. The alternative set of projections assumes that these guarantees will be progressively called (mainly during 2005–09) over the medium term.

Medium-term assumptions

5. The medium term scenario is based on a steady recovery of real GDP and a moderate recovery of the peso against the U.S. dollar in real terms:

  • Economic growth is projected to recover to about 4–5 percent a year during 2004–06, and to average 2½–3 percent a year subsequently.

  • Over the medium term, the peso is projected to recover somewhat from its sharp depreciation in real terms against the U.S. dollar (26.8 percent in 2002 and 14 percent in 2003 on average), to about 75 percent of its 2001 level.

  • Average interest rate spreads are projected to decline from 1,400 basis points in 2002 to 500 basis points over the medium term.

6. The medium term scenario is based on fiscal consolidation and improvement in the external current account:

  • The primary surplus of the nonfinancial public sector is projected to rise from close to 3 percent in 2003 to 4 percent of GDP by 2007, and to remain at that level in subsequent years. Over the medium term, the primary surplus would average 3.4 percent of GDP, representing a significant shift from a deficit of 0.2 percent of GDP on average over the past decade.

  • Mirroring this adjustment, the non-interest external current account surplus is projected to improve from 0.2 percent of GDP on average over the past decade to roughly 4 percent of GDP on average over the medium term.

Medium-term outlook and DSA

7. The staff has constructed two scenarios, taking into account the possible impact of bank restructuring (Figure 1). The first scenario assumes that the government guarantees are called in full, and this scenario therefore includes the entire gross bank restructuring costs. The second scenario assumes that the BHU and the fiduciary trust generate enough internal resources to avoid recourse to the government guarantees. In Attached Tables 1 and 2, the costs of bank restructuring for the fiscal accounts are included in the line “augmented public sector deficit” as expenditure, while bank asset recovery is treated as revenue.

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.
Table 1.

Uruguay: Medium-term Nonfinancial Public Sector Debt Dynamics

(Includes costs of bank restructuring)

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Sources: Uruguayan authorities and Fund staff estimates.

Nonfinancial public sector.

Table 2.

Uruguay: Medium-term External Debt Dynamics

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Sources: Uruguayan authorities and Fund staff estimates.

8. The projections show that, if the government guarantees were called in full, the debt-to-GDP ratio would reach 83 percent by 2006, 74 percent by 2008, and 66 percent by 2012 (Table 1 and Attached Table 1). This 2012 figure compares with 60 percent in the scenario where the restructuring costs are excluded (Attached Table 2), and 57 percent in the previous staff report, in which the cost of bank restructuring had not been factored in (Country Report No. 03/247). The scenarios assume continued access to IFI financing over the medium term, and a gradual return to international capital markets. The projections do not include any additional Fund support beyond the current arrangement.5 The resulting financing gaps—emerging in 2005—will require additional market and IFI financing, possibly including from Fund.

9. Even with the tight fiscal conditions, the debt stock will remain high over the medium term. Thus, it will be critical to avoid increasing the debt stock through a combination of: (i) achieving and, if possible, exceeding the primary surplus targets in the program; (ii) comprehensive restructuring of BHU to ensure that it can service its debts to BROU on time; and (iii) strong asset recovery by the financial trust administering BROU’s NPLs.

10. On the external side, the debt dynamics improve somewhat more rapidly, mainly due to the fact that the costs of the bank restructuring only affect the public debt. The presence of small current account surpluses, along with assumed moderate appreciation of the peso over the medium term, result in a decline of the external debt-to-GDP ratio (including private sector debt) from 96 percent in 2003 to 60 percent by 2008 (Figure 2).

Figure 2.
Figure 2.

Uruguay: Projected Debt Dynamics, 2003-08

(In percent of GDP)

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

Sources: Uruguayan authorities and Fund staff estimates.

Sensitivity analysis

11. As experienced in the 2002 financial crisis, Uruguay’s debt stock is highly exposed to changes in macroeconomic variables. In case of a serious shock, it is likely that most variables would deteriorate at the same time, potentially leading to a prolonged period of sluggish growth and a high interest rate environment. Alternative scenarios examine the implications of holding key variables at their historical averages,6 as well shocks to these key variables.

  • An alternative scenario for public debt which keeps the primary surplus at 2.5 percent of GDP—slightly lower than that in 2003—would lead to only a small reduction in the public debt-to-GDP ratio from 98 percent in 2003 to 90 percent in 2008 (Figure 3).

  • An alternative scenario for external debt, with key variables at their historical averages, results in a sharply worsened path for the external debt-to-GDP ratio, reaching 102 percent by 2008 (Figure 3).

  • Most sensitivity tests for public debt indicate that shocks to key variables would lead to increases in the public debt-to-GDP ratio over the next 2-3 years, followed by renewed declines thereafter (Figure 4). However, a two standard deviation shock to GDP growth7 would lead to a sharp increase in this ratio, to 126 percent in 2008. The impact of this shock is particularly severe for Uruguay’s debt profile for two reasons: (i) the V-shaped recovery assumes relatively strong GDP growth in 2004 and 2005, which means that the shock eliminates the years with the best growth performance; and (ii) the primary balance also deteriorates in this scenario since expenditure is kept constant in peso terms, thus worsening in percent of GDP, and revenue is kept constant in percent of GDP. Keeping the primary surplus unchanged in this scenario would result in a somewhat lower path, with the debt-to-GDP ratio reaching 112 percent in 2005, before falling to 96 percent in 2008.

  • The sensitivity tests for external debt also indicate significant vulnerabilities, although they do not show explosive paths. The external debt-to-GDP ratio would reach 85 in 2008 percent in the case of a shock to the U.S. dollar GDP deflator, and to 95 percent in 2008 if a combined shock were to occur (Figure 4).

Figure 3.
Figure 3.

Uruguay: Alternative Scenarios, 2003-08

(In percent of GDP)

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

Source: Uruguayan authorities and Fund staff estimates.
Figure 4.
Figure 4.

Uruguay: Selected Sensitivity Tests, 2003-08

(In percent of GDP)

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

Sources: Uruguayan authorities and Fund staff estimates.

12. Some of the stress tests appear inappropriately pessimistic in light of the fact that Uruguay is just emerging from a crisis. In 2002, Uruguay already experienced severe shocks, with a drop in real GDP of close to 11 percent, a sharp depreciation of the Uruguayan peso, and significant increases in nominal interest rates on the public debt. Thus, a repeat of such major shocks would appear rather unlikely, particularly for the exchange rate and U.S. dollar deflator shocks. Overall, the implementation of strong policies should reduce the country’s vulnerability over the medium term.

Financing needs

13. Uruguay will continue to face large financing needs in the medium term. As the return to international markets is expected to be gradual, Uruguay will continue to have to rely on short-term and multilateral financing, including from the Fund, over the medium term. Although the financing gaps projected in the central scenario are large, they should be manageable with continued support from the international community.

Concluding remarks

14. The Uruguayan economy faced a severe shock in 2002 which more than doubled its public and external debt-to-GDP ratios. As a result, strong policy performance over the medium term is needed to ensure that these ratios decline gradually to sustainable levels. To this effect, the Uruguayan authorities have committed to pursuing a primary surplus of about 3.5 percent of GDP, on average, over the medium term. This is in addition to the achievement of a nonfinancial public sector primary surplus of 2.9 percent of GDP in 2003, broadly in line with the program. Economic growth has resumed and is expected to be strong in 2004, but laying the foundation for solid growth over the medium term will require the continued pursuit of structural reforms, particularly in the banking area. On this basis, Uruguay’s debt dynamics would improve over the medium term although the projections are sensitive to renewed shocks, especially to growth, the exchange rate, and the fiscal accounts.

Table 1.

Uruguay: Public Sector Debt Sustainability.

(Includes Costs of Bank Restructuring)

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

Government guarantees on payments to BROU by BHU and AMC, assumed to be invoked fully.

Includes release of principal and cash payments in debt exchange.

Includes government guarantees to BROU (footnote 1), paid out as bonds, amounts as in line “bank assistance”.

Table 2.

Uruguay: Public Sector Debt Sustainability.

(Excludes Costs of Bank Restructuring)

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

Government guarantees on payments to BROU by BHU and AMC, assumed to be invoked fully.

Includes release of principal and cash payments in debt exchange.

Table 3.

Uruguay: Public Sector Debt Sustainability Framework, 1998-2008

(In percent of GDP, unless otherwise indicated)

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Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used.

Derived as [(r - π(1+g) - g + αε(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; α = share of foreign-currency denominated debt; and ε = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).

The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1+g) and the real growth contribution as -g.

The exchange rate contribution is derived from the numerator in footnote 2/ as αε (1+r).

For projections, this line includes exchange rate changes.

Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period.

The year 2002 is excluded from this calculation.

Derived as nominal interest expenditure divided by previous period debt stock.

Real depreciation is defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator).

Assumes that key variables (real GDP growth, real interest rate, and primary balance) remain at the level in percent of GDP/growth rate of the last projection year.

Table 4.

Country: External Debt Sustainability Framework, 1998-2008

(In percent of GDP, unless otherwise indicated)

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Derived as [r - g - ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock, with r = nominal effective interest rate on external debt;ρ = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-ρ(1+g) + εα(1+r)]/(1+g+ρ+gρ) times previous period debt stock. ρ increases with an appreciating domestic currency (ε > 0) and rising inflation (based on GDP deflator).

For projection, line includes price and exchange rate changes

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The year 2002 is excluded from this calculation.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

APPENDIX IV Uruguay-Fund Relations

(As of December 30, 2003)

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

A. 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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B. Nonfinancial Relations

VII. Safeguards Assessment: An on-site assessment of the BCU was conducted in July 2002, and the final safeguards assessment report was approved by management in January 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, the hiring of a private audit firm with international affiliation to perform a financial audit of the BCU, and the establishment of similar external audit procedures for the FSBS. The authorities are committed to the implementation of all the safeguards recommendations, including an external audit of the FSBS which was completed on September 30, 2003. A supplementary external audit of the FSBS will be completed by March 31, 2004; and an external audit of the BCU’s 2003 accounts by June 30, 2004.

VIII. Exchange Rate Arrangement: The currency is the Uruguayan peso (Ur$). Uruguay has followed an independently floating exchange rate regime since July 29, 2002. On December 31, 2003, buying and selling interbank rates for the U.S. dollar, the intervention currency, were Ur$30.28 and Ur$30.33, respectively. Uruguay’s exchange system is mostly free of restrictions on payments and transfers for current international transactions. However, the reprogramming 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 it is temporary and does not discriminate among Fund members.

IX. Article IV Consultation: The 2003 Article IV consultation was concluded by the Executive Board on July 11 (Country Report No. 03/247). Uruguay is on the standard consultation cycle approved on July 15, 2002.

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 FSAP exercise started in November 2001; its completion has been delayed until the situation stabilizes.

  • XI. Technical Assistance: Technical assistance in tax policy and tax administration was provided by FAD in May and July 2003. In April 2003, STA provided technical assistance on adequate recording of loans funded by the FSBS. MFD has been providing substantial technical assistance since 2002 in the resolution of intervened banks and the restructuring of the public bank BROU.

XII. Resident Representative: Mr. Andreas Bauer

APPENDIX V Relations with the World Bank Group

The Board considered the last Country Assistance Strategy (CAS) on May 5, 2000 and the CAS Progress Report on July 25, 2002. The Bank increased its financial support, shifting to a high case plus lending scenario ($550 million for fiscal years 2003–04) concentrated in adjustment lending. A Structural Adjustment Loan and a Special Structural Adjustment Loan were approved, totaling US$303 million, to assist Uruguay in addressing structural weaknesses and in managing the economic crisis. On April 8, 2003, another package of Structural Adjustment and Special Structural Adjustment Loans totaling US$252.5 million was approved, focusing on improving public services. Second tranche releases for these operations are still pending. New investment operations have been postponed until FY05.

The investment portfolio comprises eight projects totaling US$382 million in commitments, concentrated in the infrastructure sector (76.7 percent). The level of project execution has deteriorated as a result of the crisis, mostly because of budgetary restrictions. The latest Portfolio Review (July 2003) also pointed to the need to streamline procurement processes.

Financial Relations with the World Bank Group

(As of October 31, 2003; in millions of U.S. dollars)

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Source: World Bank.

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: (i) enhancing the regional and international competitiveness of domestic output and encouraging private investment, in order to foster healthy competition and allow for integration with both the regional and international markets; (ii) deepening the reform of the State, with a view to rationalizing expenditure, targeting interventions, and reducing 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.

As of January 5, 2004 the Bank’s active portfolio in Uruguay included 20 loans for the financing of investment projects; one sector loan, for Strengthening the Banking Sector; and 30-nonreimbursable technical cooperation operations for US$17 million. The lending portfolio amounts to US$1,162 million, of which US$499 million are pending disbursement. The IDB’s tentative lending program for 2004 includes financing for a Program to Support Employment Generation for US$80 million; a Highway Infrastructure Program for US$70 million; a Cattle Development Program for US$25 million; and a loan by the Department of the Private Sector under the Trade Financing Facility (ABN-AMRO) for US$12.5 million.

Financial Relations with the Inter-American Development Bank

(As of November 30, 2003; in millions of U.S. dollars)

Total outstanding loans: US$2,131.9

Loan transactions:

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Source: Inter-American Development Bank.

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.

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 International Financial Statistics (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, complete 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 fifth edition of the Balance of Payments Manual (BPM5). 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) for publication in the IFS and the Balance of Payments Statistics Yearbook. The new surveys would also allow for improved coverage of the private sector in the IIP.

In October 2003, Uruguay disseminated the international reserves and foreign currency liquidity data template on the Central Bank’s website for the first time. Monthly information on the data template is currently available for August-November 2003.

URUGUAY: Core Statistical Indicators

(as of February 3, 2004)

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1

The last staff report (Country Report No. 03/247) noted (paragraph 27) that BROU’s restructuring would be a major focus of the present (fourth) review.

2

Category 4 NPLs are loans overdue by 150–240 days; and Category 5 NPLs, by more than 240 days.

3

During 2003, these tariffs were increased significantly on average by: 39 percent for petroleum products, 14 percent for telephone, 18½ percent for electricity, and 20 percent for water.

4

The proposed extensions would cover the repurchase expectations of SDR 18.8 million arising on June 25, September 27, and December 27; SDR 15.3 million arising on July 2 and October 1; SDR 32.2 million arising on September 27 and December 27; and SDR 75.4 million arising on November 8. Extension of these repurchase expectations is consistent with the policies established by the Board regarding such extensions.

1

The term “debt” has the meaning set forth in point No. 9 of the Fund’s Guidelines on Performance Criteria with Respect to Foreign Debt (Decision No. 6230-(79/140, August 3, 1979), as amended).

2

The suppliers’ contracts of ANTEL with equipment providers Ericsson and NEC, which predate the Fund’s consideration of lease contracts for programming purposes, are expensed under goods and services as rental outlays and, therefore, excluded from the definition of nonfinancial public sector gross debt for program purposes.

3

Assuming timely servicing of the BHU note, projections indicate that BROU would have sufficient liquidity to cover about two-thirds of these deposits falling due.

4

The estimated cost of US$1.3 billion reflects principal and interest payments associated with the government guarantees on the BHU note and BROU’s NPLs.

5

The projections presented in Country Report No. 03/247 had explicitly assumed Fund financial support to Uruguay—on a gradually declining scale—in years following the end of the current arrangement, subject to the normal applicable requirements for Fund support, including a satisfactory policy stance (Paragraph 22 of Country Report No. 03/247, Supplement 1).

6

Historical averages do not include the year 2002 (the crisis year).

7

GDP at its historical average minus two standard deviations in 2004 and 2005 and the primary balance worsens over time as a result of the lower GDP.

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Cover IMF Staff Country Reports
Uruguay: 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
Author:
International Monetary Fund
Volume/Issue:
Volume 2004: Issue 172
Publisher:
International Monetary Fund
ISBN:
9781451839234
ISSN:
1934-7685
Pages:
84
DOI:
https://doi.org/10.5089/9781451839234.002
Figure 1.

Uruguay: Public Debt, 2001-12

(In percent of GDP)
Figure 2.

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

(In percent of GDP)
Figure 1.

Uruguay: Activity and Prices
Figure 2.

Uruguay: External Sector Indicators
Figure 3.

Uruguay: Financial Indicators
Figure 4.

Uruguay: Fiscal and Monetary Indicators
Figure 1.

Uruguay: Public Debt, 2001-12

(In percent of GDP)
Figure 2.

Uruguay: Projected Debt Dynamics, 2003-08

(In percent of GDP)
Figure 3.

Uruguay: Alternative Scenarios, 2003-08

(In percent of GDP)
Figure 4.

Uruguay: Selected Sensitivity Tests, 2003-08

(In percent of GDP)