This paper examines Uruguay’s Sixth Review Under the Stand-By Arrangement and Requests for Modification of the Arrangement. The macroeconomic framework is on track, but progress with structural reform remains uneven. Fiscal performance has been better than programmed, reflecting buoyant revenues. The monetary and balance-of-payments targets of the program are being met as well. GDP growth is now forecast at 11 percent in 2004. The restructuring of the public banks and disposal of assets in the bank liquidation funds are moving forward.
1. The Uruguayan economy has continued to show a strong performance, resulting from effective macroeconomic policies and several structural reforms. Distant from previous projections (5 percent in early 2004, and 7 percent in the revised projection presented in August), real GDP will grow slightly more than 11 percent by end year, supported by a significant boost in exports, private investment, and consumption. This has been achieved in a relatively negative external environment that has resulted especially from a very negative impact of the huge rise of oil prices and shortfalls in backup energy supplies that largely more than offset the increase of Uruguay’s export commodity prices.
2. The latest data presents a substantial rise of exports (32 percent) in the January- August 2004 period (compared to the same period last year), and an increasing trend, with August’s exports growing at an even higher rate. In the last two years, exports have risen 55 percent in dollar, 36 percent in volume terms, with an increasingly market diversification. Meanwhile, as shown in the staff report, investment contribution to growth has gone from the 0.8 percent projected in August to 2.9 percent, which, among other aspects, mirrors the significant investment established by many small and medium-size companies. Furthermore, several large-scale investment projects are being planned for the next years. These developments have led to increase consumer confidence, which has substantially contributed to boost private consumption, all of which show a broad-based recovery.
3. The electoral period and the transition so far have not resulted in reversals over the positive trends that the financial indicators have shown this year. Among other positive signs, sovereign spreads have been under 430 basis points (nearly 200 bps below those of November 2003), while Moody’s recently raised its sovereign ratings outlook from negative to stable, which added to the upgrade of Uruguay’s foreign currency debt rating given by other two international credit-rating companies.
Macroeconomic Policies and Structural Reforms
4. We have heard and noted many times at the IMF Board that a country’s structural reform process should be assessed with due consideration to its social and political constraints, and the particular circumstances of the country. In this regard, we would like to note that whereas the authorities have done their best to finish some reforms, including the ones at revenue administration, tax system and the specialized pension funds, this has not been possible due to the particular and complex constraints imposed by the deep social and economic crisis that followed the collapse of Argentina’s economy in 2001. In this regard, the crisis was considered by the government as a real window of opportunity to undertake critical and most urgent reforms. Beyond the well-known reforms on the public banks, significant structural reforms have been implemented in many areas over the last two years. These include the opening-up of activities to competition, seaport policies, concessions of basic infrastructure to the private sector, a further reduction of trade barriers this year, etc, which have been crucial in overcoming the crisis and diminishing obstacles for future growth. In other cases, as it occurred during the nineties, most of the Uruguayan population voted against some reforms promoted by the government (i.e. the recent approval of a constitutional amendment related to concessions to water and sanitation private industries).
5. Prudent management of fiscal accounts, which establishes a very good precedent in an electoral year, constitutes a key element for attaining a smooth transition. In this regard, according to the authorities’ projections, the primary surplus would end this year at 3.9 percent of GDP, 0.5 percent above the authorities’ target. While the economic recovery has led to a strong revenue performance, expenditure remained under strict control, which is reflected in the noninterest expenditure figure of 24.7 percent of GDP that is seven and a half percentage points below the one in 2001. These fiscal improvements contribute to a significant reduction of the nonfinancial public sector debt—included the Central Bank’s obligations to the IMF—relative to GDP, expected to decline from 105.3 percent in 2003 to 91.7 percent by the end 2004, which, under cautious assumptions, would continue decreasing to below 50 percent by 2012, according to the updated Public Debt Sustainability, published in the current Staff Report. Moreover, financing needs are already covered through June 2005.
6. For the first time since it was implemented, the BCU’s monthly survey shows inflation expectations below 10 percent for 12-month inflation through October 2005. Although decreasing, these expectations are somewhat above the Central Bank’s target range for September 2005 of 6–8 percent, thus the authorities have continued with a cautious stance on monetary policy. At the same time, the authorities have continued making efforts to improve the maturity profile of short-term debt. Meanwhile, the authorities have contracted a recognized international consulting firm for advice on institutional matters, such as the organizational design for a central bank that carries out an active monetary policy, the roles of financial supervision entities, and the functioning of bank depositors’ protection, including a deposit insurance scheme. The results of these assessments could prompt institutional improvements that, on top of the intrinsic benefits entailed in potential reforms could facilitate, over the medium-term, the reduction of the level of dollarization.
7. Regarding the BCU’s involvement in promoting a market in forward foreign exchange, the authorities consider that this could be an important mechanism to reduce some uncertainties of private sector companies. Whereas the authorities do not believe that the BCU should continue with this mechanism once the private market for it is developed, they think that the institution has an important role as a market maker to spur this kind of market and to encourage investor education.
8. The restructuring of BROU is presenting significant progress. Profits continue to exceed the business plan and operational costs are lower than programmed. For instance, of the 108 BROU’s branches, only five – all of them of a small size – are now presenting operating losses. Furthermore, while client evaluation and monitoring have been improved, NPL ratio has decreased sharply. This enhanced situation, particularly in liquidity terms, led BROU’s authorities to start unfreezing the third (and last) tranche of reprogrammed deposits, which has been handled with caution. This decision will allow the Bank to eliminate the interest payments for these deposits, which currently are serviced at an interest rate above that of the market. Moreover, the remaining nonperforming loans will be transferred to the BROU’s asset management company, as scheduled. With regard to BHU, the transformation to a nonbank mortgage institution establishes a milestone, considering that it has frequently been an important source of perverse incentives through amnesties to debtors and, thus, socialization of private losses. Beyond these critical advances, the authorities are fully aware that more efforts are needed to strengthen the institution’s fundamentals.
9. Following firm decisions made by the authorities to start the bank resolution process of the liquidation funds, all of the assets of these funds were transferred to the private company recently contracted to manage the assets. At the same time, the authorities have continued taking the needed actions to minimize governance risks, even though they have had to deal with substantial obstacles in this area.
10. In conclusion, the prudent macroeconomic policies in place and the expectations that there will be broad continuity in these policies within an orderly democratic transition of the administration are allowing Uruguay to enjoy a positive evaluation by markets, as proved by the continued decline in sovereign spreads. Furthermore, the authorities have been in close contact with those who have been designated by the incoming government to provide them all of the needed information and analysis. Moreover, the authorities will make repurchases to the Fund on an expectation basis through end-May 2005, which will allow the country to have a more balanced repayment schedule. Since, as noted in the staff report, gross reserves need to be bolstered further, and capacity to repay the Fund on expectation basis in 2005 is limited, the authorities are requesting the conversion of the remaining repurchase expectations in 2005 to an obligations basis, which will facilitate Uruguay in having a smooth political transition.