This paper presents an Ex Post Assessment of Longer-Term Program Engagement for Uruguay. Uruguay has had a series of Stand-By Arrangements that were treated mostly as precautionary between March 1996 and early 2002. These were viewed as a helpful seal of approval, and a vehicle for intensive IMF monitoring. The authorities undertook significant reforms during this period—notably a pension reform, a reduction in public employment, and a lengthening of wage indexation lags. However, other reforms were either not undertaken or completed with a delay.
March 18, 2005
1. On behalf of the Uruguayan authorities, we would like to thank the Executive Directors, Management and the staff for their valuable assistance and support during a very difficult period. We also thank the staff for a well-written Ex-Post Assessment (EPA) report that presents a good perspective of the last 10 years and, especially, of the future challenges that Uruguay will face. The authorities believe that this report could be useful to draw helpful lessons for the country and also for the Fund’s future policies and actions.
2. Before going into the staff EPA report, the Uruguayan authorities would like to reiterate their strong commitment to macroeconomic stability as the necessary condition to achieve a higher and sustainable growth, enhance the level and quality of employment, decisively mitigate poverty conditions, and boost social equity. In that vein, the authorities will promote a significant improvement in the investment climate so as to significantly increase investment rate. In this regard, the new government is fully committed to implement an ambitious agenda of structural reforms that allows the country to have stronger institutions that provide proper incentives for social and economic development.
Policies and Reforms
3. One of the most controversial issues in Uruguay’s last decade has been the exchange rate system. Clearly, as noted by the staff, the exact rationale for the move to an exchange rate float–and especially its timeliness in the middle of a huge deposit run- does not seem to have been fully explained in subsequent reports. Looking back, it seems to be clear that the crawling band rate system was a pillar in the strategy to gradually reduce inflation. On the other hand, as pointed out in the staff report, “while the estimates support the view that the real effective exchange rate (REER) became gradually more overvalued in the 1990s, the depreciations of the Brazilian real in 1999 and the Argentine peso had a marked impact”. In this respect, we note that just a few months before the real’s sharp depreciation, it was noted in the staff report (EBS/98/128) that “the authorities and the staff agreed that the policy of gradually lowering the rate of adjustment in the exchange rate band in line with targeted inflation was working well, and market analysts had welcomed the narrowing of the band as a further sign of the government’s commitment to bring inflation down.” Meanwhile, the exchange rate system contributed to deepen financial dollarization; dollar deposits in the banking system rose from 80 percent in 1990 to 92 percent in 2002, while dollar credits increased from 58 percent to 83 percent in the same period. For instance, it established a substantial impediment for the Central Bank to act as a lender of last resort during the 2002 crisis.
4. As noted, beyond some positive developments, financial dollarization remains as one of the main vulnerabilities of the system. Clearly, dollarization involves cultural issues and, in order to diminish this vulnerability, it will be necessary not only to continue prudent monetary policies in a context of an appropriate exchange rate flexibility–progressing toward an inflation targeting system-, but also to further strengthen institutions in the monetary area and bank supervision. In that vein, the Superintendency of Banks will remain dealing with only in regards to technical aspects. Moreover, we feel that the comments made in paragraph 57 of the staff report suggesting the central bank’s ability to supervise the banking sector has been “somewhat strengthened” are not fair enough since they fail to reflect the critical changes undertaken in the last two years in this entity. While the bank supervisory is being strengthened, prudential rules will be reinforced to diminish an exposure to exchange rate risk due to loans in dollar made to the non-tradable sector. At the same time, the authorities will attempt as soon as possible to take advantage of the current external situation to further increase the Central Bank’s reserve position.
5. Evidently, the 2002 crisis was triggered by severe external shocks that substantially affected many areas of the country. Nonetheless, the observations made in Box 1 of the staff report that are in general shared by the authorities show that there were many considerable internal problems and vulnerabilities, particularly in the banking sector, which amplified the effects of the crisis. It is clear that after 2002, many vulnerabilities of the financial system have been substantially mitigated. For instance, the restructuring of the Banco de la República Oriental del Uruguay (BROU) has advanced well, its asset management company has made good progress to recover the nonperforming loan portfolio, and the liquidation funds have shown considerable advances. Beyond the critical improvements, the authorities are well aware that many vulnerabilities remain, which require further substantial efforts in strengthening regulation and supervision of the financial system in general, and improving governance structure, risk management and credit policies, among other things, in the public banks.
6. The debt-exchange operation–which implied a net present value haircut of 20-30 percent discounted at 16 percent- was a milestone that dissipated substantial uncertainties and significantly contributed to overcome the financial crisis. For instance, in August 2002, the staff report (EBS/02/141) presented a debt-sustainability assessment (Table 4) in which the assumptions were a nominal exchange rate depreciation of 99 percent in 2002, 62 percent in 2003, 12 percent in 2004, and a country risk above 1,000 basis points between 2002 and 2005, and 700 basis point until 2012. Needless to say, today’s situation and forecast are very different. Independent from the results, the authorities are committed to fulfill Uruguay’s obligations and, more generally, to fully respect the rule of law, as has been Uruguay’s tradition.
7. Notwithstanding its substantial reduction, the level of the debt to GDP ratio remains high, being a significant source of vulnerability. In that vein, ensuring sustainable debt over the medium-term is in the first order of priority for the government. Clearly, the path of the debt to GDP ratio depends on many developments–many of them from abroad- and interrelated variables, such as the conditions to access to international financial markets, and the real exchange rate–as noted by the staff, the main vulnerability with respect to the debt is related to its large foreign currency share. Likewise, the authorities would like to emphasize the utmost importance of the GDP growth to ensure debt sustainability, together with a primary surplus consistent with that objective.
8. In the same manner as in the August 2002 staff report (EBS/02/141) -and others as well-, which recalled that the average primary surplus in the period 1990-2001 was 0.3 percent of GDP, and the historical maximum had been 2.8 percent of GDP, the EPA paper noted that primary fiscal surpluses around 4 percent are unprecedented in Uruguay’s own history, and have rarely been maintained in other countries for longer than a few years. In that August 2002 report the staff warned that “a necessary condition for stabilizing the debt ratio in the medium term is the maintenance of very large primary surpluses of about 4.5 percent of GDP”. Even with that 4.5 percent of GDP, according to the DSA presented in August 2002, the debt to GDP ratio would have been 75 percent by 2012. Thus, whereas the Debt Sustainability Analysis is a very helpful instrument, it is worth taking into account that there are many variables playing, and so there are no fixed “magical” numbers. Moreover, each country has its own history and conditions that must be considered. As stressed in the Fund paper on Sustainability Assessments (SM/03/206), “sustainability analysis needs to place the debt dynamics implied by the framework in the particular context of the country. Some of the relevant factors relate to the country: its vulnerability to shocks, its macroeconomic management, and any prior history of debt defaults or crises”. Beyond those precisions, the authorities would like to emphasize their firm conviction that fiscal discipline is key in maintaining macroeconomic stability, and thus a necessary condition to attract investment, reduce unemployment, and mitigate poverty conditions.
9. Boosting investment and higher growth rates may not be sufficient to alleviate the most extreme poverty conditions. As pointed out in the staff report, the costs of the crisis have been major, having especially severe consequences for the lowest income brackets, with poverty rates almost doubling between 2000 and late 2002. Given this ethic need, the government is going to assist the most vulnerable sectors of the population by implementing a social emergency plan, basically aimed at providing these sectors with a higher quantity and better quality of education and health. This will be carried out in a transparent manner and taking serious consideration of providing appropriate incentives. Improving the quality of life and perspectives for social insertion of the poor will be necessary to build ownership for the pending structural reforms.
10. At the same time, the authorities will aim to reorient expenditures and to improve targeting. They agree on the need to introduce adequate improvements to the budgetary process and, in this regard, assistance from Fund’s staff will be welcome. In the revenue area, figures and comments shown in Box 2 of the staff report are eloquent to conclude the necessity of reforming the revenue administration in order to efficiently achieve the objectives of a comprehensive tax reform. This reform will be gradually undertaken in order not to affect the revenue performance, while it will be strongly oriented by efficiency as well as vertical and horizontal equity considerations.
11. The authorities firmly believe that it is necessary to increase the role of the private sector to have a sustainable and higher economic growth. They consider that public’s reluctance to some initiatives that, for instance, proposed a greater involvement of private sector in activities traditionally carried out by the public sector could be significantly diminished by improving transparency and establishing more efficient regulations that, for instance, can promote more and better competition. Meanwhile, Uruguay’s strong commitment to the Mercosur is fully compatible with the authorities’ intention to continue diversifying the country’s external markets as well as its export base as an essential way to reduce Uruguay’s vulnerability to external shocks.
12. Regarding the IMF’s engagement in Uruguay, as noted above, it has been critical to overcome the severe crisis. However, in hindsight, this engagement has been far from perfect, to large extent due to lacks -or absence- in the Fund’s facilities. For instance, the staff posed an interesting question on whether a somewhat larger package early on could have prevented panic among residents, who had not yet started withdrawing massively their deposits. The staff also rightly noted that standard IMF programs do not make sufficient funds available upfront and they make funds available even after the crisis may have subsided. Indeed, the holiday bank could be lifted only after a bridge loan provided by the U.S. government. Otherwise, the Fund’s procedures for a new augmentation could have come when the crisis would have reached a dead end. Furthermore, as our Chair has stressed in many opportunities, there is a clear need to have a facility like the former Contingent Credit Lines (CCL), which had not been used not because it was not a very useful instrument, but because of significant deficiencies in its design.
13. Finally, there is no doubt about the need that Uruguay has for a successor Fund’s supported program, while regaining access to the external financial markets. The Uruguayan authorities would like to emphasize that they firmly believe in the need for macroeconomic stability and structural reforms and the benefits they provide; thus they will have a full ownership of its program. They hope to have a close and fruitful cooperation with the Fund.