The Uruguayan authorities’ goals

1. During 2005, Uruguay has been growing robustly, in a context of the lowest inflation rate in about six years, fiscal performance in line with the program’s targets, and improving market conditions reflected in decreasing sovereign spreads. Under this scenario, the Uruguayan authorities are addressing the country’s many substantial challenges. In particular, Uruguay’s potential growth needs to be impelled. To do this, domestic and foreign investment must be encouraged by further improving the business environment which, given Uruguay’s democratic tradition, requires respecting people’s entitlement to participate in the country’s growth by enhancing the level and quality of employment. Hence, in Uruguay, sustainable economic growth and improvements in human development go hand-in-hand.

Macrostability as a necessary condition for meeting the authorities’ goals

2. Uruguay’s satisfactory economic performance during 2005 is noticeable in many areas. In the first half of the year, economic activity increased at about 7 percent, led by exports, which, at the same time increased by 18 percent (compared to the same period last year) in real terms. Moreover, export diversification continues, with a higher participation of NAFTA countries (29 percent of the total exports in the last twelve months to June), while exports to Mercosur and Europe represent other important parts of Uruguay’ external sales (23 percent and 20 percent, respectively). This increasing diversification makes the country more resilient to external shocks. Meanwhile, imports have also been rising at high rates (15 percent in real terms in the first half of the year compared to the same period last year), with a prominent surge in capital good imports.

3. Fiscal discipline is essential to achieve the authorities’ objectives. As noted in the staff report, the fiscal program is on track. Meanwhile, the revenue collecting agencies (DGI, DNA, and BPS) have been showing a significant increase in their revenue collection over the year, and, in this month the government decreed gas price increases in order to be more in line with cost developments. Furthermore, critical fiscal reforms are already being introduced, while others will be implemented as scheduled. All of these measures and reforms will allow the government to achieve the medium-term primary surplus target of 4 percent of GDP by 2007 and a downward trend in the overall fiscal deficit. Both achievements will result in a substantial reduction in debt-to-GDP ratio. It is important to note that the authorities have already obtained part of the 2006 external financing needs. Meanwhile, they are undertaking the needed steps, including the Fund’s advice, to create a debt-management unit within the Ministry of Finance.

4. By the end of August, our authorities submitted to Congress a five-year spending plan, complemented with revenue projections. This plan, beyond reflecting the government’s priorities, has been oriented by four criteria. First, fiscal responsibility and, in this regard, it is worthy to note that the budget is fully consistent with primary fiscal surplus and overall fiscal targets. Second, the plan aims at improving the administration’s performance by starting to link efficiency with remuneration, as is the case of DGI officials (the national tax collection agency). The third criterion attempts to encourage a more efficient use of the resources in the administration¹, while the fourth aims at improving transparency, both in terms of tax revenue sources and use of public moneys.²

5. As underscored by the staff, annual inflation has been below the Central Bank’s target range. Whereas maintaining the current framework of monetary indicative targets in a context of a flexible exchange rate, the authorities are preparing a legislation to bolster BCU independence and to improve institutional framework. Furthermore, the authorities have already appointed the Board of the Deposit Insurance Agency, while working on a law that will clarify its coverage and operations, together with a bank resolution framework that is being prepared. In doing so, the authorities intend to increase confidence in the monetary and financial policies, which in turn will facilitate de-dolarizing the economy.

6. The important progress made in the banking area is noteworthy. The state bank (BROU) continues to improve its performance and procedures, and its trust fund continues to recover nonperforming loans. The Nuevo Banco Comercial (NBC) was sold to a private partnership of foreign financial institutions, in a very convenient operation for the country not only because of the price of the transaction is considered fair, but more importantly because of the buyers’ excellent reputation. As regards the state mortgage bank’s (BHU) vulnerabilities, the authorities are strongly committed to adopt a comprehensive strategy to address the institution’s problems.

The indissoluble link between investment and growth

7. Enhancing the availability of credit and reducing its costs are critical to increase Uruguay’s investment rates. The authorities consider that the measures and reforms in the financial system will result in a strengthened system with positive consequences in terms of confidence. This should encourage depositors to invest in longer-maturity instruments, driving banks to flexibilize their lending policies. At the same time, the authorities are committed to developing an efficient capital market that allows firms to have more credit source alternatives.

8. The authorities have taken into account that public investment in infrastructure has substantially decreased since the 2002 economic crisis, and that it is crucial to boost it in order to support private investment. In consideration of the latter, the authorities, aware of the country’s fiscal constraints, are considering introducing a Public-Private Partnership (PPP) window. In this respect, the authorities will seek advice from the IMF and other IFIs to ensure its efficiency, transparency and accountability.

9. As noted in a business environment survey from the World Bank³, inappropriately designed or administered taxes may impose direct or indirect costs on firms, and this seems to be one of the main explanations for disappointing investment rates in Latin America. Acknowledging that Uruguay is not an exception, our authorities have implemented a critical reform at the national revenue-collecting agency (DGI). Since the reform, DGI officials must work exclusively for this entity—or abandon it- in sharp contrast with the former system that allowed employees to work simultaneously at the revenue administration and at the private sector. Clearly, the former system gave an unfair edge to firms that employed revenue administration’s workers. This very much-needed reform will improve transparency and accountability in the government and reduce rent-seeking activities in the private sector.

10. The authorities continue to work with the assistance of FAD on a comprehensive tax reform that will be fully consistent with the authorities’ objective of boosting private investment. This reform will introduce a new personal income tax, will broaden the tax base, and eliminate tax exemptions and subsidies, making room to lower the current rates on indirect taxes. The aforementioned reforms seek to establish a more equitable system, with a better distribution of the tax burden. In this respect, we would like to reiterate our authorities’ commitment that the total burden of indirect taxes will not be reduced until the revenue gains from the reform materialize, ensuring that the revenue goals in the medium-term are met.

11. The quality of business regulations constitutes a key element to attract -or obstruct-investment and to encourage the creation and development of business. In this regard, the authorities are undertaking critical steps to enhance regulations aimed at encouraging investment and business. Among them, the authorities have already submitted to Congress a law that restricts anticompetitive practices, while preparing a new bankruptcy law that includes Chapter XI type corporate restructuring. The authorities are also working in cooperation with the IDB and the World Bank to facilitate the creation of new businesses in Uruguay and make it less costly.

Better distribution and more beneficiaries from stronger growth

12. At the same time, as noted in the last issue of “Doing Business” from the World Bank⁴, “less costly does not mean less protection” as the ease of doing business does not appear to be linked to low levels of social protection or lack of government regulations. Our authorities agree with this observation, and the new labor framework (with tripartite wage councils), which aims at improving the investment climate by tempering the normal distributional tensions, should be read in this context. Beyond possible improvements that will be introduced to the aforementioned wage negotiating framework, it is worth noting that nearly 80 percent of the activity sectors have already reached agreements without the government’s arbitration. More generally, the framework of the national agreement on employment, income, and responsibilities (Compromiso National para el Empleo, los Ingresosy las Responsabilidades) that includes the participation of employers, trade unions, and other social actors, will help to make the different goals prevailing in the Uruguayan society compatible. Precisely, in a further attempt to improve business climate and social cohesion, the government is committed to publish in early 2006 an agenda of growth-enhancing reforms (including timetable for implementation) that will be prepared by a business-environment commission.

13. While agreeing with the staff that the Social Emergency program is key to building ownership for the government’s reform agenda, our authorities would like to point out that this program’s main objective is to meet an imperious and ethic need of mitigating poverty conditions. Our authorities would like to underscore that this program has progressed slower than expected, due to a large extent to the government’s commitment to implement the plan with precision and transparency.

Uruguay and the Fund

14. Once again, the Uruguayan authorities would like to thank the Fund’s Management, the staff, and the Executive Directors for their fruitful recommendations and constant support. Furthermore, the authorities are considering making advance repurchases to the Fund, which would benefit the IMF-to the extent that it will collaborate with the revolving of Fund resources-and also to the country, since it would send a clear message about the Uruguayan government’s strong commitment to fiscal discipline, and, in general, to its program.