Uruguay’s Second Review Under the Stand-By Arrangement and Requests for Modification, Waiver of Nonobservance and Applicability of Performance Criteria are discussed. Growth remains robust, inflation is subdued, and the external position continues to strengthen, with buoyant exports and upward pressure on the peso. Fiscal performance has been better than expected, with public debt continuing to fall as a percentage of GDP. Structural reforms are also progressing well, with key new reform initiatives under way in several areas.
The Program’s Distinctive: The Authorities’ Ownership
1. The Uruguayan economy has been performing strongly over the recent year. GDP growth has been robust, finishing 2005 above the initial forecast; inflation has been subdued; exports have grown substantially; and fiscal performance has been in line with the authorities’ targets. More importantly, the government has continued implementing its critical agenda of structural reforms, exhibiting the program’s most important distinctive: the government’s strong ownership of the reforms that goes well beyond the IMF’s conditionality.
Starting to Reap the Fruits of Sound Policies and Reforms
2. As noted, economic activity is performing strongly, with a robust boost in exports (15 percent growth in real terms in the period January-September 2005, compared to the same period in 2004). Meanwhile, export markets continue to show an increasing diversification (for instance, the participation of NAFTA countries has grown up to 29 percent of the total exports in the last twelve months to October), which tends to strengthen the country’s resilience to external shocks. Precisely, our authorities’ view on trade underlines the critical need for the country to continue its efforts to diversify its product base and external markets by further integrating the Uruguayan economy onto the global economy. In order to achieve these objectives, the government has taken different measures, including those aimed at enhancing Uruguay’s competitiveness by implementing many structural reforms –several of which will be discussed below–, and the efforts to make agreements with different countries. In this regard, in October 2005 Uruguay signed an investment agreement with the United States of America, which was ratified by Congress in December.
3. Currently, Uruguay is attracting significant capital inflows, a good part of them being foreign direct investment (this is reflected in the significant surge in capital good imports from the private sector of 53 percent in dollar terms in January-October/05 compared to the same period in 2004). Meanwhile, taking advantage of the external and domestic conditions, including the level of the exchange rate and the inflation below the Central Bank’s envisaged targets, the authorities have strengthened the reserve position, driving to a significant overperformance of the net international reserves. Furthermore, the gross non-financial public sector debt (relative to GDP) exhibits a substantial decline from 92 percent in 2004 to 73 percent in 2005, while increasing the portion of peso-denominated debt. The authorities are fully aware of the need to keep working in diminishing debt vulnerabilities –for instance, those related to its maturity and dollarization–, having created a debt-management unit at the Ministry of Finance to continue addressing these vulnerabilities.
4. One of our authorities’ main objectives is to enhance the level and quality of employment, and, although much remains to be done to achieve the objective, there have been very positive developments during the recent months. The employment rate (according to the latest labor report) has grown to its highest since 2001 and the number of contributors to the Banco de Prevision Social (BPS) has increased by 10 percent in 2005, which means better work conditions and more people with social coverage. Meanwhile, according to a report from a private university1, the index of labor conflicts in 2005 was the lowest in the past ten years, which coincides with the introduction of the new labor framework (with tripartite wage councils) and, even before that, with the national agreement on employment, income and responsibilities launched by the government. It is important to reiterate that our authorities understand the term “economic stability” as a global concept that embraces the interests of investors, workers, and other social partners. In this regard, the authorities are committed to continue contributing to temper the normal distributional tensions, keeping in mind that social inclusion and equity are vital factors to improve the investment climate and Uruguay’s human development.
5. Beyond global and emerging market developments, our authorities’ commitment to sound macroeconomic policies and reforms has been rewarded by the investors’ confidence in the country. For instance, in November, Uruguay placed in international markets US$ 200 million of seventeen-year bond at a yield of 8.2 percent. Having presented a declining trend of the yield, this issuance brought total international bond issues in 2005 to above US$ 1 billion. Likewise, sovereign spread has fallen from 400 basis points at the beginning of 2005 to around 270 basis points currently.
Promoting a Virtuous Cycle among Stability, Growth and Fiscal Position
6. The Uruguayan authorities strongly believe that their efforts towards the consolidation of the fiscal position are fully compatible and synergetic with higher and sustainable growth. As a minor example –although it may help to illustrate the situation–, some people have already stopped receiving benefits from the social emergency program after finding employment in the region where the pulp mill projects are being implemented. Meanwhile, as noted in the staff report, the authorities are exploring options for private participation in infrastructure investment that will support Uruguay’s external trade and growth in general, being clear cases of this kind of investment those related to the revamping of the railways and the improvement of other communication facilities, including seaports. Obviously, before its implementation, the authorities will ensure that sound institutional and legal frameworks are in place according to the best international practices. Generally, on fiscal policy, the authorities would like to reiterate that the government’s budget has been prepared taking realistic targets, which are fully coherent with the implementation of prudent policies and our authorities’ strong commitment to preserve macroeconomic stability, in particular by strictly adhering to the undertaken fiscal targets.
7. Tax reform is the centerpiece of the government’s agenda. This reform aims to achieve three main objectives: distributing the tax burden more equitably; efficiency; and coherence with the government’s goal of promoting productive investment. Among the main pillars of this reform, it is important to underline the introduction of a personal income tax, a substantial reduction of tax exemptions, and the streamlining of the tax system, including the elimination of fifteen taxes that generated only a very small part of the revenues but the collection of which proved to be a heavy burden on the revenue administration. In order to ensure transparency and improve ownership, the reform proposal was posted on the Ministry of Economy and Finances’ website requesting feedback during November. Additionally, in the context of a comprehensive reform of the revenue administration, the Ministry of Finance already signed with the DGI a memorandum of understanding, establishing, among other things, quantitative targets for tax collection, which are compatible with a substantial decrease in the level of evasion.
8. The past year showed the lowest inflation rate (4.9 percent, end of period) since 2001. This rate was below the December 2005 Central Bank of Uruguay (BCU) target range (5.5-7.5 percent); accordingly the monetary authority could adopt a more expansive policy during the second semester of 2005, while the annual inflation rate has still been under the aforementioned target range. It is important to note that this inflation rate was achieved in a context of full pass-through of oil prices. Likewise, the Central Bank has announced a target range of 4.5-6.5 percent for 2006. This cautious approach to further disinflation should be viewed as part of the authorities’ efforts to promote the above-referred virtuous cycle. Furthermore, according to the latest Central Bank monthly survey, inflation expectations have converged to the official target range, which, together with other positive developments in the monetary and financial areas, reflect confidence in the prudent monetary policy followed by the Central Bank. This confidence will be reinforced by the institutional reforms already submitted to the Congress. Thus, in essence, the performance criteria (PC) related to the financial system laws was fully observed with just one difference, which, as recognized by the staff, entails advantages from the previously planned.
9. The financial system has exhibited substantial improvements during 2005, which, for instance, is reflected by many indicators, including the level of deposits, the share of nonperforming loans in total loans, and capital adequacy ratio. It is expected that the reforms aimed at strengthening the financial sector supervision will reinforce the positive trend, and that all of these favorable developments will boost the amount and quality of credit available for the private sector. Meanwhile, the authorities have already prepared a comprehensive plan to address the financial situation of BHU, which will be implemented very soon. In general, all the authorities’ measures and policies in the financial system have been fully coherent with their firm determination to establish a culture where debts have to be honored, regardless whether the creditor is a private or a public bank.
Looking Forward: Substantial Challenges and Favorable Perspectives
10. Finally, our authorities would like to reiterate their appreciation of the current arrangement with the Fund, which has been instrumental in achieving the strong performance in 2005. As has been mentioned since the beginning of the current administration, it is the authorities’ intention to establish a well-articulated exit strategy from the Fund’s financial support. Meanwhile, it is worthy to note that the BCU monthly expectation survey shows that economic growth forecast for 2006 is in line with the authorities’ estimates, and that the forecast of private analysts has been increasingly positive as the government’s structural agenda started to be implemented. Nevertheless, the authorities are fully aware of the remaining vulnerabilities and remain firmly committed to pursue their ambitious albeit achievable economic objectives within social stability and full respect for law.
The report can be found on the website of the Catholic University of Uruguay www.ucu.edu.uy/Facultades/CienciasEmpresariales/ModernizacionRRLL/Informes2005.htm