Uruguay
Selected Issues

This report includes five background studies with emphasis on vulnerabilities and growth, the focus of the 2006 Article IV Consultation with Uruguay. Stocks of key financial balance sheet vulnerabilities are also discussed. With the appreciation of the peso since early 2004, the discussion on competitiveness has intensified. To assess competitiveness, the paper looks at balance of payments trends, the ratio of tradable to nontradable prices, cost and profitability measures, and real exchange rates and their alignment with purchasing power parity (PPP).

Abstract

This report includes five background studies with emphasis on vulnerabilities and growth, the focus of the 2006 Article IV Consultation with Uruguay. Stocks of key financial balance sheet vulnerabilities are also discussed. With the appreciation of the peso since early 2004, the discussion on competitiveness has intensified. To assess competitiveness, the paper looks at balance of payments trends, the ratio of tradable to nontradable prices, cost and profitability measures, and real exchange rates and their alignment with purchasing power parity (PPP).

I. Overview

1. This report includes five background studies with emphasis on vulnerabilities and growth, the focus of the 2006 Article IV Consultation with Uruguay. The papers cover both longer-term, structural questions, as well as short-term issues.

2. The second chapter takes stock of key financial balance sheet vulnerabilities. It confirms the need to stay the course in following prudent policies as vulnerabilities have declined since the crisis, but remain important. For example, the public debt-to-GDP ratio has fallen, but is still higher than before the crisis. Savings of Uruguayan residents continue to be largely short term and denominated in foreign currency, while the government and most Uruguayan companies, the users of these savings, do not have steady income streams in foreign currency terms, and have most of their assets installed for the long term. Under a hypothetical sharp drop of the Uruguayan peso, government and companies may have difficulties honoring their dollar debt. Banks would be affected indirectly through their exposure to companies, and with them, stakeholders (including the public sector and households) will be ultimately hurt. The paper argues that developing markets for hedging Uruguayan peso risk could help reduce corporate and bank vulnerabilities.

3. The following chapter examines Uruguay’s competitiveness. As a small open economy, Uruguay depends on international competitiveness for its economic development. With the appreciation of the peso since early 2004, the discussion about competitiveness has intensified. To assess competitiveness, the paper looks at balance of payments trends, the ratio of tradable to non-tradable prices, cost and profitability measures, and real exchange rates and their alignment with purchasing power parity (PPP). Most indicators suggest that Uruguay has remained competitive. An estimation of the equilibrium REER also supports the notion that peso is near equilibrium. However, while pointing to continued competitiveness, some indicators are on a declining trend. The paper argues that Uruguay should continue to improve the institutional and business environment to improve the ability of Uruguayan companies to compete internationally.

4. The evolution of domestic credit and likely prospects for economic activity and its financing are then examined, drawing lessons from other countries. To sustain growth into the medium term while avoiding a buildup of new vulnerabilities, private sector access to credit will be important. After falling for three years, bank credit stocks, reflecting both supply and demand factors, have now stabilized at low levels. Banks have been subject to stricter prudential rules and have been reluctant to lend to indebted borrowers, while companies may have been postponing investments. Econometric estimation, using a disequilibrium framework, do not suggest the prevalence of credit rationing. International evidence illustrates that after banking and currency crises, companies typically find other sources of finance, with bank credit picking up gradually after about three years. The study concludes that the current economic recovery is likely to continue, at least in the near future, despite slow credit growth, and suggests that further institutional reforms and the use of trust funds could help facilitate companies’ access to finance.

5. The fifth chapter reviews recent trends in investment in public infrastructure and examines ways to achieve higher infrastructure spending. Infrastructure in Uruguay is generally of good quality and coverage. Nevertheless, the decline in public investment since the crisis raises concerns about the prospects for maintaining the current quality of public services. There are indications of emerging infrastructure bottlenecks that could prevent sustaining strong economic growth into the medium term. The paper argues that addressing investment needs should involve both public and private sector participation. It provides recommendations to increase public investment, consistent with the fiscal constraints imposed by the still high level of debt. Also, in light of Uruguay’s intentions to expand public sector participation through public-private partnership, the chapter draws lessons from international experience to strengthen Uruguay’s institutional framework for establishing efficient and fiscally solid PPPs.

6. This sixth chapter discusses Uruguay’s growth performance since the 1960s, focusing on the role of external factors and linkages to the region. Per capita growth in Uruguay has been low and volatility high by both regional and international standards. Periods of strong growth have been short and followed by deep recessions, closely tracking developments in Argentina. Much of Uruguay’s long-term growth performance can be attributed to total factor productivity rather than capital accumulation. In a cross-country comparison, Uruguay’s growth has been positively influenced by its high level of education and negatively by a volatile external environment. Following this insight, the paper takes a closer look at factors that have made Uruguay’s growth vulnerable to external shocks. These include the high financial integration with Argentina, regional dependencies, and a reliance on commodities. While vulnerabilities have declined recently, Uruguay needs to further reduce its exposure to external shocks.

Uruguay: Selected Issues
Author: International Monetary Fund