A. Introduction

1. This paper examines Uruguay’s expected needs for, and options to achieve, higher infrastructure spending, balancing fiscal considerations and social preferences. With public debt still high at around 70 percent of GDP, large primary surpluses will continue to be needed. At the same time, Uruguayan society’s support for a large role of the state in the economy and rejections of outright privatization also impose important constraints. Section B presents a brief review of the literature on public investment and growth. Section C discusses recent trends in public investment in Uruguay, with emphasis on infrastructure. Section D looks at the scope to increase public investment and reviews the institutional budget and investment processes. Section E draws lessons from international experience to strengthen private sector participation in infrastructure. The conclusions are presented in section F.

2. Uruguay has done remarkably well in maintaining a good quality of public infrastructure, but a recent decline in public investment raises concerns looking ahead. The fiscal retrenchment prompted by the recession that begun in 1999 and deepened after the 2002 financial crisis, has brought government’s capital spending from above 4 percent of GDP down to 2.3 percent of GDP in 2005. Notwithstanding, infrastructure indicators show that the country still enjoys good levels of provision of basic services, and compares favorably with other countries in the region in this regard.

3. The challenge for Uruguay is to increase investment in infrastructure to sustain the ongoing economic recovery into the medium term. After falling by 16 percent during 1999-2002, the economy has rebounded vigorously in 2003-2005, averaging 7 percent GDP growth per year. However, to preserve strong growth beyond the recovery from the crisis, emerging bottlenecks in infrastructure would need to be addressed. To this end, both increased public investment, financed by higher public savings, and increased private sector participation will be required.

4. Current plans to increase public savings to finance higher investment are in the right direction. Given the high public debt, there is no room for loosening the fiscal stance. The five-year budget envisages increases in investment of about 1 percent of GDP financed by higher revenues. With the revenue-to-GDP ratio targeted to reach almost 34 percent in 2009, further increases would risk imposing an excessive burden on the private sector. Additional room for investment should be created through reductions in other expenditures and from more efficient government spending.

5. Increased private sector involvement could play a major role in strengthening public infrastructure. Given the low private participation in infrastructure (PPI) in Uruguay, there is ample room to move in this direction. Efforts should be devoted to developing an attractive environment for the private sector, and the government is already planning an increased role for public-private partnerships (PPPs). International experience indicates that PPPs can be effective in expanding infrastructure, but may also pose risks. Necessary conditions to establish efficient and fiscally sound PPPs include building capacity of government entities to develop PPPs, adequately share risks with the private sector, and properly evaluate and record the fiscal costs of PPP.

B. Public Investment and Growth in the Literature

6. Empirical studies on the impact of public investment on growth are inconclusive. An early study by Aschauer (1989) found a positive cross-country correlation between public investment and productivity growth, and similar results were found by studies using the same methodology. However, subsequent work found that the outcomes were not robust to more sophisticated econometric techniques and the data employed (Holtz-Eakin, 1994; Cashin, 1995; and Gramlich, 1994). The lack of clear-cut results may have several causes: due to inefficiency or corruption, capital spending may not translate into productive assets; public investment includes elements that do not add to the productive capacity of the economy; data used in these studies often refer to gross investment rather than net, and when net data are available, their quality is affected by measurement problems of depreciation and spending on investment maintenance.

7. The literature finds stronger links between investment in infrastructure and growth, but further work is needed on the impact of the composition of public spending. Several cross-country studies have found a positive relation between various measures of infrastructure and the level and growth of output. Surveys by Briceño Garmendia et al. (2004) and by Calderón and Servén (2005) report that most recent studies find a positive impact of infrastructure on output levels, although there is variation across countries. Easterly and Rebelo (1993) and Calderón and Servén (2004b) find that investment in different components of infrastructure has a positive effect on growth. More generally, a review by Romp and de Haan (2005) concludes that consensus about the growth-enhancing effect of public infrastructure has increased, although the impact is much lower than those estimated by earlier studies, and that this impact varies significantly across countries, regions, and sectors. More work is needed, however, to understand how the composition of public spending as a whole, including on infrastructure, affects growth.

C. Investment Developments

8. Declining public investment could affect Uruguay’s ability to maintain the good quality of its infrastructure and sustain high rates of economic growth. Public investment has declined substantially since 1999 and there has been historically limited involvement of the private sector in infrastructure. While public infrastructure is in good condition, going forward, significant investments will be required to maintain this standard and address emerging bottlenecks that could stifle economic growth.

9. The fiscal adjustment undertaken by Uruguay has led to a sharp contraction of public investment. Between 1999 and 2005 the primary balance increased by 6 percentage points of GDP (Table 1). With lower revenues by close to 1½ percent of GDP, this adjustment implied large reductions in current and capital spending. Capital spending fell by more than 40 percent, from 4 to 2.3 percent of GDP, a low level relative to the region (Figure 1). This is accentuated by the fact that, in contrast to Uruguay, in most of the other countries the role of the state has declined since the 1990s when infrastructure was opened to the private sector.

Table 1.

Selected Fiscal Indicators. 1999-2005

Source: Ministry of Finance.

Table 1.

Selected Fiscal Indicators. 1999-2005

		1999	2005	Change
Revenue		33.3	31.8	−1.4
Non-interest expenditure		35.4	27.9	−7.5
	Current expenditure	31.1	25.6	−5.5
	Capital expenditure	4.3	2.3	−1.9
Primary balance		−2.1	3.9	6.0
Public saving		2.1	6.2	4.1

Source: Ministry of Finance.

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Table 1.

Selected Fiscal Indicators. 1999-2005

		1999	2005	Change
Revenue		33.3	31.8	−1.4
Non-interest expenditure		35.4	27.9	−7.5
	Current expenditure	31.1	25.6	−5.5
	Capital expenditure	4.3	2.3	−1.9
Primary balance		−2.1	3.9	6.0
Public saving		2.1	6.2	4.1

Source: Ministry of Finance.

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Public Investment in Selected Countries, 2005

(in percent of GDP)

Citation: IMF Staff Country Reports 2006, 427; 10.5089/9781451839364.002.A005

Source: Ministry of Finance.

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10. Given the small private role in this area, declining public investment has also had a negative impact on investment in infrastructure. Between 1999 and 2005 public investment in infrastructure² declined by about 30 percent, from 2.2 percent of GDP to 1.6 percent, even if the share of infrastructure in total investment increased. Despite the contraction, the level of spending still compares favorably with the region. Servén (2004a) reports that public investment in infrastructure in six Latin American countries averaged only 0.8 percent of GDP in the period 1996-2001 (down from 3.1 percent of GDP in the 1980s).

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Public Investment in Uruguay, 1999-2005

(in percent of GDP)

Citation: IMF Staff Country Reports 2006, 427; 10.5089/9781451839364.002.A005

Sources: Ministry of Finance and Fund staff estimates.

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11. Private participation in infrastructure (PPI) has played a small role in Uruguay. Infrastructure services are largely provided by monopolistic state owned enterprises (SOEs). Uruguayans have historically favored a large role for the government in income distribution as well as in the provision of public services. Consequently, PPI in Uruguay averaged only 0.5 percent of GDP in the period 1990–2004. This low level contrasts with the experiences in other countries in the region, where since the 1990’s an increase in private sector investment, in particular in transportation, energy and telecommunications, has partially compensated for lower public spending.

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Average PPI in Latin America, 1990-2004

(in percent of GDP)

Citation: IMF Staff Country Reports 2006, 427; 10.5089/9781451839364.002.A005

Source: The World Bank, Private Participation in Infrastructure Database.

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12. There is significant public opposition to an expanded role of the private sector in infrastructure. The Uruguayan Constitution stipulates that 25 percent of the registered voters can initiate a referendum appeal to repeal a law within one year of its adoption. On this basis, successful referenda took place in 1992 to prevent partial privatization of the telecommunications company, in 2003 to impede the association of the state-oil company Ancap with private partners and eliminate Ancap’s monopoly in the imports of fuel, and in 2004 to ban concessions for provision of water and sanitation services.

13. Nevertheless, there has been some experience with PPI, with mixed results. In Uruguay, PPI has mostly taken the form of concessions to build and operate infrastructure, and joint-ventures of the SOEs with private companies (Box 1). Concessions in road construction and management, gas transportation and distribution, port services, and airport management have fared relatively well, despite some contract cancellations and renegotiations. Private provision of sanitation services was vetoed by a referendum held in 2003 and this led eventually to the withdrawal of the main private operators from this sector. Private participation in mobile communications and long distance calls, in competition with the public company, has resulted in a significant improvement in quality and reduction of tariffs. In 1995 the state-owned airline was partially privatized through the sale of 51 percent of its stake in the company, but the company has suffered from recurrent financial difficulties.

14. Uruguay has been able to maintain its infrastructure generally in good condition but there are some weaker areas. The World Bank (2005a) reports that in general, there is a high level of coverage, access, and quality of basic services (Table 2). The road network’s density and the condition of the primary road network are among the best in Latin America. Port services are competitive within the region, and telephony coverage is high. Electricity reaches the entire population, but lack of investment to keep up with increased demand has left the system vulnerable to adverse weather conditions. Water quality is good, with almost universal coverage, but sewerage access is very low outside of Montevideo. There are also some problems with access to natural gas, mainly due to the small size of the distribution network. Finally, railway services are not competitive and freight volumes are low. Regarding tariffs, public enterprises often set high levels, due to low efficiency, but also to generate fiscal revenues. In particular, gasoline prices are among the highest in the region.

Table 2.

Infrastructure Indicators, 1990 and 2002 ¹/

Source: The World Bank (2005)

^1/Latest year available were indicated

^2/Income groups are based on the World Bank classification in 2005.

Table 2.

Infrastructure Indicators, 1990 and 2002 ¹/

	Fixed and Mobile
	Telephone Lines		Electricity Generation		Roads		Paved Roads		Access to Improved Water Sources
	(Subscribers per 1,000 people)		(Kwh per capita)		(Km per 1,000 people)		(m percent of total roads)		(m percent of the population)
	1990	2002	1990	2002	1990	2002	1990	2002	1990	2002
Uruguay	134	472	2,397	2,858	3.1	2.7	74	90	…	98
Argentina	93	396	1,580	2,253	6.7	5.9	29	29	94	..
Brazil	65	424	1,506	1,975	11.3	10.3	10	6	83	89
Chile	67	659	1,403	2,918	6.1	5.3	14	19	90	95
Colombia	69	286	1,034	1,032	3.1	2.7	12	14	92	92
High income 2/	463	1,230	8,146	9,678	14.3	14.0	85	95	..	99
Middle income	41	322	1,478	1,868	3.1	2.9	52	54	77	83
Low income	6	40	303	410	2.1	2.1	15	15	6	75
World	102	364	1,478	1,868	4.7	4.4	38	48	26	82

Source: The World Bank (2005)

^1/Latest year available were indicated

^2/Income groups are based on the World Bank classification in 2005.

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Table 2.

Infrastructure Indicators, 1990 and 2002 ¹/

	Fixed and Mobile
	Telephone Lines		Electricity Generation		Roads		Paved Roads		Access to Improved Water Sources
	(Subscribers per 1,000 people)		(Kwh per capita)		(Km per 1,000 people)		(m percent of total roads)		(m percent of the population)
	1990	2002	1990	2002	1990	2002	1990	2002	1990	2002
Uruguay	134	472	2,397	2,858	3.1	2.7	74	90	…	98
Argentina	93	396	1,580	2,253	6.7	5.9	29	29	94	..
Brazil	65	424	1,506	1,975	11.3	10.3	10	6	83	89
Chile	67	659	1,403	2,918	6.1	5.3	14	19	90	95
Colombia	69	286	1,034	1,032	3.1	2.7	12	14	92	92
High income 2/	463	1,230	8,146	9,678	14.3	14.0	85	95	..	99
Middle income	41	322	1,478	1,868	3.1	2.9	52	54	77	83
Low income	6	40	303	410	2.1	2.1	15	15	6	75
World	102	364	1,478	1,868	4.7	4.4	38	48	26	82

Source: The World Bank (2005)

^1/Latest year available were indicated

^2/Income groups are based on the World Bank classification in 2005.

15. Uruguay fares relatively well in international comparisons of infrastructure levels. The literature reports that since the 1980s Latin America has lagged relative to other regions in infrastructure provision. This is explained by a fiscal retrenchment that was only partially offset by private sector investment.³ Infrastructure levels and quality in Latin America now lag behind not only the successful Asian economies, but in many cases also the middle-income developing countries. In this context, Uruguay and Chile stand out as the best performers in the region. This is confirmed by Uruguayans’ own perception of their infrastructure as surveyed by the Global Competitiveness Report, which ranks Uruguay second, after Chile, among the Latin American countries.

16. However, as Uruguay recovers from the 2002 crisis, sustaining growth will require addressing emerging infrastructure bottlenecks. The following are considered to be the main areas requiring increased investment in the coming years:

• Electricity. Uruguay’s electricity generation capacity could become a major bottleneck. The droughts in 2005 and 2006 resulted in significantly higher generation costs and measures to ration electricity. Ensuring reliable electricity supplies requires installing additional generating capacity and upgrading the interconnection with Brazil.

• Railways. Increased freight transportation demand, after the pulp mills begin operations in 2007, is expected to be partially satisfied by the railway. This requires investments to upgrade the railway network and equipment.

• Roads. While the road network is in good condition, the budgeted level of spending in maintenance and rehabilitation is considered insufficient to prevent its deterioration. Pressures could also come from increased transportation related to the pulp mills.

• Ports. Uruguay is trying to position itself as a regional port hub. Attaining this goal would require, among other actions, dredging the port of Montevideo, upgrading its terminal facilities, and developing smaller ports.

• Sanitation. With sewerage coverage being one of the areas where Uruguay lags behind, sanitation coverage outside of Montevideo needs to be significantly expanded to reach a larger fraction of the population.

D. Options to Promote High Quality Public Investment

17. Achieving higher and better public investment will require higher public savings and strengthening budgetary and investment processes. Given the constraints imposed by the high level of debt, there is little room to relax the fiscal stance. The 2005–2009 budget has public investment increasing by about 1 percent of GDP, financed by increased revenues. However, revenues are projected to reach 34 percent of GDP in 2009, and further increases would risk putting an excessive burden on the economy. Additional space for investment should come from reforms to lower current spending. In addition, strengthening the institutional budget and public investment processes would also improve the efficiency of spending.

18. Large increases in savings would be difficult to achieve due to existing budget rigidities.

• While earmarking of revenues is not particularly severe by regional standards, there is some scope to free resources through increased flexibility in this area. About 1/3 of revenues have some sort of earmarking, but to a large extent this constraint is not binding. The proposed tax reform, while reducing earmarking through the elimination of several of the earmarked taxes, does not reduce rigidities as minimum spending requirements are being introduced to maintain the levels of spending currently implemented through revenue earmarking.

• The main rigidity stems from the high level of non-discretionary spending. With close to 60 percent of all spending on wages and social security benefits (Figure 4), meaningful savings would require politically difficult cuts of these categories. In the case of wages, with average salaries relatively low, possible savings would likely be small and based on reductions in employment. Moreover, while civil service reform is being considered, the main goal would be to improve efficiency and service delivery. Pension outlays are high by international standards, mostly reflecting Uruguayan demographics. The system was already reformed in 1996 and outlays are projected to decline gradually over the medium term. There is also room to achieve savings on discretionary spending through reform of procurement processes.

19. Addressing budgetary rigidities would also be important to protect investment levels at times of fiscal difficulties. The budget sets expenditure ceilings but the government can cap spending below those ceilings by decree, based on periodic assessments of revenue collections. These caps are a practical mechanism to ensure meeting fiscal objectives, as they can be imposed on all categories of spending with the exception of wages. However, given the large share of non-discretionary spending, cuts tend to fall on a few items, and in particular on capital spending. Similarly, the government also resorts to limit capital spending by the SOEs to meet its fiscal targets.

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Public Sector Expenditure in 2005

(as a percent of total)

Citation: IMF Staff Country Reports 2006, 427; 10.5089/9781451839364.002.A005

Source: Ministry of Finance.

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20. While important progress has been done, further strengthening the institutional budget process would be important to improve resource allocation. During the last budget cycle important improvements were introduced, including clearly stated government priorities, a medium-term macroeconomic framework, and revenue projections for the entire period. In addition, efforts were made to strengthen the strategic component of the budget. However, some remaining weaknesses should be addressed:

• The existing medium term budget framework is inadequate. A five-year budget is prepared to coincide with the presidential term but there are no annual updates. Development of a rolling medium budget framework is key to guide line ministries investment plans and ensure that these are consistent with available resources and macroeconomic stability.

• There is limited annual reassessment of priorities. The annual execution assessments allow modifications to the five-year budget in response to changing priorities. However, in practice few changes are made.

• The current institutional arrangement implies some coordination risks regarding the capital and current components of the budget. This is because the budget is formulated by two separate entities, the Ministry of Finance and the Office of Budget and Planning (OBP), which reports directly to the president. The MEF and the OBP are in charge of the current and capital budgets, respectively.

21. The effectiveness of public investment could be enhanced by improving the appraisal and selection of investments. The quality of procedures for selection and evaluation of projects vary across the different levels of government and SOEs. In addition, lack of coordination between the spending units sometimes results in duplication of efforts and wasted resources. Specifically:

• There is considerable scope to increase investment selection procedures at the central government level. Spending units submit proposals to the OBP, describing costs and goals of their projects, for their evaluation and inclusion in the budget. But with the exception of large transportation projects and projects financed by international organizations, no adequate cost benefit analysis is performed, preventing comparisons of projects based on their estimated returns. This, combined with insufficient staff at the OBP to assess a large amount of projects (about 600 were included in the current budget) precludes adequate prioritization of projects.

• Local governments have limited capacity to develop and assess investment projects. Investment by the local governments is approved by the local councils and submitted to congress for informational purposes. Local government investment is largely financed by central government transfers, and in general they require the central administration’s assistance to design the projects.

• Investment projects by the SOEs are generally well prepared. They are submitted as part of the company’s business plan to the OBP for their approval. Projects above US$ 1 million or 10 percent of the company’s investment budget are subject to adequate cost-benefit analysis, including their economic and social return.

22. Monitoring and ex-post evaluation of investment projects need to be expanded at all levels of government. The assessment of investment projects is carried out annually in the context of the budget execution report. Financial information on project execution is good but data on physical progress are scarce. Also, no ex-post evaluations are performed, with the exception of externally financed projects, to determine whether stated goals formulated at the onset of the project were achieved and whether the costs were in line with original estimates. Better monitoring and ex-post evaluation would be important tools to assess the productivity of public investment and provide feedback for subsequent projects.

E. Public-Private Partnerships

23. Given fiscal constraints and public opposition to privatization, PPPs could be an important vehicle to increase investment and its efficiency, but risks need to be properly addressed. International experience shows that flaws in the design of PPPs could result in significant fiscal costs (Box 2). For this reason, development of PPPs should be done gradually allowing to gain experience, and fiscal risks reduced by strengthening the institutional framework and adequately sharing risks with the private sector.

24. The government intends to expand the role of the private sector in infrastructure, initially through limited PPPs. At present, the government is developing a railway project to meet the increased demand for freight transportation from the pulp mill plants. Other projects in the area of transportation are also being considered. Besides providing necessary infrastructure, these projects are expected to build confidence on PPPs to allow expanding the use of this scheme in the future.

25. The experience with PPPs in other countries, both in and outside the region, provides useful lessons. Chile and Colombia have had PPP programs for a number of years and are setting the standard for the region (Box 3), Brazil is advancing with PPPs, particularly at the state level, and Peru has recently relaunched its PPP program with new road concessions. In addition, a number of advanced economies have now well-developed PPP programs, especially the United Kingdom, Portugal, and Australia, while many others have PPP programs at a more limited scale.

26. International practice points to the importance of a sound legal framework that covers all aspects of the PPP process. For example, the comparative success of Chile’s concessions program can be largely attributed to the existence of a comprehensive concessions law that addresses the basic requirements for effective concessions (the bidding process, rights and obligations of parties, property appropriation, etc.) as well as possible disputes and the cancellation and transfer of contracts. Brazil has recently enacted a PPP law and Colombia is in the process of strengthening related legislation. The literature finds that PPP contracts have been less likely to get renegotiated when the regulatory framework was embedded in a law⁴.

27. As Uruguay gains experience with its initial projects, it should consider developing a unified legal framework for PPPs. At the moment, Uruguay has a limited legal framework. Private equity participation and/or association with SOEs is authorized by the Constitution, subject to congressional confirmation. However, current laws set only very general terms for concessions granted by the government and by SOEs. The conditions for each project are largely left to individual implementation decrees and contracts.

28. International experience also indicates that the institutional framework could be strengthened by setting a central PPP unit and a gateway procedure for PPPs. Central PPP units exist in Chile and Brazil. Their purpose is to acquire and share expertise on negotiation and management of contracts, provide oversight and avoid duplication of efforts, and establish a single point of contact for the agents involved in PPPs. Uruguay is in the process of setting up such a unit at the Ministry of Finance. The authorities should also consider establishing a gateway procedure by which the Ministry of Finance would have veto power to stop PPPs that do not offer value for money or could endanger overall fiscal sustainability.

29. Proper project evaluation is key for the success of PPPs. This process involves two stages: first, appropriate investment planning and project appraisal should determine the viability of a project; next, it should be decided whether a viable project is best suited to be implemented as PPPs or through public procurement. To this end, the use of public sector comparators, to evaluate which of these two alternatives provides better value for money for the government, is the best practice⁵. In the region, Chile is increasingly relying on them. Evidence suggests that PPPs are better suited to provide economic infrastructure (e.g., roads, railways, ports, etc.) as opposed to social infrastructure (e.g., hospitals, schools, etc.).

30. Equally important is to ensure adequate treatment of the risks related to PPPs. PPP contracts should allocate the different risks involved to the party best suited to manage them. Construction and operation risks are typically borne by the private sector. The government should bear risks under its control, like regulatory and political risks. Others, like demand, exchange rate, and residual value risks may or may not have to be borne by the government. Colombian regulations are a good example on how to assign risks. When providing guarantees is appropriate because the government should bear the risks, they need to be valued and factored into the debt sustainability analysis, as they may entail large contingent costs. Chile and Colombia have developed sophisticated valuation techniques⁶, treating guarantees as a financial option. These countries, as well as Brazil, have set up separate funds to reduce the exposure of the private partners if guarantees are called.

31. To capture fiscal risks, PPPs should be adequately reflected in the fiscal accounts and information on known and potential costs of PPPs disclosed. Currently no accepted international accounting and reporting standards for PPPs exist. However, the IMF (2005a) provides recommendations in this area to ensure comprehensive disclosure of PPP transactions for the public finance and incorporation in the debt sustainability analysis. In particular, the paper recommends that for PPPs that are recorded as private investments⁷, known and certain payment obligations of both parties be taken into account in the budget and the expected net present value of contingent payments be recorded as primary expenditures. For projects recognized as public investment, the service component of future payments under the contract should be counted as primary spending, while the debt service component should be separated out and included in the overall projected interest and amortization payments.

F. Concluding Remarks

32. Satisfying infrastructure needs will require increased public and private investment. With a still high level of debt, higher public investment will require creating fiscal space by increasing public saving, through lower current expenditures and improved efficiency of spending, especially by strengthening investment procedures. But given fiscal constraints, improving infrastructure to desired levels will be difficult without increased private sector participation. To this end, the government needs to put in place a friendly business environment and a solid regulatory framework to attract private interest, establish efficient PPPs, and limit fiscal risks.

33. The government’s agenda includes important measures aimed at increasing resources for investment and improving the efficiency of spending. Some fiscal space is being created through increased revenues. In the area of structural reforms the government is: (i) working with the IDB on strengthening the investment process, in particular by creating a centralized database of investment projects and reinforcing appraisal capabilities to allow better prioritization; (ii) working towards strengthening procurement practices and expanding the use of online tools to improve spending efficiency; and (iii) developing a plan to upgrade the institutional budget process.

34. Uruguay’s cautious approach toward PPP program is appropriate. PPPs could be useful in developing the country’s infrastructure. To limit fiscal risks, the government should focus initially on projects that do not involve complex design and construction issues, or difficult risk sharing arrangements. These projects would help to develop a reputation of the government as a trustworthy partner as well as boosting confidence of the Uruguayan society in the positive role to be played by the private sector.