Uruguay has consolidated economic gains, supported by strong macroeconomic policies and a broadly favorable external environment. Growth has exceeded expectations, unemployment has reached record lows, and poverty has continued to fall, while economic vulnerabilities have been significantly reduced. Despite strong credit growth, financial system soundness indicators have improved, showing a well-capitalized banking system, low nonperforming loan ratios and high liquidity levels. Executive Directors have welcomed the measures the authorities have taken to reduce inflationary pressures, including increases in the policy rate and banks’ reserve requirements and tax administrative measures.
October 22, 2008
1. In 2008, Uruguay has been exhibiting another year of remarkable economic performance as a result of sound macroeconomic policies and a number of structural reforms. Certainly, the positive external environment observed in recent years has also contributed to this performance. Positive shocks can be dilapidated or capitalized to pave the way for medium and long-term growth. Evidently, the latter has been the case for Uruguay. Indeed, the Uruguayan government has placed the pillars to reach higher and sustainable development and critically reduce vulnerabilities in order to be well-prepared for a new stage in the global economy.
Growth: From Vulnerability to the Road to Strength
2. Some years ago, many analysts were concerned about the sources of growth and the low growth rates Uruguay had experienced over a number of decades. According to an IMF staff report issued in 2003, “over the past 40 years, economic growth in Uruguay has been relatively low, averaging 1.7 percent a year over 1960-2001.”1
3. GDP growth is projected to be about 9.5 percent this year. Admittedly, this high figure is influenced by the opening of a large pulp mill factory, but beyond this, the country’s medium-term potential growth appears to be significantly higher than the above-referred average. As noted, sound macroeconomic policies, as well as the implementation of structural changes, together with Uruguay’s long tradition of respecting the rule of law, are key factors in allowing the country to attract a substantial amount of direct investment in many economic sectors. There are a number of cases where investment has already had substantial effects on the productivity of these sectors. Meanwhile, having demonstrated over the years that the country enjoys a positive investment climate, as a dynamic process, investment so far is attracting more capital, with the potential of creating an investment pole.
4. Of course, research, knowledge and technology constitute key elements to reinforce the above-referred growth trend, and, among other things, it is worth noting that the government has made important progress in discussions aimed at opening relevant scientific centers in Uruguay, following the inauguration of the Institut Pasteur of France less than two years ago.
Diversifying Markets and Products: From Regional to Global
5. Exports have continued to show a robust performance. More importantly, Uruguay has enlarged both the basket of its exports and the markets to which they are shipped. In this respect, it is worth recalling that a decade ago exports to Mercosur countries represented approximately 50 percent of the country’s external sales and today it is about 25 percent. Extra-regional exports have increased significantly.
6. Of course, as an open economy, Uruguay will have to face new circumstances stemming from a substantially less benign global economic situation. The global slowdown will affect the demand for Uruguay’s products; nevertheless, the country has broadened its basket of exports, improved their quality, and is currently supplying a number of promising new external markets. This puts Uruguay in a better position to face the current headwinds and constitutes a critical intangible asset for its medium and long-term development.
Fiscal Side: When the “Unprecedented” Becomes the Norm
7. By the time the Stand-By Arrangement was signed in 2005, many analysts questioned the authorities’ capacity to deliver its ambitious fiscal targets. However, the developments have been quite different. For instance, in 2008, Uruguay will record another year of important primary fiscal surplus, while the overall fiscal balance is already very close to equilibrium. In recent years, the fiscal revenue agency has been critically transformed. This partially explains the country’s outstanding fiscal performance, but the authorities have also enhanced their expenditure policies. Both collection and expenditure improvements have been consistently pursued to comply with our authorities’ strong commitment to reinforce fiscal sustainability.
8. Furthermore, the results attained in 2008 should be taken into account considering the fiscal costs incurred by measures aimed at mitigating some of the negative effects caused by a severe drought, which occurred in a context of above-average oil prices over the medium term. Similarly, other fiscal resources were used to soften the negative impact that, through their effects on domestic prices, the surge in commodity prices (particularly, food and oil) would have had on the most vulnerable sectors of Uruguayan society.
Debt Strategy: The Benefits of Being Prepared
9. One of the first issues this administration had to deal with was associated with a stressful debt situation. Thus, the Debt Management Unit was created at the Ministry of Finance, which has significantly prepared the country to navigate through the current market turmoil. This was due to the fact that Uruguay has reduced debt costs, made solid progress on de-dollarization of the debt, and lengthened its maturity. Meanwhile, the public debt-to-GDP ratio has decreased, as noted by the staff financing needs are well covered, most of the debt is at fixed rates, and the government already has some contingent credit lines available.
Looking at Stability in a Broad Sense
10. Clearly, the steep reduction in unemployment, the prudent salary recovery from the very low level resulting from the 2002 crisis, and the better quality of employment coming from the boost in investment, have made great contributions to significantly reduce poverty conditions. Nonetheless, the above-referred developments would not have been enough to reach the results already observed. Transparent and well-targeted social plans have been essential in this regard.
11. Meanwhile, having a broader view on the issue, the Uruguayan authorities point out the importance of moving to a countercyclical policy rule when the conditions allow it. It is worth noting that using part of the fiscal space left by the debt strategy and fiscal policies, our authorities devoted an important amount of resources to education, health, and infrastructure, which, in the medium term, will entail benefits in terms of poverty reduction, employment, quality of life, and growth. Some of the social plans—for example, Plan Ceibal, which provides laptops to public school children—involve an important investment, but have initial and ending points.
12. 12. Maybe the issue of pro or countercyclical policies should be treated in another ambit, beyond Uruguay’s case and with an open mind to determine to what extent fiscal policies aimed at restoring the social and economic equilibrium after a severe crisis and establishing—in a prudent, efficient, and transparent manner—expenditures expected to have a positive impact on investment and growth should be characterized as procyclical.
13. In sum, the Uruguayan authorities firmly believe that beyond its intrinsic value, social stability, which includes better income distribution and a higher fairness in the access of opportunities—particularly in education and health—, involving a virtuous cycle, is a key factor for investment, growth and even for fiscal sustainability, all of which will contribute to further improving social conditions. Even though there has been substantial progress in this regard, the authorities consider that much remains to be done in this area.
Keeping Inflation under Control
14. Like many countries around the world, inflation has been pressured by high commodity prices. However, the authorities have implemented monetary and fiscal policies to keep inflation under control. When necessary, our authorities have tightened monetary policy, as was the case of the interest rate hike decided some weeks ago. Meanwhile, the administration’s rapid reaction to establish fiscal measures aimed at softening certain price increases—as noted, these measures were essential to protect the most vulnerable people—also helped to avoid the introduction of indexatory mechanisms which, otherwise, would have exerted further pressures on inflation through second-round effects.
15. Other measures aimed at further opening the economy and continuing to establish sound incentives for production and investment also play an important role in smoothing price increases and/or forging lower inflationary expectations. The outcomes have been positive, not only looking at the present but particularly at the future and, in this regard, it is evident that inflation expectations for the coming years are at the upper limit but within the authorities’ target range (the median for 2009 is 7 percent and 6.69 percent for March 2009/Feb 2010).
16. The Central Bank made some opportunistic foreign currency purchases in recent years, which has allowed Uruguay to increase international reserves and smooth some of the exchange rate volatility. With the benefit of hindsight, it was the right decision, to the extent that reserves are currently around the level considered as optimal for the country, while some changes in the relations among currencies observed in recent weeks in many countries has been significantly less abrupt and volatile in Uruguay, after having intervened with a very modest amount of reserves.
A Sounder Financial System
17. Six years after suffering a severe crisis and having implemented key structural reforms in the sector, the financial system is sound and resilient, which is clearly reflected in the financial soundness indicators. As underscored in the staff report, “capitalization is adequate, non-performance loans are low, and the system’s liquidity remains high”. The staff report also notes that financial dollarization is high, which has been the case in Uruguay for many decades. However, it is very important to pay attention to the declining trend, which is reflected in the figures presented in Chapter II of the Selected Issues Paper. More importantly, currency mismatching risks have been drastically minimized. In this regard, dollar loans extended to the non-tradable sector have fallen from 84 percent in 2002 to 55 percent today, while dollar loans to families represent 16 percent of the total loans to that segment. Also, on the financial system, the housing bank, BHU, has been critically transformed, and will resume activities under the best practices.
18. The global economic situation poses important challenges for an open and small economy such as Uruguay’s. However, the global turmoil has arrived at a time when Uruguay is well prepared to face it. Growth is robust, investment is continuing to increase while unemployment and poverty are decreasing, financial needs are well covered, the financial system is solid and resilient, and fiscal and monetary policies are prudent and are set to keep inflation under control. In sum, our authorities are well aware of the substantial challenges lying ahead and they are ready to take the needed measures when necessary. Likewise, the Uruguayan authorities do believe that the progress made so far and the ongoing efforts in terms of policies and reforms will continue reaping fruits for the benefit of the country and its people.
Uruguay: 2003 Article IV Consultation and Third Review under the Stand-By Arrangement, Appendix I, August 2003.