Uruguay: Selected Issues
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International Monetary Fund
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Publication Date:
19 Feb 2010
eISBN:
9781451839456
Language:
English
Keywords:
ISCR; CR; Uruguay; exchange rate; loan; revenue performance; revenue windfall; Uruguay specific; commodity exporter; revenue impulse response; Fiscal stance; trade composition
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This Selected Issues paper provides a real exchange rate and competitiveness assessment for Uruguay. It looks at the recent developments in key external competitiveness indicators such as the bilateral real effective exchange rates, export volumes, export market shares, export unit values, unit labor costs as well as foreign direct investment performance. The paper pursues an assessment of the real exchange rate following a broad-based strategy of applying four different approaches, including the purchasing power parity approach, the macroeconomic balance approach, the external sustainability approach, and the equilibrium real exchange rate approach.

Abstract

This Selected Issues paper provides a real exchange rate and competitiveness assessment for Uruguay. It looks at the recent developments in key external competitiveness indicators such as the bilateral real effective exchange rates, export volumes, export market shares, export unit values, unit labor costs as well as foreign direct investment performance. The paper pursues an assessment of the real exchange rate following a broad-based strategy of applying four different approaches, including the purchasing power parity approach, the macroeconomic balance approach, the external sustainability approach, and the equilibrium real exchange rate approach.

II. Commodity Prices, Growth and the Fiscal Position in Uruguay1

A. Introduction

1. Commodity prices are an important external factor for growth and fiscal performance in a small open economy like Uruguay’s. When agricultural commodity prices rise, Uruguay stands to gain with stronger external current account balances, output growth, and fiscal positions. However, when oil prices rise in tandem, as a net oil importer, Uruguay’s terms of trade deteriorate, as may growth and the fiscal position. Moreover to the extent that the economy is dependent on commodities, volatility in their prices introduces uncertainty for the growth and fiscal outlook.

2. Periods of high growth in Uruguay have historically occurred during commodity price booms and vice versa. An analysis of trends in growth and commodity prices during the period 1970-2008 points to a positive correlation between growth and an index of Uruguay specific commodity prices, i.e., non oil primary commodity prices exported by Uruguay. Periods of high growth have typically been preceded by rising commodity prices. Similarly, periods of negative growth have also been preceded by a sharp decline in commodity prices.

uA02fig10

Growth and Commodity Prices, 1970-2008

(percent)

Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A002

3.The impact of commodity prices on Uruguay’s fiscal performance is more difficult to delineate. Large commodity exporters in the region (Argentina, Brazil, Chile and Peru) have experienced a boost in tax revenues during the recent run-up in prices, which in some cases has fueled an increase in government spending (IMF, April 2009). In the case of Uruguay, the government does not rely directly on revenues from commodity exports, and any revenue windfalls deriving from commodities accrue indirectly through higher incomes. Moreover, lagged and often times incomplete tariff adjustments to oil price increases have carried significant fiscal costs. Historically, periods of strong revenue performance have coincided with high growth in both, real GDP and commodity prices, while periods of poor revenue performance have also coincided with low real GDP growth and commodity prices. However, the links between expenditures, growth and commodity prices are less evident.

uA02fig11

Fiscal Performance and Commodity Prices, 1970-2008

(percent)

Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A002

1/ Average real revenue growth in years when revenue performance was strongest (i.e., real revenue growth > 10 percent) during 1970-2008, and corresponding average GDP growth and growth in non-oil co mmodity prices (CP) at t=0, t-1 and t-2.2/ Average real revenue growth in years when revenue performance was the weakest (i.e., negative real revenue growth) during 1970-2008, and average GDP growth and growth in non-oil commodity prices (CP) at t=0, t-1 and t-2.
uA02fig12
1/ Average real expenditure growth in the years when spending was the highest (i.e., highest percentiles of real expenditure growth) during 1970-2008, and average growth in GDP and non-oil commodity prices (CP) at t=0, t-1and t-2.2/ Average real expenditure growth in the years when spending was the lowest (i.e., expenditure growth < 10 percent) during 1970-2008, and average growth in GDP and non-oil commodity prices (CP) at t=0, t-1 and t-2.

4.The most recent run-up in global commodity prices appears to have had a mixed impact on the Uruguayan economy. On one hand, higher commodity prices boosted the economic fortunes of Uruguayan exporters and raised incomes. Over 50 percent of Uruguayan exports during 2006-2008 comprised primary commodity exports (see Table A1), and on average international prices of these same primary commodities rose by roughly 90 percent over the same period. 2 The share of exports in real GDP growth rose steadily with the commodity price boom. Moreover, with its strong economic links to Argentina (and to a lesser extent Brazil), the Uruguayan economy stood to benefit indirectly from the positive impact of the commodity price boom on output in those countries. However, the oil import bill rose too, with total imports more than offsetting the increase in exports.

Table A1.

Uruguay: Primary Commodity Exports

article image
Source: UN WITS (World Integrated Trade Solution)

5. This paper quantifies the overall extent to which Uruguay is affected by commodity price movements. It does this by focusing on two main issues: (1) the overall effect of commodity prices on growth and the fiscal position; and (2) the importance of indirect channels of transmission of commodity price shocks, particularly through neighboring countries. The paper employs both a standard VAR methodology as well as a Bayesian VAR to assess commodity prices changes (and the corresponding impact on Uruguay specific terms of trade) on the government sector (primary fiscal balances) and on households (gross domestic product and income).

6. we find that commodity price shocks have a significant effect on growth and fiscal indicators, with intermediate channels of transmission via Argentina playing a key role. In general, the models yield the following results:

  1. An increase in commodity prices has a direct positive and significant effect on growth in Uruguay with the effect lasting approximately one year.

  2. Moreover, commodity price shocks also have a strong positive effect on Argentine growth, which in turn has a strong positive effect on Uruguayan growth. On the contrary, we do not find evidence of significant transmission channels to Uruguayan growth through higher growth in Brazil.

  3. Commodity price shocks also affect the fiscal position, although the effects are shortlived—revenues of the non-financial public sector initially fall in response to higher commodity prices, but expenditures (in line with declining revenues) fall even more, resulting in a temporary improvement in the primary balance. The deterioration in revenues reflects the negative impact of oil price shocks on public enterprises. Following the initial decline, expenditures quickly return to their initial level (with their increase likely reflecting in part higher spending on subsidies) and the primary balance deteriorates. These effects are complete within 2-3 quarters.

B. Commodity Prices, Terms of Trade and the Macroeconomy

7. The impact of simultaneous increases in oil and food commodity prices is difficult to disentangle. Changes in the terms of trade do not directly affect the level of real output, but influence real purchasing power, both through nominal incomes and through their effect on domestic prices. The indirect effects of changes in the terms of trade on real output in turn depend on the impact of these changes on spending. Moreover, domestic activity and income receives an additional boost from the indirect impact of commodity prices shocks on neighboring country GDP, Argentina and Brazil in the case of Uruguay, particularly when economic links between the countries are strong.

8. Higher commodity prices have a potential impact on both government spending and revenues. On the expenditure side, to mitigate the negative impact of higher food prices, the government implemented a range of subsidies in 2008 roughly equivalent to 2 percent of GDP. At the same time, the impact on revenues has been mixed. On one hand, higher oil commodity prices have had an adverse effect on fiscal performance, eating into the operating surpluses of two key public enterprises, the state fuel company (ANCAP) and the electricity generation company (UTE). On the other hand, it is plausible that the government sector would have captured rents due to higher commodity prices, directly through taxes on income and profits of enterprises, as well as indirectly through taxes on household incomes. While the government could save a large portion of buoyant revenues, it could also use revenue windfalls to finance growing government spending. The latter appears to have been the case in Uruguay with real expenditures growing faster than real revenues in recent years.

C. Some Stylized Facts

9.Preliminary evidence points to a strong correlation between commodity prices and measures of growth, but a weaker correlation with respect to fiscal variables. Commodity prices have a strong positive correlation with GDP growth, manufacturing output and the CERES leading indicator of activity. However, despite correlating strongly with revenues, commodity prices appear to have a weaker relationship with expenditures and the primary and overall balances. Moreover, Uruguayan export prices have a high positive correlation with international oil prices, particularly in the period 1980-2005—but this relationship is much weaker after 2005.

Covariance Analysis: Ordinary

Sample (adjusted): 1993Q1 2009Q1

Balanced sample (listwise missing value deletion)

article image

WEO commodity and non fuel commodity prices

Non financial public sector expressed in real terms

10. Moreover, the strong relationship between commodity prices and growth and revenues is specific to some commodities, but not others (Figure A1). Real GDP growth appears to have a strong positive correlation with prices of soybeans, wood and wheat, but a weaker (still positive) correlation with rice, beef and leather for example. Revenues appear to correlate strongly with prices of beef and soybeans, but not rice, wood or wheat prices.

Figure A1.
Figure A1.
Figure A1.

Uruguay: Real GDP and Selected Commodity Prices, 1970-2008

(annual percent change)

Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A002

Source: Uruguayan authorities and Commodity Price Database (IMF).

D. Methodology

11. First, we estimate parsimonious VARs analyzing the direct and indirect effects (via their effect on GDP) of commodity prices on revenues and expenditures. This method allows us to analyze the general impact of commodity prices on growth and fiscal variables using a simple model, given that a crucial transmission channel of commodity prices to the fiscal position in the case of Uruguay is through economic activity. We estimate three variable recursive VARs using quarterly data, covering the period 1994Q1-2009Q1 for commodity prices, real GDP growth and real revenues; then commodity prices, real GDP growth and real expenditures. A key motivation, is to allow for comparison with similar models estimated for other net commodity exporters in the region by Medina (2009), discussed in paragraph 18.

12. We construct a ‘Uruguay specific’ commodity price index designed to reflect more accurately the share of primary commodities in Uruguay’s export basket. The primary commodity price index is based on 2006-2008 export values for Uruguay, with the trade data derived from the UN’s World Integrated Trade Solutions (WITS). This constructed index, in our view, more accurately reflects Uruguay’s trade composition,3 and hence allows us to apply the relevant commodity price shocks to which it is vulnerable.

13. Impulse response functions derived from the VAR estimations indicate how growth, revenues and expenditures have responded to commodity price shocks. These responses take into consideration not only the direct impact of the shocks, but also their indirect impact through their feedback on real GDP growth, the endogenous variable. We impose strict exogeneity conditions on commodity prices as they are assumed not to be affected by domestic conditions in Uruguay. A Cholesky factorization is used with the following ordering: domestic economic growth; and real revenues (real expenditures).

14. The results confirm the positive impact of commodity price shocks on growth, but a more mixed impact on revenues. Commodity price shocks initially lower growth (at t=0), likely reflecting the immediate adverse impact of oil price shocks on the current account balance. However, within the first two quarters, growth increases and the impulse response becomes positive before eventually dying out after roughly 10 quarters. The impact of shocks on revenues is initially negative, again reflecting the adverse impact of oil price shocks on public enterprises and implied revenues of the non-financial public sector. Despite becoming less negative in the subsequent two quarters, the impulse response never turns positive—all in all, the negative impact of oil shocks appears to outweigh any potential benefits for higher revenues from higher export prices.

15. The fiscal response to GDP shocks suggests expenditures may tend to follow revenue developments. A GDP shock leads revenues and expenditures to rise instantaneously (at t=0)—with revenues rising by slightly more. Thereafter, both revenues and expenditures continue to rise for about a year, with the impulse responses becoming imprecise after that.

16. The response of expenditures to commodity price shocks appears similar to that of revenues. The response of GDP to commodity price shocks is as before. Like revenues, expenditures initially fall in response to commodity price shocks–this may be a response to revenues themselves falling. Thereafter, the impulse response of expenditures rises sharply within the first two quarters after the shock as expenditures return to previous levels. The response becomes imprecise after about 5 quarters.

17. These results bear a striking difference when compared to results from the large net commodity exporters of Latin America. A recent study by Medina (August 2009) analyzes the impact of commodity prices on the fiscal positions of a set of countries, including the main commodity exporters in Latin America (Argentina, Brazil, Chile, Colombia, Ecuador, Mexico, Peru and Venezuela). The paper finds heterogeneity in the response of revenues and expenditures to commodity price shocks, attributing this varied behavior in part to the diversity in fiscal institutional frameworks across these countries. Nonetheless, the response to commodity price shocks in these countries is broadly similar when compared to a net commodity importer such as Uruguay. Our findings for Uruguay compare as follows:

  1. Government revenues in the net commodity exporters are generally positively affected by commodity price shocks. As seen earlier, the response of revenues to commodity price shocks in the case of Uruguay is negative, appearing to be heavily influenced by oil price shocks;

  2. Like in Uruguay, revenues in Colombia initially fall sharply in response to commodity price shocks (Colombia is an outlier in this sense)—however, unlike in Uruguay, the revenue impulse response then recovers within the next 3 quarters, becoming positive within a year;

  3. With the exception of Chile (and to a lesser extent Peru), expenditures are highly procyclical in the net commodity exporters. In Uruguay, this result is less clear—expenditures can be thought of as procyclical to the extent that they follow the pattern of revenues (which become less negative within a few quarters of the initial commodity price shock), however, unlike the other countries they do not rise sharply in response to the commodity price shocks.

  4. The response of GDP to commodity price shocks is similar in all countries (including Uruguay)—positive commodity price shocks appear to have a strong positive influence on growth.

E. A Bayesian VAR Approach

18. In order to take better account of a full set of external shocks to Uruguayan growth and the fiscal position, we next estimate a Bayesian VAR.4 This methodology is in the same vein as Adler and Mansilla (2008) and Abrego and Par Osterholm (2008) who analyze the impact of external shocks on Uruguayan and Colombian growth, respectively. We adapt the model to examine the impact of commodity price shocks on growth and on fiscal variables, taking into account, in addition to fuel and non-fuel commodity prices, growth in Argentina and Brazil (an important conduit of commodity price shocks to Uruguayan growth and hence fiscal performance) and global financial conditions. The basic specification of the empirical model is based on the following set of variables:

x t = f { C P c o m , y A R G , y B R A , E M B I L A , y t , P B }

where:

  • CPcom is the cyclical component of the IMF’s world commodity price index, including both oil and non-oil commodities;5

  • yBRA denotes the cyclical component of Brazil’s GDP;

  • yARG denotes the cyclical component of Argentina’s GDP;

  • EMBILA is the Latin American JP Morgan EMBI Spread, and it used as a proxy for financial conditions in the region;

  • yt denotes the cyclical component of Uruguay’s GDP;

  • PB is the primary balance of the non financial public sector.

  • We also include a dummy variable for the period 2001Q1-2003QII to control for the impact of the financial crisis.

19. The model is estimated using quarterly data for the period 1994Q1-2009Q1. The steady state priors are based both on recent history and the author’s assumptions about plausible medium term ranges. The priors assume potential growth in Uruguay of a median of 3.5 percent (which is higher than the historical potential), mainly reflecting the wave of investment growth from 2006-2008. Growth in Argentina and Brazil is assumed to remain at levels in the sample period (3 percent median, respectively). The prior distribution of the EMBILA (centered at 400bps) reflects likely higher risk aversion towards the region than in the last few years, while the prior distribution for the change in commodity prices is centered on 0 percent (no change over the medium term).

20. The model yields plausible results and confirms the findings of the earlier simple VAR estimations.6 The basic specification confirms the importance of key external factors for growth and the primary fiscal balance. For example, a one standard deviation shock in the exogenous variables (expressed in each variable’s units) would cause the following effects on Uruguay’s GDP growth and primary balance (Figure 1):

Figure 1.
Figure 1.

Impulse Response Functions 1/

(At 95 percent confidence levels)

Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A002

1/ Shocks denoted by _s

  1. On balance, an increase in commodity prices raises Uruguayan growth by roughly 0.5 percentage points, with the positive impact fading away after about 5 quarters.7 An alternative specification including both oil and non-oil commodity indices indicates that the positive impact of commodity prices on growth derives mainly from the non-oil commodity index. Surprisingly, the oil index also has a positive and significant effect on Uruguayan growth, likely reflecting positive externalities from the positive effects of oil shocks on Argentine growth;

  2. Not surprisingly, the Argentina channel in particular represents an important transmission channel of commodity price shocks to Uruguay.8 First, commodity price shocks have a positive and significant impact on Argentina’s and Brazil’s growth. Secondly, an increase in Argentine growth has a strong positive and significant effect on Uruguayan growth, with the effects persisting for 8 quarters. By contrast, growth in Brazil has a very small impact on Uruguayan growth, with the impulse response becoming imprecise within 2 quarters.

  3. Commodity price shocks initially improve the primary balance (as expenditures fall more than revenues), however, the primary balance quickly reverts back as expenditures rise (with increased subsidies) and revenues of the non-financial public sector continue to fall reflecting the negative impact of oil price increases on public enterprises. This is consistent with our earlier VAR estimations where the impulse response of revenues to commodity price shocks is negative and V-shaped, while that of expenditures is negative but rising.

F. Conclusion

21. Commodity prices are important for growth and the fiscal position. Econometric estimates suggest that Uruguayan growth is sensitive to movements in commodity prices and even as a net commodity importer, the effects on growth are positive. Moreover, Uruguay’s strong economic links to the region provide an indirect channel through which commodity price shocks feed into Uruguayan growth, considering the positive impact of commodities on neighboring country growth. However, given the structure of fiscal revenues in Uruguay, any boost to revenues (from higher agricultural commodity prices) is indirect through higher growth, and easily wiped out by the negative impact of oil shocks on public enterprises. Moreover, commodity price shocks appear to raise expenditures (on subsidies for example), thus resulting in a deterioration of the primary balance.

Figure A2.
Figure A2.

Commodity Price Indices

(Uruguay specific and IMF)

Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A002

Figure A3.
Figure A3.

Response of GDP to Commodity Price Shocks (Medina, 2009)

Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A002

Figure A4.
Figure A4.

Response of Revenues to Commodity Price Shocks (Medina, 2009)

Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A002

Figure A5.
Figure A5.

Response of Expenditures to Commodity Price Shocks (Medina, 2009)

Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A002

References

  • Boccara B., 1994, “Why Fiscal Spending Persists When a Boom in Primary Commodities Ends” (Washington: The World Bank).

  • Bower U., A. Geis, and A. Winkler, 2007, “Commodity Price Fluctuations and Their Impact on Monetary and Fiscal Policies in Western and Central Africa,” ECB Occasional Paper, April.

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  • Calderon C. and K. Schmidt-Hebbel; “Macroeconomic Policies and Performance in Latin America”; Journal of International Money and Finance; Vol. 22; pp. 895–923; 2003.

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  • Calderon C. and K. Schmidt-Hebbel, and Fajnzylber, P. 2009, “How Much Room Does Latin America And The Caribbean Have For Implementing Counter-Cyclical Fiscal Policies?” April.

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  • Clements B., N. Eyzaguirre and J. Canales-Kriljenko, 2009, “Latin America: When Is Fiscal Stimulus Right?” IMF, Finance & Development (Washington: International Monetary Fund).

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  • Collier P. and B. Goderis, 2007, “Commodity Prices, Growth and the Natural Resource Curse: Reconciling a Conundrum,” University of Oxfords.

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  • Deaton A. and R. Miller, 1995, “International Commodity Prices, Macroeconomic Performance, and Politics in Sub-Saharan Africa,” Princeton Studies in International Finance 79.

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  • International Monetary Fund, 2009, Western Hemisphere: Regional Economic Outlook; “Saving for a Rainy Day? Sensitivity of LAC Fiscal Positions to Commodity Prices” Di Bella G., H. Kamil and L. Medina.

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  • International Monetary Fund, 2008: International Monetary Fund: “Western Hemisphere: Regional Economic Outlook” April.

  • International Monetary Fund, 2007a: “Norway: Selected Issues,”Rossi, M., Jafarov E., and Leigh D.; May.

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1

Prepared by Rita Babihuga.

2

Based on data from WITS (World Integrated Trading System).

3

Generalized commodity price indices e.g.,. the IMF commodity price index is weighted in favor of advanced economies’ trade, while the World Bank index is weighted toward developing economies’ trade—and hence may not provide the most accurate representation of trade weights for Uruguay. Uruguay specific terms of trade indices are not available for a sufficiently long period of time—the central bank’s index has been discontinued.

4

This methodology allows for the specification of informative steady-state priors for the variables used in the model, which reduces the problem of degrees of freedom arising from the generous parameterization associated with conventional VAR models, and improves forecasting performance. Interpreting the impulse response functions (which allow for imposing block exogeneity) is sufficient for the narrow purposes of this paper and we leave the discussion of the forecasts for a forthcoming working paper.

5

We estimate an alternative specification of the model using URY specific commodity price index.

6

We estimate several alternative specifications and report the results based on the general commodity price index (as opposed to the Uruguay specific index), as well as the separate impact of non oil commodity price shocks, and the impact on revenues and expenditures.

7

One standard deviation shock is roughly equivalent to a 17 percentage point increase in commodity prices.

8

This result is corroborated in the companion selected issues paper “The Influence of “Big Brother:” Does Uruguay Face Two Rests of the World?

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Cover IMF Staff Country Reports
Uruguay: Selected Issues
Author:
International Monetary Fund
Volume/Issue:
Volume 2010: Issue 043
Publisher:
International Monetary Fund
ISBN:
9781451839456
ISSN:
1934-7685
Pages:
62
DOI:
https://doi.org/10.5089/9781451839456.002

Growth and Commodity Prices, 1970-2008

(percent)

Fiscal Performance and Commodity Prices, 1970-2008

(percent)
Figure A1.

Uruguay: Real GDP and Selected Commodity Prices, 1970-2008

(annual percent change)
Figure A1.

Uruguay: Real GDP and Selected Commodity Prices, 1970-2008

(annual percent change)
Figure 1.

Impulse Response Functions 1/

(At 95 percent confidence levels)
Figure A2.

Commodity Price Indices

(Uruguay specific and IMF)
Figure A3.

Response of GDP to Commodity Price Shocks (Medina, 2009)
Figure A4.

Response of Revenues to Commodity Price Shocks (Medina, 2009)
Figure A5.

Response of Expenditures to Commodity Price Shocks (Medina, 2009)