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.
III. How Important are Regional Factors for Uruguay?1
A. Introduction
1. The Uruguayan economy has historically been very sensitive to changes in regional economic conditions. In addition to the typical external disturbances faced by small open economies, such as shocks to terms of trade, to capital flows, or to the rest of the world’s demand, it is subject to a number of idiosyncratic shocks stemming from its relative big neighbors Brazil and Argentina.
2. The aim of this paper is to examine the role played by regional factors and to determine how vulnerable Uruguay is to potential turmoil in the region.2 To this end, the paper quantifies the extent of regional spillovers to the Uruguayan economy, and identifies some idiosyncratic financial and real linkages with Argentina that explain the high comovement of business cycles in these two countries. The paper also examines past crisis episodes in the region, trying to shed some light on the repercussions of potential financial turbulence in either one of the neighbor countries.
3. The main results of the paper confirm the key role played by regional influences, especially from Argentina. Shocks stemming from this neighbor explain about 20 percent of Uruguay’s output fluctuations. Moreover, a typical Argentine shock has large and rapid effects on Uruguay’s GDP growth. On other hand, shocks from Brazil do not appear to account for a significant fraction of Uruguay’s GDP fluctuations—despite the larger importance of Brazil as a destination for Uruguay’s exports. This is mainly due—in addition to a similar commodity export base and similar exchange rate policies in certain periods—to the existence of idiosyncratic real and financial linkages between Uruguay and Argentina.
4. However, Uruguay is now clearly less vulnerable to financial contagion from the region. Despite the importance of the strong idiosyncratic linkages, and despite the fact that the two largest financial and economic crises in recent Uruguayan history followed deep crises in Argentina, one cannot conclude that the potential occurrence of a new crisis in the region would necessarily cause a financial crisis in Uruguay. For once, the occurrence of simultaneous crises in Uruguay and Argentina can at least partially be explained by common external shocks affecting the region. In fact, not every past crisis episode in Argentina triggered a crisis in Uruguay, as evidenced by the 1989-90 hyperinflation crisis in Argentina. Regarding Brazil, past episodes of financial turbulence in Brazil did not cause major financial turmoil in Uruguay. Finally, the Uruguayan economy has reduced vulnerabilities to regional financial shocks, with sounder macroeconomic fundamentals, a more robust and better regulated banking system with lower exposure to Argentina, and a significantly reduced regional concentration of exports.
5. The rest of the chapter is organized as follows. Section B illustrates the high comovement of business cycles in the region, and describes the idiosyncratic and strong linkages that explain the particularly high correlations between Uruguay and Argentina. Section C examines the role played by regional influences as sources of output fluctuations in Uruguay, and how GDP growth has tended to react to shocks stemming from Argentina, Brazil, and the rest of the world. Section D looks at past crisis episodes in the region, trying to shed some light on Uruguay’s vulnerability to a potential new crisis in the region. Finally, section E ends with some concluding remarks.
B. Regional Linkages: The Influence of “Big Brother”
Regional business cycle comovements
6. Uruguay’s business cycle is highly correlated with that of its regional neighbors, especially Argentina (Figure 1 and 2). For the whole sample (1980Q1-2009Q2), the contemporaneous correlation between Uruguay’s and Argentina’s cyclical components of GDP is 0.61, with Argentina’s business cycle leading Uruguay’s one by one quarter (Table 1). In fact, the highest correlation in the cross-correlogram is the one between Uruguay’s GDP in quarter t and Argentina’s GDP in quarter t-1, with a coefficient equal to 0.67. The correlation between Uruguay’s and Brazil’s business cycles is positive but smaller than the one with Argentina (with a contemporaneous coefficient equal to 0.41); and there is evidence that the Brazilian business cycle leads the Uruguayan one by three quarters (Table 2).
Business Cycle in Argentina and Uruguay
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
Business Cycle in Brazil and Uruguay
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
Cross Correlations of Uruguayan and Argentine Business Cycles
(1980.IV-2009.I)
Cyclical components of the GDP series obtained using the Hodrick-Prescott filter
Cross Correlations of Uruguayan and Argentine Business Cycles
(1980.IV-2009.I)
| Cross correlations of Uruguay’s GDP in period t and Argentina’s GDP in period | ||||||||
|---|---|---|---|---|---|---|---|---|
| t-4 | t-3 | t-2 | t-1 | t | t+1 | t+2 | t+3 | t+4 |
| 0.452 | 0.580 | 0.642 | 0.670 | 0.606 | 0.472 | 0.311 | 0.162 | 0.041 |
Cyclical components of the GDP series obtained using the Hodrick-Prescott filter
Cross Correlations of Uruguayan and Argentine Business Cycles
(1980.IV-2009.I)
| Cross correlations of Uruguay’s GDP in period t and Argentina’s GDP in period | ||||||||
|---|---|---|---|---|---|---|---|---|
| t-4 | t-3 | t-2 | t-1 | t | t+1 | t+2 | t+3 | t+4 |
| 0.452 | 0.580 | 0.642 | 0.670 | 0.606 | 0.472 | 0.311 | 0.162 | 0.041 |
Cyclical components of the GDP series obtained using the Hodrick-Prescott filter
Cross Correlations of Uruguayan and Brazilian Business Cycles
(1978.IV-2009.I)
1/ Cyclical components of the GDP series obtained using the Hodrick-Prescott filter
Cross Correlations of Uruguayan and Brazilian Business Cycles
(1978.IV-2009.I)
| Cross correlations of Uruguay’s GDP in period t and Argentina’s GDP in period | ||||||||
|---|---|---|---|---|---|---|---|---|
| t-4 | t-3 | t-2 | t-1 | t | t+1 | t+2 | t+3 | t+4 |
| 0.452 | 0.471 | 0.465 | 0.444 | 0.415 | 0.371 | 0.308 | 0.220 | 0.110 |
1/ Cyclical components of the GDP series obtained using the Hodrick-Prescott filter
Cross Correlations of Uruguayan and Brazilian Business Cycles
(1978.IV-2009.I)
| Cross correlations of Uruguay’s GDP in period t and Argentina’s GDP in period | ||||||||
|---|---|---|---|---|---|---|---|---|
| t-4 | t-3 | t-2 | t-1 | t | t+1 | t+2 | t+3 | t+4 |
| 0.452 | 0.471 | 0.465 | 0.444 | 0.415 | 0.371 | 0.308 | 0.220 | 0.110 |
1/ Cyclical components of the GDP series obtained using the Hodrick-Prescott filter
7.The correlation with the regional neighbors’ business cycles has changed over time. For instance, the correlation between Uruguay’s and Argentina’s cyclical components of GDP is much larger in 1990-2009 than in the whole sample—with the correlation coefficient reaching 0.86 (Table 3). Against this background, Figure 3 illustrates the rolling correlations between Uruguay’s GDP cycle and those of Argentina and Brazil.3 While correlations with Argentina have remained high since the early 1990s, they have declined somewhat in the most recent years. However, it is worth noting that the correlation with Argentina in recent years is partly explained by the fact that both economies experienced a simultaneous strong recovery following the 2001 and 2002 crises, likely overstating the importance of linkages in the recent period. Correlations with Brazil, in turn, seem to have increased in the last years.4
Business Cycles in Mercosur: Rolling Correlations
(16-quarters windows)
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
Cross Correlations of Uruguayan and Argentine Business Cycles
(1990.IV-2009.I)
Cyclical components of the GDP series obtained using the Hodrick-Prescott filter
Cross Correlations of Uruguayan and Argentine Business Cycles
(1990.IV-2009.I)
| Cross correlations of Uruguay’s GDP in period t and Argentina’s GDP in period | ||||||||
|---|---|---|---|---|---|---|---|---|
| t-4 | t-3 | t-2 | t-1 | t | t+1 | t+2 | t+3 | t+4 |
| 0.537 | 0.688 | 0.804 | 0.865 | 0.833 | 0.688 | 0.506 | 0.342 | 0.209 |
Cyclical components of the GDP series obtained using the Hodrick-Prescott filter
Cross Correlations of Uruguayan and Argentine Business Cycles
(1990.IV-2009.I)
| Cross correlations of Uruguay’s GDP in period t and Argentina’s GDP in period | ||||||||
|---|---|---|---|---|---|---|---|---|
| t-4 | t-3 | t-2 | t-1 | t | t+1 | t+2 | t+3 | t+4 |
| 0.537 | 0.688 | 0.804 | 0.865 | 0.833 | 0.688 | 0.506 | 0.342 | 0.209 |
Cyclical components of the GDP series obtained using the Hodrick-Prescott filter
Idiosyncratic Linkages Between Uruguay and Argentina
8. Strong trade and financial linkages help explaining the high sensitivity of the Uruguayan economy to regional influences, in particular from Argentina. These linkages—in addition to a similar commodity export base, and similar exchange rate policies during some periods—are key determinants of the high comovement of business cycles.
9. Although it has diversified in recent years, Uruguay’s external trade has historically been largely dependent on the region. The trade openness process initiated in the 1970s was accompanied by a high concentration of trade with both Argentina and Brazil. This regional concentration was due not only to geographic reasons but also to institutional considerations: the preferential trade agreements signed with Argentina and Brazil in the 1970s and the creation of Mercosur in the 1990s.5 The share of Brazil and Argentina in Uruguayan trade increased significantly through the 1990s, with these two countries becoming the most important trading partners (Table 4). In particular, Brazil has been the largest single destination of Uruguay’s exports of goods, accounting for a share of total exports twice as large as that of Argentina in recent years. In the last decade, however, there has been a diversification of export destinations, with the regional share declining from about 45 percent in 1996-2000 to 25 percent in 2006-08.
Concentration of Uruguayan External Trade in Goods
(percent of total exports and imports)
Concentration of Uruguayan External Trade in Goods
(percent of total exports and imports)
| Argentina | Brazil | Rest of the World | ||||
|---|---|---|---|---|---|---|
| Period | Exports | Imports | Exports | Imports | Exports | Imports |
| 1961-65 | 1.3 | 6.0 | 2.6 | 8.8 | 96.1 | 85.2 |
| 1966-70 | 2.3 | 9.3 | 4.8 | 12.7 | 92.9 | 78.0 |
| 1971-75 | 4.6 | 14.4 | 12.6 | 15.3 | 82.8 | 70.3 |
| 1976-80 | 8.3 | 12.1 | 17.7 | 14.3 | 74.0 | 73.6 |
| 1981-85 | 9.2 | 9.4 | 13.7 | 16.4 | 77.1 | 74.3 |
| 1986-90 | 6.6 | 14.5 | 24.0 | 26.2 | 69.3 | 59.2 |
| 1991-95 | 16.7 | 20.4 | 24.3 | 25.1 | 59.0 | 54.5 |
| 1996-00 | 15.2 | 22.2 | 30.4 | 20.9 | 54.4 | 56.8 |
| 2001-05 | 8.8 | 24.0 | 19.2 | 20.9 | 72.0 | 55.0 |
| 2006-08 | 8.7 | 23.4 | 15.8 | 21.3 | 75.5 | 55.4 |
Concentration of Uruguayan External Trade in Goods
(percent of total exports and imports)
| Argentina | Brazil | Rest of the World | ||||
|---|---|---|---|---|---|---|
| Period | Exports | Imports | Exports | Imports | Exports | Imports |
| 1961-65 | 1.3 | 6.0 | 2.6 | 8.8 | 96.1 | 85.2 |
| 1966-70 | 2.3 | 9.3 | 4.8 | 12.7 | 92.9 | 78.0 |
| 1971-75 | 4.6 | 14.4 | 12.6 | 15.3 | 82.8 | 70.3 |
| 1976-80 | 8.3 | 12.1 | 17.7 | 14.3 | 74.0 | 73.6 |
| 1981-85 | 9.2 | 9.4 | 13.7 | 16.4 | 77.1 | 74.3 |
| 1986-90 | 6.6 | 14.5 | 24.0 | 26.2 | 69.3 | 59.2 |
| 1991-95 | 16.7 | 20.4 | 24.3 | 25.1 | 59.0 | 54.5 |
| 1996-00 | 15.2 | 22.2 | 30.4 | 20.9 | 54.4 | 56.8 |
| 2001-05 | 8.8 | 24.0 | 19.2 | 20.9 | 72.0 | 55.0 |
| 2006-08 | 8.7 | 23.4 | 15.8 | 21.3 | 75.5 | 55.4 |
10. The shares of goods exports underestimate Uruguay’s trade dependency on the region—especially on Argentina, given the importance of exports of services. Services accounted for about 30 percent of total exports on average over the last decade. This is mainly due to a large increase in receipts from tourism, which reached values comparable to those from the main traditional exports—such as beef and wool, with Argentina being by far the most important source of tourism in Uruguay (Figure 4). As in the case of goods, the relative importance of Argentina has declined in recent years as the geographical sources of tourism also diversified. In fact, the number of tourists from Argentina as a fraction of total tourists—which reached 70 percent on average during the 1990s—has declined to about 50 percent.6 The share of Brazil as a source of tourism in Uruguay has been substantially smaller than that of Argentina (although it has increased in recent years), accounting for less than 10 percent of total tourists on average over the past two decades (Figure 4).
Uruguay’s Tourism: the Importance of the Region
(number of tourists, in percent of total)
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
11. Uruguay’s vulnerability to regional disturbances has been exacerbated by the importance of “regional” goods and services. While the concentration of trade within the region makes Uruguay vulnerable to shocks stemming from it, the impact of these shocks has been amplified by the existence of regional goods and services—which are traded within the region but are largely non-tradable with the rest of the world. In the absence of a regional demand for them, they would be non-tradables. In fact, they can be traded within the region either because of the low transportation costs or because of the preferential treatment under which they are traded in the region. An obvious example of the first group is given by the tourism sector, whereas an example of the second group are exports of car parts to Argentina.
12. The vulnerability to the regional trade partners depends on the composition of trade. As noted by Bevilaqua, Catena and Talvi (2001), the vulnerability to shocks stemming from Argentina and Brazil is higher the higher the proportion of regional goods and services in total trade. A decline in aggregate demand or a large real devaluation in one of the neighbors would differently affect the tradable and regional sectors. On the one hand, exports of tradable goods—for example commodities such as beef, wool or rice—can be relocated in other markets, probably after an adjustment period, perhaps at somewhat lower prices and with possibly higher transportation costs. Thus, a substantial effect in output is not expected in those sectors. On the other hand, exports of regional goods and services cannot be relocated in the rest of the world. Hence, the negative regional shock would result in a large decline in output and employment in those sectors.
13. The share of exports of regional goods in total exports to Argentina has been much larger than the corresponding share for Brazil. This may partially explain the higher vulnerability of Uruguay to shocks originated in Argentina. While tourism and car parts represent the most important export items to Argentina, exports to Brazil consist mainly of agricultural commodities such as cereals—mainly rice—and other grains.7 Hence, while the pattern of trade with Argentina is to some extent idiosyncratic given the importance of regional goods, the one with Brazil is more similar to that with the rest of the world.
14. The strong trade linkages between Argentina and Uruguay are shown in Figure 5. The panel illustrates the high correlation of Argentina’s total imports with Uruguay’s GDP and with Uruguay’s total exports, and the high correlation of Argentina’s GDP with the number of tourists and with the foreign exchange receipts from tourism in Uruguay.8 The correlations of Brazil’s imports with Uruguay’s GDP and exports are illustrated in Figure 6.
Trade Linkages Between Argentina and Uruguay
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
Trade Linkages Between Brazil and Uruguay
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
15. Other idiosyncratic real linkages with Argentina are also important. In addition to the large flows of trade in goods and services and the high share of trade in regional goods, there are other non-conventional channels through which shocks from Argentina are propagated into Uruguay. These include large flows of FDI from Argentina, including flows of real estate investment, mainly through the purchase and construction of houses and buildings in tourism centers and through the purchase of large pieces of land in Uruguayan territory. In recent years, there has also been a substantial inflow of FDI from Argentina to the agricultural sector. Figure 7 shows the co-movements of the investment cycle and the construction cycle on both sides of the Rio de la Plata.
Real Linkages Between Argentina and Uruguay
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
16. The potential vulnerabilities to shocks from Argentina are not limited to real linkages. Financial channels also play a role. The most tight and direct financial linkage is due to the fact that the Uruguayan banking system has been host to Argentine depositors for many years. By the end of 2001—just before the bank-run of 2002—deposits of non-residents (mostly Argentines) accounted for 45 percent of foreign exchange deposits in the Uruguayan banking system, and for 60 percent of foreign exchange deposits in private banks. Although they have recovered somewhat since September 2008, these figures are much lower today than in the pre-2002 crisis period, at 25 percent and 35 percent respectively. Moreover, non-resident deposits accounted for more than 40 percent of total deposits—in foreign and domestic currency—by end-2001, and that fraction has declined to 20 percent in 2009. (Figure 8).9
Uruguay: Non-Residents Bank Deposits
(in percent of total deposits)
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
17. In sum, we have identified some idiosyncratic linkages between the Uruguayan and the Argentine economies. These include: the large flows of trade of goods and services; the large share of trade in regional goods; the large flows of FDI in real estate and the agricultural sector, and the large amount of Argentine deposits in Uruguay’s banking system. The existence of this number of real and financial channels through which shocks from Argentina propagate into Uruguay explains why Uruguay’s business cycle is highly correlated with Argentina’s one, and—notably—more correlated than with that of Brazil, despite the larger importance of the Brazilian market as a destination for Uruguay’s exports.
C. How Important are Regional Factors? An Econometric Approach
18. A standard VAR model with block exogeneity restrictions is estimated to quantify the extent of spillovers from external shocks into Uruguay. This empirical approach allows one to determine the relative importance of different regions as sources of disturbances affecting the Uruguayan economy, and to identify the dynamic responses of Uruguay’s output to shocks to foreign GDP growth. A key feature of the model is that external variables are assumed to be completely exogenous to the Uruguayan economy.
19. The VAR includes real GDP in Uruguay, in the region (Argentina and Brazil), and in the rest of the world. It may be argued that the importance of the regional neighbors in driving output fluctuations in Uruguay could be explained by common external shocks not captured by global GDP growth. Hence, the VAR includes some external factors such as world real interest rates,10 oil prices, and non-fuel commodity prices. The model is estimated using quarterly data from 1980Q1 through 2009Q2. All the variables—except the world real interest rate—are expressed in log levels, and the model is estimated in first differences,11, 12
20. In order to identify the structural parameters of the model, a set of restrictions must be specified. To assume full exogeneity of the external factors, block exogeneity restrictions are imposed, with the model separated in three blocks of equations: two external blocks—one including global factors and the other including regional variables—and one block with Uruguay’s GDP (Table 5). Each row indicates whether dependent variables of equations in a certain block are affected by dependent variables of other blocks. Each column indicates whether dependent variables of equations of a particular block appear as regressors in any equation corresponding to another block. 13
Block Exogeneity Restrictions of the VAR Model
Block Exogeneity Restrictions of the VAR Model
| Independent Block | ||||
|---|---|---|---|---|
| Global | Regional | Uruguay | ||
| Dependent Block |
Global | ✓ | ||
| Regional | ✓ | ✓ | ||
| Uruguay | ✓ | ✓ | ✓ | |
Block Exogeneity Restrictions of the VAR Model
| Independent Block | ||||
|---|---|---|---|---|
| Global | Regional | Uruguay | ||
| Dependent Block |
Global | ✓ | ||
| Regional | ✓ | ✓ | ||
| Uruguay | ✓ | ✓ | ✓ | |
21. Shocks to Argentina’s GDP growth appear to have quite large and rapid effects on Uruguayan GDP. Figure 9 shows the dynamic response of Uruguay’s GDP growth to a one standard deviation positive shock to Argentina’s growth: output increases on impact, with a lasting effect of about four quarters, and the largest response occurs only one quarter after the shock. A “rule of thumb” elasticity can be derived from the impulse response, which indicates that a 1 percentage point increase in Argentina’s GDP growth leads to an increase in Uruguay’s GDP growth of ½ percentage points after one quarter. A positive shock to global GDP growth is also expansionary, with the largest impact felt two to three quarters after the shock. In contrast, a one-standard deviation shock to GDP growth in Brazil has a negligible and statistically insignificant impact on Uruguay. This is very interesting, given the large share of Brazil in Uruguay’s trade. As discussed in the previous section, this may be partly explained by the composition of trade.
Dynamic Response of Uruguay’s GDP Growth
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
22. Variance decomposition analysis also underscores the key role played by Argentina (Table 6). Spillovers from Argentina account for more than 20 percent of Uruguay’s output fluctuations.14 While shocks to global GDP growth explain about 8 percent of GDP fluctuations, spillovers from Brazil appear to be insignificant.
Variance Decomposition of Uruguay’s Real GDP Growth
(in percent)
Variance Decomposition of Uruguay’s Real GDP Growth
(in percent)
| Horizon | Standard | Global GDP | World Real | Oil Prices | Non-fuel | Brazil’s GDP | Argentina’s | Uruguay’s |
|---|---|---|---|---|---|---|---|---|
| (quarters) | Error | Int. Rates | Comm. Prices | GDP | GDP | |||
| 1 | 0.0200 | 0.01 | 0.16 | 0.11 | 0.63 | 0.10 | 2.30 | 96.69 |
| 4 | 0.0244 | 6.44 | 3.90 | 1.73 | 0.55 | 0.25 | 22.47 | 64.67 |
| 8 | 0.0249 | 7.48 | 4.60 | 2.07 | 1.57 | 0.25 | 21.73 | 62.31 |
Variance Decomposition of Uruguay’s Real GDP Growth
(in percent)
| Horizon | Standard | Global GDP | World Real | Oil Prices | Non-fuel | Brazil’s GDP | Argentina’s | Uruguay’s |
|---|---|---|---|---|---|---|---|---|
| (quarters) | Error | Int. Rates | Comm. Prices | GDP | GDP | |||
| 1 | 0.0200 | 0.01 | 0.16 | 0.11 | 0.63 | 0.10 | 2.30 | 96.69 |
| 4 | 0.0244 | 6.44 | 3.90 | 1.73 | 0.55 | 0.25 | 22.47 | 64.67 |
| 8 | 0.0249 | 7.48 | 4.60 | 2.07 | 1.57 | 0.25 | 21.73 | 62.31 |
23. The residuals from the VAR model illustrate the volatility of output shocks, and the degree to which they are correlated with disturbances in other regions (Table 7). The most striking fact is the high volatility of regional output shocks, which are about 10 times more volatile than shocks to global GDP growth. This may reflect the high degree of domestic macroeconomic volatility, especially in Argentina and Uruguay—which both suffered severe crises during the period of analysis, with real output declining dramatically. In addition, the correlation and covariance of Uruguayan domestic shocks with impulses in Argentina is approximately four times as large as with those in Brazil.
Correlations, Covariances and Standard Deviations of VAR Residuals
Correlations, Covariances and Standard Deviations of VAR Residuals
| Global | Brazil | Argentina | Uruguay | Stand. dev. of | ||
| Covariance | domestic shock | |||||
| Global | Correlation | 0.000002 | 0.000001 | 0.000000 | 0.002 | |
| Brazil | 0.060 | 0.000013 | 0.00001 | 0.019 | ||
| Argentina | 0.020 | 0.030 | 0.00006 | 0.023 | ||
| Uruguay | 0.011 | 0.027 | 0.126 | 0.020 | ||
Correlations, Covariances and Standard Deviations of VAR Residuals
| Global | Brazil | Argentina | Uruguay | Stand. dev. of | ||
| Covariance | domestic shock | |||||
| Global | Correlation | 0.000002 | 0.000001 | 0.000000 | 0.002 | |
| Brazil | 0.060 | 0.000013 | 0.00001 | 0.019 | ||
| Argentina | 0.020 | 0.030 | 0.00006 | 0.023 | ||
| Uruguay | 0.011 | 0.027 | 0.126 | 0.020 | ||
D. How Vulnerable is Uruguay to a Crisis in the Region? A Case Study Approach
Crisis Episodes in the Region: A Closer Look
The 1981-82 and 2001 crises in Argentina
24. The linkages documented above contribute to the common belief that Uruguay remains particularly vulnerable to turmoil in Argentina. Moreover, this belief seems to be true if we observe what happened after the early 1980s and the 2001 crises in Argentina. These Argentine crises were followed by the two largest crises in recent Uruguayan economic history: the “Tablita” crisis in 1982 and the more recent one in 2002. Each of these episodes entailed a “triple” crisis in both borders of the Rio de la Plata: currency, banking and debt crises. In the 1982 crisis, GDP fell by a cumulative 10 percent in Argentina and by 20 percent in Uruguay; during the 2002 crisis, those numbers were 20 percent and 23 percent respectively (Figure 10). The large real exchange rate depreciations in Uruguay in these two episodes (100 percent in 1982 and 75 percent in 2002) followed even larger depreciations in Argentina (Figure 11). In both crises, the Uruguayan banking system suffered a dramatic bank run, and in both cases Argentina was facing a simultaneous banking crisis of its own. The bank runs in Uruguay were characterized by sudden and abrupt withdrawals of deposits by both residents and non-residents (mainly Argentines). Foreign exchange deposits from non-residents fell by about 50 percent whereas those from residents fell by 40 percent in the “Tablita” crisis; during the 2002 crisis the declines amounted to 65 percent and 30 percent respectively (figure 12).
Crisis Episodes in the Rio de la Plata: Economic Activity
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
Crisis Episodes in the Rio de la Plata: the Real Exchange Rate
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
Crisis Episodes in the Rio de la Plata: Bank Deposits
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
25. However, these facts do not imply that any financial crisis in Argentina would inevitably cause a financial crisis in Uruguay. The occurrence of simultaneous crises in both sides of the Rio de la Plata might have been explained, at least partially, by some common external shock. In fact, during those crisis episodes in Argentina and Uruguay, most Latin American countries were actually affected by systemic shocks. These were associated with disruptions in international financial markets that occurred in 1982 after the Mexican default and after the Russian crisis in August 1998. These disruptions brought large synchronized increases in the cost of external financing for Latin America and large reversals in capital inflows to the region. The tightening of international financial conditions led to sharp current account adjustments and large real exchange rate depreciations in Latin America, accompanied by severe contractions of investment and sharp reductions of economic growth (see Appendix).
26. Argentina not only suffered a similar pattern of macroeconomic adjustment but also experienced major financial crises and economic collapses. This is partially due to the fact that the external shock was compounded by domestic financial vulnerabilities, in particular the high level of currency mismatches in both the private and public sector. As noted by Calvo, Izquierdo and Talvi (2003), the large required adjustment in the real exchange rate caused huge balance sheet problems in the non-tradable sector, which affected the asset side of banks and led to fiscal sustainability problems. The final consequence of this sequence of events was a deep triple crisis: banking, currency and debt crises.
27. The economic disruptions in Uruguay were especially strong because of the additional contagion effect caused by the financial crisis in Argentina. That is, the effects of the external financial shock—which affected most countries in Latin America—were exacerbated by the specific negative shock stemming from Argentina and transmitted through the idiosyncratic linkages analyzed before. Financial linkages—mainly due to the large amount of deposits from Argentines in Uruguayan banks—constituted a key channel of transmission, as was evident in the 2002 crisis. Initially, as the crisis deepened in Argentina, capital outflows from this country sought refuge in the Uruguayan banking system. But later on, when the Argentine authorities declared a freeze on bank deposits (the “Corralito”) in December 2001, Argentine firms and households—facing strong liquidity constraints—began to withdraw their deposits kept at Uruguayan banks. The withdrawals escalated and became a run on deposits amid fears that the Uruguayan central bank could either run out of reserves or (like Argentina) confiscate the deposits and also concerns about the health of some large private banks with large exposure to Argentine assets. The abandonment of the peg and the default in Argentina also contributed to the contagion effects given fears of similar measures in Uruguay.
The 1989-90 hyperinflation and financial crisis in Argentina
28. A case of a pure idiosyncratic Argentine shock is the hyperinflation episode in Argentina, in 1989-90. During this crisis Argentina suffered a large decline in economic activity, a sharp real currency devaluation, hyperinflation and a banking crisis that ended in a freezing of deposits. This is an interesting case study because even though Argentina experienced a major financial crisis and economic collapse, the Uruguayan economy did not face any major disruption: economic activity declined only slightly, the real exchange rate did not depreciate and there were no withdrawals of deposits from the Uruguayan banking sector—in fact deposits increased due to a large inflow of Argentine deposits seeking safety (Figure 13 to 15). This all is the more remarkable as Uruguayan economic fundamentals were much more fragile than before the 1999-2002 crisis.
Hyperinflation Episode in Argentina (1989-90): Economic Activity
Real GDP (1987Q3=100)
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
Hyperinflation Episode in Argentina (1989-90): the Real Exchange Rate
RER (Jan. 1980=100)
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
Hyperinflation Episode in Argentina (1989-90): Bank Deposits in Uruguay
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
Crisis Episodes in Brazil
29. Episodes of economic and financial turbulence in Brazil may have also been a source of turmoil in Uruguay. Two major episodes can be identified in Brazil: the 1981-82 crisis, and the 1999 currency crisis. Although the early 1980s crisis was accompanied by a simultaneous crisis in Uruguay (Figure 16), it is hard to argue that Uruguay’s crisis was largely a consequence of Brazil’s one. As discussed before, this was mainly a systemic crisis affecting most Latin American countries following the Mexican default. In fact, the large real exchange rate devaluation in Uruguay actually preceded the one in Brazil (Figure 17).
Crisis Episodes in Brazil: Economic Activity 1981-82 crisis: Real GDP
(1980Q3=100)
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
Crisis Episodes in Brazil: Real Exchange Rate 1981-82 crisis: RER
(Dec. 1980=100)
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
30. The large devaluation of the real in 1999 is another case of a negative shock stemming from Brazil. As noted earlier, this hardly constitutes a Brazilian idiosyncratic shock, as most countries in Latin America were actually affected by a common negative external shock. In any case, the sharp real exchange rate depreciation in Brazil was not followed by a depreciation in Uruguay (Figure 18), and—although it negatively affected economic activity and exports in Uruguay—did not cause a collapse of output, as did the contagion effects from the Argentine crisis a few years later (Figure 19).
Crisis Episodes in Brazil: Real Exchange Rate 1999 crisis: RER
(Jan. 1997=100)
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
Crisis Episodes in Brazil: Economic Activity 1999 crisis: Real GDP
(1998Q2=100)
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
How Vulnerable is Uruguay Today to Disruptions in the Region?
31. Uruguay is now clearly less vulnerable to financial contagion from the region than in the past. Given the strong influence of regional developments, the question of the vulnerability of the Uruguayan economy to disruptions in the region remains. However, while adverse effects on Uruguay—mainly through real channels—would be unavoidable, a crisis in Uruguay is unlikely:
The Uruguayan economy entered the current global crisis better prepared. Improved macroeconomic fundamentals include single digit inflation, substantial international reserves, external current account deficits more than financed by record-high FDI levels, skillful debt management, and a more flexible exchange rate regime.
The exposure of Uruguayan banks to Argentina is significantly lower. Since the 2002 crisis, the regulation and supervision of the financial system have improved significantly and the authorities have taken measures to internalize credit risks from dollarization and cross-border activities. Non-resident deposits (mainly Argentine), which accounted for more than 40 percent of total deposits by end-2001, represent only 20 percent today. Moreover, while major banks used to be heavily exposed to Argentine assets in the past, this type of exposure is currently relatively small.
Uruguay’s banks are substantially healthier than during past episodes of crisis in Argentina. Banks are very liquid and well-capitalized, and the level of non-performing loans is quite low. This partly reflects the significant downsizing of the banking system after the 2002 crisis, a consolidation process that reduced the number of banks in the system. Moreover, credit and deposit dollarization have declined significantly, and currency mismatches in households and corporates’ balance sheets have also declined substantially.15
A significant diversification of export destinations has occurred in recent years. This has also helped reducing the vulnerability to the region, especially to Argentina. In fact, the concentration of Uruguayan trade (not only in goods but also in services) in Argentina has declined substantially. While exports to Argentina represented more than 15 percent of total exports of goods in the 1990s, they accounted for only 8 percent on average since 2001. Moreover, tourism receipts from Argentines—which explained almost 70 percent of Uruguay’s total receipts from tourism in the 1990s have declined to less than 45 percent. The share of Brazil in Uruguay’s exports has also fallen, with non-regional destinations becoming increasingly relevant.
E. Final Remarks
32. How important are regional factors? This paper shows that Uruguay has been very sensitive to changes in regional conditions, especially to developments in Argentina. Shocks stemming from Argentina—which account for about 20 percent of output fluctuations in Uruguay—tend to have large and rapid effects on Uruguay’s GDP growth. This is mainly due to the existence of some idiosyncratic real and financial linkages between Uruguay and Argentina that also explain the very high correlation between business cycles in these two countries. Thus, it may be argued that—to some extent—Argentina constitutes a second “rest of the world” for Uruguay; a source of shocks that are of different nature, and are transmitted through different channels than traditional external shocks.
33. How vulnerable is Uruguay today to a potential crisis in one of its neighbor countries? The analysis of previous crisis episodes in the region suggests that despite the importance of the strong linkages, and even observing that the two largest financial and economic crises in recent Uruguayan history followed deep crises in Argentina, a potential new crisis in the region—although it would negatively affect Uruguay through real channels—is not likely to trigger a corresponding crisis in Uruguay this time around.
External Shocks and Macroeconomic Adjustment in Latin America
Citation: IMF Staff Country Reports 2010, 043; 10.5089/9781451839456.002.A003
References
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Bevilaqua, A. M. Catena, and E. Talvi, 2001, “Integration, Interdependence, and Regional Goods: An Application to Mercosur,” Economia, Vol. 2, Number 1 (Fall 2001).
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Calvo, G., and L. Leiderman, and C. Reinhart, 1993, “Capital Inflows and the Real Exchange Rate in Latin America: the Role of External Factors,” Staff Papers, International Monetary Fund, Vol. 40, pp. 108–50.
Calvo, G., and L. Leiderman, and C. Reinhart, E. Fernandez Arias, C. Reinhart, E. Talvi, 2001, “The Growth-Interest-Rate Cycle in the United States and its Consequences for Emerging Markets,” Inter-American Development Bank Working Paper no. 458.
Calvo, G., and L. Leiderman, and C. Reinhart, E. Fernandez Arias, C. Reinhart, E. Talvi, and E. Talvi, 2003, “Sudden Stops, the Real Exchange Rate and Fiscal Sustainability: Argentina’s Lessons,” NBER Working Paper No. 9828.
Calvo, G., and L. Leiderman, and C. Reinhart, E. Fernandez Arias, C. Reinhart, E. Talvi, and E. Talvi, and E. Talvi, 2005, “Sudden Stop, Financial Factors and Economic Collapse in Latin America: Learning from Argentina and Chile,” NBER Working Paper No. 9828.
Eble Stephanie, 2006, “Uruguay’s Growth Story,” in IMF Selected Issues Paper, Country Report No. 06/427.
Favaro, E. and C. Sapelli, 1989, “Shocks externos, grado de apertura y politica domestica,” Banco Central del Uruguay, Montevideo, Uruguay.
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Talvi, Ernesto, 1995, “A ‘Big Brother’ Model of a Small Open Economy: The Impact of Argentina on Uruguay’s Business Cycle”, Ph. D. dissertation, University of Chicago.
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Prepared by Sebastián Sosa.
The literature on Uruguay’s regional linkages has focused mainly on real shocks. In spite of their importance, the key financial linkages with Argentina have not been analyzed deeply. See Favaro and Sapelli (1986), Talvi (1994), Bergara, Dominioni and Licandro (1994), Masoller (1998), Bevilaqua, Catena and Talvi (1998), Kamil and Lorenzo (1998), Voelker (2004), and Eble (2006), among others.
Rolling correlations were computed using 16-quarter windows, considering lags of one quarter for Argentina’s GDP cycle and three quarters for Brazil’s, based on the cross-correlogram for the whole period.
This could reflect either a higher influence of Brazil or a more similar reaction to global shocks.
Uruguay signed two preferential trade agreements with its regional neighbors. The first one was signed with Argentina (CAUCE) in 1974; the second one was signed with Brazil (PEC) in 1975.
Similarly, the share of Argentina in Uruguay’s total receipts from tourism reached almost 70 percent in the 1990s, and has declined to less than 45 percent in recent year.
See Bevilaqua, Catena, and Talvi (2001).
Previous studies have also emphasized the correlation between Uruguay’s output and Argentina’s consumption. See, for instance, Masoller (1998) and Eble (2006).
Uruguayan banks had been exposed to Argentina from the assets side as well. Argentina accounted for about 20 percent of total bank credit before the 2002 crisis. However, that figure is negligible today.
Changes in international real interest rates constitute an important factor driving portfolio capital inflows to Latin America, thus influencing business cycles across the region (Calvo, Leiderman, and Reinhart, 1993, and Calvo, Fernandez Arias, Reinhart, and Talvi, 2001).
Standard unit root tests (augmented Dickey-Fuller) show that all variables are stationary in first differences. In addition, most cointegration tests suggest that the variables in the model are not cointegrated.
The lag length—one quarter—was selected according to the Schwarz information criterion.
Standard VAR models may be estimated by Ordinary Least Squares (OLS). However, when some of the equations present regressors not included in others, Seemingly Unrelated Regressions (SUR) appear to provide more efficient estimates of the coefficients than OLS. Thus, the system is here estimated using SUR.
For a horizon of eight quarters, which is when the percentages stabilize.
The implicit exchange rate risk index, measured as foreign currency credit to the non-tradable sector as a percentage of total credit, has declined from 55 percent in 2003 to below 35 percent in 2009.
