Abstract
This 2011 Article IV Consultation highlights that the growth momentum in Uruguay has continued into 2011 but a slowdown is under way, led by weaker exports and slower public investment. Uruguay’s economic and financial vulnerabilities are modest, and the government has reduced debt vulnerabilities significantly and built important financial buffers. Executive Directors have commended authorities’ skillful macroeconomic management that has underpinned Uruguay’s excellent economic performance, lowered public indebtedness, and strengthened buffers against shocks.
I. Background
Uruguay has exhibited critical transformations in recent years. The country went through some complicated episodes in its economic history. While these episodes had some differences among them, we can also find common patterns. In a considerable part of these episodes, crises in neighboring countries severely affected Uruguay’s economic situation due to its high level of trade and financial exposure to the region; rigid exchange rate systems turned unsustainable and were abandoned, generating, together with significant slowdowns in economic activity, huge distortions on the financial system—also frequently weakened due to its own vulnerabilities—and on public and private debt indicators. Public finances came under stress, requiring fiscal adjustments, which further aggravated growth outlooks and social conditions.
Even in regular times since the mid-fifties, investment was scarce and growth was anemic or stagnant. We recall that less than a decade ago, some IMF staff reports expressed serious concerns about Uruguay’s lack of sources of investment and growth.
Nevertheless, the current situation is substantially different. GDP is expanding robustly and soundly; foreign direct investment is in abundance; unemployment is at historical lows; inflation is under control; credit remains at moderated levels; and social indicators are displaying noticeable improvements.
More importantly, looking ahead, Uruguay’s outlook is promising, though the new virulent phase of the global crisis brings about substantial challenges and risks worldwide and, Uruguay, as a small country with an open economy, is of course not immune. At the same time, the country demonstrates a number of conditions, stemming from the authorities’ policies and reforms, and founded on the country’s sound institutions, which allow us to conclude that Uruguay is facing the difficult external circumstances from a position of strength. Nonetheless, satisfactory results do not generate complacency. It just prompts further impulse to keep working and dealing with the outstanding challenges.
II. The Firm Pillars of Sound Institutions
Uruguay possesses critical intangible assets, and is committed to keep reinforcing them. It is a very respectable democracy around the world, with solid political parties, which have fully demonstrated responsibility and accountability, especially at times when the country must face difficult circumstances.
Uruguay’s institutions have exhibited important progress over time. Among other things that may reflect the above-referred comment, the last report of Transparency International on corruption perceptions placed Uruguay in 24th position (with a score of 6.9) out of 178 countries, while the World Bank’s Governance Indicators are going in the same direction, showing Uruguay at very high percentile ranks, for instance, in terms of control of corruption, political stability, voice and accountability and rule of law. Furthermore, according to the last annual survey of Latinobarometro, most of the Uruguayan people consider that Uruguay’s citizens act following the law. Moreover, the country’s long tradition of honoring commitments and debts signifies another factor that helps us to understand Uruguay’s developments over time.
III. Mitigating Vulnerabilities and Reinforcing Strengths
III.1 Lower Exposure to the Region
In the context of a comprehensive trade strategy pursued over the last decade, which has constantly looked for expanding exports to markets outside the region, Uruguay is presenting a considerable diversification. Reflecting that, exports of goods to Mercosur countries currently comprise 29 percent of Uruguay’s total external sales, while they used to be above 50 percent during the nineties.
In particular, there has been a critical decrease in exposure to Argentina, considering that currently exports of goods to that country represent just 7 percent of total external sales. More importantly, deposits from non-residents (particularly from Argentina) have undergone a substantial decline, which makes Uruguay much less exposed to regional circumstances.
Box 4 of the staff report presents some references on the links and spillover from Argentina and Brazil, but these results are based on information between 1980 and 2010, and, as noted above, many developments and transformations have occurred during that period, thus these results do not reflect the current situation and outlook. The same applies to the staff’s comments on fluctuations in output and employment and, in this regard, the mild impact observed in Uruguay’s economy after the Lehman crisis may constitute relevant proof of the country’s greater resilience to shocks.
III.2 Sound Fiscal Balance
Bold reforms have been waged in recent years on the tax system and revenue administration, which have not only aimed to increase revenues, but also, and especially, to further improve the system’s transparency and efficiency, as well as diminish vertical and horizontal inequality. Among other results, Uruguay is exhibiting a huge reduction in tax evasion (according to the revenue administration’s estimates, VAT evasion was at 15 percent in 2010, compared with 16.7 percent in 2009, and 40 percent in 2002). Meanwhile, as a virtuous cycle, the taxpayer’s perception of the system’s transparency and fairness (for instance, among other things that could be underscored in this regard, the country does not discriminate between residents and non-residents) tends to reinforce the country’s culture of tax compliance. Mirroring the above-referred developments, public sector revenue-to-GDP ratio, at 28.3 percent, shows an elevated indicator relative to Uruguay’s peers in the region.
On the expenditure side, the authorities maintain a prudent approach, focusing on some key areas, mainly education, infrastructure, housing, and health, which are crucial to critically boost Uruguay’s medium-term economic and social prospects. The authorities are fully aware that public infrastructure imperiously requires a further impulse from the private sector. It is worth mentioning that the PPP framework has already been established, and will start operating following the best international practices and, in this regard, the authorities would like to thank the IMF for the excellent technical assistance received on this matter.
III.3 Declining Public Debt; Less Dollarized and Longer Maturity
Consistent with the previous paragraph, the government is on the way to attaining the debt targets established in its five-year budget, which forecasts a declining debt-to-GDP ratio, set to reach 40 percent in 2015. Other objectives, such as that related to the de-dollarization of the public debt has almost been attained to the extent that the current share of debt in local currency is about 41 percent (the target for 2014 is 45 percent), while it was less than 5 percent six years ago. Furthermore, a debt maturity increase to an average of 12 years and the size of the debt at a fixed interest rate is 93 percent, underlining a significant reduction of risks in all of the debt dimensions. The Uruguayan authorities appreciate the staff’s comment that debt management constitutes “an area where Uruguay can be a model for other countries”.
Chapter II of the Selected Issues Paper underscores that “the findings suggest that Uruguay is well placed to reach investment grade, and could benefit from such an upgrade in terms of further spread reductions”. Actually, many local and global analysts and investors believe that the upgrade to the investment grade for Uruguay could be imminent, although, as usual, rating agencies seem to react with some delay. In any case, as noted in the staff report, Uruguay is trading at investment grade levels (on November 29, EMBIG Sovereign Spreads for EMBIG Latam was 479 bps, for Brazil 239, Chile 160, Colombia 209, Mexico 234, Peru 238 and for Uruguay 229).
III.4 Inflation under Control; Flexible Exchange Rate System
As in many developing countries, inflationary pressures have been considerable in Uruguay during the last years, to a large extent as a result of the increasing trend of commodity prices and a vigorous domestic demand. Therefore, inflation rates have been above the central bank’s target range, which required a tightening of the monetary policy in the first half of 2011. Meanwhile, considering that inflation remains under control, and especially the expected slowdown of the economic activity driving growth for the coming years to be closer to Uruguay’s potential growth, the authorities have decided on a pause in their monetary policy stance, while waiting to see how the regional and global economy evolves. In any case, the authorities have expressed their strong commitment to return inflation to the target range as soon as possible.
The authorities consider that a flexible exchange rate system constitutes an effective buffer to cushion external shocks. Under the current scenario characterized by outstanding global uncertainties, the authorities are of the view that intervention in the exchange market should be circumscribed to contain eventual overshooting. Meanwhile, they have been urging firms to hedge their positions through a more active participation in the forward market.
III.5 A Comfortable Level of International Reserves; More Contingent Loans
The authorities have taken advantage of the global liquidity and built an important buffer by accumulating a considerable amount of international reserves, which represents almost 9 months of imports, or 683 percent of short-term debt. The authorities consider that this may be a comfortable level of reserves (according to the new reserve adequacy metric range it could be somewhat high), although they are also of the view that global conditions do not allow for a conclusive assessment on this issue.
Furthermore, Uruguay has attained some important contingent credit lines from a number of regional and international financial institutions. In sum, the government’s financing needs for the coming years are small, and the coverage remains proper.
III.6 The Financial System
One of the most relevant structural changes in Uruguay has occurred in the financial system. Eminently, the regulation and supervision of the sector has been substantially strengthened, while developments and results in public banks reflect a dramatic transformation in their governance and incentives.
Although showing an increasing trend—which, according to the latest information, has been moderating over the last two months—the credit-to-GDP ratio is low compared with peer countries’ indicators and even with historical levels in Uruguay. The real estate market has presented a reasonable increase in dollar terms, but, as noted in Annex 1 of the staff report, prices do not seem overvalued, and, more importantly, the financial system is not significantly exposed to that market, taking into account that “banking credit has not been a main source of financing for the housing activity”.
Moreover, non-performing loans exhibit a negligible level. Some might argue about the level of provisioning entailed in Uruguay’s dynamic provisioning system. Notwithstanding, the authorities consider that during uncertain times it is appropriate to follow cautious policies. At the same time, indicators related to banks’ capital adequacy and liquidity point to a solid situation of the financial system, and, as stressed in the staff report, the authorities continue undertaking structural reforms in the system to further reinforce it.
III.7 Social Stability
As often stressed by the Uruguayan authorities, economic stability and social achievements are fully compatible and synergetic. Prudent macroeconomic policies have been successful in keeping inflation under control—a vital factor to protect the most vulnerable groups of the society—and making room for devoting a higher amount of resources to transparent, efficient and well-targeted social plans. As illustrated in Box 1 of the staff report, Uruguay has made important progress in terms of mitigating poverty conditions and reducing income inequality, which, as a virtuous cycle, increases social and political ownership of prudent policies and structural reforms.
Likewise, social stability is also related to establishing fair conditions for both, employers and workers. It is possible that Uruguay’s labor market framework has produced some normal tensions—which are not frequent at all. At the same time, it is important to take into account that labor changes could have been useful to contribute to rebalancing market forces in the labor market. In any case, it is worth mentioning that these normal tensions are tackled in the civilized and democratic manner deeply enrooted in Uruguay’s sound traditions.
Meanwhile, significant changes are needed in the labor market in order to reinforce “one of the great success stories in the Uruguayan economy”, as noted in the staff report. In this regard, the authorities consider that meeting Uruguay’s productivity challenges necessarily requires, among other things: closer links between salaries and productivity; a further reduction of informal employment (Uruguay shows one of the lowest rates of informality in the region); more training and capacity building programs; and significantly more efforts to increase competitiveness in the public sector, which entail further transformations in the sector.
IV. Uruguay’s Future Challenges
As noted, Uruguay’s performance has been robust. However, the global economic situation poses key challenges for the coming years, and, of course, prudent policies and structural changes will continue to be the authorities’ means to further strengthen the considerable buffers Uruguay displays in the fiscal, monetary, financial, and social sectors. Nonetheless, the expected slowdown and the financial distress in the world’s economy are not the only risks. Global and regional protectionism risks often emerge in times of crisis, and Uruguay, as a loyal member of the international community, hopes that detrimental policies in this regard are refrained.
At the outset we underscored that Uruguay has undertaken substantial transformations in recent years. In the past, amidst an anemic economic situation, characterized by an underutilization of resources, productivity did not seem to be a high priority. Currently, the country is growing robustly, even above its potential; the unemployment rate is very low, which also means that many sectors do not easily find skilled labor; the vitality of the economic activity also produces infrastructure gaps; and, innovation and entrepreneurship are needed to support and reinforce the country’s new stage. Therefore, Uruguay has to face a new situation, referred to by the authorities as “the productivity challenge”, and, in this regard, they reaffirm their efforts and commitments towards critically heightening productivity in all of its dimensions, which constitutes an imperious step for the country in order to keep improving the welfare of Uruguay’s population.