Uruguay’s Potential Growth vs. Historic Growth Rates (4:1)

During the second half of the twentieth century, Uruguay exhibited very languid growth rates of about 1 percent on average. In contrast, 2013 will be the eleventh consecutive year of positive growth, in a period which has presented a much higher average rate. More importantly, the future poses promising perspectives: Uruguay’s potential growth is estimated at about 4 percent.

The country’s robust growth has been accompanied by other remarkable developments in many areas, which are related to creating better conditions of life for society as a whole, especially for the most vulnerable sectors; reinforcing economic and financial stability; and increasing room for maneuver to face eventual external shocks.

The Fate of a Country

Do external factors determine the fate of a small country? What are the contributions of domestic policies and reforms? On these questions, the Uruguayan authorities believe that domestic policies and structural reforms do matter, being the most critical factors to understand the different paths that countries take. Indeed, shocks could be similar for countries in the same region or with economic similarities, but results could be very different.

It is worth noting that over this decade, Uruguay has been one of the most dynamic economies in the region. However, contrary to what occurred in other countries in the region, in most of the decade Uruguay—which is an energy importer and does not export minerals—has dealt with unfavorable terms of trade. Meanwhile, the country has also suffered severe trade restrictions (especially on a regional level) and, more recently, the economic slowdown of neighboring countries; in past times these factors would have generated substantial negative effects on the country’s growth and investment. Nonetheless, economic activity continues expanding on a sound path, in line with the country’s potential growth, and it is expected that productive investment will continue to thrive. Evidently, beyond the undeniable significance of the external factors (whose total contribution for Uruguay’s case should be further elaborated), domestic policies and reforms are forging Uruguay’s present and future.

A Period of Critical Changes

As noted, Uruguay has shown a critical transformation over the past years. Without trying to establish an exhaustive list of reforms and results, it is possible to cite the following aspects:

• Diversification of trade

  • The country’s unrelenting search to diversify markets is reflected in the export figures which, for instance, show that Uruguay is exporting about 24 percent of its total external sales to Argentina (5.7 percent) and Brazil (18.1 percent), while this percentage was almost double at the end of the nineties.

• Continued enhancement of governance and transparency

  • Among other indicators, according to Transparency International’s corruption perception index, Uruguay and Chile (with a score of 72 – on a scale of 0-100) occupy the highest position in the region.

• Reform of the revenue administrations and the tax system

  • Evasion of VAT in Uruguay was estimated at 13.4 percent in 2012—relative to potential revenue of the above-referred tax—, presenting a huge decrease compared, for instance, with the levels observed ten years ago (about 40 percent); and Uruguay currently shows the lowest evasion rate in the region. Meanwhile, the transformation of the tax system aimed at increasing its efficiency and transparency, and contributing to the government’s objectives of creating an appropriate investment climate and increasing social justice.

• Creation of the Debt Management Unit

  • Risks have been substantially mitigated by extending maturities (average time to maturity increased from 7.4 years in 2004 to 11 years currently), reducing the percentage of debt denominated in foreign currency (from 89 percent to 47 percent) and in floating rate (from 23 percent to 5 percent). Of course, many of the transformations observed in Uruguay’s debt profile have generated an important fiscal cost, but, at the same time, have critically minimized risks and vulnerabilities looking forward.

• Reform of the Central Bank and the Financial Services Superintendency of Financial Institutions

  • The reform process of the Central Bank has led to a modern structure and functioning of the institution. Meanwhile, the sound indicators exhibited by Uruguay’s financial system in terms of capitalization, liquidity and non-performing loans clearly reflect the enormous transformation of the system and, particularly, of the body in charge of its regulation and supervision. Another critical aspect is the vital reduction of non-resident deposits, which literally eliminated what was an important transmission channel of regional shocks. Many other changes have been implemented in the financial system, of which the 2006 and 2012 FSAP suggestions were valuable inputs.

• Drastic transformation in the governance and incentives of the Banco de la República Oriental del Uruguay (BROU) and Banco Hipotecario del Uruguay (BHU).

  • To cite just one dimension of the BROU’s performance, there is a negligible level of 1.5 percent of non-performing loans (in the past, the BROU’s quality of assets signified an important fragility); meanwhile, the BHU has undergone a critical and historic transformation.

• Draft Law for Financial Inclusion

  • In many countries the lack of access to credit is a key obstacle that prevents them from enjoying more inclusive growth and more equal opportunities. In this regard, the law would encourage better and higher access to the financial system, particularly for weak sectors of society.

Reflecting Uruguay’s Transformation: The Illustrative Case of Investment

The very low investment rates were the Achilles’ heel of Uruguay’s economy, and a key factor in explaining the country’s tepid growth performance in the past. Historically, foreign direct investment (FDI) was negligible in Uruguay. Nonetheless, things have changed drastically. Figures 9 and 10 in the staff’s chapter on Competitiveness Trends in Uruguay provide an excellent picture of the transformation: between 2005 and 2012 FDI in the country doubled in terms of GDP, while among Latin American countries Uruguay is currently second (behind Chile) in attracting FDI (relative to countries’ GDP).

It is important to note that the substantial rise in capital imports—closely related to the surge of FDI—is a key element in explaining the widening of Uruguay’s current account deficit. The huge increase of investment, meanwhile, is critical to illustrate the new dynamic and perspectives of the country’s trade and the huge diversification of markets, all of which constitute a virtuous cycle. The country has been able to access markets that pay better prices for high quality goods. Comparative advantages always existed but, in recent years, investment has led to boosting production technologies, productivity, and quality, which is also pointed out in the above-referred chapter on competitiveness.

Some Dimensions of Uruguay’s Public Debt and Fiscal Position

As a member country of the IMF, Uruguay would like to express a few comments regarding the Fund’s assessments on debt issues, which goes well beyond this particular case. The Uruguayan authorities consider that the Fund should adapt its analysis to the new circumstances of the world and, particularly, of the emerging markets.

It is clear that monetary policies undertaken in some key advanced economies have “obligated” emerging markets to intervene in the exchange rate markets so that transitory shocks do not entail permanent effects. In that vein, Uruguay has had to accumulate a large amount of international reserves (more than 30 percent of its GDP), which is more than would have been desirable under normal circumstances. To a large extent, fiscal deficits have been higher than expected in recent years due to the above-referred interventions. Uruguay’s net public debt has critically decreased. However, the Fund’s analysis is much more focused on gross debt, which impedes a more comprehensive and fair assessment of the country’s fiscal situation, perspectives and eventual risks.

Analysts and the public in general compare countries’ debt ratios. However, are they comparable? Does the staff use the same definitions and coverage? For instance, how is the treatment of debt issued for sterilization operations in Uruguay and other similar countries? The staff’s comments are welcome.

Furthermore, how are contingent liabilities considered? Uruguay’s Central Bank has been capitalized. How is this positive development, which is recommended worldwide by the Fund, considered in the fiscal and debt figures? Likewise, Uruguay’s reform of the security system has allowed the country not to have contingent liabilities related to this matter to the extent that debt has been made explicit, and for this reason, gross debt is 20 percentage points higher compared with what would have been the case if reforms were not implemented.

Are transparency and reforms rewarded by the Fund’s analysis? The Uruguayan authorities believe that the Fund needs to redouble efforts to have better and more evenhanded assessments on debt issues, and to make ratios more comparable among countries. The authorities urge the IMF’s Management and staff to address this issue as soon as possible.

The Government’s Commitment to its Objectives

The Uruguayan authorities are fully committed to its highest priority of reducing inflation in the context of a flexible exchange rate system. In recent times, the country has had to deal with abundant portfolio inflows, which were related to ultra-loose monetary policies in advanced countries, but also, among other things, to Uruguay’s new investment grade status. Meanwhile, a vibrant domestic demand (to a large extent linked to higher employment and incomes, while it is also important to note that credit to the private sector relative to GDP remain at a modest—and sound—level of about 24 percent) and some constraints on the supply side exacerbated inflationary pressures.

As noted, the authorities are firm with their objectives and are flexible with the instruments used to reach them. In this regard, the government believed that changing instruments was sensitive and timely. Therefore, they introduced capital flow management measures which, of course, will have a temporary nature. For the reasons explained in the staff report, the Central Bank also decided to make changes to its policy framework and, particularly, its operational targets. Moreover, the authorities further tightened the monetary policy stance. After some months, it is possible to observe a more comfortable level of the real exchange rate; and, after a couple of months where depreciation intensified pressures, the last monthly report shows that inflation decreased from 9 percent in September to 8.67 percent in October. Admittedly, the figure is still high and pressures do not appear to have significantly receded, thus the authorities will continue monitoring developments and, if needed, will reinforce policies and instruments.

Economic and Social Achievements: Hand in Hand

As noted at other opportunities, the Uruguayan authorities understand the meaning of “stability” as a global concept which involves economic, financial, social and political stability. Of course, in times of robust growth and historic low records of unemployment, there are increasing wage pressures. However, wages (which decreased substantially during the 2002–03 crisis) have not been misaligned from the productivity path. In any case, the government carefully monitors these developments and has recently suggested restraining the growth of real wages. Beyond that, Uruguay has traditionally enjoyed a social, peaceful environment, and the current labor frameworks reinforce the tradition of searching better and sustainable social equilibrium and a fair treatment for all sides.

The results of the above-referred policies and reforms and, of course, active social policies are eloquent in the social area: poverty decreased from 25.7 percent in 2006 to 8.4 percent in 2012, and extreme poverty from 1.5 percent to 0.3 percent in the same period. Substantial progress has also been made with regard to the reduction of inequality. As one of the multiple dimensions of Uruguay’s social achievements, it is worth underlining the information provided in Box 1 of the staff report: “as a result of government efforts to include previously excluded segments of the population, health insurance has become near universal with about 95 percent of Uruguay’s population covered”.

As a political dimension, which may reflect the importance of gaining social consensus and increasing sustainability, an article about democracy in Latin America, published in the last issue of The Economist, brought about a survey among the countries in the region, asking “how satisfied are you with the way democracy works in your country?” 80 percent of Uruguayans responded “very satisfied” or “somewhat satisfied” which is double the regional average.

Conclusion

Of course, as any small and open economy, Uruguay is exposed to the changing circumstances of the world economy. The expected monetary tapering in advanced countries has the potential of creating noises and transitory volatility. Protectionist policies constitute another critical risk for an open economy like Uruguay. Beyond that, as noted, the country’s policies and reforms have created appropriate conditions to keep growing at a robust rate (in line with its potential growth), to be ready to withstand eventual global or regional shocks, and to continue improving the social conditions of its inhabitants. Clearly, much remains to be done in many areas. It is important to reiterate that reducing inflation constitutes a highest priority. Meanwhile, improving levels of education and infrastructure will be vital to face Uruguay’s future challenges and pave the way for further social and economic development.