Statement by Mr. Chodos, Executive Director on Uruguay, and Mr. Vogel, Advisor to Executive Director Board Meeting, February 8, 2016

Uruguay has achieved more than a decade of high and inclusive economic growth, supported by social stability and reduced regional linkages. The country has weathered the recent global and regional headwinds relatively well so far. Yet the economy is slowing down, while inflation remains above target, and deposit dollarization has risen. While the baseline projection foresees a temporary and moderate slowdown, the country is exposed to further shocks, especially from the immediate region.

Abstract

Uruguay has achieved more than a decade of high and inclusive economic growth, supported by social stability and reduced regional linkages. The country has weathered the recent global and regional headwinds relatively well so far. Yet the economy is slowing down, while inflation remains above target, and deposit dollarization has risen. While the baseline projection foresees a temporary and moderate slowdown, the country is exposed to further shocks, especially from the immediate region.

In 2015 Uruguay completed its thirteen consecutive year of positive growth, despite heightened global uncertainty and a marked regional slowdown. The staff report notes that “[the country] has become a bastion of stability in a volatile region”. Not long ago, recessions experienced in Uruguay’s biggest neighbors systematically spilled-over to the country—more often than not with amplified effects. Yet over the last few years Uruguay has been able to differentiate itself. Of course, there are substantial challenges and risks lying ahead in the short and medium term; nonetheless, it is clear that Uruguay is facing them from a position of strength. What are the factors that may explain the country’s resilience? What are the significant challenges looking forward? This Buff statement will try to elaborate on some of them.

Economic and Social Achievements Go Hand in Hand

Uruguay exhibits the lowest poverty rates and inequality indicators in Latin America. According to the latest figures, in 2014 extreme poverty was 0.2 percent (1.4 percent in 2006) and poverty continued to fall to reach 6.4 percent (24.2 percent in 2006). Meanwhile, the Gini coefficient declined to 0.38 (0.46, eight years earlier). The Uruguayan authorities have repeatedly underlined a concept of global stability, which comprised economic, social and political stability. Growth can and should be accompanied by better conditions for society as a whole, and these social achievements have in turn provided the societal consensus to undertake a critical path of sound policies and deep structural reforms. On this issue, the Uruguayan authorities would like to congratulate the Fund for its increasing attention to social issues, particularly inequality and its effects on growth.

Mercosur and Beyond

Not long ago, exports to Mercosur countries represented roughly half of Uruguay’s external sales. This has substantially changed over the last decade, as the economy opened up and diversified itself into new markets and products. As a result, Uruguay today sells goods to about 150 countries, and sales to Mercosur are less than a quarter of the total exports of goods. The authorities have repeatedly stressed that Mercosur should not be an objective by itself; instead, this regional trade block should serve as a platform for further integration with other regions and the world in general.

The Selected Issues’ chapter on “Boosting growth through diversification” provides a helpful perspective of the country’s developments and challenges, although it also has some caveats, for instance, when including an analysis on Uruguay’s linkages with Argentina based on data for the period 1980-2014; facts and links substantially changed over that long period, and thus an updated analysis that takes into account the structural changes that occurred during this time could be warranted.

From the Achilles Heel to an Essential Factor

Investment used to be one of the weakest sides of Uruguay’s economy and a drag for growth. Nevertheless, policies, reforms and the country’s investment law have allowed a reversal of the situation; investment is currently at about 24 percent of GDP and its allocation spreads across a number of sectors (involving goods and services) of the Uruguayan economy, constituting a key driver for diversification and growth. As a special case, it is worth noting that foreign direct investment (in terms of GDP) is—along with Chile—among the highest in the region, and continues to fully finance the current account deficit.

Mitigating Risks

Based on Uruguay’s traditional pillar of fulfilling commitments and honoring debts, the country’s policies over the past decade have driven the country to substantially reduce its debt-to-GDP ratio; as noted in the staff report, the country’s net public debt-to-GDP exhibits a considerable decline when comparing current levels with the average in the period 2004-12.

Meanwhile, the work of the Debt Management Unit, created a decade ago, drastically reduced financial risks in Uruguay’s debt portfolio, increasing the percentage of the Central Government debt denominated in local currency to 45 percent (vs. 11 percent ten years ago); the average time to maturity is one of the highest in the world (15.3 years, from 7.9 percent in 2005); and the composition of fixed-rate debt is 94 percent (vs. 78 percent).

Liquidity Buffers

The staff report refers to “Uruguay’s strong liquidity buffers” and to “the BCU’s ample gross reserves” that “could help cushion severe external shocks”. Indicators related to gross international reserves, published in Annex 1 of the staff report, lead to the same conclusion. Until 2014, amidst strong appreciation pressures of the domestic currency vis-à-vis the U.S. dollar, the BCU’s interventions aimed to moderate excessive volatility, which resulted in a considerable increase of international reserves and also, as a counterpart, in an increase of fiscal deficits and gross public debt (it is worth highlighting the first paragraph of Annex II of the staff report which states that “Uruguay is a particular case among emerging market economies as it is one of very few countries to report debt figures on a consolidated basis for the whole public sector, excluding public commercial banks but including the central bank”).

Thereafter, global circumstances changed and emerging-market currencies came to be under depreciating pressures. Thus, once again, Uruguay’s central bank has intervened in order to smooth excessive exchange rate volatility and reduce the likelihood of an eventual overshooting. In any case, exchange rate flexibility is seen by the authorities as essential and there has not been any policy or movement that goes against fundamentals (indeed, Annex I on External Stability Assessment concluded that “the real effective exchange rate remains in line with fundamentals”). It is important to mention that the BCU recently used reserves to reduce its costly short-term debt, which is leading to a strengthening of Uruguay’s balance sheet (thus, figure 2 of the staff report would benefit from a more nuanced analysis regarding the factors that explain the recent drop, when simply saying that “reserves are well above prudential norms despite a recent drop due to central bank intervention”).

Low or Prudent?

Over the past decade, Uruguay has made critical reforms to its financial system; among which, it is worth highlighting the substantial transformation of the Banco de la República Oriental del Uruguay (BROU) as well as critical changes to the regulatory and supervisory frameworks. The Selected Issues’ chapter on “Bank lending and completion in the banking sector” points out that “at just 25 percent of GDP in 2014, Uruguay’s private credit intermediation is among the lowest in the Latin American region”. At the same time, we can state that this relatively low credit indicator is to a good extent the consequence of Uruguay’s prudent approach (from lenders, borrowers and the Superintendency of Financial Services) which allows the country to exhibit a sound financial system with, for instance, the lowest non-performing loans (in percent of total loans) among the region (at 2.3 percent).

In any case, the Uruguayan authorities share the assessment that there is a significant scope for financial deepening and, in fact, they have been establishing additional reforms, such as the financial inclusion law, which constitutes a major structural transformation established in 2015, and will entail relevant effects on credit, growth, and social inclusiveness. The authorities fully agree with the staff’s comments that the expected changes will require “ongoing upgrades in Uruguay’s solid regulatory framework”.

There has been some increase in domestic deposit dollarization, but as noted in the staff report, a relevant part of the explanation is related to valuation effects. With regard to credit dollarization, paragraph 4 of the chapter on bank lending provides a clear picture of the situation: of the credit extended to households, only 4 percent was U.S. dollar denominated, while regulations significantly prevent currency mismatches among firms.

Consistent Objectives and Policies

The current slowdown presents a number of macroeconomic challenges; the reduction of inflation (under control but, admittedly, at higher rates than envisaged), the preservation of competitiveness, maintaining a sustainable path of fiscal accounts, and the continuation of the soundness of financial stability constitute high priorities for the Uruguayan government. In order to attain them, the Central Bank has kept a firm contractionary monetary policy stance (as said, in the context of a flexible exchange rate system); the five-year budget envisages a reduction in the fiscal deficit and a sound trajectory of the public debt; the authorities are fully committed to improving the efficiency of public enterprises and, particularly, restoring the financial position of the public oil distribution company. Furthermore, the government’s guidelines for the new round of wage council negotiations are fully in line with the above-referred objectives.

Institutional Quality

Uruguay’s solid institutions constitute a key factor when explaining the confidence that Uruguay enjoys from the investment community. In this regard, we could cite a few recent indicators that may mirror the country’s institutional quality.

According to the 2015 report of Corruption Perception Index published by Transparency International, Uruguay ranks as the 21st country with the lowest level of corruption among 168 countries, and with the lowest corruption levels across all emerging markets (and many advanced economies).

In addition, the Democracy Index (The Economist Intelligence Unit) categorizes Uruguay as a full democracy (which implies an absolute respect for civil liberties and representative governance). Furthermore, the latest Latinobarometro’s annual report enquired about the functioning of democracy; 70 percent of Uruguayans responded that they are satisfied or very satisfied (compared with an average of 37 percent in Latin America).

Looking Forward

Global, regional and domestic circumstances pose critical challenges and risks and, of course, the authorities will face them through their usual perspective: consistency among objectives and policies; substantial efforts to attain higher equality of opportunities, better income distribution and poverty reduction; and more structural changes. As also noted, Uruguay is facing this new situation from a solid position; amidst a very complicated regional situation, the country has been able to exhibit an expansion of its economy, have further upgrades in its sovereign debt ratings, and show steady sovereign spreads; the staff report speaks about “the ongoing differentiation by international investors between Uruguay and other countries in the region”.

However, the authorities are keen to emphasize that there is no room for complacency at all. Good results are just positive stimulus to face the future. The macroeconomic challenges of the new circumstances are substantial; and significantly more efforts are needed on many sides: a further integration with the world and other regions is critical; a deep change in the education system is vital; infrastructure must accompany the country’s developments; the investment climate should continue improving in order to keep attracting productive investment; and public enterprises must be consistent with the efforts made by the public sector as a whole. The Uruguayan authorities will continue working on all of these issues and would like to thank the Fund for the positive and constructive tone of the staff report and its relevant comments and suggestions.