Uruguay: 2021 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for Uruguay
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International Monetary Fund. Western Hemisphere Dept.
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Publication Date:
25 Jan 2022
eISBN:
9798400200236
ISBN:
9798400200236
Language:
English
Keywords:
monetary policy rate; Uruguayan peso; inflation expectation; core inflation; BCU estimate; COVID-19; Global
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1. Uruguay entered the pandemic with solid institutions and a high degree of social cohesion but pre-existing macroeconomic imbalances. The country stands out in the region for its well-functioning institutions, and high degree of social cohesion.1 Its solid financial sector, ample reserve buffers and investment grade status are also key pillars of its stable economy. However, after the end of the commodity boom in 2014, macroeconomic imbalances emerged, with weakening public finances and low economic growth, amid low investment and declining employment.2 Labor market frictions—including wage rigidities and a growing labor force skill mismatch rooted in poor outcomes in basic education—contributed to weak employment and persistently high youth unemployment. Inflation remained consistently above the target range.

Abstract

1. Uruguay entered the pandemic with solid institutions and a high degree of social cohesion but pre-existing macroeconomic imbalances. The country stands out in the region for its well-functioning institutions, and high degree of social cohesion.1 Its solid financial sector, ample reserve buffers and investment grade status are also key pillars of its stable economy. However, after the end of the commodity boom in 2014, macroeconomic imbalances emerged, with weakening public finances and low economic growth, amid low investment and declining employment.2 Labor market frictions—including wage rigidities and a growing labor force skill mismatch rooted in poor outcomes in basic education—contributed to weak employment and persistently high youth unemployment. Inflation remained consistently above the target range.

Pre-Pandemic Context: Solid Institutions but Growing Imbalances

1. Uruguay entered the pandemic with solid institutions and a high degree of social cohesion but pre-existing macroeconomic imbalances. The country stands out in the region for its well-functioning institutions, and high degree of social cohesion.1 Its solid financial sector, ample reserve buffers and investment grade status are also key pillars of its stable economy. However, after the end of the commodity boom in 2014, macroeconomic imbalances emerged, with weakening public finances and low economic growth, amid low investment and declining employment.2 Labor market frictions—including wage rigidities and a growing labor force skill mismatch rooted in poor outcomes in basic education—contributed to weak employment and persistently high youth unemployment. Inflation remained consistently above the target range.

uA001fig01

Investment Rate and Output Growth, 2015–19 (average)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: WEO and IMF staff calculations.
uA001fig02

Output Growth and Employment, 2000–19 (in percent)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: WEO, Haver and IMF staff calculations.1/ Excludes temporary transfers from individual pension accounts due to pension reform (’cincuentones’).
uA001fig03

Fiscal Balance and Public Debt, 2008–19 (in percent of GDP)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: WEO, Haver and IMF staff calculations.1/ Excludes temporary transfers from individual pension accounts due to pension reform (’cincuentones’).

2. A new government—with a mandate to boost growth and restore fiscal sustainability—came to power in March 2020. Despite the challenging circumstances—as the pandemic arrived only weeks after the new administration took office—an omnibus law, laying the foundations of its reform program (’Ley de Urgente Consideracion’), was passed in July 2020. Among other things, the law established the basis for a new fiscal framework to strengthen fiscal discipline, reforming state-owned enterprises, reforming the pension system, and giving regulatory agencies greater autonomy, including to set utility rates. Implementation has advanced, although at a slow pace due to the pandemic and, more recently, the prospects of a referendum in 2022H1 to unwind some of the elements of the law.

The Pandemic

A. Recent Developments

3. The pandemic had markedly distinct phases in Uruguay. Effective containment measures kept the spread of the virus remarkably low throughout most of 2020 (Figure 1) although activity contracted sharply at the onset of the pandemic due to the severe impact of the crisis on mobility and contact-intensive sectors (Figure 2). Growth rebounded strongly in 2020H2 but lost steam in early 2021 as a severe COVID wave took hold. More recently, following a rapid vaccination campaign—one of the fastest in the world— the spread of the virus has come to a near halt, and the recovery has regained speed.

Figure 1.
Figure 1.

Uruguay: COVID-19 Developments

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: Google, OWID, John Hopkins University. IMF staff calculations.1/ Hale, T. , N. Angrist , R. Goldszmidt , B. Kira , A. Petherick , T. Phillips, S. Webster, E. Cameron-Blake , L. Hallas, S. Majumdar, and H. Tatlow. (2021). “A global panel database of pandemic policies (Oxford COVID-19 Government Response Tracker).” Nature Human Behaviour.
Figure 2.
Figure 2.

Uruguay: Real Activity

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: World Economic Outlook, Haver Analytics, Banco Central del Uruguay (BCU), Instituto Nacional de Estadística, Bloomberg L.P., and IMF staff estimates and calculations.1/ Consumer confidence values above 50 indicate positive/optimistic expectations and values below 50 are negative/ pessimistic expectations. For businesses, the chart shows the difference between the respondents with positive expectations on the economy or their own firm, and those with negative expectations.
uA001fig04

COVID-19 cases. Vaccination, Mobility and Economic Activity

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: OWID, Google Mobility indicators, BCU and IMF staff calculations.1/ Daily average of the month.2/ Monthly estimates by IMF staff

4. The recovery in output has been uneven and employment has lagged. Primary activities and construction rebounded rapidly from the initial contraction—supported by the rebound in external demand, booming commodity prices, and the easing of mobility restrictions—and are already above pre-pandemic levels. Meanwhile, contact-intensive activities were highly affected and recovered more slowly, although high frequency indicators point to a speeding rebound following the recent reopening of the economy. In tandem with aggregate output, employment plateaued below pre-pandemic levels in early 2021—after rebounding rapidly in 2020H2—although there are signs of a further uptick in recent readings.

uA001fig05

Economic Activity

(Index 2019 = 100,4-quarter average)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Source: Haver and Fund staff calculations
uA001fig06

Employment and Hours Worked

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Source: INE.

5. Inflationary pressures subsided in early 2021—after peaking in 2020—although there are signs of new underlying pressures stemming from external prices. Following two years of overshooting the 3–7 percent target range, inflation spiked above 10 percent in mid-2020, due in part to the depreciation of the peso and supply disruptions. In 2021H1, headline and core inflation trended downwards—amid economic slack, mild administrative price changes, and a stable exchange rate—but there are signs of renewed inflationary pressures stemming from food and global inflation. Medium-term inflation expectations have moved closer to the target range, although remaining above it (Figure 5).

Figure 3.
Figure 3.

Uruguay: Labor Market

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: Haver, ILOSTAT, Instituto Nacional de Estadística, and IMF staff calculations.
Figure 4.
Figure 4.

Uruguay: External Accounts

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: Banco Central de Uruguay (BCU), World Economic Outlook, Instituto Nacional de Estadística, Haver Analytics, and IMF staff calculations.1/ Positive means inflow.2/ Positive means FDI inflow.
Figure 5.
Figure 5.

Uruguay: Inflation

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: World Economic Outlook, Haver Analytics, Banco Central del Uruguay (BCU), Instituto Nacional de Estal destica, Bloomberg L.P., and IMF staff estimates and calculations.1/ Excluding meat and meat products.2/ Excludes administered prices, and prices of fruits and vegetables, in line with the BCU’s definition.3/ As of September 2021.
uA001fig07

Imported inflation

(4-m MA, y-on-y percentage change)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: BCU, INE, Haver analytics and IMF staff calculations.

6. The exchange rate worked effectively as a shock absorber. Responding to the pandemic, the Uruguayan peso displayed a sizable nominal depreciation in early 2020 and has remained broadly stable since then. After some interventions to mitigate currency pressures in 2020, the exchange rate has floated, displaying some nominal and real appreciation. The real appreciation vis-à-vis Brazil and, most notably, Argentina, pose challenges for sectors that depend heavily on demand from these neighbors, adding to the significant uncertainty about the impact of the reopening of borders.

uA001fig08

Nominal and Real Exchange Rates

(2018= 100)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: IMF INS and staff calculations.
uA001fig09

Real Exchange Rates (Index, 2018M1 = 100)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Source: BCU, IMF INS, IMF staff estimates.

7. The current account shifted from a 1.6 percent of GDP surplus in 2019 to a 0.6 deficit in 2020. Weak external demand, border closures, and supply chain disruptions drove a decline in exports, only partially offset by lower imports—reflecting shrinking domestic demand—and lower fuel import prices (Figure 4). Despite a strong rebound in exports—driven by agricultural commodities—the current account deficit is expected to widen further in 2021 reflecting the sharp drop in tourism receipts—as the full effect of the pandemic was felt in the 2021 summer season— and large imports related to the UPM pulp mill project. Financial flows were resilient throughout, supported by large FDI inflows (driven by the pulp-mill project and sizeable inter-company loans) which more than offset the domestic banks’ purchases of foreign assets. The 2020 external position was broadly in line with fundamentals (see Annexes I and VI). The authorities intend to maintain the SDR allocation in international reserves.

B. Policy Response to the Pandemic

8. A comprehensive policy package was implemented to mitigate the impact of the pandemic.

  • Fiscal policy. A package of about 2.7 percent of GDP for 2020–21 was deployed to meet greater health spending needs, protect the most vulnerable and keep employment and firms afloat, within the boundaries of available fiscal space. The solid existing social protection and health care systems, and low poverty rates limited the necessary resources to tackle the health crisis, especially compared to peer countries. The fiscal package included tax breaks and additional resources for health related-expenses, enhanced unemployment insurance, and transfers to vulnerable households (see Annex II).3 The overall balance of the non- financial public sector (NFPS), excluding ’cincuentones’, weakened from -3.8 percent of GDP in 2019 to -5.2 in 2020 (Figure 6).4 The mild fiscal deterioration was aided by revenue resilience as income tax revenues remained unchanged relative to GDP and the fall in social security contributions (due employment losses and tax relief measures) was mostly compensated by a surge in VAT revenues.5 Higher spending mostly reflected the support measures, while non-COVID spending contracted somewhat. The fiscal balance is projected to improve to -4.5 percent of GDP in 2021, reflecting the economic recovery and further restraint on discretionary spending. The introduction of a new fiscal framework—aimed at strengthening fiscal discipline and ensuring medium-term sustainability—served to signal the authorities commitment to fiscal consolidation despite the impact of the pandemic on public finances (see Annex III and discussion below).6

Figure 6.
Figure 6.

Uruguay: Fiscal Developments

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: BCU, INE, MEF, CGN and IMF staff calculations.1/ Excluding cincuentones transactions.
uA001fig10

Fiscal Stimulus Package (In percent GDP)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Source: MEF and staff estimates
uA001fig11

Balance NFPS 1/

(In percent of GDP)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: MEF and IMF staff calculations.1/ Excluding ’cincuentones’ transactions.

  • Monetary policy. At the onset of the pandemic, the BCU deployed ample liquidity support by lowering reserve requirements and rapidly expanding the monetary base (a 40 percent increase from February to August 2020). The shift to the interest rate as main policy instrument, in September 2020, confirmed the highly accommodative stance, leading to deeply negative short-term real rates and a downward shift of the yield curve (Figure 7). More recently, accompanying the recovery, the monetary policy rate has been increased by 125 basis points, bringing the policy rate to 5.75 percent—although the stance remains accommodative with a real rate of about -1 percent (Figure 5). Market expectations on the path of monetary policy have been guided by the BCU’s commitment to support the economy and increase rates as the recovery was underway. Changes to the monetary policy framework (Box 1) and the recent monetary policy tightening have lent support to the BCU’s commitment to bring inflation into the target range going forward, although one-year ahead inflation expectations remain above the target range.

  • Financial sector policy. Regulatory forbearance measures and lower reserve requirements helped avoid financial stress and a contraction of credit (see Annex II). The extension of bank loan repayments up to 180 days for all non-financial corporations and individuals benefited about 45 percent of private loan repayments up to August 2021. In addition, the National System of Guarantees (SIGA) launched three lines of credit guarantees for SMEs, sectors highly impacted by the pandemic, and large companies, with an average guarantee of about 70 percent (covering over 5 percent of private sector loans or 1.4 percent of GDP). Finally, the National Development Agency (ANDE) launched credit lines for small and micro firms, resulting in loans for US$29 million (0.05 percent of GDP).

Figure 7.
Figure 7.

Uruguay: Monetary Policy

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: IMF, World Economic Outlook; Banco Central del Uruguay (BCU); and IMF staff estimates and calculations.1/ Yields on BCU paper issued in nominal pesos (Letras de Regulación Monetaria).2/ Average interest rates on new peso loans of up to one year.3/ Weighted average rate on totality of fixed term deposits.
uA001fig12

Change in Interest Rates Jan20-Jan21 1/ (In percentage points)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Source: Haver, BCU, Consensus Forecast.1/ One-month rate on Letrasde Regulacion Monetaria. reported for Uruguay. Policy rates for other countries. 12-month ahead inflation expectations is used to compute real rates.

An Enhanced Monetary Policy Framework

The central bank introduced various changes to its monetary policy framework with the goal of strengthening credibility and lowering the cost of its disinflation plan. After several years of overshooting the inflation target range, the new administration presented a new 5-year strategic plan1 with significant changes to its monetary policy framework, mainly along 3 dimensions:

• Monetary policy objective. The plan reaffirmed price stability as its primary monetary objective and clarified that smoothing short-term financial market volatility, including of the exchange rate, “will be carried out as long as it does not collide with the main targets of monetary policy.”

• Policy instrument. The policy instrument shifted from the growth rate of M1+ to the short-term interest rate. 2,3

• Disinflation path. It announced a reduction of the upper band of the range from 7 to 6 percent, effective September 2022, along with the intention to converge to a target centered around 3 percent over the medium term.

Additional efforts are underway to enhance the central bank’s independence, accountability, and transparency. The meeting of the Macroeconomic Coordination Committee (MCC)—created to facilitate coordination between the BCU and the Ministry of Finance—were decoupled from the Monetary Policy Committee (COPOM) meetings, reducing the frequency of the first and doubling the frequency of the latter. The BCU introduced new communication and transparency practices in line with international standards, including publishing minutes of the meetings and strengthening existing reports to clearly link the policies and the objectives as well as discussing expected future monetary policy actions to guide market expectations. The central bank is also working on improving its survey of inflation expectations as a step towards gaining a better understanding of the process of expectation and price formation, has recently undergone a Central Bank Transparency Review4 and is seeking technical assistance on central bank communications (a mission is planned for late November 2021).

The new BCU authorities are committed to reducing dollarization and promoting local currency debt markets, which would increase the effectiveness of monetary policy. A multipronged approach has been developed, with initiatives aimed at addressing financial (banking system and public debt) dollarization as well as price dollarization. In coordination with the Ministry of Economy and Finance, the BCU plans to develop secondary markets for debt instruments, increase the liquidity and depth along the yield curve, increase the issuance of peso sovereign debt,5 and allow for greater access by non-residents to peso instruments through Euroclear. Some measures to promote bank credit to the private sector in pesos have been deployed—like the recent reduction in reserve requirements on peso deposits—and others under consideration. The BCU is also actively engaging key price-setting players to better understand and tackle the root causes of price dollarization.6

Gains in credibility from the reforms are apparent. Soon after the change in the policy instrument, the interest rate on 1-month monetary policy instruments (Letras de Regulación Monetaria) converged to the announced policy rate, reducing its volatility, and indicating the effective working of the new intermediate policy target. Notwithstanding the spike in inflation and inflation expectations at the onset of the pandemic, the different measures of inflation expectations have moved closer to the target range in relation to pre-pandemic levels, although remaining above the range. A decreased dispersion of inflation expectations across different actors also points to some gains in anchoring expectations.

uA001fig13
Source: INE, BEVSA, Consensus Forecast. IMF staff estimates.
1 Labat D., Licandro G., 2021, “Towards a quality currency.” 2 The BCU introduced monetary aggregates as its policy instrument in 2013—switching from a short-term interest rate instrument—with the objective of facilitating the deflation process by gradually reducing M1 growth (see IMF, 2015). This responded to the view that monetary policy transmission via interest rates was weak in the context of a highly dollarized banking system. Inflation remained above the upper band of the target range, except in 2017, and short-term interest rates exhibited a high degree of volatility. 3 The one-day interest rate in the money market is the key policy rate to implement the announced policy with standing facilities and remuneration of excess reserves in line with the policy rate. 4 The Review assessed that the BCU is implementing transparency practices that are broadly aligned with international practices and it has developed a comprehensive communication framework. However, further improvements are advisable in the communication strategy on monetary policy and FX interventions, including clearly communicating to the public rationales, objectives, and evaluation of their impact. 5 The government has set a goal of reaching 50 percent of total debt denominated in local currency by 2024. 6 Some structural features may also play a role in inflation outcomes in Uruguay. For example, improving labor market flexibility, strengthening central bank institutions and fiscal responsibility can serve to lower equilibrium inflation. See the accompanying Selected Issues Paper on structural determinants of inflation.

C. Social Impact of the Pandemic

9. The authorities’ response package was effective in mitigating the impact of the crisis, although pre-existing structural issues in the labor market were exacerbated by the pandemic. While the pandemic inevitably caused a contraction of contact-intensive sectors, the existing social safety net and the additional support measures helped contain the impact on workers and firms. The enhancements to unemployment insurance (especially the new partial unemployment benefit) were instrumental in containing employment losses and facilitating a quick recovery (by maintaining employer-employee relationships), helping Uruguay to display smaller employment losses than peer countries (Figure 3). Young and low-earning workers were disproportionately affected by the crisis, partly reflecting their greater concentration in contact-intensive sectors. The leap in digitalization prompted by remote work added to pre-existing issues of skill mismatch in the labor force as a significant share of unemployed workers lack highly-demanded IT skills. Loss of schooling, although of relative short duration, also added to the pre-pandemic erosion of human capital (and to the pre-existing elevated school dropout rates).

uA001fig14

Unemployment Benefit

(in thousands of beneficiaries)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Source: BPS
uA001fig15

Change in Employment by Age Group, 2019–20 (In percentage points of group’s labor force)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: INE household survey; and IMF staff estimates.
uA001fig16

Change in Employment by Education, 2019–20 (In percentage points of group’s labor force)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: INE household survey; and IMF staff estimates.

10. The robust social protection system already in place and new policies helped to protect low-income groups. While workers at the low end of the earnings distribution were particularly affected by the pandemic, well-targeted social assistance—through unemployment benefits for formal workers and reinforced transfer programs for formal and informal ones—largely offset the loss of labor income. Poverty rates hedged up moderately relative to other countries, from a low base.

11. The authorities broadly agreed with the staff’s assessment on the strength of the recovery and the impact of the pandemic. They stressed that Uruguay’s economy and employment contracted less than other countries in the region. Authorities also highlighted that the recovery has broadened to contact-intensive sectors—after a rapid and effective vaccination campaign—and expected that approximately 70 percent of the employment losses during the pandemic would be reverted by end-2021. They also highlighted that, despite the pandemic, Uruguay was able to advance an ambitious structural reform agenda including a new fiscal institution, placing environmental objectives at the center of the planning and design of economic policies, a new mechanism for setting fuel prices, and the creation of the commission that is studying the reform of social security system, among others.

uA001fig17

Contribution to Income Variation, 2019–20 (In percent)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: INE household survey; and IMF staff estimates.
uA001fig18

Poverty Rate

(Percent of pop. below national poverty line)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Source: National statistic agencies. For Latin America, CEPAL estimateNotes: Chile (2017 and 2020 data), Mexico (2018 and 2020 data)

Outlook and Risks

12. The recovery is expected to gain strength in late 2021 and 2022. As the economy continues to normalize, following the marked drop in COVID-19 cases, contact-intensive sectors are expected to rebound, while elevated commodity prices continue to provide broad support to the recovery. Risks to growth are broadly balanced. Prospects of a partial rebound in tourism poses upside risks, although there is considerable uncertainty about the speed of normalization of tourism flows, including because of the weak currencies of neighboring countries. Downside risks stem from a resurgence of the pandemic, weaker commodity prices and capital outflows, as inflationary pressures in the US could trigger a sudden rise in interest rates (Annex IV). Risks to inflation stem primarily from food and global inflation.

13. Medium-term growth will hinge on the recovery from the pandemic, commodity prices, and progress with structural reforms. Growth is expected to remain above pre-pandemic levels over the medium term and help close the output gap by 2023, supported by the recovery from the pandemic and elevated commodity prices. The pandemic is expected to have some long-lasting effects on output—preventing a full return to the pre-crisis trend levels— mainly due to the further erosion of human capital (as a result of schooling losses) and persistent exit of workers from the labor force. On the other hand, the increase in labor productivity associated with the leap in digitalization, also visible in other countries, may be an important offsetting factor. If sustained, high commodity prices may also support medium-term growth, fostering employment and investment, as in the last commodity price boom. 7 Structural reforms could further support investment and growth over the medium term. Downside risks to medium-term growth stem primarily from lack of progress with structural reforms and insufficient fiscal discipline.

uA001fig19

Output Gap, 2017–26 1/

(In percent of potential output)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: WEO and IMF staff calculations.1/ Percentiles 20, 50 and 80 of distribution of 14 Latin American economies are reported.

14. Weakened fiscal accounts pose medium-term risks, although short-term risks remain contained (see public DSA in Annex V). The path of NFPS gross debt—½ of which is denominated in foreign-currency—is highly dependent on fiscal efforts and stable macroeconomic conditions. For example, under plausible scenarios—1 percent of GDP smaller fiscal effort, 15 percent real depreciation, or GDP growing at its pre-pandemic average—the debt-to-GDP ratio would continue to rise over the medium term, leaving limited room to respond to future shocks and potentially weakening investor confidence. However, short-term financing needs are moderate—reflecting a healthy maturity structure of public debt—and can be met with stable local funding, liquidity buffers and contingent credit lines from multilaterals. Also, access to international markets remains at low rates, with spreads below those of other investment grade countries in the region.8

uA001fig20

Debt Scenarios (In percent of GDP)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Source: IMF staff estimates
uA001fig21

Gross Financing Needs 1/ (In percent of GDP)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: Country authorities and IMF staff estimates.1/ Based on published DSA data for a sample of 115 countries.

15. Risks to financial stability also remain contained (Figure 8). Banks are well capitalized and non-performing loans—at 3.3 percent of total loans as of 2021Q2—remain low. The overall exposure of the financial system to sectors most affected by the pandemic (i.e., tourism and hospitality) is low, at about 2.5 percent of total private sector credit. Moreover, BCU estimates indicate that only about 7.8 percent of private sector loans could become problematic in an adverse scenario—once support measures are withdrawn—and banks would remain viable. Bank profitability has declined—reflecting squeezed interest rate margins and weaker demand for credits—but recent stress tests indicate the banking sector can withstand major recession scenarios.

Figure 8.
Figure 8.

Uruguay: Credit and Banking

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: IMF, World Economic Outlook; Banco Central del Uruguay (BCU); and IMF staff estimates and calculations.1/ For 2018, data as of Q3; and for 2019, as of Q2.2/ Data for Peru is from the World Bank.

Supporting the Recovery and Boosting Potential Growth

A. Rebuilding Policy Space while Supporting the Recovery

16. The authorities’ planned fiscal consolidation, while maintaining targeted support, is welcome. The envisaged plan would reduce the NFPS deficit by 2 percent of GDP over the next two years—from about 4.5 percent of GDP in 2021 (excluding ‘cincuentones’) to about 2.5 in 2023—as COVID-related measures are unwound, growth strengthens, and restraint on real public sector wages and discretionary spending continues. The plan adequately focuses on rebuilding fiscal space while maintaining targeted support to facilitate the recovery, including with continued COVID-related health spending and the extension of measures to support employment. There is also scope for spreading the adjustment more evenly between 2022 and 2023 if the recovery disappoints, including to limit long-lasting effects. Underpinning the consolidation with structural measures—for example, by undertaking a civil service reform, streamlining ministries or government’s agencies, or adopting measures to raise spending efficiency—would help ensure the durability of the consolidation efforts, as restraint on discretionary spending are more difficult to sustain. Once the economy has recovered, a greater fiscal effort will be needed to put debt on a firm downward path and restore fiscal space—that is, the room for discretionary fiscal policy without endangering debt sustainability, currently at risk.9 Pension reform is also key to ensure fiscal sustainability, although associated fiscal savings may take time to materialize (Annex VII).10

17. The authorities remain strongly committed to their fiscal consolidation plan and pension reform. They noted that, despite the pandemic, significant efforts were made to improve the efficiency of public spending, and indicated that the new work of the Monitoring and Evaluation Office would help identify further areas to improve spending efficiency. They also stressed their commitment to stabilizing the debt-to-GDP ratio over the medium term. The authorities remain committed to moving forward with the pension reform, following the recommendations from the commission of experts.

18. Greater emphasis on policies that foster employment and facilitate labor reallocation would bolster the recovery. Spending is appropriately shifting from preserving jobs and keeping firms afloat to supporting job creation, including with the implementation of a temporary employment subsidy for vulnerable groups (and the associated training programs). The extension of the enhanced unemployment insurance (especially the partial unemployment benefit) is adequate to provide further support to under and unemployed workers, although it should be gradually phased out to incentivize a full return to work and facilitate labor reallocation, where needed, especially as economic uncertainty dissipates. Wage increases should continue striking a balance between supporting the recovery in employment and protecting workers’ purchasing power. The differentiated wage-setting guidelines are welcome in this regard.

19. The authorities broadly concurred with staff’s assessment on the importance of the measures taken to boost employment. They noted that the extension of the enhanced unemployment insurance, the new subsidy for employment of vulnerable groups, and the prudent wage guidelines—that differentiated between recovered and lagging sectors— have been effective in the recovery of employment. They noted that education reforms are expected to have a positive impact in terms of improving the human capital.

20. Maintaining a tightening bias in monetary policy will be key to solidify credibility gains. Amid challenging circumstances, monetary policy adequately supported the economy through the pandemic while gradually steering inflation and inflation expectations towards the target range. The central bank is appropriately unwinding monetary support, balancing the need to support the economic recovery and mitigating inflationary pressures. As the recovery takes hold, additional carefully-calibrated tightening of monetary policy will likely be needed to ensure that inflation falls within the target range in 2022; key to build further credibility. In the meantime, a well-communicated policy strategy—that signals the expected path of monetary policy—should help sustain recent gains in re-anchoring inflation expectations. Continuing to allow the exchange rate to float would support the disinflation process. Foreign exchange intervention should be limited to addressing disorderly market conditions and the rationale of any operation clearly communicated to the public to avoid misperceptions about the BCU’s policy objectives.

uA001fig22

Inflation (Annual, percent)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: Consensus Economics; Haver Analytics; and national authorities.
uA001fig23

Policy Rate During Pandemic (In percent)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: Haver Analytics; and national authorities.1/ Max is the policy rate value in January 20, 2020. Min is the minimun policy rate value between January 20, 2020 and November 11, 2021. For Uruguay, 1-month yield for the Letrasis reported for before September 2020.

21. The authorities reaffirmed their commitment to bringing down inflation. They stressed that, despite the extraordinary challenges of the pandemic, the BCU was able to steer inflation expectations towards the target range—thanks to the enhanced monetary policy framework.

22. Timely phasing out credit support measures—while monitoring financial risks closely—is key to limiting capital misallocation and fiscal costs. The targeted extension of SIGA guarantee lines will adequately support companies in still-affected sectors. As uncertainty about the recovery dissipates, however, tightening eligibility criteria and conditions will be key to prevent misallocation of capital and to limit potential fiscal costs. Although risks to financial stability remain contained, continued close monitoring will be key as support measures are phased out. Significant exposures of specific banks to highly impacted sectors also should be identified and monitored closely.

23. The authorities expect financial stability risks to remain limited. They pointed to their continuous monitoring of risks and the low level of NPLs throughout the pandemic. Authorities also noted that, even under very adverse scenarios the banking system would remain sufficiently capitalized.

B. Boosting Medium-Term Growth

Boosting potential growth requires addressing legacies of the pandemic and pre-pandemic macroeconomic imbalances. Ensuring fiscal sustainability, addressing labor market frictions, and reforming state-owned enterprises are key priorities.

Key Priorities

24. Further strengthening the fiscal framework would bolster the credibility of the medium-term fiscal plan. Amid public finances that have been weakened by the pandemic, the new fiscal rule is an important step towards ensuring fiscal discipline. The recent establishment of the independent Advisory Fiscal Council is also a key development, as it is expected to help in calibrating the targets, establishing a rigorous and transparent methodology for estimating the structural deficit, discussing policy tradeoffs, alerting of biases and inconsistencies in fiscal projections and advocating for improved policies.11 Further refinements to the framework—for example, moving to 5-year rolling limits, introducing an explicit medium-term debt target, and formalizing escape clauses with correction mechanisms (Annex III)—would help ensure that the new rule delivers fiscal discipline over time and across administrations. Anchoring fiscal targets on stochastic debt sustainability analysis would help better identify risks and calibrate targets.

25. Greater labor market flexibility and policies to foster human capital would boost employment and growth. Durably decentralizing wage negotiations and reducing the role of the government in the (currently tri-partite) wage negotiations, in line with ILO recommendations, could help ensure that wages are aligned with firms’ conditions and productivity, helping increase competitiveness and promote employment, especially in non-commodity sectors. There is also scope for increasing flexibility in labor contracts, while protecting worker’s rights, by allowing for more flexible work schedules, wider definitions of job duties and increased intra-company mobility. The pandemic’s disproportionate impact on young and low-skilled workers, and the accentuated skill mismatch highlight the urgency of policies to foster human capital, including effective (re)training programs to facilitate a rapid re-insertion into the labor market, and broad education reform to tackle the elevated school dropout rates and ensure that formal education is adapted to the needs of an increasingly IT-based economy.

uA001fig24

Labor Productivity and Real Wages 1/

(Index, 2006=1)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Source: ILO, IME, staffs calculations.1/ GDP data (2005 base).

26. Boosting growth also requires reforming SOEs.12, 13 SOEs play an important role in Uruguay but are prone to inefficient activities partly due to simultaneous supervision by entities with conflicting objectives.14 They are required to be profitable but also to pursue social policies—such as subsidies for water, electricity, and gas for vulnerable populations—and undertake unprofitable investments, without commensurate budget funding. Inefficiencies and significant cross subsidies raise the cost of doing business. The new formula linking the domestic fuel price to the international oil price plus a gradually-falling ‘x-factor’ (to cover the cost of social programs and SOE inefficiency) is a welcome development although the path for the latter and the policies to generate the necessary cost reductions should be announced.15 Broader SOE reform is also needed to separate commercial and social objectives (while providing explicit budget financing for the latter) and to improve SOE independence and governance to shield them from political interference, with a clear separation between the state’s ownership and regulation functions.16

27. The authorities stressed that the new fiscal framework significantly improves the credibility and sustainability of public finances. They noted that, while other countries invoked escape clauses during the pandemic in 2020, they introduced a new fiscal framework and complied with it. Despite this, all the necessary expenditures to address the health, social and economic situation were made available through the creation of the Covid-19 Solidarity Fund which allowed as well for transparent accounting of resources. Authorities also highlighted that the Fiscal Advisory Council will further help improve the methodologies and enhance the quality of the discussions.

28. The authorities also concurred that the ambitious agenda of structural reforms is important to improve efficiency and bolster competitiveness. They highlighted the adoption of the new mechanism for setting fuel prices as a relevant advance. In addition, reforms to improve the business climate are another key aspect of the proposed advances.

A Broader Reform Agenda to Strengthen the Economy

29. The authorities’ policy agenda on capital markets, trade integration and climate change could also help boost medium-term growth. Given the lack of dynamism of the banking system, the development of domestic capital markets is a recent initiative that could help reenergize financial intermediation and contribute to boosting investment. Access to external markets is also key for Uruguay—given the relatively small size of its economy—and ongoing trade integration efforts on various fronts are important elements of Uruguay’s growth strategy.17 The authorities’ strong commitment to climate change policies (Box 2)—which build on the countries’ important strides in environmental goals (Figure 9)—also provides an opportunity for boosting growth by investing in green energy and infrastructure.

Figure 9.
Figure 9.

Uruguay: Climate

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: UNFCCC, WRI CAIT, Ministerio de Industria, Energía y Minería, WEO, IEA, INGEI.1/ GHG emissions including LUCF for 2018 or latest available year as reported by source.2/ The INGEI reports GHGs emissions for Uruguay net of carbon absorption from grasslands and wetlands. For 2017, the value is 0.4 thousand of CO2e per million US$ PPP-GDP. This metric is not comprehensively available across countries.3/ EMNOE = Emerging markets non-oil exporting economies.4/ The INGEI’s net GHGs value is 6.2 MeCO2e per capita for Uruguay for 2017. Mtoe stands for millions of tons of oil equivalent. A ton of oil equivalent is a unit defined as the amount of energy released by burning one ton of crude oil. MCO2e stands for millions of tons of carbon dioxide equivalent. CO2e is defined as the equivalent of each different greenhouse gas in terms of the amount of CO2 that would create the same amount of global warning impact.

30. The authorities highlighted initiatives to develop financial markets, pursue greater trade integration and advance its climate change agenda as key elements of their pro-growth reforms. They noted that initiatives to develop the domestic financial market, especially the capital market, could help re-energize domestic credit and boost investment. They stressed that, given Uruguay’s small domestic market, pursuing greater trade integration through new trade agreements is of the essence to boost growth. They also emphasized the high priority that their administration has given to climate policies having incorporated the Helsinki Principles explicitly in the Budget Law.

31. Dollarization also remains an obstacle to investment and growth (Figure 8). Private credit remains low, partly because financial intermediation remains highly dollarized (½ of private sector loans are in US dollars) and firms tend to be under-leveraged and under-invest because of the lack of peso credit. Achieving low and stable inflation—a clear priority for the current authorities—is essential to encourage local currency savings, reduce dollarization and, in turn, foster local currency credit and investment.

32. The authorities agreed on the need to continue promoting de-dollarization. They emphasize that the BCU is committed to maintaining the Uruguayan peso as a high-quality currency, which will help address dollarization over time. They concurred that durably lowering inflation is instrumental for the process of de-dollarization—which should help boost credit and investment.

Environmental and Climate Change Policies

The administration has an extensive agenda on environmental policies as a key aspect of their sustainable development objectives. This includes:

• The recent creation of a new Ministry of the Environment.

• Explicitly incorporating climate objectives and the assessment of the environmental impact of economic policies in the budget.

• Developing modeling tools to assess the macroeconomic impact of climate change and environmental policies on the economy, and to estimate the economic value of the country’s grasslands and wetlands.

• Introducing climate-related tax incentives and advancing the greening of public transport infrastructure. The government will modify the fuel excise (IMESI) and link it to carbon emissions. It is also exploring tax incentives for purchasing electric cars and buses, and to discourage single-use plastic.

• Exploring the issuance of sustainability-linked sovereign bonds. The government is currently designing the framework and identifying the appropriate indicators that could serve as benchmarks.

• Playing an active role in several international climate change initiatives. In 2020, the BCU joined the Network for Greening the Financial System, and the Ministry of Economy and Finance joined the Coalition of Finance Ministers for Climate Action and the Regional Platform of Ministries of Finance for Climate Change.

• Developing a strategy for producing green hydrogen. This public-private initiative is partially financed by the UN Sustainable Development Goals Fund.

• Finalizing Uruguay´s Long Term Climate Strategy, with an aspirational goal of net-zero C02 emissions by 2050 under the Paris Agreement.

Staff Appraisal

33. Past Fund Advice. Uruguay’s policies during 2020/21 focused on addressing the pandemic and strengthening institutional frameworks. Some of these measures were in line with previous Fund advice. While the response to the pandemic led to an increase in public debt, the authorities implemented measures to limit the increase in current expenditures in real terms, and introduced a consolidation plan and a new fiscal rule aimed at strengthening fiscal discipline and debt sustainability. Also, with some elements in line with Fund advice, the authorities advanced with a pension reform proposal, currently under discussion and expected to be sent to Congress by 2022H1. In addition, the “Ley de Urgente Consideración” laid the foundations for key SOE reforms and progress has been made to link domestic fuel prices to its international cost. Steps were also taken to improve the monetary framework, in line with past Fund advice, including by shifting to the use of the interest rate as policy instrument and introducing enhancements to central bank communications. Differentiated wage guidelines implemented during the pandemic also constitute an important step toward wage flexibility, in line with previous staff advice.

34. The authorities’ policy response to the pandemic was effective in mitigating its impact while prudently balancing fiscal sustainability objectives. The strong existing health care and social protection systems, along with low poverty rates were key in limiting the need for additional fiscal resources to directly address the health crisis. Deployed fiscal resources were adequately targeted, helping to contain the impact on vulnerable groups and to sustain employment. Monetary and financial sector policies prevented a credit contraction and financial stresses. Notwithstanding the effective policy response and the ongoing recovery, the pandemic exacerbated pre-existing imbalances and structural problems, most notably the weaking public finances, the erosion of human capital and the labor market skill mismatch.

35. As the economy recovers, policies should normalize while maintaining targeted support to lagging sectors and vulnerable groups. The envisaged withdrawal of fiscal support— in line with the expected recovery—and the shift from sustaining employment and income to fostering job creation are appropriate. Continued targeted support for firms in lagging sectors and vulnerable workers is welcome and should be phase out only gradually—including to incentivize a return to work and facilitate factor reallocation where needed—as uncertainty about the economy dissipates. At the same time, greater supply of (re)training programs is needed to address the labor force skill mismatch and high youth unemployment, and facilitate a rapid re-entry of unemployed workers into the labor market. As inflation remains above target, monetary policy will need to maintain a tightening bias to build further credibility. A well-communicated policy strategy—that clearly signals the path of monetary policy and the central bank’s objectives—will be key to continue guiding expectations, while the exchange rate should continue to float. Credit guarantee lines should be phased out as uncertainty dissipates, and financial stability risks monitored closely as regulatory forbearance measures are unwound.

36. Over the medium term, policies should focus on further strengthening public finances and ensuring continued prudent fiscal policies going forward. While the authorities’ current goal of stabilizing the debt-to-GDP ratio over the medium term is commendable, greater efforts would be desirable to put public debt on a downward trajectory, especially if elevated commodity prices continue to support the economy with (temporarily) high external income. Structural measures to underpin the consolidation efforts would also be desirable. Moreover, ensuring that fiscal discipline is preserved over time and across administrations may require refinements to the new fiscal framework. Pension reform is also a key element both for intergenerational equity and fiscal sustainability.

37. Reform efforts should focus on tackling labor market rigidities and improving efficiency in SOEs. Addressing the erosion of human capital and the heightened skill mismatch in the labor force—through retraining programs and education reform—are instrumental to boosting growth and employment. Greater flexibility to in labor conditions and wage negotiations at the firm level would also help improve competitiveness—and increase resilience—especially in non-commodity sectors. Fostering investment and growth also requires moving forward with SOE reforms—which is key to increase efficiency and reduce production costs. Finally, the authorities’ initiatives to energize domestic financial intermediation—including by developing domestic capital markets—and on climate change also provide an opportunity to boost investment.

38. Staff proposes that the next Article IV consultation with Uruguay takes place on the standard 12-month cycle.

Table 1.

Uruguay: Selected Economic Indicators

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Sources: Banco Central del Uruguay, Ministerio de Economia y Finanzas, Instituto Nacional de Estadistica, and Fund staff calculations.

Percent change of end-of-year data on one year ago.

Includes bank and non-bank credit.

Non-financial public sector (NFPS) includes the Central Government, Banco de Prevision Social, Banco de Seguros del Estado, and Non-Financial Public Enterprises.

Temporary proceeds resulting from the pension reform that allowed workers above 50 years old (and with certain income level) to voluntarily move back to the public pension system. Proceeds are projected to end in 2022.

Total public sector (PS). Includes the NFPS and Banco Central del Uruguay.

Public sector gross debt minus liquid assets. Liquid assets exclude central bank reserves held as counterpart of banks’ required reserves on foreign currency deposits.

Table 2.

Uruguay: Balance of Payments and External Sector Indicators

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Sources: Banco Central del Uruguay and Fund staff calculations and projections.
Table 3.

Uruguay: Main Fiscal Aggregates

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Sources: Ministerio de Economia y Finanzas, Banco Central del Uruguay, and Fund staff calculations.

Banco de Prevision Social (BPS).

Non-financial public enterprises (NFPE).

Banco de Seguros del Estado (BSE).

Banco Central del Uruguay (BCU).

Table 4.

Uruguay: Public Sector Debt and Financial Assets 1/

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Sources: Ministerio de Economia y Finanzas, Banco Central del Uruguay, and Fund staff calculations.

Stocks are converted into pesos using the end of period exchange rate and divided by GDP.

Excludes central bank reserves held as counterpart of banks’ required reserves on foreign currency deposits.

Table 5.

Uruguay: Statement of Operation of the Central Government 1/

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Sources: Banco Central del Uruguay, and Fund staff calculations.

Central government and Social Security Bank.

Table 6.

Uruguay: Central Government Stock Positions 1/

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Sources: Banco Central del Uruguay, and Fund staff calculations.

Central government and Social Security Bank.

Table 7.

Uruguay: Monetary Survey

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Source: Banco Central del Uruguay.

Peso monetary liabilities include base money and non-liquid liabilities.

The Banco de la Republica Oriental de Uruguay (BROU), Banco Hipotecario de Uruguay (BHU; mortgage institution), private banks, financial houses and cooperatives.

Percentage change from previous year. In pesos, unless otherwise indicated.

Includes credit to households from banks and credit cooperatives.

Table 8.

Uruguay: Medium-Term Macroeconomic Framework

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Sources: Banco Central del Uruguay, Haver Analytics and Fund staff calculations.

The non-financial public sector (NFPS) includes the Central Government, Banco de Prevision Social, Banco de Seguros del Estado, local governments and Non-Financial Public Enterprises.

Total public sector (PS). Includes the NFPS and Banco Central del Uruguay.

Excludes central bank reserves held as counterpart of banks’ required reserves on foreign currency deposits.

Table 9.

Uruguay: Selected Financial Soundness Indicators

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Sources: Banco Central del Uruguay, IMF Global Financial Stability Report, and Fund staff calculations.

Data as of July, unless otherwise specified.

For 2021, data as of April.

Data as 2021Q1

Liquid assets with maturity up to 30 days in percent of total liabilities expiring within the same period.

Annex I. External Sector Assessment

The 2020 external position was broadly in line with fundamentals and desirable medium-term policies according to the External Balance Assessment (EBA) current account model and the EBA external sustainability approach. The EBA-Lite1 real effective exchange rate (REER) model points to a 3 percent gap, also consistent with a broadly-in-line position. External stability risks remain contained given Uruguay’s broadly-in-line external position and sizable reserve buffers.

1. The current account weakened in 2020. After the onset of the pandemic, the rapid contraction in external demand and transportation disruptions adversely affected goods exports. These were partially offset by the strong increase in commodity prices in the second half of the year. Following a slow tourism season in 2020Q1 (due to weak demand from Argentina), tourism proceeds came to a near halt with the border closures, though the peak summer tourism season was mostly done before the containment measures were put in place. The impact of these factors on the trade balance was partly countered by lower imports, mainly reflecting lower fuel prices, while other import components contracted more tepidly as a shift in consumption patterns toward tradable goods offset the contraction in domestic demand. Overall, exports contracted close to 20 percent in value during 2020, while imports contracted around 15 percent. The current account balance dropped from a 1.3 percent of GDP surplus in 2019 to a 0.6 percent deficit.

Merchandise Trade Balance (In percent of GDP)

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Sources: Banco Central del Uruguay; and Fund staff calculations.

2. The current account is expected to deteriorate further in 2021 and hover around a 1.5-2.0 percent of GDP deficit over the medium term. Both exports and imports are recovering as global demand bounces back and Uruguay’s economy gradually reopens. However, service exports continue to be severely impacted by the pandemic (the 2021 summer season bore the brunt of the drop in tourism and borders are only gradually reopening) while imports continue to be supported by the new pulp plant construction by UPM (and associated large infrastructure projects) and strong demand for tradable goods (resulting from a shift in consumption pattern from non-tradable services to tradables). These drivers are contributing to a widening of the current account deficit to about 2.1 percent of GDP in 2021. Over the medium term, and as borders fully reopen, the bilateral trade balance via-a-vis Argentina is expected to weaken towards the previous long-run equilibrium (around 1.5 percent of GDP deficit), as tourism exports gradually normalize. Exports as well as primary income outflows are expected to be boosted by the new paper pulp project from UPM. Imports are projected to recover in tandem with economic growth. Strong demand for and prices of commodities (especially meat) present upside risks to the current account, although a greater deterioration of the trade balance with Argentina pose downside risks.

uA001fig25

Current Account

(In percent of GDP, 4Q sum)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

uA001fig26

Trade Balance vis-a-vis Argentina (In percent of GDP)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

3. The EBA current account model indicates that the 2020 external position was broadly in line with fundamentals and desirable policy settings. The estimated current account norm of -2.2 percent of GDP and the cyclically-adjusted current account balance of -0.7 percent of GDP point to a current account gap of about 1.5 percent of GDP. However, the 2020 cyclical-adjusted current account requires further adjustments to account for factors not captured by the model:

  • Fuel imports are estimated to have been 0.4 percent of GDP lower than expected over the medium term due to the COVID-related drop in fuel prices and quantities.

  • Consumption shifted towards tradable goods, leading to higher goods imports relative to the expected contraction in the EBA model. This effect is estimated to amount to 0.2 percent of GDP.

  • Exports of medical supplies were also higher than usual, requiring an adjustor of 0.1 percent of GDP.

Adjusting for these temporary factors brings the CA balance to -0.9 percent of GDP. It is also necessary to adjust for expected normalization of the bilateral trade balance with Argentina—which has been significantly higher than the historical balance in recent years, mainly reflecting the appreciation of the Argentinean peso in 2015–17. With Argentinian peso reverting the appreciation in vis-à-vis the Uruguayan peso in recent years, as trade normalizes over time, the bilateral trade balance is expected to gradually weaken towards the historical level. Considering this effect, the cyclically-adjusted CA balance is estimated at -1.7 percent of GDP, implying a staff-assessed CA gap of about 0.5 percent of GDP.

4. The EBA external sustainability (ES) approach assesses the REER as in line with fundamentals, as the projected current account deficit for 2026 (1.5 percent of GDP) is at the level required to stabilize the stock of NFA at its current level (a deficit of about 1.5 percent of GDP).

5. The EBA-Lite REER model also assesses the REER to be in line with fundamentals, pointing to a 3 percent gap. This reflects a 3 percent REER appreciation in 2020. However, REER movements hide differing underlying trends across key trading partners as the real exchange rate vis-à-vis Brazil appreciated by 16 percent, while the real exchange rate with respect to Argentina and the US depreciated by 1.5 and 4 percent respectively.

2020 External Sector Assessment

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Source: Fund staff calculations

Cyclically adjusted.

Based on the June 2021 EBA results.

Using a CA elasticity of 0.20 (see RES EBA CA and EBA ES results for Uruguay).

Positive values indicate overvaluation.

CA balance required to stabilize NFA in the medium-term.

2026 projection.

6. The external assessment for 2020 masks important differences across economic sectors. Over the past two 15 years, agricultural commodities have taken up the lion’s share of Uruguay’s exports, following the commodity price boom that ended in 2014. The REER appreciated significantly during the commodity price boom and has not seen significant downward adjustment since then. Over this period, the non-commodity tradable sectors—which are typically more sensitive to REER movements than commodities—have remained stagnant.

uA001fig27

Export Volume

(2005= 100)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: UN Comtrade and staff calculation.

7. External stability risks remain contained. Gross reserves increased by over 13 percent in 2020—boosted by the authority’s international bond issuance and the policy to allow for purchases of monetary policy instruments with foreign currency. Reserves remain above the upper bound of the IMF reserve adequacy metric range. Reserve buffers are also adequate when considering other prudential indicators that take into account Uruguay’s high degree of deposit dollarization and commercial banks’ foreign currency exposure. Given the level of reserves, external stability risks are contained.

Gross International Reserves

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Sources: Banco Central del Uruguay and Fund staff calculations.

Reserves-to-GDP ratio calculated after converting GDP to U.S. dollars.

Reserve adequacy metric range is the minimum reserve adequacy to 1,5 times the minimum.

Annex II. Main COVID-Related Policy Measures

Financial and Credit Support Measures 1/

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The list is not necessarily exhaustive.

Annex III. Uruguay’s New Fiscal Rule

In 2020, the new administration introduced a fiscal rule for the central government and social security administration with the objective of stabilizing the debt burden over the medium term while allowing for counter-cyclical policy. The new framework aims at reinforcing the predictability of fiscal policy and strengthening the authorities’ commitment to their consolidation plan. This describes the key elements of the new framework and discusses possible refinements to fully reap the benefits of a rules-based system.

A. Key Features of the New Rule

1. The rule sets indicative constraints to public finances with the objective of stabilizing the debt burden in the medium term. Introduced with the 2020 Urgent Consideration Law and further detailed in the 2020–24 Budget Law1, the rule entails three indicative limits on fiscal accounts:

  • An indicative structural deficit limit for the headline deficit of the central government and social security administration—corrected for the effect of the business cycle and extraordinary developments (one-offs)—such that the debt-to-GDP ratio stabilizes over the medium term.2

  • A net-indebtedness ceiling for the net annual debt issuance in US dollars of the central government (effectively limiting the headline deficit) with the possibility of invoking an escape clause that allows for an increase of up to 30 percent (relative to the budgeted amount) under exceptional circumstances.3

  • An indicative real spending limit for the real primary spending growth of the of the central government and social security administration not to exceed the estimated potential growth (including one-offs).4 5

2. These key features aim at ensuring debt sustainability while allowing for countercyclical policy. They reinforce the predictability and credibility of fiscal policy and bolster the authorities’ commitment to reaching their fiscal consolidation targets and putting public finances on a sustainable path. Specifically:

  • The structural balance limit can ensure convergence towards a certain (unadjusted) fiscal balance over the medium term (when output is expected to be at potential), while allowing for automatic stabilizers to play a countercyclical role. By focusing on a measure of the fiscal balance that also excludes one-off spending and revenues measures, this indicative target also provides space for using fiscal resources to address temporary shocks, as done during the pandemic.

  • The spending limit tied to potential growth complements the structural balance cap, effectively leading to fiscal savings when revenues are growing faster than potential (e.g., when commodity prices are booming).

  • The net debt issuance ceiling provides an overall envelop—i.e., a limit on counter-cyclical policy and one-off spending—to ensure that public debt stays on a sustainable path.

3. The law also introduces auxiliary institutions aimed at shaping and monitoring the implementation of the rule. In September 2021, an Advisory Council, was established, to monitor the compliance with the rule and contribute to the policy debate regarding the sustainability of public finances.6 By the end of 2021, a Committee of Experts will be summoned for the first time to provide technical inputs for the estimation of potential output. These auxiliary institutions are intended to be technical and independent, and they will be critical to the successful implementation of the rule.7

B. Considerations for Strengthening the Fiscal Framework

4. International best practices point to possible refinements to Uruguay’s rule. A fiscal rule is normally understood as a lasting constraint (binding for at least three years) on fiscal policy to promote fiscal discipline and mitigate the deficit bias (IMF 2018a). A rule is successful if it: i) ensures sustainability; ii) avoids procyclical policies (builds buffers during good times to be used during bad times); iii) provides clear guidance for the budgeting process; and iv) is easily understood and monitored (IMF 2018b). There is scope for further refining Uruguay’s framework to follow international best practices more closely and reap greater benefits from the rules-based framework. In particular:

  • a. Time horizon. The current framework provides indicative targets for the current and following year only, without specifying when constraints can be changed. If limits can be changed annually in the Rendición de Cuentas, the rule becomes undistinguishable from traditional annual budget ceilings and medium-term budgetary targets.8, 9 If binding targets were instead announced several years in advance this could significantly strengthen the medium-term guidance provided by the rule.

  • b. Legal limits and slippages. The framework does not stipulate corrective procedures or actions in case of slippages. For example, in case the targets are not met, there is no requirement to present an updated plan to reach the intended objectives.10 Establishing such mechanisms are especially important because, if targets are indicative only, then there is no legal basis to enforce compliance.

  • c. Multiplicity of targets. Having three concurrent constraints may render the system unnecessarily intricate, potentially complicating policymaking, creating communicational challenges, and weakening the guidance for the budgeting process. The three indicative constraints could potentially compete with each other and not be necessarily binding at the same time.11 This could imply that the short-term guidance of fiscal policy becomes blurred, as it is unclear which of the targets (if any) has a primacy over others and whether corrective measures are needed if one or more of the targets are missed. Moreover, calibrating these three limits is difficult for an economy with large TOT shocks, where some of the limits may be breached more often which could undermine the framework.

  • d. Fiscal anchor. A desirable feature of a fiscal rule is the combination of i) a fiscal anchor tightly linked to the final objective of fiscal policy (normally, debt sustainability), and ii) operational rules on fiscal aggregates to provide short-term guidance (Andrle and others 2015). The new Uruguayan framework mainly provides short-term policy guidance which could be conducive but may not guarantee debt sustainability (which is the government’s desired intention) as it does not specify a target debt-to-GDP ratio or alternative medium-term anchor. Thus, the framework allows for fiscal slippages without corrective actions. While recognizing that there is no unique debt threshold, a drifting debt path would likely increase the probability of distress and eventually require a larger fiscal effort to stabilize public finances. The authorities could consider setting multi-year targets along with the introduction of an offsetting mechanism for slippages, which could have similar stabilization properties as a debt anchor. Other anchors could be considered, such as the path and medium-term objective for the primary surplus or a cap to the debt service (which would need to carefully estimate the effective interest cost of public debt, taking into consideration the heterogeneity of debt instruments and liability-management operations that affect cash flows).

  • e. Escape clause. The current escape clause for the net indebtedness ceiling allows for a temporary suspension under exceptional circumstances without weakening fiscal credibility (as suggested by Gbohoui and Medas, 2020). Moreover, it appropriately determines (in advance) which exceptional circumstances are allowable as they are considered to be beyond the control of the government (e.g., sharp recessions, large natural disasters, or national emergency), and what are the activation procedures for triggering the temporary suspension. However, it does not specify what are the subsequent procedures to return to the rule and more importantly there is no requirement to introduce offsetting mechanisms to recoup fiscal space. Moreover, the current escape clause does apply to deviations from the structural balance and/or spending limits (provided that the net indebtedness ceiling is met).

  • f. Structural adjustment. A cyclically-adjusted balance (CAB) rule has a great theoretical appeal, as it allows for countercyclical policy (and provides guidance on the fiscal stance). However, such rule does not always yield satisfactory results, mainly because real-time estimates of the output gap are often unreliable, especially in countries experiencing structural changes, and often lead to overestimation of potential output.12 Moreover, an additional complication for commodity-exporting countries is that an adequate structural adjustment would require determining whether observed changes in commodity prices are temporary or permanent, which is often highly uncertain. These pitfalls could be mitigated with rigorous and transparent methodologies for estimating potential output, which may need to explicitly err on the conservative side and contemplate correction mechanisms.13, 14

  • g. Risk disclosure. The 2021 Budget included a sensitivity analysis for public debt projections to changes in the exchange rate and growth assumptions, as a first step towards producing stochastic simulations for the debt path that take into account the historical correlation of macroeconomic shocks.15 Such simulations provide valuable information on the probability of deviating from the projected path, which should be taken into account in the fiscal plans (and fiscal rule limits).16 Moreover, a comprehensive fiscal risk report should be introduced (as an annex to the budget) that discloses all possible risks (including state contingencies, guarantees, PPP contracts, etc.) as this would help ensure that these risks are correctly identified, quantified, and managed.17

  • h. Auxiliary institutions. The Advisory Council and Committee of Experts have a key role to play in helping monitor the implementation of the rule and elevating the quality of the discussions by explaining policy tradeoffs, alerting of biases or inconsistencies in the projections, and advocating for improved policy decisions. The experience from other countries suggests that these institutions are only effective if they are delinked from political discussions and have adequate access to data and resources, including adequate remuneration of its members (to make them truly independent).18

C. Conclusion

5. The new fiscal framework is an important step towards ensuring fiscal discipline, as it provide key elements and infrastructure for a well-functioning rules-based full system.

6. Some refinements would help reap greater benefits of such system. Shifting from single to multi-year targets, establishing a debt (or related) anchor, and defining corrective actions in case of deviations would be particularly valuable as these would provide greater medium-term guidance and help enforce fiscal discipline. Ensuring that the new auxiliary institutions become well-functioning and independent is also key to ensure the credibility of the new framework. Building on the reforms made so far, these changes would bolster Uruguay’s fiscal framework and help ensure that fiscal discipline is maintained over time and across administrations.

References

  • Andrle, M., J. Bluedorn, L. Eyraud, T. Kinda, P. Koeva Brooks, G. Schwartz, and A. Weber, (2015). “Reforming Fiscal Governance in the European Union.” IMF Staff Discussion Note 15/09.

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  • Eyraud, L., and T. Wu. 2015. “Playing by the Rules: Reforming Fiscal Governance in Europe.” IMF Working Paper 15/67.

  • International Monetary Fund, (2018a). “Second-Generation Fiscal Rules: Balancing Simplicity, Flexibility, and Enforceability”, IMF Staff Discussion Notes 18/04.

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  • International Monetary Fund, (2018b). “How to Select Fiscal Rules? A Primer.” FAD How-To Note 9, International Monetary Fund, Washington, DC.

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  • International Monetary Fund, (2018c). “How to Calibrate Fiscal Rules? A Primer.” FAD How-To Note 8, International Monetary Fund, Washington, DC.

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  • Tereanu, E., Tuladhar, A., and A. Simone (2014). “Structural Balance Targeting and Output Gap Uncertainty.” IMF Working Paper 14/107.

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Annex IV. Risk Assessment Matrix1

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Annex V. Public Sector Debt Sustainability Analysis

A gradual rise of the debt-to-GDP ratio for the non-financial public sector (NFPS) is projected. Debt would exceed 70 percent of GDP over the medium term despite the authorities’ planned fiscal consolidation efforts, leaving debt dynamics vulnerable to shocks and market sentiment. However, investment-grade status, low spreads, long average maturity (13 years) and substantial liquid assets mitigate short-term risks.

1. At end-2020, gross NFPS debt was 68 percent of GDP. It has increased rapidly over the last decade—by almost 30 percentage points between 2011 and 2020—due to a continuous increase in spending which was exacerbated in 2020 by the economic downturn and stimulus measures in response to the pandemic. The debt includes:

  • Central government’s debt: 58 percent of GDP, with 13-year average maturity, and about ½ denominated in local currency and ⅓ indexed to CPI.

  • Debt from other public corporations: 4 percent of GDP (includes public enterprises and local governments).

  • Central bank capitalization bonds: 6 percent of GDP.1

2. The NFPS holds assets amounting to 10 percent of GDP and has access to contingent credit lines from multilateral institutions for about 3 percent of GDP.

  • Financial assets of the central government: 5 percent of GDP, mostly held in liquid instruments (e.g., securities and deposits), in line with the government’s prefunding policy of holding enough liquid assets to cover at least 12 months of debt service.

  • Contingent credit lines: 3 percent of GDP, with World Bank, IDB, FLAR and CAF.

  • Holdings of BCU bonds and deposits at the BCU: About 5 percent of GDP.2

3. NFPS net debt was 58 percent of GDP in 2020.

Scenarios

4. Baseline scenario. Under the baseline projection, the gross debt ratio is expected to gradually increase over the projection period and stabilize over the medium run. The negative impact of the fiscal deficits, rising interest rates, relatively high inflation, and nominal depreciation, is partly offset by the expected recovery in economic growth. If real GDP growth, real interest rates, and other debt-creating flows remain at their projected level for 2026, the debt-stabilizing primary balance is estimated at 0.9 percent of GDP compared to a projected primary balance of 0.5 percent of GDP.

5. Historical scenario. The historical scenario yields a slightly higher debt ratio, mainly because GDP growth was weaker, on average, in the previous decade. It should be noted, however, that during that period Uruguay experienced three contrasting stages. Until 2014, it had very high growth and exchange rate appreciation as it benefited from a positive terms-of-trade (TOT) shock. From 2014 to 2019, the TOT shock unraveled, and growth was stagnant. In 2020 the pandemic induced a sizeable downturn in economic activity.

Risks

6. Short-term risks are manageable. The share of debt held by non-residents is above the risk benchmark, but refinancing risks are limited given the sizable liquid financial assets and available contingent credit lines (5 and 3 percent of GDP, respectively). Short-term debt at original maturity is negligible (0.3 percent of GDP), reflecting the authorities’ long-standing preference for long maturities to minimize roll-over risk and, more recently, for locking-in possibly historically favorable rates. Gross financing needs are 8.6 percent of GDP, of which 2.2 percent corresponds to the primary deficit, 2.3 percent to interest payments, and 2.8 to amortizations of loans and securities.

7. Standardized risk scenarios show that debt dynamics are sensitive to shocks, particularly to growth and exchange rate variations, with lower sensitivity to interest rate changes and the primary balance. Fan charts of the projected debt distribution confirm that debt dynamics remain manageable under historical statistical distributions of combined shocks. Gross debt would remain below 80 percent of GDP in 90 percent of cases under symmetric shocks, and 75 percent of cases with asymmetric shocks. At the same time, with nearly 50 percent probability debt under symmetric shocks (and 75 percent probability under asymmetric shocks) would hover above 70 percent of GDP, a level that could potentially raise market concerns, affecting sovereign spreads and the ability to roll over debt.

Figure 1.
Figure 1.

Uruguay: NFPS DSA Risk Assessment

(Nonfinancial Public Sector Debt)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Source: IMF staff.1/ The cell is highlighted in green if debt burden benchmark of 70% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.2/ The cell is highlighted in green if gross financing needs benchmark of 15% is not exceeded under the specific shock or baseline, yellow if exceeded under specific shock but not baseline, red if benchmark is exceeded under baseline, white if stress test is not relevant.3/ The cell is highlighted in green if country value is less than the lower risk-assessment benchmark, red if country value exceeds the upper risk-assessment benchmark, yellow if country value is between the lower and upper risk-assessment benchmarks. If data are unavailable or indicator is not relevant, cell is white. Lower and upper risk-assessment benchmarks are: 200 and 600 basis points for bond spreads; 5 and 15 percent of GDP for external financing requirement; 0.5 and 1 percent for change in the share of short-term debt; 15 and 45 percent for the public debt held by non-residents; and 20 and 60 percent for the share of foreign-currency denominated debt.4/ EMBIG, an average over the last 3 months, 08-Jul-21 through 06-Oct-21.5/ External financing requirement is defined as the sum of current account deficit, amortization of medium and long-term total external debt, and short-term total external debt at the end of previous period.
Figure 2.
Figure 2.

Uruguay: NFPS DSA—Baseline Scenario

(in percent of GDP unless otherwise indicated)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Source: IMF staff.1/ Public sector is defined as non-financial public sector.2/ Based on available data.3/ EMBIG.4/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.5/ Derived as [(r – π(1+g) – g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).6/ The real interest rate contribution is derived from the numerator in footnote 5 as r – π (1+g) and the real growth contribution as -g.7/ The exchange rate contribution is derived from the numerator in footnote 5 as ae(1+r).8/ Includes asset changes and interest revenues (if any). For projections, includes exchange rate changes during the projection period.9/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.
Figure 3.
Figure 3.

Uruguay: NFPS DSA—Composition of Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Source: IMF staff.
Figure 4.
Figure 4.

Uruguay: NFPS DSA—Stress Tests

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Source: IMF staff.
Figure 5.
Figure 5.

Uruguay: NFPS DSA—Realism of Baseline Assumptions

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Source : IMF Staff.1/ Plotted distribution includes surveillance countries, percentile rank refers to all countries.2/ Projections made in the spring WEO vintage of the preceding year.3/ Uruguay has had a positive output gap for 3 consecutive years, 2018–2020. For Uruguay, t corresponds to 2021; for the distribution, t corresponds to the first year of the crisis.4/ Data cover annual obervations from 1990 to 2011 for advanced and emerging economies with debt greater than 60 percent of GDP. Percent of sample on vertical axis.

Annex VI. External Debt Sustainability Analysis

1. External debt in Uruguay rose to 88 percent of GDP in 2020 reverting a downward trend observed in previous years (see Table). The increase is primarily driven by a sharp contraction in GDP due to the Covid-19 crisis and the recent external government bond issuance in the context of rising fiscal needs for combating the pandemic. About 49 percent of the external debt is owed by the public sector, and 92 percent of the external debt is denominated in foreign currency.

2. Gross external debt is projected to hover around 85–86 percent of GDP over the medium term. This reflects relatively positive non-interest current account surpluses and favorable automatic debt dynamics that offset external debt interest payments.

3. Gross external financing requirements are expected to remain at manageable levels, with moderating debt repayment needs and an improving current account balance, also supported by real GDP growth. However, estimates of gross financing needs should be treated with caution, as they rely on assumptions on the residual maturity structure of private external debt (on which data are limited). A mitigating factor is that about 75 percent of the non-financial external private debt are inter-company loans (often accompanied by greater external asset holdings).

4. Stress tests indicate that the interest rate shock would have a limited impact on external debt. Shocks to growth, the non-interest current account and a combined shock (to the real interest rate, growth, and current account) would have a greater, but still moderate, impact.

5. The main risk to Uruguay’s external debt sustainability is an exchange rate depreciation. A counterfactual 30 percent exchange rate depreciation would increase the external debt-to-GDP ratio by 19 percentage points, other things being equal (see Figure).

6. Overall, risks to external debt sustainability have risen since the pandemic but remain contained. Given Uruguay’s sizeable gross international reserves and liquidity buffers, risks to external debt sustainability remain manageable barring substantial additional shocks.

Table 1.

Uruguay: External Debt Sustainability Framework, 2014–2026

(In percent of GDP, unless otherwise indicated)

article image

External debt includes non-resident deposits.

Derived as [r – g – r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period. Projections assume that 10% of long-term private debt is amortized every year and 10% of total private debt stock is short-term debt.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Figure 1.
Figure 1.

Uruguay: External Debt Sustainability: Bound Tests 1/ 2/ 3/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Sources: International Monetary Fund, Country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Six-year historical average for the variable is also shown.2/ For historical scenarios, the historical averages are calculated over the six-year period, and the information is used to project debt dynamics five years ahead.3/ External debt includes non-resident deposits.4/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.5/ One-time real depreciation of 30 percent occurs in 2021.

Annex VII. Pension Reform in Uruguay

1. Uruguay has an impressive pension system.1 The system provides ample coverage—to about 90 percent of the elderly and 80 percent of workers—and benefits— with an average replacement rate of about 60 percent. This is reflected in an elderly poverty rate of only about 2 percent, compared to a child poverty rate of 20 percent.

2. However, the system demands increasing fiscal resources and needs to be reformed. Public pension spending has risen rapidly over the last decade reaching 10 percent of GDP or almost 40 percent of fiscal revenues (Box Figure 1). This reflects not only comprehensive coverage and a relatively older population (compared to peer countries) but also the generosity of the system (Box Figure 2), especially reflected in the low retirement age (60 years for both men and women) and a constitutional mandate to index pensions to average wages (thus benefitting retirees from past high real wage increases and economy-wide productivity increases).

uA001fig28

Spending in Pensions

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Source: Ministry of Finance and IMF staff estimates
uA001fig29

Contribution rate and Pension Spending

(In percent of GDP, at end-2015)

Citation: IMF Staff Country Reports 2022, 016; 10.5089/9798400200236.002.A001

Source: IMF Departmental Paper18/05.

3. Currently, workers’ contributions only finance about ½ of costs of the social security administration (BPS). 2 About ¼ of the financing comes from earmarked taxes (7 percentage points of VAT revenues, revenues from lotteries and a special tax to support pensions) and ¼ from direct fiscal support (transfers from general taxation). Further increases in revenues are unlikely given an already elevated tax burden and competing spending needs (in health, education, and infrastructure). Population aging3 and technological change–which could shift labor demand towards workers with higher skills—are expected to put further pressure on the system. There is general consensus that a reform is needed to guarantee sustainability and promote both the intra and intergenerational fairness of the system.

4. A Commission of Experts has been appointed to prepare a reform proposal.4 The government is committed to presenting a bill to Congress in the coming months based on the recommendations of the Commission. The main recommendations from the draft proposal currently under consideration by the Commission include:

  • a. Introducing a base zero pillar, to be financed from general taxation, that guarantees a minimum pension (of about US$300 per month) and complements the years of contributions up to a maximum pension (of about US$900 per month).

  • b. Maintaining contribution rates as they are considered to be relatively high.5

  • c. Unifying the criteria across regimes for new workers (although allowing for an earlier retirement age for activities with an elevated physical toll). For existing workers, the benefits would be computed as a weighted average that considers the number of years of contributions under the old and new (unified) regimes.

  • d. Increasing the number of years considered in the computation of the reference wage (to the best 25 years, instead of the last ten or the best twenty) to make the pension more actuarially fair.

  • e. Lowering accrual rates from 1.5 percent per year to a range between 1.1–1.35 which increases with age.

  • f. Gradually raising the retirement age and linking it to life expectancy (thus allowing for more automatic updates going forward), while protecting rights of workers close to retirement age. This means fiscal savings will take considerable time to materialize.

  • g. Tightening qualification criteria for disability pensions (which are high in Uruguay) and of the use of witnesses for missing contribution records.

  • h. Creating incentives to foster voluntary savings, such as the possibility of automatically transferring 2 percentage points of VAT for electronic payments.

  • i. For the individually-funded pillar, changing the minimum profitability regulation, increasing the number of portfolios and allowable investment options (to raise exposure to variable income and foreign investments, to prevent excessive bunching into government bonds while increasing the risk exposure of young workers to increase average returns during the accumulation phase).

5. Some additional reforms would be desirable. It would be desirable to equalize the contribution rates for all regimes and sectors of the economy. Revisiting the indexation formula to inflation (to preserve the real purchasing power) instead of the average wage (which allows retirees to benefit from economy-wide productivity increases). Finally, AFAPs’ fees could be lowered by translating the book-keeping function to the BPS
1

See IMF Country Report 19/64.

2

The sharp slowdown in growth became apparent following the revision to national account statistics, implemented in December 2020.

3

The fiscal costs of COVID-related measures have been earmarked and transparently reported through a COVID Fund (Fondo Solidario COVID) to indicate their transitory nature.

4

The cincuentones transactions are transitory cash payments from the private to the public pension system reflecting the transfer of individuals over fifty years, who were allowed to voluntarily return to the public system (to compensate them for the possibility of low replacements rates, given that their contributions under the old system were not recognized when the mixed pension system was created). See Box 1 in IMF Country Report 19/64.

5

The surge in consumption partly reflected a shift in consumption patterns as unspent income in tourism and recreation was used for purchasing durable goods.

6

The rule was introduced with the 2020 Urgent Consideration Law, with further details provided in the 2020–24 Budget and the ‘Rendicion de Cuentas y Balance de Ejecucion Presupuestal’ for 2020. It is worth noting that the three indicative targets set for 2020 were met.

7

See accompanying Selected Issues Paper on Uruguay’s potential growth.

8

Uruguay also ranks high among emerging market economies in terms of Environmental, Social and Governance (ESG) score. This is an additional source of strength, as institutions investors are increasingly demanding sovereign debt with high ESG scores.

9

Which means that at most only marginal fiscal loosening is possible compared to the baseline given clear but not imminent risks to fiscal sustainability. The assessment considers the level of debt, its rising trend, its sensitivity to changes in macroeconomic and financing conditions, gross financing requirements, share of debt held by nonresidents and the required consolidation to stabilize the debt-to-GDP ratio over the medium term.

10

The reform is also needed to promote both the intra and intergenerational fairness of the system.

11

It is expected that inputs from the Committee of Experts will be requested for the first time at the end of the fiscal year, for the re-estimation of potential output.

12

A 1992 referendum and recent opinion polls showed strong support for public ownership, although, the entry of private investors in the telecommunications and finance sectors has stimulated competition with the state-owned incumbents.

13

The public sector has a strong footprint in the oil, electricity, telecommunications, financial, water and infrastructure sectors. The largest SOEs include the petroleum, cement, and alcohol company (ANCAP), telecommunications (ANTEL), electricity (UTE, although private electricity generation is allowed), water (OSE), and the largest bank (BROU).

14

SOEs are supervised by the Planning Office, Ministry of Finance, line ministries and regulatory entities.

15

The x-factor covers idiosyncratic costs related to regulations, cross-subsidies, inefficiencies, unprofitable investments, social policy, etc.

16

See more details in Box 2 in IMF Country Report 20/51.

17

See also accompanying Selected Issues Paper on Uruguay’s scope for export product diversification.

1

EBA REER models do not include Uruguay.

1

There is no overarching public financial management law in Uruguay. Various Constitutional provisions and the Accounting and Financial Administration Annotated Text, the Five-Year Budget Law, as well as administrative laws govern budgeting and financial management.

2

Extraordinary revenues include those arising from: cincuentones transactions, energy stabilization fund, SOEs profits, asset-liability management operations, sale of public assets or licenses. Extraordinary outlays include those arising from: crisis mitigation (e.g., drought, health crisis), unusual SOEs losses, judicial settlements, and election spending.

3

While the net-borrowing limit for 2021 was initially set at US$2.3bn, the escape clause was then activated to accommodate unanticipated pandemic-related spending.

4

The Ministry of Finance currently estimates potential growth at 2.3 percent of GDP (based on a production function approach) although the estimation may be revised as it is expected that the Committee of Experts, once established, will provide inputs for the estimation of this key parameter and the Advisory Council will provide feedback on the methodology.

5

The authorities estimate real spending using average inflation, although an explanation is not included in official documents.

6

Legislation calls for the Advisory Council to be composed of three members of recognized academic or professional trajectory, who are nominated by the President and will serve for up to four years, that can be renewed. However, in order to have a staggered system, two of the initial members will only serve for two years and three years.

7

The Committee of Experts is designated by the Executive branch and will be composed of a minimum of seven to a maximum of 15 experts or representatives of prestigious institutions.

8

Although the Rendición de Cuentas includes five-year Rolling forecasts they are not targets. In fact, official communications and explanations never refer to the forecasts as signaling any commitment or constraint.

9

The spending cap of the new fiscal rule may effectively provide a multi-year limit as it is tied to the estimated potential growth, provided that those estimates do not materially change from year to year.

10

Explanations about compliance with the rule are provide twice per year. At the beginning of the year in a presentation by the Minister to present the fiscal outturn and mid-year in the Rendición de Cuentas.

11

Creating the possibility that a future administration could choose only to comply with “easier” targets and argue that compliance with one or two out of three targets is good enough.

12

For example, Eyraud and Wu (2015) estimate that the CAB rule allowed EU countries to run deficits that were 0.5 percent of GDP higher than their ex-post estimates. Similar experiences occurred in Chile and Peru, where the structural balance rule did not preclude very large increases in the net debt over the past decade.

13

For example, Tereanu et. al. (2014) based on potential growth revisions for the European Union, propose a rule of thumb that 1/3 of the changes in observed growth capture changes in potential output. Which corrects for the tendency of policymakers to assume positive growth shocks are permanent and negative shocks are temporary.

14

Once the auxiliary institutions become operational, disclosing the details of the rule is necessary to improve communication and ensure replicability of estimates. For example, making Excel files with the necessary inputs and estimations (data, parameters, assumptions, formulas, computation etc.) publicly available would allow that the rule and its merits are well understood by the public.

15

The results show that relatively small changes to growth or exchange rate projections lead to non-stationary debt trajectories.

16

For example, fiscal plans should consider whether targets under the baseline projections allow for the buildup of sufficient fiscal buffers (fiscal space) to allow for counter-cyclical policy in case of a bad shock. Similarly, authorities should consider if the additional fiscal effort that would be necessary to sustain a higher debt burden (after the occurrence of a bad shock) would be feasible or if more restraint would be needed in the baseline scenario to accommodate such shocks without distress.

17

This would be in line with the third pillar of the IMF’s Fiscal Transparency Code.

18

The staggered design of the members of the Advisory Council seems appropriate to isolate it from the political cycle.

1

The Risk Assessment Matrix (RAM) shows events that could materially alter the baseline path. The relative likelihood is the staff’s subjective assessment of the risks surrounding the baseline (“low” is meant to indicate a probability below 10 percent, “medium” a probability between 10 and 30 percent, and “high” a probability between 30 and 50 percent). The RAM reflects staff views on the source of risks and overall level of concern as of the time of discussions with the authorities. Non-mutually exclusive risks may interact and materialize jointly.

1

The first capitalization bond was issued in 2008 and further issuances were made in 2010, 2011, 2012 and 2013. At end 2018, all debt was consolidated into a single 30-year inflation-linked bond. This debt is not market based, its transactions do not involve cash and does not pay amortizations. In the previously used public sector coverage, this debt was netted out from the consolidated debt numbers as it is an asset of the central bank and a liability of the central government.

2

These are assets of the NFPS and liabilities of the central government.

1

The pension system is highly fragmented. It includes a universal defined-benefit public pillar (which covers more than 90 percent of contributors and pensioners), a complementary mandatory individual savings accounts pillar (for monthly earnings above US$1,500 which are managed by pension fund administrators, AFAPs) and a public insurance company (BSE) that provided lifetime annuities. In addition, there are five separate special regimes for banking employees, university professionals, public notaries, the military, and the police, with vastly different rules and benefits.

2

About ¾ of these costs correspond to pensions.

3

The old-age dependency ratio (based on the current retirement age of 60) is expected to increase from below 33 percent in 2015 to 50 percent in 2050.

4

A draft proposal was unveiled by 9 of the 15 members of the commission in October but can still be adjusted as it is discussed with the other members of the Commission. Once the proposal is approved by a majority it will then be presented to the government.

5

Contribution rates vary across sub-systems and sectors. In the manufacturing and retail sectors, contribution reach 15 percent for workers and 7.5 percent for employers. This is considerably higher than in other countries in the region and the 18 percent average mandatory pension contribution rate across OECD countries.

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Cover IMF Staff Country Reports
Uruguay: 2021 Article IV Consultation—Press Release; Staff Report; and Statement by the Executive Director for Uruguay
Author:
International Monetary Fund. Western Hemisphere Dept.
Volume/Issue:
Volume 2022: Issue 016
Publisher:
International Monetary Fund
ISBN:
9798400200236
ISSN:
1934-7685
Pages:
85
DOI:
https://doi.org/10.5089/9798400200236.002

Investment Rate and Output Growth, 2015–19 (average)

Output Growth and Employment, 2000–19 (in percent)

Fiscal Balance and Public Debt, 2008–19 (in percent of GDP)
Figure 1.

Uruguay: COVID-19 Developments
Figure 2.

Uruguay: Real Activity

COVID-19 cases. Vaccination, Mobility and Economic Activity

Economic Activity

(Index 2019 = 100,4-quarter average)

Employment and Hours Worked
Figure 3.

Uruguay: Labor Market
Figure 4.

Uruguay: External Accounts
Figure 5.

Uruguay: Inflation

Imported inflation

(4-m MA, y-on-y percentage change)

Nominal and Real Exchange Rates

(2018= 100)

Real Exchange Rates (Index, 2018M1 = 100)
Figure 6.

Uruguay: Fiscal Developments

Fiscal Stimulus Package (In percent GDP)

Balance NFPS 1/

(In percent of GDP)
Figure 7.

Uruguay: Monetary Policy

Change in Interest Rates Jan20-Jan21 1/ (In percentage points)

Unemployment Benefit

(in thousands of beneficiaries)

Change in Employment by Age Group, 2019–20 (In percentage points of group’s labor force)

Change in Employment by Education, 2019–20 (In percentage points of group’s labor force)

Contribution to Income Variation, 2019–20 (In percent)

Poverty Rate

(Percent of pop. below national poverty line)

Output Gap, 2017–26 1/

(In percent of potential output)

Debt Scenarios (In percent of GDP)

Gross Financing Needs 1/ (In percent of GDP)
Figure 8.

Uruguay: Credit and Banking

Inflation (Annual, percent)

Policy Rate During Pandemic (In percent)

Labor Productivity and Real Wages 1/

(Index, 2006=1)
Figure 9.

Uruguay: Climate

Current Account

(In percent of GDP, 4Q sum)

Trade Balance vis-a-vis Argentina (In percent of GDP)

Export Volume

(2005= 100)
Figure 1.

Uruguay: NFPS DSA Risk Assessment

(Nonfinancial Public Sector Debt)
Figure 2.

Uruguay: NFPS DSA—Baseline Scenario

(in percent of GDP unless otherwise indicated)
Figure 3.

Uruguay: NFPS DSA—Composition of Debt and Alternative Scenarios
Figure 4.

Uruguay: NFPS DSA—Stress Tests
Figure 5.

Uruguay: NFPS DSA—Realism of Baseline Assumptions
Figure 1.

Uruguay: External Debt Sustainability: Bound Tests 1/ 2/ 3/

(External debt in percent of GDP)

Spending in Pensions

Contribution rate and Pension Spending

(In percent of GDP, at end-2015)