Uruguay: 2024 Article IV Consultation-Press Release and Staff Report
Author:
International Monetary Fund. Western Hemisphere Dept.
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Publication Date:
11 Jul 2024
eISBN:
9798400282904
Language:
English
Keywords:
BCU inflation target; adaptation effort; inflation expectation; IMF staff calculation; contractionary monetary policy; Inflation; Caribbean; Global
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1. In 2023, Uruguay confronted the impact of a once-in-a-century severe drought. From October 2022 to April 2023, rainfall was about 47 percent below historical averages, affecting key agricultural areas, and causing significant direct losses to the primary sector, especially for soybean production and cattle farming. Agricultural output was mostly affected between the last quarter of 2022 and the second quarter of 2023 when it declined by 25 percent on a year-on-year basis, although it quickly recovered in the second half of the year as rainfall normalized. The authorities declared an agricultural emergency between October 2022 and December 2023 to support affected sectors.

Context

1. In 2023, Uruguay confronted the impact of a once-in-a-century severe drought. From October 2022 to April 2023, rainfall was about 47 percent below historical averages, affecting key agricultural areas, and causing significant direct losses to the primary sector, especially for soybean production and cattle farming. Agricultural output was mostly affected between the last quarter of 2022 and the second quarter of 2023 when it declined by 25 percent on a year-on-year basis, although it quickly recovered in the second half of the year as rainfall normalized. The authorities declared an agricultural emergency between October 2022 and December 2023 to support affected sectors.

2. The economic situation in Argentina created further headwinds for Uruguay. Amid a strong Uruguayan peso, the substantial depreciation of Argentina's currency, particularly in the parallel market, motivated important cross-border consumption flows taking advantage of relatively cheaper Argentinian goods and services, doubling the number of Uruguayans visiting Argentina in 2023. This situation depressed commercial activity in Uruguay, particularly in border cities, and weighed on domestic consumption and tax collection. Meanwhile, there were no financial sector spillovers.

3. Against this backdrop, the economy remained resilient, owing to the authorities’ sound macroeconomic policies, the country’s political stability, and strong institutions. Despite the challenging environment, Uruguay maintained favorable market access with improved sovereign debt ratings and sovereign spreads at historically low levels, including the lowest spreads in the region. The current administration, in office since 2020, has implemented a significant upgrade of the fiscal and monetary policy frameworks and has advanced decisive structural reforms. In 2023, the authorities approved a key pension reform, placing medium-term public finances on a more sustainable path, and started implementing an education reform. Consolidating these gains should be the most important priority, as they provide the necessary macroeconomic policy space to confront domestic and external risks and support long-term growth.

Recent Developments

4. Economic growth decelerated in 2023. Real GDP growth slowed to 0.4 percent in 2023, owing to the effects of the drought on agricultural production and electricity generation. IMF staff estimates that the impact of the drought on growth was about 1 percent in 2023 (Annex I). Moreover, the temporary closure of the country's oil refinery since September and a slowdown in construction as works associated with the UPM-II pulp mill were completed also weighed on growth. Imports of goods and services rose as fuel imports increased to cover the oil refinery stoppage and the drought led to higher imports of foods and intermediate inputs for agricultural production, applying further downward pressure on growth. Employment rose by 37,000 to 1.7 million in 2023, while the unemployment rate continued to hover around 8 percent, and the share of labor informality increased moderately relative to 2022 while remaining amongst the lowest in the region.

5. Inflation fell within the target range in mid-2023, reaching its lowest level in the last eighteen years. CPI inflation fell from 8.3 percent in December 2022 to 5.1 percent in December 2023, the lowest end-of-year value since 2005, owing to a strong contractionary monetary policy response in 2022, the appreciation of the Uruguayan peso, and falling import prices. Inflation expectations have recently converged to the central bank target range, reflecting gains in policy credibility, enhanced central bank communication and the continued easing of price pressures in the first quarter of 2024. CPI inflation reached 4.1 percent in May, achieving one year within the target range. The decline in inflation has been driven by lower goods inflation, while non-tradables core inflation, that includes services, has proved stickier (currently at 6.7 percent).

6. As inflationary pressures cooled off, the Banco Central del Uruguay (BCU) started its easing cycle in April 2023. The Monetary Policy Committee of the BCU gradually lowered the monetary policy rate from 11.5 percent at the start of 2023 to 8.5 percent in April 2024 as headline inflation reverted within the target range and inflation expectations gradually declined. While cutting nominal interest rates, the BCU kept a contractionary stance by keeping ex-ante real rates above the neutral rate throughout 2023. At the end of 2023, the authorities reaffirmed that the BCU inflation target is the center of the target band (4.5 percent) in a Macroeconomic Coordination Committee meeting. The authorities have continued to not intervene in the foreign exchange market, providing clarity and consistency on the main objectives of monetary policy.

A001fig3
Sources: World Economic Outlook, Banco Central del Uruguay (BCU), and IMF staff calculations.

7. The financial sector remained resilient. The banking system is well capitalized, highly liquid, and profitable. With capital requirements for credit, market, operational and market risks, the Uruguayan banking sector maintains almost twice the minimum regulatory requirement. Amid higher international interest rates and a more stable exchange rate, profitability increased to about 3 percent of assets (from 1.8 percent by end 2022). Despite last year's economic slowdown and losses in the agricultural sector, non-performing loans remained low (1.7 percent of total loans) with adequate loan loss provisions (NPL coverage ratio of 256 percent). Financial intermediation remains low with the private credit-to-GDP ratio at 29 percent while dollarization remains high at 69 percent for liabilities and around 51 percent for loans, compared to other countries in the region.

8. Uruguay’s fiscal rule played a notable role in strengthening fiscal discipline, while the pension reform approval improved longer-term debt dynamics. The deficit and debt outcomes were consistent with the targets of the fiscal rule in 2023, which are defined at the Central Government (including the Banco de Prevision Social) level. Adherence to the fiscal rule for four consecutive years has bolstered fiscal credibility, helping stabilize the debt-to-GDP ratio under a sequence of negative shocks and curb its upward trend (the debt-to-GDP ratio had increased by about 20 percentage points between 2010 and 2019). The pension system reform, that was approved in May 2023, is expected to stabilize spending over the medium term, by including a gradual increase in the retirement age, a restructuring of pension contributions, and a revision of the pension calculation basis towards OECD norms.1 The improved fiscal outlook is being reflected in historically low sovereign spreads, including the lowest EMBI spread in Latin America.

9. Amid external headwinds and the severe drought, the fiscal deficit increased during 2023. The deficit for the non-financial public sector (NFPS), excluding cincuentones2, widened to 3.2 percent of GDP in 2023, driven by the smaller balance of the rest of the NFPS (state-owned enterprises and local governments). The deficit of the Central Government (including the Banco de Prevision Social) was unchanged, despite the increase in transfers to support drought-affected sectors and the impact on tax collection caused by the situation in Argentina. The faster-than-expected disinflation in 2023, which is a welcome development, had adverse implications for the fiscal accounts, because real spending in wages and social security benefits increased while weighing on revenues as a share of GDP, driven by a lower-than-expected GDP deflator (Annex II). Extreme dry conditions particularly affected the power company (UTE), forcing lower hydropower generation and larger energy purchases from neighboring countries, and affecting its operating surplus.

10. Gross NFPS debt increased in 2023 but remains below pandemic levels. Gross NFPS debt was 64.5 percent of GDP at the end of 2023, about 4 percentage points below its 2020 level. The government issued a non-marketable, zero-coupon, five-year bond to recapitalize the central bank in the amount of USD 1.6 billion (2 percent of GDP) at the end of 2023, to compensate for the valuation losses incurred in the foreign exchange reserve position due to the cumulative peso appreciation. This bond temporarily raises NFPS gross debt but does not affect medium-term sustainability, as it represents both an asset and a liability for the government at the consolidated public sector level.

11. Uruguay’s 2023 external position was broadly in line with the level implied by medium-term fundamentals and desirable policies (Annex III). The current account (CA) deficit narrowed to 3.6 percent of GDP in 2023. The weakening of the trade balance from 5.0 percent of GDP in 2022 to 2.7 percent in 2023, driven by a decline in agricultural exports, was partially offset by an improvement in the primary income balance to -7 percent of GDP in 2023 (from -9.2 percent of GDP in 2022). The post-pandemic recovery of tourist arrivals was offset by a substantial increase in the cross-border flows of Uruguay residents taking advantage of favorable relative price differentials with Argentina, affecting the services balance. Net FDI inflows reached USD 4.2 billion (5.5 percent of GDP), providing more resilient sources of external financing. The nominal exchange rate appreciated by 2.6 percent, compared to 10 percent in 2022, driven by several factors, including domestic and U.S. monetary policy, lower domestic and foreign risk, and terms-of-trade fluctuations (Box 1).

Understanding Uruguay's Exchange Rate Fluctuations

The exchange rate can potentially respond to domestic and foreign monetary, financial, and real factors. This box presents the results of an estimated daily SVAR with sign restrictions for the Uruguay economy to understand the most recent appreciation.1 Our estimation period starts in September 2020, when the BCU adopted the short-term interest rate as a policy instrument and ends in April 2024.

Domestic monetary policy, improved risk perceptions, and the terms of trade were partially responsible for the peso appreciation in 2022-2023. The tightening cycle of the Banco Central de Uruguay to bring inflation to within the target range (3 to 6 percent), contributed to the peso appreciation, while the easing cycle that started in April 2023 has had the opposite effect. Favorable terms of trade, which signal rising export prices compared to imports, was also an important contributor to the peso appreciation. Improved perceptions reflected in lower borrowing spread also impacted the peso favorably in 2022.

Global favorable perceptions also helped appreciate the peso, while tightening US monetary policy provided a counterbalance. Contractionary monetary policy by the Federal Reserve, strengthened the dollar globally during 2022 and 2023, although expectations of Fed pausing its tightening cycle in the middle of 2023 dampened this channel. The model also finds that relatively "bad" news for the US economy, with a recession expected for most of 2023, depreciated the dollar and appreciated the peso.

Sign Restrictions Used to Decompose the Uruguayan Exchange Rate

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1/ Exchange rate decomposition exercise is conducted using a Bayesian Structural Vector Autoregression (SVAR) identified using sign restrictions. This box follows a similar approach to Brandt, L., A. Saint Guilhem, M. Schroder and I. Van Robays (2021), "What drives euro area financial market developments? The role of US spillovers and global risk", ECB Working Paper Series, No. 2560.

Outlook and Risks

12. The economy is expected to strongly rebound in 2024, while macroeconomic risks are broadly balanced. The recovery of agricultural exports, increased cellulose production, easing of financial conditions and robust private consumption, as real wages recover and the price differential with Argentina normalizes, are expected to support a growth rate of 3.4 percent in 2024 and 3 percent in 2025. From 2026 onwards, growth is expected to gradually converge to the potential growth rate of 2.2 percent. Inflation is projected to pick up in the second half of 2024, but stay within the target range, following a gradual easing of monetary policy and robust wage growth. Downside risks are derived from a worsening of external financial conditions, deterioration of international geopolitical tensions and the potential for further extreme climate events. Upside risks draw from events that could bring higher-than-expected agricultural export prices or lower fuel import prices (Annex IV).

13. Overall fiscal and external risks are low (Annexes V and VI). Near-term fiscal risks are limited due to several mitigating factors, including the gradual reduction of FX-denominated debt through new global issuances in domestic currency (both in nominal and in inflation-linked terms), ample liquidity buffers, access to precautionary credit lines, long debt maturities, and favorable borrowing conditions. Meanwhile, medium-term risks, stemming from the public debt composition and profile, are moderate. Additionally, staff assesses that there is some fiscal space available to address adverse shocks without impacting market access. Systemic risks remain broadly contained, owing to the low credit-to-GDP ratio, a limited sovereign-banking nexus, and the international investment position liabilities composition (mostly FDI). The financial sector is well-positioned to sustain severe funding pressure while banks are generally resilient to severe macro-financial shocks. While financial dollarization increases FX credit and liquidity risks, household indebtedness is low and corporate debt remains moderate and mostly hedged.

Authorities' Views

14. The authorities broadly concurred with the outlook and the balance of risks. They agreed that growth is likely to rebound in 2024 and that the growth momentum will continue into 2025. The authorities also expect that inflation will pick up somewhat over the second half of 2024 but will remain within the target range over the next 24 months - the monetary policy horizon target.

Policy Discussions

A. Fiscal Policy

15. The 2024 revised budget is aligned with the net indebtedness target of the fiscal rule and social protection objectives. The projected NFPS deficit, excluding cincuentones, of 3.1 percent of GDP balances deficit reduction with safeguarding social spending, a sizeable share of total expenditures, but the ongoing disinflation could continue to adversely affect the fiscal accounts in 2024. The post-drought growth momentum creates opportunities for reinvigorating consolidation efforts. However, capitalizing on these opportunities requires navigating inherent spending rigidities that constrain policy options. Some policies that could be considered include: (i) constraining the wage bill growth through public employment attrition and increased efficiency, including through the adoption of artificial intelligence,3 (ii) continuing efforts to improve the targeting of some subsidies, particularly for LPG (Supergas), and (iii) rationalizing tax expenditures. Current improvements to the management and efficiency of state-owned enterprises (SOEs) are commendable, but further efficiency gains are needed to increase their profitability and support the budget.

16. The crafting of the next five-year budget law opens an opportunity to recalibrate the fiscal rule targets to place debt on a downward path. Under current policies, the NFPS debt-to-GDP ratio remains largely stable over the projection period with low near-term risks—as financing needs are manageable and market access remains at favorable terms. While the current fiscal rule has been successful at stabilizing the debt-to-GDP ratio under challenging circumstances, further efforts are needed to ensure a sustained downward path for the debt-to-GDP ratio and rebuild fiscal buffers over the medium term, requiring lower targets for the structural balance and net indebtedness pillars of the fiscal rule. IMF staff estimates suggest that reducing the NFPS debt to a range of 50-55 percent of GDP over the medium term would provide adequate buffers against shocks, particularly considering the country's vulnerability to more frequent climate events.4 Lowering the NFPS debt-to-GDP ratio to 55 percent in ten years would require gradually increasing the primary balance to a constant level of about 1 percent of GDP by 2029.

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Source: MEF, BCU and IMF staff estimations.

17. Refinements to the fiscal framework would help consolidate recent credibility gains. The successful implementation of the new fiscal framework under challenging circumstances has strengthened policy credibility. The authorities have complied with the fiscal rule targets for four years in a row, curbing the upward trajectory of the debt-to-GDP ratio observed between 2010 and 2019. Within the current framework, the following refinements could be considered: (i) adopting five-year binding targets, consistent with lowering the debt-to-GDP ratio to a reference level over the forecasting period, when the new budget law is approved,5 (ii) establishing corrective mechanisms if escape clauses need to be triggered or should slippages occur, (iii) increasing the operational autonomy of the Advisory Fiscal Council, including through adequate resources, in line with best international practices (see Box 2), and (iv) exploring alternative methodologies to estimate potential output, the output gap, and desirable medium-term debt-to-GDP ratios.

Best International Practices for Fiscal Councils

Uruguay established the Advisory Fiscal Council with the 2020 Fiscal Responsibility Law. The council became operational in September 2021 and currently consists of three experts in public finance, appointed ad-honorem with overlapping terms, and one executive secretary. Its main function is to evaluate the Structural Fiscal Balance, with the aim of enhancing transparency and accountability and to promote fiscal sustainability. Additionally, the Advisory Fiscal Council provides accessible and detailed reports on the fiscal position and advises the MEF with technical recommendations on policies related to revenues, expenditures, and public debt.1 Moreover, according to the Fiscal Responsibility Law, the Advisory Fiscal Council has unrestricted access to government data, a necessary condition to fulfil its mandate.

Strong independent fiscal councils support fiscal discipline. Independent scrutiny by fiscal councils enhances governments’ commitment to fiscal discipline, providing objective, external and technical expertbased assessment of macro-fiscal projections and fiscal policies. Furthermore, fiscal councils play a crucial role in educating the public about fiscal issues, promoting transparency and the public understanding of government finances.

Additional efforts are needed to align the Advisory Fiscal Council with international standards. The provision of a dedicated budget mandated by law and remuneration of its members is crucial for the Advisory Fiscal Council 's operational autonomy. Such financial autonomy would also facilitate the acquisition of advanced analytical software and secure IT systems for data management. Moreover, a robust team is vital for conducting research, preparing reports, and effectively communicating fiscal matters to the public and policymakers. These additional resources would strengthen the Advisory Fiscal Council’s capacity to independently assess the authorities’ macro-fiscal projections, including risk analysis and scenarios.

Several countries have successful experiences with fiscal councils that can serve as reference for Uruguay, such as the Spanish Independent Authority for Fiscal Responsibility (AIReF). Also, in Latin America, Chile, Colombia, and Peru have evolving fiscal councils. These institutions demonstrate the positive impact fiscal councils can have on fiscal policy and transparency.

1/ These functions are regulated by Law No. 19.889 and Decree No. 315/021, which establish the normative framework of the Advisory Fiscal Council.

Authorities' Views

18. The authorities reiterated their unwavering dedication to prudent fiscal policies and emphasized that changes to the fiscal framework should be introduced cautiously and gradually. The authorities concurred that their compliance with the fiscal rule targets for a fourth year in a row had strengthened fiscal credibility, by stabilizing the debt-to-GDP ratio (despite significant external challenges and the severe drought), as reflected in sovereign debt rating upgrades and the lowest EMBI spreads in Latin America. They also highlighted the role that the Advisory Fiscal Council plays in independently verifying the achievement of the fiscal rule targets, improving transparency and credibility. While appreciating staff’s recommendations, the authorities emphasized the need to proceed cautiously and gradually on any changes to the current fiscal framework, to continue building on credibility gains as the country gains experience from conducting fiscal policy under a fiscal rule. They underscored that the current objective is the stability of the debt-to-GDP ratio. The authorities will continue to assess the prudent medium-term debt-to-GDP ratio and associated fiscal targets. Regarding the social security reform of 2023, they underscored that it provides long term fiscal sustainability to the system, while ensuring it is implemented in a fair and equitable way and concurred that the reform improves longer-term debt dynamics.

B. Monetary and Exchange Rate Policies

19. Monetary policy should remain contractionary to ensure that inflation and inflation expectations stay within the target range in a sustained manner. With the policy rate at 8.5 percent and one-year ahead expectations at 5.8 percent, the real interest rate is 2.7 percent - above the neutral rate, making the monetary policy stance appropriately contractionary. The BCU should continue to closely monitor the evolution of inflationary pressures and ensure monetary easing is conditional on inflation and inflation expectations remaining durably within the central bank's target range. Sustained monetary policy vigilance is crucial for continuing to build credibility and supporting de-dollarization efforts by delivering low and stable inflation rates. The exchange rate should continue to be allowed to act as a shock absorber and foreign exchange intervention should only be used to address disorderly market conditions. The presence of wage indexation in the wage bargaining process leads to a persistent response of both wage growth and CPI inflation to shocks, increasing the trade-offs faced by the central bank in stabilizing inflation and the output gap (see f27).

20. Further enhancements to the monetary policy framework would help increase the effectiveness of monetary policy and continue strengthening credibility. The BCU has significantly improved the monetary framework and communication since 2020, which has reduced the volatility of benchmark interest rates and facilitated the convergence of inflation to the target band for twelve months. The authorities should continue emphasizing that the inflation target is the mid-point of the target band (4.5 percent) in their public communications, to help anchor expectations. Enhancing de jure central bank independence, by appointing the central bank board members for fixed terms not overlapping with the electoral cycle, would further improve credibility and support policy continuity (Box 3).

Enhancing De Jure Central Bank Independence

Improved central bank independence has been critical to deliver low and stable inflation in Latin America. One way to measure central bank independence is through the construction of a qualitative index. A recent example is the Central Bank Independence (CBI) index, that quantifies the central bank’s governing arrangement, its mandate, the monetary policy autonomy, and the legal provisions to lend to the government to create a comparable measure across countries in Latin America.1 The correlation between the CBI index and inflation from 1960 for the LA7 countries is negative, highlighting the benefits of greater autonomy of the monetary authority.

To close the gap with other central banks in the region, the appointment of BCU Board members should be aligned with best international practices. The BCU has made important strides in enhancing their monetary policy framework, continuing to improve communication and strengthing credibility. According to the CBI, the BCU is assessed as less independent than most of its LA7 peers. A crucial step to help close the gap to the top performers would be to align the appointment of the BCU Board members with best international practices. Appointing the central bank board members for fixed terms not overlapping with the electoral cycle would help increase Uruguay’s rating in the Central Bank Independence index.

1/ See Jacome, Luis I. and Samuel Pienknagura 2022, "Central Bank Independence and Inflation in Latin America - Through the Lens of History," IMF Working Paper 22/186, International Monetary Fund, Washington, DC.

Authorities' Views

21. The authorities agreed that the monetary policy stance is appropriate and underscored their commitment to maintain inflation within the target range. The authorities emphasized that CPI inflation has remained within the target range for one year, a significant achievement that would help continue building credibility. The authorities agreed on the need to continue emphasizing that the inflation target is the mid-point of the target band (4.5 percent) in their public communications, to help make explicit the policy objective. Meanwhile, against a background of rigid inflation expectations caused by a history of inflation, expectations have been slowly converging to the central bank target range, reflecting gains in policy credibility and enhancements in communication. The authorities agreed that the exchange rate should be allowed to act as a shock absorber and to limit FX intervention to addressing disorderly market conditions. The authorities concurred with staff’s external sector assessment.

C. Financial Sector Policies

22. The authorities have reaffirmed their commitment to enhancing their supervision framework, implementing the recent FSAP recommendations (Annex VII) and creating an enabling environment for the financial system to contribute to growth and development. The Superintendency of Financial Services (SSF) should continue pursuing efforts to upgrade its riskbased supervision framework, by enhancing its stress-testing framework. Closing data gaps will also be key in building more comprehensive measures for credit risk analysis (such as probability of default and loss given default) and for assessing system-wide FX liquidity and concentration risks. Operationalizing the Pillar II capital add-ons will create an opportunity to address the adverse effect on capital buffers from the bank wealth tax. The BCU aims at creating an efficient, integrated, and accessible payment system, promoting competition, preserving financial stability, and fostering compliance with AML/CFT regulations. Promoting the development of the peso capital market and fostering greater competition in the retail banking sector could provide more attractive investment opportunities and alternative sources of funding, and lower lending-deposit spreads (see Box 4).

23. The authorities should redouble efforts in increasing AML/CFT effectiveness in line with FATF standards. In recent years the country has improved its AML/CFT framework by enacting new laws and regulations—including a law creating a Special Prosecutor's Office for ML/TF. While this has to some extent mitigated its ML/TF risks, the 2023 National Risk Assessment (NRA) highlights that the main threat of drug trafficking has grown since the last NRA while new high risks relating to the use of virtual assets have emerged. Drawing on the National Anti-Money Laundering Secretariat (SENACLAFT) statistical report, the 2023 NRA also points out that convictions for money laundering remain low even though investigations on money laundering predicate offences have increased from 2018 to 2022. The NRA provides recommendations to the authorities, including: i) strengthening mechanisms for timely information sharing across agencies, ii) increasing operational coordination, iii) deepening collaboration for the identification of typologies as well as sectoral risk assessments, and iv) granting adequate resources for effective risk-based supervision.

Uruguay’s Banking Spreads: A Regional Perspective

The cost of financial intermediation in Uruguay is relatively high compared to peers, owing to a high degree of concentration and dollarization as well as relatively high operational expenses. Uruguay's largest bank held 44 percent of total banking assets, while the top five banks held 90 percent of total assets at the end of 2023. Despite the recent history of macroeconomic stability, households still prefer holding their savings in U.S. dollars, driven by the memories of the 1982 and 2002 large devaluations. This high degree of financial dollarization seems to limit the banks' supply of peso lending, which is directed mostly to households, making it relatively more expensive while corporates borrow in USD.

From the demand side, customers’ savings are conservatively managed, contributing to low interest expenses. Almost 90 percent of total deposits are held in the form of sight deposits, which are not remunerated. Despite the recent introduction of new investment products, depositors have a marked preference for liquidity over profitability.

Authorities' Views

24. The authorities underscored that the financial sector remains sound and resilient. They emphasized that the banking system's profitability has increased, liquidity indicators remain strong and non-performing loans remain low despite the drought. They reaffirmed their commitment to further enhancing risk-based supervision and regulation, particularly through upgrading their stresstesting framework. The SSF highlighted its efforts to improve data collection for households and firms allowing for enhanced assessments of credit risks as well as systemic FX liquidity risks. The authorities concurred with the need to increase financial sector efficiency and to foster greater competition while developing the peso capital market. The authorities noted they are advancing with the recommendations from the 2023 National Risk Assessment, particularly on increasing operational coordination and information sharing protocols to better support the Special Prosecutor's office in AML/CFT issues. The authorities also noted that they are continuing to pursue a modernization plan for the payments system.

D. Structural Reforms

25. Efforts to continue implementing structural reforms are key to unlock potential growth, create policy space to preserve the country’s safety net and social cohesion, and support favorable sovereign debt ratings.

  • Education and human capital development. The implementation of the education reform is critical to provide the human capital Uruguay needs in the medium-term to foster the adoption of innovative technologies, increase productivity and particularly sustain the growth of its non-traditional sectors (ICT, deep tech, green tech, and bio tech). In the short-term, drawing on the successful implementation of on-demand training programs, coordinated public-private initiatives should be prioritized to bridge the skills gap in high-growth and high-demand technology sectors. The country's Innovation Hub could play a pivotal role in bolstering the digital transformation of local businesses, which would help accelerate the country's development and productivity.

  • Trade policy and competitiveness. The deepening of Uruguay's global integration should focus on pursuing efforts for trade facilitation, addressing nontariff barriers and red tape, and reducing logistics costs. In 2023, the country consolidated its trade openness within Mercosur by agreeing on a flexibilization of rules of origin and signed a free trade agreement with Singapore. Amid a fast-growing global services industry in Uruguay, the BCU is enhancing its international trade in services statistics compilation, focusing on improving coverage and granularity.

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Main Goods Trade Flows

Citation: IMF Staff Country Reports 2024, 215; 10.5089/9798400282904.002.A001

  • State-Owned Enterprises. The authorities' efforts to strengthen SOEs corporate governance and management are commendable. Recent initiatives from the electrical power company (UTE) to reduce electricity commercial losses should contribute to lowering overall energy costs and improve competitiveness. The state fuel company (ANCAP) has improved the targeting of the LPG (Supergas) subsidy to focus on vulnerable households. Similarly, curbing relatively high freshwater distribution losses will also be key in increasing the country's resilience to extreme weather events. Consistent with past Fund advice, SOE tariffs should be cost reflective, and the cost of their social programs should be transparently financed from the budget (instead of the current practice of using cross-subsidies).

  • Crime. While traditionally exhibiting some of the lowest crime rates in the region, Uruguay has undergone a steady rise in crime, much of which is linked to drug trafficking. Higher crime rates have a damaging macroeconomic impact, reducing output growth by lowering both capital accumulation and productivity.6 The increase in crime over the last decade, albeit from a low base, needs to be addressed before it starts weighing on growth.

26. Closing the labor force participation gender gap would help increase long run growth. Uruguay has made significant gains in raising female labor force participation, from 51 percent in 2006 to 56 percent in early 2024. Compared to regional peers, Uruguay's gender participation gap is relatively narrow, but is wider than the top 10 percent of countries worldwide.7 Closing the gender participation gap to the top 10 percent countries over the next 30 years would result in a growth increase of 0.2 percentage points per year - a more ambitious goal would bring further output growth gains. Expanding childcare support programs, providing training opportunities for women and removing asymmetric parental leave policies that discourage hiring of women or affect their pay can help raise female participation.

27. Reducing backward-looking indexation and introducing more sectoral differentiation in wage negotiations would support the disinflation process and competitiveness (Annex VIII). The wage bargaining process is characterized by widespread collective bargaining that covers all formal employment in practice. Wage indexation is prevalent in wage negotiations because expected inflation is a key input to the wage bargaining guidelines, and wages are adjusted if actual inflation exceeds inflation expectations. The presence of wage indexation leads to a persistent response of both wage growth and CPI inflation to shocks, increasing the trade-offs faced by the central bank in stabilizing inflation and the output gap. Moreover, the wage bargaining outcomes at the sectoral level do not generally include sector-specific considerations. Additional efforts to incorporate measures of productivity and other sector-specific conditions could be useful to increase the efficient allocation of labor and competitiveness, such as the current proposal to differentiate wage guidelines between tradable and non-tradable sectors in the next wage bargaining round.

28. Uruguay has been a trailblazer in climate mitigation and finance, but climate adaptation efforts need to be intensified. Uruguay has been at the forefront of climate finance innovation, with the issuance of its pioneering sustainability-liked bond and securing access from multilateral banks to global-first loans with financing conditions linked with the achievement of environmental targets. As climate hazards have become more frequent, the authorities' adaptation efforts need to be intensified. Droughts are becoming particularly relevant considering the output losses to the agricultural sector and the required recurrent fiscal interventions. Staff estimates that a one standard deviation drought shock could lower output by 0.3 percent, with a severe drought causing around a one percent loss in GDP (Annex I). Against this backdrop, it is critical to enhance water resource management, promote sustainability, and increase resilience to droughts. Key actions include: i) strengthening institutional coordination and planning for a sustainable use of water, ii) increasing capital expenditure for water security and reduction of losses in the drinking water distribution system, and iii) creating a drought response protocol.

Authorities' Views

29. The authorities agreed on the importance of continuing the implementation of structural reforms to boost potential growth and maintain favorable credit ratings and international markets access. The authorities also highlighted the innovation and digital transformation agenda to propel Uruguay to the forefront of the knowledge economy. The education reform is a key landmark to build highly skilled human capital and support the fast-paced IT sector growth. Newly implemented measures, such as the reduction in import tariffs, the introduction of trade-facilitating procedures and the planned logistical upgrade of the Port of Montevideo should contribute to the country's competitiveness. The authorities also stressed their efforts to improve the performance of SOEs by transparently reporting their financial statements and the cost of subsidies, improving risk management, and reducing inefficiencies, particularly electricity distribution losses. The authorities appreciated the importance of closing the labor force participation gender gap to increase potential growth yet noted that further analysis is needed to understand the impact of focused gender policies implemented in the past. The authorities reaffirmed that Uruguay remains at the forefront of the design of economic policies and financial instruments to address climate change mitigation while mobilizing resources for climate adaptation. They highlighted efforts on the way to enhance the water management regulatory framework, ensure the sustainable use of natural resources and to reduce losses in water distribution networks.

30. Past Fund advice. The authorities sound and prudent economic policies are consistent with key principles advocated by the Fund. The updating of the risk-based supervisory framework in line with international initiatives and the deployment of macroprudential tools to safeguard financial sector stability are in line with previous Fund advice. The recent upgrading of the monetary policy framework and communication, including allowing the exchange rate to act as a shock absorber, are in line with past Fund advice. Recent efforts to improve the targeting of some SOEs subsidies are also consistent with Fund advice. Staff and the authorities agree with the need to maintain fiscal prudence as it is key to preserve favorable market access and low sovereign spreads, while safeguarding social cohesion.

Staff Appraisal

31. In 2023, Uruguay confronted the impact of a once-in-a-century severe drought and external headwinds, but the economy remained resilient, owing to the authorities’ sound macroeconomic policies, the country’s political stability, and strong institutions. Despite the challenging environment, Uruguay maintained favorable market access with improved sovereign debt ratings and sovereign spreads at historically low levels, including the lowest spreads in the region. The current administration, in office since 2020, has implemented a significant upgrade of the fiscal and monetary policy frameworks and has advanced decisive structural reforms. In 2023, the authorities approved a key pension reform, placing medium-term public finances on a more sustainable path, and started implementing an education reform. Consolidating these gains should be the most important priority, as they provide the necessary macroeconomic policy space to confront domestic and external risks and support long-term growth.

32. While the 2024 revised budget is aligned with the net indebtedness target of the fiscal rule and social protection objectives, further efforts are needed to ensure a sustained downward path for the debt-to-GDP ratio over the medium term. The projected NFPS deficit, excluding cincuentones, of 3.1 percent of GDP in 2024 balances deficit reduction with safeguarding social spending, a sizeable share of total expenditures. While the current fiscal rule has been successful at stabilizing the debt-to-GDP ratio under challenging circumstances, further efforts are needed to ensure a sustained downward path for the debt-to-GDP ratio and rebuild fiscal buffers over the medium term, requiring lower targets for the structural balance and net indebtedness pillars of the fiscal rule. Refinements to the fiscal framework would help consolidate recent credibility gains.

33. Monetary policy should remain contractionary to ensure that inflation and inflation expectations stay within the target range in a sustained manner. Sustained monetary policy vigilance is crucial for continuing to build credibility and supporting de-dollarization efforts by delivering low and stable inflation rates. The authorities should continue emphasizing that the inflation target is the mid-point of the target band (4.5 percent) in their public communications, to help anchor expectations. Enhancing de jure central bank independence would further improve credibility and support policy continuity.

34. The financial sector remained resilient. The banking system is well capitalized, highly liquid, and profitable. Amid higher international interest rates and a more stable exchange rate, profitability increased. Despite last year's economic slowdown and losses in the agricultural sector, non-performing loans remained low with adequate loan loss provisions. In line with past FSAP recommendations, the SSF should continue pursuing efforts to upgrade its risk-based supervision framework, by enhancing its stress-testing framework and closing data gaps. Operationalizing the Pillar II capital add-ons will create an opportunity to address the adverse effect on capital buffers from the bank wealth tax.

35. Efforts to continue implementing structural reforms are key to unlock potential growth, while climate adaptation efforts need to be intensified. The implementation of the education reform is critical to provide the human capital Uruguay needs in the medium-term to foster the adoption of innovative technologies and increase productivity. The deepening of Uruguay's global integration should focus on pursuing efforts for trade facilitation, addressing nontariff barriers and red tape, and reducing logistics costs. Reducing backward-looking indexation and introducing more sectoral differentiation in wage negotiations would support the disinflation process and competitiveness. Uruguay has been at the forefront of climate finance innovation. Droughts are becoming particularly relevant considering the output losses to the agricultural sector and the required recurrent fiscal interventions. Against this backdrop, it is critical to enhance water resource management, promote sustainability, and increase resilience to droughts.

36. Staff recommends that the next Article IV consultation take place on the standard 12months cycle.

Figure 1.
Figure 1.

Uruguay: Real Activity

Citation: IMF Staff Country Reports 2024, 215; 10.5089/9798400282904.002.A001

Sources: World Economic Outlook, Haver Analytics, Banco Central del Uruguay (BCU), Instituto Nacional de Estadistica, Bloomberg L.P., and IMF staff calculations.
Figure 2.
Figure 2.

Uruguay: Labor Market

Citation: IMF Staff Country Reports 2024, 215; 10.5089/9798400282904.002.A001

Sources: Haver, ILOSTAT, INE, and IMF staff calculations.
Figure 3.
Figure 3.

Uruguay: Inflation

Citation: IMF Staff Country Reports 2024, 215; 10.5089/9798400282904.002.A001

Sources: World Economic Outlook, Haver Analytics, Banco Central del Uruguay (BCU), Instituto Nac ional de Estadistica, Bloomberg L.P., and IMF staff calculations.
Figure 4.
Figure 4.

Uruguay: External Accounts

Citation: IMF Staff Country Reports 2024, 215; 10.5089/9798400282904.002.A001

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

Uruguay: Fiscal Sector

Citation: IMF Staff Country Reports 2024, 215; 10.5089/9798400282904.002.A001

1/ USD-10Y: Yield on 10-year dollar-denominated securities.2/ WA Spread: Weighted average spread vis-a-vis US Treasuries of comparable maturity.Source: Uruguayan authorities, Bloomberg, Bolsa Electronica de Valores del Uruguay, and IMF staff calculations.
Figure 6.
Figure 6.

Uruguay: Monetary Policy

Citation: IMF Staff Country Reports 2024, 215; 10.5089/9798400282904.002.A001

Sources: IMF, World Economic Outlook; Banco Central del Uruguay (BCU), and IMF staff calculations.1/ Yields on BCU paper issued in nominal pesos (Letras de Regulacion Monetaria).2/ Average interest rates on new peso loans of up to one year.3/ Weighted average rate on totality of fixed term deposits.
Figure 7.
Figure 7.

Uruguay: Credit and Banking

Citation: IMF Staff Country Reports 2024, 215; 10.5089/9798400282904.002.A001

Sources: IMF, World Economic Outlook; Banco Central del Uruguay (BCU), and IMF staff calculations.
Figure 8.
Figure 8.

Uruguay: Climate

Citation: IMF Staff Country Reports 2024, 215; 10.5089/9798400282904.002.A001

Sources: UNFCCC, WRI CAIT, Ministerio de Industria Energia y Mineria, WEO, IEA, INGEI, IMF staff calculations.
Table 1.

Uruguay: Selected Economic Indicators, 2021-25

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Sources: Banco Central del Uruguay, Ministerio de Economia y Finanzas, Instituto Nacional de Estadistica, and IMF staff calculations. 1/ Percent change of end-of-year data. 2/ Includes bank and non-bank credit. 3/ Non-financial public sector (NFPS) includes the Central Government (CG), Banco de Prevision Social (BPS), Banco de Seguros del Estado (BSE), and Non-Financial Public Enterprises (NFPE). 4/ 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
Table 2.

Uruguay: Balance of Payments and External Sector Indicators, 2020-29

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

Uruguay: Main Fiscal Aggregates, 2020-29

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Sources: Ministerio de Economia y Finanzas, Banco Central del Uruguay, and IMF staff calculations. 1/ Banco de Prevision Social (BPS). 2/ Non-financial public enterprises (NFPE). 3/ Banco de Seguros del Estado (BSE).
Table 4.

Uruguay: Monetary Survey, 2016-23

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Source: Banco Central del Uruguay and IMF staff calculations. 1/ Peso monetary liabilities include base money and non-liquid liabilities. 2/ The Banco de la Republica Oriental de Uruguay (BROU), Banco Hipotecario de Uruguay (BHU; mortgage institution), private banks, financial houses and cooperatives. 3/ Percentage change from previous year. In pesos, unless otherwise indicated. 4/ Includes credit to households from banks and credit cooperatives.
Table 5.

Uruguay: Medium-Term Macroeconomic Framework, 2020-29

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Sources: Banco Central del Uruguay, Haver Analytics and IMF staff calculations. 1/ 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.
Table 6.

Uruguay: Selected Financial Soundness Indicators, 2015-23

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Sources: Uruguayan authorities and IMF Financial Soundness Indicators.

Annex I. Macroeconomic Impacts of Droughts in Uruguay

1. Uruguay’s exposure to extreme climate events has been increasing, causing substantial economic losses. Uruguay confronted the impact of a once-in-a-century severe drought, which mostly affected the agricultural sector lowering agricultural output between the last quarter of 2022 and the second quarter of 2023 by 25 percent on a year-on-year basis. Rain and floods are also becoming more frequent, forcing vulnerable groups to relocate (3 percent of the population in 2015-19) and impacting livelihoods. Uruguayan agricultural sectors are increasingly exposed to weather events impacting on crop yields and food production more broadly. As La Nina conditions prevailed for four consecutive years since 2020, Uruguay confronted the impacts of one of the worst dry spells in the last century, causing significant direct losses to the primary sector in 2023, especially for soybean production and cattle farming.

2. As weather events have become more frequent, the modelling of climate change impacts has become a priority. As recurrent responses to climate shocks have put pressure on fiscal space, the authorities have focused in enhancing the modelling of fiscal impacts from climate change (i.e. coastal floods, excessive rainfall, droughts) and integrating them into the national budget. This study’s approach contributes to widening the authorities’ toolkit for impact assessments.1

3. Considering the predominance of the agriculture in Uruguay’s economy, weather shock events are captured through soil moisture conditions. A key input for this endeavor is the soil water available (PAD) indicator produced by the National Institute of Agriculture Research (INIA). This high frequency indicator relies on INIA’s spatially distributed hydrologic modeling and daily inputs captured through a nation-wide grid coverage. The PAD allows for a comprehensive assessment of soil moisture conditions as it factors in precipitations, surface runoff, infiltration, evaporation, water plant uptake and soil properties. For the modeling of macroeconomic impacts of weather shocks, the PAD is used to develop a soil moisture deficit indicator (SMDI) following the methodology of Narasimhan and Srinivasan (2005).2 Long-term PAD reference values for each month are obtained from the 2000-2023 period. As drought impacts are larger when dry conditions are sustained over time, the SMDI is calculated in an incremental basis. The SMDI succeeds in capturing periods of drought-related losses in agricultural output (see text chart).

4. A rise in the soil moisture deficit index (drought) causes a prolonged fall in overall GDP, agricultural output and investment. According to a Structural VAR model that includes key macroeconomic variables and the soil moisture deficit index, an adverse weather shock, a one-standard deviation rise in the drought variable (Figure 1), generates a contraction in Uruguay's economy.3 A rise in soil moisture deficits implies a contemporaneous 0.1 percent decrease in the agricultural sector (primary activities: agricultural, fishing and mining) and a peak decline in GDP of 0.3 percent after 3 quarters. The weather variable vanishes after a year, however its impact on the economy is persistent - impacting agricultural output for 2 years in the SVAR and up to 5 years in the DSGE model. The weather shock manifests itself through the labor market by a fall on impact of employment followed by a rebound, which mimics the behavior of a TFP shock.

5. A similar fall in key macroeconomic variables from the drought is seen in an estimated DSGE model of Uruguay economy. A small open economy DSGE quarterly model with a flexible exchange rate and agricultural and non-agricultural sector estimated to the Uruguay economy shows that droughts have persistent negative impacts on output and consumption. The weather shock acts as a negative supply shock through a combination of rising employment and falling output. Land productivity is negatively affected by the drought, weighing heavily on agricultural output. The real exchange rate, which acts as a shock absorber, depreciates driven by the depressed competitiveness of farmers, which helps to restore part of their competitiveness.

Figure 1.
Figure 1.

Uruguay: Response of the Uruguayan Economy from a Drought Shock

Citation: IMF Staff Country Reports 2024, 215; 10.5089/9798400282904.002.A001

Source: IMF staff calculations.Note: Time period is quarterly.

6. Model estimates show around one percent GDP loss due to the recent drought episode. Simulating the recent drought by matching the rise in the soil moisture deficit index seen between 2022Q4 and 2023Q2 provides around a one percent fall in GDP for 2023, driven by losses in agricultural output and investment. A third of the downward revision to 2023 GDP growth, comparing the October 2022 WEO forecast to the latest data, can be explained by the drought where the rest is partly explained by the closing of the ANCAP oil refinery and consumption leakage to Argentina. According to the Structural VAR model, the impact of the drought should subside in 2024, while the DSGE model shows a longer lasting effect. However, normalization of rainfall in the second half of 2023, shown by a fall in the SMDI, has bolstered the primary sector recovery.

Figure 2.
Figure 2.

Uruguay: Estimated Impact of the 2022/23 Drought

Citation: IMF Staff Country Reports 2024, 215; 10.5089/9798400282904.002.A001

Source: IMF Staff calculations

References

  • Clevy, JF., and Evans, C. (2024). Macroeconomic Impact of Droughts in Uruguay: A General Equilibrium Analysis Using the Soil Moisture Deficit Index. IMF Working Paper, forthcoming.

  • Gallic, E., and Vermandel, G. (2020). Weather shocks. European Economic Review, 124, 103409.

  • Narasimhan, B. and Srinivasan, R. (2005). Development and evaluation of Soil Moisture Deficit Index (SMDI) and Evapotranspiration Deficit Index (ETDI) for agricultural drought monitoring. Agricultural and Forest Meteorology, 133, 69-88.

Annex II. Estimating the Budgetary Impact of Disinflation Surprises1

1. The faster-than-expected disinflation in 2023 was a welcome new development, but it has implications for the fiscal accounts. CPI inflation was 5.1 percent at the end of 2023, while at the time of the 2023 Article IV Staff Report the projection was 7 percent. Following these developments, the authorities revised their 2024 macroeconomic assumptions compared to the 2023 Rendition de Cuentas. Disinflation surprises can impact budget outcomes in two ways. First, the nominal value of both spending and tax receipts change, and the real (inflation-adjusted) value of those spending and taxes that depend on past (rather than current) prices increase. Second, if unexpected inflation surprises are linked to unforeseen changes in the GDP deflator, the budget can be impacted by the difference between actual nominal GDP and the originally projected GDP, leading to mismatches between the planned and executed ratio of spending and revenue to GDP.

2. Counterfactual projections are needed to estimate the direct impact of inflation surprises on the budget. Counterfactual projections aim at isolating the partial equilibrium effect of inflation shocks, independent of other factors influencing the budget. Using actual inflation outturns and updated projections for 2024, revised paths for GDP, revenues, and spending are estimated, based on the macro and fiscal parameters implicit in the 2023 and 2024 budget projections (from the June 2022 and 2023 Rendition de Cuentas, respectively). The methodology to construct a counterfactual projection is as follows:

  • Counterfactual GDP. The real growth rate is kept constant at the original budget projections. The actual CPI inflation outturns from 2022 and 2023 alongside the updated 2024 inflation projections are used, together with the elasticities of the GDP deflator to the CPI implicit in the budget projections.

  • Counterfactual revenues. The counterfactual GDP projections, together with estimated revenue elasticities with respect to GDP that are implicitly embedded within the original budget projections, are used to construct counterfactual paths for taxes collected by the DGI (internal revenue administration), foreign trade taxes, social security contributions, and other revenue streams.

  • Counterfactual spending. Some additional assumptions are needed to construct counterfactual spending figures, accounting for the impact of inflation on various components while holding quantities constant. These quantities, including number of employees, recipients of pensions and social transfers, and volumes of goods and services and investment, are derived from budget projections and knowledge on how inflation affects wages, pensions, and transfers (directly or indirectly). Due to current indexation practices, it is assumed that a surprise in inflation during one-year impacts only the wages, pensions, and cash transfers of the following year. Based on the breakdown of goods and services as well as investment goods, unexpected inflation in a single year is assumed to have a contemporaneous impact on 56 percent of the planned budget for goods and services and on 25 percent of planned budget for investment. Finally, it is assumed that the amount budgeted for transfers to entities, and other unclassified transfers are not affected by inflation surprises, while outlays related to health insurance are fully affected by the inflation surprise of the same year.

3. Keeping constant the growth projections, elasticities, and real spending as in the budget allows to isolate the direct effect of inflation on nominal variables (and on their ratio to GDP), by filtering out (i) second order (general equilibrium) effects of inflation surprises (on growth, income, employment, domestic demand, etc.), (ii) forecast errors (such as real growth or the GDP deflator), (iii) estimation errors of elasticities such as revenues to GDP), and (iv) endogenous fiscal policy responses.

4. The faster-than-expected disinflation added about 0.17 percent of GDP to the primary deficit projected in the 2023 budget and about 0.16 percent of GDP to the primary deficit in the 2024 budget. The estimated effects mostly reflect that nominal spending decreases with lower inflation, but by less than nominal GDP does. Moreover, the same framework is used to quantify the direct impact of shocks to the growth of the GDP deflator on GDP and revenues.2 The impact of lower-than-expected GDP deflator is quantified as a further deterioration of the primary deficit of about 0.72 percent of GDP in 2023, and as a slight further deterioration of the primary balance of 0.04 percent in 2024.3

5. These estimates mean that, in 2023, other changes to macroeconomic variables and fiscal policy had a positive impact on the primary balance of about 0.3 percent of GDP. Real GDP growth was lower than projected and revisions to past GDP levels lowered nominal GDP. At the same time, revenue elasticity surprised on the upside (both DGI revenues and social security contributions were stronger than anticipated) driven by strong employment creation. These developments helped offset the deterioration of the primary balance from lower inflation and lower GDP deflator.

Figure 1.
Figure 1.

Uruguay: Estimated Impact of Faster-than Expected Disinflation in 2023 and 2024

Citation: IMF Staff Country Reports 2024, 215; 10.5089/9798400282904.002.A001

Source: IMF staff estimates.

Annex III. External Sector Assessment

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Annex IV. Risk Assessment Matrix1

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Annex V. Public Sector DSA

Table 1.

Uruguay: Risk of Sovereign Stress

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Table 2.

Uruguay: Debt Coverage and Disclosures

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Table 3.

Uruguay: Public Debt Structure Indicators

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Table 4.

Uruguay: Baseline Scenario

(in percent of GDP unless indicated otherwise)

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Table 5.

Uruguay: Realism of Baseline Assumptions

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Source: IMF Staff calculations. 1/ Projections made in the October and April WEO vintage. 2/ Calculated as the percentile rank of the country's output gap revisions (defined as the difference between real time/period ahead estimates 3/ Data cover annual obervations from 1990 to 2019 for MAC advanced and emerging economies. Percent of sample on vertical axis. 4/ The Laubach (2009) rule is a linear rule assuming bond spreads increase by about 4 bps in response to a 1 ppt increase in the projected debt-to-GDP ratio.
Table 6.

Uruguay: Medium-Term Risk Analysis

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Source: IMF staff estimates and projections. 1/ See Annex IV of IMF, 2022, Staff Guidance Note on the Sovereign Risk and Debt Sustainability Framework for details on index calculation. 2/ The comparison group is emerging markets, commodity exporter, surveillance. 3/ The signal is low risk if the DFI is below 1.13; high risk if the DFI is above 2.08; and otherwise, it is moderate risk. 4/ The signal is low risk if the GFI is below 7.6; high risk if the DFI is above 17.9; and otherwise, it is moderate risk. 5/ The signal is low risk if the GFI is below 0.26; high risk if the DFI is above 0.40; and otherwise, it is moderate risk.
Table 7.

Uruguay: Long-Term Risk Analysis: Large Amortizations

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Table 8.

Uruguay: Long-Term Risk Analysis II, Demographics, Health

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Annex VI. External Sector DSA

1. After peaking in 2020, external debt in Uruguay reached 67.2 percent of GDP in 2023, trending down for the third consecutive year (see Table 1). In 2023, despite the widening of the trade balance deficit, debt dynamics (including exchange rate appreciation) and non-debt creating flows helped bringing down the debt ratio. About 46 percent of the external debt is owed by the public sector.

2. Gross external debt is forecasted to increase in 2024, leveling at around 69 percent of GDP. Over the medium term, external debt is projected on a downward trend owing to favorable automatic debt dynamics, the contribution of non-debt creating capital inflows, as well as narrower fiscal and current account deficits.

3. Gross external financing requirements are expected to gradually converge to 12 percent of GDP. This reduction would be underpinned by a stronger non-interest current account surplus and stable amortization of longer-term debt.

4. Stress tests indicate that the standard interest rate shocks would have a limited impact on external debt. Shocks to the non-interest current account, growth or a combined shock (to the real interest rate, growth and current account) would have a greater, but still moderate (lower than 10 percentage points increase), impact.

5. The main risk to Uruguay’s external debt sustainability is an exchange rate depreciation. A one-off 30 percent exchange rate depreciation would increase the external debt-to-GDP ratio to 100 percent of GDP in the short-term, while stabilizing in the medium-term around 95 percent of GDP (see Figure).

6. Overall, the outlook for external debt sustainability has improved on the back of stronger macroeconomic performance and favorable debt dynamics. Despite an external context marked by higher interest rates and the impacts of an historical drought, under the baseline scenario, the medium-term external debt is lower in almost 8 percentage points when compared to the previous external DSA in 2023. Considering that Uruguay’s external liabilities are mainly comprised of foreign direct investments and that the country maintains sizeable gross international reserves and fiscal liquidity buffers, risks to external debt sustainability remain limited.

Table 1.

Uruguay: External Debt Sustainability Framework, 2017-2029

(In percent of GDP, unless otherwise indicated)

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1/ External debt includes non-resident deposits. 2/ 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. 3/ 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). 4/ For projection, line includes the impact of price and exchange rate changes. 5/ 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. 6/ 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. 7/ 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 2024, 215; 10.5089/9798400282904.002.A001

Sources: International Monetary Fund, Country desk data, and IMF 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 seven-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 2024.

Annex VII. List of FSAP Recommendations

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1 I —Immediate (within 1 year), ST—Short term (within 1-2 years), MT—Medium term (within 3-5 years)

Annex VIII. Collective Wage Bargaining and Macroeconomic Outcomes in Uruguay

1. Understanding the link between inflationary shocks and wage setting has become increasingly important as it affects the ability of central banks in achieving their mandates. A recent example of this mechanism was the inflation shock of 2021 -2022, when inflation increased globally due to a succession of supply (post-Covid supply chain constraints and Russia's war in Ukraine) and demand shocks (fiscal and monetary expansions in advanced economies). As discussed by Lorenzoni and Werning (2023) for the United States, the initial CPI inflation increase was followed by a delayed pick-up in the employment costs index, with the concern that high wage growth would further complicate the return of inflation to target or even set-off a "price-wage" spiral. Similar discussions took place in other advanced and emerging market economies (see IMF WEO, October 2022, Chapter 2).

2. In Uruguay, the wage setting process is characterized by widespread collective bargaining that covers in practice all formal employment, with substantial indexation to inflation. Negotiations are tripartite, including labor unions, employer associations, and the government, with agreements negotiated at the sector level. The Tripartite Superior Council (TSC) is the body in charge of the coordination and governance of labor relations. The duration and scope of the agreements as well as the relevant parameters to adjust wages have changed over time. Contracts typically have three components for adjustment: (i) expected inflation, (ii) compensation when past actual inflation was higher than expected (corrective), and (iii) recovery or real growth which has been partially linked aggregate productivity (recuperation). The relevant inflation expectation measure used in negotiations has changed overtime. In the first collective wage bargaining rounds, that were reinstated in 2005, the option to select among different measures of inflation was given, including past inflation or the inflation expected by private analysts. Overtime, the agreements moved to using the central bank's measure of inflation expectations. However, in most recent rounds, the measure of expected inflation has been the one published in the Ministry of Economy and Finance (MEF) fiscal reports to parliament (the "Rendition de Cuentas").

3. A natural question that emerges is to what extent the prevalence of collective bargaining affects wage dynamics and macroeconomic outcomes. As a first step, an augmented wage Phillips curve is estimated for Uruguay in the spirit of Gali (2011), who proposed the following wage inflation dynamics equation, that is derived by assuming staggered nominal wage setting with indexation, and is extended with partial nominal wage growth adjustment:

πtw=ρπt−1w+(1−ρ)(α+βINDt+γut+δΔut)+εt

where the "IND" variables can be either expected or lagged annual inflation. The estimates suggest that wages in Uruguay are more responsive to lagged inflation than inflation expectations, and also that there is a significant relationship between wage growth and the level of the unemployment rate, but not the change in the unemployment rate (Table 1). The importance of lagged inflation in the regression could reflect that while wage negotiations typically include a measure of expected inflation, additional wage increases are triggered if past observed inflation exceeds expected inflation. In an alternative specification, nominal wage growth is shown to react to productivity growth instead of the unemployment rate.1 These results are broadly consistent with the crosscountry evidence provided in the Chapter 2 of the October 2022 World Economic Outlook for a sample of emerging markets that excluded Uruguay.

Table 1.

Uruguay: Aggregate Wage Equation Estimates

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Source: IMF staff estimates, based on Rabanal and Sbrancia (2024). Notes: Standard errors in parenthesis. One, two, and three stars denote significance at the 10, 5 and 1 percent levels. Wage equations is estimated via Generalized Method of Moments (GMM) method with 2 lags of all variables as instruments, and robust standard errors.

4. A small open economy DSGE model is used to understand how wage indexation affects the joint behavior of price-wage dynamics and the role of monetary policy. The model includes several real, nominal and financial frictions, and also international trade linkages with the rest of the world, as in Adrian et al. (2021), and is estimated with Bayesian methods and Uruguay data. Specifically, the model features wage rigidities, partial nominal wage adjustment and indexation to lagged annual CPI inflation, consistent with the reduced form estimates in Table 1. It also includes a price Phillips Curve with estimated backward-looking behavior in Uruguay. The model includes other features including slow pass-through to exchange rate movements, and a monetary policy Taylor-type rule that reacts to output and inflation fluctuations.

5. Wage indexation increases the persistence in the response of CPI inflation to several shocks, leading to more severe monetary policy trade-offs. The estimated reaction of the economy to different shocks (Figure1, blue line) is compared to a counterfactual where wages are only indexed to the inflation target of the central bank (red dashed line), and in addition, the price Phillips curve becomes more forward looking (black line).

  • In response to a large depreciation driven by an increase in global risk, CPI inflation initially increases because of the reaction of imports prices, but the lagged response of nominal wage growth due to indexation leads to a persistent response of inflation through the increase in labor costs. Initially, the output gap is negative because domestic demand contracts more than the improvement in the trade balance, that builds up reflecting lagged effects of the initial depreciation. In the counterfactual economy where wages are indexed to the central bank target, the impact response of inflation is similar, but the persistence is smaller due to more muted price-wage joint effects. The initial contraction in the economy is smaller when wage indexation is no longer prevalent, and the expansionary effects of the depreciation are larger.

  • In response to a wage mark-up shock, CPI inflation increases because of the increase in labor costs, with a highly persistent response. The output gap declines due to the tightening by the central bank, which not only leads to a decline in domestic demand but through exchange rate appreciation, of the trade balance. The reaction of CPI inflation is not only less persistent but also quantitatively smaller when wages are indexed to the central bank inflation target compared to the estimated economy. The output gap costs of bringing inflation back to target are also smaller in the counterfactual economy, because the smaller and less persistent response of CPI inflation requires less tightening to bring inflation back to target.

Figure 1.
Figure 1.

Uruguay: Estimated and Counterfactual Responses

Citation: IMF Staff Country Reports 2024, 215; 10.5089/9798400282904.002.A001

Source: IMF staff estimates, based on Rabanal and Sbrancia (2024).Note: Time period is quarterly.

6. Given the centralized wage bargaining process in Uruguay, an additional question to explore is to what extent wages at the sectoral level respond to sector-specific conditions. To analyze this question, a database with wages at the sector level from Banco de Prevision Social (BPS) is used to estimate a similar equation to the Gali (2011) framework with aggregate and sector-specific variables.1 Specifically, the framework is extended by including a panel data dimension (sector and time), and employment and labor productivity at the sectoral level (Table 2). The two main results from this analysis are as follows. First, wages respond to lagged inflation and to the unemployment rate. This result is consistent across specifications, and with the aggregate results. Moreover, the specification with expected inflation measures delivers the wrong sign for this variable. Second, sectorspecific employment or productivity growth measures are not significant. This finding is consistent with the fact that measures of productivity are not systematically incorporated in the rounds of negotiations and confirmed by plotting real wage growth and productivity growth at the sector level (Figure 2).

Table 2.

Uruguay: Sector Wage Equation Estimates

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Source: IMF staff estimates. Notes: Standard errors in parenthesis. One, two, and three stars denote significance at the 10, 5 and 1 percent levels. Wage equations are estimated with fixed effects and robust standard errors.
Figure 2.
Figure 2.

Uruguay: Real Wage and Productivity Growth (2011-2022)

Citation: IMF Staff Country Reports 2024, 215; 10.5089/9798400282904.002.A001

Source: IMF staff estimates and calculations, Banco de Previsión Social, Banco Central del Uruguay.

7. To summarize, there would be gains from reducing the degree of indexation in wage contracts, and current efforts to incorporate sector-specific conditions in the wage bargaining process should continue. Using a structural model, the analysis shows that the prevalence of wage indexation increases the persistence in the response of CPI inflation to shocks, through the joint dynamics of prices and wages. Moreover, additional efforts to incorporate measures of productivity and other sector-specific variables could be useful to increase the efficient allocation of labor and competitiveness, such as the current proposal to differentiate wage guidelines between tradable and non-tradable sectors.

References

  • Adrian, Tobias, Erceg, Chris, Kolasa, Marcin, Linde, Jesper, and Pavel Zabczyk, 2021. "A Quantitative Microfounded Model for the Integrated Policy Framework,” IMF Working Paper 21/292.

  • Gali, Jordi, 2011. "The Return of the Wage Phillips Curve.” Journal of the European Economic Association. Vol. 9, Issue 3, pp. 436-461.

  • International Monetary Fund, 2022. "Wage Dynamics Post-COVID-19 and Wage-Price Spiral Risks,” Chapter 2 of World Economic Outlook, October 2022.

  • Lorenzoni, Guido and Ivan Werning, 2023. "Wage-Price Spirals,” Brookings Papers on Economic Activity.

  • Rabanal, Pau and M. Belen Sbrancia, 2024. "Examining Price-Wage Dynamics in a Small Open Economy: The Case of Uruguay,” IMF Working Paper No. 2024/105.

Annex IX. Data Issues

(As of May 9, 2024)

Table 1.

Uruguay: Data Adequacy Assessment for Surveillance

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Table 2.

Uruguay: Data Standards Initiatives

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Table 3.

Uruguay: Table of Common Indicators Required for Surveillance

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1 Includes reserve assets pledged or otherwise encumbered, as well as net derivative positions. 2 Both market-based and officially determined, including discount rates, money market rates, rates on treasury bills, notes and bonds. 3 Foreign, domestic bank, and domestic nonbank financing. 4 The general government consists of the central government (budgetary funds, extra budgetary funds, and social security funds) and state and local governments. 5 Including currency and maturity composition. 6 Frequency and timeliness: ("D”) daily; ("W”) weekly or with a lag of no more than one week after the reference date; ("M”) monthly or with lag of no more than one month after the reference date; ("Q”) quarterly or with lag of no more than one quarter after the reference date; ("A”) annual.; ("SA") semiannual; ("I") irregular; ("NA") not available or not applicable; and ("NLT") not later than;. 7 Encouraged frequency of data and timeliness of reporting under the e-GDDS and required frequency of data and timeliness of reporting under the SDDS and SDDS Plus. Any flexibility options or transition plans used under the SDDS or SDDS Plus are not reflected. For those countries that do not participate in the IMF Data Standards Initiatives, the required frequency and timeliness under the SDDS are shown for New Zealand, and the encouraged frequency and timeliness under the e-GDDS are shown for Eritrea, Nauru, South Sudan, and Turkmenistan. 8 Based on the information from the Summary of Observance for SDDS and SDDS Plus participants, and the Summary of Dissemination Practices for e-GDDS participants, available from the IMF Dissemination Standards Bulletin Board (https://dsbb.imf.org/). For those countries that do not participate in the Data Standards Initiatives, as well as those that do have a National Data Summary Page, the entries are shown as "..."
1

See IMF Country Reports 23/178 (Annex VIII) and 22/16 (Annex VII) for more details on the pension reform.

2

Temporary proceeds from the pension reform that allowed certain workers to voluntarily move back to the public pension system.

3

Uruguay ranks third in Latin America for its governmental readiness for artificial intelligence according to the 2023 index of Government Readiness for Artificial Intelligence by Oxford Insights.

4

See IMF Country Report 23/179.

5

Currently, the administration includes indicative targets for the medium-term horizon (5 years) in the Five-Year Budget and Accountability Law (Ley de Presupuesto Quinquenaly Rendition de Cuentas), which may be revised during subsequent annual reports to parliament (Rendition de Cuentas), as macroeconomic conditions evolve.

6

October 2023 Regional Economic Outlook - Western Hemisphere - Online Annex 4.

7

Uruguay's female labor force participation gap stands at 13 percentage points as of March 2024. To reach the top 10 percent of countries worldwide the gap would need to narrow to under 7 percentage points. Output gain estimates from closing the labor force participation gender gap (text chart) are based on the toolkit described in Ostry, J.D., J. Alvarez, R. Espinoza, and C. Papageorgiou (2018), "Economic gains from gender inclusion: New mechanisms, new evidence" International Monetary Fund, Staff Discussion Notes 18/06. The toolkit is further calibrated to Uruguay using data on the gender-wage gap and findings from the 2020 World Bank study on gender in Uruguay.

1

See Clevy and Evans (2024) for further details.

2

The indicator is developed based on the relevant grids for agriculture production, covering particularly the departments of Colonia, Durazno, Flores, Paysandu, Rio Negro, San Jose and Soriano.

3

Figure 1 outlines the impulse response of each macroeconomic variable to a one-standard-deviation increase in the soil moisture deficit index in a SVAR and DSGE model. In the SVAR the weather shock is identified using a Choleski decomposition. The analysis follows work by Gallic and Vermandel (2020), who find similar results for New Zealand.

1

Prepared by Paolo Dudine and Rodrigo Cerda (both FAD).

2

While the 2023 budget was predicated on a deflator elasticity to the CPI of about 1, which is consistent with historical data, the growth of the GDP deflator is projected to be about two/thirds of inflation for 2023.

3

Moreover nominal GDP in 2023 turned out to be 7.9 percent lower than in the 2023 budget, and in 2024, it is projected to be 5.5 percent lower than in the 2024 budget. This is due to both lower GDP deflator inflation and real growth, and to recent historical revisions to the GDP series since 2019.

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. The conjunctural shocks and scenarios highlight risks that may materialize over a shorter horizon (between 12 to 18 months) given the current baseline. Structural risks are those that are likely to remain salient over a longer horizon.

1

When both unemployment and productivity growth are included in the regression, none of these variables is significant, likely due to multicollinearity. See Rabanal and Sbrancia (2024) for details.

1

The regressions are estimated at quarterly frequency for the period 2010Q1 - 2022Q4. The data on wages is originally at monthly frequency and contains data for 22 economic sectors. Productivity is defined as output per worker which reduces the number of sectors to 7 once the data on GDP for the whole period is spliced (there is no GDP data available on public administration and financial services for the period prior to 2016). Employment data, instead of unemployment, is used at the sectoral level.

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Cover IMF Staff Country Reports
Uruguay: 2024 Article IV Consultation-Press Release and Staff Report
Author:
International Monetary Fund. Western Hemisphere Dept.
Volume/Issue:
Volume 2024: Issue 215
Publisher:
International Monetary Fund
ISBN:
9798400282904
ISSN:
1934-7685
Pages:
81
DOI:
https://doi.org/10.5089/9798400282904.002

Main Goods Trade Flows
Figure 1.

Uruguay: Real Activity
Figure 2.

Uruguay: Labor Market
Figure 3.

Uruguay: Inflation
Figure 4.

Uruguay: External Accounts
Figure 5.

Uruguay: Fiscal Sector
Figure 6.

Uruguay: Monetary Policy
Figure 7.

Uruguay: Credit and Banking
Figure 8.

Uruguay: Climate
Figure 1.

Uruguay: Response of the Uruguayan Economy from a Drought Shock
Figure 2.

Uruguay: Estimated Impact of the 2022/23 Drought
Figure 1.

Uruguay: Estimated Impact of Faster-than Expected Disinflation in 2023 and 2024
Figure 1.

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

(External debt in percent of GDP)
Figure 1.

Uruguay: Estimated and Counterfactual Responses
Figure 2.

Uruguay: Real Wage and Productivity Growth (2011-2022)