Public Information Notice: IMF Concludes Article IV Consultation with Uruguay
July 30, 1999
|Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.|
On July 27, 1999, the Executive Board concluded the Article IV consultation with Uruguay.1
Since 1990, Uruguay has implemented a gradual anti-inflation strategy, based on de-indexing the economy, slowing the rate of depreciation of the exchange rate band, strengthening the public finances, liberalizing foreign trade, reforming the state and social security system, and privatizing certain public services. The economy has responded well. Per capita real GDP growth averaged 3¼ percent a year since 1990, the highest rate for any decade since the 1940s, inflation fell steadily to a single digit by end-1998, and the current account deficit remained modest. However, unemployment has remained high since increasing sharply during 1993-96 due to economic restructuring.
The economy continued to perform well in 1998. Inflation nearly halved during the year to 8½ percent by December, while real GDP growth was 4½ percent. Unemployment dropped from over 11 percent in 1997 to about 10 percent in 1998 with strong employment growth in the services sectors. The consolidated public sector deficit was 1 percent of GDP, slightly below the authorities' program target, and the external current account deficit remained modest at just under 2 percent of GDP. Uruguay met all quantitative performance criteria under the Fund supported program, and virtually all structural benchmarks were observed.
However, external conditions started to worsen significantly around mid-1998. Owing to uncertainties in Russia and Brazil, access to global capital markets was temporarily interrupted during the third quarter, prompting the authorities to make a single cumulative drawing under the Fund supported program, previously treated as precautionary. Towards the end of the year prices and demand weakened, but output growth remained buoyant, based partly on inventory accumulation in the agricultural sector.
The authorities' economic objectives for 1999 included reducing the 12-month rate of inflation to 5½ percent by year-end, while limiting the uptick in unemployment, and maintaining a viable external current account position and preserving a sound level of gross official reserves. Following the sharp depreciation of the Brazilian real in January and the slowing of economic activity in the region, real GDP for the year was originally projected to drop by 1 percent. By May, however, it was apparent that the economy had been affected more severely than first anticipated, and real GDP is now anticipated to drop by 2 percent in 1999. At the same time, inflation also dropped faster than anticipated and is now expected to decline to 4¾ percent by year-end. Notwithstanding a difficult first quarter, the authorities met all their program objectives through end-March 1999. However, in June, the BCU was not able to finalize the sale of an intervened bank.
The external current account deficit is expected to widen to 2½ percent of GDP, reflecting weaker commodity prices and reduced foreign demand. Agricultural goods, such as rice normally destined for Brazil, found other buyers beyond Mercosur, but at substantial discounts. Also, tourism, a key service export, turned out slightly weaker than expected. Moreover, reduced import volumes were partially offset by increased oil prices.
To help meet the challenge of the competitiveness shock of January, private sector firms reduced working hours and restrained wage growth. In some cases, labor and management agreed upon nominal wage reductions. Supporting such efforts, the government has kept the rate of depreciation of the exchange rate band at 0.6 percent monthly (7 ½ percent annualized) and granted some reductions in selected public tariffs, and social security contributions and wealth taxes in the agricultural sector.
Events in early 1999 left Uruguay's financial markets and capital account largely unaffected, apart from a temporary increase in the interbank interest rate. Access to foreign capital was not interrupted, and by May peso interbank interest rates had dropped to below their level just prior to the Russia crisis in 1998. Indeed, adjusted for expected exchange rate depreciation, the short-term peso interest rates have converged recently to the equivalent U.S. dollar rates. This, along with the renewal of Uruguay's investor grade credit rating (first granted in 1997) confirmed investor confidence in Uruguay. In late April, the government placed a US$250 million, 10-year eurobond at a modest spread of 213 basis points over the comparable U.S. Treasury issue. These factors have also meant a good performance on net international reserves, which have remained well above the program floor so far in the year.
The Uruguayan banking system had a good performance in 1998, especially the private banks which comprise just over half of all bank assets. Excluding intervened banks, the ratio of non-performing loans to total assets in private banks has remained under 2 percent in recent years. The public banks also improved their performance in 1998 but remained well behind their private sector counterparts in efficiency and profitability. In early 1999, the state-owned Bank of the Republic (BROU) experienced some pressure to refinance loans, especially in the cattle-raising sector.
Executive Board Assessment
Executive Directors agreed with the thrust of the staff appraisal. They noted that Uruguay has made substantial progress under the 1999 Fund-supported program notwithstanding a more difficult international economic environment than first thought, and they approved the authorities' request for a modification of the fiscal and the overall debt targets under the program for end-June 1999 and the rest of the year.
Directors welcomed the authorities' adherence to cautious fiscal and monetary policies and their demonstrated willingness to take timely steps in these areas, as required by the circumstances. Indeed, the faster-than-expected slowing of inflation partly reflected the authorities' credibility and the public's underlying confidence in overall macroeconomic policies. They also noted with satisfaction that the regional crisis had not affected Uruguay's access to international financial markets.
The main challenge facing the authorities in the short term was to mitigate the deceleration in economic activity, while preserving the trend of medium-term fiscal consolidation. Directors felt that a moderate widening of the fiscal deficit target consistent with the impact of the automatic stabilizers struck a broadly appropriate balance between the need for some accommodation of the recession in fiscal policy and the risks of further turbulence in the international capital markets which could easily tighten up financing conditions on a short notice. Moreover, they welcomed the authorities' steps in judiciously lowering some taxes to help reduce costs in the economy and regain competitiveness. Some Directors, however, thought that-in view of the depth of the recession on the one hand, and Uruguay's strong fundamentals on the other, consideration could be given to adopting a more supportive fiscal policy-while taking care to ensure that Uruguay's record of prudent financial policies with financial markets is not jeopardized.
Directors noted that the adjustable exchange-rate band had provided a valuable guide for lowering inflation expectations, while providing flexibility to respond to the weaker export environment, and saw merit in continuing with the present exchange rate arrangement, including the authorities' decision to leave the pace of depreciation of the band unchanged for now.
Directors stressed the importance of continuing to promote prudent credit policies and assuring bank soundness, and noted that recent measures by the Central Bank and adjustments in lending behavior by the private sector banks had been timely and appropriate. Nevertheless, Directors shared the staff's concern that two large public banks were not operating on an equal footing with the private banks, and urged the authorities to reconsider the special position and privileges of public banks. They encouraged the authorities to seek assistance from the World Bank through a structural adjustment loan for the financial system, which could help Uruguay in accelerating reforms in public banks and further strengthen the financial system. Directors noted that Uruguay's medium-term prospects had been enhanced by progress achieved in reforming the social security system and in the reform of the state, but important initiatives to reform special pension regimes and some draft laws to improve the functioning of the capital markets should now be pursued more actively.
Directors also stressed the importance of improving data provision and they welcomed the authorities' preparatory efforts to subscribe to the SDDS .
It is expected that the next Article IV consultation with Uruguay will be held on the standard 12-month cycle.