## 1uryea2019001

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---

### CONTEXT: Resilience in the Face of Market Turmoil
- Uruguay’s economy remains resilient, reflecting strong institutions, prudent policies, and large buffers.
- Differentiating factors:
  - Progress in export market diversification.
  - Prudent and coordinated public-sector asset-liability management.
  - Pre-financing of sizeable external financing needs.
  - Lower banking sector vulnerabilities.
  - Ample reserves.
- Implication: public sector borrowing costs have remained subdued despite significant depreciation pressures; growth, though slowed, remains positive.
- Policy priority: maintain resilience and differentiated status by strengthening fiscal and monetary anchors—put debt on a firm downward trajectory and reduce inflation to within the target band.
- Medium-term priorities: use institutional advantages to improve fiscal and monetary frameworks and implement structural reforms to support growth, address low investment, declining employment, and strengthen educational outcomes.

### RECENT DEVELOPMENTS
- Growth and real activity:
  - Economic activity grew by 2.3 percent in the first three quarters of 2018, after expanding by 2.7 percent in 2017.
  - Consumption supported domestic demand; private investment remained sluggish; net exports turned negative.
  - Manufacturing weak (excluding oil refinery reopening); severe drought in Q1 reduced summer crop yields (particularly soybeans).
  - Unemployment fluctuated between 7 and 9 percent.
- Inflation and monetary conditions:
  - 2017 inflation fell to 6.6 percent (within the central bank’s 3-to-7-percent target range).
  - Inflation exceeded the target since May 2018 and currently stands at 8 percent.
  - Peso depreciated about 13 percent since April 2018.
  - Short- and medium-term rates gradually increased after reduction in monetary indicative references; real rates remain lower than neutral guidance.
  - Medium-term inflation expectations somewhat above the target range.
- Fiscal developments:
  - Overall public sector deficit (includes central bank interest payments) 3.5 percent of GDP in 2017 (improvement of 0.3 percentage points vs 2016).
  - Current budget envisages deficit of 3.3 percent of GDP in 2018 (up from 2.9) and 2.8 percent of GDP in 2019 (up from 2.5).
  - 12-month rolling fiscal deficit stood at 2.7 percent of GDP in November 2018; 3.8 percent of GDP excluding cincuentones effects.
  - Non-financial public sector spending 30.1 percent of GDP in 2018 prelim.; current spending 27.9 percent of GDP in 2018 prelim.
- External accounts, capital flows, and reserves:
  - Current account: surplus in 2017 (0.7 percent of GDP) reversed to a deficit of 0.4 percent of GDP in first three quarters of 2018.
  - Drivers: negative investment income, higher oil prices, lower exports to Argentina and Brazil, lower agricultural exports due to drought.
  - Gross reserves declined from $17.9 billion to $15.6 billion; reserves remain about 26 percent of GDP.
- Exchange rate intervention (operational notes):
  - Central bank intervenes actively in FX market; small wholesale exchange rate market (~12 percent of GDP) and small exchange forward market (~3 percent of GDP).
  - Late Aug/early Sep 2018 interventions (mostly spot) and repurchase of central bank paper amounting to US$0.5 billion; gross reserves declined from $17.2 billion in August to $15.6 billion in December.

### Cincuentones transactions — fiscal implications
- Law 19.590 allows affiliates older than 50 years in April 2016 (“cincuentones”) to revert to public pillar.
- October 2018: public pension system received a transfer of about 1 percent of GDP related to cincuentones; recorded as revenue and thus lowers fiscal deficit under IMF methodology.
- Transfers placed in a trust fund ring-fenced for 6 years; transfers to continue over next three years, reducing fiscal deficit in near term.
- Authorities estimate after 5 years the operation will weaken the government’s balance sheet and burden the public pension system by about 4 percent of GDP (net present value over next 30 years).

### BOX 4 — Pilot for Central Bank Digital Currency (E-Peso)
- Pilot duration: 6 months (November 2017-April 2018).
- E-peso is legal tender digital currency issued by central bank; electronic money and does not use distributed ledger technology.
- Issuance and limits: $20 million for 10000 mobile users; $30,000 per wallet and $200,000 for registered businesses.
- Participants/use cases: payments in registered stores and peer-to-peer transfers; banks did not participate.
- Technical features: instantaneous settlement; ran through mobile line (no internet needed); anonymous but traceable; unique bills prevented double spending.
- Expected benefits: reduce cash transaction costs (estimated at 0.6 percent of GDP); improve financial innovation; foster financial inclusion.
- Macro-financial implications and open questions:
  - Potential to enhance monetary policy transmission via real-time money demand information.
  - Could lower interest rates if it fosters competition; could raise banks’ funding costs if it substitutes for deposits.
  - Financial integrity gains via better information; likely minor impact on dollarization and exchange rate channels.
- Research agenda: further analysis on payment systems, intermediation, monetary policy, and financial integrity; outcomes hinge on design and country-specific characteristics.

### SELECTED INDICATORS (highlights)
- Real GDP growth: 2.1 percent (2018), projections: 1.9 (2019), 3.0 (2020–2023).
- CPI inflation (average): 7.6 (2018), projections: 7.5 (2019), ~7.0–7.2 thereafter.
- Gross official reserves: 15,551 (2018, US$ millions).
- Gross non-financial public sector debt: 54.2 percent of GDP (2018).
- Gross public sector debt: 69.6 percent of GDP (2018).
- Unemployment (eop): 8.3 percent (2018).
- Current account (US$ millions): -389 (2018).
- External debt service (percent of exports of g&s): 20.5 (2018).

### OUTLOOK AND RISKS
- Baseline near-term projections:
  - Growth: moderate to 2.1 percent in 2018 and 1.9 percent in 2019; subsequent years slightly above potential.
  - Current account: expected deficit of 0.6 percent of GDP in 2018.
  - Inflation: 2019 inflation expected to moderate but remain at 7.5 percent; beyond 2019 projected to stay at 7 percent.
- External position assessment:
  - Staff: external position broadly consistent with fundamentals.
  - REER: peso appreciated in real effective terms by about 5 percent since December 2017; EBA-Lite REER points to an 8 percent overvaluation (adjusted).
- Risk Assessment Matrix — key risks and policy responses:
  - Further slowdown in neighboring economies — Likelihood: High; Impact: Medium (↓); Policy: maintain flexible exchange rate; diversify trade.
  - Sharp tightening of global financial conditions — Likelihood: High; Impact: Medium/High (↓); Policy: flexible exchange rate; solid macro fundamentals; use liquidity buffers.
  - Rising protectionism — Likelihood: High; Impact: Low/Medium (↓); Policy: flexible exchange rate; diversify trade.
  - Significant slowdown in China — Likelihood: Low/Medium; Impact: Medium (↓); Policy: use exchange rate as shock absorber; pass-through oil import price declines.
  - Insufficient public and private investment — Likelihood: Medium; Impact: Medium (↓); Policy: rationalize current expenditure; improve access to finance, business environment, human capital, and diversification.
  - Sizeable deviations from baseline energy prices — Likelihood: Medium; Impact: Low/Medium; Policy: use oil hedges; pass through oil price changes to households over medium term.
  - Cyber-attacks — Likelihood: Medium; Impact: Medium (↓); Policy: increase cyber-security.
  - Large infrastructure projects (e.g., UPM plant, PPPs) — Likelihood: High; Impact: High (↑); Policy: save additional tax revenues to build buffers; monitor PPP fiscal risks.

### POLICY IMPLICATIONS HIGHLIGHTED BY STAFF
- Monetary policy:
  - Objective: lower inflation into the target band and anchor medium-term expectations.
  - Guidance: allow exchange rate flexibility; maintain credibility; adjust monetary indicative references until short- and medium-term real rates move toward estimated real neutral rates and medium-term expectations approach 5 percent.
  - Central bank encouraged to strengthen policy framework given high dollarization, low credit-to-GDP, and wage indexation.
- Fiscal policy:
  - Objective: restore consolidation and put public debt on a firm downward trajectory.
  - Cincuentones temporarily improve headline deficits but have long-term balance sheet implications (estimated net present value burden ~4 percent of GDP over 30 years).
  - Staff projects overall public-sector deficit (excluding cincuentones transfers) of 3.7 percent of GDP in 2018.
  - Recommendations:
    - Introduce measures of at least 0.3 percent of GDP in 2019 (amounting to a 0.5 percent-of-GDP total adjustment in 2019).
    - Delivering on budgetary targets would reduce non-financial public sector debt to 49 percent of GDP in 5 years and to about 44 percent of GDP in 10 years, but would require 0.8 percentage points of GDP in measures until 2020 (total adjustment of 1.2 percent of GDP) during slowdown and elections.
    - Composition: focus on reducing elevated current expenditures; adjust utility tariffs in line with cost and investment needs; improve efficiency of social spending to create space for capital spending.
    - Institutional reform: introduce medium-term fiscal framework with a binding fiscal rule focused on nonfinancial public-sector balance and medium-term debt objective.
- External and financial sector policies:
  - Maintain flexible exchange rate as first line of defense.
  - Preserve ample reserves and use liquidity buffers if necessary.
  - Monitor capital flow volatility; use reserve operations and central bank interventions judiciously to limit disorderly FX outcomes.
  - Promote financial sector stability and enhance intermediation.

### Maintaining Financial Sector Stability and Enhancing Intermediation
- Financial sector resilience: improved regulatory capital to risk-weighted assets ratio and bank profits; comfortable buffers.
- Risks to monitor: exchange rate volatility, high dollarization, rising NPLs (increase largely due to drought and slowdown).
- Regulatory/liquidity developments:
  - Adoption of net stable funding ratio regulations welcome.
  - Gross reserves equal to 26 percent of GDP and above external financing requirement of about 16 percent in 2019.
  - Ratio of gross reserves to the ARA metric is 180 percent.
- Financial inclusion and Fintech:
  - Measures under 2014 Financial Inclusion Law: free bank accounts and debit cards for low-income households and SMEs.
  - Peer-to-peer lending small; regulation introduced for consumer protection and AML.
  - Successful e-peso pilot noted; support for Fintech conditional on consumer protection and AML safeguards.

### Enhancing Inclusive Growth and Competitiveness
- Structural challenges: need action to continue income convergence; low investment and declining employment threaten potential growth.
- Policy priorities:
  - Create fiscal space to close infrastructure gaps.
  - Reform education to enhance human capital.
  - Improve access to finance and business environment to support private investment.
  - Make labor market more flexible and align real wage increases with productivity.
- Trade and export diversification: progress achieved; continue efforts to diversify products toward non-commodity sectors and improve market access.

### A. Maintaining Fiscal Sustainability — key findings and projections
- Staff Baseline public sector overall balance (percent of GDP) excluding cincuentones:
  - Staff Baseline: -3.5 (2017), 2018: -3.7, 2019: -3.5, 2020: -3.3
  - *with cincuentones: -3.5 (2017), 2018: -2.5, 2019: -2.4, 2020: -2.3*
- Under baseline, non-financial public sector debt projected to reach 54 percent of GDP in 2018 and stabilize at 53 percent thereafter.
- Gross financing needs for 2019 projected to be comfortably met due to coordinated asset-liability management, stable local currency funding (including wage-indexed bonds), pre-financing policy, and buffers in liquid assets and contingent credit lines.
- Fiscal vulnerabilities: debt level below benchmarks but elevated; share of debt in foreign currency held by non-residents relatively high; fiscal space constrained.
- Recommended measures:
  - 0.3 percent of GDP measures in 2019; additional 0.6 percent of GDP annually beyond 2019 to reach 2012–14 debt levels in 5 years.
  - Emphasize current expenditure reduction, utility tariff adjustments, and improved efficiency of social spending.
  - Institutional reforms: medium-term fiscal framework and enhanced fiscal rule.

### D. Inequality, Institutions, and Structural Orientations
- Gini coefficient: "0.455 to 0.38, reflects significant progress towards reducing inequality."
- Social spending: 25 percent of GDP (with 6.5 percent on health and 5 percent on education).
- Institutional strengths: democracy and governance indicators high (Democracy Index score "8.38"; Corruption Perception Index rank "23rd out of 180" with score 70).
- Financial buffers and debt management:
  - Debt in foreign currency: "54 percent of total debt (it was 89 percent in 2005)."
  - Average time to maturity: "14.5 years (compared to 8 years)."
  - Debt at fixed-rate: "94 percent (vs. 78 percent)."
  - Uruguay issued a new dollar global bond maturing 2031 at "175 bps over US Treasuries".
  - Moody’s reaffirmed "Baa2" rating with stable outlook.
- Challenges ahead: population aging, need for higher private investment, education improvements, and continued inclusiveness and infrastructure planning (2015-19 infrastructure plan; potential new pulp mill by UPM).

### Debt Dynamics and Stress Tests
- Stylized downside combined shock: permanent 20 percent exchange rate depreciation; temporary drop in growth and primary balances; permanent increase in real interest rates — PS net debt would increase by 12 percentage points.
- Under baseline projections (selected):
  - Real GDP growth: 2019: 1.9; 2020–2023: 3.0 each year.
  - Inflation (GDP deflator): 2019: 6.8; 2020: 7.3; 2021: 7.3; 2022: 7.2; 2023: 7.4.
  - Primary balance (percent of GDP): 2019: -0.5; 2020: -0.6; 2021: -0.2; 2022: -0.1; 2023: -0.1.
  - Nominal gross debt NFPS: 2018: 51.7; 2019: 54.2; 2020: 54.2; 2021: 53.3; 2022: 53.1; 2023: 53.1 (percent of GDP).
  - Nominal gross debt PS: 2018: 65.8; 2019: 69.6; 2020: 70.5; 2021: 70.0; 2022: 70.1; 2023: 70.4 (percent of GDP).
- Stress test outcomes:
  - Under Combined Shock, gross nominal public debt paths and gross financing needs rise notably.
  - Individual shocks (primary balance, growth, interest rate, exchange rate) show varying impacts; Combined Shock notably elevates debt and financing needs.
- External debt sustainability:
  - External debt peaked at 82 percent of GDP in 2015 and fell to 70 percent of GDP in 2017.
  - Gross external debt estimated to decline slightly to 68 percent of GDP in 2018; projected to gradually rise afterwards.
  - Main vulnerability: exchange rate depreciation — a counterfactual 30 percent depreciation would increase external debt-to-GDP ratio by nearly 40 percentage points.
  - Given sizeable gross international reserves and liquidity buffers, external debt sustainability risks remain limited.

### Annex I — External Sector Assessment (highlights)
- Staff assesses external position broadly consistent with fundamentals per EBA current account model.
- Model results:
  - EBA current account model: adjusted current account balance at model’s norm (-2.5 percent of GDP); cyclically adjusted current account in 2018 larger by 1.3 percent of GDP than the norm; adjusted for bilateral trade with Argentina, gap ~0.04 percent of GDP.
  - EBA-Lite REER: Uruguay 7.7 percent overvalued.
  - EBA external sustainability: REER overvalued about 2 percent given projected 2023 CA deficit of 1.8 percent of GDP vs required -1.3 percent of GDP to stabilize NFA.
- Capital flows: volatile between 9 percent of GDP to -3 percent of GDP; first three quarters of 2018 FDI outflows 0.3 percent of GDP and portfolio inflow 1 percent of GDP; high-frequency data show continued nonresident portfolio outflows in Q4.
- Reserves and external stability:
  - Key reserve metrics (Dec 28, 2018): 15.6 (US$ billions).
  - In months of imports (2017): 15.2.
  - In percent of GDP (2017): 25.9.
  - Short-term external (STE) debt (2017): 179.4.
  - STE debt and nonresident deposits (2017): 135.7.
  - Banks’ gross foreign assets (US$, billions, 2017): 9.7.
  - Reserve adequacy: reserves above upper bound of IMF reserve adequacy metric range and prudential indicators; ratio to ARA metric 180 percent.

*Source: IMF staff report excerpt (Uruguay).*

### 2018. The staff team comprised S. Pelin Berkmen (head), Dmitry

### CONTEXT: RESILIENCE IN THE FACE OF MARKET TURMOIL

### Context and key assessments
- Uruguay’s economy remains resilient, reflecting its strong institutions, prudent policies, and large buffers.
- Differentiating factors cited:
  - Progress in export market diversification.
  - Prudent and coordinated public-sector asset-liability management.
  - Pre-financing of sizeable external financing needs.
  - Lower banking sector vulnerabilities.
  - Ample reserves.
- Implication: public sector borrowing costs have remained subdued despite significant depreciation pressures, and growth, though slowed, remains positive.
- Policy priority: maintain resilience and differentiated status by strengthening fiscal and monetary anchors—put debt on a firm downward trajectory and reduce inflation to within the target band.
- Medium-term: use institutional advantages to improve fiscal and monetary frameworks and implement structural reforms to support growth, address low investment, declining employment, and strengthen educational outcomes.

### Cincuentones transactions (Box 1) — fiscal implications
- Law 19.590 (approved end-2017) allows affiliates older than 50 years in April 2016 (“cincuentones”) to revoke participation in the private pillar and bring accrued contributions to the public system.
- In October 2018, the public pension system received a transfer of about 1 percent of GDP related to cincuentones; recorded as revenue and thus lowers the fiscal deficit under IMF methodology.
- Transactions placed in a trust fund ring-fenced for 6 years; transfers will continue over the next three years, leading to further reductions in the fiscal deficit in the near term.
- Authorities estimate that after 5 years the operation will weaken the government’s balance sheet and that the burden on the public pension system from this operation will be about 4 percent of GDP (in net present value terms over the next 30 years).

---

### RECENT DEVELOPMENTS

### Growth and real activity
- Economic activity grew by 2.3 percent in the first three quarters of 2018, after expanding by 2.7 percent in 2017.
- Domestic demand composition:
  - Consumption continued to support domestic demand.
  - Private investment remained sluggish and net exports turned negative.
- Production and external shocks:
  - Manufacturing activity weak (excluding impact of reopening of the oil refinery).
  - Severe drought in the first quarter reduced yields of summer crops (particularly soybeans).
- Labor market: unemployment fluctuated between 7 and 9 percent.

### Inflation and monetary conditions
- Inflation developments:
  - 2017 inflation fell to 6.6 percent (within the central bank’s 3-to-7-percent target range).
  - Inflation exceeded the target since May 2018 and currently stands at 8 percent.
  - Drivers: impact of drought and peso depreciation; temporary factors noted.
- Monetary policy and rates:
  - Reduction in monetary indicative references since July led short and medium-term rates to gradually increase.
  - Real rates remain lower than guidance offered by neutral rates.
  - Medium-term inflation expectations are somewhat above the target range.

### Fiscal developments
- Fiscal deficit reduction stalled; time to reach target of 2.5 percent of GDP extended to 2020.
- Indicators:
  - Overall public sector deficit (includes central bank interest payments) was 3.5 percent of GDP in 2017 (improvement of 0.3 percentage points relative to 2016).
  - Current budget envisages a deficit of 3.3 percent of GDP in 2018 (up from previous objective of 2.9 percent of GDP) and 2.8 percent of GDP in 2019 (up from 2.5 percent of GDP).
  - 12-month rolling fiscal deficit stood at 2.7 percent of GDP in November 2018, but amounted to 3.8 percent of GDP excluding effects of transactions related to cincuentones.
- Spending: non-financial public sector spending 30.1 percent of GDP in 2018 prelim.; current spending 27.9 percent of GDP in 2018 prelim.

### External accounts, capital flows, and reserves
- Current account:
  - Surpluses in 2016 and 2017 (revised down), but turned to deficit of 0.4 percent of GDP in the first three quarters of 2018 (compared with a yearly surplus of 0.7 percent of GDP in 2017).
  - Reasons for swing: negative investment income, higher oil prices, lower exports to Argentina and Brazil, and lower agricultural exports due to drought.
- Capital inflows volatile; inclusion of merchanting activities affected volatility.
- Peso depreciation and reserves:
  - Peso depreciated by about 13 percent since April 2018.
  - Gross reserves declined from $17.9 billion to $15.6 billion; about $0.5 billion of this decline reflects repurchases of central bank paper to accommodate portfolio reallocation by pension funds.
  - Reserves remain about 26 percent of GDP.

### Exchange rate intervention (Box 2) — operational notes
- Central bank intervenes actively in FX market since floating regime in 2002; small wholesale exchange rate market (~12 percent of GDP) and small exchange forward market (~3 percent of GDP).
- Interventions include spot and forward market operations and accommodation of government and large institutional investor FX needs to avoid undue exchange rate volatility.
- In 2017, central bank sterilized upward pressure by buying foreign currency in return for central bank paper; with reversal of flows since May 2018, central bank intervened in late August/early September (mostly spot) and repurchased central bank paper amounting to US$0.5 billion. Gross reserves declined from $17.2 billion in August to $15.6 billion in December.

---

### OUTLOOK AND RISKS

### Baseline projections (near term)
- Growth:
  - Growth expected to moderate to 2.1 percent in 2018 and 1.9 percent in 2019.
  - Drivers: slowdown in consumption due to peso depreciation, lower confidence and real wages; weakening of tourism revenue and goods exports in first half of 2019 due to expected contraction in Argentina and appreciation against regional partners; rebound of agriculture after drought expected to support growth and exports; private investment expected to gradually recover after contracting four years in a row.
  - Subsequent years: economy expected to grow slightly above potential, gradually closing the output gap.
- Current account: expected deficit of 0.6 percent of GDP in 2018.
- Inflation:
  - 2019 inflation expected to moderate but remain at 7.5 percent (above central bank’s ceiling of the target range).
  - Beyond 2019, with medium-term inflation expectations above target, inflation projected to stay at 7 percent (upper limit of target range).

### External position assessment
- Staff assesses external position broadly consistent with fundamentals and desirable policy settings (Annex I).
- REER: peso appreciated in real effective terms by about 5 percent since December 2017; EBA-Lite REER model points to an 8 percent overvaluation (adjusted for cyclical position and bilateral trade with Argentina).

### Risk Assessment Matrix — key risks, likelihood, impacts, and policy responses
- Further slowdown in growth in neighboring economies
  - Likelihood: High
  - Impact if realized: Medium (↓)
  - Policy response:
    - Maintain flexible exchange rate.
    - Continue efforts to diversify trade.
- Sharp tightening of global financial conditions
  - Likelihood: High
  - Impact if realized: Medium/High (↓)
  - Policy response:
    - Maintain flexible exchange rate.
    - Maintain solid macroeconomic fundamentals, including monetary and fiscal anchors.
    - Use liquidity buffers if necessary.
- Rising protectionism and retreat from multilateralism
  - Likelihood: High
  - Impact if realized: Low/Medium (↓)
  - Policy response:
    - Maintain flexible exchange rate.
    - Continue efforts to diversify trade.
- Significant slowdown in China
  - Likelihood: Low/Medium
  - Impact if realized: Medium (↓)
  - Policy response:
    - Use exchange rate as a shock absorber.
    - Pass-through declines in oil import prices to households.
- Insufficient public and private investment
  - Likelihood: Medium
  - Impact if realized: Medium (↓)
  - Policy response:
    - Create fiscal space by rationalizing current expenditure.
    - Continue efforts to improve access to finance, business environment, human capital, and diversification.
- Sizeable deviations from baseline energy prices
  - Likelihood: Medium
  - Impact if realized: Low/Medium
  - Policy response:
    - Use the oil price hedges.
    - Pass through oil price changes to households over the medium term.
- Cyber-attacks
  - Likelihood: Medium
  - Impact if realized: Medium (↓)
  - Policy response:
    - Continue efforts to increase cyber-security.
- Large infrastructure projects (e.g., UPM paper pulp plant, PPPs)
  - Likelihood: High
  - Impact if realized: High (↑)
  - Policy response:
    - Save additional tax revenues to build fiscal buffers and finance associated public investment.
    - Monitor fiscal risks stemming from PPPs.

---

### POLICY IMPLICATIONS HIGHLIGHTED BY STAFF

### Monetary policy
- Objective: lower inflation to within target band and anchor medium-term inflation expectations.
- Tools and considerations:
  - Continue to allow exchange rate flexibility to absorb external shocks.
  - Maintain monetary policy credibility by keeping inflation expectations anchored.
  - Monitor real rates relative to neutral guidance as monetary policy works through lags.

### Fiscal policy
- Objective: restore fiscal consolidation and put public debt on a firm downward trajectory.
- Near-term considerations:
  - Recognize that cincuentones transactions temporarily improve headline fiscal deficits but have long-term balance sheet implications (estimated net present value burden ~4 percent of GDP over 30 years).
  - Time to reach deficit target of 2.5 percent of GDP extended to 2020; meeting new objectives would allow gradual public debt decline.
- Policy recommendations:
  - Create fiscal space by rationalizing current expenditure.
  - Save additional tax revenues from potential large projects to build fiscal buffers.
  - Monitor and manage fiscal risks from PPPs.

### External and financial sector policies
- Maintain flexible exchange rate as first line of defense against external shocks.
- Preserve ample reserves and use liquidity buffers if necessary.
- Continue to monitor capital flow volatility and use reserve operations and central bank market interventions judiciously to limit disorderly FX market outcomes.
- Promote financial sector stability and enhance intermediation (detailed discussion in other sections).

---

*IMF staff report (2018): “CONTEXT: RESILIENCE IN THE FACE OF MARKET TURMOIL”; sections summarized from the source content provided.*

### 13.      There are both sizeable downside and upside risks to the outlook, given the more

### 1uryea2019001 - 13.      There are both sizeable downside and upside risks to the outlook, given the more

### Risks to the outlook and macroeconomic context
- There are both sizeable downside and upside risks to the outlook given a more difficult external environment and large infrastructure projects.
- Downside risks:
  - An abrupt tightening in global financial conditions caused by a sharp increase in international risk premia coupled with a further strengthening of the U.S. dollar could have negative repercussions for Uruguay’s economy.
  - A further slowdown in trading partners could worsen the growth outlook.
- Upside risks:
  - Plans for the construction of a large cellulose plant, an associated railway system, and other infrastructure projects.
- Structural medium-term risk:
  - Low investment and declining employment, if not reversed, could lower potential growth.
- Authorities’ view:
  - Expected the unfavorable external environment to moderate GDP growth in 2018 and 2019, with a pick-up in investment (also supported by tax incentives introduced in 2018) leading to a more robust recovery in the outer years.
  - Saw inflation falling to within the target range in 2019, partly driven by a successful round of wage negotiations.
  - Emphasized that Uruguay—with a flexible exchange rate and ample financial buffers—was well positioned to manage external shocks.

### A. Maintaining Fiscal Sustainability — key findings and projections
- Staff projects an overall public-sector deficit (excluding cincuentones transfers) of 3.7 percent of GDP in 2018.
- Projections for the public sector overall balance (percent of GDP) 1/ (excluding transfers from cincuentones):
  - 2017 Budget: -3.5, 2018, 2019, 2020: -2.9, -2.5, -2.5
  - 2018 Budget: -3.5, 2018, 2019, 2020: -3.3, -2.8, -2.5
  - Staff Baseline: -3.5, 2018, 2019, 2020: -3.7, -3.5, -3.3
  - *with cincuentones: -3.5, 2018, 2019, 2020: -2.5, -2.4, -2.3
- Under the baseline scenario, non-financial public sector debt is projected to reach 54 percent of GDP in 2018 and to stabilize at 53 percent thereafter.3
- Gross financing needs for 2019 projected to be comfortably met given:
  - Coordinated public-sector asset-liability management.
  - Stable local currency funding from domestic institutional base (particularly after this year’s introduction of wage-indexed bonds).
  - Authorities’ pre-financing policy.
  - Sufficient buffers in the form of nonfinancial-public-sector liquid assets and contingent credit lines.4
- Fiscal vulnerabilities:
  - Debt level below relevant benchmarks but remain elevated.
  - Share of debt in foreign currency held by non-residents remains relatively high, leaving debt vulnerable to exchange rate pressures.
  - Fiscal space is at risk—room for discretionary fiscal policy without endangering debt sustainability is constrained.
- Recommended fiscal measures and targets:
  - Delivering on budgetary targets would reduce non-financial public sector debt to 49 percent of GDP in 5 years and to about 44 percent of GDP (average level of 2012–14) in 10 years, but would require 0.8 percentage points of GDP in measures until 2020 (a total adjustment of 1.2 percent of GDP) during an economic slowdown and elections.
  - Authorities should introduce measures of at least 0.3 percent of GDP in 2019 (amounting to a 0.5 percent-of-GDP total adjustment in 2019) to help put debt on a downward path.
  - Beyond 2019, bringing debt to 2012–14 levels in a 5-year period would require additional adjustments of about 0.6 percent of GDP annually.
- Composition of adjustment:
  - Fiscal adjustment should come from reducing the elevated level of current expenditures to contain the impact on growth.5
  - Utility tariffs should be adjusted in line with the cost structure and investment needs of public enterprises.
  - Medium-term: improve efficiency of social spending to create space for needed increase in capital spending.
- Institutional reforms:
  - Introduce a medium-term fiscal framework supported by a binding fiscal rule to strengthen multi-year fiscal discipline.
  - Enhanced fiscal rule could: limit frequent use of escape clauses, focus on the nonfinancial public-sector balance, and be anchored on a medium-term debt objective.
- Other medium-term fiscal priorities:
  - Address growing pension spending and maintain financial health of public enterprises.
  - Pension spending about 11 percent of GDP at end 2018 (of which about 3 corresponds to the special regimes).
  - Social spending amounts to 25 percent of GDP—with 6.5 percent on health and 5 percent on education.
  - Ongoing efforts to enhance governance, risk-management practices, and consolidated monitoring of public enterprises are welcome.
- Authorities’ stance:
  - Reaffirmed commitment to fiscal sustainability, to enhancing SOE governance, and to improving the fiscal rule.
  - Working on measures to achieve the 2.5-percent deficit (excluding cincuentones) targeted in 2020.
  - Will propose legislation to professionalize boards of public companies and limit revolving-door practices.
  - Agreed on need for comprehensive reform of the social security system.

### B. Lowering Inflation — findings and policy guidance
- Objective:
  - Bring inflation close to the middle of the central bank’s 3-to-7 percent target range to anchor expectations.
- Current indicators:
  - Medium-term inflation expectations currently at 7.5 percent.
  - Estimated real neutral rates: 2-3 percent as of 2018Q4.
  - Nominal interest rates: around 8 percent for the 1-month rate and around 10 percent for the 1-year rate after the most recent reduction in monetary indicative references at end-December.
- Policy guidance:
  - Monetary indicative references should continue to be adjusted until short- and medium-term real rates increase further to within the range of estimated real neutral rates and medium-term inflation expectations move towards the middle of the target range (5 percent).
  - Central bank encouraged to further strengthen monetary policy framework given high dollarization, low credit-to-GDP ratios, and remaining wage indexation.
  - Improvements could focus on strategies, instruments, and communication practices to enhance commitment to achieve targets and better anchor inflation expectations.
- Exchange rate guidance:
  - The exchange rate should remain the key shock absorber; the peso should continue to adjust in line with fundamentals.
  - Interventions should be reserved for addressing disorderly market conditions.
  - Reserve buffers should be kept above or in line with prudential norms.6
- Authorities’ view:
  - Reaffirmed commitment to bringing inflation within the central bank’s target range.
  - Noted one-off factors (drought and peso depreciation) pushed inflation outside the range.
  - Considered the monetary policy stance to be adequate and the level of real interest rates appropriate, mindful of growth impacts and capital inflow risks from overly high rates.
  - Confirmed importance of maintaining a flexible exchange rate while avoiding undue volatility.

### C. Maintaining Financial Sector Stability and Enhancing Intermediation
- Financial sector resilience:
  - Financial sector has fared well; remained resilient despite regional turmoil due to limited linkages to Argentina and enhanced supervision since the 2002 crisis.
  - Improvements in regulatory capital to risk-weighted assets ratio and bank profits mean the banking sector has comfortable buffers.
- Risks to monitor:
  - Given exchange rate volatility and high dollarization, supervision should continue to closely monitor banks' exposures.
  - Share of nonperforming loans has risen and, while still manageable, needs monitoring; increase largely attributed to drought and economic slowdown.
- Regulatory and liquidity developments:
  - Recent adoption of regulations on net stable funding ratio—aligning liquidity profiles of banks’ assets and liabilities—is welcome.
  - Gross reserves equal to 26 percent of GDP and substantially above the external financing requirement of about 16 percent in 2019.
  - Ratio of gross reserves to the ARA metric is 180 percent.
- Financial inclusion and Fintech:
  - Extensive dollarization and market segmentation limit bank credit and make it expensive, especially in the peso market.
  - Authorities implementing measures to promote electronic transactions and competition under the 2014 Financial Inclusion Law.
  - Since the Law: low-income households and small and micro enterprises have access to free bank accounts and debit cards.
  - Peer-to-peer lending remains small; regulation introduced to protect consumers and guard against money laundering.
  - Authorities’ efforts to improve inclusion, innovation, and intermediation, while limiting risks—including a successful e-peso pilot—are welcome.
- Authorities’ view:
  - Financial system described as stable and profitable.
  - NPLs warrant monitoring but banks have safeguards and buffers to address the issue.
  - Support for Fintech conditional on consumer protection and AML concerns being addressed.

### D. Enhancing Inclusive Growth and Competitiveness
- Structural challenges:
  - Need further action to continue income convergence to advanced economy levels despite institutional strength, low income inequality, and low poverty.
  - Facing low investment and declining employment; consensus that further efforts are needed.
- Policy priorities to support inclusive growth:
  - Create fiscal space to close infrastructure gaps.
  - Reform the education sector to enhance human capital.
  - Support private investment by improving access to finance and the business environment.
  - Make the labor market more flexible and ensure real wage increases aligned with productivity increases to support employment resilience and private investment.
- Trade and export diversification:
  - Uruguay has diversified export products and destinations and raised global market share in many products.
  - Some manufacturing sectors lost market share and are sensitive to exchange rate movements.
  - Continued efforts needed to improve competitiveness, further diversify export products (including towards non-commodity sectors), and improve market access through multilateral and bilateral free trade agreements.

*Source: IMF staff report excerpt (Uruguay).*

### Box 4. Pilot for Central Bank Digital Currency (E-Peso)

### Box 4. Pilot for Central Bank Digital Currency (E-Peso)

### Pilot design and implementation
- Pilot duration: 6 months (November 2017-April 2018).
- Legal status: E-peso is a legal tender digital currency issued by the central bank; it is an electronic money and does not use distributed ledger technology.
- Issuance and limits:
  - Limited bill issuance: $20 million for 10000 mobile users.
  - Size per person limits: $30,000 per wallet and $200,000 for registered businesses.
- Participants and use cases:
  - Mainly used for payment transactions in registered stores and businesses, and peer-to-peer transfers.
  - Banks did not participate in the pilot.

### Technical features and operations
- Settlement and connectivity:
  - The system used instantaneous settlement.
  - Ran through mobile line (no internet connection was needed).
- Anonymity and traceability:
  - E-peso was anonymous but traceable.
  - Unique bills prevented double spending and falsification.

### Expected benefits and objectives
- Primary objectives cited by the central bank:
  - Reduce transaction costs of cash (estimated at 0.6 percent of GDP).
  - Improve financial innovation by creating a supportive regulatory environment and infrastructure.
  - Foster financial inclusion by reaching out to nonbanked segments of the society through mobile networks.
- Broader rationale:
  - The world is increasingly digitalized which provides both opportunities and challenges.
  - The central bank of Uruguay is one of the pioneers in the world in taking a proactive approach in evaluating the case for the CBDC (IMF SDN No. 18/08, 2018).

### Potential macrofinancial implications and open questions
- Monetary policy transmission:
  - E-peso has the potential to enhance the transmission mechanism as it provides a more systematic and transparent information on money demand in real time (given Uruguay’s monetary targeting framework).
- Banking system and interest rates:
  - If e-peso encourages innovation and competition, in the new equilibrium, interest rates could decline, improving financial intermediation and inclusion.
  - If e-peso becomes a substitute for bank deposits, it can lead to an increase in the funding costs of the banks, leading to an increase in the equilibrium interest rates.
  - Analysis is limited because banks did not participate in the pilot.
- Financial integrity:
  - Improved information can help improve financial integrity by preventing tax evasion and money laundry.
- Dollarization and exchange rate channels:
  - The impact on dollarization and exchange rate channels are likely to be minor as the demand for domestic and foreign assets are determined by other fundamental/external factors such as credibility and global financial conditions.

### Research and policy agenda
- Further analysis needed to assess impact on:
  - Payment systems.
  - Financial intermediation.
  - Conduct of monetary policy.
  - Financial integrity.
- Central bank’s planned focus:
  - Analyzing implications of Fintech on payment systems and traditional banking systems.
  - Design-dependent assessments, recognizing consequences hinge on CBDC design and country-specific characteristics.

*Source: Box 4. Pilot for Central Bank Digital Currency (E-Peso), 1uryea2019001.*

### 37.      Staff proposes that the next Article IV consultation with Uruguay take place on the

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

### Real activity
- Real GDP growth remained steady, supported by consumption.
- Contributions to Real GDP Growth, Demand components (Percent change, y/y): private investment, public investment, private consumption, public consumption, net exports, changes in inventories, Real GDP (chart series shown for 2014Q3–2018Q3).
- Consumer Confidence (3-month moving average) values shown around 30–70 (Nov-14 to Nov-18); values above 50 indicate positive responses outnumber negative responses.
- Production-side contributions (Percent change, y/y) include primary, manufacturing, electricity, construction, commerce & hotels, transport, other, total (2014Q3–2018Q3).
- Historically, high growth periods coincided with positive investment; investment declined in recent years (Investment percent of GDP; dashed lines: 2007-2017 averages).
- Labor market indicators: labor force participation rate and unemployment rate show a stagnant labor market (series through 2018Q3).

### Inflation
- CPI inflation (Percent change, y/y): Headline and Core (BCU core definition excludes administered prices, fruits and vegetables, and tobacco). Charted Dec-12 to Dec-18.
- "Inflation has exceeded the central bank's seven-percent ceiling..." (target mid-point noted elsewhere as 5 percent).
- Contributions to inflation (percentage points): fruits and vegetables were significant in early 2018 (regional drought impact).
- Tradable vs non-tradable contributions show the tradable component remained substantial.
- Real private consumption and real salary index decelerated as inflation increased (series 2014Q3–2018Q3).
- Inflation and depreciation (yoy percent): non-fruit/veg inflation and depreciation (RHS) indicate depreciation of the peso contributed to inflation.
- Inflation expectations (percent): Consensus (12 months ahead) and BCU (median expected for 24 months ahead) are above the target range.

### External accounts
- Current account (percent of GDP, 4Q sum): surplus turned to a deficit due to a declining income balance (series 2013Q3–2018Q3).
- Terms of trade and key commodity prices: beef, soy, petroleum, rice and merchandise terms of trade (2014–2018).
- Goods exports volume growth contributions by trading partner (4Q mva): declines to Argentina, Brazil, and China noted (2014Q3–2018Q3).
- Trade balance remained positive because imports of capital and intermediate goods remained compressed (Trade balance percent of GDP, 4Q sum shown).
- Services balance of the current account (4-quarter basis, percent of GDP): net services balance was positive.
- Financial account balance (percent of GDP, net): capital flows have been volatile.

### Monetary policy
- M1+ growth rate (y/y) and reference ranges: the central bank lowered M1+ growth targets since July in response to above-target inflation and lower money demand.
- Interest rates & Taylor Rule (2017Q1–2018Q3): short-term interest rates remained below estimated and calibrated Taylor Rules as of 2018Q3.
- Average peso interest rates (Mar-17 to Nov-18): 1 month yield on government securities, corporates, households — transmission to bank lending rates has been muted; peso interest rate for households already at a high level.
- Real interest rates vs "neutral" (2017Q1–2018Q3): in 2018Q4 real rates were close to zero at short maturities and at the lower bound of the estimated neutral rate range at longer maturities (estimated neutral range for one-year horizon is around 3 percent).
- Interest rates by currency (Nov-13 to Nov-18): loans in pesos vs loans in U.S. dollars; deposits in pesos vs deposits in U.S. dollars — there is a very large spread over US dollar deposits.
- Spreads (2017Q1–2018Q3): spread 1-3 months, 1-12 months, 1-24 months — longer-term spreads stabilizing at a higher level.
- Last observation 2018Q4.

### Fiscal developments
- Public sector primary balance and fiscal effort (percent of GDP): primary balance became positive in 2018 due to the pension transfer.
- Public sector balance components (percent of GDP): public enterprises balance, primary balance excluding public enterprises, interest, overall balance — overall balance improved in 2018 for the same reason.
- Composition of central government expenditures (In percent of GDP): capital expenditure subdued while current expenditures remain elevated; capital-to-current ratio presented.
- Public sector revenues (percent of GDP): tax revenues close to 20 percent of GDP.
- Public sector debt (percent of GDP): gross, gross non-financial, net — public debt has increased and is mostly long-term, with more than one half in local currency and residence (detailed compositional shares shown).

### Global and Argentina spillovers
- Uruguay exposure to global shocks illustrated by impulse response functions to a 1 percent increase in the US dollar broad index and a 1 basis point increase in the VIX (cumulative IRFs after three months).
- Non-resident foreign currency deposits (Nov-98 to Nov-18) in billions of USD and share in total FX deposits shown.
- Argentina tax amnesty (May-16) noted.
- Elasticity of domestic financial variables to changes in the US dollar broad index and to changes in the VIX: EMBIG spreads (basis points) and exchange rate depreciation (percent; r.h.s) for selected countries including URY.
- Share of tourists by region (2014Q2–2018Q2): Argentina remains the key tourist market.
- Growth and business cycle correlations between Uruguay and Argentina (10-year rolling average): Uruguay's real economy has become less dependent on Argentina; China has become a key trading partner for exports.

### Credit and banking
- Credit growth by sector (y/y percent, Oct-13 to Oct-18): household credit from banks and cooperatives (real pesos) and private firms (US$) — credit to companies began to recover.
- Credit to private sector, end-2017 (percent of GDP) is relatively low compared with peers (CHL, BRA, COL, PER, MEX).
- Non-performing loans (NPLs as share of total loans) increased: NPLs and provisions (percent of NPLs) series show rises through 2018Q3.
- Share of FX loans to nontradable sector stands at around one-third of total loans (series to 2018Q3).
- ROA and regulatory capital to risk-weighted assets improved; banks' capitalization improved and profitability picked up.
- Dollarization: deposits and credit dollarization remain high despite improvements since 2015; series Sep-13 to Sep-18.

### Structural issues
- GDP per capita (Ratio to US) shows Uruguay converging to advanced country income levels faster than regional peers but an important gap remains.
- Investment (Percent of GDP) series (2002–2018F) shows Uruguay below some peers; need to increase investment levels.
- Rule of law and institutional quality indicators: Uruguay has superior institutional quality but more is needed to guarantee convergence.
- Infrastructure quality gaps (overall, air transport, roads, ports, railroads) indicate gaps relative to LAC, EMs, OECD.
- Human capital: while Uruguay scores well on social indicators, additional efforts needed to increase human capital stock by improving education outcomes.
- Poverty indicator and other rankings referenced (definitions and notes provided).

### Financial soundness indicators (Table 1 highlights)
- Dollar loans in percent of total loans: 58.5 (2011), 53.6 (2018 1/).
- Loan dollarization (constant exchange rate, January 2013): 52.9 (2011) to 40.6 (2018).
- Dollar deposits in percent of total deposits: 71.9 (2011) to 74.5 (2018 1/).
- Credit to private sector in percent of GDP 3/: 19.8 (2011) to 26.0 (2018 3/).
- Regulatory capital in percent of risk-weighted assets: 13.7 (2011) to 14.9 (2018 1/).
- Non-performing loans in percent of total loans: 1.3 (2011) to 4.0 (2018 1/).
- Specific loan-loss provisions in percent of non-performing loans: 71.1 (2011) to 54.1 (2018 1/).
- Return on assets: 0.8 (2011) to 2.0 (2018 1/).
- Liquidity ratio 5/: 47.8 (2011) to 75.0 (2018 1/).
- Deposits/Loans ratio in national currency 2/: 1.0 (2011) to 0.9 (2018 1/).
- Deposits/Loans ratio in foreign currency 2/: 2.2 (2011) to 2.5 (2018 1/).
- Notes: 1/ Latest available data November, unless otherwise specified. 2/ For 2018 data as of February. 3/ For 2018 data as of the third quarter. 4/ For 2018, data as of the second quarter. 5/ Liquid assets with maturity up to 30 days in percent of total liabilities.

### Selected economic indicators (Table 2 key figures)
- Real GDP (percent change): 4.6 (2013), 2.1 (2018), projections: 1.9 (2019), 3.0 (2020–2023 each year except 2019).
- GDP (US$ billions): 57.5 (2013), 60.2 (2018), projections: 60.1 (2019) to 74.5 (2023).
- Unemployment (in percent, eop): 6.5 (2013), 8.3 (2018), projections: 8.7 (2019) to 7.4 (2023).
- Output gap (percent of potential output): 3.3 (2013) to -0.9 (2018), projections negative through 2023.
- CPI inflation (average): 8.6 (2013), 7.6 (2018), projections: 7.5 (2019) and around 7.0–7.2 thereafter.
- Exchange rate (UY$/US$, average): 20.5 (2013), 30.7 (2018).
- Public sector: Revenue ~31.2 percent of GDP (2018); Tax revenues ~19.8 percent of GDP (2018).
- Primary balance: 1.2 percent of GDP (2018); primary balance excluding cincuentones transactions = 0.0 percent (2018).
- Gross public sector debt: 69.6 percent of GDP (2018); gross non-financial public sector debt 54.2 percent (2018).
- Gross official reserves (US$ millions): 15,551 (2018); months of imports ~15 (2018).
- Total external debt + non-resident deposits: 67.8 percent of GDP (2018).
- External debt service (percent of exports of g&s): 20.5 (2018).

### Balance of payments and external sector (Table 3 highlights)
- Current account (US$ millions): -389 (2018); projections -359 (2019), -633 (2020), -1,308 (2023).
- Trade balance (US$ millions): 2,448 (2018); exports of goods 11,556 (2018); imports of goods 9,108 (2018).
- Services balance: 1,133 (2018).
- Income balance: -3,970 (2018) — decline in income balance contributed to current account deficit.
- Financial and capital account balance: -379 (2018).
- Foreign direct investment: 200 (2018).
- Gross official reserves (stock, US$ millions): 15,839 (2018); In months of imports of goods and services: 14.8 (2018).
- Reserve adequacy: in percent of short-term debt 238.8 (2018).

### Main fiscal aggregates (Table 4 highlights)
- Primary balance of the non-financial public sector (percent of GDP): 1.2 (2018); projections 1.1 (2019), 0.9 (2020), 0.2 (2021).
- Revenues (billions of pesos): 576 (2018); Taxes 365 (2018); Social security 162 (2018).
- Primary expenditures (billions of pesos): 556 (2018); current 515 (2018); capital 41 (2018).
- Overall balance of the public sector (percent of GDP): -2.5 (2018); overall balance excluding cincuentones transactions: -3.7 (2018).
- Memorandum items: real revenues growth 6.4 percent (2018); real primary spending growth 0.8 percent (2018).

### Public sector debt and assets (Table 5 highlights)
- Gross debt of the public sector (US$ billions and percent of GDP): 39.5 (2018) in billions of U.S. dollars and 69.6 percent of GDP (2018).
- Gross assets of the public sector: 19.1 (2018) in US$ billions and 33.7 percent of GDP (2018).
- Liquid reserve assets of the central bank: 9.8 (2018) in US$ billions and 17.3 percent of GDP (2018).
- Net public sector debt (gross debt minus liquid financial assets): 27.1 (2018) in US$ billions and 47.7 percent of GDP (2018).
- Authorities' definition of net debt: 20.3 percent of GDP (2018).

### Central government operations and stock positions (Tables 6–7 highlights)
- Central government revenue (percent of GDP): 30.0 (2012) rising to 38.3 (2017) in the top-line table (Table 6 shows series 2012–2017).
- Central government expense (percent of GDP): 30.5 (2012) to 40.0 (2017).
- Net lending (+) / borrowing (-) central government: -2.0 (2012) to -3.0 (2017).
- Central government net financial worth (percent of GDP): -35.6 (2010) to -40.6 (2017) (Table 7).
- Liabilities composition: debt securities and loans are dominant instruments; residency breakdown provided.

### Monetary survey (Table 8 highlights)
- Banco Central del Uruguay net foreign assets (in local units): 254 (2012), 461 (2017).
- Gross international reserves: 264 (2012), 459 (2017).
- Broad money (M-3): 440 (2012) to 826 (2017) (end of period, in billions of pesos).
- Composition of credit (percent of total private credit): credit to firms ~56.8–60.9 percent; credit to households ~39.1–43.2 percent.
- Memorandum: Base money growth and M1, broader M1, M-2, M-3 series displayed (2012–2017).

### Medium-term macroeconomic framework (Table 9 highlights and projections)
- Real GDP projections: 1.9 percent (2019), 3.0 percent (2020–2023).
- CPI inflation projections (average): 7.5 (2019), 7.2 (2020), 7.2 (2021), 7.0 (2022–2023).
- Current account (percent of GDP) projections: -0.6 (2019), -1.0 (2020), -1.3 (2021), -1.6 (2022), -1.8 (2023).
- Primary balance (total public sector) projections: 1.1 percent of GDP (2019), 0.9 (2020), 0.2 (2021), 0.1 (2022), -0.1 (2023).
- Gross public sector debt projected around 70.6 percent (2019) and ~70.4 percent by 2023.
- Gross international reserves projected US$16.5 billion (2019) rising to US$19.4 billion (2023).
- Gross domestic investment and gross national saving series and projections provided.

*Source: IMF staff estimates and calculations; Banco Central del Uruguay; Ministerio de Economia y Finanzas; Instituto Nacional de Estadística; World Economic Outlook; Haver Analytics; Bloomberg L.P.; and Fund staff.*

### Annex I. External Sector Assessment

### Annex I. External Sector Assessment

### Summary assessment
- Staff assesses that the external position is broadly consistent with fundamentals according to the External Balance Assessment (EBA) current account model.
- The EBA-Lite real effective exchange rate (REER) model and the EBA external sustainability approach indicate Uruguay is overvalued.
- External stability risks remain contained given that the level of reserves is larger than the external financing requirements.

### Current account dynamics and outlook
- After achieving a historic surplus in 2016–17, the current account weakened substantially in 2018.
- Drivers of previous improvement (2014–2017): low oil prices (imports of fuel declined from 5.6 percent of GDP in 2012 to 1¾ percent of GDP in 2017), weak investment spending, and a sharp improvement in the bilateral trade balance with Argentina.
- 2018 deterioration factors: more negative primary income; worsening terms of trade (primarily higher oil prices); drought that affected primary exports (soybeans exports declining some 60 percent in volume during the first seven months of 2018 compared to the same period in 2017); weaker demand from Argentina and Brazil.
- Near-term outlook:
  - The market turmoil in Argentina began after the end of the 2018 tourism season; correction in the Argentinean REER and decline in demand will affect Uruguay’s tourism and goods exports at the end of 2018 and in early 2019.
  - Bilateral trade balance with Argentina expected to be slightly below zero in 2018, after a record surplus of 0.9 percent of GDP in 2017, and to converge to its 2005-17 average of -1.5 percent thereafter.
  - In 2019, decline in tourism revenues expected to be somewhat offset by a rebound in exports of primary goods.
  - Medium term: current account projected to weaken further as imports of capital and intermediate goods grow with expected recovery in investment and the trade balance with Argentina reverts to historical levels.
- Note: The current account balance for 2018 reflects data through 2018Q3. The bilateral balance against Argentina for 2018 reflects merchandise trade through 2018Q3, tourism through 2018Q2, and staff estimation for the remainder of the year.

### External position metrics and model results
- EBA current account model:
  - The adjusted current account balance is at the model’s current account norm (-2.5 percent of GDP).
  - The cyclically adjusted current account in 2018 is larger by 1.3 percent of GDP than the norm according to the EBA current account model.
  - Given reversion of unusually high 2017 trade and tourism revenues from Argentina (from the estimated 0.3 percent of GDP deficit in 2018 to 1.5-percent-of-GDP deficit), the adjusted current account gap is almost zero (0.04 percent of GDP).
- EBA-Lite REER model:
  - Shows Uruguay is 7.7 percent overvalued, driven largely by its actual appreciation relative to the level consistent with fundamentals and desirable policies.
- EBA external sustainability (ES) approach:
  - Assesses the REER to be overvalued (about 2 percent), given that the projected current account deficit for 2023 (1.8 percent of GDP) is below the level required to stabilize the stock of NFA at its current level (a deficit of 1.3 percent of GDP).

### Capital flows
- Capital flows have been volatile, fluctuating between 9 percent of GDP to -3 percent of GDP.
- First three quarters of 2018: foreign direct investment outflows of 0.3 percent of GDP (after declining 3.7 percentage points in 2017), and an inflow of portfolio investment of 1 percent of GDP.
- High frequency data show continued nonresident portfolio outflows for the fourth quarter, following 1.7-percent-of-GDP portfolio outflows in the third quarter.

### Reserves and external stability
- External stability risks are contained given reserve levels.
- As of December, gross reserves are at a slightly lower level than last year but remain above the upper bound of the IMF reserve adequacy metric range and other prudential indicators.
- Reserves are considered appropriate given the high degree of dollarization and commercial banks’ foreign currency requirements.
- Net reserves appear more than adequate to offset possible disorderly conditions in the foreign exchange market, if needed.

Key reserve and related metrics (as presented)
- In billions of U.S. dollars (December 28, 2018): 15.6
- In months of imports (2017): 15.2
- In percent of: GDP (2017) 1/: 25.9
- Short-term external (STE) debt (2017): 179.4
- STE debt and foreign currency deposits (2017): 51.7
- STE debt and nonresident deposits (2017): 135.7
- M2 (latest): 173.8
- M3 (latest): 55.3
- Memo items: IMF's new reserve adequacy metric range in 8.6 to 12.9 US$, billions (2018 Q2) 3/
- Banks' gross foreign assets (US$, billions, 2017): 9.7
- 83.9

### Interpretations and caveats
- The differing model results may reflect that quantities adjust slower than prices and the impact of lower FDI in recent years, which reduces imports on impact and export capacity in the long run.
- Table of exchange rate assessment deviations (as presented):
  - I. EBA - Current Account model (based on October 2018 EBA results): CA norm -2.5; CA projection -1.2; Difference 1.3; Adjusted for bilateral trade with Argentina: CA norm -2.5; CA projection -2.5; Difference 0.0.
  - II. External Sustainability (ES) approach: 1.9; CA norm -1.3 7/; -1.8 8/; Difference -0.4.
  - III. EBA-lite REER model: 7.7.
  - (Notes: Positive values indicate overvaluation. RES calculations based on the EBA ES approach, but using team's latest CA forecast. Using a CA elasticity of 0.22. Cyclically-adjusted in 2018. CA balance required to stabilize NFA in the medium-term. 2023 CA balance projection.)

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

### 10.      Debt dynamics are moderately sensitive to shocks. In a stylized downside scenario which

### 10.      Debt dynamics are moderately sensitive to shocks. In a stylized downside scenario which

### Debt dynamics and stylized downside scenario
- The stylized downside scenario combines:
  - a permanent 20 percent exchange rate depreciation (relative to the baseline),
  - a temporary drop in growth and primary balances,
  - a permanent increase in real interest rates.
- Under this combined shock, PS net debt would increase by 12 percentage points (as valuation effects on foreign-currency assets partially offset the impact on debt).
- Fan charts indicate debt dynamics are generally manageable under statistical distributions of combined shocks, although they have deteriorated from last year.
- Gross NFPS debt would remain below 70 percent of GDP in 95 percent of the cases.

### Baseline projections and automatic dynamics (selected figures)
- Real GDP growth (projections): 2019: 1.9; 2020: 3.0; 2021: 3.0; 2022: 3.0; 2023: 3.0 (in percent).
- Inflation (GDP deflator, projections): 2019: 6.8; 2020: 7.3; 2021: 7.3; 2022: 7.2; 2023: 7.4 (in percent).
- Primary balance (percent of GDP, projections): 2019: -0.5; 2020: -0.6; 2021: -0.2; 2022: -0.1; 2023: -0.1.
- Effective interest rate (projections): 2019: 6.7; 2020: 6.5; 2021: 6.6; 2022: 6.5; 2023: 6.4 (in percent).
- Nominal gross debt NFPS (selected years): 2016: 54.8; 2017: 51.2; 2018: 51.7; 2019: 54.2; 2020: 54.2; 2021: 53.3; 2022: 53.1; 2023: 53.1 (in percent of GDP).
- Nominal gross debt PS (selected years): 2016: 61.4; 2017: 61.6; 2018: 65.8; 2019: 69.6; 2020: 70.5; 2021: 70.0; 2022: 70.1; 2023: 70.4 (in percent of GDP).
- Gross financing needs NFPS (selected years): 2016: 8.6; 2017: 8.3; 2018: 8.5; 2019: 7.0; 2020: 5.9; 2021: 5.7; 2022: 6.4; 2023: 8.0 (in percent of GDP).
- Gross financing needs PS (selected years): 2016: 11.6; 2017: 14.0; 2018: 14.4; 2019: 3.4; 2020: 17.3; 2021: 17.5; 2022: 18.1; 2023: 19.9 (in percent of GDP).
- Effective interest rate (historical/projection row): 2016: 7.4; 2017: 6.9; 2018: 7.1; 2019: 7.4; cumulative change in gross debt PS examples: 2016: -1.2; 2017: -3.0; 2018: 4.2; 2019: 3.8; 2020: 0.9; 2021: -0.6; 2022: 0.2; 2023: 0.3; projection cumulative: 0.0; overall last shown cumulative: 4.6.

### Stress tests and scenario outcomes
- Individual stress tests shown include:
  - Primary Balance Shock: Primary balance falls to -0.9 in 2019 and -1.9 in 2020 (percent of GDP) under the shock; real GDP growth in shock: 2019: -0.4; 2020: 0.7.
  - Real GDP Growth Shock: Real GDP growth under shock: 2019: -0.4; 2020: 0.7; inflation and primary balances adjust accordingly.
  - Real Interest Rate Shock: Effective interest rate rises under the shock to 7.1 in 2020, 7.5 in 2021, 7.8 in 2022, 8.0 in 2023.
  - Real Exchange Rate Shock: Inflation jumps to 14.4 in 2019 in that shock scenario.
  - Combined Shock (macro-fiscal): Real GDP growth under combined shock: 2019: -0.4; 2020: 0.7; Primary balance: 2019: -0.9; 2020: -1.9; Effective interest rate: 2019: 7.4; 2020: 7.0; 2021: 7.6; 2022: 7.8; 2023: 8.0.
- Under the Combined Shock, gross nominal public debt paths and public gross financing needs rise notably across 2018–2023 (charts indicate elevated percent-of-GDP and percent-of-revenue outcomes, with levels shown across 2018–2023).

### Composition of public debt and alternative scenarios
- Composition and alternative scenarios include Baseline, Historical, and Constant Primary Balance scenarios with underlying assumptions:
  - Baseline primary balance path: 2018: 0.0; 2019: 0.0; 2020: -0.1; 2021: -0.2; 2022: -0.1; 2023: -0.1 (percent of GDP).
  - Historical scenario primary balance assumption: 2018: 0.0; 2019: 0.5; 2020: 0.5; 2021: 0.5; 2022: 0.5; 2023: 0.5 (percent of GDP).
  - Constant Primary Balance scenario sets Primary Balance at 0.0 across 2018–2023.
- Debt maturity: charts separate medium and long-term versus short-term debt by percent of GDP (historic series and projections through 2023).
- By currency: charts separate local currency-denominated and foreign currency-denominated debt shares (historic series and projections through 2023).
- Public gross financing needs path (percent of GDP) shown rising across projection period.

### External debt sustainability (Annex III)
- External debt peaked at 82 percent of GDP in 2015 and fell to 70 percent of GDP in 2017.
- In 2017 about 45 percent of the external debt is owed by the public sector.
- Gross external debt is estimated to decline slightly to 68 percent of GDP in 2018, and projected to gradually rise afterwards.
- Gross external financing requirements are expected to increase gradually over the medium term with a normalization of the non-interest current account and amortization of longer-term debt.
- Non-debt creating capital inflows are expected to support a slowly increasing long-term ratio of external debt to GDP.
- Stress tests indicate:
  - Standard growth and interest rate shocks would have a minimal impact on external debt.
  - Shocks to the non-interest current account and a combined shock (to the real interest rate, growth and current account) would have a greater, but still moderate, impact.

*Source: IMF staff.*

### 5.      The main risk to Uruguay’s external debt sustainability is an exchange rate

### 5.      The main risk to Uruguay’s external debt sustainability is an exchange rate depreciation

### Main finding
- A counterfactual 30 percent exchange rate depreciation would increase the external debt-to-GDP ratio by nearly 40 percentage points, other things being equal.
- Given Uruguay’s sizeable gross international reserves and liquidity buffers, risks to external debt sustainability remain limited.

### Baseline projections and key statistics (2013–2023) — selected rows from the External Debt Sustainability Framework table
- Baseline: External debt 1/: 66.2 72.0 82.1 75.9 69.6 67.9 70.2 70.7 71.3 71.5 72.2 -0.6
- Change in external debt: -4.8 5.8 10.1 -6.2 -6.3 -1.7 2.3 0.5 0.6 0.3 0.7
- Identified external debt-creating flows (4+8+9): -1.0 -1.3 3.6 -0.8 3.5 3.0 -1.6 -2.1 -1.6 -1.2 -0.8
- Current account deficit, excluding interest payments: 1.8 1.2 -1.4 -2.9 -2.7 -1.3 -1.4 -1.0 -0.7 -0.4 -0.2
- Deficit in balance of goods and services: -1.4 -2.8 -3.2 -5.2 -6.1 6.0 5.9 5.4 5.2 4.8 4.7
- Exports (percent of GDP): 31.5 32.1 29.3 27.6 26.8 27.3 27.0 27.2 27.4 27.5 27.8
- Imports (percent of GDP): -30.1 -29.3 -26.1 -22.4 -20.7 -21.4 -21.1 -21.8 -22.2 -22.7 -23.2
- Net non-debt creating capital inflows (negative): 4.8 4.4 1.6 -2.1 -3.7 -0.3 0.5 0.7 0.8 1.0 1.2
- Automatic debt dynamics: -7.7 -6.9 3.4 4.1 9.9 4.6 -0.7 -1.8 -1.7 -1.9 -1.8
  - Contribution from nominal interest rate: 1.7 1.7 2.2 2.3 2.5 2.1 1.9 1.9 1.9 2.0 2.0
  - Contribution from real GDP growth: -2.9 -1.9 -0.3 -1.4 -2.2 -1.5 -1.2 -2.0 -2.0 -2.0 -2.0
  - Contribution from price and exchange rate changes 3/: -6.5 -6.8 1.5 3.3 9.6 4.0 -1.4 -1.8 -1.6 -1.8 -1.8
- Residual, incl. change in gross foreign assets (2-3): -3.8 7.1 6.5 -5.4 -9.8 -4.8 3.5 2.6 2.2 1.4 1.6
- External debt-to-exports ratio (in percent): 210.5 224.0 279.8 275.0 259.5 248.5 260.3 259.9 259.9 259.6 259.6
- Gross external financing need (in billions of US dollars): 11.8 12.7 13.4 11.2 9.2 9.1 9.3 9.9 10.7 11.5 12.2
- Gross external financing need (in percent of GDP): 20.4 22.2 25.1 21.3 15.5 15.1 15.5 15.6 16.3 16.4

### Key macroeconomic assumptions underlying the baseline (historical and projections)
- Real GDP growth (in percent): 4.6 3.2 0.4 1.7 2.7 3.0 1.5 2.1 1.9 3.0 3.0 3.0
- GDP deflator in US dollars (change in percent): 10.1 11.4 -2.1 -3.8 -11.3 2.8 8.8 -5.5 2.0 2.5 2.3 2.5 2.5
- Nominal external interest rate (in percent): 2.8 3.0 3.0 2.7 3.0 3.5 0.9 2.9 2.9 2.9 2.9 2.9
- Growth of exports (US dollar terms, in percent): 0.0 1.6 -15.0 -7.0 9.1 -2.1 9.1 3.6 -1.3 6.3 6.4 5.9 6.7
- Growth of imports (US dollar terms, in percent): 4.2 -3.0 -17.0 -15.2 4.0 -5.4 10.2 4.8 -1.2 8.6 8.0 7.6 7.7
- Current account balance, excluding interest payments: -1.8 -1.2 1.4 2.9 2.7 0.3 2.3 1.3 1.4 1.0 0.7 0.4 0.2
- Net non-debt creating capital inflows: -4.8 -4.4 -1.6 2.1 3.7 -1.5 3.7 0.3 -0.5 -0.7 -0.8 -1.0 -1.2

### Scenario and stress tests (from Figure 1 and notes)
- Individual shocks are permanent one-half standard deviation shocks; permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance for combined tests.
- One-time real depreciation of 30 percent occurs in 2018.
- Figure labels (selected): i-rate shock baseline 74 / baseline 72; historical 77; combined shock 77; CA shock 78; combined shock with 30% depreciation 109 (External debt in percent of GDP under the 30% real depreciation scenario).
- Baseline and historical scenario summary boxes indicate baseline and scenario averages for real growth, interest, and current account variables (examples shown in figure: Baseline: 2.9, Scenario: 3.3, Historical: 3.5; Baseline: 2.8, Scenario: 2.0, Historical: 3.0; Baseline: 0.7, Scenario: -0.4, Historical: 0.30).

### Policy implications and context
- The main vulnerability to external debt dynamics is exchange rate depreciation: a severe real depreciation can sharply raise external debt ratios (near 40 percentage points for a 30 percent depreciation).
- Maintaining sizeable gross international reserves and liquidity buffers is important to limit external debt sustainability risks.
- Stress testing (interest rate, growth, current account, and large real depreciation shocks) highlights the sensitivity of external debt ratios to exchange rate and macroeconomic shocks.

*Source: Uruguay — Staff Report for the 2018 Article IV Consultation — Informational Annex (January 29, 2019).*

### 0.455 to 0.38, reflects significant progress towards reducing inequality.

### 1uryea2019001 - 0.455 to 0.38, reflects significant progress towards reducing inequality.

### Inequality and social progress
- Gini coefficient: "0.455 to 0.38, reflects significant progress towards reducing inequality."
- Social improvements have continued even in years of tepid but positive growth, aligned with the authorities’ objective of inclusive growth.
- Authorities welcome the IMF’s emphasis on the need to reduce inequalities, noted as a potential trigger of downside risks in the last World Economic Outlook (WEO) update.

### Orientations, policies, and reforms — Diversification
- Merchandise exports have diversified: twenty years ago exports to Brazil and Argentina were about 50 percent of Uruguay’s exports; currently the figure is half of what it used to be.
- Diversification dimensions:
  - Markets and origins of foreign direct investment.
  - Products: non-traditional exports of goods and services (software, financial consultancy, audiovisual products, logistics, among others) have substantially increased.
  - Impact: increased skilled-labor demand and wages.
- Tourism: Uruguay remains heavily dependent on Argentine demand within the country’s borders, representing around two thirds of total tourism revenue.

### Orientations, policies, and reforms — Prudence (fiscal policy)
- Fiscal consolidation is a key priority aimed at reducing debt levels relative to GDP.
- Budget and fiscal figures diverged from earlier projections given changing regional and global growth forecasts (IMF April 2018 WEO: Argentina growth 2 percent for 2018 and 3.2 percent for 2019; world economy 3.9 percent for the year instead of the current 3.5 percent).
- Private investment reacted to less benign circumstances; authorities introduced tax incentives to reactivate private investment, "which is starting to bear fruit."

### Orientations, policies, and reforms — Consistency (macroeconomic stability)
- Policy consistency across fiscal, monetary, exchange rate, debt-management, and income policies is deemed crucial for sustainable expansion and social progress.
- Inflation history and monetary policy:
  - Two-digit inflation rates in Q1 2016 prompted a tighter monetary stance.
  - Inflation was within the target range (close to its middle point) from March 2017 to April 2018 (except February 2018).
  - Subsequent factors: drought and peso depreciation affected inflation; once dissipated, inflation restarted a declining trend.
  - Latest inflation figure: "7.4 percent accumulated during a 12-month period until January 2019."
  - Central Bank announced it will maintain a contractionary policy bias to contain inflationary pressures.
- Wage-setting: multi-year wage negotiations are closing in line with guidelines that "continue to eschew indexation," anchoring non-tradable prices and tempering inflation inertia.
- Exchange rate policy: reaffirmed full adherence to a flexible exchange rate regime; interventions reserved to limit excessive volatility. Interventions were more frequent during third-quarter 2018 volatility.
- International reserves:
  - By end-December 2018, international reserves totaled "USD15.6 billion (approximately 25.4 percent of GDP)."
  - Reserves-to-GDP ratios have consistently surpassed "25 percent since 2012."
- External position: authorities take note of staff’s assessment that the external position is broadly consistent with fundamentals and desirable policy settings.

### Orientations, policies, and reforms — Financial buffers
- Active debt management reduced vulnerabilities from currency and maturity mismatches:
  - Debt in foreign currency: "54 percent of total debt (it was 89 percent in 2005)."
  - Average time to maturity: "14.5 years (compared to 8 years)."
  - Debt at fixed-rate: "94 percent (vs. 78 percent)."
- Early 2019: Uruguay issued a new dollar-denominated global bond with maturity 2031 at "175 bps over US Treasuries", being the first Latin American sovereign to tap international debt markets in 2019.
- Sovereign risk management: transactions across public-sector institutions designed to offset risks, attain hedging gains, reduce borrowing costs, and increase asset returns across the public sector.
- Rating agencies: Moody’s reaffirmed Uruguay’s "Baa2" rating with stable outlook; R&I and DBRS also confirmed the country’s ratings.

### Orientations, policies, and reforms — Soundness (financial sector)
- Reforms in governance of public banks, regulation and supervision, and macro-prudential measures (Basel framework) strengthened financial stability.
- Banking sector indicators: high capital levels and adequate liquidity buffers.
- Financial linkages to Argentina have drastically reduced (see staff report Figure 6 reference).
- Non-performing loans: "about 4 percent" — described as low at regional and global levels despite transitory increases.
- Banco República Oriental del Uruguay (BROU): governance and professional management reforms led to record profits in 2018 and improved capital indicators.

### Institutions
- Democratic and governance indicators:
  - Democracy Index 2018 (The Economist Intelligence Unit): Uruguay is within the group of 20 full democracies out of 167, with overall score "8.38" (scores between 0 and 10), recording "10 or about 10" in the Civil Liberties and Electoral Process and Pluralism sub-indexes.
  - Corruption Perception Index (Transparency International): Uruguay ranked "23rd out of 180 countries, with a score of 70 (0-100)," occupying the first place among all emerging economies.

### Looking forward — Challenges and priorities
- Key challenges: global, regional, and domestic developments, with fiscal consolidation a priority.
- Population aging: staff report stresses impact on fiscal accounts and notes that "early action will help smooth the transition to a revised system and reduce costs compared to a delayed response when aging pressures become more acute."
- Policy priorities identified:
  - Build consensus across the political spectrum and society to address aging and fiscal pressures.
  - Attain more vigorous private investment for growth and employment; "significantly more efforts are needed."
  - Improvements in education to successfully face the future and continue integration into the global economy.
  - Continue progress on inclusiveness (financial inclusion highlighted): "low-income households and small and micro enterprises have access to free bank accounts and debit cards."
- Infrastructure planning:
  - Ongoing infrastructure planning to establish foundations for long-term growth.
  - Government’s 2015-19 infrastructure plan targets new investments in transportation, energy, communications, and social infrastructure under PPP schemes.
  - Flagship project: a new railway line in the corridor of the country.
  - Potential private investment: potential construction of a new pulp mill by Finland’s UPM.

- Concluding orientation: positive results and international recognition "do not by any means constitute reasons for complacency, but further stimulus to keep working along the lines of robust policies and institutions."

*Source: https://www.imf.org/-/media/files/publications/cr/2019/1uryea2019001.pdf*

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_Source: https://www.imf.org/-/media/files/publications/cr/2019/1uryea2019001.pdf_