## _cr05431 ## Source details **Canonical URL:** [_cr05431](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05431.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05431.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05431.pdf.json) --- ### Executive summary — program and macro outlook - A three-year Stand-By Arrangement of SDR 766.3 million (250 percent of quota) approved on June 8, 2005. - Program status and governance: - Program on track and supported by strong domestic ownership. - President Vázquez’ government enjoys strong political support; broad consensus across main parties on key program elements. - Macroeconomic outcomes (high level): - Growth slowed from very rapid pace but expected to remain strong. - Inflation subdued; annual inflation dropped to about 3½ percent at end-August (below BCU target of 5½–7½ percent for end-December). - External position strengthened; peso appreciation of 9½ percent in nominal effective terms over the past year contributed to lower inflation. - Key vulnerabilities: - Medium-term debt sustainability depends critically on sustained growth and fiscal consolidation. - Banking system weaknesses persist. - Wage and social spending pressures are strong. - Structural agenda: advancing as planned but key challenges remain (important fiscal reforms, reforming BHU, improving investment climate). ### Recent macroeconomic performance (first half 2005) - Output and demand: - Seasonally adjusted GDP broadly constant Q1 2005 vs Q4 2004; some 7 percent higher than Q1 a year earlier. - Output growth slowed in Q1 2005; indicators suggest stronger growth in Q2 2005 due mostly to a pick-up in private demand. - External sector and reserves: - Exports grew by 21 percent (y/y) through June; imports increased by 30 percent (y/y). - Gross reserves at end-June: US$2.5 billion (some US$150 million higher than envisaged). - Real effective exchange rate remained some 23 percent below pre-2002 crisis level (figure text: some 25 percent below its previous level). - Fiscal: - Primary surplus of consolidated public sector: 3.1 percent of GDP in first half of 2005 (about ½ percent of GDP higher than programmed). - Public enterprises weaker by some ½ percent of GDP (drought impact, rising oil prices, delays in tariff adjustment, weak domestic demand). - Noninterest expenditure slightly below program. - Monetary and financial: - BCU eased monetary policy moderately; in June raised target range for base money by about 4 percent while maintaining inflation target range for June 2006 at 5–7 percent. - Base money growth higher-than-programmed reflecting faster-than-expected remonetization. - Credit to private sector remained subdued; market-determined peso short-term interest rates negative in real terms. - Sovereign spreads fell to lowest since crisis; authorities used placements to increase long-term, fixed-rate, and domestic-currency debt. ### Policy discussions and staff appraisal — near term and fiscal priorities - Near-term outlook: - Growth target of 6 percent in 2005 described as well within reach. - Staff supported recent moderate easing of monetary policy; authorities ready to tighten if inflationary pressures emerge. - Fiscal policy and implementation priorities: - 2005–09 budget supports medium-term fiscal objectives; important to implement it. - Key priorities: - Planned tax policy and administration reforms to meet ambitious revenue targets. - Contain public sector wage and pension increases. - Implement Social Emergency Program (SEP) as effective, well-focused, and transitory (2 years); SEP passed by Congress in June. - Structural reforms and growth: - Sustained rapid growth requires improving investment climate and attracting private investment. - External current account deficit revised upwards to incorporate a second large-scale pulp mill project (of some 4 percent of GDP) and higher oil prices; higher deficit projected to be fully financed by higher FDI and private capital inflows and largely temporary until exports materialize expected from late 2007. - Financial sector reforms: - Continued reforms needed to minimize contingent fiscal costs and ensure resumption of credit. - NBC being privatized; restructuring of public banks to continue, especially BHU where more decisive actions needed. - Upcoming FSAP to shape reform agenda. ### Key policy recommendations and program priorities - Implement the 2005–09 budget submitted to Congress. - Press ahead with planned tax policy and revenue administration reforms. - Contain public sector wage and pension increases. - Implement SEP within overall budget envelope of US$200 million; SEP to be transitory (2 years). - Continue financial sector reforms: - Privatize NBC. - Restructure BHU with decisive actions; adopt reform plan for BHU by end-2005 (proposed structural PC). - Strengthen central bank autonomy, financial system oversight, and bank resolution framework. - Use FSAP to refine reform agenda. - Pursue a broad growth-enhancing reform agenda to improve investment climate and attract private investment. ### Risks and vulnerabilities (sections 7 and appraisal) - Main risks highlighted: - Medium-term debt sustainability hinges on sustained growth and fiscal consolidation. - Banking system fragilities: high dollarization, reserve coverage of dollar deposits and short-term debt still significantly lower than in other dollarized economies. - Large public debt with significant near-term debt-service payments (including to the Fund). - Strong pressures to recover real wages and pensions and increase social spending. - Reversal in emerging market sentiment, slowdown in world growth, and higher U.S. interest rates could heighten financing vulnerability. - Indicators and financing: - Gross reserves increased above US$2 billion; NIR remained negative (figure annotation). - Public sector primary surplus rose to above 3.5 percent of GDP (figure annotation). - Fiscal overall balance improved (figure annotation). ### Fiscal reform, revenue administration, and debt management - Tax reform: - Draft law includes new personal income tax (PIT), revamping corporate income tax, elimination of tax exemptions/subsidies, unification of VAT rates. - Reform expected to generate revenue increases starting in 2007 equivalent to ½ - ¾ percent of GDP. - Draft law to be ready by year-end and submitted after Congress returns in mid-February; implementation envisaged by mid-2006. - Revenue administration improvements (key actions): - DGI: modernization decree enacted; creation of large taxpayers unit; increased funding by some 0.15 percent of GDP; memorandum of understanding with Ministry by December 2005 (structural benchmark). - DNA (Customs): comprehensive transformation strategy by August 2006 (structural benchmark); budget proposes additional funds of some 0.15 percent of GDP. - BPS: action plan through end-2006 to improve audit and collection functions. - Pension reform: - Police pension fund reform to be enacted by November; reforms for military and bank employees to be implemented in 2006. - For general pension system, focus on strengthening contribution collection; staff recommended considering more far-reaching reforms (increasing retirement age to 65; shifting pension indexation from wages to inflation; calculating pensions on lifetime earnings). - Debt management: - Authorities using market conditions to improve debt structure: extend maturity of dollar T-bills, issue inflation-indexed T-notes (5–10 years), international bonds at longer maturities. - Establish a debt management unit in the Ministry of Finance by end-December (supported by Fund-IDB TA). ### Monetary and exchange rate policy — stance and recommendations - Staff supported easing in June given deceleration in inflation and peso appreciation pressures; stance consistent with BCU 5½–7½ inflation target for end-2005. - Caution advised given possible inflationary pressures from high oil prices and wage increases, and incomplete understanding of monetary transmission and exchange rate pass-through. - Base money target range for remainder of 2005 raised by 4 percent; staff recommended achieving as much as possible of this increase via unsterilized foreign exchange purchases to raise international reserves. - Authorities aim to maintain reserve overperformance but reluctant to commit to higher NIR floor due to shock risks and high quasi-fiscal costs of central bank securities. ### Central bank and financial sector reforms; bank restructuring status - BCU and oversight reforms: - Legislation to increase BCU operational independence to be submitted to Congress by year-end. - Deposit insurance agency operations/funding law well-advanced; preferable to place agency outside BCU. - Prudential regulation approved in August, effective July 2006, taking account of currency risks. - FSAP missions in October 2005 (and January 2006) to assess and identify longer-term agenda. - Bank restructuring: - NBC: contract signed to sell 100 percent of common equity; deal expected to close by year’s end; staff recommended using proceeds to retire debt. - BROU: profitable in H1 2005; asset management company recovering NPLs; trust funds servicing government-guaranteed note ahead of schedule. - BHU: undercapitalized and illiquid with negative cash flows, serious governance problems, large NPL portfolio; unless decisive steps taken, may be unable to meet government-guaranteed obligations to BROU beyond next few months. Authorities agreed a final plan to minimize potential fiscal costs to be adopted by December (proposed structural PC). BHU to refrain from taking deposits except specific mortgage-related savings accounts. - Liquidation funds: recoveries have exceeded original business plan by about 10 percent; transfer of NPL borrower information into credit registry expected by year’s end. ### Pro-growth agenda and structural reform roadmap (section 18) - Growth commission (government, private sector, labor) designing roadmap to be completed by end-March 2006 (proposed structural benchmark). - Key reform areas: - Tax reform to stimulate demand and reduce sectoral distortions. - Simplify business setup and tax/social security registration through one-stop windows. - New bankruptcy law to be submitted to Congress by June 2006 (proposed structural benchmark); implementation expected by December 2006. - Competition policy: legislation submitted to Congress restricting anticompetitive practices. - Labor and social policy: - Emphasis on prudent wage policies and labor market flexibility; new collective bargaining framework to bring stability and moderate wage demands. - Staff encourages efficient implementation of SEP and that it be phased out as envisaged. - PPPs and public enterprise reform: - PPPs expected to raise investment and improve public enterprise efficiency; need proper regulatory and legal framework to minimize contingent fiscal costs. - Authorities to proceed case-by-case with Fund and IDB advice. ### Financing assurances, gross financing needs, and key financing milestones - Financing secured / placements: - US$500 million international bond placement in May 2005. - EUR 300 million (US$360 million) bond issued in July 2005. - Some US$265 million disbursements under World Bank and IDB expected before year’s end (2005). - Program financing needs and debt service: - Total gross public sector financing need to average about US$2.2 billion a year (12 percent of GDP) during 2005–08. - Debt service payments will average some 15½ percent of GDP (5 percent of GDP in interest payments). - Base money ceilings proposed to be raised by Ur$0.6 billion (September) and Ur$0.7 billion (December). ### Debt sustainability assessment — baseline and scenarios (Balance of Payments / Appendix) - Baseline medium-term projection assumptions: - Primary fiscal surplus: 4 percent of GDP over medium term. - Sustained GDP growth: 3 percent a year. - Gradual recovery of real peso to 85 percent of pre-crisis level (from 71 percent at end-2004). - Sovereign spreads broadly at current levels. - Baseline outcomes: - Public debt decline to about 60 percent of GDP by 2008 and just below 50 percent of GDP by 2012. - Debt-service payments decline only moderately from 15 percent of GDP in 2005 to 12 percent of GDP in 2010. - Stress-test and scenario findings: - No-policy change vs historical-average: debt would be unsustainable under historical-average shocks (weaker growth ~1 percent annually and primary balance of -½ percent of GDP) — debt-to-GDP increases sharply (by some additional 35 percentage points by end of decade). - Half-standard-deviation shocks to interest rates or growth: debt-to-GDP 73–78 percent by 2010 vs 54 percent in baseline. - Half-standard-deviation shock to primary balance: debt-to-GDP 58 percent by 2010. - Combined shocks (three shocks of ¼ standard deviation): debt-to-GDP 71 percent by 2010. - Exchange rate shock (30 percent depreciation): debt-to-GDP jumps above 100 percent and declines to about 90 percent by 2010. - Tailored scenarios (Appendix I): - Weaker domestic policies (primary surplus 3 percent; potential growth 2 percent; spreads +50 bps; real appreciation ~5 percent): debt-to-GDP some 16 percentage points above baseline by 2012. - Contingent liabilities from financial sector (government guarantee on BHU note US$640 million; government takes over BROU note service US$380 million during 2005–1012; courts rule for former NBC owners US$120 million; deposit insurance initial funding ~US$40 million): debt-to-GDP jumps 5 percentage points and stays some 4 percentage points above baseline by 2012. - Growth (accelerated reforms; potential growth +1 percentage point to 4 percent; primary surplus 4¼ percent; spreads -50 bps): debt-to-GDP declines to 42 percent by 2012. ### Key statistics and selected social indicators - Population (estimate): 3.2 - GDP per capita in 2004 (in US$): 4,300 - Unemployment rate: 11.0 - Poverty rate: 31.0 - Gini coefficient: 44.6 ### Program monitoring, statistical issues, safeguards - Program monitoring adjustments requested: - Raise base money indicative ceilings for September and December by Ur$0.6 billion and Ur$0.7 billion, respectively. - Adjustors to NIR and NFPS debt targets to reflect pre-financing. - Move submission of tax law to end-February (from end-December). - Structural PC: adoption of BHU reform plan by end-2005; benchmarks for growth agenda and bankruptcy law for end-March and end-June 2006. - Statistical issues: - Database broadly adequate but fiscal and public debt data reporting lags exceed TMU two-month limit, mainly due to BHU and BROU reporting difficulties. - Staff urged reducing reporting lag; recording floating debt to become part of fiscal PCs from 2006. - Safeguards assessment: - New safeguards assessment nearly complete; BCU has implemented most 2003 measures but vulnerabilities remain in external audit, financial reporting, and legal framework. - Recommendations include publishing audited financial statements and including BCU’s obligations to Fund in its financial statements. ### Fund relations and projected payments (as of July 31, 2005) - Stand-By Arrangements outstanding: - Stand-By approved 6/08/05–6/08/08: Approved 766.25 SDR; Drawn 30.65 SDR. - Prior Stand-By (4/01/02–3/31/05): Approved 1,988.50 SDR; Drawn 1,988.50 SDR. - Projected payments to Fund (obligation basis, SDR millions): - 2005: Principal 84.75; Charges/interest 41.13; Total 125.88. - 2006: Principal 434.43; Charges/interest 74.67; Total 509.00. - 2007: Principal 574.40; Charges/interest 40.00; Total 614.40. - 2008: Principal 268.35; Charges/interest 18.42; Total 346.86. - 2009: Principal 133.98; Charges/interest 7.22; Total 226.42. ### International financial institution support and World Bank relations - World Bank CAS approved June 9, 2005 envisages up to US$800 million new lending over FY05–10 (base case), modulated by program strength and creditworthiness. - World Bank placements and disbursements and IFC holdings summarized for CY04–CY05; selected highlights: - DPL1 approved June 9, 2005: US$75 million (fully disbursed). - Current IBRD investment portfolio: seven projects totaling US$359.5 million commitments; undisbursed US$146.3 million as of September 12, 2005. - US$265 million expected disbursements under World Bank and IDB before year’s end (2005). ### Floating debt of central government — program treatment (section 9) - Definition scope: expenditures from general treasury account (Rentas Generales only) registered in SIIF, authorized/confirmed by central accountants, and for which no checks have yet been issued. - Exclusions: obligations for utilities, subsidies, judgment debt, obligations under “Inciso 24”, domestic suppliers’ credits of Ministry of Housing. - Treatment: floating debt ceiling is an indicative target through December 31, 2005; thereafter included in combined public sector overall balance, general government expenditure, and NFPS debt stock once approved in 2006 budget. - Valuation conventions noted: Ur$26.35 per U.S. dollar; U.S. dollar 1.3637 per Euro; U.S. dollar 0.0097 per Yen; U.S. dollar 1.54784 per SDR; Ur$1.4345 per UI with conditional rule if Ur$ to UI rate exceeds 1.5420. *Source: Executive Summary, sections 1, 7, 18, Appendices I–III, and related sections of _cr05431* ### Executive Summary ...................................................................................................... ### _cr05431 - Executive Summary ### Background - A three-year Stand-By Arrangement in the amount of SDR 766.3 million (250 percent of quota) was approved on June 8, 2005. - Uruguay’s recovery from the 2002 crisis continues to impress: growth slowed from last year’s very rapid pace but is expected to remain strong; inflation has been subdued; and the external position has strengthened further with continuing upward pressure on the peso. - The program is on track and supported by strong domestic ownership. President Vázquez’ government continues to enjoy strong political support, and there is broad consensus across the main parties on the key elements of the program. - Structural reform agenda advancing as planned, but key challenges remain, including important fiscal reforms, reforming the ailing public housing bank (BHU), and steps to improve the investment climate. - Significant vulnerabilities remain: - Medium-term debt sustainability depends critically on sustained growth and fiscal consolidation. - Weaknesses remain in the banking system. - Wage and social spending pressures are strong. ### Recent macroeconomic performance (first half 2005) - Output: - Seasonally adjusted GDP remained broadly constant in Q1 2005 compared to Q4 2004, but was some 7 percent higher than in Q1 a year earlier. - Output growth slowed in Q1 2005 but available indicators suggest growth strengthened considerably in Q2 2005 owing mostly to a pick-up in private demand. - Inflation: - Annual inflation dropped to about 3½ percent at end-August, below the central bank’s target range for end-December (5½–7½ percent). - Peso appreciation of 9½ percent in nominal effective terms over the past year contributed to lower inflation. - External sector: - Exports grew by 21 percent (y/y) through June; imports increased by 30 percent (y/y). - Gross reserves at end-June stood at US$2.5 billion, some US$150 million higher than envisaged under the program. - Real effective exchange rate remained some 23 percent below the pre-2002 crisis level (figure text: some 25 percent below its previous level). - Fiscal: - The primary surplus of the consolidated public sector was 3.1 percent of GDP in the first half of the year, about ½ percent of GDP higher than programmed. - Revenues benefited from strong collections of corporate income and property taxes, and of social security contributions. - Weaker performance of public enterprises of some ½ percent of GDP, reflecting mainly drought impact, rising oil prices, delays in tariff adjustment, and weak domestic demand in early 2005. - Noninterest expenditure slightly below program, owing to start-up delays of social emergency partially offset by advance oil purchases by ANCAP. - Monetary and financial: - The central bank (BCU) eased monetary policy moderately: in June the BCU raised the target range for base money by about 4 percent while maintaining the inflation target range for June 2006 at 5–7 percent. - Base money growth was higher-than-programmed reflecting faster-than-expected remonetization; currency issue remains significantly below pre-crisis level. - Credit to the private sector remained subdued; market-determined peso short-term interest rates turned negative in real terms. - Sovereign spreads continued to fall to their lowest level since the financial crisis; authorities used new placements to improve public debt profile by increasing share of long-term, fixed rate, and domestic currency debt. - The government extended maturity of new placements of dollar-denominated treasury bills by 6 months to two years, increased inflation-indexed debt maturity from 3 to 5–10 years, and made three large bond issues in fixed interest rate long-term bonds (more than 10 years). - Program monitoring: - Available data for end-June suggest all quantitative performance criteria (PCs) were observed (final for NDA and NIR of the BCU and non-interest expenditure, preliminary for the primary surplus and NFPS debt PCs). - The attached TMU clarifies definitions of public debt coverage and the combined public sector balance for monitoring performance under the program. ### Policy discussions and staff appraisal - Near-term outlook: - The growth target of 6 percent in 2005 is well within reach. - With inflation well below the central bank target band, staff supported a recent moderate easing of monetary policy. The authorities stand ready to tighten monetary policy should inflationary pressures emerge. - Fiscal policy: - The 2005–09 budget submitted to Congress supports the medium-term fiscal objectives of the program and it is now important to implement it. - Key fiscal implementation priorities: - Planned tax policy and administration reforms to help achieve ambitious revenue targets. - Contain public sector wage and pension increases. - Implement the social emergency program (SEP) in an effective, well-focused and transitory way, as planned. SEP was passed by Congress in June and is designed to be transitory (2 years). - Structural reforms and growth: - Sustained rapid growth will require improving the investment climate. - Government is developing a broad agenda of growth-enhancing reforms focused on attracting more private investment. - Growth objectives beyond 2005 should be attainable, helped initially by ongoing large FDI projects, although the longer-term outlook depends on a successful strategy to improve the business environment. - The external current account deficit was revised upwards to incorporate a second large-scale pulp mill project (of some 4 percent of GDP) and higher oil prices; the higher deficit is projected to be fully financed by higher FDI and private capital inflows and expected to be largely temporary until projects generate export receipts expected from late 2007. - Financial sector reforms: - Continued reforms are needed to minimize contingent fiscal costs and ensure a sustainable resumption of credit. - Programmed central bank and financial sector oversight reforms are progressing as planned. - NBC is being privatized; restructuring of public banks needs to continue, especially at BHU where reforms to date have not produced expected improvements and more decisive actions are needed. - The upcoming FSAP should help shape the future reform agenda in this area. - Political economy: - Political support for the government has remained strong; President Vázquez’s approval rating continues to be relatively high. - Pressures within the Frente Amplio coalition for increased state intervention (labor market and debt resolution) have led to some measures (e.g., reinstatement of tripartite wage councils) that concern the business community but have not altered the program’s broad direction. - The coming months are a critical test as the five-year budget must be passed by Congress and important reform measures implemented. ### Risks and vulnerabilities - Main risks: - Medium-term debt sustainability hinges on sustained growth and fiscal consolidation. - Banking system weaknesses and potential contingent fiscal costs remain important risks. - Strong wage and social spending pressures could complicate fiscal consolidation. - The external current account widened due to large FDI projects and higher oil prices, but financing is expected from FDI and private capital until projects generate exports. - Indicators and financing: - Gross reserves increased above US$2 billion; net international reserves (NIR) remained negative (figure annotation). - Public sector primary surplus has risen to above 3.5 percent of GDP (figure annotation). - The fiscal overall balance has also improved (figure annotation). ### Key policy recommendations and program priorities - Implement the 2005–09 budget submitted to Congress. - Press ahead with planned tax policy and revenue administration reforms to meet revenue targets. - Contain public sector wage and pension increases. - Implement the SEP as an effective, well-focused, and transitory (2 years) program. - Continue financial sector reforms, including: - Privatization of NBC. - Restructuring and decisive actions at BHU. - Strengthen central bank autonomy, financial system oversight, and the bank resolution framework. - Use the FSAP to refine the future reform agenda. - Pursue a broad growth-enhancing reform agenda to improve the investment climate and attract private investment. *Source: Executive Summary, _cr05431* ### 7. While short-term financing risks have decreased in the context of the benign ### _cr05431 - 7. While short-term financing risks have decreased in the context of the benign ### Key risks and vulnerabilities - Strong pressure to recover real wages and pensions and increase social spending persist; changes made to the draft budget to forge cabinet consensus highlight this risk. - Sustaining growth is critical for social progress and debt sustainability; recent mixed signals by the government, including concessions to unions, have created some investor uncertainty about policy direction. Medium-term growth prospects depend critically on a clear and effective strategy to improve the environment for private investment. - Fragilities remain in the banking system: dollarization remains high, and the reserve coverage of dollar deposits and short-term debt is still significantly lower than in other dollarized economies. - Public debt remains high, with large debt-service payments due in the next years, including to the Fund. A reversal in emerging market sentiment, slowdown in world growth, and higher U.S. interest rates could heighten vulnerability of Uruguay’s financing outlook. ### Vulnerability indicators (high-level findings from figures) - Public sector debt remains high (percent of GDP; chart spans 2001–2005). - Debt composition: a large share is in foreign currency (in US$ billions; series labeled In dollars, In SDR, In pesos, Other across Dec-02 to Dec-04). - Exposure to interest rate risk: presence of Fixed and Libor exposures (in US$ million). - Maturity structure: amounts up to 1-year, between 1 and 5-year, and more than 5-year (in US$ million); some roll-over risk noted. - Sovereign risk (EMBIG Global) for Uruguay has declined sharply, in line with Latin America (time series Jan-03 to May-05). - 6-month Libor rate has been rising (time series Jan-03 to May-05; labeled "in percent"). - Dollarization in the financial system remains widespread (peso deposits and dollar deposits, in US$ billion; Jan-02 to Jul-05). - Foreign assets of the banking system as percent of dollar short term debt plus total FX deposits: reserve coverage still needs to be improved (time series Jan-02 to Jul-04). - Large amortization payments will fall due over the next years (percent of GDP; projected 2005–2012 chart). - Public expenditure composition: a large share is used for pensions and wages (percent of GDP; 2000–2005 series). - Public sector gross borrowing requirements are significant (percent of GDP; 2001–2006 series). - Public sector real wages have recently started to recover (Public Sector Wages index, Dec-00=100; nominal and real series Dec-00 to Dec-04). ### Macroeconomic policy: fiscal stance and near-term measures - Authorities committed to save any revenue overperformance in 2005 toward a higher primary surplus, noting some 2005 overperformance reflected temporary factors (seasonally strong local government revenue). - Authorities emphasized ongoing efforts to strengthen tax administration and social security collections and to maintain primary expenditure within program limits. - Slightly higher-than-programmed public sector wage increases reflect supplements to teachers and lower-wage employees; in July, public wages were increased on average by 3.7 percent, above the 2.5 percent assumed in the program. - Authorities noted deterioration in public enterprises partly due to a drought and rising oil prices in 2005 and committed to strengthen management; fuel price increases were announced to take place by early October, with current estimates pointing at the need of an 8 percent increase (a possible agreement with Venezuela could lower oil import costs). - Staff support: the five-year budget submitted to Congress was supported, but staff warned that higher revenue and spending targets imply somewhat heightened risks. Key quantitative points: - Projected revenues are about 1½ percent of GDP higher over the medium-term relative to 2005. - Projected spending levels are about 1 percent of GDP higher over the medium-term relative to 2005. - The budget incorporates an agreement with unions for an increase in real wages of about 3 percent per year over the next four years, in line with GDP growth, plus additional allocation to priority sectors reaching 0.4 percent of GDP in 2009. - Authorities stressed that improvements in tax administration and planned tax reform should ensure revenue targets; they also stressed readiness to adjust spending plans, including investment, if revenues come in lower than expected. Staff intends to discuss appropriate contingency plans in the context of each annual budget. - Social Emergency Program (SEP): authorities and staff concurred on need to improve execution. Authorities committed to keeping SEP within the overall budget envelope of US$200 million; any underspending on SEP should not be substituted by other spending. ### Monetary and exchange rate policy - Staff supported the authorities’ decision to ease monetary policy in June, given faster-than-envisaged deceleration in inflation and continued pressures for peso appreciation; the stance is consistent with the authorities’ 5½–7½ inflation target range for end-2005. - Caution advised due to potential inflationary pressures from high oil prices and wage increases, and incomplete understanding of the monetary transmission mechanism and exchange rate pass-through under the relatively new flexible exchange rate regime. - The base money target range for the remainder of 2005 has been raised by 4 percent; staff recommended that as much as possible of this increase be achieved through unsterilized foreign exchange purchases to further increase international reserves. - Authorities agreed to aim at maintaining overperformance in reserves but were reluctant to commit to a higher NIR floor under the program given shock risks and noted benefits of reducing outstanding central bank securities (high quasi-fiscal costs). NDA ceilings for end-September and end-December were proposed to be increased consistent with revised base money targets; monetary program to be reexamined at the next review to seek to lock in overperformance. Authorities reiterated readiness to adjust monetary policy as necessary to achieve inflation objectives for 2005 and 2006. ### Fiscal reforms and debt management - Fiscal reforms aim to bolster resilience to shocks, improve efficiency, and ensure achievement of medium-term fiscal targets. Timely and full implementation is important. Main elements: - Tax reform: draft law includes a new personal income tax (PIT), revamping of corporate income tax, elimination of tax exemptions and subsidies, and unification of VAT rates. The reform is to generate increases in revenues starting in 2007 equivalent to ½ - ¾ percent of GDP. The draft law will be ready by year-end and submitted after Congress returns in mid-February; implementation still envisaged by mid-2006. Implementation sequencing emphasized to avoid reducing the burden of indirect taxation before targeted revenue increases are assured. - Strengthening revenue administration: progress includes creation of a large taxpayers unit, collection targets at the social security bank (BPS), and improved coordination of tax audits. The authorities are implementing several July 2005 Fund-World Bank recommendations. Key administrative actions (Box 2): - DGI: modernization decree enacted; creation of large taxpayers unit and internal audit department; new human resources policy and professional career stream; increased funding by some 0.15 percent of GDP; memorandum of understanding with Ministry to be signed by December 2005 (structural benchmark) including collection goals for 2006, performance incentives, and quantitative criteria. - DNA (Customs): comprehensive transformation strategy to be prepared by August 2006 (structural benchmark) with Fund TA; budget proposes additional funds of some 0.15 percent of GDP for DNA. - BPS: action plan through end-2006 adopted to improve audit and collection functions, services to contributors, and coordination with other government entities. - Budget process reform: the budget submitted incorporates a medium-term macroeconomic framework, expands coverage, and aligns appropriations with execution ceilings. Staff encouraged moving forward with FAD recommendations (organic financial management law, annual budgets within a rolling five-year framework, improved budget classification and coverage, tax expenditure analysis) after budget approval in early 2006. - Pension reform: police pension fund reform to be enacted by November; reforms of other specialized funds (military and bank employees) to be implemented in 2006. For the general pension system, authorities focus on strengthening collection of contributions. Staff noted that recovery of real wages will add strain under current indexation linking pensions to wages and recommended that more far-reaching reforms be considered (suggested reforms include increasing retirement age to 65; shifting indexation of pensions from wages to inflation; calculating pensions based on lifetime earnings and accounting for interruptions in labor force participation). Pension projections: pensions are projected to decline moderately as a percent of GDP over the medium term, remaining substantially below pre-2002 levels. - Debt management: government is using favorable market conditions to gradually improve debt structure: extension of maturity of dollar-denominated T-bills, issuance of inflation-indexed T-notes and international bond issues at longer maturities. Staff supported further international bond placements to pre-finance needs. Establishment of a debt management unit in the Ministry of Finance—supported by Fund-IDB TA—by end-December is on track with appropriations made in the budget. ### Central bank and financial sector reforms - Authorities committed to programmed reforms of the central bank and financial sector oversight authorities. Final decisions on organizational structure of supervisory agencies to be taken shortly; legislation to increase operational independence of the BCU to be submitted to Congress by year-end. Legislation clarifying operations and funding of the deposit insurance agency is well-advanced; authorities agreed it would be preferable to place the agency outside the central bank. Prudential regulation approved in August takes into account currency risks (effective July 2006). A first FSAP mission in October will take stock and identify a longer-term reform agenda. - Bank restructuring status: - Nuevo Banco Comercial (NBC): contract signed to sell 100 percent of common equity; deal expected to be closed by year’s end. Staff recommended using proceeds to retire debt. - State bank (BROU): profitable in first half of 2005; loan portfolio quality remained consistently strong. BROU’s asset management company is making progress in recovering NPLs, allowing trust funds to service government-guaranteed note to BROU ahead of schedule. - Housing bank (BHU): undercapitalized and illiquid with negative cash flows and serious governance problems; large portfolio of nonperforming assets and high operating expenses. Unless decisive steps are taken, it may be unable to meet government-guaranteed obligations to BROU beyond the next few months. Authorities agreed a final plan aimed at minimizing potential fiscal costs would be adopted by December (proposed structural PC). In the meantime, BHU would continue to refrain from taking deposits, with the exception of offering peso-denominated, mortgage-related savings accounts as part of its reform program. - Liquidation funds: collection by the private asset manager is proceeding on schedule, recoveries for the three banks have exceeded the original business plan by about 10 percent. To enhance transparency, publication of semi-annual financial reports on liquidation funds’ operations should continue. Transfer of information on non-performing borrowers of the liquidation funds into the credit registry is expected to be completed by year’s end. *Sources: Central Bank of Uruguay; Ministry of Economy and Finance; and Fund staff estimates.* ### 18. The authorities are developing a strong pro-growth agenda, which they deem ### _cr05431 - 18. The authorities are developing a strong pro-growth agenda, which they deem ### Pro-growth agenda and structural reforms - A growth commission, including government officials and representatives of the private sector and labor, is designing a detailed roadmap with pro-growth reforms to be implemented over the next years; expected to be completed by end-March 2006 (proposed structural benchmark). - Key reform areas being advanced: - Tax reform: upcoming tax reform is expected to further stimulate consumer demand and reduce distortions across productive sectors. - Reducing the cost of doing business: streamlining business setup procedures; tax and social security registration simplified through one-stop windows. - Creditor and debtor rights: a new bankruptcy law will be submitted to Congress by June 2006 (proposed structural benchmark), allowing Chapter 11-like corporate restructurings; implementation would be expected by December 2006. - Competition policy: legislation restricting anticompetitive practices has been submitted to Congress. ### Labor market, wages, and social programs - Staff highlighted the need for prudent wage policies and labor market flexibility to protect competitiveness and growth. - Authorities reported wage increases agreed in the new wage councils for 2005 remained broadly in line with productivity growth. - The new collective bargaining framework is intended to bring stability to labor relations and channel demands in an environment conducive to moderation. - Staff encourages efficient implementation of the Social Emergency Program and that it be phased out as envisaged. ### Public-Private Partnerships (PPPs) and public enterprise reform - PPPs are expected to play a key role in raising investment and improving efficiency of public enterprises given fiscal constraints and society’s preference for continued public involvement. - Staff stressed the importance of a proper regulatory and legal framework for PPPs to maximize benefits and minimize contingent fiscal costs. - Authorities plan to proceed on a case-by-case basis, taking into account Fund and IDB advice, while building experience and strengthening the institutional framework over time. ### Financing assurances and public sector financing outlook - The program has adequate financing assurances in place: - Most of the government’s 2005 market financing needs secured through placements in the domestic market and a US$500 million international bond placement in May. - Some US$265 million disbursements under the World Bank and IDB lending programs are expected before year’s end. - The government obtained part of the 2006 external financing needs through issuance of a EUR 300 million (US$360 million) bond in July. - Gross financing requirements for the remainder of the program will need to be met through sustained fiscal discipline, increasing access to domestic and international financial markets, and continued IFI support. - The total gross public sector financing need (including for the programmed buildup in international reserves) will average about US$2.2 billion a year (12 percent of GDP) during 2005–08, and debt service payments will average some 15½ percent of GDP (5 percent of GDP in interest payments). ### Program monitoring, statistical issues, and safeguards - Proposed adjustments to program targets and timelines: - Indicative ceiling on base money for September and December would be raised by Ur$0.6 billion and Ur$0.7 billion, respectively, in line with the BCU’s new target range; ceiling on NDA proposed to be adjusted upwards accordingly. - Adjustors to NIR and NFPS debt targets proposed to be modified to reflect pre-financing. - Structural performance criterion on tax law submission proposed to be moved to end-February (from end-December) to align with resumption of congressional sessions. - A new structural performance criterion in the financial sector, and structural benchmarks in growth and tax administration areas are proposed: adoption of a reform plan for BHU proposed as a structural PC for end-2005; benchmarks on completion of growth-enhancing reform agenda and on submission of the bankruptcy law are proposed for end-March and end-June 2006, respectively; signing an MoU between the Ministry of Finance and the DGI (December 2005) and designing an action plan to reform the customs office (August 2006) are new benchmarks. - The second review is expected to take place in December 2005; quantitative quarterly performance criteria and main elements of the structural reform agenda for 2006 will be established then. - Statistical issues: - Uruguay’s statistical database is broadly adequate for program monitoring, but fiscal and public debt data provision still exceeds the two-month limit specified in the TMU, mainly due to reporting difficulties from BHU and BROU. - Staff urged efforts to reduce reporting lag and welcomed strengthened recording of floating debt, which will become part of the fiscal PCs beginning 2006, and publication of the Fund’s Data Template on International Reserves and Foreign Currency Liquidity. - Safeguards assessment: - The BCU has implemented most measures proposed under the 2003 safeguards assessment. - A near-complete new safeguards assessment found broadly adequate mechanisms to safeguard Fund resources and minimize misreporting risk, but identified vulnerabilities in external audit, financial reporting, and the legal framework that remain to be addressed. ### Staff appraisal, risks, and policy recommendations - Early program results are encouraging: rapid growth, low inflation, and strong fiscal performance; some buildup in reserves; partial completion of external financing plan for 2006. - Staff commends commitment to save any fiscal revenues exceeding program levels in 2005 toward achieving the medium-term primary surplus target of 4 percent of GDP as soon as possible. - Staff urged prompt tariff adjustments in public enterprises in line with cost developments and recommended continuing to take advantage of market conditions to improve net international reserve position and public debt profile. - Remaining priorities and risks: - Sustain growth and progress in social area; downside risks remain and social situation remains difficult. - Encourage private sector investment by improving investment climate; welcome establishment of the growth commission and recommend close collaboration with the World Bank and the IDB. - Tax policy and administration reforms are key to meet ambitious revenue targets; contain public sector wage and pension increases as necessary to safeguard fiscal objectives. - Authorities should remain vigilant against potential inflationary pressures from private sector wage increases, pending utility tariff increases due to higher energy prices, and excess banking liquidity; be ready to tighten policies if needed to safeguard the inflation objective of the program. - Staff recommends that as much as possible of the targeted increase in base money be achieved through unsterilized international reserve accumulation. - Proceed with debt management reforms, including establishing a debt management unit at the Ministry of Finance. - Implement pending pension reforms: police pension fund reform implementation by November 2005; proceed with reforms for military and bank employees’ pension funds and consider second-generation reforms for the general pension system in collaboration with the World Bank. - Consolidate financial system restructuring: reform of the BCU, supervisory authority of banks, and creation of a deposit insurance agency; upcoming FSAP to take stock of reform process. - Continue restructuring public banks, with immediate attention to BHU; develop and implement an action plan to minimize systemic risks and contingent fiscal costs. ### Key statistics and program milestones (selected) - Growth commission completion expected by end-March 2006 (proposed structural benchmark). - Bankruptcy law submission to Congress by June 2006; expected implementation by December 2006. - US$500 million international bond placement in May 2005. - US$265 million expected disbursements under World Bank and IDB lending programs before year’s end (2005). - EUR 300 million (US$360 million) bond issued in July 2005. - Total gross public sector financing need will average about US$2.2 billion a year (12 percent of GDP) during 2005–08. - Debt service payments will average some 15½ percent of GDP (5 percent of GDP in interest payments). - Base money ceilings proposed to be raised by Ur$0.6 billion (September) and Ur$0.7 billion (December). - Structural benchmarks and PC timing highlights: - Structural PC: adoption of reform plan for BHU by end-2005. - Structural benchmarks: completion of growth-enhancing reform agenda by end-March 2006; submission of bankruptcy law by end-June 2006. - MoU signing between Ministry of Finance and DGI: December 2005. - Customs action plan design: August 2006. - Selected social and macro indicators from the text: - Population (estimate)3.2 - GDP per capita in 2004 (in US$)4,300 - Unemployment rate11.0 - Poverty rate31.0 - Gini coefficient44.6 *Source: _cr05431 - 18. The authorities are developing a strong pro-growth agenda, which they deem* ### 1. Balance of Payments ### 1. Balance of Payments ### Public Sector Operations: Key Figures and Ratios - Revenue (in millions of UR peso): 80,866 (2001); 81,138 (2002); 98,180 (2003); 113,856 (2004); 60,646 (H1 2004); 61,242 (H2 2004); 32,083 (Q3 2005 Report No. 05/235 proj.); 32,104 (Q4 2005 Report No. 05/235 proj.); 126,304 (2005 proj.); 126,005 (2005 proj. alternative). - Taxes (in millions of UR peso): 54,007 (2001); 57,832 (2002); 70,096 (2003); 83,002 (2004); 44,552 (H1 2004); 45,838 (H2 2004); 22,249 (Q3 2005 proj.); 23,671 (Q4 2005 proj.); 91,070 (2005 proj.); 92,255 (2005 proj. alternative). - VAT and excise taxes: 29,437; 29,708; 37,667; 47,200; 26,056; 25,648; 13,107; 14,136; 53,513; 52,891. - On income and profits: 12,719; 14,302; 15,621; 17,683; 9,598; 10,449; 4,655; 4,864; 18,864; 19,968. - On foreign trade: 2,428; 2,730; 3,780; 4,958; 2,525; 2,431; 1,370; 1,416; 5,456; 5,216. - On property and other: 9,424; 11,091; 13,028; 13,161; 6,373; 7,311; 3,117; 3,256; 13,237; 14,181. - Social security contributions (in millions of UR peso): 14,381; 12,836; 11,794; 13,146; 7,960; 8,331; 4,420; 3,546; 15,774; 16,285. - Nontax revenue (in millions of UR peso): 5,250; 5,274; 6,200; 7,831; 3,962; 3,970; 2,062; 2,077; 8,115; 8,125. - Current surplus of public enterprises (in millions of UR peso): 7,227; 5,196; 10,090; 9,876; 4,172; 3,102; 3,352; 2,810; 11,345; 9,339. - Noninterest expenditure (in millions of UR peso): 83,954; 81,066; 89,529; 99,572; 55,174; 54,762; 28,276; 28,451; 111,657; 111,043. - Current (in millions of UR peso): 74,871; 74,653; 81,721; 90,269; 49,923; 49,891; 25,437; 26,597; 101,123; 101,479. - Wages: 18,074; 18,158; 19,701; 23,409; 12,760; 12,602; 6,229; 7,044; 25,639; 25,878. - Goods and services: 12,833; 12,057; 15,031; 17,015; 10,023; 9,230; 5,250; 5,311; 20,273; 19,840. - Social security benefits: 41,907; 42,818; 44,218; 47,702; 25,465; 25,815; 13,145; 13,407; 51,914; 52,367. - Capital (Government and enterprises) (in millions of UR peso): 9,083; 6,413; 7,808; 9,303; 5,252; 4,871; 2,839; 1,854; 10,535; 9,564. - Primary balance (in millions of UR peso): -3,088 (2001); 72 (2002); 8,651 (2003); 14,284 (2004); 5,471 (H1 2004); 6,489 (H2 2004); 3,807 (Q3 2005 proj.); 3,653 (Q4 2005 proj.); 14,647 (2005 proj.); 14,962 (2005 proj. alternative). - Interest (in millions of UR peso): 7,276; 12,163; 18,881; 22,666; 10,558; 9,197; 6,711; 4,563; 21,719; 20,471. - Overall balance (in millions of UR peso): -10,364; -12,091; -10,231; -8,382; -5,086; -2,708; -2,904; -910; -7,072; -5,510. - Selected ratios (in percent of GDP): Revenue 32.7; 31.1; 31.1; 30.0; 29.0; 29.4; 30.8; 30.9; 30.2; 30.3. - Taxes 21.8; 22.2; 22.2; 21.9; 21.3; 22.0; 21.4; 22.8; 21.8; 22.2. - Social security contributions 5.8; 4.9; 3.7; 3.5; 3.8; 4.0; 4.2; 3.4; 3.8; 3.9. - Noninterest expenditure 34.4; 31.1; 28.4; 26.3; 26.4; 26.3; 27.2; 27.3; 26.7; 26.7. - Primary balance -1.2; 0.0; 2.7; 3.8; 2.6; 3.1; 3.7; 3.5; 3.5; 3.6. - Interest 2.9; 4.7; 6.0; 6.0; 5.0; 4.4; 6.5; 4.4; 5.2; 4.9. - Overall balance -4.2; -4.6; -3.2; -2.2; -2.4; -1.3; -2.8; -0.9; -1.7; -1.3. - Memorandum: Augmented Balance 3 (in millions of UR peso): -10,364; -56,106; -10,231; -1,229; -5,086; -2,708; -2,904; -910; -7,072; -5,510. - GDP (billions of pesos): 247; 261; 315; 379; ...; ...; ...; ...; 418; 416. Sources: Ministry of Finance; and Fund staff estimates. ### Banking System: Summary Accounts and Indicators - Banco Central del Uruguay (in millions of U.S. dollars): - Net foreign assets: -689 (2002); -52 (2003); -512 (2004); 285 (2005 proj.); 20 (2005 proj. alternative). - Net international reserves 2/: -1,269; -430; -164; 115; 218. - Gross international reserves: 772; 2,087; 2,512; 2,656; 2,762. - Reserve liabilities 2/: -2,041; -2,517; -2,675; -2,541; -2,544. - Net domestic assets: 1,120; 553; 775; 577; 361. - Net credit to the public sector: 1,541; 2,464; 2,626; 2,391; 2,418. - Monetary liabilities: 431; 501; 777; 858; 934. - Public and Private Banks (in millions of U.S. dollars): - Net foreign assets: 551; 1,213; 1,887; 1,718; 1,905. - Net domestic assets: 5,254; 5,331; 5,090; 5,511; 5,275. - Credit to the private sector: 6,319; 4,726; 4,307; 4,813; 4,508. - Liabilities to the private sector (residents): 5,805; 6,544; 6,977; 7,250; 7,180. - Banking System (in millions of U.S. dollars): - Net foreign assets: -138; 1,161; 1,835; 1,945; 2,426. - Net domestic assets: 6,288; 5,788; 5,738; 5,700; 5,450. - Credit to the private sector: 6,398; 4,797; 4,369; 4,748; 4,567. - Broad money (M3): 6,150; 6,949; 7,573; 7,646; 7,876. - Financial sector indicators (percent changes or percent levels): - Broad money: 21.3; 24.2; -9.5; 4.0 (proj.). - Credit to the private sector (const. exch. rate): -13.7; -25.5; -20.1; 0.0 (proj.). - Share of nonperforming loans in total loans (in percent) 1/: 31.5; 8.6; 3.8; 3.0. - Capital adequacy ratio (in percent) 1/: -9.6; 9.2; 10.9; 11.9. - Interbank interest rates (percent, end of period) 1/: 45.0; 2.5; 1.3; 1.0. - FX deposits held by residents (in percent of total deposits): 88.3; 88.8; 87.6; 85.0 (proj.). - FX loans to residents (in percent of total loans): 80.4; 77.6; 73.3; 73.2 (proj.). - Public debt indicators (in percent of GDP): - Public sector gross debt (PSGD): 95.5 (2002); 104.5 (2003); 92.5 (2004); 72.9 (proj. 2005). - Of which exposed to rollover risk (in percent of total PSGD): 17.2; 12.1; 13.5; ... - Of which exposed to exchange rate risk (in percent of total PSGD): 96.0; 94.3; 90.2; ... - Of which exposed to interest rate risk (in percent of total PSGD): 57.0; 45.5; 44.6; ... - External indicators: - Merchandise exports (percent change): -10.2; 18.7; 32.4; 15.7. - Merchandise imports (percent change): -35.7; 12.0; 42.5; 28.8. - Merchandise terms of trade: 4.3; 2.9; -3.1; -9.6. - REER appreciation (+): -20.3; -13.2; 9.3; ... - Current account balance: 3.2; -0.5; -0.8; -2.8. - Capital and financial account balance: -18.5; 9.3; -0.2; 2.7. - Net foreign direct investment: 1.5; 3.6; 2.3; 2.3. - Total gross external debt (ED) in percent of GDP: 87.5; 98.2; 87.4; 69.7. - Short-term ED (original maturity, in percent of total ED): 12.5; 6.7; 7.6; 5.3. - External interest payments (in percent of exports of GNFS): 24.5; 19.2; 18.9; 18.3. - Gross official reserves (U.S. million): 776; 2,087; 2,512; 2,762. - In months of imports GNFS: 3.7; 9.3; 8.2; 7.0. - In percent of short-term external debt excl. nonres FX deposits: 25.1; 86.8; 158.0; 124.9. - In percent of broad money: 12.2; 28.7; 34.4; 35.1. - In percent of base money: 175.4; 427.3; 418.1; 417.4. - Financial market indicators: - Foreign currency debt rating (Moody's) 5/: B3; B3; B3; B3. - Foreign currency debt rating (S&P) 5/: B-; B-; B-; BB-. - EMBI secondary market spread (bps, end of period) 5/: 1,228; 624; 388; 376. - Exchange rate (per U.S. dollar, period average): 21.6; 28.2; 28.6; ... Sources: Central Bank of Uruguay; and Fund staff estimates. ### Vulnerability Indicators and Debt Sustainability: Findings and Projections - Principal findings: - "Uruguay’s public debt at end-2004 stood at 92 percent of GDP, of which 90 percent was exposed to exchange rate risk (mainly the U.S. dollar and SDR rates), 45 percent was exposed to interest rate risk, and 13 percent to rollover risk." - "Uruguay’s public debt is still high with a large share of foreign-currency and floating rate debt." - Recent movements: - "The public debt-to-GDP ratio has declined by 12 percentage points since end-2003, to 92 percent by end-2004, and continued to fall sharply in the first half of 2005 to some 80 percent of GDP." - Drivers of decline: "high GDP growth, a strong appreciation of the real exchange rate, and to some extent to lower domestic interest rates and continued fiscal consolidation." - Baseline medium-term projection (Table 1 summary): - Baseline assumptions: "a primary fiscal surplus of 4 percent of GDP over the medium term, sustained GDP growth of 3 percent a year, a gradual recovery of the real value of the peso vis-à-vis the U.S. dollar to 85 percent of its pre-crisis level (from 71 percent at end-2004), and sovereign spreads remaining broadly at current levels." - Outcome: "public debt would decline to about 60 percent of GDP by 2008 (the end of the program period) and to just below 50 percent of GDP by 2012." - Mechanism: "With nominal debt staying broadly at the 2004 level, this reduction would be mainly achieved through strong economic growth and real appreciation of the peso." - Debt-service outlook: - "Debt-service payments, albeit declining, would remain high over the next years." - Projection: "debt-service payments would decline only moderately from 15 percent of GDP (or 50 percent of public sector revenue) in 2005 to 12 percent of GDP (or 40 percent of public sector revenue) in 2010 because of high obligations coming due." - Implication: "This makes the public sector debt sustainability outlook subject to roll-over and interest rate risks." - No-policy change vs. historical-average scenario: - "Public debt remains on a declining path under the no-policy change scenario but becomes unsustainable when key economic variables are set at their historical averages." - Historical-averages outcome: "the debt-to-GDP ratio would increase sharply (by some additional 35 percentage points at the end of the decade)" under weaker growth (~1 percent annually) and a primary balance of "- ½ percent of GDP." - Standardized bound tests and shock sensitivity: - Half-standard-deviation shocks to interest rates or growth: "the public debt-to-GDP ratio would stay at 73–78 percent of GDP by 2010 compared to 54 percent of GDP in the baseline scenario." - Half-standard-deviation shock to the primary balance: "would leave the public debt-to-GDP ratio at 58 percent by 2010." - Combined shocks (three shocks of ¼ standard deviation simultaneously): "the debt-to-GDP ratio would end up at 71 percent of GDP by 2010." - Exchange rate shock: "if the exchange rate were to depreciate by 30 percent, the debt-to-GDP ratio would jump up above 100 percent of GDP and only decline to about 90 percent by 2010." ### Tailored Scenarios and Specific Vulnerabilities - Scenario: "A stronger than envisaged deterioration in the external environment." - Assumptions: "a sharper-than-currently-envisaged increase in U.S. interest rates, leading to both a slowdown in world demand and higher costs of external financing; higher domestic interest rates and slower growth; the real appreciation of some 10 percent over the medium term (expected in the baseline) will not take place." - Quantitative shocks assumed: "an increase in international interest rates of 100 basis points, an increase in the spread by some 50 basis points, and a reduction in annual GDP growth of ½ percent." - Outcome: "the debt-to-GDP ratio would fall only to 62 percent of GDP in 2012, some 14 percent of GDP above baseline projections." ### Analytical Implications - Main vulnerabilities identified: - High public debt level with large exposure to exchange rate risk (90 percent), interest rate risk (45 percent), and rollover risk (13 percent). - Significant sensitivity to adverse shocks in exchange rates, international interest rates, growth, and primary fiscal balances. - Medium-term sustainability depends critically on: - Achieving and sustaining a primary fiscal surplus of 4 percent of GDP. - Sustained GDP growth (assumed 3 percent annually in baseline). - Real appreciation/recovery of the peso relative to the U.S. dollar (to 85 percent of pre-crisis level). - Favorable external financing conditions and contained sovereign spreads. *Source: _cr05431 - 1. Balance of Payments (PDF chapter/section)._ ### APPENDIX I ### APPENDIX I ### Scenarios and their fiscal impact - Weaker domestic policies - Assumptions: - Primary surplus stays at 3 percent of GDP over the medium term (instead of 4 percent GDP). - Growth-enhancing structural reforms only partially implemented. - Potential growth assumed to be on average 2 percent per year (instead of 3 percent). - Spreads increase by 50 basis points. - Real appreciation about 5 percent. - Result: Debt-to-GDP ratio some 16 percentage points above the baseline projections by 2012. - Contingent liabilities from the financial sector coming due - Assumptions (identified contingent liabilities called): - Government guarantee on the BHU note to BROU called: US$640 million. - Government takes over service of the BROU note: US$380 million during 2005–1012. - Uruguayan courts rule in favor of former owners of NBC: US$120 million. - Initial funding of deposit insurance scheme: some US$40 million. - Result: Debt-to-GDP ratio would jump up by 5 percentage points and stay some 4 percentage points above baseline by 2012. - Growth (accelerated reforms) - Assumptions: - Comprehensive structural reform agenda accelerates implementation. - Potential growth increases by 1 percentage point, to 4 percent. - Primary surplus strengthens to 4¼ percent of GDP. - Spreads reduce by 50 basis points. - Result: Debt-to-GDP ratio would decline to 42 percent by 2012. ### Table 1: Uruguay — Public Sector Debt Sustainability (selected projections and indicators) - Real GDP growth (percent): -3.4, -11.0, 2.2, 12.3, 6.0, 4.0, 3.5, 3.0, 3.0, 3.0, 3.0 (years 2001–2011 sequence shown in table). - Interest rate spread (bps): 284, 1400, 900, 600, 400, 545, 450, 450, 450, 450, 450, 450 (table sequence). - Real U.S. dollar exchange rate (avg.) (change in percent): -13.7, -11.0, -22.1, -0.2, 9.4, 4.1, 2.5, 1.0, 1.0, 1.0, 1.0, 1.0. - Primary balance: Consolidated public sector (percent of GDP): -1.2, 0.0, 2.7, 3.8, 3.6, 3.7, 4.0, 4.0, 4.0, 4.0, 4.0, 4.0. - Non-financial public sector primary balance (percent of GDP): -1.0, 0.2, 2.9, 4.0, 3.8, 3.9, 4.2, 4.2, 4.2, 4.2, 4.2. - Overall Balance: Consolidated public sector (percent of GDP): -4.1, -4.6, -3.2, -2.2, -1.3, -1.1, -0.7, -0.6, -0.5, -0.4, -0.3, -0.4. - Gross nonfinancial public sector debt (percent of GDP): 46, 96, 104, 92, 76, 64, 60, 57, 54, 51, 48 (table shows sequence; header indicates 2001–2012). - Contribution from REER (cum since 2004): 0, 7, 9, 11, 11, 11, 11, 11, 11 (table entries). - Contribution from Growth (cum since 2004): 0, 1, 3, 17, 20, 23, 27, 31, 34, 36 (table entries). - Gross borrowing needs (millions of U.S. dollars): 1,210; 3,209; 1,251; 2,504; 2,114; 2,209; 2,090; 1,597; 1,786; 1,830; 2,406; 1,701 (table header "Gross borrowing needs1,2103,209..." shows sequence). - Total debt service (in percent of GDP): 5.6, 13.1, 14.0, 18.1, 15.8, 16.1, 14.7, 11.9, 12.3, 12.0, 13.9, 10.7. - Average interest rate (in percent): 12.6, 5.5, 5.7, 6.6, 6.6, 7.2, 7.4, 7.6, 7.9, 8.2, 8.5, 9.1. - Memorandum items: - GDP (millions of dollars): 18,561; 12,089; 11,211; 13,267; 16,791; 18,435; 19,630; 20,801; 22,107; 23,504; 24,911; 26,271. - Nominal debt (millions of dollars): 8,538; 11,551; 11,705; 12,272; 12,242; 12,399; 12,478; 12,538; 12,582; 12,609; 12,610; 12,634. - Fund credit outstanding (millions of dollars): 145; 1,754; 2,416; 2,684; 2,432; 2,259; 1,817; 1,424; 966; 565; 184; 17. - Fund credit outstanding (in percent of GDP): 0.8, 14.5, 21.6, 20.2, 14.5, 12.3, 9.3, 6.8, 4.4, 2.4, 0.7, 0.1. ### Debt dynamics and baseline projections (Table 2 — selected lines) - Baseline: Public sector debt (percent of GDP) (selected years): 38.5 (2000), 46.0 (2001), 95.5 (2002), 104.4 (2003), 92.5 (2004), 72.9 (2005), 67.3 (2006), 63.6 (2007), 60.3 (2008), 56.9 (2009), 53.6 (2010). - Change in public sector debt (percent of GDP): 0.5, 7.5, 49.5, 8.9, -11.9, -19.6, -5.7, -3.7, -3.3, -3.4, -3.3. - Identified debt-creating flows (4+7+12) (percent of GDP): 5.9, 10.3, 57.5, -8.3, -14.0, -6.9, -6.0, -4.5, -3.5, -3.2, -3.1. - Primary deficit (percent of GDP): 1.5, 1.2, -0.1, -2.7, -3.8, -3.6, -3.7, -4.0, -4.0, -4.0, -4.0. - Automatic debt dynamics (percent of GDP): 4.4, 9.2, 40.7, -5.6, -10.3, -3.3, -2.3, -0.5, 0.5, 0.8, 0.9. - Contribution from interest rate/growth differential: 1.7, 2.3, 2.2, -10.7, -11.6, -3.3, -2.3, -0.5, 0.5, 0.8, 0.9. - Contribution from real interest rate: 1.1, 1.0, -2.6, -8.9, -0.9, 1.7, 0.3, 1.7, 2.3, 2.5, 2.5. - Contribution from real GDP growth: 0.5, 1.3, 4.8, -1.7, -10.7, -5.1, -2.6, -2.2, -1.8, -1.7, -1.6. - Contribution from exchange rate depreciation: 2.7, 6.9, 38.5, 5.1, 1.3, ... (table continues). - Residual, including asset changes (2-3): -5.4, -2.8, -8.0, 17.1, 2.1, -12.7, 0.4, 0.8, 0.2, -0.1, -0.1. - Public sector debt-to-revenue ratio (percent): 133.4, 138.5, 306.9, 336.2, 307.6, 240.7, 229.5, 216.9, 207.1, 195.6, 184.4. - Gross financing need (percent of GDP): 8.2, 7.3, 12.0, 14.0, 13.8, 11.9, 12.3, 10.6, 7.6, 8.0, 7.8. - In billions of U.S. dollars: 1.6, 1.4, 1.4, 1.6, 1.8, 1.9, 2.2, 2.1, 1.6, 1.8, 1.8. - Scenario with no policy change (constant primary balance) in 2005-2010: - Debt-stabilizing primary balance: 72.9, 67.4, 64.1, 61.3, 58.3, 55.5. - Debt service-to-GDP ratio: 17.0, 17.8, 15.9, 12.6, 13.1, 12.9. ### External debt dynamics and external sustainability (Table 3 — selected lines) - Baseline: External debt (percent of GDP): 44.3, 48.1, 87.5, 98.2, 87.4, 69.7, 62.2, 57.2, 52.9, 49.4, 46.1. - Change in external debt (percent of GDP): 4.8, 3.9, 39.4, 10.7, -10.8, -17.7, -7.5, -5.0, -4.3, -3.5, -3.3. - Identified external debt-creating flows (4+8+9) (percent of GDP): 3.1, 4.8, 22.5, 3.8, -16.6, -3.6, -2.4, -3.3, -3.0, -2.0, -2.0. - Current account deficit, excluding interest payments (percent of GDP): 1.3, 0.2, -7.8, -2.6, -4.6, -1.9, 1.7, -1.5, -2.6, -2.8, -2.9. - Automatic debt dynamics (percent of GDP): 3.1, 6.3, 30.4, 9.9, -9.7, 0.5, 2.1, 2.2, 2.5, 2.5, 2.5. - Contribution from nominal interest rate: 1.5, 2.7, 4.6, 3.1, 5.4, 4.7, 4.6, 4.3, 4.1, 4.0, 3.9. - Contribution from real GDP growth: 0.6, 1.6, 8.2, -2.1, -10.2, -4.1, -2.5, -2.0, -1.6, -1.5, -1.4. - Contribution from price and exchange rate changes: 1.0, 2.0, 17.6, 8.9, -4.9, ... (table continues). - Residual, including change in gross foreign assets (2-3) (percent of GDP): 1.7, -0.9, 16.8, 6.9, 5.7, -14.1, -5.1, -1.7, -1.3, -1.5, -1.2. - External debt-to-exports ratio (percent): 243.1, 272.8, 392.8, 357.1, 289.3, 251.4, 226.9, 202.0, 179.9, 168.7, 156.1. - Gross external financing need (in billions of US dollars): 3.2, 3.5, 3.8, 3.0, 1.8, 2.7, 3.3, 2.7, 2.0, 1.9, 1.9. - In percent of GDP: 15.8, 19.0, 31.3, 26.4, 13.6, 16.3, 17.8, 14.0, 9.5, 8.6, 8.2. ### Key macroeconomic and fiscal assumptions underlying baseline (selected) - Real GDP growth (percent): -1.4, -3.4, -11.0, 2.2, 12.3, 6.0, 4.0, 3.5, 3.0, 3.0, 3.0. - Average nominal interest rate on public debt (percent): 7.0, 7.8, 10.7, 7.5, 6.8, 5.8, 7.4, 7.5, 7.7, 7.9, 8.3. - Inflation rate (GDP deflator, percent): 4.0, 5.3, 18.7, 18.4, 7.0, 3.5, 6.6, 4.6, 3.7, 3.5, 3.5. - Growth of real primary spending (deflated by GDP deflator, percent): -3.6, 9.4, -19.6, -6.6, 4.0, 7.6, -0.3, 2.3, 2.2, 3.0, 3.0. - Nominal external interest rate (percent): 3.6, 5.6, 6.2, 3.2, 6.5, 6.8, 7.3, 7.3, 7.7, 8.0, 8.3. - Growth of exports (US dollar terms, percent): 5.2, -10.5, -17.8, 14.5, 30.0, 16.1, 8.5, 10.0, 10.1, 5.9, 7.3. - Growth of imports (US dollar terms, percent): 4.9, -11.2, -33.1, 9.7, 34.3, 28.7, 23.1, -1.7, 5.4, 4.6, 6.6. - Current account balance, excluding interest payments (percent of GDP): -1.3, -0.2, 7.8, 2.6, 4.6, 1.9, -1.7, 1.5, 2.6, 2.8, 2.9. ### Stress tests and shocks (Figure 1 overview) - Bound tests include permanent one-half standard deviation shocks to real interest rate, growth rate, and primary balance (individual shocks are permanent one-half standard deviation). - Additional scenarios illustrated: - Growth shock (permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and primary balance referenced). - Primary balance shock and no policy change scenario (constant primary balance). - Interest rate shock (in percent) and combined shock scenarios. - Real depreciation and contingent liabilities shocks: one-time real depreciation of 30 percent and 10 percent of GDP shock to contingent liabilities occur in 2006 (real depreciation defined as nominal depreciation minus domestic inflation based on GDP deflator). *Sources: Ministry of Finance; Banco Central del Uruguay; and Fund staff estimates.* ### APPENDIX II ### _cr05431 - APPENDIX II ### Debt Sustainability and Stress Tests - Figure 2: Uruguay: External Debt Sustainability: Bound Tests (External debt in percent of GDP) - 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. - One-time real depreciation of 30 percent occurs in 2006. - Ten-year historical average and average projections for baseline and scenarios shown in figures. - Notable scenario labels and referenced averages in figures: - Historical: 83 - Baseline: 46 - CA shock: 53 - Combined shock: 55 - Combined shock (alternate box): 46 - Real depreciation shock 30% depreciation: 76 - Gross financing need under baseline (right scale) - Growth shock: 55 - Growth shock label: 46 - Baseline:3.3; Scenario: 0.1; Historical:0.9 - Baseline: 7.7; Scenario: 8.3; Historical: 5.4 - Baseline:1.6; Scenario:0.2; Historical:1.6 ### Table 4 — Public Sector Debt Sustainability Framework: Gross Public Sector Financing Need, 2000-2010 - Gross financing need (in percent of GDP) — Actual and Projections: - 2000: 8.2 - 2001: 7.3 - 2002: 12.0 - 2003: 14.0 - 2004: 13.8 - 2005: 11.9 - 2006: 12.3 - 2007: 10.6 - 2008: 7.6 - 2009: 8.0 - 2010: 7.8 - Gross financing need in billions of U.S. dollars: - 2000: 1.6 - 2001: 1.4 - 2002: 1.4 - 2003: 1.6 - 2004: 1.8 - 2005: 1.9 - 2006: 2.2 - 2007: 2.1 - 2008: 1.6 - 2009: 1.8 - 2010: 1.8 - Alternative Scenarios (Gross financing need in percent of GDP): - A1. Key variables are at their historical averages in 2006-10: 11.9; 17.3; 17.5; 15.0; 17.1; 18.3 - A2. No policy change (constant primary balance) in 2006-10: 11.9; 12.5; 11.1; 8.2; 8.7; 8.5 - Bound Tests (Gross financing need in percent of GDP): - B1. Real interest rate is at baseline plus one-half standard deviations: 11.9; 16.6; 15.6; 13.1; 14.6; 15.3 - B2. Real GDP growth is at baseline minus one-half standard deviations: 11.9; 13.8; 13.6; 12.1; 14.8; 16.9 - B3. Primary balance is at baseline minus one-half standard deviations: 11.9; 13.3; 11.8; 8.9; 9.6; 9.5 - B4. Combination of B1-B3 using 1/4 standard deviation shocks: 11.9; 15.2; 14.2; 11.7; 13.0; 13.6 - B5. One time 30 percent real depreciation in 2006: 11.9; 18.5; 19.5; 15.1; 16.4; 16.6 - B6. 10 percent of GDP increase in other debt-creating flows in 2006: 11.9; 13.9; 12.8; 9.5; 10.1; 10.0 - Gross financing need in billions of U.S. dollars — Alternative Scenarios: - A1: 1.9; 3.3; 3.9; 3.8; 5.1; 6.3 - A2: 1.9; 2.3; 2.2; 1.7; 1.9; 2.0 - B1: 1.9; 3.0; 3.1; 2.7; 3.2; 3.6 - B2: 1.9; 2.4; 2.5; 2.3; 2.9; 3.4 - B3: 1.9; 2.4; 2.3; 1.9; 2.1; 2.2 - B4: 1.9; 2.7; 2.7; 2.3; 2.7; 3.0 - B5: 1.9; 2.1; 2.4; 2.0; 2.3; 2.5 - B6: 1.9; 2.5; 2.5; 2.0; 2.2; 2.3 - Notes: - 1/ Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period. - 2/ Gross financing under stress test scenarios assumes same ratio of short-term to total debt and same average maturity as baseline; interest expenditures derived by applying respective interest rate to previous period debt stock. - 3/ Key variables include real GDP growth; real interest rate; the primary balance in percent of GDP; inflation; and exchange rate change. - 5/ Real depreciation defined as nominal depreciation minus domestic inflation (based on GDP deflator). ### Table 5 — External Sustainability Framework: Gross External Financing Need, 2000-2010 - Gross external financing need in billions of U.S. dollars — Actual and Projections: - 2000: 3.2 - 2001: 3.5 - 2002: 3.8 - 2003: 3.0 - 2004: 1.8 - 2005: 2.7 - 2006: 3.3 - 2007: 2.7 - 2008: 2.0 - 2009: 1.9 - 2010: 1.9 - Gross external financing need (in percent of GDP): - 2000: 15.8 - 2001: 19.0 - 2002: 31.3 - 2003: 26.4 - 2004: 13.6 - 2005: 16.3 - 2006: 17.8 - 2007: 14.0 - 2008: 9.5 - 2009: 8.6 - 2010: 8.2 - Alternative Scenarios (Gross external financing need in billions of U.S. dollars): - A1. Key variables are at their historical averages in 2006-10: 2.7; 2.5; 2.7; 2.2; 2.2; 2.4 - B1. Nominal interest rate is at baseline plus one-half standard deviations: 2.7; 3.4; 2.8; 2.1; 2.0; 2.1 - B2. Real GDP growth is at baseline minus one-half standard deviations: 2.7; 3.3; 2.8; 2.0; 2.0; 2.1 - B3. Non-interest current account is at baseline minus one-half standard deviations: 2.7; 3.6; 3.1; 2.4; 2.4; 2.6 - B4. Combination of B1-B3 using 1/4 standard deviation shocks: 2.7; 3.5; 3.0; 2.3; 2.3; 2.4 - B5. One time 30 percent nominal depreciation in 2006: 2.7; 3.1; 2.8; 2.2; 2.2; 2.3 - Alternative Scenarios (Gross external financing need in percent of GDP): - A1: 16.3; 15.2; 16.5; 13.8; 14.5; 15.7 - B1: 16.3; 18.2; 14.4; 9.9; 9.1; 8.8 - B2: 16.3; 18.3; 15.0; 10.7; 10.2; 10.3 - B3: 16.3; 19.3; 15.9; 11.6; 11.1; 11.1 - B4: 16.3; 19.0; 15.7; 11.4; 10.9; 11.0 - B5: 16.3; 26.6; 22.4; 16.3; 15.4; 15.3 - Notes: - 1/ Defined as non-interest current account deficit, plus interest and amortization on medium- and long-term debt, plus short-term debt at end of previous period. - 2/ Gross external financing under stress-test scenarios assumes same ratio of short-term to total debt and same average maturity as baseline; interest expenditures derived by applying respective interest rate to previous period debt stock. - 3/ 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. ### Fund Relations (As of July 31, 2005) - Membership Status: - Joined March 11, 1946; Article VIII - Financial Relations: - Quota: 306.50 (of Quota) — 100.0 (percent of SDRs) - Fund holdings of currency: 1,972.76 — 643.64 (percent of SDRs) - Reserve position: 0.0 — 0.0 (percent of SDRs) - SDR Department: - Net cumulative allocation: 49.98 — 100.0 (percent of SDRs) - Holdings: 23.82 — 47.66 (percent of allocation) - Outstanding Purchases and Loans (in millions of SDRs and percent of quota): - Stand-By Arrangements: 1,666.25 — 543.64 - Financial Arrangements (SDR; Approval Date; Expiration Date; Approved; Drawn): - Stand-By: 6/08/05 — 6/08/08 — Approved 766.25 — Drawn 30.65 - Stand-By: 4/01/02 — 3/31/05 — Approved 1,988.50 — Drawn 1,988.50 - Of which: SRF 6/25/02 — 8/08/02 — 128.70 — 128.70 - Stand-By: 5/31/00 — 3/31/02 — Approved 150.00 — Drawn 150.00 - Stand-By: 3/29/99 — 3/28/00 — Approved 70.00 — Drawn 0.00 ### Projected Payments to Fund - Obligation basis (SDR millions; forthcoming): - 2005: Principal 84.75; Charges/interest 41.13; Total 125.88 - 2006: Principal 434.43; Charges/interest 74.67; Total 509.00 - 2007: Principal 574.40; Charges/interest 40.00; Total 614.40 - 2008: Principal 268.35; Charges/interest 18.42; Total 346.86 - 2009: Principal 133.98; Charges/interest 7.22; Total 226.42 - Expectation basis (SDR millions; forthcoming): - 2005: Principal 84.75; Charges/interest 41.13; Total 125.88 - 2006: Principal 1008.73; Charges/interest 60.71; Total 1069.43 - 2007: Principal 328.44; Charges/interest 18.99; Total 347.43 - 2008: Principal 219.20; Charges/interest 7.21; Total 226.41 - 2009: Principal 25.14; Charges/interest 1.16; Total 26.30 - Note: Except for 2005, schedule shows illustrative payments under assumption that repayment expectations would be extended to obligation dates by IMF Executive Board upon request of debtor country. ### Nonfinancial Relations and Institutional Assessments - Safeguards Assessment: - A new full safeguard assessment is near completion. - Preliminary assessment found that the BCU has strengthened the safeguards framework, but vulnerabilities remain in external audit, financial reporting, and legal framework. - Staff recommendations included: - (i) BCU should publish audited financial statements and audit opinions shortly after issuance. - (ii) Include the BCU’s obligations to the Fund in its financial statements. - (iii) Periodically review that data submitted to the Fund under the program is consistent with the Technical Memorandum of Understanding. - Exchange Rate Arrangement: - Currency: Uruguayan peso (Ur$). - Independently floating exchange rate regime since July 29, 2002. - On September 12, 2005, buying and selling interbank rates for the U.S. dollar (intervention currency) were Ur$24.06 and Ur$24.11, respectively. - System free of restrictions on payments and transfers for current international transactions. - Article IV Consultation: - 2003 Article IV consultation concluded by Executive Board on July 11 (Country Report No. 03/247). - Uruguay on standard consultation cycle approved July 15, 2002. - Next Article IV discussions scheduled for April 2006, together with the FSAP. - Ex Post Assessment: - Ex Post Assessment of Longer-Term Program Engagement considered by Executive Board on March 18, 2005 (Country Report No. 05/202). - FSAP participation and ROSCs: - FSAP exercise to be conducted over two missions in October 2005 and January 2006, completing exercise started November 2001 but suspended in 2002. - ROSC-module on fiscal transparency published March 5, 2001. - ROSC-module on data dissemination practices published October 18, 2001. - Technical Assistance: - FAD provided technical assistance on tax, customs, and social security administration in June 2005 and July 2003; on tax policy in May 2003; on budget preparation in March 2005. - STA provided technical assistance in April 2003 on adequate recording of loans funded by the FSBS. - MFD provided substantial and continuous technical assistance since 2002 on resolution of intervened banks, restructuring of BROU, recently on BHU, and in July 2005 jointly with ICM on debt management. - Resident Representative: - Mr. Gaston Gelos. ### Relations with the World Bank Group (As of September 12, 2005) - New Country Assistance Strategy (CAS) approved June 9, 2005: - Envisages base case scenario of up to US$800 million in new lending over FY05–10. - Lending program to be modulated on Government program strength, implementation capacity, and evolution of country’s creditworthiness. - Strategy anchored on programmatic development loans supporting public sector management, financial sector reform, and reform of social programs. - Plans to rebuild investment portfolio supporting priority investments in infrastructure, social programs, and innovation. - Two investment operations approved June 9, 2005: - Integrated Natural Resources: US$30 million (not yet effective) - Transport Infrastructure and Rural Access: US$70 million - Previous CAS and crisis response: - Previous CAS approved May 5, 2000; CAS Progress Report July 25, 2002. - Following 2002 crisis, Bank increased support to high case lending scenario of US$550 million for FY2002–04, concentrated in adjustment lending. - SAL I and SSAL I approved with CAS Progress Report totaling US$303 million. - SAL II and SSAL II approved April 8, 2003 totaling US$252.5 million. - Last tranches totaling US$100 million (US$50 of SAL I and US$50 of SSAL I) released in October 2004. - DPL1 and social reform support: - DPL1 approved June 9, 2005 in amount of US$75 million supports reform progress in social policies and measures in health, education, and social protection. - DPL1 has been fully disbursed. - Government actions: - Government reaffirmed commitment to objectives of SAL II, taking into account 2003 referenda results on petroleum products and water. - Outstanding second and third tranches of SSAL II cancelled at Government’s request. *Source: _cr05431 - APPENDIX II (PDF)._ ### APPENDIX III ### APPENDIX III ### Investment portfolio and disbursements - Current investment portfolio: seven projects totaling US$359.5 million in commitments, with an undisbursed amount of US$146.3 million as of September 12, 2005. - CY04 disbursements for investment operations: US$43.8 million. - Projected CY05 disbursements: around US$ 50 million. - Portfolio monitoring: performance reviews conducted every six months. ### Financial relations with the World Bank Group — IBRD (as of September 12, 2005) - Sector commitments (Net of Cancellations) and undisbursed amounts / disbursed amounts as presented: - Agriculture: Commitments US$18.5; Undisbursed US$16.3; Disbursements US$2.2 - Central Government and Administration: Commitments US$151.5; Disbursements US$51.5; Undisbursed US$100.0 - Telecommunication: Commitments US$6.0; Undisbursed US$1.6; Disbursements US$4.4 - Education: Commitments US$42.0; Disbursements US$12.5; Undisbursed US$29.5 - Power: Commitments US$125.0; Disbursements US$105.9; Undisbursed US$19.1 - Transportation: Commitments US$141.0; Disbursements US$62.4; Undisbursed US$78.6 - Water Supply: Commitments US$27.0; Undisbursed US$14.5; Disbursements US$12.5 - Totals: Commitments US$511.0; Disbursements US$264.7; Undisbursed Amount US$246.3 ### Financial relations with the World Bank Group — IFC (as of August 31, 2005) - Loans Held: US$20.27 - Equity Held: US$0.21 - Quasi Participation Held: US$10.71 - Loans Disbursed: US$20.27 - Equity Disbursed: US$0.19 - Quasi Participation Disbursed: US$10.71 - Participation Disbursed: US$0.0 ### IBRD Loan Transactions (calendar year; as of August 31, 2005) - Disbursements by year: - 1996: 38.7 - 1997: 50.4 - 1998: 143.9 - 1999: 66.3 - 2000: 134.2 - 2001: 64.7 - 2002: 233.5 - 2003: 97.4 - 2004: 143.8 - 2005: 109.8 - Repayments by year: - 1996: 69.7 - 1997: 67.9 - 1998: 64.1 - 1999: 63.2 - 2000: 57.9 - 2001: 72.5 - 2002: 75.3 - 2003: 78.2 - 2004: 80.2 - 2005: 43.3 - Net Lending by year: - 1996: -31.0 - 1997: -17.5 - 1998: 79.8 - 1999: 3.1 - 2000: 76.3 - 2001: -7.8 - 2002: 158.2 - 2003: 19.2 - 2004: 63.6 - 2005: 66.5 *Italic: Source: _cr05431 - APPENDIX III, as provided.* ### 20. The government has been successful in funding itself on the domestic market as well ### _cr05431 - 20. The government has been successful in funding itself on the domestic market as well ### Program financing and external support - The government has been successful in funding itself on the domestic market as well as in placing bonds in international financial markets. - As a result, the program’s financing for 2005 is well in hand. - The authorities remain strongly committed to the reforms supported by lending programs from the IDB and the World Bank, and expect timely disbursements in support of program implementation. ### Requested modifications to the performance criteria (MEFP of May 24, 2005) - The authorities request modification of: - (i) the monetary targets noted in paragraph 7; - (ii) the adjustors to the NFPS debt and NIR targets to better reflect the concept of pre-financing; - (iii) the structural PC on tax reform. - Additional requests: - Set an additional structural performance criterion on BHU for end-December. - Set structural benchmarks on growth-enhancing reforms (paragraph 9) and revenue administration (paragraph 12), as presented in Tables 1 and 2. ### Quantitative performance criteria and indicative targets (selected table figures) - A. Quantitative performance criteria (selected rows and reported values) - 1. Combined public sector primary balance (floor) 2/ - 2004 Stock: 5,471 - PC Sept. 30: 5,372 - P Dec. 31: 6,489 - C (adjusted) March 30: 1,117 - Actual June 30: 4/ - Margin (+) Sept. 30: 9,687 - 2007 IT Dec. 31: 14,647 - Dec. 31 (columns): 2,382; 7,995; 17,011; 19,966 - 2. General government noninterest expenditure (ceiling) 2/ - 2004 Stock: 23,561 - PC Sept. 30: 23,539 - P Dec. 31: 22,126 - C (adjusted) March 30: 1,413 - Actual June 30: 34,643 - Margin (+) Sept. 30: 46,561 - 2007 IT Dec. 31: 13,286 - Dec. 31 (columns): 26,572; 53,144; 58,039 - 3. Net domestic assets of the BCU (ceiling) 2/ - 2004 Stock: 74,079 - PC Sept. 30: 3,983 - P Dec. 31: 3,983 - C (adjusted) March 30: -302 - Actual June 30: 4,284 - Margin (+) Sept. 30: 4,572 - 2007 IT Dec. 31: -3,910 - Dec. 31 (columns): 5,143; -1,612; -4,580; -13,369 - 4. Net international reserves of the BCU (floor) 2/ - 2004 Stock: -2,218 - PC Sept. 30: -130 - P Dec. 31: -130 - C (adjusted) March 30: 18 - Actual June 30: 148 - Margin (+) Sept. 30: -110 - 2007 IT Dec. 31: 280 - Dec. 31 (columns): -226; 50; 241; 580 - 5. Nonfinancial public sector gross debt (ceiling) 3/ - 2004 Stock: 12,189 - PC Sept. 30: 12,510 - P Dec. 31: 12,517 - C (adjusted) March 30: 12,368 - Actual June 30: 148 - Margin (+) Sept. 30: 4/ - 2007 IT Dec. 31: 12,575 - Dec. 31 (columns): 12,550; 12,775; 12,740; 12,775; 12,925 - 6. Accumulation of external payment arrears of the public sector (on a continuous basis) 2/ - Reported value: 0 000 0 00 000 0 - B. Indicative targets (selected rows and reported values) - 7. Combined public sector overall balance (floor) 2/ - 2004 Stock: -5,086 - PC Sept. 30: -5,086 - P Dec. 31: -2,708 - C (adjusted) March 30: 2,378 - Actual June 30: -7,459 - Margin (+) Sept. 30: -7,072 - 2007 IT Dec. 31: -3,204 - Dec. 31 (columns): -3,176; -5,332; -3,338 - 8. Monetary base (ceiling) 2/ - 2004 Stock: 15,648 - PC Sept. 30: 557 - P Dec. 31: 557 - C (adjusted) March 30: 1,070 - Actual June 30: -513 - Margin (+) Sept. 30: 1,673 - 2007 IT Dec. 31: 3,468 - Dec. 31 (columns): -824; -294; 1,770; 1,914 *Source: _cr05431 - 20. The government has been successful in funding itself on the domestic market as well* ### 9. Floating debt of the central government (ceiling) ### 9. Floating debt of the central government (ceiling) ### Definition and scope - Floating debt of the central government is defined as: - Expenditures from the general treasury account (“Rentas Generales” only) that are: - registered in the integrated information system (SIIF), - authorized for execution and confirmed by the respective central accountants, - and for which no checks for payment have yet been issued. - Excluded from the floating debt definition: - obligations for utilities; - obligations related to subsidies; - judgment debt; - obligations falling under “Inciso 24” of the accounting plan of the “Contaduria General de la Nacion” (international organizations and other credit); - domestic suppliers’ credits of the Ministry of Housing. ### Measurement, coverage, and treatment under the program - The floating debt ceiling is treated as an indicative target. - Adjustment rule: - The ceiling on floating debt will be adjusted upward (downward) by revisions made to the actual stock of floating debt at end-2004. - Timeframe for application: - This indicative target applies through December 31, 2005. - Afterwards—once approved in the 2006 budget—floating debt will be monitored by including it in: - the definition of the combined public sector overall balance measured from below the line, - general government expenditure, - and in the stock of the NFPS debt. ### Related program measurement and valuation conventions (context affecting ceilings and adjustors) - Valuation and exchange rates used elsewhere in program definitions: - Ur$26.35 per U.S. dollar; - U.S. dollar 1.3637 per Euro; - U.S. dollar 0.0097 per Yen; - U.S. dollar 1.54784 per SDR; - Ur$1.4345 per UI; if Ur$ to UI rate exceeds 1.5420, UI debt valued at Ur$1.4345 plus the difference between actual rate and Ur$1.5420. - Related program schedules and figures (cumulative, as presented in the Technical Memorandum of Understanding): - Schedule A — Projected social security contributions (In millions of Uruguay pesos, cumulative basis): - Jun-05: 1,798 - Sep-05: 2,712 - Dec-05: 3,587 - Schedule B — Projected revenues from the FLD (In millions of Uruguayan pesos, cumulative basis): - Jun-05: 3,044 - Sep-05: 4,664 - Dec-05: 6,277 - Schedule C — Stock of debt of the NFPS, excl. CG FX deposits in domestic commercial banks (In millions of US dollars): - Dec-04: 12,316 - Sep-05: 12,715 - Dec-05: 12,690 ### Program linkage and monitoring - The floating debt indicative target interacts with broader fiscal and debt ceilings and adjustors: - It will be incorporated into measurements of the combined public sector overall balance and general government expenditure after formal inclusion in the 2006 budget. - Adjustment by revisions to the end-2004 floating debt stock ensures consistency with the program’s baseline. *Source: Technical Memorandum of Understanding and Attachment III definitions (excerpts) in the IMF staff report materials.* ### 1. During 2005, Uruguay has been growing robustly, in a context of the lowest inflation ### _cr05431 - 1. During 2005, Uruguay has been growing robustly, in a context of the lowest inflation ### Overview - Uruguay experienced robust growth during 2005 in a context of the lowest inflation rate in about six years. - The authorities face substantial challenges, notably impelling Uruguay’s potential growth by encouraging domestic and foreign investment and enhancing the level and quality of employment. - Sustainable economic growth and improvements in human development are presented as mutually reinforcing goals. ### Macrostability and recent economic performance - Economic activity increased at about 7 percent in the first half of 2005. - Exports increased by 18 percent in real terms in the first half of 2005 (compared to the same period last year). - Export diversification: NAFTA countries accounted for 29 percent of total exports in the last twelve months to June; Mercosur accounted for 23 percent; Europe accounted for 20 percent. - Imports increased by 15 percent in real terms in the first half of 2005, with a prominent surge in capital good imports. - Annual inflation has been below the Central Bank’s target range. ### Fiscal policy, revenue, and medium-term targets - The fiscal program is reported to be on track; revenue-collecting agencies (DGI, DNA, and BPS) showed a significant increase in revenue collection over the year. - The government decreed gas price increases to better align prices with cost developments. - The authorities aim to achieve a medium-term primary surplus target of 4 percent of GDP by 2007 and a downward trend in the overall fiscal deficit. - Achieving these fiscal targets is expected to result in a substantial reduction in the debt-to-GDP ratio. - The authorities have already obtained part of the 2006 external financing needs. - Steps are being undertaken, including the Fund’s advice, to create a debt-management unit within the Ministry of Finance. - By end-August, the authorities submitted to Congress a five-year spending plan with revenue projections; the plan is oriented by four criteria: - fiscal responsibility (budget consistent with primary fiscal surplus and overall fiscal targets); - improving administration performance by linking efficiency with remuneration (example: DGI officials); - encouraging more efficient use of administration resources (the budget would allow different entities to use money not used in current expenditure for investment during the following year); - improving transparency in tax revenue sources and use of public moneys. ### Financial sector, banking reform, and de-dolarization - Authorities are preparing legislation to bolster BCU independence and improve the institutional framework while maintaining the current framework of monetary indicative targets within a flexible exchange rate regime. - The Board of the Deposit Insurance Agency has been appointed; work is underway on a law to clarify its coverage and operations and on a bank resolution framework. - These measures aim to increase confidence in monetary and financial policies and facilitate de-dolarizing the economy. - Banking developments: - BROU (state bank) continues to improve performance and procedures; its trust fund continues to recover nonperforming loans. - Nuevo Banco Comercial (NBC) was sold to a private partnership of foreign financial institutions; the transaction price is considered fair and buyers have excellent reputation. - Authorities are committed to adopt a comprehensive strategy to address vulnerabilities of the state mortgage bank (BHU). ### Investment, infrastructure, and business environment reforms - Enhancing credit availability and reducing its costs are critical to increase investment rates. - Financial system measures and reforms are expected to strengthen confidence, encourage depositors to invest in longer-maturity instruments, and prompt banks to flexibilize lending policies. - The authorities are committed to developing an efficient capital market to provide firms with alternative credit sources. - Public investment in infrastructure has substantially decreased since the 2002 economic crisis; boosting public investment is considered crucial to support private investment. - Given fiscal constraints, the authorities are considering introducing a Public-Private Partnership (PPP) window and will seek IMF and other IFIs’ advice to ensure efficiency, transparency, and accountability. - Tax and regulatory reforms to boost private investment: - DGI reform: DGI officials must now work exclusively for this entity or leave it; previous dual-employment arrangements that advantaged certain firms have been removed to improve transparency and reduce rent-seeking. - Work with FAD on a comprehensive tax reform to introduce a new personal income tax, broaden the tax base, and eliminate tax exemptions and subsidies, making room to lower current rates on indirect taxes. - Authorities commit that the total burden of indirect taxes will not be reduced until revenue gains from reform materialize, ensuring medium-term revenue goals are met. - Submitted to Congress: a law to restrict anticompetitive practices; preparing a new bankruptcy law that includes Chapter XI type corporate restructuring. - Cooperation with IDB and World Bank to facilitate creation of new businesses and reduce costs of business formation. - Reference to external assessments: - A World Bank business environment survey indicates inappropriately designed or administered taxes impose costs on firms and help explain disappointing investment rates in Latin America. ### Social cohesion, labor framework, and distributional considerations - The new labor framework (with tripartite wage councils) aims to improve the investment climate by tempering normal distributional tensions. - Nearly 80 percent of activity sectors have already reached agreements without government arbitration. - The national agreement on employment, income, and responsibilities (Compromiso Nacional para el Empleo, los Ingresos y las Responsabilidades) includes employers, trade unions, and other social actors to reconcile different societal goals. - The government commits to publish in early 2006 an agenda of growth-enhancing reforms (including timetable for implementation) prepared by a business-environment commission. - The Social Emergency program is viewed by authorities primarily as a program to mitigate poverty; its implementation has progressed slower than expected due to a commitment to implement with precision and transparency. ### Relations with the IMF and debt management - Authorities thank the Fund’s Management, staff, and Executive Directors for recommendations and support. - Authorities are considering making advance repurchases to the Fund; this would assist IMF revolving of resources and signal Uruguay’s strong commitment to fiscal discipline and its program. *Source: _cr05431 - 1. During 2005, Uruguay has been growing robustly, in a context of the lowest inflation* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2005/_cr05431.pdf_