## 1. Macroeconomic Performance (_cr0845)

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### A. Overview
- Growth and macro performance since 2002:
  - Growth averaged 7 percent since 2002.
  - Inflation remained moderate historically but rose in 2007.
  - Poverty rates declined considerably; unemployment at lowest level in this decade.
- External and fiscal positions:
  - Substantial increase in international reserves driven by renewed market access and strong FDI.
  - Strong primary fiscal surpluses reduced debt ratios and improved debt structure.
- Near-term prospects (as presented):
  - Real GDP growth could reach 5¼ percent in 2007.
  - The 4 percent of GDP primary surplus target for 2007 is likely to be met or surpassed.
  - Inflation likely to exceed the target range (4½–6½).
- Macroeconomic framework indicators (as presented):
  - Real GDP growth (in percent): 2005: 6.6; 2006: 7.0; 2007 (Proj.): 5.2
  - Inflation (in percent, end of period): 2005: 4.9; 2006: 6.4; 2007 (Proj.): 7.0
  - Public sector primary balance (in percent of GDP): 2005: 4.1; 2006: 3.9; 2007 (Proj.): 4.0
  - Public sector overall balance (in percent of GDP): 2005: -0.7; 2006: -0.6; 2007 (Proj.): -0.1
  - Public sector debt (in percent of GDP): 2005: 75; 2006: 66; 2007 (Proj.): 62
  - External current account balance (in percent of GDP): 2005: 0.0; 2006: -2.4; 2007 (Proj.): -2.8
  - Excluding pulp mills projects (in percent of GDP): 2005: 0.0; 2006: -1.1; 2007 (Proj.): -1.3

### B. Rising Inflation
- Recent inflation status and expectations:
  - At 8.1 percent, inflation is reported as well above the target range.
  - Latest survey shows expected inflation near 7 percent by end-2007, declining into the target range in 2008.
- Drivers of higher core inflation:
  - Imported inflation: tradable goods prices rising well above the inflation target.
  - Capacity constraints after prolonged high growth; some measures suggest output above potential.
  - 2006 growth reached 7 percent; private consumption was main source of growth.
  - Wage pressures: unit labor costs growing above the inflation target; real wages recovered to 90 percent of pre-crisis levels.
  - Expansionary monetary and exchange rate policies: large foreign exchange purchases were not sterilized; money growth reached 35 percent by mid-2006.
- Inflation inertia and expectations:
  - Lagged inflation less important than forward-looking expectations.
  - A higher fiscal primary balance could help lower inflation expectations.

### C. Capital Inflows, Monetary Policy, and Competitiveness
- Current account and capital flows:
  - Current account moved into deficit in 2006 reflecting FDI and oil-related imports.
  - Import growth approximately 30 percent in US dollar terms; exports grew 17 percent in US dollar terms.
  - Large FDI inflows amounted to 7 percent of GDP in 2006.
- Reserve accumulation and debt operations:
  - Sovereign operations repaid all Fund obligations (US$2.4 billion) and placed US$1.2 billion in inflation indexed bonds.
  - Net international reserves (excluding private banks’ reserves and recent prefinancing) rose by US$2½ billion since early 2006.
- Exchange rate and monetary policy stance (policy chronology and numbers):
  - Late 2005: adopted M1 as intermediate objective; base money as operational target.
  - M1 growth slowed to about 20 percent by end-2006; core inflation increased in early 2007.
  - March 2007: lowered 12-month ahead indicative M1 target from 15 percent to 9 percent.
  - M1 growth accelerated in May to 26 percent; base money growth contained at around 15 percent in mid-July.
  - Sterilization operations helped offset central bank’s foreign exchange purchases from the government.
- Ambiguity and efficacy:
  - Lack of nominal exchange rate flexibility limited monetary policy effectiveness.
  - Central bank appears to be targeting inflation and an implicit exchange rate (~Ur$ 24 per dollar), creating ambiguity.
- Competitiveness assessment:
  - Real effective exchange rate (REER) remains below 2001 levels; staff models suggest mild undervaluation around 5–10 percent.
  - Bilateral REER with Argentina appreciated above pre-crisis levels; bilateral rates with other partners remain favorable.

### D. Financial Sector Vulnerabilities
- Improved soundness but remaining risks:
  - Soundness indicators strengthened; banks better capitalized; non-performing loans at 2 percent.
  - Banks profitable, in part due to placing deposits abroad at higher rates rather than credit expansion.
- Structural vulnerabilities:
  - High dollarization: over 75 percent of credit denominated in U.S. dollars (source statements).
  - Significant currency and maturity mismatches in the corporate sector.
  - Liquidity buffers expected to decline as credit recovery matures.
- Sectoral indicators and concerns:
  - Household credit growth remains low despite GDP growth.
  - Rising investment and real estate prices create concerns about overheating.

### Financial vulnerabilities and structural reforms
- Non-resident deposits reduced to about 20 percent.
- Country spreads declined since the crisis but investment grade not fully recovered.
- 2006 FSAP recommendations and status highlights:
  - Central bank: strengthen independence and capitalize the bank. Status: Draft law in congress.
  - Supervision: increase resources and training; Status: Draft law in congress; revised 2008 budget contains increased resources.
  - Prudential policies: credit registry expected operational by end-2007; credit procedures being strengthened.
  - State banks: BHU restructuring slow; legislation approved but business plan lacking and worker transfers incomplete.
  - Pension funds: allowed to purchase multilateral bonds; further liberalization recommended.
  - Insurance: contingent liabilities of BSE need assessment; authorities welcome external assessment.
  - Bankruptcy framework and corporate governance: draft law in congress.

### Stress tests and resilience indicators
- Increased resilience compared with 2006 FSAP:
  - Current account shock (4 percent GDP drop and 5 percent real depreciation) reduces CAR by 4 percentage points (previously 8 points).
  - Severe capital account shock (sudden stop, 8 percent GDP drop and 12 percent real depreciation) lowers CAR by 10 percentage points (previously 22 points).
- Modified contingency claims:
  - 2002 crisis simulation: banks representing over 90 percent of assets faced estimated default probability (EDP) >25 percent in 2002.
  - Today, a similar shock yields EDP >25 percent for banks representing less than 60 percent of the banking sector.
  - Under two extreme FSAP stress tests, banks would face on average 24 and 14 percent EDP today, compared with model estimate of 45 percent in 2002.

### Reserve management and regional arrangements
- Authorities joined Fondo Latinoamericano de Reservas (FLAR).
- Regional reserve pooling reduces risks but is not a substitute for global arrangements.
- Uruguay had two major crises in last 25 years originating from regional shocks.

### Fiscal adjustment and debt sustainability
- Fiscal improvements since 2002:
  - Expenditure reductions shifted primary deficit into a surplus approaching 4 percent of GDP.
  - Overall fiscal deficit close to zero.
  - Public investment at 2½ percent of GDP.
  - Wages and social security benefits ~70 percent of total noninterest spending.
- Tax reform:
  - Recently approved; implementation began on July 1, 2007; tax burden projected to remain largely unchanged.
- Debt dynamics and projections:
  - Public debt declined from 110 percent of GDP in 2003 to 66 percent of GDP.
  - Under current policies, projected to drop to 40 percent by 2012.
  - About 70 percent of public debt remains foreign-currency denominated despite inflation-indexed issuance.
  - Average maturity of public debt raised from about 7 years at end-2001 to almost 12 years in 2006.
- Rollover and interest risk have fallen via repayment of short-term and floating-rate liabilities.

### Policy challenges and reform agenda
- Near-term challenge: rising inflation and strong capital inflows.
- Medium-term priorities:
  - Reform monetary framework.
  - Strengthen financial system resilience and supervision.
  - Sustain large primary surpluses while enhancing fiscal quality.
  - Improve business climate.
- Pending structural reforms status (as of December 2006 / current status):
  - Tax Reform: Approved 2006; implementation began July 1, 2007.
  - Police Pension Fund: Submitted to congress; approval expected 2007; current status yet to be discussed.
  - Pension funds for military and banking employees: expected submission early 2007; status: yet to be submitted; possible delay beyond 2007; banking pension fund weakness likely priority in 2008.
  - Central Bank law: submitted late 2005; congressional approval could be delayed beyond 2007.
  - BHU restructuring: legislation approved; completion could be delayed; business plan not adopted; worker transfers not completed in 2007.

### Monetary policy, inflation, and exchange rate management (staff recommendations)
- Clarify objectives and instruments of monetary policy, including FX intervention.
- Exchange rate pass-through estimated below one-half.
- Staff recommended:
  - Implement faster reduction in growth rate of M1 to reach 9 percent sooner than targeted for June 2008.
  - Let interest rates adjust freely and allow nominal exchange rate to appreciate with monetary tightening.
  - Reserve buildup desirable but subordinated to inflation objective; opportunistic reserve accumulation consistent with exchange rate flexibility.
  - Officials agreed on sterilizing purchases as needed to meet monetary targets.
- Fiscal-monetary interaction:
  - Staff recommended tightening fiscal stance to ease burden on monetary policy.
  - The 4.0 percent of GDP primary surplus target for 2007 implies a 0.3 percent of GDP positive fiscal impulse, adjusted for the cycle.
  - Staff saw scope for a more ambitious target but authorities cited uncertainty and spending needs.

### Transition to inflation targeting (recommended sequencing)
- Near term: improve liquidity forecasting and streamline open market operations.
- Intermediate stage: establish an interest rate corridor and migrate from money base to commercial bank deposits at the central bank as operational target.
- Final stage: narrow interest rate corridor and set target for interbank rate.
- Authorities agreed with the thrust of advice but intended further study before committing to modalities.

### Monetary credibility and dollarization
- Legislation to increase central bank independence an important step.
- Staff stressed raising operational independence by limiting FX purchases by state bank and capitalizing the central bank (draft law in congress).
- Greater credibility, fiscal prudence, and improved debt composition would help reduce dollarization over the medium-term.
- Dollarization described as "now at the top end of comparators."

### Financial system soundness — reforms and regulatory actions (key measures)
- Strengthen state banks and increase competition:
  - Continue strengthening credit procedures at state bank.
  - Reduce government guarantees to state-owned institutions.
  - Eliminate privilege of state bank on payroll deductions.
  - Establish fit-and-proper requirements for directors of state banks.
- BHU restructuring:
  - Establish new agency for housing policy; transfer mortgage loans to new information system; further delays expected.
- Supervision and regulatory framework:
  - Passage of financial sector legislation to increase BCU independence and create resolution framework.
  - Increase resources and improve information systems for supervision (revised 2008 budget contains resources).
  - Lower requirements on FX open positions to align with capital requirements for exchange rate risk.
- Domestic capital markets development:
  - Bankruptcy law prospects optimistic; improve corporate governance and disclosure.
  - Develop hedging markets and reference yield curve for government debt.

### Fiscal policy objectives and debt sustainability (stress and probabilistic results)
- Traditional (deterministic) DSA: debt still exceeds 40 percent of GDP by 2012.
- Monte Carlo (stochastic) simulation:
  - 38 percent probability debt levels exceed 50 percent of GDP by 2012 (staff text).
  - A chart notes: "With the probability of Debt-to-GDP surpassing 50 percent in 2012 estimated at 30 percent." (Both probabilistic statements presented in source.)
- Staff recommendations:
  - Support increased spending on projects to catalyze private investment, but resist relaxing fiscal targets.
  - Maintain medium-term primary surplus target of 4 percent of GDP; small relaxation may be appropriate for counter-cyclical policy.
  - If inflation concerns persist and economy remains vigorous, staff advised exceeding the medium-term target.
  - Shift emphasis to overall balance as "headline" fiscal objective while reaffirming 4 percent primary surplus commitment.
  - Careful assessment of PPPs, minimize contingent liabilities, strengthen public financial management, commitment controls, and audit functions.
  - Gradually reduce current spending in favor of capital spending over the medium-to long-term.
  - Reform specialized pension schemes (particularly banking employees) which entail significant fiscal risks beginning in 2009.

### Business climate and labor market
- Labor conflicts frequency fallen but concerns remain; law regulating resolution of labor conflicts pending.
- Business associations resisted outsourcing liability changes.
- Uruguay compares relatively well regionally in Doing Business Survey; scope for improvement in starting a business and registering property.
- New private investment office and competition law approved; bankruptcy law approval would be important.

### Staff appraisal — outlook and prescriptions (summary)
- Recent performance:
  - Sound policies and favorable global environment supported sharp recovery since 2002 crisis.
  - Growth could reach 5¼ percent in 2007, supported by domestic demand.
  - Risk that inflation could exceed target range of 4½–6½.
- Short-term challenges and monetary policy:
  - Main short-term challenge: rising inflation amid vigorous growth and capital inflows.
  - Central bank lowered monetary targets and should continue faster reduction in money growth.
  - Allow exchange rate and interest rates to adjust freely to increase monetary policy effectiveness.
  - Tightening fiscal stance would ease burden on monetary policy.
- Remaining vulnerabilities and priorities:
  - Public debt ratio remains high and largely dollar-denominated.
  - Financial system highly dollarized with large share in sight deposits; corporate sector currency mismatches expose banks to exchange rate risk.
  - Further reserve buildup desirable as banks’ liquidity likely to decrease.
  - Complete reforms in monetary framework and public finances to reduce dollarization and increase resilience.
  - Continue implementing 2006 FSAP recommendations, reform state banks, and strengthen supervision.
  - Clarify monetary policy objectives and instruments; FX intervention subordinated to inflation objective.
  - Gradual adoption of full-fledged inflation targeting recommended.
  - Capitalization and increased independence of central bank, and limits on state bank FX intervention, important for credibility.
  - Maintain high primary fiscal surpluses to reduce debt burden; exceeding medium-term target appropriate if inflation concerns persist.
  - Improve quality of public spending and reduce nondiscretionary spending; PPPs can help if contingent liabilities minimized.
  - Further improve business climate, labor market functioning, and reduce bureaucratic impediments.

### Transition and institutional relations
- Proposed next Article IV consultation on standard 12-month cycle.
- Membership and Fund relations highlights:
  - Quota: 306.50 (SDR Million) 100.00 (Percent Quota).
  - Stand-By approved Jun 08, 2005 — Dec 27, 2006 — 766.25 SDR Million approved; 263.59 drawn.
  - Uruguay repurchased all remaining Fund obligations (SDR 726.7 million) on November 30, 2006 and cancelled the arrangement on December 27, 2006.

### Key social and demographic indicators (latest information available)
- Population (estimate) 3.5 (note: figure as presented in source).
- Physicians per 1,000 3.7
- Hospital beds per 1,000 4.4
- Life expectancy at birth (years) 75.9
- Crude birth rate (per thousand) 14.4
- Access to safe water (percent of population) 98.0
- Infant mortality rate (per thousand live births) 12.0
- Adult literacy rate 98.0
- Gross enrollment rate (Primary education) 108.3
- Gross enrollment rate (Secondary education) 101.5
- Gross enrollment rate (Tertiary education) 37.7
- Income share held by highest 10 percent of households 33.5
- Income share held by lowest 20 percent of households 4.8
- Gini coefficient 44.6
- Unemployment rate 9.7
- Poverty rate 25.3
- GDP per capita in 2006 (in US$) 6,007
- Human Development Index Rank 43

### Selected medium-term projections and series (2003–2012 excerpts)
- Real GDP (2003–2012): 2.2, 11.8, 6.6, 6.5, 7.0, 5.2, 3.8, 3.2, 3.2, 3.2, 3.2
- CPI inflation (average) (2003–2012): 19.4, 9.2, 4.7, 6.3, 6.4, 7.4, 6.2, 5.0, 4.5, 3.5, 3.3
- Current account balance (percent of GDP) (2003–2012): -0.5, 0.3, 0.0, -2.6, -2.4, -2.8, -2.8, -1.8, -1.0, -1.0, -0.9
- Foreign direct investment (2003–2012): 3.6, 2.4, 4.3, 6.0, 7.1, 5.2, 4.5, 3.3, 2.7, 2.1, 2.1
- Gross official reserves (US$ millions) (2003–2012): 2,087; 2,512; 3,438; 2,777; 3,091; 3,776; 4,018; 4,249; 4,470; 4,683; 4,885
  - In months of imports (2003–2012): 6.6; 6.5; 7.1; 5.1; 5.6; 6.1; 6.2; 6.2; 6.2; 6.2; 6.2
- Public sector debt-to-GDP (baseline, selected years):
  - 2004: 97; 2005: 75; 2006: 66; 2007: 62; 2008: 55; 2009: 50; 2010: 47; 2011: 43; 2012: 40
  - Of which foreign-currency denominated (percent of GDP): 2004: 83; 2005: 63; 2006: 53; 2007: 44; 2008: 38; 2009: 34; 2010: 30; 2011: 27; 2012: 25

### Debt management, simulations, and key probabilistic outcomes
- Gross Financing Needs (percent of GDP): 2004: 13.8; 2005: 11.7; 2006: 22.8; 2007: 3.1; 2008: 2.2; 2009: 1.9; 2010: 2.3
- Monte Carlo (1,000 scenarios) outcomes:
  - Median projected debt path declines to approximately 46 percent.
  - Probability of exceeding 65 percent of GDP in last forecast year below 18 percent.
  - Probability of debt declining below 40 percent approximately 37 percent.
  - "The probability of observing a debt to GDP ratio above 50 percent in 2012 is less than 40 percent in 1,000 simulations." (source wording)
- Policy implication emphasized:
  - Maintaining a 4 percent of GDP primary surplus would lower debt ratio to just below 40 percent by end of forecast and ensure greater stability.

### External relations, IFI engagement, and technical assistance
- World Bank current investment portfolio (as of May 17, 2007): six projects totaling US$181 million commitments; undisbursed US$141 million.
- IFC and MIGA involvement for Botnia pulp project: IFC loan US$170 million; MIGA guarantee US$350 million (approved November 21, 2006).
- IDB lending portfolio (as of May 24, 2007): US$1,017.55 million, with US$604.8 million pending disbursement.
- Technical assistance highlights: FAD, STA, MFD, LEG support across tax, customs, monetary, debt management, FSBS recording, and AML/CFT.

*Source: _cr0845 - IMF staff report content unit (excerpt).*

### 1.         Macroeconomic         Performance ...........................................................................

### 1.         Macroeconomic         Performance

### A. Overview
- Since 2002, growth has averaged 7 percent, inflation has remained moderate, and poverty rates have declined considerably, remaining among the lowest in the region.
- Renewed market access and strong foreign direct investment have resulted in a substantial increase in international reserves.
- Strong primary fiscal surpluses have helped reduce debt ratios and debt management operations have improved the structure of the debt.
- Key reforms implemented since the crisis include a comprehensive tax reform, bank restructuring and improved supervision.
- Important elements of the government’s reform agenda that would further reduce vulnerabilities and help sustain high growth still need to be implemented.
- Near-term prospects:
  - Real GDP growth could reach 5¼ percent in 2007.
  - The 4 percent of GDP primary surplus target for 2007 is likely to be met or surpassed.
  - Inflation has been rising and is likely to exceed the target range (4½–6½).

- Macroeconomic framework indicators (as presented):
  - Real GDP growth (in percent): 2005: 6.6; 2006: 7.0; 2007 (Proj.): 5.2
  - Inflation (in percent, end of period): 2005: 4.9; 2006: 6.4; 2007 (Proj.): 7.0
  - Public sector primary balance (in percent of GDP): 2005: 4.1; 2006: 3.9; 2007 (Proj.): 4.0
  - Public sector overall balance (in percent of GDP): 2005: -0.7; 2006: -0.6; 2007 (Proj.): -0.1
  - Public sector debt (in percent of GDP): 2005: 75; 2006: 66; 2007 (Proj.): 62
  - External current account balance (in percent of GDP): 2005: 0.0; 2006: -2.4; 2007 (Proj.): -2.8
    - Of which: excluding pulp mills projects (in percent of GDP): 2005: 0.0; 2006: -1.1; 2007 (Proj.): -1.3

### B. Rising Inflation
- Recent inflation status and expectations:
  - At 8.1 percent, inflation is now well above the target range.
  - Latest survey shows expected inflation near 7 percent by end-2007, and declining to within the target range in 2008.
- Drivers of higher core inflation:
  - Imported inflation: price increases of tradable goods running well above the inflation target; consensus on the need to prevent second round effects.
  - Capacity constraints: after four years of high growth, capacity is becoming a constraint in at least some sectors; according to some measures, output is now above potential.
  - 2006 growth reached 7 percent, with private consumption as the main source of growth. GDP growth during the first quarter and monthly indicators through May showed few signs of slowing.
  - Wage pressures: unemployment at its lowest level in this decade; unit labor costs are now growing at a rate above the inflation target; real wages have recovered to only 90 percent of pre-crisis levels.
  - Expansionary monetary and exchange rate policies: large foreign exchange purchases by the central bank were not sterilized, money growth reached 35 percent by mid-2006; subsequent policy moves noted below.
- Inflation persistence and expectations:
  - While inflation inertia has declined since 2002, introduction of wage agreements with backward-looking elements may raise inflation inertia.
  - Higher than expected inflation during the first half of 2007 may spur higher inflation in the period ahead.
  - Lagged inflation has become less important than forward-looking expectations in explaining inflation; a higher fiscal primary balance could help lower inflation expectations.

### C. Capital Inflows, Monetary Policy, and Competitiveness
- Current account and capital flows:
  - The current account moved into deficit in 2006, reflecting FDI and oil-related imports.
  - Deterioration largely explained by import growth (30 percent in US dollar terms), FDI-related imports, high oil prices, and temporary oil needs due to a severe drought.
  - Export growth remained robust at 17 percent in US dollar terms.
  - Large FDI inflows amounted to 7 percent of GDP in 2006.
- Reserve accumulation and debt operations:
  - Sizable sovereign debt issues used largely to improve the debt profile, including repaying all Fund obligations (US$2.4 billion) and placing US$1.2 billion in inflation indexed bonds aimed at gradually reducing dollarization.
  - Net international reserves (excluding private banks’ reserves at the central bank and recent prefinancing operations) have risen by US$2½ billion since early 2006 and are approaching adequate levels.
- Exchange rate and monetary policy stance:
  - Authorities moved from a free float adopted after the 2002 crisis to a managed float; significant exchange purchases reduced appreciation and volatility.
  - In 2007, foreign exchange purchases have been largely undertaken by the government, partly to meet its foreign currency needs.
  - Central bank policy changes:
    - Late 2005: adopted M1 as the intermediate objective of monetary policy, with base money as operational target.
    - M1 growth slowed to about 20 percent by end-2006, but core inflation increased in early 2007.
    - March 2007: authorities announced a shift toward a “contraction” phase, lowering the 12-month ahead indicative M1 target from 15 percent to 9 percent (well below nominal GDP growth).
    - M1 growth accelerated in May to 26 percent; base money growth contained at around 15 percent in mid-July.
    - Sterilization operations have helped offset central bank’s foreign exchange purchases from the government.
- Ambiguity and limited efficacy of monetary policy:
  - Lack of nominal exchange rate flexibility has limited the effectiveness of monetary policy and prompted ambiguity in the policy framework.
  - Exchange rate rigidity closed off an important channel from money to prices and increased market perceptions of an exchange rate ceiling.
  - The central bank appears to be targeting inflation and an implicit exchange rate (about Ur$ 24 per dollar), creating ambiguity about objectives and instruments.
- Competitiveness assessment:
  - Uruguay remains competitive: external current account (net of FDI related imports) is close to balance; exports are buoyant; profitability indicators of the tradable sector remain higher than pre-crisis levels.
  - The real effective exchange rate remains below 2001 levels; bilateral REER with Argentina has appreciated above pre-crisis levels, but bilateral rates with other key partners remain favorable.
  - Staff models suggest at most a mild undervaluation of the real effective exchange rate of around 5–10 percent, despite a deterioration in the terms of trade since 2005.

### D. Financial Sector Vulnerabilities
- Improved soundness but remaining risks:
  - Since the crisis, soundness indicators have strengthened considerably and are now broadly in line with comparator countries.
  - Banks better capitalized; only 2 percent of non-performing loans.
  - Banks are now profitable, largely reflecting ability to capture deposits and place them abroad at higher rates, rather than a resumption of credit.
- Structural vulnerabilities:
  - High dollarization: over 75 percent of credit denominated in U.S. dollars.
  - Significant currency and maturity mismatches in the corporate sector.
  - With high demand deposits and improved profitability driven by foreign placements, as the economic and credit recovery mature, banks’ liquidity buffers against shocks are expected to decline.
- Sectoral indicators and concerns:
  - Household credit (consumer credit and mortgages) growth remains low despite strong GDP growth.
  - Rising investment is creating capacity expansion, while rising real estate prices are creating concerns about overheating.

*Italic: Source: _cr0845 - 1.         Macroeconomic         Performance .....................................................................................*

### 12.      Uruguay also remains exposed to international spillover risks. Trade has been

### 12.      Uruguay also remains exposed to international spillover risks. Trade has been

### Financial vulnerabilities and structural reforms
- Non-resident deposits —a key factor triggering the 2002 crisis— have been halved to about 20 percent.
- Country spreads have declined substantially since the crisis, but Uruguay has yet to recover the investment grade it had before the crisis.
- Sovereign spreads behavior is now more closely linked to most Latin American countries, compared with pre-crisis years.
- The 2006 FSAP stressed the need to further reducing financial vulnerabilities, including from high dollarization.
- Key recommendations and status (as presented):
  - Central bank: Strengthen its independence and capitalize the bank. Status: Draft law in congress.
  - Supervision: Increase resources and training; improve information systems; legal protection to staff. Status: Draft law in congress. The revised 2008 budget contains increased resources.
  - Prudential policies: Facilitate usage of credit registry and incorporate BHU loans and small loans of BROU; strengthen credit and debt relief practices of public banks; shorten foreclosure and bankruptcy processes. Status: Credit registry expected to be operational by end-2007. Credit procedures are being strengthened.
  - State banks: Restructure and downsize institutions. Require directors and managers to satisfy supervisory fit and proper requirements and to be subject to supervisory corrective actions. Status: Slow progress is being made in restructuring the housing bank (BHU).
  - Pension funds: Liberalize rules for investments in nongovernment obligations, including allowing limited, high-quality offshore investments. Eliminate the government-guaranteed minimum return in AFAP Republica. Status: Pension funds can purchase bonds by multilateral institutions.
  - Insurance: Ensure that mortgage default insurance prices underlying risks. Contingent liabilities from state insurance company BSE need to be assessed. Status: The authorities would welcome an external risk assessment at BSE.
  - Bankruptcy framework and corporate governance: To facilitate efficient reorganization of viable firms and liquidation of nonviable ones. Improve corporate governance and disclosure practices. Status: Draft law in congress.

### Financial system: progress and remaining risks
- Several soundness indicators continue to improve (figures referenced in the source).
- Structure of the financial system (end 2005) shows a large state presence in the financial system.
- Private sector credit recovery: household credit (excl BROU), corporate credit, and total credit show recovery with 12-month growth rates displayed in the source.
- Dollarization: Credit dollarization and deposit dollarization remain high.
- Sight deposits are increasing (demand deposit (% total deposit) rising).
- Short-term debt: Despite the significant decline in short-term debt, banks will need to be prepared to increase credit without jeopardizing stability as recovery matures.
- Financing structure of firms in Uruguay, 2004 indicates banks are still to play a more important role in financing investment.

### International linkages and contagion channels
- Economic developments remain heavily influenced by those in Argentina, despite increased diversification in merchandise trade.
- Regional tourism and tourism proceeds rely on neighbouring countries, though diversification is rising.
- EMBI spreads show that while Uruguay was perceived as a regional safe haven before the crisis, post-crisis sovereign spreads are now associated with other non-investment grade countries.
- Reserve coverage: central bank reserve coverage is still low compared to other dollarized economies, though it has improved.
- Reserves and foreign exchange liquidity: Official Reserves plus Net Foreign Assets of commercial banks are high in percent of short-term debt plus FX deposits (figures shown in source).
- Foreign exchange liquidity of the financial system is high, but large liquidity levels held by banks are likely to decline as lending picks up.
- The currently large levels of foreign direct investment are likely to be temporary.

### Fiscal adjustment and debt sustainability
- Fiscal accounts have improved considerably since 2002:
  - Expenditure reductions shifted a primary deficit into a surplus approaching 4 percent of GDP.
  - The overall fiscal deficit is now close to zero.
- Public investment is low: public investment is at 2½ percent of GDP, significantly lower than in the 1990s.
- Spending composition: wages and social security benefits represent about 70 percent of total noninterest spending.
- Tax reform: recently approved tax reform is expected to improve efficiency; the tax burden is projected to remain largely unchanged.
- Debt dynamics and projections:
  - Public debt has declined to 66 percent of GDP, from 110 percent of GDP in 2003.
  - Under current policies, this ratio is projected to drop to 40 percent by 2012.
  - About 70 percent of public debt remains denominated in foreign currency despite increased issuance of inflation-indexed bonds.
  - The government raised the average maturity of public debt from about 7 years at end-2001 to almost 12 years in 2006.
- Rollover and interest risk have fallen: the government repaid short-term, floating interest rate or more expensive debts and extended maturities.

### Policy challenges and reform agenda (policy issues for discussions)
- Near-term challenge: rising inflation and strong capital inflows.
- Medium-term priorities:
  - Reform of the monetary framework.
  - Further strengthening the financial system and its resilience to shocks.
  - Sustaining large primary surpluses while enhancing the quality of fiscal policies.
  - Improving the business climate.
- Key measures under the previously cancelled SBA and expected to be completed in 2007 are facing further delays; many require congressional approval.

### Pending structural reforms (status as of December 2006 / current status)
- Fiscal reforms:
  - Tax Reform: Approved by congress in 2006. Implementation began on July 1, 2007.
  - Police Pension Fund: Submitted to congress, approval expected in 2007. Current status: Yet to be discussed by congress.
  - Pension Fund for the Military and Banking Employees: Expected to be submitted to congress in early 2007. Current status: Yet to be submitted; congressional approval could be delayed beyond 2007; addressing the weakness of the banking pension fund is likely to become a priority in 2008.
- Financial sector reforms:
  - Central Bank: Submitted to congress in late 2005; approval expected in 2007. Current status: Congress approval could be delayed beyond 2007, given widespread opposition to delinking board terms from political cycle.
  - BHU: Legislation to restrict BHU's activities and creating a new housing agency had been submitted; completion of the restructuring expected in early to mid-2007. Current status: Legislation was approved, but completing the restructuring could be delayed further: a business plan has not been adopted and the transfer of workers from BHU will not be completed in 2007.

### Monetary policy, inflation, and exchange rate management
- Staff recommended clarifying the objectives and instruments of monetary policy, including foreign exchange intervention, noting the appearance of multiple objectives could leave the system without an anchor.
- Authorities stated inflation was the overriding objective of monetary policy.
- Exchange rate pass-through: staff research suggests the exchange rate pass-through has declined below one-half.
- Lending channel: while still low, is increasing as the share of local currency credit grows.
- Authorities view much of the upward pressure on the peso as deriving from temporary FDI (pulp mills) projects.
- Staff recommended:
  - Implementing a faster reduction in the growth rate of M1 and to achieve the 9 percent growth rate sooner than currently targeted for June 2008. This should help control inflation and bring expectations to within the 2007 target range.
  - Let interest rates adjust freely and allow the nominal exchange rate to appreciate in reaction to monetary tightening.
  - A small nominal appreciation should not lead to competitiveness concerns given expected large FDI levels increasing exports and productivity of the tradable sector.
- Reserve buildup:
  - Reserve buildup desirable but subordinated to the inflation objective.
  - Staff simulations suggest that, while in 2002 the central bank required substantial assistance, a similar shock today could be nearly covered by central bank reserves and banks’ own liquidity.
  - Coverage still below other dollarized economies; large liquidity levels held by banks likely to decline as lending picks up.
  - Opportunistic approach to reserve accumulation appropriate; foreign exchange purchases should be consistent with exchange rate flexibility to avoid deviations from long-term equilibrium.
  - Officials agreed on importance of sterilizing purchases as needed to ensure meeting the monetary targets.

### Fiscal stance and interaction with monetary policy
- Staff recommended that the policy mix should include a tightening of the fiscal stance to help ease the burden on monetary policy.
- Analytical work indicates the primary fiscal balance is important in explaining inflation expectations.
- The 4.0 percent of GDP primary surplus target for 2007 still implies a 0.3 percent of GDP positive fiscal impulse, adjusted for the cycle.
- Staff saw scope for setting a more ambitious target given strong revenue performance in the first semester, but authorities cited uncertainty about tax reform revenue effects and high spending needs as reasons not to commit ex-ante to a higher primary surplus target.

### Transition to inflation targeting
- Agreement that adoption of full-fledged inflation targeting should proceed gradually.
- Recommended sequencing (in line with recent Fund technical assistance):
  - Near term: improve liquidity forecasting and streamline open market operations.
  - Intermediate stage: establish an interest rate corridor and migrate from money base to commercial bank deposits at the central bank as an operational target.
  - Final stage: narrow the interest rate corridor and set a target for the interbank interest rate.
- Authorities agreed with the thrust of Fund advice but indicated intention to further study alternatives before committing to operational modalities.

*Sources: Central Bank of Uruguay; Ministry of Economy and Finance; and Fund staff estimates.*

### 23.      Enhancing credibility will be

### _cr0845 - 23.      Enhancing credibility will be

### Monetary credibility and dollarization
- Approval of legislation in congress to increase the independence of the central bank is an important step to enhance credibility.
- Staff stressed the need to raise operational independence by:
  - limiting foreign exchange purchases by the state bank;
  - capitalizing the central bank envisaged in draft law in congress.
- Greater monetary credibility, together with continued fiscal prudence and further improvements in the composition of public debt, would help reduce dollarization over the medium-term.
- Improving transparency and communications with markets is important to strengthen the expectation channel of monetary policy, although some officials argued that ambiguity in instrument choice in a small market can have benefits.
- Dollarization is described as "now at the top end of comparators."

### Financial system soundness — reforms and regulatory actions
- Implement key recommendations of the 2006 FSAP, including:
  - Strengthening state banks and increasing competition:
    - continue strengthening credit procedures at the state bank;
    - reduce government guarantees to state-owned institutions;
    - eliminate the privilege of the state bank on payroll deductions;
    - establish fit-and-proper requirements for directors of state banks.
    - officials noted legal challenges to implementing fit-and-proper criteria (requiring a by-law regulating criteria included in the constitution).
  - BHU restructuring:
    - establishment of a new agency to execute housing policy and transfer of all mortgage loans to a new information system welcomed;
    - officials noted further delays expected owing to pending business plan and worker transfers;
    - staff urged swift completion to allow resumption of sound mortgage lending.
  - Supervision and regulatory framework:
    - help ensure early passage of financial sector legislation to increase central bank independence, provide a bank resolution framework, and enhance financial sector supervision structure;
    - increase resources and improve information systems for effective supervision and to maintain credit standards as credit picks up (revised 2008 budget contains resources for this purpose).
    - agreement to lower requirements on foreign exchange open positions and make them consistent with recently approved legislation on required capital for exchange rate risk.
  - Developing domestic capital markets:
    - prospects for passage of bankruptcy law in Congress are optimistic;
    - improve corporate governance and disclosure practices;
    - develop markets for hedging instruments through establishment of a reference yield curve for government debt.
    - Fund is sponsoring a conference in Montevideo on development of domestic capital markets in the region.

### Stress tests and resilience indicators
- Updated stress tests show increased resilience compared with the 2006 FSAP:
  - A current account shock (4 percent GDP drop and a 5 percent real exchange rate depreciation) would cause, on average, a reduction of 4 percentage points in capital adequacy ratios (CAR), compared to a decline of 8 percentage points calculated in the 2006 FSAP.
  - A severe capital account shock (sudden stop, 8 percent GDP drop and a 12 percent real exchange rate depreciation) would lower CARs by 10 percentage points, against a fall of 22 percentage points estimated in the FSAP.
- Modified contingency claims approach:
  - Simulation of the 2002 crisis suggests that, in the absence of external assistance, banks representing over 90 percent of banking sector’s total assets were facing an estimated default probability (EDP) exceeding 25 percent in 2002.
  - A similar shock today would yield an EDP exceeding 25 percent for banks representing less than 60 percent of the banking sector.
  - Under the two extreme FSAP stress tests, banks would face today, on average, 24 and 14 percent EDP, compared with a model estimate of 45 percent in 2002.

### Reserve management and regional arrangements
- Authorities joined Fondo Latinoamericano de Reservas (FLAR) largely to improve reserve management.
- Officials agreed regional reserve pooling helps reduce risks but is not a substitute for global arrangements in case of a regional crisis.
- Historical note: Uruguay experienced two major economic crises over the last 25 years, both originating from regional shocks.

### Fiscal policy objectives and debt sustainability
- Traditional (deterministic) debt sustainability analysis indicates Uruguay’s debt will still exceed 40 percent of GDP by 2012.
- Monte Carlo (stochastic) simulation suggests:
  - even if fiscal policy remains on track, there would be a 38 percent probability that debt levels exceed 50 percent of GDP by 2012.
  - a chart notes: "With the probability of Debt-to-GDP surpassing 50 percent in 2012 estimated at 30 percent."  
    (Both probabilistic statements are presented in the source.)
- Staff recommendations and findings:
  - Support increased spending on projects to catalyze private investment, but resist pressures to relax fiscal targets.
  - Maintain the medium term primary surplus target of 4 percent of GDP to support debt reduction, while a small relaxation may be appropriate to allow for counter-cyclical policy in the event of a slowdown.
  - If inflation concerns persist and the economy remains vigorous, staff advised exceeding the medium-term target.
  - Authorities reaffirmed commitment to the 4 percent of GDP primary surplus target but intend to shift emphasis to the overall balance as the "headline" fiscal objective.
  - Tax reform started to be implemented on July 1; progress in customs and tax administration reforms noted.
  - Implementation of Private-Public Partnerships (PPPs) and reforms should help deal with substantial nondiscretionary spending; staff encouraged careful assessment of PPP criteria, including contingent liabilities, and creation of a general legal and accounting framework.
  - Further strengthen public financial management, including commitment controls and audit functions.
  - Staff recommended gradually reduce current spending in favor of capital spending over the medium-to long-term.
  - Officials noted little scope for large reductions in current spending due to demographic factors and social preferences, but plan to reform specialized pension schemes (particularly for banking employees) which entail significant fiscal risks beginning in 2009.
  - Ensure envisaged reform to the civil service helps increase budget flexibility in the medium-term.

### Business climate and labor market
- Labor:
  - Frequency of labor conflicts has fallen, but concerns remain.
  - A law regulating resolution of labor conflicts is still to be agreed on.
  - Business associations resisted a new law on outsourcing that partly makes outsourcing companies liable for labor code violations by subcontractors.
  - Agreement on importance of a well functioning and competitive labor market given high structural unemployment.
- Bureaucratic impediments to investment:
  - Uruguay compares relatively well regionally in the World Bank’s Doing Business Survey, but scope for improvement remains in areas such as starting a business and registering property.
  - New private investment office and approval of competition law are positive steps.
  - Approval of the bankruptcy law would be an important step.

### Staff appraisal — summary of outlook and policy prescriptions
- Recent performance and outlook:
  - Sound policies and favorable global environment contributed to sharp recovery since the 2002 crisis.
  - Strong primary fiscal surpluses have helped reduce debt ratios and sound debt management improved debt structure.
  - Financial sector restructuring strengthened resilience; prudent monetary policy reduced inflation to single digits.
  - Economic growth could reach 5¼ percent in 2007, supported primarily by domestic demand.
  - Risk that inflation could exceed the target range of 4½–6½.
- Short-term challenges and monetary policy:
  - Main short-term challenge is addressing rising inflation amid vigorous growth and capital inflows.
  - Central bank has appropriately lowered monetary targets and should continue faster reduction in money growth to achieve end-year targets earlier.
  - Allowing exchange rate and interest rates to adjust freely would help increase effectiveness of monetary policy.
  - Tightening the fiscal stance would help ease the burden on monetary policy.
- Remaining vulnerabilities and policy priorities:
  - Public debt ratio remains high and largely dollar-denominated.
  - Financial system is highly dollarized with a large share in sight deposits; corporate sector currency mismatches expose banks to exchange rate risk.
  - Given banks’ high liquidity levels, central bank reserves appear near adequate, but further reserve buildup is desirable as banks’ liquidity is likely to decrease in the future.
  - Complete reforms in monetary framework and public finances to reduce dollarization and increase resilience.
  - Continue deepening financial sector reforms and implement 2006 FSAP recommendations, further reform state banks and strengthen supervision.
  - Clarify objectives and instruments of monetary policy to avoid multiple objectives leaving the system without an anchor.
  - Foreign exchange intervention should avoid hindering exchange rate movements and be subordinated to the inflation objective.
  - Adoption of full-fledged inflation targeting should proceed gradually.
  - Legislation increasing central bank independence should enhance policy credibility, and capitalization plus limits on state bank FX intervention are important.
  - Maintain high primary fiscal surpluses to reduce debt burden; exceeding medium-term target appropriate if inflation concerns persist and debt remains high.
  - Improve quality of public spending and gradually reduce nondiscretionary spending (including reforming banking pension scheme).
  - PPPs are an opportunity for infrastructure upgrading provided contingent liabilities are minimized.
  - Further improve the business climate: private investment office, competition law, bankruptcy law, good labor relations, enhanced competition in labor markets, and reduction of bureaucratic impediments to investment.

*IMF staff report content as provided in the source document.*

### 40.      It is proposed that the next Article IV consultation with Uruguay take place on the

### It is proposed that the next Article IV consultation with Uruguay take place on the standard 12-month cycle.

### Latest information available (social and demographic)
- Population (estimate)3.5
- Physicians per 1,0003.7
- Hospital beds per 1,0004.4
- Life expectancy at birth (years)75.9
- Crude birth rate (per thousand)14.4
- Access to safe water (percent of population)98.0
- Infant mortality rate (per thousand live births)12.0
- Adult literacy rate98.0
- Gross enrollment rate (Primary education)108.3
- Gross enrollment rate (Secondary education)101.5
- Gross enrollment rate (Tertiary education)37.7
- Income share held by highest 10 percent of households33.5
- Income share held by lowest 20 percent of households4.8
- Gini coefficient44.6
- Unemployment rate9.7
- Poverty rate25.3
- GDP per capita in 2006 (in US$)6,007
- Human Development Index  Rank43

### Output, prices, and employment (real growth and contributions: 2003–2012 series)
- Real GDP (2003–2012): 2.2, 11.8, 6.6, 6.5, 7.0, 5.2, 3.8, 3.2, 3.2, 3.2, 3.2
- Real consumption (2003–2012): 1.1, 9.5, 2.8, 5.5, 8.6, 5.0, 4.2, 3.1, 2.7, 2.6, 2.3
- Real investment (2003–2012): 18.0, 22.0, 12.7, 41.0, 24.7, 16.4, 5.1, -5.5, 0.5, 8.7, 8.3
- Contributions to real growth (percent):
  - Consumption (2003–2012): 1.0, 8.7, 2.5, 4.8, 7.4, 4.3, 3.7, 2.7, 2.4, 2.2, 2.0
  - Investment (2003–2012): 1.9, 2.7, 1.7, 5.6, 3.5, 2.7, 0.9, -1.0, 0.1, 1.4, 1.4
  - Net exports (2003–2012): -0.7, 0.5, 2.4, -3.9, -3.9, -1.8, -0.8, 1.5, 0.8, -0.5, -0.2

- GDP (Ur$ billions) (2003–2012): 316, 379, 407, 465, 465, 523, 578, 630, 679, 725, 773
- GDP (US$ billions) (2003–2012): 11.2, 13.3, 16.7, 19.4, 19.3, 21.9, 24.5, 26.9, 29.1, 31.1, 33.2

### Prices, inflation, and exchange rate
- GDP deflator (2003–2012): 18.4, 7.5, 0.6, 6.2, 6.8, 7.0, 6.5, 5.5, 4.5, 3.5, 3.3
- CPI inflation (average) (2003–2012): 19.4, 9.2, 4.7, 6.3, 6.4, 7.4, 6.2, 5.0, 4.5, 3.5, 3.3
- CPI inflation (eop) (2003–2012): 10.2, 7.6, 4.9, 6.0, 6.4, 7.0, 6.0, 5.0, 4.5, 3.5, 3.3
- Exchange rate change (Ur$/US$) (average): 30.4, 1.5, -15.0, ..., -1.0, ... (series contains ellipses in source)
- Exchange rate change (Ur$/US$) (eop): 7.3, -9.9, -10.1, ..., 3.2, ... (series contains ellipses in source)
- REER (percentage depreciation -, e.o.p.) -13.2, 8.7, 12.4, ..., -4.9, ...

### Savings, investment, and external sector (levels and projections)
- Gross domestic investment (2003–2012): 12.6, 13.1, 13.3, 16.0, 16.5, 17.4, 17.4, 16.8, 16.3, 16.8, 17.3
- Gross national savings (2003–2012): 12.1, 13.4, 13.3, 13.4, 14.1, 14.6, 14.6, 15.0, 15.3, 15.7, 16.4
- Foreign savings (2003–2012): 0.5, -0.3, 0.0, 2.6, 2.4, 2.8, 2.8, 1.8, 1.0, 1.0, 0.9
- Merchandise exports, fob (US$ millions) (2003–2012): 2,281; 3,145; 3,758; 4,433; 4,389; 4,861; 5,495; 6,028; 6,514; 6,916; 7,319
- Merchandise imports, fob (US$ millions) (2003–2012): 2,098; 2,992; 3,730; 4,894; 4,863; 5,581; 6,267; 6,547; 6,843; 7,240; 7,619
- Merchandise terms of trade (percentage change) (2003–2012): 2.9, -3.1, -9.7, -2.7, -1.5, -0.4, -1.1, -0.6, 0.2, 0.5, 0.2
- Current account balance (percent of GDP) (2003–2012): -0.5, 0.3, 0.0, -2.6, -2.4, -2.8, -2.8, -1.8, -1.0, -1.0, -0.9
  - Excluding pulp mills projects (2003–2012): -0.5, 0.3, 0.0, -1.1, -1.1, -1.3, -1.3, -1.2, -1.0, -1.0, -0.9
- Foreign direct investment (2003–2012): 3.6, 2.4, 4.3, 6.0, 7.1, 5.2, 4.5, 3.3, 2.7, 2.1, 2.1

### External debt, reserves, and balance of payments
- Overall balance of payments (US$ millions) (2003–2012): 1,380; 454; 951; -689; -337; 685; 243; 231; 220; 213; 202
- External debt (percent of GDP) (2003–2012): 98.2; 87.4; 68.3; 53.7; 54.7; 50.1; 45.1; 41.7; 38.9; 36.8; 34.5
  - Of which: external public debt (2003–2012): 85.3; 76.9; 60.8; 47.3; 48.2; 44.5; 39.5; 36.1; 33.3; 31.2; 28.9
- External debt service (percent of exports of goods and services) (2003–2012): 52.3; 44.8; 53.1; 89.7; 92.5; 24.4; 20.8; 19.1; 19.9; 20.4; 17.5
- Gross official reserves (US$ millions) (2003–2012): 2,087; 2,512; 3,438; 2,777; 3,091; 3,776; 4,018; 4,249; 4,470; 4,683; 4,885
  - In months of imports of goods and services (2003–2012): 6.6; 6.5; 7.1; 5.1; 5.6; 6.1; 6.2; 6.2; 6.2; 6.2; 6.2
  - In percent of short-term debt (2003–2012): 131.3; 112.4; 153.8; 221.3; 149.2; 90.6; 297.0; 275.7; 261.0; 262.5; 295.1
  - In percent of short-term debt plus bank non-resident deposits (2003–2012): 51.2; 55.4; 75.8; 75.5; 101.5; 98.9; 101.3; 99.8; 98.7; 99.6; 104.5
  - In percent of short-term debt plus FX deposits (selected values available)20.0; 27.7; 32.9; 28.4; 34.1; 34.5; 34.4; 34.5; 34.9; 35.8; 36.5

### Monetary indicators and banking system (selected)
- Net foreign assets (selected years): -52; -511; 1,307; 3,333; 4,041 (series continues)
- Net international reserves 1/-321; -164; 1,135; 3,091; 3,776
- Gross international reserves: 2,087; 2,512; 3,438; 3,091; 3,776
- Monetary base (end-of-period) (mem. items) 24.9, 11.1, 34.1, 34.1, 13.0, 8.0 (series entries as in source)
- Broad money (M3) (selected): 6,949; 7,573; 8,288; 9,221; 10,263
- Credit to the private sector (constant exch. rate) (selected): -23.9; -11.2; 2.7; 5.0; 9.1; 13.8
- Financial sector indicators (selected):
  - Broad money (percent change) 21.7, -2.0, 0.1, 12.6, 11.3
  - Credit to private sector (const. exch. rate) -23.9, -11.2, 2.7, 9.1, 13.8
  - Share of nonperforming loans in total loans (in percent) 1/ 14.3, 4.7, 3.6, 1.9, 2.1
  - Provisions to nonperforming loans (in percent) 1/ 91.4, 106.8, 118.8, 218.6, 296.2
  - Capital to asset ratio (in percent) 1/ 7.2, 8.3, 8.6, 9.8, 10.2
  - Return on assets (in percent) 1/ -1.1, -0.1, 0.7, 1.2, 1.7
  - Interbank interest rates (percent, end-of-period) 1/ 2.5, 1.3, 1.0, 3.0, 2.8
  - FX deposits held by residents (in percent of total deposits) 88.8, 87.0, 83.7, 82.3, 81.4
  - FX loans to residents (in percent of total loans) 76.8, 73.4, 70.0, 66.0, 62.3

### Public sector operations (2004–2009, selected amounts and percent of GDP)
- Revenue (millions of current Uruguayan pesos) (2004–2009): 117,367; 130,824; 147,865; 170,285; 167,413; 189,324; 207,388
  - Revenue (percent of GDP) (2004–2009): 30.9; 32.2; 31.8; 32.5; 33.1; 32.7; 32.9
- Taxes (millions) (2004–2009): 83,716; 92,280; 107,146; 118,908; 115,872; 132,064; 143,157
  - VAT and excise taxes (millions) (2004–2009): 47,200; 53,124; 61,574; 70,059; 67,018; 74,611; 80,604
  - On income and profits (millions) (2004–2009): 18,397; 20,148; 23,314; 26,694; 27,837; 34,125; 37,153
- Social security contributions (millions) (2004–2009): 16,657; 21,532; 25,115; 28,035; 28,527; 31,811; 35,894
- Nontax revenue (millions) (2004–2009): 7,117; 8,399; 9,027; 10,554; 9,729; 10,989; 11,965
- Current surplus of public enterprises (millions) (2004–2009): 9,876; 8,614; 6,577; 12,788; 13,285; 14,460; 16,373
- Non-interest expenditure (millions) (2004–2009): 103,082; 114,860; 130,320; 149,701; 147,174; 166,445; 182,744
  - Non-interest expenditure (percent of GDP) (2004–2009): 27.2; 28.2; 28.0; 28.6; 29.1; 28.8; 29.0
  - Current (percent of GDP) (2004–2009): 24.7; 25.9; 25.4; 25.5; 26.1; 25.8; 26.0
  - Wages (percent of GDP) (2004–2009): 6.2; 6.3; 6.1; 6.3; 6.6; 6.4; 6.4
  - Social security benefits (percent of GDP) (2004–2009): 12.6; 13.0; 12.7; 12.6; 13.0; 13.1; 13.2
- Capital (Government and enterprises) (millions) (2004–2009): 9,303; 9,582; 12,312; 16,303; 15,303; 17,276; 18,809
- Primary balance (cash basis) (millions) (2004–2009): 14,284; 15,963; 17,544; 20,585; 20,239; 22,879; 24,645
  - Primary balance (percent of GDP) (2004–2009): 3.8; 3.9; 3.8; 3.9; 4.0; 4.0; 3.9
- Interest (millions) (2004–2009): 22,666; 18,756; 20,564; 21,398; 21,398; 22,919; 23,797
  - Interest (percent of GDP) (2004–2009): 6.0; 4.6; 4.4; 4.1; 4.4; 4.0; 3.8
- Overall balance (millions) (2004–2009): -8,382; -2,793; -3,020; -325; -670; 60; 947
  - Overall balance (percent of GDP) (2004–2009): -2.2; -0.7; -0.6; -0.1; -0.4; 0.0; 0.2
- Memorandum: GDP (billions of pesos) 2004–2009: 379; 407; 465; 523; 506; 578; 630

### Balance of payments detailed items (2003–2012 series, selected)
- Current account (US$ millions, 2003–2012 selected): -564, 32, -457, -609, -687, -478, -293, -310, -298
- Trade balance (US$ millions, 2003–2012 selected): 183, 153, 28, -474, -720, -772, -519, -329, -323, -300
- Services (exports/imports, selected): Exports f.o.b. (services) 803, 1,151, 1,335, 1,284, 1,424, 1,506, 1,613, 1,719, 1,833, 1,954; Imports f.o.b. (services) 636, 786, 926, 923, 1,040, 1,157, 1,240, 1,321, 1,404, 1,490
- Income (net) (2003–2012): -489, -588, -585, -470, -373, -364, -434, -463, -516, -564
- Transfers (net) (2003–2012): 83, 113, 149, 126, 100, 101, 101, 102, 101, 102
- Financial and capital account (2003–2012): 1,039; 671; 1,016; 202; 1,294; 929; 777; 713; 647; 606
  - Foreign direct investment (2003–2012): 401; 315; 715; 1,377; 1,127; 1,109; 895; 780; 655; 708

### Vulnerability indicators and financial soundness (selected highlights)
- Public sector gross debt (PSGD, in percent of GDP) (selected years): 110.4, 96.3, 74.1, 66.0, 61.7
  - Of which: Exposed to rollover risk (percent of total PSGD) 12.1, 13.5, 16.0, 5.1, 6.8
  - Exposed to exchange rate risk (percent of total PSGD) 86.4, 85.9, 80.3, 71.2, 69.3
  - Exposed to interest rate risk (percent of total PSGD) 45.5, 44.6, 40.0, 19.0, 18.4
- Total gross external debt (ED) in percent of GDP (2003–2007): 98.2; 87.4; 68.3; 54.7; 50.1
  - Short-term ED (original maturity, percent of total ED) 6.7; 7.6; 6.4; 8.0; 8.0
- Financial market indicators:
  - Foreign currency debt rating (Moody's) 1/ B3, B3, B3, B1, B1
  - Foreign currency debt rating (S&P) 1/ BBB-, BB+, B+
  - EMBI secondary market spread (bps, end of period) 1/ 388, 462, 298, 185, 141
- Banking system soundness (selected ratios and indicators):
  - NPL to total loans (net of provisions) (2001–2007): 11.5, 33.9, 14.3, 4.7, 3.6, 1.9, 2.1
  - Loan provisions to nonperforming loans (percent) 61.9, 58.3, 91.4, 106.8, 118.8, 218.6, 296.2
  - Capital/assets (2001–2007): 7.2, -10.0, 7.2, 8.3, 8.6, 9.8, 10.2
  - Tier 1 capital/risk-adjusted assets (percent) 2/ 8.5, -11.7, 9.2, 10.9, 11.2, 12.3, 18.8
  - Return on assets (ROA) (2001–2007): 0.0, -25.3, -1.1, -0.1, 0.7, 1.2, 1.7
  - Liquid assets to total assets (percent) 25.1, 23.8, 35.2, 45.1, 45.3, 43.8, 42.6

### Appendix note
- APPENDIX I. DEBT SUSTAINABILITY

*Sources: Data provided by the Uruguayan authorities; Central Bank of Uruguay; Ministry of Finance; and Fund staff estimates and projections.*

### 1.      The authorities have made substantive changes in the debt profile in recent years.

### _cr0845 - 1.      The authorities have made substantive changes in the debt profile in recent years.

### Overview and recent structural changes
- The net present value of public debt declined and its structure improved after the 2003 debt exchange.
- Vigorous growth, the strengthened fiscal position, and currency appreciation have lowered the debt-to-GDP ratio "from above 100 to below 65 percent."
- The government fully repaid all remaining Fund obligations (SDR 726 million) in November 2006.
- The authorities increased issuance of inflation-indexed bonds (including two combined placements in 2007 exceeding US$1.2 billion) and swapped US$1.1 billion in amortization payments due mostly in 2011 and 2015 into longer maturity bonds.

### Gross financing needs and portfolio composition
- Gross financing requirements have fallen in the medium term: from "10 percent forecasted for 2007 a year ago to just over 3 percent."
- Specific figures and trends:
  - Gross Financing Needs (In percent of GDP) reported: 2004: 13.8; 2005: 11.7; 2006: 22.8; 2007: 3.1; 2008: 2.2; 2009: 1.9; 2010: 2.3.
  - Gross financing need under baseline (right scale) and scenarios (selected): Baseline: 3.2; Scenario: 6.2; Historical: -2.2.
  - In billions of U.S. dollars (selected): 2004: 1.8; 2005: 2.0; 2006: 4.4; 2007: 0.7; 2008: 0.6; 2009: 0.5; 2010: 0.6; 2011: 0.8; 2012: 0.4.
- The overall debt strategy emphasized regaining peso-denominated issuance, shifting toward inflation-indexed bonds, lowering dollarization while controlling costs.
- Average maturity of public debt rose from "about 7 years at end-2004 to nearly 12 years."

### Debt dynamics and sustainability simulations
- Staff modeled 1,000 potential five-year economic scenarios via Monte Carlo simulation; each scenario invoked the authorities’ fiscal reaction to that scenario using an estimated fiscal reaction function.
- Fiscal reaction function estimation details (as in source): estimated over data from 1965 to 2006; function uses lagged US dollar external debt, REER change index, and output gap (HP filtered); instruments applied for output gap; robustness tests performed.
- Key probabilistic simulation outcomes:
  - Median projected debt path declines to "approximately 46 percent."
  - Probability of exceeding 65 percent of GDP in the last year of the forecast is "below 18 percent."
  - Probability of the debt declining to below 40 percent is "approximately 37 percent."
  - "The probability of observing a debt to GDP ratio above 50 percent in 2012 is less than 40 percent in 1,000 simulations."
- Deterministic and scenario-bound tests (selected results from Appendix I. Figure 2 and tables):
  - Under a fiscal rule maintaining a 4 percent of GDP primary surplus, the debt ratio falls "to just below 40 percent of GDP by the last year of the forecast."
  - Baseline public sector debt-to-GDP (selected years from Appendix I. Table 1): 2004: 97; 2005: 75; 2006: 66; 2007: 62; 2008: 55; 2009: 50; 2010: 47; 2011: 43; 2012: 40.
  - Of which foreign-currency denominated (public sector debt as percent of GDP): 2004: 83; 2005: 63; 2006: 53; 2007: 44; 2008: 38; 2009: 34; 2010: 30; 2011: 27; 2012: 25.
  - Change in public sector debt (percent of GDP): 2004: -14.1; 2005: -22.2; 2006: -8.1; 2007: -4.5; 2008: -6.4; 2009: -4.7; 2010: -3.8; 2011: -3.3; 2012: -3.1.
  - Identified debt-creating flows (4+7+12) (percent of GDP): 2004: -15.1; 2005: -18.9; 2006: -10.7; 2007: -7.2; 2008: -5.9; 2009: -4.6; 2010: -3.8; 2011: -3.3; 2012: -3.1.
  - Primary deficit (percent of GDP) across projection years: -3.8; -3.9; -3.8; -3.9; -4.0; -3.9; -3.9; -3.9; -3.9.
  - Public sector debt-to-revenue ratio: 2004: 320.3; 2005: 242.3; 2006: 207.5; 2007: 188.9; 2008: 168.2; 2009: 152.9; 2010: 141.2; 2011: 131.2; 2012: 121.7.
  - Key macro-fiscal assumptions (selected): Real GDP growth (percent) 2004: 11.8; 2005: 6.6; 2006: 7.1; 2007: 5.2; 2008–2012: 3.8, 3.2, 3.2, 3.2, 3.2; Inflation rate (GDP deflator, percent) 2004: 7.5; 2005: 1.7; 2006: 5.6; 2007: 7.0; 2008: 6.5; 2009: 5.5; 2010: 4.5; 2011: 3.5; 2012: 3.3.
- External debt sustainability (Appendix I. Table 2, selected):
  - Baseline external debt-to-GDP (percent): 2002: 87.5; 2003: 98.2; 2004: 87.4; 2005: 68.3; 2006: 54.7; 2007: 50.1; 2008: 45.1; 2009: 41.7; 2010: 38.9; 2011: 36.8; 2012: 34.5.
  - Gross external financing need (in billions of US dollars) (selected): 2004: 3.8; 2005: 3.0; 2006: 2.1; 2007: 2.7; 2008: 5.4; 2009: 2.0; 2010: 2.1; 2011: 1.9; 2012: 2.0.

### Stress tests and scenario results (selected)
- Individual and combined shocks examined include:
  - Permanent one-half standard deviation shocks to growth, interest rates, and primary balance.
  - Combined shocks and "30 percent real depreciation and 10 percent of GDP shock to contingent liabilities in 2007."
  - One-time real depreciation of 30 percent occurring in 2008 in external debt stress tests.
- Representative scenario averages (figures in boxes in source diagrams):
  - Growth shock baseline and scenario box averages (visual summaries in source): baseline projected debt-to-GDP often near 40–46 percent depending on shock; selected box numbers cited in figures: 46 (median under Monte Carlo); 40 (under fiscal rule).
  - External debt scenarios show baseline and shocked paths with average projections and historical averages displayed in source figures and tables.

### Policy implications emphasized by staff
- Recent debt management actions—lengthening maturities, increasing inflation-indexed and peso-denominated issuance, and repaying Fund obligations—have materially reduced vulnerability and gross financing needs.
- Maintaining a primary surplus of 4 percent of GDP (an implicit fiscal rule observed in recent years) would yield stronger debt reduction: debt ratio "falls below 40 percent" by the last forecast year and "ensure greater stability for Uruguay."
- Simulation results highlight remaining exposure to exchange rate risks and lower GDP growth; stress tests show meaningful upside risks under adverse scenarios.

*Source: _cr0845 - 1.      The authorities have made substantive changes in the debt profile in recent years.*

### Appendix I. Table 3. Uruguay: Debt Profile

### Appendix I. Table 3. Uruguay: Debt Profile

### Fund relations — recent arrangements and status
- A three-year SBA was approved on June 8, 2005 under the exceptional access procedures (SDR 766.3 million, 250 percent of quota).
- Uruguay repurchased all remaining Fund obligations (SDR 726.7 million, 237 percent of quota) on November 30, 2006, and cancelled the arrangement on December 27, 2006.
- A safeguard assessment was completed in September 2005; authorities are in the process of addressing all safeguards concerns and have implemented many recommendations.
- In April, 2006, Uruguay’s de facto exchange rate regime was reclassified from an independent float to a managed float with no predetermined path for the exchange rate.
- The 2006 Article IV consultation was concluded by the Executive Board on June 28, 2006 (Country Report No. 06/425).

### Relations with the World Bank Group
- Current investment portfolio (as of May 17, 2007) comprises six projects totaling US$181 million in commitments, with an undisbursed amount of US$141 million.
- Disbursements for investment operations:
  - CY04: US$43.8 million
  - CY05: US$58.6 million
  - CY06: US$42.1 million (decrease due to renewal of the portfolio and slow start-up of new operations)
- On November 21, 2006, the Board approved a loan of US$170 million by the IFC, and a guarantee of US$350 million by MIGA, to the Finnish company Botnia for construction of a wood pulp plant in Fray Bentos.

### Relations with the Inter-American Development Bank
- As of May 24, 2007 the Bank’s current portfolio in Uruguay includes loans for financing of 18 investment projects and two policy based operations (social sectors and improvements in competitiveness).
- Lending portfolio amount: US$1,017.55 million, of which US$604.8 million are pending disbursement.
- Portfolio performance was affected by the government’s fiscal constraint; project implementation pace increased markedly in 2006 as fiscal accounts strengthened.

### Annex I — Fund relations (as of May 31, 2007): key institutional and financial statistics
- Membership status: Joined: March 11, 1946; Article VIII.
- General Resources Account:
  - Quota: 306.50 (SDR Million) 100.00 (Percent Quota)
  - Fund holdings of currency: 306.51 (SDR Million) 100.00 (Percent Quota)
  - Reserve Position: 0.00 (SDR Million) 0.00 (Percent Quota)
- SDR Department:
  - Net cumulative allocation: 49.98 (SDR Million) 100.00 (Percent Allocation)
  - Holdings: 0.68 (SDR Million) 1.36 (Percent Allocation)
- Outstanding purchases and loans: None.
- Latest financial arrangements (Type — Arrangement Date — Expiration Date — Amount Approved (SDR Million) — Amount Drawn (SDR Million)):
  - Stand-By — Jun 08, 2005 — Dec 27, 2006 — 766.25 — 263.59
  - Stand-By — Apr 01, 2002 — Mar 31, 2005 — 1,988.50 — 1,988.50
    - Of which SRF — Jun 25, 2002 — Aug 08, 2002 — 128.70 — 128.70
  - Stand-By — May 31, 2000 — Mar 31, 2002 — 150.00 — 150.00
- Projected payments to Fund (SDR Million; based on existing use of resources and present holdings of SDRs):
  - Forthcoming by year: 2007 2008 2009 2010 2011
  - Principal: (no figures provided)
  - Charges/Interest: 1.07 2.12 2.12 2.12 2.12
  - Total: 1.07 2.12 2.12 2.12 2.12

### Safeguards, technical assistance, and institutional engagement
- Safeguards assessment (September 2005): Uruguay included total Fund obligations in the BCU's financial statements and amended external audit firm selection criteria in line with recommendations.
- FSAP and ROSCs:
  - Financial Sector Stability Assessment considered June 28, 2006 (Country Report No. 06/187).
  - ROSC-module on fiscal transparency published March 5, 2001.
  - ROSC-module on data dissemination practices published October 18, 2001.
  - ROSC on AML/CFT published December 2006 (Country Report No. 06/435).
- Technical assistance:
  - FAD: tax, customs, and social security administration in February 2007, March 2006, June 2005, July 2003; tax policy in October 2005 and May 2003; public financial management in March 2005 and July 2006.
  - STA: adequate recording of loans funded by the FSBS in April 2003.
  - MFD: continuous assistance since 2002 on resolution of intervened banks, restructuring of BROU, BHU, and in July 2005 jointly with ICM on debt management; assistance on monetary and exchange rate policies in July 2006 and May 2007.
  - LEG: technical assistance in February 2007 to develop a framework for a national AML/CFT strategy consistent with the Fund’s 2005 AML/CFT assessment.
- Resident Representative: Mr. Gaston Gelos. Starting late August, the Resident Representative will cover Uruguay from the Buenos Aires’ office.

### Exchange rate arrangement and related operational details
- Currency: Uruguayan peso (Ur$).
- De facto regime: reclassified in April 2006 from an independent float to a managed float with no predetermined path.
- On May 31, 2007, buying and selling interbank rates for the U.S. dollar (the intervention currency) were Ur$ 23,97 and Ur$24.02, respectively.
- Uruguay’s exchange system: free of restrictions on payments and transfers for current international transactions.
- The exchange restriction associated with reprogramming of time deposits at BROU and BHU during the 2002 crisis was removed ahead of schedule in April 2005.

*Staff Report for the 2007 Article IV Consultation—Informational Annex. Prepared by the Western Hemisphere Department. July 31, 2007.*

### 2002. Following the 2002 crisis, the Bank increased its financial support, shifting to a high

### _cr0845 - 2002. Following the 2002 crisis, the Bank increased its financial support, shifting to a high

### Bank lending response and adjustment operations (2002–07)
- High case lending scenario of US$550 million for fiscal years 2002–04, concentrated in adjustment lending.
- SAL I and SSAL I approved with the CAS Progress Report, totaling US$303 million, to assist Uruguay in addressing structural weaknesses and in managing the economic crisis.
- On April 8, 2003, SAL II and SSAL II approved totaling US$252.5 million, focusing on improving public services and human development policies.
- Progress in implementation of SAL I and SSAL I has been satisfactory; last tranches in an aggregate amount of US$100 million (US$50 million of SAL I and US$50 million of SSAL I) were released in October 2004.
- SAL II restructuring:
  - Because of the 2003 referendum on petroleum and the 2004 constitutional amendment on water, SAL II was restructured.
  - In January 2007, a second tranche of US$40 million was released and the third tranche was cancelled.
- SSAL II:
  - Objectives achieved; outstanding second and third tranches cancelled at the Government’s request.
- Development Policy Loans (DPLs) supporting social reform:
  - DPL1 approved June 9, 2005, amount US$75 million; supported health, education and social protection measures; DPL1 fully disbursed.
  - A subsequent First Programmatic Reform Implementation Development Policy Loan in the amount of US$100 million to be considered by the Board of Directors on May 30, 2007; will support tax reform, business climate and capital markets development, and improving the social protection system.
- Other operations presented or to be presented:
  - Institution Building Technical Assistance Project in the amount of US$15 million to be presented to the Board on May 30, 2007.
  - Second phase of an APL for OSE Modernization and Rehabilitation Systems (US$50 million) to be presented for approval before the end of the fiscal year.

### Investment operations and portfolio (approvals, commitments, disbursements)
- Investment operations approved since beginning of new CAS period:
  - Integrated Natural Resources: US$30 million (approved June 9, 2005).
  - Transport Infrastructure and Rural Access: US$70 million (approved June 9, 2005).
  - Supplemental Financing for the Foot and Mouth Disease Project: US$6.5 million (approved December 2006).
  - Promoting Innovation to Enhance Competitiveness Project: US$26 million (approved May 1, 2007).
- Current investment portfolio (six projects) totals US$181 million in commitments, with an undisbursed amount of US$141 million as of May 17, 2007.
- Investment portfolio disbursements by calendar year:
  - CY04 disbursements: US$43.8 million.
  - CY05 disbursements: US$58.6 million.
  - CY06 disbursements: US$42.1 million (decrease due to portfolio renewal and slow start-up of new operations).
- IBRD Operations (as of May 21, 2007) — Commitments / Disbursed / Undisbursed (In millions of U.S. dollars):
  - Foot & Mouth Disease (Add. Financing): 7 / 0 / 7
  - Public Services Modernization: 6 / 2 / 4
  - Basic Education III: 42 / 20 / 22
  - Transport Infrastr. Maint. & Rural Access: 70 / 14 / 56
  - Integrated Nat. Resources & Biodiv. Mgnt.: 30 / 2 / 28
  - Innovation to Enhance Competitiveness: 26 / 0 / 26
  - Total: 181 / 39 / 141

### IFC and MIGA involvement; Botnia project
- On November 21, 2006, the Board of Executive Directors of the WB Group approved:
  - a loan of US$170 million by the IFC, and
  - a guarantee of US$350 million by MIGA,
  - to the Finnish company Botnia for the construction of a wood pulp plant in Fray Bentos.
- IFC Operations (as of April 30, 2007) — Committed / Outstanding (In millions of U.S. dollars):
  - Loans: Committed 115.1 / Outstanding 59.8
  - Equity: Committed 0.0 / Outstanding 0.0
  - Quasi: Committed 8.3 / Outstanding 8.3
  - Participation: Committed 100.0 / Outstanding 63.8

### IBRD loan transactions (calendar year) — aggregates (As of May 21, 2007)
- Disbursements by year (calendar year):
  - 2002: 234
  - 2003: 97
  - 2004: 144
  - 2005: 134
  - 2006: 42
  - 2007: 171
- Debt service payments by year:
  - 2002: 75
  - 2003: 78
  - 2004: 80
  - 2005: 104
  - 2006: 205
  - 2007: 61
- Net Disbursements by year:
  - 2002: 158
  - 2003: 19
  - 2004: 64
  - 2005: 30
  - 2006: -163
  - 2007: 110

### Relations with the Inter-American Development Bank (IDB) and lending program (2005–09)
- IDB Country Strategy for Uruguay approved March 15, 2006; priority areas:
  - (i) improving public sector management to support fiscal and debt sustainability;
  - (ii) enhancing regional and international competitiveness and encouraging private investment; and
  - (iii) reducing poverty and increasing social inclusion.
- Proposed likely lending scenario about US$1.2 million for the five-year period 2005–09 (document text).
- IDB approvals and pipeline examples:
  - Program to support productivity and development of new livestock products: US$15.8 million (approved July 2005).
  - Investment project to improve cluster competitiveness: US$9 million (approved July 2006).
  - Two-year programmatic loan to improve competitiveness: total US$150 million (US$75 million each); first loan approved January 2007; second expected approval in early 2008.
  - Sector loan for social policy: US$250 million (approved August 2005).
  - Loan for sanitation: US$118.6 million (approved January 2006).
  - Loan to support public debt management unit: US$2.45 million (approved November 2005).
  - Three-year programmatic loan to support improvements in tax administration and public sector management: first loan US$50 million (approved October 2006); second loan estimated US$150 million likely end-2007; amount for 2008 to be determined.
- As of May 24, 2007:
  - Bank’s current portfolio in Uruguay includes loans for financing of 18 investment projects and two policy based operations.
  - Lending portfolio amounts to US$1,017.55 million, of which US$604.8 million are pending disbursement.
- Debt management actions:
  - Authorities paid in February 2006 US$100 million due and pre-paid remaining US$300 million due in August 2006 and 2007, corresponding to the Social Protection and Sustainability Program approved in August 2002.

### IDB financial table highlights (In millions of U.S. dollars)
- Total outstanding loans: US$1,868.7 (As of April 30, 2007).
- Loan transactions — Disbursements by year (selected):
  - 2000: 162.9
  - 2001: 214.2
  - 2002: 558.6
  - 2003: 67.2
  - 2004: 53.1
  - 2005: 242.3
  - 2006: 114.8
  - 2007: 92.5
- Loan transactions — Amortization by year (selected):
  - 2000: 59.4
  - 2001: 60.7
  - 2002: 73.1
  - 2003: 103.7
  - 2004: 113.3
  - 2005: 220.0
  - 2006: 519.6
  - 2007: 138.1
- Net Loan Flows by year (selected):
  - 2000: 103.5
  - 2001: 153.5
  - 2002: 485.5
  - 2003: 263.6
  - 2004: -60.2
  - 2005: 22.3
  - 2006: -404.8
  - 2007: 354.4
- Note: IDB staff projection indicated in table.

### Statistical issues and data quality
- Uruguay subscribed to the SDDS in February 2004 and meets SDDS specifications, using flexibility options for timeliness of central and general government operations and analytical accounts of the banking sector.
- Real sector statistics shortcomings:
  - Use of an outdated benchmark year (1983).
  - Limited coverage of the enterprise survey.
  - Long publication lags.
  - Inadequate information on the informal economy.
  - Incomplete quarterly accounts.
- National accounts and price statistics:
  - Central bank (BCU) compiles annual GDP estimates in current and constant prices by production and expenditure approaches, and quarterly constant price GDP estimates by production and expenditure approaches.
  - CPI base period: March 1997 = 100.
  - WPI base updated to 2001.
  - CPI coverage limited to the capital city.
  - Authorities do not provide trade price and volume indices for publication in the IFS.
- Government finance statistics:
  - Official data on central administration, state enterprises and social security system are complete and current.
  - Problems with timeliness of data on local governments; revenue and expense for local governments not reported since 1994.
  - Financing and debt data timeliness issues reported for Fund statistical publications.
  - Monthly and quarterly financing and debt data disseminated on the BCU website from 1999 onwards for central government and total public sector.
- Monetary and financial statistics:
  - Prepared in accordance with the IMF's Monetary and Financial Statistics Manual (2000).
  - Authorities have yet to report monetary data using the standardized reporting forms (SRF).
  - STA mission in April 2003 assisted with recording loans funded from the Fund for the Stabilization of the Banking System (FSBS) in the Central Bank’s balance sheet; recommendations implemented and reflected in IFS June 2003 issue.
- External sector statistics:
  - Balance of payments compiled and published quarterly following BPM5 recommendations.
  - Quarterly balance of payments and annual IIP data reported to STA for publication in the IFS and the Balance of Payments Statistics Yearbook.
  - Uruguay started disseminating the international reserves and foreign currency liquidity data template on the Fund’s external website in 2005.
  - BCU disseminates quarterly external debt statistics on its website, although not in SDDS format.

### Uruguay: Table of Common Indicators Required for Surveillance (As of July 19, 2007) — selected entries
- Exchange Rates: Date of latest observation May 2007; Date received 6/15/07; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- International Reserve Assets and Reserve Liabilities of the Monetary Authorities: Date of latest observation May 2007; Date received 7/2/07; Frequency of Data M; Frequency of Reporting M; Frequency of Publication M.
- Reserve/Base Money: Date of latest observation Apr. 2007; Date received 6/6/07; Frequency M / M / M.
- Broad Money: Date of latest observation Mar. 2007; Date received 6/6/07; Frequency M / M / M.
- Central Bank Balance Sheet: Date of latest observation Apr. 2007; Date received 6/6/07; Frequency M / M / M.
- Consolidated Balance Sheet of the Banking System: Date of latest observation Mar. 2007; Date received 6/6/07; Frequency M / M / M.
- Interest Rates: Date of latest observation Apr. 2007; Date received 6/6/07; Frequency M / M / M.
- Consumer Price Index: Date of latest observation Jun. 2007; Date received 7/13/07; Frequency M / M / M.
- Revenue, Expenditure, Balance and Composition of Financing – General Government: Date of latest observation Mar. 2005; Date received 6/30/2005; Frequency M / M / M.
- Revenue, Expenditure, Balance and Composition of Financing – Central Government: Date of latest observation Dec. 2006; Date received 4/2/07; Frequency M / M / M.
- Stocks of Central Government and Central Government-Guaranteed Debt: Date of latest observation Mar. 2005; Date received 6/30/2005; Frequency Q / Q / Q.
- External Current Account Balance: Date of latest observation Q4/06; Date received April 2007; Frequency Q / Q / M.
- Exports and Imports of Goods and Services: Date of latest observation Q4/06; Date received April 2007; Frequency Q / Q / M.
- GDP/GNP: Date of latest observation 2006; Date received April 2007; Frequency A / A / M.
- Gross External Debt: Date of latest observation Q4/05; Date received March 2006; Frequency Q / Q / Q.

### Staff developments, inflation and market reaction (August–September 2007)
- Staff Representative statement (August 29, 2007):
  - Twelve-month inflation at end-July was 8.0 percent.
  - Authorities’ target range for end-2007: 4½–6½ percent; risks of exceeding target increased.
  - Latest survey shows expected inflation for end-2007 near 7½ percent, but still declining toward the target range in 2008.
  - Recent financial turmoil had only moderate impact in Uruguay: exchange rate did not come under pressure; sovereign spreads widened marginally (reaching 238 basis points in mid August, compared to 213 at end July).
- Public Information Notice (PIN) No. 07/111 — FOR IMMEDIATE RELEASE September 10, 2007:
  - IMF Executive Board concluded the 2007 Article IV consultation with Uruguay on August 29, 2007.
  - Background summary: economy continues to expand after 2002 crisis; poverty rates declined considerably; unemployment at lowest level in a decade; growth exceeded expectations; recent increase of inflation and ongoing structural reform implementation remain key challenges.
  - Real GDP grew by 7 percent in 2006.

*Source: IMF staff report content unit _cr0845 (excerpt).*

### 2002. The growth momentum remains solid this year, led by foreign investment and

### _cr0845 - 2002. The growth momentum remains solid this year, led by foreign investment and

### Macroeconomic performance and outlook
- Real GDP growth has been robust through 2007, supported by foreign investment and consumption.
- Twelve-month inflation through July 2007 was 8 percent, above the upper limit of the central bank’s target range (6.5 percent).
- Primary balances have averaged near 4 percent of GDP since 2004.
- Public debt declined from 110 percent of GDP in 2003 to a projected 62 percent of GDP by end 2007.
- Peso-denominated, inflation-indexed notes represent approximately 30 percent of the outstanding public debt stock.
- The central bank has accumulated US$3.6 billion in reserves to date, equivalent to six months of imports or three times short-term debt.
- Financing needs are described as remaining moderate in the next few years.

### Fiscal policy and public finances
- Fiscal performance has been strong, enabling room for priority social and capital expenditures while maintaining primary balances consistent with the five-year budget approved in December 2005.
- Key fiscal figures and developments:
  - Primary balances averaging near 4 percent of GDP since 2004.
  - Total revenues around 32.5 percent of GDP (2007 projection in table).
  - Expenditure around 32.7 percent of GDP (2007 projection in table).
  - Overall balance projected at -0.1 percent of GDP in 2007 (table).
  - Public sector debt projected at 62.0 percent of GDP in 2007 (table).
- Policy recommendations and priorities:
  - Continue tax administration and customs reforms and monitor implementation of the landmark tax reform effective July 2007.
  - Maintain large primary surpluses to further reduce the public debt ratio.
  - Gradually reduce nondiscretionary spending to free resources for public investment.
  - Press ahead with reform of specialized pension funds.
  - Carefully assess, minimize contingent liabilities, and strengthen legal and accounting frameworks for public-private partnerships (PPPs).

### Monetary policy, inflation, and exchange rate
- Inflation drivers: pass-through from oil and other commodity prices and strong domestic activity; imported inflation via commodity prices and fuel price pass-through; weather shocks (drought, flood, severe cold) also affected agricultural output and CPI.
- The central bank has acted to address rising inflation by substantially lowering its monetary targets; the BCU's target-range is expected to decrease in the future (4-6 percent in 2008).
- Directors’ guidance and staff commentary:
  - Continue efforts to bring inflation and expectations within the target range, including allowing interest rates to adjust freely to monetary tightening.
  - Clarify objectives and instruments of monetary policy, including foreign exchange intervention, to enhance effectiveness amid large capital inflows.
  - Some additional reserve buildup would be helpful given high dollarization and likely declines in banks’ liquidity.
  - Foreign exchange purchases should not hinder exchange rate movements and should be subordinated to the inflation objective by allowing the currency to adjust more freely to shocks.
  - Adoption of inflation targeting should proceed gradually given still high dollarization.
  - Steps to enhance credibility: capitalize the central bank and strengthen its autonomy.
- Authorities’ approach:
  - Opportunistic foreign currency purchases used to increase reserves and smooth volatility, while agreeing exchange rate should float more freely in response to normal shocks.
  - Monetary and fiscal instruments will be pragmatically tuned-up if necessary to meet the inflation target.

### External sector and market access
- External sector described as strong with buoyant exports and import growth driven by large foreign direct investment projects.
- Measures of exchange rate competitiveness indicate the peso broadly in line with fundamentals, though appreciation pressures may increase with persistent high capital inflows.
- Sovereign spreads are below pre-crisis levels.
- Reserves and external indicators:
  - Gross official reserves: US$3.6 billion (accumulated to date).
  - Reserves equivalent to six months of imports or three times short-term debt.
  - Selected balance of payments table highlights:
    - Current account: projected -2.8 percent of GDP in 2007 (table).
    - Foreign direct investment: 5.2 percent of GDP in 2007 (table).
    - Overall balance of payments (US$ millions): 685 in 2007 (table).
    - Debt service ratio: 24.4 (in percent of exports of goods & services) in 2007 (table).

### Financial sector soundness and vulnerabilities
- Financial indicators improved considerably since the crisis: well-capitalized banking system, low non-performing-loan ratios, high liquidity levels, and improved profitability.
- Short-term debt sharply reduced through debt management operations.
- Stress tests confirm increased resilience of the financial system.
- Remaining vulnerabilities:
  - High dollarization: Uruguay remains one of the most dollarized economies in the world (70 percent of public debt and over 80 percent of total liabilities are denominated in dollars).
  - State dominance in the financial system remains large.
  - Spillovers from regional shocks remain a concern given increasing financial risk.
- Policy recommendations for financial sector:
  - Deepen financial sector reforms and implement recommendations of the 2006 Financial Sector Assessment Program.
  - Further strengthen state banks and banking supervision.
  - Complete restructuring of the housing bank (BHU) to allow resumption of sound mortgage lending.
  - Swift approval of the financial sector law to enhance central bank independence and strengthen supervisory and resolution frameworks.
  - Reduce debt dollarization over time to lower vulnerabilities.
  - Participation in regional arrangements: directors welcomed the authorities’ decision to join the Latin American Reserve Fund (FLAR).

### Structural reforms, business climate, and social outcomes
- Structural achievements and reforms under way:
  - Debt Management Unit established at the Ministry of Finance improved debt cost, maturity, and currency structure.
  - Privatization of Nuevo Banco Comercial (NBC) and introduction of a limited deposit insurance scheme after the Cofac cooperative bank insolvency.
  - Creation of a Private Investment Office and transformation of the Tax Agency (DGI); customs agency and social security bank (BPS) undergoing reforms.
  - Investment Treaty with the United States and a Trade and Investment Framework Agreement (TIFA) signed.
  - Passage of a competition law; bankruptcy law expected to be approved.
  - Legal framework for BHU reform approved and at implementation stage.
  - Tax reform implemented in July 2007; reforms intended to improve efficiency, equity, and investment promotion.
- Social and labor outcomes:
  - Unemployment below 9 percent (the lowest rate in more than a decade).
  - Real wages have increased significantly but have not yet fully recovered to pre-crisis levels.
  - Poverty rate is five percentage points lower than it was two and a half years ago.
  - Investment relative to GDP at an inedited high level for the country.
- Authorities’ reform priorities going forward:
  - Approval of financial sector laws and reform of the police pension fund.
  - Continued emphasis on consensus-building and social inclusiveness to ensure sustainable reforms.
  - Improve business climate further, including enhancing competition in labor markets and reducing bureaucratic impediments to investment.

### Executive Board assessment and recommendations
- Executive Directors commended sound policies and structural reform progress that produced vigorous recovery since the 2002 crisis and reduced vulnerabilities.
- Key messages:
  - Inflation above the target range and steadfast implementation of ongoing structural reforms are among the key challenges.
  - Encourage efforts to bring inflation and expectations within the target range while allowing interest rates to adjust.
  - Support further reserve accumulation but caution that foreign exchange purchases should not impede exchange-rate adjustment.
  - Strengthen monetary framework credibility by capitalizing the central bank and strengthening its autonomy.
  - Maintain large primary surpluses to reduce the public debt ratio, and consider exceeding medium-term targets if inflation concerns persist.
  - Continue reforms to reduce debt dollarization and deepen financial sector reforms, including implementing FSAP recommendations and completing BHU restructuring.
  - Welcome authorities’ progress in tax and customs administration and support careful use of PPPs with minimized contingent liabilities.
- Directors welcomed review of Uruguay's experience under the 2005–06 Stand-By Arrangement and supported the ex post evaluation’s messages that strong ownership and prudent macroeconomic policies contributed to program success.

*IMF staff report and Executive Board assessment (Article IV consultation, Uruguay, August 2007).*

### Chapter III of the Selected Issues Paper deserves an in-depth analysis. This study notes that

### _cr0845 - Chapter III of the Selected Issues Paper deserves an in-depth analysis. This study notes that

### Emerging market spread dynamics and Uruguay's position
- Since the loss of investment grade, Uruguay's spreads are mostly associated with those of other emerging market economies - particularly neighboring countries.
- Almost every country in the world is affected by deeper links to the global financial markets established by a high integration and more sophisticated products; Uruguay is no exception.
- During 2004 and 2005 the average of EMBI global bond spreads for emerging markets were noticeably lower than Uruguay's.
- The current situation is showing a positive change for the country in absolute and relative terms.

### Rating developments and recognition of policy
- During the period of market turbulences in recent weeks, Uruguay's rating was upgraded.
- The upgrade is described as an arms-length recognition to the authorities' fiscal policies and debt strategy, firmly settled on Uruguay's long and unalterable tradition of honoring its debts.
- This recognition was "fully recognized by many outstanding international policymakers during a recent conference on Uruguay's 2002 crisis and its aftermath."

### Authorities' assessment, policy stance, and outlook
- The authorities are satisfied with the positive results achieved so far, as well as the encouraging prospects based on sound policies and the reform advances undertaken in two and a half years.
- The authorities state this is not bringing complacency but rather reinforcing their determination to continue making progress to fully implement the government's policies and reform agenda.
- The aim is to set the basis for Uruguay's sustainable growth and human development.
- The Article IV consultation "ratifies once again the excellent relation between Uruguay and the IMF."
- Authorities "very much value the candid and fruitful discussions on different issues, even in those where both sides had different approaches."

### Notable references and remarks included in the text
- Footnote [1]: Cites Alejandro Foxley (cited by Allan Drazen in Political Economy in Macroeconomics, Princeton University Press, 2000) underscoring that "economists must not only know their economic models, but also understand politics, interests, conflicts, passions -the essence of collective life. For a brief period of time you could make changes by decree; but to let them persist, you have to build coalitions and bring people around."
- Footnote [2]: "For instance, Euromoney awarded Uruguay as the best borrower among emerging countries in 2007."
- Footnote [3]: Reference to "Uruguay: The 2002 Crisis and its Aftermath. Montevideo, May 29, 2007."

*Source: _cr0845 - Chapter III of the Selected Issues Paper deserves an in-depth analysis. This study notes that*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2008/_cr0845.pdf_