## I. COMMODITY PRICES: THEIR IMPACT ON INFLATION IN URUGUAY ## Source details **Canonical URL:** [I. COMMODITY PRICES: THEIR IMPACT ON INFLATION IN URUGUAY](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2009/_cr09103.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2009/_cr09103.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2009/_cr09103.pdf.json) --- ### Overview - Purpose: quantify importance of international food and oil price inflation for Uruguayan inflation; draw international comparisons; examine spillovers to measures of core inflation using VAR and Phillips-curve estimations. - Key methodological notes: - Phillips-curve estimations use quarterly CPI inflation, lags of inflation, unemployment rate gap, nominal effective exchange rate (NEER), changes in peso price of world fuel and food prices. Sample covers 1998 Q1-2008 Q1, with 41 observations. - VAR: six-variable recursive VAR with quarterly data, covering 1996Q1-2008Q2 for nominal prices of fuel and food (US$), economic activity (output gap proxied by unemployment deviations), nominal effective exchange rate, monetary aggregates, and headline, food, fuel and underlying consumer prices. ### Main empirical findings — Magnitude and pass-through - World food prices: - A 10 percentage point increase in world food prices raises domestic CPI inflation by about 1.2 percentage points after a full year (VAR, US$-based index). - Phillips-curve estimate: coefficient on world food prices around 0.05 implies a 10 percentage point increase in world food prices is associated with an immediate 0.5 percentage point increase in domestic CPI inflation. - Using indices in local currency, estimated impact is higher: 1.8 percentage points after one year. - Impact on food sub-component: a 10 percentage point increase in world food prices raises domestic food prices immediately by 1.6 percentage points, and by 4 percentage points after a full year. - Spillovers to core inflation: on average, a 10 percentage point shock raises core inflation by 0.8 percentage points immediately, and close to 2 percentage points by the end of one year. Duration of core inflation response typically lasts between 1½ and 2 years. - Uruguay’s pass-through of world food price shocks is relatively high compared to other emerging markets (higher than all but two countries in the sample referenced). - Authors’ summary: "Roughly one third of current headline inflation levels can be traced to world food price inflation." (¶18) - World fuel prices: - No statistically confirmed pass-through to headline inflation when using US dollar-based index. Fuel shocks: positive and significant impact on domestic fuel inflation but minimal and not statistically significant spillover to non-fuel (headline excluding fuel) inflation in US$-based estimations. - Using a peso-based price index, initial impact is positive and significant, but loses significance after the first quarter. - Phillips-curve and hybrid Phillips-curve GMM estimates: fuel price coefficient around 0.01 (10 percentage point increase in world fuel prices associated with a 0.1 percent rise in headline inflation) or insignificant in baseline Phillips-curve. - Low share of fuel in CPI: gasoline products account for just under 3 percent of the total CPI basket. - Exchange rate and demand effects: - Exchange rate: a 10 percentage point appreciation of the NEER lowers headline inflation by about 3.8 percentage points within the first year. The nominal effective exchange rate rose 17 percent since mid-2007, helping to buffer external commodity shocks. - Demand/output gap: a negative (positive) shock of 10 percentage points to the output gap measure is expected to lower (raise) headline inflation by 0.4 percentage points after 1 year. (On average, this would be equivalent to a 0.5 percentage point increase (decrease) in the unemployment rate.) - Variance decomposition (longer horizon): - In the last 10 years, variations in world food and oil prices have contributed about 15-20 percent of the variation in total (headline) inflation. - Exchange rate changes explain around 28 percent of the variation in headline inflation. - Remaining variation attributed to inertia and other factors not captured by the model. ### Phillips-curve estimation (selected results) - Estimation details: dependent variable headline inflation; sample 1998 Q1-2008 Q1; 41 observations; Newey-West standard errors. - Selected coefficients (Table 1): - Crisis Dummy: Coefficient 1.706; Std. Error 0.572; t-Statistic 2.981; Prob. 0.0058 - Inflation (-1): Coefficient 0.419; Std. Error 0.050; t-Statistic 8.350; Prob. 0.0000 - Inflation (-2): Coefficient -0.067; Std. Error 0.075; t-Statistic -0.899; Prob. 0.3763 - World Fuel Prices: Coefficient -0.008; Std. Error 0.011; t-Statistic -0.695; Prob. 0.4925 - World Food Prices: Coefficient 0.049; Std. Error 0.021; t-Statistic 2.356; Prob. 0.0254 - Unemployment Gap: Coefficient 0.362; Std. Error 0.181; t-Statistic 1.994; Prob. 0.0556 - Unemployment Gap(-1): Coefficient -0.905; Std. Error 0.214; t-Statistic -4.235; Prob. 0.0002 - Unemployment Gap(-2): Coefficient 0.457; Std. Error 0.129; t-Statistic 3.542; Prob. 0.0014 - NEER: Coefficient -0.100; Std. Error 0.022; t-Statistic -4.362; Prob. 0.0001 - Adjusted R-squared 0.873; S.D. dependent var 1.819; Log likelihood -33.21; Durbin-Watson stat 2.156 ### VAR impulse-response and pass-through details - VAR setup: imposed exogeneity on world oil and food prices; Cholesky ordering for remaining variables: domestic economic growth; money growth; exchange rate growth; domestic inflation. - Headline inflation response to a 10 percentage point world food price shock: - Immediate increase: 0.5 percentage points. - After one year: 1.2 percentage points (US$-based index). - Local currency index: 1.8 percentage points after one year. - Core inflation responses to a 10 percentage point food shock (percentage point change in inflation): - 1 quarter: - headline 0.53 - CPI less fruits and vegetables 0.43 - CPI less regulated prices 0.91 - CPI less fruits, vegetables and regulated prices 0.82 - CPI less fruits, vegetables, regulated prices and housekeeping 0.94 - CPI less fruits, vegetables, regulated prices, housekeeping and tobacco products 0.94 - principal component index 0.72 - 1 year: - headline 1.17 - CPI less fruits and vegetables 1.07 - CPI less regulated prices 1.87 - CPI less fruits, vegetables and regulated prices 1.82 - CPI less fruits, vegetables, regulated prices and housekeeping 1.89 - CPI less fruits, vegetables, regulated prices, housekeeping and tobacco products 1.71 - principal component index 1.75 - 2 years: - headline 0.97 - CPI less fruits and vegetables 0.86 - CPI less regulated prices 1.75 - CPI less fruits, vegetables and regulated prices 1.75 - CPI less fruits, vegetables, regulated prices and housekeeping 1.76 - CPI less fruits, vegetables, regulated prices, housekeeping and tobacco products 1.50 - principal component index 1.59 - Producer Price Index (PPI): world food price shocks have a large positive and significant impact on producer prices; PPI response exceeds the CPI response in magnitude and duration. - Fuel shocks: - Response of headline inflation to world fuel shock: positive and significant in first two months, then negative and insignificant thereafter (US$-based). - Response of domestic fuel inflation to world fuel shock: positive and significant. ### Policy-relevant interpretations and implications highlighted - Distinguish between domestic overheating (requires contractive policy response) and external price shocks (monetary policy challenge is to limit second-round effects). - Second-round effects from world food price increases are considerable given spillovers to core inflation. - An appreciating currency has helped dampen the effects of external commodity shocks on domestic inflation (NEER appreciation of 17 percent since mid-2007 cited as buffer). - Low pass-through from world fuel prices to headline inflation likely reflects: - Low share of fuel in CPI (gasoline products just under 3 percent). - Delays in adjustment of domestic fuel prices and regulated energy prices. ### Conclusions (as stated) - The rise of world food prices is an important factor behind the rise in inflation in Uruguay. - The link between world food prices and domestic inflation is significant and robust, and stronger than in many other emerging markets. - Over the last 10 years, commodity prices (food and oil) explain only about 15-20 percent of variation in total inflation; exchange rate changes explain around 28 percent. - Second-round effects from world food price increases are sizeable and affect core inflation measures. *Source: IMF staff paper — “I. COMMODITY PRICES: THEIR IMPACT ON INFLATION IN URUGUAY” (extract provided).* ### Credit Surge, Financial Soundness, and Risks ### Uruguay’s credit surge: overview and headline statistics - After years of depressed levels, credit growth accelerated sharply, reaching about 40percent in the 12 months to June 2008. - Expansion driven mostly by growing consumption and corporate loans. - Financial deepening remains low relative to historical levels and other countries in the region. - Credit dollarization remains high, although currency denomination of loans generally matches borrowers’ income. - Up to August 2008, turbulence in global financial markets did not seem to affect the credit recovery; more recent prospects of a global slowdown and heightened volatility could halt the recovery. ### A. Historical perspective — 2001–2006 - Pre-crisis (1990s): Uruguay was a regional financial center with an over 50 percent credit-to-GDP ratio in 2001. - Non-resident deposits reached some 40 percent of deposits; loans to non-residents were about 10-12 percent of total loans. - Deposit run led to a 48 percent contraction of deposits from end-2001 to end-2003. - Credit to domestic non-financial private sector contracted from US$ 10.5 billion (51 percent of GDP) at end-2001 to about US$ 4.0 billion (24 percent of GDP) at end-2004. - Deposits bottomed at US$ 6.8 billion in April 2003, then increased to US$10 billion by end-2006. - Despite deposit recovery, domestic credit hovered around US$ 4.0-4.5 billion due to stricter prudential regulations, risk aversion, and low investment demand. - Tight legal restrictions precluded public banks—particularly Banco Hipotecario Nacional (BHU)—from expanding credit portfolios. ### B. Recent credit acceleration (late 2006–June 2008) - Credit to the non-financial private sector grew by 50 percent in dollar terms (adjusted for exchange rate variations) from end-2006 to June-2008, with much of the hike occurring during the last 12 months (39 percent). - Non-bank financial enterprises (“Administradoras de Credito”) have been expanding domestic lending rapidly (though still small). - Contributing factors to credit resumption: - Improvement in the balance sheet of Banco de la Republica Oriental del Uruguay (BROU) and normalization of its lending. - Strong deposit inflows. - Falling interest rates in the US and uncertainty over quality of financial assets in mature markets, inducing portfolio shifts toward local assets. - Improving incomes—several years of high growth and recovery of real wages—and favorable growth prospects supported by prudent macroeconomic policies and a booming external environment for exports. - Improving firms’ balance sheets making them attractive to lenders. ### Funding, composition, and sectoral patterns - Funding: - Rapid expansion of credit funded mainly with growing deposits. - Until 2006, a significant share of new funding was invested in foreign and domestic assets other than credit to the private sector. - Example: during 2005-06 banks increased domestic credit only by US$0.5 billion despite receiving US$ 1.3 billion in deposits. - Since end-2006, banks extended about US$1.8 billion in domestic credit out of a US$2.3 billion increase in deposits. - Composition: - Credit growth mainly driven by consumption and corporate loans. - Mortgage and auto loans growth rates: over 300 and 100 percent, respectively, though their contribution to overall credit growth remains low given limited volume. - Within corporate credit, loans to tradable-good sectors (agriculture, mining and manufacturing) have grown most markedly; credit to the service sector also increased considerably. - Contributions and growth figures (as presented): - Growth Rate (12-month) indicators include values such as 55.8, 37.5, 25.5, 8.0, -6.6, 103.0, 15.7, -0.7, -23.8, -9.8, 21.5, 37.4, 31.4, and 339.7. ### Dollarization, maturities, and currency matching - Dollarization: - Share of credit denominated in U.S. dollars fell from 65 percent of total credit in 2000 to 58 percent in 2008. - Public banks: dollarization fell from 50 percent to 32 percent. - Private banks: dollarization remained broadly constant at around 80 percent. - Dollar loans largely extended to corporate tradable sectors; peso loans mostly to consumers—indicating an appropriate match between loan currency and borrower income (service sector is an exception). - Maturities: - About 60 percent of private sector credit has maturities of less than 3 years. - Maturities have become slightly shorter between 2005 and 2008, possibly reflecting resumption of short-term consumption credit and persistence of short-term deposit funding (about 70 percent of deposits remain of less than 30-day maturity). ### Public vs. private banks and non-bank lenders - Credit growth from end-2006 to June-2008: - Public and private banks—excluding BHU—grew credit by 36 percent and 41 percent, respectively. - Public banks expanded lending in local currency; private banks continued to lend mostly in foreign currency. - Market segmentation: public banks (BROU) specialized in consumer loans; private banks focused on corporate loans. - Public banks invested a significant share of new funding in foreign assets; bulk of new non-resident deposits went to private banks, which channeled such funds toward foreign assets. - Non-bank financial enterprises (“Administradoras de Credito”): - Credit stocks about US$250 million—mostly high-interest-rate consumer loans. - Rapidly expanding portfolios and some linked to commercial banks, operating as loan originators. - They have been entering local capital markets through issuance of relatively short term paper. - When loans are transferred to commercial banks, standard prudential regulations apply. ### C. Risks of a sustained rapid credit expansion - The report flags that while sustained rapid credit growth could lead to vulnerabilities, the risk of a possible loosening in lending standards appears contained at present by a broadly appropriate prudential framework. - However, the report notes that more recent prospects of a global slowdown and heightened volatility in global financial markets could halt the credit recovery. ### Inflation pressures, policy implications, and key findings (policy recommendations) - Domestic demand pressures have played an important role in inflation dynamics and spillovers to core inflation support the need to contain second-round effects. - Policy recommendations: - Tighter fiscal and monetary policy would help dampen demand pressures. - More exchange rate flexibility would help, as evidenced in the sizeable contribution of exchange-rate movements in explaining variations in inflation. - Avoiding backward-looking indexation mechanisms is critical to prevent exogenous shocks from becoming entrenched in inflation and inflation expectations. ### Credit levels and international comparison - At about US$ 6.2 billion (24 percent of GDP), credit to the non-financial private sector compares low with levels of about 50 percent or GDP prior to 2002. - Uruguay’s still low level of credit relative to some neighboring countries is particularly evident if alternative financing channels are taken into account, as other countries in the region (e.g. Brazil, Mexico) have significantly more developed local private capital markets. ### Cross-border banking and non-resident deposits - The pace of growth of non-resident deposits, while recently accelerating, has been in line with that of residents deposits, thus keeping the share of non-resident deposits at about 15 percent of total deposits in the system (20 percent in relation to foreign currency deposits). - The growth of non-resident deposits seems to be properly backed by further accumulation of net foreign assets. - The expansion of credit by banks has been concentrated solely in the domestic economy, keeping loans to non-resident below 2 percent of total loans in the system. - Note on drivers: The recent increase in non-resident deposits has been, arguably, driven by a flight to ‘safety’ triggered by some financial turbulence in Argentina in the first quarter of 2008. ### Key financial soundness indicators (selected statistics) - Credit to the private sector has remained below 30 percent of total assets despite recent expansion. - (30-day) liquidity ratios remain high at about 62 percent of short-term liabilities. - Non-performing loans (NPLs) are very low at about ½ percent. - Provisions are high as share of NPLs. - Capitalization ratios are at about 10 percent of total assets, remaining above the 8 percent requirement. - Table 1 excerpt (selected series and exact values): - Capital/total assets (book value): Dec 2005 = 8.2; Dec 2006 = 9.4; June 2007 = 10.1; Dec 2007 = 10.5; June 2008 = 10.6. - Return on assets (weighted by market share): Dec 2005 = 0.84; Dec 2006 = 1.02; June 2007 = 1.71; Dec 2007 = 1.32; June 2008 = 0.99. - Credit NFPS/total assets: Dec 2005 = 22.8; Dec 2006 = 24.5; June 2007 = 25.2; Dec 2007 = 29.0; June 2008 = 29.5. - Foreign assets/total assets: Dec 2005 = 21.6; Dec 2006 = 24.2; June 2007 = 26.8; Dec 2007 = 23.0; June 2008 = 18.3. - Liquidity ratio (30 days, weighted): Dec 2005 = 80.7; Dec 2006 = 110.6; June 2007 = 69.1; Dec 2007 = 53.9; June 2008 = 62.2. - NPLs % weighted: Dec 2005 = 5.66; Dec 2006 = 4.11; June 2007 = 3.37; Dec 2007 = 1.12; June 2008 = 0.44. - Provisions (share of NPLs, weighted): Dec 2005 = 1082; Dec 2006 = 1068; June 2007 = 1008; Dec 2007 = 718; June 2008 = 683. ### Assessment of current vulnerabilities and medium-term challenges - The evidence points to a healthy revival of credit. - At the current juncture, vulnerabilities associated to Uruguay’s rapid credit expansion seem contained. - Immediate risks point to a possible halt of this recovery, as global financial conditions and growth prospects worsen. - Even if the economic cycle reverts and non performing loans come back to normal levels, banks provisions are likely remain ample. - Continued vigilance by monetary and regulatory authorities will be key to ensure that vulnerabilities do not build up if rapid credit growth persists. - Macroeconomic management challenges: - In the context of inflationary pressures, a credit boom exacerbates domestic demand pressures and potential macroeconomic imbalances (e.g. fueling a current account deficit), and further complicates monetary and fiscal policy. - A credit boom could also lead to assets price bubbles. - Continued monitoring and management of domestic credit conditions should remain an important component of monetary policy. *Source: _cr09103 - IMF staff chapter/section extract.* ### References ............................................................................................................. ### I. COMMODITY PRICES: THEIR IMPACT ON INFLATION IN URUGUAY ### Overview - Purpose: quantify importance of international food and oil price inflation for Uruguayan inflation; draw international comparisons; examine spillovers to measures of core inflation using VAR and Phillips-curve estimations. - Key methodological notes: - Phillips-curve estimations use quarterly CPI inflation, lags of inflation, unemployment rate gap, nominal effective exchange rate (NEER), changes in peso price of world fuel and food prices. Sample covers 1998 Q1-2008 Q1, with 41 observations. - VAR: six-variable recursive VAR with quarterly data, covering 1996Q1-2008Q2 for nominal prices of fuel and food (US$), economic activity (output gap proxied by unemployment deviations), nominal effective exchange rate, monetary aggregates, and headline, food, fuel and underlying consumer prices. ### Main empirical findings — Magnitude and pass-through - World food prices: - A 10 percentage point increase in world food prices raises domestic CPI inflation by about 1.2 percentage points after a full year (VAR, US$-based index). - Phillips-curve estimate: coefficient on world food prices around 0.05 implies a 10 percentage point increase in world food prices is associated with an immediate 0.5 percentage point increase in domestic CPI inflation. - Using indices in local currency, estimated impact is higher: 1.8 percentage points after one year. - Impact on food sub-component: a 10 percentage point increase in world food prices raises domestic food prices immediately by 1.6 percentage points, and by 4 percentage points after a full year. - Spillovers to core inflation: on average, a 10 percentage point shock raises core inflation by 0.8 percentage points immediately, and close to 2 percentage points by the end of one year. Duration of core inflation response typically lasts between 1½ and 2 years. - Uruguay’s pass-through of world food price shocks is relatively high compared to other emerging markets (higher than all but two countries in the sample referenced). - Authors’ summary: "Roughly one third of current headline inflation levels can be traced to world food price inflation." (¶18) - World fuel prices: - No statistically confirmed pass-through to headline inflation when using US dollar-based index. Fuel shocks: positive and significant impact on domestic fuel inflation but minimal and not statistically significant spillover to non-fuel (headline excluding fuel) inflation in US$-based estimations. - Using a peso-based price index, initial impact is positive and significant, but loses significance after the first quarter. - Phillips-curve and hybrid Phillips-curve GMM estimates: fuel price coefficient around 0.01 (10 percentage point increase in world fuel prices associated with a 0.1 percent rise in headline inflation) or insignificant in baseline Phillips-curve. - Low share of fuel in CPI: gasoline products account for just under 3 percent of the total CPI basket. - Exchange rate and demand effects: - Exchange rate: a 10 percentage point appreciation of the NEER lowers headline inflation by about 3.8 percentage points within the first year. The nominal effective exchange rate rose 17 percent since mid-2007, helping to buffer external commodity shocks. - Demand/output gap: a negative (positive) shock of 10 percentage points to the output gap measure is expected to lower (raise) headline inflation by 0.4 percentage points after 1 year. (On average, this would be equivalent to a 0.5 percentage point increase (decrease) in the unemployment rate.) - Variance decomposition (longer horizon): - In the last 10 years, variations in world food and oil prices have contributed about 15-20 percent of the variation in total (headline) inflation. - Exchange rate changes explain around 28 percent of the variation in headline inflation. - Remaining variation attributed to inertia and other factors not captured by the model. ### Phillips-curve estimation (selected results) - Table 1 selected coefficients (dependent variable: headline inflation; sample 1998 Q1-2008 Q1; 41 observations; Newey-West standard errors): - Crisis Dummy: Coefficient 1.706; Std. Error 0.572; t-Statistic 2.981; Prob. 0.0058 - Inflation (-1): Coefficient 0.419; Std. Error 0.050; t-Statistic 8.350; Prob. 0.0000 - Inflation (-2): Coefficient -0.067; Std. Error 0.075; t-Statistic -0.899; Prob. 0.3763 - World Fuel Prices: Coefficient -0.008; Std. Error 0.011; t-Statistic -0.695; Prob. 0.4925 - World Food Prices: Coefficient 0.049; Std. Error 0.021; t-Statistic 2.356; Prob. 0.0254 - Unemployment Gap: Coefficient 0.362; Std. Error 0.181; t-Statistic 1.994; Prob. 0.0556 - Unemployment Gap(-1): Coefficient -0.905; Std. Error 0.214; t-Statistic -4.235; Prob. 0.0002 - Unemployment Gap(-2): Coefficient 0.457; Std. Error 0.129; t-Statistic 3.542; Prob. 0.0014 - NEER: Coefficient -0.100; Std. Error 0.022; t-Statistic -4.362; Prob. 0.0001 - Adjusted R-squared 0.873; S.D. dependent var 1.819; Log likelihood -33.21; Durbin-Watson stat 2.156 ### VAR impulse-response and pass-through details - VAR setup: imposed exogeneity on world oil and food prices; Cholesky ordering for remaining variables: domestic economic growth; money growth; exchange rate growth; domestic inflation. - Headline inflation response to a 10 percentage point world food price shock: - Immediate increase: 0.5 percentage points. - After one year: 1.2 percentage points (US$-based index). - Local currency index: 1.8 percentage points after one year. - Core inflation responses (various measures excluding fruits/vegetables, regulated prices, housekeeping, tobacco, etc.): - 1 quarter: headline 0.53; CPI less fruits and vegetables 0.43; CPI less regulated prices 0.91; CPI less fruits, vegetables and regulated prices 0.82; CPI less fruits, vegetables, regulated prices and housekeeping 0.94; CPI less fruits, vegetables, regulated prices, housekeeping and tobacco products 0.94; principal component index 0.72 - 1 year: headline 1.17; CPI less fruits and vegetables 1.07; CPI less regulated prices 1.87; CPI less fruits, vegetables and regulated prices 1.82; CPI less fruits, vegetables, regulated prices and housekeeping 1.89; CPI less fruits, vegetables, regulated prices, housekeeping and tobacco products 1.71; principal component index 1.75 - 2 years: headline 0.97; CPI less fruits and vegetables 0.86; CPI less regulated prices 1.75; CPI less fruits, vegetables and regulated prices 1.75; CPI less fruits, vegetables, regulated prices and housekeeping 1.76; CPI less fruits, vegetables, regulated prices, housekeeping and tobacco products 1.50; principal component index 1.59 - Note: estimates are the percentage point change in inflation in response to a 10 percentage point increase in food commodity prices. - Producer Price Index (PPI): world food price shocks have a large positive and significant impact on producer prices; PPI response exceeds the CPI response in magnitude and duration. - Fuel shocks: - Response of headline inflation to world fuel shock: positive and significant in first two months, then negative and insignificant thereafter (US$-based). - Response of domestic fuel inflation to world fuel shock: positive and significant. ### Policy-relevant interpretations and implications highlighted - Distinguish between domestic overheating (requires contractive policy response) and external price shocks (monetary policy challenge is to limit second-round effects). - Second-round effects from world food price increases are considerable given spillovers to core inflation. - An appreciating currency has helped dampen the effects of external commodity shocks on domestic inflation (NEER appreciation of 17 percent since mid-2007 cited as buffer). - Low pass-through from world fuel prices to headline inflation likely reflects: - Low share of fuel in CPI (gasoline products just under 3 percent). - Delays in adjustment of domestic fuel prices and regulated energy prices. ### Conclusions (as stated) - The rise of world food prices is an important factor behind the rise in inflation in Uruguay. - The link between world food prices and domestic inflation is significant and robust, and stronger than in many other emerging markets. - Over the last 10 years, commodity prices (food and oil) explain only about 15-20 percent of variation in total inflation; exchange rate changes explain around 28 percent. - Second-round effects from world food price increases are sizeable and affect core inflation measures. *Source: IMF staff paper — “I. COMMODITY PRICES: THEIR IMPACT ON INFLATION IN URUGUAY” (extract provided).* ### 19. However, domestic demand pressures have also played an important role, and ### _cr09103 - 19. However, domestic demand pressures have also played an important role, and ### Inflation pressures, policy implications, and key findings - Domestic demand pressures have played an important role in inflation dynamics and spillovers to core inflation support the need to contain second-round effects. - Policy recommendations: - Tighter fiscal and monetary policy would help dampen demand pressures. - More exchange rate flexibility would help, as evidenced in the sizeable contribution of exchange-rate movements in explaining variations in inflation. - Avoiding backward-looking indexation mechanisms is critical to prevent exogenous shocks from becoming entrenched in inflation and inflation expectations. ### References (selected works cited in the source) - Blanchard, Olivier, and Jordí Galí, 2008, “The Macroeconomic Effects of Oil Price Shocks: Why are the 2000s so Different from the 1970s?” NBER Working Paper. - De Gregorio, José, Oscar Landerretche, and Christopher Neilson (2007), “Another Pass-Through Bites the Dust? Oil Prices and Inflation?” Economia. - Deutsche Bank, 2007, “Inflation Pass-Through Composition in EM,” Global Markets Research Economics Special Report, May. - Deutsche Bank, 2008, “Commodity Pass-Through and 2nd Round Effects in EM Inflation” Emerging Markets Monthly, May. - Duma, Nombuelo, 2008 “Pass-Through of External Shocks to Inflation in Sri Lanka,” IMF Working Paper 08/78. - Hooker, Mark, 2002, “Are Oil Shocks Inflationary? Asymmetric and Nonlinear Specifications versus Changes in Regime” Journal of Money, Credit, and Banking, 34 (2), 540-61. - Mihaljek, Dubravko, and Marc Klau, 2000, “A Note on the Pass-Through from Exchange rte and Foreign Price Changes to Inflation in Selected Emerging Market Economies” BIS Papers 8, 69-81. - Mishkin, Frederic, “Exchange Rate Pass-Through and Monetary Policy” NBER Working Paper. ### Appendix: VAR methodology — model structure and identification - Purpose: Examine sources of inflationary pressures in Uruguay using a six variable recursive vector autoregressive (VAR) model to isolate the impact of domestic and external shocks on domestic consumer prices. - Model captures interaction between: - strictly exogenous world fuel and food commodity price shocks, - endogenous economic activity, - the exchange rate, - monetary policy, - domestic consumer prices. - World fuel and food prices are treated as exogenous variables. - Ordering of endogenous variables informed by economic theory and supported by Granger causality tests. - Recursive specification (shocks identified as follows): - πtfuel = Et-1[πtfuel] + εtfuel - πtfood = Et-1[πtfood] + εtfood - ∆yt = Et-1[∆yt] + β1εtfuel + β2εtfood + εt∆y - ∆et = Et-1[∆et] + γ1εtfuel + γ2εtfood + γ3εt∆y + εt∆e - ∆mt = Et-1[∆mt] + θ1εtfuel + θ2εtfood + θ3εt∆y + θ4εt∆e + εt∆m - πtCPI = Et-1[πtCPI] + δ1εtfuel + δ2εtfood + δ3εt∆y + δ4εt∆e + εt∆m + εtCPI - Variable definitions (as in source): - πtfuel and πtfood are world fuel and food price inflation respectively. - ∆yt is the first log difference of the activity index. - ∆et is the first log difference of the nominal effective exchange rate. - ∆mt is the first log difference of the monetary aggregates. - πtCPI is the rate of CPI inflation. - Rationale: VAR approach allows analysis of rising inflation without imposing a prior theoretical approach, letting regularities in the data inform the story. ### Uruguay’s credit surge: overview and headline statistics - After years of depressed levels, credit growth accelerated sharply, reaching about 40percent in the 12 months to June 2008. - Expansion driven mostly by growing consumption and corporate loans. - Financial deepening remains low relative to historical levels and other countries in the region. - Credit dollarization remains high, although currency denomination of loans generally matches borrowers’ income. - Up to August 2008, turbulence in global financial markets did not seem to affect the credit recovery; more recent prospects of a global slowdown and heightened volatility could halt the recovery. ### A. Historical perspective — 2001–2006 - Pre-crisis (1990s): Uruguay was a regional financial center with an over 50 percent credit-to-GDP ratio in 2001. - Non-resident deposits reached some 40 percent of deposits; loans to non-residents were about 10-12 percent of total loans. - Deposit run led to a 48 percent contraction of deposits from end-2001 to end-2003. - Credit to domestic non-financial private sector contracted from US$ 10.5 billion (51 percent of GDP) at end-2001 to about US$ 4.0 billion (24 percent of GDP) at end-2004. - Deposits bottomed at US$ 6.8 billion in April 2003, then increased to US$10 billion by end-2006. - Despite deposit recovery, domestic credit hovered around US$ 4.0-4.5 billion due to stricter prudential regulations, risk aversion, and low investment demand. - Tight legal restrictions precluded public banks—particularly Banco Hipotecario Nacional (BHU)—from expanding credit portfolios. ### B. Recent credit acceleration (late 2006–June 2008) - Credit to the non-financial private sector grew by 50 percent in dollar terms (adjusted for exchange rate variations) from end-2006 to June-2008, with much of the hike occurring during the last 12 months (39 percent). - Non-bank financial enterprises (“Administradoras de Credito”) have been expanding domestic lending rapidly (though still small). - Contributing factors to credit resumption: - Improvement in the balance sheet of Banco de la Republica Oriental del Uruguay (BROU) and normalization of its lending. - Strong deposit inflows. - Falling interest rates in the US and uncertainty over quality of financial assets in mature markets, inducing portfolio shifts toward local assets. - Improving incomes—several years of high growth and recovery of real wages—and favorable growth prospects supported by prudent macroeconomic policies and a booming external environment for exports. - Improving firms’ balance sheets making them attractive to lenders. ### Funding, composition, and sectoral patterns - Funding: - Rapid expansion of credit funded mainly with growing deposits. - Until 2006, a significant share of new funding was invested in foreign and domestic assets other than credit to the private sector. - Example: during 2005-06 banks increased domestic credit only by US$0.5 billion despite receiving US$ 1.3 billion in deposits. - Since end-2006, banks extended about US$1.8 billion in domestic credit out of a US$2.3 billion increase in deposits. - Composition: - Credit growth mainly driven by consumption and corporate loans. - Mortgage and auto loans growth rates: over 300 and 100 percent, respectively, though their contribution to overall credit growth remains low given limited volume. - Within corporate credit, loans to tradable-good sectors (agriculture, mining and manufacturing) have grown most markedly; credit to the service sector also increased considerably. - Contributions and growth figures (as presented): - Growth Rate (12-month) indicators include values such as 55.8, 37.5, 25.5, 8.0, -6.6, 103.0, 15.7, -0.7, -23.8, -9.8, 21.5, 37.4, 31.4, and 339.7 (as shown in the source figure). ### Dollarization, maturities, and currency matching - Dollarization: - Share of credit denominated in U.S. dollars fell from 65 percent of total credit in 2000 to 58 percent in 2008. - Public banks: dollarization fell from 50 percent to 32 percent. - Private banks: dollarization remained broadly constant at around 80 percent. - Dollar loans largely extended to corporate tradable sectors; peso loans mostly to consumers—indicating an appropriate match between loan currency and borrower income (service sector is an exception). - Maturities: - About 60 percent of private sector credit has maturities of less than 3 years. - Maturities have become slightly shorter between 2005 and 2008, possibly reflecting resumption of short-term consumption credit and persistence of short-term deposit funding (about 70 percent of deposits remain of less than 30-day maturity). ### Public vs. private banks and non-bank lenders - Credit growth from end-2006 to June-2008: - Public and private banks—excluding BHU—grew credit by 36 percent and 41 percent, respectively. - Public banks expanded lending in local currency; private banks continued to lend mostly in foreign currency. - Market segmentation: public banks (BROU) specialized in consumer loans; private banks focused on corporate loans. - Public banks invested a significant share of new funding in foreign assets; bulk of new non-resident deposits went to private banks, which channeled such funds toward foreign assets. - Non-bank financial enterprises (“Administradoras de Credito”): - Credit stocks about US$250 million—mostly high-interest-rate consumer loans. - Rapidly expanding portfolios and some linked to commercial banks, operating as loan originators. - They have been entering local capital markets through issuance of relatively short term paper. - When loans are transferred to commercial banks, standard prudential regulations apply. ### C. Risks of a sustained rapid credit expansion - The report flags that while sustained rapid credit growth could lead to vulnerabilities, the risk of a possible loosening in lending standards appears contained at present by a broadly appropriate prudential framework. - However, the report notes that more recent prospects of a global slowdown and heightened volatility in global financial markets could halt the credit recovery. *Source: _cr09103 - 19. However, domestic demand pressures have also played an important role, and (PDF chapter/section).* ### 11. Despite the recent acceleration, credit remains low compared to pre-crisis levels. ### 11. Despite the recent acceleration, credit remains low compared to pre-crisis levels. ### Credit levels and international comparison - At about US$ 6.2 billion (24 percent of GDP), credit to the non-financial private sector compares low with levels of about 50 percent or GDP prior to 2002. - Uruguay’s still low level of credit relative to some neighboring countries is particularly evident if alternative financing channels are taken into account, as other countries in the region (e.g. Brazil, Mexico) have significantly more developed local private capital markets. ### Cross-border banking and non-resident deposits - The pace of growth of non-resident deposits, while recently accelerating, has been in line with that of residents deposits, thus keeping the share of non-resident deposits at about 15 percent of total deposits in the system (20 percent in relation to foreign currency deposits). - The growth of non-resident deposits seems to be properly backed by further accumulation of net foreign assets. - The expansion of credit by banks has been concentrated solely in the domestic economy, keeping loans to non-resident below 2 percent of total loans in the system. - Note on drivers: The recent increase in non-resident deposits has been, arguably, driven by a flight to ‘safety’ triggered by some financial turbulence in Argentina in the first quarter of 2008. ### Key financial soundness indicators (selected statistics) - Credit to the private sector has remained below 30 percent of total assets despite recent expansion. - (30-day) liquidity ratios remain high at about 62 percent of short-term liabilities. - Non-performing loans (NPLs) are very low at about ½ percent. - Provisions are high as share of NPLs. - Capitalization ratios are at about 10 percent of total assets, remaining above the 8 percent requirement. - Table 1 excerpt (selected series and exact values): - Capital/total assets (book value): Dec 2005 = 8.2; Dec 2006 = 9.4; June 2007 = 10.1; Dec 2007 = 10.5; June 2008 = 10.6. - Return on assets (weighted by market share): Dec 2005 = 0.84; Dec 2006 = 1.02; June 2007 = 1.71; Dec 2007 = 1.32; June 2008 = 0.99. - Credit NFPS/total assets: Dec 2005 = 22.8; Dec 2006 = 24.5; June 2007 = 25.2; Dec 2007 = 29.0; June 2008 = 29.5. - Foreign assets/total assets: Dec 2005 = 21.6; Dec 2006 = 24.2; June 2007 = 26.8; Dec 2007 = 23.0; June 2008 = 18.3. - Liquidity ratio (30 days, weighted): Dec 2005 = 80.7; Dec 2006 = 110.6; June 2007 = 69.1; Dec 2007 = 53.9; June 2008 = 62.2. - NPLs % weighted: Dec 2005 = 5.66; Dec 2006 = 4.11; June 2007 = 3.37; Dec 2007 = 1.12; June 2008 = 0.44. - Provisions (share of NPLs, weighted): Dec 2005 = 1082; Dec 2006 = 1068; June 2007 = 1008; Dec 2007 = 718; June 2008 = 683. ### Assessment of current vulnerabilities and near-term risks - The evidence points to a healthy revival of credit. - At the current juncture, vulnerabilities associated to Uruguay’s rapid credit expansion seem contained. - Immediate risks point to a possible halt of this recovery, as global financial conditions and growth prospects worsen. - At current levels, even if the economic cycle reverts and non performing loans come back to normal levels, banks provisions are likely remain ample. ### Medium-term challenges and policy implications - Credit standards risks: - An expansion of credit and the associated financial deepening should, in principle, help foster economic growth by allowing capital to reach investments with high rate of return and support consumption smoothing. - Empirical evidence has shown that there is often a trade-off between rapid financial deepening and financial stability and credit booms have often been associated with a loosening of lending standards. - While at the current juncture these risks seem contained in Uruguay, continued vigilance by monetary and regulatory authorities will be key to ensure that such vulnerabilities do not build up if rapid credit growth persists. - Macroeconomic management challenges: - In the context of inflationary pressures, a credit boom exacerbates domestic demand pressures and potential macroeconomic imbalances (e.g. fueling a current account deficit), and further complicates monetary and fiscal policy. - A credit boom could also lead to assets price bubbles. - Continued monitoring and management of domestic credit conditions should remain an important component of monetary policy. *Source: _cr09103 - 11. Despite the recent acceleration, credit remains low compared to pre-crisis levels.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2009/_cr09103.pdf_