Uruguay and the IMF

News Brief: IMF Completes Uruguay Second Review

Country's Policy Intentions Documents

Free Email Notification

Receive emails when we post new items of interest to you.

Subscribe or Modify your profile

Uruguay—Letter of Intent, Memorandum of Economic Policies, Technical Memorandum of Understanding

Montevideo, September 12, 2001

The following item is a Letter of Intent of the government of Uruguay, which describes the policies that Uruguay intends to implement in the context of its request for financial support from the IMF. The document, which is the property of Uruguay, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.

Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington DC, 20431

Dear Mr. Köhler:

For the second review of the 22-month stand-by arrangement from the Fund, which was approved by the Executive Board on May 31, 2000, the attached policy memorandum and annexes describe recent developments under the economic program for 2001, and the policies and objectives of the Government of Uruguay for the remainder of the year. Because the external environment was becoming more difficult, the Government placed its external borrowing needs in advance of the programmed calendar, as the markets permitted. This provided an early boost to the international reserves of the Central Bank, but it caused the debt to exceed slightly the program ceiling at end-June 2001, for which the Government is requesting a waiver. All other performance criteria for end-June 2001 were observed. Moreover, the level of economic activity in the second half of 2001 is now projected to be significantly below that envisaged in the program at the beginning of the year, and, reflecting the impact this is having on tax receipts, the Government is modifying the fiscal deficit objective, and corresponding overall debt ceiling, for the quarters ending in September and December 2001, relative to the indicative targets envisaged earlier in the year. The Government believes that the policies described in the attached will promote the recovery of sustainable growth of output and employment, safeguard low inflation and external viability, improve efficiency in the economy in general and in the public sector in particular, and address priority social needs.

The authorities of Uruguay will continue to maintain close relations with the Fund and consult on the adoption of any measures that may be needed, in accordance with the Fund's practices on such consultations. The next Fund mission is expected to visit Uruguay no later than February 2002, to conduct the Article IV consultation discussions and consider the economic developments in the context of the third review under the stand-by arrangement.

Sincerely yours,

Cesar Rodriguez Batlle
Central Bank of Uruguay

Alberto Bensión
Minister of Economy
and Finance

Memorandum of Economic Policies

I. Recent Developments and Policies under the Program

1. The Uruguayan economy has again faced severe negative shocks in 2001. The strong policy efforts undertaken since early 2000 to lower production costs, improve competitiveness, and place the economy on a sounder footing for sustainable growth, were beginning to bear fruit and the pace of economic activity increased by a deseasonalized 0.4 and 1.8 percent, respectively, in the last quarter of 2000 and the first of 2001 (q-o-q). However, since then three new shocks have weakened confidence and economic activity. There was a large outbreak of foot-and-mouth disease in April which interrupted activity in meat producing and exporting sectors. Then, the impact of the crisis in Argentina weakened confidence and demand. And third, Brazil's energy shortage, together with the spill-over effects from the Argentine crisis, slowed growth and led to a 30 percent depreciation of the real, and an increase in uncertainty on export prices--Brazil is Uruguay's most important commodity export market, accounting for a quarter of our sales. The size and the velocity of the deterioration in economic conditions in the region were significant, and our economy continues to feel the negative consequences of these shocks.

2. Notwithstanding these difficulties, Uruguay is adjusting and making progress in establishing the conditions for sustainable growth. Costs in U.S. dollar terms are falling with moderate tax reductions for the tradable goods sectors, some reductions in the wage-wedge through cuts in employer social security contributions, a moderation of wages in the economy, and the containment in real public sector primary expenditures. While spending containment is difficult because it can initially slow domestic demand, the expenditure switching effects of the policies are in clear evidence. Since 1999, the foreign balance is making a strong contribution to output growth, despite the slow growth in the regional trading partners.

3. The economic program through end-June 2001 was on track. All quantitative performance criteria for end-June were observed, except for the technical excess of the debt ceiling noted in the cover Letter. Regarding the fiscal balance, while revenues slowed, expenditure containment secured the achievement of the deficit target for end-June. The targets on international reserves and net domestic assets were also met, and by wide margins. There was progress with the structural measures under the program. The four large nonfinancial public sector enterprises published their annual reports for 2000 and the quarterly reports for March 2001, and the Ministry of Economy published the annual and quarterly figures for the smaller enterprises, together with the full set of monthly fiscal data. The office of banking superintendency placed on the web its Quarterly Bulletin with the accounts of the state-owned Bank of the Republic (BROU) and the Banco Hipotecario (BHU). The large enterprises and the banks were audited, as agreed, and we completed with the assistance from the Fund's Fiscal Affairs Department (FAD) the background work for the study on quasi-fiscal activities in the public enterprises and banks--FAD is preparing the report on this study. The Government submitted to Congress the reform proposal for one special pension fund (for notaries), and it is close to reaching agreement on the reform of two more special pension funds (for university professionals and the police), which are scheduled to be presented to Congress by end-September and early October, respectively. The negotiations on the reform of the pension fund for bank employees and for the military are requiring more time than was originally anticipated, and are likely to extend into 2002. The state-owned National Insurance Bank (BSE) has submitted information on its March 2001 operating results and balance sheet, but not yet on its annual position for 2000, and has not been audited. We are committed to provide full disclosure of the financial position of the BSE and will report on this matter during the next Article IV mission.

4. The Government has maintained good access to the international financial markets. By June, it had placed US$685 million in bonded debt in four markets abroad, slightly more than was originally envisaged for the year as a whole, at an average spread of 260 basis points over comparable U.S. Treasury issues. The Government will take advantage of opportunities for debt placement at reasonable spreads, as these arise. Rating agencies have maintained Uruguay's investment grade credit rating.

5. The external current account deficit is close to 3 percent of GDP. While the foreign balance, in real terms, has contributed to growth in recent years, the terms of trade have been quite weak, and the external current account deficit has remained roughly unchanged in 2000 and 2001. Merchandise exports in U.S. dollar terms, which were recovering strongly early in the year, dropped precipitously beginning in the second quarter because of the interruption of meat exports and the slowdowns in Argentina and Brazil. Moreover, the tourism season was satisfactory in the number of visitors, but spending per capita declined. Imports have slowed sharply recently, with the downturn in domestic demand and a drop in investment activity. In the capital account, in addition to the borrowing by the Government, there were substantial private capital inflows in recent months. The bulk of these flows was re-intermediated into external assets, and the liquidity of Uruguayan banks increased significantly.

II. The Macroeconomic Framework and the Economic Objectives
for the Second Half of 2001, and the Medium Term

6. Uruguay has been affected adversely by external shocks in recent years, and new difficulties presented themselves in 2001, as noted above. These developments led to a gradual deflation of national income measured in U.S. dollars, whereas the public debt, mostly denominated in dollars, increased, hence leading to an increase in the debt ratio. The Government's policies are focused on turning around this debt buildup while creating the conditions for a resumption of growth--this requires fiscal adjustment and continued structural reform. The fiscal path aims at a turnaround in the debt-GDP ratio from 2003 onward; the structural reforms aim at improving the allocation of resources in the economy, and crowding-in private sector investment and consumption.

7. The Government has adapted its exchange rate policy to assist in the adjustment of relative prices in a deflationary environment. The Government accelerated the pace of crawl of the exchange rate band from 0.6 to 1.2 percent a month, and widened the band from 3 to 6 percent, effective for 12 months through end-June 2002. This temporary acceleration will help to strengthen the external sector of the economy. Most wage adjustments in the economy have taken place for 2001, and public enterprise tariffs do not need to be adjusted for the remainder of the year, so the pass-through from the exchange rate to domestic prices is expected to be small, leading to only a moderate increase in domestic inflation.

8. Output growth for the year as a whole is now assumed to be marginally negative, compared with an increase of 2 percent envisaged in the program. Economic growth in the rural sector is expected to resume gradually toward the fourth quarter of the year, and, together with a bottoming out of the recession in Argentina and the slowdown in Brazil, the economic conditions for the rest of 2001 are expected to recover slowly. The unemployment rate increased to 16 percent in June, reflecting an increase in labor supply and the downturn of employment in the rural areas. To bring unemployment down, employment will need to accelerate, which requires the perseverance with wage moderation (average wages in U.S. dollar terms are declining). Inflation at mid-year was in line with the program assumption at around 5 percent, and is expected to be 6-7 percent by year-end.

9. The slowing of economic activity has put pressure on the fiscal balance, but the Government does not wish to accommodate a full play of the automatic stabilizers. Indeed, while we are modifying the target for the fiscal deficit for the year as a whole from 2.6 percent to 3.3 percent of GDP, the automatic drop in revenue would have lifted the deficit to at least 4 percent of GDP--the Government does not believe that such a deficit can be permitted in the context of the new exchange rate policy and to limit the effect on indebtedness in an uncertain financial environment. With faster exchange rate depreciation, the peso interest bill increased, and the deficit is being contained through primary expenditure restraint, mainly in the central government and the state enterprises. Moreover, to address concern about the debt ratio and to anchor firmly confidence and expectations in the economy in the medium term, the Government strengthened the fiscal balance objectives for the medium-term, by _ percentage point of GDP a year on average from the path that was envisaged in the program. These adjustments compensate for the higher deficit in 2001 and preserve the sought-after turnaround in the debt ratio from 2003 onward.

10. In June, the Government announced a substantial package of tax restructuring and expenditure measures to assure compliance with the fiscal objectives while lowering production costs in the economy. The Government has obtained approval in Congress for: (i) lowering the tariff of diesel fuel by 10 percent, (ii) reducing to zero the tax on net worth in the agricultural and livestock sector, (iii) reducing to zero the employer social security (pension) contributions of the manufacturing, agricultural, livestock, and cargo and passenger transport sectors; (iv) cutting in half the employer social security (health) contributions of the manufacturing, agricultural, and livestock sectors and, (vi) reducing capital goods import tariffs to zero. These tax reductions, which on a full-year basis amount to around US$130 million (0.7 percent of GDP) were offset by a new three percent tax on imported and domestically produced final manufactured goods (the "Cofis"). The tax restructuring package is being phased in (Cofis went into effect on June 1). Moreover, in August the Government announced its intention to implement gradually a tax reform, centered around unifying the VAT rate at 19 percent, and eliminating exemptions, from the present system with a top rate of 23 percent, a rate at 14 percent, and a zero rate. This tax reform will substantially reduce distortions in the VAT and assist in improving tax compliance and transparency.

11. The Government is monitoring closely developments in the banking system, and is taking measures to improve efficiency in the public banks. The portfolio of private banks has held up well with only a small increase in nonperforming assets and, for 2000 as a whole, a rate of return on equity of over 12 percent. The public banks, which are exposed to long-term development lending, are more sensitive to weakness in the economic cycle. The BROU broke even in 2000, and its capital was reduced by some US$200 million in one-time write-offs as a result of the independent audit of the bank. The capital of the bank is now US$497 million, the equivalent of 17.6 percent of risk-weighted assets, compared to a regulatory minimum of 10 percent. In early 2001, the BROU assisted the livestock sector with a refinancing program of its debts which may lead to some increased provisioning requirements, and a second year of break-even results. To improve efficiency in the bank and return on equity, the BROU is reducing operating costs, introducing credit risk differentiation in its credit pricing guidelines, and phasing-out implicit subsidies (quasi-fiscal operations). The BROU is investing in software and new servers to provide management with a real-time picture of the financial position and operations in the bank--this will improve significantly the ability to cut costs, control credit risks, and bolster profitability.

12. The Banco Hipotecario also needs significant reforms. The BHU incurred a loss of US$215 million (1 percent of GDP) in 2000, and its capital was reduced by a one-time charge of US$430 million as a result of the independent audit. After the write-down and the loss, the capital of the bank at end-2000 was US$752 million (more than double the minimum capital requirement). The bank is expected to incur another loss in 2001, partly because its mortgages are indexed to average wages in the economy and its liabilities are almost all in U.S. dollars, hence giving rise to a currency mismatch on the balance sheet. The bank is phasing out issuing mortgages indexed to wages and shifting to dollar mortgages only. It is also cutting operating costs, and securitizing parts of its mortgage portfolio in the secondary market, which will improve cash-flow and currency risk management. The management of the bank is formulating a restructuring plan that will be ready before year-end. In this context, the Government is requesting technical assistance from the Fund and participation in the FSAP before the next Article IV consultation cycle in early 2002.

13. Structural reforms are essential to improve supply conditions in the economy and to help jump-start output growth. The Government is directing its efforts at deregulation, and appropriate anti-trust regulation where needed, to foster private sector investment in competitive markets. Uruguay has substantial economic potential to attract foreign direct investment and to expand concessions of capital projects to the private sector. The concession of the container port facilities in Montevideo was concluded in July 2001. The Government is inviting bids from private sector companies to build and operate an electricity generating plant fueled by natural gas, and the National Petroleum Company (ANCAP) has entered into an association with private sector companies to remodel and expand the refinery in Montevideo. In relation to this project, in June, the Government already placed in Congress a draft law for the removal of the monopoly on petroleum importation and refining (in advanced of the end-December schedule in the program). Since then, the Government has strengthened further the reform agenda with: (i) measures to improve the functioning of the labor markets (including modernizing regulations affecting the distribution of working hours; for flex-time labor contracts; and for seasonal employment); (ii) some forty measures to update or remove outdated and distortionary regulations and obstructions (red tape) to economic activity; (iii) the liberalization of the market for worker accidents insurance (hitherto a monopoly of the BSE); and (iv) new concessions in road, railroad, and ports facilities maintenance and management. Moreover, the Government announced:(v) the concession of two telecommunications frequencies to private sector firms, and (vi) of services in the Carrasco International Airport in Montevideo; (vii) the demonopolization of the market for international long-distance telephony, and; (viii) to complement the liberalization of crude petroleum imports and refining, before year-end, the Government will present to Congress a draft law to liberalize the importation of petroleum derivatives.

14. Increased transparency and data dissemination are improving the policy discussions, and the Government will continue these efforts. The publication of quarterly reports of the public enterprises, the data on the public banks in the Boletín Informativo of the Superintendency, the monthly publication on the web of the fiscal position of the Government, and the independent audits of the enterprises and banks, are having a positive effect on the public's understanding of economic developments. The Government will continue to publish on the web the Letters of Intent signed with the Fund, and the relevant appropriate staff documents associated with the Fund's annual Article IV Consultations. The Government will continue to publish on the web all quarterly reports mentioned above with a lag not exceeding ten weeks after the close of the relevant quarter; and the results of the annual independent audits and the annual reports of the public enterprises and banks with a lag not exceeding six months after the end of the calendar year. Also, following completion of the paper on quasi-fiscal activities now being prepared by the Fund's Fiscal Affairs Department, the Government will prepare a policy paper on the presence of quasi-fiscal operations in public sector enterprises and banks, with the objective of reducing them or bringing them into the budget. A ROSC module has been published on fiscal transparency, and one on data dissemination is to be published shortly. Uruguay aims to finalize before year-end its statistical work to subscribe to the Fund's SDDS.


Table 1. Uruguay: Revised Quantitative Performance Criteria for
the 2001 Economic Program1

Jan-Jun 2001
Jan-Sep 2001 Jan-Dec 2001

(In millions of Uruguayan pesos)
1. Combined public sector balance (floor) -4,376       -7,000       -8,385      
2. General government expenditure (ceiling) 13,887       22,100       29,600      
3. Change in the net domestic assets of the BCU (ceiling) -4,824       875       1,325      
(In millions of U.S. dollars)
4. Net international reserves of the BCU (-decrease) (floor) 298       -150       -60      
(Stock of debt at the end of the period; in millions of U.S. dollars)
5. Combined public sector debt      
    a. All maturities 9,762       10,195       10,285      
    b. Less than one year 200       200       200      

Sources: Ministry of Economy and Finance, and Central Bank of Uruguay
1As defined in the Technical Memorandum of Understanding

Structural Reform Benchmarks

Before end-September 2001

1. Submit law to Congress to reform the special pension fund (Caja Especial) for university professionals.

2. The Central Bank to issue a regulation requiring all banks to obtain and publish a corporate credit rating, or place debentures in the capital market equivalent to at least 2 percent of their deposit base, effective no later than March 2002.

Before end-December 2001

3. Submit law to Congress to reform the special pension fund (Caja Especial) for the police.

4. Submit law to Congress to liberalize the importation of petroleum derivatives.

Technical Memorandum of Understanding

This memorandum presents the definitions of the variables included in the quantitative performance criteria annexed to the Policy Memorandum.

1. Cumulative balance of the Combined Public Sector. The Combined Public Sector comprises the Central Administration (including as defined in "Article 220" of the Constitution, Salto Grande, and the funds managed directly in the ministries (Fondos de Libre Disponibilidad), the social security system (Banco de Previsión Social), the local governments (Intendencias), the public enterprises (ANCAP, ANTEL, UTE, OSE, AFE, ANP, INC, CND, and ANCO), and the quasi-fiscal balance of the Central Bank (BCU). The public sector balance will be measured from below the line on the basis of information provided by the BCU on: (a) combined public sector debt (defined below), including all short-term debt, in foreign currency and pesos; (b) bank borrowing and bank deposits in foreign currency and pesos; and (c) net asset transactions of the combined public sector. The result of the BCU is defined as interest earnings on gross international reserves, as defined below, and on domestic assets minus operating expenses and interest paid on domestic and foreign debt administered by the BCU. The limit on the balance of the combined public sector will be adjusted downward (upward), i.e., the deficit would be allowed to widen (narrow), by the amount that the actual social security contributions to the private pension system exceeds (falls short) the projected amount in the program. The limit on the balance of the combined public sector will be adjusted downward by any receipts in 2001 from the planned concessions of two telecommunications frequencies.

2. Cumulative ceiling on general government expenditure applies to total (current and capital) noninterest expenditure of the central administration and social security system, excluding outlays on pensions and automatic transfers to the private pension funds (AFAP), and on internal transfers.

3. Cumulative changes in net domestic assets (NDA) of the BCU is defined as the difference between currency held outside banks and net international reserves (NIR) of the BCU as defined in 4. below. The flow of NIR will be valued at the average exchange rate projected in the program for the corresponding quarter.

4. Cumulative changes in net international reserves (NIR) of the BCU. NIR is defined as the difference between the gross international reserves and BCU reserve liabilities. Gross international reserves include all foreign exchange assets that are in the direct effective control of the BCU and are readily available for such purposes of the BCU as intervention or the direct financing of payment imbalances. Such assets may be in any of the following forms, provided that they meet the test of effective control and ready availability for use: currency, bank deposits in nonresident institutions and government securities and other bonds and notes issued by non-residents (with a rating not below "A" in the classification of Fitch IBCA and Standard and Poor's or "A2" in the classification of Moody's). In addition, holdings of SDRs or of monetary gold would be included under gross reserves assets (provided they meet the test of effective control and ready availability of use) as would the reserve position in the IMF.

  • Excluded from gross international reserves are all foreign currency claims arising from off-balance sheet transactions (such as derivatives instruments), claims on residents, capital subscriptions in international financial institutions, any assets in nonconvertible currencies, claims on any nonresident Uruguay-owned institutions, or any amounts (in all components of assets, including gold) that have been pledged in a direct or contingent way.

  • Gross reserve liabilities include all foreign currency-denominated liabilities of the BCU with original maturity of one year or less to residents and nonresidents, the use of Fund resources, any net position on foreign exchange derivatives with both residents and nonresidents undertaken directly by the BCU or by other financial institutions on behalf of the BCU. For the purpose of the NIR calculation, (a) the gold holdings of the BCU will be valued at the accounting rate of US$42 per troy ounce; (b) liabilities to the IMF will be valued at US$/SDR rate of December 31, 2000; (c) gains or losses from gold-swaps and other operations will be excluded; and (d) non-U.S. dollar denominated foreign assets and liabilities will be converted into U.S. dollars at the market exchange rates of the respective currencies as of December 31, 2000. Regarding valuation effects for NIR operations during the year, such flows will be valued at the exchange rate at which the operation took place.

5. Combined Public Sector stock of debt refers to (a) the outstanding stock of debt in domestic and foreign currency owed or guaranteed by the combined public sector; and (b) debt in URs ("Unidades Reajustables").1 Debt will be measured on a disbursement basis; it excludes nonresident deposits and other short-term liabilities of the BROU and the BHU. Debt in the form of leases will be calculated as the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair or maintenance of the property.2 The overall limit will be adjusted upward (downward) by (1) the upward (downward) revisions made to the actual debt stock at end-2000; (2) the difference between the actual and projected amount of social security contributions that are transferred to private pension funds;  (3) the overperformance with respect to the targets on the BCU's net international reserves up to a limit of US$250 million; (4) any upward (downward) changes in the amount of export prefinancing in the BCU in relation to the level of December 31, 2000 (also for short-term debt); and (5) by any amount equivalent to the increase (decrease) in the sum of free and required foreign currency deposits up to US$200 million of the BROU, BHU, private banks, AFAPs and investment funds, in the BCU from their level of December 31, 2000. Certificates of deposit issued by the BCU to banks and/or their substitute Treasury instrument (treasury bills of maturity longer than one year) are included in medium and long-term debt.

1 The term "debt" has the meaning set forth in point No.9 of the Fund's Guidelines on Performance Criteria with Respect to Foreign Debt (Decision of August 24,2000).
2 The suppliers' contracts of ANTEL with equipment providers Ericsson and NEC, which predate the Fund's consideration of lease contracts for programming purposes, are expensed under goods and services as rental outlays. The lease contract of ANCAP associated with the reform and expansion of the Montevideo oil refinery is included in the calculation of the public sector debt.