Uruguay: Staff Concluding Statement of the 2016 Article IV Mission

IMF News, December 8, 2016

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• Published: December 8, 2016

Recent developments and outlook

• Uruguay has demonstrated resilience amid deep recessions in Argentina and Brazil.
• Growth projections and exchange rate:
  • Projected growth of 0.7 percent in 2016.
  • GDP growth projected to recover to about 1.1 percent in 2017.
  • The Uruguayan peso appreciated about 6 percent in the year through end-October, with depreciation pressures reemerging in November.
• External balance and inflation:
  • Current account deficit expected to shrink to just under 2 percent of GDP in 2016, before gradually rising to 2½ percent in the medium-term.
  • Inflation temporarily peaked at 11 percent (y-o-y) in May.
  • Inflation expected to remain below 9 percent in 2017, tapering to about 6 percent in the medium-term.
  • Staff projections foresee inflation moving into the 3–7 percent target range by 2019.
• Financial stability:
  • Real credit growth to corporates and households has come to a virtual halt since 2015.
  • Non-performing loans are 3.5% of total loans, having more than doubled as a share of gross loans since 2014, while provisions are high.
  • Staff stress tests indicate banking system could withstand a large exchange rate shock affecting non-hedged borrowers.
• Buffers and adjustment:
  • Strong liquidity buffers, access to contingent credit lines, and a flexible exchange rate should enable orderly adjustment to shocks.
  • BCU’s gross reserves are ample relative to standard prudential benchmarks.

Risks to the outlook

• External risks:
  • A slower-than-expected recovery in Argentina and Brazil could weigh on Uruguay.
  • Weaker-than-projected growth in China and a tightening in global financial conditions could raise Uruguay’s cost of financing.
  • High share of nonresident holdings of public debt could pose external risk, although maturities are long.
• Domestic risks:
  • Weaker-than-expected recovery in 2017 could force a difficult trade-off between fiscal consolidation and avoiding a strongly pro-cyclical fiscal stance.
  • A potential large foreign investment (about 7 percent of GDP) in a third pulp mill presents an upside risk to growth.

Fiscal policy — findings and recommendations

• Findings:
  • Authorities avoided an overly pro-cyclical fiscal stance in 2016 and locked in fiscal adjustment for 2017.
  • Debt levels have risen sizably in recent years; financial markets monitor implementation of fiscal adjustment closely.
  • Announced structural consolidation aims to reduce the overall deficit to 2.5 percent of GDP by 2019.
  • As growth rebounds, staff projects the primary surplus to exceed 0.5 percent of GDP in 2019, enabling gradual reduction in gross and net public debt.
  • Population aging will raise the annual deficit of the defined-benefit pillar of the pension system to well above 2 percent in 2050.
• Recommendations:
  • Implement the authorities’ fiscal consolidation path to put net debt on a downward trajectory.
  • Preserve fiscal credibility to allow automatic fiscal stabilizers to operate and retain some space to respond to unanticipated shocks.
  • Reform special pension regimes to address long-run fiscal pressures from population aging.
  • Improve management and profitability of public companies; allow retail fuel prices to fully adjust with international oil prices as soon as feasible and consider basing adjustments on a transparent formula once the current oil price hedge expires.
  • Design fiscal adjustment to foster growth by supporting infrastructure investment plans, rationalizing the public wage bill and public enterprises’ expenditures, and using PPPs with effective monitoring to control explicit and contingent liabilities.
  • Strengthen public debt management: foster a more liquid local-currency bond market, establish benchmarks for long-term peso debt instruments, and consider an overall debt limit as part of the existing rule with annual limits that adjust to the economic cycle.

Monetary policy — findings and recommendations

• Findings:
  • Inflation remains above the central bank’s target range driven by one-off administered-price increases and earlier nominal exchange rate depreciation.
  • Central bank tightened reserve requirements in April 2016 and lowered its reference range for narrow money (M1+) growth in April and July.
  • Short-term interest rates increased in April but have fallen somewhat since mid-2016.
  • De-dollarization is a priority to improve monetary policy transmission.
• Recommendations:
  • Maintain readiness to tighten monetary policy in 2017 if demand pressures pick up to guide inflation toward the target range.
  • Use the new wage agreements (nominal terms with lower increases over time) to reduce inflation persistence and support de-dollarization.
  • Reduce inflation persistence by eliminating indexation provisions as expeditiously as possible.
  • Strengthen the policy framework by carefully monitoring money demand and exploring tools (e.g., standing facilities to create an interest rate corridor) to reduce short-term rate volatility and support development of peso debt instruments and derivatives.
  • Preserve the flexible exchange rate as the key mechanism to absorb external shocks; intervene parsimoniously to counter disorderly market conditions but not to counter trends driven by fundamentals.

Financial development and stability — recommendations

• Findings:
  • Implementation of the 2014 Financial Inclusion Law can help increase peso deposits and competition in the peso market.
  • Financing public infrastructure projects could foster development of new peso capital market instruments.
• Recommendations:
  • Encourage private banks to capitalize on payroll deposit accounts to increase peso funding and boost the peso credit market.
  • Reinstate differentiated reserve requirements on peso and foreign-currency deposits to encourage peso deposits.
  • Maintain vigilant supervision to monitor banks’ exposures and contain stability risks.

Supporting inclusive and sustainable growth — findings and recommendations

• Findings:
  • Social policies and transfers have significantly reduced poverty and inequality; Uruguay has the largest drop in the Gini coefficient in Latin America over the past decade.
  • Education outcomes are not better than regional averages despite a higher teacher-to-student ratio, indicating scope to improve efficiency of education spending.
  • Female labor force participation is fairly high relative to other Latin American countries but could be further increased.
  • Trade integration developments (trade agreement with Chile, potential Mercosur-EU negotiations) could benefit exports.
• Recommendations:
  • Design redistributive policies mindful of fiscal costs and impacts on labor supply and incentives for training.
  • Implement education reforms to improve efficiency and outcomes.
  • Increase affordable public child care and consider extending paternity leave to raise female labor force participation.
  • Pursue trade agreements and international integration to secure beneficial market access for diversified and regulated agricultural exports.

Mission thanks the authorities for the warm hospitality, the open discussions, and the quality of the engagement.

Uruguay: Staff Concluding Statement of the 2016 Article IV Mission

References

• Argentina and the IMF
• Brazil and the IMF
• Chile and the IMF
• Uruguay and the IMF
• Mission Concluding Statements
• PRESS CENTER
• https://www.imf.org/en/home