Mission Concluding Statement 

Uruguay: Staff Concluding Statement of the 2021 Staff Visit

May 25, 2021

Washington, DC: An International Monetary Fund (IMF) mission met virtually with the Uruguayan authorities during May 18–24 to discuss recent economic developments and policy priorities. This concluding statement summarizes the mission’s main takeaways.

1. Uruguay entered the COVID-19 crisis with solid institutions but pre-existing macroeconomic imbalances. The country enjoys a well-functioning democracy, strong governance and institutions, and a high degree of social cohesion—with high per-capita income and relatively low rates of poverty, inequality, and informality. In a region with recurrent financial and social instability, Uruguay’s stable economy stands out, bolstered by its solid financial sector, healthy reserve buffers and investment grade status. However, following a decade of robust growth fueled by a commodity price boom that ended in 2014-15, public finances weakened, and growth became anemic in the years preceding the pandemic——with growing evidence of lack of labor market dynamism, low investment, and competitiveness concerns, especially in non-commodity tradable sectors. Inflation remained high in comparison to other inflation-targeting countries, and de-dollarization was still a pending assignment.

2. The policy response to the pandemic effectively deployed available policy space while balancing medium-term objectives. The government’s efforts have simultaneously focused on mitigating the economic and social effects of the pandemic while advancing reforms to tackle pre-existing macroeconomic imbalances and boost potential growth.

• The successful handling of the health crisis kept a low case count for much of 2020, while preventing large-scale lockdowns and, thus, limiting the impact on economic activity. While the situation deteriorated markedly in recent months, the country’s fast vaccine rollout is commendable and should allow for a prompt reopening of the economy.

• Fiscal policy appropriately focused on sustaining the economy and protecting the most vulnerable while taking steps to ensure medium-term fiscal sustainability, in the context of limited fiscal space. The sound existing social protection and health care systems, combined with the low case count in the early months, limited the demand for resources needed to directly tackle the health crisis, especially compared with other countries in the region, allowing the government to focus fiscal efforts on sustaining employment, keeping firms afloat and supporting vulnerable groups. Earmarking through the COVID Fund promoted fiscal transparency and provided clarity on the temporary nature of the fiscal loosening. The legislated fiscal rule to underpin the authorities’ envisaged medium-term fiscal consolidation and the steps taken toward its implementation—despite the need to attend the urgency of the pandemic—are important advances.

• The temporary relaxation of financial regulations (especially the extension of bank loan repayments), the expansion of credit guarantees for SMEs and direct credit lines to COVID-affected businesses provided needed relief to firms and households. Negative real monetary policy rates, coupled with clear forward guidance, provided adequate support to the economy while the recently announced reforms to the monetary policy framework signaled a renewed commitment to the objective of bringing down inflation as the recovery takes hold. April’s inflation reading, the first to fall within the target range in several years, is an encouraging development.

3. While COVID cases are still high, the recovery is expected to accelerate in the second half of 2021, supported by favorable external conditions and a rapid vaccination campaign. Following the 5.9 percent contraction in 2020 and a setback in the recovery in the first months of 2021 amid a spike in COVID-19 cases, the economy is expected to gain strength on the back of elevated commodity prices and large ongoing investment projects. Activity is expected to accelerate in the second half of this year—to deliver growth for the year as a whole near 3 percent—as the economy gradually reopens, although the precarious health situation in neighboring countries will remain a headwind, especially for tourism-related sectors. Near-term fiscal risks are limited thanks to an efficient debt management in the last two decades—which has resulted in a more resilient debt maturity and currency structure—and healthy liquidity buffers. Supported by its investment grade status, market access to sovereign borrowing remains at very favorable conditions, including in the recent local currency issuance. Despite lower profitability, the financial sector also remains resilient with capital and liquidity beyond regulatory requirements.

4. Fiscal policy should continue to support the recovery while completing the foundations for a durable medium-term consolidation. As the economy reopens and continues to recover, fiscal support should shift from policies to preserve jobs and keep firms afloat to policies that stimulate demand and job creation. Given weak public finances, laying out a clear path to regaining fiscal sustainability and rebuilding fiscal policy space will also be of the essence, especially with a view to maintaining Uruguay’s favorable rating in the markets. The authorities’ envisaged consolidation appears achievable although it needs to be underpinned with concrete measures and a full implementation of the fiscal rule. The planned savings are expected to stabilize the debt-to-GDP ratio over the medium-term, although leaving limited space to respond to future shocks. The pension reform would also lend credibility to fiscal sustainability, although the associated fiscal savings will likely take time to materialize.

5. Enhancements to the monetary policy framework are commendable. Recent reforms to re-affirm the primacy of inflation over other objectives—e.g. re-adopt the interest rate as main instrument, recalibrate the inflation target range, improve transparency, and enhance the central bank’s communication strategy—are welcome. The monetary stance remains appropriately accommodative in response to the pandemic shock. As the economy comes out of the crisis, maintaining a monetary policy stance consistent with the inflation target will be key to strengthen credibility and anchor inflation expectations. Initiatives to encourage a greater use of the peso in lending and pricing of goods and services are welcome, although reducing dollarization and fostering financial deepening hinge primarily on achieving low and stable inflation.

6. Advancing envisaged structural reforms will be needed to boost potential growth over the medium term. While the recovery is underway, achieving higher growth—especially if the current favorable terms of trade are not sustained—will require addressing pre-existing structural weaknesses. Reforms that mitigate ‘scarring’ from the COVID-19 crisis and facilitate resource reallocation may need to be prioritized. In particular, labor market policies that allow for retraining, provide incentives to hire and conduct on-the-job training, and better align wages with productivity would support the recovery while sustaining employment and building the foundations for healthy and inclusive growth. Continuing with the reform of state-owned enterprises to increase their efficiency and reduce public utility costs would also improve competitiveness and foster investment. Policies to increase female labor force participation and to improve education outcomes will also be key to raise growth and living standards over the medium term.

7. Protecting vulnerable groups will be key for the recovery and the success of the reform agenda. While the country continues to compare favorably to peers, weakened social conditions due to the pandemic and pre-existing problems of youth unemployment and child poverty could gradually erode the social fabric. Promoting growth while guarding social protection programs and maintaining adequate welfare benefits—that balance coverage and incentives to work—will ensure the benefits of higher growth are shared evenly and the success of the reform agenda. Given limited fiscal space, this will require enhancing spending efficiency by carefully prioritizing spending.

8. The mission supports the authorities’ prudent macroeconomic management during the last year and their reform agenda. The general political consensus on the needed reforms is encouraging, although Uruguay’s challenges are longstanding and have been magnified by the pandemic. As the economy recovers from the health crisis, the authorities should advance decisively to complete the implementation of the envisaged reforms.

The mission thanks the authorities for the warm hospitality, the open discussions, and the quality of the engagement. The annual Article IV consultation mission is expected to take place in September of this year.