Uruguay: Staff Concluding Statement of the 2017 Article IV Mission
IMF News, December 7, 2017
Source details
- Canonical URL
- Uruguay: Staff Concluding Statement of the 2017 Article IV Mission
Other formats
Bibliographic details
- Published: December 7, 2017
Key findings and recent developments
- Uruguay experienced stronger GDP growth in 2017; the increase in unemployment since 2012 has come to a halt.
- Monetary policy stance was relatively tight and the exchange rate appreciated, contributing to a notable decline in inflation, bringing it within the central bank’s target range for the first time in seven years.
- The current account balance improved and is now in surplus; the government reduced its fiscal deficit and continues to access international markets on favorable terms.
- Social inclusion performance remains strong, including gender equality.
- Since April through October 2016, a nominal appreciation of the peso vis-à-vis the U.S. dollar reduced tradable goods inflation and boosted real wages, pensions, and consumption through 2017.
- Inflation declined to 6 percent.
- Real GDP growth projected to rise to 3.1 percent in 2017 (from 1.5 percent in 2016), driven largely by private consumption and net exports (with an exceptionally strong tourist season).
- Monetary policy effectively tightened mid-2016 through Q1 2017; since then interest rates have fallen, with short-term real rates moderating to 2–3 percent.
- Fiscal policy in 2017 was countercyclical; overall deficit projected to decline to 3.3 percent of GDP.
- Bilateral real exchange rate versus Argentina depreciated between April 2016–July 2017 while the multilateral real exchange rate appreciated by 12½ percent over the same period.
- Current account turned positive in 2016 and 2017; staff’s preliminary assessment: the current account is expected to maintain a surplus of more than 1½ percent of GDP in 2017.
- Staff estimates the current account balance is 1-3 percent of GDP stronger than justified by fundamentals (after adjustments described in text); a real effective exchange rate model points to a 14 percent overvaluation of the peso.
- Financial flows remained volatile: nonresident holdings of government and central bank paper fell by more than $1 billion in late 2016–early 2017 due to one-off portfolio adjustments by a single investor; Uruguay’s pension funds shifted into local currency offsetting pressures; central bank added US$3 billion to net reserves in the first three quarters of 2017.
- Since August 2016, a tax amnesty in Argentina led to the orderly withdrawal of about US$2 billion in nonresident foreign-currency bank deposits.
Outlook and risks
- Growth is projected to remain somewhat above its 3-percent potential rate in 2018 and 2019, supported by planned investment in rail infrastructure; the output gap is projected to approach zero.
- Inflation is projected to pick up to 6½ percent by end-2017 and is subsequently expected to edge down to about 6 percent.
- Upside risks: potential large foreign investment (agreement, in principle, with Finnish company UPM on a possible third paper pulp-processing plant), which would be the largest FDI project in the country ever and could boost confidence and growth, especially during construction.
- Downside risks: prolonged loss of competitiveness; dampened investor interest in emerging markets; reversal of recoveries in Argentina and Brazil; significant slowdown in China; a correction of the real exchange rate in Argentina could result in depreciation pressures in Uruguay.
- Uruguay’s buffers—gross reserves, liquid financial assets, and contingent credit lines—support the country’s ability to weather short-term shocks; allowing the exchange rate to adjust is an important shock absorber.
Policy recommendations — Keeping inflation low
- Some monetary tightening would be appropriate to bring inflation close to the middle of the central bank’s 3-to-7 percent target range.
- Baseline projection of gradually falling inflation assumes prudent monetary policies with short-term real interest rates staying above 2½ percent.
- Strengthen the policy signal:
- Continue to closely monitor and accommodate changes in money demand.
- Explore options to reduce volatility of short-term interest rates further, for example by using standing facilities to create an interest rate corridor.
- Utilize the 2018 wage round:
- Continued moderation of annual nominal wage growth in the 2018 (multi-year) wage agreements will help anchor inflation.
- Remove remaining provisions that involve backward-looking wage indexation in case of higher-than-expected inflation to reduce inflation inertia.
- De-dollarization and complementary policies:
- Keeping inflation within the target range would support central bank credibility and could set the stage for broader efforts towards de-dollarization.
- Complementary policies include maintaining higher reserve requirements on foreign currency deposits and promoting that prices for domestic transactions are quoted in local currency.
Policy recommendations — Exchange rate flexibility
- Recent interventions to counter disorderly market conditions were justified by sizeable and abrupt portfolio shifts.
- Exchange rate flexibility should remain an important stabilizer; interventions should be limited to countering disorderly market conditions.
- Interventions cannot substitute for necessary structural reforms to enhance productivity and competitiveness; clear communications are important so interventions do not undermine central bank credibility.
Policy recommendations — Fiscal consolidation and investment support
- Staff estimates cumulative structural fiscal effort during 2015–17 amounted to 1.3 percent of GDP (split between years 2015 and 2017, with minimal adjustment in 2016).
- The 2018 budget envisages a decline in the overall deficit from 4.0 percent of GDP in 2016 to 2.9 percent in 2018, and reaffirms commitment to reducing deficit to 2.5 percent of GDP by 2019.
- Higher import fees for goods for consumption (by 3 percentage points, estimated to yield 0.1 percent of GDP) are not helpful for trade integration efforts.
- It would be prudent to reach the 2019 deficit target earlier and reverse the reduction in public investment:
- Achieve the 2.5-percent-of-GDP fiscal deficit objective already in 2018 by saving revenue windfalls and ensuring implementation of spending allocations, helped by lower interest costs.
- Reorient budget spending from the public wage bill to investment and accelerate preparation of PPPs (without relaxing safeguards).
- Assess carefully costs and benefits, including potential synergies, of each project and of incentives to attract private investment.
- Public debt and markets:
- In mid-2017 Uruguay issued nominal-peso bonds in the global market following the decline in inflation, creating a longer local-currency yield curve.
- Implicit liability from future deficits of the defined benefits pillar of the pension system should be carefully assessed and controlled.
- Fiscal rule:
- Amending the existing fiscal rule could strengthen confidence in sustainability of public finances as the government term ends in 2019.
- An enhanced fiscal rule could: (i) include further safeguards to limit use of escape clauses; (ii) constrain annual deficits (or net debt increases) specified in structural terms to allow automatic stabilizers; and (iii) be anchored on a medium-term objective for the level of debt.
- State-owned enterprises (SOEs) require strong governance to avoid quasi-fiscal costs; ANCAP’s restoration to financial soundness suggests a transparent fuel-price pass-through formula would promote efficiency and reduce fiscal risks.
Policy recommendations — Financial sector and inclusion
- Bank credit remains weak and has not been an engine for growth; dollarization and market segmentation make bank credit expensive and limited, especially in the peso market.
- Implementation of the 2014 Financial Inclusion Law should help expand the banking sector’s reach, increase supply of peso funding, and access to credit by consumers and small businesses.
- New capital market instruments for public infrastructure and regulatory changes to facilitate issuance of bonds by medium-sized private enterprises can help develop domestic financial markets and promote competition.
- Banking sector stability:
- Operating costs are high; non-performing loans have risen but remain moderate; bank profitability declined after the 2016 peso appreciation as most banks were long in U.S. dollars.
- Stability risks remain limited, evidenced by authorities’ stress tests and rising capital-asset ratios.
- Supervision should continue to closely monitor banks’ exposures.
- Recent steps to implement Basel III—phased introduction of the 2.5-percent capital conservation buffer, capital surcharges for larger banks, and liquidity ratio regulations—are useful risk-mitigation measures.
Policy recommendations — Enhancing the business climate and structural reforms
- Uruguay’s business climate benefits from strong institutions, stability, and increasing integration in world markets; the country shifted to renewable power sources and developed export connections to Argentina and Brazil; it is implementing a comprehensive care system supporting women’s participation in the economy.
- Ambitious structural reforms are recommended to sustain medium-term growth amid a declining workforce due to population aging:
- Improve educational attainment and quality of education (enhance teacher qualifications and expand vocational training).
- Facilitate further economic integration by upgrading transport and logistic infrastructure and promoting new free trade agreements.
- Enhance labor market flexibility to facilitate shifts to relatively productive sectors and firms and ensure wage increases reflect productivity improvements.
Mission thanks the authorities for the warm hospitality, the open discussions, and the quality of the engagement.