## Uruguay: Staff Concluding Statement of the 2017 Article IV Mission

_IMF News, December 7, 2017_

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## Bibliographic details
- Published: December 7, 2017

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### 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.*

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## References

- [Argentina and the IMF](http://www.imf.org/external/country/ARG/index.htm)
- [Brazil and the IMF](http://www.imf.org/external/country/BRA/index.htm)
- [Uruguay and the IMF](http://www.imf.org/external/country/URY/index.htm)
- [IMF Policy Advice -- A Factsheet](https://www.imf.org/en/about/factsheets/imf-surveillance)
- [Mission Concluding Statements](https://www.imf.org/en/news/searchnews)
- [PRESS CENTER](http://presscenter.imf.org/)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2017/12/07/ms120717-uruguay-staff-concluding-statement-of-the-2017-article-iv-mission_