For more information, see Uruguay and the IMF

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.

Montevideo, Uruguay
April 14, 2000

Mr. Stanley Fischer
Acting Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. Fischer:

The attached policy memorandum and annexes describe the economic policies and objectives of the Government of Uruguay for the period 2000–01, in support of which the Government requests a 22-month stand-by arrangement from the Fund, which it intends to treat as precautionary, in an amount equivalent to SDR 150 million. The Government believes that these policies will promote sustainable growth of output and employment in conditions of low inflation and external viability, improve efficiency in the economy in general and in the public sector in particular, and address priority social needs.

During the period of the arrangement, the authorities of Uruguay will 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. Semi-annual reviews of the program will be carried out with the Fund no later than December 2000, and June and December 2001.



César Rodríguez-Batlle
Central Bank of Uruguay
Alberto Bensión
Minister of Economy
and Finance


Memorandum of Economic Policies

I.  Background

1.   The Uruguayan economy achieved substantial progress during the 1990s. After stagnating during the first half of the 1980s, output growth per capita increased to an average of almost 3 percent per annum since then, and inflation was brought down from 133 percent in 1990 to below 5 percent by end-1999. All Uruguayan citizens benefited from this progress, as the country maintained one of the most equal income distributions and best overall social indicators among the Latin American countries. During this period, economic policies have emphasized cautious fiscal management combined with moderate incomes policies; international trade and payments liberalization; domestic market deregulation; fundamental reforms in the areas of social security and education; and a gradual reduction in the rate of depreciation of the exchange rate band to help lower inflation expectations.

2.   However, important macroeconomic challenges remain. Competitiveness was adversely affected by the Brazilian devaluation in early 1999, unemployment is high, and structural inefficiencies, including in the fiscal area, need to be addressed to support saving and private investment in the economy. Indeed, actions to streamline public sector activities are necessary as, through its ownership of the largest financial and nonfinancial enterprises, the public sector remains a dominant player in the economy. Society is searching for an appropriate balance of policies to help deliver a flexible and dynamic economy while generating equitable opportunities for all Uruguayans.

3.   The year 1999 was difficult for Uruguay. The economy suffered from the combined impact of the sudden devaluation of the Brazilian real early in the year, the growth slump in Mercosur partner countries, a sharp deterioration in the terms of trade, and uncertainties associated with presidential elections toward the end of the year. As a result, real GDP is estimated to have declined by 3.4 percent (from growth of nearly 5 percent in 1998). Economic activity touched bottom in the third quarter of 1999 but the recovery has been hampered by a drought which reduced agricultural output, a slow summer tourist season, and the impact of the increase in oil prices on energy costs. The unemployment rate increased from 10 percent in mid-1998 to 11.4 percent in December 1999, but inflation was cut in half to 4.2 percent.

4.   The public finances weakened significantly, with the overall deficit rising from 0.9 percent of GDP in 1998 to one of 3.8 percent (nearly US$800 million) in 1999. A significant part of the fiscal slippage resulted from the economic downturn, but the Government also granted special assistance to sectors most affected by the recession and the drought, and incurred one-time election expenses and some unforeseen capital and interest outlays. In the public sector enterprises, the National Petroleum Company faced higher than expected oil import costs, and the National Electricity Company used expensive oil-fired generators since the drought reduced water pressure in the reservoirs. The local governments ran an unanticipated deficit of 0.3 percent of GDP in 1999, reflecting the impact of the recession, general elections at end-1999, and their own elections in May 2000.

5.   The Government did not experience difficulties in financing the deficit in 1999. While access to international capital markets remained open (government bonds have an investment grade credit rating from international rating agencies), the government chose to place only one ten-year US$250 million Eurobond (issued in April 1999 at an interest rate spread of 225 basis points over the comparable U.S. Treasury instrument). Instead, as credit demand from the private sector was weak during 1999, while deposits continued to flow in, the government financed its remaining borrowing needs from domestic sources. The private banks appear to have weathered the recession of 1999 reasonably well, with adequate profitability and no substantial deterioration in their loan portfolio. However, the public sector banks assisted some sectors of the economy most affected by the recession and adverse terms-of-trade developments by refinancing loans and stretching out payment periods, and their ratio of nonperforming loans increased relative to that in private banks. Nevertheless, the public sector banks are substantially more capitalized than private banks and they can withstand additional provisioning for any amounts that may prove irrecoverable. The banks are closely monitoring the refinanced loans.

6.   The external current account deficit widened from 2.1 percent of GDP in 1998 to 2.9 percent (or US$600 million) in 1999. Merchandise exports contracted by more than 18 percent in U.S. dollar terms (over 7 percent in volume), while imports dropped by nearly 12 percent (also about 7 percent in volume). Exports to Brazil were particularly hard hit by weak demand and the appreciation of the bilateral real exchange rate. Consequently, export prices for selected commodities were deeply discounted and the merchandise terms of trade declined by nearly 8 percent in the year. Foreign direct investment was boosted by a few large operations in the hotel and retail sectors and covered nearly a third of the current account deficit, and was supplemented by continued substantial private deposit inflows. Net international reserves remained about unchanged, following substantial increases in recent years.

7.   Developments in interest rate policy and the exchange rate band mechanism evolved broadly as had been envisaged in the program for 1999. Confidence in overall economic policies and in the exchange rate regime remained strong, and in July the Central Bank (BCU) eased its benchmark short-term interest rate from 12½ to 9½ percent, where it remains today. Meanwhile, the rate of depreciation of the exchange rate band was maintained at 7½ percent a year. While the external environment was unfavorable and Uruguay suffered a competitiveness shock with the devaluation of the Brazilian real, the pressures on the exchange rate band were limited to those normally seen during an election year. The exchange rate drifted gradually from the lower, and most appreciated, limit of the band at mid-year, to the upper, and most depreciated, limit of the band just prior to the elections in October/November. However, the peso quickly returned to the most appreciated limit of the band after the elections.

II.   The Economic Program for 2000–01

8.  The new Government, which took office on March 1, 2000, is determined to build on the economic progress achieved in the 1990s, and is committed to addressing the difficulties and challenges that remain present in the economy. In Uruguay's consensus-oriented society, the Government is seeking broad-based social and political support for this effort. The Government is also seeking support from the international financial community, including the International Monetary Fund, and therefore it requests from the Fund a 22-month stand-by arrangement.

9.   The Government's first priority is to create the conditions for a sustainable recovery in output growth while preserving price stability. The resumption in output growth is needed to reduce unemployment. The policy measures will focus on strengthening the public sector finances and structural reform. There is a need to increase saving in the economy which, in turn, will stimulate investment while limiting the country's overall indebtedness. Simultaneously, structural reforms are crucial to improve competitiveness of domestic production, within the framework of the adjustable-band exchange rate system, and in the course of efforts at regional economic integration. This will require cost containment, deregulation and increased competition, improved disclosure, and other structural reforms for the private and public sector.

III.   The Macroeconomic Framework

10.   Uruguay is gradually emerging from the recession and the rebound in output growth is expected to gain strength towards the middle of 2000. The Government is confident that with a recovery of economic activity in Argentina and Brazil, the international economic environment has already turned more favorable than that prevailing during 1999. Nevertheless, the region still faces risks, as international interest rates are rising, and Uruguay will confront, for now, continued soft commodity prices and higher energy costs. Accordingly, the Government expects real GDP growth of between 2–2½ percent in 2000, led by a turnaround in the foreign balance and a gradual recovery in private investment and consumption. The rate of inflation is likely to pause in the range of 4–6 percent, about the same as in 1999, before resuming its downward trend in 2001. Employment is expected to begin a recovery, but the unemployment rate initially is expected to drop only moderately as participation rates typically also rebound with a recovery. With improved external conditions and lower overall domestic costs in U.S. dollars, the external current account deficit is projected to narrow to between 2–2½ percent of GDP in 2000.

IV.    Economic Policies

11.   The Government believes that its economic program for 2000–01 is best seen as part of a medium-term effort to restore competitiveness and resume high output growth. In this context, it intends to follow a two-pronged fiscal strategy, combining a consolidation of the public finances to strengthen confidence and lower the national debt ratio, with gradual tax cuts to help reduce costs in the economy and foster competitiveness. Both objectives require expenditure restraint and structural reform. The Government is preparing a five-year budget plan for the course of the new Presidential term. This budget plan will aim at bringing the fiscal deficit down to below 1 percent of GDP over the medium term, and will be presented to Congress prior to end-August 2000. The structural fiscal objectives cannot be reached all at once, but the government will significantly reduce the deficit in 2000–01, and is committed to seeking a turnaround, over the medium-term, in the public sector gross debt-GDP ratio, which has risen sharply recently as it includes the costs of the social security reform (over 1 percent of GDP a year) since 1996.

12.   In 2000, the Government aims to cut the fiscal deficit in half to 1.8 percent of GDP. Some 40 percent of the implied adjustment is the result of the non-recurrence of the one-time expenditures that affected the deficit in 1999. The remainder reflects improved tax receipts in response to the recovery in economic activity, and planned cuts in noninterest discretionary expenditures.

13.   On the revenue side, the Government will not seek tax increases during its term in office. Indeed, for 2000, there will be a tax reduction on land and a cut in the employer social security contributions in the farm sector to help lower costs and assist in absorbing the effects of the drought. Notwithstanding these tax cuts, the ratio of overall revenue to GDP is expected to recover in 2000 from its drop in 1999. There are three reasons: firstly, with the return of output growth, purchases of durable consumer goods are expected to recover from the sharp decline experienced during the recession, and such products are among the strongest value added and excise tax revenue sources. Secondly, imports are projected to recover as well, boosting import tax receipts. And thirdly, the (public enterprise) tariffs for petroleum products and derivatives are being adjusted to reflect higher energy import costs.

14.   Noninterest expenditures are programmed to drop in real terms, thereby reducing their share in GDP by 1¾ percentage points, and helping to lower costs in the economy. Wages in the central government (which account for some 5 percent of GDP) were adjusted by 1½ percent in January 2000 and will not be adjusted further this year (see below). Moreover, social security outlays (nearly 17 percent of GDP in 1999) are indexed to average private and public sector wages in the economy and are expected to fall in relation to GDP as well. Lastly, reflecting discretionary expenditure containment and the effects of the nonrecurrence of some one-time outlays noted above, purchases of goods and services, other discretionary outlays, and capital spending will all be cut in relation to GDP. The bulk of the programmed reductions in expenditure (and the deficit) for 2000 will take place in the central government and public sector enterprises, whereas local governments, which have virtually no access to financing, will need to eliminate their deficit recorded in 1999.

15.   Moderating wage growth is critical to help bolster competitiveness and improve prospects for employment growth. The public sector indexation law that was adopted in Congress at end-1998 stipulates that if 12-month inflation remains below 10 percent since the last public sector general wage adjustment, the Government has the option to reduce the frequency of indexation from twice to once a year. With the drop in inflation in 1999, this condition has been satisfied and wages in the central government will be limited to the increase in January noted above. Police and military personnel will receive an additional pre-committed adjustment later this year, effective from March 2000. Together with moderate wage adjustments in the public enterprises and local governments, wages for the public sector combined are expected to drop slightly in real terms in 2000, following a real wage increase exceeding 3 percent in 1999. Wage pressures in the private sector were weak in 1999 and are expected to remain so for this year. There have been some instances of wage settlements that favored jobs over wage increases and there are downward pressures from the high rate of unemployment.

16.   Monetary policy is subordinated to the exchange rate regime. During 2000, currency in circulation is projected to rise about in line with nominal GDP, while the BCU's net international reserves are programmed to remain unchanged from their level at end-1999. The program envisages that broad money will increase by 8–10 percent, reflecting increasing deposits, and that a significant share of the government borrowing needs will be satisfied from abroad (see below). This will permit banking system credit to the private sector to increase by 4–6 percent in real terms.

17.   Sound financial intermediation is critical for a vibrant and healthy economy, and the Government will pay special attention to fostering a competitive banking system. The Uruguayan banking system enjoys a good reputation in the region and confidence in the banks is strong. At the same time, the Government is aware of the emergence of new banking technologies and financial system reforms in our neighboring countries that are slowly eroding our traditional comparative advantages, such as our central geographic location and macroeconomic stability. As a result, the efficiency of the banking sector in Uruguay needs to be improved, while the need for sound prudential norms and regulations, close supervision, and market-based credit allocations is becoming increasingly important. At end-February 2000, the Government obtained approval in the Board of the World Bank for a US$81 million financial sector adjustment loan in support of steps to remove gradually some privileged treatment of the public sector banks; to improve prudential and statistical compliance; to equate reserve requirements across all private and public sector banks; to open up to competition from private banks some activities now reserved for the public sector banks; and to strengthen supervision from the Central Bank (i.e., through the establishment of regular in-situ inspections). The objective of these reforms is to place public sector banks on a level playing field with the private banks in all aspects of financial intermediation. The Government will work closely with the staff of the World Bank to administer this program, and keep Fund staff informed of progress in this area.

18.   In recent years, and consistent with the financial and wage policies described above, the government has slowed gradually the pace of adjustment of the exchange rate band in line with the targeted decline in inflation. The Government maintains these policy intentions for the medium term until inflation has been brought down further and an even firmer inflation anchor can be considered. However, this year there is a need to support a gradual decrease in the real effective exchange rate of the peso, reinforced with domestic cost reductions. To this end, the Government will proceed cautiously and maintain the pace of depreciation of the band at its current rate of 7½ percent a year. The foreign exchange market remained calm after the devaluation of the real and despite the increased uncertainties related to the electoral cycle, and the Government has responded to temporary pressures by permitting the exchange rate some flexibility within the band. In view of the absence of wage pressures in the economy, continued moderate inflation, and the lack of supply constraints, this policy will be continued in 2000.

19.   The Government continues to make efforts to strengthen confidence in the overall financial position of Uruguay. The 2000 financing plan envisages net lending from the Inter-American Development Bank and the World Bank of some US$125 million, and the net placement of around US$300 million in long-term U.S. dollar denominated bonds. Most of these bonds will be placed abroad but a part can also be placed with the domestic private pension funds (AFAPs) which receive some US$220 million in inflows of contributions every year. To preserve an average maturity structure of at least seven years, the Government will not issue any net short-term debt, and with this financing schedule, Uruguay will have virtually no short-term public sector debt.

20.   The Government is committed to structural reform as an essential instrument to help improve productivity and competitiveness. Structural reform measures require ample discussion and participation by political representatives and the public alike, and the Government believes that the best incentives for increasing productivity, lowering costs, and strengthening competition, are provided by improving the flow of information to the public and seeking greater disclosure on public and private sector activities. The attached annex describes a number of structural reform benchmarks that may be grouped in three broad categories: (1) those that improve transparency and disclosure, such as preparing quarterly and (audited) annual reports on corporate activities; a release calendar for information on the public sector's monthly fiscal position; external independent audits for financial and nonfinancial public enterprises; and the undertaking of a study to document and quantify all quasi-fiscal activities presently carried out through the public banks and entities; (2) those that reduce costs specific to public enterprises, to prepare them for deregulation and a competitive market, such as the elimination of the tax on foreign exchange operations, and the gradual removal of the social security surcharge that is also unique to public enterprises; and (3) those specific to securing a strong and competitive banking system, such as the independent external analysis of the loan portfolios of the public sector banks, and the requirement for all banks to place debentures in the capital market equivalent to at least 2 percent of their deposit base.

21.   The Government intends to maintain Uruguay's exchange rate system free of restrictions on payments and transfers for international transactions. Uruguay has implemented on schedule all customs tariff reductions as agreed under the Mercosur convention, and the Government will continue to argue for the removal at end-2000 of the 3 percent surcharge on the common external tariff as it believes that this surcharge hinders the competitiveness of the economy.

22.   The Government continues its efforts to improve the accuracy, timeliness, and comprehensiveness of statistical data on the economy. A two-year project to revise and expand national accounts statistics is on track to be finalized by mid-2001. Also, the BCU is implementing a revised system for the compilation and structure of the monetary statistics, for which it has received technical assistance from the Fund. In this context, the Government will ensure that by September 2000, the Bank of the Republic (BROU) and the National Mortgage Bank (BHU) reduce their reporting lag of monetary data to the BCU to that of the private banks, as included among the structural reform benchmarks reported in Annex I. The statistical efforts and measures described above are preparatory steps for Uruguay's subscription to the Fund's SDDS.

23.   The economic program for 2000–01 contains indicative quantitative targets for 2001. With a steady reduction in domestic production costs, and assuming the dissipation of recent shocks, Uruguay will be in a position to benefit fully from the recovery in the region and real GDP growth should be picking up to at least 4 percent. In those circumstances, the Government intends to bring the consolidated fiscal deficit down to 1.2 percent of GDP, and the more favorable export conditions are expected to allow for some renewed accumulation of net international reserves. Also, the total public sector gross debt-GDP ratio will then be close to its inflection point after which it can begin to drop in the medium term. The Government will consult with the Fund on the economic outlook and policy options for 2001, and determine the quarterly distribution of the indicative annual targets on the occasion of the discussions for the first review of the program toward the end of 2000.

Table 1. Uruguay: Quantitative Limits and Targets for the 2000–01 Economic Program
Dec. 31

Dec. 331
  Jun. 30 Sept. 30 Dec. 31
Performance Criteria

(Cumulative flows from the end of the previous year; millions of Uruguayan pesos)
1. Combined public sector balance (floor)1   -4,050 -4,400 -4,700 -3,500
2. General government expenditure (ceiling)2   14,400 21,000 28,000 30,075
3. Change in the net domestic assets of the BCU
  735 445 650 250
(Cumulative flows from the end of the previous year; millions of U.S. dollars)
4. Net international reserves of the BCU (- decrease)
  -110 -140 0 50
(Stock of debt at the end of the period; in millions of U.S. dollars)
5. Public sector debt denominated in foreign
    currency and UR (ceiling)5
       a. All maturities 7,514 7,950 8,025 8,080 8,530
       b. Less than one year 200 200 200 200 250

Sources: Ministry of Economy and Finance, and Central Bank of Uruguay.
1The combined public sector comprises the central government, the social security system, the municipalities, the public enterprises, and the quasi-fiscal result of the central bank. This limit will be adjusted by the difference between the actual and projected social security contributions transferred to the private pension system.
2Defined as total expenditure by the central administration and social security system, excluding outlays on interest, pensions and internal transfers. This limit will be adjusted by any difference between projected and actual social security contributions transferred to the private pension system.
3The net domestic assets of the Central Bank are defined as the difference between currency in circulation and the net international reserves of the BCU as defined in footnote 4 below. The changes in NIR are to be valued at the average exchange rate (projected in the program) for the corresponding quarter. The limit on NDA will be adjusted by the equivalent in Uruguayan pesos of the adjustments made to the limit on the NIR of the BCU.
4The NIR of the BCU are defined as the difference between the foreign assets of the BCU and its reserve liabilities including swaps and outstanding purchases from the Fund. The gold holdings of the BCU will be valued at the accounting rate of US$42 per troy ounce. Gains or losses from gold-swaps and other operations are to be excluded from the calculation of NIR (also from the debt). Non-U.S. dollar denominated foreign assets and liabilities are to be converted into U.S. dollars at the market exchange rates of the respective currencies as of December 31, 1999. The targets for NIR will be adjusted: (1) upwards by the amount in which free foreign currency deposits of the BROU, the BHU and the private commercial banks exceed their level of December 31, 1999; and (2) downwards (by up to US$150 million) by the amount in which those deposits fall short of their level of December 31, 1999.
5Refers to the stock of public sector debt denominated in foreign currency, external debt guaranteed by the public sector, and debt in UR ("Unidades Reajustables"). Excludes reserve liabilities of the BCU and short-term liabilities of the BROU and the BHU; and foreign currency deposits of nonresidents in the local banking system. The overall limit will be adjusted by (1) the difference between projected and actual debt at end-1999; (2) the difference between the projected and actual 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 changes in the amount of export prefinancing in the BCU in relation to the level of December 31, 1999 (also for short-term debt); and (5) by an amount equivalent to the reduction (in excess of US$150 million) in free foreign currency deposits of the BROU, HBU and a the private banks in the BCU from their level of December 31, 1999. Certificates of deposit issued by the BCU to banks and/or their substitute Treasury instrument (treasury bills > one year) are included in medium and long-term debt.



Structural Reform Benchmarks

Before end-September 2000

1. Complete external independent analysis of the loan portfolio of the BROU and the BHU.

2. Submit law to Congress to revoke ICOME by January 1, 2001.

3. Submit law to Congress to eliminate the social security surcharge for public enterprises (12 percentage points) in 12 quarterly steps of 1 percentage point each. The first reduction to take effect in January 2001.

4. Initiate a study of the quasi-fiscal operations of all public sector financial institutions and other entities. This study to be completed before end-June 2001.

5. Start release calendar for monthly data on the public sector finances: government to publish results of (a) tax collections (DGI table), (b) central government operations, (c) social security operations (BPS), (d) public enterprise results, and (e) quasi-fiscal balance (BCU), for July 2000. Subsequent monthly data to be published with a lag not exceeding 60 calendar days.

6. Reduce the BROU and BHU reporting lags of monetary data to the Central Bank of Uruguay to that equivalent of the reporting lag of private banks.

Before end-December 2000

7. Publish quarterly reports for the three-month period ending September 31, 2000, for the public sector financial and nonfinancial enterprises (BROU, BHU, BSE, ANCAP, UTE, ANTEL, OSE, AFE, ANP). The reports to include annotated summary tables of the results of operations, cash flow, and balance sheet. Subsequent quarterly reports to be published with a lag not exceeding 10 weeks from the end of the relevant calendar quarter.

Before end-March 2001

8. Submit law to Congress to reform special pension funds (Cajas Especiales) for the banking sector, university professionals, notaries, police, and the military.

9. Complete independent external audit of BROU, BHU, and BSE.

10. Complete independent external audit of ANCAP, UTE, ANTEL, OSE, AFE, and ANP.

Before end-June 2001

11. Publish annual reports of BROU, BHU, BSE, ANCAP, UTE, ANTEL, OSE, AFE, and ANP, approved by independent external auditors. The reports to include summary tables of results of operations, cash flow, and balance sheet. Subsequent audited annual reports to be published with a lag not exceeding four months.

12. Private and public sector banks to place debentures in the capital market equivalent to a minimum of two percent of their deposit base.