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Uruguay—Letter of Intent, Memorandum of Economic Policies, and Technical Memorandum of Understanding

Montevideo, Uruguay, March 12, 2002

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.

Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. Köhler:

The attached policy memorandum and annexes describe the economic policies and objectives of the Government of Uruguay for the period 2002-03, in support of which the Government requests a 24-month stand-by arrangement from the Fund, in an amount equivalent to SDR 594.1 million.

The Government is also requesting approval of the last review of the 22-month stand-by arrangement from the Fund, which was approved by the Executive Board on May 31, 2000 and expires on March 31, 2002. In 2001, the economy continued to be affected by adverse external developments which contributed to a drop in national income for the third year in a row, and resulted in the nonobservance of the performance criteria for the public sector deficit. Prefinancing of 2002 borrowing needs contributed to the nonobservance of the performance criteria for the debt ceiling. Under these circumstances, the Government is requesting a waiver for these nonobserved performance criteria.

The Government believes that the policies described in the attached memorandum for the period 2002-03 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. Reviews of the program will be carried out with the Fund no later than September 2002, December 2002, March 2003, September 2003, and March 2004.


Cesar Rodriguez-Batlle
Central Bank of Uruguay
Alberto Bension
Minister of Economy
and Finance

Memorandum of Economic Policies

I. Developments under the program in 2001

1. Uruguay faced difficult economic conditions in 2001 in the wake of a downturn in economic activity the previous two years. Exports were affected by an outbreak of foot-and-mouth disease, which halted meat exports during most of the year (meat and related exports account for about 20 percent of total merchandise exports). At the same time, the deepening of the Argentine crisis weakened confidence, prompting caution in consumers and investors, and causing domestic demand to fall in real terms for the third consecutive year. Real GDP is estimated to have declined by 2 percent in 2001 and the unemployment rate reached 14.9 percent. Consumer price inflation ended the year at 3.6 percent, the lowest annual inflation rate in decades.

2. The quantitative performance criteria of the Fund-supported program through end-December 2001 were observed, with the exception of the fiscal deficit and public sector debt targets. The consolidated public sector deficit reached 4 percent of GDP compared with a program target of 3.3 percent. The larger-than-programmed deficit was mainly explained by a drop in consumption taxes and the effects of tax concessions granted to the sectors most affected by the foot-and-mouth disease. The nominal public sector expenditure target under the program was met with a margin of about 2.5 percent.

3. The government maintained good access to market financing in 2001, placing five international bond issues for a total of around US$1.1 billion at an average spread of 240 basis points over corresponding U.S. Treasury bonds. In addition, the government had recourse to the domestic market. The public debt, which is denominated mostly in U.S. dollars, rose to 52 percent of GDP by end 2001, reflecting mostly the effects of the real depreciation of the peso vis-à-vis the U.S. dollar and the build up of international reserves. The program ceiling on public debt was exceeded by US$41 million, in part due to the pre-financing of 2002 borrowing needs.

4. The peso was under on-and-off pressure throughout the year. In June, the Central Bank doubled the pace of depreciation of the exchange rate band to 15 percent annually and widened the band from 3 to 6 percent. The peso came under renewed pressure following the September 11 attacks and again at the end of the year, reflecting the turbulence in Argentina. Uruguay continued to attract nonresident deposits in 2001, which rose by US$1.3 billion to US$6.6 billion at end-year. The banking system weathered the difficult economic conditions relatively well, although in early 2002 problems developed in the two largest private banks in the country, both with close links with Argentina. One of the banks experienced liquidity problems, while the other was affected by alleged fraud. The government took immediate steps to address the problems of these banks, but there were important deposit outflows, contributing to a drop in international reserves of the Central Bank. In addition, the state Mortgage Bank (BHU) incurred losses on account of a currency mismatch between assets and liabilities.

5. The external current account deficit is estimated to have widened to 3.1 percent of GDP in 2001 (some US$590 million). Merchandise exports fell by 10.7 percent in U.S. dollar terms (9 percent in volume), reflecting the effects of the foot-and-mouth disease and the slowdown in regional demand, while merchandise imports declined by 11 percent in value and 8 percent in volume terms. The nonfactor services balance declined markedly reflecting a sharp decline in tourism. In the capital account, net foreign investment rose to US$320 million, with inflows mostly directed towards the hotel sector, retailing, and forestry. Portfolio inflows, dominated by the placement of government bonds abroad, remained strong and there was a net inflow of nonresident deposits into the banking system. The overall balance of payments registered a surplus in 2001 and gross reserves of the Central Bank rose to US$3.1 billion at the end of 2001, equivalent to almost a year of imports or 115 percent of short-term debt on a residual maturity basis. The external debt, most of it public, amounted to 48.8 percent of GDP at end 2001.

6. The economic difficulties have stimulated the debate about the urgency of structural reforms in Uruguay. During 2001, the government strengthened transparency in the financial and nonfinancial public sector, deregulated markets, and deepened the reform of the pension system. The two structural benchmarks for end-2001 were met, including presentation to congress of laws to reform special pension funds for university professionals and the police, and the liberalization of imports of petroleum products, as part of a bill that restructured the oil market in Uruguay which was approved in late 2001. This law: (i) allows the oil state company (ANCAP) to seek a private partner for its operations, including the oil refinery and those in Argentina, (ii) aligns domestic oil prices with international prices by March 2004, and (iii) removes ANCAP's monopoly on the importation of crude oil immediately and that of petroleum derivatives by January 2006. The government privatized one of the two remaining intervened banks, Caja Obrera, which was acquired by Banco Montevideo with financial assistance from the International Finance Corporation (IFC)

II. The Economic Program for 2002-2003

7. Uruguay has been affected by successive adverse external shocks resulting in a prolonged recession and a rise in unemployment. These shocks, which became more severe after Argentina introduced a deposit freeze in late 2001, have contributed to a gradual decline of national income measured in U.S. dollars and a significant increase of the public debt to GDP ratio, and lately to pressures on the banking system. The government is strongly committed to addressing the challenges posed by these developments, and already has adopted significant measures in several areas to deal with these problems, including particularly in the banking system. Broad-based social and political support has been secured for this effort. Support from the international financial community will also be needed, including a new stand-by arrangement from the International Monetary Fund.

8. The government's economic program will underpin a recovery in economic activity and a decline in unemployment, while addressing social needs, maintaining price stability, making the economy more competitive, and strengthening the external sector. The policy measures are focused on strengthening the process of fiscal consolidation, keeping the banking system healthy, and intensifying structural reforms, particularly with regard to the public banks and deregulation of the economy. The exchange rate will continue to absorb competitiveness shocks while additional monetary policy instruments will be developed. Such a framework will help Uruguay minimize the contagion effects from the crisis in Argentina.

9. These policies are part of an overall strategy to liberalize the Uruguayan economy over the medium-term, to allow faster growth of productivity and hence economic activity. These conditions will open up and diversify the economy, resulting in a greater role for exports and tradable services which will be further encouraged by additional trade agreements that are to be negotiated. The public sector's role in the economy will be downsized through the opening of an increasing number of activities to private sector competition and a continuing compression of public sector costs. These policies, together with a simplification of the tax system and a reduction of red tape, will create room for a more dynamic private sector.

III. The Macroeconomic Framework

10. The Argentina crisis is resulting in problems in the financial sector and payments systems, a drop in tourism receipts, and a closing of Argentine markets for Uruguayan goods. These developments are exerting a downward pressure on output, and real GDP will decline in the first half of the 2002. Nonetheless, with the gradual reopening of markets to meat exports that is underway, the positive effects of the real depreciation of the peso, and a rekindling of confidence, the government expects output growth to turn positive toward the end of the year and to rise substantially in 2003. In annual terms, real GDP would decline by around 1¾ percent in 2002, but would grow by at least 3 percent in 2003. The pressure on domestic prices from the accelerated pace of depreciation of the peso will be partly offset by the effects of the decline in domestic demand and the moderation of wage increases in both the private sector and public sector (see below). Inflation would not exceed 10 percent during 2002 and is projected to decline to around 8 percent during 2003. The external current account deficit would decline by around 1 percentage point of GDP to 2 percent of GDP in 2002 and 2003, largely on improved public savings.

IV. Economic Policies and Structural Reforms

11. In response to the devaluation of the Argentine peso in January 2002, the Government doubled the pace of depreciation of the exchange rate band to an annual rate of 33 percent and the total width of the band to 12 percent. The program assumes that this arrangement will be maintained until the end of the year. However, the Government will consider a reduction of the pace of depreciation, as early as the second half of 2002 if allowed by external and domestic economic circumstances.

12. A strengthening of the public finances is essential to ensure a sustainable medium-term fiscal position in the current context of tighter financing constraints and a heavier debt burden associated with the real depreciation of the peso vis-à-vis the U.S. dollar. Under these circumstances, the government intends to reduce the public sector deficit to 2.5 percent of GDP in 2002 from 4 percent of GDP in 2001, equivalent to a reduction in the primary (noninterest) deficit of the public sector of about 2.3 percentage points of GDP. The public sector deficit will be cut further to at most 1.5 percent of GDP in 2003, and fiscal balance will be achieved in 2004, with the primary surplus increasing from 1 percent of GDP in 2002 to 2.6 percent of GDP in 2003 and to 4.2 percent of GDP in 2004. Sustained expenditure moderation will be the key instrument of the medium-term fiscal strategy, while tax increases will be minimized in the short term in view of the still fragile recovery in economic activity, and the already high tax to GDP ratio.

13. Noninterest expenditures are programmed to fall by nearly 1.5 percentage point of GDP to 31.7 percent of GDP in 2002. Wages in the central government (which account for about one fifth of total expenditures) were increased by 1.5 percent in January and will not be increased further during the year. Social security outlays (nearly half of total expenditures) are indexed to average wages in the economy, and were raised by 3.6 percent in January. In addition, a number of measures are being implemented, including: (a) reducing contractual services; (b) postponing the filling of positions created by the budget law; (c) cutting overtime; (d) reducing travel expenditures for public employees; (e) cutting leasing costs; (f) a package of cost cutting measures introduced by decree in February, (g) cuts in subsidies for the forestry sector and bonuses for military personal abroad approved by congress in February; (h) a bill recently submitted to congress that eliminates an autonomous entity and phases out government guarantees; and (i) limiting the rate of implementation of the budget. For 2003, the Government will maintain the policy of spending moderation, including on wages. This, together with additional discretionary expenditure cuts, will ensure a further decline of noninterest expenditure at the national government level to less than 30 percent of GDP. At the same time, local governments are taking steps to eliminate arrears and the small deficit they ran in 2001.

14. Expenditure cuts will not affect social spending, whose ratio (excluding pensions) with respect to GDP will remain at about 10 percent of GDP during the program period. Efforts will continue to be made to strengthen the administration of social programs and improve their targeting, including efforts to: (i) ensure full enrollment for children of elementary-school age, (ii) broaden the coverage of food programs, unemployment benefits, and family allowances, and (iii) establish new programs targeting the elderly, pre-school children, and families headed by women.

15. Consolidated public sector revenues are projected to rise by 1 percentage point of GDP in 2002 to 32.4 percent, despite the continued recession and a decline in real terms of social security contributions, associated with the slower pace of wage increases in the economy. The increase in revenue reflects the effects of: (a) a tax package that was approved by Congress in February which includes an increase of the wage tax, a tax on international telephone and cellular telephone calls, cigarettes, juices and fruit concentrates, a broadening of the base of the VAT to cover wine, lottery games, interest on loans, and inputs of the forestry sector, the closing of loopholes in the VAT, net worth tax, and the tax on bank assets, and a 2 percent consular fee on imports; and (b) receipts from the leasing of telecommunications frequencies and duty-free shops in airports. Reflecting the full year effects of the measures just approved, the ratio of consolidated public sector revenue to GDP is projected to remain at about the same level in 2003, despite the absence of one-off revenues such as the leasing of telecommunication frequencies.

16. To ensure a continuing strong performance in the tax area over the medium term, the government will submit to congress before the end of 2002 a proposal to reform the VAT aimed at broadening its coverage and harmonizing its rate (structural benchmark). This will allow a reduction in the maximum VAT rate and the elimination of other taxes that distort the allocation of resources and hamper growth prospects. At the same time, the government will prepare a study of a more comprehensive reform of the tax system, with the assistance of the Fund and other international institutions. The main objective of this reform would be to simplify the tax system, including the elimination of some taxes, the broadening of the coverage of others, a reduction in tax rates, and the closing of loopholes, thus discouraging tax evasion. The reform will create the conditions for a strengthening of tax administration and an increase in tax collections that will ensure achievement of the primary surplus that is being sought.

17. The gross borrowing needs of the government are projected to be around US$1.5 billion in 2002. Taking into account expected lending from the Inter-American Development Bank and the World Bank of at least US$300 million, and US$250 million from a global bond issued in late 2001, the financing plan envisages a need for market borrowing in 2002 of no more than US$950 million. Of this, some US$300 million will be via international issues, and the remainder, equivalent to the rollover of domestic maturities in 2002, will be placed in the domestic market. Among the local investors, the most important are the pension funds (AFAPs), which receive some US$150 million in contributions every year. Gross borrowing requirements are projected to fall slightly in 2003 to nearly US$1.4 billion, reflecting mainly an increase in amortization payments.

18. Because of the effects of the real depreciation of the peso and the fiscal deficit, the public debt to GDP ratio will rise during the program period. To limit the increase in the debt, the Government will design, by the time of the first review (structural benchmark), a program to sell public assets, as envisaged in the Fiscal Responsibility Law, which will be implemented during 2002-04. The public debt to GDP ratio would rise to around 65 percent in 2003-04, before declining thereafter. The government attaches great importance to creating the conditions for an early reversal of the upward trend of the debt. This will reinforce market confidence in Uruguay and allow an upgrade of Uruguay's sovereign debt back to investment grade status which, in turn, will contribute to fiscal consolidation by containing the growth of the government's interest bill. The ongoing strategy of deepening Uruguay's capital markets, together with the growth in the size of funds managed by the pension funds (AFAPs), should help improve the liquidity of the domestic debt. The government also plans to introduce CPI-indexed bonds. To facilitate this process, the Government will introduce and publish a CPI-indexed financial unit (Unidad Indexada,UI), no later than end-September 2002 (structural benchmark).

19. The Government will conduct a study on ways to develop additional monetary policy instruments in the economy by June 2002 (structural benchmark), including open market operations in the peso market. The program will limit the rise of the net domestic assets of the central bank to be consistent with the projected increase in money demand and net international reserves movements. In advance of the implementation of the study's recommendations to manage liquidity in the peso market, the Central Bank will rely on a more active use of the central bank call and rediscount rates. The Central Bank will also ensure that interest rates on banks' excess reserves at the central bank remain competitive with respect to international interbank interest rates. Net international reserves are programmed to remain unchanged at end-2003 from their level at end-2001, after an adjustment is made for the use of the 2001 pre-financing of the public sector. Room has been provided within 2002 to take account of temporary liquidity assistance to the banking system.

20. The soundness of the financial system has been one of the cornerstones of macroeconomic stability in Uruguay. Private banks are well managed, liquid, and well capitalized, and nonperforming loan ratios net of provisions are very low at under 5 percent. The government will continue to take measures to strengthen the financial system and is seeking the commitment of banks' shareholders to ensure that their institutions remain liquid and well capitalized, including provision of funds by headquarters if necessary. The strategy of the government for strengthening the private banking sector and reducing the vulnerability to external shocks is focused on four main areas: (i) a rapid resolution of the situation of ailing banks, in particular two private banks that have been affected by developments in Argentina; (ii) strict supervision and enforcement of laws and regulations to maintain the soundness of the rest of the private banking system; (iii) further strengthening the regulatory framework towards fuller compliance with the Basle Core Principles; and (iv) enhanced disclosure of financial institutions' financial statements, allowing the market better to monitor the soundness of the system.

21. As mentioned above, the government has promptly dealt with problems that developed in the two largest private banks in the country. The Central Bank intervened in one of them, a subsidiary of a private bank in Argentina, and in practice an offshore institution with no major exposure and customer base in Uruguay, in February 2002, suspending its operations temporarily to allow its management time to design a plan to restore the liquidity of the bank. In the case of the other bank, an institution with a large presence in the Uruguayan financial system, and affected by an alleged fraud that depleted its capital base, the government reached an agreement with three of its shareholders to recapitalize the bank. These three shareholders and the government contributed each one fourth of the total recapitalization effort which amounted to US$133 million. The management of the bank has been replaced and a new board of directors has been appointed. Legal actions have been initiated against those charged with the alleged fraud. The central bank will grant liquidity assistance as needed, within the limits imposed by its charter, and will ensure that the bank operates in full compliance with all prudential regulations.

22. The measures to strengthen the system are mainly of a precautionary nature. These efforts will be driven by an increased supervisory presence of the Superintendency of Banks and strict enforcement of all prudential regulations. While the Uruguayan banks already operate with high levels of liquidity reflecting the heavy presence of short-term nonresident deposits in the system, an enhanced monitoring system for the liquidity position in all financial institutions has been introduced to ensure that banks follow sound practices in this area. The Superintendency will closely monitor the maturity mismatches in banks, with particular emphasis on those emanating from nonresident liabilities. Any bank not meeting prudential regulations will be subjected to enhanced monitoring and supervision and strict performance targets. In particular, the Superintendency will require all banks to operate fully capitalized or it will enter into capital strengthening agreements with capital deficient banks. Loan loss provisioning rules also will be strictly enforced. To meet the above challenges, the Superintendency will need to enhance its supervisory capacity by increasing its staffing with qualified specialists. To further strengthen the ability of the financial sector to respond to new developments in the economy and in international financial markets, the central bank intends to review over the coming months the medium-term strategy for the financial system in Uruguay. Progress in this area will be discussed at the time of the first review and in light of the findings of the forthcoming FSAP mission.

23. The regulatory framework will be further strengthened by introducing guidelines on internal risk management in banks and other institutions and regulations on: (i) capital charges for sovereign risk; (ii) capital charges for market risk; and (iii) regulations to limit liquidity risk, in all cases in line with Basel Committee guidelines or standards. In some cases there would be a need to go beyond these guidelines because of the special characteristics of the Uruguayan financial system. In particular, to reduce the exposure of the banking system to combined credit and foreign exchange risk resulting from banks' lending in dollars to nondollar earners, the market risk regulation will include charges for this combined risk. In addition, the Superintendency will tighten regulations in the area of exposure to single borrowers and on insider lending. These guidelines and regulations will be developed in consultation with a MAE technical assistance mission that the government requested for March 2002 to conduct an assessment of compliance with the Basel Core Principles, and will be issued no later than end-June 2002 (structural benchmark).

24. Enhanced disclosure by banks of their financial data will provide information to the market on an accessible, understandable and timely basis. The government will start publishing the complete balance sheets of financial entities, including audit's findings, and from March, it will require all financial institutions to obtain ratings from international risk rating agencies.

25. With regard to public banks, the Government has submitted to congress a law that strengthens the regulatory and supervisory powers of the central bank over these banks. The operational and organizational restructuring of the Banco de la Republica (BROU)--the largest bank in the system accounting for about a quarter of total bank assets-is underway and will be finalized by March 2003. The reforms at the bank aim at improving the monitoring and management of liquidity and credit risk, developing credit analysis procedures, strengthening internal controls, and setting up a system for combating money laundering. The restructuring program has already improved the profitability of the BROU and resolved the reporting delays to the Central Bank, with reporting now being broadly in line with that of the rest of the system. The BROU is addressing the problem of the existing large stock of nonperforming loans through case-by-case restructuring, legal steps to collect on guarantees in court, and, in the case of personal credits to public servants, recourse to direct deductions from payroll.

26. The Government will take steps to strengthen the financial situation of the Mortgage Bank (BHU). The accelerated real depreciation of the peso vis-à-vis the U.S. dollar has resulted in large losses to the bank. Despite these losses, and a significant write-down of its capital as a result of an independent audit in 2000, the bank currently still has capital above its regulatory minimum (amounting to the equivalent of 1.5 percent of GDP). Nonetheless, a continuation of current trends would erode the bank's capital by end-2002. The Government will maintain the bank fully capitalized, with the interest cost explicitly incorporated in the fiscal accounts and subject to the overall ceiling for the deficit mentioned above. The full capitalization of the bank will be a structural benchmark for the first and second review. The superintendency of banks has put the BHU under intensive supervision and a task force has been appointed with representatives from the Central Bank and the Ministry of Economy to prepare a plan to deal with this institution. Following the recommendations of this commission, the Government will: (a) halt BHU new construction projects by April 2002, except those where a legal commitment already had been made (structural benchmark); (b) strengthen loan recovery; (c) increase intermediation margins by April 2002; (d) require that operations of the BHU be conducted on a commercial basis by end-2002 (structural benchmark); (e) introduce administrative improvements, and (f) starting by end-2002, require the BHU to issue obligations denominated in UI to replace maturing dollar liabilities, with a view to reducing the currency mismatch. The authorities are preparing a comprehensive restructuring proposal to provide a permanent solution to BHU problems over the medium term, with assistance from the World Bank. This reform proposal will be ready by September 2002 and appropriate legislation, either approval by decree or a bill to be submitted to congress, will be ready before the end of the year (structural benchmark). The BHU will provide to the Superintendency all the information that is needed to monitor in a timely manner compliance with the changes mentioned above.

27. The Government is committed to structural reform as an essential instrument to help improve productivity and competitiveness. Uruguay has substantial economic potential to attract foreign direct investment. The Government is directing its efforts towards deregulating the economy to allow private sector participation in areas previously limited to the public sector, through partnership arrangements and a more widespread granting of concessions. In this context, the Government's reform agenda includes during 2002: (i) the concession of telecommunications frequencies to private sector firms, (ii) the concession of freight services in Montevideo's International Airport; (iii) new concessions in road, railroad, and port facilities maintenance and management; (iv) changes in the regulatory framework and partnership arrangements with the private sector to facilitate private sector participation in the energy sector, including inter alia in the generation and distribution of electricity, oil activities, transportation, and in the distribution of natural gas by December 2002 (structural benchmark); and (v) the liberalization of the market for workers' accident insurance (currently a monopoly of the state insurance bank, BSE) by September 2002.

28. The government is committed to reducing the cost of doing business in Uruguay and will implement a number of steps in this regard, including (i) a reductions of government fees especially in the area of foreign trade, (ii) the elimination of regulations hindering foreign trade, (iii) a rationalization of registration procedures for businesses, (iv) a liberalization of business hours, (v) an ongoing process of modernization of information technologies in the public administration, (vi) a revision of regulations in the agricultural sector, and (vi) continuing deregulation of air, land, and river transportation.

29. The Government is also continuing with the reform of the state, which aims at strengthening efficiency and ensuring additional savings over the medium term. This reform focuses mainly on (i) a revision of personnel policies and the management of human resources in the government and public enterprises, aimed at strengthening the efficiency of public workers; (ii) a simplification of procurement procedures to ensure transparency and efficiency; and (iii) a close monitoring of government spending on a real-time basis to prevent--or correct early on--deviations from budgetary guidelines. The government will conduct a study of the tax system with a view to proposing a reform aimed at simplifying the system and eliminating distortions affecting private sector activity. Technical assistance from FAD will be requested. The public health system will also be made more efficient, allowing for greater flexibility to services providers. At the same time, the Government will continue to strengthen the state social security system, through technology improvements and the overhauling of its information systems to allow for a closer cooperation at the collection level with the tax revenue office. The Government intends to submit to congress, by September 2002, a reform of the special pension funds for the military and bank workers; the financial positions of these funds is weakening and needs to be strengthened.

30. The Government intends to maintain Uruguay's exchange rate system free of restrictions on payments and transfers for international transactions. Uruguay customs tariffs are in line with the Mercosur's common external tariffs. Problems that may arise with intra-regional trade will be dealt relying on Mercosur's mechanisms for the resolution of trade disputes and in agreement with the guidelines of the World Trade Organization.

31. Improving the accuracy, timeliness, and comprehensiveness of statistical data on the economy is an ongoing effort. A two-year program to revise and expand national accounts, was finalized at the end of 2001. This program was a preparatory step for Uruguay's subscription to the Fund's SDDS. Uruguay is now on track to subscribe to the SDDS by March 2002. Much progress has been achieved with data dissemination on the internet. The publication of quarterly reports of the public enterprises, the data on the public banks in the Superintendency Bulletin, the monthly publication on the web of the fiscal accounts, and the independent audits of state enterprises and banks, are having a positive effect on the public's understanding of economic developments. The Fund completed a Report on Observance of Standards and Codes (ROSC) on fiscal transparency in Uruguay in 2001 and is finalizing a ROSC on data dissemination practices. The Central Bank has also provided the Fund with the information it needs to conduct a full stage one Safeguard Assessment of the bank. The Government will continue to publish on the web the Policy Memorandum signed with the Fund and the relevant appropriate staff documents, including those associated with the Fund's annual Article IV Consultations.

32. The economic program for 2002-2003 establishes quantitative performance criteria for end-June 2002, end-September 2002, and end-December 2002, with annual indicative targets for 2003. Program reviews would be concluded before the end of September and December 2002, March and September of 2003, and March 2004. The Government will consult with the Fund on the economic outlook and policy options for 2003, and determine the quarterly distribution of the indicative annual targets on the occasion of the discussions for the second review of the program toward the end of 2002.

Table 1. Uruguay: Performance Criteria under the 2002 Economic Program1
  31-Dec-01 Ind. Target
  Performance criteria

  (In millions of Uruguayan pesos)
A: Quantitative Performance Criteria                
1. Combined public sector balance
  -2,370   -4,450 -6,500 -6,780   -4,700
2. General government expenditure
including Fondos de Libre
    7,960    16,350  24,200  32,550    36,800 
3. Change in the net domestic assets of the
    BCU (ceiling)
  7,000   7,450 7,250 5,850   -2,500
  (In millions of U.S. dollars)
4. Net international reserves of the BCU
    (–decrease) (floor)
  -550   -570 -570 -430   180
  (Stock of debt at the end of the period; in millions of U.S. dollars)
5. Combined public sector gross debt
9,773 9,775   9,925 10,125 10,060   10,360

Sources: Ministry of Economy and Finance; and Central Bank of Uruguay.
1As defined in the Technical Memorandum of Understanding.
2The cumulative limit will be adjusted by the difference between the actual and projected social security contributions transferred to the private pension system.
3All maturities. Includes leasing operation associated with ANCAP. US$115 million included at end-December 2001, excluding the IMF. The overall limit will be adjusted by (1) the difference between projected and actual debt at end-2001; (2) the difference between the actual and projected 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, 2001; and (5) by an amount equivalent to the change in the sum of free and reguired foreign currency deposits up to US$200 million of the BROU, BHU, public enterprises, insurance companies, exchange houses, private banks, AFAPs and investment funds, in the BCU from their level of December 31, 2001.

Technical Memorandum of Understanding

This memorandum presents the definitions of the variables included in the quantitative performance criteria annexed to the Policy Memorandum.

1. Cumulative balance of the Combined Public Sector. The Combined Public Sector comprises the Central Administration (including as defined in "Article 220" of the Constitution, Salto Grande, and the funds managed directly in the ministries (Fondos de Libre Disponibilidad), the social security system (Banco de Previsión Social), the local governments (Intendencias), the public enterprises (ANCAP, ANTEL, UTE, OSE, AFE, ANP, INC, CND and ANCO), operational balance excluding valuation adjustments, and the quasi-fiscal balance of the Central Bank (BCU). The public sector balance will be measured from below the line on the basis of information provided by the BCU on: (a) combined public sector debt (defined below), including all short-term debt, in foreign currency and pesos; (b) bank borrowing and bank deposits in foreign currency and pesos; and (c) net asset transactions of the combined public sector. The result of the BCU is defined as interest earnings on gross international reserves, as defined below, and on domestic assets minus operating expenses and interest paid on domestic and foreign debt administered by the BCU. The limit on the balance of the combined public sector will be adjusted downward (upward), i.e., the deficit would be allowed to widen (narrow), by the amount that the actual social security contributions to the private pension system exceeds (falls short) the projected amount in the program.

2. Cumulative ceiling on central government expenditure applies to total (current and capital) noninterest expenditure of the central administration (includes Fondos de Libre Disponibilidad but excludes transfers to the social security system and automatic transfers to the private pension funds (AFAP), and on internal transfers) and social security system (BPS).

3. Cumulative changes in net domestic assets (NDA) of the BCU are defined as the difference between currencies held outside banks and net international reserves (NIR) of the BCU as defined in 4. below. The flow of NIR will be valued at the average exchange rate projected in the program for the corresponding quarter.

4. Cumulative changes in net international reserves (NIR) of the BCU. NIR is defined as the difference between the gross international reserves and BCU reserve liabilities. Gross international reserves include all foreign exchange assets that are in the direct effective control of the BCU and are readily available for such purposes of the BCU as intervention or the direct financing of payment imbalances. Such assets may be in any of the following forms, provided that they meet the test of effective control and ready availability for use: currency, bank deposits in nonresident institutions and government securities and other bonds and notes issued by nonresidents (with a rating not below "A" in the classification of Fitch IBCA and Standard and Poor's or "A2" in the classification of Moody's). In addition, holdings of SDRs, or of monetary gold would be included under gross reserves assets (provided they meet the test of effective control and ready availability of use) as would the reserve position in the IMF.

- Excluded from gross international reserves are all foreign currency claims arising from off-balance sheet transactions (such as derivatives instruments), claims on residents, capital subscriptions in international financial institutions, any assets in nonconvertible currencies, claims on any nonresident Uruguay-owned institutions, or any amounts (in all components of assets, including gold) that have been pledged in a direct or contingent way.

- Gross reserve liabilities include all foreign currency-denominated liabilities of the BCU with original maturity of one year or less to residents and nonresidents, the use of Fund resources, the future and contingent claims to sell foreign exchange arising from financial derivatives with both residents and nonresidents undertaken directly by the BCU or by other financial institutions on behalf of the BCU. For the purpose of the NIR calculation, (a) the gold holdings of the BCU will be valued at the accounting rate of US$42 per troy ounce; (b) liabilities to the IMF will be valued at US$/SDR rate of December 31, 2001; (c) gains or losses from gold-swaps and other operations will be excluded; and (d) non-U.S. dollar denominated foreign assets and liabilities will be converted into U.S. dollars at the market exchange rates of the respective currencies as of December 31, 2001.

5. Combined Public Sector stock of debt refers to (a) the outstanding stock of debt in domestic and foreign currency owed or guaranteed by the combined public sector; and (b) debt in URs ("Unidades Reajustables").1 Debt will be measured on a disbursement basis; it excludes resident and nonresident deposits and other short-term liabilities of the BROU and the BHU. Debt in the form of leases will be calculated as the present value (at the inception of the lease) of all lease payments expected to be made during the period of the agreement excluding those payments that cover the operation, repair or maintenance of the property.2 The overall limit will be adjusted upward (downward) by (1) the upward (downward) revisions made to the actual debt stock at end-2001; (2) the difference between the actual and projected 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 upward (downward) changes in the amount of export prefinancing in the BCU in relation to the level of December 31, 2001; and (5) by any amount equivalent to the increase (decrease) in the sum of free and required foreign currency deposits up to US$200 million of the BROU, BHU, public enterprises, insurance companies, exchange houses, private banks, AFAPs and investment funds, in the BCU from their level of December 31, 2001. Certificates of deposit issued by the BCU to banks and/or their substitute Treasury instrument (treasury bills of maturity longer than one year) are included in medium and long-term debt.

Structural Reform Benchmarks

Before end-June 2002

  1. Completion of proposal to develop additional monetary policy instruments.

  2. BHU will halt new construction projects

  3. Completion of assessment of compliance with Basle Core Principles

Before end-September 2002

  1. Central Bank will issue regulation ensuring that the credit risk of lending in foreign exchange is appropriately internalized by banks.
  2. BHU starts replacing maturing U.S. dollar liabilities with obligations denominated in UI.
  3. Introduction and publication on a daily basis of the CPI-indexed financial unit (UI)

Before end-December 2002

  1. Legislation either a decree or a bill submitted to congress, if needed, with a medium term reform proposal for the BHU.
  2. BHU operations start to be conducted on a commercial basis and subsidies included in the budget explicitly.
  3. Submission to congress of a comprehensive VAT reform proposal.
  4. Completion of partnership arrangements in the areas of oil, energy, transportation, and natural gas.

1The term "debt" has the meaning set forth in point No.9 of the Fund's Guidelines on Performance Criteria with Respect to Foreign Debt (Decision of August 24,2000).
2The suppliers' contracts of ANTEL with equipment providers Ericsson and NEC, which predate the Fund's consideration of lease contracts for programming purposes, are expensed under goods and services as rental outlays. The lease contract of ANCAP associated with the reform and expansion of the Montevideo oil refinery is included in the calculation of the public sector debt.