Public Information Notice No. 03/91

Public Information Notice: IMF Concludes 2003 Article IV Consultation with Uruguay

August 4, 2003

On July 11, 2003, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Uruguay.¹

Background

During 1990-98, Uruguay enjoyed relatively high rates of growth, averaging 3.9 percent a year. In 1999, however, Uruguay's economy fell into a prolonged recession, following a series of external shocks that were compounded by domestic fragilities. These external shocks included: slower economic growth in Argentina and Brazil, two of Uruguay's major export markets; the outbreak of foot-and-mouth disease, which harmed Uruguay's meat exports; and a severe outflow of nonresident deposits, associated with the financial crisis in Argentina. In 2002, the economy contracted by nearly 11 percent, wiping out most of the per-capita GDP gains that had been achieved during the 1990s. The public debt dynamics also deteriorated significantly.

In June and August 2002, Uruguay's existing Stand-By Arrangement was augmented to SDR 2.13 billion (694 percent of quota). In March 2003, at the completion of the second review, the arrangement was extended to March 2005, with a rephasing of purchases.

Uruguay's economy is now showing signs of improvement. In the first quarter of 2003, real GDP grew by ½ percent (quarter-on-quarter, seasonally adjusted), and leading indicators point to a stronger increase in activity during the second quarter, led by an improvement in exports. Uruguay is expected to benefit further from the reopening of North American markets to beef exports.

Financial indicators have also improved. Private sector deposits are now almost back to their end-July 2002 level, when a bank holiday was declared. Reflecting the reflow of deposits, as well as sizeable loan disbursements from multilateral organizations, gross official reserves have more than doubled since mid-March, to US$1 billion in late-June (five months of imports of goods and services).

On May 29, Uruguay successfully completed a comprehensive and voluntary exchange, covering almost all of its market debt in foreign currency (US$5.4 billion). Overall participation reached 93 percent, well above the 80-percent threshold established for completion. The exchange reduced the net present value of participating bonds by about 20 percent on average.

Under the Stand-By Arrangement, the primary balance of the combined public sector is programmed to rise from equilibrium in 2002 to 3 percent in 2003, and to 4 percent over the medium term, consistent with debt sustainability. To meet these primary surplus objectives, the government intends to continue restraining expenditure and improving revenue collection.

The government is also implementing measures to restore the functioning and stability of the banking system. Several banks were liquidated during the financial crisis and US$2.2 billion in savings and time deposits in the public banks BROU and BHU were reprogrammed. A new bank has been opened with assets of three liquidated banks.

With the adoption of a flexible exchange rate system, monetary policy has shifted to targeting the monetary base as an intermediate target. So far this year, inflation has come down faster than projected.

In the structural area, several reforms are being adopted, in conjunction with the World Bank and Inter-American Development Bank, to help foster a return to growth. These measures include: deregulation of utilities, reform of the specialized pension systems, and restructuring of the public bank BHU.

Executive Board Assessment

Directors noted that, since the last Article IV consultation with Uruguay, the country has suffered a protracted recession and a deep financial crisis, resulting in a large output loss and a significant increase in poverty. While external shocks have triggered these adverse developments, their impact was compounded by deep-seated weaknesses and rigidities in Uruguay's economy. Directors commended the authorities for the significant progress made in recent months in containing the crisis, stabilizing the economy, and preparing the foundations for a durable recovery. They were encouraged by the recent improvements in economic and financial indicators, and welcomed the exemplary manner in which the authorities have conducted a landmark debt exchange, which has addressed near-term financing needs and helped to improve confidence.

Directors agreed that significant challenges nevertheless still lie ahead, and that returning the economy to a path of lasting growth and stability will require continued sound macroeconomic policies and structural reforms. Decisive progress on fiscal and banking reforms will be critical to further improve confidence, while in the coming years, the Uruguayan economy will need to develop new sources of growth against the backdrop of an external environment which is likely to be less sanguine, an ageing population, and constraints to capital accumulation. To surmount these constraints, Directors urged the authorities to implement policies that promote a shift of resources toward higher-productivity sectors and increase the economy's resilience to shocks. Such policies, coupled with better targeting of social support, will be key to raising economic growth and reducing poverty.

Directors emphasized that a strong fiscal policy will need to remain the cornerstone of the authorities' economic strategy. A permanent strengthening of the primary surplus will be needed to ensure medium-term debt sustainability, regain the capacity for countercyclical policies, and allow room for private sector growth. The challenging fiscal targets to which the authorities have committed themselves are appropriate, but Directors stressed that they will require a sustained reform effort, together with continued readiness to adjust fiscal policies as needed, to achieve them. Directors commended the authorities for their commitment to improve the tax system and strengthen revenue administration. They welcomed the recent submission to congress of a revised tax reform package, and looked forward to its full implementation. On the expenditure side, Directors underscored the need for deep reforms to reduce rigidities, especially in wages and pensions, and to continue enhancing the efficiency of social spending programs.

Directors welcomed the authorities' continued commitment to the floating exchange rate regime, with base money as the intermediate target for monetary policy. They supported the authorities' intention to move over time toward an inflation targeting framework, and noted that to achieve this goal the central bank should continue to broaden the range of monetary instruments, deepen technical capacity, and strengthen its operational and administrative autonomy.

While progress has been made in stabilizing the banking system, Directors stressed the need for further work to address remaining balance sheet vulnerabilities in the economy and restore a sound financial system. They urged the authorities to accelerate the restructuring of the public banks, which will be key to restoring confidence and contain fiscal costs. Looking ahead, Directors underscored that a strong and well-supervised banking sector will be a cornerstone of the strategy to enhance the role of the private sector in the economy. They also encouraged the authorities to continue promoting the development and use of peso instruments, and to work towards the development of a properly funded, limited deposit insurance scheme.

Directors urged the authorities to press ahead with a wide range of structural reforms to promote growth and reduce vulnerabilities. They agreed that further efforts to strengthen competition, governance, and regulatory frameworks, and expand the room for private sector activity in the economy, will be key to improving resource allocation, raising investment, and attracting higher levels of foreign direct investment. In this respect, Directors emphasized the need to reduce the size of the public sector by improving its efficiency and opening up to private activity those sectors currently reserved for the state. They also encouraged the authorities to take advantage of Uruguay's well-educated population to implement policies aimed at diversifying the country's production and export base, including by pursuing ongoing trade liberalization efforts and streamlining investment procedures. In this regard, a number of Directors also highlighted the importance of further market-opening efforts by Uruguay's trade partners.

Directors were encouraged that Uruguay's political and legal institutions have proved effective in dealing with the recent economic and financial challenges, and that the rule of law and private contracts have been safeguarded in difficult circumstances. They urged the authorities to build on these foundations by continuing to make strong efforts to forge a sufficient consensus and broad ownership that will help them to move forward with their ambitious structural reform agenda. Mobilizing support for the privatization of state-owned enterprises ought to be a priority in this regard.

Directors commended the authorities for the progress in improving the quality and timeliness of data dissemination. They welcomed the authorities' intention to subscribe to the Special Data Dissemination Standard and to implement the recommendations of the safeguards assessment.