Press Release No. 17/31

IMF Executive Board Concludes 2016 Article IV Consultation with Uruguay

February 1, 2017

On January 9, 2017, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation^[1] with Uruguay, and considered and endorsed the staff appraisal without a meeting.^[2] 

Uruguay is demonstrating resilience in the face of recessions in its large neighbors. The economic slowdown has bottomed out in 2016 and there are signs that the economy is on an incipient recovery path. Real growth is estimated at 1.2 percent in 2016 and projected to reach 1.4 percent in 2017, as the external environment strengthens, together with private consumption. 

The peso appreciated against the U.S. dollar between April and October 2016, but depreciation pressures reemerged in November, following the U.S. elections. The current account deficit is expected to remain around 2¼ percent of GDP in 2016, and would edge up to 2½ percent in the medium-term as domestic demand recovers. 

Despite the slowdown in activity, inflation remains at levels above the central bank’s target range. Inflation is projected to slow and remain well below 9 percent in 2017, tapering to about 6 percent in the medium-term as the output gap gradually closes. Monetary policy remains relatively tight but its transmission has been constrained by the high dollarization and low level of peso credit in Uruguay. 

Fiscal policy has remained broadly neutral in 2016 and the public sector deficit is estimated at 3.8 percent of GDP in 2016. In line with the government’s objective to reach a 2.5 percent deficit by 2019, parliament has approved tax increases and expenditure cuts for 2017. 

Risks to the outlook are both external and domestic, but tempered by Uruguay’s strong liquidity buffers and flexible exchange rate. A slower than expected recovery in Argentina and Brazil, and weak growth in China would weigh on Uruguay’s economy, while a tightening in global financial conditions could raise the cost of financing. Furthermore, given limited space for countercyclical policies, slower than expected growth in 2017 would accentuate the tradeoff between the authorities’ announced fiscal consolidation plans and avoiding an overly pro-cyclical stance that would exacerbate the slowdown. Nonetheless, Uruguay’s strong liquidity buffers, high level of gross reserves, and flexible exchange rate regime would put the country in good stead to weather such shocks. 

Financial stability risks are limited. Non-performing loans remain relatively low, at 3.5 percent of total loans, while provisions are high. 

Executive Board Assessment 

In concluding the 2016 Article IV consultation with Uruguay, Executive Directors endorsed staff’s appraisal, as follows: 

Uruguay is managing the deep recession in its large neighbors relatively well. After a marked slowdown, growth started to recover in the third quarter of 2016. Investment and consumption bottomed out through mid-2016, as inflation stabilized and the exchange rate stopped depreciating. The current account deficit has been cut in half since 2014, and international reserves have stabilized well above prudential norms. The real effective exchange rate appears aligned with fundamentals and desirable policy settings. 

The external environment continues to present risks. Continued weakness in Argentina and Brazil, and a slowdown in global demand would adversely affect exports, while higher interest rates would raise funding costs and capital flow volatility would complicate the conduct of monetary policy. Uruguay’s flexible exchange rate and strong liquidity buffers would, however, support an orderly adjustment to shocks. 

The authorities have demonstrated a clear commitment to putting the public finances on a sustainable track. The widening of the fiscal deficit in 2016 was a helpful response to moderate the sharper-than-expected slowdown. At the same time, the government has locked in tax increases for 2017, sustaining its commitment to bring the fiscal deficit to 2.5 percent of GDP by 2019 which is projected to put debt on a downward trajectory. The fiscal consolidation effort is essential to safeguard Uruguay’s hard-won credibility with international investors and face the long-term fiscal challenges of population aging. Automatic fiscal stabilizers should be allowed to operate along the structural consolidation path. The long-term credibility and countercyclicality of fiscal policy could also be enhanced through a well-designed and stronger fiscal anchor. 

Future policies should protect the announced infrastructure investment increase. Public investment significantly decreased in 2015, and public-private partnerships are taking off slowly, whereas there is a clear need for infrastructure upgrades, in particular in transportation. Further improvements in the profitability of public enterprises and efforts to contain current public spending can create room for capital spending. 

Lower inflation is a prerequisite for reducing dollarization. The high dollarization of deposits constrains the provision of peso credit and the effectiveness of monetary policy, and calls for higher scrutiny of banks’ credit risk exposures. A commitment to low inflation, supported by regulatory incentives such as reserve requirements differentiated by currency and initiatives to deepen local currency capital markets, can encourage a gradual de-dollarization of the economy. 

A tight monetary policy will be needed to help guide inflation toward the target range. Inflation has continuously surpassed the central bank’s target range for the past 6 years, temporarily exceeding single digit levels in mid-2016. The stance of monetary policy should be tightened further if and when activity recovers during 2017, to help sustain the disinflation process. 

A further reduction in inflation persistence, through the wage-setting process, will also be important. In this context, the ongoing move to wage increases that are stipulated in nominal terms is most helpful. Looking ahead, inflation inertia should be lowered further through steps toward the full elimination of backward inflation indexation. 

Structural reforms in education and trade liberalization would help to deepen the social gains of the past decade and boost potential growth. Efforts to promote free trade within Mercosur, as well as to ensure market access to third countries are welcome. Education reform is also necessary to develop the skills that will strengthen Uruguay’s competitiveness in international markets.