Memorandum of Economic Policies
I. Developments under the program in 2000
1. Following a downturn in economic activity in 1999, Uruguay
continued to face unexpectedly difficult economic conditions in 2000.
After the competitiveness shock incurred with the devaluation of the Brazilian
real in January 1999, the output contraction appeared to be
coming to an end when Uruguay registered a slight expansion in seasonally
adjusted real GDP in the last quarter of 1999 and the first quarter
of 2000. However, the recovery was not sustained in the second quarter,
nor did economic activity accelerate in the second half of the year, as
was expected under the program. As a result, real GDP is now estimated
to have declined by more than 1 percent in 2000. Consumer price
inflation ended the year at 5 percent, slightly below program assumptions,
but the unemployment rate increased from 11 percent at end-1999 to
14½ percent in recent months, reflecting the delay in the economic
recovery, and some distortions in the labor market, such as the high health
care premium for labor market entrants.
2. A number of adverse factors help to explain these economic difficulties.
Uruguay experienced a sharp drop, for the second year in a row, in
the terms of trade as the economy faced a large increase in oil import
prices, while prices for most of our (agricultural) export commodities
remained weak. Moreover, demand for Uruguayan products in Europe was depressed
by the 22 percent depreciation of the euro against the U. S. dollar
during 2000. There were also some interruptions in access for products
from Uruguay (rice, dairy products, bicycles, etc.) to the countries in
the region, which are now being resolved, but nevertheless caused some
export losses. Moreover, economic activity in Argentina has been weaker
than envisaged, and has affected consumer confidence and demand. Lastly,
the availability of manufacturing exports of agricultural origin was limited
early in the year by adverse weather conditions, while a localized outbreak
of foot and mouth disease interrupted meat exports in November and December 2000
(meat exports account for 21 percent of total merchandise exports).
Consumers and investors have been concerned about these shocks, and they
maintained cautious spending plans. For the second year in a row, domestic
demand fell in real terms, which limited output growth. Regarding producers
in Uruguay, we believe that some of the shocks noted above imply a new
relative price equilibrium in the economy, and that producers and suppliers
will need additional time and effort to adjust their own costs and prices
accordingly.
3. Notwithstanding the challenges, Uruguay also made important progress
in several economic areas in 2000. Competitiveness is on the
rebound. By end-2000, a significant share of the sharp appreciation in
the real effective exchange rate of January 1999 had been reversed,
but, as noted above, costs must continue to fall in U.S. dollar terms
for Uruguayan producers and exporters. Exporters made significant progress
in reducing their costs and diversifying their markets, especially in
the NAFTA countries and in Asia, while maintaining adequate volume growth
in our traditional markets (albeit at lower prices). Also, as implied
above, the structure of aggregate demand is changing, toward stronger
net exports with more subdued domestic absorption, which is a more sustainable
balance of output growth. Finally, the economic difficulties have stimulated
an important debate about the need for structural reform in Uruguay to
make the economy more agile, and better able to respond to external shocks,
and the government has restarted the structural reform agenda. This debate
is important as the government is not in a position to take unilateral
decisions on structural reform in Uruguay's consensus-based culture, and
it is working with Congress to implement appropriate reform measures in 2001,
as described below.
4. With the exception of the fiscal deficit and public sector overall
debt targets, the quantitative objectives agreed with the Fund through
end-December 2000 were met. The consolidated public sector deficit
reach 3.7 percent of GDP, compared with a program target of 1.8 percent.
The larger-than-programmed deficit corresponds mainly to a drop in public
sector revenue, and is broadly consistent with the operation of automatic
stabilizers on the deficit, considering lower-than-expected output growth,
and the particular weakness in domestic demand which, through consumption
based taxation, is the largest revenue base in Uruguay. Notably, the public
sector expenditure target under the program was met with a margin exceeding
3 percent, despite the adverse conditions, and the government continues
to view the containment of public sector expenditure as the anchor of
its medium-term fiscal strategy. The structural reform benchmarks under
the program have been observed, except for the publication of the quarterly
annotated reports of the public sector banks and enterprises; this benchmark
was rescheduled for the end-March 2001 program period.
5. The government did not experience major difficulties in financing
the larger deficit in 2000, and developments under the exchange rate
regime and with interest rates were as envisaged in the program. The
government placed three international bond issues (in June, September,
and November) for a total of around US$640 million at an average
spread of 290 basis points over corresponding U.S. Treasury
bonds, and it placed the remaining financing requirement in the domestic
market. In mid-2000, international credit rating agencies confirmed Uruguay's
investment credit rating. The adjustable band exchange rate regime continued
to work well in 2000. The band is 3 percent wide and currently
is adjusted at an annual pace of 7.5 percent, slightly faster than
inflation. The position of the exchange rate on average remained within
the most appreciated half of the band. There were no substantial changes
in interest rate policies of the BCU, which are largely subordinated to
the exchange rate regime.
6. The external current account deficit is estimated to have widened
slightly to 2.9 percent of GDP in 2000 (some US$600 million).
Merchandise exports increased by around 3 percent in U.S. dollar
terms (over 8 percent in volume); imports also increased by 3 percent
in value, and dropped slightly in volume terms. The merchandise and services
terms of trade were very weak, declining by 7.5 percent in the year,
after declining by over 2 percent in 1999. Nonfactor services,
especially tourism, held up well in 2000, in part as Argentines continued
to come to Uruguay, and there were more visitors from Europe and the United
States. In the capital account, net foreign direct investment was around
US$200 million, with inflows mostly directed towards the hotel sector,
retailing, and forestry. Portfolio inflows, dominated by the placement
of government bonds abroad, remained sound, and there were renewed inflows
of nonresident deposits into the Uruguayan banking system. The overall
balance of payments registered a surplus in 2000, with net international
reserves stronger than had been expected in the program.
II. The Economic Objectives for 2001
7. The Government's first priority is to foster a sustainable recovery
in output while preserving low inflation. The resumption in output growth
is needed to reduce unemployment. The policy measures will focus on assuring
sound public sector finances to bolster national saving and limit indebtedness,
and intensifying structural reform to help increase exports and private
sector investment, which we believe need to be the engine of growth. The
structural reforms are crucial to improve competitiveness of domestic
production, and make the economy more responsive to foreign shocks, within
the framework of the adjustable-band exchange rate system. These objectives
will require cost containment, deregulation, and increased competition.
III. The Macroeconomic Framework
8. Emerging from the recession has taken longer than was envisaged.
While at first the government anticipated an acceleration in growth in
the second half of 2000, we now project that the rebound in output
growth will gain strength towards the middle of 2001. The recovery
of economic activity in Brazil has taken hold and, with a quarter of our
merchandise exports sold in Brazil, this will begin to support growth
in Uruguay as well. While Argentina is undergoing a difficult adjustment
process, it has made substantial progress in recent time, and the prospects
for the region as a whole are now becoming more favorable. We believe
that international interest rates will decline somewhat further, while
petroleum prices are expected to ease from their sharp runup to well above
US$30 a barrel in 2000. At the same time, since costs in the economy
are falling, and with ample capacity available for output growth, Uruguay
could rebound quickly, especially if commodity prices turn somewhat more
favorable. For now, the Government expects real GDP growth of around
2 percent in 2001, led by continued strength in the foreign
balance and a gradual recovery in private investment and consumption,
including with some recovery in the terms of trade. The rate of inflation
is likely to be in a range of 3½–5½ percent, mainly
because of slightly higher overall import prices, offset by the absence
of domestic price pressures. Employment is expected to increase, but unemployment
initially is expected to drop only moderately as participation rates
typically also rebound with a recovery. With improved competitiveness
and modest domestic absorption, the external current account deficit
is projected to narrow to about 2½ percent of GDP.
IV. Economic Policies
9. The economic policies for 2001 are part of the medium-term
effort to restore competitiveness and resume high output growth. The
Government submitted to Congress a medium term budget for the Presidential
term (2000-2005), based on expenditure restraint and which envisages achieving
a turnaround in the public sector gross debt-GDP ratio by 2003. In
December 2000, the budget was approved by Congress broadly in line
with these deficit and debt objectives, but with slightly higher expenditures
and taxes than those sought by the government.
10. The Government aims to cut the fiscal deficit from 3.7 percent
of GDP in 2000 to 2.6 percent in 2001, equivalent to
a reduction in the primary (noninterest) deficit of the public sector
by about 1¼ percentage point of GDP. The indicative economic program
for 2001 agreed with the Fund at the time of approval of the stand-by
arrangement in May 2000, envisaged a deficit in 2001 of 1¼ percent
of GDP. However, we believe that maintaining this target would not be
realistic in view of the delayed recovery, as it would have required a
large increase in taxation that could impede the resumption of growth.
Instead, the government considers sustained expenditure moderation the
key instrument of its medium term fiscal and competitiveness strategy,
while tax increases should be minimized in view of the still fragile recovery
in economic activity.
11. Noninterest expenditures are programmed to drop from 32.5 percent
of GDP in 2000 to 31.9 percent in 2001. The general
wage increase in the central government, already announced in January,
was 3 percent. However, during the budget negotiations in Congress,
it was also agreed that members of the judiciary, university professors,
and teachers will receive a complementary one-time salary adjustment
in 2001 equivalent to about 2½ percent of the total wage
bill. These measures combined, and a small drop in public sector employment
due to retirements, are projected to permit a small decline in the public
sector wage bill in relation to GDP. More significant savings are expected
from a drop in social security expenditure from 16.8 percent of GDP
in 2000 to 15.6 percent in 2001. This reflects, on one
hand, the gradual moderation in labor costs in the economy, as social
security benefits are indexed to average private and public sector wages,
and, on the other hand, the effects of the social security reform as the
number of beneficiaries in the public system has recently started falling
at a rate of 0.7 percent a year. Capital outlays are programmed to
increase from their depressed level in 2000. Most of the expenditure
adjustments are expected to take place in the central government, whereas
local governments, which have limited access to financing, are curtailing
their own expenditures. Their taxes have shrunk in the recession of 1999-2000,
but local governments will receive 0.2 percentage points of GDP in
additional transfers in 2001 in the context of political commitments
to support greater decentralization which recently went into effect (see
¶13).
12. Moderating labor costs is essential to help bolster competitiveness
and improve prospects for employment growth. The public sector indexation
law that was adopted in Congress at end–1997 stipulates that if 12-month
inflation remains below 10 percent since the last public sector general
wage adjustment, the government can increase public sector wages only
once a year. As this condition has been met, the general wage increase
in government will be limited to the one granted in January, noted above.
Private sector wages dropped by around 2 percent in real terms in 2000,
and some contracts even had small reductions in nominal wages to preserve
jobs. Private sector wages are expected to increase by around 3 percent
in 2001.
13. Consolidated public sector revenues are projected
to increase from 31.3 percent of GDP in 2000 to 31.9 percent
of GDP in 2001. The largest component of this increase, 0.5 percentage
points of GDP, is expected from the recovery of the operating result of
the public enterprises, which had a difficult year in 2000. Input
costs are falling as the total wage costs in real terms are declining
and petroleum import prices are expected to be lower on average compared
with 2000. The average tariffs of the public enterprises will be
adjusted in line with overall inflation. Other revenue gains are small
in proportion: receipts from import taxes are expected to increase with
the rebound in imports, and the government has removed a VAT exemption
for private healthcare providers (expected to yield 0.1 percentage
point of GDP each). Also, as agreed with Congress, the mandated increase
in transfers to local governments will be financed with an increase in
gasoline taxes, equivalent to 0.2 percentage points of GDP. Employer
social security contributions were lowered slightly to help reduce labor
costs and promote employment.
14. Monetary policy is subordinated to the exchange rate regime. During 2001,
currency in circulation is projected to rise about in line with nominal
GDP, while the BCU's net international reserves are expected to remain
virtually unchanged from their relatively high level at end-2000. Broad
money is envisaged to increase by 8-10 percent, reflecting the growth
in deposits, and with nearly all of the public sector deficit financed
abroad (see below), this will permit banking system credit to the private
sector to expand by around 6 percent in real terms.
15. The government is taking steps to improve the efficiency of the
financial system. The emphasis is on improving the performance of
the public sector institutions. In the banking area, the Bank of the
Republic (BROU) is receiving an independent external audit and analysis
of its operations. The preliminary conclusions of these audits point out
the need for additional reforms in the computer systems; to update the
accounting systems in some parts of the bank; to fully implement the credit
manuals, and to make more transparent the costs for the bank in its functions
as a development institution. Management is already following up on these
issues, and working with external experts to improve the efficiency of
the bank. The external audit is expected to be completed by March 2001.
16. The National Mortgage Bank (BHU) also is receiving an independent
external audit and analysis of its operations. So far, the preliminary
results of the audit suggest a need to obtain an assessment of the properties
on the books of the bank and for which mortgages have been extended, as
existing assessments are out of date. The bank is taking measures to bolster
its ongoing operations. Most importantly, it is reducing its balance sheet
currency mismatch. Liabilities of the bank are denominated in U.S. dollars,
but most mortgages are denominated in Adjustable Units (UR) which is an
index linked to average wages in the economy. As wages have increased
somewhat below the pace of depreciation of the exchange rate recently,
the bank is experiencing valuation losses on its mortgage portfolio. To
help limit these losses, the bank is extending new mortgages denominated
in U.S. dollars only. Lastly, the bank is establishing reserve requirements
at the BCU, as is required of any other bank in Uruguay. The State
Insurance Bank (BSE) is being put on a more level playing field with
private sector competitors in the insurance industry as taxes on its activities
and income are being equalized to that of private sector insurance companies.
Finally, the supervisory office of the BCU has strengthened its
on-site presence in the BROU and the BHU, and has started publishing the
individual balance sheet and profit and loss positions of these banks
(as well as for all other banks in the system) on the BCU internet page,
and is working with banks to shorten the time lag in which this information
is made available. To gain further assistance with these efforts, the
government has request a Financial Sector Assessment Program (FSAP) for
the next Article IV consultation with the Fund.
17. The government will continue to adjust the exchange rate band
at an annual rate of 7.5 percent. There is no wage pressure in
the economy and supply constraints are virtually absent, while the depreciation
of the currency just in excess of domestic inflation will support the
export oriented growth model. There may be some further pass-through of
oil costs in the near term but, on balance, the government does not believe
that inflation pressures will be strong. Confidence in the adjustable
exchange rate band mechanism has been strong in Uruguay, with the peso
fluctuating close to the most appreciated limit of the band, and international
reserves steadily growing in recent years. As the level of economic activity
regains strength and unemployment eases, the government intends to resume
slowing the pace of adjustment of the band, and complete the transition
of inflation down to industrial country levels.
18. The gross borrowing needs of the government for 2001 are
projected to be around US$1,400 million, and the net financing needs
at US$530 million. The government envisages placing US$700 million
(net) in long-term foreign currency denominated bonds (most of it abroad).
These placements would permit some amortization of domestic bank debt,
and an early repurchase of some medium-term notes, which is desirable
to ease a projected bunching of amortizations of these notes falling due
in 2003. The average maturity of the bonded debt in Uruguay will
remain over seven years, and the government has little short-term debt.
19. Structural reforms are important to help increase private sector
investment in the economy, and to improve productivity and competitiveness.
The guiding principle is to place public and private enterprises on a
level playing field, in a demonopolized, appropriately regulated, and
transparent market. In 2000, the Government already has expanded
private sector concessions in water and sanitation works; created a regulatory
agency to implement the new legislation for the electricity market (with
free competition in electricity generation); cleared for auction two telecommunications
frequencies; renounced existing contracts in fuels distribution so that
this sector can now be opened up to competition; obtained legal authorization
to open up the national railway to private sector participation, and to
incorporate the Montevideo container wharf as a sociedad anónima
(SA) under private sector law; and eliminated a bias in pension funds
against investments in private sector securities. In 2001, the government
has already obtained legislative approval for a new regulatory agency
for telecommunications and mail services, and it intends to seek equivalent
legislative approval to establish a regulatory agency for the other public
sector utilities. Also, in January, the market for cable television was
opened up to foreign investment. Moreover, the government will eliminate
the monopoly for ANCAP on imports and sales of asphalt and its by-products;
eliminate the monopoly for the BSE on insurance needs for the government,
the public enterprises, and the public sector banks; eliminate the monopoly
status on imports and commercialization of natural gas; open up competition
in the telecommunications sector for international long distance service,
cellular telephony, and all telecommunications services offered through
new technology (not including basic domestic fixed-line services which
remain the monopoly of ANTEL); open up for concessions the management
of state-owned hospitals; allow the establishment of private ports; and
a number of smaller deregulation measures intended to cut red tape and
bureaucracy in the economy. Moreover, the government intends to introduce
a bill in Congress for the removal of the monopoly on imports and sales
of petroleum and its derivatives, and of the refining of petroleum. Lastly,
the government does not believe that it can finish all the requisite legislative
work for submitting the reform of the special pension funds to Congress
by March, 2001, so this benchmark was delayed slightly to end-June 2001.
20. The government intends to maintain Uruguay's exchange rate system
free of restrictions on payments and transfers for current international
transactions. Uruguay has implemented on schedule all customs tariff
reductions as agreed under the Mercosur convention, and the government
has lowered on January 1, 2001 the surcharge on the common external
tariff, as agreed with Mercosur partners. The "special sugar regime"
that is allowed for countries under Mercosur, expired at the end of December 2000,
implying the elimination of minimum reference prices and quantitative
restrictions, and a significant reduction in protectionism. The proposed
common external Mercosur tariff for sugar is 35 percent, and remaining
(quantitative) trade restrictions within the Mercosur would be phased
out in coming years.
22. Improving the accuracy, timeliness, and comprehensiveness of statistical
data on the economy is an ongoing effort. A project to revise and
expand national accounts statistics is on track and is expected to be
finalized in 2001 and, together with other efforts, Uruguay intends
to subscribe to the Fund's SDDS by the end of the year. Much progress
has already been achieved with data dissemination on the internet, and
the government remains committed to providing additional timely information
on the operation of the government, and its financial and nonfinancial
enterprises, to the public, as described in the attached Annex of
structural benchmarks.
23. The economic program for 2001 establishes quantitative performance
criteria for end-March and end-June, with indicative quantitative targets
for the second half of the year. The region remains subject to
economic risks, and it is difficult to project how quickly the level of
economic activity will rebound. The government proposes to consult with
the Fund and establish the quantitative performance criteria for the third
and fourth quarter of 2001 on the occasion of the second review of
the program in June/July 2001.
