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IMF Report Highlights Uruguay's Strong Economic Recovery

Uruguay has shaped an impressive recovery from the deep economic and financial crisis of 2002, report says

Posted: July 19, 2005

The International Monetary Fund (IMF) Country Report No. 05/235 released July 18, 2005, indicates that Uruguay has recovered well from the deep recession of 1999 - 2002. Growth was over 12 percent in 2004, inflation fell to single digits, and the fiscal position has been strengthened considerably. While the external current account shifted to a moderate deficit, mainly reflecting the recovery in imports, export performance has been robust, and gross international reserves are now about three-quarters of their pre-crisis level (but NIR on program definition remain negative). Data for early 2005 suggest continued growth, moderate inflation, and continued strength in exports.

The report further indicates that notwithstanding the good recent economic performance, vulnerabilities remain. The public debt is still high (92 percent of GDP at end-2004), mostly denominated in foreign currency, with gross financing needs averaging some 12 percent of GDP over 2005-08. Public spending pressures are high following the compression of real wages and pensions in recent years, and the social situation remains difficult. Weaknesses also remain in the financial system, including widespread dollarization.

Key achievements under the Fund-supported program include:

• Economic growth rebounded sharply following the 1999-2002 recession, with real GDP growth exceeding 12 percent in 2004.
• Inflation was quickly brought under control. After the float of the currency in 2002, inflation fell steadily and reached single digits in 2004. Real wages fell sharply during the crisis, but have begun to recover since late-2004.
• The external position has strengthened, and the peso first stabilized and then came under pressures to appreciate. Since late 2003, the peso has appreciated 15 percent in real effective terms, although it remains some 25 percent below its pre-crisis level. The external current account, after improving strongly in 2002, shifted to small deficits in 2003-04—despite rapid export growth—reflecting the sharp recovery in imports. The capital account has also progressively strengthened, on account of both FDI and portfolio inflows. Together with large IFI assistance, this contributed to a buildup of international reserves to US$2.5 billion at end-2004, some 75 percent of the pre-crisis (2001) level.
• The fiscal primary balance has strengthened significantly, and the public debt has been set on a downward path. The primary balance improved from a deficit of 1.2 percent of GDP in 2001 to a surplus of 3.8 percent of GDP in 2004. The adjustment mainly reflected expenditure restraint, especially on wages and pensions, timely increases of public tariffs, and temporary surcharges on specific taxes. Rebounding growth and peso appreciation also helped bring down the debt-to-GDP ratio from its peak of 104 percent in 2003 to 92 percent at end-2004.
• The banking system has been stabilized. Resident bank deposits of the private sector recovered to about 80 percent of their pre-crisis level by end-2004, although nonresident deposits (almost exclusively off-shore) have recovered only modestly. Dollarization remains high (at about 90 percent of deposits), and real credit growth was still negative in 2004.
• Good progress was made in restructuring the financial system. The state commercial bank (BROU) has been implementing a comprehensive restructuring program and made profits in 2004. The state mortgage bank (BHU) began the transformation process into a mortgage company (with World Bank support). The bank created from the good assets of the failed banks (NBC) is well-capitalized and liquid, with asset recoveries of the failed banks well underway. Financial system oversight was strengthened, with a new focus on managing the risks from dollar lending to clients that earn income in pesos.

Developments in 2005 continue to be favorable:

• Leading indicators point to a continuing recovery in Q1-2005. Domestic demand is benefiting from rising real wages and falling unemployment (12 percent in March, about half the crisis peak).
• Annual inflation has been running at 5½ percent since the beginning of the year, helped by the appreciation of the peso. In March, the central bank (BCU) announced an inflation target of 5–7 percent for March 2006 (½-percentage point lower than the December 2005 target). Domestic short-term interest rates are at their lowest levels in decades, reflecting stabilized inflationary expectations and still-high liquidity in the system.
• The external position remains robust. Export growth in Q1-2005 remained strong (16 percent). Official reserves dropped somewhat in early 2005, reflecting advanced repayments to the Fund and buybacks of Brady bonds, but have rebounded lately with continuing capital inflows. Net international reserves (program definition) are still negative, however, mainly reflecting the large Fund credit outstanding.
• Fiscal performance in Q1-2005 was in line with the program. Real nondiscretionary spending growth was capped at 1.5 percent (y/y), including the January wage and pension increases (nominal) of 3.5 percent and 5 percent, respectively. Revenues were in line with projections, and public tariffs (petroleum products and energy) were adjusted in April to reflect increased input costs.
• Banking reforms have proceeded as planned, although the recent suspension of a small cooperative bank indicates the still fragile state of the system.
  - Cooperative bank (COFAC). The bank was suspended in March 2005, which touched off fairly widespread, albeit relatively small, deposit withdrawals in the banking system. The new government quickly implemented a resolution strategy that involved the capitalization of deposits and introduction of a deposit insurance scheme
to protect small depositors. Deposit flows in the banking system subsequently stabilized, and have been recovering since end-March.
  - State commercial bank, or Banco de la Republica Oriental del Uruguay (BROU). The bank continued to make profits in the first quarter of 2005, and a new Board was appointed in March. The release of reprogrammed deposits was completed in April, and 93 percent of them were retained. The bank’s asset management company (AMC) is making good progress in working out the nonperforming loan (NPL) portfolio, allowing BROU’s trust fund to continue making repayments to BROU on the government-guaranteed note ahead of schedule.
  - State mortgage bank or Banco Hipotecario del Uruguay (BHU). Steps have been taken toward its conversion into a mortgage company, but vulnerabilities remain, including a large NPL portfolio (which is being addressed) and high operating costs (coming down, albeit only slowly). The bank serviced its government-guaranteed note to BROU in Q1-2005, but risks remain as scheduled repayments will rise over the next few years.
  - NBC and the liquidated banks. The authorities are moving forward with the sale of NBC, and potential buyers have submitted preliminary proposals. The private asset manager of the liquidation funds has moved forward in the collection process, broadly on schedule.
  - Financial system oversight. The banking superintendency (SIIF) published its annual work plan that focuses on bolstering on- and off-site supervision, improving the bank resolution process, strengthening accounting and audit standards, and assessing the adequacy of minimum capital requirements. Also, the incorporation of information on non-performing borrowers of the liquidation funds into the credit registry is to be completed by end-May and will be disseminated to creditors in June.

A complete copy of the IMF Country Report No. 05/235 is available online.

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