IMF Executive Board Concludes 2018 Article IV Consultation with Uruguay
On February 13, 2019, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Uruguay.
Recent Developments and Outlook
In a deteriorating external environment, Uruguay has successfully differentiated itself from its neighbors, thanks to progress in export market diversification, a prudent and coordinated public-sector asset-liability management, pre-financing of sizeable external financing needs, lower banking sector vulnerabilities, and ample reserves. As a result, public sector borrowing costs have remained subdued despite significant depreciation pressures, and, although growth has slowed—to an estimated 2.1 percent—it remains positive. Still, private investment has remained sluggish, and labor market outcomes are weak.
Inflation has risen above the central bank’s target range—partly reflecting temporary factors—and is now at around 8 percent. The central bank has reduced the monetary indicative targets, but medium-term inflation expectations remain somewhat above the target range.
Fiscal deficit reduction has stalled, and the time to reach the target of 2.5 percent of GDP has been extended to 2020. The 12-month rolling fiscal deficit stood at 3.8 percent of GDP in November 2018 (excluding the impact of a large transaction related to pension asset transfers), suggesting that attainment of the 2018 objective (3.3 percent of GDP) and 2020 target is difficult.
The current account has turned to deficit in the first three quarters of 2018, because of negative investment income, higher oil prices, lower exports to neighboring countries facing difficulties (such as Argentina and Brazil), and lower agricultural exports due to the drought. High-frequency data point to portfolio outflows during the last quarter of 2018, as seen in many emerging markets. The authorities ably took advantage of favorable financing conditions through mid-2018 by issuing bonds in global markets at long maturities.
Despite the regional market turmoil, the financial sector has remained resilient, reflecting limited linkages to Argentina and enhanced supervision since the 2002 crisis. With the improvements in regulatory capital to risk-weighted assets ratio and bank profits, the banking sector has comfortable buffers.
There are both sizeable downside and upside risks to the outlook, given the more difficult external environment and large infrastructure projects. An abrupt tightening in global financial conditions, caused by a sharp increase in international risk premia coupled with a further strengthening of the U.S. dollar, could have negative repercussions for Uruguay’s economy. A further slowdown in trading partners could also worsen the growth outlook. At the same time, prudent macroeconomic policies and strong institutions have improved Uruguay’s ability to withstand regional shocks, and plans for the construction of a large cellulose plant, an associated railway system, and other infrastructure projects are a major upside risk. Over the medium-term, low investment and declining employment, if not reversed, could lower potential growth.
Executive Board Assessment
Executive Directors noted that prudent macroeconomic policies combined with strong reform implementation, and quality institutions have enabled Uruguay to maintain macroeconomic stability, accumulate sizeable buffers, improve social outcomes, and differentiate itself in the region. Directors noted that policy priorities ahead should focus on maintaining resilience, keeping public debt on a sustainable path, sustaining low inflation, and implementing structural reforms to boost the economy’s growth potential.
Directors welcomed the authorities’ commitment to maintain fiscal sustainability. They considered that the postponement of the fiscal deficit target by a year is appropriate given the current outlook. However, Directors underscored that additional fiscal measures would be needed to achieve the deficit target. They highlighted that fiscal sustainability could benefit from a medium‑term fiscal framework which focuses on the nonfinancial public sector and is supported by an appropriate fiscal rule. Directors encouraged the authorities to introduce measures to put public debt on downward path. They also recommended that adjustment efforts should focus on reducing current expenditure while further improving its efficiency to increase capital spending. Priority should also be given to making further progress on the reforms of the pension system and the state‑owned enterprises.
Directors welcomed the authorities’ commitment to bring inflation to within the central bank’s target range. Looking ahead, they encouraged the central bank to further strengthen the monetary policy framework by addressing the high degree of dollarization and enhancing its communication strategies, thereby better anchoring inflation expectations. Directors underscored the need to maintain exchange rate flexibility and limit interventions to address disorderly market conditions. They acknowledged the resilience of the financial sector and encouraged the authorities to remain vigilant about the non‑performing loans and continue their efforts to increase financial inclusion while ensuring that it remains resilient in the face of regional shocks.
Directors welcomed Uruguay’s success in reducing poverty and inequality. To foster inclusive growth and ensure continued income convergence to advanced country levels, they encouraged the authorities to sustain implementation of structural reforms. Directors highlighted that reform efforts should focus on further increasing public investment, employment and labor force participation, enhancing competitiveness, and improving overall business environment and educational outcomes.
Source: International Monetary Fund
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