IMF Executive Board Concludes 2017 Article IV Consultation with Uruguay

January 31, 2018

On January 22, 2018, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation^[1] with Uruguay. 

Recent Developments and Outlook

Uruguay has had a good year in 2017, with growth estimated at above 3 percent and the rise in unemployment forecast to have come to a halt. A relatively tight monetary policy stance and an appreciating exchange rate have contributed to a notable decline in inflation—estimated at 6½ percent by year end—bringing it within the central bank’s target range for the first time in seven years.   

The fiscal adjustment is on track. Fiscal policy has been countercyclical in 2017, with higher income tax receipts partly offset by rising pension and health care costs. The overall deficit is estimated to decline to 3.3 percent of GDP, and the government continues to be able to access international financial markets on favorable terms, including through global nominal-peso bonds. 

Financial flows have remained volatile, and local and nonresident investor interest in the peso has been strong overall. The central bank intervened to accommodate these portfolio shifts, adding US$3 billion to its stock of net reserves in the first three quarters of 2017.   

The current account balance has been improving and is now in surplus, estimated to approach 2 percent of GDP in 2017. The increased competitiveness against Argentina has supported a rapid and strong increase in tourism inflows, while the real appreciation relative to the rest of the world has weakened export competitiveness for many agricultural and manufacturing products (even if output remained strong, in part owing to good harvests). 

Risks to the outlook nonetheless remain. On the upside, a possible foreign investment in Uruguay’s third paper pulp-processing plant could be the largest FDI project in the country ever, boosting confidence and growth beyond the current projections. Downside risks include a prolonged loss of competitiveness or dampened investor interest in emerging markets. A reversal of the recoveries in Argentina and Brazil, or a significant slowdown in China could undermine investment and growth as well. Uruguay’s large buffers—gross reserves of the central bank, liquid financial assets, and contingent credit lines at international financial institutions—together with the flexible exchange rate regime would allow the country to weather potential short-term shocks relatively unscathed.   

Financial stability risks are limited. Uruguay’s banking sector is small relative to the size of the economy, and even though non-performing loans have increased in the last few years, they remain moderate, at less than 4 percent, and are covered by provisions and excess capital. 

Executive Board Assessment^[2] 

Executive Directors commended the authorities on their prudent policies, which allowed the country to capitalize on favorable external conditions to achieve good macroeconomic outcomes in 2017. Directors noted that fiscal adjustment is proceeding broadly as planned and that inflation has successfully been brought within the central bank’s target range. They encouraged the authorities to take advantage of the country’s strong position to continue to strengthen economic resilience and address structural constraints to inclusive growth over the medium term. 

Directors noted that keeping inflation on a downward path over the medium term would greatly enhance the credibility of the central bank. Toward this end, maintaining a tight monetary stance would be appropriate as demand pressures materialize. Keeping nominal wage growth on a declining path would help anchor inflation and set the stage for broader efforts toward de dollarization, which in turn would help enhance monetary transmission. 

Directors welcomed the authorities’ commitment to exchange rate flexibility as an important stabilizer in the face of shocks. They stressed that interventions should be limited to countering disorderly market conditions, and highlighted the importance of clear communications to ensure that interventions do not undermine the credibility of the central bank’s commitment to reducing inflation. 

Directors agreed that Uruguay’s main fiscal challenges are of a medium term nature. In the short term, Directors generally agreed that revenue windfalls should be saved if possible. While a few Directors noted that revenue windfalls could also be directed toward public investment, a number of other Directors recommended taking the opportunity to achieve the 2.5 percent of GDP fiscal deficit target already in 2018. In the medium term, an enhanced fiscal rule could be helpful to keep net debt on a sustainable and declining path, and reforms to ensure the viability of the pension system will be needed. To address Uruguay’s infrastructure gap, reallocating public spending toward investment will be important, while carefully assessing the costs and benefits of public and public private projects and the adequacy of incentives to attract private investment. Strong governance of state owned enterprises will also be important for limiting fiscal risks. 

Directors emphasized that to provide the conditions for sustained robust and inclusive growth, ongoing fiscal and monetary prudence should be combined with a greater focus on structural reforms. They noted that Uruguay’s strong institutions and hard won economic stability are widely recognized. Nonetheless, there is scope to address weakness in transportation infrastructure, education and skills formation, labor market flexibility, and access to foreign markets. Reforms to improve the business climate to support a vibrant and diverse manufacturing and agricultural base will be important for enhancing competitiveness, especially in case of further appreciation pressures. Increasing firms’ access to credit and hedging instruments would also be important to strengthen their resilience.

[1] Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

[2] At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. An explanation of any qualifiers used in summings up can be found here: http://www.imf.org/external/np/sec/misc/qualifiers.htm.