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Country Report Uruguay

Country Report

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Economic growth in Uruguay eased somewhat in 2012, but nevertheless remained much stronger than in neighboring Argentina and Brazil. Growth in the coming years is likely to be boosted by large inflows of foreign direct investment. Inflation remained far above the central bank’s target range. The government has tried to fight inflation through an agreement with retailers to reduce prices on around 150 products and freeze prices of other products. In 2012, the primary balance deteriorated from a surplus of 2% of GDP to a deficit of 0.2% of GDP. Meanwhile, the government has maintained its business friendly policies. 

National facts of Uruguay
National facts of UruguaySource: EIU, CIA World Factbook, UN, Heritage Foundation, Transparency International, Reporters Without Borders, World Bank.

Economic structure and growth

Economic growth in Uruguay is estimated to have slowed to 3.7% in 2012, after two years of very high growth rates. Nevertheless, growth in Uruguay was much stronger than in its big neighbors Argentina and Brazil, where 2012 was a year of economic stagnation. The EIU forecasts that the economy will grow by 4% in 2013. In 2012, private consumption continued to boost growth in Uruguay, but less so than in 2010 and 2011, when it grew very rapidly. This was, in fact, a welcome development, as the Uruguayan economy is operating at full capacity; unemployment is now at a very low level and the current account deficit has widened.

Fortunately, a significant part of the high growth rates of the past years has been realized through an increase of total factor productivity. Yearly growth of total factor productivity was roughly 3% between 2005 and 2011, and thus accounted for about half of all the total economic growth achieved in this period, with substantial innovation taking place in the agricultural, logistics and forestry sectors. Meanwhile, the country has received a lot of foreign direct investment (FDI) in the past ten years and is likely to continue to do so, as several major investment projects are being realized and new ones are planned. A new pulp plant (another was already finished a few years ago), which entails an investment of USD 1.9bn, is expected to open in the course of 2013. Another smaller pulp facility will also open in the not so distant future. Furthermore, the mining industry is likely to grow quickly in the coming years following the discovery of mineral reservoirs. Foreign direct investment is also important given the fact that, like in many other South American countries, saving and investment are relatively low in Uruguay, with investment accounting for only roughly 20% of GDP in 2012. Foreign direct investment is likely to boost diversification of the economy. This is welcome, as Uruguay still primarily exports agricultural products. Meat and meat products are Uruguay’s most important export product. Other major agricultural export products are soy products, rice, wheat and wool. Tourism also is also an important sector and accounts for roughly USD 2bn in foreign income. Uruguay has relatively good institutions, together with Chile it’s the least corrupt country of South America according to the Corruptions Perceptions Index. Although the level of dollarization has declined, according to S&P dollarization was still high at 50% for loans and 72% for deposits by mid-2012. However, the banking sector is relatively small, partially thanks to the consolidation of the sector after the financial crisis that hit Uruguay in 2001 and 2002, and accounted for only 24% of GDP in 2011. Contingent liabilities from the financial sector are thus relatively low. Meanwhile, banks are liquid and NPLs are low. 

Figure 1: Growth performance
Figure 1: Growth performanceSource: EIU
Figure 2: Public finances
Figure 2: Public financesSource: EIU

Political and social situation

Uruguay has a stable political system and democracy is now well established following the end of military rule in 1985. Trust in institutions such as the legislature, judicial power and political parties is relatively high. In 2005, the Frente Amplio, a center-left coalition, for the first time gained power in Uruguay. Jose Mujica, who is a member of the left wing of this coalition, became the president in 2010. Throughout this period, Uruguay’s business friendly and relatively prudent macroeconomic policies have been maintained. However, the government’s popularity got a hit when it failed to adequately address the bankruptcy of national airline Pluna in 2012. Meanwhile, the opposition seems to have become less willing to cooperate with the government lately. Nevertheless, Uruguay’s political system remains characterized by a high level of consensus. In October 2014 general elections will take place. Tabaré Vázquez, a pragmatic figure within the Frente Amplio who was Uruguay’s president between 2005 and 2010, may become the leader of the Frente Amplio, even as he will be 74 years old in 2014. He remains very popular and therefore stands a good chance of winning the election should he decide to run.

By Latin American standards, poverty and income inequality are low in Uruguay. Both income inequality and poverty have fallen considerably recently. According to the Economic Commission for Latin America (ECLA) the percentage of the urban population that lives in absolute poverty has fallen from 15.4% in 2002 to 6.7% in 2011. Meanwhile, rural poverty has also fallen. On the international front, relations with Argentina are difficult, due to Argentina’s trade protectionism and policy unpredictability and the fact that the Argentine government has some frustrations with Uruguay’s banking secrecy laws. There is also the risk that relations with Argentina may deteriorate due to protest against Uruguayan paper mills. In recent years Uruguay has turned more to Brazil and has also tried to enhance its ties with countries in Asia and Africa. 

Economic policy

In 2012, the fiscal deficit increased to 2.8% of GDP, the highest level since 2003. The primary balance deteriorated from a surplus of 2% of GDP in 2011 to a deficit of 0.2% in 2012. This was the result of high energy costs, which were caused by a drought, extraordinary one time payments and a newly implemented healthcare scheme. As most of these factors have a one-off nature, the deficit is likely to decrease somewhat this year. It is important for Uruguay to limit the fiscal deficit, as the country still has a relatively large debt burden, with public debt being equal to 58% of GDP in 2011. Just like its big neighbors, public social spending in Uruguay is relatively high by Latin American standards. As a result, the public expenditure structure is relatively rigid. However, the government has continued to work to improve the profile of Uruguayan debt. The foreign currency share has fallen from 89% in 2005 to 51% in 2011 and rollover risks have been reduced, as Uruguay has increased the maturity of its loans. In November 2012 the government was even able to issue a USD 500m loan with a tenor of 33 year with a yield of just 4.125%.

Inflation has been relatively high in Uruguay. The central bank has a target range of 4-6%, but inflation rose above 9% in October and November 2012. In December, the central bank increased its benchmark interest rate by 25 basis points to 9.25%. It was the second consecutive quarter in which the central bank increased its interest rate. In 2011 the central bank had already tightened monetary policy by 225 basis points. Uruguay has not only tried to limit inflation through monetary policy though. In October supermarkets agreed with the government to freeze prices until January and reduce to the price of some basic products. It was a sort of emergency measure, as the government wanted to avoid inflation exceeding 10% at the end of the year, which would trigger an automatic adjustment of pensions and salary renegotiations that could fuel a vicious wage-price spiral. Within the business sector and the central bank there was some unease about this measure. So far, wage indexation, an important structural cause of inflation in Uruguay, has not been addressed. Inflation is therefore expected to ease only gradually. Since July 2012, the Uruguayan peso has appreciated strongly from 22 peso per dollar to less than 19 peso per dollar. In August, the central bank introduced a capital control to fight the appreciation of the currency when it introduced a reserve requirement of 40% on foreign purchases of central bank notes. This in spite of the fact that the central bank had earlier stated that it would not impose capital controls. However, Uruguay is not the only South American country to introduce capital controls. Brazil has already done so far more extensively and other countries may follow.

Meanwhile, most of the government policies remain business friendly. Attracting foreign direct investment has been an important part of government policy and the government has a good reform track record. Several reforms have been implemented in the past years, such as the introduction of a personal income tax in 2007, a bankruptcy law in 2008 and a public-private partnership law in 2011. Right now the government focuses on reforming the educational system, developing basic infrastructure and creating a fair framework for the mining sector. 

Balance of Payments

Uruguay’s current account deficit grew from 1.3% of GDP in 2009 to 3.6% of GDP in 2012 and is expected to deteriorate somewhat further in the coming years. Uruguay has deficits on the trade and income accounts, but thanks to the important tourism sector the country has a surplus on the services account. Inflows of foreign direct investment remain very strong and can easily cover the current account deficit. In the past seven years net inflows of foreign direct investment has always been above 5% of GDP and they are likely to remain very strong in the coming years. The current account deficit is partially directly the result of the high FDI inflows, as the large foreign direct investment financed projects boost imports. Other types of capital inflows were relatively modest in 2012. The most important balance of payments vulnerability is Uruguay’s reliance on agricultural exports and tourism income from Argentine visitors. 

External position

Uruguay’s foreign reserves grew from USD 10.3bn in late-2011 to an estimated USD 12.2bn in late 2012 and now exceed the country’s total foreign debt. Furthermore, the banking system has a sizeable net foreign asset position and the country has a good relationship with multilateral financial institutions, which translates into relatively easy access to emergency assistance. Uruguay had a Net International Investment Position (NIIP) of -8% of GDP in 2011. The structure of the NIIP is favorable though. Out of a total stock of foreign liabilities of USD 32.8bn, USD14.9bn consisted of FDI foreign direct investments, while Uruguay’s foreign assets are relatively liquid. The external position is therefore relatively comfortable, although the still high level of dollarization somewhat increases the risk profile. 

Figure 3: Current account
Figure 3: Current accountSource: EIU
Figure 4: External liquidity
Figure 4: External liquiditySource: EIU
Economic indicators of Uruguay
Economic indicators of UruguaySource: EIU & Rabobank estimates
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