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AmericasSeptember 3 2006

A return to health

Monica Campbell reports from Montevideo on the new Uruguayan government’s successful efforts to revive the economy and strengthen the banking sector.
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After years of rehab following a crippling economic crisis in 2002, Uruguay is snapping back to its relaxed self. The old-fashioned, wood-panelled cafes in the capital of Montevideo are bustling, and so are the shopping malls. New, modern apartment complexes are being built in the country’s middle class and well-off neighbourhoods, while (albeit controversial) pulp mills that represent huge foreign investment are under construction. And, most recently, Uruguay delivered a strong sign of strength to international markets by prepaying a sizeable chunk of loans to the International Monetary Fund (IMF).

“The economy is growing at a good rhythm and we expect the same this year,” says Fernando Lorenzo, the economy and finance ministry’s chief economist. “We’re recuperating the volume of exports and our levels of investment, which fell dramatically during the crisis. We’ve been working intensely to rebuild the economy and it’s now paying off.”

The mood in Uruguay, a South American country about the size of Florida squeezed between Brazil and Argentina, could not be any different than it was in 2002. That is when Argentina’s economy collapsed and took Uruguay – already battling a recession since 1999 – down with it.

The poverty rate in Uruguay, known for economic equality and a high standard of living, soared to 23%. Banking customers, including non-Uruguayans who often view the country as a safe, Swiss-style banking spot, rushed to withdraw their deposits.

Today, signs of the economic crash remain visible. Although the number of poor people has declined considerably, income levels are still below pre-crisis levels. The number of informal workers has also risen.

Along major streets in Montevideo, children can be spotted juggling for cash at traffic lights. It is a scene typical in much of Latin America, but not in Uruguay, a country known for societal welfare and taking care of its citizens’ basic needs. In addition to this, the rates of crime and drug use are also up.

But there is reason to believe that Uruguay, a country of only 3.5 million inhabitants, is crawling out of its slump. Unemployment has dropped from 17% in 2003 to about 10% this year. The economy is set to expand by more than 5% this year, higher than expected, and will be driven by stronger consumer demand and better exports of beef, grain and dairy products, Uruguay’s principal exports.

The peso is stable, inflation is in the single digits, in line with the government’s target range, and salaries are recovering. Industrial leaders have positive expectations of the economy’s future, according to recent polls.

This summer, the Tabare Vázquez government, which began its term in March 2005, sent a strong sign of economic strength to the markets when it announced that Uruguay would prepay $916m of IMF debt it owed in 2007. That payment followed an earlier prepayment in March of $630m and nearly halved Uruguay’s total IMF debt burden.

Debt restructuring

Although public debt remains high, the early IMF payment has strengthened Uruguay’s debt structure by ridding it of expensive, dollar-dominated, short-term financing. “At the beginning of the current administration, half of our debt was dollarised and short term, with interest rates at above 8%,” says Mario Bergara, vice-minister of economy and finances. “This set-up clearly had to change. We’re now creating a far more manageable debt burden.”

After the 2002 crisis forced four locally owned banks out of business, Uruguay’s financial sector is also in better shape. “The sector is in far better shape to withstand market shake-ups,” Walter Cancela, Uruguay’s Central Bank president, told The Banker. “We’ve spotted where supervision and transparency were lacking and have worked on reforms to address those weaknesses.”

Importantly, the biggest bank, the state’s Banco de la República Oriental del Uruguay, is under stricter management and official scrutiny. Banco Hipotecario del Uruguay, the state-run mortgage bank, is also being overhauled. And, across the board, private commercial banks are showing better results. “The sector is regaining its health,” says Jose Fuentes, head of Nuevo Banco Comercial. “We’ve regained our customers’ confidence, we’re liquid, and deposit levels are returning to pre-crisis levels.”

In large part, Uruguay’s inherent strengths – a stable democracy, solid public institutions, fair income distribution and an educated population – will help lock-in the current economic recovery. But close government watch is needed over what keeps Uruguay vulnerable: a dependence on global commodity prices for meat and dairy products, its top agricultural exports; high oil prices; and economic ups and downs in Brazil and Argentina.

These realities have left-leaning Mr Vázquez, in the spirit of Michelle Bachelet in Chile and Luiz Inacio ‘Lulu’ da Silva in Brazil, sticking to orthodox, market-friendly reforms. Mr Vázquez’s presidency, which marked the end of 170 years of National and Colorado party rule, is focused on creating new opportunities in the formal labour market, attracting fresh foreign investment and stopping the post-crisis rise in unemployment, crime and informal labour.

A comprehensive tax reform is one major initiative. It is cast as a bill that makes the tax system fairer and simpler by introducing a first-ever personal income tax; revamping the corporate income tax; broadening the value-added tax; providing incentives for research and development initiatives; and tackling evasion.

Other reforms are geared toward reforming public utilities, modernising state-managed pension funds and sealing a free-trade accord with the US. The chances are good that Mr Vázquez’s Frente Amplio (Broad Front) coalition, despite its internal splits, should manage to move forward its agenda.

Neighbourly dispute

Yet there are wrinkles on the international front. Relations with Argentina are tense thanks to a long-running battle over Uruguay’s decision to allow the construction of two cellulose plants on the Uruguay River, which borders Argentina. The $1.6bn-dollar project – which represents thousands of jobs, Uruguay’s biggest injection of foreign capital in history – was loudly opposed by President Nestor Kirchner’s administration in Argentina, which requested the International Court of Justice in The Hague to halt construction of the cellulose mills on the environmental threat they posed to the river.

Argentina also said that the mills violated a bilateral pact between the two countries that requires agreement on how to develop the waterway. Argentina’s ire and the potential environmental threat prompted protests and blockages of the bridges of the Uruguay River beginning last December. The protests came during the high tourist season and complicated thousands of Argentinians’ summertime jaunts to Uruguay’s Punta del Este resort town. Million of tourist dollars were lost in Uruguay.

Uruguay has remained firm during the uproar. The government assured that the owners of the mills, Finland’s Metsa-Botnia and Spain’s Ence, would follow the strictest set of international standards. Uruguay also highlighted the hypocrisy of the dispute, pointing to numerous pulp mills in Argentina that use outmoded and environmentally harmful machinery and techniques. It now appears that Uruguay has won the battle, thanks to rulings in The Hague that favour Uruguay.

That is a relief, considering that the project at stake is estimated to be worth equivalent to 10% of Uruguay’s gross domestic product in 2005. But the dispute will drag on. Argentina has rejected The Hague’s conclusions and will test other international legal avenues in its attempt to thwart the riverside project. In the meantime, Argentina will lobby multilateral lenders to refrain from funding the mills.

Also, the row will do nothing but increase Uruguay’s disappointment with the Southern Cone customs union, known as Mercosur.

Mercosur failings

The trade bloc whose five members are Brazil, Argentina, Paraguay, Uruguay and Venezuela, with Chile and Bolivia as associates, failed to strongly address the pulp mill conflict between Uruguay and Argentina. Moreover, Uruguay sees nothing good in the union’s labyrinthine bureaucracy and has yet to see Mercosur significantly boost trade.

“Mercosur represents less than one quarter of our investment,” says Mr Bergara. “If Uruguay remains intent on growing its exports, than expanding ties with other parts of the world is necessary.” So, Uruguay is working on a trade deal with the US. But with Venezuela as a new member of Mercosur – which adds President Hugo Chavez’s anti-American to the mix – Uruguay may be forced once again to defend how it decides to better its economy.

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Read more about:  Americas , Uruguay