Uruguay: Selected Issues

May2023 URUGUAY SELECTEDISSUES IMFCountryReportNo.23/179 ThispaperonUruguaywaspreparedbyastaffteamoftheInternationalMonetaryFundasbackgrounddocumentationfortheperiodicconsultationwiththemembercountry.ItisbasedontheinformationavailableatthetimeitwascompletedonApril26,2023. Copiesofthisreportareavailabletothepublicfrom InternationalMonetaryFundPublicationServicesPOBox92780Washington,D.C.20090Telephone:(202)623-7430Fax:(202)623-7201 E-mail:publications@imf.orgWeb:http://www.imf.orgPrice:$18.00perprintedcopy InternationalMonetaryFundWashington,D.C. ©2023InternationalMonetaryFund April26,2023 URUGUAY SELECTEDISSUES PreparedByJeanFrançoisClevyAguilar,JesúsSánchez, M.BelénSbrancia,andMauricioVargas(WHD) ApprovedBy PatriciaAlonso-Gamo CONTENTS ENSURINGMEDIUM-TERMFISCALSUSTAINABILITY3 A.Context3 B.APrudentMedium-TermRangeforPublicDebt4 C.ConsolidationOptions:TheCompositionofRevenuesandSpending9 D.Conclusions13 References15 DRIVERSOFFINANCIALDOLLARIZATIONANDTHEROLEOFPRUDENTIALPOLICIES16 A.Introduction16 B.StylizedFacts17 C.TheDeterminantsofDollarization21 D.PolicyRecommendations26References28 FIGURES 1.DollarizationTrends18 2.Pass-ThroughfromERtoDomesticPrices20 3.UncoveredInterestRateParityPremium20 4.MarginalReserveRequirementandDepositDollarization22 5.ContributionstotheFittedValues–PanelDataRegression23 6.ContributionstotheFittedValues–Uruguay’sCountry-SpecificRegression25 1INTERNATIONALMONETARYFUND URUGUAY TABLES 1.AverageCPIInflationandERVolatility:2005-202219 2.FinancialDollarizationandChangesintheUIPComponents21 3.DriversofDollarization24 ANNEXES 1.SelectedChartsandTables29 2.TheMVPModel33 3.UIPPremium34 4.RobustnessAnalysis35 EMBRACINGCLIMATECHANGECHALLENGES36 A.BackgroundandRecentDevelopments36 B.EmissionsTargetsandOutlook38 C.PoliciesSupportingClimateChangeAdaptation39 D.PoliciesSupportingClimateChangeMitigation41 E.TheRoadAhead44References46 2INTERNATIONALMONETARYFUND ENSURINGMEDIUM-TERMFISCALSUSTAINABILITY1 Globalpublicdebtisathistoricallyhighlevelsraisingquestionsaboutitssustainabilityandhowitcouldbebroughtdown.InUruguay,theauthorities’policies,togetherwithafavorablemacroeconomicenvironment,haveledtoadeclineofthepublicdebt-to-GDPratiotopre-pandemiclevels.Shorttermrisksarelow,anddebtissustainable,yetasequenceofunfavorableshockssuchasaprolongedincreaseininternationalinterestratesandagrowthslowdowncouldleadtofurtherincreasesindebt.Thisnoteexploresrangesofpublicdebtthatwouldincreasefiscalbuffersandprovideroomformaneuverintheeventofnegativeshocksortorespondtohigherspendingneeds.Italsoexploresfiscalconsolidationmeasuresthatcouldgeneratethesavingsneededtolowerdebt. A.Context 1.Uruguaystrengtheneditsfiscalframeworkduringthepandemic,atatimewhenmostcountrieswereeitheractivatingescapeclauses,suspendingtheirrulesormodifyingtargets.AccordingtoDavoodietal(2022),only20percentofthecountrieswithfiscalrulesdidnotmakechangestotheirframeworksduringthepandemic,whilemostcountriesinvokedescapeclausestorelaxtheirfiscalrules.Inthiscontext,Uruguaystandsoutforstrengtheningitsfiscalframeworkduringthepandemicby:(i)establishinganewfiscalrulebasedonthreepillars(structuraldeficit,realprimaryspendinggrowth,andnetindebtedness),(ii)creatingaFiscalCouncilandCommitteeofExperts,(iii)startingtopresetrolling5-yearprojectionsonanannualbasis,and(iv)introducingstochasticdebtsustainabilityanalysis.Theauthoritiesalsoimprovedtheircommunicationstrategyandincreasedthefrequencyofreportingontheirpoliciesandcompliancewiththetargetsoftherule.2 2.Moreover,theauthoritieshavemanagedtoreducepublicdebtintheaftermathofthepandemicthroughacombinationoffiscalprudenceandstrongmacroeconomicperformance.Non-financialpublicsector(NFPS)debtpeakedat68.1percentofGDPin2020andhassincethencomedownto59.3percentin2022,belowitspre-pandemiclevel.DuringthisperiodtheNFPSprimarybalancemovedfromadeficitof2.7percentofGDPwithoutcincuentonestoadeficitof0.6percentofGDPin2022andisexpectedtoreachbalancein2028.3Thedeficitreductionwasachievedthroughacombinationofspendingrestraint,inparticularonpublicwagesandpensions,andthepositiveeffectoffasterthanexpectedgrowthandinflation.Asaresult,andincombinationwithasolidtrack-recordofpolicyimplementation,Uruguay’ssovereigndebtratinghasconsistentlyimprovedsince2021,reaffirmingitsinvestmentgradestatus,whilesovereignspreadsareathistoricallylowlevels.4 1PreparedbyM.BelénSbrancia(WHD). 2Previously,therewasanannualpresentationtoCongressbytheMinisterofFinancereferredtoas“RendicióndeCuentasyExposicióndeMotivos”towhichnowtheauthoritieshaveaddedapresentationinFebruaryontheoutturnofthepreviousyearandtheirperformanceonthedifferentpillarsoftherule. 3Theongoingdrought,themostsevereinthelast30years,isexpectedtoleadtoatemporarydeteriorationofthefiscalbalancein2023relativeto2022. 4FitchimprovedtheoutlooktostableinDecember2021,whileS&PincreasedtheratingtoBBB+withstableoutlookinApril2023. INTERNATIONALMONETARYFUND3 GovernmentDebtandFiscalBalance (PercentofGDP) 80 NFPSdeficit(rhs) 6.0 70GrossDebt 5.0 4.0 60 3.0 50 2.0 40 1.0 30 0.0 2010201220142016201820202022 Sou