URUGUAY GROWS STRONG FOR THIRD CONSECUTIVE YEAR

,UNCLAS MONTEVIDEO 000296 SIPDIS SIPDIS STATE FOR WHA/BSC AND EB DEPT PASS USTR TREASURY FOR OASIA FOR DOUGLASS USDOC FOR ITA/MAC/WBASTIAN E.O. 12958: N/A TAGS: ECON ETRD EINV ECIN UY SUBJECT: URUGUAY GROWS STRONG FOR THIRD CONSECUTIVE YEAR ¶1. Summary: In 2005, Uruguay met its key IMF targets and achieved a 6.6% growth rate, outpacing expectations and driving real GDP back to pre-crisis levels. Still, despite the ongoing strong recovery, per capita GDP (in dollar terms),investment and several social indicators remained below pre-crisis levels. Uruguay continued to diversify its exports away from Mercosur, with the U.S. now purchasing as much as the entire trade bloc. Initial numbers for 2006 indicate that the U.S. has now overtaken Mercosur as Uruguay's first export destination. Growth perspectives for 2006 are good, with mid-range estimates at 4.0%-4.5%, but foot-and-mouth disease in neighboring Argentina and a potential deterioration of the labor and investment climate are incipient dangers. End Summary. -------------- -------------- Sound growth in 2005 drives GDP to pre-crisis levels -------------- -------------- ¶2. Uruguay's economy grew 6.6% in 2005, outpacing previous GOU forecasts and exceeding analysts' expectations of a 4.0% to 6.0% range. After four years of deep crisis and three years of recovery, GDP (in real terms) is back to its pre-crisis levels. Per capita GDP (in dollar terms) reached $5,200 --still under its 1998 peak of $6,800-- and nominal GDP (also in dollar terms) reached $16.8 billion. Growth was led by robust private sector investment, nevertheless below pre-crisis levels, and record-breaking exports. Inflation fell from 7.6% in 2004 to 4.9% in 2005. ¶3. Uruguay's trade deficit surged from $180 million in 2004 to $474 million in 2005, as imports grew faster than exports (25% and 16% respectively). Imports were driven by industrial raw materials, which mirrored the 10% industrial growth. Capital goods imports, which rose about 50% over 2004 following the economic recovery and a 24% growth in investment, accounted for about 23% of the increase in the import bill. Oil imports accounted for another quarter of the increase. -------------- High scores for the new economic team -------------- ¶4. The transition to this left-of-center Frente Amplio administration was smooth, thanks to its solid economic team. By implementing prudent monetary and fiscal policies, the GOU slightly outperformed its IMF primary surplus target of 3.5% of GDP and slashed its debt/GDP ratio from 101% in 2004 to 82% in 2005. Tax revenues rose 13.7% in 2005, led by the continuing recovery, a major reform of the tax collection authority, and an aggressive tax collection campaign. The GOU benefited from the positive emerging markets conjuncture to place three dollar-denominated issuances for $1.7 billion and an euro-denominated issuance for Eur300 million. ¶5. In its second review of a 2005 stand-by program, the IMF stated that the ""program is on track"" and that near-term vulnerabilities have declined."" Still, the Fund warned that ""significant risks remain (...), public debt is still high, the financial system remains highly dollarized, and the fiscal program is subject to risks from spending pressures."" The IMF program ""is designed to contain these risks"". ¶6. According to the IMF, ""monetary policy has been managed prudently, and needs to be focused on achieving the program's inflation objective."" However, several local analysts have argued that the Central Bank has implemented an overly stringent policy that has appreciated the peso against the dollar and impacted on competitiveness. Following a 15% fall in the peso/dollar exchange rate, competitiveness (measured by the real exchange rate) dropped 10% in 2005, but remains at an adequate level. ¶7. The banking sector continued to recover from the 2002 crisis. Deposits rose 4% and, after several years of running deficits, most private banks showed positive results. According to the IMF, ""financial sector reforms continue to progress well (...),including the Central Bank and supervisory authorities."" -------------- -------------- Social and labor indicators improved but remain weak -------------- -------------- ¶8. While social indicators improved in 2005, following the ongoing recovery, most remain below pre-crisis levels. Unemployment dropped from 13% in 2004 to 12% in 2005, but is still 20% above 1998. After dropping five years in a row, real wages grew 4.5% in 2005, but also remain 20% below 1998 levels. The latest official figures show a doubling of the poverty rate to about to one-third of the population from 1998 through 2004. -------------- -------------- Uruguay continues to diversify exports away from Mercosur -------------- -------------- ¶9. Uruguay continued to diversify its exports away from Mercosur, with the U.S. market absorbing an increasing share. The U.S. became Uruguay's largest single export market in 2004. In 2005, the U.S. absorbed the same share of Uruguay's exports as Argentina, Brazil and Paraguay (Mercosur) combined. Initial numbers for 2006 indicate that the U.S. has by now overtaken Mercosur as Uruguay's lead export market. On the other hand, the market share for U.S. exports to Uruguay continued to decline, from 12.0% in 1998 to only 6.7% in 2005. -------------- -------------- Comment: Continued growth in 2006, but risks remain -------------- -------------- ¶10. While the GOU and the IMF expect 4.0% growth for 2006, private analysts' forecasts range from 3.5% to 6.5%. The paper mills conflict between Uruguay and Argentina, which resulted in the extended blocking of bridges by Argentine protestors, has already had an impact on trade and tourism between the two countries. It will likely have some negative effect on this year's GDP. Other possible constraints to growth are the risks of contagion from an outbreak of foot-and-mouth disease in Argentina, only 250 miles away from the Argentine-Uruguayan border, and of a possible worsening of an already tense labor situation with the unions. A deteriorating labor climate could affect investment and hinder further declines in unemployment. End Comment. NEALON