GOU CONCERNS ABOUT GLOBAL FINANCIAL CRISIS; WAITING FOR THE

UNCLAS MONTEVIDEO 000583

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN PGOV UY
SUBJECT: GOU CONCERNS ABOUT GLOBAL FINANCIAL CRISIS; WAITING FOR THE
SHOE TO DROP

REF: A) MONTEVIDEO 356, B) MONTEVIDEO 468

SUMMARY
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1. (U) SUMMARY: Remembering well their own devastating economic
crisis of 2002, the GOU is anxiously watching how the current
worldwide financial crisis will affect the previously booming
Uruguayan economy. The country is in a better position than before,
but vulnerabilities remain. In the first sign that the slowing
economy will hit Uruguayan exports, beef sales to Russia and Europe
dropped precipitously two weeks ago. Prices are dropping for other
key commodity exports such as rice, wheat and soybeans.
Slaughterhouses and shoe manufacturers are starting to lay off
workers and government officials believe that Uruguayan expatriates
in Spain have begun to return due to the economic situation there.
Local deposits have shot up as Uruguayan investors appear to be
bringing their capital closer to home. The country risk rating has
increased from 376 to 512 basis points as of this writing. The GOU
so far has no plans to adjust public spending but is carefully
watching currency moves in neighbor Brazil that would have an impact
on regional competitiveness and tourism. The GOU has lined up USD
1.8 billion in contingency lines of credit from international banks.
END SUMMARY.

COMMODITY PRICES AND BEEF EXPORTS
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2. (U) Total Uruguayan exports, which grew vigorously from January
to September, have slowed following the drop in commodity prices,
affecting key export products rice, wheat and soybeans. Although
the price of beef (Uruguay's principle export product) remains above
its 2007 average, it has fallen 23% in the last week. Beef sales to
Russia and Europe have dropped precipitously; slaughterhouses have
run out of storage capacity and have temporarily laid off workers.
In one bright spot, the GOU is benefiting from the sharp fall in oil
prices, although the savings are not being fully transmitted to the
consumer due to an increase in the dollar/peso exchange rate (see
below).

THE SHOE DROPS
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3. (U) The long suffering shoe industry is another early victim of
the economic downturn. Alpargatas, a manufacturer of the typical
gaucho slipper as well as uppers and heels used by its parent
company in Argentina, has laid off 100 workers and reduced the hours
of its remaining workforce. Alpargatas in Argentina has suspended
orders for shoe parts until further notice due to dropping demand.
Other shoe manufacturers report they will also have to cut employees
and close factories in the coming weeks, citing their inability to
compete with low cost Chinese imports in the domestic market.


DOLLAR HIKES IN FACE OF INCREASED UNCERTAINTY
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4. (U) Economic uncertainty has boosted demand for the dollar,
increasing its value 16% since early September. This rise is a
major reversal from the dollar's 11% drop from January through
August. Central Bank reserves fell by USD 150 million as it sold
dollars to prevent sharper increases, but reserves remain above USD
6 billion, an historical high. On October 3, the Central Bank
stopped making peso-denominated one-day loans to banks, which has
created a shortage of pesos and prevented the dollar from rising
further.

GOU CLAIMS BANKING SYSTEM REMAINS SOUND
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5. (SBU) Superintendent of Financial Institutions Jorge Ottavianelli
told emboffs that local banks are in good shape and have not
suffered ill effects so far. Local banks have higher liquidity and
solvency than in the past. Deposits rose 10% in 2008 and have not
been hit by the recent turmoil. In fact, reports indicate that
there has been a significant inflow of deposits since June.
Nevertheless, sight deposits still account for 74% of the total.
The GOU insures up to $10,000 for peso-denominated deposits and
$5,000 for dollar-denominated accounts.

INCREASE IN COUNTRY RISK
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6. (U) Following the general trend in the Emerging Markets Bond
Index Plus (EMBI+),Uruguay's country risk rose from 376 basis
points (bp) in late September to 512 bp, its highest mark since
mid-2004. The increase is mainly due to the fall in the price of
Uruguay's bonds as investors divest from them. On average, the
price of Uruguay's dollar-denominated global bonds has dropped 17%
since early September. Demand for local short-term bonds has dried
up and the Central Bank has reduced its weekly issues.

KEEPING AN EYE ON THE REGION
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7. (U) While Uruguay has greatly diversified its export markets, it
remains vulnerable to developments in neighboring Argentina and
Brazil. The GOU is closely following the value of the Brazilian

real (which has depreciated sharply against the peso) as Brazil is
not only Uruguay's major export destination, but a major source of
tourism. So far, the GOU has shown no intent to impose
trade-restrictive policies vis-a-vis its Mercosur partners or the
rest of the world.

GOU PUBLIC STATEMENTS
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8. (U) President Vazquez and senior GOU officials have issued a
steady stream of statements reassuring the public that the
government is concerned about the crisis' effect on trade, but not
alarmed, and that Uruguay is much better positioned economically now
than in during the last crisis precipitated by Brazil's devaluation
in 1999. The President recalled that when the Brazilian Real
devalued in 1999, Uruguay was dependent on Brazil and Argentina for
67% of its exports. Today those countries represent only 30%.
Vazquez added that the GOU had secured a 1.8 billion dollars worth
of lines of credit from the World Bank, the Andean Development
Corporation and the International Development Bank, among others.
This credit line is not needed at the moment, he said, but was
available as a contingency.


9. (SBU) New Vice Minister of Economy Andres Masoller echoed the
President's statements and emphasized Uruguay's reduced
vulnerability to external shocks. Masoller indicated that foreign
investment remained at record levels. Masoller reiterated these
points privately during the Ambassador's initial meeting with him
October 13. At the meeting he acknowledged that internal GOU growth
estimates for 2009 were between 3-4%, lower than the current public
estimate of 4.5% and about half the level of 2008. Opposition
politicians have argued that planned increases in public spending
for 2009 should be revisited in light of the crisis; however
Masoller responded during the weekly cabinet meeting that the GOU's
budget was completely financed and that the government has an
obligation to protect the level of public support for its social
policies.

NO DEBT ISSUANCE UNTIL 2010
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10. (U) Minister of Economy Alvaro Garcia touted that Uruguay has
satisfied its financing needs until 2010, and that it has greatly
improved its debt structure in recent years. In effect, the GOU has
reduced its exposure to risk by cutting the debt/GDP ratio,
extending the debt's maturity and increasing the share of
peso-denominated debt. COMMENT: Despite the decrease, indebtedness
remains relatively high at 69% of GDP, and a major part of the
decline in the debt/GDP ratio has been due to the strong rise in GDP
measured in dollar terms caused by the depreciation of the dollar
(GDP rose 40% in constant terms from 2002 to 2007, and 88% in dollar
terms). END COMMENT.

INFLATION STILL A CONCERN
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11. (U) While officials confide they are concerned about the
slowing economy, recent actions suggest that the prospect of
inflation (following unprecedented GDP growth of 13% in the first
half of 2008) is a greater concern. Inflation rose to 7.6% in
January-September, above GOU's 3%-7% target range. To try to
alleviate inflationary pressures and keep inflation under 10%, the
Central Bank raised its peso-denominated reference rate from 7.25%
to 7.75% on October 3. This rate increase also contributed to slow
the dollar's rise.

COMMENT
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12. (SBU) Behind the measured caution in public statements, GOU
officials have privately expressed heightened concern. The
government is circling the wagons to prepare for an undetermined
economic fallout. Uruguay has made great strides to reduce its
vulnerability to external shocks by lowering its dependence on
neighbors Brazil and Argentina, but we agree with President Vazquez
that that Uruguay has reason for concern and should remain vigilant
as this global crisis unfolds. The country remains vulnerable to a
global economic downturn as a high percentage of its exports are
commodities.
BAXTER