Identifier
Created
Classification
Origin
08MONTEVIDEO627
2008-11-10 13:12:00
UNCLASSIFIED//FOR OFFICIAL USE ONLY
Embassy Montevideo
Cable title:  

Uruguayan Economists Weigh In on Global Crisis

Tags:  ECON EFIN PGOV UY 
pdf how-to read a cable
VZCZCXYZ0004
PP RUEHWEB

DE RUEHMN #0627/01 3151312
ZNR UUUUU ZZH
P 101312Z NOV 08
FM AMEMBASSY MONTEVIDEO
TO RUEHC/SECSTATE WASHDC PRIORITY 8577
INFO RUCNMER/MERCOSUR COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHDC
UNCLAS MONTEVIDEO 000627 

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN PGOV UY
SUBJECT: Uruguayan Economists Weigh In on Global Crisis

REF: A) MONTEVIDEO 583, B) MONTEVIDEO 468

SUMMARY
-------

UNCLAS MONTEVIDEO 000627

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN PGOV UY
SUBJECT: Uruguayan Economists Weigh In on Global Crisis

REF: A) MONTEVIDEO 583, B) MONTEVIDEO 468

SUMMARY
--------------


1. (SBU) SUMMARY: Uruguayan economists expect the global financial
crisis, lower commodity prices and economic slowdown to slow growth
in Uruguay to an anemic 1-3% in 2009. Despite this, observers
believe the GOU is in a good position to weather the downturn, with
government spending financed through the end of 2010, open lines of
credit with international financial organizations, and healthy
levels of hard currency reserves. Debt to GDP ratio is
substantially improved since the 2002 economic crisis, but the
strengthening dollar and increased GOU spending threaten to push it
back upward. Argentina is a major point of concern, with many
predicting significant economic fallout there within months, which
would have a strong negative impact on Uruguay. END SUMMARY

BOOM TIMES ARE OVER...
--------------


2. (SBU) Uruguay is feeling the effects of the global economic
downturn, especially as commodity prices fall and exports
decelerate. A common refrain from economists is that Uruguay's
position in the region tends to amplify external shocks. When times
are good, Uruguay exports its commodities directly to the world as a
whole and provides many inputs to the Argentine and Brazilian
economies which do well under the same circumstances. When prices
fall and exports drop, Uruguay loses twice, they say. Local
economists across the board predict Uruguay's GDP growth to drop as
low as 1%-3% in 2009, a sharp fall from an annual high of 13% during
the first two quarters of 2008 (ref A) and sustained rates of
growth above 7% since 2005. Peso depreciation is expected to take
its toll, with the GDP (expressed in U.S. dollars) falling from
about 28 billion to 23 billion. If this bears out, it will result
in a substantial increase in the debt/GDP ratio, a rising debt
burden that would constrain public spending, and possibly negatively
impact Uruguay's country risk rating, future financing options, and
access to credit. Economists expect Uruguay will allow the dollar
to rise to 22-24 pesos/dollar (at the time of this cable it was
23.4),but say the country does not have further room to maneuver
due to the high dollarization of its economy.

...BUT GOU SPENDING REMAINS STEADY
--------------



3. (SBU) With the dipping economy comes the prospect of lower tax
revenues, despite the fact that public spending is already locked in
through the end of 2010, based on previous, fatter projections.
Fernando Lorenzo, former Director of the Macroeconomic Unit at the
Ministry of Economy, said the GOU has systematically adjusted its
expected revenue figures (and spending) upward in the past four
years in line with the previously strengthening economy. Other
economists told econoff that the GOU did not plan for a rainy day,
but instead planned as if the "best case scenario" would continue
unabated. Opposition Senator and former Minister of Economy Isaac
Alfie was also critical of increased government spending as a
percentage of GDP under the Frente Amplio government.


4. (U) In contrast to Senator Alfie and orthodox economists who
have been critical of high spending levels, Minister of Economy
Alvaro Garcia presented statistics to Congress on October 29 that
highlighted the increase in social spending during the Frente Amplio
government. Such spending increased from 36% to 49% of total
spending from 2004 to 2009 and was partly enabled by the drop in
debt interest payments from 31% to 18% of total spending. Garcia
emphasized that such spending increases were essential to speed
recovery from the 2002 financial crisis and combat rising poverty
levels, unemployment, and falling salaries. Poverty levels had
increased from 17% to 32%, unemployment from 10% to 13% and salaries
fell 20% during the previous administration (relative to pre-crisis
levels). As of mid-2008, the Vazquez government, by increasing
social spending and buoyed by remarkable economic growth, had
lowered poverty to 22%, kept unemployment less than 8% and achieved
a 13% increase in salaries - a good return on investment in Garcia's
mind.

ECONOMY REMAINS REASONABLY SOUND
--------------


5. (SBU) Despite expectations that the economy in Uruguay will slow
substantially, economists pointed out that the fundamentals remain
strong and Uruguay is better prepared today as a result of policies
implemented since the crisis in 2002. Lorenzo noted that investment
(both foreign and domestic) remains very strong and continues to
grow. He cited COMAP, the agency that approves tax incentives to
investment projects, which reported that USD 800 million in
investment projects were approved in 2008, compared to a USD 320
million in 2007. The GOU has publicly stated that Spanish paper
giant ENCE continues to progress toward constructing its USD 1.4
billion pulp mill that will be the largest investment project to
date in Uruguay. Lorenzo also pointed out the GOU's success in
pre-financing its spending through the end of 2010 and in acquiring
lines of credit with international financial organizations to back
that up.


6. (SBU) Economic observers note that Uruguay has sufficient hard
currency reserves to protect its currency and inject money into the
economy if needed. While the GOU boasts more than USD six billion
in reserves, Economists Michelle Santo and Alfie suggest the actual
figure of available reserves is much lower, although still adequate
since as much as USD three billion are private banks' reserve
requirements held by the Central Bank. Santo also said reserves
could drop if local investors stop rolling over short term GOU debt,
since excess liquidity would put upward pressure on the dollar,
forcing the Central Bank to sell hard currency. Santo was critical
that the GOU had not bought reserves with fiscal surplus, but rather
through debt, either with private banks or investors.


7. (SBU) Santo said Uruguayan banks have excess liquidity but are
reluctant to loan it since (unlike the 2002 crisis) they believe
their headquarters may be unable to assist in case of local trouble.
He does not foresee any run on deposits against government-owned
Bank of the Republic (BROU) or private foreign-owned banks. Also,
he pointed out that the banks' credit is in better shape than in the
past, as bank supervision has greatly improved.

WATCHING THE SLOW-MOTION TRAIN WRECK NEXT DOOR
-------------- -


8. (SBU) Uruguayan economists generally dedicate a substantial
portion of their energy to analyzing their larger neighbors. While
generally comfortable with Brazil's position (Uruguay's number one
trading partner),all economists we have talked to have been
extremely bearish about prospects in Argentina, adding to the
public's general malaise about potential effects on Uruguay. As a
member of an economic panel, Senator Alfie predicted that economic
problems in Argentina were "certain," while Brazil could also
stumble. Argentina is a country without credit, which limits its
ability to adjust to economic changes. Its ability to purchase
dollars is limited to those entering the country through trade,
raising the chance that the Central Bank will be unable to
adequately defend the peso. Alfie said he had never seen a
government itself initiate a run on the banks like Argentina just
did, referring to the GOA's October 21 announcement that it would
re-nationalize its pension program. Meanwhile, Santo predicted that
before year-end 2008 Argentina will suffer a capital outflow crisis
that will end in a sharp increase of the dollar or in a new
default.

WHAT THE EXPERTS ARE WATCHING
--------------


9. (SBU) Economists told econoff they are keeping an eye on the
unemployment rate as employment levels are hard to recoup at the end
of a crisis, a lesson which Uruguay learned the hard way during past
crises. The University of the Republic's Institute of Economics
predicted employment would grow 2% in 2008 (compared to 5% growth in
2007) and stagnate in 2009. On government spending, Economist
Javier de Haedo predicted that good summer rains could return
hydroelectric power to normal levels, offsetting the huge 2008
expenditures on fossil fuels to supply the grid. Lower fuel prices
will alleviate some of the pressure even if drought-like conditions
persist. Senator Alfie is keeping an eye on financing availability
for large projects planned by the state oil company and utilities,
including connecting Uruguay's electrical grid with Brazil.
Finally, Senator Alfie reiterated his public support for a free
trade agreement with the U.S., saying trade is the motor for growth
and it is important to have access to such a critical market that he
believes will be the first to recover from the current global
downturn.
BAXTER