CONCERNED ABOUT INFLATION, GOU TIGHTENS MONETARY POLICY AND

UNCLAS MONTEVIDEO 000074 SIPDIS SENSITIVE E.O. 12958: N/A TAGS: EFIN EAGR UY SUBJECT: CONCERNED ABOUT INFLATION, GOU TIGHTENS MONETARY POLICY AND PASSES NEW PACKAGE ¶1. (SBU) SUMMARY: Uruguay has steadily taken steps to moderate the impact of the global economic slowdown in recent months, including measures to keep consumer confidence and spending steady. However, concerns about rising inflationary pressures caused a shift in emphasis in late January. While only a few years ago, 10 percent inflation would not have raised eyebrows, single-digit inflation is the new norm, and Uruguay's economic team, and its public, has come to expect it. The GOU significantly tightened its monetary policy and passed an economic package that includes the moderation of government-administered prices and utilities. Tighter monetary policy has driven down the price of the dollar and had a negative impact on export competitiveness. In order to control the prices of food -- the fastest growing and most volatile component of the consumer price index basket -- the GOU has temporarily streamlined imports of fruits and vegetables and eliminated the value-added tax on these products. As in the past, the Vazquez administration has publicly called private food industry representatives to discuss cuts in their prices. Labor unions are agitating for more government action, while some private sector reps are uncomfortable with the GOU's strategy. END SUMMARY. -------------- -------------- GOU CONCERNED ABOUT HIGHER-THAN-EXPECTED INFLATION -------------- -------------- ¶2. (U) Inflation reached 9.2 percent in 2008, well above the GOU target range of 3-7 percent. President Vazquez has mandated his Cabinet members to keep a close eye on the pricing of staple goods and reportedly follows up on the issue regularly during his weekly Cabinet meetings. The President's brother and Chief of Staff Jorge Vazquez has also expressed his concerns about the impact of inflation on workers' purchasing power and highlighted the need to have a basket of staples available at a low cost for the population. Minister of Finance Garcia assesses that inflation will ease in upcoming months as the price of fruits and vegetables go down and aggregate demand slows. -------------- --- INFLATION PRESSURE AND THE 10 PERCENT THRESHHOLD -------------- --- ¶3. (SBU) Reasons for the higher-than-expected inflation rate include a robust domestic demand for goods and services (driven by unprecedented 11 percent GDP growth in 2008, rising real wages and record low unemployment),soaring commodity prices during most of 2008, and a lenient monetary policy during most of the past year. Uruguay is also enduring a severe drought that has reduced agricultural production, driving up the price of fruits and vegetables. Should inflation hit the threshold of 10 percent, a legal provision would kick in, requiring public wages and pensions -- which constitute about half of total public expenditure -- to adjust every six months instead of annually, hurting public accounts at a time when fiscal revenues are expected to be grim. Some private sector wages would also adjust every six months, adding to inflationary pressure. -------------- -------------- THE ANTI-INFLATION PACKAGE AND AN ECONOMIC POLICY DILEMMA -------------- -------------- ¶4. (U) In order to fight inflation, on January 23 the GOU significantly tightened monetary policy by raising the peso-denominated interest rate from 7.75 percent to 10 percent. The interest rate hike -- together with seasonal capital inflows from tourism -- has driven the dollar down by 9 percent (from 25.2 to 23.0 pesos per dollar) and is affecting export competitiveness, especially in contrast to other countries in the region whose currencies are depreciating. On top of adopting a more stringent monetary policy, the GOU has passed a new package to fight inflation which temporarily allows imports of fruits and vegetables (and even considers the possibility of the GOU importing them itself to later distribute to the private sector),eliminates the value added tax on these products and moderates government-administered prices and utilities. While Chief of Staff Jorge Vazquez reportedly considered the possibility of imposing taxes on exports (or even banning them) to control prices, the MFA's Director General for International Economics and former Central Bank President recently told Charge that such measures would not be seriously considered, absent a drastic worsening of the situation in Uruguay. -------------- -------------- GOU "COORDINATES" WITH PRIVATE SECTOR TO CUT PRICES -------------- -------------- ¶5. (SBU) The GOU has also put pressure on the private food producers to reduce their prices by calling on them to publicly discuss their pricing policies. Since January 19, the GOU called together slaughterhouses and supermarket associations to discuss their margins and prices. As a result, and around the time that the government aired its concerns about inflation exceeding the 10 percent trigger, supermarkets agreed to cut the price of a basket of over one hundred goods by 10 percent in the next two months and slaughterhouses will slash the price of certain popular beef cuts between 5 percent and 10 percent. The GOU is also carrying out conversations with the chain of producers of wheat-based products, such as breads and pastas. Particularly in the case of beef and other agricultural goods, the GOU was concerned that the drop in international commodity prices had not been reflected in the local market. While senior GOU officials, including in the Ministry of Finance, describe talks with the private sector as informal negotiations, they have in practice put considerable pressure on the private sector, at least publically, to strike a deal. During a recent meeting with econoffs, the head of the slaughterhouse association (please protect) was extremely critical of the GOU's actions and accused the Planning and Budget Office of intellectual dishonesty aimed at gaining votes in this year's national elections. On February 4 the government announced that its measures had yielded the desired result -- an inflation rate of 9.2 percent. The state-owned oil company announced new declines in the price of fuel which should help lower inflationary pressures further. -------------- --- COMMENT: INFLATION IS ALSO POLITICALLY IMPORTANT -------------- --- ¶6. (SBU) COMMENT: Uruguayans are preoccupied with keeping inflation below 10 percent, in part due to recognition that it could trigger a self-reinforcing inflationary cycle, but also because single-digit inflation has taken on political significance as a signal of stability, something the governing Frente Amplio is keenly aware of during this election year. While government pressure on the private sector was the subject of some criticism, the two sides quickly came to an agreement, at least for now. We do not believe the implied threat of export controls would ever have been implemented. Uruguay hotly contests these kinds of measures when their neighbors and trading partners undertake them; there would be no advantage to a change in its free market stance now. End Comment. MATTHEWMAN