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.

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GOU CONCERNED ABOUT HIGHER-THAN-EXPECTED INFLATION
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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.

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INFLATION PRESSURE AND THE 10 PERCENT THRESHHOLD
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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.

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THE ANTI-INFLATION PACKAGE AND AN ECONOMIC POLICY
DILEMMA
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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.

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GOU "COORDINATES" WITH PRIVATE SECTOR TO CUT PRICES
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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.

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COMMENT: INFLATION IS ALSO POLITICALLY IMPORTANT
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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