Uruguay: Economy Continues to Grow; GOU Seeks to Counter

UNCLAS MONTEVIDEO 000002 SIPDIS STATE PASS TREASURY FOR BLINDQUIST E.O. 12958: N/A TAGS: ECON EFIN PGOV UY SUBJECT: Uruguay: Economy Continues to Grow; GOU Seeks to Counter Falling Dollar REF: MONTEVIDEO 74; MONTEVIDEO 558; MONTEVIDEO 670 -------------- SUMMARY -------------- ¶1. SUMMARY: Uruguay's economy continued to grow in the third quarter of 2009, led by strong private consumption, exports, and countercyclical government spending. The GOU expects GDP growth of 2.0 percent and 4.0 percent for 2009 and 2010, respectively. The sharp fall in the price of the dollar is impacting Uruguay's competitiveness, however. Seeking to counter the dollar's depreciation, the Central Bank -- which continues to buy dollars -- implemented a sharp cut in interest rates and reduced banks' reserve requirements. After a slight increase, the dollar soon resumed its downward trend vs. the Uruguayan peso. END SUMMARY. -------------- GDP EXPECTED TO GROW IN 2009 AND 2010 -------------- ¶2. Uruguay's economy continued growing in the third quarter of 2009, up 1.9 percent over the third quarter of 2008 and an accumulated 1.7 percent growth in the first three quarters (over the same period of 2008). Third quarter growth was higher than forecast by private analysts and the GOU. Consequently, the GOU revised its growth forecast for 2009 and 2010 up to 2.0 percent and 4.0 percent, respectively. Growth was led by strong private consumption, government spending and exports. Imports declined significantly. A counter-cyclical increase in public sector investment (up 32 percent in the first three quarters of 2010) partially offset a drop in private investment (down 10 percent). -------------- COMPETITIVENESS AFFECTED BY FALLING DOLLAR -------------- ¶3. The price of the dollar fell almost 20 percent from December 2008 through December 2009 (from 24.0 pesos to 19.6 pesos),owing to factors including the global depreciation of the dollar, steady local growth perspectives, and carry trade operations prompted by high interest rates in pesos. NOTE: Per Ref A, in February 2009, at a time when other developing countries were cutting their interest rates, the Central Bank sharply increased its own to control inflation. END NOTE. The decline in the dollar has negatively impacted Uruguay's global competitiveness, which has been fallen gradually since 2004. Competitiveness is now at its lowest levels since 2002, when the GOU was forced to devalue its peso. As Uruguay is more competitive outside the region than within, extra-regional competitiveness has deteriorated more rapidly. Within the region, Uruguay remains competitive against Brazil (its top export market),but not against neighboring Argentina (its third largest export market after China). Outside the region, Uruguay has lost significant ground against the United States, but remains competitive against Europe. -------------- -------------- MAJOR CUT IN INTEREST RATES AND A NARROWER INFLATION TARGET -------------- -------------- ¶4. GOU officials say they are watching the price of the dollar and Uruguay's competitiveness closely, but claim not to be overly concerned about competitiveness. Nevertheless, on December 21 the Central Bank cut interest rates by 175 basis points in order to counter the decline of the dollar. The sharp cut (to 6.25 percent from 8.0 percent) was the most significant since September 2007, and surprised private analysts who were expecting a 50-100 basis point cut. In order to attempt to keep positive interest rates in real terms, the Central Bank also lowered its inflation target to 5 percent and narrowed its range to 4-6 percent from 3-7 percent). ¶5. The interest rate cut had a minor and transitory effect on the price of the dollar, which rose slightly on the day interest rates were cut but soon resumed its downward trend. While Central Bank President Mario Bergara said that the narrower inflation range is "an additional sign of responsibility," some private analysts think the recent measures will impose major challenges to the next administration's monetary and fiscal policies. -------------- LOWER BANK RESERVE REQUIREMENTS -------------- ¶6. In another expansionary measure, the Central Bank also decided to gradually reduce reserve requirements on bank deposits. The reduction (to 15 percent from 25 percent for peso denominated deposits, and to 12 percent from 20 percent for dollar denominated ones) will allow banks to offer new credits of about $200 million. As in the case of the reduction of interest rates, the reduction of bank reserve requirement is a partial reversal from the sharp February 2009 monetary contraction taken to fight inflation. -------------- -------------- CENTRAL BANK TO DEVELOP FORWARD MARKET FOR DOLLARS -------------- -------------- ¶7. While implementing the measures above, the Central Bank continues to buy dollars and is considering the development of a forward market for dollars. In November, a team of two experts from Treasury OTA's Debt Issuance and Management Team performed an initial assessment of the feasibility of providing technical assistance to the Central Bank on this issue (Ref B). SCHANDLBAUER