Uruguay: Staff Report for the 2013 Article IV Consultation

Background: Uruguay has experienced a decade of strong and inclusive expansion since its 2002 crisis, thanks to important institutional reforms, large-scale FDI projects attracted by Uruguay's stable macroeconomic environment and business-friendly investment climate, and favorable external conditions.Current setting: Growth has moderated to a more sustainable pace since 2012, mostly owing to weaker external demand from regional trading partners with which Uruguay is highly interconnected. Unemployment remains near historical lows, fiscal policy has loosened, and inflation persists above the target. Monetary policy, on the other hand, has tightened considerably since August. The baseline scenario is for the output gap to close gradually. Near-term risks are mostly to the downside, but vulnerabilities are limited given the strong liquidity buffers of the public sector.Focus: Discussions focused on policies to support a smooth convergence of output to potential in the near term; the optimal policy response in case of inward spillovers; and requirements to bolster the medium-term outlook.Policies: Staff supported the authorities' objective of gradually reducing inflation. Additional efforts to communicate the targeted monetary policy stance would help smooth the volatility in short-term interest rates and enhance the central bank's control over inflation expectations. A tighter fiscal policy stance and a moderation in wage growth would support monetary policy in taming inflation. In case of adverse external shocks, the exchange rate should be the main shock absorber and the ample liquidity buffers could be used to smooth out excessive volatility. Staff recommended that the reserve requirements on non-residents' purchases of central bank and government securities be unwound once there is clear evidence that the capital inflow surge has subsided. Uruguay's medium-term growth would benefit from more flexible wage determination and deeper financial markets. It is critical to press on with efforts to boost infrastructure.Past advice: There is broad agreement between the authorities and staff on the macroeconomic policy priorities. In recent consultations the Fund has placed greater emphasis on reducing inflation to the mid-point of the target range and called for fiscal restraint, in part to help monetary policy. In addition, staff has encouraged prudent wage growth to facilitate disinflation, safeguard competitiveness, and promote macroeconomic flexibility. Recently, the authorities tightened monetary policy and issued new wage setting guidelines aimed at restraining the growth of real wages and reducing the use of backward-indexation.