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Uruguayan economy: long, medium and short term challenges Montevideo UNDP Office August 26, 2009 Uruguay is a middle income country1 internationally ranked among the high human development nations. According to the last Human Development Index (HDI) update2, Uruguay ranks 47 among 75 countries with high HDI. With a life expectancy at birth of 76.1, an adult literacy rate of 97.8%, a combined gross enrolment ratio for education of 90.9% and a per-capita gross domestic product (GDP) of 10,445 purchasing power parity US dollars (PPP US$), the Uruguayan society is one of the most developed in the continent. Additionally, it has a well established democracy and an ongoing welfare state as it is reflected by the high value of its “democratic support index” and the importance of public expenditure in social policies. Nevertheless, in spite of its relevant achievements in health and education, Uruguay has severe problems to ensure that its population has access to resources, the third dimension of the HDI. As the next chart shows, Uruguay is one of the leading countries according to the index rankings of health and education, compared to the top nine regional middle income countries with high HDI3, but it falls back to the bottom of the list with Panama, Costa Rica and Cuba when ranking per-capita income. Thus, the improvement on the per-capita GDP is a critical issue for the Uruguayan economy in order to climb up in the world HDI ranking. HDI dimensions of the top nine Latin American and the Caribean middle income countries with high HDI in 2006 (displayed in HDI ranking order form left to right) HDI dimensions index 1 Health Educatio n Inco me 0,8 0,6 0,4 0,2 0 Chile A rgentina Uruguay Cuba Co sta Rica Source: Human Development Index Update (december 2008), UNDP M exico Trinidad and To bago P anama A ntigua and B arbuda The poor performance of the Uruguayan economy is a long-standing phenomenon as the country has not been able to sustain a stable rate of per-capita GDP growth in the long term. The subsequent chart shows that Uruguay’s per-capita GDP level with respect to the average of four of the most developed economies, dramatically deteriorated in the XXth century, and since the fifties the decline accelerated. That long standing trend is composed by short periods of high growth rates which are not 1 In terms of the per capita Gross National Income (GNI). Launched in December 2008 and reporting figures from year 2006. 3 The list of the middle income countries was derived from the Development Assistance Committee of the OECD list of aid recipients (OECD, 2006). The list of countries with high HDI was derived from the latest update launched on December 2008. The chart omits four regional middle income countries (Venezuela, St. Lucia, Ecuador and Brazil) with lower HDI. 2 1 maintained in the medium term: the expansive phases often end up in profound crises (the most recent occurred in 1982 and 2002). Uruguayan per capita GDP level respect to the average of France, Germany, United Kingdom and United States: 1870-2007 (1990 International Geary-Khamis dollars) 110,0 100,0 90,0 80,0 70,0 60,0 50,0 40,0 30,0 20,0 2005 2000 1995 1990 1985 1980 1975 1970 1965 1960 1955 1950 1945 1940 1935 1930 1925 1920 1915 1910 1905 1900 1895 1890 1885 1880 1875 1870 Sources: -1870-1950: Maddison, A. (2003) The World Economy: Historical Statistics. OECD -1950-2006: The Conference Board and Groningen Growth and Development Centre, Total Economy Database, January 2009 Those extreme economic fluctuations are now part of Uruguayans’ way of life and impose a severe negative conditioning in the population’s economic expectations, which, in turn, have great repercussions in investments and technological innovation, two main factors that directly stimulate long term sustainable growth. This growth issue is Uruguay’s strongest structural economic vulnerability, which repeatedly instigates inequalities in the society. As already mentioned the last crisis in Uruguay was in 2002 (but GDP growth was decelerating since 1999). The economy entered to a financial crisis that added pressure to other previous macroeconomic imbalances and to the bad external commercial performance since 1999. Those factors led to the flight of capital abroad, the abandonment of fixed exchange rate and a deep recession. Public finance was badly damaged and credit sources –such as the IMF- had to be used. GDP fell, in real terms, 3.8% in 2001 and 7.7% in 2002; unemployment reached 19.2% in October 2002, while real wages fell more than 20%. As a consequence in 2004 poverty and extreme poverty reached 31.9% and 3.9% respectively. Public debt grew during the crisis as the deficit widened, and external debt greatly increased: in 2004 it still was 87.2% of the GDP. The 2002 crisis recovery phase was considered to be over on 2006 as the per-capita GDP in current US$ attained the pre-crisis levels (in 2001 it reached 6254 US$ and dropped to 3987 US$ in 2002). As shown in the next table, between years 2005 and 2008 annual real GDP growth rates were high (around 7%), well above historical average. Renewed market access, the return of capital flows and a strong foreign direct investment allowed the increase of international reserves and the reactivation of the economy. Financial confidence was improved through key reforms, including bank restructuring and improved supervision. Since 2005, the new government implemented structural reforms that spurred economic growth (an important tax reform was implemented in 2007 which introduced progressive taxes on personal income); while debt management operations improved the structure of the external debt (the ratio 2 gross external debt to GDP dropped from 65.7% to 37.4%) and fiscal results were improved. Uruguayan Economic Indicators (2005-2009) GDP (million US dollars) GDP per-capita (PPP dollars) GDP per-capita (US Dollars) Population Inflation (%) Real GDP growth rate (%) US dollar depreciation (%) Real wages variation (%) Unemployment rate (%, Av.) Current account balance (% of GDP) Consolidated fiscal results (% of GDP) Gross external debt (% of GDP) 2005 17.381 9.695 5.462 3.305.723 4,9 6,6 -8,6% 4,5 12,2 0,2 -0,2 65,7 2006 20.044 10.445 6.250 3.314.466 6,4 4,6 1,2% 3,7 10,9 -2,0 -0,3 52,7 2007 24.280 11.506 7.635 3.323.906 8,5 7,6 -11,9% 4,1 9,2 -0,3 0,0 50,3 2008 32.186 12.757 10.082 3.334.052 9,2 8,9 13,1% 4,3 7,6 -3,5 -1,2 37,4 2009* 29.641 12.767 3.344.938 6,0 -0,2 3,2% 8,6 -1,5 -2,4 32,4 Sources: IMF-International Finance Statistics; Instituto Nacional de Estadistica (INE), Banco Central del Uruguay. *Projections: Economist Intelligence Unit The main drivers of this last expansion of growth were exports, investment and domestic consumption. Foreign Direct Investment averaged a yearly US$ 1200 million between 2005 and 2008, in contrast with US$ 280 million between 1999 and 2004. An important part of this increase was achieved through the approval of the new Investment Law in 2006. Domestic consumption grew considerably above the historical average, while exports of goods and services grew 22.8% in real terms between years 2005 and 2008. Concerning the labor issues, unemployment rates declined considerably –from 12.2% in 2005 to 7.6% in 2008- remaining among the lowest historically. Some sectors even confronted bottlenecks to further production as lacked white collar and qualified workers. As for wages, in real terms growth was vigorous -4.2% per year on average-, leading to a partial recovery of the purchase power lost during the crisis. The reinstallation of trilateral salary collective negotiations was important in some productive sectors to achieve the recovery of real wages. As shown in the next chart, despite the fact that economic performance was very good until 2008, the country was not able to recover to the pre 2002 crisis poverty rates (18, 8% of the population of poor people and 1,3% of extremely poor people 4). Yet, between 2004 and 2008, extreme poverty was reduced to a half and poverty descended from 31.9% to 20.5% of the population5. These social achievements resulted together from GDP growth, the focalized social policies undertaken by the Ministry of Social Development (created in 2005) and the reform of the Health Care System 6. 4 The poverty line was calculated with the methodology created by the Instituto Nacional de Estadísticas (INE) in year 2002. Although, poverty concentration among children and young people persists. The law-reforming healthcare was implemented at January 2008. It set up a Sistema Nacional Integrado de Salud (SNIS, Integrated National Health System) which incorporated near half million children and teenagers from poor households. This is funded by the FONASA with contributions from the state, private firms, pensioners and workers. 5 6 3 Poverty (% of population) 35 4,5 31,9 poverty (left) 4,0 extreme poverty (right) 30 3,5 3,9 25 3,0 20,5 18,8 20 2,5 2,0 1,5 15 1,3 10 1,5 1,0 1996 Source: INE 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Additionally, the Gini Coefficient7 fell from 0.441 in 2005 to 0.424 in 20088. Although, it still indicates high inequality with respect to the world ranking. Thus, the achievement of a pro poor economic growth –involving changes in the distribution of incomes which benefit poor households- is still a major challenge that the country faces in the next years. In conclusion, the economic expansion that allowed the recovery from the 2002 crisis and beyond it can be explained as a by-product of the favorable external context, but also because there have been significant improvements in macroeconomic institutions and policies and the real economy has responded well to this stable framework. The combination of vigorous growth, structural reforms and social programs allowed the improvement of the social indicators, although some important vulnerabilities persist. Still, the impact of the ongoing global recession shows that this recent boom may not represent a break from the past. Analysts agree that the country has been hit by the world crisis, but disagreement prevails regarding the depth of the impact. The currently ongoing world crisis is affecting Uruguay through the three drivers of growth already mentioned. As a result, GDP contracted 2.9% in the first quarter of 2009 relative to the last quarter of 2008, as Central Bank figures show. The Government recently adjusted GDP growth projections for 2009 from 2% to 0.7%, while local private consultancy firms expect an annual growth rate between 0.7% and -1.4% (The Economist Intelligence Unit, as shown before in the Economic Indicators table, is projecting a growth rate of -0.2% for Uruguay). Local experts do agree on the fact that Uruguay is better prepared than before to face a crisis: short term external debt and foreign currency nominated external debt have fallen; external debt to GDP ratio is lower, the Central Bank has enough reserves9 to cope with difficulties, and the financial system is sound, unexposed to “toxic assets” and weakly linked with international markets.10 Exports are the most affected channel: figures from the Instituto Uruguay XXI show that exports of goods in the first half of 2009 were 13.3% lower than in the same period 7 The Gini Coefficient is the most common measure of income inequality. A Gini Coefficient of 0.4 and above is taken as an indicator of high inequality. 8 Calculated by the INE. 9 Around US$ 7.400 million by July 2009 10 The financial sector is still recovering from the 2002 crisis. This lack of development of capital markets has proven to be a strength in the recent international context, however, some experts point to this as one of the factors that has restricted growth. 4 of last year and indicators show that the fall could continue in the third trimester. Nonetheless, the exports fall is not even for all the categories of goods. A product taxonomy by its technological content shows that manufactures with high technological content (as pharmaceuticals) were the only exports that rose in 2009 with respect to 2008 (0.8%), while the world contraction strongly affected middle (-3.7%) and low (6.5%) technological goods, primary goods (-7.9%) and manufactures based in natural resources (-2.5%). These include goods as meat, furs and leathers, milk and dairy products, wool and wool fabrics and car parts and accessories. Primary exports are also suffering the reduction of international prices after the burst of the price bubble of the last years. These results show that the export specialization, still mainly composed of primary-based products (with a low degree of transformation or differentiation) is a structural vulnerability that greatly exposes the economy to negative external impacts. Although there are important levels of exposure to developed countries, links with the region involve even much more productive complementarities and interdependence. For instance, Argentineans represent about half of the total tourists that Uruguay receives, while Brazil is the traditional destination of most milk and rice exports. In 2007, Brazil alone received 16% of total Uruguayan exports, while MERCOSUR accounted for a 27.5%. Additionally, figures from the transit of goods in the Montevideo’s seaport – where the activity is highly concentrated on the regional exchange- are showing less containers mobilized in 2009 compared to the same months of last year. For all these reasons analysts agree on the fact that the direct impact of the crisis will be followed by an indirect impact caused by the effects it will have in the neighbor countries. As for the other channels of growth, the government announced that public investment would not fall, and private investment has slowed down. Central Bank’s figures show that Gross Fixe Capital Formation grew 4.9% in real terms in the first trimester of 2009 compared to 2008, principally due to the building construction sector and public investment. While Foreign Direct Investment felt 34.3%, a deep fall that reflects the impact of the crisis. Nonetheless, another indicator of investment –the number of investment projects promoted by the Comisión de Aplicación de la Ley de Inversiones (COMAP)- show that the firms are willing to invest in the next months as, to July 2009, the total projects are 1,1% more important compared to the same period of 2008. Additionally, imports fell in the first semester of 2009. It affected mainly industrial inputs and intermediate goods in the first months of 2009 -which preceded the actual reduction in industrial activity levels-, but then recently spread to consumer goods also. Some indicators showed a slight retraction of consumption of durable goods in the first trimester, which persisted and was followed by a slowdown in consumption of consumer goods in recent months. Further falls are feared, as the government and private analysts project a rise in unemployment. Industrial production has been falling since February, and the economic slowdown took unemployment to 8% in the second trimester of the year, while real wages slightly fell (-1.0%) in June. The contraction of activity levels is due not only to the impact of the crisis, but also to another exogenous shock: a new drought started to affect the country by the end of last November, receding just a month ago. This affected almost every agricultural activity and damaged exports, and also had a negative impact in the generation of electricity. The government reacted late; in January announced thirty four measures, attending the situation of the dairy industry and other affected groups, including tax breaks, subsidies and credit to buy supplies. 5 The government has taken other measures to counter the slowdown, promoting investment and employment with focus on specially affected sectors. Some fiscal measures include tax devolutions and the creation of a National Guarantee System to facilitate credit to SMEs.11 But an important policy, recently approved, is the adjustment of unemployment benefits for four affected sectors: automotive, textile, wood, and metalworking industry. Government will cover part of the salaries of workers in these sectors, a measure that is expected to benefit around 5,200 workers. Some of these workers will be asked to attend courses at a recently created public entity dedicated to technical and professional training and re-training of working force. Government is still discussing the reduction of working hours in affected sectors; other minor actions focused on the effects of the drought were also implemented. The economic slowdown has generated concerns about a worsening in social indicators, but the government announced that social expense would remain untouched and that additional poverty-aimed measures will be taken. For example, the government negotiated with the private sector to avoid excessive price increases in strategic goods (as meat) and may extend the coverage of some programs, as income transference for children in poor households. The combination of measures to counter the economic slowdown and prevent social worsening, added to the extraordinary energy imports and the fiscal measures taken to reduce inflationary pressures will result in a fiscal deficit: government expects a rise to 2.6% of the GDP (the Economist Intelligence Unit projects a deficit of 2,4%). Although this deficit -which will be covered with internal debt emissions12- it is still a low value compared to historical trends, it represents a small threat. In this context, future fiscal expansion to stimulate demand could clash with the lack of resources. Last but not least, 2009 will also be a complicated year for Uruguay as it is an election year; public attention and government activity will surely be distracted by the election process. In summary, Uruguay has a relatively sound fiscal position until now and may manage without compromising its external debt position, but vulnerability to the world recession arises mainly because of the high integration of the Uruguayan economy with Argentina and Brazil: the crisis will have a stronger impact as a result of the regional slowdown. Looking at the medium term picture, sound policies and favorable external conditions have led to a strong economic recovery from the 2002 crisis while renewed market access and strong foreign direct investment have allowed for the increase in international reserves. Growth has averaged outstanding rates, inflation has remained moderate until 2008, and the unemployment rate has declined considerably, reaching an historical minimum. Primary fiscal surpluses and debt management operations have reduced the debt and improved its structure. Key reforms have been implemented since the 2002 crisis, including a comprehensive tax reform, a health sector reform, salary collective negotiations, bank restructuring and improved supervision. Many international organisms and private parties consider Uruguay as one of the best prepared countries in the region to face the crisis; that will almost for sure avoid a prolonged recession. Still, four intertwined endogenous structural vulnerabilities are threatening the possibilities of Uruguay to find a long term sustainable social and economic development path: the low levels of investments and technological innovations (key to solving the long term problem of a sustainable growth path); the still high external debt burden with respect to GDP; the commodity specialization of the export structure; and 11 Other measures included a temporary reduction of VAT for gasoil used in some industrial activities, and a rise in a small tax charged to sensitive imports –as clothing and footwear. 12 This required the modification of the law that sets the limits of public indebtment. 6 the difficulties to achieve a pro-poor economic growth. These, added to the exogenous vulnerabilities resulting from current turbulence in international markets, set a real challenge for Uruguay’s economy in the near future. 7