VZCZCXYZ0004
PP RUEHWEB

DE RUEHMN #0627/01 3151312
ZNR UUUUU ZZH
P 101312Z NOV 08
FM AMEMBASSY MONTEVIDEO
TO RUEHC/SECSTATE WASHDC PRIORITY 8577
INFO RUCNMER/MERCOSUR COLLECTIVE
RUEATRS/DEPT OF TREASURY WASHDC

UNCLAS MONTEVIDEO 000627 
 
SENSITIVE 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN PGOV UY
SUBJECT: Uruguayan Economists Weigh In on Global Crisis 
 
REF: A) MONTEVIDEO 583, B) MONTEVIDEO 468 
 
SUMMARY 
------- 
 
¶1.  (SBU) SUMMARY:  Uruguayan economists expect the global financial 
crisis, lower commodity prices and economic slowdown to slow growth 
in Uruguay to an anemic 1-3% in 2009.  Despite this, observers 
believe the GOU is in a good position to weather the downturn, with 
government spending financed through the end of 2010, open lines of 
credit with international financial organizations, and healthy 
levels of hard currency reserves.  Debt to GDP ratio is 
substantially improved since the 2002 economic crisis, but the 
strengthening dollar and increased GOU spending threaten to push it 
back upward.    Argentina is a major point of concern, with many 
predicting significant economic fallout there within months, which 
would have a strong negative impact on Uruguay.  END SUMMARY 
 
BOOM TIMES ARE OVER... 
---------------------- 
 
¶2.  (SBU) Uruguay is feeling the effects of the global economic 
downturn, especially as commodity prices fall and exports 
decelerate.  A common refrain from economists is that Uruguay's 
position in the region tends to amplify external shocks.  When times 
are good, Uruguay exports its commodities directly to the world as a 
whole and provides many inputs to the Argentine and Brazilian 
economies which do well under the same circumstances.  When prices 
fall and exports drop, Uruguay loses twice, they say.  Local 
economists across the board predict Uruguay's GDP growth to drop as 
low as 1%-3% in 2009, a sharp fall from an annual high of 13% during 
the first two quarters of 2008  (ref A) and sustained rates of 
growth above 7% since 2005.  Peso depreciation is expected to take 
its toll, with the GDP (expressed in U.S. dollars) falling from 
about 28 billion to 23 billion.  If this bears out, it will result 
in a substantial increase in the debt/GDP ratio, a rising debt 
burden that would constrain public spending, and possibly negatively 
impact Uruguay's country risk rating, future financing options, and 
access to credit.  Economists expect Uruguay will allow the dollar 
to rise to 22-24 pesos/dollar (at the time of this cable it was 
23.4), but say the country does not have further room to maneuver 
due to the high dollarization of its economy. 
 
...BUT GOU SPENDING REMAINS STEADY 
-------------------------------------- 
 
¶3.  (SBU) With the dipping economy comes the prospect of lower tax 
revenues, despite the fact that public spending is already locked in 
through the end of 2010, based on previous, fatter projections. 
Fernando Lorenzo, former Director of the Macroeconomic Unit at the 
Ministry of Economy, said the GOU has systematically adjusted its 
expected revenue figures (and spending) upward in the past four 
years in line with the previously strengthening economy.  Other 
economists told econoff that the GOU did not plan for a rainy day, 
but instead planned as if the "best case scenario" would continue 
unabated.  Opposition Senator and former Minister of Economy Isaac 
Alfie was also critical of increased government spending as a 
percentage of GDP under the Frente Amplio government. 
 
¶4.  (U) In contrast to Senator Alfie and orthodox economists who 
have been critical of high spending levels, Minister of Economy 
Alvaro Garcia presented statistics to Congress on October 29 that 
highlighted the increase in social spending during the Frente Amplio 
government.   Such spending increased from 36% to 49% of total 
spending from 2004 to 2009 and was partly enabled by the drop in 
debt interest payments from 31% to 18% of total spending.  Garcia 
emphasized that such spending increases were essential to speed 
recovery from the 2002 financial crisis and combat rising poverty 
levels, unemployment, and falling salaries.  Poverty levels had 
increased from 17% to 32%, unemployment from 10% to 13% and salaries 
fell 20% during the previous administration (relative to pre-crisis 
levels).  As of mid-2008, the Vazquez government, by increasing 
social spending and buoyed by remarkable economic growth, had 
lowered poverty to 22%, kept unemployment less than 8% and achieved 
a 13% increase in salaries - a good return on investment in Garcia's 
mind. 
 
ECONOMY REMAINS REASONABLY SOUND 
-------------------------------- 
 
¶5.  (SBU) Despite expectations that the economy in Uruguay will slow 
substantially, economists pointed out that the fundamentals remain 
strong and Uruguay is better prepared today as a result of policies 
implemented since the crisis in 2002.  Lorenzo noted that investment 
(both foreign and domestic) remains very strong and continues to 
grow.  He cited COMAP, the agency that approves tax incentives to 
investment projects, which reported that USD 800 million in 
investment projects were approved in 2008, compared to a USD 320 
million in 2007.  The GOU has publicly stated that Spanish paper 
giant ENCE continues to progress toward constructing its USD 1.4 
billion pulp mill that will be the largest investment project to 
date in Uruguay.  Lorenzo also pointed out the GOU's success in 
pre-financing its spending through the end of 2010 and in acquiring 
lines of credit with international financial organizations to back 
that up. 
 
¶6.  (SBU) Economic observers note that Uruguay has sufficient hard 
currency reserves to protect its currency and inject money into the 
economy if needed.  While the GOU boasts more than USD six billion 
in reserves, Economists Michelle Santo and Alfie suggest the actual 
figure of available reserves is much lower, although still adequate 
since as much as USD three billion are private banks'  reserve 
requirements held by the Central Bank.  Santo also said reserves 
could drop if local investors stop rolling over short term GOU debt, 
since excess liquidity would put upward pressure on the dollar, 
forcing the Central Bank to sell hard currency. Santo was critical 
that the GOU had not bought reserves with fiscal surplus, but rather 
through debt, either with private banks or investors. 
 
¶7.  (SBU) Santo said Uruguayan banks have excess liquidity but are 
reluctant to loan it since (unlike the 2002 crisis) they believe 
their headquarters may be unable to assist in case of local trouble. 
 He does not foresee any run on deposits against government-owned 
Bank of the Republic (BROU) or private foreign-owned banks.  Also, 
he pointed out that the banks' credit is in better shape than in the 
past, as bank supervision has greatly improved. 
 
WATCHING THE SLOW-MOTION TRAIN WRECK NEXT DOOR 
--------------------------------------------- - 
 
¶8.  (SBU) Uruguayan economists generally dedicate a substantial 
portion of their energy to analyzing their larger neighbors.  While 
generally comfortable with Brazil's position (Uruguay's number one 
trading partner), all economists we have talked to have been 
extremely bearish about prospects in Argentina, adding to the 
public's general malaise about potential effects on Uruguay.  As a 
member of an economic panel, Senator Alfie predicted that economic 
problems in Argentina were "certain," while Brazil could also 
stumble.  Argentina is a country without credit, which limits its 
ability to adjust to economic changes.  Its ability to purchase 
dollars is limited to those entering the country through trade, 
raising the chance that the Central Bank will be unable to 
adequately defend the peso.  Alfie said he had never seen a 
government itself initiate a run on the banks like Argentina just 
did, referring to the GOA's October 21 announcement that it would 
re-nationalize its pension program.  Meanwhile, Santo predicted that 
before year-end 2008 Argentina will suffer a capital outflow crisis 
that will end in a sharp increase of the dollar or in a new 
default. 
 
WHAT THE EXPERTS ARE WATCHING 
----------------------------- 
 
¶9.  (SBU) Economists told econoff they are keeping an eye on the 
unemployment rate as employment levels are hard to recoup at the end 
of a crisis, a lesson which Uruguay learned the hard way during past 
crises.  The University of the Republic's Institute of Economics 
predicted employment would grow 2% in 2008 (compared to 5% growth in 
2007) and stagnate in 2009.  On government spending, Economist 
Javier de Haedo predicted that good summer rains could return 
hydroelectric power to normal levels, offsetting the huge 2008 
expenditures on fossil fuels to supply the grid.  Lower fuel prices 
will alleviate some of the pressure even if drought-like conditions 
persist.  Senator Alfie is keeping an eye on financing availability 
for large projects planned by the state oil company and utilities, 
including connecting Uruguay's electrical grid with Brazil. 
Finally, Senator Alfie reiterated his public support for a free 
trade agreement with the U.S., saying trade is the motor for growth 
and it is important to have access to such a critical market that he 
believes will be the first to recover from the current global 
downturn. 
BAXTER