VZCZCXYZ0005
RR RUEHWEB

DE RUEHMN #0074/01 0401100
ZNR UUUUU ZZH
R 091100Z FEB 09
FM AMEMBASSY MONTEVIDEO
TO RUEHC/SECSTATE WASHDC 8784
INFO RUCNMER/MERCOSUR COLLECTIVE
RHEHNSC/NSC WASHDC
RUEATRS/DEPT OF TREASURY WASHDC

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 
--------------------------------------------- ----- 
 
¶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 
--------------------------------------------- --- 
 
¶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 
--------------------------------------------- ----- 
 
¶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 
--------------------------------------------- ------ 
 
¶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 
--------------------------------------------- --- 
 
¶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