IMF Loan to Uruguay: To save or to enslave? Ranja Sengupta

On 25 August in 2002, Uruguay’s 177th year of independence, 70,000 people protested on the streets of Montevideo. The protestors raised slogans against unemployment, the continuing agricultural recession and the financial crisis. Their ultimate protest was against government policies that blindly pursue IMF conditions, and which have resulted in complete dependence on the IMF and an inability to break away from the stranglehold of the US. Strikes and protest marches, fuelled by the economic decline and banking difficulties, have become an increasingly common sight in Montevideo.

Following in the footsteps of its Latin neighbours Argentina and Brazil, Uruguay has been having its share of major economic events that reflect the present state of confusion and panic in the economy, if at a smaller scale.

The continuous outflow of foreign reserves in the wake of a peaking demand for the dollar forced Uruguay to completely float its currency on 20th June, in discontinuance of a floating exchange rate within a 12 per cent band system tied to the dollar. The Uruguayan Central Bank announced that, unlike in the past when major interventions had kept the inflation rate down, there would now be only limited intervention to prop up the currency. This was also apparently aimed at pleasing the IMF, which generally favours floating of currencies, especially in situations of a possible external debt default.

This was followed by the declaration of a four-day bank holiday amidst fears of a bank run caused by continuous withdrawals. Further, at the insistence of the IMF and the US Treasury, a legislation (the law for the Fund for the Stabilization of the Banking System [FSBS]) limiting bank withdrawals was passed by the Uruguayan Congress on 4th August. The legislation introduced a measure preventing depositors at Uruguay’s two public banks from getting access to $2.2 billion (which is three-quarters of the total) in long-term dollar deposits until 2005.

These measures seemed to achieve their purpose. The bank holiday was followed by a reversal of the previous US position denying any further loans to Uruguay. The IMF granted an additional 1.16 billion SDR (US$1.5 billion) in short-term loans (with a 24-month stand-by credit) on 25 Jul, and another SDR 376 million (about US$494 million) was given in the first week of August. The new IMF commitment to Uruguay under stand-by terms amounts to a total of SDR 2.13 billion, or about US$2.8 billion (IMF news brief no. 02/87, 8 August 2002). The measures undertaken by the Uruguayan authorities, together with the sanction of the loans, stabilized the banking system somewhat, and no bank run seemed evident on 4 August, when the bank holiday ended.

The banking legislation, however, proved to be less than popular with the Inter-Union Workers Plenary–National Workers Convention (PIT-CNT), which held a 14-hour general strike on 7 August in which large numbers participated. Previous strikes too, for example, the 24-hour general strike of 12 June, had drawn an increasingly large number of people. The tenor of these strikes has been similar: a demand for higher employment, higher wages and a reversal of the government’s efforts to comply with IMF conditions by attempting a cut in fiscal expenditure in the form of higher taxes and increasing the rates of essential services. The government’s attempt to endear itself to the IMF is obviously hitting the people on the streets a bit too hard.

Compliance with the IMF directives has not however protected Uruguay’s economy much. The country’s economic turmoil has been multifaceted and long-lasting, although panic has been the major cause of its undoing in recent times.

The cornerstone of the Uruguayan economy, its agriculture sector, has been hit by a long-drawn recession. A drought in the second half of 1999 compounded by an outbreak of the foot-and-mouth disease in April 2001, devastated the agricultural economy. There was also a fall in demand from neighbouring countries. The problem in agriculture has spilled over to the rest of the economy, since Uruguay’s industry is mainly agro-based. The industrial sector, which produces 17 per cent of the GDP, is largely based on the transformation of agricultural products. Leading industrial sectors include meat processing, agri-business, leather production, textiles, and leather footwear, handbags and apparel. Exports, too, take place mainly in agricultural products, which make up more than half of the total exports. Stock-raising is the mainstay of agricultural activity that contributes 35 per cent of total exports in the form of meat, wool and hides. The unfortunate timing of the foot-and-mouth disease has therefore taken a heavy toll on especially this sector of the Uruguayan economy.

Exports, which are a major source of Uruguay’s revenues, have also been badly affected by the deterioration in Brazil’s economy, which takes 25 per cent of Uruguay’s exports. Demand from Brazil fell because of: (a) an energy crisis and (b) a devaluation of its currency that made exports more expensive. The economic conditions in Argentina, another major trading partner, have further reduced Uruguay’s export demand. And markets in America have not yet opened up fully. This has added to the country’s economic woes before it could recover from its agricultural slump.

In the light of the above, it is not surprising that Uruguay is going through its fourth consecutive year of the general economic recession that began in 1999. Apart from the recession in Brazil and the economic collapse of Argentina, the fall in international commodity prices have also had a severe impact. The steep increase in international petroleum prices have hit Uruguay hard as it is completely dependent on oil imports. Foreign direct investment, exports, imports and GDP growth have all been falling rapidly, while inflation has been rising. Year-on-year GDP fell by 10.1 per cent in the first quarter of 2002. GDP was primarily affected by a 20 per cent fall in tourism, an 18 per cent decline in manufacturing and a 14 per cent drop in construction. Further deterioration seems inevitable if the present policies continue — the government has predicted an 11 per cent decline in economic growth this year and a further 4.5 per cent fall in 2003, while inflation could reach an annual rate of 50 per cent in twelve months’ time.

Uruguay’s IMF-led economic policies have been hopelessly misdirected. Despite widespread protests, the Parliament approved a ‘fiscal stability’ law in May this year, that increased taxes on wages and pensions and allowed the government to raise tax rates on various public services, including drinking water, electricity and telecommunications. The law is intended to bring the fiscal deficit within the limits the IMF has set as a condition for loans. The government’s economic team, headed previously by Alberto Bensión and now by Alejandro Atchugarry, is trying to reduce the fiscal deficit. Simultaneously, limited interventions by the Central Bank from now on will raise real interest rates and tighten liquidity. This will obviously only deepen the recession that has already been in effect for several years. In the face of all these costs it is an irony that further loans granted by the IMF are likely to be short-term, and will have very little impact on the economy.

Foreign direct investment has not picked up despite concessions and privatization moves by the Battle government. These include privatization of the national airline, civil service restructuring, social security reform, concessions to the national gas company, port concessions, road maintenance concessions, and improvements in financial sector regulation with Bank support. But all these measures have not brought about the economic stability they promised. They have, of course, opened up the path for future economic control by big powers like the US. More than a hundred US-owned companies operate in Uruguay, and many more market US goods and services.

The recent lower ratings by credit rating agencies have not helped either, since they have made it more difficult for the government to sell its bonds to raise resources.

In addition to the above, the recent banking difficulties have worsened the situation. Fear of a bank run was caused by the banking collapse in neighbouring Argentina. At the beginning of July 2002 the Central Bank reserves had fallen by 5.5 per cent, bringing the fall to 55 per cent so far in the year 2002. Reserves, which currently amount to US$1.39 billion, have been hit by a 29 per cent fall in bank deposits in the first five months of this year. A major share of Uruguay’s bank deposits are held by Argentineans, whose accounts at home are frozen. So the pressure on capital flight is even stronger as domestic and foreign deposits are being simultaneously withdrawn.

Unlike Brazil, both Argentina and Uruguay also have bank deposits in dollars or tied to the dollar. In Uruguay, 85 per cent of the bank deposits are in dollars or indexed to the dollar. So the run on the banks has been fast draining the country’s foreign reserves. Uruguay faces the risk of running out of cash to make debt payments. Fear of this brought on the bank holiday and the freeze on withdrawal of long-term deposits. The latter measure was implemented at the insistence of the IMF and the US Treasury, thereby putting out of reach of ordinary Uruguayans, access to their own long-term deposits for three years. A restructuring plan of the Uruguayan Central Bank also includes measures such as liquidation of insolvent private banks like Banco Montevideo/Caja Obrera, Banco Comercial and Banco Credito, and transformation of the mortgage bank (BHU) into a non-bank housing institution.

The banking sector in Uruguay has for long been open to directives from the IMF. Though foreign investment in this sector requires government authorization, the fact that a lot of foreign, mainly US, banks operate in Uruguay shows that this is not very restrictive. Among the private banks operating in the country, the majority are Uruguayan corporations that are mostly owned by foreign banks, and the rest are branches of foreign banks. Under Uruguayan banking legislation, banks operating in Uruguay are considered national banks even if their capital is held by a foreign bank. Foreign banks may set up branches in Uruguay that enjoy the same operating privileges as banks incorporated in Uruguay. Financial houses, the majority of which are owned by foreign banks, may conduct any type of financial operations except those reserved exclusively for banks, such as accepting deposits from Uruguayan residents. In 2000, US direct investment in the banking sector stood at US$257 million. This is likely to have been another reason for the IMF’s eagerness to offer help to Uruguay.

Uruguay: What does the Future Hold?
Even though the IMF loan has come through, it will not solve Uruguay’s problems unless investor panic can be controlled. This panic seems to be suspiciously encouraged by the apparently loose statements made by people like Paul O’Neill, the US Treasury Secretary, after which an IMF loan becomes all the more necessary. The IMF loan, which will increase indebtedness, will have to be paid back soon, and Uruguay is thus playing into the hands of the US. Such debts cannot be repaid nor can they help the economy, unless real sector changes are operative. The government would do better to concentrate on developing its sagging agricultural sector, hydropower potential and gas pipelines.

On the other hand, desperate attempts have been made by the present President to cut the fiscal deficit, in compliance with IMF conditions,. This has moved government resources away from key sectors like electricity and water, increased unemployment and penalized wage-earners by levying taxes on them, thus inducing greater panic and misery among the people. In such a situation, it is not surprising that they will seek to secure whatever little savings they have in banks. But given the new legislation and the threat of more bank holidays, their access to their own deposits will also be severely limited from now on.

Further, Uruguay has definitely not been helped by factors like the recently announced increase in agricultural subsidies to farmers in the US by the Bush Administration. In fact, the continuance and increase of agricultural subsidies in countries like the US and the EU run contrary to the agreements of the WTO, and double cross the signatory developing countries. In the words of Benjamin Lessing, “With friends like that, who needs enemies? Or, to put a finer point on it, what good is an IMF bail-out if your economic future is to sell agricultural products to the United States on ridiculously poor terms of trade?” (‘The Last Domino’, The American Prospect, 9 August 2002).

Even as following IMF policies has proved to be disastrous for many countries, it becomes more so in an atmosphere of economic domination and collusion within and among developed countries like the US, Canada and the EU. The IMF has been brokering individual country deals in Latin America, mainly to prevent a strong coalition within it, and to further strengthen US control over individual markets by ensuring unimpeded access. The proposed Free Trade Area of the Americas (FTAA) that will combine all the American markets, is one such attempt. The idea is to weaken the Mercosur trading bloc, previously the third most powerful in the world, which partially integrated markets in Brazil, Argentina, Uruguay and Paraguay. Recent sessions of Mercosur have recognized the need for resisting such moves and forming coalitions and support systems within it. The US offer of individual loans to Brazil and Uruguay is a counter-move to pre-empt such an attempt. By making these countries indebted and dependent on the US, the latter hopes to break any possible threat to its own interests from a Latin American coalition. It is trying to make allies of some and enemies of others, thus ensuring a conflict of interests among the Latin American countries.

Regional coalitions, based on local interests, that can challenge such domination is the only way Uruguay can hope to maintain its economic freedom and profitability. It should strengthen its ties with Mercosur and other Latin American economies. Such need has been recognized by many of its neighbours, often at a bitter cost, but unfortunately the Uruguayan government still seems far from this realization. It has been more pro-North than many of its neighbours. President Batlle’s administration has shown remarkable alacrity in forging both a bilateral trade agreement and a Four-plus-One free trade agreement between Mercosur and the US. He has also severed diplomatic ties with Cuba, much to the chagrin of many Uruguayans. His aim is obviously to secure his own future and that of the economy, which he hopes to do by securing loans. And the US has tried to cash in on that. But as is evident from the effects of the IMF policies — higher inflation and lower wages, to name just two — Battle’s well-being is not synonymous with that of the people on the streets.

Opening up and privatization may be the operative words in the Washington Consensus era, but indiscriminate and complete opening up or privatization is not a must for Uruguay. Uruguay is, in fact, the fourth most free economy in Latin America, as adjudged by the 2002 version of the ‘Index of Economic Freedom‘ by the Heritage Foundation. But that has not helped it much. It needs to explore more cautious and wiser policies for the few areas of the economy that are not yet open, for example, transmission and distribution rights in energy and oil imports. Uruguay would do well to learn from Argentina, which immediately precedes Uruguay in the ‘Index of Economic Freedom’ list.

The fact that opening up is not a necessary option in today’s world is highlighted by the recent attempts to sell off energy utilities by private multinationals in Brazil, the delay of privatization of two oil companies in India, and the consideration of re-nationalization of private sector units in England. As highlighted in Brazil, private sector interests, especially foreign, in continuing investments in a country will be determined by the state of that economy and its own state of affairs elsewhere. This makes them very prone to sell at any given point of time. Given the fact that Uruguay at the moment does not fulfil the first requirement and since many multinationals (led by Enron) are facing trouble at home, the Uruguayan government may do well to start looking inward rather than outward, especially where the essential sectors of the economy are concerned.

Similarly, keeping the US happy may bring in loans now but will take away the economic autonomy that Uruguay will need sooner or later. The Uruguayan economy has been traditionally strong. Its advantage in livestock production has ensured substantial export revenues in previous years. It is relatively free from corruption and has a strong social security base. What it needs to do is to develop its own industry, agriculture and energy sector. There is no reason why it cannot go back to standing on its own legs. It can also become a strong ally of its neighbours, rather than of the US.

Uruguay: Economic forecast summary

Real GDP (% change) -3.1     -6.3  3.0
Consumer prices
(% change; av) 
4.4  8.2 9.6
Exchange rate Ps:US$ (av) 13.319  18.042 24.786
Current account
(US$ m) Goods: exports fob
2,110 1,987 2,256
Goods: imports fob  -2,914 -2,284  -2,642
Trade balance   -804  -297 -386
Current-account balance -511 -303 -345
Current-account balance
(% of GDP) 
-2.8  -2.2  -3.1
External financing
(US$ m) Financing balance   
-1,071  -992 -1,482
Total debt 8,669 11,670 11,574
Total debt service   1,067 1,172 1,875
Debt-service ratio, paid (%) 28.0 36.7  48.3
Debt-service ratio, due (%) 28.0  36.7 48.3
SOURCE: Country Risk Service, Economist Intelligence Unit