A decade since its economic collapse, Uruguay has become a hotspot for investment, lured by its encouraging prospects for growth and political stability.
The country, the second smallest in South America, with a population of 3.4 million, is poised to grow 4% to 4.5% this year, aided by high prices for its export commodities.
While that’s a slowdown from 6% in 2011 and an average of 6.5% between 2003 and 2010, few are frowning, even as inflation runs high and Argentina and Brazil, its main trade partners, limit imports.
The cheer is rooted in a track record of sound policies, a long-running thread in Uruguayan politics and a foundation for its rebound from a 2002 economic collapse caused largely by an over-reliance on Argentina, for everything from bank deposits to trade flows.
“Uruguay is an example of how to recover from a shock,” says Benito Berber, a Latin America economist at Nomura Securities in New York. “It has followed a playbook of the things that the market wants: reducing vulnerability and setting foundations for potential growth to increase.”
Indeed, the 2002 economic collapse unleashed “a concerted effort to reduce Uruguay’s exposure to Argentina and to diversify,” says Franco Uccelli, an executive director at JP Morgan in New York.
Ten years on, Uruguay is reaping the fruits of the diversification. It has ramped up exports elsewhere so that shipments to Argentina fell to 7% of the total in 2011 from 18% in 2000. Over the same period, exports to China climbed to 7% of the total from 4%, according to central bank data.
Likewise, the government has shaved its foreign currency debt by issuing more in pesos, helping to shield it from exchange rate pressures. The share of its foreign currency debt dropped to 59% of the total in 2011 from 69% at the end of 2009 and nearly 100% in 2003, a reduction seen as a requisite for regaining the investment grade it lost in 2002, says Berber.
PRAGMATIC POLITICS
The efforts are expected to continue, spurred by a deep-rooted “centrist ethos” in the middle class that was only subdued by the 1973–85 dictatorship, says Riordan Roett, who chairs the Western Hemisphere Program at Johns Hopkins University in Washington, DC.
“Centrist politics are followed,” he says. “It doesn’t matter who is in charge.”
Roett had feared that José Mujica, a former leftist guerrilla, could stray when he became president in 2010. But Mujica has kept in line with the policies of his more centrist predecessor, Tabaré Vázquez, by sticking with economic orthodoxy to underpin a progressive social agenda.
This is the latest sign of how pragmatic leftist politics are proving successful in Latin America, while a brand of populist, strongman and interventionist socialism is doing much the opposite by depressing investor confidence in Ecuador, Nicaragua and Venezuela and to a lesser extent in muddling-along-in-the-middle Argentina.
Chile started the process in 1988 to build a sturdy economy. Brazil’s Luiz Inácio Lula da Silva then popularized the model now copied in Colombia, Peru, Uruguay and to some extent in Costa Rica, El Salvador and Panama, says Mark Jones, an expert on Latin American politics at Rice University in Houston, Texas.
“If you are on the left or in the centre, the pragmatic model works well by addressing social ills and doing so in a sustainable
manner over the long term by promoting economic growth, fiscal discipline and foreign investment,” he says. “You can’t achieve social goals without pro-business policies and a thriving economy.”
For Uruguay, the approach has paid off by taming inflation, slashing poverty and getting the public debt in order, while funds have gone towards improving education, infrastructure and public services. The jobless rate has dropped to a record low of 5.3%, helped by a fivefold surge in foreign investment since 2001.
Investors are pleased. “Foreign investors trust that their investments will be safe in Uruguay and the return will be high,” Uccelli says.
Dollars are flowing in to build pulp mills and wind farms and to plant soybeans, with Argentines crossing the muddy waters of the Rio de la Plata drawn by the lower taxes. This has swelled soy fields over the last decade to 900,000 hectares from 16,000, says Jorge Caumont, an economist in Montevideo.
CHALLENGES
Not all is cheery, however. Uruguay is facing economic headwinds, principally from protectionist trade controls in neighbouring Brazil and Argentina. Exports to the latter have fallen steadily since September and were down 45% year-on-year at the end of February. This has had a significant impact on local manufacturing, in particular textiles and car parts, as industrial output fell by around 10% year-on-year in Q4 2011.
Meanwhile Argentina’s tightening of capital controls since last October in a bid to stem capital flight is likely to have a disproportionate impact on Uruguay, especially as tourism and property in the country both rely heavily on hard currency from its wealthier neighbour.
A recent research note by Capital Economics puts it starkly: “Uruguay is undoubtedly one of the major losers from a lurch towards protectionism within the Mercosur block.”
“Close linkages on the trade and capital accounts make Uruguay’s business cycle highly correlated with its larger neighbours. Based on our expectations for growth in Brazil and Argentina to decelerate to 2.5% in 2012, Uruguay’s economy may slow by more than most are expecting this year.”
But the report adds that a cooling down, so long as it’s moderate, might be just what the doctor ordered. “To the extent that there is a silver lining, however, it is that in the near term these measures will put the dampers on an economy which is displaying signs of overheating.”
Inflation is higher than a target range of 4–6%, closing at 8.6% in 2011. It is expected to moderate to 7% in 2012.
Even so, it would be “very expensive” for the central bank to bring down inflation to the target, as this would require an increase in debt issuance and interest payments on the paper, Uccelli says.
The focus is on keeping inflation at less than 10%, to avoid automatically triggering wage negotiations by shifting them to a semi-annual basis for the public and private sector, which would put more wage pressure on inflation.
“It is more critical to keep inflation less than 10% than to get to 5%,” he says.
Although a decline in exports will be challenging, Uruguay has already taken steps to reduce its exposure to any one market by diversifying trade partners. This allowed it to ride through the 2008–09 global financial crisis with few hiccups, says Tamara Schandy, an economist at Deloitte Uruguay in Montevideo. While it still sells a lot of its food, car parts and paper to Argentina, automobiles, cleaning supplies and plastics now have a wider reach, and leather and milk even more so, she says.
The sturdy policies are fuelling investor demand, with the government selling US$491 million in 10-year yen bonds at a price to yield an annual 1.64% last year. It went ahead with the sale even though it didn’t need the money, as it reduces the public debt and progressively cuts the fiscal deficit to a target of 1% of GDP this year, from 1.7% in 2009, shooting for 0.7% in 2015.
“Uruguay is one of the shining stars of the region,” says Uccelli. “It is a low-key country amid giants that get all the attention from the international press and the markets. It is doing things quietly and keeping things on track and posting positive numbers. It is a country that is firmly on its way to investment grade, and this could come this year.”