Uruguay - Current economic position and prospects

R E S T R I C T E D Report No. W.H.4 This document was prepared for internal use in the Bank. In making it available to others, the Bank assumes no responsibility to them for the accuracy or completeness of the information contained herein. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT CURRENT ECONOMIC POSITION AND PROSPECTS OF URUGUAY May 3, 1955 Department of Operations - Western Hemisphere  CURRENCY EQUIVALENTS Official Basic Selling Rate U.S. $1.00 1.90 1 peso - $0.527 1 million pesos = $527,000 Special selling rate: U.S. $1.00 = 2.45 pesos Official basic buying rate: 1.519 V Special buying rate I 1.78 Special buying rate II 2.35 Free rate 3.20 (Jan. 1955)  TABLE OF CONTENTS Page BASIC DATA SUIJi1ARY AND CONCLUSIONS ............................. i I. RECENT ECONOMIC TRENDS A. Background .. .............. ..................... .. 1 B. Agricultural and Pastoral Production ............ 2 C. Industrial Production . .......................... 3 D. National Income, Investment and Savings 4........ 4 E. Internal Prices and Inflationary Pressures ...... 5 F. Development Prospects ...... ..................... 6 II. EXTERNAL TRADE AND PAYIVIENTS A. Exports and the Trade Pattern ............... 7 B. Imports ......... ............................. 8 C. Non-Trade Transactions ..... ..................... 9 D. Gold and Foreign Exchange Reserves . ............. 9 E. Exchange Rates and Lxchange Profits Fund ........ 9 F. Prospects . ...................................... 10 III. PUBLIC FI-TJdIl-. A. Ordinary Budget ....................... 13 B. Official B3ond Issues ....................... 14 C. Prospects .... ................... 15 IV. B=TERNAL LIT ... ...... 17 A1NEX I - National Income, investment and Saving ANNEX II - I'ioney Supply and Bank Lending ANNEX I1l - Proposed Public Investment Expenditure STATISTICAL APPENDIX Table 1 - Summary of External Public Debt Table 2 - External Debt Service Table 3 - Popular Savings Table 4 - Mvioney Supply, Time Deposits and Savings Deposits Table 5 - Bank Loans Table 6 - Main Exports Table 7 - Destination of Pastoral Exports Table 8 - Raw Wool Exports Table 9 - Trade Balances by Area Table 10 - Composition of Imports Table 11 - Balance of Payments Summary Table 12 - Public Finance Table 13 - Ordinary Budget Expenditure Table 14 - Ordinary Budget Revenue Table 15 - Purpose of Government Bond Issues Table 16 - Holding of Government, Miunicipal and lMiortgage Bonds, December 31, 1952.  BASIC DATA Area 72,153 square miles (83-0 arable and pastoral) Population 2.5 to 3 million (1954) Trade (6 million) 1950 1951 1952 1953 1954 - -(Lst.) Exports 254 235 209 270 249 Imports 201 309 237 193 274 Trade balance f53 -74 -28 /77 -25 Gold and Foreign Exchange (End of year: net) 312 199 216 234 227(gold only) Ordinary Budget Expenditures (million pesos) (Excluding debt amortization in 1950 through 1953) 290 350 336 391 477 Current deficits (including extra-budgetary accounts) 49 57 44 75 61 Cost-of-living, Montevideo (1948 . 100) 101 115 131 140 157 Internal Funded Debt (million pesos) (End of year) 761 783 823 901 1096 External Public Debt: August 31, 1954 Total in sUS equivalent 124.3 million  SULTitRY 1i' CONCLUSIOP'IS 1. Economic development in Uruguay, based upon exports of pastoral products such as wool and meat, had by 1949 advanced further than in most other Latin American countries. Since 19b9 progress in total real output has not been spectacular, but changes in the terms of trade caused by the war in Korea brought a rapid rise in prosperity in 1950 and 1951, and a rapid fall in 1952. Since then terTms of trade have turned mildly favorable afain, and production generally picked up in 1954. 2. In recent years pastoral and agricultural production has had no unused land to draw upon and has advanced little in productivity. Conse- quently, increases in wool and wheat production, while substantial, h-iave been accompanied by decreases in production of meat, linseed and other crops. Prospects for pastoral developnent depend upon improved methods of pasture use. Industrial production slumped somewhat after 1950 but by 1954 had recovered. Protection by import controls and special exchange rates have fostered high cost manufacturing. 3. Uruguay's past good record of comparative internal economic stability is now in some danger from inflationary pressures, indicated by rising internal prices and a tendency towards balance of payments deficit (which has to be restrained by quantitative import controls). The pace of economic advance has slackened. To stimulate the economy without adding to inflation, in both the private and public sectors, more productive and urgently needed investnent should be encouraged and less urgent be discouraged. Proposed IBRD loans for pastoral development, electric power and railvway rehabilitation wiill help the economy at vital points. T'he long-term outlook for further economic progress is favorable; but in the short term the newf goverrnnent is faced with a problem of finan- cing both new developiment and past budgetary deficits. 4. The traditional trade pattern of a dollar deficit and a European surplus has been re-established since 1950 and there are no grounds for expecting this pattern to change in the long run. Special pressures upon dollar resources will remain until other currencies become convertible. 5. Budgetary deficits on current account have averaged about 16% of ordinary revenues over the five years 1950 to 195M. These are consolidated from time to tii,me in public debt issues. Such issues finance also public works and capital expenditures of public entities. Public institutions, especially pension funds, take up most of these bond issues, and this has in the past greatly facilitated official finance. It appears, however, that recently too many claims have been made upon this savings channel. Uruguay now faces a crisis in public financing. It is of crucial importance for the longer-termn outlook that the goverrnent should now stop running deficits on current account. So far as can be judged from proposals men- tioned from tii,e to time, public capital expenditure in prospect is about twice as great as non-inflationary fiinance likely to be available.  - ii - 6. Proposed lending by the IBRD would raise external debt service to 915-5 million in 1961, which would not be an unduly heavy burden. But it would be inadvisable to take on any heavier external debt burden that this until it is seen that productivity is improving and inflationary pressures are not threatening the economy. 7. At present 63' of external debt is U.S. dollar debt. So long as non-dollar currencies are not expected to become and to remain convertible, Uruguay should not assume more debt burdens in dollars iL it can secure the same advantages by borrowing in non-dollar currencies. If non-dollar cur- rencies cannot be borrowved, or if dollar borrowing has other advantages, san,e new borrowing in dollars would be justified withiin the proposed IBRD loans, the amount depending in part upon prospects for convertibility of European currencies.  I. RECENT iCONOMIC TRENDS A. Background 1. In many respects Uruguay is unique among Western Hemisphere countries. The population of 2.5 to 3 million is wholly European, with a considerable addition of other nationalities to the original Spanish. Its area is small, 72,000 square miles, but over 80% is in crops and pastures The economy has been basically rural, lacking minerals, forests or fuels,- yet it has achieved one of the highest levels of output per head in Latin America, probably higher than that of Italy and somewhat lower than that of France. 2. Elementary education has been free and compulsory since 1877, and male suffrage universal for literates over 18 since 1919. Female suffrage was introduced in 1934. The Constitution provides for old-age pensions, child welfare, workmen's accident insurance, the eight-hour day and six-day week and other social measures. Uruguay is a complete democracy, with free- domn of speech, publication and worship, and has a record of over fifty years of political stability. Per capita figures are never lower than second in Latin America for newspaper circulation, radio receivers in use, telephones, trucks, passenger cars, tractors, and government revenues. Literacy and infant mortality rates are among the two best in Latin America. 3. The basis of Uruguay's economic development has been the land, and particularly the export of pastoral products -- wool, meat and hides. Rough estimates made in 1937 and 1953 give the following distribution of employed population: 1937 1953 (percentages7 Agriculture and Livestoclc k5 36 Manufacturing Industry 13 22 Government Service ( 9 Business and Commerce (42 14 Other Services ( 19 100 100 While farming still absorbs over a third of the working population the trend over these 16 years has been a reduction of the proportion in farming and an equivalent increase of the proportion in manufacturing -- a familiar develop- ment in an advancing country. 1/ In November 1954 it was announced that for the first time signs of oil deposits were discovered in Uruguay.  - 2 - 4. Uru&uayan achievement in developing the country has been notable. An IBRD report six years ago (February 18, 1949) could say: "The groundwork of past capital formation . . . . has already been laid." What can be said now of the colntryts economic development in the years between? The follow- ing sections try to assess the pace of development and the course it has taken. B. Agricultural and Pastoral Production 5. Agricultural and livestock production !h ows advances, especially of wool and wheat, together with some contraction of meat and linseed. Wool production by 1953 was 20% higher than in 1950 -- a remarkable increase, induced by high wool prices in the world market. Wheat production had varied little since 1950, until in the 1953-54 season acreage expanded by one-third, and production by 60%. This great increase was encouraged by government price-support policy. An unusually large export surplus was sold after some difficulties, but at a price lower than the support fixed by the government. 6. It is normal for an increase in acreage of one crop, say wheat, to cause a reduction in another crop, say linseed. Indeed, the responsive- ness of Uruguayan agriculture to price changes is an element of strength to the economy -- a flexibility of land use allowing production of the more re- munerative product. When the changes take place in rcsponse to world prices they ensure the maximum foreign exchange income. When government policy intervenes, however, the price relationship for different products may or may not reflect world prices. With the recent increase in wheat production in Uruguay went a fall in linseed production, and at a time when world mar- ket prices for linseed oil fell heavily, much more heavily than prices for wheat. The changes of production of these two products were therefore in the same directions as they would have been had the government not inter- vened. It seems, however, that the increase in wheat acreage has reduced the area under pasture and may tlhus be cutting into the cattle industry. Increased wool production also has reduced the capacity to carry cattle. 7. Since meat is an important export, the question of wheat versus meat production is discussed further in the section on external trade. What is important to notice in considering farm production as a whole is that there has been no unused land from wiiich to secure more production, and that there has been little increase in productivity in recent years, except a trend among wool growers towards breeds of sheep carrying higher quality wool. The 1949 IBRD report, mentioned in paragraph 4, said: "No great increase of production, and hence of exports, seems likely under these customary methods of extensive pasture, under which the land is probably at a temporary limit of utilization." Since that was written there has been considerable activity in examining Uruguayan methods and prescribing for their improvement. There has been also some spontaneous but slow improve- ment on Uruguayan fanms. The Uruguayan Governrment now has under considera- tion a project, to be financed partly by an IBRD loan, designed to guide and speed change of pasture use.  -3- C. Industrial Production 8. iM4anufacturing in Uruguay is mainly of consumer goods such as textiles, food and drink, leather and rubber goods and many others. It is claimed that local industry supplies 70% to 80% of all consumer goods. The absence of statistics of industrial production makes it difficult to estimate whether and to what extent industry has been developing in the last few years. Rapid expansion took place after the second World lvar until 1950, but a period of recession followed. In late 1953 and 1954 industrial activity picked up again. 9. This trend of over-expansion and set-back can be partly explained by referring to world trading conditions and the Uruguayan balance of pay- rnents. Difficulty in securing supplies immediately after the war encouraged manufacturing inside Uruguay, and protection by import controls reinforced this inducement. A sharp improvement in the terms of trade in 1950 and 1951 allowed an easing of import controls and imports flooded the market. It seems likely that stocks, built up in the period of comparative freedom to import, provided effective competition against local production long after import controls were again tightened. High internal demand in late 1953 and in 1954, from wage increases and good prices for the main exports, combined with controls on imports to stimulate manufacturing output from capacity that had been partly idle. 10. Industrial consumption of electric power generated by the public electricity authority (U.T.E.) increased by over 10% a year from 1950 to 1953. Some of this increase, perhaps a large part of it, was due to demiand for the authority's power, as it became available, to replace power generated by small units in individual factories. Some of the increase, however, must have been due to greater industrial activity, especially in late 1953. Earlier that year there were stoppages in factories, and consequently reduced output, due both to power shortages and to wage disputes. The rate of in- crease in power consumption by industry was rather higher than the rate of consumption increase by all users. 11. Manufacturing has been fostered in Uruguay by protection through import controls and by granting more favorable exchange rates to exports of some manufactures. The customs tariff is not an effective device for pro- tection because duties (ad valorem) are levied upon out-dated values much below present-day values. The Export-Import Commission responsible for import controls has on it;representatives of both importers' interests and manufacturers', and import quotas varying from time to timae remind manufac- turers that there is always potential competition outside the import control barrier. Costs of local manufactures are generally high, at present exchange rates, compared with imports. 12. Prospects for increased industrialization are limited by (a) the comparatively small internal market and (b) the capacity already established in some branches of industry and not fully used. The immediate need seems to be to lower costs by working to full capacity, which may mean some weed- ing out of inefficient units. Less protection would help to achieve this,  -4 - but the authorities seem committed to a highly protective policy. There are efficient factories in Uruguay which should be able to meet reasonable competition, and indeed to export. The rate of exchange is clearly of crucial importance in this context, but the many and changing rates in Uruguay make it difficult to generalize on this subject. Some extension of local manufacturing into new industries is expected to continue in the next few years at a comparatively slow rate. D. NJational Income, Investment and Savings 13. Official information is scanty on national income and investment; but in Annex I an attempt is made to build up a picture from the information offering. Broadly, the impression is that real output made some advance since 1949, but not a very steady or spectacular advance. Improvement in the terms of trade, however, due to the war in Korea, swept the economy to a new high level of prosperity in 1951. But in 1952 as export prices fell real national income returned swiftly to its former level, and since then has probably risen gradually, again helped by a favorable trend in the terms of trade. Exports account for about 25/O of national income, hence the potency of these changes in terms of trade. Summing up, real national income prob- ably moved roughly as follows: (Index numbers on base 1949 = 100.) 1949 = 100 1952 = 100 1950 = 110 1953 = 105 1951 = 120 1954 = 108 14. Gross investment relative to national income has probably been among the highest in Latin America, especially in 1951 and 1952, which indi- cates that the economy took advantage of prosperity in 1951 to increase its stock of capital goods, including buildings. Some 80% to 85% of gross invest- rnent has been private and 15%o to 20$ public. The latter is not a high pro- portion, including as it does not only public works but investment by publicly- owv'ned railways, the electricity authority (U.T.E.) and the petroleum authority (.NCAP). 15. It seems that 80% to 90% of investment has been financed internally. About 10% of private investment and 20% of public investment has been financed externally. Internal savings as a proportion of national incorne must be comparatively high, as Annex I points out; but the level of investment has also been high. In addition the government has run a series of current deficits. It is possible, therefore, that total investment Plus public deficits have been outrunning savings. It is impossible with data now available to verify this directly. There is indirect evidence, however. Internal prices have recently been rising steadily, indicating inflationary pressures in the economy. Further, it has been necessary to maintain direct controls on imports, and even with controls there have been external deficits in 1951 and 1952. Such pressure on the balance of payments can be explained, partly if not wholly, in terms of investment exceeding savings.  - 5 - 16. If, as seems likely, Uruguay is now generating inflationary pres- sures through undertaking more investment than can be financed by savings, it is obviously important for the economy that more productive and urgently needed investment be encouraged and less urgent be discouraged. Certain types of investment can be recognized at once as likely to contribute to greater productivity -- investment needed for better pastoral methods, for example, and in electric power to enable improved productivity in industry. Reliabilitation of the railways is clearly needed to improve the efficiency of transport. 17. It is not easy to say which investment should be discouraged. So far as private investment is concerned, if rigidities of import controls could be eased permanently it would have a salutary effect in discouraging uneconomic new investment. So far as public investment is concerned, in the past few years its total was probably not excessive; but on recent occasions various plans and schemes have been outlined by the authorities, and if they are all attempted at once in the coming years they will mean a substantial increase in public investment expenditure. This is discussed fur-ther in Section 111. It suggests that priorities should be established among the various plans that have been referred to publicly. E. Internal Prices and Inflationary Pressures 18. A cost-of-living index for liontevideo, the only official measure of price movements in Uruguay, showed a relatively moderate price increase of 34% from 1947 through 1952. Since then the rate of increase has steepened, with a lZbo rise between 1953 and 1954. This is a relatively large increase, less than the 18,J rise in Brazil over the same period, but more than the rises in Colombia (9,1), MIexico (5%) or Peru (5%). Export or import price movements can hardly be held responsible for the continued rise. It is true that export prices rose steeply in 1950 and 1951, but they fell thereafter. Import prices rose in 1951 and 1952, but they too fell in the next two years (judging by the index for imports of all Latin American countries). 19. Inflationary pressures, sustained by fiscal deficits and protec- tionist policies, have tended to force prices up, and this tendency has been re-inforced by wage increases granted by wage boards for most industries, especially in 1952 and 1954. There is no general wage rate index, but examples reveal that between 1949 and 1954 many wage rates doubled. This is a high rate of increase. It probably does not apply to rural rates, although they too have risen. 20. The existence of wage boards to hear wage claims and pronounce upon them is another example of Uruguay's advanced social development. The wage boards' pronouncements have been the immediate cause of rising costs and prices because they have awarded high rates of increase (20%, 30% and even 60% at a time), and because productivity has not risen so fast. In addition, as mentioned in earlier paragraphs, other influences in the economy, especially protective policies, seem to have been encouraging investment to outrun savings and in these circumstances the demand for labor is high and  - 6 - profits are good. In this atmosphere a wage board's award of large in- creases is often popular all round and causes no immediate pressing prob- lems. 21. The comparatively high wage increases do not seem to have been accompanied by price rises at an equivalent rate. This has been due partly to a fuller use of existing manufacturing capacity, and partly to the fact that prices for imported raw materials, fuel and equipment were rising little, and from 1952 were falling slightly. Real wage rates have therefore risen somewhat. 22. Money supply and bank lending are considered in Annex II. The general impression gathered by examining price movements, money supply and banking is that the good record of comparative internal economic stability enjoyed up to 1952 is now in some danger. Inflationary pressures are begin- ning to show and if the new government should institute a regime of more wage increases and more investment expenditure all round without regard to priorities, while continuing to run current deficits in the public accounts, these pressures will worsen. The extermal effects of these internal pres- sures is a tendency to over-import (which has to be restrained by quantita- tive import controls) and the need for special depreciated exchange rates for some exports whose costs are too high to meet foreign competition. F. Development Prospects 23. In contrast with most other Latin American countries Uruguay's economic development started early and travelled far. Now the pace of ad- vance has slackened, and there is even a danger of stagnation in pastoral activity. Proposed IBRD loans for pastoral development, electric power and railway rehabilitation will help stimulate the economy at vital points. Demand prospects for Uruguay's traditional exports are good; the country is blessed with political stability and has had a good record of economic sta- bility. These advantages give a favorable long-term outlook for further economic progress. In the short term, however, as part !II or this report snows, the new government is faced with the problem of financing both new development and past budgetary deficits. This problem is by no means in- soluble, but if not handled wisely it could seriously retard Uruguay's economic progress.  - 7 - II. EXTERNAL TRADE AND PAYXvENTS A. Exports and the Trade Pattern 24. Pastoral products -- wool, meat, hides and skins -- account for over 80% of Uruguay's exports (Table 6). World wool prices are the domi- nating influence on export earnings. In 1950 there was the "Korean" rise in wool prices, and by 1952 a return almost to the 1949 level; throughout 1953 and early 1954 prices rose mildly. Although raw wool export receipts fell heavily in 1952, meat and hides fell only slightly, and wool tops (the first stage in producing wool yarn), flour, linseed and wheat exports rose, showing that all Uruguay's eggs are not in the one basket. Though wool is by far the greatest single export, there is a good variety of others. Wool stocks accumulated from 1952 allowed the export of "a clip and a half" in 1953 -- hence the record value of total exports in that year. 25. Buoyant receipts for meat exports nave been masking a deterioration in meat production for export. The 1952-54 average volume of meat exports was 28% lower than the average for the years 1949 to 1951. The other main pastoral export, hides and skins, averaged about the same volume over 1952-54 as over 1949-51 but lower prices have somewhat reduced their export earnings. 26. Since 1951 the direction of exports has changed significantly. The United Kingdom has been buying more wool and the United States less (Tables 7 and 8), resulting in a severe dollar shortage, because wool is the principal dollar earmer. The fall in raw wool sales to the U.S.A. was partly replaced in 1951 and 1952 by a rise in wool tops, exported writh the aid of a more favorable exchange rate. Whereas the rate for exchange earned by raw wool was 1.5 pesos (per USE), the rate for tops was 2.35 pesos before 1v1ay 1952, 2.15 from hMay 1952 to July 1953, 2.06 to January 1954, and 1.97 thereafter.l/ Complaints about these exchange practices have come from the United States and Europe, and the United States has imposed countervailing duties on Uruguayan tops, causing a drastic decline in tops exports to the United States, from 16 million in 1952 to p5 million in 1953 and an in- significant anount in the first five months of 1954. Exports of tops to other countries have risen steadily. 27. Exports to Europe and to other Latin American countries have risen while exports to the United States have fallen. Exports to Latin America, mainly wheat and meat to Brazil, do not earn free dollars, but thirough trade agreements are in effect bartered for such items as coffee, cacao and yerba mate. Each year after 1950 has seen a deficit with the Western Hemisphere averaging 036 million a year (1951 through 1953, see table 9). Excluding deficits which do not have to be settled in dollars, it averaged ''25 million. In some recent years there have been surpluses with the U.S.A. outweighed by dollar deficits with Latin America. Even within the large over-all surplus of 1953 there was a deficit with the Western Hemisphere. In short, after the unusual dollar surplus in 1950, the traditional trade pattern of dollar deficit has re-established itself and is likely to continue. 1/ In February 1955 the rate returned to 2.03.  B. Imports 28. Following the 1950 rise in wool prices and a favorable balance of payments, import controls were eased in 1951 by suspending quotas. Imports expanded, but as wool prices fell the trade balance became heavily in deficit. The Central Bank thereupon borrowed short-term from New York commercial banks and arranged forward exchange sales rather than prompt settlement for some dollar imports. This "backlog" of unpaid commercial or financial commitments was liquidated over 1953 and 1954. 29. Import controls reduced 1952 import values 24% below 1951, and 1953 imports 18% below 1952. Such steep reductions from the high level of 1951 were facilitated by the stocks built up in 1951. Since import prices fell over this period import values fell more than their volume. Imports in 1954 were 40% higher than in 1953. Prominent in this increase were greater imports of industrial machinery, building materials, and raw materials for Uruguayan manufacturers. Provisional figures show a trade deficit in 1954 in sharp contrast to the large trade surplus of 1953. 30. Uruguay has had a system of import licensing since 1931. Origi- nally its object was to keep the over-all balance of payments within manage- able limits. While this is still the main object there are now two other important aims in administering the system: (a) to ration available supplies of particular currencies among importers and (b) to protect local industries. The Bank of the Republic determines import quotas from time to time in each currency of payment, depending upon available exchange. The Export-Import Commission and the bank then agree upon the categories of goods to be li- censed under each quota. This system insures that exchange is available for evexy license issued. 31. Essential imports such as fuels, foods and raw materials make up between 40% and 50% of the total (Table 10). It is not surprising thlat in 1952 and 1953 as total imports were cut back the proportion of this group to the whole rose considerably, while the proportion of capital goods and "other" both fell. Capital goods make up over 40%. While these are essen- tial to maintain the pace of development they can be squeezed to help meet a short-term balance of payments deficit. At such a time therefore imports are reasonably flexible -- a source of strength to an economy with fluctu- ating export receipts. 32. Dollar imports bre not as flexible as total imports. In 1953 two- thirds of dollar imports/.. were fuels, foods or raw materials. Almost 30% was vehicles and othaer capital goods. All dollar imports have been subject to strict licensing to save dollars. If dollars became scarcer, or if dol- lar imports had to be reduced further in order to meet, say, external debt payments, imports of some capital goods and of other goods apart from 1/ That is, imports from all Western Hemisphere countries except Brazil with whom trade settlements are not usually made in dollars.  - 9 - fuels, foods and raw materials could no doubt be replaced by non-dollar suppliers, but not to any great extent without hardship to the economy. C. Non-Trade Transactions 33. Current non-trade transactions have in recent years been in deficit for small amounts varying from $2 to $8 million. The main "in- visible& receipts are from tourism which in the post-war years up to 1952 supplied <15-20 million equivalent annually, largely in Argentine pesos, but in 1952 only 10 million and in 1953 $6 million, due to severe restric- tions on travel from Argentina to Uruguay. Tourist expenditure by Uruguayans has been roughly two-thirds tourist receipts since 1950, so that this item has continued to be a net earmer of foreign exchange. Profits and interest on direct investment have resulted in a small net outflow averaging 41.5 million annually over the past six years. Other interest payments, mainly on external public debt, have been between $3 million and $4 million a year. Transport is a small net earner of foreign exchange. 34. Private long-term capital inflow, averaging 423 million a year over the three years 1950 to 1952, more than offset the current non-trade deficit. In 1953 no inflow of private long-term capital was recorded. This item is estimated and, while the greater part is described as direct investment, it possibly includes some capital movement through the free market, held in more or less liquid form (bank accounts, mortgage bonds or real estate) rather than used in acquiring or constructing productive assets. Most of the capital inflow is believed to be in U.S. dollars. D. Gold and Foreign Exchange Reserves 35. Since 1950 gold holdings of the Bank of the a'epublic have never fallen below "'200 million which is greater than the total value of l953 imports. Apart from gold, net holdings of foreign exchange .iave fluctuated between 470 or .80 million in 1950 and a minus quantity in 1951 when the Bank of the Rep-ublic received a short-term advance from New York banks. At the end of 19$4, gold holdings stood at 4227 million and it is believed that net foreign exchange holdings, including balances in payments agreement accounts, were a small positive sum. 36. Such large gold reserves are a source of strength in time of energency. It should be noticed that they are legal backing for a large part of the note issue, however, which limits the extent to which they can be used. E. Exchange Rates and Exchange Profits Fund 37. Uruguay has not declared a par value with the DIF. The selling rate for most imports is 1.9 pesos to the dollar, with a 6y> tax in many cases making an effective rate of 2.01. There are other import rates vary- ing from 1.5 to 3.35. Basic exports such as wool, meat, hides and skins, linseed, wheat and flour receive a rate of 1.5. Other exports receive rates varying from 1.6 (for washed wool) to 2.58 (for exports of leather and woolen  - 10 - textiles). Generally, any manufactured export receives a more favorable rate than the basic rate for raw products. Some recent special deals for exports have resulted in heavily depreciated exchange rates. For example, sunflower seed oil was exported as a compensation deal against motor car imports. The rates officially fixed were 2.35 for the exporter and 2.45 for the importer, but in addition the car importer had to pay 1.05 pesos per dollar to the oil exporter, so the effective rates were 3.40 for the exporter and 3.50 for the importer. 38. Non-trade transactions are made through the free market, where the rate remained just under 2.75 pesos per dollar throughout 1951 and 1952, beginning to depreciate in 1953. By July l954 it was 3.29 and fell as low as 3.h0 later in the year. Early in December 1954 it had recovered to 3.25. 39. Exchange profits, resulting from the differences between buying and selling rates, are paid into a special fund which is used by the government to finance subsidies (paid on most basic foods to keep retail prices down) and losses on the public export marketing of wheat. Such payments have usually exceeded exchange profits in the past, so that the fund has been in deficit each year (Table 12). Hopes have been expressed during the past year or so in Uruguay that this fund will provide finance for public works. Reve- nue to the fund has been buoyant, but there is no definite indication that it will be able to provide much finance for nublic works after it foots the subsidy bill. Provisional figures for 1M54 show a deficit of 7.7 million pesos. F. Prospects 40. UJruglay's balance of payments over the past five years has swung violently from surplus to deficit (Table 11). In 1953 and the first half of 1954 it was in surplus, but in 1954 as a whole it was probably in deficit. The longer term prospect depends mainly upon world prices for pastoral prod- ucts, the degree of inflation inside iruguay and production, especially of pastoral products. The main types of balance of payments difficulties likely to arise are: (1) A temporary fall in export earnings due to a cyclical fall in world prices for the main exports. This is less a risk for Uruguay than for overwhelmingly single-product exporters. (2) A long-period trend of falling demand for wool. (3) Domestic irflation causing demand pressures for imports and high costs for exports. There are signs that the economy is already faced, or at least tnreatened, with this difficulty. (4) A short- age of dollar earnings despite satisfactory total export receipts. This is an ever-present difficulty which would of course disappear if European cur- rencies, or sterling along, became convertible. 41. Wool production, both in quantity and quality, has improved since dorld War II. Sheep share the pastures with cattle, and future expansion of both depends basically upon improvement of pastures and pasture management, an improvement technically and economically practicable. Continued increase of Uruguayan wool output is thus possible, given remunerative prices, which depend on world prices and the exchange rate. At current prices and the relatively unfavorable exchange rate (compared with same other Utruguayan export rates) wool production earns a good profit.  - 11 - 42. The future of world wool demand is somewhat obscure because of corapetition from synthetic fibres. However, recent developments indicate that prospects are more favorable than was feared a few years ago. The outlook for wool may now be considered reasonably bright, even though competition from synthetics tends to set a ceiling on wool prices. A preferential exchange rate has allowed Uruguay to sell wool tops at very little, if any, more cost to the foreign buyer than raw wool. Prospects for Uruguayan tops are therefore uncertain, depending upon a lowering of production costs or a continued advantageous exchange rate. 43. Exported meat, frozen and canned, has been second in importance to wool for many years as an earner of foreign exchange. Canned meats go regularly to the United States, Brazil and various European countries. The United Kingdom has been the main traditional market for frozen meat, taking the equivalent in sterling of 416 million worth annually on average over the years 1950 to 1953. From 1940 to mid-1954 the government was the sole U.K. importer, and prices to Uruguay were the same as to Argentina and generally higher than those to other main suppliers. Now U.K. trade is again in pri- vate hands. Demand for good quality beef will remain high in this market in the near future. Later, Uruguay may have to face sharper competition from Argentina, Australia and New Zealand (who together with South Africa are its main competitors in wool markets also). If it can meet this competition, Uruguay will continue to enjoy a steady demand for its exportable meat surplus. 44. The short-term outlook for expanding Uruguay's meat exports is not very encouraging. Cattle numbers have been falling, due to the increase of sheep and probably also of wheat, increases resulting from high world wool prices and internal gtuaranteed wheat prices. i4eat is exported mainly by foreign-owned "frigorificos," while the rNontevideo meat supply is handled entirely by a publicly-owned "frigorifico.'" About 80% of production is con- sumed internally at subsidized prices, which in effect determine the prices exporting companies must pay to producers to get meat for export. The price exporters receive is determined by the external market and the exchange rate. In these circumstances the foreign exporting companies have been making heavy losses. They have recently claimed compansation from the government for losses incurred in the 1954 season, and have received a part payment while the rest is still under consideration. A healthy meat export trade depends basically upon increasing the numbers of cattle and this in turn depends upon raising the carrying capacity of pastures -- the object of the livestock scheme which the IBRD loan is to help finance. 45. The encouragement given to wheat production stemmed originally from the commendable desire to reduce wheat imports. -Wheat now seems to be cutting into meat production, though perhaps to only a small extent so far. Some informed opinion in UrugLay now believes that an annual export- able surplus of 200,000 tons of wheat should be aimed at, rather than the 400,000 achieved last season. The prospects are that other Latin American countries, especially Brazil, would regularly absorb a Uruguayan surplus of 200,000 tons.  - 12 - 46. Prospects for dollar earnings must be considered apart from total earnings so long as a large part of earnings are inconvertible. It cannot be foreseen that any export item -ill become a greater dollar earner, or indeed necessarily remain a dollar earner. United States demand for imported wool is expected to contract rather than expand over the long term. Dollar imports, it has been held in paragraph 32, are not on the whole as flexible as total imports, but one item deserves special mention -- fuel. Oil con- sumption is likely to increase over the long term, but the proportion wThich has to be settled in dollars has recently fallen. It may fall furtlier if a contemplated enlargement of the IMlontevideo refinery permits processing a higher proportion of sulphur-rich Middle Eastern crude oil. 47. Before World War II, when European currencies were convertible into dollars, the trade pattern of dollar deficit and European surplus presented no financing problem, provided of course there was no unmanage- able over-all deficit. In the post-war period when the pattern became re- established, Uruguay met the situation partly by gettinig dollar payments for some exports to iurope, partly from capital inflow, and partly by draw- ing down its own exchange reserves. It has used other devices from time to time. For example, the authorities have requested dollars from exporters, regardless of the exports' destination. The exporters are allowed to retain some percentage of the export proceeds. They secure their dollars in free markets (Montevideo or New York) against "inconvertible" currencies, espe- cially transferable sterling, and cover their loss by changing their retained percentage into Uruguayan pesos in the free market. Thus the Uruguayan authorities secure de facto convertibility at the cost of lower total foreign exchange receipts. The existence of a free exchange market in Montevideo is another source of dollars, again at a cost because of the less favorable ex- change rate. Pressures upon dollar resources remain, however, and will remain until other currencies become convertible.  - 13 - III. PUBLIC FINANCE A. Ordinary Budget 48. Under Uruguayan law each new administration presents an ordinary budget which remains in force throughout its four-year tenure of office, although it can be and is amended by special legislation from time to time. wlhen a National Executive Council replaced the office of president in 'arch 1952, the new regime prepared a new budget which did not receive approval until Miarch 1953. It should now remain in effect until Miarcil 1957. A new government took office in March 1955, and although it will be a different administration it can continue with the present budget, making whatever changes it wishes by special le gislation. 49. A large part of the ordinary budget is for wages ald salaries. Capital expenditure is not included. A separate long-term plan covers public works and this is financed by public debt issues, whose service becomes a charge on the ordinary budget. Ordinary budget expenditure is about 20% of national income, a very high figure which ordinary budget revenues have not been able to meet in recent years. The resulting deficits in the ordinary budget, together with deficits in several accounts which are not part of the ordinary budget, are consolidated from time to time in public debt issues. Over the five years 1950 to 1954, total deficits have averaged about 57 million pesos or 16% of ordinary revenues (Table 12). 50. Uruguayan fiscal results are seldom published in detail. Tables 12, 13 and 14 are believed to show the situation with fair accuracy. It is apparent from Table 14 that over half the ordinary budget revenue comes from indirect taxes, mainly customs duties and sales tax. These receipts of course contract when imports fall, hence their higher level in 1'951 than in following years. Direct taxes account for 20/2 to 24% of ordinary reve- nues. There is no personal income tax in Uruguay because income taxes are considered discouraging to enterprise. It is a question, however, whether various direct taxes now accumulating upon enterprise may not become more discouraging than a progressive tax on all incomes. Examples are: a tax, usually 1% of capital, on all comrmercial firms; taxes on real estate and property; a tax on limited companies, based on capital and reserves; a tax on profits of banks and commercial firms; and in addition to these a "high profits" tax varying from 20% to 80% of profits exceeding 12% of capital. This last tax applies to all limited companies and to all firms whose capi- tal exceeds 100,000 pesos, but not to agriculture and livestock. During 1953 some taxes were increased and some new taxes were introduced -- a tax on bank accounts, for example, and an additional import tax. These meant higher revenues for 1954 and future years, and they show that the govern- ment has been aware of the need to increase revenues.  - 14 - 51. Compulsory pensions schemes provide pensions after 30 years serv- ice for almost all urban and some rural workers at rates equal to the full average earnings for the last few working years. These generous pensions are financed bv contributions from both employee and employer, in each case l0' to 125 of wages. Various pension funds manage the contributions and payments -- Industries and Commerce Fund, Rural Workers and Old Age Fund, Civil Fund (for government workers), Banks Fund and Military Fund. The resources of these funds, together with other savings through public institutions such as the Post Office Savings Fund, have been the main sources of the govern- ment's loan finance. The existence of savings available for investirient in bonds is a feature which of course greatly facilitates official finance. There are, however, indications that over the past few years too many claims have been made upon this savings channel. The financing of current deficits from savings is reducing financial resources available for investment. In- deed, as the following paragraphs try to show, Uruguayan public finance is now facing a crisis, with too many claims ahead for the resources likely to be available. 52. It is significant, illustrating the growing difficulties of financing public expenditure, that short-term financing by treasury notes has become more important in the last two years (Table 12). Until 1952 the net annual increase in treasury notes outstanding had been small. The in- crease in 1953 and 1954 has been largely in dollar notes whlich are taken up by commercial banks and others with dollar balances that they wish to invest on a short-term basis. B. Official Bond Issues 53. Government bond issues provide finance for: (a) current deficits of the ordinary budget and extra-budgetary public accounts, (b) government capital expenditure on public works, and (c) capital expenditure of public entities such as the N\ational Railways, U.T.E. (Electricity and Telephones Institute), Av\iC'CP (Petroleum institute) and others. From 1950 to 1954 over half the governmrent debt issues have been for consolidation of deficits (including both interest and amortization of public debt), about one-eighth of the debt issues have been for public works, and about one-third to pro- vide capital for public entities (Table 15). 54. At the end of 1952 public institutions held almost 80% of all government bonds and private holders held about 20% (Table 16). Official bonds are issued not only by the government, but also by the municipalities and the State Mortgage Bank. From mid-1948 to December 1952 the increase of government bonds outstanding was wholly absorbed by the state institutions, other holders actually reducing their portfolios. In 1952 (see Table 15) the reduction of private holdings of government and municipal bonds was greater than the increase in private holdings of mortgage bonds, so that there was a small net decrease in private holdings of all official bonds. It is not known what the holdings of state and non-state investors were at any later date than December 31, 1952, but the gross issues of governm.ent bonds during the period January 1 to October 31, 1954 (173.6 niillion pesos) were placed thus:  - 15 - Allotted ("adjudicaciones") to state institutions 145 m. or 84% Sold to state institutions 23 m. or 13% Sold to private investors 6 m. or 3/0% 55. The bonds sold to both state and private investors can be regarded as mobilizing savings. The bonds "allotted" seem to be issued mainly to discharge government debts. For example, 95 million pesos of the 145 million allotted up to October 31, 1954, were passed to the Pension Funds to satisfy the government's arrears of payments due to those funds. The state of at least some of the pension funds is becoming, if not already, precarious. The fund for government workers ran into a deficit in 1954 when a new law granted retirement bonuses without making provision for increased revenue for the fund. To meet its obligations the fund liquidated some of its bond holdings through the larger Industries and Commerce Pensions Fund. 56. Table 12 shows that at the end of 1954, 442 million pesos of government bonds had been authorized but not issued; authorizations of 76 million pesos for the National Railways, 165 million for U .T.E., 42 million for consolidating deficits (incurred up to 1952) and 32 million for improving water supplies accounted for most of this total. Perhaps 80 million pesos of this authorized debt is expected to be covered by external loans, leaving say 360 million to be raised internally. On the basis of past sales it seems that roughly 40 million pesos of government bonds can be absorbed annually by savings held in state institutions or privately. Assuming no new authoriza- tions, these figures would indicate a nine-year program, at the past rate of absorption, if the bonds are to be issued against internal savings. Besides these calls on internal finance in the years ahead, however, there is a long- term public works plan and possibly other public investment such as a pro- posed cement plant. No complete account of these plans or intentions has been published. Annex III outlines proposals that have been mentioned from time to time and atternpts to assess roughly the internal finance that would be needed annually for the next few years if all these proposals were attempted. C. Prospects 57. Annex III is obviously not a precise statement of the public investment plans of the Uruguayan authorities, but the broad conclusion it arrives at probably expresses reasonably accurately the kind of problem facing the new government which took office in Niarch 1955. Proje_ted public capital expenditure to be met from internal financial resources totals about 80 to 90 million pesos annually; in addition it is intended to place about 30 million pesos of government bonds internally each year for the next few years to consolidate deficits already incurred, making 110 to 120 million pesos total annual internal financing. Perhaps 20 million of this could be raised annually from other internal funds (although this is doubtful on present indications), leaving 90 to 100 million to be financed by govern- ment bonds. Yet on present prospects bonds to the value of only 40 million a year can be exchanged for savings in the hands of state institutions and the public.  - 16 - 58. It can be seen that the long-term financing of deficits already incurred is to be a considerable burden on the finance available to the government in the next few years. At the rate of about 30 million pesos annually it will probably take about five or six years to fund deficits incurred up to the end of 195h. It is clearly of cr ucial importance for the longer-tern outlook that the government should stop running deficits on current account so that this call on the bond market should not continue indefinitely. 59. Looking at the prospect for the next few years it would seen that if the Uruguayan authorities cannot tap some new source of non-inflationary finance, and if they continue to fund past deficits at the rate they have indicated, they will be forced to cut their intended rate of capital expend- iture by more than half. Underlying this conclusion is the assumption that the ordinary budget and other public accounts will not continue to run defi- cits after 1954. If current deficits continue, the financing problern becomes worse; on the other hand if new sources of current revenue can achieve a budgetary surplus the problem becomes easier. Anothler assumption is that municipal and mort6,age bonds will continue to absorb savings at about their present rate. If these issues can be contracted, government bond issues rmay expand correspondingly. 60. Before it left office in February 1955 the outgoing governnent made some tentative efforts to borroi externally to finance the internal costs of its proposed public investment works, including power and railways whose external costs are expected to be met by IBRD loans. To do this would be to misuse Uruguay's external credit, for it would only increase the future burden of debt service without of itself attacking the causes of the problem. Such external borrowing would of course force the TBRD to review its proposed lending. 61. The solution for Uruguay's internal financial problem should not be sought in further external borrowing. The solution lies rather in steps whichv will lead to a balancing of the current budget and of the extra- budgetary accounts, and to an improvement in the bond market and in the attractiveness of goverrnent bonds. If such steps are taken the new govern- rnent's financing problem need not be unmanageable. The funding of past budget deficits can probably be spread over a long period, and as this fund- ing takes place it should make available some financial resources that a better-organized bond market could absorb. At the same time a postponement of less urgent public works will be necessary and will be possible without hardship to the economy.  - 17 - IV. EXTERNiL DEBT 62. At August 31, 1954, Uruguayan public extermal debt (including un- disbursed portions of official loans) was equivalent to -124.3 million, of which .p77.8 million, or 63%O, was U.S. dollar debt and P40 million equivalent (32%) sterling debt (T7able 1). Service payments were p8.7 million in 1954 and reach a peak of 4p0.8 million in 1955, falling slowly so that in 1965 service on present debt will still be over 48 million (Table 2). 63. External public debt outstanding as a percentage of national in- come is somewhat below that of Chile, but above that of Colombia and iYiexico. As a percentage of exports (1953) total external debt is about the same as Colombia's, and less than Mexico's. Peak debt service represents 4.6% of average 1949-1954 exports (0;235 million), a smaller figure than tha-t for Colombia or Iiexico. Proposed lending by the IBRD for livestock development, electric power and railway rehabilitation would raise peak debt service to P15.5 million in 1961, or 6-3/Lu; of average 1949-1954 exports. This would not be an unduly heavy burden. It would be inadvisable for the economy to take on any heavier debt burden than this, however, in present circumstances. The loans proposed are for high priority investment designed to raise pro- ductivity. Further external loans should not be assumed until it is seen that productivity is improving and inflationary pressures are not threaten- ing the economy. 64. The amount of new borrowing that can be in dollars must be con- sidered separately. Peak service payable in dollars on present deb-t is p7.5 million in 1955, or 13%o of average dollar exports in 1952 and 1953, which were K69 million. (Dollar exoorts here are exports to all Western Hemisphere countries except Brazil. Exports to the United States averaged $50 million in these two years.) If all the proposed IBRD lending were dollars, debt service in dollars would rise to 411 million in 1959 and 4P12.3 million in 1961, or 21%a of average 1952-53 dollar exports. 65. So long as non-dollar currencies are inconvertible, clearly uruguay should not assume debt service in dollars if it can secure the same advantages by borrowing in non-dollar currencies. But if non-dollar currencies cannot be borrowed or if dollar borrowing has other advantages, such as access to cheaper or better equipment, then some new, borrowing in dollars would be advisable, provided of course that the purpose of the loan is considered to be a real contribution to the economy's development. Uruguay's existing dollar debt service is burdensome, compared with dollar receipts from exports, and there is always the possibility of drought, or falling wool prices, or reduced U.S. purchases of wool cutting dollar receipts still further, temporarily or permanently.  66. There are, however, somne broad considerations to justify further borrowing in dollars, within the proposed iBH.D loans. Uruguay has an un- usually large gold reserve to draw upon in an emergency. It has a long tradition of discharging external debt obligations. It has been able to finance dollar trade deficits in the period since wVQorld war II, as outlined in paragraph 47, nven with little prospect of resurned convertibility of European currencies some new dollar lending would be justified. Tn addit-ion, undoubted progress is being made towards convertibility of European curren- cies, even if its comLing cannot be foretold with absolute certainty. It is not appropriate in this report to assess the prospects for achieving and maintaining convertibility; but if those prospects were considered favorable they would give further support to Uruguay's assumption of additional dollar debt.  ANNEX I NATIONAL INCOME, INVESTIPNT AND SAVINIG 1. A broad assessment of the progress made by Uruguay in recent years is handicapped by the absence of national income figures. An unof- ficial estimate has put the national income at about 1,900 million pesos in 1953, and this figure has been used as a base in broad estimates m.de for this report. 2. To estimate an index of total real output, figures of agricul- tural and pastoral production have been drawn upon, together with "impres- sions" of industrial output since no attempt has been made in Uruguay to measure total industrial output. The "impressions" are based upon such things as consumption of rawl materials and electric power and the views of Uruguayans close to manufacturing. Obviously the result is only a rough indication of industrial production. Allowing also for production other than agricultural, pastoral and industrial gives an index of real output as follows (base 1949 = 100): 1949 = 100 1952 = 101 1950 = 100 1953 = 102 1951 - 103 1954 _ 107 3. No index of terms of trade has been prepared in Uruguay. How- ever, movements in main export prices are known, and these have been combined for purposes of this report into an export prices index. Using the I.F.S. import prices index for all Latin lAmerica gives an estimated terms of trade index, i.e. Export prices, as follows (1949 = 100): Import prices 1949 = 100 1952 = 100 1950 = 135 1953 = 110 1951 = 180 1954 = 110 4. Combining the index of real output with the terms of trade in- dex for the export sector gives an estimated index of national income in real terms as follows: 1949 = 100 1952 = l1o 1950 = 110 1353 = 105 1951 = 12) 1954 = 110 5. Estimates of gross investment, based upon statistics of capital goods imports and building in Montevideo, indicate that the proportion of gross investment to national income has averaged about 18% from 1950 through 1953, reaching 20% in 1951 and 1952. Public investment, that is public works expenditure plus gross investment expenditure of the railways, U.T.E.,  and ANCAP, has been between 15s and 20'o6 of total gross investment. Hvlos't of TUruguay's investment has been financed internally in these recent years; but since capital can enter the country tihrough the free market and be unre- corded in any statistics it is impossible to be very definite on the pro- portions firnanced externally and internally. About 10%8 of private invest- ment was covered by private capital inflow recorded in the balance of pay- ments statistics (Table 11), and about 20% of public investment was financed by external borrowing, so that it would seem 80% to 90%"0 of gross investment was financed internally. 6. Savings available for financing investment are shown in part in Table 3, which gives annual changes in savings deposit accounts, life in- surance premiums and compulsory pension funds. These cavinge alone are probably equivalent to about 8% of national incorme - a high figure. Over half of this type of savings comes from pension funds. Besides the savings detailed in Table 3 there are business and other private savings to an amount unknown but probably large, especially since there is no personal income tax in Uruguay. In total, savings as a proportion of national in- come must be cornparatively high. Yet the calls on savings, in the form of investment and public current deficits, are also high, and it is argued in paragraph 15 of the foregoing report that total irzestment plus public deficits have been outrunning total domestic savings plus external borrow- ing, and contributing to inflationary pressures in the economy. - 2-