Uruguay - Economic memorandum

Report No. 3652-UR FILE COPY Economic Memorandum on Uruguay March 1982 Latin America and the Caribbean Region Country Programs Department II FOR OFFICIAL USE ONLY Donmen of the WkId Bank This docunent has a restricted distnbuton and may be used by recpents oy in the performance of their official duties Its contents may not otherwise be disclosed without World Baik authorization  CURRENCY EQUIVALENTS Exchange Rates Effective January 29, 1982 Currency Unit = New Uruguayan Peso Buying US$1.00 = NUr$11.699 Selling US$1.00 = NUr$11.729  FOR OFFICIAL USE ONLY This report is based on the findings of an economic mission that visited Uruguay in October 1980, consisting of: John H. Johnson (Mission Chief) Roberto Incer (Consultant) Juan Antonio Zapata (Consultant) Nessim Zagha (Young Professional) Irma Jacobsen (Research Assistant) The report was discussed with the Uruguayan government in November/December 1981. This report examines the economic stabilization and liberalization policies enacted between 1974 and 1981, and their implications for macro-economic policy management, the allocation of resources, external balance, growth, employment, income distri- bution, and long-range development prospects. Attention is drawn to the significant improvement in overall economic performance achieved between 1975 and 1980 in terms of a marked acceleration in output and employment growth, a strengthened external position, and more efficient resource allocation. High and variable inflation is noted as a persistent phenomenon during most of this period. Special consideration is devoted to movements in relative prices and interest rates arising from the introduction in late 1978 of a price stabilization and resource allocation strategy, which relies heavily on opening the economy via a slowing of exchange rate adjustments and a reduction of trade barriers. While the impact of these measures was immediately felt by the exporting sector, import- competing activities were affected only after some lag. By early 1982, major progress had been achieved toward slowing inflation, but developments otherwise pointed toward a weakening of Uruguay's economic position. The report suggests the adoption of prompt corrective measures restoring internal consistency to fiscal, wage, and external policies, so that the potential for growth may be renewed, while maintaining progress toward opening the economy. Also highlighted are recent policy actions affecting livestock and financial markets, and recommendations for additional measures to further reforms in these sectors. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  TABLE OF CONTENTS Page No. MAP COUNTRY DATA SUMMARY AND CONCLUSIONS .......................................... i-x I. RECENT ECONOMIC PERFORMANCE, 1976-81 1 Introduction. 1 Stabilization Policy Framework. 4 Monetary, Fiscal, and Financial Policies. 5 Domestic Monetary Adjustment and the Balance of Payments. 7 Results of the Reforms .9 - Growth and Resource Mobilization. 9 - The External Sector .11 Preannouncement of Exchange Rate Changes and Trade Liberalization as Price Stabilization Instruments .12 Results of the New Strategy. 12 - Prices. 12 - Money and Credit .13 Impact of Policies on Relative Prices of Domestic Tradeable and Non-Tradeable Goods. 14 Factors related to Inflation . .16 Development Issues Emerging from Current Stabilization Strategy .. 19 - Relative Prices of Tradeables and Non-Tradeables. 22 - Export-Oriented Industries .22 - Import-Competing Industries .27 - Capacity of Export and Import-Competing Sectors to Adjust 27 Economic Performance during 1981 ............................... 32 - Outlook for 1982 .39 - Policy Recommendations .42 - Implications of Relative Price Changes Within the Tradeables Sector .42 - Macro Policy Consistency .42 - Protection .43 - Non-Tradeables Prices .44 - General Government Services .44 - Investment Allocation .45 - Current Expenditures .46 - Social Security System .46 - Domestic Retail Trade Services .47  Cont ... TABLE OF CONTENTS Page No. II. LIVESTOCK DEVELOPMENT: POLICIES AND ISSUES Introduction ..48 Agricultural Stagnation ..48 - Instability of Livestock Policy .48 - Prices .50 - Export Marketing .50 - State Interventionism .55 - Geographic Concentration of Exports .56 - Hoof-and-Mouth Disease .56 - Prohibition of Live Cattle Exports .59 - August 1978 Reforms . .59 - Livestock Sector and Beef Export Industry .59 - Agricultural Imports .62 Implementation of the Reforms ..63 - Record of Intervention .63 - Export Marketing .65 Impact of the Reforms ..65 - The International Livestock Cycle .66 - Profile of the Livestock Cycle in Uruguay .67 - Domestic Macro-Policy Environment : Impact on the Livestock Sector Financial Crisis of 1980-81 .69 - Impact of Trade Liberalization and Cattle Price Decontrol on Rancher Gross Incomes and Costs .69 - Impact of Exchange Rate on Potential vs. Actual Producer Cattle Prices .73 - Impact on Rancher Indebtedness of Financial Liberalization and Agricultural Reform Policies .77 - Livestock Sector Borrowing Costs .77 - Livestock Sector Demand for Credit .80 Official Financial Relief Measures ..83 - Evaluation of Official Relief Measures .83 Policy Recommendations for Livestock Sector . .84 - Completing the August 1978 Reform Process .85 - Complementary Measures .86 III. FINANCIAL SECTOR DEVELOPMENT: POLICIES AND ISSUES 89 Introduction .89 Chronology of Major Financial Reforms .89 Results of Reforms to Date .90 - Credit Operations .90 - Structure of Bank Resources .90 Development Issues in the Financial Sector .97 Segmentation of Domestic Credit Markets .97 - Borrower and Economic Activity Risks .97 - Currency Denomination of Credit .99 - Type of Lending Institution .103  Cont... TABLE OF CONTENTS Page No. - BROU . ...................................................... 103 - PLAN AGROPECUARIO .......................................... 108 - BHU . ........................................................ 109 - Private Commercial Banks ................................... 109 Implications of Credit Market Segmentation for Development .... 110 Recent Government Measures to Reduce Interest Rates .... ....... 114 Recommendations ............................................... 115 - Liberalizing Bank Entry ....... ................. ............ 115 - Bank Supervision ............................. .............. 117 - Standardized Bank Financial Balances ......... .. ............ 117 - Early Warning System ....................................... 118 - Upgrading Staff in Comptroller's Department ........ ... ..... 118 - Uniform Regulatory and Institutional Environment for Banks . 119 - Transparency of Information .................. ... ........... 120 IV. SOCIAL DEVELOPMENT AND GROWTH PROSPECTS Current Labor, Wage, and Social Developments .................. 121 - Real Wage Rate Trends ................................. 121 - Income Distribution ................................... 125 - Government Social Expenditures ........................ 125 Economic Prospects ............................................ 125 External Finance .............................................. 125 ANNEX I. THE FINANCIAL SYSTEM OF URUGUAY - A DESCRIPTIVE FRAMEWORK 131 Banco Central del Uruguay .................................... 131 Banco de la Republica Oriental del Uruguay ................... 131 Commercial Banking System ..................................... 132 Banco Hipotecario del Uruguay ................................. 132 ANNEX II. EVOLUTION OF THE BANKING SYSTEM, 1934-74 ................... 133  LIST OF TABLES (TEXT) Table No. Title Page No. CHAPTER I I.1 GDP PER CAPITA, 1950-75 ..................................... 1 I.2 PUBLIC SECTOR FINANCE, 1958-80 .............................. 2 I.3 STOCK OF MONEY AND CREDIT, 1956-80 .......................... 3 I.4 SECTORAL GROWTH OF REAL GDP, 1956-80 ............ ............. 4 1.5 REAL INTEREST RATES ON LOCAL CURRENCY TIME DEPOSITS, 1952-81 . ...................... 5 I.6 ANNUAL GROWTH OF NET CENTRAL BANK DOMESTIC ASSETS, 1971-80.. 6 I.7 BALANCE OF PAYMENTS, EXTERNAL DEBT, AND INTERNATIONAL RESERVES, 1956-80 .................................................. 7 I.8 AVAILABILITY AND USE OF RESOURCES, 1956-80 ............... .. 10 1.9 CONSUMER AND WHOLESALE PRICE INFLATION, 1976-81 .... ........ 12 I.10 RELATIVE PRICES OF TRADEABLE AND NON-TRADEABLE GOODS, 1975-80 15 I.11 SELECTED EXTERNAL AND INTERNAL INFLATIONARY FACTORS, 1976-80 17 I.12 STRUCTURE OF IMPORTS, CIF 1976-80 ..20 1.13 ESTIMATED FIRST-ORDER DOMESTIC INFLATIONARY IMPACT OF REDUNDANT PROTECTION, 1978-80..... 21 I.14 SELECTED INDICES OF BASIC INDUSTRIAL COSTS FOR EXPORTERS, 1975-80 ..23 I.15 ESTIMATED COMPOSITE COST INDICES FOR EXPORT-ORIENTED INDUSTRIES, 1975-809 7 5 - 80........... .. . 24 I.16 INDICES OF INTERNATIONAL PRICES FOR MAJOR URUGUAYAN EXPORTS BY INDUSTRIAL BRANCH, 1975-80 .25 1.17 NOMINAL EFFECTIVE EXCHANGE RATES BY EXPORT PRODUCT GROUP ..... 26 I.18 REAL EXCHANGE RATES FOR EXPORT-ORIENTED INDUSTRIES, 1975-80 28 I.19 VOLUME EXPORT INDICES BY INDUSTRIAL BRANCH, 1975-80 .... ..... 29 I.20 VOLUME INDICES OF INDUSTRIAL PRODUCTION BY BRANCH OF ACTIVITY 1975-1980 ................................................ 30 I.21 INDICES OF TOTAL MANHOURS WORKED BY BRANCH OF INDUSTRIAL ACTIVITY, 1975-1980 ....................................... 31 I.22 VALUE-ADDED PRODUCED PER WORKER HOUR BY BRANCH OF INDUSTRY, 1978 ............................................... ....... 33 I.23 INDICES OF LABOR PRODUCTIVITY BY BRANCH OF INDUSTRIAL ACTIVITY, 1975-1980 ....................................... 34 I.24 ESTIMATED REAL GROWTH OF EXPORTS IN 1981 ................... 36 I.25 VOLUME OF INDUSTRIAL GROWTH IN SELECTED PERIODS, 1980-81 ..... 36 I.26 COURT PETITIONS FOR DEBT RESCHEDULING, 1966-81 ............. . 37 I.27 INDEX OF PRIVATE SECTOR DOLLAR WAGES BASED ON MINIMUM SALARY INCREASES DECREED IN PESOS FOR MONTEVIDEO REGION, 1976-81 ... 38 I.28 GENERAL GOVERNMENT EXPENDITURES, 1976-81 ..................... 45 1.29 SOCIAL SECURITY SYSTEM OPERATIONS, 1976-81 ................... 47 CHAPTER II II.1 LIVESTOCK POLICY BY SUB-PERIOD, 1957-81 ..................... 49 II.2 LIVESTOCK INVESTMENT AND PRODUCTIVITY INDICES, 1970-81 ....... 51 II.3 REAL LIVESTOCK PRODUCER PRICES AND GROSS LIVESTOCK OUTPUT, 1965-80 .................................................... 52  Cont.. LIST OF TABLES (TEXT) Table No. Title Page No. II.4 DOMESTIC AND INTERNATIONAL, LIVEWEIGHT BEEF CATTLE PRODUCER PRICES, 1978-80 ............................................ 53 II.5 EXPORTS OF REFRIGERATED, COOKED AND PROCESSED BEEF AND MUTTON, SELECTED YEARS, 1907-1980 ......................... 54 II.6 DIRECTION OF CHILLED AND FROZEN BEEF EXPORTS, SELECTED PERIODS, 1960-80 ................................ 57 II.7 REGISTERED AND UNREGISTERED EXPORTS OF CATTLE-ON-HOOF IN SELECTED YEARS, 1965-JUNE 1981 ........................... 60 II.8 PRODUCER AND EXPORT PRICES OF BEEF IN URUGUAY AND BRAZIL, 1966-80 .61 II.9 PERFORMANCE INDICATORS, BEEF LIVESTOCK SECTOR, 1966-80 64 II.10 QUARTERLY STATEMENT OF PROFITS AND LOSSES IN THE PRIVATE FRIGORIFICO INDUSTRY, OCTOBER 1973 TO JUNE 1980 .......... 70 II.11 FINANCIAL RATE OF RETURN ON CAPITAL INVESTED IN LIVESTOCK OPERATIONS BY FARM YEAR, 1973-81 ......................... 71 II.12 INDEX OF REAL RETAIL PRICES OF SELECTED AGRICULTURAL INPUTS, AUGUST 1975-AUGUST 1980 ...... ........................... 72 II.13 RELATIVE PRICES OF INPUTS AND OUTPUTS IN BEEF LIVESTOCK PRODUCER SECTOR, 1975-81 ................................. 74 II.14 ESTIMATED TRANSFER OF REAL EXPORT INCOME FROM LIVESTOCK SECTOR, 1965-MARCH 1981 ...... ........................... 75 II.15 ESTIMATED TRANSFER OF REAL EXPORT INCOME FROM LIVESTOCK SECTOR, BY SOURCE, 1965-MARCH 1981 ....................... 76 11.16 ESTIMATED MOST FREQUENT NOMINAL AND REAL ANNUAL LENDING RATES TO THE LIVESTOCK SECTOR IN SELECTED YEARS, 1960-81. 78 II.17 LOANS OUTSTANDING TO AGRICULTURAL SECTOR BY FINANCIAL SOURCE, 1969-81 ........................................... 79 1I.18 REAL INDEBTEDNESS OF THE AGRICULTURAL SECTOR, END 1969 TO END JUNE 1981 ............................... ............ 81 II.19 LIVESTOCK HERD SIZE, 1916-1980 ............................. 82 CHAPTER III III.1 STOCK OF REAL OUTSTANDING CREDIT TO THE PRIVATE SECTOR BY CLASS OF BANK, 1974-SEPT. 1981 .93 III.2 SUMMARY OF KEY FINANCIAL SYSTEM PERFORMANCE INDICATORS, 1974-Sept. 1981. 94 III.3 STOCK OF REAL FINANCIAL ASSETS OF NON-BANK PRIVATE SECTOR, 1974-SEPT. 1981 .95 III.4 CURRENCY ARBITRAGE BY PRIVATE COMMERCIAL BANKING SYSTEM, DEC. 1976-JUNE 1980 .104 III.5 ESTIMATED DISTRIBUTION OF CREDIT BY SECTOR AND SOURCE, END-1979 .105 III.6 CURRENCY COMPOSITION OF LOANS AND DEPOSITS BY CLASS OF COMMERCIAL BANK, END-1976 TO JUNE 1980 .111 III.7 AVERAGE COMPOSITION OF PRIVATE COMMERCIAL BANK EARNINGS AND EXPENSES BY BANK SUB-GROUP DURING FISCAL YEARS 1976-79.... 112 III.8 DISTRIBUTION OF PRIVATE COMMERCIAL BANK LENDING BY SOURCE, END 1975 TO JUNE 1980 .113  Cont.. LIST OF TABLES (TEXT) Table No. Title Page No. III.9 AVERAGE PESO SAVINGS DEPOSIT AND LENDING RATES IN THE PRIVATE BANKING SYSTEM, 1952-SEPT. 1981 ............... 134 III.10 SUMMARY INDICATORS OF PRIVATE BANKING SYSTEM, SELECTED YEARS, 1957-80 .135 CHAPTER IV IV.1 SELECTED COMPARATIVE SOCIAL INDICATORS .122 IV.2 INCOME CONCENTRATION INDICES, SELECTED YEARS, 1966-81 .123 IV.3 EVOLUTION OF SHARE DISTRIBUTION OF HOUSEHOLD WAGE INCOME IN MONTEVIDEO REGION, SELECTED YEARS, 1968-81 .126 IV.4 REAL EXPENDITURES BY FUNCTION, CONSOLIDATED CENTRAL GOVERNMENT, 1972-80 .. .... . 127 IV.5 PROJECTED NATIONAL ACCOUNTS, 1982-87 .129 IV.6 PROJECTED BALANCE OF PAYMENTS, EXTERNAL CAPITAL REQUIREMENTS AND FINANCING, 1982-87 ...................... 130  LIST OF CHARTS Chart No. Page 1So. 1 Real Beef Prices and Beef Exports, 1965-March 1981 .... ..... 68 2 Destination of Net Banking System Credit ............... .. ... 91 3 Origin of Net Banking Credit ........... .................... 92 4 Financing of Banking System Credit ......................... 96 5 Segmentation of Financial Credit Market by Source, Destination, and Currency Denomination of Credit 98 6 Estimated Private Commercial Bank Mean Annual Lending Rates in Local Currency by Borrower's Line of Economic Activity, 1977-April 1981 .100 7 Private Commercial Bank Interest Rates in Local and Foreign Currency, December 1976-April 1981 ..... 101 8. Representative Real Bank Lending Rates by Source and Destination of Credit, 1977-April 1981 .102 9. Most Frequent Lending Rates Charged by BROU and Private Commercial Banks, Range and Average by Sub-Group, July 1979-June 1980 ..107 10. Industrial Real Wage Rate and Employment Trends, 1940- September 1981 .......... . ......... 124  _~~1 ~ ~ _- - - - - - - - - _ _ _ _ _ _ _ - - 1~~ -5 K0~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~0 URUGUAY & Maoin Roads _____Secrndery Roads Main Airports + Secondary Airports| Department Boundaries - -i to-