Fitch issued a note on Uruguay after the narrow victory of Luis Lacalle Pou of the center-right National Party after 15 years of rule by the center-left Frente Amplio. Pou faces the challenge of reducing a large fiscal deficit in the face of low growth.
Fitch issued a note on Uruguay after the narrow victory of Luis Lacalle Pou of the center-right National Party after 15 years of rule by the center-left Frente Amplio. Pou faces the challenge of reducing a large fiscal deficit in the face of low growth.
Fitch issued positive comments saying political stability is a credit strength amid volatility elsewhere in Latin American, but stabilizing the debt burden will test the administration’s capacity for decisive and credible policy action.
The narrow victory of Luis Lacalle Pou of the center-right National Party marks a change of government after 15 years of rule by the center-left Frente Amplio. Lacalle has pledged to lift anaemic growth rates and cut the fiscal deficit to stabilize rising government debt. These trends led Fitch to revise the Outlook on Uruguay’s ‘BBB-’ rating to Negative in October 2018 and have worsened since then. Fitch said Uruguay’s institutional stability has helped avoid dramatic policy shifts in the past, but it does not guarantee decisive action on economic challenges, as evidenced by some reform inertia and erosion in policy credibility in recent years.
Fitch note on Uruguay
Real GDP growth has averaged just 1.3% since 2015, and even this slow pace has been largely driven by only a few non-labor-intensive sectors, chiefly telecommunications. Fitch expects growth to pick up to 1.5% in 2020 from 0.3% in 2019 as construction on a large UPM pulp mill and other infrastructure projects advances. Beyond this, growth prospects appear muted following a dramatic 32% contraction in fixed investment since 2014 (even greater than in Brazil).
Lacalle has pledged to address key obstacles to competitiveness, including lowering utility rates and adopting more flexible salary and labor policies. However, while the National Party has formed a coalition that will give it a legislative majority, its diverse ideological makeup could hinder ambitious reforms. For example, in a document outlining its shared goals, the coalition dropped plans to liberalize fuel imports to incorporate the views of more left-wing factions. Inclusion of Cabildo Abierto, a socially conservative party, could create friction within the coalition. Fiscal consolidation is a key challenge.
The public sector primary deficit rose to 1.7% of GDP in October, net of extraordinary pension revenues, from 0.8% in 2018. Fitch projects general government debt will reach 66% of GDP in 2019 (including bonds issued to recapitalize the central bank), having risen 17pps in the last five years – the biggest increase in the ‘BBB’ category. Fitch estimates that a 2.5pp-of-GDP improvement in the primary deficit would stabilize debt, but this may require more than 2.5pps in measures given persisting spending pressures.
Stronger growth would support consolidation, but we believe its impact could be much smaller than implied by the outgoing government’s estimate that the economic slowdown explains 1pp of GDP of the wider deficit. Tax revenues have not fallen as a share of GDP despite sluggish growth. This resilience is positive but highlights how structural spending pressures have driven fiscal deterioration. Primary current spending has risen by 3pps of GDP since 2014, widely overshooting budget projections every year including 2019 (the 0.8pp-of-GDP rise through October far surpassed the June projection of 0.1pp).
The new government has committed to containing spending to lower the deficit rather than raise taxes, but this could be difficult. Pledged spending cuts of USD900 million (1.6% of GDP) have met some scepticism from current and former government officials and may face implementation challenges. Social security reform, while widely understood across the political spectrum to be necessary, could take time to negotiate and much longer to yield savings. Even then, these savings may only stabilize spending rather than lower it and contribute to deficit reduction.
Parts of the government’s growth agenda (e.g. utility rate cuts) could conflict, to some degree, with fiscal consolidation. The administration’s five-year fiscal goals, to be released in next year’s budgeting exercise, will indicate how it hopes to balance these tradeoffs.
Source: Fitch
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