Uruguay 'BBB/A-2' Ratings Affirmed; Outlook Remains Stable

Foreign Currency: BBB/Stable/A-2
Local Currency: BBB/Stable/A-2
For further details, see Ratings List.

OVERVIEW
  • Uruguay's GDP is likely to continue to grow in 2019 at 0.9% despite a challenging international context.
  • A growing level of mandatory spending and only limited room to adjust revenues will contribute to fiscal deficits that are likely to gradually increase net general government debt above 60% of GDP by 2021.
  • We are affirming our sovereign credit ratings on Uruguay at 'BBB/A-2'.
  • The outlook remains stable, reflecting our view of high fiscal deficits and a gradually increasing debt trajectory in a context of subdued economic growth and political stability.
RATING ACTION
On May 7, 2019, S&P Global Ratings affirmed its 'BBB' long-term foreign and 
local currency sovereign credit ratings on Uruguay. In addition, we affirmed 
our 'A-2' short-term foreign and local currency ratings. The outlook on the 
long-term ratings remains stable. 

The transfer and convertibility assessment is unchanged at 'A-'.

OUTLOOK
The stable outlook reflects our view of continuity in key economic policies 
after national elections later this year. We expect that, over the next two 
years, Uruguay will continue to show high general government (GG) fiscal 
deficits and an increase in its net GG debt burden. At the same time, we 
expect that Uruguay will continue to sustain GDP growth, with per capita GDP 
likely expanding by 1.8% per year during 2019-2021. 

A sustained decline in inflation, along with further deepening of local 
capital markets, could facilitate the government's ongoing efforts to increase 
the share of local currency in its debt stock. A falling exposure to 
foreign-currency-denominated debt could reduce the hit of exchange-rate 
fluctuations on the sovereign's balance sheet and improve the conduct of 
monetary policy, potentially leading to a higher rating over the next two 
years. We could also raise the ratings if a combination of good GDP growth and 
greater-than-expected fiscal consolidation measures contain fiscal slippage 
and decrease the debt burden.

We could lower the ratings on Uruguay over the next two years if failure to 
advance on important investment projects and on policies to reverse the 
current decline in investments undermine the government's revenue generation 
base. In this scenario, the already high GG deficit and the net GG debt burden 
could continue to rise beyond our expectations.  

RATIONALE
Our ratings on Uruguay are supported by its track record of prudent and 
predictable economic policies and its well-established institutions, which 
have underpinned consistent economic growth over the past 16 years. The 
ratings also benefit from Uruguay's strong external position. Uruguay's 
persistently high--and increasing--fiscal deficits and debt burden are 
constraints on the sovereign ratings, as are its relatively high inflation and 
still high level of dollarization in the financial system. The ratings also 
reflect the sovereign's per capita GDP of US$16,500 in 2019, one of the 
highest in Latin America.

Institutional and economic profile: Well-established institutions and policies 
to promote investment will continue to support economic growth
  • We expect Uruguay's GDP growth to average 2.1% in 2019-2022, propelled by strong exports and new investments.
  • We expect that the government will be able to reverse a recent decline in real investment and to improve the country's physical infrastructure.
  • Uruguay's strong checks and balances and low perception of corruption, which sustains investor confidence in the country, continue to support economic policies.
Uruguay has been growing consistently over the past 16 years, and we expect 
growth to average 2.1% in 2019-2022. We expect the economy to decelerate in 
2019, with a modest 0.9% GDP growth. High unemployment, around 8.6% of the 
workforce, and an average inflation rate of around 7.6% should continue to 
limit private consumption, while investment has yet to fully recover following 
four years of consecutive drop. At the same time, while Uruguay has made 
considerable progress in reducing its economic exposure to its two neighboring 
countries, the current recession in Argentina has hurt tourism. There was a 
30% decrease in visitors from Argentina to Uruguay in 2018. Because we expect 
the Argentine economy to remain in a recession in 2019, our base case is that 
tourist inflows from this country to Uruguay will remain weak in 2019 and are 
likely to dampen the part of the services sector that has greatly benefited in 
the past from increased tourism. 

At the same time, exports of goods and services should remain strong, thanks 
to a recovery in Uruguay's traditional exported commodities and stable 
performance of exports of nontraditional services. Gradual increases in 
investment will buttress economic growth. We expect that by the second half of 
2019, large infrastructure projects through public-private partnerships that 
the government has been pursuing will start to slowly materialize. From 2020 
on, investment should gain traction and reverse the four-year decline. 
Furthermore, the second round of wage negotiations that the government 
initiated in March 2018 should contribute to containing unemployment from 
increasing, reduce inflation inertia, and consequently steer inflation toward 
the central bank target range by 2021. 

In 2018, GDP grew 1.6%, following 2.6% growth in 2017, and we estimate GDP per 
capita around US$17,800 between 2019-2022. The real GDP per capita growth rate 
should average 1.5% over the next three years. We expect that the government's 
planned investments in a variety of sectors, including an US$800 million 
public-private partnership railroad, and the potential investment by 
Finland-based forest and paper company UPM-Kymmene Corp. (UPM) in the country, 
will have positive effects for the economy as a whole and thus continue to 
buttress GDP per capita above Latin American standards.

We believe that Uruguay's broad political consensus and its stable and 
well-established institutions have anchored--and will continue to 
anchor--economic stability. We expect that in the last year of President 
Tabaré Vazquez's Administration, from the Frente Amplio, a coalition of 
parties from the moderate to the extreme left, policymaking will continue to 
target growth through the accomplishment of large infrastructure projects and 
foreign investment.

Meanwhile, we believe that the pace of fiscal consolidation will be very slow 
and extend beyond the timeframe announced by the government in its yearly 
budget revision in 2018. Given the current electoral context and already high 
tax burden, in addition to the announcement in 2018 that the government 
wouldn't make any further tax increases, as well as the high level of 
nondiscretionary spending (that continues to increase), we expect that fiscal 
consolidation and consequent decline in GG deficits will extend beyond 2022. 
At the same time, we do not expect abrupt changes in policymaking in Uruguay 
given the current electoral context and change in administration.

Uruguay continues to have a strong democracy and ranks highly in global 
institutional quality rankings. Institutional strength sustains investor 
confidence in the country despite adverse economic and political events in 
neighboring Argentina and Brazil. Uruguay is a largely middle-class society 
with a relatively strong social contract that emphasizes consensus and social 
cohesion. The country ranks highly in international scores for governance and 
has the best ranking, indicating the least corruption, in Latin America and 
across global emerging markets in Transparency International's 2018 Corruption 
Perceptions Index. The Economist Intelligence Unit ranked Uruguay first in 
Latin American in its Democracy Index.

Flexibility and performance profile: Lower GDP growth, persistent fiscal 
deficits, and likely moderate peso depreciation will lead to increasing debt 
levels

  • We expect that modest GDP growth and persistent fiscal deficits will lead to an increasing debt burden, with net GG debt likely to exceed 60% of GDP in 2021.
  • We expect the current account deficit (CAD) to remain below 2% of GDP in the next two years, sustaining Uruguay's favorable external position.
  • Inflation is likely to be 7.6% in 2019 and average 7.1% in the next couple of years.
In late 2017, Congress approved changes to the social security system wherein 
groups of future retirees in private pensions are able to return to the 
public-sector pension system. This boosted government revenues in 2018 by 1.3% 
of GDP, which contributed to a lower GG deficit. The estimated GG deficit 
stood at 2.7% of GDP in 2018, including the one-off revenues from the pension 
system (the deficit would be 4% of GDP excluding such revenues). Our 
definition of the GG includes the central bank and excludes public-sector 
enterprises. In its yearly budget revision in 2018, the government announced 
it would not make any further tax changes. We do not expect any changes to 
occur in this year's budget revision, either.

At the same time, while the one-off revenues will continue to flow to the 
general government in 2019 and 2020, we expect the GG deficit to average 2.6% 
of GDP in these years. We expect the GG deficit to widen to an average of 3.5% 
of GDP in 2021-2022 as the government will no longer be receiving these 
one-off revenues. Moreover, we do not expect material fiscal consolidation 
measures to be taken until 2021, when there is a new five-year budget.

While the headline deficit and estimated GG deficit in 2018 have shown an 
improvement, the change in net GG debt for the prior year was 6.2% of GDP. Net 
GG debt increased to 58.3% of GDP. Part of the increase stems from the sharp 
peso depreciation in 2018, as around 50% of the GG debt is denominated in 
foreign currency. Part of the increase reflects government deficits (without 
considering the one-offs from the pension system). Since our base case assumes 
ongoing peso depreciation in 2019-2022, high GG deficits (without taking into 
account the extraordinary revenues), and possible continuation of the central 
bank policy of issuing debt to intervene in the foreign currency market to 
contain depreciation, we see the net GG debt increasing in the next three 
years. We estimate changes in net GG debt at around 5.8% of GDP in the next 
three years. Our expectation is that Uruguay's net GG debt will reach 60% of 
GDP by 2021 and will continue to increase in the following years. We also 
expect GG interest payments to average 7.5% of GG revenues between 2019 and 
2022.

Effective debt management has significantly reduced the risks of Uruguay's 
debt profile. This is reflected in the central government debt management 
milestones, which show that average maturities have continued to increase and 
are now about 14 years, from eight years in 2005. About 95% of the central 
government debt is at a fixed rate, compared with 78% 14 years ago, and bonds 
compose 91% of central government debt, while 9% are loans. External market 
debt accounts for 78% of debt, while local market debt is about 22%.

We expect the government to continue to meet its financing needs primarily 
through bond issuances and increasingly through multilateral financing 
sources. International bond issuances--most recently a US$1.25 billion bond 
issued in January--have helped to boost liquidity and extend maturities. The 
government has also continued with its prefinancing policy to cover debt 
service payments for the subsequent 12 months. The strategy of prefunding 
amortization payments by holding substantial levels of liquid assets provides 
insulation against Uruguay's external vulnerabilities but also has a fiscal 
cost. As of March 2019, the government's liquid assets and contingent credit 
lines represented 8% of our estimated GDP for the year. 

The accumulated inflation rate reached 8.2% in April, and inflation 
expectations over the next 12 months remain above the central bank target 
range of 3%-7%. By the end of 2019, we expect that inflation will remain above 
the central bank target, as continued depreciation of the Uruguayan peso and 
pass-through effects to the tradable sector will continue to put pressure on 
prices. At the same time, ongoing efforts to reduce the indexation of wages to 
inflation will counterbalance the potential volatility of the currency. 

High inflation and still high dollarization continue to limit Uruguay's 
monetary-policy flexibility. They also pose risks to the financial sector, 
should sudden spikes in the exchange rate occur. Over 50% of resident loans 
are denominated in dollars, while more than 70% of resident deposits are 
denominated in dollars. 

At the same time, despite still high levels of dollarization, the Uruguayan 
banking system remains relatively healthy and resilient. We classify it in 
group '6' of our Banking Industry Country Risk Assessment (or BICRA, see "
Banking Industry Country Risk Assessment: Uruguay," published Aug. 6, 2018. 
BICRAs are grouped on a scale from '1' to '10', ranging from what we view as 
the lowest-risk banking systems, or group '1', to the highest risk, or group 
'10'). The level of deposits increased around 13% in 2017, essentially 
mimicking the depreciation of the Uruguayan peso and not reflecting an actual 
increase. Nonresident deposits accounted for 9% in 2018, flat compared with 
2017. 

The financial system's (consisting of private and public banks) asset-quality 
metrics remained stable, with nonperforming loans (NPLs) accounting for 3.2% 
of total loans in 2018, from 3.4% in 2017. We expect NPLs to remain around 3% 
in 2019. 

Uruguay's external sector has remained resilient despite unfavorable regional 
and global conditions. While the current account posted a deficit of 0.6% of 
GDP in 2018, Uruguay's trade and services balance posted a surplus of 3.9% and 
1.9% of GDP, respectively, despite the recession in Argentina and resulting 
decline in tourism and the drought that affected the country in the first 
months of 2018. Uruguay's main exports continued to be beef, cellulose, dairy 
products, and soybeans, which declined in volumes because of the drought that 
hurt the 2017-2018 harvest. 

Our base case assumes that the CAD will be 1.3% of GDP in 2019, growing to 
around 2% of GDP by 2022. We expect a pickup in foreign direct investment 
between 2019 and 2022, matching the projected CAD, because of large 
infrastructure investments, including construction of the second pulp mill by 
UPM. Gross external financial needs should remain around 91% of current 
account receipts (CAR) plus usable reserves in 2019 and average 92% over the 
next three years. Given Uruguay's still narrow and shallow domestic capital 
markets, the sovereign depends on external debt. We expect Uruguay to continue 
financing half of its central government deficit abroad, and thus narrow net 
external debt should be around 32% of CAR in 2019.
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