Fitch Confirms Uruguay’s Investment Grade BBB-, Warns of Inflation and Public Debt

RIO DE JANEIRO, BRAZIL – Fitch Ratings, one the world’s leading credit rating agency has confirmed Uruguay’s Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘BBB-‘, however with a Negative Outlook, despite the country faring much better than its neighbors.

The Negative Outlook reflects deterioration in growth and public finances that has been compounded by the coronavirus shock, and risks to government plans to arrest these trends. Deft management of the pandemic has underscored Uruguay’s institutional strengths and helped its economy fare better than it neighbors.

But Uruguay has faced sluggish growth and a recession that predates the crisis, despite ramp-up in a large pulp mill project (UPM), reflecting structural issues which are likely to persist. High public debt-to-GDP is projected to rise sharply and diverge further from the peer median in 2020 despite a smaller fiscal expansion, given the high starting point of the fiscal deficit and a dollarized debt stock sensitive to exchange-rate swings.

The new administration of president Luis Lacalle Pou aims for a swift fiscal consolidation after 2020, but this could be difficult to achieve in the absence of the high growth rates expected in its new five-year budget, given downside domestic and external economic risks.

The ratings are also supported by robust external liquidity, prudent debt management practices, and stable (albeit low) economic growth. These strengths are counterbalanced by high inflation and dollarization and low financial intermediation that narrow scope for counter-cyclical policies, although the authorities have laid out plans to tackle these issues in the coming years.

Fitch projects Uruguay’s economy will contract by 4.6% in 2020, a moderate decline relative to peers that reflects its successful containment of the pandemic and a less severe lockdown, the ramp-up in the UPM project, and the outsized weight of telecom activity in GDP data (the 2Q20 contraction of 11% yoy was 16% net of this).

Growth rates could be subject to change in new 2016-base GDP data set for release in December as these are likely to re-weight telecom and include new activities, also resulting in higher nominal GDP.

Fitch projects growth to rebound 2.8% in 2021 and 2.0% in 2022, below the authorities’ baseline given a greater drag from real wage losses and fiscal austerity, risks to exports and tourism (the pandemic, record-strong exchange rate relative to neighbors, and Argentine capital controls), and a smaller contribution from UPM (negative in 2021-2022 as project outlays decline, and positive in 2023-2024 as exports begin).

Fitch projects the central government and social security (CG+BPS) deficit will rise to 7.3% of GDP in 2020 from 4.3% in 2019 (net of “cincuentones” pension transfers), a smaller rise than in peers but above the official projection of 6.6%. This reflects the shock to revenues and spending increases related to the pandemic, partially offset by extraordinary dividends from the state-owned commercial bank (BROU).

The five-year budget aims to reduce the CG+BPS deficit to 3.8% of GDP in 2021 and 2.7% by 2024 by containing spending growth below high expected GDP growth. The plan centers on a 4.8% cut in real primary spending in 2021 – mostly in opex, investment and wages, but also reflecting phase-out of all pandemic transfers – followed by increases averaging 2.3% in 2022-2024.

Fitch projects a slower fall in the deficit to 5.2% of GDP in 2021 and 4.8% in 2022 as lower GDP growth results in a smaller reduction in spending/GDP. Fitch expects pension pressures to ease amid a real decline in wages (to which benefits are indexed) but that these outlays will exceed budget estimates, as has already occurred in 2020. Pressure for restitution in public and private real wages, which the government has pledged after 2021, and political factors could make austerity more difficult further into the five-year term.