Scenario Review – Uruguay: Better economic outlook for 2018

Activity in the region is recovering, and Uruguay is likely to benefit.

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• We expect 3% GDP growth this year, and we have revised our 2018 GDP forecast to 3% from 2.5% due to the improved scenario for Argentina and Brazil.

• Inflation went up in October but remains within the BCU’s target range. We expect consumer price inflation rates of 6.5% this year and 7.5% in 2018.

We have adjusted our 2018 GDP growth forecast

Activity in the region is recovering, and Uruguay is likely to benefit. On the domestic front, there has been an improvement in business sentiment. According to the latest Deloitte business survey, most participants stated that they were optimistic about next year (only 15% of participants expect the scenario to deteriorate in the next 12 months). Meanwhile, the CERES index rose by 0.5% mom in August, following a 0.4% increase the previous month. The diffusion index reached 77% in August, up from 62% in July. The index already anticipated the expansion in 3Q17 and the August result represented the first positive signal for 4Q17. Meanwhile, the La Teja refinery has already started operating after being closed for several months due to the technical stoppage and will likely contribute positively to Uruguay’s industrial production.

Consumer confidence has returned to the zone of moderate pessimism but is still running above its 2016 levels. The consumer confidence index compiled by Universidad Católica (UCU) fell by 3.9% mom in September, following a 10.6% increase in August. All the sub-indices that compose the index deteriorated at the margin. “Willingness to buy durable goods” fell by 7.8% mom in the month, while “personal economic situation” decreased by 2.7% and “economic situation of the country” fell by 2.5%. The confidence index is 3.1% above the level recorded in the same month of last year.

Job creation remains weak. The unemployment rate climbed to 7.8% in August 2017 from 9% in March (the highest reading since September 2007). Unemployment was 0.1% above the reading recorded in the same month of 2016. The activity rate declined by 1.1% yoy in August, while employment fell by 1.1% yoy. The increase in real wages could be attributable to slower employment creation. We expect the unemployment rate to average 8% this year, broadly unchanged from 2016 (7.9%) despite the recovery of the economy.

The negotiations between the government and UPM continue. The negotiations for the installation of a third pulp mill have advanced and the government expects a response from the company shortly. The first step would be infrastructure work, notably the construction of a railroad that would link the new plant to a deep-sea port, and would be carried out through a public-private partnership (PPP). If this project goes ahead, we will likely have to correct our medium-term growth forecast due to the size of the undertaking.

We have increased our 2018 GDP growth forecast to 3% from 2.5%, supported by higher growth in Brazil and Argentina, Uruguay’s main trading partners, and the La Teja oil refinery operating normally. Our 2017 GDP growth forecast remains at 3%.

Expected pick-up in inflation

Inflation accelerated for the third consecutive month. Consumer prices rose by 0.46% mom in October, taking the annual reading to 6.04%, up from 5.75% in September. The October inflation rate was slightly higher than the market expected (0.4%) according to the latest survey by the BCU. The October number reflects an increase in food and non-alcoholic beverage prices (+0.56% mom, with an impact of 0.15). We would highlight the rise in the prices of meat, legumes and vegetables and an increase in clothing and footwear prices (1.62%). Annual inflation remained within the central bank’s target range (3%-7%) for a seventh consecutive month. Trend inflation (a measure produced by the consulting firm CPA Ferrere that excludes volatile components) rose to 7.1% in October from 6.9% in September. Our YE17 inflation forecast remains at 6.5%, incorporating a temporary reduction in electricity prices as the government implements the UTE premium program again in December.

Our YE18 inflation forecast remains at 7.5%, due to the prospect of a weaker currency next year. 

Loans decelerated in 3Q17. Private-sector loans denominated in local currency grew by 1.8% yoy in 3Q17, down from 2.7% and 6.6% yoy in 2Q17 and 1Q17, respectively. Private sector loans denominated in foreign currency decreased further (-3.2% in 3Q17, from -2.6% in 2Q17 and -0.1% yoy in 1Q17). On the other hand, private-sector deposits denominated in local currency grew by 16.6% yoy in 3Q17 (+12.9% yoy in 2Q17), while private-sector deposits denominated in foreign currency decreased by 9.2% yoy (-7.0% in 2Q17), mainly due to a decline in non-resident deposits. In fact, the proportion of non-resident deposits in total deposits in hard currency reached a historical low (13.9%). Thus, the dollarization of the economy remains high: 75% of deposits and 52% of total loans are denominated in foreign currency.

The BCU purchases dollars, and international reserves continue to soar

The central bank purchased USD 269 million in the FX market in October and has purchased USD 3.0 billion since the beginning of the year. Moreover, the monetary authority stipulated that purchases of monetary regulation bills are to be exclusively in pesos (previously it was also possible to make these purchases in USD). Our exchange-rate forecasts remain at 29.5 UYU/USD for 2017 and 31.7 UYU/USD for 2018.

International reserves have reached their highest mark in the last two years. At the end of October international reserves reached USD 15.5 billion, marking a USD 2.0 billion increase since the end of 2016. Reserves currently represent around 26% of GDP and are equivalent to 24 months’ worth of imports. We have adjusted our YE17 and YE18 international reserves forecast to USD 16.0 billion, up from USD 14.5 billion in our previous scenario.

Higher exports improve the trade balance

Exports of primary products are boosting the trade balance. The FOB trade balance (excluding free-trade zones) showed a USD 79 million surplus in September, reversing the USD 52 million deficit observed in the same month of last year. The 12-month FOB trade balance showed a USD 47 million surplus in September, up from a USD 600 million deficit in December 2016. Exports grew by 31.2% yoy in September, once again driven by the exports of primary products (+62% yoy) and to a lesser extent by manufacturing exports (+12% yoy). Imports, on the other hand, increased by 7.9% yoy, as higher purchases of consumer goods (16% yoy) and intermediate goods (7.4% yoy) were partly offset by a fall in purchases of capital goods (-6%). We are maintaining our forecast for a trade deficit of USD 300 million in 2017, although we now see downside risks due to the solid performance of exports. For 2018, we continue to forecast a trade deficit of USD 700 million.

The reopening of the refinery worsens the fiscal deficit. Uruguay’s public-sector nominal deficit increased in September following a temporary improvement in August. The 12-month cumulative deficit increased to 3.6% of GDP in September from 3.3% in August. The primary deficit increased to 0.4% of GDP from 0.1% the previous month. Revenue from the non-financial public sector grew by 6.4% yoy, driven by higher DGI revenues (+7.5% yoy) and higher revenues from the social security bank (+10.6% yoy). Primary expenditures increased by 20.5% yoy due to higher investments (+463% yoy) related to the replenishment of ANCAP’s crude oil inventory following the reopening of the La Teja oil refinery after a several-month maintenance shutdown. Pensions grew by 12.4% yoy, while transfers increased by 11.6% yoy due to higher contributions to the national health fund. We maintain our forecast for a 2017 fiscal deficit of 3.3% of GDP. For 2018, we expect a fiscal deficit of 3.0% of GDP.

Frente Amplio is the favorite to win the 2019 elections. A poll published by the consulting firm Cifra showed Frente Amplio voting intentions at 31%, while Partido Nacional garnered 26%. The number of undecided voters remains high (32%), however. President Tabaré Vázquez maintains his popularity. His approval rate reached 51% in October, up from 48% in July.

Fuente: ITAU BBA

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