Argentina Shakes, Uruguay Rattles


By: Jennifer L. Rich
 The New York Times, May 8, 2002



Not long ago, the beaches of Uruguay were filled with Argentine tourists, its banks stuffed with Argentines' offshore wealth.

Now, Argentina is mired in the worst economic crisis in its history, and Uruguay appears to be the only South American nation that is being taken under by its neighbor's troubles.

As many ties that once bolstered the Uruguayan economy have come unraveled, the government in Montevideo has been scrambling to adjust.

Its task recently became even more difficult. On Friday, Moody's Investors Service lowered Uruguay's precious investment-grade rating to junk status, saying the country was "increasingly vulnerable to macroeconomic shocks emanating from Argentina." The downgrade followed similar moves earlier this year by the other two major credit rating agencies, Standard & Poor's and Fitch Ratings.

Uruguay's financial troubles predate the current Argentine crisis. Several years ago, a series of global emerging markets crises pushed down world commodities prices, forcing Brazil, and then Argentina, into an economic tailspin. Sandwiched by the much larger Argentina and Brazil, Uruguay, about the size of the state of Washington and with a population of just 3.3 million, is highly dependent on its neighbors. It soon followed them into recession.

Last year, Uruguay had its third year of economic contraction, with gross domestic product falling 2 percent. G.D.P. is expected to decline a similar amount this year.

When the Argentines were forced to devalue their currency in January, the Uruguayan government reacted by doubling, to 12 percent, the band in which it allows its peso to float. Last week, the government predicted that its peso would depreciate 2.4 percent a month until the end of the year while floating within that band.

Because of the devaluation, Uruguay's mostly dollar-denominated debt now adds up to more than 60 percent of G.D.P.

In an effort to reduce the $779 million fiscal deficit posted in December from 4 percent of G.D.P. to 2.5 percent, the government has come up with a plan to cut spending by $270 million and increase tax revenue. Praising the "energetic" response by the government, the International Monetary Fund in March granted a standby loan of $743 million over three years to the country. This month, the economy minister, Alberto Bension, announced that Uruguay would receive about $1 billion in aid from the World Bank and the Bank of International Development from now to the end of 2003.

But many analysts and economists said that the spending cuts had failed to go to the heart of Uruguay's structural spending problems and that increased taxation was counterproductive after four years of recession, when tax revenues are falling over all.

The country, which has one of the strongest centrally planned economies left in Latin America, needs to privatize its energy, telecommunications and infrastructure assets to pay down the debt, they say. But such moves are tricky politically.

"Uruguay is a country where one in six people work for the government," said Morgan Harting, sovereign-debt analyst at Fitch Ratings. "Public opinion is conservative and opposed to rapid change."

Although a depreciating currency will increase the competitiveness of Uruguayan exports, until now the bulk of such goods have gone to Argentina and Brazil, its biggest partners in the Mercosur trade bloc, which also includes Paraguay.

To help expand its export base, Uruguay recently signed a trade pact with Mexico. It also established a Joint Commission on Trade and Investment with the United States to explore ways to increase trade and address bilateral trade issues.

Financiers are closely watching Uruguayan banking. Many wealthy Argentines, fearing devaluation (or avoiding taxes) at home, had substantial deposits in Uruguay; when the Argentine government severely limited withdrawals from their Argentine accounts, the depositors drew cash from their Uruguayan accounts instead, draining hundreds of millions of dollars. Uruguay's central bank had to intervene in the Uruguayan operations of Banco Galicia, Argentina's largest private bank, because of a run on deposits.

As the crisis next door continues, the concern is that Uruguayans will start putting their money under the mattress, too.

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