Country Audit-----CHINA (3-4 PAGES)

URUGUAY

Country Audit

Executive Summary

The following report is an evaluation of multiple facets of the Uruguayan economy, its overall investment attractiveness, and feasibility of doing business. After conducting research and analysis on the country in areas such as legal frameworks, fiscal policy, trade relations, infrastructure, housing, and monetary policy, Uruguay proves to be an economy of strong opportunity when evaluated against its regional/continental partners, but with significant and pressing challenges that would place the nation lower when considered at a global level. The national government and political system are proven to be stable, offering legal protections and investment frameworks that are comparable to developed economies. As a member of MERCOSUR and independently, Uruguay has ratified trade agreements, particularly with developed nations and Latin America, in a variety of structures, namely goods, services, investment promotion and protection, public procurement, and double taxation avoidance. The country offers valuable exports, and derives its imports significantly from MERCOSUR members in which people, goods, and currency are permitted to move freely. Uruguay has shown strong numbers in growth, particularly GDP and unemployment rate. Having reacted appropriately to an economic and banking crisis in the early 2000s, Uruguay was one of the few countries that was not significantly impacted by the 2008-09 economic crisis. The housing market has also seen considerable growth and looks to continue growing as the level of foreign direct investment in construction increases. Challenges that have limited the country and are foreseeable as continuing to limit Uruguay’s attractiveness include a public banking system that offers limited access to credit, undesired volatility in prime rate lending, seemingly unsustainable fiscal policy, and a lack of coordination in monetary and exchange rate policies. Given the widespread availability and transparency of information on the country and having taken all these factors into consideration, we determine Uruguay to be one of best investment opportunities in terms of a Latin American scope, but as still significantly behind developed economies. A total score of 30.5 points out of a possible 55 was assigned.

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Description and Analysis of Each Measured Attribute

A.1 Government Expenditure, Tax System, Rule of Law, and Education System - 2/5; This ranking reflects Uruguay’s controlled government spending and competitive tax rate. The tax free zones are a great way to incentivize companies to operating in Uruguay. However, it does take into account the difficult experiences that corporations undergo in paying taxes. Uruguay benefits from a mature democracy with a stable political system and independent judiciary system. Uruguay has a well-established education system that provides free education and equal access to all students through the university level. However, the socioeconomic gap becomes increasingly wide at the university level.

A.2 Trade Policy - 2/5; Uruguay’s government is generally open to and encourages foreign direct investment (FDI) and trade with the country. While the previous is true, a “level playing field” is not necessarily in place; the MERCOSUR nations significantly benefit from trade with Uruguay, as opposed to other markets such as the United States or most of Western Europe, due to limited specialized agreements with the aforementioned governments.

A.3 Economic Growth - 2.5/5; This ranking reflects Uruguay’s overall economic growth. After the 2001-2002 economic and banking crisis in Uruguay, the country made a series of consolidated structural improvements which enabled the country in later years to post very good economic performance in overall GDP, GDP growth and the unemployment rate. Uruguay survived the global economic crisis of 2008-2009 because of the previously mentioned improvements and prior economic stability. However, the country’s performances in quality of infrastructure and domestic savings rate prove to be disappointing.

B.1 Budget Deficit, Sustainable fiscal policies, Debt management and the yield curve, Interest rates - 7/10; Uruguay has experienced significant volatility in all topics comprising this portion of the assessment. Historical data shows consistent budget deficits for Uruguay from 2010 to 2013 primarily resulting from ineffective fiscal policies. A lack of transparency in fiscal targets is causing additional volatility in short-term interest rate markets. The bond market also shows Uruguay as being unstable, commanding a 5-6% premium in its 10 and 20-year treasury bills against the United States’. Unpredictability and spontaneous fluctuations in prime lending rates adds to uncertainty in the domestic lending market.

B.2 Housing, Financial Market Development, Government Ownership - 6/10;

Uruguay’s housing market is relatively strong. Outside investment continues to flow into the country, supporting demand for new housing development on the coast. Increased construction demand causes increases in the labor cost component as it related to overall construction cost, but other cost components have remained relatively stable over the last 10 years. This allows for housing to be priced at affordable levels. The Financial Market Development is bogged down by the lack of access to capital markets (i.e. equity and debt). This inhibits the growth of investment and pursuit of economic advancement inside of a country. Government Ownership and Control is looked upon as being favorable, according to the Economic World Forum. Uruguay’s legal framework and transparency in policy making is seen as extremely favorable in comparison to the global community.

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B.3 Growth and predictability of monetary policy. Inflation. Wage increases. Unemployment. Central bank independence - 4/10; Due to high political stability and economic policy predictability Uruguay earned a high predictability and growth of monetary policy rating. Inflation and the government’s quick reactions to battle this enemy has been the main focus for the central bank. This rating reflects the positive changes over the past decade and the ability to lower the economic monster that is inflation. Although the country has taken promising steps to increase the quality of life for its citizens, Uruguay still has below average wages. Although there are low and uneven wages, the future shows promise of equality and prosperity. The unemployment rating was based on a strong number that reflects a low unemployment rate but the possible repercussions that might arise in the future. And finally, all the factors that are taken into account when allowing independence for the central bank and the below average rating from the IMF, Uruguay ranked poorly in comparison to neighboring countries for its central bank independence.

B.4 Exchange Rate Stability - 7/10; The Uruguayan peso’s (UYU) recent history experienced significant changes in the value of its currency (relative to the USD) without mindful monetary policy coordination from the Central Bank. From commentary and market interventions performed by Uruguay’s Central Bank, it is clear there is little coordination between monetary and exchange rate policies. As a nation that offers valuable exports and has posted trade surpluses in its past, the exchange rate should be considered by the Central Bank more so than it ever has been, particularly in protecting the export attractiveness of products produced within the country by its citizens. However, it is important to recognize this as a difficult challenge moving forward, as the Central Bank focuses its efforts on limiting the country’s current inflation rate of roughly 8%; regardless, the Central Bank’s monetary policy should more closely consider its decisions’ effects on the UYU’s exchange rate relative to other currencies such as the Brazilian real, the Argentine peso, and the United States dollar, three significant import/export and investment sources.

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A.1 (0-5) Main policy objectives. Government expenditures. The tax system and possible effects on the business environment. The rule of law and enforcement of property rights. The education system. Ranking: 2/5

Government Expenditures

The Uruguayan Central Bank reported that government spending in Uruguay totaled UYU 317.39 billion in 2012, or 31.3% of GDP (IMF). The IMF has forecasted government expenditures since 2013 and estimated it to reach UYU 464.61 Billion in 2015, or 33.1% of GDP (App A.1 Figure 1). Compared to the rest of South America, Uruguay leads the group of five countries with the lowest government spending in terms of GDP (App A.1 Figure 2).

Tax System and Possible Effects

Corporations in Uruguay are subject to a 25% tax rate. Only income that is derived from activities within its borders, from property located in Uruguay, or derived from the economic rights use within its borders, is taxed. Capital gains are treated as ordinary income and taxed at the corporate rate (IMF). Doing Business, which ranks countries in terms of how easy it is to do business, ranked Uruguay 140 out of 189 in 2015 (Doing Business in Uruguay). This was mainly due to the difficulties experienced when paying taxes.

To promote business, Uruguay has established double taxation avoidance treaties with Germany, Hungary, Spain, and Mexico; it has also established general tax treaties with 10 countries including Portugal, France, and Switzerland (Deloitte). Uruguay’s corporate tax rate is the comparable to other South American countries, having the same rate as Colombia, Brazil, Bolivia, and Ecuador (App A.1 Figure 3). When compared to the average tax rate of various economic blocs, it is evident that Uruguay’s tax rate is very competitive (App A.1 Figure 4). Uruguay has instituted various policies to promote movement in its business environment. In 1987, the country established free zones. Free zones are defined as privately or publicly owned

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areas that are isolated and fenced off with the purpose of being used for manufacturing, commercial, and service activities within the zone. Companies that operate within these zones are exempt from all current and future national taxes but are only allowed to conduct business within the zone or with third countries. The only requirement is that 75% of those hired by companies operating within a free zone be Uruguayan citizens (Zonas Francas). Free zones have been established near ports, airports, and business sectors to provide companies within the zone prime locations in which to conduct business. The newest zone, Punta Pereira, has had investments surpassing $1B. These free trade zones benefit from the presence of multinational enterprises such as IBM, HP, Fisher-Price, and Tata Consulting.

Rule of Law and Enforcement of Property Rights

Uruguay is a mature democracy with a stable political system. Its judiciary system is independent and legal safeguards are generally observed. In 2014, the Rule of Law Index ranked Uruguay 1st in Latin America and 20th overall (App A.1 Figures 5 & 6). This ranking was based on government accountability and the absence of corruption. The index, published by the World Justice Project, found that Uruguay benefited from agencies that were effective in enforcing regulations. The country also has civil courts that are independent and free of improper influence (World Justice Project).

Property rights in the country are upheld. The 2015 Index of Economic Freedom reported that private property in Uruguay is secure and expropriation unlikely. Out of 100 possible points, Uruguay was awarded 70 in this measure (App A.1 Figure 7). It came in second to Chile at 90 and outperformed Mexico, Brazil, Colombia, and Costa Rica, who tied in 3rd at 50 points (Heritage Foundation).

Education System

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Uruguay has instituted various initiatives to improve its public school system. As a result, almost 100% of Uruguayan children attend school. The country has one of the highest literacy rates, 98.1% in 2014, among Latin American countries. Public education is free from primary school through university. Socioeconomic inequalities in access to primary and secondary education are not as strong in Uruguay when compared to the rest of the Latin American countries. Government expenditure on education accounted for 4.5% of GDP in 2012, well below the average for the OECD countries and slighter lower than Latin American countries (App A.1 Figure 8). In terms of performance, Uruguay achieved a higher than average score for Latin American countries that participated in the PISA 2012 assessment. However, similar to the rest of the region, Uruguay performed well below the OECD average in the same assessment (OECD).

A.2 (0-5) Trade Policy. Policy toward foreign direct investment. Central banking coordination. Government and antidiversion policies (attribute towards corruption). Value of exports and imports. Balance of payment deficits. Ranking: 2/5

Foreign direct investment (FDI) in general is respected and encouraged by the government of Uruguay. Data from the Central Bank of Uruguay indicates that FDI in 2013 reached a level of USD 2,796 M; as a percentage of the country’s GDP (5%), Uruguay came second only to Chile across Latin America that year (Foreign Direct Investment in Uruguay). The data reveals a significant upward trend of FDI from 2001 (App A.2 Figure 1). As part of the government’s promotion of FDI, a strong legal framework and various investment promotion schemes have been established. Arguably, the most significant of these is Law 19,906 of January 1998, which offers a guarantee of equal treatment for foreign investors relative to domestic investors, and places no restrictions on the introduction of capital to the country, nor on the repatriation of capital or profits (Foreign Direct Investment in Uruguay). Foreign investors may operate in Uruguay through a variety of registration methods, such as a Corporation (S.A.), a

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form of LLC (S.R.L.), other types of personal companies, or as a foreign branch (Business Environment). It is important to note that of these business structures, there is no limitation on the recruitment of foreign personnel or the ownership percentages of Uruguayan nationals and foreigners of a company’s organizational structure (Business Environment), with the exception of the free zones as noted previously. One of the most important aspects for a foreign investor in Uruguay to consider is the country’s impressive track record on corruption; the country was ranked first with Chile on combating corruption across Latin America, and 20th worldwide by Transparency International’s 2014 Corruption Perception Index (Transparency International). Compared to the rest of Latin America, this is a significant difference in ranking; after Chile, the next closest Latin American country was Brazil at 69, and the rest with a ranking of 100 or above (Transparency International). Uruguay also enforces internationally-accepted standards with respect to intellectual property, and was considered the best in South America by the World Economic Forum’s Global Competitiveness Report for 2013-14.

Albeit a small country with roughly 3.3 million inhabitants, Uruguay has proven to be a country that offers valuable exports and important trade balance information. Trade balance data indicates the country posted a trade deficit of roughly USD 1,400 M in 2014; data from five previous years posts changes in moderate trade surpluses and deficits (Trading Economics). With regard to balance of payments, the current account shows consistent deficits and the capital account shows consistent surpluses (App A.2 Figure 2). The capital account surpluses reflect the significant levels of FDI into the country as noted previously.

Uruguay has largely positioned itself as a regionally-focused importer and exporter of goods but has international agreements across multiple continents. From analyzing the country’s import/export markets and national sources of FDI, it is clear to see the significant influence that

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Uruguay’s participation in MERCOSUR has. Among Uruguay’s import and export partners, Argentina and Brazil appear in both (CIA). The two countries also comprised Uruguay’s top two sources of FDI in 2012 (App A.2 Figure 3). Regarding other international agreements, Uruguay, as part of MERCOSUR or independently, has agreements with other nations in the following categories: goods, services, public procurement, investment protection and promotion, and double taxation avoidance (International Agreements).

What is perhaps of most importance to notice is the extent of agreements with particular

countries and its effect on trade and FDI (App A.2 Figure 4). Uruguay’s agreements with Spain

in investment protection and promotion and double taxation is likely the most significant reason

for Spain being Uruguay’s third-highest source of FDI. Figure 4 in Appendix A.2 reveals other

notions about Uruguay’s attractiveness as a country to trade or invest in; while Uruguay’s

government is largely receptive to foreign investment and trade, real benefits of economic

activity with Uruguay vary significantly based on the foreign country’s location. An example is

the United States’ investment protection and promotion agreement with Uruguay; while a good

incentive, it is obviously more incentivizing for a Spanish company to invest in Uruguay given

that country’s additional agreement in double taxation avoidance. The Exhibit outlining

Uruguay’s international trade agreements largely influenced the group’s trade ranking of 2 out 5

for Uruguay. Basic incentives are available for many developed countries looking to do business

in Uruguay via trade or investment, but the strong preference Uruguay has for MERCOSUR and

other South American nations means the country loses out on incentivizing more developed

countries such as the United States or most of Europe.

A.3 (0-5) Economic Growth. Economic growth performance. Quality of infrastructures. Saving rate and economic rate. Ranking: 2.5/5

Economic Growth Performance

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In analyzing Uruguay’s economic growth performance we chose to assess the country’s GDP, GDP growth and unemployment rate. The economy of Uruguay is characterized by an export oriented agriculture sector and a well-educated work force, along with high level of social spending (Wikipedia). From 1999-2002, the economy of Uruguay suffered a significant downturn; after bank deposits in Argentina were frozen, Argentinean citizens made massive withdrawals from Uruguayan banks, “which led to a plunge in the Uruguayan peso, a banking crisis, and a sharp economic contraction” (Wikipedia). Furthermore, “real GDP fell in four years by nearly 20%, with 2002 the worst year. The unemployment rate rose, inflation surged, and the burden of external debt doubled” (Wikipedia). After this crisis, the government restructured its external debt and made consolidated structural improvements. These improvements enabled Uruguay to withstand the external shocks during the 2008-2009 world economic crisis. In July 2013, the World Bank ranked Uruguay as a high-income country with a gross national income per capita of $13,580. The average annual growth rate of Uruguay was 5.5% between 2006 and 2013. In 2013, Uruguay’s GDP was $55.71 billion and its GDP growth rate was 4.4% (Uruguay Overview). Compared to the world and the Latin America and Caribbean area, Uruguay posted higher GDP growth for 2005-2013, especially during the 2008-2009 world economic crisis. (App A.3 Figures 1 and 2)

Strong macroeconomic performance has reflected in Uruguay’s labor market, which recorded historically low unemployment levels in 2013 at 6.3% (App A.3. Figure 3). The country has made substantial progress in poverty reduction, going from 39.9% in 2004 to 11.5% in 2013, and reduced extreme poverty from 4.7% in 2004 to 0.5% in 2013 (Uruguay Overview). Export markets have diversified in order to reduce dependency on the country’s main trade partners; trading partners went from 14 to 19 from 2000 to 2012 (Uruguay Overview). Fiscal policy shows

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some sign of improvement as well. The country decreased its public debt ratio from 100% in 2003 to 60% in 2014; it has also managed to decrease the cost of its debt, reduce dollarization from 80% in 2002 to 50% in 2014, and adopt more mature financial commitments (Uruguay Overview). Despite the country’s progress in these areas, debt still remains at relatively high levels and its regional partners still receive major shares of its exports (Uruguay Overview).

Quality of Infrastructures

Compared to Germany (the world’s top performer in infrastructure), Uruguay’s performance is not very good (App A.3. Figure 4). Uruguay’s performance is better than Latin America and Caribbean area from 2007-2014. Nevertheless, in 2014 the score performance of Uruguay has declined to the average level of that area. (App A.3. Figure 5)

Road Sector: According to “Infraestructura Uruguay 2030,” a study commissioned by an Argentine investor, Uruguay’s lack of investment in its road network for the past 15 years has left it in dire need of maintenance. However, The Ministry of Transport and Public works is conducting, in conjunction with the National Development Corporation, the structuring of a project for the reconstruction and maintenance of a corridor between Routes 21 and 24, comprising a total of 170 kilometers of highway.

Railway Sector: According to the Global Competitiveness Index, quality of the railway network of Uruguay is ranked 117 out of the 142 countries. The whole system is like the 19th century’s railway systems in some developed countries. The current President insisted that it is important to improve the quality of the railway network and modernize it because the rail freight transport is viable alternative to trucking. Government now is making large investment to the railway system and its quality has substantially increased.

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Port Sector: Montevideo is Uruguay’s main commercial port with annual movements of 10 million metric tons, 500,000 passengers and 100 cruise ships. The government has no plans of development in this sector, but the rapid growth experience in recent years has required an expansion of the Port of Montevideo.

Education Sector: Over 40% directors of schools with children in primary education reflected that desks in the classroom and the bathrooms are problematic for the development of the school. Nearly 50% directors expressed concern about the conditions of leasable capacity and playgrounds. Lack of properly soundproofed facilities has also been acknowledged as an issue of major concern by teachers. Even though the government has made some investment to improve the school facilities, it still will continue to be developed under unsuitable conditions.

Energy Sector: The country is transforming the structure of its energy sector, reducing its costs and making it more diversified and less susceptible to climate conditions.

Tourism Sector: After granting the construction and operation of a $30 million convention center in Punta del Este, the government is planning to invest a large amusement center.

Sanitation Sector: In the water and sewage sector, the State Water and Sanitation Works

Company (OSE) will be investing USD 100 million throughout 2014 in constructing sewage

treatment plans.

Data source for entire Quality of Infrastructures section: Canadian Trade Commissioner Service

Saving Rate

Uruguay’s saving rate is lower than the World’s average saving rate from 2011-2013. (App A.3 Figures 6 and 7). A high saving rate is important for a country’s economic growth so Uruguay must make an effort to increase this.

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B.1 (0-10) The budget deficit. Sustainable fiscal policies. Debt management and the yield curve. Interest rates. Ranking: 7/10

Budget Deficit

Uruguay has posted budget deficits from 2010 to 2013, ranging from -1.0% to -2.6%; for comparative purposes, the world average was -3.1% in 2013 (Cash Surplus/Deficit). These figures are calculated as (1) Government Revenue, (2) Less: Expenses, (3) Less: Acquisitions of Non-Financial Assets and shown as percentage of GDP. A chart comparing the budget surplus/deficits for Uruguay against other nations is included in Appendix B.1 Figure 1.

Fiscal Policy

Fiscal policy in Uruguay is currently under criticism and to be revised, as it is seen as being too relaxed. There is building inflationary pressure in Uruguay, which the Country believes is due to inflation contagion. Additionally, Uruguay switched from an Overnight Fixed Exchange Rate to a Monetary Aggregate system. This caused significant volatility in overnight interest rates, with rates ranging from 2.5% to 40% as the market adjusted to the new framework. Ultimately, the International Monetary Fund sees Uruguay as having better success in calming short-term interest rate fluctuation simply being more transparent and open regarding fiscal targets. Last but not least, the Country is considering the capping of real wage growth from 0-3% in the coming years (IMF Country Report). This is because wage growth has begun outpacing production per worker. In an effort to combat this phenomenon, the Country would consider overall economic growth (via GDP) and any given sector’s productivity prior to determining the appropriate wage cap.

Debt Management and Yield Curve

The Country has been historically successful and prompt as related to its government bond program. There are significant spreads (~5-6%) in the 10 and 20 year Treasury bond

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coupon rates in comparison to a stable market, such as that of the United States (App B.1 Figure 2). Investors command higher interest rates for countries with governments that are seen are riskier investments, this is the basis for the higher Uruguayan coupon rates. For purpose of comparison, 10 year treasury rates are 3.3% and 4.5% for Mexico and Brazil, respectively (DMU).

Interest Rates

With respect to interest rates, our team has used the Prime Lending Rate as our basis for this analysis. The Prime Rate is the rate at which a commercial bank will lend to its best customer and serves as the basis for the rate at which it lends to the rest of the market. Uruguay’s Prime Lending Rate has experienced significant fluctuations and volatility since 2006; swings of approximately 6%, both positive and negative, can be seen from 2006-2013 (CIA). This creates concern on the part of borrowers, and uneasiness in the market. A graph has been provided as Figure 3 in Appendix B.1. for more granularity on the subject. The volatility in the Prime Rate is made clear by the United States Prime Rate, shown in the aforementioned Figure. Comparatively speaking, the United States Prime Rate is stable, almost to a point of predictability. This allows for the marketplace to instill confidence in interest rates over the short-to-medium term. However, this mentality is lost in Uruguay due to the sharp peaks and declines in the prime lending rate.

B.2 (0-10) The banking system and financial development. Degree of government ownership and control. Degree of globalization and capital control. Degree of globalization of the banking system and capital market. The housing sector. Ranking: 6/10

Financial Development

The Global Competitiveness Report shows Uruguay’s financial market development as a 3.8/7.0. The primary drag on this rating is due to access to capital markets, both domestic and international. The ratings for local equity market financing, access to loans, and venture capital

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availability are 2.2, 2.8, and 2.6, respectively. The limited access to capital markets fails to aid in the financial development of the Country; however, these are representative of only the lowest rated factors contributing to the stymied financial development. Overall ratings are low with respect to components dictating the Country’s performance in this sector, leaving the Country with a rank of 83 out of 144 countries in this regard. See Table 1 in Appendix B.2. for more

detail into the lower scores assigned to the Country for this category.

Data Source for entire Financial Development section: World Economic Forum Global Competitiveness Report 2014-15.

Government Ownership and Control

The Global Competitiveness Report appears to capture Government Ownership and

Control in the subsection entitled “Government Efficiency”, in which the Country is ranked 56

out of 144 countries. Uruguay’s government does impose a significant amount of regulation and

is considered to be very wasteful with respect to spending, as indicated by its poor ranks in the

categories. However, if one takes into account the additional factors comprising the government

(or “Institution”) ranking, Uruguay is very favorable; ranking in the top 25% of Countries

assessed. Table 2 has been provided in Appendix B.2. that details the Country’s performance.

Data Source for entire Government Ownership and Control Section: World Economic Forum Global Competitiveness Report 2014-15.

Housing Sector

Uruguay has realized significant growth in the real estate sector since the recession of 1999-2002. Construction activity maintained consistent upward growth from 2003-2013, a leading indicator for both increased floor area growth and Gross Production Value. Floor area refers to actual square meters of new housing product constructed and Gross Production Value (GPV) referring to the cost of inputs required to complete the floor area. The data provided by

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the National Statistics Institute for the Country’s housing sector is strictly from Montevideo, the capital.

The Construction Index Graph (App B.2 Figure 1) shows a sharp decline in construction activity from 1999 through 2003, before its subsequent recovery. The recovery in the construction market leads to the obvious expansion in both physical space developed and GPV of this space (App B.2 Figures 2 and 3), which can be seen in the correlation observed between Figure 1 and 2 and Figure 1 and 3. The GPV is broken down further into major construction components. The sharp increase in labor is due to supply and demand factors in the market as idle construction labor becomes scarcer (App B.2 Figure 4). Moreover, the rise in construction activity signifies confidence in the investment market (App B.2 Figure 5). This makes sense as private investment is the catalyst for the increase in construction.

Coastal areas in the Capital are home to high income population and generate housing investment based on that fact. However, areas outside of the coast are experiencing increase development as well due tax exemptions that encourage the construction of social housing for middle to lower income families. The Central Bank of Uruguay expects that credit availability with continue to generate demand in the housing sector. In terms of development and construction, the coastal region will begin to see a slow in construction activity, but overall

activity will be buoyed by the middle and lower income regions.

Data Source for entire Housing Sector section: Uruguay XXI - Real Estate Investment Opportunities in Uruguay.

B.3 (0-10) Growth and Predictability of Monetary Policy. Inflation. Wage Increases. Unemployment. Central Bank Independence. Ranking: 4/10

Inflation

Today the inflation rate of Uruguay sits at 8.05%. The Central Bank of Uruguay has consistently battled inflation in the country that has been observed since the mid-1900s. By

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exercising monetary policy, the central bank has managed to keep inflation in the single digits for the longest period since the inception of the country, dating back to the 1990s. During this time period, Uruguay has set target ranges for inflation that has rarely been met because the country focuses on setting aggressive benchmarks (IMF).

Inflation is such an important issue for the continued prosperity of the country that reducing it is now a top priority for the central bank. The worldwide financial crisis has put the country on red alert. As inflation rose during this period, the central bank with the help of the government has begun to issue moral suasion actions: freezing or reducing prices on specific consumer goods. Over the past few years the central bank has acted by raising the policy rate by 275 basis points and by increasing reserve requirements (IMF).

It is important to note why Uruguay continues to focus on battling inflation. In doing so the country, can better support de-dollarization in the economy, lower public debt in local currency, promote financial deepening, and help give the central bank wiggle room to use monetary easing during the next recession or boom.

Growth and Predictability of Monetary Policy

Predictability of monetary policy in Uruguay’s economy is based on a stable political system, anticipated economic policies, favorable government debt ratio, and promising medium growth prospects. The government’s aptitude to make well-timed modifications, especially the central bank’s ability to react in dire situations encompasses the main reasons why the economy continues to grow. Economists believe that these economic policies aimed at lowering inflation, increasing pro-investment policies, and focusing on debt management programs will continue beyond the next election leaving Uruguay in the prime position to strengthen its economic promise and continue to excel (IMF).

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Uruguay has one of the most stable economic policies in South America. This assumption is based on the reigning political party’s standing on the far left of the political ideology spectrum. The President of Uruguay, Jose Mujica, has stayed in line with political party beliefs. He has focused on strengthening economic stability, promoting investments in the country and abroad, and increasing social program spending.

The main takeaway on this topic of predictability is based on the economic beliefs of the many parties in the country. Over the past decade, economic ideologies have narrowed as the different factions have joined forces to fight the country's main economic enemies: inflation and external economic risks. There is a general consensus along these party lines. In essence, no matter who is elected the next president, or whether another black swan like the global recession will occur again, Uruguay is known for economic consistency and will continue to promote its current economic policies (Trading Economics).

Wages

The nominal wage rate in Uruguay has more than doubled over the past 10 years as the country battles the world economic crisis and its greatest enemy: inflation. With an average nominal monthly wage rate of about 17,000 UYU in 2012, which is roughly equivalent to $800, Uruguay suffers from very low wages compared to approximate countries (Fedec).

According to the Global Wage report, in 2005, in an attempt to match wages with the inflation rate in the country that continued to increase inequality, Uruguay created wage councils to add stability to the job market by fixing wages in line with inflation. Moreover, these councils were in charge of fixing minimum wages for the various sectors of the country. During this period, real wages increased by 9.1% although wage dispersion did also increase at this time.

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Positive changes related to this move include gender equality of pay, educational equality of pay, and the reduction of regional pay gaps.

Unemployment

Unemployment in Uruguay is currently at an all-time low following a disastrous scenario ten years ago when a financial crisis first hit the country and the unemployment rate was over 20%. The unemployment rate currently sits at around 6.5%, a promising number to encourage economic recovery (Fedec). This low unemployment rate is the main factor for an increase in wages and quality of life in Uruguay.

An issue has recently evolved, however. With such a low unemployment rate, new and expanding businesses are finding it more difficult to find workers. The hardest hit sectors include construction and engineering jobs. This dilemma is putting a huge strain on the growing economy as companies prepare for salary wars as the number of available workers continues to decrease. These salary wars are causing prices to increase. And as prices increase, inflation tends to increase as well. And as the paper stresses, inflation is the main economic enemy of Uruguay. In an attempt to counter this low unemployment issue, the country is trying to lure some ex- patriots abroad to return home to enjoy more favorable conditions and work. By giving certain incentives, Uruguay aims to embrace this low unemployment rate by increasing the workforce and encouraging individuals to live and work in the country.

Central Bank Independence

According to the IMF, central bank independence in Uruguay is below average compared to all Latin American countries. This rating is based on the selection process and limits placed on the central bank by the government. Central bank members are selected to short terms positions and appointed directly by the legislature. It is mandatory that they be independent from private

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and public sectors to limit underlying incentives. Moreover, they can be removed from office by any reason deemed appropriate by the legislature.

In terms of operations, the central bank does not extend credit to the government and does not receive government capitalization either. It has full independence of monetary and exchange rate policy. Moreover, any proposals or policy changes need only be submitted to the legislature by ways of a paper report, no formal appearance is necessary. However, all actions and proposals are reviewed and approved by an independent agency.

B.4 (0-10) The exchange rate system. Consistency of monetary and exchange rate policies: the holy triology. capital controls. Stability of the exchange rate and inflation. Degree of over or undervaluation of the currency. Ranking: 7/10

“Uruguay offers free movement of capital, foreign currency and gold from and to other countries and a free convertibility exchange system for national currency” (Business Environment). The absence of capital controls on the Uruguayan peso (UYU), coupled with the Uruguayan Central Bank’s presence in determining monetary policy, implies that the country rests on the lateral of independent monetary policy and free capital mobility, comparable to systems such as those of the United States, Canada, or Japan. The UYU’s exchange rate history relative to the USD shows significant swings in appreciation and depreciation in short periods (App B.4 Figure 1). The last two years, however, reflect a consistent depreciation of the UYU relative to the USD. Given this depreciation, the country’s exports should look more attractive to foreign purchases. What is interesting to note is the Central Bank’s limited coordination of monetary and exchange rate policies, with then Central Bank President Mario Bergara declaring “we do not have any specific target, because we think that the exchange rate flexibility is one of the corners of our economy policy strategy” (Goodman & Kuzmanovic). As the country looks to establish policy to combat aforementioned inflation levels of roughly 8%, the UYU could be

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considered undervalued. If the Central Bank were to take action in the future to lower inflation, the currency will then likely appreciate, defining its current status as undervalued.

20

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APPENDICES

APPENDIX A.1

Figure 1 - Uruguay Government Expenditure

Figure 4 - Average Corporate Tax Rates of Economic Blocs

Figure 2 - Government Spending of South American Countries, % of GDP)

Figure 3 - Corporate Tax Rates of South American Countries

Figure 5 - Rule of Law Overall Score & Ranking

Figure 6 - Rule of Law Ranking, Latin America & the Caribbean

Figure 7 - 2015 Index of Economic Freedom (out of 100 points)

Figure 8 - Uruguay Government Spending on education as % of GDP

APPENDIX A.2

Figure 3 - Top Ten Sources of FDI - 2012

Figure 1 - FDI inflow to Uruguay (Millions of US$ and GDP %)

Figure 2 - Current Account, Capital Account, and FDI; Source: Uruguay in Focus. Uruguay XXI.

Figure 4 - Uruguay’s International Agreements by Category

APPENDIX A.3

Figure 1 - GDP Growth Rate (Uruguay vs World)

Figure 3 - Uruguay Unemployment Rate

Figure 2 - GDP Growth Rate (Uruguay vs. Latin America & Caribbean)

Figure 4 - Infrastructure Overall Score (Uruguay vs. Germany)

Figure 5 - Infrastructure Overall Score (Uruguay vs. Latin America & Caribbean)

Figure 6 - Average Gross Domestic Saving Rate (Uruguay)

Figure 7 - Average Gross Domestic Saving Rate (World)

APPENDIX B.1

Figure 1 - Comparative Budget Deficit Figure 3 - Prime Lending Rate Comparison (2010-2012)

Figure 2 - Comparative Treasury Yield Curve

APPENDIX B.2

Table 1 - Financial Market Development Rankings (Economic World Forum)

Figure 2 - Floor Area built in Montevideo by Product Type

Table 2 - Government Ownership and Control Rankings (Economic World Forum)

Figure 3 - New Housing GPV in Montevideo ($MM)

Figure 1 - Construction Index

Figure 4 - Construction Cost Input

Figure 5 Private Investment in Construction ($MM)

APPENDIX B.4

Figure 1 UYU per 1 USD; Source: XE