Sovereign Credit Ratings on Uruguay (Oriental Republic of) Lowered; Outlook Remains Negative

Lisa M Schineller, New York

NEW YORK (Standard & Poor's) Feb. 14, 2002-- Standard & Poor's today downgraded its sovereign credit ratings on the Oriental Republic of Uruguay. The republic's long-term local and foreign currency ratings were lowered to triple-'B'-minus and double-'B'-plus from triple-'B'-plus and triple-'B'-minus, respectively. The short-term local and foreign currency ratings were lowered to 'A-3' and single-'B' from 'A-2' and 'A-3', respectively. The outlook remains negative. The downgrade and negative outlook reflect the government's difficulty in meaningfully addressing persistent fiscal and structural weaknesses. These weaknesses have been compounded by Uruguay's minimal growth prospects, given its inherent dependence upon the Mercosur region, and by fragility in the financial sector.

Recently drafted fiscal adjustment measures are narrow in scope, with marginal cuts in operating and capital spending and increased taxation seemingly counterproductive in a fourth year of recession. The general government deficit, which has amounted to about 4% of GDP in each of the last three years, may improve only marginally in 2002 (although the government intends to bring it down to 2.5% of GDP). Peso depreciation exacerbates debt-servicing costs, as essentially all of Uruguay's debt is denominated in foreign currency; at a projected 18% of revenue in 2002, the interest burden will be almost double its 1994 level. The gross general government debt is projected to reach 60% of GDP in 2002 and could increase again next in 2003, should depreciation of the Uruguay peso accelerate further and the economy remain weak. A material decline in the debt burden would require action, such as the use of privatization proceeds, to pay down debt. Such a strategy is, however, neither politically nor socially feasible in Uruguay.

Structural weaknesses impede Uruguay's ability to overcome severe external shocks. The economy is not dynamic: investment is less than 15% of GDP, FDI is minimal, and taxes and labor costs undermine competitiveness. Inherent dependence upon the Mercosur region underpins the likelihood of a fourth consecutive year of recession in Uruguay. The economy is highly dependent upon Argentina for tourism, other services, and capital inflows-all of which are under severe pressure. Emergent financial system vulnerabilities in Uruguay are linked to the Argentine crisis. Difficulties at the two largest private banks (Banco Commercial and Banco Galicia), while being addressed by the authorities, could damage the country's image as a safe haven for regional capital flight.

The negative outlook reflects expectations of continued sluggishness in effectively addressing fiscal and structural problems. Uruguay's social and political consensus-based approach to policymaking has impeded faster progress, which has advanced slowly under the administration of President Jorge Batlle, but at a pace inconsistent with rising vulnerabilities. The ratings could come under downward pressure should fiscal deficits not diminish, political frictions impede limited policy adjustment, or pressure in the banking sector deepen. Creditworthiness could improve if the government takes meaningful measures to strengthen fiscal flexibility, most likely by reducing the debt burden.

SOVEREIGN CREDIT RATINGS LOWERED; OUTLOOK REMAINS NEGATIVE

Oriental Republic of Uruguay