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While Uruguay’s current financial position is significantly stronger than in the early 2000s when its economy suffered from the effects of the Argentine crisis, a severe downturn in Argentina could still have an important impact on Uruguay’s economy through a variety of transmission channels, according to a new special report published by Fitch Ratings.

‘Substantive external and fiscal buffers, together with its improved fiscal position, large contingency lines, flexible exchange rate regime and sound financial system give Uruguay significant space to maneuver through potentially more adverse developments in Argentina,’ said Santiago Mosquera, Director in Fitch’s Latin America Sovereign Group.

Uruguay’s banking system is much stronger than it was a decade ago, when negative spillovers from Argentina ignited a run on the country’s highly-dollarized financial system, put pressure on foreign reserves and the exchange rate, substantially increased government indebtedness due to a high level of dollarization of the debt and ultimately led to public debt restructuring.

Financial dollarization is far below the 90% mark observed in 2001 but it remains elevated at 74% of total bank deposits. The exposure to foreign-currency non-resident deposits has, nevertheless, decreased to 15% of total deposits in 2013 from over 41% in 2002.

‘The increase of Argentine FDI flows into Uruguay since 2007 has somewhat replaced the traditional accumulation of deposits in Uruguayan banks’ added Mosquera. On average, 29% of total FDI over the period 2007-2012 came from Argentina, with most of it going to land acquisition and real estate. Limited access to foreign currency and deteriorating local conditions in the case of heighted instability in Argentina could impact investment flows into Uruguay.

A severe downturn in Argentina could also affect tourism, by far the most important transmission channel between these two countries. Fewer Argentine arrivals would have negative consequences on Uruguay’s economic activity, employment levels and FX generation capacity, with the latter being further undermined by increasing FX outflows by Uruguayans travelling abroad.

On the other hand, trade has become a weaker transmission channel, as the share of Uruguayan exports to Argentina decreased to 5.5% of total exports in 2013, from 15.4% in 2001. However, the high degree of specificity of certain exports may make it difficult for Uruguayan exporters to place their products in alternative markets if Argentine demand softens or trade barriers increase.

Thus, while some risks remain due to still strong transmission channels between both economies, Uruguay’s improved credit buffers leave it in a better position to face a further deterioration in Argentina’s economy. In addition, the sovereign’s debt profile has substantially improved, with longer maturities and a larger local-currency component reducing rollover and exchange rate risks.

Source: http://en.mercopress.com/2014/04/09/uruguay-significantly-stronger-but-still-vulnerable-to-argentina-says-fitch

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