URUGUAY'S TRANSFORMATION IN 2003 from pariah to economic miracle was the result of the hard work of many people and organizations.
President Jorge Batlle deserves a huge amount of the credit – not least for hiring an extraordinarily competent economic team and then shielding them from political interference.
The Washington crowd deserves praise too. Batlle is no fan of the IMF, but when the Fund finally signed on to Uruguay's plans, it did so wholeheartedly.
Then, when Uruguay found itself having to go to the international capital markets to restructure all its bonds, it got flawless execution from its advisers at Citigroup and law firm Cleary, Gottlieb, Steen & Hamilton. Behind the scenes, the country was receiving invaluable advice and support from the US Treasury, from the capital markets team at Deutsche Bank, and from the president of the Federal Reserve Bank of New York, William McDonough.
The Uruguay story started at the beginning of 2002, when Argentina's default coupled with a high-profile banking fraud to undermine confidence in Uruguay's banking system. By the middle of 2002, the country was experiencing possibly the worst bank run the world has ever seen, culminating in a bank holiday, devaluation and an IMF bailout in August.
Attention then turned to the government's debt situation, which had become unsustainable overnight. Debt service was much more difficult in the wake of the devaluation, and total debt had increased massively when the IMF loaned the country $1.5 billion. Uruguay faced its problems, and in April 2003 launched a $5.3 billion bond swap that was successfully concluded in May. From that point on, Uruguay's weak currency was an asset rather than a liability, and the country ended the year with 12% GDP growth. It even managed to tap the capital markets in October, with an inflation-indexed bond denominated in Uruguayan pesos and payable in dollars.
Astonishingly, Uruguay had managed to sell bonds on the international capital markets in 2002, warn its bondholders that they faced default, restructure its entire debt, and then sell bonds again in 2003.
The cause of the Uruguay crisis can be summed up in one word: Argentina. Uruguay has always been very much in Argentina's shadow, with an economy largely based on providing nice beaches for Argentines' summer holidays, as well as offshore banking services for Argentina's middle classes. So when Argentina imploded at the end of 2001, Uruguay was hit by a double whammy. The last thing that Argentines were thinking of was spending their summer holidays in Uruguay. More important, Argentina froze all its bank accounts, which meant that many Argentines' only source of funds was their deposits in Uruguay. Thus began the run on Uruguay's banks.
Things went from bad to worse when a fraud was discovered at Uruguay's largest private-sector bank, Banco Comercial, and depositors began a run on the bank.
Credit rating humiliation
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Batlle, McDonough and
Taylor (top to bottom): the Uruguayan president used his good relations with the New York Fed president to persuade the US Treasury deputy secretary to temporarily bail out Uruguay with $1.5 billion
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Soon, the problems spread. Banco Galicia, another major player in Uruguay, was based in Argentina, and therefore regulated there. It had a good business in Uruguay, but needed to inject funds to support withdrawals. The problem was that the Argentine authorities prevented it from doing so.
Simultaneously, Uruguay was losing one of its greatest sources of national pride, its investment-grade credit rating. Standard & Poor's was the first to act, in February 2002, followed by Fitch in March and Moody's in May. "Our credit rating was downgraded every month, an announcement from one rating agency after another," recalls Júlio de Brun, now president of the central bank. "The people received a clear notice that you could cast doubts on the capability of Uruguay to support its debt, and probably its capacity to support the implicit debts in the financial system."
By June, things were getting very bad, in full view of the public. Uruguay had already signed up to an IMF programme, which required the central bank to publish daily data on reserves. Each day, these were $50 million lower than the day before. "It was inviting people to retire their deposits from the banking system," says de Brun.
Then, another fraud was discovered, at Banco Montevideo – the second-largest private bank in Uruguay, after Banco Comercial.
The government had faced this sort of problem before: in the 1980s it had taken over failing banks, guaranteed deposits, and, by stepping in early, avoided panic.
In 2002, though, people could see what was going on in Argentina: accounts were frozen, dollars were forcibly converted into pesos at a completely unrealistic exchange rate, and funds that people thought were safe vanished into thin air. There was no reason it couldn't happen in Uruguay, too. And the data being published by rating agencies and the central bank indicated that matters were deteriorating fast.
What's more, depositors had no way of knowing which banks were solid and which were not. "This country's deposit run was much more dramatic than Argentina's," says Eric Simon, the country representative for Uruguay at ABN Amro in Montevideo. "In five months it lost 50% of its deposits; Argentina lost 27% in a year."
The IMF, at this point, was not being particularly helpful. In a way, the Fund's reluctance to throw good money after bad was understandable. If Uruguay was going to devalue and default, better it do so sooner rather than later, and without the added burden of extra multinational debt.
Batlle, in a television interview in July 2003, identified Uruguay's low point. It had taken place a year previously, when he was sitting with his wife and received a phone call from Eduardo Aninat, the deputy managing director of the IMF.
"The most bitter day was the 20th of July, a Saturday, at midday," Batlle recalled.
"Mercedes was sitting next to me. Aninat called. Aninat told me that we had to do the same thing as Argentina. Mercedes said she thought that I was going to have a heart attack. And I told him no. Under no circumstance. That if we had to sink with the ship, we would sink, but that we wouldn't be the ones to do it."