Uruguay and Argentina, Profiting from Virtue

BUENOS AIRES AND MONTEVIDEO (Economist) February 12, 2009 ― Uruguay, lying just across the muddy waters of the River Plate from Argentina, has been fated in recent decades both to be buffeted by, and to benefit from, its big neighbor's secular instability. Argentina’s economic collapse of 2001-2 duly prompted a bank run and recession in Uruguay. While Argentina defaulted on its debt, nationalized foreign businesses and imposed price controls, Uruguay quietly reached an amicable rescheduling agreement with its creditors. It stuck to its orthodox ways even after the leftish Broad Front of President Tabaré Vázquez came to power in 2005. Now it is reaping some benefit.

As a small, open economy dependent on banking, beach tourism and beef exports, Uruguay ought to be more exposed to the world recession than Argentina, with its large domestic market. Both economies have slowed sharply after years of rapid growth. But Uruguay looks set to fare much less badly than Argentina.

That is because the growth in Argentina owed much to expansionary fiscal and monetary polices which caused the economy to overheat. Over the past year prices for its farm exports have fallen, bringing down tax revenues. To keep public spending going, President Cristina Fernández de Kirchner nationalized the private pension system in October, destroying what little confidence investors had in her government. Argentines, long inured to such behavior, responded as they always do, by taking their money out. Capital outflows reached 7% of GDP in 2008.

Much of that money went across the river. Deposits in Uruguay’s banks by non-residents rose by 41% in the 12 months to December. These pesos follow others: during the presidency of Néstor Kirchner, Ms. Fernández’s husband and predecessor, some Argentine beef farmers sold their herds rather than submit to export bans and price controls, and ploughed the money into Uruguayan ranches.

Uruguay has ridden out a bitter dispute with Mr. Kirchner over a $1.2 billion cellulose factory on its side of the border river. This vast plant, opened last year by Botnia, a Finnish company, added 1.8% to the country’s GDP while producing no evidence of the feared pollution which has led Argentine protesters to block a border bridge for the past three years, hurting Uruguay’s economy. Mr. Vázquez’s firm stance spurred other foreign investment.

This will now inevitably slow. But Uruguay is better placed to mitigate recession than its neighbor. Argentina may struggle to roll over the $23 billion in debt maturing this year and next because of investors’ distrust: its bonds yield 15 percentage points more than American Treasury bonds. Uruguay is charged a premium of only five percentage points, and can thus more easily afford a fiscal stimulus.

The main source of uncertainty for Uruguay is a presidential election in October. Mr. Vázquez cannot stand again. In the Broad Front’s primary campaign, his former economy minister and chosen candidate, Danilo Astori, trails José Mujica, a former guerrilla leader who criticizes the government as too moderate. But if Mr. Mujica is elected as president — and that is far from certain—he is likely to have to govern from the centre. Uruguay may have been outpaced by Argentina earlier this decade, but the tables seem now to have been turned.