by Win Thin
Moody’s upgraded Uruguay two notches to Ba1 from Ba3 previously, bringing it into line with S&P’s BB+. We recently added Uruguay to our sovereign ratings model universe, bringing the total number of EM countries ranked to 39. As we wrote earlier this week, “Uruguay has an implied rating of BBB+/Baa1/BBB+ and so actual ratings of BB+/Ba3/BB are subject to upgrades.” Fitch’s BB remains way too low, but at least the other agencies are moving towards our model rating. We note that Uruguay is a fallen angel, getting investment grade ratings back in 1997 from all three agencies before losing them all in 2002.
The economy remains strong after avoiding recession during the financial crisis, with GDP rising 10.4% y/y in Q2 vs. 8.9% y/y in Q1. As a result, inflation has picked up to 6.9% y/y in November, above the central bank’s 4-6% target range and led to the first hike in the tightening cycle (25 bp) to 6.5% in September. We think further tightening will be seen in the coming months. Note that Uruguay’s economy remains dependent on agriculture and services, with agriculture and agriculture-related industry accounting for almost a quarter of GDP and for over two-thirds of total exports. The current spike in agricultural prices is thus good for Uruguay, though higher oil prices do offset some since Uruguay is an energy importer. Uruguay has diversified its trade in recent years and reduced its longstanding dependency on Argentina and Brazil. Exports to the EU now account for almost 25% of total exports, and exports to China over 10% of the total.
Uruguay’s USD-denominated global bonds are trading mostly cheap to fair value. For instance, the 5-year is trading at a spread to USTs of +221 bp, which is wider than Panama (+170 bp), Brazil (+148 bp), and Mexico (+169 bp), all credits that we view as having higher sovereign risk relative to Uruguay. From a local currency perspective, T-bills offer a good yield pickup, including some that are inflation-linked and USD-settled offshore. Earlier this year, the government engineered peso weakness by stepping up its dollar purchases, but USD/UYU has since grinded lower to trade around 19.95 vs. USD. The 2010 low is around 18.70 and if risk appetite returns as we expect, that makes for a good target in early 2011. We do not see much risk of capital controls at this juncture.
