Fitch Revises Uruguay's Outlook to Positive; Affirms Sovereign Ratings.

NEW YORK -- Fitch Ratings has today revised the Outlooks on the Oriental Republic of Uruguay's Sovereign ratings to Positive from Stable. The long-term foreign currency (LTFC) Issuer Default Rating (IDR) is affirmed at 'B+', and the long-term local currency IDR is affirmed at 'BB-'. The Short-term IDR is affirmed at 'B' and the Country Ceiling is affirmed at 'BB-'.

According to Morgan C. Harting, Fitch Senior Director and lead sovereign analyst for Uruguay, 'favorable international conditions and adherence to prudent economic policy settings through what could have been a difficult political transition have helped bring public and external debt ratios down, but they still remain high relative to 'B'-rated peers.' Refinancing requirements are also significant, particularly for public external debt, but market appetite for Uruguayan assets has been hearty, so it appears likely these needs will be met, at least in the near term. General government debt is equal to 82% of GDP compared to the 'B' median of 66%, and net external debt is equal to 170% of broad external receipts versus the peer median of 86%. The fact that government debt is owed primarily in foreign currencies and that external debt is owed disproportionately by the public sector makes these comparisons all the more unfavorable for Uruguay.

Although economic growth has been rapid in the past two years, much of the improvement is a recovery rather than a true expansion. Investment has accelerated, but remains low, raising the possibility that growth momentum will sputter out. 'Authorities need to seize the moment to improve competitiveness and the investment environment by focusing on microeconomic reforms, continued strengthening of the banking sector, and consolidation of fiscal policy,' said Harting. Sustaining above-average GDP and export growth rates will be critical in order to bring public and external debt ratios into line with peers. Lower indebtedness will help improve the resiliency of the economy to shocks, a perennial problem for Uruguay. Dependence on Brazil (LTFC IDR 'BB-')and Argentina (LTFC IDR 'RD') have declined as trade and investment with other countries has increased, but Fitch believes Uruguay's high external financing needs still leave it vulnerable to potential contagion from these neighbors. Caution is therefore warranted in raising the LTFC into the 'BB' range prematurely, but a favorable forward credit trajectory is likely enough to warrant moving the Outlook on that rating to Positive from Stable.

Continued reductions in banking system risks will also be important for further credit improvement because Uruguay's heavy state ownership and high degree of dollarization present significant contingent claims on public finances and international reserves. State-owned BROU and BHU hold 58% of system deposits and these are fully guaranteed by the government. Fully 88% of system private-sector deposits are in foreign currency, claims that could add to pressure on international reserves in the event of a crisis.

Over the next six months, key developments to watch will include the sustainability of economic growth and an ambitious legislative agenda including tax reform, changes to the central bank law, and the reform of certain public-sector pension plans. Collective wage negotiations will also be important indicators of potential pressures on inflation or public spending. The ratings could become constrained or face downward pressure if refinancing prospects deteriorate significantly, if authorities relax fiscal and monetary objectives, or if the economy suffers a significant shock to output or financial system confidence.

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