Financial Rating of Uruguay

Contents

List of figures

List of tables

Abbreviations

1. Introduction

2. Part I: Rating
2.1 Brief description of Uruguay and its economy
2.2 Country rating according to Moody’s rating methodology
2.2.1 FACTOR 1
2.2.2 FACTOR 2
2.2.3 FACTOR 3
2.2.4 FACTOR 4
2.2.5 Detailed guidance to obtain Moody’s final country rating
2.3 Risks arising from doing business within Uruguay

3. Part II: Business Planning and Modelling
3.1 Define the problem
3.2 Gather information from the internet
3.3 Apply an exploratory analysis
3.4 Choose a model
3.5 Fit the model
3.6 Use and evaluate the model

4. Bibliography

List of figures

Figure 1: Export and Import Data of Uruguay

Figure 2: Moody’s country rating for Factors 1 and 2

Figure 3: Moody’s country rating for Factor

Figure 4: Moody’s country rating for Factor

Figure 5: Mapping Factors to the Rating Categories

Figure 6: Economic Resiliency

Figure 7: Government Financial Strength

Figure 8: Alpha-numeric Range

Figure 9: Top10 Export Products of Uruguay

Figure 10: Sourced data

Figure 11: Descriptive Statistics

Figure 12: Decomposition

Figure 13: Triple Exponential Smoothing

Figure 14: Linear regression

List of tables

Table 1: Comparison of Uruguay’s ranking with LACM countries

Abbreviations

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1. Introduction

Financial Planning and Rating are two enormous important topics in the world’s economic markets. Since many years global rating agencies like Standard & Poor’s, Moody’s, and Fitch are ranking countries and enterprises worldwide according to their individually estab­lished methodologies to deliver transparency. Financial Planning in the form of Business Planning is essential to establish or keep a company effective.

2. Part I: Rating

Hereafter, the focus is on describing and evaluating Uruguay and its economy. Followed by determining a country rating according to Moody’s rating methodology of it. The last section of this part deals with the risks that might arise from doing business with or within Uruguay referring to the agricultural export sector. In addition, the implication of the coun­try rating for the respective business model is evaluated.

2.1 Brief description of Uruguay and its economy

Uruguay, officially the Oriental Republic of Uruguay is a South American country, in which Spanish is the native language. It is located on the South Atlantic Ocean coast, south of Brazil and bordering Argentina in the west. Since the country spreads over an area of only 176,000 km[2] it is known as the second-smallest nation in South America, di­rectly after Suriname. According to Nations Online (2017), more than 3.25 million people are living in Uruguay, of whom approximately one third, namely 1.3 million are living in its capital Montevideo. In 2012, it became a high-income country according to World Bank standards due to its GDP per capita, adjusted by purchasing power parity, which is the highest on the South American continent and covers around 40 percent of the one of the USA (U.S. Embassy Montevideo, 2017). In addition, the United Nation’s reports state Uruguay as the country with the most equal income distribution in Latin America. As most of the terrain exists of plains and low hills, in the center of the country, 84% of nature are used for agricultural products like wheat, rice, corn, barley, and livestock farming. Where­as tourism is concentrated on the East, industry, trade and financial services are located in its capital (Societe Generale, 2018). Food processing, electrical machinery, transporta­tion equipment, petroleum products, beverages, textiles, and chemicals are counted among Uruguay’s main industries.

Since the nation is a member of Mercosur, a common market agreement for Paraguay, Argentina, Brazil, and Uruguay, exports and imports rose significantly. When looking at the export commodities, Uruguay mainly concentrates on selling beef, soybeans, cellu­lose, wheat, rice, wool, wood, and dairy products to its partners China, Brazil, USA, and

Argentina (percentages in a descending order). In contrary, the Uruguayans primary im­port refined and crude oil, cellular phones, passenger and other transportation vehicles, and parts for those, from Brazil, China, Argentina, USA, Germany, and Nigeria (percent­ages in a descending order).

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Figure 1: Export and Import Data of Uruguay: Author’s own illustration (Numbers from NationsOnline, 2017)

Uruguay’s political and labor conditions are considered among the freest on the South American continent. Due to a violent Marxist urban guerrilla movement, launched by the Tupamaros^[1] in the late 1960s, the Uruguayan president agreed to military control of his administration in 1973. By the end of 1973, the rebels had been shattered, but the military still proceeded to extend its hold throughout the government. Civilian rule has not been restored until 1985. Today, the country is considered as a constitutional republic, which amended its constitution in December 1996 (Nations Online, 2017).

When considering all above-mentioned aspects, Uruguay seems to be a country rich in natural resources and with a functioning economy. But by focusing on their currency, the Uruguayan Peso (UYU), it can be seen that the exchange rates are comparatively disad­vantageous (1 USD = 31,42 UYU; Finanzen.net, 11th of July 2018). Anyway, the nation shows a stable economy and interacts intensively with some of the most powerful coun­tries in the world.

2.2 Country rating according to Moody’s rating methodology

In the following part, a country rating for Uruguay according to the rating methodology of Moody’s is provided. When looking either at Standard & Poor’s or Moody’s rating scheme, it is highly difficult to weigh those against each other, since both have overlapping ad­vantages and disadvantages. Anyway, in this paper, Moody's framework is applied since I wanted to create an own Excel sheet to leam how such kind of rating is elaborated, in­stead of simply using the prefabricated one.

When looking for all underlying numbers, the IMF Reports of Uruguay (2013 and 2018), Trading Economics (2017a and 2017b), The Global Economy (2016a), and Statista (2018) were fundamental resources. After gathering all the needed data, the formulas behind each Indicator had to be calculated according to Moody's Rating Methodology (Moody's Rating Methodology, 2016), as to be seen in chapter 2.2.5.

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Figure 2: Moody’s country rating for Factors 1 and 2: Author’s own illustration

As shown in Figure 2, the first rating factor Economic Strength is determined by the Sub- Factors Growth Dynamics, Scale, Nominal Income, and Adjustments. Those are mainly subdivided into numbers referring to the GDP, Competitiveness Index, and GDP per capi­ta of the rated country. Factor 2 of Moody's Rating Methodology, Institutional Strength, consists of the Sub-Factors Institutional Framework and Effectiveness, Policy Credibility and Effectiveness, and Adjustments. Those are broken down to Government Effective­ness Index, Rule of Law Index, Control of Corruption Index, Inflation Level, and Inflation Volatility of the considered nation.

To calculate the sub-factor Growth Dynamics GD (weighs 50% of Factor 1), the Average Real GDP Growth of Uruguay (50% of GD) from t-4 to t+5, in this case t is 2017 and therefore annual data of the years 2013 until 2022 have to be gathered and divided by the amount of years to get the average of 2,82% increase per annum, the Volatility in Real GDP Growth (25% of GD) from t-9 to t needs to be collected and calculated to receive a value of 2,4, and last the WEF Real Competitiveness Index of 4,17 (25% of GD) needs to be looked up at Trading Economics (2017a). Furthermore, the figures for the sub-factors Scale (weighs 25% of Factor 1) and Nominal Income (also 25% of Factor 1) can be found in the IMF Report of Uruguay (2018) and at Trading Economics (2017b). Adjust­ments to Factor Score are considered to be highly subjective opinions. Anyway, the sub­factor indicator Credit Boom may apply in the case of Uruguay, since according to Pa- zarbasioglu (2004, page 2) many studies show that those are associated with:

- Domestic investment and consumption boom
- Significant increases in domestic interest rates
- Increase in capital inflows but worsening of current account
- Shortening of maturity of external debt and declines in foreign reserves
- Appreciation of domestic currency
- Decline in trend output growth
- Worsening of the fiscal situation

Since solely bullet point two might apply, depending on the definition of “significant in­crease”, the overall decision is to disregard this factor in my rating. Other adjustments to Factor Score are not applicable since Uruguay does not show any unusual scale, wealth, diversity, concentration, or structural shifts according to (Moody's Rating Methodology, 2016, pages 10 - 13).

2.2.2 FACTOR 2

For the calculation of the sub-factor Institutional Framework and Effectiveness IFE (75% of Factor 2) the sub-factor indicators Worldwide Government Effectiveness Index (50% of IFE), Worldwide Rule of Law Index (25% of IFE), and Worldwide Control of Cor­ruption Index (also 25% of IFE) can be found at the websites of The Global Economy (2016a) and World Justice Project (2017). Moreover, Policy Credibility and Effective­ness PCE (25% of Factor 2) consists of the average Inflation Level (50% of PCE) from t-4 to t+5 in percent and the Inflation Volatility (remaining 50% of PCE) from t-9 to t. Related numbers to be found at Statista (2018) and the IMF Reports of Uruguay (2013 and 2018). Adjustments to Factor Score are applicable to Factor 2 since a Track Record of Default for Uruguay was detected after a well-founded research. The country’s banks went tech­nically insolvent due to financial troubles in Argentina and the devaluation of the Uruguay­an Peso in 2003 (Financial News, 2011). Other Adjustments to Factor Score do not apply.

A comparison in real life shows the following: Whereas Latin America and Caribbean Me­dian LACM are ranked with L+ in Moody’s Government Report (2017, page 20) for Factor 1, Uruguay receives a L in this ranking. By contrary, Factor 2 obtains a L by Moody's for LACM, but a VH- for Uruguay in this case.

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Figure 3: Moody’s country rating for Factor 3: Author’s own illustration

As illustrated in Figure 3, the third rating factor Fiscal Strength is determined by the Sub- Factors Debt Burden, Debt Affordability, and Adjustments. Those are mainly subdivided into fiscal numbers referring to GDP, Government Debt, Revenues, Interest Payments, and Funds of Uruguay. Furthermore, adjustments to the scores consider trends, assets, and other factors.

2.2.3 FACTOR 3

All necessary numbers for the final rating of Factor 3 were taken out of the IMF Report of Uruguay (2018). To generate the sub-factor Debt Burden DB (50% of Factor 3) the sub­factor indicators General Government Debt/GDP (weighs 50% of DB) and General Gov­ernment Debt/Revenues (50% of DB), both in percent, need to be calculated. In addition, Debt Affordability DA (remaining 50% of Factor 3) is determined by General Govern­ment Interest Payments/Revenue (weighs 50% of DA) and General Government Interest Payments/GDP (50% of DA), both in percent. Adjustments to Factor Score is solely utilized for General Government Foreign Currency Debt/General Government Debt in per­cent since Debt Trend, Other Public Sector Debt and Public Sector Financial Assets or Sovereign Wealth Funds SWFs do not apply for Uruguay. To determine General Govern­ment Foreign Currency Debt/General Government Debt, data from the Sovereign Debt Report of Uruguay (Debt Management Unit of the Ministry of Economy and Finance, 2017, page 4) were gathered. After receiving the result, 53%, a look into Exhibit 12 of Moody's Rating Methodology (2016, page 18) provides an adjustment score of -5. Debt Trend is calculated as the percentage point change in General Government Debt/GDP between the periods t-4 and t+1, which results in 2 percent and therefore receives a score of 0 (Moody's Rating Methodology, 2016, page 18, Exhibit 12). Adjustments concerning SWFs are not applicable to Uruguay since the transparency of those is comparably high.

A comparison in real life demonstrates: While Factor 3 is ranked as M- for LACM in Moody’s Government Report (2017, page 20), Uruguay receives a L- in this ranking.

Figure 4: Moody’s country rating for Factor 4: Author’s own illustration

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As shown in Figure 4, the fourth and last rating factor Susceptibility to Event Risk is determined by the Sub-Factors Political Risk, Government Liquidity Risk GLR, Bank­ing Sector Risk BSR, and External Vulnerability Risk EVR. Those are subdivided into the sub-factor indicators Domestic Political Risk, Geopolitical Risk (does not apply for Uruguay, since its creditworthiness is not affected by geopolitical risk concerns), Funda­mental Metrics (weighs 50% of GLR), Market Funding Stress (remaining 50% of GLR), Strength and Size of Banking System (weighs 80% of BSR), Funding Vulnerabilities (re­maining 20% of BSR), (Current Account Balance + FDI Inflows)/GDP (weighs 25% of EVR), External Vulnerability Indicator EVI (weighs 50% of EVR), and Net International Investment Position (remaining 25% of EVR). The indicator components Worldwide Voice and Accountability Index and GDP per capita are figures from The Global Economy (2016b) and the World Bank (2017), whereas Gross Borrowing Requirements/GDP and Non-Resident Share of General Government Debt were taken out of the IMF Report of Uruguay (2018). Moody‘s Market Implied Ratings were published at Moody’s (2018), the Average Baseline Credit Assessment (BCA) was found in the IMF Report of Uruguay (2018), Total Domestic Bank Assets/GDP in a database of the World Bank (2015), Bank­ing System Loan-to-Deposit Ratio in Moody’s Government Report (2018, page 5), (Cur­rent Account Balance + FDI Inflows)/GDP was calculated by adding the Current Account Balance (IMF Report of Uruguay, 2018) to FDI Inflows (Indexmundi, 2016) and dividing this sum by the GDP of Uruguay (IMF Report of Uruguay, 2018), which resulted in 2,06%. Last, the External Vulnerability Indicator (EVI) was taken from the Moody’s Government Report (2018, page 5), and the Net International Investment Position/GDP was found in a report of Rabobank (2011).

In real life, Moody’s Government Report (2017, page 20) ranks LACM with M- for Factor 4, whereas Uruguay obtains a VH- ranking in this paper.

2.2.5 Detailed guidance to obtain Moody’s final country rating

As a first step, all the indicators of Factors 1 to 4 are put into the designated category ac­cording to Moody's Rating Methodology (2016). For example, the indicator Average Real GDP Growth, belonging to Factor 1, for Uruguay from t-4 to t+5 is 2,82 (cell G5 in Excel- sheet). The next step is to have a look at Exhibit 8, page 9 of Moody's Rating Methodolo­gy (2016), were 2,9 falls in the range between 2,75 and 3. As a result category H is as­signed to Average Real GDP Growth. This scheme is running through the entire rating process.

Next, the Mid-Points for all Indicators have to be assigned. To manage this, a look at Fig­ure 5, page 8 is needed. Every category assigned to an Indicator has a predefined Score Range and a Mid-Point, which is essential to proceed with the rating process. To make this step easier to understand, an example of Factor 1 is taken, again. The WEF Real Competitiveness Index has a value of 4,17 (Trading Economics, 2017a) and therefore

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^[1] Tupamaros = Movimiento de Liberacion Nacional: guerilla movement and since 1985 a left-wing radical political party of Uruguay (Wikipedia, 2018).