The civilian government that entered office in 1985 faced a severe fiscal problem: the chronic public-sector deficit. It also faced a broader difficulty: an economy in deep recession. The deficit was believed to be perpetuating inflation. Inflation, in turn, prevented the economy from reaching a stable posiÍÍÍÍtion conducive to renewed growth. Thus, the priorities of the Sanguinetti administration's economic plan--devised in cooperation with the International Monetary Fund ( IMF--see Glossary)--were to reduce the deficit, bring down inflation, and improve the balance of payments.

These multiyear fiscal measures were considered essential for renewed growth, but the serious consequences of the recession called for immediate action to spur economic activity. Between 1981 and 1984, the recession had taken its toll on all sectors of the economy. GDP had declined by almost 17 percent agricultural production by 12 percent manufacturing by 21 percent construction by 48 percent and capital formation (investment) by 56 percent. Workers were especially hard-hit by the decline. Between November 1982 and March 1985, real salaries fell by 19 percent. In real terms, workers only earned half of what they had earned in 1968, and unemployment had increased to 13 percent. Unable to ignore these signs of distress, the Sanguinetti administration also adopted an economic growth policy.

Initially, the stabilization effort took precedence over efforts to boost economic activity. The idea was to break the inflationary momentum of the economy first and restore growth second. In fiscal terms, the goal was to reduce the public-sector deficit from 10 percent of GDP in mid-1985 to 5 percent of GDP by 1986. The scope of government involvement in the Uruguayan economy meant that the public-sector deficit had to be attacked on three fronts: the central government, by reducing expenditures and increasing revenues the Central Bank of Uruguay, which accounted for about half of the deficit and the state enterprises, many of which had run small deficits through most of the 1980s.

The results of the stabilization effort were ambiguous. On the one hand, the Sanguinetti government easily reached its fiscal targets. During its first two years in office, the government enacted tax increases that raised real government revenues by 58 percent. Meanwhile, real expenditures increased by only 43 percent (see table 10 table 11 table 12, Appendix). As a result, the public-sector deficit declined to about 3 percent of GDP, better than the government had planned. Simultaneously, however, inflation--the underlying target of the government's fiscal policy--hardly slowed at all. Inflation went from an annual rate of 72 percent in 1985 to 57 percent in 1987, but it increased to 85 percent in 1989. The persistence of inflation in the face of fiscal restraint did not reflect a failure of the Sanguinetti government's fiscal p 2c9olicy r rather, inflation persisted because of the government's monetary and exchange-rate policies, the instruments it used to promote economic growth (see Monetary and Exchange-Rate Policy , this ch.). Fiscal policy was also inadequate because the government expanded the money supply to pay for the fiscal deficit (8.5 percent by the end of 1989).

Data as of December 1990