By Dean Steinbeck.

After months of negotiations, Uruguay capitulated to OECD and Argentine demands to end bank secrecy with respect to Argentine tax investigations. Once the deal is ratified by both countries’ legislatures, Argentine tax inspectors will have access to Uruguayan bank account information for Argentine citizens suspected of tax evasion.

In order to understand the magnitude of this announcement, it is important to understand the significant degree to which Argentine investors dominate the Uruguayan economy and its banking system.

Over the last decade, the business environment in Argentina has been so bad, so business-unfriendly, that Argentine farmers, investors and businessmen were desperate to escape Argentina, and Uruguay was a natural destination for them. It’s close, it’s safe, and financial privacy was a sacred right. As a result, Argentine investors flocked to Uruguay and invested heavily.

Argentine farmers came first, buying up huge parcels of land and planting record quantities of soy. As the years progressed, more and more Argentines came to Uruguay to invest. In Punta del Este, Uruguay, over 75% of the homes are owned by Argentines. All of the infrastructure, banks, restaurants and amenities were created to cater to Argentines. At times, the town is just a suburb of Buenos Aires.

But the Uruguayan government could only raise wages, taxes and social benefits for so long before their economy began to stutter. And that’s where things stood in Uruguay before this new tax sharing agreement. Uruguay was at a critical moment. The cost of living had risen uncomfortably. Social entitlement programs made Uruguayan workers less affordable. The cost of real property, and especially farmland, had skyrocketed. Construction costs were matching or exceeding those in the United States, and the quality was still generations behind. Uruguay was, by any standard, becoming expensive. As a result, foreign investment and tourism dollars were slowing. This summer, for example, tourists spent 17% less in Punta del Este than they did the year before. Local businessmen and real estate developers were already concerned and cautious. Many development projects were put on hold…

As much as it defies common sense, Uruguay entered into a tax sharing agreement that will scare off Argentine investors; the same group of people who are Uruguay’s biggest source of capital, investment, and innovation.

The truth is that a large percentage of money held in Uruguay by Argentines is undeclared in Argentina because Argentines don’t trust their own government. They’ve seen their government unfairly seize pension funds, and expropriate private businesses. The Argentine people are justifiably concerned and they’ve responded by moving their money out of the Argentina and hiding it from their government.

For Uruguay, a tax sharing agreement with Argentina ensures that a large portion of Argentine money will leave Uruguay and go to more welcoming places.

Unfortunately for the Uruguayan working and middle class, driving Argentine investors out of Uruguay is clearly the final straw that will push Uruguay’s economy over the edge (but hopefully not off a cliff). All that’s left now is to watch the economic balloon deflate as Argentines pull their money out of Uruguayan banks and stop investing in the country.

Sure, intelligent minds can squabble over the timing and severity of the impact. Some politicians, journalists, government economists, and real estate agents believe the impact will be ”manageable”: a minor speed bump in an otherwise healthy economy. But some foreign investors are less optimistic as they remember the last time Argentine depositors withdrew funds from Uruguayan banks in unison. In 2002, as Argentine investors withdrew money in response to the crises in Argentina, a full-fledged bank run in Uruguay caused a complete collapse of the banking system. There were also ample real estate opportunities for those with available cash to invest.

Of course, to be fair, prior to 2002 bank deposits from Argentines accounted for nearly 50% of all deposits in Uruguay. Today that number is significantly lower and more likely sits around 25%, so it’s unlikely that Uruguay will experience another full-fledged bank run. Regardless of the strain placed on the banking system, one thing is universally agreed on: the tax sharing agreement with Argentina is not going to help the Uruguayan economy.

With fewer Argentine buyers to prop up the inflated real estate market, apartment prices are expected to drop dramatically, especially in resort towns like Punta del Este. Apartments that doubled or tripled in value over the last 24 months will likely fall to earth as Argentine sellers realize there are no buyers. With fewer construction projects to soak up every available worker, the cost of labor will go down, as will demand for the Uruguayan peso, which has appreciated significantly over the last eight years. A cheaper peso means lower costs of goods and services for foreign investors. At last, foreign investors hope that Uruguay will be affordable, again.

Because of the uncertainty surrounding the timing of the new tax sharing arrangement, many foreign investors believe the timing will be right in 12 to 18 months to start picking up real estate at reduced prices, and in particular, they expect income producing property to start yielding more attractive rates of return.

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Dean Steinbeck, a California-licensed attorney, resides in Punta Del Este, Uruguay. Mr. Steinbeck is a founder and partner in Uruguay Residency Group, a legal group that assists individuals and families in their efforts to obtain Uruguayan residency and citizenship. Mr. Steinbeck holds a J.D. from UC Berkeley School of Law and a Masters in Accounting & Finance from the London School of Economics. For more information please visit www.UruguayResidencyLawyers.com.

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