Press Release No. 12/470

Press Release: Statement by an IMF Mission on Paraguay

December 4, 2012

An International Monetary Fund (IMF) team, lead by Mr. Gabriel Lopetegui, visited Paraguay during November 25 to December 4, 2012 for discussions with government officials and the private sector on Paraguay’s economic situation. At the end of the visit, Mr. Lopetegui issued the following statement in Asunción today:

“Negative supply shocks have impacted Paraguay’s economic performance. After expanding by 4.3 percent in 2011, the economy contracted by 2.4 percent in the first half of 2012 as a severe drought decreased agricultural output by 28 percent. Cement shortfalls and restrictions on meat exports to regional markets, related to foot and mouth disease, also placed a drag on growth. Nevertheless, the non-agricultural sector grew by 4 percent, supported by a marked increase in government wages and swift re-direction of meat exports to non-traditional markets. At the same time, inflation steadily declined from about 5 percent at end-2011 to 4.1 percent in November as temporary food price shocks eased. Core inflation, however, has remained near 6.0 percent. For 2012, we now expect the economy to contract by 1.5 percent, with inflation at 4.0 percent.

“In this environment, macro-policies have been appropriately accommodative. In response to the supply shocks, the central bank cut the policy rate by 300 bps in the current cycle to 5.5 percent, below neutral in real terms. At the same time, fiscal policy—albeit through increases in recurrent spending—has provided a strong fiscal stimulus in 2012 of some 2 percent of GDP.

“However, with the economy expected to rebound sharply in 2013, the authorities should stand ready to tighten policies to protect macro-stability. Projected bumper agricultural yields and a re-opening of regional meat markets should provide a strong boost to the recovery in 2013. At the same time, a marked inflow of foreign exchange related to additional electricity compensation and the envisaged flotation of a new sovereign bond will result in additional spending—and another moderate fiscal impulse. In this context, we project the economy to grow by 11 percent in 2013. Coupled with payments system reform, which may lead to a liquidity excess in the financial system, inflationary pressures are likely to rise substantially in 2013 as temporary food shocks reverse. As we have noted in the past, the authorities will need to be vigilant and stand ready to adjust policies accordingly. Assuming an appropriate response, including allowing some appreciation of the Guarani as agricultural exports rebound, we expect inflation to rise only slightly to 5 percent in 2013.

“In line with previous policy recommendations, we remain of the view that public sector institutions and the fiscal framework also need further strengthening.

“We acknowledge and support the authorities’ desire to increase capital spending in order to reduce Paraguay’s sizable infrastructure gap and improve potential growth. However, we would stress that the public sector’s investment planning and implementation capacity is still weak. The national public investment plan (SNIP) should prioritize infrastructure projects based on thorough examination of technical aspects and estimates of social and economic payoff. Local governments, which could play an important role in infrastructure implementation, still lack basic project planning capacity, and feature weak fiscal accounting and reporting controls.

“The tax ratio in Paraguay remains one of the lowest in Latin America, and is well below that in neighboring countries. While the recent implementation of the personal income tax is a positive step, Paraguay still needs to augment its tax revenues to finance basic infrastructure, improve social indicators, and reduce poverty in a sustainable way. In this regard, we emphasize the importance of raising the tax burden on the agricultural and financial sectors.

“After a near decade of persistent surpluses, the public sector position has switched to deficit. While this is not an immediate concern given low debt and strong expected growth, we recommend that the authorities strengthen the fiscal framework through the implementation of a financial transparency law, multi-annual budgets, and fiscal anchors, to ensure a return to a medium-term structural balance.

“The authorities should continue the process of adopting an inflation-targeting (IT) regime. We welcome the: (i) completion of the BCP’s board of directors; (ii) enhanced BCP-ministry of finance coordination in the production of liquidity forecasts; (iii) improved signaling of intended foreign exchange operations; (iv) additional allocation of long-term instruments; (v) and expanded financial education outreach activities. Nevertheless, market understanding of central bank objectives and processes could be further improved and the central bank is working on clearer communication policies. Finally, we would stress that a solid central bank balance sheet, which could be achieved through a recapitalization of the BCP, is considered a prerequisite for credible and independent monetary policy.

“The team welcomes the authorities’ continued efforts at strengthening financial sector supervision. Overall, the banking system continues to remain highly profitable, well capitalized, and liquid. While there has been a small deterioration in non-performing loans, this is generally in line with the slowdown in the economy, although the growth of consumption loans should be closely monitored. Progress has been made in strengthening anti-money laundering policies and we encourage the authorities to finalize their national strategy in this area in the first half of 2013. We support the objective of developing domestic capital markets to, inter alia, lengthen the maturity of investment financing; however, we have cautioned that the operation of a public development bank should be contained to avoid future financial sector stability risks.

“Finally, the IMF mission would like to thank the authorities and private sector representatives of Paraguay for a very open and stimulating dialogue and for their cooperation and warm hospitality.”