IMF Staff Completes 2017 Article IV Mission to Paraguay

June 2, 2017

End-of-Mission press releases include statements of IMF staff teams that convey preliminary findings after a visit to a country. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF's Executive Board for discussion and decision.

  • Stronger growth can be largely attributed to a combination of positive supply shocks in key sectors, firmer private spending, and public sector efforts to close infrastructure gaps
  • With recent indicators suggesting vigorous activity, we have revised our real GDP growth forecast upwards to 4.3 percent for 2017
  • Beyond the near-term, continued policy efforts will be needed to ensure stronger, sustainable and more inclusive growth

A staff team from the International Monetary Fund (IMF), led by Mr. Hamid Faruqee, visited Asunción and Encarnación during May 22 to June 2 to hold discussions for the 2017 Article IV consultation. At the conclusion of the visit, Mr. Faruqee issued the following statement:

“Paraguay’s economy is performing robustly, with growth among the highest in Latin America. Stronger growth can be largely attributed to a combination of positive supply shocks in key sectors, firmer private spending, and public sector efforts to close infrastructure gaps. There are signs that the expansion this year is becoming more broad based across sectors. With recent indicators suggesting vigorous activity, we have revised our real GDP growth forecast upwards to 4.3 percent for 2017. Recent wage increases should support consumption, while investment is picking up, reflecting both public and private sector activity.

“The BCP lowered the inflation target from 4.5 to 4 percent earlier this year. While still below target, headline inflation has been rising and underlying inflation pressures have edged higher. Although monetary conditions remain accommodative, inflation expectations appear to be well anchored around the lower target. On the fiscal side, the authorities have shown laudable restraint on the growth of current primary expenditures, while accelerating public investment. The external current account surplus is expected to narrow with imports gaining strength relative to last year. International reserves remain above standard adequacy measures.

“The banking system remains profitable and well capitalized. Given past rapid credit growth, however, some sectors need to reduce indebtedness and ongoing adjustment in bank balance sheets will take more time to complete. Broad-based measures of loan quality deteriorated last year. In response, banks have increased provisioning and NPLs remain manageable. There are signs that credit from unregulated non-traditional lenders is growing, but this remains a small fraction of credit.

“The macroeconomic policy-mix has been broadly appropriate. If the expansion continues to broaden and become more durable, as bank credit growth resumes, monetary policy accommodation should be gradually removed to maintain low inflation. If downside risks to growth materialize, the authorities have policy space to respond within the constraints of the central bank’s price stability mandate. The broadly neutral fiscal stance envisaged for 2017 is appropriate, as is continuing a growth-friendly shift in the composition towards capital investment. Public sector debt is relatively low and remains on a sustainable path.

“Looking beyond the near-term, continued policy efforts will be needed to ensure stronger, sustainable and more inclusive growth. Overcoming structural challenges requires further strengthening of institutions and policy frameworks, as well as closing key infrastructure gaps.

“The inflation targeting regime has served Paraguay well in promoting macroeconomic stability. The BCP has become increasingly transparent and credible. Monetary policy effectiveness could be further enhanced by strengthening the central bank’s policy framework and improving predictability. In particular, for the operation of the interest rate corridor, continuing efforts in draining excess liquidity through additional issuance of Instrumentos de Regulación Monetaria would help better align targeted policy rates with interbank rates. Predictability of foreign exchange operations could also be improved, given that dollar sales have not always been implemented as announced. Discretionary interventions in the foreign exchange market should continue to be limited to exceptional circumstances such as disorderly market conditions. In addition, credit dollarization remains high. Finally, greater use of forward-looking policy guidance in public statements could strengthen communications, policy signals, and improve the public’s understanding of the BCP’s reaction function.

“On fiscal policy, the 2017 budget culminated in an unprecedented presidential veto, highlighting the need to strengthen the budget process. We expect that the authorities will meet the numerical ceilings of the fiscal responsibility law (FRL) with efforts already underway to exercise continued spending restraint. To enhance the credibility of the fiscal anchor, it would be desirable to modify the assessment of FRL compliance to include the execution stage as well as the budget approval stage. The authorities should strengthen the budget process, for example with procedural rules to have any amendments require an offset to respect a given budgetary envelope.

“Over the last decade, Paraguayan authorities implemented essential measures to strengthen tax administration and revenue mobilization with technical assistance from the IMF. Institutional capacity at the revenue authority (SET) has expanded in several dimensions. Nevertheless, staffing, institutional, and legal constraints—including on tax compliance, enforcement, and penalties—present substantial barriers to further efficiency gains. Furthermore, coordination between the SET and the customs administration authority (DNA) could be strengthened.

“Paraguay’s pension system faces near- and longer-term problems and needs to be reformed. Containing risks from current and future imbalances in the Instituto de Previsión Social (IPS) is a crucial priority. The IPS public health program is underfunded, as is the major public sector retirement program (Caja Fiscal). Moreover, pressures will rise over time and additional pension programs, including that of the IPS, will experience funding shortfalls as the population ages. The authorities should consider parametric reforms as well as other options, such as cost sharing (e.g., copays, deductibles) arrangements for health programs. More broadly, progress on legislation to introduce a regulator for pension funds could also contribute to better mobilize saving held there to deepen domestic capital markets.

“The authorities have made important progress on introducing risk-based bank supervision, ratifying a new banking law in December 2016. However, the law is only part of a broader agenda to strengthen financial sector oversight that needs to advance. Crucial initiatives include: (i) revisions to the BCP organic charter; (ii) establishment of a financial stability council; (iii) implementation of deposit insurance for savings and loan cooperatives; and (iv) integrating financial information through a single credit bureau. Furthermore, approving legislation regarding the Sociedades Anonimas would bring regulations on bearer securities on par with international standards and help safeguard banking correspondent relationships.

“Raising potential growth requires addressing key structural issues that constrain productive capacity and public service quality. The authorities continue to advance in the implementation of their National Development Plan (NDP) for 2014-30. Additional investment in transport infrastructure would relieve congestion and facilitate trade. Improving electricity transmission and distribution, which are inadequate to meet growing energy demand and tap the potential of the binational hydropower plants, is also desirable. Finally, improving public investment management would generate more infrastructure for each guaraní spent.

“Paraguay’s record on reducing poverty and inequality was strong over the past decade. To secure these gains and further reduce income disparities, however, stronger implementation of NDP priorities is needed, such as investment in education and training, as well as an expansion of conditional cash transfer programs. Tax reform that rebalances away from indirect taxation and maintains low income tax rates but limits deductions could improve progressivity and help finance these initiatives to promote inclusive growth.

“We are grateful to the authorities and all our counterparts for their hospitality and the open and productive dialogue.”

The team met with Central Bank of Paraguay (BCP) President Carlos Fernández, Minister of Finance Santiago Peña, Minister of Public Works and Communications Ramón Jiménez, Minister of Planning José Molinas, Minister of Labor Guillermo Sosa, Social Action Minister Héctor Cárdenas and other senior officials, as well as representatives from the private sector, think tanks, and the donor community.

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