Paraguay and the IMF

Press Release: IMF Approves 15-Month US$73 Million Stand-By Arrangement for Paraguay
December 15, 2003

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ParaguayLetter of Intent, Memorandum of Economic and Financial Policies, and Technical Memorandum of Understanding

Asunci??December 5, 2003

The following item is a Letter of Intent of the government of Paraguay, which describes the policies that Paraguay intends to implement in the context of its request for financial support from the IMF. The document, which is the property of Paraguay, is being made available on the IMF website by agreement with the member as a service to users of the IMF website.

Mr. Horst Köhler
Managing Director
International Monetary Fund
Washington, D.C. 20431

Dear Mr. Köhler:

1. The attached Memorandum of Economic and Financial Policies describes the economic program and objectives of the Government of Paraguay for the remainder of 2003 and for 2004. In support of this program, the Government requests a Stand-By Arrangement from the Fund for the period through March 31, 2005 in an amount equivalent to SDR 50 million. The government intends to treat this arrangement as precautionary.

2. The program will strengthen the fiscal balance and permit the elimination of payments arrears, putting the government finances on a sustainable path for the medium term. It will provide for a monetary policy focused on reducing inflation and maintaining a floating exchange rate regime. The program also includes important structural reforms of the state, the Central Bank, and the financial sector. Finally, various measures are contemplated to improve transparency and governance of the public sector's operations.

3. The government believes that the policies set forth in the attached Memorandum of Economic and Financial Policies are adequate to achieve the objectives of its program, but it will take any further measures that may become appropriate for this purpose. Paraguay will consult with the Fund on the adoption of these measures, and in advance of revisions to the policies contained in the MEFP, in accordance with the Fund's policies on such consultations. The government will provide the Fund with any information it requests to monitor progress in achieving the objectives and policies of the program. The arrangement will include quarterly program reviews to assess overall performance under the program. The program will include quarterly quantitative performance criteria and certain structural performance criteria. These reviews will be completed by March 15, 2004; June 15, 2004; September 15, 2004; December 15 2004; and March 15, 2005.

Yours sincerely,


Angel Gabriel González Cáceres
Central Bank of Paraguay

Dionisio Borda
Minister of Finance

Memorandum of Economic and Financial Policies

A. Introduction and Recent Developments

1. This memorandum describes the government's economic program for 2003-04 in support of which the government is requesting a 15-month Stand-By Arrangement (SBA) from the Fund.

2. In 2002, Paraguay suffered a sharp fall in economic activity. The slump was brought on, in part, by a crisis in the region and a poor harvest, and was exacerbated by weak domestic economic policies. Real GDP fell by nearly 2½ percent, inflation accelerated from 8½ to 14½ percent, and the guaraní lost 34 percent of its value. The third-largest bank, Banco Alemán, collapsed, sparking substantial capital flight. Fiscal problems led to the accumulation of large payments arrears. Open unemployment rose from 7.6 percent in 2000 to 10.8 percent in 2002.

3. Modest economic growth has returned in 2003. A good harvest and the improved regional situation are expected to contribute to growth of around 2 percent in real GDP for 2003; however, the nonagricultural economy is expected to remain stagnant, due mainly to a sharp decline in private investment. The guaraní has appreciated by nearly 15 percent so far this year against the U.S. dollar, reflecting the appreciation of currencies in Brazil and Argentina, rising agricultural exports, and reduced uncertainty following the general elections. Official reserves and bank deposits have also risen (by 36 percent and 23 percent, respectively since end-2002). Annual inflation was 10 percent in October, down from the peak of 21 percent reached in April.1

4. Despite the temporary improvement in economic activity, growth cannot be sustained unless serious underlying problems are addressed. The public sector has large accumulated arrears and faces financing difficulties in 2003 and 2004. The highly-dollarized banking system suffered the collapse of a local bank, Multibanco, early in the year and has high nonperforming loans and an inadequate regulatory framework and resources for bank supervision. The National Development Bank also remains a source of concern, despite its recent recapitalization and management changes. Absent reforms to address structural impediments to growth and to improve the flexibility of the economy, per capita income will continue to decline in the medium term, and Paraguay will remain highly vulnerable to exogenous shocks.

5. The new government has developed a program to deal with Paraguay's economic difficulties. An agreement has been signed between the government and political leaders in Congress (including main opposition parties) on initiatives to permanently correct the fiscal imbalance and pay off its arrears, strengthen the banking system, and undertake structural reforms to improve governance, economic growth, and flexibility. This letter of intent reflects the key elements of that agreement. It also reflects the government's commitment to reduce inflation and strengthen Central Bank reserves as an essential element of its macroeconomic strategy.

B. The Fiscal Program

6. The government's fiscal strategy seeks to contain the central government deficit in 2003 to -0.3 percent of GDP, with adjustment measures designed to generate a surplus of 0.2 percent of GDP in 2004. This path is consistent with available financing—including the normalization of payments arrears—and sets public debt on a firmly declining path. In contrast, in the absence of measures the deficit would rise to near 2 percent of GDP, with further increases likely in the medium term.

7. The government's strategy relies on a combination of expenditure reduction and revenue enhancement measures to generate the needed fiscal adjustment. Key components of the package are:

(i) Tight control on current spending in the 2004 budget, expected to produce savings of 0.2 percent of GDP. The government will use its discretionary powers over spending to assure that any budget increases introduced by the Congress will not affect the program's expenditure targets.

(ii) Increases in the excise tax on diesel fuel (a 6 percentage point hike introduced in August 2003, and another 6 percentage point rise is in the 2004 budget to cover part of the cost of war veterans' pensions). The increases in the fuel tax are expected to yield almost 1 percent of GDP on an annual basis.

(iii) Passage of a law reforming the public employees' pension plan to increase the retirement age, increase years of service for retirement, reduce the replacement ratio, and increase contribution rates. The law would yield 0.2 percent of GDP initially, with substantially higher savings in future years.

(iv) Passage of an Administrative Reorganization and Fiscal Adjustment Law, which seeks to substantially widen the tax base from consumption and profits tax, and includes a new vehicles tax, a personal income tax, the closure of most loopholes in VAT and the corporate income tax (along with lower, flat corporate income tax rate), and increases in maximum excise tax rates. Once in effect, the law could produce 1.4 percent of GDP in net revenues on an annual basis.

(v) A major overhaul of tax and customs administration to restore tax collection efficiency at least to 2001 levels. Measures already applied have produced a 1 percent of GDP increase in revenues in the first three months of new government.

The first increase in the fuels tax (from 14 to 20 percent), and the implementation of tax administration reforms, (generating 1½ percent of GDP in annual revenue) are prior actions to Fund Executive Board discussion of Paraguay's SBA request. Passage of the Public Pension Reform Law is a performance criterion for the first review under the program, and approval of the Administrative Reorganization Law is a performance criterion for the second review. The associated targets for the overall balance and the central government wage bill are described in the Technical Memorandum of Understanding (TMU).

8. The government will take steps to assure that the program will be fully financed in both 2003 and 2004. In 2003, the fiscal deficit will be financed by: (i) net external debt disbursements for multilateral and bilateral project lending of US$18 million; (ii) the rollover of US$138 million in domestic bonds held by the banking system and suppliers; (iii) multilateral program lending of US$15 million; and (iv) a drawdown of deposits in the banking system of US$25 million. For 2004, the program envisages net project disbursements of US$8 million; program lending from the World Bank and IDB of US$85 million; and additional effects of the domestic debt rollover of US$39 million.

9. Improving the management of the public debt is a key policy objective. The government recognizes the need to halt the rapid increase in the stock of public debt that took place in recent years, from under 20 percent of GDP in 1997 to near 50 percent of GDP in 2003. The proposed fiscal adjustment will be crucial in reversing this trend and setting Paraguay on a more sustainable medium-term debt path. Given the significant amounts of contracted but undisbursed debt, the government will further carefully consider the contracting or guaranteeing of any new external debt with a view to ensuring that debt and debt service ratios remain manageable in the future. The program sets limits on the contracting of medium- and long-term external debt of the nonfinancial public sector, and the cumulative change in the short-term debt of the nonfinancial public sector will also be limited, as specified in the TMU (performance criteria). The public sector will accumulate no new external arrears during the program period (continuous performance criterion) and is committed to clearing all public external debt arrears during the program (performance criterion). The government will also eliminate all domestic arrears beyond a normal payments float (performance criterion on domestic floating debt). In cases where payment arrears are in dispute, the government is involved in active negotiations to come to a settlement with the relevant creditors. The government is also approaching the Paris Club to request forbearance from bilateral creditors to permit the gradual clearance of all arrears (including past due interest) during 2004. The relevant quarterly targets for arrears reduction are described in the TMU.

10. The government's social policy will be directed at implementing the National Strategy for Poverty Reduction, which encompasses fighting against rural poverty, deepening the educational reform started in 1994, and investing in the country's infrastructure and housing. To that end, the government will protect social expenditure as part of its agreement for economic program support from the World Bank and IDB. Proceeds from the revenue increases in the fiscal strategy will allow the government to maintain social expenditure, including expenditure for health care. The government's priorities include improving the country's infrastructure, particularly in rural areas; promoting rural communities and better directing rural credit to small borrowers through the reform of the public development banks; investing in preschool, primary and secondary education and in health care, particularly in maternal health and child development; improving the efficiency of social security institutions and guaranteeing their long-term financial viability; and mitigating the effects of river flooding. Several of these projects are to be implemented with support from the IDB and the World Bank.

11. The government expects that the rest of the consolidated public sector will record a small (0.3 percent of GDP) deficit in 2003. A cash surplus in the social security institute (the pension and health care plan for private sector employees) and operating surpluses in certain public enterprises will compensate for losses in other firms and for the quasi-fiscal losses of the Central Bank. For 2004, the rest of the public sector will post a slight surplus. To improve the performance of the public enterprises, the government will ensure that their management is improved and that tariffs are adjusted at least to fully cover operating costs. In particular, the government will make regular adjustments in utilities tariffs and fuel prices which fully reflect changes in world prices, costs, and the exchange rate (performance criterion).

C. Monetary and Exchange Rate Policy

12. Monetary policy will be geared mainly to achieving the inflation target of the program, in the context of a freely floating exchange rate regime. Achieving this objective rests on containing the public sector's domestic borrowing requirement, the deceleration of growth of the monetary base from the high 2003 levels, and on permitting interest rates to adjust as needed. The program will accommodate a modest expansion in real private sector credit in 2004 to help support the frail economic recovery. To help implement the monetary program, quarterly ceilings on Central Bank net domestic assets (NDA) and quarterly floors on net international reserves (NIR) have been established as described in the attached TMU (performance criteria). The government agrees to coordinate policy on public sector deposits with the Central Bank in support of the monetary policy objectives.

13. The central bank's international reserves are an important cushion against external shocks and banking system difficulties, particularly given Paraguay's high level of dollarization. Following the 2002 crisis, there has been a healthy recovery in international reserves. For 2003, reserves are expected to increase by US$177 million, to US$818 million. In 2004, reserves are programmed to strengthen further to US$855 million, maintaining reserves in excess of 3½ months of import cover. The Central Bank will limit foreign exchange market interventions to those strictly necessary to dampen seasonal fluctuations and to achieve the program's NIR targets.

D. Structural Policies

14. Paraguay suffers from serious structural impediments to growth. These problems have contributed to zero real GDP growth between 1997 and 2002, which led to a cumulative decline of 15 percent in per capita income and a sharp increase in poverty. Among the key structural challenges are: improving transparency and governance, improving the efficiency of the state and placing the public finances on a more solid and sustainable footing, providing for a more stable and efficient financial sector (see following section), and reforms to reduce the role of the state in the economy and increase productivity. The government's program will include several important initiatives toward these objectives.

15. A series of reforms in the fiscal area will be undertaken to place the public finances on a solid footing. A major proposal to overhaul the public sector employees' pension plan (caja fiscal) was presented to Congress in October in the Pension Reform Law. This law seeks to eliminate the existing deficit (1.9 percent of GDP) of the fund over time. It includes: (i) a hike in contributions by two percentage points to 16 percent over an increased base wage; (ii) a significant increase in the ordinary retirement (from as low as 40); (iii) the indexation of benefits to projected inflation rather than to salaries; and (iv) the elimination of year-end bonus payments (aguinaldo). In addition, the government will conduct a review of beneficiaries with an aim to reducing the rolls of retirees. Approval of the Public Pension Reform Law is a performance criterion for the first review of the program.

16. The government has sent to Congress a comprehensive fiscal reform, known as the Administrative Reorganization and Fiscal Adjustment Law. The law: (i) eliminates most exemptions from VAT and broadens the tax base; (ii) lowers the corporate tax rate while eliminating most exemptions and tax holiday regimes; (iii) introduces a new motor vehicle tax (the patente fiscal); (iv) introduces a personal income tax, initially applying only to households with income above 10 times the minimum wage, but specifying a declining threshold in future years; (v) raises the ceiling on excise taxes for items like tobacco and alcohol; (vi) modifies and clarifies an existing financial transactions tax; and (vii) redefines the agricultural land tax (IMAGRO) and the unified tax for small contributors. Under the program, the government agrees that the financial transactions tax will not be applied. Approval of the Reorganization Law is a performance criterion for the second review.

17. The government is committed to continuing its efforts to reform tax and customs administration. In the tax area, the government has, among other measures, began a program of spot checks on VAT compliance, and intends to revive the practice of shutting down businesses if they fail to properly pay; enhance computerized cross check of tax compliance data; strengthen audit units; and improve training and incentives for tax collectors. In customs administration, the government will seek approval by Congress of a comprehensive reform of the Customs Code in line with the requirements of the revised Kyoto convention and the Mercosur Customs Code. The customs authorities will also undertake reforms to simplify import and export procedures; apply risk-based selection criteria for the physical inspection of goods prior to release from customs; institute post-release controls; fully apply the SOFIA computerized system; and reformulate the career system—including hiring, incentives, and promotion—for the Custom Administration staff. Passage of the new Customs Code is a structural benchmark under the program.

18. During 2004, the government will take steps to streamline the public sector and improve governance by increasing the transparency of its operations. As part of this effort, the government will approve a plan to reform the civil service with a view toward reducing its size and improving hiring practices, training, and working conditions (structural benchmark). The government will increase transparency in public sector contracts and help reduce spending on goods and services and capital investment by full application in all public agencies of the recently passed Public Procurement Law (a structural benchmark under the program). As a first step toward an eventual reform of the social security institute (IPS), an external audit will be required by an internationally recognized accounting firm (structural PC).

19. Reform of the Central Bank (BCP) is essential to improve its ability to conduct monetary policy. The Central Bank intends to refocus its monetary policy framework, increase operational autonomy, and improve technical capabilities in order to move toward an inflation targeting regime in the medium term (with technical support from the Fund). As recommended by the 2002 IMF Safeguards Assessment mission, the BCP will undertake a number of reforms. The BCP and the MOF will sign a memorandum of understanding (MOU) regularizing the financial relationship between the government and the BCP (performance criteria), including: (i) a phase-out of the annual contributions to be made by the BCP to the MOF; (ii) granting the BCP autonomy in its monetary policy budget; (iii) facilitating the operational budget and procurement process; and (iv) agreeing on a timetable to normalize the existing stock of government debt, and providing for the orderly recapitalization of the BCP's balance sheet if needed. The BCP will increase its frequency of external audits from bi-annual to annual starting with 2003 and will begin to apply and publish these accounts according to international accounting standards (structural benchmark). It will also begin in 2004 a reorganization process designed to streamline its operations, strengthen the Bank Superintendency, and improve statistical and analytical capabilities (structural benchmark). The BCP will also continue with the modernization of the payment system and banking supervision. As a more permanent mechanism for increased central bank autonomy, a reform to the Central Bank's charter law will be prepared during 2004 for submission to Congress.

20. Key economic sectors in Paraguay (water, telecommunications, electricity, wholesale fuel distribution, cement) are dominated by public enterprises. Inefficiencies and lack of investment in these firms constitute a barrier to economic growth and productivity improvements throughout the economy. As a first step, key public institutions (ANDE, COPACO, ESAAP, Petropar, INC and Conatel, ANNP, Dinac) will have external audits of their accounts (performance criterion) and begin publication of monthly cash flow statements. Under the program, the government will develop a plan for the participation of private capital in the public enterprises (structural benchmark).

E. The Banking Strategy

21. Paraguay's banking sector has shown remarkable resilience in face of the effects of the regional crisis and the economic downturn. Nevertheless, these stresses uncovered legal rigidities in dealing efficiently with systemic banking problems while the recession exacerbated current structural weaknesses in the system. The correction of these structural weaknesses and legal rigidities will make the banking system more resistant to shocks and enhance the government's ability to confront systemic bank problems.

22. The government has prepared a strategy to enhance its banking supervision and resolution capabilities, reform the public banks, and modernize regulatory requirements for financial institutions. Legislative approval of the Bank Resolution Law, submission to Congress of the Public Banking Reform Law and approval by the BCP of the regulation on asset classification and provisioning (Resolución 8) are all prior actions and the passage by Congress of a Public Banking Law and of a comprehensive banking system legislation are performance criteria under the program. The government has requested a Financial Sector Assessment Program (FSAP) to take place during 2004.

23. The Bank Resolution Law will: (i) create a deposit insurance fund to protect the general public up to a defined limit per individual, (ii) create a bank recapitalization fund to provide additional public capital support to banks in difficulty and that involve systemic risk (on a case-by-case basis, within strict guidelines); (iii) develop legal tools to allow for the quick transfer of deposits to other financial institutions during bank resolutions; (iv) provide adequate legal protection to public officials working in the bank resolution process; and (v) delegate to the BCP the authority to issue regulations related to the deposit guarantee and banking resolution.

24. The Public Banking Law (prepared with the assistance of the World Bank and IDB) aims at consolidating several public lending institutions into a retail bank for micro enterprises and small farmers, and a small second tier bank to on-lend resources from bilateral and multilateral development lenders. In the interim, the National Development Bank has been recapitalized and its operations are being modernized and streamlined.

25. The Comprehensive Banking Law (prepared with the assistance of the World Bank) will aim to: (i) strengthen the institutional framework for monetary policy management; (ii) upgrade regulatory requirements for risk-weighted capital; (iii) bring accounting and prudential standards up to international best practices; (iv) bring regulation and supervision of nonbank deposit-taking institutions up to international best practices; and (v) improve the operational capacity of the Superintendency of Banks.

26. The regulations on asset classification, credit risk, provisioning requirements and imputation of accrued interest (Resolución 8) seeks to bring asset classification and provisioning levels to standard international practice. The gradual implementation of this regulation in 2004-6 will lead to a substantial increase in the level of provisions and thus improve the resilience of financial institutions to shocks.

27. Among other initiatives, the government will extend regulatory supervision to the largest financial cooperatives (currently including over 20 percent of system deposits), applying appropriate prudential standards for their financial operations (structural benchmark). The Bank Superintendency will implement a requirement that commercial banks be rated by internationally recognized rating agencies (structural benchmark). The Superintendency will also take steps to enhance bank supervision, including more frequent monitoring of banks' deposits and liquidity. The Central Bank will implement a transparent, nondiscriminatory policy of providing Central Bank liquidity support to solvent banks with preannounced interest rate, including (i) continued use of the Central Bank's lender of last resort (LOLR) facility; and (ii) permitting banks to use, under proper conditionality and within legal limits, required reserves to meet their short-term liquidity needs.

F. External sector

28. Paraguay is an open economy, with imports and exports each representing over one third of GDP. Paraguay has eliminated most tariffs on intra-regional trade in MERCOSUR. The special tariffs imposed in mid-2001 on selected products were a response to extraordinary measures adopted by other MERCOSUR members and would be eliminated as soon as these measures are withdrawn. Paraguay is also actively seeking the elimination of nontariff barriers imposed by other countries on Paraguayan exports. The government will also observe the standard performance criterion against imposing or intensifying exchange rate restrictions, introducing or modifying multiple currency practices, concluding bilateral payments agreements that are inconsistent with Article VIII of the Fund's Articles of Agreement, and imposing or intensifying import restrictions for balance of payments reasons.

29. Paraguay is expected to run current account surpluses in 2003 and 2004. Repayments of public sector loans (US$200 million, excluding the clearance of external arrears), private sector loans and other capital outflows are projected to result in total financing requirements of about US$315 million in 2004. Financing will come from borrowing of about $225 million (excluding program loans) from multilateral and bilateral creditors, foreign direct investment (US$34 million) and other capital inflows. External arrears will be repaid as described above.

G. Statistics

30. The Paraguayan government will expand coverage of the system of government financial statistics (Sistema Integrado de Administración Financiera) to all levels of government. It will also harmonize accounting standards in the public sector and will establish a uniform monthly information system for all entities within the nonfinancial public sector. The government will ensure that monthly financial information on the large public institutions (PETROPAR, ANDE, COPACO, ESSAP, Dinac, ANNP, Conatel, and INC) and on the social security institute (IPS) will be made available to Fund staff with a lag of no longer than 30 days after the end of each quarter. In addition, these enterprises will publish their monthly cash flow statements and their external audit reports via the internet. The government will develop a system for collecting and reporting regular financial data from the largest financial cooperatives and will report these data to the Fund on a monthly basis along with its regular banking system reports.


Paraguay—Technical Memorandum of Understanding

This memorandum presents definitions of the quantitative targets specified in the Memorandum of Economic and Financial Policies. Targets for December 2003 and March 2004 are performance criteria; for June, September, and December 2004 the targets are indicative, with the performance criteria to be set at the time of the second review.

A. Monetary Targets

1. Performance Criterion on Net International Reserves of the Central Bank of Paraguay (BCP)

(In millions of U.S. dollars)

Outstanding stock as of:
September 30, 2003 (actual) 824
December 31, 2003 818
March 31, 2004 762
June 30, 2004 (indicative) 836
September 30, 2004 (indicative) 822
December 31, 2004 (indicative) 855

For monitoring purposes, net international reserves (NIR) of the BCP are defined as the U.S. dollar value of gross foreign assets in foreign currencies minus gross liabilities in foreign currencies. Data will be provided by the BCP to the Fund with a lag of not more than five days past the test date.

Gross foreign assets are defined consistent with SDDS and include all foreign currency-denominated claims of BCP, including monetary gold, holdings of SDRs, the reserve position in the IMF, and foreign currency in the form of cash, deposits abroad, and Paraguay's net cash balance within the Latin America Trade Clearing System (ALADI). Excluded from gross foreign assets are participations in international financial institutions (including Corporación Andina de Fomento (CAF), IDB, IBRD, Asociación Internacional de Fomento, and Banco de Desarrollo del Caribe), the holdings of nonconvertible currencies, and holdings of precious metals other than gold. Gross foreign liabilities are all foreign currency denominated BCP liabilities of contracted maturity up to and including one year plus the use of Fund credit. Non-U.S. dollar denominated foreign assets and liabilities will be converted into U.S. dollars at the market exchange rates of the respective currencies as of September 30, 2003.

NIR targets will be adjusted upward (downward) for any increase (decrease) in reserve requirement deposits (encaje) associated with foreign currency deposits in commercial banks, compared to the following levels: December 31, 2003- US$240 million; March 31, 2004- US$247 million; June 30, 2004- US$260 million; September 30, 2004- US$263 million; and December 31, 2004- US$267 million.

2. Performance Criterion on Net Domestic Assets

(In billions of guaraníes)

Outstanding stock as of:
September 30, 2003 (actual) -3,416
December 31, 2003 -2,890
March 31, 2004 -2,770
June 30, 2004 (indicative) -3,085
September 30, 2004 (indicative) -3,055
December 31, 2004 (indicative) -2,761

Net domestic assets (NDA) of the BCP are defined as the difference between currency issue (provided by the BCP) and the net international reserves (NIR) of the BCP, both measured on the basis of end-of-period data. Data will be provided to the Fund by the BCP with a lag of not more than five days past the test date.

For the purpose of NDA calculation, NIR will be converted into guaraníes at an accounting exchange rate of G 6,280/US$. The ceiling on NDA will be adjusted upward (downward) by the equivalent in guaraníes of the downward (upward) adjustments made to the floor on the NIR of the BCP as described above.

B. Fiscal Targets

3. Performance Criterion on the Overall Balance of the Central Administration (Financing Side)

Cumulative Balance Floor
(In billions of guaraníes)

Overall balance of the central administration from January 1, 2003 to:
End-September 30, 2003 (actual) -6
December 31, 2003 -125
From January 1, 2004 to:
March 31, 2004 240
June 30, 2004 (indicative) 320
September 30, 2004 (indicative) 440
December 31, 2004 (indicative) 55

For the purposes of the program, the overall balance of the central administration (CA) is measured as the sum of the CA's: (i) net external financing; (ii) the change in net credit to the central government from the banking system, excluding government bonds; (iii) the change in the stock of government bonds; and (iv) net financing from all other sources to the government, including by the private sector, asset sales and change in domestic floating debt (deuda flotante) as defined below. Items denominated in foreign currency will be converted into guaraníes at the average exchange rate for each month.

Net external financing is defined as central government's foreign borrowing, including bonds issued abroad, less amortization payments (including debt prepayments) of foreign debt. Net credit from the financial system is defined as the change in net credit to government, as reported in the monetary accounts of the BCP, excluding government bonds. The change in the stock of government bonds will be defined net of valuation changes as reported by the Ministry of Finance. Net change in arrears are defined as net increase in arrears between the beginning and the end of the period. Domestic floating debt is defined as the difference between accrued expenditure (gastos obligados) and payments transferred (gastos transferidos). External arrears are as reported by the Ministry of Finance's SIGADE system. Data will be provided to the Fund by the Ministry of Finance with a lag of not more than three weeks past the test date.

4. Performance Criterion on the Wage Bill of the Central Administration

Cumulative Expenditure Ceiling
(In billions of guaraníes)

January 1, 2003 to:
End-September 30, 2003 (actual) 1,891
December 31, 2003 2,750
From January 1, 2004 to:
March 31, 2004 650
June 30, 2004 (indicative) 1,310
September 30, 2004 (indicative) 1,990
December 31, 2004 (indicative) 2,900

For the purposes of the program, the central administration includes the executive, judicial and legislative branches. The wage bill is defined as the accrued remuneration to all CA employees (servicios personales), including overtime and effective social contributions (budget line items 100-199), as reported in by the Ministry of Finance's monthly Situación Financiera de la Administración Central. Data will be provided to the Fund by the Ministry of Finance with a lag of not more than three weeks past the test date.

5. Performance Criterion on the Overall Balance of the Public Sector (Financing Side)

Cumulative Balance Floor
(In billions of guaraníes)

January 1, 2003 to:
End-September 30, 2003 (actual, measured from the financing side) -387
December 31, 2003 -321
From January 1, 2004 to:
March 31, 2004 250
June 30, 2004 (indicative) 350
September 30, 2004 (indicative) 495
December 31, 2004 (indicative) 130

For the purposes of the program, the consolidated public sector comprises: (i) the CA as defined above; (ii) the social security institutes, the provincial governments, autonomous decentralized agencies, and the nonfinancial public enterprises2; and (iii) the Central Bank of Paraguay (BCP).

The public sector's overall balance is measured as the sum of: (i) net external financing; (ii) the change in net domestic credit to public sector from the financial system, excluding government bonds; (iii) the change in the stock of government bonds; (iv) financing of the quasi-fiscal balance of the BCP; and (v) other net financing of the nonfinancial public sector by the private sector, including net increase in the stock of floating debt, external arrears, the registry float and asset sales. Items denominated in foreign currency will be converted into guaraníes at the average exchange rate for each month.

Net external financing of the public sector is defined as all external disbursements less amortizations paid of the entities of the public sector as defined above, including any debt of the financial public sector guaranteed by the Republic of Paraguay or the BCP. The change in net credit is defined as the net flow of gross domestic credit (excluding treasury bonds) plus use of deposits by the nonfinancial public sector (excluding the BCP) in the domestic financial system. The change in the stock of government bonds is defined as the net change in public bonded debt held by the financial system (excluding the BCP) and the private sector. It is measured net of valuation changes. Domestic floating debt of the public sector is defined as the difference between accrued expenditure (gastos obligados) and payments transferred (gastos transferidos).with the private sector. External debt arrears are defined as principal and interest not paid by the due date of debt guaranteed by the Republic of Paraguay or the BCP as reported by the Ministry of Finance's SIGADE plus the net change in arrears to foreign suppliers of the consolidated public sector. The financing of the quasi-fiscal balance of the BCP is measured as the negative of all administrative and financial revenues minus costs (including costs of monetary policy and interest on BCP external debt), and net capital transfers to other financial institutions, as reported by the BCP. The registry float is defined as all net payments executed by the Treasury of the CA and payments units of the other public sector entities but not yet cashed or registered in the accounts of the financial system. Data will be provided to the Fund by the Ministry of Finance with a lag of not more than three weeks past the test date.

C. Public Debt and Arrears Targets

6. Performance Criterion on Contracting or Guaranteeing of New Nonconcessional External Debt by the Nonfinancial Public Sector

(In millions of U.S. dollars)

Cumulative change in stock from September 30, 2003:
December 31, 2003 50
March 31, 2004 100
June 30, 2004 (indicative) 150
September 30, 2004 (indicative) 200
December 31, 2004 (indicative) 200

The nonfinancial public sector (NFPS) is defined as the consolidated public sector (as defined above) excluding the Central Bank of Paraguay. The limit applies to the contracting or guaranteeing by the NFPS of net new nonconcessional external debt with an original maturity of more than one year, including commitments contracted or guaranteed for which value has not been received.3 For program purposes, a debt is concessional if it includes a grant element of at least 35 percent on the basis of currency-specific discount rates based on the OECD commercial interest reference rates (CIRR).4 Excluded from the limits are credits extended by the IMF and balance of payments support loans extended by multilateral and bilateral creditors. Data will be provided by the Ministry of Finance to the Fund with a lag of not more than 30 days from the test date.

The concessionality of loans in currency baskets will be assessed on the basis of U.S. dollar interest rate tables. For loans with interest rates based on the internal policy of the creditors, the relevant interest rate to define concessionality will be the interest rate for each creditor at the time of the commitment. Loans or portions of loans extended in the context of a debt rescheduling or a debt reduction operation will be excluded from the ceiling.

7. Performance Criterion on Short-Term External Debt of the Nonfinancial Public Sector

As a continuous performance criterion, the NFPS will neither contract nor guarantee any short-term external debt during the program period. Short-term debt is defined as debt with a contractual maturity of one year or less. Excluded are normal import-related credits, reserve liabilities of the BCP, forward contracts, swaps, and other futures market contracts. The public enterprises will provide the necessary information to the Ministry of Finance, which will provide the data to the Fund, with a lag of not more than 30 days from the test date.

8. Performance Criteria on External Payments Arrears of the Public Sector

The NFPS will accumulate no new external arrears during the program period. It will maintain zero arrears with the World Bank and IDB throughout the program period. In addition, existing arrears will be reduced according to the following performance criterion:

  Overall Ceiling Ceiling on official bilateral arrears

  (In millions of U.S. dollars)
Outstanding stock of external arrears as of:
September 30, 2003 (actual) 102 51
December 31, 2003 102 51
March 31, 2004 75 38
June 30, 2004 (indicative) 45 22
September 30, 2004 (indicative) 10 5
December 31, 2004 (indicative) 0 0

In addition, the government is engaged in good faith efforts to resolve certain overdue payments in dispute, and will attempt to resolve these disputes as soon as possible. The stock of external arrears will be calculated based on the schedule of forthcoming external payments obligations reported by SIGADE and the BCP's information on which external payments were made. Data on external arrears will be reconciled with the relevant creditors, and any necessary adjustments will be incorporated in these targets at the time of the first review. For the purposes of this performance criterion, an arrear will be defined as when a payment has not been made within 30 days after falling due. In addition, the public enterprises will report to the Ministry of Finance and the BCP arrears on any external debt that is not recorded under SIGADE. The same 30-day grace period will be applied to all external payments of public enterprises, except where explicit agreements exist with creditors on an extended grace period (as the case for some of PETROPAR's external providers). The BCP will provide the final data on the stock of public sector external arrears to the Fund, with a lag of not more than 30 days from the test date.

9. Performance Criterion on Central Government Floating Debt

During the program period, floating debt will be reduced according to the schedule below. The Ministry of Finance will provide the data to the Fund, with a lag of not more than three weeks from the test date.

(In billions of guaraníes)

Outstanding stock of domestic floating debt as of:
September 30, 2003 (actual) 277
December 31, 2003 360
March 31, 2004 350
June 30, 2004 (indicative) 320
September 30, 2004 (indicative) 285
December 31, 2004 (indicative) 250

On the first test date only, the ceiling on central government floating debt will be adjusted upward (downward) by any shortfall (excess) in program lending below (above) US$15 million.

D. Reporting

Monitoring the program requires accurate and timely data. All information on performance criteria, indicative targets, and balance of payments support loans will be reported to Fund staff within the timeframes prescribed above. Debt stocks and associated flows broken down by both creditor and debtor types and maturity will be provided on a quarterly basis.

The Ministry of Finance will be responsible for gathering data on a monthly basis from all the institutions that comprise the consolidated public sector, including the incorporated enterprises (Sociedades Anónimas) COPACO and ESSAP. It will compile this information according to the standard format of the Ministry of Finance's monthly financial situation report (Situación Financiera). The data will be supplied to the Fund and published on the Ministry of Finance's external website within 30 days of each test date. In addition, specific public sector institutions (IPS, ANDE, COPACO, ESAAP, Petropar, INC and Conatel, ANNP, Dinac) will be required to provide to the Fund and publish on the internet monthly cash flow statements and the full external audit reports of their accounts beginning no later than June 30, 2004.

Table. Paraguay: Structural Conditionality Under Program

Measure Conditionality Timing Paragraph in MEFP

Financial Sector
Approval by Congress of the Bank Resolution law Prior Action 30 Nov. 2003 23
Approval by Central Bank Board of banking supervision
   reform (Resolution 8)
Prior Action 30 Nov. 2003 26
Passage by Congress of a public banking law to
   consolidate and Restructure the public development
PC   24
Passage by Congress of new comprehensive banking
   system legislation
PC 31 Dec. 2004 25
Require all banks to obtain international risk rating SB 31 Dec. 2004 27
Extension of regulatory supervision to financial
SB 1 Jan. 2005 27
Central Government and Central Bank
Implementation of tax and custom administration reform
   generating 1.0 percent of GDP annually, including:
   - Replacing Large Taxpayer Unit's auditors and
     reducing the number of firms in 5 this Unit from 3,500
     to 3,000
   - Simplifying customs checkpoints;
   - Conducting on-site tax inspections and follow-ups
     to commercial establishments to verify compliance
     with VAT procedures.
Prior Action 30 Nov. 2003 7
Increase in fuel tax from 14 to 20 percent Prior Action 31 Aug. 2003 7
No accumulation of external arrears Prior Action/
Continuous PC
Approval by Congress of the public pension reform law PC 8 Mar. 2004 7, 15
Approval by Congress of Administrative Reorganization
   and Fiscal Adjustment
PC   7, 16
Approval by Congress of a new customs code and
   implementation of a customs reform program
SB 31 Aug. 2004 17
Full application of Public Procurement Law
SB 30 June 2004 18
Development of a plan for comprehensive civil service
SB 31 Oct. 2004 18
Begin implementation of a central bank restructuring plan SB 31 July 2004 19
BCP and MOF to sign a memorandum of understanding
   regularizing the financial relationship between the
   government and the BCP
PC 28 Feb. 2004 19
Application of international accounting standards and
   annual external audits of the central bank
SB 30 June 2004 19
Public Enterprises
Government to make regular adjustments in fuel and
   utilities prices to fully reflect input costs and exchange
   rate changes
PC 1 July 2004
1 Jan. 2004
Presentation of a plan for the participation of private
   capital in key public enterprises
SB 31 Dec. 2004 20
Conduct independent external audits of the accounts of
   key public institutions and the Social Security Institute
PC 30 Sept. 2004 18, 20
Increased data publication for government and public
SB 30 Sept. 2004 20

1For 2004, the macroeconomic framework is based on an expected increase in growth to around 2½ percent, with inflation of around 8 percent.
2Instituto de Previsión Social (IPS), Caja Bancaria, Caja Ande, Caja Ferroviaria, Caja Municipalidades, the public universities (UNA, UNE, UNP, UNI), 17 provinces (gobiernos departamentales), 13 autonomous regulatory and development agencies, the public enterprises (PETROPAR, ANDE, ANNP, DINAC, FFCC, INC) and incorporated enterprises owned by the state (ESSAP, COPACO).
3The term "debt" has the meaning set forth in point No. 9 of the Guidelines on Performance Criteria with respect to Foreign Debt adopted on August 24, 2000 (Board Decision No. 12274-(00/85).
4The grant element is calculated as the difference between the net present value (NPV) of debt and its nominal value, expressed as a percentage of the nominal value of the debt (i.e., Grant = (Nominal Value - NPV) / Nominal Value). The NPV of debt is calculated by discounting the future stream of payments of debt service due on this debt. For debt with a maturity of at least 15 years, the ten-year average CIRR will be used to calculate the NPV of debt. For debt with a maturity of less than 15 years, the six-month average CIRR will be used. For the purposes of the program, the CIRRs published by the OECD in November 2003 will be used.