Statement by an IMF Mission to Paraguay

Press Release No. 11/233
June 14, 2011

An International Monetary Fund (IMF) mission visited Paraguay during June 1-14, 2011 for discussions with government officials and the private sector, as part of the IMF’s regular Article IV consultations with its member countries. At the end of the visit, mission chief Lisandro Ábrego issued the following statement today in Asunción:

“Paraguay weathered the global crisis well, supported by an appropriate policy response. In 2010, economic growth rebounded strongly, and real GDP grew by 15 percent, driven by favorable external conditions, a record harvest, and strong monetary stimulus and credit growth. Fiscal policy was appropriately countercyclical in 2010, while public debt continued to decline. Spending growth was kept under control and tax revenue increased sharply, allowing the central government to achieve a surplus of about 1½ percent of Gross Domestic Product (GDP) and to withdraw most of the fiscal stimulus provided in 2009.

“At the same time, overheating pressures have emerged, reflecting the using up of slack capacity. Core inflation rose to 10.3 percent in May 201—one of the highest in the region—driven largely by domestic demand growth. Despite very favorable terms of trade, the external current account weakened substantially in 2010, recording a deficit of 2¾ percent of GDP. The Banco Central del Paraguay (BCP) started tightening monetary policy in mid-2010, and policy rates have increased by 775 basis points since then, from levels close to zero. However, real policy rates remain negative and deposit and lending rates have increased only modestly in real terms, while year-on-year credit growth is still very high at 42 percent in April 2011.

“The banking system has remained sound. Profitability of banks continues to be very high in international comparison. Key financial soundness indicators, such as capital-adequacy ratios and nonperforming-loans ratios, are at reassuring levels, although provisions are relatively low. In late 2010, the BCP appropriately approved measures to strengthen financial system buffers, including through higher generic loan provisions and minimum capital requirements for banks and financial institutions. While regulation and supervision standards for cooperatives have improved in a few areas, they still remain laxer than those for banks.

“In line with regional trends, the guaraní has strengthened significantly vis-à-vis the dollar in recent months, supported by strong fundamentals and capital inflows. The BCP appropriately allowed the exchange rate to adjust, but tried to contain appreciation pressures by stepping up intervention in the foreign exchange market. While the recent appreciation has been substantial in real terms, the mission estimates that the guarani is still broadly aligned with its medium-term fundamentals, given improvements in the terms of trade.

“Real GDP growth for 2011 is projected at 6¾ percent, reflecting continued agricultural growth, stimulative macroeconomic conditions, and strong confidence. Under current macroeconomic policies, and with excess domestic demand pressures, rising commodity prices, and cost-push factors (such as wage increases), inflation will probably remain slightly over 10 percent for end-2011. The external current account deficit would continue widening in 2011 to 3¾ percent of GDP, before easing somewhat over the medium term. The fiscal stance would turn pro-cyclical this year, driven by large increases in current and capital spending. There is also the risk that fiscal balances would continue deteriorating in 2012, as pressures to increase spending rise ahead of the 2013 presidential and congressional elections.

“Economic policies will need to continue adjusting to ensure a soft landing of the economy. They should be geared toward reducing excess demand to limit second-round effects from rising commodity prices and lower core inflation and the current account deficit, as well as toward preserving financial system stability. Rising prices also pose a threat to social policy achievements, as they disproportionately hit the poorest and most vulnerable segments of the population, who may be less prone to benefit from rising incomes and opportunities.

“The BCP would need to continue observing closely credit, inflation and economic activity developments, and normalizing monetary conditions. The fiscal policy stance in 2011 and beyond should become at least neutral, if not countercyclical, in order to lower the burden on monetary policy in its efforts at lowering domestic demand pressures. To this end, constraining current expenditures and saving any revenue over-performance will be critical. These policy corrections should be complemented with macro-prudential measures that selectively aim at specific financial system vulnerabilities and risks while helping reduce excessive credit growth. At this stage of Paraguay’s economic cycle, it will be important to discourage the financial sector from excessive risk-taking, which poses risks to the country’s hard-won financial stability, while encouraging it to build cushions to increase resilience to a change in the current favorable domestic and external economic environment.

“Higher tax revenues are needed to address important deficiencies in infrastructure and substantial shortages of basic social services. The mission strongly supports government efforts to implement the personal income tax without further delay. It will also be essential to ensure sound management of increased revenues from Itaipú energy sales. The mission supports the authorities’ plans to safeguard the additional revenues by placing them in a special fund, which would finance high-return infrastructure projects and human capital formation and build a countercyclical reserve. The mission recommends that a significant part of these revenues are used to build up the countercyclical reserve.

“The mission welcomes the BCP’s recently announced plans to implement an inflation-targeting regime. Many necessary components for this step are already in place, thanks to long-lasting and continued reforms and institutional strengthening at the BCP. Swift implementation of the recapitalization of the BCP and modernization of the payments system are also needed to complement this decision, further enhance the credibility of the central bank, and increase the effectiveness of monetary policy operations. In addition, the mission encourages the authorities to implement the recommendations of the recent Financial Sector Assessment Program (FSAP), with a view to further strengthen the regulation and supervision of banks, financial institutions, and of financial cooperatives.

“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 warm hospitality and cooperation. The constructive and cordial relationship between Paraguay and the IMF will continue. As in the past, the IMF stands ready to provide advice and technical assistance in the areas of its competence, and wishes Paraguay every success in its endeavors to attain sustainable and equitable growth.”


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