Press Release No. 12/174

Press Release: Statement by an IMF Article IV Staff Mission to Paraguay

May 11, 2012

An International Monetary Fund (IMF) mission visited Paraguay during May 2-11, 2012 for discussions with government officials and the private sector, as part of the IMF’s annual Article IV consultations with its member countries. At the end of the visit, mission chief Lisandro Ábrego issued the following statement today in Asunción:

“A series of negative supply shocks has adversely impacted economic performance over the last year. GDP growth slowed to 3.8 percent in 2011, as cement shortages and problems in accessing beef export markets arose in a context of monetary policy normalization. A severe drought during the summer growing season caused large agricultural losses. As a result, under current policies, the mission expects the economy to contract by 1.5 percent in 2012. Inflation has steadily declined, reaching 5 percent by end-2011 and 3.3 percent in April, driven mainly by food prices, notably meat. Core inflation (which in the Fund team’s definition excludes the food basket and fuels) has remained above the central bank’s target, at 6¼ percent in April. We expect inflation to end 2012 at around 5 percent, aided by subdued local food and global commodity prices.

“Current macroeconomic policies appear to be broadly appropriate. The central bank (BCP) has lowered interest rates by 225 basis points since November 2011, bringing the monetary policy rate below its neutral level. Fiscal policy is set to provide a strong stimulus in 2012. Macroeconomic policies will thus help cushion the impact of the drought on the nonagricultural sector, which is projected to grow at over 4 percent. As favorable weather conditions reappear, the economy is expected to rebound sharply in 2013, expanding by 8½ percent.

“It is important not to ease macroeconomic policies further. With non-agriculture GDP near its potential level, economic slack should quickly diminish as the effects of the recent supply shocks dissipate. Given the nature of these shocks, additional monetary and fiscal stimuli would do little to mitigate their impact on the primary sector, and would only lead to a higher external current account deficit and a more depreciated exchange rate, fueling inflationary pressures.

Furthermore, given the strong recovery anticipated for next year and the likely reversal of the decline in meat prices once the beef export ban is lifted, inflationary pressures are likely to reappear as we approach 2013. Against this background, the BCP should stand ready to tighten monetary policy in a timely manner while allowing for enough exchange rate flexibility.

“The 2012 budget deficit is projected at about 2.5 percent of GDP (from a surplus of 0.8 percent of GDP in 2011), which is scheduled to be financed through the issuing of bonds in the domestic market (with the first placement already successfully achieved in the first quarter) and multilateral loans. Timely congressional approval of these loans will allow the government to better plan and implement its operations, especially regarding capital budget execution, and support economic activity this year. In 2013, fiscal policy should also play a role by restoring fiscal discipline through the gradual withdrawal of the strong stimulus being granted this year.

“Higher tax revenues are required to support economic development. The tax ratio in Paraguay remains one of the lowest in Latin America. Insufficient public resources are an important factor behind large infrastructure gaps, relatively weak social indicators, and high poverty incidence. In this regard, the mission supports the authorities’ efforts to raise the tax burden, which will also help improve tax equity. In particular, the personal income tax should be put into effect as soon as possible, with its overly generous deductions eliminated over time. The generous deductions and loopholes under the agricultural income tax (IMAGRO) should be closed. Consideration should also be given to increasing the financial sector’s tax contribution, including by broadening the tax base and eliminating exemptions.

“The mission welcomes government efforts to improve public enterprise monitoring and performance. Public enterprises play an important role in key sectors, and increasing their efficiency can help ease some constraints to higher long-run growth while benefiting the Paraguayan population at large. In this regard, it is important that recent government efforts to improve their performance are sustained over time, including through the enactment of appropriate legislation.

“The banking sector remains sound, although the non-performing loans (NPL) ratio has risen slightly. Introduction of more stringent provisioning and capital requirements has helped strengthen financial institutions’ buffers. However, key structural reforms still need to be implemented. It would important to move forward with the reform of bank and BCP legislation to support a more effective risk-based supervision and bring prudential norms fully in line with international standards. The mission welcomes advances on the program to strengthen regulation and supervision, and create a financial safety net, in the cooperative sector. Full implementation of this program will strengthen the sector and the overall financial system. The mission also supports the authorities’ plans to improve regulation and supervision of the pension systems and looks forward to further details on the initiative to set up a superintendence of pensions.

“The plan to shift public sector deposits in the banking system to a state-owned bank constitutes a risk to financial sector stability. Movements in government deposits within normal operations have an impact on banking system liquidity, and its concentration could have disruptive effects. It is essential that appropriate legal options are found to prevent its potentially negative effects.

“It is important that the existing vacancies on the BCP Board of Directors be filled without delay. With the two open positions and one director temporarily staying past his mandated term, core operations of the central bank may soon be compromised.

“The mission supports the authorities’ decision to adopt an inflation-targeting (IT) regime. The BCP has taken several important steps, including the publication of a bi-annual inflation report and the establishment of single a short-term interest rate as its policy rate. Additional advances would help achieve the BCP’s goal of moving to a full-fledged IT regime by end-2013. These include strengthening liquidity forecasting and foreign exchange operations, and completing the yield curve through a better allocation of long-term instruments.

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