## PARAGUAY — 2019 ## Source details **Canonical URL:** [PARAGUAY — 2019](https://www.imf.org/-/media/files/publications/cr/2019/1pryea2019001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2019/1pryea2019001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2019/1pryea2019001.pdf.json) --- ### CONTEXT - Real GDP grew by over 4.5 percent annually over the past decade, well above the 1¾ average for Latin America. - Real GDP per capita increased sharply; poverty fell from 47 percent in 2002 to 20 percent currently (using the World Bank’s Upper Middle Income Poverty Line of US$5.50 PPP). - Rapid growth drivers: - Bounce-back from the late 1990s crisis; recovery to 1997 levels by 2003. - Improved macroeconomic policies and opening of the economy (including shift to inflation targeting). - Prudent fiscal policy reduced government debt from 52 percent in 2002 to around 20 percent currently. - Global agricultural commodity price boom: agricultural exports in dollar terms are now 5 times their 2003 level; sowing areas for main crops are two and a half times those of 15 years ago. - Structural changes: - Share of electricity and water in GDP declined by two thirds, to 8 percent. - Share of services is now almost 50 percent. - Share of labor in agriculture declined from 28 percent in 2007 to 20 percent currently due to mechanization. - Exports diversification: electricity share in exports declined from 40 to 15 percent. - External vulnerability improvements: - External debt declined from 193 percent of GDP in 2003 to 40 percent at end-2017. - Excluding binationals’ debt, external debt is 21 percent of GDP at end-2017. - Reserves increased. ### RECENT DEVELOPMENTS - 2018 external and exchange rate shocks: - Crisis in Argentina caused sharp appreciation of the guaraní vis-à-vis its neighbors (peso by 65 percent, y/y; real by 10 percent, y/y) and depreciation vis-à-vis the dollar; real effective appreciation of the guaraní was 4 percent (y/y). - Central Bank of Paraguay (BCP) intervened: sold US$517 million between March and October via Ventas Complementarias; net foreign reserves fell from US$8.1 billion in 2017 to US$8 billion in 2018 (about 187 percent of the level of reserve considered adequate under the assessing reserve adequacy metric). - Central bank intervention aimed to provide foreign exchange liquidity to prevent disorderly moves in a small, illiquid FX market. - Trade and demand effects: - Sharp guaraní appreciation vs. Argentina and Brazil affected border trade and tourism. - Softening of agricultural export prices mid-year weighed on export growth. - Imports rose due to strong domestic demand and real appreciation, causing deterioration of the trade balance and current account. - About half of exports to Argentina and Brazil are hydro-energy (not dependent on domestic demand). - 2018 macro outcomes: - Growth estimated at 3.7 percent in 2018; strong first half, weaker second half due to border trade slowdown, weather events affecting agriculture, and under-execution of public investment. - Inflation around 4 percent in 2018; fell from 4.7 percent in January to 3.2 percent in December. Core inflation fell from 5.7 to 2.5 percent. - Real policy rates increased from 0.9 percent at end 2017 to 2.1 percent at end 2018. - Monetary policy: policy rates on hold in 2018; BCP cut policy rate twice in February and March 2019 from 5¼ to 4¾ percent. - Credit growth: accelerated to 12 percent in 2018 (constant exchange rate basis), from 6 percent in 2017 and less than 1 percent in 2016; agriculture-related sector remained largest contributor. - Fiscal policy: 2018 fiscal deficit estimated at 1.3 percent of GDP, up from 1.1 percent in 2017; FRL observed. Fiscal Responsibility Law (FRL) requires deficit ≤ 1.5 percent of GDP and primary current expenditure annual rise ≤ 4 percent in real terms. 2018 deficit remained below 1.5 percent partly because GDP was revised up by about 30 percent. - Political: Parliamentary elections in April won by incumbent Colorado Party; new government took office in August aiming for cautious macro policy, anti-corruption, and inclusive growth. Fitch upgraded Paraguay’s credit rating from BB to BB+, citing fiscal discipline and resilience. ### OUTLOOK - Staff projections: - Growth of 3.5 percent in 2019; affected by an early drought reducing the soybean harvest, partially offset by pickup in tourism and cross-border trade as real exchange rate shock unwinds. - Medium-term real growth projected at around 4 percent, close to potential; about 2½ percent in per capita terms. - Risks: - Tilted to the downside. - External risks: economic instability in Argentina, weak growth in Brazil. - Agricultural commodity prices pose downside risk. - Domestic demand uncertainty depends on recovery of public investment after government transition. ### AUTHORITIES’ VIEWS - Authorities acknowledged growth likely below official December forecast of 4.0 percent; later published a revised forecast of 3.5 percent in late March. - Expected lower soybean harvest to affect 2019 growth, but industrial dynamism and pickup in construction could offset some drag. - Planned efforts to speed up public investment; interest rate cuts expected to support demand recovery. - Central bank reiterated commitment to inflation targeting and floating exchange rate; interventions were to prevent disorderly market conditions, not to target an exchange rate level. BCP judged 2018 FX pressure was spillover from Argentina and not reflective of fundamentals. ### Exchange rate policy and inflation outlook - The authorities’ implementation of inflation targeting, with some foreign exchange intervention to mitigate disorderly market conditions, has supported exchange rate flexibility. - The BCP forecasts inflation to return to the middle of the inflation band by end-2019. - A recent rate cut was motivated by: - signs of weakness in domestic demand; - a change in the US monetary policy outlook; - continued uncertainty regarding the economic situation in Argentina. - Authorities expect the guaraní to move back to a valuation in line with fundamentals in 2019; last year’s temporary shock (sharp depreciation of the peso) led to a real exchange rate appreciation that would be reversed in 2019 as a result of higher inflation in Argentina. - Over the medium term, structural reforms are expected to lead to increased foreign direct investment and a moderately negative current account balance. - The authorities view the exchange rate as an important risk absorber; example: in 2014/15, the guaraní depreciated by 30 percent vis-à-vis the dollar in few months when agricultural commodity prices fell sharply. ### External position and current account - Paraguay’s external position in 2018 was stronger than implied by economic fundamentals and desirable policies according to the External Balance Assessment Lite (EBA-Lite) methodology. - From a saving-investment perspective, the current account surplus is the result of low investment levels—not high saving. - If economic reforms improve the business climate and governance, capital inflows and investment would pick up and the gap with the current account “norm” would close. ### Composition of exports and risks to growth - Around 70 percent of Paraguay’s exports are agricultural commodities and related products. - The non-energy/non-agriculture export sector is around 7 percent of total exports. - Maquila industry: average annual export growth of over 20 percent, but from a very low base; would need consistently rapid expansion over the next 15 to 30 years to rival the traditional export sector. - Continued expansion of agricultural export volumes will be difficult: - Much expansion driven by increased sowing areas rather than yields per hectare. - Average yields have not increased much as production expanded to more marginal land. - Yields of major crops are already close to the technological frontier. - Agricultural export values could come under pressure if commodity prices soften further; demand growth of China—world’s largest soybean importer in the last decade—is already showing signs of slowing. ### Investment, productivity, and structural constraints - Investment and FDI levels are low compared to other middle-income countries that have achieved faster convergence; FDI is minimal. - Informal employment is estimated at about 65 percent of total employment. - The number of new, registered businesses is 0.145 per thousand adult population. - Labor productivity and TFP growth have rebounded in the last decade, but their level is still well below previous peaks. - Capital intensiveness has risen substantially, driven by labor substitution in agriculture, but offset by lower TFP. - A larger non-agriculture tradable sector is needed for sustainable investment and productivity growth. ### Structural reform priorities and estimated impacts - Transport infrastructure: - 45 percent of exporting firms identify transportation as a main business constraint. - Staff estimates improving transport infrastructure to the average level of high-converging middle-income countries can increase the rate of economic convergence with the United States by 2.7 percentage points annually. - Quality of education: - 30 percent of private firms identify uneducated labor force as a main constraint. - Rule of law: - 40 percent (20 percent) of firms identify corruption (courts system) as a major constraint. - Improving “law and order” to the level of high-converging middle-income country average can improve the rate of convergence by 1.9 percentage points annually. - With low electricity costs and proximity to large consumer markets, Paraguay could attract more FDI if it improves business climate, governance and infrastructure. ### Governance, regulation, and authorities’ reform agenda - Progress in public governance transparency: - Law of Free Access to Public Information (2014); membership in Global Forum on Transparency and Exchange of Information for Tax purposes in 2016; implementation by 2020 when first compliance review will take place. - Authorities’ reform actions and priorities: - Simplifying company formation and registration; a new bankruptcy law; allowing movable assets as collateral; cutting bureaucratic procedures; increasing digitization in government services; reviving the National Commission for Competition. - Human capital: plans include building 400 more family care units across the country in the next five years and an education reform committee to publish a reform roadmap by end of 2019 with measures such as improving teacher training and performance evaluation. ### Fiscal policy stance, constraints, and needs - Public debt and fiscal stance: - Prudent fiscal policies reduced public debt; public debt is low by international standards and expected to remain stable over the medium-term. - Public debt issued abroad in foreign currency has increased considerably since 2012, increasing vulnerability to shocks. - Fiscal Responsibility Law (FRL) ceiling limits central government deficit to 1.5 percent of GDP. - 2019 budget and fiscal space: - Budget for 2019 targets a deficit of 1.4 percent of GDP; cyclically appropriate and in line with FRL. - Reaching FRL target may require keeping spending below budget, as revenue estimates are likely too optimistic. - Paraguay has a history of overly optimistic nontax revenue projections but has adhered to the FRL ceiling by containing expenditure. - Revenue and spending facts: - Tax rates: personal and corporate income tax rate and the VAT rate are all 10 percent. - Personal income tax yields 0.1 percent of GDP. - Corporate income tax yields 1.9 percent of GDP. - Spending needs: - OECD and Global Infrastructure Outlook estimate total infrastructure investment needs of US$1 billion to 3 billion per year (3 to 8 percent of GDP). - 2017 Article IV report identified infrastructure investment needs of about 20 percent of GDP over the next five years. - World Bank estimate for education investment: over US$1 billion needed. - Longer-term fiscal opportunities and reforms: - More fiscal revenue could become available starting in 2023, after the Itaipú loan is fully paid-off, but this depends on renegotiation of the Itaipú treaty with Brazil; outcomes uncertain. - Government installed an independent commission to provide a blueprint for tax reform by March 2019; proposals include curbing deductible expenses for the personal income tax, eliminating exemptions and reduced rates for the VAT, and unifying the corporate income tax with the agricultural income tax. - Alternative financing sources needed, including PPPs; high standards of governance and transparency essential. - Improve efficiency of public investment and rebalance expenditure from current to investment; a public-private commission for review of public expenditure expected to make reform proposals by end-June 2019. - Social sector effectiveness: - Despite large increases in education spending, learning outcomes have not improved. PISA: only 8 percent of 15-year-old students in Paraguay reach the minimum level in math competency, compared to 31 percent of the LAC average. - Social safety net is inefficient due to multiplicity of small, overlapping programs; government aims to eliminate fragmentation and build an integrated social protection system. - Pension system: - Long-term unfunded liabilities of the pension system estimated at 200 percent of GDP. - Largest social security fund (IPS) is still in surplus; the pension fund for public employees (Caja Fiscal) is running deficits. - Recommendation: gentle parametric adjustments to pension age, benefits, and contribution rates should be made now rather than later. ### Domestic financing, pension funds, and exchange-rate exposure - Currently about 80 percent of public sector is external debt denominated in foreign currency. - Pension funds are not allowed to invest in government debt and hold a large share of their assets in bank deposits, while banks suffer from excess liquidity. - Allowing pension funds to invest in government bonds would: - reduce both external vulnerabilities and government’s exposure to the banking sector; - effectively channel domestic savings for financing public investments. - Authorities agreed parametric adjustments to the pension system should be introduced sooner rather than later and stressed improving social insurance coverage. ### Financial sector soundness and supervision - Banking sector strength: - Tier I capital-to-asset ratio: 13.4 percent (well above regulatory minimum of 8 percent). - Return on equity is above the regional average. - Banks performed well in BCP’s recent stress tests; all banks maintained capital adequacy ratio above regulatory requirement under stress scenarios. - Non-bank financial sector risks: - Casas de crédito and casas comerciales: around US$570 million (3 percent of total banking sector assets). - No systematic data collection for this sector; urgent need to adopt supervision standards; BCP has started a study to evaluate scope and feasibility of regulating them. - Supervision of financial cooperatives should continue to be strengthened. - Progress on 2017 FSSR recommendations: - Establishment of protocols for interagency coordination, a financial stability council, surveillance data on interconnectedness, and revisions to bank resolution law. - Superintendency of Banks upgraded organizational structure and supervisory model, including risk matrix. - More work needed to operationalize protocols and resolution laws and implement supervision for casas de crédito and casas comerciales. - Reducing dollarization: - FX borrowing is risky; regulatory measures such as higher capital requirements on dollar-denominated loans could lower credit dollarization. - Pension fund regulation and capital market development: - Pension funds face legal limitations prohibiting broader investments; recommendation to introduce a pension fund supervisor to allow a wider range of investments and develop domestic capital markets. - A law project to establish a pension fund supervisor was not recently approved by parliament—political dialogue should resume. ### AML/CFT and anticorruption priorities - Updated national risk assessment (2018) identifies: - Main ML risks: organized crime (drug-trafficking, counterfeiting, human and firearms trafficking) and informality. - Corruption identified as structural and endemic, impacting government control institutions and enabling ML. - Priorities: - Strengthen legal framework. - Enhance capacity and cooperation of key agencies. - Produce data and statistics on the phenomenon. - Complement AML/CFT measures with strengthened anticorruption efforts. - Timing: - Paraguay faces an upcoming evaluation by the regional AML/CFT standard-setting body in late 2019. ### Financial Soundness Indicators (selected) - Regulatory capital/risk-weighted assets (2013–2018): 14.7, 15.2, 16.1, 17.9, 18.3, 17.5 - Tier 1 capital/risk-weighted assets (2013–2018): 11.3, 11.2, 11.7, 13.4, 13.8, 13.4 - NPLs/total loans (2013–2018): 2.1, 2.0, 2.6, 2.9, 2.8, 2.5 - Provisions/NPLs (2013–2018): 135.7, 135.0, 116.5, 120.4, 126.1, 126.7 - Return on assets (2013–2018): 2.7, 2.6, 2.5, 2.2, 2.3, 2.3 - Return on equity (2013–2018): 24.6, 24.2, 23.4, 20.8, 20.3, 20.0 - Liquid assets/total assets (2013–2018): 25.2, 25.0, 27.6, 24.1, 19.1, 18.7 - FX loans/total loans (recommended indicators, 2013–2018): 45.4, 47.8, 50.0, 48.1, 46.7, 47.2 - FX liabilities/total liabilities (2013–2018): 45.7, 49.3, 54.6, 51.6, 48.4, 48.1 ### Staff appraisal — key findings and recommendations - Policy mix and macro outlook: - Current policy mix is appropriate: fiscal policy neutral and monetary policy expansionary to mitigate slowdown and reduce downside risks. - Inflation projected to return to midpoint of target range by year’s end. - External position is stronger than level implied by fundamentals and desirable policies. - Growth and structural challenges: - Paraguay has grown rapidly in the past 15 years; vulnerabilities have declined. - Key question: how to maintain rapid growth of per capita incomes given heavy reliance on agriculture and limited scope to expand agricultural land. - Future growth needs to come from the non-agriculture/non-electricity export sector; higher private sector investment, including FDI, is needed. - Priority policies: improve transport infrastructure, rule of law, and quality of education. - Fiscal space and revenue: - Revenues are low by international standards; to create room for investment, revenues need to be increased. - Reducing exemptions and deductions and improving tax compliance will raise effective tax rates even if headline rates remain unchanged. - Reprioritize expenditure within existing envelope: reduce wage share and increase infrastructure and social spending. - Financial sector reform priorities: - Continue strengthening supervision of financial cooperatives. - Quickly adopt supervision standards for casas de crédito and casas comerciales. - Establish a pension fund supervisor to mitigate risks and develop domestic capital market. - Restore long-term sustainability of pension system through timely parametric adjustments. - Implementation of structural reforms combined with prudent macroeconomic policies would allow Paraguay to continue growing rapidly and improving living standards. - Staff proposes next Article IV consultation follows standard 12-month cycle. ### Risk Assessment Matrix — Selected risks and responses - External risks: - Rising protectionism and retreat from multilateralism (High / ST, MT): Expected impact Medium. Recommended response: maintain macroeconomic and financial stability; diversify exports. - Significant drop in agricultural commodity prices (Medium / ST, MT): Expected impact High. Recommended response: short term allow exchange rate depreciation and accommodative monetary policy; long run diversify exports. - Sharp tightening of global financial conditions and US dollar appreciation (High / ST): Expected impact Medium. Recommended response: allow exchange rate adjustment. - Slowdown in neighboring countries (High / ST): Expected impact Medium. Recommended response: mitigate disorderly market conditions via interventions; monetary policy accommodative if shock persists. - Domestic risks: - Weather-related shocks (Medium to High / ST): Expected impact Medium to High. Recommended response: exchange rate absorption; budget execution compliant with FRL; FX interventions to avoid disorderly conditions. - Government capacity constraint affecting execution of public investment projects (Medium / ST, MT): Expected impact Medium. Recommended response: strengthen capacity in budget execution, adopt effective public investment framework. ### Annex II — External Sector Assessment (highlights) - NIIP improved due to reserve accumulation and decline in external debt; external debt fell from nearly 193 percent of GDP in 2003 to 40 percent of GDP in 2018, reflecting amortization of binational hydroelectric company debt (Itaipú). - Current account: - Surplus averaged 1.2 percent of GDP over last 20 years. - Deteriorated in 2018 but remained in surplus; 2019 expected deterioration due to lower soybean exports from drought. - Medium-term current account expected to increase gradually to around 0.6 percent of GDP. - EBA-lite regression results for 2018 (selected): - Current Account Balance (CA): 0.5% - CA excluding amortization to binationals: -1.3% - Export of Goods and Services: 35.7% - Import of Goods and Services: 34.3% - Multilaterally Consistent Cyclically adjusted CA Norm: -3.3% - CA-Gap: 3.9% and 2.1% (two columns reported) - Elasticity of current account to REER: -0.26 - Implied REER Gap: -15.3% and -8.1% - Total CA (percent of GDP): Actual REER (in log) 4.74; Fitted REER (in log) 4.80; REER Norm (in log) 4.81; REER Gap -7.0% - Reserves: - International reserves net decline of US$146 million to US$8,004 million at end-2018. - BCP sold US$1,273 million in FX market in 2018. - Reserves remain ample (about 7 months of imports) and above Fund metrics (close to two times adequate level). - Recommendation: continue rules-based regular dollar sales and limit discretionary interventions to exceptional disorderly market conditions. - External debt projections (baseline selected years, percent of GDP): 2018: 37.6; 2019: 37.4; 2020: 34.5; 2021: 31.9; 2022: 29.6; 2023: 27.7. ### Annex III — Public Sector Debt Sustainability (selected figures) - Nominal gross public debt (percent of GDP): 2016: 13.9; 2017: 19.4; 2018: 19.8; 2019: 21.6; 2020: 22.4; 2021–2023: 22.3. - Public gross financing needs (percent of GDP): 2016: 0.9; 2017: 1.4; 2018: 1.7; 2019: 1.5; 2020: 1.8; 2021: 1.9; 2022: 1.8; 2023: 2.2 (alternate 2023 figure shown: 3.5). - Real GDP growth (in percent, selected): 2016: 4.7; 2017: 4.3; 2018: 5.0; 2019: 3.7; 2020: 3.5; 2021–2023: 4.0. - Inflation (GDP deflator, percent): 2016: 5.8; 2017: 4.1; 2018: 2.1; 2019: 4.9; 2020: 3.2; 2021: 4.5; 2022: 3.9; 2023: 3.5. - Contributions to change in gross public debt (percent of GDP, 2016–2023 cumulative): Cumulative change 2.5; Identified debt-creating flows cumulative -0.2; Automatic debt dynamics cumulative -4.8; Other identified debt-creating flows cumulative 5.0; Residual cumulative 2.2. - Baseline scenario assumptions (selected): - Real GDP growth: 2018: 3.7; 2019: 3.5; 2020–2023: 4.0 (each year). - Primary Balance: 2018–2022: 0.0; 2023: 0.1. ### Authorities’ Statement (April 24, 2019) — Highlights - Real sector: Real GDP growth estimated at 3.6 percent in 2018 (statement); growth forecast for 2019 of 4 percent; adverse weather affected agricultural performance in 2019. - Monetary sector: - Annualized inflation 2.8 percent in March 2019. - Central Bank reduced policy rate by 25 bps in both February and March 2019 to 4.75 percent. - Guaraní depreciated by around 7 percent vis-à-vis the U.S. dollar during 2018. - Net international reserves slightly over USD 8.2 billion (20 percent of GDP). - Fiscal sector: - Fiscal deficit estimated at 1.3 percent of GDP in 2018. - 2019 deficit expected to remain below legal ceiling of 1.5 percent of GDP. - Tax revenue at 10 percent of GDP. - Ministry of Finance estimated revenue increase potential of 1 percentage point of GDP from reforms without raising headline rates; potential expenditure savings another 1 percentage point of GDP. - Bill expected to be sent to Congress during first half of 2019 related to these measures. - Financial sector: - Financial system remains stable; solvency indicators in line with Basel minimum capital requirements. - Stress testing shows system resilience to extreme shocks. - Ongoing regulatory reforms and draft laws covering Credit Bureau, Crowdfunding, Transparency of the Total Cost of Credit, Foreign Exchange Brokers, and changes to Cooperatives Law and INCOOP charter. - Policy priorities and reforms: - Accelerate investment plan in roads, education, hospitals, social housing leveraging private sector through PPPs. - Continue scholarship programs; modernize and simplify tax collection; reduce tax expenditures; equalize VAT rates to increase revenues by 1 percentage point of GDP. - Optimize public expenditures to realize potential savings of 1 percentage point of GDP. - Advance institutional reforms to improve transparency, governance, and ease of doing business. - Strengthen AML/CFT framework and related judicial and enforcement measures (twelve new laws under discussion). *IMF staff report excerpt: 2019 Article IV Consultation — Paraguay (content unit 1pryea2019001).* ### 2019. The staff team comprised of Bas Bakker (head), Tobias Roy, ### PARAGUAY — 2019 ### CONTEXT - Real GDP grew by over 4.5 percent annually over the past decade, well above the 1¾ average for Latin America. - Real GDP per capita increased sharply; poverty fell from 47 percent in 2002 to 20 percent currently (using the World Bank’s Upper Middle Income Poverty Line of US$5.50 PPP). - Rapid growth drivers: - Bounce-back from the late 1990s crisis; recovery to 1997 levels by 2003. - Improved macroeconomic policies and opening of the economy (including shift to inflation targeting). - Prudent fiscal policy reduced government debt from 52 percent in 2002 to around 20 percent currently. - Global agricultural commodity price boom: agricultural exports in dollar terms are now 5 times their 2003 level; sowing areas for main crops are two and a half times those of 15 years ago. - Structural changes: - Share of electricity and water in GDP declined by two thirds, to 8 percent. - Share of services is now almost 50 percent. - Share of labor in agriculture declined from 28 percent in 2007 to 20 percent currently due to mechanization. - Exports diversification: electricity share in exports declined from 40 to 15 percent. - External vulnerability improvements: - External debt declined from 193 percent of GDP in 2003 to 40 percent at end-2017. - Excluding binationals’ debt, external debt is 21 percent of GDP at end-2017. - Reserves increased. ### RECENT DEVELOPMENTS - 2018 external and exchange rate shocks: - Crisis in Argentina caused sharp appreciation of the guaraní vis-à-vis its neighbors (peso by 65 percent, y/y; real by 10 percent, y/y) and depreciation vis-à-vis the dollar; real effective appreciation of the guaraní was 4 percent (y/y). - Central Bank of Paraguay (BCP) intervened: sold US$517 million between March and October via Ventas Complementarias; net foreign reserves fell from US$8.1 billion in 2017 to US$8 billion in 2018 (about 187 percent of the level of reserve considered adequate under the assessing reserve adequacy metric). - Central bank intervention aimed to provide foreign exchange liquidity to prevent disorderly moves in a small, illiquid FX market. - Trade and demand effects: - Sharp guaraní appreciation vs. Argentina and Brazil affected border trade and tourism. - Softening of agricultural export prices mid-year weighed on export growth. - Imports rose due to strong domestic demand and real appreciation, causing deterioration of the trade balance and current account. - About half of exports to Argentina and Brazil are hydro-energy (not dependent on domestic demand). - 2018 macro outcomes: - Growth estimated at 3.7 percent in 2018; strong first half, weaker second half due to border trade slowdown, weather events affecting agriculture, and under-execution of public investment. - Inflation around 4 percent in 2018; fell from 4.7 percent in January to 3.2 percent in December. Core inflation fell from 5.7 to 2.5 percent. - Real policy rates increased from 0.9 percent at end 2017 to 2.1 percent at end 2018. - Monetary policy: policy rates on hold in 2018; BCP cut policy rate twice in February and March 2019 from 5¼ to 4¾ percent. - Credit growth: accelerated to 12 percent in 2018 (constant exchange rate basis), from 6 percent in 2017 and less than 1 percent in 2016; agriculture-related sector remained largest contributor. - Fiscal policy: 2018 fiscal deficit estimated at 1.3 percent of GDP, up from 1.1 percent in 2017; FRL observed. Fiscal Responsibility Law (FRL) requires deficit ≤ 1.5 percent of GDP and primary current expenditure annual rise ≤ 4 percent in real terms. 2018 deficit remained below 1.5 percent partly because GDP was revised up by about 30 percent. - Political: Parliamentary elections in April won by incumbent Colorado Party; new government took office in August aiming for cautious macro policy, anti-corruption, and inclusive growth. Fitch upgraded Paraguay’s credit rating from BB to BB+, citing fiscal discipline and resilience. ### OUTLOOK - Staff projections: - Growth of 3.5 percent in 2019; affected by an early drought reducing the soybean harvest, partially offset by pickup in tourism and cross-border trade as real exchange rate shock unwinds. - Medium-term real growth projected at around 4 percent, close to potential; about 2½ percent in per capita terms. - Risks: - Tilted to the downside. - External risks: economic instability in Argentina, weak growth in Brazil. - Agricultural commodity prices pose downside risk. - Domestic demand uncertainty depends on recovery of public investment after government transition. ### AUTHORITIES’ VIEWS - Authorities acknowledged growth likely below official December forecast of 4.0 percent; later published a revised forecast of 3.5 percent in late March. - Expected lower soybean harvest to affect 2019 growth, but industrial dynamism and pickup in construction could offset some drag. - Planned efforts to speed up public investment; interest rate cuts expected to support demand recovery. - Central bank reiterated commitment to inflation targeting and floating exchange rate; interventions were to prevent disorderly market conditions, not to target an exchange rate level. BCP judged 2018 FX pressure was spillover from Argentina and not reflective of fundamentals. ### POLICY ISSUES AND RECOMMENDATIONS - Near-term macro policy: - Monetary policy stance judged appropriate and expansionary to mitigate slowdown and reduce downside risks. - Inflation expected to recover to middle of BCP target range by end of year as real exchange rate appreciation reverses. - If upside risks materialize beyond 2019, monetary policy may need gradual tightening. - If downside spillovers from neighbors generate pressure on guaraní-dollar rate, policy action could be required, including foreign exchange intervention to prevent disorderly conditions and close monitoring of pass-through to inflation expectations. - Structural and fiscal challenges: - Sustaining rapid growth of real incomes requires diversification away from agriculture and expansion of non-energy/non-agricultural exports and productivity growth. - Spending needs (including infrastructure) are large; with GDP per capita growing around 2½ percent, revenues will grow slowly at current revenue ratios — implying need for policy focus on generating higher, sustainable growth and revenue mobilization. - Over the longer term, structural reforms to boost supply and raise TFP are key for sustained convergence and poverty reduction. *IMF staff report: 2019 Article IV consultation — Paraguay* ### 24. The authorities’ implementation of inflation targeting, with some foreign exchange ### 1pryea2019001 - 24. The authorities’ implementation of inflation targeting, with some foreign exchange ### Exchange rate policy and inflation outlook - The authorities’ implementation of inflation targeting, with some foreign exchange intervention to mitigate disorderly market conditions, has supported exchange rate flexibility. - In the past few years the level of the exchange rate has moved freely, broadly in line with other small commodity exporting countries in the region. - The BCP forecasts inflation to return to the middle of the inflation band by end-2019. - A recent rate cut was motivated by: - signs of weakness in domestic demand; - a change in the US monetary policy outlook; - continued uncertainty regarding the economic situation in Argentina. - The authorities expect the guaraní to move back to a valuation in line with fundamentals in 2019: - Last year a temporary shock (the sharp depreciation of the peso) led to a real exchange rate appreciation. - This year the appreciation would be reversed—the result of higher inflation in Argentina. - Over the medium term, structural reforms are expected to lead to increased foreign direct investment and a moderately negative current account balance. - The authorities view the exchange rate as an important risk absorber; the guaraní tends to move quickly in response to real and permanent shocks (example: in 2014/15, the guaraní had depreciated by 30 percent vis-à-vis the dollar in few months when agricultural commodity prices fell sharply). ### External position and current account - Paraguay’s external position in 2018 was stronger than implied by economic fundamentals and desirable policies according to the External Balance Assessment Lite (EBA-Lite) methodology. - From a saving-investment perspective, the current account surplus is the result of low investment levels—not high saving. - If economic reforms improve the business climate and governance, capital inflows and investment would pick up and the gap with the current account “norm” would close. ### Composition of exports and risks to growth - Around 70 percent of Paraguay’s exports are agricultural commodities and related products. - The share of agriculture in employment has declined over the past two decades, with most of the shift towards the non-tradable sector, primarily services; the employment share of the more productive, tradable sector (e.g. manufacturing) shrank. - Continued expansion of agricultural export volumes will be difficult: - Much expansion has been driven by increased sowing areas rather than yields per hectare. - Average yields have not increased much as production expanded to more marginal land. - Yields of major crops are already close to the technological frontier. - Agricultural export values could come under pressure if commodity prices soften further: - Demand growth of China—world’s largest soybean importer in the last decade—is already showing signs of slowing. - Declining export prices would likely reduce incomes and domestic demand, lead to a depreciation of the exchange rate, and reduce demand for both tradables and nontradables. - The non-energy/non-agriculture export sector is around 7 percent of total exports. - The maquila industry has been growing rapidly with an average annual export growth of over 20 percent, but it started from a very low base and would need consistently rapid expansion over the next 15 to 30 years to rival the traditional export sector. ### Investment, productivity, and structural constraints - Investment and FDI levels are low compared to other middle-income countries that have achieved faster convergence with advanced economies; FDI is minimal. - Informal employment is estimated at about 65 percent of total employment. - The number of new, registered businesses is 0.145 per thousand adult population, significantly lower than in other middle-income countries. - Labor productivity and TFP growth have rebounded in the last decade, but their level is still well below previous peaks. - The capital intensiveness of the economy has risen substantially, driven by labor substitution in agriculture, but offset by lower TFP. - A larger non-agriculture tradable sector is needed for sustainable investment and productivity growth: - The capital/output ratio of the existing sectoral structure is already high. - Labor productivity growth rates and levels in the tradable sector, manufacturing in particular, are higher than in the mostly non-tradable, tertiary sector. ### Structural reform priorities and estimated impacts - Staff conducted an empirical analysis ranking reform priorities by potential impact on the speed of GDP convergence and private-sector support. Reform areas with high estimated impact and high private-sector support include: - Transport infrastructure: - 45 percent of exporting firms identify transportation as a main business constraint. - Paraguay scores low on quality of roads, road density, airport connectivity and efficiency of air transport services. - Staff estimates improving transport infrastructure to the average level of the group of high-converging middle-income countries can increase the rate of economic convergence with the United States by 2.7 percentage points annually. - Quality of education: - 30 percent of private firms identify uneducated labor force as a main constraint. - Paraguay scores low on quality of vocational training and skill set of graduates in the Global Competitiveness Report. - Rule of law: - Paraguay lags in institutional qualities regarding law and order, judicial system, legal process, anti-corruption and public security. - 40 percent (20 percent) of firms identify corruption (courts system) as a major constraint to business. - Empirical estimates suggest improving Paraguay’s score in “law and order” to the level of high-converging middle-income country average can improve the rate of convergence by 1.9 percentage points annually. - With low electricity costs and neighboring two large consumer markets, Paraguay could attract more FDI if it improves business climate, governance and infrastructure; Paraguay currently consumes only part of electricity produced by the two bi-national dams and exports the rest at cheap rates to its neighbors. ### Governance, regulation, and authorities’ reform agenda - Paraguay has made progress in public governance transparency: - The Law of Free Access to Public Information (2014) allows online access to public officials’ wages and public procurement data. - Paraguay was accepted as a member of Global Forum on Transparency and Exchange of Information for Tax purposes in 2016 and will implement the internationally agreed standard of transparency and exchange of information on tax by 2020 when the first compliance review will take place. - Too many and complicated regulations hamper business dynamics and provide fertile ground for corruption; Paraguay scores relatively poor in business regulation and regulatory quality. - Authorities’ views: - The authorities concurred with staff’s assessment of the main bottlenecks to long-term economic growth and agreed structural reforms would help attract more foreign investments and increase domestic private sector dynamism. - They concurred that development of the non-agriculture/non-energy tradable sector was key to sustain convergence, noting rapid growth in the maquila industry. - Authorities noted that beyond business climate and governance, Paraguay needs to make more efforts to promote itself to foreign investors; positive macro stability and solid growth have started attracting more investment inquiries. - Improving the business environment is a government priority; reforms include simplifying company formation and registration, a new bankruptcy law, allowing movable assets as collateral, cutting bureaucratic procedures, increasing digitization in government services, and reviving the National Commission for Competition. - Improving human capital is a priority: plans include building 400 more family care units across the country in the next five years and an education reform committee that will publish a reform roadmap by end of 2019 with measures such as improving teacher training and performance evaluation. ### Fiscal policy stance, constraints, and needs - Prudent fiscal policies over the past fifteen years have reduced public debt; public debt is low by international standards and expected to remain stable over the medium-term. - Public debt issued abroad in foreign currency has increased considerably since 2012, increasing vulnerability to shocks. - Fiscal policy has been mostly countercyclical in the past decade. - The budget for 2019 targets a deficit of 1.4 percent of GDP: - This is appropriate from a cyclical perspective (the cyclically adjusted fiscal impulse for 2019 is estimated at zero; the output gap, while negative, is close to zero) and in line with the FRL ceiling of 1.5 percent of GDP. - Reaching the FRL target may require keeping spending below budget, as revenue estimates are likely too optimistic. - Paraguay has a history of overly optimistic nontax revenue projections but has adhered to the FRL ceiling by containing expenditure; prospects for meeting 2019 targets are good, but it will be important to restore public investment, which slipped in 2018. - The Fiscal Responsibility Law (FRL) ceiling limits the central government deficit to 1.5 percent of GDP, effectively constraining fiscal space and leaving little room for countercyclical fiscal policy. - Revenue and expenditure levels are relatively low: - Tax rates: personal and corporate income tax rate and the VAT rate are all 10 percent. - Spending needs are large: - OECD and Global Infrastructure Outlook estimate total infrastructure investment needs of US$1 billion to 3 billion per year (3 to 8 percent of GDP). - The 2017 Article IV report identified infrastructure investment needs of about 20 percent of GDP over the next five years for electricity distribution, roads, sanitation, and other large transportation projects. - For education, the World Bank estimated over US$1 billion is needed for investment in schools. - More fiscal revenue could become available starting in 2023, after the Itaipú loan is fully paid-off, but this will depend on the renegotiation of the Itaipú treaty with Brazil; outcomes are uncertain. - Current tax yields and effective rates: - Personal income tax yields 0.1 percent of GDP. - Corporate income tax yields 1.9 percent of GDP. - The government installed an independent commission to provide a blueprint for tax reform by March 2019; proposals include: - curb deductible expenses for the personal income tax; - eliminate exemptions and reduced rates for the VAT; - unify the corporate income tax with the agricultural income tax. - Given limited fiscal space, alternative financing sources are needed, including public-private partnerships (PPPs); high standards of governance and transparency are essential to attract private participation. - Improving efficiency of public investment and rebalancing expenditure from current to investment would help maximize resources; a public-private commission for review of public expenditure is expected to make reform proposals by end-June 2019. - Efficacy of health and education spending needs improvement: - Despite large increases in education spending, learning outcomes have not improved. - PISA: only 8 percent of 15-year-old students in Paraguay reach the minimum level in math competency, compared to 31 percent of the LAC average. - The social safety net is inefficient due to multiplicity of small, overlapping and sometimes duplicative programs; with World Bank assistance, the government aims to eliminate fragmentation and build an integrated social protection system. - Pension system challenges: - Long-term unfunded liabilities of the pension system estimated at 200 percent of GDP. - Largest social security fund (IPS) is still in surplus due to recent extension of coverage; the pension fund for public employees (Caja Fiscal) is already running deficits. - Recommendation: gentle parametric adjustments to pension age, benefits, and contribution rates should be made now rather than later. *International Monetary Fund — Paraguay staff report content unit 1pryea2019001 (section 24 and subsequent sections as provided).* ### 59. It would be desirable to increase the share of government debt that is financed ### It would be desirable to increase the share of government debt that is financed domestically. ### Domestic financing, pension funds, and exchange-rate exposure - Currently about 80 percent of public sector is external debt denominated in foreign currency. - Pension funds are not allowed to invest in government debt and hold a large share of their assets in bank deposits, while banks suffer from excess liquidity. - Allowing pension funds to invest in government bonds (see paragraph 65) would: - reduce both external vulnerabilities and the government’s exposure to the banking sector, - effectively channel domestic savings for the financing of much-needed public investments. - If banks were to get into trouble, the government would likely need to bail out the pension funds’ deposits, which are above the thresholds of deposit insurance. ### Authorities’ views on fiscal and pension reform - Tax revenue: - Authorities agreed that tax revenue needed to be raised to create space for public investment and structural reforms. - They cautioned this would take time and immediate efforts would focus on simplifying the system and improving tax compliance, followed by later steps to reduce exemptions and eventually raise tax rates. - Pension reform: - Authorities agreed parametric adjustments to the pension system should be introduced sooner rather than later. - As a first step, social insurance coverage needed to be improved because a large share of workers is not formally registered and does not contribute to the system. ### Financial sector soundness and supervision - Banking sector strength: - Financial soundness indicators show the banking sector is well capitalized and profitable. - Tier I capital-to-asset ratio: 13.4 percent (well above the regulatory minimum of 8 percent). - Return on equity is above the regional average. - Banks performed well in the BCP’s recent stress tests under extreme adverse scenarios; all banks maintained capital adequacy ratio above the regulatory requirement under stress scenarios. - Non-bank financial sector risks: - Since the interest rate ceiling on bank credit card loans, casas de crédito and casas comerciales have become main providers of uncollateralized consumer loans and instalment credit to lower- and middle-income households. - Current size of casas de crédito and casas comerciales: around US$570 million (3 percent of total banking sector assets). - There is no systematic data collection for this sector, except SEPRELAD’s recent attempt to register a handful of large borrowers and acquire a list of entities. - Urgent need to adopt supervision standards for this sector; BCP has started a study to evaluate scope and feasibility of regulating them. - Supervision of financial cooperatives should continue to be strengthened. - Progress on 2017 FSSR recommendations: - Establishment of protocols for interagency coordination, a financial stability council, surveillance data on financial sector interconnectedness, and revisions to bank resolution law. - Superintendency of Banks upgraded organizational structure and supervisory model, including the risk matrix, to facilitate transition to risk-based supervision. - More work needed to operationalize protocols and resolution laws; revisions to the risk matrix to include broader measures of asset quality (NPLs, restructured, renewed and refinanced loans) would be helpful. - A supervisory regime still needs to be implemented for casas de crédito and casas comerciales. ### Reducing dollarization and regulatory options - Reducing financial dollarization is desirable: - Borrowing in dollars is risky, even for the agricultural sector, which receives export earnings in dollars. - Given that the guaraní-dollar exchange rate tends to depreciate when main agricultural commodity prices weaken, borrowing in guaranís would provide a natural hedge against commodity price shocks. - Previous research suggests regulatory measures such as using higher capital requirements on dollar-denominated loans could lower credit dollarization. ### Pension fund regulation and capital market development - Regulatory gaps: - Pension funds face basic legal limitations prohibiting investment in anything else but domestic private sector assets and there is no oversight of a sector that captures long-term savings from a large part of the population. - Unintended consequence: pension funds hold a large share of their assets as domestic bank deposits. - Recommendations: - Introduce a pension fund supervisor to enhance accountability and allow pension funds to invest in a wider range of assets to facilitate the development of a domestic capital market. - A law project to establish a pension fund supervisor was not recently approved by parliament—political dialogue should resume the path toward reform. ### AML/CFT and anticorruption priorities - Updated national risk assessment (2018) identifies: - Main ML risks: organized crime (drug-trafficking, counterfeiting, human and firearms trafficking) and informality. - Corruption is identified as a structural and endemic problem impacting government control institutions, acting as both a source and enabler for ML. - Priorities from the national risk assessment: - Strengthen the legal framework. - Enhance capacity and cooperation of key agencies. - Produce data and statistics on the phenomenon. - Complement AML/CFT measures with strengthened anticorruption efforts. - Timing: - Paraguay faces an upcoming evaluation by the regional AML/CFT standard-setting body which will assess the country’s framework and its effectiveness in late 2019. ### Authorities’ views on supervision and reforms - Banking sector resilience: - Authorities stressed the banking sector is well capitalized and can withstand shocks. - Progress in implementing FSSR recommendations, including risk-based supervision, macroprudential tools, and strengthening institutional and crisis preparedness frameworks. - Non-bank sector supervision: - Authorities acknowledged supervisory weaknesses in the non-bank financial sector. - Some progress to strengthen risk-based supervision for cooperatives via improved coordination with INCOOP and collecting surveillance data on interconnectedness with the banking sector. - Agreed on need to improve supervision of casas de crédito and casas comerciales and reiterated commitment to establish pension fund supervision. ### Financial Soundness Indicators (selected years and indicators, in percent) - Basic indicators (2013–2018): - Regulatory capital/risk-weighted assets: 14.7, 15.2, 16.1, 17.9, 18.3, 17.5 - Tier 1 capital/risk-weighted assets: 11.3, 11.2, 11.7, 13.4, 13.8, 13.4 - NPLs net of provisions/equity: 0.9, 1.2, 3.7, 3.1, 2.5, 3.1 - Asset quality: - NPLs/total loans: 2.1, 2.0, 2.6, 2.9, 2.8, 2.5 - Provisions/NPLs: 135.7, 135.0, 116.5, 120.4, 126.1, 126.7 - Profitability: - Return on assets: 2.7, 2.6, 2.5, 2.2, 2.3, 2.3 - Return on equity: 24.6, 24.2, 23.4, 20.8, 20.3, 20.0 - Interest Margin/ gross income: 11.6, 10.2, 7.4, 8.0, 9.8, 12.2 - Admin. expenses/operating margin: 29.3, 34.1, 36.2, 38.2, 39.5, 33.7 - Liquidity: - Liquid assets/total assets: 25.2, 25.0, 27.6, 24.1, 19.1, 18.7 - Liquid assets/sight deposits: 9.8, 9.5, 10.1, 9.3, 7.9, 7.5 - Market risk: - FX position/equity: 10.2, 8.4, 9.1, 8.6, 9.6, 17.3 - Recommended indicators: - Capital/assets: 7.0, 7.0, 7.2, 7.9, 8.2, 8.4 - Personnel expenses/admin. expenses: 14.2, 10.4, 6.4, 6.6, 7.8, 11.3 - FX loans/total loans: 45.4, 47.8, 50.0, 48.1, 46.7, 47.2 - FX liabilities/total liabilities: 45.7, 49.3, 54.6, 51.6, 48.4, 48.1 - Source of indicators: Banco Central del Paraguay and IMF, Financial Soundness Indicators. ### Staff appraisal — key findings and recommendations - Policy mix and macro outlook: - Current policy mix is appropriate: fiscal policy is neutral and monetary policy expansionary, which should help mitigate the slowdown and reduce downside risks. - Inflation is projected to return to the midpoint of the target range by year’s end. - The external position is stronger than the level implied by fundamentals and desirable policies. - Growth and structural challenges: - Paraguay has grown rapidly over the past decade and a half, contributing to a sharp drop in poverty; vulnerabilities have declined with a significant reduction of both external and public debt. - Key question: how to maintain rapid growth of per capita incomes given heavy reliance on agriculture and limited scope to expand agricultural land. - Future growth needs to come increasingly from the non-agriculture/non-electricity export sector; higher private sector investment, including from abroad, is needed. - A better business climate and improved governance would facilitate diversification and productivity growth; priority policies include improving transport infrastructure, rule of law, and quality of education. - Fiscal space and revenue: - Prudent fiscal policies reduced the debt-to-GDP ratio, but fiscal space is limited as the deficit is close to the 1.5 percent ceiling under the Fiscal Responsibility Law. - Revenues are low by international standards; to create room for investment, revenues need to be increased. - Reducing exemptions and deductions and improving tax compliance will raise effective tax rates even if headline rates remain unchanged. - There is scope to reprioritize expenditure within the existing envelope: high share of government expenditure goes to wages; need to increase infrastructure and social spending, including in health and education. - Financial sector reform priorities reiterated: - Continue strengthening supervision of financial cooperatives. - Quickly adopt supervision standards for casas de crédito and casas comerciales. - Establish a pension fund supervisor to mitigate risks, allow pension funds to invest in a wider range of assets, and facilitate development of a domestic capital market. - Restore long-term sustainability of the pension system through timely and gentle parametric adjustments to pension age, benefits and contribution rates. - Implementation of structural reforms combined with prudent macroeconomic policies would allow Paraguay to continue growing rapidly and improving living standards. - Staff proposes the next Article IV consultation follows the standard 12-month cycle. *Source: IMF staff report excerpt.* ### Box 1. Paraguay: Risk Assessment Matrix ### Box 1. Paraguay: Risk Assessment Matrix ### External risks - Rising protectionism and retreat from multilateralism (High / ST, MT) - Expected impact: Medium. "The higher uncertainty in the global environment could hurt investment, increase risk premium, and reduce foreign demand for the traditional exports of Paraguay." - Recommended response: "Maintaining macroeconomic and financial stability will help contain the perception of investment risks. Continued diversification of exports will also help diffuse the risks." - Significant drop in agricultural commodity prices (Medium / ST, MT) - Expected impact: High. "As agricultural commodity exports are a significant driver of the economy, a negative price shock will impact GDP growth, financial soundness of the banking sector, and reserve position." - Recommended response: Short term: "the exchange rate should be allowed to depreciate, and monetary policy can become more accommodative." Long run: "the most effective risk mitigation measure is to diversify exports." - Sharp tightening of global financial conditions and US dollar appreciation (High / ST) - Expected impact: Medium. - Recommended response: "The exchange rate should be allowed to adjust. The tightening of financial conditions may hurt the economy if other negative shocks to growth also materialize, though the impact may be limited due to the lack of financial linkages between Paraguay and the rest of the world." - Slowdown in growth and higher risks in neighboring countries (High / ST) - Expected impact: Medium. "Shock to neighboring countries may impact growth through the exchange rate and exports. Lower growth in Brazil may reduce FDI inflows, impairing investment and employment." - Recommended response: "Disorderly market conditions should be mitigated through interventions. Monetary policy can become more accommodative if the shock persists." - Changes in preferential tax treatment for Paraguayan exports (Medium / ST, MT) - Expected impact: Medium. "The incentive of Brazilian firms to invest in Paraguay may drop, as the final outputs from these FDI flows mainly target the Brazilian market. This would hurt the prospect of export diversification." - Recommended response: "The government should be proactive in securing customs agreements with main trading partners, while exploring trade agreements with other countries to diversify the sources of investment inflow." ### Domestic risks - Weather-related shocks (Medium to High / ST) - Expected impact: Medium to High. "Shocks to the agriculture sector not only affect GDP growth, export performance and exchange rate, but also the financial sector, due to banks’ agricultural lending. Shocks to the energy sector will negatively affect government revenue." - Recommended response: "The exchange rate could absorb much of the shock, while budget execution should remain compliant with the FRL. Foreign exchange interventions can be used to avoid disorderly market conditions." - Government capacity constraint affecting the execution of public investment projects (Medium / ST, MT) - Expected impact: Medium. "Under execution of the investment budget may affect the performance of construction and related services, dampening aggregate demand and GDP growth. Lowered public investment also jeopardizes infrastructure development, needed for future growth." - Recommended response: "The government should strengthen its capacity in budget execution, including through adopting an effective public investment framework." ### Key related findings and context (selected) - "Paraguay has experienced significant economic convergence since the early 2000s" driven by "rapid growth in the last 15 years" and "the agricultural commodity price boom during the 2000s." - Structural notes: "The structure of the economy has shifted towards mostly-non-tradable, service sector." Agricultural products have become a major source of export revenue, overtaking hydro-energy exports. - Fiscal stance: "Paraguay’s fiscal deficit has increased over the past 15 years and is now close to the FLR ceiling." Public debt has remained low relative to peers. - Monetary conditions: "Inflation is close to the middle of BCP’s target range" and "the output gap is near zero." "The BCP has cut the policy rate in February and March of 2019... but the transmission of the policy rate is impeded by high dollarization." - Financial sector: "There has been significant financial deepening over the past decade. Private sector credit is now higher than the regional average." Banks are described as "liquid and well capitalized." - Long-term growth challenges: "GDP per capita has increased because of higher labor inputs, rather than higher labor productivity." Agriculture growth has relied on "extensive margin—through increasing areas of cultivation." Export concentration remains high in agricultural commodities and derivatives; non-energy, non-agriculture export share remains very low. *Box 1. Paraguay: Risk Assessment Matrix. INTERNATIONAL MONETARY FUND.* ### Annex I. Recommendations of the 2017 Article IV Consultation ### Annex I. Recommendations of the 2017 Article IV Consultation and Authorities’ Actions ### Monetary Policy - Fund recommendation: - Foreign Exchange interventions should continue to be limited to exceptional circumstances such as disorderly market Conditions. - Authorities’ actions: - The BCP intervened in the foreign exchange market, mainly between May and October in 2018 (in reactions to the development in Argentina) to prevent the guaraní from having large and unwarranted exchange rate movements in a foreign exchange market that is small and illiquid. ### Fiscal Policy - Fund recommendations and status: - Pension reform. - A draft law to establish the superintendence of pension was rejected by Congress in 2018. The authorities are revising the draft and will resubmit to Congress later. - Strengthen the budget process to prevent Congress approval of budgets that exceed the ceiling of the FRL. - The government budgets for 2018 and 2019 approved by Congress stayed within the limits of the FRL ceiling. - Expenditure review to identify spending re-prioritization including for social assistance programs. - The World Bank has recently completed a public expenditure review on social sectors. The results are an important input for the public-private commission for the review of public expenditure. ### Financial Sector - Fund recommendations and status: - Revisions to the BCP organic charter. - The BCP organic charter was approved and promulgated in 2018. - Establishment of a financial stability council with a public decree. - The financial stability committee is created at the BCP. - Improving data collection on the shadow banking sector. - The bank superintendence is setting up data reporting of income statements and balance sheets from the unregulated lenders. - Integrating financial information through a single credit bureau. - Financial information on all segments of the financial sector is not yet fully integrated in the existing credit bureau. Weaknesses still exist in building the appropriate infrastructure to collect and process surveillance data for cooperatives and credit houses and their interconnectedness with banks. - Approving legislation regarding the Sociedades Anonimas and bearer securities in line with international AML/CFT standards. - Congress approved the legislation Sociedades Constituidas por Acciones in September 2017, Decree is signed by the President in June 2018 and the BCP issued regulation in September 2018. ### Structural Reforms - Fund recommendations and status: - Improving transportation and electricity distribution infrastructure. - The government is planning to tender seven transport infrastructure projects of around US$1.5 billion between 2019 and 2021. - The national electricity administration, ANDE, is actively investing in transmission lines and other electricity distribution infrastructure, with a financing package of US$500 million for next 5 years. - Reducing the informal sector. - The government is proposing legislation to simplify company formation and registration, with the goal to encourage formalization. *Source: Annex I. Recommendations of the 2017 Article IV Consultation and Authorities’ Actions (IMF).* ### Annex II. External Sector Assessment ### External Balance Sheets — Background and Assessment - Background: - Paraguay's net international investment position (NIIP) has improved in the past decade and a half, the result of an increase in foreign reserves and a decline in external debt. - The reduction in external debt, from nearly 193 percent of GDP in 2003 to 40 percent of GDP in 2018 was the result of the amortization of the debt of the binational hydroelectric company (ITAIPU; about 18 percent of GDP in 2018), which was only partly offset by an increase in external government debt. - Currently, FDI (mainly in the agrobusiness sector) is be the largest source of liabilities of the private sector, at around 15 percent of GDP. - Assessment: - Going forward, external debt is expected to decline steadily as the debt of the binational hydroelectrical company continues to fall. - The external position remains sustainable under a range of adverse shocks. ### Current Account — Background and Assessment - Background: - Paraguay's current account has been in surplus over the last 20 years, averaging 1.2 percent of GDP. - The current account surpluses in 2016 and 2017 were particularly strong, the result of record hydro-electricity exports and a surge in agricultural exports. - The current account balance deteriorated in 2018 but remained in surplus. The deterioration was the result of the sharp decline in the trade balance, which reflect both weaker exports (the result of the exchange rate appreciation) and strong import demand. - National savings have remained relatively stable as a share of GDP. - The current account balance in 2019 is expected to deteriorate due to lower soy bean export, resulting from the drought in the early planting season. - Over the medium-term, the current account balance is expected to increase gradually to around 0.6 percent of GDP, reflects the rebound in soy bean production and the decline in interest payment to the binational loan. - Assessment: - The current account balance of Paraguay is stronger than the multilateral consistent cyclically adjusted current account norm. The estimated current account gap is 3.8 percent of GDP. - Components of the current account gap (2018): - Policy gap: -0.6 percent of GDP - Adjustment for natural disasters and conflicts: insignificant (0.0 percent of GDP) - Multilateral consistency adjustment: -0.5 percent of GDP - Residual from the current account regression model: 4.9 percent of GDP - The large size of the residual suggests the regression model does not capture well factors specific to Paraguay (e.g., landlocked status, business climate impacts on FDI). - Staff’s preferred approach to assess the current account position is based on the current account balance that nets out the amortization to binationals. Explanation: - Paraguay borrowed heavily to build the binational hydro-electric plant and uses less than half of Itaipu’s electricity production it is entitled to, exporting the remainder to Brazil while servicing Itaipu’s debt. These transactions generate a positive current account item and an offsetting capital outflow with no impact on the rest of the economy. ### EBA-lite Current Account Regression Results for 2018 (summary table items preserved) - Current Account Balance (CA): 0.5% - CA excluding amortization to binationals: -1.3% - Export of Goods and Services: 35.7% - Import of Goods and Services: 34.3% - Cyclical Contributions (from model): -0.2% - Multilaterally Consistent Cyclically adjusted CA Norm: -3.3% - CA-Gap: 3.9% and 2.1% (two columns reported) - Policy Gap: -0.6% - Natural Disasters and Conflicts: 0.0% - Multilateral Consistence Adjustment: -0.5% - Residual: 5.0% and 3.2% (two columns reported) - Elasticity of current account to REER: -0.26 - Implied REER Gap: -15.3% and -8.1% - Note on elasticity calculation: - The elasticity of current account is calculated as Export of Goods and Service/GDP multiplied by an export elasticity of -0.44 minus Import of Goods and Services/GDP multiplied by import elasticity of 0.29. - Total CA (percent of GDP): Actual REER (in log) 4.74; Fitted REER (in log) 4.80; REER Norm (in log) 4.81; REER Gap -7.0% - Residual: -5.9% - Policy Gap: -0.3% - Natural Disasters and Conflicts: -0.8% ### Real Exchange Rate - Assessment: - The real exchange rate regression approach yields results consistent with the current account regression approach. - There is a strong link between dollar-denominated agricultural commodity export prices and Paraguay’s real exchange rate: when commodity prices strengthen, the real exchange rate tends to appreciate, and when they fall, so does the REER. - In 2018, the real exchange rate was somewhat stronger than suggested by the historical link between commodity prices and the REER. This reflected in part the appreciation of Paraguay against its neighbors. ### Capital and Financial Flows — Background and Assessment - Background: - Foreign direct investment has been the major source of capital inflows in last few years. - The government has been tapping funding from the international markets with a placement of bonds for US$500 million each year from 2016 to 2018. These international offerings have become another stable source of capital inflows. - Assessment: - Paraguay has a fully open capital and financial account, but financial markets are not deep or developed yet. - Paraguay enjoyed a stable flow of FDI in the last decade, and despite the economic turmoil in Argentina and Brazil in 2018, FDI is expected to remain positive for 2018, albeit at a lower level than in 2017. - Vulnerabilities to the financial flows remain contained as the major source of capital is direct investment and government’s external borrowing, which was received well in the last few international public offerings, given the low level of public debt. ### Reserves — Background and Assessment - Background: - International reserves registered a net decline of US$146 million to US$8,004 million at end-2018. - Strong accumulation of international reserves continued in Q1-2018 but the trend reversed as the BCP started to intervene in the foreign exchange market to contain the depreciation pressure on the Guaraní. - The BCP sold a total of US$1,273 million in the foreign exchange market in 2018. The sales of foreign reserve slowed down towards the end of the year after peaking in mid-2018, as the depreciation pressure on the Guaraní subsided. - Assessment: - Reserves remain ample (about 7 months of imports) and above the Fund metrics for a small open economy (the level of reserves at end-2018 was close to two times the level of reserves considered adequate under the metric). - The flexible exchange rate continues to be the first line of defense against external shocks. - Staff recommends continuing with a rules-based approach for regular dollar sales and to limit discretionary interventions to exceptional situations of disorderly market conditions. ### External Debt Sustainability — Key Table Highlights (2013–23, percent of GDP unless specified) - Baseline: External debt series (selected years): - 2013: 41.0 - 2014: 40.6 - 2015: 43.8 - 2016: 43.0 - 2017: 39.9 - 2018: 37.6 - 2019: 37.4 - 2020: 34.5 - 2021: 31.9 - 2022: 29.6 - 2023: 27.7 - Change in external debt (selected): -7.2; -0.4; 3.2; -0.8; -3.0; -2.4; -0.1; -3.0; -2.6; -2.3; -1.9 - Identified external debt-creating flows (4+8+9) (selected): -8.9; -2.6; 4.2; -4.4; -7.5; -2.8; -1.5; -2.7; -2.8; -2.8; -2.8 - Current account deficit, excluding interest payments (selected): -3.3; -1.4; -1.4; -5.3; -4.6; -2.0; -0.8; -2.0; -2.1; -2.1; -2.1 - Exports (percent of GDP): 37.5; 35.0; 33.0; 35.4; 36.4; 35.2; 34.5; 34.8; 34.2; 33.7; 33.2 - Imports (percent of GDP): 33.8; 33.0; 31.5; 30.0; 32.3; 33.8; 34.3; 33.4; 33.4; 32.7; 32.2; 31.8 - Net non-debt creating capital inflows (negative): -0.6; -1.0; -0.8; -1.0; -1.2; -0.9; -1.0; -0.9; -1.0; -0.9; -0.9 - Automatic debt dynamics (contribution) (selected): -5.0; -0.2; 6.4; 1.9; -1.7; 0.1; 0.3; 0.2; 0.2; 0.2; 0.2 - External debt-to-exports ratio (in percent) (selected): 109.4; 116.0; 132.9; 121.4; 109.7; 106.6; 108.4; 99.0; 93.3; 87.8; 83.4 - Gross external financing need (in billions of US dollars): 1.9; 2.5; 2.7; 1.3; 1.3; 2.4; 3.0; 2.5; 2.4; 2.4; 3.2 - Gross external financing need (in percent of GDP) (selected): 5.0; 6.3; 7.4; 3.6; 3.4; ... - Scenario with key variables at their historical averages: 37.6; 32.2; 27.2; 22.7; 18.4; 14.5; -1.8 - Key Macroeconomic Assumptions Underlying Baseline (selected): - Real GDP growth (in percent): 8.4; 4.9; 3.1; 4.3; 5.0; 4.7; 3.5; 3.7; 3.5; 4.0; 4.0; 4.0; 4.0 - GDP deflator in US dollars (change in percent): 6.9; -0.5; -12.9; -4.4; 3.1; 4.0; 12.8; 2.8; -1.6; 3.0; 2.6; 2.4; 2.1 - Nominal external interest rate (in percent): 4.0; 3.9; 4.0; 4.1; 3.8; 4.2; 0.3; 4.0; 4.4; 4.6; 4.7; 4.8; 4.8 - Growth of exports (US dollar terms, in percent): 16.5; -3.2; -14.5; 7.5; 11.5; 7.5; 17.8; 3.2; -0.2; 8.0; 4.8; 4.9; 4.7 - Growth of imports (US dollar terms, in percent): 8.3; 1.4; -13.4; -4.6; 16.9; 9.0; 22.6; 11.7; 3.3; 4.3; 4.3; 4.5; 4.7; 4.8 - Current account balance, excluding interest payments: 3.3; 1.4; 1.4; 5.3; 4.6; 3.2; 1.7; 2.0; 0.8; 2.0; 2.1; 2.1; 2.1 - Net non-debt creating capital inflows: 0.6; 1.0; 0.8; 1.0; 1.2; 1.2; 0.5; 0.9; 1.0; 0.9; 1.0; 0.9; 0.9 ### External Debt Sustainability: Bound Tests (high-level) - Figures and scenario descriptions indicate stress tests: - Individual shocks are permanent one-half standard deviation shocks; permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance. - One-time real depreciation of 30 percent occurs in 2019 in the specified scenario. - Visual summary (textual): - Historical, baseline, i-rate shock, interest rate shock, CA shock, growth shock, combined shock, combined shock with 30% depreciation show varying external debt paths with baseline around 28 (percent of GDP) in the chart annotations. *Source: Annex II. External Sector Assessment (IMF).* ### Annex III. Public Sector Debt Sustainability Analysis ### Annex III. Public Sector Debt Sustainability Analysis ### Debt Indicators and Projections (Selected figures, in percent of GDP unless otherwise specified) - Nominal gross public debt: - 2016: 13.9 - 2017: 19.4 - 2018: 19.8 - 2019: 21.6 - 2020: 22.4 - 2021: 22.3 - 2022: 22.3 - 2023: 22.3 - Public gross financing needs: - 2016: 0.9 - 2017: 1.4 - 2018: 1.7 - 2019: 1.5 - 2020: 1.8 - 2021: 1.9 - 2022: 1.8 - 2023: 2.2 - 2023 (alternative figure shown): 3.5 - Real GDP growth (in percent): - 2016: 4.7 - 2017: 4.3 - 2018: 5.0 - 2019: 3.7 - 2020: 3.5 - 2021: 4.0 - 2022: 4.0 - 2023: 4.0 - Inflation (GDP deflator, in percent): - 2016: 5.8 - 2017: 4.1 - 2018: 2.1 - 2019: 4.9 - 2020: 3.2 - 2021: 4.5 - 2022: 3.9 - 2023: 3.5 - Nominal GDP growth (in percent): - 2016: 10.8 - 2017: 8.6 - 2018: 7.2 - 2019: 8.8 - 2020: 6.8 - 2021: 8.7 - 2022: 8.0 - 2023: 7.8 - 2023 (alternate row): 7.7 - Effective interest rate (in percent) 2/: - 2016: 5.2 - 2017: 5.2 - 2018: 5.5 - 2019: 3.4 - 2020: 3.6 - 2021: 3.7 - 2022: 4.2 - 2023: 4.5 - 2023 (alternate row): 4.7 - Sovereign spreads: - EMBIG (bp): 231 - 5Y CDS (bp): ... ### Contributions to Change in Public Debt (in percent of GDP; 2016–2023) - Cumulative change in gross public sector debt: - 2016: 0.1 - 2017: 0.8 - 2018: 0.4 - 2019: 1.8 - 2020: 0.8 - 2021: -0.1 - 2022: 0.0 - 2023: 0.0 - Cumulative (2016–2023): 2.5 - Identified debt-creating flows: - 2016: 0.1 - 2017: 0.6 - 2018: 0.0 - 2019: 0.7 - 2020: 0.5 - 2021: -0.3 - 2022: -0.2 - 2023: -0.2 - Cumulative: -0.2 - Primary deficit: - 2016: -0.7 - 2017: -0.5 - 2018: -0.1 - 2019: 0.0 - 2020: 0.0 - 2021: 0.0 - 2022: 0.0 - 2023: 0.0 - Cumulative: -0.1 - Primary (noninterest) revenue and grants (levels): - 2016: 16.5 - 2017: 19.1 - 2018: 19.0 - 2019: 18.1 - 2020: 18.4 - 2021: 18.2 - 2022: 18.3 - 2023: 18.3 - Cumulative (sum over projection horizon): 109.8 - Primary (noninterest) expenditure (levels): - 2016: 15.7 - 2017: 18.6 - 2018: 18.8 - 2019: 18.1 - 2020: 18.4 - 2021: 18.2 - 2022: 18.3 - 2023: 18.3 - Cumulative: 109.8 - Automatic debt dynamics (contribution): - 2016: -0.6 - 2017: -0.7 - 2018: -0.8 - 2019: -1.0 - 2020: -0.6 - 2021: -1.0 - 2022: -0.8 - 2023: -0.7 - Cumulative: -4.8 - Interest rate/growth differential (contribution) 4/: - 2016: -0.7 - 2017: -0.6 - 2018: -0.3 - 2019: -1.0 - 2020: -0.6 - 2021: -1.0 - 2022: -0.8 - 2023: -0.7 - Cumulative: -4.8 - Real interest rate (component): - 2016: -0.1 - 2017: 0.2 - 2018: 0.6 - 2019: -0.3 - 2020: 0.1 - 2021: -0.2 - 2022: 0.0 - 2023: 0.1 - Cumulative: 0.2 - Real GDP growth (component): - 2016: -0.6 - 2017: -0.7 - 2018: -0.9 - 2019: -0.7 - 2020: -0.7 - 2021: -0.8 - 2022: -0.8 - 2023: -0.8 - Cumulative: -4.7 - Exchange rate depreciation (contribution) 5/: - 2016: 0.1 - 2017: -0.1 - 2018: -0.5 - Other identified debt-creating flows (including NFPS asset accumulation) 6/: - 2016: 1.4 - 2017: 1.8 - 2018: 0.9 - 2019: 1.6 - 2020: 1.1 - 2021: 0.7 - 2022: 0.6 - 2023: 0.5 - Cumulative: 5.0 - Residual 7/: - 2016: -0.1 - 2017: 0.1 - 2018: 0.5 - 2019: 1.0 - 2020: 0.3 - 2021: 0.2 - 2022: 0.2 - 2023: 0.2 - Cumulative: 2.2 Notes on formulas and definitions (as provided in source) - Effective interest rate defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year. 2/ - Automatic debt dynamics derived as [(r - π(1+g) - g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation. 3/ - Real interest rate contribution derived from numerator in footnote 3 as r - π (1+g) and real growth contribution as -g. 4/ - Exchange rate contribution derived from numerator in footnote 3 as ae(1+r). 5/ - NFPS asset accumulation includes social security surplus, accumulation of deposits from the sovereign bond issuance in 2014, and financing of the national development bank. 6/ - Residual includes asset changes and interest revenues (if any). For projections, it includes the impacts of exchange rate changes. 7/ - Balance-stabilizing primary balance assumes key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year. 8/ ### Scenario Assumptions and Alternative Scenarios (selected) - Baseline scenario underlying assumptions (in percent): - Real GDP growth: 2018: 3.7; 2019: 3.5; 2020: 4.0; 2021: 4.0; 2022: 4.0; 2023: 4.0 - Inflation: 2018: 4.9; 2019: 3.2; 2020: 4.5; 2021: 3.9; 2022: 3.7; 2023: 3.5 - Primary Balance: 2018: 0.0; 2019: 0.0; 2020: 0.0; 2021: 0.0; 2022: 0.0; 2023: 0.1 - Effective interest rate: 2018: 3.4; 2019: 3.6; 2020: 3.7; 2021: 4.2; 2022: 4.5; 2023: 4.7 - Historical scenario (alternative): - Real GDP growth: 2018: 3.7; 2019–2023: 4.7 (each year) - Inflation and interest rate paths adjusted accordingly (inflation same as baseline; effective interest rate slightly different: 2018: 3.4; 2019: 3.6; 2020: 3.8; 2021: 4.4; 2022: 4.7; 2023: 4.8) - Primary Balance under historical scenario: 2018: 0.0; 2019–2023: 0.5 (each year) - Constant Primary Balance scenario: - Primary Balance held at 0.0 across 2018–2023 - Other variables same as baseline for growth and inflation; effective interest rate path slightly different (noted values: 2018: 3.4; 2019: 3.6; 2020: 3.7; 2021: 4.3; 2022: 4.7; 2023: 4.8) ### Composition of Public Debt and Financing Needs (high-level) - Charts in the DSA show projections of gross nominal public debt, public gross financing needs, composition by maturity (short-term vs. medium/long-term), and by currency (local vs. foreign currency). (Numerical series for these charts are presented above in selected indicators and financing needs.) ### Authorities’ Statement — Real, Monetary, Fiscal, and Financial Sector Highlights (Statement by Mr. Lopetegui and Mr. Corvalan Mendoza, April 24, 2019) - Real sector: - Economic activity dynamism in early 2018, moderation in second half of 2018. - Real GDP growth estimated at 3.6 percent in 2018 (statement text). - Growth forecast for 2019 of 4 percent, driven by tertiary and secondary sectors; primary sector expected to grow at a slower rate. - Adverse weather conditions affected agricultural performance in 2019, notably soybean production; growth projection could be revised downwards at end of April. - Monetary sector: - Annualized inflation was 2.8 percent in March 2019, within the target range of 4 +/-2 percent. - Central Bank reduced the monetary policy rate by 25 bps in both February and March 2019 to 4.75 percent. - Exchange rate: Guarani depreciated by around 7 percent vis-à-vis the U.S. dollar during 2018. - Net International Reserves slightly over USD 8.2 billion (20 percent of GDP). - Fiscal sector: - Fiscal deficit estimated at 1.3 percent of GDP in 2018, below Fiscal Responsibility Law limit. - 2019 deficit expected to remain below the legal ceiling of 1.5 percent of GDP. - Tax revenue at 10 percent of GDP. - Ministry of Finance established commissions in mid-2018 to modernize tax system and optimize public expenditures; initial projections suggest: - Revenue could increase gradually by 1 percentage point of GDP without raising tax rates (via reducing deductible expenses in personal income tax, eliminating exemptions, equalizing VAT rates). - Potential expenditure savings could add another 1 percentage point of GDP. - A bill expected to be sent to Congress during first half of 2019 related to these measures. - Expenditure composition shifting toward capital and social spending while keeping current expenditures in check. - Financial sector: - Financial system remains stable; solvency indicators in line with Basel minimum capital requirements. - Liquidity, non-performing loans, and profitability indicators at adequate levels. - Stress testing shows system resilience to extreme shocks. - Ongoing regulatory reform to address digital environment, market transparency, and discipline; draft laws include Credit Bureau, Crowdfunding, Transparency of the Total Cost of Credit, Foreign Exchange Brokers, and changes to Cooperatives Law and INCOOP charter. ### Policy Priorities and Reforms (as stated by authorities) - Accelerate an ambitious investment plan in road infrastructure, education, hospitals, and social housing, leveraging private sector through PPPs. - Continue scholarship programs to train Paraguayans (over 500 students trained for Master’s and PhD programs under described eligibility rules). - Modernize and simplify tax collection, reduce tax expenditures, and equalize VAT rates to increase revenues by 1 percentage point of GDP. - Optimize public expenditures to realize potential savings of 1 percentage point of GDP. - Advance institutional reforms to improve transparency, governance, and ease of doing business (recent legislative actions and proposals include free access to public information law usage, digital agenda financing, bankruptcy law, company formation simplification, and movable asset collateral legislation). - Strengthen AML/CFT framework and related judicial and enforcement measures (twelve new laws under discussion relating to financial intelligence secretariat, specialized criminal procedures, and transnational bribery). *Source: Fund staff estimates and projections; Statement by Paraguayan authorities (April 24, 2019).* --- _Source: https://www.imf.org/-/media/files/publications/cr/2019/1pryea2019001.pdf_