## _cr06302 - Executive Summary ## Source details **Canonical URL:** [_cr06302 - Executive Summary](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06302.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06302.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06302.pdf.json) --- ### Background and recent developments - Previous SBA performance: largely achieved objectives of restoring stability and starting reform process. - Remaining challenges: sustain fiscal consolidation; strengthen monetary policy operations to reduce inflation; further strengthen the financial system; remove impediments to growth. - Authorities request: a 27–month precautionary SBA to cover remaining period of President Duarte-Frutos’ administration. - Proposed access: SDR 65 million (29 percent of quota on an annual basis). Authorities intend to treat the arrangement as precautionary. ### Program objectives and pillars - Key objectives: - Secure macroeconomic stability. - Create conditions for sustained high growth. - Reduce poverty. - Main pillars: - Strong macroeconomic program (entrench macroeconomic management). - Public sector reform (improve budgetary planning and expenditure control; institutionalize tax improvements; reduce current expenditure rigidities). - Financial sector reform (address banking system weaknesses and supervision; improve financial intermediation). - Pro-growth agenda (improve judicial system, agriculture, public enterprises, labor markets, investment climate). - Effective social safety net (alleviate poverty; mitigate social costs of reform). ### Performance under the 2003–05 program — macroeconomic outcomes - Economic activity: - 2004 growth: 4 percent. - 2005 growth: 3 percent. - Reports of continued drought in early 2006 could jeopardize growth objectives. - Inflation: - 2004: 2¾ percent. - 2005: 10 percent (outside 4–8 percent objective range). - First four months of 2006: 4½ percent (raising the 12–month rate to 10½ percent). - Central Bank raised LRM rates by 375 basis points (to 10½ percent) in February and April 2006. - Monetary developments (reported): - Base money growth: 57.7 (2003), 17.7 (2004), 4.3 (2005), 3.2 (Jan-Mar 2006). - Money supply growth: 24.9 (2003), 24.6 (2004), 16.1 (2005), 15.9 (Jan-Mar 2006). - Central Bank increased LRM rates by 425 basis points (to 6¾ percent) during 2005 (noted insufficient to offset large FX purchases in first half 2005). - Fiscal performance: - Treasury surplus in 2004 (first time in a decade). - 2005: reported Treasury surplus of over ½ percent of GDP, against program objective of a deficit of the same magnitude. - Early indications of further strengthening in tax collections in Q1 2006. - Congress approved a large and underfinanced budget for 2006; authorities aim to re-align it to achieve an overall balance of zero. - External sector: - Current account: small surplus in 2004 turned to a deficit of 2½ percent of GDP in 2005. - Record NIR: US$1.3 billion in 2005. - Central Bank introduced limited foreign exchange intervention policy in mid-2005. ### Rationale and medium-term objectives (2006–08 program) - Program designed to consolidate macroeconomic stability, address vulnerabilities, and create conditions for higher growth. - Medium-term objective: lay foundations for gradual but sustainable increase in economic growth to 4–5 percent a year, lower inflation to industrialized country levels, and reduce poverty significantly. - Staff view: program ambitious and comprehensive with strong ownership. ### Key macro policy commitments and numeric projections - Fiscal policy: - 2006 objective: achieve a zero-deficit in the public finances based on strict implementation of a financial plan containing expenditure cuts relative to the approved budget. - Monetary policy: - 2006 objective: lower inflation to 7 percent. - Selected macro projections (as presented): - Real GDP (annual percent change): 2002: 0.0; 2003: 3.8; 2004: 4.1; 2005: 3.2; 2006 (Est./Prog): 3.0; 2007: 3.5; 2008: 4.0-4.5. - Inflation (e.o.p.): 2002: 14.6; 2003: 9.3; 2004: 2.8; 2005: 9.9-10. ? (table shows "89.9" formatting anomaly in source); 2006: 2½-7½; 2007: 4.0; 2008: 3.0. - Money supply (annual percent change): 2002: -2.2; 2003: 24.9; 2004: 24.6; 2005: 10.7; 2006: 16.1; 2007: 8.5; 2008: 6.5-6.0. - Domestic investment (percent of GDP): 2002: 18.7; 2003: 19.9; 2004: 20.8; 2005: 21.3; 2006: 23.2; 2007: 23.8; 2008: 24.7-25.2. - External current account (percent of GDP): 2002: 1.8; 2003: 2.4; 2004: 0.2; 2005: -0.4; 2006: -2.5; 2007: -2.2; 2008: -1.9-1.9. - Primary fiscal balance (Central Government, percent of GDP): 2002: -1.9; 2003: 1.0; 2004: 2.7; 2005: 0.7; 2006: 1.9; 2007: 1.0; 2008: 1.2-1.2. - Overall fiscal balance (Central Government, percent of GDP): 2002: -2.5; 2003: -0.3; 2004: 2.0; 2005: -0.5; 2006: 0.6; 2007: 0.0; 2008: 0.0-0.0. - Public sector debt (percent of GDP): 2002: 57.6; 2003: 55.0; 2004: 42.5; 2005: 39.4; 2006: 37.8; 2007: 33.1; 2008: 30.6-28.7. ### Fiscal policy measures and financing (2006) - Authorities plan to cut budget expenditures by about 1¾ percent of GDP through strict implementation of a financial plan. Measures include: - reducing allowances for senior public servants; - lowering over-time outlays; - eliminating hiring of temporary workers; - freezing positions in the first four months; - phasing salary increases during the year; - restricting the purchase of goods and services. - Capital expenditure envisaged: about 4¼ percent of GDP (mostly to improve basic infrastructure). Staff does not expect additional public investment to exceed ½ percent of GDP in 2006 unless adequately financed. - External and multilateral financing for 2006: - World Bank expected disbursement: US$15 million. - IDB expected disbursement: US$30 million. - These disbursements expected to reduce net external financing need of the Treasury to almost zero in 2006. - Consolidated public sector target: zero deficit in 2006; Central Bank projected losses of ¾ percent of GDP imply rest of non-financial public sector expected to continue generating surpluses. ### Monetary policy stance and Central Bank finances - Objective: reduce inflation to low single digits over medium term; Central Bank announced intention to keep inflation within 2½–7½ percent range for 2006. - 2006 monetary tightening: reduce growth of currency issue from 17½ percent in 2005 to 8½ percent in 2006. - Interest rates: short-term interest rates raised by 375 basis points to 10½ percent in two stages (February and April 2006). - Monetary program figures (percent of previous period currency / growth rates): - Currency: 2004 12.7; 2005 10.0; 2006 Prog. 17.6; 2007 Prog. 8.5; 2008 Prog. 6.5. - Net international reserves: 2004 52.6; 2005 9.6; 2006 Prog. 32.6; 2007 Prog. 4.3; 2008 Prog. 6.5. - Net domestic assets: 2004 -39.8; 2005 0.4; 2006 Prog. -15.0; 2007 Prog. 4.2; 2008 Prog. 0.0. - Base money growth (%): 2004 17.6; 2005 8.2; 2006 Prog. 4.3; 2007 Prog. 6.0; 2008 Prog. 4.2. - Money supply growth (%): 2004 24.6; 2005 10.7; 2006 Prog. 16.1; 2007 Prog. 8.5; 2008 Prog. 6.5. - Central Bank profit (+)/losses (-) (percent of GDP): 2003 -1.1; 2004 -0.8; 2005 -0.2; 2006 Prog. -0.7. - Costs of monetary policy projected to rise to 0.7 in 2006. - Authorities committed to design strategy to strengthen Central Bank financial position by end–2006 (structural benchmark). ### Financial sector reform — objectives and targets - Program focus over next three years: - strengthen financial position of Central Bank; improve framework for monetary operations; upgrade banking supervision; strengthen prudential regulations; restructure public banks (BNF); foster capital markets; improve payments system. - BNF capital adequacy targets (CAR, fully provisioned): - End-June 2006 (indicative target): 5.0 percent. - End-December 2006 (performance criterion): 10.0 percent. - BNF measurement rules: loans portfolio fully classified and provisioned per Central Bank Resolution No. 8/2003; BNF’s CAR under this definition for end–2005 was about zero percent. - Estimated additional capital need for BNF to achieve targeted CAR by end–2006: about /G50 trillion (some US$8 million or 0.1 percent of GDP). [Preserve source presentation.] ### Structural conditionality, benchmarks and timing (selected) - Public sector: - Prepare tax procedures/code: performance criterion end-December 2006. - Design action plan to strengthen commitment-level expenditure controls and rationalize Treasury accounts: structural benchmark end-June 2006. - Financial sector: - Audited and inspected CAR (provisioned) of 5 percent for BNF at end-June 2006 — Benchmark Sep 2006. - Implement banking regulatory measures and draft legislation — Benchmark Sep 2006. - Strategy to strengthen Central Bank financial position and timetable — Benchmark Dec 2006. - Audited and inspected CAR (provisioned) of 10 percent for BNF at end-December 2006 — PC Mar 2007. - Send bill to Congress reflecting plan to strengthen BCP — Benchmark Apr 2007. - Pro-growth and social: - Plan to improve business climate — Benchmark Sep 2006. - Implement management contracts for ANDE, COPACO, ESSAP, INC, PETROPAR — Benchmark Dec 2006. - Create conditional cash transfer mechanism for 7,000 families living under extreme poverty — Benchmark Dec 2006. ### Program modalities, access, and phasing (numeric details) - Arrangement length: 27–months (May 2006–August 2008). - Proposed access: SDR 65 million or 65 percent of quota (29 percent on an annual basis). - Comparisons and phasing: - Previous arrangement access: 50 percent of quota (40 percent on an annual basis). - First purchase would be first credit tranche (25 percent of quota). - Following five purchases would be for 6 percent of quota until reaching 50 percent of quota within 15 months from approval. - Subsequently, remaining four purchases would be for 2½ percent of quota. ### Conditionality, reviews, and monitoring - Authorities requested quarterly reviews in first year, switching to semi-annual reviews thereafter while retaining quarterly quantitative performance criteria and quarterly scheduled purchases. - Eight quantitative performance criteria include: - overall balance of the central administration; - wage bill of the central administration; - overall balance of the public sector; - net international reserves; - net domestic assets; - contracting or guaranteeing of nonconcessional external debt of the public sector; - contracted or guaranteed short-term external debt of the NFPS; - non-accumulation of external debt arrears. - Program Monitoring Group to continue oversight (senior officials from Ministry of Finance and Central Bank, IMF resident representative, IMF mission). - Safeguards assessment of Central Bank ongoing; FIN mission visited Asuncion in March and assessment to be finalized before first review in September 2006. ### Program risks and scenarios - Main vulnerabilities: - Exogenous shocks: drought, oil prices, exchange rate pass-through. - Political developments: municipal elections November 2006; potential delays/ politicization of reforms; delays in Congress approval of key legislation. - Financial sector risks: dollarization, incomplete supervision of credit cooperatives. - Implementation risk: ambitious structural agenda requiring coordination. - Medium-term scenarios: - Baseline: lasting commitment to macro stability and reforms; real GDP growth to 5 percent by 2010; public debt-to-GDP ratio decline to below 30 percent by decade end. - Passive scenario (no reform): growth around 2 percent; higher inflation; weaker fiscal outcomes; debt-to-GDP ratio over 30 percent by decade end. - Capacity to repay Fund: - Staff view: capacity to repay is quite strong; current Fund credit outstanding is zero; risk of nonpayment negligible. ### Debt sustainability analysis (selected numeric findings) - Historical: public debt-to-GDP rose from less than 20 percent in 1997 to over 70 percent in 2002; at end–2005 debt-to-GDP fell to below 40 percent. - With higher growth (4½ percent) and low real interest rates (3 percent), an expected primary surplus (1¾ percent of GDP) would ensure declining debt-to-GDP ratio. - Public debt projections resilient to temporary shocks but vulnerable to exchange rate shocks. - Table excerpt preserved in source: "Paraguay: Sustainable Primary Fiscal Balance 1/ (As a percent of GDP)" — example entries preserved verbatim (e.g., for GDP Growth Rate 4.5 and Real Interest Rate 3.0: -1.0). ### Key quantitative targets and monitoring (selected calendar and figures) - Fiscal floors/ceilings (in billions of guaraníes): - Overall balance of the central administration (floor): end-Jun: 250; end-Sep: 325; end-Dec: 0. - Wage bill of the central administration (ceiling): end-Jun: 1,795; end-Sep: 2,695; end-Dec: 3,880. - Overall balance of the public sector (floor): end-Jun: 350; end-Sep: 440; end-Dec: 0. - Monetary targets: - Net international reserves (floor, in millions of U.S. dollars): end-Jun: 1,297; end-Sep: 1,307; end-Dec: 1,317. - Net domestic assets (ceiling, in billions of guaraníes): end-Jun: -5,711; end-Sep: -5,751; end-Dec: -5,098. - Continuous performance criteria: - Contracted or guaranteed short-term external debt by the NFPS — continuous PC: 0. - Non-accumulation of external debt arrears — continuous PC: 0. - Technical Memorandum of Understanding projections (selected): - NIR of BCP (stock; floor; US$ millions): End-April 2006: 1,254; End-May 2006: 1,273; End-June 2006: 1,297; End-Dec 2006: 1,317. - NDA of BCP (outstanding stock; ceiling; G billions): End-April 2006: -5,372; End-May 2006: -5,540; End-Jun 2006: -5,711; End-Dec 2006: -5,098. - External program disbursements (cumulative; US$ millions): End-August 2006: 30; End-Sep 2006: 45; End-Dec 2006: 45. ### Technical assistance, statistics, and donor coordination - Strengthened TA program focused on public sector reform, financial sector reform, pro-growth agenda, and social safety net. - Active loan portfolio (as of January 2006): US$530.4 million; undisbursed loan balance: US$272.2 million. - Active Technical Cooperation operations: 45 operations for US$18.8 million; undisbursed TC balance: US$9.9 million. - STA assistance planned for CPI/PPI methodology, monetary and financial statistics (including deposit-taking cooperatives), and follow-up to ROSC recommendations. - IDB lending pipeline and World Bank/IDB cooperation highlighted for implementation support. ### Staff appraisal and recommendation - Performance under previous SBA broadly satisfactory though inflation revival disappointing. - New program: comprehensive, ambitious, and appropriately calibrated; high degree of ownership increases chance of success. - Staff supports authorities’ request for a new SBA and highlights need for sustained efforts and international technical assistance for reform implementation. *Source: IMF staff report — Executive Summary and selected chapters of _cr06302* ### Executive Summary ...................................................................................................... ### _cr06302 - Executive Summary ...................................................................................................... ### Background and Recent Developments - Performance under the previous SBA was satisfactory: the program largely achieved the objectives of restoring stability, and starting a reform process to create conditions for sustained growth and poverty reduction. - Remaining challenges require significant institutional reforms to sustain macroeconomic achievements and mitigate vulnerabilities: sustain fiscal consolidation; strengthen monetary policy operations to reduce inflation; further strengthen the financial system; remove impediments to growth. - The authorities are requesting a 27–month precautionary SBA to cover the remaining period of President Duarte-Frutos’ administration. - The proposed access under the arrangement is SDR 65 million (29 percent of quota on an annual basis). The authorities intend to treat the arrangement as precautionary. ### Program Objectives and Policy Pillars - Key objectives: - Secure macroeconomic stability. - Create conditions for sustained high growth. - Reduce poverty. - Short-run context: macroeconomic conditions weakened in early 2006 as the drought seems to continue, and inflationary pressures persist. - Main pillars: - Strong macroeconomic program (entrench macroeconomic management). - Public sector reform (improve budgetary planning and expenditure control; institutionalize tax improvements; reduce current expenditure rigidities). - Financial sector reform (address banking system weaknesses and supervision; improve financial intermediation). - Pro-growth agenda (improve judicial system, agriculture, public enterprises, labor markets, investment climate). - Effective social safety net (alleviate poverty; mitigate social costs of reform). ### Performance under the 2003–05 Program and Recent Developments Macroeconomic Performance - Economic activity: - 2004 growth: 4 percent. - 2005 growth: 3 percent (reduced by supply shocks including drought and higher oil prices). - Reports of continued drought in early 2006 could jeopardize growth objectives. - Inflation: - 2004: 2¾ percent. - 2005: 10 percent (outside the 4–8 percent objective range). - First four months of 2006: 4½ percent (raising the 12–month rate to 10½ percent). - Central Bank action: raised short-term interest rates on “letras de regulación monetaria” (LRM) by a total of 375 basis points (to 10½ percent) in February and April 2006. - Central Bank estimates: about half of 2005 inflation was due to the oil shock and imported inflation from the strengthening of the Brazilian real; about half of Q1 2006 inflation due to temporary increases in fruits and vegetables. - Monetary developments: - Base money growth (reported): 57.7 (2003), 17.7 (2004), 4.3 (2005), 3.2 (Jan-Mar 2006) — as presented in the Paraguay: Recent Developments table. - Money supply growth (reported): 24.9 (2003), 24.6 (2004), 16.1 (2005), 15.9 (Jan-Mar 2006). - Significant sterilization efforts; Central Bank increased LRM rates by 425 basis points (to 6¾ percent) during 2005 (noted as insufficient to offset large FX purchases in first half 2005). - Fiscal performance: - Treasury surplus in 2004 (first time in a decade). - 2005: reported Treasury surplus of over ½ percent of GDP, against a program objective of a deficit of the same magnitude. - Better-than-programmed performance driven by strong tax collections, low investment project implementation, and across-the-board expenditure cuts in last quarter 2005. - Early indications of further strengthening in tax collections in Q1 2006. - Congress approved a large and underfinanced budget for 2006; authorities aim to re-align it to achieve an overall balance of zero. - External sector: - Current account: small surplus in 2004 turned to a deficit of 2½ percent of GDP in 2005, mostly reflecting rapid growth in oil imports. - Exports slowed; traditional export items affected by drought and lower commodity prices; non-traditional exports (meat) grew faster. - Private capital inflows surged in 2005 (including an almost doubling of FDI), producing a balance of payments surplus and record NIR: US$1.3 billion in 2005. - Central Bank introduced a policy of limited foreign exchange intervention in mid-2005. Structural Reform - Achievements under the previous program included Congressional approval of: - The fiscal adjustment law: introduced the personal income tax, eliminated tax exemptions, simplified the tax system and broadened the tax base. - The customs code: granted operational and financial autonomy to customs and expanded powers of investigation and enforcement. - The banking resolution law: set up a deposit guarantee fund and provided the Superintendence of banks with increased ability to deal with banks in trouble. - The public pension fund law: parametric reform of the pay-as-you-go public pension system— increased contributions, reduced benefits, and increased years of service. - The second-tier public banking law: created the Financial Development Agency (AFD) to provide long-term financing by making available external funds from international financial institutions and donors to commercial banks. - Other measures: census on public servants; plan to reform the civil service career; introduction of prudential regulations for cooperatives; audits of public enterprises. - Outstanding legislative issues: the general banking law was not approved; the version of the first-tier public banking law considered by Congress is significantly different from that supported by the government (government intends to veto this law). Political Situation - President Duarte-Frutos won the Presidency of the Colorado party with 63 percent of the votes in February 2006. - Controversy over whether he could legally exercise the presidency of the party while being President of the Republic led to delegation of party responsibilities to Mr. José Alberto Alderete, who subsequently resigned as Minister of Public Works. - Duarte-Frutos’ victory could consolidate political power and help advance economic policies, though his brief decision to assume party presidency provoked negative reactions. ### The 2006–08 Program Rationale and Design - The program is designed to consolidate macroeconomic stability, address remaining vulnerabilities, and create conditions for higher growth. - Medium-term objective: lay foundations for a gradual but sustainable increase in economic growth to 4–5 percent a year, lower inflation to industrialized country levels, and reduce poverty significantly. - The staff regards the program as ambitious and comprehensive, with strong ownership by the authorities. Key macro policy commitments and targets - Fiscal policy: - Pursue a tight fiscal stance to reduce the debt burden over the medium term. - For 2006, achieve a zero-deficit in the public finances based on strict implementation of a financial plan containing expenditure cuts relative to the approved budget. - Monetary policy: - Follow a solid monetary policy to reduce inflation to low digits toward the end of the arrangement. - For 2006, the objective is to lower inflation to 7 percent. - Structural agenda (selected measures): - Improve expenditure control. - Modernize the tax code. - Restructure public enterprises. - Enhance regulations and legislation for the financial sector. - Strengthen the balance sheets of the central bank and the national development bank. - Improve Paraguay’s business climate. - Introduce a conditional cash transfer mechanism for poor families. - Social safety net: - Introduce an effective social safety net to alleviate widespread poverty and mitigate social costs of reform. - Context: about 1/3 of the population lives with less than US$2 a day, and about 1/6 of the population lives under conditions of extreme poverty. Selected numeric projections and framework (as presented) - Macroeconomic projections and historical estimates (annual percent change or percent of GDP as presented in the Paraguay: Macroeconomic Framework table): - Real GDP: 2002: 0.0; 2003: 3.8; 2004: 4.1; 2005: 3.2; 2006 (Est./Prog): 3.0; 2007 (Projection): 3.5; 2008 (Projection): 4.0-4.5. - Inflation (e.o.p.): 2002: 14.6; 2003: 9.3; 2004: 2.8; 2005: 9.9-10. ? (table shows "89.9" formatting anomaly in source); 2006: 2½-7½; 2007: 4.0; 2008: 3.0. [Preserve source presentation of numbers.] - Money supply (annual percent change): 2002: -2.2; 2003: 24.9; 2004: 24.6; 2005: 10.7; 2006: 16.1; 2007: 8.5; 2008: 6.5-6.0. - Domestic investment (percent of GDP): 2002: 18.7; 2003: 19.9; 2004: 20.8; 2005: 21.3; 2006: 23.2; 2007: 23.8; 2008: 24.7-25.2. - External current account (percent of GDP): 2002: 1.8; 2003: 2.4; 2004: 0.2; 2005: -0.4; 2006: -2.5; 2007: -2.2; 2008: -1.9-1.9. - Primary fiscal balance (Central Government, percent of GDP): 2002: -1.9; 2003: 1.0; 2004: 2.7; 2005: 0.7; 2006: 1.9; 2007: 1.0; 2008: 1.2-1.2. - Overall fiscal balance (Central Government, percent of GDP): 2002: -2.5; 2003: -0.3; 2004: 2.0; 2005: -0.5; 2006: 0.6; 2007: 0.0; 2008: 0.0-0.0. - Public sector debt (percent of GDP): 2002: 57.6; 2003: 55.0; 2004: 42.5; 2005: 39.4; 2006: 37.8; 2007: 33.1; 2008: 30.6-28.7. Program emphasis and implementation - The program couples macroeconomic discipline with an ambitious structural reform agenda to eliminate impediments to growth and alleviate poverty. - Staff supports the authorities’ request and views the program as comprehensive and ambitious with strong ownership. ### Program Risks and Related Analysis (high-level) - Program vulnerabilities and risks remain: exposed to exogenous shocks (drought, oil prices, exchange rate pass-through), political developments, and implementation risks for structural reforms. - Staff provides medium-term scenarios, capacity to repay the Fund, and debt sustainability analysis (DDA) as part of the program assessment (referenced in the source structure). *IMF staff report: Executive Summary of Paraguay program (2006–08) — _cr06302 - Executive Summary* ### 1. Unsustainable Macro Policies1. Maintain Coherent Macro Policies1. Macroeconomic Program ### _cr06302 - 1. Unsustainable Macro Policies1. Maintain Coherent Macro Policies1. Macroeconomic Program ### Technical assistance and program support - The technical assistance program has been strengthened and refocused to address reform areas identified in the program, with additional technical assistance requested from the Fund (on fiscal and financial issues), the World Bank and the Inter-American Development Bank (IDB) (on growth and poverty issues). - Efforts have been made to provide technical assistance prior to the adoption of key structural measures (Appendix IV). ### Macroeconomic Framework (program objectives and projections) - Medium-term objective: lay the foundation to double potential real GDP growth to 4-5 percent, reduce inflation and poverty, while maintaining macroeconomic stability. - 2006 expectations: real GDP to grow 3½ percent (gradually increasing to 4½ percent by 2008); inflation to fall to 7 percent (gradually declining to the low single digits by 2008). - Central Bank announced intention to keep inflation within the range of 2½–7½ percent; given first-quarter price pressures, inflation for 2006 likely at upper end of this range. ### Fiscal Policy — objectives, measures, and financing - Objective: reduce public debt to GDP ratio to 30 percent by end of the decade, supported by maintaining an overall balance of zero in the public finances. - Policy stance: maintain overall balance of zero over the medium term; realistic price policy for public enterprises and efficiency gains to generate moderate surpluses to offset Central Bank losses. - For 2006 the authorities plan to cut budget expenditures by about 1¾ percent of GDP through strict implementation of a financial plan. Expenditure measures include: - reducing allowances for senior public servants; - lowering over-time outlays; - eliminating hiring of temporary workers; - freezing positions in the first four months; - phasing salary increases during the year; - restricting the purchase of goods and services. - Capital expenditure: fiscal program envisages capital expenditure of about 4¼ percent of GDP (mostly to improve basic infrastructure). Staff does not expect additional public investment to exceed ½ percent of GDP in 2006; additional projects could relax fiscal targets in program reviews if financed adequately and not jeopardize macro stability. - Revenues and tax policy: - Over the past two years tax collections increased by over 1½ percent of GDP. - Tax revenue GDP ratio expected to fall temporarily in 2006 due to reduction in advances of the corporate income tax rate from 30 percent to 10 percent; tax revenue ratios expected to recover to almost 12 percent of GDP by end of program. - Non-tax revenues expected to pick up in 2006 from higher royalties from binational hydroelectric entities. - External and multilateral financing for 2006: - The World Bank expected to disburse US$15 million (first operation of the financial sector reform loan). - The IDB expected to disburse US$30 million in budgetary support. - These disbursements will be sufficient to reduce net external financing need of the Treasury to almost zero in 2006. - To cover scheduled amortizations of domestic bonds for G200 billion (almost ½ percent of GDP), the program allows the Treasury to use its deposits at the Central Bank. - Consolidated public sector target: zero deficit in 2006; given Central Bank projected losses of ¾ percent of GDP, the rest of the non-financial public sector is expected to continue generating surpluses similar to past levels. ### Fiscal aggregates (selected figures, in percent of GDP) - Total Revenues: 2004 18.4; 2005 18.3; 2006 Budget Prog. 18.2; 2006 Approved 18.5; 2007 Prog. 17.9; 2008 Estimates 18.4. - Tax: 2004 11.9; 2005 11.4; 2006 Budget Prog. 11.9; 2006 Approved 11.3; 2007 Prog. 11.3; 2008 Estimates 11.9. - Non-tax: 2004 6.5; 2005 6.8; 2006 Budget Prog. 6.4; 2006 Approved 7.2; 2007 Prog. 6.7; 2008 Estimates 6.5. - Total Expenditures: 2004 16.8; 2005 18.8; 2006 Budget Prog. 17.5; 2006 Approved 19.8; 2007 Prog. 19.8; 2008 Estimates 18.4. - Current Expenditure: 2004 12.9; 2005 13.7; 2006 Budget Prog. 13.5; 2006 Approved 14.3; 2007 Prog. 14.3; 2008 Estimates 13.3. - Capital: 2004 3.9; 2005 5.1; 2006 Budget Prog. 4.0; 2006 Approved 5.6; 2007 Prog. 5.6; 2008 Estimates 5.1. - Overall Balance: 2004 2.0; 2005 -0.5; 2006 Budget Prog. 0.6; 2006 Approved -1.4; 2007 Prog. -1.9; 2008 Estimates 0.0. ### Monetary Policy — stance, instruments, and central bank balance sheet - Objective: reduce inflation to low single digits over the medium term; currency issue suggested as monetary anchor for 2006; continue flexible exchange rate policy with intervention guided by the NIR target. - Staff recommendation: prepare to introduce inflation targeting (strengthen statistical infrastructure and develop transmission models). - 2006 monetary tightening: Central Bank plans to reduce growth of currency issue from 17½ percent in 2005 to 8½ percent in 2006 (significantly lower than nominal GDP growth). - Interest rates: Central Bank increased short-term interest rates by 375 basis points to 10½ percent in two stages (February and April 2006) and is ready to raise further if needed. - Monetary program details (percent of previous period currency): - Currency: 2004 12.7; 2005 10.0; 2006 Prog. 17.6; 2007 Prog. 8.5; 2008 Prog. 6.5. - Net international reserves: 2004 52.6; 2005 9.6; 2006 Prog. 32.6; 2007 Prog. 4.3; 2008 Prog. 6.5. - Net domestic assets: 2004 -39.8; 2005 0.4; 2006 Prog. -15.0; 2007 Prog. 4.2; 2008 Prog. 0.0. - Base money growth (%): 2004 17.6; 2005 8.2; 2006 Prog. 4.3; 2007 Prog. 6.0; 2008 Prog. 4.2. - Money supply growth (%): 2004 24.6; 2005 10.7; 2006 Prog. 16.1; 2007 Prog. 8.5; 2008 Prog. 6.5. - Central Bank losses and risks: - Central Bank profit (+)/losses (-): 2003 -1.1; 2004 -0.8; 2005 -0.2; 2006 Prog. -0.7 (in percent of GDP). - Revenues: 2003 0.2; 2004 0.3; 2005 0.5; 2006 Prog. 0.5. - Expenditures: 2003 1.3; 2004 1.1; 2005 0.7; 2006 Prog. 1.3. - Costs of monetary policy projected to rise to 0.7 in 2006. - The large Central Bank losses (projected ¾ percent of GDP in 2006) weaken monetary policy effectiveness; authorities committed to design a strategy to strengthen the bank’s financial position by end–2006 (structural benchmark). ### External Issues and balance of payments - Current account: following an oil-related deterioration in 2005, projected current account deficits of about 2 percent of GDP over the next few years. - Financing: deficits expected to be more than covered by private capital inflows (mostly FDI); authorities intend to keep net external borrowing to a minimum. - Net international reserves target: expected to grow to maintain an import coverage of about 3½ months. - No financing gaps envisaged; arrangement treated as precautionary given vulnerability to large shocks (regional economies, commodity prices, droughts). - Balance of Payments (selected figures, in percent of GDP): - Current Account: 2004 0.2; 2005 -0.4; 2006 Prog. -2.5; 2007 Prog. -2.2; 2008 Prog. -1.9. - Exports: 2004 39.6; 2005 39.1; 2006 Prog. 40.6; 2007 Prog. 39.4; 2008 Prog. 39.2. - Imports: 2004 -45.4; 2005 -45.4; 2006 Prog. -49.1; 2007 Prog. -46.6; 2008 Prog. -45.5. - Overall Balance: 2004 3.9; 2005 0.5; 2006 Prog. 1.6; 2007 Prog. 0.5; 2008 Prog. 0.4. - Disputed external claims and creditor relations: - Disputed claims at end-March 2006 amount to some US$270 million (3¾ percent of GDP), including claims by: Belgium’s Ex-Herstal (US$7½ million); a South African supplier (US$0.03 million); French and Swiss import verification companies (US$75 million); the National Bank of Argentina (US$75 million); and a syndicate of European and American banks following a Swiss court ruling (US$85 million). - The government regards the syndicate claim (US$85 million or 1¼ percent of GDP) as disputed and is not willing to recognize it; PETROPAR will clear suppliers’ credits with maturities over 90 days by end-December 2006. - Authorities encouraged to find early resolution to disputed claims; exploring appeal to the International Court of Justice for the syndicate ruling. ### Public Sector Reform — objectives, 2006 focus, and benchmarks - Reform objective: address institutional weaknesses to improve composition and efficiency of public expenditure and consolidate revenue collection gains. - Broad three-year agenda includes: - strengthen the budgetary framework as an effective financial management tool; - reinforce tax and customs administrations; - enhance expenditure control mechanisms at commitment level; - rationalize the civil service; - design comprehensive reform for public and private pensions and health insurance to secure financial sustainability. - 2006 priorities and structural benchmarks: - Tax Administration: preparation of a tax procedures code is a structural performance criterion for December 2006 to provide better legal and regulatory capacity to revenue collecting agencies (MEFP ¶19). - Expenditure Control: design of an action plan to strengthen budget preparation, develop expenditure controls at the commitment level, and streamline the treasury account system is a structural benchmark for June 2006. The plan is expected to: - define a broad-based path for public financial management (PFM) reform; - prepare a long-term macro-fiscal framework for setting expenditure limits and medium-term fiscal goals; - prepare a medium-term expenditure framework; - prepare a Treasury law significantly reducing the number of accounts and regulating treasury operations; - ensure recording of expenditure commitments for all transactions. - FAD and LEG are providing technical assistance in these areas. *Source: _cr06302 - 1. Unsustainable Macro Policies1. Maintain Coherent Macro Policies1. Macroeconomic Program* ### 25. This reform seeks to reduce financial vulnerabilities, foster financial ### This reform seeks to reduce financial vulnerabilities, foster financial intermediation, bring the regulatory framework closer to international standards, and bolster monetary policy by improving the operational capacity of the central bank. ### Financial sector reform — objectives and program focus - Program will focus over the next three years on: - strengthen the financial position of the central bank to ensure its solvency and integrity; - improve the framework for monetary operations by strengthening lender-of-last-resort facilities, enhancing the reserve requirement system, and strengthening the regulatory framework for repurchase agreements; - upgrade banking supervision by granting more autonomy and regulatory powers to the superintendence of banks and improving its human, material and technological resources; - strengthen prudential regulations to enhance governance, sharpen the identification of corporate risk and enhance sanctioning capacities; - restructure public banks (especially the National Development Bank, BNF) to eliminate systemic risks; - foster capital markets by developing the legal basis for a securities depositary and revamp electronic systems and procedures; - improve the payments system by establishing real-time gross settlement and an automatic clearing house. - The reform agenda draws heavily on the diagnosis of the FSAP exercise conducted in 2005. - MFD is providing technical assistance in these areas. ### Conditionality, benchmarks and measures (selected) - Structural and performance targets and timing (as presented in program table): - Action plan to develop commitment control system and rationalize Treasury accounts (Benchmark, Jun 2006). - Audited and inspected CAR (provisioned) of 5 percent for BNF at end-June 2006 (Benchmark, Sep 2006). - Implement regulatory measures outlined in banking strategy and put together legislation (Benchmark, Sep 2006). - Plan to improve business climate (Benchmark, Sep 2006). - Prepare a tax code in consultation with the Fund (PC, Dec 2006). - Strategy to strengthen the financial position of Central bank and timetable (Benchmark, Dec 2006). - Implement management contract for ANDE, COPACO, ESSAP, INC, and PETROPAR (Benchmark, Dec 2006). - Create cash transfer mechanism for 7,000 families living under extreme poverty (Benchmark, Dec 2006). - Audited and inspected CAR (provisioned) of 10 percent for BNF at end-December 2006 (PC, Mar 2007). - Send bill to Congress that reflects the implications of plan to strengthen BCP (Benchmark, Apr 2007). ### Public banks (BNF) - Objective: strengthen BNF’s financial position to meet international standards. - Recent developments: - Over the last two years, BNF has improved its financial situation markedly and is expected to continue improving by accumulating undistributed profits and engaging in a more aggressive asset recovery policy. - Specific targets and commitments: - Audited CAR of 5 percent for end-June 2006 is a structural benchmark for September 2006. - Audited CAR of 10 percent for December 2006 is a performance criterion for March 2007. - Any shortfall on these CAR targets will be met by the government (MEFP ¶21). - Authorities committed to maintain subsequently BNF capital sufficient to meet both CAR of 10 percent as well as any other prudential requirements of the central bank. - Continued restructuring of BNF in 2007–08 aiming at reducing operating cost, improving risk management, lending practices and internal controls; BNF will limit scope of credit operations and remain an anchor to the payment system given its large branch network. - Measurement and capital needs: - CAR will be measured under fully provisioning rules, similar to those included in the amended regulation 8 of the Central Bank, effective January 2007. - BNF’s CAR under this definition for end–2005 was about zero percent. - It is estimated that BNF needs an additional capital of about /G50 trillion (some US$8 million or 0.1 percent of GDP) to achieve the targeted CAR by end–2006. ### Central Bank strengthening - Rationale: the Central Bank’s growing losses could weaken resolve to implement tight monetary policy; financial strengthening is a priority. - Required actions and timing: - Preparation of a joint strategy by the Ministry of Finance and the Central Bank for the financial strengthening of the Central Bank (structural benchmark for December 2006). - Submission of a law to Congress adopting all legal and budgetary elements necessary to implement the strategy (structural benchmark for April 2007). - Timing constraints: budgetary law requires draft budget submission by end-August 2006 (before strategy is ready); earliest date to submit to Congress the budget implications of the strategy is April 2007 (first date government can introduce a supplementary appropriations budget) (MEFP ¶23). ### Commercial banks and regulatory framework - Objective: strengthen the banking system and prevent further financial instability. - Actions: - Implement the financial sector action plan to achieve broad objectives of the general banking bill currently in Congress (structural benchmark for September 2006). - Plan envisages strengthening monetary operations, redefining minimum capital requirements, setting fit and proper tests for banking licenses, sharpening identification of corporate risk, enhancing sanction capabilities. - Central Bank Board can adopt some actions; others require amendments to current banking law. Authorities expect to submit any required legislation to Congress by September 2006 (MEFP ¶22). - Background: - General banking bill was submitted to Congress in December 2004 and not yet considered. - Central Bank prepared an action plan in November 2005 to achieve most of the banking bill objectives (design of such plan was a structural benchmark under previous SBA). ### Pro-Growth Agenda (selected measures) - Pillar objectives over three years: - Restructure public enterprises to increase coverage and efficiency and raise investment; - Improve investment climate to boost investment and productivity; - Reform hydrocarbon sector to modernize and regulate for more efficient delivery; - Strengthen agricultural sector performance and small farmers’ access to markets; - Enhance civil court efficiency by increasing judicial security and reducing time to rulings; - Introduce labor market flexibility to reduce cost of formal employment and avoid firings before thresholds that increase benefits. - 2006 focus: - Enhance efficiency in public enterprises and improve investment climate. - Public enterprises: - Enter into result-oriented management contracts with ANDE, COPACO, ESSAP, INC and PETROPAR (structural benchmark for December 2006) (MEFP ¶24). - Investment climate: - Design of an action plan to improve the investment climate (structural benchmark for September 2006). - Plan expected to include simplifying company registration and licensing, one-stop shops for exporters and foreign investors, improving dispute resolution and enforcement of judicial decisions, strengthening public institutions certifying product quality (MEFP ¶25). ### Social safety net (selected measures) - Pillar objectives: - Strengthen social assistance programs to advance some Millennium Development Goals; - Reorient and improve efficiency of social expenditure, especially to reach rural poor via education and health; - Improve income inequality through an explicit transfer system. - 2006 focus and measures: - Increase social spending in 2006 while remaining within overall expenditure limits by lowering expenditure elsewhere. - Create a centralized system of targeted cash transfers to benefit 7,000 families living in extreme poverty conditioned by contracts with beneficiaries (structural benchmark for December 2006). Conditions include children’s school attendance and visits to health centers; plan to broaden coverage in 2007–08 (MEFP ¶27). - Improve efficiency of fuel subsidy program; legislation sent to Congress to provide limited subsidies to public transportation to protect users from recent increases in international oil prices and facilitate gradual elimination of indiscriminate diesel subsidies. ### Program risks — vulnerabilities - Country vulnerabilities to exogenous shocks and domestic setbacks emphasized. - External risks: - Sharp and prolonged rise in oil prices; - Large drop in external demand; - Macroeconomic imbalances from much larger neighboring countries; significant regional risks due to uncoordinated policies in bigger neighbors. - Domestic risks: - Financial dollarization carries liquidity and solvency risks for the banking system. - Delays in implementing structural reforms would lead to lower growth, threaten fiscal sustainability and undermine de-dollarization. - Municipal elections scheduled for November 2006 increase risk of politicization and potential challenges to macroeconomic policies and structural reform agenda. - Delays in approval of key legislation by Congress remain potential risk. - Deterioration of political and social climate could complicate economic management. ### Medium-term scenario and alternative (numeric projections) - Baseline (lasting commitment to macroeconomic stability and broad-based reforms): - Assumes continuation of measures to consolidate macroeconomic stability, lock in improvements in tax collection and administration, mobilize resources to reduce poverty, and improve environment for private investment. - Assumes favorable external demand conditions, particularly from MERCOSUR partners. - Projections: - real GDP growth projected to rise to 5 percent by 2010; - price and financial stability will be maintained; - public debt-to-GDP ratio will decline to below 30 percent by the end of the decade. - Passive scenario (no reform): - Assumes prudent macroeconomic policies but no additional structural reforms. - Projections: - growth projections around 2 percent; - higher inflation; - external current account in surplus as investment depressed; - weaker fiscal policy would drive debt-to-GDP ratio to over 30 percent by the end of the decade. ### Capacity to repay the Fund - Staff view: Paraguay’s capacity to repay the Fund is quite strong. - Even if proposed access under precautionary arrangement is fully used, capacity to repay remains strong. - Current Fund credit outstanding is zero. - Success of previous arrangement improved payment capacity significantly. - Staff believes risk of nonpayment to the Fund—in the event a purchase is made—is negligible; program does not pose serious risks to the Fund. ### Debt sustainability analysis (DSA) — key findings and numeric details - Historical context: - Public debt-to-GDP rose from less than 20 percent in 1997 to over 70 percent in 2002. - One main achievement of previous SBA was placing public debt on sustainable path. - At end–2005, debt-to-GDP fell to below 40 percent. - Projections and resilience: - With prospect of higher growth (4½ percent) and low real interest rates (3 percent), expected primary surplus (1¾ percent of GDP) would be more than enough to ensure a declining debt-to-GDP ratio. - Public debt projections appear sustainable and relatively resilient to temporary negative shocks but economy particularly vulnerable to an exchange rate shock. - Table excerpt: "Paraguay: Sustainable Primary Fiscal Balance 1/ (As a percent of GDP)" (tabulation preserved in source) showing combinations of GDP Growth Rate (%) and Real Interest Rate (%) with entries such as: - For GDP Growth Rate 2.0 and Real Interest Rate 2.0: 0.0 - For GDP Growth Rate 4.5 and Real Interest Rate 3.0: -1.0 (table entries preserved verbatim in source). - (Table notes: 1/ To maintain constant a debt to GDP ratio of 40 percent. (3 percent).) - External debt: - Bulk of external debt (about 95 percent) is public debt. - External debt-to-GDP ratio expected to decline from about 40 percent in 2005 to below 30 percent by the end of the decade. - Outlook resilient to less favorable macroeconomic assumptions but vulnerable to prolonged deterioration of the current account balance. ### Program modalities — length, access and phasing (numeric details) - Length: - Arrangement covering 27–months (May 2006–August 2008) to align with remaining Presidential term. - Access and phasing: - Proposed access of SDR 65 million or 65 percent of quota (29 percent on an annual basis). - Comparison: previous arrangement access was 50 percent of quota (40 percent on an annual basis). - Since current Fund credit outstanding is zero, the first purchase would be the first credit tranche (25 percent of quota). - Following five purchases would be for 6 percent of quota until reaching 50 percent of quota within 15 months from approval. - Subsequently, remaining four purchases would be for 2½ percent of quota. *Source: Paraguayan authorities and Fund staff; MEFP excerpts and program documentation from the cited IMF program chapter.* ### 39. Reviews. The authorities requested quarterly reviews in the first year of the program, ### _cr06302 - 39. Reviews. The authorities requested quarterly reviews in the first year of the program, ### Reviews and Program Frequency - The authorities requested quarterly reviews in the first year of the program, switching to semi-annual reviews subsequently (while retaining quarterly quantitative performance criteria and quarterly scheduled purchases). ### Conditionality - The structure of quantitative performance criteria under the previous SBA was considered adequate and an analogous structure is proposed for this arrangement. - This report includes conditionality mostly for 2006. - Conditionality for 2007/08 will be proposed to the Board at the time of the second review under the arrangement (scheduled for December 2006). - There are 8 quantitative performance criteria: (i) overall balance of the central administration; (ii) wage bill of the central administration; (iii) overall balance of the public sector; (iv) net international reserves; (v) net domestic assets; (vi) contracting or guaranteeing of nonconcessional external debt of the public sector; (vii) contracted or guaranteed short-term external debt of the NFPS; (viii) non-accumulation of external debt arrears. ### Monitoring and Program Oversight - The Program Monitoring Group was created and successfully used in the previous program. - A similar group, meeting periodically, will continue to monitor the program. - The program-monitoring group consists of senior officials from the Ministry of Finance and the Central Bank, as well as the IMF resident representative and the IMF mission. ### Safeguards Assessment - Under the Fund's safeguards policy the Central Bank is subject to a safeguards assessment. - An assessment was completed in January 2003 under the previous arrangement. - A FIN mission visited Asuncion in March and the ongoing assessment will be finalized before the first review of the program in September 2006. ### Staff Appraisal — Performance under Previous SBA - Performance under the previous program supported by an SBA was broadly satisfactory, although the revival of inflation was disappointing. - Fiscal consolidation efforts were successful and the Treasury registered a surplus in 2004 and 2005. - The situation in the banking system improved with restored confidence, better profitability and much lower non-performing loan indices. - Five major pieces of economic legislation were approved: fiscal adjustment law, customs code, banking resolution law, public pension fund law, and second-tier public banking law. - The economy grew 11½ percent in the period 2003–05 under the previous SBA, compared with 10½ percent growth in the period 1993–2002. ### Staff Appraisal — New Program Assessment and Risks - The authorities’ new program is comprehensive and calibrated to the challenges still facing Paraguay, combining prudent macroeconomic policies and an ambitious structural reform agenda. - The program is ambitious and has more than a reasonable chance of success due to the high degree of ownership and commitment. - Technical assistance from the Fund and experts from other international financial institutions will be needed for some reforms. - The staff reached understanding on the program with broad sectors within the government. - The staff welcomes the authorities’ decision to implement a strict financial plan to achieve the program objective of a zero fiscal deficit in 2006. - The approved budget—adjusted for realistic revenues—entails a deficit of almost 2 percent of GDP, against a target of a balanced budget in the program. - The financial plan will apply to wage items for the first time. - The program allows for some flexibility on additional capital expenditure but has no margin for extra current expenditures. - Monetary program specifics and concerns: - The authorities adopted a very tight monetary program, with the growth in currency issue expected to decelerate sharply to 8½ percent in 2006, a much lower rate than nominal GDP growth. - To achieve this objective, the central bank has raised its short-term interest rates by nearly 400 basis points in recent months. - Further actions may be needed to bring inflation down to the target rate. - The authorities are encouraged to implement rapidly their strategy for strengthening the financial position of the Central Bank. - Structural reform agenda: - The agenda is quite ambitious and implementation will require a high degree of coordination among different policy makers. - Efforts were made to rely less on reforms that require congressional approval, though some laws remain unavoidable. - Frequent meetings of the program monitoring group will help identify problems early and design corrective measures. - Risks: - Vulnerabilities arise from financial, political, and social uncertainties. - Municipal elections are scheduled for November 2006 and pressures to stop reforms and increase expenditures could arise. - The staff welcomes the introduction of legislation to establish a subsidy on public transportation to protect vulnerable groups and facilitate a diesel pricing policy that would eliminate indiscriminate subsidies. - Success depends on authorities’ determination to implement reforms and their ability to communicate policies and persuade stakeholders. ### Growth, Productivity, and Inflation Highlights - Paraguay’s real per capita income fell by 8½ percent over the last 25 years. - Population growth is projected at about 2 percent a year. - A growth accounting exercise found that TFP (the Solow residual) declined, on average, by 1¼ percent annually during 1980-2004. - Comparative growth accounting figures presented: - Paraguay: Economic Growth 2.4; Contributions from Labor 1.5; Capital 2.1; Productivity (TFP) -1.2. - Paraguay with Productivity of Chile: Economic Growth 5.2; Contributions from Labor 0.9; Capital 2.0; Productivity (TFP) 2.2. - Chile: Economic Growth 5.8; Contributions from Labor 1.5; Capital 2.1; Productivity (TFP) 2.2. - Inflation dynamics (annualized inflation by phase): - Nov 2003 - Nov 2004 (Annualized inflation = 2.1%) - Nov 2004 - May 2005 (Annualized inflation = 14.5%) - May 2005 - Feb 2006 (Annualized inflation = 9.4%) ### Recommendation - The staff supports the authorities’ request for a new SBA, judging the program appropriate to address Paraguay’s challenges and noting that achieving objectives will require sustained efforts and full support of the international community. *Source: IFS; IMF staff estimates.* ### 2005. A combination of improved macroeconomic management and a benign external environment ### _cr06302 - 2005. A combination of improved macroeconomic management and a benign external environment ### Inflation developments (2004–2006) - 2004: Paraguay recorded the lowest inflation rate in over 30 years during 2004; overall inflation was very low (about 2 percent) in 2004 (phase I), and was primarily driven by oil prices. - 2005 phases: - Phase II (first half of 2005): external pressures intensified and brought inflation up to an annualized rate of 14½ percent. - Phase III (since the second half of 2005): external factors subsided and inflation appears to be driven increasingly by domestic factors, including non-core inflation. - Core inflation (which excludes fruits and vegetables) displayed continued inflationary pressures during 2005, while headline CPI movements were partly masked by the erratic behavior of fruits and vegetables prices. - External drivers noted: - Agriculture was hit by a drought in 2005. - International oil prices continued to rise in 2005. - Brazil’s real appreciated by 30 percent against the U.S. dollar since May 2004, exacerbating the real depreciation of the guaraní. ### Monetary conditions and policy response - During the first half of 2005: - Monetary policy was eased as the Central Bank (BCP) was overwhelmed with inflows of foreign exchange and was unable to fully sterilize the monetary impact of international reserves accumulation. - Annual currency growth accelerated to 17½ percent at end-December 2005 while money demand growth began to ease up. - BCP tightening (early 2006): - During the first four months of 2006, the BCP’s Executive Committee for Monetary Operations (CEOMA) increased its key interest rates for Central Bank securities (LRM) by some 400 basis points to 10½ percent (35 days maturity). - Currency growth fell to about 15 percent by end-March 2006. - The authorities are committed to tighten further to maintain a firm control on monetary aggregates. - Central bank balances and reserves: - Net international reserves (gross reserves) reached 1,297 (in millions of U.S. dollars) for 2005. ### Financial sector assessment and reform priorities (Box 3) - System recovery and remaining vulnerabilities: - The financial system was recovering after several years of crises following rapid financial liberalization in the early 1990s and the 2002/03 run on deposits and currency attack. - Macroeconomic policy contained inflation and restored growth, preventing further instability, but progress in resolving structural weaknesses has been piecemeal. - Key recommendations to strengthen oversight and soundness: - Upgrade the banking legal framework and prudential regulations to spur oversight. - Strengthen governance and risk-oriented supervision. - Improve supervisory capacities and accountability, including legal protection to central bank (BCP) and superintendency of banks (SB) employees. - Grant more autonomy and sanctioning/regulatory powers to the SB and upgrade the resources of the SB. - Restructure the National Development Bank (BNF) to minimize fiscal costs, eradicate moral hazard and assure good future performance. - Credit cooperatives: - Credit cooperatives have grown fast and are gaining systemic relevance: they account for 10 percent of total deposits and 16 percent of total credits of the financial system. - The framework for supervision of credit cooperatives needs completion and implementation, including new prudential regulations and coordination arrangements with the SB. - Improved quality and quantity of information provided by cooperatives should be a priority to ensure adequate measurement and control of monetary aggregates. - Other financial sector reform priorities: - Strengthen creditor rights and streamline insolvency procedures to promote credit supply. - Designate an authority to regulate pension funds and define clear risk management guidelines for the Instituto de Previsión Social (IPS); IPS should be allowed to invest in government securities and be repaid long overdue government obligations that constrain its capital base. - Develop a debt management strategy consistent with Paraguay’s budget cycle to gain credibility and reduce implicit and explicit costs of public debt; develop a secondary market to catalyze the local capital market and facilitate use of government securities for monetary operations. - Overhaul the payments system: priority areas include settlement finality protection, legal bases for dematerialization/immobilization of securities, custody and netting arrangements, electronic documents and signatures, and legal definition of repo operations; consider approval of a comprehensive payments system law. ### Fiscal and debt stance — selected indicators and scenarios - Recent fiscal and inflation indicators: - Consumer prices (end-of-period) for 2004: 2.8; for 2005: 9.9 (Table 1 headline figures as presented). - Public finances and projections (program scenario, Table 11 highlights): - Real GDP growth projections: 2006: 3.5; 2007: 4.0; 2008: 4.5; 2009–2011: 4.5–5.0 (annual percent change). - Consumer prices (annual percentage change) in the program scenario: 2006: 7.0; 2007: 4.0; 2008: 3.0; 2009–2011: 3.0. - Revenues (percent of GDP): steady at about 21.8–22.2 in the program scenario. - Primary balance (percent of GDP): projections decline from 2.7 (2005) to 1.3 (2011) in the program scenario. - Overall consolidated public sector balance (percent of GDP): projected at about 0.0 from 2006 onward in the program scenario. - Public sector debt (percent of GDP) in the program scenario: 2006: 33.1; 2007: 30.6; 2008: 28.7; 2009: 27.9; 2010: 27.2; 2011: 26.4. - Debt sustainability and stress testing (selected results): - Baseline public sector debt-to-GDP falls from 37.0 percent (2005) to 26.4 percent (2011) under the baseline scenario (Table 13). - External debt (percent of GDP) baseline projections: 2005: 41.2; 2006: 37.3; 2007: 35.6; 2008: 34.4; 2009: 33.6; 2010: 33.0; 2011: 32.4 (Table 14). - Stress tests include scenarios such as historical-average key variables, higher interest rates, lower growth, weaker non-interest current account, combinations of shocks, and a one-time 30 percent real depreciation in 2006; these tests show varying increases in debt ratios under adverse conditions. ### External sector and financing - Current account and reserves: - Current account (in percent of GDP): 2005: -2.5; projected -2.2 (2006) under program tables; program scenario current account in millions of U.S. dollars: -190 (2005), -180 (2006). - Gross international reserves: 2005: 1,297 (in millions of U.S. dollars); reserves in months of imports around 3.6 (2005). - External financing structure (Table 12 highlights): - Total external financing requirements and sources are projected and include net FDI, disbursements of medium- and long-term debt, borrowing by domestic private and public sectors, and changes in reserves. - Net FDI inflows shown in historical and projection tables (e.g., net FDI 2005: 122; 2006: 48 in Table 12 context). ### Key macroeconomic risks and recommended policy priorities - Risks identified: - Re-emergence and persistence of inflationary pressures driven increasingly by domestic factors. - Vulnerabilities in the financial sector stemming from incomplete supervisory frameworks (notably for credit cooperatives) and weaknesses in insolvency and creditor-rights frameworks. - External shocks: commodity price volatility, exchange rate pressures (notably strong appreciation of the Brazilian real), and potential sudden stops in capital inflows. - Recommended policy priorities: - Continue monetary tightening and strengthen sterilization capacity to control currency and broad monetary growth. - Implement comprehensive financial sector reforms: upgrade legal and prudential frameworks, strengthen the SB, restructure BNF, complete supervision framework for credit cooperatives, and improve insolvency and pension regulation frameworks. - Pursue a debt management strategy aligned with the budget cycle to lengthen maturities and develop a secondary market for government securities. - Prioritize payments system reform, including legal protections for settlement finality and definitions for repo operations. *Source: _cr06302 - 2005. A combination of improved macroeconomic management and a benign external environment (IMF staff report content as provided).* ### 1. As of January 2006, the active loan portfolio amounts to US$530.4 million, with an ### _cr06302 - 1. As of January 2006, the active loan portfolio amounts to US$530.4 million, with an ### Active portfolio and technical cooperation - Active loan portfolio: US$530.4 million (as of January 2006). - Undisbursed loan balance: US$272.2 million. - Active Technical Cooperation operations: 45 operations for US$18.8 million. - Undisbursed Technical Cooperation balance: US$9.9 million. ### IDB new strategy for Paraguay (2004–2008) — priority areas - Strengthening governance - Restore credibility of State institutions. - Enable State coordination of economic development by heightening efficiency and transparency of public administration, promoting greater citizen participation, and consolidating democratic institutions. - Laying foundations for sustainable growth - Consolidate the market economy and deepen regional and global integration. - Create conditions for increased private-sector participation, greater competitiveness, and deeper integration. - Reducing poverty and improving quality of life - Develop human capital and provide greater access to quality basic services for low-income sectors. ### Lending pipeline (2006-A) - Strengthening of the Judiciary System II, US$10.8 million - Electric Power Transmission and Distribution Program, US$80 million - Integration Corridor and Road Rehabilitation Program, Phase I, US$100 million - Institutional Strengthening of the National Institute of Cooperatives (INCOOP), US$5 million - Asunción Coastal Development Program, US$80 million - Depositary, Compensation and Liquidation Program, US$2 million - Modernization of the Agriculture Public Sector Management, US$20 million - Technical Education and “Escuela Viva” Program, US$45 million ### Lending pipeline (2006-B) - Support to Paraguayan Exports Program, US$10 million - Global Credit Line to Small, Medium and Micro enterprises, US$25 million ### Paraguay — Fund technical assistance (TA) program objectives and focus - TA strategy concentrates on supporting reforms in the main policy pillars of the SBA program: - (i) public sector reform; - (ii) financial sector reform; - (iii) a pro-growth reform agenda; - (iv) a social safety net. - STA support for statistics to help Paraguay meet international statistical standards. - TA planned to support authorities’ efforts preceding adoption of key structural measures. ### TA substantive priorities and planned actions (highlights) - Public sector reform - Strengthen tax administration: Prepare a tax code in consultation with the Fund (performance criterion for end-December 2006). LEG and FAD mission, mid-May 2006. - Public financial management: Design action plan for effective commitment control system and rationalize Treasury account system (structural benchmark for end-June 2006). FAD mission, March 20-31, 2006 and follow up. - Strengthen customs administration: Coordinate execution of action plan for customs reform (ongoing). FAD customs advisor: three visits scheduled in 2006: (i) March 16-May 5; (ii) July 10-August 25; (iii) October 16-December 16. - Financial sector reform - Strengthen financial position of the central bank: Assess financial situation and develop recapitalization options; complete plan and submit necessary legislation (structural benchmark end-December 2006). MFD mission, March 7-16, 2006 and follow up. - Strengthen legislation and regulations of the banking system: Implement regulatory measures and draft legislation (structural benchmark for end-September 2006). MFD expert visits (monthly) through June 2006. - Strengthen and restructure the National Development Bank (BNF): Audited and inspected CAR for BNF of 5 percent in-June 2006 and 10 percent in December 2006 (structural benchmark for end-September-06 and performance criterion for end-March-07). MFD mission requested. - Pro-growth reforms - Improve business climate: Design a plan to improve business climate (structural benchmark for end-September 2006). WB experts’ mission, mid-2006. - Restructuring public enterprises: Design implementation of result-oriented management contracts with ANDE, COPACO, ESSAP, INC, and PETROPAR (structural benchmark for end-December 2006). WB and IDB to provide expert advice. - Social safety net - Create a conditional cash transfer mechanism for 7000 families living under extreme poverty based on contract with beneficiaries (structural benchmark for end-September 2006). TA requested to IDB. - Statistics - CPI/PPI: STA technical assistance to improve methodologies (STA mission, April 2006). - Monetary and financial statistics: Expand coverage to include deposit-taking cooperatives (STA mission, RAP 2007). - Follow-up to 2006 data ROSC mission: STA TA to be requested to evaluate implementation of recommendations including improving methodological quality of national accounts and government finance statistics, enhancing intersectoral data consistency, strengthening data sources, and adopting an advance release calendar. ### Scheduling and benchmarks (selected dates and targets) - Tax code preparation: LEG and FAD mission, mid-May 2006 (performance criterion end-December 2006). - Commitment control system design: FAD mission, March 20-31, 2006 (structural benchmark end-June 2006). - Customs advisor visits: March 16-May 5; July 10-August 25; October 16-December 16, 2006. - Central Bank strengthening: MFD mission March 7-16, 2006 (structural benchmark end-December 2006). - Banking legislation: Draft legislation target end-September 2006. MFD expert visits monthly through June 2006. - BNF CAR targets: 5 percent in-June 2006 and 10 percent in December 2006 (structural benchmark end-September-06; performance criterion end-March-07). - Conditional cash transfer mechanism: structural benchmark for end-September 2006 (7000 families). ### Work program and mission timetable (selected items) - Stand-By Arrangement mission: Feb 23-Mar 8, 2006; Board Meeting May 31, 2006. - First SBA Review mission: Jul 26-Aug 9, 2006; Board Meeting September 22, 2006. - Second SBA Review and the 2006 Article IV Consultation mission: Oct 25-Nov 8, 2006; Board Meeting December 15, 2006. - Third SBA Review mission: Jan 24-Feb 7, 2007; Board Meeting March 9, 2007. - Memorandum items: Approval of SBA December 15, 2003; subsequent reviews and mission dates listed through November 30, 2005 and FSAP missions April 18–29, 2005 and July 5-15, 2005. Board Meeting May 31, 2006. ### Program request and government commitment (from letter dated May 8, 2006) - Government requests a 27-month Stand-By Arrangement (SBA) through August 2008. - Requested amount: SDR 65 million (65 percent of quota). - Intention to treat the arrangement as precautionary. - Program aims: entrench macroeconomic stability and pursue an ambitious structural reform agenda to increase sustainable growth with equity. - Review schedule: quarterly quantitative performance criteria with quarterly reviews during the first year, switching to semi-annual reviews later; six reviews to be completed by mid-September 2006, mid-December 2006, mid-March 2007, mid-June 2007, mid-December 2007, and mid-June 2008. ### Statistical issues — major findings and deficiencies (ROSC 2006 and as of April 30, 2006) - Real sector - New national accounts series released in 2005 (base year 1994) broadly consistent with 1993 SNA but weaknesses remain: 1994 reference year becoming obsolete; excessive use of fixed coefficients; changes in inventories obtained residually; informal activities not monitored; supply and use tables compiled only until 1997. - Periodicity of annual GDP meets GDDS recommendations, but timeliness does not — data are disseminated with 11-months lag. - CPI geographic coverage limited to Asunción; CPI base weight period 1992; PPI base period December 1995; PPI basket (150 items) not fully representative and excludes electricity, water, gas, and services. - Household budget survey 2005-2006 underway to update CPI basket and weights. - Resources are insufficient for real sector statistics development, constraining full adoption of 1993 SNA. - Fiscal sector - GFS broadly consistent with GFSM 1986; no plan yet to migrate to GFSM 2001. - Monthly data available for central administration only; local government operations not included. - Deficiencies: consolidated central government and general government statistics not prepared; central administration statistics include Postal Service Directorate (a nonfinancial public corporation); nonfinancial public sector definition includes financial public corporations; discrepancy between monetary and fiscal authority fiscal data. - Annual data covering only budgetary central government through 2004 reported for GFS Yearbook; since 1994 no outstanding debt data and no breakdowns for expenditure by function reported for GFS Yearbook. Monthly and quarterly data not reported for IFS — resumption recommended. - Money and banking - Money and banking statistics broadly reliable after 1995 accounting plan for commercial banks and unified compilation/reporting system. - Lack of coverage of credit unions remains a concern as they account for around 25 percent of deposits and loans of the banking sector. - Plan for technical assistance in fiscal year 2007 to include credit unions in other depository corporations’ survey. - Superintendency of banks publishes detailed report on financial system soundness. - External sector - Quarterly and annual balance of payments and IIP data available from 2001 onwards and reported to STA; annual IIP compiled for 1995–2004. - Classification follows BPM5; improvements in capital flow data coverage and FDI recording. - Deficiencies in capturing private capital outflows due to open capital account. - Major ROSC recommendations: design sample surveys to capture excluded items (some services, direct and portfolio investment abroad, real estate); review techniques for estimating unrecorded trade; prepare periodic reports on survey quality; initiate quarterly reconciliation of flows and stocks of medium- and long-term external public debt with MOF. *Source: IMF staff report content as provided.* ### 1. Paraguay was experiencing one of the most severe economic crises at the time ### _cr06302 - 1. Paraguay was experiencing one of the most severe economic crises at the time ### Crisis context and initial stabilization (2003–05) - President Duarte-Frutos took office in the second half of 2003 amid: - rapidly accumulating arrears to creditors and suppliers, - bank failures, shrinking credit, rising non-performing assets, and low market confidence, - serious risks of a deeper financial and fiscal crisis. - IMF-supported program and policy response: - A 15-month precautionary Stand-By Arrangement (SBA) for SDR 50 million approved by the IMF Board in mid-December 2003. - Authorities adopted a tight 2004 budget, appropriate monetary policy, and a strong structural reform agenda. - Key legislation approved by Congress: banking resolution law, deposit guarantee law, fiscal adjustment law, customs code, and second-tier public banking law. - Macroeconomic outcomes: - 2004: economy grew by 4 percent, the highest in a decade; inflation fell below 3 percent, the lowest in a decade. - 2005: strong performance continued despite supply shocks. ### Recent developments (2005) - Sectoral growth disparities: - Livestock, forestry and mining expanded at healthy rates; agriculture depressed due to drought; manufactures and construction grew modestly. - Estimate: the economy grew about 3 percent last year. - Inflationary pressures and drivers: - Inflationary pressures emerged in December 2004 from a temporary liquidity overhang. - Since early 2005, appreciation of the Brazilian real increased the price of Brazilian imports in guaranies and raised domestic demand for local goods, putting upward pressure on domestic prices. - Meat producers' access to foreign markets (Chile, Israel and Russia) also pushed domestic meat prices up. - Sharp increases in international oil prices prompted domestic hydrocarbon price adjustments; diesel experienced less than full pass-through. - Result: inflation rebounded to almost 10 percent in 2005. - Estimate: about one-half of the 2005 inflation is due to exogenous factors. - Fiscal position and actions: - Despite a reduction in the rate of advances on corporate income tax from 30 to 10 percent in August 2005, authorities managed a small surplus in 2005. - A decree in November 2005 limited public expenditures to those in the approved financial plan for the last two months of the year to prevent reprogramming. - Reserves and credit policy: - Short-term interest rates on “letras de regulación monetaria” increased by about 400 basis points during 2005, contracting central bank credit and allowing reserve accumulation. - Central Bank purchased foreign exchange in the first half of the year and maintained a more neutral position in the second half. - External account pressures from higher oil prices and drought were offset by private flows. ### Medium-term macro framework and objectives (2006–08) - Main objective: reinvigorate growth and reduce poverty while entrenching macroeconomic stability. - Growth targets: - Raise growth from historical average of 2 percent to 4-5 percent over the medium-term. - Inflation objective: - Bring inflation down over the next few years to levels of industrialized countries through prudent fiscal policies and strengthened monetary framework. - Fiscal strategy: - Maintain broad fiscal balance over the medium-term to manage the debt burden and create incentives for private investment. - Structural reform agenda addresses four main areas: - Public sector reform: strengthen budgetary framework; institutional framework for tax and customs administration; expenditure control; rationalize civil service; comprehensive reform for public and private pensions and health insurance. - Financial sector reform: strengthen Central Bank financial position and operations; upgrade banking supervision; strengthen prudential regulations and public banks; foster capital markets; improve payment system. - Pro-growth agenda: improve public enterprise performance; investment climate; agricultural productivity; civil court efficiency; labor market functioning. - Social safety net: strengthen social assistance to reach Millennium Development Goals ahead of time; adopt poverty reduction strategy; better target diesel subsidies by realigning domestic to international prices facilitated by a public-transportation subsidy; introduce a conditional cash transfer system for the most vulnerable. ### Macroeconomic policies for 2006 - Program objectives: - Consolidate stabilization gains. - Growth objective of 3½ percent for 2006. - Significant reduction in the inflation rate; Central Bank announced inflation objective range of 2½ to 7½ percent for 2006. - Note: unexpected price pressures in January and February suggest inflation in 2006 will be at the higher end of the announced range. - Fiscal policy (Treasury and consolidated public sector): - Approved 2006 Treasury budget envisages a fiscal deficit of almost 2 percent of GDP, which is not consistent with inflation and debt objectives. - Ministry of Finance will adopt a strict financial plan under the financial administration law to make the budget executable. - Tax-to-GDP ratio expected to fall temporarily in 2006 after reductions in corporate income tax rate; personal income tax introduction will be gradual over next few years. - Financial plan will limit current expenditures while allowing public investment to rise. - Public investment: increase from about 4 percent of GDP in 2005 to over 4¼ percent of GDP in 2006. - Program permits higher public investment and poverty-alleviation spending if appropriately safeguarded and financed; allowance to tolerate a moderate fiscal deficit for growth-enhancing additional investment, subject to program review. - Additional efforts required to reach consolidated public sector fiscal balance in 2006, given likely rising Central Bank losses. - Measures to ease budgetary financing constraints: explore reorganizing the bond market to maintain sustainable debt and prevent negative net domestic and external financing. - Monetary policy: - Main monetary objective for 2006: reduce inflation significantly to within the 2½–7½ percent range. - Actions taken: interest rates on “letras de regulación monetaria” raised by 250 basis points in the last quarter of 2005 and by some 400 basis points in the first four months of 2006; further tightening possible if necessary. - For 2006, Central Bank will accommodate an expected 8½ percent increase in the demand for currency, consistent with inflation and growth objectives. - Expectation to accumulate about US$20 million in international reserves in 2006. - International reserves reached almost US$1.3 billion at end-2005, an all time high. - To facilitate reserve accumulation, Central Bank will limit expansion of net domestic assets (NDA); government use of deposits will be sterilized with placements of “letras de regulación monetaria” to maintain the NDA target. ### Structural reforms for 2006 — priorities and benchmarks - Overarching aim: modernize institutions and remove impediments to growth; work with National Congress for required legislation. - Public sector reform (selected actions and benchmarks): - Prepare a new tax code to modernize and standardize tax practices and rationalize tax exemptions; draft code to be approved by the economic cabinet by end-December 2006 (structural performance criterion). - Strengthen budgetary framework and public financial management: - Action plan to strengthen public financial management, including a more effective expenditure control system at the commitment level for the Central Administration and rationalization of the Treasury account system by end-June 2006 (structural benchmark). - Long-term objective of a Treasury single account. - Requested IMF technical assistance for tax code and public financial management reforms. - Financial sector reform (selected actions and benchmarks): - Strengthen and restructure the National Development Bank (BNF): - Continuation of efforts totalling about G 50 billion in 2006 to improve BNF balance sheet through undistributed profits and recovery of NPLs. - Two-step restructuring: (i) strengthen balance sheet in 2006 to meet strict prudential norms; (ii) comprehensive operational restructuring in 2007-08 to reduce operating expenses and improve credit risk management, lending practices and internal controls. - Capital-adequacy ratio (CAR) targets under full classification and provisioning rules of Central Bank Regulation 8/2003: - reach 5 percent by end-June 2006 (structural benchmark), - reach 10 percent by end-December 2006 (performance criterion), - maintain CAR of 10 percent after end-December 2006 and meet all other prudential regulations. - BNF subject to audits for end-June and end-December 2006 and on-site inspections by the Superintendency of Banks; government will promptly cover any shortfalls revealed. - Increase in credit in 2006 limited to 10 percent over end-2005 level to focus on balance-sheet strengthening. - BNF to create a subsidiary or hire an independent firm by end–2006 to transfer all the NPL during the first quarter of 2007. - Design action plan to streamline BNF cost structure; IMF technical assistance requested. - Central Bank action plan to strengthen functioning of the financial system: - Legal plan (six legislative issues to modify): (i) deficiencies in sanctioning financial institutions; (ii) elimination of sanctions when appealed; (iii) creation of fit and proper criteria for issuing banking licenses; (iv) modification of minimum capital requirements; (v) coordination with foreign supervisory bodies when issuing licenses to foreign banks; (vi) strengthening monitoring of presumed connected lending. - Operational plan (measures implementable by Central Bank): (i) design, structure and publication of the banking ranking (CADEF); (ii) provisioning for credit risk; (iii) foreign exchange position limits; (iv) streamlining sanctions’ procedures; (v) capital requirements; (vi) further changes needed after banking law amendments. - Expectation to implement the operational plan and submit banking law amendments to Congress by end-September 2006 (structural benchmark). - IMF technical assistance requested. *Source: _cr06302 - 1. Paraguay was experiencing one of the most severe economic crises at the time* ### 23. We will strengthen the financial position of the Central Bank to improve its ### _cr06302 - 23. We will strengthen the financial position of the Central Bank to improve its ### Strengthening the Central Bank’s financial position - Weaknesses in the balance sheet of the Central Bank have been hampering the conduct of monetary policy. - Actions and timelines: - The Central Bank, in coordination with the Ministry of Finance, will design a plan and a timetable to strengthen its financial position. - We will announce the agreed plan by end-December 2006 (structural benchmark). - The government will send a bill to Congress by April 15, 2007 reflecting the legal and budgetary implications of the agreed plan to strengthen the financial position of the Central Bank (structural benchmark). - We have requested technical assistance from the IMF for this purpose. ### Pro-growth agenda (public enterprises, investment climate, Development Financial Agency) - Result-Oriented Management Contracts (ROMC) for public enterprises: - Design and announce ROMCs for ANDE, PETROPAR, INC, COPACO, and ESSAP by end-September 2006. - Implement these ROMCs by end-December 2006 (structural benchmark). - Each contract will include relevant financial and managerial performance indicators to be reviewed quarterly by the Planning Ministry (STP). - STP will publish the reviews and specific recommendations to monitor performance. - Similar contracts for DINAC and ANNP during 2007. - Possibility of private sector participation via management concessions with a “success fee”, private-public partnership schemes (PPP), or outsourcing specific business units. - Coordination with the World Bank and the Inter-American Development Bank. - Master plan to improve the investment climate: - Objectives: promote SME development and direct investment by (i) simplifying procedures to start and close business; (ii) implementing a plan for the modernization of properties registration; (iii) establishing a one-stop shop for exporters; (iv) strengthening institutions regulating firms and certifying product quality; and (v) improving mechanisms for VAT refunds. - Finalize design of the master plan by end-September 2006 (structural benchmark). - Work closely with the World Bank and the Inter-American Development Bank. - Development Financial Agency (AFD): - Expected role: mobilize long-term resources and channel resources from international financial institutions to the local financial system, which will intermediate funds on competitive terms to private investors (and assume the credit risk). - Eligible intermediaries: commercial banks, “financieras” and cooperatives. - AFD is expected to begin operations in May 2006. ### Social safety net - Conditional cash transfer system: - Create a system of targeted cash transfers conditioned by contracts with beneficiaries to alleviate extreme poverty. - Some 7,000 families expected to benefit by end-December 2006 (structural benchmark). - Introduce a centralized system to identify the most vulnerable groups and those living under conditions of extreme poverty. - Intensify implementation of projects aimed at reducing the economic burden on the most vulnerable within the envelope of allocated public investment and additional transfers. - Work closely with the donor community. ### Other - Continue negotiating disputed claims in good faith and seek resolution during the program. ### Key quantitative targets (Table 1 — selected items; preserve units and precisions) - Fiscal targets (floor/ceiling, in billions of guaraníes unless noted): - 1. Overall balance of the central administration (floor, in billions of guaranies) — end-Jun: 250; end-Sep: 325; end-Dec: 0 - 2. Wage bill of the central administration (ceiling, in billions of guaranies) — end-Jun: 1,795; end-Sep: 2,695; end-Dec: 3,880 - 3. Overall balance of the public sector (floor, in billions of guaranies) — end-Jun: 350; end-Sep: 440; end-Dec: 0 - Monetary targets: - 4. Net international reserves (floor, in millions of U.S. dollars) — end-Jun: 1,297; end-Sep: 1,307; end-Dec: 1,317 - 5. Net domestic assets (ceiling, in billions of guaranies) — end-Jun: -5,711; end-Sep: -5,751; end-Dec: -5,098 - Public debt and arrears targets: - 6. Contracting or guaranteeing of nonconcessional external debt by the NFPS (ceiling, in millions of US$) — end-Jun: 500; end-Sep: 500; end-Dec: 500 - Continuous performance criteria (PCs): - 7. Contracted or guaranteed short-term external debt by the NFPS — continuous PC: 0 - 8. Non-accumulation of external debt arrears — continuous PC: 0 ### Proposed structural conditionality under the program (Table 2 — selected items) - Public Sector Reform: - A. Preparation of a tax code in consultation with the Fund — PC — end-Dec 2006 - B. Design of an action plan to develop an effective commitment control system for the public sector and rationalize the Treasury account system — SB — end-Jun 2006 - Financial Sector Reform: - C. Audited and inspected CAR (fully provisioned) of 5 percent for BNF at end-June 2006 — SB — end-Sep 2006 - D. Audited and inspected CAR (fully provisioned) of 10 percent for BNF at end-December 2006 — PC — end-Mar 2007 - E. Implement regulatory measures outlined in the banking strategy and put together draft legislation — SB — end-Sep 2006 - F. Announce a strategy to strengthen the financial position of the Central bank and a timetable for its implementation — SB — end-Dec 2006 - G. Send a bill to Congress that reflects the legal and budgetary implications of the agreed plan to strengthen the financial position of the Central Bank — SB — mid-Apr 2007 - Pro-Growth Reform: - H. Design a plan to improve business climate — SB — end-Sep 2006 - I. Implement result-oriented management contract for ANDE, COPACO, ESSAP, INC, and PETROPAR — SB — end-Dec 2006 - Social Safety Net: - J. Create a conditional cash transfer mechanism for 7,000 families living under extreme poverty based on contracts with beneficiaries — SB — end-Dec 2006 ### Technical Memorandum of Understanding — selected monitoring definitions and projections - Overall balance of the central administration (cumulative flows from December 31, 2005; floor, in billions of guaraníes): - End-April 2006 (program projection) 213 - End-May 2006 (program projection) 277 - End-June 2006 (performance criterion) 250 - End-July 2006 (program projection) 285 - End-August 2006 (program projection) 309 - End-September 2006 (performance criterion ) 325 - End-October 2006 (program projection) 320 - End-November 2006 (program projection) 322 - End-December 2006 (performance criterion) 0 - Central administration wage bill (cumulative flows from December 31, 2005; ceiling, in billions of guaraníes): - End-April 2006 (program projection) 1,185 - End-May 2006 (program projection) 1,487 - End-June 2006 (performance criterion) 1,795 - End-July 2006 (program projection) 2,090 - End-August 2006 (program projection) 2,389 - End-September 2006 (performance criterion ) 2,695 - End-October 2006 (program projection) 2,999 - End-November 2006 (program projection) 3,309 - End-December 2006 (performance criterion) 3,880 - Overall balance of the consolidated public sector (cumulative flows from December 31, 2005; floor, in billions of guaraníes): - End-April 2006 (program projection) 289 - End-May 2006 (program projection) 361 - End-June 2006 (performance criterion) 350 - End-July 2006 (program projection) 395 - End-August 2006 (program projection) 426 - End-September 2006 (performance criterion ) 440 - End-October 2006 (program projection) 441 - End-November 2006 (program projection) 448 - End-December 2006 (performance criterion) 0 - Net International Reserves (NIR) of the BCP (outstanding stock; floor; in millions of U.S. dollars): - End-April 2006 (program projection) 1,254 - End-May 2006 (program projection) 1,273 - End-June 2006 (performance criterion) 1,297 - End-July 2006 (program projection) 1,303 - End-August 2006 (program projection) 1,306 - End-September 2006 (performance criterion ) 1,307 - End-October 2006 (program projection) 1,311 - End-November 2006 (program projection) 1,314 - End-December 2006 (performance criterion) 1,317 - NIR adjustments: - NIR targets will be adjusted upward (downward) for any increase (decrease) in reserve requirement deposits associated with foreign currency deposits in commercial banks, compared to the following levels: June 30, 2006: US$263 million; September 30, 2006: US$267 million; and December 31, 2006: US$265 million. - NIR targets will also be adjusted upward (downward) by the surplus (shortfall) in program disbursements relative to the baseline projection. - External program disbursements (baseline projection; cumulative flows from December 31, 2005; in millions of U.S. dollars): - End-April 2006 (program projection) 0 - End-May 2006 (program projection) 0 - End-June 2006 (program projection) 0 - End-July 2006 (program projection) 0 - End-August 2006 (program projection) 30 - End-September 2006 (program projection ) 45 - End-October 2006 (program projection) 45 - End-November 2006 (program projection) 45 - End-December 2006 (program projection) 45 - Net Domestic Assets (NDA) of the BCP (outstanding stock; ceiling; in billions of guaraníes): - End-April 2006 (program projection) -5,372 - End-May 2006 (program projection) -5,540 - End-June 2006 (performance criterion) -5,711 - End-July 2006 (program projection) -5,740 - End-August 2006 (program projection) -5,742 - End-September 2006 (performance criterion ) -5,751 - End-October 2006 (program projection) -5,768 - End-November 2006 (program projection) -5,728 - End-December 2006 (performance criterion) -5,098 - NDA calculation note: - For the purpose of NDA calculation, NIR will be converted into guaraníes at an accounting exchange rate of G 6,280/US$. - The ceiling on NDA will be adjusted upward (downward) by the equivalent in guaraníes of the downward (upward) adjustments made to the floor on the NIR of the BCP as described above. *Source: _cr06302 - 23. We will strengthen the financial position of the Central Bank to improve its* ### 6. Targets on Banco Nacional de Fomento (BNF) ### 6. Targets on Banco Nacional de Fomento (BNF) ### Measurement and calculation of CAR for BNF - The capital adequacy ratio (CAR) of the Banco Nacional de Fomento (BNF) will be measured as the ratio of the summation of risk-weighted assets, excluding risk-free assets as Cash and Government Bonds (Disponibilidades and Valores Publicos), divided by total net equity, as of end-June 2006 (structural benchmark) and end-December 2006 (performance criterion). - For the calculation of risk-weighted assets and net equity: - The bank’s loans portfolio (inclusive of both performing and non-performing loans, to the financial and the non-financial sectors) will be fully classified, provisioned for, risk-weighted and accrued for interests in accordance with the rules set by the Central Bank in the Resolution No. 8/2003. ### Targets on the Capital Adequacy Ratio for BNF - CAR of BNF (In percent): - End-June 2006 (indicative target) 5.0 - End-December 2006 (performance criterion) 10.0 --- ### Public debt and arrears targets — Contracting or guaranteeing new nonconcessional external debt - Cumulative flows (from December 31, 2005): Ceiling (In millions of U.S. dollars) - End-April 2006 (program projection) 500 - End-May 2006 (program projection) 500 - End-June 2006 (performance criterion) 500 - End-July 2006 (program projection) 500 - End-August 2006 (program projection) 500 - End-September 2006 (performance criterion ) 500 - End-October 2006 (program projection) 500 - End-November 2006 (program projection) 500 - End-December 2006 (performance criterion) 500 - The limit applies to the contracting or guaranteeing by the public sector within the calendar year of new nonconcessional external debt with an original maturity of more than one year, including commitments contracted or guaranteed. - For program purposes, a debt is concessional if it includes a grant element of at least 35 percent on the basis of currency-specific discount rates based on the OECD commercial interest reference rates (CIRR). - Excluded from the limits are credits extended by the IMF and balance of payments support loans extended by multilateral and bilateral creditors. - The Ministry of Finance will provide data to the Fund with a lag of not more than 30 days from the test date. - Additional operational details on concessionality and NPV calculations: - The grant element is calculated as the difference between the net present value (NPV) of debt and its nominal value, expressed as a percentage of the nominal value of the debt (i.e., Grant = (Nominal Value – NPV) / Nominal Value). - The NPV of debt is calculated by discounting the future stream of payments of debt service due on this debt. - For debt with a maturity of at least 15 years, the ten-year average CIRR will be used to calculate the NPV of debt. - For debt with a maturity of less than 15 years, the six-month average CIRR will be used. - For the purposes of the program, the CIRRs published by the OECD in February 2006 will be used. - The concessionality of loans in currency baskets will be assessed on the basis of U.S. dollar interest rate tables. - For loans with interest rates based on the internal policy of the creditors, the relevant interest rate to define concessionality will be the interest rate for each creditor at the time of the commitment. - Loans or portions of loans extended in the context of a debt rescheduling or a debt reduction operation will be excluded from the ceiling. ### Performance criterion on short-term external debt of the Nonfinancial Public Sector (NFPS) - As a continuous performance criterion, the NFPS will neither contract nor guarantee any short-term external debt during the program period. - Short-term debt is defined as debt with a contractual maturity of one year or less. - Excluded are normal import-related credits, forward contracts, swaps, and other futures market contracts. - The public enterprises will provide the necessary information to the Ministry of Finance, which will provide the data to the Fund, with a lag of not more than 30 days from the test date. ### Performance criteria on external payments arrears of the Public Sector - The Public Sector, excluding PETROPAR, will accumulate no new external arrears during the program period. - The stock of external arrears of the PS will be calculated based on the schedule of external payments obligations reported by SIGADE. - Data on external arrears will be reconciled with the relevant creditors, and any necessary adjustments will be incorporated in these targets as they occur. - For the purposes of this performance criterion, an arrear will be defined as a payment, which has not been made within 30 days after falling due. - Public enterprises will report to the Ministry of Finance and the BCP arrears on any external debt that is not recorded under SIGADE. - The same 30-day grace period will be applied to all external payments of public enterprises, except where explicit agreements exist with creditors on an extended grace period. - The Ministry of Finance will provide the final data on the stock of public sector external arrears to the Fund, with a lag of not more than 30 days from the test date. - The government is engaged in good faith efforts to resolve overdue claims in dispute, and will attempt to negotiate and resolve these as soon as possible. --- ### Reporting requirements and responsibilities - Monitoring the program requires accurate and timely data. All information on performance criteria, indicative targets, and balance of payments support loans will be reported to Fund staff within the timeframes prescribed above. - Debt stocks and associated flows broken down by both creditor and debtor types and maturity will be provided on a quarterly basis. - The Ministry of Finance will be responsible for gathering data on a monthly basis from all the institutions that comprise the consolidated public sector, including the incorporated enterprises (Sociedades Anónimas) COPACO and ESSAP. - The Ministry of Finance will compile this information according to the standard format of the Ministry of Finance’s monthly financial situation report (Situación Financiera). - The data will be supplied to the Fund and published on the Ministry of Finance’s external website within 30 days of each test date. *Source: _cr06302 - 6. Targets on Banco Nacional de Fomento (BNF)_* ### 9. Over the past two years, tax collections have increased by over 1½ percent of GDP. ### 9. Over the past two years, tax collections have increased by over 1½ percent of GDP. ### Fiscal revenue and tax reform - Over the past two years, tax collections have increased by over 1½ percent of GDP. - Additional tax collection gains are expected over the medium-term through the full implementation of the 2004 tax reform (fiscal adjustment law) and sustained strengthening of the tax administration office, which should continue to increase revenue collections from Paraguay’s large informal sector. - Objectives and measures of the fiscal adjustment law of 2004: - Simplify the tax system and broaden the tax base. - Eliminate most exemptions from the corporate income tax and reduce its rate. - Broaden the base of the VAT. - Introduce a new personal income tax (to be phased in over time). - Establish a new agricultural income tax to replace the previous IMAGRO tax. - Adjust certain excise tax rates. - Strengthen the tax administration’s enforcement powers. - Authorities will prepare a new tax code to modernize and standardize tax practices and rationalize tax exemptions. - The draft code will be approved by the economic cabinet by end-December 2006. - Authorities will request technical assistance from the Fund for this purpose. ### Budgetary financing and public debt management - The public sector faces increasing amortizations in the next few years, arising mostly from the repayment of obligations restructured in 2004. - While deposits at the Central Bank are sufficient to meet these obligations, using them would put undue pressure on monetary policy. - Authorities will explore ways to reorganize the government bond market, which has been closed for some time. - Broad objective: maintain a sustainable level of public debt and prevent negative net domestic and external financing. - Fiscal stance and projections: - A realistic price policy for public enterprises, together with efficiency gains, will permit moderate surpluses. - These surpluses would cover expected losses of the Central Bank, yielding a balanced position for the consolidated public sector. - This prudent fiscal stance, together with faster economic growth, would reduce the public debt-to-GDP ratio towards 30 percent by the end of the decade. ### Public financial management reforms - Authorities will design an action plan to strengthen public financial management to rationalize budgetary processes by improving planning and design and incorporating macroeconomic constraints. - Measures include introduction of a more effective expenditure control system at the commitment level for the Central Administration and rationalization of the Treasury account system by end-June 2006. ### Monetary policy objectives and actions - Authorities are committed to reducing inflation to a low single digit in 2006 and maintaining a flexible exchange rate regime. - Monetary program main objective for 2006: bring inflation down to 7 percent. - Planned currency growth reduction: from 17½ percent in 2005 to 8½ percent at the end of 2006 (significantly lower than projected nominal GDP growth). - Central Bank of Paraguay actions: - Tightened monetary policies during the first quarter of 2006, hiking interest rates further by 375 basis points to 10½ percent in two stages, in February and April 2006. - Adjusted foreign exchange policies to allow a freer floating of the Guarani. - Inflation drivers in Q1 2006: - Meat domestic supply shortage. - Increase of very volatile prices of fruits and vegetables. - Recent months: tighter monetary policies have begun to bring results and annual inflation rates have started to converge to the Central Bank’s target for 2006. ### Central Bank balance sheet, reserves, and sterilization - Monetary policy framework anticipates a US$20 million increase in net Central Bank international reserves (NIR), equivalent to 4¼ percent of currency. - Net domestic assets of the Central Bank (NDA) will expand by about 4¼ percent of currency, as the public sector is expected to use its deposits at the Central Bank, that is to say about 6½ percent of currency. - In this context, authorities will expand open market operations with banks, which will gradually limit currency growth to 8½ percent at the end of 2006. - Central Bank losses and remedial actions: - Losses associated with non-performing assets — mostly old Treasury and public companies loans and rescue operations during recent financial crises — and the current burden of paying interest rates on Letras de Regulación Monetaria are undermining the Central Bank’s balance sheet. - New Central Bank management adopted revenue-enhancing measures and moderated expenditures to reduce losses by 2/3 in 2005. - During 2006, increasing sterilization efforts and higher interest rates would lead to more capital losses which are estimated at around ¾ of GDP. - Authorities are focusing on designing a strategy to strengthen the Central Bank’s financial position by end–2006. - Government reform agenda includes elaborating a law by end-December 2006 and submitting it to Congress in April 2007, at most, to strengthen the Central Bank’s financial position and guarantee greater monetary policy soundness for medium and long term prospects. ### Balance of payments and external vulnerabilities - Authorities expect the balance of payments to remain under control, with the main part of the deficit covered by private capital inflows, mostly foreign direct investment. - Expected level of net international reserves is envisaged to cover about 3½ months of imports. - Remaining vulnerabilities stem mainly from commodity price shocks and drought, but there is no impending balance of payment gap. ### Structural and financial sector reforms - Commitment to structural reforms to improve the business climate and promote investment and growth. - Public sector reform includes strengthening the institutional framework for tax collection and preparing a new tax code (see Fiscal revenue and tax reform). - Financial sector measures: - Strengthening and restructuring the systemically-important state-owned National Development Bank (BNF) to reduce financial system vulnerabilities. - BNF progress over the last two years: improving financial position through undistributed profits and recovery of non-performing loans (NPL). - BNF capital targets: - Reach a capital-adequacy ratio (CAR) of 5 percent by end-June 2006. - Reach a CAR of 10 percent by end-December 2006. - Monetary authorities completed a study identifying legal weaknesses in banking regulations. - Response: a legal plan (required changes in banking legislation) and an operational plan to be implemented by the Central Bank to correct prudential regulatory loopholes. - State-owned enterprises (SOE) monitoring: - Close monitoring of management of SOEs by end-September 2006 for ANDE, PETROPAR, INC, COPACO, and ESSAP; and during 2007 for DINAC and ANNP. - Strategy will rely on relevant financial and managerial performance indicators to be reviewed and published quarterly by the Planning Ministry (STP). - Measures to improve investment climate and level playing field: - Fight informality and combat corruption. - Simplify procedures for company registration and licensing regulations. - Promote development of small and medium enterprises. - Support exporters and foreign investors through one–stop shops. - Improve dispute resolution and enforcement of judicial decisions. - Strengthen public institutions certifying product quality. - Mobilizing medium- and long-term financing for private companies: - Plan to mobilize resources through a new second-tier Public Financial Institution, the Development Financial Agency (AFD), which recently began operations. ### Social policy and poverty alleviation - Extreme poverty alleviation is a top priority. - Government intends to improve the quality of social spending by setting up a conditioned cash-transfer system for low-income families. - Expected beneficiaries: almost 7,000 families in 2006. - To reach the most vulnerable groups and avoid indiscriminate subsidies, the government is realigning domestic and international prices and plans to create focalized subsidies for the public transportation system. ### Closing remarks - Authorities are strongly committed to achieving further progress towards ambitious economic objectives. - They express gratitude for the Fund’s continuing support and cooperation. - Authorities evaluate the previous precautionary Stand By Agreement as a crucial factor in the success of Paraguay’s macroeconomic management and hope joint efforts will bring a sustainable path of greater growth and equity for the nation of Paraguay. *Source: _cr06302 - 9. Over the past two years, tax collections have increased by over 1½ percent of GDP.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06302.pdf_