## _cr08179

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---

### Executive summary
- Program status:
  - The program is broadly on track.
  - All quantitative performance criteria and structural benchmarks for end-June 2007 were observed.
  - All quantitative targets for end-June 2007 have been met with substantial margins.
  - Staff will update the Board on performance for end-September 2007 ahead of the Board meeting; all indications are that the performance criteria and most structural benchmarks for end-September 2007 would be observed.
- Staff recommendation:
  - Staff supports completion of the fourth SBA review in view of Paraguay’s strong performance and commitment to the program.

### Macroeconomic conditions and outlook
- Growth:
  - Economy grew 4¼ percent in 2006 and is expected to grow at least 5 percent in 2007.
  - Authorities raised their projection for economic growth to 5 percent for 2007; staff agreed and noted upside risks that Paraguay could exceed 5 percent.
  - For 2008, real GDP growth could moderate to 4 percent.
- Sectoral projections and developments (2007):
  - Agriculture: could grow 15 percent in 2007, reflecting strong soybeans performance after three years of drought.
  - Livestock: likely to moderate in 2007 after strong expansion over the past three years.
  - Industry: manufacturing growth expected around 2 percent in 2007.
  - Services: growth likely to slow to 3½ percent in 2007 as the cellular phone services boom ends.
- Inflation dynamics:
  - Headline inflation rebounded to 12½ percent at end-2006 but fell to 10½ percent in August 2007.
  - Core inflation fell to 5 percent in August 2007, consistent with the program target.
  - After seven months of deflation, monthly inflation rose to 3½ percent in August 2007, largely due to food price movements from a harsh winter-related supply disruption.
  - The 12-month rate of non-food inflation was 2 percent in August 2007 and non-tradeable goods inflation was 3⅓ percent in August 2007.
  - Fruits and vegetables prices jumped almost 20 percent in August 2007 alone.
  - Later updates: Headline inflation fell to 0.9 percent in September 2007 (from 3.4 percent in August), reducing the 12-month rate of inflation to around 10 percent (from 10½ percent). Core inflation was 5½ percent in September (against a 5 percent target).

### Fiscal performance and public sector
- Fiscal balances:
  - Overall fiscal balance close to zero in 2006; surplus of about 1¾ percent of GDP in the first half of 2007.
  - Central government surplus of about 1¾ percent of GDP (about 1½ percent of GDP higher than programmed).
  - Consolidated public sector recorded a surplus significantly higher than programmed.
  - Sizeable overall surplus of 2 percent of GDP recorded in the first eight months of 2007 (update through August 2007).
- Revenues and expenditures:
  - Tax collections increased by almost 9 percent through June 2007, driven by income and value-added taxes.
  - Nontax revenues remained strong, boosted by increased royalties from bi-national entities (particularly Yacyretá).
  - Most spending categories registered negative growth rates through June 2007; wages and salaries were limited to program levels.
  - Significant under-execution of the capital budget due to backlog in approval of work orders at the Ministry of Public Works; authorities intend to reverse this in the second half of the year.
  - Congress approved a 20 percent salary increase for teachers in late September 2007, which will put pressure on the end-December 2007 target on the wage bill.
- 2008 budget and medium-term framework:
  - Authorities submitted a 2008 budget with a deficit of about ½ percent of GDP; implementation on historical execution rates suggests fiscal position in 2008 will be in balance.
  - Budget includes a 10 percent salary increase (0.1 percent of GDP) to about 30,000 civil servants.
  - For the first time, the budget outlines a multi-year fiscal framework anchoring fiscal balance over the medium-term.
- Public enterprises:
  - PETROPAR’s overdue payments to suppliers amounted to about US$25 million at end-June 2007.
  - Diesel subsidies eliminated; mission urged authorities to maintain flexible pricing policy to enhance PETROPAR’s financial position.
  - Program’s performance criterion on arrears excludes PETROPAR’s overdue payments to suppliers as they are not sovereign debt.

### Monetary policy, domestic credit and external reserves
- Monetary policy actions:
  - Central Bank initially reduced LRMs interest rates from 11 percent to around 4 percent in March 2007 to contain large foreign exchange inflows; LRMs were adjusted upward to 4½ percent in August 2007 in response to an inflation uptick.
  - Monetary policy tightened in early October 2007: the 3-month rate on central bank liquidity control instruments (LRM) increased from 4½ percent to 5 percent and the 12-month rate from 7 percent to 8 percent.
  - Following August spike, Central Bank increased LRM rates by 50 basis points.
  - Policy stance: monetary policies to be tightened gradually; authorities considering raising policy rates for short-term LRMs to curb money supply.
- Domestic credit and sterilization:
  - Central Bank modified the auction system for LRMs, placing large amounts of LRMs beyond program projections and increasing average LRM maturity from about 2½ months (end-April 2007) to over 4 months (end-August 2007).
  - Fiscal over-performance and increased public deposits at the BCP helped observe the NDA ceiling for end-June 2007.
  - Currency growth accelerated to over 25 percent by end-June 2007 (against a program projection of less than 20 percent); estimate for currency growth by end-2007 increased from 12 percent to 15 percent to accommodate stronger money demand while preserving same level of domestic credit.
  - Assuming recent shift in money demand is satisfied, currency growth will fall to about 7 percent by end-2008.
  - Staff expressed concerns about rapid growth of monetary aggregates and potential impact on inflation, while acknowledging stronger domestic money demand.
- International reserves and FX intervention:
  - International reserves reached almost US$2¼ billion at end-August 2007.
  - The NIR floor for end-June 2007 was surpassed by some US$250 million (over 10 percent of the stock of reserves).
  - Central Bank intervention in the FX market was heavy in first quarter 2007 and virtually stopped since April 2007 as inflows moderated.
  - PC on net international reserves of the Central Bank for end-September 2007 was met by a margin of US$265 million (in the absence of significant intervention in the foreign exchange market).
- Selected monetary program figures (central bank accounts; exact entries preserved):
  - Currency Issue: 15.3 (2006), 12.0 (2007), 15.0 (Proj. 2007), 7.1 (Proj. 2008)
  - Net international reserves: 87.1 (2006), 32.9 (2007), 35.9 (Proj. 2007), 7.1 (Proj. 2008)
  - Net domestic assets: -71.8 (2006), -20.9 (2007), -20.9 (Proj. 2007), 0.0 (Proj. 2008)
  - Credit to public sector: -13.5 (2006), -2.7 (2007), -5.1 (Proj. 2007), 0.2 (Proj. 2008)
  - Credit to banks: -27.4 (2006), -33.4 (2007), -20.0 (Proj. 2007), -1.6 (Proj. 2008)

### Financial system performance and structural reforms
- Banking system indicators (as of June 2007):
  - LRMs and deposits abroad represent almost 30 percent of bank’s assets.
  - Credit to the private sector grew by about 10 percent in June 2007.
  - Foreign currency deposits fell from over 50 percent of the total in June 2006 to about 45 percent in June 2007.
  - Capital adequacy ratios at over 20 percent (well above the regulatory minimum of 10 percent).
  - Non-performing loans declined to 3 percent in June 2007.
  - Return on equity increased to over 35 percent in June 2007.
  - Banks remain liquid, well-capitalized, and profitable; relatively good conditions attributed mostly to a strengthening of the economy.
- Financial deepening and dollarization:
  - Credit to the private sector is growing, increasing financial deepening.
  - Dollarization is declining as demand for guaraní-denominated assets increases.
  - Average maturity of assets and liabilities has lengthened.
  - Nonperforming loans declining and profitability increasing; system remains well-capitalized with CARs well above the 10 percent regulatory minimum.
  - BNF no longer represents a systemic risk; its financial soundness has improved dramatically.
- Structural reform momentum:
  - Momentum was regained after an impasse in late 2006 and early 2007; authorities resumed implementation of structural reforms despite a difficult political environment.
  - Benchmarks for end-June 2007 were observed, including a Basel compliance plan, BNF business plan, and Central Bank balance-sheet strengthening strategy.

### Box 1 — Enhancing regulation and supervision of the banking system (summary of plan and status)
- Objective:
  - Increase compliance with the BCPEBS from about 20 percent currently to at least 80 percent by end-2009.
- Core elements and timing (preserve percentages and timing):
  - Resolution 8/03:
    - Approve a modified Resolucion 8/03 on credit requirements, loan classification and provisioning requirements by September 2007, with effect in January 2008.
    - Weight in strategy: 4 percent.
  - Operational plan:
    - Implement parts of the original 2005 central bank action plan that do not require legislative changes.
    - Timing: by Dec 2007.
    - Weight in strategy: 16 percent.
  - Legal amendments:
    - Amend, by end-2009, the current legislation, in particular the Banking Law and the Central Bank Law.
    - Timing: by 2009 (end-2009).
    - Weight in strategy: 40 percent.
  - Supplementary efforts (not part of the core strategy but being considered):
    - By end-2008, consider additional regulatory changes.
    - Weight attributed in diagram: 20 percent.
- Implementation status and constraints:
  - Current compliance with BCPEBS: 20 percent.
  - Modified Resolution 8/03 was approved by the BCP Board in late-September 2007 but with implementation deferred until the latter part of 2008 (staff had sought an effective date of January 2008).
  - Strategy emphasizes incremental steps combining regulatory approvals, operational strengthening, and legal amendments to reach the 80 percent target by end-2009.
- Key operational priorities:
  - Strengthen coordination between supervisory bodies.
  - Strengthen “fit and proper” criteria for bank officials.
  - Enhance on-site, off-site, cross-border and consolidated supervision.
  - Improve governance rules, Superintendency of Banks’ independence and sanctioning capacity, and capital requirements through legal amendments.
  - Study and possibly implement supplementary measures by end-2008 to further raise compliance.

### External position, arrears, and balance of payments indicators
- Current account and capital flows:
  - Current account projected at ¼ percent of GDP for 2007 (down from 2 percent in 2006).
  - Capital account projected at 2¾ percent of GDP for 2007 (down from 6¼ percent in 2006).
  - Net foreign direct investment (percent of GDP) entries include: 0.2 0.4 0.5 0.9 1.9 (Table 10 values preserved where presented).
- Exchange rate developments:
  - As external position strengthened, the guaraní appreciated by about 3 percent with respect to the U.S. dollar in September.
  - Authorities limited foreign exchange intervention after March-April; resisting market pressures toward appreciation could bear significant risks to inflation outlook.
- Non-accumulation of external debt arrears:
  - Arrears deferral (+)/clearance (-) sequence (Table 9): 91 -84 -130 50 -27 -290.
  - Exceptional Financing (Table 9): 132 -84 -130 50 -27 -290.
  - PETROPAR arrears on suppliers credits are not considered sovereign arrears per TMU definition.
- Selected exact balance of payments and reserves figures (exact sequence preserved):
  - Current account (in millions of U.S. dollars): 125 139 11 -194 -1 24 -146 -24 -29
  - Trade balance (in millions of U.S. dollars): -280 -248 -484 -911 -319 -253 -886 -744 -754
  - Overall balance (in millions of U.S. dollars): 211 270 130 402 197 401 244 266 54
  - Net International Reserves (increase -) (in millions of U.S. dollars): -343 -186 -128 -406 -197 -450 -217 -237 -54
  - Gross reserves (millions of U.S. dollars): 983 1,168 1,297 1,703 1,900 2,153 1,920 1,940 1,994
  - Gross reserves in months of imports of GNFS: 3.5 3.4 2.5 2.9 3.2 3.5 3.2 3.1 3.0
  - External public debt in percent of GDP: 48.1 41.3 34.6 26.1 22.3 22.7 23.2 23.9 22.3
  - Debt service in percent of exports GNFS: 11.6 7.5 8.8 6.0 5.5 5.1 5.8 5.2 5.3
- Implications:
  - Continued monitoring of arrears lines (including non-sovereign supplier credits) is necessary given the observed sequence of deferrals and clearances.
  - Maintaining gross reserves around reported levels can support adherence to the non-accumulation commitment.

### Political, social context and risks
- Political calendar and tensions:
  - April 2008 general elections expected to be very competitive; ruling Colorado Party primaries in December 2007.
  - Opposition front coalesced around Mr. Lugo; PLRA supports Mr. Lugo. Mr. Oviedo was released in early September and announced intention to run for President.
  - Intermittent strikes in June and July by public sector employees requesting significant salary increases.
  - Tightening of trade controls at Ciudad del Este sparked social unrest; Supreme Court’s overruling of land expropriations created social pressures.
- Risks to outlook:
  - International: potential global slowdown associated with credit tightening could spill over to neighbors and affect Paraguayan exports.
  - Domestic political: spending pressures in the run-up to the April 2008 congressional and presidential elections; Congress can approve non-programmed supplementary budgets.
  - Staff concerns emphasized rapid growth of monetary aggregates and potential inflationary impact; preliminary indications of an uptick in inflation in August 2007 (mostly food supply shock) prompted the authorities to raise LRM rates by 50 basis points in late August 2007.

### Program changes, requests, and publication
- Authorities’ requests to the Fund:
  - Reduce access under the SBA from 65 percent (SDR 65 million) to 30 percent of quota (SDR 30 million).
  - Maintain the same timing and number of program reviews as specified before.
  - Grant a waiver of applicability on the end-September 2007 performance criteria as the relevant data is not yet available.
  - Complete the fourth review under the SBA-supported program.
- SBA review and press release (October 15, 2007):
  - IMF Executive Board completed the fourth review under Paraguay’s 27-month Stand-By Arrangement originally approved in the amount equivalent to SDR 65 million.
  - Arrangement reduced from SDR 65 million to SDR 30 million; SDR 26 million made available immediately.
  - Deputy Managing Director Mr. Takatoshi Kato highlighted strong macroeconomic performance and progress on structural reforms; cautioned monetary policy must avoid monetary overhang and inflationary pressures.
- Publication:
  - Authorities intend to publish the letter on the websites of the Ministry of Finance and Central Bank and authorize the Fund to publish the letter.
  - Signatories: Germán Rojas — President, Central Bank of Paraguay; César Barreto — Minister of Finance.

*Source: Executive Summary and selected chapters and appendices of IMF staff report content provided (IMF mission report content). *

### Executive Summary ......................................................................................................

### _cr08179 - Executive Summary ......................................................................................................

### Performance and Developments
- The program is broadly on track. All quantitative performance criteria and structural benchmarks for end-June 2007 were observed. Benchmarks included: (i) a plan to increase significantly the compliance with Basel regulations; (ii) a business plan for the National Development Bank (BNF); and (iii) a strategy to strengthen the financial position of the Central Bank. Significant progress continues to be made in the macro and structural areas toward observing conditionality for end-September 2007.
- All quantitative targets for end-June 2007 have been met with substantial margins. Public finances remain under control with tax revenues improving while expenditures have been contained. Domestic credit and international reserve targets have been observed, although currency has been growing faster than programmed.
- The staff will update the Board on performance for end-September 2007 ahead of the Board meeting, and all indications are that the performance criteria and most structural benchmarks for end-September 2007 would be observed.

### Macroeconomic conditions and outlook
- The economy grew 4¼ percent in 2006 and is expected to grow at least 5 percent in 2007, well above the historical average of around 2 percent.
- Growth drivers (2007 projections and developments):
  - Agriculture: could grow 15 percent in 2007, reflecting strong soybeans performance after three years of drought.
  - Livestock: likely to moderate in 2007 after strong expansion over the past three years.
  - Industry: manufacturing growth expected around 2 percent in 2007.
  - Services: growth likely to slow to 3½ percent in 2007 as the cellular phone services boom ends.
- Inflation dynamics:
  - Headline inflation rebounded to 12½ percent at end-2006 but fell to 10½ percent in August 2007.
  - Core inflation fell to 5 percent in August 2007, consistent with the program target.
  - After seven months of deflation, monthly inflation rose to 3½ percent in August 2007, largely due to food price movements from a harsh winter-related supply disruption.
  - The 12-month rate of non-food inflation was 2 percent in August 2007 and non-tradeable goods inflation was 3⅓ percent in August 2007.
  - Fruits and vegetables prices jumped almost 20 percent in August 2007 alone.

### Fiscal performance
- The overall fiscal balance was close to zero in 2006 and shifted to a surplus of about 1¾ percent of GDP in the first half of 2007.
- Central government fiscal performance through end-June 2007:
  - Central government surplus of about 1¾ percent of GDP (about 1½ percent of GDP higher than programmed).
  - Consolidated public sector recorded a surplus significantly higher than programmed.
- Revenues:
  - Tax collections increased by almost 9 percent through June 2007, driven by income and value-added taxes.
  - Nontax revenues remained strong, boosted by increased royalties from bi-national entities (particularly Yacyretá).
- Expenditures:
  - Most spending categories registered negative growth rates through June 2007; wages and salaries were limited to program levels.
  - Significant under-execution of the capital budget due to backlog in approval of work orders at the Ministry of Public Works; authorities intend to reverse this in the second half of the year.
- Fiscal policy intentions:
  - Authorities submitted to Congress a tight budget for 2008 and staff supported maintaining a zero balance position in 2008.
  - Authorities cited strong expenditure pressures approaching the general election (scheduled for April 2008) but stressed commitment to fiscal balance.

### Monetary policy and external reserves
- The Central Bank initially reduced LRMs interest rates from 11 percent to around 4 percent in March 2007 to contain large foreign exchange inflows; LRMs were adjusted upward to 4½ percent in August 2007 in response to an inflation uptick.
- International reserves:
  - International reserves reached almost US$2¼ billion at end-August 2007.
  - The NIR floor for end-June 2007 was surpassed by some US$250 million (over 10 percent of the stock of reserves).
  - Central Bank intervention in the FX market was heavy in first quarter 2007 and virtually stopped since April 2007 as inflows moderated.
- Domestic credit and sterilization:
  - The Central Bank modified the auction system for LRMs, placing large amounts of LRMs beyond program projections and increasing average LRM maturity from about 2½ months (end-April 2007) to over 4 months (end-August 2007).
  - Fiscal over-performance and increased public deposits at the BCP helped observe the NDA ceiling for end-June 2007.
  - Currency growth accelerated to over 25 percent by end-June 2007 (against a program projection of less than 20 percent). The acceleration in currency growth is partly attributed to higher-than-programmed domestic money demand.
  - Staff expressed concerns about rapid growth of monetary aggregates and potential impact on inflation, while acknowledging stronger domestic money demand.

### Financial system and structural reforms
- Financial sector performance:
  - Credit to the private sector is growing, increasing financial deepening.
  - Dollarization is declining as demand for guaraní-denominated assets increases.
  - Average maturity of assets and liabilities has lengthened.
  - Nonperforming loans declining and profitability increasing; system remains well-capitalized with CARs well above the 10 percent regulatory minimum.
  - BNF no longer represents a systemic risk; its financial soundness has improved dramatically.
- Structural reforms:
  - Momentum was regained: after an impasse in late 2006 and early 2007, authorities resumed implementation of structural reforms despite a difficult political environment.
  - Benchmarks for end-June 2007 were observed (including Basel compliance plan, BNF business plan, and Central Bank balance-sheet strengthening strategy).

### Discussions, risks, and staff recommendation
- Authorities reiterated intention to maintain prudent macroeconomic policies; the newly appointed Minister of Finance, Mr. Barreto, reaffirmed commitment to the program and adherence to the financial plan of the fiscal budget.
- Staff concerns:
  - Rapid growth of monetary aggregates and potential inflationary impact.
  - Preliminary indications of an uptick in inflation in August 2007 (mostly food supply shock) prompted the authorities to raise LRM rates by 50 basis points in late August 2007.
- Staff supports completion of the fourth SBA review in view of Paraguay’s strong performance and commitment to the program.

*Source: Executive Summary (IMF mission report content provided).*

### 6.      The banking system has continued expanding its operations and improving its

### 6.      The banking system has continued expanding its operations and improving its

### Banking system: balance sheet and income
- Assets and liquidity
  - LRMs and deposits abroad represent almost 30 percent of bank’s assets.
  - Credit to the private sector grew by about 10 percent in June 2007.
- Liabilities and currency composition
  - Foreign currency deposits fell from over 50 percent of the total in June 2006 to about 45 percent in June 2007.
- Capital
  - Capital adequacy ratios at over 20 percent (well above the regulatory minimum of 10 percent).
- Income and asset quality
  - Non-performing loans declined to 3 percent in June 2007.
  - Return on equity increased to over 35 percent in June 2007.
- Overall assessment
  - Banks remain liquid, well-capitalized, and profitable; relatively good conditions attributed mostly to a strengthening of the economy.

### External position and balance of payments
- Current account
  - Projected at ¼ percent of GDP for 2007 (down from 2 percent in 2006).
  - Narrowing driven by higher export growth (high commodity prices and bumper crops) and a slowdown in import growth (partly due to lower oil prices in the first half of the year).
- Capital account
  - Reduced external capital account surplus to a projected 2¾ percent of GDP for 2007 (down from 6¼ percent in 2006).
  - Higher FDI offset by slowdown in other private inflows.
- Other external indicators and risks
  - Disputed claims amounted to about US$270 million or about 2½ percent of GDP at end-June 2007.
  - Ongoing assessment of claims by import verification companies (BIVAC and SGS) and a US$185 million Swiss court ruling against Paraguay under study.
  - As the external position strengthened, the guaraní appreciated by about 3 percent with respect to the U.S. dollar in September.
  - NIR increases driven by large inflows from binationals.

### Political and social context
- Elections and politics
  - April 2008 general elections expected to be very competitive.
  - Ruling Colorado Party will hold primaries in December 2007.
  - Opposition front coalesced around Mr. Lugo; PLRA supports Mr. Lugo.
  - Mr. Oviedo was released in early September and announced intention to run for President.
- Social tensions
  - Intermittent strikes in June and July by public sector employees (including the Ministry of Finance and teachers’ union) requesting significant salary increases.
  - Tightening of trade controls at Ciudad del Este sparked social unrest in south eastern part of the country.
  - Supreme Court’s overruling of land expropriations in the north eastern part of the country created social pressures.

### Outlook and risks
- Growth and inflation projections
  - Authorities raised their projection for economic growth to 5 percent for 2007; staff agreed and noted upside risks that Paraguay could exceed 5 percent.
  - Achievement of the core inflation objective of 5 percent (+/- 2 ½ percent) for 2007 remains feasible.
  - For 2008, real GDP growth could moderate to 4 percent; core inflation objective of 3 percent for 2008 remains optimistic but feasible.
- External and political risks
  - International risk: potential global slowdown associated with credit tightening could spill over to neighbors and affect Paraguayan exports.
  - Domestic political risk: spending pressures in the run-up to the April 2008 congressional and presidential elections; Congress can approve non-programmed supplementary budgets.

### Fiscal policy and public sector
- 2007 fiscal outlook and pressures
  - Fiscal outcome for the first half of 2007 relied in part on expenditure compression; outlays likely to rise in the second half.
  - Congress approved a 20 percent salary increase for teachers in late September 2007, which will put pressure on the end-December 2007 target on the wage bill.
  - Additional supplementary budget requests under consideration could compromise the fiscal objective for 2007 unless offset by expenditure cuts elsewhere.
- 2008 budget and medium-term framework
  - Authorities submitted a 2008 budget with a deficit of about ½ percent of GDP; implementation on historical execution rates suggests fiscal position in 2008 will be in balance.
  - Budget includes a 10 percent salary increase (0.1 percent of GDP) to about 30,000 civil servants.
  - For the first time, the budget outlines a multi-year fiscal framework anchoring fiscal balance over the medium-term.
- Public enterprises and PETROPAR
  - PETROPAR’s strong financial position affected by higher international oil prices.
  - PETROPAR’s overdue payments to suppliers amounted to about US$25 million at end-June 2007.
  - Diesel subsidies eliminated; mission urged authorities to maintain flexible pricing policy to enhance PETROPAR’s financial position.
  - Program’s performance criterion on arrears excludes PETROPAR’s overdue payments to suppliers as they are not sovereign debt.

### Monetary policy
- Policy stance for remainder of 2007
  - Monetary policies to be tightened gradually; authorities considering raising policy rates for short-term LRMs to curb money supply.
  - Recent decline in dollarization indicates strengthening of real domestic money demand; currency growth estimate for end-2007 was raised cautiously from 12 percent to 15 percent to accommodate stronger money demand while preserving same level of domestic credit.
- Projections for 2008
  - Inflation targeted at 3 percent.
  - Assuming recent shift in money demand is satisfied, currency growth will fall to about 7 percent by end-2008.
- Selected monetary program figures (central bank accounts)
  - Currency Issue: 15.3 (2006), 12.0 (2007), 15.0 (Proj. 2007), 7.1 (Proj. 2008)
  - Net international reserves: 87.1 (2006), 32.9 (2007), 35.9 (Proj. 2007), 7.1 (Proj. 2008)
  - Net domestic assets: -71.8 (2006), -20.9 (2007), -20.9 (Proj. 2007), 0.0 (Proj. 2008)
  - Credit to public sector: -13.5 (2006), -2.7 (2007), -5.1 (Proj. 2007), 0.2 (Proj. 2008)
  - Credit to banks: -27.4 (2006), -33.4 (2007), -20.0 (Proj. 2007), -1.6 (Proj. 2008)

### External sector policy
- External position strengthening
  - Current account deficit expected to narrow from 2 percent in 2006 to ¼ percent of GDP in 2007.
  - Exports expected to remain strong, supported by soy and cereal exports and high commodity prices.
  - Current account being more than financed by private capital flows, mainly FDI related to Yacyretá hydropower plant capacity increases and private sector loans reflecting profitability in agricultural exports.
- Exchange rate policy
  - Authorities limited foreign exchange intervention after March-April; as external position strengthened, guaraní appreciated about 3 percent in September.
  - Resisting market pressures toward appreciation could bear significant risks to inflation outlook.

### Structural reform and conditionality
- End-June 2007 conditionality status
  - Authorities complied with structural conditionality for end-June 2007.
  - Prudential regulations: design of a plan to achieve at least 80 percent of the Basel Core Principles of banking supervision over the medium term; authorities presented a timely plan, recognizing about 40 percent of the principles can only be adopted through legal modifications.
  - National Development Bank (BNF): developed a medium-term business strategy to refocus operations, improve management, and reduce operating costs; authorities presented an adequate plan with projected cash flows.
  - Central Bank (BCP): prepared a strategy to strengthen BCP’s financial position addressing negative income; plan includes government transfers to BCP of 0.2 percent of GDP a year.
    - Fund staff view: government should finalize reconciliation quickly and increase annual transfer to BCP to 0.4 percent of GDP to fully cover Central Bank losses.
  - Authorities expect to finalize reconciliation of undisputed claims by end-2007.
- Progress on end-September 2007 conditionality
  - Four out of seven benchmarks due in September were observed in a timely manner; an additional two could be met shortly thereafter; the third will be effective only in the latter part of 2008.
  - Tax code regulations: implementing regulations for draft tax procedures code prepared and presented; reform faces opposition alleging undue power to tax collectors; authorities strengthening information policy and staff suggested forming a committee with broad private sector representation to build consensus.

*Source: IMF staff report (extract).*

### Box 1. Paraguay: Enhancing Regulation and Supervision of the Banking System

### Box 1. Paraguay: Enhancing Regulation and Supervision of the Banking System

### Background and recent history
- 2005: draft general banking law ran aground in Congress; initial efforts to address weaknesses in banking regulation faltered.
- Post-2005: authorities developed an alternative strategy covering sequential reforms identified in the 2005 FSAP, including legal amendments to the existing law and an action plan for central bank resolutions.
- End-2006: important central bank resolution for loan classification and risk provisioning (Resolution 8/03) could not be implemented due to political resistance.
- April 2007: new administration at the BCP renewed the initiative, focusing on convergence toward international standards.

### Strategy to increase compliance with Basel Core Principles for Effective Banking Supervision (BCPEBS)
- Overall objective: increase compliance with the BCPEBS from about 20 percent currently to at least 80 percent by end-2009.
- The strategy contemplates the following steps (each entry preserves the percentage and timing as in the source):
  - Resolution 8/03:
    - Approve a modified Resolucion 8/03 on credit requirements, loan classification and provisioning requirements by September 2007, with effect in January 2008.
    - Weight in strategy: 4 percent.
  - Operational plan:
    - Implement parts of the original 2005 central bank action plan that do not require legislative changes, including strengthening coordination between supervisory bodies, strengthening “fit and proper” criteria, and enhancing on-site, off-site, cross-border and consolidated supervision.
    - Timing: by Dec 2007.
    - Weight in strategy: 16 percent.
  - Legal amendments:
    - Amend, by end-2009, the current legislation, in particular the Banking Law and the Central Bank Law, to improve governance rules, enhance the independence and sanctioning capacity of the Superintendency of Banks, further strengthen “fit and proper” criteria, and strengthen capital requirements.
    - Timing: by 2009 (end-2009).
    - Weight in strategy: 40 percent.
  - Supplementary efforts (not part of the core strategy but being considered):
    - By end-2008, consider additional regulatory changes including strengthening protection for supervisors, and credit and operational risk management practices aimed at increasing further compliance with the BCPEBS.
    - Weight attributed in diagram: 20 percent.

### Implementation status and constraints (as described in the source)
- Current compliance with BCPEBS: 20 percent.
- Political resistance and timing issues affected implementation:
  - Modified Resolution 8/03 was approved by the BCP Board in late-September 2007 but with implementation deferred until the latter part of 2008 (staff had sought an effective date of January 2008).
  - The strategy emphasizes incremental steps that combine regulatory approvals, operational strengthening, and legal amendments to reach the 80 percent compliance target by end-2009.

### Key operational priorities embedded in the plan
- Strengthen coordination between supervisory bodies.
- Strengthen “fit and proper” criteria for bank officials.
- Enhance on-site, off-site, cross-border and consolidated supervision.
- Improve governance rules, Superintendency of Banks’ independence and sanctioning capacity, and capital requirements through legal amendments.
- Study and possibly implement supplementary measures by end-2008 to further raise compliance.

*Source: Box 1. Paraguay: Enhancing Regulation and Supervision of the Banking System (from the provided IMF content).*

### 8. Non-accumulation of external debt arrears

### 8. Non-accumulation of external debt arrears

### Policy requirement and context
- The program emphasizes non-accumulation of external debt arrears as a specific commitment by the authorities.
- Sources: Paraguayan authorities; and Fund staff estimates.

### Recent developments and evidence
- Arrears deferral (+)/clearance (-) entries (Table 9): 91 -84 -130 50 -27 -290
- Exceptional Financing (Table 9): 132 -84 -130 50 -27 -290
- The documentation notes: "Reflects PETROPAR's arrears on suppliers credits, which are not considered sovereign arrears (see definition in the TMU)."

### Key balance of payments and reserves indicators (selected exact figures from tables)
- Current account (in millions of U.S. dollars): 125 139 11 -194 -1 24 -146 -24 -29
- Trade balance (in millions of U.S. dollars): -280 -248 -484 -911 -319 -253 -886 -744 -754
- Overall balance (in millions of U.S. dollars): 211 270 130 402 197 401 244 266 54
- Net International Reserves (increase -) (in millions of U.S. dollars): -343 -186 -128 -406 -197 -450 -217 -237 -54
- Gross reserves (millions of U.S. dollars): 983 1,168 1,297 1,703 1,900 2,153 1,920 1,940 1,994
- Gross reserves in months of imports of GNFS: 3.5 3.4 2.5 2.9 3.2 3.5 3.2 3.1 3.0
- External public debt in percent of GDP: 48.1 41.3 34.6 26.1 22.3 22.7 23.2 23.9 22.3
- Debt service in percent of exports GNFS: 11.6 7.5 8.8 6.0 5.5 5.1 5.8 5.2 5.3

### Assessment elements relevant to non-accumulation of arrears
- The schedule of arrears deferral/clearance shows both positive and negative movements across periods (exact sequence: 91, -84, -130, 50, -27, -290), indicating episodes of deferral and subsequent clearance actions reflected in the balance of payments tables.
- PETROPAR arrears on supplier credits are explicitly flagged and treated as non-sovereign for the purpose of the TMU definition, affecting the interpretation of arrears movements in the tables.

### Monitoring and vulnerability indicators related to external obligations
- Current account in percent of GDP (selected values): 2.3 2.0 0.1 -2.0 -0.6 0.8 -1.3 -0.2 -0.3
- Capital and financial account (percent of GDP): 1.0 3.2 0.5 4.2 4.7 (Table 10)
- Net foreign direct investment (percent of GDP) (Table 10): 0.2 0.4 0.5 0.9 1.9
- Short-term external indicators: gross reserves and months of imports (exact values above) provide liquidity context for meeting external obligations.

### Implications for policy and program implementation
- Continued monitoring of arrears lines (including non-sovereign supplier credits) is necessary given the observed sequence of deferrals and clearances (91, -84, -130, 50, -27, -290).
- Maintaining gross reserves around the reported levels (e.g., 1,703; 1,900; 2,153; 1,920; 1,940; 1,994 millions of U.S. dollars in the sequence reported) and preserving improvements in the overall balance can support adherence to the non-accumulation commitment.

*Source: _cr08179 - 8. Non-accumulation of external debt arrears*

### 1. This letter updates our previous correspondence (of May 8, 2006, September 12,

### _cr08179 - 1. This letter updates our previous correspondence (of May 8, 2006, September 12,

### Purpose and context
- Updates previous correspondence dated May 8, 2006, September 12, 2006, and June 15, 2007.
- Describes performance under the economic program supported by a 27-month Stand-By Arrangement (SBA).
- Reiterates commitment to the program whose objectives are:
  - to entrench stabilization while reducing poverty; and
  - to increase the potential growth of the economy by adopting an ambitious reform agenda.

### Program performance and compliance
- The program remains on track.
- Performance under the economic program has been described as "very good."
- All quantitative and structural performance criteria as well as all structural benchmarks through end-June 2007 have been observed, "some by large margins."

### Macroeconomic developments
- Macroeconomic conditions improved markedly since program adoption in May 2006.
- Economic growth accelerated and inflation fell significantly in the first half of 2007.
- The public finances remain on a strong footing anchored by the financial plan.
- International reserves reached another record high in June 2007.
- There was an uptick in inflation in August due to supply shocks; authorities will remain vigilant and ensure adequate policies to achieve the inflation objective.

### External position and vulnerabilities
- The external position strengthened beyond expectations.
- External vulnerabilities have reduced significantly.

### Requests to the Fund
- Against the improved external position and to strengthen the reform agenda, the following requests are made:
  - (i) Reduce access under the SBA—which the authorities intend to continue treating as precautionary—from 65 percent (SDR 65 million) to 30 percent of quota (SDR 30 million).
  - (ii) Maintain the same timing and number of program reviews as specified before.
  - (iii) Grant a waiver of applicability on the end-September 2007 performance criteria as the relevant data is not yet available.
  - (iv) Complete the fourth review under the SBA-supported program.

### Commitments and cooperation
- The government will continue the productive dialogue with the Fund.
- The government believes the program policies are adequate to achieve program objectives but will take additional measures, if necessary.
- The government will consult and provide Fund staff with all relevant information required to complete program reviews and monitor performance.

*Source: _cr08179 - 1. This letter updates our previous correspondence (of May 8, 2006, September 12,*

### 6. As it is customary now, we intend to publish this letter in the websites of the Ministry

### _cr08179 - 6. As it is customary now, we intend to publish this letter in the websites of the Ministry

### Publication of the Letter
- The authorities intend to publish this letter on the websites of the Ministry of Finance and Central Bank “to maintain our citizens informed about our policy intentions.”
- The authorities also authorize the Fund to publish this letter.
- Signatories:
  - Germán Rojas — President, Central Bank of Paraguay
  - César Barreto — Minister of Finance

### Appendix 2 — Paraguay: Fund Relations (As of August 31, 2007)
- I. Membership Status:
  - Joined December 28, 1945; Article VIII
- II. General Resources Account (In millions of SDRs; In percent of Quota):
  - Quota: 99.90 100.00
  - Fund holdings of currency: 78.43 78.51
  - Reserve position in Fund: 21.48 21.50
- III. SDR Department:
  - Net cumulative allocation: 13.70 100.00
  - Holdings: 93.41 681.94
- IV. Outstanding Purchases and Loans:
  - None
- V. Latest Financial Arrangements:
  - Stand-By: Approval Date May 31, 2006; Expiration Date Aug 31, 2008; Amount Approved (SDR Million) 65.00; Amount Drawn (SDR Million) 0.00
  - Stand-By: Approval Date Dec 15, 2003; Expiration Date Nov 30, 2005; Amount Approved (SDR Million) 50.00; Amount Drawn (SDR Million) 0.00
- VI. Projected Payments to Fund (SDR Million; based on existing use of resources and present holdings of SDRs):
  - Forthcoming 2007 2008 2009 2010
  - Principal: 0.00 0.00 0.00 0.00
  - Charges/Interest: 0.00 0.00 0.00 0.00
  - Total: 0.00 0.00 0.00 0.00
- VII. Exchange Rate Arrangement:
  - Currency: Paraguayan guaraní
  - Regime: managed float; interbank foreign exchange market determines rate; central bank intervenes to smooth out exchange rate fluctuations in real effective terms
  - Principal intervention currency: U.S. dollar
  - On August 31, 2007, the average interbank rate for the U.S. dollar was  /G5,090 =US$1.
  - Paraguay has accepted the obligations of Article VIII, Sections 2(a), 3 and 4 of the Fund's Articles of Agreement.
  - Staff is considering whether the application of the income tax regime and the new Law of Administrative Reorganization and Financial Adequacy (Ley No. 2421/04) may give rise to exchange restrictions subject to Fund jurisdiction.
- VIII. Article IV Consultation:
  - The Executive Board concluded the 2007 Article IV consultation on June 29, 2007.
- IX. Technical Assistance: (selected entries with Departments and Dates)
  - MAE Policy Advisory to the Central Bank March 1994–2004
  - FAD Tax Policy February 1999
  - STA Monetary Statistics February 2000
  - STA Balance of Payments Statistics June 2000
  - MAE Currency Operations March–September 2002
  - TRE Safeguards Assessment January 2003
  - MFD Banking Supervision January 2003–April 2004
  - MFD Currency Handling and Reform February 2002–April 2004
  - MFD Payment System July 2003
  - MFD Central Bank Recapitalization March 2006
  - FIN Safeguards Assessment March 2006
  - STA Consumer Price Index April–May 2006
  - MCM Development of Local Capital Markets June 2007
  - STA Quarterly National Accounts August 2007
  - STA Consumer Price Index August 2007
- X. Safeguards Assessment:
  - CBP subject to a full safeguards assessment in respect to arrangement approved on May 31, 2006.
  - Safeguards assessment of the CBP completed in October 2006; report states vulnerabilities remain in areas such as financial reporting and program data reporting to the Fund.
- XI. Resident Representative:
  - Mr. Luis H. Duran-Downing appointed as senior resident representative since May 2005.

### Appendix 3 — Paraguay: World Bank Relations (As of September 10, 2007)
- Country Assistance Strategy (CAS) approved December 16, 2003; aims at restoring confidence and supporting reforms in financial sector, rural development, health, and education.
- Current portfolio (three operations, two under implementation, one awaiting Parliament approval):
  - Pilot Community Development ($9m, approved in FY00)
  - Secondary Education Reform ($24m, approved in FY02)
  - Road Maintenance Project ($74m, approved on August 24, 2006) — awaiting Parliament approval
- Aggregate project figures:
  - Total value of the three World Bank-financed projects: US$107 million in commitments
  - Undisbursed as of September 10, 2007: US$87.6 million
- Grants mobilized:
  - Congress institutional strengthening $0.4m
  - Ministry of Finance $0.3m
  - Management of indigenous lands $1.7m
  - Social development in two municipalities $0.9m
  - Promote development in indigenous communities $1.6
  - Improve biodiversity and forestry $0.3m (IDF) and $0.3m and $0.9m (GEF)
- Analytical work in FY07:
  - Land Tax Study completed; preparing Integrated Fiduciary Framework (with Interamerican Development Bank) and Education Attainment Assessment.
- Projects under preparation: additional financing for Pilot Community Development, Sustainable Rural Investment project, Modernization of the Water Sector project, Private Sector Development project, Forestry Project.
- Financial Relations table (IBRD/IDA Active Operations as of September 10, 2007):
  - Active loans:
    - Community development: Committed 9.0; Disbursed 7.4; Undisbursed 1.6
    - Education Reform: Committed 24.0; Disbursed 12.0; Undisbursed 12.0
    - Road Maintenance*: Committed 74.0; Disbursed 0.0; Undisbursed 74.0
  - Total active loans: 107.0 19.4 87.6
  - Total IBRD/IDA: 1,046.3
  - Repaid: 602.0
  - Total outstanding: 252.8
  - O/w IBRD (including exchange rate adjustment): 234.3
  - O/w IDA: 18.5
- II. IFC Operations (as of September, 2007):
  - Commitments (Loans/Equity/Total): 15.0 0.0 15.0
  - Held by IFC: 15.0 0.0 15.0
  - Undisbursed: 0.0 0.0 0.0
- III. IBRD/IDA Loan Transactions (calendar year) (As of September 30, 2007):
  - Disbursements by year: 1998 37.7; 1999 42.1; 2000 46.6; 2001 26.8; 2002 13.5; 2003 42.3; 2004 16.2; 2005 16.7; 2006 31.9
  - Repayments by year: 1998 24.6; 1999 24.6; 2000 20.2; 2001 15.3; 2002 16.8; 2003 21.0; 2004 34.8; 2005 26.6; 2006 27.5
  - Net lending by year: 1998 13.1; 1999 17.5; 2000 26.4; 2001 11.5; 2002 -3.3; 2003 21.3; 2004 -18.6; 2005 -9.9; 2006 4.4
  - Note: Road Maintenance* — Not yet effective.

### Appendix 4 — Paraguay: Inter-American Development Bank Relations (As of August 31, 2007)
- Portfolio:
  - Active loan portfolio: US$788.6 million
  - Undisbursed balance: US$468.8 million
  - Active Technical Cooperation operations: 65 operations for US$24.1 million, of which US$15.4 million are undisbursed
  - Loan approvals in 2006: US$251.4 million
- Strategy:
  - IDB Country Strategy review approved November 2006; main focus for 2007-2008: support economic growth and poverty alleviation.
- Pipeline for 2007 (selected operations):
  - Program to Support the Economic Census of Paraguay, US$5.0 million
  - Program to Support Paraguayan Exports - REDIEX, US$10 million

### Appendix 5 — Paraguay: Statistical Issues
- Overview:
  - Data provision broadly adequate for program purposes but timeliness and accurate reporting need improvement.
  - Paraguay became a GDDS participant in September 2001; data ROSC mission visited January–February 2006; authorities’ response published June 30, 2006.
- A. Real Sector:
  - New national accounts series released in 2005 (broadly consistent with 1993 SNA); base year 1994.
  - Deficiencies and concerns:
    - No comprehensive regular program for economic censuses and surveys; industrial survey conducted in 2002.
    - (i) 1994 reference year is becoming obsolete;
    - (ii) excessive use of fixed coefficients for value added and household consumption;
    - (iii) changes in inventories are obtained residually;
    - (iv) informal activities are not monitored;
    - (v) supply and use tables compiled only until 1997.
  - Timeliness: annual GDP data disseminated with a lag of 11 months (periodicity meets GDDS but timeliness does not).
  - An exploratory TA mission on compilation of quarterly national accounts was fielded in August 2007.
  - Prices:
    - CPI and PPI reported regularly and timely.
    - CPI geographic coverage limited to Asunción; CPI base weight period 1992; PPI base December 1995.
    - Household budget survey 2005–2006 will be used to update CPI basket and weights; new CPI scheduled for publication by January 2008.
    - IMF Statistics department providing technical advice; latest IMF price statistics mission July–August 2007 — authorities largely on target to meet publication schedule.
    - PPI basket (150 items) not fully representative; electricity, water, gas, and services not covered.
  - Employment statistics improved since 1998 household survey; frequencies annual; publication lag close to one year; wage indices updated twice a year.
  - Resources for real sector statistics are insufficient, constraining adoption of 1993 SNA.
- B. Fiscal Sector:
  - Government finance statistics (GFS) broadly consistent with GFSM 1986 recommendations.
  - No plan yet to migrate to GFSM 2001.
  - Monthly data available for central administration; local government operations not included in GFS.
  - Asset position of social security system available on a daily basis.
  - Nonfinancial public sector statistics include four employer social insurance schemes treated as financial corporations in monetary and financial accounts.
  - External debt (medium- and long-term) data reliable and available monthly; domestic debt data available on request but need integration with external debt database.
  - Deficiencies in recording short-term supplier and commercial credit of public sector; discrepancy exists between fiscal data reported by monetary and fiscal authorities — measures being taken to increase transparency.
  - Annual general government data for 2005 reported for publication in 2006 GFS Yearbook; since 1994 no outstanding debt data and no expenditure-by-function breakdowns provided for GFS Yearbook; monthly and quarterly data not reported for publication in IFS.
- C. Money and Banking Sectors:
  - Money and banking statistics broadly reliable owing to new accounting plan for commercial banks and finance companies (1995) and unified compilation/reporting system.
  - Reduction in discrepancies of interbank positions following classification revision.
  - Lack of coverage of credit cooperatives remains a concern (they account for around 25 percent of deposits and loans of the banking sector).
  - Superintendency of banks publishes detailed reports on financial soundness.
  - Authorities have commenced submission of monetary statistics based on standardized report forms.
- D. External Sector:
  - Quarterly and annual BOP and IIP data available from 2001 on central bank website and reported to STA.
  - In October 2006, Paraguay became the first non-SDDS participant to report quarterly external debt data to QEDS.
  - Classification follows Balance of Payments Manual, 5th edition.
  - Improvements: quality of capital flow data, coverage of FDI, recording of external debt transactions.
  - Central bank produces an informative bulletin with balance of payments statistics.
  - Special studies improved estimation methods for remittances and unregistered trade, but serious deficiencies remain, particularly for private capital outflows due to open capital account.
  - Major ROSC recommendations include:
    - (i) design and conduct sample surveys to capture currently excluded items (some services, direct and portfolio investment abroad, real estate);
    - (ii) review and update techniques to estimate unrecorded trade;
    - (iii) prepare periodical reports to inform CBP management on survey quality (response, coverage, response errors);
    - (iv) initiate quarterly reconciliation of flows and stocks of medium- and long-term external public debt with MOF.
  - Follow-up TA mission in November 2006 assisted CBP in implementing ROSC recommendations, focusing on surveys, unrecorded trade techniques, treatment of binational hydroelectric enterprises, and template for reporting international reserves and foreign currency liquidity.

### Paraguay: Table of Common Indicators Required for Surveillance (As of September 19, 2007)
- Memo Items / Selected entries:
  - Date of latest observation / Date received / Frequency of Data / Frequency of Reporting / Frequency of publication / Data Quality Methodological soundness / Data Quality Accuracy and reliability
  - Exchange Rates: 09/18/07 09/19/07 D D D
  - International Reserve Assets and Reserve Liabilities of the Monetary Authorities2: Aug. 2007 09/11/07 D M D
  - Reserve/Base Money: Aug. 2007 09/11/07 D M D — O, LNO, LO, O (methodological soundness) — O, O, O, LO, LO (accuracy/reliability)
  - Broad Money: May 2007 06/29/07 M M M
  - Central Bank Balance Sheet: Aug. 2007 09/11/07 D M D
  - Consolidated Balance Sheet of the Banking System: Jul. 2007 09/11/07 M M M
  - Interest Rates3: Jul. 2007 09/11/07 M M M
  - Consumer Price Index: Aug. 2007 09/03/07 M M M — O, LO, O, O (methodological soundness) — O, LO, LNO, O, LO (accuracy/reliability)
  - Revenue, Expenditure, Balance and Composition of Financing — General Government5: Jun. 2006 08/03/07 M M M — LO, LO, LO, LO (methodological soundness) — LO, LNO, O, LO, LO (accuracy/reliability)
  - Stocks of Central Government and Central Government-Guaranteed Debt6: Q1 2007 07/19/07 Q Q Q
  - External Current Account Balance: Q1 2007 07/19/07 Q Q Q — O, LO, LO, LO (methodological soundness) — LO, O, LO, LO, LO (accuracy/reliability)
  - Exports and Imports of Goods and Services: Jun. 2006 08/03/07 M M M
  - GDP/GNP: 2006 08/03/07 A A A — O, LO, LO, LO (methodological soundness) — LO, O, LNO, O, LO (accuracy/reliability)
- Notes included in table:
  - Frequency codes: Daily (D); Weekly (W); Monthly (M); Quarterly (Q); Annually (A); Irregular (I); Not Available (NA).
  - Footnotes clarify inclusion of reserve assets pledged or otherwise encumbered, market-based and official interest rates, and definitions for general government and debt composition.
  - Data quality assessments reflect the data ROSC published June 30, 2006 and findings of mission during January 25–February 8, 2006.

*Source: _cr08179 - 6. As it is customary now, we intend to publish this letter in the websites of the Ministry*

### 2006. For the dataset corresponding

### _cr08179 - 2006. For the dataset corresponding

### Recent developments
- Headline inflation fell to 0.9 percent in September 2007 (from 3.4 percent in August), reducing the 12-month rate of inflation to around 10 percent (from 10½ percent).  
- Higher food prices explain the whole inflation rate of September.  
- Core inflation was 5½ percent in September (against a 5 percent target).  
- The 12-month rate of non-food inflation was only 1¾ percent in September 2007.  
- Monetary policy tightened in early October 2007: the 3-month rate on central bank liquidity control instruments (LRM) increased from 4½ percent to 5 percent and the 12-month rate from 7 percent to 8 percent.  
- Fiscal position strengthened through August 2007: tax collection grew at 11 percent in the 12 months to August, expenditures grew by 8 percent, and a sizeable overall surplus of 2 percent of GDP was recorded in the first eight months of the year.

### Performance criteria (end-September 2007)
- Two performance criteria for end-September 2007 were observed; remaining end-September 2007 PCs lacked sufficient information for assessment and authorities requested a waiver of non-applicability.  
- International reserves: PC on net international reserves of the Central Bank was met by a margin of US$265 million (in the absence of significant intervention in the foreign exchange market).  
- Domestic credit: PC on the net domestic assets of the Central Bank was met by a margin of G 1.0 trillion (placements of LRMs higher than programmed due to better functioning LRM market and higher rates).

### Structural benchmarks and implementation status
- Four out of seven end-September 2007 benchmarks were met.  
- Approval of modified Resolution 8/03: approved at end-September 2007; effectiveness delayed from January to October 2008 to secure stakeholder support and allow financial institutions time to adjust accounting systems. Staff regrets delay because it temporarily limits legal enforcement by the Superintendency of Banks.  
- Other benchmark statuses and planned actions:
  - Legislation to partially cover Central Bank losses: agreement to transfer 0.2 percent of GDP to the Central Bank annually; draft law under internal legal review and expected to be sent to Congress by end-October 2007.
  - Legislation to improve payment system: draft law reviewed by private law firm and expected to be approved by the economic cabinet by end-November 2007.
- Specific benchmark on prudential rule for banks’ loan classification and provisioning: Central Bank resolution approved on September 28, 2007; staff assesses benchmark as non-observed because implementation was delayed until October 2008. Authorities note partial implementation from January 2008 via disclosures and forms by the Superintendency of Banks.

### Press Release — Fourth SBA Review (October 15, 2007)
- IMF Executive Board completed the fourth review under Paraguay’s 27-month Stand-By Arrangement originally approved in the amount equivalent to SDR 65 million (about US$101 million).  
- The Board approved Paraguay’s request for reduction and rephasing of access: Arrangement reduced from SDR 65 million to SDR 30 million (about US$46.6 million); SDR 26 million (about US$40.4 million) made available immediately. Authorities intend to treat the arrangement as precautionary.  
- Deputy Managing Director Mr. Takatoshi Kato highlighted:
  - Strong macroeconomic performance and progress on structural reforms.
  - Fiscal performance remains strong; larger-than-anticipated fiscal surplus for first eight months of 2007 provides margins for potential expenditure pressures.
  - Monetary policy must avoid monetary overhang and inflationary pressures; recent more active stance is welcome.
  - Progress on financial sector reforms noted: business plan for National Development Bank; plan to enhance Paraguay’s coverage of Basle Core Principles for Banking Supervision; strategy to strengthen Central Bank’s financial position.
  - Upcoming reforms include a bill to Congress reflecting legal and budgetary implications for Central Bank strengthening, and completion of draft payments system law.
  - Continued defense of macroeconomic stability and acceleration of structural reforms urged.

### Statement by Paraguayan authorities (Executive Director Javier Silva-Ruete and Senior Advisor Jose H. Maciel)
- Real sector:
  - Real GDP growth could exceed 5 percent in 2007, driven mostly by agriculture growth projected at 15 percent (soybean main driver), despite declining contributions from livestock and services.
  - This would be the highest rate of economic expansion since 1995.
- Fiscal developments:
  - Central government surplus of nearly 2 percent of GDP according to end-June estimates due to expansion of the economy, increased inflows from hydroelectric bi-national entities, and under-execution of the capital budget (expected to reverse in second half of year).
  - 2008 budget submitted to Congress maintains fiscal discipline with a slight deficit of about 0.5 percent of GDP; includes a 10 percent increase for public employees.
  - Budget includes a multi-year fiscal framework aimed at achieving fiscal balance over a mid-term period.
  - PETROPAR faced stress from higher international oil prices but first-half profits expected to offset pressures.
- Monetary and financial developments:
  - Headline inflation declined from 12.5 percent in 2006 but remains volatile due to supply shocks; core inflation fell to 5 percent at end-June 2007 (in line with program target).
  - Following August spike, Central Bank increased LRM rates by 50 basis points.
  - Decline in dollarization implies greater domestic money demand; estimate for currency growth by end-2007 increased from 12 to 15 percent.
  - Demand shifted to longer-maturity Central Bank instruments.
  - By end-August 2007, international reserves rose to an unprecedented peak; expected to remain strong, reaching more than $2.25 billion (equivalent to more than 3 months of imports).
  - Financial system improvement: capital adequacy ratios around 20 percent; banks’ profits increased over 35 percent by end-June 2007; non-performing loans close to international standards.
- External developments:
  - Current account deficit narrowed as of end-June 2007 due to higher export growth (agricultural commodity prices) and slowdown in import growth.
  - Current account deficit largely financed by capital account surplus from higher foreign direct investments (mainly related to hydroelectric bi-national plants).
  - Exchange rate: guaraní appreciation expected to continue; in September guaraní appreciated by approximately 3 percent with respect to the U.S. dollar; Central Bank may intervene to avoid abrupt appreciation but significant interventions not foreseen.
- Structural reforms:
  - Medium-term strategy for the National Development Bank submitted to reorient operations, improve management, and reduce operational costs.
  - Plan to adopt at least 80 percent of the Basel Core Principles over the medium term: about 24 percent already in place, 16 percent to be adopted by end-2007; remaining 40 percent require legal framework changes.
  - Plan for strengthening the financial position of the Central Bank presented, including reconciliation of accounts and transfer equivalent to 0.2 percent of GDP per year to cover possible losses from monetary policy tools.
- Program changes and authorities’ requests:
  - Authorities requested reduction of access under the SBA from 65 to 30 percent of quota and a waiver of applicability for the end-September 2007 performance criteria.
  - Authorities reaffirm commitment to complete structural reforms to improve the business climate, promote investment and growth, and reduce poverty; commit to continued policy dialogue with IMF staff and Management.

*Source: IMF staff report and related statements (Press Release No.07/231) — October 15, 2007.*

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