## _cr10169

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---

### Executive Summary — Context and recent performance
- Real GDP grew by 5 percent a year in 2003–08.
- Government ran a sizable primary surplus in 2003–08 and cut public debt to less than 25 percent of GDP by end-2008.
- Central bank brought inflation down to 7.5 percent during 2008 while maintaining exchange rate flexibility.
- Net international reserves rose to almost US$3 billion by 2008.
- 2009 developments:
  - Real GDP declined by 3.8 percent.
  - Headline inflation fell to 2 percent.
  - Credit to the private sector slowed to 25 percent (y-o-y) by end-2009, down from a peak of 78 percent in May 2008.
  - Current account deficit narrowed to 1.3 percent of GDP.
  - REER declined by 5 percent in the first half of 2009.
  - Net capital inflows expanded to 5 ½ percent of GDP.
  - Net international reserves rose by US$1 billion in 2009, reaching US$3.8 billion (340 percent of short-term debt on remaining maturity basis and 25 percent of GDP).
- Central government fiscal stance in 2009:
  - Government expenditures increased by 25 percent in real terms.
  - Wage bill rose from 7.1 percent of GDP in 2008 to 8.4 percent of GDP in 2009.
  - Total revenues rose by almost 2 percent of GDP; royalties from hydroelectric power rose to 3.1 percent of GDP.
  - Primary surplus fell from 3.1 percent of GDP in 2008 to 0.7 percent of GDP in 2009.
  - Overall balance registered a surplus of 0.1 percent of GDP.
  - Fiscal impulse is estimated at 2 percent of GDP.
- Central bank policy in 2009:
  - Average policy interest rate fell from 4.0 percent at end-2008 to 0.6 percent in April 2009, then rose to 2.0 percent by mid-2009.
  - The guaraní depreciated by 13 percent vis-à-vis the U.S. dollar in 2009.
  - Central bank reduced reserve requirements, opened a new short term liquidity facility, and made partially sterilized purchases of foreign exchange.
- Financial sector indicators at end-2009:
  - Banking system capital adequacy ratio: 16.4 percent.
  - Tier 1 capital ratio: 10.1 percent.
  - Liquid assets equivalent to one third of total assets.
  - Non-performing loans in banks: 1.9 percent of total loans.
  - About 15 percent of total loans were restructured or refinanced.
  - Cooperatives account for one quarter of total financial system assets; cooperative NPLs rose to 8 percent of total loans by end-2009.
- Structural and institutional progress:
  - Law allowing government to capitalize the central bank in up to 6¼ percent of GDP through transfer of interest-bearing Treasury notes approved by Congress.
  - Strengthened tax administration (enforcing tax collection, re-establishing on-site tax audits).
  - Improved monitoring of public enterprises (re-established supervisory council; created specialized unit in ministry of finance).
  - Enhanced banking supervision, including a generic provisioning requirement of 0.5 percent.
- Political context:
  - Government of President Lugo lacks a majority coalition in congress.
  - In April 2009 congress delayed for another three years the implementation of the personal income tax originally approved in 2004.

### Outlook for 2010 and medium term projections
- 2010 projections and near-term outlook:
  - Real GDP expected to grow by 6.0 percent in 2010.
  - Inflation projected to increase from 1.9 percent in 2009 to 5 percent in 2010.
  - External current account deficit projected to expand to 1.7 percent of GDP in 2010.
  - Net international reserves projected to rise to US$4.1 billion (25 percent of GDP).
  - Bank credit to the private sector (25 percent of GDP baseline) projected to grow by 18 percent during 2010.
  - Broad money projected to expand by 19 percent in 2010.
  - First-quarter 2010 indicators point to renewed domestic demand momentum.
- Medium-term projections and commitments:
  - With institutional reforms, staff projects real GDP would grow by 4–5 percent a year in 2010–15.
  - By 2015 private investment and savings would recover to their 2004–05 ratios to GDP.
  - Central bank committed to lowering annual inflation to 3 percent by 2014.
  - External current account expected to register small deficits; sustained capital inflows would lead to steady gains in net international reserves.
  - Gradual real appreciation of the guaraní expected; indicators suggest the level of the guaraní is broadly in line with fundamentals.

### Key vulnerabilities and risks
- High exposure to swings in world commodity prices, demand in key trading partners, and weather cycles due to heavy dependence on agriculture and international trade.
- High dollarization in the financial system.
- Limited oversight of cooperatives.
- Fiscal risks from potential losses of public enterprises.
- Volatile inflation history; inflation expectations for end-2010 have come down to 5 percent.

### 2010 Article IV consultation and mission
- Discussions focused on institutional reforms with Fund technical assistance: adoption of a medium-term fiscal framework, adoption of an inflation targeting regime, and further enhancements to the macro-prudential framework.
- With these reforms, projections indicate real GDP would grow by 4−5 percent a year over the medium term and inflation would decline to 3 percent a year by 2014.
- 2010 Article IV consultation discussions held in Asunción during April 12–20.
- Mission composition: R. Rennhack (head), T. Dabán-Sánchez, S. Acosta-Ormaechea (all WHD), E. Crivelli (FAD), Sylwia Nowak (MCM); T. Roy (Resident Representative) assisted; J. Maciel (OED) participated.

### Short-term demand management (policy stance for 2010)
- Authorities and staff agreed to continue supporting the recovery in 2010 while removing some 2009 stimulus to keep inflation under control.
- Authorities expect the overall balance of the central government to be in equilibrium in 2010 (compared with a surplus of 0.1 percent of GDP in 2009), yielding a fiscal impulse of 0.3 percent of GDP.
- Total revenues expected to remain stable in relation to GDP:
  - Tax revenues to rise moderately.
  - Appreciation of the guaraní vis-à-vis the U.S. dollar would lower domestic currency value of royalties.
- Spending to remain stable in relation to GDP, reflecting increased conditional cash transfers to low-income households, increased pension payments, and scaled-back capital expenditures.
- Central bank intends to limit inflation to no more than 5 percent and will withdraw excess liquidity as necessary, driving up the policy interest rate.

### Fiscal reforms — medium-term fiscal strategy
- Objective: maintain a small primary surplus to keep public debt in the range of 20–25 percent of GDP over the medium term.
- Priorities within that constraint:
  - Raise spending on infrastructure and social programs while controlling growth of current spending.
  - Urgent infrastructure needs: upgrade transmission and distribution of electricity; improve quality of telephone landlines and internet connectivity; expand the road network.
  - Address poverty: 40 percent of the population below the poverty line; rural poor most affected by the 2009 drought.
  - Expand conditional cash transfer program (Tekopora extended from 15,000 to 100,000 families in 2009); further extension and improvements in basic health and education services warranted.
- Finance additional spending by aiming to raise the tax ratio to 15 percent of GDP over the medium term.

### Medium Term Fiscal Framework (MTFF) — progress and recommendations
- Progress made: formulation of a macro-fiscal model, reinforcement of human resources of the macro-fiscal unit, and preparation of a document outlining the government’s fiscal strategy.
- Staff recommendations:
  - Fully integrate the MTFF in the budget process.
  - Include realistic medium-term revenue projections.
  - Allow reconciliation of line ministries ceilings and macroeconomic constraints.
  - Envisage regular debt sustainability analysis.
  - Attach the MTFF and the government’s fiscal strategy paper to the draft budget to focus legislative discussion on medium-term constraints.
- Authorities committed to implement FAD recommendations and have requested further Fund assistance, especially on debt management issues.

### Improve quality of spending
- Staff encouraged development of performance-based budgeting to measure expenditure impact.
- Increase in the government’s wage bill during 2009 will lock in a higher level of current spending; authorities noted much additional employment was in social sectors.
- Agreement on the importance of restraining growth of current spending going forward.

### Manage additional compensations from Itaipu
- Projection: Revenues from Itaipu could rise by another 1.5 percent of GDP a year starting in 2010, once the Brazilian congress approves a 2009 agreement.
- Staff supports de-politicizing the use of additional revenues by law placing them in a special fund to:
  - Pay for high-return projects in infrastructure and technology.
  - Build up a countercyclical reserve fund.
- Staff suggestion: include a “permanent income clause” to allow the fund to provide a permanent source of income.
- Authorities intend to channel a significant share of payments to the reserve fund.

### Additional tax effort (Box 1) — measures and options
- Rationale: provide fiscal space for social programs and infrastructure and diversify revenue away from hydroelectric royalties projected to decline relative to GDP over the next 10‒15 years.
- Recent measure: October 2008 expanded the base of the income tax for the agricultural corporate sector (IMAGRO) by beginning to phase out the ability to deduct VAT payments from this tax; authorities expect this step to raise revenues by 1 percent of GDP a year over the next 3–4 years.
- Staff estimates: with this measure and continued administrative strengthening, tax revenues will grow by 1 to 1.5 percent of GDP by 2015.
- Policy options and staff views:
  - Explore a small tax on sales of agricultural products (as in Uruguay) — seen as second best.
  - Encourage extension of the VAT to agricultural products (currently exempt) and raise selective consumption taxes.
  - PIT viewed as important for efficiency and fairness despite congressional delay.

### Box 1 — Tax structure findings and recommendations (selected figures)
- Tax ratio: 12.7 percent of GDP (2008).
- VAT, excises, and import duties account for about 80 percent of total tax revenue (9.4 percent of GDP).
- Peers average about 60 percent (10.3 percent of GDP).
- Taxes on profits account for less than 20 percent of total revenue (versus 30 percent on average elsewhere).
- Recommendations: taxation of agriculture changes, streamline VAT reduced-rate items, phase out VAT exemption on agricultural products, apply excises to fewer products and gradually increase rates, introduce PIT.

### Public enterprise reform
- Context: 9 major public enterprises across sectors; problems include complex subsidies, excessive staffing, arrears with suppliers, and lack of transparency.
- Institutional steps: Re-established Supervisory Council of State-Owned Enterprises (August 2008) to set up and monitor performance agreements; proposed law to enhance council’s powers (quarterly financial reports, rationalizing staffing).
- Staff recommendations: explore private sector participation via capitalization or privatization; expose public enterprises to competition and consider public-private partnerships.

### Monetary policy reforms and transition to Inflation Targeting (IT)
- Central bank commitment: adopt an inflation-targeting framework over the medium term with MCM technical assistance.
- 2010 announcement: inflation target of 5 percent with a band of +/- 2.5 percent.
- Agreed approach: maintain a flexible exchange rate regime and limit FX intervention to counter disorderly markets; consider market-based mechanisms (e.g., auctions) for transparency.
- Essential elements for transition:
  - Continued fiscal discipline and careful control of banking system liquidity.
  - Recapitalization of the central bank via transfer of Treasury bonds per recently approved law; details to be decided by the central bank and ministry of finance; recapitalization should safeguard long-term solvency.
  - Strengthen central bank operational capacity: coordination with ministry of finance; improve forecasting and analytical models; strengthen domestic money market and secondary market in government securities; modernize payment system.
  - Transparency and communication: implement an explicit, forward-looking communication strategy.

### Monetary transmission and implementation challenges (Box 2)
- BCP policy instruments: open-market operations with sterilization bills (IRM), reserve requirements, short-term collateralized liquidity facility, occasional FX intervention.
- Implementation challenges: openness of economy (imported inflation and exchange rate importance); underdeveloped money markets; small stock of IRM; partial sterilization of FX purchases in 2009.
- Empirical results:
  - Increase in stock of open market instruments (a contraction of credit) reduces price level and output.
  - Increase in stock of net international reserves produces only a short-lived increase in output and prices.
  - Paraguay has a sizable exchange rate pass-through compared to Bolivia, Chile, Peru and Uruguay.

### Financial sector reforms and supervision
- Banking supervision strengthening recommended to improve information sharing among supervisors, strengthen licensing criteria for foreign banks, enhance credit risk assessments, set provisions for problem assets, establish exposure limits, improve internal control and audit, and improve off-site supervision.
- Expected outcome: bring banking supervision into compliance with about 50 percent of the Basel Core Principles; remaining gaps require amendments to banking law (weak bank governance; deficient sanctioning capacity; unclear “fit and proper” criteria).
- Deposit guarantee fund:
  - Current fund value: US$87 million.
  - 2003 law expected government contribution: about US$50 million in interest-free, non-negotiable bonds; government has contributed only US$26 million so far.
- National Development Bank:
  - Capital adequacy ratio: 35 percent.
  - Plans to focus on extending credit to small and medium enterprises while complying with prudential norms.
- Cooperatives supervision:
  - INCOOP strengthening with IDB and German association support: developing early warning system, strengthening reporting, planning a deposit guarantee fund and a lender of last resort.
  - Staff urged extension of prudential bank norms to cooperatives and cautioned that INCOOP’s governance lacks sufficient independence.

### Financial sector resilience and risks (selected figures)
- Banking system capital adequacy ratio series examples: 20.9, 20.5, 20.4, 20.1, 16.8, 16.3, 16.4, 18.0 (Table 8).
- NPLs/total loans series examples: 20.6, 10.8, 6.6, 3.3, 1.3, 1.1, 1.6, 1.7.
- Non-performing loans in banks: 1.9 percent of total loans (end-2009).
- Cooperative NPLs: 8 percent of total loans (end-2009).
- Private credit to GDP: rising trend since 1996 (figures provided).
- Dollarization: high foreign-to-domestic ratios for deposits and loans (figures provided).
- Banking system remains well capitalized with capital adequacy ratio well above the 10 percent regulatory minimum.

### External sector and balance of payments
- Current account:
  - Current account (percent of GDP) series: 0.3, 1.4, 1.8, -2.2, -1.3, -1.7, -1.5, -0.8, -0.3, -0.1, 0.1 (series as presented).
  - Current account deficit narrowed in 2009 while capital account surplus expanded.
  - Current account balance projected to post a small deficit of 1.7 percent of GDP in 2010.
- Reserves and trade:
  - Net international reserves (millions of US$) series: 1,298; 1,703; 2,462; 2,864; 3,861; 4,133; 4,257; 4,404; 4,554; 4,689; 4,828 (Table 1/Table 6).
  - Gross reserves (millions of US$) series: 1,168; 1,297; 1,703; 2,462; 2,864; 3,861; 4,133; 4,257; 4,404; 4,554; 4,689; 4,828 (Table 6).
  - Exports (fob) and Imports (cif) saw strong Q1 2010 performance, especially imports; 2009 annual changes: Exports (fob) -25.6; Imports (cif) -23.6.

### APPENDIX 1 — Real exchange rate assessment (selected figures)
- REER depreciated about 7 percent in 2009 y-o-y.
- CGER misalignment estimates (Table A1.1. In percent):
  - I. MB approach: -5.5
  - II. ES approach: -1.9
  - III. ERER approach: 2.9
  - IV. Average I–III: -1.5
- MB approach suggests guaraní about 5.5 percent undervalued in real effective terms.
- ES approach indicates slight undervaluation; NFA position end-2009: -15 percent of GDP.
- ERER approach indicates REER slightly overvalued by about 2.9 percent vs long-run equilibrium; mild undervaluation of about 1.4 percent vs current equilibrium.

### APPENDIX 2 — Debt sustainability analysis (selected findings and scenarios)
- 70 percent of total external debt is public debt and 85 percent of public debt is denominated in foreign currency.
- As of end-2009, total outstanding public debt (excluding central bank’s bills) is about 18 percent of GDP, of which 85 percent corresponds to external debt.
- Baseline projections: Debt-to-GDP ratio declining to about 13 percent of GDP by 2015.
- Alternative scenarios:
  - If tax revenues do not increase from 12.9 to 14.0 percent of GDP (baseline assumption), debt level would stay constant at about 16 percent.
  - Under most adverse scenarios (low growth, 30 percent depreciation, contingent liabilities), debt would rise to the range of 18–22 percent of GDP by 2015, with risks of an explosive path if low growth persists.
- External debt projected to stay below 20 percent of GDP over the medium term.
- Stress-test note: A 30 percent currency depreciation would raise the debt-to-GDP ratio by about 11 percentage points in that year or about 8 percentage points over the medium term.

### Real sector, fiscal, monetary, and social indicators (selected exact figures)
- Real GDP growth rates:
  - 2004: 4.1
  - 2005: 2.9
  - 2006: 4.3
  - 2007: 6.8
  - 2008: 5.8
  - 2009: -3.8
  - 2010 (proj.): 6.0
  - 2011 (proj.): 4.0
- Consumer prices (end of period):
  - 2004: 2.8
  - 2005: 9.8
  - 2006: 12.5
  - 2007: 5.9
  - 2008: 7.5
  - 2009: 1.9
  - 2010 (proj.): 5.0
  - 2011 (proj.): 4.5
- Net international reserves (millions of US$):
  - 2004: 1,168
  - 2005: 1,298
  - 2006: 1,703
  - 2007: 2,462
  - 2008: 2,864
  - 2009: 3,861
  - 2010 (proj.): 4,133
  - 2011 (proj.): 4,257
- Current account (percent of GDP):
  - 2004: 2.1
  - 2005: 0.3
  - 2006: 1.4
  - 2007: 1.8
  - 2008: -2.2
  - 2009: -1.3
  - 2010 (proj.): -1.7
  - 2011 (proj.): -1.5
- Central Government revenues (percent of GDP):
  - 2004: 18.4
  - 2005: 18.2
  - 2006: 18.3
  - 2007: 17.6
  - 2008: 17.3
  - 2009: 19.2
  - 2010 (proj.): 19.1
  - 2011 (proj.): 19.0
- Central Government overall balance (percent of GDP):
  - 2004: 2.0
  - 2005: 0.6
  - 2006: 0.1
  - 2007: 0.9
  - 2008: 2.5
  - 2009: 0.1
  - 2010 (proj.): 0.0
  - 2011 (proj.): -0.2
- Consolidated public debt (percent of GDP):
  - 2004: 48.8
  - 2005: 42.7
  - 2006: 34.1
  - 2007: 28.2
  - 2008: 23.2
  - 2009: 22.5
  - 2010 (proj.): 22.2
  - 2011 (proj.): 22.3
- Population 2009: 6.2 (millions).
- Gini index (2007/2008): 58.4.
- Unemployment rate (2009): 5.7.
- Life expectancy at birth (2007, Proj.): 71.7.
- Percentage of population below the poverty line (2009): 37.9.
- Adult illiteracy rate (2008): 5.2.
- GDP per capita (US$, 2009): 2,317.5.
- Agricultural production accounts for about one quarter of the economy.

### Data, statistical issues, and ROSC follow-up
- Data provision to the Fund has some shortcomings, but is broadly adequate for surveillance.
- National accounts: estimates broadly consistent with 1993 SNA; data collection gaps and methodological weaknesses identified (1994 reference year needs updating; excessive use of fixed coefficients; changes in inventories obtained residually; informal activities not monitored; supply and use tables compiled only until 1997).
- Timeliness: annual GDP data disseminated with a lag of 11 months.
- CPI and PPI: CPI updated using 2005–06 household budget survey since January 2008; CPI geographic coverage limited to Asunción; PPI base weights dated December 1995 and lacks coverage of electricity, water, gas, and services.
- Monetary data: unified compilation and reporting system established; lack of coverage of credit cooperatives remains a concern (account for around ¼ of deposits and loans).
- Balance of payments: follows BPM5; quarterly and annual data available from 2001; deficiencies remain in recording private capital outflows and unregistered trade.
- ROSC mission follow-up: authorities’ response to the 2006 ROSC published on June 30.

### Staff appraisal and Directors’ recommendations (selected)
- 2009: authorities managed the drought and global financial crisis reasonably well; shifted to countercyclical policies and continued structural reforms.
- Policy advice:
  - Central bank should withdraw excess liquidity quickly and lift the policy interest rate above expected inflation to signal commitment to the inflation goal.
  - Central government should monitor growth of spending and keep fiscal accounts balanced to support monetary efforts.
- Directors’ main conclusions:
  - Commended authorities for preserving macroeconomic stability in 2009 and adopting countercyclical policies.
  - Emphasized fiscal reforms: adopt MTFF; curtail current spending; strengthen tax administration and broaden tax base (including agribusiness); implement PIT without further delay; enhance public enterprise efficiency including via PPPs.
  - Monetary and financial sector recommendations: withdraw excess liquidity and raise policy interest rate above expected inflation; adopt IT framework over medium term; early implementation of central bank recapitalization law; develop secondary markets for government securities; strengthen supervision of cooperatives and move toward a unified supervisory framework; improve compliance with Basel Core Principles.

*Source: IMF staff report content unit _cr10169.*

### Executive Summary

### Executive Summary

### Context and recent performance
- Real GDP grew by 5 percent a year in 2003–08, supported by sound demand policies and structural reforms.
- The government ran a sizable primary surplus in 2003–08 and cut public debt to less than 25 percent of GDP by end-2008.
- The central bank brought inflation down to 7.5 percent during 2008 while maintaining exchange rate flexibility.
- Net international reserves rose to almost US$3 billion by 2008.
- In 2009, a severe drought and the global financial crisis triggered a recession; real GDP declined by 3.8 percent.
- Headline inflation fell to 2 percent in 2009.
- Credit to the private sector slowed to 25 percent (y-o-y) by end-2009, down from a peak of 78 percent in May 2008.
- The current account deficit narrowed to 1.3 percent of GDP in 2009.
- The real effective exchange rate (REER) declined by 5 percent in the first half of 2009.
- Net capital inflows expanded to 5 ½ percent of GDP in 2009.
- Net international reserves rose by US$1 billion in 2009, reaching US$3.8 billion (340 percent of short-term debt on remaining maturity basis and 25 percent of GDP).
- The central government fiscal stance in 2009:
  - Government expenditures increased by 25 percent in real terms.
  - The wage bill rose from 7.1 percent of GDP in 2008 to 8.4 percent of GDP in 2009.
  - Total revenues rose by almost 2 percent of GDP, partly due to a jump in income tax collections and royalties from hydroelectric power rising to 3.1 percent of GDP.
  - The primary surplus fell from 3.1 percent of GDP in 2008 to 0.7 percent of GDP in 2009.
  - The overall balance registered a surplus of 0.1 percent of GDP.
  - The fiscal impulse is estimated at 2 percent of GDP.
- Central bank policy in 2009:
  - The average policy interest rate fell from 4.0 percent at end-2008 to 0.6 percent in April 2009, then rose to 2.0 percent by mid-2009.
  - The guaraní depreciated by 13 percent vis-à-vis the U.S. dollar in 2009.
  - The central bank reduced reserve requirements, opened a new short term liquidity facility, and made partially sterilized purchases of foreign exchange.
- Financial sector in 2009:
  - Banking system capital adequacy ratio: 16.4 percent at end-2009.
  - Tier 1 capital ratio: 10.1 percent at end-2009.
  - Liquid assets equivalent to one third of total assets.
  - Non-performing loans in banks: 1.9 percent of total loans.
  - About 15 percent of total loans were restructured or refinanced.
  - Cooperatives account for one quarter of total financial system assets; cooperative non-performing loans rose to 8 percent of total loans by end-2009.
- Structural and institutional progress since last Article IV:
  - Congress approved law allowing government to capitalize the central bank in up to 6¼ percent of GDP through transfer of interest-bearing Treasury notes.
  - Strengthened tax administration (enforcing tax collection, re-establishing on-site tax audits).
  - Improved monitoring of public enterprises (re-established supervisory council; created specialized unit in ministry of finance).
  - Enhanced banking supervision, including a generic provisioning requirement of 0.5 percent.
- Political context:
  - The government of President Lugo lacks a majority coalition in congress.
  - In April 2009 congress delayed for another three years the implementation of the personal income tax originally approved in 2004.

### Outlook for 2010 and medium term projections
- 2010 projections and near-term outlook:
  - Real GDP is expected to grow by 6.0 percent in 2010.
  - Inflation is projected to increase from 1.9 percent in 2009 to 5 percent in 2010.
  - External current account deficit projected to expand to 1.7 percent of GDP in 2010.
  - Net international reserves projected to rise to US$4.1 billion (25 percent of GDP).
  - Bank credit to the private sector (25 percent of GDP baseline) projected to grow by 18 percent during 2010.
  - Broad money projected to expand by 19 percent in 2010.
  - First-quarter 2010 indicators (tax collections, imports of capital and durable consumer goods, credit to private sector) point to renewed domestic demand momentum.
- Medium-term projections and policy commitments:
  - With institutional reforms, staff projects real GDP would grow by 4–5 percent a year in 2010–15.
  - By 2015 private investment and savings would recover to their 2004–05 ratios to GDP.
  - The central bank is committed to lowering annual inflation to 3 percent by 2014.
  - External current account expected to register small deficits; sustained capital inflows would lead to steady gains in net international reserves.
  - A gradual real appreciation of the guaraní is expected; available indicators suggest the level of the guaraní is broadly in line with fundamentals (see Appendix 1).
- Key vulnerabilities and risks:
  - High exposure to swings in world commodity prices, demand in key trading partners, and weather cycles due to heavy dependence on agriculture and international trade.
  - High dollarization in the financial system.
  - Limited oversight of cooperatives.
  - Fiscal risks from potential losses of public enterprises.
  - Inflation history is volatile; inflation expectations for end-2010 have come down to 5 percent.

### 2010 Article IV consultation and mission
- Discussions centered on advancing an agenda of institutional reforms, drawing heavily on Fund technical assistance, including:
  - Adoption of a medium-term fiscal framework.
  - Adoption of an inflation targeting regime.
  - Further enhancements to the macro-prudential framework.
- With these reforms, projections indicate real GDP would grow by 4−5 percent a year over the medium term, and inflation would decline to 3 percent a year by 2014.
- The 2010 Article IV consultation discussions were held in Asunción during April 12–20.
- The mission comprised R. Rennhack (head), T. Dabán-Sánchez, S. Acosta-Ormaechea (all WHD), E. Crivelli (FAD), and Sylwia Nowak (MCM). T. Roy (Resident Representative) assisted the mission, and J. Maciel (OED) participated in the meetings.
- The mission met with Vice President Franco, Minister Borda, Central Bank Governor Corvalán, congressional leaders, senior government officials and representatives of the private sector and the donor community.

### Short-term demand management (policy stance for 2010)
- Authorities and staff agreed demand policies should continue supporting the recovery in 2010, with some removal of 2009 stimulus to keep inflation under control.
- Authorities expect the overall balance of the central government to be in equilibrium in 2010 (compared with a surplus of 0.1 percent of GDP in 2009), yielding a fiscal impulse of 0.3 percent of GDP.
- Total revenues expected to remain stable in relation to GDP:
  - Tax revenues to rise moderately.
  - Appreciation of the guaraní vis-à-vis the U.S. dollar would lower domestic currency value of royalties.
- Spending to remain stable in relation to GDP, reflecting:
  - Increased conditional cash transfers to low-income households.
  - Increased pension payments.
  - Scaled-back capital expenditures.
- Central bank intends to limit inflation to no more than 5 percent and will withdraw excess liquidity as necessary, driving up the policy interest rate (currently less than expected inflation).

### Fiscal reforms (medium-term fiscal strategy)
- Authorities agreed fiscal reforms should maintain a small primary surplus to keep public debt in the range of 20–25 percent of GDP over the medium term (see Appendix 2).
- Within that constraint, intended priorities:
  - Raise spending on infrastructure and social programs while controlling growth of current spending.
  - Urgent infrastructure needs: upgrade transmission and distribution of electricity; improve quality of telephone landlines and internet connectivity; expand the road network.
  - Address poverty (40 percent of the population); rural poor were most affected by the 2009 drought.
  - Expand conditional cash transfer program (Tekopora extended from 15,000 to 100,000 families in 2009); further extension and improvements in basic health and education services warranted, subject to control mechanisms and financing constraints.
- To finance additional spending, aim to raise the tax ratio to 15 percent of GDP over the medium term.

*IMF staff report: Executive Summary (2010 Article IV consultation).*

### 14.      The key fiscal reforms include:

### _cr10169 - 14.      The key fiscal reforms include:

### Medium Term Fiscal Framework (MTFF)
- Progress made: formulation of a macro-fiscal model, reinforcement of human resources of the macro-fiscal unit, and preparation of a document outlining the government’s fiscal strategy.
- Staff recommendations:
  - Fully integrate the MTFF in the budget process.
  - Include realistic medium-term revenue projections.
  - Allow reconciliation of line ministries ceilings and macroeconomic constraints.
  - Envisage regular debt sustainability analysis.
  - Attach the MTTF and the government’s fiscal strategy paper to the draft budget to focus legislative discussion on medium-term constraints.
- Authorities’ position: committed to implement FAD recommendations and have requested further Fund assistance, especially on debt management issues.

### Improve quality of spending
- Staff encouraged development of performance-based budgeting to measure expenditure impact.
- Observation: increase in the government’s wage bill during 2009 will lock in a higher level of current spending.
- Authorities’ explanation: much additional employment was in social sectors to improve delivery of services.
- Agreement: importance of restraining growth of current spending going forward.

### Manage additional compensations from Itaipu
- Projection: Revenues from Itaipu could rise by another 1.5 percent of GDP a year starting in 2010, once the Brazilian congress approves a 2009 agreement.
- Staff support: de-politicize use of additional revenues by law placing them in a special fund to:
  - Pay for high-return projects in infrastructure and technology.
  - Build up a countercyclical reserve fund.
- Staff suggestion: include a “permanent income clause” to allow the fund to provide a permanent source of income.
- Authorities intend to channel a significant share of payments to the reserve fund.

### Additional tax effort (Box 1)
- Rationale: Additional tax revenues would provide more fiscal space for social programs and infrastructure and diversify revenue away from hydroelectric royalties projected to decline sharply relative to GDP over the next 10‒15 years.
- Recent measures:
  - October 2008: expanded the base of the income tax for the agricultural corporate sector (IMAGRO) by beginning to phase out the ability to deduct VAT payments from this tax.
  - Authorities expect this step to raise revenues by 1 percent of GDP a year over the next 3–4 years.
- Staff estimates: with this measure and continued administrative strengthening, tax revenues will grow by 1 to 1.5 percent of GDP by 2015.
- Policy options and staff views:
  - Explore introduction of a small tax on sales of agricultural products (as in Uruguay) — seen as second best.
  - Encourage extension of the VAT to agricultural products (currently exempt) and raise selective consumption taxes.
  - Authorities noted strong political resistance to extending VAT to agricultural products.
  - Personal Income Tax (PIT) viewed as important for a more efficient and fairer tax system and to enhance VAT administration, despite a recent congressional decision to delay implementation.

### Box 1 — Key tax structure findings and recommendations
- Paraguay’s tax ratio and composition:
  - Tax ratio: 12.7 percent of GDP (2008).
  - VAT, excises, and import duties account for about 80 percent of total tax revenue (9.4 percent of GDP).
  - By comparison, peers average about 60 percent (10.3 percent of GDP).
  - Taxes on profits account for less than 20 percent of total revenue (versus 30 percent on average elsewhere).
- Recommendations to bring tax ratio in line with peers:
  - Taxation of agriculture: disallow deductions for expenses other than business costs and inventory losses; implement unified regime for big and medium-size properties; consider a sales tax on some agricultural products at a rate of 2–3 percent.
  - VAT: streamline reduced-rate items (5 percent rate) and exemptions; phase out exemption on agricultural products.
  - Excises: apply to fewer products and gradually increase rates to regional standards (especially tobacco and alcohol).
  - PIT: introduce to formalize the economy, strengthen administration, diversify the tax structure, and add progressivity.

### Public enterprise reform
- Context: 9 major public enterprises across sectors; problems include complex subsidies, excessive staffing, arrears with suppliers, and lack of transparency.
- Institutional steps:
  - Re-established Supervisory Council of State-Owned Enterprises (August 2008) to set up and monitor performance agreements.
  - Authorities will propose a law to enhance the council’s powers to require improvements, including publishing quarterly financial reports and rationalizing staffing levels.
- Staff recommendations:
  - Explore private sector participation via capitalization or privatization.
  - Expose public enterprises to competition and consider public-private partnerships to improve efficiency.

### Monetary Policy Reforms
- Central bank commitment: adopt an inflation-targeting (IT) framework over the medium term with MCM technical assistance.
- 2010 announcement: inflation target of 5 percent with a band of +/- 2.5 percent.
- Agreed approach: maintain a flexible exchange rate regime and limit foreign exchange intervention to counter disorderly markets; consider market-based mechanisms (e.g., auctions) to strengthen transparency of intervention.
- Essential elements for transition to IT:
  - Continued fiscal discipline and careful control of banking system liquidity.
  - Recapitalization of the central bank: transfer of Treasury bonds to capitalize the central bank per recently approved law; details (maturities and interest rates) to be decided by the central bank and ministry of finance; recapitalization should safeguard long-term solvency.
  - Strengthen central bank operational capacity by:
    - Strengthening coordination with the ministry of finance.
    - Improving forecasting and analytical models.
    - Strengthening the domestic money market, especially a secondary market in domestic government securities.
    - Modernizing the payment system.
  - Transparency and communication: implement an explicit, forward-looking communication strategy.

### Financial Sector Reforms
- Banking supervision strengthening (in line with MCM recommendations):
  - Modify regulations to improve information sharing among supervisors, strengthen licensing criteria for foreign banks, enhance credit risk assessments, set provisions for problem assets, establish exposure limits, improve internal control and audit within banks, and improve off-site supervision.
  - Expected outcome: bring banking supervision into compliance with about 50 percent of the Basel Core Principles.
  - Remaining gaps require amendments to the banking law (weak bank governance; deficient sanctioning capacity of the superintendence of banks; unclear “fit and proper” criteria).
- Deposit guarantee fund:
  - Current fund value: US$87 million.
  - 2003 law expected government contribution: about US$50 million in interest-free, non-negotiable bonds; government has contributed only US$26 million so far.
- National Development Bank:
  - Capital adequacy ratio: 35 percent.
  - Plans to focus on extending credit to small and medium enterprises while complying with prudential norms.
- Cooperatives supervision:
  - INCOOP institutional strengthening with IDB and German association support: developing early warning system, strengthening reporting, enhancing procedures, planning a deposit guarantee fund and a lender of last resort for cooperatives.
  - Staff urged extension of prudential bank norms to cooperatives to limit regulatory arbitrage and cautioned that INCOOP’s governance lacks sufficient independence.

### Box 2 — Monetary transmission findings
- BCP framework: objectives include preservation of price and financial sector stability; 2010 inflation target of 5 percent within band of +/- 2.5 percent.
- Policy instruments: open-market operations with sterilization bills (IRM), reserve requirements, short-term collateralized liquidity facility, occasional foreign exchange intervention.
- Implementation challenges:
  - Openness of economy makes imported inflation and exchange rate important for inflation.
  - Underdeveloped money markets with very little secondary market trading of government securities.
  - Small stock of IRM makes injection of liquidity harder than withdrawal.
  - BCP relied on partially sterilized foreign exchange purchases in 2009 for countercyclical policy.
- Empirical results:
  - An increase in the stock of open market instruments (a contraction of credit) reduces price level and output.
  - An increase in the stock of net international reserves produces only a short-lived increase in output and prices.
  - Paraguay has a sizable exchange rate pass-through compared to Bolivia, Chile, Peru and Uruguay.

### Other issues
- Promote FDI by improving business climate: streamline business registration procedures, improve judicial effectiveness and predictability, reinforce property rights, upgrade creditor registries and bankruptcy procedures.
- Ongoing potential investment: government discussing an agreement with a private company considering an aluminum smelter, which would lead to a sharp rise in FDI.
- Foster export diversification by improving farming methods and encouraging adoption of international quality standards.

### Staff Appraisal (summary)
- 2009: authorities managed severe drought and global financial crisis reasonably well; shifted demand policies to a countercyclical stance and continued structural reforms (tax administration, public enterprise monitoring, financial supervision).
- By end-2009: inflation expectations for end-2010 declined to 5 percent, in line with central bank objective.
- Policy advice:
  - Central bank should withdraw excess liquidity quickly and lift the policy interest rate above the expected rate of inflation to signal commitment to the inflation goal.
  - Central government should monitor growth of spending and keep fiscal accounts balanced to support monetary efforts.
- Outlook: Provided institutional reform agenda advances, real GDP would grow by 4–5 percent a year over the medium term, supported by steady growth in exports and private investment, while inflation and the external position would remain under control.

*Source: IMF staff report content unit _cr10169 - 14.      The key fiscal reforms include:*

### 23.      Fiscal reforms should focus on increasing the tax ratio, strengthening fiscal

### Fiscal reforms should focus on increasing the tax ratio, strengthening fiscal management and reducing fiscal risks

### Fiscal framework, tax policy, and fiscal risks
- Top priority: develop a medium term fiscal framework to keep public debt in the range of 20−25 percent of GDP.
- Control the growth of current spending and press for higher taxes to preserve sufficient room for public investment and social spending.
- Continue strengthening tax administration and broadening the tax base, especially by increasing taxation on agribusiness activities.
- Staff welcomes recent steps to broaden the base of the current tax on agriculture income and success in improving customs administration.
- De-politicize the use of additional revenues from Itaipu.
- Enhance the efficiency of public enterprises; current poor operation of these enterprises reduces competitiveness in:
  - electricity distribution,
  - sales of petroleum products,
  - telecommunications,
  - other sectors critical for growth.

### Monetary policy and central bank actions
- Staff welcomes the central bank’s commitment to adopt an inflation-targeting framework in the next few years to enhance monetary policy credibility and provide a transparent communication framework.
- Implement without delay the recently-approved law for the recapitalization of the central bank.
- Strengthen liquidity management through:
  - better coordination with the ministry of finance,
  - development of secondary markets for government securities.
- Staff supports the authorities’ intention to maintain exchange rate flexibility for the guaraní, which appears to be at a level consistent with its fundamentals.

### Financial supervision and regulatory harmonization
- The financial system has coped well with the global financial crisis and remains solid and solvent.
- Significant disparities exist in regulatory and supervisory practices between banks and cooperatives.
- Central bank plans to improve compliance with the Basel Core Principles through regulatory modifications are welcomed; these will help preserve the quality of bank loans amid the ongoing recovery in credit.
- INCOOP, the supervising agency of the cooperatives, has achieved a few procedural advances, but cooperative-provided information still lacks scope and timeliness.
- Address the potential for conflict of interest inherent to the self-regulatory design of the cooperatives’ regulatory framework to achieve qualitative improvements in supervision.
- Advise extending prudential norms for banks to cooperatives to limit regulatory arbitrage and move towards a unified supervisory framework for all financial institutions.

*Source: IMF staff assessment in the provided chapter.*

### 26.      Consultation. The staff proposes that the next Article IV Consultation take place

### 26.      Consultation. The staff proposes that the next Article IV Consultation take place 

### Real sector: developments and outlook
- GDP contracted significantly through mid-2009, mainly because of the drought; after contracting by 6 percent by mid-2009, the economy started to stabilize in Q3 2009 and rebounded in the first quarter of 2010.
- Real GDP projections and recent estimates:
  - Real GDP contracted by 3.8 percent in 2009 (text: "helped to limit the GDP contraction at 3.8 percent").
  - Real GDP is projected to grow by 6 percent in 2010 (text: "real GDP is projected to expand by 6 percent in 2010").
- Sector contributions:
  - Strong rebound in agriculture expected in 2010; agriculture, livestock, secondary, and services show variable historic contributions (figures provided).
- Inflation:
  - Annual inflation declined substantially in 2009 and started to pick up; core inflation at 3.2 percent in April 2010.
  - Annual inflation is estimated to reach 5 percent in 2010.

### Fiscal developments
- Countercyclical fiscal policy in 2009:
  - The authorities adopted a countercyclical budget in 2009, imparting a 2 percent fiscal stimulus into the economy (text: "which imparted a 2 percent fiscal stimulus into the economy, which will be removed in 2010").
  - The stimulus concentrated on capital expenditures, especially in the second half of 2009 and first quarter of 2010.
  - With recovery, tax collections are picking up and the fiscal stimulus will be gradually removed.
- Public debt and composition:
  - Paraguay's public debt remains low but concentrated on external debt, most of which is denominated in foreign currency-denominated loans.
  - Public Debt (Percent of GDP) shown in historical series; consolidated public debt figures in Table 1 include: 42.7, 34.1, 28.2, 23.2, 22.5, 21.7, 21.0, 20.5, 19.9, 19.1, 18.3 (as presented in the consolidated public debt row).
- Fiscal indicators and balances (selected figures taken verbatim from tables):
  - Central Government revenues and expenditures (in percent of GDP and in billions of Guaraníes) are provided in Tables 2 and 3.
  - Central Government overall balance: 0.6, 0.1, 0.9, 2.5, 0.1, 0.0, -0.2, -0.2, -0.2, -0.1, -0.1 (series from Table 1).
  - Primary balances and financing details shown in Tables 2 and 3 (primary balance examples: 2.7, 1.9, 1.5, 1.8, 3.1, 0.7, 0.5, 0.4).

### Monetary policy and liquidity
- 2009 monetary stance:
  - Monetary policy in 2009 focused on providing ample liquidity through interventions that were partially sterilized; the authorities implemented a very accommodative monetary policy, with reductions in the policy rate.
  - Resulted in a large accumulation of international reserves and excess liquidity that will need to be mopped up in 2010.
- Reserves and intervention:
  - Net international reserves (NIR) series (in millions of U.S. dollars): 1,298; 1,703; 2,462; 2,864; 3,861; 4,133; 4,257; 4,404; 4,554; 4,689; 4,828 (Table 1 / Table 6).
  - NIR in months of imports (left axis in figures): 2.9, 3.1, 3.1, 4.7, 4.9, 5.1, 4.9, 4.7, 4.6, 4.4, 4.1 (series as presented).
- Banking system liquidity and instruments:
  - Large accumulation of liquidity in the banking system; Letras de Regulación Monetaria (LRM) and free reserves at the BCP (percent of base money) rose (figures).
  - Monetary base and narrow monetary base growth (Table 4): Monetary base levels and annual growth (e.g., Monetary base: 4,006; 4,180; 4,724; 6,390; 7,548; 10,113; 10,821; 11,151 with annual growth rates 17.6, 4.3, 13.0, 35.3, 18.1, 34.0, 7.0, 3.1).

### Financial system resilience and risks
- Overall assessment:
  - The financial sector held up relatively well during the downturn, reflecting low integration with international financial markets and improvements in prudential regulations.
  - Important weaknesses remain in the lightly supervised and poorly monitored cooperative sector, which has grown significantly in recent years.
- Main risks identified (verbatim):
  - "The main risks are the financial dollarization of the banking system, which although declining, still remains high..."
  - "...the still quite low maturity of Paraguay's banking deposits, ..."
  - "...and the lightly supervised cooperative sector, which has grown significantly in the last few years."
- Banking indicators (selected numbers from tables and figures):
  - Capital Adequacy Ratio (Percent) series and levels by subgroups shown (examples in Table 8: overall system CAR values such as 20.9, 20.5, 20.4, 20.1, 16.8, 16.3, 16.4, 18.0).
  - NPL ratios and profitability: NPLs/total loans series shown (e.g., overall system: 20.6, 10.8, 6.6, 3.3, 1.3, 1.1, 1.6, 1.7); rate of return on assets (ROA) and return on equity (ROE) series presented.
  - Private credit to GDP: Paraguay Private Credit (Percent of GDP) historical series in figures (e.g., rising trend from 1996 onward).
  - Dollarization: foreign to domestic ratios for deposits and loans series shown (figure with values across years).
  - Banking system remains well capitalized with capital adequacy ratio well above the 10 percent regulatory minimum (text: "with a capital adequacy ratio well above the 10 percent regulatory minimum").

### External sector and balance of payments
- Current account and capital flows:
  - The current account deficit narrowed significantly in 2009 while the surplus of the capital account expanded.
  - The current account balance is projected to post a small deficit of 1.7 percent of GDP in 2010 (text: "The current account balance is projected to post a small deficit of 1.7 percent of GDP in 2010").
  - FDI and other private capital inflows are expected to continue in 2010.
- Trade and reserves:
  - Exports and imports performed strongly in Q1 2010, especially imports; exports' weak performance in 2009 was more than compensated by a decrease in imports.
  - Accumulation of reserves in 2009 continued into 2010, albeit at a more moderate pace than in 2009.
  - Real Effective Exchange Rate depreciated in 2009 and "remains in line with fundamentals."
- Selected balance of payments figures (from Table 6 and Table 1):
  - Current account (percent of GDP) series: 0.3, 1.4, 1.8, -2.2, -1.3, -1.7, -1.5, -0.8, -0.3, -0.1, 0.1 (series as presented).
  - Gross reserves (in millions of U.S. dollars): 1,168; 1,297; 1,703; 2,462; 2,864; 3,861; 4,133; 4,257; 4,404; 4,554; 4,689; 4,828 (Table 6).
  - Exports (fob) and Imports (cif) percentage changes and levels provided in Table 1 (e.g., Exports (fob) series including -25.6 for 2009; Imports (cif) -23.6 for 2009 in the annual series).

### Social and macro indicators (selected)
- Population 2009: 6.2 (millions).
- Gini index (2007/2008): 58.4.
- Unemployment rate (2009): 5.7.
- Life expectancy at birth (2007, Proj.): 71.7.
- Percentage of population below the poverty line (2009): 37.9.
- Adult illiteracy rate (2008): 5.2.
- Rank in UNDP development index (2008): 98 of 179.
- GDP per capita (US$, 2009): 2,317.5.
- Key time-series included for Income and prices, Monetary sector, External sector, and fiscal aggregates (full series provided in the tables).

### Policy and institutional notes
- Policy adjustments recommended by the narrative:
  - Gradual removal of the 2009 fiscal stimulus in 2010 as recovery takes hold (text: "the fiscal stimulus will be gradually removed").
  - Mop up excess liquidity accumulated in 2009 as the recovery gathers momentum (text: "the resulting excess liquidity will need to be mopped up in 2010").
  - Strengthen supervision and monitoring of cooperatives to address weaknesses in the cooperative sector (text references cooperative supervision weaknesses).
- Consultation timing:
  - "The staff proposes that the next Article IV Consultation take place within the 12-month cycle."

*Sources: Paraguayan Authorities and Fund staff estimates (figures, tables, and text as provided in the content unit).*

### APPENDIX 1. PARAGUAY’S REAL EXCHANGE RATE ASSESSMENT

### APPENDIX 1. PARAGUAY’S REAL EXCHANGE RATE ASSESSMENT

### Recent exchange rate developments
- The REER appreciation trend since 2005 was interrupted by the global financial turmoil and the severe drought that started to affect the Paraguayan economy around 2008Q3.
- The REER depreciated about 7 percent in 2009 y-o-y, mainly driven by the significant depreciation of the guaraní against the U.S. dollar in the period.
- Since mid-2009, and consistent with the recovery of the economy and the emergence of significant capital inflows, the guaraní started to appreciate against the U.S. dollar, and has remained stable since early 2010.
- The REER closely follows nominal exchange rate movements against the U.S. dollar, and reached a level somewhat close to its historical average as of February 2010, and somewhat below its pre-crisis level.

### CGER methodologies and misalignment estimates
- Standard CGER methodologies suggest Paraguay’s REER is broadly in line with fundamentals, yet slightly biased towards an undervaluation. None of the methodologies indicates a major misalignment.
- Table A1.1. Real exchange rate deviation from equilibrium (In percent):
  - I. MB approach: -5.5
  - II. ES approach: -1.9
  - III. ERER approach: 2.9
  - IV. Average I–III: -1.5
  - (Overvaluation (+); Undervaluation (-))

### Macroeconomic balance (MB) approach
- The MB approach suggests the guaraní is about 5.5 percent undervalued in real effective terms.
- This estimation considers the difference between the underlying current account (CA) balance in 2009 (-0.4 percent of GDP)—which takes the CA balance in that year (-1.3 percent of GDP) stripping away several transitory factors such as the lower import and export values induced by the drought—and Paraguay’s CA norm (-2.16 percent of GDP).

### External sustainability (ES) approach
- The ES approach indicates the REER is slightly undervalued.
- The estimation assumes Paraguay’s net foreign assets (NFA) position remains at its end-2009 level (-15 percent of GDP).
- Accordingly, the stabilizing CA balance at the benchmark level of NFA, roughly -1 percent of GDP, requires a REER appreciation of about 1.9 to close the gap with the underlying CA.

### Equilibrium real exchange rate (ERER) approach
- A direct estimation of the ERER considering long-run determinants indicates the REER is slightly overvalued by about 2.9 percent when comparing the REER as of February 2010 against its long-run equilibrium level.
- Comparing the REER against its current equilibrium level, this approach points to a mild undervaluation of about 1.4 percent.
- The approach shows the REER appreciation that started in 2005 led to a moderate overvaluation relative to equilibrium around 2008, which was later reversed.

---

### APPENDIX 2. DEBT SUSTAINABILITY ANALYSIS

### General assessment
- The dynamics of Paraguay’s external and public debt levels are very similar: 70 percent of total external debt is public debt and 85 percent of the public debt is denominated in foreign currency.
- Both external and public debt levels are low and robust to alternative scenarios for the underlying macroeconomic variables.
- Setting key variables at their historical averages gives rise to debt levels below those of the baseline scenario.
- Temporary negative shocks to key variables (interest rates, the exchange rate, and real GDP growth) increase public and external debt, but ratios return to a stable or declining path once conditions normalize.

### Public debt
- Paraguay’s gross public debt (domestic and external) is mostly long-term concessional debt denominated in foreign currency.
- As of end-2009, total outstanding public debt (excluding central bank’s bills) is about 18 percent of GDP, of which 85 percent corresponds to external debt held mostly by multilateral organizations.
- The government does not issue bonds in international markets nor finances its borrowing on the domestic capital markets on a routine basis.
- Baseline projections:
  - Debt-to-GDP ratio declining to about 13 percent of GDP by 2015.
- Alternative scenarios:
  - If authorities fail to increase tax revenues from 12.9 to 14.0 percent of GDP (assumption in baseline), the debt level would stay constant at about 16 percent.
  - Under most adverse scenarios (low growth, 30 percent depreciation of the exchange rate, emergence of contingent liabilities), the debt level would rise to the range of 18–22 percent of GDP by 2015, with some risks of reaching an explosive path in the case of persistent low growth.

### External debt
- The external debt level is projected to stay below 20 percent of GDP over the medium term.
- Since 2002, reflecting continuous sizeable primary surplus, Paraguay’s external debt experienced a downward trend; this trend was interrupted in 2009 when the debt level rose moderately from 21 percent of GDP to 25 percent of GDP due to increased recourse to multilateral lending to fund fiscal stimulus.
- Going forward, the external debt ratio is expected to decrease significantly due to expected fiscal discipline and sustained growth.
- Stress-test results:
  - The most adverse shock is a 30 percent currency depreciation, which would raise the debt-to-GDP ratio by about 11 percentage points in that year or about 8 percentage points over the medium term.

### Stress-test and scenario notes (figures)
- Public and external debt stress tests present baseline, historical, and scenario paths under shocks including:
  - Growth shock
  - Interest rate shock
  - Primary balance shock (constant primary balance scenario)
  - Combined shocks
  - One-time real depreciation of 30 percent and a 10 percent of GDP shock to contingent liabilities occurring in 2011
- Figure captions and annotations specify:
  - Individual shocks are permanent one-half standard deviation shocks (figure notes).
  - Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and primary balance (figures).
  - One-time real depreciation of 30 percent occurs in 2011 for external debt bound tests.
- Representative values shown in figures and boxes (selected examples):
  - Public debt baseline projections and scenario box averages shown: Baseline: 13 (public debt, percent of GDP) and scenario/historical comparators visible in figures.
  - External debt figures: Historical 13.8; Baseline 18.5 (external debt in percent of GDP) in one figure panel; CA shock panel shows 23.8 (scenario box) vs Baseline 18.5.
  - Growth shock panel lists Baseline: 2.4; Scenario: 2.8; Historical: 3.8 (growth rates) in a figure footnote area.
  - Additional boxed figure values for baseline and scenario projections are presented in the figures.

*Source: Staff Report for the 2010 Article IV Consultation—Informational Annex (May 21, 2010).*

### 4. Statistical Issues ..................................................................................................

### ANNEX 4. PARAGUAY—STATISTICAL ISSUES

### Data provision and adequacy
- "Data provision to the Fund has some shortcomings, but is broadly adequate for surveillance."

### ROSC mission and follow-up
- "Following a data ROSC mission in January–February 2006, the authorities’ response to the report and the mission’s recommendations were published on the Fund’s website on June 30,"

*Source: _cr10169 - 4. Statistical Issues (excerpt).*

### 2006. The country is a GDDS participant.

### _cr10169 - 2006. The country is a GDDS participant.

### A. Real Sector
- National accounts estimates, broadly consistent with the guidelines of the 1993 SNA, were released in 2005.
- Data collection gaps and methodological weaknesses:
  - No comprehensive regular program for data collection through economic censuses and surveys exists (an industrial survey was conducted in 2002).
  - Source data for nonfinancial services, household consumption, and changes in inventories are insufficient.
  - Major areas of concern:
    - (i) the 1994 reference year needs to be updated;
    - (ii) excessive use is made 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 have been compiled only until 1997.
- Periodicity and timeliness:
  - Periodicity of annual GDP meets GDDS recommendations, but timeliness does not because data are disseminated with a lag of 11 months.
- QNA and base-year update:
  - Several STA missions on compilation of quarterly national accounts (QNA) were fielded in August 2007, August 2008 and November 2009.
  - Production of definite QNA series would need to await a revision of the national accounts base year and the compilation of supporting basic data, tentatively scheduled for completion by 2009/10.
  - The STA mission of November 2009 assisted the authorities in outlining a work program for updating the national accounts’ base year.
- Price indices and coverage:
  - Both the consumer (CPI) and producer price indices (PPI) are reported on a regular and timely basis.
  - Since January 2008, the Central Bank of Paraguay (BCP) has been using a new CPI index based on the 2005–06 household budget survey.
  - CPI geographic coverage is limited to Asunción and expenditure weights are representative of urban households.
  - The PPI has a base weight period of December 1995; basket (150 items) is not fully representative of current national output; electricity, water, gas, and services are not covered.
- Labor statistics:
  - Since the introduction of a regular household survey in 1998, coverage and quality of employment and unemployment statistics have improved significantly.
  - Frequencies remain annual and the publication lag is close to one year.
  - Wage indices are updated twice a year.
- Resource constraints:
  - The data ROSC mission found resources insufficient for real sector statistics, constraining further development, particularly full adoption of the 1993 SNA.
  - Authorities have tried to address resource shortcomings in the context of the new CPI and provisional QNA series.

### B. Fiscal Sector
- Framework and reporting:
  - Government finance statistics (GFS) used internally and for reporting to WHD is broadly consistent with GFSM 1986.
  - Authorities have not prepared a plan to migrate to GFSM 2001.
  - Monthly data are available for the central administration (budgetary central government).
  - Asset position of the social security system is available on a daily basis.
- Coverage and classification:
  - Statistics on the central administration include data of the Postal Service Directorate (a nonfinancial public corporation).
  - Statistics of the nonfinancial public sector include data of financial public corporations — four employer social insurance schemes, treated as financial corporations in monetary and financial accounts.
- Debt statistics:
  - Data on medium- and long-term external debt are reliable and available on a monthly basis.
  - Domestic debt data are available on request, but need full integration with the external debt database.
  - Deficiencies remain in recording short-term supplier and commercial credit of the public sector.
- Data discrepancies and reporting:
  - There is a discrepancy in fiscal data reported by monetary and fiscal authorities; measures are being taken to make reporting more transparent.
  - Annual data covering general government for 2007 have been reported for publication in the 2008 edition of the GFS Yearbook.
  - Since 1994 no outstanding debt data and no breakdowns for expenditure by function have been provided for publication in the GFS Yearbook.
  - Monthly and quarterly data are not reported for publication in IFS.

### C. Money and Banking Sectors
- Compilation and harmonization:
  - Paraguay completed establishment of a unified compilation and reporting system for monetary data to harmonize monetary data for BCP use, STA reporting (IFS), and operational/monitoring purposes.
  - Revision of classification criteria reduced discrepancies of interbank positions.
- Coverage gaps:
  - Lack of coverage of credit cooperatives remains a concern — they account for around ¼ of deposits and loans of the banking sector.
  - BCP, with STA assistance, plans to include monthly data of the 20 largest credit cooperatives in the monetary survey during 2010.
- Supervision and reporting:
  - The Superintendency of Banks publishes a detailed and informative report on the soundness of the financial system.

### D. External Sector
- Standards and availability:
  - Classification of the balance of payments and the international investment position (IIP) follows the Balance of Payments Manual, 5th edition.
  - Quarterly and annual data on balance of payments and the IIP are available from 2001 onwards on the central bank website and are reported only once a year to STA for IFS publication.
- Improvements and remaining deficiencies:
  - Improvements in data quality for capital flows, especially foreign direct investment coverage and recording of external debt transactions.
  - Special central bank studies improved estimation methods for remittances of Paraguayans abroad and unregistered trade transactions, but serious deficiencies remain.
  - Deficiencies exist in recording private capital outflows due to Paraguay’s open capital account.
- STA assistance:
  - An STA mission on Balance of Payments Statistics assisted BCP in November 2006 implementing ROSC recommendations, focusing on:
    - (1) assessing surveys to capture data on services, direct investment, nonfinancial private sector portfolio investment, and other investment;
    - (2) reviewing and updating statistical techniques to calculate unrecorded trade;
    - (3) reassessing treatment of binational hydroelectric energy enterprises in external sector accounts;
    - (4) reviewing and preparing a preliminary template for reporting international reserves and foreign currency liquidity.

### Executive Board Assessment and PIN Highlights (June 4, 2010)
- Background developments:
  - During 2003–08: real GDP rose by 5 percent a year; inflation declined to 7.5 percent during 2008; net international reserves reached almost US$3 billion by end-2008; government ran a sizable primary surplus cutting public debt to less than 25 percent of GDP by end-2008.
  - In 2009: real GDP declined by 3.8 percent; drought affected agricultural production (about one quarter of the economy); headline inflation fell to 2 percent; capital account surplus expanded to 5½ percent of GDP; net international reserves reached US$3.8 billion (25 percent of GDP and 340 percent of short-term debt on remaining maturity basis).
  - In 2010 projections: real GDP expected to grow by 6 percent; net international reserves projected to rise to US$4.1 billion; central government overall balance expected to be in equilibrium; central bank intends to limit inflation to no more than 5 percent.
- Directors’ main conclusions and recommendations:
  - Commended authorities for preserving macroeconomic stability in 2009 and adopting countercyclical policies.
  - Noted vulnerabilities: swings in commodity prices, weather-related shocks, financial risks from high dollarization and cooperative operations.
  - Emphasized fiscal reforms to increase tax ratio, strengthen fiscal management, and reduce fiscal risks:
    - Adopt medium-term fiscal framework.
    - Curtail current spending.
    - Strengthen tax administration and broaden tax base, including increasing taxation on agribusiness activities.
    - Implement personal income tax without further delay.
    - Enhance efficiency of public enterprises, including through public-private partnerships.
  - Monetary and financial sector recommendations:
    - Withdraw excess liquidity and raise policy interest rate above expected inflation.
    - Adopt an inflation-targeting framework over the medium term.
    - Early implementation of the law for recapitalization of the central bank to increase credibility and operational flexibility.
    - Develop secondary markets for government securities to strengthen liquidity management.
    - Strengthen supervisory and regulatory framework for cooperatives; extend prudential norms for banks to cooperatives and move toward a unified supervisory framework.
    - Improve compliance with Basel Core Principles through regulatory modifications.
    - Look forward to upcoming Financial Sector Assessment Program update.

### Key Statistics and Indicators (selected exact figures from tables and text)
- Real GDP growth rates:
  - 2004: 4.1
  - 2005: 2.9
  - 2006: 4.3
  - 2007: 6.8
  - 2008: 5.8
  - 2009: -3.8
  - 2010 (proj.): 6.0
  - 2011 (proj.): 4.0
- Consumer prices (end of period):
  - 2004: 2.8
  - 2005: 9.8
  - 2006: 12.5
  - 2007: 5.9
  - 2008: 7.5
  - 2009: 1.9
  - 2010 (proj.): 5.0
  - 2011 (proj.): 4.5
- Net international reserves (in millions of U.S. dollars):
  - 2004: 1,168
  - 2005: 1,298
  - 2006: 1,703
  - 2007: 2,462
  - 2008: 2,864
  - 2009: 3,861
  - 2010 (proj.): 4,133
  - 2011 (proj.): 4,257
- Current account (percent of GDP):
  - 2004: 2.1
  - 2005: 0.3
  - 2006: 1.4
  - 2007: 1.8
  - 2008: -2.2
  - 2009: -1.3
  - 2010 (proj.): -1.7
  - 2011 (proj.): -1.5
- Central Government revenues (percent of GDP):
  - 2004: 18.4
  - 2005: 18.2
  - 2006: 18.3
  - 2007: 17.6
  - 2008: 17.3
  - 2009: 19.2
  - 2010 (proj.): 19.1
  - 2011 (proj.): 19.0
- Central Government overall balance (percent of GDP):
  - 2004: 2.0
  - 2005: 0.6
  - 2006: 0.1
  - 2007: 0.9
  - 2008: 2.5
  - 2009: 0.1
  - 2010 (proj.): 0.0
  - 2011 (proj.): -0.2
- Consolidated public debt (percent of GDP):
  - 2004: 48.8
  - 2005: 42.7
  - 2006: 34.1
  - 2007: 28.2
  - 2008: 23.2
  - 2009: 22.5
  - 2010 (proj.): 22.2
  - 2011 (proj.): 22.3
- Agriculture share note:
  - Agricultural production accounts for about one quarter of the economy (text).

*Source: IMF staff report content in the provided PDF (_cr10169 - 2006. The country is a GDDS participant).*

### 1.      Paraguay’s economy has rebounded strongly after last year’s recession.

### 1.      Paraguay’s economy has rebounded strongly after last year’s recession.

### Economic rebound and external position
- Economic output fell by 3.8 percent in 2009, mainly due to a harsh drought, the drop in export commodity prices, and a contraction in domestic demand.
- Authorities’ countercyclical response was timely and decisive; domestic demand began to recover during the second half of 2009.
- Central Bank of Paraguay (BCP) injected liquidity promptly and fiscal policies were deliberately expansionary.
- Fiscal accounts ended 2009 with a small surplus, supported by strong fiscal revenues.
- The current account deficit narrowed in 2009; net inflows grew mainly due to strong repatriation of capitals by residents.
- Central Bank international reserves increased by a billion dollars, reaching US$ 3.8 billion (near 25 percent of GDP) at end-2009.
- GDP growth for 2010 is conservatively forecast at 6 percent.
- Recovery drivers and indicators for 2010:
  - Favorable climate and improved international environment.
  - Strong recovery of the agricultural sector (main driver in 2010).
  - Monthly indicators: high soybean harvests, flourishing meat production, greater volumes in commerce and transports, increased activity in construction and services.
- Authorities consider an appropriate level of reserves a necessary buffer against external shocks.

### Fiscal Sector: outcomes, reforms, and priorities
- Fiscal stimulus in 2009 amounted to 2 percent of GDP; central government accounts achieved a surplus of 0.1 percent of GDP.
- Public debt remained low at 23 percent of GDP.
- Policy focus in 2009: countercyclical policies while maintaining macroeconomic stability.
- Public spending measures: increased public investments and conditional cash transfers.
- Improved tax administration raised revenues equivalent to 2 percent of GDP.
- 2010 budget focal points:
  - Maintain disciplined fiscal policies.
  - Public investment and well-targeted, transparent conditional cash transfer programs.
  - Aim to maintain fiscal position in balance.
- Fiscal reform objectives:
  - Enhance efficiency of the tax system.
  - Increase tax revenue-to-GDP ratio to levels similar to regional peers.
- IMF engagement:
  - Several IMF technical assistance missions underway or planned to enhance tax revenues and improve public debt management.
  - Priority: adoption of a medium-term fiscal framework to anchor policy and avoid procyclical budgets.
  - Consideration of future increases of revenues from the hydroelectric binational plant Itaipú (jointly owned with Brazil).
  - Authorities sought Fund advice for the creation of a special sovereign fund for additional resources from Itaipú; proceeds to be used exclusively for infrastructure, research and development, and countercyclical funds.
- Personal Income Tax (PIT) status:
  - PIT created in 2004 but not fully in effect.
  - Senate voted to delay its application until 2013; lower chamber must ratify or reject the delay.
  - PIT supported by majority of population, think tanks, and entrepreneurial organizations; political resistance from vested interests continues.

### Monetary Sector: inflation targeting and policy stance
- Inflation was 1.9 percent in 2009, among the lowest in South America; slightly below the Central Bank’s target of 5 ± 2.5 percent.
- Inflation target for the year is 5 percent with a fluctuation band of ± 2.5 percent.
- BCP committed to adoption of a pure inflation-targeting (IT) regime; steps taken toward this end.
- Recapitalization law for the Central Bank recently approved and important for policy flexibility.
- Changes in BCP communication: CEOMA decisions are released to the public to improve transparency.
- Authorities have requested IMF technical assistance to move toward full-fledged IT regimes.
- Monetary operations and instruments:
  - Central Bank sterilization bill interest rates kept low throughout 2009 and 2010.
  - Domestic-currency treasury bonds issued at longer maturities, reflecting increased confidence.
  - Central Bank announced tightening of monetary policy stance to dissuade inflationary pressures; will be reflected in gradual raises of its referential rate.
- Exchange rate policy: authorities and staff view exchange rate as in line with fundamentals; commitment to maintain the current flexible exchange rate system.

### Financial Sector: stability, supervision, and priorities
- Banking system described as solid, highly liquid, and strongly profitable.
- Non-performing loans remained low at 1.66 percent as of end-April 2010.
- Excessive liquidity decreased since the beginning of the year, shown by reduction in banks’ current account balances within the Central Bank.
- Paraguayan banks were largely shielded from global financial crisis due to limited exposure to foreign banks and a well-regulated, supervised system.
- Improvements since 2005 FSAP: increased compliance with Basel principles.
- Ongoing needs and targets:
  - Continue reforms to strengthen legal and regulatory framework for banking supervision.
  - IMF advice critical for raising compliance; more technical assistance required.
  - Authorities’ goal: comply with at least 50 percent of the Basel Core Principles by the end of the year (target considered achievable without legal changes).
  - A new FSAP mission planned for November 2010.
- Cooperatives supervision issue:
  - Loans and savings cooperatives account for 20 percent of total deposits of the entire financial system.
  - Strengthening supervision framework for cooperatives is a high priority.
  - Supervisory agency for cooperatives implementing an institutional capacity strengthening program funded by multilaterals and bilateral donors.

### Final remarks and IMF engagement
- Paraguay benefited from IMF-supported programs and the Fund’s technical assistance; Fund advice contributed to improved resilience and growth opportunities.
- Authorities view this as the beginning of a process to change Paraguay’s economy and request reconsideration of the decision to withdraw the Fund’s Resident Representative in Paraguay.
- Policy dialogue since creation of the IMF office in 2005 has been continuous and fruitful; Res Rep credited for coordinating technical assistance and explaining institutional reform needs to the public.
- Authorities argue the permanent presence of an IMF representative will be needed as Paraguay moves toward inflation targeting and strengthens financial systems.
- IMF’s medium-term budget plan to scale back Res Rep offices was decided before the global financial crisis; a working group on Fund Staff Presence in the field is reassessing staff balance.
- Authorities confident the reassessment will confirm the value added by Res Reps and caution against mechanically executing the closure of the Fund representation in Paraguay.
- Authorities express appreciation to staff and Management and look forward to continuing close dialogue with the Fund.

*Source: _cr10169 - 1.      Paraguay’s economy has rebounded strongly after last year’s recession.*

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_Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2010/_cr10169.pdf_