Press Release No. 13/198

Press Release: IMF Concludes Staff Visit to Paraguay

June 5, 2013

An International Monetary Fund (IMF) team, led by Mr. Gabriel Lopetegui, visited Paraguay during May 28 to June 4, 2013 for discussions with government officials and the private sector on Paraguay’s economic situation. At the end of the visit, Mr. Lopetegui issued the following statement:

“After contracting by 0.9 percent in 2012, the economy is rebounding rapidly in 2013. Agricultural production, which was severely affected by a drought last year, has recovered sharply on the back of a record soy harvest. At the same time, a marked increase in government spending coupled with relaxation in the monetary stance has underpinned non-agricultural Gross Domestic Product (GDP), which is growing somewhat above potential, notably in services and construction. Total bank credit growth has stabilized, with foreign-currency denominated credit still growing at a rapid pace. Given the excellent yields in agriculture, and supportive macro policies we expect real GDP to grow at 11 percent in 2013, and normalize at 4.6 percent in 2014.

“Inflation, however, has remained surprisingly subdued as supply shocks have yet to reverse. Inflation has declined—to less than 1 percent year-on-year (y-o-y)com in May—given lower meat prices, a stronger currency earlier in the year, and an increase of imports from Argentina favored by the weaker peso and porous border. Core inflation, however, has declined less sharply to 4 percent y-o-y. In line with expectations, inflation is projected to pick up during the rest of the year as these supply shocks dissipate, to 4¼ percent in 2013 and 5 percent in 2014.

“Nevertheless, a further easing of monetary policy should be avoided in light of transient effects on headline inflation and low real interest rates. After a marked easing in 2011-12 of some 350 basis points, the policy rate has remained at 5.5 percent since August 2012. Interbank rates have recently fallen by over 100 basis points and the yield curve has shifted downward and flattened. At the same time, new liquidity management instruments imply a remuneration of commercial banks’ excess liquidity, increasing their incentives to maintain its reserves at the Central Bank. All in all, monetary conditions remain accommodative, as real interest rates remain below neutral levels, given inflation expectations. Although inflation has remained muted, staff’s view is that it should pick up as meat prices normalize—and the authorities should stand ready to react quickly.

“The authorities should start to withdraw the fiscal stimulus in 2014, given sustained domestic demand growth and a positive output gap. The fiscal policy is providing some additional impulse this year after a stimulus of 2 percent of GDP in 2012, mostly related to a sharp increase in current spending, in particular personnel expenses. Given that the wage bill has been gradually taking a larger share of total central government spending, withdrawing the fiscal impulse will be a challenge and may imply an unfortunate compression of capital expenditures.

“The fiscal framework should be strengthened to safeguard macro-financial stability and to ensure that fiscal resources are used efficiently. The budget process in Paraguay is overly complicated, and fails in its primary purpose of allocating resources efficiently and effectively to support government policies.

• Over the last few years, current expenditures, particularly the wage bill, have grown faster than potential GDP. Until recent, this has not been reflected in worsening overall budget outcomes given that strong cyclical commodity prices have resulted in relatively buoyant revenue flows. However, current expenditure growth is increasingly eroding available space for capital and social spending, and policy flexibility.
• In this context, particularly during the parliamentary discussion of the budget, Paraguay should adopt the best practice of only adding permanent expenditures when permanent resources have been clearly identified and included in the budget. Moreover, any budget modification for the year should be previously assessed by the ministry of finance, to prevent the emergence of unfunded expenses. Although politically difficult, these measures would help spur a needed discussion to strengthen revenue to GDP ratios—which are currently one of the lowest in the region.
• To strengthen the fiscal framework, the authorities should promptly consider a fiscal transparency and responsibility law that clearly spells out the country’s fiscal priorities. While a “golden rule” that limits debt financing to investment is now in place, thought should be given to how fiscal policies can be further anchored while developing the country’s infrastructure and expanding social inclusion. Possible anchors could include limits or caps on current expenditure, and primary balances.

“We welcome the Central Bank’s efforts to strengthen financial sector supervision and regulation. Both the central bank and commercial bank laws are in the process of being modernized, to incorporate best practices in regulation and supervision, including giving more flexibility in the conduct of these functions and underpin the move towards risk-based supervision. In particular, the amended legal framework will: (i) provide legal protection to supervisors; (ii) expand the regulatory perimeter; (iii) empower the central bank to adjust regulatory ratios and develop prudential regulations; (iv) raise the standards to authorize new financial institutions and (v) strengthen oversight.

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