Press Release No. 15/63

Press Release: IMF Executive Board Concludes 2014 Article IV Consultation with Paraguay

February 20, 2015

On February 12, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with Paraguay, and considered and endorsed the staff appraisal without a meeting.²

Economic activity in Paraguay has slowed from the record-high growth in 2013, but remains buoyant. Construction, manufacturing, and services led the expansion in 2014, whereas electricity production declined, and re-exports suffered from weak growth in Brazil. Full-year growth is estimated to have slightly exceeded 4 percent. Inflation spiked in early 2014 on account of higher food and regulated prices, but subsequently eased, ending the year at 4.2 percent, slightly below the authorities’ midpoint target. Credit growth has moderated from earlier peak rates but still hovers around 20 percent, while banks continue to report strong capitalization and profitability.

Macroeconomic policies have been tightened somewhat since late 2013. Tax revenue grew at a brisk pace in 2014, linked to better enforcement and new taxes. Due to lower revenue from electricity royalties and faster execution of spending in the latter part of the year, the headline deficit increased slightly relative to 2013. Still, estimates point to a modest contractionary impulse. Monetary policy has been on hold since the central bank (BCP) raised the official policy rate by 125 basis points, to 6.75 percent, between December 2013 and February 2014.

Real GDP is projected to remain close to 4 percent in 2015. Weak trading partner growth and lower export prices cloud the outlook, and agricultural production is projected to rise only marginally above the high level of 2014. However, positive impulses should come from the projected rebound in electricity generation, the lower oil price, and the launch of new infrastructure projects. The external current account is projected to switch from a small surplus in 2014 to a moderate deficit in 2015, reflecting weaker terms of trade.

Risks around the outlook are broadly balanced. On the one hand, worsening terms of trade could affect domestic spending more than anticipated, while further ruble depreciation might hurt exports to Russia. On the other hand, looser-than-expected macroeconomic policies and efforts to exploit a recently discovered hydrocarbon resource could create upside surprises. Inflation is expected to hover around the 4.5 percent target in 2015, as recent guaraní depreciation and a small positive output gap offset the impact of lower commodity prices.

Executive Board Assessment

In concluding the 2014 Article IV consultation with Paraguay, Executive Directors endorsed the staff’s appraisal as follows:

The government has started to tackle some of the long-standing structural weaknesses holding back development. Tax collection has improved significantly, creating space for higher public investment; preparations are underway to launch several large infrastructure projects; and the recently adopted “freedom-of-information” law will foster government transparency. These efforts are commendable, and should be extended to achieve lasting improvements in public services, institutional quality, and the rule of law. Such improvements, in turn, are critical to attract investment, boost productivity, and underpin medium-term growth and poverty reduction.

Paraguay’s macroeconomic fundamentals remain sound, though the 2015 budget has dimmed hopes that the Fiscal Responsibility Law (FRL) would provide a firm institutional anchor for fiscal prudence. Paraguay boasts moderate public debt, low inflation, and strong external balances. To consolidate macroeconomic stability, the authorities have adopted new policy frameworks in recent years, notably an inflation targeting regime and the FRL. These frameworks provide appropriate anchors for policy. It is thus unfortunate that the approved 2015 budget envisages spending and a deficit above the mandated limits. With due restraint in the execution of the budget and continued efforts to improve tax enforcement, it remains possible to achieve the original FRL targets and thereby bolster the credibility of the fiscal rules. Over time, a stronger budget process will be essential to support fiscal discipline.

More broadly, it will be crucial to integrate the planned improvement of public services into a prudent fiscal plan for the medium term. The authorities’ reform strategy holds great promise, but should not come at the expense of weakening Paraguay’s solid macroeconomic position. This puts a premium on generating sufficient revenue to accommodate spending plans and preserve favorable debt dynamics. To ensure public support, it is important that additional revenue effectively translates into better public services. Civil service reform would assist this endeavor, by rationalizing public employment and raising efficiency. A prudent medium-term fiscal plan should also incorporate some buffer against adverse shocks, given the high volatility of Paraguay’s economic environment.

In the same vein, it will be important to contain fiscal risks related to infrastructure projects, State Owned Entreprises (SOEs), and public pension funds. Private sector participation in infrastructure is welcome but must be managed carefully to contain risks to the public finances. Particular caution is warranted with respect to deferred financing schemes that could create government liabilities without the scrutiny of the regular budget process. Fiscal risks could also arise from the missing oversight of Paraguay’s pension funds and their actuarial imbalances. It is encouraging that the authorities plan to address these risks proactively, starting with the planned creation of a regulator. Similar resolve is required to address the financial and operational challenges in the SOE sector.

Monetary policy is currently well calibrated, and efforts should focus on further enhancing the effectiveness of the inflation targeting regime. To strengthen the transmission of monetary policy, it will be instrumental to develop a more active money market and encourage gradual de-dollarization. Meanwhile, the central bank’s plan to make its sales of government foreign-currency receipts more predictable will help to distinguish these transactions clearly from occasional discretionary intervention within the flexible exchange rate regime.

In light of continued strong credit growth, the authorities should closely monitor potential risks and consider targeted macroprudential tightening. Paraguay’s banking system remains sound, but the long-running credit expansion calls for vigilance. To contain the risks from rising consumer indebtedness, lenders should be formally required to observe prudent limits on households’ debt servicing capacity. Other areas for stepped-up oversight include foreign-currency lending; and the proper recognition of credit risk in renegotiated loans. In this context, the proposed revision of the central bank and banking laws is essential to put risk-based regulation and supervision on a robust legal basis. Another priority is to strengthen the governance, resources, and enforcement powers of Instituto Nacional de Cooperativismo (INCOOP).