Public Information Notice: IMF Concludes Article IV Consultation with Paraguay

May 18, 2001

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On May 11, 2001, the Executive Board concluded the Article IV consultation with Paraguay.1


During the decade from 1990 to 2000, real GDP per capita in Paraguay fell by over 5 percent. Growth was moderate in the early years and accelerated briefly during a credit-driven expansion in the mid-1990s. However, after a banking crisis brought the expansion to a halt in 1996, the Paraguayan economy has undergone a sustained contraction. A steep decline in investment, falling terms of trade, slow growth among trading partners and a contraction of the re-export business combined to reduce real GDP first in per capita terms and, since 1998, in absolute terms. As a result, poverty has deepened - especially in rural areas - and the income distribution has become more unequal.

In the fiscal area, structural reforms and a comprehensive adjustment in 1990 led to a series of fiscal surpluses during the first half of the decade that helped reduce the country's debt burden. The fiscal position deteriorated during the second half of the decade, as the public wage bill and pension payments crept up, and the public sector assumed the cost of a major banking crisis. Public enterprises saw their cash flow squeezed, as tariffs were not adjusted in line with costs. In addition, the social security system lost its surplus position after half of its assets were frozen in intervened banks and ceased to earn interest. The public sector deficit reached more than 5½ percent of GDP in 2000, when spending surged, financed by a large injection of external debt.

As a consequence of increasing fiscal deficits, Paraguay's public external debt has doubled over the last five years to about 32 percent of GDP at the end of 2000. Virtually all the debt is owed to multilateral agencies or foreign governments, and has a relatively long residual maturity. As to net domestic debt, the public sector has a net asset position of around 2 percent of GDP, mainly as a result of former surpluses in the social security system.

The external current account recorded surpluses at the beginning of the decade. It swung into deficit during the credit-financed expansion of the mid-1990s, before narrowing briefly at the onset of the recession. Sharp increases in public spending widened the deficit again to around 4 percent of GDP in 2000.

Throughout the decade, Paraguay maintained an adjustable peg of the Guaraní vis-à-vis the US dollar. Monetary policy was largely geared towards keeping the exchange rate under control. In the early 1990s, the public sector surpluses permitted the absorption of net foreign exchange inflows from the external current account without creating pressure on domestic liquidity. Monetary growth temporarily accelerated in the mid-1990s, when the central bank assisted ailing banks. Under these circumstances, widening public sector deficits towards the end of the decade led to a progressive loss of international reserves, and to a higher frequency of exchange rate adjustments. However, the exchange rate anchor helped lower inflation from over 40 percent in 1990 to the single digits at the close of the decade.

After a sweeping deregulation in the early 1990s, Paraguay's financial sector underwent a boom-bust cycle similar to other countries where prudential supervision was not strengthened at the same time. During the upswing, the volume of credit expanded quickly, while real lending rates and spreads declined as competition among banks intensified. Strains appeared towards the middle of the 1990s, and during 1995-98 several banks representing a third of total deposits had to be closed.

As a result of problems in the financial system, private sector credit contracted sharply, and real interest rates rose to around 25 percent, while depositors increasingly shifted towards U.S. dollar-denominated assets. Foreign banks increased their market share to over 80 percent. The recession since 1998-which was in part a result of the banking crisis- led to a sharp rise in non-performing loans, and increased banks' reluctance to extend credit to the private sector. Increasing capital flight during the last two years reflected a deep lack of confidence and compounded the shortage of credit in the financial system.

Executive Board Assessment

Directors observed that, while adverse terms of trade developments and an unfavorable external environment have contributed to Paraguay's lackluster economic performance, policy slippages also bear a large responsibility.

Directors therefore welcomed the authorities' new resolve to restore macroeconomic discipline and to proceed with much needed structural reforms in the context of a staff monitored program. They agreed that strict and timely implementation of the program will be critical in restoring investor confidence and paving the way for sustainable growth.

Directors expressed concern over the rapid deterioration of Paraguay's fiscal position. While recognizing that the weak economy has reduced fiscal revenue, they noted that the sharp increase in expenditure has played the determining role in the widening fiscal deficit. Directors welcomed the authorities' intention to reduce the fiscal deficit in 2001 significantly to a lower level. They were encouraged by the performance through end-April, but stressed the importance of continuing to adhere strictly to this ambitious target.

Directors observed that, aside from measures to curb tax evasion and extend the tax base, the scope for a significant improvement in revenue collection is limited in view of the present low level of economic activity. While revenue measures should not be ruled out, they emphasized that the envisaged reduction in the deficit will require a significant curtailment of expenditure, particularly current expenditure. In this regard, they pointed to the urgency of correcting the growing imbalance in the public sector employees' pension scheme.

Directors agreed that the authorities should seek to strengthen the tax base over the medium term, along the lines of the Fund's Fiscal Affairs Department recommendations of 1999, in order to generate needed resources to finance improvements in basic infrastructure and social services. While Paraguay's public debt is low by international standards, a number of Directors considered that its recent rapid increase, as well as the existence of significant liabilities that have not yet been recorded as public debt, required vigilance on the part of the authorities. They welcomed their decision to prepare consolidated public sector debt accounts which will improve monitoring capabilities.

Directors stressed the importance of moving forward with structural reform measures that are key to greater economic stability and efficiency. They expressed concern over the continued deterioration of the financial situation of the Social Security Institute, and urged the authorities to eliminate direct lending by the Institute, separate its health and pension sections, and avoid the concentration of its deposits in any single financial institution.

Directors noted that delays in the adoption of tariff adjustment in the public enterprises had led to a deterioration of their finances. While noting that an important adjustment was introduced at the beginning of the year, they suggested that smaller but more frequent changes to tariffs might better facilitate covering enterprise costs while being more socially acceptable.

Directors welcomed the progress made in the privatization of the telecommunications and water and sewage companies. They encouraged the authorities to complete these operations this year, to privatize additional enterprises, and to improve the efficiency of the remaining state enterprises. Care should be taken not to use privatization proceeds to finance public expenditure overruns. Directors also encouraged the authorities to press ahead with the planned reforms of the central administration.

Directors noted that price stability should remain the objective of monetary policy, as well as the importance of preserving and, if possible, increasing the level of international reserves. To this end, and to preserve competitiveness, Directors welcomed the authorities' intention to allow the market to play a larger role in determining the exchange rate, and to act on interest rates, if necessary, to counter inflationary pressures. They agreed that strict implementation of the fiscal adjustment program would help to prevent large exchange rate and interest rate movements, and safeguard the quality of the banks' loan portfolios. Directors encouraged the authorities to further strengthen bank supervision.

Directors welcomed the authorities' commitment to address the problem of the National Development Bank by the end of the year. They were concerned over the government's plan to reschedule nonperforming loans to the industrial sector and urged the authorities to pay due regard to the moral hazard risks and additional fiscal costs that the plan could entail.

Directors welcomed the marked improvement in Paraguay's statistical base, particularly in the areas of balance of payments, money, and the central government's finances, but noted that weaknesses remain in national accounts calculations, and the statistical coverage of public enterprise operations and external tariffs. They recommended that these data limitations be addressed by implementing the recommendation of recent technical assistance missions by the Fund's Statistics Department. They were encouraged by the progress made toward meeting the General Data Dissemination Standard (GDDS).

Paraguay: Selected Economic Indicators

  1996 1997 1998 1999 2000

Real economy (change in percent)          
GDP 1.3 2.6 -0.4 0.5 -0.4
GDP per capita -1.3 0.0 -3.0 -2.1 -3.0
CPI (period average) 9.8 7.0 11.5 6.8 9.0
CPI (end of period) 8.2 6.2 14.6 5.7 8.6
Gross national savings (percent of GDP) 19.7 16.7 21.0 21.9 19.0
Gross domestic investment (percent of GDP) 23.4 23.6 22.9 23.0 23.2
Public finance (percent of GDP)          
Public sector savings 5.7 6.1 6.2 4.9 3.3
Public sector overall balance 0.0 -2.3 -1.0 -4.7 -5.7
Money and interest rates          
Money (M1) (change in percent) 3.0 13.5 7.5 9.5 15.0
Broad money (M2) (change in percent) 0.2 5.5 -2.9 10.7 2.2
Broad money incl. foreign currency deposits 12.8 12.4 8.8 17.6 3.6
(M3) (change in percent)          
Interest rates(average, in percent per annum)          
Domestic currency deposits 1/ 13.0 7.6 6.7 9.5 8.1
Domestic currency loans 1/ 40.0 36.0 39.5 39.2 35.8
Balance of payments (in millions of US$)          
Merchandise exports 3,797 3,328 3,549 2,673 2,251
Merchandise imports 4,383 4,192 3,942 3,042 2,837
Current account balance -353 -650 -160 -86 -315
(percent of GDP) -3.7 -6.8 -1.9 -1.1 -4.2
Net international reserves (end of period) 1062 846 875 998 772
External public debt (end of period) 1,398 1,444 1,596 2,108 2,354
(percent of GDP) 14.9 16.1 19.3 28.9 31.8

Sources: Central Bank of Paraguay, Ministry of Finance; and Fund staff estimates.

1/ Weighted annual average.      

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities. In this PIN, the main features of the Board's discussion are described.


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