IMF Staff Concludes Visit to Paraguay

IMF News, November 12, 2019

Source details

Mission dates: November 6-12, 2019.
Statement issued by Mr. Bas Bakker.
The mission will not result in a Board discussion.
The views expressed are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board.
Main headline: growth in 2019 expected to be near-zero; expectation for growth to rebound to 4 percent in 2020.

Shocks in 2019:
- Agricultural output hit first by a drought and then by flooding.
- Hydro-electricity production hurt by low water levels.
- Exports suffered from economic weakness in Argentina and Brazil and the sharp depreciation of the peso.
Near-term outlook:
- Growth in 2019 expected to be near-zero.
- Growth expected to bounce back to 4 percent next year.
- Recovery aided by a rebound in agriculture and a pick-up in recent-month momentum.
Risks:
- Regional risk from developments in Paraguay’s main regional trading partners, particularly Argentina (low growth and potential further decline of the peso affecting cross-border trade).
- Global risk from ongoing trade tensions between China and the United States.
- Historical pattern: downturns in Paraguay tend to be followed by strong recoveries—bad weather has only a temporary impact on the economy.

Headline inflation path:
- Fallen from 4 percent in August 2018 to 2.4 percent in October 2019.
- 2.4 percent is below the middle of the target band of 4 +/- 2 percent.
Monetary policy response:
- The BCP has lowered the policy rate this year by 125 basis points to 4.00 percent.

Fiscal outcomes:
- Deficit increased from 1.3 percent of GDP in 2018 to an expected 2.5 percent in 2019.
- Causes: shortfall of tax revenue and a rebound in public investment that mitigated the recession.
FRL considerations:
- The 1.5 percent of GDP deficit ceiling in the FRL has been breached in 2019, but the FRL allows a temporary excess in case of a fall in domestic economic activity.
- The FRL has helped keep deficits and public debt at moderate levels and warded off worries about debt sustainability.
- Abandoning the FRL would jeopardize fiscal credibility and could increase Paraguay’s borrowing costs in international capital markets.
Policy guidance to return to the FRL ceiling:
- Returning to the 1.5 percent of GDP deficit ceiling next year will be challenging.
- Requires keeping spending growth in check—including from the wage bill, which has been growing rapidly in recent years.
- Any additional spending approved by Congress after the budget is finalized should be offset by spending reductions elsewhere.
- If tax revenue were to fall short of expectations next year, commensurate spending adjustments will be needed.

Long-term growth challenge:
- To sustain rapid growth over the next fifteen years, the economy needs to diversify as agriculture will likely not provide the same boost.
- Needed improvements: infrastructure, education, governance, and business climate.
- Some reforms will require additional resources, putting further pressure on expenditure.
Revenue and expenditure:
- Current revenue levels are not sufficient to finance the needed reforms.
- Scope exists to reprioritize existing spending and make spending more efficient.
- Recommendation: implement the recommendations by the joint public-private commission for the consolidation of current expenditure.
- Concern: composition of expenditure has deteriorated, trending towards a higher wage bill and higher interest payments, rather than higher investments.
- The tax reform recently approved was described as a good first step, but more may be needed to increase revenues.

Pensions:
- Modest parametric changes now are needed to prevent large deficits in the pension sector within the next decade due to demographic changes.
- Recent increases in retirement benefits for selected groups approved by Congress add to medium- and long-term pressures and go in the wrong direction.
- Important to establish a pension fund supervisor, similar to supervision for other financial institutions that are custodians of the population’s savings.
- Strengthened oversight would mitigate risks, allow pension funds to invest in a wider range of assets, and facilitate the development of a domestic capital market.
Governance and financial system risks:
- Paraguay has seen improvements in governance and corruption indicators, both in absolute terms and relative to the region, but more remains to be done.
- At the request of the government, the IMF is helping analyze the problem and develop a strategy to be discussed in the Article IV report next year.
- Authorities have taken legal initiatives to tackle emerging money laundering and cybersecurity risks for the financial system including compliance with AML-CFT standards.

The IMF mission met with government officials, private sector representatives and academics.
The mission thanks the authorities for their hospitality and fruitful discussions.

IMF Communications Department — Press Release No. 19/410, November 12, 2019