Paraguay: Staff Concluding Statement of the 2019 Article IV Mission
IMF News, March 6, 2019
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- Published: March 6, 2019
Summary Overview
- Paraguay has grown rapidly in the past decade and a half, contributing to a sharp drop in poverty.
- Prudent macro policies, with low inflation and low government deficits, played an important role.
- Vulnerabilities have declined, with a significant reduction of both external and public debt.
- Key challenge: sustain rapid growth as past drivers—including the boom in agriculture commodity prices—may provide less support going forward.
- Improving the business climate and governance will be key to continued convergence to higher living standards.
Near-term Outlook
- GDP grew by around 3¾ percent in 2018, driven by strong domestic demand, fueled by a rebound in credit growth; contribution of net exports was negative.
- Growth was uneven in 2018: strong first half followed by a weaker second half due to regional financial turbulence.
- Crisis in Argentina increased regional risk aversion and contributed to a depreciation of the guarani against the dollar, although by less than neighboring countries; the guaraní appreciated sharply vis-à-vis the Argentinean peso and the Brazilian real.
- Weather-related shocks in agriculture contributed to the slowdown in growth.
- For 2019, growth is expected to reach around 3½ percent.
- 2019 downside factor: drought early in the planting season reducing the soybean harvest; partial offset from pickup in tourism and cross-border trade as the real exchange rate shock of 2018 unwinds.
- Risks to growth are broadly balanced: developments in neighboring countries, agricultural commodity prices, and the strength of domestic demand (dependant on recovery of government investment after government transition).
- Fiscal policy in 2019 will be neutral, with the deficit changing little from 2018.
- Nontax revenue estimates in the budget appear overly optimistic and reaching targets will necessitate containing expenditure.
- Monetary policy: the monetary policy rate was on hold in 2018; inflation fell to 3.2 percent by end-2018. In February 2019, the BCP cut the monetary policy rate from 5¼ to 5 percent citing uncertainty about the external environment and incipient weakening of domestic demand.
- The current monetary policy stance appears appropriate.
- Year-on-year Inflation should move back to 4 percent by year’s end (the middle of the central bank’s target range), as last year’s real exchange rate appreciation reverses.
- Exchange rate flexibility should help absorb shocks; intervention should aim at preventing disorderly market conditions and mitigating excess volatility only.
Longer-term Growth Challenges
- Real GDP grew by an average 4½ percent annually in the past decade and a half, well above the Latin America average.
- Poverty reduced from 58 percent in 2002 to 26 percent currently.
- Public debt reduced from 52 percent in 2002 to around 20 percent currently.
- Total external debt of the private and public sector fell from almost 200 percent of GDP in 2002 to 40 percent currently.
- Agricultural exports in dollar terms are now 5 times what they were in 2003.
- Sowing areas for the main crops are 2½ times what they were fifteen years go.
- Economy remains heavily dependent on agriculture; agricultural prices are off previous highs and may decline further as global demand slows; agricultural land expansion cannot continue at past rates.
- Future growth needs to come increasingly from the non-agriculture/non-electricity export sector, which is growing rapidly but is still small.
- Higher private sector investment, including from abroad, is needed to support diversification.
Improving the Business Climate and Governance
- Low taxes and low energy prices attract investors, but are offset by a weak business climate and governance.
- Paraguay scores relatively weak on business climate and governance indicators compared to other countries in the Western Hemisphere and Europe.
- Cross-country data show a strong link between these indicators and GDP per capita.
- Policy priorities identified:
- Improve transport infrastructure.
- Strengthen rule of law.
- Improve quality of education.
- Mission welcomes new government initiatives to increase ease of doing business, including:
- Legislation to simplify small business registration.
- A new bankruptcy law.
- Legislation to allow companies to use moveable assets as collaterals.
- Removal of outdated bureaucratic procedures and increased digitization of government services.
- Revival of the National Commission for Competition to combat monopolies and improve transparency of industry regulations.
Fiscal Policy
- Fiscal space is limited: the deficit is close to the 1.5 percent ceiling under the Fiscal Responsibility Law.
- Spending needs are large; to create room for investment, revenues need to be increased (revenues are low by international standards).
- Current headline tax rates are low; effective tax rates are even lower.
- Personal income tax rate is 10 percent, but this tax yields only 0.1 percent of GDP.
- Recommendations to raise effective tax rates without changing headline rates:
- Reduce exemptions and deductions.
- Improve tax compliance.
- Mission looks forward to proposals of the tax commission tasked with modernizing and simplifying the tax system.
- There is scope to reprioritize expenditure within the existing envelope.
- Spending composition is lopsided: high share of government expenditure going to wages; need to increase infrastructure and social spending, including health and education.
- Government wage bill in Paraguay is similar as a percent of GDP to other countries in the region, despite a smaller government role.
- Mission looks forward to recommendations of the expenditure review commission.
Financial Sector
- Banking sector is well capitalized and profitable; risk-based supervision is progressing.
- Supervision of financial cooperatives should continue to be strengthened.
- There is scope to improve supervision of the casas de credito and casas comerciales; supervision standards for this sector should be adopted quickly.
- Important to establish a pension fund supervisor: currently pension funds operate under a few, overly rigid rules but without oversight.
- Supervision would mitigate risks, allow pension funds to invest in a wider range of assets, and facilitate development of a domestic capital market.
- Restoring long-term sustainability of the pension system is a challenge that should be tackled now through timely and gentle parametric adjustments to pension age, benefits and contribution rates.
Policy Recommendations and Outlook
- Continue prudent macroeconomic policies and implement structural reforms to sustain rapid growth and improve living standards.
- Prioritize reforms to improve business climate and governance to facilitate diversification and productivity growth.
- Increase revenues through tax base broadening (reduce exemptions/deductions) and better compliance; consider expenditure reprioritization to finance infrastructure and social spending.
- Strengthen financial sector supervision (cooperatives, casas de credito, casas comerciales) and establish a pension fund supervisor.
- Implement pension reforms to ensure long-term sustainability before demographic advantages dissipate.
Paraguay: Staff Concluding Statement of the 2019 Article IV Mission — March 6, 2019