IMF Executive Board Concludes 2010 Article IV Consultation with ParaguayPublic Information Notice (PIN) No. 10/74
June 10, 2010
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 June 4, 2010 the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Paraguay.1
During 2003–08, Paraguay took advantage of the favorable global conditions to strengthen economic performance. The government ran a sizable primary surplus, which cut public debt to less than 25 percent of GDP by end-2008. The central bank maintained a prudent monetary policy, supported by exchange rate flexibility. Structural reforms advanced in several areas, including financial supervision, budget management, and the tax system. As a result, real GDP rose by 5 percent a year during 2003–08, inflation declined to 7.5 percent during 2008, and net international reserves reached almost US$3 billion by end-2008.
In 2009, the global financial crisis coupled with a severe drought buffeted the economy, causing a 3.8 percent decline in real GDP. Exports fell sharply in response to the effect of the drought on agricultural production (about one quarter of the economy) as well as the depressing effect of the global crisis on world commodity prices and growth in trading partners. With the strong links between agriculture and the rest of the economy, real domestic demand declined and imports plummeted. This, together with the reversion of international commodity prices, brought headline inflation down to 2 percent and slowed the growth in credit to the private sector. Banks held up relatively well during the downturn but some signs of stress appeared in the cooperative sector.
In 2009, the authorities shifted policies to support aggregate demand. The central government scaled back the primary surplus, resulting in a fiscal impulse of 2 percent of GDP. The central bank focused on providing ample liquidity to the banking system and made partially sterilized purchases of foreign exchange to smooth currency volatility, which depreciated by 7 percent in real effective terms in 2009. The capital account surplus expanded to 5½ percent of GDP, especially reflecting repatriations by residents seeking a safe haven for their assets, and net international reserves reached US$3.8 billion (25 percent of GDP and 340 percent of short-term debt on remaining maturity basis).
In 2010, the prudent stance of demand policies, as well as the global recovery and the favorable weather conditions, are expected to help real GDP to grow by 6 percent. The projected rebound in agriculture production and faster growth in key trading partners will boost exports and private demand. These trends, together with rising international commodity prices, are expected push inflation up and widen moderately the external current account deficit. With continued net capital inflows, net international reserves would rise to US$4.1 billion. The overall balance of the central government is expected to be in equilibrium, while the central bank intends to withdraw excess liquidity as necessary to limit inflation to no more than 5 percent.
Executive Board Assessment
Executive Directors commended the Paraguayan authorities for preserving macroeconomic stability in 2009 in the face of a severe drought and the global financial crisis. Sound macroeconomic policies in recent years had permitted the timely shift to a countercyclical stance, which had helped limit the fall in real GDP. A rebound in growth is expected for 2010, underpinned by the continuation of prudent demand policies while keeping inflation under control. Directors noted, however, that the economy remains vulnerable to swings in commodity prices, weather-related shocks, and financial risks associated with high dollarization and the operations of savings and loans cooperatives. These highlight the need to continue to press ahead with the ambitious agenda of institutional reforms and export diversification, with Fund technical assistance as appropriate.
Directors emphasized the importance of fiscal reforms, aimed at increasing the tax ratio, strengthening fiscal management, and reducing fiscal risks. They supported the authorities’ objective of keeping public debt at prudent levels, which would be facilitated by the adoption of a medium-term fiscal framework. This would require curtailing current spending, as well as continued efforts to strengthen tax administration and broaden the tax base, including further steps to increase taxation on agribusiness activities. These measures would help preserve sufficient fiscal space for public investment and social spending. Directors called for the implementation of the personal income tax without further delay. They also encouraged continued efforts to enhance the efficiency of public enterprises, including through public-private partnerships, with a view to increasing the competitiveness of economic sectors critical for growth.
To keep inflation in check, Directors encouraged the authorities to begin to withdraw excess liquidity from the banking system and raise the policy interest rate above the expected rate of inflation. They supported the goal of adopting an inflation-targeting framework over the medium term, and looked forward to the early implementation of the recently-approved law for the recapitalization of the central bank—a step critical to increasing its credibility and operational flexibility. The development of secondary markets for government securities would also help strengthen the central bank’s liquidity management. Directors welcomed the authorities’ intention to maintain exchange rate flexibility for the guaraní, which appears to be at a level consistent with its fundamentals.
In the financial sector, Directors welcomed ongoing efforts to strengthen the supervisory and regulatory framework for cooperatives. They recommended extending prudential norms for banks to cooperatives to limit the scope for regulatory arbitrage, and moving toward a unified supervisory framework for all financial institutions. Measures to improve compliance with the Basel Core Principles through modifications in regulations would help preserve the quality of bank loans as credit picks up. Directors looked forward to the upcoming Financial Sector Assessment Program update.