IMF Executive Board Concludes 2017 Article IV Consultation with Paraguay

July 24, 2017

On July 24, 2017, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation [1] with Paraguay, and considered and endorsed the staff appraisal without a meeting. [2]

Background

Despite a more challenging external environment, Paraguay has grown robustly. The economy gained momentum towards the end of 2016 and expanded by 6½ percent (y/y) during the first quarter of 2017. The ongoing economic expansion appears to be broadening across sectors, though private credit growth remains weak. On the supply side, robust growth reflects a record soy harvest, booming construction activity, and a rebound in the maquila industry. On the demand side, private investment and consumption have strengthened, alongside public investment. Inflation remains below the newly lowered target of 4 percent, though underlying inflationary pressures are rising.

Monetary policy remains accommodative, following two policy rate cuts in mid-2016, given well-anchored inflation expectations and sluggish credit growth. Fiscal policy has been characterized by restraint in current expenditures and a shift towards capital spending. The fiscal deficit outturn of 1.4 percent of GDP last year complied with the Fiscal Responsibility Law (FRL), implying a policy tightening.

Real GDP growth is projected to reach 4.2 percent in 2017, reflecting a more moderate pace of activity in the second half of the year. Investment will likely be a crucial driver of growth, as major infrastructure projects are undertaken. Consumption growth should also strengthen further. Given stronger domestic demand, the current account surplus is expected to narrow this year to 1.2 percent of GDP from 1.7 percent last year, despite solid export growth. Over the medium term, real GDP growth is expected to remain near potential of just below 4 percent. Risks around the outlook are to the downside, especially from heightened political uncertainty in Brazil.

Executive Board Assessment

Despite a more challenging external environment, Paraguay has grown faster than others in the region and momentum is broadening. Above-potential growth around 4 percent in 2016 and this year is well above main trading partners in the region and the Latin-American average. Part of this growth is also due to catch-up with levels of income per capita in other emerging markets and owes to a continued improvement in productive capacity, diversification of markets and strengthening of institutions. In addition, more recently, some positive supply shocks, mostly related to climate worked as tailwinds in agriculture and electricity, but signs are that economic momentum is broadening to other sectors as well as domestic demand.

The policy mix has been adequate and broadly supportive of activity but monetary accommodation should be gradually removed. Fiscal policy is expected to be neutral this year, maintaining the compositional shift towards capital spending and adhering to the FRL on the basis of budget outturns. Monetary policy has been appropriately accommodative to support the recovery towards the end of last year. However, as underlying inflation pressures rise and bank credit growth resumes, monetary policy accommodation should be gradually removed to maintain low inflation. The external position is now assessed to be stronger than implied by fundamentals and desirable policies. Draining excess liquidity through additional issuance of BCP paper (IRMs) and selling dollar reserves would help better align targeted policy rates with interbank rates.

The authorities have strived to comply with the FRL, but there is room for further fiscal reforms. The 2017 budget culminated in an unprecedented presidential veto, highlighting the need to strengthen the budget process and to reform the Public Financial Management (PFM) framework. To enhance the credibility of the fiscal anchor, it would be desirable to modify the assessment of FRL compliance to include the execution stage as well as the budget approval stage. The pension and health system also faces near- and longer-term imbalances and needs to be reformed.

Regarding monetary policy, the IT framework is serving Paraguay well but can be further strengthened. In addition to tighter operation of the policy corridor, predictability of foreign exchange operations could also be strengthened, given that dollar sales have not always been implemented as announced. Discretionary interventions in the foreign exchange market should continue to be limited to exceptional circumstances such as disorderly market conditions. In addition, high credit dollarization continues to limit the BCP's ability to affect market interest rates. Finally, greater use of forward-looking policy guidance in public statements could enhance central bank communications and improve predictability of monetary policy.

The financial sector appears sound, though banks need to continue strengthening their balance sheets after a decade of rapid credit growth. The banking system remains profitable and reported capital ratios appear comfortable but the ongoing adjustment in bank balance sheets will take more time to complete. Broad-based measures of loan quality deteriorated over the year and remain at elevated levels. In response, banks have increased provisioning and NPLs remain manageable. There are signs that credit from unregulated non-traditional lenders is growing, but this remains a small fraction of credit.

The authorities have made important progress on introducing risk-based bank supervision, ratifying a new banking law in December 2016. However, the law is only part of a broader agenda to strengthen financial sector oversight that needs to advance. Authorities should make additional progress in crucial initiatives including: (i) revisions to the BCP organic charter; (ii) establishment of a financial stability council; (iii) implementation of deposit insurance for savings and loan cooperatives; and (iv) integrating financial information through a single credit bureau. Furthermore, approving legislation regarding the Sociedades Anonimas and bearer securities in line with international standards should enhance entity transparency and could help safeguard correspondent banking relationships.

The authorities have advanced their structural reform agenda but further progress is needed. Progress has been achieved in several areas of the National Development Plan (NDP) with strategic infrastructure projects underway. Transparency and tax administration have been strengthened in several dimensions. However, additional effort should be made in removing institutional barriers in combating tax evasion and stepping up investment in transportation as well as electricity transmission and distribution, given large infrastructure gaps. In addition, to secure gains in terms of reduced inequality in the past decade, stronger implementation of the NDP priorities in education, training and expansion of conditional cash transfers will be needed. A tax reform that rebalances away from indirect taxation and maintains low income tax rates but limits deductions could improve progressivity and help finance these initiatives to promote more inclusive growth.

Data for surveillance is being strengthened. Paraguay recently implemented an enhanced general data dissemination (e-GDDS) system to make essential macroeconomic data available. Executive Directors encouraged the authorities to complete the remaining few steps to satisfy the higher special data dissemination or SDDS standards.

 

Paraguay: Selected Economic and Social Indicators

I. Social and Demographic Indicators

Population 2016 (millions)

6.8

Gini index (2015)

47.1

Unemployment rate (2016)

6.0

Life expectancy at birth (2015)

73.0

Percentage of population below the poverty line (2016)

28.9

Adult illiteracy rate (2015)

4.5

Rank in UNDP development index (2015)

110 of 186

GDP per capita (US$, 2016)

4,003

II. Economic Indicators

Est.

Proj.

Proj.

2011

2012

2013

2014

2015

2016

2017

2018

(Annual percent change, unless otherwise indicated)

Income and prices

Real GDP

4.3

-1.2

14.0

4.7

3.0

4.1

4.2

3.9

Nominal GDP

10.8

3.4

15.0

10.1

3.1

9.6

8.4

7.7

Per capita GDP (U.S. dollars, thousands)

3.9

3.8

4.4

4.6

4.0

4.0

4.2

4.4

Consumer prices (end of period)

4.9

4.0

3.7

4.2

3.1

3.9

4.1

4.0

Nominal exchange rate (Guarani per U.S. dollar, eop)

4,440

4,289

4,524

4,626

5,807

5,767

…

…

Monetary sector

Currency issue

11.6

17.5

13.2

8.9

2.9

4.9

5.6

5.6

Credit to private sector 1/

25.6

15.8

19.7

19.8

8.7

1.2

0.7

2.3

Liabilities to private sector

19.3

14.0

20.0

15.9

4.0

3.8

1.5

4.6

Monetary policy rate, year-end

7.3

5.5

6.0

6.8

5.8

5.5

5.8

6.0

External sector

Exports (fob, values)

20.7

-7.8

16.7

-3.7

-16.8

2.4

5.5

4.9

Imports (cif, values)

22.9

-5.9

7.8

1.1

-14.6

-5.1

6.6

7.9

Terms of trade

14.3

-10.2

11.4

9.8

-4.9

3.5

-4.3

0.7

Real effective exchange rate 2/

11.8

-1.6

5.2

3.2

-1.9

-2.1

…

…

(In percent of GDP, unless otherwise indicated)

Current account

0.4

-2.0

1.7

-0.4

-1.1

1.7

1.2

0.1

Trade balance

3.4

2.3

5.7

3.3

2.1

5.0

4.6

3.5

Exports

50.3

47.4

47.0

42.4

39.9

40.7

40.4

39.9

Of which: Electricity

9.0

9.1

7.7

7.1

7.5

7.8

7.3

6.9

Imports

-46.9

-45.1

-41.2

-39.1

-37.8

-35.7

-35.9

-36.4

Of which: Oil imports

-6.0

-6.7

-6.0

-5.5

-3.3

-2.9

-3.7

-3.6

Capital account and financial account

1.9

3.7

0.3

5.2

-1.2

-0.2

2.2

0.2

General government

-0.2

-0.1

1.8

3.2

1.5

2.8

2.5

0.6

Private sector

2.1

3.9

-3.0

1.0

-0.9

-0.4

-0.3

-0.3

Of which: Direct investment

2.2

1.9

0.2

1.1

0.9

1.0

1.1

1.1

Errors and omissions

0.8

-1.8

1.6

-1.2

-0.3

2.0

0.0

0.0

Gross international reserves (in millions of U.S. dollars)

4,984

4,994

5,871

6,891

6,200

7,143

8,128

8,244

In months of next-year imports of goods and services

5.0

4.6

5.3

7.2

6.8

7.4

7.8

7.6

Ratio to short-term external debt

2.7

1.9

2.4

2.9

2.5

2.7

3.1

3.1

Gross domestic investment

17.1

15.1

15.4

16.3

16.8

18.0

20.2

20.6

Gross national saving

17.5

13.0

17.1

15.9

15.8

19.7

21.4

20.7

Central government revenues

18.0

19.0

17.1

17.9

18.7

18.3

18.0

18.0

Of which: Tax revenues

12.6

12.7

11.8

12.7

12.7

12.5

12.6

12.7

Central government expenditures

17.0

20.6

18.8

19.0

20.5

19.7

19.5

19.6

Of which: Compensation of Employees

7.5

9.4

9.1

8.8

9.3

8.5

8.3

8.3

Of which: Net Acquisition of Non Financial Assets

2.3

2.6

2.3

2.4

2.6

2.9

3.0

3.0

Central government net lending/borrowing

1.0

-1.7

-1.7

-1.1

-1.8

-1.4

-1.5

-1.5

Central government primary balance

1.3

-1.4

-1.4

-0.7

-1.1

-0.7

-0.8

-0.7

Public sector debt (excl. central bank bills)

13.0

16.2

17.0

19.7

24.0

24.6

25.4

25.1

Of which: Foreign currency

11.0

10.8

11.6

14.0

18.0

19.3

20.8

20.2

Of which: Domestic currency

1.9

5.3

5.4

5.8

6.0

5.3

4.6

4.9

Memorandum items:

GDP (billions of Guaranies)

105,203

108,832

125,152

137,798

142,003

155,603

168,691

181,666

GDP (US$ billions)

25.1

24.6

29.0

30.9

27.3

27.4

…

…

Sources: Central Bank of Paraguay; Ministry of Finance; and IMF staff estimates and projections.

1/ Includes local currency credit and foreign currency credit valued at a constant exchange rate.

2/ Average annual change; a positive change indicates an appreciation.

[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.

[2] The Executive Board takes decisions under its lapse-of-time procedure when the Board agrees that a proposal can be considered without convening formal discussions.

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