Press Release No. 03/218

ANNEX

Recent economic developments

In 2002 Paraguay's economy fell into its worst recession in decades as a result of the regional crisis, a poor harvest, and lack of political consensus to implement the necessary reforms. Real GDP fell by nearly 2½ percent, inflation accelerated from 8½ percent to 14½ percent, and the guaraní lost 34 percent of its value in relation to the U.S. dollar. Fiscal problems led to the accumulation of large payment arrears, including to some multilateral institutions, and default on some domestic bonds. Open unemployment rose from 7.6 percent in 2000 to 10.8 percent in 2002.

The economic situation has improved in 2003. A good harvest, the improved regional situation, and first steps towards the implementation of the new authorities' program have combined with a more stable domestic political environment to produce a projected increase of around 2 percent in real GDP for the year. Annual inflation was below 10 percent in October, down from the peak of 21 percent reached in April. However, significant economic imbalances remain. In particular, large financing gaps in the public sector and a recovering banking system leave the economy vulnerable to shocks.

Program summary

Paraguay's economic program, which is supported by the Stand-By Arrangement, seeks to create conditions for sustained economic growth and poverty reduction, and to address long-standing governance problems by improving the efficiency and transparency of government operations. The program aims to stabilize the fiscal situation and to initiate structural reforms in the public sector and the banking system. Growth is projected to rise to around 2½ percent in 2004 and climb to around 3½ percent in the medium term. Underlying inflation should fall from 9 percent in 2003 to 6½ percent in 2004. The current account would remain broadly in surplus.

The fiscal policy package prepared by the new government is intended to close the fiscal financing gap, pay off arrears, and place the public debt on a more sustainable path. Fiscal adjustment measures already implemented will produce an improvement of at least 1½ percent of GDP on an annual basis, and measures to be implemented during the program period would yield an additional 2-2½ percent of GDP annually. The adjustment would bring the overall balance into slight surplus and initiate a decline in the debt/GDP ratio toward around 30 percent of GDP by the end of the decade, while accommodating increased capital spending and social investment. On the revenue side, the government's strategy is to raise revenues while minimizing increases in tax rates.

For 2004 the authorities are committed to a monetary policy geared toward controlling inflation while maintaining exchange rate flexibility. The program establishes targets on net domestic assets designed to bring the growth in the money supply down to a rate more consistent with single-digit inflation in the medium term, while allowing for a recovery in private lending. Paraguay's central bank will also work to develop the necessary technical and statistical capabilities to move eventually to an inflation targeting regime.

Financial sector reforms are intended to make the system more resilient and efficient. The authorities have already taken measures to enhance bank supervision and resolution capabilities, as well as pass legislation to introduce a deposit insurance system. Under the program they plan to reform the public banks and modernize regulatory requirements for all financial institutions.

The structural reform agenda is focused on strengthening public sector efficiency and governance. Initiation of public sector reform (in particular the public enterprises, the central bank, and the social security institute) and a public banking law, among other measures, will provide an improved institutional environment for sustained economic stability and growth.

Paraguay joined the IMF on December 28, 1945; its quota is SDR 99.9 million (about US$146 million), and it has no outstanding use of IMF credits. Paraguay last had an IMF program in 1960.