1. On behalf of the Paraguayan authorities, we would like to express our appreciation to the Fund’s management and staff for their valuable advice and constant support in the implementation of Paraguay’s economic program, which have been crucial for the successful economic outcomes achieved so far. The government that took office in August 2003 has prepared an ambitious economic program to avoid a debt crisis, reverse the serious fiscal deterioration, and address the long-term structural and governance weaknesses that undermined economic management. The authorities aim at stabilizing the economy and implementing structural reforms to lay the foundation for high and sustained growth, reduce unemployment, and alleviate poverty.
2. The Paraguayan authorities’ implementation record under the current Fund-supported program—the first in more than three decades—has been outstanding. The government’s ability to muster the necessary political consensus for economic reforms has led to congressional approval of key economic legislation over the past two years, including the banking resolution law, the public pension reform law, the fiscal adjustment law, the public procurement law, the customs code, and recently, the second-tier public bank reform law. Even though the pace of reforms was not as fast as originally envisaged, it should be noted that a number of important reforms were made in a short period of time in a country characterized by relatively new democratic institutions, a high poverty level, and strong social pressures.
3. Likewise, permanent efforts to combat corruption and reduce tax evasion, as well as prudent economic policies, have been crucial in reinstating macroeconomic stability and ensuring impressive economic results during the past year. As a result of these first steps, real GDP in 2004 reached 4.1 percent, one of the highest growth rates in recent history, even after a drought that severely affected soy production—Paraguay’s main export crop—with an estimated cost of ½ to 1 percent of GDP. In addition, the inflation rate has dropped sharply to its lowest level in 30 years, the guarani has stabilized, a fiscal surplus was achieved for the first time in a decade, public sector external arrears were eliminated, confidence in the financial system has been restored, credit to the private sector is recovering, and the level of international reserves has risen from US$ 786.1 million in July 2003 to US$ 1,284 million in June 2005, exceeding program expectations.
4. The new economic authorities are reputed professionals and enjoy a high degree of independence in their decisions. They recognize the difficult challenges that lie ahead, and wish to reassure the Board of their firm commitment to lock in the economic gains achieved so far. They acknowledge the importance of keeping fiscal and monetary discipline to ensure macroeconomic stability, and of implementing the measures and reforms needed to increase transparency, improve the business environment, and pave the way for more rapid growth and higher employment over the medium term. They also consider that efforts aimed at strengthening public and private institutions, as well as enhancing transparency, are key for a further formalization of the economy. In this context, the government’s main objective is to significantly reduce poverty levels and enhance social equity by developing a more productive, competitive, and diversified economy.
5. A more modest pace of expansion in the global economy, a downward pressure on the prices of Paraguayan exports, higher than expected international oil prices (particularly harmful given Paraguay’s dependence on imported oil), increasing international interest rates, and another drought that affected some key crops earlier this year, represent considerable threats to the Paraguayan economy in 2005. However, our authorities are monitoring these developments closely and introducing appropriate policies to offset the negative impact these shocks may have.
6. In this context, for the first time since the program was launched, the government successfully fulfilled all quantitative targets for this review. Likewise, all quantitative performance criteria for end-June 2005 were also met. These results reflect the authorities’ strong commitment to implementing prudent monetary policies and a strict plan to control fiscal expenditures, as well as their success in avoiding past slippages by enhancing monitoring procedures. Although with some delays, the passage of the second-tier public bank law last month, together with compliance with a structural benchmark for end-May 2005, shows the government’s ability to build consensus, as well as continuous congressional support. The ambitious plan for the reform of the civil service (a structural benchmark for end-April 2005) was approved by the cabinet last July. Nevertheless, the authorities request a waiver for the non-observance of two performance criteria, in view of the corrective measures taken. In this regard, we would like to make the following remarks:
The independent audits for four public enterprises (ANNP, DINAC, INC, and PETROPAR), an April 2005 performance criterion, suffered some delays due to an unexpected legal issue raised by the General Comptroller’s Office (officially in charge of conducting public entities’ audits), and to stricter procedures under the new procurement law. Nevertheless, once legal support was obtained, the authorities stepped up the process, and selected independent audit companies. Audits have already been initiated in three of the companies and the fourth will start in the next few weeks. The authorities are confident that all of them will be finalized in the coming months.
The general banking legislation that was to be approved by end-June 2005 was submitted to Congress in December 2004, ahead of schedule, but has not yet been considered, given that lately the congressional agenda has focused on public banking legislation. Moreover, as the Financial Sector Assessment Program (FSAP) was underway, the new economic authorities considered it important to wait for its results and recommendations, evaluate, and consider them when developing an appropriate framework to confront vulnerabilities and weaknesses in the financial sector. In this vein, a plan to enhance financial sector legislation and further strengthen the banking system is being designed, and is expected to be finalized by mid-September 2005.
7. Our authorities’ strong determination to maintain fiscal discipline is reflected in the better than expected fiscal performance so far this year. They are firmly committed to pursuing their current strategy in order to meet the 2005 fiscal target agreed under the program. The Fiscal Financial Plan, a strong legal and administrative instrument geared to limit spending units’ operations to the available resources, is proving to be instrumental again this year in keeping fiscal discipline, in view of the expansionary 2005 budget approved by Congress. Additionally, continuous efforts to improve tax and customs administration, and constant administrative measures to combat tax evasion, have led to increased collections. Government revenues during the first six months of the year rose by 15 percent relative to the same period last year. It is relevant to recall that revenues increased by around 35 percent in 2004 vis-à-vis 2003, while in May 2005 collections reached a historical record—79 percent higher than the total revenues received in August 2003, when the government took office.
8. The authorities acknowledge the importance of ensuring an efficient use of resources in productive public investment with the aim of achieving higher GDP growth. In this regard, they are permanently strengthening the Public Investment Coordination Unit (UCIP) at the Ministry of Finance, which plays a crucial role in prioritizing public capital expenditure, and ensuring an efficient use of external resources and a proper development of projects.
9. The government is confident that the gradual implementation of the Fiscal Adjustment Law, which broadens the tax base and intends to further formalize the economy; the introduction of the new Customs Code in early 2005; and the launching of the public pension system reform early last year, will sustain tax efficiency gains and contribute significantly to long-term fiscal sustainability. The authorities have also been successful in resolving central government domestic and external public debt arrears, and in placing the debt-to-GDP ratio on a declining trend. After having risen to nearly 50 percent in 2002, the debt burden decreased to 39.8 percent at end-December 2004, and it is expected to further diminish to 30 percent by 2009.
10. The government is well aware of the difficult financial situation of the petroleum company (PETROPAR), and of the continued accumulation of arrears with suppliers. In order to confront this problem, the authorities have raised domestic diesel prices several times this year, and are willing to continue to do so in the event of higher international oil prices. At the same time, the government has a strategy for a more permanent solution to PETROPAR’s financial problems, including a new regulatory framework for the fuel sector, for which a draft has already been submitted to Congress, proposing the liberalization of diesel prices.
11. Despite stronger inflationary pressures during the first months of 2005, our authorities remain committed to achieving the inflation objective for 2005. The surge in inflation was associated with the decision in April to raise the minimum wage in response to the increase in fuel prices, which particularly affects transport costs. Additionally, a seasonal peak in food prices, together with the sharp real appreciation of the Brazilian real against the domestic currency, has underpinned inflationary pressures. Nevertheless, the Central Bank has been proactive in implementing tighter monetary policies in order to contain pressures and achieve the inflation objectives. In this context, and consistent with staff’s recommendations, recently the authorities increased further the rates on Central Bank bills, and are willing to gradually tighten monetary policy over the remainder of the forecast period to keep up with interest rate developments in neighboring countries and the U.S., while containing eventual inflationary pressures. At the same time, the Central Bank is implementing a more flexible exchange rate policy in line with movements in currencies of other countries in the region, with the aim of reducing imported inflationary pressures. Likewise, the monetary authorities will continue implementing the recommendations made by MFD’s technical assistance missions to enhance the conduct of monetary and exchange rate policies.
12. Our authorities acknowledge the importance of an efficient and stable financial system to promote investment and growth. To this end, significant progress has been made in advancing the financial reform agenda, including the implementation of a new framework to supervise financial cooperatives; new legislation for banks’ resolution and the deposit guarantee fund; and streamlined regulatory and supervisory regimes for banks’ asset classification and provisioning, aimed at providing prudential norms in line with international standards. At the same time, our authorities are convinced that improving the governance structure, risk management, and credit policies in public banks is crucial to achieve efficiency and financial sector stability, as well as to reduce the fiscal burden caused by mismanagement in public banks. The implementation of the new second-tier public bank law will be instrumental in improving management of credit lines, ensuring medium- and long-term credits, and intermediating external resources efficiently, so as to promote production, employment, and growth.
13. It is important to emphasize that the measures and reforms being implemented by the government are improving market confidence, as reflected by the continuous rise in deposits and the de-dollarization process observed lately. Private deposits in the banking system increased by 8.6 percent in June 2005 compared to the same month in 2004, and the structural composition of deposits indicates that 57 percent of them are in foreign currency—5.2 percent lower than in June 2004 and 11 percent lower than the peak of dollarization registered in 2002. At the same time, private banking credit continues to recover, after dropping at an annual rate of more than 20 percent at end-2003. At end-July 2005, private banking credit in local currency grew at an annual rates of around 30 percent Moreover, the banking system is in better shape to sustain this credit growth, considering that the ratio of non-performing loans dropped to 10.4 percent in June 2005, from 22.7 percent in September 2003–including BNF which has a more deteriorated loan portfolio vis-à-vis private banks’ portfolio.
14. Our authorities wish to express their firm determination to advance steadily with the remaining structural reforms. It is important to emphasize that many elements of the reform program have been achieved in a short period of time, reflecting strong ownership, broad political consensus, and the government’s commitment, in contrast with the reluctance to implement reforms that prevailed for many years under previous administrations. Enhancing the efficiency and governance of public institutions by carrying out regular independent audits, improving public procurement, and introducing measures to combat corruption are at the top of the government’s agenda. In this connection, the Minister of Finance has recently created an Internal Affairs Unit, a new office whose core responsibility is to investigate and report corruption practices. Likewise, the government is implementing a new initiative entitled “Tools Against Corruption”, which will essentially work together with the private sector to educate the population on combating corruption. Our authorities consider that the comprehensive external audits that are being carried out in public companies will be instrumental in addressing performance weaknesses. At the same time, business plans are being developed to enable private sector participation in some public enterprises with the aim of fostering investment and improving efficiency.
15. Along these lines, the government has a firm determination to implement a strategy to further enhance the investment climate, which is essential to attract investors, reduce unemployment, and improve the country’s socio-economic conditions. To this end, an ambitious six-year economic plan has been articulated in consultation with the civil society and the business community in the context of a broad participatory Seminar, aimed at founding the basis for increasing agricultural and agro-industrial production, enhancing competitiveness, diversifying the economy, reducing inequalities, and improving the business environment.
16. The Paraguayan authorities are strongly committed to continuing with their efforts towards ensuring the achievement of their ambitious economic objectives. They consider that support from the international community and the Fund is crucial in this process, and request continued cooperation and support to tackle the difficult challenges ahead.