Paraguay: Selected Issues and Statistical Appendix

This Selected Issues paper analyzes the background, stages and developments, and estimation of the direct costs of Paraguay's banking crisis. The paper provides the estimates on the size and evolution of the informal sector, and examines the extent to which the national accounts capture informal activity. The study also estimates the potential output and total factor productivity by examining trends in output, investment, and population growth as well as the direction and size of fiscal impulse on its economy. The paper also provides a statistical appendix report of Paraguay.

Abstract

This Selected Issues paper analyzes the background, stages and developments, and estimation of the direct costs of Paraguay's banking crisis. The paper provides the estimates on the size and evolution of the informal sector, and examines the extent to which the national accounts capture informal activity. The study also estimates the potential output and total factor productivity by examining trends in output, investment, and population growth as well as the direction and size of fiscal impulse on its economy. The paper also provides a statistical appendix report of Paraguay.

IV. Fiscal Impulse in Paraguay1

This note estimates the direction and size of the fiscal impulse on the economy of Paraguay. The fiscal impulse measures the extent of discretionary changes in fiscal policy, after filtering out cyclical effects. These cyclical effects—the so-called automatic stabilizers— make the public sector balance a poor indicator of the overall direction of fiscal policy. A deterioration of the fiscal balance, e.g., might not always be expansionary. During a recession, automatic stabilizers widen the deficit naturally, as tax receipts fall and unemployment benefits rise. The calculations below show that most of the recent deterioration in the public finances of Paraguay was due to cyclical effects. The fiscal impulse has been close to zero since 1998.

A. Measuring the Cycle: Potential vs. Actual Output

Potential output grew at an average rate of 2.6 percent per year during the 1990s, which was slightly below the increase in population. Actual GDP grew above potential during the mid-1990s, but experienced a significant downturn after 1997. Negative growth in both 1998 and 1999 has resulted in an output gap of some estimated 4½ percent of GDP (see Figure 5 in Section III).

B. Isolating Automatic Stabilizers: The Cyclically Passive Balance

The benchmark for an assessment of the fiscal impulse is the cyclically neutral, or passive, balance. Such a balance would result from allowing only the automatic stabilizers to play. To proxy this situation, discretionary expenditures are maintained as an unchanged proportion of long-run GDP (potential output), while tax rates are left constant. In other words, imagine a government that takes its hands off from fiscal policy, making the resulting balance endogenous to the cycle. The fiscal impulse can be derived by comparing the balance that results in this passive scenario to the actual outcome.2 In particular, taxes are frozen as a ratio of actual GDP. This way, tax receipts will vary with the cycle. The same treatment is given to the operating surplus of public enterprises, since the sales of these entities are also sensitive to the cycle. Because there is no unemployment insurance and very few welfare programs, the cyclically sensitive expenditures are minimal in Paraguay and will be ignored.

All other expenditures are assumed to be insensitive to the cycle, and to follow a constant proportion of potential GDP. This captures the notion that the government has to meet a demand for public goods that follows trend growth. On the other hand, two revenue items in Paraguay are neither cyclically sensitive nor under the direct control of the state. Interest payments follow a pattern that is determined by past public debt obligations, and nontax revenues consist mainly of royalties from the hydroelectric plant of Itaipú. Power generation in turn depends on the amount of rainfall in the upper reaches of the Paraná, and is exogenous. These two components are taken at their actual value for the calculation of the cyclically passive balance. The assumptions can be summarized in the following equation:

d*=tby-gby*+z

where d* is the cyclically passive deficit, tb and gb are tax and expenditure ratios frozen at the base year level, in which actual and potential output are deemed to be equal, y is actual output, y* is potential output and z are exogenous factors, such as interest costs and royalties.

Figure 9.
Figure 9.

Actual and Cyclically Passive Balance of the Public Sector in Paraguay.

Citation: IMF Staff Country Reports 2000, 051; 10.5089/9781451832365.002.A004

An important question is the choice of the base year. This determines the levels at which tax rates and expenditures are frozen. Ideally, the base year has output close to potential, with fiscal policy on a sustainable path. For recent years in Paraguay, 1993 has the smallest output gap with 0.4 percent. Public finances—defined as the balance of the nonfinancial public sector—recorded a small surplus and the structure of the budget was quite representative for the 1990s.3 Figure 9 shows the actual and the cyclically adjusted deficit for Paraguay over the period 1970–99.

A particular problem concerns the measurement of the deficit on an accrual or cash basis. In Paraguay, the public sector often incurs arrears, which drive a wedge between the accrual and cash deficit. This section will mainly draw on accrual data, because a continuous time series exists since 1970. However, a comparison with the cash deficit (which is available only since 1995) shows that the qualitative differences are not very large.

C. Fiscal Stance and Fiscal Impulse

The fiscal stance is defined as the difference between the cyclically passive and the actual balance. A positive sign is identified with a lax, a negative sign with a tight fiscal stance. In equation form:

STANCE=dt*-dt

Figure 10 shows the fiscal stance for the period 1970–99.

Figure 10.
Figure 10.

The Fiscal Stance in Paraguay, 1970–99, in Percent of GDP

Citation: IMF Staff Country Reports 2000, 051; 10.5089/9781451832365.002.A004

A strong expansion in 1997 has resulted in a positive fiscal stance over the most recent years. The public sector balance has worsened below the cyclically passive benchmark. A further relaxation of the fiscal stance should be considered risky, as it limits the flexibility of fiscal policy over the longer term and eventually calls for a retrenchment. Such a retrenchment could happen during a recession, when the overall balance is worst, causing destabilizing procyclical effects. However, for several reasons, the fiscal stance is not an ideal gauge of fiscal policy. First, it is sensitive to the choice of the base year. A different base year can lead to a vertical shift of the time series in Figure 10. Second, the structure of the budget may change over long time intervals, according to changes in relative prices and shifting demands for public goods. Third, the ease of accessing debt financing and the relation between real interest rates and GDP growth can lead to a changing “sustainable” deficit over time. Therefore, the fiscal stance (or the structural deficit) does not necessarily suggest a “correct” level of the public sector deficit. It is a static concept that serves well as an intermediate step in calculating the fiscal impulse.

The fiscal impulse is defined as the first difference of the fiscal stance. It is independent of the choice of base year. A positive sign means that fiscal policy is becoming more expansionary, a negative sign means it is becoming more contractionarys The fiscal impulse is measured in percentage points of GDP and can be understood as the dynamic shock that fiscal policy sends to the rest of the economy. In equation form, the fiscal impulse can be written as:

IMPULSE=ΔSTANCE=(dt*-dt)-(dt-1*-dt-1)

Figure 11 shows the fiscal impulse for Paraguay for the 1990s.

Figure 11.
Figure 11.

Fiscal Impulse in Paraguay, 1990–99

Citation: IMF Staff Country Reports 2000, 051; 10.5089/9781451832365.002.A004

Figure 11 shows clearly the marked adjustment of 1990, a year after the transition of Paraguay to democracy. The country’s foreign debt burden had become unsustainable at over 50 percent of GDP, and forced the government to pursue fiscal surpluses. The data also suggest the establishment of an electoral cycle. The fiscal impulse is most expansionary in 1992 and 1997, the years that preceded presidential elections. In both cases, the impulse turns contractionary right after the elections. Although the actual deficit widened further in 1998 and 1999, this was primarily a consequence of the recession and not of a further relaxation of policies. The fiscal impulse of the last two years was roughly neutral.

D. An Analytical Breakdown of the Fiscal Impulse

Figure 12 breaks down the fiscal impulse by sector. A pronounced swing in the finances of public enterprises was at the heart of the large adjustment of 1990. For the first time since 1970, public enterprises recorded an overall surplus. The following relaxation was caused mainly by the central government, which was expansionary in six out of ten years. In contrast, the social security system was contractionary in six of ten years, due to the young demographics of Paraguay which ensure a large excess of contributors over beneficiaries. A notable exception to this trend were the years 1997 and 1998, when the system suffered losses from a failed investment strategy. Temporarily, the stance of the central government tightened in 1998, as tax collections improved and current expenditures were kept under firm control. Tax collections slackened again in 1999, leading to renewed expansion.

Figure 12.
Figure 12.

Breakdown of the Fiscal Impulse by Public Entities, 1990–99

Citation: IMF Staff Country Reports 2000, 051; 10.5089/9781451832365.002.A004

Figure 13 examines the fiscal impulse according to economic classification. It can be seen that the improvement in the finances of public enterprises—the driving force behind the adjustment of 1990—was achieved by a combination of tariff increases and cuts in investment. Most of the following expansion was due to increases in current spending in the central government, as wage outlays doubled in percent of GDP between 1990 and 1999. In contrast, capital spending contributed a negative impulse in five out of ten years. Investment was often treated as a residual in the process of budgetary resource allocation, leading to an increasingly inefficient mix of public sector output, and to persisting deficiencies in public infrastructure.

Figure 13.
Figure 13.

Fiscal Impulse by Economic Classification, 1990–99

Citation: IMF Staff Country Reports 2000, 051; 10.5089/9781451832365.002.A004

The fiscal impulse methodology filters out cyclical effects from public finances and measures deliberate changes in fiscal policy. Calculations for Paraguay show a sizeable fiscal expansion in 1997, before the last presidential elections. In contrast, the deterioration of the public sector balance during 1998–99 was mainly driven by a cyclical downturn, as the fiscal impulse remained roughly neutral.

STATISTICAL APPENDIX

Table 1.

Paraguay: National Accounts at Current Prices

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Sources: Central Bank of Paraguay; and Fund staff estimates.
Table 2.

Paraguay: National Accounts at Constant Prices

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Sources: Central Bank of Paraguay; and Fund staff estimates.

Contribution to GDP growth.

Table 3.

Paraguay: Savings-Investment Balance

(In percent of GDP)

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Source: Central Bank of Paraguay, and Fund staff estimates.
Table 4.

Paraguay: GDP by Sector of Origin at Current Prices

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Sources: Central Bank of Paraguay; and Fund staff estimates.
Table 5.

Paraguay: GDP by Sector of Origin at Constant Prices

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Sources: Central Bank of Paraguay, and Fund staff estimates.
Table 6.

Paraguay: National Income at Current Prices

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Source: Central Bank of Paraguay, Cuentas Nacionales.
Table 7.

Paraguay: National Income at Constant Prices

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Source: Central Bank of Paraguay, Cuentas Nacionales.
Table 8.

Paraguay: Volume of Agricultural Production 1/

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Sources: Central Bank of Paraguay; and Fund Staff estimates.

Agricultural years; for example, 1991 refers to the 1990/91 agricultural year.

Table 9.

Paraguay: Value of Agricultural Production 1/

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Sources: Central Bank of Paraguay; and Fund staff estimates.

Agricultural years; for example, 1991 refers to the 1990/91 agricultural year.

Table 10.

Paraguay: Production, Area Cultivated and Yields of Selected Crops 1/2/

(Production in metric tons; area in thousands of hectares; yields in kg/hectare)

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Sources: Ministry of Agriculture; and Fund staff estimates.

Agricultural years; for example, 1991 refers to the 1990/91 agricultural year. Data include seeds.

Data may not fully agree with those in Table 8 because of differences in sources and methodology.

Table 11.

Paraguay: Value-Added in Manufacturing

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Sources: Central Bank of Paraguay; and Fund staff estimates.
Table 12.

Paraguay: Consumer Price Movements in Asunción 1/

(Annual percentage change)

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Source: Central Bank of Paraguay.

Refers to the metropolitan area, including Asunción and 14 other municipalities.

Table 13.

Paraguay: Producer Prices

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Source: Central Bank of Paraguay.