Statement by Javier Silva-Ruete, Executive Director for Paraguay and Jose H. Maciel, Senior Advisor to Executive Director

The rebound in inflation since mid-2007 is mostly owed to a jump in food prices in Paraguay. The price volatility of fruits and vegetables explains the divergence between headline and core inflation indicators observed in 2007. Following a decline that started in 2006, core inflation has risen in the second part of 2007. High export volume growth, coupled with a slowdown in import growth, have led to a turn around in the current account from a small deficit in 2006 to a surplus of about 1 ½ percent of GDP in 2007.


The rebound in inflation since mid-2007 is mostly owed to a jump in food prices in Paraguay. The price volatility of fruits and vegetables explains the divergence between headline and core inflation indicators observed in 2007. Following a decline that started in 2006, core inflation has risen in the second part of 2007. High export volume growth, coupled with a slowdown in import growth, have led to a turn around in the current account from a small deficit in 2006 to a surplus of about 1 ½ percent of GDP in 2007.

1. On behalf of the Paraguayan authorities, we thank the staff for an insightful report and for the candid policy discussions held with the Paraguayan authorities in the context of the fifth review of the current Stand-By Arrangement (SBA). As the staff rightly points out, the broad macroeconomic outcomes were significantly better than anticipated and the program remains on track. All performance criteria have been met since the approval of the SBA on May 31, 2006 and most structural benchmarks for end-September and end-December 2007 were fully implemented.

2. The authorities wish to express their commitment to meeting the objectives under the program in order to achieve sustained and high growth, create stability, and diminish poverty, despite the political complexities of an election year.

The Real Sector

3. As noted by the staff, macroeconomic conditions are the best in many years. Paraguay has not had such a good performance since the construction of the Itaipú hydroelectric dam in the 1970s. As a result of the policies implemented under the program, supported by strong exports, improved productivity in the agricultural sector, and high commodity prices, GDP grew by 6½ percent last year, duplicating the long-term average of the Paraguayan economy, and exceeding the 5 percent estimate projected by the staff during the last review. It was the fifth consecutive year of positive growth, with an average annual growth of 4.7 percent.

4. Most productive sectors achieved high annual growth rates, especially agriculture, which was by far the highest, at 25 percent. The top performer was soybean production, which increased by more than 71 percent relative to 2006. Other sectors with positive outcomes were services and construction, with growth rates of around 9 percent. The IMAEP or Monthly Index of Economic Activity reached 9.8 percent in 2007.1 Registered exports posted a record 70 percent increase.

5. In general, these positive outcomes have placed the country in a favorable position to confront possible external shocks as a consequence of the global slowdown. The expectations are to achieve sustainable growth over the medium and long term and, consequently, a decrease in the level of poverty.

The Fiscal Sector

6. Over the last five years, public finances have been consolidated, resulting in a continued surplus. At the end of last year, the consolidated public sector posted a surplus of 1 percent of GDP and the overall balance registered a surplus of 1.6 percent of GDP. These results were achieved thanks to a tax reform that has improved revenues and the administration of the tax system, and to greater expenditure control.

7. The Ministry of Finance reported that import duties and tax collections grew by 28 percent in dollar terms in 2007. Moreover, since 2002 they have increased by 176 percent, reflecting a buoyant economy and a broader tax base—although import duties grew at a slower pace due to the appreciation of the currency. As the staff mentions in the report, Paraguay has one of the strongest fiscal positions compared to its neighboring countries. All these indicators were better than projected.

8. The 2008 budget approved by Congress points to a deficit of 2 percent of GDP, including increases in salaries for all public servants. Although not originally planned, the salary raise was granted to prevent unrest among public sector employees, whose salaries have been frozen for several years. To offset this imbalance, the authorities have prepared a financial plan to maintain expenditures within a balanced budget. They have expressed their commitment to restrain non-social current spending to create room for higher social and capital expenses to alleviate poverty and to continue with the Social Safety Net program.

The Monetary Sector

9. The monetary targets included in the SBA were fully met during 2007. Although headline inflation has been very volatile, reflecting food supply shocks, it fell to 6 percent at the end of the year, significantly less than the 12.5 percent at the end of 2006. This achievement was, in part, thanks to the prompt reaction of the Central Bank, which started to increase its interest rate in the second half of last year. As the staff explains, 70 percent of the inflation level is due to higher food prices. Starting this year, the Central Bank is using a new CPI index, where the share of food will be reduced to 35 percent from its previous share of 40 percent in the index; although at 35 percent, this level is still the highest in the region. The expectations are that the new index will bring less volatility to the inflation movements. However, inflation has jumped to 10½ year-on-year in the first months of 2008 and the authorities are ready to switch to a tougher stance in order to comply with the program objective of reducing core inflation within a 2½-7½ range.

10. A matter of concern for the staff is the rapid pace of currency growth and the risks of inflationary pressures attached to it. However, as pointed out by the Paraguayan authorities, there is a strengthening in money demand and a deepening in financial intermediation, as evidenced by the reestablishing of stability and confidence in the economy, the appreciation of the currency, high remittances from abroad, a continued decline in dollarization, and rising maturities of term deposits. Nevertheless, the monetary authorities are committed to monitoring currency growth to anchor inflationary expectations.

11. By the end of 2007, international reserves had increased by almost 30 percent, to a level equivalent to 3½ months of imports or near 20 percent of GDP, well above projections. Despite increased pressures to curb the appreciation of the guaraní, the authorities are committed to preserving a flexible exchange rate regime, with mild interventions to prevent sudden variations of the exchange rate.

The Financial System

12. The continued improvement of the financial system can be measured by the sustained expansion of credit to the private sector, with 55 percent annual growth by January 2008, increased private sector deposits (30 percent annual growth), a substantial reduction of non-performing loans, narrowing interest rate spreads, increased profits, and well-capitalized banks. In this regard, the authorities are thankful for the continued support from Fund missions and technical assistance, which enabled a successful restructuring of the financial system—after the painful crisis of a decade ago—mainly through adequate banking regulations.

The External Sector

13. The continued boost in commodity prices over the last year, as well as increased productivity, contributed to an impressive growth in exports, which led to a current account surplus of 1½ percent of GDP in 2007. Also, the capital account registered a surplus thanks to increased foreign direct investments, large inflows from bi-national hydroelectric plants, and high remittances from expatriates—although in a lesser amount than in 2006. These results led to favorable balance of payments for the fifth consecutive year and the outlook for 2008 remains favorable.

14. The guaraní-dollar exchange rate appreciated by near 13 percent year-on-year at the end of 2007 and this trend is expected to continue in 2008. The staff agreed with the Paraguayan authorities that the exchange rate is in line with fundamentals and is not a source of concern.

15. The authorities have pointed out that the accumulation of international reserves and the fact that most of the capital inflows to Paraguay are directed to the current account, as opposed to the capital account, provide resilience against a global slowdown and would shield the economy against spillovers. Regarding the international claims in dispute, the authorities are engaged in reaching a prompt settlement with the involved parties.

Structural Reforms

16. As mentioned before, most of the structural conditions for end-September and end-December 2007 were complied. Regarding the partial implementation of the Central Bank norm that strengthens loan classification and provisioning requirements, the staff pointed out that, although the authorities approved the norm on the due date, its implementation was delayed to October 2008 to ensure consensus and adequate support from all stakeholders.

17. With respect to the delay in the Economic Cabinet's approval of the legislation draft to revamp the payment system, the Central Bank has informed that the draft was shared with the involved parties to muster ownership of the proposed bill, in order to avoid setbacks when presented for approval. The Association of Paraguayan Banks welcomed this initiative and has already sent some comments on the draft bill.

18. Regarding the compliance of the benchmark for State Owned Enterprises (SOE), which sought the adherence to performance standards by the five largest public enterprises (suppliers of electricity, telecommunications, water and sanitation, fuel, and cement), two of them felt short of expectations. However, the authorities are committed to continuing with the reform of the SOE to further improve their efficiency and productivity. During the course of the present year, the government will persist with the practice of signing result-oriented contracts with these enterprises, which has proven to be a useful tool to measure performance. At the end of last year, a draft bill was sent to Congress to reduce the debt burden and to address the governance problem of one of them (ESSAP), whose ownership structure was altered after a failed privatization attempt. The new result-oriented contracts will include the elaboration and compliance of strategic business plans addressing the weaknesses already identified in previous assessments.

19. We would also like to mention the progress regarding some aspects of the financial sector reform. As indicated by the staff, the monetary and fiscal authorities will continue to strengthen the financial position of the Central Bank. A reconciliation of claims between the public records of the Ministry of Finance and the Central Bank has finally been agreed and is likely to be resolved shortly. The remaining claims were sent to the Attorney General to rule on the subject before submitting a draft legislation to Congress authorizing the corresponding payments to the Central Bank.

20. The Social Safety Net program has proved to be an effective tool to reduce extreme poverty. Last year, 17,000 families were assisted by the program—a structural benchmark under the SBA. For 2008, the authorities are planning to extend the coverage to 50,000 families.

Closing Remarks

21. As highlighted in the World Bank's Doing Business Report 2008, Paraguay has been among the top ten reformers on the starting business indicator. This is a strong signal that the authorities are committed to achieving the necessary reforms to improve the business climate and attain a high level of investment. In this context, the assistance from the Fund and other multilateral organizations is highly appreciated by the authorities, who look forward to acontinuing support from staff and Management and commit to maintaining a frank policy dialogue.


Preliminary estimates. The IMAEP is prepared by the Central Bank of Paraguay to deliver short-term economic trends, in constant numbers.

Paraguay: Fifth Review Under the Stand-By Arrangement: Staff Report; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Paraguay
Author: International Monetary Fund