This technical paper focuses on the challenges faced by Paraguay’s budget resources. Paraguay’s government should adopt a forward-looking fiscal strategy. The strategy’s main goals should be to contain budget dependence on Itaipu revenues, preserve fiscal discipline, and allow for the gradual and sustainable transformation of the envisaged, yet temporary, windfall into other forms of financial, physical, and human capital. The creation of a special fund could help mobilize public support for saving part of the windfall and building a buffer for the future.


This technical paper focuses on the challenges faced by Paraguay’s budget resources. Paraguay’s government should adopt a forward-looking fiscal strategy. The strategy’s main goals should be to contain budget dependence on Itaipu revenues, preserve fiscal discipline, and allow for the gradual and sustainable transformation of the envisaged, yet temporary, windfall into other forms of financial, physical, and human capital. The creation of a special fund could help mobilize public support for saving part of the windfall and building a buffer for the future.

I. Sustainable Management of Revenues from Itaipu1

A. Introduction

1. In the near term, Paraguay may receive a sharp increase in revenues from electricity sales from the Itaipu dam, raising the question of how to manage these resources effectively. This windfall would come from the July 2009 agreement between Paraguay and Brazil to triple the price of Paraguay’s electricity exports to Brazil, if this agreement is ratified by both legislatures (Box 1). It would offer important opportunities, while posing certain challenges. One of the main challenges is to guarantee the efficient and sustainable use of the windfall. This is especially important given its temporary nature and the projected declining profile of Itaipu revenues, which are estimated to reach ½ percent of GDP by 2025. Another important challenge is to avoid that the windfall could further reduce the incentive to mobilize tax revenues, which are lower in Paraguay (as a share of GDP) than in similar countries in terms of income per capita and dependence on natural resource revenues. This is especially critical at the level of sub-national governments, which may make less of an effort to mobilize taxes, because of the existing sharing mechanism for Itaipu revenues.

2. This paper outlines a medium-term fiscal strategy and a management mechanism to address the challenges posed by the Itapu windfall. It proposes to deposit the windfall in a special fund, which could help mobilize public support for saving part of the windfall and building a buffer for the future. The fund could also provide an easy and transparent way to present and manage the stocks and flows associated with the windfall. In line with best practices, the fund management should be supported by special legislation, which will include stringent investment and transparency rules, as well as, clear criteria for the selection of the projects to be funded.

3. The document is organized as follows. Section B overviews the main challenges and risks posed by the revenues derived from Itaipu. Section C describes the main components of a sustainable fiscal strategy to overcome these risks and challenges. Section D presents key considerations to design an effective fund to manage the forthcoming windfall. Section E summarizes and concludes.

Revenues from the Hydroelectric Plant Itaipu

Under the Itaipu Treaty, Paraguay and Brazil agreed to exploit jointly the hydroelectric resources of the Parana River In addition, both countries agreed on the creation of a binational entity, the Binational Itaipu,1 for the administration of the dam. Under the Treaty it was agreed that the two countries will be obliged to acquire, either jointly or separately, all of the power produced by the dam Itaipu at cost.

The Itaipu Treaty mandates that Binational Itaipu pay royalties to each country. The royalties are compensation for the use of the water of the Parana River in the production of electric energy. The royalties are calculated as the product of the electric energy effectively produced by the dam, measured in GWh, and a fixed price by GWh in U.S. dollars, established in the Treaty at US$650 per GWh. In order to maintain constant their real value in U.S. dollars, the royalties are updated monthly basis according to the Industrial Production Index and the CPI of the U.S. In 2009, royalties paid to the Paraguayan government amounted to US$222 million (1.5 percent of GDP).

The Treaty also gives each country the right to purchase the energy not used by the other country for its own consumption. The volume of electric energy that Paraguay annually acquires from Itaipu is still well below its 50 percent share. In particular, in 2008 Paraguay only acquired 18 percent of its share or 9 percent of Itaipu’s total production. Under these circumstances, the Treaty gives Brazil the right to acquire, at cost, the electric energy not used by Paraguay.

Paraguay receives a compensation for the sale of the excess of electric energy to Brazil. The compensation is calculated according to the product of the amount of energy sold to Brazil in GWh, and a price per GWh established in the Treaty at US$350 multiplied by a factor M. The compensation is also updated on a monthly basis in line with the Industrial Production Index and CPI of the U.S.. The factor M originally took the value of 3½ in the Treaty and has been revised upward on several occasions (now stands at 5.1).2

According to a July 2009 agreement between Brazil and Paraguay, the compensation that Paraguay receives from Brazil could rise substantially over the medium term. In 2009, Brazil paid a compensation of US$120 million to Paraguay (0.8 percent of GDP). Once the agreement is ratified by the two legislatures, compensation to Paraguay would rise by US$240 million (1.5 percent of GDP) to US$360 million (equivalent to a tripling in the parameter M to 15.3).

An important portion of Itaipu revenues are at present shared with sub-national governments. The central government currently transfers 30 percent of both royalties and compensations to sub-national governments. A recent law requires the central government to share 50 percent of royalties with sub-national governments (municipalities and gobernaciones) by 2013. However, the distribution of compensation payments is still unclear, since this is not mandated by law.

1 The Itaipu Treaty was signed on April 26, 1973 and will expire in 2023. The Binational Itaipu was created on May 17, 1974.2 At present Paraguay receives US$45 per MWh (US$45,000 per GWh), almost one-third of the price currently paid in the Chilean market, where the price is 120US$ per MWh. Even though the costs of exporting to Chile would be higher, $60/MWh, than the cost of production of Itaipu ($42/MWh), the profit from exporting to Chile ($60/MWh) is 20 times higher than the only benefit that Paraguay gets from exporting to Brazil, namely the compensation of $3/MWh.

B. Main Challenges and Risks Posed by Itaipu Revenues

4. Itaipu revenues may pose important macroeconomic, intergenerational, political economy and governance challenges. Some of the challenges derive from the macroeconomic and budgetary difficulties of managing large and relatively volatile funds. Some of other challenges derive from the way in which these funds are generated, without the scrutiny of taxpayers, donors, and lenders. Specifically:

  • Volatility. As they are generated in U.S. dollars, the Itaipu revenues present certain volatility. In addition, Itaipu revenues could vary as a result of the sudden increase in some of the parameters used in their calculation, such as the one derived from the recent agreement with Brazil. If the windfall derived from the new arrangement is fully spent, it could put some pressure on the country’s administrative capacity, and lead to waste or an increase in spending programs of questionable quality.

  • Budget dependence. Paraguay’s central government budget highly depends on the 2⅓ percent of GDP revenues derived from the binational Itaipu (Figure 1). Actually, when Itaipu revenues are excluded, the public balance surplus of 0.1 percent of GDP achieved in 2009 becomes a 2⅓ percent of GDP deficit. This is mainly the result of Paraguay’s low tax ratio, which at present amounts to only 12.7 percent of GDP, even lower than in peer countries with similar income per capita and volume of resource revenues.

  • Rentier mentality. The theory of rentier states sustains that countries that receive substantial amounts of resource revenues from the outside world on a regular basis risk become unaccountable to their citizens and less prone to promote the increase in tax collections (see Moore, 2004). Although data are scarce, anecdotal evidence suggests that the existing mechanism to share Itaipu revenues among levels of governments may have substantially discouraged the subnational governments’ efforts on tax mobilization. Itaipu revenues may have also discouraged in the past, and may continue to discourage in the future, tax reforms in Paraguay.

  • Declining profile over time. Although the energy generated by the Itaipu dam is considered a renewable resource, Itaipu revenues are estimated to decline overtime. The declining profile will result from the following factors: (i) the unitary price per GWh, in U.S. dollars, is adjusted monthly in line with the CPI and the Industrial Production Index of the U.S., which probably will grow by less than Paraguay’s nominal GDP; and (ii) the electricity surplus currently exported to Brazil is expected to shrink over time, in tandem with the envisaged increase in Paraguay’s domestic consumption of electricity (Box 2).

Figure 1.
Figure 1.

Itaipu Revenues

Citation: IMF Staff Country Reports 2010, 170; 10.5089/9781455207534.002.A001

Long-Term Projections of Itaipu Revenues

Paraguay’s revenues from Itaipu are projected to decline even under favorable assumptions. These assumptions include:

  • Itaipu production remains constant. This assumption seems reasonable as the dam is already operating at maximum capacity.

  • Paraguay’s domestic consumption of electric energy increases by 5 percent during 2010–15 and by 10 percent during 2016–30. As Paraguay’s domestic consumption of power increases, the volume of excess energy to be sold to Brazil will be smaller, and the compensation received from Brazil will decrease.

  • Economic activity in Paraguay will grow faster than industrial production and consumer prices in the United States. During 2010–30, staff projects nominal economic activity in Paraguay to grow by 8–10 percent a year, while nominal growth in the U.S. economy is projected at about 5 percent a year.

  • Real exchange rate of the guaraní against the U.S. dollars remains constant during the projection period. This implies a small depreciation of the guaraní to offset the expected inflation differential between Paraguay and the United States.

Under these assumptions, Itaipu revenues are projected to decline from the current 2⅓ percent of GDP to less than ½ percent of GDP by 2025. The recent agreement with Brazil to triple the compensation payments, if ratified by the legislatures, would lead to a rise in Itaipu revenues in the near term. However, even these additional revenues would sharply in relation to GDP by 2025, under these assumptions.


Paraguay: Itaipu Revenues Projections

(In percent of GDP)

Citation: IMF Staff Country Reports 2010, 170; 10.5089/9781455207534.002.A001

C. Strategy to Manage Itaipu Revenues

5. A sustainable medium-term fiscal strategy would help address the challenges and risks associated to Itaipu revenues. The strategy should aim to (i) increase tax revenues to help diversify the government’s revenue sources away from Itaipu revenues; (ii) implement a medium-term fiscal framework, which would aim at smoothing the expenditure envelope over the medium-term; and (iii) adopt a mechanism to save part of the Itaipu windfall to provide a more sustainable source of revenue.

6. As in other natural resource-rich countries, Paraguay could adopt a rule to determine the portion of the Itaipu windfall to be saved. Some of these rules would also allow for a certain degree of intergenerational equity, in the sense that future generations will also enjoy part of the windfall. Options include (see Figure 2):2

  • Going on a binge rule. One option could be to spend the whole annuity of the windfall, under the so-called “going on a binge” or “hand to mouth” rule. However, this rule has important drawbacks. First, it would privilege current over future generations; and, it would lead to a non-sustainable fiscal path, since substantial fiscal adjustment, which will may be difficult to implement, would be needed when the Itaipu windfall start declining.

  • Bird-in-hand rule. Under this rule the government would spend only the interest income accruing from accumulating the windfall revenues in a fund. A similar rule is used by Norway, for instance, where the oil revenues contribution to the annual budget cannot be larger than 4 percent of the return of the oil fund. This rule would yield small annual payments during the first years, while the stock of additional revenues accumulates.

  • Permanent Income Hypothesis (PIH). The PIH implies that a transitory increase in resource revenues should not influence the current level of spending.3 Therefore resource windfalls should be almost completely saved to ensure a stable path of spending overtime. Under this rule, the government would use in fiscal year t only the sustainable (permanent) annual income, (SIt) which is the maximum amount that can be spent from the Itaipu windfall in that year and still leave enough savings. This amount would equal the real rate of return multiplied by the net present value (NPV) of all of the windfall inflows in the future. In the case of Paraguay, the NPV of the future windfalls is not much higher than annual payments in the early years, and for this reason, this rule does not deviate much from the bird in hand rule.

  • Declining budget dependence on the Itaipu windfall.4 Another option is a rule that links the share of windfall to be spent with progress on increasing tax revenues. If the authorities make good progress in increasing the tax ratio (and reducing dependence on Itaipu revenues), the Itaipu windfall could be spent more rapidly. This rule would suggest that, if tax revenues rose by 0.3 percent of GDP a year, the government could spend 0.3 percent of GDP a year out of the windfall. The rest of the windfall would be invested in a fund, which could reach a sufficient balance to provide a permanent annuity by 2025, although somewhat less than under the PIH.

Figure 2.
Figure 2.

Annuities for Itaipu Windfall Under Different Rules

Citation: IMF Staff Country Reports 2010, 170; 10.5089/9781455207534.002.A001

D. Key Considerations for the Design of a Fund for the Itaipu Windfall

7. This section proposes the design and implementation of a special fund for the management of the windfall expected from Itaipu. Key considerations would include: (i) where to deposit the windfall; (ii) the legal framework to govern its management; (iii) the criteria to identify the projects to be funded; (iv) special requirements for transparency and communication; and (v) guidelines for efficient management of the fund.

8. The Itaipu Fund could be managed as a separated account. According to best practices, the revenues derived from the Itaipu windfall should be deposited in the government’s treasury account, together with the rest of government revenues. However, Paraguay may find it useful to create a separate account to help insulate deposits and withdrawals from political pressures, which in turn could help mobilize public support for this step. Paraguay could benefit from the enactment of a special piece of legislation for the Itaipu Fund, which could be altered only under special majorities in congress to ensure a high degree of legal stability. Such a law should: (i) establish the main purpose of the fund (i.e. a saving fund); (ii) exclude the windfall from the current de facto rule that earmarks 30 percent of compensations to subnational governments; (iii) outline the rules that will govern the annual withdrawals; and (iv) specify the circumstances (e.g. national emergency) under which the law would authorize annual withdrawals above the rules.

9. The management of the Itaipu Fund would depend on the volume, the expected use, and time horizon of the envisaged savings. In case of small-to-moderate deposits, which are expected to be used in the short to-medium term, and mainly on domestic transactions, the fund could be a domestic currency-denominated account managed under a well defined protocol. The main transactions will entail manageable deposits and withdrawals and unsophisticated and limited investment operations. However, in case of large deposits, which are expected to be saved for the long run, it would be advisable to maintain the fund as a foreign-currency denominated off-shore account, which could be managed by the central bank (e.g. Norway) or outsourced to a financial institution (e.g. Saõ Tomé and Principe), according to a more sophisticated investment strategy. The strategy could be return-driven, yet conservative, with prudent provisions for diversification of risks and liquidity. The ministry of finance should take responsibility for designing the investment strategy, with assistance from a non-partisan Investment Committee to add an extra layer of independent control.

10. The legal framework should also establish the criteria for the allocation of the Itaipu Fund among line ministries. The authorities’ intention to allocate the Itaipu windfall to funding infrastructure and IT projects is well placed. On a first stage, and in line with previous advice to save part of the windfall, the fund could focus on supporting projects of reduced scale but with high impact. To enhance the project effectiveness and efficiency, the legal framework could establish that the Itaipu Fund will be distributed among line ministries in response to their project submissions, which could be assessed by the ministry of finance.

11. All of the operations of the Itaipu Fund should be as transparent as possible and subject to special audits. The success of the Itaipu Fund—in terms of both actual financial returns and public perception—will depend in part on the transparency of its operations. Therefore, it would be advisable to establish specific reporting mechanisms, including: (i) a short report describing the Itaipu Fund’s annual activities, comprising an inflow and outflow statement and a balance sheet presentation; (ii) the overall annual return on the assets of the fund; and (iii) a statement by independent external auditors.

E. Conclusion

12. Itaipu revenues represent a great contribution to Paraguay’s budget resources, but pose specific challenges. To address these challenges, Paraguay’s government should adopt a forward-looking fiscal strategy. The strategy’s main goals should be to contain budget dependence on Itaipu revenues, preserve fiscal discipline, and allow for the gradual and sustainable transformation of the envisaged, yet temporary, windfall into other forms of financial, physical and human capital. This could be achieved by implementing medium-term fiscal plans to keep public expenditure in line with Paraguay’s absorptive capacity, save some of the windfall to insure future financing of public spending, as Itaipu revenues decline, and increase tax revenue. The creation of a special fund could help mobilize public support for saving part of the windfall and building a buffer for the future. The fund could also provide an easy and transparent way to present and manage the stocks and flows associated to the Itaipu windfall.


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Prepared by Teresa Dabán-Sánchez and Walter Zarate.


See Dabàn and Hélis (2010) for a more detailed presentation and a discussions of the pros and cons of the most commonly rules used by resource-rich countries.


The PIH has been applied by several resource-rich countries, including Timor-Leste and Saõ Tomé and Príncipe (see Segura, 2006, and Kim, 2005), and has been proposed for Gabon (Leigh and Olters, 2006), and Trinidad and Tobago (Velculescu and Rizavi, 2005).


This kind of adjustments to the PIH has been proposed for other countries. In the case of Saõ Tomé and Príncipe and Chad the PIH annuity has to be rescaled down in line with national administrative absorptive capacity (see Segura, 2006 and Dabàn and Lacoche, 2007). For the case of Gabon, Leigh and Olters (2006) proposed a smoothing mechanism rule for consolidating the non-oil primary deficit to the sustainable PIH level, which given Gabon’s relative high tax ratio, focuses on gradually reducing expenditure. East-Timor also allows for deviations from the PIH under special circumstances and based on clear guidelines.

Paraguay: Selected Issues
Author: International Monetary Fund