Background Information

For almost two decades, various governments embraced the idea of laying the foundations to reduce poverty and inequality in a sustainable manner. Technical assistance from regional and international organizations, as well as development partners, proved handy on this long-term quest to improve the social indicators of Paraguay. Between 2002 and 2019 the poverty rate more than halved.

The benign super-cycle of commodity prices from the early 2000’s offered a unique opportunity for Paraguay to modernize its fiscal, monetary, and financial sectors. Progress was possible in all these sectors, buttressed by a precautionary Stand-By Arrangement in 2003. Since then, the country was able to implement a Fiscal Responsibility Law (FRL), an inflation-targeting regime, and strengthen the financial system regulation and supervision in line with international best practices. Macroeconomic variables have experienced continuous improvements and allowed the country to buildup buffers to mitigate climate-change-related shocks (mainly droughts and floods), regional and global volatilities, and more recently the COVID-19 pandemic.

In April 2020, during the time of great uncertainty created by the pandemic and the challenges to tap domestic and foreign markets, the authorities made a request for a purchase under the Rapid Financing Instrument (RFI) in the amount of SDR 201.4 million (100 percent of quota). Shortly after the IMF Executive Board approved the RFI, Paraguay managed to issue a US$ 1 billion sovereign bond at favorable terms and is continuing to do so.¹ The Fund’s swift action may have produced a signaling effect that helped the country catalyze enough financial resources from capital markets and reinvigorated the pace of disbursements from other multilaterals, regional, and bilateral sources. As a result, the authorities advised the Fund of their plan not to draw on the RFI.

As a result of the COVID-19 pandemic, certain weaknesses resurfaced in sensitive areas, such as promoting inclusive growth to reduce poverty and informality, enhancing the preparedness of the health system, and the quality of education. The authorities are aware of the ample room for improvement in these sensitive areas, and efforts are now being focalized on governance, transparency, the civil service system, public procurement, and the FRL update, among others, to enhance the effectiveness and efficiency of the state provision of quality services to citizens. In this regard, the government’s Economic Recovery Plan is appropriately focused to tackle these challenges.

Governance Assessments

In August 2019, the authorities requested a full-fledged assessment on governance, which was positively responded to by a collaboration with the IMF and the Inter-American Development Bank (IADB). The team was deployed to Asunción in February and early March 2020 (right before the country’s lockdown) to start discussions with the principal stakeholders. Later, the discussions on governance continued online throughout 2020, and a report was recently submitted to the authorities for their attention. The authorities recognize there is ample room to improve the country’s institutions and seek to close the income gap relative to well-performing economies. The surge of the COVID-19 pandemic clearly signaled to policy makers, that going forward, society will demand stronger governance.

Two Consecutive Years with Adverse Scenarios and the Use of Buffers

In 2019, the economy was significantly affected by a drought, which reduced agricultural production, especially soybean, which also led to a weakening of some branches of the manufacturing sector and various sectors linked to agriculture. The drought also severely influenced the generation of electricity from binational hydroelectric dams. By the second half of the year, floods also negatively impacted livestock and construction sectors. Nevertheless, a swift recovery economic plan was deployed in 2019 to mitigate the fall, from an initial forecast of 4.0 percent of annual GDP growth to 0 percent. Positive signals of recovery started to build GDP momentum from July onwards. In this context, the fiscal deficit inched up to 2.8 percent of GDP. It is worth mentioning that the fiscal deficit in 2019 was also largely the result of a significant increase in public investments. Therefore, the composition of expenditures was moving in the right direction, with more resources being deployed to capital investments, while keeping current expenditure in check.

In early 2020, the country experienced a robust growth driven by a recovery in agriculture, electricity generation, manufacturing, services, and construction, and the data collected in January and February of 2020 was consistent with the initial forecast of 4.1 percent of annual GDP growth. With the surge of COVID-19, supply and demand shocks affected the nascent economic recovery, and the country ended up with a contraction of GDP (-0.9 percent) in 2020. The two consecutive shocks in 2019 (climate related) and 2020 (the pandemic) consumed part of the country’s buffers. The fiscal deficit reached 6.5 percent of GDP in 2020, but with the caveat that public investments were still an important component of the final outturn. Public debt was 35.4 percent of GDP and gross international reserves touched US 8.5 billion (or the equivalent of 6.7 months of imports).

At the onset of the COVID-19 pandemic the authorities acted quickly and forcefully and helped prevent the health system from collapsing, while keeping the death toll per million in the first few months to among the lowest in the region. They also swiftly implemented two novel social temporary assistance programs for vulnerable families and for the informal sector with positive results. In addition, their swift actions helped contain the economic situation from further deterioration; even though it ended up in negative territory, it was one of the lowest in the region.

The Authorities’ Commitments

To enhance the transparency and accountability of the state regarding the use of public funds, the authorities made specific commitments to ensure that related expenditures authorized last year, related to the emergency law during the COVID-19 pandemic, were subject to robust budgetary procedures. The Court of Accounts of Congress, the Office of the Comptroller, and the Anti-Corruption Secretariat performed an audit of all crisis-mitigation spending, which is all available to the public online. Transparency reinforces the engagement of civil society with the public sector.

The authorities are continuing with the accommodative stance in 2021, with fiscal, monetary, and financial policies in order to promote an environment for economic recovery of 4.0 percent.

A gradual return to the FRL is envisaged with 1.5 percent of the GDP deficit ceiling by 2024, while continuing the analysis in Congress on new ways to enhance the FRL. A proposal for more stringent measures on current expenditure is now under consideration with the addition of a debt ceiling mechanism in the FRL.

Full implementation of the inflation-targeting regime will allow the exchange rate mechanism to act as the first line of defense against shocks. The level of inflation remained well anchored, and this environment was conducive for the Central Bank of Paraguay (BCP) monetary policy rate to be reduced by 325 bps cumulatively in 2020 to the current rate of 0.75 percent.

Regarding the vigilance of the financial system, last year, liquidity provision to the financial sector was strengthened by the BCP, and banks could renew, refinance, and restructure loans without penalty, and with a lower risk weight. A Micro Small and Medium Enterprises (MSMEs) Guarantee Fund (FOGAPY) was capitalized to provide credit guarantees on new loans to MSMEs. The Development Finance Agency (AFD, a second-tier public institution) eased financing conditions for housing loans and set in place new credit lines targeting MSMEs. On top of that, the BCP made a sizable share of the legal reserve requirement in domestic and foreign currency accessible to the banking system and created a special liquidity window to pump-up liquidity to the financial system. The overall size of the monetary and financial stimulus represented roughly 4 percent of GDP in 2020, among other measures.

Actions are underway to speed up a digital agenda for the public sector, which aims to improve the competitiveness of the economy and the quality of public services provided to citizens and corporations.

Implementation is underway of more than ten new laws related to AML/CFT mitigation risks. These include court sentencing, criminal appeal (all specialized in money laundering, drug trafficking, anti-kidnapping, financing terrorism, corruption, and organized crime), along with the creation of punishable acts of transnational bribery.