Paraguay: 2022 Article IV Consultation-Press Release; and Staff Report
Author:
International Monetary Fund. Western Hemisphere Dept.
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Publication Date:
21 Jun 2022
eISBN:
9798400213779
ISBN:
9798400213779
Language:
English
Keywords:
U.S. dollar; transfer program; policy space; potential GDP; government entity; Inflation; Global
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1. The Covid-19 pandemic had a strong impact on Paraguay, but the pandemic currently appears under control. Imposing a strict lockdown and closing borders, the country avoided the brunt of the first wave through July 2020. However, cases and deaths started to pick up in August 2020, and during June 2021 Paraguay experienced one of the highest cases and deaths counts in Latin America. Paraguay’s vaccination campaign was slow to start, and its vaccination rate continues to lag regional peers. Most of the remaining restrictions have recently been lifted, and public life has largely normalized.

Abstract

1. The Covid-19 pandemic had a strong impact on Paraguay, but the pandemic currently appears under control. Imposing a strict lockdown and closing borders, the country avoided the brunt of the first wave through July 2020. However, cases and deaths started to pick up in August 2020, and during June 2021 Paraguay experienced one of the highest cases and deaths counts in Latin America. Paraguay’s vaccination campaign was slow to start, and its vaccination rate continues to lag regional peers. Most of the remaining restrictions have recently been lifted, and public life has largely normalized.

Context

1. The Covid-19 pandemic had a strong impact on Paraguay, but the pandemic currently appears under control. Imposing a strict lockdown and closing borders, the country avoided the brunt of the first wave through July 2020. However, cases and deaths started to pick up in August 2020, and during June 2021 Paraguay experienced one of the highest cases and deaths counts in Latin America. Paraguay’s vaccination campaign was slow to start, and its vaccination rate continues to lag regional peers. Most of the remaining restrictions have recently been lifted, and public life has largely normalized.

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COVID-19 New Cases and Deaths

(Per million, 7-day moving average)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: John Hopkins CSSE, IMF staff calculations.

2. After two consecutive years of GDP decline, Paraguay’s economy rebounded in 2021. In 2019, drought and flooding reduced economic growth to -0.4 percent. In 2020, the impact of the pandemic on the secondary and tertiary sectors was partly compensated by a rebound of agriculture and an extensive emergency package, and the economy shrank by only -0.8 percent. Growth rebounded to 4.2 percent in 2021, though heatwaves and a severe drought decelerated the recovery in 2021 and have diminished Paraguay’s 2022 growth prospects.

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People Fully Vaccinated against COVID-19

(per hundred people)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: John Hopkins CSSE, IMF staff calculations.

3. After years of progress, the pandemic is retarding the reduction of poverty, gender and income inequality, and informality (see Box 1, SM/21/9). The Paraguayan government responded fast through two new social assistance programs (Pytyvõ and Ñangareko) that targeted informal and self-employed workers and vulnerable families in the subsistence economy. These measures and the increase in allocations to the established Tekoporã social assistance program helped substantially mitigate the impact of the pandemic (¶25). On the other hand, schools were closed for in-classroom teaching until August 2021 and have only recently resumed full operations. Given low-grade internet connectivity, the loss of in-person teaching could exact a toll on the quality of future human capital.

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Real GDP Growth: Paraguay vs LAC

(percent)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: IMF staff calculations
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Employment Growth

(y-o-y change, percent)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: Paraguayan authorities, IMF staff calculations
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Income Inequality

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: Paraguayan authorities

4. The recent recurrence of external shocks reaffirms the need for rebuilding policy buffers. After substantially reducing the monetary policy rate (to 0.75 percent) and expanding the provision of liquidity to the financial sector during the pandemic, the central bank (BCP) has taken quick steps to normalize the stance of monetary policy. In addition, the level of international reserves remains high. The process of rebuilding fiscal buffers is still ongoing after a significant debt buildup during the past three years that increased the ratio of public debt to GDP from 22 in 2018 to nearly 38 by end-2021. The government aims to reduce the central government’s budget deficit to 3 percent of GDP as part of its plan to converge back to a deficit ceiling of 1.5 percent of GDP by 2024. However, to achieve this target, expenditure consolidation and sizable cuts in public investment (or social spending) may become unavoidable.

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Changes and Average Levels of Worldwide Governance Indicators

Grouped by Region

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: World Governance Indicators and IMF staff calculations.

5. Paraguay needs to tackle structural and social obstacles to achieve a more balanced growth model (as noted in previous Article IV consultations, Annex I). Strong governance, good business climate, and human capital have been identified as important factors for growth, and Paraguay continues to score poorly on many of those indicators (see chart).1 A 2020 governance diagnostic by the IMF identified administrative and legal weaknesses in public institutions and the judicial system, feeding perceptions of corruption, clientelism, and impunity, and undermining the efficiency of expenditure control. Finally, severe weather events (droughts, flooding) have occurred more frequently in recent years, raising concerns about Paraguay’s vulnerabilities to current and future climate.

6. The government’s policy space is constrained by an intensifying pre-electoral cycle. The President’s approval ratings have suffered from perceptions of poor handling of the pandemic and inaction against corruption. Recent municipal elections strengthened the ruling Colorado party. The political calendar is heating up with primary elections in the fourth quarter of 2022 and general elections in April 2023, intensifying frictions between the different factions of the ruling party. The pre-electoral uncertainty is compounded by populist proposals to counter the impact of rising fuel and food prices on the population.

Recent Developments

7. The economy recovered in 2021, but progress was uneven. The BCP estimates economic growth for 2021 at 4.2 percent driven by services, in particular commerce, restaurants and hotels, as well as manufacturing. By contrast, agricultural production and electricity generation contracted in 2021 aggravated by low water levels in the Paraná River.

8. Paraguay’s balance of payment benefited from favorable commodity prices and benign external financing conditions. Exports prospered from a good harvest in 2020 and from high soy prices in 2021. While agricultural production stagnated in 2021, total export proceeds rose by 21 percent that year, with soy and meat as the strongest contributors. Imports also rebounded, most notably for fuels and machinery. The guaraní appreciated slightly against the dollar. In early 2021, the government issued long-term external sovereign bonds for US$800 million on favorable terms. Gross international reserves rose by US$594 million to US$10.6 billion (8.9 months of prospective imports) at end-2021.

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Nominal Exchange Rate, eop

(USD/LC, Index: Dec-2019=100)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: Haver, IMF staff calculations

9. Annual headline inflation started increasing in the second half of 2021, primarily due to higher food (particularly meat) and fuel prices. 12-month inflation seemed to have peaked in October at 7.6 percent, receded to 6.8 percent in December, before jumping sharply to 10.1 percent in March 2022. But a core index that excludes prices of fuels, fruits and vegetables, and meat, increased by 5 percent. The BCP reacted quickly to the price shock, raising its policy interest rate in several steps by a cumulative 650 basis points to 7.25 percent by end-May 2022, a level the BCP considers consistent with the neutral rate.

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LA5: Core Inflation

(Year-over-year percent change)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Sources: Haver Analytics; and national authorities Note: Peru refers to Lima

10. The BCP’s accommodative monetary policy stance since 2020 has helped cushion the impact of the external shocks on the financial system. Interest rates for bank lending decreased in line with the reduced policy rate to their lowest (11 percent) in October 2021 but have started rising again. Credit to the private sector grew by 10.5 percent in 2021. The banking system appears solid and well-capitalized (2.3 percent NPL ratio and a tier-1 capital asset ratio of 15.2 percent). However, many banks took advantage of regulatory forbearance measures during the pandemic (due to expire in June 2022) to refinance, renew, and restructure loans. The share of those loans is trending downward and currently estimated below 10 percent of total loans. A high degree of dollarization (FX liabilities and FX loans are at 47.6 and 41.3 percent of total liabilities and total assets, respectively) remains a risk to financial stability.

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Bank Credit and Deposits: Private Sector

(Billion Guaranies)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: Paraguayan authorities

Financial soundness Indicator Heatmap

article image
Note: L = Low vulnerability; M = Medium vulnerability; H = High vulnerability. Source: Central Bank of Paraguay IMF staff calculations.

11. The fiscal position has improved since the 2019 and 2020 shocks. To stabilize employment, the government accelerated public investment, in roads and social housing. Because of low river water levels, receipts from the two binational hydroelectric dams declined in 2020 and 2021. Wages rose in 2020 for the hiring of extra personnel for medical and security services but were remarkably contained afterwards. As a result, the government had to suspend the 1.5 percent of GDP fiscal deficit limit under the Fiscal Responsibility Law (FRL) in 2019 and in 2020.2 The expiration of one-off emergency measures during 2021 helped contain spending, while tax revenue improved with the economy’s rebound. The fiscal deficit, after increasing to 6.1 percent of GDP in 2020, fell to 3.7 percent of GDP in 2021.

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Revenue and Expenditure

(12-month moving total, in percent of rolling GDP)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: Paraguayan authorities, IMF staff calculations

12. In 2021, the government used the general SDR allocation (SDR 193 million, 0.7 percent of GDP) to finance expenditures related to the Covid-19 emergency plan. Both their ownership and corresponding external liability were legally transferred to the Ministry of Finance, and the new SDR liability is reported as part of central government external debt. The expenditures associated with the use of SDR were recorded above the line, adding to the computed fiscal deficit, whereas the disbursement was recorded as a financing item.

Central Government Operations

article image

Outlook and Risks

13. The near-term outlook is marked by the confluence of several negative shocks. This year’s harvest has been damaged by sustained drought conditions and heatwaves during the critical summer months of 2021/22.3 In addition, supply chain obstructions have caused scarcities and sharp price increases for vital import products. The low water levels of the Paraguay and Paraná rivers threaten navigability, shipping costs, and electricity production. These factors have been aggravated by the supply shock triggered by the war in Ukraine, given Paraguay’s dependence on imports of oil and derivatives.4 Staff projects GDP growth at 0.3 percent for 2022, a 4.5 percent rebound in 2023, and 3.5 percent growth over the medium-term. The recent sharp increases in international fuel and food prices exacerbate inflation risks. Inflation is projected to converge back to the authorities’ target of 4 percent by end-2023, but end-2022 inflation would be above the central bank’s tolerance corridor of 4 percent +/- 2 percent, at about 8 percent.

Medium-Term Outlook for Selected Macroeconomic Indicators

(In percent of GDP, unless otherwise indicated)

article image
Sources: Central Bank of Paraguay; Ministry of Finance; and IMF staff estimates and projections.

14. The authorities remain committed to their medium-term fiscal targets despite existing challenges. On top of potentially lower revenue from binational hydroelectric dams and agro producers, the government has announced limited support measures for small and medium agricultural producers. In addition, the government also faces salary increase pressures and various bills in Congress that put fiscal stability at risk.5 The external current account is projected to record a sharp, but temporary, deterioration in 2022 given a severe drop in export volumes that more than offsets the impact of higher export prices and higher imports linked to elevated prices for fuels, shipping, and agricultural inputs.

15. Paraguay is proactively responding to the risk of globally rising core yields and risk premia. For 2022, the government already locked in its external financing needs from the market by issuing a US$500 million sovereign bond at 10 years maturity and 3.85 percent interest in January. But going forward, there is global uncertainty about future financial terms and conditions. The authorities have stepped up discussions with multilateral partners on additional financing options for this and next year.

16. Paraguay is vulnerable to climate change. Rising average temperatures pose a threat starting in the short-term and will intensify as time goes by, affecting both agricultural yields and the population’s health and social welfare. In the second half of the century, Paraguay faces risks from changes in precipitation patterns and the frequency and intensity of severe weather events, though these changes are hard to predict based on past long-term data. Some climate studies predict higher average precipitation in the future, but they also acknowledge deep uncertainty about their local and temporal distribution, as well as their volatility. Moreover, the potential impact from important “tipping points”, such as the deforestation of the Amazon rainforest, is poorly understood.

17. Recent extreme weather events provide a stern warning. The recent three years have seen a series of droughts and lack of rainfall in the waterhead areas of the Paraná and Paraguay rivers outside Paraguay. The intense drought in southern Amazonia and the Pantanal of 2020 led to catastrophic wildfires. While there is no solid scientific evidence linking these events to climate change, they may serve as a glimpse into what the future climate holds for Paraguay. These events may also increase financial system risks. While the BCP has successfully implemented measures to extend banks’ grace periods for declaring affected loans as nonperforming, a more systematic approach towards managing risks from extreme weather events would be advisable. More generally, a better integration of climate adaptation, transition, and (to some extent) climate mitigation measures into the overall policy framework is needed.

Authorities’ Views

18. The authorities acknowledged the challenges brought about by more recurrent shocks. The previously expected positive economic prospects for 2022 have been derailed by a drought, the war in Ukraine, and continued low water levels in the Paraná River. The authorities agreed that downside risks over the near- and medium-terms were significant, including potential new outbreaks of Covid-19 variants and weather-related shocks.

19. The authorities noted that external factors were the main drivers of the current high inflation, which started back in 2021 and has been exacerbated by the spillovers from the war in Ukraine. The authorities have taken firm action and sharply increased the monetary policy rate since mid-2021 and expect inflation to moderate by the second half of the year and to slowly decline towards the 4 percent inflation target. They reconfirmed their objective of achieving the 1.5 percent of GDP fiscal deficit target by 2024, but expressed concerns about rising fiscal pressures during the pre-electoral cycle.

Policy Discussions

A. Creating Fiscal Space to Ensure Sustainability, Rebuild Buffers, and Tackle Development Needs

20. Converging back to the 1.5 percent of GDP deficit ceiling by 2024 remains appropriate to ensure public debt sustainability (Annex III).6 Over the medium term, achieving this objective is also appropriate from a cyclical perspective, as the cumulative negative fiscal impulse would be compensated by a post-COVID recovery of private demand, though fiscal policy would be pro-cyclical in 2022. Public debt is now close to 40 percent of GDP. While this can still be considered a relatively “safe” level,7 fiscal buffers are largely depleted in the face of large development gaps (¶21), relatively low fiscal revenue, and the need to make room for climate change adaptation investment and transition management. In light of ongoing external shocks and fiscal pressures from initiatives to implement a fuel subsidy, salary increases, and tax exemptions, reaching those targets will be challenging. In any case, Paraguay should further reduce its reliance on external commercial financing for funding its budget deficit.

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Fiscal Deficit vs Debt

(in percent of GDP)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

21. Paraguay would face SDG spending gaps above 5 percent of GDP per year (Annex V). As a way to assess Paraguay’s development needs, staff undertook a standardized analysis designed by FAD based on achieving key SDG objectives at a level of the best performers in Paraguay’s per-capita income country group. According to those benchmarking estimates, spending gaps in Paraguay are the largest in education (2.9 percent of annual additional investment of the estimated 2030 GDP), road infrastructure (2.3 percent), and water and sanitation (0.2 percent).

22. Enhancing domestic revenue mobilization is a priority as tax revenue in Paraguay is relatively low. Paraguay’s tax-to-GDP ratio falls below the averages of various comparator groups and a simple regression line linking tax revenue performance with per-capita GDP.8 A closer crosscountry comparison of tax productivity reveals that Paraguay fares poorly on personal income tax, better at VAT (when measured against private consumption), and very well on corporate income tax, which could partly be explained by large multinational grain companies shifting regional profits to low-tax Paraguay. Tax rates are low (rates for VAT, corporate income tax, and personal income tax at 10 percent). A tax reform was enacted in 2020, but the expected long-term yield is relatively modest at 0.8 percent of GDP.9

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Paraguay: Sustainable Development Goals Performance Comparison

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: Source: IMF staff calculations using Sachs, J., Kroll, C, Lafortune, G., Fuller, G.t Woelm, F. (2021). The Decade of Action for the Sustainable Development Goals: Sustainable Development Report 2021. Cambridge: Cambridge University Press.Note: SDG3j 5DG4, and 5DG6 are the indexes ranging from 0 to 100 (left scale); SDG7 is the access to electricity as percentage of population (left scale); and SDG9 is the 2018 World Bank’s Logistics Performance Index’s Quality of Trade and Transport Infrastructure Component Score ranging from 1 to 5 (right scale), (available from: http://lpi.worldbank.org/internatiDnal/global).

23. Revenue losses from tax expenditures are relatively significant (about 1.4 percent of GDP despite very low tax rates). Paraguay offers a wide range of tax relief and exemptions for specific sectors, with cumbersome administration and disputable economic benefits. The authorities should usefully reassess the impact of these tax expenditures, publish their cost estimates as part of their budget reporting, and consider trimming them.

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Income Level and Tax-to-GDP Ratio, 2019

(In percent)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: WEO, IMF Internal World Revenue Longitudinal Database (WoRLD).

24. Efficiency of spending could also be enhanced. A comparison with other LAC country reveals that Paraguay’s public sector spends less on wages than the average in terms of GDP, but more in terms of total expenditure, leaving less room for public investment and social services. In addition, applying regional estimates from a 2018 IADB (Inter-American Development Bank) study10 would suggest “waste” in Paraguay’s public purchases of goods and services of about 1 to 1.3 percent of GDP, which could be salvaged from better procurement systems and oversight.11 Finally, the pension system for public employees (“Caja Fiscal”) is running growing deficits and needs to be overhauled with urgency.

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Paraguay and Comparators: Tax-to-GDP Ratio, 2008–2019

(In percent)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: WEO, IMF Internal World Revenue Longitudinal Database (WoRLD).
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Wage Bill

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

25. Paraguay’s social assistance programs were crucial to mitigate the impacts of the COVID-19 pandemic shock on the vulnerable population. Staff, in collaboration with the World Bank, prepared an assessment of the novel cash transfer program “Pytyvõ,” which targeted informal sector workers affected by the shock.12 The results suggests that it effectively prevented a larger erosion of poverty and inequality indicators. Without those transfers, poverty incidence would have reached 30 percent in 2020 (a 3.2 percentage points increase from 2019), and extreme poverty would have increased by 2.5 percentage points. The Pytyvõ program experience thus provides important lessons on deploying benefits in a timely manner. However, the results also show important opportunities to enhance the targeting strategy, for example through a beneficiary system that could be extended to existing or new social assistance programs.

Authorities’ Views

26. The authorities are committed to bringing the fiscal deficit back to the FRL ceiling despite challenges from the recent drought and price shocks. They reconfirmed their fiscal deficit objective of 3.0 percent of GDP for this year. To face rising fiscal pressures from Congress, they submitted to Congress a law that, if approved, will protect fiscal execution in pre-electoral periods from such pressures.13 The authorities appreciated staff’s analysis on spending gaps for reaching SDG objectives and noted that they had recently updated the National Development Plan 2030.14 With regard to domestic tax revenue, the authorities expressed openness to consider an analysis and reform of special tax regimes. They also concurred with the need to reform the “Caja Fiscal” and to enhance efficiency of public spending, noting that the pending procurement law and the civil service reform aim to achieve exactly that objective.

27. The authorities agreed with the results from the staff’s analysis on the effectiveness of social assistance programs implemented during the pandemic. They are keen to support their social protection system by enhancing cash transfers programs, including the implementation of a more suitable system of beneficiaries.

B. Monetary and Exchange Rate Policies

28. The BCP is appropriately considering further tightening, should inflationary pressures persist. The BCP has proactively managed the monetary policy rate in response to increased inflation, having substantially increased the monetary policy rate since mid-2021 (¶9). Inflation expectations continue to be well anchored, though they have started to slightly surpass the 4 percent target over the 2-year monetary policy horizon. Any further adjustments to the monetary policy stance should remain responsive to new information, particularly with regards to inflation drivers and the feedback effects between actual inflation and inflation expectations.

29. The exchange rate flexibility within a well-functioning inflation targeting regime has served Paraguay well. With the onset of the pandemic, the exchange rate depreciated by about 7 percent in 2020 and FX interventions specifically aimed at preventing excessive volatility in the FX market amounted to US$133 million. The guaraní regained some strength in 2021 and the BCP further supported the currency with FX interventions of US$356 million. This year, the diminished harvest in combination with rising import prices might generate exchange rate depreciation pressures and higher volatility in FX markets. The high level of financial dollarization and the currently high inflation rates add to the challenges for the BCP’s exchange rate policy. Staff analysis15 suggests that, up to now, FX interventions by the BCP seem to have been effective to avoid disorderly market conditions linked to very short-term exchange rate volatility. For instance, at the daily level, exchange rate volatility has been lower than those of other (non-highly dollarized) Latin American countries, but similar over longer periods. Given the tightening bias of the monetary policy stance, staff recommended that the BCP not (or only partially) sterilize the monetary impact of any targeted FXI.

30. Paraguay’s external position in 2021 continued to be stronger than implied by economic fundamentals and desirable policies (Annex III). The external current account position will deteriorate substantially in 2022, but that should be a temporary phenomenon as it is projected to return to small surpluses over the medium-term. As staff has highlighted before, stronger than the norm current account balances (even adjusting for amortizations to binationals) are the result of low investment levels. Closing the gap should stem from increased capital inflows and foreign direct investment as a result of business climate and governance reforms. External stability risks remain contained with continued improvement in Paraguay’s net international investment position in 2021 on account of the amortization of the binational hydroelectric company’s external debt. The external debt sustainability analysis shows that the debt trajectory is overall robust to standard shocks.

Authorities’ Views

31. In the authorities’ view, the more hawkish monetary policy stance adopted since August 2021 has been appropriate to respond to inflation pressures. Also, the authorities underscored that they are carefully monitoring inflation expectations and expressed their readiness to continue responding to increasing prices using monetary policy tools. They noted that the temporary use of forward guidance policy in the last quarter of 2021 helped reduce uncertainty about the monetary policy stance then. The authorities acknowledged the monetary tightening impact of unsterilized FX sales, but noted that they had to calibrate their approach based on the overall liquidity position of the financial system. The authorities also highlighted that the hike in the monetary policy rate has been in line with their neutral interest rate estimates.

32. The authorities agreed on the role of exchange rate as an important shock absorber. They have also agreed on the appropriateness and the need to step up foreign exchange interventions to curb short-term and excessive volatilities of guaraní stemming from the recent shocks including the recent war in Ukraine. The authorities emphasized that real shocks have more prominent impact on the exchange rate in Paraguay than financial shocks.

C. Financial Sector Policies

33. Financial soundness indicators continue to suggest that the banking system remains well capitalized and profitable (¶10). It is critical to closely monitor banks’ health following the unwinding of forbearance measures implemented during the pandemic due to expire in June 2022. Supervisory activities should continue to focus on assessing underlying asset quality, including under adverse shocks, to ensure that future capital and liquidity buffers will be appropriate. The BCP should also continue with comprehensive stress-testing programs that would disclose remaining pockets of solvency risks including outside the banking system.

34. The authorities should accelerate the implementation of FSSR recommendations, primarily on consolidated and risk-based supervision. Efforts to introduce risk-based regulatory frameworks and develop the supervisory risk-matrix for cooperatives and insurance companies are still ongoing. The strengthening of institutional stress testing capability and coordination on related frameworks in and among regulatory bodies is still pending. Supervision needs to be extended to the pension system. Under the existing (outdated) legislation, pension funds are not financially supervised, but instead are subjected to rigorous asset holding restrictions, which undermine the development of long-term capital markets and forces pension funds to hold shorter-term deposits with private banks. Supervision also needs to be strengthened in the financial cooperatives’ sector. The BCP has started publishing online its audited financial statements under IFRS and has undergone a safeguards assessment. An FSAP is scheduled to start in late 2022 and would provide an opportunity to assess progress with FSSR recommendations and to look more broadly at emerging financial sector issues.

35. Further progress in financial inclusion will benefit from a more coordinated supervisory framework. Following the successful implementation of the National Financial Inclusion Strategy (ENIF), approximately 60 percent of the adults in Paraguay have access to formal or commercial financial products. A draft Financial Inclusion Law has been submitted to Congress to foster the use of digital payments in local currency (specifically to pay salaries into no-cost accounts in the banking system) and allow the traceability of financial transactions. The planned launch of a 24/7 instant payment system promises to further increase financial inclusion, helping the country achieve its objective of providing financial access to 100 percent of households by 2030. However, efforts should be made to limit financial integrity risks and regulatory arbitrage.

36. An AML/CFT evaluation by GAFILAT will be completed soon. The preliminary mutual evaluation report (MER) prepared by GAFILAT identified technical shortcomings and effectiveness issues in various areas of Paraguay’s AML/CFT regime, as well as in key stakeholders. A recent face-to-face meeting with GAFILAT allowed the authorities the opportunity to provide additional clarifications and explanations, which may impact the final report conclusions. The final MER will be presented to and discussed by GAFILAT in July. Under the Thematic Trust Fund, the Legal Department (LEG) recently established a comprehensive capacity development project that aims to strengthen Paraguay’s AML/CFT regime in three key areas, including enhancing the legal and regulatory framework, strengthening risk-based supervision of financial institutions and designated businesses and professions, and enhancing the financial intelligence unit’s capabilities to conduct operational financial intelligence reports and strategic analyses. Technical assistance will also be coordinated with the IADB, who will provide assistance in areas not covered under LEG’s project.

Authorities’ Views

37. The authorities stressed that the impact of rising inflation and monetary policy tightening on the banking sector and on asset prices remains limited. They also highlighted the role of the National Financial Stability Committee in coordinating supervision activities across the whole financial system. They also emphasized the progress made in establishing risk-based supervision, in developing macro-prudential tools, and in strengthening crisis preparedness frameworks, including with technical assistance from the Fund. Work to develop a risk-based regulatory framework for cooperatives and insurance companies is ongoing, and a law has been drafted to introduce a pension system supervisory entity and enhance its regulations.

38. The authorities aim at increased financial inclusion as a key instrument to reduce poverty and boost economic growth. They highlighted the progress in implementing the National Financial Inclusion Strategy and believe that the draft Financial Inclusion Law and the rollout of the 24/7 instant payment system will further facilitate access to financial services. They remain actively engaged with the banking sector to discuss the new system’s cost distribution and risk-sharing.

D. Structural and Governance Issues

39. The pandemic has laid bare structural deficiencies identified in the past. Health and education reforms remain on the agenda, as well as continued public investment in transport infrastructure. The authorities committed to publishing by end-June the governance diagnostic report prepared by the IMF with IADB participation. To address some of the vulnerabilities made in the report, the government has mainly focused on anti-corruption, public procurement, fiscal responsibility, civil service reform, pension reform and supervision, and a reform of the structure of the state to reduce core government functions’ fragmentation and improve coordination, oversight, and control. Improved governance and reduced corruption are necessary for economic diversification and productivity growth in Paraguay.

40. However, progress towards implementation of the reforms has been slow. Draft public procurement, civil service reform, and fiscal responsibility laws have been submitted to the Congress and are pending approval, but the law to reform the structure of the state has not yet been sent. Assisted by the IADB, a new anti-corruption law was drafted (and submitted to Congress) which enhances the roles and investigative competences of the National Anti-corruption Secretariat (SENAC) and strengthens the anti-corruption and transparency units established within each government agency. Also, a new Transparency and Anti-Corruption National Plan 2021–2025 was developed with assistance from the U.S. Agency for International Development (USAID) and approved in 2020. The authorities have also established formal registries for legal persons/arrangements and beneficial ownership information.

41. The government’s main fiscal functions have become more integrated. Better coordination and integration in managing the social spending should arise from the annual budgetary law, which now requires that all social spending funded with resources from binational hydro-electric companies has to be included in the budgetary proposals of the government entities, though this provision has not been fully observed. In addition, a 2021 law established that the accounts of the binational hydro-electric companies are subject to external control by the Court of Accounts (Contraloría General de la República). The stronger oversight of social spending financed by Itaipú and Yacyretá through annual audits alongside a broader availability of information on social spending should help make it more efficient. A fiscal risk statement is being elaborated with technical assistance support from FAD, the results-based budget was used for the first time in 2021, but the treasury single account’s coverage has not been expanded to provinces yet, and the certification system of public works has not been extended to other government institutions beyond the Ministry of Public Works.

42. Some planned reorganization of processes can help reduce vulnerabilities to corruption and strengthen coordination and oversight. The intended reinforcement of pre- and post-procurement phases would facilitate a better integration of the activities of the National Directorate of Procurement (DNCP) with those of the Ministry of Finance. This reorganization, the automatization and integration of planning and budget allocations within the integrated financial management information system, and the extension of the procurement system to the entire public sector can strengthen coordination and oversight by the Ministry of Finance. At present, all public procurements, including for COVID-19 contracts, are being processed and awarded by the DNCP, which verifies all required information related to the providers of goods and services, including their beneficial ownership, before any contract is approved and awarded. Independent verification of all procurement activities and related information is conducted by the Comptroller General through yearly audits, as noted in audit reports presented to Congress for 2020 and 2021.

43. The pandemic hit women harder in Paraguay, but digitalization could play a mitigating role to reduce gender gaps in employment and job loss in the future (Annex VIII). The pandemic disproportionately affected female employment, and male employment has recovered more quickly. At the same time, Paraguay is experiencing a digitalization spurt, with women digitalizing more rapidly than men, though women with no education continue to have the lowest digitalization levels. Analysis done by staff and the World Bank suggests that women having internet access recorded higher employment and lower job loss, reinforcing the importance of promoting digitalization in Paraguay.

Authorities’ Views

44. The authorities will continue to push for the implementation of structural and governance reforms. They are committed to press congress for the discussion and approval of substantial pieces of legislation prepared by the government (public procurement law, civil service reform, fiscal responsibility law). The authorities agreed with staff on the importance of strengthening the anti-corruption framework and on the need to foster digitalization, particularly for women.

E. Climate Change Policies

45. Paraguay stands in the middle ground of climate change adaptability and vulnerability (ranked 94th among 181 countries by ND-GAIN). Its relatively low score is explained by the failure of readiness to compensate for significant vulnerability. Paraguay’s clean electricity matrix and its relatively large non-CO2 emissions stand out in terms of contributions to GHG emissions. Paraguay’s electricity generation is dominated by the binational hydroelectric dams, though a lot of cooking and heating energy is derived from biomass, often sourced from deforestation. Water is crucial for the Paraguay economy, for irrigation, hydropower generation, and fluvial transportation. Methane is released in large quantities from cattle breeding and from the use of industrial fertilizers. Mitigation measures should focus on taking advantage of the renewable energy potential and from price-based and regulatory policies to stop deforestation and reduce the carbon footprint of agriculture and animal husbandry. The ability of Paraguay to adapt to changing water flows may require strong international cooperation among countries on the same watershed.

uA001fig16

Paraguay: ND-GAIN, Vulnerability, and Readiness Indices

(1995 – 2019)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

46. Paraguay’s climate change policies are still in their infancy. A National Adaptation Plan was formulated in 2016 and it is focused mainly on building public awareness and environmental capacity within and across government institutions. The matrix of proposed measures was neither costed nor embedded in medium and long-term fiscal planning and budget formulation. Paraguay has also submitted and continuously updated its Nationally Defined Contributions (NDC), starting in 2015. In its latest NDC update (2021), Paraguay went a step further by significantly pulling down the GHG values of the baseline scenario, against which GHG reduction commitments will be measured.

47. To improve climate change adaptation policies, Paraguay should strive to move toward an integrated climate change and adaptation policy framework. Such a framework would have to consider policy options in several dimensions, including fiscal and energy policies. For instance, there might be a need to investigate the impact on public investment plans of adaptation and transition investment needs and determine how this would be incorporated within a credible fiscal path. In addition, Paraguay should endeavor to take advantage of its significant hydroelectric energy potential and analyze ways to engage private firms and households toward that objective (see also Annex VII).

Authorities’ Views

48. The authorities explained that they are increasingly including the challenges presented by climate change in their policy and developments planning. They presented various analytical work and policy initiatives. They also appreciated the Fund’s concern about these issues and expressed interest in a continued dialogue and in further support to tackle the challenges posed by climate change.

Staff Appraisal

49. After three years of continuous external shocks, Paraguay faces difficult challenges in 2022 and beyond. Just as the country was recovering from the impact of the Covid-19 pandemic, recent drought and international price shocks have halted the economic expansion. Countercyclical fiscal policies since 2019 mitigated the impact of the shocks, but they also raised public debt and depleted fiscal buffers. The monetary policy stance needs to maintain a tightening bias in the face of global inflationary pressures, while striving to avoid adding to undue strains on the financial system and the economy. Despite the challenges Paraguay is facing in 2022, it is worth noting that the external position in 2021 was stronger than the level implied by fundamentals and desirable policies.

50. To protect the hard-won fiscal credibility, the commitment to the fiscal rule should be maintained. The government’s goal to return to the FRL’s deficit ceiling remains appropriate, but the transition path appears increasingly rocky in the face of ongoing fiscal pressures during a pre-electoral period. In this context, it would be helpful to codify the return to the deficit ceiling in the updated version of the Fiscal Responsibility Law, which is still awaiting discussion in Congress.

51. Rebuilding fiscal space is even more important considering Paraguay’s substantial spending needs in critical sectors for long-term inclusive growth. The Covid-19 pandemic has laid bare shortcomings in the public health system, but education is also under-resourced, and investment needs in basic infrastructure and resilience to climate change are large. Eliminating waste and raising public spending efficiency would be part of the response, as well as greater involvement of the private sector, for example through public-private partnerships. However, on their own these policy levers are not likely to generate sufficient resources to cover the gaps.

52. The government also needs to raise more domestic revenue to address these challenges. Over the medium-term there is room to increase the tax per GDP ratio. Besides continued improvement in tax administration, the authorities should reassess Paraguay’s special tax regimes for specific sectors and activities, and consider another tax reform that goes beyond the improvements enacted in 2020.

53. Paraguay responded well to the pandemic through quick and novel temporary social assistance programs. The timely delivery and quick implementation of cash transfers through digital and mobile systems prevented a larger spike in poverty, but those programs could have been, with the benefit of hindsight, targeted even better. The lessons learnt and the data collected should be carried over to upgrade the system of beneficiaries of the overall social safety net.

54. Returning to price stability remains the main objective of the Central Bank, and the BCP is well-equipped to address the challenges and has responded fast and appropriately. However, the underlying price pressures are of a global nature, which will require both a balanced approach and patience. Further adjustments to the monetary policy stance need to remain flexible and data dependent, particularly with regard to inflation drivers and the feedback effects between actual inflation and inflation expectations.

55. The banking system remains well-capitalized and profitable, and the authorities should continue their efforts to both deepen and widen financial supervision. Supervisors should continue to follow their work plan to implement risk-based supervision. The supervisory perimeter should be extended to include pension funds and the independence and integrity of the regulatory agency for financial cooperatives should be strengthened. Authorities’ efforts to enhance financial inclusion are welcome and should continue. Paraguay should also continue to follow guidance by the peer evaluation on AML/CFT issues.

56. Paraguay should step up the implementation of structural reform measures. Governance, business climate, and the efficiency of the public sector would all improve by implementing proposals that have been largely formulated: reforms of public procurement, the civil service, and the structure of the state have matured into legal bills and could be approved and implemented fairly quickly. These would go a long way in reducing corruption risks and unleashing the growth potential of non-traditional sectors of the economy.

57. Policies to counteract the impact of climate change are being formulated. They should be fully integrated in the planning framework for national development and for the medium-and long-term fiscal budget. Paraguay’s favorable electricity matrix offers opportunities for the transition toward net-zero GHG consumption and production routines. These efforts should be complemented by further investment in the supply of renewable energies and revitalized initiatives to stop deforestation and degradation in the vulnerable habitats of the country.

58. Staff proposes that the next Article IV consultation with Paraguay follows the standard 12-month cycle.

Figure 1.
Figure 1.

Paraguay: Recent Developments

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Sources: BCP, Ministry of Finance and IMF staff calculations.
Figure 2.
Figure 2.

Paraguay: Fiscal Developments

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Sources: Ministry of Finance, WEO and IMF staff estimates.
Figure 3.
Figure 3.

Paraguay: External Sector Developments

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Sources: BCP and IMF staff calculations.
Figure 4.
Figure 4.

Paraguay: Monetary Indicators

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Sources: BCP, Ministry of Finance and IMF staff calculations.
Figure 5.
Figure 5.

Paraguay: Financial Sector Developments

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Sources: BCP and IMF staff calculations.
Table 1.

Paraguay: Selected Economic and Social Indicators

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Sources: Central Bank of Paraguay; Ministry of Finance; and IMF staff estimates and projections.

Includes local currency credit and foreign currency credit valued at a constant exchange rate.

Average annual change; a positive change indicates an appreciation.

Historical GDPs were revised in 2018, including a 30 percent upward revision in nominal GDP for 2017.

Table 2.

Paraguay: Operations of the Central Government

(In percent of GDP unless specified otherwise)

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Sources: Ministry of Finance; Central Bank of Paraguay; and IMF staff estimates and projections.

Includes mainly use of government deposits at the Central Bank.

Captures the discrepancy between above-the-line calculations and financial accounts.

In percent of potential GDP.

Table 3.

Paraguay: Operations of the Consolidated Public Sector 1/

(In percent of GDP)

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Sources: Ministry of Finance; and IMF staff estimates and projections.

Includes the nonfinancial public sector and the central bank.

Includes social contributions and grants.

Includes social benefits, grants, and capital transfers.

Corresponds to net losses of CB capital which are not automatically compensated by the government.

Table 4.

Paraguay: Balance of Payments

(In millions of U.S. dollars)

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Sources: Central Bank of Paraguay; and IMF staff estimates and projections.

Based on average exchange rate valuation of GDP.

Table 5.

Paraguay: Summary Accounts of the Central Bank

(In billions of Guaranies: end-of-period)

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Sources: Central Bank of Paraguay; and IMF staff estimates and projections.

Includes overnight-deposit facility and central bank bills (LRM). A fraction of LRM is held by non-bank institutions.

Includes LRM held by the non-banking sector.

Monetary base comprises currency issued plus legal reserve requirement deposits in guaraní held at the BCP.

Table 6.

Paraguay: Summary Accounts of the Financial System 1/

(In billions of Guaranies: end-of-period)

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Sources: Central Bank of Paraguay; and IMF staff estimates and projections.

Includes banks, finance companies, and the 20 largest cooperatives.

Excludes LRM held by the banking sector.

Table 7.

Paraguay: Indicators of External Vulnerability

(In percent of GDP, unless otherwise indicated)

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

Foreign-currency components are valued at the accounting exchange rate.

Based on end-of-period exchange rate conversion of U.S. dollar-denominated debt.

Private and public external debt with a residual maturity of one year or less.

Table 8.

Paraguay: Medium-Term Outlook

(In percent of GDP, unless otherwise indicated)

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Sources: Central Bank of Paraguay; Ministry of Finance; and IMF staff estimates and projections.

In percent of potential GDP

Table 9.

Paraguay: Financial Soundness Indicators

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Source: Banco Central del Paraguay and IMF, Financial Soundness Indicators .

Annex I. Status of Past Article IV Recommendations

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Annex II. Risk Assessment Matrix

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Annex III. External Sector Assessment and External DSA

After a 2020 affected by the pandemic, the external position in 2021 was stronger than the level implied by fundamentals and desirable policies. An increase of FDI would correct that, underpinned by the desired policies that will enhance Paraguay’s attractiveness for FDI (structural reforms, governance, education).

External Balance Sheets

1. Paraguay’s net international investment position (NIIP) has improved in the past decade and a half, the result of an increase in foreign reserves and a decline in external debt. As of end 2021, the NIIP was about -22.9 percent of GDP, increasing from -25.4 percent of GDP in 2019. The reduction in external debt, from nearly 215 percent of GDP in 2002 to 31.9 percent of GDP in 2021 was mostly the result of the amortization of the debt of the binational hydroelectric company (ITAIPU; about 17 percent of GDP in 2019), which was only partly offset by an increase in external government debt.

2. Currently, FDI (mainly in the agrobusiness sector) is the largest source of liabilities of the private sector, at around 17.8 percent of GDP in 2021, a modest decline since 2019 (about 19.4 percent of GDP).

Assessment

3. External debt is expected to decline going forward. Before the pandemic, the external debt was expected to decline steadily as the debt of the binational hydroelectrical company continued to fall. With the additional financing needs during the pandemic and the need to resort to cheaper external financing, public external debt rose above 31 percent of GDP as of end-2021, a temporary trend that is expected to reverse. The external position remains sustainable under a range of adverse shocks.

Current Account

Background

4. Paraguay’s current account has been in surplus over the last 20 years, averaging 1.2 percent of GDP per year. The current account surpluses in 2016 and 2017 were particularly strong, the result of record hydro-electricity exports and a surge in agricultural exports. The current account balance deteriorated in 2019 owing to large agricultural shock associated with a drought and lower hydro-electricity production owing to lower water levels. While national savings remained relatively stable as a share of GDP through 2019, investment share in GDP increased somewhat. With the COVID pandemic onset, the current account balance in 2020 improved reaching 2.7 percent of GDP from a negative 0.5 percent of GDP in 2019 owing to sharp decline in imports, lower oil prices, and a sharp increase in soybean prices. In 2021, the current account surplus is estimated to have fallen to 0.8 percent of GDP owing to the rebound of imports with the partial resumption of activities through the COVID pandemic and higher oil prices. Over the medium-term, the current account balance is expected to remain at around 0.4–0.7 percent of GDP, reflecting the rebound in soybean production, stabilization of international oil prices, and the phase-out in interest payments linked to the binational loan.

Assessment

5. The current account balance of Paraguay is stronger than the multilateral consistent cyclically adjusted current account norm and is broadly consistent with last’s year’s results. The estimated current account gap slightly narrowed from 3.6 percent of GDP in 2019 to an estimated 2.7 percent of GDP owing to an improvement in the current account from a small deficit in 2019 to a surplus of 0.8 percent of GDP in 2021. The current account gap consists of the policy gap (1.2 percent of GDP) and the residual from the current account regression model (1.5 percent of GDP). The real exchange rate regression approach yields similarly consistent results.1

Paraguay: EBA-lite Model Results (2021)

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Based on the EBA-lite 3.0 methodology

Cyclically adjusted, including multilateral consistency adjustments.

6. Staff’s preferred approach to assess the current account position is based on the current account balance that nets out the amortization to binationals. Paraguay has borrowed heavily in the past to build the binational hydro-electric plant (which showed as a large current account deficit in the 1980s). It uses less than the half of Itaipu’s electricity production that it is entitled to and exports the remainder to Brazil. Paraguay also needs to service the debt of Itaipu to Brazil. It pays off the debt through electricity exports. These transactions generate a positive current account item, and an offsetting capital outflow, with no impact on the rest of the economy.2

Capital and Financial Flows

Background

7. Foreign direct investment has been the major source of capital inflows in last few years. In addition, the government has continued to tap funding from the international markets, placing bonds for US$1,000 million each year from 2016 to 2020. In the context of the COVID-19 pandemic, there was also a sovereign bond issuance of US$1,450 million in 2020. In 2021, the government issued sovereign bonds worth US$826 million to finance the 2021 budget and to soften the maturity of bonds falling due in 2031.These international offerings have become another stable source of capital inflow.

Assessment

8. Paraguay has a fully open capital and financial account, but still shallow financial markets. Paraguay has enjoyed a stable flow of FDI in the last decade, and despite the economic turmoil mainly in Argentina in 2019, FDI inflows are rather stable constituting about 0.3 percent of GDP in 2021. Vulnerabilities to the financial flows remain contained as the major source of capital is direct investment and government’s external borrowing, which was received well in the last few international public offerings, given the low level of public debt.

Reserves

Background

9. Gross international reserves have increased since 2019, from US$7,500 million then to US$10,570 million at the end of 2021. Reserves increased by US$1,805 million in 2020 reflecting the sovereign bond issuances of that year, though there was an increase in foreign exchange interventions to contain depreciation pressures of the Guaraní early that year. In 2021, foreign exchange interventions declined somewhat, and the Guaraní closed the year with a slight appreciation.

Assessment

10. Reserves have increased to the coverage of 8.9 months of imports in 2021. The fluctuation in the import coverage of reserves from 8.3 in 2019 to 8.9 in 2021 is largely related to the sharp fall of imports in 2022 owing to lower exports. The level of 2021 reserves is comfortably above the Fund’s metrics for a small open economy. The flexible exchange rate continues to be the first line of defense against external shocks. Staff recommends to limit discretionary interventions to exceptional situations of disorderly market conditions.

Table 1.

Paraguay: External Debt Sustainability Framework, 2017–2027

(In percent of GDP, unless otherwise indicated)

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Derived as [r – g – r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock, with r = nominal effective interest rate on external debt; r = change in domestic GDP deflator in US dollar terms, g = real GDP growth rate, e = nominal appreciation (increase in dollar value of domestic currency), and a = share of domestic-currency denominated debt in total external debt.

The contribution from price and exchange rate changes is defined as [-r(1+g) + ea(1+r)]/(1+g+r+gr) times previous period debt stock. r increases with an appreciating domestic currency (e > 0) and rising inflation (based on GDP deflator).

For projection, line includes the impact of price and exchange rate changes.

Defined as current account deficit, plus amortization on medium- and long-term debt, plus short-term debt at end of previous period.

The key variables include real GDP growth; nominal interest rate; dollar deflator growth; and both non-interest current account and non-debt inflows in percent of GDP.

Long-run, constant balance that stabilizes the debt ratio assuming that key variables (real GDP growth, nominal interest rate, dollar deflator growth, and non-debt inflows in percent of GDP) remain at their levels of the last projection year.

Figure 1.
Figure 1.

Paraguay: External Debt Sustainability: Bound Tests 1/ 2/

(External debt in percent of GDP)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Sources: International Monetary Fund, Country desk data, and staff estimates.1/ Shaded areas represent actual data. Individual shocks are permanent one-half standard deviation shocks. Figures in the boxes represent average projections for the respective variables in the baseline and scenario being presented. Ten-year historical average for the variable is also shown.2/ For historical scenarios, the historical averages are calculated over the ten-year period, and the information is used to project debt dynamics five years ahead.3/ Permanent 1/4 standard deviation shocks applied to real interest rate, growth rate, and current account balance.4/ One-time real depreciation of 30 percent occurs in 2010.

Annex IV. Public Sector Debt Sustainability Analysis

Figure 1.
Figure 1.

Paraguay: Public Sector Debt Sustainability Analysis – Baseline Scenario

(In percent of GDP, unless otherwise specified)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: Fund staff estimates and projections.1/ Public sector is defined as consolidated public sector. It includes the non-financial public sector and the central bank. The stock of public debt excludes central bank bills.2/ Defined as interest payments divided by debt stock (excluding guarantees) at the end of previous year.3/ Derived as [(r – π(1+g) – g + ae(1+r)]/(1+g+π+gπ)) times previous period debt ratio, with r = interest rate; π = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar).4/ The real interest rate contribution is derived from the numerator in footnote 3 as r – π (1+g) and the real growth contribution as -g.5/ The exchange rate contribution is derived from the numerator in footnote 3 as ae(1+r).6/ Includes social security surplus, accumulation of deposits from the sovereign bond issuance in 2014, and financing of the national development bank.7/ Includes asset changes and interest revenues (if any). For projections, it includes the impacts of exchange rate changes.8/ Assumes that key variables (real GDP growth, real interest rate, and other identified debt-creating flows) remain at the level of the last projection year.
Figure 2.
Figure 2.

Paraguay: Public DSA Co Composition of Public Debt and Alternative Scenarios

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: Fund staff estimates and projections.

Annex V. Expenditure Gaps Toward SDGs

Achieving inclusive growth is a critical objective for Paraguay going forward, building on the macroeconomic stability and the economic and social development successes over the last two decades. Relying on the UN-sponsored Sustainable Development Goals (SDGs) and a costing framework that the Fund has applied to other countries (IMF Staff Discussion Note (SDN) No. 19/03), this note provides a first approximation for Paraguay of the increase in public spending outlays needed to attain health, education, and roads, water, and sanitation infrastructure SDGs, which would amount to up to 7 percent of GDP per year. These cost estimates will need to be refined as more data is available and accompanied with a financing strategy encompassing continuing tax administration efforts, broad-based tax reform, scaled-up private sector participation, and greater spending efficiency.

1. The authorities have embraced the SDGs as part of their national development strategy. In fact, Paraguay was formulating its National Development Plan “Paraguay 2030” at the time of preparation of the 2030 Agenda and the SDGs, which allowed to align both sets of objectives. An interinstitutional SDG Commission involving the three branches of government was established to coordinate policies and monitor progress towards the achievement of SDG commitments. Still, moving from planning to executing policies remains challenging. As a way to operationalize some key objectives under a practical framework, we estimate the additional spending in the education, health, and infrastructure (water, sanitation, and roads) sectors needed to bring Paraguay’s spending patterns in line with good performing countries of a similar level of income (US$6,000 to US$15,000 of GDP per capita) by 2030. While these sectors only represent a selection of SDGs, they are deemed to have substantial synergies with other goals, such as ending poverty and hunger, promoting gender equality, and tackling inequality. In those areas Paraguay fares relatively well within emerging market economies and Latin America and the Caribbean (Panel 1) but lags the good performers.

Figure 1.
Figure 1.

Paraguay: Sustainable Development Goals Performance Comparison

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: Source: IMF staff calculations using Sachs, J., Kroll, C, Lafortune, G., Fuller, G., Woelm, F. (2021). The Decade of Action for the Sustainable Development Goals: Sustainable Development Report 2021. Cambridge: Cambridge University Press.Note: SDG3, SDG4, and 5DG6 are tbe indexes ranging from 0 to 100 (left scale); SDG7 is tbe access to electricity as percentage of population (left scale); and SDG9 is the 2018 World Bank’s Logistics Performance Index’s Quality of Trade and Transport Infrastructure Component Score ranging from 1 to 5 (right scale), (available from: http://lpi.worldbank.org/international/global).

Education

2. Education performance is assessed with the SDG4 index constructed using three variables: net primary school enrolment rate, expected years of schooling, and literacy rate for the population aged 15–24. The SDG4 index is 76.2 for Paraguay (Table 1). The benchmarking exercise consists of deriving the median value for cost items for education (e.g., teachers’ salaries, pupils per teacher, and allocation of total expenses between other non-compensation current spending and capital spending) consistent with delivering an SDG4 score of 84. Based on these reference values, we estimate that total education expenditure as a percent of GDP should increase from 4.5 in 2021 to 8.8 in 2030, an increase concentrated in public spending (+4.5 percent of GDP).

Table 1.

Paraguay: Benchmarking Education Needs

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Health

3. Health performance as assessed by SDG3 index reaches 73.9 in Paraguay (Table 2). The SDG3 index is constructed using 14 variables, among which maternal, neonatal and under-5 mortality rates, HIV prevalence, and healthy life expectancy at birth. The benchmarking exercise then consists of deriving the median value for cost drivers in healthcare (population density of different types of health personnel, doctors’ and nurses’ remuneration, and shares of current and capital expenditure in total health spending) consistent with delivering an SDG3 score of 84. This exercise suggests that Paraguay does not need to increase public outlays in health. Improvements in spending efficiency would seem the best way to reach the health-related SDG in Paraguay.

Table 2.

Paraguay: Benchmarking Health Needs

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Water and Sanitation Infrastructure

4. Water and sanitation performance is assessed by the SDG6 index, which comprises universal safe drinking water and adequate sanitation. According to the World Bank WASH costing model (World Bank, 2015, 2016, and 2017), to achieve the SDG targets of universal safe access to water and sanitation by 2030, total new investment would need to be on average US$150 million per year (0.2 percent of 2030 GDP) (Table 3).

Table 3.

Paraguay: Benchmarking Water and Sanitation Infrastructure Needs

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Roads Infrastructure

5. Paraguay would still have a substantial roads infrastructure gap despite a recent boost in public investment. On the basis of SDG9’s link between infrastructure and economic development, the proposed methodology estimates the costs of closing the existing road infrastructure gap by 2030, measured as the target road density minus the current road density. The target road density is determined by GDP per capita, population density, and access by those living in remote locations per the Rural Access Index (RAI, share of rural population with access to an all-season road within 2 kilometers). The total cost is obtained by multiplying the road gap by a unit cost per kilometer. This exercise, based on the World Bank figures, suggests that approaching the density observed in good performing countries would imply an increase in annual expenditures of about 2.3 percent of GDP. However, the World Bank’s measured RAI is reportedly 56, but it is consistent with a road density of 0.08 Km per square Km which seems too low relative to data from the authorities (closer to 0.2 Km per square Km).

Annex VI. Assessment of Tax Efficiency

Using FAD’s Assessment of Revenue Tool (ART), which relies on FADTP Internal World Revenue Longitudinal Database and FADTP Internal International Tax Rates Database, we are able to compare Paraguay’s tax revenue performance over the period 2008–19 against a set of comparator countries and country groupings. They comprise respectively, Chile, Colombia, Costa Rica, Ecuador, Peru, and Uruguay, and Latin America and the Caribbean, Upper Middle Income Countries (World Bank classification), Emerging Markets (IMF classification), and OECD.

uA001fig17

Paraguay and Comparators: Income Level and Tax-to-GDP Ratio, 2019

(In Percent)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: WEO, IMF Internal World Revenue Longitudinal Database (WoRLD).

1. At a broader level, when linking tax revenue performance with per capita GDP in 2019, Paraguay substantially underperforms its comparators, with Paraguay’s tax-to-GDP ratio farther away from a simple regression line.

uA001fig18

Paraguay and Comparators: Tax-to-GDP Ratio, 2008–2019

(In Percent)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: WEO, IMF Internal World Revenue Longitudinal Database (WoRLD).

2. Since 2008, Paraguay’s tax-to-GDP ratio has slightly improved but remains well below the one for its comparator country groupings and the comparator country average.

3. When comparing personal income taxes (PIT) in 2019 (i.e., before the recent personal income tax reform in Paraguay), it is noticeable that Paraguay has the lowest PIT tax rate among comparator countries in the region and the lowest collection in percent of GDP.

uA001fig19

Paraguay and Comparators: PIT Revenue and Top Combined Rate, 2019

(In Percent of GDP and Percent)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: IMF Internal World Revenue Longitudinal Database (WoRLD); IMF Internal Tax Rates Database; IBFD.

4. The situation in the corporate income tax (CIT) is slightly better for Paraguay. In fact, even though CIT collection in percent of GDP is lower than in comparator countries, its productivity (computed as (CIT Revenue) / [(CIT Rate) * (GDP)]) is the best one as Paraguay has a standard CIT rate of only 10 percent1

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Paraguay and Comparators: CIT Revenue, Top Combined Rates and Productivity, 2019

(In Percent of GDP and Percent)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: IMF Internal World Revenue Longitudinal Database (WoRLD); IMF Internal Tax Rates Database; IBFD IMF staff calculation. CIT Productivity is calculated as (CIT Revenue) / [(CIT Rate) * (GDP)].

5. In the case of the VAT, Paraguay collected less than most its comparator countries, though its productivity as measured by C-Efficiency (calculated as (VAT Revenue) / [(VAT Rate) * (Total Consumption)]) was the highest (on par with Ecuador).

6. Looking at the evolution of general goods and services tax revenue (i.e., VAT, excises, and trade taxes), Paraguay has consistently collected below its comparator country groupings and the comparator country average.

uA001fig21

Paraguay and Comparators: General Goods and Services Tax Revenue, 2007–2019 (In Percent of GDP)

Citation: IMF Staff Country Reports 2022, 177; 10.5089/9798400213779.002.A001

Source: IMF Internal World Revenue Longitudinal Database (WoRLD)

Annex VII. Climate Change Impact and Policies

In the long term, rising average temperatures will negatively impact both agricultural yields in Paraguay’s main export crops and the population’s health and social welfare. In the medium term, Paraguay faces risks from changes in precipitation patterns and the frequency and intensity of droughts and flooding. These pose a threat to agriculture, electricity generation, and water levels in the Paraguay and Paraná rivers, which are Paraguay’s main transportation channel for external trade. In the face of these risks, Paraguay will need to intensify efforts to integrate climate adaptation, transition, and mitigation into its overall policy framework.

Paraguay’s Exposure to Climate Change and Adaptation Potential

1. Paraguay has a subtropical climate, with dry zones to the west and humid zones to the east. The average annual temperature is 23°C, and the average annual total precipitation is 1,500 mm.1 Paraguay is rich in natural resources, with a growing agricultural and livestock sector. Clean and renewable hydroelectric energy is abundant, produced by two large binational dams, and the unconsumed surplus is exported to Brazil and Argentina. Paraguay’s reliance on these sectors makes it particularly vulnerable to the impacts of increasing climate variability and climate change. Vulnerability is aggravated by substantial habitat deterioration due to deforestation, both for the conversion of land use for agriculture and for widespread cooking and heating with biomass. According to the World Bank, Paraguay is already subject to the impact of severe climate events.2

2. Both the projected path and recent history point to a clear warming trend. A CMIP5 BAU scenario points to a temperature increase in the range of +1.7 to +6.6 degree Celsius, with a median of 4.3.3 By the second half of the century, rising temperatures are projected to lead to more frequent periods of extreme heat waves, affecting negatively the productivity of people, livestock, and crops. Public health is at the risk of deteriorating from diarrheal and respiratory illnesses, as well as from diseases like malaria and dengue.4 These risks are compounded by deep uncertainty about precipitation patterns. While a BAU scenario of the IPCC climate model considers an average increase of overall rainfall, the regional and temporal distribution of precipitation is uneven, pointing to an increase of both extreme drought and flood events. Moreover, the risks emanating from tipping points such as deforestation of the Amazon are not well understood. In recent years, Paraguay has already experienced increasingly frequent and intense drought periods that have hit the country’s agricultural and electricity production.

3. By the standards of ND-GAIN5, Paraguay is located in the middle range of climate change vulnerability. Paraguay is ranked 94th out of 184 countries in the overall ND- GAIN index based on 2019 data. Its relatively low ND-GAIN score compared to the (unweighted) average of all countries is explained by the failure of readiness to compensate for vulnerability. Paraguay’s vulnerability is in the middle range of its South American peers, with comparable exposure and a somewhat higher sensitivity to climate change, which is partly compensated by adaptive capacity. With regard to sectoral components, human habitat, food, and health are found to be relatively vulnerable. As to the general conditions that facilitate climate adaptation, social readiness performs worse than economic and governance readiness. This sub-index is particularly impacted by Paraguay’s low scores of education and of innovation.

National Policy Framework

4. Paraguay’s first National Adaptation Plan (NAP) was formulated in 2016. It is closely aligned with the government’s National Development Plan 2014–30 towards reaching the country’s SDGs, which originally focused on three pillars: (1) Poverty reduction and social development; (2) Inclusive economic growth; and (3) Insertion of Paraguay in global markets.6 The NAP, which was formulated under the auspices of Paraguay’s Secretariate of the Environment (SEAM), focuses on measures related to raising climate-change awareness and capacity building within and across government institutions.

5. Paraguay has also submitted and continuously updated its Nationally Defined Contributions (NDCs) for climate mitigation. Paraguay’s first NDCs were communicated in 2015. They proclaim unconditional commitments to reduce greenhouse gases (GHG) by 10 percent, with a commitment to reduce GHG by another 10 percent, conditional on external financing. In its latest NDC update (2021) Paraguay went a step further by significantly reducing the GHG emission values of the baseline BAU scenario, effectively lowering the target for future GHG emission levels.

Climate Change Policies

6. To improve climate change adaptation policies, Paraguay should strive to move toward an integrated policy framework. Development policy goals are not separable from climate policy goals, and both need to be integrated with medium and long-term fiscal planning. Recent moves toward performance budgeting and strengthened links between the Secretariate of Planning and the Ministry of Finance are positive steps in this direction, as well as the issuance of guidelines for environmental risk management by financial institutions regulated by the banking superintendency to promote sustainable financing practices.

7. Paraguay’s hydro-based electricity matrix provides a favorable starting point for decarbonizing the energy sector. A recent study by the Columbia Center on Sustainable Investment7 found that the transition to a zero-emissions energy sector is feasible, provided that an appropriate policy framework will be put in place. This will require enhanced long-term investment in renewable energy sources, transmission systems, technologies that boost energy efficiency, and a better regulation and alignment of public and private sector incentives toward electrification of energy uses.

Annex VIII. Digitalization in Paraguay, and the Differential Impact of COVID-19 on Female Employment: Some Insights1

A. Some Stylized Facts on Digitalization On LAC Region and Paraguay

1. The evidence points to the LAC region experiencing a digital growth spurt. 2 Nearly half of the LAC countries register a moderate momentum measured by the digital evolution index across four key drivers (supply, demand, institutional environment, and innovation). A few countries are advancing rapidly, with Chile, Costa Rica, Paraguay, Uruguay, Mexico, and Colombia leading the way, both in the state of digital evolution and the rate of progress i.e., digital momentum.

2. Paraguay does well in terms of digitalization compared to the LAC average, and women are also doing slightly better than men. The penetration rate of internet use in LAC is about 68 percent, slightly lower than the rate observed in Paraguay (69 percent) as of 2019. Over 77 percent of female Paraguayans with 7 to 12 years of formal education use the internet. The highest usage rate was among the female population who had 13 to 18 years of education, amounting to 95.9 percent, nearly the same as for men. Meanwhile, the lowest usage rate was among women without any formal education, with 5.7 percent.

B. Stylized Facts on Digitalization, the Pandemic, and Gender Gaps in Paraguay

3. In Paraguay, the pandemic shock affected male and female employment differently increasing pre-existing gaps. According to the Paraguay High-Frequency Survey (a World Bank initiative), more than half of women reported having lost their jobs as of May 2020, at the very onset of the pandemic, compared to 35 percent for men. Moreover, men’s employment recovered more quickly.

uA001fig25
Source: High-Frequency Phone Survey – Paraguay

4. By June 2021, women’ employment in Paraguay was higher and job loss was lower for those women who had internet access. It is striking that for mens’ employment and job loss during the pandemic, digitalization does not seem to matter much. This is perhaps related to the occupational differences of men and women with men involved in less internet intensive sectors, including construction and mining.

uA001fig26
Source: High-Frequency Phone Survey – Paraguay (2021)

5. In Paraguay, almost half (48.1. percent) of women who are inactive report that they do not work or look for a job because they do household chores and housekeeping. In the case of men, less than 1 in 10 are in this situation. It appears that greater childcare and household chores responsibilities for women account for the differences in gender employment and job loss for these segments of the population. The imbalances of unpaid work defined as household chores and childcare are more pronounced in rural households (40 percent of the population), where women representing about 53.9 percent spent 16.2 more hours in these activities than their male counterparts (World Bank, 2020). Women are over-represented in unskilled and informal employment, with 27 percent concentrated in unskilled occupations (as opposed to 17 percent of men) – many of whom work as domestic workers. It is worth noting that job loss for women that do and do not take part on household chores is higher than job loss for men without household chores.

uA001fig27
Source: High-Frequency Phone Survey – Paraguay (2021)

6. COVID-19 amplified women’s unpaid work burdens. For instance, the widespread closure of schools and childcare facilities did not only increase the amount of time that parents had to spend on childcare and child supervision, but also forced many to supervise or lead home schooling. Much of this additional burden fell on women as can be seen from the analysis below. The job loss for women who had children and had to take care of them and were responsible for their education, was much higher than for those without those responsibilities.

uA001fig28
Source: High-Frequency Phone Survey – Paraguay (2021)

7. Finally, it is critical again to recognize and delineate the role of digitalization/internet usage and its interaction with the impact of COVID-19 on women with additional chores including the care for children. The employment gap between men and women having children for those with internet access is much lower than for those with no internet access. Similarly, the job loss for women with internet access is much lower compared to men despite them having children.

uA001fig29
Source: High-Frequency Phone Survey – Paraguay (2021)

C. Conclusions and Policy Implications

8. For Paraguay, the increased use of technological solutions has been reinforced by the COVID-19 crisis. Almost two years of lockdowns triggered a transition towards digital interactions, including remote work, online education, and digital health among others. Awareness of women’s additional chores in Paraguay in terms of large gaps in household chores, unpaid work, and childcare has become extremely important. Thus, going forward reducing the gender gap in sectoral employment and labor market flexibility and reducing informality (unpaid work for women) can help increase the share of women in digitalization and reduce the impact of the COVID-19 and other crises on women. More prominence should be given to the Ministry of Women Affairs to lead these initiatives for women, including at the legislative level.
1

The degree of uncertainty of World Governance Indicators point estimates is captured through the confidence interval range of likely values. There is an approximately 90 percent likelihood that a country’s governance rank falls within the stated confidence range.

2

Technically, the 2019 suspension was covered by an escape clause in the Fiscal Responsibility Law. That mechanism was not available in 2020, as the fiscal deficit would by far exceed the ceiling allowed by the escape clause.

3

Local sources estimate that about 60 percent of the summer soy harvest have been destroyed, leading to a loss of export revenue by US$3 billion.

4

Paraguay is the region’s country most exposed to trade links with Russia and Ukraine. It sells about 5 percent of its exports to Russia (basically beef).

5

Recent initiatives in Congress included various attempts to implement a fuel subsidy and VAT tax holidays.

6

To codify this commitment, the government formulated a new FRL draft (“FRL 2.0”) in 2020, which includes new transition rules, a tightening of the ceiling on real current expenditure (capped at a 2 percent increase), and a public debt ceiling (40 percent of GDP). However, the law is still being discussed in Congress (see SM/21/9, Annex 1).

7

A 2017 FAD TA report estimated the range of 30–45 percent of GDP as a safe area for an eventual public debt anchor (“Paraguay – Establishing a Structural Balance Rule and a Public Debt Target”).

8

The country also collects non-tax revenue from the binational hydroelectric dams (Iyaipú and Yacyretá), averaging about two percent of GDP over the past decade. This contribution is expected to decrease with a rise in Paraguay’s energy demand. A renegotiation of the tariffs Itaipú receives from Paraguay and Brazil is due by 2023, when Itaipú’s long-term debt is repaid, but it is unclear whether and to what extent this will result in a fiscal windfall for Paraguay.

9

The tax reform unified several different corporate income taxes, strengthened the tax on dividends and profits, reduced deductible expenses on the personal income tax, and increased the margin by which the administration can lift several excise taxes without the need for going to Congress. But tax rates were left unchanged.

10

IADB (2018), “Better Spending for better Lives: How Latin America and the Caribbean can do more with less”, p. 55.

11

A new procurement law was approved by one of the chambers of Congress in December 2021.

12

See Selected Issues: Effectiveness of Social Assistance Program in Paraguay during Covid-19 Times.

13

The draft “law of governmental behavior in administrative and fiscal matters during electoral times” proposes to suspend salary increases beyond the original budget during the five quarters before the general election. The same applies for policy initiatives that would result in a reduction of tax collection.

14

The plan is closely aligned with the UN’s SDG and is guiding the medium-term planning of the government’s performance budget.

15

See Selected Issues: Foreign Exchange Interventions in Paraguay and their Role in the Monetary Policy Framework.

1

The policy gap is mainly the result of the low level of public health expenditure in 2021 and the gap between Paraguay’s productivity growth and the world (measured by relative GDP, in PPP terms, per worker). Closing the productivity gap requires structural reforms, see Bakker et al (2020) for details.

2

As the construction of the binationals finished and Paraguay started to pay off the debt, the current account position started to strengthen. Such strengthening, however, is not a consequence of undervalued real exchange rate).

1

However, this chart does not include individual rates and revenue.

1

Grassi, B.,2020: Estudio del Clima Paraguay 2019. MADES-STP. Asunción, Paraguay.

2

Climate Risk Profile: Paraguay (2021): The World Bank Group.

3

World Bank (2021), p. 8.

4

Plan Nacional de Adaptación al Cambio Climático (SEAM/PNUD/FMAM, 2017).

5

“The Notre Dame-Global Adaptation Index (ND-GAIN) Country Index is a free open-source index that shows a country’s current vulnerability to climate disruptions. It also assesses a country’s readiness to leverage private and public sector investment for adaptive actions” (ND-GAIN Country Index Technical Report, Nov. 2015, p. 2). Rising readiness pulls up the index, whereas rising vulnerability (including lack of capacity to adapt) pulls it down.

6

The plan has recently been revised and updated under the lead of Paraguay’s Technical Secretariate of Planning. It now includes the strengthening of public institutions as a fourth pillar.

7

CCSI (2021): Evaluación y Planificación del Sector Energético del Paraguay: Vías de Descarbonización, New York.

1

Prepared by Silvia Granados (World Bank), Manuk Ghazanchyan, Gustavo Canavire (World Bank), and Yuanchen Yang.

2

Digitalization refers to the widespread use of digital technologies, such as the internet and mobile phones, to collect, store, analyze, and exchange information (World Bank 2016; Brookings 2017). For the purposes of this study, and consistent with the literature, we define digitalization, as internet usage as a percent of the population.

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Cover IMF Staff Country Reports
Paraguay: 2022 Article IV Consultation-Press Release; and Staff Report
Author:
International Monetary Fund. Western Hemisphere Dept.
Volume/Issue:
Volume 2022: Issue 177
Publisher:
International Monetary Fund
ISBN:
9798400213779
ISSN:
1934-7685
Pages:
69
DOI:
https://doi.org/10.5089/9798400213779.002

COVID-19 New Cases and Deaths

(Per million, 7-day moving average)

People Fully Vaccinated against COVID-19

(per hundred people)

Real GDP Growth: Paraguay vs LAC

(percent)

Employment Growth

(y-o-y change, percent)

Income Inequality

Changes and Average Levels of Worldwide Governance Indicators

Grouped by Region

Nominal Exchange Rate, eop

(USD/LC, Index: Dec-2019=100)

LA5: Core Inflation

(Year-over-year percent change)

Bank Credit and Deposits: Private Sector

(Billion Guaranies)

Revenue and Expenditure

(12-month moving total, in percent of rolling GDP)

Fiscal Deficit vs Debt

(in percent of GDP)

Paraguay: Sustainable Development Goals Performance Comparison

Income Level and Tax-to-GDP Ratio, 2019

(In percent)

Paraguay and Comparators: Tax-to-GDP Ratio, 2008–2019

(In percent)

Wage Bill

Paraguay: ND-GAIN, Vulnerability, and Readiness Indices

(1995 – 2019)
Figure 1.

Paraguay: Recent Developments
Figure 2.

Paraguay: Fiscal Developments
Figure 3.

Paraguay: External Sector Developments
Figure 4.

Paraguay: Monetary Indicators
Figure 5.

Paraguay: Financial Sector Developments
Figure 1.

Paraguay: External Debt Sustainability: Bound Tests 1/ 2/

(External debt in percent of GDP)
Figure 1.

Paraguay: Public Sector Debt Sustainability Analysis – Baseline Scenario

(In percent of GDP, unless otherwise specified)
Figure 2.

Paraguay: Public DSA Co Composition of Public Debt and Alternative Scenarios
Figure 1.

Paraguay: Sustainable Development Goals Performance Comparison

Paraguay and Comparators: Income Level and Tax-to-GDP Ratio, 2019

(In Percent)

Paraguay and Comparators: Tax-to-GDP Ratio, 2008–2019

(In Percent)

Paraguay and Comparators: PIT Revenue and Top Combined Rate, 2019

(In Percent of GDP and Percent)

Paraguay and Comparators: CIT Revenue, Top Combined Rates and Productivity, 2019

(In Percent of GDP and Percent)

Paraguay and Comparators: General Goods and Services Tax Revenue, 2007–2019 (In Percent of GDP)