Abstract
Socio-economic risks are mounting around the world due to a high level of uncertainty. The unintended spillover effects of these risks on small, open economies like Paraguay require well calibrated policy responses to restore depleted economic buffers that were used up during multiple shocks in recent years. In the same vein, a blueprint of what is needed for the economy to recover its potential medium-term growth is warranted.
Socio-economic risks are mounting around the world due to a high level of uncertainty. The unintended spillover effects of these risks on small, open economies like Paraguay require well calibrated policy responses to restore depleted economic buffers that were used up during multiple shocks in recent years. In the same vein, a blueprint of what is needed for the economy to recover its potential medium-term growth is warranted.
The COVID-19 pandemic was managed relatively well during the peak of the health crisis in 2020-2021, buttressed by the Emergency Law and the Economic Recovery Plan (Ñapu’a) passed in Congress. Consequently, the government deployed decisive fiscal, monetary, financial, and social measures during the pandemic. The Economic Consolidation and Social Containment Law was also approved in Congress to buttress the economy and protect the most vulnerable. These important and much needed measures dented the Paraguayan economic buffers built in previous years.
More recently, in 2022, the conflict between Russia and Ukraine, geopolitical tensions, monetary policy tightening in major central banks, and a higher probability of recession in advanced economies are adding new risks and difficult trade-off for policy makers; not to mention the impact on the agricultural sector stemming mainly from weather disruptions. The government support deployed to mitigate the hit of inflation on the most vulnerable, due to food and fuel price hikes, had an impact on fiscal balance and public sector debt.
For all these reasons and recognizing the very positive experience with the International Monetary Fund (IMF) -supported programs, the Paraguayan authorities met Management and staff to request a two-year program, supported by the Policy Coordination Instrument (PCI).
The Paraguayan authorities would like to thank Mission Chief Mauricio Villafuerte and his team for their candid technical dialogue during discussions in Asuncion, and more recently in Washington, D.C. during the annual meetings. They also appreciate their close collaboration in these times of uncertainty to bring in this program to the Board for discussion.
A blueprint to recover potential medium-term economic growth.
During the fruitful discussions with Management and staff, the Paraguayan authorities recognized key elements that would be needed when designing the PCI, which are articulated around three main pillars, namely: i) ensuring macroeconomic stability and resilience, ii) improving productivity and fostering economic growth, and iii) improving social protection and inclusion.
How to raise productivity and the quality of public and private investment, and improve governance to tackle corruption, while enhancing transparency, reducing informality, and accelerating pension system reforms were some salient points considered for this program. Supply-side policies to improve human capital, modernize labor regulations, and lift barriers to enhance the business environment were also key themes under consideration.
Governance elements incorporated in the three main pillars.
What is relatively new from previous IMF programs with Paraguay is the incorporation of governance elements in the current PCI. At the request of the Paraguayan authorities, a governance assessment report was completed with the support of the IMF and the Interamerican Development Bank, and its publication was part of the prior action for the proposed PCI program.
A few examples of governance elements are detectable in areas like:
Pillar I. Ensure macroeconomic stability and resilience.
The authorities aim for the approval in Congress of a revamped version of the Fiscal Responsibility Law (FRL) to maintain the deficit ceiling as it is today (1.5 percent of GDP), but to reduce the provisions on current primary expenditure growth and civil servants’ salaries. This new version envisages to strengthen the fiscal council participation and complement the deficit ceiling with a staggered debt ceiling.
A draft law to safeguard the fiscal policy in pre-electoral times is also under discussion in Congress, which aims to restrain initiatives to increase salaries or reduce taxes during electoral periods.
A corporate governance law is under revision to strengthen the role of the State-Owned Enterprises supervisory board.
Pillar II. Enhance productivity and foster economic growth.
Paraguay’s AML/CFT regime has improved significantly since its last evaluation. The 2021 mutual evaluation report by GAFILAT showed that the country obtained a substantial effectiveness rating on international cooperation, but there is room for improvement in other areas. For the latter, the Paraguayan authorities are thankful for the IMF’s swift response to support the plan through a multi-year capacity development project, which would allow the country to strengthen its governance in this sensitive area.
The authorities are well advanced in the implementation of the law on public procurement. As of today, the Senate and the Chamber of Deputies have approved the reform to enhance the planning, transparency, and effectiveness of this fiscal tool.
The civil service reform was a salient element in the governance assessment report. Considering this important input, the government submitted a bill to Congress to seek approval for a modern and competent civil service structure to reinforce the central role of meritocracy to access the public service force.
Pillar III. Enhance social protection and inclusiveness.
The authorities are aware that social programs have room for improvement and how important it is to avoid potential duplication of efforts and costs when implementing them, as well as keeping an accurate record of beneficiaries. Thus, they plan to strengthen the Pension System (SIPEN) to harmonize procedures, and use the technological solution developed by the Ministry of Finance to expand the management of pensions in the non-contributory sector and to other social assistance programs.
Latest developments.
The current GDP growth projection for 2022 stands at 0.2 percent. However, it must be noted that the initial GDP growth forecast for this year was 3.7 percent. The considerable downward adjustment of the projection takes place in the context of a severe drought—registered between the end of 2021 and beginning of 2022—which has significantly affected agriculture, causing important losses in the harvest of soybeans and other farm crops. On the expenditure side, despite this downward revision of economic activity, a rebound in domestic demand (private consumption and investment) continues to be foreseen, although at a lower growth rate than previously expected, while net external demand will have a significant negative incidence. In accumulated terms, GDP contracted 2.2 percent in the first semester of the year, while GDP (excluding agriculture and the hydro electrical bi-national entities) grew by 1.6 percent.
Better results are expected for economic activity in the upcoming months, considering the beginning of the 2022/2023 soybean crop season and the spillover effects that agriculture exerts on other sectors of the economy. Initial calculations aim towards an economic growth rate of above 4 percent in 2023.
Latest figures of Direct Investments (DI) net flows from the rest of the world to Paraguay are showing positive signs of recovery since the COVID-19 pandemic. For example, in 2021 the net flow of DI reached USD192 million, which surpassed by a large margin the figures observed during the pandemic (74 percent increase). In this vein, for 2023 and 2024 the country will receive its largest Foreign Direct Investments (FDI) projects in recent history. A paper pulp from eucalyptus foresting and a biofuels projects have pledged to invest around USD4 billion in the coming years.
As regards the labor market, the results for employment and unemployment indicators have been more favorable in the second quarter of 2022. In this period, employment grew by 47,239 positions as compared to the same period in 2021, representing an increase of 1.4 percent y-o-y. By economic sector, the percentage of the population employed within the tertiary sector (particularly trade, restaurants, and hotels) increased, while an inter-annual reduction was observed in the primary and secondary sectors. By occupational category, there was an improvement in the number of wage-earning workers, although this was offset by the decrease in self-employment. On the other hand, the number of unemployed persons decreased by 69,001 and the unemployment rate dropped from 8.6 percent in the second quarter of 2021 to 6.7 percent in the second quarter of 2022.
Total inflation continued to increase during the first months of 2022, due to the persistence of external pressures on commodity prices. However, the pressures on external prices have moderated recently which, together with the lower dynamism of domestic demand, have contributed to contain inflationary pressures. As for inflation forecasts, a rate of 8.6 percent is foreseen for 2022, decreasing to 4.1 percent for 2023.
On monetary policy, the Central Bank of Paraguay (BCP) has continued with the process of upward adjustments of its reference rate, although at a slower pace within the last few months, given the deceleration of inflation and the potentially lower pressures stemming from the external scenario, mainly those derived from commodity prices. Between March and June 2022, the Monetary Policy Rate (MPR) was revised upward by 200 basis points, while in July to September it increased 75 basis points to stand at 8.50 percent annually.
Total bank loans and other forms of credit have continued to show favorable dynamism, boosted largely by the accelerated growth that loans extended in foreign currency have been experiencing. Loans in U.S. dollars expanded 25.2 percent inter-annually in August 2022, while loans granted in Paraguayan guaranies registered a growth rate of 7.8 percent y-o-y. The financial soundness indicators of the financial system remain at satisfactory levels. In this vein, the solvency ratios continue well above the minimum required levels and the profitability indexes have started to increase in recent months, as compared to the reductions registered since the beginning of 2020.
The payments system has performed normally, in a fluid and efficient manner. In May 2022, the Instant Payments System (SPI) was launched. This system will allow for the availability of 24 hours a day seven days a week (24x7) inter-bank transfer services for all citizens, thereby constituting a qualitative leap of immense relevance for the country’s payments system. This new module of the Paraguayan Payment System (SIPAP) is being successfully developed in stages, with the gradual incorporation of financial institutions.