Source: International Monetary Fund
November 17, 2020
A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF’s Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.
The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.
1. In the past two decades Paraguay has seen strong but volatile growth and a sharp reduction in poverty. Strong GDP growth was the result of sound macro policies (with low inflation and low fiscal deficits and debt) and an agricultural commodity price boom which spilled over to the non-tradable sector. Strong growth led to a sharp reduction in poverty: between 2002 and 2019 the poverty rate more than halved. Growth was not just high but also volatile. Bad weather led to poor harvests, which spilled over to the broader economy.
2. In 2019, another weather shock reduced full-year growth to near zero. A severe drought early in the planting season which was followed by floods later led to a sharp reduction in the harvest. In response, the central bank lowered its policy rate in five steps from 5¼ to 4 percent. The government stepped up public investment. Together with the shortfall in fiscal revenue, this led to a widening of the deficit to 2.8 percent of GDP, above the 1½-percent ceiling under the Fiscal Responsibility Law (FRL). The deficit overrun did not violate the FRL, as parliament approved the FRL’s emergency escape clause, which allows a deficit of up to 3 percent of GDP in case of a “decline in economic activity”.
3. The economy was rebounding strongly in the first few months of 2020, before the COVID-19 crisis hit. Favorable weather pushed the soybean harvest for the 2019-2020 season to a historical high. In February, economic activity was over 7 percent higher than a year earlier, and full-year growth was projected at over 4 percent.
4. The Covid-19 epidemic halted the recovery. An early lockdown helped prevent the health system from being overwhelmed and kept the death toll per million of the pandemic to among the lowest in the region. The lockdown also led to a sharp drop-in activity. In April, the main economic activity index was 20 percent below the February level.
5. Swift and forceful government action helped contain the health, social and economic impact of the pandemic:
· To mitigate the health impact, the government bought medical supplies, expanded medical staff and built new hospitals. It also set up hostels near the borders, where returning Paraguayans could be quarantined.
· To mitigate the social impact, the government started two new and temporary social assistance programs (Pytyvõ and Ñangareko) and temporarily expanded a third (Tekoporã). Pytyvõ was targeted at informal and self-employed workers affected by the Covid-19 crisis, who had never been covered by the social security system before. Ñangareko supported food security of vulnerable families in the subsistence economy whose livelihoods had been affected by the COVID-19 crisis. The government also increased allocations to the established Tekoporã social assistance program and provided a one-off additional payment to beneficiaries of the program.
· To mitigate the economic impact, the government increased investment in public works and social housing. The government also reduced VAT rates on selected goods and deferred corporate income tax payments for three months. The crisis and the associated policy responses raised this year’s fiscal deficit to about 6½ percent of GDP.
· The monetary policy rate was reduced by 325 bps cumulatively, to the current 0.75 percent. Inflation fell below the target band, to 0.5 percent in June, and is projected to remain below the midpoint of the central bank’s target range through 2021. Liquidity provision to the financial sector was strengthened, and banks could renew, refinance, and restructure loans without penalty, and with a lower risk weight. An MSME Guarantee Fund (FOGAPY) was created to provide credit guarantees on new loans to MSMEs.
6. Strong measures were put in place to ensure that the crisis funds were well spent. Transfers and purchases were scrutinized ex-ante; reported on a public data portal; and regularly audited. An inter-institutional committee was created to ensure better controls. The legislative branch has created a bicameral commission to oversee COVID-19 spending. The Contraloría and the Auditoría General del Poder Ejecutivo plan to conduct an audit covering the entire COVID-19 spending.
7. The economy rebounded from May onward as lockdown restrictions were eased in four phases. The recovery was further supported by a strong bounce back of the agricultural sector from last year’s drought and by the increase in construction that resulted from additional government investment. We now expect GDP to decline by 1½ percent this year—one of the smallest declines in the region.
8. For 2021, we expect growth of 4 percent, but the outlook is very uncertain. Near-term risks are dominated by the economic impact of the Covid-19 epidemic. A sharp increase in infections and daily deaths could still happen. And in some countries where a new wave of the pandemic happened, sanitary restrictions have been re-imposed. Cross-border trade with Brazil and Argentina will only resume in full if the epidemic in these countries is brought under control. Global demand and commodity prices may suffer if the pandemic lingers much longer than currently projected. Bad weather could reduce the harvest, with spillovers to the rest of the economy.
9. In the coming months, the emphasis will be on recovering from Covid-19, trying to revive activity, and recovering lost ground in important areas such as poverty and education. The social damage from the epidemic will likely be considerable, while children’s education will be affected by an almost full year’s closing of most schools.
10. If downside risks materialize, a slower reduction of the deficit in 2021 would be called for. The government plans to reduce the deficit to 4 percent of GDP in 2021. The expiration of the temporary Covid-19 related expenses in and of itself would reduce government expenses by 3 percent of GDP. It is important to keep things under review so as not to withdraw fiscal support prematurely. If the Covid-19 epidemic were to significantly worsen, more spending would be needed, including for health care and for social protection of vulnerable workers. If the current La Niña cycle were to reduce the harvest and economic growth, tax revenues would likely disappoint. In all these cases, it would be important to protect investment; and the reduction of the deficit in 2021 would need to be commensurately smaller.
11. Beyond 2021, the government’s goal to return the deficit to the FRL ceiling by 2024 is appropriate. Returning to the ceiling is important to ensure that debt dynamics remain favorable, to ensure the continued credibility of the fiscal framework, and to build up buffers for when new shocks hit. It would be useful to codify the new target date for return to the deficit ceiling in an updated version of the Fiscal Responsibility Law, together with stricter limits on growth of current spending.
12. Bringing the deficit back toward the ceiling through expenditure compression only will likely necessitate a sharp cut in government investment, beginning in 2022. The government’s focus on making government spending more efficient is certainly appropriate. And successful implementation of reform of the state, civil service reform, and rationalization of public procurement would help reduce current spending. But its contribution may not be enough to reduce the deficit sufficiently—let alone create room for much needed other spending in areas as education and infrastructure. Public investment would likely need to be cut as well. Current medium-term fiscal projections envisage a fall in public investment from 3 to 2.2 percent of GDP.
13. In our view, tax revenue may need to rise as well. Tax revenue in Paraguay is very low by international standards. While further curbing tax evasion would help create additional resources, the near-term scope is likely to be modest—Paraguay has already been working for the past decade and a half on improving tax administration, including with Technical Assistance of the IMF. The potential of further tax administration improvements is likely not enough to close the revenue gap.
14. Once Paraguay has firmly recovered from the Covid-19 crisis, the key question going forward is how to sustain rapid growth of real incomes, as the factors that propelled growth in the last decade (including the agricultural commodity price boom) are likely to provide less support going forward. Future growth will increasingly need to come from the non-energy/nonagricultural sector, which is growing rapidly but is still small. To foster growth, Paraguay will need to continue with its policies focused on macro-economic stability, but also improve human capital, the business climate and governance. Paraguay scores poorly on these indicators, not only compared with advanced countries, but also with emerging market countries, including in the region.
15. Efforts are also needed to further reduce social inequality and improve education. The pandemic is reverting some of the progress made in reducing inequality and poverty, as the crisis disproportionately affected the low-income population, women, and informal sector workers. Improving education would help reduce inequality. Paraguayan students have low PISA scores in international comparisons, and learning outcomes have not improved in the past decade.
16. The Economic Recovery Plan sets the right priorities. It combines economic support measures, which focus on social protection, public investment, and financing for the private sector, with appropriate structural reform measures to foster the formalization of the economy and enhance the effectiveness of spending and of public sector operations. If these projects and measures can be implemented, they will lay the base for a resumption of sustained economic growth in the medium term, once the Covid-19 crisis will have subsided.
17. An IMF mission in early 2020 helped the government assess weaknesses in governance. In response, some measures to address governance vulnerabilities at the strategical level have been undertaken, including the preparation of laws to reform the civil service and procurement procedures. Measures were also taken to strengthen fiscal institutions and processes, including the reform of the Customs legal framework; the improvement in sharing information between key governance institutions (Supreme Audit Institution (Contraloría), SENAC, SEPRELAD and AGPE) and the making all fiscal information available on one online platform. This enhanced institutional cooperation has allowed the authorities to register and track a large number of workers operating in the informal sector.
18. According to Financial Stability indicators, the banking system is well capitalized and NPLs are low . The nonperforming loan ratio is modest, at 3.0 percent, and the Tier I capital-to-asset ratio is at 14.9 percent—well above the regulatory minimum of 8 percent. However, policy actions to secure the flow of finance during the crisis make it difficult to assess to what extent these statistics are reflective of the underlying situation. A deterioration of asset quality this year is unlikely to show up in the statistics, as banks have been allowed to renew, refinance and restructure loans until the end of 2020. A continuous assessment of asset quality, including under adverse shocks, will help ensure that future capital and liquidity buffers will remain appropriate.
19. The pension system requires supervision and needs to be reformed. Currently, there is no financial supervision and regulatory oversight of pension fund activities. Introducing a pension fund supervisor and abolishing outdated legal restrictions would help safeguard the public’s long-term savings and more effectively channel long-term savings into investment. In addition, the pension system ensuring private sector employees needs to expand its coverage among uninsured informal workers. In the longer term, parametric adjustments are needed to strengthen its equity and financial sustainability. The system ensuring public civil servants (Caja Fiscal) is severely underfunded and requires even more urgent reforms.
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