Wed, 11 Dec 2019

Paraguay's economy impacted by several shocks

Lola Evans
13 Nov 2019, 14:15 GMT+10

ASUNCION, Paraguay - An International Monetary Fund (IMF) team has concluded the economy in Parayguay, despite enduring a number of shocks this year, will bounce back in 2020.

Subject to how the world and regional economies perform, the economy in Paraguay should grow by 4% next year, the IMF said in a statement released on Tuesday.

The country is in urgent need of reforms, but does not necessarily have the funds to finance them, the report said. Increases in pension payments have exacerbated the problem.

"Paraguay's economy has been impacted by several shocks this year. Agricultural output was first hit by a drought and then by flooding. Hydro-electricity production was hurt by low water levels. Exports suffered from economic weakness in Argentina and Brazil and the sharp depreciation of the peso. And all these shocks spilled over to the rest of the economy. As a result, we now expect growth in 2019 to be near-zero," Bas Bakker, the IMF official who has just completed an on-site review of the country over the past week said on Tuesday.

"However, our expectation is for growth to bounce back to 4 percent next year. The recovery that has been visible in recent months should pick up steam, aided by a rebound in agriculture."

"There are regional and global risks to economic growth in 2020. An important source of risk is developments in Paraguay's main regional trading partners. Risks from Argentina not only pertain to low growth, but also to a further decline of the peso, which would hurt cross-border trade. At the global level, the ongoing trade tensions between China and the United States are weighing on global growth prospects. However, downturns in Paraguay tend to be followed by strong recoveries-bad weather has only a temporary impact on the economy," he said.

"Headline inflation has fallen from 4 percent in August 2018 to 2.4 percent in October 2019, below the middle of the target band of 4 +/- 2 percent. In this setting, the BCP has appropriately lowered the policy rate this year by 125 basis points to 4.00 percent."

"The economic downturn has resulted in a shortfall of tax revenue. Together with a rebound in public investment (which mitigated the recession), this has resulted in an increase in the deficit from 1.3 percent of GDP in 2018 to an expected 2.5 percent in 2019. While this is above the 1.5 percent deficit ceiling stipulated in the Fiscal Responsibility Law, the FRL does allow a temporary excess of the deficit over the ceiling in case of a fall in domestic economic activity, and credibility will be maintained if strong efforts are made to return to the ceiling," the IMF official said.

"In the past fifteen years, sound macroeconomic policies have played a key role in sustaining rapid growth and reducing poverty. Sound fiscal policies, together with the inflation targeting framework of the central bank, contributed to avoiding the boom-bust cycles that other countries in the region have experienced. The FRL has been an important anchor to keep fiscal policy sound. It has helped keep deficits and public debt at moderate levels and warded off worries about debt sustainability. In this context, abandoning the FRL would jeopardize the hard-won fiscal credibility that took various governments years to build. It could also increase the borrowing costs for Paraguay in international capital markets. It is important therefore that the deficit continues to abide by the rules spelled out in the FRL."

"Returning to the 1.5 percent of GDP deficit ceiling next year will be challenging and will require keeping spending growth in check-including from the wage bill, which has been growing rapidly in recent years. It will also be important that any additional spending approved by Congress after the budget has been finalized will be offset by spending reductions elsewhere. If tax revenue were to fall short of expectations next year, commensurate spending adjustments will be needed," Bakker said.

"A paramount issue facing Paraguay is to ensure that the rapid growth of the past fifteen years will continue in the next fifteen years. For this to occur the economy will need to diversify, as agriculture will likely not be able to provide the boost it has in the past. Improvements in infrastructure, education, governance and business climate would all contribute to this important goal. Some of these needed reforms will require additional resources, putting further pressure on expenditure."

"Current revenue levels are not sufficient to finance these reforms. There is certainly some scope to reprioritize existing spending and make spending more efficient, so it will be important to implement the recommendations by the joint public-private commission for the consolidation of current expenditure. These efforts are all the more warranted given that the composition of expenditure has deteriorated, trending towards a higher wage bill and higher interest payments, rather than higher investments. But revenues will need to increase as well. The tax reform that has recently been approved was a good first step, but more may be needed," said the IMF official.

"Fiscal sustainability would also benefit from pension reform. Modest parametric changes now are needed to prevent that large deficits will emerge in the pension sector within the next decade, as a result of demographic changes. Unfortunately, the recent increases in retirement benefits for selected groups that were approved by Congress go in the wrong direction, as they add to existing medium- and long-term pressures from demographic trends. It is also important to establish a pension fund supervisor, just as for other financial institutions that are custodians of the population's savings. Strengthened oversight would mitigate risks, allow pension funds to invest in a wider range of assets, and facilitate the development of a domestic capital market."

"Paraguay has seen improvements in governance and corruption indicators, both in absolute terms and relative to the region, but more remains to be done. At the request of the government, the IMF is helping the government analyze the problem and develop a strategy, which will be discussed in the Article IV report next year. The authorities have also taken legal initiatives to tackle the emerging money laundering and cybersecurity risks for the financial system including compliance with AML-CFT standards," said Bakker.

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