On February 14, 2014, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV Consultation with Paraguay.1
Paraguay enjoyed robust economic growth in the past decade, on the heels of the export commodity boom, and supported by prudent macroeconomic policy implementation. Despite weather-related shocks hitting the key agribusiness sector, the economy has grown at an average rate of 4.7 percent a year since 2003 compared with about 2 percent the previous decade. Robust growth has been accompanied by declining inflation, particularly since 2011 when the central bank adopted inflation targeting. Despite the acceleration in growth in the 2000s, poverty and inequality in Paraguay remain among the highest in the region.
Activity rebounded to an estimated 13 percent in 2013 as the agricultural sector recovered sharply from the previous year’s severe drought. Rising agricultural output led to higher exports and a surplus of close to 1 percent of GDP in the external current account, despite a deterioration in the terms of trade. Non-agricultural activity has been less volatile, growing at about potential in the past two years, underpinned by rising consumption. End-2013 inflation fell to 3.7 percent—below the central bank’s inflation target rate of 5 percent—despite increasing food prices. Private sector credit growth has slowed to about 17 percent in nominal terms since end-2012, with loans concentrated on the agricultural sector; consumer credit has also grown rapidly, albeit from a low base. Paraguay’s banking sector remains well capitalized and profitable, with low nonperforming loans.
Macroeconomic policies broadly supported the recovery. Fiscal spending under the stimulus implemented in 2012 decelerated in 2013 due to stricter spending controls, though the central government deficit increased slightly to about 2 percent of GDP from 1.8 percent in 2012 as tax revenue remained modest. Monetary policy was on hold during much of 2013 until the central bank raised the policy rate by 100 basis points over December 2013 and January 2014, in light of incipient inflationary pressures.
The outlook for 2014 is positive. Growth should be strong at 4.8 percent, underpinned by continued dynamism in the agricultural sector and rising infrastructure investment. Annual inflation will likely increase to the central bank’s target rate of 5 percent. The fiscal deficit should remain low, under the introduction of the recently approved Fiscal Responsibility Law. The external current balance would revert to a small deficit amid slightly deteriorating terms of trade and rising import volumes. Overall, the risks to this outlook are balanced. The main downside risks stem from regional growth and global borrowing conditions, while upside risks include faster-than-expected progress in reforms.
Executive Directors welcomed Paraguay’s recent economic recovery and favorable outlook, underpinned by strong economic policies and fundamentals, with low debt, sizeable official reserves, and small fiscal and external imbalances. Directors noted that the key challenge ahead is to improve social and economic development, while strengthening the macroeconomic policy framework. They took positive note of the authorities’ ambitious reform agenda and the critical legislation that has already been enacted to address institutional and structural weaknesses. Directors emphasized that resolute implementation of these laws and continued sound macroeconomic policies are necessary to reduce poverty and foster broad-based sustainable growth.
Directors welcomed the strengthening of the fiscal framework. The fiscal responsibility law provides a sound anchor to underpin fiscal sustainability. They encouraged the authorities to make the framework stronger, by further improving the quality of government spending, strengthening tax and customs administration, and enhancing the capacity to deal with potential risks from public-private partnerships. Civil service and pension reforms are also needed.
Directors welcomed the authorities’ prudent monetary policy stance and the advances made in implementing an inflation-targeting regime. They encouraged additional steps to complete the transition towards a full-fledged inflation-targeting regime, including developing an active interbank money market, strengthening risk-based bank supervision, and updating financial sector legislation. Maintaining exchange rate flexibility and greater efforts to reduce dollarization will strengthen the monetary policy framework and help cushion the economy against potential shocks. Over the medium term, macroeconomic policies should be guided by the fiscal responsibility law and inflation-targeting frameworks. Directors called for steps to address the remaining deficiencies in the anti-money laundering regime.
Directors agreed that reducing poverty and inequality is a priority. They encouraged the authorities to sustain all the initiatives underway to promote social and economic inclusion while protecting vulnerable groups through social safety nets. Reform efforts should particularly focus on improving the business climate, addressing labor market inefficiencies, and increasing female labor participation as well as human capital investment. Improved public enterprises management will also facilitate access to basic public services at reasonable cost.