IMF Concludes 2022 Article IV Consultation with Paraguay

Washington, DC : The Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation[1]with Paraguay on June 15, 2022 and endorsed the staff appraisal without a meeting on a lapse-of-time basis.[2]

After two consecutive years of GDP decline, Paraguay’s economy rebounded in 2021, growing by 4.2 percent thanks to a recovery in the secondary and tertiary sectors and despite contractions in agricultural production and electricity generation. The Covid-19 pandemic currently appears under control and most of the remaining restrictions have recently been lifted. Annual headline inflation started increasing sharply in the second half of 2021 primarily due to higher food and fuel prices, a phenomenon exacerbated by the war in Ukraine, reaching 11.8 percent in April 2022. The Central Bank of Paraguay reacted quickly and has raised its policy rate by a cumulative 650 basis points to 7.25 percent by end-May 2022. The fiscal position has improved since the 2019 and 2020 shocks. After increasing to 6.1 percent of GDP in 2020, the fiscal deficit fell to 3.7 percent of GDP in 2021 partly thanks to the expiration of one-off emergency measures.

The medium-term outlook remains favorable though there are challenges in the near-term. While heatwaves and a severe drought have diminished 2022 GDP growth prospects to 0.3 percent, staff projects a rebound of 4.5 percent in 2023, and 3.5 percent growth over the medium term. End-2022 inflation would be above the central bank’s tolerance corridor of 4 percent +/- 2 percent, at about 8 percent, but is projected to converge back to the authorities’ target by end-2023. The authorities remain committed to their medium-term fiscal target of converging back to the 1.5 percent of GDP deficit limit under the Fiscal Responsibility Law.

Risks to the outlook include fiscal pressures from demands for salary increases and various bills in Congress. Over a longer horizon, Paraguay is vulnerable to climate change and faces risks from changes in precipitation patterns and the frequency and intensity of severe weather events.

Executive Board Assessment

In concluding the 2022 Article IV consultation with Paraguay, Executive Directors endorsed the staff’s appraisal, as follows:

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.

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.

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.

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.

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.

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.

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.

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.

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.