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Country Report Paraguay

Country Report

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Following a slight economic contraction in 2012 on the back of adverse weather conditions and livestock disease, real GDP growth is estimated to increase to around 9.5% in 2013, as conditions have improved markedly recently. Fernando Lugo was impeached last year and interim president Franco will remain in charge until the April 2013 elections, which the Colorado Party is expected to win. Paraguay’s institutions are weak and underdeveloped. A large part of the economy operates in the informal sector and the rule of law is weak in large parts of the country. The current account balance is expected to improve on the back of improved performance of the agricultural export sector, which will be reflected in an improvement of Paraguay’s external liquidity indicators. 

National facts of Paraguay
National facts of ParaguaySource: EIU, CIA World Factbook, UN, Heritage Foundation, Transparency International, Reporters Without Borders, World Bank.

Economic structure and growth

The Republic of Paraguay is a landlocked country in South America, nestled between Argentina, Bolivia and Brazil. With a nominal GDP of USD 24bn it is one of the smaller economies and one of the poorer countries on the continent. Per head, Paraguay’s 6.6 million inhabitants’ GDP amounts to USD 3,600 (or USD 6,185 in PPP terms) and the country is classified as a lower middle-income country by the World Bank. In spite of improvement in past years, the country’s poor infrastructure and weak institutions, illustrated by a low level of government effectiveness, weak rule of law and high levels of corruption, continue to hamper its economic performance. As the weak institutions result in an uncertain investment environment and high transaction costs, the country’s competitiveness is weak (reflected by Paraguay’s poor rank on the World Economic Forum’s Global Competitiveness index: 116 out of 144 countries). Another expression of the country’s weak institutions is the fact that a large part of economic activity takes place in the informal sector. Moreover, property rights are not adequately protected, the judicial system is weak and inefficient and acquiring land title documents is a cumbersome process. As a result, conflicts regarding land ownership, which sometimes turn violent, occur frequently, many subsistence farmers are still officially landless and smuggling is a flourishing business at the Argentina and Brazilian borders. 

Paraguay’s economy depends on the agricultural sector, which accounts for some 18% of GDP and employs roughly half the working population, and the country has grown into an important global soybean producer and exporter. The country is rich in mineral resources as well, but the exploitation of these has yet to be developed further. The country lacks a strong and diversified industrial base and, as a result of its undiversified economic structure, Paraguay’s exports consist mainly out of agricultural primary exports. Imports, meanwhile, are for a large part sourced from within the region, although China and the US are important suppliers of imports as well. Paraguay is a relatively open country, with imports and exports of goods and services together equaling nearly 100% of GDP, partly because the country is an important transit country for trade between Argentina and Brazil. Given its open economy and its trade structure Paraguay’s economic performance is vulnerable to external shocks, while the impact of domestic supply problems, particularly in the agricultural sector, will quickly translate into a growth slowdown and a weakening of the balance of payments.

Together with Brazil, Paraguay operates the Itaipu hydroelectric dam (the second-largest hydroelectric dam in the world, located on the border between the countries), which ensures the country of more than sufficient energy resources as well as foreign exchange inflows, as surplus energy is exported to Brazil.

In 2012, poor weather conditions (drought) negatively affected the output of the important corn and soy sectors. The drought coincided with an outbreak of foot and mouth disease, which had a significant and negative impact on the beef sector’s output, while beef exports were disrupted by export bans imposed by important import countries in response to the outbreak. As a result, investment and export growth contracted, while private consumption growth slowed to a mere 1% last year. A 23% increase of government consumption managed to contain the negative impact on growth somewhat, but real GDP still contracted by 0.3% in 2012, sharply down from a positive 4.3% in 2011. This year, the economy is expected to rebound strongly. Good weather conditions have led to a bumper soy harvest and beef exports are resuming as well. The EIU forecasts that real GDP will grow as a result by a staggering 9.5% in 2013, although potential adverse developments in the eurozone, the US and China pose important downside risks to this forecast. 

Figure 1: Growth performance
Figure 1: Growth performanceSource: EIU
Figure 2: Social indicators
Figure 2: Social indicatorsSource: See factsheet

Political and social situation

Paraguay has a tumultuous political history and the election of former president Fernando Lugo of the center-left Patriotic Alliance for Change (APC) in 2008 was the first peaceful handover of power in the country’s history. Before he was elected, the Colorado Party (CP) had uninterruptedly ruled the country for more than sixty years, including during the country’s long period under dictator Stroessner (1954-1989) who was also head of the Colorado Party. The presidency of Fernando Lugo, who did not have a majority in Congress, was turbulent. Impeachment procedures loomed constantly and on top of that he had to battle lymphatic cancer in 2010. In mid-2012, after a land conflict had turned violent and led to the death of 17 people, the senate voted almost unanimously to remove him from office because he allegedly mishandled the incident. His vice-president Luis Federico Franco Gómez, of the Authentic Radical Liberal Party (PLRA), was sworn in as president until the April 2013 elections. The CP’s candidate, Horacio Cartes, is widely expected to win the presidential elections but it is not certain if his party will be able to secure a majority in Congress, which would imply a continuation of weak governability.

Paraguay’s level of development is low and provision of healthcare and education is inadequate overall. Both the education and healthcare sectors are in dire need of public investment. Some positive steps have been taken in this regard, in the form of conditional cash transfers to enhance school attendance and to counter poverty. With GDP per head being relatively low and, in addition, income inequality being very high, as indicated by a Gini-coefficient of 52, many people live below the poverty line. Weak rule of law in large parts of the country often leads to land conflicts, which present a major source of political instability that the government has found hard to address.

External relations mainly focus on MERCOSUR and its members. The swift impeachment of Lugo led to strong criticism from other MERCOSUR countries, which have not recognized the Franco government and have suspended the country until a new government takes office, expectedly in August this year. However, no economic sanctions were imposed and the impact of the impeachment of Lugo is therefore relatively limited, although it has hurt trade with Argentina and Brazil somewhat due to delays at the border. Relations with MERCOSUR will likely return to normal when the new democratically elected government takes office in August. 

Economic policy

President Franco has maintained the government’s policy focus aimed at maintaining macroeconomic stability and supporting growth by improving the business climate – Paraguay currently ranks 103rd out of 185 countries on the ease of doing business index - and by improving the country’s infrastructure. In spite of this focus, progress is slow. A medium-term fiscal framework and inflation targeting regime are only slowly being adopted. Given the country’s large informal sector, broadening the tax base – currently Paraguay’s tax ratio is a mere 14% of GDP and hinges on indirect taxes - is important to generate sufficient revenue for the government’s spending programs. In this light, a personal income tax regime was approved in November last year, but enforcing it will prove a challenge. In spite of the political division within the country, Congress has worked with both Lugo with regard to strengthening social policies. Furthermore, under both Lugo and current president Franco, Congress has passed budget plans, indicating that there is consensus on macroeconomic policies.

From 2003 to 2011, the budget balance was in surplus. However, weakening economic growth and a public sector wage increase drove the budget into a deficit of 3.4% of GDP last year. Increased tax revenues derived from the newly implemented personal income tax and lower public spending growth should help to narrow the deficit to around 1% of GDP by 2014. Public debt is relatively low at roughly USD 3bn (equal to 13% of GDP) in 2012. In the coming years, public debt is projected to increase by around 10% in nominal terms by 2014. However, as GDP growth is estimated to be relatively strong in the coming years, this will translate to a lower debt-to-GDP figure of around 10% that year.

Inflation is highly erratic, climbing rapidly when the economy is booming (to above ten percent a year) and falling quickly (to between three and four percent) in years in which the economy performs weakly. In the coming years, inflation is forecast to remain within the Central Bank’s inflation target range (of 5% ± 2%), but rise from 3.7% in 2012 to around 5% in 2014. Due to the country’s underdeveloped capital markets and high level of dollarization, the effectiveness of monetary policies is limited. S&P estimates that some 43% of total private sector credit was in US dollars mid-2012, although this does represent an improvement compared to the 47% in 2005. The Central Bank of Paraguay intends to adopt an inflation targeting regime, but needs to be recapitalized (to the extent of 6% of GDP) first. Although a recapitalization plan was approved by Congress in 2010, it still has to be implemented.

In the second half of 2011, Paraguay’s currency, the guarani, depreciated strongly, as exports declined. After regaining some strength, the currency depreciated again mid-2012 due to political uncertainty caused by the impeachment of president Lugo, which prompted the central bank to intervene. In 2013, the guarani is expected to appreciate on the back of strong export growth, which will also help to contain inflation. 

Figure 3: Public finances
Figure 3: Public financesSource: EIU
Figure 4: Exchange rate
Figure 4: Exchange rateSource: Reuters EcoWin

Balance of Payments

The structure of Paraguay’s trade makes it vulnerable to domestic supply shocks and external demand fluctuations. Paraguay’s exports hinge on agricultural primary products, while many consumer and most capital goods need to be imported. In particular, any supply problems in the agricultural sector, such as last year’s drought, will thus translate into a deteriorating trade balance. As a result, the trade and current account balances are very volatile, but always (trade balance) or mostly (current account balance) in deficit. In 2012, the trade deficit widened from an already hefty deficit of 6.5% of GDP in 2011 to 12% of GDP in 2012. This year, the trade balance is estimated to narrow again, to still a large deficit of around 8% of GDP, on the back of good harvests and thus strong export performance.

Figure 5: Current account
Figure 7: Current accountSource: EIU
Figure 6: External liquidity
Figure 8: External liquiditySource: EIU, Rabobank

Steadily increasing surpluses on the services and current transfers accounts largely make up for the trade deficit, limiting the current account deficit to 3.8% of GDP in 2012 and around 1% of GDP in 2013. When agricultural exports perform strongly, and the deficit on the current account is thus limited, this deficit is adequately covered by steady FDI inflows of  between 1.5 and 2 percent of GDP. However, when agricultural production is disrupted, the current account deficit has to be covered by external debt inflows (in 2012 in the form of borrowing by Paraguay’s private sector from foreign private creditors in 2012) and FX reserves. Private debt flows covered the current account deficit in 2012. Portfolio inflows are non-existent. As a result, FX reserves fell by USD 382m in 2012. In most years of the past decade, however, FX reserves increased, albeit in a volatile manner. 

External position and liquidity

Paraguay’s external debt is at acceptable levels. Total foreign debt is forecast to increase to around USD 6.7bn (in 2014), up from around USD 5.7bn in 2012. As a percentage of GDP, total foreign debt stood at 24% in 2012 and strong GDP growth is expected to reduce this figure to 21% this year. The public sector’s share of medium- and long-term external debt has fallen to 52%. The share of short term debt in total foreign debt is decreasing, from nearly 25% in 2011 to an estimated 22% in 2013 and 2014. Strong growth of FX reserves in past years, except in 2012, has led to an improvement of Paraguay’s external liquidity. FX reserves are expected to rise to nearly double the end-2008 level by end-2013, from around USD 2.8bn to nearly USD 5.5bn. The liquidity rating also improved, from 119% in 2008 to an estimated 128% in 2013. However, the country’s liquidity position deteriorates sharply in years in which agricultural exports disappoint. In 2012, the liquidity ratio fell to 118%, from 127% in 2011. The import cover ratio generally lies between 4.5 and 5 months, which is adequate. Because Paraguay’s external debt is relatively low, FX reserves covered 80% of total external debt in 2012 and nearly 250% of debt service. In the coming years, these figures will improve to roughly 85% and 295% respectively.  

Economic indicators of Paraguay
Economic indicators of ParaguaySource: EIU
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