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Country Report Paraguay

Country Report

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Economic growth is expected to remain robust at around 5% in 2014. Meanwhile, relations with the Mercosur countries are improving after tensions had increased in 2012. Similarly, the fiscal position is set to improve after deteriorating in recent years. 

Strengths (+) and weaknesses (-)

(+) Low public indebtedness

Public debt has averaged a low 15% of GDP in the past five years, and has resulted in positive debt dynamics and fiscal solvency.

(-) High commodity dependence

High (agricultural) commodity dependence increases the economy’s vulnerability to swings in agricultural production which frequently faces adverse weather conditions in Paraguay.

(-) Weak political institutions

Governance indicators are weak, which is particularly reflected in low government effectiveness, a poor control of corruption, and a weak rule of law.

(-) Weak international competitiveness

As a result of anuncertain investment environment, a weak business environment and high transaction costs due to poor infrastructure, the country’s international competitiveness is weak. 

Key developments

1. Economic growth will normalize

After spectacular GDP growth of 12.8% in 2013, GDP growth is expected to normalize to around a still robust 5% in 2014. In 2013, a strong economic rebound occurred as markets for beef exports had fully re-opened after several countries banned imports of Paraguayan beef as Paraguay suffered an outbreak of foot and mouth disease in 2012 and the economy had overcome the negative effects of a devastating drought in late-2011 and early-2012. The agricultural sector, and especially soy and cotton production, is expected to lead economic growth in 2014. Also, Paraguay has shown increased economic resilience to weaker economic conditions in neighbouring countries, which are its main trade partners. Brazil’s weak GDP growth and deteriorating economic conditions in Argentina have not materially affected Paraguay’s economic performance. Lower credit flows given the normalization of US monetary policy presents a downside risk.

Figure 1: Growth will normalize
Figure 1: Growth will normalizeSource: EIU
Figure 2: Fiscal position is set to improve
Figure 2: Fiscal position is set to improveSource: EIU

 2. Relations with Mercosur countries have improved

Relations between Paraguay and Venezuela took a turn for the worse in 2012, after Paraguay objected to Venezuela’s express incorporation into the Mercado Común del Sur (Mercosur, the Southern Cone customs union). This happened just weeks after Paraguay was suspended from Mercosur following the impeachment of then-president, Fernando Lugo, in June 2012, which displeased the Mercosur member countries. However, Paraguay’s formal suspension was soon lifted after the new president Cartes was inaugurated in August that same year. Paraguay argued that Venezuela’s entry was illegal because not all Mercosur had approved its membership, which is required according to the statutes of Mercosur. Paraguay’s senate in the end approved Venezuelan entry to Mercosur in December 2013, partly because Venezuela accepted to renegotiate a USD 300m debt Paraguay owes the state owned oil company Petróleos de Venezuela (PdVSA. We believe that external pressure from Brazil may also have played a part in the mending of relations, since Brazil is a large trader partner of Paraguay. Brazil benefits from Paraguay’s presence in Mercosur, as the EU has made free trade talks with Mercosur conditional on Paraguay’s inclusion, since such trade agreements are based on the principle of block agreements the EU does not want trade agreements separately per country.  

3. Fiscal position is set to improve

The fiscal position is set to improve in the coming years after having a deteriorated trend since 2011. Fiscal discipline weakened under the interim government of Federico Franco in 2012 and 2013, and the budget balance recorded a deficit of 1.8% of GDP in 2012 after several years of surpluses. However, we see an improving trend since now, incumbent president Horacio Cartes, who has been in office since August 2013, managed to pass a fiscal responsibility law in late 2013 with an overwhelming majority in the lower house. This is a highly positive development since the fiscal law will give the government a legal mandate to undertake fiscal adjustments this year. Another positive development for the country’s fiscal position is that Cartes managed to push through a tax reform bill which raises tax rates on the agricultural sector. This should have been accomplished earlier, since tax contribution by commercial farmers has been extremely low at around 2% of total tax revenues. However, previous administrations failed to do so due to opposition from the country’s powerful soybean lobby. Even though the tax reforms will be implemented gradually, we expect to see fiscal improvements in 2014, and we expect consequently expect the budget deficit to narrow to 1% of GDP in 2014, from 1.7% in 2013. 

Factsheet of Paraguay
Factsheet of ParaguaySource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank.

Background information

The Republic of Paraguay is a landlocked country in South America, nestled between Argentina, Bolivia and Brazil. With a nominal GDP of USD 28bn it is one of the smaller economies. It is one of the poorer countries on the continent and is classified as a lower middle-income country by the World Bank. The country’s poor infrastructure, weak institutions, weak rule of law and high levels of corruption continue to hamper its economic performance. As weak institutions result in an uncertain investment environment and high transaction costs, the country’s competitiveness is weak. A very large part of economic activity takes place in the informal sector, property rights are not adequately protected and the judicial system is weak and inefficient. As a result, conflicts regarding land ownership occur frequently and many subsistence farmers are still officially landless. Smuggling is a flourishing business at the Argentine and Brazilian borders. Paraguay’s economy depends on the agricultural sector, which accounts for some 22% 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. Paraguay has a tumultuous political history: the first peaceful handover of power in the country’s history occurred in 2008. Before then, 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 CP.

Economic indicators of Paraguay
Economic indicators of ParaguaySource: EIU
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