OREANDA-NEWS. March 01, 2016. A staff team from the International Monetary Fund (IMF), led by Mr. Hamid Faruqee, visited Asunci?n during February 15–26 to hold discussions for the 2016 Article IV consultation. The team met with Central Bank of Paraguay (BCP) President Carlos Fern?ndez, Minister of Finance Santiago Pea, Minister of Industry and Commerce Gustavo Leite, Minister of Public Works and Communications Ram?n Jim?nez, Minister of Planning Jose Molinas, Social Action Minister Hector Cerdenas and other senior officials, as well as representatives from the private sector, think tanks, and the donor community.

At the conclusion of the visit, Mr. Faruqee issued the following statement:

“Against the backdrop of a prolonged regional slowdown, Paraguay’s economy remains relatively resilient. We expect growth at around 3 percent this year and next, reflecting sound macroeconomic fundamentals, lower oil prices, and vibrant construction activity. Public debt is low and international reserves are adequate. Downside risks to the growth outlook have risen mainly from the external side—linked to lower agricultural commodity prices and economic weaknesses among trading partners, including a deep recession in Brazil. These risks add to longstanding structural challenges that the authorities have begun to address through an ambitious reform agenda to reduce poverty, promote inclusion, improve education, and close infrastructure gaps.

“The current mix of macroeconomic policies is broadly appropriate. In response to some underlying inflation pressures from currency depreciation, the BCP has recently tightened policy to keep inflation expectations anchored. Some fiscal expansion is expected for 2016, as tax revenues are likely to be weaker given slower growth and soft commodity prices, while important public investment projects are likely to be executed. By implication, the budget deficit for 2016 may exceed the Fiscal Responsibility Law’s (FRL) ceiling.

“Monetary policy remains slightly accommodative and, coupled with a flexible exchange rate, should be the principal tool if growth were to weaken further, within the limits of meeting the central bank’s price stability objectives. Headline inflation is temporarily elevated due to volatile food prices but should decrease this year to the BCP’s inflation target. To further strengthen monetary policy effectiveness and credibility of the inflation targeting framework, discretionary interventions in the foreign exchange market, like those observed in 2015, should continue to be limited to exceptional circumstances such as disorderly market conditions. These policy actions can affect money markets and interfere with normal operations of the interest rate corridor involving the BCP’s main instrument—its policy rate. Thus, measures to deepen money markets and limiting discretionary intervention would improve the transmission of monetary policy. Finally, it would be important to further recapitalize the BCP, as possible concerns about its financial position could undermine its financial and price stability mandates.

“Turning to fiscal policy, there are clear signs of increased effectiveness of the FRL this year. It is important that, going forward, the fiscal limits under the law are fully internalized in the budget process. This will help establish a track record and solidify the credibility of the fiscal framework. If changes to the law are sought to address design and implementation issues, reforms should be made carefully and explained clearly to the public to minimize reputational costs. Specifically, reforms should balance credibility and flexibility considerations to avoid perceptions of dilution. An independent fiscal council of experts to provide non-partisan evaluation of fiscal policy would be a welcome step forward.

“To further strengthen the fiscal position, there is still scope to enhance revenue collection and shift the composition of public expenditures toward investment. Measures to broaden the tax base, such as the extension of the VAT to cooperatives, are welcome efforts. More generally, the revenue authority (SET) has made good progress in strengthening administrative capacity, registering taxpayers, and detecting tax evasion, but still faces formidable challenges with tax compliance. On the expenditure side, there is room to increase public investment to close infrastructure gaps and restrain growth in current primary expenditures in line with the limits imposed by the FRL. Authorities should also closely monitor project selection and implementation, as well as mitigate medium-term fiscal risks that could arise from the planned scale-up of public private partnerships.

“Paraguay’s pension funds remain fragmented and unregulated, and they do not effectively mobilize national saving to finance investment or help develop local capital markets. Meanwhile, actuarial and operational deficits in the pension system pose substantial risks to public finances through contingent liabilities. Enacting the draft law creating a pension regulator and expanding investment options will be instrumental in tackling some of these challenges, but additional efforts will also be needed to address long-term financial sustainability concerns with pension funds.

“The financial system appears sound and banks are adequately capitalized. Still rapid credit growth warrants vigilance, although a portion of this reflects financial deepening. The health of the banking system compares favorably to regional peers though bank profits have weakened and non-performing loans have risen, albeit from low levels, since last year given the economic slowdown.

“The authorities are moving forward with welcome reforms to enhance financial supervision, including a new banking law and plans for a new central bank charter. Draft legislation on risk-based supervision will help further develop monitoring frameworks and strengthen capacity to track credit and liquidity risk. To build upon these gains, priorities include continuing to upgrade capacity, strengthening institutional arrangements, and securing adequate resources to perform these functions. To safeguard against risks from weaker credit quality, loan classifications should be carefully examined to ensure appropriate provisioning and adequate buffers in banks. Additionally, credit developments outside traditional banks should be monitored carefully and the supervision of the cooperative sector should be strengthened.

“In terms of structural reform, Paraguay has embarked on an ambitious agenda in the National Development Plan to raise living standards, promote inclusive growth and deepen economic integration. Authorities have made progress in several areas, which is tracked through comprehensive internal scorecards. Within the National Poverty Reduction Program Sembrando Oportunidades, Paraguay has broadened its conditional cash transfer program Tekopora and introduced new programs to empower the poor to generate their own income. Staff and authorities agreed on the need to prioritize infrastructure—notably, improving electricity distribution, transportation, especially waterways—including through public private partnerships. These efforts should attract investment, boost productivity, and sustain growth.

“With the introduction and implementation of the Law of Free Access to Public Information, the authorities have begun to establish much greater transparency in public processes to increase public accountability and strengthen governance. This is an important step to improve the quality of institutions in Paraguay on a lasting basis.

“We are grateful to the authorities and all our counterparts for their kind hospitality and the open and productive dialogue.”