Washington, DC: The Executive Board of the International Monetary Fund (IMF) concluded the First Review under the Policy Coordination Instrument for Paraguay on June 7, 2023, and endorsed the staff appraisal without a meeting on a lapse-of-time basis.[1]
Paraguay's two-year program under the Policy Coordination Instrument (PCI) was approved in November 2022. The PCI supports Paraguay's macroeconomic policies and structural reforms, aiming at ensuring macroeconomic and fiscal stability, fostering economic growth, and enhancing social protection and inclusion. The program is performing well, and all but two of the program's targets for December 2022 were met.
Paraguay's economy has demonstrated remarkable resilience during a four-year period of multiple adverse shocks. As it was recovering from the impact of the Covid-19 pandemic, a severe drought hit the economy in early 2022. Economic growth is now rebounding, mainly on behalf of the recovering agricultural sector. Inflation peaked in 2022, but has since declined, following a proactive and persistently tight monetary policy stance, which also helped anchor inflation expectations close to the central bank's target. The fiscal position continued to improve in 2022 on behalf of strengthening revenue and expenditure constraint, reducing the fiscal deficit to 3.0 percent of GDP. The negative impact of lower exports on the external current account was appropriately absorbed by private-sector financing and a flexible exchange rate.
The medium-term outlook remains favorable. Paraguay is exposed to various external risks, but their potential impact appears moderate in the near-to-medium term. Economic growth is projected at 4.5 percent for 2023, the external current account is projected to improve notably, and the rate of inflation is expected to converge back to the central bank's target of four percent in the first half of 2024 at the latest. Continued sound and credible fiscal policies will be critical to safeguard the favorable scenario. The banking system is projected to remain stable, assuming continued sound supervision and healthy internal safeguards. Other domestic risks need to be addressed by continued implementation of the structural reform agenda, including measures to strengthen governance, reduce vulnerabilities to corruption, and intensify policies to cushion the potential impact of ongoing climate change.
Executive Board Assessment
In concluding the First Review under the Policy Coordination Instrument for Paraguay, Executive Directors endorsed the staff's appraisal, as follows:
Paraguay has shown resilience to recent external shocks, and its policy responses have been effective and appropriate. The severe shortfall in export earnings caused by the 2022 drought was successfully weathered given the private sector's capacity to mobilize external resources, combined with moderate exchange rate adjustment, which resulted in a better-than-expected international reserves position at the end of the year. Fiscal policy held a steady course despite very challenging international shocks to energy and food prices, supporting sustainable public finances going forward. The central bank's early and proactive monetary tightening appears to be vindicated by a steadily decreasing inflation rate, with a favorable outlook to converge to the midpoint of the inflation target band by end-2023. In addition, Paraguay's banking system remains stable and solvent.
For resilience to endure, Paraguay needs to continue to rebuild its fiscal buffers and advance important structural reforms. The significant build-up of public debt in recent years has narrowed the fiscal space, and this trend must be reverted by reestablishment of the fiscal deficit rule. Structural reforms to strengthen public sector efficiency are a necessary ingredient to a sustainable fiscal strategy. High on the agenda are measures to contain the losses from the public servants' pension fund ("Caja Fiscal") and the contingent financial risks from unsupervised pension funds. Improving public companies' oversight and strategic management would also reduce fiscal risks. Finally, raising more domestic tax revenue remains key to providing sufficient investment in infrastructure, health, and education for Paraguay's population, which would enhance productivity toward future growth and shared prosperity.
Structural reforms to modernize public institutions, increase government effectiveness, strengthen governance, control corruption, and improve the business climate will help to foster the conditions for sustained economic growth. Paraguay has benefited from previous technical assistance in the areas of public financial management, governance, and financial supervision. Staff concurs that the reforms covered by this PCI would strengthen the efficient use of public resources and create more favorable conditions for private investment.
While Paraguay has made significant strides in developing social programs, there is still ample opportunity to enhance their effectiveness. Paraguay features high informality, inequality, and poverty rates. In response to those challenges, Paraguay has been implementing measures that would improve the efficiency of social expenditure, expand their reach to more vulnerable populations, enhance social programs targeting, promote greater formalization of the economy, and strengthen financial inclusion.
[1] The Executive Board takes decisions under its lapse-of-time procedure when the Board agrees that a proposal can be considered without convening formal discussions.
