People walk past a shopping center in Ciudad del Este, Paraguay (photo: Joel Carillet/iStock by Getty Images)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Paraguay Seeks New Transformation after 15 Years of Rapid Growth

By Bas Bakker and Natasha Che

(EspañolPortuguês)

In the past decade and a half, Paraguay has been one of the fastest-growing economies in South America—helping to reduce poverty levels in the country from 58 percent in 2002 to the current 26 percent.

Real GDP grew by over 4.5 percent annually, well above the 1¾ percent average for Latin America as a whole. Further, income per capita grew from US $1,300 dollars in 2002, to almost US $6,000 in 2018.

But, maintaining this strong growth may be more challenging, as the factors that supported growth in the past will provide less support going forward. Policies that boost investment and productivity can help Paraguay sustain inclusive growth for future generations.

 

Economic transformation

The stellar growth performance has left clear marks on Asuncion, the nation’s capital. Shiny apartment buildings and bustling shopping malls have popped up. Industrial-chic hotels and new corporate headquarters ooze a cosmopolitan vibe. Growth has been so fast that traffic jams, which were rare 15 years ago, are now a daily reality to the city’s residents.

Moreover, while the business cycle of Paraguay used to follow that of its neighbors, during the last decade the country has become much more resilient and continued to grow in the face of significant external shocks and volatility. When Brazil—one of its main trading partners—had one of its deepest recessions ever in 2015 and 2016, Paraguay grew at rate of almost 4 percent.

Why growth was strong

So, why has growth been so fast, and will it continue?

Strong growth was in part the result of a bounce-back from an earlier crisis. In the late 1990s and early 2000s Paraguay suffered from a banking crisis, a deep recession, and a sharp depreciation of the exchange rate. By 2003, per capita incomes were lower than they were in 1980.

The bounce back was helped by a turnaround in economic policies. Economic stability was first restored, aided by two IMF programs . Economic policies then remained prudent, even during good times. Inflation and exchange rate volatility came down as the central bank shifted to inflation targeting. Fiscal deficits were reduced, and public debt was brought down from 52 percent of GDP in 2002 to around 20 percent of GDP currently. A fiscal responsibility law came into force in 2015 to keep deficits and debt low. As a result, Paraguay avoided the boom-bust cycle that affected other countries in the region.

The boom in soybean prices and other agricultural commodities further boosted growth. Dollar export prices of soybeans tripled between 2000 and 2014. This not only led to a sharp increase in export values, it also triggered a large increase in export volumes as investing in agriculture became very profitable. The export boom spilled over to the rest of the economy through an appreciation of the real exchange rate, which boosted real incomes and domestic demand.

 

The challenge of maintaining strong growth

Maintaining strong growth may be more challenging, as the factors that supported growth in the past will provide less support going forward. Soybean prices peaked in 2014 and have since fallen by a third. The land under cultivation for the main crops has doubled in the past 15 years, and further sharp increases will be difficult.

Growth has also come to a large extent from using more inputs rather than from using inputs more effectively. Employment has grown rapidly, but productivity growth has remained modest.

Continuing the transformation

With the agricultural sector likely to grow slower than in the past, fast growth will only continue if other sectors can step up. The good news is that new export sectors are starting to emerge, such as the manufacturing exports under the maquila regime. Nevertheless, they are still small. Non-agricultural and non-hydro-energy exports are only 7 percent of total exports.

Making Paraguay a more attractive investment destination could help speed up the transformation. As discussed in the latest economic assessment for Paraguay and its accompanying background papers , an improvement of the business climate and governance indicators would facilitate diversification and productivity growth. Policies that focus on improving transport infrastructure, rule of law and governance, and quality of education would be particularly helpful.

Fiscal policy

Some of the reforms will cost money. Government spending levels in Paraguay are low. Reprioritizing spending could create some room, as the composition of spending is lopsided, with a high share going to wages. Increasing revenue would create further room for reform-related spending and investment needs. Tax rates in Paraguay are low, but tax revenues are even lower than would be expected, given the rates. The personal income tax rate is 10 percent, but the tax yields only 0.1 percent of GDP, the result of exemptions and deductions. Tax reform that focus on reducing exemptions and deductions and improving tax compliance would help.

When it comes to the fiscal policy, it is important to not only think about the near-term, but also about longer-term challenges. Paraguay’s population is still young. But with the population gradually aging, large deficits will emerge in the future in the pension system. To avoid this, small changes in the pension system now (for example, a modest increase in the retirement age) would be better than big changes later.

Going forward

Paraguay has done well in the past fifteen years. It bounced back from an earlier crisis, decoupled from its larger neighbors, and made strides in reducing poverty. These accomplishments are aided by a turnaround in macro-economic policies, as well as an agricultural commodity price boom. If it continues applying what has worked well (prudent macro policies), while implementing other reforms that focus on the supply side, strong growth may well continue.

When people think of small, economically successful land-locked countries with lots of hydro-energy, they typically think Switzerland. But if its stellar economic performance continues, people can soon think of Paraguay.