VZCZCXYZ0000
PP RUEHWEB

DE RUEHAC #0043/01 0181343
ZNR UUUUU ZZH
P 181343Z JAN 08
FM AMEMBASSY ASUNCION
TO RUEHC/SECSTATE WASHDC PRIORITY 6529
INFO RUCNMER/MERCOSUR COLLECTIVE

UNCLAS ASUNCION 000043 
 
SIPDIS 
 
SIPDIS 
 
PASS TO WHA/BSC KREAD 
 
E.O. 12958: N/A 
TAGS: ECON EFIN PGOV PREL PA
SUBJECT: AN ECONOMIC ASSESSMENT OF DUARTE'S TENURE 
 
¶1. (U) SUMMARY: President Duarte,s 2003-2007 economic 
performance yielded mixed results.  Macroeconomic stability 
was achieved but a rigid expenditure structure, a visible 
bias to support current expenses instead of public 
investments, and a political rather than an economic spending 
rationale undermined the economic impact of stability. Public 
sector reforms significantly improved revenue collections but 
failed to address, among other issues, the lack of 
predictability in the judicial system and the inefficiency of 
state-owned companies. Paraguay registered impressive 
economic growth rates but most of the growth is attributed to 
exogenous factors (good weather, high commodity prices, and 
increasing remittances). The country,s competitiveness 
declined, unemployment increased and, extreme poverty levels 
deteriorated. The next (August 2008) government will have to 
deal with these challenges, but it does not need to reinvent 
the wheel.  It will need an economic policy framework that is 
independent of specific interests, provides incentives to 
improve the business environment, promotes private sector 
growth (especially for small and medium size enterprises) and 
maintains macro economic stability.  END SUMMARY 
 
¶2. (U) President Nicanor Duarte Futros, 2003-2008 economic 
plan identified most of the country,s economic challenges 
but had mixed results in the execution. Key challenges 
recognized included: a small, open economy vulnerable to 
external shocks (high oil prices) and exogenous factors 
(international commodity prices, weather conditions); a 
rapidly growing population coupled with urban migration and 
intellectual immigration; high levels of income inequalities 
and poverty; a non-competitive economy with incipient 
industrial capacity; sluggish growth rates compared to the 
region; high levels of unemployment and sub-employment where 
informal small and medium enterprises (SMEs) comprised most 
of the economy activity; a weak financial system; limited tax 
revenue collections; poor infrastructure for essential 
services (communications, electricity, water) and commercial 
activity (roads, rail lines, river ports); and, a labor 
market that is mostly uneducated and lacks training. (NOTE: 
The economic plan failed to mention state-owned companies and 
a weak judicial system as key factors sinking Paraguay,s 
competitiveness. END NOTE). Duarte,s economic plan addressed 
these challenges in a policy agenda that focused on 
macroeconomic stability, structural reforms, economic growth, 
and poverty reduction. These themes have defined the economic 
hits and misses of Duarte,s tenure thus far. 
 
--------------------------------------------- ---- 
MACROECONOMIC STABILITY -- IS IT THE BIGGEST HIT? 
--------------------------------------------- ---- 
 
¶3. (U) In general terms, Duarte,s administration achieved 
macroeconomic stability (NOTE: Consensus among local 
economists is that Duarte,s hands-off approach--minimal 
political interference in his cabinet,s economic 
policies--largely contributed to results. END NOTE). From 
2003 to 2007, the government exercised fiscal discipline and 
fiscal expenditure increases were offset by higher revenue 
collections. From a fiscal deficit of 3.2 percent of GDP in 
2002, the country moved to a surplus of 0.5 percent of GDP in 
¶2007. Though prices experienced upward pressure and several 
inflationary swings during 2007, effective Central Bank 
interventions controlled and brought down inflation to 
targets at an average annual rate of 6.0 percent.  As an 
indicator of financial sector stability, total bank deposits 
doubled to USD 3.5 billion from 2003 to 2007 with a 10.5 
percent increase in Guarani deposits during the same period. 
International reserves almost tripled from USD 983 million in 
2003 to over USD 2.3 billion in 2007.  External debt declined 
11.2 percent from 2003 to 2.1 billion USD in 2007 and, the 
country,s long-term sovereign debt risk rating, as reported 
by S&P, improved from B- to B.  Paraguay renewed May 2006 its 
Stand-by Agreement with the International Monetary Fund (IMF) 
and received a very positive review and outlook on the IMF,s 
October 2007 revision. 
 
¶4. (U) Undermining the economic impact of the achieved 
macroeconomic stability is the administration,s rigid 
expenditure structure, its evident bias to make larger 
increments in current expenses instead of capital 
investments, and its incapacity to adequately prioritize 
investments based on economic returns.  From 2003 to 2007, 
the annual distribution of expenditures remained roughly 83 
percent for current expenses (around 70 percent is directly 
or indirectly related to personnel expenses) and 17 percent 
for capital investments.  For the first 10 months of 2007, 
the 18.3 percent increase in current expenses (mostly for 
government jobs) was three times higher than the accompanying 
6.2 percent increase in public investments.  For public 
investments there is no real cost-benefit analysis. Though 
always framed within a tight fiscal framework, priorities 
often follow a political more than an economic return.  Out 
of 64,310 km only 4,234 km of roads were paved during 
2003-2006; and, electricity shortages in a hydro-power rich 
country are two examples of under-investment. 
 
¶5. (U) The 2008 budget had a USD 300 million increase (10.7 
percent), from USD 2.6 billion to USD 2.9 billion. According 
to Minister of Finance Barreto, the increase had no clear 
financing sources and pushed the fiscal surplus into a 
deficit. Barreto gained approval January 2008 to cut roughly 
USD 200 million. (NOTE:  With this budget cut the government 
appears serious in its intent to maintain fiscal disciple. 
The cut, however, is counter-intuitive. Most of the 
increments were planned for government salaries and benefits. 
 With elections this year, there are growing fiscal 
pressures, through increments in current fiscal spending, to 
use the government,s political patronage and get votes. It 
is early to see if the cuts will hold. The budget is due for 
revision and adjustment May 2008. END NOTE). 
 
------------------------------------------ 
STRUCTURAL REFORMS - MORE MISSES THAN HITS 
------------------------------------------ 
 
¶6. (U) Perhaps the most important achievement of Duarte,s 
structural reforms was the tax reform which simplified the 
code, expanded the taxpayer base, and increased revenues. 
From USD 582 million in 2003 to USD 1.4 billion in 2007 tax 
revenues increased 145 percent.  The number of taxpayers 
increased 54 percent from 278,290 in 2003 to 429,851 in 2007. 
 Another public sector reform with modest results was the 
reduction of illegally registered people in the pension 
system.  From 2003 to 2007, 14,700 illegally registered 
individuals were removed from the pension system, saving the 
government USD 47 million.  The government missed the other 
two public reform targets -- improving the quality of fiscal 
expenditures and rationalizing the number of government 
employees. The quality of fiscal expenditures, measured as 
how expenses are allocated, deteriorated.  The number of 
government employees increased more than 15 percent from 2003 
to 2007.  (NOTE: Another public sector item in dire need of 
reform but not addressed is the institutionalization of the 
civil service. Most government jobs are still based on 
political affiliation. END NOTE). Other reforms to improve 
the business environment and promote private sector growth 
yielded modest results: bank regulations and supervision were 
strengthened; the number of procedures to export and register 
new business was simplified; and, a new fund, Financial 
Development Agency (AFD), facilitated the expansion of credit 
to SMEs and low income housing through risk sharing 
guarantees with commercial banks. 
 
¶7. (U) The structural reforms excluded reforms to improve the 
predictability and transparency of the judicial system and 
failed to address the inefficiency of state-owned companies. 
Paraguay,s judicial system is characterized by a lack of 
independence and corruption.  Efforts are needed to 
strengthen the rule of law and make the judicial process more 
transparent, unbiased and fair.  Corruption, patronage and 
bias are pervasive features of the current judicial system. 
With regard to state-owned enterprises, powerful interest 
groups oppose the attempts to privatize and reduce the role 
of the government.  Large state-owned companies (rail, 
petroleum, cement, electricity, water, and basic and long 
distance telephone services) employ thousands of potential 
voters and are outlets for political patronage. 
 
----------------------------------------- 
ECONOMIC GROWTH UP - COMPETITIVENESS DOWN 
----------------------------------------- 
 
¶8. (U) Though 2007,s impressive 6.4 percent GDP growth rate 
to USD 12.8 billion is Paraguay,s highest in over 20 years, 
growth is tied and highly vulnerable to exogenous factors. 
Growing world demand for commodities combined with high 
prices and favorable weather to support Paraguay,s 
commodity-based export expansion.  Agriculture production 
drove 66 percent of 2007 GDP growth rate.  Soy and 
soy-related products (54.1 percent), cereals (11.6 percent) 
and meat (10.9 percent), represent 76.7 percent of 2007 USD 
3.3 billion registered exports. On the external side, a high 
internal consumption fueled by current expenditures and 
remittances (over USD 250 million in 2007 according to the 
Central Bank of Paraguay) also significantly contributed to 
the GDP growth rate. (NOTE: An Inter-American Development 
Bank,s study estimated Paraguay,s 2006 remittances at USD 
650 million.  Local economists 2007 estimates are at USD 800 
million or around 6 percent of GDP. END NOTE). 
 
¶9. (U) Mechanized agriculture production increased cultivated 
land area and yields per hectare.  In 2007 the yields for soy 
increased 56 percent reaching 2.68 kilogram per hectare and 
production totaled 6.5 million tons, 71 percent more than 
¶2006. For 2008 the commodity export market outlook is 
positive.  Soy production fields expanded 10 percent and, 
while it is early in the cycle, there have been adequate rain 
levels.  Farmers are already selling soy production for 
shipment in May 2008 at an average of USD 270 per ton (farm 
gate prices).  Similarly, meat prices are at sustained high 
levels for key export markets (USD 3,500 per ton for Chile 
and USD 2,214 per ton in Russia) and, the expectation is that 
growing global demand will continue to drive prices up. 
 
¶10. (U) According to the World Economic Forum 2007 Global 
Competitiveness Index (GCI), Paraguay has one of the least 
competitive economies in the world.  It ranks 121 out of 131 
countries. Only Guyana (126) ranks lower in Latin America. 
Except for macroeconomic stability, Paraguay,s 
competitiveness is undermined by poor infrastructure, low 
institutional capacity, scarce trained labor, limited 
predictability in the regulatory and legal framework, and 
market distortions from state-owned enterprises in the supply 
of essential services (electricity and communications). 
 
------------------------ 
NOT EVERYONE IS A WINNER 
------------------------ 
 
¶11. (U) Income inequalities, extreme poverty, and 
unemployment marked Paraguay,s 2003 to 2007 growth.  The 
percentage of people living in poverty increased to 42 
percent in 2006 from 38.2 percent in 2005, with extreme 
poverty growing from 15.5 percent to 21 percent.  Most of 
Paraguay,s growth benefited the capital intensive 
agribusiness and pushed migration of unemployed rural workers 
to urban centers. Mechanized agricultural production 
supported the commodity export expansion but did not generate 
jobs. Labor intensive crops such as cotton experienced 
production volume declines of 55.1 percent in 2007.  Total 
unemployment (open plus hidden unemployment) increased from 
9.4 percent in 2005 to 11.3 percent in 2006 and, 
under-employment reached 24 percent in 2006.  58 percent of 
5.9 million Paraguayan reside in urban areas, mainly 
Asuncion.  The expansion of mechanized agribusiness will 
continue to displace workers. (NOTE: The next government 
needs to accompany this production shift with policies to 
encourage the growth of SMEs, especially along the agro value 
chain.  Though there are incentives to promote "maquilas", 
Paraguay lacks a coherent policy to encourage and sustain 
investment projects of labor intensive manufacturing 
industries. END NOTE). 
 
12.(U) COMMENT:  Overall, the economic performance of 
Duarte,s 2003-2007 tenure is below average and the next 
government will have to deal with conditions similar to those 
in existence when Duarte took office in 2003.  The benefits 
of Paraguay,s macroeconomic stability and explosive growth 
did not reach the majority of the population.  Powerful 
interests groups continue to reap most of the gains.  As 
unemployment and sub-employment raises more people leave the 
country, a disfranchised feeling, amid all the talks of 
economic growth, exists and, the perceived lack of economic 
opportunities pervades the economy.  Sustained growth largely 
depends on macroeconomic stability and the next government 
does not need to reinvent the wheel.  It will need, however, 
an economic policy framework that is independent of specific 
interests, prioritizes economic infrastructure, improves the 
judicial system, attracts foreign investment, privatizes 
state-owned enterprises, promotes private sector growth 
(especially SMEs) and maintains the achieved macroeconomic 
stability. 
 
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