idb - country strategy with paraguay

8/22/2019 Idb - Country Strategy With Paraguay

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DOCUMENT OF THE INTER-AMERICAN DEVELOPMENT BANK

PARAGUAY

THE BANKS COUNTRY STRATEGY WITH PARAGUAY

(2004-2008)

This document was prepared by the project team consisting of Pablo Molina and Marilia Mirza(RE1/OD1). The following persons collaborated in its preparation: Hctor Malarn (RE1/EN1);Paolo Giordano (INT/ITD); Dino Caprirolo (RE1/SC1); Ernesto Castagnino and FernandoStraface (SDS/SGC); Mnica Rubio y Silvia Raw (RE1/SO1); Gabriel Casaburi and MarioDurn (RE1/FI1); Eduardo Feliciangeli (COF/CPR); Claudia Piras (SDS); Jos Daniel Reyes,Nicole Fragano and Mara Victoria Cabo (RE1/OD1).


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CONTENTS

EXECUTIVE SUMMARY

I. THE ECONOMIC AND SOCIAL CONTEXT ................................................................................... 1A. Recent trends .................................................................................................................... 1B. The context ....................................................................................................................... 3

1. The opportunities ..................................................................................................... 32. Constraints................................................................................................................ 5

C. The governments program ............................................................................................. 8D. Medium-term economic prospects.................................................................................. 9

II. THE MAIN DEVELOPMENT CHALLENGES...............................................................................11

A. Restoring the credibility of State institutions so that the State can lead the way

towards economic development and support the consolidation of democraticinstitutions: the challenge of governance...................................................................... 11

B. Laying the foundations for sustainable economic growth based on the marketeconomy: the challenge of competitiveness. ................................................................ 14

C. Reducing poverty and inequality: The challenge of promoting humandevelopment. .................................................................................................................. 20

III. LESSONS LEARNED FROM PREVIOUS STRATEGIES AND PORTFOLIO PERFORMANCE............ 24

A. Review of the previous strategy and major achievements........................................... 24B. Status of the portfolio..................................................................................................... 28

C. Conclusions and lessons learned ...................................................................................30

IV. THE BANKS OBJECTIVES, ITS STRATEGY, AND THE AGENDA FORDIALOGUE ....................31

A. Objectives....................................................................................................................... 31B. Core areas of the strategy...............................................................................................31

1. Strengthening governance .....................................................................................322. Strengthening the foundations for sustainable growth by deepening the

market economy and achieving greater regional and global integration............. 353. Reducing poverty and improving the quality of life of low-income sectors of

the population......................................................................................................... 40

C. Implementation of the strategy...................................................................................... 42D. Participation and coordination with other donors......................................................... 44E. Lending scenarios and the countrys debt position ......................................................46F. Possible sector and country studies...............................................................................48G. Risks associated with the strategys implementation...................................................48H. Monitoring of the strategy and indicators..................................................................... 50I. Agenda for dialogue with the country........................................................................... 50


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ANNEXES

Annex1 Operations programAnnex 1-A Linkages with objectives for sustainable economic growth and poverty

reduction and with the Banks sector strategiesAnnex 2 Classification of the current loan portfolio and sums to be disbursed, bystrategy area

Annex 3 Possible sector and country studiesAnnex 4 Selected bibliographyAnnex 5 Consultations conducted in connection with the preparation of the Banks

country strategy with ParaguayAnnex 6 Indicators of exposure in Paraguay


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ABBREVIATIONS

AECI Agencia Espaola de Cooperacin Internacional [Spanish Agency for

International Cooperation]AFS Audited financial statementsCAS Country Assistance Strategy (World Bank)CFAA Country Financial Accountability AssessmentCIPE Country Institutional and Policy EvaluationConACYT Consejo Nacional de Ciencia y Tecnologa (National Council on Science

and Technology)CPRA Country Procurement Review AssessmentCREMA Contratos de Rehabilitacin y Mantenimiento [contracts for road

rehabilitation and maintenance]CSOS Civil society organizations

EAP Economically active populationEC European CommissionECLAC Economic Commission for Latin America and the CaribbeanFTAA Free Trade Area of the AmericasGTZ German Technical Cooperation AgencyIIC Inter-American Investment CorporationIIRSA Initiative for the Integration of Regional Infrastructure

in South AmericaJBIC Japan Bank for International CooperationJICA Japan International Cooperation AgencyKFW Kreditanstalt fr Wiederaufbau [Reconstruction Loan Corporation)

KOICA Korea International Cooperation AgencyMERCOSUR Mercado Comn del Cono Sur [Southern Cone Common Market]MIF Multilateral Investment FundOECD Organization for Economic Co-operation and DevelopmentPBL Policy Based LoanPPP Public-private partnershipPRI Private Sector DepartmentPROPAIS Programa de Inversiones Sociales [Social Investment Program]PROPEF Project Preparation and Execution FacilitySEP Social Entrepreneurship ProgramSIAF Sistema Integrado de Administracin Financiera [Integrated Financial

Management System]UCIP Unidad Central de Inversin Pblica del Ministerio de Hacienda [Central

Public Investment Unit of the Ministry of Finance]UNDP United Nations Development ProgrammeWTO World Trade Organization


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EXECUTIVE SUMMARY

Introduction: This strategy will coincide with a turning point in Paraguays history,since the political conditions now in evidence hold out the possibility ofreversing the institutional and economic deterioration and the rising

poverty levels seen in the country in recent years. The Bank has animportant role to play in Paraguay, and this is reflected in the commonthread running throughout the new strategy: the provision of support forsteps that the government can take, based on the legitimacy it hasacquired and in the context of an enabling environment, to set in motion asustained growth cycle that will provide relief from poverty and lead togreater equity.

The government

program:

The government has set four strategic objectives: (i) restoring trust in theinstitutions of the State and its representatives; (ii) promoting the activecitizen participation in building democratic institutions; (iii) reactivating

the economy and creating jobs within the framework of a sustainabledevelopment model; and (iv) combating poverty, corruption, andproblems of public safety.

Development

challenges:

Paraguay will have to overcome challenges in three main areas in order toattain sustainable economic growth and reduce poverty:

Restoring the credibility of State institutions so that the State can leadthe way toward economic development and support the consolidationof democratic institutions: the challenge of governance.

Laying the foundations for sustainable economic growth based on themarket economy: the challenge of competitiveness.

Reducing poverty and inequality: the challenge of promoting humandevelopment.

Objectives of the

Banks strategy:

The objective of the Banks work in Paraguay is to collaborate with thecountry as it strives to overcome major development challenges as ameans of attaining sustainable growth and reducing poverty.

Main strategy

components:

The strategy agreed upon for 2004-2008 calls upon the Bank to focus itswork in the following spheres of action:

Strengthening governance by restoring the credibility of Stateinstitutions. The aim of this component will be to enable the State tocoordinate the economic development process by heightening theefficiency and transparency of public administration, promotinggreater citizen participation, and consolidating democraticinstitutions;


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Laying the foundations for sustainable growth through the

consolidation of the market economy and greater regional and

global integration by creating conditions conducive to increasedprivate-sector participation, greater competitiveness, and deeper

integration; and

Reducing poverty and improving the quality of life of low-income

sectors of the population through the development of human capitaland the provision of greater access to quality basic services.

Implementation

of the strategy:

The new strategy has been designed to take the pivotal role of the portfoliointo account. Consideration has been given both to the volume of funds tobe disbursed and to their concentration in areas which are critical to thegovernment programs success and which address the challenges to bemet. Initially, the main thrust of the strategy will concern portfolio

performance and support for institutional consolidation and economicreactivation. Fresh resources will be devoted primarily to helping to boostthe countrys competitiveness and to complementary measures in thehuman development and social sector.

The strategy takes the actions of other international cooperation agenciesinto consideration and seeks to help pave the way for the diversification offunding sources. One of the strategys cross-cutting themes is thestrengthening of the public sectors management capacity as it relates topolicy and project implementation, coordination, and evaluation.

Two loan scenarios have been formulated. The baseline scenario positsUS$350 million in approvals over the life of the strategy (thus maintainingthe annual average of US$70 million recorded in 1998-2003) and assumesa marginal improvement in portfolio execution. The high scenario ofUS$450 million is identical to the baseline scenario for the first year butwould entail increased lending volumes in the following years. It is basedon the assumption that actions already in progress are being built on,creating conditions for new reforms, which will also require financing. Itfurther assumes that the investment climate improves, thus attracting moreprivate capital, and that the pace of project execution speeds up.

Risks: The possibility that events may occur that could generate political

instability poses a risk. This risk is reduced, however, by the governmentsnotable legitimacy and by the Executive and Legislative Branchesinteragency agenda, which was signed in September 2003 and is based ona multi-party agreement regarding major areas of reform (taxation,customs, the public banking and financial systems, fiscally responsiblebudgeting, and the pension system).


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The Paraguayan economy is highly vulnerable to external shocks,particularly from downturns in soybean and cotton prices or productionand from economic instability in the region. Because the economy is sosmall, such shocks may be magnified by minor macroeconomicdisequilibria. Recent measures and the IMF agreement have done a great

deal to reduce this risk in the short term.

Paraguay is also vulnerable to the reaction of domestic groups that areadversely affected by government measures. The effort being made tocombat corruption, informal economic dealings, and the illegaltriangulation of trade activities affects powerful groups that wieldinfluence in various spheres of political and economic affairs in Paraguayand could trigger a reaction against the governments reform program.International backing and greater citizen participation in the workings ofgovernment would mitigate this risk.

One of the risks associated with this strategy is that, during the transition,the volume of external resources coming into the country may fall short ofthe desired level for any of a variety of reasons, even if no crisis erupts. Ifthis occurs, difficulties may arise that have not been provided for in thecountrys financial programming. Conversely, there is also a risk that theconfluence of favorable conditions at the outset and the reforms successcould fuel high expectations that would lead to a relaxation of fiscaldiscipline and, if suitable coordination is lacking, a duplication of effort.In order to mitigate this risk, the new unit within the Ministry of Financeresponsible for coordinating loans and donor activity will be strengthenedand multilateral agencies will continue to monitor events.

Agenda for

dialogue with

the country:

In monitoring the strategys implementation and relations betweenParaguay and the Bank, the following core areas of dialogue are proposed:

The progress made in carrying out the most urgent reforms and inportfolio performance. As headway is made in these areas, the Bankwill proceed with the proposed loan operations and the definition ofnew operations in the areas identified by the strategy.

Measures for improving public administration, with emphasis onthose having the greatest impact in terms of fiscal sustainability,increased transparency, and the participation of society in monitoringState management.

Efforts to backstop a steady improvement in the business climate. Thiswould include steps to enhance Paraguays competitive profile and itsposition in the international arena, in general, and to promote thedevelopment of competitive small and medium-sized enterprises(SMEs), in particular.


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Efforts designed to attract the private sector and encourage it to takepart in the operation and expansion of infrastructure and basic servicedelivery in a way that will complement public-sector investment.

The possible role of the Bank in helping to deepen regional integration(in particular, prioritization of the investment plans of the Initiative forthe Integration of Regional Infrastructure in South America (IIRSA)).

Steps to speed progress in social sectors and in the development of thecountrys human capital, with emphasis on interventions related to theMillennium Development Goals and the monitoring of relevantindicators.


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MATRIX OF THE BANKS COUNTRY STRATEGY WITH PARAGUAY FOR2004-20

IDB action

Governmentstrategy IDB strategyIn progress Proposed

Action by otheragencies

1. Strengthening governance. Country goal: Doubling Paraguays government effectiveness indicator, from 7 in 2004 to 14 in 2008 (World Bank, Governance M

Fiscal sustainability Preinvestment Program (1143/OC)

Fiscal Management Strengtheningand Modernization Program(1253/OC)

ATN/SF-7216 IntegratedAccounting and AdministrativeSystems Projects

TC: Strengthening of Office of theUnder Secretary for Economic Affairsand Integration/Ministry of Finance

Strengthening of the Central PublicInvestment Unit / Ministry of Finance

IMF: Stand-byarrangement

World Bank:Economic recoveryloan, pension systemreform

Reform athe customadministrimplemenoperatingthan 4.5%(5.5% in 2

Evaluatiothat coordinternation

public invimplemen

by 2007

Fiscal sustainability

Restoration of trustin State institutionsand theirrepresentatives

Promotion of activecitizen participationin buildingdemocratic

institutions

Combatingcorruption and lackof public safety Consensus-building

mechanisms for thebranches ofgovernment

Strengthening of technical-cooperation coordinationmechanisms for the Legislative andExecutive Branches

TC: Strengthening of Office of theAttorney General

TC: Strengthening of Auditing Office,Executive Branch

TC: Strengthening of LegislativeBranch

OAS: TA elections,2003

Evaluatiothat moni

been stren


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IDB action Government

strategyIDB strategy

In progress Proposed

Action by other

agencies

Rule of law and

administration ofjustice

State Modernization Program

Civil Registry (Strengthening ofthe Judicial Branch and the PublicProsecutors Office) (934/OC)

PR-0146. Strengthening of justice

system and streamlining of legalprocedures

Criminal Code: AECI,

GTZ, KfW

Program

that admithe judiciimplemengeneral p

been apprjudicial sbeen imp

Participation by civilsociety

TC in support of the National Anti-Corruption Plan, Defensora delPueblo (the Peoples Ombudsman),Comptroller-General, Central Bankeconomic statistics, civil education

ATN/7244-PR. Increasedtransparency and efficiency ingovernment procurement

TC: Development of an e-governmentstrategy

TC: Prevention of violence andpromotion of civil coexistence inAsuncin

TC: Combating trafficking in humanbeings

TC: Support of the National IntegrityPlan (Promotional Council for the

National Integrity System [CISNI])

TC: Citizens Comptroller-General forGovernance

TC: Transparency International/Paraguay

Decentralization and

citizen participation:GTZ, KfW, AECI,USAID, JICA

45 publicusing the

procurem

Public exincorpora2008

MechanisCSOs padesign, mevaluatio2007


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Action by other

agencies

Quality and

efficiency in theworkings ofgovernment

2002 National Population and

Housing Census (1301/OC)

ATN/MT-7244-PR. Design of newpublic procurement system

CFAA

Operational management of theSocial Security Institute

TC operations: Managementcapacity of the Office of the VicePresident

PR-L1008. Professionalization of the

Civil Service

PR-L1004. Restructuring of theCentral Bank

PR-L1005. Strengthening of theExternal Trade Sectors BargainingPower

PR-L1001.Modernization of PublicAdministration in Agriculture inSupport of the Campesino Sector

TC: Strengthening the Ministry ofFinance

Ref. civil service: World

Bank, OAS, UNDP,UNICEF

Profession

service in ministries

More thangovernmeoperatingmanagemthat includaccountab2008


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Action by other

agencies

2. Laying the foundations for sustainable economic growth by consolidating the market economy and promoting greater regional and global integration.

Country goal: Raising competitiveness indicators to levels approaching those of countries with comparable per capita incomes, moving up from a Growth Com2008 (World Economic Forum)

Economicreactivation and jobcreation within theframework of asustainabledevelopment model

based onagriculture andagroindustry inconjunction with adiversification andincrease in exports

Improving thebusiness climate,developing aservices market tosupport SMEs and

boosting agriculturalproductivity whilediversifying exports

MIF: Strengthening the consumerprotection system, reform of theinsurance industry

Enterprise development (1349/OC)

Program to Support Small-ScaleCotton Producers (1109/OC)

Modernization and Diversification ofSmall-Scale Farming (1255/OC)

Census and Property Registration

Program (1448/OC)Global Microenterprise CreditProgram (1016/OC)

TCs and MIF: SMEs andmicroenterprises and small

businesses, credit, entrepreneurialnetworking, training of youngentrepreneurs

PR-126. Science, technology andinnovation program

Paraguay Sector Program on theCompetitiveness and Diversification ofProduction

IIC: Lines of credit for agroindustry.

TC: International auditing andaccounting standards.

TC: Strengthening institutions

responsible for standards and qualitycontrol

MIF:

Clean technology in production chains

Corporate social responsibility

Quality management of SMEs

Development of rural microenterprises(SEP)

SMEs: GTZ, KfW,AECI (Spain), JBIC,JICA, USAID, TaipeiChina, EC

European Union:

Three programminglevels (regional,MERCOSUR andParaguay)

Double thadhering 2008 (stain 2004).

Legal framrecords, infor regula

proceedinland deed2008


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Action by other

agencies

Strengthen the

financial system andupgrade financialintermediation

MIF: Strengthening transparency

and promoting the growth of theformal sector of the economy;financial system

IIC: Credit for hotels andagricultural exporters

PBL-0137. Ref. Public Banking

PR-127Global Credit Program forSMEs

Reimbursable TC - PR0145. Ref.Public Banking

TC: Best practices in mortgaging

TC: Societies for ReciprocalGuarantees

MIF:

Strengthening of regulatory system forcooperatives

Office of the superintendent for non-financial banking activities

Deepening the rural financial system

World Bank:

Strengthening thefinancial sector

Payments system,Central Bank ofParaguay

Completi

and restrubanking s

Expand, upgrade,and maintain basicinfrastructure

Yacyret Transmission SystemProject (918/OC)

Program to Improve HighwayCorridors in Paraguay (933/OC)

National Rural Roads Program II(1230/OC)

Emergency and Infrastructure

Rehabilitation Program. El Nio(1117/OC)

Western Integration CorridorsProgram (1278/OC)

PR-L1007 National RoadsRehabilitation and MaintenanceProgram

PR- National Rural Roads Program II

PR-L1009 Rural ElectrificationProgram

Infrastructure: KfW,JICA, JBIC, TaipeiChina, World Bank,CAF, BNDES/FINAME, FONPLATA

20% reduoperationand 2008 or maintai


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Action by other

agencies

Targeted programsto combat poverty;health andeducation

programs in poorrural areas;agrarian reformand support forfamily farms; job-creation andincome-generation

programs for poorsectors, etc.

2. Access to qualityhealth and basicsanitation services

Primary Health Reform Program(1006/OC)

Water Supply and Sanitation inSmall Communities (1312/OC)

Social Protection Program forParaguay (1520/OC)

Social Investment ProgramPROPAIS II (1422/OC)

PROPEF PR-L1002: Support for theexecution of PROPAIS II

TC: Youth, civil society, studies on

policies and management of aquifersin Asuncin

Design of the Social Safety Net(ATN/SF-8167)

Inclusion of Youth through Music(ATN/FC-8299)

Strengthening the Instituto Nacionaldel Indgena [National IndigenousPeoples Institute] (ATN/SF-8015)

PR-0143 Asuncin RiversideDevelopment Program

PR -L1006 NeighborhoodImprovement Program

TC- Preparations for operation tomodernize public transportation inAsuncin

World Bank, USAID,UN: Mother and childhealth

GTZ, AECI:Basic health services

PAHO, WHO

World Bank:Community development

Water and sanitation:EC, World Bank, JBIC,Korea (KOICA)

Evaluatio

that by 20

The sociaformed an

Social serdevelopmimplemen

better job people livpoverty

Suitable pdevelopmcommuni

designed coordinat

Nacional with otherinstitution


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INTRODUCTION

This strategy will coincide with a turning point in Paraguays history, since the politicalconditions now in evidence hold out the possibility of reversing the institutional andeconomic deterioration and the rising poverty levels seen in the country in recent years.

The Bank has an important role to play in Paraguay, and this is reflected in the commonthread running throughout the new strategy: the provision of support for steps that thegovernment can take, based on the legitimacy it has acquired and in the context of anenabling environment, to set in motion a sustained growth cycle that will provide relieffrom poverty and lead to greater equity.

The priority placed on these strategic areas reflects Paraguays need to find its way backto an economic growth path in per capita terms, following the significant deterioration inthe growth rate seen since 1995. This downturn has had a considerable impact onpoverty levels (three fourths of the increase in the poverty rate is accounted for by thecountrys low growth rate). State action is vital in order to make any substantial gain in

competitiveness and to capitalize upon the economic reactivation that has been sparkedby the improvement in external conditions, as well as to ensure that programs aimed atreducing inequality are truly effective.

This country strategy paper sets forth the Banks strategy with Paraguay for 2004-2008and replaces the country paper (document GN-2118-1) approved in October 2000. Thepreparation of this country strategy paper has been based on an analysis of the relevantfactors,* an extensive dialogue with the authorities, and consultations with politicalparties and the main stakeholders in society at large, as well as with other financialinstitutions and donors active in the country (see Annex 5).

These consultations were begun at a difficult juncture in the political affairs of thecountry, following the end of the Administration of Gonzlez Macchi, who, as Presidentof Congress, had taken office as President of Paraguay after the assassination of the VicePresident and the resignation of the countrys elected President. The presidentialcandidates thus embarked upon the electoral process in the midst of a power vacuum anda deterioration in governance. Fewer than 10% of Paraguayans were satisfied with thestate of their democracy (the lowest rating in Latin America), and the level of confidencein the countrys political parties was 7%, according to a Latinobarmetro survey. TheBank met with all the presidential candidates and their economic teams to familiarizethem with its activities in the country and to learn about their various governmentalplatforms. Meetings were also held with a number of business associations and civil

society organizations.Both the party primaries and the general elections in April were transparent and thus gavePresident Nicanor Duarte Frutos and the elected congressional representatives thenecessary legitimacy to build the publics confidence in the countrys democratic

* The studies and notes prepared in connection with the formulation of the Banks country strategy with Paraguay arecited throughout the text, and the corresponding bibliographical information is provided in Annex 4. All the documentslisted in that annex can also be accessed at the webpage for the country strategy.


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institutions. The President is a member of the traditional Partido Colorado (the redparty, or National Republican Association), but his party does not have a majority inCongress. His Administration has, however, managed to put together a legislative agendabased on a consensus with the various political forces in Paraguay. In addition, political

representatives have engaged in ongoing consultations with the private sector, and thisprocess is giving private stakeholders an increasing role in decision-making in publicpolicy decision-making.

The Bank held a working meeting with the transition team which was attended by thePresident-elect and his designated ministers. The chief objective was to exchange ideasregarding the situation in the country and the main challenges facing Paraguay. Later on,based on diagnostic assessments and recommendations developed for use in the countrystrategy paper, seminars were organized for national officials in the Executive andLegislative Branches, union leaders, analysts, and representatives of various schools ofpolitical thought, as well as experts on the subjects being discussed. These seminars focusedon possible approaches for meeting the challenges that had been identified and buildingconsensus around the reforms to be undertaken. A large number of Bank personnel workingin areas relating to Paraguay were involved in the preparation of the country strategy paper.This process drew upon the lessons learned from the evaluation of the program withParaguay (1991-2002) compiled by the Office of Evaluation and Oversight (OVE).


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I. THE ECONOMIC AND SOCIAL CONTEXT

1.1 Paraguay has made headway during the past two decades in arriving at long-termdecisions that are of vital importance in structuring its integration into the

international arena. First, it is returning to the path of democracy. It is still in atransitional phase in this respect, and the consolidation of its democratic institutionsis therefore of crucial importance. Second, by joining MERCOSUR Paraguay hasvoluntarily become party to institutional arrangements and disciplines that areessential to the modernization of its society and economy, while at the same timegaining access to a market far larger than its own.

1.2 However, the lack of positive results on the economic and social fronts since themid-1990s has prompted the population to question the strategy being used topursue this long-term vision. The new Administration has acknowledged theseconcerns in its program and has proposed structural solutions for consolidating the

basic pillars of a democratic institutional framework and market economy.government action in this regard, based on the Administrations legitimacy andgrowing credibility, together with the currently favorable external environment,could mark a turning point in Paraguays economic development process.

A. Recent trends

1.3 Economic growth. Duringthe period 1997-2002, theeconomy grew at an averagerate of 0.5%, as compared to

an annual average of 3%during the first half of the1990s. When measured interms of per capita GDP, thismeans that the economyshrank by 14.6%. Paraguaysgrowth pattern was in linewith the average trend forLatin America as a wholeuntil the early 1990s, butsince then has been divergingfrom that trend more andmore. The fact that this gap has been steadily widening is due less to a lack ofinvestment, although it has decreased steeply, than to a continuing decline inproductivity and a relative lack of improvement in the educational level of the laborforce.1

1 Economic Growth in Paraguay (2002), by Carlos G. Fernndez Valdovinos and Alexander Monge Naranjo,mimeo, IDB.

Figure I-1. GDP trends in Paraguay

-5,0%

0,0%

5,0%

10,0%

15,0%

1980

1983

1986

1989

1992

1995

1998

2001

RealGDPgrowth

Paraguay

90

95

100

105

110

115

PercapitaGDP

(index:1980=100)

Paraguay Latin America and the Caribbean

Source: World Development Indicators, World Bank.


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1.4 Poverty. Between 1995 and 2001, thepercentage of the total population that wasbelow the poverty line rose from 30.3% to

33.8% (see Table I-1).

3

The percentage of thepopulation living in extreme poverty climbedfrom 13.9% to 15.4%, and almost the whole ofthis increase occurred in rural areas.Preliminary data suggest that the upward trendin poverty steepened in 2002, with the povertyrate reaching 49% and extreme poverty 25%.Based on disaggregated figures for this rise inpoverty, it is estimated that over three fourthsof the total increase occurringbetween 1995 and 2001 isattributable to the growth effect,with income distribution remainingconstant.4,5

1.5 Governance. According to thegovernance indicators developedby Kaufmann et al.,6 the situationwith respect to corruption control,government effectiveness, the ruleof law, and political stability inParaguay was quite serious in2002. As may be seen from FigureI-2, the situation, which was

2 The data for 2000/2001 were taken from the integrated household survey conducted over the 12-monthperiod starting in September 2000 and ending in August 2001.

3 These measurements are based on a poverty-line method whereby the poor population is defined as thosepersons whose level of well-being is lower than the cost of a basic shopping basket that meets the minimumrequirements for subsistence. Not enough information is available to arrive at internationally comparablemeasurements, which define the percentage of the population living on less than US$2 per day as poor andthose living on less than US$1 per day as extremely poor.

4 Redistribution had a slight effect in the case of the total poverty rate, while, nationwide, the growth effectaccounts for over 70% of the increase in extreme poverty. For the Asuncin metropolitan area,redistribution has been of even less importance in accounting for the upswing in total poverty, and even inthe case of extreme poverty, its contribution in helping to hold these rates down has been slight.

5 M. Robles has undertaken a similar analysis for the period 1995 and 1997-1998. His study demonstratesthat the low GDP growth rate for this period was also the main cause of the relative increase in povertyin the Asuncin metropolitan area (M. Robles, Crecimiento, Desigualdad y Pobreza, November2000).

6 Governance Matters III: Governance Indicators for 1996-2002 by D. Kaufmann, A. Kraay, and M.

Mastruzzi (2003), World Bank Policy Research Working Paper 3106.

Table I-1

Poverty levels, by region, 1995 and 2000/12

(% of total)

1995 2000/1

Poverty (total) 30.3 33.8

Urban 23.7 27.6

Rural 37.2 41.2

Extreme poverty (total) 13.9 15.4

Urban 6.8 7.1

Rural 21.4 25.1

Source: Encuesta Integrada de Hogares (EIH),2000/01, Direccin General de Estadsticas,Encuestas y Censos (DGEEC).

Figure I-2

Governance indicators

1998 and 2002

010203040506070

Voice and accountability

Political stability

Government efffectiveness

Regulatory quality

Rule of law

Control of corruption

LAC

PY


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already critical in 1998 (dotted line) in each of these areas as compared to the LatinAmerican average, had grown worse by 2002 (solid line). For Latin America, onaverage, these indicators are all situated around 50, while for the OECD countries

they are about 90. In the specific cases of corruption (4) and governmenteffectiveness (7), there is a substantial gap between the levels of these indicators forParaguay and for the other countries of the region in both years.

1.6 Macroeconomic stability. The weakness of Paraguays economy in 2002magnified the effects of the regional crisis. The situation was further exacerbated bythe political void that had existed previously. The guaran depreciated by 54%, thefinancial system had to come to grips with the failure of the countrys third largestbank and the loss of 20% of its dollar-denominated deposits, and the public sectorwas buffeted by a liquidity crisis that paralyzed it for a time. The countrys debtprofile deteriorated. Public-sector debt reached 33.9% of GDP, and the service onthe external debt was equivalent to 10.4% of the value of its exports in 2000. Thelack of growth and the depreciation of the guaran drove the debt up to 49% of GDPin 2002, although the external debt service did not rise proportionately (11.6% ofthe value of exports). Paraguay managed to avert the collapse of its economy,however, and the situation has brightened substantially since then, thanks to theadvent of more favorable external conditions, decisive action on the part of the newauthorities, and the political support forthcoming from the various parties. In 2003,the economy began to grow again (by 2.6% according to the central bank) as aresult of higher soybean and cotton prices and the economic recovery seen inParaguays partners in MERCOSUR. The central government posted a deficit of0.4% of GDP (consolidated public-sector accounts were balanced), and the tightliquidity situation is being resolved with the help of the stand-by arrangementreached with the International Monetary Fund. As is also true of the currencies ofthe other countries in the region, the guaran has appreciated against the dollar(14%). Credit remains tight, however, even though interest rates, after havingsoared to over 40% in real terms, have been moving downward.

B. The context

1.7 These trends reflect the difficult situation facing the incoming authorities and theturnabout that is beginning to occur as a result of external factors, the dynamics ofthe Paraguayan economy, and the action being taken by the government.Opportunities to turn the Paraguayan economy around exist, but are subject to a

series of structural constraints whose modification calls for efforts that will extendfar beyond the scope of any single Administrations agenda.

1. The opportunities

1.8 A reformist policy approach. The chaos and anarchy that erupted following theassassination of the Vice President of Paraguay in March 1999 bore witness to thehazards entailed in the effort to consolidate a democratic form of government in the


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wake of over 50 years of authoritarian regimes.7 Nevertheless, the subsequentreaction to the events in March contributed to the countrys democratization, bothin terms of building the initial consensus that emerged in the aftermath of the crisis

and in relation to the formation of new political parties and movements. Thesedevelopments set the stage for the appearance of new leadership styles and for theinitiation of a dialogue oriented toward the search for participatory approaches forresolving the countrys most pressing needs. This revitalization has permitted theparties concerned to build a fundamental consensus that is now producing visibleresults. The possibility of maintaining this interaction constitutes Paraguays mostvaluable opportunity for setting in motion a virtuous cycle of institutionalconsolidation and economic development.

1.9 Macroeconomic stability. The absence of any sizeable macroeconomicdisequilibria opens the way for a consolidation of the economys reactivation,which is being driven by the agricultural sectors strong performance. The liquiditycrunch that troubled public finances in 2002 and 2003 is now easing, thanks toincreased tax revenues, the renegotiation of the domestic debt, and the supportbeing provided by multilateral institutions within the framework of the IMFarrangement. The tax reforms being advanced by the government and the expectedupswing in royalty income from Paraguays share in the Itaip and Yacyretbinational hydroelectric facilities will be used to underpin the countrys fiscalaccounts in the medium term, while the financial-sector reforms are designed tocreate a stable framework for the sectors reinforcement and for resolving the creditsqueeze.

1.10 Positive external shocks. The recovery being made by the MERCOSUR

economies, the return of capital flows to the region, and rebounding soybean andcotton prices would appear to be generating a positive external shock that will pavethe way for more rapid economic growth in the near future. On the other hand, thesteady expansion of the amount of farmland being used to grow soybeans, which isnot a labor-intensive crop, could stimulate migration to the cities. The challengehere is to turn these circumstances to advantage in order to lay the foundations forsustained growth.

1.11 A turnaround in reexport activities. As trade liberalization programs withinMERCOSUR continue to expand, reexports have been gradually waning. This, inturn, has had a palpably negative impact on commerce.8 This trend can be expected

to continue as the MERCOSUR partners harmonize their legislation andmacroeconomic policies as they work toward convergence in a common externaltariff. Where resources, infrastructure, and a spirit of enterprise exist, a leadershiprole should be taken in reengineering the commercial activities of the regions that

7 Paraguay returned to a democratic system in 1989 with the election of General Rodrguez as President.

8 In 1995, reexports accounted for 71.2% of total registered exports, but by 2002 the contribution of thisvariable had declined to 52.7%.


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have been adversely affected (Ciudad del Este, Pedro Juan Caballero, andEncarnacin) in order to cushion them from the economic impact of thediscontinuation of reexports and to take advantage of the broadened MERCOSUR

market.1.12 The development of social capital. In total, there are around 10,000 civil society

organizations (CSOs) in the country. These groups include grassroots organizations,trade unions, neighborhood councils, womens groups, school volunteers,campesino organizations, indigenous communities, and cooperatives. Almost all ofthese organizations have been founded after the fall of the dictatorship. Amongthese CSOs, cooperatives are one of the most common associative models inParaguay (10% of the population belongs to at least one cooperative). The work ofthese organizations provides an opportunity to build up social capital, monitorgovernment affairs more closely, build leadership capacity, and deliver services thathave significant externalities.

1.13 Opportunities associated with the countrys demographic profile. Paraguay hasa high population growth rate (2.3%) and its population is quite young: 26% of thepopulation is under 10 years of age, and 15.4% is between 0 and 5 years of age. Theaverage age is 23, which is one of the lowest in Latin America. This means that ahuge number of young people are poised to enter the labor force in the near future,which will create an opportunity to boost production and thus speed up the growthrate. The unique challenge that this poses for the country is to help these newentrants to boost productivity. The avenue for accomplishing this is to ensure thatthe system provides these young people with an education good enough to enablethem to function successfully in the integrated markets that are emerging as part of

the globalization process. A failure to take action on this front would, in the best ofcases, mean that access would be restricted to low-productivity jobs and, hence,slow economic growth. In the worst-case scenario, existing problems ofunderemployment and unemployment would grow even worse.

2. Constraints

1.14 The countrys landlocked status. Paraguay lacks an outlet to the sea and has atopography that divides the country into two different regions: the eastern portion,which has a plentiful water supply, and the western region, known as the Chaco,which is arid. These characteristics make the construction and maintenance of road

infrastructure much more expensive and make the integration of these regions andintegration with other countries much more difficult. A recent ECLAC study 9indicates that Paraguays transportation costs for foreign trade activities are 43%higher than the average cost for the other South American countries.

9 Estudio Preliminar del Transporte de los Productos de Comercio Exterior de los Pases sin Litoral deSudamrica [Preliminary study on the transportation of exports from landlocked countries in SouthAmerica], Thomason, Ian, Ricardo Sanchez, and Alberto Bull, March 2003.


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Table I-2: Composition of exports

89-92 93-95 96-98 99-01$ to the world1 3.362 2.461 3.198 2.602

% Agriculture 38.3 30.2 16.6 14.7% Foodstuffs 50.8 50.2 67.5 67.8% Fuels 0.1 0.2 0.2 0.1% Manufactures 10.7 19.2 15.3 17.0% M etals 0.1 0.2 0.4 0.4

1.Billions of US dollars.

Source:Paraguay. Nota Tcnica sobre Comercioe Integracin, IDB, 2003

1.15 Corruption, informal-sector activity, and triangulation are critical problems.The general impression is that corruption abounds and that there is an extensiveinformal sector and a high degree of what has come to be known as triangulation.

Although these are separate issues, in Paraguay they are clearly interrelated.Transparency Internationals perceived corruption index for 2003 ranks Paraguay asthe country with the fourth worst rating for perceived corruption out of a total of133 countries. At the same time, the informal sector is large and is growing larger.Whereas the informal sector accounted for 42.5% of the economically activepopulation (EAP) in 1997-1998, in 1999/2000 the figure had risen to 48.1%.10Meanwhile, the problem of triangulation is fueled by the other two phenomena,since foreign products are reexported with no regard for intellectual property rightsand without paying customs duties.

1.16 Paraguays business cycle is linked to its neighbors cycles. The Paraguayaneconomy has been integrated with Brazils through the agricultural development ofthe border area and the construction of the Itaip hydroelectric facility and of ahighway that links the two countries. Increasingly, its business cycle is a reflectionof events in Brazil and in its other partners in MERCOSUR, which account for halfof its total trade flows (53% of its exports and 52% of its imports). This makesParaguay vulnerable to adverse shocks in those countries. The 1999 devaluation inBrazil and Argentinas financial crash in 2002 have had a decisive impact onParaguays economic performance in recent years.

1.17 The economy is highly vulnerable to changes in international prices. Thestructure of the economyin which the farm sector accounts for 30% of GDP,provides 45% of the jobs, and generates 80% of all exportsis such that variations

in agricultural commodity prices have a highly disproportionate effect on theeconomy. A substantial part of the economys stagnation is attributable to the factthat soybean and cotton prices plunged by around 50% between 1995 and 2001,while oil prices climbed (Paraguay is anet oil importer).

1.18 Exportable supply is concentrated inagroindustrial products. Paraguaysexternal revenues come mainly fromenergy and agroindustrial products. Itsincome from energy resources takes the

form of royalty payments from the

10 The findings of an industrial survey conducted by the Direccin General de Estadsticas, Encuestas yCensos [Bureau of Statistics, Surveys and the Census] (DGEEC) in 2001 indicate that there areapproximately 15,000 formally-constituted industrial firms in Paraguay and a like number of small,informal enterprises.


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binational hydroelectric facilities,11 while its export earnings come primarily fromagroindustrial products (mainly soybeans and soy products). Paraguay exhibits verylittle dynamism in the production of nonagroindustrial exports. It therefore needs to

make an effort to maintain and improve the competitiveness of firms in thesesectors in order to promote products in key markets and, above all, to improve thequality of these products and meet higher sanitation standards.

1.19 The economys level of competitiveness is low. According to the 2003-2004Global Competitiveness Report of the World Economic Forum, Paraguay wasranked 95th out of 102 countries on the Growth Competitiveness Index (GCI) and91st out of 95 countries on the Business Competitiveness Index (BCI). In terms ofthe quality of its public institutions, it ranked above just two countries, and its totalfactor productivity has been dwindling at an average annual rate of 1% over thepast decade, which means that it has been steadily losing competitiveness.

1.20 Income distribution is highly unequal in Paraguay. The countrys Ginicoefficient is 0.576, according to the 2001/2002 household survey. Thismeasurement needs to be disaggregated, however, because income inequality inAsuncin is relatively low (a Gini coefficient of 0.499), but is considerably higherin rural areas (0.582). In all, the poorest 40% of the population receives about10% of total income in the country, while the wealthiest 10% obtains 42.3% of thetotal. Per capita income is, overall, half as much in rural areas as it is in urban areas.This gap is generally in line with the situation in other Latin American countrieswith a similar distribution of income. However, although the size of this differentialremains constant for the higher-income deciles, in the case of the lowest deciles thedifference in personal income comes to nearly one third.

1.21 The skill level of Paraguays human capital hinders the absorption of newtechnologies. Figure I-3 shows the percentages of the population that have noformal education and that have a primary, secondary, and higher education. Only35% of Paraguays population has more than a primary education. According toECLAC (1999), only 9% of the labor force has technical skills, and only7.6% possesses professional qualifications. These shortcomings are exacerbated bythe absence of a system for certifying technical skills, which would permit the labormarket to function more effectively. The low level of training possessed by thepopulation interferes with peoples ability to assimilate new technologies andorganizational models, diminishes the mobility of labor and, as a result, dampens

productivity.12

11 Royalties from Itaip and Yacyret amounted to US$233 million in 2002 and US$255 million in 2003,which was the equivalent of 24.5% and 20.5% of the value of registered exports, respectively. Once twonew turbines with a capacity of 14,000 MW come on line at Itaip, royalty proceeds are expected to rise.

12 See Closing the Gap in Education and Technology, by David De Ferranti. World Bank Latin Americanand Caribbean Series, (2003).


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FIGURE I-3: STOCK OF HUMAN CAPITAL

Source: Competitiveness: The Business of Growth. Economic and Social Progress in LatinAmerica, 2001 Report, IDB.

C. The governments program

1.22 The new Administrations aims, as set forth in its program, are to foster a new

sustainable development model and lead the way toward the reform andmodernization of public administration. The new development model it isproposing is based on the concept of a socially, fiscally, and environmentallyresponsible market economy. The programs supporting pillars are: the restorationof clear, predictable rules emanating from the State and the modernization ofgovernment administration; environmentally-friendly agricultural andagroindustrial production; increased exports, with emphasis on diversification andan increase in value added; empowerment of the different productive regions;increased investment in physical and human capital, especially in the area of roadinfrastructure; and the use of energy as an engine of private investment.

1.23 The reform and modernization of public administration is aimed at building astrong, socially aware State and an efficient, policy-neutral, transparent,participatory government that is committed to improving the peoples quality oflife. The idea is to restore the confidence of economic stakeholders by enforcing thelaw, implementing clear, simple rules, producing visible administrative outputs andmounting coordinated programs focusing on specific goals.

(In percent)

0 10 20 30 40 50 60 70 80 90 100

Guatemala

Honduras

Nicaragua

Paraguay

El Salvador

DominicanRepublic

Brazil

Colombia

Venezuela

CostaRica

Ecuador

Bolivia

Mexico

Jamaica

Uruguay

Chile

Panama

Argentina

Peru

Thailand

Taiwan

UnitedStates

Population

No Schooling Primary Education Secondary Education

LatinAmerica

highstock

LatinAmerica

intermediatestock

LatinA

merica

low

stock


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Box I-1

Government of Paraguay

Main program components

Modernization of public administration; Reliable, predictable economic environment for

investment; Sustainable economic growth; A revolution in education to improve human

capital; Prioritization of health care; Advancement of public works and housing

construction; Utilization of energy potential; Environmental protection; External outreach and a new approach to

international relations; Development of new nexuses between the

government and society; The human rights agenda; Efforts to combat poverty and social exclusion; Efforts to combat corruption.

1.24 The government has set itself fourstrategic objectives: (i) restoring trustin the institutions of the State and its

representatives; (ii) promoting activecitizen participation in buildingdemocratic institutions;(iii) reactivating the economy andcreating jobs within the framework ofa sustainable development model; and(iv) combating poverty, corruption,and the lack of public safety.

1.25 In order to attain these strategicobjectives, 14 main programcomponents have been defined, eachof which falls into one of twocategories: (i) the first ninecomponents address the first twoprogram objectives, which focus onrestoring public confidence andreactivating the economy; and (ii) theother five focus on the next two program objectives, which relate to citizenparticipation and the effort to combat poverty, corruption, and the lack of publicsafety.

1.26 The Administration has initially focused its efforts on dealing with the liquidity

squeeze affecting the central government and on providing a stable macroeconomicframework. To this end, it has built the necessary alliances and agreements tounderpin the work of attaining these objectives. The most notable initiatives in thisregard are the political agreement reached with the major parties, the arrangementmade with the private sector to back the Fiscal Organization and Adjustment Act,and the countrys agreement with the IMF.

D. Medium-term economic prospects

1.27 The IMF program. For the first time since 1957, in December 2003 thegovernment signed a 15-month stand-by arrangement with the IMF. The agreement

is based on the governments program. Its main objectives are to stabilize thecountrys fiscal accounts and its financial system, provide the necessary frameworkfor launching the reform process, restore the governments credibility, andengender the necessary confidence among economic stakeholders. On the fiscalfront, the aim is to eliminate the fiscal shortfall, pay up arrears, ensure thesustainability of the debt, and set the stage for increased investment and a moreactive social policy. The administrative measures provided for in the agreement areexpected to improve the fiscal balance by the equivalent of 1.5% of GDP, while the


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planned legislative measures should contribute between 2% and 2.5% of GDP,which would mean that the country ought to be able to post a fiscal surplusamounting to 0.3% of GDP in 2004. In the realm of monetary policy, the objective

is to keep inflation under control with a floating exchange rate, enhance the centralbanks ability to guide monetary policy, and ensure the financial systems stability,which will entail reforming the public-sector banking system and improving itsregulation and supervision.

1.28 The medium-term outlook. The IMF projections on which the agreement wasbased are predicated on the implementation of the government program. Economicgrowth is expected to rebound and then level off at an annual rate of 3.4% within acontext of single-digit inflation (6%), assuming a stable real effective exchangerate. The fiscal balance (consolidated public sector) will trend toward equilibrium(a surplus of 0.3%). This will set the stage, in the long run, for a primary surplus ofabout 2.3% of GDP, which would be enough not only to service the debt, but alsoto reduce it to 35.7% of GDP by 2008. In the course of this period of time,Paraguay is expected to balance its current account and to gradually build up itsinternational reserves to US$1.162 billion by 2008. (see Table I-3).

Table I-3

Medium-term Prospects

1999 2000 2001 2002e 2003p 2004p 2005p 2006p 2007p 2008p

Production Sector (Annual growth, percentages)

GDP 0.5 -0.4 2.7 -2.3 2.0 2.4 3.2 3.4 3.4 3.4

Consumer prices 5.4 8.6 8.4 14.6 8.8 6.0 6.0 6.0 6.0 6.0

Nominal GDP (US$ millions) 7,756 7,734 6,858 5,633 5,741 6,116 6,461 6,818 7,178 7,554

Public Finances (% of GDP)

Revenues 21.1 20.1 21.3 19.3 19.6 20.4 21.5 21.4 21.2 21.1Tax revenues 9.9 10.0 10.2 9.2 9.9 10.8 11.9 11.9 11.9 11.9

Corporate surplus 5.2 2.7 2.5 1.4 1.1 1.7 1.7 1.8 1.9 2.0

Primary current expenditure 16.9 18.3 17.7 16.1 14.8 14.3 14.3 14.3 14.3 14.3

Interest payments 1.3 1.5 1.7 1.9 1.9 1.9 2.1 2.0 2.0 2.0

Investment 11.2 7.0 5.1 5.9 4.8 5.5 6.2 6.5 6.5 6.5

Primary balance -1.8 -2.6 1.0 -1.3 1.2 2.2 2.7 2.3 2.3 2.2

General balance -3,1 -4,0 -0,7 -3,2 -0,6 0,3 0,6 0,3 0,3 0,3

Public-sector debt 31.9 33.9 38.4 49.7 49.1 45.8 42.7 40.2 37.8 35.7

Public-sector debt balance(US$ millions)

2,478 2,618 2,630 2,801 2,818 2,798 2,760 2,739 2,717 2,697

Balance of payments (millions of US$)

Exports 2,307 2,322 1,876 1,878 2,102 2,111 2,212 2,334 2,462 2,586

Imports 2,750 2,864 2,495 2,159 2,339 2,398 2,551 2,693 2,842 3,000

Current account -165 -163 -278 92 83 26 16 9 -5 -31Capital account 509 157 152 5 -232 116 20 41 73 114

International reserves 988 772 723 641 818 855 892 942 1,009 1,092

Source: IMF.


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II. THE MAIN DEVELOPMENT CHALLENGES

2.1 The main challenges that Paraguay must overcome in order to attain sustainableeconomic growth and reduce poverty refer to three specific areas:

Restoring the credibility of State institutions so that the State can lead theway toward economic development and support the consolidation ofdemocratic institutions: the challenge of governance.

Laying the foundations for sustainable economic growth based on the marketeconomy: the challenge of competitiveness.

Reducing poverty and inequality: the challenge of human development.

A. Restoring the credibility of State institutions so that the State can lead the

way towards economic development and support the consolidation of

democratic institutions: the challenge of governance132.2 Paraguay is a relatively young democracy; its institutional structure is weak and

needs to be strengthened to permit the defense of basic rights and the furtherdevelopment of a market economy. When the preceding Administration left office,the countrys population had little confidence in State institutions, and there waslittle support for democracy as a system of government. The indices of perceivedcorruption and weakness in the judicial system made it difficult for the rule of lawto prevail. This translated into an unsuitable business climate for foreign investmentor large-scale investment projects. This situation was compounded by significantshortcomings in infrastructure and basic services, the large size of the informalsector of the economy, and the fact that civil society was, on the whole, uninvolvedin public policy debates and oversight. All of this undermined the competitivenessof businesses. What is more, the public sector was being poorly managed, and thisled to unsatisfactory budget execution, low rates of public utility coverage, rent-seeking, and significant market distortions.

2.3 The new Administration that has taken office in Paraguay will have to grapple withserious failings in virtually all dimensions of State activity and operations. Thechallenges it faces can be grouped into five main areas of State operations based on

the institutional and political factors that lie at the root of these problems: (i) fiscal

13 The contents of this section summarize the diagnostic assessment presented in the briefing paper ongovernance that was prepared as an input for this country strategy. This paper included the findings of thetechnical papers that were prepared on fiscal sustainability, budget, civil service, and the

political/institutional situation. The institutional assessment of the Republic of Paraguay, prepared byUNDP and the International Governance Institute, provides a detailed description of existing institutionalweaknesses.


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sustainability; (ii) political/institutional governance of the country (democraticgovernance); (iii) upholding of the rule of law; (iv) the relationship among theState, the market, and civil society; and (v) the quality, effectiveness, and efficiency

of government policy, organizations, and operations.a. Ensuring fiscal sustainability

2.4 The administrative measures adopted by the government have had an impact on taxrevenues. In the last five months of 2003, revenues were up by 40%, therebyenabling the central government to post a 0.2% fiscal surplus for the year. Havingrestored fiscal equilibrium in the short run, and with the outlook for 2004 havingbeen defined by both the budget and the targets agreed upon with the IMF, asurplus equivalent to 0.3% of GDP is expected for 2004.

2.5 The main challenge is to keep fiscal accounts balanced over the medium term. In

order to accomplish this, action needs to be taken in the following areas:(i) implementing a new tax structure, improving tax administration, and reducingtax evasion; (ii) rationalizing expenditure and contingent liabilities, which willmainly entail reforming the civil service pension system; (iii) generating sufficientrevenues to lower the countrys debt and permit implementation of a social policythat will reduce poverty and inequality; and (iv) coping with the fiscal implicationsof trade liberalization, given the States strong reliance on tariffs as a source offiscal revenue.

b. Democratic governance: Promoting mechanisms for consensus-

building by the Legislative and Executive Branches and for

coordinating their working agendas

2.6 One of the main obstacles hindering the Paraguayan governments efforts to moveforward with reforms that will enable it to meet the development challenges facingthe country has been the difficulty of arriving at a consensus among the differentbranches of government regarding policies, agendas, and program priorities. Hence,the absence of consensus-building and partnering mechanisms has blocked theprogress of the countrys structural reform agenda. As part of the changeover in theExecutive and Legislative Branches occurring in the wake of the April 2003elections, the Administration that took office in August 2003 signed an agreementwith legislative authorities and leaders of the political parties with seats in Congress

to carry forward an interagency agenda consisting of major reforms in the Statebanking system, the social security system, the civil service, and the tax system,together with reforms to increase the sustainability of fiscal accounts The challengehere is to consolidate this new framework for consensus-building.


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c. Strengthening the rule of law and the administration of justice

2.7 Despite the efforts made in terms of the design of the States institutional structure(separation of powers) via the Constitutional reform of 1992, various shortcomingsremain in terms of the separation of the different branches of government and thesystem of checks and balances. Although changes have been made in order toprovide the Judicial Branch with greater political and financial autonomy, inParaguay the rule of law continues to be influenced and, at times, co-opted bygroups within the political and economic elite. Government corruption, a lack oftransparency and of societal oversight of public affairs, and the high transactioncosts existing in the private sector are the clearest signs of the weakness of the ruleof law in Paraguay.

2.8 From an organizational perspective focusing on the institutional capabilities of thejustice system, a series of shortcomings exist in terms of the professionalization of

personnel in the Judicial Branch and in the development of technologicalcapabilities and infrastructure. In consequence, opinion polls show that theParaguayan public has little confidence in the justice system. Steps therefore needto be taken to continue supporting efforts to create a reliable, independent,effective, predictable, efficient legal system that is accessible for all Paraguayancitizens.14

d. Strengthening the relationship among the State, the market, and

civil society

2.9 The challenge taken up by Paraguay in 1989, with the restoration of democracy,

remains. This challenge concerns the creation of the basic economic institutionsneeded to foster entrepreneurship, promote international investment, integrate astronger Paraguayan market into MERCOSUR and the global economy, and devisemechanisms for social consensus-building as a basis for the design of publicpolicies to boost growth and competitiveness.

2.10 In order to meet a challenge of this magnitude, the struggle against corruption beingwaged by the new Administration must continue, substantial improvements in theStates institutional capacity will be needed, and steps must be taken to enforce theexisting regulations that provide a stable environment for investment. Thedevelopment of the business sector can be successful only if the State removes the

obstacles standing in its way and firmly supports the development of a marketeconomy and the participation of civil society in public policy discussions and

14 According to Latinobarmetro, in 2003 only 20% of the Paraguayan population (along with the figure forArgentina, the lowest percentage in the region) believes that the judicial system punishes the guilty, nomatter who they are. Furthermore, fewer than 5% of Paraguayans think that their peers and the rest of thecitizenry obey the law, and fewer than 20% trust the judiciary as an institution (the lowest percentage in theregion).


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oversight.15 The administration of government affairs also has to be transparent. Tothis end, channels for conveying public opinion regarding the definition,implementation, and assessment of public policies have to be strengthened. The

participation of civil society in this sphere should also, however, be expanded toencompass the analysis of national issues, the definition and formulation of publicpolicy, and the monitoring of its implementation. The government, for its part,needs to increase the transparency of its actions by providing the public with greateraccess to the relevant information, as well as setting up an institutional process forensuring accountability in all areas of government affairs. These measures will laythe groundwork for a participatory democracy and the development of soundpolitical governance.

e. Enhance the quality and efficiency of public administration

2.11 The structural lack of institutional capacity for the design and implementation of

public policy involves more than simply the administrative efficiency of the State.The combination of a lack of technology and transparency results in high degrees ofdiscretionality, instability, and inefficiency in administrative processes. Thissituation leads the public to conclude that the State hampers growth rather thanpromoting it. The main challenges to be dealt with in this connection are: (i) toimprove the management of fiscal resources and the social security system; (ii) tostrengthen budgetary management; (iii) to backstop measures designed tostrengthen the civil service; (iv) to increase the efficiency of public spending,especially expenditure on social service delivery and the promotion of production;(v) to implement the government procurement system; and (vi) to promote the useof e-government as a channel for social oversight.

B. Laying the foundations for sustainable economic growth based on the market

economy: the challenge of competitiveness.16

2.12 Based on the Paraguayan economys structural characteristics, five crucial areas canbe identified in which obstacles hinder Paraguayan firms from improving theirperformance and generating a sustainable economic growth process. The followingmeasures are called for in order to overcome these barriers: (i) build up thenecessary institutional capacity to safeguard the operation of the market andparticipation in it; (ii) strengthen the financial system; (iii) upgrade infrastructure;(iv) enhance the countrys international profile; and (v) turn economic development

into an environmentally sustainable process.

15 Support for fundamental components of the market economy are discussed in the section on support forcompetitiveness.

16 The contents of this section summarize the diagnostic assessment presented in the briefing papers oncompetitiveness and on trade and integration that were prepared as inputs for this country strategy. The firstof these papers includes the findings of the technical papers prepared on the financial sector, transportation,the farm sector, regional development, and education.


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a. Improving the business climate

2.13 The first step in increasing Paraguays competitiveness is to remedy the flaws thatexist in its investment climate. Both the private sector and the currentAdministration have characterized this weakness as a problem of the first order interms of the countrys competitiveness. The challenge of governance deals withissues relating to the rule of law, the ground rules and the need to build capacity tostreamline administrative processes and public-agency enforcement capacity. Thissection deals with the specific types of measures that are needed.

2.14 Supporting small and medium-sized enterprises.17 Small and medium-sizedenterprises (SMEs) have received some degree of support from macroeconomicpolicies that help foster competitiveness under adverse circumstances. Theestablishment of maquilas, regulations that promote cleaner production methods,quality programs, and multi-level training programs have yielded positive results.

Now those results need to be built upon in order to address the wide range of needsthat exist in terms of institutional improvements for SMEs. These enterprises play avital role in the domestic market because of their productive and job-creationpotential and their ability to serve as a vehicle for an expansion of the formal sectorof the economy. Another part of this challenge is to backstop SME exporters bybolstering their ability to have a say in international trade negotiations. This can bedone by encouraging the formation of linkages, networks, and partnerships throughwhich they can heighten their competitiveness and capitalize upon opportunities togain access to international markets.

2.15 Assisting firms to incorporate technology. The globalization process has clearly

generated a greater demand for technological advances in countries involved ininternational trade. Firms have to be competitive in order to participate in themarket, and the main way for them to do this is by using technology to makeexisting resources more productive. Paraguay can build on its existing institutionalstructure. The Consejo Nacional de Ciencia y Tecnologa [National Council onScience and Technology] (CONACYT) can serve as a platform for thedevelopment of a policy on technology that addresses the countrys needs.

2.16 Upgrading the exportable supply to conform to regional and world demand.The export base can be expanded and diversified in terms of both the availablesupply and destination markets so long as improvements in exportable supply are

supported and geared toward satisfying regional and world demand. This entailsmeeting the quality standards demanded by the international market and having thenecessary technical and health certification (for plant and animal products) tosecure a lasting position in new markets. In the case of health and sanitation

17 The importance of SMEs is obvious. For example, 99% of Paraguays industrial sector, which accounts for14% of GDP and employs 13% of the EAP, is made up of microenterprises and small and medium-sized

businesses.


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services, the country lacks the type of modern legal and institutional frameworkneeded to achieve a comprehensive and efficient reduction in the risk of exoticpests and diseases entering the country, ensure an efficient, prompt assessment of

sanitary conditions, or control and eradicate existing pests and diseases. Theabsence of a technically and financially autonomous agency of this sort has resultedin the entry of devastating pests and diseases, such as the boll weevil invasion of1992, or the periodic outbreaks of hoof-and-mouth disease seen in the country. Theeconomic costs of these epidemics have been quite high, since they have had adirect impact on the competitiveness of Paraguays principal export products, aswell as triggering disputes with neighboring countries and tarnishing the countrysimage as a reliable supplier of quality agricultural products.

2.17 Strengthening the business sectors leadership role in economic development.Most firms in Paraguay cater to the domestic market and especially its servicessector. This situation reflects the lack of an international orientation on the part ofParaguayan entrepreneurs and the weakness of their position in terms of thepromotion of a better investment climate that would permit market expansion. Thechallenge here is to turn the business sector into a dynamic partner that will drivethe development process forward. To this end, trade unions will need to bestrengthened, and opportunities should be created for greater collaboration andconsensus-building between the public and private sectors.

2.18 Improving the quality of education as a means of boosting productivity. Therelationship between increased education and higher productivity is wellestablished.18 The challenge is to build upon the great strides made in primaryeducation during the 1990s by increasing the coverage and quality of secondary and

higher education. At the secondary level, even though enrollment has risen by anannual rate of 11% over the last 11 years, the net enrollment rate is still low(31%). The main tasks at this level are: (i) to expand coverage, especially in ruralareas; (ii) to improve teaching quality; (iii) to create secondary educationalopportunities that can be attended on a part-time basis by young people who workin urban areas and by rural youths in remote areas where no schools exist; and(iv) to design new initial and on-the-job teacher training systems.

2.19 The coverage of higher education (universities, teacher training institutions,advanced vocational education) is less than 20% and is of poor quality.19 Theprivate sector has helped to expand the educational opportunities at the university

level, and between 1990 and 2000, university enrollment jumped from 25,989 to

18 See, for example, part III of Competitiveness: The Business of Growth. Report on Economic and SocialProgress in Latin America, 2001, IDB.

19 On the importance of higher education, see the World Bank report, Constructing Knowledge Societies:New Challenges for TertiaryEducation.


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59,836.20 The tasks to be done in this connection focus on: (i) creating andimplementing an evaluation and accreditation system for universities that willuphold certain basic standards of educational quality and inform the public about

the findings; (ii) linking the system of higher education with the rest of theeducational system; (iii) promoting the establishment of a special fund for scientificand technological research; and (iv) designing new ways of financing publicuniversities and creating an educational loan mechanism to assist low-incomestudents.21

2.20 The existing system focuses more on vocational training than on the developmentof skills that will produce workers who are capable of performing effectively in avariety of areas and who are competent in problem-solving, decision-making, andteamwork. One of the main aims of Paraguays educational reforms is therefore todevise a policy that will galvanize and overhaul technical and vocationalinstruction.

b. Strengthening the financial system

2.21 In recent years the banking system22 has been quite vulnerable, in large measure dueto the countrys slow economic growth and, since 1995, to three banking crisesduring which 15 banks and 11 other financial institutions failed. In consequence,(i) a series of administrations have taken steps to put the financial system on a moresolid footing and tighten up its supervision, and (ii) private financial institutions inthe country have become so much less active in inland areas that, in practice, thepublic banking system has come to be the only major player in the rural sector.

2.22 The financial system suffers from a number of structural problems that dull itscompetitiveness. These problems fall into three categories: (i) issues relating to thegeneral workings of the sector, ranging from the need to ensure the central banksautonomy, improve the authorities monetary policy tools, and tighten up theregulation and supervision of the banking system, to dealing with the effects of thecountrys highly dollarized system on deposits and lending activity; (ii) the traitsand performance of the public-sector banking system; and (iii) the regulation andsupervision of savings and loan cooperatives.

20 Rivarola, M. (June 2002): Informe Nacional sobre Educacin Superior en Paraguay (National report onhigher education in Paraguay). Asuncin. CREASAL/UNESCO; op cit.: CONEC. (2002): Estrategias detransformacin de la educacin superior (Strategies for transforming higher education). Asuncin;CONEC (Consejo Nacional de Educacin y Cultura), page 20.

21 The capacity of teacher training institutes has been growing rapidly, and there is now an oversupply forteachers at the basic education level. Very few offer training for teachers at the early education andsecondary levels, however. The problems faced by technical institutes providing instruction for teachers inhigher education (5 public and 9 private institutions) are similar.

22 Paraguays financial system is composed of 40 private, formally constituted institutions (18 banks and22 other finance companies), 8 public institutions, and nearly 250 savings and loan cooperatives.


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c. Upgrading the countrys infrastructure

2.23 For Paraguay, given its position as a small, landlocked economy that is far awayfrom world consumption centers and that exports natural-resource-based products,the availability, quality, and cost of infrastructure is a highly important factor inovercoming its disadvantages in relation to other countries of the region andboosting its competitiveness.

2.24 Improving the road network and its maintenance. Paraguays transportationinfrastructure, which is almost completely publicly-owned, is generally poor.23 Itstands in serious need of integration, both internally and externally, and roadmaintenance is insufficient. In addition, the institutional structures of the publicagencies that bear the main responsibility for these areas are very weak.

2.25 Creating suitable frameworks for attracting private-sector participation tocomplement public investment. Given its unstable institutional and economicconditions, Paraguay has not managed to achieve continuity in its policies andmeasures aimed at attracting private operators and investors in key sectors. Becauseof its situation as a landlocked country, the highway network and the availability ofefficient ports and river transportation along the Paran-Paraguay river corridor isextremely important.24 Port infrastructure needs to be developed to permit theefficient handling of containers and to hold down port costs, as well as to keepdredging operations functioning properly so that ports are consistently of asufficient depth.25 Another crucial task is the modernization of the Silvio PettirossiInternational Airport. This is the primary port of entry and departure from thecountry for international passengers, and its present level of service and

maintenance are unsatisfactory.

2.26 Expanding electricity and telecommunications services and ICTs. Paraguay hasan ample supply of electrical energy and does not need to made additionalinvestments to expand its generation capacity. It should capitalize upon thissituation to increase coverage and efficiency in the delivery of this service and toensure its financial sustainability. It is also vital for Paraguay to take advantage ofthe low cost of technology and the private sectors willingness to providetelecommunications infrastructure and ICT in order to help its telecommunications

23 In 2001 the country had 15,100 km of roadways, of which 23% were paved and approximately 43% were ingood condition.

24 The technical, economic, and environmental viability of the Paran-Paraguay waterway between PuertoCceres in Brazil (3,442 km upriver from Buenos Aires) and Nueva Palmira, in Uruguay, is under study.

25 The feasibility of converting the Port of Asuncin to serve as the site of a large-scale commercial, cultural,and tourism project is currently being studied. The idea would be to transfer port activities, which mainlyinvolve container traffic, to another port to the south of Asuncin. In the short run, this port would beVilleta, but in the longer run, use would be made of a deep-water port further to the south.


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and ICT sectors catch up and to boost competitiveness, mitigating the costsassociated with the countrys landlocked status.

d. Improving the countrys international profile

2.27 Making an aggressive effort to seek out new markets. The small size ofParaguays domestic market is one of the obstacles hindering the development of itsproduction sector. Access to international markets is essential for the achievementof greater economic growth. Given the export structure and geographic pattern ofParaguays trade activity, access to MERCOSUR is of particular importance for itsdevelopment. Even more importantly, Paraguays membership in MERCOSUR andits relations with other countries on the basis of international agreements act as astimulus for the consolidation of governance in Paraguay by providing a gateway toa set of consensus-based rules founded upon such principles as respect for the law,contract performance, and the availability of specific dispute settlement

mechanisms.

2.28 During the 1990s, MERCOSUR consolidated its position as the principaldestination for Paraguays exports, accounting for 37% of the total at the start of thedecade and 53% by its end. MERCOSUR gained in importance as an exportdestination by virtue of a sizeable reduction in the proportion of exports going tothe European Community, whose share shrank from 30% at the start of the 1990s to19%. MERCOSURs imports also rose (from 33% to 52%), while the shares of allother sources declined. Paraguay needs to expand its foreign trade activity withcountries other than those belonging to MERCOSUR.

2.29 Improving the countrys bargaining power in order to strengthen its positionin the international economy. Access to international markets is being negotiatedwith Paraguays partners in MERCOSUR in various regional and multilateralforums (MERCOSUR, the Andean Community, FTAA, the European Union,WTO, etc.). Paraguay needs to identify and promote its interests, particularly in theagricultural sector, and to take the necessary steps to raise the quality of itsexportable supply and implement second-generation trade disciplines.

2.30 Reaping the benefits of open access to MERCOSUR. MERCOSURsshortcomings stemming from intraregional trade restrictions generate costs andprevent Paraguayan producers and exporters from taking full advantage of the

benefits of regional integration. Paraguays marked interdependence with itsregional partners magnifies the contagion of macroeconomic instability within thesubregion, as occurred in the case of Brazils and Argentinas recent devaluations.In addition, since Paraguay is a less developed, landlocked country, it stands tobenefit the most from regional initiatives for promoting the development ofinfrastructure and from mechanisms designed to offset the asymmetries thatinvariably arise in regional integration processes. The recent changeover ofAdministrations in three of the four countries in this integration bloc have created a


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favorable setting for the reformulation of an integration strategy that would meetParaguays needs. The country should seize this opportunity to participate fully inthe work of defining MERCOSURs strategic objectives and to implement

domestic policies that will magnify the benefits of its integration in this regionseconomy.

e. Achieving an environmentally sustainable form of economic

development

2.31 Since its economy relies on natural resources (especially land), Paraguay needs touse those resources appropriately if it is to achieve sustainable growth rates over thelong run. Yet the environmental costs of three decades of development efforts basedon an expansion of the agricultural frontier have been significant. Erosion,deforestation, and the indiscriminate use of agricultural chemicals are alreadyimpairing the countrys ability to generate wealth and its populations quality of

life, particularly in rural areas. The steps to be taken in order to ease the pres

idb - country strategy with paraguay

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