US embassy cable - 05ASUNCION621

UNCLAS SECTION 01 OF 04 ASUNCION 000621 
 
SIPDIS 
 
STATE FOR WHA/BSC, WHA/EPSC, EB/IFD/OMA 
STATE PASS TO USTR FOR SCRONIN, LYANG 
USAID FOR AA/LAC ADOLFO FRANCO 
TREASURY FOR OSIA MAUREEN WAFER 
COMMERCE ITA SARAH COOK 
NSC FOR MIKE DEMPSEY 
SOUTHCOM FOR POLAD 
US SOUTHERN COMMAND MIAMI, FLORIDA 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, ETRD, PINR, PA 
SUBJECT: PARAGUAY: IMF MISSION BRIEFS AMBASSADOR 
 
1.  Summary:  On May 3, the Ambassador received the 
visiting IMF team, here for the fifth review of 
Paraguays Standy-by Arrangement.  The program remains on 
track quantitatively, but faces some continued delays on 
the structural reform front.  The Mission Chief was not 
overly concerned since, in his opinion, the GOPs reform 
program was overly ambitious.  The team commented that, 
, 
according to Finance Minister Borda, his relationship 
with President Duarte is better than ever.  Borda appears 
to be keeping the fiscal deficit in line with program 
targets despite the large deficit implicit in the budget 
approved by Congress.  The team was pleased with the 
nomination of an IMF economist, Monica Perez, to take 
over the Central Bank, and expressed their belief that 
relations between Perez and Borda will be excellent.  The 
financial sector remains reluctant to lend, in part due 
to very low recovery rates on bad loans driven by poor 
regulation.  The team felt that the key to increasing 
Paraguays growth is robust structural reform and 
positioning the country as a low-cost supplier for 
Mercosur.  The team was concerned about a threat received 
by the IMFs technical advisor to Customs, which caused 
him to depart the country.  End Summary. 
 
2.  On May 3, the Ambassador hosted at his residence the 
visiting IMF delegation, led by new mission chief 
f 
Alejandro Santos.  The two-week mission to prepare the 
fifth review of Paraguays Stand-by Arrangement is due to 
conclude around May 11.  IMF resident representative Luis 
Duran, DCM, USAID Mission Director and Economic Counselor 
also attended.  During the wide-ranging discussion the 
team expressed satisfaction with the GOPs sound 
macroeconomic management, but noted that significant 
structural reforms will be necessary to break Paraguay 
out of its low-growth doldrums. 
 
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BORDA, THE PRESIDENT AND THE BUDGET 
----------------------------------- 
 
3.  The Ambassador asked Santos about how he saw Bordas 
standing with President Duarte.  Borda told the team that 
his relationship with the President has never been 
better.  Neither Duran nor Santos said they saw any signs 
of micromanagement on the part of President Duarte, who 
appears to have delegated significant authority for 
economic policy to Borda and the rest of the Economic 
Cabinet. 
 
. 
 
4.  The team was cautiously optimistic that Borda, whom 
they characterized as extremely cautious with spending, 
could succeed in meeting the program target of a small 
(half percent of GDP) deficit this year, despite the 
unrealistic budget passed by Congress with its implicit 
2.5% of GDP deficit.  The two principal tactics are the 
use of a financial plan (provided for in Paraguayan law 
to more closely align revenues and expenditures) and the 
Ministry of Finances Central Unit for Public Investment 
(UCIP) to control public investment.  The latter should 
be fairly easy according to the team, since capacity 
constraints make it difficult to effect budgeted 
investment in any case.  The first quarter results were 
quite strong, with an overall surplus, suggesting that 
Borda is on the right track. 
 
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ON AN IMF ECONOMIST AS THE NEW CENTRAL BANK PRESIDENT 
--------------------------------------------- -------- 
 
- 
 
5.  Monica Perez, President Duartes choice to succeed 
Gabriel Gonzalez as President of the Central Bank (BCP), 
is an IMF economist who most recently worked on the 
Nicaragua team.  The team was naturally pleased, and in 
fact honored that one of their own was chosen to lead 
the BCP.  Duran said he knew her and Santos said she is a 
top notch economist.  Santos said her relations with 
Borda are excellent as far as they know.  While Perezs 
family has a personal relationship with the Presidents 
family, all agreed that her selection was a significant 
signal from President Duarte about his commitment to 
sound economic policy.  He had a universe of options, 
including non-technical political allies, but chose an 
IMF economist, despite the existence of factions that 
view the IMF as a problem for Paraguay. 
 
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FINANCIAL SECTOR ISSUES 
----------------------- 
 
6.  Financial sector intermediation remains a problem for 
Paraguay.  Real interest rates remain extremely high, and 
 and 
despite the macroeconomic stability in Paraguay and the 
region in recent years, financial sector demand for 
liquidity remains strong.  In response to the 
Ambassadors question about the possible effects of 
rising global interest rates, the teams financial sector 
expert downplayed the impact.  With real interest rates 
so high, some increase in global rates will probably not 
have a major effect.  Financial institutions are driven 
more by sentiment, and many firms self-finance, even now. 
 
7.  A Financial Sector Assessment Program (FSAP) team 
visited Paraguay in late April and found significant 
legal problems related to collateral recuperation. 
Impediments are such that banks can expect recovery rates 
near zero in most cases, a factor that clearly 
contributes to banks reluctance to lend.  Santos 
commented on the need to create a capital market.  Most 
bonds remain paper-based, to include paper coupons that 
must be signed by Minister Borda himself.  Santos cited 
ed 
the dematerialization of bonds (allowing book-entry 
issuance and trading of bonds) as a priority to deepen 
local capital markets.  Note: bond dematerialization is a 
priority of Treasurys Resident Debt Advisor.  End note. 
 
8.  When asked about the regulation of cooperatives, now 
overseen by the National Institute of Cooperatives 
(INCOOP) rather than the Superintendent of Banks as 
originally preferred by the IMF, Santos remarked that 
there is always room to improve.  Nevertheless, INCOOP 
has been willing to work with the World Bank and a global 
organization of credit unions and is improving.  The Fund 
noted that the top 5 cooperatives have about 80% of the 
cooperative sectors assets, making it possible to 
minimize the systemic risk by focusing on a relatively 
few institutions. 
 
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STRUCTURAL REFORMS 
------------------ 
 
9.  Santos was relatively sanguine about structural 
reforms, remarking that they have their own pace and 
given their long-term focus, delays of several months are 
e 
understandable and not deleterious.  He acknowledged, 
though, that not all his colleagues share his view. 
Audits of Paraguays State-Owned Enterprises (SOEs) are 
behind schedule, but progressing.  Delays were caused in 
part by resistance from the Controller General, who 
considered it unconstitutional for the Ministry of 
Finance to be undertaking audits of SOEs.  Finance won 
the day, but the Ministry is just now receiving bids for 
several of the audits. 
 
10.  Santos also took the view that Congress ought to be 
respected, and its outputs accepted.  If not ideal, the 
task is to find a way to make the best of them.  The team 
noted that in most countries, they find themselves 
prodding Finance Ministers to pick up the pace, whereas 
they find Borda to be overly ambitious and often feel the 
need to inject some reality into his plans.  Certain 
reforms, such as comprehensive banking legislation, are 
languishing in part because Congress has been overloaded 
with reform projects. 
 
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THE PATH TO FASTER GROWTH 
------------------------- 
 
11.  Paraguay has stabilized macroeconomically, and 2004 
was one of the best years (high growth and low inflation) 
in decades.  However, per capita income barely improved. 
As the Ambassador noted, Paraguays growth rate was below 
the world average and significantly below the average for 
Latin America.  Santos remarked that stability for 
Paraguay isnt enough.  Reform of the largest public bank 
(the BNF) is a top IMF reform priority, but in the teams 
view, structural reforms to make Paraguay attractive to 
Foreign Direct Investment (FDI) are the key to shifting 
upward the growth potential of Paraguays economy. 
 
12.  Privatization of the SOEs is a principal avenue for 
attracting FDI and the technology that would accompany 
it.  Paraguay is poor because productivity is low and not 
increasing.  Other examples of important issues affecting 
Paraguays attractiveness for FDI include a rigid labor 
market and judicial insecurity.  The team thought that 
that 
Paraguay should make a stronger play for secure access to 
the Brazilian and Argentine markets.  With secure access 
and Paraguays lower taxes and labor costs, the country 
should be able to attract FDI, especially from Brazil and 
Argentina. Comment: Paraguayan officials and 
businesspeople charge that Brazil, in particular, used 
varied means to preclude Paraguayan exports from gaining 
a foothold in the Brazilian market and competing with 
Brazilian producers.  End comment. 
 
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THREAT RECEIVED BY IMF TECHNICAL ADVISOR 
---------------------------------------- 
 
13.  The team was concerned about the recent departure of 
IMF technical advisor to Paraguayan Customs, Ives Soler, 
who is a French customs investigator.  At a party on 
April 27, an unidentified man approached Soler and warned 
him he should be careful.  Soler had received veiled 
threats in the past and, after consulting with IMF 
headquarters, decided to depart the country.  He is not 
expected to return, a significant loss for Paraguayan 
Customs.  Soler had been doing excellent work with 
Customs and was a colleague of Treasurys Resident 
Enforcement Advisor. 
 
14.  The team had raised the issue with Minister Borda, 
who promised a thorough investigation.  The Ambassador 
urged the Fund to follow through and demand appropriate 
action to minimize the chances that Solers departure 
will be seen as a success for intimidation tactics. 
Santos noted that customs revenues had increased on the 
order of $400 million under the Duarte administration and 
that prices had not risen commensurately, implying a 
major hit to corrupt officials and tax evaders.  Comment: 
As reform efforts take stronger hold, we may see more 
examples of intimidation tactics.  End comment. 
 
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NEXT STEPS 
---------- 
 
15.  Santos was vague about the prospects for a follow-on 
program.  Borda has asked for one, but serious 
discussions have not yet begun, and the President has not 
t 
yet signaled his support (nor his disapproval).  Santos 
noted that macroeconomic stability, the IMFs specialty, 
has been achieved here.  Nevertheless, Borda and others 
argue that the Funds presence acts as a catalyst for the 
reform process. 
 
KEANE 
E