US embassy cable - 05ASUNCION1069

UNCLAS SECTION 01 OF 03 ASUNCION 001069 
 
SIPDIS 
 
STATE FOR WHA/BSC, WHA/EPSC, EB/IFD/OMA 
STATE PASS TO USTR FOR LYANG 
USAID FOR AA/LAC ADOLFO FRANCO 
TREASURY FOR OSIA MAUREEN WAFER 
COMMERCE ITA SARAH COOK 
NSC FOR MIKE DEMPSEY, SUE CRONIN 
SOUTHCOM FOR POLAD 
US SOUTHERN COMMAND MIAMI, FLORIDA 
 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON, EFIN, ETRD, PA 
SUBJECT: PARAGUAY: IMF MISSION BRIEFS AMBASSADOR 
 
REF: A) 05 Asuncion 951 
     B) 05 Asuncion 726 
     C) 05 Asuncion 625 
 
1.  (U) Sensitive but unclassified.  Please protect 
accordingly. 
 
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Summary 
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2.  (SBU) During a lunch hosted by the Ambassador, the 
visiting IMF team told us that the government appears to 
have stayed the course on fiscal responsibility and to have 
tentatively met all of the end-June criteria.  The team 
noted, though, that the change in Finance Ministers and the 
departure of nearly all of former Minister Borda's closest 
advisors has caused delays and some misunderstandings. 
Discussions on a follow-on arrangement continue, and the GOP 
appears to be seeking another precautionary SBA, but with a 
longer term, ideally for three years to last through the end 
of President Duarte's term in 2008.  The team also discussed 
the status of several pending structural reforms, including 
private sector participation in state-owned enterprises, 
bank reform laws, and civil service reform.  End Summary. 
 
3.  (U) On August 10, the Ambassador hosted lunch for the 
visiting IMF delegation, led by new mission chief Alejandro 
Santos.  The short technical mission was in Asuncion to 
review quantitative performance through June and to continue 
discussions with the GOP about a follow-on arrangement.  IMF 
resident representative Luis Duran, USAID Mission Director, 
Deputy Chief of Mission and Economic Counselor also 
attended. 
 
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FISCAL PERFORMANCE AND GROWTH 
----------------------------- 
 
4.  (U) The team told us that all quantitative end-June 
targets appeared to have been met.  Revenues have been 
higher than envisioned in the program, which has covered 
some increased spending, leaving the results in line with 
program goals.  However, in Santos' opinion, the GOP is over- 
spending on non-productive items such as transfers, while 
significantly under-spending on public investment, despite 
the fact that there is room in the program to increase 
public investment, as well as obvious political incentives 
to do so. 
 
5.  (U) The discussion concluded that the problem remains a 
lack of capacity with excess bureaucracy, which makes 
execution of public investment projects slow and 
inefficient.  Real economic growth this year is expected to 
disappoint, probably coming in near three percent.  Santos 
pointed out that Paraguay has been unlucky, experiencing two 
external shocks: a rare second year of drought that affected 
crop yields, and the border controls instituted by Brazil in 
the tri-border area that have negatively impacted commercial 
activity there. 
 
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THE NEW TEAM AND TALKS ON A NEW PROGRAM 
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6.  (SBU) Santos said that the GOP appears to be seeking 
another precautionary SBA, but with a longer term, ideally 
for three years to last through the end of President 
Duarte's term.  In response to the Ambassador's question, 
staff said that they hadn't discussed a Policy Support 
Instrument (PSI) with the GOP, and pointed out that the PSI 
is not yet fund policy and will likely be for PRGF countries 
only.  The GOP wants a multi-year program that lasts through 
Duarte's term in part to help fend off pressures to 
overspend near the end of the current government's term in 
2008.  The GOP sees its principal challenge moving forward 
to be to consolidate the macroeconomic stability achieved so 
far and turn that into results such as more jobs and a 
sustainable increased growth rate. 
 
7.  (SBU) The team admitted that the change in Finance 
Ministers in May and the departure of nearly all of former 
Minister Borda's closest advisors (ref C) has caused delays 
and some misunderstandings.  Vice Minister of Economy Jorge 
von Horoch, one of Minister Bergen's closest deputies (and 
his Vice Minister of Industry when Bergen was the Minister 
of Industry and Commerce) is the IMF's principal 
interlocutor.  Von Horoch is very capable, but has a 
multitude of issues on his plate, making it difficult to do 
it all.  A rather thin team around von Horoch and Minister 
Bergen has further slowed progress as the team gets up to 
speed and relearns the understandings that existed between 
the Fund and Borda's team.  Only former Vice Minister of 
Economy Jose Buttner still acts as an advisor to the new 
team at Finance.  Santos guessed that it would take until at 
least October to conclude discussions on a follow-on 
program. 
 
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STRUCTURAL REFORMS 
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State-Owned Enterprises 
----------------------- 
 
8.  (SBU) As on previous occasions, the team acknowledged 
that structural reforms that attract capital and improve 
productivity are prerequisites for any sustainable boost in 
Paraguay's economic growth rate.  Santos noted, though, that 
privatization is a bad word in Paraguay.  Some discussion 
continues within the government about trying to open up some 
of the State-Owned Enterprises (SOEs) to private sector 
participation through management contracts or other 
mechanisms.  The planning is very preliminary, though, and 
it remains to be seen if a formula can be found that is 
politically attractive and yet provides enough risk-adjusted 
upside to attract private investors. 
 
9.  (SBU) President Duarte reportedly told Santos at one 
point that while privatization of the national cement 
company (INC) was a non-starter, he could envision a 
privatized Petropar (the state-owned fuel company).  The 
Ambassador remarked that such a stance is not surprising: 
INC is profitable and employs many people in the interior; 
Petropar still loses money by subsidizing diesel fuel.  The 
diesel subsidy is lower now than a year ago after numerous 
price adjustments, but with rising oil prices, Petropar 
remains in the red. 
 
Banking Sector Law 
------------------ 
 
10.  (SBU) The Ambassador asked about the banking system law 
that has remained stuck in the Senate since it was presented 
in December 2004.  In an earlier meeting (ref A) Central 
Bank President Monica Perez expressed concerns that the law 
would create a semi-independent superintendent of banks, but 
leave the BCP President legally responsible.  Santos said 
there are a few other concerns with the law, but that the 
status of the superintendent is the principal issue, and one 
he considers reasonable.  Santos expects that changes to the 
draft law will be worked out over time. 
 
Public Banking Law 
------------------ 
 
11.  (SBU) Santos confirmed that he understands that 
President Duarte has been quietly working to convince the 
Chamber of Deputies to undo the negative changes made by the 
Senate to the first tier public bank law.  The Senate 
introduced changes that would make repeated refinancings 
possible and remove loan classification provisions, possibly 
making the law worse than the existing public bank 
structure.  According to Santos, the original version 
submitted to the Senate by the executive was a good law. 
However, the GOP put a number of recommendations into the 
law that had come from the committee exploring ways to 
reform the largest public bank (Banco Nacional de Fomento - 
BNF) without legislation.  This in effect has put all of the 
GOP's eggs into this one basket, since those reforms can't 
proceed while the law is under consideration, according to 
Santos. 
12.  (SBU) Once reformed, the BNF could, in his opinion, 
have a positive development impact through its extensive 
branch system that reaches many people not served by the 
traditional banking system.  He speculated that one 
political problem associated with cleaning up the BNF is the 
fact that reform would involve transferring bad loans (about 
half of the portfolio) to a trust fund.  Managers of the 
fund would presumably seek repayment of those loans, many of 
which have influential borrowers on the other side. 
 
Civil Service Law 
----------------- 
 
13.  (SBU) On a positive note, the team understands that the 
central government is working with the legislature and the 
judiciary to draft a new law to reform the civil service.  A 
previous attempt, passed in 2000, has been bogged down by 
hundreds of court challenges.  The idea would be to 
professionalize the civil service, which in Paraguay means 
starting from the beginning: creating entry requirements, 
position descriptions, and performance expectations, none of 
which exist now.  Santos expected the law to be submitted in 
the relatively near future.  The moribund civil service is a 
significant drag on the GOP's ability to provide services. 
 
KEANE