The COVID-19 pandemic hit Paraguay just as the country was embarking on a strong recovery path after growth had stalled in 2019. The global recession is likely to lead to a GDP decline of 1.2 percent in 2020. Thereafter, growth is expected to return to 4 percent, as the world economy recovers. This is subject to the downside risk of a slower than expected normalization of global markets. In turn, poverty is expected to increase in 2020, and income inequality to remain high.
The COVID-19 outbreak hits the Paraguay economy in a moment of economic recovery after growth had stalled in 2019. The economy was in a recession in the first half of 2019 (-3 percent year-on-year) due to weak performance of the main trading partners, especially Argentina, and adverse climatic conditions, but started to recover in the second half of the year (+3 percent year-on-year) as agriculture output rebounded along with favorable weather. Similarly, in the labor market, after the combined unemployment and underemployment rate reached 14.5 percent in the first half of 2019, it retracted to 12.9 percent in the second half of the year.
With a weaker economy and inflation close to the lower band of the target range (4 +/- 2 percent), the Central Bank of Paraguay (BCP) moved to a more accommodative stance, consistent with the inflation objective. During 2019, the BCP lowered the policy rate by a cumulative 125 bps to 4 percent. In February 2020, the inflation rate was 2.4 percent year-on-year. The flexible exchange rate regime continued to cushion external shocks. Meanwhile, foreign currency reserves remained at prudent levels, recovering after an initial decline at the onset of the Argentina crisis in 2018.
Given the recession in the first half of 2019, the authorities invoked the escape clause from the fiscal rule, capping the budget deficit (the Fiscal Responsibility Law, FRL, allows an increase of the deficit ceiling from 1.5 percent of GDP up to 3 percent GDP in times of crises). Therefore, the central government’s budget was executed with a deficit of 2.9 percent GDP in 2019. While current expenditure grew by 8.2 percent, capital expenditure increased by 28.9 percent, although from a low base. The Parliament approved the 2020 Budget Law with a deficit of 1.5 percent of GDP, coherent with the FRL.
With the economic slowdown, poverty reduction continued, but at a slower pace: poverty rate fell from 24.2 percent in 2018 to 23.5 percent in 2019. There remain 1.6 million people below the official poverty line. Poverty reduction almost halted in urban areas (17.8 percent in 2018 compared to 17.5 percent in 2019) due to a decrease in labor incomes in commerce and manufacturing. Rural poverty dropped from 34.6 percent in 2018 to 33.4 percent, despite stable labor incomes in agriculture, which concentrates almost half (0.6 million) of mostly informal rural workers. While an improvement on income inequality was recorded, the Gini index remains high 46.1.
Against this backdrop and the ongoing Dengue outbreak, the authorities have reacted swiftly to the outbreak of the COVID-19 in March 2020 to mitigate the impact on the economy and people. The Government implemented social distancing measures and population movement controls. The BCP reduced the policy interest rate by 175 bps to 2.25 percent, and temporarily relaxed provisioning rules not to penalize credit restructurings and prolongations. An anti-crisis fiscal package approved by Parliament includes additional spending on health and social protection programs, a subsidy for informal workers, support to small businesses, reallocation from non-priority spending lines, and a moratorium on fines for delayed tax payments. To finance it, the Government received authorization for an increase of the borrowing limit by US$ 1.6 billion and suspension of the FRL for up to four years.
Economic dynamics in 2020 is expected to be severely affected by the global recession accentuated by the reaction to the COVID-19 outbreak. After the strong first quarter of 2020 due to “normalization” of agricultural harvest (as indicated by the high-frequency data for Jan-Feb), the economy will likely strongly contract in the next two quarters. The downturn will be driven by the decline in external demand and in domestic demand, especially in services, as a result of social distancing measures to slow the expansion of the pandemic. The economic package of the authorities, which is expected to increase fiscal deficit to 4 percent GDP, will soften the impact but would not fully compensate for it. In 2021-22, growth is expected to return to 4 percent, as the global economy recovers, and helped by consistent macroeconomic policies, anchored in the inflation targeting and a gradual return towards the FRL ceilings. Inflation is projected to return to the mid-point of the target range (4 percent) in 2021.
Going forward, poverty reduction is expected to stall, implying the need for a higher social protection support in the face of the expected global recession. Driven by the COVID-19 pandemic, unemployment and underemployment are expected to increase in commerce, services and construction. Labor incomes are expected to drop, especially for workers in the informal sector in the urban areas. The performance of family-based agriculture will be crucial for the protection of the most vulnerable in the rural areas. In addition, stronger labor income growth is needed in the services sector to improve livelihoods of those at the bottom of the income distribution in urban areas to attenuate the effects of the pandemic.
Paraguay has a solid macroeconomic framework based on fiscal rules, inflation targeting, and a flexible exchange rate regime. With the track-record of prudent macroeconomic policy over the last decade, low public debt and adequate FX reserves, the macroeconomic policies and crisis response measures are expected to be effective in absorbing a part of the COVID-19 shock. However, Paraguay is vulnerable to the domestic economic slowdown resulting from measures to contain the COVID-19 outbreak and its effects (social distancing, fiscal responses), as well as a steep reduction in economic activity in the global economy, and in neighboring countries. This will compound other, “pre-existing” economic risks and could disproportionally affect labor incomes of the 65 percent of informal workers in commerce and services. While the banking sector of Paraguay has a minimal exposure to Argentina, the real sector linkages through exports and remittances are stronger. Moreover, the concentration of exports in a few agricultural products continues to render growth and poverty vulnerable to fluctuations in agriculture commodity markets and to weather-related shocks (as showcased in 2019), affecting especially the most vulnerable population.
Last Updated: Apr 20, 2020