Don’t underestimate Paraguay’s potential, says Sudameris Bank CEO

Having seen its fair share of political strife and economic disdain, it’s not surprising that Paraguay only became a democratic country 21 years ago. Its predominantly young population is now focused on spearheading its strong independent exports

Supporters of Colorado Party candidate Horacio Cartes at a campaign event ahead of last year's presidential elections. Paraguay, as a true practicing democratic country, is just 21-years-old
Supporters of Colorado Party candidate Horacio Cartes at a campaign event ahead of his election as president last year. As a respected businessman, a majority hoped that he could translate his successes in the private sector to the public one 

Surrounded by Bolivia to the northwest, Brazil to the east and northeast, and Argentina to the south and southwest, the Paraguay of the 21st century – a landlocked nation of 6.8 million inhabitants – has been shaped by more than 200 years of tense relationships with its neighbours.

Twice the country faced obliteration and twice it had to reinvent its future as an independent nation that today is 90 percent dependent on the combined river systems of the Rio Pilcomayo, Rio Parana and Rio Paraguay, which all converge to form the Rio Plata, near the Atlantic Ocean between Uruguay and Argentina.

Paraguay remains a mystery to most of the outside world, even to its neighbours. Surrounded by myths and legends, it would be unfair to summarise this country to the historic fame of its border city Ciudad del Este; the tri-border city, at the crossroads of Brazil, Argentina and Paraguay, is no longer the centre of contraband and illegal trade that characterised it in previous decades when Brazil and Argentina banned importation of Western goods.

Rather, it is a country the size of Germany or California, with a young and connected population: the average age is 23 and mobile penetration is nearing 100 percent. The UN rates Paraguay as the least violent country in all Latin America; and with 84 percent of the population under 60 and a 94 percent literacy rate, it has a number of important building blocks for a great success story.

A country still in its infancy
Paraguay became independent in 1811. Until 1989, the country only experienced glimpses of democracy. Even after the fall of General Stroessner in 1989, another general became president, until the election in 1993 of the first civilian president, Juan Carlos Wasmosy. This means that Paraguay, as a true practicing democratic country, is just 21-years-old. Most of the public institutions are still trying to find their role and assert their authority in the midst of a major lack of general infrastructure (Paraguay’s only real crisis).

Source: International Monetary Fund. Notes: Post-2012 figures are IMF estimates
Source: International Monetary Fund. Notes: Post-2012 figures are IMF estimates

In spite of its relatively traumatic history, Paraguay is a country that functions, albeit not efficiently, and has managed to experience tremendous growth over the past 10 years on the back of the revolution of its agricultural sector. Recent growth has averaged five to six percent since 2002.

Although democracy has been in effect for the past 20 years, Paraguay experienced only one term with a president who did not come from the historic ‘Colorado’ party. President Lugo, elected in 2008 to everybody’s surprise (including his own), was the manifestation of a coalition of leftist parties that in the end did not manage to implement the changes that were required to modernise Paraguay.

President Lugo’s term ended in June 2012, with his impeachment for bad management of the State’s affairs. Not a single shot was fired and in the evening his Vice-President, Federico Franco, was sworn in for nine months, until the next presidential elections of April 2013.

This impeachment would have dramatic consequences for the country. It upset carefully laid plans for the extension of the Bolivarian ideology across South America and happened at a time when Paraguay was being forced to allow the Venezuela of Hugo Chavez to enter the Mercosur alliance, already integrated by Dilma Rousseff’s Brazil, Cristina’s Kirchner’s Argentina and Jose Mujica’s Uruguay, all partisans of the Bolivarian revolution.

The impeachment gave a ‘reason’ to the Mercosur alliance to exclude Paraguay from its political process, thus allowing Venezuela to join the alliance by the back door. Paraguay also got suspended, although for a shorter period, from the Organisation of American States.

S&P Credit ratings:







Source: Standard & Poor’s
Notes: 2014 ratings

The election in April 2013 of Horacio Cartes as the new president of the country allowed for new hopes. As a successful businessman, a majority hoped that he could translate his successes in the private sector to the public sector government institutions. After swearing in during August 2013, the country quickly reintegrated into Mercosur, and had to accept the fact that Venezuela was now a part of it, and embarked on a number of reforms critical for the future development of the country.

Challenges of governing Paraguay
Paraguay’s credit rating (see right side-bar) is the perfect example of what such ratings really mean. A country that only experienced three years of budget deficits out of the past 13 years, a GDP growing at an average five to six percent per year over the past 10 years (see Fig. 1), a foreign debt-to-GDP ratio of some 10 percent that becomes negative when considering the foreign reserves, and with a relatively solid financial system that presents few systemic risks. The country is currently set at BB+ by Standard & Poor’s, the same as Greece in 2010 just before it went into virtual bankruptcy.

Paraguay’s current rating reflects the number of friends it would have coming to help in case of economy turmoil, which is very few. As such, expectations are vague and disappointment is constant for the 6.8 million inhabitants who find it hard to exist between the two giants, Argentina and Brazil. In this context, President Cartes has put the country into intensive care, voting a fiscal responsibility law within two months of his legislature to prevent excessive public spending.

A public private partnership law was voted to provide the legal bases for the major infrastructure projects this government expects to tender. He also dealt with each of the ministries on a re-institutionalisation quest, naming for the most part, non-politics in the key posts. Most ministers have had to re-build their ministries to organise the way they function and report, and how they spend. The project was expected to last a few months, yet is still ongoing more than a year later.

However long this reorganisation of the public sector may last, it is a necessity as it lays the foundation for long-term growth that would no longer be entirely dependent upon climate conditions and international demand for soy and meat. It also helps to provide a different vision on what the government should do and how it should behave, two notions that are still relatively new in this country. Both the public sector and the citizens are on a fast track learning curve.

Source:  CIA World Factbook. Notes:  2012 figures
Source: CIA World Factbook. Notes: 2012 figures

A massive reservoir for growth
Ironically, for a country that has not engaged in any significant infrastructure projects over the past 30 years, it is home to the largest dam in the world in terms of electricity production, surpassing the Three-Gorges dam in China. Sitting on the border, and shared 50/50 with Brazil, the Itaipu Dam generated more than 98Twh of electricity in 2013 (83Twh for the Three-Gorges). However, considering its size and needs, Paraguay only uses some 10 percent of its 50 percent share in that production and exports the rest to its partner.

The same goes for the Yacyreta Dam, sitting on the border of Argentina and Paraguay. Today the country is one of the world’s largest exporters of electricity (see Fig. 2). Considering that another five areas have been identified as viable dam projects within the country itself, clean energy production is not going to be an issue for the foreseeable future. Equally important for the coming years, Paraguay sits on the second largest reservoir of fresh water in the world, the Guarani aquifer, providing a reliable source of fresh water for responsible farming.

Paraguay’s agriculture has the capacity to triple its food production output, having more than eight million hectares still available for mechanised agriculture. However, more efforts need to be put in land rehabilitation and implementation of the current environmental laws to prevent more deforestation. Paraguayan agricultural successes can easily be measured. In just under 10 years, it managed to become the first exporter of organic sugar, the second largest exporter of stevia, the fourth largest exporter of soy, the fourth largest exporter of starch, the fifth largest exporter of chia, the sixth largest exporter of corn, the eighth largest beef exporter and the 10th largest exporter of wheat.

In addition to its agriculture potential, the country has not tapped its underground wealth that, if we consider its geographical location between Bolivia, Brazil and Argentina, is likely to be composed of significant mineral and energy resources. As a production centre, Paraguay is getting more and more attractive to countries facing growing production costs and higher taxes. A number of companies are expressing interests in relocating part of their operations in Paraguay under some of the very attractive tax regimes offered to foreign investors. Electrical parts manufacturing companies for the auto industry, for example, have already installed production facilities in the country to serve the Brazilian market. Other industries should follow.

The geographical location of the country, which can be a challenge for the movement of goods (see Fig. 3) in and out of the country, is also a blessing. In the heart of South America, it is a natural hub between all its neighbours and beyond. It doesn’t suffer from natural disasters such as tornadoes, hurricanes or earthquakes, and its topography makes it a country with massive swath of land ready to use for production.

Source: US Census Bureau. Notes: Figures taken in January of that year
Source: US Census Bureau. Notes: Figures taken in January of that year

Not just another emerging market
Human nature likes to classify and order everything, including countries. Because of this, it was decided that Brazil, Russia, India and China had certain similarities and therefore should be grouped from an economic analysis standpoint known as BRICs. We therefore institutionalised more than 2.9 billion people that have very little in common. Everybody that is not an OECD country or part of the BRICs is deemed an emerging market.

With this concept of amalgamation, Paraguay is being analysed in the same way as Madagascar, Surinam or Bangladesh. The story is however radically different. Apart from its demographic, which is characteristic of a young developing country with over 60 percent of its population below the age of 35 (see Fig. 4), Paraguay’s growth story differs in many aspects from other emerging nations.

It has been a very conservative country when it comes to macroeconomics over the past 12 years. It has managed to achieve an average growth rate of five percent over that period with only two years of budget deficits. These were due to election pressure, and not structural economical issues. All the while the country has been growing its foreign reserves more than 10-fold to over $7bn today. Overall, total public debt remains at a low 15 percent of GDP and when considering only public external debt, that number drops to below 10 percent, making the country a net creditor as foreign reserves account for more than 20 percent of GDP.

In other words, Paraguay has grown substantially over the past decade almost entirely thanks to its private sector initiative. That differs substantially from other emerging stories that have relied heavily on foreign and public funding, and welfare driven consumer demand. The public sector has been helpful in facilitating this growth, primarily in reducing the tax burden on companies, providing solid regulation for the financial sector and facilitating the development of private ports, which are the main point of transit for goods in the country.

The country now has the third-largest fleet of river barges in the world, after the US and China. However, successive governments have been much less efficient in developing their own investment programmes, almost abandoning plans to improve existing and develop new roads, airports, railways, and other transport links, while limiting critical investments needed in healthcare and education. The current government team is trying to catch up but the task ahead is enormous, as it needs to train its own staff before it can start tendering projects to national and international groups for large infrastructure projects.

Paraguay’s agriculture has the capacity to triple its food production output, having more than eight million hectares still available for mechanised agriculture

Growth to-date has not been sourced through the government’s funding or subsidies, but mainly through the development of the private financial sector. Bank assets grew six-fold in the past 12 years, thanks to the solidity of the Central Bank of Paraguay and its Superintendence for Banks. Strong regulation has allowed the sector to attract interest from multilateral institutions as well as various development banks from the US and Europe that have helped by providing long-term funding to the local financial institutions at a time when domestic deposits would not average more than 12 months. Change in the funding profile of the financial sector has been promised through pension fund reform.

Key aspects of the banking regulation have been centred on provisions and minimum capital requirements. Paraguay is ahead of Europe in its implementation of Basel III rules, especially in terms of solvency ratios. Local regulation has already established a minimum of 12 percent for total solvency and eight percent for Core Tier I capital.

Considering the fact there are no capital market activities, trading and other forms of volatile investment banking activities, the systemic risks of the financial sector are very limited. Today, total financial assets only represent approximately 30 percent of GDP, which remains low when compared to other developing countries, for example over 95 percent in Brazil or over 65 percent in Colombia.

Paraguay has the most stable currency in Latin America and has the second highest return-on-investment for the private sector in Latin America. It has the lowest tax burden in the region. Therefore, the country benefits from strong macro-economic numbers, a financial sector that is well regulated and has funded growth to-date, and financial assets that account for a relatively low percentage of GDP. But the main potential resides in the origin of the growth and what latent growth remains to be tapped.

Having benefited from sustained demand in agriculture products – mainly soy, but also corn, wheat, sesame and meat – put another way, the growth has not been fuelled by demand from developed countries for raw materials used in construction (iron ore), minerals used for consumer goods (copper, gold, lithium, rare earths) or oil, but from demand for feeding a growing number of people living on the planet. This is also very different from other emerging economies and is not about to change any time soon. Paraguay is slowly but surely setting itself as a key provider of food for the world, through higher production volume and higher quality standards.

Finally, the country benefited from being the largest exporter of clean, renewable energy, setting energy prices at half the price of its neighbours for industrial clients. As Paraguay only uses about 10 percent of what it produces, its capacity to provide competitively priced electricity in the future remains very strong. Its ability to increase the volume and the quality of agro-industrial production with the nascent, but fast growing, industrialisation of the country, provides Paraguay with a strong growth outlook over the next few decades.

Source:  CIA World Factbook. Notes: 2013 figure
Source: CIA World Factbook. Notes: 2013 figure

Intelligent business practices
Paraguay remains an interesting story for investors that need to look beyond the obvious problems of the country. Red tape, and to a certain extent, administrative blockades of all kinds, can be at times frustrating, but doing business in Paraguay remains relatively easy when compared to other countries in the region. Being so small, business intelligence is easy to gather and a number of professional associations exist to facilitate the integration of newcomers, allowing them to establish themselves in Paraguay.

The key challenge for the country will be to invent the second phase of its growth story outside of the obvious development of its agro-industrial sectors. Paraguay has the capacity to become a key producer in certain heavy industries, and it can also become a regional energy player. But providing education standards are raised, it can substantially develop its services and consumer sectors.

An immediate next step objective for the country is connectivity, to connect itself to the regional network of roads, railways and airports. This lies at the heart of the current strategy of the public sector. In addition to fiscal responsibility reform, legislation has been introduced for private sector participation in this infrastructure build-out. Combine this with the pre-existing fiscal incentives (the so called Law 60/90) such as zero percent tax on capital goods (machinery and equipment), no VAT on capital goods purchased locally or abroad, no taxes on remittance abroad of capital or interest, and a 10 year holiday of dividend and profit repatriation for new projects, and you have a potent cocktail for stimulating private sector investment.

In short, Paraguay has attractive geography, a great energy balance, good demographics, strong fiscal and monetary stability, and has embarked on an outreach programme to build multimodal logistics and seek new international corridors to market. There is no ideological agenda short of a desire to raise domestic standard of living. The speed at which this can be implemented will dictate the speed at which the economy can grow
in future decades.

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