[from Silvia Pavoni @ The Banker: Global Financial Intelligence since 1926, 20 August 2010]
Paraguay banks on natural resources
The government of Paraguay has faced many challenges when striving to implement democratic reform and social policies while maintaining economic stability and promoting growth. The country's minister of finance, Dionisio Borda, outlines the government's efforts to make the most of its natural resources, attract private investment and build up Paraguay's infrastructure.
Q: In what areas does Paraguay have opportunities for growth?
A: Paraguay has several very important competitive advantages. The country is a food producer, involving agriculture and cattle-raising. We're also a clean energy producer; we're the largest energy exporter in the region. We consume only about 6% of the output of Itaipú [a hydroelectric plant on the border between Paraguay and Brazil] and we're now in discussion with a foreign company [Rio Tinto Alcan of Canada] over the installation of an aluminium plant, which is very energy-intensive. The [aluminium] project is being studied by an economic team within the government, formed by the finance minister, the central bank governor and the industry, agriculture and public works ministries. It is a signal of the level of interest in the country.
The third advantage that Paraguay has is its low population density: 11 inhabitants per square kilometre - this is a density you don't see very often.
The country has another very important natural resource: water. The Guarani aquifer [one of the world's largest sources of fresh water that lies beneath the surface of Argentina, Brazil, Paraguay and Uruguay], which is underground and suitable for human consumption, has hardly been developed at all and has huge strategic value.
Paraguay is also defined by its rivers. If you look at a map of Paraguay, you'll see how the rivers look like the veins of a body. A friend of mine, who is a hydrologist, went into that profession because, when he was a child, he opened the encyclopaedia and looked at what it said about Paraguay. Against the many pages of information about other countries, what it said about our country was this: 'it is a country permeated by rivers; it is the country of water'.
This is a country of great inequality but of great [social] integration. We don't have direct access to the sea, but this is one of the challenges that this government has undertaken: the development of infrastructure and logistics.
Another advantage for Paraguay is being part of Mercosur [a regional trade agreement between Argentina, Brazil, Paraguay and Uruguay]. Paraguay has taken advantage of its membership, although it has its negative sides too. But in the medium to long term, membership of Mercosur offers many advantages and that's one of the reasons why Rio Tinto Alcan wants to put its plant here: low-cost energy and access to the markets of Brazil and Argentina.
Q: Paraguay has a very low tax/gross domestic product (GDP) ratio. If this increases, it might create more funds for infrastructure and education. What are the government's plans?
A: Yes, we have very few fiscal pressures. Our value-added tax (VAT) is the lowest in South America: 10% against 21% in Argentina, 23% in Uruguay, 19% in Brazil and 18% in Chile. Our corporate profit tax is 10%, while in the region the average is about 30%. We have yet to introduce a personal income tax; we have been trying to do so since 2003, but there is resistance.
Since 2003, though, we have had an expansion of the [corporate] taxpayer base from 100,000 to 500,000 today. We reduced the tax rate and this became an incentive for people in the 'informal' sector to join the formal sector. The tax/GDP ratio used to be 9%, then it went up to [the current] 12%, and we hope it will reach 15% [by 2013]. This would give us a better chance of funding our infrastructure and public works.
We keep on finding resistance from [Paraguay's] congress against the implementation of a personal income tax but we keep on fighting for it. It is going to be difficult to introduce it this year, but hopefully we can do so next year.
There are three objectives behind the introduction of a personal income tax: one is to increase the government's revenue. The second is to formalise the economy; people would be able to deduct VAT from their taxable personal income, so they'd have an incentive to ask for a receipt when they purchase items. The third objective is to fight illegal activities. Paraguay doesn't have a good reputation in this area, and the more we clarify how large someone's assets are, the more we can see where their income comes from. This should help resolve the issues of prestanombres [an individual who lends his or her name as owner of assets to circumvent regulations].
Also, we think that public-private partnerships (PPPs) will help develop the country's infrastructure. Right now, there is a legislative proposal to give the private sector a highway management concession. The roads concerned connect Asunción to Ciudad del Este and Encarnación in a triangle. This would be the country's most serious infrastructure plan to date through concessions to private investors.
We're also working on a PPP scheme for airports, which would be a first for Paraguay. There are already [smaller] private airports here and we need to work on a framework that would guarantee fair competition between all of them and guarantee that the government can comply with its obligations [in all of them].
Q: One of this government's promises was to enact stronger social policies but some say that the introduction of wider benefits has discouraged people from looking for jobs. What have been the results of the welfare strategy?
A: In reality, there isn't a true unemployment benefit scheme, but what the government did was to accelerate its conditional money transfer policy. This means that the government gives a small subsidy to people in extreme poverty [earning less than $1 per day]. Families in this situation receive about $50 per month on the condition that their children go to school and that the children go for medical check-ups once a month.
The government didn't have 100% control over the success of these measures but fundamentally I believe the impact has been positive. From 17,000 families in this programme in 2008, there were 103,000 families in 2009. This has complemented the [poor families'] income from remittances from their relatives in the US and Europe, which decreased last year.
We want sustainable growth that will generate employment and will not destroy the environment. We're working on some important environmental regulations in agribusiness.
We also want to promote private and public investment and attract foreign investors. Paraguay is a safe country in terms of security. It is an amicable country. It is welcoming towards foreigners. We have a law that gives incentives to foreign investors and says that they don't need to pay taxes until they start production - no VAT is charged on the installation of machinery and no tax is charged on capital imported. Glass companies, beverage companies and textiles companies from the wider Latin American region and from Europe have taken advantage of this.
Q: Do both Paraguay and its government have a perception problem?
A: Paraguay is not a country that does much promotion of itself abroad. We are a government with a social mission. We have a very high degree of poverty but there are no other restrictions. We work really well with businesses and their associations.
We are trying to eliminate the preconceptions about this government as populist because it has a social mission - this is not a populist government. This government wants to combine social policies with market policies for the sustainable growth of the country.
Companies that are present in Paraguay recognise that this government has improved the security situation. Social spending has increased, much of which has been directed towards the security of the country. Direct investment in security and education are also objectives. We also need to improve the institutions of the state - to ensure that the government, as an institution, works.
Q: The government has not played a significant role in developing Paraguay's infrastructure in the past, leaving the private sector to fill the gaps - building schools and roads that connect companies to highways, for example. Is there a risk that the private sector will increasingly become disaffected with the public sector?
A: In the past, during the dictatorship and early post-dictatorship period, public resources were not what they should have been. If the private sector is not provided with infrastructure or schools, it will try to create them itself, but this is not the correct approach. What we believe is that we should work in harmony with the private sector, that people should pay their taxes and that they should receive services from us. We are now working with the private sector on PPP programmes.
We have not had a very democratic government in Paraguay or a government committed to social issues. Being committed to social issues doesn't mean going to war with the private sector. We need to work with the private sector and deal with these issues. These are the conditions for [economic] growth. If you have social instability, none of the government's or private sector's efforts will produce any results: this is the history of central America. Countries where there was a lack of social policies had social instability in the end, and that hinders the development of the private sector too.
Q: You were finance minister for the first two years of the previous government, held by the right-of-centre Colorado party. How does this government differ from its predecessors?
A: There is more effort in this government. For 61 years, no government has handled this kind of public policy [focusing on social issues]. There is a learning curve, the bottom of which coincided with the international financial crisis. This made our efforts to meet our objectives much harder.
The international financial crisis and a terrible drought, combined with new people being brought into government and therefore lacking in public administration experience - all of this called for more communication and presentation [of our programmes and policies].
We solved some of the fiscal issues in the previous government term. First, we had to renegotiate the [public debt] maturity and the rate for internal debt; second, we implemented a partial reform of the fiscal base - we reduced corporation tax from 30% to 10% because in practice that was the actual rate that was being paid. We wanted to introduce a personal income tax.
We reformed the five cajas [savings banks] and the pension funds, so that their deficit would be reduced. We also created a 'second floor' bank, the Agencia Financiera de Desarrollo [financial development agency].
Q: You are known to be very strict with the budget. How do other ministries react when you do not accommodate their requests for additional funds?
A: It is not just one person's decision, it has to do with the availability of resources. At the beginning, it was difficult to establish a certain discipline; everybody wanted funds. Another part of the problem is efficiency. Initially, people thought that problems could be solved only with additional funding, but one also needs to develop the ability of doing things more efficiently. People understand this now.
Having a deficit gives a country inflation problems and affects its negotiating power for external loans. Since 2003, Paraguay has not had a deficit. Even during the crisis, in 2009, with a gross domestic product contraction of -3.8%, Paraguay increased the amount of tax collected. This is because there has been a big jump in the management of tax administration since 2003.
Q: What's the biggest challenge for the Ministry of Finance?
A: There is still much to be improved. We need to make all parts of the public administration more efficient; we need to invest more and to improve the service. Unfortunately, the political effort is not sufficient for the economic effort. If we have stronger political parties, they will make better public policies and better economic policy, and this means creating a better environment for growth and investment.
We need to work a lot with congress [to get our reforms approved]. It's a challenge. The political side of things needs to mature more. On the other hand, this society needs to create a stronger middle class, which would be the engine for growth. Our entrepreneurial class needs to look beyond Paraguay. Paraguay has a future in the export market. We need to learn from the emerging markets that have a good policy of investment distribution, such as Chile, Uruguay, Brazil and countries in Asia; [we must focus on] greater social justice, production geared for exports and investment in infrastructure.
The largest sector of employment in Paraguay is currently in family agricultural companies that have fewer than 50 employees. We need to generate employment and invite investments into Paraguay.
