PARAGUAY: IMF MISSION BRIEFS AMBASSADOR

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. -------------- Summary -------------- ¶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. -------------- 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. -------------- THE NEW TEAM AND TALKS ON A NEW PROGRAM -------------- ¶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. -------------- STRUCTURAL REFORMS -------------- 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