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.

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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
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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
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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
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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
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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
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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