Overview and Outlook · Hydroelectric energy generation from three dams – Itaipú, Yacyretá, and Acaray – is a significant part of the Paraguayan economy as well, accounting

CREDIT ANALYSIS

SOVEREIGN & SUPRANATIONAL MARCH 7, 2014

RATINGS

Paraguay Foreign

Currency Local

Currency Gov. Bond Rating Ba2-POS Ba2-POS Country Ceiling Ba1 Baa3 Bank Deposit Ceiling Ba3 Baa3

Table of Contents:

OVERVIEW AND OUTLOOK 1 Key Drivers behind Paraguay’s upgrade and outlook change 2

RATING RATIONALE 3 Economic Strength: Low (+) 3 Institutional Strength: Low (-) 5 Fiscal Strength: High (+) 9 Susceptibility to Event Risk: Low 14 Rating Range 24 Comparatives 25

APPENDICES 26 Chart Pack 26 Rating History 28 Annual Statistics 29

MOODY’S RELATED RESEARCH 31 RELATED WEBSITES 31

Analyst Contacts:

NEW YORK +1.212.553.1653

Sarah Glendon +1.212.553.4534 Assistant Vice President - Analyst [email protected]

Mauro Leos +1.212.553.1947 Vice President - Senior Credit Officer [email protected]

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This Credit Analysis provides an in-depth discussion of credit rating(s) for Paraguay, Government of and should be read in conjunction with Moody’s most recent Credit Opinion and rating information available on Moody's website.

Paraguay, Government of

Overview and Outlook

Paraguay’s rating balances the government’s strong fiscal position and improving institutional framework against its lack of diversification, agriculture-dependent economy, and volatile growth. Fiscal metrics remain favorable compared to both Ba and Baa peer medians, and a recently approved package of legislation is set to bolster the country’s fiscal position and institutions. Owing to climate-related shocks and agriculture’s significant contribution to output, growth has been more volatile over the past five years than in the five years prior. However, government revenues are somewhat shielded from this volatility, since one-quarter of total revenues are non-tax revenues, including binational dam-related revenues that are denominated in US dollars.

In addition to including fiscal oversight measures, the government’s recently passed legislation incorporates measures to foster higher levels of public investment and attract more foreign investment into the country, with the ultimate goal of improving infrastructure and utilizing more of the country's hydroelectric energy domestically. One of Paraguay’s greatest strengths is its position as the world’s largest net exporter of clean energy; however, the authorities plan to utilize more of this energy domestically in order to receive a higher price than they currently do from Brazil and Argentina.

The positive outlook reflects our expectation that, even though it will take time for the government to implement the various laws approved in late 2013, they are likely to improve fiscal oversight and allow for higher levels of infrastructure investment over the medium-to-long term.

The rating could be upgraded further in the case of successful implementation of recently passed laws, and investments that support economic growth and infrastructure development.

Conversely, the rating and the outlook could come under pressure if there is a reversal of the government’s prudent fiscal management, a significant and prolonged commodity shock driven by declining prices or adverse climate conditions, or recurrent political instability.

This Credit Analysis elaborates on Paraguay’s credit profile in terms of Economic Strength, Institutional Strength, Fiscal Strength and Susceptibility to Event Risk, which are the four main analytic factors in Moody’s Sovereign Bond Rating Methodology.

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SOVEREIGN & SUPRANATIONAL

2 MARCH 7, 2014

CREDIT ANALYSIS: PARAGUAY, GOVERNMENT OF

Key Drivers behind Paraguay’s upgrade and outlook change1

On 4 February 2014, Moody’s upgraded Paraguay’s government debt rating to Ba2 from Ba3. Concurrently, we changed the outlook to positive from stable. Our decision to change the rating and the outlook was driven by the following factors:

» The improving standing of Paraguay’s key fiscal metrics relative to Ba peer medians. Central government debt amounted to just 12.7% of GDP and 79% of revenues in 2013, well below the Ba medians of 36% and 151%, respectively.

» A strengthened institutional framework as a result of the legislation package that was approved last year. These laws aim to improve fiscal oversight and encourage investment in the country. The Cartes government, which took office in August 2013, has secured a governability pact and demonstrated a high degree of effectiveness in passing key legislation.

» A smooth political transition since the impeachment of former President Fernando Lugo in 2012. The transition of power from an interim government to the current Cartes administration has been seamless and there was no material impact on the economy or the country’s creditworthiness during the transition period.

The positive outlook reflects our expectation that, even though it will take time for the government to implement the various laws approved in late 2013, they are likely to improve fiscal oversight and allow for higher levels of infrastructure investment over the medium-to-long term.

1 For complete details, see “Key Drivers for Moody’s Decision to Upgrade Paraguay’s Ratings to Ba2; Outlook Changed to Positive,” 4 February, 2014.



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Rating Rationale

Our determination of a sovereign’s government bond rating is based on the consideration of four rating factors: Economic Strength, Institutional Strength, Fiscal Strength and Susceptibility to Event Risk. When a direct and imminent threat becomes a constraint, that can only lower the preliminary rating range. For more information please see our Sovereign Bond Rating Methodology.

Economic Strength: Low (+)

Paraguay is a small economy based on agriculture and hydroelectric energy production

Factor 1

Scale VH+ VH VH- H+ H H- M+ M M- L+ L L- VL+ VL VL-

+ -

Economic strength evaluates the economic structure, primarily reflected in economic growth, the scale of the economy and wealth, as well as in structural factors that point to a country’s long-term economic robustness and shock-absorption capacity. Economic strength is adjusted in case excessive credit growth is present and the risks of a boom-bust cycle are building. This ‘Credit Boom’ adjustment factor can only lower the overall score of economic strength.

Paraguay’s nominal GDP of $30 billion is slightly below the Ba median of $47 billion and less than the median of countries rated Ba1. The small size of the economy and limited economic diversification justify assessing economic strength at a low (+) level. However, there are ongoing positive developments in the realm of diversification, particularly as they relate to improving the country’s infrastructure in order to attract more foreign investment (see next sub-section).

Paraguay, while a poor country, has a GDP (PPP) per capita of $6,053, which is just about on par with the $6,704 median for countries rated Ba, although Armenia (Ba2) and Morocco (Ba1) have incomes per capita below Paraguay’s.

Despite the openness of the economy, growth is largely driven by domestic demand – primarily private consumption and fixed capital formation (Exhibit 1). The IMF estimates Paraguay’s potential growth rate at 4.5% and, from 2009-13, real GDP grew by 5.2%, on average. Nevertheless, growth has been very volatile in recent years as well (standard deviation of 8.0 percentage points over the past five years). This volatility is related to El Niño related climate events that, from time to time, cause a drought in Paraguay, impacting the agricultural sector negatively. As Exhibit 2 demonstrates, primary goods (agriculture, livestock, forest products, fishing, and mining) account for 24% of GDP (agriculture alone: 18%). The performance of these sectors tends to have a spillover effect on the rest of the economy, helping to explain the growth volatility.



4 MARCH 7, 2014


EXHIBIT 1

Contribution to Real GDP Growth (pct pts)

Sources: Central Bank of Paraguay, Moody’s Investors Service p=preliminary and f=forecast

EXHIBIT 2

2013 GDP by Economic Sector (%)

Sources: Central Bank of Paraguay, Moody’s Investors Service

The key commodities produced by Paraguay are soy and meat, but grains, flour, and vegetable oil are important as well. Favorable climate conditions in 2010 and 2013 explain those years’ double-digit growth rates, but 2011 and 2012 were marked by a series of adverse shocks, including an outbreak of foot-and-mouth disease and a severe drought. Both government finances and Paraguay’s external position were resilient to those shocks, as they were to the combined drought and global financial crisis in 2009.

Hydroelectric energy generation from three dams – Itaipú, Yacyretá, and Acaray – is a significant part of the Paraguayan economy as well, accounting for 10% of GDP. Since Paraguay’s domestic electricity demand is far lower than generation, the country sells the vast majority of the electricity it generates to Brazil (37,000 gigawatt hours per year) and Argentina (18,000 gigawatt hours per year). Of the ten turbines that Paraguay owns at the Itaipú dam, it uses only one to supply the domestic market. Brazil tripled its payment to Paraguay for electricity, beginning in May 2011 – to USD360 million per year. Paraguay’s treaty with Argentina is up for renewal this year, and we expect that it will be renewed.2

Efforts to diversify the economy are underway While the economy remains largely focused on commodities and hydroelectric energy production, the government is embarking upon efforts to diversify the structure of the economy. The diversification strategy is centered on the country’s abundant domestically-generated hydroelectric energy, which explains plans to build industrial parks that will be able to utilize this energy for domestic production. In this area, there has been some progress already, with the installation of maquilas, autoparts producers, and other manufacturers which primarily export to Brazil.

Moreover, last year the country installed (with Fund for the Structural Convergence of MERCOSUR – FOCEM – funds) and activated a new 500KW transmission line from the Itaipú dam to Asunción. The government has received funds from the Inter-American Development Bank (IDB) and the Andean Development Corporation (CAF) to build a second 500KW transmission line, which will extend from the Yacyretá dam to Asunción. These transmission lines show the government’s intention of improving the country’s infrastructure in order to attract more private investment. The recent approval of a public-private partnership (PPP) law also highlights the government’s interest in

2 The treaty with Brazil is up for renewal in 2023.

4.34.1

2.14.8 5.4

6.4

-4.0

13.1

4.3

-1.2

13.6

4.8

-10.0

-5.0

0.0

5.0

10.0

15.0

2003

2004

2005

2006

2007

2008

2009

2010

2011

p

2012

p

2013

p

2014

f

Private consumption Public consumption

Gross Fixed Investment Net Exports

GDP

Agriculture18%

Wholesale and retail trade15%

Binational dams10%

Industry10%

Finance3%

Construction4%

General government9%

Livestock5% Transport and

communications8%

Other services11%

Taxes on products6%

Forest products, fishing, and mining1%


5 MARCH 7, 2014


attracting private investment, primarily for infrastructure such as a highway running from Asunción to Ciudad del Este, a shipping channel on the Paraguay and Paraná rivers, and water, sanitation, and electricity projects. All-in-all, the government’s $16.5 billion investment plan for the time horizon spanning from 2013-2018, incorporating both public and private resources, has the potential to help gradually reduce growth volatility.

Education, infrastructure, and informality remain challenges to the long-term growth outlook From the perspective of long-term growth, Paraguay’s key challenges are in the areas of social development, specifically education, infrastructure, and informality. According to the UN Human Development Report 2013, only 37% of people ages 25 and older have at least a secondary education. However, Paraguay has a young population, with 39% of the total population between ages 10 and 29, and the secondary school enrolment rate is 67%, indicating that education levels have the potential to improve. Informality is high because labor market rigidities are significant.3 Estimates of informality are difficult to come by, but an International Monetary Fund (IMF) study places Paraguay’s informal sector at around 70% of GDP, the highest in Latin America.4 The informal sector is concentrated in Paraguay’s second-largest city, Ciudad del Este, which is on the border with Argentina and Brazil.5

Basic infrastructure in roads, ports, and utilities is lacking, a fact associated with the country’s low investment rate, averaging 16% of GDP over the past five years. The authorities recognize the need to increase investment and, therefore, are planning to use the proceeds of the $500 million global bond issued in January 2013, and any additional bonds issued on the international capital markets, for infrastructure projects, namely roads, airports, electricity infrastructure, and a shipping waterway. The government also plans to enter into public-private partnerships, now that Congress has approved the PPP law.

Institutional Strength: Low (-)

Recent legislation reflects a strengthened institutional framework

Factor 2


+ -

Institutional strength evaluates whether the country’s institutional features are conducive to supporting a country’s ability and willingness to repay its debt. A related aspect of institutional strength is the capacity of the government to conduct sound economic policies that foster economic growth and prosperity. Institutional strength is adjusted for the track record of default. This adjustment can only lower the overall score of institutional strength.

3 The World Economic Forum ranks Paraguay 117th out of 148 countries in the area of labor market efficiency in “The Global Competitiveness Report, 2013-2014.” 4 IMF Working Paper, “Measuring the Informal Economy in Latin America and the Caribbean,” April 2008. The most recent poll done in Paraguay, “Encuestas

Permanente de Hogares 2011,” estimates the informal sector at around 60% of the employed population, which is the percentage of the employed population (excluding domestic workers) that lack a work contract.

5 In order to increase formality in the economy, the government recently issued a decree which increases the fine that businesses must pay when they do not provide receipts.


6 MARCH 7, 2014


World Bank Governance Indicators are weak Within the context of institutional strength, the World Bank Governance Indicators for Paraguay (specifically, government effectiveness, rule of law, and control of corruption) compare poorly relative to peers. In the case of Paraguay, government effectiveness, rule of law and control of corruption are consistently among the lowest 15% of rated countries, rendering a weak stance compared to the median for Ba-rated countries (Exhibit 3). However, these data are from surveys conducted in 2012, a year in which the president was impeached and there was a fair amount of political uncertainty. Furthermore, over the past year there have been meaningful developments that have improved Paraguay’s institutional strength.

EXHIBIT 3

World Bank Governance Indicators 2012

Sources: World Bank, Moody’s Investors Service

Political transition after Lugo’s impeachment has been smooth On 22 June 2012, Congress voted to impeach former president Fernando Lugo of the center-left Alianza Patriótica por el Cambio (APC), 14 months before his term was set to end, on the grounds that he was not properly fulfilling his duties.6 The impeachment was officially carried out within the parameters of the Constitution.7 The Chamber of Deputies voted 76-1 to impeach Lugo on 21 June (3 were absent), while the Senate voted 39-4 (2 were absent) for impeachment the following day. The transition of power since Lugo’s impeachment has been smooth and seamless, and there were no adverse effects on the economy or the government’s creditworthiness as a result of the impeachment.

Immediately after the impeachment, Vice President Federico Franco of the centrist Partido Liberal Radical Auténtico (PLRA) assumed the presidency and remained in office until August 2013. General elections took place in April 2013 and were monitored by international observers from the Organization of American States (OAS) and the Carter Foundation, among others. Horacio Cartes of the right-wing Partido Colorado (PC), the party that held office in Paraguay for 61 years until 2008, won the elections with 45.8% of the vote. As Exhibit 4 shows, the PC also made significant headway in the legislative elections, winning 45 of the 80 seats in the Chamber of Deputies (compared to 26 seats prior to elections), and 19 of the 45 seats in the Senate (compared to 14 seats prior to elections). The PC now has a majority in the Chamber of Deputies, though not in the Senate. It is apparent that

6 The impeachment of former president Lugo was triggered by a conflict between police and peasant farmers one week prior, in which 17 people died. 7 The Constitution states that the president may be removed from office for failure to fulfill his/her duties and that this may be done via two-thirds majority in the Senate

and two-thirds majority in the Chamber of Deputies.

0

25

50Political Stability

Government Effectiveness

Rule of Law

Control of Corruption

Voice & Accountability

Regulatory Quality

Paraguay Median - Ba Median - L F2 Mean - VL F2


7 MARCH 7, 2014


government effectiveness has improved, since the Cartes government was able to enter into a governability pact with the second-largest party, the PLRA, and secure passage of several new laws in the first few months of the new administration. These laws include the Fiscal Responsibility Law, the Law to Modernize the State’s Financial Administration, the PPP Law, and a revision of the sovereign bond law, among others.8

EXHIBIT 4

Composition of Congress Senate

Chamber of Deputies

Sources: Honorable Chamber of Senators of Paraguay, Honorable Chamber of Deputies of Paraguay, Moody’s Investors Service

Cartes administration has cracked down on Congressional corruption Furthermore, President Cartes has cracked down on corruption, including an investigation into, and publication of, the salaries and spending practices of each member of Congress. This investigation ultimately resulted in public outrage against corruption in Congress. This public backlash was significant enough for Congress to reverse its decision to protect one Senator’s political immunity. The spotlight that Cartes placed on Congress in Paraguay has raised the public’s awareness of public sector corruption and led to widespread demands for cleaner politics. Ultimately, this event also reduced Congress’ clout, a positive development in terms of institutions, because Congress in Paraguay has typically been very strong (a response to the long-standing Stroessner dictatorship) and had the capacity to, year after year, approve large salary increases in the budget, reducing the government’s ability to focus on capital expenditures. The new Fiscal Responsibility Law limits Congress’ power by placing a cap on the annual increase in budgeted current primary expenditures and preventing Congress from being able to alter the revenues in the budget that it receives from the Ministry of Finance (details in Factor 3 section).

Inflation has been lower and less volatile in the past five years than in the five years prior In May 2011, in response to historically high inflation, the central bank shifted from targeting monetary aggregates to an inflation targeting regime, utilizing the 14-day rate as the key interest rate.9 The inflation target range is 5% +/- 2 percentage points, slightly narrower than the 5% +/- 2.5 percentage-point range that it adopted originally. Inflation has remained within the target range for most of the time since the targeting regime was adopted. However, it was above the range in the first few months after adopting inflation targeting, and it was below the range for six months in 2013,

8 See “Paraguay's New Legislation Set to Bolster Country's Fiscal and Institutional Framework,” 6 March, 2014. 9 The central bank now targets the overnight rate.

PC56%

PLRA34%

Other10%

PC42%

PLRA29%

FG11%

Other 18%

https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_164345


8 MARCH 7, 2014


owing in part to supply side shocks related to a drop in meat prices in the first half of the year, due to foot-and-mouth disease.

The fact that the central bank has commenced inflation targeting and remained within the range for the majority of the time since its adoption provides a boost to institutional strength. It is also noteworthy that annual (Dec/Dec) inflation has averaged just 4.5% over the past five years, with a standard deviation of 2.0, compared to an average of 7.7% inflation in the five years prior and a standard deviation of 3.7.

In terms of monetary policy management, in 2013 Carlos Fernández Valdovinos became the new president of the central bank. Fernández has a PhD from the University of Chicago and has worked as a senior economist at the World Bank and IMF. Most recently, he was the resident representative for the IMF in Brazil and Bolivia. The technical capacity of the central bank – as well as the Ministry of Finance – is advanced and professional, particularly in comparison to peer countries, Bolivia and Suriname, where much of the technical capacity tends to rest in the hands of one or very few individuals.

Box 1: Paraguay’s arrears are long since cleared, and it has implemented reforms outlined in IMF SBAs

The government has not reported debt arrears since 2003. However, in 2002-2003, Congress’ decision to reject a package of tax rises and spending cuts led the IMF to deny Paraguay a Stand-By Arrangement (SBA) which, in turn, shut off the country’s access to multilateral loans. As a result, the government had insufficient funds to finance its deficit, so it entered into arrears on Treasury bills held by local banks, as well as on debt owed to the Inter-American Development Bank (IDB) and World Bank, for a total of $65 million. Eventually, by the end of December 2003, the IMF approved a 15-month SBA after the government approved several reforms.10 The SBA was treated as precautionary, so the available funds were never used by the government. It also led to the release of previously approved funds from multilaterals, allowing the government to meet most of its debt-service falling due at the end of 2003. As a condition of receiving the SBA, the government agreed to clear all of its domestic and external arrears. Domestic banks agreed to roll over all debt coming due from 2003-2005 (approx. $138 million), including bonds in default since December 2002. The new bonds carried maturities of 1-5 years and interest rates that implied a slight reduction in net present value. In addition, the government eliminated all arrears to the World Bank and IDB within one month.

The December 2003 SBA was the first of two for Paraguay, with the second one lasting from May 2006 -August 2008, also precautionary. Upon completion of both SBA’s, spanning over a time frame of nearly five years, the IMF concluded that the program remained broadly on track, all performance criteria for end-March 2008 had been met, and it expected the end-June criteria to be met as well. Additionally, the IMF noted that “macroeconomic fundamentals [were] among the best in over a quarter century, although inflation [remained] a problem.” Since then, the central bank has adopted inflation targeting and inflation is both lower and less volatile. Also, the economy has remained sufficiently stable since 2008 so as not to require another SBA, even in the midst of the global financial crisis and several droughts.

10 This SBA was extended twice and eventually ended in November 2005.


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Fiscal Strength: High (+)

Fiscal metrics have improved relative to peer medians

Factor 3


+ -

Fiscal strength captures the overall health of government finances, incorporating the assessment of relative debt burdens and debt affordability as well as the structure of government debt. Some governments have a greater ability to carry a higher debt burden at affordable rates than others. Fiscal strength is adjusted for the debt trend, the share of foreign currency debt in government debt, other public sector debt and for cases in which public sector financial assets or sovereign wealth funds are present. Depending on the adjustment factor the overall score of fiscal strength can be lowered or increased.

Debt metrics are favorable compared to Ba and Baa peer medians Paraguay’s key fiscal and government debt metrics compare favorably against the medians for Ba- and Baa-rated countries (Exhibits 5-8). Owing to eight consecutive years of budget surpluses, general government debt fell to less than 10% of GDP in 2011. It has since risen, but only slightly, to an estimated 12.7% of GDP in 2013, well below both the Ba and Baa medians. As a percent of revenues, government debt amounted to an estimated 79% in 2013, also well below the Ba and Baa medians. Our projection is that debt/GDP will rise to 14% of GDP in 2014 and debt/revenues will rise to 84%.

EXHIBIT 5

Fiscal Balance/GDP (%) vs. Peers

Sources: National Sources, Moody’s Investors Service p=preliminary

EXHIBIT 6

Debt/GDP (%) vs. Peers


-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

Paraguay Median BaMedian Baa

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

50.0

Paraguay Median Ba

Median Baa


10 MARCH 7, 2014


EXHIBIT 7

Debt/Revenue (%)


EXHIBIT 8

Interest Payments/Revenues (%)


Most of the government’s debt is multilateral In 2012, the most recent year for which we have final data in detail, the majority of central government debt was external (60%); however, this is down from 83% the year before and all of it was owed to multilateral development banks and bilateral creditors (Exhibits 9-11). As a result, debt affordability was very high – interest payments amounted to just 1.3% of government revenues in 2012, well below the medians for Ba- and Baa-rated countries (Exhibit 8).

Within multilateral debt, the most important creditor was the IDB, followed by the World Bank and CAF. Japan Bank of International Cooperation was the most important bilateral creditor, followed by Taiwan.11 The government’s domestic debt (40% of the total) is comprised mostly of bonds held by private banks (primarily BBVA, Banco Itaú, Banco Continental, and Banco Regional), as well as the Deposit Guarantee Fund and the state development bank, Banco Nacional de Fomento.

Although we do yet not have a high level of granularity for 2013 central government debt, we know that it amounted to 12.7% of GDP and that the composition has changed, because the government issued its first global bond in early 2013.12 That $500 million issuance comprises just 13% of the total 2013 debt stock.

The largely multilateral/bilateral nature of Paraguay’s debt reduces rollover risk and explains the long average maturity of 20.8 years. The prevalence of multilateral/bilateral debt, as well as the government’s first international bond issuance, means that some 60% of general government debt is denominated in foreign currency, posing an element of exchange rate risk. However, this risk is mitigated by the fact that all of the government’s revenues associated with the Itaipú and Yacyretá dams are paid in US dollars – around $600 million per year. The government must pay approximately $213 million in foreign currency-denominated principal, interest, and commissions in 2014, so US dollar-denominated revenue amounts to roughly three times the government’s foreign currency-denominated debt service. Going forward, we expect US dollar-denominated revenues to remain at

11 After the Stroessner dictatorship in Paraguay, the democratically-elected government received an invitation from the People’s Republic of China to switch its diplomatic

recognition, but Paraguay refused. Debt owed to Taiwan consists of bonds issued to Chinatrust Commercial Bank and the International Commercial Bank of China (Mega International Commercial Bank).

12 The 2013 debt stock includes a central bank recapitalization bond amounting to roughly 1.7% of GDP.

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

180.0

200.0

Paraguay Median Ba

Median Baa

0.0

2.0

4.0

6.0

8.0

10.0

12.0

Paraguay Median Ba

Baa Median


11 MARCH 7, 2014


around $600 million per year or more,13 while foreign currency-denominated debt service amounts to $196 million and $188 million in 2015 and 2016, respectively.14

EXHIBIT 9

Government Debt Composition, 2012 (%)

Sources: Ministry of Finance of Paraguay, Moody’s Investors Service

EXHIBIT 10

Bilateral Debt Composition, 2012 (%)


EXHIBIT 11

Multilateral Debt Composition, 2012 (%)


Tax reforms will boost revenues without contributing significantly to revenue volatility Paraguay has lower revenues than all but two of its Ba-rated peers, Guatemala (Ba1) and Bangladesh (Ba3). Over the past five years, Paraguay’s government revenues have averaged 17.6% of GDP compared to the Ba median of 28.3%. Expenditures have outweighed revenues over the past two years, such that the central government has posted deficits, whereas it posted eight consecutive years of budget surpluses from 2004-2011 (Exhibit 12). The fiscal deficit was 1.9% of GDP in 2013, roughly the same as the 2012 deficit of 1.8% of GDP.

13 In March, Paraguay and Argentina entered into negotiations about Argentina’s treaty, which expires this year. Due to Argentina’s significant energy demands we expect

that the contract will be renewed after negotiations regarding (i) price paid for the energy, and (ii) interest payments that Argentina receives on Yacyreta’s debt. Paraguay will likely request a higher price for the energy it sells to Argentina and lower interest payments on Yacyreta’s debt, while Argentina will likely seek to maintain the status quo.

14 The government sells most of its USD-denominated revenue to the central bank in exchange for guaranies, since the budget is executed in guaranies. However, the authorities have noted that the Ministry of Finance keeps the USD-denominated revenues that it needs in order to make USD debt service payments each year.

Bilateral17%

Multilateral43%

Domestic40%

Japan49%

China11%

Taiwan37%

Other3%

IDB65%

World Bank24%

CAF6%

Other5%


12 MARCH 7, 2014


EXHIBIT 12

Government Revenues and Expenditures (% of GDP)

Source: Ministry of Finance of Paraguay, Moody’s Investors Service (p)=preliminary

With the passage of the new Fiscal Responsibility Law, beginning in 2015 the government is not permitted to post a deficit larger than 1.5% of GDP except in years of crisis. It has taken both revenue and expenditure measures to ensure that it will be able to comply with this law. On the revenue side, the government has begun to progressively implement a personal income tax (IRP),15 transformed its agricultural income tax (IRAGRO) from a progressive rate to a simple rate so all producers pay 10% no matter their size, and it has introduced a new 5% agricultural sector value-added tax (VAT). Exhibit 13 shows our estimates of additional revenue/GDP from 2014-2018, using Ministry of Finance revenue projections and our GDP growth projections. The boost to revenues will be around 0.4% of GDP this year, 0.9% in 2015, and nearly 1% of GDP through 2018.

EXHIBIT 13

Projected Impact of Tax Reforms Additional Tax Revenue (% of GDP)

2014 2015 2016 2017 2018

IRAGRO -- 0.41 0.44 0.46 0.48

Agro VAT 0.31 0.33 0.35 0.37 0.39

IRP 0.11 0.12 0.12 0.13 0.13

Total 0.43 0.86 0.91 0.95 1.00

Source: Ministry of Finance of Paraguay; Moody’s Investors Service Note: Assumes real GDP growth of 4.8% in 2014 and 4.5% thereafter.

In last year’s credit analysis, we noted that “if the agricultural sector were to be taxed, it would be credit positive, but that in the meantime, the agricultural sector’s negligible contribution to tax revenues actually shields government revenues from volatility stemming from shocks to the agricultural sector.” We made this comment because the agricultural sector is the largest and most volatile sector of the Paraguayan economy, thus if it were taxed heavily, it could increase revenue volatility. In this vein, we looked closely at the new composition of government revenues – after implementing the above-mentioned tax reforms – in order to determine whether or not the additional agricultural sector taxes would be likely to contribute significantly to revenue volatility. In short, because the two agricultural

15 According to authorities, the personal income tax’s (IRP’s) most important purpose is to help formalize the economy. IRP implementation began in 2012 and will be

progressively implemented until 2019.

Tax

Current

Tax

Current

Tax

Current

Tax

Current

Tax

Current Tax

Current

Non-tax

Capex

Non-tax

Capex

Non-tax

Capex

Non-tax

Capex

Non-tax

Capex Non-tax

Capex

0.0

5.0

10.0

15.0

20.0

25.0

2008 Rev.

2008 Exp.

2009 Rev.

2009 Exp.

2010 Rev.

2010 Exp.

2011 Rev.

2011 Exp.

2012 Rev.

2012 Exp.

2013 Rev. (p)

2013 Exp. (p)


13 MARCH 7, 2014


sector taxes will together amount to less than 1% of GDP at their maximum, our conclusion is that these additional taxes will not contribute significantly to the overall volatility of government revenues.

Fiscal institutions are set to strengthen with the Fiscal Responsibility Law On the expenditure side, the Fiscal Responsibility Law places a limit on the growth of current primary expenditures, imposes strict rules about salary increases and election-year spending, and curtails Congress’ ability to inflate budgeted revenues and therefore also limits its ability to increase expenditures.

Budgetary approval process in the past:

In last year’s credit analysis, we highlighted that Congress typically had a great deal of control over budgetary expenditures – both amount and allocation thereof – and that the budget tended to include a high level of current expenditures. Congress has historically had a great deal of strength in Paraguay, related to the country’s 35-year dictatorship under Alfredo Stroessner (1954-1989), during which time Congressional powers were dwarfed by the executive. Since its return to democracy, Congress has frequently used its powers to increase expenditures and, when it does so, it has simultaneously increased the line item for “other revenues” without actually identifying the source of those revenues.

However, the Ministry of Finance has long had the authority (Law 1535/99, Article 21) to spend less than that which is allocated in the budget, depending on seasonal changes in revenues, differing levels of expenditure execution within departments, etc. The Ministry of Finance has typically exercised this authority, which has been an important mitigating factor to Congress’ control over budgeted expenditures.

Whereas the Ministry of Finance has historically managed public finances soundly, the repeated approval of expansionary budgets by Congress previously left the door open for future administrations to be less fiscally responsible.

Budgetary approval process in the future:

With the approval of the Fiscal Responsibility Law (Box 2) late last year, Congress has lost its ability to inflate projected revenues in the budget that it receives from the Ministry of Finance. Moreover, there is a limit on the annual increase in current primary spending in the budget and strict rules about when there may be salary increases. As mentioned above, the strong fiscal oversight of the Ministry of Finance mitigated risks associated with Congress’ regular passage of expansionary budgets in the past. However, that practice placed a great deal of emphasis on the Ministry of Finance and left open the possibility that a future Ministry could be less fiscally responsible. The passage of the Fiscal Responsibility Law eliminates this risk and helps to institutionalize fiscal responsibility.


14 MARCH 7, 2014


Box 2: Fiscal Responsibility Law

In late October 2013, Congress approved Law 5098, the Fiscal Responsibility Law. The law includes the following stipulations:

» The central government’s fiscal deficit is not to exceed 1.5% of GDP beginning in 2015, or 1% of GDP in the medium-term (i.e., 3 years from now); in crisis years, there may be an exception, but even in those years, the deficit may not exceed 3% of GDP;

» The annual increase in current primary spending of the public sector shall not exceed the inflation rate plus 4%;

» There may be no salary increases, except when there is an increase in the minimum wage, and the minimum wage may be increased only when inflation exceeds 10% year-over-year (y/y). When a salary increase takes place it shall, at a maximum, be equivalent to the increase in the minimum wage and will be incorporated into the budget for the following year;

» Congress may no longer adjust the revenues in the budget submitted to it by the Executive branch;

» In general election years, central government current primary spending during January-July may not exceed 60% of the budget for that year;

» The government will create a multi-year (3-year) budget for referential purposes, in order to determine the adequate provision of revenues and expenditures over the medium-term.

The overarching purpose of this law is to strengthen fiscal institutions and oversight, with an added goal of managing the growth of current expenditure in order to focus on stronger growth of capital expenditure.

Other recent laws will boost efficiency of government finances The government has also secured passage of several other laws that will lead to more efficient fiscal expenditure, including the Law to Modernize the State’s Financial Administration, a revision of the sovereign bond law to make it more flexible, and the law creating the National Board of Public Companies (CNEP) to evaluate the management of public companies.16

Susceptibility to Event Risk: Low

The most significant risk involves climate-related shocks

Factor 4

Scale VL- VL VL+ L- L L+ M- M M+ H- H H+ VH- VH VH+

+ -

Susceptibility to Event Risk evaluates a country’s vulnerability to the risk that sudden events may severely strain public finances, thus increasing the country’s probability of default. Such risks include political, government liquidity, banking sector and external vulnerability risks. Susceptibility of Event Risk is a constraint which can only lower the preliminary rating range as given by combining the first three factors.

16 See “Paraguay's New Legislation Set to Bolster Country's Fiscal and Institutional Framework,” 6 March, 2014.



15 MARCH 7, 2014


Political risk is low Whereas social demands were significant enough in 2012 to lead to political instability – i.e., Lugo’s impeachment – the instability had no clear impact on the economy or the government’s willingness or ability to service its debt obligations. In retrospect, the impeachment tested the resilience of Paraguay’s institutional framework, which demonstrated its adequate strength. Even after being temporarily suspended from MERCOSUR, sanctions with key trading partners – our primary concern – did not materialize. And since a two-thirds majority is needed in both the Senate and Chamber of Deputies in order to impeach a president in Paraguay, we view the likelihood of another impeachment as low.

Finally, in our last credit analysis, we cited Congress’ significant control over budgeted expenditures as a potential political risk. However, the magnitude of this risk has changed markedly since Cartes has cracked down on Congressional corruption, and because the Fiscal Responsibility Law places a cap on current primary expenditure growth, delineates strict rules about when salaries may be increased, and has taken away Congress’ ability to inflate revenues in the budget. Therefore, we no longer view Congress’ power over the budget as a material political risk.

Government liquidity risk is low For 2014, we are projecting a fiscal deficit of 1.6% of GDP. Since there are no salary increases budgeted for 2014 and the Fiscal Responsibility Law places a cap on current primary expenditure growth, the deficit in 2014 will be largely due to an increase in capital expenditures. The proceeds of the government’s first $500 million global bond have not yet been completely spent and are currently deposited at the central bank. The revision of the sovereign bond law should make it easier for the government to execute this year’s capital expenditures, which are budgeted at roughly $1.7 billion (5.4% of projected GDP).

In addition to the projected deficit of 1.6% of GDP, the central government’s debt service in 2014 amounts to $434 million (1.4% of projected GDP), bringing gross financing needs to 3% of GDP, an amount that could be financed by a combination of multilateral/bilateral and domestic credit. However, the government has indicated that it may issue another global bond in 2014. The authorities highlight three reasons for the second planned issuance, aside from the primary goal of increasing infrastructure investment: (1) promoting recognition of the Paraguayan economy and its progress over the past several years, as a means of establishing investor interest in the country, (2) developing a yield curve to serve as a benchmark for other debt in the Paraguayan market, and (3) greater discretion with respect to expenditures – all multilateral loans must be passed by law in Congress, a process that takes up to a year.17

17 Congress must also approve international bond issuance, as it did in the case of the planned 2013 issuance. The 2014 budget law incorporates Congress’ approval of

roughly USD437 million in international bond issuance.


16 MARCH 7, 2014


Exhibits 14 and 15 show Paraguay’s debt service schedule, which demonstrates no major spikes in the foreseeable future.

EXHIBIT 14

Debt Service Schedule, USD mn External vs. Domestic Debt Service

Principal, Interest, and Commissions


Current account typically posts a small surplus Paraguay’s current account has been in virtual balance – average over the past decade: +1% of GDP – posting surpluses more often than deficits.

In 2012, the last year for which full-year data are available, there was an exception when the current account posted a 1% of GDP deficit, owing to that year’s foot-and-mouth disease and drought; the deficit was more than fully covered by foreign direct investment (FDI). In 2013, the three quarters of data that are available, plus our estimate based on past fourth quarter current account trends, indicates that the current account likely posted a surplus of just under 1% of GDP.

Using the new presentation of the balance of payments (Box 3), the trade and transfers accounts typically post surpluses, which deficits on the services and income accounts only partially offset (Exhibits 15 and 16).

EXHIBIT 15

Current Account Components (% GDP)


EXHIBIT 16

Current Account and FDI (% GDP)

Sources: Central Bank of Paraguay, Moody’s Investors Service p=preliminary

0

50

100

150

200

250

300

350

400

450

500

2014 2015 2016 2017 2018 2019 2020

0

50

100

150

200

250

300

350

400

450

500

2014 2015 2016 2017 2018 2019 2020

-25%

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

25%

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Goods Services Income Transfers

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013p

Current account FDI


17 MARCH 7, 2014


Box 3: Paraguay’s balance of payments accounting has changed

The way in which Paraguay implements its balance of payments accounting has changed, bringing it in line with the IMF’s 5th Edition of the Balance of Payments Manual. The main change is that Paraguay’s 50% share of the binational dams was previously classified as “non-resident,” but is now classified as “resident.” As a consequence, the overall result of the balance of payments has not changed, just the accounting thereof.

First, the current account result is more positive: On the trade account, the central bank now includes hydroelectric energy exports to Brazil and Argentina, and excludes hydroelectric energy imports from energy produced in the 50% that used to be classified as “non-resident.” On the services account, services (royalties, construction services, etc.) sold to the 50% share of the dams that used to be classified as “non-resident” are no longer included. On the income account, compensation of residents of Paraguay working at the then “non-resident” dams is now excluded from inflows, since the dams are classified as “resident,” and interest payments for debt owed by Itaipú are now included as an outflow. The accounting of the transfers account did not change.

Second, the capital and financial account result is less positive: This is because outflows on the financial account are larger, due to amortization payments of the debt owed by the Itaipú dam.

Hydroelectric energy and soy exports keep the trade account in surplus The top three exports in 2013 were soy (27%), hydroelectric energy (24%), meat (11%), and grains (8%). Although some of these exports are commodities that are vulnerable to climate and other events (Exhibits 17 and 18), hydroelectric energy prices and export volumes, set by treaty, are stable.

Paraguay has benefited from high commodity prices over the past several years (Exhibits 19 and 20). Although there is a risk that commodity prices could fall, 18 it is important to note that during 2000-2006, when soy, meat, and grain prices were much lower than their current levels, the current account deficit was never larger than 3% of GDP.

The largest single sub-component of imports includes machinery, machine parts, and motors (26%), used in the agricultural sector. Fuels and lubricants are the second-largest import sub-component, but account for only 14% of total goods imports, given that oil is not needed for electricity generation in Paraguay.

18 Since most of Paraguay’s commodity exports are food products, they are relatively inelastic and are therefore somewhat shielded from the risk of a demand-driven drop

in prices.


18 MARCH 7, 2014


EXHIBIT 17

Exports by product, USD billions


EXHIBIT 18

Exports by product, % total value


EXHIBIT 19

Soy and Meat Prices, $ per ton

Sources: Central Bank of Paraguay, Reuters, Moody’s Investors Service

EXHIBIT 20

Corn and Wheat Prices, $ per ton


Export markets have become more diversified and Brazil dependency has declined Official figures from the central bank show that Paraguay’s export markets are well diversified. Its largest trading partners are MERCOSUR members, Argentina, Brazil, and Uruguay, which together purchased 42% of Paraguay’s exports in 2013, followed by the European Union at 14%, Russia at 10%, and Asia at 9% (Exhibit 22).

Paraguay’s export markets become steadily more diversified each year. MERCOSUR accounted for 75% of total exports a decade ago, the European Union accounted for just 3%, and Russia comprised only 1% of the total. Export market diversification is not only evident when comparing current figures with those from a decade ago. As recently as four years ago, export markets were less diversified as well (Exhibit 21).

Finally, Brazil alone accounted for 47% of exports in 2004, 44% in 2009, and now accounts for just 30% of total exports, a trend which will benefit Paraguay, given Brazil’s weaker growth trend.

0.00

2.00

4.00

6.00

8.00

10.00

2004

2005

2006

2007

2008

2009

2010

2011

2012

p

2013

p

Soy Electric Energy Meat

Grains Flour Vegetable oil

Wood Cotton Other

0

20

40

60

80

100

2009

2010

2011

2012

p

2013

p

Soy Electric Energy MeatGrains Flour Vegetable oilWood Cotton Other

0

100

200

300

400

500

600

0

500

1,000

1,500

2,000

2,500

3,000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Meat (LHS) Soy (RHS)

0

50

100

150

200

250

300

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

Corn Wheat


19 MARCH 7, 2014


Box 4: Paraguay is once again fully integrated into MERCOSUR

After Congress removed former president Fernando Lugo from office in the summer of 2012, MERCOSUR temporarily suspended Paraguay’s membership in the organization. Paraguay was re-integrated into the trade bloc in December 2013, three months after the new president, Horacio Cartes, took office. The re-integration took place after Paraguay’s Congress officially approved Venezuela’s membership in MERCOSUR.

It is worth noting that the temporary suspension only restricted Paraguay’s ability to participate in the decision-making body of MERCOSUR. Since none of the MERCOSUR countries imposed sanctions on Paraguay, its trade relations remained unaffected and FOCEM (Fund for the Structural Convergence of MERCOSUR) funds continued to flow into Paraguay, just as they had prior to its temporary suspension.

EXHIBIT 21

Goods Export Markets, 2009 (%)


EXHIBIT 22

Goods Export Markets, 2013 (%)


Services and income accounts post deficits, while remittances keep the transfers account in surplus Small deficits on the services account reflect primarily transport costs, as the tourism subcomponent posts a small surplus. As mentioned above, the services account no longer posts a surplus within the new balance of payments accounting because it excludes services exports related to the dams, since they are now classified as “resident.”

The income account posts a moderate deficit because of profit remittances related to the dams, as well as interest payments on Itaipú’s debt.

Surpluses on the transfers account stem from a combination of workers’ remittances and international donations. Workers’ remittances accounted for 70% of the transfers surplus in 2012, the last full year for which data are available, and amounted to 2.2% of GDP. During January-October last year, the majority of remittances (64%) came from Spain, followed by the US (26%). For the period from January-October 2013, remittances contracted by 7% year-over-year (y/y), mostly because of a 29% decline in remittances from the US. Despite weak economic conditions in Spain, remittances from that country grew by 6.4% y/y over the same period. Our expectation is that remittances from the US will recover as the US economy continues its gradual recuperation.

Mercosur56%European

Union10%

Asia7%

Russia5%

ROW22% Mercosur

42%

European Union14%

Asia9%

Russia10%

ROW25%


20 MARCH 7, 2014


FDI is set to increase, due to the new PPP law and revisions to the sovereign bond law Net foreign direct investment (FDI) over the past five years has averaged around 1.4% of GDP per year, below the 2.5% Ba median. However, in the infrequent years when the current account has posted a deficit, FDI has been sufficient to fully cover it. Moreover, FDI has contributed to steady surpluses on the capital and financial accounts over the past decade. The combination of these surpluses and frequent current account surpluses has led to a significant increase in gross international reserves (excluding gold) since 2003.

In terms of stock as of the third quarter of 2013, the most important FDI sectors in Paraguay were financial intermediation (25%), trade (22%), production of oils (17%), transport and communications (9% each), and beverages and tobacco (6%). In terms of flows in 2012, the last year for which we have full-year data, production of oils received the most FDI as a percent of GDP, followed by financial intermediation, communication, and chemical products (Exhibits 23 and 24).

In the years to come, we expect Paraguay to attract more FDI, particularly as the government makes a concerted effort to increase infrastructure development in the country. In 2013, the Cartes administration managed to secure passage of a PPP law, which had been under discussion during the previous administration. With this law, the government plans to attract investment into projects such as the industrial shipping channel on the Paraguay and Paraná rivers, highways linking Asunción with Ciudad del Este (Route II) and Caacupé with Caaguazú (Route VII), water and sanitation projects, and electricity infrastructure (i.e., transmission lines). The government itself plans to increase infrastructure investment, using the proceeds from the $500 million bond that it issued in January 2013. The 2014 budget takes into account a proposed 52% increase in capital expenditure relative to 2013.

Because the law overseeing the use of the bond proceeds was previously very rigid (i.e., stating that the proceeds may only be used for certain new infrastructure developments), the government was unable to spend the money, since the bidding process for those projects was very time consuming. Therefore, the bond proceeds remained in an account at the central bank last year. In November 2013, however, Congress approved a change to the law overseeing the use of the sovereign bond proceeds, such that the government may now use them for projects that are already in progress. This change will help the government improve its capital expenditure execution, leading to the strengthening of the country’s infrastructure which will, in turn, help attract additional FDI. Our expectation is that FDI will increase to around 2% of GDP this year.


21 MARCH 7, 2014


EXHIBIT 23

2013 Foreign Direct Investment Stock (% total, by sector)


EXHIBIT 24

2013 Foreign Direct Investment Flows (% of GDP, by sector)


Climate-related shocks remain the country’s most significant risk Climate-related events impact government revenues via lower growth, as seen in 2012 with the double shock of drought and foot-and-mouth disease, which drove the economy into recession. Although the majority of government revenues are vulnerable to growth volatility which is often driven by climate-related shocks, the government has a buffer in the form of US dollar-denominated revenues which tend to increase when the guaraní depreciates in years of weak growth or recession.

As the economy’s high dependence upon soy and meat is a relatively recent development (i.e., the past ten years), and prices of these products have been stable or rising during that time, the economy has yet to experience a price-driven shock. Nevertheless, the Ministry of Finance expects that the impact of lower soy and/or meat prices would be similar to that of a drought, which the economy has experienced on various occasions – most recently in 2009 and 2012.19 In both years, government finances remained sound, with the financial balance in surplus or posting a small deficit and government debt remaining below 15% of GDP.

19 In addition to the technical assistance that the IDB will provide to the government in the realm of energy, they will also work on a climate study whose outcome is

intended to include recommendations that will help shield the country from unanticipated climate-related shocks.

Agriculture3%

Production of oils17%

Beverages and tobacco6%

Chemical products3%

Trade22%Transport

9%

Communication9%

Financial intermediation25%

Other6%

2.1

1.1

0.7

0.5

0.2

-0.1

-0.4

-0.5 0.0 0.5 1.0 1.5 2.0

Total FDI

Production of oils

Financial Intermediation

Communication

Chemical Products

Trade

Transport


22 MARCH 7, 2014


Importantly, the country’s resilience to external shocks has increased significantly. Gross international reserves have grown nearly six-fold over the past decade. International reserves now amount to $5.5 billion, nearly 20% of GDP, and provide almost six months of import cover. Due to the stronger reserves cushion, external liquidity indicators have improved markedly over the past several years, such that gross international reserves are sufficient to fully cover gross (public and private) external debt (Exhibit 25). And the external vulnerability indicator20 was 63% in 2013, just about on par with the Ba and Baa medians (Exhibit 26).

EXHIBIT 25

Total External Debt/Official Foreign Exchange Reserves (%)

Sources: National Sources, Moody’s Investors Service e=estimate

EXHIBIT 26

External Vulnerability Indicator (%)

Sources: National Sources, Moody’s Investors Service e=estimate

Financial dollarization stems from a legacy of volatile inflation and exchange rate Paraguay is a small, open economy whose exchange rate is vulnerable to exogenous factors impacting the current account (e.g., climate related events). There are also elevated levels of financial dollarization, which in the case of Paraguay, stems from a history of high inflation and exchange rate volatility (Exhibits 27 and 28). It is important, however, to note that the central bank has taken several measures to enhance its credibility and ability to implement monetary policy. These measures should help anchor inflation expectations in the future: the central bank adopted inflation targeting in May 2011, appointed members to fill vacancies on its board in September 2012, and completed its recapitalization in December 2012. The inflation rate has been lower and less volatile in the past five years than in the five years prior. Also, the dollarization ratio has fallen to 40% from 60% in 2002 (Exhibits 29 and 30).

20 External vulnerability indicator = Short-term external debt + currently maturing long-term external debt + total nonresident deposits over one year/Official foreign

exchange reserves (%).

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

Paraguay Ba Median

Baa Median

0.0

50.0

100.0

150.0

200.0

250.0

300.0

350.0

Paraguay Ba Median

Baa Median


23 MARCH 7, 2014


EXHIBIT 27

Nominal PGY/USD Exchange Rate


EXHIBIT 28

Inflation, y/y (%) and the Target Range

Sources: Central Bank of Paraguay, Reuters, Moody’s Investors Service. Note:

Blue dotted line indicates inflation target range.

EXHIBIT 29

Composition of Total Banking System Deposits (%)


EXHIBIT 30

Composition of Banking System Loans to the Private Sector (%)


3,000

3,500

4,000

4,500

5,000

5,500

6,000

6,500

Jan-

04

Sep-

04

May

-05

Jan-

06

Sep-

06

May

-07

Jan-

08

Sep -

08

May

-09

Jan-

10

Sep-

10

May

-11

Jan-

12

Sep-

12

May

-13

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

Jan-

04

Sep-

04

May

-05

Jan-

06

Sep-

06

May

-07

Jan-

08

Sep-

08

May

-09

Jan -

10

Sep-

10

May

-11

Jan-

12

Sep-

12

May

-13

30

35

40

45

50

55

60

65

70

Jan-

01

May

-01

Sep-

01

Jan-

02

May

-02

Sep-

02

Jan-

03

May

-03

Sep-

03

Jan-

04

May

-04

Sep-

04

Jan-

05

May

-05

Sep-

05

Jan-

06

May

-06

Sep-

06

Jan-

07

May

-07

Sep-

07

Jan-

08

May

-08

Sep-

08

Jan-

09

May

-09

Sep-

09

Jan-

10

May

-10

Sep-

10

Jan-

11

May

-11

Sep-

11

Jan-

12

May

-12

Sep-

12

Jan-

13

May

-13

Sep-

13

Local currency Foreign currency

30

35

40

45

50

55

60

65

70

Jan-

01

May

-01

Sep-

01

Jan-

02

May

-02

Sep-

02

Jan-

03

May

-03

Sep-

03

Jan-

04

May

-04

Sep-

04

Jan-

05

May

-05

Sep-

05

Jan-

06

May

-06

Sep-

06

Jan-

07

May

-07

Sep-

07

Jan-

08

May

-08

Sep-

08

Jan-

09

May

-09

Sep-

09

Jan-

10

May

-10

Sep-

10

Jan-

11

May

-11

Sep-

11

Jan-

12

May

-12

Sep-

12

Jan-

13

May

-13

Sep-

13

Local currency Foreign currency


24 MARCH 7, 2014


Rating Range

Combining the scores for individual factors provides an indicative rating range. While the information used to determine the grid mapping is mainly historical, our ratings incorporate expectations around future metrics and risk developments that may differ from the ones implied by the rating range. Thus, the rating process is deliberative and not mechanical, meaning that it depends on peer comparisons and should leave room for exceptional risk factors to be taken into account that may result in an assigned rating outside the indicative rating range. For more information please see our Sovereign Bond Rating Methodology.

Sovereign Rating Metrics: Paraguay

Economic Strength

How strong is the economic structure?

Economic Resiliency

Sub-Factors: Growth Dynamics, Scale of the Economy, Wealth

VH+ VH VH- H+ H H- M+ M M- L+ L L- VL+ VL VL-

+ -

Institutional Strength

How robust are the institutions and how predictable are the policies?


+ -

Government Financial Strength

Sub-Factors: Institutional Framework and Effectiveness,

Policy Credibility and Effectiveness


+ -

Fiscal Strength

How does the debt burden compare with the government's resource mobilization capacity?


+ -

Sub-Factors: Debt Burden, Debt Affordability


+ -

Susceptibility to Event Risk

What is the risk of a direct and sudden threat to debt repayment?

Sub-Factors: Political Risk, Government Liquidity Risk,

Banking Sector Risk, External Vulnerability Risk

VL- VL VL+ L- L L+ M- M M+ H- H H+ VH- VH VH+

+ -

Rating Range: Baa3 – Ba2

Assigned Rating: Ba2



25 MARCH 7, 2014


Comparatives

This section compares credit relevant information regarding Paraguay with other sovereigns rated by Moody’s Investors Service. It focuses on a comparison with sovereigns within the same rating range and shows the relevant credit metrics and factor scores.

Paraguay’s economic strength of low (+) is weaker than most key peers due to the economy’s small size, low income per capita, lack of diversification, and growth volatility. Institutional strength of low (-) is similar to key peers, owing to the country’s low ranking in the World Bank’s governance indicators, however recent legislation in Paraguay should help strengthen the institutional framework in the years ahead. The government’s fiscal strength is high (+), which compares favorably to key peers because of very low debt ratios as a percent of revenues and GDP. Moreover, most of the government’s debt is concessional, leading to a low interest payments/revenues ratio. Low susceptibility to event risk compares favorably to key peers and reflects not only Paraguay’s resilience to a recent political shock, but also healthy government liquidity and the country’s strengthened external position.

EXHIBIT 31

Paraguay Key Peers

Year Paraguay Dominican

Republic Bangladesh Guatemala Suriname Bolivia Armenia Latin America &

Caribbean Median

Rating/Outlook Ba2/POS B1/STA Ba3/STA Ba1/STA Ba3/STA Ba3/STA Ba2/STA Ba2

Rating Range Baa3 - Ba2 Ba3 - B2 Ba3 - B2 Ba2 - B1 Ba1 - Ba3 Ba2 - B1 Ba1 - Ba3 Baa3 - Ba2

Factor 1 L+ M M- L M- M- L- M-

Nominal GDP (US$ Bn) 2012 24.6 58.9 116.1 50.2 5.0 27.0 10.0 31.6

GDP per Capita (PPP, US$) 2012 6,053 9,547 1,963 5,153 12,299 5,041 5,924 11,747

Avg. Real GDP (% change) 2008-2017 4.9 4.6 6.2 3.1 4.4 4.8 3.1 3.1

Volatility in Real GDP growth (ppts) 2003-2012 4.5 3.5 0.4 1.6 1.3 1.0 8.6 2.6

Global Competitiveness Index, percentile [1] 2012 7.0 14.9 12.2 29.8 14.0 19.2 33.3 27.2

Factor 2 L- L- VL+ L L+ L- M- M

Government Effectiveness, percentile [1] 2012 5.5 18.8 8.6 13.3 44.8 26.7 41.7 36.2

Rule of Law, percentile [1] 2012 11.0 19.6 10.2 6.2 47.2 7.0 33.0 30.7

Control of Corruption, percentile [1] 2012 14.1 14.9 12.5 19.6 36.2 17.3 26.7 35.4

Avg. Inflation (% change) 2008-2017 5.2 5.2 7.8 4.9 6.4 5.5 5.1 4.9

Volatility in Inflation (ppts) 2003-2012 3.6 15.4 1.9 2.7 6.7 3.8 2.8 2.7

Factor 3 H+ L- L M+ H- H- H- M+

Gen. Gov. Debt/GDP 2012 12.5 32.9 38.9 24.4 21.3 33.4 44.1 33.4

Gen. Gov. Debt/Revenues 2012 66.0 237.5 302.3 209.2 87.6 95.2 180.8 163.3

Gen. Gov. Interest Payments/Revenue 2012 1.3 17.7 17.2 13.1 3.5 2.6 4.2 9.0

Gen. Gov. Interest Payments/GDP 2012 0.2 2.4 2.6 1.5 0.9 0.9 1.0 1.9

Gen. Gov. Financial Balance/GDP 2012 -1.8 -5.6 -4.3 -2.4 -2.7 1.8 -1.5 -2.1

Factor 4 L M M- M- M+ M+ M M-

Current Account Balance/GDP 2012 0.2 -7.2 -0.1 -2.9 4.8 7.9 -11.1 -3.5

Gen. Gov. External Debt/Gen. Gov. Debt 2012 59.7 66.9 18.6 57.6 53.1 42.9 -- 48.0

External Vulnerability Indicator 2014F 57.4 117.6 29.1 30.6 7.1 14.0 119.1 57.4

Notes: [1] Moody’s calculations. Percentiles based on our rated universe. Source: Moody’s, [ ]


26 MARCH 7, 2014


Appendices

Chart Pack

Paraguay

EXHIBIT 32

Economic Growth

Source: Moody’s Investors Service

EXHIBIT 33

Investment and Saving


EXHIBIT 34

National Income


EXHIBIT 35

Population

Source: Moody’s Investors Service, World Bank

EXHIBIT 36

Global Competitiveness Index Rank [119] out of [148] countries

Source: World Economic Forum

EXHIBIT 37

Inflation and Inflation Volatility


0.0

1.0

2.0

3.0

4.0

5.0

6.0

-5

0

5

10

1520

03

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

E

2014

F

Real GDP Volatility, t-9 to t (ppts) (RHS)

Real GDP (% change) (LHS)

0

5

10

15

20

25

30

35

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

E

2014

F

Gross Investment/GDPGross Domestic Saving/GDP

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

E

2014

F

GDP per capita (US$) GDP per capita (PPP basis, US$)

1.6

1.7

1.7

1.8

1.8

1.9

1.9

2.0

2.0

2.1

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

E

2014

F

Population (Mil.) (LHS)

Population growth (% change) (RHS)

119

110

106

105

98

86

0 50 100 150

Paraguay (Ba2/POS)

Bangladesh (Ba3/STA)

Suriname (Ba3/STA)

Dominican Republic (B1/STA)

Bolivia (Ba3/STA)

Guatemala (Ba1/STA)

0.0

1.0

2.0

3.0

4.0

5.0

0

2

4

6

8

10

12

14

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

E

2014

F

Inflation Rate Volatility, t-9 to t (ppts) (RHS)

Inflation Rate (CPI, % change Dec/Dec) (LHS)


27 MARCH 7, 2014


EXHIBIT 38

Institutional Framework and Effectiveness

Notes: [1] Composite index with values from about -2.50 to 2.50: higher

values correspond to better governance. Source: World Bank Governance Indicators

EXHIBIT 39

Debt Burden


EXHIBIT 40

Debt Affordability


EXHIBIT 41

Financial Balance


EXHIBIT 42

Government Liquidity Risk


EXHIBIT 43

External Vulnerability Risk


-1.6

-1.4

-1.2

-1.0

-0.8

-0.6

-0.4

-0.2

0.0

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Government Effectiveness[1] Rule of Law[1]Control of Corruption[1]

0

50

100

150

200

250

0

5

10

15

20

25

30

35

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

E

2014

F

Gen. Gov. Debt/GDP (%) (LHS)

Gen. Gov. Debt/Gen. Gov. Revenue (%) (RHS)

0123456789

0.0

0.2

0.4

0.6

0.8

1.0

1.2

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

FGen. Gov. Interest Payment/GDP (%) (LHS)

Gen. Gov. Interest Payment/Gen. Gov. Revenue (%) (RHS)

-3

-2

-1

0

1

2

3

4

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

E

2014

F

Gen. Gov. Financial Balance/GDP (%)Gen. Gov. Primary Balance/GDP (%)

0

10

20

30

40

50

0

20

40

60

80

100

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Gen. Gov. Debt/GDP (%) (RHS)

Gen. Gov. External Debt/Total Gen. Gov. Debt (%) (LHS)

-2

0

2

4

6

8

10

12

-250

-200

-150

-100

-50

0

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Net International Investment Position/GDP (%) (LHS)Current Account Balance/GDP (%) (RHS)


28 MARCH 7, 2014


Rating History

Paraguay

Government Bonds Foreign Currency Ceilings

Foreign Currency Local Currency Outlook Bonds & Notes Bank Deposit Date

Long-term Short-term Long-term Short-term

Rating Raised Ba2 Ba2 Positive -- -- Ba3 -- February-14

Rating Raised Ba3 Ba3 Stable Ba1 -- B1 -- January-13

Rating Raised B1 B1 Stable Ba3 -- B2 -- December-10

Review for Upgrade B3 B3 RUR+ -- -- -- -- June-10

Rating Raised B3 B3 Stable B2 -- B3 -- April-08

Review for Upgrade Caa1 Caa1 RUR+ -- -- -- -- November-07

Rating Raised -- -- -- B3 -- -- -- May-06

Rating Lowered Caa1 Caa1 Stable Caa1 -- Caa2 -- April-03

Rating Assigned B2 B1 Stable B2 NP B3 NP July-98


29 MARCH 7, 2014


Annual Statistics Paraguay

2005 2006 2007 2008 2009 2010 2011 2012 2013E 2014F

Economic Structure and Performance

Nominal GDP (US$, Bil.) 8.7 10.6 13.8 18.5 15.9 20.0 25.1 24.6 29.9 31.9

Population (Mil.) 5.9 6.0 6.1 6.2 6.3 6.5 6.6 6.7 6.8 6.9

GDP per capita (US$) 1479.4 1770.0 2252.1 2967.2 2510.3 3103.5 3818.5 3677.9 4392.6 4605.1

GDP per capita (PPP basis, US$) 4564.2 4840.0 5143.3 5478.2 5209.1 5860.3 6123.9 6053.2 -- --

Nominal GDP (% change, local currency) 12.4 11.2 15.7 16.3 -2.0 20.0 10.8 3.4 17.8 9.3

Real GDP (% change) 2.1 4.8 5.4 6.4 -4.0 13.1 4.3 -1.2 13.6 4.8

Inflation (CPI, % change Dec/Dec) 9.7 12.5 6.1 7.6 2.0 7.5 5.1 4.1 4.2 4.5

Gross Investment/GDP 17.0 17.1 15.8 16.4 13.8 16.2 16.8 15.5 16.5 17.0

Gross Domestic Savings/GDP 29.2 26.8 25.6 20.9 20.6 19.8 19.3 18.2 18.1 18.5

Nominal Exports of G & S (% change) 16.3 23.0 25.0 27.8 -17.8 34.5 19.6 -4.5 20.2 11.2

Nominal Imports of G & S (% change) 21.5 29.9 23.8 41.7 -22.2 44.9 21.7 -4.9 14.1 13.3

Openness of the Economy [1] 104.2 107.8 103.5 103.5 96.3 106.6 102.7 99.9 96.4 101.4

Government Effectiveness [2] -0.8 -0.9 -0.8 -0.9 -0.9 -0.9 -0.8 -0.9 -- --

Government Finance

Gen. Gov. Revenue/GDP [3] 15.6 16.0 15.7 15.8 17.6 17.1 18.1 19.0 16.1 16.5

Gen. Gov. Expenditures/GDP [3] 15.0 15.6 14.8 13.6 17.5 15.9 17.3 20.8 18.0 18.1

Gen. Gov. Financial Balance/GDP [3] 0.7 0.4 0.9 2.3 0.1 1.2 0.7 -1.8 -1.9 -1.6

Gen. Gov. Primary Balance/GDP [3] 1.7 1.3 1.6 2.8 0.6 1.6 1.0 -1.6 -1.7 -1.4

Gen. Gov. Debt (US$ Bil.) [3] 2.1 2.1 2.2 2.2 2.4 2.5 2.3 3.2 3.8 4.3

Gen. Gov. Debt/GDP [3] 23.5 18.3 15.3 13.8 13.8 11.9 9.8 12.5 12.7 13.9

Gen. Gov. Debt/Gen. Gov. Revenue [3] 150.3 114.3 97.9 86.9 78.7 69.4 54.2 66.0 79.1 84.0

Gen. Gov. Int. Pymt/Gen. Gov. Revenue [3] 6.4 5.4 4.7 3.5 3.1 2.1 1.5 1.3 1.5 1.5

Gen. Gov. FC & FC-indexed Debt/GG Debt [3] 87.6 85.8 83.9 84.0 80.2 80.5 83.4 59.7 60.0 59.8

External Payments and Debt

Nominal Exchange Rate (local currency per US$, Dec) 6120.0 5190.0 4875.0 4945.0 4610.0 4573.8 4439.9 4288.8 4290.0 4500.0

Real Eff. Exchange Rate (% change) -6.0 13.6 11.1 16.3 -7.4 2.8 13.4 -0.3 -- --

Current Account Balance (US $ Bil.) -0.1 0.2 0.8 0.2 0.5 -0.1 0.1 0.0 0.2 0.2

Current Account Balance/GDP -0.8 1.6 5.6 1.0 3.0 -0.3 0.5 0.2 0.8 0.5

External Debt (US $ Bil.) 3.1 3.1 3.2 3.9 3.9 4.5 4.7 4.9 5.4 5.7

Public Sector External Debt/Total External Debt 85.4 84.6 79.4 73.0 76.1 69.4 67.3 67.0 67.9 67.4

Short-term External Debt/Total External Debt 31.1 33.5 35.9 47.4 42.5 47.9 50.9 47.1 48.7 48.9

External Debt/GDP 35.4 29.4 23.3 21.1 24.5 22.5 18.7 19.8 18.2 18.0

External Debt/CA Receipts [4] 57.0 45.3 38.1 36.4 43.7 38.5 33.2 35.9 33.3 31.6

Interest Paid on External Debt (US$ Bil.) 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.2 0.2 0.2

Amortization Paid on External Debt (US$ Bil.) 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.7 0.5 0.6

Net International Investment Position/GDP -153.6 -121.8 -93.4 -69.3 -66.6 -49.3 -37.9 -40.0 -- --

Official Foreign Exchange Reserves (US$ Bil.) 1.1 1.5 2.4 2.8 3.6 3.9 4.7 4.4 5.5 5.8

Net Foreign Assets of Domestic Banks (US$ Bil.) 0.3 0.3 0.2 0.3 0.3 0.2 -0.1 -0.4 -- --


30 MARCH 7, 2014


Paraguay

2005 2006 2007 2008 2009 2010 2011 2012 2013E 2014F

Monetary, External Vulnerability and Liquidity Indicators

M2 (% change Dec/Dec) 16.3 15.9 39.4 42.7 25.8 16.5 17.4 12.6 -- --

Short-term Nominal Interest Rate (% per annum, Dec 31) [5] 1.7 6.7 5.0 3.1 1.5 1.2 4.0 3.9 -- --

Domestic Credit (% change Dec/Dec) 10.8 3.4 26.2 53.5 16.4 31.7 22.6 20.9 -- --

Domestic Credit/GDP 17.0 15.8 17.3 22.8 27.1 29.7 32.9 38.4 -- --

M2/Official Forex Reserves (X) 1.0 1.0 1.0 1.4 1.2 1.3 1.5 1.7 -- --

Total external Debt/Official Forex Reserves 270.9 204.0 134.8 141.0 107.4 114.9 98.8 111.9 98.4 99.8

Debt Service Ratio [6] 8.2 5.7 4.7 4.0 4.8 3.8 3.1 6.0 3.8 4.0

External Vulnerability Indicator [7] 137.9 107.9 85.3 60.9 78.0 54.3 62.5 64.4 63.6 58.1

Liquidity Ratio [8] 70.0 48.7 51.4 69.2 45.7 57.7 101.5 92.6 -- --

Total Liab. due BIS Banks/Total Assets Held in BIS Banks 120.6 62.7 67.3 63.9 45.3 63.6 87.2 81.5 -- --

"Dollarization" Ratio [9] 51.3 47.7 42.5 43.9 39.8 42.1 39.1 38.5 -- --

"Dollarization" Vulnerability Indicator [10] 66.9 57.9 53.0 65.0 52.7 63.0 65.8 71.8 -- --

Notes: [1] Sum of Exports and Imports of Goods and Services/GDP [2] Composite index with values from -2.50 to 2.50: higher values suggest greater maturity and responsiveness of government institutions [4] Current account receipts [5] Deposit Rate [6] (Interest + Currently Maturing Long-Term Debt)/Total Current Account Receipts [7] (Short-Term External Debt + Currently Maturing Long-Term External Debt + Total Nonresident Deposits Over One Year)/Official Foreign Exchange Reserves [8] Liabilities to BIS Banks Falling Due Within One Year/Total Assets Held in BIS Banks [9] Total Foreign Currency Deposits in the Domestic Banking System/Total Deposits in the Domestic Banking System [10] Total Foreign Currency Deposits in the Domestic Banking System/(Official Foreign Exchange Reserves + Foreign Assets of Domestic Banks)


31 MARCH 7, 2014


Moody’s Related Research

Credit Opinion:

» Paraguay, Government of

Issuer Comments:

» Paraguay's New Legislation Set to Bolster Country's Fiscal and Institutional Framework, March 2014 (164345)

Credit Focus:

» Key Drivers for Moody’s Decision to Upgrade Paraguay’s Ratings to Ba2; Outlook Changed to Positive, February 2014 (163923)

Statistical Handbook:

» Moody’s Statistical Handbook, November 2013 (159963)

Rating Methodologies:

» Sovereign Bond Ratings, September 2013 (157547)

» Sovereign Default and Recovery Rates, 1983-2012, June, 2013 (154805)

Moody’s Website Links:

» Sovereign Risk Group Webpage

» Sovereign Ratings List

To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of this report and that more recent reports may be available. All research may not be available to all clients.

Related Websites

For additional information, please see:

» The Central Bank website: www.bcp.gov.py

» The Ministry of Finance website: www.hacienda.gov.py

MOODY’S has provided links or references to third party World Wide Websites or URLs ("Links or References") solely for your convenience in locating related information and services. The websites reached through these Links or References have not necessarily been reviewed by MOODY’S, and are maintained by a third party over which MOODY’S exercises no control. Accordingly, MOODY’S expressly disclaims any responsibility or liability for the content, the accuracy of the information, and/or quality of products or services provided by or advertised on any third party web site accessed via a Link or Reference. Moreover, a Link or Reference does not imply an endorsement of any third party, any website, or the products or services provided by any third party.

https://www.moodys.com/credit-ratings/Paraguay-Government-of-credit-rating-600044126








http://www.moodys.com/researchandratings/market-segment/sovereign-supranational/-/005005/4294966293/4294966623/-1/0/-/0/-/-/en/global/rr

http://v2.moodys.com/moodys/cust/content/loadcontent.aspx?source=staticcontent/businesslines/sovereign-subsovereign/ratingslistgbr.htm&param=all

https://www.bcp.gov.py/

http://www.hacienda.gov.py/web-hacienda/index.php

http://www.surveygizmo.com/s3/1133212/Rate-this-research?pubid=163746


32 MARCH 7, 2014


» contacts continued from page 1

Analyst Contacts:

NEW YORK +1.212.553.1653

Bart Oosterveld +1.212.553.7914 Managing Director - Sovereign Risk [email protected]

Report Number: 163746

Author Sarah Glendon

Associate Analyst Carlos Morales-Villarreal

Editor Robert Cox

Production Specialist Kerstin Thoma

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