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RESUPD

Research Update: Paraguay 'BB/B' Ratings Affirmed; Outlook Remains Stable


Research Update: Paraguay 'BB/B' Ratings Affirmed; Outlook Remains Stable

Overview

  • We expect Paraguay's economy to contract and its fiscal deficit to widen in 2020 as a result of the COVID-19 pandemic and the downturn in global demand.
  • We expect that a prompt economic recovery in 2021 and the government's commitment to fiscal consolidation will help stabilize Paraguay's debt level and external profile.
  • We are affirming our 'BB/B' long- and short-term sovereign credit ratings on Paraguay.
  • The stable outlook reflects our expectation of only limited long-term deterioration in Paraguay's financial and economic profile based on the government's commitment to fiscal consolidation in the coming years as the economy recovers.

Rating Action

On May 5, 2020, S&P Global Ratings affirmed its 'BB/B' long- and short-term sovereign credit ratings on Paraguay. The outlook remains stable. At the same time, we affirmed our 'BB+' transfer and convertibility assessment.

Outlook

The stable outlook reflects our expectation that in the next 12 to 18 months the global economic slowdown and the COVID-19 pandemic will translate into extraordinarily high fiscal deficits and a rapid increase in government debt for the sovereign. That said, an economic recovery in 2021 and sustained growth thereafter, in addition to the government's commitment to fiscal consolidation, should stabilize any erosion of Paraguay's external profile and its government debt burden.

Downside scenario

We could lower the rating over the next 12 to 18 months if worse-than-expected economic performance or an inadequate policy response from the government undermine Paraguay's long-term growth trajectory and worsen its financial and economic profile. Failure to stabilize public finances following an expected deterioration in 2020 could significantly increase the net general government debt, leading to a downgrade.

Upside scenario

We could raise our ratings over the next 12 to 18 months if we see more effective policymaking and strengthening of public institutions and governance, thereby reducing the risk of instability or unexpected changes in economic policy that undermine investor confidence. Stronger checks and balances between public institutions and greater predictability and transparency of policy decisions could improve our institutional assessment of Paraguay.

We could also raise our ratings if continued diversification of the economy increases per capita income and reduces vulnerability to low commodity prices and adverse weather conditions. Additionally, we could raise our ratings if monetary policy credibility strengthens, contributing to a sustained decline in dollarization in the economy, strengthening the central bank's ability to conduct policy.

Rationale

Our ratings on Paraguay reflect the balance between relatively sound macroeconomic fundamentals and weak political institutions, low per capita income, limited monetary flexibility, and high level of dollarization in the financial system. Despite an increase in government debt due to the impact of the COVID-19 pandemic and subsequent global downturn, a moderate net external debt profile and government debt burden sustain the ratings on Paraguay.

On the other hand, Paraguay's weak institutions and evolving political system affect long-term visibility and predictability of overall policymaking. Moreover, the economy is vulnerable to volatility due to its still high economic concentration in a few commodities and trade partners.

Institutional and economic profile: Paraguay's economy is likely to contract sharply in 2020, but rapidly recover over the next two years
  • We expect Paraguay's economy to contract 2.5% in 2020 and recover to about 4.5% in 2021.
  • We believe that the government will remain committed to fiscal consolidation as the economy begins to recover.
  • Despite gradual progress, still developing political institutions and weak checks and balances limit the predictability and effectiveness of policymaking.

In March 2020, Paraguay promptly declared a state of national emergency and implemented a series of measures to contain the spread of COVID-19, including closing its borders, implementing mandatory curfews, and suspending of all nonessential activities. We expect the sudden drop in domestic and external demand to have a severe impact on Paraguay's economy in 2020, which will only be partially mitigated by somewhat better agricultural prospects this year. Under our base-case scenario, the economy would contract 2.5% in 2020, following a year of zero growth in 2019 due to a severe drought, floods, and heightened political uncertainty.

We project that the economy will quickly recover in 2021, thanks to better agricultural prospects and a recovery in external demand. Paraguay's economy remains concentrated in agricultural products, making it vulnerable to adverse weather conditions and volatile commodity prices. Paraguay is one of the largest soybean exporters in the world, and its export base is concentrated in this commodity and its byproducts, along with beef and energy. We expect GDP per capita of US$5,100 in 2020 and per capita GDP real growth at an average of 3% in 2021-2023.

Despite some progress on the economic and institutional front, we believe that the overall implementation and effectiveness of policymaking remain weak. Limited institutional capacity continues to constrain Paraguay's economic and human development. For instance, corruption perceptions remain relatively high and reflect the country's weak institutional fabric. Currently, almost 24% of the Paraguayan population lives in poverty, while life expectancy at birth is below the Latin American average. In addition, the country ranks poorly in Worldwide Governance Indicators, such as government effectiveness and rule of law.

Despite the change in government priorities after the COVID-19 outbreak, its agenda includes various structural reforms, such as modifications to the Fiscal Responsibility Law (FRL) and a new framework for the pension system in Paraguay. Continued progress in strengthening the country's institutional framework could boost private investment, strengthen long-term GDP growth prospects, and reduce the risk of potential political or policy instability.

Flexibility and performance profile: Paraguay will use its external and fiscal buffers to contain the impact of the crisis
  • The fiscal deficit is likely to increase to 6% of GDP in 2020, and the sovereign will finance it through external issuances and official debt.
  • We expect the government to remain committed to medium-term fiscal consolidation by taking corrective fiscal measures as the economy recovers from recession.
  • Expectations of inflation remain well-anchored, but monetary policy flexibility is limited, due in part to a high level of dollarization in the economy.

We expect the general government deficit to widen to 6% of GDP, from 3% in 2019 as the recession reduces tax revenues and the government increases spending on health-related goods and services. The government approved a fiscal package of 4% of GDP in March 2020, which included direct money transfers to individuals, a reallocation of spending to health care, and the temporary suspension of taxes. In order to avoid further fiscal slippage, the government announced progressive cuts to public-sector wages and is advancing on reforms to increase spending efficiency.

Given the weak economic performance in 2019-2020, we don't expect significant tax reforms from the government that could limit the economy's ability to bounce back. Furthermore, Paraguay ranks relatively low compared with regional neighbors in terms of physical infrastructure. Spending aimed to close this gap will continue to constrain the sovereign's fiscal flexibility over the next years, and the government will have difficulty adhering to both its investment plans and its fiscal consolidation goals, as reflected in the gradual convergence toward FRL targets.

Nevertheless, we expect the government to pursue a fiscal policy that results in a moderate deficit but still broadly in line with the FRL, which has served as an anchor for fiscal consolidation. We expect that general government fiscal deficits will average 2% of GDP between 2022 and 2023 and that changes in net general government debt over the next three years will move largely in tandem with the deficit, averaging 2.5% of GDP. We expect general government interest payments will average 5.2% of general government revenues in the next three years.

We expect the government to continue financing its deficit largely from abroad, mainly from international bond issuances, given the shallow domestic market. Net general government debt could spike toward 24% of GDP in 2020, as the government pursues a moderately countercyclical fiscal policy to address the current crisis. The government's growing issuance of foreign-currency debt has increased its exposure to exchange-rate movements, as about 80% of the public sector's debt stock is denominated in foreign currency. The currency exposure is only partially mitigated by dollar-denominated royalty inflows from two large hydroelectric dams. Furthermore, a significant share of external debt is held by nonresidents, adding further risk to potential sudden changes in investor confidence and capital outflows.

The combination of higher external debt issuance and adverse movements in the exchange rate is likely to worsen Paraguay's external profile. We expect narrow net external debt to rise to about 20% of current account receipts (CAR) in 2020. However, we project gross external liquidity ratios to remain strong and stable, with gross external financing needs estimated at 77% of CAR and usable reserves, given that much of external debt has long maturities or is owed to official creditors. Paraguay has been able to boost international reserves through debt issuances. Such external assets now reach about $8 billion, equivalent to about 20% of GDP or 11 months of imports.

We expect Paraguay to be able to post current account surpluses of about 0.5% of GDP over the next three years, supported by a recovery in external demand and higher agricultural prospects. Paraguay's external openness, along with its export concentration in both products and destinations, makes it vulnerable to external shocks. Roughly two-thirds of exports come from soya, beef, grain, and energy, while about half of exports go to Brazil, Russia, and Argentina. Another important segment of Paraguay's external sector is the "Maquila Regime", which waives import duties for a number of inputs used in the manufacturing of industrial exports, as well as provides other tax benefits.

Paraguay's flexible exchange rate has helped to absorb negative external shocks, containing the risk from export concentration. The Guaraní's recent depreciation relative to the U.S. dollar has helped to maintain the competitiveness of the country's external sector.

Since the adoption of the inflation-targeting regime in 2011, Paraguay has been able to keep inflation in line with the central bank target and has been slowly strengthening its supervision of the financial system. We expect inflation to decelerate, given weaker domestic demand. We expect that the inflation rate will be in the middle of the central bank's target, at about 4% through 2022, suggesting a credible policy commitment and well-anchored inflation expectations.

However, we weigh these strengths against what we view as still high dollarization in the economy and lack of a track record in managing financial risks, particularly stemming from currency mismatches. The highly dollarized Paraguayan economy reflects an economic structure that's tightly linked to the external sector. While the risks are somewhat counterbalanced by revenues also denominated in U.S. dollars from the export sector, we believe that such levels of dollarization continue to limit monetary flexibility.

Key Statistics

Table 1

Paraguay--Selected Indicators
2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023
Economic indicators (%)
Nominal GDP (bil. LC) 166,714.59 179,721.61 188,230.72 204,447.28 219,188.42 231,489.28 238,054.15 237,673.26 257,558.19 278,574.94 301,306.66
Nominal GDP (bil. $) 38.59 40.28 36.16 36.05 39.01 40.38 38.15 36.39 38.46 40.44 42.47
GDP per capita (000s $) 5.9 6.1 5.4 5.3 5.7 5.8 5.4 5.1 5.3 5.5 5.7
Real GDP growth 8.4 4.9 3.1 4.3 5.0 3.4 (0.0) (2.5) 4.5 4.0 4.0
Real GDP per capita growth 6.9 3.4 1.7 2.9 3.6 2.0 (1.3) (3.7) 3.2 2.7 2.7
Real investment growth 7.9 7.1 (2.1) 2.0 5.9 6.9 (6.6) (6.5) 6.5 4.0 4.0
Investment/GDP 22.3 22.5 22.1 20.2 21.2 22.8 22.4 17.7 18.1 18.1 18.1
Savings/GDP 23.9 22.4 21.7 23.8 24.3 22.6 21.2 17.1 18.5 18.9 19.1
Exports/GDP 37.2 34.8 33.0 35.4 36.4 35.9 34.7 31.2 35.2 36.7 37.2
Real exports growth 13.1 (2.5) 0.1 9.5 8.3 1.8 (2.9) (10.1) 22.3 12.8 9.6
Unemployment rate 5.0 6.0 5.4 6.0 5.2 5.6 5.7 8.0 6.0 5.5 5.5
External indicators (%)
Current account balance/GDP 1.6 (0.1) (0.4) 3.6 3.1 (0.2) (1.2) (0.6) 0.4 0.8 1.0
Current account balance/CARs 4.1 (0.3) (1.1) 9.5 8.0 (0.5) (3.1) (1.8) 1.1 2.0 2.5
CARs/GDP 39.4 36.4 35.1 38.1 39.2 38.7 38.3 33.3 37.9 39.7 40.4
Trade balance/GDP 4.3 2.5 2.2 6.1 4.8 2.0 1.2 2.2 2.7 2.9 2.9
Net FDI/GDP 0.6 1.0 0.9 1.2 1.3 1.2 1.3 0.8 1.1 1.1 1.2
Net portfolio equity inflow/GDP 1.3 3.2 0.8 0.8 1.3 1.3 1.3 0.7 1.3 1.2 1.2
Gross external financing needs/CARs plus usable reserves 81.2 80.4 76.4 75.7 73.1 75.9 77.8 74.8 77.0 77.3 79.7
Narrow net external debt/CARs (12.9) (12.9) (8.2) (11.4) (13.0) (5.6) 3.4 19.6 17.9 16.6 15.1
Narrow net external debt/CAPs (13.5) (12.9) (8.2) (12.6) (14.1) (5.6) 3.3 19.2 18.1 16.9 15.5
Net external liabilities/CARs 66.6 74.5 75.9 63.8 54.2 59.9 68.7 102.6 93.3 91.1 90.6
Net external liabilities/CAPs 69.4 74.3 75.0 70.5 58.9 59.6 66.6 100.8 94.3 92.9 92.9
Short-term external debt by remaining maturity/CARs 7.8 8.0 11.5 10.2 7.0 6.2 7.4 8.8 9.0 8.4 11.7
Usable reserves/CAPs (months) 3.5 4.2 5.6 4.4 4.6 4.8 4.9 5.6 4.9 4.6 4.6
Usable reserves (mil. $) 5,096 6,010 4,539 5,421 6,346 6,114 5,800 5,835 6,039 6,348 6,781
Fiscal indicators (general government; %)
Balance/GDP (1.1) (0.6) (1.8) (0.4) (0.9) (1.4) (3.0) (6.0) (3.2) (2.0) (1.5)
Change in net debt/GDP 1.6 1.2 2.6 2.4 2.6 1.8 3.8 6.4 3.8 2.7 2.2
Primary balance/GDP (0.8) (0.3) (1.3) 0.2 (0.3) (0.7) (2.1) (5.1) (2.3) (1.0) (0.5)
Revenue/GDP 16.6 17.5 18.7 19.1 18.6 18.4 18.4 16.4 17.9 18.4 18.4
Expenditures/GDP 17.6 18.0 20.5 19.5 19.5 19.7 21.4 22.4 21.1 20.4 19.9
Interest/revenues 1.5 1.7 2.5 3.0 3.1 3.6 4.5 5.5 5.2 5.5 5.5
Debt/GDP 10.6 13.0 15.1 17.0 19.0 20.1 23.2 29.7 31.2 31.6 31.4
Debt/revenues 63.9 74.7 80.6 89.4 102.2 109.6 126.1 181.1 174.3 171.7 170.6
Net debt/GDP 3.4 4.4 6.8 8.7 10.7 11.9 15.4 21.8 24.0 24.9 25.2
Liquid assets/GDP 7.2 8.6 8.2 8.4 8.3 8.2 7.9 7.9 7.3 6.7 6.2
Monetary indicators (%)
CPI growth 2.7 5.0 3.1 4.1 3.6 4.0 2.8 2.4 3.7 4.0 4.0
GDP deflator growth 4.4 2.8 1.6 4.1 2.1 2.2 2.9 2.4 3.7 4.0 4.0
Exchange rate, year-end (LC/$) 4524.00 4626.26 5806.92 5766.90 5590.48 5960.54 6453.14 6608.02 6786.43 6990.02 7199.73
Banks' claims on resident non-gov't sector growth 23.2 19.8 19.0 3.5 4.9 14.1 9.0 (0.2) 8.4 8.2 8.2
Banks' claims on resident non-gov't sector/GDP 34.5 38.3 43.6 41.5 40.6 43.9 46.6 46.6 46.6 46.6 46.6
Real effective exchange rate growth 4.6 1.9 (2.3) (3.5) (0.8) 3.2 (3.0) N/A N/A N/A N/A
Sources: National Central Bank, National Statistical Institute (Economic Indicators), International Monetary Fund, National Central Bank, National Ministry of Finance (External Indicators), International Monetary Fund, National Central Bank, National Ministry of Finance (Fiscal Indicators), and International Monetary Fund, National Central Bank (Monetary Indicators). Adjustments: General government revenues adjusted by including incomes from National Central Bank. General government expenditures adjusted by including expenditures from National Central Bank. General government debt adjusted by including debt of National Central Bank. General government liquid financial assets adjusted by including assets of National Central Bank. Definitions: Savings is defined as investment plus the current account surplus (deficit). Investment is defined as expenditure on capital goods, including plant, equipment, and housing, plus the change in inventories. Banks are other depository corporations other than the central bank, whose liabilities are included in the national definition of broad money. Gross external financing needs are defined as current account payments plus short-term external debt at the end of the prior year plus nonresident deposits at the end of the prior year plus long-term external debt maturing within the year. Narrow net external debt is defined as the stock of foreign and local currency public- and private- sector borrowings from nonresidents minus official reserves minus public-sector liquid assets held by nonresidents minus financial-sector loans to, deposits with, or investments in nonresident entities. A negative number indicates net external lending. N/A--Not applicable. LC--Local currency. CARs--Current account receipts. FDI--Foreign direct investment. CAPs--Current account payments. e--Estimate. f--Forecast. The data and ratios above result from S&P Global Ratings' own calculations, drawing on national as well as international sources, reflecting S&P Global Ratings' independent view on the timeliness, coverage, accuracy, credibility, and usability of available information.

Ratings Score Snapshot

Table 2

Paraguay--Ratings Score Snapshot
Key rating factors Score Explanation
Institutional assessment 5 Weak institutional capacity and political polarization are constraints to Paraguay’s economic development. Fiscal rules were introduced, although short track record of compliance. Political divisions embedded in parties and disputes with opposition constraints policymaking. Still high perceived corruption alongside risks regarding rule of law and social inequalities.
Economic assessment 5 Based on GDP per capita (US$) and growth trends as per Selected Indicators in table 1.
External assessment 2 Based on narrow net external debt and gross external financing needs/(CAR + useable reserves) as per Selected Indicators in Table 1.
Fiscal Assessment: flexibility and performance 3 Based on the change in net general government debt (% of GDP) as per Selected Indicators in Table 1
The sovereign faces shortfalls in basic services and infrastructure, as reflected in the share of population living in poverty and quality of basic infrastructure.
Fiscal Assessment: debt burden 3 Based on net general government debt (% of GDP) and general government interest expenditures (% of general government revenues) as per Selected Indicators in Table 1
About 80% of gross government debt is denominated in foreign currency.
Nonresidents are estimated to hold over 60% of government commercial debt.
Monetary assessment 5 The Guaraní is a free-floating currency and the Central Bank intervenes occasionally in foreign exchange markets.
The central bank independence is still limited. Still short track record of inflation targeting monetary policy. The central bank has the ability to act as lender of last resort for the financial system.
Resident deposits/loans in foreign currency has fluctuated around 50% of the total.
Indicative rating bb-
Notches of supplemental adjustments and flexibility 1 Institutions are gradually improving, although with not sustained track record of being able to mitigate political uncertainty and provide visibility to policymaking. Furthermore, external profile could improve in coming years with more available resources from hydroelectric dams. These factors have a positive impact on creditworthiness and are not fully captured in the indicative rating.
Final rating
Foreign currency BB
Notches of uplift 0 Default risks do not apply differently to foreign- and local-currency debt
Local currency BB
S&P Global Ratings' analysis of sovereign creditworthiness rests on its assessment and scoring of five key rating factors: (i) institutional assessment; (ii) economic assessment; (iii) external assessment; (iv) the average of fiscal flexibility and performance, and debt burden; and (v) monetary assessment. Each of the factors is assessed on a continuum spanning from 1 (strongest) to 6 (weakest). S&P Global Ratings' "Sovereign Rating Methodology," published on Dec. 18, 2017, details how we derive and combine the scores and then derive the sovereign foreign currency rating. In accordance with S&P Global Ratings' sovereign ratings methodology, a change in score does not in all cases lead to a change in the rating, nor is a change in the rating necessarily predicated on changes in one or more of the scores. In determining the final rating the committee can make use of the flexibility afforded by §15 and §§126-128 of the rating methodology.

Related Criteria

  • Criteria | Governments | Sovereigns: Sovereign Rating Methodology, Dec. 18, 2017
  • General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017
  • General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009
  • General Criteria: Methodology: Criteria For Determining Transfer And Convertibility Assessments, May 18, 2009

Related Research

  • Banking Industry Country Risk Assessment Update: April 2020, May 1, 2020
  • Sovereign Risk Indicators, April 24, 2020 (An interactive version is also available at https://www.spratings.com/sri/.)
  • COVID-19 Deals A Larger, Longer Hit To Global GDP, April 16, 2020
  • Sovereign Ratings History, April 7, 2020
  • Sovereign Ratings List, April 7, 2020
  • Sovereign Ratings Score Snapshot, April 1, 2020
  • Sovereign Debt 2020: Global Borrowing To Increase To $8.1 Trillion Amid Favorable Financing Conditions, Feb. 20, 2020
  • Global Sovereign Rating Trends 2020: Sovereign Debt Buildup Continues, Jan. 29, 2020
  • Banking Industry Country Risk Assessment: Paraguay, June 28, 2019
  • Summary: Paraguay, June 13, 2019

In accordance with our relevant policies and procedures, the Rating Committee was composed of analysts that are qualified to vote in the committee, with sufficient experience to convey the appropriate level of knowledge and understanding of the methodology applicable (see 'Related Criteria And Research'). At the onset of the committee, the chair confirmed that the information provided to the Rating Committee by the primary analyst had been distributed in a timely manner and was sufficient for Committee members to make an informed decision.

After the primary analyst gave opening remarks and explained the recommendation, the Committee discussed key rating factors and critical issues in accordance with the relevant criteria. Qualitative and quantitative risk factors were considered and discussed, looking at track-record and forecasts.

The committee's assessment of the key rating factors is reflected in the Ratings Score Snapshot above.

The chair ensured every voting member was given the opportunity to articulate his/her opinion. The chair or designee reviewed the draft report to ensure consistency with the Committee decision. The views and the decision of the rating committee are summarized in the above rationale and outlook. The weighting of all rating factors is described in the methodology used in this rating action (see 'Related Criteria And Research').

Ratings List

Ratings Affirmed

Paraguay

Sovereign Credit Rating BB/Stable/B
Transfer & Convertibility Assessment BB+

Paraguay

Senior Unsecured BB

Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors, have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such criteria. Please see Ratings Criteria at www.standardandpoors.com for further information. Complete ratings information is available to subscribers of RatingsDirect at www.capitaliq.com. All ratings affected by this rating action can be found on S&P Global Ratings' public website at www.standardandpoors.com. Use the Ratings search box located in the left column.

Primary Credit Analyst:Patricio E Vimberg, Buenos Aires (54) 114-891-2132;
patricio.vimberg@spglobal.com
Secondary Contact:Manuel Orozco, Sao Paulo (55) 11-3039-4819;
manuel.orozco@spglobal.com

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