Document of The World Bank FOR OFFICIAL USE ONLY Report No. 66782-PY INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT COUNTRY PARTNERSHIP STRATEGY PROGRESS REPORT FOR THE REPUBLIC OF PARAGUAY FOR THE PERIOD 2009-2013 April 9, 2012 Argentina, Paraguay and Uruguay Country Management Unit Latin America and the Caribbean Region This document is being made publicly available prior to Board consideration. This does not imply a presumed outcome. This document may be updated following Board consideration and the updated document would be made publicly available in accordance with the Bank‘s policy on Access to Information. PARAGUAY - GOVERNMENT FISCAL YEAR January 1 – December 31 CURRENCY EQUIVALENTS (Exchange Rate Effective as of March 21, 2012) Guaraní 4,280 US$ 1.00 Weights and Measures Metric System Vice President: Hasan A. Tuluy Country Director: Penelope Brook Co-Task Team Leader: Andrew Follmer Co-Task Team Leader: Rossana Polastri ABBREVIATIONS AND ACRONYMS AAA Analytical and Advisory Activities BCP Central Bank of Paraguay (Banco Central de Paraguay) CCT Conditional Cash Transfer CEP Council for State-Owned Enterprises (Consejo de Empresas Públicas) CPPR Country Portfolio Performance Review CMU Country Management Unit CPS Country Partnership Strategy DPL Development Policy Loan EU European Union FHU Family Health Unit FONDES National Fund for Economic and Social Development (Fondo Nacional para el Desarrollo Económico y Social) FSAP Financial Sector Assessment Program GAC Governance and Anti-corruption GDP Gross Domestic Product GEF Global Environmental Facility GTZ German Agency for International Cooperation IBRD International Bank for Reconstruction and Development IDA International Development Association IADB Inter-American Development Bank IDF Institutional Development Fund IFC International Finance Corporation IMF International Monetary Fund MAG Ministry of Agriculture and Livestock (Ministerio de Agricultura y Ganadería) MECIP Paraguayan Standard Model of Internal Control (Modelo Estándar de Control Interno del Paraguay) MSME Medium and Small Enterprises NLTA Non-Lending Technical Assistance PEFA Public Expenditure and Financial Accountability PPIAF Public Financial Management PFM Public-Private Infrastructure Advisory Facility PPP Public-Private Partnership PR Progress Report SEAM Environment Secretariat (Secretaría del Ambiente) SFLAC Spanish Trust Fund SFP Secretariat of Public Services (Secretaria de la Función Pública) SOE State-owned Enterprise TA Technical Assistance TTL Task Team leader UMEP State Owned Enterprise Monitoring Unit (Unidad de Monitoreo de Empresas Públicas) UN United Nations WB World Bank Y-O-Y Year-on-year ACKNOWLEDGEMENTS This CPSPR was prepared under the guidance of Penelope Brook, Country Director, by Andrew Follmer and Rossana Polastri (TTLs), John Barham, and Ricardo Habalian. The Bank team greatly appreciates the collaboration and contributions of the Government of Paraguay in the preparation of the Country Partnership Strategy (CPS) progress report. In particular, the team thanks the Minister of Finance, Mr. Dionisio Borda, and his team for the insightful suggestions during the progress report preparation and portfolio reviews. Special thanks also to members of the international community in Paraguay, think tanks, and civil society in general who were consulted. Contributions are gratefully acknowledged from Marlo Acerbi, Alejandro Alcala, Diego Arias, Alexandre Arrobbio, Daniel Benitez, Mikul Bhatia, Yanina Budkin, Eva Clemente, Bruce Courtney, Robert Davis, Rafael De Hoyos, Carolina Diaz-Bonilla, Victor Dumas, Ruth Gonzalez, Michele Gragnolati, Abid Hasan, Thomas Haven, Peter Holland, Jane Hwang, Michel Kerf, Lizmara Kirchner, Friederike Koehler-Geib, Mariano Lafuente, Barbara Mierau- Klein, Juan Martin Moreno, Arturo Muente, Zafer Mustafaoglu, Renato Nardello, Maria Margarita Nunez, Luis Orlando Perez, Renan Poveda, Christophe Prevost, Tatiana Proskuryakova, Robin Rajack, David Reinstein, Patrick Rittenauer, Benjamin Roseth, Graciela Sanchez, Miguel Vargas-Ramirez, Alys Willman, and Tevfik Yaprak. Administrative support was provided by Carla Cutolo. REPUBLIC OF PARAGUAY COUNTRY PARTNERSHIP STRATEGY PROGRESS REPORT TABLE OF CONTENTS EXECUTIVE SUMMARY ..................................................................................................... I I. INTRODUCTION .............................................................................................................. 1 II. COUNTRY CONTEXT ...................................................................................................... 2 A. RECENT DEVELOPMENTS ................................................................................................... 2 B. OUTLOOK ........................................................................................................................... 3 III. PROGRESS TOWARDS CPS OUTCOMES .............................................................. 5 C. PROGRAM IMPLEMENTATION AND PORTFOLIO PERFORMANCE ........................................... 5 D. RESULTS TO DATE .............................................................................................................. 6 E. ADJUSTMENTS TO THE CPS RESULTS FRAMEWORK .......................................................... 12 IV. FUTURE ENGAGEMENT ........................................................................................... 13 V. PROGRAM RISKS AND MITIGATION ................................................................... 14 ANNEXES ANNEX 1: UPDATED RESULTS FRAMEWORK ......................................................................... 16 ANNEX 2. SUMMARY OF CHANGES TO CPS RESULTS FRAMEWORK ...................................... 24 ANNEX 3. PARAGUAY IBRD LENDING AND GOVERNMENT-EXECUTED TRUST FUND PROGRAM .............................................................................................................................. 27 ANNEX 4. AAA PROGRAM IN PARAGUAY, FY10-FY13 ........................................................ 28 ANNEX 5. OPERATIONS PORTFOLIO (IBRD/IDA AND GEF GRANTS).................................... 29 ANNEX 6. PARAGUAY: IFC INVESTMENT OPERATIONS PROGRAM ........................................ 30 ANNEX 7. IFC COMMITTED AND DISBURSED OUTSTANDING INVESTMENT PORTFOLIO ........ 31 ANNEX 8. SELECTED INDICATORS* OF BANK PERFORMANCE ............................................... 32 ANNEX 9. PARAGUAY AT A GLANCE ..................................................................................... 33 ANNEX 10. GROWTH AND POVERTY TRENDS IN PARAGUAY 2003-2010 ............................... 35 ANNEX 11. FINANCING GAP .................................................................................................. 38 ANNEX 12. DEBT SUSTAINABILITY ANALYSIS ....................................................................... 39 EXECUTIVE SUMMARY The development goals defined in the CPS remain aligned with the Government’s agenda for the second period of the strategy. The CPS envisioned three main goals: supporting the transition to a modern economy through improving governance and reducing corruption; addressing the needs of vulnerable groups; and restoring growth in the aftermath of regional financial crisis. This last goal was achieved successfully in 2010, with Paraguay registering an impressive 15 percent growth rate. However, the benefits of strong recovery were not shared by a large portion of the population, thus highlighting the need to increasingly focus on equity going forward. The 2009 CPS was not a joint Bank-IFC CPS as the IFC was not engaged in Paraguay at the time the CPS was prepared. However, the IFC has made significant progress since re- engaging with Paraguay in 2009, nearly tripling the size of its Paraguay portfolio between FY08 and FY12. Paraguay has proven an opportune environment for innovative IFC work. High poverty and inequality rates continue to be major development challenges in Paraguay despite noticeable improvements over the last decade. Sound macroeconomic management and a number of key social reforms have contributed to a declining trend in poverty. Nevertheless, poverty and inequality rates remain high. Poverty was 34.7 percent in 2010, while the extreme poverty rate of 19.4 percent places Paraguay among the poorest countries in Latin America. Inequality is also among the highest in the LAC region, with a Gini coefficient of 0.512. Rural households account for a disproportionate amount of the poor, and extreme poverty--in particular--is mainly a rural phenomenon. The Government‘s policy agenda has a strong focus on poverty alleviation through policies that promote growth with inclusion while at the same time strengthening safety nets. Changing economic realities and experience with the current portfolio will inform the strategy’s implementation in the remainder of the CPS period as the Government seeks to contain the effects of global economic turbulence, drought and outbreaks of foot and mouth disease that severely affect Paraguay‘s second largest export, beef. There has been important progress under the CPS, but implementation challenges remain. The lending program is on track and has responded strategically to evolving government priorities. To date three operations for a total of US$ 300 million have been approved. Financial and knowledge services were critical in providing timely support during the global economic crisis of 2009. The lending program has a strong focus on basic infrastructure services, complemented with analytic and advisory activities (AAA) work on other sectoral areas during the first period of the CPS. The remainder of the CPS will continue to focus on infrastructure and support government efforts to foster growth with inclusion Bank Portfolio performance, in particular the pace of implementation, has remained a challenge. Complex project design, delays in effectiveness, frequent staff turnover in project implementation units, and limited procurement and safeguards capacity are the main reasons for a relatively low disbursement rate. In coordination with the Government, the Bank has worked to improve implementation through capacity-building activities and intensified implementation support. As a result of this concerted effort and reflecting the project cycle, implementation has improved by midpoint of the CPS. i Overall progress toward expected CPS outcomes as defined in the results matrix has been satisfactory. Among the most important results are sound macroeconomic policies supportive of growth and investment, greater access to health and education services, and improved targeting of social protection programs. However, structural and governance weaknesses need to be addressed to sustain the achievements to date. Pillar I: Improved Governance and Anti-Corruption: The current Government established improved governance as a priority at the outset, requesting Bank support to improve the effectiveness of public investments, develop a governance framework for all IBRD-financed projects, and strengthen public institutions through DPL support focused on strengthened accounting in public enterprises, civil service reform, and stronger internal system of controls for the Government. Paraguay was also chosen as a pilot country under the Bank‘s Governance and Anti-Corruption (GAC) Strategy. While the objectives related to strengthening governance have been largely achieved under Pillar I with DPL support, significant challenges remain. The remainder of the CPS period will be used to consolidate these gains and focus the dialogue on the next phase of this effort. Pillar II: Poverty Reduction: Moderate and extreme poverty levels fell significantly during recent years, yet have remained relatively high. Reducing poverty remains a top priority and challenge. Total poverty fell from 44 percent in 2003 to 34.7 percent in 2010. The reduction of extreme poverty has been more volatile, and in 2010, extreme poverty rose from 18.8 percent to 19.4 percent despite the strong economic growth. The Bank has supported Government‘s efforts through a selective program of knowledge services as well as investment projects with significant poverty reduction focus. A Bank-financed Poverty Assessment (Report No. 58638-PY) detailed the evolution of growth, poverty, inequality, and employment in Paraguay. It shows that characteristics such as gender, ethnic background, geographical location, and level of income have a strong effect on access to land, education, and health services. In 2010, poor, rural households did not share in the increased incomes enjoyed by the rest of the population. Inequality increased as well; the Gini coefficient of income distribution moved up from 0.487 in 2009 to 0.512 in 2010, one of the highest in Latin America. These finding have raised awareness of equity issues among decision-makers. The Government and the Bank will place a stronger focus on equity and expanding social safety nets in the remaining CPS period. Pillar III: Economic Growth and Inclusion. Addressing Paraguay‘s gap in infrastructure and the provision of basic services has been central to the Bank‘s engagement under this pillar, and it has been redesigned as part of this progress report to focus more on the need to foster economic growth with inclusion. An example of how the Bank and Government are rising to this challenge is an ―inclusive competitiveness‖ initiative being undertaken by the Bank, Ministry of Finance, Ministry of Industry and Trade, Ministry of Agriculture and Livestock (MAG), and the Technical Planning Secretariat. The CPS identified the need to ensure that economic growth did not come at the expense of the environment. While two key interventions have been undertaken toward this objective -- a WBI Development Marketplace grant and a GEF Biodiversity grant -- implementation has been delayed due to significant institutional coordination challenges. ii The primary focus of the Bank program during the remainder of the CPS period will be to consolidate the progress made to date against the CPS outcomes, support the achievement of those outcomes, and target specific needs that have emerged during the first part of the CPS period. Implementation of the remainder of the CPS will be dominated by a package of products reflecting an intensified focus on inclusion. A multi-sectoral DPL (US$100 million) is envisaged to support a policy framework focused on ensuring the benefits of growth reach the most vulnerable. The proposed DPL would provide fast-disbursing resources to address financing requirements for the 2012 budget while protecting critical social spending. In addition, a US$20 million Rural Connectivity investment loan is proposed to support a key element of the Government‘s strategy to reach the most vulnerable. The AAA components of this package reflect a list of government priorities that emerged from a recent workshop on the Poverty Assessment. IFC’s strategy during the remainder of the CPS period will likely remain focused on inclusive growth through a continued focus on financial services and agribusiness investments. The Corporation will also continue seeking new infrastructure investment opportunities. IFC‘s Advisory Services hopes to expand its portfolio across the four business lines: investment climate, PPP, access to finance, and sustainable business. In addition, the Government and Bank are discussing the next steps of a technical assistance that will complement IFC‘s investments in river navigation, supporting government efforts to improve the navigation conditions of the Paraguay River. Most risks highlighted in the CPS remain relevant. Political and governance risks remain high due to the relatively weak and fragmented government coalition combined with lack of majority in Congress and powerful unions. Paraguay is exposed to fluctuations in international demand and commodity prices through its strong dependence on agricultural exports. Furthermore, the country is at risk of external shocks with possible causes including weather cycles and deceleration of the world economy. Both of the latter risks materialized during the CPS period, and the risk associated with external shocks and natural disasters is assessed as high. The CPS also identified the pressures from social demands as a high risk to deliver on its program. The political transition generated high expectations, particularly among the rural poor, for the fulfillment urgent social needs and land tenure reform. These have not been met due to political bottlenecks and a lack of political consensus. The CPS also identified weaknesses in the Government‘s control system, together with inefficient aspects of the budget process and the lack of fiscal transparency, as risks to the Bank program. The Government has made strong efforts to address these issues; however, fiduciary risk remains high. The Bank will continue close supervision of the program. The CPS period will be extended six months until December 31, 2013, in order to ensure sufficient time for consultation on a new CPS following presidential elections in April, 2013. Meanwhile, continued achievement of existing CPS targets will be supported by US$100 million in DPL lending and US$20 million in additional investment lending, as well as knowledge products expected to contribute to the foundations for government reforms. iii I. INTRODUCTION 1. The Board of Executive Directors discussed the 2009-2013 Country Partnership Strategy (CPS) for the Republic of Paraguay on May 5, 2009 (Report No. 48087-PY). The CPS provides strategic support to the Republic of Paraguay in the following areas: governance, poverty reduction, and economic growth and environment. The strategy focuses on implementation of the existing portfolio, new investment and development policy lending, and a range of knowledge services to help achieve country development outcomes. 2. The development goals defined in the CPS remain aligned with the Government’s agenda for the second period of the strategy. The CPS envisioned three main goals: supporting the transition to a modern economy through improving governance and reducing corruption; addressing the needs of vulnerable groups; and restoring growth in the aftermath of the global financial crisis. 3. The 2009 CPS was not a joint Bank-IFC strategy as the IFC was not engaged in Paraguay at the time the CPS was prepared. However, IFC has made significant progress since re-engaging with Paraguay in 2009, nearly tripling the size of its Paraguay portfolio between FY08 and FY12. IFC’s private sector-oriented strategy fits closely with the Bank’s Economic Growth and Inclusion pillar. IFC has been able to launch highly innovative financial structures in Paraguay, several of which were global ‗firsts‘ for the IFC. 4. Changing economic realities and experience with the current portfolio will inform the strategy’s implementation in the remainder of the CPS period as the Government seeks to contain the effects of global economic turbulence, drought and outbreaks of foot and mouth disease that severely affect Paraguay’s second largest export, beef. Resources for lending and AAA will be allocated to key areas with good track records of engagement and government commitment. The IFC will continue to complement the IBRD program, focusing on financial services, infrastructure, and agribusiness as channels to reach small rural enterprises and the poor. 5. The CPS period will be extended six months until December 31, 2013, in order to ensure sufficient time for consultation on a new CPS following presidential elections in April, 2013. Meanwhile, continued achievement of existing CPS targets would be supported by US$100 million in DPL lending and US$20 million in additional investment lending, as well as knowledge products expected to contribute to the foundations for government reforms. 6. Consistent with the results-based approach, this Progress Report focuses on the main achievements to date and proposes adjustments to realign the strategy with the Government’s current needs and developmental priorities. Section II of the Report provides a summary of recent country developments. Section III describes progress towards CPS outcomes and proposes changes to the results framework in light of implementation experience and evolving government priorities. Section IV sets out the program for the rest of the CPS period, and Section V contains a brief summary of key risks 1 II. COUNTRY CONTEXT A. Recent Developments 7. Three years into its mandate, the Government of President Lugo has made progress in the execution of key themes of the Government’s Strategic Economic and Social Plan 2008/2013. Paraguay successfully recovered from the 2009 global economic crisis and was the fastest growing country in Latin America in 2010. There has been a significant increase in private investment and a marked turn-around in agriculture, industry and construction. The Government successfully implemented a counter-cyclical stimulus package in response to the crisis while maintaining progress in medium-term reforms such as tax administration and oversight of state-owned enterprises. The Government successfully re- negotiated terms under the treaty with Brazil for the sale of excess electricity from the Itaipu power plant1 and will receive incremental annual revenues of US$240 million starting in 2012. On the social front, there have been important advances in health and education, such as free access to primary health care and primary education. There has also been progress in the expansion of a conditional cash transfer program, Tekopora, to target the extreme poor, with a temporary employment program pilot and the launching of a non-contributory pension program for the elderly living in poverty. 8. The 2009 crisis temporarily interrupted Paraguay’s economic turn-around. A severe drought exacerbated the impact of the international economic crisis, triggering a 3.8 percent real contraction of the economy in 2009. Agriculture was hit hardest – production fell by an estimated 23.8 percent in real terms, primarily as a result of the drought. The Government responded with a package of counter-cyclical policies that contained the impact. The Anti-Crisis Plan aimed to provide fiscal stimulus through expanded public spending to ensure sufficient liquidity in the financial system, access to financing for the productive sectors and accelerated mobilization of external resources. Concurrently, the Government adhered to the prudent macroeconomic policies in the Government‘s Strategic Economic and Social Plan. Despite the increase in spending, the fiscal balance closed in surplus due to an increase in tax revenues, underlining the positive impact of recent tax administration reforms. 9. In 2010, the economy rebounded strongly based on an agricultural export boom. Paraguay‘s 15 percent real growth rate in 2010 marks the country‘s highest growth on record. Real exports grew by 35.3 percent in 2010, led by an unprecedented boom in agriculture. Fiscal policy remained expansionary, yet the fiscal balance posted a surplus supported by strong revenue collection. Total public expenditures remained above pre-crisis levels relative to GDP in 2010 (19.2 percent of GDP), based on sustained attention to social programs. 10. Agricultural growth decelerated in 2011, one of the main reasons behind the economy’s below-trend growth of 4.0 percent (Table 1). The agricultural sector reached an average 7.5 percent year-on-year (y-o-y) growth in the first three quarters of 2011, strongly contrasting the average of 49 percent during the previous year. In addition, an outbreak of foot and mouth disease during the last quarter of the year triggered a significant fall in meat exports, the second most important source of export earnings. The construction sector contracted based on the economy hitting capacity constraints in the previous year and slower 1 Royalties from the hydroelectric power plants on the Paraná River at the Brazil-Paraguay border, which represent a significant proportion of public revenue. 2 credit growth to the private sector (Table 1). With signs of overheating subsiding, lower beef prices, and a tighter monetary stance, inflation closed the year at 4.9 percent—within the Central Bank‘s target range. The trade and current account deficits decreased due to lower domestic demand, despite weaker export performance. Fiscal policy continued to be expansionary, yet generated a surplus based on strong revenue collection. 11. High poverty and inequality rates continue to be major development challenges in Paraguay despite noticeable improvements over the last decade. Paraguay is a landlocked country with a relatively large rural sector. Poverty was 34.7 percent in 2010, while the extreme poverty rate of 19.4 percent places Paraguay among the poorest countries in Latin America. Inequality is also among the highest in the LAC region, with a Gini coefficient of 0.512. Over half of the poor and more than two thirds of the extreme poor are located in rural areas. With only 41.2 percent of the population in 2010, rural households have a disproportionate amount of the poor (58.1 percent). The unprecedented growth rate of 15 percent in 2010 was driven mostly by sectors that are not labor intensive, thus not translating into faster poverty reduction. In addition, high food prices also affected the poor in 2010. Annex 10 presents a more detailed discussion about growth and poverty trends in Paraguay. 12. Socio-economic conditions have improved in Paraguay over the past decade; however, over a longer horizon, poverty and inequality have shown less progress and an inability to overcome existing structural issues. Since 2003, Paraguay considerably improved its socio-economic indicators including poverty, inequality, and health and education coverage. However, evaluated over a longer term and with respect to average trends in the region, poverty declined more gradually in Paraguay, from 36.1 percent in 1998, while inequality increased from 0.489 in 1998, indicating the structural nature of the problem. Poverty decompositions highlight that growth is an important component in poverty reduction. However, inequality in terms of endowments, particularly land and human capital, limit the economic opportunities for the poor. Such inequality has hampered efforts to reduce poverty: better distribution of income would have allowed economic growth to translate into stronger poverty reduction. While there has been some progress in addressing these structural issues, barriers remain that inhibit growth from translating into greater poverty reduction by itself. Social expenditures have increased substantially but are still low compared to other LAC countries. Poverty and inequality trends suggest the need to ensure that policies supporting growth be combined with social and economic policies to invest in connectivity and human capital, as well as to strengthen safety nets. B. Outlook 13. In the period remaining before the April 2013 Presidential elections, the Government is planning to consolidate reforms already achieved in areas such as public financial management, tax administration, oversight of state-owned enterprises and sustaining and expanding social policies. The Government also intends to create a special fund to support development and counter-cyclical stabilization with incremental revenues from Itaipu. Currently a draft law for this fund is pending approval by Congress. Progress on these issues will be contingent on the dynamics of the relationship between the Executive and the Legislative branches of the Government. 14. Early economic indicators suggest a GDP contraction of 0.7 percent in 2012, reflecting the combined impact of drought, foot and mouth disease outbreaks, and weaker global demand. The La Niña weather phenomenon is severely affecting the 3 agricultural sector. To date, the soy harvest is expected to show a 40 percent decline. In addition, a second outbreak of foot and mouth disease in January 2012 has further limited meat exports, and they will take time to recover. The rest of the economy has continued to grow solidly during the first quarter of 2012. With an expected recovery in meat exports, an abating La Niña phenomenon, and a base year effect, growth is expected to rebound to 7.5 percent in 2013. In 2014, growth is expected to revert to trend. Table 1. Selected Macroeconomic Indicators Prelim. Projected 2008 2009 2010 2011 2012 2013 2014 Real GDP growth (%) 5.8 -3.8 15.0 4.0 -0.7 7.5 4.5 Consumer prices (% y-o-y change, eop) 7.5 1.9 7.2 4.9 5.0 6.5 5.0 Credit to private sector (% y-o-y change) 49.3 24.1 42.9 26.3 15.0 19.5 22.0 Terms of Trade (% y-o-y change) 38.9 -19.1 6.7 4.0 -4.0 0.2 0.2 Trade balance (% of GDP) -2.9 -1.1 -4.6 -4.4 -6.5 -3.5 -4.0 Current account balance (% of GDP) -1.8 0.5 -3.2 -2.1 -4.0 -2.0 -2.0 Primary fiscal balance (% of GDP) 3.1 0.7 1.5 0.9 -1.7 -1.5 -1.0 Overall fiscal balance (% of GDP) 2.5 0.1 1.1 0.6 -2.1 -1.6 -1.3 Source: Central Bank of Paraguay and WB staff projections 15. An additional risk is related to the potential impact of the ongoing global crisis on Paraguay’s financial sector. Paraguay is directly linked to the global financial system through various channels, including foreign ownership of banks, financing to the agriculture sector by large international grain traders, and bank borrowing from abroad. Stress abroad could put pressure on any of these channels. Foreign ownership is particularly relevant, given that nearly half of the banking system assets are held in local subsidiaries of foreign banks. Disruptions in financing for large international grain traders from European banks could have spillovers in Paraguay‘s economy (as occurred during the 2008 crisis). Bank borrowing from abroad is less of a source of concern since foreign credit (less than US$700 million) is not a significant source of funding for the system (less than 10 percent of loans). In terms of potential policy responses, the authorities have room to lower interest rates and substantial foreign reserves to intervene in the foreign exchange market if needed, as they did in 2008. Yet developments in Europe should be followed closely for potential fallout in Paraguay. 16. The Government has room to buffer these negatives shocks. Overall, public debt stocks in Paraguay are low, with central government debt reaching around 12 percent of GDP in 2011. The primary balance is projected to deteriorate to a deficit of 1.7 percent of GDP in 2012, due to a substantial wage bill increase approved by Congress and lower than expected non-tax revenues (Table 1). As a result, financing needs are projected to increase significantly, though these are expected to be generally manageable given fiscal resources, including the fiscal savings of the Government in the Central Bank accounts, and access to domestic and foreign sources. (Annex 11). Downside risks arise from a potentially worse impact of the drought and of another global crisis mainly through lower commodity prices and lower demand from major trading partners. In such a scenario, a projected current account deficit of 4 percent of GDP would expose Paraguay to sudden decreases in international financial inflows. Yet, an economy-wide credit crunch appears unlikely given that the banking system‘s share of foreign to total liabilities is moderate at around 6.5 percent (about 4 half the regional average). Even if another global crisis materializes, the Paraguayan Government has fiscal and monetary space to mitigate the likely impact on the economy. III. PROGRESS TOWARDS CPS OUTCOMES C. Program Implementation and Portfolio Performance 17. A key element of CPS implementation has been increased integration in delivery of IBRD’s range of products. The Government and Bank have focused on implementation constraints in the existing portfolio, while knowledge services have focused on strategic sector reforms linked to poverty reduction, inclusion and governance. As part of this decision to increasingly focus on a cohesive package of services, greater rigor was applied to develop a program of select knowledge services in priority areas, including non-lending technical assistance (NLTA) in some sectors where new lending had been previously envisioned. Among these are education, competitiveness, social protection, and land access. Selectivity has been supported by strengthening the role of the Ministry of Finance on knowledge products, bringing it in line with the Ministry‘s role on lending, to ensure the AAA program reflects the Government‘s priorities and demands more broadly. New lending commitments since the start of the CPS period include one investment operation for US$100 million [Energy Sector Strengthening Project (P114971)] and two development policy loans (DPLs) totaling US$200 million supporting public sector reforms. The indicative program of a series of three programmatic DPLs was adjusted to two stand-alone DPLs, both with the objective of supporting the effectiveness and efficiency of the public sector. 18. Trust funds have been used selectively in the Bank program to support key institutional reforms and project implementation. During the first half of the CPS, the Bank administered a US$1.37 million trust fund portfolio, supporting activities related to the water and sanitation sector, public-private options to improve river navigation conditions, public sector reform and governance, indigenous land regulation and strengthening of the national statistics office. A trust fund portfolio of US$5.3 million is under client execution (Annex 3), of which the most important is a GEF project supporting the conservation of the biodiversity of the Atlantic Forest in Paraguay. 19. IFC has aggressively increased its investments in Paraguay since 2009, building a strong portfolio, booking 32 new operations. IFC has focused heavily on inclusive growth through its support to microfinance, MSMEs, small farms, and infrastructure. The Corporation committed US$513.16 million to 13 clients between 2009-12 (a nearly 180 percent increase in its portfolio), after three years in which it had made no investments. The program mostly focuses on financial services, but it has also supported Paraguay‘s burgeoning agribusiness sector and made several river transportation investments. These investments have enabled the Corporation to reach substantial numbers of the poor and underserved. For instance, two transactions with financial institutions are expected to reach almost 7,000 SMEs in 2011, and another investment with an agricultural services company will benefit 750 farms. 20. IFC has launched highly innovative financial structures in Paraguay, including several global ‗firsts‘. In 2009 IFC‘s Bank Capitalization Fund made its first investment, a US$20 million equity stake in Banco Continental. In 2011, IFC‘s new Global Warehouse Finance Program made its inaugural commitment to Paraguay‘s Sudameris Bank (US$15 million) seeking to increase liquidity in the agribusiness sector by making commodities 5 available as collateral. A 2011 swap agreement with the Central Bank enables IFC to provide local currency loans to non-exporting companies by eliminating exchange rate risk. 21. Bank Portfolio performance, in particular the pace of implementation, has remained a challenge. Total investment commitments to date amount to US$275 million. However, achieving timely disbursement remains a challenge. Of the four active projects in the portfolio, three are in problem status. Complex project design, delays in effectiveness, frequent staff turnover in project implementation units, and limited procurement and safeguards capacity are the main reasons for a relatively low disbursement rate. The Government‘s annual budget cycle has also contributed to disbursement delays as investment expenditure is not authorized during the first quarter of the calendar year, interrupting implementation for several weeks at the start of each year. Disbursements in FY11 reached 7.5 percent, still below the 30.9 percent average for the Latin America and Caribbean region as a whole, but a significant improvement over the previous year‘s 2 percent. The pace of FY12 disbursements to date is 50 percent above FY11. IFC‘s investments are relatively new; only four have been active long enough to receive development evaluations. Nonetheless, all four projects received successful or mostly successful development outcome ratings. 22. In coordination with the Government, the Bank has worked to improve implementation through capacity-building activities and intensified implementation support, particularly in the area of procurement. The 2010 Country Portfolio Performance Review (CPPR) yielded an action plan to strengthen the portfolio which included, among other measures: (i) increased country management presence through increased frequency of visits, (ii) increased budget coefficient to facilitate more frequent missions by TTLs, and (iii) strengthened channels of Bank-client communications. Proposed new lending is screened for (i) project design appropriate to level of implementation capacity, (ii) political consensus, and (iii) relevance to the Government‘s highest priority internal and external challenges. 23. The CPS portfolio complements the ongoing support to Paraguay provided by the IMF. The next Article IV staff visit will take place in May 2012. In addition, technical assistance is ongoing in the areas of energy subsidies, monetary policy framework, tax and customs administration reform, agricultural taxation, macro projection models to improve budgeting, and stress testing for cooperatives. D. Results to Date 24. Overall progress toward expected CPS outcomes as defined in the results matrix has been satisfactory, but structural and governance weaknesses need to be addressed to sustain the achievements to date. While the CPS objectives related to strengthening governance have been largely achieved under Pillar I with DPL support, significant challenges remain. The remainder of the CPS period will be used to consolidate these gains and focus the dialogue on the next phase of this effort. Pillar I: Governance and Anti-Corruption 25. The current Government established improved governance as a priority at the outset, requesting Bank support to improve the effectiveness of public investments, develop a governance framework for all IBRD-financed projects, and strengthen public institutions through DPL support focused on strengthened accounting in public enterprises, civil service reform, and a stronger internal system of controls for the Government. Paraguay was also chosen as a pilot country under the Bank‘s Governance and Anti-Corruption (GAC) Strategy. 6 26. Improving Governance, Fighting Corruption and Increasing Transparency. During the first half of the CPS period, the Bank program contributed to the GAC objective through four instruments: structural public sector reform supported by DPLs, GAC frameworks in investment projects, public policy dialogue, and technical assistance financed by trust funds. In addition, the GAC framework in project design for the roads maintenance and water and sanitation projects has proven effective, and the Government has indicated their interest in expanding the model to other sectors. 27. Strengthening Financial Public Control. The targets for increasing the effectiveness of internal controls and internal audit functions have been met. At the request of the Ministry of Finance, a Public Expenditure and Financial Accountability (PEFA) assessment led by the European Union (EU) was conducted jointly with the IDB. It concluded that important progress was made in the area of internal control and internal audit. In particular, a standardized internal control framework was introduced by decree early in the CPS period, and intensive capacity building was delivered for this purpose. Under the policy framework for the DPLs and with multiple Spanish Trust Fund for Latin America (SFLAC) grants, five ministries, representing approximately 70 percent of the central administration‘s overall budget, have established internal control committees, internal control norms, and have trained staff to implement the Paraguayan Standard Model of Internal Control (MECIP). The Office of the Executive‘s Internal Auditor was upgraded to ministerial level with a significant increase in budget and intensive staff training. The authorities will continue focusing on control effectiveness in key expenditure areas--such as State Owned Enterprises or salary expenditures, as well as control capacity in tax collection and compliance--and have requested the continuation of Bank support in this area. 28. Effective Government Oversight of State-Owned Enterprises (SOEs). SOEs‘ size and performance pose a significant challenge. They account for about 30 percent of public sector expenditures and provide essential goods and services, including oil, water, telecommunications and electricity. Their service delivery and management need significant improvement largely due to institutional limitations that prevailed up to 2008: ineffective oversight, institutional framework, non-disclosure of audited financial statements, asymmetric information and a partial regulatory framework for utilities. 29. The CPS and DPL policy framework focused on making SOEs’ finances more transparent and subject to greater scrutiny by Government and civil society. This included the establishment of a Council for SOEs (CEP) ensuring public sector oversight and the definition of a government policy for SOEs. CEP‘s capacity for fast institutional decision- making and the professional and technical monitoring of UMEP created a responsive, technically-sound supervisory body. In 2010, CEP established an inter-institutional commission to calculate accrued debts and credits maintained between SOEs and the central administration, and CEP has also been working with UMEP to ensure timely payment for services provided by SOEs to Government. Payment for these services increased from 27 percent in 2008 to 51 percent in 2010. Furthermore, service delivery has been enhanced through the adoption of performance contracts, now covering 80 percent of SOE-provided services, and of a balanced scorecard to measure SOEs‘ economic, financial and technical performance. 30. Gradually Professionalize Civil Service. The goals in this area have been largely met through resolutions enforced voluntarily by individual line ministries. The instrument to achieve the objective of professionalizing the civil service identified at the CPS was a civil 7 service law, which has been postponed. The path chosen for moving ahead in this area has been one of selective steps with interventions to build consensus for future passage of a civil service law. Since 2008, over 13,000 promotions and recruitments have been decided based on merit and professional skills, following the Secretariat of Public Services (SFP) guidelines in about 30 percent of public sector institutions. This has been accompanied by significant capacity building of the SFP. The number of civil servants earning less than minimum wage was reduced by more than two-thirds, from 28,000 in 2008 to 9,000 in 2010, and the number of institutions that regularly report payroll data to the SFP more than doubled between 2008 and 2010, reaching 87 percent. The challenge going forward is to institutionalize and sustain these gains through a stronger and more enforceable legal framework. A key development was the approval of Law No. 4.394/2011, mandating the creation of two new institutions for professionalizing the civil service at the Ministry of Finance. 31. The Bank has contributed to these efforts through a package of lending and non- lending products. The First Public Sector Programmatic DPL (FY09) supported the introduction of merit-based, competitive processes for recruitment and promotions in the public sector. The SFLAC Enhancing Public Sector Effectiveness (FY10-13) has contributed to this agenda through analysis on pay and classification reform, a comparative study on civil service management, and support to the Paraguay-hosted XVI Latin American Conference on Public Administration, focusing on civil service issues and with over 1500 participants. 32. Payment systems. The Central Bank of Paraguay (BCP) sought technical assistance (TA) to support the modernization of the clearing and settlement of their payments systems. A fee-based service (FBS) arrangement has allowed the Bank to assist the BCP from the initial concept to implementation of an electronic, modern central payments system. The Bank team helped formulate a new legal and regulatory framework for operating the system to properly manage risks, and operational rules of the new Automated Transfer System were created and communicated to private sector banks. Furthermore, oversight capacity is being developed and strengthened within the BCP to monitor the payments systems. 33. A Financial Sector Assessment Program (FSAP) was undertaken in November 2010 that produced a comprehensive set of recommendations to strengthen the financial sector. For example, the financial inclusion analysis found that much progress has been achieved in the last few years to broaden financial inclusion in Paraguay, and the Government has initiated some important reforms that enhance access to financial services. Nevertheless, coverage of the rural areas continues to be limited, many people--in particular those without formal employment--find themselves excluded from the financial system due to high minimum balance requirements, lack of a credit history and collateral, and high costs. Analysis of the pension system revealed that only 16 percent of the working population contribute to a pension fund, suggesting substantial scope for increasing financial inclusion related to pensions, and major structural shortcomings which, if addressed, should make available a stable source of long-term financing for critical infrastructure. The Bank is collaborating with the Ministry of Finance and Central Bank on follow-up TA. 34. The Bank also contributed to the debate on critical issues of governance and accountability. A series of seminars organized jointly with the three powers--executive, legislative and judiciary--had the objective of promoting and enhancing the debate for consensus building on a development strategy and a policy road map to addresses Paraguay‘s main developmental challenges. The seminars served as a platform to discuss reform priorities and practical development solutions in which governance and accountability was the 8 common thread. The Bank has also provided technical assistance through the Stolen Asset Recovery Initiative (STAR) for the creation of a specialized unit dedicated to asset recovery within the Attorney General‘s Office. In addition, the Bank has worked with the Office of Integrity in identifying areas for support through the Governance Partnership Facility. 35. Governance and Accountability in Media. The CPS focused on improving the independent role of the media as a ―watchdog‖ and on assisting the Government in improving the effectiveness and articulation of accountability in institutions to fight corruption. With financing from the Governance Partnership Facility, 200 journalists participated in trainings on investigative journalism. A feasibility study for a public media system was prepared and utilized as the basis for discussions with local stakeholders, resulting in the establishment of a public TV station. In addition, the Bank has organized several courses through a partnership between the Central Bank of Paraguay and the Catholic University of Asunción. Pillar II: Poverty Reduction 36. Moderate and extreme poverty levels fell significantly during recent years, yet have remained relatively high. Reducing poverty remains a top priority and challenge. Total poverty fell from 44 percent in 2003 to 34.7 percent in 2010. The reduction of extreme poverty has been more volatile; it fell from 21.2 in 2003 to 19.4 in 2010, but reached as low as 16.5 in 2005 and as high as 23.7 in 2006. In 2010, extreme poverty rose from 18.8 percent to 19.4 percent despite the strong economic growth. Extreme poverty remains particularly prevalent in rural areas with an incidence of 32.4 percent, compared to 10.3 percent in urban areas. The Bank has supported Government‘s efforts through a selective program of knowledge services as well as investment projects with a significant poverty reduction focus. 37. Employment Generation and Poverty Reduction. As indicated above, ambitious poverty reduction objectives were surpassed over the first three years of CPS implementation. Government achieved this by reaching more than 75,000 beneficiaries with the Tekopora conditional cash transfer program and improving the targeting methods and supply of health, education and nutrition services under the program. However, systematic budget cuts by Congress since 2010 have made it difficult to secure the funds necessary to pay the benefits of this expanded pool of beneficiaries. In addition to support under the DPL and other lending operations, poverty reduction has been a key focus of the AAA and grants included in the Bank program. For the remainder of the CPS period, the Bank will continue providing TA to improving the targeting of the Tekopora program, as well as providing TA to strengthen the Temporary Employment Program, Nambaapo Paraguay, in collaboration with the ILO. 38. A Bank-financed Poverty Assessment (Report No. 58638-PY) depicted the evolution of growth, poverty, inequality, and employment in Paraguay. The study included a gender dimension and progress on other socio-economic indicators, and it analyzed the determinants of poverty and inequality—building on Technical Assistance and Capacity Building previously provided by the Bank to support the updating of poverty measurement methodology. The study shows that characteristics such as gender, ethnic background, geographical location, and level of income have a strong effect on access to land, education, and health services. For example, although female labor force participation increased by 6.2 percent between 2003 and 2008, female workers experience higher rates of unemployment (7.6 versus 4.7 percent for men), more under-employment (32 percent versus 26 percent for men), higher levels of informality (72 percent versus 61 percent for men), and a wage gap of 5.5 percent that cannot be explained by observable characteristics such as education, age, etc. 9 Ethnicity plays a more important role in wages however, as the earnings differences between minorities and non-minorities are higher than those found between males and females. 39. Initial analyses suggest that Paraguayans at the low end of the income distribution in urban areas were negatively affected by surging international food prices in 2009 that outstripped the increase in wages. Also in 2010, poor households in rural areas did not see increases in their income, as the positive effects of high growth seem not to have reached them. In 2010, extraordinarily strong meat and soy production were main drivers for growth, products that small-scale and subsistence farmers do not produce. Inequality increased as well; the Gini coefficient of income distribution moved up from 0.487 in 2009 to 0.512 in 2010, one of the highest in Latin America. These finding have raised awareness of equity issues in Paraguay. In particular, the awareness of the disadvantage of rural households is reflected in the initiation of programs under the PRODERS project. In the same way, the expansion of the CCT programs, in particular Tekopora, is an important step targeting the lowest income percentiles. 40. Consensus on land reform and regularization has been difficult to achieve. Diverse views on how to address land ownership issues in Congress have limited the capacity of Government to comply with initial commitments. Deficiencies in the national cadastre significantly limit targeting of policy actions; however, the Government has begun addressing this with the assistance of IDB and recently negotiated a second phase (US$25m) to finance its cadastre program, although the latter will only reach nine pilot rural municipalities. 41. The CPS aims to strengthen policies to reduce drop-outs, increase enrollment, and improve quality of secondary education. During the first half of the CPS period, the Bank focused on completing the Education Reform project. Previous plans for new lending have been revisited by the Government in favor of a program of technical assistance to provide technical inputs to improve the Government‘s evidence-based decision making. 42. Increase access to water and sewerage services, including indigenous populations: With support from other development partners, including JICA, the Bank-financed Water Sector Modernization Project (P095235) supports the CPS objectives of expanding access to sewerage and to clean drinking water to 20 percent and 71 percent of the population, respectively, by 2013. The Project has suffered from implementation delays, exacerbated by a complex design. However, commitment to the sector is strong, with public investment in the sector increasing from 1.7 percent of GDP in 2008 to 2.8 percent in 2010. 43. The Bank remains productively engaged in the health sector with TA focused on strengthening health policies to benefit populations without coverage and the poor. This has successfully supported the design and implementation of a free drugs policy and a Family Health Units program (500 FHUs are operational) and an analysis of the social determinants of health. For the second half of the CPS period, the Ministry of Health has requested Bank NLTA support to reduce fragmentation of the health system which is resulting in inequitable access and quality of health services. Pillar III: Economic Growth and Inclusion 44. Sound and prudent economic policies have contributed to strong macroeconomic fundamentals and reduced vulnerabilities. Macroeconomic stability in turn has provided a conducive environment for private sector growth and attracted investments. Paraguay has sufficient fiscal space to borrow in case financial needs increase as a consequence of the 10 worsening global environment. Nevertheless access to international financing could be limited, and domestic market issuances could come with a high price. Currently, international reserves exceed US$5 billion or 19 percent of GDP. It will be crucial to protect gains in macro and financial sector stability from the impact of a deteriorating external environment. 45. In spite of the important macroeconomic achievements, challenges remain for the inclusiveness of growth. Reflecting the failure of 2010’s boom growth to benefit the most vulnerable, the CPS will place a stronger focus on equity and expanding social safety nets going forward. The Government and the Bank jointly organized and financed a multi-sectoral round table workshop with the Social Ministries and other government agencies linked to social policy, on the theme of ―Growth, Poverty Reduction, and Inequality‖. The objective was to analyze the main sectoral problems and how to approach them in order to improve the efficacy and efficiency of Paraguay‘s policies and programs in decreasing poverty and inequality. The output served as a basis for policy discussions at the executive level and input into the design of the food emergency package recently approved to protect the most vulnerable and ensure food security in response to the drought. 46. IFC’s operations are also supporting the inclusive growth goal, mainly through projects with financial institutions and agribusiness companies. IFC has made five investments in Paraguayan banks and microfinance lenders for a total $96.2 million. In addition, IFC has opened 19 trade finance lines with local banks, both to support exports and to channel liquidity to MSMEs and small farms. IFC has made $47 million in loans since 2009 to four agribusiness firms to increase Paraguay‘s agricultural output and to support small farms by expanding technical support, agricultural inputs, and pre-harvest financing. 47. Given the challenge of making growth more inclusive, the Bank is working with the Ministry of Finance, Ministry of Industry and Trade, Ministry of Agriculture and Livestock (MAG), and the Technical Planning Secretariat on an “inclusive competitiveness� initiative that builds on a rural productivity mapping exercise that identified regions of the country with high poverty and untapped agricultural growth potential. It also attempts to address identified constraints to competitiveness such as: weak linkages between small producers and export value chains; lack of mechanisms to promote regional- sectoral competitiveness; weak public-private dialogue mechanisms; and lack of clear, prioritized action plans to operationalize high-level competitiveness diagnostics. The Bank is coordinating its competitiveness work with, and leveraging work done by, a range of development partners, including the IDB, USAID, EU and JICA. 48. Public expenditure and its role in fostering inclusive growth. Paraguay has one of the lowest tax-to-GDP ratios in Latin America and faces challenges in social sector outcomes, foremost in health and education. A key question in the context of public service provision is whether sufficient resources are available and whether the available resources are spent in an efficient way to provide key public services to citizens. The Bank is currently exploring with the Government topics that would assist them in this area. 49. Infrastructure for growth and inclusion. The Bank supports government efforts to accelerate growth and facilitate inclusion through improvement in access to basic services and infrastructure, with special focus on the needs of the most vulnerable. The Bank contributes, first, through the infrastructure and logistic agenda that supports the competitiveness and diversification of the economy while also creating new jobs; and second, by improving the access and quality of infrastructure services while also addressing affordability issues. A key 11 intervention is the Energy Sector Strengthening Project (P114971), which finances a portion of a Government Master Plan that is cofinanced by CAF, FOCEM and JICA. It will increase the delivery and the quality of electricity services, allowing for an increase in productivity for small farmers and small entrepreneurs. At the same time, this project will strengthen the performance of the public utility responsible for the provision of electricity services. 50. Improving the efficiency of public spending in infrastructure. Efficiency gains and increased sources of financing, including private sector participation, could help bridge the large infrastructure gap in Paraguay in a context of limited public resources. The Bank is defining a capacity building program to assist the Ministry of Finance in the identification, design, implementation, and evaluation of infrastructure investments. The objectives are (i) to increase the efficiency of public spending by improving the capacity to define, evaluate and respond to infrastructure needs; and (ii) to maximize public and private financing to reduce the infrastructure gap. With the support of a PPIAF, the Bank conducted three feasibility studies for improving navigation conditions of the Paraguay river, including an assessment of a public-private partnership option. The economy is highly vulnerable to the river navigation conditions given the country‘s landlocked nature. IFC has made significant investments to support the expansion of river transportation. It has committed $76.3 million in the leading barge operator on the Paraná-Paraguay river system, UABL, which transports Paraguayan soy to ports in Argentina for processing and export. 51. Safeguarding the Environment. The CPS identified the need to ensure that economic growth did not come at the expense of the environment. Progress toward the CPS goal of decreasing unsustainable forest management practices and slowing the expansion of the agriculture frontier under a WBI Development Marketplace grant has encountered delays, but the grant has been extended until November, 2012. Two workshops and five technical studies were successfully conducted to assess the low carbon potential in relevant productive sectors, in pursuit of the CPS outcome of strengthening national capacity to enable the growth of Clean Development Mechanism projects and other mitigation activities. A GEF Biodiversity grant supports the establishment of a biodiversity corridor, strengthening the National Protected Areas system; however, implementation has been delayed due to significant institutional coordination challenges. E. Adjustments to the CPS Results Framework 52. Most elements of the 2009-2013 CPS results framework remain relevant, and the achievement of most intended results is on track. The following adjustments are proposed in light of changes in priority and implementation experience discussed above (Annex 2). 53. The Governance and Anti-Corruption pillar was modified to capture additional efforts and ensure clarity on expected results. Outcomes were incorporated to reflect progress made on timely payments by the state to SOEs, the inclusion of GAC frameworks in all investment projects, and the modernization of the BCP‘s payments system. Also, transparency indicators were reformulated to track the strengthening of the Office of Integrity and the independent role of the media as a ―watchdog‖ of the political arena. 54. Changes to the Poverty Reduction pillar mainly reflect the Government’s decision to direct additional Bank support towards NLTA activities until implementation bottlenecks in the current portfolio are resolved. A lending operation to the education sector did not materialize, and instead the Bank is supporting the Government to 12 strengthen educational policies and build capacity to enhance teacher quality and ensure basic conditions are met in all public schools. A sub-pillar on health was incorporated to track joint efforts to make health services accessible to the poor through the implementation of a free drugs policy and the creation of more than 500 Family Health Units. After surpassing the set target for the CCT programs, the Bank is now focusing its efforts on improving the targeting instruments of the Tekopora and non-contributory pension program Adultos Mayores, and helping the Government enlarge the scope of the country‘s social safety nets through the design of the Nambapoo temporary employment program. 55. The section on Land Reform was reformulated to capture the difficulty of reaching consensus on the matter, especially in light of the weakened coalition supporting the Lugo administration in Congress. Together with implementation challenges faced by the Indigenous Community Development Trust Fund, this implies that the current CPS support to indigenous populations would be less comprehensive than previously envisaged. 56. The third pillar was renamed “Growth with Inclusion� in line with the Government’s policy agenda. The objective is to highlight the efforts made to increase the reach of social services and safety nets while maintaining a stable macroeconomic framework and boosting the public investment/GDP ratio. New outcomes and milestones were added to reflect additional improvements in several areas and further support planned for the remainder of the CPS period, such as increased supervision and auditing of large taxpayers and the development of competitiveness action plans in pilot sectors and regions. Indicators for the electricity and environment sectors were revised to reflect delays in the implementation of projects. Lastly, work on airports did not materialize due to an Executive veto, and telecommunications indicators were removed as the sector was not supported by the CPS. IV. FUTURE ENGAGEMENT 57. The primary focus of the Bank program during the remainder of the CPS period will be to consolidate the progress made to date against the CPS outcomes, support the achievement of those outcomes, and target specific needs that have emerged during the first part of the CPS period. Consultations with the Government centered on how the Bank could best respond to pressing needs and focus the program during the remainder of the CPS period. Particular attention will be on better targeting of social safety net programs and ensuring that economic growth benefits the most vulnerable. In addition, the Government requested the Bank to identify policy interventions for inclusion in the its program to contain the effects of the global economic slowdown, drought, and foot and mouth disease. These areas are reflected in the remaining CPS agenda. Consultations with civil society groups verified that the Bank is seen as a valuable and reliable partner for the Government, and there was consensus on the strategy‘s focus. Coordination with development partners will continue, especially in areas such as efficiency of public spending, governance, infrastructure, poverty and inclusiveness. 58. Implementation of the remainder of the CPS will be dominated by a package of products intended to reflect an intensified focus on inclusion. A multi-sectoral DPL (US$100 million) is envisaged which would incorporate a policy framework focused on ensuring the benefits of growth reach the most vulnerable. It would provide fast disbursing resources to address financing requirements for the 2012 budget while protecting critical 13 social spending. In addition, a US$20 million Rural Connectivity investment loan would support a key element of the Government‘s strategy to reach the most vulnerable. The AAA components of this package reflect a list of government priorities that emerged from a recent workshop on the Poverty Assessment. In addition to those mentioned elsewhere in this report, these include: (i) an analysis of the links among economic growth, poverty and inequality during 2005-2010, including an ex-ante evaluation of the impact of another global crisis; and (ii) an analysis of the efficiency of public expenditures. The Bank is also providing TA to complement IDB‘s financial support to Paraguay‘s upcoming Economic Census polls. 59. In addition to the gender dimensions of the Poverty Assessment and the mainstreaming of gender as an issue in the Bank’s lending and AAA portfolios, the Bank is preparing a review of the data and the key existing literature on gender issues in Paraguay. This will inform a more in-depth analysis which will, building on the Poverty Assessment, inform the next CPS. 60. The Government and the Bank will continue to apply lessons of CPPRs and project implementation to strengthen portfolio performance. Proposed lending will continue to be screened as described in paragraph 23. A joint CPPR held in November 2011 identified weaknesses in the areas of contract administration and safeguards, and capacity building programs have been planned in response. The Government has also committed to scale up efforts for project implementation. The Ministry of Finance recently created a unit to monitor externally-financed investments and follow up on agreed actions. The Bank and other development partners (IDB, GTZ, EU, and UN) are working together to identify common issues in project implementation and offering joint proposals for addressing these. 61. IFC’s strategy during the remainder of the CPS period will likely remain focused on inclusive growth through a continued focus on financial services and agribusiness investments. The Corporation will also continue seeking new infrastructure investment opportunities. IFC‘s Advisory Services hopes to expand its portfolio across the four business lines: investment climate, PPP, access to finance, and sustainable business. In addition, the Bank and Government are discussing the next steps of a technical assistance that will complement IFC‘s investments in river navigation, supporting government efforts to improve the navigation conditions of the Paraguay River. V. PROGRAM RISKS AND MITIGATION 62. Most risks highlighted in the CPS remain relevant. The CPS identified the relatively weak and fragmented government coalition combined with lack of majority in Congress and powerful unions as important risks to the program. The Bank will continue supporting the Ministry of Finance to improve its communication strategy for building consensus and obtaining Congressional approval. Through AAA the Bank will support the line ministries in better informing stakeholders of their investment programs and the results and impact of the reforms. Second, there is a risk that a failure to secure Congressional backing on budget decisions would put at risk sound fiscal management and critical social expenditures. The Bank will support the executive‘s ability to build consensus among stakeholders for maintaining a sound fiscal policy while protecting the social programs for the most vulnerable. Despite these efforts, political and governance risk is assessed as high. 14 63. Paraguay is exposed to fluctuations in international demand and commodity prices through its strong dependence on agricultural exports. The debt sustainability analysis shows a scenario that is consistent with a significant slowdown in the global economy. In the medium term, growth is expected to revert to its trend of around 4 percent. 64. Progress in the Bank program could be affected by weak human resource capacity in the public sector, as well as limited inter-institutional cooperation. Limited institutional capacity and high turnovers within the counterpart agencies have caused delays in the Bank portfolio. The Bank and the Government are monitoring the program through CPPRs and action plans to address the problems identified. 65. The CPS identified the pressures from social demands as a risk to deliver quickly on its program. Poverty reduction and inequality remain key challenges, stressing the risks for social tensions. Social tensions regarding land tenure have escalated. The political transition generated high expectations, particularly among the rural poor, for urgent social needs and land tenure reform, which have not been met due to political bottlenecks and a lack of consensus on an agenda. The Bank is assisting the Government to improve targeting of social safety nets and identify land use, tenure and land market dynamics that could inform solutions to the land access and tenure challenges. Nonetheless, social risk is assessed as high. 66. The Government has made strong efforts to address weaknesses in the Government’s control system identified in the CPS as risks to the Bank program. Despite these efforts in Public Financial Management (PFM) and particularly control effectiveness issues, the lack of accountability, inadequate human resources policies, and cumbersome procedures and work practices continue to pose concerns. Thus, the fiduciary risk remains high for the remaining CPS period. The Bank will continue close supervision of the program and related technical assistance over the remaining CPS period. 67. The risk of external shocks was identified in the CPS, with possible causes including weather cycles and deceleration of the world economy. Both risks materialized during the CPS period. The severe drought of 2009 and the global crisis caused a contraction of the economy. While the severity of the current global downturn is still uncertain, Paraguay could be impacted through lower fiscal revenues, and trade and capital flows. Government is prepared to weather the effects of the global slowdown and introduce a fiscal stimulus plan if needed. The effects of La Niña are already being felt, and the Government is putting together an emergency package to protect small farmers and the most vulnerable. In addition, increased revenues from the Itaipu hydroelectric power plant will provide fiscal flexibility. The risk associated with external shocks and natural disasters is assessed as high. 15 Annex 1: Updated Results Framework CPS Outcomes Milestones Status Bank Group Program I. Governance and Anticorruption: Strengthening state institutions to improve policy making, public service provision, and rule of law for investments and households Fighting corruption and increasing transparency Improving the independent role of the media as a ―watchdog‖ 4 trainings on investigative journalism delivered. 196 journalists trained on investigative journalism. GPF Building an Accountability to of the powerful generating a more plural communications Address Systemic Corruption environment. Feasibility study for a system of public media guides Government used study to engage with key stakeholders. discussion in Paraguay. Assisting the Government in improving the effectiveness and Institutional Strengthening of the Office of Integrity. Preparing work program. SFLAC Strengthening Paraguay articulation of accountability institutions to fight corruption. National Audit Office Road Maintenance Project includes an Improvement of Include Governance component on every project Governance Action Plan (IGAP). It is partially functioning Paraguay Strengthening within an electronic platform called Control Board, since Congressional Legislative Process 2010. Remaining areas for full operation of the IGAP are and Budget Oversight Capacity to be completed by March 2012. The uses of the Control Board and the IGAP have been expanded to all activities Road Maintenance Project and projects of the MOPW. Water and Sanitation Modernization The PRODERS Project has helped strengthen Project neighborhood committees in 30 micro watersheds in the State of San Pedro and Caaguazu, allowing for social Sustainable Rural Development control mechanisms for public sector investments. Project Water and Sanitation Modernization Project: 1) Each Energy Sector Strengthening Project W&S sector institution has developed a website; 2) DAPSAN has prepared an action plan for the governance strategy and a framework to monitor its governance indicators. Modernization of the Public Administration to improve service delivery Increase effectiveness of internal control and internal audit The Government has issued two decrees to upgrade the The standardized internal control framework was Programmatic DPL function: Office of the Executive‘s Internal Auditor (AGPE) to introduced by decree soon after the presidential elections. ministerial level; and to strengthen the authority and Also, the Office of the Executive‘s Internal Auditor Public Sector AAA - PEFA Indicators for Internal Control and Internal Audit (PI- independence of AGPE in order to establish a standard (AGPE) was upgraded to ministerial level accompanied by 20 and PI-21) have been upgraded internal control model (MECIP) and determine criteria for a significant increase in its budget and intensive staff SFLAC Strengthening Paraguay Baseline: D+ (IFA 2008) selection of internal auditors throughout the central training. National Audit Office Target: C (2013) administration. Paraguay Strengthening 50 percent of ministries and secretariats have established Five ministries, representing approximately 70% of GoP‘s Congressional Legislative Process internal control committees, internal control norms, and overall budget, have met this milestone. and Budget Oversight Capacity trained staff to implement the MECIP; and their respective internal audit units (AIIs) have the number of employees PEFA Indicators for internal control and internal audit (PI- PEFA and competitive hiring processes required by AGPE. 20 and PI-21) for 50% of the ministries are rated C. 16 CPS Outcomes Milestones Status Bank Group Program I. Governance and Anticorruption: Strengthening state institutions to improve policy making, public service provision, and rule of law for investments and households Modernization of the Public Administration to improve service delivery The clearing and settlement of the Central Bank‘s payment An electronic, modern central payment system has been A new Automated Transfer System has been implemented Paraguay (FBS) Payment System system has been modernized and Government payments are implemented. with Bank assistance. The legal and regulatory framework made through an automated transfer system. for operating the system has been created and operational The legal and regulatory framework for operating the new rules have been communicated to private sector banks. system has been created and operational rules are communicated to private sector banks. Personnel recruitment and promotions are based on merit and Government introduces competitive and transparent Reclassification and pay reform road map proposal Programmatic DPL professional skills: processes for recruitment and promotion of civil servants, delivered to client. and the Civil Service Secretariat is overseeing those Public Sector AAA - Public sector institutions following competitive recruiting processes. and promoting practices and reporting to the Civil Service Since August 2008, over thirteen thousand promotions and Secretariat (SFP) recruitments have been decided through competitive Baseline: 0, only some consultants (2007) processes following the Secretariat of Public Services Target: 40% of public sector institutions (2013) (SFP) guidelines and methodology and supervised by SFP officials in about 30 percent of public sector institutions. - Public sector institutions supervised by the Civil Service These, however, remain voluntary as there is no Secretariat (SFP) enforcement mechanism in place. Baseline: 40% of institutions (2008) Target: 80% (2013) Number of civil servants earning below minimum wage was reduced to less than a third, from 28,000 in 2008 to - Number of civil servants earning below minimum wage. 9,000 in 2010. Baseline: 28,000 (2008) Target: 0 (2013) SOEs finances and operations are transparent and subject to Government has issued a decree to establish a Council for The Inter-ministerial Council of SOEs (CEP) and the SOEs Programmatic DPL greater scrutiny by Government and civil society. SOEs (CEP) ensuring (i) public sector oversight on SOEs, Monitoring Unit (UMEP) were established soon after the and (ii) the definition of a Government policy for SOEs‘ presidential elections. The ability to combine CEP‘s fast Public Sector AAA reform. inter-institutional decision-making capacity with the professional and technical monitoring of UMEP created a Water and Sanitation Modernization The Government has strengthened the institutional responsive, technically-sound SOE supervisory body. The Project framework associated with SOE management through: (i) Board of CEP meets regularly, and its agenda is jointly the submission to Congress of a law draft proposing the prepared by CEP‘s executive secretary and UMEP. IE on Water Access to Rural legal establishment of the CEP and the UMEP; and (ii) the Communities (SIEF) approval by CEP of the UMEP‘s Organizational- By June 2010, all SOEs had already signed their respective Operational Manual. external audit contracts with independent audit firms Electricity Strengthening Project according to procedures established by UMEP and the CEP ensures greater transparency in SOE management via National Public Procurement Law. 7 SOEs have concluded implementation of annual external audits, elaborated and published their reports and the remaining one is according to CEP standards, and published. expected to do so by mid-2012 17 CPS Outcomes Milestones Status Bank Group Program I. Governance and Anticorruption: Strengthening state institutions to improve policy making, public service provision, and rule of law for investments and households Modernization of the Public Administration to improve service delivery Rate of timely payments reaches 60% for basic services The Ministry of Finance establishes clear rules with respect In 2010, CEP designated members from of an inter- Programmatic DPL provided to the state by SOEs (Electricity, to transfers and payments between SOEs and the Central institutional technical commission (CTI) to calculate Telecommunication, and Water). (Baseline 2008: 27%) Administration. accrued debits and credits maintained between the SOEs Public Sector AAA and Central Administration. Rate of timely payments of SOE-provided services jumped from 27% in 2008 to 51% Water and Sanitation Modernization in mid-2010. Project Electricity Strengthening Project Coverage of ESSAP water access as measured by the Projects in support of investments by ESSAP become Water and sanitation project effective. percentage of households in urban areas with access to water effective (i.e., are approved by congress) has increased to 89.2% (baseline 2010: 79.4%) ANDE satisfactorily implements ongoing investment Energy Sector Strengthening Project effective. Number of hours of power outage as measured by hs/year per program and develops (jointly with financiers) a user has declined to 11 hours (Baseline 2010: 11.2 hs/year) transmission investment program ESSAP is receiving enhanced support from WB Procurement specialist and consultant on technical issues Appropriate fiduciary management of public investments and utility transformation to prepare bidding documents. by ESSAP and ANDE Same kind of intensive support is required for Financial Management. II. Poverty: Improving investments in the social sectors (health and education) and focusing public spending on fighting extreme poverty Employment Generation and Fighting Poverty (especially in light of the effects of the global financial crisis on Paraguay) Focus the limited country capacity and financial resources on Gradually increase beneficiaries of the conditional cash Target surpassed as programs benefitted 98,000 Programmatic Dialogue on Social a few programs to: transfer programs as follows: households living in extreme poverty (Tekopora: 83,000 Policy Increase the number of beneficiaries (households) for the beneficiaries by 2009 (2) 25,000 and PRO-PAIS II: 15,000). Between 2007 and 2010, conditional cash transfer program—Tekopora, PRO-PAIS II, beneficiaries by 2011 (3) 50,000 poverty rates declined to 19.4% (extreme) and 34.7% Programmatic poverty NLTA and Ñopotivo beneficiaries by 2013 (4) 75,000 (overall), but high growth in 2010 left extreme poverty Baseline: 18,700 (2008) rates practically unchanged for that year. Multi-sectoral DPL Target: 75,000 (2013) HD Programmatic NLTA Targeting CCTs significantly improved as beneficiaries for Improve targeting of social expenditures on cash transfer Update the targeting instrument of the CCT program the Tekopora program were identified by a two-fold JSDF Indigenous Community programs ―Tekopora‖ approach of geographic targeting and a door-to-door Development. census. The Bank is supporting the Government in updating the targeting instrument, which is expected to be ready before mid-2012. Introduce a new targeting instrument to select and enroll The Bank helped design and implement a targeting beneficiaries of the non contributory pensions program instrument for the Adultos Mayores program. Next steps ―Adultos Mayores‖ include the legal formalization of the instrument, expected to ready by end-2013 18 CPS Outcomes Milestones Status Bank Group Program II. Poverty: Improving investments in the social sectors (health and education) and focusing public spending on fighting extreme poverty Employment Generation and Fighting Poverty (especially in light of the effects of the global financial crisis on Paraguay) Retool institutional capacity to address other important Launch a dialogue on the options that Paraguay has to A poverty assessment NLTA was conducted to analyze the Programmatic Poverty NLTA poverty concerns, particularly those arising from the crisis, counteract the effects that the Global financial crisis might impact of rising inequality and food prices in national via decentralized mechanisms, such as community driven have on poorest households (including, if appropriate, poverty rates. It also presented the new poverty projects partnership with private sector in support of active labor methodology, analyzed the determinants of poverty, market policies, vocational education, etc.). analyzed trends in the urban labor market and analyzed the possible poverty impacts of a (simulated) expansion in monetary transfer programs (both CCTs and the new non- contributory pension law). Develop active labor market policies to prepare the country, The Temporary Employment Program ―Nambapoo‖ has The Bank is helping the Ministry of Justice and Labor HD Programmatic NLTA and especially the vulnerable groups, to respond to the effects been designed and is ready to be implemented. design the temporary employment programs, to be ready to of an economic crisis that may harm employment. implement by end of CPS Integrated Agrarian Reform, and reactivation of small-scale (household) agriculture Land use change detection completed for major hot spots. Broad -based stakeholder support achieved for evidence- Paraguay Land Assessment focusing on land use and land Paraguay Land Assessment with based land policy options, to facilitate more tenure dynamics from a market perspective launched mid- support from FAO. Land market analysis completed for major hot spots. environmentally and socially sustainable agricultural 2011. growth and urbanization by mid 2013. Sustainable Rural Development First round of national dialogue on evidence-based land Poverty Assessment was completed in 2010 and confirmed Project policy complete. association between limited land access and rural poverty. Programmatic municipal development dialogue. Launch program to provide integrated support to the rural Sustainable Agriculture project effective and As of mid-2011, 150 neighborhood development poor in San Pedro and Caaguazu implementation arrangements deployed committees were established, together with 4 aboriginal Paraguay Poverty Assessment. Baseline: 0 (2008) community organizations. Target: 300 communities and 60 indigenous communities JSDF financed pilot land titling in (2013) First two micro-watershed participatory management plans indigenous communities. are being implemented. 140 small farms have seen their production increase by JSDF Indigenous Community 20%. Development. It is expected that PRODERS will benefit more than 6,000 poor families by the end of FY13. Increased number of indigenous communities with formal 6 indigenous communities have obtained formal land titles. property titles Baseline: 0 (2008) Target: 30 (2013) 19 CPS Outcomes Milestones Status Bank Group Program II. Poverty: Improving investments in the social sectors (health and education) and focusing public spending on fighting extreme poverty Increase enrollment rates and quality of secondary education Improve Evidence-Based Decision Making within the Development of a methodology to identify the most The Government of Paraguay recently requested the Education NLTA (FY12) Ministry of Education on: important needs of the school system. The goal is to help Bank‘s assistance to develop the studies described in the prioritize expenditure (infrastructure, teachers training, milestones Multi-sectoral DPL (1) ensuring basic conditions in all public schools (primary equipment, etc,) based on a set of benchmarks. and secondary) and Activities are currently under development and a workshop HD Programmatic NLTA (FY13- in Asuncion to show the interim results will be organized Fy14) (2) designing an effective strategy to enhance teachers‘ Diagnostic of Paraguay‘s current teachers‘ policies (hiring, in June 2012. quality training, academic requirements, and professional development) together with a plan for improving teachers‘ qualifications (pre and in service training). Increase access to water and sewerage services for the entire population, including indigenous populations Increase coverage of water and sanitation system in rural and Framework for managing the sector agreed (rural and Water and Sanitation project approved and effective, but Water and Sanitation Modernization urban areas and in particular increasing the number of urban) suffering implementation delays. Project additional families (over 2007): Investment program for water and sewerage approved Rehabilitation works planned to start during the second - Using sanitation systems in the Asunción metropolitan area: semester of 2012. Target of 15,000 new families by 2013 DAPSAN initiative (―mesa de coordinación‖) to improve - Using water supply systems in rural and indigenous areas: sector stakeholders‘ coordination is promising. Meanwhile, Target of 5,000 new families by 2013; and Water and Sanitation project requires better coordination from DAPSAN. - Using basic sanitation in rural areas: Target of 4000 new families by 2013). Talks on ESSAP concession contract are progressing well. Increased level of public investment in the sector Public investment increased from 1.7% of GDP in 2008 to materialized. 2.8% of GDP in 2010. Increase access to basic health services of good quality Reduce out-of-pocket payments on drugs and increase access Policy of free drugs designed and implemented Done. Programmatic Health AAA to basic health services, especially for the poor and in remote areas. Family Health Units Program designed and under 500 FHU are operational Multi-sectoral DPL implementation Early experience with Family Health Units program has been evaluated. HD Programmatic NLTA (FY13- Fy14) Analysis of social determinants of health has been Social health determinants are analyzed to design health completed. policies. 20 CPS Outcomes Milestones Status Bank Group Program III. Growth with Inclusion: Fostering growth with a focus on employment generation and on improving income distribution, without destabilizing the country’s macroeconomic framework, and in an environmentally friendly manner. Appropriately responding to the global financial crisis, while safeguarding macroeconomic and financial stability Adoption of a countercyclical fiscal policy to mitigate the Adoption by congress of the emergency, anti-crisis, An anti-crisis plan was launched, helping the country‘s Programmatic DPL impact of the crisis on the most vulnerable population, but package of $300M which is co-financed by IDB, CAF, impressive economic recovery in 2010 and neutralizing the maintaining a sustainable fiscal stance in terms of public debt Japan and the World Bank. effects of the crisis in poverty rates. Programmatic public sector reports to GDP: Programmatic growth notes - The overall fiscal balance to move from surplus to deficit, Gradually (as political economy permits) expand the base Tax/GDP ratio reached 13.5% in 2010, surpassing the set but to avoid sharp increases in the debt to GDP ratio the of tax payers by, for instance eliminating VAT deductions target and allowing the Government to maintain a positive Macroeconomic and financial sector average deficit should be around 1% of GDP (2009-2011) from the profit tax paid by agricultural enterprises (the overall fiscal balance even during the crisis. monitoring - Increased tax-to-GDP ratio IMAGRO), improving administration for the 114 largest Baseline: 11.9% (avg 2004-08) firms and increasing consumption taxes as well as VAT Public Expenditure Review Target: 13.0% (2013) withholding agents NLTA on debt management - Ratio of audits of large tax payers that result in additional Under-Secretariat of Taxes (SET) has strengthened its (SET) has strengthened its audit capacities for large including the assessment of assessment exceeds 70%. audit capacities for large taxpayers through: (i) the taxpayers through: (i) the issuance of a resolution by SET contingent liabilities issuance of a resolution by SET and the Superintendencia and the Superintendencia de Bancos to allow for the audit de Bancos to allow for the audit of financial institutions of financial institutions classified as large taxpayers; and classified as large taxpayers.; and (ii) the implementation (ii) the implementation of a training program for auditors of a training program for auditors from the large taxpayers from the large taxpayers unit (DGGC). unit (DGGC). The Ratio of audits of large tax payers that result in additional assessment was 55% in 2010. Utilizing the fiscal headroom to increase targeting of public Adoption by the Executive of financial programs (which The share of social programs in the overall budget spending, away from wages and other recurrent spending and control non-protected such as social programs and public expenditures increased from 47.8 in 2006-2007 to 50.8 towards capital and social protection items: investments) that are consistent with social and during the crisis while coverage of social protection infrastructure priorities (for 2009 and beyond). programs increased more than 6 fold. - Increase public investment/GDP ratio Public investment/GDP reached 2.8% in 2010. Baseline: 1.7% in 2008 Target: 3.5% in 2013 - Increase coverage for the conditional cash transfer program Efficient institutional and operational mechanisms for A Social Economic Unit was created within the Ministry of Baseline: 2008: 18,700 public entities responsible for social policy implementation Finance to support the design and evaluation of social Target: 75,000 in 2013 are introduced. programs. CCT programs beneficiaries reach 98,000. Moving towards a more sustainable pattern of growth, based in greater diversification of products and external markets; supporting investments in infrastructure and human capital, and improvements in the investment and business climate, that will unambiguously move the country in that direction in the short to medium term Energy Sector Strengthening Project Launch investment program to improve the transmission and Begin manufacturing of equipment for the installation of Energy Sector Strengthening Project effective. Preparation transformation capacity, as well as improvement of the new transmission and transformation capacity, and for the of key documentation is well advanced to begin Paraguay Conservation of system losses. modernization of distribution system to support loss implementation of works. Biodiversity and Sustainable Land reduction. Management in the Atlantic Forest of Eastern Paraguay (GEF). 21 CPS Outcomes Milestones Status Bank Group Program III. Growth with Inclusion: Fostering growth with a focus on employment generation and on improving income distribution, without destabilizing the country’s macroeconomic framework, and in an environmentally friendly manner. Moving towards a more sustainable pattern of growth, based in greater diversification of products and external markets; supporting investments in infrastructure and human capital, and improvements in the investment and business climate, that will unambiguously move the country in that direction in the short to medium term Improve the quality of road infrastructure though the increase First maintenance contracts awarded to the private sector. 1,218 kilometers of roads are maintained through Road maintenance project. of km of road under systematic road maintenance 2009 performance-based contracts. Also, an estimated 50 Baseline: 25% of paved road network under routine percent of the paved road network was under routine Programmatic AAA on small maintenance in 2007 All maintenance contracts for the paved road network maintenance in 2010. cities/rural development. Target: 50% by 2013 awarded. 2011 Toll network optimized. 2012 Achieve a 10 feet operational depth and 24 hour navigation Develop a strategy for the institutional framework of river A feasibility study on concessions for river navigation was IFC Investment in logistic company on 90 percent of the year in waters of Paraguayan rivers and navigation (and the role of the ANNR, the state‘s port prepared in 2011 for river transportation. shared jurisdiction in the Paraguay and Parana rivers. authority, in this framework). 2012 Reduce transport cost by 30 percent through the dredging of Complete study necessary to assess the convenience of the Paraguay river implementing the dredging and maintenance of the river through a public works, PPPs or other contractual arrangement – 2012 Complete technical studies to implement the dredging of the river. Sources of Growth and Overall Competitiveness Competitiveness strategies and action plans agreed upon by Methodology developed and pilot sectors selected for Preliminary methodology agreed upon with the WB‘s Programmatic Growth Notes stakeholders (through a public-private dialogue mechanism) development of competitiveness strategies and action Government and pilot selection process initiated for for pilot sectors/regions. plans. technical assistance to develop pilot competitiveness WB‘s Competitiveness NLTA strategies and action plans. IFC‘s ongoing financial sector operations Launch dialogue on sources of growth (including the Participatory diagnostic prepared on major constraints to A multi-sectoral workshop was carried out on November potential role of the modernization of agricultural enterprises) sustainable growth 7-8, where Bank and Social Ministries discussed the issues IFC‘s ongoing operations in launched. of growth, poverty reduction and inclusion logistics IFC‘s investment in selected Business climate is improved by reductions in red tape. Start a program to simplify the opening of a business and Business climate improved by making it easier to obtain a agribusiness companies Baseline: 291 days to deal with construction permits (2009) the issuance of construction licenses in Asunción. construction permit. In 2010, the creation of a ―single Target: 137 days to deal with construction permits (2013) window‖ for building permit approvals and associated Potential IFC Investment Climate, Continue programs to promote public/private dialogue regulatory changes reduced the time to obtain a building Access to Finance advisory towards resolving business obstacles permit from 63 to 21 days in Asuncion. programs. Continue programs to support private sector development 22 CPS Outcomes Milestones Status Bank Group Program III. Growth with Inclusion: Fostering growth with a focus on employment generation and on improving income distribution, without destabilizing the country’s macroeconomic framework, and in an environmentally friendly manner. Safeguarding the environment Decrease in unsustainable forest management practices and Agreement with OAS and IDEA to promote payment for Initial delay due to the finalization of the legal Development Market Place. slow down of the expansion of the agricultural frontier as a ecosystem services and sustainable agriculture. documentation. The project closing date was extended to result of the implementation of PES in pilot areas. November 2012. WB Carbon Finance Assist Paraguay Conservation of Strengthening of the national capacity to enable the Completion of the Carbon Finance Assist Country Work Two workshops and five technical studies were Biodiversity and Sustainable Land development of Clean Development Mechanism (CDM) Program. successfully carried out to assess the low carbon potential Management in the Atlantic Forest projects and other mitigation activities. in relevant productive sectors. of Eastern Paraguay (GEF). Sustainable Agriculture & Rural Establishing a biological corridor and encouraging Grant effectiveness achieved during 2011. The project implementation is dealing with significant Development Project. sustainable agricultural practices; institutional coordination challenges between Itaipú Binacional, MAG/PRODERS and SEAM to agree on some Water & Sanitation Sector Strengthening the institutional capacity of MAG and SEAM basic operational principles. Modernization. to improve management capacity; and The Project‘s Indigenous People Strategy needs to be updated. Energy Sector Strengthening Project Strengthening the National Protected Areas System. 23 Annex 2. Summary of Changes to CPS Results Framework Pillar I: Governance and Anticorruption Deleted Added Reformulated CPS Outcomes  5 successful high profile  Improving the  Indicators tracking corruption trials. independent role of the competitive recruiting  Ministers formally adopt media as a watchdog of practices changed from good governance the political arena. percentage of officials to practices.  Assisting the Government percentage of public in improving sector institutions accountability institutions.  Indicators tracking  Modernization of clearing improvements in public and settlement of the service deliver changed Central Bank‘s payment from share of capital system. expenditures to concrete  Reduce number of civil water and electricity servants earning below the indicators minimum wage  Rate of timely payments for SOE-provided services to the state reaches 60%. Milestones  Subscription to the Stolen  Journalism trainings and  Road and water sectors Assets Recovery Program. media studies governance agreement  Preparing and  References to Central specified as a component anticorruption plan. Bank payments system of all Bank projects in the  Reference to Civil Service modernization country. Law amendments  Reference to timely  References to the payments by the state to establishment of SOE SOEs holding agency summarized. Bank Program  StAR Initiative  Strengthening the  Previous reference to a Instruments National Audit Office possible Trust Fund SFLAC. substituted by actual  Congressional project ―Building an Strengthening IDF. accountability to Address  IE on Water Access to Systematic Corruption‖. Rural Communities (SIEF). 24 Pillar II: Poverty Deleted Added Reformulated Country Strategic Goals  Increase access to basic health services of good quality. CPS Outcomes  Reference to road  Improve targeting of  CCT beneficiaries targets maintenance by social expenditures on now cover whole CPS community groups. cash transfer programs. period.  Develop active labor  Reference to land reform market policies to prepare to reflecting current the country to the effects emphasis on reaching of a crisis that may harm consensus on the issue. employment.  Education outcomes were  Reduce out-of-pocket reformulated to reflect payments on drugs and changes in the nature of increase access to basic Bank support to the sector, health services for the now focusing on policy poor. strengthening. Milestones  Capacity building  Reference to design of  Specific reference of activities for school Nambapoo. social programs to receive teachers.  Policy of free drugs support on updating or  Continued support to the designed and designing targeting cash transfers conditioned implemented. instruments (Tekopora on secondary school  Family health units and Adultos Mayores). attendance. program designed and  Milestones on land-reform implemented. reformulated and  Social health determinants emphasis given to analysis to inform policy reaching broad stake- design. holder consensus.  Milestones on education reformulated to reflect current emphasis on policy dialogue. Bank Program  Secondary education  HD Programmatic NLTA. Instruments project.  Education NLTA.  Possible social safety nets  HD Programmatic Health operation. AAA.  Multi-sectoral DPL. 25 Pillar III: Growth with Inclusion Deleted Added Reformulated Pillar  Pillar renamed Growth with Inclusion (formerly ―Growth with Equity‖) CPS Outcomes  Reference to airports and  Increase the ratio of audits  Electricity sector the potential and costs of of large tax payers that objectives reformulated to air traffic. results in additional reflect specific objectives  Issues related to assessment. of Energy Project. improving  Reduce transport costs  Business climate telecommunications and through the dredging of indicators now focused on the internet. the Paraguay river reduction of red tape  Strengthening financial  Competitiveness strategies (formerly investment to sector supervision and action plans for pilot GDP ratio).  Reference to land regions/sectors.  Establishing a biological ecological services in pilot  Strengthening the corridor and encouraging areas. institutional capacity of sustainable agricultural MAG and SEAM and the practices replaced National Protected Areas objective of exposing 15 System. groups to conservation practices n Caaguazú and San Pedro.  Milestones  Reference to Ministry of  Reference to the auditing  References to carbon Industry and Commerce of large taxpayers. finance changed from working group to resolve  Reference to analysis of the potential to obstacles faced by key Manufacturing of participate in the program industries. equipments to modernize to completion of Carbon  Reference to introducing electricity sector. Finance Country Work international standards for  Complete technical study Program. cooperatives supervision. to implement dredging of Paraguay river  Develop methodology and pilot sectors selected for competitiveness strategy.  Biodiversity GEF grant effectiveness in 2011. Bank Program  Environment evaluation  Programmatic AAA on Instruments state. small cities/rural  FMAM Biodiversity development.  Potential IFC Investment Climate and Access to Finance Advisory programs.  Carbon Finance program.  Development Market Place  GEF Biodiversity Project.  Water and Sanitation Project.  Energy Sector Strengthening Project. 26 Annex 3. Paraguay IBRD Lending and Government-Executed Trust Fund Program Amount Fiscal Year Quarter Project (US$ million) Loan 2009 Q4 Water and Sanitation Sector Modernization (approved under previous CPS) 64 2009 Q4 Public Sector Reform DPL 100 2011 Q2 Energy Sector Strengthening Project 100 2012 Q2 Public Sector DPL 100 Government-Executed Trust Fund 2009 Q4 Strengthening Congressional Legislative Process and Budget Oversight Capacity (IDF) 0.44 Conservation of Biodiversity and Sustainable Land Management in the Atlantic Forest of Eastern 2010 Q4 4.50 Paraguay (GEF) 2011 Q3 Strengthening National Audit Office (SFLAC) 0.33 27 Annex 4. AAA Program in Paraguay, FY10-FY13 Delivery FY Project Name Theme Output Type Delivered to Client 2010 Public Sector NLTA Governance Institutional Development Plan MTDS Report Economic Policy Macroeconomics and Growth Report FSAP Update Financial Development Financial Sector Assessment Report 2011 Social Protection NLTA Social Protection Advisory Services/Technical Assistance (FBS) Payment System Governance Advisory Services/Technical Assistance Implications of Trade Liberalization within MERCOSUR Economic Policy Knowledge-Sharing Forum Programmatic Poverty Non-Lending Technical Assistance (NLTA) Poverty Reduction Advisory Services/Poverty Assessment 2012 CDM Technical Assistance for Paraguay Environment Advisory Services/Technical Assistance Support for the Design of River Navigation Concessions-Phase II Transport Advisory Services/Technical Assistance Currently Underway Building an Accountability Coalition to Address systemic corruption Governance Advisory Services/Technical Assistance 2012 Paraguay Land Dialogue Rural Development Advisory Services/Technical Assistance Programmatic Poverty Poverty Reduction Advisory Services/Poverty Assessment Medium and Long-Term vision for the Paraguay Health Sector Development Health Sector Study Report 2013 Paraguay Competitiveness and Innovation Economic Growth Advisory Services/Technical Assistance 2013 Paraguay Public Expenditure Report Governance Public Expenditure Review 2013 Education Education Advisory Services/Technical Assistance 2013 Public Sector Effectiveness (SFLAC) Governance Advisory Services/Technical Assistance 2013 (FBS) Payment System 2 Governance Advisory Services/Technical Assistance 2013 Infrastructure and Logistics Transport Advisory Services/Technical Assistance 2013 Strengthening the Pension System Social Protection Sector Study Report 28 Annex 5. Operations Portfolio (IBRD/IDA and GEF Grants) As of 04/09/2012 Active Projects Difference Between Last PSR Expected and Actual Supervision Rating Original Amount in US$ Millions Disbursements a/ Development Implementation Frm Project ID Project Name Fiscal Year IBRD IDA GRANT Cancel. Undisb. Orig. Objectives Progress Rev'd P114971 PY Energy Sector Strengthening Project MU MU 2011 100 99.75 -0.249995 P094335 PY GEF Biodiversity Conservation MS MS 2010 4.5 4.05 P088799 PY PRODERS - Sust. Agric. & Rur Dev. Prj MS MS 2008 37.5 32.14675 23.401441 P117043 PY Public Sector DPL # # 2012 100 100 P082026 PY Road Maintenance MU MS 2007 74 45.85723 45.072229 19.69056 P095235 PY Water & Sanit. Sector Modernization MU U 2009 64 60.50835 22.508349 Overall Result 375.5 4.5 342.3123 90.282032 19.69056 29 Annex 6. Paraguay: IFC Investment Operations Program 2009 2010 2011 2012* Original Commitments (US$m) IFC and Participants 85.76 101.63 217.72 112.82 IFC's Own Accounts only 85.76 101.63 217.72 112.82 Original Commitments by Sector (%)- IFC Accounts only AGRICULTURE AND FORESTRY 11.66 9.84 4.59 15.07 FINANCE & INSURANCE 18.38 88.88 95.41 71.63 TRANSPORTATION AND WAREHOUSING 69.96 1.28 13.3 Total 100 100 100 100 Original Commitments by Investment Instrument (%) - IFC Accounts only Equity 6.1 Guarantee 18.38 58.18 65.55 71.64 Loan 81.62 34.44 34.45 28.36 Risk product 1.28 Total 100 100 100 100 * Data as of April 01,2012 30 Annex 7. IFC Committed and Disbursed Outstanding Investment Portfolio As of 3/31/2012 (In USD Millions) Committed Disbursed Outstanding **Quasi Partici **Quasi Partici FY Approval Company Loan Equity Equity *GT/RM pant Loan Equity Equity *GT/RM pant 2010 Agrihold group 11.5 0 0 0 0 6.5 0 0 0 0 2012 Agrofertil sa 8.26 0 0 0 0 8.26 0 0 0 0 2011 Banco regional 29.44 0 0 0 0 29.44 0 0 0 0 2010 Bbva paraguay 18.75 0 0 0 0 18.75 0 0 0 0 2011 Itau paraguay 20 0 0 0 0 20 0 0 0 0 2012 Nfd agro 17 5 0 0 0 5 5 0 0 0 2012 Sudameris bank 15 0 0 6.5 0 15 0 0 6.5 0 2010 Uabl 75 0 0 3.32 0 75 0 0 2.38 0 Total Portfolio: 194.95 5 0 9.82 0 177.95 5 0 8.88 0 * Denotes Guarantee and Risk Management Products. ** Quasi Equity includes both loan and equity types. 31 Annex 8. Selected Indicators* of Bank Performance As of 04/09/2012 Indicator 2009 2010 2011 2012 Portfolio Assessment a Number of Projects Under Implementation 6 3 4 5 b Average Implementation Period (years) 3.0 2.5 3.0 3.3 a, c Percent of Problem Projects by Number 50.0 0.0 75.0 60.0 a, c Percent of Problem Projects by Amount 25.0 0.0 62.7 62.6 a, d Percent of Projects at Risk by Number 66.7 66.7 75.0 80.0 a, d Percent of Projects at Risk by Amount 48.3 56.4 62.7 73.7 e Disbursement Ratio (%) 4.7 1.2 7.2 7.7 Portfolio Management CPPR during the year (yes/no) Supervision Resources (total US$) Average Supervision (US$/project) Memorandum Item Since FY 80 Last Five FYs Proj Eval by OED by Number 36 2 Proj Eval by OED by Amt (US$ millions) 796.7 28.7 % of OED Projects Rated U or HU by Number 40.0 50.0 % of OED Projects Rated U or HU by Amt 42.5 69.7 a.As shown in the Annual Report on Portfolio Performance (except for current FY). b.Average age of projects in the Bank's country portfolio. c.Percent of projects rated U or HU on development objectives (DO) and/or implementation progress (IP). d.As defined under the Portfolio Improvement Program. e.Ratio of disbursements during the year to the undisbursed balance of the Bank's portfolio at the beginning of the year: Investment projects only. * All indicators are for projects active in the Portfolio, with the exception of Disbursement Ratio, which includes all active projects as well as projects which exited during the fiscal year. 32 Annex 9. Paraguay at a Glance Paraguay at a glance 02/29/12 Latin Lower Key Development Indicators America middle Paraguay & Carib. income Age distribution, 2009 (2010) Male Female Population, mid-year (millions) 6.5 572 3,811 Surface area (thousand sq. km) 407 20,394 31,898 75-79 Population growth (%) 1.8 1.1 1.2 Urban population (% of total population) 61 79 41 60-64 GNI (Atlas method, US$ billions) 19.1 4,011 8,846 45-49 GNI per capita (Atlas method, US$) 2,960 7,007 2,321 30-34 GNI per capita (PPP, international $) 4,430 10,286 4,784 15-19 GDP growth (%) 15.0 -1.9 7.1 GDP per capita growth (%) 13.0 -3.0 5.9 0-4 10 5 0 5 10 (most recent estimate, 2004–2010) percent of total population Poverty headcount ratio at $1.25 a day (PPP, %) 5 8 .. Poverty headcount ratio at $2.00 a day (PPP, %) 13 17 .. Under-5 mortality rate (per 1,000) Life expectancy at birth (years) 72 74 68 Infant mortality (per 1,000 live births) 19 19 43 60 Child malnutrition (% of children under 5) .. 4 24 50 Adult literacy, male (% of ages 15 and older) 96 92 87 Adult literacy, female (% of ages 15 and 93 90 74 40 Gross older) primary enrollment, male (% of age 104 118 109 30 Gross group) primary enrollment, female (% of age 101 114 105 group) 20 Access to an improved water source (% of 86 93 86 Access to improved sanitation facilities (% of population) 70 79 50 10 population) 0 1990 1995 2000 2009 Net Aid Flows a 1980 1990 2000 2010 Paraguay Latin America & the Caribbean (US$ millions) Net ODA and official aid 30 57 82 148 Growth of GDP and GDP per capita (%) Top 3 donors (in 2008): Spain 0 1 5 39 Japan 16 26 52 37  20 European Union Institutions 0 1 5 32 15 Aid (% of GNI) 0.7 1.1 1.1 1.0  10 Aid per capita (US$) 10 13 15 23  5 0 Long-Term Economic Trends -5 Consumer prices (annual % change) 22.4 37.3 9.0 9.2 -10 GDP implicit deflator (annual % change) 16.7 36.3 12.4 6.7 95 05 Exchange rate (annual average, local per 126.0 1,229.8 3,486.4 4,592.0  Terms of trade index (2000 = 100) US$) .. .. .. ..  1980– GDP 1990– 2000– capita GDP per (average annual growth) 90 2000 10 Population, mid-year (millions) 3.2 4.2 5.3 6.5 2.8 2.3 %) 1.9 GDP (US$ millions) 4,579 5,265 7,095 18,904 2.5 2.2 3.8 (% of GDP) Agriculture 28.6 27.8 17.0 22.3 3.6 3.3 5.2 Industry 27.4 25.2 22.7 20.4 0.3 0.6 2.1 Manufacturing 16.0 16.8 15.7 12.2 4.0 1.4 1.3 Services 43.9 47.0 52.0 46.8 3.1 1.6 3.8 Household final consumption expenditure 75.7 77.2 79.2 69.0 2.4 2.6 3.3 General gov't final consumption expenditure 6.0 6.2 12.7 9.3 1.5 2.5 4.3 Gross capital formation 31.7 22.9 18.8 19.5 -0.8 0.7 4.0 Exports of goods and services 15.3 33.2 38.1 57.1 11.5 3.1 7.5 Imports of goods and services 28.7 39.5 48.8 55.0 4.4 2.9 6.8 Gross savings 19.2 18.8 16.5 13.4 Note: Figures in italics are for years other a. Aid data are for 2009. than those specified. 2010 data are preliminary. Group data are for 2009. .. Development Economics, Development Data indicates data are not available. Group (DECDG). 33 Paraguay Balance of Payments and Trade 2000 2010 Governance indicators, 2000 and 2009 (US$ millions) Total merchandise exports (fob) 2,329 8,335 Voice and accountability Total merchandise imports (cif) 2,050 9,400 Net trade in goods and services -362 -867 Political stability Current account balance -163 -805 Regulatory quality as a % of GDP -2.3 -4.3 Rule of law Workers' remittances and compensation of employees (receipts) 278 609 Control of corruption Reserves, including gold 772 4,168 0 25 50 75 100 Central Government Finance 2009 Country's percentile rank (0-100) (% of GDP) 2000 higher values imply better ratings Current revenue (including grants) 17.2 18.3 Tax revenue 10.8 13.1 Source: Kaufmann-Kraay-Mastruzzi, World Bank Current expenditure 16.7 13.7 Technology and 2000 2009 Overall surplus/deficit -4.6 1.4 Infrastructure Paved roads (% of total) 50.8 .. Highest marginal tax rate (%) Fixed line and mobile phone Individual 0 10 subscribers (per 100 21 95 Corporate 30 10 High technology exports people) (% of manufactured 2.9 11.3 External Debt and Resource Flows exports) Environment (US$ millions) Total debt outstanding and disbursed 3,088 4,938 Agricultural land (% of land 51 51 Total debt service 352 464 area) area (% of land area) Forest 48.7 44.3 Debt relief (HIPC, MDRI) – – Terrestrial protected areas (% of .. .. land area) Total debt (% of GDP) 43.5 26.1 Freshwater resources per capita 16,873 15,343 Total debt service (% of exports) 10.6 4.4 (cu. meters)withdrawal (billion cubic Freshwater 0.5 .. meters) Foreign direct investment (net inflows) 104 274 CO2 emissions per capita 0.69 0.67 Portfolio equity (net inflows) 0 0 (mt) GDP per unit of energy use (2005 PPP $ per kg of oil 5.3 6.2 Composition of total external debt, 2009 equivalent) Energy use per capita (kg of oil 720 699 equivalent) 15 IDA,IBRD, 281 IMF, 0 Short-term, 752 World Bank Group 2000 2009 portfolio Other multi- (US$ millions) lateral, 1,057 IBRD Total debt outstanding and 201 281 Disbursements disbursed 47 101 Private, 1,254 Principal repayments 19 33 Interest payments 11 7 Bilateral, 625 IDA Total debt outstanding and 28 15 US$ millions Disbursements disbursed 0 0 Private Sector Development 2000 2010 Total debt service 2 2 Time required to start a business (days) – 35 IFC (fiscal year) Cost to start a business (% of GNI per capita) – 55.1 Total disbursed and outstanding 0 71 Time required to register property (days) – 46 of which IFC own portfolio 0 71 Disbursements for IFC own account 0 60 Ranked as a major constraint to business 2000 2010 Portfolio account sales, (% of managers surveyed who agreed) repayments for prepayments and IFC own 0 0 Anticompetitive or informal practices .. 25.8 account Access to/cost of financing .. 21.0 MIGA Gross exposure 5 0 Stock market capitalization (% of GDP) 3.5 0.2 New guarantees 0 0 Bank capital to asset ratio (%) 12.4 9.7 Note: Figures in italics are for years other 1/11/12 than those specified.not available. – indicates .. indicates data are 2010 data are observation preliminary. is not applicable. Development Economics, Development Data Group (DECDG). 34 Annex 10. Growth and Poverty Trends in Paraguay 2003-2010 i. High poverty and inequality continue to be major development challenges in Paraguay despite noticeable improvements over the last decade. Poverty was 34.7 percent in 2010, while the extreme poverty rate of 19.4 percent places Paraguay among the poorest countries in Latin America. Inequality is also among the highest in the LAC region with a Gini coefficient of 0.512. Over half of the poor and more than two thirds of the extreme poor are located in rural areas of Paraguay. 2 With only 41.2 percent of the population in 2010, rural households have a disproportionate amount of the poor (58.1 percent). Overall, poor household heads have similar age and gender characteristics as non-poor household heads, but much higher rates of incomplete primary education (45 percent versus 25 percent for the non-poor) and of informality (60 percent versus 42 percent), with a third working in agriculture (as compared to 16.5 percent for the non-poor). Poor households have a higher dependency ratio, with an average of 5.3 members (versus 3.7 members for the non-poor), and tend to speak Guarani at home. Poor households also live in lower quality dwellings. ii. Socio-economic conditions have improved in Paraguay over the past decade; however, over a longer horizon, poverty and inequality show less improvement and an insufficiency to overcome existing structural issues. Since 2003, Paraguay has improved considerably its socio- economic indicators including poverty, inequality, health, and education. Nonetheless, evaluated in a longer term perspective and with respect to average trends in other LAC countries, poverty declined more gradually in Paraguay, from 36.1 percent in 1998 to 34.7 percent, while inequality increased from 0.489 in 1998 to 0.512, indicating the structural nature of the problem. iii. Growth continues to be necessary for poverty reduction, but is not sufficient. Poverty decompositions throughout the period highlight that growth continues to be an important component in poverty reduction. However, increases in food prices and, in recent years, high levels of inequality have not helped reduce poverty. A better distribution of income would have helped reduce poverty more strongly along with the economic growth. Poor people living in rural areas do not benefit much from an expansion in agriculture due to land access issues and mass production by big firms. Social transfer programs exist but are insufficient to have a significant impact on poverty and inequality. The government does not have a sufficient revenue basis to afford stronger transfer programs: the tax to GDP ratio in Paraguay is still around 12 percent, one of the lowest in LAC. iv. Poverty rates have also shown strong differences between rural and urban areas. Paraguay‘s economy is strongly based in the agricultural sector (especially soy and meat) which represents more than 20 percent of total value added. Paraguay‘s exports and export partners are also heavily concentrated. About 80 percent of exports are agriculture-based products, half of which are soy and meat. This makes the economy extremely sensitive to weather and commodity price changes. Paraguay is also very vulnerable to a slowdown in trade activity of the MERCOSUR region, as 50 percent of exports are destined to Argentina, Uruguay and Brazil. However, the poor in rural areas do not participate strongly in soy and meat production. Soy and meat production are not labor intensive and, thus, growth in these exports does not translate into faster poverty reduction. Changes in the distribution of income and in food prices also matter in terms of changes in poverty rates. In 2010, a 5 percent increase in the extreme poverty line (which reflects only food prices), would have increased extreme poverty by about 8 percent and affected the rural extreme poor by relatively more than the urban. v. A closer look at poverty since 2003 shows that most of the above-explained factors were at work. Between 2003 and 2008, Paraguay experienced six consecutive years of positive output 2 Paraguay measures poverty in monetary terms using the poverty line method: persons with income below the poverty line (measured by the value of a basic basket of food and non-food goods and services) are considered poor. Those below the extreme poverty line (measured by the value of a basic basket of food) are considered extreme poor, or indigent. 35 growth with an annual average growth rate of 4.6 percent and an overall decline in poverty and inequality. Poverty fell from 44 percent in 2003 to 37.9 percent in 2008 (Figure 1), and the Gini declined by 0.04 points to reach 0.506 in 2008. Unlike in 2010, improvements in both mean incomes and its distribution worked towards the reduction of poverty. Figure 1: Poverty and Extreme Poverty Trends, Paraguay 60 Rural 50 43.7 44.0 41.2 41.3 38.6 37.9 40 Urban 35.1 34.7 Percentage Poverty 30 23.7 21.2 23.2 18.3 19.0 18.8 19.4 Extreme 20 16.5 Poverty 10 0 2003 2004 2005 2006 2007 2008 2009 2010 vi. The severe drought and global financial crisis in 2009 had little effect on national poverty levels, but had a differentiated effect on the rural and urban sectors. National poverty and inequality continued to decline in 2009, reaching 35.1 percent and 0.487, respectively, in that year. In urban areas, the negative impact on GDP was not as strong, and urban poverty declined from 30.2 in 2008 to 24.7 percent as a result. This reflected rising wages for urban low skilled workers, in part possibly due to countercyclical government spending on public works that benefitted low-skilled sectors such as construction. Real wages in construction increased by about 20 percent between 2008 and 2009. Increasing remittances, which represented 10 percent of urban household income of the poorest decile, and increased public transfers (Tekopora) to extreme poor urban households may also have buffered these households. However, contrary to the developments in the urban sector, rural GDP fell strongly as the agriculture sector was hit hard by the drought. Rural poverty went up 1 percentage point to 49.8 percent. The labor force participation of family members increased in search of additional income, but this may have led to a further dampening of wages. Neither extra family labor income nor remittances nor public transfers (Tekopora) were enough to buffer household incomes. Nevertheless, all these sources of income likely kept poverty from increasing even further. In all, the net effect of the changes in rural and urban areas resulted in a relatively stable poverty rate –a small reduction at the national level. vii. In 2010, Paraguay enjoyed an unprecedented 15 percent GDP growth, yet poverty decreased by only 0.4 percent (to 34.7 percent) and extreme poverty even increased by 0.6 percent (from 18.8 percent in 2009 to 19.4 percent). The rebound in the agricultural sector accounted for more than half of the strong rebound in 2010, while the commerce sector accounted for another third. One possible explanation for the difference in these trends as compared to 2003-2008 could be the growing importance of soybeans, as the acreage devoted to this commercial export crop has increased significantly since 2008 responding to higher world market prices. The production of soybeans and meat requires large extensions of land and are not labor-intensive. This not only weakens the links to employment creation and poverty reduction, but it is also characteristic of an economy with high inequality. The extreme poor in rural areas do not work in commercial export agriculture (soybean and cattle); therefore, growth driven by these sectors has not trickled down sufficiently to offset higher food prices for the rural poor. 36 viii. The failure of growth to translate into a reduction in extreme poverty since 2009 seems to be linked mainly, but not exclusively, to three main phenomena. First, high levels of initial inequality in income and assets holdings (such as land), which makes growth less effective in reducing poverty. Second, a growth pattern in the rural area based on relatively capital-intensive sectors, which extends to service sectors in urban areas (such as commerce), with the exception of construction that has a clear link to public investment. Third, a non-structural factor but one determined by external conditions: price and weather shocks that affect primary goods and have an impact on real wages. Public transfers and remittances have played a role, but compensating only partially the other components. 37 Annex 11. Financing Gap Based on a significant increase in the primary deficit, financing needs are projected to be challenging but generally manageable. Gross financing needs are projected to increase from US$206 million in 2011 to US$827 million in 2012. This translates into an increase from 1 percent of GDP to 3.2 percent of GDP. Total amortizations substantially add to the financing needs on top of those arising from the increase in the primary deficit. Amortizations are expected to peak at US$ 367 in 2014. Beginning in 2012, projected fiscal deficits add to the financing needs. Disbursements of external loans are expected to reach US$456 million in 2012 and US$419 million in 2013, including new budget support. After abstaining from bond issuance in 2011, the Government is planning to step up domestic bond issuance from US$172 million in 2012 to US$187 million in 2014. If all or part of the budget support operations is not approved by Congress in the course of 2012 or 2013, the Government still has some room to increase the issuance of domestic bonds and/or use part of the net public sector deposits with the Central Bank.3 In 2010 alone, the Government deposited US$260 million, including US$100 million from the Inter-American Development Bank (IADB). Central government's medium-term financing plan* (USD million) 2010 2011 2012 2013 2014 Financing needs 104 206 826 697 817 Primary surplus/deficit 273 220 -435 -444 -337 Amortizations 305 324 283 220 367 Domestic 89 122 82 44 203 External 217 202 202 176 164 Multilateral 135 128 122 111 99 Bilateral 81 74 79 65 65 Interest payments 72 102 107 32 113 Financing Sources 364 159 456 419 387 Disbursements 364 159 456 419 387 External 278 159 283 233 193 Multilaterals 267 132 235 172 127 o/w new budget support 1/ 145 0 100 75 0 Bilaterals 11 28 48 61 67 Domestic bonds 86 0 172 187 194 Use of public sector deposits at CB -260 47 370 277 430 Financing gap 0 0 0 0 0 *90% of public sector figures 1/ 2010: BID ($100m), CAF ($45.2); 2012: PSDPL ($100m); 2013: BID ($75m) 3 The annual budget law usually authorizes the issuance of domestic bonds up to US$300 million. 38 Annex 12. Debt Sustainability Analysis 1. The debt sustainability analysis is performed on the basis of two methodological approaches. The deterministic approach presents the evolution of main determinants of public debt over time. The stochastic approach shows how the main determinants of public debt are affected by stochastic shocks. 2. A favorable medium-term macroeconomic framework would help preserve a stable path for Paraguay’s public debt in 2011-2014. The baseline for the debt sustainability analysis is conservative. Fiscal accounts are expected to deteriorate in 2011- 2014 although at sustainable levels. Under these assumptions, central government gross debt is projected to decline from 20.0 percent of GDP in 2009 to 11.3 percent of GDP in 2014. The baseline scenario is based on the assumption of an average primary deficit of 1.4 percent of GDP during 2012-2014. 3. Fiscal prudence, economic growth and exchange rate stability are critical for continued improvement in public debt indicators. For the baseline scenario, it was found that during 2008 and 2010 exchange rate appreciation, fiscal adjustment (primary surplus) and continued healthy growth played a significant role in reducing the debt-to-GDP ratio. In addition a shock of a 2 percentage point decline in the real growth rate due to a potential global crisis is applied. In this scenario the debt-to-GDP ratio would peak at about 14 percent in 2013 to then fall back in the following year. Central Government Debt Sustainability (baseline scenario) 2008-2014 Act. Est. Proj. 2008 2009 2010 2011 2012 2013 2014 Central government (% of GDP) 18.4 19.9 16.5 11.9 12.6 12.7 11.3 o/w foreign currency-denominated 13.6 13.1 11.1 9.3 8.6 7.3 6.5 Key assumptions Real GDP growth (%) 5.8 -3.8 15.0 4.0 -0.7 7.5 4.5 Primary balance (% of GDP) 3.1 0.7 1.5 0.9 -1.7 -1.5 -1.0 Overall balance (% of GDP) 2.5 0.1 1.1 0.6 -2.1 -1.6 -1.3 Growth of real primary spending (%) -4.9 28.2 4.7 4.7 3.9 4.5 4.7 Average nominal interest rate (%) 3.3 2.8 3.8 3.6 4.0 4.2 4.6 Exchange rate (Gs/US$), eop 4945.0 4610.0 4574.0 4439.9 4300.0 4250.0 4100.0 4. Following a deterministic approach to the debt sustainability analysis, it can be found that adverse shocks could temporarily reverse the favorable debt trends observed under the baseline scenario. Various stress tests to evaluate the behavior of the central government debt ratio under different scenarios have been considered. For example, a one- time 30 percent exchange rate depreciation in 2012. This shock would cause the debt-to-GDP ratio to deteriorate rapidly to 17.8 percent in 2012, reverting to below 15.5 percent by 2014. 39 Gross Public Debt: Alternative Scenarios and Bound Tests, 2009-14 (in percent of GDP) Actual Projections 2010 2011 2012 2013 2014 II. Stress Tests for Public Debt Ratio A. Alternative Scenarios A1. Key variables are at their historical averages in 2012-14 1/ 16.5 11.9 8.5 6.4 3.0 A2. No policy change (constant primary balance) in 2012-14 16.5 11.9 9.0 7.1 4.3 B. Bound Tests B1. Real interest rate is at baseline plus one standard deviations 16.5 11.9 12.8 13.2 12.0 B2. Real GDP growth is at baseline minus one-half standard deviation 16.5 11.9 13.4 14.6 14.7 B3. Primary balance is at baseline minus one-half standard deviation 16.5 11.9 13.3 13.9 13.1 B4. Combination of B1-B3 using one-quarter standard deviation shocks 16.5 11.9 13.2 13.8 12.9 B5. One time 30 percent real depreciation in 2012 2/ 16.5 11.9 17.8 17.3 15.5 B6. 10 percent of GDP increase in other debt-creating flows in 2012 16.5 11.9 22.6 21.4 19.3 B7. Real GDP growth is at baseline minus 2% in 2012 16.5 11.9 13.3 13.7 12.6 1/ The key variables include real GDP growth; real interest rate; and primary balance in percent of GDP. 2/ Real depreciation is defined as nominal depreciation (measured by percentage fall in dollar value of local currency) minus domestic inflation (based on GDP deflator). Table Central Government Debt Sustainability Framework 2000-2014 Actual Projections 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 I. Baseline Projections Central government debt 1/ 31.5 39.6 54.4 43.0 36.7 30.0 22.3 22.6 18.4 19.9 16.5 11.9 12.6 12.7 11.3 o/w foreign-currency denominated 28.2 34.3 47.3 38.0 32.8 26.9 20.0 15.7 13.6 13.1 11.1 9.3 8.6 7.3 6.5 Change in public sector debt 1.1 8.1 14.8 -11.3 -6.3 -6.7 -7.7 0.2 -4.1 1.5 -3.4 -4.6 0.7 0.1 -1.4 Identified debt-creating flows (4+7+12) 3.7 8.0 16.7 -15.2 -6.9 -5.1 -7.7 -5.4 -6.0 -0.3 -4.8 -3.1 1.3 -0.1 -0.1 Primary deficit 3.3 -0.5 1.8 -1.0 -2.7 -2.0 -1.5 -1.8 -3.1 -0.7 -1.5 -0.9 1.7 1.5 1.0 Revenue and grants 17.2 18.8 17.4 17.0 18.4 18.3 18.3 17.6 17.3 19.6 18.5 18.9 20.0 18.3 17.5 Primary (noninterest) expenditure 20.5 18.3 19.2 16.0 15.7 16.3 16.8 15.8 14.2 18.9 17.0 18.0 21.6 19.8 18.5 Automatic debt dynamics 2/ 0.4 8.5 14.9 -14.2 -4.2 -3.2 -6.2 -3.6 -2.9 0.3 -3.3 -2.1 -0.4 -1.6 -1.0 Contribution from interest rate/growth differential 3/ -1.2 -0.7 -2.1 -8.7 -4.9 -2.5 -2.5 -2.5 -3.1 1.3 -3.2 -1.9 -0.1 -1.5 -0.8 Of which contribution from real interest rate -2.2 -0.1 -2.1 -7.0 -3.4 -1.6 -1.4 -1.2 -2.0 0.6 -0.8 -1.3 -0.1 -0.7 -0.3 Of which contribution from real GDP growth 0.9 -0.6 0.0 -1.7 -1.5 -0.9 -1.2 -1.3 -1.1 0.7 -2.4 -0.6 0.1 -0.8 -0.5 Contribution from exchange rate depreciation 4/ 1.6 9.2 17.0 -5.5 0.8 -0.6 -3.7 -1.1 0.2 -1.0 -0.1 -0.3 -0.3 -0.1 -0.2 Other identified debt-creating flows 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Privatization receipts (negative) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Recognition of implicit or contingent liabilities 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other (specify, e.g. bank recapitalization) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Residual, including asset changes (2-3) -2.6 0.1 -1.9 3.8 0.6 -1.6 0.1 5.6 1.9 1.8 1.5 -1.6 -0.6 0.2 -1.3 Central government debt-to-revenue ratio 1/ 183.9 210.9 311.8 253.1 199.5 163.9 121.7 128.0 106.4 101.7 89.3 62.8 63.1 69.3 64.5 Gross financing need 5/ 8.9 5.8 9.4 6.7 5.1 4.9 4.0 2.5 0.8 3.4 1.7 1.7 4.1 3.3 3.0 in billions of U.S. dollars 0.6 0.4 0.5 0.4 0.4 0.4 0.4 0.3 0.1 0.5 0.3 0.4 1.0 1.0 1.0 Key Macroeconomic and Fiscal Assumptions Real GDP growth (in percent) -3.3 2.1 0.0 3.8 4.1 2.9 4.3 6.8 5.8 -3.8 15.0 4.0 -0.7 7.5 4.5 Average nominal interest rate on public debt (in percent) 6/ 4.3 4.7 4.2 3.0 3.1 3.5 3.7 4.4 3.2 3.2 2.4 2.0 3.7 1.0 2.9 Average real interest rate (nominal rate minus change in GDP deflator, in percent) -8.1 -0.2 -5.9 -15.0 -8.7 -4.6 -4.8 -5.8 -10.0 3.0 -3.9 -8.4 -1.3 -5.5 -2.1 Nominal appreciation (increase in US dollar value of local currency, in percent) -5.6 -24.7 -34.1 16.2 -2.2 2.1 17.9 6.5 -1.4 7.3 0.8 3.0 3.3 1.2 3.7 Inflation rate (GDP deflator, in percent) 12.4 4.8 10.0 18.0 11.8 8.1 8.5 10.2 13.2 0.2 6.3 10.4 5.0 6.5 5.0 Growth of real primary spending (deflated by GDP deflator, in percent) -3.9 -9.0 5.0 -13.3 1.7 7.3 7.7 0.2 -4.9 27.7 3.7 10.0 19.4 -1.7 -2.4 Primary deficit 3.3 -0.5 1.8 -1.0 -2.7 -2.0 -1.5 -1.8 -3.1 -0.7 -1.5 -0.9 1.7 1.5 1.0 1/ Indicate coverage of public sector, e.g., general government or nonfinancial public sector. Also whether net or gross debt is used. 2/ Derived as [(r - p(1+g) - g + ae(1+r)]/(1+g+p+gp)) times previous period debt ratio, with r = interest rate; p = growth rate of GDP deflator; g = real GDP growth rate; a = share of foreign-currency denominated debt; and e = nominal exchange rate depreciation (measured by increase in local currency value of U.S. dollar). 3/ The real interest rate contribution is derived from the denominator in footnote 2/ as r - π (1+g) and the real growth contribution as -g. 4/ The exchange rate contribution is derived from the numerator in footnote 2/ as ae(1+r). 5/ Defined as public sector deficit, plus amortization of medium and long-term public sector debt, plus short-term debt at end of previous period. 6/ Derived as nominal interest expenditure divided by previous period debt stock. 40