CGD Podcast: Paraguay’s Sustainable Growth Strategy with Carlos Fernández Valdovinos

LILIANA ROJAS-SUAREZ:
Welcome to the CGD Podcast. I am Liliana Rojas-Suarez, Senior Fellow and Director of the Latin American Initiative, and it is my pleasure to be joined today by Carlos Fernandez Valdovinos, Minister of Finance of Paraguay, with an outstanding career, having previously been the governor of the Central Bank, where he received a number of international recognitions for his work. He also knows the multilateral organizations well since he worked both at the IMF and the World Bank. Today, we hope to take advantage of his vast experience by discussing how the strategy for growth and development in Paraguay stands out in the Latin American region, and also seek his view on other regional and global issues. Welcome, Minister.

CARLOS FERNANDEZ VALDOVINOS:
Thank you, Liliana. It's a pleasure for me to be here.

LILIANA ROJAS-SUAREZ:
Alright. So let me start with a fact that distinguishes Paraguay from most other Latin American countries, economic growth. Forecasts by multilateral organizations and Wall Street suggests that Latin America will only grow between 2%, 2.3%, and the most optimistic go to 2.5% this year, with not really much change for next year. In fact, Latin America's growth will be the lowest among developing regions in the world. And this has been the story over the last decade. In contrast, Paraguay grew at 4% last year and is expected to maintain similar rates of growth this year. We know that Paraguay has been very successful in implementing stabilization policies and the control of inflation, but so have many other Latin American countries. What explains the growth outcome in Paraguay?

CARLOS FERNANDEZ VALDOVINOS:
Well, it is true that multilaterals, Wall Street forecasts almost 4% growth for this year. But if you look at the high-frequency indicators that the Central Bank publish, that forecast for sure will be reviewed up in the near term. It's going to be something between 4.5% and 5% growth rate for this year. We're very happy for that, but not because it's going to be a nice number in any report from multilaterals or any report from Wall Street. We are happy because we believe that all this economic growth at the end is going to affect the welfare of the people here in Paraguay. That's the reason why we want to have the strongest growth rate as possible here in Paraguay. The idea of Paraguay being the fastest-growing economy in Latin America is something that started back in 2002 when we started to implement the first stabilization plan. Since then, average growth until the pandemic was an average of 4.2%, basically year on year. So the number for this year is basically online with that potential growth rate that we have pre-pandemic.

Now, after the pandemic, there are many questions about how sustainable were the potential that we observed previous to the pandemic, but we continue to do the right things that actually promote economic growth in the medium to long term. I have to highlight first the stabilization that you can observe on the macro side. For us, a low inflation, low fiscal deficit, sustainable level of debt is quite important and is fundamental for you to set the base for economic growth in the medium term. On top of that, we are a government who started only nine months ago. But so far, if you look at the number of reforms that we were doing with the support of Congress is quite extraordinary. For example, in the first four months of the administration, we passed seven different reforms based on new legislation that will promote, for example, better spending in the long term. It's going to promote more investment by the private sector. It's going to promote also sustainability of public finance because we are addressing something that was crucial for all the problems that we observe in countries in Latin America, and that is the pension reform.

So we create, for example, a superintendency of pension back in December. So we are setting the fundamentals to continue to have this growth rate. And we have one idea. And let me give you an example on the soccer. We as government, we can be in charge of preparing the field. See the lines that are all well-painted? See the goals that they have the nets in the right position and probably act as referee. But it's going to be the private sector who is going to play the game and is going to score the goals. We made this clear. And in order to bring confidence on the private sector, even though they know us because we were in government also between 2013 to 2018, we made very clear that one crucial part that is part of our competitiveness that is attracting a lot of investment, we are not going to change, and that is the tax burden on the people, meaning tax rates. We believe that we can get more revenues doing some reforms but without changing any tax rate. This type of certainty is something that is actually attracting a lot of investment from the private sector, and it's one of the main reasons why we are achieving this extremely high growth rate, at least for historical standards.

So we will continue to work together. The government preparing the field and the private sector playing the game so that we achieve the 4.5%, 5% growth rate this year and in the future.

LILIANA ROJAS-SUAREZ:
Well, certainly 5% of economic growth is a number not seen in Latin America since at least the commodity boom period. So that's really impressive. So let's talk now about the sustainability of that economic growth. In many emerging markets and developing countries, there seems to be a trade-off between development objectives and the environmental objectives. This is not the case in Paraguay where both objectives are complementary. And this is reflected in what you call the project Green Paraguay. Can you please explain us about this project and its connection with the development strategy in Paraguay?

CARLOS FERNANDEZ VALDOVINOS:
We really think that we can balance all the policies for economic growth with all the policies for taking care of the environment, but it's similar to what I said before on the soccer example. I'm probably not an extremely good economist as you are, but if I play professional soccer, I will be very awful. So the same as person, countries have comparative advantage. And Paraguay has a lot of water, very fertile land. We are very competitive on the agricultural sector, on cattle raising. And if you look at the numbers, even though we are small, we are on the top ten of the world producing and exporting soybeans, wheat, corn, stevia, etc. And can mention something that not many countries in the region, all the world, have clean and renewable energy. Products that you can use to produce alternate fuels. So for that reason, we are thinking about diversifying the metrics of the Paraguayan economy, but based on what we already have. For example, given that we produce a lot of corn, we can start producing biodiesel.

Given that we have a lot of sugarcane, we can start producing biofuels to complement with the fossil fuel that we are importing. Given that we are a country where 100% of the electricity is produced by clean and renewable means, and also that we have excess energy and excess water, we are promoting the country as a hub for producing green hydrogen. But of course, green hydrogen at this moment is very expensive, difficult to transport, etc. So something that is actually working very well here in Paraguay is using that green hydrogen, not to put in our cars, is to produce, combined with some other elements, green fertilizer, something that is highly demanded in the region. And what I'm talking about, green fertilizer, we are green greens because some countries are producing green fertilizers, but how they produce the electricity to actually produce the green fertilizer is not that great. Therefore, this is 100% green fertilizer. That is one way how we are actually putting Paraguay as a place where you can respect the environment and at the same time have a way to develop the economy and also to actually improve the life of the people.

This is one of the ways how we are looking to have Paraguay as a country with the highest growth rate in the region. Of course, this is not going to be enough. So we are also taking more and more advantages of one trade agreement that we have seen in the 80s and that many people criticize over all these years. We are taking advantage of Mercosur. We are using that in order to also diversify the economy through something that is very popular, probably in Mexico, Dominican Republic, and other countries. That is the Maquila regime. Not to export to the US because we have another country with 300 million population next door. That is Brazil. And thanks to the Mercosur agreement, we are able to implement the Maquila regime here in Paraguay in order to actually fit the Brazilian market. This is going to be a win-win situation because we're not trying to replace Brazilian production. We are trying to replace at least part of the 100 billion of imports from China that are going every year to Brazil.

Therefore, Brazilian entrepreneurs invest in Paraguay, generating jobs for Paraguayan people, and then re-export those products into the Brazilian market, replacing not Brazilian production but Chinese products. Therefore, the Brazilian wins because they have the opportunity to invest with a very high return. And Paraguay actually benefits because it's creating a lot of jobs. The amount of Maquila exports at this moment is around 1 billion per year, out of 10 billion in total that we are exporting every year. So it's gaining more and more share participation on the export and we are able to insert ourselves in the Brazilian productive chain. That is another way we are diversifying the economy, complementing the Green Paraguay, complementing also what we know we can do good, that is agriculture and cattle raising, and therefore we don't have only one engine of growth. We have at least three different engines of economic growth. And that is the way we are seeing the country going forward and making this 4.5% economic growth rate on a sustainable way in the near future.

LILIANA ROJAS-SUAREZ:
The model that you are presenting is one of an open economy with diversified exports. This is actually quite refreshing in a world with intensified political tensions, geopolitical tensions. Because of that, recently there has been, as you know, a plethora of increasing restrictions on trade through tariffs and quantitative restrictions, quotas. Right now, there is really no consensus of whether, in fact, there has been or will be significant de-globalisation. Protectionist measures, however, has certainly increased around the world. Now, when we look at Brazil, which is Paraguay's major trading partner, as you mentioned, Brazil has recently increased duties on steel products from China. What is your view about this tariff war? And is Paraguay benefiting from the tariff war at all?

CARLOS FERNANDEZ VALDOVINOS:
Let me tell you that this fragmentation of trade in the world is something that is a concern for us because, as you may know, we are a very small economy. Therefore, we cannot rely only on the domestic market. Throughout our history, we rely on external market in order to actually produce and sell to them. I forgot to mention the four engine of economic growth from now on in Paraguay. That is the service sector, the sector that is basically a reflection of a strong economic growth in the past 20 years, creating less poverty and an increasing middle class that is demanding more and more services. So right now, services is around, if I remember correctly, around 60% of GDP right now. But in any case, the Paraguayan economy continued to be very small, but our policy is always to be an open economy. We were always like that. We do have exception to the Mercosur tariff. All the other countries are using the exception in order to increase external tariff. We're using to reduce the external tariff that we have in Mercosur.

Now, the fragmentation depends on the different economies and their different reasons for that fragmentation. Some of them, of course, are the wars, some others are some ideas that only the environment is important and only some people can do the right thing on environmental policy and therefore are protecting. Based on environmental excuses are protecting some sectors that are very noisy politically. I'm referring to what happened with the European Union on the trade agreement with Mercosur. At the end, due to'environmental policies', they are refusing to sign a final agreement with Mercosur. But given that, since we assumed the presidency of Mercosur, we mentioned, OK, somebody else will take the place of Europe if they don't want to actually sign an open trade agreement with Mercosur. And we started to push with some other regions, a potential trade agreement with Mercosur. Before the end of the year, we are going to finish the agreement with the Emirates. After that, we go and try to sign an agreement, probably with the Saudis and also with some countries in Asia.

Therefore, some doors will be closed, some other doors will open. But we have to continue to fight overall on a more open world world trade that was quite successfully promoting economic development in the whole world will continue to be easy to do and not like during or after the pandemic where we have a situation where trade decreased sharply and also decreased sharply the economic growth in the world.

LILIANA ROJAS-SUAREZ:
I think that point that you are making in terms of diversification, not only on product but also on partners, trade partners, is very important because going back to Mercosur, right now, the countries in Mercosur are the most important destination of Paraguay exports. And even more in the future when your plan for exporting green fertilizer for the region materializes, as you just explained. But the history of Mercosur is full of instabilities, with periods when it appeared that the trade agreement was actually going to disappear. So I guess that you are very conscious of that, and maybe that's a reason why your diversification plan extends to beyond Mercosur because the instability within Mercosur actually is a source of fragility for your growth model, right?

CARLOS FERNANDEZ VALDOVINOS:
Yeah, in a way, yes. Let me mention that it's not only because they put some trade restrictions for whatever, I believe, phytosanitary reasons that they mentioned sometimes for some of agricultural products going, for example, to Argentina. But more instability was created recently due to bad macroeconomic policy. So even though there is no trade restriction as per se, the fact that you have very high inflation or the fact that you have an exchange rate that is not fully reflecting the fundamental, always create trade tensions without being per se a restriction or a tax or a phytosanitary restriction over there. Let me mention something that the president always said here in Paraguay in any speech, and he is quite open, and I repeat it and I support the idea. This is a tough neighborhood. Being in the middle of Brazil and Argentina is a tough neighbor, but it has been tough during the past 200 years. So we learned how to survive this tough environment. This is an advantage that we do have here in Paraguay.

We learn how to deal with volatility. Sometimes you can see zillions of products, very good wines from Argentina coming, smuggling into the Paraguayan economy. But right now, given that Argentina is quite expensive, you can see zillions of Paraguayan products flying the other part of the border going to the Argentina. This is a typical volatility we have. We didn't have to change the exchange rate here. But at the end, given macroeconomic policy, you have trade going in one direction or the other. And we have learned to deal with that.

LILIANA ROJAS-SUAREZ:
Let me now move to the challenges a little bit more on the domestic side. From 2017 to 2018, I had the honor of forming part of the International Commission for Paraguay's Growth, Equity and Development, promoted by the Ministry of Finance at that time by your predecessor, Lea Gimenez, was at the post with the technical support of the World Bank. The Commission made a number of recommendations. The government actually seems to have made significant progress in many of them, especially two of the most important recommendations. One was to generate a business climate to foster private investment, and the other one is to diversify the economy to reduce the dependency on agriculture. So those two you have already mentioned and already have discussed as part of the growth strategy. So as you can imagine me being part of the commission, I can not be more happy than that. Now, to other areas recommended by the Commission where the prioritisation of public investment and development of modalities to engage the private sector in the improvement of connectivity and logistics, which is needed to support the diversification of the economy.

The other recommendation was enhancing the capabilities of the state. Can you tell us if there has been progress in these areas? Let's take connectivity and logistics first.

CARLOS FERNANDEZ VALDOVINOS:
OK. Let me first go back to something that you mentioned before. That is the ease of doing business here in Paraguay. We have a very competitive tax regime here that is the 10-10-10, 10% personal, 10% corporate income taxes, and 10% VAT. And on top of that, some special regimes that further reduce the tax burden for any investment coming here. So it's helping to attract investment in Paraguay. But that section is something that we realize, OK, besides taxation, there could be bureaucratic burden that prevents investment to come in the way that we want. And that's the reason why we pass a law and a special regime for creating enterprises here in Paraguay. There is a simplified process by which you can create a company here in Paraguay in five days. Five days. This is a pity that finally we have improved all this. We don't have any measure like the one that had the World Bank before on the ease of doing business. But really, here in Paraguay, we continue to work on cutting the red tape that prevents investment to come in to Paraguay.

Now on logistics, this is something I love to talk. If you can imagine the South American map, Paraguay is at the heart of South America. It's in the same place as zillions of years, same place. But something changed recently. We used to say Paraguay is in the middle of nowhere, far away from everything. We used to say we are far away from beaches. We are far away from the mountains. We are in the middle of nowhere. But then we started changing our mind because that was a very negative way to see Paraguay. And then we start thinking, well, Paraguay is actually in the middle of everything because we are two hours at most of the main metropolitan areas in the region to our flight. And if you do a cross in South America, actually in the cross, in the middle of the cross, it's Paraguay. The shortest way to go from the east to the west, from the Atlantic to the Pacific, goes through Paraguay. And we're building right now the Bioceanic way, by which it's going to be much cheaper to trade with Asia, but not going around South America, but going through South America, therefore going through Paraguay.

That's the reason why we're building with Brazilian bridges, with Argentina's new bridges, and the highway that goes from the Atlantic to the Pacific is going to go through Paraguay. This is one part of the cross. The other part of the cross is the waterway. If you know geography, you see that there is a river going from north to south in this part of South America. That is, first, the Paraguay River and then the Parana River. And most of the production, being that mining in Bolivia, being that agricultural products from Paraguay, from Uruguay, from Argentina, or from Rio Grande, Mato Grosso do Sul in Brazil, is using right now the waterway in order to export. Because for Mato Grosso do Sul, for example, is much cheaper to do it by the water instead of going all the way to Sao Paulo and start exporting by boat from there. So Paraguay actually is right in the middle. We do have the waterway. We do have also the Bioceanic we are going to produce, but we are going to be also a hub that actually secure.

It's going to be the place in order for you to embark all the production, or you're going to be the center where probably some trucks will stay overnight in order to continue the road to the Atlantic or the Pacific. It depends on how you are using the Bioceanic. Therefore, we have a geographic location that is strategic for the future. But of course, we need actually to invest in order for that to be useful. I mean, convert a potential into actual capability. And that's the reason why the government is actually putting a lot of investment on the Bioceanic, a lot of investment also on the waterway. We are seeing Paraguay as that economy that is in the middle of everything.

LILIANA ROJAS-SUAREZ:
And what about improvement in the capabilities of the state, especially on its ability to deliver services, fight corruption, and improve citizens' security? I am not talking here about laws or regulations but in the actual capabilities of the staff of the state and its credibility.

CARLOS FERNANDEZ VALDOVINOS:
Well, the legal framework is important. Complying with the legal framework is much more important. You can pass many law, but if you do not comply with the law, it's very useless. And in the case, for example, of corruption or in the case of security, you can have all the idea. But if you don't put actually your resources into that, that is not going to deliver the results that you are expecting. Therefore, what we are trying to do since we became part of the government is to change the quality of spending here in Paraguay. First, raising more revenues, given that we have a very competitive tax regime, is very important to reduce tax evasion. That is part of corruption also. And that's the reason why we pass a law by which we combine the domestic revenue office with customs. We do have only one head right now. We have only one strategy for revenue. And that's the reason why so far during this year, we are increasing tax revenues by around 20% year on year. So I remind all the people, 20% increase with the same tax rate, we didn't touch any tax rate, and also with an inflation rate that is around 4%.

This is 16% real. So more revenues by fighting corruption. Getting more revenue is going to be important for what? To finance the priority area of the government that are health, education, social transfer, and security. That is the important part. We are giving a lot of revenue to the security sector, being that police or being that also the army. The army, not for fighting other countries. We are a peaceful country. Fighting, for example, international drug dealers. This is important for us to have new radars, to also have new airplanes that are going to be able to fight that. So we are putting a lot of resources also on the security. We are working closely with some partners, countries that are providing technical assistance in order to fight transnational crime. That is the problem right now in the region, not only national crime. And I believe that the numbers will probably reflect the fact that we are putting all those resources in the security.

LILIANA ROJAS-SUAREZ:
You just talked about the importance of mobilizing domestic sources of finance, which is critical, is central for development. But right now, still there is a big gap, right? You still need to improve that because that takes time and that's quite understanding. So for now at least, Paraguay growth model depends significantly on the multilateral organizations. Now, this year is the 80th anniversary of the Bretton Woods Institutions. And there's a lot of discussions among experts about the need for reforming the IMF and the World Bank. Do you have any thoughts or what are your advice for reform in this area, given your experience working in both organizations?

CARLOS FERNANDEZ VALDOVINOS:
Well, let me mention something that for me is really amazing. That have to be probably one of the objective of any reform that you have to do on multilaterals. And let me go back to the World Bank. That actually lends, because the IMF is more like the macro, but the other is lending in order to finance some projects, important projects, social infrastructure, health, etc. I remember President Banga mentioning the following. From the beginning until you pass at the board of the World Bank, any loan on average, I'm saying average, could be more, takes 19 months in order to really pass the board. Plus you have to go then to Congress and then pass again. So probably it's more than two years. And I used to work in the private sector. And if you are in the private sector, and for you, lending approval takes 19 months, probably you are out of business very, very quickly, out of it totally. Therefore, the way how this multilateral, in this case, I'm talking about the World Bank, its delivery is awful.

We need to do reforms in order to create really a much more agile institution that will be serving the countries much better or the people of those countries much better because it's unacceptable that for any law, it's going to take 19 months of promotion. So I do not know exactly what reform I have to do in that institution in particular, but I know what is going to be the final goal that is cutting in half, at least, the time that takes for any loan to get approved by the board. Otherwise, it's a failure. Some other multilateral institution, some regional ones, they learn the hard way and they are now much, much more agile in the way how they approve some loans to our country. Therefore, there is a lot to learn from those institutions also by the World Bank in order to be really strong because it's strong but also useful for our countries in order to promote economic growth, social development and create an environment that will promote less poverty.

LILIANA ROJAS-SUAREZ:
The progress of Paraguay is so impressive that listening to you, it looks like being small can indeed be beautiful. The hope is that Paraguay will be able to avoid the middle-income trap, where many other emerging markets have fallen after a period of high growth. That's something to be developed over time. I like to finish this podcast with two standard questions that we ask our guests from CGD. The first one is if you had to look back at your time so far at the head of the ministry, what is a funny, weird, or memorable thing that happened to you in the job?

CARLOS FERNANDEZ VALDOVINOS:
Alright, this is the toughest question probably that you're asking me. What is funny is the fact that I'm a big soccer fan, and I have my soccer team here in Paraguay. That is the greatest. Of course, according to myself. And if you look at my Twitter, probably 60% of my tweets are regarding my soccer team and 40% something serious about the economy. You know that the people, of course, they know me because I'm Minister. But everyone actually asked me a comment about soccer, how our club is doing bad, how the other team is doing better, and whatever. And very few occasions, who ever talk to me talk about economics. We talk about soccer.

LILIANA ROJAS-SUAREZ:
Well, OK. So one final question. Imagine you had a magic wand and you could change any one policy in the world, just one, what change do you think could do the most good?

CARLOS FERNANDEZ VALDOVINOS:
The one I would change is the possibility of the fiscal sector to borrow from the central bank. There is nothing more dangerous, something that creates more damage to any economy or to any population than inflation. And usually, inflation is a monetary phenomenon that is based on a huge fiscal deficit. So if you can change all the constitution by which under any reason the central bank is forbidden to actually lend to the Minister of Economy or the Minister of Finance, we are on the right track.

LILIANA ROJAS-SUAREZ:
Advanced economies would have a problem with you. They have bought the central bank, have bought so much government paper, as you know.

CARLOS FERNANDEZ VALDOVINOS:
I know.

LILIANA ROJAS-SUAREZ:
(LAUGHS) But I guess maybe the story is still evolving on what's going to happen with the debt of the US or the European countries.

CARLOS FERNANDEZ VALDOVINOS:
Yes, I know that idea that under extreme circumstances could be useful. But in general, if you look at the history, really over the long, long term, there is no policy that creates more damage than inflation.

LILIANA ROJAS-SUAREZ:
Well, thank you very much, Minister. It's been a fascinating conversation. We have all learned much more about Paraguay and had the pleasure of sharing your views about the world. (MUSIC PLAYS)

SPEAKER:
Thanks for listening to the CGD Podcast. You can learn more about the topics discussed on our website, cgdev.org. That's cgdev.org. See you next time. (MUSIC PLAYS)