Paraguay: an emerging opportunity not to be missed

Click here to view an edited video of the discussion

Participants:

• Jorge Raúl Corvalan, governor, Central Bank of Paraguay
• Liz Cramer, minister of tourism, Paraguay
• Rossana Polastri, World Bank representative in Paraguay
• Tobias Roy, IMF representative in Paraguay
• Conor McEnroy, chairman, Sudameris Bank
• Agustín Magallanes, president, Conti Paraguay
• Yan Speranza, executive director, Fundación Moises Bertoni
• Chair: Silvia Pavoni, investment editor, The Banker

As the world’s largest developing countries continue to grow, so too does the price of investing in them, and it is only natural that investors are increasingly looking towards frontier markets with strong, if less lauded, potential. In Latin America, Brazil now has the world's seventh largest economy, after the UK and before Italy. However, the growing strength of its economy means that very few bargains are to be found there. But on its south-western border, sharing some of its natural resources as well as the ownership of the most powerful hydroelectric plant in the world, Itaipu Dam, is Paraguay.

For investors that view challenges as opportunities, Paraguay is a gem in the making. Landlocked within the southern cone of Latin America, Paraguay is permeated by rivers, which cross its abundant land (the country is the size of Germany and has a population of less than 7 million), but irrigation systems are sadly lacking. Infrastructure in general is needed, in terms of road, air and water transport as well as in terms of energy transmission and distribution. Power cuts are not unusual, the country's road network is about 30,000 kilometres long, of which only about 35% of it is paved; and the river transport system is in need of modernisation to deal with shallow waters.

Tackling infrastructure deficiencies

Much can be done to help Paraguay take full advantage of its resources, and its government is well aware of the country's shortcomings and of the fact that it may soon hit a bottleneck if improvements to its infrastructure are not carried out. The government also welcomes collaborations with the private sector to solve such problems, which will likely result in several public-private partnership programmes over the next few years.

“If we can develop [the infrastructure] which will ensure the cheaper coming and going of our goods and services, then you are really setting up a base that will attract even more investors,” says Agustín Magallanes, president of Conti Paraguay, an oilseed crusher and early investor in the country.

If overcoming such vast infrastructural problems poses too big a challenge for some nervy investors, what may assuage many of their fears is the country’s phenomenal growth over the past year. After a sluggish 2009, when Paraguay was marginally hit by the effects of the global financial crisis and badly hurt by a severe drought, the country's gross domestic product (GDP) grew at a phenomenal 15% in 2010, according to the central bank and the International Monetary Fund’s (IMF's) office in Paraguay. Few other countries in the world can match such growth.

Export growth

Paraguay’s main economic drivers are agricultural businesses and meat products, which are being exported in growing volumes. Other sectors are also expanding, such as tourism, hospitality and banking. Paraguay is also becoming a significant exporter of specialised products, such as menthol and railway sleepers.

“Since 2007-08, [the world has been] experiencing an increase in commodity prices and food prices, all products for which Paraguay is very well placed to compete in the marketplace,” says Tobias Roy, the IMF representative in Asunción, the country’s capital. “Under these circumstances, when these external factors met the sound and solid base that was laid here by good policies, Paraguay started taking off and we saw things such as a spectacular [GDP] growth rate of 15% in 2010, which is unheard of in the history of the country.” 

In economic terms, from the 1980s to mid-2000s, Paraguay went through a period of economic stagnation with real income falling and a number of financial crises. Since 2003, a combined effort by the public and private sector started to turn things around and initiate reforms that would change the economic structure of the country.

“What we have witnessed in the past two years is that the stable macro policies have allowed the space for a vibrant private sector, and that is one of the reasons why you see this [GDP growth] of 15% in 2010,” says Jorge Raúl Corvalan, governor of the Central Bank of Paraguay.

Mr Roy adds that fiscal reforms and new banking regulation, among other changes, were at the basis of Paraguay's current, more stable macroeconomic environment. 

Resource rich

A democracy only since 1989, Paraguay emerged from the 35-year dictatorship of General Alfredo Stroessner in poor economic condition. Dictators had ruled the country since 1870, after the end of a war against the united forces of Brazil, Argentina and Uruguay which almost eradicated its male population. But more than 20 years on from the end of General Stroessner's regime, little is known about Paraguay beyond its borders, both in terms of its economic potential and its land – an expedition by the British Natural History Museum to study the rich biodiversity of the Chaco region was cancelled late last year following concerns that it might encounter and unsettle the Ayoreo people, one of the last uncontacted tribes in the world.

Other scientific expeditions, however, were carried out and encountered not tribes, but natural resources, which were previously unknown to exist in the country. David Lowell, an American explorer who discovered the world’s biggest copper deposit in Chile, claims that the world’s largest deposit of titanium may lie in Paraguay. He is not the only one investigating the country’s underground potential, while others are focusing on taking full advantage of its land.

“[Mr Lowell] is one of about three or four guys going around with a hammer, chipping rocks and having a look,” says Conor McEnroy, chairman of Sudameris Bank. “We are virgin territory here. We haven't even scratched the surface, literally. We haven't even been able to exhaust growing stuff on the land.”

Paraguay’s land does indeed hold great potential. The country sits on one of the largest underground reservoirs of water in the world, the Guarani aquifer, which is suitable for human consumption and stretches for 1.2 million square kilometres beneath Brazilian, Argentinian and Uruguayan territory. Paraguay also benefits from the smaller Patiño aquifer, covering about 1170 square kilometres. The country's vast amounts of fertile and cheap land have been exploited in a very low-intensive way, which means its agricultural sector has great potential.

“In Paraguay, 95% of the mechanical culture is under the ‘no tilling’ system, which is environmentally friendly and preserves the land,” says Mr Magallanes. The no-till system is a way of growing crops without disturbing the soil through tillage, which would require digging, stirring and overturning the soil.

This will appeal to investors in organic products. “We don't plough up the whole country every six months,” says Mr McEnroy. “Paraguay slowly but surely is turning this into money. This country is now the largest exporter in the world of organic sugar. The beef from Paraguay: I laugh when I look at the natural label that they use in Europe because the consumer thinks it means organic. Here, in this country, every cow gets at least two acres.”

Change of mentality

As a landlocked country, Paraguay also seems to suffer from a ‘landlocked’ mentality, according to Yan Speranza, executive director of Fundación Moises Bertoni, an organisation that works on socially responsible economic development and on the preservation of the environment. Mr Speranza is referring both to the effects that geographical isolation has on people’s ability to communicate outside of national borders and on their ambitions to expand abroad or attract foreigners. “When we talk about a landlocked country, we normally refer to an economic problem [affecting] trade; but to me, the real problem is the mentality,” he says.

Tourism minister Liz Cramer agrees. “I face that all the time. [When] I sell the country to the regional markets, to the long-haul market, I have two major challenges,” she says. “One is to convince Paraguayans that we are an emergent destination; there are great things to see and do here. [Luckily], now that’s changing. And outside, I encounter different [problems]. Regionally, we do face a problem [with our] image, especially in Brazil. And long-haul, they [simply] don't know us.”

However, there are signs that Paraguay's 'isolated' mentality is changing, through a generation of young Paraguayans who not only consume information through the internet, but are also the first generation not to know life under a dictatorship. This has enabled an entrepreneurial culture to develop, which has been amplified by the demographic situation Paraguay is experiencing, with 67% of its population under 30 years of age and 50% under 20. 

“We are [experiencing] something of a cultural shift in our society,” says Mr Speranza. “You can have stability, good conditions, you can have good macroeconomic indicators, you can have land, clean energy, water, but you also need people who want to make [business] ventures.” He adds: “We are living what the demographers call the demographic bonus. This is a huge opportunity.” 

Mr Magallanes adds: “Paraguayans are demanding different [things] from what they used to demand 10 years ago or 20 years ago. So I think they will force the change. They don't put up with what they were putting up with 20 years ago, that I can tell you for sure.”

Banking developments

A developing economy needs an active, stable banking market to sustain its growth and Paraguay has been moving in this direction. Over the past few years, the country has stabilised its financial system, updated its regulatory practices and standards, and created a governmental agency, the Agencia Financiera de Desarollo (AFD), which provides long-term financing to banks that extend long-term loans to customers.

“When I first arrived here, I was somewhat surprised that [our] company was pre-financing farmers for up to $35m a year,” says Conti Paraguay's Mr Magallanes. “We were filling a gap to help our clients, because it was difficult to be part of the banking system. The financial sector has covered that gap and now we don't need to pre-finance anybody.”

Banks have been improving their services and focusing on developing a strong capital base at the same time. Paraguay's central bank has played a key role in this and has also encouraged a prudent level of provisions as well as prudent management of banks.

Mr McEnroy has strong views on what Paraguayan banks have achieved. “Here [banks] have a Tier 1 capital of about 15% to 16%,” he says. “Over in Europe, I think you are hoping to reach 6% sometime in the next few years under Basel III. We have very simple, plain rules. We don't let our banks take client deposits and speculate in derivatives on Thai bhat versus Japanese yen. That is not called banking; that is called making a bet. You go to the bookies if you want to make a bet and you do not do it with depositors’ money.”

Paraguay has suffered its own financial crises in the past, notably in the early 1990s and at the beginning of 2000, as a consequence of economic problems in Argentina. As with other countries in Latin America, Paraguay has learned from its past mistakes and strengthened the supervision of its financial sector.

“The crises were painful and we learned from that,” says central bank governor Mr Corvalan. “We started to be more pragmatic, more conservative. We put more and more employees in the supervision sector, we trained them a lot, we sent them to whatever place they could be trained for a couple of months, half a year, whatever it took. The superintendence [effort] has to be really strong in order to keep the house in order. That's what we have been doing for the past 10 years or more, and it is working.”

Greater competition

A greater degree of stability, coupled with the high returns that lenders offer, creates an interesting proposition for international players looking for new markets. Mr Corvalan anticipates greater competition in the banking market and growing interest from foreign lenders. “What we see for the future is more competition in the system,” he says. “The rate of return [of banks] in Paraguay is 30%. This tells you something. It means there is still enough room to do business.”

Mr McEnroy also points out how prudent management does not imply lower returns. “The central bank gives banks a tax break to make a 2% generic provision on their total portfolio on top of required provisions. We have extremely high solvency [ratios]. And yet we have very high returns on equity. We don't have to have very little equity to have a high return. In fact, we've got much more equity than the first world and we still have very decent returns.”

In a virtuous cycle, as the economy grows and remains stable, banks are encouraged to extend their products to longer maturities and to a wider customer base. Businesses expand their operations and improve productivity, and higher amounts of cash circulate in the economy, improving confidence in various business sectors and in the financial sector.

“[Banking] is a sane industry and you don't need to do crazy things to make a reasonable return on your capital,” says Mr McEnroy. “In addition to that, the banking market is very liquid; there is lots of money available. With every year of economic growth, there's more acreage [used by the agriculture sector]. And as farming techniques get better and better, the yields are going up and this cash keeps coming back every year and gets reinvested into the economy. So we are in a virtuous cycle. It is not possible to have an economic recovery, let alone the launch of a sustained growth period, unless you have a very solid financial system. That is why you will not be able to have an economic recovery in the US and in Europe until they deal with the fundamental problem which is that the balance sheets of the banks are still in bad shape.”

Overheating risk?

As with all fast growing markets, the risk of overheating has to be considered. The structure of Paraguay's economy is also changing as a result of the fast expansion of the banking sector, which has been growing at a much faster rate than its GDP. This requires a continuous supervision effort and enough flexibility to adapt to an evolving market.

“It is important to keep in mind that the financial system here has actually grown very fast in the past five years,” says Mr Roy. “We have seen a process of what you might call financial deepening in the economy from admittedly a very low base. For several years now, all banking and credit aggregates have consistently grown faster than GDP. I think that in 2010 we had close to 50% of credit growth and that is something that always raises questions because it implies so much of a structural transformation that you have to consistently adjust and adapt your practices. Upgrading and continuing to improve prudential regulation and banking supervision is an ongoing task, and, fortunately one that is being tackled.”