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InterviewsAugust 1 2016

Paraguay central bank governor: a steady hand in a turbulent region

After eight successive years of fiscal surplus, the governor of Paraguay’s central bank, Carlos Fernández Valdovinos, explains to Silvia Pavoni how the country has managed to remain immune to the financial instability experienced in its Latin American neighbours. 
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Carlos Fernandez Valdovinos embedded

The Central Bank of Paraguay can make a striking claim when compared with its Latin American peers: it has never had to adjust its currency, the guarani, because of spiralling inflation. After the Colombian peso, it is the oldest currency in the region and the central bank governor, Carlos Fernández Valdovinos, says: “This year we celebrate the 73rd anniversary of our currency; we never had to take away some zeros like Brazil or Argentina.”

The comparison is all the more significant given that Paraguay’s economic fate has traditionally been affected by its larger neighbours and partners in the Mercosur trade bloc. “This is a difficult neighbourhood but it has been difficult for the past 200 years,” says Mr Valdovinos. “We have developed some kind of immunity to whatever cycle, political or economic, they are going through.”

A clean break

Indeed, Paraguay has managed to reduce its dependence on Brazil as an export market and has broken the statistical correlation that kept the two economies moving in tandem. While Latin America’s biggest market sank into recession in 2014 and 2015, Paraguay’s gross domestic product (GDP) grew an average of 3%. Local exporters also learned to do without Argentina; at least until the change of government at the end of 2015, Buenos Aires had made transporting goods across the border challenging, according to Mr Valdovinos.

As Paraguay has grown, the country has focused on developing a local market, diversifying away from traditional destinations, and prioritised improving productivity. “As of this June, we exported 8% more tonnes of beef than a year ago despite the fact that Brazil and Russia [another key market] dropped their demand,” he notes proudly. “Times are not the best for [Paraguay and] emerging markets; everyone has to work hard to create conditions for economic growth in the medium term. Forget about the golden years when soy was $600 per ton and oil $100 per barrel; those times are over. We have learned from other countries’ experience that improving productivity is crucial [right now].”

The maquila manufacturing system is a case in point. It is made up of free-trade zones of exceptionally low taxation that serve as suppliers of components to foreign firms. A Brazilian car manufacturer may wish to build some parts in a Paraguayan maquila, for example. With costs rising in other outsourcing markets in the world, such as China, a local option becomes appealing. And thanks to Brazil’s size, even when in recession, certain products will continue to be sold in large numbers to the benefit of the cost-effective neighbour. Construction and services, including financial services, have also contributed to Paraguay’s economic growth, which has averaged 4.8% over the past 12 years, according to the central bank. The ratio of bank credit to GDP has more than doubled over that period and went from accounting for 20% of GDP in 2004 to nearly 45% today.

Calm amid a storm

In stark contrast to many of its neighbours, Paraguay has reported eight consecutive years of fiscal surpluses, foreign reserves twice the size of external debt and a relatively low and predictable inflation rate, which the central bank forecasts will drop to 4.5% this year.

Paraguay's central bank governor since October 2013, Mr Valdovinos is intent on continuing the good work of his predecessors and wants the country's financial sector to provide an even bigger boost to the economy. The central bank is overseeing changes that will modernise the banking sector and the institution itself to improve stability and make the system more flexible.

And with commodity prices falling, often dramatically, in 2014 the central bank introduced reforms that allowed lenders to adapt to the new conditions. For example, soybean prices dropped by 40% in the course of just a few months, which meant that producers were unable to meet forecasts. Because of the importance of the agrobusiness sector in Paraguay, this failure had a negative effect on overall non-performing loans (NPLs). In December 2015, the central bank introduced a resolution that facilitated loans restructurings, a practice that was not commonly used.

Paraguay NPLs:total loans

“It is a problem of liquidity, not solvency,” says Mr Valdovinos. “Since [the resolution] we have seen more stability in the banking system. At this moment, the financial sector is waiting to see the conditions of the agrobusiness with the new harvest before granting new loans.”

Overall, Paraguayan banks are in good shape. Despite the poor conditions, NPLs did not go beyond 2.5% of total loans in 2015, up from 1.4% in 2014. Total loans in 2015 were $16bn, a modest increase from the previous $15.4bn. The banking system scored an average return on equity of 27.8% in 2015, lower than in 2014 but still a very healthy result, particularly considering the high capitalisation of Paraguayan banks: Tier 1 capital over risk-weighted assets was 14% in 2015. By this May, the ratio had moved to 16%.

Reforms on the way

More change is coming once congress passes important banking reforms over the next few months. Before the financial crisis that Paraguay experienced in the 1990s, when liquidity dried up and banks shut down, there was barely any governance of the country's financial sector, according to Mr Valdovinos. “Then we went to other extreme: currently the weight of an asset is fixed in law. If you want to do some cyclical movements, if you want to reduce the weight of loans to a [certain] sector, you can’t. This was very useful post-crisis but it has been outdated [for over a decade]. We were not in a position to do it in the past, but we’re going to adopt international best practice now,” he says.

Paraguay bank's market share

A reform of the central bank will follow suit by the end of the year, mirroring the changes in banking rules to allow effective supervision and clarifying some aspects of board membership tenure. Mr Valdovinos hopes that a pension fund reform will materialise soon to encourage the channelling of long-term savings into long-term investments. At the moment, such funds are mostly kept in short-term products or invested abroad. This would help the growth of the nascent public-private partnership market, which has already suggested upgrades to Silvio Pettirossi Airport in capital Asunción as well as important road connections.

Construction and infrastructure are booming in the country, thanks to both private investment and higher government spending: state investment in infrastructure was $200m per year on average between 2008 and 2013; it has reached $500m for the past two years and the target is $600m for 2016, according to the central bank. The airport development project has attracted much international attention, from the point of view of both construction and financing, says Mr Valdovinos.

As the economy grows and Paraguay’s open market attracts foreign investment, the central bank will need to guarantee that the local banking and financial sector is flexible but also stable. “In Paraguay, we need to preserve financial stability,” says Mr Valdovinos. “That’s why we’re passing the [banking] law. We need to make sure the financial sector continues to contribute to economic growth, rather than becoming an obstacle. The average [ratio of bank credit to GDP] is 65% in the region. We have room to grow, but we need to make sure that it will be sustainable.”

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Silvia Pavoni is editor in chief of The Banker. Silvia also serves as an advisory board member for the Women of the Future Programme and for the European Risk Management Council, and is part of the London council of non-profit WILL, Women in Leadership in Latin America. In 2019, she was awarded an honorary fellowship by City University of London.
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