Fitch Ratings has initiated the sovereign coverage of the Republic of Paraguay and has assigned Long-term foreign and local currency Issuer Default Ratings (IDR) of ‘BB-‘. The Rating Outlook on both ratings is Stable. Fitch has also assigned a Short-term foreign currency rating of ‘B’ and a Country Ceiling of ‘BB’.
Paraguay’s ratings balance the strength of the sovereign’s fiscal and external balance sheets, low financing risks and prudent macroeconomic policies against high commodity dependence, volatile macroeconomic performance, a low government revenue base and structural constraints such as low income per capita and comparatively weak institutional framework.
The economy is estimated to have contracted in 2012 by 1.2% due to the severe drought, sanitary bans on beef exports, and weaker economic activity among the main trade partners. The economy could post a 10% recovery in 2013 if weather conditions normalize and domestic demand maintains a strong pace. Global economic uncertainty, as well as economic sluggishness in Brazil and Argentina, pose additional downside risks to the agency’s economic projections for Paraguay.
The Paraguayan economy has shown higher average growth rates relative to the ‘BB’ median, but growth volatility has also been greater due to the large size of its agriculture sector and the negative shocks it receives from adverse weather cycles.
Nevertheless, changes in commodity prices of Paraguayan exports and supply shocks in the primary sector do not directly affect fiscal accounts, given the current tax framework. In addition, the financial system has demonstrated resilience to negative shocks in the agriculture sector due to its moderate loan exposure, long loan terms and borrowers’ low leverage position.
Risks related to high commodity dependence and financial dollarization are partly mitigated by a relatively strong external liquidity position, the sovereign’s net external creditor position, comparatively low external amortizations and the availability of multilateral sources of funding.
Over the past decade, Paraguay has developed a record of fiscal restraint through different economic and political cycles, which has resulted in moderate fiscal surpluses, low maturities and financing requirements, and one of the lowest debt burdens in the ‘BB’ rating category in spite of the sovereign’s relatively low revenue share. Nevertheless, this fiscal performance is also partially explained by years of public underinvestment.
The decision to set up an investment fund (FONACIDE) with additional royalties from the Itaipu dam and to increase both infrastructure and social investment, if properly implemented, could improve growth prospects, and contribute towards diversifying the country’s economic base over the long term. However, the decision to use all of FONACIDE’s funds as part of the annual government budget instead of partially saving them would limit Paraguay’s capacity to accumulate savings in the absence of fiscal surpluses.
Paraguay’s credit profile is characterized by weaker structural factors in relation to its rating category. Despite faster GDP growth and some progress in reducing poverty, Paraguay remains a relatively poor country compared to ‘BB’ peers. At the same time, Paraguay lags its rating category peers in Human Development Indicators, the investment rate, business environment and governance indicators. Weak institutions and corruption undermine the rule of law and government effectiveness, and could pose risks to social and political stability.
RATING OUTLOOK STABLE
The main factors that could lead to a positive rating action are:
–Sustained good growth momentum that would improve debt ratios and allow for improvements in GDP per capita;
–Improvement in the government’s revenue base and continued progress in broadening financing sources.
The main factors that could lead to a negative rating action are:
— Increased macroeconomic and financial sector instability;
–A sustained fiscal deterioration in the context of financing constraints.
KEY ASSUMPTIONS AND SENSITIVITIES
The ratings and Outlooks are sensitive to a number of assumptions:
–Fitch’s economic growth forecasts factor in a modest recovery in Brazil and Argentina in 2013. Given Paraguay’s significant ties to Argentina and Brazil through trade, a sharp deterioration in their economies would materially weaken Paraguay’s economic growth performance.
–Fitch assumes that no drought will affect the next agriculture cycle in Paraguay, and that sanitary bans on Paraguayan beef exports are lifted entirely. At the same time, agricultural prices in the commodity markets are expected to remain at current levels.
–Fitch assumes that Paraguay will continue to diversify and develop its financing sources and have access to multilateral funding.
Applicable Criteria and Related Research:
–‘Sovereign Rating Methodology’ (Aug. 13, 2012).
Applicable Criteria and Related Research:
Sovereign Rating Methodology