The World Bank · 1. The proposed Paraguay First Economic Management Development Policy Loan ( EMDPL1) in the amount of US$200 million is thefirst operation, in a programmatic series

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Document of The World Bank

FOR OFFICIAL USE ONLY

Report No: PGD116

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

PROGRAM DOCUMENT FOR A

PROPOSED LOAN

IN THE AMOUNT OF US$200 MILLION TO THE

REPUBLIC OF PARAGUAY

FOR THE

FIRST ECONOMIC MANAGEMENT DEVELOPMENT POLICY LOAN

WITH A DEFERRED DRAWDOWN OPTION

February 20, 2020

Macroeconomics, Trade and Investment Global Practice Governance Global Practice Poverty and Equity Global Practice Latin America and the Caribbean Region

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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GOVERNMENT FISCAL YEAR January 1 – December 31

CURRENCY EQUIVALENTS

(Exchange Rate Effective as of February 20, 2020) Currency Unit = Paraguay Guarani

US$1.00 = PYG 6,539.99

ABBREVIATIONS AND ACRONYMS AFD Second-Tier Development Bank (Agencia Financiera de Desarrollo) AML/CFT Anti-Money Laundering and Counter Financing of Terrorism ARTNet Asia-Pacific Research and Training Network ASA Advisory Services and Analytics BCP Central Bank of Paraguay (Banco Central de Paraguay) BNF National Development Bank (Banco Nacional de Fomento) CAF Development Bank of Latin America CB Citizen Budget CIT Corporate Income Tax CITES Convention on International Trade in Endangered Species CPF Country Partnership Framework DDO Deferred Drawdown Option DNCP National Directorate of Public Procurement (Dirección Nacional de Contrataciones

Públicas) DPL Development Policy Loan EAS Simplified Joint-stock Company Type (Empresas por Acciones Simplificadas) EIB European Investment Bank EIGyCV Income and Expenditure Survey (Encuesta de Ingresos y Gastos y de Condiciones de Vida) EMBIG Emerging Markets Bond Index Global EMDPL Economic Management Development Policy Loan EPH Permanent Household Survey ESCs Environmental Service Certificates EU European Union FAO Food and Agriculture Organization FATF Financial Action Task Force FOCEM Structural Convergence Fund (Fondo de Convergencia Estructural del MERCOSUR) FRL Fiscal Responsibility Law FY Fiscal Year (July 1 – June 30) of the World Bank

GAFILAT Financial Action Task Force Group of Latin America GDP Gross Domestic Product GHG Greenhouse Gas GNP Gross National Product GRS Grievance Redress Service PYG Paraguay Guarani (local currency) IBRD International Bank for Reconstruction and Development ICR Implementation Completion Report ICT Information and Communication Technology IDA International Development Association IDB Inter-American Development Bank IFC International Finance Corporation IFMIS Integrated Financial Management Information System IFRS International Financial Reporting Standards IMF International Monetary Fund INFONA The National Forestry Institute (Instituto Forestal Nacional) IPS Social Security Institute (Instituto de Provision Social) IPSAS International Public Sector Accounting Standards IRACIS Tax on Commercial, Industrial or Services Income (Impuesto a la Renta Comercial,

Industrial o de Servicios) IRAGRO Tax on Agricultural Activities (Impuesto a la Renta de las Actividades Agropecuarias) IT Indicative Trigger LDP Letter of Development Policy MADES Ministry of Environment and Sustainable Development (Ministerio del Ambiente y Desarrollo Sostenible) Mha Millions hectares MIPIMES Micro, Small and Medium Enterprises (Micro, Pequenas y Medianas Empresas) MoF Ministry of Finance MTEF Medium-Term Expenditure Framework NDP National Development Plan NFMS National Forest Monitoring System NGO Non-Government Organization NSI National Statistics Institute NSS National Statistical System OBS Open Budget Survey OECD Organization for Economic Co-operation and Development p.p. Percentage points PA Prior Action PdG Government’s Plan (Plan de Gobierno) PEFA Public Expenditure and Financial Accountability

PER Public Expenditure Review PFM Public Financial Management PIT Personal Income Tax PSIA Poverty and Social Impact Assessment RAS Reimbursable Advisory Service SCD Systematic Country Diagnostic SDG Sustainable Development Goal SDR Special Drawing Rights SEPRELAD Secretariat of Prevention of Money or Property Laundering (Secretaría de Prevención de

Lavado de Dinero o Bienes) SET Undersecretary of the State of Taxation (Subsecretaría de Estado de Tributación) SIAF Integrated Financial Administration System (Sistema Integrado de Administración

Financiera) SICO Integrated Accounting System (Sistema Integrado de Contabilidad) SNC National Cadaster (Servicio Nacional de Catastro) SUACE Unified System for Opening and Closing Companies (Sistema Unificado de Apertura y

Cierre de Empresas) TA Technical Assistance TF Trust Fund TTL Task Team Leader UOC’s Operative Procurement Units (Unidad Operativa de Contrataciones) USAID United States Agency for International Development VAT Value Added Tax WBG World Bank Group WRI World Resources Institute WTO World Trade Organization .

Regional Vice President (acting): J. Humberto Lopez

Country Director: Jordan Z. Schwartz Regional Director: Robert Taliercio O’Brien

Practice Managers: Jorge Thompson Araujo, Adrian Fozzard, Ximena del Carpio Task Team Leaders: Ruslan Piontkivsky, Marco Larizza, Maria Gabriela Farfan

TABLE OF CONTENTS

SUMMARY OF PROPOSED FINANCING AND PROGRAM .......................................................................7

1. INTRODUCTION AND COUNTRY CONTEXT ...................................................................................9

2. MACROECONOMIC POLICY FRAMEWORK .................................................................................. 11

2.1. RECENT ECONOMIC DEVELOPMENTS .......................................................................................... 11

2.2. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY ........................................................ 15

2.3. IMF RELATIONS ............................................................................................................................ 16

3. GOVERNMENT PROGRAM ........................................................................................................ 16

4. PROPOSED OPERATION ............................................................................................................ 17

4.1. LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION .......................................... 17

4.2. PRIOR ACTIONS, RESULTS AND ANALYTICAL UNDERPINNINGS .................................................. 18

4.3. LINK TO CPF, OTHER BANK OPERATIONS AND THE WBG STRATEGY .......................................... 30

4.4. CONSULTATIONS AND COLLABORATION WITH DEVELOPMENT PARTNERS ............................... 31

5. OTHER DESIGN AND APPRAISAL ISSUES .................................................................................... 32

5.1. POVERTY AND SOCIAL IMPACT .................................................................................................... 32

5.2. ENVIRONMENTAL ASPECTS ......................................................................................................... 33

5.3. PFM, DISBURSEMENT AND AUDITING ASPECTS .......................................................................... 34

5.4. MONITORING, EVALUATION AND ACCOUNTABILITY .................................................................. 36

6. SUMMARY OF RISKS AND MITIGATION ..................................................................................... 36

ANNEX 1: POLICY AND RESULTS MATRIX .......................................................................................... 39

ANNEX 2: FUND RELATIONS ANNEX .................................................................................................. 42

ANNEX 3: LETTER OF DEVELOPMENT POLICY ..................................................................................... 45

ANNEX 4: ENVIRONMENT AND POVERTY/SOCIAL ANALYSIS TABLE .................................................. 55

The Paraguay EMDPL1 was prepared by an IBRD team consisting of Ruslan Piontkivsky (TTL, ELCMU), Marco Larizza (co-TTL, ELCG2), Maria Gabriela Farfan (co-TTL, ELCPV), Peter Siegenthaler (ELCDR), Alejandro Espinosa-Wang (ELCFN), Alejandro Roger Solanot (ELCG1), Julian Lee (SLCEN), Giovanni Ruta (SENGL), Francis Fragano (SLCEN), Carole Megevand (SLCDR), Mariana Vijil (ELCFN), Ernani Argolo Checcucci Filho (ETIRI), Gustavo Canavire Bacarreza (ELCPV), Gustavo Adrian Canu (ELCRU), Silvana Kostenbaum (ELCG2), Rafael Pardo (ELCFN), Ignacio Raul Apella (HLCSP), Cecile Thioro Niang (ELCFN), Maria Pia Cravero (LEGLE), Paul Procee (LCC7C), Matilde Bordon (LCCPY), Maria Eugenia Echague (LCCPY), Ruth Gonzalez Llamas (LCREC), Maria Virginia Hormazabal (WFACS), Anjali Kishore Shahani (ELCMU), Olga Gavryliuk (Consultant), Sebastian Maria Caceres Sisa (Consultant), Flavia Giannina Sacco Capurro (Consultant).

The World Bank Paraguay First Economic Management DPL (P169505)

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SUMMARY OF PROPOSED FINANCING AND PROGRAM

BASIC INFORMATION

Project ID Programmatic If programmatic, position in series

P169505 Yes 1st in a series of 2

Proposed Development Objective(s)

The Development objectives of the proposed DPL are to (a) improve the enabling conditions for more resilient, private sector-led growth, (b) promote economic growth that is more environmentally sustainable and resilient to climate-induced shocks, and (c) increase resilience through more efficient and accountable management of public resources.

Organizations

Borrower: REPUBLIC OF PARAGUAY

Implementing Agency: MINISTRY OF FINANCE

PROJECT FINANCING DATA (US$, Millions) SUMMARY

Total Financing 200.00 DETAILS International Bank for Reconstruction and Development (IBRD) 200.00

INSTITUTIONAL DATA

Climate Change and Disaster Screening

This operation has been screened for short and long-term climate change and disaster risks

Overall Risk Rating

Substantial .


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Results

Indicator Name Baseline Target

Average number of days to register a business; 35 (2018) 18 (2022)

Average time for customs clearance; 189 hours (2018) 132 hours (2022)

Data on land use change is publicly available in online data portals; No (2018) Yes (2022)

Response time to forest fire alerts; 1 week (2018) 1 day (2022)

Annual number of proceedings (initiated / with a ruling) by INFONA for alleged violations of Article 2 of Resolution 094/2020;

203/51 (2019) 300/75 (2022)

Volume of loans extended for commercial forest plantations; US$0 million (2018) US$5 million (2022)

Exports of exotic timber logs and beams; 0 cubic meters (2018) 90,000 cubic meters (2022)

Index of real value of revenue from direct taxes; 100 (2018) 130 (2022)

Annual growth of real current primary expenditure of central administration;

4.7% (2018) Below 3% (2022)

Report on risks of money laundering from tax evasion is completed;

No (2018) Yes (2022)

Percentage of total assets of Paraguay’s pension funds invested in local government securities;

0% (2018) 5% (2022)

Average number of bidders per procurement process; 2.55 (2018) 4 (2022)

Score of the Open Budget Index; 11/100 (2017) 26/100 (2021)

Percentage of the SDG indicators produced; 20% (2018) 38% (2022)

Percentage of the SDG indicators on gender produced; 38% (2018) 57% (2022)

Percentage of the SDG indicators on environment produced; 16% (2018) 25% (2022)

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IBRD PROGRAM DOCUMENT FOR A PROPOSED LOAN TO THE REPUBLIC OF PARAGUAY

1. INTRODUCTION AND COUNTRY CONTEXT

1. The proposed Paraguay First Economic Management Development Policy Loan (EMDPL1) in the amount of US$200 million is the first operation, in a programmatic series of two, aimed at supporting Paraguay’s efforts to reduce its external, environmental, and public finance vulnerabilities. The operation is a key instrument for the implementation of the Country Partnership Framework (CPF) for Paraguay for FY19-FY23, discussed by the Board on January 22, 2019, and supports select priorities of the Paraguayan Administration within the framework of its Plan de Gobierno 2018-2023: Paraguay de la Gente. The Government plans to use the EMDPL1 with the Deferred Drawdown Option (DDO) as a contingency line of financing to address repercussions from increased regional volatility and weaker global growth. 2. Since 2004, Paraguay has been characterized by solid economic growth supported by prudent macroeconomic policies and leveraging of the country’s natural wealth. Economic growth has been above the regional average, inflation is under control and public debt is low. Foreign reserves have remained at prudent levels. The financial sector is sound, with well-capitalized banks with low non-performing loans. Growth has been based on extensive leveraging of the country’s natural resources, particularly land and hydroelectric potential, and on an expanding service sector. Due in large part to the strong performance of the agricultural exporting sector, Paraguay stands out in the region for the positive contribution of net trade to growth. Demographic change in Paraguay has led to a sizable expansion of the working-age population, adding to economic output. However, in the first half of 2019, Paraguay faced a recession due to weak growth of its main trading partners and adverse climatic conditions. The economy is expected to return to positive growth in 2020. 3. In line with the solid economic growth, Paraguay has experienced substantial poverty reduction and shared prosperity, though the rate of this progress has noticeably slowed-down since 2013. Measured as the share of individuals living on less than US$5.5 (2011 PPP) per day, the poverty rate in 2017 is less than half of what it was in 2003, and the income of individuals at the bottom 40 percent of the population grew at an annualized rate of 4.2 percent (larger than both mean income growth of 2.5 percent and median income growth of 3.5 percent). However, in rural areas, the growth of commercial agriculture has not been mirrored by the performance of family-based agriculture; in urban areas, job creation was mostly in low-productivity sectors, especially services. Monitoring the evolution of income inequality remains a challenge due to the large year-to-year variations of Paraguay’s income inequality trend. Consistent with this pattern, the Gini coefficient fell by over 2 percentage points (p.p.), from 48.8 to 46.6, between 2017 and 2018. Following a stagnation of gains between 2013-2016, poverty and shared prosperity resumed positive trajectories over 2017-2018. However, the sharp deceleration of economic growth in 2019 is estimated to have stalled further progress. 4. Paraguay’s real GDP growth has been one of the most volatile in Latin America over the last decades, highlighting the structural characteristics of its economy and vulnerability to external shocks. This reflects an increase in the volatility of agricultural GDP, which generates about 60 percent of merchandise exports, with limited diversification achieved in the past decade. While the diversification of products exported by Paraguay improved—as measured by a score on the Herfindahl-Hirschman Index of


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0.13 in 2016, down from 0.26 in 2004—the concentration of the country’s export base is the highest among its comparator countries. Most of the growth in Paraguay’s exports from 2004-2016 came from increasing export volumes of existing products to established markets.1 While the agriculture sector is affected by international commodity prices, weather-related shocks alone account for more than 50 percent of agricultural GDP volatility. Although Paraguay has built strong macroeconomic buffers, its vulnerability to the current high volatility in neighboring economies and the prospects of weaker global growth increases risks to the outlook. Growth performance is vulnerable to the current economic crisis in Argentina via lower remittances and demand for Paraguayan exports. This could pose a threat to sustainability of social gains, as the poor have limited means to manage the impact of negative shocks. 5. Another source of vulnerability for Paraguay is the unsustainable expansion of agriculture into native forests and the extraction of forest biomass for energy. The recent boom in exports of agricultural commodities has come with an expansion of the agricultural frontier - a rapid and sustained change in land use from forest to cropland and pastureland. As a result, significant amounts of renewable natural capital, particularly in the form of native forests, as well as ecosystem services, including carbon storage and sequestration, have been lost. According to the World Resources Institute, from 2001 to 2018, Paraguay lost 5.72Mha of tree cover, equivalent to a 24 percent decrease in tree cover since 2000, and 822Mt of CO₂ emissions. While the country has one of the lowest levels of greenhouse gas emissions in the region (it contributes just 0.08 percent to GHG emissions internationally), they correlate strongly with deforestation. Since 2005, emissions nearly doubled2, and change of land-use as well as forestry contributed to nearly 78 percent of total emissions in 2014. At the same time, solid biomass is an important source of energy for the country (firewood and charcoal satisfies 44 percent of all final energy consumption3) and there is an annual deficit of sustainably-sourced biomass of around 10-13 million tons.4 The annualized cost of deforestation in the Chaco, where most remaining natural forest is found, is estimated in the range 0.5-4.0 percent of GDP.5 This process is partly of an illegal nature and made possible by a weak legal and regulatory framework, insufficient monitoring and enforcement, and market and policy failures that prevent the development of forestry as a revenue generating and job creating sector. 6. While fiscal management has been generally prudent, it still falls short of reducing Paraguay’s vulnerability to shocks, as revenue mobilization remains low, there is insufficient public investments in infrastructure needs, and expenditure tends to reinforce rather than smoothen economic cycles. The tax base has been eroded by exemptions, deductions, low taxation of commercial agriculture, and incentives with limited reach, coupled with high informality. Revenues from income and profits, as a share of total tax revenue, are the second lowest in the region. Rates of 10 percent for the main taxes (VAT, PIT, and CIT) are among the lowest in the world. In recent years, Paraguay has increased public investment but still faces a substantial gap in terms of its public capital stock. Growth in current spending does not allow for the creation of fiscal space for higher public investment. The nominal deficit target does not

1 World Bank. 2018. Paraguay-Systematic Country Diagnostic (English). Washington, D.C.: World Bank Group. http://documents.worldbank.org/curated/en/827731530819395899/Paraguay-Systematic-Country-Diagnostic 2 World Resource Institute. Climate Watch Data (https://www.climatewatchdata.org/countries/PRY). Retrieved June 20, 2018. 3 Viceministerio de Minas y Energía (2018) Balance Energético Nacional, 2017 https://www.ssme.gov.py/vmme/pdf/balance2017/BEN2017.pdf 4 Republic of Paraguay (2014), “Readiness Preparation Proposal (R-PP)” 5 World Bank. Análisis del Costo económico de la Deforestación en Paraguay. Informe Avance, Programa Apoyo Estratégico para el Desarrollo del Corredor del Bosque Atlántico en el Paraguay (P161498), 2017, unpublished paper.

http://documents.worldbank.org/curated/en/827731530819395899/Paraguay-Systematic-Country-Diagnostic

https://www.climatewatchdata.org/countries/PRY


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consider the country’s cyclical position, leading to ad hoc expenditure execution controls and thereby decreasing the government's margin to tackle poverty and reduce inequality. 7. The proposed EMDPL series supports policy reforms aimed at reducing Paraguay’s vulnerability to external economic and environmental shocks and mitigating their impact. Pillar A aims at enhancing the enabling conditions for a more resilient growth path led by the private sector. The policy actions supported under this pillar promote competitiveness, economic diversification and trade facilitation (business entry and customs reform). Pillar B aims at ensuring that this growth path is more environmentally sustainable and resilient to climate-induced shocks, notably by strengthening natural resource management in the agriculture and forestry sectors. The actions promote improved forest monitoring, the use of modern tools in forest law enforcement and create the conditions for forestry to become a more economically viable activity. Pillar C is centered around measures that strengthen resilience by improved public financial management, by increasing fiscal space, strengthen countercyclical fiscal management and accountability of the public sector. The measures proposed under this pillar seek to enhance resilience through simplified and more efficient collection of domestic resources (tax reform, tax evasion), and improved use of those resources by making expenditure more effective, equitable, and transparent (procurement, citizen budget). In the second operation, these actions would be complemented by reform measures aimed at supporting sustainability and improving countercyclicality of fiscal policy, enhancing efficiency and equity of social security, and strengthening the statistical system to provide timely and good-quality data to inform policy-making. 8. President Mario Abdo Benitez took office for a 5-year term on August 15, 2018 with an aspirational platform for the reform of the State. His administration has shown a commitment to consolidating reform progress in key areas such as fiscal and macroeconomic stability, progress towards formalization and economic diversification, mobilizing private investment and important transparency and accountability reforms. This reform commitment sends an important signal to the international business community and international ratings agencies – thereby improving potential for lowering foreign financing costs and attracting more, and more diversified, investments.

2. MACROECONOMIC POLICY FRAMEWORK

2.1. RECENT ECONOMIC DEVELOPMENTS

9. After decades of sluggish growth, Paraguay has been growing at 4.4 percent per year on average, in the 2004-2018 period. The country’s growth rate was notably faster than the average for the Latin America and the Caribbean region. Growth was driven largely by agriculture and, to a lesser extent, hydroelectric generation—exploiting the country’s comparative advantage in abundant natural resources — and by an expanding services sector. Both crops and livestock were among the top five contributors to growth, along with commerce, government services, and manufacturing. Due in large part to the strong performance of the agricultural exporting sector, Paraguay stands out in the region for the positive contribution of net trade to growth. However, neither export-oriented agriculture nor commodity exports are labor-intensive. In fact, most private sector employment in Paraguay is informal self-employment with small capital inputs.


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10. Economic growth has been supported by prudent macroeconomic policies. Paraguay averaged a fiscal surplus of 0.1 percent of GDP in the 2004-2018 period. A rise in public expenditure and stagnation of revenues have led to fiscal deficits since 2012, but these deficits remain moderate and public debt remains low. In 2015, the country began implementing the Fiscal Responsibility Law (FRL), which limits the central government deficit to 1.5 percent of GDP and the real growth of primary current expenditure to 4 percent of GDP. The Central Bank of Paraguay (BCP) has adopted an inflation-targeting regime. Inflation has fallen significantly below regional comparators since 2012 and is comparable with the OECD average. Paraguay’s flexible exchange rate arrangement has helped absorb recent external shocks. Foreign reserves remain at prudent levels. The financial sector is sound, with well-capitalized banks with low non-performing loans. However, it is small, bank-centric and highly exposed to a volatile agricultural sector, with agribusiness and livestock representing 35 percent of banks’ total loan portfolio.

Table 1. Paraguay: Key Macroeconomic Indicators (2014-2023) 2014 2015 2016 2017 2018 2019F 2020F 2021F 2022F 2023F

INCOME AND ECONOMIC GROWTH Real GDP growth (% change) 4.9 3.1 4.3 5.0 3.6 0.7 3.1 3.9 4.0 4.0

Real GDP per capita growth (% change) 3.5 1.7 3.0 3.6 2.5 -0.4 2.0 2.8 2.8 2.8 Private Consumption growth (% change) 5.6 4.0 2.7 5.0 4.5 1.8 3.3 4.2 4.1 4.0

Gross Investment (% of nominal GDP) 22.5 20.8 19.7 21.2 22.1 21.9 22.8 23.1 23.3 23.5

MONEY AND PRICES Inflation, consumer prices (%, eop) 5.0 3.1 4.1 3.6 3.2 2.8 4.0 4.0 4.0 4.0 Credit to the Private Sector (% change) 19.1 8.6 4.5 5.6 10.6 8.0 7.0 6.5 6.5 6.0

Monetary policy rate (%, eop) 6.8 5.8 5.5 5.3 5.3 4.25 FISCAL Revenue (% of GDP) 13.7 14.1 13.9 14.2 14.1 14.1 14.4 14.4 14.5 14.5 Expenditure (% of GDP) 14.6 15.5 15.0 15.3 15.4 16.9 15.9 15.9 15.9 15.8 Overall Fiscal Balance (% of GDP) -0.9 -1.3 -1.1 -1.1 -1.3 -2.8 -1.5 -1.5 -1.4 -1.4 Primary Fiscal Balance (% of GDP) -0.6 -0.9 -0.5 -0.5 -0.6 -2.0 -0.6 -0.6 -0.5 -0.5 Public Debt (% of GDP) 15.6 18.6 19.4 19.8 21.6 24.7 24.5 24.3 24.3 24.2 EXTERNAL ACCOUNTS Current account balance (% of GDP) -0.1 -0.4 3.5 3.1 0.5 -0.7 0.5 0.4 0.4 0.3

Foreign Direct Investment, (% of GDP) 1.0 0.9 1.0 1.2 0.9 1.0 1.1 1.1 1.1 1.1

External debt (% of GDP) 40.6 43.8 43.0 39.9 37.6 39.4 36.5 33.9 31.6 29.7

Source: MOF, BCP, IMF, WB estimates. 11. Paraguay’s economy was in a recession in the first half of 2019 due to weak performance of the main trading partners, especially Argentina, and adverse climatic conditions, but started on a path to recovery in the second half of the year. Real GDP declined 2.8 percent year-on-year in the first half of 2019. Low growth in Brazil and contraction in Argentina (accounting for 30 and 31 percent of Paraguay’s exports, respectively), coupled with a sharp depreciation of the Argentinian peso, contributed to reduction in Paraguayan exports by 4.6 percent, while fixed investments dropped by 11.7 percent. The level of private consumption remained unchanged, and only public consumption performed on a high growth trajectory (+5 percent). On the production side, a drought negatively impacted value added in agricultural crops (-11.6 percent), and in production of electricity and water (-12 percent). The two sectors


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combined account for 18.5 percent of GDP. Growth of services decelerated to 2.4 percent. In the third quarter, the economy recovered with a 2.8 percent year-on-year growth. Private consumption and exports returned to growth (+2.8 percent and 1.5 percent year-on-year, respectively), while the decline of fixed investments softened to -4.2 percent. On the production side, agriculture and construction retuned to positive year-on-year dynamics, while production of electricity and water remained in the negative. 12. With a weaker economy and inflation close to the lower band of the target range, the Central Bank moved to a more accommodative stance, consistent with the inflation objective. In December 2019, inflation was 2.8 percent year-on-year. Between February and August 2019, the Central Bank of Paraguay (BCP) lowered the policy rate by cumulative 125 bps to 4 percent. The BCP considers the current accommodative stance of the monetary policy consistent with the medium-term inflation objective of 4 percent. 13. The flexible exchange rate regime continued to cushion external shocks. The crisis in Argentina and sharp depreciation of its currency contributed to depreciation of the Paraguay Guarani (PYG) against the US dollar. However, the Guarani appreciated moderately in real terms, due to its real appreciation to the Argentinian Peso and Brazilian Real. Meanwhile, foreign currency reserves of the Central Bank of Paraguay (BCP) remained at prudent levels, recovering after an initial decline at the onset of the Argentina crisis. Balance of Payments data indicates that Paraguay had a current account surplus in 2016-18, underscoring solid fundamentals. Table 2. Paraguay: Balance of Payments Financing Requirements and Sources, 2013-2020 (US$ million) 2013 2014 2015 2016 2017 2018 2019e 2020f

Financing requirements 256 1071 -546 -331 -213 -399 614 298

Current account deficit -621 51 145 -1275 -1215 -213 264 -202

Change in reserves 877 1020 -691 944 1002 -186 350 500

Financing sources 256 1071 -546 -331 -213 -399 614 298

Capital transfers 61 141 154 163 166 170 173 175

Direct investment 245 412 308 371 456 381 385 420

Portfolio investment 500 1300 280 300 500 517 460 420

Other investment -543 -180 -1346 -834 -746 -352 -154 -467

Errors and omissions -7 -602 58 -331 -589 -1115 -250 -250

Source: BCP, IMF, WB estimates. 14. Due to the recession in 2019, the authorities invoked the escape clause from the fiscal rule capping the budget deficit. The FRL allows an increase of the fiscal deficit ceiling up to 3 percent GDP in


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times of economic crises. To support countercyclical policies, the Government requested6 and received permission from the Parliament for a temporary, only for 2019, “escape” from the rule. In 2019, the central government’s budget was executed with a deficit of 2.8 percent of the estimated GDP, above the 1.5 percent ceiling established by the law. Tax revenues increased by only 1.7 percent in nominal terms, as a reflection of the economic downturn. The higher-than-expected increase of non-tax revenue was due to larger transfers from the bi-national electricity generators, leading to an overall revenue increase of 3.2 percent year-on-year. Meanwhile, current expenditure grew by 8.2 percent (wage bill – by 8.1 percent), while public capital investment increased by 28.9 percent, although from a low base, to reinvigorate the economy in the downturn. International investors showed confidence in Paraguay’s overall macroeconomic management and outlook. In February 2019, the Government placed US$500 million as a 31-year Eurobond at 5.4 percent. With public debt among the lowest in the region, the overall EMBIG spreads for Paraguay have barely changed since the beginning on the Argentina’s crisis. Table 3. Paraguay: Key Fiscal Indicators for the Central Government, 2013-2020 (Percent of GDP) 2013 2014 2015 2016 2017 2018 2019e 2020f

Revenue 12.9 13.7 14.1 13.9 14.2 14.1 14.1 14.4

Tax revenue 8.9 9.7 9.6 9.5 9.9 10.0 9.9 10.1 Income taxes 1.9 2.0 2.1 2.1 2.3 2.3 2.5 2.6

Excises 1.2 1.4 1.3 1.2 1.3 1.4 1.3 1.3

VAT 4.7 5.2 5.2 4.8 5.1 5.1 4.9 5.0

Nontax revenue and grants 4.0 4.0 4.5 4.4 4.3 4.1 4.2 4.2 Expenditure 14.1 14.6 15.5 15.0 15.3 15.4 16.9 15.9

Expense 12.4 12.8 13.5 12.8 12.8 13.3 14.0 13.9

Compensation of employees 6.9 6.7 7.0 6.5 6.3 6.6 6.9 7.0 Purchases of goods and services 0.9 1.1 1.2 1.2 1.2 1.3 1.3 1.2

Interest payments 0.2 0.3 0.5 0.6 0.6 0.7 0.8 0.9 Transfers 1.8 1.9 2.1 2.0 2.1 2.3 2.4 2.4

Other expense 2.6 2.7 2.7 2.6 2.6 2.5 2.5 2.4

Gross operating balance 0.5 1.0 0.7 1.1 1.3 0.7 0.1 0.5 Net acquisition of nonfinancial assets 1.8 1.8 2.0 2.2 2.4 2.0 2.9 2.0 Net lending/borrowing (overall balance) -1.3 -0.9 -1.3 -1.1 -1.1 -1.3 -2.8 -1.5

Primary balance -1.0 -0.6 -0.9 -0.5 -0.5 -0.6 -2.0 -0.6

Public sector debt (w/o BCP) 13.2 15.6 18.6 19.4 19.8 21.6 24.7 24.5

Domestic public debt 4.1 4.4 4.5 4.1 4.0 4.1 3.8 3.9

Foreign public debt 9.2 11.2 14.1 15.4 15.8 17.5 20.9 20.6 Source: MOF, BCP, IMF, WB estimates.

6 Technically speaking, the FRL requires compliance with the deficit ceiling at a time of budget approval only, not during the execution stage. Nevertheless, the Government requested a permission from the Parliament to ensure a broad-based support for such a decision.


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2.2. MACROECONOMIC OUTLOOK AND DEBT SUSTAINABILITY 15. Economic growth in 2019 is expected to be close to zero before returning gradually to its recent average of 4 percent. Economic growth is estimated to have dropped to 0.7 percent in 2019. After the negative dynamics in the first half of 2019, the economy is estimated to have grown by over 3 percent in the second half of 2019. In 2020-21, the pace of expansion is projected to gradually return to its potential of 4 percent, among other factors, benefiting from the reforms supported by the EMDPL series. The authorities are expected to maintain prudent macroeconomic policies, anchored in the inflation targeting and the FRL. Inflation is projected to return to the mid-point of the target range (4 percent) in 2020. The current account is expected to temporarily turn into a small deficit in 2019, before returning to surpluses. 16. Public and external debt are low by international standards and are expected to remain so in the medium term. Total external debt is below 40 percent of GDP, with public external debt of the central government below 15 of GDP. Going forward, external debt is expected to decline. According to the external sector assessment of the IMF, the external position of Paraguay remains sustainable under a range of adverse shocks. Public sector debt, at around 20 percent of GDP, is also projected to remain low and sustainable under a variety of scenarios. 17. Paraguay’s macroeconomic policy framework is sustainable and deemed adequate for the proposed operation. The macroeconomic framework is based on fiscal rules, inflation targeting, and a flexible exchange rate regime. The Fiscal Responsibility Law (FRL) caps annual deficits at 1.5 percent of GDP and real current primary expenditure growth at 4 percent. The Central Bank targets consumer inflation at 4 +/- 2 percent, while a flexible exchange rate helps cushion external shocks. In recent years, the authorities have adhered to the main parameters of the macro framework (with prudent use of the escape clauses in the FRL). Sound macroeconomic policies have enabled high, though volatile, economic growth, with low public and external debt, and predictable inflation. Foreign reserves at about seven months of imports are above the IMF’s metrics for a small open economy. 18. However, the macroeconomic outlook is subject to downside risks. Although Paraguay has built strong macroeconomic buffers—low sovereign debt and high international reserves—supported by prudent policies, crises and volatility in the neighboring countries (Argentina and Brazil) may increase the country’s vulnerability and risks to the outlook. In Argentina, the situation remains fragile, fiscal and external financing requirements are large, and further escalation of the crisis could not be ruled out. While the banking sector of Paraguay has a minimal exposure to Argentina, the real sector linkages through exports and remittances are stronger, with Argentina accounting for 31 percent and 15 percent of the totals, respectively. Moreover, concentration of exports in a few agricultural products continues to make growth vulnerable to fluctuations in agriculture commodity markets, primarily soya, and to weather-related shocks (as showcased in 2019). Finally, while the current public debt level is low, Paraguay faces a significant infrastructure gap that requires greater public investment. Additional expenditure not supported by commensurate efforts to mobilize domestic revenue or adjust inefficient spending elsewhere could gradually lead to elevated debt levels and eventually derail sustainability. Paraguay has already been experiencing fast reversals of debt trajectories, including between the late 1990s and the early 2000s. Policy measures, supported by these EMDPL series, are expected to mitigate some of the


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macroeconomic risks, since Pillars A and C directly target vulnerabilities from external shocks and weaknesses of public finances.

2.3. IMF RELATIONS

19. On April 24, 2019, the Executive Board of the International Monetary Fund (IMF) concluded its Article IV consultation with Paraguay. There is no program in place between the IMF and Paraguay. According to the IMF’s appraisal, the current policy mix is appropriate. Fiscal policy is neutral and monetary policy expansionary, which should help mitigate the slowdown and reduce downside risks. Inflation is projected to return to the midpoint of the target range by the end of 2020. The external position is stronger than the level implied by fundamentals and desirable policies. Paraguay has grown rapidly in the past decade and a half, contributing to a sharp drop in poverty. The report notes that prudent macro policies, resulting in low inflation and low government deficits, played an important role. Vulnerabilities have declined, with a significant reduction of both external and public debt. According to the IMF, the key question going forward is how to maintain rapid growth of per capita incomes.

3. GOVERNMENT PROGRAM

20. The proposed EMDPL series is fully aligned with the core priorities of the Government’s program. These priorities are laid out in its two key development strategy documents – namely, the long-term National Development Plan 2030 which was developed in 2014 under the previous administration and the Plan de Gobierno 2018-2023 “Paraguay de la Gente” (PdG 2023), which lays out the medium-term priorities of the current administration. The NDP’s overarching goals include a focus on eliminating extreme poverty and achieving higher-than-average growth in the incomes of the bottom 40 percent. Within the NDP objectives and framework, the PdG 2023 lays out critical priority areas in which the current administration intends to make progress within its five-year term. These include: (i) Social Development, particularly Education, Health and Social Protection; (ii) sustained, inclusive growth with a focus on diversification and on increased private sector investment via an improved investment climate; (iii) Infrastructure development especially Transport, Water and Sanitation as well as Information and Communication Technology (ICT); (iv) Energy and Environment; (v) Science, Technology and Innovation; and (vi) Security, Defense and Justice. The Plan is anchored in a medium-term economic framework which supports sustainable fiscal policies, enhanced tax revenue efforts, improved efficiency in social protection polices and targeting, and widened financial inclusion. While public sector governance and capacity building are not explicitly addressed in the Plan—except with respect to tax and judicial reform— achievement of stated objectives under all the pillars will necessarily involve improving the effectiveness of institutions, including increasing transparency, accountability and participation.

21. As evidenced by reform actions initiated in the first year of its term, the Government is committed to an ambitious reform agenda, aimed at strengthening the foundations of private sector-led growth, eliminate market distortions and promoting efficiency while protecting the vulnerable. The new administration expressed a strong commitment to consolidate reform progress in key areas such as fiscal and macroeconomic stability, progress towards formalization and economic diversification, increasing international credibility, mobilizing private investment and important transparency and accountability reforms. In this context, the new administration is seeking to make strides in accountability in sensitive areas such as customs, procurement and anti-money laundering. The Government is also


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working toward improving conditions for the private sector to make Paraguay more attractive for foreign and domestic investors through removing bottlenecks and market distortions. In this context, actions aimed at improving business conditions, through lowering barriers to starting a new business and improving access to credit for companies, are among the Government’s priorities. In addition, the Government is pursuing reforms to strengthen transparency and public integrity in the public administration, aligning it to the international best practice. 22. These reforms are complemented by concerted actions aiming at promoting environmentally more sustainable development through the sound management of forest resources and the conservation of critical ecosystems with a view to enhancing resilience to weather shocks. Paraguay’s law recognizes the need to protect the native forest cover.7 The central provisions are Article 42 of Law 422/73 (Forest Law), that mandates that private owners of land exceeding 20 hectares preserve as “forest reserve” at least 25 percent of the original native forest cover (as recorded in the 1986 baseline forest map), and Law 2524/04, also known as “Zero Deforestation Law”, enacted in 2004 and extended multiple times, with the latest extension being implemented by Law 6256/18, that prohibits clearing native forests in Eastern Paraguay. As described in Decree 175/18, those who fail to comply with Law 422/73 have a “forest deficit” on private land and are required to either: (i) reforest a surface equivalent to 5 percent of their property area; (ii) restore forest cover; or (iii) purchase Environmental Service Certificates (ESCs). Decree 1743/14, replaced by Decree 3312/20 and Resolution 094/20 as part of this program, provided the framework for dealing with forest law violations and penalties.8

4. PROPOSED OPERATION

4.1. LINK TO GOVERNMENT PROGRAM AND OPERATION DESCRIPTION

23. The proposed DPL is the first in a programmatic series of two operations that supports policy reform measures aimed at reducing Paraguay’s vulnerability to shocks impact by: (i) improving the enabling conditions for a more resilient growth path led by the private sector, (ii) rendering its economic growth path more environmentally sustainable and resilient to climate-induced shocks, and (iii) increasing resilience through more efficient and accountable management of public resources. The program complements the government’s reform agenda as laid out in the PdG 2023. Pillar A is fully aligned with the Plan’s second priority area “sustained, inclusive growth with a focus on diversification and on increased private sector investment via an improved investment climate”. Pillar B contributes to priority (iv) on Energy and Environment. Pillar C supports an ambitious reform agenda in terms of efficiency and accountability, including sensitive areas such as taxes, pensions, and procurement; complemented by the customs policies supported under Pillar A.

7 The National Forestry Institute (Instituto Forestal Nacional, INFONA) is the leading agency in the forestry sector. INFONA reports directly to the Presidency and its roles and responsibilities include the formulation and implementation of the national forest policy with the aim of promoting economic development through the sustainable management of forest resources and the conservation of critical ecosystems. Other key agencies include the Ministry of Environment (Ministerio del Ambiente y Desarrollo Sostenible, MADES) and the National Cadaster (Servicio Nacional de Catastro, SNC). 8 Decreto 1743/14 “Por el cual se establece el Régimen de Infracciones y Sanciones forestales y el reglamento de trámites administrativos relativo a los sumarios administrativos por infracciones a la legislación forestal y se derogan varios artículos del DecretoNº3929/10”.


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24. The operation incorporates lessons learnt through previous engagements. The Implementation Completion and Results (ICR) report of the Paraguay Enhancing Fiscal Management, Social Protection and Financial Inclusion Development Loan with a Deferred Drawdown Option (P151007), implemented between 2014 and 2017, highlights important lessons that were taken into consideration through the design of the DPL. The team initiated the preparation of the operation soon after the new administration took office, as both the ICR and CPF highlight the timing of the engagement to be particularly critical and the initial period of an administration to be an important window of opportunity to implement big reforms. Following another lesson highlighted in the ICR, the team coordinated with other Multilateral Development Partners throughout preparation to build on complementarities, avoid duplicity, and maximize impact. Finally, hands-on technical support is being provided on many of the proposed prior actions to help address the weak institutional capacity, as advised in the ICR. Close monitoring and supervision during preparation is also critical to avoid problems faced in previous operations, including the last-minute policy changes that jeopardized the consistency of the program.

4.2. PRIOR ACTIONS, RESULTS AND ANALYTICAL UNDERPINNINGS

Pillar A: Improve the enabling conditions for more resilient, private sector-led growth

25. Reforms proposed under Pillar A aim to improve the enabling conditions for a more resilient growth path led by the private sector. In the absence of a healthy competitive environment that promotes firm and productivity growth, firms in Paraguay face multiple barriers and competitiveness challenges when conducting business. Starting a business and trading across borders were among the areas with the lowest rankings in Doing Business 2020 for Paraguay, 160 and 128 respectively. Both agricultural and non-agricultural production involve a high degree of market concentration that creates disadvantages for smaller economic actors. In many subsectors, for example, the top four firms account for more than half of all sales, and in some cases over 90 percent.9 The policy measures supported under this pillar promote competitiveness, economic diversification and trade facilitation, with a view to developing a more broad-based and resilient economic structure.

Prior Action 1: To support the facilitation of business entry and the reduction of the cost of starting a business, the Borrower has enacted a law creating the simplified joint-stock company type (Empresas por Acciones Simplificadas - EAS).

26. Rationale for the PA: High regulatory barriers to business entry and growth, including business registration formalities, discourage entrepreneurship and contribute to an unlevel playing field, stifling competition and productivity. Paraguay’s regulatory environment is not conducive to the entry and establishment of new firms whether domestic or foreign-owned. The business legalization process in Paraguay is one of the most complex and costly worldwide, requiring 35 days10 compared to 1.5 days in Canada, 4 in Chile and 29 on average in Latin America. Firms in Paraguay need to pay the equivalent of 52.2 percent of income per capita to establish a firm, compared to 0.3 percent in Canada, 3.6 percent in Brazil (Sao Paulo) and 31.4 percent on average in Latin America. The complexity of business registration 9 “Firms’ Productivity and Employment in Paraguay 2010-2014”, by E. Ruppert Bulmer and A. Scutaru, Jobs Group, World Bank, June 2018. 10 World Bank. 2019. Doing Business 2020. Washington, DC: World Bank. https://openknowledge.worldbank.org/bitstream/handle/10986/32436/9781464814402.pdf


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in Paraguay can be attributed to the persistence of outdated requirements (and multitude of agencies involved) combined with a lack of integration, data-sharing and the mandatory use of costly notarization services (notaries account for almost half of current incorporation costs at around US$600). Notarial functions related to company formation such as confirming the identity of the founders, ensuring the validity of the documents, and keeping the original documents can be achieved in more efficient ways. Standardized pre-approved articles of association or company statutes can ensure legality of the document without the need for legal professionals, particularly in the case of small companies. To facilitate formal entrepreneurship, several countries have implemented corporate law reforms to introduce new company types (e.g. Argentina, Colombia, Greece, Germany, Mexico) with greater flexibility for incorporation and operation, including making the use of notaries optional.

27. Substance of the PA: This PA supports a law that creates a new company type (EAS) that facilitates new business formation by: (i) making the use of notaries optional; (ii) promoting the use of standardized, pre-approved articles of association or company statutes; (iii) strengthening the legal framework to encourage the use of digital technology for company incorporation and record keeping; and (vi) including a limited liability structure to protect entrepreneurs from personal liability. Following the enactment of the law, authorities plan to conduct a business reengineering exercise to improve workflow efficiency and transparency of the business registry (SUACE), including guiding interconnection and interoperability efforts to link it to other agencies such as SET (Subsecretaría de Estado de Tributación), Ministry of Finance (Abogoacía del Tesoro) and SEPRELAD (Secretaría de Prevención de Lavado de Dinero o Bienes). To further improve the business environment, the proposed Indicative Trigger (IT1) supports enactment of laws on movable guarantees (that would, among other effects, improve access to credit for afforestation), insolvency, and credit bureaus.

28. Expected impact: The implementation of comprehensive business registration reforms is expected to lower bureaucratic barriers to entry and encourage formal registration of firms. It will also improve the quality and accessibility of data on registered firms. Economic literature and empirical evidence suggest that policies aimed at reducing regulatory barriers to entry can have positive effects on firm registrations, formal job creation, and productivity. Cross-country research on the effect of entry barriers on productivity and output shows that higher entry costs significantly reduce output per worker and that they do so by lowering total factor productivity.11 An increase in entry costs by 80 percent of income per capita is estimated to decrease total factor productivity and output per worker by 22 percent and 29 percent, respectively. The Government's medium-term objective is to generate compliance cost-savings through simplifying the process for business entry by reducing the time to start a business in Paraguay. The simplification of business registration process is expected to benefit mostly small and medium firms, which account for about a quarter of firm jobs. The proposed indicator is the reduction of the current time to start a business by 50 percent, from 35 days in 2018 to 18 days in 2022.

Prior Action 2: To support the improvement of risk management at the National Directorate of Customs and the reduction of foreign trade transactions costs, the Borrower: (a) through its Executive Branch, has amended the regulatory decree of the Customs Code to eliminate desk review of customs declarations for goods submitted for physical inspection (red channel), and (b) through the SEPRELAD, has issued a

11 Research in Mexico (Bruhn, 2011; Bruhn 2013; Kaplan et al, 2011), Peru (Mullainathan and Schnabl, 2010), Colombia (Cárdenas and Rozo, 2009) and Portugal (Branstetter et al, 2010) documented an increase in business registration rates following business registration reforms.


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resolution establishing interchange of information requirements to be complied with by the National Customs Directorate and the entities of the financial sector.

29. Rationale for the PA: Customs efficiency is a major determinant of Paraguay’s participation in global value chains. Indeed, border control inefficiencies, including from Customs, are among the major constraints to doing business. Paraguay ranks 128 in Trading Across Borders indicator of the 2020 Doing Business. Such inefficiencies are affecting relatively large firms more, with 22 percent of them identifying Customs and trade regulations as a major constraint versus 15 and 13 percent for small and medium firms, respectively (World Bank Enterprise Survey, 2017). Foreign-owned firms are also relatively affected more, as 41 percent of them highlighted the topic as a major constraint versus 13 percent for local-owned firms. Therefore, enhancing Customs efficiency is key to improve the business environment and foster export performance. Among the institutional weaknesses of the Customs agency, identified by the IMF’s and World Bank’s Technical Assistance, are: frequent cases of corruption; poor coordination with other agencies; and heavy reliance on controls based on physical inspections (over 40 percent), with low effectiveness of collection or seizure of prohibited goods.

30. Substance of the PA: This PA supports strengthening of risk management at Customs through measures that allow better control and enforcement, but at same time, promote trade facilitation. The PA supports introduction of regular interchange of information between anti-money laundering (SEPRELAD) and customs agencies, and elimination of the desk review of declarations with goods submitted to physical inspections (red channel). By limiting the desk review, the administration is committing itself to a new paradigm of compliance management that will require successful implementation of post clearance audit. Currently, post clearance audit, a key function of modern customs offices, is not conducted in Paraguay due to the lack of regulatory framework. Post clearance audit is an integral part of the overall risk management and reinforces and complements the desk reviews at customs. It also allows to decongest Customs warehouses and facilitate trade. The proposed Indicative Trigger (IT5) supports adoption of Customs’ post-clearance audit procedures by Customs.

31. Expected impact: The implementation of measures supported by this PA is expected to lead to more transparent and efficient customs procedures, higher collections of taxes and duties, and reduction of release time. Through this reform, the Customs administration expects to gradually replace compliance management that is currently exclusively based on inspections of individual transactions at the borders by post clearance audits, at the premises of traders, covering a set of operations. These measures will impact more on frequent traders, with compliance records known by the administration, enabling automatic release of goods and reducing time and costs associated. The proposed result indicator to track progress for this series is the decrease on average time for customs clearance from 189 hours in 2018 to 132 hours in 2022. Pillar B: Promote economic growth that is more environmentally sustainable and resilient to climate-induced shocks

32. Reforms proposed under Pillar B aim at promoting an economic growth path that is more environmentally sustainable and resilient to climate-induced shocks, notably by strengthening natural resource management in the agriculture and forestry sectors. This is pursued by improving the Government’s ability to monitor land use change and related greenhouse gas emissions and by


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strengthening its ability to identify and declare forest law infractions by using remote sensing technology and by streamlining the process of administrative proceedings. The pillar also supports the development of the forest economy in a manner that is sustainable and creates jobs and valuable inputs to other sectors, by promoting access to appropriate credit conditions and by promoting exports of timber products.

Prior Action 3: To improve availability and quality of information to support forest management, the Borrower, through its Executive Branch, has adopted a decree regulating the establishment of the main interinstitutional, financial and functional structures of the Borrower’s National Forest Monitoring System that collects and publishes remote sensing information on forests.

33. Rationale for the PA: Native forests are under high pressure from land use change and unsustainable exploitation. While Paraguay’s legislation recognizes the need to protect the native forest cover, the Government does not yet have the tools to exert control over its forest stock. This leads to an uneven application of the law with resulting distortions. A key gap is the lack of a system for forest and forest carbon monitoring that exploits the full potential of modern remote sensing technologies. In March 2019, the National Forestry Institute (INFONA) signed a memorandum of understanding with the World Resources Institute (WRI) under its Global Forest Watch program. With technical assistance from WRI, Paraguay plans to compile official forest data into a publicly accessible Paraguayan Forest Atlas. The five-year agreement will serve to enhance government and private sector enforcement mechanisms by enabling improved monitoring of commodity-driven deforestation, and compliance with legal provisions such as on natural forest reserve, invasions into indigenous lands, and carbon emissions. However, stronger inter-institutional coordination as well as more comprehensive and better integrated information systems are needed to properly monitor changes in land use and forest cover. In addition, forest fires are becoming an increasing concern, notably in the Chaco ecoregion. In August 2019, the forest fires that swept across Bolivia, Brazil and Paraguay have been particularly intense, emitting large quantities of carbon dioxide, with a potential to disrupt rainfall distribution across South America’s grains-and-beef producing regions for the coming years. Early detection and response to forest fires requires better coordination and the efficient use of limited management resources, which in turn depend on the quality of the Government’s monitoring systems. 34. Substance of the PA: This prior action consolidates recent initiatives for strengthening forest monitoring by establishing the National Forest Monitoring System (NFMS). The NFMS promotes data sharing and cooperation between INFONA, charged of applying the Forest Law, the Ministry of Environment and Sustainable Development (MADES)12, charged of issuing environmental licenses, including for agricultural expansion into forested land, and the cadaster service, and incorporates Global Forest Watch. It integrates satellite monitoring systems, national forest, greenhouse gas inventories and EIA data published by MADES. The NFMS collects, analyzes and publishes remote sensing information on forests, creating the first national platform for systematic monitoring of the forest cover with sufficient resolution to detect unauthorized land use change at the property level. The system will allow to compare actual changes in land use to those approved under the Forest Law (Law 422/73)13. By interacting with

12 MADES and INFONA are required to enter into an inter-institutional cooperation agreement within 90 days as from the date of Decree No. 3246/20 on the technical and operative aspects to implement the SNMF. 13 Paraguay’s law recognizes the need to protect the native forest cover. The central provisions are Article 42 of Law 422/73


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the National Forest Inventory, the system will also allow to monitor, at the national level, the state of forests in terms of structure and composition. In addition to strengthening the monitoring and enforcement capacity of environmental agencies, notably INFONA, the creation of the NFMS also supports compliance with the “zero deforestation” Law 6256/18 and Paraguay’s international climate commitments. To improve coordination, response planning, and response times to forest fires, the Indicative Trigger (IT3) supports institutional reform through the creation of an interagency task force that will produce a definition of roles and responsibilities in the event of forest fires. The taskforce will include INFONA, the National Emergencies’ Secretariat, the Armed Forces, the Ministry of Interior and the Fire Brigade. The role of the taskforce will be to plan and execute coordinated responses in the case of forest fire alerts. The use of remote sensing will be instrumental to allow the taskforce to function more effectively.

35. Expected impact: These measures are expected to increase the ability of the Paraguay to use remote sensing information to monitor changes in forest cover, carbon sinks and to accelerate the response to forest fire emergencies. The indicators to monitor progress under this prior action include: (i) data on land use change is made publicly available in online data portals; and (ii) a decrease in the response-time to forest fire alerts from 1 week in 2018 to 1 day in 2022 (annual average). Prior Action 4: To support the increase in the efficiency of enforcement of the forest legislation, the Borrower, through its Executive Branch, has updated the regulations on the regime of forest offenses, forest sanctions and the administrative proceedings for violations of forest legislation. 36. Rationale for the PA: Dealing with forest infractions has historically been time consuming and ineffective. A lax and uneven application of the law and high levels of deforestation has led to loss of the forestry sector’s potential for acting as an important carbon sink, sustainable provision of biomass, and other environmental services, as well as to market distortions. As mandated by Decree 175/18, those who fail to comply with Law 422/73 have a “forest deficit” on private land and are required to either: (i) reforest a surface equivalent to 5 percent of their property area; (ii) restore forest cover; or (iii) purchase Environmental Service Certificates (ESCs). Under Decree 1743/14 that previously provided the framework for dealing with forest law violations and penalties,14 administrative proceedings tended to last 7 to 12 months and are rarely concluded or result in an injunction to repair the forest deficit. To date, moreover, the only means to initiate an administrative proceeding against an alleged case of illegal deforestation was through an “intervention act” (acta de intervención), i.e. a report prepared by an agent who inspects the property and records the forest law violation. The intervention act used to constitute the main element of proof in an infraction proceeding and it has proven to be an obstacle for prosecution of forest infractions due to the difficulties in accessing the properties. Adding to these challenges, Decree 175/18, which regulates Article 42 of the Forest Law 422/73, contains several ambiguities in the definitions of forests and the forest deficit, the modalities of the remedies (e.g. timeframe for reforestation), making enforcement difficult. The decree also contains a loophole: the tacit possibility of applying for new permits (Forest Law), that mandates that private owners of land exceeding 20 hectares preserve as “forest reserve” at least 25 percent of the original native forest cover (as recorded in the 1986 baseline forest map), and Law 2524/04, also known as “Zero Deforestation Law”, enacted in 2004 and extended multiple times, with the latest extension being implemented by Law 6256/18, that prohibits clearing native forests in Eastern Paraguay. 14 Decreto 1743/14 “Por el cual se establece el Régimen de Infracciones y Sanciones forestales y el reglamento de trámites administrativos relativo a los sumarios administrativos por infracciones a la legislación forestal y se derogan varios artículos del DecretoNº3929/10”.


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to deforest after a rural property has been subdivided and one of the subdivisions contains more than 25 percent of forest area. By successive subdividing, this could result in shrinking forest areas. 37. Substance of the PA: This PA consists of Decree 3312/2020 which abrogates Decree 1743/14, conferring the power to INFONA to update the regime of forest infractions and sanctions and, through a subsequent resolution of INFONA, introducing a series of innovations aimed at more effective enforcement of forest infractions. First, the new decree and INFONA resolution opens up the possibility of using other evidence besides the “Acta de Intervencion” to initiate the proceeding. This allows, for example, using remote sensing and digital technology to collect and present evidence of unauthorized deforestation. In the former decree, the “Acta de Intervencion” was considered the only formally admissible evidence allowing to initiate a proceeding. Second, the resolution centralizes the process for initiating proceedings against private land owners, reducing the discretion and exposure of field agents. Third, the INFONA resolution establishes the possibility for the legal department of INFONA to carry out the collection and analysis of evidence ahead of opening the proceeding, no longer relying solely on the judge to lead the investigations and the collection of evidence after the summary had been initiated, as previously established. This simplifies the judge’s mandate and harnesses INFONA’s ability to use its technical and technological tools to contribute to the judge’s decision. Fourth, the INFONA regulation includes the possibility of “plea of guilty” with a lower fine, to promote faster resolution of the proceeding. The Indicative Trigger (IT4) under DPL2 would remove ambiguities in forest law enforcement and support the amendment of Decree 175/18 and the issuance of an accompanying resolution, by eliminating inconsistencies in the definition of the forest deficit and exceptions to the obligation to maintain the legal forest reserve.

38. Expected impact: As the result of a more effective system to declare and deal with forest deficits, these measures are expected to increase the capacity of INFONA to detect and act upon violations of the Forest Law, leading in turn to an increase in the area of land that is destined to reforestation, forest restoration or forest protection. This will also favor the creation of carbon sink contributing to the country’s climate change mitigation targets. The results indicator measures the increase in the annual number of administrative proceedings initiated by INFONA and in the annual number of rulings issued by INFONA for violation of Article 2 of Resolution 094/2020, which are expected to go, respectively, from 203 and 51 in 2019 to 300 and 75 in 2022.

Prior Action 5: To facilitate access to credit for the forestry sector: (a) the Development Finance Agency has issued resolutions that modified the credit line for commercial afforestation removing both the ceiling for maximum loan amounts and the explicit requirement to put the land on which the pertinent forest project is based as a collateral, and (b) the National Development Bank has issued a resolution that created a credit line for commercial afforestation.

39. Rationale for the PA: There is an important potential for the forest sector to generate inputs to manufacturing, and generate jobs and exports in Paraguay, with limited risks to depleting natural forests as these are located far from markets and because of their protected status. However, the sector faces a weak investment climate and limited access to credit and markets, resulting in significant market distortions. Commercial forestry is perceived as a high-risk activity, notably due to the relatively long project cycles (8-12 years) and uncertain access to markets. Given the long investment horizons and absence of the requisite financial regulations for competitive lending to the forestry sector, commercial


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banks are reluctant to finance forest projects. At the same time, commercial forestry entails large up-front investments. In terms of market access, low wood processing capacity exists in Paraguay. Law 515/92 prohibits exports of timber logs and beams of both native and exotic species, which limits commercial opportunities for plantations of Eucalyptus or other fast-growing exotic species that are of interest to investors. 40. Substance of the PA: The actions taken respectively by the AFD (a second-tier bank) and the BNF (a state-owned commercial bank) aim to create more favorable loan terms to potential commercial plantation investors. AFD, through Resolution No. A68R01F140819 and through the amendment in Resolution No. A11R02F060220, modified its forest loan instrument, PROFORESTAL, by extending its validity, removing the ceiling for loan amounts and eliminating the explicit requirement for the land on which the pertinent forest project is based to be used as collateral to secure a loan under this credit line. While the change in loan terms of PROFORESTAL is already available to private commercial banks, BNF’s Resolution No. 4 Act 94 makes the product available via a first-tier bank. In particular, the Resolution enables setting of more competitive interest rates and allows investors to use their forest stock as collateral (which is recognized as separate from the underlying land property rights following Law 4890/13, “Ley de vuelo forestal”). If successful, this will serve as example for other commercial banks to enter the market. The enabling conditions for these reforms were provided by the Central Bank’s Circular No. 00088/2019, which clarifies that commercial banks that apply grace periods of more than one year to long-term investment projects will not incur a sanction in terms of their credit classification. The circular also specifies that long-term investments could very well incur short-term losses, and that this will not be considered a weakness in the financial standing of the bank providing the loan. The Indicative Trigger (IT2) will further increase investment incentives and reduce market distortions in the forestry sector by amending Law 515/94 to lift the ban on exports of timber logs and beams for exotic species. The ban on the export of native species timber logs, pieces and beams, will be maintained. This will allow continued compliance with the Convention on International Trade in Endangered Species (CITES).

41. Expected impact: These measures are expected to lower the transaction costs and increase the financial attractiveness of exotic timber plantations. Fast-growing species like Eucalyptus also contribute to carbon sequestration, hence contributing to the country’s climate change mitigation targets. Plantations can also provide biomass that would replace illegally and unsustainably sourced biomass from natural forests. The DPL1 prior action will provide for more favorable credit conditions to plantation investments, and the DPL2 trigger will allow a more predictable revenue stream to private operators. The result indicator to track progress for this operation is the increase in the volume of loans extended to commercial forest plantations from zero in 2018 to US$5 million in 2022, and the exports of exotic timber logs and beams from zero in 2018 to 90,000 cubic meters in 2022. Pillar C: Increase resilience through more efficient and accountable management of public resources 42. Reforms supported by Pillar C are centered around measures that strengthen efficiency, countercyclicality and accountability of public resource management. Limited capacity in the public sector reduces Paraguay’s capacity to reduce vulnerability to different types of shocks. This includes low accountability of public sector management, as well as high public perceptions of corruption.15 The

15 World Bank. 2018. Paraguay-Systematic Country Diagnostic (English). Washington, D.C.: World Bank Group. http://documents.worldbank.org/curated/en/827731530819395899/Paraguay-Systematic-Country-Diagnostic


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measures proposed under this pillar seek to improve public sector performance by (i) simplifying and making more efficient the collection of domestic resources (tax reform, tax evasion), and (ii) improving the use of those resources by making expenditure more effective, equitable, and transparent (procurement, citizen budget). Under the second operation, these actions are complemented by measures aimed at improving countercyclicality and supporting sustainability of fiscal policy, enhancing efficiency and equity of social security, and strengthening the statistical system to underpin policy making with timely and good-quality data.

Prior Action 6: To simplify and modernize its tax system, the Borrower has enacted a law that limits deductions in the personal income tax (PIT), creates a separate Dividend and Profits tax, unifies corporate profit tax and agriculture profit tax, and raises maximum rates on select excise taxes on products with negative environmental externalities.

43. Rationale for the PA: At below 10 percent, Paraguay’s tax-to-GDP average ratio in the last decade has been among the lowest in Latin America and the Caribbean region, and less than half of the OECD average. Tax revenue from income and profits (as percentage of total tax revenue) is the second lowest in the region. The tax base has been eroded by numerous tax exemptions and deductions, coupled with high informality. Paraguay’s tax rates for its main taxes –value added tax (VAT), Corporate Income Tax (CIT) and personal income tax (PIT) –are the lowest in the region at 10 percent by a large margin, and among the lowest in the world. Moreover, unlimited deductions in the PIT – which include consumption and investment expenditures and the rollover of previous losses – make the statutory rates largely uninformative, with observed effective rates close to 0 for any level of income. The minimum level over which income is subject to PIT – at 3.7 times GDP per capita – is by far the highest in the region. Also, excise taxes for goods with known negative health externalities are relatively low, including for tobacco, alcohol, and high-calorie beverages. Additional inefficiencies within the system include a differential treatment in corporate taxes across sectors (benefiting the agriculture sector), and the application of a unique PIT rate based on gross income brackets, which introduces distortive jumps in marginal rates. The redistributive effect of the tax system is among the smallest in the region. Inadequate levels of tax revenue and minimal distributional impact of the tax system limit Paraguay’s capacity to deliver sustained and inclusive growth, as significant investments are needed to address the large infrastructure and human capital gaps – including protection of the most vulnerable.

44. Substance of the PA: The tax reform law, supported by this PA, is a significant step to a simpler and more effective tax system, while marginally improving its progressivity and increasing tax collection. Regarding the PIT, deductible expenditures and investments continue to be mostly unrestricted (subject to a few exceptions and the elimination of carryovers), but these can only be claimed over labor income. Capital income (either rents or gains) are no longer subject to any deduction, and neither is the newly created Dividends and Profits tax. Rates on labor income remain between 8 and 10 percent, but these are now marginal rates and determined by net income. On the corporate side, two new simplified tax systems are established for small and medium-sized firms, promoting formalization, and the two corporate taxes (Tax on Commercial, Industrial, or Services Income – IRACIS - and Tax on Agricultural Activities - IRAGRO) are unified into one. This implies raising the tax rate for agricultural activities to the same level as other sectors and eliminating the exemption on dividends tax to the agriculture sector. Maximum excise rates on select fuels – including gas, gasoil, kerosene, etc. - are raised to 50 percent, which represent an increase from 12p.p. to 50p.p., depending on the product.


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45. Expected impact: The new law puts in place a more simplified and efficient tax structure, setting the basis for potentially more substantive changes in the future. The new structure of direct taxes is expected to significantly increase the number of contributors to the system, particularly from the top deciles of the distribution, as well as result in modest increase in tax collection. The simplified tax system for small firms has the potential to incentivize formalization and therefore expand the tax base. The impact of fuel excise taxes can have a beneficial impact on the urban environment and reduce fossil fuel greenhouse gas and other fossil fuel related pollutants’ emissions, while the resulting increase in the cost of living among the poor is expected to be small. The overall distributional impact is expected to be limited, but relative to the negligible starting tax base, total contributions and effective rates among individuals at the top-end of the distribution are expected to increase significantly. The progress indicator for this PA is an expected increase in revenues from direct taxes by 30 percent during 2018-2022.

Indicative Trigger 6: To support sustainability and improve countercyclicality of fiscal policy, the Borrower enacts a law amending the fiscal responsibility law.

46. Paraguay has made significant progress in strengthening macroeconomic management, including regarding its public finances, and its track record is well-recognized by international markets. Moving forward, the country’s fiscal framework could be further strengthened with a view to smoothing its highly volatile economic performance. As experienced in 2019, the nominal fiscal deficit target in the Fiscal Responsibility Law (FRL) does not consider the country’s cyclical position and may contribute to the procyclicality of fiscal policy. Adjustments to the fiscal rule could make it more suitable to help smooth economic cycles while maintaining fiscal sustainability. The Government intends to fine-tune the FRL, without altering the 1.5 percent deficit ceiling. This would involve adjusting the definition of the escape clause and tightening the constraint on real current primary expenditure growth (currently – at 4 percent), which limits the fiscal space for capital spending.

Prior Action 7: To support the facilitation of reduction of tax evasion, the Borrower has amended the Criminal Code to criminalize money-laundering of assets obtained from tax evasion.

47. Rationale for the PA: Paraguay’s tri-nation border (with Argentina and Brazil), according to numerous reports, is host to a multibillion-dollar illicit goods trade, and substantial amounts of assets are laundered through the country’s financial system. Currently Paraguay is undergoing a mutual evaluation of its anti-money laundering and counter financing of terrorism (AML/CFT) systems by the regional body GAFILAT (financial action task force group of Latin America), with an onsite visit scheduled for May 2020. Paraguay must comply with the financial action task force (FATF) standards on AML/CFT, which include the criminalization of tax evasion as a predicate offense of money laundering, as per FATF recommendation 3. Tax evasion is deemed high in Paraguay. VAT tax evasion was estimated at 30.9 percent in 2014, highly affected by informal activities. It is higher than the average for Latin America of 25.9 percent.16

48. Substance of the PA: This PA supports Paraguay’s efforts to comply with FATF recommendation 3 and promote fiscal efficiency and accountability of the public sector. Through this reform, the concealing of foreign tax evasion can now be prosecuted in Paraguay as money laundering. This reform is part of a 16 Gimenez et al. (2017). “Paraguay: Analisis del sistema fiscal y su impacto en la pobreza y la equidad”. CEQ WP74.


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larger package of twelve laws, which have been discussed and approved by the legislative power in 2019 with the objective of strengthening the country’s AML/CFT regime, in preparation for the GAFILAT evaluation.

49. Expected impact: This reform is expected to result in a reduction in money laundering of proceeds of foreign tax evasion, and an overall improvement of fiscal discipline. This reform is intended to reduce the incentives for actors to use Paraguay as their economic base for the purpose of evading taxes from foreign jurisdictions. A critical element of the reform is to enhance institutional capacity for assessing money laundering risks associated with such tax evasion. Therefore, the result indicator for this PA reflects the completion of an assessment of risks related to money laundering from tax evasion.

Indicative Trigger 7: To enhance sustainability and equity of social security, the Borrower enacts a law to improve asset allocations of pension funds and initiates parametric changes of the public sector’s pension schemes.

50. The pension system in Paraguay is fragmented and not well supervised. There is no uniform pension policy. The pension system for the private sector is managed by the Instituto de Provision Social (IPS), while the public pension system is managed by the Caja Fiscal. The latter is segregated into six separate sub-schemes for teachers, university professors, judiciary, military, police, and other civil servants, each with separate accounting and different pension eligibility rules. The diversity of unsupervised pension funds presents an important fiscal risk. The largest public funds are not allowed to invest in government debt forcing them to pursue short-term, undiversified investment strategies increasing the systemic risk of the banking sector. The proposed trigger supports strengthening of the institutional framework of the pension system, including the creation of an advisory council and investments committee. The investment committee would establish investment limits providing options for alternative assets to diversify their risk profiles. The trigger might also involve initiation of parametric changes to Caja Fiscal to better align the eligibility rules for differences sub-schemes. Prior Action 8: To support the improvement of public procurement, the Borrower, through its Executive Branch, has issued a decree that simplifies and consolidates the Borrower’s procurement regulatory framework and promotes centralization of public procurement of goods and services.

51. Rationale for the PA: Public procurement in Paraguay in its current state does not ensure the best value for money. Government procurement of goods and services in Paraguay is growing and currently represents about 15 percent of total central government expenditure. However, government demand is highly fragmented with 313 different buyers in the Central Government, negatively affecting contractual prices even though 75 percent of procurement needs were made up by only six categories of items. Evidence from the 2018 Public Expenditure Review suggests additional challenges in the procurement framework, including: (i) low levels of competition for government contracts (84 percent of all processes had three bidders or less); (ii) bunching of procurement at the end of the year (25 percent of procurement happens in December but due to seasonality factors this is one of the most expensive months to buy); (iii) fragmentation of demand and purchases among too many agencies; and (iv) uneven capacity to implement procurement processes across agencies (open bidding takes 83 days to be carried out, but in one third of the agencies it takes much longer than that). In addition, government agencies in Paraguay


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rely on the exact same procedures and strategies to procure goods, works and services of varying complexities and prices, making the process inefficient.

52. Substance of the PA: This PA aims at streamlining public procurement processes and practices and thereby creating fiscal savings. The new Decree seeks to unify, harmonize and modernize procurement processes and regulations, reducing current complexity and introducing new practices that better reflect international standards. More specifically, the Decree consolidates several regulatory standards as defined in two laws and eight decrees, providing a single reference document to regulate public procurement practices. Among other things, the new Decree extends the competencies of the National Directorate of Public Procurement (DNCP) to consolidate purchases and updates frameworks agreements rules. Measures to build capacity and improve the transparency and efficiency in procurement are also put in place, such as to professionalize UOC’s (Operative Procurement Units) staff, enhance complain mechanisms, publish the result of evaluations, reinforce the control of bidders’ ineligibility and of impartiality of evaluation committees members, simplify processes, and incorporate value for money as a core principle in procurement. Finally, emphasis is also placed on the use of business intelligence tools for the management and dissemination of public procurement contracts, to further strengthen transparency and public access to procurement data. The proposed Indicative Trigger (IT8) supports institutionalization of the consolidated public procurement to reduce the fragmentation of the public demand, notably through the signing of at least 5 inter-agency agreements to concentrate the purchase of recurring high cost and low complexity goods and services.

53. Expected impact: The implementation of these agreements, fostered by the new decree is expected to increase value for money for procurement contracts by leveraging the demand of the government (i.e., reducing fragmented demand and the administrative burden) for high-value and low-complexity items (about half of total value). The significant expansion of the quantities will make processes more attractive for the market, increasing the competition, with its associated benefits (lower prices, quality improvement, innovation, etc.). Moreover, improving capacity of the government to deliver public services and freeing resources for social investments is expected to have beneficial effects for the poor. The result indicator to track progress in the level of competition in procurement is the average number of bids received in the procurement processes, which is expected to increase from 2.55 in 2018 to 4 in 2022.

Prior Action 9: To support budget transparency, the Borrower, through the Minister of Finance, has issued a resolution, to be applicable as from the 2020 budget cycle, to adopt the digital web-platform called “Citizen Budget.

54. Rationale for the PA: Since 2014, the Government has taken positive steps to promote the transparency and integrity of the public administration. An important milestone was achieved with the adoption of a landmark Access to Public Information law (law 5282/2014) and the subsequent enactment of supporting regulations for its implementation (Decree 4064/2015). Recent innovations have significantly expanded access to fiscal information, such as the BOOST database of government expenditure, the Open Government Portal of the Ministry of Finance and the Open Contracting database of the National Directorate of Public Procurement (DNCP). Despite this progress, several institutional challenges remain that affect effective implementation of fiscal transparency and open data initiatives. Likewise, progress on fiscal transparency and accountability of public spending is undermined by limited


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institutionalized mechanisms available for the citizens to engage in the budget process and interact with government authorities in the monitoring of public spending.

55. Substance of the PA. According to OECD best practices, improving access to information alone does not translate necessarily into improvements in accountability in public spending. Providing opportunities for citizens and data users to engage throughout the budget formulation process can result in more effective accountability as – by being formally involved - citizens have a stronger incentive to request and use fiscal information. This PA will contribute to promote such institutional mechanisms, by supporting the production and publication of citizen budget (CB) for the 2020 budget cycle. The CB tool comprises a web-based Platform managed by the Ministry of Finance and an Open Source smart phone application (PresuppuestApp). More specifically, the CB makes the content of the public budget understandable and accessible to the citizens, thereby making information more actionable. It also allows users to rank their priorities, thus providing the Government with valuable information before making the final budget submission to Congress. The initial pilot of the CB (covering about 30 percent of the total budget) is expected to be scaled up to include the full Central Government budget by the 2021 budget cycle. This is expected to complement other ongoing reform initiatives that make it easier for citizens to access information on Government processes and procedures, and more effectively interact with public authorities.

56. Expected impact: The CB tools are expected to foster greater understanding among the population of how public money is being managed, by presenting budget information in a more accessible format and introducing citizens and civil society to the knowledge they need to participate as informed stakeholders and hold the Government accountable. The result indicator to track progress on this PA is the improvement on the country’s score (0-100) published every 2 years as part of the Open Budget Survey (OBS), from 11/100 in 2017 to 26/100 in 2021.

Indicative Trigger 9: To strengthen the country’s statistical system, the Borrower enacts the law that modernizes the National Statistics System and creates the National Institute of Statistics.

57. Paraguay operates under an outdated regulatory framework and without an institutional framework that coordinates and articulates the production and dissemination of official statistics. Together with El Salvador, Paraguay is one of the only two countries in the region without an independent Statistics Institute. The Statistics Office – created under a Decree issued in 1942, does not have the institutional hierarchy, financial autarky, and institutional autonomy required to effectively act as the normative authority within the statistical system, which involves 45 institutions in charge of producing about 300 statistical operations. Critical principles needed to ensure quality, transparency, and accountability - such as “statistical confidentiality” or “impartiality for the dissemination” - are absent from the current legislation. Without a well-articulated statistical system, the country’s ability to produce timely and impartial statistics to inform policymaking, promote transparency and accountability of the public sector, and monitor adherence to international commitments is greatly limited. The proposed trigger addresses these needs with a law that modernizes the National Statistical System (NSS) and creates the National Statistics Institute (NSI) following international standards. The draft law – already in place - was prepared in close consultations with the Bank.


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58. The establishment of a well-articulated National Statistics System and the positioning of the National Statistics Institute as a normative authority with enhanced independence is a significant step towards improving the country’s capacity to inform policy-making and safeguard trust in official statistics. The creation of the NSI is expected to have a positive impact on the ability of the Government to collect and monitor the main statistics of the country. Through the governance in the process of production of administrative records, the NSI will be able to report most of the SDG indicators, which are heavily dependent on administrative records. At the same time, an independent and autonomous NSI will be able to further enhance the monitoring of gaps between men and women to facilitate the design and formulation of public policies that help to move towards real and effective equity, as indicated by the IV National Equity Plan 2018-2024.

Table 4: DPL Prior Actions and Analytical Underpinnings

Prior Actions Analytical Underpinnings


Prior action 1 World Bank. 2019. Doing Business 2020; Paraguay Policy Notes (2018)

Prior action 2 IMF Customs Assessment TA report (with participation of the WB) (2018)

Pillar B: Promote economic growth that is more environmentally sustainable and resilient to climate-induced shocks

Prior action 3 Inclusive Forest Economy in Paraguay ASA (2018-2020); Cost of Environmental Degradation in Paraguay Study (2018); Systematic Country Diagnostics (2018)

Prior action 4 Inclusive Forest Economy in Paraguay ASA (2018-2020); Cost of Environmental Degradation in Paraguay Study (2018); Systematic Country Diagnostics (2018), Legal analysis to support the revision of the legal framework in the forestry sector in Paraguay, consultant background report (2019)

Prior action 5 Inclusive Forest Economy in Paraguay ASA (2018-2020); Cost of Environmental Degradation in Paraguay Study (2018); Systematic Country Diagnostics (2018); Diagnostic of the investment climate in forestry sector in Paraguay, consultant background report (2019)

Pillar C: Increase resilience through more efficient and accountable management of public resources

Prior action 6 Fiscal ASA; Poverty and Equity ASA (2015-2020); Paraguay Policy Notes (2018)

Prior action 7 FATF recommendations

Prior action 8 Public Expenditure Review (2018); Paraguay Policy Notes (2018)

Prior action 9 Paraguay Policy Report “Making Transparency Work for Development” (2018); Paraguay Policy Notes (2018); OECD Public Governance Reviews: Paraguay (2018); Systematic Country Diagnostics (2018)

4.3. LINK TO CPF, OTHER BANK OPERATIONS AND THE WBG STRATEGY


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59. The proposed EMDPL1 is the first in a series of two operations supporting the World Bank Group’s Country Partnership Framework (CPF) for Paraguay discussed by the Board on January 22, 2019. The CPF presented a shift in WBG engagement relative to previous strategies, with support to governance and institutional reforms at the center and a move towards environmental governance. In this context, the DPL was envisioned as an anchor instrument that if successful could enable the implementation of policy reforms needed for future while at the same time lending operations and strategic technical assistance interact together in different areas to be effective to strengthen engagement in key development areas in the country. The three pillars of the proposed DPL are directly linked to the first and second CPF Focus Areas - “Promoting accountable institutions and an improved business climate”, and “Reducing volatility, natural capital management and integration into sustainable value chains”, while contributing to CPF Focus Area 3 – “Building human capital”. Overall, the proposed operation directly contributes to 5 out of the 10 objectives stated in the CPF. It is also closely aligned with the priorities identified in the SCD, which highlighted the need to strengthen public institutions and the business climate, natural wealth management, quality of public services, and human capital, to make the development path more inclusive and sustainable. 60. The EMDPL series will be complemented by World Bank technical assistance and investment projects in Paraguay in the coming years. The World Bank is preparing an operation in rural development and another in forestry which will help increase market access of small farmers, while ensuring critical forests are protected and agriculture development is sustainable. A health project is pending Congress approval and a transport sector project is being prepared, both will help improve public management systems, efficiency of expenditures, and, in the case of transport, introduce e-tolling systems to partially recover investment costs. Among others, the World Bank is providing assistance to vulnerable population in peri-urban areas of Asuncion to increase community resilience, conducting a number of public expenditure reviews to identify critical issues and improve public expenditures in selected sectors and engaging in early childhood education to better target vulnerable children and improve quality of education system. These engagements provide important entry points for future operations and will benefit from important reforms fostered by the EMDPL series.

4.4. CONSULTATIONS AND COLLABORATION WITH DEVELOPMENT PARTNERS

61. The Government has undertaken consultations on the main measures supported by the EMDPL1. Public deliberation and participation have been an effective—and legally mandated—mechanism to work on overcoming polarization and increase political support for contested reforms. The legislative packages on taxation and business environment have both been subject to extensive consultations inside and outside the congress with the private sector to gather views and facilitate the articulation of the reform agenda. In particular, the legislative amendments that make foreign tax evasion a crime, are part of a larger package of laws which have been widely debated in different national and international forums since the GAFILAT mutual evaluation mission in November 2018. In the case of the Citizen Budget, a broad consultation process with citizens and civil society organizations is embedded in the design of the reform process itself: following the official launch of the CB platform by the Government in October 2019, formal consultations events were organized by the Ministry of Hacienda in four major cities in collaboration with Universities and local NGOs, and the citizens’ feedback integrated in the final CB report submitted by Hacienda to Congress.


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62. Collaboration with other Development Partners. The present operation contributes to a broader package of financial assistance developed under the CPF, under the overall guidance of MoF and in close coordination with international partners, including the IMF, CAF, the European Union (EU), Mercosur through its Structural Convergence Fund (FOCEM) and the Inter-American Development Bank (IDB). The PA on custom reforms has been designed following a joint IMF/WB custom assessment mission, which contributed to strengthen synergies and clarify respective roles and contributions to support reform in this area. The PA on business climate directly built upon an EU-funded TF that financed WB-led technical assistance over the past 2 years. The design and the dissemination of the Citizen Budget expands and upgrades a recent pilot developed by USAID to strengthen fiscal transparency in Paraguay.

5. OTHER DESIGN AND APPRAISAL ISSUES

5.1. POVERTY AND SOCIAL IMPACT

63. The poverty and social impact of the policies supported by the DPL is expected to be neutral or positive in the short run, and positive in the medium and long-term. The analysis looks into impact on poverty and distribution, as well as other social outcomes such as labor market outcomes and health. The assessment draws on quantitative analysis from household and firm level data, analytical works produced by WB teams through recent ASAs or TA, and a review of academic literature. The evaluation of the tax reform relies on a detailed incidence analysis based on a simulation tool produced for this purpose. Though not all actions have a direct impact on poverty or shared prosperity, overall the policies supported by the proposed operation are expected to contribute to a more sustained and inclusive development process. Reforms aimed at improving the enabling conditions for more resilient, private sector-led growth (Pillar A) are expected to facilitate private sector development, and ultimately lead to more and better-quality jobs, raising living standards. Policies aimed at promoting economic growth that is more environmentally sustainable and resilient to climate-induced shocks (Pillar B) are expected to have social benefits in the long-run and little effects in the short-run. Policies aimed at increasing resilience through more efficient and accountable management of public resources (Pillar C) are expected to ultimately result in better quality public service provision, which has been identified as a critical bottleneck in Paraguay for a more inclusive development path. A detailed analysis is presented in Annex 4. 64. Prior actions supported under the pillar A are expected to improve labor market conditions in the formal sector and small effects on poverty and inequality. Strengthening regulation to increase the efficiency and contestability of markets was one of the priorities identified in the SCD to promote more sustainable and inclusive growth, with indirect implications for poverty and inequality reduction through its positive impact on job creation, social cohesion, and the break of the self-reinforcing structural challenges of concentration, informality, and inefficient service provision (WB 2018). The simplified registration process supported under PA#1 has the potential to contribute to improved labor market conditions for the poor and vulnerable by promoting formal job creation among small and medium-sized firms. However, this policy on its own is unlikely to lift current barriers to formalization unless complemented with other policies such as those supported under DPL2.17 Furthermore, most poor work in micro-sized firms, which are less likely to benefit directly from this intervention. 17 See for example, Galiani et al. 2015; De Mel et al. 2013; McKenzie and Sakho 2010; Branstetter et al. 2014


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65. Prior actions supported under the pillar B are not expected to have any direct impact on poverty or inequality in the short term and may have neutral or positive social impacts in the medium term. The improved regulatory framework on managing forest resources (PA#3&4) will help protect the livelihoods of indigenous communities, small-scale producers and rural households who depend directly on forest ecosystems for subsistence (Da Ponte E. et al 2017). In the long-term, indirect effects from reduced exposure to climate change risks may bring substantial benefits for the poor. Additionally, the potential development of the commercial forestry sector supported under PA#5 may offer new employment opportunities to the poor, provided small landholders and rural households also benefit from the new business incentives (as the most immediate beneficiaries are expected to be large firms), or policies are in place to make sure good-quality employment is generated.

66. Prior actions supported under pillar C are expected to have neutral or positive poverty and social impacts in the short term, and overall positive effects in the medium and long term. Accountability of public institutions and the quality of public services were highlighted in the SCD as critical constraints towards a more inclusive and sustainable development path (WB 2018). The tax reform (PA#6) is not expected to have negative effects on poverty and should have a small but positive effect on income distribution in the short term. Contributors to the PIT belong to the top 30 percent of the distribution, and excise taxes will not be raised for a minimum of one year after the law comes into force. The separation between labor and capital income, together with the new dividend tax, is expected to have a positive albeit small impact on income inequality. In the medium term, the increase in excise taxes may have a marginally negative impact on poverty, while the creation of a simplified tax structure for small and medium enterprises may have positive indirect effects through potential formalization. Increased resources through higher collection (PA#6 & PA#8) and more efficient spending (PA#8), together with improved monitoring, transparency and accountability (PA#9) should set the basis for improved policy-making and service provision in the long term.

5.2. ENVIRONMENTAL ASPECTS 67. The prior action on coordinated forest monitoring (PA#3) is likely to have significant positive effects on the environment and forests. The National Forest Monitoring System (NFMS) will facilitate comparison of actual changes in land use to those permitted under the legal regime. This will provide a transparent and publicly accessible information base that will contribute to strengthening of the monitoring and enforcement capacity of environmental agencies, notably INFONA. It will also support compliance with the “zero deforestation” Law 6256/18 and Paraguay’s international climate commitments. The trigger on the creation of an interagency taskforce for forest fire prevention and response will also have positive impacts as it will increase the ability to plan and execute a more effective and coordinated response to forest fire alerts. 68. The prior action on forest law enforcement (PA#4) is likely to have significant positive effects on the environment and forests. The prior action introduces a series of improvements to the process of prosecuting forest infractions, namely: allowing the use of new technologies to collect evidence of the infraction; reducing the reliance on field agents to initiate proceedings; allowing INFONA to play a key role in collecting evidence of infractions; and creating an accelerated route for declaring infractions. This, in synergy with prior action #3, will allow faster law enforcement response. This is expected to have two effects: (i) prompt restoration of illegally-cleared forest; and (ii) eventually reduce illegal deforestation


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and pressure on carbon sinks, leading to a reduction in GHG emissions caused by land use change. The trigger on the amendment of Decree 175/18, which implements Art. 42 of the Forest Law, will also have positive effects as it will eliminate ambiguities in the definition of what constitutes a forest deficit. 69. The prior action on incentives to commercial forestry (PA#5) is likely to have significant positive effects on the environment and forests. The prior action will boost commercial forestry activities, and this will have two main effects. The first is an increase in timber biomass and carbon sinks in the areas where the plantations are located. Note that exotic timber species plantations are not likely to crowd out natural forests which are currently located either in remote rural areas of Western Paraguay (hence far from export routes) or in protected areas in the Eastern Paraguay. The second is a reduction in the domestic demand for wood biomass obtained from natural forests, leading in turn to reduced deforestation. The trigger on eliminating the export ban for logs of exotic timber species may have perverse effects on natural forests, particularly in the absence of effective custom controls. To avoid the loosening of timber export regulations resulting in leakage from the natural forest stock, INFONA is planning to institute in-situ controls of export-bound containers, require the containers to be sealed at the point of loading, and verify their weight at the point of loading and export. The Bank will provide technical assistance to further analyze and strengthen the export control regime and can provide investments in technology and training through the Paraguay Sustainable Production and Conservation Landscapes project (P171351). 70. Other prior actions, including the tax reform that raises the maximum rates on select excise taxes with negative environmental externalities (PA#6), are not expected to have significant positive or negative effects on the environment and forests. Although PA#6 includes an increase in the maximum excise tax levied on petroleum-based fuels, the evidence that a change or switch in fuel demand may occur as a result of this reform is weak. First, literature suggests that energy products tend to be relatively price inelastic and there is low substitution among alternative energy products (Galindo (2005), Labandeira et al (2017)). Second, petroleum-derived products are used predominantly in transport. According to the analysis of final energy consumption in 2017 conducted by the Vice Ministry of Mines and Energy, 93 percent of petroleum-derived products were used by the transport industry, where substitution for other fuel sources such as biomass is unlikely.

5.3. PFM, DISBURSEMENT AND AUDITING ASPECTS

71. Paraguay Public Financial Management (PFM) system is not fully aligned with international good practices as defined by the 2016 Public Expenditure and Financial Accountability (PEFA) Framework. According to the latest PEFA Assessment completed in 201618, Paraguay’s Public Financial Management (PFM) system shows improvement in some performance areas compared to the previous assessment19, namely: (i) government budget comprehensiveness and transparency, (ii) internal control, (iii) timeliness of preparation of government annual financial statements, (iv) public debt management, and (v) follow-up of external audit recommendations.

18 Evaluación PEFA de la Gestión de las Finanzas Públicas en Paraguay, Agosto 30 de 2016. Paraguay Public Expenditure and Financial Accountability Report PEFA. Document of the European Union, August 30, 2016. 19 Paraguay Public Expenditure and Financial Accountability Report (PEFA Repeat Assessment) December 2011. European Union, The World Bank and IDB.


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72. Major strengths of Paraguay PFM system are transparency of public finances and predictability and control in budget execution, while budget credibility and internal audit functions remain weak. Besides, management of public assets and policy-based fiscal strategy and budgeting also show some strength. However, substantial modifications of the approved budget regularly occur during the annual budget implementation stage. These reallocations often deviate from the originally approved budget, thereby hindering the credibility of the annual budget and undermining the PFM system’s capacity for efficient public service delivery. The internal control framework and internal audit function also lack effectiveness. Despite some progress, the PEFA Report states that Government internal control system is still limited in providing reasonable assurances that operations meet the main control objectives. Coverage of internal audit has been expanded to all Central Government entities; however, there is no evidence that internal audit activities meet professional standards including focus on high risk areas. 73. Financial reporting and audits have improved, while still facing shortcomings. Government consolidated annual financial reporting prepared by the Directorate of Public Accounting is submitted to the Legislative and the Auditor General by March 31 of the following year. These reports are comparable with the approved budget and include information on revenues, expenditures, and cash balances. However, the accuracy of information on assets and liabilities included in the financial statements has been challenged by the external auditor. Government financial statements are prepared following national financial accounting and reporting standards which are not fully consistent with International Public Sector Accounting Standards (IPSAS). External audit performance has slightly improved regarding submission of the audit report to the Legislative and follow-up of external audit recommendations, while audit coverage and standards aspects suggest the existence of gaps in relation to international best practices and indicate further opportunities for improvement.

74. Foreign exchange management. The Central Bank financial statements for the year 2018 were reviewed as part of the assessment. KPMG Uruguay carried out an audit on BCP’s 2018 financial statements following international auditing standards. An unqualified audit opinion was given by the auditors on BCP financial statements. Based on the review of the audited financial statements, there are no indications of risks other than a moderate element of risk arising from BCP control environment into which the loan proceeds will flow20. Since late 2016, the BCP has embarked in a project for adoption of International Financial Reporting Standards (IFRS) and modernizing information and technology systems infrastructure including the implementation of Integrated Financial Management Information System (IFMIS) with technical support from the Bank21.

75. Disbursement arrangements. The Bank would disburse the Loan proceeds to a US dollar account that forms part of the country's official foreign reserves at the Central Bank of Paraguay (BCP). Disbursements would be made upon the Bank's assessment of satisfactory compliance with prior actions agreed and with the adequacy of the Borrower’s macroeconomic policy framework. Disbursements will not be linked to any specific purchases and no procurement requirements would be needed. Upon receipt of the Loan disbursements, the Borrower will promptly account for the receipt of the loan in the country’s budget management system, so called SIAF-SICO, in an account used to finance budgeted expenditures and deposit an equivalent amount into a local currency bank account from which budgetary expenditures

20 The latest safeguards assessment of foreign reserves control environment of the Central Bank of Paraguay (BCP for its Spanish acronym) was performed in October 2006 and is outdated. 21 (P165552) PY BCP RAS II TA to support transitioning to IFRS and IFMIS Reimbursable Advisory Service (RAS)


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are paid. If the proceeds of the Loan or any part thereof are used for ineligible purposes, as defined in the Loan Agreement, the Bank will require the Borrower to refund an equivalent amount directly to the Bank. The deposit account in US dollars would be maintained at BCP and the local currency account, its transactions and balances fully incorporated into the Borrower’s accounting records and financial statements, via the financial management information system (SIAF-SICO).

76. Auditing. The Borrower trough the MoF will: (i) report, within one month from the date of receipt, the exact sum received into the Central Bank account; (ii) provide the Bank with written evidence that the Paraguayan currency (Guarani) equivalent of the Loan proceeds were credited to a local currency account, (iii) ensure that all withdrawals from said account were for budgeted public expenditures, excepting military expenditures or other items on the Bank’s excluded expenditure list; and (iv) the Bank will reserve the right to request an audit of the deposit account should the need arise.

5.4. MONITORING, EVALUATION AND ACCOUNTABILITY

77. The monitoring, evaluation, and results framework has been agreed with the Ministry of Hacienda (MoH), which has the responsibility to coordinate actions across relevant ministries and agencies involved in the operation. The agencies responsible for the implementation of the prior actions listed in the operation include: MoH; Customs; Secretary of Prevention of Money or Property Laundering (SEPRELAD); National Forestry Institute (INFONA); Central Bank of Paraguay (BCP); National Development Bank (BNF). Monitoring and coordination capacity is weak, and the participation of multiple agencies has been highlighted as a significant risk. The World Bank will maintain close dialogue with counterparts throughout preparation and collaborate with MoH for the monitoring of indicators. The results framework discussed with the government is presented in Annex 1. Most indicators rely on publicly available information.

78. Grievance Redress. Communities and individuals who believe that they are adversely affected by specific country policies supported as prior actions or tranche release conditions under a World Bank Development Policy Operation may submit complaints to the responsible country authorities, appropriate local/national grievance redress mechanisms, or the WB’s Grievance Redress Service (GRS). The GRS ensures that complaints received are promptly reviewed in order to address pertinent concerns. Affected communities and individuals may submit their complaint to the WB’s independent Inspection Panel which determines whether harm occurred, or could occur, as a result of WB non-compliance with its policies and procedures. Complaints may be submitted at any time after concerns have been brought directly to the World Bank's attention, and Bank Management has been given an opportunity to respond. For information on how to submit complaints to the World Bank’s corporate Grievance Redress Service (GRS), please visit http://www.worldbank.org/GRS. For information on how to submit complaints to the World Bank Inspection Panel, please visit www.inspectionpanel.org.

6. SUMMARY OF RISKS AND MITIGATION 79. The overall risk to achieving the operation’s development objective is assessed as Substantial. The major risks identified include: (i) political and governance; (ii) institutional capacity for

http://www.worldbank.org/GRS

http://www.inspectionpanel.org/


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implementation and sustainability; and (iii) sector strategies and policies. Risks will be monitored throughout preparation of the DPL series, and mitigation measures are put in place to reduce their impact. 80. Downside political and governance risks are considered Substantial as carrying through with reforms will require strong political consensus in a complex context. The government’s reform agenda is ambitious, and some prior actions involve traditionally sensitive areas, including customs, fiscal policy, forest law enforcement, and the pension system. While general consensus around priority areas has been built within and outside the Government, there is no complete agreement over specificities of reform plans despite intense consultation processes. Legislative measures need strong bipartisan support in Congress, and thus to overcome strong political divisions. There are also risks of delays in Congress for approving the Loan Agreement for this DPL. Moreover, the political capital of the current administration is now under growing pressure to deliver on its electoral promises, in a more challenging economic context of climate-induced and external shocks. The key mitigating factors against these risks are Government’s commitment to implementing important reforms in the remaining years of its term and the targeted approach to sequencing main reforms, also embedded in the programmatic approach of the proposed EMDPL series – can help to partially mitigate the political and governance risks. 81. The risk of institutional capacity for implementation and sustainability is Substantial, particularly as the series involve multiple agencies. Enacting sound laws is an important and necessary first step, but consistent implementation is required to translate legislation into implementation to bring about positive results. Limited institutional capacity has been a significant barrier to the implementation of previous WBG-financed operations in Paraguay. Intergovernmental coordination is weak, and the consensus building process is usually long, leading to delays in implementation. The implementation risks, which arise from the lack of resources, capacity constraints, resistance from special interest groups, changes in reform directions, could hinder the effective implementation of the reforms to legal frameworks and undermine the impact of the operation. Moreover, the lack of high-quality monitoring systems based on readily available data might complicate the implementation of sectoral reforms. Some prior actions directly address and mitigate risks arising from limited institutional capacity, including areas where interinstitutional coordination (such as procurement), or monitoring capacity (such as forest law enforcement and statistics system) are key for the achievement of the development outcomes. Most prior actions and indicative triggers are being complemented with a strong technical assistance program in order to mitigate these risks. Also, the programmatic design of the operation helps to partially mitigate some of the implementation and sustainability risks. 82. Achievement of the EMDPL objectives could also be adversely affected by inadequacies in sector strategies. Discrepancies between the legal and policy framework, the supporting ecosystem, communications and the sector leadership may reduce reform effectiveness. Policy reform implementation in key sectors could be affected by the strong vested interests. These risks are being partially mitigated by a strong technical assistance program that complements the EMDPL objectives.

Table X: Summary Risk Ratings


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Risk Categories Rating

1. Political and Governance Substantial

2. Macroeconomic Moderate

3. Sector Strategies and Policies Substantial

4. Technical Design of Project or Program Moderate

5. Institutional Capacity for Implementation and Sustainability Substantial

6. Fiduciary Moderate

7. Environment and Social Moderate

8. Stakeholders Moderate

9. Other

Overall Substantial

.


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ANNEX 1: POLICY AND RESULTS MATRIX

Prior Actions (PA) for the DPL1 Indicative Triggers (IT) for the DPL2 Result Indicators


PA1: To support the facilitation of business entry and the reduction of the cost of starting a business, the Borrower has enacted a law (No. 6480) creating the simplified joint-stock company type (EAS).

IT1: To further improve the business environment, the Borrower enacts laws on movable guarantees, insolvency, and credit bureaus.

Average number of days to register a business; Baseline: 35 (2018) Target: 18 (2022)

PA2: To support the improvement of risk management at the National Directorate of Customs and the reduction of foreign trade transactions costs, the Borrower: (a) through its Executive Branch, has amended the regulatory decree (No. 2908) of the Customs Code to eliminate desk review of customs declarations for goods submitted for physical inspection (red channel), and (b) through the SEPRELAD, has issued a resolution (No. 056) establishing interchange of information requirements to be complied with by the National Customs Directorate and the entities of the financial sector.

IT2: To further improve risk management at customs and reduce foreign trade transactions costs, the Borrower adopts customs’ post-clearance audit procedure regulations.

Average time for customs clearance: Baseline: 189 hours (2018) Target: 132 hours (2022)


PA3: To improve availability and quality of information to support forest management, the Borrower, through its Executive Branch, has adopted a decree (No. 3246) regulating the establishment of the main interinstitutional, financial and functional structures of the Borrower’s National Forest Monitoring System that collects and publishes remote sensing information on forests.

IT3: To improve coordination and response planning to forest fires, the Borrower approves a decree that creates a forest fire task force and puts in place protocols for multi-agency coordination and response.

Data on land use change is publicly available in online data portals; Baseline: No (2018) Target: Yes (2022) Response time to forest fire alerts; Baseline: 1 week (2018) Target: 1 day (2022)

PA4: To support the increase in the efficiency of enforcement of the forest legislation, the Borrower, through its Executive Branch, has updated the regulations (Decree No. 3312 and Resolution INFONA 094/2020) on the regime of forest offenses, forest sanctions and the administrative proceedings for violations of forest legislation.

IT4: To facilitate the forest law enforcement, the Borrower amends decree to eliminate inconsistencies in the definition of the forest deficit and exceptions to the obligation to maintain the legal forest reserve.

Annual number of proceedings (initiated / with a ruling) by INFONA for alleged violations of Article 2 of Resolution 094/2020; Baseline: 203/51 (2019) Target: 300/75 (2022)

PA5: To facilitate access to credit for the forestry sector: (a) the Development Finance Agency has issued resolutions (AFD No. A68R01F140819 and AFD No.A11R02F060220) that modified the

IT5: To increase investment incentives for commercial afforestation and reduce market distortions, the Borrower enacts an amendment to

Volume of loans extended for commercial forest plantations; Baseline: US$0 million (2018) Target: US$5


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credit line for commercial afforestation removing both the ceiling for maximum loan amounts and the explicit requirement to put the land on which the pertinent forest project is based as a collateral, and (b) the National Development Bank has issued a resolution (BNF No. 4-94) that created a credit line for commercial afforestation.

the law to remove prohibition of export of exotic (non-native) species’ roundwood.

million (2022) Exports of exotic timber logs and beams Baseline: 0 cubic meters (2018) Target: 90,000 cubic meters (2022)


PA6: To simplify and modernize its tax system, the Borrower has enacted a law (No. 6380) that limits deductions in the personal income tax (PIT), creates a separate Dividend and Profits tax, unifies corporate profit tax and agriculture profit tax, and raises maximum rates on select excise taxes on products with negative environmental externalities.

Index of real value of revenue from direct taxes: Baseline: 100 (2018) Target: 130 (2022)

IT6: To support sustainability and improve countercyclicality of fiscal policy, the Borrower enacts a law amending the fiscal responsibility law.

Annual growth of real current primary expenditure of central administration; Baseline: 4.7% (2018) Target: below 3% (2022)

PA7: To support the facilitation of reduction of tax evasion, the Borrower has amended the Criminal Code (Law No. 6452) to criminalize money-laundering of assets obtained from tax evasion.

Report on risks of money laundering from tax evasion is completed; Baseline: No (2018) Target: Yes (2022)

IT7: To enhance sustainability and equity of social security, the Borrower enacts a law to improve asset allocations of pension funds and initiates parametric changes of the public sector’s pension schemes.

Percentage of total assets of Paraguay’s pension funds invested in local government securities; Baseline: 0% (2018) Target: 5% (2022)

PA8: To support the improvement of public procurement, the Borrower, through its Executive Branch, has issued a decree (No. 2992) that simplifies and consolidates the Borrower’s procurement regulatory framework and promotes centralization of public procurement of goods and services.

IT8: To operationalize consolidation of public procurement, the Borrower signs at least 5 inter-agency agreements to concentrate the purchase of recurring high-cost and low complexity goods and services.

Average number of bidders per procurement process: Baseline: 2.55 (2018) Target: 4 (2022)

PA9: To support budget transparency, the Borrower, through the Minister of Finance, has issued a resolution (M.H.N. No. 20 and M.H.N. No. 21), to be applicable as from the 2020 budget cycle, to adopt the digital web-platform called “Citizen Budget”.

Score of the Open Budget Index: Baseline: 11/100 (2017) Target: 26/100 (2021)

IT9: To strengthen the country’s statistical system, the Borrower enacts the law that modernizes the National Statistics System and creates the National Institute of Statistics.

Percentage of the SDG indicators produced; Baseline: 20% (2018) Target:38% (2022) Percentage of the SDG indicators on gender produced; Baseline:38% (2018) Target: 57% (2022)


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Percentage of the SDG indicators on environment produced; Baseline: 16% (2018) Target: 25% (2022)


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ANNEX 2: FUND RELATIONS ANNEX


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ANNEX 3: LETTER OF DEVELOPMENT POLICY


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(Translated Version)

Asunción, February 13, 2020 MH No.: 98 MR. DAVID MALPASS, PRESIDENT, WORLD BANK WASHINGTON, DC 20433 UNITED STATES OF AMERICA Dear President Malpass, I am pleased to write to you to outline the measures and actions being taken by the Government of President Mario Abdo Benítez, and in particular by this ministry, to successfully meet the significant challenge posed by the implementation of the projected development plans. In this regard, arrangements are being made with the World Bank Group for a Development Policy Loan through the International Bank for Reconstruction and Development (IBRD). It includes commitments to introduce major changes aimed at strengthening and contributing to Paraguay’s social and economic development. Paraguay’s 2030 National Development Plan (NDP) is a strategic instrument that coordinates public policies and will guide economic, social, and international policies in such a way as to achieve the country’s development objectives by 2030. The main aim is to build a diversified and competitive economy based on the sustainable use of Paraguay’s natural wealth and an increase in the inflow of knowledge through the development of human capital and the gradual use of state-of-the-art technologies. The 2030 National Development Plan guides the government’s short-, medium-, and long-term actions and thus provides a framework for objectives by establishing a nexus among three strategic pillars that facilitate linkage of the government’s policies and actions, namely (i) reducing poverty and achieving social development as they relate to the capacity of the Paraguayan society to meet the basic human needs of its citizens and communities; (ii) making economic growth inclusive with the aim of accelerating the pace of growth and productive diversification by promoting the participation of all economic agents and sharing the dividends of growth primarily with the bottom 40 percent of the population; and (iii) achieving the global integration of Paraguay in an appropriate manner by striving to position the country and improve its image, increase national participation in integration processes and international forums, and enhance resource allocation and the inflow of knowledge. Inclusive economic growth is one of the main strategic pillars of the 2030 NDP, which seeks to accelerate the pace of growth and productive diversification by promoting the participation of all economic agents and sharing the dividends of growth primarily with the bottom 40 percent of the population. As a result, a new Country Partnership Framework with the World Bank Group has also been prepared for the 2018-2023 period in which three focus areas for World Bank Group assistance are identified: (i)


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promoting accountable institutions and improving the business climate; (ii) reducing volatility and strengthening the management of natural capital and the rural economy; and (iii) building human capital. To carry out these actions, the Country Partnership Framework includes initiatives to foster an improved business climate that facilitate a reduction in the time and cost of starting a business and gaining easier access to credit, which will mainly benefit small businesses, promote access by smallholder farmers to markets and protect them from climate events, provide universal access to primary health care for the most vulnerable groups, increase public expenditure on social development, as well as reduce unequal access to the education system and improve learning outcomes for Paraguayan students.

This Development Policy Loan consists of a programmatic series of two operations, the policy support reform measures of which are aimed at reducing Paraguay’s vulnerability to external shocks and are focused on (i) improving the enabling conditions for more resilient private sector-led growth; (ii) promoting economic growth that is more environmentally sustainable and resilient to climate-induced shocks; and (iii) increasing resilience through more efficient and accountable management of public resources. The implementation areas of the Development Policy Loan are presented below. In particular, the Government of Paraguay wishes to bolster the recent progress made, which is supported by three key pillars. Improving the enabling conditions for more resilient private sector-led growth The proposed reforms in this pillar are aimed at creating enabling conditions for more resilient private sector-led growth. The country faces major challenges with improved competitiveness in every productive sector. Enterprises in Paraguay face multiple barriers and competitiveness challenges when conducting business, in the absence of a healthy competitive environment that promotes enterprise and productivity growth. It should be noted that the lowest rankings obtained by Paraguay in Doing Business 2020 were in the areas of starting a business and trading across borders—160 and 128, respectively. To help facilitate business entry and reduce start-up costs, Law No. 6480/20 “starting businesses through streamlined actions” was promulgated. It creates a new model for legal entities with a view to promoting the formalization, streamlining, and modernization of administrative management. It is hoped that the implementation of comprehensive business registration reforms will lead to fewer bureaucratic entry barriers and encourage the formal registration of businesses and that the streamlining of the registration process will largely benefit small and medium enterprises. Inefficient border controls are among the obstacles to starting a business. Improvement in this area aimed at managing risks associated with customs inspections will inspire greater confidence and thus promote trade facilitation. Decree No. 2908/19 was implemented to help the National Customs Directorate better manage risks and reduce foreign trade transaction costs. It amends the Customs Code Regulatory Decree by eliminating the review of customs declaration documents for merchandise presented for physical inspection. In addition, Resolution No. 056/19 establishing the information requirements to be met by the National Customs Directorate and financial sector entities was issued through SEPRELAD.


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Promoting economic growth that is more environmentally sustainable and resilient to climate-induced shocks Over the past decade, the policy framework and economic fundamentals have been strengthened. The adoption of sound policies and structural reforms in recent years has boosted the potential growth rate. The goal of this pillar is to promote an economic growth path that is more environmentally sustainable and resilient to climate-induced shocks by strengthening natural resource management in the agricultural and forestry sectors. Decree No. 3246/20 was approved with the aim of improving the availability and quality of information to support forest management. It regulates the establishment of the main interinstitutional, financial, and functional structures of the National Forest Monitoring System, which compiles and periodically publishes information on the national forest cover in a way that is measurable, verifiable, and comparable with other geographic information systems, and provides parameters and information that facilitate determination of the carbon content stored in national forests and the qualitative and quantitative classification of the forests species in national forests. High levels of deforestation have led to significant carbon sink loss. The provisions of Decree No. 175/18 stipulate that non-compliance with Law No. 422/73 and forest deficits on private land give rise to the obligation to (i) reforest an area equivalent to five percent of the property owner’s land area; (ii) restore the forest cover; or (iii) purchase environmental services certificates. Decree No. 1743/14 establishes the framework to address forest law infractions. Administrative proceedings related to forest infractions tend to last between 7 and 12 months and have rarely resulted in decisions or judicial orders to make up forest deficits. Consequently, with the aim of strengthening the sanctioning of forest law infractions, Decree No. 3312/20 amends Decree No. 1743/14 and vests the National Forestry Institute (Instituto Forestal Nacional INFONA) with the authority to establish guarantees and procedures related to administrative proceedings and issue implementing regulations by means of an institutional resolution that will introduce a number of updates to the system as well as innovations intended to make its enforcement more effective, including identifying and taking action with respect to forest infractions in a centralized and transparent manner. Significant potential nonetheless exists in Paraguay, within a suitable framework, for the forestry sector to generate inputs for forestation and export that pose a low risk in terms of the conversion of native forests, given the protections in place and their remoteness relative to the timber markets. The sector does, however, face a weak investment climate and limited access to credit and markets, which create significant distortions in its markets. To facilitate access to forest sector credit, the Financial Development Agency (Agencia Financiera de Desarrollo AFD) issued Resolution No. A68R01F140819 amending the Proforestal line of credit for commercial forestation, eliminating the ceiling for individual credit, and removing the obligation to include, by way of guarantee, the land on which a project is to be developed, thus allowing investors who rent land to have access to credit. In addition, Resolution A11R02F060220 extends the validity of Proforestal indefinitely, until all funds are used. Furthermore, the National Development Bank (Banco Nacional de Fomento BNF) issued Resolution No. 4 Record 94, which creates a line of credit for commercial


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forestation. These measures are aimed at creating more favorable loan conditions for potential commercial forestation investors. The Proforestal product is part of a long-term commitment by the Government of Paraguay to promote the development of an economically and financially sound forest economy. Increasing resilience through more efficient and accountable management of public resources The efficient and accountable management of public resources through reforms aimed at reducing vulnerability to different shocks will facilitate improved public sector performance so as to support fiscal policy sustainability and improve social security efficiency and equity. Law No. 6380/19 was promulgated with the aim of streamlining and modernizing the country’s tax system. It limits the deductions on personal income taxes and creates a separate tax on dividends and profits, combines the tax on enterprise profits with the tax on agricultural profits, and increases the maximum rates for certain special taxes associated with negative environmental externalities. It is hoped that with this new law, the number of taxpayers in the system will rise significantly, tax collection will increase, incentives will be provided for the formalization of small businesses, and the tax base will be expanded. To support efforts to comply with anti-money laundering/countering the financing of terrorism (AML/CFT) guidelines and facilitate the reduction of tax evasion, Law No. 6452/19 was promulgated to classify the laundering of money derived from tax evasion as a crime. Enforcement of this law is aimed at strengthening institutional capacity to assess the money laundering risks associated with tax evasion. It should be noted that this reform is part of a package of 12 laws that were passed in order to strengthen AML/CFT measures, in preparation for GAFILAT evaluation. Decree No. 2992/19 was issued to support improved public procurement. It streamlines and consolidates the regulatory procurement framework for borrowers and promotes the centralized public procurement of goods and services. This legislation is intended to simplify public procurement processes and practices, promote fiscal savings, and introduce new practices that better reflect international guidelines so as to improve the quality-price ratio with respect to procurement contracts by leveraging government demand. The Government adopted positive measures as far back as 2014 to foster public administration transparency through the passage of Law No. 5282/14 on Access to Public Information. Access to information cannot be improved without the extensive and active participation of citizens and users. Consequently, and with the aim of encouraging fiscal transparency and public expenditure accountability, the Ministry of Finance issued Resolution No. 20 and Resolution No. 21 on the design and dissemination of the Citizens’ Budget via a web-based platform and other digital solutions for the 2020 budget cycle and subsequent years. From a medium-term perspective, the Government of Paraguay will monitor and deepen the reforms undertaken in the context of the loan. With regard to the first pillar, it suggests moving forward with reforms so as to further improve the business climate and customs-related risk management and reduce foreign trade transaction costs. Similarly, the Government has set the objective of continuing to strengthen institutional capacity for forest monitoring and increasing investment incentives in the commercial forestry sector. In order to further improve public resource management, the Government


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will implement tax system, AML/CFT, public procurement, and Citizens’ Budget reforms. These efforts will be supplemented by reforms in such areas as fiscal accountability, social security, and the statistical system. In light of the foregoing, the Government of Paraguay considers it necessary and appropriate to receive World Bank assistance to move forward with the actions mentioned above and strengthen the gains made with the ambitious strategic development objectives outlined by the Government. Very truly yours, BENIGNO LÓPEZ Minister of Finance


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ANNEX 4: ENVIRONMENT AND POVERTY/SOCIAL ANALYSIS TABLE Prior Actions Significant positive or negative environment

effects Significant poverty, social or distributional effects positive or negative


PA1. Business registration

No significant effect. No significant impact on poverty or income distribution in the short term. Potential positive distributional effect in the medium to long term through improved labor market outcomes when combined with policies supported under DPL2. If benefits materialize, potential positive gender impact, as informal and micro-sized firms have significantly higher shares of female employees.

PA2. Customs No significant effect. No significant direct effects. In the medium term, potential positive indirect effects from increased revenue collection (relaxing the government’s constraint to invest in human and physical capital), and potential job creation through improved business climate (provided lower export costs encourage export diversification, as the current export industry is very capital intensive).


PA3. Coordinated forest monitoring

Significant positive effect. Coordinated forest monitoring, using remote sensing, will provide relevant and transparent information to enforcement authorities. The prior action will have positive synergies with prior action #4. The prior action will also favor access to forest cover change information to the broader public, favoring civil society engagement on forest issues.

No significant direct effects on poverty and inequality in the short run, but potential beneficial social effects in the long-run through job creation, protection of natural environments of indigenous and rural communities, and reduced vulnerability to climate change risks.

PA4. Forest law enforcement

Significant positive effect. The prior action introduces improvements to the process to prosecute forest infractions, providing a stronger tool to curb illegal deforestation and reduce land use change GHG emissions and encourage restoration of illegally-cleared forest

PA5. Incentives to commercial forestry

Significant positive effect. The prior action will favor plantation of exotic timber species, and hence increase carbon sinks, and decrease pressure on natural forests to meet the domestic demand for wood biomass.


PA6. Tax reform No significant effect. Small but positive effect on income distribution in the short term. In the medium to long term, the increase in excise taxes can have a marginally negative effect on poverty while increased revenues can potentially result in


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improved conditions for the poor and vulnerable. The simplification in the tax system for small and medium enterprises may have a positive indirect effect in the medium term through potential formalization.

PA7. Tax evasion No significant effect. No significant poverty or social effects.

PA8. Public procurement

No significant effect. No significant poverty or social effects in the short-term. In the medium to long term, these policies have the potential to improve the welfare of the poor and vulnerable by improving public services and increasing fiscal savings.

PA9. Citizen budget

No significant effect. No significant effects.

POVERTY AND SOCIAL IMPACT ASSESSMENT (PSIA)

1. The analysis focuses on the effects of the prior actions on poverty and income inequality, as well as the potential impact on additional welfare indicators such as labor market outcomes or human capital, among others. The analysis is based on analytical work produced by WB teams through recent ASAs or TAs, and a literature review from academic journals and reports from international organizations. The evaluation of the tax reform relies on a detailed incidence analysis based on a simulation tool produced for this purpose. Pillar A: Improve the enabling conditions for more resilient, private sector-led growth

PA1. Business registration

To support the facilitation of business entry and the reduction of the cost of starting a business, the Borrower has enacted a law creating the simplified joint-stock company type (EAS).

2. By facilitating firm creation and formal employment, this PA has the potential to contribute to improved labor market conditions. Firms can affect labor outcomes through three channels: starting new business, expanding existing businesses, or improving productivity (which should eventually result in increased returns to labor). To the extent that the burden of the business registration process is a deterrent to the creation of firms, and/or informality is a barrier to firm and productivity growth, the law has the potential to improve labor outcomes through all the three channels. The potential formalization of employment also brings additional direct benefits to workers through access to social insurance benefits and improved health services.22 According to the 2011 Firm Census, unregistered informal firms account for about 40 percent of firms in Paraguay. The simplification and streamlining of the business registration process is expected to disproportionally benefit small and medium enterprises, which account for about a quarter of firm jobs.23 Finally, it may also have a broader impact on the development of the

22 Employment registration brings access to benefits such as protection in case of illness, work-related accidents, occupational diseases, and maternity leave. It also grants access to a separate network of health services that has much better service-to-patient ratios than the overcrowded public system. It also gives access to a pension. 23 About half are employed in micro-sized firms (<10 employees), and the other quarter in large firms (>100 employees). While most informal firms are micro or small, a non-trivial share of informal firms is large (Jobs report based on 2011 Firm Census).


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private sector. Informality can pose a big cost to the economy by sustaining an inefficient allocation of resources (Hsieh and Klenow 200924; Levy 200825). Consistent with this evidence, the 2018 Enterprise

survey in Paraguay identifies the informal sector as one of the three most important obstacles for firms, a raking that holds across all firm sizes. Notes: own calculations based on EPH 2018. Sample excludes public employees, domestic workers, and workers in updaid jobs. Informality measured at the worker level (by whether they contribute to social security) is higher but follows the same income gradient.

3. Individuals at the lower-end of the income distribution stand more to gain from the formalization process. The incidence of job informality follows a clear income gradient, going from 95 percent among those in the first decile to 18 percent among those in the top decile of the income distribution (Figure 1). Firm size also correlates with the position of the worker along the distribution, with workers in the B40 more likely to work in unipersonal or micro-sized firms (Figure 2). It should be noted, however, that in order for the policy to benefit the poor the regulation has to reach micro-sized firms. In that case, the law may also have a differential effect on the quality of female employment as women are over-represented in informal micro-sized firms (Ruppert Bulmer and Scutaru 201826). 4. However, this intervention on its own is not expected to have significant direct effects on the labor market. Cross-country correlational evidence shows a strong relationship between costly entry regulations on one hand, and the size of the informal sector or the creation of limited liability companies on the other (Djankov 200227; Klapper et al. 200628). However, causal evidence shows mixed results. Evidence from Mexico and Brazil suggest that lowering entry costs can result in the creation of new firms

24 Hsieh, C. and Klenow, P.J. (2009). “Misallocation and Manufacturing TFP in China and India,” Quarterly Journal of Economics, 124(4), pp. 1403-1448. 25 Levy, S. (2008). "Good Intentions, Bad Outcomes: Social Policy, Informality and Economic Growth in Mexico", Washington: Brookings Institution Press. 26 Ruppert Bulmer and Scutaru, 2018. Firm productivity and employment in Paraguay 2010-2014. Jobs Working Paper No19. The World Bank. 27 Djankov, S. (2002). “The Regulation of Entry”. Quarterly Journal of Economics, 117(1), pp. 1-37. 28 Klapper, L., Laeven, L. and Rajan, R. (2006). “Entry Regulation as a Barrier to Entrepreneurship.” Journal of Financial Economics, 82(3), pp. 591-629.

0%

20%

40%

60%

80%

100%

D1 D2 D3 D4 D5 D6 D7 D8 D9 D10

Unipersonal Micro (2-10)

Small and Medium (11-100) Large (>100)

Figure 12. Distribution of workers across firm size, by income decile

0%10%20%30%40%50%60%70%80%90%

100%

D1 D2 D3 D4 D5 D6 D7 D8 D9 D10

Formal firm Don’t know Informal firm

Figure 21. Distribution of workers across formal/informal firms, by income decile


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and increased formal employment in select industries (Bruhn 201129; Monteiro and Assunção 201230; Fajnzylber et al. 201131). However, other studies point to the existence of other – more binding – barriers or the lack of tangible benefits to formalization to explain why firms remain informal following the lowering of registration costs (Galiani et al. 201532; De Mel et al. 201333; McKenzie and Sakho 201034). The characteristics of those that register as a result of the reform also explain why benefits may be temporary (Branstetter et al. 201435). In the case of Paraguay, rigidities in labor regulations can be a significant obstacle to formal employment, and low productivity levels would make impossible for the majority of informal firms to comply with labor regulations (Ruppert Bulmer and Scutaru 2018).36 The Doing Business Indicators shows that Paraguay’s distance to frontier is greatest for credit access, resolving insolvency, and protecting minority investors, followed by enforcing contracts and paying taxes (WB 201837). The distance to frontier for starting a business, while large, is the smallest among all indicators. 5. The full business package expected to be enacted under DPL2 is projected to result in more significant impacts for the poor and vulnerable. The triggers proposed for the second operation tackle complementary barriers and – jointly - constitute a significant step towards relaxing constraints to private sector development. Evidence shows that financing obstacles are more growth-constraining for small firms, and overall business environment is probably the most effective way of relaxing SMEs growth constraints (Beck and Demirguc-Kunt 200638). Similarly, collateral registries for movable assets have been found to increase firms’ access to bank financing particularly among smaller and younger firms (Love et al. 201339). In Paraguay, only 28 percent of MIPIMES have access to formal credit.

PA2. Customs

To support the improvement of risk management at the National Directorate of Customs and the reduction of foreign trade transactions costs, the Borrower: (a) through its Executive Branch, has amended the regulatory decree of the Customs Code to eliminate desk review of customs declarations for goods submitted for physical inspection (red channel), and (b) through the SEPRELAD, has issued a resolution establishing interchange of

29 Bruhn, M. (2011). "License to sell: the effect of business registration reform on entrepreneurial activity in Mexico". The Review of Economics and Statistics, 93(1), pp. 382–386. 30 Monteiro, J. and Assunção, J. (2012). “Coming Out of the Shadows? Examining the Impact of Bureaucracy Simplification and Tax Cut on Formality in Brazilian Microenterprises.” Journal of Development Economics, 99(1), pp. 105-115. 31 Fajnzylber, P., Maloney, W. and Montes-Rojas, G. (2011). “Does Formality Improve Microfirm Performance? Evidence from the Brazilian SIMPLES Program.” Journal of Development Economics, 94, pp. 262-276. 32 Galiani, S., Melendez, M., and Navajas, C. (2015). “On the Effects of the Costs of Operating Formally: New Experimental Evidence”. National Bureau of Economic Research. Working Paper 21292. 33 De Mel, S., McKenzie, D., and Woodruff, C. (2013). “The Demand for, and Consequences of, Formalization among Informal Firms in Sri Lanka”. American Economic Journal: Applied Economics, 5(2), pp. 122-150. 34 McKenzie, D., and Sakho, Y.S. (2010). “Does it Pay Firms to Register for Taxes? The Impact of Formality on Firm Profitability.” Journal of Development Economics, 91(1), pp. 15-24. 35 Branstetter, L., Lima, F., Taylor L.J., and Venancio A. (2014). "Do Entry Regulations Deter Entrepreneurship and Job Creation? Evidence from Recent Reforms in Portugal". The Economic Journal, 124(577), pp. 805–832. 36 Over half of formal firms and the majority of informal firms have average productivity levels below the minimum wage. 37 World Bank 2018. Paraguay Systematic Diagnostic. 38 Beck, T., and Demirguc-Kunt, A. (2006). “Small and medium-size enterprises: Access to finance as a growth constraint”. Journal of Banking and Finance, 30 (2006), pp. 2931-2943. 39 Love, I., Peria, M.S.M., and Singh, S. (2013). “Collateral Registries for Movable Assets: Does their Introduction Spur Firms’ Access to Bank Financing”. Journal of Financial Services Research, 2013:2, pp. 1-37.


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information requirements to be complied with by the National Customs Directorate and the entities of the financial sector

6. The supported measures aimed at improving risk management and reducing foreign trade transaction costs are not expected to have a direct impact on the poor and vulnerable in the short-term. These measures are expected to foster export performance by improving trade efficiency at the border, which currently constitutes an important constraint to doing business in Paraguay. While there is evidence suggesting that trade facilitation can have a positive impact on poverty and inequality (McCulloch et al. 200140, Nguyen-Viet 201541), it is mostly large firms that are expected to benefit from these policies (Tambunan 201342). Evidence on the challenges that the poor face to fully benefit from trade facilitation policies are also highlighted in WB and WTO 201543. These observations are particularly valid in the context of Paraguay, whose export industry is largely concentrated in capital-intensive agricultural products (WB 2018). By design, the supported policies are expected to benefit big firms who trade more frequently, and therefore the potential benefits from increased employment opportunities among low-skilled workers are not expected to materialize in the short-term. To the extent that these measures are effective at improving control of illegal trafficking in the medium term, the potential increased in revenue collection will help loosen the government’s resource constraints. If well targeted, these could increase social investments and the quality of public services delivered for the poor and vulnerable. Pillar B: Promote economic growth that is more environmentally sustainable and resilient to climate-induced shocks

PAs 3, 4 & 5. Incentives to commercial forestry, Coordinated forest monitoring and fire response, and Forest law enforcement

PA3. To improve availability and quality of information to support forest management, the Borrower, through its Executive Branch, has adopted a decree regulating the establishment of the main interinstitutional, financial and functional structures of the National Forest Monitoring System that collects and publishes remote sensing information on forests.

PA4: To support the increase in the efficiency of enforcement of the forest legislation, the Borrower, through its Executive Branch, has updated the regulations on the regime of forest offenses, forest sanctions and the administrative proceedings for violations of forest legislation.

PA5. To facilitate access to credit for the forestry sector: (a) the Development Finance Agency has issued resolutions that modified the credit line for commercial afforestation removing both the ceiling for maximum loan amounts and the explicit requirement to put the land on which the pertinent forest project is based as a

40 McCulloch, N., A. Winters, and X. Cirera. (2001). “Trade Liberalization and Poverty: A Handbook.” London: Centre for Economic Policy Research. 41 Nguyen-Viet, C. (2015). “The impact of trade facilitation on poverty and inequality: Evidence from low- and middle-income countries.” The Journal of International Trade & Economic Development. Vol. 24, Iss. 3. 42 Tambunan, T.T.H. (2013). “Ongoing trade facilitation and poverty reduction in Asia and the Pacific: A case study of a South Asian Economic Corridor”, Chapter 7 in “Impacts of trade facilitation measures on poverty and inclusive growth: Case studies from Asia”. A Study by the Asia-Pacific Research and Training Network (ARTNet). Edited by Ravi Tarnayake, Rajan Sudesh Tarna, Martina Francesca Ferracane and Yann Duval. United Nations Publications. 2013. 43 World Bank and World Trade Organization (2015). “The Role of Trade in Ending Poverty.” World Trade Organization, Geneva.


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collateral, and (b) the National Development Bank has issued a resolution that created a credit line for commercial afforestation.

7. PAs 3, 4 and 5 are not expected to have direct effects on poverty and inequality in the short-run but can have beneficial social effects in the long-run. These actions constitute a substantive package that offers a combination of monitoring and enforcement for the protection of native forest, and incentives to develop the commercial forestry sector. It is well documented that forests matter for the livelihoods of those around it. Globally, it is estimated that about 1.3 billion people – or about 1/5 of the global population – benefit from forest-related activities either directly or indirectly (WB 201644). In Paraguay, FAO 2014 estimates that in 2011 there were about 300,000 individuals working either formally or informally in the forestry sector (Szulecka J. and Zalazar E.M45). The proposed measures can have a potentially positive impact in the medium to long term through three channels: direct employment opportunities (mostly through PA5); protection of the natural environment of indigenous and rural populations through more effective monitoring and enforcement systems; and reduced vulnerability to environmental risks due to climate change. Regarding the first channel, the most immediate beneficiaries of credit incentives are relatively large firms, as up-front investment costs are substantial and project cycles are long. Therefore, the impact on poverty reduction will depend on the degree to which small landholders and rural households benefit from these incentives. As highlighted in the Systematic Country Diagnostic, Paraguay is characterized by high levels of concentration in multiple dimensions, and the development of the agriculture sector already shows how progress can develop into a dual economy – with a prosperous capital-intensive agriculture on the one hand and relatively stagnant family agriculture on the other (WB 201846). Commercial forestry – mostly timber – is not a labor-intensive industry, and plantation forestry, while more promising in terms of employment, needs to be accompanied with the promotion of good plantation practices (WB 2016), and protection against exploitation and market power (Mayers 200647). Evidence suggests that developing smallholder plantations and tree planting can generate significant impacts on reducing poverty (WB 2016), but policies should be put in place to promote it. The conservation of natural habitats, on the other hand, is expected to have direct benefits on rural and indigenous communities. A small-scale study in Eastern Paraguay shows how rural households depend heavily on the forest ecosystem for subsistence, and the current deforestation process is threatening their environments (Da Ponte et al. 201748). Evidence on the impact of forest conservation policies in Bolivia and Mexico shows either positive or neutral impacts on poverty (Canavire-Bacarreza and Hanauer 201349, Alix-Garcia et al. 201250), suggesting that conservation efforts need not come at the cost of poor communities. Finally, to the extent that the development of the forestry sector takes-off and brings environmental benefits through reduced exposure to climate change risks, the poor

44 World Bank (2016). World Bank Group. Forest action plan FY16-20. Washington: World Bank; 2016 45 Szulecka J., Zalazar E.M. (2017), “Forest plantations in Paraguay: historical developments and a critical diagnosis in a SWOT-AHP framework”. Land Use Policy, 60, pp. 384-394. 46 World Bank (2018). Paraguay Systematic Country Diagnostic. 47 Mayers 2006 "Poverty Reduction through Commercial Forestry. What evidence? What prospects?". The Forest Dialogue Research Paper, 2, Yale University 48 Da Ponte, E., Kuenzer, C., Parker, A., Rodas, O., Oppelt, N., and Fleckenstein, M. (2017), “Forest cover loss in Paraguay and perception of ecosystem services: a case study of the Upper Parana Forest”. Ecosystem Services, 24, 2017, pp 300-212 49 Canavire-Bacarreza, G. and Hanauer, M. (2013). "Estimating the Impacts of Bolivia’s Protected Areas on Poverty", World Development Vol. 41, pp. 265–285 50 Alix-Garcia, J., Sims, K., Yanez-Pagans, P., Radeloff, V., and Shapiro, E. (2012). "Two-Dimensional Evaluation: The environmental and socioeconomic impacts of Mexico's payments for hydrological services program".


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and vulnerable have a lot to gain. Agricultural households – which are at high risk of being poor – report high exposure to natural disasters, and their most common coping strategies (selling assets and reducing food consumption) perpetuate their status and have significant consequences for the human capital accumulation of their children (WB 2018). Estimations suggest that climate change will have important consequences on the productivity of the agricultural sector in Paraguay (WB 2018), and this will translate into lower household income and increased vulnerability to food insecurity (Ervin and Gayoso 201951). Pillar C: Increase resilience through more efficient and accountable management of public resources

PA6. Tax reform

To simplify and make the tax system more efficient, the Borrower has, through the President, enacted a law that limits deductions in the personal income tax (PIT), creates a separate Dividend and Profits tax, unifies corporate profit tax and agriculture profit tax, and raises maximum rates on select excise taxes on products with negative environmental externalities.

8. The tax reform is expected to have a small but positive effect on income distribution in the short term. In the medium to long term, the increase in excise taxes can have a marginally negative effect on poverty while increased revenues can potentially result in improved conditions for the poor and vulnerable. Contributors to the PIT after the reform continue to belong to the top-end of the income distribution, thereby not affecting poverty rates. On the other hand, the separation between labor and capital income, together with the new dividend tax, is expected to have a positive albeit small positive impact on income inequality. The new maximum excise rates – particularly on gas – are expected to result in a small increase in the cost of the food basket, thus potentially raising poverty rates. On the corporate side, the reform is not expected to have any direct impact on poverty and inequality in the short term. Finally, increased tax revenues can improve the welfare of the B40 in the medium to long term by improving the quality of public services. Own estimations suggest that revenues from the PIT could increase by about 50 percent in the short run. A Computable General Equilibrium Model estimated within the Ministry of Hacienda suggests that the tax-to-GDP ratio would increase by 0.7pp by 2025 as a result of the reform. A key assumption behind the model is that the tax reform will result in an increase of labor productivity by half a percent per year on average, following the article that stipulates that the increased revenues would be assigned to investments in health, education, and infrastructure. 9. The changes introduced to the personal income tax are not expected to have any impact on poverty rates.52 The high threshold over which labor income is subject to the PIT, together with the possibility of claiming unlimited deductions from consumption or investment expenditures, means that only those at the top end of the distribution pay any labor income tax. In principle, the split between labor and capital income introduced by the reform, together with the fact that capital income does not have a minimum threshold and is not subject to any deduction, could result in higher tax liabilities among those

51 Ervin, P. and L. Gayoso (2019). “Household vulnerability to food insecurity in the face of climate change in Paraguay”, FAO Agricultural Development Economics Working Paper 19-04, Rome, FAO pp.44 52 Analysis based on a detailed fiscal incidence simulation tool build by the poverty team to analyze this tax reform. Source data is the Permanent Household Survey (EPH) 2016, Income and Expenditure Survey (EIGyCV) 2012, and tax administration records.


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at the bottom of the distribution. However, the number of individuals in households living under the poverty line that report any capital income is very small53, and therefore it doesn’t have any effect on estimated poverty rates. Furthermore, it is very likely that this income remains unreported to tax authorities. 10. However, the new PIT system is expected to contribute marginally to reducing income inequality. The total number of taxpayers is expected to increase by two to three times, with the highest impact among the top deciles. Individuals in deciles 8 and 9 increase their representation among total taxpayers from 3 and 14 percent to 10 and 22 percent, respectively (Figure 3). In terms of collection, however, the top decile continues to contribute with over 90 percent of total collection. Furthermore, this change builds on an extremely small tax base. In 2016, there are only about 40,000 individuals registered with tax authorities, of which only about half paid any positive amount on taxes. As a result, coverage continues to be very low. Only about a third of the population in the top 10 percent of the distribution live in households that pay any PIT tax (Figure 4). Virtually all the impact can be attributed to the split between capital income and labor income, and the elimination of deductions from capital income. With labor income still being the largest income source for most households – which remains subject to unlimited deductions and is the only component with progressive tax rates - effective rates are expected to increase only marginally and they remain fairly flat along the distribution (Figure 4). As a result, the expected impact on income distribution is modest. The Gini coefficient falls by 0.1 points (from 52 to 51.9, measured by gross market income net of PIT contributions) when moving from the current system to that proposed by the reform.

53 Some households report receiving income from rents

Figure 1. Estimated number of taxpayers under current and new system, by income decile (left). Distribution of taxpayers across deciles (right)


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Notes: own calculations based on fiscal incidence tool. 11. If implemented, potential increases to excise taxes may have a marginally negative impact on poverty and no impact on income distribution.54 In order to compensate for potential negative externalities, the tax reform increases the allowed maximum tax rate on select groups of goods, including tobacco, sugar and alcoholic beverages, and gas. Regarding the first two groups, there is growing evidence pointing to the benefits of increased taxation to reduce the use and abuse of tobacco, alcohol, and high-calorie beverages (Task Force on Fiscal Policy for Health 201955), and the positive distributional impacts that can take place (Fuchs & Menesses 201756). Paraguay could benefit from these policies. It ranks fourth 54 Analysis based on a detailed fiscal incidence simulation tool build by the poverty team to analyze this tax reform. Source data includes Income and Expenditure Survey (EIGyCV) 2012, Livings Standards Survey (EPH) 2016, and IO matrix 2012. The IO matrix was used to take into account indirect effects along the production chain, as well as bounds on effective tax rates when goods are reported to be purchased informally. Survey to survey imputations based on DMATCH methodology. No behavioral responses taken into account. 55 The Task Force on Fiscal Policy for Health (2019). “Health taxes to save lives. Employing effective excise taxes on tobacco, alcohol, and sugary beverages”, 56 Fuchs, A. and Menesses, F. (2017). “Are tobacco taxes really regressive? Evidence from Chile”, Policy Research Working Paper 7988, World Bank, Washington, DC.; Fuchs A. and Menesses F. (2017). “Regressive or Progressive? The effect of tobacco taxes in Ukraine”, December 27, World Bank, Washington, DC

206 1,504 6,298

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Current: Inner circle / Reform: Outer circle

Figure 2. Effective rates (left panel) and Coverage (right panel), by income decile.


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in the region in terms of alcohol consumption, 58 percent of the population is overweight or obese, 10 percent is diagnosed with diabetes, and 15 percent smokes. However, the changes proposed under the tax reform are very small, particularly for beverages, and would not allow for periodic increases in tax rates which are needed to maintain lower levels of consumption.57 Furthermore, the reform only increases the maximum rates and therefore is up to the government to decide when and by how much to increase the rates. 12. Tax rates on fuels, on the other hand, do suffer a more significant change, though the timing of the increase is also subject to the Executive. Depending on the specific product, current rates range from 0 to 38 percent, and the all go to a max rate of 50 percent. In addition to suffering the largest increase, gas tax represents a relatively higher share on households’ budgets and have a compounding effect on other goods through their impact on the production chain. Indeed, estimations suggest that - as a share of total income - the amount spend on gas tax would double as a result of the reform. This shift is more or less flat along the distribution, so it is neither regressive nor progressive.58 In absolute terms, absolute incidence is higher among households with higher income (Figure 5).

Notes: own calculations based on fiscal incidence tool.

57 Max tax rates on sugar and alcohol drinks only increase by 1pp to 2pp, and they start from very low bases (5 to 13 percent). The changes in tobacco taxes are somewhat larger: they increase by 50 percent, from 18 to 27 percent. 58 The flat curve is the result of a combination of factors. While poorer households spend a larger share of their income on consumption, a larger share of their consumption goes to non-market and informal goods.

0.7% 0.8%

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Share of excise taxes over total income, current system

Gas Beverages Tobacco Total

Figure 3. Relative and Absolute incidence of excise taxes, by income decile


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13. If all tax rates were increased to the maximum allowed by the reform, total expenditure would increase by less than one percent on average among households in the bottom 30 percent of the distribution. A simulated increase in the value of the poverty line of this magnitude would result in an increase of about 0.5pp in total poverty and 0.3pp in extreme poverty. However, the evidence of switching consumption patterns due to an increase in gas rates is weak. A study by Galindo (2005) regarding the short and long – run demand for energy in Mexico found that the income elasticity is less than one and the price elasticity is quite inelastic. The small price sensitivity indicates that there is a low substitution among alternative energy options. Additionally, the study finds that all types of energy demand are price sensitive considering the short and long term except for residential energy consumption. The results express the possibilities and limitations of the use of an energy tax to control consumption through an increase in energy prices. According to Labandeira et al (2017), energy products are price inelastic, so that policies (through taxes or other regulatory tools) can lead, ceteris paribus, to a less than proportional reduction in the demand for these goods both in the short and long term. Additionally, they suggest that the energy product less price sensitive is the healing fuel used by households both on the short and longer term. 14. Changes to corporate taxes are not expected to have any direct impact on poverty or income inequality in the short-term. Small- and medium-size firms benefit from a new simplified tax system.59 This has the potential to increase formalization, though these benefits are subject to the limitations raised for PA#1. The unification of the two corporate taxes (INAGRO and IRACIS) levels the playing field between the agriculture and non-agriculture sectors, raising the contribution from the former. The commercial agriculture sector has been the most vibrant economic sector in the economy in the last fifteen years, and has benefited from large public investments, especially in infrastructure (Paraguay Policy Notes 2018). Yet its contribution to public revenues has remained low due to preferential treatment with lower tax rates and exemptions from the dividends tax. While the majority of the poor in rural areas works in the agriculture sector, it is mostly informal small-scale agriculture with weak links to commercial large-scale agriculture. Therefore, the changes are not expected to have a negative impact on the poor and vulnerable, while they do eliminate distortive treatments and create a more equitable contribution across economic sectors. Moreover, given the small increase in the INAGRO tax rate, along with the fact that it affects mostly medium and large-scale agriculture (which are more capital intensive), potential concerns of its effect on poverty through labor demand are attenuated. In fact, empirical evidence for Latin American countries shows that increases in corporate income tax have small effects, both in employment and wages60. PA7. Tax evasion

To support the facilitation of reduction of tax evasion, the Borrower has amended the Criminal Code to criminalize money-laundering of assets obtained from tax evasion.

59 The income threshold below which small firms that are not legally constituted (‘sociedades simples’) can benefit from a simplified tax system was raised from 100 million to 2,000 million, and the simplified system was split into two different sub-systems depending on the level of gross income (below or above 80 million). 60 Lora, Eduardo and Fajardo, Johanna. “Employment and taxes in Latin America: An empirical study of the effects of payroll, corporate income and value-added taxes on labor outcomes”. Cuadernos de Economia v. 35, issue 67, 2016


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15. The proposed PA is not expected to have any direct impact on poverty and inequality. In the long run, this measure may indirectly affect social outcomes by improving the business climate. PA8. Procurement

To improve public procurement, the Borrower has, through the President, approved a decree that simplifies and consolidates the regulatory framework and promotes centralization of public procurement of goods and services.

16. More effective procurement processes are expected to improve service delivery and generate fiscal savings in the medium term. The quality and quantity of public service provision is intrinsically linked to the ability of the government to procure goods and services. Everything from infrastructure investments - such as construction and maintenance of schools, clinics, or roads, to the provision of textbooks, medicines, or ambulances, for example, require going through the public procurement system. In Paraguay, between 2011 and 2016 government acquisitions grew at an average rate of 11 percent, reaching 15 percent of the central government expenditure in 2016 (Public Expenditure Review 201861). The demand is highly fragmented across institutions and agencies, with very heterogeneous capacity among them. The simplification of the regulatory framework and the adoption of framework contracts is expected to shorten procurement times, lower unit prices, and ensure minimum standards for quality of goods and services, which will ultimately improve the capacity of the government to deliver good-quality services. At the same time, these changes are expected to generate significant fiscal savings. With almost 50 percent of the government revenues spent on salaries, and a fiscal rule governing public debt, Paraguay has limited room for growing investments. Evidence from other countries suggests that there can be significant savings generated by procurement reforms. The Philippines realized savings ranging from 11 percent for vehicles and supplies to 55 percent on drugs and medicine after posting procurement on the electronic system; the health sector in Guatemala saved 43 percent by eliminating biased technical specifications in the purchase of medicines; the Republic of Korea realized annual savings of about $2.5 billion after implementing an e-procurement system (WB & OECD 200462). For the case of Paraguay, it is estimated that lower prices and better contract conditions alone could generate savings of about 0.8 percent of GDP (Public Expenditure Review 2018). Provided the implementation of the reform is comprehensive enough, a complementary, medium-term effect, is supporting the development of the private sector through increased competition and the promotion of transparent practices (WB & OECD 2004). 17. Better public service delivery is expected to improve the welfare of the poor and vulnerable. One of the three structural challenges identified in the Systematic Country Diagnostics was poor public service provision, which has significant implications for the living conditions of the poor and vulnerable (WB 201863). Therefore, improving the capacity of the government to deliver public services and freeing resources for social investments is expected to have beneficial effects for the poor. About 40 percent of total procurement expenditures is concentrated in the health and education sectors – two critically

61 World Bank (2018). “Paraguay. Investing in Human Capital. A revision of public spending and the management of social sectors”, World Bank Group, Washington DC. 62 World Bank and OECD (2004). “Mainstreaming and strengthening public procurement: a strategic framework”. Third Join Round Table on Strengthening Procurement Capacities in Developing Countries. 63 World Bank (2018). Paraguay Systematic Country Diagnostic.


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important sectors for the development of human capital (Public Expenditure Review 2018). In the health sector, about 50 percent of procurement expenses are spent on high-value low-complexity goods, and therefore can greatly benefit from streamlined procurement processes. At the same time, the distribution of public spending in these sectors is generally progressive: over 50 percent of the resources go to the bottom 40 percent of the distribution (Gimenez et al. 201764). The share going to those at the bottom of the distribution is higher if one doesn’t account for tertiary education. Still, accomplishing social gains would require improving the quality of expenditure and the allocation of increased resources to be guided by effective targeting and distribution mechanisms to ensure that investments reach the bottom 40 percent of the distribution and contribute to the closing of existing socio-economic gaps.

Figure 4. Incidence of public spending in social sectors (% of benefits by income quintile)

Source: Gimenez et al. 2017

PA9. Citizen Budget

To promote budget transparency, the Borrower, through the Minister of Finance, has issued a resolution, to be applicable as from the 2020 budget cycle, to adopt the digital web-platform called “Citizen Budget.

18. The proposed PA is not expected to have any direct impact on poverty and inequality in the short term. In the long run, this measure may indirectly affect social outcomes by increasing transparency on the use of public resources.

64 Gimenez, L., Lugo, M.A., Martinez, S., Colman, H., Galeano, J.J.; Farfan, G., 2017. "Paraguay: Analisis del sistema fiscal y su impacto en la pobreza y la equidad," Commitment to Equity (CEQ) Working Paper Series 74, Tulane University, Department of Economics.

https://ideas.repec.org/p/tul/ceqwps/74.html

https://ideas.repec.org/p/tul/ceqwps/74.html

https://ideas.repec.org/s/tul/ceqwps.html

Documents

The World Bank · 1. The proposed Paraguay First Economic Management Development Policy Loan ( EMDPL1) in the amount of US$200 million is thefirst operation, in a programmatic series