“It was a perfect storm,” says Benigno López, Paraguay’s minister of finance, of last year’s economic headwinds. A drought, then flood, combination hit production in the agricultural and protein sectors – still two of the most important sectors for the country’s economy, despite a drive for industrial diversification.
The drought also hit production of electricity at the Itaipu hydroelectric dam, the joint project between Brazil and Paraguay that once claimed the world record for water-generated power, at 103.1 million MWh in 2016. The energy produced by the Itaipu in 2016 would have been enough to supply the world’s energy consumption for two days without interruption, or power Argentina for more than a year (or Paraguay for 12 years).
However, in 2019 the dam produced 18% less energy than in the previous year, reducing revenues.
Nevertheless, the topic that tends to dominate conversations among business and finance professionals in Asunción isn’t so much about Itaipu’s generation capacity, but rather what agreement will be reached between Paraguay and Brazil when their current power-sharing agreement expires in 2023.
The existing agreement is very favourable to Brazil (the dam’s production is divided equally, but Brazil has exclusive rights to buy, at cost price, whatever Paraguay does not use – which is roughly 85% of the Paraguayan share).
In 2019 Paraguay received $700 million directly from the dam’s operations and estimates it contributes a further $350 million to the economy indirectly, and a total of 30% of all the country’s internal tax generation.
The renegotiation is going to be fraught. Brazil has already signalled that it does not expect a radically different outcome in the next agreement. However, many Paraguayans see the talks as a test of national sovereignty and there are expectations that the government should try to reassert its independence.
López says he has brought Jeffrey Sachs, an economist from Columbia University, into the team that will help plan for the added revenues expected from the new deal (whatever happens in those talks, Paraguay will be more than $1 billion a year better off from debt payments for the dam’s construction).
In 2013 Sachs wrote a report that concluded that Paraguay has been “dramatically undercompensated” for its surplus energy that Brazil has been using.
Another study quantified the level of under-compensation: Miguel Carter, of the Paraguay-based Demos think-tank calculated it to be a $75 billion loss income, a huge nominal loss for any economy but particularly for one that is valued at $40 billion.
The negotiations will start this year and, given their hugely sensitive nature, few want to go on the record about how Paraguay should approach them but, within the private sector at least, there seems to be an emerging consensus view.
That view is that Brazil won’t increase the price for its payments unless Paraguay is in a position to begin to use more of its 50% share of the energy. To do that, Paraguay will need to develop the transmission lines to be able to take and distribute energy from Itaipu into the country’s grid.
Without developing transmission lines Brazil would, rightly, see such claims to use their allocation as a bluff.
“If you are going to build that transmission capability we need to start now,” says one senior banker in Asunción. “And if you are going to build the transmission and distribution infrastructure, we may as well use the electricity to grow our industrial base. Let’s get to 50% usage as quickly as possible.”
What does López think about this consensus view?
Benigno López, minister of finance: If you follow the consumption of energy by Paraguay, it has been increasing sharply; it’s just a matter of time before Paraguay uses its share. Some people say that we will have reached our capacity in five to seven years, others that it will take more than 15 years before we will need to have developed additional generation capacity.
We built the dam to use the energy to industrialize our economy and develop our country. We should continue to follow that path. We have developed a pipeline to invest in electricity distribution and the transmission lines in the coming years in order to be ready to use all of it.
Euromoney: If you need another dam in 15 years, wouldn’t you need to start work on that now?
López: Our challenge is to start thinking about other sources of energy for Paraguay, and any single project for such a source would take years to be completed. In those projects 15 years is ‘tomorrow’.
Euromoney: As well as helping with the public finances, how can Paraguay best use Itaipu’s energy? Are you interested in high-energy businesses such as bitcoin mining?
López: I think we have to be careful. We have to make investments that will have a real impact on the economy and create jobs. It also has to be environmentally friendly. As to bitcoin and projects like that, I do not want to go ahead at the moment – we should wait and evaluate the market as it develops. There are others ideas such as green bonds, public transport, solar energy and so on that will have a deep impact in our economy.
Euromoney: What do you plan to do with the added revenues and the money you are currently spending on Itaipu debt, post-2023?
López: We have a whole team working on the proposal, including Jeffrey Sachs, and they have yet to report to the president. The discussion will go on Annex C [of Itaipu Agreement] and not the whole treaty, which, by the way, can be renegotiated at any time. Annex C concerns the financial conditions, the cost of energy and so on. However, the main discussion is about what we do with the debt that will be paid off by 2023: How will the cost of energy be calculated (of which the debt component is about 60%)?
Should we reduce tariff? Or should we keep the tariff as it is? I don’t dislike the proposal to keep the tariff as it is and share the energy between the two countries, with each keeping the added revenues, such as the $1 billion expiring in debt repayments.
And if either country wishes to change the tariffs, they can do that unilaterally with their own share in their own country or, for instance, Paraguay can create a sovereign wealth fund to finance the many future needs we have as a country.
Such a fund for infrastructure education and health will enable Paraguay to be able to provide quality services for its people and enable us to better prepare for the challenges of the future. There are also many other ideas that the team of experts is working on.
Euromoney: Would a sovereign wealth fund further differentiate Paraguay’s financial model to that of the rest of the region?
López: The key to our success is the reputation we have built up for responsible macroeconomic behaviour over the past 15 to 20 years. We have a fiscal responsibility law, the golden rule [where government budget deficits can’t be financed with debt issuance], low debt-to-GDP [22%] and a business-friendly taxation regime [the country has a 10% income tax, 10% corporation tax and 10% VAT].
We have a ‘trademark’ now, regarding macroeconomic responsibility, and we don’t want to lose that – we will keep on being a responsible country.
I also think that in the near future we are also going to be recognised for our commitment to structural reforms.
If you see our recent history it is a country like a coin; on one side we have the economic side, which is doing very well. On the other side are the social indicators, in which we are working hard to improve the quality of life for the Paraguayan people. That’s the challenge we have to improve.
We are rated high in macro, and low in institutional effort, and low on quality of public services, such as the provision of education and health. We are working very hard on these issues, and the rating agencies, investors and the investment banks have noticed this. In the near future, these efforts will produce results.
To finance those challenges we need to remain competitive in terms of taxation, and this is where the sovereign wealth fund can make a huge impact in Paraguay.
Euromoney: These are the reforms that are very difficult to do and do well. How confident are you that Paraguay can be successful here – have you a model from another country in mind?
López: The president is giving us the best chance to succeed by bringing together the private and public sectors to develop a roadmap to present to congress. This will happen before the end of this year.
It will develop a roadmap for the education reform, which will set out how we will educate our young people for the next 15 to 20 years. We have to face this challenge, to anticipate what the future labour market will be so that we prepare our children for a totally different environment. If we don’t prepare our children for that challenge then we are missing a large opportunity.
The key to our success is the reputation we have built up for responsible macroeconomic behaviour over the past 15 to 20 years.
We also introduced a tax reform to make the system more equal, and we are working also on developing systems to improve the efficiency of public expenditure. We are also planning reforms to the pensions system and incorporating technology in the everyday lives of our system, which will also have a tremendous impact on our quality of life.
Euromoney: Do you expect that congress will be receptive to these next-stage challenges?
López: I would say, in respect to congress, so far so good. We were able to pass 12 laws last year to strengthen the anti-money laundering regime.
We have also recently passed legislation that provides transparency to political party funding, and we are working on ways to improve the efficiency of the civil service – through better procurement for example.
We also passed a law to improve the business climate.
If we don’t go ahead with these reforms, we believe the ceiling of our growth will be near 4%. We need higher growth and more inclusive results, and so there are many initiatives in the labour market as well.
Everything happens through a good education and health system, and we are absolutely committed to improving the quality of these services.
At the end of the day, congress wants the same as us: to improve the quality of lives of the Paraguayans. We will work together to achieve that.
Euromoney: Will these improvements in institutional strength and transparency lead to Paraguay attaining an investment-grade rating?
López: Well, the direction is right – we are on the right path. The effort is being noticed. The market is already treating us as investment-grade country and the improvement and commitment is there. Eventually they will see it and recognize it.
Euromoney: The market is already pricing you well inside investment grade [Paraguay re-tapped its benchmark 2050s in January with a net negative new issue premium] – that has to be encouraging?
López: It is very encouraging indeed. Those are very good signs from the international market. Not only on the bond issuance side but also to close two important infrastructure projects such as Bioceanica [transport routes connecting the Pacific and the Atlantic] and the first public private partnership project [which links Asunción to Brazil through the improvement of Rutas 2 and 7] reinforce the feeling we are being recognised internationally as a solid and improving financial jurisdiction.
Euromoney: How can you develop infrastructure financing without leveraging the country’s balance sheet?
López: We have closed the financing of the country’s first PPP, two highways that will connect Asunción to Brazil. We are also going to use PPPs to develop an important pipeline of roads, bridges, energy grid upgrades. We’re also going to upgrade the airport, both the runway and the terminal, so that we can receive visitors from all over the world.
It has been many, many years since we made an investment to improve the connections between Paraguay and Argentina, and we are going to build three or four bridges to make us more connected. We also need to boost the country’s internal infrastructure to the Chaco region, because that is going to be very important for the economy in the coming years.
One way to develop infrastructure without leveraging our balance sheet is doing exactly this, attracting private investors.
Euromoney: Is soy production ramping up in that region?
López: Soy production is expected to make a record high this year, and it is very important for the economy. Last year’s drought proved that.
Euromoney: Rating agencies typically like to see governments have a greater ability to finance themselves in the local markets before awarding investment grade – is that a challenge?
López: We are working on that. We have money and assets that could be better invested in longer-term investments, and so if we unleash pension funds to invest, they will be more productive, while remaining safe. We could develop the market further, and there would even be interest in 30-year government debt locally. We need to be able to tap domestic liquidity, as well as the international, and if we can achieve this, it would be very good for the future of the economy.
Euromoney: When – if – the investment-grade rating comes, do you think it will lead to a big increase in FDI [which has already been steadily increasing, reaching $6.7 billion in 2018, the latest full years statistics, up from under $1 billion in 2003]?
López: I believe that the investors who come first, those that come before we attain investment grade, will receive more benefit. Investment grade will happen – it’s just a matter of time – because we are working on our weaknesses and these remedies will be in place very soon. Every country has its problems and at least we are facing ours.
We have so much to offer investors: a strong economy, business-friendly taxes and lots of cheap energy. We also have great demographics – the average age of our population is under 30 years of age – but we are few people for such a big country. We are as big as Germany but have just close to seven million people, so we have the room to grow in Paraguay. But our market is very small, so we have to look outside for partners.
Euromoney: How important will Mercosur’s trade deal with the EU be for Paraguay?
López: I have no doubt it’s going to have a big impact on Paraguay. We are developing an export-orientated economy, and this will give us access to the third biggest economy in the world.
Euromoney: Are you concerned that political issues, specifically around some European country’s concerns about Brazil’s environmental policies and record, will lead to the postponement or abandonment of the deal from the EU side?
López: No, we think ratification will proceed. Paraguay has environmental standards and all the countries in Mercosur are signatories to the Paris Climate Agreement, so I am optimistic this treaty will become operational in the near future.
