Summary: KEY ISSUES Context: Paraguay has strong economic fundamentals—low debt, sizeable official reserves, and small fiscal and external imbalances. The main challenge ahead is to improve social and economic development, while strengthening the macroeconomic policy framework to cement strong fundamentals. To address these challenges, the government that assumed office in August 2013 with a strong mandate, has proposed important reforms and made a solid start by enacting key pieces of legislation—new taxes, and private-public partnerships (PPPs) and fiscal responsibility laws. Prospects: Paraguay’s outlook for 2014–18 is favorable with broadly balanced risks, despite less buoyant external conditions. The economy would continue to be one of the most dynamic in the region, with growth returning to potential of about 4.5 percent a year by 2016, inflation in line with the central bank’s target rate and small fiscal and current account deficits. Consistent with this outlook, a tightening in the policy stance should take place in the near term, with policies guided by the fiscal responsibility and incipient inflation targeting frameworks over the medium term. Cementing sound economic fundamentals: The fiscal responsibility law provides a sound anchor to underpin fiscal sustainability but stronger budget institutions are needed to improve the quality of spending along with strengthened tax and customs administration and capacity to deal with potential risks from PPPs. Civil service and pension reforms are also needed to further strengthen the fiscal framework. The central bank has made important advances in implementing an inflation-targeting (IT) regime along with greater exchange rate flexibility. The focus should remain on steps to achieve a full-fledged IT regime and on strengthening risk-based bank supervision in line with international best practices. Inclusive growth: Success in reducing poverty will depend on ensuring the long-term sustainability of initiatives underway and on increasing labor market flexibility to reduce informality as well as improved public enterprises management to bolster access to basic public services at reasonable cost.

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