You don’t often hear much about Paraguay, but its economy is doing surprisingly well – it grew by a staggering 13 per cent last year, boosted by a bounce from 2009 and a record soya harvest, and is on track for growth of 3.7 per cent this year, according to ratings agency Standard & Poor’s.

Now, it has been rewarded with a upgrade by the agency, which on Tuesday lifted its long-term sovereign rating to BB- from B+.

S&P’s based its upgrade on Paraguay’s improved fiscal flexibility following a deal with Brazil to give the country a bigger share of revenues from their shared Itaipú hydroelectric dam. This was a key campaign push of Fernando Lugo, the president, who was elected in 2008, and the extra revenues – equivalent to 1.5 per cent of GDP – will enable his government to boost social spending without busting fiscal discipline.

Yet Paraguay is not without its problems. These include weak institutions, a tradition of corruption and low development that were compounded by more than 60 years of one-party rule, which Lugo ended. There had been talk of his seeking to change the constitution to allow him to stand for reelection in 2013, but that was recently ruled out by Congress. Inflation could overshoot official goals this year and hit 8 per cent, S&P’s added, and the economy remains heavily dependent on agriculture and foreign trade, which expose it to price fluctuations and the external environment. Accumulated inflation for the first seven months of the year stood at 5.9 per cent.

That said, Paraguay’s central bank chief, Jorge Corvalán, is confident Paraguay is well placed to avoid any problems stemming from the international global slowdown. Reuters quoted him as saying:

We are sufficiently protected to support any international shock, which is good … The main protection we have is: fiscal surpluses for eight years in a row and a very good quantity of international reserves … This puts Paraguay in a very good situation even if the international situation gets complicated.

S&P’s also highlighted debt reduction (debt is estimated at 14 per cent of GDP for this year) and central bank reserves that are more than three times the size of current account payments as having strengthened the country’s outlook.

Paraguay’s neighbour Argentina also boasts enviably low debt, high growth and high reserves, although analysts say it is only managing to maintain a budget surplus because of transfers of funds from other government revenue sources, like the pensions agency, Anses. It also has a reputation (though to a far lower degree) for corruption, and has an inflation problem. Its debt is rated B by Standard & Poor’s.

But Argentina blames ratings agencies in part its financial problems, saying their advice – which it considers questionable – affects investment decisions.

Moody’s last week downgraded the outlook for Argentina’s banking sector – which is widely thought to be solid, in part due to the lack of sophisticated financial instruments that caused problems in the US and elsewhere. Why? Moody’s said banks were reliant on unsustainable government policies and could be vulnerable to political risk in the future. That is possible – a government that nationalised pension funds is widely seen to be capable of co-opting banks into buying a bond, for example, if it needs to raise finance. But the Moody’s assessment seemed unusually speculative and the government made its outrage felt swiftly and severely, as did banking associations. Analysts were also left scratching their heads at what looked like a rather out-on-a-limb analysis.

Argentina wastes few opportunities to dismiss ratings agencies as irrelevant in what it considers a new economic world order in which emerging markets are key drivers of world growth and developed countries are having the kind of problems that used to be the preserve of the developing world.

Still, Paraguay will be happy with its upgrade – its second in a year. Argentina also got an upgrade last year, but it may have to wait a while for more to come.

Related reading:
Paraguay beefs up meat exports, beyondbrics
Paraguay: LatAm’s new mineral power?, beyondbrics
Latin America’s impressive little guys: Uruguay and Paraguay, beyondbrics

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