In the 1970s, the government pursued cautious fiscal policies and achieved large surpluses on the national accounts, mainly as a result of the vibrant growth in the second half of the decade. By the early 1980s, there were growing demands for increased government expenditure for social programs. By 1983, the first fiscal year of increased government spending and the first full year of a recession, the government had entered into a significant fiscal crisis as the budget deficit reached nearly 5 percent of GDP (the deficit had been only 1 percent of GDP in 1980). In 1984 the government imposed austere measures to remedy national accounts. Cuts in current expenditures curtailed already meager social and economic programs. In addition, from 1983 to 1986, real wages of government employees were allowed to drop by 37 percent. Capital expenditures were cut back more seriously. Capital expenditures as a percentage of total expenditure dropped from 31 percent in 1984 to 10 percent by 1986. Austerity measures were successful in economic terms, and by 1986 budget deficits were under 1 percent of GDP. In 1986 the government announced a highprofile Adjustment Plan, which continued previous policies of expenditure cutbacks but also proposed more structural changes in fiscal and monetary policies. The most prominent of these was a proposal for the country's first personal income tax. Many observers characterized the plan as mainly rhetorical, however, citing the government's lack of political will to implement many of its proposals.
Despite the government's ability to control budgetary matters, fiscal policy faced two new and growing problems in the 1980s. The first was the poor financial performance of state-owned enterprises. The overall public-sector deficit, which reached 7 percent of GDP in 1986, had swelled in part because of the high operating costs of parastatals (state-owned enterprises), which accounted for 44 percent of the overall deficit in 1986. Rather than continually increasing the price of utilities and the services of parastatals, the government accepted the loss to avoid the inflationary pressures of increasing costs to consumers. This policy, however, was seen by critics as only a stopgap measure, short of more painful structural solutions, such as examining the financial viability of certain parastatals. The second growing fiscal problem in the 1980s directly involved the country's complex exchange-rate system. Created in July 1982, the multitiered system allowed a preferential exchange rate for the imports of certain government-owned companies. It was the Central Bank, however, that forfeited the losses involved in these exchange transactions, which were recorded as part of the overall public-sector deficit. In 1986 Central Bank losses of this kind accounted for nearly half of all the public sector's deficit. Again to avoid inflation, the government chose to maintain the multitiered system, at least in the short run.
In 1943 the guaraní replaced the gold peso (which had been pegged to the Argentine peso) as the national currency, laying the foundation for the country's contemporary monetary system. Guaraníes are issued exclusively by the Central Bank (Banco Central) in notes of 1, 10, 100, 500, 1,000, 5,000 and 10,000 and as coins of 1, 5, 10, and 50 guaraníes. One guaraní is worth 100 céntimos.
Changes in banking laws in the 1940s set the stage for the creation of the county's new Central Bank, which was established in 1952, replacing the Bank of Paraguay and the earlier Bank of the Republic. As the center of the financial system, the Central Bank was charged with regulating credit, promoting economic activity, controlling inflation, and issuing currency. As a result of the growth in the financial system, a new general banking law was introduced in 1973, authorizing greater Central Bank regulation of commercial banks, mortgage banks, investment banks, savings and loans, finance companies, and development finance institutions, among others. In 1979 the Central Bank also began to regulate the nations' growing capital markets.
The Central Bank also controlled monetary policy. One of the major aims of monetary policy in the 1980s was price stability. After experiencing extreme price instability--a familiar threat to the economies of the Southern Cone--in the 1940s and 1950s, Paraguay entered into two decades of price stability, credit expansion, economic growth, and a stable exchange rate. Inflation was only 38 percent in the 1960s, a dramatic turnaround from the 1,387-percent figure recorded during the previous decade. Although the rate climbed to 240 percent in the 1970s, it remained far below the postwar level. The pace of inflation accelerated in the 1980s, however, after the economic downturn in 1982. Inflation, as measured by Paraguay's consumer price index, reached an annual rate of 27 percent in 1986 and climbed to well over 30 percent in 1987. Government authorities wrestled with how to control inflation without implementing policies that could unleash even greater inflation and popular discontent. Although influenced by many factors, inflation in the 1980s was exacerbated by fiscal deficits, exchange-rate losses of the Central Bank, the exchange-rate system in general, the country's declining terms of trade, and the inflation of neighboring trading partners, Brazil and Argentina.
The Central Bank regulated the allocation of credit, the supply of credit, and the country's interest rate in an attempt to promote economic growth and restrain inflation. The Central Bank held considerable control over the national banking system, but many regulations were loosely enforced.
From 1960 to 1982, Paraguay enjoyed extraordinary exchange-rate stability as the guaraní remained pegged to the United States dollar at g126=US$1. After the virtual financial chaos of 1947-54, this stability was especially welcome in Paraguay. Although the country's exchange rate was overvalued in the 1970s, it was not until the 1982 recession that the government devalued the guaraní.
Exchange-rate policy in the 1980s came to be characterized by numerous devaluations and almost annual changes in the number of exchange rates employed. In early 1988 five exchange rates were in use, making exchange-rate policy very complicated. The first rate of g240=US$1 was used for the imports of certain state-owned enterprises and for external debt service payments. The second rate of g320=US$1 was applied to petroleum imports and petroleum derivatives. The third rate of g400=US$1 was reserved for disbursements of loans to the public sector. The fourth rate of g550=US$1 was used for agricultural inputs and most exports. The fifth rate, the only one not set by the Central Bank, was a freemarket rate set by the commercial banks. The free-market rate, which was applied to most of the private sector's nonoil imports, exceeded g900=US$1 by 1988. Exchange-rate adjustments were expected to continue in the late 1980s.
One of the most distinctive and complex features of the nation's exchange-rate policy was a system of official minimum export prices for selected agricultural commodities. The system, called Aforo, was essentially a way of guaranteeing foreign-exchange earnings to the Central Bank. Aforo values, assessed by the government immediately before a harvest or slaughter, designated the minimum prices exporters should receive for the goods and determined what percentage of foreign-exchange earnings must be turned over to the Central Bank. The difference between the Aforo price and the actual price was traded in the free-exchange market. In 1987 the official export rate for Aforos was g550=US$1, whereas the free-market rate was upwards of g900=US$1. Lower Aforos generally made Paraguayan exporters more competitive but guaranteed less revenue to the Central Bank. Aforos were one of several government policies that fueled contraband trading.
As the manipulation of Aforos demonstrated, exchange-rate policy was an important economic policy tool of the Paraguayan government and directly affected most sectors of the economy. Although the government ostensibly intended to reduce the gaps among the various tiers of the exchange rate, it was reluctant to reunify the rates in fear of greatly speeding inflation. Paradoxically, however, the multitiered exchange-rate system increased inflationary pressures in numerous indirect ways. One of its most important effects was the fall in Central Bank reserves associated with the exchange-rate subsidies for parastatals, a policy that created a growing publicsector deficit. Likewise, Central Bank losses encouraged a more expansionary monetary policy, most notably through rediscounting rates. An overvalued exchange rate also hampered export growth in general, which in turn aggravated Paraguay's balance-of-payments deficits and potentially its external debt.
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