Tue | Aug 4, 2020

Walter Molano | Hidden gem in the high-yield space

Published:Friday | July 31, 2020 | 10:16 AM

Mario Abdo Benítez, president of Paraguay.
Mario Abdo Benítez, president of Paraguay.

OP-ED CONTRIBUTION: EMERGING MARKET ADVISER

Paraguay is one of the most interesting countries in Latin America; with a complex history and a unique culture. It is also one of the better managed economies of the region.

Like its neighbour Bolivia, Paraguay is landlocked. It is also surrounded by two of the largest countries of the continent: Brazil and Argentina.

It was born as a backwater of the Spanish empire, bereft of precious metals, and ended up being one of the buffer states that physically separate the largest countries of South America.

The other buffer states are Uruguay, Ecuador and Bolivia. Its only access to the outside world is through the mighty Parana River. It is home to the Guarani, a proud and vast indigenous population that spreads well into southern Brazil, northern Argentina, eastern Bolivia and northern Uruguay.

During the early 1800s, Paraguay was one of the most technologically advanced countries of Latin America, boasting the first telegraph, railroad, iron foundry and shipyard. In 1864, it was the victim of a genocidal war with the Triple Alliance of Brazil, Argentina and Uruguay. They felt that the Guarani posed an existential threat to their nations, since the indigenous people had a greater allegiance to each other rather than to their respective countries.

As a result of the war, Paraguay lost 40 per cent of its landmass and 60 per cent of its population. Yet, the Paraguayan government was able to hold on for six years, and today its culture still survives.

Modern-day Paraguay is relatively small, about half the size of Chile. It has a population of seven million and a GDP of only US$39 billion. The country is abundant in water, serving as the drainage basin for much of the southern Amazon. Not surprisingly, its major exports are agricultural products, such as soy beans, vegetable oils and proteins – beef and poultry. It also has hydrocarbon deposits in the west, under the Chaco desert. This was the region, and the reason, for a vicious war with Bolivia during the 1930s.

Sadly, the two sides were supported by international oil companies, Royal Dutch Shell and Standard Oil, as they vied for control of the oilfields.

Paraguay is also a major exporter of electricity, from its impressive Itapúa hydroelectric facility. Most of Paraguay’s trade is inter-regional – a third is with Brazil and a quarter with Argentina, thus making up half of its exports and imports. Paraguay has averaged a steady GDP growth rate of 3.5 per cent during the last five years. However, growth was a dismal 0.2 per cent y/y in 2019, and the economy is expected to contract one per cent in 2020.

The country suffered several setbacks. The first was a drought in 2019, followed by severe rains and flooding, which wreaked havoc with agricultural production and hydroelectric production. Exports also suffered from the deep recessions in Argentina and Brazil. As a result, the current account deficit widened out to 2.8 per cent of GDP, due to the decline in exports. The low levels of domestic demand also triggered a decline in the inflation rate to below one per cent.

Fortunately, COVID-19 has not been much of an issue for the country. As of early July, Paraguay had only registered 19 deaths, ranking it one spot better in Latin America than Uruguay. The International Monetary Fund expects GDP growth to rise to 4.0 per cent next year, as the effects of the drought subside and the agricultural sector bounces back to life. Unfortunately, the risk aversion produced by the onset of COVID-19 resulted in a depreciation of the currency, losing more than five per cent since April.

Paraguay has a solid double-B credit rating, with a gross debt-to-GDP ratio that is better than most of its double-B peers, and a net debt-to-GDP ratio of only 19 per cent. However, it does not stand out as strong on the fiscal accounts. It has a primary fiscal deficit of two per cent of GDP and an operational deficit of 2.8 per cent of GDP.

The country has a well-populated yield curve, with seven major bond issues, which range from 2022 to 2050. On the political side, the political drama has subsided after the 2012 impeachment of President Fernando Lugo. Starting in 2013, Paraguay has been governed by presidents from the centre-right ANR Colorado party. The current president, Mario Abdo Benítez, was elected in August 2018, and his term will end in 2023; but he cannot be re-elected.

The only meaningful downside to the country is its high level of crime, which is an impediment to investment and development. The centre of criminal activity is in Ciudad del Este, an important city that sits at the junction of Brazil, Argentina and Paraguay, and it is a notorious transit point for arms, contraband and money laundering.

Still, the problems in Ciudad del Este seem to be contained to its region.

Overall, despite the drama of Ciudad del Este, Paraguay is one of the hidden gems of the high-yield sovereign space, with sound macroeconomic management and strong credit metrics.

Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.

wmolano@bcpsecurities.com