Paraguay is going through some fundamental changes, with the introduction of personal income tax and proposals for agrarian reform, but it is not yet clear whether these moves will lead to more or less foreign investment.

On January 1 this year, many people started to pay personal income tax of 10% for the first time. Commentators say this is a positive step, improves the rule of law and should encourage foreign investment.

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However, the government of President Fernando Lugo, a former Catholic bishop who took office last August, wants to redistribute large swathes of land given to the cronies of generals during the long military dictatorship. Some observers believe this will be hard to achieve in practice, and could undermine the rule of law and deter foreign businesses from entering the country.

Improvements made

Conor McEnroy, head of Ireland’s Abbeyfield Group, which owns the Sudameris Bank in Paraguay, says: “The country did not have personal income tax as a concept until the start of this year. This is a transformational development in Paraguay and shows that the country is getting its act together. People have more of a stake in a democracy when they have to pay personal taxation.”

Carlos Pereira Benza, president of the meat commission of the country’s Rural Association, the main agricultural organisation, is more concerned about Mr Lugo’s proposed agrarian reform. “I think a country needs clear rules if it is to attract foreign investors and I am not sure investors will be confident that Paraguay has them if it allows land to be redistributed.”

From 2005 until last year, Paraguay enjoyed one of its biggest economic booms ever on the back of record commodity prices. Large tracts of land in the east, previously used for cattle grazing, have been turned over to soya bean production. Today Paraguay is the world’s fourth most important producer of the crop after the US, Brazil and Argentina. It used to be famous for its cotton production but that is now far less important, and soya has become the main engine of economic growth.

Another important factor in the rise in soya production has been the increasing mechanisation of production. Since 2000, combine harvesters have been used in the country and tractors are now involved in every stage of production. Luis Enrique Arréllaga, general manager of Grupo Espirito Santo in Paraguay, a Portuguese conglomerate that has invested heavily in agriculture in the country, says: “Paraguay has seen a boom in the agricultural sector in the past few years and mechanisation has become much more common. Of the 3.5 million hectares of land being cropped in the country, 2.6 million are being used for soya production. Soya has become very important for the local economy.

“Soil quality in Paraguay is very similar to that found in Brazil or Argentina but the price of land is much lower. That has been one of the factors that has most attracted investors into the country. However, I think there are likely to be less investors now because of the recent, steep falls in commodity prices.”

Soya prices have now dropped sharply since the middle of last year and a bad drought is affecting the current harvest.

Paraguay has several features that have made it attractive to foreign investors: huge quantities of fertile land, a low population density, vast sources of fresh water and great potential for hydroelectricity. Family and multi-family offices have been one of the principal investors in the country, purchasing farmland outright or taking a majority stake in farms and agricultural businesses.

Mr McEnroy adds: “Family and multi-family offices from the US and continental Europe have been the key investors during the past few years. These people are highly networked and they have heard about the opportunities in Paraguay. I do not think the fall in commodity prices will affect their level of investment in the country. The problems in the financial markets make these people more interested in investing in real assets like land.”

Image problems

Historically, Paraguay has had a poor reputation for corruption, ranking 138th in the world, according to Transparency International’s corruption perceptions index. This has hindered foreign investment and is one reason why the new president must focus on cleaning up the country’s image.

Another major problem is the poor infrastructure, though it is possible that foreign groups could become involved in its improvement in the future. Many roads are dirt tracks and the country’s main highways – such as the one between capital city Asunción and Encarnación – have only two lanes.

The government has suggested that it wants to involve the private sector in the construction and management of new toll roads. Concessions for these are expected to be granted this year.

Work needed

The River Paraguay is used by barges to transport more than 95% of the country’s soya crop but it needs further dredging because, during periods of drought, water levels fall significantly making navigation difficult.

The dam at Itaipú, shared between Paraguay and Brazil, forms one of the world’s biggest hydroelectric plants, but Paraguay does not seem to benefit from it at the level that it should. Mr Lugo is attempting to get Brazil to pay more for electricity generated by the plant but his giant neighbour is resisting such moves.

The country also has such poor transmission lines that, although it should not have any energy deficiencies, the electricity supply can be haphazard.

Paraguay has just enjoyed one of its most important periods of economic expansion in its history but faces a much tougher economic environment this year. In the future, its many natural resources could attract major foreign investment – but to achieve this, it must reinforce the rule of law and root out corruption.

The cost of this report was underwritten by Sudameris Bank. Reporting and writing were carried out independently by fDi Magazine.

COUNTRY PROFILE

PARAGUAY

Population: 6.8 million

Pop. growth rate:

2.4%

Area:

397,300 sq km

Real GDP growth: 4.7%

GDP per capita:

$4300

Current account:

$178m

Largest sector (% of GDP): Services 48.9%

Labour force: 2.8 million

Unemployment rate:

5.4%

Source: CIA World Factbook, 2009