Courtesy of STRATFOR (subscription required), a detailed look at Paraguay:

The downturn in global commodity prices has hit Latin America hard. Although Brazil and Venezuela are the most notable cases, several countries in the region are experiencing major economic slowdowns or even contractions. Paraguay, however, has managed to buck this trend and become a hotspot for economic growth. The country’s small but robust low-end manufacturing sector lies at the heart of this growth, buoyed by business-friendly tax incentives and low wages. Meanwhile, the Paraguayan economy is becoming increasingly diverse. Though Paraguay will find it challenging to sustain growth in the coming years, it will continue to outpace its larger neighbors and to boost the momentum it has already built up in its manufacturing center.

Analysis

The International Monetary Fund’s World Economic Outlook projects that Paraguay will grow by 3 percent in 2015 compared to the previous year, and again by 3.8 percent in 2016. This outlook stands in stark contrast to expectations for Paraguay’s neighbors and fellow Mercosur members Brazil and Argentina, which are set to either contract or see negligible growth over the same period. With the exception of Bolivia, Paraguay is projected to have the highest rate of growth in Latin America over the next two years, just as it has been the region’s leader in growth for much of the past decade. Unlike Paraguay’s diversified industrial growth, Bolivia’s economy has been fueled by an increase in natural gas production and exports. 

Paraguay’s strong economic growth stems from several factors. Like most in Latin America, the country’s economy is largely driven by commodity exports. Paraguay is the world’s fourth-largest exporter of soybeans, sixth-largest exporter of corn and 10th-largest exporter of wheat. These exports, particularly soybeans, have been hurt by the decline in global commodity prices, but the trend has still proved to be a net positive for Paraguay. Because the country is a net importer of oil and natural gas, the drop in oil prices has been a boon. Furthermore, the country meets most of its energy consumption needs through the Itaipu dam, which produces 75 percent of its energy as well as 17 percent of Brazil’s consumption needs. Paraguay’s beef exports have also increased recently, up by 70 percent to value $1.3 billion over the past two years, mainly on the back of Russian consumption amid Moscow’s ban on European agricultural goods.

But over the past decade, Paraguay’s manufacturing boom has spurred the country’s diversification away from a primarily commodity-based economy to one broadly based in different sectors. While Paraguay is still reliant on commodity exports, the country has seen substantial growth in industries such as textiles, pharmaceuticals and auto parts. Collectively, these sectors account for around 24 percent of the country’s total exports. Their growth has been aided by business- and investment-friendly policies pursued by the government of Paraguayan President Horacio Cartes, who came to power in 2013. The country employs a flat 10 percent rate on income tax and a value-added tax that is the lowest among Mercosur members and one of the lowest in Latin America.

 

These policies have also made Paraguay an attractive destination for foreign direct investment. According to Brazil’s National Confederation of Industry, 42 Brazilian companies have moved to Paraguay in the past few years in search of lower labor costs and preferential tax rates. The contrast to its neighbors is striking: In Brazil, businesses must pay a 25 percent income tax in addition to other taxes and fees. Many of the new businesses are textile companies, and Brazilian officials have said they hope to use Paraguay to replace Chinese imports. Currently, textile products made in Paraguay make up only 2 percent of Brazil’s total textile consumption, but there are plans to raise this figure. Several auto parts factories based in Brazil are also starting to move to Paraguay, and many companies from Europe and Japan have also expressed interest in setting up operations there.

At the same time, Paraguay has the youngest population in Latin America, with around 33 percent of its people between the ages of 15 and 24. This benefit is enhanced by wages that are much lower and labor laws that are more flexible than those in neighboring Brazil and Argentina. The country’s two primary production and population centers, Asuncion and Ciudad del Este, both have relatively well-established infrastructure for the manufacturing sector and are the site of most of the country’s textiles and auto parts production. The Ciudad del Este region, which abuts the Argentinian and Brazilian borders and is close to Brazil’s main industrial center in Sao Paulo, is also home to a maquiladora program similar to that along the U.S.-Mexico border, through which factories receive raw materials from and sell value-added goods directly to third countries. Low levels of government debt, moderate inflation and a relatively stable currency have also buoyed the Paraguayan economy.

Despite these strong foundations, challenges linger for Paraguay. The country is landlocked and therefore does not control the ports through which it exports, although Asuncion does have seasonal access to the Atlantic Ocean via the Parana River. Paraguay thus has to rely on Brazil, Uruguay and Argentina to facilitate trade. These countries, along with Venezuela and soon to be Bolivia, are all part of the Mercosur customs union to which Paraguay also belongs. Paraguay has an agreement allowing it to use Brazil’s port of Paranagua, and Paraguay’s national port administration controls one full terminal there. However, Brazil and Argentina together account for nearly 40 percent of Paraguay’s export market, and both countries are facing either recession or negligible growth for at least the next two years. This will likely hurt Paraguay’s own economic outlook over the same period. Paraguay has supported external trade initiatives like the Mercosur-EU free trade agreement, but ratification will largely depend on Argentina since any free trade deal must have unanimous support from within Mercosur.

Nevertheless, the country’s position as a low-end manufacturing center will likely improve in the coming years, especially as China transitions away from a low-wage, high-growth exporting model and companies from Brazil and elsewhere seek to exploit Paraguay’s favorable regulatory and tax structure. Paraguay is thus well positioned to maintain its place as one of the fastest growing economies in South America far beyond 2015.