Paraguay special report 2014: Diversification: building a broader-based economy

When, in June 2014, Standard & Poor’s raised Paraguay’s sovereign rating to BB (from BB-) its rationale led with the government’s “recent steps … to boost investment in infrastructure … [which] will sustain economic growth and gradually diversify the economy, reducing its volatility”. This infrastructure building programme will not only strengthen the construction sector, but will also boost the competitiveness of all sectors – including agriculture – while bringing in new companies and generating new industries. “We have very ambitious and proactive plans for the development of the infrastructure in roads, rail, airports, the waterway and electricity projects,” says José Molinas Vega, minister of planning. “We are basing this programme on government money but also with the new PPP [public-private partnership] law, approved in November 2013 and another new law [Law 5074] that allows public money to go to financing private sector works.”

The two laws are designed to be complementary, with the possibility that the financing and construction of a project could begin under Law 5074, while feasibility is being studied for a transfer to PPP for the operation and sharing of the performance risk. “The key element is that works under both laws will be open to international competition,” says Molinas Vega.

International companies have already begun work on the programme: South Korea’s Il Sung Construction won the contract to build ‘Highway 8’ through a public tender process. More will come, with the aim of private companies investing between $800 million and $1 billion within a couple of years. When public money is added – and most of the proceeds of the 2013 and 2014 international bond transactions are being channelled into infrastructure projects – the investment rate on infrastructure should peak at about 3.5% of GDP, from 0.6% in recent years.

This huge acceleration in investment will create issues of capacity. “It’s a big challenge for our construction companies, our engineering capacity and our project management – everything is being put to the test,” says Ramón Jiménez, minister of public works. “The target of infrastructure spending of 3.5% of GDP is in line with sustainable GDP growth of 7% and we want to move to that level as quickly as possible. We are preparing to do that in an orderly fashion.”

Jiménez says international consultants are advising the public sector about how to increase its capacity to manage projects effectively, including gaining the expertise to manage PPP projects. “PPP projects will be new to the ministry and we will also be working with leasing contracts and project finance across a wide variety of sectors. Road construction is the key priority – we have $3.5 billion worth of road infrastructure development over the next five years, as well as $1.5 billion of water projects and electricity works of about $2 billion.”

Taking to the water

Part of the integrated infrastructure plan, which incorporates construction projects for the next 20 years, is the development of the Parana River to boost export and import capabilities. The river will be dredged: at present, low water levels mean barges cannot be loaded to their full capacity. A series of signals will also enable 24-hour navigation: currently there can be little or no movement out of daylight hours. These projects should cost around $150 million and take three years but will vastly improve productivity. The road between the two main cities – Asunción and Ciudad del Este – is being increased from two lanes to four. The airport will be modernized and its capacity increased. A light train network, with 44km of track, will be developed in the capital to reduce congestion and improve the efficiency of the road network. In rural areas, $1 billion of roads will be built in the next five years.

Jiménez estimates that Paraguay’s construction industry will require 1,000 qualified engineers every year for the coming years. Currently, the country produces 150 and Jiménez is working with colleagues responsible for education and training to improve the quality and quantity of graduates coming from technical colleges. He has also been in discussions with foreign governments to enable Paraguay to bring in teams of qualified workers. “We are talking to the ambassador of Spain and to other countries where we believe there could be an expert labour force that could come to Paraguay and participate in this process,” he says.

Paraguay is taking capacity issues in the construction industry seriously because the sector holds the key to growth in other industries and further diversification of the economy. For example, it is projected that the development of the waterway will lead to a boost in river transport that will require an extra 2,000 barges. At $1 million a barge, that equates to a $2 billion industry, in purely domestic terms, and was part of the logic behind Japanese company Tsuneishi Group opening its first Latin American operations in Paraguay. The company opened in 2011 and made its first delivery in 2013. This year it should produce 32 barges. Kenshu Okano, commercial manager, says the company was attracted to the low cost base – with only 10% income tax – and its low level of bureaucracy. The company now employs 300 – plus providing local subcontractors with business – and has plans to export barges to the region and as far away as the US and Germany.

Energy surplus

Another key ingredient in attracting international companies is surplus and low-cost energy. Paraguay currently consumes 2,600MW of energy but plans to double that by 2018. It can easily meet extra demand from power generated by its two mega-dams: it shares ownership of Itaipu with Brazil and Yacyretá with Argentina. At present, Paraguay needs only half the energy these dams produce and its neighbours consume the rest, compensating Paraguay at low prices. Paraguay is therefore building a transmission network to capitalize on its share of Yacyretá, with the aim of being able to use 50% of the dam’s energy by 2018. In 2023 Itaipu will be fully paid off and will start generating income of $1.2 billion (at today’s prices).

Paraguay is the only country in Latin America with surplus energy capacity, leading to rumours that it will be attracting large energy consumers, such as aluminum smelters. Minister of industry and commerce Gustavo Leite says the government will take a very pragmatic approach: “We have a three-stage approach to this question: first, will any proposal damage the environment? If not, then the next question is, will it require subsidy? If not, then the final question is, will it provide many jobs? We won’t close the door to anyone.”

Other ministries are also planning to aid diversification. Marcela Bacigalupo, minister of tourism, says the sector should be able to grow at 7% a year for the next decade, nearly double the projected rate for the global tourist industry of 4%. “We aim to grow significantly but we are keen to stress the importance of quality over quantity,” says Bacigalupo. “The aim is to develop a tourist industry that integrates Paraguay into the Latin American trail and also leads to repeat tourism – as well as domestic tourism, which will create an economic base that is more stable and less exposed to volatility.”

Mineral potential

Gustavo da Silva, deputy minister for mines and energy, says there is huge potential to develop industries from Paraguay’s rich mineral deposits. The ministry is working with British company President Oil to examine the commercial viability of oil production. There are also many mining opportunities: US company United Energy Corporation is exploring the possibility of mining uranium. A gold mine opened in 2001 and there are 10 other possible sites, as well a project in the pipeline to extract 500,000 tonnes of titanium and 400,000 tonnes of pig iron. The country also has lithium, diamonds, nickel and palladium deposits that could attract foreign businesses and capital.

The relatively deep-lying nature of many of these minerals – as well as the current logistical difficulties of exporting to key Asian markets – has led to inactivity in the past. However, da Silva says he believes momentum will come. “Paraguay is compensating for these issues with a low royalties regime: we take between 2% and 8%, depending on the stage of production, whereas most countries’ royalties regimes start at 5%,” says da Silva. “We think that as Paraguay begins to attract foreign companies then others will take notice and come to the country to explore opportunities.”

Leite agrees: “International companies and investors are very smart in their decision-making procedures. I don’t foresee Paraguay being the destination for major global companies – we are aiming for the medium to large companies,” he says. And on Leite’s key metrics, the recently implemented policies are already working: the creation of an accelerated business establishment programme, SUACE, has led to four times as many companies being opened in the country in the first half of 2014 compared to 2013.