Fitch Revises Paraguay's Outlook to Positive; Affirms at 'BB-'

Fitch Ratings has affirmed Paraguay's ratings as follows:

--Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'BB-'; Outlook revised to Positive from Stable;

--Senior unsecured foreign and local currency bonds at 'BB-';

--Country Ceiling at 'BB';

--Short-term foreign currency IDR at 'B'.

KEY RATING DRIVERS

The revision of the Outlook on Paraguay's IDRs to Positive from Stable reflects the following key rating drivers:

--Economic activity has accelerated in recent years. Real GDP grew 13.6% in 2013, the fastest among the countries rated by Fitch, without exerting pressure on domestic inflation. Although agriculture offered the largest contribution to growth after a severe drought in 2012, the non-agriculture sector posted a 7.7% expansion rate and has averaged 5% over the past five years. Such dynamism has enhanced economic diversification and mitigated output volatility in the primary sector. Moreover, large investments in agroindustry have supported the progressive transition towards production of higher value-added goods. Prospects for 2013-2014 are positive with a 4.9% average GDP expansion, higher than the 4.5% 'BB' median.

--Commodity dependence is high relative to peers in the 'BB' rating category. However, adverse weather-related shocks have had a modest effect on government revenues and external accounts as observed during severe droughts in 2009 and 2012. Sustained increases in productivity and commodity export diversification mitigate the risks from a correction in international food prices. Electricity -- the second largest export -- has more stable demand than other commodities.

--Paraguay is showing increased economic resilience to weaker economic conditions in its main neighboring trade partners. Brazil's low growth, and deteriorating economic conditions in Argentina have not materially affected Paraguay's performance. Paraguay's strong export performance and continued FDI inflows supported the reserve accumulation process observed over the last decade, resulting in a solid net sovereign external creditor position. FDI into Paraguay is attracted by its low energy and labor costs and low corporate taxes. Increased interest from Brazilian companies to open operations on the Paraguayan border could result in an important maquila-type industry over the medium term, with important gains in terms of FX generation and employment.

--Important changes in legislation could help to address some of the key weaknesses in Paraguay's credit profile, including low investment ratios, poor infrastructure due to years of underinvestment, and one of the lowest tax ratios in the 'BB' category. The recent approval of a Public Private Partnerships Law could reduce infrastructure bottlenecks and lift investment rates and economic growth potential over the medium term. Nevertheless, delays and execution risks remain present.

--The passage of the Fiscal Responsibility Law (FRL) in 2013 and its successful implementation could institutionalize the fiscal prudence observed in Paraguay during the period 2003-2011, which resulted in positive debt dynamics and fiscal solvency indicators that are among the strongest in the 'BB' rating category. The FRL, which will be implemented in 2015, reduces discretionary power of the legislature and the executive, limits the size of the public deficit to 1.5% of GDP, puts a cap on current expenditure growth, and links wage increases in the public sector to the evolution in private sector wages. Fitch expects the fiscal deficit to converge to the fiscal rule target by 2015.

--A Tax Reform also passed recently could increase government revenue over the medium term, discourage economic informality and reduce loopholes, exemptions and tax incentives. Changes also harmonized the corporate tax at 10% across all economic sectors, including agriculture, without affecting Paraguay's low tax advantage.

RATING SENSITIVITIES

The Positive Outlook reflects the following risk factors that may, individually or collectively, result in an upgrade:

--Sustained growth momentum that would allow for improvements in GDP per capita in an environment of low and stable inflation and sound public and external finances;

--Improvement in the business environment leading to higher investment rates;

--Expansion in the government's revenue base and moderation in fiscal expenditures that increase the likelihood of a successful implementation of the FRL in 2015.

The Outlook is Positive. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a material likelihood, individually or collectively, of leading to a downgrade. However, future developments that may, individually or collectively, lead to a revision of the Outlook to Stable include:

--Increased macroeconomic and financial sector instability;

--A sustained fiscal deterioration in the context of financing constraints.

KEY ASSUMPTIONS

The ratings and Outlooks are sensitive to a number of assumptions:

--Fitch assumes slow economic growth in Brazil and Argentina in 2014-2015. A sharper than expected deterioration in economic conditions could affect Paraguay's economic performance given the important trade and investment linkages with these countries.

--Soy prices are expected to remain at current levels after an 8.6% correction observed in 2013.

--Fitch assumes that Paraguay will continue to diversify and develop its financing sources and have access to multilateral funding.

Additional information is available on www.fitchratings.com.

Applicable Criteria and Related Research:

--'Sovereign Rating Criteria' dated Aug. 13, 2012;

--'Country Ceilings' dated Aug. 9, 2013.

Applicable Criteria and Related Research:

Sovereign Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=685737

Country Ceilings

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715618

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=818812

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