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Jun 28, 2016 | 09:15 GMT

The Paradox of Paraguayan Manufacturing

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(Stratfor)
Forecast Highlights

  • Paraguay's strategic location within 1,500 kilometers (about 930 miles) of Mercosur's most important markets will continue to drive foreign investment.
  • But the country's overdependence on Brazilian and Argentine business cycles will limit its industrial growth in the coming years, prompting Paraguay to look for alternative sources of foreign direct investment in neighboring countries, the United States or the European Union.
  • Because Paraguay's workforce lacks experience in the production of high-end technological products, its manufacturing industry will remain focused on the agriculture, textile and, to a lesser extent, automotive sectors.

Compared with North America, which features abundant navigable rivers and flatlands, South America is not so geologically lucky. Impenetrable rain forests and the world's longest continental mountain range divide country from country, inhibiting social and political cohesion. But of all the South American territories that colonial Spain controlled for nearly 300 years, Paraguay, with its vast thorn forests and savannahs, was among the most remote. Even after Paraguay gained its independence in 1811, a series of isolationist dictators kept the country cloistered from the rest of South America. Its seclusion came at a cost: Throughout its history, Paraguay's economy has been one of the most underdeveloped in the Southern Cone.

But since President Horacio Cartes came to power in 2013, Paraguay's economy has grown substantially. In the face of a global commodities slump, the country has proved more resilient than Brazil and Argentina have, thanks to its business-friendly policies and proximity to the Southern Cone's most important markets. Despite its sustained economic growth and stable political environment, however, Paraguay's manufacturing industry — the source of its newfound prosperity — faces long-term limitations that will not be easy to surmount.

From Isolation to Connection

Foreign investment drives Paraguay's economy: Between 2013 and 2014, foreign direct investment in Paraguay grew by more than 230 percent. Even in 2015, when low commodity prices drove FDI down by 15 percent in the region, U.S. companies invested over $140 million in Paraguay, and Brazilian firms kicked in roughly $130 million. Each country invested most heavily in Paraguay's manufacturing and service sectors, which claimed just over 30 percent and 65 percent, respectively, of the country's FDI in 2014.

Several factors explain Paraguay's appeal to foreign investors. With a flat income tax of 10 percent, the country has one of the lowest tax rates in the region. Moreover, Paraguay owns half of the energy generated by the Yacyreta Dam, a joint hydroelectric project with Argentina, and by the Itaipu Dam, shared with Brazil. As a result, the country can produce between 3,200 and 14,000 megawatts of electricity. This capacity translates to lower electricity prices; at an average industrial rate of less than approximately $95 per megawatt-hour, electricity is much cheaper in Paraguay than it is in other countries. Brazil's industrial rate, for instance, exceeds $250 per megawatt-hour, leading many Brazilian companies to set up shop in Paraguay. In the past two years, more than 100 companies — around 80 percent from Brazil — have established operations in the country to develop the textile, automotive parts and plastics sectors of Paraguay's manufacturing industry. Paraguay, in turn, has exported over $300 million worth of textiles and more than $150 million worth of auto parts since 2015.

Beyond manufacturing, Paraguay boasts a large and robust agricultural industry. It is the world's 10th-largest exporter of wheat, sixth-largest exporter of corn and fourth-largest exporter of soybeans. Furthermore, the country's Chaco region offers great potential for cattle-ranching ventures: Of 24 million hectares (59 million acres) suitable for livestock production, less than 9 million hectares are currently in use. Regional investors are taking notice, and already Uruguayan investors own more than 2 million hectares in the area.

But Paraguay's greatest advantage is its location. The country's capital and largest city, Asuncion, occupies an important transit point in the Paraguay-Parana waterway, which connects Brazilian, Paraguayan and Argentine markets and transports roughly 100 million metric tons annually. In addition, Paraguay's proximity to the Southern Cone's major markets makes it an ideal export platform. Products manufactured in the country can reach cities such as Cordoba and Sao Paulo, less than 1,600 kilometers (1,000 miles) away, quickly and cheaply. Consequently, Paraguay stands to become a competitive rival to China, which currently supplies most of Argentina's and Brazil's manufactured imports.

Growing Pains

Despite its competitiveness and political stability, however, many challenges lie ahead for Paraguay's industrial growth, some of which are beyond its control. For instance, Brazilian, Uruguayan and Argentine transportation infrastructure could facilitate or constrict Paraguayan exports. Relative to its neighbors, Paraguay is a small country without the resources necessary to build more transit routes, and it will depend on Argentina and Brazil to extend their infrastructure to connect with Paraguay's. This reliance extends beyond infrastructure as well. Not only is Brazil a major export market for Paraguay, but it is also its second-largest foreign investor. This means that Paraguay will remain at the mercy of Brazil's dramatic boom-and-bust economic cycles. Although the United States has become the country's biggest foreign investor, Paraguay will be compelled to court new backers in Asia and Europe.

In the short term, Paraguay's manufacturing industry, however prosperous, could curb its economic growth. Paraguay has one of the youngest populations in the region — more than 30 percent of its citizens are between the ages of 15 and 24 — but its workforce is mostly unskilled. Outside of agriculture, workers will be limited to jobs in the agricultural and textile industries. Since most of the country's auto parts production, another booming sector in Paraguay, relies heavily on Brazilian investment, its stability is tied to Brazil's economic security. And because Paraguay imports all of its inputs, it will likely remain a platform for its neighbors to assemble goods more cheaply than they would be able to at home.

Though Paraguay's manufacturing sector has benefited recently from the country's location, geography remains a problem. The country's major infrastructure and connectivity are confined to its two largest cities, Asuncion and Ciudad del Este. Meanwhile, north of the capital, the environmentally protected Alto Paraguay region remains as secluded as ever.

Lead Analyst: Diego Solis

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