IN SPITE OF their geographical propinquity, Central Americans have never like being lumped together, championing their diversity rather than what they have in common. But new governments take office this year in Guatemala, Panama and El Salvador that face similar economic challenges. They are ones that investors hope can be dealt with successfully, enabling these small republics to build on their nascent reputation as alternative safe havens for bondholders in volatile Latin America.
Highest on the agenda is a cap on rising fiscal deficits. A close second is the urgency of tax and expenditure reform, which is likely to be a battle given the divisions in each nation's legislature. The good news is that voters this year opted for business-savvy newcomers with a pro-US agenda, not the rebel leftists of the war-torn past.
Guatemala's Oscar Berger has been the first to face up to the challenges. A former mayor who leads a centre-right coalition and is backed by the country's most influential business chambers, Berger took office in January for a four-year period. His rise to the presidency put a welcome end to the dominance of the governing party of former dictator Efraín Ríos Montt. That weak administration left Central America's largest economy stagnating, despite some attempt at fiscal discipline and success in maintaining a low debt to GDP ratio of around 20%, beneath Latin America's 43% ratio average.
The first few months in power have not been easy for Berger, who lacks a majority in congress and heads one of the most polarized democracies in Latin America, with a powerful business elite and a largely impoverished rural electorate. Berger's priority is to push a fiscal package through congress that will increase tax collection and find resources that should have come via a business tax that was annulled in February. That will cause a shortfall in the public accounts of over $300 million in 2004. Guatemala's tax take was one of the lowest in Latin America in 2003, at about 10% of GDP.
Berger presented his fiscal package to congress in May and is hoping it will generates around $625 million in additional revenues this year. Berger has also asked congress to authorize up to $625 million in debt to meet the country's financing needs for this year. To date, investors hold more than $750 million in Guatemalan dollar-denominated bonds, maturing in 2007, 2011 and 2013.
"If nothing is done, the deficit could reach 4% of GDP this year. The government would have to cut spending drastically or find other ways to finance such a high deficit," says Sebastian Briozzo, an analyst at rating agency Standard & Poor's.
Investors are waiting to see if Guatemala will sign a new stand-by agreement with the IMF, which would send a signal to bondholders that the country was unlikely to default on its foreign debt. Guatemala negotiated access to a line of credit in April 2002 but the agreement was not renewed in March this year, as many had hoped would happen. Analysts now hope that even without a loan agreement, Guatemala will keep its finances in line with earlier IMF targets. Those include raising tax revenues to 12% of GDP and maintaining the budget deficit at 2% of GDP. The financial stipulations will be well within Berger's reach if he meets a campaign pledge to attract some $2 billion in private investment for major road, port and airport infrastructure projects.
El Salvador's new president takes charge of one of the healthiest economies in the region. Elias Antonio "Tony" Saca, a former football commentator and media businessman, won in March elections against a former leftist rebel. He will begin a five-year term on July 1. His triumph, a relief for investors worried about a shift away from orthodox economic policies, should ensure the continuation of the market-friendly strategy that Saca's Alianza Republicana Nacionalista (Arena) party has built up over the past 10 years. This has put the economy in a strong structural position. Arena policy has stressed privatization of state assets, monetary stabilization, trade liberalization and foreign investment.
"Tony Saca ensures policy continuity, which is helpful for investors," said Shelly Shetty, analyst at Fitch Ratings in New York.
El Salvador, which dollarized in 2001, is one of only three Latin American countries with an investment-grade rating and boasts low interest rates and low inflation. Remittances from Salvadorians in the US boost private consumption and contribute 13% of GDP.
However, risks abound over the fiscal deficit, which closed 2003 at near 4% of GDP amid high levels of public debt. The deficit was a more manageable 1.8% in 1997 but has ballooned since earthquakes hit the country in 2001 and millions were spent on reconstruction.
Reconstruction spending is expected to be completed by 2005 but the burden on public accounts seems likely to be replaced by the cost of the changes to the pensions scheme. A shift from public to private means state pensions payouts continue while contributions will go to the recently established private pension funds.
The IMF has urged a deficit cut to 3 % of GDP, an increase in the tax take and changes to the onerous pensions system. But that will not be easy in a congress where Arena does not have a majority.
"Saca has run on a platform of providing a human face to economic growth, which implies higher spending on education and the social sector. One has to ask how he will get the resources to meet his electoral promises," says Fitch's Shetty.
Weak tax collection efforts, tax exemptions and loopholes in VAT have all contributed to a low tax haul in El Salvador, something Saca will need to remedy. Outgoing president Franciso Flores laid the basis for a recovery in tax revenues, which increased to near 12% of GDP in 2003 from 10.5% in 2001. But low economic growth has made it harder to increase income taxes or VAT, and Saca will face a political cost if he tries to raise taxes and improve the fiscal outlook