Central America: A region finds its feet

After tumultuous decades of war, economic stagnation and isolation, Central America is at last standing on fairly stable ground with its eyes on wider horizons. In a relatively short period of time, the region has put an end to a number of debilitating civil wars, achieved steady economic growth and laid the groundwork for foreign investment.

In response to these efforts, several countries in the region were assigned investment-grade ratings for the first time last year. Standard & Poor's rated Costa Rica BBB-, while Moody's gave El Salvador Baa3 and Panama Baa1. The region's two poorest nations, Honduras and Nicaragua, are also making slow progress on restructuring their economies as they privatize and streamline bloated state bureaucracies under IMF pressure.

When Panama tested the international waters with the region's inaugural Eurobond last February, international investors gave a broad welcome. Led by Bank Boston, the five-year issue was to have been for $250 million but was increased to $500 million as a result of the high demand. Guatemala followed in August with a 10-year $150 million Eurobond also led by Bank Boston which was oversubscribed by $300 million. Panama returned to the market in September with a 30-year deal for $700 million which retired $713 million worth of Brady bonds.

These bond issues have shown some sensitivity to the Asia crisis. Panama 02, launched at 175 basis points over treasuries, has widened to around 235bp since the crisis. The republic's 30-year issue has widened out from 250bp at launch to nearer 320bp. Likewise the spread over treasuries on the Guatemala issue has increased significantly from 240bp in August to over 300bp. With very little trading in these bonds, the exact spreads can only be estimated. "There's no market for the Panamanian or Guatemalan bonds at the moment," comments one trader.

But when the market improves new issuance can certainly be expected. This year Costa Rica and El Salvador are waiting on the sidelines for the right opportunity to issue a total of $400 million in Eurobonds. Panama has plans to issue a further $145 million in the international markets.

While the Asia crisis has scared away some investors, Central America has generally weathered the Asian turbulence well. Although some investors have stopped buying long-term government paper for the time being, there is still some demand for shorter-term paper. Once investors recover from their wariness about emerging markets in general, many are likely to be enticed back to Central America by the prospect of high yields coupled with currency stability.

"Since the crisis, investor demand is still very high for the area," notes Roberto Zamora, head of Latin American financial services for Lafise, a Miami-based boutique specializing in Central American government debt. "The macroeconomic indicators are very good. Enthusiasm is growing about Central America."

After decades in which economic progress was held up in much of the region by chronic instability and violence, Central America can now focus its efforts on sustainable development. In late 1996 the Guatemalan government signed a treaty to end the country's 36-year civil war, the area's last remaining armed conflict. With the peaceful resolution of the civil wars in El Salvador, Nicaragua and Guatemala, the region seems poised for a next historic step. Perhaps the time is finally ripe for an idea first pondered in the 1800s: regional economic integration.

The countries of the region (excluding Panama which was then part of Colombia) made their first attempt to integrate on independence from Spain in 1821 when they formed the short-lived Central American Confederacy which lasted until 1838. They tried again in the 1960s with the creation of the Central American Common Market, a protectionist trade agreement which quickly dissolved amid squabbling. But last September, the region's leaders met in Nicaragua to iron out an agreement on a more outward-looking political and economic union modelled largely on the European Union. A future union is likely to include the core countries of Central America - Guatemala, El Salvador, Honduras, Nicaragua and Costa Rica - while other countries may have some kind of associate membership. Panama, the Dominican Republic and Belize sent representatives to the Nicaragua meeting to discuss free-trade or tariff agreements with the core participants.

As well as moving closer together politically ­ all now have reasonably well-established democratic systems ­ the countries of Central America have already converged economically as a result of pursuing similar policies of trade liberalization and privatization. As bloated public sectors are streamlined, more investment opportunities are opening up. This year should be a banner year for privatizations, notably in telecommunications. Nicaragua, Guatemala, Honduras and El Salvador are expected to sell major interests in their state telecommunications companies by the end of the year.

Central American countries have been integrating in other ways. The region's stock exchanges have formed a network, the Association of Central American Stock Exchanges, or Bolcen, which allows companies to achieve a multiple listing on each Central American stock exchange. Each country is also expected to sign a treaty to connect the region's energy grids by the year 2000, although it has so far been approved only by Nicaragua

But despite the regional integration underway, big differences remain between Central American countries in terms of wealth, level of economic stability and creditworthiness.

Costa Rica

In Costa Rica, the election of Miguel Angel Rodriguez of the Social Christian Unity Party to the presidency last month may bring new momentum to economic policy. Until Rodriguez takes office in May few expect any major government initiatives from outgoing president Jose Maria Figueres. A Eurobond issue and major banking privatizations are pending.

Parliament has already authorized the government to issue as much as $500 million in long-term bonds in the next four years. Last November, a $200 million bond issue was suspended in response to the Asian crisis, just as lead manager Credit Suisse First Boston was about to start the roadshow. The government plans to resume the issue some time this year, depending on market conditions.

Last year Moody's gave a Ba1 rating ­ just short of investment grade ­ to government bonds based on a broadly favourable medium- and long-term economic outlook. Growth reached 3.2% last year with 11.2% inflation. This year, the central bank estimates GDP growth of 4.5% with inflation dropping to 10.5%. The bank also predicts the current-account deficit will decrease to 3.9% of GDP from 4.4% last year. The colon, currently trading at CRc247 to the dollar, devalues in increments according to a crawling peg regime.