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
For both Guatemala and El Salvador, the best news of the year would be the ratification of the Central America Free Trade Agreement, which will bring free trade between Central American nations and the US. Negotiations ended in December and Cafta is expected to be signed by 2005 after US congress approval.
Cafta and after Central America, excluding Panama and Belize, exports 40% of its $10 billion annual goods to the US, and as tariff barriers come down, the region’s economic growth is predicted to double by the end of the decade.
For Guatemala, Cafta is crucial if GDP growth is to reach 3.5% in 2005. In 2003, just 2.2% growth was posted. El Salvador’s manufacturing sector stands to gain most from Cafta. Its assembly-for-export maquiladoras face stiff competition from China, but with Cafta the country could grow by 3.5% in 2005, according to Saca. Analysts say growth will only reach 2.5% without the trade deal: the economy grew a sluggish 1.7% last year.
Cafta also groups Honduras, Costa Rica and Nicaragua, and the trade relationship between the US and the five Central American countries generated around $22 billion in two-way trade in 2002. The free-trade pact would gradually eliminate tariffs on US exports to the five countries in return for trade reforms, including strengthening copyright and patent laws. Duty-free access to the US is likely to include almost all goods except for sugar, which is a politically sensitive subsidized crop in the US.
Under a so-called fast track arrangement, the US congress must now approve or reject the free trade pact but cannot modify it. The only hitch for Central America is the political uncertainty of the November US elections. Many Democrats, including presidential candidate John Kerry, oppose the agreement on the grounds that its labour and environmental provisions are too weak. They want Cafta reworked to require the countries to incorporate the International Labour Organization’s “core labour standards” into their laws rather than relying on a promise by each nation to enforce their existing labour laws. “We are not in the lead at this moment,” Kevin Brady, a Texas Republican – responsible for collecting votes in Congress in favour of the free-trade pact – recently told a group of Central American business leaders and ambassadors. Brady, along with many other Republican lawmakers, argues that a free-trade deal would greatly help Central America’s economies while opening up new opportunities for US exporters.
Panama’s new government also hopes to drive its economy forward with help from the US, its major trading partner. Shortly before the May elections, the country started negotiations for a free-trade deal with the world’s biggest economy and hopes to improve on last year’s 4.1% GDP growth via an influx of capital into its $11 billion-a-year economy. Negotiations are likely to continue apace now that PRD party candidate Martin Torrijos, son of Panama’s former strongman Omar Torrijos, has emerged victorious from the elections. Torrijos, who campaigned on his father’s popular legacy and beat off a challenge from former president Guillermo Endara, will be sworn in for a five-year term in September. Most positively for investors, he has a pro-business, pro-US policy and should make an acceptable change from the populist incumbent, Mireya Moscoso. After several years of low growth, the economy is expected to power ahead by 6% in 2004, led by a construction boom.
“The majority of investors know Martin (Torrijos) and are not worried by his economic programme, so there is a feeling of calm … there is not the uncertainty that often occurs with a change of government because he is a known quantity,” says Mauro Leos, analyst at Moody’s Investors Service.
One of the most significant developments under Torrijos is likely to be the $5 billion upgrading of the Panama Canal, which carries 4% of world trade. Yet to be approved, it would enable some of the world’s largest ocean-going container vessels to use the canal. Many ships are too big for the canal and Panama is losing out on a lucrative slice of Asian-US trade, as the canal reaches full capacity. A failure to increase the route’s capacity could undermine its position in global trade.
“The expansion will be the real motor behind the Panamanian economy in the next decade,” says incoming vice-president Samuel Lewis Navarro.
How big is the deficit?
Away from the grandeur of the canal, thankless tasks await Torrijos, who must grapple with Panama’s fiscal position and the country’s social security system, which is destined for bankruptcy by 2012 without reform. Panama also needs an expenditure reform to make a recent $80 million tax reform efficient. According to the Moscoso administration, Panama is running a fiscal deficit of 2% of GDP, but Torrijos has said he fears that the deficit is much larger and analysts have put the figure at around 4%.
Since the end of 2002, the finance ministry has calculated Panama’s deficit by including the budget surplus of the canal, around $90 million, in its public accounts despite the fact that the government is unable to transfer funds from the canal. A widening deficit is particularly worrying for Panama because of its high debt load as a proportion of GDP, leaving less money for the debt service. With a 70% debt to GDP ratio, Panama has some $8.8 billion in debt, a high number for a nation of just 3 million people.
Analysts say that from September, Torrijos will have to dramatically cut fiscal spending to keep the deficit under control, but that will be a difficult task and could cost the new government valuable political capital correcting the mistakes of the unpopular Moscoso administration. Given its ambitious structural reform programme, the PRD party will not want to waste away its capital, although a majority in congress should make Torrijos’ job easier.
Panamanian global bond prices are expected to remain strong however, thanks to a law that allows the government to take bonds out of the market via the Fiduciary Fund for Development, which analysts expect Torrijos to continue.
The fund, which is a trust made up of money raised from privatizations of state companies, allows the government to buy up to $1 billion of global bonds, holding the debt in reserve and effectively paying itself interest.
“The government’s fiduciary fund did not undertake much net buying of Panamanian global bonds in 2003, thus retaining its technical bid, potentially limiting their downside price movements,” Jan Dehn, analyst at CSFB, says in a recent report. According to CSFB, the government increased the share of the Panamanian global bonds in the fund by only $19 million in 2003 to $398 million at the end of 2002.
Cabei expands lending to boost regional growth
As Central America states undertake changes of government this year and look forward to the benefits of a free trade deal with the US, the region’s largest financial institution, the Central American Bank for Economic Integration, is busy laying the groundwork for faster regional economic growth.
Cabei, which is based in Tegucigalpa, Honduras, and has assets of $3.4 billion, equity of $1.2 billion and a loan portfolio of $2.6 billion, in March approved a $392 million loan for the Plan Puebla Panama. With backing from the Mexican government, the plan seeks to modernize energy, transport and service infrastructure in southern Mexico, Central America and Panama. That loan goes towards meeting a pledge by Cabei to provide $608 million in financing for the plan.
The resources for that and future loans are likely to come from the capital markets. Recently, Cabei established a $750 million multi-currency EuroMTN programme and used it to issue a benchmark $200 million, 10-year bond with a 6.809% yield to maturity and a 6.75% coupon. Since then, Cabei has placed two dollar-denominated issues with local investors. The financing links in with a Cabei initiative to unify the region’s regulatory and accounting standards.
According to recent figures, Cabei granted $1.1 billion to Central America between July 2002 and June 2003 to boost economic recovery in line with the pick-up in the world economy. The private sector makes up 35% of Cabei’s borrowers, which comprise some 50 banking institutions across Guatemala, El Salvador, Honduras, Nicaragua and Costa Rica.
One of the most pressing projects backed by Cabei is the construction of La Unión port in El Salvador. The port’s authority says it needs another $25 million more than the $125 million it is set to borrow. The Japan Bank for International Cooperation (JBIC) will fund 75% of the $125 million while Cabei will finance $25 million and the government another $10 million.
Cabei, which gained its investment grade rating in mid-2002, could expand significantly if it decided to lend to projects by using A/B loans, a structure tried and tested by international development banks for decades. Cabei would assume the political risk in the A tranche of the loan and syndicate the B tranche, which would carry no political risk, to Central American investors. Such an approach is possible as a result of Fitch Ratings having in March upgraded Cabei’s long-term foreign currency rating after Spain became a non-regional shareholder. Fitch has raised Cabei’s long-term foreign currency ratings to BBB+ from BBB and affirmed the short-term foreign currency rating at F2, reflecting the bank’s solid outlook.
