A Brief Analysis of the Central America and the Caribbean Economy

Central America Overview

Fiscal stimulus in the U.S., the region’s largest trading partner, will propel growth in Central America this year, supporting remittances, exports and tourism. Looking at a country-by-country picture, Panama’s economy will enjoy another stellar year thanks to strong fixed investment growth and solid earnings from the expanded Panama Canal. In Costa Rica, greater political certainty following victory for the establishment candidate in the second round of presidential elections should boost confidence, while Guatemala’s economy will be buoyed by robust infrastructure spending. Risks stem from faster-than-expected monetary tightening by the Fed, which would tighten financial conditions in Central America. Rising global protectionism and higher oil prices could weaken the external sector.

In general terms, Central America will likely find it difficult to make substantial headway in reducing fiscal imbalances. This is partly because many necessary measures—such as tax rises, subsidy cuts and pension reforms—could be politically unpopular, as demonstrated by recent unrest in Nicaragua over the government’s attempt to increase pension contributions. Another potential stumbling block is parliamentary arithmetic. In the case of Costa Rica, for instance, newly elected President Carlos Alvarado lacks a majority in parliament and could struggle to pass substantial fiscal reform measures. However, with its pension bill approved late last year, El Salvador showed that well-prepared proposals with broad-based support can bridge the political divide and overcome a fragmented legislature. Our panelists see Central America’s fiscal deficit coming in at 2.8% of GDP this year and narrowing only slightly over the forecast horizon to 2022.

– Central America Economist Oliver Reynolds

The latest from Costa Rica

What to expect from the new government and future economic policy

Carlos Alvarado and his new government will take the reins of a country whose public finances are flashing red. Moreover, when Alvarado takes office on 8 May, his political party, the Citizen’s Action Party, will only have 10 out of the 57 elected lawmakers in the Legislative Assembly. The extent to which his economic agenda can be enacted is therefore not entirely in his party’s hands.

The fiscal balance deteriorated to a deficit of 6.2% of GDP last year, the largest on record, and it continued to worsen in the first quarter this year, highlighting the urgent need for fiscal reforms. Alvarado supports the imposition of a fiscal spending rule, constraining government current expenditure levels, and transforming the current sales tax into a Value Added Tax with a wider range of taxable goods and services. All in all, he aims to bring the fiscal deficit down to 2.0%–3.0% of GDP by 2022. He has also outlined measures to shore up the country’s flagging economic growth, such as completing its entry into the OECD, establishing greater incentives to hire workers with disabilities, and promoting the science and technology industries. If effectively enacted, this encompassing agenda should improve Costa Rica’s economic outlook.

FocusEconomics Consensus Forecast panelists surveyed last month expect Costa Rica’s economy to expand 3.5% in 2018 and 3.6% in 2019. In terms of the country’s fiscal balance, they pencil in a deficit of 6.8% of GDP for 2018 and 6.6% of GDP for 2019.

FDI in Costa Rica and its longer-term prospects

Foreign direct investment (FDI) in Costa Rica, which benefits from an educated population and a friendly inward investment environment, was strong last year, despite uncertainty in the run-up to this year’s elections and higher interest rates. FDI was particularly strong in the tourism sector and in areas of the country that operate as free trade zones.

This year, the tourism sector should continue to support FDI in Costa Rica, as the country continues to be an attractive travel destination and important works such as the opening of a new Planet Hollywood are in the pipeline. Moreover, the longer-term prospects for the sector are likely to also benefit FDI, particularly if a recent Central American Council of Tourism proposal to create a common regional tourist visa gets off the ground.

However, risks to the FDI outlook for Costa Rica and the Central American region include a general rise in protectionism. This would be concerning for Costa Rica given that its economy depends to a large extent on FDI to finance persistent current account deficits.

– Costa Rica Economist Edward Gardner

The latest from Guatemala

The future of economic growth and its distribution between industries

Remittances from the U.S. have buoyed consumer spending in recent years and are expected to continue fueling consumption-driven growth in the years ahead, barring a slowdown in the U.S. or any abrupt policy changes by the Trump administration. That said, on the international stage, the two countries have been in lockstep in recent months, and warmer relations are likely to go some way in keeping stricter policies targeting Guatemala off the books in the U.S. Tepid government spending is set to get a much-needed boost over the next few years as heavier outlays into education and infrastructure are realized. Investment is seen picking up as economic sentiment recovers from years of political scandal and following recent government moves towards greater transparency.

How President Jimmy Morales’ corruption scandal affects current economic policy and the future of Guatemala’s government leadership

President Jimmy Morales has burned much of his political capital amid unending scandals, making it increasingly difficult to enact further (and sorely needed) economic reforms ahead of next year’s elections. Unfortunately, Congress also faces significant challenges as gridlock and political fragmentation keep necessary progress from materializing. Center-right parties still hold the advantage going into the elections, but they could see formidable challenges from political outsiders promising to crack down on corruption. Outgoing Attorney General Thelma Aldana now looks to be the one to beat given her broad popularity, influential political backing and anti-corruption agenda.

How foreign investment is affected by recent government corruption and instability

Investor confidence was badly shaken by the political scandals of the past few years, with international investors holding off as the crises unfolded. FDI inflows have been falling in recent years as political instability scared away more risk-averse investors. As the country looks to be moving away from the depths of these scandals, however, there is renewed hope that stronger foreign investment will eventually return.

– Guatemala Economist Christopher Thomas

The latest from Nicaragua

How the recent calling off of pension reform affects the ongoing deficit

Last year, the SPNF (non-financial public sector) deficit fell to 1.9% from 2.0% in 2016, despite a substantially larger INSS (social security institute) deficit. This came on the back of a healthier financial position in state-owned enterprises. However, with the pension reform shelved for the time being, the INSS deficit is likely to increase further this year, which should see the SPNF deficit rise too. The IMF had previously warned that liquid reserves could be exhausted by 2019 without fundamental structural changes to shore up the system. On the positive side, the impact on the public debt ratio should be limited, thanks to expected robust GDP growth. Last month our panelists expected the fiscal deficit to reach 2.2% this year and 2.2% again in 2019.

How recent riots will affect government stability and the economy

The riots will generate uncertainty and cause jitters among investors. One of Nicaragua’s key draws for investors in recent years has been the relatively stable macroeconomic and political environment; this now seems at risk. Although calling off the pension reform will placate those angered by that particular issue, it will do nothing to appease many who were shocked at the level of police violence. The dialogue promised by Daniel Ortega with firms, workers and students will be crucial, but a firm date has yet to be set. The success of these crunch talks will depend in part on how broad the demands of the different sectors are—and whether they will be limited to shedding light on police brutality and providing justice for victims, or go further and call for enhanced democratic freedoms and a new government. In the case of the latter, Ortega has shown few signs of wanting to relinquish his grip on power.

– Nicaragua Economist Oliver Reynolds 

The latest from Panama

Economic growth in 2017 in Panama was supported by a recovery in the country’s service sectors, which expanded 5.1% in annual terms (2016: +3.8% year-on-year). The expansion in services was driven by stronger growth in trade-related sectors including ports and Panama Canal transits, reflecting the pick-up in global trade observed last year.

The construction sector, which has, along with services, been one of the main drivers of economic growth in the past 10 years, had a more muted performance in 2017 as large-scale infrastructure projects were finalized. The Panama Canal expansion project culminated in 2016, and the expansion of the Inter-American highway finished in early 2018. This trend is expected to persist, as the expansion of Panama City’s international airport and the construction of its second metro line are nearing completion this year. Despite the slowdown, construction is nevertheless set to remain buoyant, which should help propel strong economic growth in the upcoming years. 

On the proposed law to introduce more transparency in the financial industry and how this will affect Panama’s economy

The proposed law was introduced as a necessary step to modernize Panama’s financial sector, as international pressure from organizations like the OECD and countries including France hindered activity in the sector. The tax proposal includes measures that in the interest of all key players involved because it was jointly drafted by the government and industry players such as interest groups and lobbies. This implies that the bill should not undermine the sector’s competitiveness. 

The bill forms part of the government’s efforts to adhere to existing standards of international transparency and exit grey and black lists the country currently finds itself on. This would help overcome barriers and restrictions that impede the normal functioning of the financial sector.

The law must be understood as part of ongoing efforts by the Panamanian government to make the financial sector more competitive and efficient by adhering to international standards of transparency and good practice. According to the Panamanian Ministry of Economy and Finances, the bill stipulates the creation of special entities to broaden the financial services offering and boost competition in the sector, among other things. As it is aimed at making the financial sector more efficient and competitive, this should have a positive spillover effect on the country’s GDP growth in the medium and long term.

– Panama Economist Jean-Philippe Pourcelot 

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As you can see there is a lot going on in Central America and the Caribbean and we here at FocusEconomics cover the region extensively with our monthly Consensus Forecast report. We cover 12 countries in the region with forecast and analysis on over 30 macroeconomic indicators for each economy. If you are interested in downloading a free sample of the report, just click on the button below.

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