Describes the preliminary findings of IMF staff at the conclusion of certain missions (official staff visits, in most cases to member countries). Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, and as part of other staff reviews of economic developments.
Guatemala—Concluding Statement of the 2013 Article IV MissionMay 20, 2013
This note summarizes preliminary findings and conclusions of the mission that visited Guatemala during May 9-20 to conduct the 2013 Article IV consultation. The mission thanks the Guatemalan authorities for their cooperation and open dialogue.
Recent developments, Outlook, and Risks
1. Guatemala’s economic performance has been sound since the 2008-09 global financial crisis. In its aftermath, activity rebounded quickly, spurred by both net exports and domestic demand. Activity is now nearing potential and macroeconomic policies stay a prudent course, not least with declining fiscal deficits—helping maintain low inflation. The financial system appears robust.
2. Economic developments since the 2012 Article IV Consultation have been positive.
• Growth has been solid, while converging to trend. Rebounding from the global financial crisis and natural disasters in 2010, activity surged by 4¼ percent in 2011. Economic expansion decelerated to 3 percent in 2012, underpinned by robust domestic demand and near the estimated potential of about 3½ percent.
• Inflation declined in 2012, but has begun to pick up. As commodity prices stabilized and domestic demand pressures weakened, inflation fell sharply in 2012—closing at 3.4 percent by December. However by April 2013, inflation rose to 4.1 percent, still within the central bank’s target range.
• The external sector continues to do well. The current account deficit declined to just below 3 percent of GDP in 2012 (from about 3½ percent of GDP in 2011)—as a softening in traditional export prices was more than offset by a strong recovery in remittances from the U.S. and higher factor income, amid tepid growth in import values. Net international reserves are in line with reserve adequacy metrics. Competitiveness is broadly adequate, though with some signs of erosion.
3. The outlook is also broadly sanguine. Under our baseline scenario, growth is expected to increase to 3½ percent in 2013 and 2014, reaching its potential rate, supported by still-buoyant domestic demand and healthy private sector credit. Inflation will linger in the upper half of the central bank’s target range in 2013-14 before converging toward the center of the band. The external current account deficit would decline to 2.6 percent of GDP in the medium term, more than fully financed by FDI and other capital inflows. Some fiscal consolidation is anticipated, with the central government deficit stabilizing at 2¼ percent of GDP and public debt rising slowly to 28 percent of GDP by 2018.
4. Risks are on the downside, stemming from both global uncertainties and domestic policy constraints. In the near term, weaker than expected growth in the U.S. would have adverse spillovers through trade and remittances. In addition, a hike in global risk aversion could curtail access to international capital markets. Domestic risks could arise from threats to policy implementation, including a reversal of key elements of the 2012 tax reform, or introduction of new tax incentives. In the longer term, persistence of insufficient revenue mobilization could deter investment in physical and human capital.
5. The fiscal deficit continued to narrow in 2012, but not enough to prevent a further rise in the public debt ratio. The central government deficit declined to just below 2½ percent of GDP in 2012, down from about 2¾ percent in 2011. Consolidation was driven by spending containment. Public sector debt, however, continued its upward trend as a share of GDP and is comparatively high in relation to tax revenue.
6. Fiscal structural reform attempts have suffered setbacks and delays. Claims against the tax reform package approved last year—yielding 1-1½ percent of GDP—have piled up before the Constitutional Court. So far these challenges have been largely unsuccessful, though associated uncertainties have weighed down on collections and possible amendments to the reform may erode revenues. Additionally, the implementation of the reform has been plagued problems in the tax and customs administration, which have held back gains in revenue. A draft Competitiveness Law sent to Congress by the President grants fiscal incentives to firms incorporated outside Guatemala City, with potentially non-negligible fiscal costs in the medium term. Accumulated domestic arrears, which spiked in 2010, remain unresolved.
7. The broadly neutral fiscal stance expected for 2013 is adequate from a demand management perspective. The 2013 budget targeted a central government deficit of 2½ percent of GDP. However, accumulated revenue underperformance and delays in the disbursement of some multilateral loans will be offset by lower spending on capital, goods and services, and transfers. Thus, we project a broadly neutral central government deficit of 2¼ percent of GDP in 2013, appropriate in light of a virtually closed output gap and growth projected at potential.
8. However, the mission stresses that continued increases in the burden of public debt are a source of vulnerability. While the government debt-to-GDP ratio is comparatively low, it has been rising steadily since the 2008 crisis, and will continue to grow in the medium-term. In our view, Guatemala cannot comfortably rely on debt financing to support prolonged expansionary counter-cyclical policies as funding risks could escalate, especially in light of its high debt-to-revenue ratios. Exposures to rollover and FX risks could also rise steadily in the medium- to long-run, as the country gains access to international markets. Moreover, the lack of depth in the domestic financial market and rigidities that curtail access to official financing in FX provide thin coverage against spikes in global risk aversion.
9. Hence, fiscal sustainability should be reinforced over the medium term. Stabilizing the debt-to-GDP ratio at its current level would require a permanent improvement in the primary balance of about 1 percent of GDP—the sustainability gap. This gap would be larger if the actuarial deficit of the social security system were taken into account. However, with output not exceeding potential, continuing global uncertainties exacerbating growth risks, and no pressing financing constraints, in our view immediate adjustment is not needed. Nevertheless, the mission recommends initiating in 2014 a moderately paced adjustment, with limited frontloading and spaced over several years which would strike the right balance between sustainability and growth. In this regard, the mission understands that the medium term fiscal plans of the authorities already envisage a gradual reduction of the sustainability gap.
10. The mission urges additional efforts to mobilize revenue beyond consolidation needs. Higher government revenues will be necessary to support priority public spending and achieve long-term sustainability. In particular, we advocate reducing tax expenditures and realigning VAT rates with those prevailing in the region. Regarding the draft law on fiscal incentives, the mission cautions that similar initiatives in other countries have often resulted in revenue erosion, while of dubious efficacy to stimulate investment. Other potential areas of intervention include: (i) lowering the degree of revenue earmarking, (ii) strengthening the tax and customs administration, and (iii) reducing informality.
11. In addition, it will be essential to improve the efficiency of public expenditure and reinforce the fiscal framework more generally. Planned IMF-recommended amendments to the Organic Budget Law would improve transparency and efficiency of public spending and help reallocate resources toward priority areas. Reforms should also focus on granting more flexibility to the approval of official financing, and preventing the under-execution of IFI-supported priority spending. Faster progress would be desirable with approval of the rest of the transparency package, in Congress since last year, and with implementation of a results-based budget. The mission reiterates also the need to improve public financial management to avoid spending arrears, finalize a reliable estimate of their outstanding stock, and establish a strategy for their clearance.
12. The mission supports the recent tightening of monetary policy. Having reduced the policy rate by 50 bps last June (to 5 percent), the central bank kept it unchanged until late April 2013 when it was raised by 25 bps. Given the uptick in inflation, higher inflation expectations, strong growth in consumer credit, and demand pressures, the April increase in the policy rate was prudent. Nonetheless, the authorities should stand ready to enact further policy rate increases and absorb excess liquidity should inflationary pressures persist.
13. Reform of the monetary policy framework must remain focused on anchoring low and stable inflation. Although Guatemala’s annual inflation is below that of its regional peers and within its target band, the transmission channels of monetary policy remain feeble, with significant pass-through effects from commodity prices. The mission believes that, in order to reinforce inflation as the primary objective of monetary policy, exchange rate (XR) flexibility should be gradually enhanced. In this regard, the mission welcomes the slight widening at the end of 2012 of the XR fluctuation margin used to determine intervention and the associated decline in FX intervention. At the same time, we observe that the latter is still significant, while XR flexibility remains quite low relative to the region. Development of public debt and private securities markets would also be helpful, not least to facilitate monetary operations. As a precondition, the draft capital markets law should be finalized in compliance with IOSCO best practices and passed.
14. Close vigilance over rapid credit growth to the private sector is advisable, though the financial system appears solid. Banks are profitable, liquid, well-capitalized, and domestically-funded, while non-performing loans are low and fully provisioned. However, private sector credit as a share of GDP has recovered to above pre-global-crisis levels, and loan dollarization, already quite high, has been picking up. Albeit there are no immediate concerns, the mission cautions that a persistent period of high rates of credit expansion could eventually undermine the stability of the financial system.
15. Key reforms of the financial system have advanced and the mission urges continued regulatory strengthening. Long-awaited amendments to the Banking Sector Law and the Central Bank Organic Law were approved in 2012 and entered into force in April 2013. Their implementation is expected to reduce risks from offshore operations and connected lending, strengthen supervision and enforcement powers of the superintendence of banks, and enhance the banking sector safety net and resolution procedures. In 2012, Guatemala was reclassified into the OECD’s “white list” and the mission encourages the authorities to foster passage of the draft Banking Secrecy Law, along with other measures to combat money laundering. Guatemala is well placed to apply key Basel III components, and is in compliance with most of the Basel I framework. The mission supports the authorities’ plans to further strengthen risk-based supervision.
Structural reforms and poverty alleviation
16. Guatemala has gained some ground toward achieving the MDGs, but poverty and crime are widespread. Modest-to-strong progress has been recorded for 12 out of 16 MDG targets: extreme poverty has declined somewhat, primary enrollment has risen (albeit from low levels), and maternal mortality has fallen. However, a third of the population is below the minimum dietary energy consumption, and chronic malnutrition of children younger than 5 years is pervasive. At the same time, the level of informality is very high and security concerns are very serious.
17. Well-targeted social spending and structural reforms should be stepped up. Social spending in Guatemala is too low, leaving critical social needs unmet. Beyond the benefit of reducing poverty and hunger, measures undertaken by the public sector have the potential to improve social indicators that impinge on the country’s productivity. There is still much scope to enhance competitiveness through structural reforms to improve the business climate and by reducing violence and impunity.