Public Information Notice No. 07/41

Public Information Notice: IMF Executive Board Concludes 2006 Article IV Consultation with Guatemala

March 27, 2007

On February 14, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Guatemala.¹

Background

Economic performance in Guatemala has improved markedly since the last consultation. Growth increased to 4½ percent in 2006, fueled by the increasing flow of family remittances, which spur consumption, and higher fixed capital formation. For the first time in several years, inflation has declined below 6 percent, the central bank target. The external current account deficit is stabilizing at 4.5 percent of GDP while the overall surplus of the balance of payments has permitted the accumulation of international reserves, which remain at about 4 months of imports of goods and services.

The improved performance has been grounded on prudent macroeconomic policies, anchored in low public debt and deficits, and on the important progress made in many areas of structural reform.

The central government deficit is expected to remain at around 1½ percent of GDP in 2006, below the level originally envisaged, and non financial public sector debt is expected to remain at about 18 percent of GDP, one of the lowest levels in the region. On the revenue side, losses from the elimination of some taxes and improvements in refunding value-added tax credits to exporters have been offset by enhanced tax administration. Prospects in this area have improved after the passage in June 2006 of a tax administration reform that is expected to offset revenue losses from entry into CAFTA-DR. On the expenditure side, management and transparency of fiscal operations improved with the extension of coverage of the Integrated Financial Management System (SIAF) and the expanded reporting of Guatecompras, increasing competition in public sector procurement.

The central bank has made important progress preparing for the implementation of an inflation targeting regime, reducing discretion, and increasing transparency in the conduct of monetary policy.

Structural impediments to growth are being addressed, contributing to attracting more investment. Legislation has been passed to enhance competition in government procurement and telecommunications, strengthen intellectual property rights, and upgrade customs procedures. As a result of these political efforts, CAFTA-DR came into effect in July 2006, improving prospects for efficiency gains from economic integration.

The failure of two banks, in particular the case of Bancafe, a large bank that was hurt by financial problems in its offshore affiliate following the failure of Refco in 2005, threatened to disrupt broadly positive macroeconomic trends. However, both banks were resolved quickly and onshore depositors were protected, which helped to minimize systemic repercussions.

Executive Board Assessment

Directors commended the Guatemalan authorities for the sound fiscal framework, improvements in tax administration, increase in transparency of fiscal and monetary policies, and structural reforms to promote growth and regional economic integration. These policies, together with robust remittances and benign external conditions, have contributed to higher economic growth, macroeconomic stability, and low public debt. To consolidate these gains, key priorities are to strengthen the financial system, address social needs by raising tax revenue, consolidate the decline in inflation, and gradually allow for more flexibility in the exchange rate. Downside risks to the outlook arise from tensions in the financial system and slowing growth in trading partner countries.

Directors noted that a key challenge for the medium term will be to strengthen the banking system. While the authorities managed to avert a disruption to financial stability arising from the failure of two banks, they need to take immediate steps to bolster the banking resolution framework and strengthen confidence in the banking system. These include re-capitalization of the deposit insurance fund, an increase in the annual deposit insurance premium paid by banks, taking action to prevent banks from engaging in unsupervised intermediation and steps so that the assets of the failed banks are properly administered, and development of additional tools and contingency plans to deal with systemic bank failures. For the medium term, Directors stressed that, although progress has been made in implementing the Financial Sector Assessment Program recommendations, more needs to be done to strengthen bank supervision and regulation and the legal authority of supervisors. In particular, financial conglomerates should be subjected to improved risk assessment and effective consolidated supervision, and onshore bank operations should be immunized against problems in offshore affiliates. Other important measures include tightening credit classification and provisioning rules, and limiting connected lending and exposure of unhedged borrowers to exchange rate risks.

Directors commended the central bank for meeting the inflation objective, but noted that money and credit expansion has been rapid as a result of high liquidity associated with strong capital inflows. They recommended that short-term interest rates be raised to positive levels in real terms, with due consideration given to the impact on the financial sector. Directors also noted that greater exchange rate flexibility would strengthen monetary control, limit the cost of sterilizing of external inflows, and help the economy to adjust to changes in global and domestic conditions.

Directors agreed that the proposed fiscal stance for 2007 will help to consolidate public debt at a low level, but expressed concern that the budget has not yet been approved. The critical issue is how to raise the tax revenue relative to GDP, as the current low tax ratio limits the government's ability to provide adequately for social needs, infrastructure investment, and contingencies. Directors welcomed the ongoing political dialogue on the need to increase the tax ratio, and encouraged the government to prepare a tax reform, based on the recent IMF technical assistance, that could be considered by congress later this year.

Directors welcomed the authorities' efforts to improve the business environment, and encouraged greater progress with reforms to enhance productivity and the benefits of regional integration.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.