IMF Executive Board Concludes 2008 Article IV Consultation with GuatemalaPublic Information Notice (PIN) No. 08/65
June 4, 2008
Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.
On May 19, 2008, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation with Guatemala.1
Macroeconomic developments have been broadly positive since the last Article IV consultation, anchored by prudent macroeconomic policies. Despite tensions in the financial sector in late 2006 and early 2007, macroeconomic stability has been maintained, and growth has risen substantially above historical averages, to 5.2 percent in 2006 and 5.7 percent in 2007. Despite the rising oil import bill, the current account remained at 5 percent of GDP, thanks to continued growth of exports and remittances. The overall surplus of the balance of payments has permitted the accumulation of international reserves, which remain equivalent to about 4 months of imports and 100 percent of public external debt. Inflation rose to 8¾ percent in 2007, due to both large external price shocks (oil and food) and domestic demand pressures.
The fiscal position remains solid, with the central government deficit contained and the public debt, estimated at about 22 percent of GDP in 2007, among the lowest in the region. The central government deficit declined only slightly to 1.8 percent of GDP in 2007 despite a substantial increase in revenues, mainly due to spending on infrastructure in excess of approved budget ceilings. To avoid the reoccurrence of these overruns, measures have been taken to improve the control of budget execution. Revenue performance has been strong, especially as a result of tax administration reforms introduced in 2006, yielding about 0.7 percent of GDP in additional revenues in 2007.
Higher oil and food prices, explaining about 3 percentage points of headline inflation in 2007, contributed to the rise of inflation above the central bank objective in 2007. However, domestic demand pressures, including due to high credit growth, still persist. An early response of monetary policy to contain them was constrained by tensions in the banking sector in late 2006 and early 2007, but since then the central bank has increased gradually the policy interest rate to 6.75 percent by end-March 2008.
The structure of the Guatemalan banking system has undergone important changes. Two bank failures in late 2006 and early 2007 were resolved quickly and effectively, and in the aftermath, the system has consolidated through a wave of mergers and acquisitions. Mirroring developments in other countries in the region, international banks have also increased their presence in the country. The authorities have taken measures to improve financial sector regulation and supervision, including through better monitoring of bank liquidity, implementing risk-based supervision, and issuing new regulations, including on credit concentration limits and liquidity requirements for offshore banks, and rules for the appointment of external auditors.
Executive Board Assessment
Executive Directors commended the Guatemalan authorities for the strong performance of the economy in 2007, substantial improvements in tax administration, and continued efforts to promote growth and regional economic integration. While near-term prospects remain favorable overall, there are downside risks from a sharper deceleration of the U.S. economy, given strong economic linkages through trade, remittances, and financial flows. In addition, inflation risks remain tilted to the upside, given the increase in international food and fuel prices.
Directors welcomed the authorities' focus on improving Guatemala's resilience to shocks and sustaining high growth rates to reduce poverty. This will require further strengthening of banking regulation and supervision, raising tax revenue and key pro-poor expenditures, and continuing efforts to improve the business environment and lower inflation.
Directors noted that the low level of public debt has been a key strength of Guatemala's macroeconomic policies. The recent strong revenue performance provides an opportunity to address social and infrastructure needs without jeopardizing debt sustainability. Directors supported recent initiatives to strengthen the social safety net and to protect the poor from the impact of higher food prices. They saw scope for automatic stabilizers to work in the event of a larger-than-expected economic slowdown. They concurred with the authorities' plan to secure contingent external financing, if needed, to avoid crowding out private sector credit and drawing down government deposits at the central bank. Directors supported the authorities' intention to submit a revenue-enhancing tax reform to congress to achieve the objectives of the 1996 Peace Accords. Higher revenues should be directed to strengthening social policies, public security, and infrastructure. Directors called for continued efforts to improve the transparency and efficiency of public spending.
Directors noted that high food and oil prices were a major factor behind the increase in inflation in 2007, and that continuing external inflation pressures are complicating the conduct of monetary policy. They welcomed the increase in the policy interest rate, and noted that, while downside risks warrant a close monitoring of developments, further monetary tightening may be needed to avoid second-round effects of external inflation and to anchor inflation expectations at a low level. To increase monetary policy effectiveness and strengthen the credibility of the inflation targeting framework, most Directors recommended that the authorities allow greater exchange rate flexibility. This would also lower sterilization costs, reduce incentives for dollarization, and help the economy adjust more smoothly to changes in global and domestic conditions. A few Directors, however, advised caution in revising exchange rate policy, noting the significant pass-through of exchange rate movements to the domestic economy. A number of Directors supported the authorities' request for Fund technical assistance in developing the secondary market for government debt, which will strengthen the monetary policy transmission mechanism.
Directors observed that Guatemala's current account is projected to be sustainable over the medium term, and that the appreciation of the real effective exchange rate has been broadly consistent with fundamentals. While the strong export growth in recent years suggests that competitiveness has been maintained, the authorities should continue pursuing productivity-enhancing reforms to boost long-term growth.
Directors commended the authorities for their effective resolution of two bank failures in 2006 and 2007. Actions are needed to strengthen the banking system's prudential and legal framework and address remaining vulnerabilities, including the increasing dollarization of loans. Directors welcomed the recent progress made to implement risk-based supervision and the plan to reform the banking law in 2008. These should be accompanied by additional efforts to enhance the bank resolution framework, better ring-fence offshore banks, and eliminate legal constraints to effective banking supervision. Directors emphasized that building larger capital cushions, increasing loan-loss provisioning, and closely monitoring credit concentration in the banking sector will increase the financial system's resilience to adverse economic shocks.
Directors welcomed the progress made in improving macroeconomic statistics and encouraged the authorities to continue with their efforts, especially with respect to the quarterly GDP figures, consolidated public sector statistics, and measurement of balance of payments flows.