## IMF Survey: Central America Aims for Stronger Growth

_IMF News, August 2, 2007_

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## Bibliographic details
- Authors: Alfred Schipke IMF Western Hemisphere Department August
- Published: August 2, 2007

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### Overview
- Author: Alfred Schipke, IMF Western Hemisphere Department; August 2, 2007.
- Central America has made important economic advances after years of political and economic turmoil, aided by improved political stability and favorable global conditions.
- Recent improvements:
  - Real GDP has recovered.
  - Inflation has remained under control despite the upsurge in oil prices.
  - Exports have been strong.
- Persistent challenges:
  - Poverty remains persistent and widespread.
  - The region remains vulnerable to economic events outside its control.
- Conference context:
  - Sixth annual regional conference held in San José, Costa Rica on June 29-30.
  - Coincided with publication of IMF Occasional Paper No. 257, Economic Growth and Integration in Central America.

### Reforms to reduce poverty and boost growth
- Central objective: reduce poverty, described as Central America's biggest challenge.
- Growth performance:
  - Average growth rates of the past decade have fallen short of records from the 1960s and 1970s.
  - The region's growth has lagged more dynamic emerging market economies, especially in Asia.
- Country outcomes:
  - Only three countries—Costa Rica, Panama, and the Dominican Republic—have raised GDP per capita above levels observed in the late 1970s.
  - Only Costa Rica has a substantially lower poverty level now than three decades earlier.
- Sources of growth (1960-2005):
  - Increases in output per worker reflected almost exclusively increased investment in capital equipment rather than productivity growth.
  - Variations in growth across subperiods and countries were closely associated with differences in productivity growth.
- Implication: improving productivity through reforms is paramount to raising living standards and reducing poverty.

### Strengthening institutions
- Institutional improvements identified as key to raising productivity.
- Simulation findings:
  - Bringing institutional quality up to Chile's level could raise growth by:
    - half a percentage point a year in Central American countries with relatively strong institutions (Costa Rica).
    - 3 percentage points or more a year in countries with relatively weak institutions (Guatemala, Honduras, and Nicaragua).
- Institutional dimensions cited: government effectiveness, control of corruption, political instability and violence, regulatory burden, voice and accountability, and the rule of law.
- Trade agreements:
  - A concerted effort to improve institutions and the business environment is paramount to ensure benefits from the Central American Free Trade Agreement with the United States and a potential Association Agreement with the European Union.

### Fiscal sustainability and pensions
- Public finances:
  - Macroeconomic policies have strengthened, but high debt levels and future contingent claims, especially pension benefits, leave public finances vulnerable.
  - Debt levels (with the exception of Guatemala's) remain high, averaging 47 percent of GDP at the end of 2006.
  - Authorities need to reduce debt levels and raise tax revenue further to meet social and investment needs in a fiscally responsible manner.
- Pension systems:
  - Demographics: the ratio of the working-age population to the elderly will fall from about eight today to less than three in 2050.
  - Sustainability requires combinations of increased contribution rates, higher retirement ages, and lower benefits in most countries.
  - Political support and reform design are both critical for success.
- Debt structure:
  - Sustainability depends on debt level and structure—currency denomination, maturity composition, capital structure, and solvency.
  - Regional characteristics:
    - On average, Central America has a lower share of short-term debt than the rest of Latin America but a higher share of foreign currency debt.
    - More recently, Central America has reduced foreign currency exposure and lengthened maturity structure modestly.
  - Recommendation: continue efforts to move toward "safer" debt structures.

### Strengthening monetary policy and central bank credibility
- Achievements:
  - Countries have succeeded in reducing inflation.
  - Progress in strengthening institutional underpinnings for monetary policy: new central bank legislation has enhanced autonomy and focused mandates on price stability.
  - Direct political intervention in central bank decisions and monetary financing of fiscal deficits has been curtailed.
- Remaining shortcomings:
  - Tension between maintaining price stability and preserving external value of domestic currency can cause policy conflicts (e.g., during strong capital inflows) and undermine credibility.
  - The executive branch retains substantial leeway to remove central bank governors and directors, maintaining a potential link between the political business cycle and monetary policy decisions.
  - Central banks generally lack financial autonomy because legal provisions to protect the integrity of central bank capital are often absent, undermining effectiveness and credibility.
- Priority: make progress on legal and institutional features that enhance central bank independence and financial autonomy.

### Development of financial systems and debt management
- Financial sector structure:
  - Region's financial sector is dominated by banks.
  - Substantial room for development, except Panama which has a bank-asset-to-GDP ratio of 250 percent.
  - Capital markets are underdeveloped; equity and corporate bond listings are generally in the single digits.
  - Institutional investors intermediate only a small share of national savings.
- Public debt market development:
  - Substantial room to develop public debt markets through institutional and operational improvements.
  - Recommendation: transfer quasi-fiscal debts of central banks to the government to aid establishment of liquid public debt markets and a unified sovereign yield curve, addressing dual sovereign debt issuers.
- Nonstandard and nontradable debt:
  - Region has a large stock that should be restructured.
- Debt management improvements:
  - Important to develop and implement a medium-term debt management strategy and improve technical capacity of debt management units.
  - Costa Rica, El Salvador, and Panama have made some improvements in recent years.
- Policy linkage:
  - Deeper and more liquid public debt markets would allow authorities in countries with their own currency to conduct monetary policy more effectively.

### Policy message and timing
- Central message from IMF Deputy Managing Director Murilo Portugal: now is the time for Central America to reform and take advantage of the benign global environment.
- Quotation highlighted: "it is in the sunny days that we should fix the roof of the house."

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## References

- [https://www.imf.org/en/News/country-focus](https://www.imf.org/en/News/country-focus)
- [PRESS CENTER](http://presscenter.imf.org/)
- [IMF Country Focus](https://www.imf.org/en/news/country-focus)
- [IMF Occasional Paper](http://www.imf.org/external/pubs/nft/op/257/index.htm)
- [Strengthening regional approach](https://www.imf.org/external/pubs/ft/survey/so/2007/CAR082A.htm)
- [Conference agenda](http://www.imf.org/external/np/seminars/eng/2007/centram/index.htm)
- [Conference communique](http://www.imf.org/external/np/sec/pr/2007/pr07148.htm)
- [Murilo Portugal speech](https://www.imf.org/external/np/speeches/2007/062807.htm)
- [communiqué](https://www.imf.org/external/np/sec/pr/2007/pr07148.htm)
- [Occasional Paper No. 257](https://www.imf.org/external/pubs/cat/longres.cfm?sk=19748.0)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2015/09/28/04/53/socar082b_