Make changes in favorable times, before things get more complex, is the recommendation of the senior advisor in the IMF's Western Hemisphere Department.

The economic outlook for Latin America and the Caribbean, like that for the global economy, is in general good. At closer look, however, this picture of health is clouded by underlying weaknesses that should be addressed by policymakers.

All countries in the region can do more to strengthen their prospects for lasting rapid growth-and they should do so now, while the environment is favorable.

Central America has a unique opportunity to seize the moment, as it enters a historic Free Trade Agreement with United States (CAFTA-DR). This agreement offers important economic benefits, although it also challenges policy makers to make sure their economies can compete successfully in the global market place for jobs and investment.

Oil and prices

After reaching a 24-year high in 2004, growth in Latin America and the Caribbean is projected to moderate in 2005 and 2006, though it will remain well above historical averages at 4 percent and 3 percent respectively. The strong performance in recent years reflects a supportive global environment, but also commendable efforts by countries to improve policies and conditions for growth.

In most nations, the results are evident: more jobs, growing incomes, stronger fiscal and external positions, and healthier balance sheets in the financial and corporate sectors. Inflation too has generally been contained despite the pressure from the recent large increase in world oil prices.

Central America and the Caribbean

Although the current picture is generally positive, there is considerable variation among countries depending on individual economic and political circumstances. Countries in Central America and the Caribbean, for instance, have faced a more difficult growth challenge, in part because of pressures exerted by their higher oil import bills.

Indeed, external factors pose important risks. These include the possibility of a sharp slowdown of growth in key trading partners, possibly triggered by a further surge in oil prices or rising protectionist sentiment. The region remains vulnerable to an abrupt tightening of global financial market conditions, as debt burdens are still high in many countries.

Opportunities and potential

What can be done to keep these risks at bay? The current juncture provides a continuing window of opportunity to further strengthen countries' fundamentals and boost their growth potential.

Policymakers must take advantage of it to entrench macroeconomic stability, mainly by further reducing public debt burdens and keeping inflation low, and to deepen structural reforms to encourage private investment and entrepreneurship.

For Central America, regional integration under CAFTA-DR is a strategy to compete successfully in a more globalized economy. Mexico's experience under the North American Free Trade Agreement (NAFTA) suggests that lowering trade barriers does provide a boost to trade and foreign direct investment, which in turn spurs economic growth. Indeed, estimates suggest that GDP in the region could increase by at least 1.5 percent as a result of the agreement.

Investment flows

CAFTA-DR goes substantially beyond trade. It includes provisions about investment flows, financial and government services, and other part of the institutional framework (such as property rights) so crucial to economic development and growth.

In providing an anchor for further economic and institutional development, it will help the region take full advantage of its potential (read: The Challenge).

Rules and supervision

But whether the expected impact of CAFTA-DR will materialize depends, crucially, on the impetus of complementary policies. Without appropriate regulation, supervision, and policy coordination, the benefits that integration has to offer could be limited.

For instance, it is crucial to avoid the "race to the bottom" that would result from harmful tax competition, as lowering tax rates or conceding unnecessary tax privileges to attract foreign direct investment would erode the already low revenue-to-GDP ratios in the region (read: Fiscal Losses).

With the assistance of the IMF, the authorities of the region are taking the first steps to prevent this by developing a "code of conduct" on corporate tax policy.

Financial sector

In the financial sector, there is a need to guard against regulatory arbitrage-that is, efforts by institutions to exploit the differences and loopholes in regulation across regions, and transfer risks to less supervised areas.

Integration can enhance the provision of financial services, reduce funding costs, and allow diversification of risks across markets, but it raises new challenges for regulation and supervision.

International Monetary Fund

FISCAL LOSSES

Some fiscal revenue losses are expected as tariff rates drop once CAFTA-DR takes effect.

Offsetting revenue measures have either already been implemented or proposed and, in all countries, higher growth is expected to help offset these reductions in taxes.

Efforts should also be made to address the adverse effects that some groups could face as firms and labor move to the new growth areas spurred by growing integration.

THE CHALLENGE

For Central America, as for Latin America more broadly, the challenge is to thus persist in the good efforts that are being made to strengthen fundamentals and boost growth prospects.

With most countries in the region facing elections in the next 18 months or so, there may be a temptation to slacken the pace.

This is not the time to rest-it is far less painful, and more rewarding, to make reforms when economies are healthy, rather than wait until adverse circumstances force policy makers' hands.