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The countries in Central America are recovering gradually, led by a rebound indomestic demand (following its sharpcontraction in 2009), which has partly spilled over into imports. Pickups in exports and morerecently remittances have been further positive developments. Foreign direct investment (FDI)has been fairly resilient throughout the downturn and continues to finance the bulk of the region’scurrent account deficit.
The recovery has been faster in Panama and Costa Rica, where stronger policy frameworks were able to accommodate a larger policy stimulus. The recent slowdown in activity in the United States has thus far not affected the region’s recovery, although this may reflect transmission lags.
For 2010, output in the Central American region as a whole is projected to expand by about 3 percent, somewhat below potential. Output gaps are relatively small (the downturn in 2009 was not too severe, and potential output growth slowed), so room and desirability for active demand policies is very limited. Growth will remain dependent on the path of U.S. imports, which given the permanent output loss in the United States, would imply lower income levels for the region than those projected prior to the crisis.
The fiscal stimulus is being gradually withdrawn in most countries, though growth in real primary spending in 2010 in some countries remains well above trend growth. Monetary policy remains constrained in many cases by fixed exchange rate regimes and high levels of dollarization, as well as a low degree of financial intermediation.
Looking forward, Central American countries should focus on restoring the fiscal policy space used during the crisis to give them more scope to conduct countercyclical policies in the future. Public debt in the Central American region is projected to average slightly more than 40 percent of GDP by end-2010 (4½ percentage points higher than in 2008), and debt ratios continue to be highly sensitive to growth and interest rate shocks.
Over the near term, fiscal consolidation should focus on slowing the growth in current spending, particularly on wages (Honduras, Nicaragua), and generalized energy subsidies (El Salvador). Efforts should also be made over the medium term in mobilizing revenues (Guatemala) and making public pension systems more viable (Honduras and Nicaragua), including to make space for much needed social and infrastructure spending (Figure 2.10).10 If downside risks to growth were to materialize, those countries with low public debt levels could make the pace of consolidation more gradual.
Countries with scope to conduct monetary policy (Costa Rica and Guatemala) should continue strengthening their monetary frameworks, including by allowing greater exchange rate flexibility (Figure 2.11). In dollarized economies (El Salvador) or those with pegs (Honduras and Nicaragua), priority needs to be placed on keeping central bank credit in check and continuing to develop interbank markets, while embarking on reforms that reduce nominal price and wage rigidities.
Emphasis will also need to be placed in improving the business climate in Central America (which ranks low by international standards) and increasing the diversification of exports.
Source: International Monetary Fund
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