Central America today: recovering from natural disasters, Central America is attracting foreign investment

Business Economics, July, 1999 by Manuel Lasaga

Against the odds, the Central American economies have made substantial progress and are moving closer to achieving a common market. Buffeted by natural disasters, first El Nino, and then the devastation of Hurricane Mitch last October, these economies have demonstrated much resilience. Rebuilding from the ravages of the hurricane should dominate the Central American economies this year.

On the political front, the end of civil strife, first in El Salvador in 1991, and then followed by Guatemala in 1996, has triggered a boom in private sector investment. The international financial community has responded positively to these trends.

Economic reforms, particularly the eradication of trade barriers, accompanied by privatization, have resulted in a wave of foreign investments. Much of the direct investment has gone into the assembly industries, the so-called maquiladoras. Recently, Intel completed a major investment in Costa Rica to develop an assembly plant for microprocessors, which is bound to attract other investments from microelectronics firms.

While the large economies of Latin America were rocked by financial market turbulence, Central America was relatively immune from the panic outflows of capital. These economies have very small financial markets and thus do not attract the hot-money [TABULAR DATA FOR TABLE 1 OMITTED] investors, but rather long term production-related investments.

With slower growth expected this year, the region should rebuild quickly from the damages of Hurricane Mitch. Continued progress in the consolidation of the Central American Common Market bodes well for increasing investment opportunities. Nevertheless, there are important differences between these economies that are brought out by the individual country analysis presented in this report.

Costa Rica

Recent Trends

Costa Rica's GDP growth accelerated moderately in 1998, boosted by a 16.3 percent surge in investment and an excellent export performance. Foreign investment concentrated mainly in the free zones. Investment is also rising in the booming tourism sector, which generated an estimated income of $1.0 billion in 1998.

Greater credit availability to the private sector fueled construction and consumer spending. Concerned about possible inflationary pressures, the Central Bank adopted several measures last year:

1. A hike in interest rates;

2. The establishment of a mandatory ceiling for bank credit, until September 1999;

3. The postponement of a planned reduction in the reserve requirement rate;

4. The imposition of additional reserve requirements for certain types of credit; and

5. The issuance of more stabilization bonds to mop up excess liquidity.

The Central Bank also decided to step up the monthly devaluation rate, to help exports and to stem the growth of imports. The Central Bank measures were also designed to counter inflationary pressures caused by a combination of ample liquidity and disruptions in the supply of agricultural products, due to damages wrought by Hurricane Mitch to grain crops and cattle.

The 1998 fiscal budget deficit narrowed to 2.9 percent of GDP from 3.9 percent of GDP the previous year. Dynamic economic activity and lower unemployment boosted VAT and income tax collections, while surging imports provided substantial tariff revenues.

On the external front, exports have been expanding rapidly in spite of the weakness in coffee prices. Most of the damage from the effects of El Nino has been to domestic crops such as rice and beans. El Nino actually benefitted export crops. Hurricane Mitch did extensive damage to coffee crops and only slight to moderate damage to other export crops. The recent investment by Intel in a large manufacturing facility has helped boost employment in manufacturing as well as the value of exports. Foreign exchange reserves diminished by $200 million in 1998, due to the turbulence in global financial markets. They now cover a scant three months of imports.

The Outlook

President Miguel Angel Rodriguez has continued the promarket reforms initiated by his predecessor government. The principal challenge in terms of economic policy [TABULAR DATA FOR TABLE 2 OMITTED] is the reduction of the budget deficit. In this regard, the government's goal of privatizing Banco de Costa Rica, Banco International de Costa Rica, Instituto Nacional de Seguros and the beverages company FANAL bode well for the fiscal accounts. The sale of these enterprises should help to bring down the deficit. Nevertheless, these would be one-time gains, while the government needs to focus on revenue enhancements and additional cuts in expenditures.

The government hopes to buy some time to straighten the fiscal tangle with a two-year loan from the International Development Bank to pay off a portion of the huge domestic debt. This could allow President Rodriguez to negotiate congressional approval for further privatization. Some laws already in the legislative pipeline would permit a gradual opening of the energy and telecommunications sectors, as well as switching 40 percent of social security funds to a private management company. Nevertheless, the government plans to offer concessions to the private sector this year, for improvement and operation of roads and airports. In addition to shifting that spending from the public to the private sector, those improvements will benefit tourism and transportation.