COSTA RICA: Deficit Solution Needed
Our short-term outlook for Costa Rica calls for moderate growth with financial stability, but continued fiscal vulnerability. Recent developments suggest that the fiscal situation will be better than expected, though, as government revenues rose faster than spending. But the deficit is still large, and we don’t foresee major reductions in the next 18 months. Hence, fiscal vulnerability continues to condition our outlook, with an increased government debt to GDP ratio.
Strategies for financing the public deficit are crucial to the short-term economic trajectory. Until now, the government has been able to place domestic debt mainly in public institutions, without putting heavy pressure on the market, so domestic interest rates have been rather low. But rates have also been supported by relative currency stability, and by low H1 inflation.
Things are changing. The colon depreciated in May and June, partially affecting the portfolio mix between national and foreign currency. The increase in external prices, combined with currency depreciation, is expected to increase inflation in H2. Hence, we see domestic rates rising in H2, unless the government can land some external financing to cover its deficit, and to avoid a crowding-out effect on lending to the private sector.
In El Salvador, economic activity rebounded timidly in Q1, rising 1.8% to April 2016 (vs. 0.1% a year ago). But growth is still modest compared with the Central American and Latin American averages. Negative factors for economic activity are the partial reversion of fuel prices, stagnant agricultural activity, the government’s struggle to gather more revenues and uncertain fiscal perspectives, offsetting the impact of robust growth of foreign remittances and credit to the private sector. Solutions to the fiscal problem have made few advances, although the government could now agree to negotiate a standby agreement with the IMF, including a fiscal agreement under terms subject to consensus, at least between the two largest political parties in Congress.
In Guatemala, real GDP growth slowed down in Q1, as expected. The economy grew only 2.8% y/y, well below 5% y/y in Q1 2015, and the 4.1% in the full year of 2015. A similar pattern was observed in the Monthly Index of Economic Activity (IMAE) as of May, with a trend-cycle level up 2.7% y/y, down from 4.2% y/y in May 2015. The slowdown is also reflected in the Private Sector Confidence Index, which stood at 50.90 in June, down from 61.67 in May. Headline inflation was running at 4.43% as of June, within Bank of Guatemala´s target range (4% ±1pp.) But core inflation (1.53% y/y) was below the target range’s lower limit.
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