GUATENOMICS 101 – IMF Assessment, Fitch Downgrade and Inflation Data

The IMF’s latest release on the Guatemalan economy coincided with my arrival in the country – whilst this is a short piece relative to the complex issues addressed, as an introduction to the economy, it’s nonetheless a good starting point. The report addresses 15 topic areas focused on macroeconomic factors, economic policies, risks and financial system resilience, with caveats around the country’s need to focus more on social development to reduce poverty and mitigate crime.

 

The IMF report follows the Fitch downgrade in late June – whereby the ratings agency cut the country’s debt rating one notch from BB+ to BB (i.e. below investment grade – same basket as Tunisia and Nigeria) with a stable outlook. Key concerns included the country’s ability to broaden its tax base and stimulate growth. Following the Fitch report, the press reported that during July, Minister for the Economy, Sergio de la Torre will visit the three ratings agencies for further engagement, so no doubt it will be interesting to see whether Moodys and S&P follow in their competitor’s footsteps (Sergio’s Facebook page does not mention this Fitch downgrade or upcoming meetings, guessing the social media team don’t ‘do’ bad news). Nonetheless, the country’s debt to GDP ratio is half that of peers in the BB category, and whilst low, increased funding costs are detrimental for government funded growth, particularly given concerns regarding tax revenue collection.

 

Key findings of the IMF report include a fairly positive tone on macroeconomic management and benign outlook for growth, which has now returned to trend at around 3.5%, supported by buoyant demand. Monetary policy is slightly accommodative for now. However, the mission notes that risks are tilted to the downside due to policy concerns and global uncertainties (ah, the catch-all provision… such as a slowdown in emerging markets and the US exit of QE – however, for now, Yellen’s ‘gradual policy approach’ doesn’t suggest any imminent threat around volatility induced by QE withdrawal).

 

In terms of policy – the IMF is supportive of the neutral fiscal policy approach given the closure of the output gap, however, strongly advocates improved taxpayer compliance and further efforts to address implementation setbacks from tax reform in 2012. Further discussion focuses on the need for 2015 budget approval to ensure for provision of multilateral loans – essential for spending outlays on social programs as well as infrastructure and other public investment programs. Reforms such as the draft competitiveness law as it currently stands pose a concern from a fiscal perspective as this will also result in reduced fiscal receipts in the short term (due to special exemptions), despite attempting to accelerate growth over the longer term.

 

Focus on the overall financial system form an important part of the IMF assessment. Although Guatemala’s debt to GDP ratio is very low by international standards (see chart below), like Fitch, the IMF flags the country’s low tax revenue, shallow financial markets, policy rigidities and the danger of a debt driven growth trajectory as a source of vulnerability. Whilst noting that inflation has remained relatively low for some time now, it remains prone to spikes in commodity prices, requiring a further degree of flexibility in the exchange rate mechanism. A more flexible exchange rate mechanism would also result in a ‘de-dollarisation’ of credit – particularly important over the longer term given an expected gradual turnaround in US growth, and would result in the internalisation of foreign exchange risks. The IMF strongly advocates for the finalisation on the draft capital markets law to develop public debt and private securities markets. The IMF report notes the fast rise in consumer credit (now moderated) – with particular concern over the bias towards foreign currency and consumer credit, and calls for higher capital requirements for FX loans to non-exporters. This would mitigate the adverse impact of not only FX shocks, but also any credit quality deterioration. Given the shallow financial system in the country – whilst Tier I capital requirements appear adequate, the IMF advocates the phasing in of Basel III standards, especially given prevailing high liquidity within the bank system.

 GuateGraph

Guatemala Debt to GDP ratio (source: IMF)

  Inflation figures were released on the same day as the IMF report – inflation declined dramatically year-on-year to 3.13% vs 4.79% in June 2012. Whilst the composition of the CPI basket of goods is not disclosed – fair to assume that food and energy are key drivers of inflation movements. Low inflation in developing countries is particularly important given the high percentage of the population living a subsistence existence. An inability to cover basic food and energy requirements due to volatility in prices can underpin social disharmony – again, negative for growth prospects.

 

And… where to now?

 

From initial reading – macroeconomic policy appears to be reasonably solid with the Central Bank demonstrating an ability to control inflation, and providing stability to the currency and reserves. Policy, implementation and adherence appear to be the key stumbling blocks to achieving a more convincing sustainable growth profile, with key concerns around fiscal policy and revenue collection. Whilst development of more efficient capital markets is essential in internalising risks within the financial system, primarily due to the impact of USD denominated loans – this is a lengthy process and will not be completed overnight.   The inability of policy to adequately address poverty and crime pose a serious threat to future growth. Efficient and timely budgetary processes are crucial in securing financing for social programs, however spending needs to be balanced with tax revenue collection. Despite pledges to cut spending and improve tax collection, and after two years in office, Molino has not appeared to make any great advances in this domain as yet.   With a lot more research ahead – hopefully I have a more definitive answer to the ‘where to now?’ at a later stage. At first glance, the key to Guatemala’s growth lie in the ability of policy makers’ ability to create, implement and ensure adherence to holistic pro-growth policy, without overlooking the social side of the equation, which threatens the ability of the country to develop effectively.

 

Further reading: Facebook – Sergio de la Torre: www.facebook.com/de.la.Torre.Sergio Fitch release:  https://www.fitchratings.com/creditdesk/press_releases/detail.cfm?pr_id=835658 IMF release: http://www.imf.org/external/np/ms/2014/070714.htm Miscellaneous country debt to GDP ratios: http://online.wsj.com/news/articles/SB10001424052748703789104576272891515344726 Press item: http://www.prensalibre.com/economia/Mesa_de_riesgo_pais-calificacion_de_pais-calificadoras_de_riesgo-Guatemala-mision-funcionarios-sector_privado_0_1162084003.html

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