What awaits Central American economies this year?

According to the Central American Institute for Fiscal Studies (ICEFI), inflation control and some of the measures that countries adopted in recent years will continue to represent a challenge in 2023.

ICEFI economist Abelardo Medina speaks to BNamericas about the challenges and the countries he believes are most at risk given the turbulent economic outlook.

BNamericas: What is the current outlook for the countries of the region?

Medina: We must remember that most governments and a good part of the business community immediately pay attention to macroeconomic indicators: GDP, inflation, the exchange rate or exports. Although it’s true that this analysis is not incorrect, it must be considered that a large part of the governments have neglected microeconomics, or how individuals are within their countries. In 2020 the growth rates fell dramatically in all countries because there was no production, exports or imports. There was a severe contraction of economic activity. 

In 2021 we saw an expansion because the normality that existed until 2019 was recovered, and this made it appear that the economy was expanding. Politicians were quick to sell the idea that the recovery was because economic policies had been excellent, but no. We were just getting back to normal. 

Unfortunately, in order to reactivate economic activity, an expansion of public spending was used in some countries, particularly in developed countries, where public spending was financed with the issuance of money. In many of the Central American countries they did the same.

BNamericas: What was the result?

Medina: The problem is that when more money is put into circulation than what is needed, inflation is caused, and by the end of 2021 the countries were already beginning to see it. There was another collateral phenomenon: many of the most important companies and industries began to notice that their production was not enough to satisfy all the demand. It was what was called the “container crisis.” Many products became scarce in the market because there was not enough production, and their prices began to rise. In 2022 we thought that there was going to be normalization, and then the war in Eastern Europe came, which pushed prices up again.

BNamericas: What did this represent for Central America?

Medina: That was the key. Most of the inflation in the Central American countries is "imported" inflation, so prices rise, but not as a consequence of the Central American countries having implemented incorrect policies, but rather as a consequence of international prices going up.

BNamericas: Are there any other obstacles besides inflation?

Medina: The other problem that is beginning to emerge is that the countries spent a lot and lowered interest rates in 2020 and 2021 to make economic activity recover, but now that inflation has grown they have to raise them to combat it. Growth in developed countries is beginning to slow down, because it’s paying the cost of the recovery of 2020 resulting from spending. The United States is not expected to go into recession, but growth will still be very low. When our buyers don’t grow, exports don’t grow and what happens to them affects us too. 

In this scenario, the growth of the countries in Central America is recovering its normality, but this is now being affected by the need for recovery in developed countries. It’s simply like paying for the dishes that we ate as a world in the year 2020 from the issuance of extraordinary money.

BNamericas: What do you think would have been the correct policy to attack inflation?

Medina: Normally consumers have to pay the cost of price increases, especially when there are no other options. I must admit that in Central America many of the markets are imperfect, with a high level of concentration, so it turned out that to try to protect the consumer, what was done practically everywhere was to subsidize fuel consumption. This certainly kept consumption up, but prices didn't necessarily go down because the companies that import fuel kept them up and even increased them. The problem is that when general subsidies are given in this way, people who do have the ability to pay end up benefiting more and the government runs out of money, so now they cannot help those who do need it.

BNamericas: What will happen to inflation in the coming months?

Medina: It will decrease. However, the situation worldwide is unlikely to be corrected, because it’s not expected that the situation in Eastern Europe is going to be fixed soon, much less is it expected that European countries or the United States are going to stop imposing sanctions on Russia. Consequently, the smaller countries have to realize that the conditions of the world are going to be maintained. We’re observing that the economic activity of the Central American countries is going to recover more or less the normality it had before 2020, but a little less than in 2019 due to these two phenomena.

BNamericas: Wasn't it helpful then to raise interest rates locally?

Medina: Raising interest rates on average will lower inflation, but what it’s causing is that many people and companies end up being more affected, such as those related to construction, which will have to pay a higher interest rate.

BNamericas: So should Central American countries cut public spending?

Medina: They’re already doing it. With the exception of El Salvador, which maintained a policy that expanded spending in 2020 and 2021, all governments are dramatically tightening spending to not only recover the economic normality they had in 2019, but also to try to reduce spending to compensate for the interest payments.

BNamericas: Did this also affect tax collection?

Medina: In 2022, as a consequence of inflation and the increase in prices, collection increased. So the governments came out to say that they were doing wonders in terms of tax collection, but no. It was simply a consequence of the increase in international prices. Right now, we’re facing a situation in which prices are decreasing and collection is falling. Expenses are decreasing and the deficit tends to be smaller to reduce the growth of the debt. The countries are managing to recover the level of debt they had before, but they have a very complex situation economically this year.

BNamericas: Which are the countries of greatest concern in this regard?

Medina: Probably Panama and Honduras – which saw a change in government policies in 2022. They have a greater possibility of having more deficits, because the [tax] collection of these two countries is falling to relatively normal levels but their level of spending is growing to try to meet the needs of its population. The growth of debt in these two countries may cause some problems later.

BNamericas: What’s happening in Panama?

Medina: In Panama, the real problem is that the government has more expenses than income and it has very little income because it has a very poor collection level. I’m not saying that they should increase taxes, but rather that it has a low collection level. Even with the income from the canal it’s not enough for them, so they’ve been expanding the deficit and their debt. It’s a very dynamic country but, unless Panama's economy returns to normality, their debt is going to grow a bit.

BNamericas: Which ones would have less financial risk?

Medina: Those that would have less financial risk during this period would be Guatemala, Nicaragua and Costa Rica, in that order. El Salvador has moderated a lot, but they’ve not been able to regularize their relations with the IMF.