Front Matter

Front Matter

Marco Pinon, Alejandro Lopez Mejia, M. (Mario) Garza, and Fernando Delgado
Published Date:
July 2012
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    © 2012 International Monetary Fund

    Cover design: IMF Multimedia Services Division

    Cataloging-in-Publication Data

    Joint Bank-Fund Library

    Central America: challenges following the 2008-09 global crisis / editors, Marco Pinon … [et al.]. – Washington, D.C. : International Monetary Fund, 2012.

    • p. ; cm.

    ISBN 978-1-61635-378-0

    1. Central America–Economic conditions. 2. Global Financial Crisis, 2008–2009. 3. Financial crises–Central America. 4. Fiscal policy–Central America. 5. Monetary policy—Central America. 6. Banks and banking—State supervision—Central America. I. Piñon, Marco. II. International Monetary Fund.

    HC141.C46 2012

    Disclaimer: The views expressed in this book are those of the authors and should not be reported as or attributed to the International Monetary Fund, its Executive Board, or the governments of any of its members.

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    It is with a strong sense of partnership that I introduce to you this book on the challenges and opportunities that the economies of Central America, Panama, and the Dominican Republic (CAPDR) face at the current juncture. The book attests to the long-held tradition of fruitful policy dialogue between the staff of the Western Hemisphere Department of the IMF and the seven CAPDR countries. Most of the chapters in the book are based on research conducted by the IMF staff to inform the discussions at the high-level conferences that the staff and the economic authorities of the region held during 2009–11, following a tradition that dates back more than a decade.

    The resilience displayed by CAPDR countries in the immediate aftermath of the global financial crisis of 2008–09 is a testament to the remarkable strengthening of the policy frameworks of those economies in the years prior to the crisis. The people and the governments of CAPDR can proudly point to their economic performance during these difficult years for the world economy. Their decade-long efforts to lower fiscal deficits, reduce public debts, modernize financial systems, upgrade financial supervision, and adopt other structural reforms were justly rewarded. While many world economies continue to suffer the consequences of excessive indebtedness or compromised financial systems, macroeconomic and financial conditions in the economies of CAPDR remain generally propitious for strong and sustained economic growth.

    But there is still work to do. The resilience to external shocks exhibited by CAPDR following the global crisis cannot be taken for granted. The macroeconomic and financial buffers these economies had built prior to the crisis have been eroded and have to be replenished. It is also imperative to advance structural reforms. In an uncertain world environment with subdued growth prospects in the United States and other traditional markets for CAPDR countries, economic growth will have to come primarily from productivity-enhancing reforms anchored on strong macroeconomic and financial frameworks. It is my hope that the material in this book will contribute to inform the debate and policy decisions in these areas.

    Nicolas Eyzaguirre


    Western Hemisphere Department


    Marco Piñón

    Central America, Panama, and the Dominican Republic (CAPDR) coped well with the global financial crisis of 2008–09. Although GDP growth began to decelerate rapidly by late 2008, the impact was generally less severe and shorter-lived than in previous episodes. The region’s GDP contracted mildly in 2009, with some economies remaining in positive growth territory, and was already on the rebound by late 2009. Moreover, even though the region has experienced several balance of payments and financial crises since the 1980s, this time around the balance of payments adjustment was orderly and the stability of the financial system was not compromised.

    The recent resilience of the region can be attributed to a great extent to the strengthening of macroeconomic and financial frameworks during the years preceding the 2008–09 crisis. Of particular importance was the reduction of fiscal deficits, which, together with strong growth, reduced debt-to-GDP ratios significantly, and provided space for countercyclical fiscal policies at the time of the downturn. Despite some strengthening of monetary frameworks before 2008, room to maneuver with regard to monetary policy was constrained by limited exchange rate flexibility, especially in the two countries that use the U.S. dollar as legal tender. Still, central banks made liquidity available to the financial system (including through relaxing reserve requirements). In addition, the authorities requested IMF financial support to anchor investor confidence and provide liquidity buffers against the downside risks from the external environment. Although some of the potential external risks did not materialize, this strategy likely contributed to safeguarding macroeconomic and financial stability.

    Nevertheless, CAPDR faces considerable challenges for the period ahead, including the need to protect the hard-earned macroeconomic and financial stability achieved in recent years and raise medium-term growth above historical levels. In this connection, the still high uncertainty surrounding the global economy poses macro stability risks because the region has already used some of the buffers and policy space created during the previous years; but also because, in a scenario of renewed global instability, the region’s resilience could be subject to more severe tests than the relatively short-lived and generally manageable capital outflows and deposit withdrawals experienced during the recent crisis. Moreover, over the medium to longer term, the region needs to improve the living standards of its population considerably—per capita income in most countries of the region has lost ground in relation to much of the world in recent decades.

    Meeting these challenges will have to occur from within. With only slow to moderate growth projected for their trade partners, the region’s economies cannot count on external demand to be the engine of growth. Thus, boosting growth will depend on the adoption of structural reforms that generate substantial productivity gains. Moreover, resisting the winds of potential external financial turbulence and safeguarding macroeconomic stability will depend on maintaining and broadening the policy tools available to policymakers, while also implementing reforms to strengthen the resilience of their economies. More specifically,

    • Bold measures on the structural front are required if the region is to make strides toward achieving significantly higher income levels over the medium to long term. Although per capita income in the region has risen considerably during the last decades, the record is less satisfactory when assessed against progress in other parts of the world. Indeed, most countries in the region have seen their per capita incomes decline with respect to advanced and emerging market economies. Moreover, growth rates in CAPDR are projected to be lower than in the period immediately preceding the global crisis, in part as a result of slow global growth (including in the United States, the region’s major trade partner) and high international fuel prices. Against this background, a key challenge confronting the region is to identify and adopt reforms and policies to increase productivity significantly and achieve higher sustained growth over the medium term.
    • The fiscal buffers used during the crisis need to be rebuilt to restore the region’s capacity to respond to potential future shocks. Given the current external environment and the high incidence of natural disasters in the region, CAPDR has to be prepared, once again, to adopt countercyclical policies without jeopardizing macroeconomic stability or market perceptions. The fiscal policies adopted in 2008–09 included increases in permanent spending, compounding the challenge of rebuilding these buffers and likely complicating efforts to achieve fiscal consolidation.
    • There is also significant scope for further improvement in the monetary and financial sectors’ frameworks. In countries with independent monetary policy (i.e., where the U.S. dollar has not been adopted as legal tender), the monetary framework needs to be strengthened to increase the effectiveness of monetary policy as a tool to help ensure macroeconomic stabilization (including during crises). Additional progress in making exchange rate arrangements more flexible, further clarifying the mandate and operational independence of central banks, and developing monetary instruments are prime areas for improvement. Similarly, although the domestic banking sector weathered the 2008–09 global financial crisis relatively well, key risks that would have further tested its resilience did not materialize. A close examination of financial regulation and supervision, for example, shows that the region still lags in compliance with some areas of the Basel Core Principles, including the need to move toward risk-based supervisory practices. Moreover, as in the rest of the world, the crisis also revealed areas of vulnerability, such as the perimeter covered by financial regulation.

    The book is organized into two main parts and nine individual chapters.

    Central America Before And During The Global Crisis

    Part I deals with major economic developments in CAPDR before 2009 and the region’s economic performance during the global crisis. It also covers the role played by the IMF in recent years. It finds that since the mid-1990s the region has become increasingly integrated with the rest of the world through stronger trade links, rising cross-border financial asset holdings and capital flows, and higher remittances (Chapter 1). This development, together with progress in advancing key economic reforms, supported macroeconomic stability and improved growth performance in the region before 2008. With this increased integration, CAPDR also became more directly influenced by cyclical fluctuations in the United States and potentially more exposed to external shocks.

    The challenges posed by greater economic integration became evident when the 2008–09 global crisis hit the region (Chapter 2). A critical concern was that the external shock could lead to large capital outflows and output contractions in CAPDR and that, despite progress in strengthening macroeconomic and financial frameworks, remaining vulnerabilities could be exposed and give rise to a crisis. As it happened, a less negative than envisaged external environment and strong domestic policy responses, including under IMF-supported programs, mitigated output losses and helped safeguard macroeconomic and financial stability and anchor investor confidence. However, the simultaneous economic downturn experienced in CAPDR illustrated the potentially greater impact if downside risks to the global economy were to materialize in the future.

    Policy Challenges: A View From 2011

    Part II of the book is divided into three main sections. The first section seeks to provide guidance on crucial structural reforms that would help CAPDR countries boost medium- to long-term growth prospects. The region has made important progress in some areas, including in macroeconomic stability, but significant scope remains for structural reforms that would facilitate increased private investment and productivity (Chapter 3). In particular, in the absence of vigorous implementation of structural reforms, the region will be unlikely to converge to the income levels observed in more advanced developing economies (including several in Latin America), given the historical record and weak prospects for external demand growth.

    The second section examines the fiscal challenges confronting the region and the policy options available to regain fiscal space, and offers a variety of potential metrics to measure the size of the necessary fiscal adjustment. The section starts by arguing that reducing debt levels, after the increases that took place during the crisis, would be beneficial for the region (Chapter 4). It then assesses possible fiscal measures to achieve the debt targets and offers a broad view about measures that could be considered to close the gaps (Chapter 5). It suggests that, in most cases, achieving the fiscal targets would require increasing fiscal revenues, although gradually reducing nonessential current spending as a percentage of GDP is also necessary to make space for capital expenditure and other priority spending.

    The third section analyzes the monetary and financial frameworks in CAPDR, taking stock of the advances achieved in recent years and offering a path for further progress. For the monetary sector, this section’s chapters cover a broad array of issues for nondollarized economies, including an in-depth analysis of their monetary frameworks (Chapter 6); an evaluation of dollarization as an alternative framework, with emphasis on El Salvador (Chapter 7); and an assessment of the effectiveness of monetary policy, focusing on the pass-through of policy rates to market interest rates (Chapter 8). With regard to the regulatory and supervisory framework for the financial system, this section presents a detailed evaluation of compliance with best international practices, including with respect to areas that have become more important following the global crisis. The assessment is also carried out for other countries considered to have strong regulations, and uses these countries as benchmarks (Chapter 9).



    Central Bank of Guatemala


    Central Bank of Chile


    Central Bank of Costa Rica


    Central Bank of Honduras


    Central Bank of Nicaragua


    Basel Core Principles


    Central Bank of the Dominican Republic


    Central Reserve Bank of Peru


    Central Bank of Uruguay


    Bank for International Settlements


    Central America and the Dominican Republic (Costa Rica, Guatemala, Honduras, Nicaragua, and the Dominican Republic)


    Dominican Republic–Central America Free Trade Agreement


    Central America, Panama, and the Dominican Republic (Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, Panama, and the Dominican Republic)


    consumer price index


    Emerging Markets Economic Data


    European Union


    Flexible Credit Line


    generalized method of moments


    International Financial Statistics


    impulse response function


    inflation targeting


    Chile, Mexico, and Peru


    Brazil, Chile, Colombia, Mexico, and Peru


    Brazil, Chile, Colombia, Mexico, Peru, and Uruguay


    medium-term expenditure framework


    North American Free Trade Agreement


    net international reserves


    public-private partnership


    Penn World Table


    real-time gross settlement


    self-assessment index


    special drawing right


    value added tax

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