We would like to thank the Staff for a comprehensive and well-written set of papers. The Guatemalan authorities broadly agree with the Staff’s assessment and fully support its recommendations. They view positively the changes in the Fund’s lending framework, in particular because they represent new valuable preventive instruments to deal with the current global crisis. Our authorities consider this high-access precautionary Stand-By Arrangement (HAPA) appropriate for their present needs. They also value the new review-based conditionality and expect that staff monitoring of the program will be guided by this new flexible approach, especially given the present global circumstances.

Guatemala has a long track record of fiscal and monetary discipline that, along with the implementation of important structural reforms, has resulted in the consolidation of macroecomic stability and the acceleration of economic growth, with growth rates close to 5 percent in average in 2005–2008, reaching a high 6.3% in 2007 just before the financial global crisis intensified. In this context, prudent fiscal policies and the lowest level of debt in the region provide space for countercyclical policies. Therefore, the Guatemalan economy is well prepared to face the adverse external environment and to remain committed to its medium-term development challenges including progress in reducing poverty and protection of the neediest.

Notwithstanding the above, given the openness of the economy and its close connection to the United States’ economy it is inevitable that the impact of the crisis will be significant. The crisis is expected to affect the Guatemalan economy through three main channels: (i) lower exports and deteriorating export prices; (ii) decline in remittances; and (iii) significant slowdown in private capital flows. Although the external current account has benefited from lower oil prices, the combination of these three transmission channels is likely to require real and financial adjustments. The authorities’ program aims at safeguarding macroeconomic and financial stability.

The Guatemalan strategy is based on the following pillars: (i) a moderate countercyclical fiscal policy to support internal demand, financed primarily through external resources; (ii) a monetary policy focused on reducing inflation and a flexible exchange rate; and (iii) a set of financial sector policies to increase the resilience of the system, improve regulation and supervision and enhance the banking sector safety net and the effectiveness of bank resolution procedures.

Prudent fiscal policy has been a key feature of the Guatemalan economic policy. A moderate fiscal impulse in 2009–10 is intended to prevent a large decline in domestic demand. Public expenditure will increase 0.4 percent with respect to 2008. Tax collections are expected to decline by about 0.8 percent of GDP from the 2008 levels and the central government deficit could increase to 2.8 percent and then decline to 2.6 percent in 2010. In the event that fiscal policy may require any adjustment, the authorities’ priority will be to protect social spending. These deficits will be mainly financed by a package of almost $1 billion already secured by loans from the IDB and the World Bank.

Monetary policy will focus on achieving a gradual reduction of inflation to 5.5 percent in 2009 and toward a medium-term target of 4 percent (+/- 1 percent). At the same time, the authorities remain committed to exchange rate flexibility to facilitate economic adjustment to shocks. Private capital flows have slowed, but nonetheless net international reserves have increased to US$4.8 billion by the end of March 2009.

The Guatemalan financial sector has had only moderate exposure to the sources of the global financial crisis. The financial system underwent a significant consolidation process in the aftermath of two bank failures in late 2006 and early 2007. However, in order to increase resilience of the system, the authorities have introduced preemptively a number of measures to reduce risks. Continuous and enhanced on-site supervision has been in place since June 2008. The central bank has introduced temporary and limited measures to ensure bank liquidity. Stronger capital cushions are being built and provisioning requirements revamped to ensure that by mid-2011 all nonperforming loans are fully provisioned. Changes to banking legislation will be introduced to strengthen regulation and supervision, and enhance the current bank resolution framework.

A key priority for the authorities is to offset the effect of the current crisis on the neediest sectors of the population and to continue with the mid-term effort to reduce poverty. Securing adequate nutrition, health and education are key to this strategy. To attend extreme poverty, emphasis will be placed on a new government program of conditional cash transfers. The program, Mi familia progresa, aims at securing that poor children attend school and visit health centers regularly. In 2009, this program will be expanded to cover 500,000 families with a total budget of US$150 million.

The authorities intend to treat the proposed Stand-By Arrangement as precautionary. They expect that the SBA will support the strong commitment to sound macroeconomic policy, anchor investor confidence and provide a larger liquidity cushion to face the downside risks in the global environment. The Guatemalan authorities view the level of access as sufficient at this time, however, should further downside risks materialize, they would expect the Fund to respond flexibly and reassess the needs.