Guatemala
Third Review Under the Stand-By Arrangement: Staff Report; Staff Statement; Press Release on the Executive Board Discussion; and Statement by the Executive Director for Guatemala.

The Guatemalan economy is recovering faster than anticipated during the previous program review. The economic outlook has improved since the second program review. The fiscal deficit in 2010 will decline somewhat. There was agreement that a comprehensive tax reform remains the key medium-term challenge. There was agreement that monetary policy should remain vigilant. There has been progress in advancing financial sector reforms, but key elements of the reform agenda are pending. The near-term outlook has improved since the second program review, and downside risks have declined further.

Abstract

The Guatemalan economy is recovering faster than anticipated during the previous program review. The economic outlook has improved since the second program review. The fiscal deficit in 2010 will decline somewhat. There was agreement that a comprehensive tax reform remains the key medium-term challenge. There was agreement that monetary policy should remain vigilant. There has been progress in advancing financial sector reforms, but key elements of the reform agenda are pending. The near-term outlook has improved since the second program review, and downside risks have declined further.

I. Background1

1. The Guatemalan economy is recovering faster than anticipated during the previous program review IMF Country Report No. 10/36. Notwithstanding the adverse effects of the global crisis, real GDP increased by 0.6 percent in 2009, above the regional average. In 2010, the economic recovery is gaining steam, with the monthly index of economic activity (IMAE) posting a rate of growth of 2.5 percent (y/y) as of February. Inflation rose to 3.8 percent (y/y) in April, from a low of -0.7 percent in October, owing to base effects and one-off increases in food prices and electricity (Figure 1).

Figure 1.
Figure 1.

Recent Economic Developments

Citation: IMF Staff Country Reports 2010, 187; 10.5089/9781455202492.002.A001

Source: Fund staff based on national authorities.

2. Balance of payments flows are normalizing (Figure 2). Exports and imports are recovering, and remittances and tourism flows have bottomed out. After posting a small surplus in the first half of 2009, the external current account balance switched back to deficit during the second half, and ended the year with a deficit of 0.6 percent of GDP. Private capital flows picked up strongly in the last quarter of the year and, as a result, the overall balance of payments, including large errors and omissions, posted a surplus of US$473 million (about US$300 million higher than envisaged during the second review). The exchange rate has been stable since end-March, following a 4.5 percent appreciation in the first quarter prompted by a rebalancing of banks’ portfolios. As of mid-May, net international reserves stood at US$5.2 billion, about US$400 million higher than at end-2009.

Figure 2.
Figure 2.

Guatemala: External Sector Developments

Citation: IMF Staff Country Reports 2010, 187; 10.5089/9781455202492.002.A001

Sources: Bank of Guatemala; and Fund staff estimates.
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The currency has strengthened

Citation: IMF Staff Country Reports 2010, 187; 10.5089/9781455202492.002.A001

Source: Bank of Guatemala.

3. Fiscal performance has been strong. The fiscal deficit in 2009 was 3.2 percent of GDP (compared to a program target of 3.4 percent), with both revenues and expenditures stronger than envisaged during the previous review. The increase in revenues in the fourth quarter of 2009 was broad-based and helped finance higher expenditures. The end-March target for the overall balance of the central government was met comfortably.

4. The financial system remains resilient. Banks remain well capitalized and liquid. As of March 2010, nonperforming loans stood at 2.7 percent of total loans, down from a peak of 3.2 percent in October, while bank profitability increased during 2009 (with returns on equity and on assets of 17.1 and 1.7 percent, respectively). Bank deposits are growing by about 9 percent y/y, but credit growth to the private sector remains sluggish (0.6 percent y/y in March), with credit demand restrained by a still negative output gap.

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Sources: National authorities and Fund staff estimates.

5. Program implementation remains strong. All quantitative performance criteria for end-December 2009 and end-March 2010 were met. In addition, the annual rate of inflation remained within the inner consultation band, and government deposits at the central bank exceeded the indicative target. The two structural benchmarks for end-December (on banks’ liquidity and foreign currency credit risk management) were also met.

6. Congressional support for key economic legislation remains elusive. Following a standstill of several months, Congress authorized the borrowing necessary to finance the government expenditure planned for 2010 only in May. 2 In April, the law on Private-Public-Partnerships submitted in 2008 was approved. Approval for the proposed amendments to the banking law, and for the rises in stamp and income tax rates submitted last November, however, have not been obtained.

II. Policy Discussions

A. Macroeconomic Outlook and Risks

7. The economic outlook has improved since the second program review. In view of a stronger-than-anticipated recovery in the United States and Central America (Guatemala’s main trading partners), the projection for 2010 real GDP growth was revised to 2.1 percent—from 1.3 percent envisaged at the previous review. Factoring in the one-off increases in food prices and electricity tariffs recorded in the first quarter, the projection for end-2010 inflation was also raised to about 5.5 percent, still within the target band set by the Monetary Board. The external current account deficit is expected to widen to 3.2 percent of GDP in 2010, largely driven by higher imports. Private capital inflows are projected at 1½ percent of GDP (up from -2.4 percent of GDP in 2009), owing to a recovery in net flows to banks (including for trade credit). Nonetheless, net private capital flows in 2010 are projected to be lower than in 2008.

The recovery is firming up

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Sources: Bank of Guatemala; Ministry of Finance; and Fund staff projections.

Staff Report for the 2009 Article IV Consultation and Second Review under the SBA.

8. Risks to the outlook have declined. External current account flows have started to normalize in line with the global recovery and private capital inflows have resumed, lowering risks to the balance of payments. Weaker global growth or sharply higher oil prices remain the main downside risks to the outlook. The authorities reiterated their intention to continue treating the SBA as precautionary.

B. Fiscal Policy

9. The fiscal deficit in 2010 will decline somewhat. Excluding new tax measures, the overall deficit of the central government is expected to reach 3.1 percent of GDP (down from 3.2 percent of GDP in 2009). The primary deficit would decline by 0.3 percent of GDP (to 1.5 percent of GDP) owing to automatic stabilizers (0.2 percent of GDP) and a small withdrawal of the fiscal stimulus (0.1 percent of GDP). Social spending, however, is projected to reach 5.5 percent of GDP (up from 5.3 percent in 2009), in line with the reallocation of current and capital expenditures recently approved by Congress. The projected deficit will result in a modest increase in the public debt-to-GDP-ratio by end-2010. Loans from multilateral organizations, borrowings in the domestic market and the drawdown of government deposits are expected to be sufficient to finance the deficit. The authorities and staff concurred that a larger reduction in the fiscal deficit would facilitate rebuilding fiscal space and maintaining sustainable debt dynamics. In this regard, the mission welcomed the authorities’ intention to reduce the 2010 fiscal deficit below 3.1 of GDP if revenues were significantly higher than projected.

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10. There was agreement that a comprehensive tax reform remains the key medium-term challenge. The authorities continue working with Congress to secure support for the draft law submitted last November which proposed rate increases in income and stamp taxes. If the proposal were approved, revenues would increase by about 0.3 percent of GDP on an annual basis.3 While the approval of this tax package would be an important step, a comprehensive tax reform is still necessary to make sustained progress in fiscal consolidation and stabilize the public debt-to-GDP ratio, particularly given the higher level of current expenditures (largely reflecting higher social spending) that the government has undertaken since 2008. The authorities have prepared a draft law that contemplates reforms to the corporate and personal income tax regimes and a reduction in tax exemptions. Staff welcomed the authorities’ intention to continue trying to secure political support for such initiative as well as their plan to seek prompt approval of a draft law to reduce tax evasion, strengthen tax administration, and modify the small taxpayers VAT scheme.

11. Staff welcomed the authorities’ continued efforts in improving public expenditure management. Recent measures in this area include issuing norms to increase the transparency of public procurement and investment contracts, and restricting the role of trust funds in the execution of expenditure. Staff noted that there is scope to further improve expenditure control and transparency by taking full advantage of the Integrated Financial Management System (SIAF) and the National System of Public Investment (SNIP). The mission welcomed the authorities’ intention to seek a full understanding of the size and sources of floating debt,4 including domestic arrears. It strongly supported their request for Fund technical assistance to develop a methodology to measure that debt and the intention to supplement improvements in measurement with concrete actions to reduce the stock of such debt and keep its size under control.

12. There has been progress in developing a framework for Private-Public Partnership (PPPs). A PPP law was recently approved by Congress and the authorities plan to request technical assistance on enabling regulations to help ensure a strong institutional framework. The mission and the authorities concurred that the Ministry of Finance has to remain the gatekeeper of public finances, and that this would require enhancing its technical capabilities to evaluate PPP projects and integrate them with the government investment strategy. There was also agreement on the need to record transparently actual and contingent fiscal costs associated with PPPs and taking them into account in the assessment of debt sustainability.

C. Monetary, Exchange Rate, and Financial Sector Policies

13. There was agreement that monetary policy should remain vigilant. The Monetary Board has kept the monetary policy rate at 4.5 percent since September 2009. Although inflation expectations have risen somewhat, the mission and the authorities concurred that the current monetary policy stance remains broadly appropriate considering that the recent increase in inflation was largely explained by one-off factors, the output gap remains negative and bank credit to the private sector remains weak. The main risks to the inflation outlook stem from possible second round effects from higher oil and food prices and their impact on inflation expectations, but the authorities reiterated their commitment to tighten the monetary policy stance if those risks were to materialize. Staff welcomed the progress made to further strengthen the monetary transmission mechanism and the monetary operations framework, including the gradual move toward the adoption of an overnight interest rate as policy rate.

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Sources: Bank of Guatemala, and Fund staff calculations.1/ Expectations for 12-month ahead inflation, derived from monthly Bank of Guatemala Inflation Expectations Survey (EEI).

14. The authorities and staff agreed on the importance of preserving exchange rate flexibility. There was agreement that the flexible exchange rate regime had helped cushion the impact of the downturn in 2009, and was essential for strengthening the inflation-targeting monetary policy framework. In this regard, the rules-based foreign exchange intervention framework has continued to work well, allowing for timely interventions without precluding movements driven by fundamentals.

15. There has been progress in advancing financial sector reforms, but key elements of the reform agenda are pending. The full provisioning of nonperforming loans targeted for 2011 is being implemented ahead of schedule and new regulations on liquidity and foreign currency credit risk management (end-December structural benchmarks) became effective in April. The regulations will strengthen the financial system further by inducing banks to compute liquidity gaps at different maturities and reduce foreign-currency credit risks. The mission recommended extending the regulations on foreign currency credit risk management to mortgages and loans to electricity distributors, but the authorities did not think that was necessary. They noted that the value of collateral in those two activities was high and stable, and had doubts about the legal grounds of staff’s recommendation. Staff stressed that seeking prompt congressional approval of the pending amendments to the banking law should remain a priority to further increase the resilience of the financial system. The mission also recommended enhancing crisis preparedness further, including by developing a systemic banking resolution plan.

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Source: Superintendency of banks of Guatemala.

D. Program and Statistical Issues

16. Staff recommends to maintain unchanged all performance criteria set at the previous review. The mission agreed to lower the indicative target for government deposits at the central bank for end-June to take account of delays in the congressional approval of the borrowing plan for 2010. The indicative target on the inflation consultation band for September and December was moved upward to factor in the one-off increases in food prices and electricity recorded in the first quarter of 2010.

17. The authorities are stepping up efforts to comply with the requirements of the Special Data Dissemination Standard (SDSS). With Fund technical assistance, an action plan has been developed which, if fully implemented, would allow Guatemala to subscribe to the SDSS by end-2010. Key components of this plan are the compilation and dissemination of labor statistics and consolidated general government operations. In addition, staff encouraged the authorities to further improve their balance of payments statistics, including through measures to reduce the persistently large (and positive) entries on the errors and omissions (E&O) line.

III. Staff Appraisal

18. The recovery of the Guatemalan economy is firming up. Economic activity is picking up, while the rise in inflation observed in recent months was the result of one-off factors. Exports and imports are recovering, private capital inflows are increasing, and the balance of payments position has strengthened. The financial system remains resilient, with adequate liquidity and capitalization levels.

19. Performance under the precautionary SBA with the Fund has continued to be strong. All quantitative performance criteria for end-December and end-March were met, and annual inflation remained within the inflation consultation band. The two structural benchmarks for end-December (on banks’ liquidity and foreign currency credit risk management) were also met, and are being implemented.

20. The near-term outlook has improved since the second program review and downside risks have declined further. Stronger-than-anticipated growth in the United States and regional trading partners has prompted an upward revision of growth projections for Guatemala in 2010 and 2011. Easy financing conditions have strengthened capital flows and lowered the risk of balance of payment pressures. A slower recovery in the United States or a rise in oil prices are the main downside risks to the outlook.

21. Fiscal policy in 2010 will start withdrawing the stimulus of past years. The overall deficit of the central government is expected to decline to 3.1 percent of GDP, which will help contain the rise in public debt. The authorities plan to reduce the fiscal deficit further if revenues grow significantly faster than projected. This would facilitate rebuilding fiscal space and maintaining sustainable public debt dynamics.

22. Securing political support to increase government revenues remains a key challenge. Although the approval of the draft law submitted to Congress last November would be a positive step, a more comprehensive revenue-enhancing reform is needed to sustain social spending and increase investment, ensure fiscal consolidation and stabilize the public debt-to-GDP ratio. The approval of the draft law to combat tax evasion and strengthen tax administration would also be a positive step in that direction. The mission welcomes progress in improving expenditure management, including the authorities’ intention to improve the measurement of floating debt and develop a plan to keep it under control. Recent efforts to establish a sound PPP framework are positive; it will be important to record the costs associated with PPPs transparently and take them into account when assessing public debt sustainability.

23. Monetary policy should remain vigilant. The current monetary policy stance remains broadly appropriate despite the recent rise in inflation. Monetary policy should be tightened if there are signs of second-round effects from higher food and oil prices or inflation expectations continue to rise. Staff welcomes the authorities’ commitment to exchange rate flexibility, which is essential to absorb shocks and to strengthen the inflation-targeting framework.

24. Continued implementation of the financial sector reform agenda is important. The newly approved regulations on liquidity and foreign credit risk management will strengthen the financial system further by lowering risks of maturity and currency mismatches. Securing congressional approval of the amendments to the banking law remains a priority to further increase the resilience of the system. Enhancing crisis preparedness, including by developing a systemic banking resolution plan, is also important.

25. Staff recommends completion of the third review under the SBA.

Table 1.

Guatemala: Selected Economic and Social Indicators

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Sources: Bank of Guatemala; Ministry of Finance; and Fund staff estimates and projections.

Staff Report for the 2009 Article IV Consultation and Second Review under the SBA.

Table 2.

Guatemala: Summary Balance of Payments

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Sources: Central Bank of Guatemala; Ministry of Finance; and Fund staff estimates and projections.

Staff Report for the 2009 Article IV Consultation and Second Review under the SBA.

Includes 2009 SDR allocations of US$271 million.

Table 3A.

Guatemala: Public Sector Balance

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Sources: Ministry of Finance; Bank of Guatemala; and Fund staff estimates and projections.

Staff Report for the 2009 Article IV Consultation and Second Review under the SBA.

Table 3B.

Guatemala: Public Sector Balance

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Sources: Ministry of Finance; Bank of Guatemala; and Fund staff estimates and projections.

Staff Report for the 2009 Article IV Consultation and Second Review under the SBA.

Table 4.

Guatemala: Monetary Sector Survey

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Sources: Bank of Guatemala; and Fund staff estimates.

Staff Report for the 2009 Article IV Consultation and Second Review under the SBA

Program definition which includes foreign currency liabilities of the central bank to financial institutions.

Includes open market placements with the private sector (financial and nonfinancial).

Fund staff estimates.

Table 5.

Guatemala: Financial Soundness Indicators

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Sources: Superintendency of Banks; Bank of Guatemala; and Fund staff estimates.
Table 6.

Guatemala: Indicators of External Vulnerability

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Sources: Bank of Guatemala; and Fund staff estimates.