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

The natural disasters that hit the country recently caused human losses and had a negative impact on the economy; however, they did not deviate the economic recovery path. Currently, growth in exports and imports is accelerating, remittances are recovering, and international reserves are well above end-2009 levels. The authorities have recently adopted regulations on liquidity and foreign currency credit risk management and have made further progress toward full provisioning of nonperforming loans. Finally, the IMF-supported program has also contributed to the achievement of their economic program goals.

Abstract

The natural disasters that hit the country recently caused human losses and had a negative impact on the economy; however, they did not deviate the economic recovery path. Currently, growth in exports and imports is accelerating, remittances are recovering, and international reserves are well above end-2009 levels. The authorities have recently adopted regulations on liquidity and foreign currency credit risk management and have made further progress toward full provisioning of nonperforming loans. Finally, the IMF-supported program has also contributed to the achievement of their economic program goals.

I. Developments Since the Third Review1

1. Natural disasters hit Guatemala in late May, causing human and economic losses. The eruption of a volcano near Guatemala City and a powerful tropical storm caused losses of human lives, disrupted transportation and trade, and damaged public infrastructure and agricultural crops. Total economic losses have been estimated at 2.4 percent of GDP.2

2. The economic recovery has continued to firm up. While the natural disasters had a negative impact on the economy, they did not derail the recovery. The monthly index of economic activity (IMAE) rose to 3.1 percent (y/y) in June (up from 2.8 percent in March). Consumer price inflation remained broadly stable, with headline and core inflation at 4.1 percent and 2.6 percent (y/y), respectively, as of end-August (Figure 1).

Figure 1.
Figure 1.

Guatemala: Recent Economic Developments

Citation: IMF Staff Country Reports 2010, 309; 10.5089/9781455208463.002.A001

Source: Fund staff based on national authorities.

3. A new Minister of Finance, Mr. Edgar Balsells, took office in late June. Minister Balsells indicated to the mission that he is committed to maintain prudent fiscal policies. His priorities in the near term will be to accommodate relief and reconstruction spending associated with the natural disasters, contain non-priority spending to help meet the 2010 fiscal deficit target, seek approval of the draft 2011 budget (submitted to congress in early September), avoid new domestic payment arrears by the government, and secure congressional support for an anti-tax evasion law.

4. Balance of payments flows have continued to normalize. Growth in exports and imports is accelerating, and remittances have begun to recover. The balance of payments is estimated to have posted a surplus of about US$500 million in the first half of the year, taking net international reserves 10 percent above end-2009 levels (Figure 2). The exchange rate has remained broadly stable since March despite limited central bank intervention in the foreign exchange market under the rules-based framework.

uA01fig01

The currency has remained stable since March

Citation: IMF Staff Country Reports 2010, 309; 10.5089/9781455208463.002.A001

Source: Bank of Guatemala.
Figure 2.
Figure 2.

Guatemala: External Sector Developments

Citation: IMF Staff Country Reports 2010, 309; 10.5089/9781455208463.002.A001

Sources: Bank of Guatemala, and Fund staf f estimates.1/ 2010Q3 observation covers flows through August 12.2/ 2010Q2 observation estimated based on available merchandise trade and remittances data.3/ 2010Q3 observation depicts stock as of August 24.

5. The fiscal deficit in the first semester was lower than envisaged in the program. The deficit of the central government through June 2010 reached 0.9 percent of annual GDP, lower than the 1.5 percent of GDP projected in the program. This outturn was largely explained by delays in obtaining congressional authorization for the financing necessary to undertake the spending envisaged for the year (consistent with a deficit of 3.1 percent of GDP).3

6. The financial system remains resilient. Bank capitalization and liquidity indicators remain sound. As of June, nonperforming loans stood at 2.8 of total loans, down from a peak of 3.2 percent in October 2009. Bank profitability is increasing (with returns on equity and on assets of 18.1 and 1.9 percent, respectively, as of June 2010). Bank deposits continue growing at a healthy pace (10.6 percent y/y in July), but credit growth to the private sector remains sluggish (1.7 percent y/y in July). The sharp reduction in lending in foreign currency observed in 2009—associated with lower trade-related financing, tighter credit standards, and a reduction of foreign-currency exposures—appears to be abating (-7.1 percent y/y in July), while credit in local currency is picking up (6.2 percent y/y in July). In addition, there is some evidence that international banks operating in the region have increased lending in foreign currency.

uA01fig02

Credit in foreign currency has stabilized

Citation: IMF Staff Country Reports 2010, 309; 10.5089/9781455208463.002.A001

Source: Superintendency of Banks.

7. Program implementation remained strong. All quantitative performance criteria for end-June 2010 were met. The annual rate of inflation stood within the inner consultation band, and government deposits at the central bank exceeded the indicative target set in the program.

II. Policy Discussions

A. Macroeconomic Outlook and Risks

8. The macroeconomic outlook has not been affected materially by the natural disasters of last May. Real GDP is projected to grow by about 2½ percent in 2010 and 2011. Annual inflation is projected to end the year at 5.5 percent, within the target band set by the Monetary Board. Terms of trade gains will help limit the increase in the external current account deficit in 2010 to 2.9 percent of GDP (up from -0.6 percent of GDP in 2009), though the deficit is projected to increase further in 2011. Private capital inflows are projected to average 2 percent of GDP per year in 2010–11, on the back of firmer FDI. Unrecorded inflows (errors and omissions) are expected to abate as the authorities continue improving data collection. Net international reserves are projected to reach US$5.2 billion at end-2010, and to rise by another US$0.2 billion in 2011. External debt service payments remain manageable.

The recovery is taking hold

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

Staff Report for the Third Review under the SBA.

9. Risks to the outlook have declined. The ongoing recovery in exports and remittances and the pickup in FDI flows have lowered risks to the balance of payments and activity. The main downside risks to the outlook come from a more sluggish-than-projected economic recovery in the United States, a sharp increase in oil prices, and heightened political uncertainty ahead of the September 2011 presidential elections.

B. Fiscal Policy

10. The authorities raised their 2010 target for the central government deficit to 3.4 percent of GDP (from 3.1 percent of GDP previously) to accommodate the demand for relief and reconstruction expenditures. Excluding reconstruction spending (0.3 percent of GDP for this year), the deficit target is broadly the same as the one projected during the third review. With this revised target, the primary deficit in 2010 would rise to 1.8 percent of GDP, and the discretionary stimulus (0.5 percent of GDP) will more than offset the cyclical rebound in revenues. As a result, the fiscal stance in 2010 would now be modestly expansionary, and public debt by end-2010 will rise to 24½ percent of GDP (from 20 percent of GDP at end-2008).4

uA01fig03

The fiscal impulse will be positive in 2010, and broadly neutral in 2011

Citation: IMF Staff Country Reports 2010, 309; 10.5089/9781455208463.002.A001

Source: Fund staff estimates.

11. The draft 2011 budget recently submitted to Congress would result in a modest start of the consolidation process. The draft envisages a small decline in the central government deficit in 2011, which would imply a broadly neutral policy stance. The draft budget, which excludes reconstruction expenditures, would imply a deficit of 2.7 percent of GDP, higher than the target in the medium-term budget framework presented by the authorities last May (2.5 percent of GDP).5 The mission welcomed the authorities’ intention to lower the fiscal deficit in 2011, but recommended a more ambitious pace of consolidation. Staff stressed that a faster pace of consolidation would signal a strong commitment by the government to stabilize the public debt-to-GDP ratio and regain fiscal space. The authorities agreed that it was desirable to lower the fiscal deficit to pre-crisis levels over the medium term, but considered that a more ambitious pace of consolidation in 2011 was not feasible given the rigidity of several expenditure categories and ongoing spending pressures.

12. Staff reiterated that a comprehensive tax reform should remain at the center of fiscal consolidation. Although political resistance to tax reform remains strong, the authorities indicated that they will continue working with congress to build support for some of the measures proposed in the draft law submitted last November, including the increases in income and stamp tax rates. In addition, the authorities intend to seek approval of measures aimed at reducing tax evasion, strengthening tax administration and improving the small tax-payers VAT scheme. The mission welcomed these initiatives, but stressed that a comprehensive revenue-enhancing reform remained necessary to ensure sustainable public debt dynamics, particularly given the higher level of current spending (largely reflecting higher social expenditure) the government seeks to maintain. In the absence of new revenues, the burden of reducing the fiscal deficit to below 2 percent of GDP (the debt-stabilizing level) would have to fall on social and capital expenditures, which are low.

13.There was agreement on the importance of adopting measures to avoid new domestic arrears and regularize the outstanding stock. Staff welcomed the authorities’ intention to undertake several actions recommended by the recent Fund technical assistance mission on domestic arrears (Box 1). In particular, the authorities indicated that they plan to tighten legislation and controls, introduce (and enforce) stricter sanctions, seek passage of a draft law to regulate public trust funds, and phase out contracts signed under the old procurement law. The mission also supported the authorities’ intention to conduct an audit to quantify and assess the legitimacy of outstanding arrears and stressed the importance that the audit be undertaken by an internationally recognized firm. In addition, staff suggested that the clearance of outstanding arrears be done through the issuance of domestic bonds and that future budget allocations penalize the entities that have been more prone to generate arrears. The mission also recommended to strengthen the role of the ministry of finance in the enabling regulations of the law on Private-Public Partnerships approved earlier this year.

Avoiding New Domestic Arrears

Public sector arrears are a chronic problem in Guatemala and appear to have increased in the last three years. A recent Fund technical assistance mission helped the authorities identify the sources of these arrears and recommended measures to prevent their recurrence. The key findings and recommendations of the mission are summarized below.

Sources

Government arrears in Guatemala are of two types. The first, the most common, is generated by government entities committing resources for the purchase of goods or services that are not contemplated in the budget or covered by financial information systems. These arrears are rarely sanctioned, and are difficult to quantify and control. The second type of arrears arises during budget execution possibly as a result of unexpected reductions in revenues and weaknesses in public financial management.

Remedial Measures

To avoid the first type of arrears, it would be critical to:

  • Tighten legislation and administrative controls. This would help ensure that line ministries do not engage in contracts and purchases without proper budgetary allocations and recording. To enforce this control, it would be important to issue norms that declare illegal any contract and purchase order not accompanied by a “certificate of budget availability” issued by the ministry of finance and/or not recorded in the financial information system.

  • Impose (and enforce) stricter sanctions on public officials that do not comply with budget and procurement rules and regulations.

To avoid the second type of arrears, it would be important to:

  • Increase budget flexibility including by establishing a contingency reserve and an emergency fund to accommodate unanticipated expenditures.

  • Improve the control of budget execution including by recording all expenditures and obligations when they accrue (and not only when payments are made).

  • Improve cash and liquidity management, including by increasing the coverage of the single treasury account and improving coordination with spending units.

  • Phase out contracts signed under the old procurement law and gradually eliminate the role of trust funds in budget execution.

C. Monetary, Exchange Rate and Financial Sector Policies

14. Staff and the authorities agreed that monetary policy should remain vigilant. The monetary policy rate has been kept at 4.5 percent since September 2009, while inflation expectations have begun to increase from December 2009 to April 2010. Since then, inflation expectations have broadly converged to 6 percent, the upper bound of the inflation target range set by the Monetary Board. Staff and the authorities concurred that the convergence in inflation expectations, sluggish credit growth, and a still negative output gap suggested that the monetary policy stance remained appropriate. However, there also was agreement on the need to continue monitoring closely inflation expectations and capital flows, and stand ready to raise the policy rate if conditions change.6

uA01fig04

Inflation expectations are converging to the target band

Citation: IMF Staff Country Reports 2010, 309; 10.5089/9781455208463.002.A001

Source: Bank of Guatemala.

15. There was agreement on the importance to continue strengthening the monetary policy framework, including maintaining exchange rate flexibility. The mission welcomed the authorities’ efforts to further develop a yield curve and their commitment to exchange rate flexibility, which helped cushion the impact of the global economic crisis and is key to enhance the channels of transmission of monetary policy. A transitional framework for monetary operations (comprising daily auctions of seven-day instruments) may come into place in October. The mission concurred with the authorities that the fully upgraded framework (centered on an overnight interest rate) should be put in place once the central bank and the market are confident that procedures and systems are working satisfactorily.

16. Financial sector reforms have continued to advance, though key elements of the reform agenda remain pending. A new insurance law, enhancing the capacity of the Superintendency of Banks to effectively supervise insurance intermediaries and products, was approved in July. Progress has also been made in implementing the regulations on liquidity and foreign currency credit risk management, and plans to reach full provisioning of nonperforming loans by 2011 remain on schedule. The authorities are also preparing regulations to further strengthen information technology risk, banks’ risk governance and comprehensive risk management; these regulations are expected to be approved by end-2010. The mission encouraged the authorities to step up efforts to seek prompt congressional approval for the amendments to the banking law, which are essential to further strengthen the resilience of the banking sector. Staff reiterated its recommendation of enhancing crisis preparedness, including by preparing a systemic banking resolution plan.

III. Fund Relations

17.The authorities considered that the SBA had been useful. In particular, they were of the view that Fund support played a key role in maintaining confidence in the consistency of policies and the strength of financial buffers, and allowed them to focus the policy response on mitigating the effects of the global slowdown. The authorities indicated their interest in exploring options for continued engagement with the Fund, including under the new lending facilities that were recently approved by the Board.

IV. Staff Appraisal

18. The recovery of the Guatemalan economy continues to firm up. Although the natural disasters that hit Guatemala in late May caused human losses and had a negative impact on the economy, they did not derail the recovery. Economic activity is gaining steam and inflation has stabilized. External trade is rebounding, remittances have begun to recover, and the overall balance of payments is strengthening. In addition, the financial system remains resilient, and credit to the private sector in local currency is gradually picking up.

19. Performance under the SBA has remained strong. All quantitative performance criteria for end-June 2010 were met. The annual rate of inflation stood within the inner consultation band, and government deposits at the central bank exceeded the indicative target set in the program. The authorities plan to continue treating the SBA as precautionary. Even if Guatemala were to draw the full amount available under the program, they would be in a strong position to repay the Fund.

20. The near-term outlook is favorable, and risks to the outlook have declined. Real GDP is projected to grow by about 2½ percent during 2010–11 driven by domestic demand, and improved global financial conditions have lowered risks to the balance of payments. The main downside risks stem from more-sluggish-than projected growth in the United States, a sharp increase in oil prices, and heightened political uncertainty ahead of the presidential elections in 2011.

21. The small withdrawal of fiscal stimulus that was envisaged for 2010 will not take place. The deficit of the central government in 2010 is now projected at 3.4 percent of GDP, somewhat higher than projected earlier, due to relief and reconstruction expenditures associated with the natural disasters. This higher deficit will provide some additional stimulus to domestic demand this year and postpone the withdrawal of stimulus to 2011.

22. A comprehensive revenue reform remains a key priority. Seeking approval of an anti-evasion law and of some elements of the draft law submitted to congress last November would be positive steps, but a comprehensive revenue reform remains necessary. Higher revenues would help stabilize the public debt-to-GDP ratio and avoid that the burden of fiscal consolidation falls on social and capital expenditures. While the draft budget for 2011 would help shift the fiscal stance, it would be desirable to set a more ambitious target to send a strong signal about the government’s commitment to fiscal consolidation. Staff also urges the authorities to find a prompt solution to the problem of domestic arrears, which weakens the budgetary and fiscal framework.

23. Monetary policy should remain vigilant. Stable inflation expectations, a negative output gap and slow credit growth suggest that the monetary policy stance remains broadly appropriate. Staff agrees with the authorities on the importance to continue monitoring closely monetary indicators, capital flows, and inflation expectations, and to stand ready to tighten the policy stance, if needed. Staff welcomes the authorities’ continued commitment to exchange rate flexibility, which is essential to absorb shocks and to strengthen the inflation-targeting framework.

24. The financial sector reform agenda should remain a priority. Staff welcomes the recent adoption of the regulations on liquidity and foreign-currency credit risk management, the continued progress towards full provisioning of nonperforming loans, and the approval of a law governing the insurance sector. Securing congressional approval of the draft amendments to the banking law would be key to further increase the resilience of the banking sector. Increasing crisis preparedness, including by putting together a systemic banking resolution plan, is also important.

25. Staff recommends completion of the Fourth Review under the SBA.

Table 1.

Guatemala: Selected Economic and Social Indicators

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

Staff Report for the Third Review under the SBA.

Table 2.

Guatemala: Summary Balance of Payments

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

Staff Report for the Third Review under the SBA.

Includes 2009 SDR allocations of US$271 million.

Table 3A.

Guatemala: Public Sector Balance

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

Staff Report for the Third Review under the SBA.

Table 3B.

Guatemala: Public Sector Balance

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

Staff Report for the Third Review under the SBA.

Table 4.

Guatemala: Monetary Sector Survey

article image
Sources: Bank of Guatemala; and Fund staff estimates.

Staff Report for the Third Review underthe 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).

Table 5.

Guatemala: Financial Soundness Indicators