COSTA RICA: A Happy Ending? Not Exactly

CENTRAL AMERICA - Report 28 Jun 2017 by Francisco de Paula Gutiérrez and Felix Delgado

Costa Rica’s Central Bank succeeded in controlling FX market turmoil in May, bringing the exchange rate down from the high levels it reached by the third week of May. But pressures persist, since Central Bank FX market intervention has not been neutral over the medium and long-term, as the official policy maintains. A fast and significant interest rate rise will reduce arbitrage of local savings, discouraging FX demand for dollarization of domestic portfolios. Economic activity has slowed, despite some dynamism in merchandise exports. Inflation is moving toward the lower boundary of the Central Bank’s target range. The fiscal deficit is worsening – the persistent major economic policy challenge. We expect to revise our short-term economic outlook in our July report.

In El Salvador, economic activity drivers are performing modestly, except for foreign remittances that cannot bring dynamism to economic activity. The seasonally adjusted index grew at a modest 1.7% y/y, with a decreasing trend that orients economic activity toward our 2017 2% y/y forecast. The fiscal deficit is increasing again, as is the risk of missing new payments to the pension trust fund in July, as happened in April. Exports are volatile, with ups running in the low figures. Lending to the private sector has also risen modestly, while interest rates maintain a weak but steady uptrend. The political climate continues negative, without clear possibilities of near-term improvement.

Guatemala hasn’t often been able to plan for the long-term. Short-term economic policy is very clear, but longer-term development strategy isn’t. Recent news of the government’s attempt to develop a multiyear (2018-2022) budget, and to revitalize the Northern Triangle Alliance for Prosperity, with the support of the United States, opens a window of hope for the medium term.

Inflation continues to run within the 4% ±1 p.p. target range. Data as of May showed a 3.93% y/y rate (1.68% ytd), while core inflation, at 2.82% y/y, was slightly below the lower limit of the range. Economic activity is recovering slightly: The Monthly Index of Economic Activity, trend cycle, grew 3.59% y/y both in March and April, up from 3.24% in December 2016. FX continues to appreciate, and the Bank of Guatemala has purchased more than $1.1 billion, to stave off further appreciation. Net international reserves already exceed $10.5 billion, including $500 million from the early June $500 million Eurobond placement.

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