COSTA RICA: Two cheers for fiscal reform

CENTRAL AMERICA - Report 27 Dec 2018 by Francisco de Paula Gutiérrez and Felix Delgado

Costa Rica’s significant political step, of congressional approval of the fiscal reform package, has generated mixed results. It brought some calm and lowered uncertainty, by building up confidence in the political system’s capacity to make decisions, even when unpopular measures are required. In two previous episodes in the last 15 years, bills with similar content were ruled out by the Constitutional Court, blocking approval in Congress; now that source of uncertainty has been eliminated. Yet the insufficiency of this reform is well known, both in terms of the relatively modest financial contribution tax measures will make, and the difficulty of implementing spending measures that will affect public employment and pay. Economic activity continues decelerating as forecast, against the optimism of Central Bank estimates; recently a visiting IMF mission talked about a 2.6% y/y real GDP increase in 2018, the same as the short-term economic outlook we presented in our July report.

In El Salvador, preferences for the February 3rd, 2019 presidential election have changed significantly this year. Now most electoral polls put outgoing San Salvador mayor and ex-FMLN politician Nayib Bukele as the frontrunner, far ahead of the right-wing ARENA, which holds a very firm second place, and the leftist FMLN, at a distant third. This means a challenge to the reigning bipartisanship since the peace agreements in the 1990s. It also raises questions about implications for short-term governance, as well for an eventual rearrangement of domestic political forces. Macroeconomic trends haven’t changed significantly, while important economic policy decisions seem unlikely, particularly if they contain political risks for the governing FMLN party, now with low and falling electoral support. Fiscal and external gaps continue increasing beyond our predictions, and economic activity isn’t advancing, while consumer prices and interest rates will probably close the year below our forecasts.

Guatemala continues to pursue relatively orthodox fiscal and monetary policies, which support economic stability, but with weak institutions that limit growth. Inflation ytd as of November was just 2.18%, after a 0.3% m/m drop in the price index. The exchange rate, which climbed from Q7.40 per dollar as of January 1st to Q7.7 as of September 30th, remained in the neighborhood of Q7.7 during Q4. The fiscal deficit, although higher than in 2017, is expected to remain below 2% of GDP by yearend, and the government debt-to-GDP ratio will continue to be around 25%. But an escalation of events between President Jimmy Morales’ administration and the UN’s Guatemala commission against impunity (CICIG) plants a big question mark over the strength of Guatemalan institutions -- a key element for attracting productive foreign investment, and for sustaining aid flows.

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