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Walter Molano | Central America an oasis in the storm

Published:Friday | October 23, 2015 | 10:00 AMWalter Molano

PROBLEMS IN China, the tightening of financial conditions in the United States, and the plunge in commodity prices have spread turmoil throughout the emerging world.

Although some bond prices recovered when market participants realised that the US Federal Reserve would probably delay its rate hike into the second quarter of next year, outflows from the asset class have been high.

The downward correction has highlighted the flaws in some of the larger countries, such as Brazil, Colombia, Chile and Peru. However, some parts of the emerging markets will be less affected by the storm. Central America and the Caribbean have fundamental conditions that help isolate them. This region is more correlated with the US economy and less affected by the downturn in the commodity markets.

The strength of the US labour market has allowed workers to send funds to relatives and loved ones back home. Furthermore, the decline in oil prices has eased pressure on their balance of payments. So much has been the relief on their trade accounts, that in some cases, it has more than compensated for the drop in export commodity prices.

Two countries, Guatemala and Costa Rica, stand out. Their ability to withstand the international volatility has made them a safe haven in a ruckus market.

Three days remain until Guatemala's second-round presidential elections, and comedian Jimmy Morales leads the way. He is running on a centre-right platform against former First Lady Sandra Torres.

Even though Morales has no political experience, he is riding the wave of popular discontent against the political establishment. President Otto Perez Molina was ousted after 20 weeks of mass protests against blatant incidents of corruption. At the same time, Torres, who is campaigning on a platform of leftist populism, represents the old guard that has siphoned billions of dollars from the government's coffers. Many people question Morale's ability to govern. Where will he recruit a cabinet, and how will he pass legislation through the opposition-controlled congress?

Fortunately, the Guatemalan economy is in relatively good shape. GDP is expected to grow about four per cent y/y this year. Inflation has been trending down, dropping below two per cent y/y in August. The quetzal has been stable for almost 15 years, and the central bank has mainly intervened to prevent the appreciation of the currency. As a result, international reserves have steadily climbed, and are now approaching US$8 billion.

The biggest inflow has been remittances, which has equalled about 12 per cent of GDP. This has allowed the government to keep the fiscal accounts under control, with a primary fiscal deficit of less than 0.5 per cent of GDP. Consequently, the country's debt to GDP ratio is only 24 per cent of GDP.

The massive influx of money has led to the creation of a solid middle class that extends well into the countryside. Therefore, a Morales Administration would not need to get difficult reforms through the congress to keep the economy afloat.

A similar situation describes Costa Rica. Although smaller in size and with weaker macroeconomic numbers, it has a vibrant private sector and strong political institutions that ensure the county's economic and political stability.

Costa Rica's biggest problem is its fiscal accounts. The primary fiscal deficit is 1.2 per cent of GDP, and the operational deficit, which includes interest payments, could reach 7 per cent of GDP in 2016. Nevertheless, a tidal wave of remittances preclude a major problem.

Costa Rica also has a well-developed tourist industry that is benefiting from the rebound of the US economy. While the country lived under the cloud of the post-Lehman slump, it is now basking in the glow of the US recovery.

Costa Rica is also moving into higher-value sectors. Many service companies are setting up operations around San Jose. These include back-office and support operations that have higher remuneration than call centres. One such example is Intel. It recently shut down an assembly plant and replaced it with a technology centre that employs less workers, but where the total compensation is higher than the previous operation.

These conditions are allowing the Costa Rican economy to grow 3 per cent to 3.5 per cent y/y in 2015, in an environment where most Latin American economies are moving into recession.

The situations in Guatemala and Costa Rica are mirrored across the region. Honduras is in the midst of a thorough fiscal overhaul. The Dominican Republic and Jamaica are being boosted by the revival of the North American tourist.

As a result, Central America and the Caribbean are benefiting from its strong ties with the US, the weak commercial ties with China, and its lack of dependence on mineral exports.

 

Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.

wmolano@bcpsecurities.com