Central America Economic Forecast

Economic Snapshot for Central America

February 15, 2017

Weak economic performance in 2016 carries over into 2017

Economic activity in Central America and the Caribbean softened in 2016 mainly due to weak external demand, particularly from the United States. In the full year 2016, growth in the region decelerated to 2.7% from 3.4% in 2015, according to preliminary estimates. The print was below the 3.0% expansion projected last month by our panel of analysts. Economic growth did accelerate in the second half of 2016, supported by improving dynamics in the U.S. and higher commodity prices, and yet this has not carried over into 2017, with regional growth expected to decelerate in Q1.

Overall, in 2016, growth in Central America and the Caribbean benefited from low interest rates, still subdued inflationary pressures and rising remittances from overseas. Although weak global trade limited any upswing in regional growth, low energy prices led the aggregate current account deficit for the region to narrow to levels not seen since the trough of the financial crisis in 2009.

Going forward, growth will be supported by stronger economic activity in the United States, particularly if President Donald Trump’s pledges to boost infrastructure spending materialize. Healthier dynamics in Latin America and other key economies such as the European Union will also support external demand. On the downside, a number of headwinds are threatening the region’s economic outlook for this year. How new policies adopted by the U.S. administration will impact the Central American and Caribbean economies is shrouded in uncertainty. Trump’s initiatives to restrict free trade do not bode well for the region, while stricter migration controls could negatively affect all-important remittance flows from the U.S. Moreover, faster-than-expected growth in the U.S. could prompt the Fed to tighten its monetary policy more quickly than previously anticipated, which could fuel volatility in the region’s financial and exchange rate markets. On the domestic side, higher energy prices will erode real income, hurting private consumption, while large fiscal deficits will prevent governments from taking further action. 

Looming challenges weigh on 2017 economic prospects 

The economies of Central America and the Caribbean will expand at a faster pace this year. Our analysts expect GDP to expand 3.0% in 2017, which is down 0.1 percentage points from last month’s estimate. This month, growth projections were revised down for the Dominican Republic and Panama. Forecasts were revised up for Honduras, while they were left unchanged for the other nine countries, including Costa Rica, Guatemala and Nicaragua. Our analysts expect growth to inch up to 3.1% in 2018.

Panama will be the fastest growing economy this year with an expected growth rate of 5.4%, followed by the Dominican Republic and Nicaragua, in that order. In contrast, Puerto Rico’s economy will contract again in 2017 as spillovers from its massive debt crisis continue to hit the economy badly. 

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COSTA RICA | Fiscal imbalances continue to constrain otherwise healthy growth

Economic growth is likely to have dipped in Q4, capping a year of robust growth despite the economy facing a number of fiscal headwinds. Economic activity was still strong in December, although decelerating from November’s reading. Imports were up considerably in January, suggesting that private consumption remained resilient into the new year. Improvements to both the fiscal deficit and collected tax revenues in January were not sufficient for S&P Global Ratings, however, which maintained its BB- rating and negative outlook. The other two major credit rating agencies have recently downgraded Costa Rica’s government bond rating as consistently high fiscal deficits have sent the government debt burden soaring. Institutional gridlock has prevented any meaningful tax reform legislation, even as the Ministry of Finance presented worst-case scenarios for public debt in the absence of action in late February.

While the economy is expected to moderate this year, growth should remain healthy on the back of robust private consumption and solid fixed investment growth. FocusEconomics Consensus Forecast panelists expect the economy to expand 4.0% in 2017, which is unchanged from last month’s estimate. In 2018, they see GDP growth inching down to 3.9%.

DOMINICAN REPUBLIC | Growth momentum remains robust

According to recent data from the Central Bank, economic activity continued to expand robustly in January, mainly supported by the manufacturing industry in the free trade zones and the services sector, which benefited from strong lending activity. In the same month, tourist arrivals—especially from Europe—maintained a healthy pace of expansion compared to January 2016, which attests to the country’s success in its effort to improve and expand its tourist accommodation facilities. The strong start to the year comes after GDP expanded at the fastest rate in Latin America for the third consecutive year in 2016, thanks to a rebound in mining activity, a booming tourism sector and healthy growth in remittances. One lingering concern is the country’s fiscal position, with a sizeable budget deficit remaining despite the economy operating above potential. Following a staff visit in February, the IMF encouraged the Caribbean country to improve its fiscal position, mainly by broadening its tax base and streamlining its electricity pricing policies.

Growth will remain healthy this year, although it will decelerate. Growth will once again come on the back of robust fixed investment and private consumption, which will benefit from increasing incomes. Nevertheless, higher financing costs and a protectionist shift in the U.S. could dampen the expansion. FocusEconomics analysts expect the economy to expand 4.9% in 2017, which is down 0.1 percentage points from last month’s forecast, and 4.5% in 2018.

GUATEMALA | Political developments threaten outlook

The country is on the brink of another political crisis, threatening its economic recovery. The investigation into the Odebrecht scandal revealed that over 100 deputies in Congress accepted bribes during the public tendering process for the construction of a highway in 2012. Some 40,000 protesters gathered in the capital demanding President Jimmy Morales’ resignation as a result. Morales is not directly implicated in the Odebrecht case but his credibility has been seriously weakened since his brother and son were arrested in January on corruption charges. He seemingly worsened the situation by refusing to publicly defend the UN-backed anti-corruption commission, which is widely credited with helping stabilize the country but currently the victim of a smear campaign. Political tensions rose further still when rumors of a Congress-led attempted coup emerged, prompting Morales to publicly deny them. Morales had been elected in late 2015 on an anti-corruption platform after large-scale protests had forced the previous scandal-ridden administration to resign.

A rapid erosion yet again in public trust in government, coupled with Donald Trump’s restrictive policy course, could disrupt the country’s economic recovery. FocusEconomics Consensus Forecast panelists forecast that GDP will grow 3.7% in 2017, which is unchanged from last month's estimate. In 2018, the panel also expects GDP growth of 3.7%.

PANAMA | Weak global trade hits growth in 2016

The sustained deceleration of the Panamanian economy continued in 2016, with growth coming in at a six-year low. The disappointing figure highlights the many challenges the country faces and reveals the extent to which the recently opened Panama Canal expansion has failed to provide much impetus to the economy amid a global economic cooldown. This year should be more promising for the small, open economy as trade-related activities are set to pick up on improving global economic prospects. Against this backdrop, Fitch Ratings left the country’s rating and outlook unchanged in its latest revision in February. The agency noted that increased Canal earnings and ongoing construction of large-scale infrastructure projects should shield the economy from adverse economic headwinds and keep growth on a steady path. This should also contribute to reducing the country’s debt burden and fiscal deficit.

Panama is set to be one of the best performing economies in the region for another year. Nevertheless, challenges to the outlook persist. Growing protectionist rhetoric, flagging maritime trade and a slower-than-expected recovery in Latin America represent the main downside risks to growth. Analysts expect the economy to expand 5.4% in 2017, which is down 0.2 percentage points from last month’s forecast. For 2018, GDP is expected to grow 5.5%.

INFLATION | Inflation firms at start of 2017

Inflation continued to rise at the outset of the year, propelled mainly by higher energy prices. A preliminary estimate for February shows that inflation jumped from 2.9% in January to 3.1% in February, which represented the highest print in one year. The print reflected mainly reflected higher inflation in Costa Rica, the Dominican Republic and Guatemala. Moreover, El Salvador registered the first positive reading in five months.

Our Consensus Forecast panelists left their inflation estimates for 2017 unchanged at 3.1% for the fourth month in a row. For 2018, inflation is expected to increase to 3.3%.

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Written by: Ricard Torné, Head of Economic Research

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