Central America Economic Outlook August 2018

Central America: Economic Snapshot for Central America

August 12, 2018

Second-quarter growth strengthens on upbeat industrial metrics

Available data suggests that the Central America and Caribbean economy picked up speed in the second quarter as early-year trends in industrial activity and remittance inflows firmed up. Regional growth appears to have gotten back on track following a subdued start to the year and is estimated to have clocked in at an upbeat 2.3% year-on-year. Meanwhile, more comprehensive data now pegs the first quarter’s expansion at 1.9% annually, up 0.1 percentage points from last month’s preliminary estimate. Notably, most economies in the region appear to have ramped up activity through the first half of the year. That said, regional growth was held back by Puerto Rico, which has been mired in a years-long recession most recently exacerbated by last year’s deadly hurricane season; excluding Puerto Rico, growth in the second quarter looks to have been the region’s strongest outturn in more than a year.

Although second-quarter national accounts data has yet to be released for most of the region’s economies, leading metrics suggest an upturn across its major economies. In the Dominican Republic, the region’s standout performer and one of its heaviest hitters, growth surged in the second quarter as duty-free manufacturing zones facilitated a rapid increase in output. Meanwhile, a buoyant tourism sector—bolstered by a booming U.S. economy—continued to underpin employment gains and construction activity. In both Guatemala and Costa Rica, leading data suggests similar trends were at play in the quarter; domestic demand appeared to strengthen on solid manufacturing gains in Guatemala, while in Costa Rica the ongoing and rapid recovery of the construction sector appears to have lifted second-quarter growth amid the fading of political uncertainty. On the other hand, and although Panama is expected to have grown at a slightly more upbeat pace in the second quarter, labor strikes through May are seen eating into economic activity.

Throughout the region, remittance inflows have been flooding into economies as the increasingly tight U.S. job market has delivered strong real wage gains. In June, remittances in Guatemala continued to break records as the 12-month trailing sum hit USD 8.5 billion—a substantial 10.9% gain from a year earlier. Along with rising tourism dollars, these transfers are supporting household spending and international reserves across the region. Moreover, they have become increasingly vital to the region’s economy as it faces a growing imported fuel bill and to consumers grappling with rising fuel costs.

In politics, ongoing protests in Nicaragua have left scores dead and the economy reeling. So far, economic losses have been estimated in the hundreds of millions of dollars, and dialogue between President Daniel Ortega and his critics has thus far proven fruitless. In seeking an end to the crisis, Ortega recently raised the possibility of UN-mediated resolution, although no clear path forward has yet appeared. In Haiti, protests broke out in July in the wake of an IMF-backed fuel price hike. The instability, which crippled economic activity, also brought down Prime Minister Jack Guy Lafontant on 14 July.

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 Firm U.S. growth bodes well for regional growth this year

Looking ahead, the region’s economies will continue to realize gains this year from the strength of the U.S. economy, which is expected to continue benefiting from fiscal stimulus over the short term. As the labor market in the U.S.—the Central America and Caribbean economy’s largest trading partner, by far—continues to tighten this year, remittance inflows and tourist dollars are expected to pad household incomes across the region. Moreover, buoyant U.S. demand should prop up exports, which will help offset the region’s growing imported fuel bill. Recovery efforts in Puerto Rico will continue in earnest as electricity is restored and federal aid reaches the island’s shores. Downside risks include faster-than-expected tightening by the Fed, which will put pressure on regional credit growth and investment. Moreover, stricter U.S. immigration policy, if finally enacted, could upset the recent surge of remittance inflows.

FocusEconomics panelists expect regional growth of 2.0% this year, which is unchanged from last month’s forecast. An upgrade to the Dominican Republic’s full-year growth estimate, following a stellar second quarter, offset slashed growth estimates for Costa Rica, Guatemala, Nicaragua and Panama. Along with the Dominican Republic, only Puerto Rico saw its short-term outlook revised upward. Meanwhile, two additional economies had their growth estimates cut in August, while four economies saw no change to their short-term outlook. Next year, regional growth is seen accelerating to 3.7%.

Dominican Republic and Panama are expected to log the region’s fastest growth this year, with both economies expanding close to 5.0%. Conversely, Puerto Rico is expected to be the region’s worst performer, contracting 6.8% in FY 2018.

GUATEMALA | Domestic demand to drive growth in Q2

Economic activity is expected to have picked up pace in the second quarter, recovering from the first quarter’s multi-year low. The average reading of the Central Bank’s monthly economic activity index in April and May trended above the average reading recorded in the first quarter. Indeed, growth in economic activity reached the highest level in April since October of last year. Data for April and May pointed towards a robust manufacturing sector, while the financial sector and wholesale and retail trade also chipped in. Moreover, annual growth in remittances in the second quarter more than tripled the first quarter’s pace of expansion. In USD value terms, remittances reached the highest monthly level on record in May. In June, confidence in the economy increased after two consecutive drops on the back of a rosier view on the current economic situation and in the next six months.

The economy is expected to shift into a higher gear this year, thanks to robust domestic demand. A tight labor market and strong remittances growth should support household consumption growth, while government expenditure is likely to increase sharply due to infrastructure spending. However, downside risks include potential political and economic uncertainty in the lead-up to next year’s presidential elections. FocusEconomics Consensus Forecast panelists expect the Guatemalan economy to expand 3.1% this year, down 0.1 percentage points from last month’s estimate, and 3.3% in 2019.

DOMINICAN REPUBLIC | Growth soars on manufacturing gains in Q2

The economy continued to surge in Q2, underpinned by double-digit expansions in the duty-free manufacturing and construction sectors, and a solid performance in the commerce sub-sector. Strong economic activity in recent quarters translated into healthy year-on-year formal employment growth in Q1 and a lower unemployment rate. Moreover, the number of tourist arrivals expanded robustly in Q2, while fiscal receipts increased by nearly 15% in the year to May. On the other hand, the external sector has weakened so far this year: Higher oil prices pushed up the import bill and led the trade deficit to widen. On 12 July, the country issued USD 1.3 billion in international bonds. This should bolster international reserves—which dipped notably in recent months—and help satisfy dollar demand.

Growth will likely dip going forward but remain healthy, supported by fixed investment and a strong U.S. economy, which will boost remittances, exports and tourism activity. However, tighter monetary policy will dampen activity. The vulnerable fiscal position, with elevated debt servicing costs and a narrow tax base, poses a downside risk. FocusEconomics panelists expect GDP growth of 5.2% in 2018, which is up 0.1 percentage points from last month’s forecast. For 2019, panelists see the economy expanding 4.5%.

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PANAMA | Economic activity hit by labor strikes in Q2

The latest available data indicates that economic growth likely remained sluggish in the second quarter, after hitting an over seven-year low in Q1 due to weak showings from the construction and trade-related sectors, which likely continued in Q2. In May, the Economic Activity Index (Indice Mensual de Actividad Economica) reached a nine-year low, hampered by a month-long union strike that ended on 18 May and brought the construction sector to a virtual standstill. Furthermore, social unrest remained high heading into Q3: There were widespread protests in June and July against a planned hike of electricity prices—backed by the IMF—which has for now been suspended.

Widespread labor union strikes and the completion of large-scale infrastructure projects should mute growth in 2018. Prospects look brighter in 2019 thanks to the opening of a large copper mine and a likely pick-up in construction activity. The country, however, remains vulnerable to an escalation of global trade tensions, a key downside risk which could disrupt the export-oriented sectors and activity in the Panama Canal. FocusEconomics Consensus Forecast panelists project that the economy will grow 4.9% in 2018, which is down 0.1 percentage points from last month’s forecast. They expect GDP will expand 5.2% in 2019.

COSTA RICA | Recovery of the construction sector to bolster growth in Q2

The economy improved in recent months, after annual growth moderated to an over four-year low in the first quarter of 2018. A fast-recovering construction sector and a strong information and communications sector helped economic activity to increase at the fastest pace in over two years in May. However, from January to May, the accumulated fiscal deficit grew to 2.8% of GDP, 0.2 percentage points more than in the same period last year. Furthermore, instability in Nicaragua has created an element of uncertainty. Over 20,000 Nicaraguans have sought refuge in Costa Rica since April, according to the United Nations. Given that Nicaragua is positioned between Costa Rica and El Salvador, the two countries accelerated preparations for a ferry link in July to help mitigate disruptions to bilateral trade.

The swearing-in of President Carlos Alvarado and the new representatives of the Legislative Assembly in May lifted a cloud of political uncertainty, which should benefit the economy going forward. However, despite recent legislative efforts, a persistent fiscal deficit and high public debt will continue to weigh on prospects, as could escalated instability in Nicaragua. Our analysts expect GDP to grow 3.2% in 2018, which is down 0.2 percentage points from last month’s projection, and 3.4% in 2019.

INFLATION | Inflation stable in June

According to a preliminary estimate produced by FocusEconomics, regional inflation was 3.4% in June, stable from May’s reading. Inflation jumped in Nicaragua, where ongoing protests have hampered economic activity. Meanwhile, inflation ticked up across most of the region on rising fuel costs, including in Costa Rica, the Dominican Republic and Panama. On the other hand, price pressures eased in Guatemala.

Moderate inflation left most of the region’s central banks room to keep rates on hold in recent weeks. In Costa Rica and Guatemala, officials held tight amid contained price pressures. On the other hand, in the Dominican Republic, officials hiked rates as concerns over the pace of the Fed’s tightening grew. Meanwhile, if all goes according to plan, inflation-targeting will become the Bank of Jamaica’s new policy framework later this year when legislation is tabled in parliament.

As a net energy importer, inflation in the Central America and Caribbean region will be driven higher this year by rising international oil prices. FocusEconomics sees inflation coming in at 3.3% in 2018, which is unchanged from last month’s forecast. For 2019, FocusEconomics expects inflation to remain stable at 3.3%.

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Written by: David Ampudia, Senior Economist

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