Central America Economic Outlook August 2016

Brexit poses limited risks to Central America and the Caribbean

Central America: Brexit poses limited risks to Central America and the Caribbean

August 10, 2016

Fear and uncertainty surrounding the United Kingdom’s decision to separate from the European Union adversely affected economic sentiment on a global scale in the days following the referendum. However, with the dust now settled, the impact of Brexit on the economy of the Central American and the Caribbean region is expected to be limited as the region’s links with the UK in key areas such as trade, investment and remittances are weak.

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The effect of Brexit through trade will be contained since only 1.5% of the overall exports from the region go to the UK and only 0.7% of the region’s imports come from the UK. That said, the region’s trade share with the European Union is larger and a deceleration of the European Union economy poses more risks to the Central American and the Caribbean region. Nearly 10.0% of the region’s exports are destined for the EU, while imports from the EU account for 7.5% of total imports.

Once the separation process officially begins, the United Kingdom will need to negotiate new trade deals with the remaining 27 members of the European Union and the rest of the world. As a result, the economic and political impact of Brexit and its spillover effects are still unclear and will depend on the new relationship established between the UK and the EU. This means that in the short term the effect on trade will be limited, but in the long-term the UK could seek to increase its trade links with the non-EU markets, including the countries in Central America and the Caribbean, particularly with the British Overseas Territories. 

The U.S. dollar strengthened significantly in the aftermath of the Brexit, thus threatening the export competitiveness of the dollarized countries in the region such as Belize, El Salvador and Panama. A stronger dollar also put considerable pressure on commodities prices, except for safe haven assets such as gold. This boded well for the commodity-importing countries of the region, but was bad news for commodity-exporting countries, in particular for the oil-exporting countries such as Trinidad and Tobago. The first direct effect of the referendum outcome was the collapse of the pound, which plummeted to a multi-year low in the days following the vote and has still not recovered. A weaker pound has hurt disposable income, decreased real wages and also increased the cost of holidays for the British. This may in turn affect the tourism sector in Central America and the Caribbean. In terms of remittances, the links with the UK are relatively weak, with Jamaica being the largest receiver. According to the World Bank, in 2015, Jamaica received nearly USD 292 million in remittances from the UK, which is equivalent only to 2.0% of the country’s GDP.

The main view held by analysts is that the referendum outcome poses both risks to and opportunities for the region. The fallout on the British economy and the European Union might have an impact on tourism and remittances, and possibly trade. However, looking beyond the two-year trade negotiation period, the UK might seek to enhance its trade ties with non-EU countries, thus leading to new opportunities for trade partnerships with Central America and the Caribbean. 

Economy stalls in Q2 on slowdown in region’s key players

The economy of the Central American and the Caribbean region slowed in the first quarter and more recent data show that the economy likely stalled in the second quarter. GDP increased 2.7% in Q1 over the same quarter of the previous year, which was down from the increase in Q4 2015 and marked the slowest expansion in three years. Q1’s deceleration came on the back of slowdowns in economic activity in the majority of the economies in the region, with Guatemala, Panama and Puerto Rico recording the steepest decelerations. Conversely, the economies of Costa Rica and Jamaica strengthened slightly in Q1.

An analysis of some specific economies in the region shows that a deceleration in the construction sector took a toll on Guatemala’s economy in Q1 and it expanded at the softest pace in over three years. Panama’s economy suffered the consequences of weak expansions in the industrial and agricultural sectors. Nevertheless, prospects are bright in Panama as substantial public investment will foster growth this year. Elsewhere in the region, the never-ending debt crisis in Puerto Rico intensified after a group of hedge funds launched a lawsuit against Governor Alejandro García Padilla in July following the country’s default on nearly USD 1.0 billion in payments at the beginning of the month. This adds to the island’s fiscal problems—Puerto Rico has struggled with a high debt-to-GDP ratio and dismal economic growth for years. 

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Analysts continue to forecast deceleration for 2016

The region’s economy is expected to decelerate slightly this year even though economic activity will be supported by an improvement in remittances and tourism amid a gradual recovery of the U.S. economy. This month, the GDP growth outlook for Central America and the Caribbean was left unchanged for the third consecutive month. Our panel expects the region’s economy to expand 3.0% this year. The economic outlook was left unchanged for 6 of the 12 economies surveyed, including the Dominican Republic and Guatemala. On the other hand, 2016 GDP estimates were cut for four economies including Jamaica and Trinidad and Tobago. Costa Rica and El Salvador were the only economies for which the growth outlook improved. The regional projection for 2017 also remained stable with GDP expected to increase 3.1%.

Panama will grow the fastest this year followed by the Dominican Republic with growth rates of 5.8% and 5.6%, respectively. Conversely, Trinidad and Tobago’s economy will be the worst performer and its economy is expected to contract 1.8%.

COSTA RICA | Economy gains momentum in the second quarter

Costa Rica’s economy likely expanded at another robust rate in Q2, according to the latest data on the country’s economic activity. In May, the economy grew at its fastest pace in four years on an annual basis, mainly driven by the acceleration of the manufacturing sector and the quickly-expanding financial intermediation sector. Performance in the agricultural sector also improved in the first half of the year and grew at the fastest rate in a year in May. The expansion was mainly driven by a boost in melon and banana production, propped up by favorable weather conditions. However, experts pointed out that the agricultural sector is still recovering from the losses it incurred in 2015.

Costa Rica’s economic outlook broadly depends on its fiscal performance. Fiscal consolidation will continue to weigh on growth until revenue collection measures are implemented. However, the upturn of the agriculture and manufacturing sectors will bolster economic growth in the near future. Analysts polled by FocusEconomics foresee the economy expanding 3.8% in 2016, which is 0.1 percentage point up from last month’s projection. For 2017, the panel expect GDP growth to remain stable at 3.8%.

DOMINICAN REPUBLIC | Domestic demand will support the economy this year

The Dominican Republic’s economy grew robustly in the first quarter of 2016, mainly on the back of the strong performance of the service sector. The economic momentum seems to have carried over into the second quarter: the latest available monthly indicators for economic activity showed that the economy expanded at a strong pace in both April and May, and June’s data on tourism indicate that growth in tourist arrivals accelerated over the previous month. In other news, the Central Bank announced on 21 July that the country had repaid in full the credit extended by the IMF under the Stand-By Agreement signed in 2009. On the political side, the National Assembly of the Dominican Republic named Danilo Medina and Margarita Cedeño as president and vice president, respectively.

In 2016, the Dominican economy will expand robustly on the back of solid domestic demand, though the weak external environment could also weigh on growth. Analysts expect the economy to grow 5.6% in 2016, which is unchanged from last month’s projection. For 2017, the panel projects GDP to increase 4.7%. 

GUATEMALA | Growth remains resilient despite political troubles

Guatemala’s economy is still showing signs of strength, even as aftershocks from the latest wave of corruption scandals in politics last year continue to shake the country. In June, the Central Bank’s economic activity index recorded its first acceleration since October of last year amid signs of improving conditions. Although remittances dropped at their sharpest pace in five years in July, the long-term trend continued to point upwards. On the political side, the cleanup continued with the arrest of one of the country’s most high-profile business tycoons on suspicion of tax fraud. Meanwhile, disgraced former President Otto Perez Molina is being formally investigated for corruption. The previous administration’s legacy of mismanagement and corruption in the healthcare sector, which has left it in a poor state, spilled over into the new administration of Jimmy Morales and drove the new health minister to resign in July after only 7 months in office.

A gradually more stable political situation, along with continued growth in remittances, should help keep the Guatemalan economy on a solid growth path. FocusEconomics panelists forecast that the economy will rise 3.5% this year, which is unchanged from last month's projection. Next year, the panel expects GDP to inch up to 3.6%.

PANAMA | Economy gains traction in Q2  

The Panamanian economy decelerated to a multi-year low in 2015 due to sluggish global trade. Ongoing weakness in the country’s service and agricultural sectors caused the economy to slow to a two-year low in Q1. Despite these challenges, data from Q2 suggest that the economy is gaining traction. In May, economic activity reached an over-one-year high as construction of large-scale public infrastructure projects picked up pace. Similarly, the opening of the Panama Canal expansion in late June and the income it generates will provide further impetus to the Panamanian economy.

Panama’s diverse service-oriented sectors and substantial public investment will keep external headwinds at bay and foster growth, though flagging global demand and subdued trade activity in the Colón Free Trade Zone still weigh on the outlook. Analysts expect the economy to expand 5.8% in 2016, which is unchanged from last month’s projection. For 2017, the panel forecasts growth of 6.0%.

INFLATION | Inflation inches up in June  

Inflation in the Central American and the Caribbean region inched up in June from the previous month’s 2.7% to 2.8%. The Dominican Republic and Puerto Rico recorded higher inflation in June while inflation in Costa Rica, Nicaragua and Panama decreased. Looking forward, inflationary pressures are expected to remain broadly stable this year. A preliminary estimate for July elaborated by FocusEconomics shows that regional inflation likely remained stable at 2.9%. Looking forward, inflationary pressures are expected to remain broadly stable this year.

The August Consensus Forecast for inflation in 2016 is in line with last month’s forecast. The Consensus still projects inflation to tally 2.5% this year. Inflation forecasts are unchanged for 8 of the 12 countries in our survey, including the Dominican Republic and Puerto Rico. Projections were downgraded for Costa Rica and Honduras while the 2016 inflation estimate was increased only for Panama and Trinidad and Tobago. For next year, our panelists expect regional inflation to accelerate slightly to 3.1%. 

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Written by: Dirina Mançellari, Senior Economist

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