Financial Policies and Credit Control Techniques in Central America

Financial Policies and Credit Control Techniques in Central America Eduardo Laso * N EACH OF THE FIVE Central American countries, Costa Rica, I El Salvador, Guatemala, Honduras, and Nicaragua, the sound monetary policies which have in general been pursued in recent years have been helpful in promoting internal and external stability and in ensuring balanced and orderly economic development.1 Since 1950, both agricultural and industrial production have expanded in each of these countries. In several of the countries, the imports of food which formerly were necessary are no longer required, and in normal crop years there now are actually small export surpluses. Social capital has been expanded rapidly. New and better roads have been constructed, more electric power has been produced, and more schools and hospitals have been built since 1950 than in the whole of the preceding 20 years. This expanded social capital will facilitate an even more rapid in- crease of production in the future. These increases in capital investment and in production have been achieved without recourse to inflation. Despite the effects of rising world prices for coffee, the leading export commodity of these countries, upon bank lending and private spending, remarkable stability has been maintained in the cost of living, except in Nicaragua. Such increases as have occurred in prices and the cost of living have been moderate; this attests the soundness of the monetary policies adopted. Moreover, the fact that a rapid rate of development was maintained without undue pressure on the balance of payments shows that the authorities did not forget the importance of external payments equilibrium as a primary objective of monetary policy. It cannot, of course, be maintained that the rapid progress made by the Central American countries in recent years stems exclusively from * Mr. Laso, Advisor, Western Hemisphere Department, is a graduate of the University of California, Los Angeles, and of the Central University of Ecuador. He was formerly a member of the faculty of the Central University of Ecuador, Minister of Economy of Ecuador, and Chief of the Economic Research Depart- ment of the Central Bank of Ecuador. 1 This is a revised version of a paper presented to the Fifth Meeting of Tech- nicians of Central Banks of the American Continent held in Bogota in November 1957. 427 ©International Monetary Fund. Not for Redistribution 428 INTERNATIONAL MONETARY FUND STAFF PAPERS their sound monetary policies, although experience shows clearly that economic progress is often retarded by inadequate monetary policies. Nor can it be claimed that the monetary techniques developed by the Central American countries completely eliminate any risk of monetary disturbance in the future. It is true, however, that the monetary policies pursued in these countries have been an important part of the favorable environment in which orderly economic development has gone on. They have also been a factor in the development of a public opinion favorable to the economic integration of the Central American region. The record is sufficiently impressive to justify a care- ful examination of recent developments in the banking institutions of the area. This examination will necessarily take account of the important differences which exist between the Central American countries. Their circumstances and traditions are sufficiently different to warrant the expectation that their development will not be along uniform lines. Honduras is the least developed of the Central American countries, but it appears to be on the threshold of important economic progress as a result of basic improvements in transportation and electric power. In El Salvador, on the other hand, which has a high population density, there is already a well developed industrial sector. The highest level of general education and of per capita purchasing power is to be found in Costa Rica, and the largest urban center in Central America is in Guatemala. Nicaragua has expanded its agriculture very rapidly in recent years. However, geographical proximity and historical ties, the similarity of their economic structures, and especially the movement in Central America toward economic cooperation and integration, make it appropriate, before attempting any detailed analysis of the development of banking and monetary policy in the individual countries, to make some general observations that are applicable to more than one country or to the region as a whole. A brief summary of the development of banking in each of the five countries, and some com- ments on the history of their monetary policy up to the end of 1955, are given in later sections of this paper. Monetary policy is, in this context, to be understood as being applied by means of the instruments used by the government, acting through its specialized agencies, and in particular through the central or national banks, to influence the volume, the availability, and the cost of credit. Fiscal policy, on the other hand, acts upon other variables in the economic system, such as the volume of income and employment, the price level, the distribution of income between classes and sectors, the allocation of productive resources to various economic ©International Monetary Fund. Not for Redistribution FINANCIAL POLICIES IN CENTRAL AMERICA 429 activities, the composition of investment, etc. Monetary policy, of course, has many possible objectives; for example, it may aim at a high level of real income and employment, at stability of the general price level or of some sector of the price level, or at balance of payments equilibrium and the defense of foreign exchange reserves. In some circumstances, these objectives may be incompatible, and one of them will then have to be sacrificed for the sake of others which are regarded as more important. The duty of the monetary authorities is to develop policies which will ensure the most satisfactory com- promise between competing objectives. In some circumstances, even though there is no conflict between objectives, monetary policy by itself may be quite ineffective; it normally has to be applied in con- junction with other appropriate policies, and in particular with fiscal policy. Indeed, in countries with characteristics similar to those usually found in Central America, fiscal action is more than an indispensable condition for the success of monetary policy. There is a wide scope for its effective action,- and it may by itself achieve substantial results. The best single measure of the current effectiveness of monetary policy in Central America is the contribution it has made to the achievement of the objective of economic development without the generation of inflationary pressures. This objective, however, has had to be related, as far as possible, to the wider objectives listed above, the achievement of which also requires simultaneous appropriate fiscal action. Central Bank Development in Central America The development of effective monetary policy in Central America has been made easier by the establishment of modern central banking institutions and the increasing use of the up-to-date instruments of credit control with which these institutions have been equipped. In 1945, the Bank of Guatemala became a central bank; and in 1950, central banks were established in Costa Rica and Honduras. The establishment of a central bank in Honduras was part of the transition from a monetary system in which U.S. silver coins, Guatemalan quetzales, and Salvadoran colones formed most of the means of pay- ment to a modern system in which the central bank could exercise close control over monetary developments.2 The privately owned Central Reserve Bank of El Salvador, established in 1934, has acquired 2 See Paul Vinelli, 'The Currency and Exchange System of Honduras," Staff Papers, Vol. I (1950-51), pp. 420-31. ©International Monetary Fund. Not for Redistribution 430 INTERNATIONAL MONETARY FUND STAFF PAPERS considerable prestige as a result of its long record of efficient manage- ment. The government-owned and government-controlled National Bank of Nicaragua, which was reorganized in 1940, was not originally designed to be exclusively a central bank. Up to 1953 it did practically all the banking business of the country, and no strong need was felt for a central bank. Through its Issue Department it performed many central bank functions, and its Banking Department supplied all the most important commercial bank services. With the development of additional credit institutions since 1953, the need for an independent central bank has become more evident, and the National Bank has itself recently engaged in a more active monetary policy. Studies relating to the establishment of a central bank in Nicaragua are well advanced. The growth of efficient central banks has proceeded in close relation to the growth of other specialized credit institutions, which have made possible a more efficient use of credit within a program of balanced development. Increases in the capital of the Central Bank of Costa Rica and of the National Bank of Nicaragua have also enabled these institutions to take a more active interest in economic development. In general, active monetary policy has been synchronized with more positive fiscal policies with a view to accelerating development and assisting the execution of government development plans. The central banks of Costa Rica, Guatemala, and Honduras, being of recent origin, have modern statutes that embody many of the recent advances in central bank theory. They have been endowed with broad powers of monetary control, including the power to vary commercial bank reserve requirements and to influence commercial bank lending by establishing differential rediscount rates, prescribing credit ceilings for commercial banks, etc. The formal powers of the Central Reserve Bank of El Salvador, which was established earlier, are less extensive. However, in recent years the bank has, by means of moral suasion, effectively influenced the policy of the commercial banks, and reforms instituted in 1952 have greatly strengthened the instruments for credit control which are at its disposal.

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