CENTRAL AMERICA Integration, investment and trade opportunities 2 CENTRAL AMERICA: INTEGRATION, INVESTMENT AND TRADE OPPORTUNITIES
About the Central American Bank for Economic Integration The Central American Bank for Economic Integration (CABEI), is an international multilateral development financial institution. Its resources are continuously invested in projects that foster development to reduce poverty and inequality; strengthen regional integration and the competitive insertion of its member countries in the global economy; providing special attention to environmental sustainability. bcie.org
About OMFIF With a presence in London, Singapore, Washington and New York, OMFIF is an independent forum for central banking, economic policy and public investment — a neutral platform for best practice in worldwide public-private sector exchanges. For more information visit omfif.org or email [email protected]
Report authors Danae Kyriakopoulou, Chief Economist and Director of Research, Kat Usita, Deputy Head of Research, Natalia Ospina, Research Assistant Production Simon Hadley, Director, Production, Fergus McKeown , Julie Levy-Abegnoli, Subeditors
Support from CABEI: Office of the Chief Economist, Finance Department, Social and Environmental Sustainability Office and the Institutional Relations Office BCIE.ORG | OMFIF.ORG 3
Contents
Foreword 4 Pillar 3 16 GREATER INTEGRATION, GREATER INTEGRATION OPPORTUNITIES Dante Ariel Mossi Reyes, Executive Pillar 4 21 President, CABEI FINANCE, TAX AND TRANSPARENCY Executive Summary 6 INTEGRATION PROVIDES CENTRAL Pillar 5 26 AMERICA WITH RESILIENCE AND SUSTAINABLE INVESTMENT OPPORTUNITIES Conclusion 31 Pillar 1 8 MACROECONOMIC OVERVIEW
Pillar 2 12 COMMERCE, EXTERNAL TRADE AND FOREIGN DIRECT INVESTMENT
Country focus Belize 11 Costa Rica 15 Dominican Republic 19 El Salvador 20 Guatemala 23 Honduras 24 Nicaragua 29 Panama 30 4 CENTRAL AMERICA: INTEGRATION, INVESTMENT AND TRADE OPPORTUNITIES
FOREWORD GREATER INTEGRATION, GREATER OPPORTUNITIES
Integration has helped Central America outperform other blocs in terms of economic growth recently. It has also put the region on strong footing to recover from the pandemic. Reaching out to the wider world will build on this achievement. Dante Ariel Mossi Reyes, Executive President, Central American Bank for Economic Integration BCIE.ORG | OMFIF.ORG 5
THE Central American region has made significant progress in terms of economic and social integration in the past 60 years. Despite its high vulnerability to financial, economic, climate and health-related events, the region has moved closer to achieving its long-held goal of integration. This has led to higher economic growth over the past five years compared with other economic blocs. This has enabled the region address the Covid-19 pandemic and be better prepared for a stronger recovery.
The ‘Central America: Integration, investment and trade opportunities’ report presents relevant, updated information on the region structured in five pillars: a macroeconomic overview; commerce, external trade and foreign direct investment; integration; finance, tax and transparency; and sustainable investment.
This is the first of a series of reports that will share key insights on the region. It will provide valuable information for stakeholders, including government entities in the Central American region; governments with political, economic, and social interests in the region; the donor community; international financing institutions; and local, regional and international investors to make data-driven decisions. Thus, the report is meant to be a tool for anyone who is interested in doing business in Central America.
The Central American Bank for Economic Integration is proud to be part of this initiative. As the financial arm of the Central American region, CABEI will continue working and collaborating with its member countries, the private sector and the international community to fulfil its mission of a balanced economic and social development in the region.
After 60 years since its creation, CABEI is committed to its pivotal role in linking the opportunities of the Central American region with the world. Through its efforts, it continues to improve the region’s competitiveness in global markets and create favourable, innovative investment climates in its member countries. 6 CENTRAL AMERICA: INTEGRATION, INVESTMENT AND TRADE OPPORTUNITIES
EXECUTIVE SUMMARY INTEGRATION PROVIDES CENTRAL AMERICA WITH RESILIENCE AND OPPORTUNITIES
At a time of global uncertainty, Central America presents opportunities for growth and sustainable recovery driven by the region’s dynamism and economic integration. The ‘Central America: Integration, Investment and Trade Opportunities’ report, in its inaugural year, comes at a key moment in the region’s economic development. Despite global economic and social challenges, there are clear pointers to Central America’s resilience and growth potential. Its economy is forecast to have one of the strongest rebounds in Latin America and the Caribbean, supported by the agility and responsiveness of individual economies in coping with the pandemic’s disruptions. The region’s initiatives aimed at promoting sustainable growth and investment create important opportunities to build back better. This report takes us into one of the blocs with the most member countries in Latin America and the Caribbean. It looks at the results of an integration project that goes back more than 60 years. The report covers eight countries: Belize, Costa Rica, the Dominican Republic, El Salvador, Honduras, Guatemala, Nicaragua and Panama. It presents a wide-ranging view of the region through five pillars: a macroeconomic overview; commerce, external trade and foreign direct investment; integration; finance, tax and transparency; and sustainable investment. The aim is to show where the region and its countries stand within each pillar and how they can improve to meet yardsticks for foreign investors as they begin to consider post-Covid-19 opportunities. BCIE.ORG | OMFIF.ORG 7
inflows are highly concentrated, with 85% coming from the US and the rest of Latin America. The highest recipients in the region are Panama, the Dominican Republic and Costa Rica. The region’s exports have increased steadily, with steep growth since 2016. Central America stood out from the rest of Latin America and the Caribbean as the only bloc to have year-on-year export growth in the first quarter of 2020, with Guatemala taking the lead. The region’s main trading partner is the US, with intraregional trade also playing a significant role. Regional co-operation will help Central American economies break into new markets like Europe.
BEYOND ECONOMIC INTEGRATION At the centre of the progress towards integration in Central America is the region’s aim to build strong and resilient economic ties. However, integration across the region has extended beyond the economic. Central American countries have been working together on a unified front in social matters, climate change, institutional strengthening and security. Integration has further benefited Central America as international co-operation from global partners has been aimed at supporting growth and development in the region as a whole. The European Union has been the primary partner in such direct co-operation and development projects since 2014. Within the region, Guatemala, Honduras and El Salvador have achieved a common customs union that facilitates intraregional trade and reduces its cost. These countries, MAIN REPORT FINDINGS along with Nicaragua, also have achieved free movement of both nationals and foreigners across their borders. STRONG REBOUNDS FROM PANDEMIC Central American economies have been growing steadily SOUND FINANCIAL INFRASTRUCTURE over the past five years. Although Covid-19 has interrupted The region is catching up with internationally recognised growth, Central America is forecast to experience a less standards. Half of the region’s countries are already partially pronounced economic decline than other regions in Latin implementing Basel III, and most of them require domestic America and the Caribbean. Its recovery is set to be stronger and foreign companies to follow international financial too. The Dominican Republic and Panama are the region’s reporting standards. Overall, financial soundness indicators fastest-growing economies. Inflation has remained stable and reveal that Central America’s banking system entered living standards have improved across the region in recent the Covid-19 economic recession in a strong position, years, with Panama and Costa Rica enjoying the highest gross outperforming minimum international benchmarks. domestic product per capita. International tax treaties can help reduce complexity. Only Central American economies have demonstrated sound Costa Rica, the Dominican Republic and El Salvador have at fiscal management in recent years, with most public deficit to least one. However, almost all countries in the region grant GDP ratios under 3%. The regional average ratio of external tax incentives for investments in specific sectors. public debt to GDP was 35% in 2019, with Guatemala and Costa Rica having the lowest rates in the region. This positive MOBILISING FINANCE FOR SUSTAINABILITY past performance has helped confront the fiscal challenges Central American economies offer meaningful opportunities brought by the pandemic and has allowed all countries to for sustainable investments, particularly in the areas of implement a mix of fiscal and monetary policy measures to green transport and energy infrastructure. The region has counteract the economic crisis prompted by Covid-19. made substantial progress in renewable energy. In four out of eight Central American countries, over three-quarters of BUILDING A STRONG GLOBAL PLAYER THROUGH energy generated is from renewable sources, with Costa Rica REGIONAL CO-OPERATION approaching 100%. While agriculture, mining, and the manufacturing and The region has taken significant steps in other climate construction industries remain important sectors, wholesale change mitigation efforts, launching projects that cover and retail trade contributes the most to the region’s economy. biodiversity conservation, the blue economy, sustainable Costa Rica is the outlier with its internationally renowned water, waste management and more. Five green bonds have medical devices and equipment industry, which forms the been issued in Central America to fund these and other largest part of the country’s GDP. Foreign direct investment climate-related initiatives. 8 CENTRAL AMERICA: INTEGRATION, INVESTMENT AND TRADE OPPORTUNITIES
PILLAR 1: MACROECONOMIC OVERVIEW CENTRAL AMERICA READY TO BOUNCE BACK
Compared to other CENTRAL American economies in the following year. In contrast, blocs, Central America have been growing steadily over the the whole of the Latin American and past five years. Although Covid-19 Caribbean economy is expected to suffered less economic has interrupted growth in the region, contract by 9.4%, with an estimated decline from the a healthy rebound is expected growth of 3.7% in 2021 (Figure 1). pandemic. Its recovery compared to Latin America and Rapid growth in recent years has is set to be stronger the Caribbean as a whole. Based on created policy space for pro-growth too. estimates from the International measures boosting the region’s Monetary Fund, Central America’s macroeconomic outlook. The region’s economy is projected to shrink by fastest-growing economies stand out. 4.5% in 2020 but will grow by 6.8% On average, the Dominican Republic’s
8 1. Central 6.8 6 America poised 4.8 4.4 4 4.2 3.8 3.2 to perform 2 better than 0 other blocs in -2 the region -4 -4.5 -6 Real GDP growth, -8 % -10 Source: -12 International 2015 2016 2017 2018 2019 2020 2021 Monetary Fund, Central America Mercosur Oxford Economics, OMFIF analysis Pacific Alliance Latin America and the Caribbean World BCIE.ORG | OMFIF.ORG 9
economy grew by 6.1% between 2015 PANDEMIC RESPONSE and 2019, partly due to its strong Countries have responded to the external position. Without tourism Covid-19 crisis with a mix of fiscal and MACROECONOMIC to drive growth, it is expected to monetary policy measures (Figure 2). HIGHLIGHTS contract by 1% in 2020. Panama grew Governments provided cash relief to by an average of 4.6% over the last the most vulnerable households. Most Source: OMFIF analysis five years. The Panama Canal, despite countries postponed due dates for seeing a decline in traffic, remains utility payments, with some doing the an important logistics route. The same for social security contributions. Panamanian economy is expected to El Salvador granted temporary tax Belize shrink by 2.1%. Both economies are holidays for tourism workers, while Greatest improvement in expected to rebound by 4% in 2021, the Dominican Republic did the same fiscal management (7.8% above the estimated 3.7% for Latin for the hotel sector. Other forms of public deficit to GDP ratio in America and the Caribbean. exemptions and deferrals on income 2015, down to 1.0% in 2018) Inflation across the region has tax and value-added tax were given. remained stable. Dollar appreciation To support businesses, special in 2019 created a deflationary credit facilities were established for Costa Rica environment for Belize, El Salvador small and medium enterprises as well Comprehensive Covid-19 and Panama. The Belize dollar as larger companies. Every country response is pegged to the US dollar, while in the region granted some form the Salvadoran colón and the of debt restructuring or temporary Panamanian balboa are completely moratorium on loan repayments. dollarised. Since 2016, annual change Banks’ reserve requirements were Dominican in average consumer prices in the relaxed to encourage lending. The Republic region has remained in a range of central banks of Belize, Costa Rica, Strongest growth record 1.8% to 2.6%. the Dominican Republic, Guatemala Living standards have improved and Honduras eased monetary policy (6.1% compound annual across the region in recent years. through policy rate reductions. growth rate, 2015-19) Panama ($15,734) and Costa Rica The pandemic brings difficult ($12,309) enjoy the highest GDP fiscal challenges. Countries in Central per capita in the region, surpassing America have demonstrated sound Guatemala the global average of $11,436. The fiscal management in recent years, Lowest external public debt six remaining countries have lower with most public deficit to GDP ratios to GDP ratio in 2019 (11.9%) living standards than the world in under 3%. El Salvador has kept its aggregate, but 2019 figures for the deficit ratio under 2% in the last five Dominican Republic, Guatemala, El years, while Honduras has brought Honduras Salvador and Honduras all showed this down to 2.5% in 2019 from 4.4% Declining unemployment improvement from the previous year. in 2014. While public deficits are rate (7.3% in 2015 down to Remittance-dependent economies expected to rise sharply as economies are likely to struggle from the effects contract, governments in the region 5.7% in 2018) of the global slowdown. These include have demonstrated an ability to move El Salvador, Honduras and Guatemala. closer to a balanced budget after the An estimated 4.7m Central Americans 2008 financial crisis. El Salvador live in the US, indicating that its With the exception of Nicaragua, Lowest public deficit to recovery from the crisis will have an every government in the region GDP ratio in 2019 (1.6%) impact on economies of the region. has tapped loans from multilateral Every country in Central America organisations, including the Central has at least two sovereign credit American Bank for Economic Nicaragua ratings from a major ratings agency Integration, the IMF, the World Bank, Stable outlook from (Standard & Poor’s, Moody’s and the Inter-American Development Bank international ratings Fitch). Panama is the only country and the Latin American Development agencies with investment-grade credit ratings, Bank. Managing external public debt but Guatemala and the Dominican levels will be key to governments’ Republic are close to achieving this ability to return to a sustainable as well. Effective pandemic response growth path. In 2019, Guatemala had Panama and economic management during the lowest ratio of external public Highest living standards this period of contraction will debt to GDP (11.9%) followed by Costa ($15,734 GDP per capita, prove critical in avoiding any rating Rica (21.2%), well below the regional 2019) downgrades. average of 35%. Other countries have 10 CENTRAL AMERICA: INTEGRATION, INVESTMENT AND TRADE OPPORTUNITIES
kept debt to GDP ratios under 40%, ‘Crucial to the recovery relief to workers in affected sectors. with the exception of Belize (66.5%) is the region’s ability Crucial to the recovery is the region’s and Nicaragua (50.2%). External public ability to maintain diversified trade to maintain diversified debt includes all fiscal and public flows, strong economic integration and sector debt owed to foreign entities but trade flows, strong healthy financial systems. It must also excludes debts of public enterprises. economic integration take advantage of new opportunities During a difficult year, the and healthy financial in sustainable investments and green macroeconomic record and pandemic systems.’ finance, especially where these could response of Central American be harnessed for cleaner transport and economies indicate that it is poised to energy for the region’s fast-growing make a sustainable recovery. It must population. The succeeding sections demonstrate continued fiscal discipline will explore these areas of investment while providing adequate support and and policy-making.
2. Effective pandemic response critical to continued growth Overview of Covid-19 response measures Source: IMF, IADB, CABEI, Secretaria Ejecutiva del Consejo Monetario Centroamericano, Economic Commission for Latin America and the Caribbean, Organisation for Economic Co-operation and Development, System of Central American Integration, OMFIF analysis
Dominican Belize Costa Rica El Salvador Guatemala Honduras Nicaragua Panama Republic
Fiscal policy
Increase public debt • • • • • • • Increase public investment • • • Public budget cuts and/or reallocations • • • Public subsidies • • • • • • • Postponement and/or reduction of basic services payments • • • • • • Tax payments deferrals and waivers • • • • • • Postponement of social security contributions • • • • Salary compensation for workers • • • • • Moratorium on import duties • • • • Monetary policy and lending Monetary policy rate reduction • • • • • Reduction of reserve requirements • • • • • • • Reduction of repo rates • • • Other liquidity measures • • • • • Purchase of government bonds in the secondary market • • Debt restructuring and payment moratoriums • • • • • • • • Debt service deferrals • • • • Credit rating freeze • • • • Credit and/or guarantees to SMEs • • • • • • • Credit to non-SMEs • • • • • • Foreign exchange market intervention • • • • BCIE.ORG | OMFIF.ORG 11
COUNTRY FOCUS: BELIZE
BELIZE successfully reduced its As part of the country’s climate unemployment rate to 9.4% in 2019 change mitigation efforts, Belize from 11.1% in 2014. This positive has undertaken various green trend is forecast to reverse by the projects. A water treatment International Monetary Fund as a plant is under construction, and result of the pandemic. Covid-19’s a project to produce biogas and grave impact on tourism is leading renewable energy from biomass Belize to experience the highest and organic waste is being increase in unemployment in the planned. Belize is one of the few region, which is expected to rise to countries globally that are part 18.7% in 2020. of the Climate Change Policy Although Belize tends to Assessment. CCPA is a joint receive the lowest level of foreign initiative between the IMF and investment in the region, it may World Bank aimed at assisting see some improvement as the small states in the management country received 366% more FDI in of their climate change response, 2018 compared to the year before. considering its expected economic To boost investor confidence, the and fiscal impacts. Macroeconomic country has adopted the latest Belize has successfully reduced financial and accounting standards its fiscal deficit in recent years, to indicators that help ensure transparency 1% of its gross domestic product in • GDP growth: 0.3% and financial soundness. Belize 2018 from 7.8% in 2015. However, • GDP per capita: requires domestic companies to the country faces significant fiscal adhere to international financial challenges, especially as a result $4,784 reporting standards, while the of the government’s efforts to • Inflation: 0.6% financial system already has a plan cope with the pandemic. Before • Unemployment rate: to implement Basel III. the outbreak, it already had the 9.4%* In 2018, Belize had the second- highest public external debt in the highest share of renewable sources region, which represented 67% of • Public external debt in its energy mix (83%), second its GDP in 2018. to GDP: 66.5%* only to Costa Rica in the region. • Public deficit: 1%*
Trade indicators • FDI inflows: $120m* ‘To boost investor confidence, the country • Total exports in 2019: has adopted the latest financial and $931m accounting standards that help ensure transparency and financial soundness.’ • Free trade agreements: 2
*2018
83% Belize gets most of its energy from renewable sources 12 CENTRAL AMERICA: INTEGRATION, INVESTMENT AND TRADE OPPORTUNITIES
PILLAR 2: COMMERCE, EXTERNAL TRADE AND FOREIGN DIRECT INVESTMENT DIVERSIFYING MARKETS KEY TO CONTINUED GROWTH
Central America relies KEY to Central America’s continued corporations. growth are its well-diversified Central American economies on the US and intra- economies. While agriculture, are externally oriented, with fruits, regional trade as its mining, and the manufacturing coffee and sugar amongst the region’s major export markets. and construction industries remain top exports. Mineral fuel and oils Regional co-operation important sectors, wholesale and are the main imported goods. Strong will help Central retail trade contributes the most to export growth in the first quarter of the region’s economy. In Costa Rica, 2020 and sustained foreign direct American economies the medical devices and equipment investment inflows highlight the break into new markets, industry forms the largest part of the region’s potential. such as Europe. country’s gross domestic product. Although Central American This fast-growing subsector reflects exports have increased steadily the success of fiscal incentives (Figure 1), more sophisticated for new medical technology firms merchandise destined for that have attracted multinational international markets can improve BCIE.ORG | OMFIF.ORG 13
1. Historically, 120,000 Central FOREIGN DIRECT American 100,000 exports have INVESTMENT increased 80,000 HIGHLIGHTS steadily Source: CEPAL, OMFIF analysis Total exports, $m 60,000 Source: World
Bank, OMFIF 40,000 analysis Belize Main recipients of FDI in 2018 20,000 were real estate (30%) and
- construction (26%) 2011 2012 2013 2014 2015 2016 2017 2018 2019 Costa Rica Manufacturing received 51% of FDI in 2018, partly due revenue prospects. While the goods Free trade agreements contribute to fast-growing medical exported from Central America are to economic activity and job creation equipment industry diverse, it is important that countries as they open doors to new markets. increase efforts to improve their All countries in Central America have technological content. Costa Rica is free trade agreements in place. Costa Dominican already taking significant steps in Rica stands out with 14, followed by this direction. In 2017, it ranked 46th Honduras with 11. Republic out of 133 in the world’s economic Free trade agreements are Santo Domingo ranks sixth complexity ranking, closely followed designed to promote regional globally for business service by Panama (52) and El Salvador (54). economic integration, and Central outsourcing centres While exports plunged in most America is a case in point. Greater of Latin America, Central America coordination of trade policy at the experienced 9.1% year-on-year regional level has been the result of El Salvador growth in the first quarter of 2020 countries negotiating almost half of Largest aeronautics (Figure 2). The main driver of their free trade agreements as a bloc. maintenance centre in Latin Central American export growth was The significant number of free America demand from the US, followed by trade agreements in place has yet to the rest of Latin America and Asia. translate into a greater diversification Central America’s performance was of the region’s export markets. Its Guatemala hampered by weaker appetite for sales are heavily dependent on the Main sources of FDI in 2018 foreign goods in the US, the global US, which received 39% of total were the US (24%), Mexico epicentre of Covid-19. exports in 2018, followed by intra- (18%) and Colombia (13%) Within Central American regional commerce, with 23%. countries, Guatemala outperformed Although the intra-regional its peers with a 16.9% year-on-year market is gaining momentum, the Honduras increase in external sales. Latin diversification of the region’s export High growth of FDI in export America was the main driver for destinations is essential to reduce processing industry (55.6%, this demand, followed by the US and its dependency on North American 2018) European Union. Guatemala was markets. The EU could be an followed by Costa Rica with 9.4% important trading partner. According year-on-year growth. to 2019 figures, almost all Central Nicaragua Central America adapted quickly American countries had at least one New investments in mining, to the technological boom that country from the European single including $120m from Condor Covid-19 brought, allowing it to market among their top 10 trading Gold overcome the challenges presented partners. All Central American by the pandemic. The Centre for countries are part of free trade Economic Integration Studies agreements with the EU. A value Panama launched the Central American chain analysis performed as part Top recipient of FDI in the Trade Network in June, a free digital of the Central American Regional region and fifth in Latin platform of commercial intelligence Economic Integration Project America and the Caribbean that connects enterprises from more revealed that Europe could be a top in 2018 than 28 countries around the world. export destination for the region’s 14 CENTRAL AMERICA: INTEGRATION, INVESTMENT AND TRADE OPPORTUNITIES
2. Central 25 and Costa Rica. The latter two America’s 20 finished 2019 with FDI growth integration Guatemala rates of 19% and 16%, respectively. has proven its 15 Panama attracts more investment resilience Costa Rica 10 from abroad, as a result of projects Dom Rep Export growth rate, 5 to expand the Panama Canal and the ic o Bolivia
%, Q1 2020 vs Q1 Ecuador Mex country’s successful development 2019 0 as a logistics and transport hub. In Source: Inter- -5 Brazil
Chile Costa Rica, the medical devices and
American El Salvador
Development -10 Paraguay equipment industry has attracted Bank (IDB), OMFIF Argentina Colombia -15 Colombia substantial investment from Peru analysis Peru transnational corporations from Uruguay
Central America Pacific Andean the US, Germany and Denmark. Mercosur Alliance Community In the Dominican Republic, where Santo Domingo was ranked as sixth among the world’s best outsourcing coffee. Considering there is robust ‘Free trade agreements centres by the fDi Intelligence World competition for this market, Central are designed to promote Ranking, expanding business service American countries could benefit regional economic centres are drawing the most amount from engaging in intra-regional of foreign capital into the country. integration, and Central co-operation to take advantage of South Korea’s investments abroad economies of scale in getting to America is a case in point. have been growing significantly, know and exporting to the European Greater coordination making it the world’s ninth largest market. of trade policy at the overseas investor in 2018. Panama FDI inflows give an indication regional level has been was the top recipient country of which countries are attracting the result of countries in Central America, with South attention with high levels of negotiating almost Korean investments directed at economic activity and stable half of their free trade the construction, transport and environments that are providing agreements as a bloc.’ storage sectors. Since 2018, the foreign firms with business certainty. manufacturing industry has been FDI in Central America came mostly a key investment area for South from the US, representing 48% of Korea, presenting an opportunity total inflows in 2018. The rest of Latin for the rest of the Central American America followed, with 37%. These economies. As manufacturing is two sources form 85% of foreign a major economic driver for the investment, revealing a high level of region, second only to wholesale and concentration. retail trade, Central America should Recipients of the the highest be able to attract more business levels of FDI in Central America are from investors seeking to offshore Panama, the Dominican Republic manufacturing activities. BCIE.ORG | OMFIF.ORG 15
COUNTRY FOCUS: COSTA RICA
COSTA Rica is leading the region to GDP, with the production of in climate change mitigation medical equipment attracting efforts. In 2018, it announced its investment from multinational plan to achieve carbon-neutral companies. The country has status by 2021 and has already managed consumer prices well made important steps towards in recent years, lowering the this goal, including getting almost inflation rate to 2.1% in 2019 from 99% of the country’s energy from 4.5% in 2014, still within its 2-4% renewable sources. Costa Rica’s target. work on climate change has drawn To encourage exports, Costa international attention, notably Rica is part of 14 free trade when it led the creation of the San agreements, the highest in Central Jose Principles for High Ambition America. Growth of foreign and Integrity in International direct investment to the country Carbon Markets. The Principles, (16.2%) was among the highest which 31 other countries have in the region for 2019, second adopted, were drafted as part of only to the Dominican Republic. initiatives leading up to COP25 in It also has the highest number of Macroeconomic late 2019. international tax treaties. Costa Rica has experienced a Job creation remains a indicators slight deceleration in the growth challenge, with Costa Rica’s • GDP growth: 2.1% rate of its real GDP since 2016. The unemployment rate of 12.4% at • GDP per capita: downward trend is set to continue the end of 2019. Costa Rica also through the pandemic, although needs to take caution in fiscal $12,310 improvements in manufacturing management, especially during • Inflation: 2.1% and trade openness bode well for the Covid-19 crisis, as it has the • Unemployment rate: its future economic performance. highest public deficit to GDP ratio 12.4% Costa Rica’s fast-growing health (7%) within the region. sector contributes significantly • Public external debt to GDP: 21.2% • Public deficit: 7%
‘Costa Rica’s work on climate change has drawn international attention, notably Trade indicators when it led the creation of the San Jose • FDI inflows: $2.6bn Principles for High Ambition and Integrity • Total exports: in International Carbon Markets.’ $21bn • Free trade agreements: 14
99% Costa Rica gets nearly all of its energy from renewable sources 16 CENTRAL AMERICA: INTEGRATION, INVESTMENT AND TRADE OPPORTUNITIES
PILLAR 3: INTEGRATION INTEGRATION UNDERPINNED BY SHARED OBJECTIVES AND VALUES
Central America’s integration stems from a desire to be ECONOMIC integration can accelerate regional and national economically unified. Beyond economic links, integration development, supporting growth. It has become an important facet of democratic security achieves this through reducing trade and climate change mitigation. barriers, encouraging cross-border investment, and sharing technology and employment opportunities. Stronger economic ties also improve political co-operation and stability, and reduce policy uncertainty. Central America is a prime example. Economic integration within the region has brought numerous advantages. One of them is in exports. Historically, intra-regional trade has been the second main destination of Central American countries’ exports, after the US. This is pivotal for the region’s resilience in times of stress, such as the 2008 financial crisis and the Covid-19 pandemic. While exports plummeted in most of Latin America, Central America experienced a 9.1% year-on- year growth during the first quarter of 2020. The story of economic integration in Central America goes back more than 60 years. In 1958 the Central American Free Trade and Economic Integration Multilateral Treaty was signed by Guatemala, El Salvador, Honduras, Nicaragua and Costa Rica, with the aim of promoting economic integration in the region. Since then, an intricate web of overlapping multilateral treaties has developed, linking different countries of Central America and the Dominican Republic in projects aimed at increasing their economic association. An important one was signed in 1991. The Tegucigalpa Protocol to the Charter of the Organization of Central American States created the Central American Integration System composed, BCIE.ORG | OMFIF.ORG 17
initially, of Costa Rica, El Salvador, by the original countries as well as two Central American countries Guatemala, Honduras, Nicaragua and Costa Rica and Panama. At first, have come together to form links Panama. The success of this caught Panama remained as a signatory of with trade partners from outside the attention of others. Belize and the Guatemala Protocol. However, the region, such as the European the Dominican Republic joined in drawn by the success brought by this Union, US and Asia (Figure 1). 2000 and 2013, respectively. economic union, it joined the Central These broad-ranging agreements The General Treaty of Central American Economic Integration are complemented by more targeted American Economic Integration, Subsystem in 2012. mechanisms, including treaties, signed by El Salvador, Guatemala, The shared economic goals of intra-regional agencies and projects. Honduras and Nicaragua in 1960, is Central American countries have For example, a treaty on investment another cornerstone of integration. helped them enter into free trade and trade in services between This agreement was modified by the agreements as a bloc. There are nine Costa Rica, El Salvador, Guatemala, Guatemala Protocol in 1993, signed of these accords, in which at least Honduras and Nicaragua was
1. The negotiation of free trade CENTRAL AMERICA MEXICO CARIFORUM EUROPEAN UNION
agreements as a bloc Costa Rica Mexico Antigua and Barbuda Belgium Results of aligned economic goals in El Salvador Bahamas Bulgaria Central America. Guatemala Barbados Czechia Source: Sistema de Información sobre Honduras Belize Denmark el Comercio Exterior, OMFIF analysis Nicaragua Dominica Germany *Pending ratification Dominican Republic Estonia
CENTRAL AMERICA US Grenada Ireland Guyana Greece BELIZE Costa Rica US Haiti Spain El Salvador Jamaica France COSTA RICA Guatemala St. Kitts and Nevis Italy Honduras St. Lucia Cyprus DOMINICAN Nicaragua St Vincent and Grenadines Latvia REPUBLIC Dominican Republic Suriname Lithuania
Trinidad and Tobago Luxembourg EL SALVADOR CENTRAL AMERICA CHILE Hungary
Costa Rica Chile Malta GUATEMALA El Salvador Netherlands
Guatemala Austria HONDURAS Honduras Poland
Nicaragua Portugal NICARAGUA Romania
Slovenia
PANAMA NORTHERN TRIANGLE COLOMBIA Slovakia
El Salvador Colombia Finland
Guatemala Sweden
Honduras COSTA RICA AND EUROPEAN FREE TRADE PANAMA ASSOCIATION
Costa Rica Iceland EL SALVADOR AND TAIWAN Panama Liechtenstein HONDURAS
Norway El Salvador Taiwan
Switzerland Honduras
CENTRAL AMERICA EUROPEAN UNION CENTRAL AMERICA REPUBLIC OF KOREA
Costa Rica EU countries Costa Rica Republic of Korea
El Salvador El Salvador
Guatemala Honduras
Honduras Nicaragua
Nicaragua Panama*
Panama 18 CENTRAL AMERICA: INTEGRATION, INVESTMENT AND TRADE OPPORTUNITIES
signed in 2002. It established a legal 2. The EU is framework for trade liberalisation in Central America’s services and investment. Another, major partner in direct co- signed in 1996, helps develop a operation for competitive regional electricity development market through transmission lines projects that connect national networks and % of total direct through the promotion of regional co-operation for projects for electricity generation. development To enhance this, the region created between 2014-19, by the Electricity Interconnection partner System for the countries of Central Source: Central American Integration America which provides electricity System, OMFIF European Union Spainand AECIDCABEI GEFTaiwan Others transmission facilities that benefit analysis Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua and Panama, increasing reliability and security of electricity. The region has been working towards achieving a customs ‘Integration benefits as the Central American Parliament union since 1984. While there have the region through a and the Central American Court of been various efforts on this front, Justice. systematic approach to only Guatemala, Honduras and El Countries in the region has Salvador have created a common development that makes also joined forces to achieve social customs union. investment projects more integration, including through Beyond trade, economic worthwhile and scalable the 1995 Central American Social integration has taken the form of for foreign partners.‘ Integration Treaty and the Central common standards for financial American Social Integration institutions. A treaty on payments Secretariat. Air navigation is and securities settlement in 2006 has another area in which the region helped align regional standards with has coordinated efforts through global benchmarks and reinforce the Central American Corporation supervision. Free movement for Air Navigation Services, aimed of people has also enhanced at creating common standards to integration. The CA-4 agreement, achieve safety, efficiency and quality among Guatemala, El Salvador, in a sustainable manner within this Honduras and Nicaragua, signed in sector. 2006, allows non-work travel across expansion of the use of natural Integration benefits the region borders for citizens carrying their gas to the introduction of more through a systematic approach to national identity cards. The same efficient transport alternatives and development that makes investment four countries issue a unified visa the creation of new routes that projects more worthwhile and for foreign tourists, easing travel facilitate trade. This multilateral scalable for foreign partners. between their countries and boosting bank also supports projects aimed at Regional co-operation projects tourism. combating climate change, achieving are established through mixed To promote the economic sustainable growth and increasing commissions and forums for integration and social development the region’s resilience through dialogue. These are spaces for of Central America as well as to adaptation. political and technical exchanges implement coordinated solutions Central America and the between the region and beyond. to common challenges in the Dominican Republic form a unified They include projects covering region, the Central American front with regards to democratic the development of ecommerce Bank for Economic Integration security. The 1995 framework treaty capabilities, the strengthening of was established in December for democratic security in Central small- and medium-sized enterprises 1960. CABEI acts as a regional America is the bedrock for this. and the promotion of women in partner for the promotion and Different treaties, strategies and businesses and of vulnerable groups implementation of projects aimed commissions have been constituted in regional politics. The EU is a at reinforcing integration and to coordinate policies aimed at major partner in such projects, increasing development within safeguarding the region’s democratic participating in around half of the the region. These projects cover a institutions. Moreover, supranational total directed to the region between wide spectrum, ranging from the institutions have been created, such 2014-19 (Figure 2). BCIE.ORG | OMFIF.ORG 19
COUNTRY FOCUS: DOMINICAN REPUBLIC
THE Dominican Republic in the region, it could become consistently receives high levels a hindrance to the Dominican of foreign direct investment. FDI Republic’s long-term growth if inflows grew by 18.8% in 2019, the not managed well. During the greatest increase in the region for crisis, the country must focus on that year. Export growth has been managing its debt burden. equally strong, averaging 5.2% Despite the pandemic’s annually since 2012. disruption, GDP is expected The Dominican Republic is to shrink by only 1% in 2020, home to a growing banking sector the smallest contraction and has the second-highest projected in the region. The number of banks in the region, country successfully lowered its surpassed only by Panama. To unemployment rate to 6.2% in reassure international investors 2019 from 8.5% in 2017, but this of the country’s financial may be reversed by job losses development and stability, the in pandemic-hit sectors, like Dominican Republic should work tourism. towards the implementation of Despite a promising economic Macroeconomic Basel III standards. outlook, the Dominican Republic The Dominican Republic is the needs to ensure that its long-term indicators region’s fastest-growing economy, growth is sustainable. It should • GDP growth: 5.1% expanding an average of 6.1% increase efforts to transition away • GDP per capita: annually over the last five years. from carbon-intensive energy Despite these positive results, production. $8,284 growth in the Dominican Republic While other countries in the • Inflation: 1.8% may be unsustainable since it region have taken significant • Unemployment rate: has been partly debt-fueled, with steps to switch to cleaner energy, 6.2% external public debt forming the Dominican Republic is an about a quarter of gross domestic outlier, with 85% of its energy • Public external debt product. While this is still low coming from non-renewable to GDP: 26.6% compared to other countries sources in 2018. • Public deficit: 2.2%
Trade indicators • FDI inflows: $3bn • Total exports: $18.7bn • Free trade agreements: 4
‘The country successfully lowered its unemployment rate to 6.2% in 6.1% 2019 from 8.5% in 2017, but this The Dominican Republic may be reversed by job losses in has experienced the fastest annual growth rate in the pandemic-hit sectors, like tourism.’ region over the last five years 20 CENTRAL AMERICA: INTEGRATION, INVESTMENT AND TRADE OPPORTUNITIES
COUNTRY FOCUS: EL SALVADOR
FOR the past five years, El Salvador Numerous solar farm projects has shown stable growth, with are underway. Such efforts will annual gross domestic product boost El Salvador’s self-sufficiency growth ranging between 2.3% to and improve its energy security, 2.5%. The pandemic will disrupt reducing its dependence on this steadiness as projections electricity imports. show that the country’s economy Debt sustainability is key for El will suffer one of the deepest Salvador. Although external public contractions in the region in debt has remained somewhat stable 2020 (-5.4%). Although the since 2015, averaging around 38% unemployment rate has been of GDP, it is among the highest rising as a result of the pandemic, in the region. The country’s total it is projected to be one of the public debt rose to 73.3% of GDP countries in the region where this in 2019 and could increase up rate increases the least. Living to 90% in 2020 as a result of the standards, as measured by GDP government’s efforts to cope with per capita, have improved over the pandemic. time, climbing by an average of 3% El Salvador receives a relatively annually since 2014. low level of foreign direct Macroeconomic El Salvador is taking significant investment. To raise investor indicators steps towards cleaner energy, confidence, El Salvador should with 77% of its energy coming continue efforts to maintain law • GDP growth: 2.4% from renewable resources in 2018. and order throughout the country. • GDP per capita: $4,187 • Inflation: 0.1% • Unemployment rate: 6.3% • Public external debt to GDP: 36.9% • Public deficit: 1.6%
Trade indicators • FDI inflows: $662m • Total exports: $8bn • Free trade agreements: 9
2.4% ‘El Salvador is taking significant steps towards cleaner El Salvador’s economy grew in 2019 energy, with 77% of its energy coming from renewable resources in 2018.’ BCIE.ORG | OMFIF.ORG 21
PILLAR 4: FINANCE, TAX AND TRANSPARENCY REGION CATCHING UP WITH GLOBAL STANDARDS
A stable, predictable A transparent, well-structured are completely dollarised with no financial market infrastructure is separate legal tender. In terms and internationally critical for domestic and foreign of monetary policy regimes, the competitive tax system investor confidence. Central banks majority target the exchange rate must stand on strong and regulatory authorities play a key under fixed rate arrangements. Costa financial infrastructure role in ensuring price and financial Rica, the Dominican Republic and to ensure that stability, with interest and exchange Guatemala are under an inflation- rates acting as vital tools in this targeting regime. Fixed exchange foreign investment endeavour. Due to their physical rate systems broadly remove the risk benefits economic proximity to the US market as well of currency volatility but come at a development. The as historic factors, most Central cost of reduced room for manoeuvre region is catching up American economies are closely for monetary policy-makers when with global standards, linked to the American financial idiosyncratic shocks hit. system and are heavily dollarised. On regulatory and reporting but disparities remain. This is reflected in their monetary issues, most countries in the region and exchange rate policy regimes. are catching up with fast-changing Of the regions’ eight countries, global financial regulations and six have a fixed exchange rate standards such as the International regime as either a peg, crawl-like or Financial Reporting Standards stabilised arrangement targeting and the Basel accords. Half of the dollar. Panama and El Salvador Central American countries 22 CENTRAL AMERICA: INTEGRATION, INVESTMENT AND TRADE OPPORTUNITIES
1. Implementation Belize III of Basel rules FINANCE, TAX AND I, II or III Costa Rica III TRANSPARENCY Source: World Bank, IMF, national Dominican Republic II HIGHLIGHTS central banks and supervisory El Salvador II Source: OMFIF analysis authorities, Inter-American Guatemala I Development Bank, Belize CEMLA, Alliance for Honduras III Financial Inclusion, Implementing Basel III Bank for International Nicaragua II banking standards Settlements, OMFIF Analysis Panama III Costa Rica Highest number of non- financial corporates (12) (Belize, Costa Rica, Honduras ‘Overall, financial rated after Panama and Panama) are already at least soundness indicators partially implementing the Basel III reveal that Central international regulatory framework America’s banking system Dominican for banks (Figure 1). This is a stricter framework compared to former entered the Covid-19 Republic iterations, with an increased level economic recession All three major rating of regulatory capital designed to in a strong position, agencies (S&P, Moody’s and ensure the resilience of the banking outperforming minimum Fitch) rate the Dominican system. The remaining countries international standards.‘ Republic’s sovereign debt are implementing Basel II, except for Guatemala, the only country in the region still implementing Basel El Salvador I. The pace of progress in the region IFRS reporting standards in aligns with that of other regional place for SMEs and local and alliances. In Mercosur, the Pacific foreign companies Alliance and Andean Community, all but two countries (Paraguay and Ecuador) are implementing Basel III. Guatemala Overall, financial soundness Low withholding tax rates on indicators reveal that Central dividend (5%) and interest America’s banking system entered (10%) income the Covid-19 economic recession in a strong position, outperforming minimum international benchmarks. Honduras Provides tax incentives for companies in special economic zones and SMEs
Nicaragua Banking sector with highest liquid asset ratio (32.2%, 2019)
Panama Highest score (56) on minority shareholder protection in World Bank Doing Business 2020 BCIE.ORG | OMFIF.ORG 23
COUNTRY FOCUS: GUATEMALA
GUATEMALA has been the disbursement of economic and experiencing a steady acceleration salary subsidies, to an increase in in real gross domestic product investment expenditure, especially growth since 2016, after a slight on infrastructure and housing deceleration that followed a projects. political crisis in 2015. Although Overall foreign direct the pandemic will reverse this investment inflows have been upward trend, the country is decreasing over time, but certain expected to have one of the lowest recipient sectors are growing. economic contractions in the Investment in the commercial region (-1.96%), worse only than sector rose to 32% in 2018 from that in the Dominican Republic. 23% in the previous year. To Living standards have been further draw investment from improving, although very slowly. abroad, it should continue its The country reduced inflation efforts towards strengthening to 3.7% in 2019 from 4.5% in its democratic institutions and 2016 and, while still within its addressing crime and corruption. 3-5% target, there is room for Guatemala should ramp up Macroeconomic improvement. Guatemala has the its efforts towards increasing its third-highest inflation rate in financial development by adopting indicators the region, after Honduras and international banking standards. • GDP growth: 3.6% Nicaragua. It is the only country within the • GDP per capita: Guatemala had the lowest region that is still only partially ratio of public external debt to implementing Basel I. $4,363 GDP in the region in 2019, at Guatemala is an outlier in • Inflation: 3.7% 11.9%. While its public deficit has sustainability efforts, ranking • Unemployment rate: increased gradually relative to lowest in the region in the 2.5% GDP since 2016, the ratio is still Environmental Performance Index one of the lowest in the region. (149th out of 180). It can improve • Public external debt Both fiscal advantages have given its ranking by taking important to GDP: 11.9% the government ample room steps like decreasing fossil fuel • Public deficit: 2.3% for manoeuvre in its pandemic dependence of its energy sector, response. Guatemala’s fiscal as well as executing its metro rail policies have ranged from packages project to reduce traffic congestion Trade indicators to stimulate economic activity and and carbon dioxide emissions. • FDI inflows: $998m • Total exports: $14.8bn ‘Fiscal • Free trade advantages agreements: 8 have given the government ample room for manoeuvre in its pandemic response.’ 11.9% In 2019, Guatemala had the lowest public external debt to GDP ratio in the region 24 CENTRAL AMERICA: INTEGRATION, INVESTMENT AND TRADE OPPORTUNITIES
COUNTRY FOCUS: HONDURAS
HONDURAS is the region’s pandemic, Honduras is expected third fastest growing economy, to have a healthy rebound in 2021. expanding an average of 3.8% The levels of public external debt annually in the last five years. have remained somewhat steady Living standards, as measured by since 2017 and represented 31% of gross domestic product per capita, the country’s GDP in 2019. have improved gradually since Honduras has 11 free trade 2014 but remain among the lowest agreements in force, the second- in Central America. Moreover, highest number in the region. inflation has increased steadily to However, this has yet to translate 4.4% in 2019 from 2.7% in 2016. into increased exports, remaining Honduras has achieved virtually unchanged since 2011. outstanding results in job Foreign direct investment creation, having one of the lowest has fallen sharply since 2017. unemployment rates in Central Foreign investors’ confidence America. The unemployed share may improve in coming years of the labour force has declined as Honduras continues with to 5.7% in 2018 from 7.3% in 2015. significant improvements in While unemployment is forecast strengthening the country’s Macroeconomic by the International Monetary institutions, and maintaining indicators Fund to increase as a result of the peace and stability. • GDP growth: 2.7% • GDP per capita: $2,557 ‘Honduras • Inflation: 4.4% has achieved • Unemployment rate: outstanding 5.7%* results in job creation, having • Public external debt one of the lowest to GDP: 30.7% unemployment • Public deficit: 2.5% rates in Central *2018 America.’ Trade indicators • FDI inflows: $498m • Total exports: $6.3bn • Free trade agreements: 11
3.8% Average annual growth in Honduras was the third highest in the region over the past five years BCIE.ORG | OMFIF.ORG 25
2. Number of S&P Moody's Fitch and Fitch) rate sovereign debt for corporates six Central American countries. rated by S&P, Belize 0 0 0 Fitch does not rate Honduras, and Moody’s, Fitch only Moody’s rates Belize. In terms Includes financial Costa Rica 1 4 21 of corporates, Panama ranks the institutions highest with 79 ratings (around Source: Ratings Dominican Republic 1 1 33 agencies. Note: three-quarters are financial The information El Salvador 1 2 32 institutions). El Salvador, the provided applies Dominican Republic and Guatemala to the period Guatemala 0 3 29 follow with more than 30 ratings between June 2019-August 2020 Honduras 0 0 15 each. Costa Rica and Honduras have 26 and 15 respectively. Nicaragua Nicaragua 0 0 4 only has four, while in Belize no corporates are rated by any of the Panama 13 11 55 three agencies (Figure 2). The corporate ratings landscape seems to align with other indicators of market development. For example, the de The capital adequacy ratio, at an ‘Linked to the information jure and de facto process for the average of around 17% across the environment, stable, protection of minority shareholders region, reflects the banking system’s predictable and can be a deal-maker or breaker for capital strength to withstand shocks investors seeking to enter the region. internationally- and absorb losses. It is well above Here again Panama ranks highest the Basel III minimum requirement competitive tax systems on the World Bank’s ‘protection of of 10.5%. All countries have an are key to attract investor minority shareholders’ ranking, appropriate liquid asset ratio that interest in the region. with a score of 56. It is followed by would allow their banking system Especially at the earlier Costa Rica (48) and Honduras (42). to respond with confidence to stages of financial El Salvador, the Dominican Republic unexpected changes in cash flows. market development, it and Guatemala all rank above 30, Nicaragua and Guatemala closed last is important to ensure while Belize and Nicaragua are the year with the region’s highest ratios, the tax framework is weakest in the group. 32.2% and 31.2% respectively. designed in a way that Linked to the information With the exception of Belize, environment, stable, predictable encourages financial most Central American countries and internationally competitive tax require or permit foreign companies market transactions to systems are key to attract investor to follow the IFRS for their listings. help the market reach a interest in the region. Especially For domestic companies, only healthy stage.’ at the earlier stages of financial Guatemala, Nicaragua and Panama market development, it is important do not require these standards to be to ensure the tax framework is followed. In the case of small and designed in a way that encourages medium enterprises, IFRS rules are financial market transactions to help either required or permitted across the market reach a healthy stage. the entire region. Adopting such International tax treaties can help reporting standards helps enhance reduce complexity but only Costa investors’ knowledge about the Rica, the Dominican Republic and El region and improve decision-making Salvador have at least some. Several processes. Convergence to global countries in the region offer tax standards helps simplify access to incentives for investments in specific the region for investors seeking to sectors such as high-tech production complement existing investments (Panama), tourism (Honduras, Costa elsewhere. More broadly, regulatory Rica and Nicaragua), logistics and harmonisation reduces complexity processing (Panama and Costa Rica). and compliance costs for foreign and Several countries operate free trade local investors and supports market zones. There is considerable variation development. in withholding tax rates across the Sovereign and corporate credit region. At the same time, within- ratings can improve investors’ country variation between residents information environment. All three and non-residents is fairly limited in major ratings agencies (S&P, Moody’s most Central American countries. 26 CENTRAL AMERICA: INTEGRATION, INVESTMENT AND TRADE OPPORTUNITIES
PILLAR 5: SUSTAINABLE INVESTMENT UNLOCKING POTENTIAL FOR SUSTAINABLE GROWTH
Initiatives to promote sustainable growth and investment are becoming increasingly important within global financial markets. Central American economies are exceptionally vulnerable to natural disasters and climate change, and require a focus on resilience-building and planning.
FINANCIAL market participants particularly in the areas of green Co-operation Agency channelled are becoming increasingly alert to transport and energy infrastructure. around $120m in financing to the the risks of working under a ‘business The region has made strides in region, including in an energy as usual’ economic model. These this area with the creation of various efficiency project in the Dominican risks can be direct and sudden, such programmes, such as the Co- Republic. The Dominican Republic as the loss of economic assets when financing for Renewable Energy and also runs a project on resilient infrastructure and real estate are Energy Efficiency between the Inter- transport infrastructure, supporting hit by natural disasters. Central American Development Bank and the development of infrastructure American economies are particularly the government of Japan. Under this adaptable to climate change, with vulnerable. Numerous hurricanes, programme, the Japan International technical assistance from the IDB’s floods, droughts and other disasters have hit the region in recent years. The pandemic has provided 100 1. Costa Rica additional challenges. There are 90 leads shift to also medium- and long-term risks cleaner energy to investors: changing regulations 80 Share of renewable associated with governments’ 70 energy in total commitment to the climate 60 energy generation, transition imply shifts in relative 50 %, 2018 prices with dirty-sector ‘losers’ and Source: CEPAL, 40 sustainable-sector ‘winners’. With OMFIF analysis 30 global investors seeking to rebalance portfolios towards a more resilient 20 model, Central American economies 10 can present important opportunities 0 Costa Rica Belize Panama El Salvador Honduras Guatemala Nicaragua Dominican for sustainable investments, Republic BCIE.ORG | OMFIF.ORG 27
NDC Invest programme. 2. Central 60 NDC Invest seeks to mobilise America lags behind in funds to accelerate the deployment 50 environmental of electric buses in the broader Latin protection American region, with projects 40 already running in Costa Rica and Environmental 30 Performance Guatemala. The former is also in the Index, 2020 process of designing a project for an 20 score (0=worst, electric train. Overall, the region has 100=best) Source: 10 made strong progress in renewable Environmental Performance Index energy. In four out of eight Central - 2020, OMFIF Costa Rica Panama Dominican El Salvador Belize Nicaragua Honduras Guatemala American countries, over three- Republic analysis quarters of energy generated is from Central America Rest of Latin America average renewable sources, with Costa Rica approaching 100% (Figure 1). Only the Dominican Republic presents a relatively low percentage, at just over and private investments in the ‘blue continues. In absolute terms, 15%. economy’, such as in a project aiming Central American economies still There is growing recognition of the to protect and enhance coastal lag neighbouring countries and need for a holistic understanding of natural capital scheduled for Panama. other regions when it comes to ecosystem dynamics and interactions, Given the region’s proximity to large environmental protection policies. and for projects that address these marine ecosystems, Central America Most countries featured in our accordingly. Biodiversity conservation has been home to several initiatives research earn a score of close to is at the heart of several such aimed at the sustainable management or below 40 (out of 100) in the initiatives. For example, the Global of shared marine resources. These 2020 edition of the Environmental Environment Facility and the IDB have included programmes to Performance Index (Figure 2). approved a series of projects related eliminate toxic chemicals and marine The index ranks countries on to ecosystem services, channelling litter, as well as projects to improve 32 environmental performance close to $20m to Costa Rica. A governance and management of indicators including the stage of separate consortium, supported by transboundary marine resources. A implementation of environmental the German government, established notable example is the Reef Resilience policy targets, the state of pollution the Adaptation Facility as part of Network, a partnership led by The emissions and protection of the Caribbean Biodiversity Fund Nature Conservancy, which strives to ecosystem services, and water and that covers the Dominican Republic, build marine management capacity waste management. This compares alongside other Caribbean nations. A to effectively manage, protect and to scores of between 40-50 for most separate partnership between the IDB restore coral reefs and reef fisheries other Latin American countries. and British government established around the world. Costa Rica is an exception, ranking the Blue Carbon Fund. The BCF uses It is imperative that the strong fourth overall in the region with a blended finance to catalyse public momentum behind such initiatives score of 52.5, behind Chile, Colombia
3. Presence of climate change and biodiversity policies in Central America, 2017 Source: CEPAL, OMFIF analysis *Note: Belize is not included Dominican Costa Rica El Salvador Guatemala Honduras Nicaragua Panama Republic Climate change mitigation • • • • • • Strengthening of natural protected areas • • • • • • • Climate change adaptation • • • • • • Water resources conservation and management • • • • • • • Observation and monitoring • • • • • Forest resources conservation and management • • • • • • Payment for environmental services • • • • • Erosion reduction • 28 CENTRAL AMERICA: INTEGRATION, INVESTMENT AND TRADE OPPORTUNITIES
and Mexico. ‘In four out of eight Central varying degrees (Figure 3, p. 27). The Costa Rica is also the only American countries, protection of natural reserves, and country in Central America whose over three-quarters of the conservation and management central bank has joined the Central energy generated is from of water resources draw the most Banks and Supervisors Network for attention, while policies focused renewable sources’ Greening the Financial System, a on erosion reduction are the least network dedicated to ‘mobilising popular, only implemented in mainstream finance to support the Honduras. transition towards a sustainable Governments, regulators, investors economy’. Brazil, Chile, Colombia and and corporates in the region can look Mexico have representation in the to develop new initiatives that focus NGFS. on the development of sustainable In Central America, governments financial markets and the effective and policy-makers have made a start management of non-financial sources at implementing policies related to of risk. Some suggestions in that vein climate change and biodiversity at are presented in Figure 4.
4. Policy recommendations for the design of sustainable financial markets Source: Various sources, OMFIF analysis Actor Category Comment
Central America can extend its work on the Toolkit for Strengthening Official Environmental Statistics by adopting some of the work done in the European Union’s Governments/Intra-regional bodies Underlying infrastructure Sustainable taxonomy sustainable taxonomy and adapting it to the region. This framework helps facilitate green investments while avoiding ‘greenwashing’.
Other Central American economies can Sustainability certification follow the examples of Costa Rica and Governments Underlying infrastructure schemes Honduras which have issued certification schemes for sustainable tourism.
Regulators in the region can help advance disclosure standards within green investment projects following the principles of the Financial Stability Board’s Governments/regulators Underlying infrastructure Disclosure frameworks voluntary task force on climate-related financial disclosures guidelines, as well as the more recent task force on nature- related financial disclosures.
Sovereigns and the private corporate sector in Central America could follow the example of Chile and others in issuing sovereign green (or blue) bonds. The Sustainable bonds Governments/corporates Sustainable capital markets Central Bank of Costa Rica, Ecosolutions, a Costa Rican provider of energy efficiency solutions, CABEI and the infrastructure financial institution CIFI in Panama have already issued green bonds.
Only the stock exchanges of Costa Rica and Panama have joined the UN’s sustainable stock exchanges initiative, while the Dominican Republic launched Stock exchanges Sustainable capital markets Sustainable stock exchanges the first green finance forum in July 2019. Similar initiatives to support green finance could be followed by other stock exchanges in the region.
Central American countries could follow the example of the UK Green Investment Governments/international organisations Sustainable capital markets Green investment bank Bank, to create a dedicated vehicle for green investments.
Several central banks in Europe and Asia have begun introducing climate stress tests on the institutions they supervise, Climate stress tests Central bank Regulation/supervision evaluating the banking and insurance sectors’ resilience to adverse climate scenarios. Central America should consider implementing similar processes.
The Central Bank of Costa Rica is the only Climate-related research and central bank in the region to have joined Central bank Regulation/supervision sharing of best practice the NGFS. Its peers should follow the same path. BCIE.ORG | OMFIF.ORG 29
COUNTRY FOCUS: NICARAGUA
NICARAGUA has achieved country has one of the lowest outstanding results in job export values in the region and creation, having one of the lowest these have remained virtually unemployment rates in Central unchanged since 2011. America. In 2019 this stood at Nicaragua has the second- 6.1%, the second-lowest in the highest public external debt to region after Honduras. However, gross domestic product ratio of the International Monetary Fund the region after Belize, which forecasts almost a doubling of amounted to 50.2% in 2019. This unemployment to 11.1% as a result is despite a relatively low public of the pandemic. deficit, which stood at 2% of the Nicaragua has a sound country’s GDP in 2018. financial system. The statutory capital requirements in the ‘Nicaragua has a country are higher than international standards, even sound financial though it has not implemented system. The Basel III. The country has the statutory capital Macroeconomic highest ratio of regulatory capital requirements in the to risk-weighted assets in the country are higher indicators region, 19.5%, which is well above than international • GDP growth: -3.9% Basel’s requirement of 10.5%. standards.’ • GDP per capita: Likewise, its 11.5% regulatory tier 1 capital to risk-weighted assets $1,913 surpasses the 6% requirement of Nicaragua is one of the two • Inflation: 5.4% Basel III. countries in the region that • Unemployment rate: Nicaragua has entered into receives the least amount of 6.1% eight free trade agreements with foreign direct investment. Inflows various counterparties, including plummeted in 2018, although they • Public external debt some of its main trading partners, had been continuously falling to GDP: 50.2% such as the US, China and Mexico. since 2015. To foster confidence, • Public deficit: 2%* However, this has yet to translate Nicaragua should work towards a into increased exports. The more stable political climate. Trade indicators • FDI inflows: $359m* • Total exports : $6.4bn* • Free trade agreements: 8
*2018
6.1% Nicaragua has one of the lowest unemployment rates in the region 30 CENTRAL AMERICA: INTEGRATION, INVESTMENT AND TRADE OPPORTUNITIES
COUNTRY FOCUS: PANAMA
PANAMA has the highest living corporate ratings, 58 of which standards in the region with a are banks and other financial gross domestic product per capita institutions. of $15,735, well above the global Panama is the region’s second- average of $11,436. Moreover, it has fastest-growing economy, one of the lowest inflation rates expanding an average of 4.6% in the region, which has remained annually in the last five years, below 0.9% since 2015. Since outperformed only by the Panama is completely dollarised Dominican Republic. Despite with no separate legal tender, these positive results, the fast dollar depreciation in 2019 created growth in the country has been a deflationary environment as partly debt-fueled. Public external inflation fell to -0.4%. debt has increased steadily since The country has outperformed 2014, amounting to 36% of GDP others in the region in terms of in 2019. Similarly, the country has foreign direct investment, which the second-highest public deficit increased during most of the in the region, after Costa Rica, last decade. Panama has created representing 3.8% of its GDP. The an environment that enhances pandemic will exacerbate both Macroeconomic confidence from international these situations as the country indicators investors.In the World Bank’s funds policies to cope with it. Doing Business 2020 report, it Except for a slight increase in • GDP growth: 3% was top-ranked in the region job creation between 2017 and • GDP per capita: for protection of minority 2018, the unemployment rate has $15,735 shareholders. Moreover, it is the been increasing steadily in Panama • Inflation: -0.4% only country in Central America since 2014. The pandemic will with investment-grade sovereign worsen this as unemployment is • Unemployment rate: credit ratings, and it stands out expected to rise to 8.8% in 2020 7.1% in the region with a total of 79 from 7.1% in 2019. • Public external debt to GDP: 36.3% ‘The country has outperformed others in the region in • Public deficit: 3.8% terms of foreign direct investment, which increased during most of the last decade.’ Trade indicators • FDI inflows: $4.8bn • Total exports: $23.9bn* • Free trade agreements: 10 *2017
$15,735 Panama’s GDP per capita is the highest in Central America BCIE.ORG | OMFIF.ORG 31
CONCLUSION NETWORK EFFECTS OF INTEGRATION POISED TO DELIVER
Central America has been working for decades toward integration. That effort, as well as sound management, has put it in a strong position to overcome the repurcussions of the pandemic and build back better.
THE ‘Central America: Integration, investment having run finances in a balanced way in the and trade opportunities’ report presents aftermath of the 2008 financial crisis. Like a multi-faceted look at the region through many other countries globally, most Central five pillars, ranging from a macroeconomic American economies had to acquire loans overview to the sustainable investment from multilateral organisations to support projects underway. Our intention in launching the fiscal and monetary policy measures they this as an annual publication is to regularly keep implemented to cope with the recession. To track of the region’s development across these return to a sustainable growth path, countries areas and highlight what can be improved to must be able to manage their external debt bolster investor access and sustainable growth. while continuing to provide adequate support This inaugural edition comes at a crucial to workers and businesses. point in the region’s economic development. There is great potential for the region to Our analysis suggests that Central America diversify its export destinations by harnessing entered the pandemic in a strong position. integration efforts to enter the European Integration efforts, which date back more than market. While the US has been the primary 60 years, have proven vital for the resilience of source of foreign direct investment inflows the region during these challenging times. to the region, other partners, such as South In the months ahead, countries will need to Korea, are increasing their attention on find the correct balance between restarting Central America with various infrastructure economic activity, and implementing health projects underway. The region is unlocking its policies to confront a second wave of Covid-19. potential for sustainable growth and presents Central America’s economic growth over opportunities for environmentally-friendly the past five years has created supportive investments, particularly in green transport and economic conditions. These have enabled it to energy infrastructure. manage the shock and prepare for a stronger The Covid-19 crisis has hampered education, recovery compared with other blocs in Latin increased unemployment, pushed more people America and the Caribbean. Central America into poverty and escalated social unrest. was the only bloc in the region that grew its Holistic integration projects such as those exports in the first quarter of 2020 from the in Central America will prove crucial. Unified same period in the year before, demonstrating efforts that go beyond economic integration resilience at the start of the virus outbreak. towards institutional strengthening, social Sound fiscal management has contributed integration, sustainability and security enhance to the region’s resilience, with governments the region’s ability to overcome this crisis. Official Monetary and Financial Institutions Forum 30 Crown Place bcie.org London EC2A 4EB T: +44 (0)20 3008 5262 F: +44 (0)20 7965 4489 [email protected] omfif.org