Guatemala | Setbacks, but fundamental strength

Siobhan Morden | November 10, 2023

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Recent protests in Guatemala have started to shape the economy, with a spike in October inflation and a likely shock to economic activity. But downside risks look limited absent financial contagion. The country’s fundamentals remain the most robust among Latin America’s ‘BB’ credits. Guatemala has a huge stock of assets, with foreign exchange reserves equivalent to 20% of GDP, and a low leverage, with debt at 30% of GDP. But a political risk premium persists in the country’s debt with two more painful months until the inauguration. Still, the country looks bound for a successful political transition with no negative shocks that would destabilize the strong ‘BB’ credentials.

October inflation figures showed a spike of 1.27% month-on-month and 4.98% year-on-year, marking an inconvenient setback to the prior trajectory toward the country’s 4% inflation target. But the inflation looks transitory. This should not affect the central bank reaction function through the January 14 inauguration, especially if there is no secondary impact on expectations. The worst of the social unrest has dissipated with no reported road blockades at the end of October. The central bank has held the policy rate steady at 5% since the last hike in April 2023. And annual inflation has also reached more reasonable levels just below 5% and within the target band of 3% to 5%.

The central bank may also continue to rely on foreign exchange strength as a near-term anchor against headline inflation pressure. Political uncertainty may continue, but the unique segmentation of local markets, with few if any cross-border flows, limits any domestic financial contagion on the real economy. The central bank can also easily intervene to maintain foreign exchange stability. The shallow local markets are not necessarily a structural constraint but rather just the function of low treasury financing needs from historical low fiscal deficits below 2% of GDP.

It would take a seismic shock to destabilize the strong fundamentals with repayment metrics that are closer to investment grade compared to the current ‘BB’ ratings. The track record of economic stability under an independent central bank, a flexible foreign exchange rate and a fiscal anchor has allowed for favorable growth-and-inflation tradeoff with a low stock of US dollar debt at 30% of GDP and a high stock of dollar assets at 20% of GDP.  There is no other country in the region with the same disciplined track record of fiscal deficits of 2% of GDP and low volatility of 3% trend GDP growth. Guatemala was the least vulnerable to the pandemic with the fastest economic recovery from a shallow recession. This resiliency and effective crisis management was the rationale for the rating upgrades from ‘BB-‘ a ‘BB’ from both Fitch and S&P this year. The protests have not yet reached an inflection point to destabilize the country with yet no crossover of political interventionism that would threaten the political transition. The political strategy seems more intended to weaken the Arevalo administration—via disqualification of Semilla Party status—as opposed to block the actual transition. The Arevalo-elect administration not only has the democratic support among the majority of the ruling elite and wider population but also the obvious diplomatic support from the international community.

The core anchors of democratic transition and economic resiliency is why credit spreads have not deviated much from illiquid peers like Costa Rica and Paraguay.  The longer tenors have been more resilient, especially against Paraguay while Costa Rica remains the top regional outperformer on its path towards full convergence with BB credits.  Guatemala is now trading at a 40 bp spread premium to its peers on the 10-year sector of the curve and flat to 25 bp on the 30-year sector of the curve.  The residual political risk premium may persist over the next two months. But the worst of the setbacks have already been discounted on the legal risks to the Semilla party with checks/balances that should rule out worst case threats to democracy. The democratic transition should hopefully unwind the political risk premium early next year with potential outperformance of the 10-year sector and bullish curve steepening.