The Big Idea

Guatemala | The IMF scorecard

| May 31, 2024

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. This material does not constitute research.

After 100 days of President Bernardo Arevalo’s administration, the latest annual review from the International Monetary Fund shines some light on Guatemala’s economic agenda. The IMF broadly urged stronger public management and reforms to improve the investment climate. This lines up well with the Arevalo administration’s new budget enhancement legislation and a competition law. But these initiatives require congressional cooperation, and politics now start to matter. The success of the political collaboration will determine whether the ‘B’ credit ratings move towards investment grade. The latest political setbacks undermine the recent outperformance relative to Costa Rica

The IMF’s Article IV staff statement first emphasizes economic stability. This is the trademark of their strong fundamentals.

“The Guatemalan economy continues to show remarkable stability and soundness thanks to a legacy of prudent monetary and fiscal policies- with the inflation rate on target, ample international reserves, contained fiscal deficits, and a low public debt/GDP ratio that continues to fall.”

However, this optimism was tempered by references to economic growth below potential at 3.5%, constrained by low investment. The latest foreign direct investment at 1.6% of GDP contrasts with 3%-4% of GDP at other ‘BB’ credits in the regionThis low investment is unusual for a track record of economic stability across growth, inflation and the foreign exchange rate with an independent central bank and a fiscal anchor.

There were several different IMF recommendations on reforms to improve the investment climate including a competition law, infrastructure and ports law, revision of the PPP and procurement reforms. On the regulatory front, there is some room for unilateral measures.  Minister Menkos launched a new website on public procurement with potential improvement on transparency. However, the majority of reforms require congressional cooperation.

The Arevalo administration first submitted a competition law. This represents an ambitious start considering the political controversy of de-regulation and the failure to approve on prior attempts back in 2016. There hasn’t yet been any success with the congress now in recess until August 1 with optionality for extraordinary sessions. It’s not quite clear what’s the political strategy with a competing agenda on the budget enhancement proposal (Q$14 billion), the competition law, and the reform of the Attorney General. The one floor vote to reform the Attorney General law (and legally dismiss Consuelo Porras) only had minimal support from the ruling Semilla deputies (23 deputies) from prior estimates of a 107-member coalition (67% majority). This dampens the initial optimism for a gradual and moderate reform agenda under a coalition majority.

The legislative agenda should become increasingly crowded on the push to augment the 2024 budget as well as define the 2025 budget.  The 2024 budget was rolled over from 2023 with clear capacity for higher spending on higher 2024 nominal tax revenues. The spending through April 2024 is below trend. The budget enhancement proposal for Q$14 billion is slightly expansionary (neutral budget would be around Q$8 billion based on 7% deflator). The IMF recognizes that a slightly higher fiscal deficit (from 1.4% of GDP in 2024 to 2% of GDP thereafter) would not compromise the fiscal anchor but yet allow for slightly higher spending flexibility on critical areas of social and capex spending. This was one of the main campaign platforms from Semilla. The IMF is also providing technical assistance to improve the quality, efficiency and transparency of the budget.

The IMF also recommends tax reform on what defines the lowest tax revenue in the region at below 13% of GDP. The weak infrastructure and weak social indicators merit higher resources in strategic areas sourced either from a slightly higher deficit or tax reform.  The challenge is rallying support from an extremely fiscally conservative legislature that both rejects debt accumulation and tax hikes. There has been no reference to tax reform. The next litmus test is the reception to the budget enhancement proposal.

“We recognize the efforts of the tax authorities, but at the same time it needs to be acknowledged that revenues are among the lowest in the world. Realistically, with tax revenue collection below 13 percent of GDP (11.7 percent in 2023), it will be difficult to address the country’s urgent needs (e.g., infrastructure, education, health, and malnutrition) without increasing debt.”

There is yet no apparent political pact to embrace: 1.) a social pact for a larger role of government (larger budget/higher taxes) and 2.) a pro-investment pact with stronger regulatory environment to attract foreign direct investment. The higher budget on social spending and higher FDI-led growth would provide a formula to gradually improve the weak social indicators necessary for credit rating upgrades. Until when/if there is an active economic reform agenda, credit spreads should remain somewhat stagnant with a spread premium to other illiquid BB peers (Paraguay and Costa Rica).

Siobhan Morden
siobhan.morden@santander.us
1 (212) 692-2539

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