Bmi C Amer 17 09 PDF

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ISSN: 0265-9085
September 2017 Contents

Vol 34 Issue 9
Latin America Monitor

Guatemala: Public Spending
Efforts Undermined By Weak Tax
Compliance 3
Central America Panama: Strong Canal Usage Will
Propel Growth 5
El Salvador: Legislative Gridlock Will Intensify Honduras: Remittances,
Ahead Of 2018 Elections Agricultural Exports To Narrow
BMI View: El Salvador will struggle to make necessary fiscal adjustments and promote Current Account Deficit 6
growth-friendly policies due to intensifying legislative gridlock ahead of 2018 legislative
elections. Additionally, a potential shift in US policy towards El Salvador, amid escalating Latin America – Sovereign Risk:
tensions, would threaten critical remittance and aid inflows. Politics Prevents Significant Credit
Spread Compression 9
A legislative impasse will prevent El Salvador from implementing pro-growth policies or
expenditure adjustments amid an ongoing fiscal crisis. With legislative elections set for
March 2018 and a presidential election the following year, both the ruling Frente Farabundo
Marti para la Liberación Nacional (FMLN) and the opposition Alianza Repubilcana (ARENA)
will become increasingly intransigent in an effort to fortify their political support. The
FMLN's efforts to introduce new spending measures have ground to a halt in the ARENA-
controlled National Assembly in recent months, as the opposition party digs in on its fiscally
conservative policies.
Copy Deadline: 21 July 2017
Additionally, shifting US policies under the administration of President Donald Trump
Analysts: Andrew Trahan, Jesse Wheeler,
present a critical risk to remittance and aid flows. Trump built his candidacy in part on anti- Fily Camara
...continued on page 2
Editor: Katherine Weber
Sub-Editor: Rachel Dobbs

Nicaragua: Rising Inflation Will Not Alter BCN Policy 4
Subscriptions Manager: Lyan Chan
We expect the Banco Central de Nicaragua will continue to devalue the córdoba at a steady
pace in the next two years, in spite of spiking consumer price inflation. Inflation will be Marketing Manager: Julia Consuegra
driven by rising energy prices as subsidised fuel from Venezuela dries up.
Production: Vicky Naithani
Costa Rica: Consumption and Investment Drive Strong Growth 8

Costa Rica's economic growth will remain strong over the coming years, driven by private
consumption and infrastructure investment. However, government spending cuts and
higher borrowing costs will cap growth rates below previous years' highs.
REGIONAL INDICATORS
Central America 2015 2016e 2017f 2018f Head Office
Nominal GDP, USDbn 232.5 243.6 260.5 279.0
2 Broadgate Circle, London
Population, mn 46.4 47.1 47.8 48.5
EC2M 2QS, UK
GDP per capita, USD 5,012.1 5,173.4 5,451.6 5,755.4
Real GDP growth, % 4.0 3.8 4.2 3.9
Inflation, % 1.4 2.0 2.7 3.1 Company Locations
Goods Exports, USDbn 48.8 49.8 52.4 55.1 London | New York | Singapore
Goods Imports, USDbn 79.9 81.0 85.5 90.7 Hong Kong | Dubai | Pretoria
Notes: e/f = BMI estimate/forecast. Central America = Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua,
Panama. Weighted by nominal GDP. Source: BMI.
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Central America | September 2017
CENTRAL AMERICA RISK INDEX

BMI's Country Risk Index scores countries on a 0-100 scale, evaluating short-term and long-term political stability, short-term economic
outlook, long-term economic potential and operational barriers to doing business. For a detailed methodology, visit bmiresearch.com or
contact us using the details on page 1.
RISK INDEX TABLE

Short Term Long Term Operational Country
Political Economic Political Economic Risk Risk
Panama 73.5 61.0 69.0 66.3 55.9 64.0
Costa Rica 61.9 53.5 71.8 59.1 53.6 59.4
El Salvador 48.5 47.3 60.4 53.0 42.0 49.0
Guatemala 45.4 58.8 48.9 55.8 40.0 48.2
Honduras 46.0 53.3 47.5 51.8 38.4 46.4
Nicaragua 63.8 43.1 45.2 46.1 41.5 46.5
Regional Average 56.5 52.8 57.1 55.4 45.2 52.3
Global Average 63.7 52.1 62.2 52.9 49.7 55.0
Source: BMI.
EL SALVADOR – POLITICAL OUTLOOK

...continued from front page
immigration rhetoric, and has threatened to cut Central American aid budgets as well as ramp up deportations of illegal immigrants.
Recent moves by the government of El Salvador have increased bilateral tensions with the US, and may exacerbate this threat by
prompting further US action.
Poor policy formation, coupled with a persistently poor security environment, weigh down El Salvador's score in our Short-Term Political
Risk Index. El Salvador scores 48.5 out of 100 in the index, compared to a regional average in Latin America of 56.9. This high level of
political risk will continue to weigh on investor sentiment towards the country in the coming quartets.
Legislative Gridlock Will Increase In Run up To 2018 Elections

We expect political tensions to rise as we approach legislative elections in 2018 and a presidential election in 2019, deepening the current
legislative impasse. Over the past year ARENA has adopted a hard-line on fiscal consolidation, playing towards its conservative base. As
April's polling data – the most recent available – validates this strategy, showing ARENA with a 6.5% lead over the FMLN in legislative
elections and a 5.6% lead in municipal elections slated for March 2018, we expect ARENA to dig in further in the coming months. In
contrast, the FMLN will not make the long-term cuts to spending and social programs sought by ARENA, as this would attract substantial
backlash from the party's base of left-wing voters (see 'Further Defaults Will Be Avoided, Though Finances To Remain Weak', April 12). As a
result, the ruling FMLN will continue to muddle through, making short-term budgetary adjustments to fill holes through the March 2018
elections.
Shifting US Policies Threaten Capital Inflows

Amid shifting US policies on immigration and international aid, recent moves by the El Salvadorian government may cause a deterioration
in bilateral relations between the two countries, further threatening critical remittance and aid inflows. The gang MS-13, which is highly
active in El Salvador, has been at the forefront of heightened anti-immigration rhetoric from US President Donald Trump. While we do not
think that this rhetoric will lead to a major shift in US immigration policy in the coming quarters, stricter enforcement and deportations
could limit remittance inflows to El Salvador, which reached USD4.6bn in 2016. Additionally, at a Miami meeting in June attended by Vice
President Mike Pence, the US announced it would be cutting aid to the Northern Triangle (which includes El Salvador, Honduras, and
Guatemala) to USD460mn in 2017 from USD655mn in 2016. In this climate, recent moves by the El Salvador government opposed by the
US government, including changes to forfeiture laws used to seize criminals' assets and the rejection of corruption allegations made by
US legislators towards Deputy Foreign Minister José Luis Merino, could spur further action by the US government.
www.bmiresearch.com Page 2
DATA & FORECASTS

2013 2014 2015 2016e 2017f 2018f 2019f
Population, mn 6.3 6.3 6.3 6.3 6.4 6.4 6.4
Nominal GDP, USDbn 24.4 25.1 26.1 26.8 26.9 28.0 29.1
GDP per capita, USD 3,998 4,102 4,252 4,359 4,368 4,527 4,685
Real GDP growth, % y-o-y 1.8 1.4 2.3 2.4 2.2 1.8 1.6
Industrial production, % y-o-y, ave 0.4 0.6 1.0 2.1 3.0 3.0 2.9
Consumer price inflation, % y-o-y, ave 0.8 1.1 -0.7 0.6 0.5 1.8 1.8
Consumer price inflation, % y-o-y, eop 0.8 0.5 1.0 -0.9 2.0 1.5 2.0
Exchange rate USD/USD, ave 1.00 1.00 1.00 1.00 1.00 1.00 1.00
Exchange rate USD/USD, eop 1.00 1.00 1.00 1.00 1.00 1.00 1.00
Budget balance, USDbn -0.5 -0.4 -0.4 -0.2 -0.2 -0.2 -0.1
Budget balance, % of GDP -4.0 -3.6 -3.3 -2.8 -2.8 -2.6 -2.5
Goods and services exports, USDbn 6.4 6.5 6.7 6.7 7.0 7.4 7.9
Goods and services imports, USDbn 11.1 10.9 10.9 10.5 11.0 11.5 12.3
Current account balance, USDbn -1.6 -1.2 -0.9 -0.5 -0.5 -0.4 -0.6
Current account balance, % of GDP -6.5 -4.8 -3.6 -2.0 -1.8 -1.6 -2.2
Foreign reserves ex gold, USDbn 2.7 2.7 2.7 2.8 3.3 3.5 3.6
Import cover, months 3.0 3.0 3.1 3.4 3.9 4.0 3.9
Total external debt stock, USDbn 13.5 14.5 15.0 15.8 16.5 17.3 18.2
Total external debt stock, % of GDP 55.6 58.0 57.5 58.8 61.4 61.9 62.7
e/f = BMI estimate/forecast; Source: National Sources, BMI
GUATEMALA – ECONOMIC OUTLOOK
Public Spending Efforts Undermined By Weak Tax Compliance

BMI View: An increase in public spending on social programmes and security will drive a modest widening of Guatemala's fiscal
deficit in 2017 and 2018. In addition, revenue growth will remain limited, with a persistently poor tax compliance rate limiting the
government's fiscal capacity.
Guatemala's fiscal deficit will widen in 2017 and 2018, as the government places fiscal consolidation efforts on hold in order to prioritize
social and capital spending projects along with increased spending on security. We expect little movement on reform efforts, particularly
tax reform, where a persistently weak revenue base constrain the government's consolidation efforts moving forward. We forecast the
budget balance to reach -1.4% and -1.5% of GDP in 2017 and 2018, respectively, up from a deficit of 1.1% in 2016. Deficits will remain narrow,
however, which along with low government debt levels will prevent a significant deterioration in Guatemala's sovereign credentials.
Larger Budgets To Target Human Development, Security

Pressing social and security needs, along with mounting political pressures, have led the government to opt to place fiscal consolidation
on hold and to increase spending in 2017 and 2018. The administration of President Jimmy Morales has outlined substantial goals for
spending increases, which will focus on security, infrastructure and education in an effort to enhance economic growth. On June 21, the
Ministry of Public Finance announced a budgetary target of GTQ87bn for 2018, compared to GTQ77bn for 2017, which was itself a large
increase from 2016 outlays. Through May, total monthly spending growth has averaged 16.0% y-o-y.
Current expenditures will continue to account for the lion's share of public spending increases, forecast to reach over 80% of total
expenditures in 2017. Capital expenditures will also see a rise as the government roles out its Community Development Plan (2013-2025)
aimed at improving social and education infrastructure, which has already received GTQ2.9bn in outlays in the first five months of 2017.
Weak Revenue Base Will Inhibit Public Sector Capacity

Poor tax compliance will continue to undermine Guatemala's revenue base and limit the government's fiscal capacity in the years ahead.
Guatemala currently has the weakest revenue base as percentage of GDP in Latin America, and one of the weakest globally, at 11.0% of
GDP – a product of rampant tax evasion and a large informal economy. With the Morales government's ability to push through legislation
hampered by mounting allegations of corruption, we expect little movement on tax reform in the coming quarters (see 'Allegations
Surrounding Morales Set To Intensify', June 14). As a result, low tax compliance will persist and limit the government's ability to increase
spending further without taking on large amounts of debt. Given an aversion to increasing the public debt burden, we expect that the
government will opt to return to fiscal consolidation, leading deficits to shrink once again beginning in 2019.
Sovereign Credentials Will Remain Stable

The near-term widening of the fiscal deficit will not cause a significant deterioration in Guatemala's sovereign credentials. We do not
expect the deficit to surpass 1.5% of GDP in the coming years, compared to 2.1% over the previous decade. Additionally, Guatemala's
public debt load remains manageable at 24.4% of GDP, with debt service accounting for only 1.5% of GDP in 2016. Moving forward, we
expect fiscal deficits to narrow further, averaging -0.6% from 2017 through 2026, offering additional support to sovereign credentials.
DATA & FORECASTS

2013 2014 2015 2016e 2017f 2018f 2019f
Population, mn 15.6 15.9 16.3 16.6 16.9 17.2 17.6
Consumer price inflation, % y-o-y, ave 4.3 3.4 2.4 4.4 4.5 3.9 3.3
Consumer price inflation, % y-o-y, eop 4.4 2.9 3.1 4.2 4.8 3.0 3.5
Central bank policy rate, % eop 5.00 4.00 3.00 3.00 3.50 4.50 5.50
Exchange rate GTQ/USD, ave 7.86 7.73 7.66 7.60 7.38 7.25 7.24
Exchange rate GTQ/USD, eop 7.84 7.60 7.63 7.52 7.27 7.20 7.28
Budget balance, GTQbn -9.0 -8.6 -7.0 -5.7 -8.2 -9.1 -7.9
Current account balance, USDbn -1.4 -1.2 -0.1 0.9 0.8 0.6 0.5
Current account balance, % of GDP -2.5 -2.1 -0.2 1.3 1.0 0.7 0.6
Crude, NGPL & other liquids prod, 000b/d 14.0 14.0 14.0 14.0 14.0 14.0 14.0
Total net oil exports (crude & products), 000b/d -55.0 -55.7 -56.4 -57.1 -57.8 -58.5 -59.2
Dry natural gas production, bcm 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Dry natural gas consumption, bcm 0.0 0.0 0.0 0.0 0.0 0.0 0.0
NICARAGUA – ECONOMIC OUTLOOK

Rising Inflation Will Not Alter BCN Policy
BMI View: We expect the Banco Central de Nicaragua will continue to devalue the córdoba at a steady pace in the next two years, in
spite of spiking consumer price inflation. Inflation will be driven by rising energy prices as subsidised fuel from Venezuela dries up.
Price growth in Nicaragua will accelerate substantially in the next year, driven by rising energy prices and remittance inflows. However,
this will not spur the Banco Central de Nicaragua (BCN), whose mandate is to ensure stability in the national currency and does not have a
benchmark interest rate, to change its current policy. We expect the bank will continue to steadily devalue the Nicaraguan córdoba (NIO)
in the next two years, in line with the strategy it has maintained since 2007.
Inflation To Spike On Venezuela Contagion

We forecast consumer price inflation to average 4.0% y-o-y in 2017 and 5.1% in 2018, from 3.5% in 2016. The spike will be driven primarily
by rising fuel costs, which our Oil & Gas team expects will edge higher in 2017 and 2018 (see 'OPEC Extension Will Support H2 Prices',
May 9). This jump will be exacerbated by declining support from Venezuela (see 'Petrocaribe Will Not Be Revived', April 28). Through
Venezuela's Petrocaribe programme, Nicaragua has received heavily subsidised oil imports for several years. As this support dries up, the
country will be forced to import fuel at market prices. The impact of this will filter through the broader economy. Nicaraguan consumers
have already seen electricity subsidies reduced, which we believe is indicative of a coming jump in consumer prices.
Price growth will also be bolstered by rising demand, on the back of remittance inflows. Concerns about the Trump administration have
seen remittances into Nicaragua from the US spike, which we expect will continue in the coming quarters (see 'Downside Risks To Growth
Increasing', February 22). As disposable income in the country rises, we expect that higher demand will drive a rise in prices.
Currency Devaluation Will Not Slow

Despite the rise in consumer prices, we do not expect the BCN will adjust the depreciatory path of the NIO (see 'NIO: Steady Depreciation To
Continue', March 20). Policymakers have weakened the currency by 5.0% per year since 2007 in order to increase export competitiveness.
The BCN maintained the steady depreciation of the currency even when inflation topped 20.0% during the global financial crisis. As a
result, we do not expect that the spike we forecast over the next two years will push policymakers to change policy.
DATA & FORECASTS

2013 2014 2015 2016e 2017f 2018f 2019f
Population, mn 5.9 6.0 6.1 6.1 6.2 6.3 6.4
Industrial production, % y-o-y, ave -0.4 5.2 3.5 3.5 3.5 3.5 3.5
Exchange rate NIO/USD, ave 24.72 25.96 27.25 28.55 29.98 31.48 33.05
Exchange rate NIO/USD, eop 25.33 26.60 27.93 29.32 30.79 32.33 33.94
Budget balance, NIObn -3.1 -4.6 -5.4 -4.2 -6.3 -6.5 -5.5
PANAMA – ECONOMIC OUTLOOK

Strong Canal Usage Will Propel Growth
BMI View: The Panamanian economy will continue to surge over the coming months, primarily driven by robust canal activity. How-
ever, a lack of economic diversity means the country is likely to remain vulnerable to downturns in global trade.
Panama's economy will continue to be among the strongest performers in Latin America, Growth To Outpace Region
Panama – Real GDP Growth, % y-o-y
as surging canal usage boosts trade and related industries, such as transport and
communications. Panama's location and the presence of the newly enlarged canal make
it a hub for logistics and financial services, and increased canal traffic will drive higher
revenues from fees, filtering through to the wider economy through increased service
sector activity (see 'Canal Rebound And Investment To Sustain Strong Growth', March
22). Because of the canal's increased capacity, cargo movements have risen 12.6% y-o-y
through May, while overall canal tonnage is up 22.2% compared with the same period in
fiscal year (FY) 2016/17. While we acknowledge potential headwinds could dampen global
trade volume and limit canal usage, our core view is that the uptrend in shipping volume
will continue, supporting robust real GDP growth over the coming quarters. We forecast
f = BMI forecast. Source: INEC, BMI
real GDP growth of 5.6% in 2017 and 5.7% in 2018, compared to an estimated 4.9% in 2016.
Strong private consumption and fixed investment will compliment the uptick in canal
volume. Panama's elevated growth levels over the last several years have contributed to
a significant reduction in poverty, which has declined some 20.0% since 2007. Panama
now boasts one of Latin America's highest per capita GDPs, which will support household
spending. As a result, we forecast private consumption to average 46.0% of GDP over the
next five years. Additionally Panama possesses an infrastructure pipeline valued at nearly Canal Usage Keeping Activity Elevated
Panama – Economic Activity Index, % y-o-y
USD23.0bn. Construction projects aimed at improving public facilities and transit networks
will continue to be attractive to foreign investment, as business-friendly policies apply
equal standards to foreign and domestic firms and the dollarised economy limits risks of
losses from currency volatility.
Growth Outlook Vulnerable To Global Trade Dynamics

Panama's economic performance will remain susceptible to fluctuating trends in global
trade over the coming years. Nearly two-thirds of economic output is related to the service
sector, with agriculture and manufacturing historically underperforming (see 'Services Will
Offer Modest Relief To Elevated Current Account Deficit', April 14). A slower-than-anticipated
Source: Bloomberg, BMI
recovery in global trade volumes or renewed uncertainty due to protectionist rhetoric on
the part of political leaders in developed markets could see the logistics and shipping
services sector struggle (see 'Research Highlights: Global Shifts And Hidden Gems', May
26), tempering economic activity. Moreover, in the coming years, concerns over declining
water levels as a result of climate change could limit the amount of time the canal can be
effectively operated.
DATA & FORECASTS

2013 2014 2015 2016e 2017f 2018f 2019f
Population, mn 3.8 3.9 4.0 4.0 4.1 4.2 4.2
Exchange rate PAB/USD, ave 1.00 1.00 1.00 1.00 1.00 1.00 1.00
Exchange rate PAB/USD, eop 1.00 1.00 1.00 1.00 1.00 1.00 1.00
Budget balance, PABbn -1.0 -1.6 -1.2 -1.4 -1.2 -1.3 -1.3
Crude, NGPL & other liquids prod, 000b/d 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Total net oil exports (crude & products), 000b/d -134.0 -148.2 -159.4 -169.9 -180.2 -190.2 -200.7
Dry natural gas production, bcm 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Dry natural gas consumption, bcm 0.0 0.0 0.0 0.0 0.0 0.0 0.0
HONDURAS – ECONOMIC OUTLOOK

Remittances, Agricultural Exports To Narrow Current Account Deficit
BMI View: A surge in agricultural exports and continued strength in remittance in flows will narrow Honduras's current account
deficit in 2017. From 2018 onwards, however, stronger demand for imports and deteriorating terms of trade will see the country's
deficit gradually widen.
Honduras' current account deficit will narrow further in 2017, bolstered by rising exports and strong remittance inflows. Export growth will
be concentrated in Honduras' key agricultural commodities, coffee and bananas, with modest gains in textiles and mining. Remittance
inflows will continue to be supported by a strengthening US economy. As a result we expect the current account deficit to narrow to 2.5%
in 2017, from 3.8% in 2018.
From 2018, we expect a gradual widening of Honduras' current account deficit, as rising Remittance Growth Will Support Narrower
Current Account Deficit
imports are driven by an improving economy and a deterioration in Honduras' terms of Honduras – Current Account
trade. However, the current account deficit will remain narrower than it has over the past
decade, averaging 3.2% of GDP during our 10-year forecast period compared with -7.3%
from 2007 to 2016.
Remittance Flows Provide Critical Financing Source

Remittance flows will be a critical funding source for Honduras's current account. Over the
past four years remittance growth has averaged 6.6% annually, representing the principle
driver of the narrowing seen in the current account deficit. Our view for continued growth
in remittances to Honduras is underpinned by our positive outlook for the US economy. An
improving labour market is one of the major drivers of US growth (see 'Investment To Play e/f = BMI estimate/forecast, Source: BCH, BMI
More Prominent Role In Near-Term Growth Outlook', April 3), and will support remittance
flows as workers in the US will have increased disposable income to send back to Honduras.
Strong Harvests Will Narrow Trade Deficit In 2017

A surge in agricultural exports will be the primary driver of a narrowing trade balance in Trade Balance Set To Narrow With Rise
In Agricultural Exports
2017. Our expectations for strong harvests to boost export growth continues to play out as Honduras – Trade Balance, USDmn
exports of coffee and bananas, Honduras' two principle agricultural products, have surged
over the first five months of 2017 (see 'Exports Will Drive Steady Growth', May 1). Coffee
exports were up 51% y-o-y in May, with the seasonal total (October 2016 to May 2017)
reaching 5.02mn bags, up 34% when compared with the previous year. Additionally, banana
exports recorded a 12.8% increase y-o-y in Q1 2017, despite a 1.2% decline in prices.
Rising Imports Will Gradually Push Deficit Wider

We expect Honduras' current account deficit to gradually widen in 2018 and the subsequent
years, as higher economic growth and deteriorating terms of trade cause import growth to
outpace exports. Real GDP growth, which we forecast will average 3.7% over the next five Source: Banco Central De Honduras, BMI
years, will combine with strong remittance flows to drive demand for imports, as Honduran
households have more money to spend on imported goods (see 'Exports Will Drive Steady
Growth', May 1). Additionally, our Oil & Gas Team's expects a resurgence in fuel costs over
the coming years, which will underpin a rise in import values as refined petroleum accounts
for approximately 11% of Honduran imports (see 'OPEC Intervention Crucial For Oil Price
Stability Heading To 2018', May 23). Finally, imported textile industry inputs will see prices
rise due to increasing global cotton prices (see 'Bearing From Spot Over H217, But Higher
Prices Beyond 2017', June 13). As a result, we expect imports to rise by 4.5% annually over
the next five years.
FDI And Multilateral Financing Will Provide Key Capital Flows

FDI and multilateral grants and loans will provide ample funding to cover Honduras's
current account deficit in the years ahead. While FDI has declined over the past two years,
we expect rising demand for Honduran exports to prompt foreign companies active in the
market to reinvest earnings and new entrants to bring additional capital into the country.
This is already starting to play out, as Q1 FDI showed a 5.8% y-o-y increase. Additionally,
support from multilateral development agencies will bring additional funding, with the
Inter-American Development Bank announcing a regional USD2.5bn fund for Honduras,
Guatemala and El Salvador on June 14.
DATA & FORECASTS

2013 2014 2015 2016e 2017f 2018f 2019f
Population, mn 8.7 8.8 9.0 9.1 9.3 9.4 9.6
Exchange rate HNL/USD, ave 20.11 20.50 21.85 22.92 24.30 24.50 25.50
Exchange rate HNL/USD, eop 20.25 21.02 22.37 23.49 25.10 25.60 26.00
Budget balance, HNLbn -29.6 -18.0 -13.1 -12.6 -12.8 -13.5 -13.2
COSTA RICA – ECONOMIC OUTLOOK

Consumption And Investment To Drive Strong Growth
BMI View: Costa Rica's economic growth will remain strong over the coming years, driven by private consumption and infrastructure
investment. However, government spending cuts and higher borrowing costs will cap growth rates below previous years' highs.
Strong private consumption and a relatively attractive investment climate will see Costa Growth To Moderate But Remain Elevated
Costa Rica – GDP By Expenditure
Rica's real GDP growth remain strong over the coming years, growing 4.1% and 4.0% in 2017
and 2018 (see 'Government Investment Initiatives Will Support Growth', January 25). Robust
economic performance over the past several years has boosted incomes and made Costa
Rica's per capita GDP among the highest in Latin America. Private consumption accounts
for nearly 65.0% of GDP. While consumption will face headwinds in the form of gradually
rising inflation and periodic currency weakness, lower than anticipated fuel prices should
underpin household purchasing power. We forecast real private consumption growth of
4.1% in 2017 and 4.0% in 2018.
Consumer strength will be complimented by positive investment dynamics. Costa Rica

e/f = BMI estimate/forecast. Source: BCCR, BMI
enjoys relative political stability and government initiatives continue to liberalise the
economy with tax incentives in free-trade zones and participation in multilateral and
bilateral trade agreements. These policies will enable Costa Rica to remain an attractive
destination for foreign investment despite recent setbacks, notably the departure of Intel's
manufacturing centre in 2015 and a failed USD1.0bn bond sale to China in 2016. A robust
infrastructure pipeline, which includes highway and railroad projects, factories, and hotels Economic Activity To Improve After Slow Q1
Costa Rica – Economic Activity Index, y-o-y
and resorts, will be especially appealing (see 'Construction: Public Works And Tourism
Support Growth In 2017', March 3), supporting our outlook for fixed investment growth
averaging 3.9% over the next five years.
Austerity Measures To Cap Below Previous Levels

Despite our broadly positive outlook, we expect government consolidation to temper real
GDP growth, which will trend below the levels seen over the past decade, in which growth
averaged 4.4% annually (excluding a 1.0% contraction in 2009). An elevated fiscal deficit,
forecast to reach 5.3% of GDP in 2017, has prompted the government to enact a series of
austerity measures limiting total expenditure by tying social spending to GDP and focusing Source: Bloomberg, BMI
on paying down debt (see 'Revenue Gains To Fade While Fiscal Reforms Stall', April 11). Although we expect a modest increase in spending
in early 2018 due to election-related slippage, overall government consumption will likely decline over the coming quarters. Real GDP
growth came in at 3.6% y-o-y in Q117, slower than the 4.2% recorded in Q116.
Furthermore, hawkish central bank policy will keep borrowing costs elevated, constraining lending growth and economic activity.
Monetary policymakers have prioritised defending the colón and combating inflation in recent months and have raised interest rates
275 basis points this year, bringing the benchmark rate to 4.50%, above our end-2017 forecast of 3.00% (see 'Central Bank To Focus On
Inflation And Currency', May 17). In light the central bank's response to recent currency weakness, we will be revising our interest forecast..
DATA & FORECASTS

2013 2014 2015 2016e 2017f 2018f 2019f
Population, mn 4.7 4.8 4.8 4.9 4.9 5.0 5.0
Consumer price inflation, % y-o-y, eop 3.7 5.1 -0.8 0.8 2.2 4.0 4.0
Exchange rate CRC/USD, ave 500.16 538.73 535.43 546.96 555.00 564.20 574.08
Exchange rate CRC/USD, eop 501.40 539.42 537.30 553.17 560.00 568.40 579.77
Budget balance, CRCbn -1,322.1 -1,217.1 -1,453.6 -1,397.5 -1,635.0 -1,832.4 -1,887.4
Current account balance, USDbn 0.1 0.5 -2.5 -2.1 -2.3 -2.3 -2.3
Current account balance, % of GDP 0.2 1.0 -4.7 -3.8 -4.2 -4.0 -3.7
LATIN AMERICA – ECONOMIC OUTLOOK
Sovereign Risk: Politics Prevents Significant Credit Spread Compression

BMI View: Rising political risk in several major Latin American countries in advance of general elections in 2017-2018 will prevent
significant further compression in bond yields and credit default swap spreads across the region. This comes even as budget deficits
and debt levels stabilise or modestly improve.
Sovereign credentials will remain stable or improve modestly in most major Latin American Vulnerabilities Persist Despite Recent Improvement
Americas – Sovereign Risk Heatmap
economies in the next few quarters, but rising political risk will prevent a significant narrow-
ing of credit spreads. General elections in Chile, Colombia, Mexico and Brazil by end-2018
open the door for a shift towards more expansionary fiscal policy, which could roil credit
markets. Finally, Venezuela continues to edge towards a political and economic breaking
point, with default the most likely path forward for the sovereign. Our major themes for
sovereign risk in the region are:
• Fiscal prudence to extend through 2017

• Political risk to prevent significant narrowing of credit spreads
• Fiscal risks likely to re-emerge in Brazil Long-term political risk scores are out of 100, where a higher number
indicates greater political stability. Source: BMI, 2017 forecasts –
• Default most likely path forward for Venezuela except for NIIP where the source is the latest IMF IFS figures, unless
otherwise indicated. *BMI estimate based on current account data.
Fiscal prudence to extend through 2017: In Latin America, most major countries will
pursue prudent fiscal policies through the end of 2017 at least, helping to bolster sovereign
credentials and contain deficit financing costs (see 'Fiscal Prudent To Catalyse Deficit
Narrowing', February 2). While commodity prices were less of a boon for fiscal accounts Broad Narrowing Trend In Play
Latin America – Budget Balance, % Of GDP
than we anticipated in H117, higher grains and oil prices in the latter half of the year will
provide support to government revenues, helping to narrow budget deficits (see 'Mid-Year
Update: Key Themes For 2017', June 15). In addition, the effects of efforts to broaden the
tax base will boost government intakes in Colombia this year. In Argentina and Mexico, the
phasing out of subsidies will help to contain expenditure growth. As a result, we believe that
fiscal deficits in most major countries peaked in 2016, with the exception of Argentina and
Peru, the latter of which is pursuing counter-cyclical fiscal policy. Similarly, total government
debt either peaked in 2016 or is set to in 2017. This will reduce the likelihood of additional
negative actions by credit ratings agencies, helping to contain borrowing costs. These
factors, combined with currency appreciation over recent months, are reflected in the
e/f = BMI estimate/forecast; Source: National Sources/BMI
significant compression of yields on USD-denominated bonds and in spreads over similar
maturity US Treasuries.
Political risk to prevent significant narrowing of credit spreads: Rising political

risk will prevent significant further narrowing of credit spreads in most countries, despite
the above factors. With USD bond yields and credit default swap spreads in most major
countries having compressed significantly since peaking in early 2016, we believe that the
risks are increasingly to the downside over a multi-quarter timeframe. Chile, Colombia,
Mexico and Brazil are set to hold legislative and presidential elections by end-2018, bringing
an attendant risk of a shift away from the relatively prudent policies pursued by the current
administrations (see '2017-18 Elections: Policy Direction Hangs In The Balance', April 27).
This risk is most salient in Mexico and Brazil.
In Mexico, the frontrunner in the July 2018 presidential election is Andrés Manuel López Major Compression Since 2016
Latin America – Select 10-Year USD Generic
Obrador from the left wing Movimiento Regeneración Nacional (Morena) party, who has Bond Yields, %
advocated for greater social spending and the rollback of energy sector liberalisation, 8
among other reforms passed in recent years (see 'López Obrador Consolidating Position On 7
6
Security, Trump', March 29). As the presidential field consolidates, signs that López Obrador
5
is a viable challenger to more establishment candidates could prompt selling pressure in
4
fixed income markets. 3
In Brazil, an unprecedented corruption scandal has severely weakened the main left-wing 1
Apr-13
Oct-13
Apr-14
Oct-14
Apr-15
Oct-15
Apr-16
Oct-16
Apr-17
Jul-13
Jan-14
Jul-14
Jan-15
Jul-15
Jan-16
Jul-16
Jan-17
Jul-17
party and increased frustration with the political establishment more broadly, creating an
opportunity for outsider and populist candidates in the October 2018 general election. Brazil Mexico Peru Colombia
Their success could erode ongoing fiscal consolidation efforts, specifically preventing Source: Bloomberg, BMI
further action on crucial reforms to the pension system. Nevertheless, with the election
still more than a year away, we believe that Brazilian USD debt remains attractive given the
yield on offer and the ongoing decline in inflation expectations in the country (see 'Monthly
Fixed Income Strategy – Scenarios For US Yield Curve', June 13).
Fiscal risks likely to re-emerge in Brazil: Even if pension reform is passed by Brazil's
legislature this year, this issue will need to be revisited by the next administration given the
lack of substantial changes (see 'Pension Reform Set To Challenge Next Administration',
June 15). There is limited visibility over the current draft of pension reform legislation,
but local press reports suggest that it is unlikely to do more than establish a minimum
retirement age, leaving benefits largely untouched.
While the spending cap amendment passed in 2016 will limit expenditure growth to the Rising Social Security Obligations Would Make
Spending Cap Unviable
rate of inflation, pension reform is central to ensuring that social security spending does Brazil – Non-Financial Expenditures, BRLmn (6mma)
not overwhelm the federal budget (see 'Pension Reform Central To Fiscal Outlook', March
30). In the year through April, social security expenditures accounted for 43.0% of non-
debt servicing expenditures, a figure that is likely to rise if unchecked due to an increasingly
unfavourable demographic profile and generous benefits.
Even given our expectation for modest pension reform in 2017, public debt is set to rise. We
forecast gross general government debt to reach 79.5% of GDP in 2019 up from 56.3% in
2014 and 69.9% in 2016. Relatively limited external liabilities limits repayment risks in Brazil,
but the country is significantly more indebted than many of its emerging market peers.
Should the next government enact more expansionary fiscal policy or struggle to gather Source: BCB, BMI
political support to address rising pension obligations – a salient risk given the opportunity
for populist and outsider candidates in the 2018 elections – this could drive a significant
deterioration of perceptions of Brazilian sovereign risk, sending bond yields and CDS
spreads back to levels not seen since early 2016.
Default most likely path forward for Venezuela: Venezuela is likely to default in 2017, as Wall Of Obligations Looms
Venezuela – Debt Obligations, USDmn
substantial debt payments on PdVSA bonds in October and November will prove too much
for the state-owned oil company to handle (see 'PdVSA: Approaching Default', March 15),
tipping the sovereign into default as well. PdVSA provides the sovereign's primary access
to hard currency inflows, without which it will likely be unable to service its obligations.
Latest data shows that the central bank has only USD10.0bn in foreign reserves, while the
sovereign and PdVSA face USD13.8bn in payments by end-2018.
Although both PdVSA and the sovereign have proven adept at making deals in order to
secure short-term cash, we believe that this trend is nearing its limit. Negative press
surrounding recent deals done by Goldman Sachs and Nomura, as well as a successful Source: Bloomberg, BMI
legal challenge against Nomura, are likely to reduce foreign financial institutions' willingness
to deal with Venezuela-based entities (see 'Political Crib Sheet: Peaceful Resolution
Increasingly Unlikely', July 6).
Even if Venezuela manages to avoid default in 2017, PdVSA and the sovereign are running
on borrowed time. An insufficient oil price, falling crude production and severely limited
productive capacity in the country mean that Venezuela has very few ways to generate
the hard currency needed to continue making debt payments. Moreover, the suppression
of imports enacted in the last couple of years is unsustainable without deepening the
humanitarian crisis and bringing the political situation to a breaking point. Even in the event
of regime change, we believe the next government's priority would be to restructure the
unsustainable debt burden.
SOVEREIGN CREDIT RATINGS AND CDS SPREADS

Fitch Ratings Fitch Outlook Moody's Moody's Outlook S&P S&P Outlook 5-year Sovereign
CDS Spread, bps
Argentina B Stable B3 Positive B Stable 338
Bolivia BB- Stable Ba3 Negative BB Negative -
Brazil BB Negative Ba2 Negative BB Negative Watch 238
Canada AAA Stable Aaa Stable AAA Stable -
Chile A+ Negative Aa3 Stable AA- Negative 66
Colombia BBB Stable Baa2 Stable BBB Negative 141
Costa Rica BB Stable Ba2 Negative BB- Negative 205
Dominican Republic BB- Stable B1 Positive BB- Stable -
Ecuador B Negative B3 Stable B- Stable -
Guatemala BB Stable Ba1 Stable BB Negative 322
Mexico BBB+ Stable A3 Negative BBB+ Negative 112
Panama BBB Stable Baa2 Stable BBB Stable 96
Peru BBB+ Stable A3 Stable BBB+ Positive 86
Puerto Rico - - - - D Negative -
US AAA Stable Aaa Stable AA+ Stable 22
Uruguay BBB- Stable Baa2 Negative BBB Stable 90
Venezuela CCC - Caa3 Negative CCC Negative 3637
Source: Bloomberg, Trading Economics

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IMPORTANT NOTICE:

September 2017 Contents

Latin America Monitor

Sub-Editor: Rachel Dobbs

Costa Rica: Consumption and Investment Drive Strong Growth 8

CENTRAL AMERICA RISK INDEX

RISK INDEX TABLE

EL SALVADOR – POLITICAL OUTLOOK

Legislative Gridlock Will Increase In Run up To 2018 Elections

Shifting US Policies Threaten Capital Inflows

DATA & FORECASTS

GUATEMALA – ECONOMIC OUTLOOK

Public Spending Efforts Undermined By Weak Tax Compliance

Larger Budgets To Target Human Development, Security

Weak Revenue Base Will Inhibit Public Sector Capacity

Sovereign Credentials Will Remain Stable

DATA & FORECASTS

NICARAGUA – ECONOMIC OUTLOOK

Inflation To Spike On Venezuela Contagion

Currency Devaluation Will Not Slow

DATA & FORECASTS

PANAMA – ECONOMIC OUTLOOK

Growth Outlook Vulnerable To Global Trade Dynamics

DATA & FORECASTS

HONDURAS – ECONOMIC OUTLOOK

Remittance Flows Provide Critical Financing Source

Strong Harvests Will Narrow Trade Deficit In 2017

Rising Imports Will Gradually Push Deficit Wider

FDI And Multilateral Financing Will Provide Key Capital Flows

DATA & FORECASTS

COSTA RICA – ECONOMIC OUTLOOK

Consumer strength will be complimented by positive investment dynamics. Costa Rica

Austerity Measures To Cap Below Previous Levels

DATA & FORECASTS

LATIN AMERICA – ECONOMIC OUTLOOK

Sovereign Risk: Politics Prevents Significant Credit Spread Compression

• Fiscal prudence to extend through 2017

Political risk to prevent significant narrowing of credit spreads: Rising political

SOVEREIGN CREDIT RATINGS AND CDS SPREADS

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Costa Rica: Consumption and Investment Drive Strong Growth 8