Consultative Group for the Reconstruction and Transformation of Central America

"reconstruction must not be at the expense of transformation"

Central America After Hurricane Mitch
The Challenge of Turning a Disaster into an Opportunity


A.  Summary

The implementation of the principal commitments of the Peace Accords are in progress, but there is still concern over the fiscal situation, especially in regards to collections. Economic activity that had continued an accelerated growth during the first semester of 1998, began to slow down towards the end of the year, as interest rates and private investment levels declined, as well as the effects of Hurricane Mitch on agriculture. At the same time, coffee and sugar prices were also of concern falling and the setbacks suffered by the financial sector as a result of international finances were also of concern. Different structural reforms have been making progress, especially those linked to privatization, since all of the major public service industries have been sold. If the short term outlook doesn't appear promising, those of the medium term seem favorable, so long as the reforms required by fiscal policy are implemented., and so long as the social programs continue to be first priority.

The budget increase recently approved by the National Congress in April 1999 could affect the fiscal balance. The situation of the financial sector deteriorated with the closure of several financial intermediaries, including 4 credit exchanges. The Bank provided support to the Government in the diagnostic and design of short term measures. The government has asked the IMF for technical assistance to support the sector in the short term,.

Hurricane Mitch hit on Guatemalan territory on October 26, first affecting the northwestern part of the country. It later affected the southeast, the west and the capital. This caused the overflow of rivers, landslides, erosion, and floods. The capital city was practically isolated by collapse and floods on the major highways that connect it to the rest of the country. The magnitude of the hurricane in terms of human lives and destruction was, according to ECLAC the following: 268 dead. 121 missing, 734,198 displaced, 105,055 injured, and 108,594 evacuated; the phenomenon affected 750,000 people, of which 55,000 were still in shelters at the end of November, 1998. Direct and indirect damages were estimated at US$748 million. The agricultural sector had the greatest damages (US$499 million), followed by the highway sector, including bridges and railways (US$90 million) and housing (US$35 million).

The signing of the Lasting Peace Accords on December 29, 1996, brought about it the anticipation of significant changes and the first meeting of the Consultative Group for Guatemala at the Headquarters of the European Commission, in Brussels, in January of 1997, chaired by the Bank. At that time, the international donnors community pledged support for more than US$2 billion for the 1997-2000 period towards the implementation of the peace process. The Bank once again chaired the Consultative Group for Guatemala in Brussels on October 23-24, 1998.

In 1998, 5 operations were approved by the IDB for US$196 million: Pre-Investment for Peace, Support to the Reform of the Justice System, Productive Agro-alimentary Reconversion, Emergency Program for National Disasters, and Social Investment Fund.

Since 1996, the Bank has approved thirteen (13) non-reimbursable Technical Cooperations for Guatemala, the majority of which in support of compliance and implementation of the Peace Accords, for US$4.7 million.

B. Country Analysis

B.1 Recent economic situation
Economic activity accelerated progressively during 1997 and most of 1998, as a result of the increase in exports, favorable agricultural production, an important decrease in interest rates, and, until March of 1998, a boom in coffee prices on the international market. Domestic demand also contributed to this growth. Nevertheless, these favorable factors disappeared or began to reverse themselves in the second part of the year when Hurricane Mitch caused significant damage to agriculture in the fourth quarter, and they will continue to affect the economy in 1999. It is anticipated that GDP growth will drop to 3.9% in 1999 as compared to 4.9% in 1998.

This economic dynamism benefited most sectors, all of which expanded by 3 percent or more. In addition to mining, which opened new oil wells to production and continued to outperform the rest of the economy with a 21 percent growth rate, construction, real estate and public services were particularly dynamic with 10, 9 and 7 percent growth rates, respectively. Construction and real estate have been reacting to private investment, and since 1997 to increasing availability of affordable mortgage loans. Meanwhile, public utilities are being transformed, privatized or prepared for privatization. The financial sector also showed above average growth. By 1998 estimates, agricultural output increased by over 3.2 percent, marginally better than in 1997, despite the negative impact from El Niño in the first quarter and Hurricane Mitch in the last. Manufacturing, mostly geared towards the domestic market, recorded a 3.5 percent growth rate, while the export-oriented maquila sector continued to record double digit growth.

Export performance in 1998, with a 9 percent increase in dollar terms, was somewhat below expectations at the beginning of the year, particularly for traditional products. Coffee exports, suffered a decline both in prices and volume. Prices declined by 47% in the last quarter, while export volumes were affected by El Niño and Mitch, resulting in a 17 percent decline for coffee exports. Sugar exports were also affected by 30 percent, due to a gradual softening of international prices, but increased productivity and acreage led to a 19 percent increase in export revenues, reflecting Guatemala’s competitive advantage. Among other traditional products, banana exports recorded a 9 percent increase. This helped to maintain traditional exports slightly ahead of 1997 figures, in spite of the coffee performance. Non-traditional exports to Central American countries grew by 12 percent, benefiting from improved economic activity and continuing integration with regional partner countries. The most positive achievement came from non-traditional exports to the rest of the world, which grew by 17 percent in 1998, reversing a decelerating trend. As with maquila exports, which increased by 34 percent, non-traditional exports benefited among other factors, from currency depreciation in the second part of 1998, which ended several years of real effective appreciation (overvaluation of the Quetzal).

Graph 1

Imports continued to grow fast recording an increase of 20% in 1998, or more than US$700 million. This reflects, in part, the growth of the economy which would not have been possible had it not been for the easy access to credit that the private sector had during most of the year. Imports of consumer goods increased by 25% while capital goods imports increased at even higher rates, due primarily to the demands of industry, telecommunications and construction.

The resulting trade deficit of almost US$500 million was not offset by a favorable balance of services trend. Tourism revenues increased at an 11 percent rate, but net tourism balance remained at the same level as the preceding year. The fact that interest payments by the private sector were lower was a factor that favored this trend, reflecting the reduction in interest rates and the preference for seeking loans internally rather than looking for them abroad. The main support for the balance of payments has continued to be the remittances made by Guatemalans living abroad, which increased by about US$130 million in 1998. Yet, the current account deficit worsened by almost US$370 million, or from 3.5 percent of GDP in 1997 to 5.2 percent in 1998.

Graph 2

Nevertheless, capital account movements more than compensated for this larger deficit, so that reserves increased by US$243 million, an amount equivalent to about 3 months of imports of goods and services. The main capital inflows originated from the privatization of public services, whose proceeds amounted to US$584 million, about US$500 million for the full payment of an electric company and about US$80 million for a partial payment of the telecommunications monopoly. While the successful US$150 million emission of eurobonds in 1997 was not duplicated in 1998 largely as a result of international market turbulence, net official borrowing, mainly from multilateral organizations, increased as disbursements accelerated much faster than amortization. Apart from privatization proceeds, net private capital inflows were significantly lower than in 1997, for both short and medium term capital. This US$250 million reduction reflects capital outflows motivated by higher returns in neighboring countries, and lower external borrowing as domestic interest rates became more attractive.

The depreciation of the exchange rate, mitigated by the Central Bank's foreign exchange sales was moderate until mid-August, 1998. It accelerated in the third quarter despite further official intervention. At the end of 1998, after accumulated Central Bank sales of about US$340 million, the exchange rate had undergone a 9 percent nominal devaluation. This was equivalent to a 4 percent depreciation in real effective terms.

The devaluation was unable, however, to contain the inflationary effect and the consumer price index, which had been growing at 5% and 6% until October, before Hurricane Mitch, increased to 7.5% at the end of the year, especially because of the behavior of food prices.

Graph 3

Interest rates, which had declined in 1997 from 22 percent to 16 percent for average lending rates, remained at this same level until October 1998, but then began to rise to reach 18.5 percent at the end of the year, as monetary authorities tried to curb excessive growth in private sector credit. If credit had continued growing it would have stimulated imports and the capital outflows, creating additional pressures on the exchange rate.

Fiscal revenues, which were at 8.8% of GDP in 1997, are another point of reference for both Guatemalans and foreign observers, since, in large part, they reflect the efforts of the government to increase their own resources and confront the commitments of the Peace Accords signed in December, 1996. The results for 1998 were below the expectations, with a rate equal to 8.9% of GDP. Direct taxes, which make up 21% of fiscal revenues, increased by 6%. This reflects the dynamism of imports as well as the effort of fiscal administration in customs matters, initiated in 1997. Revenues from the value added tax grew by only 5%, despite the increase in private consumption. Customs revenues were affected by another round of tariff reductions negotiated by the country as a member of the MCC. Revenues from taxes on alcohol, petroleum, fiscal stamps and departure taxes (the rates of which were raised by the Congress at the end of 1997) increased by 30% or more. As a result, total fiscal revenues increased by 14% while total revenues increased by 19%, especially due to outside help received because of Hurricane Mitch.

Graph 4

Central government expenditures increased by 34 percent, significantly faster than revenues, and represented 12.6 percent of GDP. Current expenditures increased relatively faster than capital expenditures. Most of the increase reflects efforts to meet expenditure targets mandated by the Peace Accords in the social and related sectors. In addition, the authorities had to meet additional reconstruction expenses after Hurricane Mitch. The higher expenditures generated a larger central government deficit, which recorded 2.1 percent of GDP in 1998, but the overall public sector deficit reached only 1.7 percent of GDP, as Central Bank losses were further reduced.

Graph 5

B.2 Damages caused by Hurricane Mitch

Hurricane Mitch caused the death of 268 people (not counting 121 missing), injured another 300 and initially affected about 750,000, but with the mitigation of the emergency, said figures dropped to about 106,000 people considered to be truly displaced (almost 55,000 of them were still living in provisional shelters at the end of November).

The main damages caused by the hurricane were in the municipalities of Los Amates and Morales in Izabal and Panzos in Alta Verapaz and the Amatitlán river basin. Destruction of banana plantations created not only an economic and employment problem, but one of housing and social services, including the contamination of water. Damages to the social and economic infrastructure and to the productive system, directly and indirectly, have been estimated at almost US$750 million by ECLAC, two thirds of which in the agricultural sector. Transportation and communications registered US$90 million in losses, followed by industry, US$60 million, and US$35 million in housing.

Exports and agroindustrial products were hardest hit in the agricultural sector, especially bananas, followed by coffee and cardamom, all of which lost a total of US$325 million. The most affected crops for domestic consumption were tomatoes, banana trees, corn, vegetables and beans, the losses of which were estimated at US$45 million. In addition, there are damages and losses to agricultural assets (plantations and soil) in the amount of US$121 million, to cattle (US$4 million) and to fisheries (US$4 million). In addition to the monetary losses caused by the hurricane, the precarious living conditions of the peasants and small farmers, that resulted, require attention. About 50,000 small producers find themselves in this predicament. In El Progreso, Zacapa and Chiquimula, floods caused landslides that destroyed production and in other cases flooded plantations , causing major damages, among which, bananas on 10,000 hectares. In the departments of Guatemala and Alta Verapaz, the prolonged rains and winds affected coffee on about 55,000 hectares, causing a drop in production.

Damages to the transportation infrastructure, estimated at US$60 million arose principally from the destruction of 37 bridges (another 60 incurred damages on their access ramps), 90 sections of major highways (633 kilometers), and 34 sections of secondary and tertiary rural roads, (718 kilometers). The location of many of the road, on hilly slopes, makes them vulnerable to intense rains, because of collapses in the unstable slopes. The rains, floods and landslides caused damages in several hydroelectric plants, and in lines and grids of distribution, with an estimated cost of US$10 million.

In the social infrastructure, the principal damages were in housing, with a cost of US$35 million, due to the total destruction of 6,000 dwellings, and another 20,000 affected to different degrees, Although the losses in the subsector of health and education were not significant and amount to US$13 million, furnishings and equipment were lost, and 7 health centers and 48 rural health stations which together served about 50,000 people were affected; likewise, 27 schools were totally destroyed, 175 partially destroyed and another 111 incurred some damage.

B.3 Medium term perspectives

Growth in GDP is expected to be 3.9% in 1999, as compared to 4.9% recorded in 1998. This growth will develop within a relatively stable macroeconomic framework. At the end of December 1998, inflation reached 7.5% which is considered a good index because it includes an important increase in food prices as a result of the hurricane. International reserves increased to US$1.3 billion, with a growth of US$242 million since the end of 1997, but there will be losses in the future, since there will be no revenues from privatizations, which reached US$584 million in 1998. The deficit of the current account of the balance of payments also deteriorated, from 3.5% of GDP in 1997 to 5.4% in 1998, as a result of the acceleration of imports and less dynamic exports. Exports of traditional products will be affected in 1999, as a result of the decrease in coffee prices and the impact of Hurricane Mitch.

The situation of the financial sector deteriorated at the end of 1998, with financial losses in foreign markets and the bankruptcy of two coffee lending institutions. In spite of monetary policy to stop capital flight, it persisted and, in combination with the deterioration of the current account, it generated a depreciation in the exchange rate, which went from Q.6.2 in January of 1998 to Q.7.0 per dollar in January of 1999, in spite of reserves sales.

Structural reforms also progressed significantly in the areas of privatization and de-monopolization. In July of 1998, a US-Spanish-Portuguese Consortium acquired approximately 80% of the electrical company, EEGSA for $520 million. Prior to that, FEGUA (railroads) had been concessioned to an American company for 50 years, and in the first semester of 1998, the concession of the post office was given to a Canadian company. The telecommunications company TELGUA was sold for US$700 million in October, 1998 to a group of Guatemalan investors with the support of TELMEX. In addition, the second electricity company (INDE) was sold in December 1998 for US$100 million. Preparations for the concession of the international airport in the capital, La Aurora, for two ports and the sale of two agricultural businesses are proceeding. Preparation of a pension reform is making progress, but it will not be presented to the Congress before the national elections at the end of 1999. Finally, a program to develop financial sector reforms is being prepared, which includes provisions for more effective supervision. In the long run, the impact of the implementation of a series of reforms should be considerable.

Guatemala’s medium-term perspectives look favorable if the authorities can reinforce fiscal measures and increase revenues, continue to implement structural reforms and improve the social status of the population. It is important to achieve the goal of increasing fiscal revenues to 12% of GDP, not only because said resources, will strengthen the economic environment, but they will also insure meeting the social targets that have been set in the Peace Accords.

With regard to personal security conditions, the authorities are taking encouraging actions to improve the situation. The reduction of the role of the military has been accompanied by strengthening of the civilian police, and ambitious programs are beginning to be implemented to modernize the judicial system. Programs to strengthen governance are also being prepared in other areas, including public sector procurement, and the new tax administration. Successful implementation of these reforms could significantly increase confidence, reduce costs and improve competitiveness in general.

The benefits of structural reforms could be considerable. The privatization process has just begun and the improvements are soon to come. Provided that the newly privatized telecommunications company fully complies with the law establishing open competition, important new investments in telecommunications, electricity, railroads, ports and airports will rapidly modernize key sectors of the economy. This will turn the opening up of the economy to world markets to Guatemala’s advantage. Financial reform will strengthen the banking system and make it more efficient. The planned pension reform will stimulate long-term capital markets and increase domestic savings.

The highest long-term returns for the economy are likely to come from increased social spending. A national consensus on investing in human capital is growing, helped by the Peace Agreements, and could be further strengthened if a Fiscal Pact is agreed. Sustained implementation of social investment programs will develop the large untapped Guatemalan resource, the rural indigenous population, and promote its integration into the mainstream economy to the benefit of the society at large.

C. Activities of the Bank

The Bank approved loans to Guatemala in 1998 for US$196 million, likewise, the Bank approved non-reimbursable technical cooperation operations (donations) for US$4.7 million.

The Bank has agreed with the Guatemalan Authorities, on a tentative list of operations to be prepared during 1999-2000. The strategy of the Bank has the following objectives: (i) integration of an important portion of the poorest sectors, including indigenous and rural communities to the development process; (ii) improvement and expansion of coverage and efficiency of social services, including the restructuring and decentralization of said services; (iii) the modernization and reform of the State; and (iv) the development of the private productive sectors. Priority projects include Highway Rehabilitation, Municipal Development, Reconstruction Post-Mitch, and Technological development

The portfolio of the Multilateral Investment Fund (MIF), part of the IDB group, includes 8 projects for US$8 million to support the participation of the private sector in civilian aviation, technical training in rural areas, exporting non-traditional products, alternative methods of commercial conflicts resolution, strengthening of rural financial institutions and others

D.  National Consultative Group

The Consultative Group for Guatemala, chaired by the IDB, was created in 1997, shortly after the signing of the peace accord ending 36 years of armed confrontation. Representatives from 47 countries and international organizations met twice, in Brussels and in Guatemala City in 1997. They pledged US$1.9 billion during the 1997-2000 period to develop the following priorities: to insure national peace and reconciliation through the protection of human rights and the strengthening of democratic institutions, to stimulate community participation in the process of development, to improve the living conditions of indigenous, rural and female populations, to accelerate agrarian reform and rural development, to increase raising internal resources and the efficiency of public services, to modernize all branches of the government, to strengthen the reforms of government policy and to maintain macroeconomic stability.

On October 22-23, 1998, the Consultative Group met again in Brussels, at the Headquarters of the European Commission, to examine the progress of the plans, projects and policies. The meeting ratified the commitments of the previous year.

Basic Data

Macroeconomic indicators 1990 1995 1996 1997 1998 1999*
GDP (rate of growth)







End of year Inflation(rate of growth)







Balance on current account (% of GDP)







International Reserves (months of imports)







Fiscal indicators 1990 1995 1996 1997 1998 1999*
Tax Load (% of GDP)







Combined Balance of the Public Sector (% of GDP)







Balance Non-Financial Public Sector (% of GDP)







Social Spending (% of GDP)







* Projections (Source: IDB staff)

Central America     Honduras    Nicaragua    El Salvador    Guatemala     Costa Rica


Nicaragua, May 2000   -   Honduras, February 2000   -   Stockholm, May 1999

Inter-American Development Bank