Economic growth remained poor in the first semester of 2002, as a slightly improved external demand was more than offset by historically low or worsening export prices, and a further loss in export competitiveness.  The domestic economic situation continued to be affected by low consumer and investor confidence, as efforts to improve the confrontational relationship between the government and the private sector failed, the human rights situation worsened, and the security situation deteriorated. Conversely, significant progress was achieved towards ensuring macroeconomic stability, including a marked improvement in the fiscal situation and significant advances in the strengthening of the financial sector.

The growth of the monthly index of economic activity (IMAE), which was mostly negative in the second semester of 2001, turned slightly positive in the first semester of 2002, but was still below 1 percent in June on a year-to-year basis.  Such a low rate is in part the result of a poor export performance, in particular for non-traditional goods, in part the reflection of tepid domestic conditions.

Figure 1

According to customs data, non-traditional exports ^[1] to Central America declined by just 3 percent, but non-traditional exports to the rest of the world plunged by about 30 percent in the first six months of 2002, leaving total non-traditional exports 13 percent lower than in the first semester of 2001. External trade figures are often revised, sometimes dramatically, however such a large decline is backed by similar data from another source ^[2], and by anecdotal evidence from the exporters association. Such a decrease is happening after an already large decline in 2001, suggesting a loss of competitiveness. The exchange rate has appreciated in real terms by 14 percent since early 2000, and is mentioned as a major factor by exporters, in particular as it has also appreciated relatively to neighboring Central American countries. Other factors include labor costs, which have been rising much faster than domestic prices ^[3], higher security costs, and in some cases lack of financing.

Traditional exports fared relatively better with a 3 percent decline. Sugar export proceeds rose 9 percent, as a 22 percent increase in volume in the wake of a record harvest was partially offset by an 11 percent decline in export prices. International sugar prices since 1997 have declined about 50 percent but sugar production costs are very competitive in Guatemala due to favorable natural conditions, and sugar production remains profitable even at present low prices. Such is not the case for coffee producers, as prices remain close to historic lows. Current prices are below average production costs, and many farmers are switching to alternative crops, in particular maize and bananas in lowland areas. In the highlands, where quality is better, producers are attempting to attract premium prices through internet auction, or various marketing methods. Coffee exports receipts declined by 33 percent, reflecting mostly a decline in volume. Banana exports were affected by repeated labor disputes at the main container port in July, but had been up 6 percent in volume, and 2 percent in value in the first semester. A consistent success story since 1998 has been cardamom exports, which had tripled to about US$100 million in 2001, mostly due to higher prices. Despite economic uncertainty in its main market, the Middle East, exports were rising again by 38 percent in the first half of 2002, led this time by higher volumes. 

Tourism revenues, which grew 16 percent in 2001 despite September 11, is another bright spot in the export picture. Although slowed down after the terrorist attacks, the growth rate is expected to be 8 percent in 2002. Part of the recent growth reflects an increase in home trips for immigrants, mainly from the community living in the US that has swelled in the last decade, as well as rising tourism from neighboring countries. According to the latest official data, remittances have been almost doubling, but it is in part the result of a methodology change ^[4].      

Regarding production for the domestic market, the same business surveys have been suggesting a flat profile, consistent with the actual data compiled in the IMAE.  Most negative in the surveys was the level of consumer and business confidence in the economy. Major concerns that affected confidence were continuous corruption allegations, a perceived deterioration in human rights^[6], and the renewed deterioration of security for both household and businesses, that is constantly increasing consumer as well as business costs.  

Inflation has remained around 9 percent during the semester, largely above its target level of 4-6 percent set in the monetary program, while core inflation was just a bit lower at 8.4 percent in July. Although inflation is set to decline by about 1 percent in August as the one-off effect of the rise in value added tax in August 2001 will fade, such a level is a disappointment, in particular in the current context of low domestic demand and currency appreciation.

Figure 2

Commercial bank interest rates have eased regularly since the beginning of the year, and at the end of August, average lending rates had declined 135 basis points to 16.5 percent, while deposit rates had declined 115 basis points to 7.3 percent. At this level, real deposit rates have become negative, but deposits in domestic currency remain more attractive than deposits in dollar, and even more so with the domestic currency appreciation.   For lending rates, the decline reflects increasing competition from dollar interest rates, which have become legally and widely available in the country since May 2001.

On the spending side, government expenditures, which had risen by 1 percent of GDP to 13.4 percent of GDP in 2001, are limited by the agreement to 12.8 percent of GDP in 2002.  To that effect, mechanisms of expenditure control to correct the 2001 overruns have been put in place ^[10]. The control will be facilitated by the inclusion of the social funds in the Integrated Financial Management System (SIAF). The adjustment is to fall on current expenditure, while capital outlays would remain at the same level of GDP. The government is also committed to protect social expenditure to the minimum level of at least 5 percent of GDP.  As of June 2002, the administration had complied with the conditions for expenditures set up in the agreement, and in particular expenditures in the first semester were at or below targets, with total expenditures declining by about 4 percent.

In the last few years, targets have been set for public spending in education, health, justice, security, housing and military expenditures, as required by the Peace Accords.  Most of the targets have been met in 2001 and seem likely to be met again in 2002, in particular in the social sectors.  Last year exceptions were housing and the military ^[11] and, according to preliminary figures, this situation seems to be continuing this year.

One important issue regarding public expenditures have been the level of transparency, as allegations of corruption and embezzlement from public officials have accumulated. A series of anti-corruption initiatives before and commitments at the Group Consultative meeting in February 2002, led to a brief renewal of optimism, as a dialogue with civil society groups seemed to be possible. However, despite some follow-up, the results have been disappointing, as progress in prosecuting cases has been modest.  In March the government proposed to establish an anti-corruption forum, but civil society and private sector groups declined to participate.

The exchange rate has appreciated in nominal terms by 2.6 percent since January 2002.  In real terms, the inter-annual appreciation has amounted to 6.2 percent in August, a major headache for exporters, who at times claim for Central Bank intervention.  However, Central Bank abstained to buy dollars, as it has been its policy not to intervene in the foreign exchange market, except to smooth out sudden variations.  The free float policy, which has been enforced since early 2001, is now part of the Stand-By agreement. The appreciation is somewhat surprising due to low export revenues, and a high current account deficit. Anecdotal evidence has surfaced that increasingly banks in El Salvador are lending in dollar to Guatemalans at more attractive rates than the ones offered in dollar domestically, flows that are not recorded in the official credit to the private sector data.  Similarly, capital inflows from El Salvador are said to be attracted by higher dollar deposits rates. More generally, increasing credibility of the monetary authorities since 2000 is having a supportive effect on the exchange rate.

Monetary policy in recent years has been targeting money supply ^[12] through the use of open market operations.  For 2002, the monetary program set a 4-6 percent range for inflation and an 8-10 percent range for the growth of money supply, in line with nominal GDP growth.  In the first semester money supply remained mostly within the range, although tended to be closer to the upper limit in the second quarter.  At the end of June however, accumulated inflation since January had already reached 3.8 percent, suggesting that the currency issue range may have been set at too high a level. In addition, other indicative indicators monitored by the Central Bank have been exceeding their target range. The growth in M2 reached 13 percent versus a 9-11 percent target and credit to the private sector was 14.6 percent higher versus a 10-12 percent target ^[13]. After currency issue exceeded its range in July and accumulated inflation reached 5.3 percent, the authorities decided to increase open market paper operations, while moving the inflation band up to 5-7 percent for the end of 2002.

At end-August, open market paper operations had increased by about 17 percent. Fortunately, the average interest rate on open market operations, which had declined from 24 percent in January 2000 to about 10 percent in January 2002, remained at this relatively low level in the first semester, containing the cost of monetary policy. This level reflects the rather high liquidity in the financial system together with the lack of otherwise more attractive lending opportunities for the banking sector, and should limit Central Bank losses to 0.8 percent of GDP in 2002. 

Efforts continued to clean up the financial sector.  The first bankruptcies of financial institutions occurred in late 1998, but it was only in 2001 that the authorities opted for decisive action. They took over three medium-sized banks, while providing additional credit lines to guarantee their deposits, and increased the capital requirement ratios.  Already, several indicators have improved, at least at the sector level.  The proportion of non-performing loans^[14] in the banks’ portfolio^[15] declined from 11.1 percent in July 2001 to 9 percent in July 2002, and the capital to assets ratio improved from 8.7 percent to 9.2 percent.

In January 2002, a new Banking Law was approved, which improved the prudential regulatory framework, set up a new framework for the resolution of insolvent banks, and included the supervision of offshore activities, as well onshore activities not previously supervised.  The new law provides the authority to transfer assets of non viable banks to other banks with limited judicial intervention, and removes bank secrecy to lending operations. After difficult negotiations between the majority and the opposition, Congress finally approved in May the rest of a package of sweeping financial reforms, supported by a US$200 million loan from the Inter-American Development Bank, and a US$150 million loan from the World Bank. As a result, new laws regulating the Superintendency of Banks, the Central Bank, and monetary arrangements, entered into force in June.  Altogether, the laws approved in 2002 bring the financial sector up to international standards, in particular in terms of reporting requirements, supervision of financial groups, including offshore entities, lending to related parties, money laundering, and enforcement capacity. Their approval provide a legal framework for the modernization of financial institutions, enhance the autonomy of the Central Bank, the independence of the Superintendency of Banks, and provide for the re-capitalization of the Central Bank.

As part of the Stand-By agreement, a program of on-site inspections of commercial banks has been scheduled, which should have been completed by the end of August. However, the inspection program, which could lead to the determination of additional insolvent banks, had inspected only about two thirds of them in early September.

As regards trade policy, a totally new agenda has been defined by the US proposal to negotiate a Free Trade Agreement with Central American countries, acting as one negotiating side. Such an ambitious proposal, which could accelerate enormously integration within Central America, as well as between these countries and the US entails a series of challenges that just begin to be grasped in Guatemala, where a public debate on the issues involved is now developing.

In the area of privatization, almost all the government participation in the largest enterprises has already been divested.  The government plans to sell in the second semester of 2002 the remaining shares^[16] in the power company (EEGSA), energy distribution companies (DEEGSA and DEOGSA) and the national airline.