Central America's Economic Dilemma: Food, Energy, and the Impact of the U.S. Crisis
The financial meltdown in the United States has had a profound impact on the economies of developing countries, particularly those that are highly dependent on U.S. markets. The spike in food and oil prices in 2008 added to the difficulties, threatening to increase poverty rates throughout the developing world and most especially among importers of food and oil. On October 28, 2008, the Latin American Program and Florida International University a panel of experts to discuss the impact of global economic trends on Central America, a particularly vulnerable region to the effects of the crisis.
Pablo Rodas Martina, chief economist at the Central American Bank for Economic Integration, analyzed the dimensions of the U.S. economic crisis, its impact on Central America, and possible measures to counteract the crisis. He referred to lessons from the Great Depression, when the region suffered from low banana and coffee prices and large external debts. Employment and salary levels dropped and repressive dictators rose to power. As in the 1930s, the current U.S crisis has resulted in financial loses and market volatility, thus affecting commodity prices and Central America's ability to adjust. A strengthening U.S. dollar has also affected the price of food and other products.
Rodas noted that the region's growth in exports, imports, remittances, foreign direct investment (FDI) and other sectors is faltering after a recent period of significant growth. Food and oil prices are creating inflationary pressures, while investments, bank deposits, and foreign reserves have diminished; interest rates will most likely increase, as central banks turn their attention to fighting inflation and monitor loans. Fiscal constraints will probably result in less public investment and cuts in social programs. According to Rodas, all of these factors indicate that poverty, unemployment, public deficits, and debt will be on the rise in Central America, contributing to migration pressures and social instability. Offsetting these problems will be difficult and will require coordinated measures with the IMF and other organizations.
Gregory Watson, operations officer of the Inter-American Development Bank's Multilateral Investment Fund, discussed the effects of the U.S. crisis on remittances to the region. Remittances play an important role in the economies of Central America: they make up significant percentages of the region's gross domestic product, reaching nearly 25 percent in Honduras. From 2005 to 2008 remittance growth has been stable, but 2008 saw a decrease in the trend of double digit growth, with a percentage increase of only 1.5 percent. This is the first year of single digit growth since data has been collected. Adjusting for inflation and exchange rates, remittances actually show a 1.7 percent decrease. Watson attributed this decline in growth rates to increasing unemployment rates among Hispanics, increasing inflation, and a sharp contraction of construction sectors in both Spain and the United States. The reduction in remittances will have a negative impact on investment, according to Watson, as people devote a growing share of remittance income to cover daily expenses (even before the crisis, some 60 percent of remittances went to consumption rather than investment or savings). While believing that remittances to Central America will remain stable (given job market flexibility among immigrants and their moral commitment to sending money home), Watson predicted a shift in migration trends, with migrants targeting regions closer to home, as well as changes in the patterns through which remittances are sent. He highlighted the need to channel remittances through formal financial institutions in order to strengthen Central American financial sectors affected by the current crisis.
Former Minister of Economy of El Salvador Yolanda Mayora de Gavidia explained how recent macroeconomic policies in Central America have lowered inflation, reduced public debt, decreased interest rates, and led to more open economies. However, a growing gap among economies in the region (Costa is Rica moving ahead of its neighbors), declining terms of trade, current account deficits, and galloping inflation (especially linked to food prices) are threatening this hard-earned stability. According to Mayora, oil imports have surpassed the total amount of Central American exports and have added to the pressure on current account deficits. Moreover, since May 2007 the price of the basic food basket has risen 30 percent in El Salvador alone, and the country's once decreasing poverty level has increased for the first time since signing of the peace accords that ended the civil war. Mayora noted that trade, credit, and remittances still remain relatively stable, but a prolonged recession in the United States would force further adjustments and see some macroeconomic indicators decline sharply. However, she claimed that Central American governments are caught in a difficult policy scenario of fiscal pressures and focalized demands, implying that, even with reductions in the price of oil and improvements in the terms of trade, Central America may experience a setback in the fight against poverty.
Jorge Máttar, deputy director of the sub-regional office of the United Nations' Economic Commission for Latin America and the Caribbean (ECLAC), described how recent Central American economic growth has been strong and closely aligned with trends in the U.S. economy. An U.S. economic slowdown will result in low Central American growth rates and possibly a recession due to lower demand for its goods in the United States, as well as decreased remittances and less revenue from foreign direct investment and tourism. Food and fuel prices present important challenges; Central America imports all of its wheat and significant percentages of its corn and rice. An average increase of 15.8 percent in food prices in 2008 could bring about an increase of 2.8 percentage points in total poverty. Máttar concluded that the overall impact of the current crisis will result in less economic growth and less external funding; higher interest rates, higher inflation, and higher unemployment; and volatility, uncertainty and higher costs that will affect investment.
Humberto López, lead economist of the World Bank's Central America Department, gave and in-depth report of the impact of the world food crisis in the region. The price of food has begun to drop in recent months, but it still remains above 2007 levels. This along with high local food inflation and the financial crisis has created a complex situation. Both the urban and rural households are net food consumers in Central America, with the poor spending more than 50 percent of their income on food. In order to offset the present challenges, the region must avoid untargeted subsidies and price controls, support the incomes of the poor, reduce prohibitive tariffs, support rural programs, and focus on fiscal sustainability.
Patricia Vásquez, head of the Latin America department at Energy Intelligence, addressed the main challenges related to Central America's use of oil and gas. The region is a net importer of 300,000 barrels of oil per day, 76 percent of which is used for transportation and electricity. While Central America does not import a large quantity of oil in absolute terms, relative costs are very high; for instance, 10 percent of GDP is spent on oil imports. Venezuela and the United States provide oil and petroleum products, though Venezuela gives preferential treatment to the area through the Petrocaribe initiative. Central America's low refining and storage capacity, almost all of which are in the hands of private investors, also create problems, and reduce the ability of governments in the region to react to fuel prices hikes. She recommended that in the future, Central American countries focus on producing renewable energy and diversifying their sources.
Jorge Asturias, coordinator of the Central American sub-regional Office of the Latin American Organization of Energy (OLADE), discussed overall energy trends in the region and OLADE's work to support energy policies. Given that Central America is a net importer of petroleum and derivatives, high world prices for these products become most immediately reflected in higher transportation and electrical costs. Yet the region has significant energy resources, noted Asturias. Regional integration offers important possibilities for meeting energy needs, as it would also enhance intra-regional commerce and service as well as help meet needs in zones that are otherwise isolated. Asturias emphasized that diversification of the energy matrix is needed to promote energy sustainable and security.