CENTRAL AMERICA: ECONOMIES IN CRISIS

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP84S00897R000100130005-9
• Release Decision: RIPPUB
• Original Classification: C
• Document Page Count: 33
• Document Creation Date: December 21, 2016
• Document Release Date: September 29, 2008
• Sequence Number: 5
• Publication Date: November 1, 1983
• Content Type: REPORT

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Directorate of Confidential
Intelligence
Central America:
Economies in Crisis
State Dept. review completed
Confidential
ALA 83-10175
November 1983
Copy 3 6 5
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Figure 4 Figure 6
Central America: Gross Domestic Central America: External Public
Investment as a Share of GDP Debt Compared to GDP
in Crisis, ALA 83-10175, (Confidential
November 1983.
^ I'nv'ite ^ GI)P
Pt~hnc Debt
U ; Ill I 10 ZS 3U
( cntril \mcric,i
I'1S'
Central America
Costa Rica
I.l Salvador
Guatemala
Honduras
Nicaragua
1978
1952
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Directorate of Confidential
Central America:
Economies in Crisis
This paper was prepared by
African and Latin American Analysis
Division, ALA,
Comments and queries are welcome and may be
directed to the Chief, Middle America-Caribbean
Confidential
ALA 83-10175
Novemher 1983
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Central America:
Economies in Crisisl 25X1
Key Judgments Persistent disruptions caused by insurgent activity and the global recession
/,formation available have choked economic activity and boosted foreign aid needs throughout
as of 25 October 1983 Central America. Economic performance has been dismal since 1979,
was used in this report.
when revolution in Nicaragua and coordinated guerrilla activity in
El Salvador and in Guatemala coincided with deteriorating terms of trade
for the region. As a result, in the three years following 1979, real economic
activity for Central America plunged roughly 20 percent.
In the countries most directly affected by insurgencies, destruction and
production losses caused by the fighting have been a major component in
the economic downturn. The economic interdependence of the region has
spread economic ills even to those areas not directly hurt by fighting, and
domestic investment has deteriorated sharply throughout the region.
Foreign commercial lending has nearly dried up, and regional trade,
formerly the outlet for virtually all of the area's manufactures exports, has
been hamstrung by payment arrearages, import restrictions, and barriers to
currency convertibility. Violence in the countryside has been impeding
traditional seasonal labor migration throughout the region and cutting into
harvests.
Global economic developments have also contributed to the area's woes. A
sharp rise in oil prices, weakening demand for agricultural commodities,
and skyrocketing interest rates caused the regional current account deficit
to balloon from roughly $750 million in 1979 to more than $1.5 billion in
1982 despite deep cuts in import volume. In response, Central American
countries drew down foreign exchange reserves by $2 billion and secured
foreign loans-mainly from official sources-worth about $6 billion during
1979-82.
Even with a pickup in the world economy, the outlook for 1983-84 depends
largely on security conditions. If insurgent activity continues near current
levels, we calculate-on the basis of simple national accounts modeling and
payments forecasting-that the foreign aid tab to sustain import volumes,
prop up living standards, and forestall further drops in real output would
reach roughly $2.5 billion each year. We estimate that the region will
receive only about $1.8 billion this year, despite growing appeals to
traditional bilateral OECD (Organization for Economic Development and
Cooperation) lenders and multilateral institutions. As a result, we estimate
that import volume will decline and overall economic activity in the region
probably will fall by 3 to 5 percent this year. Economic performance will
continue to deteriorate in 1984 unless unanticipated aid materializes.
Confidential
ALA 83-10175
November 1983
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25X1
Foreign economic aid will play a pivotal role in ensuring stability in this
troubled region in the years ahead, in part because insurgents will take
advantage of continuing economic decline in their campaigns to gain
popular support. The generosity and promptness of official donor responses
will determine not only whether living standards can be stabilized or will
continue to erode but also whether individual governments can muster the
will and resources needed to pursue the political, economic, and social
reforms essential to sustain any recovery over the longer run.
In any case, the danger of sudden major economic setbacks is great. Should
insurgents make strong gains, governments would be hard pressed to
contain investor panic or channel aid into productive investments. Assist-
ance would be used to sustain imports and living standards; no likely
amount of foreign aid could spark economic growth. Moreover, an upsurge
in the flight of capital and talent would further cripple these economies.
Despite the central importance of military unrest in Central America's
problems, decisive military victories over the insurgents would not by
themselves be enough to generate quick economic improvement. Even if
global economic recovery were faster than generally expected, the region's
private sector, weakened by years of political turmoil, capital flight, low
levels of investment, and dwindling inventories would take several years to
recover. In these circumstances, foreign aid need. would most likely remain
high for perhaps five to 10 years. Although we believe that an improved
military and political climate might bolster aid receipts, if foreign assist-
ance fell substantially short of requirements, there would be a high risk
that economic recovery would be jolted.
If significant insurgent activity continues beyond mid-decade, the costs of
eventual economic reconstruction would burgeon as insurgent-inflicted
damage mounted, capital stock deteriorated, and middle class emigration
grew. In a reversal of past regional development trends, governments-
rather than the private sectors-would set the economic course and could
be quickly overburdened. With a shriveled tax base and little access to
foreign private capital, these countries-with the obvious exception of
Nicaragua-would turn increasingly to the United States for aid.
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Key Judgments
iii
Introduction
1
Shallow Foundations, Rapid Growth: 1961-78
1
Shaken by Change: 1979-82
7
Effects of the Insurgency
8
Foreign Economic Factors
9
Reversals in Key Productive Sectors
I0
Government Actions and Popular Reactions
I I
Grim Prospects: 1983-84
14
Common Constraints
14
Case I: No Critical Change in Military and Political Conditions
15
Case II: Marked Insurgent Success
18
Case III: Decisive Military Victories
19
Long-Term Costs of Prolonged Insurgency
20
Implications for the United States
21
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Figure 1
Central America
North
Atlantic
Ocean
North
Pacific
Ocean
Cayman
Islands
(UK)
NASSRU
The Ba' amas
Guantanamo ?
{U.S. Nava/ Base) H m
-, . R?pub
6, sh
qp lv
(U /
Puerto
vug,n ls.
Rio (US
(U.S)
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Central America:
Economies in Crisis
The small, strategically located countries of Central
America are coping with insurgencies and subversion
that are challenging the tenuous military and political
balance in the region.' Although actual fighting thus
far has been limited to El Salvador, Guatemala, and
Nicaragua, economic deterioration is being transmit-
ted throughout the isthmus by the strong investment,
trade, currency, and labor ties that had contributed to
previous regional development. Since the violence
escalated in 1979, regional economic activity has been
plummeting as investment dries up, intraregional
trade slows, guerrilla intimidation and the fighting
disrupt migrant agricultural labor flows, and capital
flight depletes foreign currency holdings. Steep world
interest rates and soft agricultural commodity prices
are compounding these difficulties.
This paper draws together in-depth research complet-
ed on individual economies in Central America in
order to examine the similarities and dissimilarities in
their paths of economic development, trace the build-
up of economic stress and review recent performance.'
It assesses foreign funding requirements associated
with various economic growth tracks through 1984 for
the region as a whole and considers their sensitivity to
various security conditions. This assessment also eval-
uates the economic danger points of a prolonged
insurgency and draws the implications for US
interests.
' For this assessment we include Costa Rica, El Salvador, Guate-
mala. Honduras, and Nicaragua and exclude Belize and Panama
from our discussion.
Although the Central American countries vary tre-
mendously in economic development levels and strate-
gies, they shared important similarities and linkages
that provided the foundation for fast-paced economic
expansion for much of the period since World War II
until 1979. During 1961-78, for example, Central
American economic growth rates matched the Latin
American average of 5.6 percent per year and sur-
passed that of LDCs as a whole. Costa Rica led
Central American countries and sustained growth
rates in excess of 6 percent per year, while Honduras
trailed only slightly at roughly 5-percent annual
expansion. These common growth paths built on
periodic booms in agricultural commodity prices, dy-
namic, regionally protected manufacturing sectors,
and widespread foreign borrowing-failed, howev r
to foster sturdy, broad-based economic expansion.
Agriculture, the keystone of the region's economic 25X1
development, was the primary source of export earn-
ings and employment. Despite wildly fluctuating in-
ternational prices for major commodities coffee,
sugar, bananas, cotton, and meat-the region's long-
standing dependence on these items for more than
three-fourths of export earnings did not lessen. In-
deed, a threefold increase in coffee and sugar prices in
the mid-1970s helped compensate for the 1973 OPEC
oil price hikes. These vital crops were harvested by
large numbers of workers who seasonally migrated
internally and across the isthmus. Altogether, slightly
more than half the Central American labor force was
employed in agriculture in the late 1970s. F__~ 25X1
Agriculture also provided the springboard for indus-
trialization: in addition to the 26 percent of Central
American economic activity directly attributable to
agriculture in 1978, 75 percent of the fast-growing
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Central America: Dimensions of Poverty
Although sharp disparities exist among individual
Central American countries, various measures of
living standards sketch an outline of poverty in the
region that generally falls between the dirt-poor
levels of LDCs as a whole and the comparatively
affluent standards of Latin America.d This informa-
tion tends to refute the widespread notion that pover-
ty rather than other factors has been the main cause
of regional unrest.
? Before the turmoil broke out in 1979, average per
capita incomes in Central America surpassed LDC
levels by more than 40 percent but measured little
more than half of Latin American earnings. The
range within Central America was broad, however,
as the typical Costa Rican enjoyed an income more
than triple that of his Honduran counterpart.
? Land ownership patterns suggest that income dur-
ing the early 1970s at least was more evenly
distributed in Central America than in LDCs over-
all. (Income distribution data are unavailable.)
Seventy-eight percent of cropland in Central Ameri-
ca was divided into very small plots, as compared
to 87 percent in LDCs as a whole and 59 percent in
Latin America. El Salvador and Guatemala exhib-
ited the highest concentrations of tiny farms in
Central America, while Costa Rica and Nicaragua
claimed substantial numbers of moderate-si:e
holdings.
With the exception ofper capita income data, cocioeconontic
indicators from the 1970s are the most recent available. Although
they portray living standards in Central America prior to 1979,
they do not reflect the dramatic deterioration that has afflicted
? A baby born in Central America in 1979 could
expect to live seven years longer than the LDC
average and roughly as long as the average Latin
American child. A Costa Rican infant could look
forward to his 70th birthday, while a Nicaraguan
newborn, on average, would survive to age 56.
? Slightly more than half the population of Central
America had access to safe water in the mid-1970s,
as compared to less than 40 percent in LDCs
generally and 65 percent in Latin America. Nearly
80 percent ofCosta Ricans could count on a potable
water supply--almost twice the share for Guatema-
lans.
? Although all other Central American countries
matched or exceeded LDC primary school enroll-
ment rates in the late I 970s, extremely low Guate-
malan education levels dragged the Central Ameri-
can average below that of both LDCs as a whole
and Latin America. Seventy-eight percent of Cen-
tral American children attended primary school, as
compared to the 80 percent LDC average and 93
percent of Latin Americans. Despite low per capita
incomes in Honduras, 85 percent of children there
were enrolled in school.
? Electric lights were found in about one-third of
Central American homes in the mid-1970s, as
compared to slightly more than half in Latin Amer-
ica. (Worldwide LDC statistics are not available.)
Two-thirds of Costa Ricans enjoyed electric lights,
while more than 80 percent of Hondurans still
relied on lanterns and candles.
manufacturing sector was related to agriculture. Food
processing accounted for nearly half of manufacturing
activity. Textiles, wood, paper, and rubber production
together accounted for another 25 percent of this
sector's output
The nascent manufacturing sectors provided the most
energetic component of regional economic growth.
UN data show that Central America's industrial base
expanded at an average annual rate of 7.4 percent
during 1961-78, significantly faster than the
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Table 1
Central America: Investment Indicators, 1978
Latin
America
Central
America
Gross domestic investment/GDP
25.4
22.5
23.4
27.7
27.2
26.1
21.6
Public investment/gross
45.6 h
27.0
34.1
32.7
42.4
26.6
20.0
domestic investment
Direct foreign investment/gross
1.4
5.0
domestic investment
Net external financing/gross
9.1
18.0
domestic investment
Savings/GDP
23.1
16.8
19.7
15.1
11.1
13.6
10.3
Taxes/GDP
16.5 a
13.5
19.8
15.1
11.1
13.6
10.3
Outstanding public debt/GDP
NA
24.1
29.8
36.0
34.7
10.9
7.8
Data are for 1977 or nearest available year because 1978
information reflects the beginning of revolutionary upheaval and its
contractionary effects on most economic activity.
I Data are for 1974.
Data are for 1977.
J Data are for 1975.
6.3-percent rate achieved by Latin America as a
whole. El Salvador, Guatemala, and Nicaragua clus-
tered around the region's average performance, while
Costa Rica exhibited the most striking industrial
growth 8.5 percent per year. Honduran industry, the
least developed in the region, nonetheless expanded by
a respectable 5.5 percent annually
Manufacturing's impressive performance was directly
attributable to the formation of the Central American
Common Market (CACM) in 1960. The CACM
eliminated intraregional tariffs and trade quotas on
manufactured goods, established a common external
tariff, and ensured barrier-free currency convertibil-
ity--mechanisms that stimulated growth of regional
trade and permitted economies of scale otherwise
beyond the reach of small countries. As a result,
intraregional trade boomed and by 1978 accounted
for one-fifth of total international sales and absorbed
virtually all the region's manufactured exports. At the
same time, however, these countries had not devel-
oped products that would be competitive outside the
protected common market.
As in many LDCs, rapid economic growth was debt
led, but plentiful foreign financing permitted Central
American countries to increase foreign exchange re-
serves by $1.3 billion during 1970-78 according to
official statistics. Regional current account deficits
over the same period totaled $4.5 billion, or about
20 percent of export earnings, the same share as for
Latin America as a whole. To cover the current
account deficit and amortization requirements, Cen-
tral America secured about $5.2 billion in medium-
and long-term loans, of which slightly more than half
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Figure 2
Central America: Living Standard Indicators
Aterage Per Capita Incomes, 1979
1')71) 1'S S
( o,la ILal
erage Life Ivpectaii c. al 13irt1t, 1979 Population with Access to Safe
i C lI N atcr. 197
P:1'Cnt
(1111.11(ILa
( u.ld 12X.1
Latin AnlCrica
1,611
I I SaIvJIIU(
(~Li ll I1. nla d
I .1111
I ,Ilia AIllCllid
10111 4nlennl
(cntr.11 \nlcnc.I
( Inlr:II \Il1 FIL.l
111.11)ellOr
I I Sal(ador 6 11
(~.iar~m.11:1
( cnlrlI Anlrnr.l
NIL dl lCI.la (,oo
II~IIIJur.l.
1111111 111,1.
ab
VII IU( r")
N.C.11 (111.1
Gualcnl.ll,I
Ill
Il111111 ~~I1
VII 11)1
tl
:AII I I)(.
Primar School I:nrollnnvtl as
Population \1 ith Electric Lighting,
Sharc of Age Group. 1978
1975
I'CICCItt
I'ccrCCnt
100 (-ta Rica
Latin America
IN Cl rag Ll:l
I_I Sill 111111
Central AIncll 1..l
((ll:l le mala
111)1(1 U rit
M21
M17
went to the public sector directly or were publicly service requirements remained manageable. Accord-
guaranteed. Other sources of foreign exchange includ- ing to UN information, foreign interest and principal
ed net direct investment of $1.4 billion and short-term payments consumed 1 1 percent of Central American
loans of $1.1 billion. export earnings during 1970-78, as compared to 23
percent for Latin America. Wide variation existed
As a result of frequent borrowing, Central America's within Central America, however. Costa Rica's debt
external public debt reached slightly more than service ratio reached 20 percent, while Salvadoran
$4 billion by the end of 1978. On the basis of past and Guatemalan rates remained below 10 percent
financing patterns, we estimate that outstanding pri-
vate debt was nearly as high. Nevertheless, debt
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Figure 3
Central America: Agricultural Landholding, by Size, 1970
Svc of holding, in
hciLlrc~
Percent share oltotal holding,
U It) 111 3() 411 Si) 60 '0 `t)) '7U 100
#rS I cs, iliac S
~ ~I-gnu
I I - I,liti
Nlw1 Man 1.11110
Table 2
Central America: Foreign Financing Gap, 1970-78
Central
America
Costa Rica
El Salvador
Guatema'.a
Honduras
Nicaragua
Current account
-4,535
-1,721
-551
-514
-844
-905
Trade balance
-3,673
-1,356
-556
-701
-556
- 504
Exports (f.o.b.)
24,512
5,119
5,189
6,834
3,293
4,077
Imports (c.i.f.)
28,185
6,475
5,745
7,535
3,849
4,581
Net services and transfers
-862
-365
5
187
--288
-401
Amortization
1,796
746
224
279
238
309
Foreign financing gap
-6,331
-2,467
-775
-793
-1,082
-1,214
Foreign direct investment
1,381
402
156
652
63
108
Medium- and long-term loans
5,174
1,704
790
773
955
952
Private
2,231
701
269
325
464
472
Official
2,943
1,003
521
448
491
480
Net short-term capital (including
1,115
496
49
3
232
335
errors and omissions)
Change in gross reserves
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Healthy private-sector investment formed the core of
Central America's economic development before
1979. During most of the 1970s, for example, the
private sector accounted for more than two-thirds of
gross domestic investment. Total investment equaled
roughly one-fourth of GDP, a level close to the strong
Latin American average. Governmental roles in eco-
nomic development were noticeably limited.
Although government projects usually stressed devel-
opment of utilities, transportation and communica-
tions networks, private investors occasionally built
roads, utilities, and railroads needed to accommo-
date their businesses. Moreover, public construction
of schools, hospitals, and similar facilities often was
neglected.
Although domestic savings and taxes provided the
bulk of investment capital, Central America relied on
foreign funds to a greater extent than the rest of Latin
America. Foreign lending and equity investment
contributed nearly 20 percent of gross domestic in-
vestment in Central America during the 1970s, as
compared to less than 10 percent in Latin America
overall. Dependence on foreign capital partly
stemmed from a relatively low Central American
savings rate, attributable to the region's comparably
backward economic development level. Tax rates also
were somewhat lower.
Despite these broad similarities within the region,
distinctive patterns of economic development emerged
in individual Central American countries. r'
? Costa Rica. Unusually strong government participa-
tion accompanied economic development. San Jo-
se's sustained hefty investment in education, health,
transportation, and communications pushed labor
force skills, roads, and utilities toward standards
prevailing in some developed countries--a policy
that lured foreign investors. Government-driven
development and social insurance programs proved
expensive, however, and tax rates, bvJar the
steepest in the region, were nearly double those in
Guatemala and Nicaragua. Although Costa Rica's
savings rate was the highest in Central America,
San Jose relied heavily on foreign commercial
banks to finance economic expansion and rapidly
accumulated a large public foreign debt.
? Honduras. An ambitious government development
program beginning in the mid-1970s boosted invest-
ment rates to the highest in the region by 1978.
Tegucigalpa's efforts to overcome past neglect of
transportation, communications, and social services
came too late to quickly attract many international
businesses, however, and the level of direct foreign
investment remained the lowest in the region. To
fund its large investment, Tegucigalpa boosted
taxes and turned to foreign banks. As a result, by
1978 Honduran tax rates were the second highest
in Central America and external public debt
claimed the largest share of GDP in the region. F_
? Nicaragua. Managua also was a latecomer to eco-
nomic development. Until the earthquake in 1972,
investment rates were in line with Central American
averages and most of gross domestic capital forma-
tion occurred in the private sector. This changed
radically in the years following the earthquake,
when large inflows of foreign aid were channeled
into government investment and Managua's share
of total investment more than doubled. The compo-
sition of government projects also shifted. Although
construction of utilities, transportation, and com-
munications networks retained predominance, in-
vestment in health, education, and public housing
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more than doubled. Generous foreign lending
largely compensated for the country's declining
direct foreign investment inflows and permitted
Managua to carry out development plans while
holding taxes down. This strategy rapidly added to
the foreign public debt, however, and Nicaraguan
debt obligations quickly surpassed those of Costa
Rica in absolute terms
? El Salvador. Strong investment by major industri-
alists and large landowners kept capital formation
rates above the regional average. Government par-
ticipation was lower only in Guatemala. San Salva-
dor spent more than $2 for roads, bridges, and
utilities for every dollar it directed toward social
services. Because domestic savings rates were the
lowest in Central America and foreign direct invest-
ment also was weak, El Salvador relied on foreign
commercial banks for investment financing. Public
external debt remained small, however, because the
bulk of borrowing was private.
? Guatemala. Its development strategy differed mark-
edlvfrom Costa Rica's. Total investment rates were
similar, but Guatemala City played little role in
investment decisions. Development of transporta-
tion and communications links was largely left to
the private sector, and social service investment was
neglected. As a result, the public foreign debt/GDP
ratio was among the lowest in the developing world.
At the same time, direct foreign investment ac-
counted for more than 9 percent of gross domestic
capital formation-nearly twice the regional aver-
age. Investors were attracted by the lowest taxes in
Central America, low wages, and minimal bureau-
cratic redtape.
Regional economic growth fizzled in 1979 when the
beginning of sustained insurgent activity coincided
with dramatic deterioration in external terms of trade.
In those countries plagued by the fighting-Nicara-
gua, El Salvador, and Guatemala-damage and losses
directly detracted from economic activity. Through-
out the region, the specter of instability darkened the
investment climate and dampened foreign lending.
Violence and guerrilla intimidation in the countryside
reduced agricultural labor migration and cut into
harvests. Manufacturing withered as intraregional
commerce dropped precipitously. These problems
were compounded by oil prices that more than dou-
bled, softening world demand for agricultural com-
modities, and higher interest rates.
As a result of these factors, by the end of 1982 real
economic activity, measured in US dollars, plunged
nearly 20 percent from the 1979 peak, a drop of about
one-third in per capita terms. Deterioration was the
most severe in El Salvador and Nicaragua where
output slid about 25 percent.' Throughout the region,
governments struggled to cope with mounting eco-
nomic chaos. Austerity programs designed to control
inflation and mollify foreign lenders drained political
support from those segments of society most squeezed
by rising unemployment, higher taxes, and declining
public expenditures on social services.
' Although Costa Rican economic activity registered a similar sharp
decline, a large share was directly linked to the huge devaluation of
the colon against the US dollar that took place over 1981-82; if
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Effects of the Insurgency
Direct damage caused by the fighting was a major
component in the economic downturn:
? In Nicaragua, damage and production losses associ-
ated with Somoza's overthrow reached $2 billion,
according to World Bank estimates. Managua
claims that anti-Sandinista insurgent activity in
1982 alone caused an additional $58 million in
direct losses.
? In El Salvador, guerrilla attacks on crops, factories,
roads, and bridges cost at least $600 million in
direct damage and production losses from the esca-
lation of the fighting in 1979 through 1982, accord-
ing to US Embassy estimates.
? In Guatemala, attacks on economic targets were
largely limited to sporadic destruction of nonpro-
ductive assets and periodic sabotage of the major oil
pipeline. Nonetheless, we calculate that direct
damage probably totaled about $20 million by the
end of 1982.
A more devastating effect of the violence, however,
was the sharp drop in private investment that mir-
rored businessmen's fears of a worsening economic,
military, and political situation. International Mone-
tary Fund (IMF) reports show that for the region as a
whole, domestic private investment volume plummet-
ed about 75 percent during 1979-82 and foreign net
direct investment fell similarly. The decline was steep-
est in El Salvador, where guerrilla threats successfully
intimidated potential investors and reduced planting
and harvesting. Even in countries not directly affected
by insurgency, however, the proximity of trouble and
weakening regional economic health cut deeply into
investment
Struggling to sustain economic vitality in the midst of
dwindling private investment, the government sector
began to take a larger economic role. Consequently,
the public share of total investment, previously limited
to about 20 percent, reached more than 40 percent
last year. Gross domestic investment dipped to less
than 15 percent of GDP in 1982, as compared to
nearly 25 percent in 1978.
Figure 4
Central America: Gross Domestic
Investment as a Share of GDP
? Private
~71111111 PUNIC
Centrsil Anurica 1972
198?
Costa Rica
1=1 Salkador
Guatemala
1londuras
Nicaragua
The insurgency also dealt a disastrous blow to
CACM-already showing signs of stagnation because
of the limited size of the regional market. According
to official statistics, trade volume fell by about half
during 1979-82 as instability disabled the economies
of Nicaragua and El Salvador. The volume of Nicara-
guan exports to CACM plunged by 75 percent, and
Salvadoran sales fell by 50 percent as import restric-
tions and other obstacles to production depressed
exports in these countries. In turn, the unavailability
of raw materials from Nicaragua and El Salvador
further reduced output throughout Central America.
A large Costa Rican tuna exporter, for example, was
forced to slash production when his longstanding
Nicaraguan supplier of tomato paste closed.
At the same time, uneven and poorly managed pur-
chases led to massive financial arrearages within the
region that choked off its commerce. Nicaragua's
25X1
25X1 I
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Figure 5
Central America: Imports by Type, 1978 and 1982
~ ( or-m" l-, 1,
L_; I'llcrm,Jr.lr Lund, and Ill, ma;CrIal,
I ucl
- I anrtal y rul,/.yu ipnicnl U
( ),t,i Rica
f I Salvallol
(I Uat 0111,118
Ifunclura,
Nicaragua
1975
195?
I1 I
demand for imports surged in 1980 as Managua
attempted to revive a war-ravaged economy, and its
purchases from CACM-largely funded by Guate-
malan credits-nearly tripled from 1979 levels. As
the fighting heated up in El Salvador in 1980, real
imports from CACM rose 15 percent because San
Salvador boosted purchases of consumer goods in an
effort. to maintain living standards despite falling
domestic production. Worsening balance-of-payments
positions hindered these countries' ability to pay
CACM suppliers, however, and we calculate that
total arrearages to regional trading partners climbed
to about $500 million by the end of 1982. Of these
unpaid debts, Nicaragua owed about $300 million and
El Salvador $75 million despite sharp drops in import
purchases. Intraregional trade became snarled as
countries adopted foreign currency controls, deposit
requirements, and import restrictions that marked the
end of two decades of vigorous CACM growth.
Foreign Economic Factors
Global conditions exacerbated Central American eco-
nomic woes when careening commodity prices con-
tributed to a doubling of the region's current account
deficit during 1979-81 and forced deep cuts in imports
needed to sustain economic activity. I M F and World
Bank studies show that the Central American current
account deficit topped $2 billion in 1981 following a
50-percent drop in real coffee prices and a near
tripling of energy bills over the previous two years.
The deficit was held to $1.5 billion in 1982 at the cost
of a 30-percent cut in import volume that came on the
heels of earlier, less drastic reductions. By the end of
1982, total import volume reached little more than
half of 1978 levels. According to official data, imports
of capital goods and raw materials-needed to main-
tain economic growth were most severely restricted,
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Table 3
Central America: Foreign Financing Gap
Current account -1,084
-755
-1,566
-2,069
-1,517
Trade balance - 594
-431
-1,058
-1,151
--710
Exports (f.o.b.) 4,016
4,783
5,110
4,615
3,906
Coffee 1,586
1,777
1,689
1,328
1,290
Imports (c.i.f.) 4,610
5,214
6,168
5,765
4,616
Net services and transfers -490
-324
-508
-918
807
Amortization 357
510
454
842
684
Foreign financing gap 1,441
--1,265
-2,020
-2,911
-2,201
Capital account 1,512
1,138
781
2,070
2,341
Foreign direct investment 186
187
165
189
148
Medium- and long-term loans 1,211
1,016
1,218
2,212
1,766
Official 576
614
1,113
1,475
1,429
Private 636
402
105
737
337
Net short-term capital (including 115
-65
-602
-331
427
errors and omissions)
Change in gross reserves
while purchases of consumer goods, primarily for
political reasons, maintained precrisis shares of total
imports.
The Central American countries were unable to meet
soaring foreign financing needs without massive cuts
in imports because the global monetary crunch tight-
ened access to overseas commercial credit and sent
interest rates skyrocketing. As longstanding links with
commercial banks weakened, Central American coun-
tries stepped up appeals to official lenders for conces-
sional aid. Official lending-mostly from multilateral
agencies and Organization for Economic Cooperation
and Development (OECD) sources rose rapidly, and,
according to the World Bank, accounted for three-
fourths of new medium- and long-term loans dis-
bursed during 1979-82. In the process, the external
public debt of Central American countries more than
doubled to about $10 billion. Nevertheless, the more
than $6 billion secured from all sources was not
enough to counter the effects of falling production,
worsening terms of trade, and capital flight. The
region's governments drew down foreign exchange
reserves by $2 billion, leaving virtually no cushion
against possible future economic shocks.
Reversals in Key Productive Sectors
As in the past, agriculture drove overall economic
activity; output in this sector declined by 18 percent
during 1979-82 according to official statistics. Short-
ages of imported fertilizers, pesticides, and spare
parts, low investment related to uncertainty about
land reform, disruptions in the supply of migrant
labor, low international commodity prices, and
damage from insurgent activity all contributed to the
slide. Deterioration was most pronounced in El Salva-
dor and Nicaragua, where output in agriculture fell
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Figure 6
Central America: External Public
Debt Compared to GDP
Table 4
Central America: Sources of
Foreign Official Loans, 1979-82
= tin,
I7 Dcht
Co,ta Rica
I-I Sakador
Guatemala
II mdurn
Nicaragua
34 percent and 28 percent, respectively. Throughout
the region, production of export crops suffered as
farmers reverted to planting basic crops-corn, beans,
and rice--that required lower investment, fewer im-
ported inputs, and provided an ensured food supply.
Industry paralleled agricultural performance, and
production dropped 20 percent as the CACM crum-
bled. As in agriculture, the falloff was most severe in
El Salvador and Nicaragua. Large Guatemalan cred-
its extended to these countries buoyed Guatemalan
industrial production and the sector stayed intact.
Domestic import substitution throughout the region
only partially compensated for CACM's decline, and
by 1982 the value of common market trade had
shrunk to 20 percent of the value of the region's
manufacturing sector, as compared to 30 percent in
1978. Attempts to export these products elsewhere in
the world market generally were thwarted by the
uncompetitive nature of long-protected industries.
Total Multilateral Bilateral Lenders
Institutions
United Others
States
Central America 4,631 1,598 751 2,282
Costa Rica 619 295 77 247
El Salvador 1,117 302 334 481
Guatemala 493 318 71 103
Honduras 804 368 15' 284
Nicaragua 1,599 315 117 1,167
Output in other sectors dropped, and the structure of'
production shifted in response to shrinking overall
economic performance:
? Activity in the once-vigorous construction sector
slowed despite public-sector attempts to compensate
for sharply reduced private building.
? Transactions in the financial sector declined as bad
debts and foreign currency bottlenecks dampened
banking activity and growing losses threatened the
insurance industry.
? Retail and wholesale trade was hamstrung by short-
ages of imported consumer products and intermedi-
ate goods.
? Tourism, an important source of foreign exchange
and jobs in the past, was strangled by threats of
guerrilla violence.
Government Actions and Popular Reactions
As foreign payments problems intensified, all govern-
ments except Nicaragua's adopted austerity pro-
grams, often to qualify for IMF and other aid. After
much official floundering in 1981 and stiff resistance,
austerity took hold in earnest the following year:
? Government spending in the region as a whole
plunged about 25 percent in real terms. President
Luis Alberto Monge acted decisively by slashing
Costa Rica's expenditures by roughly 40 percent.
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Table 5
Central America: Economic Performance by Sector, 1982
Central
America
102
109
83
Agriculture (real value)
82
98
103
72
Selected crops (volume)
Coffee
107
122
92
109
119
97
Cotton
71
100
51
56
55
96
Sugar
91
95
75
106
101
66
Corn
113
142
82
119
143
107
Rice
99
74
107
110
144
128
Beans
106
114
88
132
86
98
Industry (real value)
80
90
69
99
104
71
Services (real value)
86
91
85
105
116
96
, Separate data for Costa Rica are shown in colones because the
steep devaluation against the US dollar exaggerates economic
decline compared to other countries. All regional data are measured
in US dollars.
? Despite the growing importance of public-sector
investment, these capital outlays slid 30 percent
because governments could no longer afford to
finance many development projects. In Honduras,
the share of the budget allocated to investment was
halved, and the government-funded development
program in effect since the mid-1970s slowed
sharply.
? Governments boosted taxes, but faltering economic
activity kept a lid on revenues. The ratio of tax
receipts to national incomes remained roughly con-
stant, except in Nicaragua, where this ratio doubled
from prewar levels.
? Domestic credit expansion was curtailed, and the
private sector shouldered more than its share of the
monetary burden. In all countries except Nicara-
gua, credit to businesses declined by an average of
about 20 percent while public-sector credit stayed
even with inflation. In Nicaragua, we estimate that
credit to the private sector slowed to a token trickle
in keeping with the Sandinistas' goal of squeezing
out the middle class.
? All countries effectively devalued their currencies,
although only Costa Rica did so across the board
through a sharp devaluation of the colon during
1982-83. Elsewhere, most governments sharply
limited the types of transactions made at overvalued
official rates and forced increasing numbers of
currency purchases onto free or parallel rate
markets.
? Public-sector work forces were pared everywhere-
except in Nicaragua, whose public sector ballooned
from about 15 percent of GDP in 1978 to more than
40 percent by last year-and wage increases lagged
inflation rates. In Honduras, press reports indicate
that about 10,000 people were cut from the public
payroll in 1982.
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Figure 7
Central America: Unemployment Rates
u>XF
.nirnl \mrnC? 19R~~
According to press and Embassy reports, worsening
economic conditions added an element of instability to
an already volatile regional political situation. Dis-
tress cut across all income levels and segments of the
population. Middle and upper classes were pinched by
rising taxes and growing bankruptcies. Lower classes
suffered from unemployment that we estimate
reached nearly 25 percent of the region's work force
in 1982 and from government cuts in social services.
Popular reaction to these problems differed markedly
by country and, indeed, by event within the same
country:
? In Costa Rica, Monge enjoyed strong popular sup-
port in his early efforts to end the financial excesses
of the Carazo administration. Nevertheless, accord-
ing 'o press reports, popular dissatisfaction forced
the government to slow the implementation of aus-
terity measures such as utility rate increases and
wage ceilings as business failures increased, unem-
ployment reached unprecedented levels, and intrac-
table inflation, combined with stagnant wages, cut
private consumption sharply.
? In El Salvador, widespread resentment over the
insurgent-inflicted damage to living standards part-
ly inspired the large voter turnout in the March
1982 elections, according to US Embassy reports.
Popular support for the government ebbed, however,
when renewed insurgent violence in the second half
of the year demonstrated the military's inability to
defeat the guerrillas or to defend key electrical,
industrial, and agricultural targets.
? In Guatemala, discord among various factions of
the powerful private sector and within the govern-
ment's economic cabinet stymied efforts to adopt
new, austere economic policies needed to secure new
IMF aid. Although many elements in the private
sector believed austerity was necessary, if bitter,
medicine, opposition from conservative businessmen
and the Central Bank President to higher taxes and
interest rates delayed the institution of a much-
needed IMF program.
? In Honduras, the government met some resistance
to planned austerity measures, but on balance we
judge that economic hardships did not translate into
much, if any, decline in the Suazo government's
popular support. Slippage occurred in austerity tar-
gets when the Honduran Congress failed to pass a
wide-ranging tariff reform measure designed to
increase revenues substantially. Nevertheless, the
administration's overall fortitude in dealing forth-
rightly with economic issues bolstered popular
support.
? In Nicaragua, worsening economic troubles, includ-
ing shortages of consumer goods, business failures,
and the government's increasingly hostile posture
against the private sector further sapped support
from the middle and upper classes. Embassy and
press reports cited mounting evidence of dissatisfac-
tion among the lower classes, which were hurt by
higher prices, scarcities of basic goods, and rising
unemployment. Internal opposition to the regime
remained weak and poorly organized, however, and
the Sandinistas retained their mass base of support,
particularly in urban areas. By portraying the Unit-
ed States as the main cause of Nicaragua's prob-
lems, the regime attempted to rally domestic sup-
port, suppress the opposition, and explain away
economic hardships to most Nicaraguans.
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Although world commodity demand and prices and
foreign aid will be important, we believe insurgent
activity and the associated climate of uncertainty will
be the most critical factors influencing Central Amer-
ican regional economic performance during 1983-84.4
Agricultural export earnings and foreign aid receipts
largely will determine the availability of desperately
needed foreign exchange, but business and govern-
ment investment decisions-colored by guerrilla
actions-will direct the course of economic develop-
ment.
Recognizing the relative magnitude of these variables,
we analyzed likely economic performance under three
scenarios for insurgent activity. In each case, we
projected the economic performance that would occur
if there were no major and unforeseen changes in
existing foreign aid and other financial patterns and
in world commodity price trends. Also, we selected
theoretical economic growth targets consistent with
averting further regional decline and then calculated
how much foreign funding would be necessary to
achieve these goals.' Thus, for 1983 we calculated
financial needs on the basis of no growth in national
output-the best performance we felt possible. For
1984 we targeted a 3-percent expansion in output-
modest in a historical context but formidable in the
current environment that would represent holding
per capita incomes steady for the first time since the
regional turmoil began in 1979. To make our calcula-
tions, we used simple national accounting models that
assumed no change in the violence, and then we
adjusted the data to reflect broad chances in the
security situation.
Case I. Guerrilla activity continues near its current
level. Despite the probable ebbs and flows in the
fighting, no significant change takes place in the
` For reasons already detailed in this paper, we assumed that
official aid rather than private sources would have to make up
most, if not all, of this support
For a further description of the sources and methodologies used in
developing these cases as well as discussions of our data sources, see
balance between insurgent and military forces
throughout the region. Although changes in gov-
ernments may occur, they are not disruptive.
Case II. The military situation shifts markedly in
favor of the insurgents in El Salvador and possibly
in Guatemala and Nicaragua. Subversive activity
becomes more widespread in Honduras and Costa
Rica.
Case III. Military forces achieve decisive victories
in El Salvador, Guatemala, and Nicaragua. Ter-
rorist threats fade in Honduras and Costa Rica.
Subject to these assumptions and conditions, we then
considered-in broad terms-the plausibility of the
region receiving the calculated financing and the
related impact on actual growth prospects.
Common Constraints
In all three scenarios, we concluded that, despite
brightening prospects for the international economy,
lower world interest rates and oil prices, apparent
progress on regional austerity programs, and fairly
generous foreign aid projections, Central America
probably will be unable to achieve dramatic economic
improvement during the next few years. Regardless of
developments on the military front, certain insur-
mountable factors will constrain economic activity:
? Even if global economic recovery is stronger than
generally expected, the spectacular surge in com-
modity prices needed to overcome the region's for-
eign exchange difficulties is unlikely to occur.7
? Absent large aid disbursements from major official
donors, foreign funding is unlikely to grow enough
to boost imports significantly.
? Potentially positive external influences, such as in-
clusion in the Caribbean Basin Initiative, under the
best of circumstances will take several years to
reach maximum effectiveness.
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? Production in the region's manufacturing sectors
will remain 40 to 50 percent below capacity until
the existing tangle of arrearages is straightened out.
In addition, depleted industrial capital stock and
inventories will take time to correct.
? Uncertainty over prospects for land reform and past
neglect of fields and equipment will hold down
agricultural production.
? The region's beleaguered private sector will not soon
provide a firm foundation for renewed economic
growth. Several years of peace and stability would
be needed before private investment could rebound.
? The shrunken tax base will limit governments'
ability to raise funds to finance public-sector
growth.
Case I: No Critical Change in Military and Political
Conditions
We judge this case to be the most likely through the
short term at least. Military developments in El
Salvador, probably the most reliable barometer of
upheaval in the region, continue to appear essentially
stalemated. The insurgency in Nicaragua, another
potential harbinger of major regional change, appears
incapable of threatening the Sandinistas' hold on
power any time soon. Although we cannot rule out
sudden developments such as coups or assassinations
that would modify the current political situation, we
believe that such events would not prove disruptive for
any length of time unless they were accompanied by a
critical shift in the military balance.
In this scenario, the same factors that derailed eco-
nomic production during 1979-82 will preclude
recovery:
? Direct damage and losses from the fighting will
continue to plague the Salvadoran, Nicaraguan, and
Guatemalan economies. In El Salvador, guerrilla
attacks on economic targets are becoming more
intense, according to press reports, with increasing
violence affecting peasant producers of basic grains.
Managua recently announced that losses from coun-
terinsurgent attacks have totaled $110 million over
the past two years. In Guatemala, although the
insurgency does not pose a threat to the government,
Embassy reports show an increase in guerrilla activ-
ity-perhaps capitalizing on the unstable political
climate-since the coup in August.
? The overall investment and commercial lending
climate will not brighten significantly even in coun-
tries not directly affected by the fighting. Wide-
spread press reports of Nicaragua's increasing
threats to Costa Rica and Honduras probably will
prevent or postpone many fledgling investment
plans. Meanwhile, prospects for new foreign com-
mercial lending in the region deteriorated recently
when a proposed $100 million commercial bank loan
to Guatemala the only loan under active consider-
ation in the area-was rejected.
? Substantial Nicaraguan and Salvadoran arrearages
will continue to prevent a resurgence of CACM 25X1
trade and the revival of the region's manufacturing
sector. Although individual countries have demon-
strated a willingness to discuss this problem and to
work out tentative reschedulings, Managua's ex-
tremely difficult financial situation and inability to
pay its $300 million debt continues to block prog-
ress. The ink was barely dry on a recent reschedul-
ing accord between Nicaragua and Costa Rica
before Managua failed to meet the new terms.
? Unless eased by unexpected foreign aid inflows, the
balance-of-payments bind will continue to limit
imports, which, in turn, will further depress eco-
nomic activity. At current financing levels, we
project that regional import volume in 1983 will fall
by roughly 20 percent below last year's low levels. 25X1
Imported raw materials, intermediate goods, and
spare parts will be in particularly short supply.
Consumer goods, relatively protected from cuts in
the past, probably will face sharp reductions
The level of foreign financial support needed merely 25X1
to stabilize these economies would be sizable. We
calculate that the region would need a total of about
$2.5 billion in 1983 just to avert further economic
slippage even if commodity prices recover somewhat.
To reach 3-percent growth next year, nearly $3 billion
would be required.
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Table 6
Central America: Projected Foreign Financing Gap, 1983-84
0-Percent
GDP Growth
3- to 5-Percent
GDP Decline
Current account
-2,003
--1,265
Trade balance
-743
-5
Exports (f.o.b.)
4,076
4,076
Imports (c.i.f.)
4,819
4,081
Net services and transfers
-1,260
-1,260
Amortization
537
537
Foreign financing gap
- 2,540
-1,802
Assumes various economic growth rates, no change in the security
conditions, and moderate commodity prices. Export earnings could
fall slightly from those shown if the tentative recovery in commod-
ity prices now apparently under way fails to develop.
n Assumes no change in current foreign financing levels.
Because foreign exchange reserves are nearly depleted
and because we judge that prospects for commercial
lending are virtually nil, foreign aid will determine
actual import levels and growth rates. Aid now antici-
pated from official sources falls short of these require-
ments, however. We estimate that Central American
countries will receive about $1.8 billion in hard
currency assistance this year, of which about $600
million will come from multilateral lenders, including
the IMF. Bilateral sources are expected to contribute
$1.2 billion, including roughly $450 million from the
United States, the largest individual lender.
We doubt that aid levels will increase significantly in
1984. Even if Central American countries manage to
adhere to austerity programs necessary for IMF and
other multilateral assistance, these agencies probably
will continue to face shortages of lendable funds. The
Central American Bank for Economic Integration, for
example, a small but important source of aid in the
past, by its own account is on the verge of insolvency.
Most bilateral lenders probably will continue to offer
only small aid packages until the regional turmoil is
3-Percent GDP Growth 3- to S-Percent GDP
(Following 0-Percent Decline (Following
Growth in 1983) . 3- to 5-Percent Decline
in 1983)
-2,382
-1,193
- 1,087
102
4,228
4.228
5,315
4,126
-1,295
-1,295
609
609
-2,991
-1,802
At these aid levels, we calculate that economic output
in the region as a whole will fall this year and next, al-
though prospects are brighter for Costa Rica and
Honduras, where further large declines may be avoid-
ed. Nevertheless, political pressures will mount every-
where in the wake of rising unemployment, increasing
bankruptcies, and shrinking consumption:
? Deterioration will be most pronounced in El Salva-
dor, where another 5-percent loss in economic out-
put is likely each year, furthering the insurgents'
goal of crippling the economy. Although steadily
worsening economic conditions may detract from
popular support for the guerrillas, we believe there
is a serious risk that the government's longstanding
inability to arrest the economic slide will work to the
advantage of the extreme right in the upcoming
elections.
resolved.
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We estimate that foreign aid disbursements in 1983
will fall $500-700 million short of the $2.5 billion
needed to prevent further economic slippage.a Com-
pliance with the terms of IMF austerity programs is
becoming more difficult, and pressure is mounting on
traditional bilateral lenders to increase assistance
accordingly. We judge that aidfrom official bilateral
sources will not grow significantly at least over the
near term, however, because most lenders-largely
for domestic political reasons-are reluctant to in-
crease commitments to the troubled region:
? Costa Rica probably will receive about $450 mil-
lion in foreign aid in 1983. Some $200 million will
come from multilateral sources, including $100
million from a one-year IMF standby agreement.
The United States, the largest individual bilateral
lender, will supply about $150 million, mostly in
Economic Support Funds (ESF). Other bilateral
aid-largely agricultural supplier credits and proj-
ect assistance-will come from West European
countries and Canada. In addition, Mexico and
Venezuela together provide concessionary financing
on oil purchases and small supplier credits for
other items.
? El Salvador is slated to receive approximately $475
million in foreign aid this year. Multilateral assis-
tance includes $35 million from combined IMF
standby/compensatory fund facility loans and $85
million from the Inter-American Development
Bank. US economic aid of about $200 million-in
development assistance, ESF, and other pro-
grams-leads other bilateral lending by far. Vene-
zuela, the second-largest individual lender, is pro-
viding about $60 million in supplier credits in
addition to partial oil financing. Colombia is a
smaller source of credits, and, according to US
Embassy reports, Bonn and Tokyo are considering
modest new aid packages.
Guatemala probably will collect about $200 million
in aid this year, much of it from multilateral
sources. Some $40 million probably will be dis-
bursed under a new $125 million, one-year IMF
standby accord. In addition, the Inter-American
Development Bank is expected to provide about $55
million. US economic assistance of about $60 mil-
lion will be closely trailed by Venezuelan credits,
mostly for oil financing.
? Honduras probably will receive approximately
$300 million in aid this year. Disbursements under
an IMF standby agreement will total about $70
million, and an additional $100 million is likely
from other multilateral sources. US loans under
various assistance programs will reach about $45
million, and other bilateral aid-West European
programs and Mexican-Venezuelan oil financing-
will total another $75 million.
Nicaragua probably will collect about $400 million
in hard currency loans and supplier credits this
year. Multilateral assistance is limited to small
project loans because Managua continues to reject
IMF austerity conditions. Mexico, traditionally
Nicaragua's largest individual lender, recently
tightened oil financing terms considerably, but we
expect that Mexican aid still will come close to the
$145 million in oil financing and supplier credits
provided last year. Managua has announced 1983
pledges from other Western sources-including
France, Spain, Scandinavia, and South America. In
addition, Nicaragua is stepping up appeals to Com-
munist countries, but we believe these sources will
continue to avoid disbursing hard currency aid.
Although Managua has announced $240 million in
supplier credits and technical assistance from
CEMA countries for 1983, we believe, in keeping
with past trends, that only a small portion of this
aid will be disbursed.
Despite the critical importance offoreign aid, we cannot project
receipts with precision because disbursements often driven by
political factors are subject to sudden change even in those
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? Economic performance probably will be similarly
weak in Guatemala, where we expect a decline of
4 percent this year. A bottoming out is possible in
1984 if the government manages to stick to the
terms of the new IMF program, but growing politi-
cal strains are making that course less likely. Mejia
already has scaled back the contentious value-added
tax in response to pressure from far right elements
in the military and business communities. The
resultant budget squeeze will force deeper cuts in
social services and public works programs, accord-
ing to the US Embassy, if Guatemala is to stay
within IMF credit ceilings. Growing economic hard-
ship probably will have the most pronounced effect
on the poor and will provide fresher opportunities
for exploitation by the guerrillas.
? The faltering economy in Nicaragua probably will
slip roughly 3 to 5 percent each year, and we believe
Managua will search for ways to protect living
standards of the lower class, the Sandinistas' core of
popular support. We expect that taxes on the middle
class will increase and that property confiscations
will be speeded up. For example, to shore up popular
support, the government recently hastened the dis-
tribution of nationalized farmland to peasants in
areas affected by the counterinsurgency.
? In Honduras, economic decline of about 2 percent is
likely this year, and constant year-to-year output
might be reached in 1984 if Tegucigalpa continues
to adhere to rigorous IMF-mandated austerity.
Nevertheless, popular support for the government-
now bolstered by the perceived threat from Nicara-
gua and the expectation that Suazo will attract
large amounts of US aid-could weaken, and labor
unrest and popular agitation could grow in the face
of expected increases in bankruptcies and unem-
ployment. Moreover, peasant land invasions could
rise because the government is short of funds for
legal expropriation of land.
? In Costa Rica, projected economic decline of about
2 percent this year and stagnation-at best-in
1984 will test Monge's willingess and ability to
adhere to the austerity measures crucial to under-
gird long-term economic recovery. Recent wide-
spread protests prompted the government to rescind
planned utility rate hikes, and Monge's substantial
public support is eroding. Not surprisingly, next
year's budget proposal, currently under legislative
consideration, contains inflationary spending meas-
ures that could torpedo the IMF program and
reverse the encouraging progress on debt reschedul-
ing made with foreign creditors.
Case II: Marked Insurgent Success
Regional security could deteriorate dramatically if
Managua and Havana significantly stepped up sup-
port for Salvadoran insurgents. This scenario also
postulates increases in insurgent activity in Nicara-
gua, growing terrorism in Honduras and Costa Rica,
and intensified Guatemalan rebel activity.
Although it is impossible to predict the regional
military and political outcome of such developments,
the economic impact would be clear:
? Production losses directly attributable to the fight-
ing would skyrocket in El Salvador, Nicaragua, and
Guatemala and could become a factor in economic
decline in Costa Rica and Honduras.
? Total investment would plunge as increased military
spending strained the shrinking tax base and soaked
up funds previously allocated to public development
projects. Net private investment at home, already
wobbling, would cease.
? The flight of capital and manpower would surge as
investors smuggled assets out of the troubled region.
In addition to peasants fleeing the violence, emigra-
tion of skilled labor and managers needed to accom-
plish any economic turnaround also would rise.
Expected increases in refugee flows would severely
strain resources of international relief agencies and
the recipient economies themselves.'
' The latest figures indicate that more than 180,000 Central
Americans are receiving assistance in foreign countries, principally
Honduras, Mexico, and Costa Rica, but reports vary and the total
number of refugees may be much larger
stimates that there are only 30,000 to 40,000 refugees in
ex co, although a paper discussed at a recent symposium suggests
that the number may be as high as 250,000. Throughout the region
an additional 740,000 are internally displaced, and larger numbers
I
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? Ironically, the current account of the balance of
payments could improve somewhat as the result of
possible steep reductions in imports but the ensuing
economic decline would be sizable. Although need
for imported food, medical supplies, and other basic
goods could grow, demand for intermediate imports
could again slacken considerably as the region
adopted a war footing. In the countries most severe-
ly affected, total imports could follow the pattern set
during Somoza's overthrow when such purchases
supplies ran down. This scenario further postulates
that insurgent activity in Nicaragua and Guatemala
also ends
were halved
Aggregate economic losses would be impossible to
calculate and would depend on the scope of guerrilla
victories. The climate of increased violence would,
however, cause distinctive shifts in production pat-
terns. In agriculture, cultivation of export crops would
wane and farmers-and, indeed, others-would shift
to subsistence crops. Regional commerce would break
down almost completely, and manufacturing sectors
probably would remain active only to the extent that
factories could be retooled to produce defense
materials.
In these bleak circumstances, foreign aid needed to
ward off economic decline would substantially exceed
the $2.5 billion projected in Case I. Moreover, no
amount of foreign aid would do more than prop up
imports and living standards. Because besieged gov-
ernments would be hard pressed to contain investor
panic or channel aid into productive investments, no
likely amount of foreign aid could spark economic
growth.
Nevertheless, governments battling vigorous insurgen-
cies would seek foreign aid with stepped-up urgency
as a means to slow the guerrilla momentum. Because
compliance with austerity programs would become
increasingly difficult-both from a political and eco-
nomic perspective-new lending from multilateral
sources would be highly unlikely. Countries would
turn their appeals toward bilateral lenders, particular-
ly the United States.
Case III: Decisive Military Victories
Should Cuban and Nicaraguan support for Salvador-
an insurgents cease entirely, sustainable guerrilla
activity in El Salvador eventually would fade as
Even if the improvement in the security climate were
dramatic, however, the region's economies would take
time to rebound proportionately:
? Guerrilla damage already inflicted would be costly
and time consuming to repair. In El Salvador and
Nicaragua, few damaged bridges, railroads, electric
power installations, and other facilities have been
repaired. Moreover, many of the repairs made to
vital facilities have been improvised because expen-
sive imported spare parts were unavailable or be-
cause further guerrilla attacks were anticipated.
? Foreign and domestic lender and investor confi-
dence would be slow to revive even under optimum
security conditions.
actoring in the US-sponsored incentives under
the Caribbean Basin Initiative, we believe several
years of peace and political stability would have to
pass before much new private capital would flow
into Central America. Moreover, local businessmen,
in our view, would want to better utilize existing
capacity before considering new undertakings.
? Governments would be largely unable to compen-
sate for soft private-sector investment. Although
substantially reduced defense needs could free up
funds for public investment purposes, interest on
public debt and expected wage hikes for government
employees could eat up most of these funds. Because
the tax base probably would expand only slowly,
overall government spending could not rise sharply
without threatening existing IMF accords.
? Demands for wage hikes would add to production
costs throughout the region as labor struggled to
regain former living standards. Unless import con-
trols remained in place, pent-up consumer demand
would compete with producers' needs for imports.
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? Low inventories, cannibalized equipment, and short-
ages of financing would constrain manufacturing
throughout the region. The pent-up import demand
for this sector probably could not be satisfied for
several years. Before regional trade in manufactures
could again become a key component of economic
growth, overdue debt to Guatemala and Costa Rica
would have to be rescheduled, import quotas re-
scinded, and barriers to currency convertibility
lowered.
? Lingering uncertainties about prospects for agrari-
an reform would constrain agricultural output in El
Salvador, Nicaragua, and, to a lesser extent, in
Guatemala and Honduras long after the fighting
stopped. Despite this problem, we would expect to
see substantial return to the cultivation of export
crops and an associated, and probably unfilled,
upsurge in demand for imported pesticides, fertiliz-
ers, and spare parts for farm machinery. The mi-
grant labor situation would return to normal only
slowly, contingent on free and safe movement, and
resolution of land reform issues and currency con-
vertibility problems.
Because the capital-starved region initially would be
unable to generate enough foreign exchange earnings
to finance import demand, large amounts of foreign
aid would be needed for several years. We estimate
that growing import demand would boost official
foreign aid needs beyond the $2.5-3.0 billion calculat-
ed in Case I until foreign private investment and
lending began in earnest. We judge that private-sector
activity and business confidence would recover faster
and become self-sustaining sooner in the presence of
adequate sums of foreign aid
Should the security climate improve, we believe some-
what more foreign assistance might become available
than would be disbursed in our first two scenarios.
Multilateral institutions might provide more funds,
particularly if Nicaragua reconsidered its longstand-
ing opposition to an IMF stabilization program. At
the same time, depending on the thrust of Central
American political developments, we believe bilateral
lenders might step up aid programs substantially
If foreign aid receipts fell substantially short of
requirements, however, there would be a high risk
that economic recovery would be jolted. Keen compe-
tition for scarce imports could set off an inflationary
spiral that would be difficult to control. Unmet
consumer expectations could translate into intractable
labor problems that would depress productivity. Un-
doubtedly, governments would be tempted to deviate
from stabilization programs even though such action
could jeopardize multilateral aid and compound eco-
nomic difficulties. In these circumstances, net new
foreign commercial lending would disappear and busi-
ness confidence would remain weak.
Long-Term Costs of Prolonged Insurgency
If insurgent activity drags on into mid-decade, the
costs of eventual economic reconstruction would soar.
The longer the fighting continues, the more damage
would be done to farms, factories, transportation
networks, and utilities, and the steeper would be the
final repair bill. Private capital stock, already neglect-
ed, would depreciate further. Businessmen who have
found ingenious ways to move their assets out of the
region would have little reason to stay, and the drain
of managerial and technical talent would be difficult
to reverse
The longer the battlefield is the arena for settling
conflicts, the smaller the eventual role of the private
sector would be in rebuilding the economies. Govern-
ments-working with minimal domestic capital re-
sources, a depleted tax base, and generally lacking the
skills found in the entrepreneurial class would as-
sume the key role in economic decision making. This
major departure from the private-sector-led growth
path of the 1960s and 1970s probably would result in
much slower growth, reduced access to private foreign
capital, and a chronic demand for foreign aid
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Economic aid will become an increasingly important
feature in US-Central American relations in the
coming years. Not only would continuing economic
turmoil prompt an increasing flow of refugees and
aggravate the already volatile political and military
balance in a region vital to US security interests, but
the Central American countries would petition Wash-
ington for aid with increasing urgency. We expect
weakening resolve to stick to tightening austerity
measures to jeopardize IMF and other multilateral
funding. Central American appeals to other tradition-
al bilateral lenders would be unlikely to meet with
much success until the military conflicts are resolved
and the political situation normalized. Indeed, all of
our scenarios forecast a large gap between aid needs
and likely receipts, a situation that would cause
continuing regional economic decline.
Although the broader implications of further econom-
ic deterioration in Central America would be serious,
the direct financial costs to the United States would
be relatively small. US private investment in the
region currently totals less than $800 million, accord-
ing to Commerce Department estimates. Of that
investment, more than half of it is concentrated in
Costa Rica and Guatemala. US trade with Central
America, which has been declining steadily since
1979, fell to about $1.4 billion in each direction in
1982. US trade is distributed about evenly among all
countries except Nicaragua, where it is substantially
lower. Agricultural commodities readily available
elsewhere on world markets account for the lion's
share of US purchases from Central America. US
exports include insecticides, herbicides, fertilizers,
grains, motor vehicle parts, petroleum products, medi-
cal supplies, and unsophisticated electrical machinery.
Because of continuing problems with overdue ac-
counts, many US exporters authorize new shipments
to the countries only when payment is guaranteed in
advance. Although a large chunk of Central Ameri-
ca's commercial debt is held by US banks, the
region's outstanding debt to these banks is dwarfed by
that of other Latin American countries.
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Appendix
Methodological Notes on Economic
Forecasts
This paper aggregates information presented in our
earlier appraisals of economic developments in indi-
vidual Central American countries.
? Foreign Debt. We relied on CIA estimates I 25X1
for our total debt
figures. We also used estimates of medium-
and long-term public and publicly guaranteed exter-
nal debt. Debt-service requirements were drawn
from official data supplied to the IMF and the US
At the heart of the projections in this paper are simple
national accounting models to which we applied vari-
ous assumptions concerning growth and exports to
determine likely import and financing needs. To deal
with uncertainties concerning world market condi-
tions, we derived two different commodity price sets
first pass through the data, we also assumed that
security conditions did not change much. We then
inspected the completed financial projections to deter-
mine--in a broad sense-their sensitivity to security
factors. This bracketing procedure provides the basis
for the discussion of the three cases in the text and the
data shown in table 6.
? Foreign Trade. Estimates were based on official
statistics as reported by the US Embassy, the US
Department of Agriculture, and the IMF.
Embassy and reflect IMF projections for debt relief
on publicly guaranteed debt.
? Agricultural Production. Our estimates and projec-
tions were based largely on field reporting by the
US Department of Agriculture.
The Projections
Our projections of foreign aid requirements for 1983-
84 were calculated as the financing needed to close a
projected foreign financial gap associated with a
particular assumed economic growth and the relat-
ed-and determinable-imports. Under this ap-
proach, the financial gap was calculated as:
FG=(1-E)-ST+A
where FG equals the financial gap, I equals import
expenditures, E equals export earnings, ST equals net
services and transfers, and A equals amortization of
medium- and long-term debt.
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Exports of primary products-such as bananas, beef, 25X1
coffee, lead, lumber, shellfish, silver, sugar, and
zinc-were calculated as the product of projected
volumes (based on a variety of open sources) and
commodity prices (derived from historical series). The
value of other exports, mostly manufactured goods,
was forecast to stagnate during 1983 and 1984 be-
cause of the continued disruption of intraregional
trade and inherent lags in increased exports, even if
economic recovery in the OECD countries is stronger
than we anticipate.
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Table 7
Central America: Projected Foreign Financing Gap, by Country, 1983-84 a
Costa Rica
0-Percent
GDP Growth
2-Percent
GDP Decline
3-Percent GDP Growth
(Following 0-Percent
Growth in 1983)
3- to 5-Percent GDP Decline
(Following 2-Percent
Decline in 1983)
Current account
-493
-340
-582
-328
175
-27
227
951
998
998
776
1,025
771
-515
-555
--555
122
134
134
Foreign financing gap
-615
-462
-716
-462
El Salvador
0-Percent
GDP Growth
5-Percent
GDP Decline
3-Percent GDP Growth
(Following 0-Percent
Growth in 1983)
5-Percent GDP Decline
(Following 5-Percent
Decline in 1983)
Current account
-400
-350
-- 400
-325
Trade balance
--235
-185
-300
-225
Exports (f.o.b.)
740
740
800
800
Imports (c.i.f.)
975
925
1,100
1,025
Net services and transfers
-165
-165
-100
- 100
125
150
150
Foreign financing gap
-525
-550
-475
Guatemala
0-Percent
GDP Growth
4-Percent
GDP Decline
3-Percent GDP Growth
(Following 0-Percent
Growth in 1983)
3- to 5-Percent GDP Decline
(Following 4-Percent
Decline in 1983)
Current account
-295
- 15
-410
0
Trade balance
-195
85
310
100
Exports (f.o.b.)
1,205
1,205
1,220
1,220
Imports (c.i.f.)
1,400
1,120
1,530
1,120
Net services and transfers
-100
-100
-100
-100
Amortization
90
90
105
105
Foreign financing gap
-385
-105
-515
-105
Honduras
0-Percent
GDP Growth
2-Percent
GDP Decline
3-Percent GDP Growth
(Following 0-Percent
Growth in 1983)
3- to 5-Percent GDP Decline
(Following 2-Percent
Decline in 1983)
Current account
-270
-250
-330
- 240
Trade balance
-30
-10
-70
20
Exports (f.o.b.)
680
680
710
710
Imports (c.i.f.)
710
690
780
690
- 240
-260
-260
110
120
120
Foreign financing gap
-380
-360
-450
Nicaragua
0-Percent
GDP Growth
3-Percent
GDP Decline
3-Percent GDP Growth
(Following 0-Percent
Growth in 1983)
3- to 5-Percent GDP Decline
(Following 3-Percent
Decline in 1983)
Current account
-545
-310
-660
-300
Trade balance
-305
-70
-380
-20
Exports (f.o.b.)
500
500
500
500
Imports (c.i.f.)
805
570
880
520
Net services and transfers
-240
-240
-280
-280
Amortization
90
90
100
100
Foreign financing gap
-635
-400
-760
a Assumes various economic growth rates, no change in security
conditions, and moderate commodity prices.
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For 1984, commodity export volumes generally were
projected to increase slightly. The reasons for these
changes varied by country and are presented in
appendixes to the individual reports.
Two different commodity price scenarios were derived
from regional export prices since 1979. One series
projects commodity prices continuing at the 1982
level through 1984; this results-on balance-in a low
price set. The other series is based on average annual
prices during 1980-82 and yields a moderately higher
price set. In keeping with CIA and other commodity
analysts' price expectations for global markets based
on the OECD business cycle and anticipated market
developments, we did not apply a high price series.
Because the net effect of the low and moderate price
series on total export earnings is only about 8 to 10
percent, for the sake of brevity we discussed only the
moderate price scenario in the text. Full detail can be
found in the country papers.
Imports were derived by applying import price in-
crease estimates to the real imports we calculated as
necessary to support our various assumptions about
economic activity. Real import aggregates were linked
with economic growth using incremental elasticity
formulas that varied by country.
Net services and transfers consisted primarily of
profit remittances and interest obligations on foreign
debt. Total interest payments for 1983-84 were pro-
jected based on the scheduled interest payments on
public and publicly guaranteed debt reported to the
IMF and on our estimate of 1982 interest paid on
private debt, which, for lack of further data, we
assumed remained the same for 1983-84. Freight and
insurance payments were projected as a constant
percentage of merchandise imports. Because other
categories of services and transfers (such as travel,
transportation, and unrequited transfers) were virtual-
ly constant during 1981-82, we kept the same values
for 1983-84.
Scheduled amortization, the remaining item needed
for our 1983-84 financial gap analysis, consisted of
principal payments on medium- and long-term exter-
nal debt. We relied on IMF projections to forecast
public and publicly guaranteed debt payments and
used the value of 1982 private-sector payments as a
proxy for amortization on private debt through 1984.
The IMF amortization figures reflect IMF projections
for debt relief on publicly guaranteed debt.
Table 6 summarizes the full range of our financial
gap analyses covered under Case I in the main text.
This projection series sets the financial conditions to
which we then applied our security assumptions to
consider possible changes in funding requirements
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