(UNTITLED)
Document Type:
Collection:
Document Number (FOIA) /ESDN (CREST):
CIA-RDP88T00768R000100020001-3
Release Decision:
RIPPUB
Original Classification:
C
Document Page Count:
34
Document Creation Date:
January 12, 2017
Document Release Date:
June 13, 2011
Sequence Number:
1
Case Number:
Publication Date:
January 1, 1986
Content Type:
REPORT
File:
Attachment | Size |
---|---|
![]() | 1.61 MB |
Body:
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Iq
Next 1 Page(s) In Document Denied
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Directorate of Confidential
Intelligence
Central American Core Four:
Struggle for Economic Recovery
Confidential
ALA 86-10002
January 1986
cony 362
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Directorate of Confidential
Intelligence
Central American Core Four:
Struggle for Economic Recovery
Division, ALA
This paper was prepared byl Ithe
Office of African and Latin American Analysis.
Comments and queries are welcome and may be
directed to the Chief, Middle American-Caribbean
Confidential
ALA 86-10002
January 1986
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Central American Core Four:
Struggle for Economic Recovery
Key Judgments Economic performance in the Core Four ' has been lackluster over the past
Information available five years, and the region has not yet rebounded from its worst recession on
as of 30 November 1985 record. Declining standards of living are generating social unrest and
was used in this report.
fueling political instability for hard-pressed governments in the region.
Trade, investment, and production have all been choked because of the
disruptions caused by the revolution in Nicaragua, guerrilla activity in El
Salvador and Guatemala, and depressed markets for the area's agricultural
exports. As the economies of the Core Four countries have stagnated, much
of their labor force and industrial capacity has been idled. Living standards
have steadily eroded, and regional per capita GDP is one-fifth below the
1979 level.
Against this regional backdrop, the Core Four countries have been unable
to date to build on increased US economic support to restart their
economies. While more US aid catalyzed a small amount of GDP growth
in 1984 and 1985, local economies have shown virtually no sign of
internally generated economic growth. According to Embassy reporting
foreign commercial lending is almost nonexistent,
capital flight is still draining domestic investment funds, public investment
programs are being trimmed because of persistent budget deficits, and
regional turmoil continues to dampen business confidence.
External constraints and an array of internal problems will probably
continue to undercut any sustained economic recovery for some time to
come. Competition in international commodity markets are keeping export
prices depressed and limiting prospects for steady economic growth based
on exports of traditional crops-coffee, bananas, cotton, and sugar.
Prospects for diversifying the export base to new crops and manufactured
goods are clouded by the poor investment climate. Large debt service
obligations, incurred when officials borrowed heavily at the onset of the
region's economic decline, further restrict growth prospects.
' The Central American Core Four includes Costa Rica, El Salvador, Guatemala, and
Honduras. Nicaragua's expanded state role in the economy and its drastically altered trade
and aid patterns eliminate many of the similarities with its neighbors that previously
enhanced regional economic analysis. We therefore exclude it from detailed consideration
and examine only its interaction with the other Central American economies.
Confidential
ALA 86-10002
January 1986
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
From a domestic standpoint, Core Four leaders are finding it increasingly
difficult to adopt and maintain measures needed to rebuild strong econo-
mies. Reform programs are being implemented only on the margin,
because governments fear political backlash. Guatemala, Honduras, and
Costa Rica for example, have all shown signs of policy compromise to avoid
public discontent in the face of local elections. Failure to adopt responsible
exchange rate, monetary, and fiscal policies has not only weakened the
local investment climate but also has resulted in the loss of badly needed
foreign financial funding that would be available with comprehensive
stabilization programs.
In our judgment, both internal and external constraints to economic
recovery are unlikely to ease significantly any time soon. For at least the
next year we see only marginal improvement in the area's security
situation, persistent trade and debt problems, and a continuing domestic
economic policy drift. In these circumstances, we judge that Core Four
economic growth will stay below 2 percent through 1986.
In our view, continuing economic troubles are likely to undercut social and
political progress in the region. Widespread frustration may revive political
instability, making the Core Four more vulnerable to political radicals or
armed insurgents. Such pressures are likely to lead to strains in US
relations with Core Four governments as they demand ever higher levels of
US financial and economic aid.
Even under favorable circumstances, our analysis indicates that it will take
more than a decade to restore living standards to pre-1980 levels. In this
situation, even with preferential trade and aid from the United States, we
expect growing local criticism of close economic and political ties to the US
from the press, opposition politicians, and labor unions. On the plus side,
we expect that even worse economic problems in Nicaragua will provide
little incentive for radical political movements within the Core Four
countries to point to Sandinista-style economic structures and institutions
as a role model.
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
The Setting for Economic Growth
4
Looking Beyond the Short Term
10
Implications for the United States
15
A. Regional Economic Integration
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
Figure 1
Central America Core Four
South
Pacific
Ocean
Boundary raprosentation is
not napassarily autnoritativa.
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
Central American Core Four:
Struggle for Economic Recovery
During the past five years, Central America's econo-
mies have been buffeted by adverse circumstances.
Since 1979, regional trade has declined, international
credits and foreign investment lost, and private-sector
business confidence has eroded. Local political and
security problems, as well as external economic condi-
tions, continue to complicate efforts by regional gov-
ernments to end five consecutive years of falling per
capita incomes.
This paper describes the economic conditions and
prospects of the Core Four countries of Central
America: Costa Rica, El Salvador, Honduras, and
Guatemala. It examines how the region's economies
are faring, and explores alternative growth scenarios
through the 1990s. It also assesses the impact of those
projections for area governments and for political
stability in the region.
Since 1979 the Core Four countries have departed
dramatically from the favorable economic growth of
the 1960s and 1970s that provided consistent improve-
ment in average living standards. The economies of
the region have been hard hit by the mutually rein-
forcing effects of a dramatic deterioration in the
international terms of trade, inadequate domestic
economic policies, and political turmoil. As a result,
the region is experiencing its worst economic perfor-
mance on record, although sharply higher US aid to
the region since 1982 has eased economic problems
somewhat.
On the international front, IMF and other financial
data show that the fall in the region's terms of trade
was touched off by the sharp fall in coffee prices in
1978 and a doubling of imported oil prices during
1979-80. Balance-of-payments positions eroded, be-
cause coffee provides one-third of the Core Four's
export earnings and petroleum purchases are 20 per-
cent of imports. El Salvador was particularly hard hit
because coffee provided more than half of the coun-
try's export earnings. Regional balance-of-payments
problems were compounded by dramatic capital
flight, which IMF estimates place at $2 billion for
Guatemala and El Salvador combined from 1979 to
1982. Capital inflows from foreign sources dried up as
commercial banks cut back on supplier credits, and
direct foreign investment fell sharply. Large numbers
of foreign investors left the area during these years
because of political violence. In El Salvador, for
example, most of the large Japanese business commu-
nity left in 1979, following the kidnaping and slaying
of several prominent Japanese businessmen. Similar
trends were seen in Guatemala and Honduras. US
Department of Commerce data show that US busi-
nesses pulled out $100 million from Core Four
projects during 1981-84.
On the domestic economic policy front, a retrospective
look at national and IMF economic data shows that
these countries did not take adequate economic ad-
justment measures in the face of these external
shocks. In general, their actions indicated they hoped
for a quick turnaround and tried to maintain living
standards and curb political reactions by boosting
government spending, raising consumer subsidies, and
by maintaining unrealistic exchange rates. These poli-
cies only worsened the depressed and unstable eco-
nomic situation. For example, by 1982 Costa Rica
had run up a budget deficit equal to 14 percent of
GDP, and inflation soared to triple-digit levels. Ac-
cording to Embassy reporting, subsidized electricity
and other services provided by government corpora-
tions greatly increased both domestic and external
debt obligations. IMF financial statistics show that all
four countries maintained overvalued exchange rates,
trying to avoid devaluing currencies that had main-
tained fixed values against the US dollar for almost
50 years. Costa Rica, facing the most severe external
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
The Central American countries-including Nicara-
gua-share important similarities and linkages that
provided the foundation for fast paced economic ex-
pansion during much of the period from World War
II until 1979, the year of the Sandinista revolution.
During 1961-78, for example, Central American offi-
cial statistics show that economic growth rates
matched the Latin American average of 5.6 percent
per year and surpassed that of LDCs as a whole.
These common growth paths-built on periodic
booms in agricultural commodity prices, regionally
protected manufacturing sectors, and foreign borrow-
ing-failed, however, to foster steady, broad-based
economic expansion.
Agriculture, the keystone of the region's economic
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-international
trade data show that the region's longstanding depen-
dence on these items for the bulk of export earnings
did not lessen. Agriculture also provided the spring-
board for industrialization;
in addition to the 26 percent of Central
American economic activity directly attributable to
agriculture in 1978, 75 percent of the fast-growing
manufacturing sector was related to agriculture.
Food processing accounted for nearly half of manu-
facturing activity.
The nascent manufacturing sectors provided the most
energetic component of regional economic growth,
expanding at an average annual rate of 7.4 percent
during 1961-78. We believe this impressive perfor-
mance was largely attributable to the expansion of
the Central American Common Market (CA CM),
which was formed in 1960. As a result, intraregional
trade boomed, and by 1980 accounted for nearly one-
fourth of total international sales and absorbed virtu-
ally all the region's manufactured exports, according
to trade data. At the same time, however, the compo-
sition of this trade suggests that CACM countries
had not developed products that would be competitive
outside the protected common market.
The rapid economic growth was supported by moder-
ate amounts of foreign borrowing. According to inter-
national financial statistics, Central America's exter-
nal public debt was a manageable $4 billion at the
end of 1979. Foreign interest and principal payments
consumed just 11 percent of their export earnings
during 1970-78, as compared with 23 percent for
Latin America as a whole.
This dynamic economic growth performance was not
without social shortcomings. Although many Central
Americans benefited from the growth of the 1960s
and 1970s, numerous observers have noted the lack
of progress on political and social problems. Academ-
ic studies indicate that more than half of the region's
population lived in poverty in the late 1970s, while a
third or more were classified as extremely poor.
Rapid population growth and urbanization over-
whelmed the region's social resources, while gains in
the manufacturing sector were often unbalanced be-
tween and within countries. Despite the rising expec-
tations stimulated by the aggregate improvement in
economic conditions, few gains were made in public
health, education, housing, and nutrition, and the
deep gulf between rich and poor remained.
25X1
25X1
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
payments problems of the Core Four, finally was
forced to make a much needed currency devaluation
? Costa Rica and Guatemala, the most advanced
economies in the region, experienced per capita
income declines of about 15 percent. Both were
heavily dependent on regional trade, and suffered
disproportionately when trade within the Central
American Common Market (CACM) shrank and
idled much of the industrial capacity.' Costa Rica
suffered the bulk of its decline in just one year,
1982, a year of 100-percent inflation and severe
problems with external and internal finances. Gua-
temala's decline was slower and more prolonged,
aggravated by diminishing demand in both domestic
and foreign markets.
in 1982.
At the same time, political turmoil in the region
increased precipitously. Following the revolution in
Nicaragua, existing insurgencies grew in El Salvador
and Guatemala, while governments in Honduras and
Costa Rica found themselves, to varying degrees,
affected by the spillover. The cost of insurgency has
been greatest in El Salvador. The US Embassy in San
Salvador estimates the cumulative war losses from
direct damage and lost production between 1979 and
1984 at $1.2 billion, with annual losses of about $250
million during the last two years. Guatemala's insur-
gency, although much reduced from the early 1980s,
continues to have an adverse effect on the business
climate and tourist industry.
Guatemalan tourist
receipts fell from $90 million in 1979 to only $13
million in 1984. Although Costa Rica and Honduras
have been spared the effects of active insurgencies,
both have had to divert budget resources to security
spending to meet the Sandinista military and subver-
sive threat.
The net impact olall this is evident in national income
statistics, which show these countries in their deepest
recessions on record. For example, by the end of 1984,
average per capita GDP in the Core Four countries
was 17 percent below the 1979 peak. Although similar
factors contributed to the decline of economic activity
throughout the region, local statistics show that the
recession was more intense in some countries:
? The sharpest drop was in El Salvador, where aver-
age income fell by 30 percent. Insurgency gripped
the country in 1979 when rebels, seeking to lessen
support for the ruling junta, attacked the economic
targets. In 1980 the government dealt an additional
blow to the economy by instituting land reform and
nationalizing banks and agricultural exports. Ac-
cording to Embassy reporting, both events seriously
eroded business confidence and accelerated the
flight of capital and entrepreneurs.
? Honduras, although the poorest country in the
region, experienced a smaller decline than the other
three-about 11 percent. Tegucigalpa was shielded
by the minor role of intraregional trade in its 25X1
economy and the predominance of agriculture, 25X1
which requires somewhat lesser amounts of import-
ed resources and goods for continued production.
The social cost of the region's economic decline,
although difficult to quantify, also was great. Accord-
ing to US Embassy reporting from El Salvador, the
trend toward industrialization, which had moved
workers from artisan to modern sector activities, has,
at least temporarily, been reversed. While UN statis-
tics suggest the population explosion of the 1960s
poured about 200,000 new workers into the Core Four
labor force each year during the 1979-84 period,
government data underscores the fact that few new
jobs were created. As a result, most of these new
workers were unemployed or underemployed. At the
end of 1984, official estimates placed the average
unemployment rate in the region at about 20 percent,
with some 1.3 million workers without jobs. In El
Salvador, nearly a third of the labor force was out of
3 The CACM was founded in 1960 to facilitate free trade in
manufactured goods among Costa Rica, El Salvador, Guatemala,
Honduras, and Nicaragua. It has been buffetted by regional
turmoil since 1980 and its future as an institution is clouded. For
details see appendix A.
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
Table I
US Aid to Core Four, 1984
Estimated
Population
(million)
GDP GDP Per US- US
(billion Capita Economic Economic
US $) (US $) Assistance Assistance
(million as Percent
US$) of GDP
work, and the situation was not much better in
Honduras. Moreover, nearly half of those with jobs in
El Salvador, Honduras, and Guatemala were under-
employed, because their jobs were only seasonal or
part time, according to Embassy reporting.
The region's economic problems eased somewhat in
1984 with a dramatic infusion of US economic assis-
tance. Annual commitments of US aid to the Core
Four rose from $83 million in 1979 to $771 million in
1984, with the first installment from the Jackson Plan
based on recommendations made by the Kissinger
Commission on Central America.' Balance-of-
payments support has been instrumental in funding
productive imports. Development assistance also has
played an important role by taking up some slack
where governments had cut development spending
and public investment outlays to control fiscal defi-
cits.
In the opinion of a number of private-sector observers,
expanded US aid to the region probably was the
determining factor that stemmed the economic de-
cline in 1984 of the Core Four countries. Despite still
negative per capita income trends, official estimates
indicate regional GDP growth was nearly 2 percent,
the first economic expansion of any kind in four years.
Each country experienced positive real GDP growth,
led by Costa Rica at 5.5 percent and trailed by
Guatemala with 0.2 percent growth. Gains also were
made on the inflation front, with all countries except
El Salvador reducing the rate of consumer price
increases. On the other hand, Core Four balance-of-
payments positions deteriorated as current account
deficits expanded across the board. With the excep-
tion of Guatemala, which receives only a little US aid,
these wider deficits were largely offset by increases in
US balance-of-payments assistance.
In our assessment, a number of factors will continue
to limit the region's economic performance. Each
country faces common external constraints and an
array of serious internal problems that must be
overcome if the region is to achieve even moderate
growth. Moreover, without a substantial improvement
in the area's political environment, even greatly in-
creased foreign assistance would be inadequate to
restore past levels of economic expansion.
25X1
25X1
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
External Factors
International economic conditions clearly will affect
the economies of Central America, both directly and
indirectly. Despite recent moderate world economic
expansion and decreasing energy prices, we do not
expect Central America's traditional markets to grow
anywhere near the pace of the 1960s and 1970s.
Moreover, from a narrower regional perspective,
CACM is unlikely to be revived in the near future
without a major reduction in trade barriers and
settlement of clearinghouse balances on a timely
basis. The region's exports of nontraditional products
outside the common market-such as light manufac-
tures, fruits, and vegetables-are likely to post only
modest gains, despite favorable tax treatment, until
the overall investment climate improves.
While prospects for most Core Four exports are dim,
better coffee prices could boost traditional exports
somewhat. Despite current record inventories, world
coffee prices strengthened at the end of 1985 as
commodity analysts began to project lower 1985/86
coffee output because of an extended drought in
Brazil's key producing states. International commod-
ity experts, however, forecast continued depressed
prices for sugar, cotton, and bananas, the Core Four's
other principal commodity exports. The benefits from
selling sugar to the United States at premium prices
are diminishing as US quotas continue to contract.
Moreover, world sugar prices have been hovering near
a 15-year low, and large stocks worldwide probably
will hold down prices for years to come. The outlook
for cotton and banana prices also is dim because of
intense competition among producers for a share of
world markets. Banana prices began to strengthen
somewhat in the first half of 1985, but industry
sources do not expect this trend to be sustained over
Figure 2
Core Four Composition of Exports,
1980-84
Manufactured goods
to CACM
Cotton
Sugar
Meat
Other
the longer term.
Prospects for the region's nonagricultural exports also
are poor. Virtually all of the Core Four's manufac-
tured goods are sold in the CACM and continuing
balance-of-payments problems are prompting member
governments to maintain or even strengthen existing
trade barriers.' According to Embassy reporting from
the area, Costa Rica has halted credit sales to CACM
countries to stem the accumulation of bilateral debts.
Honduras has restricted access to foreign currencies
to narrow its growing trade deficit within CACM. As
25X1
2bAi
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
Table 2
Core Four Debt Indicators, 1985 a
Total
External
Debt
(midyear
1985,
Debt
to
GDP
(percent)
Debt
Service
(million
US $)
Debt
Service
Ratio
(percent)
million
us $)
Latin America
380,000
48
56,000
41
Core Four
11,000
53
1,510
36
Costa Rica
4,100
123
500
53
El Salvador
2,100
47
335
33
Guatemala
2,400
25
475
37
Honduras
2,400
74
200
30
a Based on US Embassy reporting, IMF statistics, and open
sources.
a result, the regional market for manufactured prod-
ucts is shrinking. Producers cannot easily tap into
well-established outside markets after being shielded
from competition for 25 years by a protective common
external tariff.
In these circumstances, export expansion over the
longer haul probably will require a change in Central
America's export base. This, in turn, will depend on
an improvement in the region's political environment
and the creation of a climate more conducive to
private-sector investment. Recent domestic policy
measures, which grant tax holidays for new invest-
ments, complemented by incentives flowing from the
Caribbean Basin Initiative (CBI), are having some
impact in each of the Core Four countries. Exports of
nontraditional products from Central America to the
United States were up 10 percent in 1984, according
to IMF trade data, compared to only a 5-percent rise
in all categories of exports. Preliminary trade data for
1985 indicate that nontraditional exports will not
match last year's gain, but will still slightly exceed
overall export growth.
Debt service obligations of $1.5 billion each year also
will undercut the Core Four's ability to support its
import-dependent industries for the rest of this de-
cade, in our view. Official data show that the Core
Four's external debt represents a substantially higher
share of GDP than in Latin America as a whole. Even
so, because a larger portion of the region's debt is
owed to multilateral and bilateral lenders on conces-
sional terms, its ratio of debt service to exports is
somewhat less than the Latin American average.
Regional Constraints
Numerous factors at work within the region itself also
limit economic prospects for the region. The region's
governments lack the political consensus needed to
make tough economic policy changes, such as estab-
lishing and maintaining trade-competitive exchange
rates, overhauling tax systems and collection methods,
and trimming overgrown public enterprises. More-
over, candidates for elections in Guatemala, Hondu-
ras, and Costa Rica have focused consumer discontent
on declining living standards and have deterred gov-
ernments from austerity measures. Labor unions and
consumer groups have also increasingly opposed the
government on these questions.
In some ways the region's economic constraints are
beyond the control of the individual governments.
Despite almost no insurgent activity in Honduras and
Costa Rica, for example, violence in the other coun-
tries has made foreign investors wary of the entire
region, according to both Embassy and private-sector
observers. Data from the US Department of Com-
merce show that the fall in US investment in Hondu-
ras and Costa Rica during 1980-84 equalled the
decline in investment in El Salvador and Guatemala.
In addition, as the Sandinistas continue to shift their
trading focus from the region to the Soviet Bloc, the
Core Four loses Managua as a market for manufac-
tured exports.
Before investors return to the area, they will need to
be convinced that the governments can provide ade-
quate security and favorable economic policies over at
least the medium term. We expect it would take two
years or more of consistent, pro-investment policies as
well as a reduction in political tension and insurgent
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
activity, before Central American entrepreneurs could
be expected to repatriate capital. Foreign investors
would probably require an even longer track record.
While all Core Four countries have been confronted
with similar regional and domestic problems, different
social and political pressures have resulted in unique
policy mixes in each country. Each has identifiable
short- and long-term implications.
Country Prospects
Based on a review of growth prospects in each coun-
try, we believe Core Four GDP will rise only 1 percent
in 1985, down from nearly 2 percent in 1984. The
lower growth rate stems from this year's decline in the
Guatemalan economy-the largest in the region-and
lower, but still positive, growth in the other countries.
For 1986 we see slightly better conditions facing the
Core Four as Guatemala again registers positive
growth. Even so, we expect that growth will be limited
to around 1.5 percent. Internally, the new civilian
presidents in Guatemala, Honduras, and Costa Rica
will probably begin to implement some needed eco-
nomic adjustments, at least along the margin.
On the external side we expect serious and persistent
trade, debt, and security problems to cap real GDP
gains. Because the predicted modest growth falls short
of projected population increases, average living stan-
dards will continue to erode except in Costa Rica,
where a slight gain is likely. Regional unemployment
problems will persist and probably worsen as new job
creation fails to match the demographics of the work
force. Despite our forecast of sluggish economies
through 1986, modest Core Four growth is a substan-
tial improvement over the early 1980s.
The Guatemalan Government failed to implement
economic reforms in 1985. According to Embassy
reporting, the key reasons for lack of action was an
absence of consensus among interest groups and Chief
of State Mejia's unwillingness to bear the political
repercussions of tax increases or spending restraint.
The impact of lack of action was compounded by
developments on the foreign exchange front. A poorly
planned transition to a dual currency rate system in
Figure 3
Core Four Real GDP Growth,
1979-86
Core Four Core Four Real GDP
per Capita
OTM
-10 1979 80 81 82 83 84 8516" -10 1979 80 81 82 83 84 8546"
11 Projected.
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
late 1984 sharply reduced Central Bank foreign ex-
change receipts: exporters withheld funds from the
official market to obtain better rates on the free
market. The quetzal depreciated rapidly as Guatema-
lans converted cash holdings to dollars in response to
uncertainty over transferring power to a civilian presi-
dent and negative rates of return on domestic savings
from controlled interest rates. All told, Guatemala
experienced a 60-percent devaluation during the year,
well above the country's 45-percent rate of inflation.
Production during the year was disrupted because
government foreign exchange receipts were inade-
quate to pay for fuel supplies and other priority
imports. Indeed, independent forecasters suggest that
Guatemala will likely register a 1-percent decline in
GNP for 1985. By August and September, demon-
strations by labor and consumer groups, angry over
inflation and shortages forced Mejia to abandon any
thought of preelection austerity measures and to fire
two ministers favoring devaluation and fiscal re-
straint, according to Embassy reporting
Looking ahead, the civilian president scheduled to
take office in January will inherit even greater eco-
nomic problems as a result of Mejia's postponement of
fiscal and monetary restraint. Even so, some improve-
ment can be expected for 1986. According to Embas-
sy and press reporting, foreign economic assistance is
likely to increase somewhat if the transition to civilian
rule goes smoothly. Such aid could boost depleted
foreign reserves by the second half of 1986 and lead to
a rebound of crucial imports. Donor conditions for
expanded aid programs, however, will require policies
to stabilize exchange rates, raise taxes, and slow
credit expansion-moves that will be politically diffi-
cult for a democratic government. On balance, the
best we see for the economy is a rebound during the
second half of 1986, and overall GDP growth of 1
percent for the year.
Costa Rica's economic growth probably will slide in
1985 to about 3 percent, according to several indepen-
dent forecasts. That is just one-half of last year's level
but still the highest in the region. The lower growth is
largely the result of reduced production for export and
falling domestic demand. For example, according to
press a major drop in banana
In the current economic situation, public-sector bud-
get deficit problems are likely to remain severe,
limiting the usefulness offiscal policy as a political
tool. According to US Embassy reporting over the
past few years, each of the Core Four governments
has limited ability to increase public revenues. Their
margin to cut expenditures is even less.
The region's governments face a difficult challenge in
boosting revenues. Higher tax rates could discourage
production, increase tax evasion, and further harm
the business climate. A rebound in the volume of
foreign trade-from which the bulk of taxes is de-
rived-could provide some relief, but much of any
new export expansion will come from nontraditional
categories that have recently been given special tax
incentives. To both enhance revenues and smooth
cyclical fluctuations, the region's governments proba-
bly will have to revise tax structures to reduce the
reliance on export and import taxes as well as
intensify efforts to assure compliance.
Options for paring expenditures are equally con-
strained, and governments are having trouble main-
taining reduced spending levels. Attempts to cut
spending by paring public-sector employment are
hindered by already high unemployment rates and
strong unions capable of paralyzing many vital gov-
ernment services. Only limited progress has been
made by governments to divest themselves of enter-
prises whose services could be provided by the private
sector, and political considerations stand in the way
of more decisive actions. US Embassy reporting from
the Core Four countries indicates that public-sector
employees are pushing for wage increases after five
years of on-and-off wage freeze policies. These pres-
sures have become particularly acute this year in
El Salvador and Guatemala, where inflation has
sharply reduced consumers' purchasing power.
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
Figure 4
Core Four Economic Performance Indicators, 1985a
? Costa Rica
0 El Salvador
Guatemala
Per Capita GDP Unemployment
Index: 1979=100 Percent
Inflation
Percent
Budget Deficit Current Account
as a Share of GDP Deficit as a Share
Percent of GDP
Percent
output-as foreign producers abandoned their opera-
tions, citing low world prices, excessive taxes, and
bureaucratic interference-has been the chief export
problem. Based on preliminary government data, the
economic expansion that is occurring is coming from
slight industrial growth and a small boost in sales of
nontraditional exports. While many financial observ-
ers believe that Costa Rica's financial stabilization
program has been the most successful in the region-
it is the only Core Four country that had an IMF-
endorsed economic program during the year-politi-
cal pressures have held up some needed initiatives. At
midyear, for example, the US Embassy reported that
San Jose temporarily fell out of compliance with its
IMF program, in large part because election politick-
ing caused the National Assembly to block progress
on trade and budget deficits.
Economic prospects for 1086 are no better. To regain
access to funds from the IMF and the rest of the
international financial community, San Jose has pub-
licly agreed to tougher austerity steps for next year,
including spending cuts, new budget controls over
state enterprises, and a wage freeze. Thus the new
president scheduled to take over in May 1986 will
have to rely on tighter budget restraints. On the basis
of US Embassy reporting, we believe that widely
discussed initiatives on trade promotion are unlikely
to materialize because of opposition from influential
domestic business interests who will seek to maintain
their protected markets. While Costa Rica's 1986
austerity package will help set the stage for future
growth, it will check economic activity at least in the
short run. Overall, we agree with macroeconomic
forecasters who see 3-percent economic growth as the
best that San Jose can expect for next year.
Although the Salvadoran Government and indepen-
dent forecasters had been projecting 2- to 3-percent
growth for 1985, recent Embassy reporting indicates
that final growth figures will be lower, probably closer
to 1 percent. Most observers believe that the failure to
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
build on the positive growth of 1984 is largely due to
poor macroeconomic policy and private-sector distrust
of the socialist orientation of the Christian Democrat-
ic Party. A gradual improvement in President Duar-
te's strained relations with the business community
was quickly reversed in August, according to Embassy
reporting, when the government failed to consult the
private sector on a decree that limited profit margins
for some industries. The balance of payments contin-
ued to worsen because of Duarte's reluctance to adopt
stabilization measures during his first year in office.
In addition, inflation was up sharply according to
Salvadoran statistics, spurred by an acceleration of
monetary growth and a rapid currency depreciation
on the free market.
Various problems are likely to continue to constrain
economic performance in 1986. Rising price levels
will complicate efforts to keep government spending
under control; workers will seek compensating wage
hikes. Duarte probably will have to accede to workers'
demands to prevent crippling strikes and work stop-
pages. At the same time persistent insurgent attacks
against economic targets-such as electricity and
transportation networks, and export crops-will con-
tinue. Moreover, we see no sign that Duarte will
reverse the current policy drift that has further
worsened inflation and the investment climate. Under
these conditions, economic decline and deteriorating
government finances will be avoided, in our view, only
through sustained infusions of US economic and
military assistance. Indeed, on balance we believe US
aid should be enough to achieve 2-percent real growth
next year. Because policy initiatives by Duarte could
increase the effectiveness of US aid-for example, if
the colon is devalued soon as promised, and if steps.
are taken to regain private-sector confidence-growth
could be higher.
For Honduras, most forecasters are estimating real
growth of about 2 percent in 1985, although the
government's midyear estimate projects more optimis-
tic growth exceeding 3 percent. The key behind
Honduras's performance, according to US Embassy
and press reporting, is that high levels of government
spending and international support have been suffi-
cient to offset weaknesses in the private sector=
US EmbassyF ] officials believe the economy
requires a strong set of stabilization measures, partic-
ularly a devaluation of the lempira. Nevertheless,
Embassy and press reporting indicates that Hondur-
as's dependence on consumer and industrial imports
has made politicians, the military, labor groups, and
much of the private sector dead set against any
currency devaluation. Instead, the government has
openly opted to keep ailing export industries afloat by
granting special tax incentives. We believe this bodes
ill for long-term growth and investment prospects in
an economy already overburdened with graft and
favoritism. The Suazo government also has been
unwilling to limit spending or raise taxes to control
the fiscal deficit, which we estimate will be 11 percent
of GDP this year.
The lack of attention to corrective economic policy is
likely to catch up with Honduras in 1986. Sustained
levels of US support probably will be sufficient to
allow real GDP to grow by 2 percent, but other
economic indicators are likely to decline. We believe
the expansionary fiscal and monetary policies of the
last two years will begin to accelerate inflation. This
will further encourage demands by public-sector
workers for higher wages, which will require even
greater domestic financing of the deficit. On the trade
front, the international competitiveness of Honduran
products will continue to suffer from the unrealistic
exchange rate. Manufacturers selling in the domestic
market will be dealt a further blow by cheap goods
from Core Four neighbors who already have devalued
their currencies. We see little relief in sight since most
leading presidential candidates have avoided discus-
sion of economic policy issues during the campaigns,
and have not indicated that they will make needed
reforms top priorities after the elections.
As long as Nicaragua remains a threat. to its neigh-
bors and El Salvador and Guatemala are unable to
eliminate their insurgencies, Core Four economic
performance will remain substantially below poten-
tial. As pointed out by the Kissinger Commission in
1984, and others since then, Central America will not
25X1
25X1
25X1
25X1
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
Table 3
Core Four Balance of Payments a
Capital account balance, errors,
and omissions
Net change in international
reserves
697
1,528
993
1,094
1,126
-23
-152
-243
-278
-246
9
15
31
38
40
224
206
389
257
337
6
-458
54
-119
- I
Capital account balance, errors,
and omissions
Net change in international
reserves
123
-227
49
272
355
30
-288
-180
8
33
Capital account balance, errors,
and omissions
Net change in international
reserves
Net transfers balance
Capital account balance, errors,
and omissions
Net change in international
reserves
171
-91
305
415
383
121
-254
29
18
0
17
21
45
80
107
166
242
207
235
260
54
-78
-18
-8
-15
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
Table 3
Core Four Balance of Payments a (continued)
Exports (f.o.b.)
Imports (c.i.f.)
Net services balance
Capital account balance, errors,
and omissions
Net change in international
reserves
1,977
4,324
3,392
3,617
3,784
2,413
5,180
3,841
4,252
4,484
-174
-526
-802
-896
-960
589
130
950
1,179
1,335
111
-1,078
-115
-101
a Based on US Embassy reporting, IMF statistics, and open
sources.
b Figures for 1985 are estimated.
Table 4
Central American Trade With the United States, 1984 a
Percent of Exports to Percent of Imports Exports as Imports as
United States From United States a Percent of GDP a Percent of GDP
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
Figure 5
Core Four Growth Scenarios,
1979-2000a
Two percent growth
1.0
III III II VIII III 11111 III II VIII I II II II IIII
0 0
II I111111II V IIIIIIIII I I IIIIII111111111 IIIII
11111111~~~ 1111111 III
0 1979 86 2000
e All 1985 thru 2000 values are projected. Figures cited are real per capita
GDP.
see a renewal of the vigorous-5.6 percent annual-
economic growth the region enjoyed during 1961-78
until:
? The region's political turmoil is ended.
? Substantial net capital flows resume.
? Local governments adopt fundamental changes in
economic policies.
Because of the current fluid political situation, there
is considerable margin for error in long-term regional
economic projections. The only consensus among fore-
casters is that prospects for renewed vigorous econom-
ic growth any time soon are virtually nil.
Because of the uncertainty over the future course of
economic conditions in Central America, we have
examined two post-1986 economic growth scenarios
and their implications from social and security points
of view. We believe these two scenarios bound the
range of likely outcomes. The first case assumes a
general continuation of the 1984-86 economic perfor-
mance-real GDP growth of about 2 percent per
year-through the rest of this century. The second
scenario foresees a gradual restoration of security and
investment patterns, yielding average annual real
GDP growth of 5 percent-the best we believe the
region would be likely to achieve based on the histori-
cal record of previous long-term expansion.
Without some further economic rebound, the
2-percent growth path-falling short of the region's
3-percent annual population increase-would see a
steady decline in average living standards. Given
current production levels the continued sluggish
regional economy would absorb only about half of
the estimated 200,000 new entrants to the labor force
each year. Under these conditions, we believe frus-
trated youth will increasingly be channeled into the
informal economy, worsening the region's income
distribution and encouraging continued emigration.
On the other hand, while an average annual growth of
5 percent would provide gradual improvement in per
capita income, most experts agree it still would be
insufficient to create enough jobs to substantially
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
Vigorously implement the fiscal and monetary
conditions of its IMF Standby Agreement, avoid-
ing the lapses that have characterized recent
experience.
- Encourage exports by lowering trade barriers,
despite opposition from domestic business lead-
ers, and by reducing export taxes and bureaucrat-
ic interference. These incentives are especially
important for potential recovery in the banana
sector.
Make peace with the private sector by demon-
strating some willingness to make requested ac-
commodations. This could involve some revamp-
ing of the 1980 reforms: allowing the private
sector to compete with government monopolies in
banking and agricultural export marketing, or
making a stronger commitment to compensate
those affected by the land reform program.
More aggressive depreciation of the exchange rate
by expanding the parallel market and allowing it
to reflect market forces.
Increase productive efficiency through the divesti-
ture of public enterprises, whose services can be
provided better by the private sector.
Carry through on current initiative to revitalize
regional trade by working with other Core Four
countries to eliminate intraregional trade arrears
and restore former patterns of exchange.
Work to phase out wage and price controls to
allow more efficient and more productive employ-
Simplify bureaucratic procedures and end per-
ceived political favoritism, especially for those
dealing with obtaining foreign exchange.
- End discriminatory pricing policies for major
export crops, particularly coffee and cotton, to
encourage growers to increase plantings and take
better care of current and future crops.
ment of labor and raw materials.
reduce current unemployment. Even at this growth
rate, regional per capita income would not regain its
1979 peak level until 1997. Considered individually,
5-percent economic growth would return Costa Rica
and Honduras to parity with their 1979 performance
by 1993 and 1994, respectively. Guatemala would
reach its former peak by 1997, while it would take El
Salvador until 2006.5
' We qualify this projection by noting that El Salvador has a
greater potential to exceed 5-percent annual growth than the other
Core Four countries if the military and political uncertainties are
greatly reduced. This would encourage a repatriation of capital and
entrepreneurial talent and speed the return to previous production
Actual long-term growth for the Core Four will, in
our assessment, likely fall within the range of these
two scenarios. Consequently, these four economies
will have difficulty providing both improvements in
average living standards and job opportunities. We
further believe that these are two key popular expec-
tations for which electorates are likely to hold their
elected governments accountable. Growing popular
frustration over these issues could rapidly erode confi-
dence in the democratic systems and usher in a new
period of political instability.
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
Establish policies early in the term of the new
civilian president to build private-sector confi-
dence and help stem capital flight.
- Bring the Chixoy hydroelectric project into opera-
tion as quickly as possible to ensure reliable
electricity supply and allow for the much-needed
repair of present thermal power plants.
- Reform the current regulations for converting
foreign exchange earnings in the parallel market.
Current regulations create strong incentives to
rely on black markets.
- Improve public revenues by lowering government
subsidies and carrying through tax reform, stress-
ing collection enforcement to reduce the reported
high rate of evasion.
- Quickly rein in the growth of the money supply to
restore price stability and long-term confidence in
the economy.
We see a less than even but still significant chance
that economic growth could fall short of the slow
growth scenario, particularly during the next four or
five years. Economic contraction could be triggered
by renewed security threats-for example, a resur-
gence of guerrilla movements or border conflicts
involving Nicaragua. Another potential threat to posi-
tive economic growth is that governments will bow to
political exigencies and reject investment policies in
favor of demands to boost consumption prematurely.
The negative impact of such a policy path would be
compounded if Western economic activity slowed or
commodity prices further softened.
- Curtail government monopolies that are ineffi-
cient and inhibit the diversification of the export
mix, especially the government monoply on use of
forest resources.
Lower administrative barriers to both domestic
and foreign investors. At present, rules hinder new
entrants or those wishing to expand.
Develop an exchange rate policy that provides for
a realistic evaluation of the lempira and provides
assurances to business firms that foreign ex-
change will be available for imports and repatria-
tion of earnings by foreign investors.
Develop fiscal restraints to stem the recent large
increase in government spending, and get the large
public-sector deficit under control.
Implications for the United States
In our view, continuing economic troubles are likely to
undercut social and political development in the re-
gion and put new strains on US relations with the
Core Four countries. The failure to revive depressed
economies is likely to deny Core Four governments
the resources they badly need to address the area's
critical social problems. At the same time, it is likely
to limit their military and political maneuvering room
when dealing with foreign-assisted insurgencies be-
cause weakened economic conditions would provide a
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
breeding ground for radical discontent and would also
limit governments' abilities to introduce new pro-
grams to counter unrest. In our judgment, the longer
the region's per capita GDP continues to decline, the
more vulnerable the Core Four will become to inroads
by political radicals and the more difficult it will be to
maintain the movement toward more open democra-
cies.
Even in the best of circumstances-because it will
probably take a decade or more to restore living
standards to pre-1980 levels-we expect growing con-
sumer impatience to erode political support for elected
governments during the foreseeable future. As a
result, even with preferential trade and aid from the
United States, we expect growing criticism of close
US-Core Four economic and political ties from re-
gional press sources, opposition politicians, and labor
unions.
Despite concern over possible anti-US backlash, we
expect Core Four countries to continue to press for
even higher levels of financial aid. In addition, the
United States will almost surely be asked increasingly
to intercede with the IMF, World Bank, and commer-
cial bankers to provide the Core Four with easier
terms on new lending and debt rescheduling. While
official financial support clearly has the capability to
help limit economic backsliding, it also entails some
potential risks. Long-term economic recovery will be
delayed if generous financial cooperation and contin-
ued assistance weakens Core Four resolve to take the
tough steps needed to regain financial stability and
rebuild business confidence. For the next few years,
the Core Four governments are likely to be tempted to
continue delaying economic adjustments as much as
possible, believing they can obtain more resources at a
lower political cost from the United States than they
could by dealing with the IMF and complying with
rigid stabilization programs. On the positive side, US
financial and investment initiatives for the region are
likely to strengthen substantially the Core Four's
already strong trade ties to the United States. This
will allow the region's economies to benefit from the
present strong US economy, but it also will heighten
vulnerability to any US economic contractions.
To the extent that Central America falls short of its
growth potential, economic troubles are likely to
encourage advocates of radical economic policies.
Nevertheless, we believe that the Core Four will
continue to benefit from any comparison of economic
trends with Nicaragua, which has continued to regis-
ter declines even as performance in the Core Four has
bottomed out. Nicaragua's track record will provide
little incentive for radical political movements within
the Core Four to point to Managua-style economic
structures and institutions as a role model.
25X1
25X1
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
Appendix A
Regional Economic Integration
The Central American Common Market (CACM)
was for many years a highly successful experiment in
economic integration. Since 1980, however, the insti-
tution has been wracked by regional turmoil and
mounting trade and debt problems. While most mem-
ber nations are working to get CACM back on track,
we believe the short-term prospects are clouded.
CACM was founded in 1960 to establish free trade
for manufactured goods among Costa Rica, El Salva-
dor, Guatemala, Honduras,' and Nicaragua. A re-
gional bank, the Central American Bank for Econom-
ic Integration (CABEI), also was formed with the
explicit goal of financing industrial projects-primari-
ly import substitution industries-that would promote
integration. A review of trade statistics shows that the
wider market spurred growth in regional sales, so that
by 1980 nearly one-fourth of all exports from CACM
countries were bought by other countries within the
region, compared to only 6 percent in 1960. Accord-
ing to US Embassy and press reporting, however,
these emerging export industries developed under a
highly protective common external tariff, and few of
the products were competitive on world markets.
Virtually all of the region's manufactured goods were
either consumed in the producing country or exported
to other CACM members.
the attempts by manufacturers to
were uncompetitive outside CACM.
US Embassy reporting suggests that a principal barri-
er to CACM recovery has been the inability of deficit
countries to settle trade imbalances or guarantee
repayment of extended credits. Timely settlement of
the Central American Clearing House balances,
which must be covered with dollars, is hampered by
the restricted foreign exchange positions of the re-
gions' central banks. Creditor countries-Costa Rica
and Guatemala-have been reluctant to extend cred-
its to cover the persistent and substantial deficits of
Nicaragua, El Salvador, and Honduras.
Of particular concern are the bilateral debts accumu-
lated by Nicaragua since 1979, which, based on US
Embassy and press reporting, we estimate now to
exceed $435 million. Officials in Guatemala-and
probably the other countries as well-believe it un-
likely that Nicaragua's debts ever will be repaid,
according to Embassy reporting. As a result, the Core
Four members have tried to limit trade with Nicara-
gua to barter or advance-cash deals. The Core Four
countries are reluctant to completely cut off trade
with Nicaragua because many of these exports have
no other market and they hope some of the debt
25X1
25X1
Two decades of vigorous growth ended in 1980 as a
variety of factors acted to hamper intraregional trade.
Insurgencies greatly reduced the export capacities of
Nicaragua and El Salvador, and restricted transporta-
tion routes. Furthermore, balance-of-payments posi-
tions deteriorated in all five countries when agricul-
tural commodity prices fell and petroleum prices
soared. CACM members began unilaterally to restrict
free trade to protect balance-of-payments positions by
adopting foreign exchange controls, deposit require-
ments, and import restrictions. Trade volumes were
Honduras formally withdrew from the common market in 1971
but continued to participate in its regional institutions and maintain
eventually may be recovered.
The regional financing bank, CABEI, has practically
no funds to lend because of the high bankruptcy rates
among borrowing firms and public-sector arrears by
the member governments.
Without an infusion of new
capital, the bank reports that by 1986 it will be unable
to initiate new projects and will simply service existing
loans. According to diplomatic reporting, CABEI is
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
Table 5
Nicaraguan Debt to
CACM Members, Mid-1985
435
195
Costa Rica
175
270
238
167
187
176
157
El Salvador
267
296
207
174
174
164
151
Guatemala
307
441
380
337
321
291
297
a Central American Common Market.
b Figures for 1985 are estimated.
trying to increase non-Central American participa-
tion in the bank, which is now supported by the
United States, Mexico, Venezuela, European Com-
munity, and the World Bank.
The Central American governments continue to ex-
press an interest in maintaining and reinvigorating the
common market. The Core Four did not join the US
trade embargo of Nicaragua in May this year, in part,
we suspect, because of the potential harm such a move
would bring to the CACM and the regional institu-
tions. Nicaragua continues to express public support
for the preservation of the common market and
regional institutions, despite its poor payments record.
The general, regional commitment to preserving the
common market was demonstrated this year when-
after arduous negotiations-CACM members were
able to agree on a new common external tariff
schedule and adopted the Brussels nomenclature sys-
tem.
The short-term prospect for the recovery of regional
trade is bleak. Unilateral trade restrictions by mem-
ber governments were expanded this year, and we
believe, contributed to a further decline in trade
volumes. Preliminary trade data for El Salvador,
Honduras, and Nicaragua show a further decline in
regional trade from 1984 levels. We also project a
decline in Costa Rican exports to the CACM as a
result of the government's decision to stop extending
credits to common market members. Guatemala prob-
ably will show a slight increase in exports because the
rapid depreciation of the quetzal has greatly raised
demand. Despite a continuation of the downward
trend in 1985, CACM trade will continue to hold a
significant share of the region's exports, and the
institutions are likely to be maintained in their
weakened state.
Costa Rican President Luis Monge recently has pub-
licly called for increased cooperation among the Core
Four to reduce regional trade barriers and jointly
approach multilateral lenders and donors for addition-
al funding for the area. His plan, which has been
favorably received by the other three governments,
however, is unlikely to supplant existing arrangements
that include Nicaragua.
Million US $ Table 6
CACM a Regional Exports
by Country, 1979-85
25X1
25X1
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
Appendix B
Central American
Exchange Rate Adjustments
Most economic observers believe that the reluctance
of Central American governments to adjust overval-
ued exchange rates has exacerbated economic prob-
lems by substantially undercutting potential exports,
encouraging imports, and depressing import substitu-
tion industries. Governments already tightening their
belts on budget and wage restraints are loath to
change long fixed-and nearly sacred-exchange
rates. A change in the rate is among the most visible
policy options a government can take and one that
virtually all citizens can feel almost immediately
through shortages and inflation. Nevertheless, it also
is among the most effective steps that can be taken.
Over the longer run, realistic exchange rate adjust-
ments can encourage exports, boost industrialization,
and create jobs. The countries of the region are now in
various stages of adjusting their exchange rate
policies.
The Central American countries have a long history
of stable currencies pegged to the US dollar. Foreign
exchange rate trends show that Costa Rica and
Nicaragua each took just one devaluation between
1960 and 1980, while Guatemala, Honduras, and El
Salvador still maintain par values established in the
1930s, or earlier. Prior to 1980, according to academ-
ic studies, Central American governments seldom
relied on foreign exchange controls to maintain unre-
alistic currency values.
The traditionally conservative monetary and fiscal
policies were somewhat relaxed in the early 1980s
when expansionary policies were implemented to re-
duce the adverse effects of a deep recession. At the
same time, exchange rate adjustments were avoided
even though inflation rates well exceeded those of
principal trading partners, causing serious balance-of-
payments problems. All five countries responded,
according to Embassy reporting, by imposing ex-
change controls, and have since tightened them to
maintain artificially high currencies values. We be-
lieve the creeping inconvertibility, however, contribut-
ed greatly to the region's capital flight and the decline
of trade-dependent industries.
The bureaucratic delays and corruption associated
with the foreign exchange allocation systems contrib-
ute greatly to the region's poor investment climate,
according to Embassy sources, and
in some cases are a more important deterrent than
political turmoil. Businesses often face long delays in
acquiring foreign exchange for crucial imports, and
many experience difficulties trying to remit dividends.
For example, businessmen in El Salvador complain
that a full-time employee is required to process for-
eign exchange requests through the various stages of
approval. In Guatemala, businessmen report fewer
bureaucratic delays and also less price checking,
which has encouraged many to abuse invoicing proce-
dures to funnel money out of the country.
Pressure from international financial institutions and
bilateral lenders is slowly persuading governments to
realign currencies by establishing dual exchange mar-
kets, with a depreciated parallel rate for specified
transactions, in addition to the official exchange rate.
Later, the governments can gradually expand the
parallel market so that foreign exchange controls can
be relaxed. Costa Rica was the first Central Ameri-
can country to follow this policy and has continued to
show flexibility by accepting periodic minidevalua-
tions based on inflation differentials with the United
States. As of October, the Costa Rican colon had been
devalued 18 times in 1985, for a total decline of 10
percent against the US dollar.
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
Table 7
Central American Exchange Rates, 30 November 1985
Official
Exchange Rate
(currency/US $)
Free Percent of Foreign
Market Rate Exchange Transactions
(currency/US $) in Official Market
55.0 95
a Represents a weighted average between legal parallel rates and
black-market rates.
b The official rate is 20 colones to the US dollar, but less than
I percent of transactions are valued at this rate.
c Nicaragua also has fixed official rates of 10, 40, and 50 cordobas
per dollar for some trade categories.
El Salvador and Guatemala have established parallel
markets as transitions to devaluation. El Salvador
legalized the second market in 1982, and has expand-
ed its coverage over the last two years as a condition
for US aid disbursements. In Guatemala, the already
large second market was legalized in late 1984 be-
cause the government could not satisfy foreign ex-
change requests, and was further expanded in mid-
1985. We believe much of the reluctance to devalue
currencies has begun to dissipate in both El Salvador
and Guatemala as the dual exchange markets have
become firmly established.
Honduras has taken the strongest stand against deval-
uation among Core Four countries. Because of Hon-
duras's dependence on imports, virtually every sector
of the economy expresses strong opposition to devalu-
ation or establishing a dual exchange market-a fact
underscored by strong opposition in the local press. A
significant black market exists-and is tolerated by
the government-where people are willing to pay a
premium for dollars to avoid the long delays and
patronage in the official market. The government
showed some flexibility in March of this year by
agreeing to legalize parallel market transactions for
the 10 percent of trade in the CACM as a condition of
US aid disbursement, but has not helped in imple-
menting the new regulations.
While the Core Four have taken steps to improve the
convertibility of their currencies over the last two
years, Nicaragua has moved in the opposite direction.
Rapid inflation in 1984 and 1985 prompted the
government to tighten exchange controls, making the
cordoba virtually inconvertible. By last February,
depleted foreign exchange forced the Sandinistas to
devalue the cordoba for the first time since the
revolution. Nevertheless, the inflexible multiple rate
system-where rates depend on trade priorities-still
greatly overvalues the cordoba. The Sandinistas have
allowed some free foreign exchange trade for the
small tourist transactions.
We believe the need to make exchange rate adjust-
ments will continue to concern the region's govern-
ments. Although the Central American countries
have been able to keep inflation under reasonable
control, national statistics show price rises continue to
exceed those of the region's principal trading partner,
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
Table 8
Central American Inflation, 1960-84
CIA estimates of 1985 price changes based on reporting and
trends for the first nine months of the year.
the United States. Even Costa Rica, after experienc-
ing inflation of nearly 100 percent in 1982, saw
consumer prices rise only 12 percent last year. The
Salvadoran economy, despite the war, generated only
13-percent inflation in 1984, while Guatemala and
Honduras experienced average price increases of only
5 percent.
The prospects for adopting the necessary exchange
rate adjustments, however, depend on the balance
between economic pressures and political realities. If
the past few years are a guide, the region's leaders
want to avoid sharp price increases that often follow
currency depreciations and can quickly create an
unstable political environment by creating a rallying
point for economic, social, and political discontent.
Such a scenario arose this year in Guatemala, where
we estimate that the sharp depreciation of the quetzal
added at least 15 percentage points to the annual rate
of inflation. By contrast, Costa Rica's progress pre-
sents a positive example, since frequent minidevalua-
tions during the last two years have maintained a
realistic exchange rate without increasing inflation or
generating strong public reaction.
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
Appendix C
El Salvador and Costa Rica receive the largest por-
tions of total US assistance to the area, according to
official US data. In El Salvador, the insurgent war
has strained government finances, caused direct dam-
age to infrastructure, and contributed to the massive
flight of capital and entrepreneurial talent. The over-
whelming external debt accumulated by Costa Rica-
123 percent of GDP-requires extensive concession-
ary foreign financing to keep the country solvent.
Embassy reporting indicates that government policies
in these countries have been generally accommodating
to austerity measures required as a condition of US
aid, although slow implementation has occasionally
held up disbursements.
Table 9
US Economic and Military Assistance
to the Core Four, 1979-86
115
455
Figures from administration's 1986 foreign assistance submissions
to US Congress.
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
Honduras receives less aid than El Salvador or Costa
Rica, in part because it faces less threatening econom-
ic problems and has a smaller capacity to absorb
infusions of aid. Moreover, the Hondurans have been
extremely reluctant to adopt reforms as a condition of
US aid, according to Embassy reporting. The princi-
pal sticking point in recent years has been the govern-
ment's steadfast refusal to modify its exchange rate
system.
Guatemala receives the least US aid of the Core Four
even though it has the largest economy in Central
America and faces serious shortages of foreign ex-
change. Congressional restrictions on aid to the mili-
tary government, prompted earlier by human rights
abuses, have just begun to be eased. Aid levels
expanded slightly following the Constituent Assembly
elections in 1984, which were widely regarded as
honest and free of military interference. Guatemalan
officials hope for a further increase in US aid if the
transfer of power to a civilian government-scheduled
for January 1986-is carried out successfully.
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3
Confidential
Confidential
Sanitized Copy Approved for Release 2011/06/13: CIA-RDP88T00768R000100020001-3