THE CENTRAL AMERICAN DEMOCRACIES HAVE ACHIEVED A DEGREE OF ECONOMIC STABILITY SINCE THE REGION EMERGED FROM A STEEP RECESSION IN 1983, BUT PERSISTENT BUDGET AND TRADE PROBLEMS, POLITICAL TURMOIL, AND LOW PRIVATE INVESTMENT STILL STAND IN TH

• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP04T00990R000100660001-8
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 16
• Document Creation Date: December 27, 2016
• Document Release Date: December 19, 2012
• Sequence Number: 1
• Publication Date: June 24, 1988
• Content Type: MISC

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Central Intelligence e igence Agency
Washington. D. C 20505
DIRECTORATE OF INTELLIGENCE
Summary
The Central American democracies have achieved a degree of
economic stability since the region emerged from a steep
recession in 1983, but persistent budget and trade problems,
political turmoil, and low private investment still stand in the
way of sustainable longterm growth. With the exception of Costa
Rica, living standards in the region remain below,1980_levels.
Weak government revenues are making it difficult for regional
governments to rebuild decaying infrastructure, provide credit
for private businesses, or control inflation. A dependence on
traditional agricultural exports continues to subject the region
to the vagaries of world commodity prices, limiting the stable
supply of foreign-exchange needed to fund:gxowth. -Regional
political instability has made it difficult for the democracies
to enact needed economic reforms and attract the domestic
foreign private investment needed to stimulate growth.
Backed by substantial amounts of.US economic assistance, the
countries have begun to implement corrective reforms,
particularly to diversify exports; progress, however, will be
slow and uneven. If the Central American democracies are to
sustain even current levels of economic performance in the next
several years, they need substantial economic assistance from the
United States and other bilateral and multilateral lenders.
This typescript was prepared by
Middle America-Caribbean Division, Office of African and Latin
American Analysis. Comments and queries are welcome and may be
directed to the Chief, Middle American-Caribbean Division, ALA,
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El Salvador: Difficult Tradeoffs
During the last five years, modest economic growth in El
Salvador has been insufficient to halt a nine year decline in
living standards. Buoyed by a boom in construction activity as
the country began to rebuild from a destructive earthquake that
struck San Salvador in late 1986, real economic growth may have
reached 2 percent in 1987--its highest in a decade--according to
preliminary US Embassy estimates. Agricultural production, which
accounts for 25 percent of GDP and 40 percent of total
employment, withstood a punishing drought and stagnant investment
to increase by 2.5 percent. Manufacturing output grew about 3
percent on the strength of substantial increases in production of
cigarettes, alcoholic beverages, and foodstuffs.
Despite this success, San Salvador has been unable to make
significant progress in reversing the impact of a deep recession
that ended in 1983. Living standards remain depressed--per
capita income has fallen roughly 30 percent since 1979--and as
much as half the country's working population may lack-fulitime
employment, according to the US Embassy. Although the government
successfully cut inflation to 25 percent last year, the real
wages of most Salvadorans has declined by 30 to 50 percent since
1982. Moreover, capital flight probably still exceeds $100
million annually, reflecting concern about the country's
political stability and economic prospects-.- Finally, President
Duarte's Christian Democratic government largely has failed to
build upon a comprehensive economic stabilization program enacted
in 1986. Such inaction, when coupled with the effects of a
crippling insurgency, is holding back longterm, sustainable
economic growth.
Scarce Funding
One of San Salvador's most pressing economic problems is its
chronic inability to fund government operations. In 1987, nearly
70 percent of total current revenues came from consumption and
trade taxes, leaving the regime vulnerable to fluctuating world
trade trends, according to Embassy reporting. For 25X1
example, depressed world prices for coffee--the country's major
agricultural export--contributed to a 10 percent decline in.total
tax revenues in 1987. Revenue shortfalls have been exacerbated
by the conservative business community's opposition to government
efforts to shift the tax burden from the lower classes to wealthy
individuals and businesses. The government's ability to improve
its finances also has been constrained by social and political
pressures to subsidize essential public services and basic needs
of low income groups. 25X1
Limited revenues have forced San Salvador to make tough
choices between sustaining its counterinsurgency effort and
funding other public sector operations. The US Embassy reports
that spending on defense and public security, which has doubled
in real terms since 1980, now accounts for roughly 40 percent of
the government's total budget. At the same time, spending on a
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wide range of social programs--including education, health, and
agriculture--has-been halved in real terms since 1980, and now
accounts for only about one-quarter of the total budget. The
impact of these tradeoffs has-been somewhat lessened by the
infusion of US economic and military assistance--over $3 billion
since 1980--which has enabled the government to meet its most
immediate financial and material needs.
Trade problems caused by poor export performance also have
severely undercut El Salvador's economy. The country's
merchandise trade deficit has averaged $250 million annually over
the last five years; in 1987 it was nearly $400 million,
according to Embassy reporting. Foreign exchange earnings from
traditional export products have been decimated by low world
commodity prices and by a depressed regional market for
manufactured goods:
Sharply lower world prices for coffee slashed foreign
exchange earnings by nearly $200 million in 1987,
according to Embassy reporting. Depressed prices and
mismanagement by the state-run coffee export monopoly
have fueled a 30 percent decline in coffee production
since 1980.
Income from sugar exports has declined because of steep
reductions in the US sugar quota, while the insurgency
has contributed to an 80 percent drop in cotton
production since 1980, making El Salvador a net importer
of cotton, according to US Embassy reporting.
Salvadoran exports to the floundering Central American
Common Market--the traditional outlet for the region's
manufactured goods--has fallen by over 60 percent since
1980, despite a modest rebound in 1987.
Foreign exchange shortages and concerns about the security
situation continue to constrain business activity and investment,
although balance of payments pressures have been, alleviated by US
economic assistance and by foreign remittances--roughly $300
million annually from some 600,000 Salvadorans working abroad.
New foreign investment in El Salvador has totaled less than
$3 million in the last 3 years. Although the US Caribbean Basin
Initiative has stimulated some significant investment by
Salvadoran firms, it has been largely unsuccessful in attracting
foreign investment, according to Embassy reporting.
Prospects
Political maneuvering leading up to presidential elections
in 1989 is likely to postpone significant progress towards
resolving El Salvador's fundamental economic problems in the next
year. In our judgment, neither the.Christian Democrats nor the
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rightist Nationalist Republican Alliance are likely to push for
fundamental but potentially unpopular measures--such as
devaluation or tax reform--that would address El Salvador's
resource constraints.
While living standards will almost surely continue to
decline in the next year, we believe pre-election maneuvering is
unlikely to cause significant further deterioration of El
Salvador's economy. In particular, economic activity is likely
to be bolstered by scheduled infusions of US economic aid and
continued inflows of foreign credits and donations for earthquake
reconstruction activity. We estimate that real economic growth
in 1988 will approach last year's figure--averaging between 1.5
to 2.5 percent--but is unlikely to keep pace with El Salvador's
3 percent population growth rate. As a result, El Salvador
probably will experience its tenth consecutive year of falling
per capita income.
Over the longer term, pressing resource constraints and the
continuing insurgency will make it-difficult for the next
administration to engineer a sustainable longterm economic
recovery that will reverse declining living standards. As a
result, we believe El Salvador's ability to maintain a minimum
level of political and economic stability and consolidate nascent
democratic institutions will remain-largely dependent on the
level of US economic assistance.
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EL SALVADOR: SELECTED ECONOMIC INDICATORS 1982 - 1987
Real GDP
(percent change)
~9e-~ge 19v~-,~go-1419~~
Real GDP Per Capita
(Index 1980 = 100)
19~19~ 19? 14~19;y~~ -
(a) PrUminary
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Guatemala: Looming Economic Problems
Guatemalan President Cerezo's government has successfully
arrested a steep economic slide since taking office two and a
half` years ago. US Embassy estimates put real GDP growth at 2.5
percent last year, a sharp improvement over 1.986 when the economy
was stagnant. '.right control over credit and money supply growth
has kept inflation under control; it now stands at roughly 10
percent, well below the nearly 40 percent rate that Cerezo
inherited. Nevertheless, unemployment remains high, with perhaps
40 percent of the working population lacking a fulltime job.
Moreover, budgetary constraints--government revenues amount to
only 8 percent of GDP, one of the lowest rates in Latin America--
have prevented Cerezo from tackling pressing social needs or
restoring an eroding infrastructure.
After a. promising start, the Cerezo government's progress on
needed budget and trade reforms has been slowed by domestic
opposition and bureaucratic inertia. Efforts to put forward a
major tax reform package last fall were sidetracked by-strong
opposition from Guatemala's powerful business community.
Internal debate, meanwhile, has delayed the phasing out of a
complicated three-tiered exchange rate that has contributed to
costly government subsidies.
Resource Constraints
Like the other. countries in the region, Guatemala's
dependence on traditional agricultural exports---coffee, cotton,
and sugar--has undermined its trade account. Guatemala's trade
deficit widened to more than $450 million in 1987, as imports
surged due to higher economic activity. and speculation over tax
and exchange rate changes. Despite a higher volume of coffee
exports, lower world prices slashed earnings from coffee--the
country's most important export product--by $150 million last
year. The dismal performance of traditional commodities was
somewhat offset by a nearly 40 percent increase in nontraditional
exports, particularly fresh fruits and vegetables. These
products, however, still contribute only a small percentage of
total export earnings, and even if their strong performance
continues, the short term outlook for Guatemala's trade balance
Poor.export performance and uncertainty over economic
reforms has sparked a growing foreign exchange shortage in the
first half of 1988 that could force the government to ration hard
.currency b_y.imposing import controls. Guatemala reportedly lost
$70 million in foreign exchange. reserves in the first four months
of.1988, according to the US Embassy, compared to a gain of $75
million for the same period last year. Capital flight, after a
lull in 1906, reportedly has accelerated in the last 1.2 months,
reflecting concerns about an uncertain economic: climate. At the
same time, the government's failure to move forward with reform
has delayed new agreements with the IMF and World Bank, which
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could net Guatemala over $100 million in new funding. Hard
currency shortfalls in the next few months--when seasonal factors
limit export earnings even further--could sharply constrain
business activity and bring economic growth to an abrupt halt.
Guatemala faces a difficult challenge in servicing its
external debt. Although the country's total foreign debt of $2.5
billion is low by Latin standards, we estimate that scheduled
obligations--60 percent of total debt service falls due before
1990--will eat up 50 percent of export earnings in each of the
next two years. The government and creditors are particularly
concerned about $450 million in dollar-denominated stabilization
bonds, of which about $200 million fall due in July. Although
the government hopes to retire as much as $85 million before then
by using a menu of options for bondholders, it lacks the foreign
exchange reserves to redeem the remainder.
Government-Private Sector Tensions
Conflict over economic reforms and business perceptions that
Cerezo is intent on pursuing populist economic policies has
soured relations between the government and the private sector:
Businessmen argue that government policies, including
export taxes and cumbersome bureaucratic requirements,
have reduced production and export incentives at a time
when they are being asked to provide critically needed
spending.
They believe that the government needs to slash
unnecessary spending to free limited financial resources
for capital spending.
Large landowners are concerned that the government plans
a sweeping land reform program, despite repeated
assurances from Cerezo that private property rights will
be respected.
Growing distrust between Cerezo and the business community
is threatening further economic expansion and, at the extreme,
the future of democratic government in Guatemala. In the absence
of increased business confidence and a strong expansion in
private investment and employment, Guatemala is unlikely to move
beyond the 3 percent growth rate needed to restore per capita
income growth. Radical rightwing businessmen, meanwhile, have
taken their distrust of Cerezo even further by encouraging coup
plotting among discontented military officers, which led to an
abortive attempt in May. Although radical businessmen by
themselves are unlikely to succeed in removing Cerezo, their
disaffection will make it increasingly difficult for his
government to encourage growth or deal with its growing economic
problems.
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GUATEMALA: SELECTED ECONOMIC INDICATORS 1982 --1987
(a) Pnllminary
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Honduras: Dependent on Foreign Aid
Honduras in 1987 enjoyed its highest rate of economic growth
in five years, but overall performance was uneven and constrained
by longstanding structural budget and trade problems. Fueled by
government deficit spending and substantial inflows of US and
multilateral economic aid, real GDP grew more than 4 percent.
Strict control of money supply and credit growth, coupled with
relatively small wage hikes and stagnant demand in the private
sector, kept inflation below 3 percent. Nevertheless, real per
capita income remained below its 1980 level.
A growing shortage of foreign exchange over the last year--
international reserves have fallen an estimated 35 percent--has
underlined both structural and policy weaknesses in the Honduran
economy. The country's trade balance deteriorated last year as
world prices for coffee--the country's major export--fell
substantially. Demand for scarce hard currency has been fueled
by a chronically overvalued exchange rate, a weakness that
Tegucigalpa has steadfastly refused to address. Dwindling
reserves have forced a curtailment of imports and caused
Tegucigalpa to fall into arrears on its international debt
obligations.
Budget and-Debt Uncertainties
Honduras has had a chronically large budget deficit, even by
Central American standards, but so far has been able to avoid
significant spending cuts or tax increases because of large
injections of external funds. In 1987 US economic assistance
reached $196.4 million and $159 million has been requested for
1988. Tegucigalpa's creditors are insisting that Honduras reduce
its budget deficit--which has hovered above 6 percent of GDP for
the last two years--to 4 to 5 percent in 1988. The government,
however, faces a number of obstacles. The operating surplus of
government agencies has fallen steadily for the past three years,
according to Embassy reporting. Despite some revenue
enhancements due to better tax administration, the government
reduced export taxes on coffee, cutting revenues by $15 million
per year. Meanwhile, foreign aid and loans are dwindling, and
debt principal payments are coming due this year.
By the end of 1987, Honduras had amassed an external debt of
$3.9 billion, equivalent to 66 percent of the country's annual
GDP. The government's effort to reschedule debt obligations and
attract additional financing has been complicated by persistent
payment arrears. According to Embassy reporting, Tegucigalpa is
nearing final agreement with the World Bank on a macroeconomic
package that would provide up to $100 million in the next two
years. The program is contingent upon Honduras remaining current
on loan repayment and implementation of a series of fiscal,
monetary, and structural reforms. Although the IMF approves of
the World Bank program, it will not negotiate a standby
arrangement with Tegucigalpa until some $18 million in arrears
are paid. The Embassy reports that Tegucigalpa is considering an
agreement rescheduling commercial debt that capitalizes overdue
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interest and refinances approximately $235 owed in principal
arrears. Honduras faces large payments this month, and the US
Embassy reports the government is likely to request bridge ,
financing from either the United States or commercial banks.
Fate of Reforms
President Azcona does not have the political clout to carry
out economic reforms which would wean Honduras from its reliance
on foreign assistance by addressing the country's structural
problems such as dependence on agricultural exports. Although
many national leaders recognize the fiscal deficit needs to be
reduced, they disagree sharply over which fiscal and monetary
measures should be taken. Meanwhile, efforts to diversify the
country's export economy have been slowed by bureaucratic red
tape and legislative foot-dragging on a variety of initiatives.
With national elections looming in 1989, it is unlikely that the
legislature will move to pass unpopular economic measures that
would put the economy on a more sound footing. As a result, we
expect Tegucigalpa's entrenched reliance on US assistance is
likely to continue, at least for the foreseeable future.
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HONDURAS: SELECTED ECONOMIC INDICATORS 1982 - 1987
(a) Pntlminary
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Costa Rica: Heavy Debt Burden but Modest Growth
Costa Rica's economy grew modestly in 1987, continuing a
five year record of slow economic recovery. Real economic growth
exceeded 3 percent, dropping slightly from a rate of 4.6 percent
in 1986, primarily because of the relatively poor performance of
Costa Rica's major export crops and a sharp decline in world
coffee prices. The gradual economic expansion, led by increases
in banana production, manufacturing, and construction, has kept
the unemployment rate below 7 percent, but inflation has
accelerated to over 15 percent. rate estimated to be as high as
16 percent. Meanwhile, San Jose's longterm policy of economic .
diversification and gradual payment of its massive external debt
has reduced its debt as a percentage of real GDP steadily over
the last five years. Attempts to reduce public spending have
been largely ineffective, however, leaving the government
dependent on revenue-generating measures and foreign assistance
to close a persistent budget deficit.
Costa Rica's economy is heavily burdened by an extensive
foreign debt incurred in the late 1970s, when San Jose's terms of
trade deteriorated sharply and international interest rates
increased. Although San Jose's debt is small by Latin American
standards--over $4.5 billion--i.t is roughly the same size as the
annual GDP. The cost of servicing scheduled debt payments was
more than half of the value of Costa Rica's exports of goods and
services in 1987. Although efforts to reschedule its debt in
1987 repeatedly fell through, Costa Rica continues to insist that
the composition of its debt be reformulated to ensure servicing
obligations are not made at the expense of economic development.
San Jose plans to use official and multilateral lenders,
instead of commercial banks, to secure new loans on concessional
terms. According to the US Embassy, San Jose obtained a $48
million IMF standby arrangement late last year and has
renegotiated its $120 million debt with Mexico. Negotiations
with the World Bank for a second structural adjustment loan
entered its final stage in late March and awaits approval-by the
Costa Rican legislative assembly, according to Embassy reporting.
According to press reports, the government is reluctant to
increase commercial indebtedness and sees private debt
rescheduling as a means of keeping new loans to a minimum. Under
a revised plan, creditor banks would purchase 20-year, zero-
coupon, US government bonds that would guarantee the outstanding
principal; a separate fund under World Bank supervision would
guarantee interest payments. Government officials are reluctant
to predict when an agreement will be reached, however, but have
delayed a review meeting with Paris Club creditors until the end
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of July to allow time for negotiations with private creditors.
Due to political constraints, the Central Bank has warned that
San Jose will have to reschedule its commercial debt after the
1990 national elections if an agreement is not signed soon.
Exports Vulnerable
Despite recent efforts to diversify the economy, Costa Rica
remains dependent on a few agricultural exports that are
vulnerable to fluctuating commodity prices. Coffee and bananas,
Costa Rica's major foreign exchange earners, still account for
roughly 60 percent of San Jose's exports. The performance of
non-traditional exports such as ornamental plants and flowers has
been uneven during the 1980s, although such exports increased by
an average annual rate of 16 percent in the last two years.
Recently, the government has expanded fiscal incentives to make
non-traditional exports more competitive, including devaluing the
colon. The government's expansion of export subsidies in 1987
was offset by better tax- collection, the introduction of new tax
measures late in the year, and utility rate increases in order to
remain within 1987 targets set by international creditors.
Political Constraints
Attempts to reduce spending in other areas such as
agricultural subsidies and wages have been undermined by
President Arias's willingness to backtrack when faced with
domestic protests. Growing public antipathy to austerity
measures has prompted public officials to promise not to impose
additional measures this year, although demands on government
finances remain high. For example, rapid inflation is expected
to spur demands for wage increases, according to Embassy
reporting. Moreover, the government is legally required to
adiust wages when anticipated annual inflation exceeds 7 percent.
Upcoming elections in 1990 and the ruling party's slim
majority in the National Assembly are likely to further hamper
Arias' ability to control the economy and stimulate growth.
Although public pressure probably will prevent the President from
making needed economic reforms, we expect Costa Rica's economy to
grow modestly--about 2.5 percent--in 1988. Soft terms offered by
official and multilateral creditors most likely will encourage
San Jose to remain dependent on foreign assistance, although the
IMF predicts that the debt service ratio will continue to
decline. The US Embassy reports that opposition legislators are
increasingly are concerned about Costa Rica's heavy debt load and
they may stall passage of new loan agreements. Meanwhile, costly
government initiatives to promote new industries probably will
strain public finances. Costa Rica will continue to make use of
the Caribbean Basin Initiative to expand non-traditional exports
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COSTA RICA: SELECTED ECONOMIC INDICATORS 1982 - 1987
(a) Pr.llminary
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SUBJECT: Central America: Economic Problems and Prospects
24 June 1988
Distribution:
1 - LTG Colin Powell, USA, Assistant to the President
for National Security, NSC
1 - Mr. Robert Pastorino, Senior Director for Latin American
Affairs, NSC, Rm,. 392, OEOB
1 - The Honorable Donald Gregg, Assistant to the Vice
President for National Security Affairs, Rm. 298, OEOB
1 - The Honorable John D. Negroponte, Deputy Assistant to
the President for National Security Affairs,
The White House
1 - The Honorable William Walker, Deputy Assistant Secretary of
State for Central America, State, Rm. 6263
1 - Rose Ikens/Honduras, State, Rm. 4915
1 - James Callahan/El Salvador, State, Rm. 4915
1 - Richard Dotson/Guatemala, State, Rm. 4915
1 - Brian Dickson/Costa Rica, State, Rm. 4915
1 -Mr. Stephen Danzansky, Special Asst. to the President and
Senior Director, International Economic Affairs, National
Security Council, Rm. 365
1 - Mr. Stephen P. Farrar, Director, International Economic
Affairs, National Security Council, Rm. 365
1 - Mr. Eric Melby, Director, International Economic Affairs
National Security Council., Rm. 365
1 - Mr. Allen Wallis, Undersecretary, Economic Affairs, New
State, Rm. 7256
1 - Mr. Alan Larson, DAS, Economic and Business Affairs Bureau
Rm. 6828, State
1 - Mr. Luigi Einaudi, Director, Office of Policy Planning and
Coordination/ARA, State, Room 6913A
1 - Mr. Richard H. 'Soloman, Policy Planning Staff, Rm. 7311,
State
1 - Mr. Robert Fouche, Director, Office of Analysis for Inter-
American Republics/INR, -State, Rm. 7358
1 - The Honorable Richard Armitage, Assistant Secretary of
Defense for International Security Affairs, DOD,
Rm. 4E808, Pentagon
1 - Mr. Randy Fort, Special Asst. to Assistant Secretary for
Enforcement, Rm. 2049, Treasury
1 - Deputy Assistant Secretary for Inter-American Affairs, DOD,
Rm. 4C800, Pentagon
1 - BGEN Charles D. Link, JCS/J5, Rm. 2E980, Pentagon
1 - LTG Dale A. Vesser, JCS, Rm. 2E996, Pentagon
1 - RADM Anthony A. Less, JCS, Rm. 2E976, Pentagon
1 - LTG William E. Odom, USA, D/NSA, Rm. 3A156, Fort Meade
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SECRET
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DCI/DDCI Executive Staff, Rm. 7E12
DDI, 7E44
O/DDI,
NIO/LA
NIO/ECON
NIO/AG, Rm. 7E47
DO/C/LA
DO/C/LA03C3202
C/LAS
DO/C/LA Rm. 3D30
PDB Staff, Rm. 7F30
C/PES, Rm. 2G25
DDI/CPAS/ILS, Rm. 7G50
D/ALA, Rm. 3F45
DD/ALA, Rm. 3F45
C/ALA/MCD
DC/ALA/MCD
ALA/PS (1 clean copy and 1 sourced copy)
ALA Research Director,
OGI/ECD,
OGI/FSIC
CPAS/IMC/CB,
MCD FILES
DDI/ALA/MCD/CA:
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