This is the second part in a 2-part series about how Central America will once again lead growth in Latin America. For Part 1 that introduces the drivers of growth in Central America and high performing markets of Panama and Costa Rica, click here.
Chronic Laggards: El Salvador, Honduras and Nicaragua
El Salvador, Honduras and, to a lesser extent, Nicaragua will continue to face significant obstacles in achieving exceptional economic performance, as they are among the least shielded from both internal and external disruptors. Security concerns, in particular, remain an obstacle to investment and economic growth in these three markets.
El Salvador
El Salvador’s underwhelming economic performance in the past decade, with growth averaging only 2%, makes it one of the least attractive markets in Central America. Solely in terms of FDI, not only is El Salvador the worst performer in attracting net investment inflows, but MNCs are seeing higher growth and potential in most of the other markets in the sub-region.
Additionally, El Salvador’s poor growth prospects are driven in large part by undeniably escalating violence and crime, which have increased significantly in recent years and remain a burden on the country’s economy. Albeit the country expects marginal improvement in short-term economic growth as a result of increased remittance flows from the US, El Salvador’s dollarized economy will see less competitive exports given a stronger US dollar and an inability by the government to boost economic growth through monetary policy. Lastly, El Salvador’s unsustainable public deficits in recent years, acquired as the government tackled high poverty rates through social spending, mean that the government will likely have to pursue austerity measures, particularly tax increases and reduced public spending over the medium-term, which will likely result in falling domestic demand.
Honduras
Despite tangible benefits favoring Honduras as a result of stable US growth, significant macroeconomic challenges abound as the country faces a disappointing growth trajectory.
In addition to having one of the lowest average per capita incomes in the region and suffering significant instability in the last decade, Honduras has among the highest murder rates in the world, and the highest levels of crime and violence in the region. The cost of crime and violence creates a substantial burden on the country’s economy, adding up to over 20% of its GDP, which will continue to undermine local production and investment.
Although it represents 9% of Central America’s economy, Honduras remains a low priority for many MNCs as a result of weak policy continuity, political instability, and a severely weakened security environment, all of which have worsened expectations for the market. Recovery in the US, Honduras’ largest trading partner, will certainly support exports and increased inflows of remittances, which, further magnified by currency depreciation, will boost consumer purchasing power in Honduras. Furthermore, a recent IMF stand-by agreement calling for significant fiscal consolidation –particularly through higher taxes, improved tax collection and reductions in subsidies - should help guarantee stability and fiscal assistance for the country. However, this consolidation is expected to entail an increased tax burden on the private sector and to continue to place ceilings on domestic investment and consumption over the medium-term.
Nicaragua
Nicaragua, despite strong macroeconomic growth and stability, represents only 2% of Central America’s economy and remains the poorest country in Central America, with nearly half of its population living in poverty.
As a result of its low crime rates and strong adherence to macroeconomic orthodoxy, Nicaragua has seen stable growth for nearly a decade and is expected to see growth rates of over 4% in the short-term. Like several other countries in Central America, Nicaragua is expected to benefit from remittance inflows resulting from US growth and amplified by currency depreciation, which will boost consumer purchasing power. However, Central America’s most agriculture-dependent economy has seen the prices of its exports stagnate, which has created additional short-term pressures on its economy.
Although the potential development of the Nicaragua Canal, expected to eventually rival the Panama Canal, has attracted significant attention, it appears to be on hold, and the lack of transparency surrounding its development does not indicate whether the project will resume or the extent of its economic impact. That said, the small economy of Nicaragua remains too small of an opportunity for many MNCs. Its weak and inefficient institutions, poor levels of infrastructure, and low levels of educational attainment serve as significant impediments that detract from prioritizing investment in the country.
Rising Star: Guatemala
Although MNCs have traditionally focused their attention on Panama and Costa Rica, they are increasingly turning toward Guatemala, which offers the sub-region’s largest population and economy, as they look to further develop their presence in the region.
The largest country in Central America, with about one-third of the sub-region’s population (approx. 14 million), Guatemala represents nearly 30% of Central America’s GDP. Despite consistent but relatively underwhelming growth of under 4%, which lags behind that of Panama and Costa Rica, Guatemala is expected to see strong performance with growth rates above 3.5% sustained by the country’s strong macroeconomic framework and orthodox policies. Moreover, inflation is expected to return to central bank target level, and growth in the US will support both stronger Guatemalan exports as well as higher remittance inflows to the country.
While Guatemala is expected to continue experiencing stable growth, uncertainty remains around its murky political outlook and lack of security, particularly because it suffers challenges stemming from severe poverty and high crime. That said, Guatemala is gaining ground in terms of attracting foreign investment and is increasingly prioritized by MNCs, particularly B2C and pharmaceutical companies, given its large population size and improving macroeconomic stability.
Actions to Take
Given Central America’s expected growth trajectory and stable macroeconomic conditions compared to the rest of Latin America’s, MNCs should consider increasing investments in the sub-region. Multinationals should focus on targeting markets with stable economies as well as large and/or wealthy consumer bases, which are mainly concentrated in Panama, Costa Rica and Guatemala.
Additionally, MNCs should reevaluate their channel strategies in Central America and assess optimal go-to-market strategies, perhaps even considering a direct presence in certain markets. For those companies that choose to continue working through distributors in the region, it will become paramount to assess risks to profitability, as distributors are likely to face increasing tax burdens and difficulty achieving adequate coverage.
Finally, in terms of customer segmentation, companies are encouraged to map which industries and customer segments are likely to benefit most from an upswing in US growth through remittances, exports and tourism arrivals in different markets.