Central America: Under the Radar

While attention is riveted on troubled giants like Venezuela, Central America’s small economies stage a modest comeback.

The iconic F&F Tower in Panama City’s financial district.

Distracted by elections and subsequent changes of government in neighboring giants Mexico, Brazil and Colombia, international investors paid little or no attention to the smaller countries of Central America last year. The IMF, which includes Panama and the Dominican Republic in its Central America grouping, puts the region’s growth rate well above 3%, surely outperforming the rest of Latin America.

The six small countries nestled in the isthmus south of Mexico are expected to repeat this performance in the current year and probably the next as well, while the world’s attention is mostly focused on troubled Venezuela.

Across the region, with the exception of politically riven Nicaragua, investment opportunities stem mostly from large infrastructure projects and renewable energy. “The principal economic opportunities are major infrastructure programs, large-scale transport and shipping projects in Panama, and economic development projects in the Northern Triangle [Guatemala, Honduras and El Salvador], potentially benefitting from Mexican and US aid,” says Jesse Wheeler, senior country-risk analyst at Fitch Solutions.

In most cases, the need for infrastructure such as roads, ports and airports is fueling expectations of new business going forward.

“Central American infrastructure development presents significant opportunities, given the geography of the region and, particularly, Panama’s status as a logistics hub for global trade,” says Matteo Addonizio, infrastructure analyst at Fitch. “This is complemented by efforts in most of the region’s countries to boost the role of private investment in infrastructure development via public-private partnerships (PPPs). However, the region’s markets present uneven risks for infrastructure development, with Nicaragua and the Northern Triangle countries posing greater bureaucratic, security and political risks compared to Costa Rica and Panama.”

Downside and Upside

On the downside, the region suffers from an extremely high level of income inequality and, in the cases of El Salvador, Guatemala and Honduras, from serious crime problems and—partly as a result—low-to-stagnant productivity. The possibility of devastating hurricanes like the ones that have hit the region in the recent past, and the impact coming from the border tension between Mexico and the US represent even stronger headwinds.

“The key risks facing Central America and the Caribbean are largely external,” says Oliver Reynolds, an economist at FocusEconomics. “The region remains vulnerable to a slowdown in the US economy, which is a vital source of remittances, exports and tourist arrivals. Moreover, a tightening of global financial conditions could provoke capital outflows and higher domestic interest rates, while higher oil prices would weigh on the external sector. Internally, a flare-up of the conflict in Nicaragua and vulnerability to extreme weather events are the key risks.”

Yet, FocusEconomics’ panelists (who include the Caribbean in their Central American grouping) see the region expanding 3.6% this year and 3.3% in 2020. Honduras is expected to grow 3.8% in 2019 and Guatemala 3.1%. El Salvador, where the outsider center-right candidate Nayib Bukele recently won the presidency, is seen expanding by 2.3%. Even Costa Rica, where a fiscal deficit correction has prompted downward revision of growth expectations, is expected to check in with 2.8% growth this year; while the economy has stumbled on a decline in private and public consumption, fixed investment remains strong.

In dramatic contrast, Nicaragua’s economy is expected to keep contracting after registering -4% in 2018, according to IMF data, in part because it is the only country in the region impacted by the turmoil and possible changeover of power in Venezuela. In the past, Caracas supplied low-cost oil to neighboring countries in Central America and the Caribbean. These aid programs became unsustainable with the country in economic free fall.

“Nicaragua has historically received substantial aid from Venezuela, largely in the form of subsidized oil,” says Andrew Trahan, country-risk analyst at Fitch. “With the collapse in oil production in Venezuela, the Ortega government has been forced to cut back on public spending. This was one of several factors that ignited the protest movement in Nicaragua in 2018. We note that Venezuelan aid to Nicaragua has dwindled substantially in recent quarters.”

The Nicaragua Human Rights and Anticorruption Act of 2018, passed last November by the US Congress (and widely referred to as NICA, the catchy acronym for a prior version, the Nicaraguan Investment Conditionality Act), hobbles the Nicaraguan government’s ability to obtain multilateral developmental loans.

“The NICA act puts financial sanctions on key members of the Ortega government,” says Lindsey Ice, an economist at FocusEconomics, “and, more importantly, empowers US representatives in international financial institutions—such as the World Bank, Inter-American Development Bank and International Monetary Fund—to use American influence to oppose any loan to Nicaragua until the government takes steps to hold elections that meet democratic standards. The act will likely have immediate effects on the investment climate, which has already suffered tremendously since the outset of the political crisis. It remains to be seen whether President Ortega will buckle under international pressure to call an early election.”

However, political instability is unlikely to spread to other countries in the region, according to Jan Dehn, head of research at Ashmore Group. “There might well be a change in Venezuela, but I do not see it spreading to the other countries,” he says. “Venezuela’s situation is very contained; and there’s no appetite in the region to see a return of American-led intervention or coups and dictatorships, as we had in the past.”

Opportunities Big and Small

In Central America’s growing economies, often the business opportunities are small: for example, upgrades costing a little less than $200 million are proposed at La Aurora airport, Guatemala’s primary air hub and the fourth busiest in Central America. However, these countries are trying to attract private investment in such projects. For example, the Exports and Investment Promotion Agency of El Salvador (Proesa), an agency charged with overseeing public-private partnership agreements, is expected to soon launch the Lighting and Highway Surveillance project, which will be the country’s second PPP, coming fast on the heels of its first PPP, improvements to Monseñor Arnulfo Romero International Airport.

Renewable energy has catalyzed other recent opportunities. In Guatemala, over 60% of electricity comes from renewable sources. “Renewable energy has definitely been a success story for investors in Central America, although at a much smaller scale than in Mexico or South America,” says Francesco Menonna, senior power and renewables analyst at Fitch Solutions. “Several Central American countries—El Salvador, Guatemala and Panama among them—have held auctions for renewables capacity at some point over the past four years; and it is likely they will hold new tenders in the future, given that power consumption is growing at a robust rate across the region.”

Panama is the richest and the fastest growing country in Central America and after a relatively weak showing in 2018, appears to be regaining strength. FocusEconomics expects GDP to grow about 5% this year.

“In Panama, its well-developed services sector has been a major engine of growth,” says Lee Sutton, country-risk analyst at Fitch. “Canal fees boost government revenue and attract investment in maritime services, logistics and other export-driven industries.”

The government has taken steps to strengthen banking sector regulation and increase the transparency of the financial-services industry, aiming to dispel the bad odor connected to Panama’s past as a tax haven. “Panama’s dollarized economy and well-integrated banking sector means it will likely remain a financial-services hub for Central America and the Caribbean for the foreseeable future,” Sutton concludes.