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Investors to Central America: Sometimes Growth is not Enough

Even if Central America’s countries have been leading the way on the growth front in Latin America, they are still far less attractive for investors compared to the region’s South American peers. Reforms will help change that.

May 23, 2017 // 4:48PM

The economic improvement in the US and the low cost of oil, combined with the stability of low-interest rates worldwide, have contributed in cementing Central America’s status as the fastest growing region in Latin America.

The region as a whole is set to grow 3.7% in 2017 and 4.1% in 2018.  Panama look likely to lead the way with forecast growth of 5.8% in 2017 and 6.1% in 2018, followed by the Dominican Republic with 5.3% in 2017 and 5% in 2018.

Nicaragua is set to grow 4.5% in 2017 and 4.3% in 2018; Costa Rica 4.1% in 2017 and 4.0% in 2018; Guatemala 3.3% in 2017 and 3.5% in 2018; Honduras 3.3% in 2017 and 3.6% in 2018, on the bottom is El Salvador with 2.3% in 2017 and 2.3% in 2018, according to official statistics.

Compared to some of the region’s larger neighbours – Chile, Brazil, Brazil and Argentina, which are all plagued by a combination of economic stagnation and political challenges – those are some fairly impressive figures.

Traditionally, sovereign bonds issued by Central American nations have relatively high yields, even though it varies from country to country. El Salvador, which was technically in default earlier this year, borrows at an average rate of 8%, while Panama tapped the market early this year at 4.8%; Costa Rica’s 10-year benchmark government bonds carry a 7% coupon.

Yields and Growth in Perspective

 “Central America is a very mixed bag of reformers and troubled countries even if generally the region is well managed with healthy growth and moderate debt levels,” explained Jan Dehn, Head of Research at Ashmore Investment Management

Even if in recent years the sub-region might continue to grow at a faster pace than other neighbouring countries, it will likely continue to be a lot less popular than larger, more established markets in South America.  

“They are small, and some have a reputation for violence and susceptibility to natural shocks, such as hurricanes. There is a lot of poverty which sometimes generates instability and generally keeps these countries from underperforming relative to potential,” the investor mentioned.

“Overall, the region is less liquid than the rest of Latin America so tends to trade less,” Dehn explained.

This doesn’t not mean, however, there are no investment opportunities in Central America.

The nations most appealing for investors in the recent years have been The Dominican Republic and Guatemala. Both countries have seen stable growth and embraced a series of reforms that have encouraged foreign investors.

The Dominican Republic has grown 7% on average over the last few years, fuelled mainly by the tourism sector, increasing remittances, and low oil prices. The country has also broadly benefitted from the US’ economic improvement as of late.

The conservative bet in the region is Panama, which according to Dehn is viewed as a “safe haven credit” market by international investors.

Panama’s economy represents over 20% of Central America’s GDP and has grown at an impressive rate in the last few years, mostly due to its strategic position and its control of the Panama Canal.  It has also been viewed as a politically stable country with low crime rates, which has attracted many foreign investors.

Even though Costa Rica is the most developed country in the region and represents 25% of Central America’s economy, it continues to underperform given its potential.

Costa Rica has not been able to reform its fiscal policy and rein in its deficit, which has risen sharply each year since 2008.

Rating agencies have not been kind to Costa Rica either. Last year Moody’s revised its outlook on the country to negative, even though it has reputation of political stability and one of the highest GDP in Central America. S&P also has the sovereign’s foreign currency rating outlook on negative watch due to its fiscal and external vulnerabilities.

The Bad Students

“El Salvador, Honduras and Belize are the least attractive sovereign for investors,” Dehn added.

According to a report published by Frontier Strategic Group, 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.”

“El Salvador has been the worst performer in attracting net investment inflows, investors see higher growth and potential in most of the other markets in the sub-region,” the report explains.

Poor growth prospects in El Salvador in recent years have been driven mainly by a deterioration in respect for the rule of law and an escalation in violent crime, a hangover from the civil war that ended in the 1990s which continues to wreak havoc on the country’s economy.  Honduras shares this issue, albeit to a lesser extent, while Belize is viewed as a serial defaulter by investors.

Despite their size and impressive growth prospects, Central American countries still need to embrace significant economic and social reforms if they are to attract foreign investors to their shores. Sometimes, growth is not enough.

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