Central America Macro Watch April 20, 2006

Agenda External Financial Conditions Economic Growth and Outlook The Real Exchange Rate and Inflation Effects of Oil Price Increases The MDRI Initiative and its Impact

Capital Flows, CAC-7 (US$ Billion) Capital Flows have kept on increasing, and have hovered steadily… Source: BoPs (April 2006), WEO(Sep 2005). Includes errors and omissions. CAC 7 = Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua and Panama Argentinean Crisis Russian Crisis Asian Crisis Total Flows Dominican Crisis

Capital Flows, LAC 7 & CAC 7 (index 1997=100)...in contrast with LAC7 countries Source: BoPs (April 2006), WEO(Sep. 2005). CAC 7 = Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua and Panama LAC 7 = Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela * Total Capital Flows include errors and omissions. Asian Crisis Russian Crisis Argentinean Crisis Dominican Crisis F2006 F (Index 1997=100) CAC7LAC7

External Financial Conditions Spreads over US Treasury Bills (basis points) Source: Bloomberg The CAC7 Sovereign Spreads are from JP Morgan’s Latin Eurobond Index and include Costa Rica, El Salvador, Guatemala and Panama. The index shown above is an average weighted by market capitalization. This is reflected in lower spread volatility in Central America... Enron Effect BanInter Intervention Sovereign Spread CAC7 Excl. Dominican Rep. EMBI+ Excl. Argentina Apr-02 Jun-02 Aug-02 Oct-02 Dec-02 Feb-03 Apr-03Jun-03 Aug-03 Oct-03 Dec-03 Feb-04 Apr-04Jun-04 Aug-04 Oct-04 Dec-04 Feb-05 Apr-05Jun-05 Aug-05 Oct-05 Dec-05 Feb-06

GDP at Constant Prices (index 1997=100, regional averages)...higher GDP growth in the region... Source: WEO (Sep. 2005). LAC7= Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela CAC 7 = Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua and Panama Asian Crisis Russian Crisis Argentinean Crisis CAC 7 LAC Index 1997=100

....and most of all in real exchange rate stability. CAC7– Bilateral Real Exchange Rate Index (1997=100) LAC7= Argentina, Brazil, Chile, Colombia, México, Peru and Venezuela CAC 7 = Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua and Panama The bilateral real exchange rate is the regional average. Source: IFS, WEO (Sep. 2005) and own estimates. Argentinean Crisis Russian Crisis Asian Crisis BanInter Intervention

Source: WEO (Sep-05), BoPs (April-2006) CAC 7 = Costa Rica, Dominican Rep., El Salvador, Guatemala, Honduras, Nicaragua and Panama Current Account Balance & Remittances, CAC7 (% of GDP) Although remittances have financed a big share of the current account deficit...

Source: BoPs (April 2006), WEO (Sep-05). CAC 7 = Costa Rica, Dominican Rep., El Salvador, Guatemala, Honduras, Nicaragua and Panama Capital Flows and Remittances, CAC-7 (US Dollar Billion)...they have been growing steadily, and apparently isolated from economic cycles.

There is a strong link between the regional cycle and that of the US, due to large tradable sectors integrated to the US... Source: WEO (Sep. 2005), EIU (Mar 2006), BCN (NIC) and MEF (PAN). CAC 7USA CAC 7 = Costa Rica, Dominican Rep., El Salvador, Guatemala, Honduras, Nicaragua and Panama GDP at Constant Prices (Annual Growth, in percent) Argentinean Crisis Russian Crisis Asian Crisis Mexican Crisis

CAC 7 = Costa Rica, Dominican Rep., El Salvador, Guatemala, Honduras, Nicaragua and Panama GDP Growth, CAC7 (in percent, 2005E vs. 2006F) Following lower growth expectations in the US, somewhat lower growth is forecasted for 2006 Source: EIU Country Reports (Mar 2006) CRI DOM SLV GTM HON NIC PAN GDP growth in 2005E GDP growth in 2006F

Inflation and the Real Exchange Rate

Source: Central Banks, WEO (Sep-2005), EIU (March-2005) CAC7 – Inflation Rate (%) The region has experienced a sustained increase in inflation. What drives this process?

In many cases, an important policy objective is to ensure real exchange rate stability... CAC7– Bilateral Real Exchange Rate Index (1997=100) LAC7= Argentina, Brazil, Chile, Colombia, México, Peru and Venezuela CAC 7 = Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua and Panama The bilateral real exchange rate is the regional average. Source: IFS, WEO (Sep. 2005) and own estimates. Argentinean Crisis Russian Crisis Asian Crisis BanInter Intervention

Source: IFS. Own estimates. CAC7 – Bilateral Real Exchange Rate with the US (1997=100)

16 Source: BoPs (April 2006), Central Banks, WEO (Sep-05) Remittances by Country Remittances by Country (% of GDP) The substantial increase of remittances has been a source of potential real exchange rate appreciation. 270% increase 85% increase

17 * General Government Balances include grants. Source: WEO (Sep-05), Central Banks, IMF Country Reports Non-Financial Public Sector Balance (% of GDP)* Fiscal deficit financing is large in many cases... Regional average for 2005: -2.2% of GDP

CAC 7 – Central Bank Debt (% of GDP) Source: Central Banks. Information for Costa Rica and Honduras as of Feb-2006 …in an effort to keep inflation at bay and stabilize the real exchange rate, Central Banks sterilize the associated monetary expansion... Regional average for 2005: 8.4% of GDP

Source: Central Banks and IMF. CAC 7 –Net Central Bank Losses ( , % of GDP)...at a high quasi-fiscal cost. 0.0% 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5% CRIDOMGTMHONNIC Regional average for 2005: 1.4% of GDP 2005 Average

An example of Likely Deviation from Equilibrium RER by 2004: Guatemala Actual Equilibrium REER PEquilibrium REER T However, strong real appreciation has taken place in (11% )

Effects of Oil Price Increases

Oil Price Behavior Spot Price Crude WTI Cushing. Source: Bloomberg. 343%

Fuel Imports as a Share of Total Imports Note: Excludes maquila or free zone imports. Source: Central Banks. Average (2005)

Note: The Fund’s September 2005 World Economic Outlook (WEO) now envisages world oil prices averaging US$54.1/bbl in 2005 and US$61.8/bbl in 2006, some 17 percent and 40 percent higher, respectively, than projected in the April 2005 WEO. Source: Singh, Anoop. Global Context and Regional Outolook for Latin America and the Caribbean. IMF. October LAC: Oil price impact on economic activity and Inflation (in % ) Net oil Exporters South America Central America The Caribbean Latin America and the Caribbean 3.0% InflationGrowth 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% -0.5% -1.0% -1.5% Estimates of the impact of the change of WEO oil price assumptions in the LAC Region

Note: Preliminary results. * Average change in Oil Prices estimated between 2004 and 2005 for the Spot Prices of the West Texas Intermediate. ** Forecast based on annual growth rate of Oil Prices from IMF. Source: Central Banks, Bloomberg, and BoPs (April 2006); own estimates. Effect of an increase in the Price of Oil over the Real Exchange Rate CRIDOMSLVGTMHNDNICPAN Net Oil Imports (US$ million, 2004) Oil Price Increase (%)* 37.7% Oil Price Increase (%)** 57.3% Oil Imports Increase As a share of GDP As a share of Imports Oil Imports Increase As a share of GDP As a share of Imports Change in REER required ( ) Number of Standard Deviations Change in REER required ( ) Number of Standard Deviations So far, given favorable financing conditions, the oil shock has been absorbed without major RER effects. But things could be different in the absence of foreign financing

Data for Honduras as of June Source: Banking System Monitor...and there are mismatches in the financial system that make it vulnerable to changes in the real exchange rate. Credit in Foreign Currency to Non-tradable Sectors/Total Credit to the Private Sector (in %) HONGTMCRINICSLV

Note: The ratio dB/de measures changes in total debt in percentage points of GDP (B) that would occur when the real exchange rate (e) variation of 100% Source: Central Banks, Finance Ministries and IMF. Own estimates. Financial Exposure of the NFPS - dB/de (2004) On the other hand, the public sector in some countries is heavily exposed to RER depreciation. CAC 7LAC 7

Multilateral Debt Reduction Initiative

Multilateral Debt Relief Initiative (MDRI) Coverage: HIPC countries that have reached, or will eventually reach, their completion point, plus non-HIPC countries with a GDP per capita at or below US$380. Relief: 100 % of debt with three multilateral institutions: IMF, IDA, and ADF. Amount: About US$50 billion in nominal terms (outstanding stocks as of Dec-2004). Qualifying IADB members: Bolivia, Guyana, Honduras and Nicaragua. Allocation: In contrast to HIPC initiative, there is no specific allocation for social expenditure increases.

Multilateral Public Debt in HIPC4 (Present Value of Disbursed Outstanding Debt, end 2004) Note: Total Multilateral Public Debt in present value: Bolivia, 3558 US$ mill; Guyana, 629 US$ mill; Honduras 2534 US$ mill; and Nicaragua 1877 US$ mill. Source: “G8 PROPOSALS FOR EXTENDED DEBT RELIEF: IMPLICATIONS FOR THE BANK”, document prepared by IADB Staff Bolivia World Bank 28% IMF 8% IADB 37% Other Multilaterals 27% Guyana World Bank 22% IMF 12% IADB 49% Other Multilaterals 17% Honduras World Bank 30% IMF 7% IADB 44% Other Multilaterals 19% Nicaragua World Bank 32% IMF 11% IADB 48% Other Multilaterals 9%

Impact of HIPC & MDRI: NPV of Public Debt as a share of GDP (2004, in %) Source: “G8 PROPOSALS FOR EXTENDED DEBT RELIEF: IMPLICATIONS FOR THE BANK”, document prepared by IADB Staff. Own calculations Ratio of Present Value of External Public Debt to GDP in 2004, in percent GuyanaHondurasNicaraguaBolivia OutstandingAfter HIPCAfter MDRIAfter IADB "MDRI" 15% 27% 32% 38%

Source: GDF and IMF. Own calculations BoliviaGuyanaHondurasNicaragua OutstandingAfter HIPCAfter MDRIAfter IADB "MDRI" 1.4% 3.3% 1.6% 1.7% Impact of HIPC & MDRI: Amortization of Multilateral Public Debt to Reserves Ratio (2004, in %)

Source: GDF and IMF Country Reports. Own calculations GuyanaNicaraguaHondurasBolivia After HIPCAfter MDRIAfter IADB "MDRI" Impact of MDRI: Multilateral Interest as a Share of Poverty Reduction Expenditure (2004, in %)

Central America Macro Watch April 20, 2006