1. How Vulnerable is Central America to Shocks From the South? Inter-American Development Bank 10-25-02

2. Outline Central America and previous capital markets crises How has the region responded to the current crisis? How vulnerable is the region to capital markets disturbances?

3. Outline Central America and previous capital markets crises How has the region responded to the current crisis? How vulnerable is the region to capital markets disturbances?

4. CAC7 - Bilateral Real Exchange Rate with US (Dec. 1995=100) Source: WEO (Sept 2002) - forecast for 2003 from EIU Sep- 2002 Mexican Crisis Asian CrisisRussian CrisisArgentina Crisis

5. Real Exchange Rate Depreciation (vis-à-vis the US dollar, Jun. 2002 vs. Jan. 1997) Source: IFS/IMF

6. CAC6- Lending Interest Rates Source: IFS (IMF). * The values do not include El Salvador CAC7 Average LAC7 Average CAC7 Median LAC7 Median

7. CAC-7 Capital Flows (billions of US dollars) Source: WEO (Sept 2002) Includes Errors and Omissions FDI Non FDI Errors & Omissions Total Capital Flows+ Errors & Omissions

8. CAC-7 Capital Flows (% of Total Capital Flows+Errors & Omissions, Average 1997-2002f) Source: EIU (Sept 2002) FDINon FDIErrors & Omissions

9. CAC7 Current Account Balance (% of GDP) Source: WEO (Sept 2002) - forecast for 2003 from EIU Sep- 2002

10. CAC7- Current Account Balance (as a % of GDP, 2001) Source: EIU SLV DOM CRI PAN HON GTM NIC

11. 30 35 40 45 50 55 60 65 199719981999 2000 2001 2002 f LAC7 CAC7 Private Capital Flows (US$ billions) Source: WEO(Dec 2001). LAC 7 = Argentina, Brazil, Chile, Colombia, Mexico, Peru and Venezuela. CAC 7 = Costa Rica, Dominican Republic, El Salvador, Guatemala, Honduras, Nicaragua Panama.

12. Outline Central America and previous capital markets crises How has the region responded to the current crisis? How vulnerable is the region to capital markets disturbances?

13. Spreads w.r.t. US Treasury Bonds Source: Bloomberg

14. Gross Domestic Product (yoy % change) Source: EIU (Oct 2002) -2% -1% 0% 1% 2% 3% 4% 5% 6% 7% 1992199319941995199619971998199920002001 2002f2003f CAC 7LAC 7

15. Gross Domestic Product (yoy % change) Source: EIU (Oct 2002) -2% -1% 0% 1% 2% 3% 4% 5% 6% 7% 1992199319941995199619971998199920002001 2002f2003f CAC 7USA

16. Econometric Evidence: CAC7 and U.S.A. GDP Growth Dependent variable: Cyclical component of CAC7 GDP growth (1) (2) Cyclical component of U.S.A. GDP growth 0.298 0.916 (2.19) (2.12) Terms of trade 0.005 0.023 (0.68) (1.68) International interest rate -0.064 -0.574 (-0.81) (-1.64) LEI spread 0.001 (0.50) Observations 153 70 Number of countries 7 7 Fixed effects YES YES (1)Data from 1980 to 2001 (2) Data from 1992 to 2001

17. Exports + Imports (% GDP) (2001) Source: WEO (Sept 2002) and RES/BID estimates

18. CAC7 - Export Composition according to destiny (2001) Source:EIU USMexicoCAC7

19. CAC-7 Remittances (billions of US dollars) Capital Flows + Errors y Omissions Remittances

20. CAC-7 Remittances (as a % of FDI Capital Flows, for 2001) Source: WEO, Central Banks and RES estimates

21. Total Capital Flows and Remittances (% of GDP) Average 1997-2001 Source: WEO (Sept 2002), Central Banks and RES estimates Capital flows include errors and omissions

22. Outline Central America and previous capital markets crises How has the region responded to the current crisis? How vulnerable is the region to capital markets disturbances?

23. CAC-7 Capital Flows* (as a % of GDP, 5 year average as of 2001) Source: WEO & EIU * Includes Errors & Omissions

24. Public Sector Balance (% of GDP) Source: EIU (Sept 2002) CRI DOM SLV HON NIC GTM PAN

25. Fiscal Sustainability Source: Own estimates. Data from EIU Notes:/* Refers to geometric average of growth rates during the last decade Observed Public Debt (% of GDP) Real Interest Rate Real GDP Growth * Observed Primary Surplus (% of GDP) Req. Primary Surplus (% of GDP) CRI 48.9 5.98 4.8 -5 0.54 DOM 24.3 4.49 6 0 -0.35 SAL 36.89 5.12 4.26 -3.8 0.30 GTM 28.12 4.56 3.7 -1.5 0.21 HON 63 4.02 3 -5.9 0.62 NIC 202.9 1.62 3.5 -15.8 -3.78 PAN 75.6 5.67 3.38 -2.8 1.68

26. What makes countries vulnerable to costly adjustments? Low supply side openness High indebtedness High financial mismatches –Public Sector –Private Sector High financial exposure to the public sector

27. Supply-Side Openness Coefficient (Supply of Tradables - Interest Payments / Absorption of Tradables)) Source: WEO (Sept 2002) and RES/BID estimates

28. Source: EIU.(Median) CAC7:Public Debt (% of GDP) Total Public DebtExternal Public Debt

29. Source: EIU and Central Banks.(Median) CAC7 & LAC7:Public Debt (% of GDP) 0 10 20 30 40 50 60 19951996199719981999200020012002f CAC7 Total Public DebtCAC7 Ext. Public Debt LAC7 Total Public DebtLAC7 Ext. Public Debt

30. Currency Composition of Public Sector Debt (2001) [eD*/(D + eD*)] Source: Central Banks and EIU

31. Financial Mismatch of the Public Sector [ (D/eD*)/(Y/eY*)] (2001) Source: Central Banks and EIU

32. 0102030405060708090 Guatemala Dominican Rep. Honduras Costa Rica Nicaragua Deposits in FC/Deposits Loans in FC/Loans Deposits and Loans in Foreign Currency

33. 0102030405060708090 Honduras Guatemala Costa Rica Nicaragua Loans in FC to non-tradable sector/Loans

34. 05101520253035 Honduras Guatemala El Salvador Costa Rica Nicaragua Investment in Public Sector/Assets (loans to public sector are not considered)

35. Capital Flows Vulnerability: A summary = High Financial Mismatch of the Public Sector Public Debt (% of GDP) Financial System exposure to the Public Sector = Medium= Low DOMGTMCRISLVHONNIC PAN ? Financial Mismatch of the Private Sector Source: Central Banks and EIU ??

36. Concluding Remarks Central America has not been hurt by previous capital markets crisis The current crisis in South America is not an exception Despite the fact that remittances from the US help cushion crises, there are several issues of concern in some countries. The major source of concern should be the behavior of the US economy.

37. How Vulnerable is Central America to Shocks From the South? Inter-American Development Bank 10-25-02