90491 Guatemala Economic DNA Harnessing Growth With a special focus on Jobs August 2014 First Edition Contents Executive Summary XV I. Recent Economic Developments Guatemala’s Economy: Steady Economic Growth and Remaining Challenges for Shared Prosperity in the Face of Continued Global Uncertainty 01 Inflation: Food Inflation Accelerated but Headline Inflation Remains within the Central Bank’s Target Band 07 Fiscal Policy: Fiscal Stability and a Partially Successful Tax Reform 09 External Sector: Reliance on External Savings in a Context of Rising Domestic Demand and Deteriorating Terms of Trade 15 Monetary Policy and the Financial Sector: Credit Growth Accelerates 20 II. Economic Outlook and Risks The Global Outlook: Gathering Steam? 25 Guatemala’s Outlook: Steady Growth is Not Enough 26 Risk Scenario: Guatemala’s Sensitivity to a Remittance Shock 31 What could happen if remittances were to stagnate for one year? 32 III. Focus Section: Jobs in Guatemala Introduction 37 Background and Regional Context 38 Guatemala’s Private Sector Employment in Comparative Perspective 40 What Drives Job Creation in Guatemala? 42 Technological Capabilities and Job Creation in Guatemala: Evidence from the Manufacturing Sector 46 Job Creation and the Informal Sector in Guatemala 50 Conclusion 55 Annex 57 References 59   VII List of Figures Figure 1: Guatemala’s growth remained resilient during the global financial crisis, but on average has been below that of peer economies. 01 Figure 2: Guatemala’s growth in 2013 was driven by increasing consumption, while both investment and net exports weakened. 02 Figure 3: Services remain the primary driver of GDP growth. 02 Figure 4: …driven by financial services, transportation and communications. 02 Figure 5: The financial sector has been expanding rapidly. 02 Figure 6: Coffee producers in Guatemala were heavily affected by the rust among Central American exporters. 03 Figure 7: Overall agricultural growth remained solid despite the impact of the coffee rust 03 Figure 8: Productivity dynamics in Guatemala’s coffee sector show significant scope for improvement 04 Figure 9: Developments in the coffee sector have direct implications for poverty in Guatemala 04 Figure 10: Manufacturing growth was led by food and beverages and a recovering textile industry. 05 Figure 11: Guatemala’s construction sector represents a relatively small share of GDP. 05 Figure 12: Guatemala’s economic growth lags behind its regional peers, many of which have low volatility; meanwhile Guatemala’s HDI is one of the lowest 06 Figure 13: Guatemala’s recent productivity performance leaves significant scope for improvement 06 Figure 14: Higher growth could significantly reduce poverty. 07 Figure 15: Headline inflation picked up in 2013, while core inflation moderated. 08 Figure 16: Guatemala’s inflation remains relatively low compared to its regional peers. 08 Figure 17: Full implementation of the reform comprises gradual steps over three years and withstood legal challenges, unlike previous reform efforts which had been rolled-back 11 Figure 18: Government revenues in 2013 were lower than initially expected, but would have been even lower without the tax reform. 12 Figure 19: VAT collection on imported goods was weak despite growing imports. 14 Figure 20: Recent current-account developments reflect a decline in domestic savings. 17 Figure 21: Sugar and banana exports mitigated the decline in coffee and cardamom exports. 17 Figure 22: Imports of capital goods and raw materials led the growth of the imports. 17 Figure 23: Remittances represent an important component of the Guatemalan economy. 18 Figure 24: US growth, Guatemalan inflation and the past behavior of remittances are key predictors of remittances in the short-run. 19 Figure 25: In 2013 the Central Bank tightened interest rates in April, before easing them again in November as inflationary pressures receded. 20 Figure 26: The nominal exchange rate remained stable through 2013. 21 Figure 27: The real effective exchange rate (REER) depreciated as inflation in Guatemala persistently exceeded inflation in the United States. 21 Figure 28: Provinces’ share of credit is growing, but lending is concentrated in Guatemala City. 22 VIII Figure 29: Credit to the private sector grew at a robust pace, led by foreign-currency lending... 22 Figure 30: … and is diversified among economic sectors. 22 Figure 31: Growth among Guatemala’s main trading partners is expected to accelerate over 2014-16. 25 Figure 32: Guatemala’s Terms of Trade are expected to remain relatively stable going forward 26 Figure 33: Guatemala’s investment-to-GDP ratio is falling, while the investment level in many other countries is rising. 29 Figure 34: Public-private partnerships could boost investment in the coming years and become an opportunity to reduce the large infrastructure gap 31 Figure 35: A remittance shock would be felt throughout the Guatemalan economy. 33 Figure 36: If remittance inflows were to stop growing for one year, this could significantly impact GDP growth and other macroeconomic indicators in Guatemala. 34 Figure 37: Unemployment has remained stable over the past decade, but under-employment has risen 38 Figure 38: More Guatemalans are now employed in commerce and services, while the share of workers employed in the agricultural sector has decreased. 39 Figure 39: Guatemala’s labor productivity growth lags that of regional peers 39 Figure 40: Workers in Guatemalan firms tend to be less educated than in peer economies. 39 Figure 41: The 2010 WBES includes a cross-sector sample of firms in Guatemala’s formal sector... 41 Figure 42: …comprising small, medium, and large firms. 41 Figure 43: Sales grew in Guatemala between the 2006 and 2010 surveys, but sales growth was not as strong as in LAC and Middle Income Countries. 40 Figure 44: Employment growth fell sharply between the 2006 and 2010 surveys, more so than in peer economies 40 Figure 45: Employment in Guatemalan manufacturing contracted in 2010; the services sector performed better but weaker than in peer economies. 42 Figure 46: Exporting firms, foreign firms, and smaller firms led job creation in Guatemala 43 Figure 47: Relative to peer economies, exporting firms in Guatemala created more jobs in the 2006 survey, but in the 2010 survey employment creation in these firms had slowed significantly 43 Figure 48: Young firms led job creation in Guatemala and peer economies. 43 Figure 49: Guatemalan firms with access to credit and without credit constraints led job creation 45 Figure 50: Guatemalan firms cite crime, corruption and practices of the informal sector as among the most severe obstacles to doing business. 46 Figure 51: Over 70 percent of Guatemalan manufacturing firms see TCI scores below 0.6 48 Figure 52: Firms’ TCI scores are lowest on the dimension of economic linkages 48 Figure 53: The chemicals and rubber and plastics industries lead the manufacturing sector in TCI scores 48 Figure 54: Large firms tend to have higher TCI scores than small firms 48 Figure 55: Job creators, exporters, foreign firms, and firms with access to finance have a higher TCI score 49 Figure 56: More than a quarter of informal firms would like to formalize. 52 Figure 57: Firms that do not want to formalize cite a variety of reasons. 52 Figure 58: Opportunity-driven entrepreneurs are more likely to have previously held formal jobs, live in Guatemala city and have parents who own their businesses 53 IX List of Tables Table 1: Guatemala has managed to maintain fiscal stability despite its limited resources. 10 Table 2: Current account pressures were offset by a financing surplus. 16 Table 3: Economic growth is expected to keep its pace. 27 Table 4: Guatemala’s headline employment and unemployment rates are below the regional average, while labor force participation is around the regional average. 38 Table 5: Financial depth is associated with employment ceation 44 Table 6: Matrix of Technological Capabilities in Investment (TCI), Production and Linkages 47 Table 7: Opportunity-driven firms tend to be more productive than their necessity- driven counterparts 53 X List of Boxes Box 1: Coffee and Poverty. Improving the Performance of Coffee Producers Could Substantially Reduce Poverty 04 Box 2: Growing to Prosperity. Improving Guatemala’s Growth Performance Could Boost Prosperity 06 Box 3: The Long and Winding Road to Tax Reform. A Timeline of Guatemala’s Recent Reform Efforts Towards Revenue Mobilization 11 Box 4: In Search of the Lost Tax. Assessing the 2013 Performance of Taxes Related to Foreign Trade 14 Box 5: Sending Money Home. What Determines Remittance Levels in Guatemala? 18 Box 6: Picking Up the Investment Pace. Accelerating Guatemala’s Long-Term Growth Rate Through Greater Investment 30 Box 7: You Can Only Improve What You Can Measure. Firm-Level Data in Guatemala 41 Box 8: The Challenges of Understanding Informality. Surveying Informal Firms in Guatemala 51 Box 9: Last Resort or New Horizon?. Necessity and Opportunity in the Informal Sector 52 XI Abbreviations and Acronyms ANADIE National Agency for the Development Partnership in Infrastructure DB Doing Business FDI Foreign Direct Investment GDP Gross Domestic Product HDI Human Development Index IES Informal Enterprise Surveys ILO International Labor Organization IMF International Monetary Fund ISCV Tax on the Circulation of Motor Vehicle ISIC International Standard Industrial Classification ISR Income Tax (Impuesto Sobre la Renta) LAC Latin American and the Caribbean MIC Middle Income Countries OECD Organization for Economic Co-operation and Development PPP Public-Private Partnerships REER Real Effective Exchange Rate SAT Superintendence of Tax Administration SMEs Small and Medium Enterprises TCI Technological Capabilities Index TFP Total Factor Productivity VAR Vector Autoregressive Model VAT Value Added Tax WBES World Bank Enterprise Surveys WDI World Development Indicators WEO World Economic Outlook Foreword It is a great pleasure to present this first edition of the Guatemala Economic DNA (Diagnostic for National Action) prepared by the World Bank. For those of us that have had the privilege of working with Guatemala over the years, it is clear that there many Guatemalan development experiences that are worth sharing with the global community. For example, if we think of macroeconomic stability (an element that should be at the center of any development plan) Guatemala is an example to follow, and therefore for the World Bank analyzing and sharing the country’s track record on this front is of great interest. At the same time, there are experiences from other countries that we also believe could be of use to Guatemala. This would include experiences of countries that have managed to sustain high economic growth over the years and move to upper middle income and even high income status, or countries with a good track record of job creation that has helped translate economic growth into welfare gains for the whole society. The global community has now a renewed emphasis to eradicate extreme poverty by 2030 and promote shared prosperity and we believe that the World Bank can contribute to these objectives by promoting an exchange of development experiences, taking those where Guatemala excels to the rest of the world and bringing to Guatemala those where other countries have been recognized. Indeed this first edition of the Guatemala Economic DNA brings together, in a compelling way, the important achievements of Guatemala on the macroeconomic stability front. It also argues that these achievements will need to be secured and makes the case for an increased focus on accelerating economic growth. For example, this edition highlights that in 2013 the country’s economic activity expanded by 3.7 percent in 2013, and is projected to grow around 3.6 percent in the near-term, in line with the growth of Central American economies but below the growth rate in emerging markets. Meanwhile, inflation has been managed and the authorities deserve to be recognized for their commitment to maintain macroeconomic stability. A typical Economic DNA will be published every six months and will (i) review the most recent developments in the Guatemalan economy; (ii) reflect about future economic prospects; and (iii) analyze development topics of interest. In this first edition the focus is on jobs. This is a key linkage between performance at the macroeconomic level and prosperity at the microeconomic level. We find this topic particularly relevant in Guatemala given that even though the economy grew continuously in the past decade, the country created fewer jobs than other countries with the same level of income. Moreover, employment growth fell sharply in the years following the global financial crisis, more so than in other countries, and therefore there is a need to revert this trend. I hope you will enjoy this new report series which reflects the best analysis and knowledge of the World Bank for Guatemala. Humberto Lopez Director for Central America The World Bank XIII Acknowledgements This First Edition of the Guatemala Economic DNA was prepared by a World Bank team led by Marco Antonio Hernandez (Senior Country Economist). Erwin Tiongson (Senior Economist) led the Focus Section on job creation. The team consisted of Miguel Angel Saldarriaga, Mateo Clavijo, Jorge Loyola, Sean Lothrop, Kinnon Scott, Charles Udomsaph, Brendan Coates, Cesar Leon, Marek Hanusch, Matias Arnal, and Diana Lachy. Humberto Lopez (Country Director), Auguste Kouame (Practice Manager), Oscar Avalle (Country Manager), and Oscar Calvo-Gonzalez (Program Leader) provided overall guidance. Active collaboration with Guatemalan policymakers was instrumental in the production of this report. The Guatemala Economic DNA (Diagnostic for National Action) evaluates the implications of economic trends and policy reforms in terms of the government’s stated development objectives, and reviews challenges and opportunities currently facing the Guatemalan economy. The Guatemala Economic DNA is intended for a wide audience, including policymakers, business leaders, civil society organizations, academics, and the community of analysts and partners engaged in Guatemala’s evolving economy. The findings, interpretations, and conclusions expressed herein are those of the authors, and do not necessarily reflect the views of the World Bank’s Board of Executive Directors or the countries they represent. The cut-off date for the data in this report was July 8, 2014. For more information about the World Bank and its activities in Guatemala please visit: www.worldbank.org/ guatemala. If you would like to be included in the email distribution list of this semiannual series and related publications, please contact cleonjuarez@worldbank.org. For questions and comments related to this publication, please contact Marco Antonio Hernandez at marcohernandez@worldbank.org. XIV Executive Summary Guatemala’s economy has recovered at a modest inflows. Nonetheless, the medium-term outlook is but consistent pace since the global financial vulnerable to uncertain global market conditions. In crisis of 2008-09. The country avoided falling into a particular weaker growth in the United States could recession during the global financial crisis, and grew reduce remittances inflows to Guatemala. Simulation on average by 2.8 percent during 2008-12, compared analysis suggests that a slowdown in remittances to 4.4 percent during the pre-crisis period (2005-07). inflows would significantly affect GDP growth. Growth in the post-crisis period has remained less volatile than the regional average despite the natural Accelerating growth could substantially reduce disasters that struck in 2010. poverty in Guatemala, but this would require improvements in economy-wide productivity. Guatemala’s macroeconomic resilience is due Guatemala has the second lowest human to prudent macroeconomic policies and a more development index score in the Latin America and the diversified economy in comparison to other Central Caribbean (LAC) region and is also one of the poorest American countries, which has helped cushion countries in the region, with more than ½ of the the impact of shocks. Sound macroeconomic population living in poverty. Pro-poor policies could management has kept public debt sustainable and yield marginal improvements, but higher growth rates inflation within the band established by the Central would be necessary to significantly improve living Bank (4 percent ± 1 percentage point). Meanwhile, standards. According to World Bank staff simulations, terms of trade shocks in certain sectors have been if Guatemala’s rate of growth were to rise to 5 percent offset by growth in other sectors. For instance, in over the next three years, by 2016 the poverty rate 2013 the impact of the “coffee rust” on agricultural could fall by an additional 1 percentage point (from a production was countered by the strong performance projected poverty rate of 49.7 percent in 2016 under of sugar and cardamom. As a small open economy the baseline scenario), thereby allowing 160,000 this resilience is an asset to Guatemala at the macro more Guatemalans to escape poverty. level. However, shocks can have devastating effects at the household level that are not clearly reflected in Public investment is essential to achieving macroeconomic statistics. For example, when there is Guatemala’s development goals, yet it remains a shock in the coffee industry, coffee producers (many tightly constrained by a lack of resources, and the of whom live in poverty) do not necessarily benefit government continues to collect the lowest share from the success of other agricultural subsectors. of public revenues in the world relative to the size of its economy. Private investment is hindered by a In 2013 real GDP grew by 3.7 percent, up from 3.0 lack of complementary public investment, especially percent in 2012, and during 2014-2016 the country in infrastructure. Without an increase in domestic is projected to grow on average by 3.6 percent. revenues public investment (currently at 3 percent of Domestic consumption is expected to drive economic GDP) will remain inadequate to address Guatemala’s activity, while the contributions of both public and infrastructure deficit, enhance its economic private investment will recede. Growth will also be competitiveness, or boost growth. In 2013, lower- supported by the ongoing recovery in the United than-expected tax revenues forced significant cuts States, which is expected to drive higher remittances to public investment, underscoring the importance XV of strengthening tax enforcement and enhancing the Focus Section: quality of spending. Job Creation in Guatemala Tax reforms adopted in 2012 represent an important An examination of employment dynamics and milestone in the government’s efforts to mobilize their implications for income generation and firm revenues. The reform simplified the tax code and growth, presented as the Focus Section of this streamlined tax administration. Notably, the new tax report, underscores the extent to which structural legislation withstood legal challenges, unlike previous constraints on enterprise development slow hiring efforts to increase revenues which had been rolled rates, discourage technology transfer and promote back. It also increased the effective progressivity of informality. These constraints include an inadequate the tax system, as income tax collection rose by 20 and unevenly distributed supply of infrastructure percent in 2013. However, this increase in income and essential public goods, regulatory burdens that tax revenue was offset by a simultaneous decline in discourage informal firms from entering the formal the collection of value-added taxes (VAT) on imports. sector, and the prevalence of crime and corruption, As the volume of taxable trade increased during the which both compound perverse incentives and period, the shortfall in customs duties and import slow the pace of firm growth across the economy. VAT revenue appears to be the result of deteriorating Because addressing these challenges will require well- enforcement. Consequently, net gains in revenue informed policymaking, the issue of job creation was collection have been modest, though significant, selected as the Focus Section of the first Guatemala and without the reforms tax revenues would have Economic DNA. declined. Employment growth in Guatemala has lagged behind Advancing the structural reform agenda remains that of comparable countries, both in the LAC region critical; in this regard, recent efforts to improve and worldwide. The rate of job creation has closely the business climate are encouraging. Guatemala followed the country’s rate of economic growth, both was one of the countries that reformed the most during the global expansion of the late 2000s and in in order to improve the business climate, according the economic slowdown that followed the financial to the 2014 Doing Business ranking. Guatemala crisis of 2008-09. In the wake of the financial crisis, improved its ranking from 93rd in the world (out of however, Guatemala’s rate of employment growth 189 countries) in 2013 to 79th in 2014. In the past was lower than other countries with a similar level of year Guatemala has made it easier to start a business, income. deal with construction permits, and pay taxes. However, challenges remain in a number of key areas, Exporting firms, foreign firms, and smaller firms in including enforcing contracts, trading across borders, Guatemala performed better than others in terms and protecting investors. Maintaining the reform of job creation. On average, export-oriented and momentum to improve the investment climate is foreign-owned firms based in Guatemala City with vital, as foreign direct investment (FDI) in Guatemala ready access to finance, for example, exhibited the is relatively low and volatile in terms of both country strongest rates of job creation. For instance, the rate of of origin and target sector. Increasing FDI would employment growth in exporting firms was twice the boost growth and reinforce Guatemala’s resilience to size in comparison to non-exporting firms; we see a external shocks because FDI represents a non-debt- similar pattern when comparing employment creation creating source of foreign exchange. across foreign versus domestic firms. Smaller firms also experienced higher levels of employment growth XVI than larger firms. This pattern may be expected as the enforce existing legislation. Strengthening the rule initial starting point for employment in small firms of law and streamlining regulatory systems will be is, by definition, lower. However, it is worth noting essential to facilitating firm growth, fostering greater that smaller firms in Guatemala exhibited positive competitiveness, and boosting the returns to both employment growth in the years following the 2008- labor and capital. Bringing informal firms into the 09 crisis, while larger firms experienced a contraction formal sector is an especially critical objective due to in employment. implications for expanding the public revenue base and boosting firm productivity. Due to their cross- In addition, Guatemalan firms that adopt new cutting nature, employment-oriented reforms have technologies are not only more productive, but also the potential to greatly advance the government’s create more jobs. For instance, manufacturing firms objectives of economic development and poverty that collaborate with other firms, suppliers, clients reduction. and research institutions tend to be more efficient, which in turn contributes to making them more competitive and expanding their ability to generate new employment opportunities. The analysis in this report reveals that a 10 percent improvement in a firm’s “technology capability index” score (which measures the extent to which firms use different types of technologies) is associated with a 1 percentage point increase in employment growth. Several cross-cutting factors are also closely correlated with job creation in Guatemala, including financial depth, exposure to corruption, and informality. There is a strong correlation between access to finance and employment growth, while exposure to bribery and other forms of corruption constrains firm growth and slows job creation. Asymmetric competition from the informal sector also correlates with slower employment growth. While causation cannot be definitely established, measures to promote formalization and leveling the playing field between the formal and informal sectors are likely to have a significant impact on employment in the formal sector. Indeed, over ¼ of informal businesses in Guatemala report that they would like to become formal, and many of them are willing to pay to do so. Ultimately, the extent to which Guatemala’s economy will be able to capitalize on an incipient global recovery will depend less on the government’s ability to pass further reforms than on its capacity to XVII I Recent Economic Developments Guatemala’s Economy: Steady Growth and Remaining Challenges for Shared Prosperity in the Face of Continued Global Uncertainty G uatemala’s economy has recovered at a modest but consistent pace since the global financial crisis of 2008-09. GDP growth increased from 3.0 percent in 2012 to 3.7 percent drivendriven in 2013, in 2013, by rebounding by rebounding domestic domestic demand, demand, higher remittances higher remittances and favorable and generally generally favorable monetary conditions, all of which occurred against the backdrop of a monetary conditions, all of which occurred against the backdrop of a recovery in the Unitedrecovery in the United States, States, Guatemala’s Guatemala’s main main trading trading partner. Atpartner. At the the sector sector level, level, growth wasgrowth led bywas led by services, services, which which contributed contributed to about to about half half of economic of economic growth, by growth, followed followed by manufacturing. manufacturing. Banking, Banking, telecoms telecoms drove drove and transportation and transportation the expansion the expansion of the of the tertiary tertiary sectoras sector as domestic consumption continued to rise. The textile and food & beverage industries led the secondary sector, spurred by a mix of external and domestic demand. In the primary sector, agricultural production targeted for the domestic market also contributed to growth, while agricultural exports (particularly coffee) suffered from a combination of exogenous shocks and adverse price changes in global export markets. Building upon Guatemala’s recent macroeconomic resilience, the coming years present an opportunity to reduce poverty through more rapid economic growth. Indeed, Guatemala’s per capita GDP increased by less than 1 percent per year over the past decade. Achieving higher growth will depend upon continued reforms to mobilize greater private investment, while building upon recent tax reforms to improve revenue mobilization to fund important growth-enhancing investments in infrastructure and human capital. Economic growth in 2013 was driven by domestic Figure 1: Guatemala’s growth remained resilient during the global financial crisis, but on average has been below that of peer economies. consumption. The growth rate of private (Real GDP growth, %, year-on-year) consumption, which accounts for over 80 percent of GDP, accelerated from 3.1 to 3.9 percent between 2012 and 2013. Rising incomes and remittances— 9 around 50 percent of which go to consumption—as 8 well as expanding consumer credit fueled the increase 7 6 in consumption. Meanwhile, both public and private 6.3 5 investment weakened significantly. The growth rate 4 of private investment fell from 8.8 percent in 2012 to 3 3.3 4.2 3.7 3.6 percent in 2013. After contracting by 11.9 percent 2 2.4 in 2012 public investment declined by an additional 1 0.5 0 4.7 percent in 2013. Cuts in capital spending were -1 prompted by weaker-than-expected public revenues 2001 02 03 04 05 06 07 08 09 10 11 12 2013 and growing current expenditures. Meanwhile Guatemala Central America LAC5 Emerging Markets increases in exports were offset by rising imports (Figure 1). Source: Guatemalan authorities and World Bank staff estimates. 01 Guatemala’s economic activity in 2013 was led Figure 2: Guatemala’s growth in 2013 was driven by increasing consumption, while both investment and net exports weakened. by services, manufacturing, and agriculture. (Contributions to real GDP, % year-on-year) Services accounts for 45 percent of GDP and grew by 3.8 percent, slightly above the 2012 rate, while 8 manufacturing grew by 3.4 percent, up from 2.7 6 percent in 2012. Growth in the services sector 4.2 4.2 3.7 4 3.0 represented almost half of total GDP growth, or 1.7 2.9 2.9 percentage points. Manufacturing contributed with 2 0.6 percentage points (Figure 2). In the primary sector, 0 0.5 agriculture and fishing grew by 4.5 percent, below its -2 4.7 percent growth rate in 2012. Increasing yields of -4 crops for the domestic market and certain exports 2002-07 2008-13 2009 2010 2011 2012 2013 such as banana and cardamom partially compensated for the weak performance of coffee, and the sector Consumption Investment Net exports GDP as a whole contributed 0.6 percentage points to GDP. Source: Guatemalan authorities and World Bank staff estimates. Figure 3: Services remain the primary driver of GDP growth... Figure 4: ...driven by financial services, transportation and (Contrubutions to real GDP growth, %, Year-on -year) communications. (Real annual growth, %) 6.0 4.2 3.7 Restaurants and 5.6 2.9 3.0 3.0 hotels 7.7 0.5 0.0 Transport and 4.9 Comunications 8.3 -3.0 Financial 46.9 services 21.8 -6.0 2009 2010 2011 2012 2013 Entrepeneurial 4.5 Services Manufacturing GDP services 7.7 Agriculture Other 2012 2013 Source: Guatemalan authorities and World Bank staff calculations. Financial services, transportation and Figure 5: The financial sector has been expanding rapidly. (Number of bank branches) communications led growth in the tertiary sector. Financial services grew by 12.2 percent in 2013, reflecting the ongoing deepening of the financial sector and the continued growth of credit to the private sector, with a 11.3 percent increase in quetzal- denominated credit and a 25.8 percent increase in foreign-currency credit. Meanwhile, the deepening of the financial sector is illustrated by the spread of banking facilities across the country, with the total 2,833 2,980 3,132 3,275 3,395 Southwest Guatemala City: number of bank branches rising from 3,275 in 2012 to Region: 1,414 2009 2010 2011 2012 2013 3,396 in 2013 (Figure 5). 616 Source: Central Bank of Guatemala and World Bank staff estimates. 02 Guatemala Economic DNA August 2014 Agricultural production suffered in 2013 as the coffee 3 years. The coffee rust has added extra pressures industry was hit by a combination of exogenous to Guatemala’s coffee sector, which has seen little shocks including worsening global market conditions. growth in yields over the past decade (see Box 1). “Coffee rust” (or “roya”), a parasitic fungus, negatively affected coffee production throughout the region. Domestic-oriented agriculture (two-thirds of total The coffee rust is estimated to impact over two-thirds production) was boosted by rising yields of corn, of coffee plantations in Guatemala, albeit to varying beans, mango, sesame and tobacco, and by the degrees (Figure 6). Although coffee rust can be introduction of new crops such as snow peas. This managed with pesticide, its spread will likely have a subsector grew by 4.7 percent in 2013, similar to significant long-term effect on production (by cutting the rate of 4.8 percent for the sector as a whole. marginal yields in infected areas) and structural costs Meanwhile, growth in export-oriented agriculture (by requiring a re-plantation of coffee plants and slowed from 8.0 percent in 2012 to 5.0 percent in consistent pesticide use). For example, the majority 2013 primarily due to the decline in coffee production of coffee growers needed to replace coffee plants, described above, though this was partially offset by a which will in turn affect production for the coming strong sugarcane and banana harvest. Figure 6: Coffee producers in Guatemala were affected more severely by Figure 7: Overall agricultural growth remains solid despite the impact of the rust relative to other countries in Central America. the coffee rust. (Area affected by coffee rust, %; share of coffee exports, % of total experts (Real annual growth, %) in 2013) 74 12.0 El Salvador 8.7 70 8.0 Guatemala 11.3 64 4.0 Costa Rica 3.6 37 0.0 -0.9 -3.2 Nicaragua 3.9 11.2 4.5 8.0 4.7 5.0 19.3 25 -4.0 Honduras 17.7 2010 2011 2012 2013 % of Cultivated Area Affected by Rust Leaf Disease Domestic Market (cereal, tubers, fruits) Agriculture Coffe as % of total exports. Foreign Market (coffee, banana, cardamomo, sugar) Source: International Coffee Organization, Guatemalan authorities and World Bank staff estimates. Manufacturing continued to grow at a steady pace of 3.4 percent in 2013, with food and beverages and textile production leading the sector. The food and beverages industry accounts for about 45 percent of total manufacturing activity. It grew by 4.6 percent, slowing modestly from 6.3 percent in 2012. Favorable weather conditions contributed to strong sugarcane harvests in 2012 and 2013, which generated a 15 percent increase in sugar production (Figure 10). Around 70 percent of Guatemalan sugar is exported. Textile production expanded by 3.7 percent in 2013, as rising foreign demand boosted exports by around 25 percent over the previous year, reversing the contraction that occurred during 2011-12. Nevertheless, the overall development of manufacturing continues to be hampered by a large informal sector and rigidities in the formal labor market. These issues are discussed further in the Special Focus Section of this report. 03 BOX 1 Coffee and Poverty Improving the Performance of Coffee Producers Could Substantially Reduce Poverty Beyond the immediate challenges of coffee Figure 8: Productivity in Guatemala’s coffee sector has remained stagnant in the past decade. rust disease, there is substantial scope for (Coffee yield per hectare) improving yields through greater investment in the coffee sector. Over the last decade, yields 1.45 in Guatemala have remained relative stagnant, 1.25 while productivity in other major coffee exporters has improved significantly driven by 1.05 investments in new technologies (Figure 8). For instance, Brazil (the world’s leading coffee 0.85 producer) increased its yields by 4 times in 0.65 the last 15 years. A lack of investments in new technology had constrained improvements 0.45 1995 1997 1999 2001 2003 2005 2007 2009 2011 in productivity in the coffee sector. Investing Guatemala Central America in new technologies could increase yields Brasil in Guatemala, particularly in a context of Source: Guatemalan authorities and World Bank staff calculations. the renovation of coffee plantations (some plantations had not been renovated since the Figure 9: Developments in the coffee sector have direct implications for 1980s). poverty in Guatemala. (Intensity of the coffee rust and extreme poverty) Greater productivity in the coffee sector could EXTREME POVERTY INTENSITY OF THE COFFE RUST substantially reduce rural poverty. While 0% - 15% Low-Medium coffee accounts for only 1.6 percent of GDP 16% - 47% High in Guatemala—a smaller share than other 48% - 70% major coffee producers—the coffee industry has important implications for poverty and household consumption. The sector generates 500,000 jobs, employing almost 9 percent of the active labor force, and accounts for 11 percent of Guatemalan exports. The majority of coffee producers are smallholders in rural areas. Seven out of every ten households in coffee-producing regions live in poverty, and two out of ten live in extreme poverty (Figure 9). Coffee accounts for over two-thirds of agricultural production in the 50 municipalities with the highest level of extreme poverty. Source: World Bank staff estimates based on the 2011 National Survey of Quality of Life (ENCOVI). 04 Guatemala Economic DNA August 2014 Construction continues to underperform, reflecting weak residential and non-residential investment, despite strong growth in remittances and credit growth. In 2013 construction activity grew by just 1.7 percent, up slightly from 2012. The sector was hit hard during the global financial crisis; construction activity fell by 10.8 percent in 2009 and by a further 11.5 percent in 2010. Despite its recent growth construction has yet to recover to its pre- crisis level. The construction sector accounts for a small percentage of GDP, below the average of Central America (see Figure 11). There are two possible explanations for the weak performance of the construction sector. First, weaker rural incomes from declining coffee production, especially in the north and west of the country, may have weighed on self-construction activity, which accounts for half of total construction activity. Second, the Guatemalan Chamber of Construction determined that the sector’s poor performance was due in part to uncertainty regarding Articles 34 and 35 of the Actualizacion Tributaria Law, which stated that the total income tax on construction projects should be paid in advance at the beginning of the project. These articles were nullified in November 2013. Figure 10: Manufacturing growth was led by food and beverages and a Figure 11: Guatemala´s construction sector represents a relatively small recovering textile industry. share of GDP. (Contributions to non-primary manufacturing growth, percentaje points) (Share of annual GDP in 2013, %) Food and 3.2 Panama 28.6 beverage 2.0 -0.5 Textiles Honduras 6.0 1.0 Wood and 0.1 Nicaragua 6.0 furniture 0.2 Rubber and 0.1 Costa Rica 5.1 plastic 0.2 Machinery and 0.1 El Salvador 3.0 equipment 0.0 -0.1 Other Guatemala 2.8 0.1 2012 2013 Source: Guatemalan authorities, Regional Organization of Chambers of the Construction in Central America and the Caribean, and World Bank staff estimates. 05 BOX 2 Growing to Prosperity Improving Guatemala’s Growth Performance Could Boost Prosperity Guatemala’s well-diversified economy has proven resilient to shocks, but its growth has been weaker than its regional peers. Since 2000 real per capita GDP growth has averaged about 0.9 percent, roughly three- quarters of a percentage point less than the rest of Latin America and the Caribbean (LAC) and significantly less than other middle-income countries. Shared prosperity, as measured by income growth among the poorest 40 percent of the population, has lagged behind the region. Shared prosperity in LAC increased by 5 percent over the past decade, yet in Guatemala it declined by 1 percent between 2001 and 2011. Guatemala endured the 2008-09 global financial crisis better than all Central American countries except Panama, but in the last 4 years its per capita GDP growth was slower than that of most countries in LAC. Moreover, Guatemala’s recent growth has not been necessarily less volatile than that of other regional economies, yet it continues to lag the average. As shown in Figure 12, seven LAC countries have achieved higher growth rates than Guatemala while maintaining similarly low or even lower levels of volatility. Figure 12: Guatemala’s economic growth lags behind its regional Figure 13: Guatemala’s recent productivity performance leaves signi- peers, many of which have low volatility; meanwhile Guatemala’s HDI ficant scope for improvement is one of the lowest. (Real GDP growth explained by factors of production) (Real GDP growth, volatility) Real GDP Growth in Guatemala, by Factors of Production 1.2 0.05 0.04 1.0 Paraguay 0.03 0.02 Volatilty of Growth 0.8 Brasil 0.01 Argentina 0.00 0.6 -0.01 1991-2000 2001-2010 2011-2013 Belize República Dominicana Uruguay Changes in capital stock Changes in labor force 0.4 Ecuador Productivity growth Real GDP growth Colombia Average TFP Growth Per Year: 2001-2008 Guatemala MexicoNicaragua 0.2 Peru Panama El Salvador Honduras Bolivia Chile Costa Rica 0.0 0.0 2.0 4.0 6.0 8.0 10.0 12.0 -0.6 Growth 0.6 0.7 0.9 1.0 2.0 6.2 HDI 2nd quintile HDI 3rd quintile HDI 4th quintile GUA US LAC Japan LAC7 East Asia China Source: World Bank staff estimates based on World Development Indicators Slow growth is the result of low productivity growth, which has lagged regional peers. A comparison of total factor productivity reveals that Guatemala’s productivity is lower than in other peer economies, as Guatemala failed to keep pace with most Latin American countries that boosted total factor productivity (TFP) during the 20001. During the 1990s productive efficiency was a major contributor to Guatemalan growth, boosting the real GDP growth rate by an average of 1.5 percentage points over the decade. But during the 2000s productive efficiency declined, cutting annual GDP growth by an average of 0.2 percentage points. Although this trend has since reversed, with an increase in TFP adding around 0.7 percentage points to annual GDP growth since 2011, Guatemala’s TFP growth rate remains well below the regional average 1 TFP is a measure of the efficiency with which an economy uses productive factors to generate goods and services; it is obtained by subtracting changes in the stock of labor and capital from GDP growth. 06 Guatemala Economic DNA August 2014 for LAC countries. The gap in TFP between Guatemala and the “LAC7” (the 7 largest economies in the Figure 14: Higher growth could significantly reduce poverty. (Poverty and extreme poverty, simulated effects) region) is widening. Overall growth in Guatemala continues to be driven by the country’s rising labor force, with capital formation making only a modest About 160,000 and diminishing contribution to real GDP growth in more recent years. Guatemalans could escape poverty Raising growth could have remarkable impacts on Over 100,000 poverty reduction. Guatemala is one of the poorest more Guatemalans countries in LAC. Its poverty headcount rate is over could escape 50 percent; in rural areas seven out of every ten extreme poverty people are poor, and poverty is most pervasive and extreme in areas that are home to indigenous groups. While pro-poor policy reforms could yield marginal 13.3 53.7 10.2 49.7 9.5 48.7 improvements, accelerating growth will be crucial 2011 Simulation 2016 Simulation 2016 with 3.5% Growth with 5% Growth to achieving its medium-term poverty and social objectives. According to World Bank staff simulations Extreme Poverty Rate in a context of partial equilibrium, if Guatemala grows Poverty rate at 5.0 percent (the average growth rate in 2010-2013 in LAC) over the next 3 years and the growth does Source: World Bank staff estimates based on the 2011 National Survey not come at the expense of the poor, the marginal of Quality of Life (ENCOVI). impact on poverty and equity will be significant. The poverty headcount rate would fall by an additional 1.0 percent, by the end of 2016, allowing over 160,000 more people to escape poverty. Inflation: Food Inflation Accelerated but Headline Inflation Remains within the Central Bank’s Target Band G uatemala’s headline inflation rate picked up modestly in 2013 as a result of higher food prices, but remained within the Central Bank’s target band for the second consecutive year.year. Core inflation Core inflation continued continued to decline to decline over over the theof course course 2013, of 2013, consistent consistent with the with the moderate moderate pace of growth in domestic pace of growth in domestic demand. demand. 07 Inflation picked up in 2013 on the back of supply boosted supply. Relatively high food-price inflation shocks that drove domestic food prices higher, but was mitigated by low inflation rates in food service, headline inflation remained within the target of 4 healthcare, transportation, clothing, recreation, percent +/- 1 percentage point set by the Central Bank furniture, and education, each of which grew by less of Guatemala. Inflation accelerated from 3.4 percent than 3 percent in 2013. in 2012 to 4.4 percent in 2013, but remains below the 2006-2012 average of 5.5 percent. Headline inflation Core inflation remained subdued during 2013, but accelerated in the first half of 2013 to 4.8 percent, but inflation expectations are anticipated to accelerate eased in the second half of the year as seasonal factors in 2014 toward the 5 percent upper bound of the related to agricultural production provided relief to target band. Core inflation slowed from 3.4 percent in domestic food prices. In 2013, the food component 2012 to 2.6 percent in 2013 even as headline inflation of inflation (representing 29 percent of the consumer rose, suggesting that overall demand pressures remain price basket) increased by 8.8 percent, led by higher contained. Yet according to surveys conducted by the prices for meat, eggs and milk, while rising prices for Central Bank, inflation expectations for 2014 ticked fruits and vegetables in the first half of 2013 eased up over the course of 2013 as headline inflation rose in the second half of the year as a strong harvest during the first half of the year. Figure 15: Headline inflation picked up in 2013, while core inflation Figure 16: Guatemala’s inflation remains relatively low compared to its moderated. regional peers. (Inflation, % year-on-year) (Inflation in selected countries, 2013) 16.0 8 12.0 6 8.0 4 4.0 2 0.0 0 ene-11 ago-11 mar-12 dic-12 ene-13 dic-13 GUA CRI HON NIC BRA CHL CPL MEX PER Food Inflation Upper Bound of Target Upper Bound Lower Bound Inflation Headline Inflation Lower Bound of Target Core Inflation Source: Central Bank of Guatemala, Guatemala National Institute of Statistics, and World Bank staff estimates. Low and stable inflation remains a pillar of macroeconomic stability, underscoring the success of Guatemala’s inflation-targeting framework. Though it remains sensitive to domestic food prices, Guatemala’s inflation rate is lower than that of other Latin American countries, and its performance compares favorably with that of other countries that use inflation-target bands. 08 Guatemala Economic DNA August 2014 Fiscal Policy: Fiscal Stability and a Partially Successful Tax Reform G fiscal uatemala’s public finances are characterized by a low tax burden relative to the size of the economy, and without the luxury of significant non-tax revenue sources. As part of its pact, fiscal in 2012 pact, the government in 2012 the government pushed through pushed a comprehensive through a comprehensive tax reform, which tax reform, took which full took effect in January full effect 2013. The in January 2013.reform was initially The reform expected was initially to raise tax expected revenues to raise by around tax revenues by1 percentage point of GDP. around 1 percentage pointYet,ofby end-2013 Yet, by tax GDP. revenues end-2013 tax increased revenues only modestly increased onlyby 0.2 percent modestly by of 0.2GDP. Although percent the of GDP. reform increased Although the reform income taxesincome increased collection, this taxes strong growth collection, was offset this strong by growth unexpectedly weak collections of the Value Added Tax (VAT) on foreign was offset by unexpectedly weak collections of the Value Added Tax (VAT) on foreign trade andtrade and the derogation of the tax on motor aderogation of avehicles in 2013. tax on motor Yet, without vehicles in 2013. the Yet,tax reform, without Guatemala’s the tax reform, tax take in 2013 Guatemala’s tax would take inhave 2013 been wouldeven havelower. been Despite weak even lower. revenues, Despite weak fiscal consolidation revenues, continues apace, fiscal consolidation with continues apace, with recording Guatemala Guatemala the smallest recording fiscal the deficit smallest since fiscal the 2008-09 deficit financial crisis, since the 2008-09 albeit financial at crisis, the cost of cuts to public investment and the lowest social expenditure albeit at the cost of cuts to public investment and the lowest social expenditure as a share of as a share of GDP in Central America. GDP in Central WithoutWithout America. a substantial and sustained a substantial increase in and sustained domestic increase in revenue domestic collection revenue public investment collection will remain public investment inadequate will to address to remain inadequate Guatemala’s infrastructure address Guatemala’s deficit and infrastructure deficitits boost and economic boost itscompetitiveness. Public debt economic competitiveness. remains Public debtlow, although remains the growing low, although ratio of the growing interest payments to tax revenues further highlights the importance ratio of interest payments to tax revenues further highlights the importance of mobilizing of mobilizing revenues. revenues. Guatemala collects the least public revenues in the Guatemala has managed to maintain fiscal stability world relative to the size of its economy. Currently despite its limited resources (Table 1). Government government revenues totaled less than 12 percent finances were severely affected by the 2008-09 crisis, of GDP, well below the average of 26 percent in with major revenue streams remaining closely tied to Latin America and the world average of 32 percent. developments abroad, especially in the United States. In contrast to other countries with low tax-to-GDP Following the crisis, lower collection on income tax and ratios, including Mexico and Panama, Guatemala value-added tax (VAT) receipts and taxes on foreign lacks significant non-tax revenue sources. Indeed, trade, together with counter-cyclical spending, led the tax revenues represent over 94 of total government fiscal deficit to peak at 3.3 percent of GDP in 2010. revenues. While tax revenues recovered modestly from Since then, the deficit has been gradually narrowing 10.3 percent of GDP in 2009 to 11 percent in 2013, they and reached 2.1 percent in 2013. It is worth noting that remain below pre-crisis levels of 12.1 percent of GDP recent steps towards fiscal consolidation have resulted in 2007. This low level of resources constrains public predominately from reductions in already low levels of expenditures. Notably, Guatemala is also the country public expenditure, allowing Guatemala to maintain with the lowest level of public spending in the world a solid fiscal position but at the cost of important relative to the size of the economy. growth-enhancing expenditures in infrastructure and investment in human capital. 09 Table 1: Guatemala has managed to maintain fiscal stability despite its limited resources (Fiscal indicators, % of GDP) Fiscal operations of the Central Goverment 2009 2010 2011 2012 2013 Revenues and grants 11.1 11.2 11.6 11.6 11.7 Tax revenues 10.3 10.4 10.9 10.8 11.0 Incom taxes 2.3 2.3 2.7 2.7 3.0 Taxes on good and services (VAT) 4.9 5.1 5.2 5.3 5.2 a. Domestic 2.0 2.0 2.0 2.1 2.2 b. External 2.9 3.1 3.2 3.2 3.0 Taxes on fereign trade 0.7 0.7 0.7 0.6 0.5 Other tax revenues 2.4 2.3 2.2 2.3 2.3 Non-tax revenues 0.7 0.8 0.8 0.8 0.7 Total expenditures 12.8 13.0 12.9 12.5 12.2 Current expenditures 8.7 8.9 9.0 9.2 9.2 Wages 3.6 3.8 3.8 3.8 4.0 Good and services 1.8 1.9 1.9 2.2 2.0 Payments to Social Security 0.9 0.9 0.8 0.8 0.8 Transfers 2.3 2.4 2.4 2.3 2.3 Capital expenditures 4.1 4.1 4.0 3.3 3.0 Gross Public Invetment 1.8 1.8 1.8 1.0 0.9 Transfers 2.3 2.3 2.1 2.3 2.1 Primary Balance -1.7 -1.8 -1.3 -0.9 -0.6 Interest payments 1.4 1.5 1.5 1.5 1.6 Domestic 0.8 0.8 0.9 1.0 1.0 External 0.6 0.7 0.6 0.5 0.6 Overall Balance -3.1 -3.3 -2.8 -2.4 -2.1 Total debt 22.8 24.6 23.9 24.4 24.8 Source: Guatemalan authorities and World Bank staff estimates. In order to increase tax revenues, in 2012 the Guatemalan Congress approved a comprehensive tax reform, which largely took full effect in 2013 (see Box 3). The tax reform, which comprised two laws—Ley de Actualización Tributaria and Ley Antievasión II—was considered a major milestone, since similar reform efforts over the past two decades had been reversed, on occasions after being challenged at the Constitutional Court. The tax reform aimed to modernize the income tax system by expanding the tax base and eliminating tax exemptions through more effective controls on deductions and an elimination of the payroll tax credit. Furthermore, the reform sought to improve tax administration efforts to improve monitoring, control and management of records. 10 Guatemala Economic DNA August 2014 The Long and Winding Road to Tax Reform BOX 3 A Timeline of Guatemala’s Recent Reform Efforts Towards Revenue Mobilization In 2012 the Guatemalan Government launched a tax reform in order to broaden the revenue base and strengthen tax administration, which came into effect over 2012-13 (Figure 17). The reform comprised two decrees: 04-2012 (Provisions for Strengthening the Tax System and Combating Fraud and Smuggling) and 10- 2012 (Updated Tax Act). These decrees aimed to modernize income tax collection by increasing the tax base and eliminating tax exemptions through controls on deductions and elimination of the payroll tax credit. The reform also eliminated several Value Added Tax (VAT) exemptions and strengthened tax administration efforts. Figure 17: Full implementation of the reform comprises gradual steps over three years and withstood legal challenges, unlike previous reform efforts which had been rolled-back. (Timeline of major milestones related to Guatemala’s tax reform) Tax reform approved Elimination of fiscal credit • Rise in the ISR tax rate (from 6% to 7%) for by Congress for small taxpayers the simplified regimen. • Reduction in the ISR tax rate to 28% for the general regime. February April January 2012 2013 2014 Second amendment December to Tax Reform Law March July First amendment to Tax November Reform Law: Customs Tobacco tax of 75% Implementation of the first Registration tax on vehicles June Tax on vehicle circulation is derogated January • Rise in the ISR tax rate (from 5% to 6%) for the simplified regimen. • Change of ISR tax regime for dependent workers. • Implementation of tax dividends (5%) Source: World Bank staff. Following passage by Congress, several unconstitutional claims against the tax reform were made. In summary, about one of every three articles saw challenges (or 68 articles out of the 258 articles in the tax reform laws), of which only 9 were amended by the Constitutional Court, at the time of writing. Importantly, none of the amended articles affected the technical structure of the tax reform. However, the Government did reverse reforms to the tax on the circulation of motor vehicles (ISCV), foregoing revenues representing 0.1 percent of GDP (the original Law envisaged a doubling of the ISCV, but in mid-2013 Congress granted a 50 percent discount on this tax). Among its most significant aspects, the reform aimed to improve the progressivity of the tax system by increasing the share of income taxes. Key features of the new tax law included the simplification of income tax structure, the introduction of a 5 percent tax on capital gains; increases in income tax rates for the simplied 11 regime from 5 to 6 percent in 2013 and from 6 to 7 percent in 2014; changes in the frequency of income tax payments for the general regime; and an increase in the single deduction for personal expenses to Q.150,000 annually while eliminating the VAT tax credit for salaried workers and small taxpayers. Formerly, a VAT tax credit allowed salaried workers to offset VAT payments against income taxes by presenting receipts gathered during the year. This practice was considered to allow for tax evasion, in addition to being regressive, since higher income earners that paid more in VAT taxes received the greatest benefits from the exemptions Reforms to indirect taxes focused on implementing the First Registration Tax on Vehicles (Impuesto a la Primera Matrícula). This tax was created in order to replace tariffs on vehicle imports and the regular VAT on imported goods, while providing an overall lower tax rate for imported vehicles. Overall, tax revenues rose in 2013 following the Figure 18: Government revenues in 2013 were lower than initially reform but by less than initially expected. The 2013 expected, but would have been even lower without the tax reform. Budget foresaw an increase in tax revenues of about (Fiscal revenues: Budget, actual and simulated, % of GDP) 1 percentage point of GDP. Ultimately, however, revenues rose by only 0.2 percentage points, from 10.8 11.8 percent of GDP in 2012 to 11 percent in 2013 (Figure 10.8 11.0 10.4 18). Income tax collections, which account for around a quarter of government revenues, came in 16 percent 5.3 5.3 5.2 below the projections set out in the 2013 Budget. 5.2 Income taxes were expected to increase to 3.6 percent of GDP in 2013, but total collections amounted to 3 3.6 2.7 3.0 2.5 percent of GDP. Meanwhile value-added taxes (VAT), which account for around 45 percent of government 2.9 3.1 2.8 2.7 revenues, came in marginally below expectations. 2012 2013 Budget 2013 Actual 2013 Without VAT collections as a whole decreased from 5.3 to 5.2 the Reform (Est.) percent of GDP between 2012 and 2013. Total (% of GDP) VAT Income Tax Other Tax Revenues Despite falling below expectations, the reform averted a sharp fall in tax collections in 2013. Despite a smaller Source: Guatemalan authorities and World Bank staff estimates. than anticipated expansion in tax collections following the reform, it is estimated that overall tax revenues would have in fact decreased by 0.4 percent of GDP percent in 2013, well above the 5.3 percent growth from 2012 levels had the reform not been enacted, or rate recorded in 2012. This development was led by have been 0.6 percent of GDP lower than the actual the increase in collections from companies (personas outcome for 2013. As a result, the reform helped jurídicas) due to the change in date of declaration to safeguard the government’s revenue base, and of the tax returns for the general regime and the provides an important first step towards developing a increase in the tax rate from 5 to 6 percent for the more effective tax system in Guatemala. simplified regime. On the other hand, tax collection from individuals (personas naturales) decreased due The tax reform supported an increase in income tax to the devolution of the fiscal credit generated in 2012 collections in 2013. Following the implementation and executed in 2013. Therefore, the full effect of the of the reform, income tax revenues jumped by 20.6 reform for the latter category will be discernible at the 12 Guatemala Economic DNA August 2014 end of 2014. As a percent of GDP, income tax collections According to the World Economic Forum, Guatemala rose from 2.7 percent in 2012 to 3 percent in 2013. fell to 90th place in 2013, down from 55th in 2009 on this measure, while Guatemala’s overall infrastructure Poor collections on foreign trade taxes undermined has fallen 10 places in the past 5 years. increases in income tax revenues, reflecting challenges in tax administration and the decision to reverse Reflecting its limited resources, Guatemala has the some aspects of the tax reform (see Box 4). Had VAT lowest social expenditure as share of GDP in Central collections on imports performed as anticipated in America. In addition, the lack of clear prioritization 2013, overall tax revenues would have been higher by in the allocation of public resources in social sectors an estimated 0.2 percent of GDP in 2013. Furthermore, reduces the benefits of public spending for the most the decision to reverse an increase in the tax rate for vulnerable parts of the population. For example, while the circulation of vehicles (ISCV), also contributed some education programs are targeted at poorer areas, to weaker tax revenues estimated at around 0.2-0.3 such as the government’s school meal program, others percent of GDP in 2013. Originally part of the tax reform such as the provision of textbooks are concentrated in adopted in 2012, Congress and the President derogated urban and semi-urban areas. Moreover, there is not a the increase in the ISCV in June 2013, while halving the strong link between spending on health and education expected tax rate. Moreover, those taxpayers who paid and the outcomes in these sectors2. For example, the ISCV in 2013 could use the excess of the tax as fiscal immunization rates do not show a clear-cut relationship credit for future ISCV payments. either with public spending on health or with poverty levels across departments. Similarly, there is not a The government responded to lower than expected strong relationship between the level of spending revenues by cutting spending, with public investment and student achievement across municipalities, with suffering the most. The 2013 Budget included some municipalities reporting far worse 9th grade projected expenditures of Q64 billion, equivalent to 15 completion levels despite higher spending levels, percent of GDP. However, weaker-than-expected tax compared to other municipalities with similar levels of revenues prompted cuts to planned spending, leading adult literacy and malnutrition, and much lower levels to only 90 percent of approved budget spending being of public spending. executed. Despite coming in below budget, current expenditures rose slightly by 7.4 percent, reflecting In terms of financing, the government continued to rigidities in current expenditures, such as wages, which fund the budget deficit through bond issuances and increased from 3.8 percent of GDP in 2012 to 4 percent loans from multilateral agencies, albeit at higher in 2013. Instead, the reduction in the fiscal deficit in average costs. Guatemala has been able to access to 2013 was mainly explained by a 2.3 percent cut in international markets at lower rates than other Central capital expenditures, equivalent to 0.3 percent of GDP American countries3, but debt costs have increased in real terms. as the government comes to rely less on concessional loans. Government bonds accounted for 60 percent of While supportive of fiscal consolidation, recent lower government debt in 2013, up from 54 percent in 2012, capital expenditures present risks to Guatemala’s with loans from multilateral organizations accounted long-term growth prospects, particularly given the for 37 percent in 2013. However, recent tightening country’s already low levels of public investment as a in financing conditions for emerging markets debt share of GDP. For example, in recent years Guatemala’s following the onset of tapering in quantitative easing scores in international comparisons of the quality of by the US Federal Reserve in late 2013 may weigh on road networks have suffered in comparison to many Guatemalan debt financing costs going forward. Central American and Latin American countries. 2 See the World Bank’s 2013 Public Expenditure Review for Guatemala “Toward Better Expenditure Quality”, available at www.worldbank.org/guatemala. 3 In 2013 the Guatemalan government issued US$700 million in Eurobonds at a rate of 4.875 percent in February down from a rate of 5.75 percent for the same operation in 2012, at a time when many other Latin American governments were experiencing higher financing costs. 13 BOX 4 In Search of the Lost Tax Assessing the 2013 Performance of Taxes Related to Foreign Trade Despite growth in imports, VAT collection on imported goods remained flat in 2013. Imports grew by 4.9 percent in 2013, led by higher spending on consumption goods, raw materials and capital goods. A closer look at those imports not exempted under a Free Trade Agreement or a special regime shows that almost all import categories increased (except fuels and lubricants, which fell by 11.6 percent), which should have accorded with higher customs revenues. Instead, however, VAT collections on imports remained broadly unchanged in nominal terms. This disconnection points to inefficiencies in Figure 19: VAT collection on imported goods was weak despite growing customs administration, amid rising concern imports. (VAT on imports growth, imports growth, and oil prices) about tax evasion (Figure 19). Anecdotal reports point to a significant increase in tax evasion during the course of 2013, with 79 95 94 62 media outlets reporting numerous allegations 98 of corruption and bribery at Customs 40 Checkpoints. To alleviate these concerns, the 30 16.0 government dispatched army units to key 20 14.6 customs checkpoints in late 2013 to oversee 10 5.2 customs procedures, which led to an initial 0 0.2 reported increase in SAT customs collections -10 -12.7 from around USD 7.7 million to USD 8.5 million -20 -30 per day. However, the overall effect of army -40 intervention appears negligible and customs 2009 2010 2011 2012 2013 collection decreased in the last quarter of 2013. Oil Imports VAT on Imports Imports Crude oil price, WTI Tax evasion in customs may have risen in the last years. For instance, the volume of imported oil (almost 20 percent of total imports) rose Source: Guatemalan authorities and World Bank staff estimates. between 2012 and 2013. Meanwhile, the international price of oil rose during this period. According to the Guatemalan Association of Oil Retailers, tax evasion on oil and derivatives increased by 40 percent in the last two years and could be equivalent to Q400 million. On the other hand, the total volume carried by containers grew by 10.3 percent in 2013. Improving on current weak tax administration of taxes on foreign trade could generate a significant boost to government revenue. In November 2013 the Government approved a comprehensive reform package aimed at improving public financial and debt management, internal and external audit systems, and tax administration. In particular, the Government has set down implanting regulations for the National Customs Law that define customs infringements and related sanctions and procedures to combat fraud and contraband, while also establishing an international taxation unit with the Ministry of Public Finance. If successful, recent reforms could support a significant increase in collections from foreign trade taxes. For example, if VAT collections on imported goods in 2013 had grown at the same pace as overall imports, as seen in previous years, and had customs duties reflected their historical trend rate of growth, less the changes made to duties on motor vehicles, government revenues would have been higher by 0.2 percent of GDP in 2013. 14 Guatemala Economic DNA August 2014 The poor performance of both VAT on imports and customs duties reduced the potential impact of the Tax Reform. If VAT collections on imported goods had grown at the same pace as overall imports, as seen in previous years, and had customs duties reflected their historical trend rate of growth, less the changes made to duties on motor vehicles, government revenues would have been higher by 0.2 percent of GDP in 2013. Public debt as share of GDP remains low, but the ratio of public debt to tax revenues continues to grow, reflecting low government revenues. Guatemala’s debt-to-GDP ratio in 2013 remains stable around 25 percent, having risen by 2 percentage points of GDP since 2009. Nonetheless, the government’s ability to finance debt commitments from tax revenues continues to weaken. Measured as a percentage of annual tax revenues, Guatemala’s public debt rose from 178 percent of annual taxes in 2008 to 227 percent of tax revenues in 2013. Further, with capital expenditures trending down in recent years, it is clear that rising public debt has been directed to consumption rather than investment. External Sector: Reliance on External Savings in a Context of Rising Domestic Demand and Deteriorating Terms of Trade T he current account deficit widened as the consequence of a larger trade balance deficit, explained by exogenous shocks to coffee price and production and by rising import demand. Remittances Remittances remain remain an an important important source source of of financing financing consumptionand consumption and investment investment for Guatemalans. Private capital inflows continue to finance the bulk of the current-account deficit, supported by a continued inflow of foreign direct investment and the issuance of Central Government debt. As of end-2013 net international reserves were sufficient to cover close to 5 months of imports. 15 In 2013 the balance of payments remained broadly sound despite a widening current account deficit on the back of strong capital inflows. The current account deteriorated modestly in 2013 as a consequence of a higher deficit in the trade balance of goods and services, amid stronger remittances. However, this was offset by capital inflows from foreign direct investment and public external financing, and resulted in an overall balance of payments surplus. Although the external accounts may appear solid, Guatemala remains vulnerable to shocks to global commodity prices, the performance of major trading partners and access to offshore financing. Guatemala is becoming more reliant on external savings. The current-account deficit stood at 2.7 percent of GDP in 2013, similar to the share in 2012, and was driven by rising domestic demand and deteriorating terms of trade. The widening current-account deficit was exacerbated by a drop in domestic savings, particularly in the private sector. While the public savings-investment gap has narrowed over the last few years, the former surplus in private savings over private investment has reversed in recent years, reflecting robust consumption amid increasing remittances from abroad, causing the overall external gap to expand since 2010 (Table 2). Table 2: Current account pressures were offset by a financing surplus. (Percent of GDP) 2009 2010 2011 2012 2013 Current Account Balance 0.7 -1.4 -3.4 -2.6 -2.7 Trade balance -8.9 -10.3 -10.4 -11.4 -11.5 Exports of goods 19.3 20.6 22.1 20.0 18.9 Imports og goods 28.2 31.0 32.5 31.4 30.4 Services -0.1 -0.3 -0.6 -0.2 -0.4 Exports 5.5 5.5 4.7 4.8 4.7 Imports 5.6 5.8 5.3 5.0 5.1 Income -2.5 -2.7 -3.1 -2.2 -2.0 Transfers 12.3 12.0 10.8 11.2 11.2 Of which: Remittances 10.5 10.0 9.2 9.8 9.8 Capital and Financial Account Balance 0.5 3.8 4.2 5.2 4.6 Foreign direct investment 1.5 1.9 2.1 2.3 2.4 Net Portafolio investment -0.3 0.0 -0.1 0.0 0.0 Other investment (including loans) -2.1 0.5 2.2 1.4 0.8 Public external financing 1.4 1.5 0.1 1.4 1.5 Errors and Omissions 0.0 -0.8 -0.5 -1.6 -0.6 Overall Balance 1.3 1.6 0.4 1.0 1.3 Export prices (XPI - 2001 = 100) 144.8 162.1 188.0 182.2 175.0 Import prices (MPI - 2001 = 100) 152.9 169.7 196.0 197.8 197.4 Terms of Trade (XPI/MPI) 94.7 95.6 95.9 92.1 88.6 International Reserves (months of imports) 4.9 4.7 4.1 4.4 4.6 Source: Guatemalan authorities and World Bank staff estimates. Exports were affected by adverse conditions but the diversity of Guatemala’s export mix compared to other Central American economies, helped mitigate the effect of product-specific supply-side shocks. Coffee exports fell sharply by 22 percent in 2013 due to a combination of lower production volumes as a result of coffee rust disease, and falling global prices following record harvests in Brazil, India and Vietnam. In addition, cardamom prices declined by 14 percent, as a result of higher world inventories following strong production in India and Guatemala. However, the strong performance of banana, sugar and non-traditional exports (especially textiles) limited the damage arising from 16 Guatemala Economic DNA August 2014 lower coffee exports to the trade balance. Higher sugar and banana exports reflected higher global prices for these products, especially following weaker banana exports from Ecuador, the world’s largest producer. Overall, however, Guatemalan exports remain highly concentrated among primary agricultural commodities, and thus prone to shifts in global prices for these commodities. Figure 20: Recent current-account developments reflect a decline in Figure 21: Sugar and banana exports mitigated the decline in coffee and domestic savings. cardamom exports. (Guatemala’s investment-savings gap, % of GDP) (Annual change, %) 8.0 2.3 Imports of Goods 3.3 4.0 Consumptio 6.7 Goods (28.2%) 4.2 0.7 -3.1 Raw Materials 0.0 (32.8%) 3.2 -1.4 -2.6 -2.7 0.7 -3.4 Fuels (18.9$) 0.2 -4.0 2009 2010 2011 2012 2013 Capital Goods 7.7 (17.8%) 6.1 Private Gap External Gap Savings (RHS) Public Gap Total Investment (RHS) 7.5 Other (2.3%) -2.0 2012 2013 Source: Guatemalan authorities and World Bank staff estimates. Imports increased in line with rising domestic Figure 22: Imports of capital goods and raw materials led the growth of the imports. demand. Imports grew by an estimated 3.3 percent in (Annual change, %) 2013, up from 2.3 percent in 2012. Higher demand for consumer goods, raw materials, capital goods and fuels Exports of Goods -4.0 0.9 and lubricants bolstered import growth over the year. -21.9 Even though private investment decelerated, imports Cofee -21.8 of investment goods remained solid. Stronger imports 18.9 were led by capital-goods imports, which account for Sugar 18.9 almost 20 percent of all imported goods. Raw materials 5.2 Banana imports, which account for almost one third of total 29.2 imports, grew by 3.2 percent in 2013, after contracting -18.1 Cardamon in 2012, while consumption goods imports (28 percent -13.9 of total imports) slowed to grow by 4.2 percent, down Oil Products -15.3 4.3 from 6.7 percent in 2012. -2.6 Other 0.5 2012 2013 Source: Guatemalan authorities and World Bank staff estimates. 17 BOX 5 Sending Money Home What Determines Remittance Levels in Guatemala? Roughly 1.2 million Guatemalans—over 75 percent of the country’s migrant community—live and work in the United States4. Yet Guatemalans make up just 2.3 percent of the Hispanic population in the US, the sixth largest share. Mexicans, by contrast, account for 64.6 percent. Guatemalan migrants tend to be younger, poorer, and less educated than other US Hispanics. In addition, many Guatemalans work undocumented in the US, and deportations are not uncommon; in 2013, 47,769 Guatemalans were deported5. Guatemalan migrant populations are largest in California, Florida and New York. Remittances play a major role in household consumption and in the Guatemalan economy Figure 23: Remittances represent an important component of the as a whole (Figure 23). As noted above, Guatemalan economy. (Annual remittances inflows, US$ millions) remittances to Guatemala equaled almost 10 percent of Guatemala’s GDP in 2013. 12000 Household surveys indicate that remittances 10000 are critical not just to consumption, but also to investment in human and physical capital. 8000 The majority of recipients are female, relatively 6000 young and living in rural areas. In about 60 percent of cases remittances support family 4000 members who are unemployed6. At least half 2000 of all recipients have no more than a primary 0 education. Guatemalan migrants and their 2002 03 04 05 06 07 08 09 10 11 12 2013 families tend to be among the country’s less Remitances Exports FDI well off. However, migrant families are not among the poorest in the country. Source: Central Bank of Guatemala. Developments in the US labor market have a strong impact on remittances to Guatemala, and rising unemployment among the Hispanic community in the US is associated with weaker remittances flows. Since the Guatemalan diaspora is highly concentrated in a few US states, closely examining trends in these states reveals the impact of local labor-market dynamics on remittances. Wage data from California and Florida, which are home to the largest Guatemalan migrant communities, show a close relationship between wage rates and remittances. The data also suggest that changes in wage rates impact remittances for at least the next three quarters. Data from California on mass layoffs of Hispanics in the non-farm private sector shows that such layoffs are associated with a temporary increase in remittance flows to Guatemala. This is likely the result of migrant workers anticipating imminent layoffs (and perhaps subsequent deportation) and liquidating and remitting their entire wealth stock. 4 2011 estimate. See: Pew Research: http://www.pewhispanic.org/2013/06/19/hispanics-of-guatemalan-origin-in-the-united-states-2011 5 Source: U.S. Department of Homeland Security (2013) FY2013 Immigration Enforcement Report. 6 Source: UNICEF (2011) Encuesta sobre Remesas: Protección de la Niñez y Adolescencia. 18 Guatemala Economic DNA August 2014 Remittance flows are not solely dependent on the labor markets where they originate; the inflation rate in Guatemala also significantly affects remittance flows. Econometric analysis suggests a strong correlation between remittance flows and inflation in Guatemala. Inflation reduces households’ purchasing power, diminishing the real value of remittances and increasing demand for them. This effect is associated mainly with consumer-price inflation, and not so much with food prices. Based on these observations an econometric model can be developed using US economic growth, Guatemalan inflation, remittance lags, and interest rate differentials to predict changes in remittance flows in Guatemala (see Figure 24). We calculated the correlation between remittance flows and 30 different variables related to economic activity, prices, labor market indicators, and exchange rates. Under different specifications of the model, we select a group of key variables that exhibit the highest forecast accuracy (Guatemala exchange rate, interest rate differentials, Guatemala inflation, remittance lags, and US growth). To estimate the contribution of these variables, we consider both the contemporaneous and lagged effect for each variable. The chosen specification Figure 24: US growth, Guatemalan inflation and the past behavior of follows the standard Vector Autoregressive remittances are key predictors of remittances in the short-run. (Estimated determinants of remittances in Guatemala) Model (VAR) specification in the literature, as in Vargas-Silva and Huang (2006), Magnusson Interest rate differential 0% Guatemala Inflation 21% (2009), and Ruiz and Vargas-Silva (2011). Even though an omitted-variable problem may arise, Guatemalan inflation seems a more robust predictor than Guatemalan growth. USA growth 47% Remmitance lags 32% Source: World Bank staff estimates. Remittances registered strong growth as the US economic recovery continued. Remittances amounted to US$5.2 billion in 2013, equivalent to almost 10 percent of GDP and nearly half of total goods exports, and almost offset the trade balance deficit. Over 90 percent of Guatemala’s remittances come from the US. This important flow of resources has been boosting consumption (both in durable and non-durable goods) and investment in physical and human capital. Even though the high dependence on remittances raises questions regarding Guatemala’s external vulnerabilities, Guatemala’s remittances have proved especially resilient during the global financial crisis compared to those of other Central American countries because most Guatemalan workers in the United States are employed in the relatively stable agricultural and service sectors (see Box 5). The growth in foreign direct investment, the issuance of Treasury bonds in the international markets and disbursements of loans contracted by the Central Government increased overall capital inflows in 2013. The agricultural sector accounted for about one third of all FDI, followed by the financial and the energy sectors; and by origin the main flows of foreign investment came from Canada, United States, Russia and Colombia. In 2013 the Government issued US$ 400 million in bonds, lower than the US$ 700 million issued in 2012, which in turn reduced the flow of financing associated to net portfolio investment. However, other investment flows increased due to the disbursement of loans to the Central Government and to commercial banks. 19 The international reserve position has been strengthening as the Central Bank accumulated reserves. Reserves grew by US$580 million and reached 13.5 of GDP as a consequence of net investment related to bonds in US$ dollars, net disbursements of external public debt and the yields over the reserves invested in the foreign markets. Reserves in months of imports are close to five months, and are enough to cover 6 times the short-term debt of the country. It is worthy to mention that even though the Central Bank intervenes in the foreign exchange market, the net purchases of the Central Bank only account for 7 percent of the increase in reserves. Monetary Policy and the Financial Sector: Credit Growth Accelerates I n 2013 the Central Bank of Guatemala lowered the center of its headline inflation targeting band by 0.5 percent in a context of anchored expectations, setting the new band at 4 percent +/- +/- 1 percentage 1 percentage points. points. Monetary Monetary policy policy wastightened was tightenedin April2013 inApril 2013 with with a 25 basis-point hike in interest rates, which was reversed in November 2013 as inflationary pressures receded, and subsequently reduced in March 2014. The quetzal remained stable in nominal terms during 2013, but the real effective exchange rate continued to depreciate as Guatemala’s inflation rate exceeded those of its major trading partners. Conditions in the financial sector remained generally positive, and private-sector credit has grown at a robust pace. Nevertheless, a recent increase in foreign-currency lending merits close monitoring. In 2013 the Central Bank of Guatemala (BdG) Figure 25: In 2013 the Central Bank tightened interest rates in April, continued to adjust its inflation-targeting framework before easing them again in November as inflationary pressures receded. (Figure 25)7. The BdG reduced the target band from (Nominal interest rate, %) 4.5 percent +/- 1 percent to 4 percent +/- 1 percent, and during the year it adjusted interest rates in the 6.0 interbank market in line with its policy rate. Following resurgent domestic food prices through early 2013, the BdG raised the policy rate by 25 basis points to 5.25 5.0 percent in April 2013, having left the rate unchanged since June 2012. With lower food prices over the second Sep 2011: Increase Jun 2012: Reduction Apr & Nov 2013: in the policy rate (50 of policy rate (50 Increase in the half of 2013 helping to anchor inflation expectations, bps) due to domestic bps) following the plicy rate in april demand pressures, downward trend in (25 bps) followed the policy rate was returned to 5 percent in November 4.0 commodity price headline inflation by a reduction in following a 25 basis point cut. volatily, and and as risks in the nov 2013 to its higher inflation world economy previous level in expectations. eased. response to inflation expectations. 3.0 ene-11 ago-11 mar-12 oct-12 may-13 dic-13 7 Guatemala remains the only Central American country with an inflation- targeting framework; other inflation-targeting countries in LAC include Brazil, Chile, Colombia, Mexico and Peru. Source: Central Bank of Guatemala and World Bank staff estimates. 20 Guatemala Economic DNA August 2014 The quetzal remained stable in nominal terms against greater flexibility to the quetzal. Overall, in 2013 the the US dollar throughout 2013 (Figure 26). The volatility of the nominal exchange rate declined relative average exchange rate was 7.86 quetzals to the US to 2012 despite the BdG’s more relaxed policy stance. dollar, broadly unchanged from 2012. During 2013, net foreign currency purchases by the BdG amounted to Although the nominal exchange rate remained stable US$49.3 million – compared to US$140.3 million sales in 2013, the ongoing depreciation of the real effective in 2012, equivalent to 0.3 percent of the total traded exchange rate (REER) is boosting Guatemala’s export volume on the foreign exchange market. competitiveness (Figure 27). The REER continued the downward trend that began in 2010, depreciating by Since December 2013, the BdG has permitted 11.6 percent in 2013. Although the Central Bank has kept greater flexibility in daily exchange rate movements, inflation within the target band, Guatemala’s inflation yet exchange rate volatility during 2013 remained rate persistently exceeds that of the United States relatively low. The BdG defines a band for movements and its other key trading partners. This differential is in the exchange rate, and intervenes when the nominal driving the depreciation of the REER, which is a positive exchange rate moves outside that target band. In 2013 development for Guatemala’s export industries and for the band was initially set at 0.65 standard deviations domestic sectors that compete with imports. Over the either side of the moving average of the exchange rate near term the Central Bank’s inflation-targeting regime over the previous five days. By end-2013, the band was could help to stabilize the REER, but close monitoring widened to 0.7 standard deviations, in order to reduce of the relationship between the inflation and exchange the size of central bank interventions and provide rates would be important. Figure 26: The nominal exchange rate remained stable through 2013. Figure 27: The real effective exchange rate (REER) depreciated as inflation (Nominal exchange rate, quetzals to US$; Central bank net daily purchases, in Guatemala persistently exceeded inflation in the United States. US$ million) (REER index, 2010 average=100; and Guatemala-US inflation differential, %) 8.1 100 110 REER % Change: 20 Decembre 2009 2013-12: -1.5% 8 80 104.4 2013-11: -2.5% 2013-10: -7.1% 15 7.9 60 7.8 40 100 January 2009 10 95.4 Decembre 2013 7.7 20 91.7 7.6 0 5 90 7.5 Central Bank net purchases in Central Bank net purchases in -20 2012: US$ -140.3 million 2013: US$ 49.3 million 0 7.4 -40 01/01/2012 08/08/2012 16/03/2013 22/10/2013 80 -5 Exchange rate, Quetzal/Dollar Average 2012 2009 2010 2011 2012 2013 Central Bank net purchases Average 2013 Guatemala REER Index Inflation difference GUA-US (Left Axis) (Right Axis) Source: Central Bank of Guatemala and World Bank staff estimates. Guatemala’s financial sector remains sound and is among the healthiest in the region. Banks are profitable, liquid, well-capitalized and domestically funded. Guatemala’s robust financial sector is reflected in its reliably strong performance in recent years on key financial-soundness indicators. For example, the ratio of non-performing loans has continued to fall and remains below that of similar countries in the region. In addition, 60 percent of loans have a remaining maturity of more than one year due to steady growth in the residential mortgage market. 21 The expansion of domestic credit is having a positive impact on economic growth, but the rapid expansion of foreign-currency lending has raised concerns. Nominal credit growth slowed modestly in 2013 but remains robust at 11.4 percent, down from 18.8 percent in 2012. Consumer credit rose by 14.8 percent in 2013, spurred Figure 28: Provinces’ share of credit is growing, but lending is concentrated by increased demand for credit cards, and now in Guatemala City. accounts for 40 percent of outstanding bank loans. (Shares of outstanding bank loans, %) Corporate lending also saw strong growth, rising from 12.4 percent in 2013 and accounting for 35 percent of bank lending. Foreign-currency-denominated loans increased by 17.6 percent in 2013, and despite slowing modestly since 2012, the growth of foreign- Peten 2.0 currency lending has begun to draw attention (Figure Huehuetenango 2.2 29). US$-denominated loans now account for around one third of total outstanding loans, encouraging further financial dollarization, and underscoring the importance of strong macro-prudential policies to limit risks to financial stability. Guatemala Quetzaltenango 66.7 2.8 Escuintla 2.4 Source: Guatemala´s Superintendence of Banks and World Bank staff estimates. Figure 29: Credit to the private sector grew at a robust pace, led by Figure 30: … and is diversified among economic sectors. foreign-currency lending… (Shares of outstanding bank loans, %) (Credit growth, %) Entrepeneurial services 11% Manufacturing 12% 31.2 Construction 8% 30.0 Agriculture 6% 17.6 19.8 20.1 18.7 20.0 16.3 Commerce 14.8 9.7 18% Others 11% 12.2 12.6 12.4 10.0 8.9 8.2 6.2 4.1 4.4 2.3 0.1 Mining 0% 0.0 Consumption 34% 2009 2011 2012 2013 Private services 4% Corporate (total) SME Transport 2% Consumer Housing Foreign Currency National Currency Electricity 5% Source: Central Bank of Guatemala and Guatemala’s Superintendence of Banks. 22 Guatemala Economic DNA August 2014 There is considerable scope for further financial deepening and the continued strengthening of domestic capital markets. Private sector credit as a share of GDP reached 32 percent in 2012, yet it remains below the levels observed in other countries in the region, including Panama (90 percent), Honduras (52 percent) and Costa Rica (49 percent). Domestic capital markets remain relatively shallow, with a highly concentrated investor base and a virtually nonexistent secondary government-debt market. Moreover, domestic interest-rate spreads on loans denominated in local currency have widened despite the growth of the financial sector, while spreads on foreign- currency-denominated loans have narrowed. Finally, despite the expansion of credit access in the provinces supported by the government’s financial-deepening agenda, Guatemala City still accounts for over 60 percent of outstanding loans8. 8 It should be noted that in some cases loans may be recorded by bank branches in Guatemala City even if they finance investments in the provinces; e.g., loans contracted by firms with head offices in Guatemala City may be used to fund operations elsewhere in the country. 23 II Economic Outlook and Risks The Global Outlook: Gathering Steam? G uatemala’s main trading partners are expected to experience a pickup in growth over 2014-2016. Current projections anticipate a gradual return to normalcy in international financial financial markets markets as the US US as the andand other other advanced advanced economies economies continue continue to scale back toscale back their monetary stimulus policies. Emerging economies are projected to grow at a more moderate pace, with China and India rebalancing growth towards domestic consumption. Increasing supply of key commodities is expected to partly offset the increase in global demand, leading to a slight increase in global prices in year-average terms. After remaining at a sluggish 2.6 percent in 2013, Figure 31: Growth among Guatemala’s main trading partners is expected Guatemala’s primary trading partners are projected to accelerate over 2014-16 to grow by an average of 2.9 percent in 2014 and (Annual growth, percent) 3.6 percent in 2015-2016. The US economy is 8.0 projected to grow by 2.1 percent in 2014 and by 3.0 7.7 7.6 7.4 7.5 percent in 2015-2016, with low inflation, a declining 6.0 unemployment rate, and a stabilizing real estate market, all of which are expected to drive robust 4.0 consumption growth in Guatemala’s major export 2.9 3.5 3.6 3.6 3.0 3.0 market. Economic activity in Mexico, El Salvador, 2.4 2.6 2.9 1.9 1.8 1.9 2.0 Honduras and Costa Rica—which together account 1.9 2.1 1.1 for one-third of Guatemala’s trade—is also expected to recover over 2014-2016 thanks to their strong 0.0 -0.4 trade ties with the US. Mexico, Guatemala’s main regional trading partner, is expected to grow at 3.4 -2.0 2013 2014 2015 2016 2013 2014 2015 2016 2013 2014 2015 2016 2013 2014 2015 2016 2013 2014 2015 2016 percent in 2014, almost double the rate in 2013, LAC Guatemala´s U.S.A. Eurozone China driven by the construction sector and supported by Main Trading Partners recently adopted reforms in the energy, education and telecom sectors. On average, Central American Source: Global Economic Prospects and World Bank staff estimates. economies are projected to grow by between 3.1 and 3.5 percent over 2014-2016. The Euro Zone is also projected to recover gradually during 2014-2016. in advanced economies are expected to boost global Although the Euro Zone represents a small share of commodity prices, improving Guatemala’s terms Guatemala’s trade, developments in the region are of trade. On the one hand, prices for Guatemala’s relevant via flow on impacts to Guatemala’s main exports are expected to remain relatively stable. In trading partners. 2013 coffee prices fell to their lowest level since 2009, as global markets responded to an excess of supply. In Guatemala’s terms of trade are projected to improve 2014-2016, robust coffee production in several major slightly beginning in 2015, with coffee and sugar exporting countries and high levels of inventories prices expected to remain broadly stable. A decline worldwide is projected to continue to exert of 1.2 percent in the terms-of-trade is estimated for downward pressure on coffee prices. Meanwhile, 2014, as commodity exporters sell down current global sugar output may slow in the coming years inventories. However, by 2015 the stabilization of as large producers including Brazil struggle to cover the Chinese economy and accelerated growth rates increasing financing costs. Combined with rising 25 demand from large sugar importers including India Figure 32: Guatemala’s Terms of Trade are expected to remain relatively and China, on the whole sugar prices are projected to stable going forward remain broadly flat over the near term. On the other (Terms of Trade, Index 2010=100) hand, prices for Guatemala’s imports are expected to 250 decline slightly, with oil prices expected to ease over the forecast horizon due to increasing global stocks. Import Price 200 A gradual increase in global long-term interest rates Export Price 150 is projected as the US Federal Reserve slows the pace of its bond purchases (also known as “tapering”). 100 In recent years, a combination of high commodity Terms of trade prices and favorable global financing conditions has supported the growth of many developing and 50 emerging economies. However, since January 2014 the Federal Reserve began to reduce the size of the 0 2008Q1 2009Q4 2011Q3 2013Q2 2015Q1 2016Q4 size of its bond purchases, indicating an important shift in US monetary policy. During 2014-2016, (% change) 2012 2013 2014 2015 2016 Terms of trade -3.9 -3.8 -1.2 1.0 1.0 investors are expected to continue restructuring their Export Price -3.1 -4.0 0.1 2.4 2.5 portfolios and migrating toward less risky markets. Import Price 0.9 -0.2 1.3 1.4 1.4 This in turn will increase financing costs in emerging markets and slow capital inflows to Latin America and Source: World Bank staff estimates. the Caribbean. Guatemala’s Outlook: Is Steady Growth Enough? G uatemala’s economy is forecast to grow by 3.5 percent in 2014 and by 3.6 percent during 2015- 2016, driven by rising private consumption, and export and remittances growth. Inflation is projected is projected to remain to remain stable stable overover thethe forecast forecast horizon. horizon. Consumption Consumption willremain remain the will the leading component of domestic demand while the contributions of both public and private investment will recede. All sectors are projected to grow, with services, agriculture and manufacturing contributing the most to growth. Net capital inflows are expected to keep international reserves broadly stable. Guatemala’s economic outlook is vulnerable to uncertain global market conditions; global developments may impact detrimentally or helpfully upon Guatemalan export prices and remittances. Yet, steady growth at 3.5 percent may not lead to significant poverty reduction. 26 Guatemala Economic DNA August 2014 The Guatemalan economy is projected to continue create jobs and expand exports. The services sector will growing at a stable pace, with positive growth continue to grow at similar rates to those of the last forecast in all economic sectors. The scenario for two years rates (averaging 3.6 percent), while the small 2014-2016 envisages a gradual increase in the growth but growing service-export sector will also benefit from rate of the manufacturing sector supported by rising further expected expansion in information technology, domestic demand and recoveries in developed international call centers and tourism. As all of these economies, particularly the US and Europe, as well sectors are relatively labor intensive, future growth is as more integrated supply chains and productivity expected to generate new employment opportunities improvements, particularly in clothing and textiles, for Guatemalan workers, albeit at rates insufficient to beverages, paper products and the furniture industry significantly improve real per capita incomes of poorer (Table 3). Growth of manufacturing is projected to Guatemalans. Table 3: Economic growth is expected to keep its pace. (Forecast of Key Economic Indicators for Guatemala) 2012 2013e 2014f 2015f 2016f Real Economy (Percent Change) GDP 3.0 3.7 3.5 3.6 3.6 Agriculture and Fishing 4.7 4.5 3.8 3.8 3.7 Mining -19.3 3.5 3.9 5.5 6.0 Manufacturing 2.7 3.4 3.4 3.5 3.5 Electricity and water 6.4 5.2 4.0 3.9 3.9 Construction 0.8 1.7 2.0 2.3 2.7 Commerce 3.0 3.1 2.9 3.0 3.0 Services 3.6 3.8 3.5 3.6 3.6 Domestic demand 3.2 3.6 3.1 3.1 2.8 Private consumption 3.1 3.9 3.2 3.1 3.2 (Percent of GDP) 85.9 86.6 86.8 87.1 87.5 Fixed private investment 8.8 3.6 2.9 3.2 3.4 (Percent of GDP) 11.6 11.4 11.3 11.3 11.2 Exports 1.8 5.3 5.4 5.0 6.5 (Percent of GDP) 24.9 23.7 23.2 22.3 21.6 Imports 2.8 4.4 3.6 3.1 3.4 (Percent of GDP) 36.1 35.0 34.4 33.8 33.0 Consumer prices (period average) 3.8 4.3 4.1 4.4 4.4 (Percent of GDP, unless otherwise noted) Fiscal Accounts (Central Government) Revenues and Grants 11.6 11.7 11.6 11.6 11.7 Of which: Tax revenues 10.8 11.0 10.8 10.9 11.0 Income taxes 2.7 3.0 3.0 3.1 3.2 Taxes on Goods and Services (VAT) 5.3 5.2 5.1 5.2 5.2 a. Domestic 2.1 2.2 2.3 2.4 2.5 b. External 3.2 3.0 2.9 2.8 2.7 Total Non financial expenditures 12.5 12.2 12.1 12.0 12.0 Current expenditure 9.2 9.2 9.2 9.1 9.1 Capital expenditures 3.3 3.0 2.9 2.9 2.9 Primary balance -0.9 -0.6 -0.6 -0.4 -0.2 Interest payments 1.5 1.6 1.6 1.6 1.7 Overall balance -2.4 -2.1 -2.1 -2.0 -1.9 Balance of Payments Trade Balance (Billions US$) -5.7 -6.2 -6.6 -7.0 -7.4 Trade Balance (Percent of GDP) -11.4 -11.5 -11.5 -11.4 -11.3 Terms of trade (Percent Change) -3.9 -3.8 -1.2 1.0 1.1 Current Account Balance (Percent of GDP) -2.6 -2.7 -3.3 -3.2 -3.0 International Reserves (Percent of GDP) 13.3 13.5 12.6 12.2 11.8 e: estimates; f: forecasts Source: Guatemalan authorities and World Bank staff estimates. 27 Agricultural production growth in 2014-16 is expected Guatemala’s economic growth in the near term will to be stable, with a gradual recovery in agro-export be driven by consumption while the share of private activities, although pests and diseases will continue investment is projected to shrink. According to World to threaten the outlook. Ongoing programs to control Bank projections, private investment’s contribution to rust leaf disease and the renewal of the bushes will growth during 2014-2016 will be just half the level eventually reduce its impact and coffee production. recorded between 2010 and 2013. Further, public In addition to the coffee rust, a number of other pests investment is expected to decline as a share of GDP could threat Guatemala’s agricultural sector. These from 2.9 to 2.8 percent between 2014 and 2016. include Thrips, Huanglongbing and Ralstonia, which Private investment growth will depend on continued could negatively impact yields of cardamom, citrus efforts to reduce the costs of doing business and fruits, tomato and mango. However, rising production promote foreign investment, as well as improving of sugar and bananas, combined with higher prices domestic security conditions (see Box 6). Meanwhile for these commodities, are expected to partially offset government efforts to pursue its public investment lower yields in other crops. management reform agenda remain critical. Indeed, projected levels public investment will not be sufficient Mining activity’s contribution to GDP is expected to to accelerate long-run growth unless the efficiency of remain at current low levels, reflecting challenges in the investment process is significantly improved. developing projects despite Guatemala’s potential. The country has proven reserves of gold, tin and Reversing the recent downward trend in investment nickel, among other minerals, but few new projects levels presents a clear pathway towards higher are expected to proceed over 2014-2016, with the economic growth. Guatemala’s investment-to- government announcing a suspension on the issuance GDP ratio is lower now than at any time in the past of new licenses for two years from mid-2013 in order decade (Figure 33). Public investment as a share of to reform the licensing process. Moreover, the lack GDP fell by almost 6 points from 2000-04 to 2009- of an adequate regulatory and legal structure which 13, while consumer spending increased by more distributes the benefits of this activity amongst the than 3 percentage points of GDP. This contrasts with main stakeholders will represent a bottleneck for the experience of countries such as Bolivia, Peru, future developments. Colombia, Indonesia, and India, among others, which saw an expansion in investment as a share of GDP. Construction activity is expected to pick up, albeit With investment projected to grow slower than overall at a modest pace. As is described in the Focus GDP over 2014-16, the investment share of GDP is Section, construction is a key employment-generating expected to fall further over the forecast period. Over sector. Despite increasing domestic demand, the the longer term, addressing Guatemala’s substantial deepening of financial services and the growing flow gaps in human capital and essential economic of remittances, growth in the construction sector has infrastructure will likely require a significant increase not caught up with the wider economy. The sector was in the quantity of public investment to complement severely affected by the crisis, and exogenous factors sustained improvements in investment quality (see constrained its development, delaying investments Box 6). and widening housing deficit. As domestic demand and the housing deficit continue to grow over 2014- 2016, the sector is expected to expand due to greater issuance in building permits and a recovery in self- construction activity. 28 Guatemala Economic DNA August 2014 Figure 33: Guatemala’s investment-to-GDP ratio is falling, while the investment level in many other countries is rising. (Consumption and investment in Guatemala and selected countries, % of GDP; changes between 2000-2004 vs.2009-2013) 12.0 10.0 IDN ARG IND 8.0 PER NIC 6.0 ECU BOL COL NOR Investment (% points) 4.0 URY Rising ROM AUS CAN 2.0 MEX BRA TUR POL AGO CHI THA SWE 0.0 VNM Falling KOR PRY MYS -2.0 CRI DOM PHL SLV HND HRV NZL -4.0 LTU SVN GTM (09-13) -6.0 HUN SVK GTM (14-16) -8.0 -15.0 -10.0 -5.0 0.0 5.0 10.0 15.0 Falling Rising Consumption (% points) Source: World Bank staff estimates based on WEO data. The baseline scenario projects that the fiscal deficit diminish through 2016, as current measures to will total 2.1 percent of GDP in 2014 before falling to mitigate the spread of the disease lessen its impact, 1.9 percent by 2016. The fiscal deficit will continue to while the global economy continues its slow recovery be driven by low levels of public revenues combined and domestic demand increases modestly. On with a conservative fiscal policy. Tax revenues are balance, these factors are expected to widen the trade expected to remain at 11 percent of GDP in 2016, deficit from US$6.2 billion in 2013 to US$7.4 billion the same level as in 2013. Generating fiscal space for in 2016 (Table 1). Although increasing in absolute much needed development expenditures will largely terms, the current account deficit as a share of GDP depend on the government’s ability to strengthen tax will decline in the following years, and will continue to administration. be effectively financed by inflows such as remittances, which are projected to grow above 9 percent annually With limited fiscal space, it will be critical to improve over 2014-2016. the quality of spending. Better targeting of social spending would help enhance social outcomes as well The degree of vulnerability of Guatemala’s external as long-term competitiveness, while releasing funds accounts to sudden capital outflows is relatively low. for other development priorities. Stronger evaluation Long-term private capital flows will not be sufficient to and controls on public investment will be especially finance the current-account deficit during 2014-2016. important to ensure higher rates of return on public However, World Bank staff estimates indicate that if investments. Guatemala were to face a reversal in capital flows— such as due to short-term liabilities—net international The current-account deficit is projected to narrow reserves would account for 12 to 13 percent of GDP slightly to 3 percent of GDP between 2014 and 2016. between 2014 and 2016, or equivalent to more than 5 The trade-balance forecast assumes that current times short-term liabilities during the period. supply-side shocks to coffee production will gradually 29 BOX 6 Picking Up the Investment Pace Accelerating Guatemala’s Long-Term Growth Rate Through Greater Investment Guatemala exhibits one of the lowest levels of investment in the world. Guatemala’s total investment rate is currently about 14 percent of GDP, well below the 21 percent average for Latin America. This low level of investment negatively affects Guatemala’s productivity, constraining the pace of economic growth and weakening the competitiveness of Guatemalan firms. Low levels of investment hinder Guatemala’s long-run potential GDP, underscoring the urgency of the structural reform agenda as a means to build long- term productivity. For example, Swiston and Barrot (2011) suggest that raising investment in physical and human capital to the average level of Brazil, Mexico and Peru (i.e., to around 25 percent of GDP) would raise Guatemala’s economic growth by more than 1 percentage point per year. In order to raise investment levels, both public and private, the quality of the undergoing and future projects should be enhanced to widen their social returns, public-private partnerships should be strengthened, and reforms in the investment environment ought to be sustained to attract domestic and foreign investment. Improving Guatemala’s public investment management system would improve the effectiveness of public investments and ensure that any increases in investment spending would translate into improved development outcomes for Guatemalan citizens. Raising the quantity of investment, especially public investment, without improving its quality would result in only limited improvements in Guatemala’s growth prospects. Building the necessary administrative and institutional capacity to effectively scale up investment spending will help to ensure that financing is directed to projects that further the government’s development goals, that these projects are executed efficiently and transparently, and that monitoring and evaluation mechanisms are in place to review performance and incorporate lessons learned into the design of subsequent projects. Public-private partnerships (PPPs) could provide an important avenue to raise investment levels in Guatemala without placing greater pressure on public finances (Figure 34). Provided that they are well regulated, public-private partnerships provide the opportunity to leverage private sector capital and expertise to deliver major investment projects, such as by addressing Guatemala’s infrastructure needs. The Government has already established the National Agency for the Development Partnerships in Infrastructure (ANADIE) to boost investment levels through public-private partnerships. ANADIE has identified more than USD 1.7 billion in private investment for thirteen infrastructure projects, which are currently at the study stage (Figure 35). Moreover, greater use of public-private partnerships would require investment in the processes for assessing and regulating PPPs, for example to ensure that PPP tenders are awarded transparently, and that contract terms are effectively specified and regulated. Improving the overall investment climate would help encourage greater private investment in Guatemala, particularly via increased foreign direct investment. Private investment levels remain low in Guatemala, despite macroeconomic stability, while Guatemala has made strong progress in improving the investment climate as noted in the 2014 World Bank’s Doing Business report. However, challenges remain, in particular in areas such as “starting a business” and “protecting investors.” Moreover, the investment climate is constantly threatened by the high rates of crime and security issues, which increase companies’ operational costs. 30 Guatemala Economic DNA August 2014 Figure 34: Public-private partnerships could boost investment in the coming years and become an opportunity to reduce the large infrastructure gap (PPP projects in the pipeline) 2014 2015 2016 US$ 395 US$ 465 US$ 935 Tecun Uman Port (US$ 30) Highway CA2-CA9 (US$ 90) Metropolitan system (US$ 550) Government Center (US$ 145) Champerico Port (US$ 20) St. Tomas Containers (US$ 250) Urban train (US$ 180) Pacific train (US$ 240) Prison system (US$ 250) Broad band (US$ 180) Pacific Airport (US$ 40) Reu Airport (US$ 10) Solid Waste project (US$ 55) Source: ANADIE. Further increasing exchange-rate flexibility could enhance external resilience, though any move toward a less active policy stance would have to be carefully managed. A more flexible exchange rate would facilitate adjustments in the domestic economy in response to external shocks, and it could buttress the Central Bank’s inflation-targeting framework. Indeed, greater flexibility would support Guatemala’s international competitiveness in the face of weakening global commodity prices, which have been trending downward since 2011. However, efforts to increase nominal flexibility would have to be undertaken with caution given the significant dollarization of the domestic economy, as a more flexible exchange rate would affect individuals and firms with incomes, savings and liabilities denominated in US dollars. Risk Scenario: Guatemala’s Sensitivity to a Remittance Shock Global economic conditions remain the principal outlook. Emerging economies are projected to source of risk for Guatemala. As a small developing benefit from rising demand in developed countries economy with close ties to global markets, as global growth picks up. However, a shift in global Guatemala’s reliance on the performance of its trade capital markets in favor of low-risk securities in and development partners is a persistent source of advanced economies and consequently tighter external risk. The still-fragile recovery of key export financial conditions in developing countries could put markets and uncertainty regarding the pace and considerable stress on Guatemala and its regional impact of monetary policy decisions in developed trading partners. economies continue to affect Guatemala’s economic 31 What could happen if This risk scenario simulates the potential effects of a relatively modest remittance shock. As detailed remittances were to stagnate below, a fall in remittances could significantly reduce for one year? the disposable income of Guatemalan households, thereby weakening economic activity through What could generate a lower consumption and investment. The simulation slowdown in remittances flows illustrates what would happen in remittances were to Guatemala? to stop growing for one year (i.e., the scenario assumes that remittances will remain constant in nominal terms between 2013 and 2014)9. Moreover, Guatemala remains vulnerable to a slowdown in the simulation assumes that at the beginning, private remittances flows, which currently provide Guatemalan households would initially attempt to substantial support to the domestic economy. As smooth consumption using personal savings, but noted in Box 5, remittances to Guatemala equaled if the shock continues over a full year, households almost 10 percent of Guatemala’s GDP in 2013. will be forced to curtail consumption. The effects of Remittances depend upon on the capacity of migrants this demand contraction would extend through the in the host country to generate income to send following 2 years. Meanwhile, the shock is assumed back to their families at home. Since most migrants to recede, and the level of remittances is expected work as waged employees, remittances are closely to go back to normal. As household income recovers, linked to the opportunities available to migrants in so too would demand, but gradually, as households the host-economy labor market. As such, the flow attempt to rebuild their savings. of remittances would decrease in the event of a slowdown in economic activity in the host economy, especially one which causes weakness in the domestic labor market. How would a shock to For Guatemala, a downturn in the US labor market or remittances get transmitted to higher deportations of undocumented Guatemalan the Guatemalan economy? workers present sources of risk for remittance flows into Guatemala. The United States accounts for over 90 percent of all remittances sent by Guatemalan As shown in Figure 35, lower remittances flows would migrants. For example, over 2008-09, the US recession primarily impact on economic activity via lower resulted in a sharply weaker labor market, with US consumption, while also reducing private investment. unemployment rising from 7.3 percent in 2008 to 9.9 Lower remittance flows reduce the disposable percent in 2009. A weaker US labor market, together income of recipient households, thereby reducing the with turbulence in the global financial system, resulted funds available to spend on consumer goods—both in a sharp decline in remittances to Guatemala. durables and non-durables. In the case of Guatemala, Although more resilient compared to other Central as noted in Box 5, remittances primarily support rural American countries, Guatemalan remittances fell by households with relatively little formal education. around 10 percent in nominal terms in 2009, and Weaker remittances would also be expected to reduce remittances inflows did not recover to 2008 levels until private investment, since household surveys suggest 2011. Similarly, changes in US immigration policy that that income from remittances is also used to finance affect Guatemalan migrants’ access to labor income investments in human and physical capital, such as could also have a significant impact on remittances via education, or provide the capital to establish new flows. This shock is relatively modest in comparison to the 10-percent decline in annual remittances inflows in 2009, in the aftermath of the global financial crisis. 9 32 Guatemala Economic DNA August 2014 Figure 35: A remittance shock would be felt throughout the Guatemalan economy. (Transmission Channels of a Drop in Remittances) Drop in Less construction Monetary Exchange remitances International policy responds rate reserves selling foreign pressures Transfers from Current currency abroad acaunt balance Treasury will Central Bank may Private require financial opt for monetary consumption easing Demand for imports Private Lower investment Fiscal Tax déficit revenues demand and GDP imports Source: World Bank staff. businesses. Further, lower remittances would likely with expected negative impacts on Guatemala’s weaken construction activity, since many household reserve position. Meanwhile lower remittances would use remittances income to finance new homes, prompt a weakening of Guatemala’s budget deficit in or renovations to existing homes. Overall, fewer the absence of any response by the government to remittances would translate into slower economic cut expenditure, since lower economic activity— activity via weaker consumption and investment10. especially for imports—would lead to weaker tax revenues. The balance of payments would deteriorate in response to a shock to remittances, despite an improving trade balance from lower imports; What would be the economic meanwhile, the fiscal deficit would widen on lower impact if remittances were to tax revenues. Lower remittances would be expected stop growing for one year? to weaken Guatemala’s current account balance by reducing the size of current transfers, which play an important role in financing Guatemala’s trade As shown in Figure 36, a shock to remittances deficit. Weaker domestic consumption would result would weaken economic activity, especially via in declining imports, with a positive offsetting impact lower consumption and, to a lesser extent, lower on the trade balance, but this would be insufficient investment. The simulation shows that lower to alleviate the impact of declining remittances on aggregate demand would cut demand for imports the current account balance, with remittances in and, in turn, tax revenues. If remittances were to 2013 equivalent to around 50 percent of Guatemalan remain stable in nominal terms between 2013 and export earnings. Such deterioration in the current 201411 (at US$5.25 billion), this would lead to a account balance could also generate deprecation decrease in GDP growth over the next three years, pressures on the quetzal, prompting intervention from with growth dropping by 0.2 percentage points in the Central Bank to support the value of the quetzal, 2014 (relative to the “no shock” scenario) and by 1 10 Since few recipients of remittances are employed, changes in remittance flows would not be expected to have a significant impact on the labor market, possibly with the exception of the construction sector. 11 In 2009, remittances inflows fell by 10 percent relative to 2008 (a drop of US$452 million). 33 percentage point during 2015-2016. Per capita private consumption would fall in the three years after the shock. Meanwhile, Guatemala’s external accounts would remain sustainable following this shock. Flexible fiscal and monetary policies would be critical to managing a shock to remittances. With weaker domestic demand, tax revenues would be expected to decrease, especially with lower taxes on imports. Following the shock to remittances, the fiscal deficit would be expected to rise on average by 0.2 percentage points of GDP during 2014-2016. However, without the assumed government efforts to aim to mediate the macroeconomic impacts of the shock (e.g., counter-cyclical fiscal policy measures that raise expenditures), this impact would in fact be larger. Meanwhile, monetary policy is assumed to remain flexible. Figure 36: If remittance inflows were to stop growing for one year, this could significantly impact GDP growth and other macroeconomic indicators in Guatemala. (Macroeconomic impacts of a remittances shock: Baseline and Shock Scenarios) Remittances Private Consumption Per Capita (Billion US$) (annual Thousand US$) 7.0 3.5 3.44 6.6 6.0 3.42 6.0 3.3 3.27 5.6 6.2 5.2 5.7 3.13 3.25 4.9 3.07 5.0 5.2 3.1 3.12 4.0 2.9 2.87 3.0 2.7 2012 2013 2014(E) 2015(E) 2016(E) 2012 2013 2014(E) 2015(E) 2016(E) GDP Current Account Balance (Real % Change) (% of GDP) 3.9 0.0 3.7 3.7 3.6 3.6 -1.0 3.5 3.5 -1.8 3.5 3.5 -2.0 -2.6 -2.7 -2.5 3.3 3.3 -3.0 3.1 -3.0 -3.3 -3.2 2.9 3.0 -4.0 2.7 -5.0 2012 2013 2014(E) 2015(E) 2016(E) 2012 2013 2014(E) 2015(E) 2016(E) Baseline scenario Risk scenario Source: World Bank staff estimates. 34 Guatemala Economic DNA August 2014 III Focus Section: Jobs in Guatemala Focus Section: Jobs in Guatemala Introduction Jobs are the main source of income for the majority both domestic and international. It then attempts of citizens, while also giving people meaning and to determine what drives employment growth in purpose in their lives. Supporting new job creation Guatemala by identifying the key characteristics of can increase individuals’ returns and help them move job-creating enterprises, by analyzing the relationship from unemployment or low-return occupations between the technological sophistication of to higher-productivity jobs. Generating better Guatemalan manufacturing firms and the pace of job employment opportunities for a growing labor force creation, and by examining the unique characteristics is central to improving household incomes and of Guatemala’s informal sector and its impact on alleviating poverty. As noted in the World Bank’s 2013 the growth of formal enterprises. Finally, the Focus World Development Report on “Jobs”, the private Section concludes with an evaluation of policy options sector’s role is critical in creating jobs and spurring a designed to contribute to the ongoing discourse on virtuous cycle in development12. job creation in Guatemala. Like many developing countries, Guatemala faces The rate of job creation in Guatemala has closely a serious and persistent challenge in creating new, followed the country’s rate of economic growth, more productive and more remunerative jobs for both during the global expansion of the late 2000s, its labor force, a challenge which is complicated by during the economic slowdown that followed the the prevalence of a large informal sector. Over the financial crisis of 2008-09, and through the recovery past decade the pace of job creation in Guatemala— to date. like the growth of the broader economy—has lagged behind other economies at a similar level of However, the Guatemalan economy’s overall income, while underemployment has increased. performance in creating jobs masks heterogeneity at Furthermore, Guatemala’s labor market is dominated the micro level, as firms with certain characteristics by informal employment, with around 70 percent of have performed better than others. On average, workers nationwide employed in the informal sector. larger, foreign-owned, export-oriented firms based Informal employment is even more prevalent among on Guatemala City with ready access to finance indigenous groups and rural workers, and labor in have exhibited the strongest rates of job creation. the informal sector tends to suffer from lower rates Meanwhile, crime, corruption and asymmetric of productivity and earn lower incomes. Meanwhile, competition from the informal sector continue to despite overall improvements in the education of the present the most serious constraints to firm growth workforce, many firms report that they have difficulty and job creation. Reforms that promote formalization finding qualified workers to fill more highly skilled and level the playing field between the formal and positions. informal sectors are likely to have an especially significant impact on employment. In addition, more The following focus section analyzes employment technologically capable firms in Guatemala have trends in Guatemala using both macroeconomic and seen more rapid employment growth, indicating firm-level data. It begins by describing employment that significant gains could be realized by improving dynamics over the past decade and situating them the technological capabilities of Guatemalan firms, in the context of an evolving economic environment, especially in terms of human capital. The World Development Report on “Jobs” can be downloaded at: http://go.worldbank.org/TM7GTEB8U0 12 37 Background and Regional Context Over the past decade employment growth has broadly Guatemala’s headline unemployment rate is tracked the pace of economic growth. According to below the regional average, while the labor force data from the International Labor Organization (ILO), participation rate is around the regional average. employment grew on average at an annual rate of Guatemala’s unemployment rate increased slightly 3.1 percent over the period between 2000 and 2010, from an average of 3.4 percent during 2002-2004 while GDP growth averaged 3.3 percent during the to an average of 3.6 percent over 2010-2012. Today, same period. The pace of employment growth in Guatemala’s unemployment rate is lower than that of Guatemala during the past decade was slightly below all other Central American economies. Unemployment that of Costa Rica, Panama and Honduras, but still is higher in densely populated metropolitan centers faster than that of the Dominican Republic, El Salvador (6.2 percent in 2013) than in smaller urban areas (2.3 and Nicaragua. percent) and low in rural areas (2.4 percent). Table 4: Guatemala’s headline employment and unemployment rates are below the regional average, while labor force participation is around the regional average. (Selected labor market indicators in Guatemala and peers) Guatemal LAC MIC 2002-04 2010-12 2002-04 2010-12 2002-04 2010-12 Labor force participation rate (% of total population 15+ years) 66.3 63.2 64.6 66.0 65.0 62.7 Unemployment rate (% of total labor force) 3.4 3.6 8.7 6.8 6.3 5.5 Employment rate (% of total population 15+ years) 57.5 58.4 59.0 61.5 60.9 59.2 Source: World Bank staff estimates based on the National Statistics Institute’s National Employment and Income Surveys for 2004-2012, and World Development Indicators (WDI) based on modeled ILO estimates. Note: For Guatemala’s 2002-2004 average refers to the working age population of 10+ years. While unemployment has remained broadly stable, Figure 37: Unemployment has remained stable over the past decade, but under-employment has risen. the rate of under-employment―which measures (Under-employment as a % of total labor force) the extent to which employment is insufficient for 15.6 the worker, relative to some standard, as a share Rural 18.4 of the total labor force―appears to be on the rise 17.2 Urban in Guatemala13. According to national authorities, 18.0 Guatemala’s underemployment rate stood at around 16.9 Women 17 percent at end-2013, down from 21 percent 18.6 at end-201014. By comparison, of those Central men 16.0 16.3 American economies with data available, Costa Rica reported an underemployment rate of 13.8 percent Total 16.3 17.1 in 2012, whereas the Dominican Republic saw underemployment of 17.2 percent of the labor force. 14 15 16 17 18 19 2002-2004 2010-2013 Source: World Bank staff estimates based on the INE’s Surveys of Employment and Income, 2002-2013. 13 For example, workers may report that they work fewer hours than they would like, or where the employee has education, experience, or skills beyond the requirements of the job. 14 Guatemala’s underemployment rate refers to metropolitan areas only. Under-employment rates for comparator economies may refer to nationwide data (urban and rural areas). 38 Guatemala Economic DNA August 2014 Consistent with the general trend for developing Guatemala’s annual real per capita GDP grew just 0.8 economies, the share of the labor force employed percent during the 2000s. As noted earlier, the bulk of in the commercial and service sectors has increased, real GDP growth has been generated by increases in while the share of workers in agriculture has the size of the labor force rather than improvements decreased. The commerce and services sector in marginal labor productivity. In fact, ILO estimates combined currently employ about 50 percent of the indicate that Guatemala’s labor productivity Guatemalan workforce, up from 42 percent in 2004. diminished over the six years prior to 2008, whereas While employment in the agricultural sector fell over most Central American economies experienced the same period, agriculture remains the country’s positive labor productivity growth (Figure 39). If this single largest employment sector (Figure 38). trend continues, the incomes of Guatemalan workers are likely to stagnate or even decline. Guatemala’s labor force has experienced weak marginal productivity growth over the past decade. Figure 38: More Guatemalans are now employed in commerce and Figure 39: Guatemala’s labor productivity growth lags that of regional services, while the share of workers employed in the agricultural sector peers. has decreased. (Annual growth in GDP per person employed, %) (Employment by sector, % of total employment) 100% 5 19.3 21.0 4 80% 23.0 3 28.8 60% 5.5 2 14.0 5.8 40% 12.6 1 0 -0.2 -1.3-1.1 -0.2 20% 1 3 2 1 1.5 0.6 1 4 1.6 0.3 0.3 0.7 4.2 1.9 38.3 31.8 -1 0% -2 2004 2012-2013 Costa Rica El Salvador Guatremala Honduras Nicaragua Panama Agriculture Manufacturing Construction Commerce Other Services 1998-2002 2003-2008 1992-2008 Source: Left graph: World Bank staff estimates based on the National Statistics Source: United Nations Development Programme’s Human Development Report for Institute’s National Employment and Income Surveys for 2004-2013. Guatemala 2011/2012. Figure 40: Workers in Guatemalan firms tend to be less educated than in Moreover, workers in Guatemala have fewer years peer economies. of schooling than workers in peer economies. Data (Education level, % of total labor force) from the World Bank Enterprise Surveys (WBES) 80 indicates that business owners in Guatemala tend 70 to be less educated than their counterparts both 60 in the LAC region and in other middle-income 50 countries worldwide (Figure 40). These differences 40 are statistically significant. In particular, Guatemala 30 has fewer specialists in areas most crucial to 20 entrepreneurship and innovation, such as engineering 10 skills and scientific training. 0 54.7 71.1 64.2 7.7 17.9 13.7 Percent with Secondary Percent with Bachelor´s Scholling Degree Guatemala LAC15 MIC Source: World Bank staff estimates based on the WBES 2006 and 2010 surveys. No sampling weights. For comparisons, the available data closest to 2006 and 2010 is used. 39 Guatemala’s Private Sector Employment in Comparative Perspective The World Bank Enterprise Surveys (WBES) used the formal sector (later we present evidence on the in this Focus Section presents a valuable tool for informal sector). microeconomic research in Guatemala (Box 7). The WBES is a unique survey of private firms that The growth rate of sales by firms in Guatemala lagged describes economic conditions and constraints from behind peer economies in LAC and other economies the perspective of Guatemalan firms themselves. with a similar level of income (Figure 43). Firms in It covers a broad range of topics across dozens of Guatemala reported higher sales growth in Guatemala indicators, which together provide an in-depth look at than firms in a few selected countries (for example, the challenges facing Guatemalan firms. In Guatemala, Mexico and some Central American economies). the WBES covered a total of 568 firms in the 2010 Overall, however, enterprise sales growth was below survey, and 497 firms in the 2006 survey. The surveys both the regional average and the average for middle- include a nationally-representative sample of firms in income countries (MIC)15. Figure 43: Sales grew in Guatemala between the 2006 and 2010 surveys, Figure 44: Employment growth fell sharply between the 2006 and 2010 but sales growth was not as strong as in LAC and Middle Income Countries. surveys, more so than in peer economies. (Average annual growth in total sales, %) (Employment growth, %, geometric average) 50 8.0 40 6.0 30 4.0 20 2.0 10 0 3.1 4.3 7.2 11.1 9.0 43.6 0.0 5.5 0.3 6.4 4.9 7.6 6.9 Guatemala LAC15 MIC Guatemala LAC15 MIC 2006 2010 2006 2010 Source: World Bank staff estimates based on the WBES 2006 and 2010 surveys. Note: Figures for sales growth use sample weights to take out outliers from the sample. Figures for employment creation do not use sample weights as further described in the text. . For comparisons with other countries, the available data closest to 2006 and 2010 is used. Employment growth slowed down between the 2006 and 2010 surveys across middle-income countries, but the slowdown in job creation was acute in Guatemala (Figure 44). Positive sales growth did not translate into better employment growth overall. Indeed, average employment growth in Guatemala fell significantly from 5.5 percent among those firms surveyed in the 2006 wave (firms were asked to self-report on employment growth over the 2002-2005 period), a period in which the Guatemalan economy was growing relatively robustly, down to employment growth of 0.3 percent for firms surveyed in the 2010 wave (reporting on the 2007-2009 period)16. 15 LAC15 refers to Argentina, Bolivia, Chile, Colombia, Ecuador, El Salvador, Guatemala, Honduras, Mexico, Nicaragua, Panama, Paraguay, Peru, Uruguay, and Venezuela. The MIC average includes 69 middle-income economies for which WBES data are available. 16 While WBES allows for a diagnostic assessment of employment creation by Guatemalan firms, further analysis would be necessary to establish clear causal relationships in order to understand the reasons that explain job creation. Conclusions presented in this report thus represent important opportunities for additional investigation. Nevertheless, we have made an effort to rule out “endogeneity” by controlling for a series of factors and variables of interest. This is evidenced later in the Focus Section. For instance, when examining how bribes may drive down firm growth, as presented later in this Focus Section, it could be that growth “explains” bribery, such as when growing firms are able to hire more skilled managers who are able to navigate a difficult business environment and avoid paying bribes. 40 Guatemala Economic DNA August 2014 You Can Only Improve What You Can Measure BOX 7 Firm-Level Data in Guatemala To date, two waves of the World Bank Enterprise Survey (2006 and 2010) have been completed for Guatemala. These surveys have expanded the possibilities for microeconomic analysis in Guatemala by providing data on a sample of firms broken down by a number of key characteristics, including the firm’s economic sector, its size, location, and ownership type, among others. As noted in Guatemala’s 2010 WBES, “the Enterprise Surveys collect information from a representative sample of the non-agricultural formal private economy. In addition to collecting information on the business environment the surveys collect information on the characteristics of the firms interviewed. Consequently, the data collected provides a description of the representative private firm in the country and also an estimate of how some of the attributes of the average firm are distributed across the population of firms.” For more information on the WBES, including the raw datasets and a description of its methodology, see www.enterprisesurveys.org. Figure 41: The 2010 WBES includes a cross-sector sample of firms in Figure 42: …comprising small, medium, and large firms. Guatemala’s formal sector... (Number of firms surveyed in 2010 by size) (Number of firms surveyed in 2010 by sector) Other Services Food Large Small (100+ Employees) (5-19 Employees) 116 109 184 221 221 Textiles and 118 105 Garments Retail 142 185 Other Manufacturing Medium (20-99 Employees) Source: World Bank Enterprise Survey 2010. The WBES surveys provide valuable information from the perspective of private firms―the principal sources of job growth in the economy―but important data limitations should be noted. While the survey sample is designed to be representative of the economy as a whole, the samples used in the two previous WBES are not sufficiently large to guarantee accuracy. In addition, although the WBES includes sample weights, these weights may not fully reflect the diversity of firms in Guatemala. In this Focus Section we use medium sample weights to ensure that the data are as representative as possible. An expanded WBES with larger samples and more comprehensive content would strengthen the quality of future analysis of Guatemala’s business environment and the challenges facing local firms. 41 What Drives Job Creation in Guatemala? While job growth in Guatemala has been positive over the last decade, the pace of job creation has varied significantly across groups of firms. While national economic statistics provide a broad overview of trends in job creation, the WBES is a key source for firm-level information on employment patterns, revealing which types of firms are adding jobs in Guatemala and which are shedding them. In the 2006 survey employment grew across all Figure 45: Employment in Guatemalan manufacturing contracted in 2010; economic sectors, but in the 2010 survey job- the services sector performed better but weaker than in peer economies. creation rates became much more heterogeneous (Employment growth by sector, %, geometric average) across sectors. Averages17 indicate that in 2006 the manufacturing sector led job creation with an employment growth rate of 5.5 percent. Meanwhile, employment in services and in construction and 7.0 transportation grew by 5.7 percent. The slowdown in employment growth resulting from the global 5.0 financial crisis, affected all sectors, with employment rates across sectors generally stagnating and some 3.0 even declining. For example, employment growth in manufacturing turned negative in the 2010 survey, 1.0 while employment growth in the service sector 5.5 -0.3 6.3 4.9 7.1 6.5 5.7 1.3 6.9 5.6 7.8 7.3 remained positive, but fell from 5.7 percent in the -1.0 2006 survey to 1.3 percent in the 2010 survey. Guatemala LAC15 MIC Guatemala LAC15 MIC Manufacturing Services An analysis of the data provided in the WBES 2006 2010 suggests that firms with specific characteristics did measurably better than other firms during pre-crisis Source: World Bank staff estimates based on the 2006/2010 WBES. Note: No sampling weights. For comparisons, the available data closest to 2006 and 2010 is expansion. In general, exporting firms, foreign- used. owned firms, newer firms and smaller firms grew faster and generated more employment than their counterparts. These patterns are described more fully below. They are based on the regression analysis of the pre-crisis expansion exporting firms and foreign- (geometric) employment growth rates for the 2006 owned firms grew by 7.8 percent and 9.1 percent, and 2010 WBES surveys across three models: a model respectively. However, as the global financial crisis with all economic sectors pooled together, one for the began to impact Guatemala these firms ceased to manufacturing sample alone, and one for the 2010 perform measurably better than their domestically sample alone. The patterns described below hold owned, non-exporting peers, possibly reflecting across these models, even when controlling for other their greater international exposure and consequent firm characteristics simultaneously. vulnerability to global economic shocks. On average, the employment growth rates of foreign-owned firms Exporting firms enjoyed especially strong growth and exporters remained slightly higher even during during the pre-crisis period, as did foreign-owned the crisis, but these differences were not statistically firms in the manufacturing sector. On average, during significant. 17 Averages may differ depending on whether or not employment growth rates are calculated geometrically or through the Davis-Haltiwanger (1992, 1999) method. In the latter, employment growth rates are defined as the change in employment over a given period divided by the average employment level during the period. The use of sampling weights may also impact the result. For the purposes of this analysis the geometric employment growth without sampling weights is preferable due to the relatively small sample size, which increases sensitivity to outliers. The patterns reported here, however, are generally robust regardless of the analytical technique or sampling weights used. 42 Guatemala Economic DNA August 2014 Figure 46: Exporting firms, foreign firms, and smaller firms led job creation in Guatemala. (Employment growth by firm characteristic in Guatemala, %, geometric average, 2006 versus 2010) 10.0 10.0 8.0 8.0 6.0 6.0 4.0 4.0 2.0 2.0 0.0 0.0 -1.9 -0.2 7.8 4.7 5.1 9.1 8.6 2.9 3.6 0.8 0.1 0.3 0.5 2.5 -2.0 -2.0 Yes No Domestic Foreign Small Medium Large Yes No Domestic Foreign Small Medium Large (1-19) (20-99) (100+) 1-19 (20-99) (100+) Exporter? Ownership Inicial Size Exporter? Ownership Inicial Size (Permanent Employees) (Permanent Employees) 2006 2010 Source: World Bank staff estimates based on the 2006/2010 WBES. Note: No sampling weights. Young firms led job creation in Guatemala and in middle-income countries worldwide (Figure 48), but comparable countries. In Guatemala the rate of more visible in Guatemala. In the LAC15, for example, employment growth among young firms (fewer than employment growth in young firms was twice the rate five years old) was significantly higher than that of of mature firms during the same period. mature firms (more than 10 years old), particularly during the pre-crisis expansion. In 2006 young firms Smaller firms also consistently outperformed created jobs at a rate almost 5 times higher than that medium-sized and larger firms in terms of job of mature firms. This pattern was similar in LAC and in growth. In 2006 employment in small firms (fewer Figure 47: Relative to peer economies, exporting firms in Guatemala Figure 48: Young firms led job creation in Guatemala and peer economies. created more jobs in the 2006 survey, but in the 2010 survey employment (Employment growth by exporting status, %, geometric average) creation in these firms had slowed significantly. (Employment growth by exporting status, %, geometric average) 9.0 14.7 0-5 years 12.7 8.0 10.4 MIC 6-10 years 9.1 7.0 4.6 6.0 10+ years 5.4 14.4 5.0 0-5 years 11.1 LAC15 4.0 9.5 6-10 years 5.0 3.0 4.7 10+ years 4.6 2.0 14.2 0-5 years Guatemala 1.0 3.3 9.1 0.0 6-10 years 3.5 7.8 0.8 7.6 8.1 7.5 6.9 4.7 0.1 6.1 4.9 7.5 6.9 3.9 Guatemala LAC15 MIC Guatemala LAC15 MIC 10+ years -0.2 Exporter Non Exporter -2.0 0 2.0 6.0 10.0 14.0 2006 2010 2006 2010 Source: World Bank staff estimates based on the WBES 2006 and 2010 surveys. Note: Figures for sales growth use sample weights to take out outliers from the sample. Figures for employment creation do not use sample weights as further described in the text. . For comparisons with other countries, the available data closest to 2006 and 2010 is used. 43 than 20 employees) grew at a rate of 8.6 percent, In addition to the importance of firm-level while medium-sized firms (20-99 employees) and characteristics, two cross-cutting factors stand out large firms (more than 100 employees) each grew as key determinants of job creation: financial depth at a rate of roughly 3 percent. In 2010, however, and exposure to corruption. The former shows a employment growth in small firms slowed to strong positive correlation with employment growth, an average of 2 percent, while all other firms while the latter presents a binding constraint. posted net job losses in 2010. Similar patterns Financial depth is consistently associated with higher were observed across comparison countries and rates of firm employment growth18. While it is not regions, with smaller firms leading job creation in possible to confirm a causal relationship, firms with 2006 and 2010. All else equal, smaller firms should greater financial depth scores tend to be the strongest be expected to grow more quickly, in percentage job creators. It is possible that firms with greater terms, than medium or large firms, as their initial financial access are able to mobilize resources and starting point for employment is, by definition, seize new opportunities to scale-up their business. If lower. Nevertheless, patterns of job creation by this were the case, expanding financial access would size reveal important differences in the pre-crisis tend to accelerate job creation. However, it is also and crisis periods. In 2006 small and medium-sized possible that firms that are already rapidly expanding enterprises together account for 25 percent of are more willing and able to access financing than all jobs created; however, in 2010 all of the jobs their slower-growing peers. It is also possible that created were created by small enterprises. both financial access and employment growth are Table 5: Financial depth is associated with employment creation. (Financial characteristics and employment growth, %) Guatemala LAC15 MIC 2006 2010 2006 2010 2006 2010 Checking Account? Yes 84.4 57.9 89.4 87.8 84.3 90.9 If Yes: Employment Growth 6.1 1.1 6.6 4.8 7.2 6.9 If No: Employment Growth 2.4 -1.1 4.1 2.5 5.9 6.2 Access to Credit? Yes 71.3 72.9 77.5 77.9 74.6 76.7 If Yes: Employment Growth 6.6 1.2 7.0 5.3 7.7 7.5 If No: Employment Growth 3.0 -2.9 4.0 3.0 5.7 5.7 Credit Constrained? Yes 52.5 44.7 39.2 35.8 41.6 38.5 If Yes: Employment Growth 4.3 -0.3 5.3 4.2 6.5 6.3 If No: Employment Growth 6.8 0.6 6.5 4.9 7.5 7.7 Is Access to Finance an Obstacle? Yes 5.8 7.3 12.2 10.4 13.1 14.9 If Yes: Employment Growth 5.1 -5.7 6.2 2.2 6.6 5.9 If No: Employment Growth 5.6 0.7 6.4 5.1 7.3 7.0 Financial Access Index 0.649 0.633 0.636 0.645 0.623 0.640 Financial Depth Index 0.263 0.302 0.309 0.302 0.312 0.309 Source: World Bank staff estimates based on the 2006/2010 WBES. Note: No sampling weights. For comparisons, the available data closest to 2006 and 2010 is used. 18 The measure of financial depth used in this analysis is based on Love (2009). It tallies the number of credit products reported by a firm, giving one point for each of the following: an overdraft provision, a loan or credit line, bank credit for working capital, bank credit for investment, and traded stock. The total number of financial products, up to a maximum of 5 products, is then divided by 5, yielding an index of financial depth ranging from 0 to 1. 44 Guatemala Economic DNA August 2014 responding to the same independent variable, such as Econometric analysis suggests a strong negative a firm’s location in an economically vibrant area or its correlation between bribery and employment participation in a growing market. While this subject growth. In order to investigate the effects of the warrants further examination, a combination of these crime and corruption on employment growth, we factors is likely at work, and measures to expand use an econometric model to estimate the effect of financial access and further deepen the financial two key variables: (i) criminal acts, defined as theft, sector may have a positive impact on job growth. robbery, vandalism, or arson; and (ii) bribe payments. The econometric model controls for a series of firm Guatemalan firms were more likely than firms in characteristics. The results suggest a strong (and other LAC countries to identify corruption as the statistically significant) correlation between the most serious constraint to doing business. Corruption occurrence of bribery and lower employment growth, can manifests in any number of ways, but among implying that higher bribery is associated with lower Guatemalan firms bribery appears to be the most job creation. significant19. For example, in the 2010 WBES more than 30 percent of business owners in the informal sector noted the prospect of being forced to pay bribes as a major obstacle to business formalization. In the formal sector exposure to bribery is associated with poor enterprise performance and slower employment growth) across all sectors and in all time periods. Figure 49: Guatemalan firms with access to credit and without credit constraints led job creation. (Employment growth in Guatemala: Access to credit versus degree of financial constraints, %) 10.0 9.0 8.0 7.0 6.0 5.0 4.0 3.0 2.0 0.0 -2.9 1.0 6.6 1.2 3.0 7.0 5.3 4.0 3.0 7.7 7.5 5.7 5.7 -0.3 6.8 0.6 4.3 6.5 4.9 5.3 4.2 7.5 7.7 6.5 6.3 -2.0 -1.0 -4.0 Constrained Constrained Constrained Constrained Constrained Constrained Not Credit Not Credit Not Credit Credit Credit Credit With With With Without Without Without Access to Access to Access to Access Access Access Credit Credit Credit Guatemala LAC15 MIC Guatemala LAC15 MIC 2006 2010 2006 2010 Source: World Bank staff estimates based on the 2006/2010 WBES. Note: No sampling weights. 19 Bribe payments are measured as a variable that equals one in either of these three instances: (1) a firm responds with a percentage greater than zero to the question: “It is said that establishments are sometimes required to make gifts or informal payments to public officials to ‘get things done’ with regard to customs, taxes, licenses, regulations, services etc. On average, what percentage of total annual sales, or estimated total annual value, do establishments like this one pay in informal payments or gifts to public officials for this purpose?”; (2) a firm responds with a percentage greater than zero to the question: “When establishments like this one do business with the government, what percentage of the contract value would typically be paid in additional or informal payments or gifts to secure the contract?”; and lastly, (3) a firm answers affirmatively to any of the following questions in reference to a electricity, water, or telephone connection; a construction permit; tax inspections; and an import or operating license: “Was an informal gift or payment expected or requested to obtain the [public service]?”. Bribe payments equals zero if the manager answers “zero” to the first two questions and “no” to the final set of questions (public services). 45 Firms in Guatemala complain more about certain Figure 50: Guatemalan firms cite crime, corruption and practices of the aspects of the business environment, such as crime informal sector as among the most severe obstacles to doing business. and corruption, compared to their counterparts (Main obstacle facing firms, %) in other countries. The share of surveyed firms Access to finance highlighting these issues in Guatemala exceeded that 17 15 6.5 Access to land 3.3 1 0.5 of surveyed firms across Central America, and across Business licensing LAC as a whole (Figure 50). In contrast, relatively fewer and permits 2.7 2.6 2.2 Guatemalan firms highlighted issues in access to land Corruption 6.4 6.6 11.4 or finance, an inadequately educated workforce, or Courts 0.9 1 0.6 problems with customs and trade regulations, relative Crime, theft and disorder 5.5 8.7 20.8 to firms in other countries in the region. Customs and trade 3.3 4.7 1.4 regulations Electricity 13.7 8.8 4.7 Inadequately 7.6 12 6.8 educated workforce Labor regulations 2.5 4.5 0.9 Political instability 8.4 6.4 16.4 Practices of the informal sector 11.4 13.5 19 Administración tributaria 3 2.2 1.4 Tax administration 10.7 10 5.5 Transportation 3.3 3 0.5 TOTAL 100% 100% 100% latin All America & Guatemala Countries Caribean Source: World Bank staff estimates based on the 2010 WBES. Technological Capabilities and Job Creation in Guatemala: Evidence from the Manufacturing Sector The relative degree of technological sophistication The data collected in the 2010 WBES has, for the among firms in an economy is strongly correlated first time, enabled a thorough assessment of the with employment growth. Technological capability relationship between the technological sophistication is a key determinant of economy-wide productivity of Guatemalan firms and the rate at which they create and competitiveness, and it plays a major role in firm- jobs. The following analysis is based on a Technological level growth. While in the short run the introduction Capabilities Index (TCI) constructed for 355 firms of new technologies may displace existing workers, the Guatemalan manufacturing sector; the TCI is an over the long term the adoption of new equipment aggregate measure of the extent to which firms use types, production methods and organizational models relatively basic or advanced forms of technology. The drives innovation and entrepreneurship, which not index is designed according to the model developed only increases labor demand but also supports higher by Wignaraja (1998, 2002), following Lall (1992). A wages through improvements in labor productivity. TCI score is calculated based on 29 binary indicators In order to examine how this relationship functions representing the utilization of various technologies in Guatemala, the following section focuses on the in the areas of (i) investment, (ii) production and (iii) connection between technology and employment in economic linkages. Of the three areas listed above, the the manufacturing sector. third—economic linkages—is the least tangible. In this 46 Guatemala Economic DNA August 2014 exercise economic linkages are measured in terms of This analysis reveals that more technologically capable a firm’s history of successful cooperation with other firms tend to experience more rapid employment firms, its access to public-sector support, and whether growth, with a 10 percent increase in a firm’s average it plans to conduct future collaborative efforts with TCI score being associated with a 1 percentage point the public or private sector. These values are then increase in employment growth. Further, a TCI increase aggregated into a single metric ranging from 0 to 1, of one standard deviation (0.228) is correlated with a with a higher score indicating a more advanced level of 2.3 percentage point increase in employment growth20. technological capability. Table 6: Matrix of Technological Capabilities in Investment (TCI), Production and Linkages INVESTMENT PRODUCTION LINKAGES PRE PROJECT PROCESS PRODUCT INDUSTRIAL WITHIN INVESTMENT EXECUTION ENGINEERING ENGINEERING ENGINEERING ECONOMY SIMPLE ROUTINE • Pre-feasibility • Civil construc- • Debugging, • Assimilation of • Work flow • Local procure- BASIC (Experienced and feasibility tion balancing product design • Scheduling ment of goods based) studies. • Ancillary • Equality control • Minor adapta- • Time-motion and services • Site selection services preventive tion to market studies • Information • Scheduling of • Equipment maintenance needs • Inventory exchange with investment erection • Assimilation control suppliers • Commissioning of process technology • Search for • Equipment • Equipment • Product quality • Monitonig • Technology DEGREE OF COMPLEXITY ADAPTIVE INTERMEDIATE DUPLICATIVE technology procurement streching improvement productivity transfer of local (Search based) souce • Detailed engi- • Process adap- • Licensing and • Improved suppliers • Negotiation of neering tation and cost assimilatiing coordination • Coordinated contracts • Training and saving new impor- desing • Bargaining recruitment of • Licensing new ted product • Science & tech- suitable terms skilled personel technology technology nology links • Information systems INNOVATIVE • Basic process • In-hose • In-hose • Tumkey ADVANCED RISKY desing process product capacity (Search based) • Equipment innovation innovation • Cooperative desing and • Basic research • Basic research R&D supply • Licensing own technology to others Source: Adapted from Lall (2002). These results suggest that there is a great opportunity for improvement in the technological capability of Guatemalan manufacturing firms21. Guatemalan manufacturers have an average TCI score of 4.23 and a median score of 4.0. The average firm is engaged in fewer than 13 of the 29 activities recorded in the TCI. About 20 percent of all manufacturing firms have TCI scores lower than 0.2, and only 6 percent have scores higher than 0.8. Firms involved in the production of chemicals and rubber and plastics tend to score highest, while those in the non-metallic mineral products industry score lowest on the TCI scale. In addition, larger firms, export-oriented firms, foreign-owned firms, firms based in Guatemala City, and firms with access to loans all exhibit higher-than-average TCI scores. 20 This finding and the TCI analysis for Guatemala are based on “Innovation and Employment Growth in Guatemala,” a background paper prepared by Charles Udomsaph for the Guatemala Economic DNA. 21 See: Lederman et al. (2014). 47 Low rates of technological uptake are contributing to the deterioration of total factor productivity in Guatemala, discouraging investment and slowing firm growth (Figure 51, Figure 52, Figure 53, Figure 54). The rate of technological uptake in the manufacturing sector suggests in Guatemala is relatively low, as evidenced by the low rates of adoption of behaviors that facilitate technological linkages between firms, such as collaboration with other firms, suppliers, clients or research institutions. These linkages not only affect the productive efficiency of individual firms, but also the diffusion of technology throughout the economy. This implies that there is vast scope to improve productive efficiency and competitiveness in Guatemalan manufacturing. Figure 51: Over 70 percent of Guatemalan manufacturing firms see TCI Figure 52: Firms’ TCI scores are lowest on the dimension of economic scores below 0.6 linkages (Share of firms by TCI score range (Kernel density plot by TCI dimensions) 0.8 100% 5.1 2 5.9 8.2 15.8 17.7 15.8 80% 17.2 18.0 1.5 24.2 60% 28.2 30.4 Density 1 33.5 40% 27.6 27.6 0.5 15.2 20% 43.4 27.3 20.6 17.5 0 0% 0.0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0 TCI Investment Production Linkages TCI TCI TCI TCI 0