Central America: Adjustment and Reforms in the 1990s

• Author: Leonardo Cardemil, Juan Carlos Di Tata, and Florencia Frantischek
• Position: Advisor in the IMF's Western Hemisphere Department/Chief of the Central American Division in the IMF's Western Hemisphere Department/Senior Economist in the Central American Division of the IMF's Western Hemisphere Department

Following a weak performance in the 1980s, the Central American economies experienced a turnaround in the 1990s as they adopted improved policies within a more stable political environment. Now, how can they best maintain macroeconomic stability, continue structural reforms, and strengthen social policies to maximize rates of economic growth and reduce the incidence of poverty?

In many ways, the 1980s were a lost decade for the economies of Central America (for the purposes of this article, the region comprises the five members of the Central American Common Market: Costa Rica, El Salvador, Guatemala, Honduras, and Nicaragua) that featured large external imbalances, high inflation, output stagnation, and a deterioration of social conditions in most countries. Contributing factors included the armed conflicts in El Salvador, Guatemala, and Nicaragua (which also had adverse effects on the economies of Costa Rica and Honduras), weak macroeconomic and structural policies, and the impact of external shocks, including the Latin American debt crisis and a worsening in the region's terms of trade.

In the early 1990s, most countries implemented comprehensive macroeconomic adjustment and structural reforms, which were often supported by financial and technical assistance from the IMF, the World Bank, and the Inter-American Development Bank. Macroeconomic adjustment continued during the second half of the 1990s, although at a slower pace, while structural policies were strengthened on several fronts, including privatization, financial sector reform, and trade liberalization. As a result of these efforts, economic performance improved considerably: growth increased; inflation declined; the external position strengthened; and the incidence of poverty decreased.

[ SEE THE GRAPHIC AT THE ATTACHED RTF ]

Average annual regional real GDP growth rose to almost 4 percent during the 1990s, with per capita output increasing at an average annual rate of 1.2 percent (compared with a decline of 2.1 percent during the previous decade) and most countries recording increases in saving and investment rates (see table above). There were significant differences among countries, however, with the more advanced economies (Costa Rica, El Salvador, and Guatemala) growing almost twice as fast as the poorer ones (Honduras and Nicaragua). Nicaragua began to recover only in 1994, after a period of hyperinflation and implementation of bold reforms that transformed its highly regulated economy into a market-based one (real GDP growth averaged 4½ percent a year during the second half of the 1990s), while Honduras's weak performance could be traced to low factor productivity and the serious effects of Hurricane Mitch on the economy during 1998-99 (see box below).

[ SEE THE GRAPHIC AT THE ATTACHED RTF ]

Effects of Hurricane Mitch

In late 1998, Hurricane Mitch and the subsequent flooding and landslides inflicted significant damage on Central America, resulting in a large loss of human life and severe infrastructure destruction. The human and economic toll was heaviest in Honduras and Nicaragua and lighter, though still significant, in El Salvador and Guatemala.

In Honduras, where Mitch is considered the worst natural disaster to have affected the country in recent years, more than 13,500 people died and about 2.5...