Macroeconomic adjustments for debt-laden economies: The central American experience

Macroeconomic Adjustments for Debt-Laden Economies: The Central American Experience

SOUMENDRA N. GHOSH* JANET M. TANSKI CARL E. ENOMOTO New Mexico State University

In this article we formulate a simple economic model to analyze the effects of changes in the money supply, the national government deficit, and the exchange rate, on foreign debt and the debt-income ratio of four Central American countries: Costa Rica, El Salvador, Guatemala, and Honduras. The model was estimated using annual data from 1960 to 1992. Our results indicate that currency devaluation, contractionary monetary policy, and national government deficits financed through foreign aid, lead to lower debt and debt-income ratios.

INTRODUCTION Managing external debt and its repercussions on all concerned have been the most debated areas of discussion in recent literature on Latin American economies. Most of Latin America’s foreign debt has been public debt serving as a source of government revenue. Batiz and Batiz’ state that in 1992, 93% of Latin America’s debt was of this nature. Furthermore, most of this debt is owed to private banks rather than other governments or world organizations such as the IMF (International Monetary Fund), and thus creditor nations have a vital interest in how Latin America manages its external debt. Ever since the 1981- 1983 world recession which led to a drop in exports of developing nations thereby lowering their ability to pay back their debt, and Mexico’s *Direct all correspondence to: Soumendra N. Ghosh, Department of Economics/3CQ, Universitv, Las Cruces. New Mexico 88003. Teleohone: (505) 646-2340. The Social Science Journal, Volume 33, Number 2, pages 121-136. Copyright 0 1996 by JAI Press Inc. All rights of reproduction in any form reserved. ISSN: 0362-3319.

New Mexico

State

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suspension of foreign debt service payments in August of 1982, economists and politicians alike have sought solutions to the international debt crisis. In analyzing possible remedies to the debt crisis, Felix and Caskey* ran simulations for Argentina, Brazil, Chile, and Mexico, and found that if sufficient external financing were provided to allow a 2% growth rate in real GDP (gross domestic product), the debtors would most like1 not be able to service the debt (pay interest and principal due). Gallardo and Duran 3 state that the policies as suggested by the IMF and creditor countries which involve cutbacks in domestic demand and imports, and marketoriented policies to encourage exports, have not had good results in large Latin American countries. Lamdamy4 discussed Bolivia’s debt reduction program and concludes that there were costs to Bolivia in reducing its debt including the diversion of funds that otherwise would have been available for other uses. Kruege? questions the Brady plan. She argues that if international institutions use resources to retire debt that otherwise could have been used for internal investment, then developing countries will be worse off and will not be able to achieve growth rates necessary to service foreign debt. Edward@ provides evidence that those countries that use “outward-oriented’ development policies, which promote exports and trade liberalization, outperform those countries who rely on policies to limit imports such as through the use of import tariffs. However, Edwards also points out the trade-off between tariff elimination and government revenue necessary to service foreign debt. He suggests the replacement of trade restrictions with other taxes to provide the necessary government revenue.’ Most of the literature dealing with the international debt crisis is dedicated to the larger economies of Latin America, perhaps because of the size of their external debts. However, the debt problems of the relatively smaller countries in the region deserve special attention because of the very nature of their economies. The export earnings of these smaller nations are derived from agricultural and primary products and hence any restructuring in the debt service crucially hinges upon the performance of this sector. Furthermore, there seems to be a consensus for market-oriented policies within the debtor countries allowing competition, the promotion of efficiency, lower prices, and increased exports. Some analysts even suggest the possibility of currency devaluation for the debtor countries. There also seems to be a consensus for cutbacks in the government deficit and a containment of inflation in the debtor countries to achieve suitable growth and allow for sufficient revenues to service the foreign debt. The purpose of this article is to develop a simple macroeconomic model to analyze the consequences of these above stated policies as they have been applied in the smaller Central American economies. In particular we wish to examine how changes in government spending and taxes (fiscal policy), changes in the money supply (monetary policy), and changes in the nation’s exchange rate (exchange rate policy), affect a nation’s foreign debt and debt-GDP ratio. This last ratio is important since foreign debt may only be detrimental to an economy if it rises faster than the gross domestic product of the debtor nation. Next, the model is operationalized using time-series data from Costa Rica, El Salvador, Guatemala, and Honduras. While the major implications of fiscal, monetary, and exchange rate policies are similar across countries, there are some interesting nuances that are specific to each country. This analysis highlights those differences and indicates a set of feasible policy alternatives for successful achievement of a manageable level of foreign debt.

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The outline of this article is as follows. First, we describe the causes of the debt problem and give a brief background of the Central American economies. Next, we develop a simple macroeconomic model that incorporates foreign debt. We illustrate how fiscal, monetary, and exchange rate policies, affect key variables in the context of our model. In the following section we provide a discussion of the results and then present some of the other socioeconomic factors that must also be taken into account when looking at the problem of debt management. Finally, we present our conclusions and a summary of our results.

THE DEBT CRISIS AND THE CENTRAL AMERICAN ECONOMIES There are several factors that can contribute to the accumulation of foreign debt. First, for those nations importing more than they export, foreign debt is created. Second, when a national government deficit is incurred the government may turn to foreign lenders. Third, high inflation may lead to “capital flight” whereby investment funds are directed to other countries with more price stability. This provides an even greater need for foreign funds. All of these factors contributed in some way to the buildup of Latin America’s foreign debt. In the early eighties, a number of events occurred that brought on the international debt crisis for Latin America. As was stated earlier, the world-wide recession led to a drop in export earnings of developing nations, thereby lowering their incomes and their ability to service debt. Also during this period a deterioration in the terms of trade (the value of exports in terms of imports) for many Latin American nations took place; again lowering Latin America’s ability to pay back its debt from export earnings. Furthermore, high world oil prices paid by the smaller Latin American economies that lasted from the mid seventies to the early eighties, coupled with high interest rates that had to be paid on Latin America’s debt in the eighties, added to the debt-service burden. These income and terms of trade effects are shown in Table 1 for these four central American countries. The annual growth rate of GDP drops to its lowest level of -0.2% during the period 1980-1988 for Guatemala, and even for Costa Rica the gdp growth rate for the same period-2.4%, never exceeded their population growth rate. There was also significant deterioration in the terms of trade for all these countries for the period of 1980-1985. Table 7. Average Annual Growth Rates of GDP and Average Annual Percent Change in Terms of Trade for Costa Rica, El Salvador, Guatemala, GDP 1965-7980

Terms of Trade 1980-88

7980-7985

Costa Rica

6.2

2.4

-1.0

El Salvador

4.3

0.0

-0.8

Guatemala

5.9

Honduras

5.0

Source:

World

Development

Report

1990

and Honduras

-0.2 1.7

7985-7988 1.0 -3.3

-2.6

0.0

-1.4

3.0

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Table 2. Balance of Payments: Current Account Balance Before Official Transfers (millions of Dollars)

Costa Rica El Salvador Guatemala Honduras Source: World Development

7970

7988

-77 7 -8 -68

-356 -242 -506 -431

Report 1990

Table 3. External Public Debt and Debt Service Ratios Debt as a% of GNP Costa Rica El Salvador Guatemala Honduras

Debt Serviceas a % of Exports

7970

7988

7997

7970

7988

7997

13.8 8.6 5.7 12.9

81.8 30.4 26.9 65.9

74.9 37.4 29.5 113.8

10.0 3.6 7.4 2.8

17.4 16.6 26.5 25.5

18.4 17.2 15.3 30.6

Source:For 1991 figures see World Development

Report 1993, for 1970, and 1988 see World Development

Report 1990.

The current account balance (exports-imports), for Honduras, Guatemala, El Salvador, and Costa Rica, are shown in Table 2. Trade deficits which lead to the accumulation of foreign debt, occur for all countries for the time periods indicated. Foreign debt figures for Central American countries are shown in Table 3. The table shows that debt as a percent of GNP has increased substantially for all of the countries from 1970 to 1991. Debt service consists of the payment of principal and interest on foreign debt. A commonly used measure of the ability of a country to service its debt is debt service as a percentage of exports. Table 3 shows that an increasing amount of resources, as a percent of exports, are being used for debt service which comes at the expense of internal investment. Given the situation the smaller Latin American economies are now facing, what policies can be used to help reduce foreign debt and the burden it creates? In the next section we develop and estimate a simple macroeconomic model to determine the effects of monetary, fiscal, and exchange rate policies, on foreign debt and debt-GDP ratios of Costa Rica, El Salvador, Guatemala, and Honduras.

THE MODEL We begin with the following equations used to describe the debt and debt-GDP ratio in debt-Laden economies. Debt = f(MS, Deficit, EX)

(1)

DebtlY =flMS, Deficit, Ex)

(2)

and

where Debt = total accumulated foreign debt, MS = money supply, Deficit = national government deficit (government expenditures - taxes), EX = exchange rate expressed

Macroeconomic

Adjustments

for Debt-Laden

Economies

125

as the number of units of the nation’s domestic currency per U.S. dollar, Y = gross domestic product, and Debt/Y = the debt-GDP ratio. Equations (1) and (2) show that foreign debt and the debt-GDP ratio of a nation depend upon three policy instruments: the money supply, the national government deficit, and the exchange rate. Increases in the money supply (expansionary monetary policy) contribute to inflation and expectations of more inflation. This may contribute to capital flight which further increases the need to borrow to refinance the already existing debt. In such a case, foreign debt may increase. The debt-GDP ratio, however, may increase or decrease with increases in the money supply if GDP is increasing along with foreign debt. Since gross domestic product is a measure of that nation’s ability to pay back its debt, a lower debt-GDP ratio indicates that the nation can more easily manage its foreign debt. An increase in the national government deficit can affect foreign debt and the debtGDP ratio in different ways. First, a larger national government deficit can increase the indebtedness of the nation to foreign countries if the national government relies heavily on foreign borrowing to finance internal capital projects. Second, a larger national government deficit, if financed to a large extent through foreign aid, can stimulate the economy and increase tax revenue that can be used to retire existing foreign debt. Thus foreign debt may decrease with larger national government deficits. In the smaller Latin American economies, this could be the case since foreign aid constitutes a sizeable portion of government revenues. It is used for schools, roads, and other public investment projects. The exchange rate affects debt through the trade balance of the nation. As the exchange rate increases, (more domestic currency traded for a U.S. dollar), the nation’s currency depreciates. Thus the nation’s exports are cheaper to the rest of the world while its imports have become more expensive. The resulting increase in exports and decrease in imports will provide the earnings to enable the nation to retire part of its foreign debt. Finally, an increase in exports should also increase GDP. This combined with a decline in foreign debt, should lead to a lower debt-GDP ratio. In the next section, we estimate the model for Costa Rica, El Salvador, Guatemala, and Honduras. We may then identify the appropriate policy mix to be used to achieve acceptable levels of foreign debt and debt-GDP ratios.

DATA AND RESULTS Equations (1) and (2) were estimated for Costa Rica, El Salvador, Guatemala, and Honduras, using annual data (1960-1992) that were obtained from International Financial Statistics, and World Development Reports. The exchange rate used for Costa Rica and El Salvador was Colones per dollar, while the exchange rates used for Guatemala and Honduras were Quetzales per dollar and Lempiras per dollar, respectively. The money supply, national government deficit, foreign debt, and GDP of all countries, were measured in millions of that country’s currency. All variable were measured in real terms (i.e. the effect of inflation on all variables was accounted for). Since time-series data were used, the Cochrane-Orcutt iterative procedure was chosen to obtain more efficient estimates of the parameters. The results are presented in Table 4.

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Our results show that increases in the money supply, which bring about inflation, low real rates of return, and capital flight, have contributed to the debt problem of Costa Rica. For every one unit increase in that country’s real money supply, real foreign debt has increased by 0.26 of a unit. Furthermore, for a million unit increase in the real money supply, the debt-GDP ratio increased by a factor of four. These results strongly suggest that for Costa Rica, a contractionary monetary policy could be used to reduce foreign debt and their debt-GDP ratio which would free up resources to be used for internal investment and growth. For the remaining countries, changes in the money supply did not significantly affect their foreign debt position or their debt-GDP ratios. One reason for the different effects of monetary policy on the countries considered here is the different levels of inflation they have faced. For example, in Costa Rica, where inflation is highest, prices increased by 5,280% from 1960 to 1992. In El Salvador the increase was 2,028% over the same time period and for Guatemala and Honduras the increases were 1,427% and 742%, respectively. Given the high rate of inflation in Costa Rica compared to the other countries, it is not too surprising that contractionary monetary policy would have its strongest impact there. As was discussed previously, the national government deficit can either increase or decrease the country’s holdings of foreign debt. For Costa Rica, El Salvador and Honduras, our results show a negative relationship between the national government deficit and foreign debt. This suggests that for these smaller Latin American economies, a continued inflow of foreign aid can allow them to increase government expenditures on capital projects and government facilities without relying on foreign lenders. The stimulus to their economies brought about by this policy can provide the tax revenue their governments need to service their external debt. ‘In Costa Rica for example, our results indicate that for every one unit increase in the national govemment deficit, foreign debt fell by 0.64 of a unit. A million unit increase in the national government deficit was needed to decrease the debt-income ratio by a factor of one. Similar results were found for El Salvador and Honduras. In El Salvador, a one unit increase in the national government deficit led to a 1.61 unit drop in foreign debt and in Honduras the same increase in the national government deficit led to an 8 unit drop in external debt. Changes in the exchange rate were found to have a very strong impact, if not the strongest impact of all variables considered, on foreign debt. For all four countries, a negative relationship between the exchange rate and external debt was found. This indicates that devaluation of the national currency led to a reduction in foreign debt and debt-GDP ratios by increasing exports and decreasing imports. The increase in export earnings serves as the source of funds for debt retirement. Our study shows that for Costa Rica, a devaluation of their currency from say 60 to 61 Colones per dollar, results in a 90 million unit drop in their foreign debt. For El Salvador, a similar one unit devaluation reduced their external debt by 246 million units and for Honduras, a 993 million unit reduction in foreign debt occurred. One possible reason for the larger impact of exchange rate changes on foreign debt for Honduras is the lower inflation experienced there. That is, changes in domestic prices have not offset the effect of devaluation. In Costa Rica and El Salvador, where prices have risen much faster, the

OLs6f (2.77) ~.0~~~04~ 13.94) 0.0000l" c-4.90) -0.0013 b-1.63) 0.51 O.h7 1.15 11.55

Debt/Y

CostaRica

2341.P (2.00) 0.26* (4.29) -0.64* (-4.57) -9cl.3* (-1.97) 0.51 Oh9 1.06 11.58

Debt

37.52

1.68

C-6.42) 0.78 0.67

-0.035*

0.371 16.28) ~.~0~0~3 i-Ot4j -o.ooa2* k-7.64)

Debt/Y

El Salvador 2407.6* (5.55) 0,076 to.491 -1.61* G-7.23) -246.1* b-6.09) 0.76 0.66 1.71 33.89

Debt

*Nate: These coefficients are sigrtnificdntat the 5% risk level; (T-statistics are in parentheses).

0 DW F

R2

EX

DEFICIT

MS

Constant

Y~~i~b/e

Di?pWKkVlt Debt/Y 0.052* (2.80) -~.~~06 i-1.0) -0.000005 k-0.48) -0.0016 t-0.29) -0.05 0.83 1.36 0.47

Guatemala 387.7* (2.59) -0.033 b-0.69) -0.055 c-o.791 -14.54 C-0.38) -0.06 0.91 1.31 0.38

Debt

Tab/e 4. Debt and ~~bt-~~~~~~ Ratio Equation Estimates Debts 1.04* (2.95) ~~.~~02 (-0.1961 -0.0013* (-4.19) -0.175* (-3.13) 0.76 0.41 1.73 34.61

i-ionduras !S309.79* (2.95) -iB30%1 f-0.012) -8.08* (-4.72) -993.93* (-3.18) 0.80 0.41 1.84 41.42

Debt

s 3'

B 3 ff 2

g &

h 0”

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devaluation which should make their goods relatively cheaper to the rest of the world, has been offset. A final comparison can be made between the four countries by examining their adjusted R-squared statistics. For El Salvador and Honduras, our model works quite well. In fact, 76% to 80% of the variation in their debt and debt-GDP ratios was explained by our three independent variables: the money supply, the national government deficit, and the exchange rate. For Costa Rica, our model explains 5 1% of the variation in external debt, however, for Guatemala, a negative adjusted R-squared was found indicating that our model did not fit the data. One reason for this is that of all four countries examined, Guatemala had the smallest amount of external debt accumulation from 1960 to 1992. Thus, there was relatively little variation in external debt to explain compared to the other three countries. In summary, the policy implications for debt management for small Latin American economies that come out of our study include the following: (1) a contractionary monetary policy can be used to reduce foreign debt when high inflationary pressures exist, (2) national government deficits can be used to stimulate small domestic economies and reduce external debt if continued foreign aid is received by these nations, and (3) devaluation of the national currency can increase export earnings and lead to debt retirement. It is also interesting to note how the above policies have affected the larger economies of Latin America. Our results8 show that monetary, fiscal, and exchange rate policies, have had little impact on external debt in Mexico and Brazil. One reason for this may be due to the diversified industrial base of these larger economies. They not only produce agricultural products that El Salvador, Costa Rica, Guatemala, and Honduras produce, but they also produce manufactured goods and process raw materials that the smaller countries do not. Faced with these diversified economies, monetary, fiscal, and exchange rate policies must be used with more caution, given the varied effects they have on different sectors. Restrictive monetary policy for example, would have to be used with more caution in those economies in which construction is taking place due to the sensitivity of these industries to credit conditions. Faced with these constraints, policy makers may not be able to use policies aimed specifically at debt reduction but must consider other goals and objectives as well. Furthermore, foreign aid accounts for a smaller part of national government budgets in the larger economies. Thus larger national governments who run deficits may have to borrow from foreign sources, increasing the amount of external debt. Another reason for the difference in debt management strategies between large and small economies deals with their export sectors. Large economies have a diversified export base that enables them to do well even if world demand for one specific export drops. Thus, devaluation is not as readily needed as it would be for a smaller nation dependent on a few major exports. Also the larger nations have a more developed internal economy with more developed marketing and distribution systems that enable them to perform quite well on their own and not depend on devaluation as small nations must. For these reasons it is not too surprising that we see differences in debtmanagement policies between the smaller and larger Latin American economies. The larger nations may rely on debt rescheduling strategies and other debt retirement options, and less on monetary, fiscal, and exchange rate polices to retire debt.

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Economies

129

DISCUSSION While we have examined possible debt-management strategies for Costa Rica, El Salvador, Guatemala, and Honduras, it must be noted that these policies are not without their drawbacks. In fact, when any policy is being considered, the social, institutional, and political factors must also be examined. In this section, we discuss these issues both in the past and present. The debt crisis of many countries can be traced historically to their development strategies (or lack of them). Since colonial times these countries catered to the needs of Spain with respect to agricultural commodities and have continued to rely on agricultural exports for their survival. Because of their heavy reliance on the world market,they are adversely affected when international prices of their commodities fall. If they had been more concerned about developing an internal market for goods, as well as developing trade between agriculture and industry and between different industries, their reliance on outside resources would not have been so great. Furthermore,in those countries where there was an attempt to industrialize, the technology used was one based on imports of foreign capital goods rather than on the use of locally based methods. The social class structure of these countries also contributed to their debt crisis. Due to the extreme inequality in the distribution of wealth, govemments began to put more resources into military spending rather than into productive spheres. At the same time, the entrepreneurs often used profits for luxury consumption (and most luxury items were imported) rather than for reinvestment into production. When the governments were forced by their creditors to accept programs of the IMF, devaluations led to inflation and capital flight in some sectors rather than increases in local investment. Corruption within the government itself must not be overlooked either; the squandering of public resources only made the debt crisis worse. While it may be true that monetary and fiscal policies coupled with expansionary outward policies such as currency devaluation would lower debt-GDP ratios, we must also point out the detrimental effects of these policies. First, reducing the money supply can increase the level of poverty in these countries. Secondly, only relying on monetary, fiscal, and exchange rate policies to solve the debt crisis will not confront the internal imbalances which are part of the problem to begin with. In other words, trade between the agricultural sector and industrial sector needed for balanced economic development will still not exist and the root causes of the debt crisis will then still exist as well. Table 5 shows the dependence on major agricultural crops for each of the countries under discussion. When we look at the terms of trade (the value of exports in terms of imports) for each of the countries, it is obvious that reliance on revenues from traditional products has not helped the countries increase their income levels. Table 6 shows the relevant terms of trade from 1982 to 199 1. As is evident from the above table, prices for exports are not keeping up with the prices of imports, and after almost 10 years of exporting the same goods and expanding non-traditional exports, the purchasing power of exports has not even gone back to its 1980 level (except for 1986). This is true even for Costa Rica, which has increased its non-traditional exports (including flowers, “luxury” fruits, and vegetables) the most.

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Exports as a Percentage

Vat. 33iNo.

of Total Exports 7 990”

7980

7988

54.4

57.6

53.3

30.5

34.8

26.1

Coffee

10.9

3.3

2.1

Cotton

2.9

7.6

7.1

45.6

20.7

46.7

1 .a

4.8

2.2

Cuatemalab Traditional

Exports

Bananas Non-Traditional

Exports

2/l 996

Chemicals 71.2

64.6

49.4

60.9

58.3

43.2

Coffee

7.9

0.2

0.2

Cotton

1.2

2.8

3.5

Sugar

28.8

35.4

50.6 80.5

El Salvador Traditional

Exports

Non-Traditional

Exports

Honduras Traditional

Exports

Bananas

75.5

80.5

27.7

40.8

39.8

24.8

21.3

20.0

Coffee

4.4

3.3

1.8

Wood

24.5

19.5

19.5 45.9

Non-Traditional

Exports

Costa Rica Traditional

Exports

Coffee

60.0

52.6

26.2

27.0

18.4

27.5

20.2

21.8

Bananas Meat Non-Traditional

3.5

4.4

3.4

36.4

47.4

54.1

2.7

3.1

2.5

2.2

2.9

3.2

Exports

Shrimp and Fish Plants, Flowers, Foliage

dPreliminary Figures bFor Guatemala, figures on exports arc of exports to non-Central try’s exports Source:

UN,

bean, 7988,

in 1980

and 78.3%

Economic Santiago,

of total exports

Commission 1989,

American

countries

which

Economic

Survey olLdtin

of 71 .O% of the coun-

for Latin America

and the Caribbean,

Amerrc-a and the Carib-

1991.

Tab/e 6. Terms of Trade Indexes (1980 7982

consisted

in 1988.

7983

7984

7985

= 100)

7986

7987

7988

7989

7990

7997”

Guatemala

81.7

84.0

85.7

80.5

101

a7

88

89

a1

78

El Salvador

93.0

81.5

71.2

67.7

107

70

75

66

55

53

Honduras

92.0

92.8

95.8

82.1

99

83

97

99

91

97

Costa Rica

82.7

84.3

87.3

84.9

102

84

84

80

70

70

Source:

UN,

Economic

bean, 7988,

Santiago,

dPreliminary

Figures

Commission 1989,

for Latin America

and ECLAC,

and the Caribbean,

Economrc SuweyolLatina

Economic

Survey oiLdtin

America and The Caribbean,

America and the Carib-

7997,

Vol.

I (for

lVfl6-1991).

U.S. tariff and quota policies also often lead to decreased revenue for the countries of Latin America and the Caribbean. For example, the U.S. has recently cut its ‘tariffrate’ quota for sugar imports in the 1993-94 import period for the third year in a row, foreshadowing an important drop in expected income for the 23Latin American and Caribbean nations which benefit from the US’s preferential sugar quotas.’

Macroeconomic

Adjustments

/or Debt-Laden

131

Economies

Table 7. US Sugar Quotas by Country, 1992-l

994 (In thousands of Metric Tons)

Percent of US Worldwide

Country

Quota

7 992-93

7 993-94

Quota

Costa Rica

1.5

17.5

14.7

El Salvador

2.6

30.3

25.5

Guatemala

4.8

56.0

47.1

Honduras

1 .o

11.7

9.8

Table

Quota

8. Value of Imports of Goods and

Services as a Percentage of GDP 7980

7988

Guatemala

25.1

21.7

El Salvador

33.5

32.7

Honduras

45.1

33.9

Costa Rica

46.8

38.6

Sourc-e: UN,

Economic-

Commksion

for Latin

America

nomic Survey ol Lalin America and the Caribbean, ECLAC.

1991

cd

the 1993

Info.

dntl

7988,

the Caribbean,

Santiago,

1989,

h-olYY0,

I’lcd~c Almdndc

For the 1993-1994 import year (Ott 1-Sept 30), the Office of the US Trade Representative set the US’s annual tariff-rate sugar import quota at 1.037 billion metric tons, representing a 16% drop from the 1.23 1 billion MT quota in the 1992-93 cycle. The tariff-rate quota represents the amount of sugar annually permitted to enter the US at either low tariff rates, or duty-free, depending on the preferential US trade agreements signed with the particular nations that benefit from US sugar quotas. The amount a country exports to the US in excess of its quota is charged a US$O. 16 cents per pound import levy.” In Latin America and the Caribbean, 23 sugar exporting countries benefit from the US’s annual quotas, accounting for about 64% of the total worldwide quota.’ ’ Table 7 shows U.S. sugar quotas for the four countries examined in our study. The great dependence on earnings from exports also implies in each of the countries, a high reliance on imports. Since so many of each country’s resources are dedicated to export production, other items of necessity must be imported. The percentage of GDP that these countries spend on imports is noted in Table 8. If exports are stimulated at the same time that the countries continue to rely heavily on imports, there will be little reduction in external debt. Lastly, a devaluation may help exporters, but since a large percentage of inputs of non-export industries are imported, the devaluation will hurt these industries and cause inflation. Furthermore, the capitalist class whose investments are not in exportoriented production, will take their resources elsewhere rather than reinvest in local production due to the potential inflation; thus the start of capital flight. With these caveats in mind, we now turn to a discussion of some of the current political and social issues facing Central America that must also be accounted for in searching for a solution to their debt problems.

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Guatemala Coffee, cotton, and bananas have traditionally been Guatemala’s most important export crops. In order to stimulate these exports, as well as the newer non-traditional exports, the Guatemalan government modified the exchange rate policy nine times in 1990 alone. Also, the government adopted a contractionary monetary policy to lower aggregate demand, interest rates were freed, fuel subsidies were eliminated, and wages and salaries were cut. Water, electricity, and transport costs increased to the point where they consumed 60% of the lowest urban salary. The cost of inputs for peasants increased 30%. Rather than stimulate production, it appears that the new policies simply inflated the earnings of the financial and commercial interests that control exports.‘2 A recession was the result and it is estimated that about 43% of the economically active population was unemployed in 199 1. By 1993, Guatemala’s GDP per capita was 15% less than in 1980, El Salvador’s was 8% less, and Honduras’ 6% less than in 1980.13 Guatemala continues to be one of the most unjust, unequal, and violent societies in the world. About 87% of the population lives in poverty, and more than half in a state of indigence. Four out of every five Guatemalan children are malnourished, over 60% of the population is un- or underemployed, and 67% is illiterate. Barely 30% of the population has access to adequate health care and running water, while the mortality rate of 73.3 per thousand live births is one of the highest in the world.14 Certainly, at the root of this impoverishment in Guatemala is an extremely unequal distribution of wealth and one of the most backward patterns of land tenure in the hemisphere. The richest 20% of the population receives 55% of national income, compared to the poorest 20% with only 4.5%.15 Although 60% of the population labors in the agricultural sector, fewer than 2% of landowners own 65% of all arable land. At the other extreme, 78% of the rural population-composed overwhelmingly of the country’s oppressed majority of Maya and other indigenous groups-subsists on just 10% of the land16. According to AID (Agency for International Development) about one-third of the population lives on farms too small to support a family. Some 75% of all Guatemalans live off of the land.” The structural adjustment program implemented by President Jorge Serrano in 1990 and which is being continued by the current president, Ramiro de Leon, have only exacerbated these inequalities.” Honduras In 1989, the program agreed to by the Honduran government with the IMF had to be postponed because of the massive protests against the measures19. In early 1990, President Rafael Callejas launched the IMF-supported structural adjustment program. Under this program the lempira was devalued from two lempiras to the dollar to 5.7 lempiras to the dollar, taxes were increased, and subsidies on agricultural inputs were eliminated. Analysts attribute an increase in poverty in Honduras, from 69% of the population in 1989 to 73% in 1993, to fallout from the harsh measures taken under that

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program.*’ The program achieved some macroeconomic stability, but has largely failed to generate significant levels of investment or economic growth. Also, the increase in poverty has been accompanied by a marked decline in health indicators. For example, it is estimated that over 12,000 Honduran children die each year, an average of 33 per day, from preventable illnesses.*’ The implementation of the structural adjustment measures has caused popular unrest, and this is occurring in a Central American country which has not historically been the site of mass uprisings or guerrilla movements. It has been the poorest Central American country, however, and restrictive monetary and fiscal policies only seem to be making the situation worse. Real minimum wages in all sectors of activity fell 24% between 1982 and 1988.** The banana workers’ strike for a 60% wage increase in 1990 lasted for 42 days, the longest in Honduran history. The strike was broken by the Honduran military, which also has repressed protests against hikes in urban transport prices. The winner of the general elections for president in late 1993 was the Liberal Party candidate Carlos Roberto Reina. Reina has made it clear he will not abandon the neoliberal project begun under Callejas and he has not addressed the problems of massive poverty and unemployment. Americas Watch Report released in late 1993 indicated that systematic human rights violations continue in Honduras and that only minimal inroads have been made against military impunity.23 On May 12, 1994 the World Bank and the IMF approved a US$500 million loan to support the second phase of the structural adjustment program. Conditions attached to the new loan include a reduction of the national government deficit from 11% of GDP to 5%, devaluation of the lempira, and privatization of the state-owned telephone company, HONDUTEL. Although President Reina does say that he wants to put a “human face” on structural adjustment as of yet it is not clear that this is being done.24 El Salvador In El Salvador, the politico-economic conditions revolve around one central issueland. El Salvador is the smallest and the most densely populated country in Central America. Land has always been a scarce commodity whose importance has been increasin 1 magnified by the comparative absence of precious metals or lucrative minerals!’ Continuing high rates of population growth, coupled with limited productive territory and a restrictive land ownership pattern, have led to high levels of unemployment and underemployment for the nation’s still largely rural and agrarian population. Throughout the 1980s the government adopted tight monetary policies including price controls, wage controls, and fixed exchange rates, under the overall guidance of the IMF. El Salvador maintained an average annual inflation rate of about 15% between 1980 and 1986, a rate much below the Latin American average. Furthermore, compared to other indebted countries in the region, El Salvador’s debt has represented less of an obstacle to economic development. Other factors, such as the civil conflict and deteriorating terms of trade, have more adversely affected the country’s economy.

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Costa Rica In 1982, as a condition of their financial support, AID, the World Bank, and the IMF (International Monetary Fund) insisted that Costa Rica reduce government spending, reform the financial sector and devalue the currency. It has been the agricultural and food sectors which have been most affected by four of the reforms which were implemented: a curtailment of credit and price-support programs for grain producers; the privatization of components of the national stabilization institute; smaller budgets for government agencies that provide technical and land-distribution services for the nation’s small farmers; and the increased promotion of non-traditional agroexports. It has been mostly the smaller farmers which have suffered under these policies since they were the first to see their credits cut and since they can least afford to make the necessary investments to produce non-traditional crops. Also, it is the small farmers who produce most of the country’s corn and beans, so the structural adjustment and stabilization policies may be undermining Costa Rica’s food security. This is compounded by the fact that competition from U.S. produced grains makes it no longer profitable to produce basic grains.26 Interest payments as a percentage of exports of goods and services has declined from 14.6% in 1980 to 9.1 in 1992; nevertheless, total debt service as a percentage of exports has risen from 17.4% in 1988 to 20.6% in 1992.27 Other persistent problems are the large federal deficit, which is expected to reach 6.5% of GNP by the end of 1994 and an increasing inflation rate, expected to reach 17% in 1994 (up from 9% in 1993).28 To try to cut the fiscal deficit, the Costa Rican government implemented drastic tax increases in October 1994 despite the objections from diverse social sectors, including unions and workers, community groups and social organizations.29 Another suggestion to reduce the deficit has been to sell the state-owned petroleum and telecommunications industries.30 CONCLUSIONS While the debt situation of the larger Latin American economies has been examined, the situation for many of the smaller economies has not been examined as closely. In this article we have developed a simple macroeconomic model to analyze the debt situation for four Central American economies: Costa Rica, El Salvador, Guatemala, and Honduras. Our results show that expansionary monetary policy has contributed to the debt problem in Costa Rica. National government deficits financed through foreign aid have decreased debt in El Salvador, Costa Rica, and Honduras. Depreciation of the nations’ domestic currencies has lowered the debt and debt-income ratio for the same three countries. This shows that inward policies in the form of contractionary monetary policy, and expansionary fiscal policy, in conjunction with an expansionary outward policy such as currency depreciation, may help the Central American economies towards achieving lower debt-GDP ratios. This may in turn, result in lower debtservice ratios, thereby freeing up resources for internal investment. It should be noted, however, that it is necesssary to look at who will bear the cost of the cuts in the money supply and a devaluation of the local currency. The political and social cost of such measures may be more than the poorer sectors of the population can

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afford to pay. Furthermore, if wealth were redistributed more equally with less unemployment and poverty and if government military expenditures were reduced, then the debt could be reduced. At the same time, it is important to eradicate the root causes of the debt crisis, which are related to the “development strategies” that these countries have followed. Internal markets must be developed and trade between the agricultural sector and industry needs to be established for balanced economic development.

NOTES Francisco Batiz and Luis Batiz, Znternational Finance and Open Economy Macroeconomics, 2nd ed. (New York: Macmillan Publishing Company, 1994). 2. David Felix and John P. Caskey, “The Road to Default: An Assessment of Debt Crisis Management in Latin America,” in Debt and Transfiguration, edited by David Felix (New York; M.E. Sharpe, Inc., 1990) pp. 3-35. 3. Julio Gallardo and Clemente Duran, “Growth and Welfare in Latin American SemiIndustrialized Economies in the 199Os,” in Debt and Transfiguration, op. cit. pp. 45-57. 4. Ruben Lamdamy, “Voluntary Debt Reduction Operations: Bolivia, Mexico, and Beyond,” Contemporary Policy Issues, 7 (1989): 66-82. 5. Ann Krueger, et al. “Developing Countries’ Debt Problems and Efforts at Policy Reform,” Contemporary Policy Issues, 8 (1990): l-38. 6. Sebastian Edwards, “Debt Crisis, Trade Liberalization, Structural Adjustment,and Growth: Some Policy Considerations,” Contemporary Policy Issues, 7 (1989): 30-41. 7. Many other solutions to the debt crisis have been suggested such as concerted lending, debt-equity swaps, debt-debt swaps, debt for nature swaps, and exit bonds. These policies are not likely to provide much relief for the debt crisis according to Gallardo and Duran “Growth and Welfare,” op. cit. An excellent discussion of these plans can be found in Batiz and Batiz International Finance, op. cit. 8. The regression results for Mexico and Brazil are as follows: 1.

Mexico: Debt = 647 - 0.04 (MS) + 0.0022 (DEFICIT) + 2.53 (EX) (0.75)(-0.11) (0.23) (0.22) Debt/Y = 0.27 - 0.00006 (MS) + 0.000001 (DEFICIT) + 0.001 (EX) (0.36) (0.29) (1.09) (-0.53) and Brazil: Debt = 71042 - 0.077 (MS) - 0.625 (DEFICIT) - 444492 (EX) (0.97) (-0.95) (-0.79) (-1.02) Debt/Y = 0.015 - 0.00000003 (MS) - 0.0000004 (DEFICIT) - 0.156 (EX) (-1.41) (0.49) (-0.99) (-1.07)

9. 10. 11.

None of the individual coefficients in the above equations are statistically significant nor are the equations themselves. See “U.S. Slashes World Sugar Quota, Affecting Sugar Exporters in Latin America & the Caribbean,” Chronicle November 4 (1993). Ibid. Ibid.

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See “Guatemala: The Civilian Facade Collapses,” in Envio, Vol. 10, No. 117, IHCA, Instituto Historic0 Centroamericano, 1991). See “Economic Performance differs Widely in 1993 among Latin American & Caribbean Countries,” Chronicle, March 3 1 (1994). See William Robinson, “Guatemala’s Failed Coup D’Etat: Has the Clinton Administration Passed the Test?,” Notisur, July 9 (1993). Ibid. Ibid. William Robinson, “Commentary: Central America: Which Way after the Cold War?,” Notisur, January 18 (1994). Robinson, “Guatemala’s Failed Coup,” op. cit. See Gerard0 Dolinsky, “Debt and Structural Adjustment in Central America,” Latin American Perspectives, 17 ( 1990). See “Honduras: Authorities Negotiate New Accord with World Bank and I.M.F,” Chronicle, May 26 (1994). Robinson, “Commentary: Central America,” op. cit. See Economic Survey of Latin America and the Caribbean, 1988 (UN Economic Commission for Latin America and the Caribbean). Ibid. See “Honduras: Authorities Negotiate,” Chronicle, op. cit. See El Salvador: A Country Study, Area Handbook Studies, edited by Richard Haggerty (Washington, DC, 1988). Rachel Garst and Tom Barry, Feeding the Crisis: U.S. Food Aid and Farm Policy in Central America, (Lincoln, NE and London; University of Nebraska Press, 1990), pp. 77-79. See “World Development Report 1990 and 1994,” World Bank (New York: Oxford University Press, 1990, 1994). Maricel Sequeira, “Goodby to the Miracles of Adjustment, ” in InterPress Service/Spanish, September 11 (1994), reprinted in Central America Newspak, (Vol. 9, No. 16, Issue 224, Sept. 5-Sept. 18, 1994) p. 2. See “Tax Reform Plan to Go Ahead Without Social Support,” InterPress Service, September 29 (1994), reprinted in Central America NewsPak, (Vol. 9, No. 17, Issue 225, Sept. 19-Oct. 2, 1994) p. 1. Sequeira, “Goodby to the Miracles of Adjustment,” op. cit.