Adapting to the new normal: the economic impact of COVID-19 in Central America

By Miguel Angel Medina Fonseca, Economist at Chief Economist Office, Central American Bank for Economic Integration


This blog is part of a series on tackling COVID-19 in developing countries. Visit the OECD dedicated page to access the OECD’s data, analysis and recommendations on the health, economic, financial and societal impacts of COVID-19 worldwide.


Eve Orea-shutterstock_1716207883
Photo: Eve Orea / Shutterstock

The COVID-19 pandemic is causing one of the largest economic recessions in the world’s history. In Central America, the Central American Bank for Economic Integration foresees a worst case scenario where the region’s GDP will contract by 4.9%, and public debt will increase by at least 7.6 percentage points of GDP.

The COVID-19 pandemic has prompted most governments around the globe to take preventive containment and mitigation measures, often implemented under state of emergency or similar clauses. In Central America, most policies have focused on saving people’s lives and reducing the socio-economic impact of the pandemic. Some measures stand out:

  • purchasing supplies and medical equipment
  • developing and deploying COVID-19 diagnostic tests
  • tracing and isolating people who may have been in contact with a suspicious case
  • cash or in-kind transfers to vulnerable groups
  • soft loans to companies and the creation of guarantee funds
  • moratoriums on tax payments, social security and rental payments
  • maintaining liquidity in the financial system and encouraging credit flow by decreasing the monetary policy rate and reducing the legal reserve
  • implementing adequate delinquent portfolio regulations, freezing interest and facilitating loan restructuring

These measures have contributed to reducing the spread of the disease and avoiding the collapse of health systems, but with severe economic impacts, as productive activities suddenly came to a halt. In April 2020, the Office of the Chief Economist of the Central American Bank for Economic Integration (CABEI) estimated the impact of COVID-19 on economic growth and public debt in Central America, Argentina, Colombia and Mexico. These estimations identified three main impact channels for Central American economies: a drop in remittances, the collapse of international tourism and the contraction of export demand and foreign direct investment. These will have a “second round effect” on economic activity. CABEI’s modelling simulates the direct impact on economic activity under two scenarios: a two-month halt in production, and a three-month halt, both putting a stop to construction, commerce (excluding food and beverage), transportation, financial systems and recreational activities. Both scenarios account for a four-month halt of hotel and restaurant activities, which will probably be the slowest to resume to normal levels. The report’s estimates of impacts on economic growth and debt to GDP, by country and region, are summarised below:

Table 1. Estimated COVID-19 impacts on economic growth (percentage growth rate)

table-1

Note: Belize (BE), Guatemala (GT), El Salvador (SV), Honduras (HN), Nicaragua (NI), Costa Rica (CR), Panama (PA), Dominican Republic (DO), Central America (CA), Argentina (AR), Colombia (CO), Mexico (MX).
Source: Estimates from the Office of the Chief Economist, CABEI; World Economic Outlook (WEO), October 2019, IMF.

Under both scenarios, the results indicate an economic recession for all Central American countries. Given the current progression of COVID-19 in the world, and particularly in the region, scenario 2 is more likely: a drop in Central America’s GDP of about 4.9 percent.

Table 2. Estimated COVID-19 impacts on public debt to GDP (percentage points)

table

Source: Estimates from the Office of the Chief Economist, CABEI; World Economic Outlook (WEO), October 2019, IMF.

The public debt simulations indicate that the drop in public revenue associated with the economic recession, coupled with increased spending to respond to the health emergency, will generate an increase in government debt in 2020. This will most likely translate into reduced fiscal space to finance new productive investment projects in the immediate future. Governments will have to seek alternative ways to address existing gaps in productive infrastructure and avoid a fall in competitiveness.

The human, social, and economic consequences of the COVID-19 pandemic have been so devastating for Central American countries that, despite the risk of a new outbreak and the uncertainty of when a vaccine will be available, most governments in the region have decided to start reopening their economies. They have approved, and often are already implementing, multi-phase reopening plans involving: well-defined biosafety protocols for individuals and companies; different re-opening timelines according to the type of activity and geographical evolution of the disease; the promotion of teleworking where possible; the introduction of a maximum, adjustable number of clients per type of business; and in the event of a new outbreak, provisions to ensure that health systems are prepared to contain and mitigate the impacts.

Interestingly, by pressing countries to accelerate decisions in pending areas of reform, this “new normal” is opening up new opportunities to reach consensus on economic and social issues. This is particularly relevant in six areas.

First, the pandemic has highlighted the need for Central American governments to provide better social infrastructure and services, especially in health. According to our analysis, this area requires particular attention in Guatemala.

Second, the magnitude of the informal sector has made it difficult to provide support to most people during the crisis, revealing the need for an improved safety net, and policies and programmes aimed at generating more formal and resilient jobs. The need to strengthen labour markets emerged as an urgent priority in the Dominican Republic.

Third, trade interdependence among Central American countries has underscored the need to speed up efforts to nearshore and regionalise value chains, and strengthen regional integration.

Fourth, each country must assess its fiscal policy stance and debt sustainability, to design and implement reforms, even sectoral ones, aimed at strengthening their macroeconomic stability. The cases of Costa Rica’s fiscal reform and Honduras’ energy reform are noteworthy.

Fifth, the pandemic is already transforming pre-COVID-19 business models. Firms have to innovate and adopt new technology, and households are changing their consumption habits. These changes pose significant financial challenges for businesses and people to adapt and for financial institutions to generate creative solutions to speed up economic recovery.

Finally, lockdowns have had a positive impact on environmental quality, creating opportunities for the region to strengthen its commitment to sustainable development. However, improvements could be only temporary if the recovery is based on business-as-usual. Long-term decarbonisation plans are necessary: Costa Rica offers an important example to its neighbours.

As governments in Central America implement measures to mitigate the consequences of the pandemic, they should not lose sight of the fundamental, pre-existing structural vulnerabilities of their economies and societies. Adapting to the new normal will require leadership, vision and long-term strategies to design and implement much-needed reforms. In turn, this will require building support from populations and ensuring reforms generate broad-based gains. The Central American Bank for Economic Integration is working with its member countries to support the identification of good practices and help them in this journey.