Guatemala's economic outlook is supported by healthy remittances, controlled inflation, and a stable currency

Economic growth summary

The most recent data release indicates that the Guatemalan economy is on track towards a healthy 2016 outlook. The speed of expansion registered in the third quarter of 2015 translates to a 4.9% annualised growth rate, which is indeed a fast rate for Guatemala, given that IHS estimates potential GDP growth near 3.7% on an annual basis. Exports grew healthily, though similarly large import activity counteracted export growth, leading to a near-zero net effect. Agricultural exports decelerated in the third quarter of 2015, though manufacturing output accelerated, which was the driver behind the large boom in exports. Though agricultural exports constitute a significant portion of the export share in Guatemala, manufacturing output is approximately 30% larger than agricultural output, which helps explain the dynamics behind the surge in exports.

Private consumption continued its streak of healthy results, though the third-quarter figures signalled a relenting trend that will take hold in upcoming quarters. We have been communicating that weak prices support healthy consumption activity, which has clearly been the case in 2015; we expect steady consumer spending activity in the coming quarters of 2016, though moderation will come once a wide range of commodity prices begin to solidify from the exceptional declines observed over the past four quarters. With 2015 having such exceptionally healthy private consumption, our 2016 outlook includes a mild deceleration to capture this effect. Our expectation is that consumers will begin to experience a type of saturation in the goods and services acquired in 2015, thereby marginally decreasing the impulse to consume at the same high rate.

We observed healthy remittance inflows throughout 2015, in line with our baseline projections. Remittances have accelerated in terms of growth rates over the last several quarters, which has handsomely benefited Guatemalan consumer spending; these transfers help drive consumption of myriad goods and services in the Guatemalan economy. For year-end 2015, remittances totalled USD6.3 billion.

Inflation summary

Headline consumer price index (CPI) growth was controlled throughout 2015, with year-end inflation coming in at 3.1%. Transportation-related goods and services continue to put downward pressure on the aggregate index, given the resurgence in weak oil prices and the strong effect that leverages on those sub-components. However, food and non-alcoholic drink prices crept up rapidly in the final months of 2015, which strongly affected the year-end price growth in that category at almost 10%. Guatemala's food and non-alcoholic drink prices have been increasing despite international food and drink prices declining; this phenomenon is due primarily to unfavourable weather conditions, which have pushed domestic food prices higher due to declining supply.

The misalignment of food and non-alcoholic drink prices with other areas of the consumer basket of goods highlights a potential downside risk for Guatemala. Although inflation across the different sub-categories of goods and services included in the CPI has historically tended to move in unison in Guatemala, these large deviations could cause the food and non-alcoholic drink price inflation to creep into other areas of the CPI. The mechanics behind such a development would essentially flow from Guatemalans experiencing higher food prices, translating to other sectors of the economy charging higher prices to compensate for the decreased purchasing power, as well as the increased perception of inflation. However, our projections expect that food and drink prices will return to an inflation rate consistent with other sub-categories over the short term.

Outlook and implications

Overall, we believe that economic activity in 2016 will again be relatively strong; our year-end GDP growth rate expectation currently stands near 3.7%. Despite the downside risks that cast a decidedly pessimistic shadow on some other Latin American economies, the outlook for Guatemala remains stable. The main drivers of this Central American economy remain in place for healthy growth into 2016. Specifically, the US economy is projected to perform well in 2016, which has large positive spillovers for Guatemala. Healthier US growth positively affects Guatemala through: increased demand for Guatemala's exports, healthy inflows of remittances, stronger tourism inflows, and increased foreign direct investment. Our baseline projections suggest that private consumption will remain solid, though we do expect a mild deceleration from the extremely rapid growth registered in recent quarters. We believe that weak prices will be a net benefit, namely for consumer spending. Given that consumer spending is by far the largest component of GDP (at approximately 85%), positive expectations strongly condition the economic outlook. Private consumption has already received the positive shock we expected in early 2015 as a result of the strong decline in oil prices, though the continuation of weak energy prices in our 2016 outlook will essentially provide an extension to stable and healthy consumer activity, rather than drive further acceleration. Our assumptions on consumer activity will also revolve around a saturation effect, where the individual consumer begins to moderate spending activity as the goods and services acquired in recent quarters marginally reduce the need to consume in subsequent quarters. Into the first half of 2016, we project consumer spending to remain healthy, which will be further supported by expectations of continued strong remittance inflows. Year-end 2015 remittances exhibited over 13% year-on-year growth, ending 2015 at USD6.3 billion; for 2016 we expect these inflows to remain healthy, though we do expect some deceleration in terms of growth rates, with year-end 2016 total remittances expected between USD6.6 billion and USD6.9 billion.

The outlook for consumer prices will continue on a path of moderate month-on-month price growth, though prices will grow at rates below historical averages. The exchange rate in Guatemala has continued to be quite stable, which further supports our outlook. Relative to other Latin American countries, Guatemala maintains an extremely stable exchange rate, and has done so for over 10 years. Our baseline projections for energy prices – oil prices most importantly – include moderate reductions in the first months of 2016, with stabilisation coming near mid-year 2016. This feature will continue to put downward pressure on the overall CPI, given the direct effects leveraged on transportation-related goods and services, as well as the indirectly affected goods and services (for example, food and clothing that must be transported by truck to markets). El Niño may have a significant effect on weather conditions, which would naturally affect crop growth, though the shock could be either positive or negative. Any negative shock to agricultural production would have a strong influence on domestic consumer prices in the food and non-alcoholic component, which carries a large weight in the overall index (nearly 30%). Our baseline assumptions do not include large impacts from weather-related shocks. For year-end 2016, we expect inflation near 3.3%. The slow and controlled inflation will allow the Guatemalan central bank (Banco de Guatemala) more flexibility in the monetary policy rate, which will be supportive of economic growth. The interest rate hike of the US Federal Reserve has not caused disruptions in the Guatemalan exchange rate, nor has it caused the central bank to raise its policy rate. We believe that interest rates in Guatemala are increasingly likely to rise in the short term, as the Fed is scheduled to continue gradually raising rates in 2016, and as inflationary pressures pick up from the exceptionally weak price environment experienced in 2015. However, at this stage US authorities have made it extremely clear that they will only raise rates at a slow and drawn-out pace, which will favour a relatively smooth transition to the moderating monetary policy in the United States. Overall, we believe that Guatemalan economic activity will not be interrupted in a significant way due to this risk. We expect the central bank will continue with its long track record of responsible macroeconomic management, which will bring continued stability to the exchange rate, and the real economy as a whole.