Negative Risk Outlook for Guatemala

Fitch Ratings confirmed the long-term foreign currency debt default rating of "BB", but changed the outlook from stable to negative.

Friday, April 12, 2019

The review of Guatemala's negative outlook reflects political tension and greater uncertainty in agents, as well as a constant erosion in the government's low tax collection, the rating agency argued.

From the Fitch Ratings statement:

Fitch Ratings - New York/New York - 11 April 2019: Fitch Ratings has affirmed Guatemala's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BB' and revised the Rating Outlook to Negative from Stable.

KEY RATING DRIVERS
The revision of Guatemala's Outlook to Negative reflects heightened political tension and uncertainty, and a steady erosion in the government's already low tax collection. Presidential and congressional elections scheduled for this year may result in a government with a weak mandate, and are likely to lead to a fractured congress, represented by numerous political parties, resulting in continued political gridlock and diminishing reform prospects. The failure to enact reforms at the tax administration as well as pass new tax measures would lead to further erosion of revenues.

Guatemala's ratings are supported by a track record of macroeconomic stability and conservative policies, low public debt to GDP and sound external liquidity. These strengths are counterbalanced by a narrow tax base that constrains policy flexibility and limits debt tolerance, as well as weak governance, investment levels and human development indicators.

In early 2019, President Jimmy Morales decided to unilaterally terminate the mandate of the UN-backed International Commission Against Impunity in Guatemala CICIG, but his attempt has so far been blocked by the constitutional court. CICIG's two-year mandate expires in September 2019; it has been investigating corruption cases within the country since 2007. Campaign financing investigations against President Morales and members of congress, coupled with a fragmented congress, have led to political paralysis for the majority of the administration's term, undermining public and private investment and preventing the passage of the budget in 2018.

General elections - electing the president, local government and the unicameral legislature - are scheduled to be held in June 2019, and are likely to proceed to a second round run-off in August. Latest surveys place former First Lady Sandra Torres in the lead, followed by former Attorney-General Thelma Aldana and Zury Rios - daughter of former ruler Efrain Rios Montt. Several presidential candidates, including the three front-runners, face legal challenges that could weaken their candidacy and may disqualify them.

Ongoing criminal investigations into presidential candidates and mud-slinging between candidates could weaken the credibility and legitimacy of the election process and undermine the political mandate of the next administration. An atomized congress, a likely scenario given the wide array of political parties, would further decrease the likelihood of reforms promoting economic and social development and addressing the weak tax collection.

Low government revenues remain a key credit weakness. Growth in government revenue has continuously lagged economic growth. As a result, total government revenue fell to 10.6% of GDP from 11.0% in 2016, among the lowest in our rating universe. Low revenue levels and continuous weak performance reflect institutional challenges at the tax authority, high levels of tax evasion and weak control of corruption. Administrative measures tackling tax evasion (e.g. broad usage of electronic billing) could improve VAT collection in 2019; however, Fitch expects such measures will have a moderate impact.

Fitch expects the central government deficit will reach 2.2% of GDP in 2019, below the 2.4% of GDP target in the 2019 budget. Expenditure execution improved in 2018 but is likely to persist. The higher deficit is intended to tackle infrastructure and human capital gaps, but mostly reflects an increase of 0.7pp of GDP in current expenditure (goods and services) relative to 2018, while capital expenditure increases only 0.2 pp of GDP. The central government deficit reached 1.8% of GDP in 2018, above the 1.3% of GDP in 2017, due to improved capital expenditure execution. The 2018 budget failed to pass the Congress and the 2017 budget remained in effect. Guatemala's general government deficit is below the 'BB' median of 2.7% of GDP, but interest to revenues at 13.6% is double the 'BB' median of 6.3%.

Fitch forecasts a relatively stable government debt burden. Central government debt has remained steady at around 24% of GDP since 2010. General government debt to GDP of 22% (net of social security government debt holdings) is one of the lowest in the 'BB' category. Nevertheless, Guatemala's general government debt to revenues rose to 212% in 2018 from 199% in 2017 due to weak revenue performance. This ratio is significantly weaker than the 'BB' median of 154% and signals Guatemala's lower debt tolerance relative to peers.

External finances continue to be a key credit strength. Foreign reserves cover more than seven months of imports, resulting in one of the highest liquidity ratios among rating peers. Fitch expects current account surpluses for 2019 and 2020 albeit on a declining trend. The current account has shown surpluses over the last three years as remittance inflows more than offset large trade deficits. Remittances reached 12% of GDP in 2018 following four years of growth averaging 14%. However, foreign direct investment has been on declining trend since 2013.

Fitch expects growth at 3.2% in 2019 driven by a recovery of the export sector, a looser fiscal stance and positive construction performance. Remittances will continue to support private consumption. Growth picked up slightly to 3.1% in 2018 from 2.8% in 2017, due to private consumption growth funded by large remittances inflows. The construction sector showed improved activity in the second half of the year owing to easing of bureaucratic procedures. Low public and private investment will continue to restrain medium-term growth prospects. Weak infrastructure quality continues to undermine productivity and competitiveness vis-à-vis regional peers.

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