Central America’s debt vulnerability rankings: Key drivers

  • Central American economies are likely to rebound in 2021 but, unlikely to reach pre-pandemic levels until mid-2022
  • Heavy spending on healthcare infrastructure, Covid-19 relief has caused increased dependence on loans, bond issuance
  • There is little appetite for the large-scale reforms needed to restore fiscal sustainability

Analysts: Paula Diosquez-Rice, Alejandro Duran-Carrete, Lindsay Jagla, Kari Pries, Veronica Retamales Burford, Jeremy Smith, Sacha Tenenbaum, Claudia Wehbe

Heavy fiscal spending on healthcare infrastructure and relief packages has caused increased dependence on multilateral loans and bond issuance that will delay the return to fiscal stability. Most current debt indicators point to a deteriorating regional credit outlook, except in Guatemala, where pandemic-related impacts have been more modest.

Key findings

  • GDP growth for Central American economies is likely to rebound in 2021 but, excluding Guatemala, is unlikely to reach pre-pandemic levels until mid-2022 or later.

  • The economic impacts of the pandemic on Central America have been worsened by November 2020 tropical depressions Eta and Iota causing infrastructure and agricultural destruction across the region. This has increased demand for government expenditure and caused fiscal deficits to increase rapidly; a faster-than-projected US economic rebound, helping both exports and remittances, and strong multilateral lending are mitigating factors.

  • Increasing concentration of political power within the executive across the region has reduced transparency and accountability mechanisms, increasing corruption and civil unrest. Such factors exacerbate policy instability and decrease reliability of the region’s governments as counterparties for foreign investors, prolonging weak fiscal positions. There is little appetite for the large-scale reforms needed to restore fiscal sustainability.

  • Strong capitalisation across Central America’s banking sector and low levels of banking impairment mitigate financial-sector systemic risk, reducing the potential need for large-scale government intervention to preserve financial stability.


This report looks at the debt sustainability impacts of the economic fallout from the coronavirus disease 2019 (COVID-19) pandemic and considers its likely evolution over the next 12 months in Central American economies, with particular focus on Belize, Costa Rica, and El Salvador. Prior to the COVID-19 pandemic, the region had minimal resilience to disaster or crisis events with generally changeable fiscal policies leaving countries already heavily dependent on remittances, multilateral loans, and foreign direct investment (FDI) to fund current-account imbalances. Current debt indicators suggest further deterioration in the region’s credit outlook following the pandemic, in part due to healthcare infrastructure and relief package expenditures in 2020, but also due to reduced tax revenues, which curtail funding available for planned budget expenditures, leaving several governments obliged to obtain loans and place bonds at high rates.

This report reviews the key factors weakening the region’s credit quality and increasing sovereign debt vulnerabilities. It considers the prospects for economic growth in the next year and factors placing increased strain on governments’ abilities to finance intervention and encourage economic recovery. Central American economies tend to be poorly diversified, leaving them reliant on a few export commodities with heavy dependence on US economic performance to drive domestic economic growth. This ties their outlook to US economic performance. However, non-economic factors are particularly important the region’s modestly sized economies. Policy unpredictability and regulatory changes are important risks, with increasingly authoritarian regimes limiting the region’s attractiveness for businesses.

Economic growth and public finances

In Central America, economic recovery is likely to be sluggish, indicated by generally feeble economic performance even prior to the pandemic. Other than Nicaragua, all Central American countries registered significant fiscal deficits in 2020 that have continued in 2021. This leaves them without the fiscal space to extend and expand relief and stimulus measures through 2021 while the lifting of these measures has dampened recovery. Central American economies face an extended recovery period, with most countries not reaching pre-pandemic levels of economic growth until late 2022 or early 2023, or even 2025 for Belize.

Central America: Fiscal deficits and GDP growth

Belize was among the worst placed of Central America’s economies heading into the pandemic. The country fell into recession at the end of 2019, with a 2019 contraction of 1.8% of GDP and a fiscal deficit of 3.9%. The fiscal deficit grew to 14.1% in 2020 even though fiscal stimulus measures to tackle the pandemic-related collapse of the tourism sector were worth just USD12.5 million, less than 1% of GDP. Belize continues to present very high debt default risks, illustrated by its debt-to-GDP ratio, which is currently at 130%, and which IHS Markit projects to remain above 100% until at least 2031. The government restructured its “Superbond” with private creditors in August 2019 and rolled up service payments from 2020 until February 2021. It announced that it would seek further restructuring of these 2034 bonds to be implemented in May 2021 after defaulting on its 20 May USD7-million interest payment. Superbond holders have demanded Belize adopt a full International Monetary Fund (IMF) programme in exchange for additional debt restructuring, a move Belize has rejected.

El Salvador, Honduras, and Costa Rica performed slightly better than Belize in 2019 and 2020, experiencing slightly smaller GDP contractions and more moderate fiscal deficit increases as a percentage of GDP between 2019 and 2020. In addition to pandemic factors and a dramatic decrease in economic activity that stimulus spending was unable to offset, the downward trend was compounded by natural disasters in November 2020, which caused wide ranging crop and infrastructure damage. Costa Rica and El Salvador have tentatively reached Extended Fund Facilities (EFF) with the IMF for USD1.778 billion and USD1.3 billion respectively in 2021, whilst Honduras increased its stand-by credit facility by USD215 million to USD769 million in May 2021. Foreign investor concerns about their increasingly autocratic approaches to governance are a constraint for growth, reducing their perceived regulatory, contract, and payment reliability. We have moderate growth projections for the three countries but there are greater public finance risks for El Salvador in the next two years.

More positively, Guatemala, with a stronger economic trajectory and low levels of public debt prior to the pandemic, is likely to lead Central America’s post-pandemic recovery. After a modest contraction in 2020 of 1.5% of GDP, it was the first country to reach pre-COVID-19 real GDP levels during the second quarter of 2020. Exports will support strong growth of 4.1% of GDP in 2021, which permits quicker fiscal consolidation.

Economic structure and export diversification

Central American economic performance is heavily reliant on the receipt of remittances to stimulate consumer spending. A second key driver of economic performance is export earnings from manufactured goods, textiles, and agricultural products, all of which are similarly heavily sensitive to US economic performance. This reliance exposes the region to adverse external developments (notably US slowdown or recession) and limits its capacities for autonomous recovery. Exports for most countries in the region declined in 2020 although imports underwent a parallel decrease, limiting the damage to trade balances.

Central American countries, barring Costa Rica and El Salvador, receive between 9.1% and 18.9% of GDP from sales of food and agricultural products with a high concentration on bananas, coffee, palm oil, and sugar. High dependence on agricultural exports exposes these economies to global commodity price shocks and adverse production factors like extreme weather events. In Honduras, banana production was badly damaged by November 2020 storms Eta and Iota, leaving companies like Dole and Chiquita forecasting a sharply lower 2021 crop and 50%–90% export contractions. Guatemala experienced less crop damage from Eta and Iota but is heavily impacted by the so-called dry corridor that runs through Central America. El Salvador, Guatemala, Honduras, and Nicaragua are forecasting an earlier and longer than normal dry period for the affected region between June and November 2021. The resulting reduction in subsistence crop output and subsequent export crop-related job losses would worsen food insecurity, increasing dependence on government and multilateral food aid. The Famine Early Warning Systems Network (FEWS NET) is forecasting an Integrated Phase Classification (IPC) “crisis” level for much of the region until at least September 2021.

The Central American tourism industry has been hurt by the pandemic and storm damage, although most economies are not dependent on tourism revenues for foreign exchange inflows. Only Costa Rica (6.6% of GDP) and Belize (26.0% of GDP) face continuing significant government revenue and foreign exchange impacts in 2021 and into 2022. Most borders were closed during the pandemic peak between March and June 2020 and reopened only slowly from September. Re-escalation of COVID-19 numbers has produced a sluggish tourism recovery in 2021. Airline shutdowns, route cutbacks, and cancellations will extend into late-2021 or 2022, delaying tourism sector recovery and making it one of the slowest sectors to recover. Relatively rapid rollout of vaccines in the United States (which provides the most tourists) is a positive indicator for sector recovery potential, but until vaccines are more common internationally, regional tourism is unlikely to experience a marked rebound in Central American economies.

As mentioned above, a major positive factor for Central America foreign exchange inflow is workers’ remittances to family members sent from migrants working abroad, primarily in the United States. Despite initial forecasts in March 2020 of likely remittance contraction due to higher-than-average health risks and job precariousness for remittance-sending groups in the United States, the faster-than-forecast US economic recovery has resulted in a rapid rebound from July 2020 that permitted record annual remittance totals for Nicaragua (up 10% to USD1.9 billion), Guatemala (up 7.9% to USD11.5 billion), El Salvador (up 4.8% to USD5.9 billion), and Honduras (up 3.8% to USD5.4 billion). Based on initial reporting figures from January–May 2021, positive performance is likely to continue in 2021. This would imply that remittances should remain a key positive driver of consumer spending, boosting government value-added tax (VAT) receipts and foreign exchange earnings during 2021.

Political and operational outlook

Debt ratings for most Central American economies have been downgraded in recent years as government fiscal, regulatory, and operational policies have become increasingly erratic. The lack of policy consistency has increased investor concerns about capabilities to service sovereign debt. In this context, successful implementation of government commitments to fiscal prudence, like those pledged in Belize, Costa Rica, and Guatemala, and the ability of administrations to pass their policy agenda will be critical for the success of future bond issuance, provision of new loans, and credit rating stability.

Political disputes between executive and legislative bodies, corruption, and civil unrest have been drivers for deteriorating fiscal positions ahead of the pandemic and a limiting factor for investor appetite to provide new capital needed to revive economic growth. In El Salvador and Costa Rica, severe political polarisation over the last decade has delayed or prevented the passage of fiscal legislation needed to improve fiscal stability.

In El Salvador, this legislative standoff resulted has resulted in two technical debt defaults, most recently in 2017. President Nayib Bukele’s party now holds a majority in the Legislative Assembly, which opened on 1 May, removing prior legislative blockages and improving scope for passage of the president’s legislative agenda, including issuance of new debt and fiscal legislation. This position is very likely to continue throughout the president’s term, which ends in 2024. Although this appears a risk-positive development, El Salvador’s removal on 1 May of its Constitutional Court judges and Attorney General has damaged the country’s international standing. The development led to an immediate decline in Salvadoran bond prices by 7–10 percentage points, forcing the yield of its 2029 and 2032 issues above 8% within 48 hours of the move, with price losses yet to be recouped. El Salvador had achieved a tentative EFF with the IMF in April 2021 that should ease the public debt burden if implemented, but this is also put at risk by the growing policy and regulatory instability under Bukele’s leadership. Limited reporting of expenditures and a lack of compliance with other transparency mechanisms are key constraints to El Salvador’s return to fiscal stability. The president’s centralised approach to governance also is likely to pose significant risks for contract frustration and represent a persisting deterrent to FDI over the next year.

Corruption is another key driver of the political landscape in Central America, undermining legal institutions and driving civil unrest that contributes to policy instability. Political interference in the judiciary has increased across the isthmus, reducing the independence of the courts. Guatemala and Honduras closed multilateral anti-corruption investigative bodies in 2019, despite their successes in exposing and prosecuting corruption networks at the highest levels of government. A corruption scandal led to the resignation of Guatemalan President Otto Perez Molina in 2015 and government graft has triggered regular anti-government protests subsequently. Guatemala and El Salvador have replaced Constitutional Court judges in 2021 in a manner likely to significantly reduce the number of rulings running contrary to government agendas; this is likely to limit scope for independent verdicts in cases challenging government policy and in contract disputes with these states. More gradual but just as thorough in the last decade has been the appointment of pro-government judges in Honduras and Nicaragua, limiting legal dissent.

Persistent corruption within Central American government institutions has reinforced entrenched popular distrust of elected and bureaucratic officials. This provokes regular civil unrest in Guatemala and Honduras and has resulted in significant anti-government organised protests in Nicaragua. Unpopular policies continue to catalyse influential demonstrations in Belize, Costa Rica, and Guatemala, and have led to the withdrawal of annual budget bills and the failure of fiscal austerity proposals.

Case Study: Costa Rica

Lower tax revenues and increased demand for government resources – combined with fiscal stimulus measures amounting to approximately 1.4% of GDP – have exacerbated Costa Rica’s weak fiscal position. To finance its fiscal deficit of 8.4% of GDP, the government signed a 36-month EFF for USD1.778 billion with the IMF on 1 March 2021. Costa Rica committed to implement measures to reverse growth in its primary fiscal deficit (excluding interest payments) and to stabilise its finances by 2023 in exchange for the six semi-annual installments. The agreement and corresponding bills need to be approved by Costa Rica’s Congress before July 2021. Pending legislative measures include the creation of a global income tax system (setting a maximum rate of 27.5% for income of individuals from 2023), public employment reforms, the elimination of tax exemptions, a four-year tax of up to 30% on the profits of 14 public companies, and a new lottery prize tax.

The IMF deal is very unpopular within Costa Rica, increasing the probability of passage delays in the opposition-led Congress. President Carlos Alvarado’s Citizen Action Party’s (Partido Accion Ciudadana: PAC) capacity to mobilise the opposition to support its minority 10 deputies in passing legislation through the 57-seat Congress has weakened since September 2020 when the government’s first effort to acquire an IMF deal was disrupted and ultimately suspended by two weeks of protests across the country. Growing political divergence between the government and Congress is likely to continue through 2021, worsening further by mid-2021 when parties nominate their presidential candidates ahead of the February 2022 election. If Congress does not approve fiscal adjustment before the July deadline, IMF disbursements face delay versus schedule, increasing pressure to find alternative financing requirements for 2021 and harming Costa Rica’s reputation with its creditors, leading to a marked deterioration of its fiscal and debt outlook.

Public debt metrics

The pandemic has exacerbated existing vulnerabilities of Central American countries to the external environment, weakening their public-debt position in a manner likely to weaken the terms on which they can access credit while increasing vulnerabilities to refinancing and currency risks. Even prior to the onset of the pandemic, Belize and El Salvador had experienced technical defaults whilst Belize and Costa Rica had adopted debt restructuring due to unsustainable debt-servicing schedules. Conversely, Guatemala’s continuously low debt profile has been a positive indicator. Debt metrics in Honduras also improved early this century after it had implemented spending and borrowing limits, successfully shrinking its debt-to-GDP ratio from close to 70% in 2004 to 25% in 2007 before creeping back up to 35% in 2019. This success has been weakened, however, by persistent losses in Honduras’ national energy body (ENEE). The high level of foreign debt, at over 80% of the total debt burden, has increased exposure to externally driven changes (particularly periods of sharp currency depreciation) for Honduras and Nicaragua. Despite a similar debt composition, El Salvador’s relative sensitivity has been lower, due to the dollarisation of its economy, reducing the impacts from currency movements. Costa Rica and Guatemala rely more heavily on domestic debt, thus reducing their exposure to shocks from currency depreciation.

The pandemic-driven rapid expansion of fiscal deficits in much of Central America has been mitigated so far by historically low borrowing costs and emergency access to multilateral lending for small economies. In several cases in 2020, countries were permitted to defer interest payments on official debt into 2021 while benefitting from streamlined access to low-cost multilateral loans, but these pandemic-related relief measures are unlikely to be extended beyond 2022. Most Central American countries maintain low levels of short-term debt, at under 10% of the total debt burden. The exception is El Salvador, which has accelerated its placement of short-term debt over the last 12 months; short-term liabilities now account for over 11% of its total debt burden and positions the country near its legally established USD1.5-billion short-term ceiling. El Salvador’s debt servicing payments have risen overall; they reached 17.5% of total government expenditures in 2020, ranking second by this measure only behind Costa Rica (where this ratio reached 23.2%) in Central America.

Accumulated foreign exchange reserves in Central American economies provide moderate import cover. Reserves grew in 2020 assisted by the emergency funding from multilaterals cited above while remittance inflows were resilient. In the near term, all countries have at least three months of import cover, with Guatemala ranking highest at over 10 months of cover. Belize remains the least well positioned; its foreign reserves had benefited from its August 2020 payment rollup to February 2021, but failure to meet its scheduled May 2021 payment obligations now threatens to limit access to further external funding until its debt has been restructured.

Other debt risk qualifiers

Strong capitalisation in the banking sector and low levels of banking impairment mitigate systemic risk, reducing the potential need for government intervention to preserve financial stability. The sector’s numerical (unweighted) average capital-to-total assets ratio at end-2020 was 12.5%. Banks in the region are relatively profitable with an average return on assets (ROA) of 1.1% in 2020; such positive profitability provides surpluses available to provide additional capital. In the same period, the non-performing loan (NPL) ratio across the region averaged a modest 2.6%. Additionally, the region is well provisioned, with impairment coverage ratios as of end-2020 ranging from 103% in Belize to 205% in El Salvador.

A measure to assess overall financial vulnerability is to calculate the NPL ratio needed for the sector to achieve a capital-to-assets ratio of 0% (or absolute insolvency). For this to happen, the sectors would have to reach a numerical average NPL ratio of 28.4%. Under these calculations, Belize appears to be more vulnerable, with its banking sector wiping out its full capital base if it suffered an NPL ratio of 20.2%.

Another more realistic measure is to calculate the NPL ratio needed for the sector to achieve a capital-to-assets ratio of 5% (a point where the banking sector could be deemed undercapitalised and in danger of insolvency). For this to occur, the region’s banking sectors would require an average NPL ratio of 19.1%. Belize remains the most vulnerable sector, reaching partial insolvency with a hypothetical NPL ratio of 11.7%. These figures indicate that only a major surge in impairment would force most banks to obtain extraordinary government support, limiting the threat from the financial sector to fiscal stability. Despite the relative resilience at sector level, this does not preclude individual bank failures (particularly affecting smaller entities) if specific firms badly underperform their sector averages.


Remittances, emergency multilateral credit, and IMF EFFs have provided crucial support to Central American states facing significant weakening of their fiscal positions due to the impacts of the COVID-19 pandemic on global, US, and domestic economies. Other than Guatemala, all face protracted rebounds that indicate worsening debt default risks. Only Belize and Costa Rica have attempted to introduce austerity measures, and fiscal tightening elsewhere will prove politically difficult or limited in scale. In the absence of such fiscal consolidation, Central American states face near-term downgrade risks from international rating agencies, which threaten to increase borrowing costs in the next year and/or becoming increasingly reliant on credit provision by multilateral lenders. Some countries like El Salvador may look for alternative financing from China rather than relying on traditional financing sources to acquire financing for new infrastructure projects. Overall, Belize, El Salvador, and Nicaragua face the greatest debt-sustainability risks, given their weak economic performance and limited credibility with external investors due to their adverse political dynamics and poor track record of fiscal and external debt management.

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