Icefi: To successfully tackle the Economic and Social Effects of the COVID-19 Pandemic requires a Discussion of Fiscal Covenants in Central America
The Central American Institute for Fiscal Studies (Icefi) estimated the economic and fiscal impact of the COVID-19 pandemic in Central America and reviewed recent estimates by international financial institutions, such as the International Monetary Fund (IMF) and the World Bank. The findings revealed a gloomy scenario for the region, characterized by economic recession in all the countries, as well as increased public debt, and fiscal deficit, with risks of sustainability and fiscal vulnerability. To complement these calculations, Icefi estimated the impact on social well-being and economic development, and made short-, medium- and long-term recommendations. These recommendations included the urgent need for fiscal covenants to put the public finances in order, facilitating decisive actions aimed to ensure more sustainable and sustained growth, and the creation of a broader social protection floor to guarantee the well-being of the entire population.
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Since the crisis is still developing, Icefi warns that it is technically challenging to predict the impact of the COVID-19 pandemic on economic activity. Just like the IMF and the World Bank, Icefi estimated the impact of the crisis on the Central American economies. As a result, Icefi identified as determining factors a decrease by a third in the income from tourism, a decrease of 20% in the flow of family remittances and therefore of consumption, a decrease of 20% in exports, and a total shutdown of economic activity for four weeks. Although these factors have isolated effects, the Institute observes that they are interrelated with the rest of the economic activity, so it is very premature to establish with certainty their total effect. Furthermore, these scenarios show a significant loss of jobs -about 1.9 million in the worst scenario-, a phenomenon that must be urgently addressed.
The Institute organized its analysis into four scenarios (see annex 1): 1) a 50.0% loss of real Gross Domestic Product (GDP) growth in pre-crisis estimates, a 2.0% decrease in tax productivity derived from increased evasion and special emergency fiscal measures, a decrease in international fuel prices and consumption inelasticity due to quarantine and loss of tax control[1]; 2) 0.0% growth of the GDP and a loss of 4.0% in tax productivity; 3) a contraction of 2.0% of the GDP (recession) and a loss of 6.0% in tax productivity; and, 4) a contraction of 4.0% of the GDP and a loss of 8.0% in tax productivity.
Icefi believes that estimates of the impact on social well-being and economic development should be added to these calculations. For the Institute, these complementary estimates should measure the effects of extraordinary actions taken by the governments in relation to: social inequality in access to health systems, social protection and assistance, and support measures for micro, small and medium enterprises; unemployment and poverty; loss of production capacity for internal and external consumption; and the maintenance (or otherwise) of democratic governance. The Institute fears that these estimates will reveal that the current crisis is exacerbating the Central American structural problems, which has already been dragged down by an exhausted economic model, with harmful effects for the natural environment, and a low productive transformation that is incapable of absorbing the entire population of working age. Furthermore, this crisis has revealed the severity of significant structural problems. With the exception of Costa Rica, the current systems have made health a privilege rather than a fundamental right; the 22.5 million in poverty; the profoundly unequal distribution of wealth; and, fiscal policies designed and executed for the survival of States but not for development.
As a result of the economic and fiscal measures adopted to address the Covid-19 emergency, Icefi analyzed the fiscal impact for Central America countries (see Annex 2). Following the four previously described scenarios, the Institute estimated the fiscal impact in each country, concluding that, with the exception of Nicaragua, all the countries are adopting measures that will increase public spending (see Annex 3). Depending on the depth of the crisis, in each scenario and in each country the Institute forecast a fall in tax burden, so increases in public spending are being financed with emergency public borrowing, leading to an increase in the fiscal deficit in all scenarios and countries. Moreover, Icefi estimated that the stock of public debt will also increase in all scenarios and countries, exacerbating fiscal vulnerability and sustainability risks. This reveals that the financing of extraordinary spending and investment from 2021 onwards will rely on a mix of more tax revenues and less public debt.
Based on an analysis of these estimates, Icefi proposed the following short-, medium- and long-term recommendations:
1/ The role of the State should be strengthened.
- Effectively guaranteeing economic, social and cultural rights, prioritizing vulnerable population such as: childhood and adolescence; women; indigenous and afro-descendant population.
- Expanding the internal market: reducing international dependence, increasing employment and eradicating poverty.
2/ The implementation of the 2030 Agenda for sustainable development should be advanced.
- Studying the sebacks that will be caused by the COVID-19 crisis and proposing a roadmap for compliance
3/ A scheme of preferably shared responsibilities should be adopted.
- Promoting a fiscal covenant for development and democratic consolidation (2020-2030), including improvements in State revenues, increased resources and effectiveness of public spending, strategic management of the public debt, and expanded efforts for transparency and the fight against corruption.
Due to the current conditions of public finances in Central America, and taking into account the more prominent role that fiscal policy should take to mitigate the adverse social, political and economic effects of this pandemic, Icefi reiterated the urgent need for fiscal covenants to put public finances in order, generating the strength and legitimacy necessary to promote decisive actions to ensure more sustainable and sustained growth, and a broader social protection floor to guarantee the well-being of the entire population. The success of governments in the current context will depend on their political capacity to achieve fiscal covenants, adopting models of shared responsibilities with equity between entrepreneurs, politicians, workers and the society in general.
Central America, April 28th, 2020
[1] In these calculations, Nicaragua differs from the other Central American countries because its pre-crisis situation was already one of economic recession. The technical assumptions for Nicaragua took into consideration a productivity level similar to that which existed before the crisis.
