Speech

Perspectives For Economic Integration in Central America, Remarks by Markus Rodlauer, Senior Advisor, IMF Western Hemisphere Department

February 27, 2004

1. It is a great pleasure for me to be here in Tegucigalpa, on the occasion of the 40^th anniversary of the Central American Monetary Council. Four decades of important contributions by the Council to the common goal of regional integration are, indeed, a fitting opportunity to celebrate what has been achieved, and to look forward to the challenges ahead. I thank the Council and especially its Executive Secretary, Lic. Miguel Chorro, for inviting us to this important event, and I join the previous speakers in expressing our gratitude to the Honduran authorities for the warm hospitality and excellent arrangements that have welcomed us.

A timely topic

2. This is indeed a timely opportunity to reflect on the perspectives for growing integration in Central America. The region is, of course, not alone in its quest to find a common platform from which to compete more effectively in the global economy: many countries, especially smaller ones, in other parts of the world are also discussing how best to advance economic integration with their neighbors, as part of a strategy to maximize the benefits they can obtain from globalization. Most recently, the member countries of the Gulf Cooperation Council committed themselves to accelerated regional integration, including the creation of a monetary union by the end of the current decade. And the example of the European Union stands out as a beacon for successful integration efforts and as a repository of the lessons that can be learned from its experience spanning nearly half a century.

3. For Central America, the time is right to set itself an ambitious goal for further integration: More than a decade after the end of conflicts in the region, a new spirit of cooperation, democracy, and market-oriented economic reforms has firmly taken root, setting the region on a clear path toward its rightful position at the cross-roads of the Americas: a region firmly committed to outward-oriented growth, making the best of its location, natural beauty, and human resources. Central America has just completed the negotiations for a free trade agreement with the United States, which will help entrench this process further and align the region even more closely with its largest trading partner. What needs to be done to capitalize on these achievement and to prepare the region for further integration, thereby making it more resilient to shocks and able to compete more effectively in the global market for goods, jobs, and capital?

4. In my talk today, I will focus on the main stepping stones toward successful further integration. But first, let us briefly take stock of the progress that has already been made, and on which further efforts and reforms can build.

Progress made

5. Central America embarked on an integration process more than four decades ago, and the creation of the Central American Monetary Council in 1964 was an important part of this effort. Unfortunately, the process was interrupted by many years of conflict in some countries, and regained momentum only at the beginning of the 1990s. Since then, Central America has made substantial strides on both the political and economic levels. Democracy and peace have been restored throughout the region, creating a strong basis for sustained economic progress and growing integration among the peoples of Central America. Improved macroeconomic policies and a growing emphasis on trade liberalization have restored growth, lowered inflation to the single-digit range, and strengthened external positions. To be sure, poverty rates in most countries remain high, many social indicators are still below the average for Latin America, and external shocks and policy reversals have created set backs in some countries. Nevertheless, the progress made has not gone unnoticed outside of the region, as evidenced, for example, by the access that some of the countries have gained to international capital markets.

6. Important groundwork has also been done in establishing regional institutions. For example, Central America already has a regional legislature, the Central American Parliament, and it is well-advanced in reaching trade agreements, such as the Central American Customs Union and, most recently, CAFTA. You have a regional development bank (the Central American Bank for Economic Integration, CABEI), and the 1993 Guatemala Protocol envisages a strategy of "open regionalism" that sets Central America on a path of increased regional integration while fully participating in the global economy. And last, but not least, the institution whose anniversary we are celebrating today, the CAMC, has anchored the efforts of collaborating on monetary and financial sector issues in the region.

Future challenges

7. How best to entrench this process of working together and integrating the economies of Central America? The experience with similar efforts worldwide suggests three core elements of a successful integration strategy: (1) stable macroeconomic policies and structural reforms, to facilitate sustained growth, poverty reduction, and economic convergence; (2) creating institutions that underpin further integration, at the political, economic, and social level; and (3) greater regional dialogue, to reinforce policy coordination and entrench the political momentum for integration.

8. Compared to many other regions that are seeking to deepen economic integration, Central America is quite well positioned and has a number of advantages. It shares a common language and cultural heritage, which facilitates the coordination of policies, development of joint institutions, and dissemination of information. Central America's proximity and close economic ties with Mexico and the United States provide a focal point for integration and convergence. And the recent conclusion of CAFTA, besides the economic benefits it will bring, has demonstrated that Central American countries can negotiate successfully as a group, rather than individual ones.

Economic Policies

9. Sound economic policies at the national level are, of course, a prerequisite for successful further integration. As noted, Central America has made substantial progress in pursuing sound macroeconomic policies. Nevertheless, fiscal imbalances and debt levels remain a cause for concern in some countries, leaving them vulnerable to shocks and potentially undermining convergence of macroeconomic conditions and policies in the region. Achieving and sustaining strong fiscal positions should therefore receive the highest priority. Establishing a shared vision of sound fiscal management—consisting of jointly agreed fiscal policy objectives, a common accounting framework for public finances, and adequate budgetary procedures—can be instrumental in fostering individual countries' consolidation efforts.

10. Should harmonization of monetary and exchange rate policies also be a priority? Here, I would strongly caution against "putting the cart before the horse", so to speak. The experience in Latin America over the past decade clearly demonstrates the risks of overly rigid monetary—and—exchange rate regimes and the very high demands they place on the policy and institutional framework. Therefore, our advice is for the region not to tie its hands prematurely, and to develop the institutional and policy framework that allows for different regimes in an orderly way, depending on the circumstances of each country. A key precondition for further monetary integration is the need to strengthen financial markets and their regulation and supervision—I will elaborate on this in a minute.

11. Although structural reforms are desirable independently of regional integration, they are likely to enhance the positive effects of integration and help sustain domestic consensus for it in the face of economic shocks. Flexible and transparent markets are the key imperative here. In particular, the importance of flexible labor markets for growth and employment creation, particularly under conditions of economic integration, is well established, an area where Latin America in general needs to make further progress. Priority should also be given to reforms that strengthen product market competition, such as harmonized anti-trust laws and business codes and regulations. Moreover, progress is needed in harmonizing or coordinating taxes and pension systems, and ensuring well-integrated and well-supervised regional financial markets.

Institutions

12. There is no one-size-fits all template of institutions: national traditions will dictate what works best in every country. However, empirical evidence points to a clear link between the quality of institutions on one hand, and economic growth and a country's ability to benefit from international integration on the other. Moreover, the European experience has shown that strong national institutions are the bedrock for their extension or replication at the regional level, and that the creation of an interlocking web of regional institutions serves to entrench and promote the momentum of regional dialogue and collaboration.

13. What are the key institutions for stable macro-policies? International experience suggests that strong and independent central banks help achieve and sustain lower inflation rates, and more generally help promote nominal convergence. Central America has come a long way in strengthening the position of central banks, which are now largely constrained from providing direct financing to governments. Nevertheless, in some cases further legal and/or de-facto improvements are needed to insulate monetary policy-making from potential political pressures.

14. Several countries have also made good progress in recent years in establishing the key fiscal institutions for prudent budget policies, such as fiscal responsibility laws, strengthened tax collection agencies, and revamped budget processes and controls-efforts that need to continue and broaden across the region.

15. Remaining weaknesses in some countries' banking sectors pose a continuing risk to financial stability in the region—indeed, banking problems have in some countries been a major source of macroeconomic imbalances. Continued progress in financial sector reform is therefore crucial to underpin sustained growth and to avoid crises that could seriously disrupt the integration process. Increasing cross-border lending and financial links in the region imply the need for a regional approach to financial sector supervision—a task that the CAMC is well positioned to promote. A particular challenge in this context is the regulation and oversight of off-shore banking activities and of branches or subsidiaries set up by parent banks in neighboring countries. Central America needs to build on the efforts underway in some countries to establish clear and common rules for consolidated supervision and to bring offshore activities under effective oversight, to avoid the risk that such activities undermine the stability of financial systems not only in individual countries, but—given the increasing linkages and associated contagion risks—throughout the region. The CAMC could help coordinate countries' efforts to reduce informal dollarization, a significant source of risk in most countries of the region; to promote the development of domestic and regional capital markets, and to link or unify payments system.

16. Continued progress in strengthening governance, transparency, and the rule of law will be crucial in attracting private investment and sustaining citizens' confidence in their government. Again, regional coordination can make a major contribution here, by fostering the joint adherence to principles of international standards and codes, including anti-money laundering and the combating of terrorism financing. Well-working judicial systems, secure property rights, appropriate debt and commercial dispute resolution frameworks, and success in combating corruption are key for the region to emerge as a strong competitor in the globalized market place.

Closer regional dialogue

17. For the kind of economic policies and institutions described above to take root throughout Central America, a growing spirit of collaboration and regional solidarity will be needed. Throughout Europe's voyage toward unity, it was propelled by a strong political commitment to cooperate, transcending the purely economic aspects of the communion. It is very encouraging to see how the new Central America that has been emerging over the past decade and a half is already stepping up its regional dialogue in many areas, from increasing coordination of law enforcement to financial supervision, joint trade agreements and many other matters. The European experience, again, shows us how the establishment of a network of regional institutions, events, and fora for discussion and policy coordination, gradually spun an interlocking web of collaboration, dialogue, and peer surveillance that eventually became an invaluable engine of convergence and coherence—economic, cultural, and political.

18. The activities of the CAMC and the regular policy meetings of the region's central bank presidents could serve as a model to institutionalize policy coordination in other areas. In particular, Central America could consider developing a similar forum at the fiscal level, where policy makers would discuss fiscal developments and policies according to an agreed framework of common goals and best practices. Greater regional collaboration is also needed in facilitating and managing the growing integration of regional capital markets that is already underway—such as to ensure appropriate financial market supervision, payment systems, corporate governance standards, harmonization of taxation and accounting rules, rules governing foreign investment, and data standards and transparency.

19. Ultimately, economic integration will be seen as beneficial and sustainable over time if countries achieve and maintain a sufficient level of economic and social cohesion to lessen the gaps in development and living standards across the region. This is not a call for large intra-regional transfer mechanisms, which would be neither fiscally feasible nor likely very efficient, but for continued work in harmonizing and coordinating incentive systems, commercial laws and codes, tax and pension systems (perhaps making them portable to enhance labor mobility), and investment rules. It may also require increased cooperation to improve the region's infrastructure, such as by coordinating a common framework for private sector participation as well as joint, large public investment projects that could not be undertaken by individual countries themselves.

How can the IMF assist Central America in this process?

20. The IMF fully supports the region's efforts at closer integration as a key engine of growth and poverty reduction. As I have outlined above, greater regional collaboration and dialogue will make a crucial contribution to entrenching the spirit of prudent macro policies, institutional reforms, and good governance that is taking hold in the region. Fostering this process is at the heart of the mandate of the Fund, thereby helping Central America achieve the goal of boosting living standards and sharply reducing poverty across the region.

· Recognizing the importance of regional issues, we have decided, with the support of our member governments, to enhance the regional perspective of our work—to identify common elements in the policy agenda of individual countries and catalyze the exchange of cross-country experiences. In Central America, our staff has embarked on a regionally-focused research agenda that will provide a basis for more greater regional dimension in our Article IV surveillance activities.

· As part of this effort, the IMF, jointly with the CAMC, will hold its third regional conference for Central America in July 2004. We thank the Honduran authorities for hosting this conference, which will address regional integration issues as a major focus of its agenda.

· We are also enhancing our technical assistance to help strengthen institutions, including at the regional level. Central America has made good use of our services in this area, and we believe that our assistance can be particularly useful in helping the adoption of common rules, standards and codes, and institutions for regional coordination.

· And finally, we are, as you know, engaged with financial arrangements in several countries in the region. Tailored to the individual circumstances of each country, our program work is geared to supporting the kind of macro stability, outward-oriented growth and poverty reduction that are so closely intertwined with the prospects for regional integration.

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21. In conclusion, regional collaboration and integration carry great potential, also for Central America. I am confident that strong policies and reforms and continued strengthening of regional and international cooperation will allow you to seize this potential and, as a region, share fully in the benefits of globalization. The IMF stands ready to assist you in this endeavor.

¹ Written with assistance from Alfred Schipke.