Economic Analysis - Public Spending Efforts Undermined By Persistently Weak Tax Compliance - SEPT 2017

BMI View: An increase in public spending on social programs and security will drive a modest widening of Guatemala ' s fiscal deficit in 2017 and 2018. In addition , r evenue growth will remain limited, with a persistently poor tax compliance rate limiting the government's fiscal capacity .

Guatemala's fiscal deficit will widen in 2017 and 2018, as the government places fiscal consolidation efforts on hold in order to prioritize social and capital spending projects along with increased spending on security. We also expect little movement on reform efforts, particularly tax reform, which will see a persistently weak revenue base constrain the government's consolidation efforts moving forward. We forecast the budget balance to reach -1.4% and -1.5% of GDP in 2017 and 2018, respectively, up from -1.1% in 2016. Deficits will remain narrow by historical standards, however, which along with low government debt levels will prevent a significant deterioration in Guatemala's sovereign credentials.

Fiscal Consolidation On Pause In 2017 and 2018
Guatemala - Budget Balance And Total Government Debt
e/f = BMI estimate/forecast. Source: Ministerio de Finanzas Publicas, BMI

Larger Budgets To Target Human Development, Security

Pressing social and security needs, along with mounting political pressures, have led the government to opt to place fiscal consolidation on hold and increase spending in 2017 and 2018. The administration of President Jimmy Morales has outlined substantial goals for spending increases, which will focus on security, infrastructure, and education in an effort to enhance economic growth. On June 21, the Ministry of Public Finance announced a budgetary target of GTQ87bn for 2018, compared to GTQ77bn for 2017, which was itself a large increase from 2016 outlays. Through May, total monthly spending growth has averaged 16.0% y-o-y.

Current expenditures will continue to account for the lion's share of public spending increases, forecasted to reach over 80% of total expenditures in 2017. Capital expenditures will also see a rise as the government roles out its Community Development Plan (2013-2025) aimed at improving social and education infrastructure, which has already received GTQ2.9bn in outlays through the first five months of 2017.

Deficit To Widen With Return To Spending
Guatemala - Revenues, Expenditure, And Budget Balance
Source: MFP, BMI

Weak Revenue Base Will Inhibit Public Sector Capacity

Poor tax compliance will continue to undermine Guatemala's revenue base and limit the government's fiscal capacity in the years ahead. Guatemala currently has the weakest revenue base as percentage of GDP in Latin America, and one of the weakest globally, at 11.0% of GDP, a product of rampant tax evasion and a large informal economy. With the Morales government's ability to push through legislation hampered by mounting allegations of corruption, we expect little movement on tax reform in the coming quarters ( see ' Allegations Surrounding Morales Set To Intensify ' , June 14). As a result, low tax compliance will persist and limit the government's ability to increase spending further without taking on large amounts of debt. Given an aversion to growing the public debt burden, we expect the government will opt to return to fiscal consolidation, leading deficits to shrink once again beginning in 2019.

Revenue Base To Remain Weak Amid Poor Tax Compliance
Latin America - Revenue as % of GDP
Source: National Sources, BMI

Sovereign Credentials Will Remain Stable

The near-term widening of the fiscal deficit will not cause a significant deterioration in Guatemala's sovereign credentials. We do not expect the deficit to surpass 1.5% of GDP in the coming years, compared to 2.1% over the previous decade. Additionally, Guatemala's public debt load remains manageable at 24.4% of GDP, with debt service accounting for only 1.5% of GDP in 2016. Moving forward, we expect fiscal deficits to narrow further, averaging -0.6% from 2017 through 2026, offering additional support to sovereign credentials.