RESTRICTED

V MLJ CA3Vol. 1

This report was prepared for use within the Bank and its affiliated organizations.I They do not accept responsibility for it' accuracy or completeness. The report. may

not be published nor may it be quoted as representing their views.

I.

x.T1rV1EXTATTnxAT PANTK IOP PR Tn TPTTRUTTCTM% A nIT ThTTTT OVPMVMT

TMT\rrVMNATTCV..TAT T1VVTCPTMPMTThJT ASSOCTAT!OV

CURRENT ECONOMIC POSITION

A 1 T- T r ,rT 1- I'n

OF

GUAT EMALA

(in two volumes)

VC)TO.TMF T

December 17, 1970

Central America and Caribbean Department

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EQUIVALENTS

Currency

US$1.00 = 1 Quetzal (Q)

Measures and Weights

1 manzana = 0.69 hectares (ha) = 1.727 acres

1 quintal = 46 kilograms (kg) = 101 pounds

1 banana box = 42 pounds

TABLE OF CONTENTS

VOLIyME I

Paee No.

BASIC DATA

SUMMARY AND CONCLUSIONS ..........

T. PROB TEMS ^AND P PRO_P .CTS 1

Past Growt-h and Developmer.t Problem s......A Development Strategy for the 1970's 4

II. AGRICULTURE. 9

The Role of Agriculture. 9

Maini Problerus .. . . . . . . . . . . . . . . .9

Agricultural Development in the 1970's 13

III. INDUSTRY AND TOURISM . 23

A. Industry ..........................,,.23Recent Developments .2Prospects .24Policies for Industrial Development .2

B. Tourism ..Recent Developments ................... 29Prospects ................... i s

iV. PUBLIC INVESTMENT AND FINANCE .. 31

A. Public investment ..Past Performance .31Required Future investment Levels .JTransport .34Power and Telecommunication ............. 35Education .37Health .39Housing .41

Thiis report is based on the findings of an economic mission to Guatemalain April 1970 composed of Messrs. Klaus Huber (Chief), Elio Gonelia (Econo-

mist), Roberto Echeverria (Economist), Euric Bobb (Economist), Bo Rassmuson

(Investment Analyst), Harley Hinrichs (Consultant - Fiscal Economist),

Roberto Egli (Consultant - Agricultural Economist).

Table of Contents (Continued)

Yage Nr

B. Financing Requirempnts 41

Recent Trends . .41Finanning the Plann -42

C. Mobilization of .i 45The Revenue Structure .46The Expenditure Structure 48

Fiscal Capacity .49Tax PoliCi.S fv, . .... . _ . ................ 53

Summing-up: Alternative Approaches 57

V. MONEY AND CREDIT .58

Mobilization of Private Savings . .58Di'rectilon of' Private Credit arA Intitutiona

LJ4.~cL±iI Ii rLLv.j~ ~.~U.L O~LU .L L.O.L LU6L)LJ

Needs ..... 59FiLnanciLng Capacity of the Banking System' 1970=6I 60

vi* .LNL ur -a1 ~1'1v Ili L

VI. BALAN4CLE OFr PA1i NT POLICIE ^N P OSECTS ............................. 61

Past Developments ...............................Prospects and Creditworthiness ........ .. ........ 63

MAP

VOLU-ME II

STATISTICAL APPENDIX

ANNEX - List of New Projects for External Financing

I /

BASIC DATA:'

Area 42.0 thousand square miles

Population, 1970 ('000) 5,260

Growth Rate, average 1965-1969 3.1 percent p.a.Birth Rate. average 1962-1967 L5.9 per thousandDensity per square mile (1970) 12.0

D9819S 19 f0

GNP. current prices (Q million) 1,533 1AJ )1732

Per canita. (TTS$ 310 n_2_ 330

GDP. current market nrices 1,566 1,679 1,772

C.rnot.h rate. (pnre nt) 7.7 7.3 5.6Real growth, annual average 1965-1969,

(percent)-----5.2 ---Sectoral contribution (percent)

Agriculture 6 9.7

Mining 0.1 0.- M a nu a c t, i n g -3 16.3

Construction 1.9 1.8Tr-an-spor.tation and corr= ................... rnc-00-cation 5.3 ..... .2 *

Public Acministration and Defense 4.7 4.3,mrierce 2-8.1 2. ..

Other branches 16.8 16.5

Percent of GDP (current market prices)

Gross investment 14.3 14.6 14.3Pri v-ate 1.3 1.L4 ±.iL

Public 2.8 2.'9 2.'3r_ .A4 A c+ 0!AnO^,

Uiia11rU -L IA J \D 0 UeL U. @ ) -

Gross national savings 10.5 12.0 11.5Private 9.2 C. 9. 3

Public 1.3 1.6 1.7Public sector current revenues 11.2 11.7 12.1Public sector current expenditure 9.9 10.1 10.4

J All val-ue data are ln million of quetzales, unless otherwise speclTifed.Data for 1970 are estimates.

Page 2 of ?

1968 1969 1970

Public Sector Operations

Investment 40.3 45.1 56.6Savings 20.7 27.5 30.5Savings-investment gap 19.6 17.6 26K0

(Percent of investment) (48.6) (39-0) (46.o)Internal borrowing (net) - 0.5 0.2 V9External financing (net) 12.2 13.5 17.5

Resource Gap as Percent of Investment 12.1 0 3.9

Money and Prices

Money Supply 151.1 161.1 169.9Liquidity ratio (money /GNP. percent) 9.9 9.8 9.8Quasi-money 129.8 153.6 173.1Cositi ofT livivinp inciey (19)i6=1 00) 1)Ln6 Annual change (percent) 1.9 2.1Average annual change (1965-1969) ---- 1. l

PB1anceP of Pq7rmpnfts (mil. TUTS

1FYnnrt.q of goods. and servicpq 269 357 3'17 1

Imports of goods and services -296.6 -305.5 -327.0ResnurcP (1qn (-=srplus) )27.1 0.2 9. 9 °gFactor payments, net 32.9 34.7 40.0Deficit, goods and services - 60.0 - 3-.5 - 49.9Transfers, net 11.1 15.1 12.7

Private capital J (net) 43.0 24.2 22.1Public capital (net) 8.2 5.3 2414Change in reserves(-=increase) - 2.3 - 10.1 - 9.8

Commodity Concentration of Exports (Percent)

Coffee 31.4 32.0 36.1Cotton 17.9 14.9 8.7Bananas 6.o 6.9 7.8

Ext ernal Public Debt (mil. US$)2

Total debt outstanding (beginning of period) 132.7 165.7 153.5of which disbursed only 77.1 93.2 91.1

Debt service ratio 7.4 8.3 7.4

Foreign Exchange Reserves, net (mil. US$) 37.3 47.1 56.9Committed Disbursed

Bank Group Operation, as of Dec. 31, 1969(mil. -us$)

IBRD 30.2 11.7IDA - _

2/ Includes private banking sector and errors and omissions.

2/ Debt with an original or extended maturity of over one year repayable inforeign currency.

CTTUUA A KDV r'r%M T11CrUC

As the Government of President Arana, which took office in July1970, ,ormulates its econod-c policies and programs, Guatemala is enteringan important new phase in its development process. Present high coffeeprices are providing an opportunIlty to attack the deep seated lonyg-termdevelopment problems of the country and to take action now to prevent there-emergence of serious linanclal problems In the next few years. Theproblems that need the Government's attention are formidable: a rapidincrease in unemployment, a deteriorating baiance of payments position cncethe coffee boom is over and a growing shortage of public savings to financeurgently needed development programs. The present favorable coffee marketthus offers the Government an opportunity which it cannot afford to waste.President Arana, in his inaugural speech, has evinced awareness of Guatemala'seconomic and social needs and has stated his firm intention to pursue activeand development-oriented policies. in this report an attempt is made tooutline the main dimensions of Guatemala's problems and to suggest plaus-ible courses of action which would contribute to their solutions.

ii. A much more active government participation in the developmentprocess, mainly through a long overdue increase in development expenditures(both capital and current), is required to broaden the country's economicand social basis, by integrating the large subsistence sector into the mar-ket economy and diversifying the still very narrow export structure. Thiswill imply substantial strengthening of some institutional arrangements anda greater willingness of the private sector to contribute, through taxes,to financing the needed government programs. A gradual change in the struc-ture of development expenditures will be equally crucial as more expendituresare needed in education and health to prepare the labor force for the struc-tural changes in the economy, foster social development and improve the qual-ity of life of the majority of the population. A five-year public investmentplan based on well identified projects has recently been put together inGuatemala which would adequately support the above described developmenteffort. With appropriate fiscal, balance of payments and sector policies(see paragraphs vii - xii, below) (Guatemala could effectively absorb the$250 million of gross external borrowing which is called for by the Plan.If, on the other hand, the necessary changes in development and fiscalpolicies are not adopted, serious fiscal and balance of payments difficul-ties would have to be expected. Guatemala's creditworthiness for externalborrowing would substantially deteriorate and the country's development out-look would come bleak.

iii. In the past, economic growth has been modest. During the 1950'sand 1960's, GDP per capita increased by about 2 percent annually but veryirregularly. The benefits of economic growth were extremely concentratedand at least half the total population - mainly the Indians - still livesat the margin or outside the market economy. Newly created employmenthas not been sufficLent to absorb the rapidly increasing labor force.Population growth is now over 3 percent per year and rural and urbanunemployment have been rising.

- ii -

iv. Key constraints to development in Guatemala have been (i) thelimited size of the market except for a few traditional export commodities;(ii) a vulnerable balance of payments resulting from cyclical slumpsin coffee and cotton exports, reducing the economy's import and growthcapacity and; (iii) low investment levels mainly because of poor publicinvestment performance and political uncertainty. The major bottleneckto higher public investment was an inadequate tax system; at 8 percentof GDP the tax burden is one of the lowest among developing countries.The lack of public funds made it impossible to improve the extremely pooreducational and health standards, another serious impediment to growth.

v. Looking at the future, underemployment and unemployment partic-ularly in small farm (highland) agriculture and in urban service industriesare expected to increase considerably as the full impact of the accelera-tion in population growth of the 1950's and 1960's is felt. Some addi-tional 50,000 workers annually will be seeking jobs in the first halfof the 1970's. Traditional exports are expected to grow in 1970-76considerably less than in the preceding five years, thus precipitatingserious balance of payments difficulties in the mid-1970's if other sourcesof exchange earnings are not developed. Finally, public savings woulddecline without new revenue measures, just when an increasing amountof public investment needs to be financed. This is the result of theheavy reliance on taxes that grow less rapidly than income, while currentexpenditures have to expand more rapidly to provide adequate social andeconomic services to a fast growing population.

vi. An appropriate development strategy for Guatemala in the 1970'swould have to emphasize the development of new lines of foreign exchangeearnings while at the same time expanding the domestic market mainly by in-creasing productivity in small-scale agriculture.- Guatemala, in fact, hasconsiderable potential to increase employment, income and foreign exchangeearnings from a variety of new sources. The most important among theidentified possibilities are in agriculture (fruits, vegetables, flowersand shrimps), industry (both for regional and world markets), mining (nickel)and tourism. Wnile individually of relatively small size, excent for nickel-the sum total of these new lines of exports would add to export growth quitesiuhb-stnta1llv Tmprovino the nroductivitv of small-scale, stbsihstenreagriculture in order to expand the domestic market and to increase employ-ment would rpnresent a major change in Cuatemala's agriciilttirl eynpripnrpc

But as the record of other similar countries shows, it is essential thatincnq and implym..nt- opportunities are imprnvped within smali srale agyricu-i_

ture itself, since industry and/or services cannot alone absorb the rapidlyincreasing number of uinderemployed and landless peasants. Tho foc of sucha program should be to increase the production of basic grains in the high-lands by providing fertilizer, extersLion sevicS, stable prlces and storage.Traditional farming methods, topography and the cultural and linguisticisola4tion of ul.*n of Lthe 4nd.4genous population aeevident obstacles to

such an approach. But judging from the considerable success which arecent 1'ertiL'LiLzer prograr, fLor wheat lad A among the highlad A ., A

problems are not insurmountable.

vii. Availability of funds for larger public development expendituresis one cruc'ial e'lileImIL of tihe aUUve UeVe±ULoIentIL sLiategy. Creatigl t1 enecessary institutional framework capable of carrying out the investmentprogram and related policies and providiUng Llth Lncentives to cRannelprivate resources into the areas of highest social return are equally es--sential. Thie Planning Office has completed a drart five-year developmeniplan which proides an excellent basis for the authorities to guide publicpolicies in the coming years. According to this Plan, pUDliC investmentexpenditures have to rise substantially in the next five years to supportexport diversification and improvement of small farm productivity botndirectly through credit lines and indirectly by building feeder roads,storage, drainage, irrigation, power and telecommunication facilities.More investrment is also needed in the social sectors to keep up with therapid rate of populacion growth and improve education, health and housingstandards. A rough quantification of this strategy, which seems broadlysuitable to Guatemala's needs and possibilities, shows that direct publicinvestment should rise from Q 45 million in 1969 to some Q 90 million by1976, or from 2.5 to about 3.5 percent of GDP. The investment expendituresproposed by the mission on the basis of sector-by-sector analysis would beslightly below those contemplated in the Plan. They appear technicallyfeasible, given the availability of projects and the recent substantialimprovement in the physical and administrative capacity to prepare andexecute projects. Nevertheless, as is stressed in the Plan, importantinstitutional changes will be needed, particularly in agriculture andindustry, if the expansion of investment expenditures is to be fru:Ltful.Also, a continuation of the recent successful emphasis given to planningand coordination at the aggregate, sectoral and institutional leve:L inthe Planning Office would be essential.

viii. However, the key constraint to stepping up public investment wiLlbe the inadequacy of the present income-inelastic tax system which - onpast showing - seems unable to generate tihe necessary domestic resources.Thus, after allowing for substantial external borrowing (Q 250 million in1971-76) anci some domestic borrowing (Q 35 million) the above investmentlevels woulcl result in unfinanced fiscal gaps totalling about Q 200 mill-ionfor the period and rising from Q 9 million in 1971 to Q 55 million in 1976.Public savings would have to increase from at present 1.5 percent of GDP toan average of 2.2 percent in 1971-76 to fill these gaps. The income, prop-erty and export tax base is at present particularly underutilized and could,with appropriate administrative improvements cum rate changes and some ot:herminor improvements n the tax system, yield sufficient revenues to fill theidentified iinancing gaps. The indirect tax base, while still providingsome room for increased revenues, has been heavily tapped by the tax measuresintroduced ciuring the 1960's. The Government recognizes the need for largerpublic savinigs but is, for the present, concentrating its efforts on improv-ing the administration of the existing revenue system. There can be no (doubtthat the possibilities in this area are considerable; it remains to be seenwhether they will suffice to generate all the additional needed revenues.,If they do not, some of the actions proposed in this report can be regardedas a second line of defense for the financial authorities.

- iv -

ix. Major emphasis will have to be placed in agriculture on carryingout a small farm policy aimed at increasing productivity in grain production

and fostering export diversification. The Planning ffice has prepared aRural Development Program which is in line with the above objectives. Vigor-ous implementation of the policies suggested by the Plan is crucial to a suc-cessful agricultural development in the 1970's. Most important among theactions proposed by the Planning Office is the reorganization and streng-thening of agricultural institutions, mainly by centralizing all develop-ment services under the Ministry of Agriculture and by merging existingagricultural finance institutions into a new Agricultural Development Bank.Establishing an efficient marketing and price stabilizing mechanism wouldeliminate one of the most serious obstacles to agricultural development inGuatemala. A program to provide fertilizer and pesticides (credit in kind)and technical assistance would increase productivity in basic grains, whilenew export lines would mainly be developed through credit lines and techni-cal assistance.

x. Industrial policies should mainly focus on (i) expanding thedomestic market by taking full advantage of the remaining import substitu-tion possibilities and increasing effective demand, (ii) establishing in-dustries sensitive to economies of scale for the regional market (as partof a regional policy), and, in the longer run, (iii) developing new markets

outside the CACM. In order to achieve these objectives, the Governmentwill have to review (jointly with the other CACM countries) the presenttariff policy with a view to providing adequate incentives for new exports;make a strong effort to establishing an efficient institutional frameworkto promote exports; review the ratified but not yet effective new regionalsystem of fiscal incentives with a view to possibly reducing the level oftax holidays and utilizing the resources thus made available to capitalizeindustrial development banks.

xi. The viability of Guatemala's balance of payments will essentially

depend on (i) export diversification, to match the import growth consistentwith a 6 percent rate of economic growth and; (ii) improved debt managementboth in the public and private sector, i.e. abstaining from excessiveshort-term foreign borrowing. To curb the growth of consumer goods imports

so that in the future it only exceeds slightly the rate of population growth

is not an easy task, but it should prove feasible in view of the combinedeffect of the recently introduced import surcharge and suggested selective

credit policies which would reduce the level of supplier credits for con-sutmer nurnoses. Sustained export growth can be achieved but will require

an all-out diversification effort.

xii. Gross capital inflow in 1971-76 is projected at some US$1.2 bil-lion compared to UTS$07 billion in 1964-69. The increase is to a large

extent due to the mining project and the stepped-up public investment effort.Prrivate capital inflows would account for same 70 percent of the total.The public sector would require about US$250 million on a gross basis(US$15Jo mi.LlUion on a net basis), of wh4.h about two would h to

come from new loans yet to be contracted. These public capital requirements

are consistent with the lenuding prograUs o'f the .i|aor external lenders.

Foreign lenders would thus contribute about 30 percent on a net basis topublic investment expenditures. Provided that in the future virtually nopublic borrowing is at short terms - which is technically feasible giventhe high project content of the investment program, that should make itpossible to obtain long-term financing from development institutions - andthat some of it continues to be obtained at concessionary terms, Guatemala'sexternal debt service burden would gradually drop from 8 percent in 1970 toabout 5 percent in 1976. Under these circumstances Guatemala would becreditworthy for the rather large amounts of external borrowing envisagedin this report.

I. IR OoDL,IM tU1AKT PROSPECTS

Past Growth and Development Problems

t. Guatemala is a country of very considerable economic potential.

The northernmost of the five countries lorming the CentLal Aruerican Common

Market (CACM), it has not only the largest population - over 5 million -but is also the best endowed in terms of natural resources. Its rich,

mainlv volcanic soils located in a wide range of altitudes allow the culti-vation of almost any type of agricultural product. There are some mineral

deposits and a large nickel project is now ready for commercial exploitation.

Guatemala both in terms of climate and natural beauties has excellent

potential to become an important tourist attraction in the Central

American and Caribbean area. Finally, Guatemala is located in proximity

to the North American market and has, furthermore, considerably enlarged

its limited domestic market for industrial products through the participa-tion in the CACM. Nevertheless, up to now Guatemala has hardly more than

scratched the surface of its development potential. Economic growth has been

slow and irregular and social progress is still quite incipient.

2. Guatemala's political history during most of the 1950's and 19650's

has been characterized by a considerable degree of instability, with fre-

quent changes in government and civic unrest. Political uncertainty and

the often related institutional inefficiency - changes in Governments were

frequently accompanied by a complete revision of programs and replacement

of personnel - were contributing factors to the slow pace of economic

growth. The Government of President Mendez Montenegro, elected in 1966,

which completed its term of office in June 1970, had to contend with a

recrudescen(e of terrorism first in the rural and, more recently, in the

urban areas.. Nevertheless, it made a serious effort to expand the public

sector's role in the development process by stepping up investments. But1:,

given the necessary lead time it takes to launch such an effort, much of it

is yet to be implemented and little progress was made towards achieving The

major policy goals - fiscal and agrarian reform - to which the Government: had

committed itself at the beginning of its term. Elections were held in early

1970, and a new Government under President Arana has taken office inmid-1970.

3. During the last two decades, the recorded average annual per

capita growth of GDP in real terms was around 2 percent, increasing from

around 1.7 percent during the 1950's to 2.3 percent in the 1960's. These

averages, however, contain three periods of stagnating per capita income

(up to 1954, in 1956-62 and 1964-67) interrupted by two shortlived periods

of very rapid growth led by export booms. Moreover, development was heavily

concentrated in a few sectors, mainly traditional export agriculture and,

more recently, industry, so that the above trends in national incomne

aggregates in practice reflect little beyond the monetized sector's develop-ment. and thus are not reDresentative of changes in living gtandardc nna

welfare of a substantial part of the population.

4. At least half of the total population - the Indians - livesout4ide nr at the margin of the market economym Average nper rnnitr 1n,-.a

in the subsistence sector is estimated at somewhere between US 70 andUS$100 and seems to have stagnated nuer the nact twn decades. l/ The bene-fits of the recent income growth were concentrated on a relatively smallsej.enot of the tntal nnpulatofnn. The A4atr-Ihv,t-4rn of inc ar t,oal4-Iremains very uneven: it has been estimated on the basis of tax returnsthat less than one percent of the population wns almost 80 percent of theland wealth of the country. Although available employment statistics areinadequate to indicate the degree of change over t4me, 4here i

able indirect evidence that additional employment created by the modest rateof recent economic growth was insufficient to absorbL the rapi. d increase Cinlabor force. Underemployment seems particularly high in subsistence agri-cu'Lture. At the rate at. whLiLchL IC L-e urbtan population (icudn L U UdlCity) is growing - about 5 percent annually against 3.1 percent of totalpo p ulation - urban. -,dereplS . tO la -p etly - also. -sing . Unside ly,

especially in the service sector.

5. The modest rate of economic growth in the past may be attributedto a combination of severai LactLors. First, Guatemala's bDase fLor economicgrowth is still relatively narrow. The country's economic fortunes havetraditionally depended onl fluctuatingg prices and supply conditions of a

few agricultural export crops. Also, geographically development has beenlimited to a few areas. Only since the beginning of the 1960's was tne basefor economic growth somewhat broadened when Guatemala joined the CACM, whichbecame an important outlet for its industriai production. Nevertneless,one of Guatemala's major constraints to a more rapid rate of growth remainsthe small size of its internal market. The effects of past export growthhave not been spread widely through the economy. Real wages in plantationagriculture were traditionally low and have not changed significantly overthe last two to three decades, thus keeping effective demand low. Most ofthe Indians live in the overpopulated highlands, cultivating their ownminiature plots of land on which, with primitive techniques, they producelittle if any marketable surpluses. Several hundred thousand ot them there-fore either accept seasonal work in the lowland plantations or migrateseasonally to the lowlands to plant additional crops on rented or spontaneouslycoloni-zed lands. Communications in the highlands are extremely poor. More-over, the Indians still largely follow the traditions and customs of theirMayan ancestors and mostly speak only their own native languages which createsan additional problem of cultural remoteness.

,I/ A ccord'ng lo the raher quesi-4onable nai,-4onal incom.e statistics 1vdt UrLent L. LAic perA capita LJn L.h highlan has en decrese..)

departments, income per capita in the highlands h.as even decreased.

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U ( l .. LUL1U JJ~ . _ _UUL U.L y U_ _ A. £L.L _. .A_ _ . L A ". & .never coffee cnd cotton - which during the 1960's accounted on average forsome 60 percent ol total exports - LaceU cyclical s'lumps iLn worLdU umrkets,the authorities had to curtail imports through fiscal or credit polLcies.This inevitably also slowea down growth, although efLorts were uade toconcentrate import restrictions on consumer goods. The ability to compressimports in times of export shortfalls without limiting growth has now furi.herdecreased as a result of the buildup of industries heavily dependent onimported intermediate inputs which between 1959 and 1969 rose from 35 percentto 43 percent of total imports. However, considerable progress was made overthe last two decades in reducing the degree of the coffee mono-culture wniLchhad accounted for some 80 percent of total exports at the beginning of the1950's. During the 1960's the rapid growth of industrial exports spurredby the CACM aLnd the development of cotton were the major elements in thisdiversification process. Nevertheless, the balance of payments remains apotentially constraining factor in Guatemala's growth process, particularlysince the outlook for traditional exports in the medium-term is not toobright, in spite of presently prevailing high coffee prices.

7. Third, Guatemala's investment ratio has been very low. A]Lthougha significant investment effort was made during the 1960's as a resuit ofwhich the investment/GDP ratio increased from around 10 percent to 14 percent,investment levels are still among the lowest in the Western Hemisphere anclthe lowest in Central America. This ratio would be increased by about 1 t;o2 percentage points if investment were related to the monetized GDP only,since present national account estimates do not attribute any investmentor savings to the subsistence sector, but the level of capital formationwould still remain low. The public investment effort, which stagnatedthroughout the 1960's at about 2.5 to 3.0 percent of GDP, has been particu.-larly poor. The public effort was traditionally limited to providingeconomic infrastructure, mainly power and transportation in support of theexport sector. In this it was quite effective; one of the major achievementsof a government-sponsored development program was the colonization of thePacific coastal area in the late fifties and early sixties. Here publicinvestment in infrastructure were a vital ingredient in the opening of oneof the richest agricultural areas of the country, benefitting large coffeeand cotton plantations.

8. In recent years, progress has been made in the public sector inproject preparation. As a result, a large number of external developmentloans were contracted. But the major bottleneck to rising public invest-ment levels remains the inadequate savings level, derived from an unusuallylow level of taxation. At about 8 percent of GDP, the tax burden is one ofthe lowest in the developing world. There is little reason to believe thatsomewhat higher taxation would have discouraged significantly private in-vestment. The inadequacy of economic and social infrastructure is morelikely to hold down private investment levels in the long run.

9. Low educational and health standards seriously limit the possi-

bility of significantly stepping up the rate of economic growth. uver 6upercent of the working age population is illiterate and the educational

level of most of the remainder is poor: only 3 percent or tne empioyedpopulation finished secondary and only 8.5 percent primary school. The

efficiency of the educational system is low, as only one-fifth of enrolledurban school children finish the full six year cycle, while most ruralschools offer only an incomplete cycle. Health standards are equally poor.In 1965, the latest year for which comparative data are available, Guatemala'smortality rate (16 per thousand) was the highest in thelHemisphere. Over

half of all deaths occur among children under four years. These averageshide the extremely large disparities that exist between urban and ruralpopulation.

A Development Strategy for the 1970's

10. Although the recent rise in coffee prices has substantially

strengthened the balance of payments and foreign exchange reserves areclose to an all-time high, Guatemala will have to reorient its developmentpolicies considerably to be able to cope with the economic problems of the

coming decade. The key problems include: (i) a worsening employmentproblem both in the highlands, where available land resources are alreadyinadequate to feed the rapidly growing population, and in the city ofGuatemala, where new job opportunities grow at a much slower pace than theurban work force; and (ii) a likely deterioration in the balance of paymentsand the rate of economic growth, since all three of Guatemala's main exports -

coffee, cotton and bananas - are expected to grow very little over the nextfive years. Weakening of traditional exports would result in sharply risingcurrent account deficits beyond 1973 which together with substantial amorti-zation of external debt (if debt management is not improved) would consid-

erably exceed the foreseeable inflow of gross external capital.

11. During the last two decades Guatemala's population growth accele-

rated to 3.1 percent per year against 2.4 percent in earlier years. The

crude death rate fell from 25.0 per thousand in 1940 to 21.8 in 1950 and16.1 in 1964, while the birth rate declined very little (48.6 per thousand

in 1940, 50.9 in 1950 and 46.4 in 1964). After supporting a privately

organized (Family Planning Association) scheme, in July 1969 the Govern-ment established a birth control program to complement the private one and

to extend the geographical coverage of this service. The Ministry of Health

expects to increase the number of clinics where family planning services are

offered from presently 34 to 69 by the end of 1971. The programs are geared

to include a total of 250,000 women after five years and the authoritiesexpect that this factor alone should reduce the birth rate by 2.5 per

thousand. Recently. radio advertisements have been used and, in order to

reach the indigenous population, advertisements have been prepared not onlyin Spanish but also in the five maior native languages. The gradual

-5-

geographic expansion of family planning programs to inciude tne ruralindigenous population - at present virtually all of the clinics offeringsuch programs are in Guatemala City - would be an important element ofany policy to improve incomes and living conditions of the small farmpopulation (see also paragraph 65).

12. However, the pace of these programs would have to be consider-ably stepped up if they were to have a significant impact on the birth rateand thus on the longer term income and employment problems. Meanwhile, un-employment and particularly underemployment in agriculture and urban serv-ices are likely to get considerably worse in the 1970's when the impact ofthe increasing population growth of the 1950's and 1960's will be felt,as it already has in recent years. Some additional 50,000 workers an-nually will be seeking jobs in the first half of the 1970's. Althoughthe basic data do not permit great precision, it appears that during the1950's and early 1960's the corresponding figure was around 20,000 whichwas not far from the apparent annual rate of job creation. However, inthe second half of the 1960's estimated annual entrants in the laborforce were in excess of 45,000, while the rate of economic growth andjob creation did not accelerate visibly. It thus seems likely that un-employment rose substantially, a conclusion that is borne out by impres-sionisti/ evidence of conditions in urban areas.

13. The magnitude of Guatemala's foreseeable balance of payments andemployment problems is such that reliance can no longer be placed on thepast policies of merely developing a certain sector of the economy -i.e.,traditional exports earlier and industrial exports to Central America morerecently., A vigorous effort in gradually broadening its economic basis fordevelopment not only by exploiting new sources of growth, but also by bring-ing into the market economy the substantial part of the population presentlyliving outside it is needed. Such an approach to development would alsohave another important dimension. In the past, political instabilityaccompanied by rural and urban violence has repeatedly disrupted the develop-ment process. With rapid population growth and rising unemployment, theexisting sharp quantitative and qualitative differences in life between thetwo Guatemalas could easily become further accentuated. Measures directedat gradually improving the health, institutional, educational and livingstandards would have relatively high social and political as well as economicbenefits.

14. Naturally, not all of this can be done overnight. There arecertain objectives which have to be achieved within a relatively shortperiod oLf time - such as the promotion of new lines of production - whileothers are obviously long-term goals to be approached at the pace pernittedby resource availabilities. But both are an integral part of a much broad-er development effort to be carried out at the same time.

15. Thus, an appropriate development strategy for Guatemala in the1970's would mainly focus on developing new lines of foreign exchangeearnings while at the same time broadening the domestic market, mainly byimproving productivity in traditional agriculture. The additional employ-ment created by these new activities in combination with specific policiesaiming at improving educational, health and nutritional standards wouldhelp reducing the present extreme inequalities of Guatemalan life.

16. A number of possibilities for additional foreign exchange earn-ings have been identified in agriculture (mainly meat, shrimps, fruits,vegetables, flowers), industry (both to regional and world markets), min-ing (nickel) and tourism. However, with the exception of the nickel pro-ject, none of the identifiable new sources of growth are individually oflarge scale. Only in the aggregate their contribution would be significant.Moreover, several years of lead time would be required before significantexport increases can be expected. The nickel project, on the other hand,requires an initial investment of some US$200 - 250 million with expectedannual net foreign exchange earnings (after profit remittances) rising fromUS$10 million to US$30 million or almost 10 percent of 1970 exports in thetenth year of operation.

17. Improving the productivity of subsistence agriculture wouldrepresent a major shift in Guatemala's agricultural policy. The mainobjectives of such a policy would be to assure improved food productionfor a rapidly growing population, to create more employment in agricultureand eventually to widen the very small market for Guatemala's industrial pro-duction, by gradually integrating the subsistence sector into the monetaryeconomy. In principle, there are several alternative ways to achieve, atleast partially, the above mentioned objectives. Outward migration to newagricultural areas in the lowlands or to the cities could be an answer tothe serious unemployment problem among the highland Indians, provided ade-quate job opportunities were available. Additional food production couldbe concentrated in commercial agriculture. A recent comprehensive agri-

cultural sector study considers all these alternatives as inferior toimnroving agrieultural nroductivitv in the hiehlands. The study shows thatthe returns to investment in subsistence agriculture are indeed high (seeparAarAnh 66)- Althouch rtultural differences and traditional habits areimportant obstacles, they can be surmounted as the success of a wheat programrerentlv intrndiuced in the highlands shows. The maior elements of such abasic grain program would be the provision of fertilizer, extension services,stnail nfri4ro etnrnap nnd imnrnvud mnrketing

18. A successful implementation of such a development effort willrequire careful planning and a major effort to mobilize all available humanand finan.ial resources. A key role will have to be nlayed by the publicsector, not only through higher development expenditures, both investment

and current, but also in creating the necessary institutional framework andpolicies to support private sector activities and create the incentivesneeded to channel private investments into the areas yielding the highestsocial returns. The private sector will continue to carry the brunt ofGuatemala's future investment effort which increasingly will have to bedirected towards new productive activities. Mining, industry, tourism andnontraditional agriculture should get the bulk of investment in the privatesector.

19. The new Government, which took office in mid-1970, is not facingthis enormous task unprepared. The Planning Office, in collaboration withall the ministries of the outgoing Government, has over the last year under-taken a major planning effort, the results of which are available to thenew Government. Its principal features are a five-year public investmentprogram and proposals up to the stage of draft legislation on how to bringabout the necessary institutional changes in order to carry out the develop-ment effort. Generally, the program provides an excellent basis for launch-ing a major development effort in the 1970's, essentially in support of thebasic strategy described earlier (for details, see paragraphs 99-130). Thenew Government has indicated that it accepts the Plan as the basis for itsown action program.

20. A substantial increase in the level of public development expen-ditures will be essential if the Strategy outlined above is adopted. Higherpublic expenditures and loan programs will be needed to give more directsupport to productive sectors without sacrificing either the equally neededeconomic infrastructure in roads, power, communications or high priorityimprovements in social and economic infrastructure and related operatingexpenditures. The five-year plan would represent a major departure frompast nerformances. but does not annear unrealistic. nrovided the necessarvinstitutional changes - which are identified in considerable detail - arecarried out. In some sectors such as transport, power and housing, theadministrative capacity has already increased considerably. In other sectorswhere this is not the case, e.g. education and health, the proposed investmentprogram to a large extent consists of a few large projects which are eitherongoina or In an advanced staae of nrenaration. The nlan calls for an in-crease in direct public investment from Q42 million in 1969 to over Q70million ner year in 1971-1975; an average annual increase of 13 percentover 1969. Nevertheless, as a proportion of GDP, public investment wouldrise to still less than 4 npercent against 2-9-3 nprnpnt during t:he lf,0's..In addition, some Q10 million annually in financial investment are contemplated,which wouIld nlav a crutrial role in uppnnrting private investment in nnr!-traditional activities.

21. The public sector will have to mobilize a much higher level ofdomestic resources if it is to finance the needed development expendituresAs already indicated, during most of the last decade inadequate public sav-ings have been of the chief constraints on public investment levels.

0-

Planning Office and mission projections indicate that public savings wouldbecome negative within the next three co rour years if no new policies wereadopted. Although there might still be room to reduce particular non-devel-opmental current expenditures, the need to step up current developmentexpenditures to improve the economic and social services to a rapidly grow-ing population implies that no reduction - and perhaps even a slight in-crease - of the historic annual growth rate of 7 percent can be looked forin aggregate current expenditures. Tnus the needed additional public resour-ces would have to be obtained by increased revenues. 1/

22. Guatemala is entering a crucial phase in its development process.While for the time being high coffee prices would permit the continuationof past policies without visibly damaging effects, these policies could notbe adequate for more than a few years, as the medium-term prospect is forstagnating traditional exportA and growing unemployment. These problems canonly be resolved if Guatemala;s development is put on a broader and lessvulnerable basis. The circumstances to initiate such a major structuralchange are favorable. The immediate export prospects are good, which wouldnot only allow for the necessary lead time but also provide some of theresources needed to carry out the structural changes. moreover, Guatemalacould count on substantial external resources from the major lending agen-cies to complement its own increased resource mobilization. This additionalexternal borrowing, If obtained on suitably long maturities and at moderateinterest rates, would not create an undue burden for the country's debt ser-vicing capacity. A substantial number of high priority projects, in varyingstages of preparation, is now available in the public sector. But consid-erable changes in some major development institutions will be needed toexecute an expanded program. Such a program appears both overdue and feasi-ble when one looks at the immense and pressing needs of the country, at thestagnating levels of public development expenditures in the last few years,and at the ability of Guatemala, proven in the mid-1950's, when it carriedout a major investment effort, to stand up to great challenges.

1/ For details on the range of alternatives open to the Government, seeChapter III.

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!I. AGIULTURE.UK

The Role of Agriculture

23. Guatemala's economic development has traditionally dependedheavily on agriculture. Agriculture accounted in the past decacle forabout 30 percent of GNP, 80 percent of total export earnings and roughlytwo-thirds of total labor force. However, increases in agricultural out-put have during the 1960's lagged considerably behind aggregate output:exceeding the rate of population growth (3 percent) only by about onepercentage point. Moreover, the growth of output varied widely betweenexport agriculture and domestic agriculture. The former (excluding cc'f-fee) rose rapidly, dominated by cotton (20 percent per annum in 1960-69),rubber (20 percent per annum) and sugar (10.5 percent), while banana pro-duction also expanded once the United Fruit plantations had been relocatedin 1965. In contrast, domestic Eood production hardly kept pace with popu-lation growth during the past decade (see Tables 7.6 and 7.7).

24. In the future, agriculture has the potential to continue toplay a key role in Guatemala's economic development. However, if agri-culture is to contribute effectively to resolving Guatemala's employment,balance of payments and social problems in the 1970's, it will have tc,follow a different development pattern than in the past. Instead ofconcentrating virtually all available resources to develop a few exportcrops which now appear to have only limited further growth potential,public and private efforts will have to focus on expanding the basis foragricultural production by developing new export crops and on increasingfood production for the domestic market through productivity increases.If the latter efforts are mainly directed at small farmers, the overwhelm-ing majority of whom are now living at or below subsistence level, theresulting increases in employment and income would also help to enlargethe domestic market for industrial production, which is still very narrow.

Main Problems

25. Small Scale (Subsistence) Agriculture. Guatemala's dualisticproduction structure is probably the most serious impediment to a morerapid growth of agricultural output and to higher and more evenly dis-tributed incomes. While this is quite generally a major constraint toa more rapid development in Central America, the problem is particularlyacute in Guatemala. The subsistence sector accounts for almost 90 per-cent of t'he total number of farm units in Guatemala against about 70 per-cent in the other CACM countries.

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26. The commercial sector is predominantly export oriented, operat-ing mainly on medium and large farms, utilizing modern production techni-ques and absorbing virtually all of the financial assistance given toagriculture. Its principal lines of production are coffee, cotton, meat,sugar and bananas for exports, but it also produces the bulk of the market-.able surpluses in maize, rice, vegetables, fruits and other domesticallyconsumed crops (see Table 7.6). The concentration of agricultural pro-duction in the commercial sector is reflected in the extremely unevendistribution of farm land. Only about 2 percent of all farms controlabout 60 percent of total usable land on farms with an average area ofabout 1,150 manzanas (Table 7.3). The agricultural census data indicatethat, between 1950 and 1964, the concentration of farm holdings increasedfurther. The colonization of the fertile Pacific Coast resulted in a sub-stantial increase in the number of large farms. This concentration oflandholdings has contributed to a substantial under-utilization of availa-ble land resources. It has been estimated that only 28 percent of the landin large farms (exceeding 1,300 manzanas) is being exploited, against about95 percent in small farms.

27. About 88 percent of the total number of farms comprise the sub-sistence sector: they are so small (average size: 1.7 ha.) that with pre-vailing technical methods they can neither provide enough food nor adequateemployment. This definition of the subsistence sector is based on a recentstudy on small farm agriculture in Central America undertaken by FAO ex-perts. 1/ It has estimated the labor requirement for this type of farm atabout 200 to 400 man-days. Thus, assuming that the average family laborforce amounts to 2 persons or 600 man-days per year, on average only abouthalf of the people living in subsistence agriculture are fully employed.This is a serious problem which can be expected to escalate further in thenear future.

28. A further indication of the size of the subsistence farm problemin Guatemala is also given by the proportion of products entering commercialchannels. Part of the production of minifundium farms is sold to the mar-ket either because of lack of storage facilities (and is in fact repurchasedby the producers at a later date, often at inflated prices; paragraph 32),or to obtain cash to buy the few goods consumed on the farms. But theproportion of products originating in small farms which enter commercialchannels seems to be much smaller in Guatemala than elsewhere in CentralAmerica, so that little cash surpluses are generated to finance theacquisition of goods not produced on the farms. Only about 20 percent oftotal maize production, by far the most important domestic food crop, entersthe market in Guatemala, which is only half of the average in the other Cen-tral American countries.

I/ a p Mangpr - Grts and M. Berthold: Small Farm Agriculture in

Central America, 1970.

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29. Given the inadequate income and employment base for smallfarmers, moDSt of them are forced to supplement their incomes by otheractivities. The most important of these is seasonal work on large plan-tations, where wages are low (QO.80 per day). It is estimated that about400,000 seasonal workers. mostly from the highlands, work for periods ofone to three months in the lowland cotton, coffee and sugar plantations.This availability of abundant cheap labor has permitted the developmentof a profitable commercial export agriculture. There is also a considerableamount of nart-time spontaneous colonization by hiehland small farmers :Lnthe northern lowlands. After harvest these peasants return to their homes.

30. The problem of subsistence agriculture has also an importantgeographir And rilt ural dtimensionn The nrohlem nf sbtthQistenre ago-rietltuireis largely concentrated among the Indian population living in the highlands:the incidAoiac of cmall farm. ia hbtwoon t-wica an.A three t-imes higher in thehighlands than in the rest of the country (see Table 7.4). According toprsaont rned nptenti-l lande uise rG1atramnlin c-n bea diideda 4,intor a8v X ones:

(i) the Pacific coastal plain and mountain slope, which has the best soiLland rainfall conditions; most of the large coffee, cotton, sugar andcommercial. food crop plantations are located in this area producing some60 percent of total output; (ii) the westerr hlgh4 lA.d -hi4ch are character-ized by ext:remely small holdings and subsistence food crop production bythe Indian population; virtually no additional 1 and is available ;Ln this4area; (iii) the eastern highlands, which are much lower in altitude and havea much poo-rer -agricultural protential because of a long dry se aon; land--holdings are also small in this area and incomes are close to subsistencelev1.tel; f14vh Al ant4c CAoas an1T_A TakoeIzbl area whch4 ha se a largaC V .t , / vRi v* LJ OS LWA I _ V IO L W& aC * , Ot Ca SI .n na a 1 *-0 J C

agricultural potential, but so far has been little developed except forbarn.nas; (v) the northern slopes, which are st-411, ma.ostly coveredA Iby -4rgintropical hardwood forest; they are thinly populated and, apart from somespontaneous migration from. the highlands, the lack of transpot i::frast.

ture has impeded any further development. This area offers the best pros-fcts fAr sfeflemoentf of sonme of th-a western hi4g1-ffand poua.

1t4-an nd,

(vi) the Peten, located north of the 16th parallel, accounting for aboutone-third of th1e totall area but only 0.5 percent of t-otall pati.o,n; l4t-

agricultural potential is relatively limited: it has large forests hutt1heir comm.,ercial value thas r.ot yetL been.-ell lde t e ,i n e'.

3I 5. problem of .-.aJm sb tn Li t is pob U 7A LosLt~~J.L LL.n pLVUU. =LCU IL 5 U .OCI C IL6&L .JLLULC LO jJLUUaU.Ly LLIA IIJC

urgent development problem the Guatemalan authorities are presently facedwi th. Th ugec rests on two- factors. Firt, ;i ifcl ocnevA. LiI LiI- UL6rLICY L0L ULw V .WUI t L*A.3LULb. r±LL, .L'Ls. U"L"L'LcuLtU to coneL~.ve

how agricultural production can significantly be increased without improvingproductivity in theuse ZsUUe.LbL.11Lt 5ctor, andU 'uLue induseriial growLth ±lSe.LL

will have to depend increasingly on enlarging the domestic market. Second,under present conuitions the em-,ploym,ent and income problem in the nighlandsmight soon reach a stage where only massive migration to the city could pro-vide a solution. That, however, would appear to be inconsistent with theprospective urban employment opportunities.

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32. Marketing. Poor marketing facilities are an important obstacleto a higher rate of agricultural production in Guatemala, particularly forfood crops. This involves a number of factors including inadequate storagefacilities, insufficient funds of the state price support agency (INFOP) andthe extremely limited feeder road network, particularly in the highlands.Under present conditions most small farmers have to sell a substantial partof their maize crop shortly after harvest when prices are low, since theyhave limited storage capacity, only to rebuy later in the year,, when pricesare as much as 50 percent higher than at harvest time. INFOP's mini-mum support price of Q3.75 per quintal of maize is almost double the estima-ted average production cost, and wholesale prices are even higher, but thesmall farmer has no access to these channels. Over 80 percent of INFOPFspresent storage capacity is located in Guatemala City and the very smallstorage capacity in the countryside is generally not accessible to thesmall farmer. With poor feeder roads in most areas, there is little compe-tition among truckers or middlemen. Hence, they absorb most of the substan-tial price differential between farmgate and wholesale or retail markets.Although INFOP's price support policy has been in operation for the last15 years, seasonal price fluctuations have not been reduced.

33. Credit allocation. The almost complete lack of credit to smallfarmers has been one of the major reasons why they still do not use anyfertilizer or other modern inputs. During the 1960's, between 80 and 90percent of total Bank credit to agriculture was channeled to export pro-duction (Table 7.18). Credit of more than one year can only be obtainedagainst a guarantee. Even public institutions like SCICAS (Inter-AmericanCooperative Service for Supervised Agricultural Credit) and the NationalAgricultural Bank, which were created to serve subsistence producers andsmall commercial farmers, compete with the other public banks, INFOP andCredito Hipotecario Nacional, for the most creditworthy borrowers, thusleaving the small producers largely unattended.

34. The role of Government. Public institutions have in the pastcontributed little to agricultural development, except in providing roads tohelp open up the Pacific coastal areas. In fact, the present institutionalarrangements virtually prevent a coordinated sector policy. On the otherhand, various private producer associations, created to promote specific cropsand to promote the specific interests of the producers, have had considera-ble success in providing research, extension and marketing services. How-ever, private organizations cover less than 15 percent of all agriculturalproducers (mainly exporters), thus leaving the bulk of farmers outside theinfluence of an efficient coordination and promotion mechanism.

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z C_gt_ _n_ss 1_ e pres.n':p_" _c_'nst tut _ ona"_set._ Xs*J . II't, ImaCLnI WedlaIi:b: UA. LIL UL :>I L jUU±L aUia L.LLUL.U Uld U

the lack of coordination among the roughlv two dozen public institutionswhich are presently involved Ln carryinlg out agricultural policv. Some ofthe most crucial functions are carried out by a number of entities withoutany effective way of coordinating these activities. For instance, Lhere arefive institutions providing extension services and technical assistance, fiveinstitutions providing credit and also five institutions doing agriculturalresearch. These three key functions are split among ten different institu-tions. As a result, the limited technicai staff is dispersed among thevarious agencies, preventing institutional specialization. There is alsolittle regional coordination of the activities of the various agencies.It is not uncommon in Guatemala that in certain areas credit is availablebut no extension services, and vice-versa.

36. The present svstem virtually preciudes a centraiized pianningand decision-making. The Ministry of Agriculture has only a marginalinfluence on policy-decisions in the field of prices, external trade,marketing, colonization and organization of extension services. Someagencies have so many functions that they are unable to pertorm adequate-ly any specific one. INFOP is in charge of providing credit to agricultureand to industry, has a housing department and is involved in marketing andprice stabilization for basic grains. The Institute for Agrarian Transfor-mation (INTA) is in charge of colonization and, with its own limited budget,has to provide its settlements with houses, health services, schools andteachers. FYDEP, the agency in charge of the economic development ot thePeten, is practically an autonomous Government in that region with the dutyof providing economic and social infrastructure and services but withoutenough resources to do it properly. The budget of the Ministry of Agriculturefor services has in recent years never exceeded 06 million, an amount whichproved to be totally inadequate.

Agricultural Development in the 1970's

37. Recent Development and Outlook for Traditional Exports. Areaplanted witlh coffee and vields have remained more or less stable duringmost of the past decade. Variations in output were mainly the result ofweather fluctuations. Howevei, recently production practices have im-proved. Based on ANACAFE's 2 research and extension services, potentialyielding capacity is increasing.

1 / 'PL __cr__ _ :_ _. 1. k sn___ __J__ . ._…_ X1 lilt:e Lcoffee gLUWteL dasUocdLlULi, .LL I 3d 0 J reg jLtstereCLCU UIeUUUers pLUUo uC 11

over 90 percent of the total output; the remainder is accounted for byan estiated U30,000 smaii planters.

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38. Production costs for coffee during the last decade have remainedrelatively stable since 'labUor costs, accountiLrig fLor 80 percent of thle total,did not change. Production costs per quintal of parchment coffee vary fromabu; b Q1 2 or. La rlis with hghILI y ield-us to abUout Q16 on those with Low yeldus,

compared to farmgate prices in recent years of between Q22 and over Q30 perqu'ntal. LhLus, profitability 'Ls considerable even wlheri prices are low. rorthe next 3 to 4 years, as a result of the recent Brazilian frost, farmgatepriLces are expected to rer,ain above Q30. ince fertilizer use 's expectedto increase sharply with higher prices, the mission expects yields to in-crease on average by 5 percent per year as long as coffee prices are high(1974), and by 3 percent per year in the following 2 to 3 years because ofthe residual effect of fertilizers. No significant increase in the areaplanted with coffee is foreseen.

39. The Brazilian frost is likely to add some US$100 million toGuatemala's export earnings over the next five years. Aitnough the corfeequota allocated to Guatemala by the ICO is expected to grow only by some2.5 percent per year, any surplus of production over the quota is likelyto be sold in non-quota markets at prices very close to those of quotacoffee, at least during the next 2 to 3 years. in tne medlum ana longerrun coffee export values will only grow very slowly (see Table 7.8).

40. Cotton was introduced in the early fifties. It is a highlyconcentrated industry with less than 100 producers accounting for about80 percent of production. With the opening of the lowlands in the PacificCoast, cotton production increased from about 0.5 million quintals in1960-61 to 2 million in 1966-67, but has since declined to about 1.2 mil-lion. Falling world market prices have combined with severe floods andincreased plant protection costs to cause many planters to switch to othercrops, especially maize and livestock.

41. At present world market prices, the land suitable for profitableproduction is scarce. The main problems for expanding cotton productionwhich have direct bearing on production costs are drainage and pest control.A large drainage project is being considered on the Pacific. Although itmight make available an important additional amount of good cotton land andreduce the climatic risk attached to cotton production, further studies areneeded to establish its economic and technical feasibility.

42. The indiscriminate use of insecticides has broken the biologicalbalance in the cotton area, resulting in an increase in plant protectioncosts from Q30 per manzana, or 10 to 15 percent of total costs, in 1960 toQ80 to Q100, or 30 to 40 percent of production cost, in 1969. The number oftreatments per crop season went from 10-12 in 1960 to 30-35 in 1969. Never-theless, there seem to be good prospects for reducing this cost item throughresearch and joint action by all cotton growers.

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The drop In cott.on area resu.LteU .Ln s-uU LwL±a.Lj- ru eupLoyment, from an estimated 16 million man-days at the peak to some 13 millionman days per year at present. However, tle alternatives to cotton are r,,uchless labor intensive. Fcr instance, maize and cattle production respective-ly require only 80 and' one mani-uays annually per uianzana, against 122 ran-days for cotton.

44. During the last ten years, cotton yields have remained moreor less stable. They are relatively high, of the order of 12 to 14 q intalsper manzana (3.6 to 4.2 bales per hectare). Since mainly marginal producersappear to have gone out of cotton, yie:ids are expected to increase graduallyto about 14.5 quintals by 1976. If an efficient pest control program, coor-dinating the action of all producers, is initiated immediately, it couldbring production costs down by some 10-15 percent within the next 3 to 5years. This would permit profitable production at prices of 20-22 centsper lb., and area under cotton could be increased to about 130,000 manzanasby the end of 1976. ?urther expansions in area will be conditioned by thecompletion of the flood control project on the Pacific Coast, which is notexpected prior to 1976. However, even if all these measures are successfullyimplemented, cotton exports would recover only slowly, growing at some 5percent annually in 1971-76 and reaching the 1969 level at the end of theperiod (see Table 7.9).

45. Sugar exports have developed rapidly from practically nothing in1960 to about 1,270,000 quintals 'n 1969 in response to the allocation of aquota in the U.S. market. In 1969 Guatemala adhered to the world sugaragreement and was assigned a small quota of around 250,000 quintals (about15 percent of total exports) per year until 1975. At present about 6() per-cent of the sugar production goes to the local markets and 40 percent isexported.

46. The high domestic price ($7.0 per quintal) and U.S. quota prices($6.80) make sugar cane growing very profitable, although yields are Lowand production costs are substantially above the world market price. Toavoid overproduction, the sugar mills process only the quantities they havecontracted. They operate at less than full capacity, and extraction ratesare low. Thus, there is still ample room for increasing production and effi-ciency both on the crop and the processing side.

47. In the next few years, assuming continuation of present U.S,, quotapolicy (i.e., an increase of Guatemala's quota of 2 percent per annum), themain determinants of sugar production expansion will be the growth of thedomestic market. Prices in the U.S. are expected to fall slightly beiLow thepresent 6.8 cents per lb. level. Guatemala will probably continue meeting -at a loss - its small quota under the world sugar agreement in order t:o beconsidered a sugar exportin2 country (see Table 7.10).

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48. Bananas were for a long time the second most important exportcron after coffee- but production declined ranidlv after the United Fru-itCompany (UFCO) dismantled its plantations on the Pacific Coast. UFCO re-lorated its banana nlantations on the Atlantic Coast- and epnorts haverecovered to a level of around 8,000 boxes in 1970., At present, UFCO hasaround 7,0on acres with bananas. and has plans for an additionnl L,00o

acres during the next two years.

49. In 1968 UFCO started making long-term marketing contracts withindependent Guatemnlan farmers to whom it nrovides all the necessary tech-nical assistance, but no financial help. The independent growers involvedhave around 2,200 acres- iUFCO has plans to rontract production from anadditional 1,000 acres.

50. There is still plenty of additional land available for bananaproduction, -although production costs are perhaps hi-her tha- in otherCentral American countries, especially with respect to packing and localtransport. Yeilds are already high (ahouit ROO hnoxe npr acrer) nd are notexpected to increase significantly above present levels. The mission hasprojected only small increases in production and exports after 1972 (seeTable 7.11).

51. Outlook for New Exports. In the past decade Guatemala has beengradually divers4fying itsexpo t s int-o nw.T products such as meat, card:mom,essential oils, shrimp, rubber, vegetables, fruits and flowers. Export pros-pects for many of thLese crops aregood, but, with the exception of beef, the

volumes are still small. Thus, even with a vigorous effort it will takesore tiLme until neCw export's can effe.tively repIlace tLle 1liost Udynam,,mis ofL

traditional crops.

52. Beef has become an important export commodity, accounting at~L~5~IL 117 dIIWSL J IL!L CLILLii U Ld±iULCL~1ICALIdLi- tCdiL11LiI!eb UL LIICpresent f'or almlltost J) percent ofl totali fLoreiLgn exchange eanng ' the

country. Guatemala has plenty of good pasture land, particularly on thePacific slope and around Lake Izabal. hLese areas have a high potentialfor cattle breeding as well as for fattening, since they have a relativelyshort dry season of aDout 2-3 montns per year and catle can De ieu on tnepasture throughout the year. The eastern part of the country is best suitedfor breeding cattle to be fattened in other areas.

53. Most of the cattle enterprises in Guatemala are still very exten-sive. On average, production amounts to about 150 lbs. live weight permanzana. The ratio of revenues to operating expenses is high (almost twoto one), but in absolute terms the net iticome per manzana is less than Q10,which is substantially below that for cotton, an alternative crop for someof this land. As demand for alternative uses of land is growing, cattleproduction needs to be intensified. Prospects to do so are favorable. Inthe last few years substantial numbers of pure breed cattle have been im-ported, and progress has been made in cattle and pasture management. It

.- 17 -

can be expected that the cattle population will increase by some 4 percentper year in the near future, while beef production could grow at about 5percent. In the late seventies, when present and contemplated improvementsin cattle management bear fruit. beef production could grow at even higherrates. Meat exports are expected to increase at a slower rate than in thepast. This is mainlv due to the fact that the limit imDosed bv the U.S.voluntary meat import quota has been reached, and, unless some reallocationof the quota 1s grantpd to Guatemala, this ceiling is not likelv to growby more than 2-3 percent per year. U.S. prices are projected to rise bynhniit 2 nprrcnt per year over the next five vears.

54 TIn uigw of the limitations of the IT.S market; Guatemala will

have to make a strong effort to find new markets, mainly in Europe andother Western 1Hem4anisphezre countrie sv Beef reta4l pv4r- 1 trices Vn teE an4

Economic Community (EEC) are slightly higher than in the U.S., but customdui. are a...uch highe:r, of th- ordAr of 20n ------ Ad valor-m as -ainst

about 5 percent in the U.S. The EEC countries are contemplating the estab-lishment of a quotaquot ayste.. for frozen beef el4minating the present tar4ffA joint mission from all the Central American countries has recently visitedth.e EECr.-. -- ~. -. I to inesigt the po I ibtlies of thi maket wh--ich couldI becomeL.L1~~JL LU% £LLV=OL.LraLC LLL&= FUOO.LIJ £.L LA4. 5L L.II.0LO a V.L, WL.s.l1 LUL ~Jan important outlet for Central American production.

55. Present rubber plantations cover about 12,000 hectares, but theyare reLativnely new , witlii onLy one==third of this area iLn actual prodLuctiLon

and with most of the trees not having reached their full yielding capacity.So fLar, all rubuULer prodJuctiLon has beer, so'ldU iLn the domuestiLc maUrket, but LfromL

1970 onwards an exportable surplus will develop, for which there is apparentlya mar'e- e n Lne ouLner t*A'4i countrLieS. rruuucL.L1 CUoL:s 5tLt UCIOW WULU LUaLt:L

prices.

56. Cardamom is a spice exported mostly to the Near East and Scandinavia.it is grown in cofree areas. For tne last 5 years prices have been high, sLL-mulating new plantings both in Guatemala as well as abroad. Present Guatemalan

J L It2 0 J¶1It 1 L - s d - - b - e e3 - -a o e ]OprouULUII ct'or 'sUar U n .O UI1±±ULLI .UIY 1 U Fll l U1 Ut: peted LU ,LUW a Soe: 10

percent per year over the next 2-3 years. However, it has a limited market,and -when recent plantations Ln Guatemala and elsew-here are in full productionin 1971, prices can be expected to fall gradually from the present Q200 toaround Q125 per quintai. Even at the iow projected prices cardamom snouid bequite profitable, since estimated production costs are of the order of Q50per quintal.

57. (;uatemala has a small seafood (mainly shrimp) industry in thePacific. P?roduction increased from 0.7 million lbs. in 1960 to 2.1 millionlbs. in 1969 with a peak of 3.1 million in 1966. Production is not likely toincrease by more than some 0.1 million lbs. per year unless a new port isbuilt in the Pacific Coast which would permit the operation of bigger boats.Demand in the U.S. market is expected to continue to grow rapidly over thenext tew years.

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58. Starting from a low base, vegetable exports increased by about13 percent and represent now about 22 percent of total production. Theseexports were directed mainly to the other CACM countries, and only verysmall quantities have 1oen exported to the United States. Export develop-ment has taken place sDontaneously, without government assistance, and market-ing organization and facilities are still deficient. Quality of the produceis often low, grading is poor and losses are reportedly high.

59. Guatemala has good potential to increase vegetable production andexports substantially. Potentially good markets exist in the U.S. and someof the Caribbean islands. Since vegetable production is relatively labor-intensive, it could make an important contribution to increasing agriculturalemployment. However, the realization of this potential will require stronggovernment action. A 10,000 ha vegetable expansion program is a key elementof the Government's rural development program (see paragraph 68). Presentplans call for tripling of exports by 1974, but they might prove overlyoptimistic since some of the preconditions of a successful export drive arenot yet met (mainly marketing organization and storage). The mission hastherefore assumed a somewhat lower rate of expansion, still bringing totalvegetable exports to some Q16 million by 1976 from Q3.4 million in 1969.

60. Flowers are another major export diversification product. Presentlevel of exports is slightly above Q2 million, mostly directed to the U.S.market. The Government has promoted the formation of cooperatives to enterthis business on an economic scale. According to present plans, flower exportswould increase to some Q10 million per year by 1975. Again, the success ofthis program will depend mainly on improving the marketing and transportationinfrastructure.

61. There are also good possibilities of increasing fruit exports.If the goals set in the rural development program are carried out, exportsof fresh, dried and processed fruits would rise from Q3 million per yearto some Q9 million by 1976. The planting goals for the next 5 years areto establish 2,000 hectares with plantains, some 10,000 hectares with citrus(mainly oranges and tangerines). 3,000 hectares with avocado and 1,500 hec-tares (after 10 years) with cold climate fruits (apples, pears, peaches andplums). Most of these fruit exports are expected to go to the CACM countries.but eventually some of them could also enter the U.S. market.

62. Timber production and exports have hardly increased during the1lat 10 Vears. Rprpnt studips suggest that large scale timber extractionfrom the Peten is limited owing to the low density of commercial speciesand the adverse weather rcndint-ion.c In many ArPea cnmmrrci al tiTnber rF-sources have been depleted by uncontrolled exploitation and forest fires.Vigo-r-o overmental action for nr.otenrtn-oo i nA iontrnl lr,eo tho en1oi-tion of forests needs to be taken to allow some moderate increases in

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produrtion and 3rpnrtq in the mid 1970's (tnatema1l has rnnsiderah1lforest resources and could dupport a substantial wood industry. l1owever,the reanli7ation of thisc nntpntitl nn A Inraor aonAlo rvon,iiroa nrlA4ti 4c,al

studies to determine the areas best suited for commercial exploitation,the likely marketing ountl*et anA the requireents for additional tnoand processing infrastructure.

63. }fain Objectives. To meet Guatemala's development needs,, agricul-turall pollicy in the- 1970's w.l h-411 I to focs o (i4 --pport a ma4orexport diversification drive to accelerate the rate of economic growth mndto overcome thte anticipated slowfdown in tradi4tional export s and resu I -ti rgbalance of payments difficulties, and (ii) attacking the problem of smallfarm agriculture in orler to expand th-e u,srket econom,y gradually zind to4.ALiia,A .. Lt LUL 4U .L u A LI. ~tpLU L.LA Ull I.L ~LILJI~~ uU t C.L IU U

provide employment and better social conditions for the rapidly growinga.-.iy of4 ru.aL tuderer,,ployed. T hile needU Afor such a policy clhlange LhIais Ueenincreasingly recognized by the Government in recent years. In fact, theRLural DA.eve'Lopment PL"an ( ILJJL K, which i8 the centralA. element o0f Guatemaila'sfive-year development plan, responds to a very similar perception of needsand poss'bilities. The RDP is the oUtcomief of several recent in-depthagricultural sector studies from which this report has also drawn heavily 1/and provides an excellent basis for formulat'ng an agr'cultural sectorpolicy. The major features of the RDP are discussed in paragraphs 68-72.

64. The Need for a Small Farm Policy. The need for programs in thelow-income sector to proviue relief Lor the growing number of underemployedsmall holders and landless laborers is confirmed by the experience in othercountries at a similar development stage. Their experience suggests thatindustry and services cannot provide sufficient jobs to cope with massiverural unemployment and avoid rapidly growing urban unemployment and cityslums. In some countries the small farm problem has been successfullyattacked through basic changes in the land tenure system. In the case ofGuatemala, gradual changes in the land tenure system (by increasing the costof holding idle land which at present is close to zero) would have to be com-plemented by other policies.

65. There are several possible elements to such an approach: (i) in-creasing production of foodcrops in the highlands through yield increasesby using new seed varieties and fertilizer application; (ii) colonizationof new land (only about two-thirds of cultivable land is presently explo:Lted)and (iii) extending family planning services to the rural population (seeparagraph 12). It appears that at the present stage the emphasis shouldbe given to productivity increases, since large scale colonization would bemuch more costly, given the heavy infrastructure requirements, and probablyless acceptable, particularly to the highland population, which in generalhas shown little enthusiasm for permanent migration. Nevertheless, on asmaller scale, some supporting expenditures will be needed for the sponta-neous colonization which is presently taking place in the northern foothillsof the highlands.

1/ See: Agricultural Development and Policy in Guatemala, Iowa StateUniversity, 1969.

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66. Recent studies 1/ sueeest that the returns to fertilizer nrnoramqin the highlands are indeed very high, as much as Q4-7 for eaclh auetzalinvested in fertilizer. These studies also show that the returns to fpr-

tilizer application are higher in the small highland farms than in the low-lnd commercial farms. eiven the higher fertilizer response at the lower

yields prevailing on small highland farms. Output of maize per ha. couldensily he dotihled from 750 kz to 1.500 kg on highland farms. Furthermore,

it can be shown that the overall benefits to the small farmer are consider-nhlv larger if the fertilizer programs are carried out on the small f£rmrs

If the Rural Development Plan (see paragraph 68) is fully implemented,ma1ze nrnductinn Is exnected to increase at some 6 nperrent annnallv leading,at present prices, to a surplus of about 1 million quintals by 1976. Ifprices were t- dron bv some 20 npercent the above siurnlius coul d 1largelCy b-Ne

absorbed by increased demand for animal feed, which at present higher prices-- ut- for on"ly a amnll anrt of total demond.

6(7 Topoa-phyr AdpleteA an4so t-l trAt-4nna1 fmvrmina m-eh-oAs a nd

possibly language barrier make the implementation of a fertilizer program-mong the large number of farm-s in the highlands more difficult than in the

lowlands. But the recent success with a fertilizer program for wheat amonghigh.land Indiansa suggests that these problems are ot insurmountable. * ome

55,000 smallholders -incorporated in cooperatives - benefit from this program,as aresu. - ,of 4 wich. gr o ss 4 ncomeorn thesen farm ha _; ri sen 1.- _A-- f00 a L GO U~ . OL WI J~'' IA -l.. s A.l CL SO 150 ha. to cii, x, , , t,_1- S1 IlC

million and labor requirements by over 50 percent. More important even, theLILgLLher .incomes in LCtheir zone of influence have led tA-o a re.1arka1Dle increasein local activities, including school construction, community buildings,water supply --stAU - -.ommrce - .

60 -. The Rura Developme-ti Plan * RDF cons'-is mainly of a publicinvestment and credit program and detailed proposals, including draft laws,to carry out the crucial institutional changes LIt sarILy LU m1pleme1L LLne

investment plan. It mainly proposes projects for promoting production ofbasic grains, diversifIcation into other cash and export crops, mar'Ketingand storage facilities, colonization and land reform, livestock production,irrigation and rural roads. Th1e total public capital outlay (in fixed in-vestment and credit lines) amounts to about US$107 million in the five-yearperiod, $23 million of which is financed bv an AID loan. The ultimateobjective of the plan is to introduce modern technology as the base ofagricultural development, and to distribute more equitabiv the derivedbenefits. The mission fully endorses size and composition of the RDP.Almost nine-tenths of the investment contemplated in the FDP is destinedto help the small and medium farmer. About half of that is for improvingproductivity, while about one-fourth is devoted to improving marketingfacilities and one-fourth for development of natural resources. This mixof investment, which will rely heavily on credit lines, is adequate and inaccordance with the relative importance of the major needs for agriculturaldevelopment. The following comments are mainly to express the mission'sview on what it considers the key priorities of the Plan, since it entailsa very ambitious action program, riot all of which may be achievable at thesame time.

1/ See: Agricultural Development, op. cit.

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69. (a) The first and obvious step is the reorganization andstrengthening of the agricultural institutions. The RDP suggests concret:esteps for the strengthening and reallocation of responsibilities aTnong thevarious institutions dealing with agriculture. Its main proposals are thatall development services are to be centralized under the Ministry of AgriL-culture, which is to have five technical divisions in charge of research,education aid extension, natural resources, rural development and livestockdevelopment. Three autonomous institutions, coordinated by the Ministry ofAgriculture, are to absorb activities that previously were scattered invarious multi-purpose agencies. It is suggested that a new institution,the Agricult:ural Development Bank (ADB), be created which would merge theagricultural activities and assets of INFOP. Banco Nacional Agrario, CreditoHipotecario and SCICAS. The Marketing and Price Stabilization Institutewould take over the activities of INFOP and would receive its initial capi-talization 1'rom a grant from the World Food Program; and the Land TenureInstitute would take over the activities of INTA. A reorganization of thistype is an absolute necessity for an improvement of agricultural services.However, once an efficient institutional arrangement is set up! lack ofexperience and personnel in the Ministry of Agriculture to handle the lairgelyexpanded activity required by the RDP will represent a constraint which couldonly be overcome gradually, provided a systematic training and personnel up-grading procgram is intiated. Provisions for such a program are part of theRDP.

70. (b) Equally important is the improvement of marketing andthe nrice st:abilization mechanIsms for food Prains which are among the mostserious constraints to agricultural development. The RDP includes threeQrain storacrp nrnipects at different lpvpls: thp natinnal crain storrae

project, whose basic function will be to stabilize prices of basic foodgrains; a grnin storn've project for land settlements, and a notwnrk ofsmall grain silos at the village level. A fourth project concerns market-ing of fruits and vegetables. The marketing com-aonent of the RDp appearsto be of paramount importance for the successful implementation of produc-tivitty increaQes in hnbasir grains. It shnould be in onpration bhfore thll

higher output becomes available.

71. (c) Measures to increase productivity in the small farm sectorare a major element of t-he rpnP 'he tagt 4 i-- 4ti-rdA-e 4mproveA culti-4-

vation methods on 60,000 hectares to increase yields of maize, beans, wheatand rice. Tlhe other main component is a program for crop divers4fication(fruits, flowers, vegetables and sesame) which is focussing on technicalassistance and credit lines for 4nputs (i.e., fertilizers and pesticides).Success in this field will depend mainly on the ability of ADB to provideefficiently supervised credit on a large scale. Once in full operation,the productivity and diversification programs are expected to provide about11 m4llIon tmian-days of addItIonal emlymn ~ctton prsetl prV4Aeabout 13 million man-days per year - and should make a major contributionin reducing the underemploy.ment problem in smallholder areas. Crop divers4-fication for large farms is also foreseen by the Government's plan, byinstiItutincg credit li4nes an' tech_nical assiseance for the Aevelopm.en- of oilpalm tea, fruits, ariL.Lf ic L. Lal L Lp and Lb a. dair ca ttle

palm, tea, t:ropical fruits, artificial pastures, and beef and dairy cattle.

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72. (d) Complementary infrastructure including irrigation, drainage,land settlement and construction and improvement of feeder roads are otherimportant components of the RDP. Especially the provision of feeder roadsappears of the highest priority.

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III. INDUSTRY ANI) TOURISM

A. Industry

Recent Developments

73. Manufacturing has been the fastest growing sector between 196:3and 1969. increasing its value added at an average annual rate of 8.2 percentin real terms, compared with 5.7 percent in 1955-58 and 4.5 percent in1959-62. More than three-quarters of the increment in 1963-69 was accountedfor by the rise in domestic demand, somewhat less than 20 percent by theexpansion of intraregional (CACM) trade and the balance of 4 percent by exportsto the outside world, mainly of meat and sugar. Even with the rapid expansionin output, in 1969 the manufacturing sector still accounted for not more than16 percent of GDP, against 13 percent in 1960.

74. Traditional consumer goods industries predominate, representingabout 70 nprcent of niotniit in 1969 (spp Tahlp 8.2). More than four-tenthsof value added is concentrated in food, tobacco and beverages; and anotherfourth in !extiles, rlothing and fnotwepar= The above nroducts wepre resnon-sible for about one half of the increase in value added in manufacturing in196<3-69 (scee Tbhle R 1). Tho hiiUk of thp awnAc:inn in nitnipt in t-hp nnn-traditional. category has occurred in chemicals (mostly pharmaceutlcals and

Industries producing traditional products have been primarily dependent uponthe do.mestic mavrket, wh4le 4nt-rari4nnal t-rad has taken an imTnortant share

of the growlth in the output of non-traditional industries. The latter dependsto a great extent on imported raw materials and intermediate goods, therebyadding considerably to balance of payments rigidities. Imports of thesecategories of goods from areas outside Central A,merica have been increasingrapidly and their share of total imports has risen accordingly (see TabLe 3.5).

75. I]ndustrial investment increased considerably from about USM30 mil-lion annually in 1460-62 toTUS$46 mllIon annually in 1963-68, both for themodernization of existing industries and the establishment of new ones.Overall growth in mmanufacturing employ...ent has been sigrnificant, and wasaccompanied. by an increase of productivity which, however, is still at avr 7 low lev-e. Ac.cording to a-4- 0larnin Offisfc et.m.a , idstr eA. :!oy

ment grew from 129,600 in 1962 to 163,800 in 1968 (or by 4 percent annually),of *which so;me 12,000 Jobs may be a-ributeA to the creation of the rommon

U~ WilU~3L * UwU J uU LU uca LL. .L uU LU LL- ~ 1 kO LXU tSfCUIU'll

Market. During the same period, manufacturing value added grew by 8.4 per-cent annual.ly. If thlesee es tiLtes are approx'L LatelCy- corL Lab L - LoUC pi _ uc=i

tivity rose by over 4 percent annually.

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76. Guatemala's industrial outlook changed radically with the creationof the CAC'M. Increasing tariff walls and tne rapidly expanding opportunitiesof a much larger market where incomes were rising rapidly as a result ofexport booms during part of the decade, ontributed to Guatemala's rapidindustrial expansion in the 1960's. In fact, Guatemala was one of the chiefbeneficiaries of the integration process: new exports to CACM countries byfar outweighted imports diverted from world markets to often lower qualityand more expensive regional sources. As a result, Guatemala has rapidlyincreased its trade surplus with the rest of the CACM (see paragraph 183).Nevertheless, today industry is still in an incipient stage, productionunits are small (in 1969 only 106 factories or 8 percent of the total hadmore than 100 employees) and concentrate mainly on light consumer goodswhich require relatively simple production and management techniques.

77. In the past, private savings and reinvestment of earnings pro-vided the bulk of financing of investment in industry, while a considerableexpansion of commercial bank credit lent adequate support to satisfy theincreasing working capital needs. Bank credit grew in 1963-69 by 25.3 per-cent annually, with working capital requirements absorbing a rapidly growingshare of total industrial credit: 86 percent in 1968 against 61 percent in1961. Investment credit was mainly on extremely short terms: over 90 per-cent was for less than one year. Food processing and textiles absorbed thebulk of credit outstanding in 1967-68 (72 percent), in line with its sharein total production (76 percent). A study of the Banco de Guatemala on asample of manufacturing enterprises representing about 37 percent of manu-facturing production in 1967 suggests that the financial structure ofGuatemala's industry is characterized by a high degree of self-financing(the average debt-equity ratio is very low: 0.2 to 1), a satisfactoryliquidity position and a low share of investment in fixed assets (about 40percent on the average).

Prospects

78. Guatemala's industry has the potential to substantially contributeto output, employment, export diversification and the domestic aggregatedemand as well as production of inputs for other sectors, particularlyagriculture. But this would require a more active government support thanin the past to developing new sources for industrial growth, as some of thesourres which have nrovided most of the momentum - regional trade oftraditional consumer goods and national import substitution - may in thefuture show less vœonrnou growth- Tndustrial develonment will have todepend increasingly on exports to markets outside the CAGM and, in thelongeer run, on expanding domestic markets hb increasing Pffpctivp demand(see also paragraph 63). Meanwhile, further import substitution will haveto sncrelesand- toncsntretd on r roec ohmich v ri sbnli tite tint eratdomre-of scales and thus need for their economic viability the integrated re-gional market.

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79. The Government policies which are needed to increase the skilland productivity of manpower through better training, to help improveentrepreneurial skill and to broaden the domestic market by graduallyintegratingZ the subsistence sector would also foster social developmentand thus help to reduce the present inequalities in Guatemalan life.

80. The Central American Common Market is likely to continue to pLayan important role in the development of industry during the 1970's. To theextent thal: the member countries will be able to reach agreement on thelocalization and regulation of types of production which are sensitive toeconomies of scale, the further exploitation of import substitution possi-bilities at: the regional level could substantially contribute to decreasingthe import requirements of the region and each member country. The mostdifficult obstacle in the nast to establish industries of regional scoDehas been the inability of the CACM countries to reach agreement on thelocation oi these industries for which the market can only sunnort oneproduction unit. In some cases (e.g. refineries, tire production) a sub-stnntial waste of (often domestic) resOUrCeS ocriirred since several nrodiuc-tion facilities were established and are still producing inefficiently. Inother rasesc where one factory had heen estahlished in the regionn therezwas considerable reluctance by other member countries to buy the products,which led Et times to buying several years of suppnnl, of the nroduicts froumthe major foreign suppliers just prior to the going into operation of theregotnn-al "t'l-nto Mawu imnnrt all ct4Ftvlinn nrno4hilAtiaoQ will hntto 1n hazregInalplat. NwImortsubstitution possibilitieswIlhvtobstudied carefully if Central America is not to be saddled with an ineff:Lcientindustrial structure protected by high tarL4ff walls and catering to a smnn11integrated market of about 13 million people with a per capita income ofabout $300 whinich expands at about 5 percent annually. Th.e most promi4ne,tamong the identified regional projects - some of which may be located inGate.mala -- include furni ture and wooden boxes, glass, electrical, mechlni-cal and light mechanical equipment. But development of these industrieswiLll largely deper.d on the ab lit. ty ar.ld willingness of the Central A- .eri -

countries to agree on a regional industrial policy which, in addition tolocation, w Aould also have t-o deal w4 thother crucial issues such a t2ar 4:f f

policy, taxation and special incentives for extra regional exports.

81. By providing room for competition, the Common Market will continueto sti.ulate productivity Jincreases in sectors in which econom,ies of scaleare irrelevant and which cater mainly to the domestic market. Th:Ls processwill also be essential to enhance m.anagerial skills and commiercial aggre.ssivity, thus helping to overcome two of the main constraints for Guaternalanindustry to compeIte on III_ L Autid Cer.tral t1I,,eicLa. A recent sLudy

suggests that the total value of imports from third countries which would besuiLtabULe f1or UouestiLc prouuctiLon, giLven thLeiLr siLmp'le pruucLL proncess andUtheir insensitivity to economies of scale, amounts to some $20-25 million,

- 26 -

less than 4 percent of 1969 manufacturing production. 1/ The most importantamong those are processed foods, cotton textiles, leatner, salt, paper,glass containers and hand tools. While domestic demand is likely to continueto account for the bulk of demand for industrial production in the 197/0s,with the drying out of additional import substitution possibilities its rateof growth is expected to be below that achieved in the recent past.

82. Since the domestic and regional markets-alone will not providesufficient momentum for industrial production and exports to grow at therate necessary to overcome the employment and balance of payments problemsforeseen in the mid and late seventies, Government policies will have togive increasing emphasis towards developing industries oriented towardsmarkets outside Central America. Promising possibilities are offered byforest products, canned fruits and vegetables and, possibly, textiles.These lines of production would be based on resources which Guatemala hasor could develop easily. In general, Guatemala will find its best oppor-tunities in developing export products characterized by both high laborinputs (taking advantage of the prevailing reasonablv low wage rates, andthe supply of trainable manpower) and locally produced low cost raw material(e.g. wood, fruit and vegetables). In addition, supply conditions arefavorable for exporting products such as cotton textiles and clothing, asintraregional competition has been fostering the establishment of modernand reasonably efficient plants in these branches. But prospects for worlddemand of these products as related to production costs in Guatemala haveyet to be assessed. They should take into account, particularly, the com-petition from other areas such as the Far East, where wages are consider-ably below those prevailing in Guatemala. Moreover, import policies insome of the major prospective markets, mainly the U.S., may be a seriousobstacle.

83. As of now, the most serious handicap to carrying out a vigorousindustrialization policy is the lack of efficient institutions which canassist industry in undertaking the necessary studies and promotion of newlines of production, technical assistance to improve enterprise managementand organization, and export promotion toward markets outside CentralAmerica. Although a regional institution located in Guatemala - ICAITI -has done valuable work in some of these matters, its resources are limited.Important constraints on the supplv side within Guatemalan industry arelittle knowledge of world market possibilities, lack of prepared pro1ects,and scarce commercial aggressivity; in addition, there is considerablescone for improvement in nroduction orzanization and personnel management.

1/ See Table 8.1.

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There are still only few examples of transfer of technical and managerialknow-how from abroad through joint ventures. Little expertise of Guatemalaninvestors in dealing with foreign enterprises and fear of being unable toget a fair deal have hampered this process.

Policies for Industrial Development

84. Longer term industrial policies would have thus to focus on (i)developing new markets outside the CACM, (ii) establishing industries sensi-tive to economies of scale for the regional market (as part of a regionalindustrial policy) and, in the longer run, (iii) expanding the domesticmarket by increasing effective demand.

85. Import protection and exDort incentives. The creation of theCommon Market, the most important element of Government industrial policyin the nast; has resulted in increased orotection mainly for consumer goodsand their components, while duties on raw materials not produced in thereylon and capital remained at a relatively low level The overall levelof protection, however, is quite high. Recent SIECA calculations indicatethat thp Fxtprnal Tariff rpetil ti n an average tar ff ratr nf V2 nerepntcompared to 27 percent of the previous Guatemalan tariff. The averageeffertivp taFriff nrotetinn i4 miurh higher, estimated at some 70 npreent bvthe Planning Office. Moreover, in 1969 protection was substantially increasedwhen CtiA.enmala annlied the San Joae Protonrl, a regional measure to increase -

import duties by 30 percent.

86. H:Lgh tariff protection for some end products in combination withlow duties o,r duty exe 4rtons on raw .mterials or 4nterm.ed4ate goods (thus

resulting in extremely high levels of effective protection) has led to thebuild-up of some in4ustrIes, such as cosmetics and pha- -Aceuticals,1hich1contribute 'Little to value added and employment, but put a heavy burden onthe bOalance of payments (igh ih iport requirem.ents" and the ficsc "revenuelosses). Quite generally, there seems to be a need to streamline the structureof the extefnal tari.f having unIfo-m rates forbroad p cVnitt -gories according to economic criteria, instead of the present wide variationsfromJ product to produ t.

87. 'rIn orler to pus' ex-por-s 'or m-arkets outside Central A-erica,:L* I ILUL LU tOI ca ttL. 515 LC5r.L IJLO..tU tC,LA CC.~

may be necestsary to provide special incentives in the form of import dutyUrawUlack-s or other LiLscaLl UeviLces wLh.Lch WOUU tLenU L0t olffset thle preseLnt-

bias in favcor of national or regional import substitution. Ideally, theL.r-I. LVUULLLL J.t WVULU LIGVC LU a-L I JV.LIIL.Ly U&& 5U%Ll .IMCLDiCU;t O UUL UL L.LL.LA L

action by individual countries may well be consistent with the CACM treatyobligations. Export prom,lotion pol'c'es need to be further studied, includingtheir fiscal implications.

")0

88. Export promotion. Financial incentives alone, however, will notbe sufficient to reorient Guatemala industrial production towards new ex-port markets. The Government, in cooperation with the private sector, willhave to establish an efficient institutional framework to help the exportersell its products abroad. Foreign market studies, joint promotional efforts,financial assistance to trade mission and trade fairs and simplification ofthe administrative processes for exporters are just a few of the initiativesfrom which exporters could greatly benefit. Recent good experience withjoint Central American trade missions to develop new markets in Europe (e.g.for meat) point to a possible solution to overcome a crucial bottleneck.A joint Central American approach may be particularly indicated since oftenone country alone cannot provide the quantities necessary to enter a newmarket efficiently.

89. Existing institutions are not adequately equipped to carry outeffectively a promotion activity ot the above-mentioned type. The "Insti-tuto de Fomento de la Production" (INFOP), created in 1949 to promote pro-duction in a wide range of sectors (agriculture, mining, industry, housing,tourism, electric power and savings institutions), was bound to limit itsactivity to enterprise financing after the Government substantially reducedits support from 1954 onwards. Two recently created private investmentbanks (Financiera Industrial Guatemalteca, FIGSA, and Financiera Industrialy Agropecuaria, FIASA) are not in a position to carry out promotionactivities on a sufficiently large and sustained scale either, mostly be-cause they need to give in a reasonably short time an adequate remunerationto the private capital invested. The activity of industrial promotion couldprobably be executed much more effectively by an institution, financed bya share on tax and tariff exemptions granted to industry, and with substan-tially private management under a broad public supervision.

90. Fiscal incentives. 1/ In the past, the fiscal incentive policy hasbeen managed rather indiscriminately. In order to attract new industries,the Central American countries competed heavily by granting liberal taxholidays, with little regard for economic allocation criteria. The cost tothe fisc of such policies has been very high. The recently ratified, butnot yet operative, regional agreement on fiscal incentives would result inslightly less generous tax holidays than under the present system and wouldreduce but not eliminate this competition, since for an extended period itsadministration would remain in national hands. Several proposals are present-ly being considered among the CACM countries for a new less generous taxholiday policy. Another suggestion is that the foregone revenues should beincreasingly tapped by the Government to help finance either national orregional industria) development ba-kls.

-- 29 -

91. Industrial Credit. The major shbrtcoming in industrial financeis the lack of medium and long-term credit fo-r investment. In recent years

Guatemala received some $8 million in long-term official credit lines fromIDlB AID -4A rAlmPT T. F-n f ,,a,,.a ,--a-ml ll ,,4 11 an,.-4vo c .,n-

4A-nM-1

At' £1 X. X C lSLJ CA.. LJII LIt v. t =_ . CJaL LC.,t_..LLAVIAA A . C9

LAS A. C L t.taV oA.ttA aL,Z

higher level of this type of industrial financing, provided a successfulproject preparation and promotior: effort is carriec! out at the same time.The recent experience of FIASA, the private development finance company,suipports this need for long-term. funds. Out of soe40A plcainn-uvalent to Q 40 million it received in the last two years, it only approvedloans for Q. 3 r,-il:lion s4 - o-st-f- -4ro-cts were so badly prepared. A recent

experience in the setting up of some sizeable hotel projects also indicatesthat- th1e .aval]b t of41j- loca I Mt -aia is no cosrit -4rovA.ideLIla LII a L J. aU £1.4. Ly Ut .JO L A.J ~ %_,Y - .k L-CI.I. a I MIL -U IIO U A. CZ LIN A 1_ U V £UI= U

long-term loan capital is forthcoming. Since existing institutions, cominer-ciLal Ibanl", or pr4.atedevlo,men. bank -r -rsnl -o se -pt po'dcL L ULI M;5 UL 1JL 1. VCII L L UCVC_LUPiIi L UOLkr, 01. C TZ CP L I_tLL.Ly LLt)L setL Up LU PLIJ V-L.U"

long-term financing together with the necessary technical assistance, theproposeu tra nsforri ton of exlstLngi pubLic i.nstitutions intLL a uirki-pubLIc or

public industrial development bank would be an important first step.

92. Provided the above policies are pursued vigorously, industrycouldU con;:inue to grow at SoUie 08-9 perCent datLLUa.Lly oVerL Lith IlXL i.LVe

years, increasing slightly its share in GDP and making a substantialcont-ri'Dution to tne soluLion of the- en1ploy1ent puroblem.

B. Tourism

Recent Developments

93. Sofar, Guatemala's touristic potential has been little exploitedand the contribution of tourism to the economy has been very small, roughlyamounting to about one percent of GDP (compared e.g. with 5 percent inMexico). Available statistics show that the number of tourists has grownslowly in 1966-69 (3.8 percent annually on the average), reaching lessthan 200,000 in 1969, about half of whom must be considered as businessvisitors. The largest share of tourists in 1965-69 came from CentralAmerica (about 52 percent, including 24 percent from El Salvador alone).The U.S.A. provided about 27 percent and Mexico about 7 percent.

94. The major Government action so far to develop tourism was the es-tablishment of a tourism institute (Instituto Guatemalteco de Turismo -

N-LGUAT) and a fiscal exemptions law for investment in hotels in 1968. In1970, INGUAT had a budget of almost Q 650,000, a fairly substantial amountcompared with most countries. However, its past activity has been quite

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limited. A comparison of international air fares indicates that in spite ofrecent reductions in round trip fares, Guatemala remains more costly toreach from the U.S. East Coast than Mexico and much more costly than theCaribbean. Air services to Guatemala have been improved recently as newflights were inaugurated from Washington D.C., New York and Brussels (viaMontreal). The Government has constructed a new airport terminal whichcontributes to easier handling of increased traffic.

95. Since the early 1960's the development of attractive first-classhotel accommodation has failed to keep pace with the growing demand. Until1968, there was only one hotel meeting international standards. Its occu-pancy rate consistently reached 95 percent. There are now three hotels,for a total of 411 rooms, that meet first-class international touriststandards. Their occupancy rates are reportedly quite high. Of about 80hotels and guest houses in the country, with a total of 1,254 rooms in 1969.26 are located in the capital city.

Prospects

96. Guatemala's geographic and historic attractions, interestingfolklore, pleasant climate and its proximity to the United States gives itan unusually good tourism potential. Variety characterizes the land, in-cluding various climatic zones. active volcanoes, mountain lakes, ruggedmountain ranges of up to 11,000 feet in height, green fertile valleys,dense forest and sandy beaches. There are excellent hunting areas: achoice of deep sea fishing grounds with tropical game fish, and fresh waterfishing The countrv has now good direct and non-ston internationnl air ron-nections and is linked to the other Central American countries and Panamaby an extensive network of reginnnl and intern2tionnl airlinpe and pavedroads. Increased earnings from tourism could play an important role in anrogavmn to Aiveursifu rvnemn1n'c aynnrt hasC to cnnp with thep hnlnce of

payments problems foreseen in the 1970's (see paragraph 195). But in orderto exploIt Guatemnla's excellent tourist potential fully, private and publIcactions will be required. Most important will be the expansion and improve-ment of hotel capacity together with a strong promotional effort in themajor markets. There are three known projects for increasing first-classaco.oa,t,a on in %uate mala City, wi.h would add some 400 first-class rooms.Additional hotel capacity elsewhere in the country (Lake Atitlan, Chichicas-tenangol woud.u prob.abJly h.-telp tjo prolong the average duratlon of tourt.L visits which is now only 3-4 days. Public investment is contemplated atpresent to (i) i[-,,prove the airport anL u build roadu anlu otLLer .frastructure

to establish a national park at the Mayan ruins in Tikal and (ii) tobuild a new archeological museumL in Guatemala City. INGUAT plans to spend$250,000 annually in 1970 and 1971 to launch a major promotion campaignwnich, together with the substantial adverLising budgets of 9uome of Lte

international hotel chains, should be adequate. Finally, lower airfarescould provide an important additional incentive to promote eourism inGuatemala. Extending the landing rights to more than one airline servingthe U.S. market may be necessary to provide for sufficient competition tobring airfares down.

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IV. PUBLIC INVESTMENT AND FINANCE

A. Public Investment

Past Performance

97. During the 1960;s Guatemala;s public investments never exceeded

2.5 to 3 percent of GDP and fell short of the country's basic needs ineconomic and social infrastructure. In the mid and late 1950's the public

sector had carried out a major development effort and recorded at least one

major achievement: the opening up of the Pacific coast, the most fertilieregion in the country. During that time, public investment reached some 5

to 6 percent of GDP. Inadequate project preparation as well as lack of

public savings were subsequently the main obstacles to a higher investmelntlevel. Considerable progress has been made more recently with regard to the

former. Several sectors, including transport, power and housing are nowmuch better equipped to prepare and to execute sound investment projects.A major effort has been made in building up a much larger investment and

foreign borrowing program. But so far, this has resulted in only slowlyrising investment levels, since the lack of domestic resources has continuedto be a major obstacle.

98. In 1960-69, transport and power accounted for over half of totalpublic investment. In transport, resources were concentrated in buildingthe arterial road network and increasing port capacity on the Atlantic sLde.Recently, major efforts were made to build up the country's power generakingand distributing capacity, largely as a result of relatively large Bank-

financed projects. Investment in social infrastructure - e.g. education,health, housing, water and sewerage - was very low during the past decade,accounting for merely 20 percent of the total. Investment in educationalfacilities was particularly inadequate, given the country's backlog of needs.

Table I: PUBLIC INVESTMENT BY SECTOR, 1961-1969(In millions of quetzales)

1961-65 1965 1966 1967 1968 14Q6AnnualAverage

Agriculture 1.9 3.5 2.7 4.5 1.6 4.1Power 1.4 5.1 4.5 4.7 8.2 8.7Transport 10.3 13.9 7.3 10.2 11.4 13.4Social Sectcors 3.8 7.0 6.6 12.1 8.7 7.13

Others 6.0 6.3 6.7 5.7 6.3 7.8Transfers tc private

sector 7.2 4.3 5.6 4.1 3.3

Total 23.4 43.0 32.1 42.8 40.3 45.1

Source: Ta,ble 5.13

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Required Future Investment Levels

99. If Guatemala is to achieve the urgently needed broadening of itsbase for development, public investment will have to rise considerably.A major public investment effort is required to support export diversi-fication and increase the production of domestic food crops. Thediversification effort - which would imply channelling credit to the pri-vate sector, in part through public institutions - would also requiresubstantially higher infrastructure investment, mainly in feeder roads,storage facilities, drainage, irrigation and power. Equally importantwould be to raise the levels of social investment to keep up with therapid rate of population growthi and to improve the present extremely pooreducation, health and housing standards.

100. The outgoing Government recognized the need for an increasingrole of the public sector in Guatemala's development process. In the courseof the last year the Planning Office, in close cooperation with the agenciesand ministries carrying out public investment, produced an investmentPlan for the period 1971-1975 (Plan). Its major objectives are to supportdiversification of exports, increasing the domestic market by gradually in-tegrating the subsistence sector and improving the social infrastructure.The main components of the Plan are a public investment program and detailedproposals, including draft legislation, for the organizational and institu-tional changes necessary to carry out tne investment program. The Plan isa highly operationally oriented document, wlhicth provides an excellent basisfor launching a more vigorous public investment effort. It contemplates anincrease in direct public investment from Q 56 million in 1970 and Q 68 mil-lion in 1971 to over Q 90 million by 1975. This includes financial invest-ment and credit lines to productive sectors of some Q 10 million annually,as against present levels of around Q 4 million annually. It also callsfor significant changes in thie structure of investment; agriculture andthe social sectors would account for a considerably higher share than theyhad in the past (see Table II, below). The new Government that took overin July 1970 has fully endorsed the Plan and has adopted it as his ownblueprint of development.

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TID IeT TT :PTBLI r TTM T.NT, 1971-1976

(In millions of 1969 quetzales)

1971 1972 1973 1974 1975 1976I II I~ II~T I II III I -- II II

(1) Direct Investment

Agriculture 7.8 9.3 9.2 9.3 12.0 11.6 13.9 11.7 15.9 15.4It '1 I~ - It ' 1 JI fl Lfi fl I4 - I In 0 fLO J In 1Transport ;6.3 14.i 16.2 15.0 13.9 14.3 16.5 18.2 .5 1

Power 6.1 6.1 9.3 9.3 12.4 12.4 12.5 12.5 9.7 9.7SocialSector 19.9 19.9 19.8 19.8 21.4 21.4 22.7 22.7 21.9 21.9

Others 18.4 13.6 19.5 15.8 21.1 18.2 20.7 17.1 23.1 io.o

Subtotal 68.5 63.6 74.0 69.2 80.8 77.9 96.3 82.2 93.1 85.2 90.0

(2) Credit lines and other transfers to private sector

Agriculture 9.1 9.1 7.9 7.9 8.2 8.2 7.2 7.2 6.3 6.3Industry 1.5 1.5 3.0 3.0 3.0 3.0 3.5 3.5 1.5 1.5

Subtotal 10.6 10.6 10.9 10.9 11.2 11.2 10.7 10.7 7.8 7.8 8.0

Total 79.1 74.2 84.8 80.1 91.9 89.1 96.7 92.9 100.3 93.0 98.0

Source: Table 5.14 and I = Plan, II = Mission Proposal.Planning Office

101. The investment Plan represents a major departure from pasttrends, but, with the exception of municipalities and "other" sectors, wherethe proposed increases in investment appear too high compared to past pro-ject execution, the proposed investment levels appear to be largely-withinthe foreseeable public sector's administrative capacity. However, in somesectors such as agriculture (see paragraph 68), important institutionalchanges would have to take place in order to carry out a higher investmen.tlevel. Furthermore, in the initial phase of the Plan (1971-1972), a largeproportion of the proposed investment - e.g. in health and education - con-sists of either ongoing projects or projects which are in an advanced stageof preparation. In order to keep up the expansion of public investmentbeyond 1972, however, the present efforts of project preparation would haveto be further intensified. Since the Plan is largely consistent with thepresently identifiable lending programs of the external financing agencies,there should be no difficulties in continuing the present close cooperationwith these agencies in carrying out the necessary preinvestment efforts(see Annex 3). In its public investment and financing projection the

- 34 -

mission generally follows the Plan, except for municipalities and "other",whIere a lower rate of4 execution- wa -asumel,. As a result, the st gse-te

investment program would be about 5 percent lower than the Plan

10.2. lra.isport was by f'ar the si.ngle mi1ost important sector of pastpublic investments, reaching a high of 70 percent of the total in the latefifties. its share fell to some 35 percent in 1965-68, more than four-fifths being accounted for by road construction. Guatemala has during thelast 20 years undertaken a major effort to develop its road transportation

system, and the road system now reaches all important centers of production

and consumption. Guatemala?s trunk road system inciudes: (i) the Inter-

american Highway (CA-1), which extends from the Mexican to the Salvadorian

frontier passing through the Central Highlands and Guatemala Clty; (ii)

the Pacific Highway (CA-2), which crosses the Pacific Coastal plains;

and (iii) the interoceanic Highway (CA-9), which connects the Atlantic ports

of Santo Tomas and Barrios and the Pacific port of San Jose, passing through

the capital, and wnose northern portion is known as the Atlantic Highway.

All three of these major highways are paved, except for less than 100 kms

of the interamerican Highway near the Mexican frontier where work is now

in progress. Two additional regional paved highways (CA-8 and CA-12)connect Guatemala with El Salvador. A recently paved highway (CA-]O)connects Guatemala with Honduras. In 1970, the first road link connectingthe country with the northern part of the Peten was established, going fromMorales to Flores.

103. Guatemala's railway network, which is the most extended in CentralAmerica - more than 500 kms - has branch lines from the Atlantic to thePacific coast and from the Mexican to the Salvadoran borders. Since 1960,the railway has experienced an almost continuous decline in its freighttraffic mainly as a result of the completion of the Atlantic Highway (CA-9).The railway was privately owned, but was nationalized in 1968. An expansionprogram of the port of Santo Tomas on the Atlantic coast has recently beencompleted. The capacity of this port, together with the capacity of PuertoBarrios, should be sufficient to meet the needs on the Atlantic coast fora relatively long period of time. On the Pacific coast, however, there aretwo ports with insufficient capacity, San Jose and Champerico. A study ofthe feasibility of constructina a new Pacific port is under way. As toairports, the country has in general adequate facilities.

104. The lack of main trunk roads is no longer a basic constraint tothe economic development of Guatemala. Substantial improvements will,however, be necessary in the future in the national transportation system,if it is to provide adequate service at a reasonable cost. Major emphasisshould be given to build secondary highways and feeder roads. There arestill large potentially rich areas in which no real development can takenlace because of the absence of road connections. An extensive feederroad program would be an integral part of the agricultural development inth' 197n's (see paracrnnh 72).

- 35 -

105. In order to avoid a rapid deterioration of the highway system,adequate maintenance funds will have to be made available in the future.Highways in Guatemala are now inadequately maintained. The mileage ofroads has increased gradually over recent years and the number of vehiclesusing the roads has grown even faster. A new maintenance program is, atpresent, under consideration.

106. More coordination will be needed in Guatemala's transport system.Transport facilities are often duplicated without an economic distributionof traffics between the competing modes. Thus, the railway, which in itswhole extension runs parallel to paved roads, continues to compete acrossthe entire range of traffics rather than concentrating on the longer distancebulk hauls where it has a relative cost advantage. Tariffs have noDt, in thepAst, reflected costs and the railways have experienced substantial financiallosses. More recently, after it had been taken over by the Government, somerate adjustments have been introduced, traffic has picked up and the financialsituation has somewhat improved. But there still appears to exist a problemof uneconomic branch lines which should be studied carefully, particularly inview of the considerable investment in dieselization which is contemplated bythe railroacl. Future investment should be concentrated on the development ofservices and facilit:4es where rail has an obvious economic advantage oveir roadtransport.

107. IThe proposed transport investment program amounting to some Q 30millinn or ahniot 20 nprrpnt nf dirert 4nupetrmnt in 1971-7S would .adPntieP1ymeet the cotntry's transport needs in that period. Most of it would be Eorroads.

108. Power. The Guatemalan power market is presently divided into Four

regions: Central, Western, Eastern and Atlantic. Electric consumption inthe Central Region accounts for about 80 percent of the country's totalconsumption. Guatemala City is the load center in this region which cor:res-nonds to- the -o,ncsion area of Epresa Vlctr-4n An deGutemala (EEG), a

privately owned company which distributes power in the city and the adjoiningprovinces. By mAid 1970 total 4nstalled capacit 4n the Cnftral Reglonamounted to about 160 MW out of which some 30 percent pertained to EEG. There,maining .t 70Lj percent is owned by t' Ihe Tnslttuto Nacilonal de Electrificacion

(INDE), an atutonomous Government agency.

109. In the outlying regions, installed capacity is about 30 MW, ofwhi 4ch ab-out On percent is own^e Ab1y "TE ,.m plans to intercor.nect theW1I,L II uu L U.J Lw L.C L 40~ WLu uy LIJt* fLAtIL, jJLa LJ LlLL JULI. U LI

Western Region with the Central system in 1971, and the Eastern Region oneor tLwo years Later.

I I A Tll'I V -_-I-J_t__ .J J _11 ._-__X L __ _ .LLL. Wirlira, WII.LLLI wan LI. e:±LI L7J7 1b -L -,UILU.Le o tjU LL LV.±UJI&IIL

of Guatemala's electric power resources. In the last few years INDE hasincreased ILS generating capacity rapidly, asslsted by two IBRv loans

amounting tc a total of US$22.5 million. INDE has also made considerableefforts to improve its Lecnnical capacity and administrative and accounting

- 36 -

practices. At present, INDE is the regulatory agency in Guatemala, butarrangements are being made to create an autonomous agencv.

111. Demand for Dower is expected to grow at an annu,al rate nf 12percent in the next decade, as has been the case in the last decade. Tomeet this demand TNDE has nrenared a nreliminarv expnnRsnn nrnoram fnrthe period 1966-80 which includes generation, transmission and distribution.The aeneratinn nprt nf this nlan incluides nrinrinpally the differe-nt- st-agesof expansion of the hydro-power project of Atitlan (for details see listof new pro4ects frv exvernal financing). 0wing to delays in this project,however, it is likely that an interim thermal expansion will be needed in1973-74. The nlnn also 1c oenrs the transmission lines and distribut-on

networks and includes a rural electrification program. The objective istor sln117y electpri eneragy to 09 p,evrcent of the population by 190.P

112.* Tn,'o complement the present expanslon plan, and wilh a view toimproving efficiency in the power sector, special attention will have to begiven to:

i. further admin4-strative and techni.al i..provem.ents of INDE;

iiAfr.m.ning up the expar.sion program, for 1901=80 and pre=

paration of a long-term expansion plan covering the periodb-eyornd 1980;o

iiiJ. inter-connection possibilities with other Central reia..LiI. * .LL L )LLL LJ L pt ~ AL.L. L.L n WA L II ULIL _.~I L dl C'IILICLI;L

countries and with Mexico;

iv. tariffs policy;

v. possible purchase of EEG, since the Government has theoption to dUo so when rEEG's concession expires, in 1972.

113. Telecommunication. The national telecommunications systemincludes at present 43,000 automatic lines in eight principal cities, ofwhich 39,000 lines are located in Guatemala City; also about 1,500 manuallines are operated in 400 small towns or other isolated population centers.

114. National long-distance systems mostly consist of open wire linesand are used between Guatemala and only five provincial cities. Telegraplservice is provided rather extensively but is manual and obsolete.

115. International communications are satisfactorily operated but onlyGuatemala City and a few other cities are serviced with international tele-phone, telegraph and telex facilities.

116. The demand for public telecommunications, in particular telephonelines and long-distance communications, is far from being met. In GuatemalaCity alone, there is a registered demand for some additional 25,000 lines.

- 37 -

Long-distance service is inexistent for many distant or isolated places ofthL"e country and so.ue private connection sy-stems are being devloedto e.edthe lack of facilities. In view of the present critical situation and thieeconom,Lic bteniefitLs whicht would ariLse fLror. an adequate- telecommunr.nic ati on.-;system, high priority has been allocated to this sector in the public Ln-

_~~~~~7 _ a__t7r t C1.:_ _ -1 - __C ___I :1__ _£zC r)nfvestmenit pula l9 1.-/ J . 1l.Lb p.LdLI tLIVlbdt8S LLLU £LLY LdL1.LdL1L 0 1 Ul JJ, UVV

new automatic exchange lines and local networks. Basic long-distance routesand associated interurban nonswitching equipment for links between thecapital and about 12 main provincial cities would also be built to meei: theessential requirements. Tie Government has requested IBRD's financialassistance for this expansion program.

117. The crucial issue yet to be solved, before going ahead with anymajor expa-nsion, is the institutional aspect. At present there are twooperating departments: (i) the Directorate General of Telecommunications(D(tT), a ciepartment of the Ministry of Communicatons and Public Works,which is in charge of national telephone and telegraph operations; and(ii) the Empresa Guatemalteca de Telecomnicaciones Internacionales (GUATEL),a Government owned autonomous agency, which is responsible for all intier-national services and domestic telex facilities. The Government is nowfostering a merger of DGT and GUATEL into one autonomous public entity,which would be run on commercial principles. The new entity would beresponsible for all national and international telecommunications serv:icesand the telegraph services would be incorporated in the national postaLsystem. These changes would be an important factor in ensuring the successof the expansion program.

Education

118. One of the major obstacles to development of the Guatemalaneconomy is the high degree of illiteracy and low level of training of 'thelabor force. Over 60 percent of the working age population (7 years andover 1/) is illiterate and the average education of the remainder is low.In 1966 less than 3 percent of the employed population had at least asecondary level education and only a further 8.5 percent had completed theprimary level. A significant improvement of the average level of formaleducation is a key element in a policy to broaden Guatemala's longtermdevelopment base and to improve the quality of life of large parts of thepopulation. The new government is firmly committed to achieve this improve-ment.

1/ The official census defines the labor force as the population aged 7years and over. This contrasts with the standard internationaldefinition which refers to population of 15 years or more. Some LOpercent of the economically active population in the 1964 censusreference period were aged 7-14 years.

119. The present school system does not have the physical capacity tocope with the nominal der,marind. Primary education is obligatory, but in 1968less than one-half of the age group (7-14 years) was formally enrolled andthe effective enrollment ratio I/ was only 0.37. During the 1960's enroll-ment increased at an annual rate of 6.3 percent; in 1968 there were almost200,000 mOre pupils than in 1960. Despite tnis increase in tne volume orenrollment, the quantitative deficiency of the system in the rural areas isstill staggering. In 1968, only 30 percent of rural chnildren were enrolledin primary school compared to 78 percent in urban areas - more than 500,000school age children in rural areas were outside tne scnooi system. iTestudent/teacher ratio ranges from 14 to 100, with a national average of38:1. In 1968, 71 percent of rural primary schools and 8 percent of urbanschools did not offer instruction beyond Grade III. Whereas 79 percent ofurban schiools offered the complete primary cycle in 1968, only 8 percent ofrural schools were fully equipped.

120. Serious weaknesses exist in the quality of primary levelinstruction. Over the period 1970-74, the Ministry of Education intendsto spend Q 13.7 million on a project, involving extension and improvementof primary education, partly tfnanced by AID. Essential teatures ot thisproject are the development of new curricula; revision of textbooks: in-service training of teachers; experimentation with teaching methods; andthe completion of rural primary schools. Especially in rural areas, thepresent system does not seem to be adequate to equip students to face theproblems of daily life. This factor, plus the small proportion of ruralschools which offer instruction to Grade VI, explain the low retention ofthe system. Less than one-fifth of the 1963 national cohort reached GradeVI; and only 2 percent of the 1960 rural cohort survived to the final grade.

121. At the secondary level of education the salient problems are alsonarrow coverage of the student population, unbalanced syllabus, shortage ofadequately trained teachers and neglect of the rural areas. On the averageonly 26 percent of cohorts entering secondary school in the period 1957-63completed the diversified cycle (final three grades). The school systemprovides less than 2 percent of the school age population with middle levelinstruction in specific skills (primary school teaching, commercial, agri-cultural, technical) or in arts and sciences. The general official neglectof secondary education has been one of the major reasons for the rapidgrowth of the private schools which have increased their share of enroll-ment from 25 percent in 1950 to an average of 50 percent in 1967-68.

122. An appropriate modernization and expansion of the educationalsystem in the 'seventies would require the revision of teaching methods;increased supply of adequately trained teachers; and rapid expansion ofsecondary school places in the public sector. An ongoing proiect partlyfinanced by the IBRD includes a new secondary teachers school which will

1/ The ratio between average school attendance and the total school-age

population.

- 39 -

graduate 300 new teachers and provide in-service training for 75 teachersannually from 1974. It 4>s expected that this program would contributeabout 85 percent of the new and 50 percent of the retrained personnel re-quired to fulfill the objective of a fully-qualified secondary school staffby 1980. The availability of suitable teachers is a major constraint tothe re-structuring of secondary education. At present only one percent ofsecondary school teachers are formally qualified and a further 2 to 3 per-cent have a university degree in s(me other discipline.

123. University level education is dominated by the University of SanCarlos. where 81 Dercent of all university students were enrolled in 1968.The first of three private universities was established in 1962. Enroll-ment is heavily concentrated in the faculties of economirs, law andhumanities which together accounted for 61 percent of all students (exclud-ing the ronmon general studies nrogram) in 1968. The Rvytpm of highereducation is inefficient in as much as only 13 percent of students everaradtiate,

124. The two nartlv ATD and TIRT finanrpd nrniprt-s acriont for rougnly95 percent of planned investment in education. When fully carried out, thesepro4ects should have a signififcnt imparct onn the scope and character of for-mal education in Guatemala. Tne IBRD-assisted project will provide 14,700now nlaic cmpared w.it-h a t-ota1l enrollrmnct 4n 1Q6R of 9, 7580 4 -lnp 1,

schools; and the teacher training school will graduate 300 additionalfullv-qualified teachers per year compared to a total of 1,467 teachersin public schools in 1968. To support the educational policies implicitin, theose - 4oCto, current education expenditures tw11 have to grow even

more rapidly than in the past; from a growth rate of 7.4 percent per yeartLtL.S * . *-t, 'Jv V J-L J LO I LOt. 5157 & V} a ,-- -V *- j t .X CJ. L 7 w a L US LW CLI .LJ .' SJ V/Total budget expenditure on education will be much higher than in therecent past. * ,iere is, mt.oreover, a need for closer attention Lto vocationalinstruction, where only 5 percent of students at the secondary level areenrolled annd1 whi-ch is -le only form.al m.eans of equipping the potentialenroJ.~u CLU W11L ± L &-&LI UL

7A.LI L UIJ I~L3 Ii ULp £L~ LIL ~ jJL~ LL.L

labor force with essential technical skills. Some further increments ineutio .nal. expen-14l*4.J.e t ur- i e , aAA4LA 4 LUn . . A t othos A4U aA Ive maUC 0L-. '.

necessary.

Health

125. Guatemala's infant and general mortality rates are among the high-estL in thLe wtes tLe rn hemisphee;al C.,1ost 6L0) percLCent of 81l dUeaCths are record jedUUin the age group 0-14 years; and life expectancy at birth is only 49 years.

I arge decline in the death rate is possible. In l1966, .wo-thirds of al.lIn L U L.L L .11 L.LI U CLAL L. L .i.C ~ LUL) . LIJ7O ~L.L L UL DUIU dIWLl.

deaths were caused by diseases which are either water-borne (typhoid, para-typhioidLU, dysentery); or the spreadu ofL which (Udarrheal dUiseasesi couLdU bU

controlled by the use of purified water to maintain a high standard ofpersonal anu UomestiLc cleanliness; or buy ud'seases (krespiratory, malaria,tetanus, measles) which could be prevented or cured fairly easily. Therate of incidence of enteric infection and related illnesses in Guatemala

- 40 -

is due to the poor quality of water and sewerage service in both urban andrural areas. In 1969, 86 percent of the urban population, and only 10 per-cent of the rural population had easy access to pipe-borne (but not neces-sarily potable) water and only 20 percent of the total population is esti-mated to have proper sewerage disposal facilities. An effective program forraising the general standard of healtlh in the community depends on theavailability of suitably qualified medical staff (doctors, nurses, sanitaryengineers, etc.) and the provisions of adequate physical facilities (hospi-tals, health centers, etc.). The number of general hospital beds perthousand population is 1.7; there are fewer qualified nurses (710) thandoctors (1,200); and resources are heavily concentrated in Guatemala City.

126. The 1971-75 public investment plan involves annual expenditureof Q 11 million in the health sector, compared with Q 4.2 million achievedduring 1965-69. The three main projects (the first two are partly financedby the IDB) which account for approximately two-thirds of planned investmentexpenditure are: the Xaya-Pixcaya water supply project, estimated to costQ 24 million and planned to serve Guatemala City and several small cities;a rural water supply project (Q 11.6 million) which involves the construc-tion of wells and aqueducts in one hundred communities and a general hospi-tal in Guatemala City for Q 6 million. All these projects are already underexecution. There are several smaller projects which cover construction ofsmall regional hospitals, purchase of hospital equipment and construction ofsewerage systems. Owing to the impact of programs included in the plan,current expenditure on health will have to grow at a higher rate (some 13.5percent per year).

127. Although the plan contains a chapter which broadly discusses thehuman resources required by the proposed development effort, neither thehealth nor the education plan specifically provide for an increase in theoutput of medical personnel. About 70 doctors graduate each year from theUniversity of San Carlos and the school of nursing produces 30-40 trainednurses annually. At present the rural health service is largely run by nurses'aides whose training does not equip them for such responsibility. Thefamilv nlanninQ program and the effective operation of rural health centersshould severely strain existing capacity, therefore some deliberate effortwi11 hp needed to increase the suinnlv and imnrove the regionna distrlhiitinnof staff, especially of fully-trained nurses.

128. A viable long-term policy to improve conditions of health shouldemphasiz preventive mpdicrinpe An imnnrtant element of siich n nolircv i4

the development of a cheap, readily available, balanced diet. The highrate of infant mortality suggests that there is widesoread malnutritionand under-nourishment which intensify susceptibility to other diseases.Th"le ty-ical Guatem.alan di-et is b-ase-d o-n m-aiZe ar.d beans but contains 14ittle

milk, eggs, meat and other high-protein foods. There is a substantialmalnutrition, i.e. defiLciency of protelin, vit.ami4n f anA riboflav i4n, as we'llas undernourishment, i.e. calorie deficiency. The'Instituto de Nutricionde t-.eLitro 'Anmerilca y d.laLaa (INCA,P estimates thlat not even l. Guatemala

- .1 -

City does the average daily calorie intake reach the recommended diet forchildren aged 7-9 years.

Housing

129. The National Housing institute (INVI) and the National institutefor Agrarian Reform (INTA) are the two public sector agencies charged withthe planning and execution of housing programs. INVI concentrates itseffort in urban areas (mainly Guatemala City) and INTA in the rural areas.In the last three years INV! has completed 6,471 houses while INTA was onlyable to build 214 houses between 1966 and 1968. The organized private sectorcompleted houses at the rate of about 3,200 per year during 1964-67.The results of the 1964 Census show that almost 80 percent of all dwellingshave no more than two rooms and the average occupancy rate is 5 persons perdwelling. Most houses (81 percent) had only one bedroom, and almost one-half(44 percent) had a single all-purpose room. In addition to severe over-ctowding, many houses do not have adequate water, sewerage and sanitaryservices. Given the projected high rate of population growth, the existingstock of deficient dwellings and the annual replacement requirement, it isestimated that Guatemala would have to construct at least 33,000 housesannually (20,000 urban and 13,000 rural) in order to eliminate the deficitin 30 years. Without clearly specified standards, it is not possible toassess the validity of this estimate, but there undoubtedly is scope for asubstantial increase above the houses per year constructed in recent years.

130. In 1961, the Government established the Insured Mortgages Develop-ment Institution and reformed the law governing savings and loan associa-tions in order to incorporate them fully into the mortgage insurance sys-tem. The operation of this credit sector remains relatively small, butmay well meet the effective demand for middle-income housing. The invest-ment plan envisages a program of Q 6 million financed in this way, involvingthe construction of 1,328 middle-income houses. In addition, INVI wouldconstruct 5,850 lower income houses in a Q 16 million program partly fi-nanced by IDB. The projected new construction is at a substantially lowerrate than may be necessary to stabilize the deficiency in the housilg sector,especially among the poorest. However, INVI could not probably incr-ase itsfinancial resources and improve its physical capacity substantially in theshort-run.

B. Financing Requirements

Recent Trends

131. Public savings in the past provided financing for a relativelylarge share - about 50 percent of (the low) public investment. T'otaldomestic contribution to the investment program, including borrowing andcapital receipts, amounted to about 75 percent. However, the net foreign

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contribution increased sharply during the last few years rising from 7percent in 1965-66 to about one-third in 1967-69, reflecting Lhe Government'spolicy to step up the utilization of foreign loans. In fact, over the lastthree years the overall public sector deficit was largely financed fromabroad (see Table III, below). Gross foreign borrowing was more than doublethe net borrowing, because of the high level of amortization payments,largely a consequence of the substantial short-term non-project borrowingof the Government from U.S. banks. As a result, Guatemala's external debtprofile deteriorated in recent years (see paragraph 186). Domesticborrowing in the past mainly took the form of credit from the banking sys-tem (primarily Central Bank) but, with the exception of 1966, creditexpansion was only modest. Borrowing from the private sector through thesale of bonds was insignificant and declining in recent years (see Table6.5).

Table III: FINANCING PUBLIC INVESTMENT, 1965-1969(In millions of quetzales)

1965 1966 1967 1968 1969

Total public investment 43.0 32.1 42.8 40.3 45.1

Financed by:Public savings 29.1 16.3 12.3 20.7 27.5Domestic borrowing, net 8.1 14.7 7.9 -0.5 0.2Foreign borrowing, net 4.7 -1.0 18.9 12.2 13.7Capital receipts 1.1 2.1 3.7 7.9 3*7

Source: Table 5.1

Financing the Plan (1971-76)

132. To finance the investment levels identified in paragraph 99-101,above, Guatemala should be able to borrow over £he next 6 years some Q 250million from abroad. This would require, in addition to the existingpipeline of undisbursed foreign loans of Q 64 million, disbursements fromnew loans amounting to some Q 186 million. These borrowing levels largely

coincide with present lending expectations of external agencies. The Planassumes that present practices of non-proiect borrowing would be discontinuedby 1972, thus restricting foreign borrowing to project loans, the bulk ofwhirh would be long-term. If this takes place, it will be an important

positive element in establishing the future capacity of Guatemala to servicedevelopment loans. The cost--sharing for externally financed proiects impliedin the Plan is consistent with present policies of foieign lenders in regardsto financing of local currency exnPndriitrPs The grnss foreign cnntrbittionto the investment program would amount to 47 percent of total project cost

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and the net to about 29 percent of it. lHowever, since no foreign financingwould be attachable to about one-fifth of total investment, the external(gross) contribution to the financed projects would be larger, amounting toabout 60 percent, compared to an import component of these projects of 50percent. With some furtlher effort on project preparation, additional proiects(mainly for the municipalities) could be submitted for external financing.For the viabilitY of the program it is crucial that most of the new publicb6rrowing be long-term, including some of it at concessionary terms. Other-wise, the resulting debt service burden will become excessive, both from abalance of payments (see paragraph 201) and a fiscal point of view. Ifthese conditions are met, the debt burden to the fisc would remain high butmanageable, absorbing some 9 percent of projected public revenues by 1_976aoainst almost 11 nercent in 1970.

1,33. AgsiAming that external financing is fortheoming at the above -levels.the total domestic financing requirements can be estimated at some Q 340 mil-linn for thP six-vePr neriod inerensinp from 0 43 million in 1971 to 0 70

million in 1976. Actual domestic financing in 1969 was around Q 31 million.If pubhlir ssings were prorected on thp hebis of thp Peicting taxc ratf!s andadministration, they would decrease from Q 26.6 million in 1971 to Q minus0.9 millinn in 1976. Hence the unfinannced gaps to be financed dom.esticallywould rise from Q 16 million in 1971 to Q 70 million in 1976. Capital re-ceipts and borrowing from the private sector through the bankIn, syste4m Inamounts consistent both with a viable balance of payments and with the fi-na>ncial requirements for grow.th of the prlivate sector, ',n be esiaed t

rise from Q 7 million to no more than about Q 16 million annually. But ifsubstantial efforts are made by the public sector to increasingly ta pl^iV

ate savings through the sale of 'bonds, it could yield some additional re-sources once a m,arket for such.- o-perations is established.

Tc,,le TV : FTCf'AT GADS WI.TTrY PS T)DCMt'rA SCVCErM, 1971=19-76iO'L~ .I J_L . t-'LU% J C .7 ~ LAI IA LAI~ ,LL 12 Ii.J& I. IhL.II1J

(In millions of quetzales)

1071 107) 1073 1074 . 1 W, 176

* tiLER I 11kv CC LLIZCLI U ~~~~~~~~ A.. UIflICtL

Total lInvestment (fixedand financial) 74.2 80.1 89.1 92.9 93.0 98.0

Minus: net foreign financing 31.5 34.1 34.1 28.7 28.4 27.9DoLmestic financing

requirements 42.7 46.0 55.0 64.2 64.6 70.1PUUbL.Lc savings,

present system a/ 26.6 24.0 19.8 12.7 7.1 -0.9Capital receipts +r

borrowing 7.2 3.8 6.0 9.2 13.4 15.8Gap 8.9 LO.2. 29. 4-.3 4+4.I 55.2

Source: Table 5.1

a/ Assuiming no new revenue measures.

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134. The above table indicates the need to increase public savingssubstantially to cover the emerging fiscal gaps, expected to rise rapidlyfrom Q 9 million, or 5 percent of current Central Governmnent revenues, in1971 to Q 55 million, or 27 percent of Projected current Central Governmentrevenues, by 1976, if a serious fiscal crisis is to be avoided. To fillthe above gaps completely would require that public savings be raised fromabout 1.5 percent of GDP to an average of 2.2 percent in 1971-76. Whileit would imply a considerable effort, these savings targets appear to bewell within the capabilities of Guatemala. The following section (seeparagraph 137-169) contains a detailed analysis on how these additionalresources can be mobilized. If they are, the following financing planwould emerge.

Table V: FINANCING PUBLIC INVESPfENT, 1971-1976(In millions of quetzales)

1970 1971 1972 1973 1974 1975 1976est.

Total investment 56.5 74.2 80.1 89.1 92.9 93.0 98.0

Financed by:Public savings 30.5 35.5 42.2 49.0 55.0 51.2 54.3(Central Government) (23.5) (24.6) (29.9) (36.2) (42.6) (38.3) (39.1)(Rest Public Sector) (7.0) (10.9) (12.3) (12.8) (12.4) (12.9) (15.2)External borrowing net 27.2 31.5 34.1 34.1 26.7 28.4 27.9(Gross disburserients) (45.5) (46.6) (49.2) (47.6) (42.9) (40.8) (41.0)(Amortization) (-17.3)(-15.1)(-15.1)(-13.5)(-14.2)(-12.4)(-13.1)Domestic borrowing /L -1.2 7.2 3.8 6.0 9.2 13.4 15.8

Direct investment as percentof GDP /2 3.2 3.4 3.5 3.7 3.6 3.5 3.6

Public savings as percentof GDP 1.7 1.9 2.1 2.3 2.4 2.1 2.1

/1 inrldincy ranit1l recripntc/2 excluding financial investment identified in Table II.

Source: Table 5.1

135. It should be noted, however, that the Government, while agreeingon the orderA of mani4 te of th AA t addti 1 snav i tngi needd, h opted fora strategy of attempting to exploit the present system more fully byi,.proving its administrat4in, before consid-ring hg,her tax rates or newtaxes. There is no doubt that a considerable revenue potential stillexist s i n th e presen.t 4yte; 1 while it i'sA 4 ffict U I L to be prec abo-u t,

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it may well be that the 1971 gap can be covered by this approach. Andthere is a clear advantage in not moving to new or higher taxes beforethe present system is fully exploited. It remains to be seen whether thegrowing needs of subsequent years can be met by exclusive reliance onreducinp tax evasion and avoidance under the present system. If theycannot, the lines of action proposed in this report will still be availableto the (.overnment.

1 '6 Tt shoulnd ht Pmnphasiliz tblt- if the r-zesourrce mnhilization eFfort

should fiall short of tiie above targets and, as a consequence, investmentnad to- he curtvi il1ci signifir-fqntl1 this wou7d b-I qsriouslV ipc)rn1ze qurattmah,

medium and longer-term development prospects. Under these circumstances, inorrder ton minimi7e theit rinman, e-very1 effnort- chouldc beP rnd- tor ca-r-ry out- thpprograms in those sectors which are absolutely indispensable for the expansiono~f tho ri-Ai1Rc ocoriocv,n (4 4a sn,,. ,.,,lti - 4 ,,A,.,ti-oFr fworzc>v roA¢ newjcr

telecomnmunicationis, tourism) while slowing down investment in the sectorswhich Inve a olnr,er pay-off period. But fro,. a development-a -l poi n F -viethe costs would remain high for Guatemala.

r. 1#"zto o' ResourcesU. !UUL±.L 1U LL UI

137. The Guatemalan fiscal svstem faces the dilemma of many develop-cLUIIL.nt:ries: re-venues grow lesss rapldly than national incom-e and cur-rent

expenditures more rapidly, yet an increasing amount of public investmentneedUs to be financedU. TiIs in l-e past hlas resuILeeI in sowUeu uown publ1iC

investmernt nrograms and insufficient current expenditures for long-termhuman denvelopmnt needs in education and health, with only sporadic anasometimes temporary increases in tax rates. Better fiscal planning andaction would avoid the stop-go character that has been typical so far ofGuatemala's public expenditure programs and prevent the erosion in publicsavings which wili occur in the next few years uniess corrective measuresare taken.

138. Although Guatemala shares the dilemma described above witlh rmanyother countries, its fiscal problem also has some specia.l LeaLures, suggest-ing different approaches to resolve tlhem. Guatemala's membershilp in t:heCACM causes special fiscal probiems. The need to increase development:expenditure in the broader sense and not only investment, calls for morethan just maximizing public savings on current account. Finally, C;uat:emalapresents a case where income distribution is a rather more important factorthan elsewhlere in determining fiscal capacity.

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The Revenue Structure

139. In 1969, public sector current revenues equalled less than 12percent of GDP, 1/ one fourth of whicih was generated froni outside theCentral Government and less than 10 percent from non-tax sources. Iwo-thirds of total public sector revenues came from the Central Governimenttax system, which therefore produced revenues equivalent to about 8 Dercentof GDP. Less than 15 percent of Central Government tax revenues are basedon direct taxation (income and property taxes) whereas the bulk of theclare derived from taxing production and internal and foreign trade (seeTable 5.9).

140. During the 1961-69 period, Central Government current revenuesgrew at an annual rate of 7.1 percent. Thiis growth was primarily theresult of periodic increases in tax rates in 1963, 1964, 1967 and 1968(see Table 5.3). LWithout such rate increases the natural growth wouldnave been about 3.6 percent (see Table 5.4). The mission has projectednatural revenue growth in 1970-76 at a slightly hiigher rate (4.6 percentper annum), assuming a modest continuation of certain administrativeimprovemenits now underway, such as the expanding cadastral survey forproperty taxes along the Pacific Coast.

141. Mainly as a result of the special impact of the CACM, the formermajor component of thie tax system, i.e. foreign trade taxes, aave stagnatedduring the past decade, being replaced principally bV the trebling ofinternal indirect taxes, particularly the stamp tax, while the direct taxeson incomes and property grew less rapidly and still account for only 15percent of total current revenues. As a result Guatemala's tax system ishighly inelastic (.33 with regard to GDP during 1961-68) thus m.lakingfrequent changes in tax rates necessary (see Table VI).

1/ The public sector includes the Central Government, municipalities,more than a dozen decentralized agencies (excluding the Bank ofGuatemala and three other state banks), the Social Security Institute,the University of San Carlos, and six state enterprises. However,because cash flows rather than net operating profits are included forstate enterprises, revenues are somewhat overstated; adjusting tor tniiswill lower the ratio to 11 percent.

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Table VI: ELASTICITY OF CEiTRAL GOVERMENT REVENUE SYSTEM

1961-68 1970-76Ave. Annual,, Percent of ,. ProjectedGrowth Rate /.L Revenue System!.± Growth

(percent) 1961 1970 Rate

Income-elastic revenues 9.0 17.1 36.8 7.1Income taxes 5.8 8.2 11.2 6.4Property taxes 10.9 2.3 4.4 9.4Stamp taxes 8.5 6.6 21.2 7.0

Income-inelastic revenues 2.3 82.9 63.2 3.2

Total revenues 3.6 100.0 100.0 4.6

/1 Excluding effect of tax rate changes.

142. Future revenue growth based on the existing tax system is expectedto be slighitly above recent trends. This is mainly explained by the struc-tural changes which have taken place during the 1960's, whereby the propor-tion of income elastic taxes in the revenue system increased from 17 per-cent in 1961 to 37 percent in 1970 (see Table VI). However, future revenuegrowth on the whole is still expected to be slower than GDP growth. Anmongthe maior tax categories, direct taxes are expected to continue to grow atsome 7 percent aniually during 1970-76, but will remain a minor part of therevenue svstem. In tne recent nast their relative noRition has not shownsignificant improvement: in th-e 1940's the profit tax, the predecessor ofthe incomo taxj reached ahout 12 percent of tqx revennes as did the incom.etax in 1969. As already indicated, direct taxes yield only about 15 percentof current reiveniiue and merely 1 3 npercent of CDP. WiJ-despread exemptioPnand evasion have so far crippled t his potentially buoyant revenue source.

143. Foreign trade taxes accounted for more than 70 percent of taxrevenues in the 1920's but despite a slight boom in the early fifties theyhave fallen over time, reaching a plateau in absolute amount (Q40 million)and a declining share of revenues and GDP. In 1969, they accounted forslightly more than one-fourth of current revenues or 2.4 percent of GDP.nhii relativp decl:ine in imnort-nce ic escentially a recult of the follow-

ing three [actors: (i) import structure changes, from heavily taxedconsumer goode to loTwer taxed raw materials, capital aooria, nd inter-mediate products. As a result, the effective average taxation of importsdeclined from 20 npercent in 1960 to 11 nerrent in 1QAQ9 (ii) imnort Qsilbsti-

tution which equally contributed to the decline in foreign trade taxes:for instance, the devyelopment of oil ,refineriea ahift-eA nearly Q1O millionof revenues from tihe import tax category to internal indirect taxes; (iii)Guatem.ala's membership in the CACM probably the most important factor inreducing the tax base despite the rapid import growth during the 1960's.

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This occurred because duty free intra-regional imports grew from Q8 millionin 1960 to Q53 million in 1969 or from 6 to 20 percent of total imports.The revenues forgone on regional trade have been estimated to have reachedQ 23.3 million in 1968.

144. Export taxes have also fallen absolutely and relatively fromabout Q18 million in the mid-1950's to about Q6 million in 1969 or lessthan 5 percent of tax revenues. Even with relatively higlh coffee pricesin the early 1970's, export tax revenues, overwhelmingly based on coffee,are not likely to exceed Q9 to 10 million resulting in a "tax rate onexports" (export taxes/total exports) of only 3 to 4 percent as againstalmost 20 percent in the mid-1950's. This is mainly tile result of thelowering of effective coffee export tax rates resultiag from thie shift in1963 of the tax base from world market prices to domestic prices.

The Expenditure Structure

145. In 1965-1969 current expenditures grew slightly more rapidlythan GDP, at an annual rate of about 7.5 percent, despite a virtual haltduring the fiscal retrenchment in 1968. Nevertheless, at the end cfthe decade they accounted for less than 8 percent of GDP. an indicationof the relatively low level of government services for a country at theGDP per capita level of Guatemala. The structure of current expenditureshas been, however, changing as an increasing proportion was directed todevelopment expenditures, about equally distributed between economic.health and education services (see Table VII). Nevertheless, in 1969nondevelopment expenditures (administration, defense and debt service) stillaccounted for about half of the total. Guatemala still spends relativelymore on defense (1.4 percent of cOP) than on economic or health servicesand only slightly less than oni education (see Table VII).

146. The Government's ability to increase its development expenditures,both canital and current; are a key determinant of whether Guatemala willbe able to step-up its developmuent effort in the 1970's. It is possiblethat there is still some roorm for economies within general administratiupand defense expenditures. The mission has assumed as a target that thistype of crurrpnt Pxnpendituirp twouldl grow more slowlv than GDMP -nr only slightlyabove the rate of population growtlh. however, since development expenditureswill have to grow at over 12 prrernt annnall to t uport the Tl pnned much

higher investment levels (see paragraph 100) and to improve the quality andquantity of sorial cserivirc: (cno naragranhsl'L nnti)) 1 )Hi the overanl rate oFcurrent expenditure growth is projected to be about 8.5 per year, roughlyone percentage point- hig-er than in the recent past. These estimates are

largely based on a detailed and well documented forecast made by the PlanningOff1i.ce. TIP these expenditure C. argets are m.et, tlhe compositior. of currentexpenditures would further imnprove, and development expenditures would accountfor over 6vU percent of tle total b-y I'll.

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Table VII: P.AST CURRENT EXPENDITURES STRUCTURE ANDFUTURE NEEDS: 1965-1976

Structure Absolute Structure Absolute Structurein incremernts in increments in

1965 1965-1969 1969 1969-1976 1976percent Q millions nercent 0 millions Dercent

Total 1(0 32 100 94 100

Development 45 19 4 76, 63

Economic 11 6 13 16 151-Lducat ion I372 52

health 11 6 13 25 19

Non-Development 55 13 51 18 371 11 _ a - _ _ A 7 1 1

'LieL9c e ns e J 7 I L E

General Adm. 1 2 15 1 12interest ondebt andothLi e0r L5 0 17 10

Source: Ta'Ole 5.iu.

Fiscal Capacity

147. As shown above (see paragraph 133) if the Government is to step upits development effort, which will require a substantially higher levelof both public investment and current expenditure, it will have to raiseadditional taxes which by the mid--seventies should vield some 030 to 50million. The following analysis indicates that the Government has theoprortUni tv tn nrevent uii tiire fiq Ca F rr isis hv restrii rtturi ng i ts tax systemto make it more income-elastic and to improve its contribution toward funda-mental national obiectives such as economic and social development, -I widersharing of the gains from economic growth and an improved balance ofpayments.

148. A rouolh e-stimate of iL1at-emala's "fiscal rqanqritv'K habaed on acomparison with other countries with respect to some relevant character-istics- includino inrome ner ranitn- "openness" (ratin of imports and/orexports to GDP), value added in manufacturing and income distribution,su7ggests that the ratio of Gunatema1a's taxes to GDP could he exnpectei trolie somewhere between 13 to 16 percent as against the 11 percent it hasrp,echeti in iQ96_ Thiiu it woiild sppni reasonable to epnct that Gu1atemal1 a

could, withiout undue strain on the economy, raise another Q30 to 50Tn1 1

inn in tax revenrOes whrich Ic rouighly irn,itity lnt tn n nlrt 2 9tn I

percentage points of GDP.

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149. Achieving sucil a target by 1976 would imnply an annual growth ratefor Central Government revenues of about 10 percent, a rate Guatemala lhasapproximated betweena 1967-69. Nevertheless, in terms of the implied marginalpropensity to tax (i.e. the proportion of the projected GDP increase thatwould be taxedl) the required effort would be quite considerable. For theCentral Government, thie marginal tax rate would have to increase from about10 percent in 1961-69 to over 13 percent in 1971-76 or roughly double tilerate which the expected natural growtih of thle present tax system wouldimply. However, there are revenue inistrumenLs thiat h-ave thus far beenclearly under-utilized. Similarly, some identifiable sectors of thie econ-omy have been relatively under-taxed. Some tax measures tlhrough whiich theabove revenue target could be met are discussed in the following paragraphls.

150. (a) Income tax. In 1969, the total wage and salary base ihasbeen estimated at about 0700 million, out of which only Q144 millionappeared on tax returns yielding only Q2 million in taxes paid. Thesocial security system yielded more thani eight times thiis amount, althoughon a somewhat different base. Furthermore, th'e potential tax capacity ofthe personal income tax is much larger than tile average per head annual wageand salary income of Q45 6 may suggest, given the severely skewed incomedistribution. According to official income tax data, in 1966 about 2percent of people who filed income tax returns represented almost 60percent of the reported gross income and over 75 percent of tax payments(See Table 5). The effective tax rate in the same vear was very low, amount-ing to 12.7 percent for incomes between Q10,000 and 25.000 (1,200 taxpayers)and only 18 percent for incomes above Q25,000 (240 taxpayers).

151. Guatemala could collect substantial additional amounts fromthe income tax by concentrating its efforts on (i) reducing existingdeductions which at present reduce taxable income to less than 1) percentof total income and (ii) on increasing effective tax rates in middle andupper income groups wlhere virtually all of the presently reported taxableincome is located. Such an approaclh should not cause administrativedifficulties, since the number oF returns involved is less tilan ,000.

152. An analysis of income tax payTiments bv sector suggest that agri-ri ltirp is int taxed effPrtMvul t[hrourh ilnrnmo tatio.Vr-fn (see Table i 7).

'lanufacturing accounts for 35 oercent of income taxes collected wlhile itssharep in CGDP is cnlyv 15 nercrnt> 'rh-p ratio for agriculture ic rvPrsed;

it accounts for only 7 percent of incomne taxes but 30 percent of GDP (SeeTab le 5. 7) .

153. Det-e.-mdining tl:e revenue potential of the incor0-J;e oranotetxin Guatemala involves arbitrary judgTments with regard to wlhat tax ratesshould be appLleu. Dut even a very low UOne- PtiLLItL efLectViv AlilnLce tLa

rate, based on an estimated total personal income of Q1, 4 0() million itn970/U WoUul yLe.Lu QL4- *uilllIn, more t- Ltiai thiree and a hilf t'Iri;- IhL t rt t

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collectioni. For business income, a minin;um potential to be achievedwithin the next 5 to 10) years might be estimated at 2 percent of value added(against 1.5 percent at present in tne sector with the hihnest tax burden)which would treble the present Q12 million. Experience in other developingcountries suggests that a range of between 3 to 7 percent of GDP for theyield of income, social security and export taxes (the latter twc are addedsince they are obvious substitutes for income taxes) is quite reasonable.If the effective income tax rate were to be raised to one percent. of thebase and the company tax to 2 percent of value added, this would raise anadditional Q34 million thus increasing Guatemala's income tax burden (in-cluding social security and export taxes) from 2.4 percent to 3.4 percent.of GDP, still at the lower end of thie international scale. These additionalrevenues could make a substantial contribution to covering the estimatedfiscal gap (see paragraph 134).

154. (b) The property tax is by far the most underutilized taxinstrument in Guatemala. As a result of underassessment, evasion andabnormally low tax rates up to now, the surface of this potentially richtax source has been hardly scratchied. At the end of 1968 the assessedpropertv tax base amounted to Q1, 2 00 million. However, the average ratioof assessed value to market value has beeu estimated at only about one-tlhird. This, plus the fact that property values have been growing atclose to 12 percent in recent years suggests that the real property taxbase in 1970 is closer to Q4,000 million (See Table 5.6). The resultingeffective tax rate of 0.1 percent is extremnely low by international stan-dards. Thus, if the internationally more typical effective tax rate of onepercent is applied (based on a 2 percent nominal rate against the 0.3-0.6percent at present and on a ratio of assessed to-market value of one half)property taxes would yield Q40 million against Q7 million in 1970.

155. Again, the extre-me inequality of wealth distribution in.Guatemala means that collecting the above amnounts is administratively notan insurmountable problem. An efficient strategy would be to conceintrate onthe less than 10,000 parcels (value Q20,000 and above) which account forabout 60 percenit of assessed value (see Table 5.5). From a technical view-point this would appear feasible, since in the recent past some 15,000 to20,000 parcels were assessed annually; unfortunately many of them. were at thelower end of the scale. some even below the exemption limit of Ql,000. Foradministrative simplification and to reduce tax avoidance by splittingnarcels. a proportional tax rate (initially one percent, then later increasedto 2 percent, as needed) would be more efficient than the presentproaressive svstem.

156. (c) Althouch Guatemala's internal indirect tax hase has provento be hicghly income-elastic, as indicated by the past growth of thestamn tax. the relatively snmal1 size of the urban middle rl 2SS on whibrhmost of the indirect tax burden falls, makes it potentially not veryimnortant for the growth of fiutu-,re tax revenuies=_ A recent studv suggieststhat the sale tax base in Guatemala amounts to about Q300-400 million.

Thus a 3 percent sales tax would yield only Q9-12 million or 0.5 to 0.6percent ofJ GDPur. *Sumptuary taxatiLon on alcohlol and' toh'jacco a'lreadv reachabout 40 percent and 26 percent, respectively, of the gross value ofproduction and yield revenues of Q16 million and Qo million, respectiveiv.Combined, their revenue yields were equivalent to 1.3 percent of GDP in1906 Doubling thnese fairly nign tax rates would amount to additionalrevenues equivalent only to about one percent more of GDP, given increasedevasion anu sortie reduction iii consumption growth. Taxes on petroleumproducts (Q10.9 million in 1969) represent 0.6 percent of GDP; even if thepresent tax (about Q 0.20 per gallon) were doubled it would add only abouthalf a percentage point of GDP to the public sector revenues. GivenGuatemala's already high level of road user charges, such a measure wouldmoreover have a fairly high economic cost in terms of loss in efficiency.

157. (d) Foreign trade taxation appears to have very little potentialon the import side, except for the full implementation of the 30 percentsurcharge (San Jose Protocol) expected to yield some Q4-6 million, How-ever, there is substantial scope for increased export taxation given thepresent high profits in coffee. The excess of present and expected coffeeprices over those of 1969 is estimated to increase export earnings by someQIOO million for the period 1970-76. If Guatemala were to apply the same18 percent average coffee export tax rate as in 1955, the above windfallwould yield about one percentage point of GDP annually in these years.

158. Thus, export taxation - as an efficient substitute for the lackof effective income taxation of agriculture - could be expanded from itsexisting yield of 0.4 percent of GDP in 1969 to 1.5 percent of GDP in theearly 'seventies.

159. (e) Finally, the social security system offers a very importantrevenue potential: it now "breaks even" with revenues and expendituresequal to about one percent of GDP. However, given its broad payroll taxbase (Q200-300 mnillion) covering nearly one-third of the economicallv-active population of 1.3 million and the benefit-oriented nature of itsrevenue collections, it might well expand beyond its present health-accidentcoverage into the pension field. Thus, in the early years of an expandedpension plan, its revenues (collected on an annuitY basis with the proceedsinvested in government securities) would well exceed its pavments, thuspotentially contributing as much as 1-2 percent of GDP to public sectorsavings.

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Table VIII: POTENTIAL YIELD OF MAJOR ALTERNATIVES FORREVENUE INCREASES

Diffetrence1969 1970-76 between

Revenue Sources Present Revenue Potential Rev. Potentialas Percentage as Percentage and Present.

of GDP of GDP (Q millions)

Central Government 8.6 15.0 - 17.5 100 - 160Personal ini-orme tax 0.2 1.0 15 - 20Business income tax 0.8 2.0 20 - 25'Property taxation 0.3 2.5 - 5.0 40 - 80General sales (including

Starin t'r!X) 20) 2i) 0Excises 2.4 3.0 1(Foreign trade: Imports 1 8 2.0 0 -

Exports 0.4 1.5 15Non-ta-x revenues n.9 i. n

Rest of Public Sector (3--prox.) a, n A LnO_ (Social security system 1.0 1.0 - 2.0 () - 2()Rest public sector 2.0 2.0 0

To I ta P SUIlector I'. 1 = 2) - J.eo( W)S

160. Two main conclusions emerge from the above analysis. One isthat, from a technical point of view, the new Government has a wide rangeof options regarding possible new revenue measures; the total of thoseidentified above is well in excess of requirements and leaves ample choicesto the authorities regarding the particular combination of measures thatthey may find most suitable. The second conclusion is that Guatemala'smost important untapped revenue potential is concentrated in direct taxes.The relatively limited potential for further indirect taxation is mainlya function of the narrow middle class (only 50,000 qualify for the incometax) and the still small urban, industrialized, monetized sector, which inthe past has already provided the bases for successful revenue growth. Bet-ween 1961-693, indirect taxes increased their share in GDP from 2.4 percentto 4.4 percent. In the future, direct taxes will have to play an increasingrole.

Tax Policies for the 1970's

161. The Plan. The Planning Office under the previous Administrationprepared a Fiscal program as part of the 1971-75 Plan which could providethe necessary additional resources to finance the higher investment and

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current expenditure levels. The new Government has reviewed this programand accepted it. The main components of the Plan are: (1) reform theorganization and administration of the Ministrv of Finance and PublicCredit; (2) improve tax administration and collections, especially to re-duce the evasion of income and sales taxes. accelerate nronertv reassess-ments and reduce import tax exemption; and (3) introduce changes in thelaws to increase some tax rates (nronertv and ve l ne taxes)j redruep i ncometax exemptions and shift from the existing stamp taxes to a general salestax. In addition- the Plan correctly antir4in pd that Iate in 1970 CostaRica would deposit the San Jose Protocol, thus putting its 30 percent sur-charge on non-CAC'M imnorts in full force hby 1971 nl inreasng revenues byQ4 million. Total yield of this package is estimated to increase from Q5mi1ionn in 1971 to Q45 millio irn 1975 (see Table 5.8). P Cu-n.t revenuesin 1970-75 would grow on average at 9.5 percent per annum as against 5.3nperrent without the program..

162. ThPie Flan incorpo_ra1es 11-- fining -A of-- several st-udi e s which -11 hav7e±O I. * I LIC I .LctL J.LLJL% VlpL LC- tL. L.LLLU.LII5D X I...~ VCLa .lt .LC Wf LL i I~

been undertaken in recent years on a possible fiscal reform in Guatemala.I1n general, thle lLLssion LLee'ls tL'Lat the Plar. couLIU proviLUUe one of severalpossible viable approaches to resolve Guatemala's fiscal problems. ilowever,based oI toln ear ier ar.alysi ts0 e pa-ragr-aphs 150- -- 160 Lthe m4l4or, is of

the opinion that the Plan, by giving much greater emphasis to indirect thanto dULLrect taxation, does r.ot take fLul 4l.. advantage of .'.-;e c ty'potential. However, this may be more a matter of timing than of principle;the strategy to fiLrs LttiLCg L Ule LuLC t Ue I inistrdLatio Uo LIth ex±Ls"Lng systel

is clearly a sound one and may well suffice for the time being, i.e. untilthe stepped up investment program als fully UndrCLWy.

Table jXv rTENI AiLa REVENUE. uJr SE.LECTD TIALO

(In millions of quetzales)

Potential1975 Plan Reform increment

Income tax (personal and business) Q 10 Q 35 - 45Pronertv tax 4 40 - 80General sales (including stamp tax) 12 0RWc-iCP 6 10Import taxes 11 5Export taxes 0 15Other (social security) 0 0 - 20

Source: Table VII, and Table 5.8.

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163. Fiscal Incentives in the CACHI. Guatemala has had a program ofgenerous investment incentives since 1947, mainly for industry but alsofor other activities including construction and tourism. The program wasrevised in 1959 in anticipation of the Central American Agreement onFiscal Incentives. The latter was drafted in 1962 but ratified only in1969 and is not yet in operation pencling the revision of the implementingregulation. 1/ It provides for only slighltly less generous tax holidaysthan under the national system.

164. The cost to the fisc of the tax holiday scheme has been high.Import dutv exemptions rose from 04 to 16 million in 1962-69, to which anestimated Q3 million for income tax exemptions must be added. Increasingdoubts have been raised recently as to whether the benefits of tlhis schemestill justify its ihiglh cost. Studies made in other countries suggest,that tax holidlays are generally not instrumental in fostering private in-vestment. In the Cuatemalan context other factors such as the high commontariff wall and the gronwinl CACrN market- exnort booms and nolitical climatewere probablv more powerful private investment incentives. As long as therewas reoional competition among the CA,M countries in attracting foreigninvestment, the tax holiday scheme may ihave been inevitable, although forthe five count-rieR Lq a groun it undoubtedlv was unnecessarily contl1=v

iiowever, with thie expected imminent application of the regional incentiveReqrnmP tticP rromntitivce element has la.rvelv hben Hliminntpd (hilt Cfaf nll.n

paragraplh 90).,

165. This issue may well be wortl-h furthier study with a view to adjust-inc. tihe hrlliyinx, crn.ene ton iH)e nrecent1 y nprospectfiv resultis and rvenuen

needs. Of course, suclh action would have to be taken in the regionalcontext. By rerducing- the leve1 of tax holdays and/or m,aking them contribute

to investments by the beneficiaries in national or regional industrialdevelopment banks, their fiscal negative impact miht be minimized. TMiscould well be the solution for the proposed semi-public industrial develop-menrt bankr Ahir li w.7iOlrl rcall fnr -nnc4Ae-rh1e hlidgetary? tranosfer

1/ The regional incentive agreement distinguishes three categories ofindust s4 L .wL Jy c..ategory A 1.0 thef ..axi..u.. and C no tax hnollidays.For category A (new industries producing capital goods, consumer goodsanA seM4-f4n4Sh_eA products, provided r011 percent ofi inputs is 04ofAL CA. J

origin) there is a 100 percent exemption on (a) import duties formachi.4nerv (ten years", raw4 material's andA semifi4n4shed products fvI IAy14A 0/ J W IA11L£40 Wu 3L.L L.L0I1 U I L -U . LA

years; thereafter 80 percent for the next three years and 50 for thenext -wo years), a-.d fuels other thani gasoline (iv years) bi- onincome taxes (eight years); (c) on assets and net worth taxes (ten

+- ~~. .4A._ 4. 48 . . __1 _\ - _ _ __ ___ 7j_.~ = 1 years, not exisiA LngL in GateUdmLla . o r U CLategory B (existi Llnl indUUs L[ ies

the import duty exemption is for six years (limited on machinery) andthe incor,e tax exter..piLoLnUL LUL LWUo years.

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166. Moving towards an optimal internal indirect tax system. Al-though changing the present multistage (cascading,) stamp tax into a singlestage sales tax would have certain obvious benefits in terms of improvingthe efficiency of resource allocationi, this is probably not of highestpriority in the Guatemalan fiscal reform program for a variety of reasons.Guatemala has already the highest percentage of its tax revenues inindirect taxes, and, as indicated earlier, indirect taxes and among themparticularly, the stamp tax, provided much of the momentum for revenuegrowth in the 1960's (they grew from 34 percent of total tax revenues in1961 to 54 percent in 1969) thus approaching the limits of their potentialcapacity (see paragraph 160) . M4oreover, tihe present stamn tax has certainvirtues which might make it worthwqhile to keep it for some more time.These are mainly: (i) the stamp tax proved to be hiahly effective inmobilizing resources; (ii) the combination of both a low rate (1.5 percent)and broad base (02.000 million) is superior in terms of bein•: conducive toless evasion than a higher rate (3-10 percent) single stage levy on asmaller base (0300-400 million): (iii) experience in other countries sugagetthat, since the star.p tax falls on all transactions, some of it may not beshifted forward and tilus it is increasing_ taxation of otherwise "undertaxed"business. A general sales tax would certainly be shifted forward.

167. Lack of administrative capacity is likely to be an importantconstraint in ,arruing out an effective fisrnl reform program. This isone reason why, instead of broadening the tax base for agricultural, incomeand nrnnprty txatiocn as suggested in t-he drift prograrm, it may 1)e nreFer-

able that the existing administrative capacity be concentrated on the fewthousand taxpaers w_-Tho account fnr t e F 1 Ic _ th t axablh 1 _n nnn m_ n pay_,~~~1 .__. 7 _ ... ._._.__.sS_._._ ._ ._.

most of the collected taxes. 1/ The lower-income farmers, workers, entre-preneurs and property holders -- an be c ,o t- L

increased social security taxation (where visible benefits are ear-markedtAo te taxpayer) , export and iimportC taxatlon, anicdL consu.ptilon taxation.

LuV U tCe tAV tJL t C D>%_ L.1 L Lc f flete*1 svc'ot t Pl ai 'Off ices proU pos LClt

package does not contemplate any increase in coffee taxation wihich, atabout 9 percent adU vaLJLr em, ls , UUU L abVo CL c16t a.u..on V-.,! coIuLtrie bUL weLl

below what other countries such as Brazil and Colombia charoe the coffeesector. The k,VL IveIrntCLIL nt is thereby fOrUCBU1oi- avery l,,portant InLII ea.s ily

1/ Thus, instead of reassessing all properties as the Planning Officeproposes, it may be better to exempt or ignore initiallv the 55 percentof property parcels (135,710 parcels) valued at under Ql,000 whichrepresent less than 6 percent of total assessed value and concentrate(both by reassessments and tax increases) on the 4 percent of the parcels(fi.767 parcels) whiclh represent 56 percent of all values. Also, incometax tillug requirements for emplovees might be raised to about 03,000lrown tAte pireseint 01.S00 level.

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collectable potential revenue source (see paragraph 157). Indeed, ina situation where resource availability is likely to become a major constraintin carrying out the higher investment effort needed to broaden the country'sexport base and thus improve Guatemala's structurally vulnerable externalposition - mainly due to coffee monoculture - taxing coffee windfall gainswould appear to be the obvious answer. Instead, there have been strongpressures-successfully resisted by the Government-to abolish the taxbecause of its allegedly discriminatory nature. This would only be trueif there were other effective ways to tax income and wealth. But at presentincome tax action would be a poor substitute for an export tax. Agricultureis now paying less than Ql million in income taxes and only an additional.Ql.5 million are credited as coffee tax payments against income tax liabili-ties, which is little compared to the 09-l0 million estimated yield ofcoffee taxes in 1970.

Summing-t.,_ Alternative Approaches

169. The fiscal measures discussed above (paragrah 147-160) essentiallyconsist of the following actions. In income taxes, administrative improvements(including cross checks with auto licences, import licences and propertyownership) should be aimed at reducing evasion from the estimated present50 percent at least to 25 percent. The main legal retorms would be to splitthe income tax between individual and corporate tax payers and make the latterproportional; also deductions should be reduced but exemptions raised (to, say,Q3,000 for employees). For the property tax, administrative improvementswould include mainly the reassessment of properties (eitlher automatically,according to a sliding scale depending on the date of last reassessment withthe right to appeal or by concentrating reassessment on 10,000 parcelsaccounting for 60 percent of assessed value). The legal reform would beto increase rates gradually to 2 percent and exempt properties below Ql,000.Among foreign trade taxes, the application of the San Jose Protocol on rawmaterials and capital goods would require no legislative action, while theincrease in the coffee tax (to 18 percent ad valorem, as in 1955) and eli-mination of the loophole in taxing foreign air passengers travel would.The proposed changes in consumption taxes i.e. substitution of the sale taxfor the present stamp tax (low priority) and an increase in passenger carlicence fees from Q31 to QIOO (allowing part of it against income taxes to"reward" honest tax payers) would require legislative action. Finally,changing the social security system to include a pension plan and increaserates is a measure which would have to be further studied. The combined yieldof these alternatives substantially exceeds the financing requirements identi-fied earlier and thus leaves the authorities a considerable variety of choices.

170. As indicated abve, the Goyern...ent's approach is to concentrateon administrative reform before deciding what other revenue actions, if any,are meeded. Wh4 ether thi4s -ill suff1ce for m,,ore than a year or two cannotbe established with certainty at this stage. On the longer run, some struc-tural reform;i allong :he l 4nes *inAdicateA above will proaably .be nec.essaryanyway. But for the immediate future the Government's emphasis on extractingLtle most out of the existing syster. umay we.Ll pay off; whLWat3 [atters 1. s *. uitaci

a pragmatic attitude be preserved and other measures not be ruled out if i:hisshloulUd prove necessary. 'LL-is adlso appears to bJe th'Le Government's vi ew.

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V. MONEY AND CREDIT

171. Over the past decade Guatemala has had a remarkable record ofprice stability- ExRept for the 1at T years, when conum-er prices roseby some 4 percent annually, the general price level as measured by theofficial indices did virtually not ir.crease at all during t he '960's (seeTable 6.3). This was mainly the result of traditionally cautious monetarypoli44cies, the ..ain purpose of rwrhich was to m..aintain or restore balance ofpayments equilibrium, jeopardized by export fluctuations. Generally,restrlctive credit policies seem, to have been quite successfu. ni curbin

import growth in years of (or years following) balance of payments cleficits.

172. During the 1960's aggregate credit to the private sector in-creasedU bvy abUout 9 percent annually, one percentage poiLnt Less tuhan ex-ports, but annual changes were quite abrupt, mostly in line with balanceof pay-merits movemleLLts. Bank credUt to the public sector icicreased onlymoderately (see Table 6.2). WJhile restrictive credit policies seem tohave mainly arrecteu coasumer goou imports, raw material imports havealso significantly slowed down in years of credit squeeze thus negativelyaffecting industrial production.

173. If a reasonable degree of external and internal financial sta-bility is to be maintained in an open economy like Guatemala's, develop-ments in the export sector will remain hne key determinant of monetarypolicies. Only in the longer run, with an expanded and more diversifiedexport base which strengthens the baiance of payments structure and graduaiyeliminates the fluctuations in exchange earnings will a more rapid and evencredit expansion be possible. In the meantime, in order to assure thatadequate credit is available f-or developmental purposes, vigorous effortswill be required to mobilize private savings by the banking system to allowan adequate level of credit to both the private and public sector. For thepublic sector it can be complemented by attempting to capture private savingsthrough a market for government securities. Allocation of credit to itsmost productive use is another important element in a development orientedmonetary policy, which in Guatemala will require that existing institutionsare strengthened and, possibly, that some new; ones are created.

Mobilization of Private Savings

174. Monetary holdings in the banking system have risen considerablyduring the 1960's indicating the rising monetization of the economy andthe private sector's increased willingness to hold financial assets. MIoneyand quasi-money as a proportion of (TNP rose from 13 percent at the begin-ning to 19 percent at the end of the decade. As in many other countries atthis stage of development, there has been a substantial shift in the com-position of monetary holdings from currency and sighlt deposits to time andsavings deposits. The latter increased their share in the total money

supply from 25 to 50 percent during the last 10 years. Several factorshave L probably Stib L utL l to the3 rise in total deposits. First and mostimportant was the rapid increase of aggregate private savings which, start-in g ftrom a very low base, a.lmost trip 4.n absolute te,ms and doubled as aproportion of GDP from 5 percent to 10 percent during 1960-69 (see Table2.). 1%. condA, 'le -ee of - taxati+. -on remane ver -low-- _ (se - -- - e.raphs ~ 147=I * n)/ LUuIU LJLV~ .LSVSJ UL- EaxatL±Ji S.L L&LS VSLy .LVW %O55 j'tFt..*. -

149). Third, although nominal interest rates have not been changed since1954 (~avrage deposit ratLes aiiiounL to abuout 6 perce,t anLdU relendlingg rLtesto 8 percent) real interest rates were consistently positive, since pricesremaId x eU fdLLy bldU.Le. iUU L UL priLVdaL bdViLngs Were capdtLULr U cy ZUIIIL

cial and mortgage banks, while very little went to the two public develop-ment Uaniks .z^ L tbUL, J [Lthese .wo UaLKs hiave rtemained alumost ecLusLvely

dependent: on budgetary transfers and Central Bank credit.

175. In general tne public sector has not been very successful inmobilizinig private domestic savilngS tO etlp finance eVelOpMeRnt expeni-

tures. Although public sector net bonded debt increased from Q 43 mi:Llionto Q 130 million in 1960-69, tne bulk of it was either placed abroad iseeparagraph 131) or in the banking system (mainly Central Bank). Privatesector holdings of public bonds decreased over the period and remaininsignificant (see Table 6.5). Inadequate returns - interest rates weregenerally below rates for savings deposits - were probably main:iy responsiblefor the poor acceptance by the general public of public bonds.

176. Intensifying the mobilization of private savings both by thebanking system and the public sector, including development of a marketfor medium and long-term fixed interest securities, would contribute t:ofinancing a stepped up development effort. Given the substantiallyhigher interest rates abroad, it will probably be difficult to achieveambitious targets in capturing private savings unless domestic interestrates are brought in line with those offered abroad. There is no dire!ctstatistical evidence of capital flight, but indirect evidence suggeststhat substantial savings are transferred abroad, mainly via other CACN[countries which do not maintain exchange controls. Also, foreign mutualfunds have in recent years substantially increased their sales in Gua-temala. An upward adjustment in interest rates may well prove necessaryif substantially higher levels of private savings are to be generated andchannelled into domestic and public investments.

Direction of Private Credit and Institutional Needs

177. If adequate credit is to be made available for new activitieswithin the limits imposed on overall credit expansion by balance of paymentsconsiderations, most incremental credit will have to be channelled to thesenon-traditional sectors. Already in 1960-69 credit to industry increasedits share in total credit to the private sector from 10 percent to 27 per-cent, a reflection of the rapid industrialization process.

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178. It might be difficult to carry out such a redirection ofcredit within the existing institutional arrangements. While the systemof commercial banks is well developed in Guatemala, it still lacks effi-cient development banks equipped to finance medium and long-terminvestment in nontraditional sectors. About 80 percent of outstandingloans of the banking system are short-term. (less tinan one year) and thereis a shortage of long-term funds. The recently established private develop-ment finance company (FIASA) is only partly filling this gap, particularlysince it practically does not perform any of tile typical functions of adevelopment bank, such as project identification, preparation and promo-tion. The Plan proposed the creation of two semi-public development banks,one for agriculture and one for industry, whiich appear well-suited forthis purpose. Since part of the new credit programs - many of which receiveforeign financing - would have to be cihannelled through these institutions,the new Administration is accelerating the process of creation of the twobanks.

Financing Capacity of the Banking System, 1970-76

179. The key to providing adequate bank credit both to the privateand public sector is th[1e mobilization of igheIr lvs pia

savings through the banking system. Besides requiring a climnate of confi-dence - without wnich no financial incentives are lik;ely Lo be effectivefor long - a realignment of interest rates may also be necessary to achievea continuation of the past trend of a growtLh of deposits considerablyfaster than that of GNP. Under these circumstances, tiie banking systemshould be able to provide adequate credit for high prioritv private andpublic investments. With private credit growing at about 8 percent perannum or in line withi exports, there would still be room for some moderatecredit expansion to thie public sector, keeping it at about the presentproportion of total credit. Thils should be consistent with longer-termbalance of payments equilibrium.

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VT BATLANCE OF PAYVMFNTS POLICIES A.ND PROSPFTS

180. Although the balance of payments in 1968-69 did not pose anyacute prob:Lems to the authoriti4es, 4i the previous- yars recurrent halanc

of paynments difficulties have underlined the need to diversify the economyandl to red;:.e its dependence on 1th1-Le tfluctuations of crop conditio-r.s andworld irarket prices for a few primarv products. Dependence on coffee,.Ain paL par ltJicuL hLas Ueen theL main re a ls rL or tile J s VW groW fl VS t.1 V8JIIJU

in 1957-62, when stagnating coffee exports depressed incomes, savings andthe Icouaery' capacity. to Lircc LLLd .LLports L V3.GoverLLLLL4t autrLitLLeL have

been able in the past to overcome balance of payments difficulties byenactLing, whiene-ver necessary, m.eCIasurLes a:.LLr,U,d atL L.L r trLLLt n LLLPVL L. .* VW LiL.

Selective import surtaxes on consumer goods and restrictive credit policieswere Ltle riz11L ilsb Lr UdlenLts appJli.U B DUL a prLIIIILnIIL sUo'LULon L-oU L'11 proL em

of balance of payments vulnerability is yet to be provided as the economyrem-ains heavily dependent on a few exports of priruary products to the worldmarket, coffee and cotton in particular, while the industrial sector catersa'lmost exclusively to the domestic and CACM markets. The medium-term outlookfor coffee and cotton, in spite of the present high coffee prices, is notvery bright, and exports of manufactures to Central America are expected togrow much less rapidly than in the past decade. Thus the dependence oncoffee and to a lesser extent cotton exchange earnings is likely to remaina main constraint upon development. If other sources of foreign exchangeearnings are not developed, total exports will clearly be insufficient cofinance import requirements consistent with a high rate of economicgrowth. import substitution can help only to a limited extent to reconcileGuatemala's inadequate exchange earnings and growing import requirements(see also paragraph 81).

181. Fortunately, Guatemala has considerable potential for additionalexport growth. Favorable land and climatic conditions offer a good basisfor developing a wide range of agricultural exports. Mineral resourcesare still untapped. Abundant and easily trainable manpower, together withcomparatively low wage rates, and expertise in the production of ILightmanufactures give Guatemala a basis to develop industrial exports to coun-tries outside Central America. Tourism potential is large. The kcey pro-blem the government is now facing is how to take advantage of the nextfew years of high coffee prices to diversify the country's economy. Astrong export push aimed at developing new sources of foreign exchangeearnings, particularly nontraditional agricultural products, minerals andmanufactures marketed outside the CACI and tourism, should become the majorobjectives of balance of payments management. Furthermore, in order toachieve a viable balance of payments the export drive would have to becomplemented by policies directed at reducing the growth of non-essentialimports and improving the external debt structure, both in the private anclpublic sector.

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Past Developments

182. AFter 1962 export receipts started rising rapidly at an annualrate of 12 percent in 1963-69. IWhile coffee sales rose appreciably, mostof the export expansion was due to the rapid development of cotton andmeat production and to a large increase in manufactures exports to theCACM which contributed about one fourth and one hlalf of incremental ex-ports, respectively. Despite sianificant pro-ress in export diver-sification, in 1969 a few primary products (coffee, cotton, banana andsugar) still accounted for T,iore than half of Guatemala's total exports.Coffee represented almost one-third of total exports, against 56 percent in1962 (see table 3.3). Imports also started rising raoidly after 1962(10.4 percent yearlv in 1963-69) in line wuith rapid growth of industrialproduction, increasing private investments, and the relative ease in ob-taining foreign suppliers credit. As a result, the current account de-ficit rose until 1967, when it reached about $76 million or 5 per-cent of GNP. A combination of accelerated export growith and a success-ful containment of imports substantially contributed to the improvement int'he balance of payments in 1968-69. Thie current account deficit droppedto some $35 million or 2 percent of GNP in 1969. The key ineasure to curbimport growth was a 30 percent surcharce oli extraregional imports, whichwas introduced on a regional basis (Protocol of San Jose) to protect thiebalance of pavments and increase fiscal revenues. The surcharg,e was toaffect all imports from outside the region, but in effect was only ap-plied on consumer goods to safeguard the industrial competitive nosition,since one country (Costa Rica) had not approved the Protocol. Startingfrom the fourth nuarter of 1970 the surcharge will also be annlied onraw materials and capital goods following the recent Costa Rican approvalof the Prntornl=

183. GuiaPtmaa hpnpfirtd c fromrl the creation of the Commoni-arket. The elimination of tariff and other restriction-s on all but asmall portion of the trade betwen thie Central Arnri_car countries provideda wider basis for Guatemala's economic expansion. The availability of acomrAparatively developed 4nd-u4tril structure nAd some excess product vecapacity at the timie of the formation of tile Commoi '3arket put Guatemalain a paTtlcul arly VL a ana,ousa posi tion. I exp,orts to othier Cer.tral

Amierican countries increased from less than US$9 i'aillion in 1962 to about1U0S$'601 m&illion in 1'369 (i;.e. zt3a p eot analy n acou1e fr_

tJ~ tIL Lfl. 'tt i' -L tJ .L. a -. 0. .. t I. aIL CJ..-/Ct QL .J ALL U L

more than 30 percent of its total exports in 1963--69, compared with 7percet in 1 . ByL f JLar the 'Lair L estt sh ILare o tI2he LI rtradUe i nC i tn -.as with

neiglhboring El Salvador (Table 3.8). InduLstry has been thecL.ief beneficiary of the Commwl-.on Mtarket: about S6 percent of GuatemiLiala'sexports in the region in 1968 were manufactures, mostly consumer goods(sucn as textiles, clotLing and pro:Cessed fOOdS) . AS a result of Lte

rapid expansion, the share of Guatermala's exports in the intra-regionaltrade increased substantially during the 19 60's (from 22 percent in 1960,to almost 33 percent in 1969) while its imports' share decreased sligihtly.Thus, from 1961 on Guatemala had a tradie surplus w4hich reached a levelequivalent to about 11 percent of time -ntraregional trade in 1968-69(Table 3.9).

- 63 -

184 The July-T.I 16915 conflict betweerl El Sal-ador and Hionduras-; nd t:he±L U4 * 111t O..J t) A/IJ tLJA I t ' LW~

resulting transport and communications difficulties somewhat hamperedGutema la'[sd L UtraA, 1ut U l ca. A.Jd VdUL tAL LLLUL u LUL Lu XLkU .L,, Guatmalas trde, ut E Savador and Honduras startedI ir,porting fromor thirough Guatemala part of what they had previously imported from eachothLer. IA^s a resu lt, C,uatem,ala's exports in LthLe CommLon Narket continuedUto grow rapidly in 1969 (13 percent) and Guatemala thus ranked firstanong Central Anerican countries iLL value of exports, a position whichEl Salvador had kept up to 1968 (Table 3.9).

185. A strong inflow of foreign capital, mostly to the private sector,accompanied the rising trend of investment and imports after 1962. Thiscapital inflow, however, was insufficient to offset completely the currentaccount deficits. Reserve losses occurred in several years during the1960's, although net reserves at the end of 1969 were again at about thesame absolute level (US$50 millioIn or seven weeks of imports) as at thebeginning of the decade.

186. The rising level of foreign private indebtedness (increasingfrom $110 miillion in 1964 to $160 million in 1969; see Table 4.11) - mainlyshort-term supplier credits and credits to the private banking system - wasaccompaniedi by a substantial shortening of average maturities and risinginterest rates. While a shortenirng of average maturities is understandablein a time of generally rising interest rates, it nevertheless makes thebalance of payments more vulnerable to short-term liquidity pressures. Themission considers it an important element of future balance of paymentsmanagement that efforts are made to imiprove the maturity structure of thistype of debt. The authorities have the legal and administrative instrumentsto pursue such a policy, and, given their traditional concern with the pro-tection of the exchange rate and convertibility, can be expected to utilizethese instruments forcefully.

187. External public debt repayable in foreign currency rose from$26 million in 1961 to $91 million in 1969. However, debt service pay-ments rose about sixfold as average maturities shortened and interestrates increased. The ratio of amortization payments to debt outstandingincreased from about 7 percent in 1961 to 22 percent in 1969 and theaverage interest rate rose from 5 to 6 percent. The deteriorating publ:Lcdebt profile was mainly the consequence of financing a large part ofgovernment deficits by borrowing at 5 to 7 years from foreign banks.Gross bond placements with New York banks averaged about $11 million ayear, with a maximum of almost $16 million in 1967. As a result, theservice burden of public and publicly guaranteed debt rose substantiallyfrom 3 percent of current exchange earnings in 1961 to 9 percent in 1969.

Prospects and Creditworthiness

188. Expectations are that the present satisfactory balance of paymentssituation resulting from the coffee bonanza is not likely to last for verylong. As Brazilian coffee production recovers, prices are expected to declinein a few years, so that coffee export earnings are likely to fall from their

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present high levels. Since Guatemala's other traditional export products,cotton and bananas, and even some of the new export products such as meator manufactures are at best expected to grow only moderately, serious andsustained balance of payments difficulties could emerge after 1973, unlessremedial action is taken soon.

Table XI: GUATEMALA: BALANCE OF PAYMENTS WITHADDITIONAL EXPORT EFFORT, 1969-1976

(In millions of US$)

1969 1970 1971 1972 1973 1974 1975 1976A^$ Est. Projections-

Exports of Goodsand Services 308.9 320.4 346.6 377.0 398.5 449.5 494.9 550.5

Imports of Goodsand Services -343.4 -370.3 -421.1 -494.1 -517.6 -528.9 -564.0 -604.1

Transfers, net 15.1 12.7 12.5 12.3 12.1 11.9 11.7 11.5Amortization ofPublic externaldebt -16.2 -17.2 -22.7 -16.9 -15.1 -14.8 -11.2 -10.8

Gross CapitalRequirements 35.6 54.4 84.7 121.7 122.1 82.3 68.6 52.9

Financed by:PrivateCapital, net 24.2 22.1 57.1 110.4 102.9 32.0 27.5 -4.7Official Capi-tal, alreadycommitted 21.5 42.1 17.6 11.7 11.3 5.1 6.2 5.9

Official Capi-tal, addition-al recuirements - - 26.2 34.5 32.8 34.3 31.3 31.6

Change in Reservesincrease) -10.1 -9.8 -16.2 -34.9 -24.9 10.9 3.6 20.1

Source: Table 3.2

189. Guatemala has the possibilities as well as the necessary time tolaunch a manjr xpnnrt drive which would lay the hbais for acce1eretin0

economic growth while helping to maintain balance of payments equilibrium.Providing ne- soures of evxhangp earnings to the extent needed to, offsPt

the loss of dynamism of traditional agricultural exports is not, however,going to be ar. easy task, and will require a long and scutained effort.The realization of existing possibilities in mining, non-traditionalagriculture, manufactures and tourism dependso on fiscal, investment, credit

and export promotion policies which have not yet been adopted. As indi-cated earlier, the export push alone will not be sufficient to avoid future

- 65 -

balance of payments difficulties. It will have to be complemented by mea-sures reducing the growth of non-essential imports. Also, measures toavoid excessive short-and-medium private and public borrowing are calledfor. The following paragraphs describe in some detail how the balance ofpayments may develop over the next five years if a major developmient effortis carried out along the lines discussed in Chapter I.

190. Import Requirements. A development effort which would result. inan acceleration of GDP growth from about 5 to 6 percent may require thatimports of goods and services will be increasing at some 9 percent annually.Although still high, the implied import elasticity (1.4) would be much lowerthan in the recent past (1.9 in 1963-69), in line with the objective ofcurbing the growth of non-essential imports. During the next five yearsinvestment is expected to rise faster than GDP, as a result of public sec-tor programs and of the large mining project. Guatemala's high importelasticity is mainly explained by the almost complete absence of capita.lgoods production and high content of imported raw material of industria.lproduction. On the basis of observed relations between imports of inter-mediate and capital goods, gross domestic product and investment in the1960's, the mission projects import requirements of these types of goodsto grow at about 9.5 percent in 1970-76, compared with 10.0 percent in1964-69 (see Tables 3.6 and 3.7). These projections are based on: (i) se-parate estLmates of the import requirements of the mining proiect; (ii)the hypothesis that imports of other raw materials will grow more rapidlythan GDP (9) nercent ner annum; against 6 percent ner annum) as they didin the past (12 percent yearly in 1963-69, against 5 percent for GDP),but with less dlverging rates because of the exnectation that the nastrapid growth of industrial production and related raw materials' importsreqtuirementsl will slnw dnwn, anti (iii) an imnnrt tnntepnt of invePstmntother than in the mining project similar to that of the past five years(34 percen! on the average).

Tabhl XTT! TMP0RT REOUIREMENTS 1970-76

(In millions of US$)

1970 1971 1972 1973 1974 1975 1976

Total, cif. 288.6 329.7 391.4 402.1 401.3 428.1 460.5

Consumer goods 83.7 87.5 91.4 95.5 99.8 104.3 109.0Ra mateials/ 118.9 129.6 141.2 155.8 175.0 l19.0 207.5Capital goods 86.0 112.6 158.8 150.8 126.5 133.8 144.0

1/l i iL ULL- % nclu.lin lubr ic.t ants and4 fuelsSource: Table 3.6

191. Control of imports of consumer goods and services (especiallytravel expenditures auroauj wJll play a key role ir, keeping import growth

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within the above-mentioned overall target. Measures introduced in thepat hL-ave resulted ir.n a slowdoywn of growth of: cor,sumer goods from 9 per-

cent per annum in 1959-64 to about 5 percent in 1964-69. The mission'starget of Lurther redUuciLng the grUWIth rate to 4.5 perpercent per annum in1971-76 would not appear unreasonable. Travel expenditures abroad hadincreased sharply 'Ll 1962-66 (40 k ptCLLL peL aLrumLU) uefor-e measures wereintroduced in 1967. Since then travel expenditures did not increase. Forthe future, the mission assumed' that the annual growth of travel expenditureswould be kept at 5 percent. These targets are compatible with continuing toincrease imports of consumer goods from ot1her Central American Common riarketcountries (at 14 percent annually in 1971-76, the same rate as in 1969) whileimports from other countries would continue to decrease (at about US$2.1million per year, as in 1966-69). In order to achieve these targets, theauthorities will rely mainly on thle present import surcharges (Protocol ofSan Jose) which fall heavily on consumer goods, but will have also to in-troduce a selective control of foreign supplier credits and new measuresdescribed in more detail in the fiscal program.

192. Exports. Assuming that gross capital inflows of some $200 mil-lion annually in 1971-76 can be obtained (see below paragraph 199), exportsof goods and services will have to grow at slightly over 9 percent annuallyduring the same period if the above-mentioned level of imports is to befinanced and reserves to be kept at a prudent level (2 months of importsof goods and services). Although the target for tuture export growth isbelow what has been achieved recently (10 percent per annum in 1960-69),its achievement will require a substantial additional effort since thenatural export growth has been estimated to reach merely 6 percent perannum. The net balance of payments effects of the various export policyactions required to reach a 9 percent annual growth rate are summarizedbelow.

Table XIII: NET BALANCE-OF-PAYMENTS EFFECTS OF VARIOUS EXPORT POLICIES

(Tn milli-n of US$)(~

1971 1972 1973 1974 1975 1976

Export drive for non-traditional agriculturalproducts 0.4 2.6 8.0 12.4 19.2 26.2

Mining project 5.8 16.4 24.4 7.9 17.3 20.0Export drive for manufactures - - 3.0 8.6 16.0 26.0Tourism promotion - 1.9 4.6 8.0 12.4 17.9

193. As indicated in Daragraphs 50-61. the possibilities for develoDingnon-traditional agricultural exports are favorable. However, a deliberateGnvernment action will be recuired in complementing the private initiativeto set up and carry out production and marketing of these new products. Themost imnnrtant arePa nf Gnvprnment antion (see nar vranhs 67-72) would

VI

include the provision of credit and technical assistance, the building offeeder roads and storage facilities ani tle support of private LniLtiatvenow being considered with AID technical assistance in the area of jointregional marketing of new products abroad. In order to provide adequateworking capital for the new government or semi-governmental developmentbanks which will supply credit for agriculture and industry, substantialbudgetary transfers will be required. Thus, the success of the exportdrive will materially depend on taking adequate additional fiscal. action(see paragraph 134). If a vigorous and immediate effort is undertaken,agricultural exports other than coffee could increase by some 8 percentannually in 1971-76, against an expected annual increase without suchmeasures of about 4 percent. This acceleration would compensate in partfor the probable loss of dynamism of coffee exports after 1972, and totalagricultural exports would increase at about 5.6 percent yearly. Thesetargets may not appear ambitious if compared to the 12.7 percent averageannual growth of agricultural exports other than coffee in 1963-69. Buttheir real:Lzation will not be easy. The past increases were on a verysmall base (US$23.2 million in 1962) and in absolute terms were compara-tively modest, with cotton exports accounting for almost half the increaseby US$50.7 million in 1963-69. In view of the prospects of only a slowrecovery from the crisis in cotton production, in the future the mainburden of export expansion will fall on other agricultural exports (Table3.4).

194. The reversal of the recent trend of declining growth rates ofindustrial exports caused by the gradual completion of regional importsubstitution in consumer goods, will also be necessary if the overallexport targets are to be met. The CACM may still provide some furtherdynamism for industrial production and exports as some new intermediateor even capital goods are produced. within the region instead of beingimported. These possibilities have not yet been adequately studied andpresuppose, in any event, that the crisis in the CACM will be overcome. l/It appears, however, that if Guatemala is to achieve the target rates forindustrial exports (increasing from about 7 percent per annum in 1972to 12 percent in 1976 against an expected decline in the spontaneousgrowth rate from 10 percent in 1971 to 5 percent in 1970-76) it willhave to start orienting itself towards markets outside the CentralAmerican region. Some policy actions required to achieve the above in-dustrial export targets were sketched out above (see paragraphs 84-93).They mainly consist. in providing the necessary institutional and finan-cial support, including the setting up of an institution engaged in

1/ The immediate cause for the crisis was the armed confrontation, in1969, between El Salvador and Honduras. It did, however, bring to ahead longer term problems, related to dissatisfaction by some CA(Mmembers with the distribution of the trade expansion achieved. OnLyslow nroeress is being made to restructure the CACM: a modusoperandi is being discussed which would lay down the procedures bywhirh a mnre sAtisfartorv set of nolicies and institutions is to bereached eventually.

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project identification and preparation, market analysis and promotion.ad the provisio. of adequate long-term financing. In the longer rurn,a major effort to train the labor force will be required if labor pro-uc.ti iV ky to be rai sedA sufficient4 l- to allow Guatel..lan prodAUcts to

be competitive in international markets. The complex issue of providingad'equate incent-ives flor r.ontraditional export production - -- ------- edto import substitution - is another area which has not yet been suffi-cienrt'Ly stuuJ'U to allow Lthe prLeciLse UdefiLL.LLULL Ul policU,Ltsb. Gi VenI thLle

substantial level of protection, particularly after the recent 30 percentacrous LLtC uoaru Lariff 'L Lereasb, it seems tLaLiat sme import d'uty draw-backs or equivalent export subsidy measures may be called for to provideadequate incentives for launching a major export drive, provided revenuemeasures are taken simultaneously.

Table XIV: MERCHANDISE EXPORTS, 1969-1976

(In millions of US$)

i969 i970 l97i i972 i973 i974 i975 i976

Total exports 262 276 301 328 345 391 431 479

Traditional 151 161 175 190 193 188 191 199Goffpp 84 100 108 115 13 13 106 102 106Cotton 39 24 28 29 31 32 35 38Bnnann>R I8 22 26 33 39 36 39 40Other 10 15 13 13 14 14 15 15

Non-traditional 111 115 126 138 152 203 240 280Manufactures R8 89 97 104 1 1 19 13?l9 19

Minerals 4 5 5 5 5 36 52 68Vegetbles adr.

flowers 5 6 6 8 13 17 22 26Other 21 15 18 21. 21 25 27 30

Source: Table 3.4

195. Earnings from tourism, as shown by balance of payments statistics,l/have remained at the level o' about US$6.0 million per year in the decade1959-68. With its proximity to the United States and Mexico, its unusualand easily accessible scenic and historical sites, and its colorful folklore,Guatemala should be able to increase substantially both the number of touristsand their average stay. A growth rate of 25 percent annually in i972-i6,

1/ Which may understate total tourist receipts since they include trans-

actions through the banking sytem only.

although feasible, taking into account the very small starting base and theexperience in other countries, would have large implications for invest:mentin infrastructure and institutional changes.

196. The single most important element in the effort to promote non-traditional exports, accounting for over one third of the total foreign ex-change earnings expected from the measures proposed (see Table XIII) will,however, be the rapid execution of the nickel project, which is present:lyin an advanced stage of negotiation and on which construction could be startedas soon as an agreement is reached. The project would result in largenet capital inflows during the construction period - including si zeablelocal expenditures - and net export earnings are estimated to reach someUS$20 million annually in the third year after construction is completed.

197. The above export projections assume that existing trade restric-tions on the part of Guatemala's major trading partners are maintained.These restrictions affect only an estimated 15 percent of total exportsof Guatemala. Nevertheless, they include promising items such as; meat,vegetables, fruits and textiles. More liberal policies by Guaterala's maiorindustrial trading partners could be a decisive factor in permitting arapid expansion of foreign exchange earnings from these items. The prco-blem of restoring the dynamism of exports after 1972 would then becomeconsiderably easier.

198. External CaDital Requirements. Gross capital inflow in 1971-76is estimated at some US$1.23 bill:Lon compared to US$0.72 billion in1964-69- However- net canital inflows are much lower- given the con-siderable repayments falling due during the period. The much largercapnital inflnw- than in the nast are mainly reILated tn the Pxeprtinn nfthe mining project - accounting for virtually all of the increased pri-vate capital inflows - and the carrviny nut nf a m,u-h larger public in-

vestment effort.

199. ]?rivate capital inflows during 1971-76 are estimated at aboutUS$1 hillion on a gross and 11US320 milILinn nn net hbais, enmpared toa net of US$200 mi'Llion in the past 6 years. In projecting private capi-t.1 infl^ ,,,, t1hp co4nn line ~ nccinume th nft tha. r_-~,a m -- li.741 1 ha a.,--aacf.. 1ta nflows the mission ar.s..dta h Goverr.ment will be scesu

in curbing the growth of supplier credits for non-essential imports andin~~,, 4oea improvngr1 the matu.r ity strucrture both~ for. ,1, suple rs redi ts

and borrowing of the banking system, through ceilings on short-term debtsotr theor measuc r 7S 1 /

200. Th.-e public sector (including credift lines char.nellled to theprivate sector) would require in 1971-76 about US$156 million on a net

1/ For iLlustrative purposes the mission has set the following targets:iIlUpOVE theI ratiLo of a,i,ortzLtioLr.tLLUUtsaLdinLgLL1 UUL d LUIUf .98 in 196

to .75 in 1976 for debts of the private banking system and from .47to .40 for other private debt (see Table 4.11, Appendix).

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basis and 60 percent more on a gross basis (US$250 million). About US$60

million represent disbursements from the existing pipeline of foreign develop-

ment loans leaving some US$190 million to be contracted. The bulk of

new commitments will have to be ready in 1971-72, thus indicating the

need to proceed speedily with project preparation and negotiations of

these loans. In estimating public capital inflows the mission has assumed

that (i) external lending agencies continue their present policies,

and (ii) within three years the Government phases out medium-term bond

placements abroad as is suggested in the Plan.

201. Assuming average terms for the major external lending agencies

and suppliers roughly in line with their present ones, 1/ the external

public debt service burden during the next few years would fall from 8.3

percent of export earnings on goods and services in 1969 to about 5 per-

cent in 1976. Although longer-term projections are quite conjectural, a

continuation of the policies outlined should suffice to keep the ratio

below its 1969 level in subsequent years; i.e. up to the mid-1980's. The

implied policies suggest a major departure from past trends which are

crucial, if Guatemala is to step up substantially its development effort

without being saddled with an increasing debt problem. Such a change in

policy appears feasible, provided an appropriate fiscal effort is made,

since the investment program has a strong project content and a large

proportion of it (75 percent of total investment) qualifies for borrowing

from international lending agencies. The above lending mix assumes a con-

siderable share of foreign borrowing on relatively soft terms (50 percent

of total). This appears justified since, if Guatemala were to secure all

its new debts on hard terms 2/, the debt service ratio would increase sub-

stantially, reaching about 12 percent by 1976 and further increasing to

about 15 percent in the early 1980's. The budgetary burden would also be

heavy. Incremental debt service payments under the hard term assumption

would absorb about 22 percent of incremental public current revenues (in-

cluding new tax measures) against 13 percent on average in 1970. Provided

the necessary fiscal and development policies are adopted and the maturity

structure of the public debt is improved along the above lines, Guatemala

will be creditworthy for the rather substantial amouInts of external borrow-

ing envisaged in this report.

1/ IBRD: 7 percent interest, 25 years repayment (including 5 years grace)

TDB: 4 percent interest, 28 years repayment (including 4 years grace)

AID: 3 percent interest, 40 years repayment (including 10 years grace)

CABREI: 6 nercent interest, 24 years repayment (including 4 years grace)

Supplier: 8 percent interest, 7 years repayment (including 0 years grace)

Bon.ds: 13 pereent interest, 5 years repayment (including 0 years grace)

2)/ A-ss 4rg 60 percenrt of all new debt from suppliers and bond sales with

foreign commercial banks (for terms see footnote 1/); balance at terms

of 7 percent, 20 years repayment including 4 years grace.

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