VZCZCXYZ0013
RR RUEHWEB

DE RUEHGT #0446/01 1001945
ZNR UUUUU ZZH
R 091945Z APR 08
FM AMEMBASSY GUATEMALA
TO RUEHC/SECSTATE WASHDC 5124
INFO RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC

UNCLAS GUATEMALA 000446 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: EFIN ECON PGOV GT
SUBJECT: GOG STRUGGLES TO MAKE ENDS MEET 
 
¶1. SUMMARY: The Colom administration arrived in office with a 
surging economy and a reasonable budget that projected a 2008 fiscal 
deficit of 1.6% of GDP.  On April 1, Guatemala's Congress approved 
the last of five IDB and World Bank loans necessary to finance the 
2008 budget deficit.  Finance Minister Fuentes Knight is now 
searching for ways to pay for a previously undisclosed debt of $262 
million that will raise the budget deficit to 2.4% of GDP.  Adding 
to the already difficult fiscal situation is pressure to reduce a 
petroleum distribution tax and subsidize basic foodstuffs to help 
Guatemalans cope with surging prices of food and energy (inflation 
was 9.1% for the year ending March 31).  Some medium term relief 
could come from the successful enactment and implementation of a tax 
reform proposal that would increase tax revenues from 12.3% to 13.2% 
of GDP by 2010.  END SUMMARY. 
 
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Tough Start 
----------- 
 
¶2. In December 2007 Guatemala's Congress approved a budget for 2008 
that called for $5.5 billion in expenditures, a 5.8% increase over 
¶2007.  Based on this spending and estimated tax revenue, the Finance 
Ministry projected a 2008 budget deficit of $600 million or 1.6% of 
GDP. Financing for the deficit was to be primarily via five IDB and 
World Bank loans; however, these loans were not approved with the 
overall budget.  What was supposed to be a relatively simple process 
became politicized as Congress grilled Finance Minister Juan Alberto 
Fuentes Knight over the loans, complaining about the size of 
administrative expenses needed to service the loans.  Four of the 
five loans were approved by narrow margins in Congress during the 
first two months of the year.  Congress approved the fifth loan, a 
$100 million World Bank loan to finance security and social 
programs, on April 1. 
 
¶3.  In addition to the difficulty the administration had in winning 
Congressional approval to finance previously approved spending, the 
Colom administration discovered $262 million in previously 
undisclosed spending by the previous government, primarily on 
infrastructure projects.  These were generally highway projects 
undertaken by the Berger government last year (an election year), 
aimed at burnishing the electoral credentials of the GANA.  The debt 
amounts to 0.8% of GDP, which will increase the deficit to 2.4% of 
GDP in 2008.  The government plans to ask for an additional 
emergency appropriation to pay approximately half of this debt, and 
will reduce spending in the Ministry of Communications to pay for 
the other half. 
 
--------------------------------------------- -- 
Inflation creates additional budgetary pressure 
--------------------------------------------- -- 
 
¶4.  In addition to the difficulties Guatemala had in securing funds 
to finance previous obligations and planned spending, additional 
pressure on the budget is mounting.  Surging fuel costs and their 
ripple effect on transportation costs for other goods and services 
have injected significant inflationary pressure into the economy. 
Inflation for the year ending March 31 was 9.1% (as compared to 7.0% 
one year ago) with price pressure led by the energy and food 
sectors.  Congress is considering a bill to reduce taxes on 
petroleum distribution (currently 7% of the tax base) and the 
administration is considering a number of measures, including 
subsidies on basic foodstuffs, to alleviate the pressure inflation 
is placing on the pocketbooks of poor Guatemalans.  Implementation 
of any of these measures will have negative consequences for 
Guatemala's fiscal balance that can not be quantified at this time. 
QGuatemala's fiscal balance that can not be quantified at this time. 
 
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New Programs 
------------ 
 
 
¶5. Beyond immediate needs, the government would like to begin 
implementing some of the social and security programs promised 
during last year's campaign.  Social programs high on the agenda 
include the Student Remittances Program, which would make payments 
to families of children in Guatemala's poorest 45 municipalities to 
ensure they attend school, and the Elderly Citizens Program, which 
would be a pension program for the elderly.  On the security side, 
the government has proposed budget augmentations for the Judicial 
Branch and the Public Ministry (specifically, the National Institute 
of Forensic Sciences- INACIF).  According to the Finance Ministry, 
funds to support these projects could be raised through 
corresponding budget cuts in other areas or by securing an 
additional $40 million loan from the Central American Bank for 
Economic Integration.  In addition, on April 8, the government 
announced its intention to purchase six Brazilian "Super Tucano" 
aircraft and ten speedboats to assist with drug interdiction.  The 
cost and source of financing for these acquisitions has not been 
disclosed. 
 
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Tax reform package could increase revenues 
------------------------------------------ 
 
¶6.  On March 17, Colom's economic team unveiled a tax reform 
proposal that could, if approved and successfully implemented could 
raise tax revenues from 12.3% to 13.2% of GDP.  Finance Minister 
Fuentes Knight explained that the basic idea of the plan is to lower 
marginal tax rates and eliminate exemptions.  In this way, he hopes 
to simplify the tax code, eliminate many opportunities for evasion, 
improve collections and raise overall revenues.  The proposal lowers 
the corporate tax rate from 31% to 25% and lowers the percentage of 
sales that can be written off as expenses from 97% to 95%.  (Note: 
this provision is meant to ensure that even loss-generating 
companies pay some income tax.  End note.)  Proposed changes to 
individual income tax rates are more drastic.  The current range of 
tax brackets (from 15% to 31%) will be replaced by two rates:  5% 
for annual income up to 240,000 Quetzales (approximately $32,000) 
and 7% for incomes above that amount.  According to Fuentes Knight, 
the elimination of deductions would more than make up for the large 
reduction in the tax rate.  He projects the reform proposal will 
increase tax revenue by $370 million per year by 2010. 
 
¶7. COMMENT: Guatemala's sound macroeconomic fundamentals, 
historically conservative fiscal policy and flexible exchange rate 
should work together to prevent a slightly higher fiscal deficit 
from negatively impacting credit ratings or the broader economy. 
Current pressure on the budget is a result of an unusual confluence 
of factors including the hidden debt and inflation pressures that 
should abate when energy prices stabilize.  The tax reform proposal, 
if implemented, could also eventually provide the Government with 
some relief to current budgetary pressure and additional flexibility 
to pursue social and security programs.  Fuentes Knight has proposed 
a modest reform, hoping to avoid opposition from powerful business 
groups.  The private sector has expressed provisional support for 
the proposal, although some business leaders are questioning the 
elimination of specific deductions.  The administration's difficulty 
in convincing Congress to pass loans in support of a previously 
approved budget suggests it may have an uphill battle to pass tax 
reform.  In the meantime, the Colom administration will need to 
carefully weigh its desire to increase social spending against the 
need to maintain macroeconomic stability and a manageable fiscal 
deficit. 
 
DERHAM