Fitch Ratings today said that the passage of CAFTA in the U.S. Congress will have positive economic implications for the Central American region and the Dominican Republic (CAM) over the medium to long term. However, as the benefits of the treaty will only accrue over the medium term, the eventual passage of CAFTA by participating countries will not, in itself, have immediate positive rating implications for the sovereigns currently rated by Fitch. Fitch rates three of the six countries (The Dominican Republic ['B-'], Costa Rica ['BB'], and El Salvador ['BB+]) that have negotiated CAFTA with the U.S.
Fitch notes that not all the countries have approved CAFTA in their respective legislatures, and in some cases, such as in Costa Rica, the approval of the treaty may take some time. As most of the imports from the U.S. enter these countries with low tariffs and import liberalization on various U.S. products have long transition periods, with the exception of the Dominican Republic, it is unlikely that these countries will face significant fiscal pressures due to the loss of trade-related revenues. The Dominican government estimates that it could lose up to 3.5% of GDP in trade-related revenues due to the implementation of CAFTA, which could have a short-term negative impact on fiscal balances if a tax reform is not approved.
The treaty is likely to consolidate the trade relations of the CAM countries with the U.S. All of these countries already benefit from the Caribbean Basin Initiative under which textile exports enter the U.S tariff-free provided that the raw materials are sourced from the U.S. The CBI benefits had to be extended by the U.S. Congress periodically; however, with the approval of CAFTA, the access to the U.S. market will become permanent for the CAM countries. Moreover, under the CAFTA agreement, companies in the region could use inputs from countries other than the U.S., thereby improving their cost competitiveness and profitability. CAFTA would also help some of these countries compete more effectively in the textiles sector against China. This will clearly benefit countries such as dollarized El Salvador, where competing with China on the basis of only lower costs is unlikely to be successful in the long term. At this juncture, it is difficult to quantify the actual benefits in terms of higher exports, though anecdotal evidence suggests that the upturn in exports is likely to be modest in the short term. Other main benefits of the treaty would be greater legal certainty and better access for certain products such as sugar, ethanol, dairy, and other agro-based industries, nontraditional agricultural plants, ornamental flowers, and ethnic products.
In Fitch's view, the CAFTA agreement could engender a virtuous cycle of higher foreign direct investment and higher growth in some countries. Foreign companies may have an incentive to set up operations in these countries to take advantage of lower labor costs as they will be guaranteed access to the U.S. market. However, the degree to which foreign direct investment will increase in the region will depend on the efforts made by these countries to improve their legal and regulatory environment, infrastructure facilities, and human capital. In some cases, such as in Costa Rica, the state monopolies in the telecommunications and insurance sector would have to be opened up to competition, which will indirectly benefit the industrial and services sector in that country as well.
Fitch also believes that if exports and foreign direct investment flows pick up in the region in response to greater market opportunities, then the treaty will be quite helpful in diversifying these economies further in the tradable-goods sector. It is unlikely that these countries will see an increase in their export bases of the magnitude seen in Mexico as a result of NAFTA; however, even a modest increase in exports and GDP growth over the medium term could help reduce their external debt burden and alleviate pressures on their fiscal accounts. In addition, growth in nontraditional exports could make them less vulnerable to commodity price swings. Higher growth and employment creation resulting from the treaty could also strengthen the democratic institutions in these countries. Finally, CAFTA could help pave the way for broader trade integration of South America with the U.S.