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Over the course of the last twenty years, there has been a significant amount of foreign direct investment (FDI) injected into Central American economies. Much of this increase in capital inflows can be viewed as a response to the policies of economic liberalization that were widely enacted by the countries of the isthmus that began to be implemented during the late 1980s. These laws resulted in the establishment of regulatory frameworks that treated FDI in Central America favorably, allowed for entry into the region’s domestic markets, and established rights to foreign ownership.
In 2017, foreign direct investment in Central America exceeded US $12 billion. This represented an increase of 9.8% when compared to figures that were recorded during the previous year.
In the period from 2010 to 2017, investment in Central America from outside of the region grew at a rate of 7.9%. This means that, in recent years, the participation of Central America in the receipt of FDI as a percentage of the total that has been received by the whole of Latin America and the Caribbean has increased. While in 2010 the percentage of FDI received by Central America was 3.9% of the total for Latin America and the Caribbean, by 2017 this figure had doubled to reach 7.8%. The Economic Commission for Latin America and the Caribbean (ECLAC) estimates that this trend will continue for the next several years.
According to ECLAC, free trade agreements have given the countries of Central America a clear advantage as regards the attraction of foreign direct investment to the region. The most prominent free trade agreement that has positively affected FDI in Central America is the US-Central America-Dominican Republic Free Trade Agreement (DR-CAFTA).
Costa Rica and Panama lead the way in the attraction of foreign direct investment in Central America.
Figures reveal that, when considering outside investment over the last decade, Costa Rica and Panama have been the clear leaders. The two countries have accounted for more than half of the FDI revenues garnered over the ten-year period, while other economies in the region (such as El Salvador) received less than 5% of the total.
While Costa Rica captured US $2.7 billion dollars of FDI in the region in 2017, which represented 20% of the overall total, Panama came in first with over US $5.3 billion dollars. This amount constituted 47.5% of the total foreign direct investment in Central America in 2017. Countries following Costa Rica and Panama were El Salvador with 3.2%, Nicaragua with 8.2%, Honduras with 10.4%, and Guatemala with 10.8%. Although Panama led the way in foreign direct investment in Central America in 2017, Costa Rica positioned itself as the country with the largest nominal increase in FDI in that year. This corresponded to an amount totaling US $538.4 million. Countries such as Honduras, Nicaragua, and Guatemala, however, have not shown significant changes in FDI capture since 2010.
The main sources of foreign direct investment in Central America
As regards the origin of the influx of FDI in Central America, the biggest concentration of investment of external investment has its source in countries that share important commercial links with the region. The leader of investment in Central America in 2016 was the United States with capital inflows totaling approximately US $10.9 billion. This number represented 27.3% of the funds that the region attracted that year. After the United States, the European Union contributed 17.2% of foreign direct investment in Central America.
In addition to the US and the EU, the last decade has seen a rise in the participation of Latin American countries in Central American FDI income. Such is the case with Colombia. While in 2007 the foreign direct investment income from this nation did not reach 6% of Central America’s total, by 2017 the Colombian contribution to FDI in Central America rose to 12.2%.
Another Latin American country that has, in recent times, increased its investments in Central America is Mexico. In 2016, Mexico added a total of US $579.1 million in FDI revenue. This represented 5.3% of the funds received in the region as a whole and a growth rate of 9.9% over the period 2010-2016.
Over the last several decades, the service sector has been the main recipient of the region’s FDI. Capital inflows in this area increased as a result of the privatization of public enterprises in the 1990s. This was mainly in the realm of financial services, telecommunications, electrical power generation and distribution, and municipal water systems. In this way, the first wave of increased FDI in the region was focused on the acquisition of public enterprises that concentrate on the delivery of services. In more recent years, however, FDI in Central America has expanded to other productive sectors. This movement of capital has been greatly facilitated by the creation and expansion of free trade zones, as well as the signing of free trade agreements in support of export manufacturing activities.
What kind of incentives are needed to increase foreign direct investment in Central America?
According to the Economic Commission for Latin America and the Caribbean (ECLAC), one of the factors that enhances the inflow of foreign direct investment in Central America relates to the region’s promotion as a prominent point of public policy. This includes the implementation of a strategy of providing information to potential investors through specialized, government-sponsored investment promotion agencies.
Although investment tax incentives (such as exemptions on tariffs, duty drawbacks on exports, reduced corporate income tax rates and VAT payment exemptions), are of the utmost importance to many investors that seek to inject FDI into Central America, there is also evidence that suggests that there are non-monetary issues that also play a prominent role in the decision-making process as well. Among these are the presence of the educated human capital and quality infrastructure that is needed to provide support to operations.
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