RENEWED DEBATE ON DOLLARIZATION IN HONDURAS, BUT

UNCLAS SECTION 01 OF 02 TEGUCIGALPA 002996

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STATE FOR WHA/CEN, WHA/PPC, EB/OIA, INR/B
STATE PASS AID FOR LAC/CEN
STATE PASS USTR, EXIM, OPIC
STATE PASS USED IDB, USED WB, USED IMF
GUATEMALA FOR COMMAT:DTHOMPSON

E.O. 12958: N/A
TAGS: EFIN ECON EINV PGOV HO ETRDECD
SUBJECT: RENEWED DEBATE ON DOLLARIZATION IN HONDURAS, BUT
GOH POLICY UNLIKELY TO CHANGE ANY TIME SOON


1. (SBU) SUMMARY. Liberal Party congressman and businessman
Jaime Rosenthal Olivia and banker Jorge Bueso Arias have
renewed their appeals for dollarization in recent weeks. The
two bankers argue that replacement of the lempira with the
dollar would help increase capital investment and lower
interest rates. They claim the GOH has used gradual
depreciation of the lempira, the Honduran national currency,
as a tax on the public to generate revenue. GOH officials
have downplayed the issue, simply commenting that the
preconditions for dollarization do not exist in Honduras.
The leadership of the Congress has agreed to hold hearings at
Rosenthal's request but there are no plans in the legislature
to push for dollarization either. End Summary.

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Rosenthal's Complaint is With the Exchange Rate Policy
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2. (SBU) Jaime Rosenthal Olivia, Secretary-General of the
Liberal Party (PL) and a private businessman with banking
interests, renewed his public calls for dollarization in
early October. Rosenthal's key concern appears to be the
Central Bank's policy of gradual depreciation (currently five
to six percent annually) designed to maintain purchasing
power parity with the U.S. and competitiveness of Honduran
exports. Jorge Bueso Arias, president of Bank Occidente and
an active member of the Liberal Party, has expounded upon
Rosenthal's argument. Bueso Arias terms the exchange rate
policy, in which the lempira has lost 26 percent of its value
since 1998, as a tax on average Hondurans. Bueso Arias
believes that if the GOH keeps devaluing the lempira, it
would be better to dollarize.


3. (SBU) Rosenthal terms the steady depreciation of the
lempira as instability that undermines Honduras' economic
development. He argues that dollarization, by eliminating
currency risk, would increase foreign and domestic
investment. He asserts that dollarization would lower the
risk premium for investments in Honduras and result in lower
interest rates and inflation. He also claims that
dollarization would increase remittances and reduce capital
flight (which he discusses in terms of Hondurans who protect
the value of their savings by converting their lempiras into
dollars). The bankers' arguments imply they believe that
dollarization would lead to more sound fiscal policies.


4. (SBU) Comment: There are a number of apparent fallacies in
Rosenthal's argument. The GOH has instituted its exchange
rate policy purposely in order to avoid pressures that would
result in a sudden devaluation of the lempira and a financial
crisis. Hondurans are able to both save and lend in dollars
or lempiras, so there is no impetus toward capital flight or
a disincentive to the sending of remittances (which have been
growing at a high rate since 1998). The high interest rates
and limited availability of medium and long term loans are
related to country risk, problems in collection of loans, and
the weakness of the banking sector (there have been several
bank failures in recent years); currency risk appears to play
a small role. The Central Bank has brought inflation down
steadily since 1999. Because of Honduras' high indebtedness,
the government is restricted in its ability to print money to
finance deficits. Finally, the Liberal Party contingent of
the Congress has been a major impetus for the pop
ulist, budget-busting legislation which has caused the
government's intractable fiscal problems. Dollarization
would not fix this. End Comment.

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The GOH - Honduras is Not Ready
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5. (SBU) GOH officials in the Maduro administration, just
like their predecessors in the Flores government, have
downplayed the proposal, explaining quietly that Honduras is
not in a position to dollarize at this time.


6. (SBU) Maria Elena Mondragon, president of the Central Bank
of Honduras, and Ana Cristina de Pereira, president of the
National Commission of Banking and Insurance, have noted that
the country must lower inflation and the fiscal deficit to
U.S. levels before dollarization can be considered.
Mondragon also has noted to the press that international
reserves equal four months of imports, reducing the risk of
an abrupt devaluation. Mondragon also said that
dollarization will not solve the country's economic and
financial problems. Cristina de Pereira has explained to the
press it would take at least five years for the country to
make the necessary economic structural reforms before the
country can dollarize.


7. (SBU) President Ricardo Maduro has commented publicly that
while Central America is on the road to dollarization,
Honduras is not ready. He has been clear that the GOH will
not pursue dollarization during his four-year administration.

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USG Official Neutrality
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8. (SBU) Per U.S. policy, Embassy officials will not take a
position on dollarization if asked. EmbOffs will point out
that this is a decision for the government of Honduras to
make, after balancing the pros and cons. If in the unlikely
event that GOH officials ask our advice, Post will refer the
inquiries to the Treasury Department.


9. (SBU) Comment: The Embassy does share the GOH's assessment
that the preconditions for dollarization do not exist in
Honduras at this time. The GOH has not achieved fiscal
stability (fiscal deficit exceeded six percent of GDP in
2001). Inflation is declining but is still far higher than
U.S. inflation rates, resulting in the need for gradual
depreciation to avoid making exports uncompetitive. The
financial system is fragile, and despite improved supervision
under the Maduro administration, much remains to be done.
Exchange rate reserves, at about four months worth of
imports, are adequate but not sufficient to ward off a
financial crisis. To date, we have not seen clear political
commitment and civil society support for the types of
structural reforms that would make dollarization feasible.
Without these conditions in place, dollarization would lead
to greater economic stagnation and unemployment because of
the inability of the economy to adjust to external shocks.
End comment.

Pierce
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