C O N F I D E N T I A L SECTION 01 OF 04 SANTO DOMINGO 006075

SIPDIS

DEPARTMENT FOR WHA/CAR, WHA/ECPS AND EB/IFD/OMA;
TREASURY FOR OASIA; NSC FOR SHANNON

E.O. 12958: DECL: 10/27/2005
TAGS: EFIN ECON ECIN ENRG EINV DR
SUBJECT: AMBASSADOR AND EXIM BANK METTINGS WITH PRESIDENT,
ECONOMIC CABINET AND IMF

REF: SANTO DOMINGO 5564

Classified By: Ambassador Hans H. Hertell; Reasons: 1.5 (B AND D)



1. (C) Summary: The Ambassador and Ex-Im Bank officials had
a series of meetings October 20-21, with President Mejia,
members of his economic cabinet and International Monetary
Fund Representatives. Mejia expressed frustration about
delays in disbursement of loans from the IMF and the
multilateral development banks. GODR officials reaffirmed
their commitment to the Fund program; separately, IMF
representatives said they were working closely with the GODR
and noted problems in the energy sector and political
pressures on the President. Embassy is submitting septel its
assessment of the Dominican financial and political
situation. End summary.


2. (SBU) On October 20-21 an EXIMBANK team accompanied the
Ambassador for discussions of the Dominican financial
situation and bilateral lending. The group called first on
Technical Secretary Carlos Despradel, Central Bank Governor
Jose Enrique Lois Malkun and Finance Secretary Rafael
Calderon; on October 21 they met President Mejia and visiting
IMF staffers. EXIM officials also had contacts with local
bankers and the private sector. (Exim team consisted of
Senior VP for Finance Jeffrey Miller, Senior VP for Credit
and Risk Assessment John McAdams, Counsel Peter Gilbert, and
Country Manager Kathy Flanigan.)

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Difficult times
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3. (C) Technical Secretary Despradel reviewed the financial
situation since the Baninter crisis emerged this past spring:
the country has reduced imports 20-25 percent; even so,
exports, tourism and remittances are at record levels. The
GODR has reduced capital expenditures by 35 percent in
nominal terms (60 percent if inflation is into acount).
Inflation, running currently 35 percent, is a serious issue.
One proximate cause has been the "tremendous

outflow of
capital." Despradel acknowleged that the government had
increased its payroll 6 percent.


4. (C) Despradel reiterated his reluctance to approve any
new debt, including any Ex-Im financing, except for projects
of the very highest priority to the President (for example,
water projects and asphalt). He said there was a lot of
pressure on the President to approve costly projects, but he
(Despradel) was opposed. If he approved anything at all, he
wouldn't be able to control political pressure on other
projects and the GODR would not meet IMF limits.


5. (C) Finance Secretary Calderon commented that "reports
that arrive concerning the country are not always accurate."
Calderon noted that the Dominican Republic had suffered
external shocks over the past 2-3 years, "like the rest of
the world." These included the U.S. economic slowdown, the
effects on tourism of the Sept. 11 terrorist attacks and the
Iraq war, oil price spikes, and Venezuela's cutoff of oil
exports ("a situation that will remain bad as long as Chavez
is in power"). On top of that, Calderon said, came the
internal shock of Baninter, followed by two other bank
failures, that have created a huge quasi-fiscal deficit.
Calderon said that the GODR knew it had no choice but to
assure monetary and fiscal discipline "with or without an IMF
agreement."



6. (SBU) Calderon said that despite all of these adverse
factors, GDP growth for 2002 was 4.2 percent. Although IMF
has projected a three percent contaction in 2003, the first
six months of the year showed only minus eight-tenths
percent. He commented that exports for 2003 were at record
levels; tourism was up 24 percent over last year, with hotel
rooms "fully booked" until mid 2004; and remittances were up
five percent over last year. Economic statistics showed
strong investment, even in the electricity sector. (COMMENT:
In contrast to this assurance, recent press reports show
investment decreased more than 9 percent over last year, with
its annual contribution to GDP down nearly half over the past
five years -- from 7.91 percent contribution to GDP in 1999,
to a projected 3.98 percent for 2003.)
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Status of arrears to USG
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7. (C) Calderon expressed surprise when Ex-Im bank asked
about GODR arrears of USD 600,000 to EXIM for a power project
loan and said he had already instructed the Central Bank to
pay.


8. (C) Central Bank Governor Lois Malkun told Ex-IM that
the GODR was modestly in arrears to a number of creditors,
and he could not say when Ex-Im might be paid. The Governor
did takee note that if the arrears persisted byond November
15, Ex-Im would be taking steps to suspend lending.

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Central Bank Outlook
--------------


9. (C) Central Bank Governor Lois Malkun offered a less
optimistic assessment. He sees the GODR facing two principal
problems: 1) a revenue shortfall, and 2) the consequences of
the GODR decision not to honor the IMF's request to consult
before buying out the shares of electricity distribution
companies held by Spanish company Union Fenosa. Lois Malkun
mentioned the President's frustration at the political
obstacles to getting Congress to approve additional tax
measures. Though the GODR had decreased expenditures, it had
nevertheless acumulated USD 114 million in arrears in
September -- a period for which the Fund agreement set a
ceiling of USD 70 million in arrears. Lois Malkun said that
the GODR had reduced arrears to USD 63 million by October
14, but could not continue to pay "without pesos." The
Governor said a priority for him was obtaining disbursement
of IDB and World Bank loans. He said that the GODR might
need bridging finance. He projected an improvement in the
exchange rate and economic conditions by December.


10. (C) Lois Malkun said that further serious problems had
emerged in the banking sector after conclusion of the IMF
agreement. Books at the failed Bancredito were not clear and
might cause problems for the expected takeover of Banco
Profesional by the Leon Jimenez Group. Even so, he expected
the deal to be concluded very soon. He said the Central Bank
did not intend to issue certificates of deposit to back
Bancredito depositors, as it had with Baninter. (NOTE: we
have heard from various sources that some CDs were issued
quietly but then stopped. End Note.) The Governor said that
other Dominican banks were in good shape and 40 auditors
would arrive within the week to conduct the banking sector
audit required by the Fund agreement.


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President's View: A Long Time Coming
--------------


11. (C) President Mejia reiterated to the Ambassador and
Ex-Im visitors his frustration at the slow disbursement of
international financial institution (IFI) loans (reftel). He
pointed to incomplete projects in the country and said that
in three-and-a-half years of discussions and negotiations, he
had received nothing from the World Bank, despite its
repeated promises to assist with the electricity sector. The
President blamed current economic problems on the banking
sector crisis and said that subsequently, the IMF and IDB had
paralyzed the country by not disbursing funds. The President
said that if he did not help the people in need it, he would
be thrown out and that he could not wait for "manna from
heaven."


12. (C) Mejia again defended his decision to repurchase
from Union Fenosa two of the country's three electricity
distribution companies. Union Fenosa management had been
exploitive and corrupt; the company had left many unpaid
debts behind. GODR officials had commented earlier that the
repurchase would improve cash flow and reduced GODR debt
(arguing that as a partner, the GODR was already responsible
for half of the companies' liabilities).
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Raising Revenue
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13. (C) CB Governor Lois Malkun, also present along with the
other officials, said the GODR was still working with
Congress on passing a five percent export tax, but indicated
there was not much support among members. The Supreme Court
recently declared unconstitutional the August presidential
decree imposing the tax. Lois Malkun described the situation
as "complicated" and said the GODR was working on other
ideas. He commented that real fiscal reforms would be
impossible prior to presidential elections. Technical
Despradel was also pessimistic on that point: Congress would
not approve any tax increase and the business community would
not support any tax that could not be directly passed on to
the consumer. Despradel expressed concern that some elements
of the GODR might propose some type of exchange rate control.


14. (SBU) Calderon noted that the GODR did have sources of
funds to pay foreign debt and that those funds could not be
used for other purposes. These included the 3 percent carbon
tax (on fuel puchases), a two percent temporary import tax,
the 0.15 percent check cashing fee, and the departure tax at
airports, recently raised from USD 10 to USD 20.

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The IMF view
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15. (C) IMF Country Manager Marcelo Figuerola and temporary
Resident Representative Ousmene Mandeng told the Ambassador
and visitors that the GODR was cooperating with the Fund.
The President was heavily involved in all areas of the
financial issues with "the economic team taking orders."
Figuerola acknowledged a rocky start to the standby with
surprises in the banking sector and more fiscal and financial
shortfalls than the GODR had initially estimated. There had
also been GODR delays in providing information, an economic
team which appeared inexperienced in Fund procedures and not
fully aware of Fund priorities.


16. (C) Figuerola identified three issues:

-- The GODR's September approach to the Paris Club had caused
concern. It was not coordinated with the bank; the GODR was
not facing a payments gap at that point.

-- The GODR had continued to accumulate arrears.

-- The impact of the Union Fenosa on fiscal balances was
still unknown. The IMF had requested a 30-day delay, to no
avail. The GODR had proceeded, without taking into account,
for example, the consequences for the World Bank electricity
sector loan ready for approval within 2 weeks. The Union
Fenosa deal had raised questions of the degree of GODR
commitment. As for the technical side, the GODR continued to
assert that the electricity deal would not have a big impact.
Figuerola said IMF rarely got involved in energy sector
issues, but in this case, problems in the sector were serious
and the GODR needed to do something quickly.


17. (C) The IMF rep said the GODR had moved forward in a
number of areas, such as the banking sector audit and reforms
and unification of the exchange rate. Further actions were
required. He could see that a core group in the
administration was committed to the Fund agreement, but, he
said, "they need support from others in government to take
the necessary steps."


18. (C) The IMF was not negotiating yet. Figuerola said they
were consulting and helping the independent commission
evaluate the electricity sector. The review might begin
before the commission is entirely finished, but the IMF
needed commission results to conclude their analysis.
Figuerola said it was possible that the review could go to
the board before the end of the year.


19. (C) The IMF confirmed that that the banking sector audit
was underway and that the Fund continued to deal with the
consequences of the three bank failures. Figuerola echoed CB
Governor Lois Malkun: Baninter was in the liquidation
process, some issues remained with Bancredito, and the
acquisition of Banco Mercantil by Republic Bank of Trinidad
and Tobago had gone well. His impression was that banking
sector reforms were moving as they should, but results of the
audits would be important.


20. (C) Debt is another key issue. The devaluation had
essentially doubled foreign debt, a serious problem for a
government which "likes projects." The IMF reps said the
GODR must determine its payment priorities within the limits
of the agreement. The GODR would need to be very careful.
Figuerola added that the GODR had provided the IMF with a
list of assets it could sell if needed to help cushion the
payment situation.


21. (C) The IMF team commented that presidential elections
would make the situation more difficult, particularly because
of the short-term political costs of austerity. Popular
expectations were always a problem, because reforms yielded
evident gains only in the medium-term.

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Comment
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22. (C) It is clear that the Dominican Republic is facing a
difficult situation that may get worse in the next few weeks.
Septel provides Embassy's assessment. Finance Secretary
Calderon may be in the most difficult position, poised
between IMF requirements and the President's desire for
financing for priority projects such the proposals for Ex-Im
for highways (asphalt) and water supplies. The Ambassador and
emboffs continue to stress to the GODR at all levels the
importance of working with the IMF and meeting the
performance criteria. At the same time, the GODR defenders
of the IMF standby will find it politically easier once the
GODR can access IFI funds identified for the electricity
sector and social development.


23. (U) NOTE: This cable was drafted after the departure of
the EXIMBANK team.
HERTELL