EMBASSY ASSESSMENT OF DOMINICAN ECONOMIC SITUATION

C O N F I D E N T I A L SECTION 01 OF 04 SANTO DOMINGO 006124

SIPDIS

DEPT FOR WHA:DESHAZO, WHA/CAR, WHA/EPSC,EB/IFD; TREASURY
FOR INTERNATIONAL - NLEE,LLAMONICA; NSC FOR SHANNON; WHITE
HOUSE FOR USTR: GASH-DURKIN.

E.O. 12958: DECL: 10/29/2005
TAGS: EFIN PREL PGOV DR
SUBJECT: EMBASSY ASSESSMENT OF DOMINICAN ECONOMIC SITUATION
AND GODR POLICY

REF: A) SANTO DOMINGO 5998 B) E-MAIL ESMITH WHA/CAR -
KUBISKE 10-24

Classified By: Ambassador Hans Hertell. Reason: 1.5 (b) and (d).


1. (C) Summary. The Dominican Republic is moving into very
dangerous and uncharted waters. Facing an unstable financial
situation with the prospect of a downward economic spiral,
President Mejia and his senior advisors have publicly
stressed the need to meet IMF standby conditions. They moved
on October 23 to raise flagging GODR revenues by imposing a
5.25 percent increase in the levy on imports and then by
pushing key business sectors to sign voluntary commitments
equivalent at current rates to about USD 10 million per
month. The work-up by IMF consultants shows the GODR meeting
public sector expenditure targets; our scorecard indicates
that various requirements for structural reform are
incomplete. Price rises, the steady erosion of the peso, and
sporadic demonstrations worry the GODR. Presidential
Technical Secretary Carlos Despradel visits Washington this
week to ask for a previously approved 100m IDB disbursement
for the social sector. The USG response to Dominican concerns
provides an opportunity to fortify Mejia and his officials
against those in his PPH political faction who prefer to
ignore IMF discipline for the presidential election season.
See paras 12-14 for assessment. End summary.

DILEMMA: GOOD OF THE NATION VS. PRIVATE ADVANTAGE


2. (C) In response to request ref b for its assessment of
current economic conditions and their implications, Embassy
Santo Domingo considers that the Mejia administration
understands the medium- and long-term benefits to the economy
of prompt and strict compliance with IMF prescriptions but is
struggling with strong resistance from political and economic
interests that focus strictly on short term advantage.

IMF COOPERATION


3. (C) Dominican financial officials have repeatedly
stressed in private to emboffs over the last ten days that
the delayed IMF standby arrangement is the only solution to
the steadily eroding macroeconomic situation. They tell us
that they continue to work closely with IMF staffers here on
an unofficial basis. Their fiscal worksheet (faxed to WHA/CAR
and Treasury) shows the GODR in compliance with the IMF
target on spending. Their shortfall on revenue targets is
estimated at RD pesos 1.07 billion per month (about USD 28.5
million).

REVENUE EFFORTS: A PATCHWORK


4. (C) The President is leading the effort to raise
collections, stymied by his inability to date to convince his
majority in Congress to apply the desired 5 percent tax on
exports. (His attempt to impose the tax by decree was voided
by the Supreme Court.) The Senate has just postponed its
consideration of the bill for another week. On October 23
the GODR secured passage by the Monetary Board of an increase
in the levy on foreign exchange used for imports from 4.75
percent to 10.0 percent, avoiding the need to resort to the
Congress. Presidential Technical Secretary Carlos Despradel
estimates that this measure will bring in between 450 and 500
million pesos. (We do not know whether his staff has taken
into account the probable drop in import volumes due to
sharply higher costs of foreign goods due to inflation and
steady devaluation.) The government had previously
implemented a temporary two percent import tax that remains
in effect.


5. (C) To bridge the remaining 500-600 million peso gap, on
October 24 and 27 the President resorted to confrontational
jawboning of 35 influential business leaders. He has
convinced tourism operators, exporters and free trade zone
companies that it is in their own interest to help meet the
IMF's requirments. Each has signed or will sign a formal
agreement this week specifying contributions which, all told,
will raise RD pesos 375 million/month. Costs will be passed
along almost entirely to consumers, except by the untaxed
free zone (FZ) exporters. (FZ companies, earning foreign
currency, have benefited directly from devaluation; they will
make a "contribution" indexed to the exchange rate). CONEP,
an umbrella business organization, has promised to present a
proposal to President Mejia on October 29 on further means of
raising the needed funds.

STRUCTURAL CRITERIA - IN PROGRESS, NOT THERE YET


6. (SBU) Progress on structural performance criteria has
been slower than the IMF had initially prescribed. According
to Central Bank staff:

- - Exchange-rate changes are vitually complete; the by-law
implementing the Lombard and overnight windows has been
approved except for one aspect that the Central Bank expects
to resolve the first week of November.

- - The GODR is on track with disposing of the assets of
failed BANINTER and with selling Banco Mercantil. The
discovery of shady practices at Bancredito may require
judicial prosecutions but should not slow down liquidation of
the bank.

- - Authorities are reviewing comments from the banking
community on proposed regulations for implementing the
Monetary and Financial Law.

- - The Law for Bank Resolution is with Congress, and the
Central Bank's Monetary Board will meet the congressional
leadership during the first week of November.

- - The Government is still consulting with the Fund
concerning a Financial Crime Bill.

- - On October 28 Mejia issued a decree setting up a
commission to report back within 90 days on procedures and
legal changes required in order to reprivatize the
electricity distribution companies run by Union Fenosa. He
named a widely respected businessman to direct this work.


7. (C) Posing a question mark to these steps is last week's
Congressional approval of bonds to refinance about 5 million
pesos (USD 140 million) of the debt of government-owned Banco
de Reservas and the agricultural bank. Though the transaction
is presented as a "wash" -- new Central Bank debt retiring
claims on Reservas and the agricultural lender -- we are
seeking to identify the intended uses and beneficiaries of
this money.

POLITICAL AND SOCIAL PRESSURES


8. (C) Dominicans are suffering from accelerating inflation,
the steadily eroding peso exchange rate, and persistent
electricity blackouts. To date, commentators have blamed
Mejia and his administration and no one has publicly
questioned the need for IMF assistance. Bad news is the
staple of the day and no one is expecting things to get
better. The prospect of social unrest disquiets many (for
example, leading newspaper "Hoy" displayed a full color
front-page photo of street demonstrators attempting to set
off a homemade bazooka.)


9. (SBU) Among points to note:

- - Inflation is up from 8 percent in CY 2002 to near 40
percent predicted for CY 2003. Households face 50-100 percent
increases in staples such as milk, cooking oil, meats, rice,
beans and cereals. Medicines are up 30 percent. Regular
gasoline has gone up about 40 percent since January.

- - Record numbers of Dominicans are attempting the hazardous
journey by boat to Puerto Rico. Prospective illegal
immigrants to the United States now include some from the
middle class.

- - The press regularly reports reduced services or closures
of public health facilities.

- - Government social spending is at a standstill and even
salary checks are delayed.
- - Electricity blackouts will get much worse before they get
better. Available supply nationwide is 1463 megawatts, for
estimated peak demand of 1855 megawatts. Plants are running
out of fuel. Next week capacity will fall 250 megawatts and
by mid-November two additional plants will probably shut down
for lack of GODR payment, bringing capacity down to about 750
megawatts. The South (including the traffic-choked capital,
Santo Domingo) will begin to experience the persistent
failures like those which provoked street protests in the
North.


IMF-BASHERS


10. (C) Our GODR interlocutors have told us that some parts
of the government and political parties want to take an
aggressive approach to the IMF. President Mejia emphatically
rejected such a course when speaking to the Ambassador on
October 28, but he acknowledged that these sentiments exist.


11. (C) The armed forces have not shown any desire to blame
the IMF, even though their institution is largely immobilized
by budget shortfalls. The military leadership is loyal to
the PRD.


12. (C) We believe that the President's own "PPH" faction,
chaired by Agriculture Secretary Eligio Jacquez, is the most
restive. They face the dilemma of a virtually certain
renomination of Mejia in late November without any clear
prospect at this time for a winning electoral strategy. They
are probably tempted to push Mejia to ignore Fund constraints
and to borrow and spend to bolster his campaign against
Leonel Fernandez of the PLD. The PRD-dominated legislature
is probably uneasy, as well, as constituents feel the
economic plight.

ASSESSMENT


13. (C) Technical Secretary Carlos Despradel told us on
October 24 that the Government can "get along" through the
end of the year, but would be able to do nothing more than
pay salaries. (In fact, we understand that paychecks have
been delayed; the Government is in arrears to civil
servants.) Despradel was visibly unhappy and tense when he
visited the Ambassador on October 27 to ask for USG sympathy
in obtaining release of the USD 100 million disbursement
pending at the InterAmerican Development Bank to complete a
Social Sector loan.


14. (C) There is a difference between "getting along" and
the more important consideration of keeping the GODR
committed to structural adjustment. We need the Mejia
administration to stay on board. We are sailing into a storm
right now; financial indicators, already unstable, are likely
to take a vigorous kick when the public begins to react to
further deterioration in their daily living conditions.
September protests and riots in the North were prompted
largely by mischief-making local opposition politicians.
Unless the President can convince the Dominican public that
relief, though distant, is in sight, we see a possibility of
real conflict in the streets, across the country.


15. (C) President Mejia vows that he will not beg; he says
that he would prefer to resign rather than to order
repression. Some of this is characteristic Hipolito
exuberance, but he pointedly cited to the Ambassador, several
times, the example of Bolivia's Sanchez Losada. Mejia wants
to deliver on his promises to the barrios and his list of
small-scale uncompleted projects, both to do good and to do
well in the elections.

RECOMMENDATION


16. (C) Embassy recommends that the USG keep the pressure up
on the GODR to continue needed economic and financial
measures, including by withholding the bulk of the delayed
IFI disbursements, but that the USG support a one-time
lifeline in the form of the $100 million disbursement by the
IDB for highly visible and widely spread social sector
projects. Otherwise, given the increasingly turbulent
situation, we run the risk, as is said here, of "finding that
when the hats are finally ready, there will be no heads to
receive them."


HERTELL