DOMINICAN INSIDER VIEW OF FINANCIAL ISSUES, IMF

UNCLAS SECTION 01 OF 03 SANTO DOMINGO 006705 SIPDIS SENSITIVE DEPT FOR WHA, WHA/CAR, WHA/EPSC; TREASURY FOR U/S TAYLOR, DAS N LEE, R TOLUI E.O. 12958: N/A TAGS: EFIN PGOV DR SUBJECT: DOMINICAN INSIDER VIEW OF FINANCIAL ISSUES, IMF TALKS ¶1. (U) On November 20 Technical Secretary of the Dominican Presidency Carlos Despradel called on DCM to outline state of play with the IMF. He provided current copies of the worksheets elaborated with IMF help. (See separate pages.) Following is his presentation (i.e., his views). ¶2. (SBU) Summary table, percent of GDP 2003 2004 Program Actual Program Projected CENTRAL GOVT Expenditure - 0.4 - 1.8 1.1 -0.9 Public Sector Non Financial - 0.3 -0.9 0 -1.2 -------------- -------------- -------------- -------------- SUBTOTAL -0.7 -2.7 1.1 -2.2 Quasi fiscal -2.8 -2.9 -3.6 -3.9 -------------- -------------- -------------- -------------- TOTAL -3.5 -5.6 -2.5 -6.1 Difference -2.1 -3.6 ¶3. (SBU) Despradel is hoping that the IMF might accept a plan that would reduce the projected deficit to 4.0 percent of GDP. This would require the GODR to raise revenues (or lower expenditures) by 2.1 percent of GDP, or by 12 billion RD pesos. ¶4. (SBU) IMF team insists that Congress enact any revenue measures before the standby is submitted to the board. Despradel pointed to the difficulties in Congress of the 5% tax on exports ) passed finally by the Senate and now going to the House of Representatives. Congress meets only until Christmas time and then has a recess until February 27, by which time the election season will be in full swing. Presidential elections are May 16. At that time no Congressman will be willing to vote tax increases. ¶5. (SBU) Possible sources of funds not requiring congressional approval could include fuel price adjustments. Could envisage a maximum increase in electricity rates of 40 percent; could reduce subsidy on household cooking gas. Estimated yield would be up to 1.5 percent of GDP, if willing to face an 80 percent rise in electricity prices. If less, then yield would be about 1 percent. ¶6. (SBU) Tax reform, in the short term - - as demanded by the private sector - - is not feasible, in Despradel,s view. Congress would not go along. Private sector is apprehensive that a future government would not be willing to pursue reform. Mejia,s ministers are refusing to take this road, out of political/electoral considerations. Despradel is telling the IMF and private sector that this is simply not feasible. He comments that the private sector endorses tax reform as a concept, but individual firms will continue to avoid taxation. He insists that tax reform cannot be made a pre-condition for an IMF program. &IMF must see that we can deliver only that which is possible - - right now, even the ruling party and the PRSC opposition party are badly split among themselves. " I will tell them so when I meet them this afternoon." ¶7. (SBU) Electricity sector. Most recent subsidy estimate by team from Central Bank/ Presidency/Electricity Council/Foreign Ministry is that @ exchange rate of RD$ 40 = US$ 1 and with fuel oil at today,s rate of about $26/bbl, the gap, and hence the government financing requirement, is US $28 million/month, that is, about US $168 million to get through the next six months. This calculation does not address any GODR arrears to generators currently outstanding. It does not take into account sums of approximately $104 million run up by Union Fenosa in its administration of EDESUR and EDENORTE. The GODR budget for 2004 now has 4000 million pesos in subsidies; ministers voted yesterday not to exceed that amount. Difficulty is that cooking gas subsidy, previously 20 million pesos/week, is now at 60 million/week or 250 million/month, equal to 3000 million/year ) cooking gas will absorb 75 percent of planned subisidies, leaving little for electricity. ¶8. (SBU) Despradel outlined the Madrid Agreement (of 2002?), with which the various generators agreed that in return for a one-time payment totaling $150 million, they would agree to drop contractual rates established in earlier years, all negotiated during crisis times and therefore above market rates, according to Despradel. Instead, they would sell electricity at the &spot rate,8 expected to be much lower. The World Bank Energy Sector loan of $151 million which would have allowed the GODR to pay this amount was blocked by GODR decision to buy out Union Fenosa. ¶9. (SBU) The World Bank is preparing instead a fast-disbursing Structural Adjustment Loan and has spoken of about $80 million, with $40 million to be available quickly with no or few conditions and another $40 million in six months time (after elections),subject to conditions. Despradel says given the need for $168 million in &future arrears8 plus the money needed to put the Madrid Agreement into effect and the sums owed to Union Fenosa, this would not be enough. He is asking for $100 million quickly, i.e., without conditions, with another $50 million later. He is also asking for more World Bank assistance for electricity, which could be conditioned on reforms. ¶10. (SBU) The IDB is preparing an energy loan of $200 million to help mitigate the impact on the social sector of adjustment. Initial disbursement would be $100 million. Despradel welcomes the finance but notes that these funds are needed to carry out the objective of the loan - - to maintain social services at previous levels. ¶11. (SBU) Despradel said COGENTRIX is the only generator to refuse to associate with the Madrid Agreement. At the request of IDB president Enrique Iglesias, in mid-2003 Mejia agreed to pay off $42 million in arrears if Iglesias would assure that COGENTRIX would begin a renegotiation of contract terms. Mejia is angry that COGENTRIX remained obdurate and has vowed not to pay until they do so. (Current bill is about $25 million, and GODR is technically in default since November 11 - - this would allow lenders to invoke GODR sovereign guarantee of IDB loan of $140 million and of other loans, for a total of $400 million.) Despradel noted that COGENTRIX contract was negotiated by the previous (Fernandez) government: ". . . and we can suspect what happened with that." ¶12. (SBU) Bantiner. DCM inquired about GODR efforts to recover money from Baninter. Despradel replied that seizure and monetization of assets is not possible until after conclusion of a trial. ¶13. (SBU) Despradel said that he has not been involved in Baninter investigation or clean-up. He says GODR would welcome technical assistance from U.S. Treasury in this regard, including in tracking down Baninter funds sent abroad or identifying sources of Baninter deposits. ¶14. (SBU) Personnel expenditures. In response to an inquiry about possible reductions of the government payroll, Despradel said that in his opinion, expenditures were indeed high. He did not indicate any plans to reduce the civil service. He pulled out a table showing the progression of government current expenditures in terms of GDP since the early 1980,s. Under Balaguer, the share had progressed slowly from 6.8 percent to just over 8 percent; in 1997, the first year of the Fernandez administration, it had jumped to 11 percent and crept higher. The tendency was maintained, not initiated, in the Mejia administration. (He did not point to the 2003 figure, which was increased sharply to over 14 percent.) ¶15. (SBU) Incidence of taxation. Despradel said that the GODR badly needed tax reform. All talk of tax measures is focused on consumption taxes, which fall heavily on the poorest. Despradel said that retailers commonly fail to pay the government the value-added tax collected from consumers. Comprehensive tax reform was necessary, he said, but not realistic before May. It is impossible to get a consensus on taxing incomes. Despradel pulled out a chart comparing countries according to the sources of tax revenue; the Dominican Republic receives 71 percent of revenue from consumption taxes and only 26 percent from income taxes. A Harvard consultant advising the government had initially discouraged the use of a 1% withholding tax on incomes; after analyzing the figures, the consultant had suggested a higher rate. HERTELL