GOH Starting to Get Serious About Getting An IMF

UNCLAS SECTION 01 OF 04 TEGUCIGALPA 000010

SIPDIS

SENSITIVE

STATE FOR WHA/CEN, WHA/ESPC, DRL/IL, EB/IFD/OMA
STATE PASS AID FOR LAC/CEN
STATE PASS USTR, EXIM, OPIC
STATE PASS USED IDB, USED WB, USED IMF
TREASURY FOR JOHN JENKINS

LABOR FOR ILAB, ROBERT WHOLEY
PANAMA FOR CUSTOMS

E.O. 12958: N/A

TAGS: EFIN ECON EAID ETRD ELAB PGOV HO
SUBJECT: GOH Starting to Get Serious About Getting An IMF
Program

Ref A: Tegucigalpa 3149
Ref B: Tegucigalpa 3479
Ref C: Tegucigalpa 3491

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Summary
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1. (SBU) Honduran government officials are working hard to
close the gap with the International Monetary Fund over a
new three year Poverty Reduction and Growth Facility (PRGF)
program. With plans for new revenue measures of usd 175
million and planned reduction in costs (primarily personnel
cuts) of usd 35 million, the government believes it can
reduce the central government deficit to three percent of
GDP for 2003, down from 5.6 percent in 2002. The GOH is
already implementing recommendations by the Fund in the
financial sector and working closely with the World Bank-IMF
evaluation of the financial sector. A delegation of 4-6
IMF directors will visit Honduras January 17-21. The GOH's
macroeconomic team will return to Washington after that
visit to review tax reform legislation before sending it to
Congress in early February. The GOH hopes that the IMF
mission would return to Honduras in March, after approval of
the legislation to sign off on a letter of intent, and that
the program could go to the IMF Board in April. The IMF's
insistence on major reductions in public sector salaries as
percent of GDP continues to be the main sticking point,
along with the associated timing of the folding-in of
teachers into a planned civil service reform program. End
Summary.

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Significant Revenue Measures Planned
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2. (SBU) The Ministry of Finance has identified new revenue
measures that will raise central government income by 2.8
percent of GDP (about usd 175 million). These measures
include: elimination of exemptions from the sales tax, an
implementation of withholding taxes designed to reduce
evasion of sales and income taxes, broadening of the base
for income tax to include a higher percentage of bonuses and
benefits packages, and the taxing of the retirement income
above a specified level. The government plans to introduce
a decree to eliminate the tax exemption for diesel used in
the production of electricity (this exemption is believed to
be the source of enormous tax evasion); the state-owned
power company ENEE would be charged with negotiating an
adjustment to the price paid to private electricity
generation companies to cover this tax change. The Finance
Ministry plans to direct credit card companies to send sales
tax payments directly to the tax authorities (the DEI) in
order to avoid evasion of sales tax and help collect the
planned withholding taxes. Vice Minister William Chong Wong
noted that this type of measure has been extremely
successful in El Salvador and other countries. The Finance
Ministry also wants to require audits for companies with
more than ten million lempiras (approx. usd 593,000) in
sales annually, and to make financial officers of companies
and accounting firms more accountable for intentional tax
evasion. Chong Wong is heading up the effort to draft
reforms to the income tax law and tax code. The GOH plans
to review these draft legal changes with the IMF in mid to
late January.

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Wage Bill Reductions - Sticking Point with IMF
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3. (SBU) On the expenditure side, the GOH has identified
some one-time measures that will reduce government spending
and the wage bill by 0.6 percent of GDP in 2003. Six
thousand teachers who are over 65 years old will be retired
in early January (an overdue legal requirement) and will be
replaced by younger teachers with lower salaries. Similar
measures will be taken among state-employed medical staff.
The government is also cleaning up its payroll records (to
be completed by February) and expects to be able to achieve
savings of 200 million lempiras (approx. usd 11.9 million)
per year by reducing ghost workers and individuals receiving
multiple full-time salaries.


4. (SBU) According to Finance Minister Alvarado, however,
the IMF is pushing for additional reductions in the wage
bill as a percent of GDP:

2002 10.7 percent
2003 10.1 percent
2004 9.1 percent
2005 8.1 percent

The GOH does not see how they can meet these targets.
Alvarado (strictly protect) has now proposed to the Cabinet
a public sector wage freeze for 2003. There is some
interest but the government remains stymied over the idea of
freezing teacher salaries only months after reaching a
settlement on teacher wage increases for 2002-2005.


5. (SBU) During the December 16-17 consultations between the
GOH macroeconomic team and the IMF in Washington, the
government finally shared its draft Civil Service Framework
bill. Discussion focused on Article 110, which currently
says that the teachers will be folded into overall state
wage policy by 2006, indicating that the salary provisions
of the estatutos (laws governing particular professions)
will be eliminated that year. Alvarado said that IMF staff
are insisting that the teachers be covered by the civil
service reform immediately upon adoption of the law. The
GOH has commented that the World Bank is more understanding
of their stance on this issue.

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The Results: Sizable Projected Reduction in Government
Deficit Based on Reforms That Could Get Through Congress
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6. (SBU) The central government deficit for 2002 is
estimated to be 5.6 percent of GDP. This deficit is
projected to decline to 5.1 percent in 2003 if no further
measures are implemented. The IMF mission in November
estimated that the reforms envisioned by the GOH would bring
down the central government deficit to 4.0 percent of GDP.
Finance Minister Alvarado is now saying that he can get it
down to 3.0 percent of GDP.


7. (SBU) The government is determined, however, to go to the
Congress only once more on major fiscal reforms. For this
reason, they want to be absolutely sure the IMF is on board
with all legislative proposals before they are sent to the
legislature. At the same time, the GOH is certain that any
further changes to the agreement with the teachers would
undermine congressional approval. On the expenditure side,
they believe they've gone as far as they can go. Minister
Alvarado noted, in a meeting with Econ Counselor and AID
economist on December 31, that the GOH wants to be sure it
can deliver what it promises. He alluded to problems that
Nicaragua is already having in getting its program approved
by the legislature.


8. (SBU) The GOH was heartened by the Honduran Congress'
easy acceptance of the austerity budget for 2003 on December

4. The budget was virtually unchanged from the 2002 budget
in nominal terms, with the exception of usd 262 million in
needed infrastructure projects, meaning that most ministries
will face cuts in real terms of about eight percent after
accounting for inflation. The Congress identified new
funding for all of these infrastructure projects.

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Public Enterprises Still A Concern
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9. The declining surpluses in the key public enterprises
(electricity utility ENEE, phone company Hondutel, and the
Port Authority) remain a concern. Finance Minister Alvarado
acknowledged that while ENEE's financial picture should
improve by 2004-2006 when high cost power contracts are
replaced by new low-cost Lufussa and AES projects (see ref
b),2003 is going to be a very tough year for the state-
owned electricity utility. The government plans a series of
privatization and liberalization initiatives in 2003 and
2004, including privatization of some port facilities, the
postal system and some roads. This may help increase
government revenues in the short run and efficiency in the
long run. Privatization of Hondutel, a twice failed
undertaking, remains a politically charged issue, with the
government in denial about the true low value of the utility
to an outside investor and the fairly strong union trying to
fight any changes. A GOH requested study of liberalization
of the telecom sector in Honduras has been approved by the
U.S. Trade Development Agency and should begin in the first
half of 2003. In the power sector, the GOH has the results
of a USAID sponsored white paper on modernization. To
depoliticize the issue, the GOH is no longer talking about
privatization of ENEE, but rather the unbundling of its
generation, transmission and distribution activities.

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Financial Sector: Actions Underway
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10. (SBU) As reported in Ref C, Banking and Insurance
Commission President Ana Cristina Mejia de Pereira
apparently is making strides in meeting prior action
requirements of the Fund in the financial sector. Banco
Capital was liquidated on December 19. The GOH needed to
tap into about usd 30 million of Hondutel cash to cover the
deposit insurance for this failed bank; the Minister of
Finance indicated to emboffs on December 31 that this is the
last time he will authorize use of those funds to cover a
bank failure. The Commission has ordered an appraisal of
the value of Banco Sogerin, the other bank which the
government took over in May, and hopes to be able to sell it
in February (three potential purchasers have shown
interest). The Commission is working closely with five
additional banks to ensure they meet the higher
capitalization requirements. Two or three of these banks
will probably be sold to larger banks; in the remaining
cases, the shareholders are providing the needed additional
capital.

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The Road to a Program
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11. (SBU) The GOH has invited interested IMF executive
directors to visit Honduras January 17-21. Alvarado,
Minister of the Presidency Luis Cosenza and Central Bank
President Maria Elena Mondragon plan to return to Washington
right after that visit to provide IMF staff with detailed
proposals and projections and to review their drafts for new
legislation. The new laws would be submitted to Congress
upon their return for adoption in February and to enter into
force on March 1. The GOH hopes that the IMF mission would
then return to Honduras to complete a letter of intent on a
new three-year PRGF, and Honduras' program would go to the
IMF board in April. Speed is vital at this point. Quite a
few World Bank, Interamerican Development Bank, and
bilateral aid programs are on hold until Honduras gets back
on track with an IMF program. Honduras is off track for
HIPC debt relief and is now accumulating new arrears in its
service of its Paris Club debt (arrears estimated at over
usd 70 million at this point). USG agencies should track
this carefully, as the Brooke Amendment could come into
force as early as March 31, forcing agencies such as USAID
to begin drawdown plans.

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Comment
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12. (SBU) If the government adopts the identified measures
and is successful in reducing the central government deficit
to three percent of GDP (i.e. a 2.5 percentage point
reduction over the passive expected level),that will be a
substantial achievement. Similarly, adoption of the long-
awaited civil service reform that would provide the GOH with
control over wage policy and create a career civil service
would be important moves. If real progress is made in these
areas in the next month, the GOH will have a much stronger
hand with which to convince the IMF to accept a slower
timetable on inclusion of the teachers in the civil service
reform.


13. (SBU) The other possible development that could help the
fiscal imbalance is a resumption of economic growth. It
will be important for the GOH to start focusing on measures,
other than tax incentives, which can be taken to attract
investment and improve the business climate.

Palmer