IMF TEAM RETURNING TO HONDURAS TO NEGOTIATE A

UNCLAS SECTION 01 OF 03 TEGUCIGALPA 002648

SIPDIS

SENSITIVE

STATE FOR WHA/CEN, WHA/EPSC, DRL/IL, EB/IFD/OMA, INR
STATE PASS AID FOR LAC/CEN
STATE PASS USTR FOR BRETT MAKENS
TREASURY FOR E. ILZETSKI
DOL FOR ILAB

E.O. 12958: N/A
TAGS: EFIN ECON PGOV EAID ETRD ELAB EAGR PINR HO
SUBJECT: IMF TEAM RETURNING TO HONDURAS TO NEGOTIATE A
LETTER OF INTENT THIS MONTH

REF: TEGUCIGALPA 2034


1. (SBU) Summary. An October IMF mission visit to Honduras
found enough progress and high-level commitment to agree to
return in November for the negotiation of a Letter of Intent
(LOI) for a Poverty Reduction and Growth Facility (PRGF)
program. The government hopes to be able to push
legislative measures through Congress that would address all
prior actions identified in the LOI, by the end of November.
The IMF staff showed flexibility in this visit, loosening up
a bit on the fiscal targets of the budget deficit and the
staged-in decline in the wage bill. The GOH and IMF staff
both envision that the program will also require new tax
measures, particularly elimination of additional exemptions.
This extremely ambitious schedule is a recognition by all
parties of the limited political window of opportunity for
reaching an agreement. One of the danger signs is that the
GOH will need substantially higher levels of foreign
assistance from donors in the next three years in order to
meet these fiscal targets and still meet its commitments to
poverty reduction spending. As the director of the IMF
mission told the donors before departing, however, "there are
dangers on all sides." End Summary.


2. (SBU) At the GOH's request, an IMF mission led by
Assistant Director of the Western Hemisphere Department
Adrienne Cheasty and mission chief Mario Garza held
productive consultations with the GOH in Honduras on October
13-23 on the current fiscal situation and prospects for a
three-year PRGF program. Cheasty indicated to the G-15
donors group, before the mission's departure, that the GOH
had shown enough commitment to addressing the structural
fiscal problems, that they were willing to recommend a return
mission in November to negotiate a letter of intent (LOI).
Note: Post now understands that the mission is scheduled to
return during the week of November 10 to begin negotiations
in earnest. End Note. The GOH has indicated its strong
determination to reach agreement with the mission on the LOI
quickly, and to achieve rapid legislative approval of laws
required as prior conditions in the LOI, by the closing of
the legislative session at the end of November. That would
free up the GOH to adopt the 2004 budget during its
traditional "extraordinary" session in December. While this
represents an extremely ambitious schedule, all sides are
trying to make it work in recognition of the limited
political window of opportunity for reaching an agreement.
In 2004, the GOH expects its ability to push through tough
legislative measures to diminish rapidly. In addition, the
fiscal situation is deteriorating with non-inflationary
sources of deficit financing rapidly drying up and the GOH
needs an agreement to free up new sources of financing and
debt relief.


3. (SBU) The IMF mission described the baseline fiscal
situation as fairly bleak. The Central government's deficit
is expected to reach 5.5 percent of GDP in 2003, or 2 percent
higher than the GOH's target (although the GOH would argue
that it is really just 1 percentage point higher than the
target and that the IMF is not correct in charging the full
cost of the agricultural loan debt forgiveness program to the
year 2003, as the costs will be spread out over ten years).
Other contributing factors to the higher deficit are: the
high public wage bill (10.6 percent of GDP vs. the 10.0
percent target),because administrative measures were not
successful in compensating for the rising teacher and medical
employees' salaries; cost of transferring a troubled
state-owned bank to private Banpais (covering its liabilities
with bonds); and a large shortfall in the revenues projected
to come from the tax measures that were adopted in May 2003.
The GOH is financing this greater than expected deficit by
drawing on foreign reserves and issuing bonds. Net reserves
in the Central Bank declined by more than USD 100 million in
the first nine months of the year.


4. (SBU) For 2004, if the government takes no new measures,
the deficit will be approximately 4.4 percent of GDP. The
IMF staff is even more concerned about prospects for 2005 and
2006, as the projections for increased social spending rise
necessarily (to meet poverty reduction targets) and available
non-inflationary deficit financing decline.

The Outlines of a Program
--------------


5. (SBU) The IMF (very tentatively and not yet negotiated
with the GOH) plans deficit targets of 3.5 percent in 2004,
2.5 percent in 2005 and 2.0 percent in 2006. They
acknowledged that this is somewhat faster than would usually
be sought for a country with such great poverty reduction
needs, but indicated that it is necessary because of the
limited non-inflationary financing available. The Fund asks
bilateral and multilateral donors to look for possibilities
of additional donations that would help the government
maintain social spending. Very tentatively, and even with
expenditure and revenue measures, the Fund staff estimates
the GOH will need USD 120 million in new funding in 2005 and
USD 175 million in new funding in 2006.


6. (SBU) Note: Because the burgeoning wage bill has been
one of the main reasons for the structural fiscal deficits,
the IMF staff plan to require, as a prior action, the
enactment of legislation that provides the executive branch
with control over wage policy and that begins to reduce the
wage bill as a percent of GDP. End Note.


7. (SBU) The IMF is no longer requiring this percentage to
decline by one percentage point a year, perhaps as
recognition of the political constraints in reopening the
wage agreement with the teachers that would be the only
practical way of achieving this reduction. Both the Finance
Minister and IMF Resident Representative indicate that the
two sides are now in agreement on the text of the wage
legislation, which will grant the executive branch wage
policy control and will also freeze the collateral benefits
that are provided to teachers and doctors (in the special
statutes governing these professions).


8. (SBU) To compensate for the shortfall in revenues coming
from the May 2003 tax package, adopted in May 2003, the GOH
is considering a sizable increase in the taxes on gasoline
and diesel. Other potential measures, such as an increase in
the sales tax or elimination of popular tax exemptions like
the exemption on residential electricity, have been ruled out
so far by President Maduro and his inner circle on political
grounds. The GOH believes that this gas tax hike, along with
the freezing of the teacher collateral benefits, will provide
the needed revenue to make up the potential shortfall in 2004
between the baseline budget deficit (4.4 percent) and the
expected target of 3.5 percent.


9. (SBU) The program will also require the elimination of
exemptions provided to the wealthy and to many companies.
The government is likely to do this in the context of
adoption of legislation enacting the key measures from the
Fiscal Pact recently signed in the context of the National
Dialogue among the government, private sector and civil
society. Congress President Pepe Lobo has announced his
intentions to push for enactment of this legislation starting
in January 2004.


10. (SBU) In the financial sector, the program will require
the GOH to raise requirements for provisioning for bad loans,
in accordance with Basel standards. The IMF resident rep
indicated that this might also be made a prior condition in
the Letter of Intent. In addition, the IMF will require the
government to make changes to Central Bank operations to
reduce losses incurred as part of the execution of monetary
policy operations. This was an issue identified in the
Financial Sector review performed by a joint IMF-World Bank
team early this year. Finally, it appears the IMF staff is
going to accept that no further changes to the agricultural
credit law are politically/ legally possible at this point.

Comment
--------------


11. (SBU) This may be the now-or-never point for President
Maduro to reach an agreement with the Fund in his time in
office, and the GOH seems to know it. With the President's
full engagement now, Post expects the GOH to do its best to
use this window of opportunity. The wage policy
legislation, if adopted, will be a major, overdue milestone
toward structural reform. It will have to be closely
followed, in early 2004 with the development of a
professional civil service, legislation enacting the Fiscal
Pact developed in the National Dialogue process (see septel)
and elimination of a series of tax exemptions. End Comment.
Palmer