Honduras Hopes For IMF Letter of Intent by March 31

UNCLAS SECTION 01 OF 02 TEGUCIGALPA 000494 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 PGOV EAID ETRD ELAB HO SUBJECT: Honduras Hopes For IMF Letter of Intent by March 31 Ref: Tegucigalpa 00010 ¶1. (SBU) Summary. Honduras is putting the finishing touches on a package of laws that will put the GOH's fiscal house in order and satisfy the International Monetary Fund (IMF) team negotiating the terms of Honduras' three-year Poverty Reduction and Growth Facility (PRGF) program. The package will include the long-awaited Civil Service Framework bill that will supercede the salary provisions in the profession- specific laws (called estatutos); expenditure measures that will reduce the central government wage bill to 10.1 percent of GDP in 2003 and reduce the wage bill of the entire public sector by one percent of GDP annually in 2004 and 2005; and a series of revenue measures that will widen the tax base for income and sales taxes. The only important tax exemption elimination that the GOH plans to propose to Congress is the exemption for fuel products used in the power sector; however, it appears that the other tax measures will be sufficient to lower the deficit significantly. The IMF and GOH are also working together closely on improvements to the financial sector. The GOH hopes the whole fiscal package will go to Congress by the end of February and will be approved by mid March. The goal is to sign a letter of intent with the Fund by the end of March. The GOH believes that the letter of intent would be sufficient to hold off pressure from Paris Club creditors, until IMF Board approval in June. Much will depend on the GOH's skill in getting the measures through Congress. End Summary. ¶2. (SBU) In a February 18 meeting with econoffs, Minister of Finance Arturo Alvarado explained that the GOH is very close to an agreement with the IMF on the terms of Honduras' three- year Poverty Reduction and Growth Facility program. The program includes commitments on creating a professional civil service, reducing the wage bill as a percent of GDP, and adopting revenue measures. According to Ministry of Finance projections, this will bring the central government deficit down to three percent of GDP in 2003 (a marked improvement over the last two years). The IMF and GOH are also working together closely on policy changes to strengthen the financial sector. ¶3. (SBU) After contentious late January meetings between the GOH and IMF in Washington (in which the Fund at first insisted on a constitutional amendment),there is now a basic agreement on the text of the long-awaited Civil Service Framework bill. Article 110 of the bill will replace the salary provisions in the profession-specific laws - the so-called estatutos - immediately upon entry into force, except for the phasing in of the salary increases for teachers by 2006. Alvarado is waiting for the IMF's final comments on the draft bill (due any day now). ¶4. (SBU) The GOH identified expenditure measures that will allow it to reduce the central government wage bill to 10.1 percent of GDP in 2003. Many of these measures have already been implemented (wage freeze for non-unionized employees, elimination of 60 percent of vacant positions, elimination of ghost workers, retirement of public sector workers over the age of 65, etc.). For 2004 and 2005, the GOH convinced the Fund they would have more flexibility to reduce the wage bill an additional one percent of GDP per year if they included the entire public sector. Alvarado noted that reductions in staff are already underway in autonomous government agencies such as SANAA (the state water and sanitation company) and COHDEFOR (the Forestry Service). The IMF team agreed to exclude the severance payments from the wage bill calculations. Note: IMF contacts indicate that the GOH still needs to present more detail on these planned expenditure measures in order to obtain Fund staff support. ¶5. (SBU) The third part of the package is a series of revenue measures (amounting to at least 2.5 percent of GDP) that will widen the tax base for income and sales taxes. Many bonuses and allowances will now be included as income in the calculation for income tax and the minimum level of salary for individuals subject to the tax will be reduced. A type of withholding tax will be implemented for companies. Many more products will be subject to the sales tax, leaving only basic foods and medicines tax free (i.e., an expanded "basic basket of goods"). The government still plans to eliminate the tax exemption for fuel products used in the power sector and will direct the state electricity company ENEE to negotiate compensatory adjustments for the price of electricity in its contracts with the private power generators. The expected increased revenue from these measures is expected to be: Income tax 0.9 percent of GDP Sales tax 0.5 percent of GDP Oil taxes and others 1.1 percent of GDP ¶6. (SBU) Econcouns noted that the GOH has backed away from its intent to reduce the numerous special tax exemptions for companies, and that this would put the GOH on the defensive as only raising taxes on the poor and lower middle class. Alvarado acknowledged that elimination of special exemptions turned out to be politically unfeasible. The GOH will do its best to explain to the public that in fact tax rates are not being raised. Note: IMF sources indicated concern this week that the GOH might back off from some of the measures, based on criticism from the public. ¶7. (SBU) Alvarado, who is consulting closely with President of Congress Porfirio "Pepe" Lobo, hopes the whole fiscal package will go to Congress the week of February 24 and will be approved in Congress by early to mid March. The IMF team would then return to Honduras March 24 to finalize and sign off on a letter of intent on a PRGF program by March 31. The package would go to the IMF Board in June. The Fund staff said that once a letter of intent is signed, they would signal to the Paris Club that the GOH is basically back on track, taking pressure off from official bilateral creditors for resumed debt payments. Honduras' extension of debt relief from the Paris Club runs out on March 31. ¶8. (SBU) Comment: Although the umbrella public sector organization COHEP expressed solidarity with the GOH on the need to regain fiscal equilibrium and stop the dramatic growth in public sector salaries (and despite the fact that the current plan leaves many investment incentives intact), key private sector groups have started to complain about the proposed tax measures. Government pronouncements about the measures, their impact on the poor, and the relationship to the GOH's need for an IMF program have been confusing and inconsistent. The next few weeks will be a key test of the Maduro government's commitment (and ability) to take the needed measures. Palmer