EMBASSY SUPPORTS GUATEMALAN REQUEST FOR QUICK

C O N F I D E N T I A L SECTION 01 OF 02 GUATEMALA 000525

SIPDIS

WHA FOR DAS FISK AND DAS DERHAM
EB FOR DAS GREENWOOD
TREASURY FOR OASIA: BILL BLOCK

E.O. 12958: DECL: 02/02/2009
TAGS: EFIN PGOV GT
SUBJECT: EMBASSY SUPPORTS GUATEMALAN REQUEST FOR QUICK
DISBURSEMENT OF IDB SAL FUNDS

Classified By: Ambassador John R. Hamilton for reason 1.5 (d)

Summary and Action Request
--------------

1. (C) Guatemala's new government is strapped for cash. It
inherited a backlog of unpaid bills and lost 10% of its tax
base to a court challenge. It is proposing serious fiscal
reform, including cutting the military by half and attacking
the corruption that depletes or diverts revenues, but its
longer-term plans will rely on resuscitating the Fiscal Pact
so that it has the mandate and legitimacy to force enduring
reform, including any tax increases, through a fractious
Congress. It is choosing not to borrow or negotiate with the
IMF in the absence of Fiscal Pact legitimacy, and that leaves
few short-term options other than crippling austerity. To
survive though the short term without abandoning all
initiative, the GOG will shortly be asking for the release of
$80 million in IDB sector adjustment loan resources. We
understand that they have the sympathy of the Fund and IDB,
but they are not fully in compliance with the Fund program.
We urge Washington agencies to support release of the $80
million to help underwrite the new government's
extraordinarily promising start.


2. (C) We have just heard that Guatemala may request an
additional $50 million of World Bank sector adjustment
funding. Our understanding is that those funds are not
intended for budget support but instead for recapitalization
of the banking system. We would want to know more about
compliance with the Bank's program and the mechanics of
disbursement before recommending any action on this request.
End Summary and Action Request.

Bleak Short Term Outlook While Fiscal Pact Resuscitated
-------------- --------------

3. (SBU) Guatemala is strapped for cash. The Berger
administration came to office with empty coffers, backlogs of
unpaid salaries and bills, and on the heels of a court ruling
that eliminated the "IEMA" asset-based tax that had provided
ten percent of total revenues. Tax reform is necessary and
will be a Berger priority. The Berger administration
proposes to begin the process by resuscitating the Fiscal
Pact that was negotiated by the Arzu Administration in 1999,
after the Peace Accords, with some 650 civil society groups.
The Portillo government subsequently discarded the Pact. The
new administration calculates that a renewed Fiscal Pact will
provide the mandate and legitimacy needed to push a 2004
budget and tax reform plan through an unfocused and
politicized Congress. Until that happens, the government is
choosing not to approach international debt markets or
negotiate a new program with the IMF in order not to be seen
as prejudicing the outcome of the Fiscal Pact discussions.
This leaves the government dependent upon austerity measures
and a depleted tax base until the new Fiscal Pact can be
agreed and implemented.

$80 Million from the BID Requires Flexibility
--------------

4. (C) In the interim, $80 million of fast-disbursing funds
are potentially available from the IDB under the Financial
Sector Adjustment program. Disbursement is contingent,
however, upon IMF concurrence or compliance with an IMF
program. Guatemala currently is not fully compliant with its
IMF stand-by, and we understand that it is for two reasons
that are relatively minor: 1) a law exempting the sale of
bank asset portfolios from the value added tax is still stuck
in Congress, and 2) outside auditors have not been brought in
to look into the failed national mortgage bank (CHN). The
tax exemption is not particularly controversial, and we
expect it will be passed in due course. The CHN audit has
been overcome by events, as the bank's failure is no longer
just a bankruptcy but the centerpiece of high-profile
criminal cases under investigation by Guatemalan prosecutors
and the U.S. BICE. The IMF stand-by agreement will likely
lapse in mid-March without Guatemala's full compliance, and
the government does not expect to seek another Fund program
until later in the year.

Fund and IDB Staffs Look to the USG
--------------

5. (C) We understand that both the IMF and IDB staffs are
prepared to be flexible if their boards are prepared to
concur. We also hear that the staffs will be looking
specifically to the U.S. executive directors for signs of our
sentiments. This filtered back to us following IDB President
Iglesias's trip here a couple of weeks ago. We note that it
was the U.S., with this Embassy's strong urging, that
abstained on the 2002 stand-by agreement because supposed
prior conditions on financial reform legislation had not been
fully met. We heard at the time that it wasn't a pleasant
experience for Fund staff, and we're not surprised at their
caution this time. Times have changed, however. In 2002 we
were concerned about giving the benefit of the doubt to a
government that had veered seriously off course. This time,
we have a government that knows where it's going and whose
aims we support.

Economic Team to Visit Washington
--------------

6. (C) A vice ministerial delegation from the Berger
economic team arrived in Washington over the February 28-29
weekend to seek concurrence of the Fund and Treasury to
release the $80 million from the IDB. We had been told that
economic policy coordinator Aitkenhead and Finance Minister
Bonilla would lead a team later in the week, but Aitkenhead
changed his mind and dispatched a more junior mission in
order to save time. We believe strongly that we should
accommodate the Guatemlan request. The new government has,
in six weeks, brought extraordinary pressure to bear on
corrupt former officials (both the former President and his
revenues chief abruptly left the country before court orders
barring their travel took effect),and it has convoked the
renewed fiscal pact dialogue and chosen its moderators. It
has changed management in the ports, where customs and tax
evasion were largely centered, and is working on a plan to
cut the military by half. The early signals could not be
more clear that the Berger Administration wants its fiscal
house in order, with efficient revenue collection and
refocused spending on education and health. It has also made
clear that it is prepared to raise tax rates if needed to
finance what Guatemalans want from their Fiscal Pact, but
that will take some time. The quickest and most tangible
action we can take in coming days to help the government keep
its momentum would be help it access the IDB disbursement.

World Bank Funds
--------------

7. (C) The Guatemalans may also ask for disbursement of
approximately $50 million in World Bank sector adjustment
funds. We are not yet ready to recommend how to deal with
such a request and would want to consult further with our
World Bank colleagues on Guatemala's compliance with some of
the specific conditionalities in their program. The World
Bank program undewrites, at least in part, a specific
mechanism of subordinated debt to help recapitalize the
banking system and is not simply policy-linked budget
support. Our initial reaction is that the World Bank funds
are a crucial element in bank restructing efforts spanning
several years and are best left for their intended purpose.
HAMILTON