DOMINICAN PROGRAM WITH IMF: HIGH HURDLES,

UNCLAS SECTION 01 OF 04 SANTO DOMINGO 000194

SIPDIS

SENSITIVE

DEPT FOR WHA, WHA/CAR, WHA/PPSC, EB/OMA (WONG);
TREASURY FOR DO:NLEE, RTOLOUI, LLAMONICA; PARIS FOR
TREASURY ATTACHE

E.O. 12958: N/A
TAGS: EFIN DR
SUBJECT: DOMINICAN PROGRAM WITH IMF: HIGH HURDLES,
UNCERTAIN PROSPECTS, WHILE COGENTRIX POSES A BIG OBSTACLE



1. (SBU) SUMMARY. On January 7 Econoff and USAID Economist
called on IMF ResRep Ousmene Mandeng (PLEASE PROTECT) to
review current status of IMF proposed program. The GODR has
completed legislative action on budget items included as
conditionalities and is close to complying with requirements
for adjusting finances in the electricity sector. By
retaining the August target for monetary growth, the IMF is,
for now, asking for a virtually unachievable reduction of the
money supply by 14 percent. The Central Bank Governor has
explicitly restated the GODR policy of maintaining a free
exchange market. The program makes Paris Club refinancing a
condition for the announcement of the agreement. Various
other conditionalities must be met before the program goes to
the IMF board. In sum, the program poses high hurdles and
offers a holding action which may get the country through
presidential elections with a dollop of IMF money and
extensive lending from the IDB and World Bank. This strategy
could be jeopardized if creditors call sovereign guarantees
on COGENTRIX loans, blocking IDB lending. END SUMMARY.


2. (SBU) On January 7 Econoff and USAID Economist called on
IMF ResRep Ousmene Mandeng (PLEASE PROTECT) to review current
status of IMF proposed program. The Fund and the GODR are
finalizing the draft Letter of Intent (LOI),the Memorandum
of Economic Policy (MOEP),and the Technical Memorandum of
Understanding (TMOU). There are two sets of prior actions
that must be implemented before any agreement is approved by
the Fund Board.


3. (SBU) The first set of prior actions consists of
pre-conditions to the formal announcement of the LOI and the
sending of the proposed program documents to the IMF Board
for approval. There are five components in the first set of
prior actions:

a. A budget approved by the Dominican Congress. This
action has been completed. The final budget negotiations
resulted in changes of DR pesos 530 million from the original
budget. The changes, which were acceptable to the Fund
increased funding for the Congress and NGOs. This increase
was funded by cuts in pensions and transfer to
Municipalities, plus a broadening of the range of household
goods subject to excise taxes. The increased taxes would
generate DR$170 million, while the balance of DR pesos 360
million 0 would come from the expenditure reductions
mentioned above.

b. An Electricity Sector Plan to &keep the lights on8
for the next six months. This plan, which must be approved by
the World Bank, has three components:

i) tariff increases which must be formally published;
ii) development of a Statement of Electricity Development
Policy (to be sent to the World Bank); and
iii) a detailed cash flow analysis for the next six months
that shows the electricity sector companies are breaking-even
by July 2004.

(Two of three requirements have been completed. The
electricity tariff increases have been agreed to and
announced. The new pricing scheme maintains the current
subsidized rate for those consuming 200 KWH per month, for
those consuming 200-700 KWH/month the subsidy is maintained
for the first 200 KWH and the rates are increased 4 pct/month
for consumption between 200-700 KWH/month, while for those
whose monthly consumption is more than 700 KWH the subsidy on
the first 200 will be phased out and the current rate
increased by 7-8 pct/month until June 2004. Concerning the
second component, the Statement of Electricity Policy
Development, this has been done and submitted to the World
Bank in December 2003. The cash flow analysis has not been
submitted to the IMF as of yet.)

c. Reduction in the monetary base. The money supply is
growing too rapidly and the IMF wants the monetary base to be
reduced from DR pesos 77 billion to the original August
target of DR pesos 66 billion (14 percent). This would be an
enormous challenge, and ResRep indicated that the IMF would
evaluate this perfomance measure on the GODR's good faith
efforts rather than on achievement of the actual target. The
monetary base has grown in part because the holders of
government certificates were not renewing them as they
matured. There are several reasons for this reluctance to
purchase Central Bank issued certificates. One concern is the
fact that they offer a negative rate of interest. The
inflation rate at the end of the year was 42 pct while the
certificates were yielding 32-34 pct. A second concern of
certificate holders is whether the Central Bank can finance
the current stock of debt. Many think that the Central Bank
will be forced to extend the length of maturity of
certificates held by investors from 7-91 days to several
years (at present the great majority of the certificates have
a maturity of 30 days or less). Given these problems, it
would appear that it will be difficult for the GODR to meet
this target in the next several weeks.

d. A freely operating exchange rate market. In December
the President announced the formation of a Commission to
monitor the operations of the exchange houses. At the same
time the President announced predetermined daily exchange
rate reduction targets to reduce the exchange rate from
around DR pesos 44 to DR pesos 30 for one U.S. dollar. The
consequent actions resulted in a temporary reduction of the
exchange rate to around DR pesos 34 to one U.S. dollar for
several weeks. As a result of the government's actions, a
foreign exchange black market appeared with the black market
rate at around DR pesos 42 to one U.S. dollar.

(On December 30 Central Bank Governor Jose Lois Malkun
reportedly met principal actors in the exchange rate business
and told them the GODR would no longer seek to control the
exchange rate. The dollar began to appreciate. On January 7
Lois Malkun told journalists, &The policy of the Central
Bank is not to interfere in the exchange rate, which should
be set by market forces. If the dollar rises, let it rise as
it may.8 The Central Bank posted a public notice in daily
newspaper Listin Diario on January 8 stressing the GODR
agreement with the IMF to maintain a free exchange rate and
advising that projected rates used by analysts in drawing up
a program were estimates, not mandatory target rates. The
peso has depreciated from its December strong point of DR
pesos 34 per dollar to approximately DR pesos 42 as of
January 9. The black market is said to exist still for those
in urgent need of large amounts of dollars at short notice
and may take several weeks to disappear completely.)

As a measure of performance for this issue the IMF is
requesting that the Government publicly announce the
elimination of the Commission monitoring the exchange houses.
In addition the IMF has requested that the Commission on
Financial Security be eliminated. This latter Commission has
broad powers that could be used to impact the foreign
exchange market. (On January 8 the GODR published extensive
regulations dated December 18 for the oversight of exchange
operations.) The ResRep left the impression that since
bankers favor keeping this latter Commission to protect
against credit card fraud and to halt rumors about the
viability of banks within the country, the IMF might remove
its objections to this Commission if it broad powers were
curbed and clarified so as to eliminate the possibility it
could be used to manipulate the exchange rate.

e. Financing assurances from the Paris Club. Paris Club
refinancing is an essential element in the present proposed
program. Without Paris Club refinancing the program is not
viable. On January 14, the Paris Club will meet to consider
the request for refinancing. The Paris Club must approve the
request for refinancing and will consider the request to move
the current cut-off date for refinancing from 1984 to the
present or as close to the present as possible, so as to
maximize the impact of the refinancing.


4. (SBU) Once the above pre-conditions are satisfied, the IMF
will be in a position to make an official announcement of the
agreement and forward the program to the Board. Even so, the
formal Board Review will be dependent on the GODR meeting a
second set of conditions. These are:

f. The Systemic Risk Law must be passed and signed into
law. This law would among other things address weaknesses in
the legal framework for addressing banking crises. (As of
January 9 the Senate has passed this draft and it has gone to
the Finance Committee of the House of Representatives.)

Embassy does not have any information at this time on the
progress toward further remaining conditions:

g. The Monetary Board must approve regulations for the
establishment of a contingency fund. The contingency fund
would be similar to the Federal Deposit Insurance Corporation
in the U.S.

h. Establishment of a Lombard-style refinancing facility.
This facility would allow commercial banks facing a liquidity
problem to borrow from the Central Bank. It is meant to be a
last-resort lending facility. To discourage banks from using
it except in emergency situations, the interest rate charged
by the Central Bank would be substantially above market rates.

i. Finalization of the Terms of Reference for
establishment of a panel to evaluate the assets of the two
electricity distribution companies that the GODR purchased
from the Spanish company Union Fenosa. This is a follow-up to
the recommendations of the International Board that reviewed
the purchase of the distribution companies. The intent is to
assess whether the price paid was appropriate to the value of
the companies.

j. Establishment of a Panel to review the weaknesses of
the financial system and recommend actions to resolve them.
The Panel will be charged with reviewing the recent financial
sector problems to determine their cause, to identify
weaknesses that need to be addressed and develop
recommendations to address them.

k. Clearance of the more than USD 100 million of arrears
that will not be subject to rescheduling. The GODR has
recently met urgent financing needs by accumulating arrears.
The USD 100 million consists of arrears not subject to
rescheduling under Paris Club. Given the GODR,s financial
plight, clearance of the arrears would seem to be possible
only if the IDB releases the first tranche of its emergency
loan before the program goes to the Board.


5. (SBU) Once these actions have been completed, the IMF
Board will meet for approval of the resumption of the
program. It would appear that the earliest the Fund Board
could act would be in early February. Once the program is
approved, the Fund will release a second tranche of USD 60
million, the only release of Funds until after the May 2004
elections. (If a second round of presidential voting is
required, it will take place on June 30.) The Fund has
dropped the monthly reviews of the program with the GODR and
will not conduct a review until June or July, after the
elections, and will determine at that time whether conditions
warrant the release of the third tranche.

COMMENTS ON IMF PROGRAM


6. (SBU) Emboffs consider this to be a deliberately
short-term emergency program designed to give the Mejia
administration the barest chance to make it though the
presidential elections. Conditionality is strict and
challenging. The Fund itself is committing very little in
resources. Almost all the likely funding of USD 300-400
million will have to come from the IDB and the World Bank,
and of that amount about USD 100 million must go towards
arrears before the program goes to the Board.


7. (SBU) Given the upcoming May election, the GODR could well
have difficulties sticking to such a tight program, even in
the best of circumstances. Although the ResRep did not say
so, the schedule suggests that the IMF will wait until after
the May 2004 presidential elections to revise or completely
to renegotiate the program. The Fund is conserving its
resources and passing the financing burden to other IFIs over
the next six months to support the holding action. The
calendar is not kind, either -- the next GODR will not take
office until August 16, and President Mejia is not currently
favored to win his bid for re-election. And when the time
comes to elaborate a new program, the multilateral
development banks will almost certainly have to stump up just
as much, and even more than before.

COGENTRIX THREATENS TO PULL THE HOUSE DOWN


3. (SBU) Further complicating the GODR's precarious
finances is a face-off over arrears due to electricity
generating firm COGENTRIX. The GODR has been in arrears to
the firm since September and technically in default since
November. President Mejia continues to refuse to pay
COGENTRIX unless the management explicitly agrees to
negotiate lower rates for electricity generation; Mejia says
that the firm acted in bad faith in mid-2003 when it reneged
on an understanding that it would negotiate if the GODR
cleared arrears. The amount due grows monthly by about USD
3.7 million, due to a "take or pay" clause in the contract.
According to the terms of the loans, creditors have the right
to call at any time sovereign guarantees amounting to
approximately USD 400 million (including penalties) for IDB
and private sector loans.


4. (SBU) Embassy understands that COGENTRIX creditors have
given the GODR until January 14 to pay all arrears, amounting
to about USD 35 million. Ironically, COGENTRIX is obliged by
the contract to renew a performance bond of USD 10 million.
COGENTRIX has requested that the GODR waive this requirement,
in return for which the creditors offer to extend their
deadline for payment of arrears a further two weeks, until
January 29. A call of the guarantees would have catastrophic
effects on GODR finances -- it would immediately cut off IDB
lending (essential to the program defined with the IMF) and
would lead to a sharp further downgrade of the ratings for
GODR bonds. This is a commercial dispute between a sovereign
government and various creditors, including a number of U.S.
nationals, but it also has important policy implications for
the USG. The USG role should continue to advise the GODR to
come to terms, should closely monitor the developing
situation, and should encourage the IDB to mediate between
the two parties.
MARSHALL