IFIS ON DOMINICAN FINANCES - TIGHT TIMETABLE WITH

UNCLAS SECTION 01 OF 03 SANTO DOMINGO 006062

SIPDIS

DEPT FOR WHA/CAR, WHA/EPSC, EB/IFD/OMA;
TREAS FOR LCARTER

E.O. 12958: N/A
TAGS: ETRD EFIN DR PGOV
SUBJECT: IFIS ON DOMINICAN FINANCES - TIGHT TIMETABLE WITH
A LONG WAY TO GO FOR STANDBY


1. (SBU) Despite progress on institutional reforms, the
Dominican government still has a number of decisions to make
before a new standby agreement can be reached with the IMF.
Concerns about electricity sector reforms and and unanswered
questions on fiscal problems mean that a tentative IMF Board
date of December 13 might be overly optimistic. A Dominican
technical team plans to begin talks with the Fund in
Washington the week of November 8, with political
negotiations scheduled to begin November 15.

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Progress, but still more holes
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2. (SBU) On November 1, local IMF, IDB and World Bank
representatives met with the Ambassador to review the status
of a new agreement. IMF resrep Ousmene Mandieng (protect)
told the Ambassador that the Dominican Republic has made
significant progress on institutional reforms in preparation
for an agreement, but added that many questions remain
regarding electric sector problems, budget measures and the
incomplete fiscal reform. On the positive side, the
government has increased the independence of the Central Bank
and Banking Superintendency and also improved efficiency of
debt management.


3. (SBU) Plans on timing of bank recapitalization and
monetary policy have also progressed. By the end of
December, all banks must reach a 10 percent capital adequacy
rate based on national standards, but will be given until the
end of 2007 to reach international banking standards. At
present the size of the gap between local and international
norms is not clear. While this is not ideal from the IMF
perspective, Mandeng said, the long grace period was part of
the original IMF standby agreement. The Central Bank is
moving to lengthen the duration of Central Bank certificates
from the present one to six months to one to five years, and
also plans to try to lower the cost of debt by substituting
dollar linked debt for peso debt. The Central Bank (CB)has
been able to lower interest rates in recent months but they
are still high in nominal terms (up to 30 percent in the last
auction). Interest on the CB certificates is equivalent to 4
percent of GDP; he expects that it will fall to about 1.5
percent of GDP in 2005.


4. (SBU) Not enough progress has been made on fiscal reform.
Tax legislation passed in September did not provide the
revenue originally sought and now any residual fiscal
adjustment will have to be taken from the expenditure side,
since the government has declared publicly that there will be
no further tax increases. There is no clear plan for where
cuts will be made or how the Dominican government is to
control contracting of new internal debt. Cuts will have to
come largely from current expenditures, not from the capital
budget.


5. (SBU) For the troubled electricity sector, the IMF still
requires from the government 1) credible projections of the
monthly energy subsidy payments and transfers in order to
calculate the budget ceilings; and 2) identification of
specific concrete steps to be taken to reduce theft, improve
collections and focus subsidies. It is also still unclear
where the Dominicans will secure much-needed external
financing.


6. (SBU) A small delegation led by Julio Ortegawent to New
York last week to speak with commercial banks and
bondholders, but no news of results is yet available.
Dominican technicians will begin talks with the Fund in
Washington during the week of November 8; political
negotiations involving Technical Secretary Montas, Finance
Minister Bengoa and Ortega are expected for November 15.

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Details and pre conditions
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7. (SBU) Mandieng said that a new Fund program would
probably be worth $600 million over 24-28 months. Funds
would be deposited in the Central Bank and could not be used
to support the budget but only to finance the balance of
payments gap. The program would be a continuation of the
general lines of the previous agreement but would be more
focused on institutional strengthening, with a tax reform
required in 2006.


8. (SBU) Preconditions for the standby will include further
consolidation of fiscal management under the Secretary of
Finance. Debt decisions currently managed by the Technical
Secretary's office need to be transferred to Secretary of

SIPDIS
Finance, as does responsibility for the Office of the Budget.
The IMF also requires that the government procurement
process be made more transparent.

9. (SBU) Whether or not a congressional approval of the 2005
budget will be required for an IMF agreement hinges on
timing. If the IMF agreement approval process slips into
January, the IMF would probably require congressional
approval of the 2005 budget. Even in the case that a
congressionally approved 2005 budget is not required, an
accurate and clear estimate of the level of internal debt,
government payroll and revenues and all other budgetary
information would be required by the IMF.


10. (SBU) Still unclear is the process to be used to
liquidate government assets, some acquired in bank
liquidations last year. The Central Bank governor wants to
set up an independent agency to liquidate assets (both those
acquired from recently failed institutions and assets owned
by the Central Bank over a longer period).


11. (SBU) The IMF will require the Dominicans either to
continue servicing bonds or to demonstrate that they are
actively renegotiating them, in which case the IMF can lend
into arrears. There is currently $63 million in
non-reschedulable debt that must be cleared by the end of
December in order to meet Paris Club and IMF requirements.


12. (SBU) The long discussed deal for cheap oil from
Venezuela is a bright spot and constitutes direct budget
support. It will offer generous terms of 2 percent interest
over 15 years to finance 25 percent of 50,000 barrels a day
of imported Venezuelan crude. This will be worth $200 million
or more per annum. Even so, the IMF model suggests that the
government will have to find between $300 million and $400
million to close the gap, much more than might be realized
through a bond rescheduling.


13. (SBU) The IMF model uses projections of the exchange
rate in 2005 at 37 versus the current 32 per dollar; GDP
growth is predicted at 1.8 percent in 2004 and 2.5 percent in
2005; oil will be at $50/barrel; inflation will be 12 to 15
percent, with an end-2005 projection of 13.5 percent;
expenditures on the electricity sector will be $400 million
in 2005; and the free trade agreement will not be implemented
before the end of 2005 (so that no adjustment will be
required for loss of customs revenues until 2006).

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World Bank and IDB waiting
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14. (SBU) World Bank Country Manager Christina Malmberg said
that her agency has a loan of $100 million outstanding, $50
million of which was paid out in March with the remaining $50
million pending, held up for lack of an IMF agreement. If
the planned agreement goes to board, $25 million will be
released for the energy sector. The remaining $25 million
for social sector expenditure will require the Dominican
Republic to meet eight conditions, on all of which the
Dominicans are still far short. The World Bank loan
authorization terminates in December 2004, and the Bank wants
clear progress on conditionality before it will be willing to
extend the loan offer for three months. The World Bank also
has two modest technical assistance loans for energy and
financial management pending congressional approval, one of
which is 60 percent earmarked for the Banking
Superintendency.


15. (SBU) IDB Representative Moises Pineda said that the IDB
has an outstanding loan of $250 million, with $50 million
earmarked for social spending remaining to be distributed,
pending the IMF agreement. IDB has requested an audit of the
first disbursement to ensure that it was used appropriately.
The government has continued to pay electricity generator
COGENTRIX. If the government contract with COGENTRIX falls
into arrears or is abrogated, the IDB will have to pay a $70
million guarantee, triggering calls on Dominican sovereign
guarantees of $400 million, undermining any IMF agreement.
HERTELL