Honduras: Progress Toward an MCC Compact

UNCLAS SECTION 01 OF 06 TEGUCIGALPA 002299 SIPDIS STATE FOR WHA/CEN, WHA/EPSC AND EB/EPPD TREASURY FOR DDOUGLASS COMMERCE FOR MSIEGELMAN AND AVANVUREN STATE PASS USAID FOR LAC/CAM E.O. 12958: N/A TAGS: ECON EAID EAGR KMCA HO SUBJECT: Honduras: Progress Toward an MCC Compact ¶1. (SBU) Summary: MCC representatives visited Honduras October 4-8 to continue due diligence investigations in preparation for evaluating and signing a Compact agreement in the next several months. This visit is the 5th visit since May, when Honduras was short-listed as a country invited to apply for MCC funds. This visit focused on value- added agriculture and irrigation components. Other visits have focused on 1) explaining the process for submitting a proposal, 2) assessing the potential for economic growth, 3) evaluating financial oversight mechanisms, and 4) presenting MCC CEO Paul Applegarth to President Maduro and the GOH. Additional visits are scheduled for late October to conduct due diligence on the transportation infrastructure portion of the proposal and early November to conduct a similar review of the financial sector and its role in maximizing the impact of any MCC project. Next steps include due diligence on the project elements, consideration of conditionality - such as progress on anti-corruption efforts -- for future disbursements, and the need for progress on MCC's administrative concerns, including preparations for or procurement of housing, office space, and locally hired employees. End Summary. -------------- Honduras: Might be the First -------------- ¶2. (SBU) MCC representatives told Post that Honduras is likely to be one of the first countries to sign a Compact with the MCC. Not only was it among the first to submit a proposal, Honduras also prepared a thorough, well-organized proposal with obvious GOH political support for implementation. Thanks in large part to previous efforts under its Poverty Reduction Strategy and Heavily Indebted Poor Countries (HIPC) application -- not to mention vigorous efforts at donor coordination and rationalization following the Hurricane Mitch Reconstruction (1998-2001) -- the GOH had in hand a prioritized list of development objectives that they used to frame their MCC proposal. (Note: That proposal is available on the web at http://www.sierp.hn/docs/MCAespanol.pdf. End Note.) This approach helped ensure a minimum of overlap with existing development efforts, maximum ability to create synergies with established project priorities, and an internally consistent approach to overall development. Perhaps most importantly, the strategy also benefited from civil society and donor community review and approval. The GOH will be conducting additional civil-society outreach events on October 14-15. ¶3. (SBU) Several issue areas remain to be addressed, including the role of the financial sector, a detailed review of the transportation infrastructure proposal, consideration of the scope and depth of environmental impact analyses, development of methodology for evaluation and monitoring, and a legal review. It should be noted that, since this could be the first Compact proposal completed, the precise level of detail on these and the other areas of focus ("workstreams," in MCC parlance) that must be included in the Compact itself remains undecided. As a legal obligating document, a certain level of detail is required, but likely less detail than would be the case for a project- planning document. The decision on the level of detail needed in the Compact could dramatically affect the time needed to complete due diligence reviews and prepare a document for signature. ¶4. (SBU) MCC and Post are also considering the degree of conditionality to be made inherent or explicit in the Compact. MCC officials note that there might be value in undertaking project elements in prioritized tranches, with specific performance or policy triggers for moving to successive tranches. The policy reforms MCC has in mind fall into two areas of concern: (1) reforms that are necessary to ensure maximal impact from the program (such as reducing red tape, rationalizing pricing, and customs reform) and (2) reforms whose goals are continued improvement on the 16 key eligibility indicators. Regarding the latter, in the case of Honduras, MCC is considering concrete commitments that could be incorporated into the Compact as milestones in the fight against corruption. This type of conditionality would provide an extremely forceful lever for reform, while also decreasing the threat of reduced MCC project effectiveness due to losses to corruption. Post strongly supports strengthened anti- corruption efforts be included as bases for review of the Honduran Compact prior to any disbursements. -------------- -------------- Towards a Compact: We've Come a Long Way in Five Months -------------- -------------- ¶5. (SBU) The MCC approach in Honduras has been based on the approach used in the private sector: MCC is prepared to obligate large quantities of funding, on a no-year basis, to programs that promote economic growth and reduce poverty. However, the MCC will act only after being convinced that: (1) the problem (the obstacle to economic growth) has been well defined; (2) a viable solution that targets and solves that problem in a way that benefits society as a whole has been identified; and (3) the economic rate of return justifies singling this activity out as a top-priority activity. In short, the funds should be used to resolve a problem that other donor programs or private sector efforts cannot or will not resolve, and the choice of activities should yield the greatest bang for MCC's buck. ¶6. (SBU) By focusing on economic rate of return, rather than the financial rate of return used by the private sector, MCC attempts to take full account of all benefits and costs that accrue to society even if they do not have a direct cash- flow associated with the project. (Examples would include the benefits of customs reform or a cleaner environment, or the costs of providing more subsidized water as a result of increasing demand of farmers that have been taught to grow new crops.) The MCC recognizes the importance of other development objectives that are pursued by other donors, but has a mandate to focus exclusively on sustainable economic growth that results in poverty reduction. ¶7. (SBU) The GOH's initial ideas quickly focused on what they called the "dry canal" idea. The plan is to improve road infrastructure between Puerto Cortes on the Atlantic coast and Puerto Cutuco, on the Pacific, just across the border in El Salvador. The road would link Tegucigalpa and San Pedro Sula (the political and business centers of Honduras, respectively) to their largest export hubs, and would promote the development of export-oriented businesses by lowering transport costs and increasing efficiency. Secondary and tertiary roads would link farms and smaller towns to these major markets, and would ease labor shortages, without promoting uncontrolled urbanization, by linking population centers with industrial zones. ¶8. (SBU) To capitalize on this basic infrastructure idea the GOH quickly added an initiative to improve agricultural productivity, move into higher value-added crops, and encourage a shift from subsistence agriculture to export- oriented agribusiness that could also benefit from the new road network. This proposal played to MCC's strengths, in particular its ability to fund the entire range of economic activities from farm to market, crossing sectoral boundaries in a rational and linked way, and over a prolonged (five year) implementation period. This would complement a model of this type pioneered by USAID. -------------- -------------- Paring Back the Proposal: Status of the Core Elements -------------- -------------- ¶9. (SBU) Perhaps predictably, as drafting of the Compact proposal went forward within the GOH, additional programs were added to placate powerful political interests. The GOH proposal identified nine impediments to economic growth. MCC staff distilled these down to five essential impediments: (1) high transportation costs; (2) low agricultural productivity; (3) uncertain land tenure; (4) a shortage of supervisors and technicians in the light assembly sector and an overall labor shortage in the Sula Valley; and (5) a mismatch between the location of hotel facilities and tourist attractions. One of the early MCC visits, therefore, was aimed at tightening the focus of the proposal to just one or two core objectives. Thanks to extensive meetings with the GOH by EconOffs, USAID, and MCC representatives, Post gradually succeeded in convincing the GOH of the need to take most of the ornaments off the tree. What follows is a brief description of the current elements of the GOH Compact proposal and MCC views on the relative merits of those elements. ¶9. (SBU) The logistical corridor: MCC inquired broadly throughout the GOH, private sector, and civil society, and found strong support for the proposed upgrade to Honduras' transportation infrastructure. As currently envisaged, this proposal would include three elements: the main highway; improvements, maintenance, and expansion of the secondary road network; and a tertiary-level expansion of rural and urban access roads. -- The highway: If approved, MCC would pay up to $80 million to finance two segments of the logistical corridor. Other segments would be financed by other donors, and loans from the Interamerican Development Bank (IDB) and the Central American Bank for Economic Integration (CABEI). (By pooling these loans with the grant portions of the project, the GOH buys down the overall interest rates to stay below IMF-imposed borrowing limits as it approaches HIPC decision point.) -- The secondary roads: These would be key to extending the benefits of the logistical corridor to communities further afield, and to developing local capacity for appropriate road maintenance. MCC feels that additional consideration must be given, however, to how the qualifying roads would be selected. This portion of the program is currently budgeted at $19.5 million. -- The tertiary roads: These roads complete the linkage of the port to the local farm and village level, facilitating a rural transformation from subsistence farming to value-added agricultural exports. In the urban setting, access roads allow underutilized labor to more easily commute to regions of higher employment and relative labor scarcity. This approach increases employment overall without the need to relocate the labor force and therefore without the consequent strain on existing public services infrastructure in those locations. This portion of the program, covering 1,320 kilometers of road, is currently budgeted at $22.5 million. ¶10. (SBU) Improving Agricultural Productivity: This proposal consists of six elements: fixing the land titling and tenure system; establishing a "millennium challenge fund" to fund smaller projects on a rotating-fund basis; expanding drip irrigation; providing technical assistance in the agricultural sector; improving flood control in the Sula Valley; and establishing agricultural "value-added chains." -- Land titling: This element would provide a revolving fund to settle contested land titles, allowing households to use clean land titles as collateral for loans for activities such as home construction, education, or starting a business. MCC is unconvinced that this is an activity that could not be carried out by the private financial sector, and notes that the World Bank is also actively working on improving land registries. That said, MCC is interested in considering the proposal further, given the centrality of land titling issues to economic growth throughout the region. This portion of the program is currently budgeted at $10 million. -- Millennium Challenge Fund: This element would establish a revolving fund to support small projects that arise during Compact implementation, to fill any unexpected gaps and add program flexibility. This component was included by the GOH to provide a mechanism to receive unsolicited proposals, which they understood might be required by the MCC's authorizing legislation. The MCC General Counsel has determined that such a mechanism is not required by law. The GOH technical team and MCC staff discussed establishing a more focused fund to provide financing for projects in the agriculture sector. While, this portion of the program was budgeted at $10 million, it will likely be scaled down. -- Expanding Drip Irrigation: In selected areas of high potential agricultural productivity, on-farm drip irrigation systems would be supported to increase yield while potentially decreasing total water usage compared to traditional gravity-fed irrigation techniques. MCC favors this element, if implemented in conjunction with technical assistance training in use and maintenance of these technologies. This portion of the program is currently budgeted at $25 million. -- Technical Assistance: This element would train farmers in modern farming techniques, pest management, crop rotation, market analysis, business management, drip irrigation operations and maintenance, and other key aspects of enhanced productivity. MCC favors this element, particularly in conjunction with drip irrigation systems. This element could build on or follow the best practices established by proven USAID-funded systems. This portion of the program is currently budgeted at $7.5 million. -- Flood Control in the Sula Valley: This element would fund construction of the El Tablon Dam, to control flood waters and generate electricity in the Sula Valley. MCC notes that this project is not intuitively linked to the other central elements of the compact proposal, and is potentially contentious for political and environmental reasons. MCC does not intend to fund this item. This portion of the program is currently budgeted at $35 million. -- Agricultural Value Added Chains: This element would support collaboration among vertical components of agricultural commodity sectors, such as palm oil or sugar, with the intent of collecting funds to enhance production and marketing of the commodity. MCC remains unconvinced the structure of such efforts is clearly defined or would be successful in preventing major players in the sectors from benefiting disproportionately. While the MCC will probably not directly fund the value added chains, these chains (as well as other entities) would be eligible to submit proposals to a fund to support the provision of public goods to promote the growth of the agricultural sector as described under the Millennium Challenge Fund. ¶11. (SBU) Other Programs: Programs added to the core objectives of transportation infrastructure and agricultural productivity include an apparel training center, pre-school funding, small and medium enterprise development funds, and tourist centers in Tela and Tegucigalpa. MCC seeks overall to minimize the number of projects it is involved in, both to limit overhead administrative costs, and to keep the funded projects tightly focused on the core objectives of the Compact. Therefore, MCC does not plan to fund the following proposals: -- Apparel Training Center: This element would train supervisors and technicians for the light assembly sector. MCC notes that in addition to being tangential to the core Compact objectives, this proposal should be funded primarily by the private sector. Additionally, such a project could be seen as violating the MCC prohibition on funding any activities that displace U.S. jobs. This portion of the program is currently budgeted at $1.5 million. -- Pre-School Education: This initiative would fund pre- schools, linked to a foundation created by the President, thus allowing mothers to enter the workforce. MCC notes that this element is tangential to the core objectives established in the Compact proposal and suffers from dubious political optics by contributing to a charity founded by the President. This portion of the program is currently budgeted at $7.5 million. -- Small and Medium Enterprise Development Financing: This element is poorly linked to core objectives contained in the Compact proposal. While financing will likely be an integral part of the agricultural portion of the Compact, MCC does not intend to fund this broadly defined initiative. This portion of the program is currently budgeted at $4 million. -- Tela Bay Infrastructure: This element would fund development of roads, sewers, drainage systems, and water and electricity services to support the development of a luxury resort complex in Tela (on Honduras' northern Caribbean coast). MCC feels this project should be financed by the project developers and does not intend to fund it. ($15 million.) -- "Royal Mines" Tourism Center: This element would convert a former prison into a tourism center and shopping area in Tegucigalpa, to provide additional attractions to attempt to balance the mismatch between the location of hotel facilities (overbuilt in Tegucigalpa) and the location of tourist attractions (such as the Bay Islands or the Copan Ruins). This element is poorly linked to core objectives contained in the Compact proposal. MCC does not intend to fund this initiative, currently budgeted at $7.5 million. -------------- --- Looking Forward, MCC Needs to Focus on Logistics -------------- --- ¶11. (SBU) Comment: Post welcomes and continues to support the extraordinary progress made to date on the substance of a proposed Compact. However, it is increasingly urgent that progress also be made on a number of internal administrative matters facing the new MCC program. MCC indicated it expects to place a direct-hire representative in-country as soon as possible after the signing of a Compact. This will require completion of an NSDD-38 process. Post encourages MCC to begin this process as soon as possible. Post also raised with visiting MCC representatives the possibility of contracting a local-hire, part-time administrative assistant who could manage logistics and paperwork for the increasingly heavy MCC visitor load to Honduras in the run- up to Compact signing. Establishing such a position, with local office space, would not only facilitate overall progress of the proposal by providing a stable workspace for MCC visitors, it would also lay the foundation for the permanent MCC office, which would then be ready for the MCC representative upon assignment. Both Embassy and USAID management offices stand ready to discuss ICASS or other options for contracting or procurement for staff, office space, housing with MCC. End Comment. 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