DOMINICAN PROGRESS ON IMF STAND-BY

C O N F I D E N T I A L SECTION 01 OF 02 SANTO DOMINGO 004196

SIPDIS

SENSITIVE

STATE FOR WHA, WHA/CAR, WHA/PPC, WHA/EPSC. EB/OMA;
NSC FOR SHANNON AND MADISON; LABOR FOR ILAB;
USCINCSO ALSO FOR POLAD; TREASURY FOR OASIA-MWAFER

E.O. 12958: DECL: 08/29/2010
TAGS: PGOV EFIN DR
SUBJECT: DOMINICAN PROGRESS ON IMF STAND-BY

Classified By: EcoPol Counselor Michael Meigs. Reason: 1.4 (b) and (d)



1. (SBU) Summary: IMF Regional Director Guy Meredith and
Resrep Ousmene Mandeng told DCM and staff on August 24 that
things are going generally well for the Dominicans on the
macroeconomic side and they foresee no obstacles to
completing the combined first and second reviews of the
standby. This will lead to the next distribution of funds,
which the Dominicans do not need at this point. IMF reps
mentioned two areas where targets are not being met: energy
sector reform and structural reform. IMF expects the
continuing high world market petroleum prices to worsen the
outlook for the country,s energy sector, which remains in
crisis. He said that the outlook for 2006 was problematic,
citing revenue shortfalls, especially in the energy sector.
End summary


2. (SBU) On August 24 IMF Regional Director Guy Meredith and
Resrep Ousmene Mandeng provided to DCM and Embassy Staff a
status report on the IMF review of this year,s standby
arrangement. Delays in Dominican structural reforms and
other measures had pushed back completion of the first
review, originally due in June, so they will prepare a single
report to submit to the Board in early October.


3. (SBU) Meredith said that things are going well in several
areas, calling macroeconomic performance "not bad," financial
markets and debt restructuring favorable, and growth at an
estimated 5.8 percent--statistically at least--good. The DCM
asked whether the Central Bank figures on inflation and
growth could be believed; Meredith said that another IMF team
had looked at the numbers in early August and found no
evidence that they were intentionally enhanced or misleading,
only that the Central Bank was using old methodology. For
instance, the Central Bank has been using for calculations a
1971 model, which does not correspond to current economic
structures. The Central Bank plans to put a newer,
1993based model into service in early 2006.


4. (SBU) Growth has been concentrated in telecoms and
consumption, much of the latter based on growth in imports,
rather than creation of new jobs. Meredith said that the low
inflation figures are credible, referring to press reports
indicating that many items have fallen in price. The Central
Bank is expecting inflation to pick up in the second half of
year, owing to the increase in petroleum prices. On exchange
rates, Meredith said that there has been some intervention in
the exchange market, particularly early in the year to
prevent a rise in peso value but he did not see a problem of
government manipulation. Net Reserves are now USD 650
million, but the pace of growth in Central Bank accounts has
dropped due to a decrease in interest rates.


5. (SBU) IMF noted that even the Central Bank is expecting
depreciation of the peso at some point, perhaps later in

2005. The rapid growth in imports suggests that the current
account, now in surplus, may turn negative next year.

Troubles on the Horizon for 2006
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6. (C) Meredith said that all major elements of debt
restructuring are in &pretty good shape.8 Commercial bank
debt is not a problem. However, macro/fiscal prospects for
2006 do not look reassuring due to ongoing electricity
subsidies and the decision to maintain a costly cooking gas
subsidy. There are provisions required in the 2006 budget
that will be problematic if there are no offsets. In
addition, the Dominican Government plans to implement for the
first time ever, a 2003 law that transfers 0 .5 percent of
GDP (10 percent of the budget) to municipalities and other
groups such as the judiciary. This had been suspended in
earlier years. Meredith expressed concern that the
Dominicans have yet to find an offset.

Energy -- Still Problematic
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7. (C) Elaborating on the electricity problem, Meredith said
that the Dominicans did not achieve the revenue results
targeted in the first half of the year. The Cost Recovery
Index (CRI) stalled this past spring when distribution
companies failed to reduce the theft of electricity. What
was to have been a USD 350 million government subsidy will
end up being USD 500 million by year end. The government is
in the process of putting private management in place at
distribution companies EdeSur and Ede Norte, but has been
slow to finalize the contracting and key positions remain
unfilled. The visiting Fund team is perplexed by the
problem and the government,s inability or unwillingness to
address it. People are stealing power, the government knows
and denounces the theft, but people go on stealing
unpunished. The IMF is not sure that private management will
fix the problem, since it is not clear that the government
will allow the managers to implement the necessary actions.
The management replacement plan has been around since January
yet there has been no movement, perhaps because the
government is not willing to take the hard decisions until
after 2006 congressional elections.

Banking -- Mixed Results
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8. (C) On banking reform, Meredith said that progress has
been mixed. The Dominicans still need to establish formal
legal independence of the Central Bank and the Superintendent
of Banks. The banking sector as a whole is not strong
because of its lopsided loan portfolio, which is too
concentrated in the top 100 borrowers. But it is not taking
unreasonable risks. Most banks are making profits, though
not large ones.


9. (C) The strongest trait of Central Bank Governor Valdez
Albizu is his independence. He is prudent and wants to
retain an important role for himself. Director General for
Internal Revenue Juan Hernandez was put in charge of tax
reform. Despite resistance from private banks,
Superintendant of Banks Rafael Camillo has done well and
banks are coming into line.


With High Reserves, Next IMF Disbursement Not Needed.
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10. (SBU) The Fund's staff expect that the Board will approve
the next disbursement in October, based on good performance.
The Dominicans may choose not to draw on the next
disbursement, because reserves are high and the funds cannot
be used to pay down the quasi-fiscal deficit. Still
completion of the review now will be helpful for the
Dominican Republic's global image.
KUBISKE