HONDURAS: IMF VERY PLEASED WITH GOH PERFORMANCE TO

C O N F I D E N T I A L SECTION 01 OF 02 TEGUCIGALPA 001845

SIPDIS

STATE FOR EB/IFD, WHA/EPSC, INR/IAA, AND WHA/CEN
TREASURY FOR DDOUGLASS
COMMERCE FOR MSIEGELMAN
STATE PASS AID FOR LAC/CAM

E.O. 12958: DECL: 09/07/2015
TAGS: ECON EFIN PGOV ELAB HO
SUBJECT: HONDURAS: IMF VERY PLEASED WITH GOH PERFORMANCE TO
DATE

REF: A) TEGUCIGALPA 0600

Classified By: Classified By: Economic Chief Patrick Dunn for reasons 1
.4 (b) and (d).


1. (C) On September 2, an International Monetary Fund (IMF)
team completed its two-week long review of GOH macroeconomic
policies. Team Leader Luis Breuer told Charge that the GOH
is slightly outperforming its assigned fiscal and monetary
targets and the Fund is very pleased with what they have seen
to date. This performance is particularly impressive given
the sharp rise in fuel prices recently and the temptation for
the GOH to lose fiscal discipline as the November 27
elections approach. Breuer noted that the GOH has held firm
in resisting strong political pressures to exceed spending
caps to better position the ruling National Party for the
upcoming elections. (Note: Post has previously commented on
the very hard line Minister of Finance William Chong Wong has
taken, refusing any new proposed spending that is not
explicitly offset by new revenue or spending cuts elsewhere.
End note.)


2. (C) After reviewing the GOH's books, the Fund privately
confirmed to Post that there is still some money available
for the GOH to complete many of its projects such as port
improvements and anti-poverty projects. Despite this buffer
funding, the GOH continues to tell petitioners that there is
no money left. Complicating the GOH financial outlook is an
IMF-imposed spending cap on investments for CY 2005. The GOH
has complained on numerous occasions that this cap threatens
to make it impossible for the GOH to access even concessional
funding for important social spending programs such as school
infrastructure rehabilitation. Post raised this issue with
IMF ResRep Hunter Monroe and with World Bank ResRep Adrian
Fozzard. After considering the GOH's argument, Breuer
reported that the IMF believes that the GOH should invest
about $100 million more on capital spending. The Fund will
engage in a negotiation with the GOH to reach an agreement on
an investment plan covering the rest of this year.


3. (C) The team also met with both leading presidential
candidates, Liberal Party candidate Mel Zelaya and National
candidate Porfirio "Pepe" Lobo, to discuss fiscal
responsibility. The Fund was favorably impressed with both.
The Fund met with both last March in a quasi-secret meeting
in Miami (ref A) to secure their agreement to abide by the
terms of the Poverty Reduction and Growth Facility (PRGF) and
to request the candidates refrain from politicizing the Fund
agreement during the campaign (which would make it much
harder for the next government to implement). That said, the
Fund recognizes it will also need to negotiate the next
program with the new government.


4. (C) A few issues of particular concern remain. The Fund
is acutely aware of the political difficulties that will face
the new government in implementing wage reforms for the
powerful teachers union, which must be completed by 2007
under the current agreement with the Fund. The Fund is also
wary of some of the more populist proposals coming from the
campaigns. For example, Pepe Lobo has proposed eliminating a
fuel surcharge on electricity bills, which would create an
estimated 300 to 600 million lempira (USD 16 to 32 million)
hole in the budget annually. The Fund considers this proposal
"a very bad idea." Manuel "Mel" Zelaya, also under pressure
to propose solutions to the problem of sharply rising energy
prices, has proposed cutting fuel taxes, one of the primary
sources of revenue for the GOH, and one that will become
increasingly important as revenues from customs duties dry up
when CAFTA is implemented. Zelaya recognizes that offsetting
cuts must be identified to fund such a proposal, but to date
has not suggested where those (substantial) cuts would come
from. Each of these proposals is additional to the existing
targeted subsidy for electricity and for mass transportation
that benefits the poorest Hondurans (defined as those that
use less than 300 kilowatts). This subsidy is already
included in the budget and has been approved by the Fund.
Recognizing the political pressures brought about by rapidly
rising prices, the Fund concedes that there is some prospect
of increasing the electricity subsidy to the poor and is
working with the GOH on this.


5. (C) ResRep Monroe told Post that initial figures suggest
remittances to Honduras have risen an astonishing 53 percent
year-on-year to approximately USD 1.5 billion, a figure he
said he cannot yet explain. Remittances throughout the
Central American region have been growing by approximately 25
percent per year for the last several years. Conventional
wisdom attributes this rise to higher numbers of Honduran and
other Central American emigrants, improved earning power in
the U.S., and overall economic recovery in the U.S. All of
these factors combined, however, seem insufficient to explain
this year's projected jump in remittances. (Note: There is
a significant Honduran expatriate population in New Orleans
-- variously estimated at up to 150,000 -- that was hard hit
by hurricane Katrina. This could reduce remittance inflows
this year by USD 100 million or more, and could potentially
result in reverse flows for a short time as Hondurans seek to
assist their relatives in the U.S. However, even this
socio-economic catastrophe and its attendant drop in
remittances is dwarfed by the USD 400 million projected
increase in total remittances this year alone. End note.)


6. (C) These remittances are increasingly routed through
safer and less expensive formal transmission channels, rather
than via relatives or hawala-type arrangements. Once
received in a Honduran bank, the Central Bank of Honduras
(BCH) imposes a 100 percent surrender requirement on these
dollars nightly. To prevent the lempira issued for these
surrendered dollars from sparking inflation, the BCH
sterilizes the flows by issuing absorption certificates
(known as CAMs),which currently yield 11.5 percent. The
result has been a stable single-digit inflation rate (8.6
percent year on year as of July),but a rapid accumulation of
forex reserves (estimated at about 5 months of import cover
and rising). The interest rate differential between the CAMs
and dollar-denominated instruments has resulted in a large
quasi-fiscal deficit for the BCH, which the GOH seeks to
eliminate by moving all bond issuance activities to the
Ministry of Finance and limiting the BCH role to money-desk
operations (for liquidity management and interest-rate
signaling).


7. (C) Liberal candidate Mel Zelaya has proposed eliminating
the CAMs as a way of increasing liquidity to the system, to
ease the credit crunch in the rural sectors. President of
the Foundation for Investment and Export Development and
former Vice Minister of Finance Vilma Sierra de Fonseca told
EconChief that this plan is terribly risky, as it would
expose the economy to intense inflationary pressures. The
long term solution, she said, is a more flexible exchange
rate mechanism. (Note: IMF ResRep Monroe made similar
comments separately to EconChief.) That will take some time,
she said, and when it happens, the lempira -- which has been
depreciating slowly relative to the dollar (in nominal terms)
for several years -- will need to appreciate. Former
Minister of Trade and current Ambassador to the U.S. Norman
Garcia made similar comments to EconChief in July before
departing for his Washington assignment. (Note: The
exchange rate is currently a managed float, pegged to a
trade-weighted basket of currencies, overwhelmingly the U.S.
dollar. The currency depreciated 4.4 percent relative to the
dollar last year in nominal terms, and is expected to
depreciate an additional 2.5 percent this year. The lempira
settled at 18.87 to one USD last week, down slightly from the
previous week's 18.86 to one. End note.)


8. (C) Comment: This is as positive a review as Post has
heard from the IMF in quite some time, and is particularly
welcome in this election season. Post shares the Fund's
satisfaction that the GOH has thus far avoided inflationary
pressures from energy cost spikes and sharp increases in
remittance inflows, and has resisted the temptation to forego
fiscal discipline in the run-up to the November 27 elections.
We will continue to watch closely, both as the elections
approach, and as the GOH begins to appropriate an estimated
USD 212 million in savings from HIPC debt service forgiveness
this year. End Comment.

Williard
Williard