DOMINICAN PLAN TO RECAPITALIZE CENTRAL BANK SEEN

UNCLAS SANTO DOMINGO 003308

SIPDIS

SIPDIS

DEPT FOR WHA, WHA/CAR, WHA/AND, INR, EB/ESC/IEC/EPC;
TREASURY FOR OASIA-JLEVINE; DEPT PASS USDA FOR FAS; USDOC
FOR 4322/ITA/MAC/WH/CARIBBEAN BASIN DIVISION
USDOC FOR 3134/ITA/USFCS/RD/WH

E.O. 12958: N/A
TAGS: EFIN ETRD DR
SUBJECT: DOMINICAN PLAN TO RECAPITALIZE CENTRAL BANK SEEN
AS CRITICAL TO IMF PROGRAM


1.(U) In its April 2006 Letter of Intent to the IMF, the
Dominican government committed to formulate by July a plan to
recapitalize the Central Bank as part of its structural
reform agenda. The need stems from the overhang of
quasi-fiscal debt issued and managed by the Central Bank in
order to cover the hasty government guarantee of the
equivalent of nearly US$3 billion in deposits lost in a
series of bank frauds that came to light in 2003. The
recapitalization plan was originally to have been completed
by March but was delayed, according to the letter, to allow
the government time to "incorporate the recommendations of
international experts." The subsequent July deadline was also
missed. On August 31, Central Bank Governor Hector Valdez
Albizu announced that the Bank would use a ten year Treasury
bond to recapitalize itself and to "cover all of its losses
since it was established in 1947."

2.(U) When the Fernandez government took office on August 16,
2004, the Central Bank stock of CDs (called "Valores en
Circulacion" in CB statements)to bailout the 2003 bank
failures was 94.8 billion Dominican Pesos. As of August 31,

2004. By Oct-09 of this year the figure had risen to 157.4
billion Dominican Pesos. Compared with the extremely short
term debt issued in the early days following the bank crisis
(with maturities of as little as one week),maturities have
been stretched to three years and interest rates have been
reduced from over 50 percent to an average of 11 percent
today. The monthly cost of servicing the outstanding stock of
certificates has fallen from 3.4 billion pesos (about 4
percent of GDP) per month to 2 billon pesos (less than 3
percent of GDP).

3.(U) Albizu's announcement of the Bank's plan was met with
criticism primarily due to the lack of details regarding how
it would work. Albizu had referred to the issuance of a bond,
but no terms or other information was given. In early
September Central Bank General Manager Pedro Silverio
confirmed that a government bond would be used to
recapitalize the bank and said that under no circumstances
would any funds associated with the bond be substituted for
those in the CDs, which would continue to be honored.

4.(SBU) The IMF Resrep told economic officer in September
that the IMF had worked with the Dominicans to develop this
recapitalization proposal. He said the plan calls for the
Ministry of Finance to place a series of bonds in the
Central Bank over a period of 10 years. The bonds are unusual
in that they are not being sold publicly. The central
government will create the bonds as an accounting tool that
will serve as an asset to offset the Central Bank's debt and,
thereby, transfer that debt to the Ministry of Finance.
Interest earned will be used by the Bank to cover interest
payments on its stock of outstanding CDs. The Resrep said
that this strategy is not uncommon and has been used
successfullly in other countries where the IMF has programs.

5.(SBU) Central Bank Deputy Technical Manager Rolando Reyes
told economic officer on October 13 that the bonds to be
deposited in the Central Bank would be keyed to match the
interest rates of the outstanding CDs. As existing CDs come
due, the Central Bank will continue to issue new CDs to
payoff the old debt, and new bonds will be issued by the
Finance Ministry and transferred to the Central Bank
periodically to cover the new debt. What has apparently not
yet been decided is how the Central Bank and central
government plan to stop the cycle of issuing new public debt
to pay off the outstanding interest and principal, something
that must happen to eliminate the debt once and for all.

6.(SBU) Reyes commented that the public has misunderstood the
Central Bank's plan because the concept of the government
(Treasury) issuing a bond that is not sold in the market is

not common. He said the plan is critical for the government
to comply with its IMF obligations and added that the Central
Bank wants to see the IMF standby agreement extended beyond
the current March 2007 end date. Comment: Another reason why
the plan has been misunderstood--by both the general public
and by economists--is that the Central Bank has not made
details widely known. In public statements by Silverio and
other Central bank officials, the concept of a bond that is
issued and bought by the same central government has not been
discussed. The plan has merit. Unlike a line item in the
annual budget that could be used to achieve the same transfer
of funds from the central government to the Central Bank, the
bond is a promise to pay that will be more difficult to erase
under a new presidential administration than would be a
budget line item. End comment.


HERTELL