HONDURAN CENTRAL BANK PRESIDENT "QUIETLY DOING HER

C O N F I D E N T I A L SECTION 01 OF 02 TEGUCIGALPA 001489

SIPDIS

SIPDIS

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

E.O. 12958: DECL: 08/16/2016
TAGS: ECON EFIN PGOV SOCI HO
SUBJECT: HONDURAN CENTRAL BANK PRESIDENT "QUIETLY DOING HER
JOB."


Classified By: Ambassador Charles Ford for reasons 1.4 (b) and (d)


1. (C) Summary: Central Bank President Gabriela Nunez is
content with Honduras' macro-economic situation, citing a
stable exchange rate and declining inflation. Nunez was
sanguine (perhaps too much so) on the likely impact on the
economy of the recent mammoth wage increase granted by the
GOH to teachers and its implications for the GOH's agreement
with the International Monetary Fund. Nunez does not foresee
a drop in remittances, nor pressure for a devaluation of the
Honduran currency, the lempira. Nunez -- a likely future
Presidential candidate -- recognizes the need for fiscal
discipline, but has been reluctant to assume a public stance
on the issue, in part because of the political clout
teachers' unions wield in the electoral process. Nunez has
concrete plans for gradual improvements in BCH operations,
and would welcome proposed U.S. Treasury support on improving
budgeting procedures. End Summary.


2. (C) In an August 11 meeting with Ambassador and
EconChief, President of the Central Bank Gabriela Nunez
expressed confidence in the state of the Honduran economy,
and described her surprisingly low profile as "quietly doing
my job." Nunez has previously been a Minister of Finance,
and was one of the leading vote-getters in the Liberal Party
primaries for President in 2005. It is widely expected Nunez
will resign her position at the Central Bank of Honduras
(BCH) over the next year or so and devote her efforts to
another run for the Presidency. During the meeting, Nunez
did not discuss her future plans, but her comments covered a
wide range of policy issues and implicitly criticized the
Zelaya team for some of its missteps.


3. (C) Asked whether she thought the exchange rate is
overvalued (ostensibly a managed float within a seven percent
band, but in reality held steady by the GOH at 18.895
lempiras per dollar for the last several months),Nunez said
no. Falling inflation in Honduras and rising volumes of
foreign exchange (forex) reserves (currently approaching USD
2.3 billion) have helped keep the lempira strong, as has the
formula by which the GOH determines target exchange rates.
That formula is based on the difference in inflation rates in
the U.S. and Honduras, with a forex weighting included. The
result, she said, has been a "practically stable" nominal
exchange rate. Were the GOH to move to a flexible exchange
rate regime, Nunez said, there would be pressure for the
currency to appreciate, putting exporters at a competitive
disadvantage. (Note: Exporters disagree that the currency
would or should appreciate, noting that the formula used does
not eliminate the entire inflation differential and that, as
a result, the real exchange rate has been eroding for over a
decade. According to this view, the currency should
depreciate, not appreciate. A colleague from the Embassy of
Japan agrees, noting that previous investor delegations have
declined to invest in Honduras, citing what they viewed as an
overvalued currency. End note.)


4. (C) Nunez said that one of the few circumstances that
could prompt a depreciation would be wholesale capital
flight, which she sees as unlikely, given a solid
macroeconomic framework and a halt to the increase of the
interest rate spread between the U.S. and Honduran rates.
(Honduran interest rates have dropped over 400 basis points
this year to around 7 percent as the Central Bank has
undersupplied the bond market and encouraged private banks to
inject capital into the real economy. At the same time, U.S.
interest rates over the last three years have risen from 0.75
percent to 5.25 percent, before the FOMC halt on August 8.)
Her comments overlook other, more troubling developments,
such as the growing fiscal laxity evident in the Zelaya
Administration's increasingly populist tactics. While Post
does not predict capital flight any time soon, we note that
the increasingly anti-investment tenor of the GOH does not
inspire investor confidence.


5. (C) On remittances (the key contributor to the forex
buildup cited above),Nunez told Ambassador that she doubts
slowing growth in the U.S. will decrease remittances. (Note:
There are an estimated one million Hondurans living in the
United States, who will send an estimated USD 1.5 to 2.0
billion this year in remittances to Honduras, equivalent to
25 percent of the Honduran GDP. The volume of remittance
inflows has been rising 30 percent or more annually for
several years, and now is the largest source of hard-currency

TEGUCIGALP 00001489 002 OF 002


earnings for Honduras. End note.) These remittances help
the overall macroeconomic situation in Honduras, and spur
economic growth through increased consumption, Nunez said.
The multiplier effect of that increased consumption is muted,
however, by the high percentage of consumer goods that are
imported from abroad, especially the United States.


6. (C) On fiscal policies, Nunez said the next few months
will be "critical" for the GOH, as the administration
resolves pending wage bills for teachers and doctors, as well
as identifying funding for proposed dramatically increased
housing construction. (Nunez did not cite, but Post would
add to that list: funding continuing subsidies to taxi and
bus drivers; gasoline subsidies for consumers; massive losses
at state-run electric company ENEE; and sharply dropping
revenues at state-run phone company Hondutel.) Nunez cited
as her chief concerns the need for increased efficiency in
fiscal spending (getting more bang for the buck),and better
budget formulation. She also agreed with previous public
comments from her colleague, Minister of Finance Rebecca
Santos, on the need to establish a reasoned debt policy, and
to control the growth of public sector wages. (Comment:
This remark was also an implied criticism of the Zelaya
team's recent resolution of the teacher's strike, in which
striking workers were awarded 7 billion lempiras -- nearly
USD 380 million -- in increased wages and benefits. That
raise could break the GOH's accord with the IMF; will almost
certainly cripple other poverty reduction programs by
diverting scarce resources; and will likely spur other unions
to similar GOH-paralyzing strike tactics. End comment.)


7. (C) Focusing specifically on the teachers' wages issue,
Nunez said the Zelaya administration is looking for a final
solution, but "it's not easy." The teacher's union is
powerful and disciplined. In a very revealing comment about
the source of the teachers' strength, Nunez pointed out that
the polling stations ("mesas electorales") are almost always
in schools and are overwhelmingly staffed by teachers. Asked
whether the agreement will break faith with the Fund, Nunez
told Ambassador that she believes the Fund could accept "five
billion lempiras over six years." (Comment: Nunez has not
publicly commented on the teachers' wage issue. Assuming her
intention is to run for President again in 2009, her comment
on polling stations likely explains this very low-profile
stance. As to the Fund's views, Post finds it unlikely that
the Fund will be nearly so blase about the deal. New IMF
Resident Representative Mario Garza has only arrived in
Honduras this week, and has not yet reviewed the details of
the proposed deal. More to the point, the deal's timeframe
has telescoped dramatically while its total cost has
escalated, so that the GOH now faces a 7.2 billion lempira
bill over just three years. That rate of public sector wage
growth far exceeds GDP growth, almost certainly putting the
GOH out of compliance with its agreed Fund targets for public
sector wages. End comment.)


8. (C) Turning to her recent accomplishments and future
goals, Nunez highlighted a range of activities. The BCH has
moved to a two-year monetary policy, vice a one-year policy
previously. Nunez also anticipates that the IMF fourth and
fifth reviews will go well for Honduras ("assuming the
teachers' wages issue is resolved"). Over the coming years
Nunez wants to see the BCH move to an electronic auction of
dollars; improved administration of reserves; improved
investment rules; and the publishing of rules to support the
development of an electronic payments system, starting with
inter-bank transfers. Nunez said the BCH plans to begin
publishing fiscal and Balance of Payments information next
year, and will add the light industrial sector to its GDP
calculations. Post will continue to work closely with Nunez,
and is currently supporting a BCH-U.S. Treasury dialogue on
the possibilities of Office of Technical Assistance (OTA)
support for improved budgeting.

Ford
FORD