HONDURAS: IMF WAITING FOR GOH DEMONSTRATION OF

C O N F I D E N T I A L SECTION 01 OF 02 TEGUCIGALPA 001857 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 NSC FOR DAN FISK E.O. 12958: DECL: 10/01/2016 TAGS: ECON EFIN PGOV SOCI HO SUBJECT: HONDURAS: IMF WAITING FOR GOH DEMONSTRATION OF SERIOUSNESS ON FISCAL POLICIES Classified By: Ambassador Charles Ford for reasons 1.4 (b) and (d). ¶1. (C) Summary: The International Monetary Fund (IMF) shares donor concerns that GOH fiscal discipline is eroding and the GOH has lost previous momentum towards policy reforms. While the Fund has not publicly declared it, facts on the ground seem to indicate that the GOH PRGF program has gone off the rails. The Fund is receptive to a GOH request to shift from a PRGF to a PSI (essentially a PRGF without financing),but emphasizes that a PSI still carries with it all conditionalities and disciplines of the PRGF. If the GOH is serious about pursuing a PSI, it must prepare a detailed set of fiscal plans for presentation to the Fund by March 2007. A certain amount of renegotiation of existing targets is to be expected, but the donor community must identify ways to prevent the GOH from using such a renegotiation to walk away from important, but politically difficult, economic reforms. End Summary. ¶2. (C) The GOH has approached the IMF to request that Honduras transition from its current Poverty Reduction and Growth Facility (PRGF) to a Policy Support Instrument (PSI). A PSI "enables the IMF to support low-income countries that do not want - or need - Fund financial assistance. The PSI helps countries design effective economic programs that, once approved by the IMF's Executive Board, signal to donors, multilateral development banks, and markets the Fund's endorsement of a member's policies." In effect, a PSI is a PRGF without the money. ¶3. (C) As Post reported previously, Honduras failed to reach agreement with the IMF on the results of its semi-annual review of GOH performance. One possible indicator that the GOH is off-track is that the GOH has stopped calling for completion of the fourth PRGF review by the Fund. The IMF has not publicly declared the GOH to be "off-track" with its PRGF, but it did halt the semi-annual review after two separate inspections could not reassure the Fund of the GOH's progress. The Fund noted: a failure to implement solutions to mounting losses at the parastatal telephone and electric companies; lack of movement toward controlling growth of public sector wages (particularly teachers' salaries and benefits); and under-execution of capital expenditures for development. Thus, while bottom-line numbers had as of June still been under the agreed-upon deficit target of 2.5 percent, needed reforms were not taking place and lack of disbursements of investment funds masked overspending in such areas as new state subsidies to farmers and subsidized gasoline prices. More recent figures have not been published, but it is likely that the GOH will exceed its deficit target this year, perhaps significantly. ¶4. (C) Since that time the situation has worsened. No rebalancing of domestic and international telephone rates has taken place, presaging a continuing loss of revenue to the state. While a commission has taken over leadership of the parastatal electric company and is looking carefully at technical improvements, it has discarded out of hand the possibility of rate increases. This is likely to lead to continuing and mounting losses at the company. Finally, the GOH contravened a World Bank and Fund prior condition to control teachers' wages, and even agreed to increase those wages by over seven billion lempiras (nearly USD 370 million) and Congress repealed the relevant law. There is no indication of where those unbudgeted funds would come from, and this dramatic increase in public sector wages clearly violates the GOH's PRGF targets. ¶5. (C) Despite solid macro growth of an estimated 5.5 percent and single-digit inflation, it is increasingly evident that the GOH has gone off track with its PRGF. Instead of renewing or extending the PRGF, the GOH is seeking a PSI. However, according to IMF Resident Representative Mario Garza, a shift from this PRGF to a PSI does not relieve the GOH of the need to establish and abide by credible policies of fiscal discipline. Since the PSI conveys the Fund's endorsement, the Fund will not approve a PSI unless these conditions are met. ¶6. (C) That said, the shift to a PSI could buy the GOH some additional time and flexibility. Even had they opted to renew the existing PRGF (which is set to expire in February TEGUCIGALP 00001857 002 OF 002 2007),the GOH would have been forced to request an extension on certain targets, notably correcting the hemorrhage of funds at the parastatal electric company. Realistically, the enormity of that financial crisis does not allow the Fund to enforce the original February deadline. A certain amount of renegotiation is thus likely. ¶7. (C) Bilateral and multilateral donors are increasingly concerned, not just about the under-execution of projects, but also about the disorganized ("improvised") policies of the new Zelaya Administration, the crumbling fiscal discipline, and the turn from market-driven sustainable growth solutions toward statist policies favoring subsidies. Many also expressed concerns that a falling out with the IMF could result in a halt in budget support payments linked to World Bank PRSC programs and a likely reduction in the levels of their overall bilateral assistance programs for Honduras. ¶8. (C) The IMF responded positively to the GOH initiative to transition to a PSI, but put the onus on the GOH to draft a coherent, credible fiscal plan. The Fund is prepared to send an Article IV team to look at the GOH's current and proposed policies as soon as November. However, it will then be the responsibility of the GOH to turn that roadmap into a detailed program for presentation to the Fund by March 2007. If that plan is ready sooner, the Fund will engage in PSI negotiations as soon as the GOH is has presented its detailed plan. ¶9. (C) Comment: The process of negotiating a PSI could take several months, and many observers here fear that the GOH could continue to make poor spending choices during this time. Continued growth in spending on non-productive and unsustainable subsidies threatens to erode the macro-economic stability and nascent fiscal discipline so hard-won over the previous four years. The Fund wants discussions to focus on the need to implement good policies, not the need for a Fund program per se. Otherwise, pressures will be directed, not at the GOH, but rather at the IMF. For the Fund to have the moral suasion necessary to encourage difficult GOH policy reforms, the donor community will need to identify leverage that can be invoked if the GOH continues what many view as its misguided fiscal policies. Halting upcoming disbursements on loans or suspending budget support payments linked to World Bank PRSC programs might be such tools. What remains to be seen is whether the donor community can modulate a response that keeps pressure on the GOH, while leaving room for constructive donor engagement. End Comment. Ford FORD