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

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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