Identifier
Created
Classification
Origin
06TEGUCIGALPA1881
2006-10-04 16:37:00
SECRET//NOFORN
Embassy Tegucigalpa
Cable title:  

(S) HONDURAS UNDER CAFTA: AFTER SIX MONTHS,

Tags:  ETRD EPET ENRG PGOV VZ HO 
pdf how-to read a cable
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PP RUEHLMC
DE RUEHTG #1881/01 2771637
ZNY SSSSS ZZH
P 041637Z OCT 06
FM AMEMBASSY TEGUCIGALPA
TO RUEHC/SECSTATE WASHDC PRIORITY 3628
INFO RUEHZA/WHA CENTRAL AMERICAN COLLECTIVE PRIORITY
RUEHCV/AMEMBASSY CARACAS PRIORITY 0445
RHEBAAA/DEPT OF ENERGY WASHDC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
RUEAIIA/CIA WASHDC PRIORITY
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RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUEHLMC/MILLENNIUM CHALLENGE CORP WASHINGTON DC PRIORITY 0474
S E C R E T SECTION 01 OF 06 TEGUCIGALPA 001881 

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STATE FOR EB/ESC, WHA/EPSC, WHA/PPC, AND WHA/CEN
STATE FOR D, E, P, AND WHA
TREASURY FOR JHOEK
NSC FOR DAN FISK

E.O. 12958: DECL: 10/04/2036
TAGS: ETRD EPET ENRG PGOV VZ HO
SUBJECT: (S) HONDURAS UNDER CAFTA: AFTER SIX MONTHS,
LITTLE TO SHOW


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

S E C R E T SECTION 01 OF 06 TEGUCIGALPA 001881

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NOFORN

STATE FOR EB/ESC, WHA/EPSC, WHA/PPC, AND WHA/CEN
STATE FOR D, E, P, AND WHA
TREASURY FOR JHOEK
NSC FOR DAN FISK

E.O. 12958: DECL: 10/04/2036
TAGS: ETRD EPET ENRG PGOV VZ HO
SUBJECT: (S) HONDURAS UNDER CAFTA: AFTER SIX MONTHS,
LITTLE TO SHOW


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


1. (S) Summary: Six months have passed since CAFTA entered
into force for Honduras. President Zelaya's support was key
to getting Honduras on board, and he continues to profess his
support for capitalism and free markets. Yet when faced with
making the reforms necessary to let a free market develop,
the GOH has too often resorted instead to policies that favor
state intervention, protection, and the entrenched elites.
This cable considers recent examples from a wide-range of
economic sectors, and asks whether Honduras is really taking
advantage of the opportunity (and challenge) presented by
CAFTA. The record is mixed, but in the matters of most
consequence tends towards the negative. On paper Honduras is
in an excellent position for strong future growth. In
reality, the GOH is coasting on the previous administration's
economic successes, and unless the Zelaya administration can
generate its own momentum for reform, it risks squandering
one of its best-ever opportunities to pull itself up out of
poverty. End Summary.


2. (S) The Central American Free Trade Agreement (CAFTA)
entered into force for Honduras on April 1, 2006, following
several months of break-neck legislative and regulatory
reform by the GOH. Starting in meetings during the
transition period after winning the Presidency on November
26, 2005, Jose Manuel "Mel" Zelaya Rosales made it clear that
CAFTA's entry into force was one of his top priorities. New
to the realm of international trade agreements, Zelaya
questioned grace periods included in CAFTA for sensitive
products, and instead expressed his preference for moving
Honduras immediately to fully competitive markets. At the
time, Post did not doubt the genuineness or depth of Zelaya's
dedication to the overarching principle of free trade. To

Post's consternation, however, in each significant individual
decision since entry into force, the GOH has chosen the more
protectionist, less market-oriented solution to economic
challenges. Those GOH agencies and leaders eager to move
forward with positive, market-oriented reforms are hindered
by budgetary inertia and intra-governmental disorganization.
Post does not doubt Zelaya's personal dedication to the ideal
of competition, but we question whether he fully understands
what steps are needed to move towards such an outcome and
whether he has the political will to make such steps a
reality.


3. (U) The following is an illustrative list of significant
economic developments over the first six months of CAFTA.
Most have been reported extensively septels, and will only be
summarized here.

--------------
The Good News: Some Pro-CAFTA Reforms
--------------


4. (SBU) Intellectual Property Rights (IPR): GOH efforts on
IPR have tended to run hot and cold, but under CAFTA the GOH
has nevertheless made significant advances that, if
continued, should help spur investment. CAFTA restored
ex-oficio powers to Honduran law enforcement, freeing them to
crack down on pirates even without specific complaints being
filed by the aggrieved party (often a major multinational
with little time for filing the paperwork to justify each
individual raid). The IPR prosecutor's office has
enthusiastically participated in several U.S. Patent and
Trademark Office (USPTO) training sessions, and has launched
a few high-profile raids on pirated DVD and CD vendors. The
GOH has adopted a proactive IPR strategy (with significant
behind-the-scenes input from Post) and the Vice President
himself has adopted it as one of his issues. Effective
enforcement is still well in the future, and is significantly
undermined by a dysfunctional judiciary, but the GOH deserves
praise for its energetic first steps to come to grips with
the IPR challenge.


5. (S) Puerto Cortes: As the only significant deep water
port in the region and the anchor for a regional export
strategy, Puerto Cortes is a major competitive advantage for

TEGUCIGALP 00001881 002 OF 006


Honduras. Its 2004 self-certification to the International
Maritime Organization, followed by kudos from the U.S. Coast
Guard and selection for the Container Security and Megaports
Initiatives, all mark the port as a major success. On the
downside, the port has had three non-technical directors in
nine months and suffers from endemic corruption and relative
inefficiency. The newly named director of ports, Edwin
Araque (former Deputy President of the Central Bank) told
Post privately that his job is to confront the entrenched
corruption. In particular, he has been tasked with reducing
the corrosive influence wielded by Marco Avila, a major
Zelaya campaign contributor with a dark past. Avila brags
that he controls the port, and through his monopoly on cranes
there he reportedly extorts funds from port users. Araque
claims Zelaya knows Avila must be confronted but since Avila
was a significant campaign contributor Zelaya does not want
to be in the forefront of such an effort. Araque recognizes
that he risks his life with this task, and Post will seek
ways to support him in his efforts.


6. (SBU) Road Infrastructure: Closely related to the
developmental impact of the Port is improving the road system
to link the port to internal markets and to markets in
neighboring Nicaragua, Guatemala, and El Salvador. The
previous GOH administration explicitly recognized this by
making roads improvement the centerpiece of its Millennium
Challenge compact. The new administration, while recognizing
the importance of roads, has suffered from very slow project
execution. The GOH has reluctantly accepted the necessity of
funding road operations and maintenance (having been forced
to do so as a conditionality under the MCC compact). The
comprehensive nature of the roads project under the MCC
includes elements to improve transparency, accountability,
evaluation, and sustainability over the long-term. It is
hoped that success of this project will lead the GOH to adopt
similar rigor in future infrastructure projects. The highway
project will be critical to the success of exploiting new
market opportunities under CAFTA, and adopting these best
practices for future project will be the key to sustainable
growth for Honduras in the future.


7. (SBU) Banking: The Honduran banking sector is another
bright spot, as local banks slowly gear themselves up for the
faster and more competitive regional and global markets that
CAFTA will bring. As Honduran trade and investment prepares
to expand under CAFTA, regional banks have taken notice and
aggressively entered the market. Under threat, the Honduran
banking sector is looking for ways to compete. While still
conservative to a fault, the banking sector has begun to
reorient its attitudes towards more creative products and
services. Lack of access to credit has always been one of
the biggest barriers to entry and expansion for would-be
Honduran small and medium enterprises. As the banking sector
is weaned from dependence on government bonds, Post hopes to
see credit to the private sector expand accordingly.
Mortgage credit has already seen impressive growth, led by
the regional banks. The Honduran banks have a long way to
go, but have at last apparently faced the reality of the
emerging competition. The GOH for its part embarked last
year on a comprehensive set of banking sector regulatory
reforms designed to bring the sector (eventually) up to Basel
II standards. GOH cooperation on anti-money-laundering has
been outstanding, and ongoing efforts to reform the
seized-assets office will only further strengthen these
results.

--------------
Other Policies Are Major Steps Backwards
--------------


8. (S) Energy: By far the most worrisome development has
been the post-CAFTA decision by the GOH to nationalize the
importation of all fuels into the country. This
non-transparent process threatens to strip existing U.S.
investors of their rights to participate in the sector, and
could effectively strand millions of dollars in investments
and force breach of contracts with suppliers and
distributors. The GOH explains the creation of a state-run

TEGUCIGALP 00001881 003 OF 006


monopoly by claiming that it is a justifiable response to an
alleged oligopoly, and that it is (bizarrely) a step on the
road to liberalization of the sector. Post assesses that our
aggressive public and private interventions have
significantly reduced the chances that this process will
result in a political and economic alliance of the GOH with
Venezuela under a PetroCaribe arrangement. We also assess
that we have largely stymied early attempts by politically
influential powers (including former President Rafael
Leonardo Callejas) to corruptly manipulate and personally
profit from this scheme. Despite these victories, Post still
views the nationalization plan as profoundly misguided and
likely non-compliant with CAFTA. Depending how it is
implemented, the damage from this scheme, and from the
predicted follow-on lawsuits, could dramatically chill the
investment climate here and set back by years Honduran
efforts to spur investment-led growth and job creation. With
this one stroke, Honduras could lose the good will attained
by joining CAFTA, while also calling into question the depth
of its dedication to basic free-market principles.


9. (S) Presidential Meetings: In private meetings with
Ambassador, President Zelaya reiterates to his commitment to
market reforms, but in public he contradicts himself. On two
occasions (June and September 2006) President Zelaya has met
with POTUS. Despite POTUS's counsel that POTUS did not
understand how the fuel import scheme could work and that,
were it his choice, he would not pursue it, Zelaya remains
unswayed. In a move that demonstrated lack of finesse and
his reported bull-headed streak, President Zelaya exited each
of the POTUS meetings publicly declaring that POTUS supported
his plans, including the fuel scheme. On both occasions Post
was forced to issue statements correcting the record. Post
is concerned that despite receiving a strong message from the
most senior level of the USG, Zelaya has failed to moderate
his rhetoric or alter his plan. Indeed, Zelaya went even
further in a September 19 speech to the United Nations
General Assembly, in which he used phrases evocative of the
1970s to blast free markets. Post is at something of a loss
as to how to explain Zelaya's apparent cognitive dissonance
between supporting free trade as a concept and yet calling
for a government nationalization and monopolization of the
fuel imports sector.


10. (C) Mining: In the mining sector, the GOH has moved to
ban open-pit mining for precious metals, alleging
environmental damages. A 'temporary' ban on new mining
permits has been in effect since July 2004, but with no
attendant movement towards a serious review of GOH processes
and procedures to protect the environment. Most precious
metals mining in Honduras is conducted by foreign firms
(including at least two U.S. firms),while most open pit
mining for sand, gravel, and other resources -- excluded from
the proposed ban -- is conducted by Honduran firms. It is
unclear whether the intent of the ban is to target foreign
firms, to open space for Honduran investors to perhaps
take-over lucrative precious metals mines, or whether the GOH
is, as it claims, primarily motivated by concerns over the
use of cyanide and other chemicals in gold and silver mining
operations. If the latter, a far more appropriate and
targeted response would be improved environmental regulation,
not a ban. Nevertheless, the ban will likely go into effect,
as there is no political will on either side of the aisle to
stop it. When it does, existing mines will be grandfathered,
but expansions or new investments will almost certainly
cease, effectively closing off this sector to foreign
investment.


11. (C) Food Security: The GOH has altered for the worse its
agricultural policies, moving away from proven successful
methods of diversification into higher value added crops and
toward subsidies for uneconomic basic grains. This is not an
obvious breach of CAFTA, but it is a significant step
backwards from sustainable economic development policies for
a country where 50 percent of the workforce is still on small
and subsistence farms. CAFTA is a tool to spur development,
but it cannot do so without appropriate GOH policies to
support it. The GOH's return to discredited statist policies

TEGUCIGALP 00001881 004 OF 006


of the past, subsidizing non-competitive crops, calls into
question its will to challenge the traditional (but failed)
agricultural model. Worse, to fund these crop subsidies, the
GOH plundered the agricultural sector budget, robbing funds
from technical assistance programs, crop diversification
programs, and even proposing to zero-out animal health
programs, likely with expectations that donors would fill in
the funding gaps. This last cut would have left Honduras
woefully unprotected against avian flu, and also unable to
meet the sanitary standards needed to increase food exports
to the U.S., again undermining one of the key benefits of
CAFTA. Post succeeded in getting the GOH to restore funding
for the animal health inspection program, but we remain
deeply concerned by the instinct that allowed the GOH to
think such proposed cuts were ever a good idea.


12. (C) Telecommunications: The long-awaited
telecommunications reform bills remain stalled, as
protectionist elements seek to preserve inefficient and
bloated parastatal telephone company Hondutel. A draft 2005
bill was watered down and loaded up with pro-Hondutel and
anti-free market provisions by the new Congress, and debate
since then has largely centered on removing these
objectionable articles. The bill has been split into two,
one to liberalize the sector and the other to strengthen
Hondutel. It is generally accepted that politically the two
must pass at the same time if they are to pass at all.
Honduran telecomms are reportedly CAFTA compliant now, thanks
to a series of administrative decrees issued by the previous
administration in late 2005. However, the pending bill would
formalize and lock-in those changes, and would set the stage
for greater market opening. For the time being, a number of
investors (including U.S. investors) remain in limbo,
promised a chance to compete on an equal footing but not yet
given that chance. Post is cautiously optimistic a bill will
pass this year, though GOH Chief CAFTA Negotiator Melvin
Redondo recently told Post that he fears the current version
of the bill does not go far enough and might not be fully
CAFTA compliant. Post continues to watch this closely.


13. (SBU) Fiscal Policy: While not a formal part of CAFTA,
a responsible fiscal policy is a necessary enabling element
to the investment and growth CAFTA seeks to generate in
Honduras. There are signs the GOH fiscal discipline has
eroded during the Zelaya Administration, culminating with the
International Monetary Fund (IMF) failing to close its latest
Poverty Reduction and Growth Facility (PRGF) review of
Honduras, implying significant fiscal problems were
discovered. Deteriorating fiscal conditions or weaker Fund
confidence in the GOH could cool investors on Honduras by
increasing the perception (or reality) of investor risk.
Another fiscal factor that more directly impacts investment
is the GOH's under-execution of capital investment programs.
Many of these programs relate to infrastructure, which
directly supports economic activity and increased trade.
Until the GOH can organize itself to begin disbursing
effectively on these programs, the slowed construction will
likely result in slower investment and trade than would
otherwise have been the case.

-------------- --------------
Disorganization, Lack of Resources Magnify Challenges
-------------- --------------


14. (C) The Competition Commission: One of the successes of
the early Zelaya Administration was passage of Honduras'
first bill outlawing monopolistic market practices and unfair
competition and establishing a Honduran Competition
Commission (an anti-trust body, much like the U.S. Federal
Trade Commission.) The legislation, under consideration
since 1992, was finally passed in February 2006.
Unfortunately, since then the GOH has demonstrated
indications of lack of will to make this body effective by
delaying any further action for months, and then proposing as
one of three Commissioners the Chief Operating Officer of the
cement monopoly. (Note: Minister of the Presidency Yani
Rosenthal is President of that cement company. End Note.)
Outcry from several quarters, including a strong intervention

TEGUCIGALP 00001881 005 OF 006


by Post with the President himself, forced withdrawal of the
list. Following another two months of dithering, the
Honduran Congress named three acceptable commissioners, but
the decree formalizing their nomination remains unsigned on
the President's desk two months later. In the meantime, the
GOH has proposed to fund the Commission at only 60 percent of
its minimum estimated start-up costs, dramatically decreasing
the likelihood the Commission can be made effective by the
December 2006 target date. Until a budget is approved, the
Commission has no access to any funds, meaning it cannot hire
staff or ramp up activities to meet its legal mandates.
While the Ministry of Finance focuses on other fiscal crises,
funding other important initiatives lags. In the meantime,
monopolistic and crony-capitalist business practices continue
to hamper economic development.


15. (C) Foreign Trade Institute: The Ministry of Commerce
has yet to produce a comprehensive CAFTA implementation plan
for Honduras, as illustrated by its failure to launch the
legislatively-mandated Foreign Trade Institute. This organ,
designed to have been the central authority for the GOH to
administer CAFTA, has yet to be formed or funded. The
institute was intended in part to retain the expertise of
trade experts and negotiators, and to ensure the GOH had a
critical mass of experts to implement CAFTA effectively.
Lacking budget support and regulatory authority, the GOH
announced in April that it would delay formation of the
Institute until October. As October begins, there is little
sign the GOH is prepared yet to launch the body. Early in
the administration, Vice Minister of Trade and Industry Jorge
"Coki" Rosa made public remarks opposing the Institute,
remarks he was subsequently forced to retract. In private
conversations with Post, however, he blamed the failure to
establish the Institute on the Minister. Meanwhile, Minister
Azcona claims that there are problems with the hiring
procedures laid out by the legislation, a claim refuted by
the private sector, which views her claims as stall tactics
meant to limit private sector oversight of the Institute, as
written its founding legislation.


16. (S) More recently, Rosa has intimated that his price for
support of the project would be setting up the Institute as
an independent organ, outside the Ministry of Trade, with
himself as its head and carrying the rank of Minister.
(Comment: This would be a disaster, as Rosa appears
concerned about his own advancement and that of his Liberal
Party above all else. Following a two hour presentation on
the need for effective consumer protection, for example,
Rosa's sole question to the presenters was how many Liberal
Party members the new organ would hire. In another example,
Rosa backed India's very unhelpful proposal on renewable
energy technology at the recent World Trade Organization
talks, dismissing the U.S. proposal as containing "nothing"
of interest to Honduras. End Comment.) The Minister and
Vice Minister are reportedly not on speaking terms, further
exacerbating the GOH's weak follow-through in developing
CAFTA implementation strategies.

--------------
Corruption and Lack of Juridical Security
--------------


17. (SBU) Corruption/juridical security: Casting a pall
over every other aspect of doing business in Honduras is a
clear and disturbing lack of juridical security. Cited
almost universally as the greatest impediment to investment
here (even more than physical security),this pervasive
corruption and lack of rule of law undermines every contract.
Land titles cannot be trusted, which not only increases
costs and slows the process of building a plant, but also
complicates access to credit as banks are wary of using such
titles as collateral. Rights and guarantees, such as patents
and trademarks, are ephemeral, and Post is aware of cases in
which registrations have vanished from the registries,
permitting other firms to register infringing marks.
Official decisions can be arbitrary, and public officials
including judges are susceptible to both bribery and other
forms of influence or pressure. Even when caught, there is

TEGUCIGALP 00001881 006 OF 006


rarely any sanction imposed on corrupt public officials.
While official immunity was eliminated last year, official
impunity remains the acknowledged standard.


18. (C) Juridical security continued: Finally, there is a
perception if not a reality that Honduran parties to lawsuits
receive unfair advantage versus foreign parties. For
example, a U.S. mining company is being assessed a three
million dollar judgment as the result of a case to which they
are not even party, and in which the culpable party was
determined to be the GOH itself. In another case, a worker
fired for cause was nevertheless awarded punitive damages
from the U.S. employer. He is now suing the firm's affiliate
company -- for which he never worked -- for back wages and
additional damages. In a third recent case, when workers for
a small Honduran apparel plant failed to win punitive damages
from the firm, they sued the big U.S. firm to which the
Honduran firm sold its products as a subcontractor. Despite
having nothing to do with the case (other than buying its
products),the U.S. firm is potentially facing 2.5 million
dollars in damages to another company's workers. As a result
of its treatment in this case, the U.S. firm -- which employs
3000 Hondurans -- is contemplating pulling out of Honduras.

--------------
Comment
--------------


19. (S) Comment: President Zelaya repeatedly professes his
support for capitalism and free markets. Yet when faced with
making the reforms necessary to let a free market develop,
the GOH has too often resorted instead to discredited
policies that favor state intervention, protection, and the
entrenched elites. As can be seen from the above list, the
record is mixed, but in the matters of most consequence tends
towards the negative. Under the previous administration,
Honduras spent four years building a solid macro economic
foundation, securing debt relief, and winning approval of
CAFTA. Its economy is growing, its currency is stable, and
inflation is under control. Yet the policies of the new
administration, while benefiting from this historical
momentum, do not seem to build on and expand these trends.
Zelaya's populist tendencies have left him unwilling to
confront interest groups (such as teachers) in promoting
needed reforms, and all too willing to buy his way out of
social confrontation though unsustainable state subsidies.
This focus on the short-term, and on popular but largely
unproductive subsidies of consumption, limits Honduras,
ability to invest in true market reforming initiatives. Such
reforms could position Honduras to better take advantage of
CAFTA by laying solid foundations for economic expansion. On
paper Honduras is in an excellent position for strong future
growth. In reality, the GOH is coasting on the previous
administration's successes, and unless it can generate its
own momentum for reform, it risks squandering one of its
best-ever opportunities to pull itself up out of poverty. End
Comment.

Ford
FORD