DISBURSEMENT OF HONDURAN IDB DEBT RELIEF SHOULD BE

C O N F I D E N T I A L SECTION 01 OF 03 TEGUCIGALPA 002210 SIPDIS SIPDIS NOFORN STATE FOR EB/IFD, WHA/EPSC, INR/IAA, AND WHA/CEN TREASURY FOR AFAIBISHENKO COMMERCE FOR MSIEGELMAN STATE PASS AID FOR LAC/CAM NSC FOR DAN FISK E.O. 12958: DECL: 11/21/2016 TAGS: EFIN ECON PGOV HO SUBJECT: DISBURSEMENT OF HONDURAN IDB DEBT RELIEF SHOULD BE MADE CONDITIONAL ON RENEWED FISCAL DISCIPLINE REF: TEGUCIGALPA 2046 Classified By: DCM James Williard for reasons 1.5 (b) and (d). ¶1. (C) Summary: Post notes with interest the November 17 decision by the Interamerican Development Bank (IDB) to provide debt relief for five WHA countries, including Honduras. As discussions of precise amounts and delivery modalities progress within the IDB, Post requests that disbursement of this debt relief be conditioned upon strong fiscal performance by the GOH, using the same criteria, but updated data, that were applied in the HIPC Completion Point decision in 2004. IMF Resident Representative and Article IV Team are concerned about recent GOH fiscal policies and performance, and have expressed interest in Post's proposal for a conditioned and tranched IDB debt forgiveness as a potential inducement to renewed fiscal discipline by the GOH. End Summary. ¶2. (C) As Post has noted several times in recent cables (ref A),providing unconditioned debt relief for the Zelaya administration, given its poor spending policies to date, would be to reward bad behavior. The international donor community in Honduras is very concerned that the Zelaya administration,s spending is all on populist, short-term programs with little or no long-tem investment component. The foundations for sustainable growth are not being laid, while current spending is exploding. -------------- -------------- IMF Concerned; Supports Consideration of Conditionality -------------- -------------- ¶3. (C) The net result has been that the GOH is de facto off track with the IMF. The Fund refused to close its Poverty Reduction and Growth Facility (PRGF) review last April, noting several areas of concern including a GOH failure to limit public payrolls, dramatically mounting losses at the parastatal electric company, and under-execution of investment programs in favor of current spending. A Fund Article IV team completed a visit to Honduras on November 17. That team has returned to Washington to evaluate the data it has collected and recommend policies to get the GOH back on track. Before departing, the team privately told the Ambassador of its continuing concerns about deteriorating GOH fiscal policies potentially leading to major budgetary disequilibria as soon as the second quarter of calendar year ¶2007. In a conversation with Ambassador, Fund experts expressed interest in Post's proposal to attempt to stem this decline by conditioning disbursement of IDB debt relief on restoration of fiscal discipline by the GOH. IMF officials indicated that at first glance such a proposal seemed both viable and worthwhile, and encouraged the USG to raise it for discussion in Washington. -------------- -------------- Proposed IDB Conditionality Would Mirror HIPC Conditions... -------------- -------------- ¶4. (C) Post is aware that for a host of reasons that extend well beyond Honduras, the U.S. Department of Treasury supported the concept of the IDB creating a debt relief mechanism. (The IDB was not originally included in HIPC, while the AfDB was, providing the rationale for adding the IDB now). Post does not disagree with that decision. However, Post continues to advocate that, in implementing this new IDB debt relief mechanism, the Bank should also create suitable standards by which specific cases of requested debt relief are evaluated. When HIPC was decided upon, there were approximately 10 different criteria each country had to pass. Subsequent G-8 debt forgiveness was based on those same criteria, as was World Bank forgiveness. The disbursement of IDB debt forgiveness should be conditioned on those same rigorous standards. ¶5. (C) For example, one of the indispensable criteria for HIPC completion point was a bill of good health from the IMF. Based on the recent IMF Article IV review, it would appear TEGUCIGALP 00002210 002 OF 003 that the GOH no longer has this. Worse, while the GOH committed to using that debt forgiveness for poverty reduction, to date there has been very little spending under the agreed-upon poverty reduction strategy. HIPC cannot be retroactively revoked. That said, the donor community is increasingly concerned that we not throw good debt forgiveness after bad by disbursing new IDB debt forgiveness when the agreement for the use of previous HIPC debt forgiveness has not been honored by the GOH. Instead, the GOH should be held accountable for its actions. The Zelaya administration should be required to get back in the Fund,s good graces; control current spending on non-productive, populist programs; increase spending on longer-term investment for growth; and disburse funds pursuant to the poverty reduction strategy. -------------- -------------- ...But It Would Not Just Rubber-Stamp the HIPC Decision -------------- -------------- ¶6. (C) Post recognizes that future cases of HIPC-related debt relief considered by the IDB would likely be based explicitly on the HIPC decision itself (saving IDB from the need to establish a parallel evaluation process). But in the specific case of Honduras, a new evaluation -- using current data and existing HIPC guidelines -- is warranted, both because of the time that has passed since HIPC completion point and the January 2006 change in GOH administrations. Based on concerns expressed by the IMF Article IV team and other international donors, it appears likely that such a review will show that Honduras should not be granted IDB debt relief immediately. (In other words, HIPC completion point, if it were being considered today, might not be granted to Honduras based on its current performance.) Rather, the GOH should be required to again demonstrate compliance with the original HIPC debt relief criteria, but based on current performance and current policies. -------------- -------------- Why Conditioned Honduran Debt Relief is a USG Interest -------------- -------------- ¶7. (C) The GOH has strayed into unsustainable populist spending policies. The GOH seems confident that with huge remittance inflows (USD $2 billion in 2005) and previous HIPC debt relief (approximately USD $2.8 billion) it doesn,t need the IMF,s money. This reduces the Fund,s ability to influence GOH policies for the better. An unconditional debt relief package (of up to USD $1 billion) to Honduras from the IDB would only further exacerbate the situation, and undermine the donor community,s efforts locally to press the GOH for more responsible policies. ¶8. (C) Honduras, macro numbers look good for now, and will probably continue to look good for the rest of the year, but Post is concerned that the long-term sustainability of the economy is nevertheless being hollowed-out by GOH decisions to subsidize popular but unsustainable initiatives. The result of these poor GOH policies will be slower than expected growth and less job creation. Given Honduras, demographics (52% of Hondurans are under the age of 19),that means over one hundred thousand more unemployed youth per year. With no job prospects, these youth will have few options but either to join one of the ultraviolent gangs already swarming throughout the region and many U.S. cities, or become illegal immigrants to the U.S. Sustained high levels of Honduran emigration would exacerbate existing socio-political crises both in Honduras and in U.S. border states, and could overwhelm U.S. border security efforts. ¶9. (C) The modest additional effort Post proposes be included in the procedure for providing IDB debt relief for Honduras -- that of conducting an updated review of the GOH's fiscal performance as measured against existing HIPC benchmarks -- would allow the USG and the international community to apply pressure to the new GOH administration to get back on the fiscal policy straight and narrow. It is clearly in the U.S. national interest to promote long-term sustainable growth in TEGUCIGALP 00002210 003 OF 003 Honduras. Current GOH policies do not do so. The only way the international community can apply effective pressure to change those policies would be through the leverage a conditioned and tranched IDB debt relief would afford us. Ford FORD