Identifier
Created
Classification
Origin
07TEGUCIGALPA215
2007-02-02 01:18:00
CONFIDENTIAL
Embassy Tegucigalpa
Cable title:  

THE HONDURAN ECONOMY AFTER FIRST YEAR OF ZELAYA

Tags:  ECON EFIN PGOV SOCI HO 
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P 020118Z FEB 07
FM AMEMBASSY TEGUCIGALPA
TO RUEHC/SECSTATE WASHDC PRIORITY 4843
INFO RUEHZA/WHA CENTRAL AMERICAN COLLECTIVE PRIORITY
RUEATRS/DEPT OF TREASURY WASHDC PRIORITY
RUEHLMC/MILLENNIUM CHALLENGE CORP WASHINGTON DC PRIORITY 0581
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY
C O N F I D E N T I A L SECTION 01 OF 03 TEGUCIGALPA 000215 

SIPDIS

SIPDIS

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

E.O. 12958: DECL: 02/01/2017
TAGS: ECON EFIN PGOV SOCI HO
SUBJECT: THE HONDURAN ECONOMY AFTER FIRST YEAR OF ZELAYA
ADMINISTRATION: GOOD POLICIES OR JUST GOOD LUCK?


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

C O N F I D E N T I A L SECTION 01 OF 03 TEGUCIGALPA 000215

SIPDIS

SIPDIS

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

E.O. 12958: DECL: 02/01/2017
TAGS: ECON EFIN PGOV SOCI HO
SUBJECT: THE HONDURAN ECONOMY AFTER FIRST YEAR OF ZELAYA
ADMINISTRATION: GOOD POLICIES OR JUST GOOD LUCK?


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


1. (SBU) Summary: Following one year in office for the
Zelaya administration, the Honduran economy continues to
perform solidly. Some critics would say that this continued
robust performance owes more to the Maduro administration's
(2001-2005) fiscal austerity than to any new Zelaya policies.
Zelaya's policies are seen by many as populist, with a
short-term focus on consumption. Concerns remain that the
current policies being pursued are not setting the stage for
sustained future growth. This cable briefly reviews what the
Zelaya administration considers its greatest economic
achievements of 2006 and concludes that the GOH has
maintained a solid macro economic base but has yet to find
the political will and vision to grapple with the structural
issues preventing Honduras from escaping poverty. If the GOH
does not find this focus in the coming year, the inherited
positive momentum that made 2006 seem so successful could
peter out. End Summary.


2. (SBU) GDP Growth: According to Honduran Central Bank
(BCH) figures, the Honduran economy grew at a rate of 5.5
percent in 2006, compared to 4.1 percent in 2005. In 2005
the sectors responsible for the strongest growth were energy,
public administration, and transportation. Figures for 2006
are not yet available, but likely sources of growth include
consumer goods and construction. (Comment: Economic
stability is a necessary, but not sufficient condition for
continued growth. Zelaya's economic team has kept the macro
economy stable, but much-needed reforms to spur investment
and growth -- such as opening the telecommunications, mining,
and forestry sectors -- continue to languish. End comment.)


3. (SBU) Lower interest rates: Under Zelaya, interest rates
were reduced by undersupplying government bonds to the

market, thus pushing more liquidity into the banking system.
Publicly available interest rates fell from approximately
17.6 percent to 13.8 percent in less than one year (GOH bond
yields fell from over 11 percent to just 6 percent).
According to banking regulator CNBS statistics, just over USD
1 billion in increased liquidity went into new lending from
November 2005 to November 2006, particularly loans for real
estate and construction. Critics contend that the
construction boom is largely in commercial properties rather
than industrial ones, and therefore does not represent a
source of future growth and job creation. The figures tend
to support this criticism. According to BCH figures, over 50
percent of new lending went to support consumption or
imports, while only 12 percent went to industry and only four
percent to the agricultural sector. According to the CNBS,
on a relative basis the banking sector shifted its loan
portfolio out of industrial loans (down 3 percentage points
to just 16 percent of the total portfolio) and export
financing (down 1.3 percentage points to 5.3 percent). These
funds and new funds were overwhelmingly allocated to real
estate (up 3.9 percentage points to 23 percent) and to
consumption (up 1.5 points to 15 percent).


4. (SBU) Inflation under control: The BCH reports 2006
inflation of 5.3 percent, down from 7.7 percent in 2005. To
some degree this reflects the impact of price controls on
energy and basic foodstuffs. Energy subsidies alone cost the
GOH a reported 500 million lempiras (about USD 26 million) in
2006, and were responsible for shaving up to 1.8 percentage
points off the inflation rate, according to one GOH official.
Another factor contributing to low inflation has been a halt
to the depreciation of the lempira, which has been held
steady at 18.89 per 1.00 USD for the last year. As imports
have surged -- up 20 percent year-on-year to nearly USD 5
billion in 2006 -- a steady currency helped keep prices for
those imported consumer goods lower. Despite the fact
remittances have rocketed up from an estimated USD 1.5
billion in 2005 to nearly USD 2.3 billion in 2006, the
equally rapid growth of imports has absorbed much of this
liquidity, also helping to keep inflation in check. Of these
imports, 52 percent were consumer goods or fuels, while only
15 percent were capital goods. (Comment: 2006 also
benefited from a "gentlemen's agreement" between the GOH and
producers to keep prices steady through the holiday season.
However, prices on consumer goods, including some basic
foodstuffs, and construction materials are now showing upward
pressure, and yields on GOH bonds briefly spiked upwards in
December due to bank fears of potential inflation in 2007.
Prices are not spiraling upwards by any means, but the GOH

TEGUCIGALP 00000215 002 OF 003


policy of challenging any price increase -- a policy that
worries the private sector but that has helped keep prices
flat for several months -- will not be tenable over the long
term and some increased inflation is likely. If they
persist, recent world market increases in costs for fuel,
metals, and corn might also transmit some upward price
pressures to Honduras over the coming year. End comment.)


5. (SBU) Fiscal Discipline I: Spending: The GOH central
government deficit as a share of GDP for 2006 was reported as
1.0 percent, well below the IMF agreed target of 2.5 percent.
However, this largely reflects very poor project execution
on social and infrastructure projects, and is less an
indication of thrift than of disorganization. Many observers
in the donor community expect this figure to climb
substantially in 2007 as the GOH gets about the business of
executing such projects. The public sector deficit, on the
other hand, missed its target substantially, coming in at 2.1
percent versus the planned 1.7 percent. In part this is from
reduced earnings from parastatal telephone monopoly Hondutel
and from a hemorrhage of funds from the parastatal
electricity company ENEE. During this year the GOH also
embarked on a series of popular but questionable spending
programs including grain subsidies, fertilizer subsidies, and
fuel subsidies. Total spending is expected to increase
sharply in 2007, as significant public sector wage increases
take effect, and losses at ENEE continue. Some
back-of-the-envelope estimates project deficits as high as
3.0 percent, well out of the range that had been contemplated
by the IMF. This will certainly be one of the defining issues
of the upcoming negotiations with the IMF in March, when the
GOH seeks to sign a PSI agreement to replace the PRGF that
was effectively halted in April 2006 when a Fund mission
could not close Honduras' review.


6. (SBU) Fiscal Discipline II: Revenues: 2006 saw a
spectacularly successful move by the GOH to improve its tax
collections. Led by an honest and no-nonsense Director of
Taxation and backed by three years of U.S. Treasury
Department technical assistance programs, the GOH saw tax
revenues jump upwards by 17.2 percent as of October,
exceeding both IMF and GOH targets. In all, the Ministry of
Finance estimates the GOH will collect an additional five
billion lempiras (USD 263 million) this year over last.
(Comment: Regrettably, this highly successful technical
assistance program has been reduced from a resident advisor
to an intermittent one, as the USG could not identify the
approximately USD 600,000 needed to continue funding the
program. End Comment.)


7. (SBU) Strong international reserves position: The BCH
reports international reserves have increased to nearly USD
2.4 billion, a net accumulation of USD 432 million over 2005.
The BCH attributes this strong growth to hard currency
inflows from remittances (USD 2.25 billion as of December),
light manufacturing exports (USD 825 million) and tourism
(USD 197 million). The BCH policy of sterilization has
created a quasi-fiscal deficit within the BCH, but rising
interest rates in the U.S. and falling rates in Honduras have
over the last year steadily reduced the cost of maintaining
such large reserves.


8. (C) Comment: With macroeconomic results like these,
what's the worry? The biggest concerns from administration
skeptics appear to be two: the first is that Zelaya is
merely riding the momentum of Maduro's economic reforms, and
that his populist tinkering has little to do with the
economic growth seen in 2006. Post assesses this is probably
correct, particularly considering Zelaya largely inherited
CAFTA and the HIPC debt relief packages. But such "sour
grapes" is in the nature of politics. Of greater concern is
the allegation that Zelaya's short-term focus on current
spending rather than investment will have the opposite effect
in future years: where Maduro was hated for austerity
packages that lead to today's growth, Zelaya is loved for
populist programs that could undermine that growth tomorrow.
For example: Zelaya has increased teachers' wages but not
improved education. He has subsidized energy but not tackled
the looming crisis in electricity supply. He has overspent
on consumption programs, such as fertilizer subsidies, while
under-executing on public works. His administration has thus
far failed to control the serious fiscal challenges posed by
losses at ENEE and a skyrocketing public sector wage bill.
Zelaya has championed uneconomic but romantically attractive

TEGUCIGALP 00000215 003 OF 003


agricultural products like corn, while spurning
diversification into the value-added crops that could pull
the countryside out of poverty. He pays lip service to
competition, but imposes price controls. In perhaps the
worst example in recent memory, he champions CAFTA, but then
seeks to nationalize and monopolize all fuel imports into
Honduras. Finally, remittances are clearly the motor of the
Honduran economy, but they are largely supporting consumption
rather than investment. This failure to create a future
productive base, coupled with the rising threat of Dutch
disease (that is, the risk that Honduras will forego
productive work in the real economy in favor of instead
receiving the easy money of remittance checks),calls into
question the likelihood of the productivity growth needed for
Honduras to compete regionally and internationally.


9. (C) Comment continued: Zelaya has a 70 percent approval
rating -- proof that it is often better to be lucky than to
be right. Nevertheless, in 2007, the GOH must find the
political will and vision to grapple with the structural
issues preventing Honduras from escaping poverty. If the GOH
does not find this focus in the coming year, the inherited
positive momentum that made 2006 seem so successful could
peter out. The question facing Mel Zelaya in 2007 is whether
he will use his popularity to make difficult reforms, or
whether popularity is a goal in itself. Will Zelaya emerge a
leader? Or be remembered as just another populist caudillo?

Ford
FORD