DOMINICAN ECONOMY VULNERABLE TO GLOBAL CRISIS

UNCLAS SANTO DOMINGO 001610

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN PGOV DR
SUBJECT: DOMINICAN ECONOMY VULNERABLE TO GLOBAL CRISIS

REF: SANTO DOMINGO 1608


1. (SBU) Summary: The global financial crisis has not yet had
a serious impact in the Dominican Republic where the banking
system appears to be in relatively good shape as a result of
stronger regulatory measures put into place after the 2003
banking crisis. However, the private sector is publicly
expressing concern over the potential economic impact in the
DR of a prolonged slow down in the U.S. economy, especially
in the areas of tourism and foreign direct investment, and
has called on the government to prepare a strategy to address
the problem. In addition, the private sector has been
increasingly critical of the government,s deficit spending
and has called on the Fernandez administration to reign in
government expenditures, including the electricity subsidy
which could total as much as USD 1.2 billion this year. So
far, the Dominican government has been unusually quiet,
making few statements on the ongoing global economic crisis,
despite recent dire warnings from the IMF and UN that
developing economies such as the DR could suffer the most.
End Summary.

Government Response


2. (SBU) The response of the Dominican government to the
global financial crisis has been muted despite extensive
coverage by the Dominican media. On October 3, President
Fernandez spoke at a conference in Miami and acknowledged
that the financial crisis could limit the amount of credit
available to the country; however, he has not made any other
public comments on the ongoing crisis. Fernandez,s main
priority at the moment is his proposed constitutional reform
package (reftel) which is being considered by the Congress.
The rest of his economic team has also been relatively quiet,
thus giving the impression that they are unengaged. The
government initially planned to send only a low-level
delegation to the annual IMF and World Bank meetings in
Washington with Finance Minister Vicente Bengoa only deciding
to attend at the very last minute.


3. (U) On October 7, the Minister of Economy, Development and
Planning Temistocles Montas held a videoconference for
government officials with the United Nations Conference on
Trade and Development (UNCTAD) to discuss the global crisis
and the potential effects on the DR. UNCTAD was very clear
in its warning that the economic impact for the DR could be
severe given the DR,s dependence on the U.S. economy and
this message was widely covered in the press. The IMF also
warned that the Dominican economy is at risk and placed the
DR in a category of countries most vulnerable in face of the
global economic crisis. In response, Finance Minister Bengoa
told the media the IMF needs to intervene in the U.S. economy
which &has more problems than the Dominican economy.8


4. (U) As a result of the external oil and food price shocks
this year and increased spending in the lead up to the May
2008 Presidential election, the Dominican government,s
fiscal deficit has grown. The private sector has repeatedly
called on the government to cut spending, especially
subsidies. The subsidy for the electricity sector is
expected to be as much as USD 1.2 billion this year. The
government response so far has been to maintain a restrictive
monetary policy to keep interest rates high, to try to curb
inflation and maintain a stable exchange rate. The Finance
Minister announced on October 15 that government tax revenues
were projected to fall this year, in part due to reduced
consumer spending and the temporary closing of the
Falconbridge mine as a result of low nickel prices in the
world market. He described September as one of the worst
months ever for the government fiscal situation.

Financial system is sound


5. (SBU) Manuel Grullon, President of Banco Popular, the
largest bank in the country, told Econoff that he believes
the Dominican banking system is pretty strong. He added that
as a consequence of the 2003 financial crisis, banks were
required to increase capital and reserves and these measures
are still in place. Grullon emphasized that the prudential
regulations put into place after the 2003 crisis strengthened
the banks balance sheets and also put into place stricter
requirements for commercial loans. His one concern was a
measure which put a 10 percent limit on capital investments
by Dominican banks in other financial institutions, including
government treasuries. Grullon said the bank was considering
asking the banking regulators to modify this requirement in
light of the current global crisis since in his view U.S.
Treasury bills are the safest place to put money at the
moment.

6. (SBU) Grullon noted that as a result of stricter
commercial loan requirements, banks shifted their focus to
consumer and mortgage loans which are now facing pressure
from higher interest rates. He added that it is important to
make a distinction between commercial banks, which faced
increased regulation after the crisis, and savings and loans
which were only addressed more recently. Grullon said the
savings and loans have a much larger share of mortgage credit
in the domestic market (30-60 percent of their portfolios)
than the commercial banks (10-15 percent of their portfolios)
and therefore the savings and loans are more sensitive to
interest rates increases. He commented that Banco Popular is
trying not to raise mortgage rates too much compared to other
loans since the bank would lose more if the number of
mortgage defaults increased. Grullon pointed to auto loans
where rates have increased 10 points in four months (from 15
to 25 percent) and business has dropped significantly.
Grullon was critical of the Central Banks,s restrictive
monetary policy which has led to &a home grown credit
crunch8 in the local market. He said his most important
concern is that there is no erosion of confidence in the
Dominican financial system.

Citibank concerned about economic impact


7. (SBU) Max Vidal, General Manager of Citibank, told Econoff
that he believes the economic impact of the global crisis
will start to be felt in the DR at the beginning of 2009. He
noted that a tightened global credit market will make it
difficult for investors to fund large projects and they may
face delays or much higher costs. Vidal said he has already
seen a couple of projects delayed and expects the number to
increase, especially in the areas of infrastructure projects
and tourism development. Vidal also commented that he
believes the local financial system is fairly strong.
However, he noted that Wachovia is a key foreign
correspondent bank in the DR and an important source of
short-term capital for trade. Therefore, he said the future
of Wachovia is important to the DR economy. (Note: This
conversation took place before Citibank withdrew its offer to
purchase Wachovia. In a separate conversation also before
Citibank,s withdrawal, Jose Obregon, Vice President of the
Wachovia Representation Office in the DR, told econoff that
if Wells Fargo purchases the bank he is hopeful that Wachovia
will remain in the market with little change. End Note.)


8. (SBU) Vidal commented that there is a public perception
that the government is not reacting to the global crisis and
therefore not taking it seriously. He warned that the
government needs to address its fiscal deficit before the
economic impact of the U.S. slowdown is felt. Vidal noted
the ongoing payment crisis in the electricity sector (septel)
and emphasized the need for the government to find the
political will to address the problem which affects all areas
of the economy. He added that it will be more difficult for
the government to find financing for this growing subsidy
which is a huge drain on government resources. Vidal said he
expects interest rates to stay high but not to increase much
more as a result of the government,s efforts to curb
inflation and maintain exchange rate stability.

Comment


9. (SBU) More than halfway through his first 100 days in
office President Fernandez has shown no intention of taking
advantage of his new term to address pressing fiscal problems
such as the large subsidies weighing down the government
budget. Instead he appears to be focusing on seeking new
investment from countries such as Qatar and getting his
constitutional reform package passed by Congress. This lack
of leadership is of great concern to a private sector that is
already feeling some effects of the global crisis and are
greatly concerned about the potential impact in the DR. Most
people believe it is only a question of time before the
global crisis hits the local market and they fear the
government will not have done anything to prepare the country
for the outcome. The question is whether Fernandez will take
decisive action or continue to act out of the fear he has
expressed to us in the past of "political instability"
resulting from economic reforms. End Comment.



FANNIN