EFFECT OF GLOBAL FINANCIAL CRISIS ON HONDURAS

C O N F I D E N T I A L SECTION 01 OF 02 TEGUCIGALPA 001006 SIPDIS STATE FOR EEB, WHA TREASURY FOR SARA SENICH AND ANNA JEWELL E.O. 12958: DECL: 11/05/2018 TAGS: EFIN, ETRD, EAGR, HO SUBJECT: EFFECT OF GLOBAL FINANCIAL CRISIS ON HONDURAS REF: TEGUCIGALPA 772 Classified By: Ambassador Hugo Llorens for reasons 1.4 (b) and (d) ¶1. (SBU) Summary: The Honduran financial sector is beginning to feel an impact from the global financial crisis in the form of reduced credit flows and higher interest rates on correspondent bank relationships. However, because of its limited exposure to the U.S. and global financial systems, the impact so far has been modest. We predict significant economic effects beginning next year if the U.S. economy suffers a major slowdown. A U.S. recession would likely lead to a decline in remittances, which equal a fifth of GDP here, and lower demand for Honduran exports, especially for apparel and also possibly for agricultural products. About 70 percent of Honduran exports go to the U.S. market. Falling commodity prices, meanwhile, could be a two-edged sword: lower oil prices relieve pressure on inflation and the trade deficit, but lower prices for export commodities could depress income. Financial experts here agree the crisis heightens the need for tighter monetary policies and exchange-rate flexibility. End Summary. -------------- Short-term Impact Negligible -------------- ¶2. (U) Because of the limited exposure of the Honduran financial sector to the international financial system, the chaos in global financial markets over the past several weeks has not had a significant impact on markets here, according to Embassy sources. Honduras relies heavily on concessional financing from official sources, so the tightening of international commercial credit markets has had little immediate effect here. Bank lending, consumption and consumer credit remain brisk. Credit card consumption grew almost 31 percent between August 2007 and August 2008. ¶3. (SBU) However, even though the Honduran financial system has ample liquidity, as the U.S. crisis deepens, some banks are becoming reluctant to lend to the productive sector, wanting to wait to see how the international credit situation plays out. In addition, bankers and industrialists have reported to us that financing lines from overseas banks have been tightened and that interest rates have increased substantially. Nevertheless, the banking association said this week that the sector was not planning any short-term measures to stave off a potential liquidity crunch. -------------- --- Contagion Could Enter Through Remittance Channel -------------- --- ¶4. (U) There is already anecdotal evidence that slowing inflows of remittances from Hondurans living in the United States could constitute a serious blow to the Honduran economy over the next year. Remittances currently equal about 20 percent of GDP and have been a major factor in sustaining DOMESTIC demand and reductions in measured poverty rates over the past three years. The latest Central Bank data indicate that remittances, which grew 31 percent two years ago and 10 percent last year, were increasing at only single-digits in the third quarter of 2008. If Hondurans in the United States are laid off or cash-squeezed as a result of a continuing crisis or slowdown in the U.S. economy, growth in remittances could easily turn negative, with consequences for both DOMESTIC demand and the balance of payments. Remittances in 2007, at USD 2,561 million, roughly equaled the year end balance of official reserves. As of mid October, reserves had fallen about 9 percent since April, reaching USD 2,390 million -- equivalent to about 3.4 months of imports, compared with 3.9 months at the end of 2007. ¶5. (SBU) The Central Bank believes the downturn in the U.S. housing market could result in a contraction in remittance inflows as early as the beginning of 2009, as many Hondurans are employed in housing construction. -------------- Investment Inflow Could Also Slow -------------- ¶6. (SBU) Some recent closures of export processing (maquila) operations are giving rise to concerns here that the inflow of foreign direct investment could slow, further complicating TEGUCIGALP 00001006 002 OF 002 the balance of payments and growth prospects. The maquila sector, which employs nearly 140,000 Hondurans, has lost about 5,000 jobs in the last two months, in both apparel and automobile wiring harness assembly plants. Industry reps have told econoffs that this is a result of the already-suffering auto-manufacturing industry in the U.S., combined with an attempt to consolidate and increase regional efficiency in some apparel segments. To this point, no maquilas have shut as a direct result of the crisis. However, business leaders have told Ambassador the maquila sector could be hit hard because it relies almost exclusively on increasingly scarce financing from abroad. -------------- Impact of Falling Commodity Prices -------------- ¶7. (SBU) Before the U.S. financial crisis hit, the GOH had already shaved its GDP growth forecast for 2008 to around 4 percent, compared with 6.3 percent in each of the last two years, largely because of the impact of rising food and fuel prices. Falling fuel prices are likely to result in significant savings to Honduran consumers over the next year compared to 2008 (septel). ¶8. (C) On the downside, the prices of some of Honduras's key export commodities -- palm oil, coffee, bananas -- are also falling, which could negatively affect incomes and the balance of payments. One of the country's largest palm oil producers said falling palm oil prices are preventing him from obtaining financing from a large multinational bank. He is attempting to put together a bridge loan of USD 60 million in order to keep his operation running. -------------- Comment -------------- ¶9. (SBU) Honduras has weathered the global financial storm with only moderate damage to date. In fact, flood damage from physical storms in recent weeks is likely to have a greater impact on the national economy in 2008. However, there are indications the effects could be deepening. If the current global financial crisis evolves, as appears increasingly likely, into a crisis in the real economy, Honduras will definitely feel the impact on multiple fronts. Analysts seem to agree that slight devaluations of the Lempira now, spread out over time, together with continued monetary and fiscal discipline, could hold the key to minimizing the impact of a global economic downturn on Honduras over the medium term (septel). In addition to reducing the chances of a speculative run on the currency and making maquila exports more competitive, devaluation would increase the local currency value of family remittances on which many of the poorest Hondurans depend. End Comment. LLORENS