AMBASSADOR'S COURTESY CALLS WITH IMF AND CENTRAL

UNCLAS TEGUCIGALPA 001009 SENSITIVE SIPDIS STATE FOR WHA AND EEB TREASURY FOR SARAH SENICH AND ANA JEWELL E.O. 12958: N/A TAGS: EFIN ECON ETRD EAGR HO SUBJECT: AMBASSADOR'S COURTESY CALLS WITH IMF AND CENTRAL BANK PRESIDENT REF: TEGUCIGALPA 1006 ¶1. (SBU) Summary: Ambassador Llorens continued economic courtesy calls this week with visits from IMF Resrep Mario Garza and Central Bank (BCH) President Edwin Araque. Both meetings focused on the probable effects of the financial crisis (reftel),further complication to the Honduran economy because of massive flood damage in the past month, and the need for an IMF agreement in 2009 as an anchor of stability for potential foreign investors. Araque and Garza agreed that the increasingly complicated economic situation increases the need for monetary discipline, and Araque acknowledged that the BCH has downwardly revised the GDP growth projection to 4.1 percent in 2008, down from 6.5 percent. End Summary. ¶2. (SBU) In separate meetings with the Ambassador November 5, Araque and IMF ResRep Mario Garza both attested that liquidity was not a current problem in Honduras. Garza said bank credit was still growing at a 20 percent annual rate, which he said was too fast. Growth of deposits, meanwhile, are slowing, he said. As a result, the excessive bank lending is coming out of reserves. Araque maintained that the growth of bank lending had reached the level agreed to in the IMF Standby Agreement -- 18 percent, down from 36 percent in 2007. ¶3. (SBU) Araque spoke about the effects of commodity prices shocks this year, saying the increase in oil prices alone would likely reduce growth this year by 0.7 percent. The external price shocks have also driven the current account deficit this year to around 14-15 percent of GDP -- twice what the IMF considers the maximum safe level. The decline in commodity prices in the wake of the crisis will provide some relief. Araque predicted cheaper oil would save Honduras about USD 300 million on its fuel import bill this year. Araque also said falling fuel prices would help moderate inflation, which had been running at more than a 15-percent annual rate, to around 12 percent for the year. ¶4. (SBU) Before the global credit crisis hit, economic analysts here were warning that lax monetary policies threatened to fuel inflation and instability with a negative impact on growth over the next two years (reftel). Although the recent drop fuel prices has slowed the inflation rate somewhat, food prices, which have hit the poorest Hondurans especially hard this year, are not falling as quickly, if at all. ¶5. (SBU) Garza said the GOH should take advantage of the current breathing space provided by falling fuel prices to move on permitting more flexibility in the exchange rate, which has been effectively fixed since October 2005. He said the IMF was pushing for a gradual devaluation of 4-5 percent over the course of a year, utilizing the Central Bank's currently authorized flexibility within its existing band. Garza argued that a gradual devaluation now is referable to a more drastic devaluation imposed by the markets later. (Araque said he had already devalued the Lempira in April, but the move was "neutralized" by external price shocks.) Garza also called for a further increase of 2-3 percent in the mandatory investment requirement (reserve requirement) on commercial banks. ¶6. (SBU) The Central Bank reported an 89 percent rise in the demand for foreign currency in the month of September, a clear indicator that the Lempira is overvalued. While GOH officials continue to maintain publicly that even the slightest devaluation is both unnecessary and unacceptable, President Zelaya told the Ambassador that he would consider some modest move toward greater exchange rate flexibility in December, after primary elections to select candidates for next year's election to choose his successor. -------------- Comment -------------- ¶7. (SBU) The Ambassador encouraged Araque to seek to conclude an IMF agreement since it would send a clear message to international investors, in turbulent economic times, of the Zelaya Government,s commitment to macroeconomic stability. Araque said that President Zelaya,s priority is to maintain growth and employment at the highest possible levels. He therefore agreed that the argument that investment would be reduced if no agreement was reached with the Fund was a powerful one likely to influence President Zelaya. Unfortunately, Araque has so far not shown the backbone to eschew political expedience and press for forceful economic policies. On the positive side, Resrep Garza says the Fund is willing to show flexibility in most areas of the agreement except being the exchange rate. ¶8. (SBU) The outcome of the internal elections, now scheduled for November 30, will give us a better idea of the likely direction of economic policy beyond 2009. We will urge both major candidates and their prospective economic teams to visit Washington early in 2009 to meet with the international financial institutions with the hope of forging consensus positions in advance of the general election on strategies to cope with the likely emerging global slowdown. End Comment. LLORENS