GOH NEAR AGREEMENT WITH IMF ON STANDBY

C O N F I D E N T I A L SECTION 01 OF 03 TEGUCIGALPA 000242

SIPDIS

SIPDIS

STATE FOR WHA/CEN, WHA/EPSC AND EEB/OMA
TREASURY FOR IMF EXECUTIVE DIRECTOR
MADRID FOR HUGO LLORENS
BRASILIA FOR SIMON HENSHAW

E.O. 12958: DECL: 01/29/2018
TAGS: EFIN EAID IMF HO
SUBJECT: GOH NEAR AGREEMENT WITH IMF ON STANDBY

REF: A. TEGUCIGALPA 138

B. TEGUCIGALPA 84

Classified By: Ambassador Charles A. Ford, E.O. 12958 Reason 1.4(d)


1. (C) Summary: Sources here expect the IMF Board next month
to approve a Precautionary Standby Agreement with Honduras.
Under this agreement, which represents a lower level of
ambition than what was being discussed in January (ref B),
Honduras is to stabilize its international reserves and
devalue its exchange rate by means of a crawling peg. It
would not endorse limits on luxury imports, which the Central
Bank was recently pushing. Honduras will receive no balance
of payments support from the Fund under this agreement, but
the GOH will likely try to use it to pry loose budget support
funds from other donors. Unless the Board overrules IMF
Staff, the agreement would also implicitly bless a scheme by
the Central Bank to finance the debt of the state electric
utility by manipulating reserve requirements in a way that
foreign bank representatives here claim is designed to limit
their market share. End Summary.

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Fund and GOH Close to a Deal
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2. (C) IMF ResRep Mario Garza told EconCouns March 3 that the
Fund was close to closing a deal with the GOH on a
watered-down Precautionary Standby Agreement that he expected
to be presented to the IMF Board for approval in April. He
said the GOH had accepted the IMF's crawling peg proposal for
the exchange rate and had already allowed some little-noticed
microadjustments to the rate as a precondition. Also as a
precondition, the GOH is to assure that Central Bank foreign
reserves at the end of March are no lower than the year-end
2007 level, which would require them to increase slightly
from where they stand now. There will be monthly targets
thereafter under the agreement. The GOH must also get an
acceptable budget approved by Congress and commit to a
further 11 percent increase in electricity tariffs.


3. (U) Press here are reporting that the agreement will be
approved April 9. However, at a March 12 meeting between
G-16 donors and members of the National Congress, Garza said
the budget would need to be approved at least two weeks
before the IMF Board could vote on the agreement. Given that
the Congress will be in recess next week for Holy Week,
Congress Vice President Lizzy Flores said that timetable
would be difficult if not impossible to meet, since the GOH
has not yet presented the budget to the Congress. President
of Congress Roberto Micheletti said March 13 that the budget
would not be approved until April 20, assuming the GOH
submits it after the recess.


4. (C) Garza said the GOH had dropped the idea, being pushed
last month by Central Bank President Edwin Araque, of
limiting luxury imports, as the Fund had refused to support
it. But the fund has reluctantly acquiesced to Araque's
scheme to manipulate reserve requirements, conditional on the
composition of banks' loan portfolios (see below) so as to
find a market for bonds to bail out the National Electric
Company (ENEE). GE and Citibank reps have complained to us
that the scheme was deliberately designed to limit market
share of foreign-owned banks.


5. (C) Garza told us that under this minimalist agreement,
Honduras will receive no financial support from the Fund.
But the GOH wants the agreement as a "seal of approval" for
its fiscal policy, and probably as an instrument for
persuading other donors, such as the World Bank, Germany and
Spain, to release budget support funds. IMF staff, and local
World Bank officials, are supporting the agreement because it
allows the IFIs to continue to monitor GOH fiscal performance.

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U.S. Banks Concerned about New Reserve Scheme
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6. (U) Araque announced publicly the week of February 18 the
Honduran Central Bank (BCH) would increase the "obligatory
investment" requirement (the share of deposits that must be
backed by government bonds) for lempira deposits from 4
percent to 9 percent, phased in over three months beginning
in March. The clear and stated objective is to create a

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captive market for the 4 billion lempiras (USD 212 million)
of bonds the GOH needs to place to pay off the accumulated
debt of ENEE to private power producers (whose support the
GOH needs for its plan to purchase heavy fuel oil from
Venezuela through Petrocaribe). BCH also probably hopes to
lower the cost of government borrowing overall.


7. (SBU) In fact, since Araque's announcement, the GOH was
able to place 679,000 lempiras of ENEE bonds at a coupon
rates as low as 9.5 percent, which is not enough even to
cover inflation. Previously, banks had been demanding rates
of 14 percent or more. (Annualized inflation the last four
months as been 11.4 percent)


8. (U) To compensate the banks and to avoid inducing an
economic slowdown, the increased investment requirement is to
be accompanied by a simultaneous phased reduction of the cash
reserve requirement for lempira deposits from 12 percent to 7
percent, and of the obligatory investment requirement on
deposits in foreign currency (primarily dollars) from 24
percent to 14 percent. However, to benefit from the lower
cash reserve requirement, banks must have at least 80 percent
of their loan portfolios in "productive investments," defined
as something other than consumer or commercial credit.


9. (SBU) The innocent explanation for this direct portfolio
mandate is that the BCH wanted to assure that the increased
liquidity resulting from the lowered cash reserve would not
further fuel inflation, currently running at double digits.
(Comment: Treasury OTA analyst does not expect the effect of
the changes on liquidity to in fact be neutral, since the
increased obligatory investment will finance bonds that will
be used to pay off debt to private power producers, who will
then deposit it back into the banks. End Comment) However,
representatives of U.S.-invested banks strongly suspect that
the large Honduran banks intervened with the BCH to
manipulate the rules in such a way as to work to their
advantage -- and to the disadvantage of foreign banks. The
local manager for BAC (majority owned by GE) is also worried
that the changes will put upward pressure on credit card
rates -- already 30-60 percent -- reviving GOH talk of
capping them.


10. (U) A survey by the Honduran Banking Association (AHIBA)
revealed that of its 18 member banks, only one met the
criteria for the reduced reserve requirement. However, six,
all of them local, have portfolios comprising less than 30
percent consumer and commercial credit. Those banks have
told AHIBA they could reconfigure (or relabel) their
portfolios to qualify. Meanwhile, seven banks -- almost all
foreign -- hold more than 50 percent consumer and commercial
loans.


11. (SBU) Maria Solano, executive director of AHIBA, told
econoff AHIBA is strongly against the proposed changes, which
she sees as an unnecessary attempt to control the markets
and a serious disincentive for transparency among bankers
(since banks will have an incentive to misrepresent the
purpose of their loans so as to qualify for the lower reserve
requirement). AHIBA sent a letter to Araque February 20
spelling out its concerns about the new regulations,
including that they would lead to higher interest rates, that
the portfolio mandate cannot be enforced (the National Bank
and Insurance Commission says it does not have the capacity
to monitor the composition of bank loan portfolios) and that
Honduras's shadow sovereign bond rating could suffer.

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The Fund's Attitude
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12. (C) Garza said the IMF was in principle opposed to direct
controls over bank lending policies of the sort Araque is
proposing. Other critics have pointed out publicly that
these sorts of controls were tried unsuccessfully in Honduras
in the 1980s. However, Garza said IMF staff were not willing
to make this issue a deal-breaker for the Precautionary
Standby Agreement. Also, he said, the staff had some
sympathy for the GOH predicament of having to place 4 billion
lempiras of bonds in a financial market where a small number
of players can easily collude.


13. (C) The Staff report will note reservations about the
scheme and will likely insist that the policy be reviewed in

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May. Staff would also prefer the measures to have a time
limit. Garza noted that the Board could insist on stricter
limits on the measures when it votes on the agreement next
month.

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Comment
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14. (C) The draft Precautionary Standby Agreement, as we
understand it, is a minimalist package that President Zelaya
undoubtedly hopes to use domestically to confer legitimacy on
his fiscal policies and internationally to try to extract
more direct budget support from donors. We see some benefit
to the agreement in that it will give the IMF continued
leverage -- however small -- over GOH fiscal and monetary
policies. But other donors should not be fooled into
increasing their support based on this agreement. For one
thing, we expect the revenue projections and the investment
plan in the budget the GOH will submit to assume that the GOH
will receive USD 350 million over the next two years from the
Petrocaribe deal with Venezuela that the Congress approved
March 13. We and other donor reps here consider it extremely
unlikely that Petrocaribe will yield that much disposable
cash to the GOH. Thus, both the fiscal deficit and public
investment will likely miss their targets. Also, we
recommend that the U.S. Executive Director voice strong
reservations about the BCH reserve requirements and portfolio
mandate. End Comment.
FORD