Identifier
Created
Classification
Origin
08TEGUCIGALPA772
2008-08-21 13:42:00
CONFIDENTIAL
Embassy Tegucigalpa
Cable title:  

FAINT HOPE FOR IMF STANDBY AGREEMENT IN HONDURAS

Tags:  EFIN EAID ENRG EPET PGOV PREL IMF VE HO 
pdf how-to read a cable
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RUEHCV/AMEMBASSY CARACAS IMMEDIATE 0624
RUEHLMC/MILLENNIUM CHALLENGE CORP WASHINGTON DC IMMEDIATE 0783
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C O N F I D E N T I A L SECTION 01 OF 04 TEGUCIGALPA 000772 

SIPDIS

STATE FOR WHA AND EEB
TREASURY FOR SARA SENICH AND WILLIAM FOSTER
STATE PASS TO USAID/LAC

E.O. 12958: DECL: 08/21/2018
TAGS: EFIN EAID ENRG EPET PGOV PREL IMF VE HO
SUBJECT: FAINT HOPE FOR IMF STANDBY AGREEMENT IN HONDURAS

REF: TEGUCIGALPA 518 AND REFTELS

Classified By: Charge D'Affairs Simon Henshaw for reasons 1.4 (b) and (
d)

C O N F I D E N T I A L SECTION 01 OF 04 TEGUCIGALPA 000772

SIPDIS

STATE FOR WHA AND EEB
TREASURY FOR SARA SENICH AND WILLIAM FOSTER
STATE PASS TO USAID/LAC

E.O. 12958: DECL: 08/21/2018
TAGS: EFIN EAID ENRG EPET PGOV PREL IMF VE HO
SUBJECT: FAINT HOPE FOR IMF STANDBY AGREEMENT IN HONDURAS

REF: TEGUCIGALPA 518 AND REFTELS

Classified By: Charge D'Affairs Simon Henshaw for reasons 1.4 (b) and (
d)


1. (C) Summary. After a reluctant IMF assessment visit August
12-15, the IMF officially concluded that fiscal policies are
broadly on track, while advising the GOH to strengthen its
monetary and exchange rate policies. Underlying the terse
public statement was a private
consensus among IMF officials that the Precautionary Standby
Agreement is all but dead, with only faint hope it can be
revived. According to IMF ResRep Mario Garza, abysmal
monetary policies are the real problem, not ballooning public
sector wages as claimed by the press. Compounding the
frustration of IMF officials is a complete lack of urgency on
the part of the GOH economic team to draft practical fixes to
problematic policies, and Garza does not expect any serious
attempt to get the program back on track. End Summary.

--------------
Monetary Policy Had a Stronger Effect Than External Shocks
--------------


2. (C) An International Monetary Fund (IMF) assessment
mission reluctantly visited Honduras for the first official
review of April's Precautionary Standby Agreement August
12-15. The mission's reluctance was based on a well-founded
belief that Honduras was unlikely to complete
its review at this time, which was proven right. A terse
August 18 press release commending fiscal policies as broadly
on track, while advising the GOH to strengthen its monetary
and exchange rate policies was a face saving measure,
according to IMF ResRep Mario Garza. He said there was a
surprising amount of distance between IMF and GOH officials.
IMF officials articulated that poor monetary and exchange
rate policies are the primary reason Honduras is not
completing its agreement. By contrast, Central Bank (BCH)

President Edwin Araque flatly stuck to his position that
deviations in the program resulted solely from external
shocks, namely domestic demand pressure, and it was therefore
unwise to "overreact." IMF officials reminded Araque that
they had advised Honduras in May to consider the shock
permanent (reftel),therefore eliminating international
reserves as a possible temporary fix. They also acknowledged
the unexpectedly strong effect of external shocks - about
four percent of GDP - but also pointed out that simultaneous
positive shocks such as remittances and the attractive
price of exports resulted in a net negative effect on the
terms of trade of only about two percent. Araque could only
respond that President Zelaya will not allow him to react on
monetary and exchange rate policy.


3. (C) The IMF mission was careful not to tell the GOH
outright that its monetary policy is expansionary, instead
suggesting the GOH is creating a "strong impulse" to
inflation by allowing the external current account deficit to
grow rapidly. While the program originally envisioned this
deficit at nine percent of GDP, IMF expects it will reach 15
percent by the end of the year if not addressed. Araque
simply repeated his claim that external shocks were squarely
to blame. Garza lamented that while the IMF had focused on
finding out what the GOH intended to do to get back on track,
GOH officials were more focused on potential press reaction.
In the end, the economic cabinet agreed to review the aide
memoire and discuss options with the President, only
half-heartedly committing to discuss its ideas in Washington
in September. Garza noted a complete lack of urgency among
GOH officials to develop revised monetary policies and he
expects neither a constructive nor timely response.


4. (C) The mission also pointed to the huge deviation in
international reserves from the original targets. The
Agreement called for an increase in reserves from USD 2.473
billion to USD 2.726 billion by the end of 2008. Reserves
have instead fallen to USD 2.3 billion, USD 100 million of
which was lost in the last three weeks. This represents a
deviation of USD 230 million from original targets, and it
could reach USD 400 million by the end of the year without
appropriate action. Despite the precipitous decline in
reserves, the GOH was not prepared to discuss policy
responses. Araque dismissed the acceleration in losses as
seasonal, claiming that the seasonality will become favorable

TEGUCIGALP 00000772 002 OF 004


in the fourth quarter.


5. (C) Garza believes the monetary side of the program is off
track for a combination of reasons that boil down to lack of
political will:

- President Zelaya was not committed to the program from the
beginning.
- The GOH economic team, comprised of BCH President Araque
and Finance Minister Rebeca Santos, is weak and is not
informing Zelaya that the program is off track, or of the
implications.
- Though a capable technician, Araque is first and foremost a
Zelaya political loyalist who, like all of Zelaya's cabinet,
finds it difficult to advise the President, especially when
the advice means changing the current course. He is
constantly in "response" mode and lacks strategic vision of
where to take the program. This, combined with his tendency
to see everything as political, makes it very hard for Araque
to counter Zelaya's wild ideas with practical suggestions.
- Zelaya does not see the IMF program as congruent with his
increasingly close relationship with Venezuela. Ministers
seem to be buying into this trend as well - Finance Minister
Santos, who often appears willing but politically unable to
pursue rational policies, asked the IMF mission to justify
why it is in Honduras' interest to save the program.
- Division within the economic cabinet prevents a practical
approach. Previously, various Ministers of the Presidency
have been key participants in IMF discussions. The present
minister, Enrique Flores Lanza, is completely disengaged.
Santos has openly stated to IMF officials she does not like
Araque.

--------------
IMF says Fiscal Policy Not as Dire as Press Reported
--------------


6. (C) In spite of failing monetary policy, the fiscal side
is broadly on track. As it told the GOH in May (see reftel),
the mission is willing to accommodate some deviations in
current spending because the oil price shock was much bigger
than expected. Additionally, fuel subsidies have been
virtually eliminated and electricity subsidies are now
targeted. Garza said the IMF feels the current electricity
tariffs are almost consistent with cost recovery and IMF and
World Bank energy experts have agreed to meet in Washington
to discuss another possible tariff increase of about ten
percent. Despite rampant press reports that the IMF is
singularly focused on ballooning public wage spending, Garza
denied having made statements to the press to that effect,
and he suspects Araque is placing the stories in order to
divert attention from
monetary policy. On the other hand, Garza thought the
misreporting could provide enough steam for Rebeca Santos to
get the wage bill she wants, which could help address serious
overruns in hiring, especially for teachers, which could
account for losses of 0.3 percent of GDP for the year (about
USD 60 million).

--------------
Bank Supervision Needed
--------------


7. (C) Garza commented that bank supervision is a weak point
of the IMF program, and that banks seem to be operating with
increasing freedom in Honduras, signaled by the credit boom
over the last year. He sees anecdotal indications that that
lenders are finding it increasingly difficult to collect on
their loans. The IMF suggested to Banking and Insurance
Commission (CNBS) head Gustavo Alfaro that the CNBS should be
taking a closer look at individual banks. Garza explained to
econoff that the current practice is for most public sector
entities to deposit revenues in private local banks, rather
than the Central Bank. Because the BCH does not offer market
rates and because BCH does not have control over its monetary
policy, public sector enterprises have incentive to put this
liquidity into private banks, which offer higher rates. In
turn, those banks can (exponentially) expand credit
portfolios. For example, deposits from state-run telecom
company Hondutel were recently shifted from Citibank to Banco
Continental, a bank owned by media-magnate Jaime Rosenthal,
who is in turn using the funds to expand credit "like crazy."
Garza said under Araque, the GOH has intensified the existing

TEGUCIGALP 00000772 003 OF 004


practice of letting public sector institutions deposit
revenues in private banks. Though
shifting public sector deposits to the BCH would be
relatively simple, and could solve the international reserve
deviation, Araque complains it would be too hard to enforce.
In fact, Garza suspects Araque knows that taking these
deposits away from some banks that could cause a hard landing
if the credit situation worsens in Honduras.

--------------
What Should Be Done?
--------------


8. (C) Garza acknowledged that it would not be easy to get
the Precautionary Standby Agreement back on track, but said
it is theoretically possible by year's end. With concrete
action and political will in the short term, IMF is willing
to give the GOH some breathing room by pushing back the
deadline to March or even June of 2009. He said the mission
was careful to leave the solution to the GOH, offering tools
such as the monetary policy rate (TPM) and reserve
requirements. Garza did, however, present his personal ideas
to econoff, which were not articulated by the mission to the
GOH:

- The policy interest rate, which is currently negative, must
increase substantially (note: Garza noted that Araque
consistently responded to this suggestion by pointing out the
United States currently has a negative interest rate as well.
End Note.)
- Increase reserve requirements for private banks by three
percent and increase the TPM by 200 basis points. (Note:
Since April the GOH has raised the TPM by 125 points, while
inflation has gone up from nine percent to 13.8 percent
year-on-year. End Note.)
- The practice of placing public sector deposits in local
private banks should stop, in favor of the BCH. If the
lempira-denominated deposits were used to purchase dollars,
this could eliminate the international reserve level
deviation, since public sector deposits currently stand at
about USD 230 million, almost exactly the amount of the
reserve losses.
- The GOH should gradually devalue the exchange rate.


9. (C) On the exchange rate devaluation, Garza was remarkably
frank, saying there was a key difference in opinion between
his preferred approach and that of his Washington colleagues.
Evidently, the IMF team was authorized to suggest an
exchange rate devaluation of eight
percent, based on its belief that the terms of trade shock
had resulted in overvaluing of the currency by eight percent.
Garza himself talked the assessment team out of making that
politically-charged suggestion more than once, and told
econoff there was a higher chance of selling the Hondurans on
gradual adjustments. Garza said the commercial banks would
support increases in interest rates and reserve requirements.
Losing GOH deposits would be another matter. Garza
acknowledged the danger of cutting back credit growth too
rapidly.


10. (C) Garza said the options now are for Honduras to take
quick action to get its program on track or move to Article
IV consultations that would end the program. Garza said that
for all intents and purposes, the IMF feels the program is
dead, but chose to say publicly the program
review is continuing on the dim possibility that Vice
Minister of Finance Hugo Castillo will convince President
Zelaya to make practical policy changes. In the mean time,
Washington's IMF office is planning to gracefully put
distance between itself and the GOH, canceling trips of
advisors on various issues. If Article IV consultations
prove necessary, the IMF would do them as late as possible,
probably in December. This would allow a board review in
February 2009, followed by discussions with the Presidential
candidates later in the spring. Garza acknowledged that if
the GOH asks the IMF for an assessment letter, it will have
to say the program is off track.

--------------
COMMENT
--------------


11. (C) The GOH is using the assessment to pat itself on the

TEGUCIGALP 00000772 004 OF 004


back for its economic success. President Zelaya, with Finance
Minister Santos and BCH President Araque by his side,
interrupted all local and cable airwaves on the night of
August 18 to give the people of Honduras an "economic
report." The team announced that the IMF assessment had been
"extremely positive." They pointed to "solid" economic
growth of six percent for the last several years,
rising employment and a stable exchange rate. Despite the
IMF Press Release, newspapers have also gotten it wrong,
focusing instead on burgeoning wage spending. We agree with
Garza's suspicion that Araque is purposely trying to shifting
the public discussion of the IMF report from the monetary
problems to fiscal problems. Because of his past attempts to
manipulate the press in his favor and his loyalty to
President Zelaya, we believe he may have a longer term goal
of setting up the IMF as the scapegoat when unpopular, and
inevitable, restrictions are placed on public sector hiring
and wages.


12. (C) Given President Zelaya's apparent attempt to solidify
his friendship with Venezuela at any cost, the odds of a
miraculous recovery of the IMF Precautionary Standby
Agreement are close to nil. Post was surprised at Garza's
candor in the conversation, considering that he was under
instruction from Washington not to brief bilateral and
multilateral missions until the August 27 board meeting. His
bosses did not want a repeat of the extremely tense recent
World Bank food security budget support meeting in
Washington, the readout of which Garza said was leaked to the
GOH. The probable death of the Agreement until at least the
inauguration of a new administration in January 2010 will
make it easier for donors, who are increasingly skeptical of
the Zelaya administration's willingness to use multi-lateral
and bi-lateral assistance to improve his country's economy,
to argue against budget disbursements. For example, the
World Bank has told us that if the program goes off track,
Development Policy
Credit (budget support) of USD 30 million would not be
approved. The IMF may have to toughen its message in order
to convince more lenient donors - such as Spain and the IADB
- that Honduras is unwilling to take needed measures to help
its economy stabilize in the long term. Garza, too, said the
IADB should do its own thorough macroeconomic assessment. We
share his concern that the IADB will attempt to bend the
rules in order to continue providing budget support as the
IMF program fails. End Comment.
HENSHAW