TFH01: INVESTMENT MANAGER SAYS HONDURAS IS

C O N F I D E N T I A L TEGUCIGALPA 001155 SIPDIS E.O. 12958: DECL: 11/12/2019 TAGS: ECON EFIN PGOV PREL KDEM PHUM EAID HO UK TFH01 SUBJECT: TFH01: INVESTMENT MANAGER SAYS HONDURAS IS CONSIDERING ISSUING EXTERNAL BOND Classified By: AMBASSADOR HUGO LLORENS FOR REASONS 1.4 B AND D. ¶1. (C) Summary: A representative of the British investment management company Ashmore Investment Management Ltd. told the Economic Counselor that his company is considering issuing the de facto regime a $100 million bridge loan, which would be tied to the issuance of a USD 500 million dollar-denominated bond by the new government after it takes office on January 27. The representative noted that his company would be taking a risk in issuing the bridge loan, since issuance of the bond will only be possible if the new government is able to reestablish a relationship with the International Monetary Fund (IMF). This potential bond issuance is unwise and unnecessary in our view, since if the new government is recognized by the IMF it will have access to concessional lending. End summary. ¶2. (C) The Economic Counselor met on October 28 with Jan Dehn, an investment manager at Ashmore Investment Management Ltd., a British company that specializes in emerging markets. Dehn said that he was in Honduras on an exploratory visit to assess the possibility of working with the government to issue an external U.S. dollar-denominated bond. He said that he had already met with the de facto Central Bank governor and hoped to meet with de facto president Micheletti and the major political candidates as well as the IMF representative, members of the banking community, and others. ¶3. (C) According to Dehn, the Honduran de facto government decided to explore the idea of diversifying funding sources after international financial institutions cut off their lending following the June 28 coup. (Honduras has no existing external bonds.) Dehn noted that many developing countries are making similar decisions because interest rates on external bonds are at a historic low. Many countries are able to borrow at a rate of 6%, and even a country as unstable as Sri Lanka recently issued a bond at 7.5%. Dehn said that the amount of the bond, if issued, would most likely be USD 500 million, the minimum amount for listing on the Emerging Markets Bond Index (EMBI). ¶4. (C) Dehn said that Honduras would not be able to issue the bond until it renewed its relationship with the International Monetary Fund (IMF) and other international lenders. If it appeared that the bond issuance was going to go forward, Ashmore would make an initial one-year bridge loan of USD 100 million, which would be reinvested in the bond when it was issued. With the bridge loan, the government would pay off domestic debt it has incurred in the absence of lending from the IMF and other international lenders, which suspended relations with Honduras following the June 28 coup. According to Dehn, the de facto regime is currently paying 10 percent interest on its domestic debt. (Note: According to Standard and Poor's, public sector debt service from September to the end of 2009 is estimated at about USD 50 million, of which USD 32 million is principle payments. Total debt service for 2010 is estimated at USD 100 million, including USD 60 million in principle payments. Standard and Poor's estimates that the government will be able to meet its debt obligations through 2009, but believes that the absence of access to lending by international financial institutions over a longer period would have a negative impact on the economy. Micheletti stated on November 12 that the government could hold out until March 2010 without external assistance. End note.) ¶5. (C) The bridge loan, according to Dehn, presents two major risks for his company: that the crisis will continue after the November elections and the new government will not reestablish relations with the IMF, or that the new government will establish relations with the IMF but fail to reach an agreement on a program due to differences over macroeconomic policy issues. In either of these situations, Dehn said, repayment of commercial debt would be a relatively low priority for the government. Dehn also expressed concern that a new government could refuse to acknowledge debt incurred by the de facto regime. ¶6. (C) Dehn said that, aside from the political situation, he has no serious concerns about Honduras from a macroeconomic perspective. He said that the government has adequate reserves and a low level of overall debt. (Comment: The low debt level is the result of debt forgiveness in 2006 under the Heavily Indebted Poor Countries (HIPC) initiative. End comment.) He noted that the current fiscal position is poor but said that it would not be difficult for the new government to make improvements by either cutting spending or creating growth by shifting spending from recurring costs to investment in infrastructure or other areas. ¶7. (C) While Dehn believes that the Lempira is overvalued by about 20%, he does not see this as a matter of serious concern. He pointed out that governments in countries that are about to hold presidential elections are typically reluctant to devalue, since devaluations and the price rises that accompany them are politically unpopular. He believes that the government will devalue the Lempira following the election, using its existing authority to adjust the currency for inflation. (Note: The government has the authority to adjust the exchange rate within a band of plus or minus seven percent per year per year in order to accommodate inflation differentials, but has kept the Lempira fixed against the dollar since 2005 at a rate of 18.9 to 1. With inflation in Honduras consistently higher than in the U.S., the exchange rate is increasingly misaligned. End note.) ¶8. (C) Dehn asked the Economic Counselor for her assessment of the political situation and its impact on the investment climate. EconCouns said that a political settlement agreed to by the Zelaya government, the Micheletti regime, and the leading presidential candidates represents the best way forward. Such a settlement would not only ensure stability but also substantially increase the likelihood that the new government would recognize debts and other obligations incurred by the de facto regime. In the absence of such a settlement, she said, investors are operating in an atmosphere of considerable uncertainty. ¶9. (C) Comment: As Dehn noted, it would be the new government, rather than the de facto regime, that would issue the proposed external bond. From our perspective, this would be a mistake. Honduras benefited from debt relief under the HIPC initiative, but the Zelaya government squandered the opportunities the debt relief brought. The government failed to invest in infrastructure and other growth-oriented programs and instead increased salaries for public servants, who were already relatively highly paid. New commercial debt in the absence of a comprehensive framework is unlikely to achieve positive results. In adition, acquiring significant new dollar-denominate debt could make the government more reluctant t devalue the Lempira. Without a devaluation, Honduras's exports will become less competitive and a disorderly devaluation may eventually occur. Assuming international recognition of the elections, the only circumstance in which the bond would be issued, the new government would be better advised to obtain concessional lending from international financial institutions as part of a comprehensive program. It may be that, in discussing the potential bond with Ashmore, the cash-strapped de facto regime is motivated primarily by the prospect of the USD 100 million bridge loan. LLORENS