US embassy cable - 02TEGUCIGALPA2494

Honduras Asks for Help on Paris Club and HIPC

Identifier: 02TEGUCIGALPA2494
Wikileaks: View 02TEGUCIGALPA2494 at
Origin: Embassy Tegucigalpa
Created: 2002-09-05 15:07:00
Redacted: This cable was not redacted by Wikileaks.
This record is a partial extract of the original cable. The full text of the original cable is not available.

E.O. 12958: N/A 
SUBJECT: Honduras Asks for Help on Paris Club and HIPC 
1. (U) Summary and Action Request.  The Honduran government 
has requested support of the USG (and other donors) to 
extend to June 2003 in its Paris Club debt service deferral 
and changes in the methodology used for HIPC and Paris Club 
debt relief and funding of the GOH's Poverty Reduction 
Strategy.  Washington agencies are requested to provide 
guidance for a response.  End Summary and Action Request. 
2. (U) In an August 5 letter signed by the Minister of the 
Presidency, the Minister of Finance and the President of the 
Central Bank, the Honduran government updated the 
international donor community Ambassadors on the actions 
taken by the Maduro administration to date to improve 
government finances and meet conditionality of its Poverty 
Reduction and Growth Facility program with the IMF.  In the 
letter, the Ministers indicated that after analyzing the 
implications of the deterioration in government finances in 
2001 and the miscalculations in the Flores government's 2002 
budget, the GOH took a number of steps designed to improve 
tax collection, reduce public spending and make the 
government more efficient.  In the letter, the GOH 
emphasizes that it will continue to work towards fiscal 
responsibility and seeks to negotiate a new three-year 
agreement with the IMF in October. 
3. (SBU) The letter included an attachment outlining some of 
the difficulties the GOH has encountered in meeting the 
obligations in its Poverty Reduction Strategy Paper (PRS) 
and the HIPC debt relief requirements.  The attachment ends 
with an appeal to the donor countries to support the GOH's 
requests for Paris Club debt service deferral through June 
2003, for lowering the amount of debt relief assigned to pay 
for poverty reduction projects, and for its efforts to reach 
an agreement with the IMF on a new three-year PRGF program 
by the end of 2002.  An informal translation of the letter 
is provided in para 5.  An informal translation of the 
lengthy attachment on the Poverty Reduction Strategy is 
provided in para 5. 
4. (U) Begin informal translation of August 5 letter. 
Dear Ambassador Almaguer, 
The purpose of the following letter is to make you aware of 
the actions that the Government of Honduras, under the 
Maduro administration, has taken during 2002 to stabilize 
Honduras' medium-term macroeconomic outlook in light of 
serious public finance problems. 
As the IMF confirmed during its visit in May 2002, public 
finances significantly deteriorated in 2001 leading to 
Honduras' non-fulfillment in December 2001 of the 
macroeconomic targets that had been agreed by the IMF and 
the previous Honduran government.  The central government 
deficit was six percent of GDP in 2001, while the 
consolidated public sector debt was three percent.  These 
deviations resulted in an unexpected situation for the new 
government, especially since the close relationship between 
the IMF and the previous government until the end of 2001 
had raised expectations that Honduras' fiscal situation was 
within the norms established under the IMF agreement.  This 
situation severely limited our capacity to act over the last 
To complicate matters, the previous government's budget for 
2002, which was approved by the National Congress in 
December 2001, did not include important spending 
obligations and overestimated projected income for 2002 by 
about 1.5 percent of GDP.  Our belief that there were 
miscalculations was confirmed by the marked difference 
between actual and projected tax collections. 
Conscious that this situation was totally unsustainable and 
with the intention of orienting the country towards a medium 
and long-term vision of fiscal stability, the Honduran 
government implemented and is in the process of implementing 
a number of corrective measures, including: 
-- Issuing Executive Decree PCM-005-2002 which contains a 
series of austerity measures to reduce public spending and 
save the government an approximately usd 12.3 million in 
-- Passage in Congress of the Financial Stabilization Law 
which expands the tax base, reduces tax exemptions, 
contemplates sanctions for tax evasion (including the 
temporary closure of business), reduces import taxes to 
discourage contraband, harmonizes tariffs with the rest of 
the region and simplifies payment procedures for tax payers. 
Unfortunately, prolonged development of the law and 
discussion in the National Congress caused its 
implementation to be delayed until July, thus delaying 
improvement in tax receipts before then. 
-- After a long and difficult negotiation, the Honduran 
government agreed to phase-in increases, over a four-year 
period, in public school teacher salaries that were due in 
2002.  Beginning in 2006, new salary increases will be 
granted based on increases in the minimum wage.  This 
agreement will help reduce steep annual salary increases for 
public school teachers and will allow the discussion of 
teacher's salaries to be included in the government's 
unified salary policy in 2006. 
-- In July 2002, Honduran authorities began closing 
businesses (note: temporarily) that were not paying sales 
tax.  This is the first time that businesses have been 
closed for sales tax evasion and we hope this measure will 
help instill a culture of honoring tax commitments in 
-- In the second half of 2002, the Honduran government will 
begin implementing new administrative procedures to improve 
tax collection.  We will also conduct a study to re-engineer 
the public sector.  The results of the study will allow for 
greater efficiency and quality of service in the public 
sector and at the same time reduce its size. 
-- We will soon submit to the National Congress a modern and 
equitable Income Tax Law that will complement the expansion 
of the tax base and the administrative simplification 
process.  We will also review the Tax Code. 
-- The Ministry of Finance presented to the National 
Congress for consideration a report on budget performance 
for 2001 and the first six months of 2002.  The revised 
budget was also published in the two Honduran daily 
newspapers with the highest circulation. 
-- A new budget formulation policy was designed for 2003, 
consistent with the IMF's budget transparency code, which 
will eliminate global expenditures (note: large budget line 
items which previously were left to the discretion of the 
Honduran president to assign to different ministries). 
-- By December 2002, a comprehensive, coherent and 
consistent civil service reform law will be submitted to the 
National Congress. 
To complement the government's fiscal measures, the 
government has made progress in other important areas to 
create an environment that encourages economic growth, 
-- The Honduran government has improved its institutional 
framework by proposing to create the Supreme Accounts 
Tribunal, instituting a new selection process for Supreme 
Court Justices, implementing the new Criminal Procedures 
Code, making government procurement more efficient and 
transparent, transferring management of government 
procurement to organizations like the United Nations 
Development Program and the World Food Program, who are 
improving prices and reducing the potential for corruption, 
and working with the Anti-Corruption Commission. 
-- With the help of the World Bank and the IDB, the 
government is committed to increasing private sector 
participation in public services and infrastructure projects 
and has begun the public bid process for a new cellular 
system contract, selected port services, national mail 
service and electricity distribution. 
-- The Poverty Reduction Fund Law was approved and 
legislative reforms to strengthen the financial system are 
close to being approved in the National Congress. 
-- The Central Bank of Honduras has instituted open market 
operations to orient the market towards an interest rate 
more consistent with the decreasing inflation rates 
experienced in recent years and obtain monetary base growth 
rate in line with the expectations of GDP growth for 2002. 
-- The recently approved Monetary Program for 2002 includes 
measures to eliminate during July and September the 
obligatory investments in government securities by financial 
institutions, equivalent to three percentage points of local 
currency obligations, and update the minimum capital 
requirements for financial institutions.  In conformity with 
the Monetary Transparency Code, an external audit of Central 
Bank operations was completed for the first time. 
-- Reforms to the Insurance Deposit Law have been introduced 
to the National Congress and immediate actions were taken to 
confront two longstanding bank insolvency problems.  Assets 
and deposits were also transferred from one problematic bank 
to a stable institution.  Technical assistance has been 
solicited from the World Bank to help the Deposit Insurance 
Institution value the two intervened banks and formulate a 
strategy for their sale over the next year.  In the short- 
term, the IMF and the World Bank will assist in an analysis 
of the financial system that will serve as the basis for 
further consolidation of the financial sector. 
-- Implementing regulations for the Securities Market Law 
have been issued to improve the functioning of Honduras' 
securities markets.  Technical assistance has been 
contracted with IDB funds to issue implementing regulations 
for the Insurance Law.  The Private Pension Fund Law will be 
discussed soon in the National Congress. 
-- A program will begin in September with IDB funds to 
improve the technical capacity of bank auditors in the 
National Banking and Insurance Commission.  Basic and 
advanced CAMEL training for Banking Commission officials, 
with assistance from the IMF's resident advisor in the 
Banking Commission, is also underway. 
-- The National Competitiveness Council, under the 
leadership of the Vice President, was created to encourage 
private investment in sectors that have the greatest 
potential to generate economic growth. 
-- By the end of 2002, a project will be underway to 
restructure the different institutions in the public sector 
and reduce duplicative functions by government agencies, 
eliminate excess jobs and in general terms improve the 
provision of services by the public sector to guarantee 
efficiency and efficacy in the assignment of financial 
resources, public spending and better service to the public. 
Before beginning this project, measures will be taken by the 
end of the year to reduce the size of the public sector. 
The measures described above clearly demonstrate that the 
Honduran government is committed to fulfilling its medium 
and long-term macroeconomic goals by maintaining balanced 
public finances, creating an environment to achieve high and 
sustainable economic growth necessary to reduce poverty, 
improving the efficiency and quality of public spending, 
widening the coverage and reach of programs to reduce 
poverty and social spending, eliminating the domestic 
financing needs of the public sector and maintaining a 
monetary and exchange rate policy in accord with the 
requirements of economic growth and competitiveness for the 
productive sectors. 
The Honduran government presented to the IMF a proposal to 
establish a joint work plan for the rest of 2002: 
-- The Honduran government reiterates its commitment to 
continue coordinating and working with the IMF in 
preparation for negotiations by October 2002 of a new three- 
year program beginning in 2003. 
-- The Honduran government confirms its decision to define 
achievable goals within a reasonable timeframe to reduce the 
public wage bill as a percentage of the GDP. 
-- The Honduran government is committed to take additional 
measures to strengthen tax collection, either through 
technical assistance by hiring auditing firms and/or 
reducing public spending, to achieve a non-inflationary and 
sustainable deficit with foreign resources available at 
concessional rates. 
We hope that the IMF, international donors and other 
multilateral institutions accompany the Honduran government 
down this difficult road.  We are convinced that maintaining 
a balanced budget is fundamental to achieving equitable 
economic growth, reducing inflation and generating resources 
to combat poverty. 
Recognizing that it is important that international 
bilateral donors and multilateral institutions are informed 
about Honduras' current fiscal situation and the actions the 
Honduran government has taken and will take to resolve the 
fiscal situation, attached are copies of the reformulated 
2002 budget, a document reiterating the Honduran 
government's medium-term fiscal goals and a detailed 
analysis of the current fiscal situation. 
End informal translation of letter. 
5. (SBU) Begin Informal Translation of Attachment. 
A crucially important element for any country is to have a 
clear vision of its medium and long term goals, along with a 
strategy for the design and implementation of the means and 
actions that will allow the country to gradually close the 
gap between the current situation and the long-term vision. 
In this sense, in 2001, the Government of the Republic of 
Honduras developed the Poverty Reduction Strategy (PRS) 
which represents in and of itself both a commitment and a 
shared effort between the Government and Honduran society. 
At the same time, this strategy will serve as a general 
framework so that the country promotes investment in 
projects that are oriented towards the goal of reducing 
In this regard, a concern of the current administration is 
maintaining a macro-economic environment that promotes a 
sustainable economic growth.  Macroeconomic stability is one 
of the fundamental pillars of the strategy, without it, the 
country will not be able to generate the necessary funds to 
implement the priority investments defined within the 
framework of the PRS. 
We should note that the main premises that make up the PRS 
are sustained economic growth, with equity, macroeconomic 
stability, and sustainable government finances. 
Within this conceptual framework, we present the medium and 
long-term vision of the non-financial public sector (NFPS), 
an analysis of the current situation in order to determine 
the existing gap between the two situations, and the fiscal 
policy measures that the current Government will implement 
to close that gap and provide the optimal fiscal framework 
to sustain the PRS. 
Medium and long-term vision (plan) for the non-financial 
public sector 
To achieve the necessary conditions to reduce poverty, the 
plan that the non-financial public sector needs to have 
centers on four primary aspects: 
a) Maintain balanced public finances in order to avoid 
inflationary pressures and reduce market distortions, thus 
guaranteeing the growth of a more solid private sector. 
b) Generate the necessary financial resources to carry out 
the programs designed to reduce poverty and social costs, as 
delineated within the Poverty Reduction Strategy. 
c) Improve the efficiency and quality of public spending, 
increasing the extent and reach of the programs designed for 
social sectors. 
d) Reduce the amount of public financing using domestic 
resources as much as possible to guarantee that the private 
sector will have funds available to finance its productive 
activities and generate economic growth and employment. 
This plan is based on the principle that the primary 
generator of economic growth should be the private sector 
and the role of the public sector should be focused on 
social activities with the goal of poverty reduction, 
establishing a regulatory framework for the development of 
the private sector and maintaining the macro economic 
stability of the country. 
Nevertheless, we need to keep in mind the fact that the non- 
financial public sector is made up of diverse players which 
we can group as: central government, social security 
institutes, government owned companies and municipalities; 
each one of these should define their own objectives so that 
they may accomplish the goals set out in the global plan. 
Central Government 
The objectives of the central government should be: 
a.  Finance the deficit solely with foreign assistance 
available at concessional terms to assure the availability 
of domestic resources to meet the needs of the private 
b. Increase savings in the current account to raise the 
funds required for the execution of infrastructure and 
social benefits programs. 
c.  Control the growth of salaries in administrative 
positions and functions that have no positive impact on the 
delivery of services to social sectors.  This group has had 
the most pressing impact on government spending in recent 
years.  In this way coverage of services can be amplified 
without provoking inequality in public financing. 
Social Institutes 
The objectives that social institutes should set according 
to the established plan are: 
a.  Continue generating a surplus of 1.5 to 2% of GDP 
Public Companies 
a.  Public companies should generate surpluses of 0.5 to 1% 
of GDP 
b.  Establish competitive tariffs for services to citizens, 
using existing tariffs in other countries in the region as 
an example. 
c.  Improve and expand service coverage. 
d.  Control spending growth, especially related to salaries 
and payrolls. 
Taking into consideration that the process of 
decentralization will put municipalities into a more 
preponderant role in the country's destiny.  Based on the 
experiences of other countries in similar situations, 
municipalities should work from a balanced budget in such a 
way as the total expenditures are entirely financed by the 
municipalities own income plus transfers received from the 
central government. 
Expected Results 
The results expected upon completion of the outlined 
a. Reach a consolidated net deficit for the non-financial 
public sector of 0.0% GDP. 
b. The net deficit of the central government should be no 
more than 2% of GDP 
c.  Finance the central government deficit entirely with 
available concessional foreign funding 
d.  The rest of the non-financial public sector should 
generate a surplus equal to 2% of GDP. 
e.  Reach annual inflation levels of 2 to 3% 
f.  Generate real economic growth no less than 5% per year 
g.  Maintain stability in the monetary exchange market, 
guaranteeing the Lempira maintains its competitiveness. 
h.  Generate a substantial reduction in extreme poverty, 
keeping with the goals and indicators as defined in the 
Poverty Reduction Strategy. 
Actual Situation and estimates for 2003-2007 
In order to determine the need to take measures aimed at 
achieving the objectives set out in the plan of the Poverty 
Reduction Strategy, an analysis of the current situation is 
presented which shows the different parts 
Central Government 
At the central government level, we have seen a decrease in 
income through 2001, falling from 19.4% of GDP in 1999 to 
18.2% of GDP in 2001.  For this reason, the government 
presented to Congress the Financial Stabilization and Social 
Protection law.  It is hoped these measures will increase 
income to the Central Government to 20.2% in 2002.  After 
2002, income will remain relatively stable with revenues 
reaching 20.1% of GDP in 2007. 
On the expenditure side, there has been marked growth in the 
last few years, reaching 25.6% of GDP in 2001 and an 
estimated 27.2% of GDP for 2002. 
The main source of spending growth is the public sector wage 
bill which has grown consistently in the last four years 
reaching 10.5% of GDP in 2002.  Due to this fact and since 
the projections have been elaborated under the assumption of 
salary adjustments based solely on inflation, for 2007 we 
won't have reached sustainable salary and payroll levels 
related to GDP (less than 9%.) 
As a result of these tendencies in income and spending, it 
is estimated that the central Government could meet its 
objectives congruently with the public sector plan presented 
earlier and with the fundamental principles of the Poverty 
Reduction Strategy up to 2005, at which time the central 
Government would generate a savings in their current account 
equal to 1.3% of GDP and a net deficit of 1.6%. 
Additionally, it should be taken into consideration that for 
the years 2003-2005 the projections indicate that the 
central government will have to refinance the deficit by 
emitting bonds (though this is not congruent with the 
objective of reducing the crowding out of the private sector 
and maintaining inflation at low levels) or by requesting 
new external loans. 
According to these projections, the country will be counting 
on money inflows on the order of $230 million yearly, a 
figure the World Bank has established as adequate to 
maintain a reasonable level of indebtedness for the country. 
Therefore, financing this gap by additional external loans 
could generate problems in the ability to sustain the 
foreign debt. 
Remainder of the non-financial public sector 
In the rest of the non-financial public sector we see a 
definite tendency towards a decline in income, after 
reaching 14.5% of GDP in 1999 to an estimated 12.3% of GDP 
in 2007.  This behavior stems from the continued 
deterioration of incomes from the most important public 
enterprises without any adjustment to the prices of their 
This factor has been partially compensated by a declining 
trend in expenditures by public enterprises, principally due 
to the lack of investment; but after 2002, expenditures are 
expected to increase considerably due to planned investments 
in HONDUTEL and SANAA. In spite of being necessary for 
modernizing and improving customer service this investment 
had been postponed in previous years. 
In terms of surplus, we see that the rest of the non- 
financial public sector could present a surplus of around 2% 
of GDP, established as a goal of the PRS, until 2006.  This 
surplus has shown a downward trend since 2000.  This trend 
will continue until 2003, when the trend will reach the 
point of inflection and turn towards moderate stability. 
Overall, the decreases in revenue by the rest of the NFPS 
will not be compensated by the revenues to the Central 
Government, resulting in declining revenues for the 
consolidated NFPS.  Simultaneously, the expenses for the 
rest of the NFPS, as for the Central Government, show a 
downward trend; but not sufficient to counteract the drop in 
revenues.  The NFPS is expected to be in deficit for 2001- 
2005.  By 2005, the NFPS should reach its goal of a balanced 
financial account.  (Chart shows deficit beginning late 
2000, dipping and bottoming out in 2001 to 2003 then 
reducing the deficit to zero in 2005 and then a surplus 
after that. 
From our analysis, it is evident that the measures taken 
during the course of the current year are insufficient to 
generate the conditions of fiscal sustainability required to 
achieve the objectives of the Poverty Reduction Strategy. 
Some of the most relevant factors that the Honduran 
Government face are the salary pressures generated by the 
Medical Statute and Teachers Statute (Congressional statutes 
requiring exorbitant salary levels for doctors and 
teachers).  These factors have contributed significantly to 
the constant increase in spending in the last few years.  It 
is also necessary to strengthen the tributary administration 
by reducing fiscal evasion and creating a plan for a 
reversal of the downward trend in income for the rest of the 
Taking the necessary measures to confront the difficult 
fiscal situation that faces the country is an undeniable 
fact, especially if we consider the deviation between the 
projections presented in this document and the macro- 
economic framework of the Poverty Reduction Strategy. 
             Comparative Table of the Deviations 
                   with respect to the PRS 
              Deficit of the NFPS as a % of GDP 
     Year      Projections    PRS       Deviation 
     1999           0.6        1.5       -0.9 
     2000           0.1         1        -0.9 
     2001          (2.6)      (0.8)      (1.8) 
     2002          (2.5)      (0.6)      (1.9) 
     2003          (2.5)      (1.9)      (0.6) 
     2004          (1.7)      (0.7)      (1.0) 
     2005          (0.2)      (0.3)       0.1 
Note: Positive numbers represent a surplus and negative 
number represent a deficit. 
Complementary measures in the implementation process 
In order to correct the deviations and close the existing 
gap between the current fiscal situation and the medium-term 
plan presented, the current Honduran Government has 
identified additional methods for the short term in the 
following areas: 
    Measures for strengthening tax revenue 
    Reengineering Government Program 
    Additional revenue enhancement measures 
Means of strengthening tax revenue 
In this area, the Honduran Government will emphasize the 
enlargement of the tax base by exchanging information with 
municipalities, large contributors and Ministries and 
Decentralized Institutions.  Also, the government will 
conduct prompt audits to detect businesses that are not 
registered (additionally eliminating the penalties for not 
registering) and businesses that fail to pay taxes, and to 
take steps that will instill a new tax-paying culture in the 
country.  The recent initiative of closing businesses that 
evade paying sales taxes is a clear example of this. 
Additionally, we will be receiving technical assistance and 
initiating a program of external audits to complement these 
measures to combat tax evasion. 
As a complement to the actions leading to the expansion of 
the contributor base, we will be submitting an equitable and 
modern Income Tax Law to the National Congress for approval, 
emphasizing tax simplification as well as the transformation 
from a Sales Tax to a Value Added Tax effective 2004, 
consistent with the best tax practices worldwide. 
Additionally, the DEI (note: Honduran tax authority) will be 
restructured in order to strengthen the tax administration 
and make it more efficient.  The DEI will be restructured 
according to type of taxpayer, consolidating administrative 
functions and clearly defining collection operations for 
small businesses.  To complement this, new automated systems 
for information exchange and the administration of the 
taxpayer accounts are being established. 
Reengineering Program 
The objectives of the government-reengineering program are: 
    Evaluate the composition of the quality and technical 
  capacity of government personnel to determine a uniform 
  evaluation and position classification system with 
  respective requirements for qualification. 
    Identify the processes and procedures employed in the 
  performance of duties and provision of services and 
  improvements needed to increase quality and efficiency. 
    Define and implement plans to reduce and rationalize 
  each agency's funding. 
    Complete an institutional restructuring that will allow 
  for a reduction in the number of agencies that comprise up 
  the Public Sector and modernize their functions. 
We have elaborated the terms of reference and budget for the 
re-engineering project.  With the support of the World Bank, 
we will solicit an international bid in the near future, 
with progress expected by the end of the year. As a 
preliminary step, we have identified the necessity to reduce 
by 21% (equivalent to 5,000 jobs) the number of governmental 
administrative positions. 
Additional revenue measures 
In addition, the Government will be designing a set of 
measures designed to improve tax collection that will be put 
into effect in January 2003. 
Required support 
With everything shown here, it can bee seen that Honduras 
has advanced considerably in its objective to achieve fiscal 
sustainability and the medium-term plan for the public 
sector, through the design and implementation of measures 
for improvement of tax collection, modernizing spending and 
improving the efficiency and effectiveness of public 
It is worth noting that the current Government is aware of 
the need for a civil service framework law, which is why it 
maintained a firm position during the negotiations with the 
teachers.  The government expects similar pressures from 
other unionized groups in the Public Sector will arise 
(Social Security and HONDUTEL).  Facing this, the Honduran 
Government considers reducing the expectations the other 
labor groups have in regards to salary increases to be a 
fundamental step.  Similarly, we have initiated the process 
of drafting a Civil Service Framework Law, for presentation 
to the National Congress.  This law will emphasize 
compensation systems based on inflation and efficiency. 
To reach the medium and long-term plan for public finances 
and in order to achieve the objectives established in the 
Poverty Reduction Strategy, the Honduran Government requests 
the support of its allies and multilateral organizations in 
the following ways: 
  1.   Receive an extension on Paris Club debt deferral until 
     June 2003, at which time we hope to reach the HIPC 
     completion point. 
  2.   Allow the traditional relief received from the Paris 
     Club to be used for budgetary relief, as has been done since 
     1991 when the framework was negotiated in the Paris Club for 
     the first time, and that the debt relief received under the 
     HIPC initiative be used to finance projects in the Poverty 
     Reduction Strategy. 
  3.   Include the costs that the government incurs in 
     increasing the coverage of services in the areas of health, 
     education and security as part of the expenses to be 
     financed with HIPC relief funds for a three-year period, 
     after which they will become a part of the normal expenses 
     anticipated by the Government and financed with domestic 
  4.   Support the efforts of the Honduran Government to 
     improve its public finances and achieve a three-year 
     agreement with the International Monetary Fund by the end of 
     this year. 
End informal translation of attachment. 

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