US embassy cable - 03TEGUCIGALPA2648

UNCLAS SECTION 01 OF 03 TEGUCIGALPA 002648 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR WHA/CEN, WHA/EPSC, DRL/IL, EB/IFD/OMA, INR 
STATE PASS AID FOR LAC/CEN 
STATE PASS USTR FOR BRETT MAKENS 
TREASURY FOR E. ILZETSKI 
DOL FOR ILAB 
 
E.O. 12958: N/A 
TAGS: EFIN, ECON, PGOV, EAID, ETRD, ELAB, EAGR, PINR, HO 
SUBJECT: IMF TEAM RETURNING TO HONDURAS TO NEGOTIATE A 
LETTER OF INTENT THIS MONTH 
 
REF: TEGUCIGALPA 2034 
 
1. (SBU) Summary.  An October IMF mission visit to Honduras 
found enough progress and high-level commitment to agree to 
return in November for the negotiation of a Letter of Intent 
(LOI) for a Poverty Reduction and Growth Facility (PRGF) 
program.   The government hopes to be able to push 
legislative measures through Congress that would address all 
prior actions identified in the LOI, by the end of November. 
The IMF staff showed flexibility in this visit, loosening up 
a bit on the fiscal targets of the budget deficit and the 
staged-in decline in the wage bill.  The GOH and IMF staff 
both envision that the program will also require new tax 
measures, particularly elimination of additional exemptions. 
This extremely ambitious schedule is a recognition by all 
parties of the limited political window of opportunity for 
reaching an agreement.   One of the danger signs is that the 
GOH will need substantially higher levels of foreign 
assistance from donors in the next three years in order to 
meet these fiscal targets and still meet its commitments to 
poverty reduction spending.  As the director of the IMF 
mission told the donors before departing, however, "there are 
dangers on all sides."  End Summary. 
 
2. (SBU) At the GOH's request, an IMF mission led by 
Assistant Director of the Western Hemisphere Department 
Adrienne Cheasty and mission chief Mario Garza held 
productive consultations with the GOH in Honduras on October 
13-23 on the current fiscal situation and prospects for a 
three-year PRGF program.  Cheasty indicated to the G-15 
donors group, before the mission's departure, that the GOH 
had shown enough commitment to addressing the structural 
fiscal problems, that they were willing to recommend a return 
mission in November to negotiate a letter of intent (LOI). 
Note: Post now understands that the mission is scheduled to 
return during the week of November 10 to begin negotiations 
in earnest.  End Note. The GOH has indicated its strong 
determination to reach agreement with the mission on the LOI 
quickly, and to achieve rapid legislative approval of laws 
required as prior conditions in the LOI, by the closing of 
the legislative session at the end of November.  That would 
free up the GOH to adopt the 2004 budget during its 
traditional "extraordinary" session in December.  While this 
represents an extremely ambitious schedule, all sides are 
trying to make it work in recognition of the limited 
political window of opportunity for reaching an agreement. 
In 2004, the GOH expects its ability to push through tough 
legislative measures to diminish rapidly.  In addition, the 
fiscal situation is deteriorating with non-inflationary 
sources of deficit financing rapidly drying up and the GOH 
needs an agreement to free up new sources of financing and 
debt relief. 
 
3. (SBU) The IMF mission described the baseline fiscal 
situation as fairly bleak.  The Central government's deficit 
is expected to reach 5.5 percent of GDP in 2003, or 2 percent 
higher than the GOH's target (although the GOH would argue 
that it is really just 1 percentage point higher than the 
target and that the IMF is not correct in charging the full 
cost of the agricultural loan debt forgiveness program to the 
year 2003, as the costs will be spread out over ten years). 
Other contributing factors to the higher deficit are: the 
high public wage bill (10.6 percent of GDP vs. the 10.0 
percent target), because administrative measures were not 
successful in compensating for the rising teacher and medical 
employees' salaries; cost of transferring a troubled 
state-owned bank to private Banpais (covering its liabilities 
with bonds); and a large shortfall in the revenues projected 
to come from the tax measures that were adopted in May 2003. 
The GOH is financing this greater than expected deficit by 
drawing on foreign reserves and issuing bonds.  Net reserves 
in the Central Bank declined by more than USD 100 million in 
the first nine months of the year. 
 
4. (SBU) For 2004, if the government takes no new measures, 
the deficit will be approximately 4.4 percent of GDP.  The 
IMF staff is even more concerned about prospects for 2005 and 
2006, as the projections for increased social spending rise 
necessarily (to meet poverty reduction targets) and available 
non-inflationary deficit financing decline. 
 
The Outlines of a Program 
------------------------- 
 
5. (SBU) The IMF (very tentatively and not yet negotiated 
with the GOH) plans deficit targets of 3.5 percent in 2004, 
2.5 percent in 2005 and 2.0 percent in 2006.  They 
acknowledged that this is somewhat faster than would usually 
be sought for a country with such great poverty reduction 
needs, but indicated that it is necessary because of the 
limited non-inflationary financing available.  The Fund asks 
bilateral and multilateral donors to look for possibilities 
of additional donations that would help the government 
maintain social spending.  Very tentatively, and even with 
expenditure and revenue measures, the Fund staff estimates 
the GOH will need USD 120 million in new funding in 2005 and 
USD 175 million in new funding in 2006. 
 
6.  (SBU) Note:  Because the burgeoning wage bill has been 
one of the main reasons for the structural fiscal deficits, 
the IMF staff plan to require, as a prior action, the 
enactment of legislation that provides the executive branch 
with control over wage policy and that begins to reduce the 
wage bill as a percent of GDP. End Note. 
 
7.  (SBU) The IMF is no longer requiring this percentage to 
decline by one percentage point a year, perhaps as 
recognition of the political constraints in reopening the 
wage agreement with the teachers that would be the only 
practical way of achieving this reduction.   Both the Finance 
Minister and IMF Resident Representative indicate that the 
two sides are now in agreement on the text of the wage 
legislation, which will grant the executive branch wage 
policy control and will also freeze the collateral benefits 
that are provided to teachers and doctors (in the special 
statutes governing these professions). 
 
8. (SBU) To compensate for the shortfall in revenues coming 
from the May 2003 tax package, adopted in May 2003, the GOH 
is considering a sizable increase in the taxes on gasoline 
and diesel.  Other potential measures, such as an increase in 
the sales tax or elimination of popular tax exemptions like 
the exemption on residential electricity, have been ruled out 
so far by President Maduro and his inner circle on political 
grounds.  The GOH believes that this gas tax hike, along with 
the freezing of the teacher collateral benefits, will provide 
the needed revenue to make up the potential shortfall in 2004 
between the baseline budget deficit (4.4 percent) and the 
expected target of 3.5 percent. 
 
9. (SBU) The program will also require the elimination of 
exemptions provided to the wealthy and to many companies. 
The government is likely to do this in the context of 
adoption of legislation enacting the key measures from the 
Fiscal Pact recently signed in the context of the National 
Dialogue among the government, private sector and civil 
society.  Congress President Pepe Lobo has announced his 
intentions to push for enactment of this legislation starting 
in January 2004. 
 
10. (SBU) In the financial sector, the program will require 
the GOH to raise requirements for provisioning for bad loans, 
in accordance with Basel standards.  The IMF resident rep 
indicated that this might also be made a prior condition in 
the Letter of Intent.  In addition, the IMF will require the 
government to make changes to Central Bank operations to 
reduce losses incurred as part of the execution of monetary 
policy operations.  This was an issue identified in the 
Financial Sector review performed by a joint IMF-World Bank 
team early this year.   Finally, it appears the IMF staff is 
going to accept that no further changes to the agricultural 
credit law are politically/ legally possible at this point. 
 
Comment 
------- 
 
11. (SBU)  This may be the now-or-never point for President 
Maduro to reach an agreement with the Fund in his time in 
office, and the GOH seems to know it.  With the President's 
full engagement now, Post expects the GOH to do its best to 
use this window of opportunity.   The wage policy 
legislation, if adopted, will be a major, overdue milestone 
toward structural reform.  It will have to be closely 
followed, in early 2004 with the development of a 
professional civil service, legislation enacting the Fiscal 
Pact developed in the National Dialogue process (see septel) 
and elimination of a series of tax exemptions.   End Comment. 
Palmer