US embassy cable - 04SANTODOMINGO194

UNCLAS SECTION 01 OF 04 SANTO DOMINGO 000194 
 
SIPDIS 
 
SENSITIVE 
 
DEPT FOR WHA, WHA/CAR, WHA/PPSC, EB/OMA (WONG); 
TREASURY FOR DO:NLEE, RTOLOUI, LLAMONICA; PARIS FOR 
TREASURY ATTACHE 
 
E.O. 12958: N/A 
TAGS: EFIN, DR 
SUBJECT: DOMINICAN PROGRAM WITH IMF: HIGH HURDLES, 
UNCERTAIN PROSPECTS, WHILE COGENTRIX POSES A BIG OBSTACLE 
 
 
1.  (SBU) SUMMARY.  On January 7 Econoff and USAID Economist 
called on IMF ResRep Ousmene Mandeng (PLEASE PROTECT) to 
review current status of IMF proposed program.  The GODR has 
completed legislative action on budget items included as 
conditionalities and is close to complying with requirements 
for adjusting finances in the electricity sector.  By 
retaining the August target for monetary growth, the IMF is, 
for now, asking for a virtually unachievable reduction of the 
money supply by 14 percent.  The Central Bank Governor has 
explicitly restated the GODR policy of maintaining a free 
exchange market.  The program makes Paris Club refinancing a 
condition for the announcement of the agreement.  Various 
other conditionalities must be met before the program goes to 
the IMF board.  In sum, the program poses high hurdles and 
offers a holding action which may get the country through 
presidential elections with a dollop of IMF money and 
extensive lending from the IDB and World Bank. This strategy 
could be jeopardized if creditors call sovereign guarantees 
on COGENTRIX loans, blocking IDB lending.  END SUMMARY. 
 
2.  (SBU)  On January 7 Econoff and USAID Economist called on 
IMF ResRep Ousmene Mandeng (PLEASE PROTECT) to review current 
status of IMF proposed program.  The Fund and the GODR are 
finalizing the draft Letter of Intent (LOI), the Memorandum 
of Economic Policy (MOEP), and the Technical Memorandum of 
Understanding (TMOU). There are two sets of prior actions 
that must be implemented before any agreement is approved by 
the Fund Board. 
 
3. (SBU) The first set of prior actions consists of 
pre-conditions to the formal announcement of the LOI and the 
sending of the proposed program documents to the IMF Board 
for approval. There are five components in the first set of 
prior actions: 
 
a.    A budget approved by the Dominican Congress. This 
action has been completed. The final budget negotiations 
resulted in changes of DR pesos 530 million from the original 
budget. The changes, which were acceptable to the Fund 
increased funding for the Congress and NGOs. This increase 
was funded by cuts in pensions and transfer to 
Municipalities, plus a broadening of the range of household 
goods subject to excise taxes. The increased taxes would 
generate DR$170 million, while the balance of  DR pesos 360 
million 0 would come from the expenditure reductions 
mentioned above. 
 
b.    An Electricity Sector Plan to &keep the lights on8 
for the next six months. This plan, which must be approved by 
the World Bank, has three components: 
 
i) tariff increases which must be formally published; 
ii) development of a Statement of Electricity Development 
Policy (to be sent to the World Bank); and 
iii) a detailed cash flow analysis for the next six months 
that shows the electricity sector companies are breaking-even 
by July 2004. 
 
(Two of three requirements have been completed.  The 
electricity tariff increases have been agreed to and 
announced. The new pricing scheme maintains the current 
subsidized rate for those consuming 200 KWH per month, for 
those consuming 200-700 KWH/month the subsidy is maintained 
for the first 200 KWH and the rates are increased 4 pct/month 
for consumption between 200-700 KWH/month, while for those 
whose monthly consumption is more than 700 KWH the subsidy on 
the first 200 will be phased out and the current rate 
increased by 7-8 pct/month until June 2004. Concerning the 
second component, the Statement of Electricity Policy 
Development, this has been done and submitted to the World 
Bank in December 2003. The cash flow analysis has not been 
submitted to the IMF as of yet.) 
 
c.    Reduction in the monetary base. The money supply is 
growing too rapidly and the IMF wants the monetary base to be 
reduced from DR pesos 77 billion to the original August 
target of DR pesos 66 billion (14 percent). This would be an 
enormous challenge, and ResRep indicated that the IMF would 
evaluate this perfomance measure on the GODR's good faith 
efforts rather than on achievement of the actual target.  The 
monetary base has grown in part because the holders of 
government certificates were not renewing them as they 
matured. There are several reasons for this reluctance to 
purchase Central Bank issued certificates. One concern is the 
fact that they offer a negative rate of interest. The 
inflation rate at the end of the year was 42 pct while the 
certificates were yielding 32-34 pct. A second concern of 
certificate holders is whether the Central Bank can finance 
the current stock of debt. Many think that the Central Bank 
will be forced to extend the length of maturity of 
certificates held by investors from 7-91 days to several 
years (at present the great majority of the certificates have 
a maturity of 30 days or less). Given these problems, it 
would appear that it will be difficult for the GODR to meet 
this target in the next several weeks. 
 
d.    A freely operating exchange rate market.  In December 
the President announced the formation of a Commission to 
monitor the operations of the exchange houses. At the same 
time the President announced predetermined daily exchange 
rate reduction targets to reduce the exchange rate from 
around DR pesos 44 to DR pesos 30 for one U.S. dollar. The 
consequent actions resulted in a temporary reduction of the 
exchange rate to around DR pesos 34 to one U.S. dollar for 
several weeks. As a result of the government's actions, a 
foreign exchange black market appeared with the black market 
rate at around DR pesos 42 to one U.S. dollar. 
 
(On December 30  Central Bank Governor Jose Lois Malkun 
reportedly met principal actors in the exchange rate business 
and told them the GODR would no longer seek to control the 
exchange rate. The dollar began to appreciate. On January 7 
Lois Malkun told journalists, &The policy of the Central 
Bank is not to interfere in the exchange rate, which should 
be set by market forces.  If the dollar rises, let it rise as 
it may.8  The Central Bank posted a public notice in daily 
newspaper Listin Diario on January 8 stressing the GODR 
agreement with the IMF to maintain a free exchange rate and 
advising that projected rates used by analysts in drawing up 
a program were estimates, not mandatory target rates. The 
peso has depreciated from its December strong point of DR 
pesos 34 per dollar to approximately DR pesos 42 as of 
January 9. The black market is said to exist still for those 
in urgent need of large amounts of dollars at short notice 
and may take several weeks to disappear completely.) 
 
As a measure of performance for this issue the IMF is 
requesting that the Government publicly announce the 
elimination of the Commission monitoring the exchange houses. 
In addition the IMF has requested that the Commission on 
Financial Security be eliminated. This latter Commission has 
broad powers that could be used to impact the foreign 
exchange market.  (On January 8 the GODR published extensive 
regulations dated December 18 for the oversight of exchange 
operations.)  The ResRep left the impression that since 
bankers favor keeping this latter Commission to protect 
against credit card fraud and to halt rumors about the 
viability of banks within the country, the IMF might remove 
its objections to this Commission if it broad powers were 
curbed and clarified so as to eliminate the possibility it 
could be used to manipulate the exchange rate. 
 
e.    Financing assurances from the Paris Club. Paris Club 
refinancing is an essential element in the present proposed 
program. Without Paris Club refinancing the program is not 
viable. On January 14, the Paris Club will meet to consider 
the request for refinancing. The Paris Club must approve the 
request for refinancing and will consider the request to move 
the current cut-off date for refinancing from 1984 to the 
present or as close to the present as possible, so as to 
maximize the impact of the refinancing. 
 
4. (SBU) Once the above pre-conditions are satisfied, the IMF 
will be in a position to make an official announcement of the 
agreement and forward the program to the Board. Even so, the 
formal Board Review will be dependent on the GODR meeting a 
second set of conditions. These are: 
 
f.    The Systemic Risk Law must be passed and signed into 
law. This law would among other things address weaknesses in 
the legal framework for addressing banking crises.  (As of 
January 9 the Senate has passed this draft and it has gone to 
the Finance Committee of the House of Representatives.) 
 
Embassy does not have any information at this time on the 
progress toward further remaining conditions: 
 
g.    The Monetary Board must approve regulations for the 
establishment of a contingency fund. The contingency fund 
would be similar to the Federal Deposit Insurance Corporation 
in the U.S. 
 
h.    Establishment of a Lombard-style refinancing facility. 
This facility would allow commercial banks facing a liquidity 
problem to borrow from the Central Bank. It is meant to be a 
last-resort lending facility. To discourage banks from using 
it except in emergency situations, the interest rate charged 
by the Central Bank would be substantially above market rates. 
 
i.    Finalization of the Terms of Reference for 
establishment of a panel to evaluate the assets of the two 
electricity distribution companies that the GODR purchased 
from the Spanish company Union Fenosa. This is a follow-up to 
the recommendations of the International Board that reviewed 
the purchase of the distribution companies. The intent is to 
assess whether the price paid was appropriate to the value of 
the companies. 
 
j.    Establishment of a Panel to review the weaknesses of 
the financial system and recommend actions to resolve them. 
The Panel will be charged with reviewing the recent financial 
sector problems to determine their cause, to identify 
weaknesses that need to be addressed and develop 
recommendations to address them. 
 
k.    Clearance of the more than USD 100 million of arrears 
that will not be subject to rescheduling. The GODR has 
recently met urgent financing needs by accumulating arrears. 
The USD 100 million consists of arrears not subject to 
rescheduling under Paris Club.  Given the GODR,s financial 
plight, clearance of the arrears would seem to be possible 
only if the IDB releases the first tranche of its emergency 
loan before the program goes to the Board. 
 
5. (SBU) Once these actions have been completed, the IMF 
Board will meet for approval of the resumption of the 
program. It would appear that the earliest the Fund Board 
could act would be in early February. Once the program is 
approved, the Fund will release a second tranche of USD 60 
million, the only release of Funds until after the May 2004 
elections.  (If a second round of presidential voting is 
required, it will take place on June 30.)  The Fund has 
dropped the monthly reviews of the program with the GODR and 
will not conduct a review until June or July, after the 
elections, and will determine at that time whether conditions 
warrant the release of the third tranche. 
 
COMMENTS ON IMF PROGRAM 
 
6. (SBU)   Emboffs consider this to be a deliberately 
short-term emergency program designed to give the Mejia 
administration the barest chance to make it though the 
presidential elections. Conditionality is strict and 
challenging. The Fund itself is committing very little in 
resources. Almost all the likely funding of USD 300-400 
million will have to come from the IDB and the World Bank, 
and of that amount about USD 100 million must go towards 
arrears before the program goes to the Board. 
 
7. (SBU) Given the upcoming May election, the GODR could well 
have difficulties sticking to such a tight program, even in 
the best of circumstances.  Although the ResRep did not say 
so, the schedule suggests that the IMF will wait until after 
the May 2004 presidential elections to revise or completely 
to renegotiate the program.  The Fund is conserving its 
resources and passing the financing burden to other IFIs over 
the next six months to support the holding action. The 
calendar is not kind, either --  the next GODR will not take 
office until August 16,  and President Mejia is not currently 
favored to win his bid for re-election.  And when the time 
comes to elaborate a new program, the multilateral 
development banks will almost certainly have to stump up just 
as much, and even more than before. 
 
COGENTRIX THREATENS TO PULL THE HOUSE DOWN 
 
3. (SBU)   Further complicating the GODR's precarious 
finances is a face-off over arrears due to electricity 
generating firm COGENTRIX.  The GODR has been in arrears to 
the firm since September and technically in default since 
November.  President Mejia continues to refuse to pay 
COGENTRIX unless the management explicitly agrees to 
negotiate lower rates for electricity generation; Mejia says 
that the firm acted in bad faith in mid-2003 when it reneged 
on an understanding that it would negotiate if the GODR 
cleared arrears.  The amount due grows monthly by about USD 
3.7 million, due to a "take or pay" clause in the contract. 
According to the terms of the loans, creditors have the right 
to call at any time sovereign guarantees amounting to 
approximately USD 400 million (including penalties) for IDB 
and private sector loans. 
 
4. (SBU) Embassy understands that COGENTRIX creditors have 
given the GODR until January 14 to pay all arrears, amounting 
to about USD 35 million.  Ironically, COGENTRIX is obliged by 
the contract to renew a performance bond of USD 10 million. 
COGENTRIX has requested that the GODR waive this requirement, 
in return for which the creditors offer to extend their 
deadline for payment of arrears a further two weeks, until 
January 29.  A call of the guarantees would have catastrophic 
effects on GODR finances -- it would immediately cut off IDB 
lending (essential to the program defined with the IMF) and 
would lead to a sharp further downgrade of the ratings for 
GODR bonds. This is a commercial dispute between a sovereign 
government and various creditors, including a number of U.S. 
nationals, but it also has important policy implications for 
the USG. The USG role should continue to advise the GODR to 
come to terms, should closely monitor the developing 
situation, and should encourage the IDB to mediate between 
the two parties. 
MARSHALL