US embassy cable - 04TEGUCIGALPA2299

UNCLAS SECTION 01 OF 06 TEGUCIGALPA 002299 
 
SIPDIS 
 
STATE FOR WHA/CEN, WHA/EPSC AND EB/EPPD 
TREASURY FOR DDOUGLASS 
COMMERCE FOR MSIEGELMAN AND AVANVUREN 
STATE PASS USAID FOR LAC/CAM 
 
E.O. 12958: N/A 
TAGS: ECON, EAID, EAGR, KMCA, HO 
SUBJECT: Honduras:  Progress Toward an MCC Compact 
 
 
1. (SBU) Summary:  MCC representatives visited Honduras 
October 4-8 to continue due diligence investigations in 
preparation for evaluating and signing a Compact agreement 
in the next several months.  This visit is the 5th visit 
since May, when Honduras was short-listed as a country 
invited to apply for MCC funds.  This visit focused on value- 
added agriculture and irrigation components.  Other visits 
have focused on 1) explaining the process for submitting a 
proposal, 2) assessing the potential for economic growth, 3) 
evaluating financial oversight mechanisms, and 4) presenting 
MCC CEO Paul Applegarth to President Maduro and the GOH. 
Additional visits are scheduled for late October to conduct 
due diligence on the transportation infrastructure portion 
of the proposal and early November to conduct a similar 
review of the financial sector and its role in maximizing 
the impact of any MCC project.  Next steps include due 
diligence on the project elements, consideration of 
conditionality - such as progress on anti-corruption efforts 
-- for future disbursements, and the need for progress on 
MCC's administrative concerns, including preparations for or 
procurement of housing, office space, and locally hired 
employees.  End Summary. 
 
----------------------------- 
Honduras:  Might be the First 
----------------------------- 
 
2. (SBU) MCC representatives told Post that Honduras is 
likely to be one of the first countries to sign a Compact 
with the MCC.  Not only was it among the first to submit a 
proposal, Honduras also prepared a thorough, well-organized 
proposal with obvious GOH political support for 
implementation.  Thanks in large part to previous efforts 
under its Poverty Reduction Strategy and Heavily Indebted 
Poor Countries (HIPC) application -- not to mention vigorous 
efforts at donor coordination and rationalization following 
the Hurricane Mitch Reconstruction (1998-2001) -- the GOH 
had in hand a prioritized list of development objectives 
that they used to frame their MCC proposal. (Note:  That 
proposal is available on the web at 
http://www.sierp.hn/docs/MCAespanol.pdf. End Note.) This 
approach helped ensure a minimum of overlap with existing 
development efforts, maximum ability to create synergies 
with established project priorities, and an internally 
consistent approach to overall development.  Perhaps most 
importantly, the strategy also benefited from civil society 
and donor community review and approval. The GOH will be 
conducting additional civil-society outreach events on 
October 14-15. 
 
3. (SBU) Several issue areas remain to be addressed, 
including the role of the financial sector, a detailed 
review of the transportation infrastructure proposal, 
consideration of the scope and depth of environmental impact 
analyses, development of methodology for evaluation and 
monitoring, and a legal review.  It should be noted that, 
since this could be the first Compact proposal completed, 
the precise level of detail on these and the other areas of 
focus ("workstreams," in MCC parlance) that must be included 
in the Compact itself remains undecided.  As a legal 
obligating document, a certain level of detail is required, 
but likely less detail than would be the case for a project- 
planning document.  The decision on the level of detail 
needed in the Compact could dramatically affect the time 
needed to complete due diligence reviews and prepare a 
document for signature. 
 
4. (SBU) MCC and Post are also considering the degree of 
conditionality to be made inherent or explicit in the 
Compact.  MCC officials note that there might be value in 
undertaking project elements in prioritized tranches, with 
specific performance or policy triggers for moving to 
successive tranches.  The policy reforms MCC has in mind 
fall into two areas of concern:  (1) reforms that are 
necessary to ensure maximal impact from the program (such as 
reducing red tape, rationalizing pricing, and customs 
reform) and (2) reforms whose goals are continued 
improvement on the 16 key eligibility indicators.  Regarding 
the latter, in the case of Honduras, MCC is considering 
concrete commitments that could be incorporated into the 
Compact as milestones in the fight against corruption.  This 
type of conditionality would provide an extremely forceful 
lever for reform, while also decreasing the threat of 
reduced MCC project effectiveness due to losses to 
corruption.  Post strongly supports strengthened anti- 
corruption efforts be included as bases for review of the 
Honduran Compact prior to any disbursements. 
 
--------------------------------------------- ----------- 
Towards a Compact:  We've Come a Long Way in Five Months 
--------------------------------------------- ----------- 
 
5. (SBU) The MCC approach in Honduras has been based on the 
approach used in the private sector:  MCC is prepared to 
obligate large quantities of funding, on a no-year basis, to 
programs that promote economic growth and reduce poverty. 
However, the MCC will act only after being convinced that: 
(1) the problem (the obstacle to economic growth) has been 
well defined; (2) a viable solution that targets and solves 
that problem in a way that benefits society as a whole has 
been identified; and (3) the economic rate of return 
justifies singling this activity out as a top-priority 
activity.  In short, the funds should be used to resolve a 
problem that other donor programs or private sector efforts 
cannot or will not resolve, and the choice of activities 
should yield the greatest bang for MCC's buck. 
 
6. (SBU) By focusing on economic rate of return, rather than 
the financial rate of return used by the private sector, MCC 
attempts to take full account of all benefits and costs that 
accrue to society even if they do not have a direct cash- 
flow associated with the project. (Examples would include 
the benefits of customs reform or a cleaner environment, or 
the costs of providing more subsidized water as a result of 
increasing demand of farmers that have been taught to grow 
new crops.)  The MCC recognizes the importance of other 
development objectives that are pursued by other donors, but 
has a mandate to focus exclusively on sustainable economic 
growth that results in poverty reduction. 
 
7. (SBU) The GOH's initial ideas quickly focused on what 
they called the "dry canal" idea.  The plan is to improve 
road infrastructure between Puerto Cortes on the Atlantic 
coast and Puerto Cutuco, on the Pacific, just across the 
border in El Salvador.  The road would link Tegucigalpa and 
San Pedro Sula (the political and business centers of 
Honduras, respectively) to their largest export hubs, and 
would promote the development of export-oriented businesses 
by lowering transport costs and increasing efficiency. 
Secondary and tertiary roads would link farms and smaller 
towns to these major markets, and would ease labor 
shortages, without promoting uncontrolled urbanization, by 
linking population centers with industrial zones. 
 
8. (SBU) To capitalize on this basic infrastructure idea the 
GOH quickly added an initiative to improve agricultural 
productivity, move into higher value-added crops, and 
encourage a shift from subsistence agriculture to export- 
oriented agribusiness that could also benefit from the new 
road network.  This proposal played to MCC's strengths, in 
particular its ability to fund the entire range of economic 
activities from farm to market, crossing sectoral boundaries 
in a rational and linked way, and over a prolonged (five 
year) implementation period.  This would complement a model 
of this type pioneered by USAID. 
 
--------------------------------------------- --------- 
Paring Back the Proposal:  Status of the Core Elements 
--------------------------------------------- --------- 
 
9. (SBU) Perhaps predictably, as drafting of the Compact 
proposal went forward within the GOH, additional programs 
were added to placate powerful political interests.  The GOH 
proposal identified nine impediments to economic growth. 
MCC staff distilled these down to five essential 
impediments:  (1) high transportation costs; (2) low 
agricultural productivity; (3) uncertain land tenure; (4) a 
shortage of supervisors and technicians in the light 
assembly sector and an overall labor shortage in the Sula 
Valley; and (5) a mismatch between the location of hotel 
facilities and tourist attractions.  One of the early MCC 
visits, therefore, was aimed at tightening the focus of the 
proposal to just one or two core objectives.  Thanks to 
extensive meetings with the GOH by EconOffs, USAID, and MCC 
representatives, Post gradually succeeded in convincing the 
GOH of the need to take most of the ornaments off the tree. 
What follows is a brief description of the current elements 
of the GOH Compact proposal and MCC views on the relative 
merits of those elements. 
 
9. (SBU) The logistical corridor:  MCC inquired broadly 
throughout the GOH, private sector, and civil society, and 
found strong support for the proposed upgrade to Honduras' 
transportation infrastructure.  As currently envisaged, this 
proposal would include three elements:  the main highway; 
improvements, maintenance, and expansion of the secondary 
road network; and a tertiary-level expansion of rural and 
urban access roads. 
 
-- The highway:  If approved, MCC would pay up to $80 
million to finance two segments of the logistical corridor. 
Other segments would be financed by other donors, and loans 
from the Interamerican Development Bank (IDB) and the 
Central American Bank for Economic Integration (CABEI).  (By 
pooling these loans with the grant portions of the project, 
the GOH buys down the overall interest rates to stay below 
IMF-imposed borrowing limits as it approaches HIPC decision 
point.) 
 
-- The secondary roads:  These would be key to extending the 
benefits of the logistical corridor to communities further 
afield, and to developing local capacity for appropriate 
road maintenance.  MCC feels that additional consideration 
must be given, however, to how the qualifying roads would be 
selected.  This portion of the program is currently budgeted 
at $19.5 million. 
 
-- The tertiary roads:  These roads complete the linkage of 
the port to the local farm and village level, facilitating a 
rural transformation from subsistence farming to value-added 
agricultural exports.  In the urban setting, access roads 
allow underutilized labor to more easily commute to regions 
of higher employment and relative labor scarcity.  This 
approach increases employment overall without the need to 
relocate the labor force and therefore without the 
consequent strain on existing public services infrastructure 
in those locations.  This portion of the program, covering 
1,320 kilometers of road, is currently budgeted at $22.5 
million. 
 
10. (SBU) Improving Agricultural Productivity:  This 
proposal consists of six elements:  fixing the land titling 
and tenure system; establishing a "millennium challenge 
fund" to fund smaller projects on a rotating-fund basis; 
expanding drip irrigation; providing technical assistance in 
the agricultural sector; improving flood control in the Sula 
Valley; and establishing agricultural "value-added chains." 
 
-- Land titling:  This element would provide a revolving 
fund to settle contested land titles, allowing households to 
use clean land titles as collateral for loans for activities 
such as home construction, education, or starting a 
business.  MCC is unconvinced that this is an activity that 
could not be carried out by the private financial sector, 
and notes that the World Bank is also actively working on 
improving land registries.  That said, MCC is interested in 
considering the proposal further, given the centrality of 
land titling issues to economic growth throughout the 
region.  This portion of the program is currently budgeted 
at $10 million. 
 
-- Millennium Challenge Fund:  This element would establish 
a revolving fund to support small projects that arise during 
Compact implementation, to fill any unexpected gaps and add 
program flexibility.  This component was included by the GOH 
to provide a mechanism to receive unsolicited proposals, 
which they understood might be required by the MCC's 
authorizing legislation.  The MCC General Counsel has 
determined that such a mechanism is not required by law. 
The GOH technical team and MCC staff discussed establishing 
a more focused fund to provide financing for projects in the 
agriculture sector.  While, this portion of the program was 
budgeted at $10 million, it will likely be scaled down. 
 
-- Expanding Drip Irrigation:  In selected areas of high 
potential agricultural productivity, on-farm drip irrigation 
systems would be supported to increase yield while 
potentially decreasing total water usage compared to 
traditional gravity-fed irrigation techniques.  MCC favors 
this element, if implemented in conjunction with technical 
assistance training in use and maintenance of these 
technologies.  This portion of the program is currently 
budgeted at $25 million. 
 
-- Technical Assistance:  This element would train farmers 
in modern farming techniques, pest management, crop 
rotation, market analysis, business management, drip 
irrigation operations and maintenance, and other key aspects 
of enhanced productivity.  MCC favors this element, 
particularly in conjunction with drip irrigation systems. 
This element could build on or follow the best practices 
established by proven USAID-funded systems.  This portion of 
the program is currently budgeted at $7.5 million. 
 
-- Flood Control in the Sula Valley:  This element would 
fund construction of the El Tablon Dam, to control flood 
waters and generate electricity in the Sula Valley.  MCC 
notes that this project is not intuitively linked to the 
other central elements of the compact proposal, and is 
potentially contentious for political and environmental 
reasons.  MCC does not intend to fund this item. This 
portion of the program is currently budgeted at $35 million. 
 
-- Agricultural Value Added Chains:  This element would 
support collaboration among vertical components of 
agricultural commodity sectors, such as palm oil or sugar, 
with the intent of collecting funds to enhance production 
and marketing of the commodity.  MCC remains unconvinced the 
structure of such efforts is clearly defined or would be 
successful in preventing major players in the sectors from 
benefiting disproportionately.  While the MCC will probably 
not directly fund the value added chains, these chains (as 
well as other entities) would be eligible to submit 
proposals to a fund to support the provision of public goods 
to promote the growth of the agricultural sector as 
described under the Millennium Challenge Fund. 
 
11. (SBU) Other Programs:  Programs added to the core 
objectives of transportation infrastructure and agricultural 
productivity include an apparel training center, pre-school 
funding, small and medium enterprise development funds, and 
tourist centers in Tela and Tegucigalpa.  MCC seeks overall 
to minimize the number of projects it is involved in, both 
to limit overhead administrative costs, and to keep the 
funded projects tightly focused on the core objectives of 
the Compact.  Therefore, MCC does not plan to fund the 
following proposals: 
 
-- Apparel Training Center:  This element would train 
supervisors and technicians for the light assembly sector. 
MCC notes that in addition to being tangential to the core 
Compact objectives, this proposal should be funded primarily 
by the private sector.  Additionally, such a project could 
be seen as violating the MCC prohibition on funding any 
activities that displace U.S. jobs. This portion of the 
program is currently budgeted at $1.5 million. 
 
-- Pre-School Education:  This initiative would fund pre- 
schools, linked to a foundation created by the President, 
thus allowing mothers to enter the workforce.  MCC notes 
that this element is tangential to the core objectives 
established in the Compact proposal and suffers from dubious 
political optics by contributing to a charity founded by the 
President.  This portion of the program is currently 
budgeted at $7.5 million. 
 
-- Small and Medium Enterprise Development Financing:  This 
element is poorly linked to core objectives contained in the 
Compact proposal.  While financing will likely be an 
integral part of the agricultural portion of the Compact, 
MCC does not intend to fund this broadly defined initiative. 
This portion of the program is currently budgeted at $4 
million. 
 
-- Tela Bay Infrastructure:  This element would fund 
development of roads, sewers, drainage systems, and water 
and electricity services to support the development of a 
luxury resort complex in Tela (on Honduras' northern 
Caribbean coast).  MCC feels this project should be financed 
by the project developers and does not intend to fund it. 
($15 million.) 
 
-- "Royal Mines" Tourism Center:  This element would convert 
a former prison into a tourism center and shopping area in 
Tegucigalpa, to provide additional attractions to attempt to 
balance the mismatch between the location of hotel 
facilities (overbuilt in Tegucigalpa) and the location of 
tourist attractions (such as the Bay Islands or the Copan 
Ruins).  This element is poorly linked to core objectives 
contained in the Compact proposal. MCC does not intend to 
fund this initiative, currently budgeted at $7.5 million. 
 
--------------------------------------------- --- 
Looking Forward, MCC Needs to Focus on Logistics 
--------------------------------------------- --- 
 
11. (SBU) Comment:  Post welcomes and continues to support 
the extraordinary progress made to date on the substance of 
a proposed Compact.  However, it is increasingly urgent that 
progress also be made on a number of internal administrative 
matters facing the new MCC program.  MCC indicated it 
expects to place a direct-hire representative in-country as 
soon as possible after the signing of a Compact.  This will 
require completion of an NSDD-38 process.  Post encourages 
MCC to begin this process as soon as possible.  Post also 
raised with visiting MCC representatives the possibility of 
contracting a local-hire, part-time administrative assistant 
who could manage logistics and paperwork for the 
increasingly heavy MCC visitor load to Honduras in the run- 
up to Compact signing.  Establishing such a position, with 
local office space, would not only facilitate overall 
progress of the proposal by providing a stable workspace for 
MCC visitors, it would also lay the foundation for the 
permanent MCC office, which would then be ready for the MCC 
representative upon assignment.  Both Embassy and USAID 
management offices stand ready to discuss ICASS or other 
options for contracting or procurement for staff, office 
space, housing with MCC.  End Comment. 
 
PIERCE 
 
 
Z:\econ\DunnPM\MCC update 100904 jw.doc